Item 1. Business.
General
We are Harrington West Financial Group, Inc., a Delaware corporation and a diversified, community-based, financial institution holding company headquartered in Solvang, California, with executive offices in Overland Park, Kansas. We conduct our operations primarily through our wholly-owned subsidiary, Los Padres Bank, FSB, a federally chartered savings bank, located in central California and Scottsdale, Arizona, and its division in the Kansas City metropolitan area, Harrington Bank. Los Padres Bank provides an array of financial products and services for businesses and retail customers through its thirteen full-service offices. At December 31, 2004, we had consolidated total assets of $1.1 billion, total deposits of $598.2 million and stockholders’ equity of $52.7 million.
We are focused on providing our diversified products and personalized service approach in three distinct markets: (i) the central coast of California, (ii) the Kansas City metropolitan area and (iii) the Phoenix/Scottsdale metropolitan area. Los Padres Bank will operate eleven offices on the central coast of California, when we complete our purchase and assumption in May 2005 of a banking office in Thousand Oaks, two offices in the Kansas City metropolitan area under the Harrington Bank brand name, and two banking offices in the Phoenix/Scottsdale, Arizona metropolitan area, when we open our second office in the Scottsdale Airpark in late March 2005. Each of our markets has its own local independent management team operating under the Los Padres or Harrington names. Our loan underwriting, corporate administration, and treasury functions are centralized in Solvang, California to create operating efficiencies. Our commercial lending operations are centralized in Mission, Kansas.
On February 2, 2005, Los Padres Bank entered into an agreement with Western Financial Bank for the purchase and assumption of their office in Thousand Oaks, California. In the purchase agreement, Los Padres Bank has agreed to purchase approximately $51.9 million in deposits and their associated overdraft protection accounts or line of credits, all furniture and fixtures and assume the lease for the building. This transaction is subject to regulatory approval and the Bank has submitted its application to the Office of Thrift Supervision and is awaiting final approval.
Los Padres Bank is primarily engaged in attracting deposits from individuals and businesses and using these deposits, together with borrowed funds, to originate commercial real estate, commercial business, single-family and multi-family residential and consumer loans. We also generate fee income from the brokering of mortgage loans, deposit services, early prepayments of loans, and loan originations.
We maintain a portfolio of highly liquid mortgage-backed and related securities as a means of managing our excess liquidity and enhancing our profitability. We utilize various interest rate contracts as a means of managing our interest rate risk. We also operate Harrington Wealth Management Company, which provides trust and investment management services to individuals and small institutional clients on a fee basis, by employing a customized asset allocation approach and investing predominantly in low fee, indexed mutual funds and exchange traded funds.
On November 12, 2002, we completed our initial public offering. An aggregate of 1,344,000 shares of common stock were sold to the public at $10.00 per share, comprised of 1,168,338 shares sold by us and 175,662 shares sold by certain of our stockholders. In connection with the initial public offering, we raised approximately $10.2 million of net proceeds, which we initially used to reduce our secured line of credit.
Lending Activities
General. At December 31, 2004, Los Padres Bank’s net loan portfolio totaled $598.4 million, representing approximately 55.3% of our $1.1 billion of total assets at that date. Los Padres Bank’s primary focus with respect to its lending operations has historically been the direct origination of single-family residential, multi-family residential, consumer and commercial real estate loans. While we continue to emphasize single-family residential loans products that meet our customer’s needs, we now generally broker such loans on behalf of third party investors in order to generate fee income and have been increasing our emphasis on loans secured by commercial real estate, consumer loans, and commercial and industrial loans. We also offer multi-family residential loans, land loans, construction loans secured by both residential and commercial properties and consumer loans.
The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.
(1)
Includes loans secured by residential and commercial properties. At December 31, 2004, we had $22.4 million of construction loans secured by residential properties, $3.2 of land and development and $9.4 million of construction loans secured by commercial properties.
(2)
Includes loans collateralized by deposit accounts and consumer line of credit loans.
The following table sets forth certain information at December 31, 2004, regarding the dollar amount of loans maturing in our total loan portfolio based on the contractual terms to maturity or scheduled amortization, but does not include potential prepayments. Loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.
(1)
Includes loans secured by residential and commercial properties.
(2)
Includes loans collateralized by deposit accounts and consumer line of credit loans.
Scheduled contractual amortization of loans does not reflect the expected term of our loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sale clauses, which gives us the right to declare a conventional loan immediately due and payable in the event that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan rates are higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are lower than current mortgage loan rates. Under the latter circumstance, the weighted average yield on loans decreases as higher-yielding loans are repaid or refinanced at lower rates.
The following table sets forth the dollar amount of total loans due after one year from December 31, 2004, as shown in the preceding table, which have fixed interest rates or which have floating or adjustable interest rates.
(1)
Includes loans secured by residential and commercial properties.
(2)
Includes loans collateralized by deposit accounts and consumer lines of credit loans.
Origination, Purchase and Sale of Loans. The lending activities of Los Padres Bank are subject to the written, non-discriminatory underwriting standards and loan origination procedures established by Los Padres Bank’s board of directors and management. Loan originations are obtained by a variety of sources, including referrals from real estate brokers, builders, existing customers, walk-in customers and advertising. In its present marketing efforts, Los Padres Bank emphasizes its community ties, customized personal service, competitive rates and terms, and its efficient underwriting and approval process. Loan applications are taken by lending personnel, and the loan department supervises the obtainment of credit reports, appraisals and other documentation involved with a loan. Property valuations are performed by independent outside appraisers approved by Los Padres Bank’s board of directors. Los Padres Bank requires title, hazard and, to the extent applicable, flood insurance on all security property.
Mortgage loan applications are initially processed by loan officers who do not have approval authority. All real estate loans which are either at or below the Federal Home Loan Mortgage Corporation’s (“Freddie Mac”), lending limit and which meet all of the bank’s underwriting guidelines can be approved by designated senior management of Los Padres Bank. All consumer loans up to $250,000 may be approved by designated senior management of Los Padres Bank. All loans in excess of these amounts up to $1.0 million ($500,000 for commercial and industrial loans) require the approval of two members of Los Padres Bank’s Executive Loan Committee, which consists of designated senior management of Los Padres Bank. Loans in excess of $1.0 million ($500,000 for commercial and industrial loans), but not exceeding $5.0 million, require the approval of a majority of Los Padres Bank’s Loan Committee, consisting of designated senior management of Los Padres Bank. All loans in excess of $5.0 million, up to Los Padres Bank’s legal lending limit, must be approved by either Los Padres Bank’s Loan Oversight Committee, comprised of both designated senior management and certain members of the Board of Directors, or the Board of Directors of Los Padres Bank.
A savings institution generally may not make loans to any one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus, although loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured
by readily marketable securities. At December 31, 2004, Los Padres Bank’s regulatory limit on loans-to-one borrower was $11.6 million and its five largest loans or groups of loans-to-one borrower, including related entities, aggregated $9.6 million, $9.2 million, $9.1 million, $8.8 million and $8.6 million. These five largest loans or loan concentrations were secured by commercial real estate and development of single family homes. All of these loans or loan concentrations were performing in accordance with their payment terms at December 31, 2004.
The risks associated with lending are well defined. Credit risk is managed through the adherence, with few exceptions, to specific underwriting guidelines. We rely on our internal credit approval and administrative process to originate loans as well as our internal asset review process, which oversees our loan quality in order to ensure that our underwriting standards are maintained. We believe that the low level of our non-performing assets is evidence of our adherence to our underwriting guidelines.
As a federally chartered savings bank, Los Padres Bank has general authority to originate and purchase loans secured by real estate located throughout the United States. Despite this nationwide lending authority, we estimate that at December 31, 2004, the majority of the loans in Los Padres Bank’s portfolio are secured by properties located or made to customers residing in each of our primary market areas located in the California central coast, the Kansas City metropolitan area, and the Phoenix/Scottsdale metropolitan area.
Single-Family Residential Real Estate Loans. Los Padres Bank has historically concentrated its lending activities on the origination of loans secured by first mortgage liens on existing single-family residences. The single-family residential loans originated by Los Padres Bank are generally made on terms, conditions and documentation, which permit the sale of such loans to Freddie Mac, the Federal National Mortgage Association (“Fannie Mae”), and other institutional investors in the secondary market. Since January 2001, as a means of generating additional fee income and in order to reflect management’s decision to emphasize holding higher spread earning loans in its portfolio, Los Padres Bank has been brokering conforming permanent single-family residential loans on behalf of third parties in order to generate fee income. During the years ended December 31, 2004 and 2003, Los Padres Bank brokered $36.5 million and $99.4 million, respectively, of such single-family residential loans on behalf of third parties.
Los Padres Bank still holds a portfolio of single-family residential loans. Los Padres Bank will retain in its portfolio single-family residential loans that, due to the nature of the collateral, carry higher risk adjusted spreads. Examples of these types of loans include construction loans that have converted into permanent loans and non-conforming single-family loans, whether as a result of a non-owner occupied or rural property, balloon payment or other exception from agency guidelines. At December 31, 2004, Los Padres Bank had $100.5 million of single-family residential loans in its portfolio, which amounted to 16.6% of total loans receivable as of such date. At December 31, 2004, $50.0 million or 49.7% of Los Padres Bank’s single-family residential loans had fixed interest rates and $50.5 million or 50.3% had interest rates, which adjust in accordance with a designated index. Single-family residential loans have terms of up to 30 years and generally have loan-to-value ratios of 80% or less, or 90% or less to the extent the borrower carries private mortgage insurance for the balance in excess of the 80% loan-to-value ratio.
Multi-Family Residential and Commercial Real Estate Loans. At December 31, 2004, Los Padres Bank had an aggregate of $84.9 million and $260.8 million invested in multi-family residential and commercial real estate loans, respectively, or 14.0% and 43.1% of total loans receivable, respectively.
Los Padres Bank’s multi-family residential loans are secured by multi-family properties of five units or more, while Los Padres Bank’s commercial real estate loans are secured by industrial, warehouse
and self-storage properties, office buildings, office and industrial condominiums, retail space and strip shopping centers, mixed-use commercial properties, mobile home parks, nursing homes, hotels and motels. Substantially all of these properties are located in Los Padres Bank’s primary market areas. Los Padres Bank typically originates commercial real estate loans for terms of up to 20 years based upon a 30-year loan amortization period and multi-family residential loans for terms of up to 20 years based upon up to a 30-year amortization schedule. Los Padres Bank will originate these loans on both a fixed-rate or adjustable-rate basis, with the latter adjusting on a periodic basis of up to one year based on the London Interbank Offered Rate (“LIBOR”), the one-year U.S. Treasury index of constant comparable maturities, a designated prime rate or the 11th District Cost of Funds Index. Adjustable-rate loans may have an established ceiling and floor, and the maximum loan-to-value for these loan products is generally 75%. As part of the criteria for underwriting commercial real estate loans, Los Padres Bank generally requires a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service) of 1.3:1 or more. It is also Los Padres Bank’s general policy to seek additional protection to mitigate any weaknesses identified in the underwriting process. Additional coverage may be provided through secondary collateral and personal guarantees from the principals of the borrowers.
Commercial real estate lending entails different and significant risks when compared to single-family residential lending because such loans typically involve large loan balances to single borrowers and because the payment experience on such loans is typically dependent on the successful operation of the project or the borrower’s business. In addition, the balloon payment features of these loans may require the borrower to either sell or refinance the underlying property in order to make the payment. These risks can also be significantly affected by supply and demand conditions in the local market for apartments, offices, warehouses or other commercial space. Los Padres Bank attempts to minimize its risk exposure by requiring that the loan does not exceed established loan-to-value and debt coverage ratios, and by monitoring the operation and physical condition of the collateral.
Construction Loans. Los Padres Bank originates loans to finance the construction of single-family and multi-family residences and commercial properties located in its primary market area. At December 31, 2004, Los Padres Bank’s construction loans amounted to $35.0 million or 5.8% of total loans receivable, $22.4 million of which were for the construction of residential properties, $3.2 million of which were for land acquisition and the development of residential properties, and $9.4 million of which were for the construction of commercial properties.
Los Padres Bank primarily provides construction loans to individuals building their primary or secondary residence as well as to local developers with whom Los Padres Bank is familiar and who have a record of successfully completing projects. Residential construction loans to developers generally are made with terms not exceeding two years, have interest rates which are fixed or adjust, with the latter adjusting on a periodic basis of up to one year based upon a designated prime rate or LIBOR, and are generally made with loan-to-value ratios of 80% or less. Residential construction loans to individuals are interest only loans for the term of the construction and then generally convert to a permanent loan. Los Padres Bank’s construction/permanent loans have been successful due to its ability to offer borrowers a single closing and, consequently, reduced costs. Los Padres Bank also offers adjustable-rate loans based on a designated prime rate or other indices with terms of up to two years for the construction of commercial properties. Such loans are generally made at a maximum loan-to-value ratio of 85% of discounted appraised value or less.
Construction lending and acquisition and development lending are generally considered to involve a higher degree of risk of loss than long-term financing on improved, owner-occupied real estate. Risk of loss on construction loans and acquisition and development loans is dependent largely upon the accuracy of the initial appraisal of the property’s projected value at completion of construction as well as the estimated cost, including interest, of construction. During the construction phase, a number of factors
could result in delays and cost overruns. If either estimate proves to be inaccurate and the borrower is unable to provide additional funds, the lender may be required to advance funds beyond the amount originally committed to permit completion of the project and/or be confronted at the maturity of the construction loan with a project whose value is insufficient to assure full payment. Los Padres Bank attempts to minimize the foregoing risks primarily by limiting its construction lending to experienced developers and by limiting the total amount of loans to builders for speculative construction projects. It is also Los Padres Bank’s general policy to obtain regular financial statements and tax returns from builders so that it can monitor their financial strength and ability to repay.
Land acquisition and development. Los Padres Bank has increased its loans for land acquisition and development from $8.3 million at December 31, 2003 to $27.5 million at December 31, 2004. The increase is caused by the expansion of our products to meet our customer needs. Land acquisition and development loans are typically issued with short terms, bearing adjustable-rates of interest based on a designated prime rate or LIBOR and are generally made with loan-to-value ratios of 70% or less.
Commercial and Industrial Loans. Los Padres Bank is placing increased emphasis on the origination of commercial business loans because of the higher risk-adjusted spreads generally associated with these types of loans. During the year ended December 31, 2004, Los Padres Bank originated $108.5 million in loan commitments of commercial and industrial loans, as compared to $78.3 million and $41.0 million as of December 31, 2003 and 2002, respectively. At December 31, 2004, Los Padres Bank’s commercial and industrial loans amounted to $72.2 million or 11.9% of total loans receivable.
The commercial and industrial loans that Los Padres Bank is originating include lines of credit, term loans and letters of credit. These loans are typically secured by collateral and are used for general business purposes, including working capital financing, equipment financing, capital investment and general investment. Depending on the collateral pledged to secure the extension of credit, maximum loan-to-value ratios are 80% or less. Loan terms generally vary from one to seven years. The interest rates on such loans are generally variable and are indexed to the Wall Street Journal Prime Rate, plus a margin. Commercial and industrial loans typically have shorter maturity terms and higher interest spreads than mortgage loans, but generally involve more credit risk than mortgage loans because of the type and nature of the collateral. Los Padres Bank’s business customers are typically small to medium sized, privately-held companies with local or regional businesses that operate in Los Padres Bank’s primary markets.
Consumer and Other Loans. Los Padres Bank is authorized to make loans for a wide variety of personal or consumer purposes. Los Padres Bank has been originating consumer loans in recent years in order to provide a wider range of financial services to its customers and because such loans generally carry higher interest rates than mortgage loans. The consumer and other loans offered by Los Padres Bank include home equity lines of credit, home improvement loans, vehicle loans, secured and unsecured personal lines of credit and deposit account secured loans. At December 31, 2004, $24.8 million or 4.1% of Los Padres Bank’s total loans receivable consisted of consumer loans.
Home equity lines of credit are originated by Los Padres Bank for up to 90% of the appraised value, less the amount of any existing prior liens on the property. Los Padres Bank also offers home improvement loans in amounts up to 80% of the appraised value, less the amount of any existing prior liens on the property. Home improvement loans have a maximum term of 15 years and carry fixed or adjustable interest rates. Home equity lines of credit have a maximum repayment term of 15 years and carry interest rates that adjust monthly in accordance with a designated prime rate. Los Padres Bank will secure each of these types of loans with a mortgage on the property, generally a second mortgage, and may originate the loan even if another institution holds the first mortgage. At December 31, 2004, home equity lines of credit and home improvement loans totaled $23.3 million or 98.1% of Los Padres Bank’s
total consumer loan portfolio and an aggregate of $33.8 million was committed and undrawn under these loans and lines of credit.
Los Padres Bank currently offers loans secured by deposit accounts, which amounted to $779,000 or 3.2% of Los Padres Bank’s total consumer and other loan portfolio at December 31, 2004. Such loans are originated for up to 90% of the deposit account balance, with a hold placed on the account restricting the withdrawal of the account balance.
At December 31, 2004, vehicle and secured and unsecured personal line of credit loans amounted to $631,000 or 3.9% of Los Padres Bank’s total consumer and other loan portfolio.
Consumer loans generally have shorter terms and higher interest rates than mortgage loans but generally involve more credit risk than mortgage loans because of the type and nature of the collateral. In addition, consumer lending collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness and personal bankruptcy. Los Padres Bank believes that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans and Los Padres Bank intends to continue to offer consumer loans in order to provide a full range of services to its customers.
Asset Quality
General. Los Padres Bank’s Internal Asset Review Committee and the Internal Asset Oversight Committee, consisting of Los Padres Bank’s senior executive officers and certain Board of Directors, monitors the credit quality of Los Padres Bank’s assets, reviews classified and other identified loans and determines the proper level of reserves to allocate against Los Padres Bank’s loan portfolio, in each case subject to guidelines approved by Los Padres Bank’s board of directors.
Loan Delinquencies. When a borrower fails to make a required payment on a loan, Los Padres Bank attempts to cure the deficiency by contacting the borrower and seeking payment. Contacts are generally made following the sixteenth day after a payment is due, at which time a late payment is assessed. In most cases, deficiencies are cured promptly. If a delinquency extends beyond 16 days, the loan and payment history is reviewed and efforts are made to collect the loan. While Los Padres Bank generally prefers to work with borrowers to resolve such problems, when the account becomes 45 days delinquent, Los Padres Bank will institute foreclosure by issuing a Notice of Intent to Foreclose or other proceedings, as necessary, to minimize any potential loss. After 75 days and the loan is not brought current or no workout agreement has been initiated, a Notice of Default is recorded.
Non-Performing Assets. Los Padres Bank will place loans on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When such a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. Los Padres Bank generally does not accrue interest on loans past due 60 days or more.
Non-performing loans are defined as non-accrual loans. Non-performing assets are defined as non-performing loans and real estate acquired by foreclosure or deed-in-lieu thereof. Troubled debt restructurings are defined as loans, which Los Padres Bank has agreed to modify by accepting below market terms either by granting interest rate concessions or by deferring principal and/or interest payments. The following table sets forth the amounts and categories of our non-performing assets and troubled debt restructurings at the dates indicated.
At December 31, 2004, we had a $95,000 non-performing loan representing a increase of $83,000 from December 31, 2003. At December 31, 2004, 2003 and 2002, we had one, two and two non-performing loans, respectively. At December 31, 2004, we had no real estate owned or troubled debt restructurings.
The interest income that would have been recorded during the years ended December 31, 2004, 2003 and 2002 if Los Padres Bank’s non-accruing loans at the end of such periods had been current in accordance with their terms during such periods is $52,269, $46,437 and $43,496, respectively. The interest income that was recorded during the years ended December 31, 2004, 2003 and 2002 with respect to Los Padres Bank’s non-accruing loans at December 31, 2004, was $3, $3 and $33, respectively.
Classified Assets. Federal regulations require that each insured savings institution classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them. Los Padres Bank has established three classifications for potential problem assets: “substandard,” “doubtful” and “loss.” Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable,
and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. Los Padres Bank has established another category, designated “special mention,” for assets which do not currently expose Los Padres Bank to a sufficient degree of risk to warrant classification as substandard, doubtful or loss. Assets classified as substandard or doubtful require Los Padres Bank to establish allowances for loan losses based on the methodology described below. If an asset or portion thereof is classified as loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge-off such amount. At December 31, 2004, in addition to the non-performing assets described above, Los Padres Bank had $3.4 million of classified loans, $3.4 million of which was classified as substandard and none were classified as doubtful or loss. As of December 31, 2004, Los Padres Bank had $13.7 million of loans that were designated special mention. Our classified and special mention loans, in addition to the non-performing loans discussed above, are the extent of the loans in our portfolio that give us some repayment concern at this time.
Allowance for Loan Losses. The allowance for loan losses reflects management’s judgment of the level of allowance adequate to provide for probable losses inherent in the loan portfolio as of the balance sheet date. On a quarterly basis, Los Padres Bank assesses the overall adequacy of the allowance for loan losses, utilizing a consistent and systematic approach which includes the application of an allocated allowance for specifically identified problem loans, a formula allowance for non-homogenous loans, a formula allowance for large groups of smaller balance homogenous loans and an unallocated allowance.
Allocated allowance for specifically identified problem loans. A specific reserve is established for impaired loans in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The specific reserve is determined based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, we may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.
Formula allowance for non-homogenous loans. Los Padres Bank segments its non-homogenous loan portfolio into pools with similar characteristics based on loan type (collateral driven) and risk factor (loan grade). Currently, these loans are segmented into four categories by collateral, further stratified by loan grade (pass, special mention and substandard). The general pool categories are multi-family residential, commercial real estate, land acquisition and development, and commercial and industrial. These non-homogenous loans are reviewed individually.
The formula allowance is calculated by applying adjusted loss rates to these pools. Pool loss rates are established by examining historical charge-off data for groups of loans and adjusting them for a variety of qualitative factors deemed appropriate by management. The analysis of historical loss data in determining the initial loss rates is based on a average ten-year period. Where Los Padres Bank has no or nominal actual charge-off data for certain loan types, industry data and management’s judgment is utilized as representative starting loss rates.
Formula allowance for large groups of smaller balance homogenous loans. The allocated loan loss allowance for large groups of smaller balance homogenous loans is focused on loss experience for the pool rather than on an analysis of individual loans. Large groups of smaller balance homogenous loans consist of consumer loans and single-family residential loans. The allowance for groups of performing loans is based on historical losses over a ten year period.
Unallocated Allowance. The unallocated allowance contains amounts that are based on management’s evaluation of conditions that are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the unallocated allowance include the following, which existed at the balance sheet date:
• trends in criticized and non-accrual assets;
• the levels and trends in charge-offs, recovery history and loan restructuring;
• changes in volumes and terms of the loan portfolio;
• changes in the effectiveness of the internal asset review process;
• changes in lending policies, procedures and practices;
• changes in the experience, ability and depth of lending management;
• changes in the national and local economic conditions; and
• the trend in local real estate values.
Management and the Internal Asset Review Committee review these conditions quarterly in discussion with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance, applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the probable loss related to such condition is reflected in the unallocated allowance.
The allowance for loan losses is based upon estimates of probable losses inherent in the loan portfolio. The actual losses can vary from the estimated amounts. Our methodology includes several features that are intended to reduce the differences between estimated and actual losses. The loss migration model that is used to establish the loan loss factors is designed to be self-correcting by taking into account our loss experience over prescribed periods. Similarly, by basing the loan loss factors over a period reflective of two business cycles, the methodology is designed to take our recent loss experience for consumer and commercial and industrial loans into account. Furthermore, based on management’s judgment, our methodology permits adjustments to any loss factor used in the computation of the formula allowance for significant factors, which affect the collectibility of the portfolio as of the evaluation date, but are not reflected in the loss factors. By assessing the probable estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon the most recent information that has become available.
Although our management believes it uses the best information available to establish the level of the allowance, there can be no assurance that additions to such allowance will not be necessary in future periods. Furthermore, various regulatory agencies, as an integral part of their examination process, periodically review our valuation allowance. These agencies may require us to increase the allowance, based on their judgments of the information available to them at the time of the examination.
The following table is an allocation of our allowance for loan losses as of the dates presented:
At December 31, 2004, the formula allowance for non-homogeneous loan allowance increased by $503,000 from December 31, 2003, primarily due to an increase in total non-homogeneous loans and, to a lesser extent, a decrease in criticized loans related to non-homogeneous loans.
The formula allowance for homogeneous loans increased by $96,000 for the year ending 2004 and decreased by $15,000 for the year ending December 31, 2003, as a result of decreasing single-family loan balances. Los Padres Bank shifted its strategic focus away from originating single-family loans for its portfolio and has opted to originate such loans on a brokered basis due to high competition and the resulting low risk-adjusted spreads.
Specific reserves are established for impaired loans in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” In 2004, we reclassified the $50,000 in specific reserves to the general valuation allowance since the loan was no longer impaired as per SFAS No. 114. From December 31, 2002 to December 31, 2003, the balance in specific reserves has remained constant at $50,000 and relates to one single-family loan.
The following table sets forth the activity in our allowance for loan losses for the periods indicated
(1)
In November 2001, we acquired from Harrington Bank, FSB the Shawnee Mission, Kansas branch, along with related loans and deposits.
The following table sets forth information concerning the allocation of our allowance for loan losses by loan category at the dates indicated.
Investment Activities
General. Our securities portfolio is managed under the direction of our Chief Executive Officer in accordance with a comprehensive written investment policy which addresses strategies, types and levels of allowable investments and which are reviewed and approved by Los Padres Bank’s board of directors. The management of the securities portfolio is set in accordance with strategies developed by Los Padres Bank’s Asset and Liability Committee (“ALCO”). In addition, Los Padres Bank has entered into an agreement with Smith Breeden Associates, Inc. (“Smith Breeden”) whereby Smith Breeden has been appointed as investment advisor with respect to the management of Los Padres Bank’s securities portfolio. With the assistance of Smith Breeden, Los Padres Bank’s Chief Executive Officer, in his role as Chief Investment Officer, has the primary responsibility for managing the investment portfolio in accordance with the policy. The Chief Investment Officer’s responsibilities include informing ALCO of the types of investments available, the status and performance of the portfolio and current market conditions. Designated officers of Los Padres Bank are authorized to: purchase or sell eligible investments under repurchase or reverse repurchase agreements; execute hedging strategies approved by the ALCO; pledge securities owned as collateral for public agency deposits or repurchase accounts or agreements; and lend securities to approved dealers in government securities or approved commercial banks. The Chief Executive Officer, the President, Principal Accounting Officer or the Director of Financial Reporting of Los Padres Bank has the authority to purchase or sell designated instruments up to $5.0 million in any one transaction and, acting together, any two members of the ALCO have authority to purchase or sell securities of between $5.0 million and $30.0 million in any one transaction. For purchases or sales greater than $30.0 million, the prior approval of a majority of the ALCO is required. Designated officers are also authorized to invest excess liquidity in approved liquid investment vehicles. In addition, the Board of Directors of Los Padres Bank ratifies all securities purchased and sold by Los Padres Bank.
We invest in a portfolio of mortgage-backed and related securities, interest rate contracts, U.S. Government agency securities, asset-backed securities, corporate securities and, to a much lesser extent, equity securities. In selecting securities for our portfolio, we employ option-adjusted pricing analysis with the assistance of Smith Breeden in order to ascertain the net risk-adjusted spread expected to be earned with respect to the various investment alternatives. The nature of this analysis is to quantify the costs embedded in the yield of an investment, such as the duration-matched funding cost, the costs of the options embedded in the investment’s cash flow (such as a borrower’s ability to prepay a mortgage) and servicing costs. The objective of our investment management process is to select investments with the greatest net spreads and actively manage the underlying risks of these investments.
We manage our securities portfolio in order to enhance net interest income and net market value on a risk-adjusted basis and deploy excess capital until we can reinvest such assets into loans or other community banking assets. As a result, we monitor the net risk-adjusted spread of our investments and compare them with the spreads available with respect to other securities in the market. Accordingly, as market conditions fluctuate (e.g., as risk-adjusted spreads narrow), we may sell individual securities prior to their maturity and reinvest the proceeds into new investments, which generally carry wider risk-adjusted spreads. We utilize various interest rate contracts such as interest rate swaps, caps, floors, options and futures in order to hedge our interest rate exposure in our securities portfolio, which allows us to respond to changing prepayment rates on our mortgage-backed and related securities. The investment portfolio, although hedged for interest rate risk, is still susceptible to adverse changes in the spreads between the yields on mortgage-backed and related securities and the related Treasury and LIBOR based hedges. Substantially all of our securities are classified as available for sale securities and, pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 115, are reported at fair value with unrealized gains and losses included in stockholders’ equity.
Mortgage-Backed and Related Securities. At December 31, 2004, our mortgage-backed and related securities including pass-through mortgage-backed securities, collateral mortgage obligations and mortgage related asset-backed securities classified as available for sale and held to maturity amounted to $431.7 million or 98.1% of our securities portfolio and 39.9% of our total assets. By investing in mortgage-backed and related securities, our management seeks to achieve a targeted option-adjusted spread over applicable funding costs.
We invest in mortgage-backed and related securities, including mortgage participation certificates, which are insured or guaranteed by U.S. Government agencies and government sponsored enterprises or by private issuers which are rated based on the underlying collateral and priority of cash flows, and investment grade collateralized mortgage obligations (“CMOs”) and real estate mortgage investment conduits (“REMICs”). Mortgage-backed securities, which also are known as mortgage participation certificates or pass-through certificates, represent a participation interest in a pool of single-family mortgages. The principal and interest payments on these securities are passed from the mortgage originators, through intermediaries, generally U.S. Government agencies and government sponsored enterprises, that pool and repackage the participation interests in the form of securities, to investors such as us. Such U.S. Government agencies and government-sponsored enterprises, which guarantee the payment of principal and interest to investors, primarily include Freddie Mac, Fannie Mae and the Government National Mortgage Association (“Ginnie Mae”).
Mortgage-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a range and have varying maturities. The characteristics of the underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the certificate holder. The term of a mortgage-backed pass-through security thus approximates the terms of the underlying mortgages.
Our mortgage-backed and related securities, including CMO’s, include securities issued by entities which have qualified under the Internal Revenue Code of 1986, as amended (the “Code”) as REMICs. CMOs and REMICs, referred to in this document as CMOs, were developed in response to investor concerns regarding the uncertainty of cash flows associated with the prepayment option of the underlying mortgagor and are typically issued by governmental agencies, government sponsored enterprises and special purpose entities, such as trusts, corporations or partnerships, established by financial institutions or other similar institutions. In contrast to pass-through mortgage-backed securities, in which cash flow is received pro rata by all security holders, the cash flow from the mortgages underlying a CMO is segmented and paid in accordance with a predetermined priority to investors holding various CMO classes. By allocating the principal and interest cash flows from the underlying collateral among the separate CMO classes, different classes of bonds are created, each with its own stated maturity, estimated average life, coupon rate and prepayment characteristics.
Like most fixed-income securities, mortgage-backed and related securities are subject to interest rate risk. Unlike most fixed-income securities, however, the mortgage loans underlying a mortgage-backed or related security generally may be prepaid at any time without penalty. The ability to prepay a mortgage loan generally results in significantly increased price and yield volatility, with respect to mortgage-backed and related securities, than is the case with non-callable fixed income securities. Furthermore, mortgage-backed securities often are more sensitive to changes in interest rates and prepayments than traditional mortgage-backed securities and are, therefore, even more volatile. Nevertheless, we attempt to hedge against both interest rate and prepayment risk. No assurance can be made, however, that these hedges will be effective.
Although mortgage-backed and related securities often carry lower yields than traditional mortgage loans, these securities generally increase the quality of our assets by virtue of the securities’
underlying insurance or guarantees or collateral support. These securities also require less capital under risk-based regulatory capital requirements than non-insured or non-guaranteed mortgage loans, are more liquid than individual mortgage loans, which enhances our ability to actively manage our portfolio, and may be used to collateralize borrowings or other obligations. At December 31, 2004, $197.2 million or 45.6% of our mortgage-backed and related securities were pledged to secure various obligations (such as Federal Home Loan Bank (“FHLB”) advances, repurchase agreements and collateral for interest rate swaps). In addition, as a result of our maintaining a substantial portion of our assets in mortgage-backed and related securities, we have been able to maintain a relatively low level of operating expenses.
At December 31, 2004, the contractual maturity of substantially all of our mortgage-backed or related securities was in excess of 10 years. The actual maturity of a mortgage-backed or related security may be less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and affect its yield to maturity. The yield to maturity is based upon the interest income and the amortization of any premium or discount related to the security. In accordance with generally accepted accounting principles, premiums and discounts are amortized over the contractual life of the loans, which decrease and increase interest income, respectively. The prepayment assumptions used to determine the amortization period of premiums and discounts can significantly affect the yield of the mortgage-backed or related security, and these assumptions are reviewed periodically to reflect actual prepayments. Although prepayments of underlying mortgages depends on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of falling mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages and the related security. At December 31, 2004, of the $376.5 million of mortgage-backed and related securities held by us, an aggregate of $61.3 million was secured by fixed-rate mortgage loans and an aggregate of $315.2 million was secured by adjustable-rate mortgage loans.
We also invest in investment grade commercial mortgage backed securities (“CMBS”), which are securities collateralized by mortgage loans secured by industrial, office, warehouse, retail space strip shopping centers, motels and other commercial related real estate. The cash flows from these mortgages are normally paid in a predetermined priority to investors holding the various classes of securities. The mortgage loans underlying these securities typically have a prepayment lockout for a period of five to ten years and, as such, have less prepayment risk than single-family mortgage securities. At December 31, 2004, we held $47.9 million of commercial mortgage-backed securities.
Corporate Debt Securities. We plan, from time to time, to invest in corporate investment grade notes and bonds that are general obligations of the issuing company or backed by specific equipment or other collateral of the issuing company. These securities are rated by the major rating agencies based on the financial strength of the issuing company, priority in the debt structure of the company, and the underlying security, if any. At December 31, 2004, we held $1.7 million of corporate debt securities.
Trading Account Assets and Other Securities. At December 31, 2004, we held a variety of assets classified as trading securities pursuant to SFAS No. 115, including mortgage-backed securities, which had a carrying value of $388,000, and equity securities (consisting of mutual funds invested in a variety of corporate fixed income and equity securities) with a carrying value of $581,000 as of December 31, 2004.
We also have total rate of return interest rate swaps in our trading portfolio with a notional amount of $120.0 million, with a carrying value of $77,000, which we use to enhance our returns. As of December 31, 2004, we had CMBS total return swaps with an aggregate notional amount of $95.0 million that mature by the end of June 2005. With regard to the CMBS total return swaps, we receive the net spread between the yield on the Lehman Brothers AAA CMBS Index or the Lehman 6 - 8.5 year AAA index and the duration matched LIBOR yield (less a spread) plus any market value changes due to the spread changing between the index and the duration matched LIBOR yield. We also have one asset backed home equity total return swap with a notional amount of $25.0 million that expires on February 28, 2005. We receive the net spread between the yield on five referenced A rated home equity, asset backed securities and one month LIBOR (less a spread) plus the market value change due to the spread changing between the referenced securities and one month LIBOR yields. For a 10 basis point change in spreads, the net market value of the total return swap portfolio would change by $668,000 at December 31, 2004. As spreads tighten, gains are realized, and as they widen, losses are realized. The purpose of these total return swaps is to create incremental income for Los Padres Bank.
The net interest income relating to our total returns swaps was $ 1.1 million, $820,000 and $916,000 during the years ended December 31, 2004, 2003 and 2002, respectively. The approximate net market value of our total return swaps maintained as trading account assets was $77,000, $166,000 and $(17,000) as of December 31, 2004, 2003 and 2002, respectively.
The following table presents certain information regarding the composition and period to maturity of our securities classified as available for sale as of the dates indicated below.
The following table presents certain information regarding the composition and period to maturity of our securities classified as held to maturity as of the dates indicated below.
The following table presents certain information regarding the composition of our trading account assets as of the dates indicated below.
The following table sets forth the fair value of our securities activities with respect to our securities classified as available for sale and held to maturity for the periods indicated.
Sources of Funds
General. We consider various sources of funds to fund our investing and lending activities and we evaluate the available sources of funds in order to reduce our overall funding costs. Deposits, reverse repurchase agreements, advances from the FHLB of San Francisco, notes payable, and sales, maturities and principal repayments on loans and securities have been the major sources of funds for use in our lending and investing activities, and for other general business purposes. We closely monitor rates and terms of competing sources of funds on a daily basis and utilize the source that we believe to be cost effective.
Deposits. Los Padres Bank attempts to price its deposits in order to promote deposit growth and offers a wide array of deposit products in order to satisfy our business and retail customers’ needs. Los Padres Bank’s current deposit products include passbook accounts, negotiable order of withdrawal (“NOW”) and demand deposit accounts, money market deposit accounts, fixed-rate, fixed-maturity retail certificates of deposit ranging in terms from one month to five years and individual retirement accounts.
Los Padres Bank’s retail deposits are generally obtained from residents in each of its primary market areas. Los Padres Bank is opening a new location in the Scottsdale Airpark in early 2005 and, has a definitive agreement to purchase a banking office and acquire the related deposits in Thousand Oaks, California in May 2005, and is in the process of finalizing negotiations to open a third location in Kansas in the latter part of 2005. The principal methods currently used by Los Padres Bank to attract deposit accounts include offering a variety of products and services and competitive interest rates. Los Padres Bank utilizes traditional marketing methods to attract new customers and savings deposits, including various forms of advertising.
The following table presents the average balance of each deposit type and the average rate paid on each deposit type of Los Padres Bank for the periods indicated.
The following table sets forth the maturities of Los Padres Bank’s certificates of deposit having principal amounts of $100,000 or more at December 31, 2004.
The following table sets forth the activity in Los Padres Bank’s deposits during the period indicated.
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The following table sets forth by various interest rate categories the certificates of deposit with Los Padres Bank at the dates indicated.
The following table sets forth the amount and remaining maturities of Los Padres Bank’s certificates of deposit at December 31, 2004.
Borrowings. We obtain both long-term fixed-rate and short-term variable-rate advances from the FHLB of San Francisco upon the security of certain of our residential first mortgage loans and other assets, provided certain standards related to creditworthiness of Los Padres Bank have been met. FHLB of San Francisco advances are available for general business purposes to expand lending and investing activities. Borrowings have generally been used to fund the purchase of mortgage-backed and related securities and lending activities and have been collateralized with a pledge of loans, securities in our portfolio or any mortgage-backed or related securities purchased. Advances from the FHLB of San Francisco are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. At December 31, 2004, we had five advances from the FHLB of San Francisco, which mature between January 2005 and June 2010. At December 31, 2004, we had total FHLB of San Francisco advances of $316.0 million at a weighted average coupon of 2.52%. Our borrowings from the FHLB of San Francisco are limited to 35% of Los Padres Bank’s total assets, or $378.0 million at December 2004 and $340.6 million at December 31, 2003.
During 2003 and 2004, we obtained funds from the sales of securities to investment dealers under agreements to repurchase, known as reverse repurchase agreements. In a reverse repurchase agreement transaction, we will generally sell a mortgage-backed security agreeing to repurchase either the same or a substantially identical security on a specific later date. The difference between the sale and the purchase price (referred to as the “drop”) together with the foregone coupon interest represents the cost of the financing transaction. The mortgage-backed securities underlying the agreements are delivered to the dealers who arrange the transaction. For agreements in which we have agreed to repurchase substantially identical securities, the dealers may sell, loan or otherwise dispose of our securities in the normal course of their operations; however, such dealers or third party custodians safe-keep the securities which are to be specifically repurchased by us. In this type of transaction, we are subject to the risk that the lender may default at maturity and not return the collateral. The amount at risk is the value of the collateral, which exceeds the balance of the borrowing. In order to minimize this potential risk, we only deal with large, established dealers when entering into these transactions. Reverse repurchase transactions are accounted for as financing arrangements rather than as sales of such securities, and the obligation to repurchase such securities is reflected as a liability in our consolidated financial statements. At December 31, 2004, we had five repurchase agreements with Citigroup Financial Services totaling $79.0 million with a weighted average coupon of 2.59% and maturities ranging from July 2005 to July 2010. At December 31, 2003, we had four repurchase agreements with Citigroup Financial Services totaling $65.0 million with a weighted average interest coupon of 2.61% and maturities ranging from July 2005 to July 2010.
We are parties to a credit agreement with Harris Trust and Savings Bank and US Bank, N.A. Under the credit agreement, we have a revolving credit facility that enables us to borrow up to $15.0 million for general corporate purposes from time to time with a maturity of September 30, 2007. As of December 31, 2004 and December 31, 2003, we had no outstanding borrowings under the credit agreement.
We pay interest on the outstanding amount of our borrowings from time to time under the credit agreement at an interest rate that adjusts based upon our compliance with certain financial criteria and our selection of an interest rate formula. At our option, the interest rates per annum applicable to any particular borrowing under the credit agreement is either (1) adjusted LIBOR plus a margin ranging from 1.75% to 2.75% or (2) the prime rate announced from time to time by Harris Trust and Savings Bank minus a margin ranging from 0.5% to 0.0%. In September 2004, the credit agreement was renegotiated to reduce the LIBOR plus a margin range. The factors that determine the amount of the margin include our core profitability and our non-performing asset ratio. We are currently at the most favorable pricing level under the credit agreement. In each year, we also pay a commitment fee to the lenders equal to 0.25% of the average daily un-drawn portion of the borrowings available to us under the credit agreement for that year.
The credit agreement contains a number of significant covenants that restrict our ability to dispose of assets, incur additional indebtedness, invest in mortgage derivative securities above certain thresholds, create liens on assets, engage in mergers or consolidations or a change-of control, engage in certain transactions with affiliates, pay cash dividends or repurchase common stock. The credit agreement also requires us to comply with specified financial ratios and tests, including causing Los Padres Bank to maintain a ratio of non-performing assets to the sum of Tier 1 risk-based capital plus loan loss reserves of not more than 0.20 to 1, maintaining a ratio of outstanding loans under the credit agreement to the stockholders’ equity of Los Padres Bank of less than 0.50 to 1, maintaining Los Padres Bank’s status as a “well capitalized” institution and complying with minimum core profitability requirements. Management believes that as of December 31, 2004, it was in compliance with all of such covenants and restrictions and does not anticipate that such covenants and restrictions will significantly limit its operations.
On September 27, 2004, we completed a $10.3 million capital trust offering with a newly formed trust, Harrington West Capital Trust II, in a private transaction. The capital trust securities bear an interest rate of three-month LIBOR plus 1.90% and will mature on October 7, 2034 and have a five-year call feature. We used a portion of the proceeds to downstream capital to Los Padres Bank for the continued expansion of their operations.
On September 25, 2003, we completed a $15.5 million capital trust offering. The capital securities were issued through a newly formed trust, Harrington West Capital Trust I, in a private transaction. The capital trust securities bear an interest rate of three-month LIBOR plus 2.85% and will mature on October 8, 2033 and have a five-year call feature. We used $11.3 million to pay off the secured line of credit with Harris Trust and Savings Bank and US Bank, N.A. The remainder of the proceeds were used to expand the Los Padres Bank operations in Overland Park, Kansas, Ventura, California and Scottsdale, Arizona.
The following table sets forth certain information regarding our short-term borrowings that mature in one year or less at or for the dates indicated.
Subsidiaries
Our primary subsidiary is Los Padres Bank. We were formed for the purpose of acquiring Los Padres Bank, and we completed the acquisition in 1996. Los Padres Bank is a wholly-owned subsidiary.
In February 1999, we purchased a 49% interest in Harrington Wealth Management Company, (“HWM”) which provides trust and investment management services to individuals and small institutional clients for fee income. In November 2001, we purchased the remaining 51% interest in HWM. HWM performs management of investment portfolios through knowledge and analysis of the customer’s investment needs, risk tolerance, tax situation and investment horizon. At December 31, 2004, HWM administered approximately 364 accounts and had $134.8 million of assets under management that are not included on our balance sheet. For the years ended December 31, 2004, 2003 and 2002, HWM generated revenues of $614,000, $456,000, and $412,000, respectively. HWM is a wholly owned subsidiary of Los Padres Bank.
On September 30, 2004, we decided to terminate our joint venture, Los Padres Mortgage Company, LLC (LPMC) with Resource Marketing, the holding company for RE/MAX Achievers. LPMC brokered residential and commercial mortgage loans for fee income. We terminated the LPMC joint venture as the penetration rates of RE/MAX Achievers’ clientele for mortgage loans were below the expected levels, and could broaden loan originations on the Bank’s platform. The termination of the LPMC joint venture is also expected to provide economies by eliminating duplication of loan administration activities within LPMC and the Bank. The Bank retained selected LPMC loan origination staff and loan officers to continue its loan origination expansion in the Scottsdale, Arizona market.
Valley Oaks Financial Corporation was formed as a wholly owned service corporation of Los Padres Bank in 1983 and serves as the title-holder with respect to the mortgages we originate.
Harrington West Capital Trust I was formed as a deconsolidated subsidiary of Harrington West Financial Group in 2003 and was created in conjunction with the $15.5 million capital trust offering.
Harrington West Capital Trust II was formed as a deconsolidated subsidiary of Harrington West Financial Group in 2004 and was created in conjunction with the $10.3 million capital trust offering.
Employees
As of December 31, 2004, we had 177 full-time equivalent employees. Our employees are not subject to any collective bargaining agreements and we believe that our relationship with our employees is satisfactory.
Regulation of Harrington West Financial Group, Inc.
General. Savings and loan holding companies and savings associations are extensively regulated under both federal and state law. This regulation is intended primarily for the protection of depositors and the Savings Association Insurance Fund (“SAIF”) and not for the benefit of our stockholders. The following information describes certain aspects of that regulation applicable to us, Los Padres Bank and Harrington Wealth Management Company, and does not purport to be complete. The discussion is qualified in its entirety by reference to all particular statutory or regulatory provisions. We are a unitary savings and loan holding company subject to regulatory oversight by the Office of Thrift Supervision (“OTS”). As such, we are required to register and file reports with the OTS and are subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over us and our
subsidiaries, which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to Los Padres Bank.
Activities Restriction Test. As a unitary savings and loan holding company, we are generally not subject to activity restrictions, provided Los Padres Bank satisfies the Qualified Thrift Lender (“QTL”), test or meets the definition of a domestic building and loan association pursuant to the Code. We presently intend to continue to operate as a unitary savings and loan holding company. Recent legislation terminated the “unitary thrift holding company exemption” for all companies that apply to acquire savings associations after May 4, 1999. However, since we are grandfathered, our unitary holding company powers and authorities were not affected. Despite our grandfathered status, if we acquire control of another savings association as a separate subsidiary, we would become a multiple savings and loan holding company, and our activities, and any activities of our subsidiaries (other than Los Padres Bank or any savings association), would be restricted generally to activities permissible for financial holding companies and other activities permitted for multiple savings and loan holding companies under OTS regulations, unless such other associations each also qualify as a QTL or a domestic building and loan association and were acquired in a supervisory acquisition. Furthermore, if we were in the future to sell control of Los Padres Bank to any other company, such company would not succeed to our grandfathered status and would be subject to the same business activity restrictions.
Restrictions on Acquisitions. We must obtain approval from the OTS before acquiring control of any other savings association. Such acquisitions are generally prohibited if they result in a multiple savings and loan holding company controlling savings associations in more than one state. However, such interstate acquisitions are permitted based on specific state authorization or in a supervisory acquisition of a failing savings association.
Federal law generally provides that no “person,” acting directly or indirectly or through or in concert with one or more other persons, may acquire “control,” as that term is defined in OTS regulations, of a federally insured savings association without giving at least 60 days written notice to the OTS and providing the OTS an opportunity to disapprove the proposed acquisition. In addition, no company may acquire control of such an institution without prior OTS approval. These provisions also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of a savings and loan holding company, from acquiring control of any savings association not a subsidiary of the savings and loan holding company, unless the acquisition is approved by the OTS.
Regulation of Los Padres Bank
General. As a federally chartered, SAIF-insured savings association, Los Padres Bank is subject to extensive regulation by the OTS and the Federal Deposit Insurance Corporation (“FDIC”). Lending activities and other investments of Los Padres Bank must comply with various statutory and regulatory requirements. Los Padres Bank is also subject to certain reserve requirements promulgated by the Federal Reserve Board.
The OTS, in conjunction with the FDIC, regularly examines Los Padres Bank and prepares reports for the consideration of Los Padres Bank’s Board of Directors on any deficiencies found in the operations of Los Padres Bank. The relationship between Los Padres Bank and depositors and borrowers is also regulated by federal and state laws, especially in such matters as the deposit insurance of savings accounts and the form and content of mortgage documents utilized by Los Padres Bank.
Los Padres Bank must file reports with the OTS and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with or acquisitions of other financial institutions. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the SAIF and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulations, whether by the OTS, the FDIC, or the Congress could have a material adverse impact on us, Los Padres Bank, and our operations.
Insurance of Deposit Accounts. The SAIF, as administered by the FDIC, insures Los Padres Bank’s deposit accounts up to the maximum amount permitted by law. The FDIC may terminate insurance of deposits upon a finding that Los Padres Bank:
• has engaged in unsafe or unsound practices;
• is in an unsafe or unsound condition to continue operations; or
• has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS.
The FDIC charges an annual assessment for the insurance of deposits based on the risk a particular institution poses to its deposit insurance fund. Under this system as of December 31, 2004, SAIF members pay within a range of 0 cents to 27 cents per $100 of domestic deposits, depending upon the institution’s risk classification. This risk classification is based on an institution’s capital group and supervisory subgroup assignment. In addition, all FDIC-insured institutions are required to pay assessments to the FDIC at an annual rate for the fourth quarter of 2004 at approximately $0.02 per $100 of assessable deposits to fund interest payments on bonds issued by the Financing Corporation (“FICO”), an agency of the Federal government established to recapitalize the predecessor to the SAIF. These assessments will continue until the FICO bonds mature in 2017.
Proposed Legislation. From time to time, new laws are proposed that, if enacted, could have an effect on the financial institutions industry. For example, deposit insurance reform legislation is currently pending in Congress that would:
• merge the Bank Insurance Fund and the SAIF.
• increase the current deposit insurance coverage limit for insured deposits to $130,000 and index future coverage limits to inflation.
• replace the current fixed 1.25 designated reserve ratio with a reserve range of between 1.0 and 1.25, giving the FDIC discretion in determining a level adequate within this range.
While we cannot predict whether such proposals will eventually become law, they could have an effect on our operations and the way we conduct business.
Regulatory Capital Requirements and Prompt Corrective Action. The prompt corrective action regulation of the OTS, requires certain mandatory actions and authorizes certain other discretionary actions to be taken by the OTS against a savings association that falls within certain undercapitalized capital categories specified in the regulation.
Under the regulation, an institution is well capitalized if it has a total risk-based capital ratio of at least 10.0%, a Tier 1 risk-based capital ratio of at least 6.0% and a leverage ratio of at least 5.0%, with no written agreement, order, capital directive, prompt corrective action directive or other individual
requirement by the OTS to maintain a specific capital measure. An institution is adequately capitalized if it has a total risk-based capital ratio of at least 8.0% and a Tier 1 risk-based capital ratio of at least 4.0% and a leverage ratio of at least 4.0% (or 3.0% if it has a composite rating of “1”). The regulation also establishes three categories for institutions with lower ratios: undercapitalized, significantly undercapitalized and critically undercapitalized. At December 31, 2004, Los Padres Bank met the capital requirements of a “well capitalized” institution under applicable OTS regulations.
In general, the prompt corrective action regulation prohibits an insured depository institution from declaring any dividends, making any other capital distribution, or paying a management fee to a controlling person if, following the distribution or payment, the institution would be within any of the three undercapitalized categories. In addition, adequately capitalized institutions may accept brokered deposits only with a waiver from the FDIC and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew, or roll over brokered deposits.
If the OTS determines that an institution is in an unsafe or unsound condition, or if the institution is deemed to be engaging in an unsafe and unsound practice, the OTS may, if the institution is well capitalized, reclassify it as adequately capitalized; if the institution is adequately capitalized but not well capitalized, require it to comply with restrictions applicable to undercapitalized institutions; and, if the institution is undercapitalized, require it to comply with certain restrictions applicable to significantly undercapitalized institutions. Finally, pursuant to an interagency agreement, the FDIC can examine any institution that has a substandard regulatory examination score or is considered undercapitalized without the express permission of the institution’s primary regulator.
OTS capital regulations also require savings associations to meet three capital standards:
• tangible capital equal to at least 1.5% of total adjusted assets,
• leverage capital (core capital) equal to 4% of total adjusted assets, and
• risk-based capital equal to 8.0% of total risk-weighted assets.
These capital requirements are viewed as minimum standards by the OTS, and most institutions are expected to maintain capital levels well above the minimum. Minimum capital levels higher than those provided in the regulations may be established by the OTS for individual savings associations, upon a determination that the savings association’s capital is or may become inadequate in view of its circumstances.
The following table reflects as of December 31, 2004, Los Padres Bank’s actual levels of regulatory capital and the applicable regulatory capital requirements.
The Home Owners’ Loan Act (“HOLA”) permits savings associations not in compliance with the OTS capital standards to seek an exemption from certain penalties or sanctions for noncompliance. Such an exemption will be granted only if certain strict requirements are met, and must be denied under certain circumstances. If the OTS grants an exemption, the savings association still may be subject to enforcement actions for other violations of law or unsafe or unsound practices or conditions.
Loans-to-One Borrower Limitations. Savings associations generally are subject to the lending limits applicable to national banks. With certain limited exceptions, the maximum amount that a savings association or a national bank may lend to any borrower (including certain related entities of the borrower) at one time may not exceed 15% of the unimpaired capital and surplus of the institution, plus an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral. Savings associations are additionally authorized to make loans to one borrower, for any purpose, in an amount not to exceed $500,000 or, by order of the Director of OTS, in an amount not to exceed the lesser of $30.0 million or 30% of unimpaired capital and surplus to develop residential housing, provided:
• the purchase price of each single-family dwelling in the development does not exceed $500,000;
• the savings association is in compliance with its capital requirements;
• the loans comply with applicable loan-to-value requirements; and
• the aggregate amount of loans made under this authority does not exceed 150% of unimpaired capital and surplus.
At December 31, 2004, Los Padres Bank’s loans-to-one-borrower limit was $11.6 million based upon the 15% of unimpaired capital and surplus measurement. At December 31, 2004, Los Padres Bank’s largest single lending relationship had an outstanding aggregate balance of $9.6 million, and consisted of six loans secured by commercial real estate, each of which was performing in accordance with its terms.
Qualified Thrift Lender Test. Savings associations must meet a QTL test, which may be met either by maintaining a specified level of assets in qualified thrift investments as specified in HOLA or by meeting the definition of a “domestic building and loan association” under the Code. Qualified thrift investments are primarily residential mortgages and related investments, including certain mortgage related securities. The required percentage of investments under HOLA is 65% of assets while the Code
requires investments of 60% of assets. An association must be in compliance with the QTL test or the definition of domestic building and loan association on a monthly basis in nine out of every 12 months. Associations that fail to meet the QTL test will generally be prohibited from engaging in any activity not permitted for both a national bank and a savings association. As of December 31, 2004, Los Padres Bank was in compliance with its QTL requirement and met the definition of a domestic building and loan association.
Affiliate Transactions. Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms and under circumstances that are substantially the same, or at least as favorable to the savings association or its subsidiary, as transactions with non-affiliates. Certain of these transactions, such as loans or extensions of credit to an affiliate, are restricted to a percentage of the association’s capital and surplus. In addition, a savings association may not make a loan or other extension of credit to any affiliate engaged in activities not permissible for a bank holding company or purchase or invest in securities issued by most affiliates. Affiliates of a savings association include, among other entities, the savings association’s holding company and companies that are under common control with the savings association. HWFG and HWM are considered to be affiliates of Los Padres Bank.
Capital Distribution Limitations. OTS regulations impose limitations upon all capital distributions by savings associations, like cash dividends, payments to repurchase or otherwise acquire its shares, payments to stockholders of another institution in a cash-out merger and other distributions charged against capital. Under the rule, a savings association in some circumstances may:
• be required to file an application and await approval from the OTS before it makes a capital distribution;
• be required to file a notice 30 days before the capital distribution; or
• be permitted to make the capital distribution without notice or application to the OTS.
The OTS regulations require a savings association to file an application if:
• it is not eligible for expedited treatment of its other applications under OTS regulations;
• the total amount of all of capital distributions, including the proposed capital distribution, for the applicable calendar year exceeds its net income for that year to date plus retained net income for the preceding two years;
• it would not be at least adequately capitalized, under the prompt corrective action regulations of the OTS following the distribution; or
• the association’s proposed capital distribution would violate a prohibition contained in any applicable statute, regulation, or agreement between the savings association and the OTS, or the FDIC, or violate a condition imposed on the savings association in an OTS-approved application or notice.
In addition, a savings association must give the OTS notice of a capital distribution if the savings association is not required to file an application, but:
• would not be well capitalized under the prompt corrective action regulations of the OTS following the distribution;
• the proposed capital distribution would reduce the amount of or retire any part of the savings association’s common or preferred stock or retire any part of debt instruments like notes or debentures included in capital, other than regular payments required under a debt instrument approved by the OTS; or
• the savings association is a subsidiary of a savings and loan holding company.
If neither the savings association nor the proposed capital distribution meet any of the above listed criteria, the OTS does not require the savings association to submit an application or give notice when making the proposed capital distribution. The OTS may prohibit a proposed capital distribution that would otherwise be permitted if the OTS determines that the distribution would constitute an unsafe or unsound practice.
Community Reinvestment Act and the Fair Lending Laws. Savings associations have a responsibility under the Community Reinvestment Act and related regulations of the OTS to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities and the denial of applications. In addition, an institution’s failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in the OTS, other federal regulatory agencies as well as the Department of Justice taking enforcement actions. Based on an examination conducted in November 2004, Los Padres Bank received an outstanding rating with respect to its performance pursuant to the Community Reinvestment Act.
Federal Home Loan Bank System. Los Padres Bank is a member of the FHLB system. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available loans or advances to its members in compliance with the policies and procedures established by the Board of Directors of the individual FHLB. As an FHLB member, Los Padres Bank is required to own capital stock in an FHLB in an amount equal to the greater of:
• 1% of its aggregate outstanding principal amount of its residential mortgage loans, home purchase contracts and similar obligations at the beginning of each calendar year; or
• 5% of its FHLB advances or borrowings.
Los Padres Bank’s required investment in FHLB stock, based on December 31, 2004, financial data, was $15.1 million. At December 31, 2004, Los Padres Bank had $15.1 million of FHLB stock.
Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain noninterest-bearing reserves at specified levels against their transaction accounts (primarily checking, NOW, and Super NOW checking accounts) and non-personal time deposits. At December 31, 2004, Los Padres Bank was in compliance with these requirements.
Activities of Subsidiaries. A savings association seeking to establish a new subsidiary, acquire control of an existing company or conduct a new activity through a subsidiary must provide 30 days prior notice to the FDIC and the OTS and conduct any activities of the subsidiary in compliance with regulations and orders of the OTS. The OTS has the power to require a savings association to divest any subsidiary or terminate any activity conducted by a subsidiary that the OTS determines to pose a serious threat to the financial safety, soundness or stability of the savings association or to be otherwise inconsistent with sound banking practices.
Recent Legislation
USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. that occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law enforcement’s and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.
Financial Services Modernization Legislation. In November 1999, the Gramm-Leach-Bliley Act of 1999 (“GLB”) was enacted. The GLB repeals provisions of the Glass-Steagall Act which restricted the affiliation of Federal Reserve member banks with firms “engaged principally” in specified securities activities, and which restricted officer, director, or employee interlocks between a member bank and any company or person “primarily engaged” in specified securities activities.
In addition, the GLB also contains provisions that expressly preempt any state law restricting the establishment of financial affiliations, primarily related to insurance. The general effect of the law is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the Bank Holding Company Act framework to permit a holding company to engage in a full range of financial activities through a new entity known as a “financial holding company.” “Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.
The GLB provides that no company may acquire control of an insured savings association unless that company engages, and continues to engage, only in the financial activities permissible for a financial holding company, unless the company is grandfathered as a unitary savings and loan holding company. The Financial Institution Modernization Act grandfathers any company that was a unitary savings and loan holding company on May 4, 1999 or became a unitary savings and loan holding company pursuant to an application pending on that date.
The GLB also permits national banks to engage in expanded activities through the formation of financial subsidiaries. A national bank may have a subsidiary engaged in any activity authorized for national banks directly or any financial activity, except for insurance underwriting, insurance investments, real estate investment or development, or merchant banking, which may only be conducted through a subsidiary of a financial holding company. Financial activities include all activities permitted under new sections of the Bank Holding Company Act or permitted by regulation.
To the extent that the GLB permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. The GLB is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis and which unitary savings and loan holding companies already possess. Nevertheless, the GLB may have the result of increasing the amount of competition that we face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than we have.
Sarbanes-Oxley Act. In July 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (“SOA”) implementing legislative reforms intended to address corporate and accounting improprieties. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (the “Exchange Act”). The SOA includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC and the Comptroller General. The SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
The SOA addresses, among other matters:
• audit committees;
• certification of financial statements by the chief executive officer and the chief financial officer;
• the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
• a prohibition on insider trading during pension plan black out periods;
• disclosure of off-balance sheet transactions;
• a prohibition on personal loans to directors and officers; expedited filing requirements for Forms 4s;
• expedited filing requirements for Forms 4s;
• disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;
• “real time” filing of periodic reports;
• the formation of a public accounting oversight board;
• new disclosure requirements regarding internal controls;
• auditor independence; and
• various increased criminal penalties for violations of securities laws.
As a public reporting company, we are subject to the provisions of the SOA and related rules and regulations issued by the SEC and Nasdaq. It is anticipated that we will incur additional expense as a result of the SOA.
Regulation of Non-banking Affiliates
Harrington Wealth Management Company is registered with the SEC as an investment advisor. Harrington Wealth Management Company is subject to various regulations and restrictions imposed by the SEC, as well as by various state authorities.
Item 2.
Item 2. Properties
Office Locations
The following table sets forth certain information with respect to our offices at December 31, 2004.
Item 3.
Item 3. Legal Proceedings
We are involved in a variety of litigation matters in the ordinary course of our business and anticipate that we will become involved in new litigation matters from time to time in the future. Based on the current assessment of these matters, we do not presently believe that any one of them or all such matters taken as a whole is likely to have a material adverse impact on our financial condition, results of operations, cash flows or prospects. However, we will incur legal and related costs concerning litigation and may from time to time determine to settle some or all of the cases, regardless of our assessment of our legal position. The amount of legal defense costs and settlements in any period will depend on many factors, including the status of cases, the number of cases that are in trial or about to be brought to trial, and the opposing parties’ aggressiveness in pursuing their cases and their perception of their legal position.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Stock Information
On November 12, 2002, the initial public offering of 1,344,000 shares of our common stock was completed, consisting of 1,168,338 shares sold by us and 175,662 shares sold by certain of our stockholders. As of March 7, 2005, we had 5,285,084 shares of common stock outstanding and approximately 122 stockholders of record, which does not include the number of persons or entities holding stock in nominee or street name through various brokers and banks.
The following table sets forth the high and low sale prices of our common stock for each of the quarters of 2004 and 2003. Our common stock began trading on the Nasdaq National Market on November 6, 2002 under the stock symbol “HWFG.”
Dividends
In the first quarter, we paid a quarterly dividend of $.08 and, in the second, third and fourth quarters of 2004, we paid a quarterly dividend of $0.10. Also, on June 28, 2004 a special dividend of $0.50 was declared. In the first and second quarter of 2003, we declared a quarterly dividend of $0.032 per share. In the third quarter of 2003, we declared a dividend of $0.064 per share. In the fourth quarter of 2003, a quarterly dividend of $0.08 was declared.
The dividend rate on our common stock and the continued payment of dividends is determined by our board of directors, which takes into account our consolidated earnings, financial condition, liquidity and capital requirements, applicable governmental regulations and policies, and other factors deemed relevant by our board of directors. More specifically, Delaware law provides that a corporation may make a dividend to its stockholders out of the corporation’s capital surplus or, in case there shall be no surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. The holders of our common stock are entitled to receive and share equally in such dividends as may be declared by our board of directors out of funds legally available therefore. Our ability to pay dividends may also be dependent on our ability to receive dividends from Los Padres Bank, which is subject to compliance with federal regulatory requirements. Additionally, under the terms of our revolving line of credit agreement with unaffiliated lenders, we cannot declare dividends in an amount exceeding the greater of $450,000 or 40% of our consolidated net income during any fiscal quarter or declare dividends at any time an event of default has occurred under the revolving line of credit.
The ability to declare or pay dividends would also be restricted if the Company deferred quarterly interest payments due for the subordinated debt of $25.8 million. As of December 31, 2004, all interest payments due were paid in full in accordance with the capital trust securities agreements.
On February 11, 2004, we declared a 6 for 5 stock split in the form of a stock dividend payable on March 11, 2004 to holders of record on February 25, 2004. Fractional shares distributed in connection with this stock dividend were paid in cash based on the closing market price on the record date.
Recent Sales of Unregistered Securities
In September 2004, our special purpose business trust, Harrington West Capital Trust II, issued $10.3 million of trust preferred securities in a private placement offering. In connection with this transaction, we issued certain junior subordinated debentures and guarantees. We and Harrington West Capital Trust II relied on the exemption from the registration requirement set forth in Rule 144A of the Securities Act.
Item 6.
Item 6. Selected Financial Data.
(Dollars in Thousands, Except Share and Per Share Data)
The following summary presents our selected consolidated financial information at or for the five years ended December 31, 2004. Financial information at or for each of the five years ended December 31, 2004 is derived from our audited consolidated financial statements. The selected historical consolidated financial and other data set forth below should be read in conjunction with, and is qualified in its entirety by, our historical consolidated financial statements, including the related notes, included in Item 8 herein.
(1)
Consists of service charges, wholesale mortgage banking income, other commissions and fees and other miscellaneous noninterest income.
(2)
Consists of computer services, consulting fees, marketing and other miscellaneous noninterest expenses.
(3)
With the exception of return on average assets and return on average equity, all ratios are based on average daily balances.
(4)
Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate on interest-bearing liabilities. Net interest margin represents net interest income as a percentage of average interest-earning assets.
(5)
Efficiency ratio represents noninterest expenses as a percentage of the aggregate of net interest income before provision for loan losses and noninterest income, excluding gains on sales of securities, deposits and loans.
(6)
Non-performing loans generally consist of non-accrual loans and non-performing assets generally consist of non-performing loans and real estate acquired by foreclosure or deed-in-lieu thereof.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Mission
Our mission is to develop diversified and highly profitable community-focused, banking operations in the markets of the Central Coast of California, the Kansas City metro, and the Phoenix/Scottsdale metro. Although these markets are geographically dispersed, we have considerable market knowledge of each of these areas, local management with extensive experience in banking and the particular market, relationship development potential due to our ties to the communities, and each market offers favorable demographic and economic characteristics. All of these banking operations are operated under the Los Padres Bank, FSB charter so that we can gain operating efficiencies from centralized administration and operating systems. However, each region’s banking operation is distinct to its market and its clientele, and lead by a local management team
responsible for developing and expanding the banking operations on a profitable basis. The Kansas City banking offices operate under the Harrington Bank (dba) brand name, and the California and Arizona offices operate under the Los Padres Bank brand name.
Multiple Market Strategy
We believe this multiple market banking strategy provides the following benefits to our shareholders:
1. Diversification of the loan portfolio and economic and credit risk.
2. Options to capitalize on the most favorable growth markets.
3. The capability to deploy the Company’s diversified product mix and emphasize those products that are best suited for the market.
4. The ability to price products strategically among the markets in an attempt to maximize profitability.
We plan to grow the banking operations in these markets opportunistically and expect the opening of two to three banking offices every 18 months through new branching. We evaluate financial institution acquisition opportunities but are value oriented. Acquisitions are expected to be accretive to earnings per share within a 12-month period.
Since 1997, we have grown from 4 banking offices to 15 banking offices after the completion of the Thousand Oaks deposit acquisition and the opening of the Scottsdale Airpark office by mid 2005. We will have 11 full service banking offices on the Central Coast of California from Ventura to Atascadero along Highway 101, 2 banking offices in Johnson County, Kansas in the fastest growing area of the Kansas City metro, and 2 offices in Scottsdale, Arizona, when the second office is completed and opened in the Scottsdale Airpark in early 2005. We are working on additional expansion opportunities in each market.
Product Line Diversification
We have broadened our product lines over the last 5 years to diversify our revenue sources and to become a full service community banking company. In 1999, we added Harrington Wealth Management Company, a federally registered trust and investment management company, to provide our customers a consultative and customized investment process for their trust and investment funds. In 2000, we added a full line of commercial banking and deposit products for small to medium sized businesses and expanded our consumer lending lines to provide Home Equity Lines of Credit. In 2001, we added internet banking and bill pay services to augment our in-branch services and consultation. In 2002, we further expanded our mortgage banking and brokerage activities in all of our markets.
Modern Financial Skills
We believe we have considerable expertise in investment and asset liability management from the CEO’s background in this field for 20 years, wherein he spent 13 years consulting on risk management practices with banking institutions and advising on billions of mortgage assets managed on a short duration basis. We attempt to control interest rate risk to a low level through the use of interest rate risk management tools, and we utilize excess capital in a low duration and high credit quality investment portfolio of largely mortgage related securities to enhance our earnings. Our goal is to produce a pre-tax return on these investments of 1.25% to 1.50% over the related funding sources. We believe our ability to price loans and investments on an option-adjusted spread basis and then manage the interest rate risk of longer term, fixed rate loans allows us to compete effectively against other institutions, who can not offer these products due to their inability to manage the interest rate risk.
Control Banking Risks
We seek to control banking risks. We have established a disciplined credit evaluation and underwriting environment that emphasizes the assessment of collateral support, cash flows, guarantor support, and stress testing. We manage operational risk through stringent policies, procedures, and controls and interest rate risk through our modern financial and hedging skills.
Performance Measurement
We evaluate our performance based upon the primary measures of return on average equity, which we are trying to maintain in the mid teens, earnings per share growth, and additional franchise value creation through the growth of deposits, loans and wealth management assets.
Profitability Drivers
The factors that we expect to drive our profitability in the future are as follows:
2. Growing our non-costing consumer and commercial deposits and continuing to change the mix of deposits to less time based certificates of deposit. This strategy is expected to lower our deposit cost and increase our net interest margin. We have emphasized the development of low cost business accounts and our full-service, free checking and money market accounts for consumers. As such, we have increased these accounts from 16% to 29% of deposits from December 31, 2000 to December 31, 2004.
3. Diversifying and growing our banking fee income through existing and new fee income sources such as our overdraft protection program and other deposit fees, loan fee income from mortgage banking, prepayment penalty fees and other loan fees, Harrington Wealth Management trust and investment fees, and other retail banking fees.
The following chart shows the comparison of banking fee income sources for 2004, 2003 and 2002.
Over the last three years, we have increased our recurring deposit and retail banking fee income and Harrington Wealth Management fees. However, mortgage brokerage and prepayment penalty fees have been very volatile. In 2003, these fees were at record levels due to the unprecedented decline in interest rates and the surge of mortgage refinancing activity. Although we will continue to provide mortgage brokerage services, we are emphasizing purchase mortgage originations though our banking platform.
4. Achieving a high level of performance on our investment portfolio by earning a pre-tax total return over one month LIBOR of approximately 1.25% to 1.50% per annum. With our skills in investment and risk management, we utilize excess equity capital by investing in a high credit quality, mortgage and related securities portfolio managed to a short duration of three to six months. From 2001 to 2004, the investment portfolio’s performance has exceeded our goals and has contributed to our record profit performance. The chart below illustrates that the total excess return of the investment portfolio (the total return over one month LIBOR) over the last five years with the net returns exceeding 2.0% for the last four years and our goal of 1.25% to 1.50%.
5. Controlling interest rate risk of the institution and seeking high credit quality of the loan and investment portfolios. The company maintains rigorous loan underwriting standards and credit risk management and review process. As such, non-performing asset levels have been low with corresponding low loan charge-offs.
Together, we believe these factors will contribute to more consistent and growing profitability. The effect of these factors on our financial results is discussed further in the following sections.
Critical Accounting Policies
General. The following discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, and the notes thereto, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable in the circumstances; however, actual results may differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods.
The financial information contained in our consolidated financial statements is, to a significant extent, based on approximate measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when recognizing income or expense, recovering an asset or relieving a liability. We use historical loss factors to determine the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. We also calculate the fair value of our interest rate contracts and securities based on market prices and the expected useful lives of our depreciable assets. We enter into interest rate contracts that are classified as trading account assets or to accommodate our own risk management purposes. The interest rate contracts are generally interest swaps, caps, floors and futures contracts, although we could enter into other types of interest rate contracts. We value these contracts at fair value, using readily available, and market quoted prices. We have not historically entered into derivative contracts, which relate to credit, equity, commodity, energy or weather-related indices. Generally accepted accounting principles themselves may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. As of December 31, 2004, we have not created any special purpose entities to securitize assets or to obtain off-balance sheet funding. Although we have sold loans in past years, those loans have been sold to third parties without recourse, subject to customary representations and warranties.
Allowance for loan losses. The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two principles of accounting: (i) Statement of Financial Accounting Standards, or SFAS, No. 5, “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and estimable; and (ii) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures,” which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Our allowance for loan losses has four components: (i) an allocated allowance for specifically identified problem loans, (ii) a formula allowance for non-homogenous loans, (iii) an allocated allowance for large groups of smaller balance homogenous loans and (iv) an unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a model based on historical losses as an indicator of future losses and as a result could differ from the losses incurred in the future; however, since this history is updated with the most recent loss information, the differences that might otherwise occur may be mitigated. The specific allowance uses various techniques to arrive at an estimate of loss. Historical loss information, discounted cash flows, fair market value of collateral and secondary market information are all used to estimate those losses. The use of these values is inherently subjective and our actual losses could be greater or less than the estimates. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose
impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowances.
Trading and Investment Portfolio. Substantially all of our securities are classified as available for sale securities and, pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 115, are reported at fair value with unrealized gains and losses included in stockholders’ equity. We invest in a portfolio of mortgage-backed and related securities, interest rate contracts, U.S. Government agency securities and, to a much lesser extent, equity securities. The Company has also entered into various total return swaps in an effort to enhance income, where cash flows are based on the level and changes in the yield spread on investment grade commercial mortgage backed security indexes relative to similar duration LIBOR swap rates. These swaps do not
qualify for hedge accounting treatment and are included in the trading account assets and are reported at fair value with realized and unrealized gains and losses on these instruments recognized in income (loss) from trading account assets, pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 115.
Hedging Activity. Accounting for Derivative Instruments and Hedging Activities was implemented on January 1, 2001. SFAS No. 133 requires that an entity recognize all interest rate contracts as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. If certain conditions are met, an interest rate contract may be specifically designated as a fair value hedge, a cash flow hedge, or a hedge of foreign currency exposure. The accounting for changes in the fair value of an interest rate contract (that is, gains and losses) depends on the intended use of the interest rate contract and the resulting designation. To qualify for hedge accounting, the Company must show that, at the inception of the interest rate contracts, and on an ongoing basis, the changes in the fair value of the interest rate contracts are expected to be highly effective in offsetting related changes in the cash flows of the hedged liabilities. The Company has entered into various interest rate swaps for the purpose of hedging certain of its short-term liabilities. These interest rate swaps qualify for hedge accounting. Accordingly, the effective portion of the accumulated change in the fair value of the cash flow hedges is recorded in a separate component of stockholders’ equity, net of tax, while the ineffective portion is recognized in earnings immediately.
Results of Operations
Summary of Earnings. We reported net income for the year ended December 31, 2004 of $8.2 million, compared to $7.4 million and $5.0 million for the years ended December 31, 2003 and 2002. Our net income improved by $796 thousand or 10.7% during 2004 as compared to 2003 and $2.4 million or 46.9% in 2003 as compared to 2002. On a diluted earnings per share basis, we earned $1.46, $1.36, and $1.15 for the years ended December 31, 2004, 2003 and 2002, respectively.
The Company’s earnings performance continues to be driven by growth in net interest income from relatively stable margins and loan and investment portfolio growth, banking fee income, trading profits from our investment activities, and operating expense control relative to our planned expansion of banking offices.
Net Interest Income. Net interest income is determined by our interest rate margin, which is the difference between the yields earned on our interest-earning assets and the rates paid on our interest-bearing liabilities and the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income increased by $3.6 million or 14.1% to $28.9 million during the year ended December 31, 2004 over 2003. The increase in net interest income is partly due to a $156.6 million or 18.4% increase in the average balance of interest-earning assets, while the interest rate margin decreased slightly by 14 basis points to 2.93% for 2004 from 3.07% for 2003. The decline in net interest margin reflects the slight lag in the repricing of floating rate borrowings and floating rate loans and hedges, and the prepayment of higher rate loans. We believe our hedging activities will result in our maintaining relatively stable margins over
time (refer to the Asset and Liability Management section of this discussion for a detailed discussion of what our strategies are for hedging of interest rate exposure and why we believe that our management of interest rate fluctuations give us a competitive advantage over other financial institutions).
Net interest income increased by $4.2 million or 19.6% to $25.3 million during the year ended December 31, 2003 over 2002. The increase is partly due to a $164.3 million or 23.9% increase in the average balance of interest-earning assets, while the interest rate margin decreased slightly by 7 basis points to 3.07% for 2003 from 3.14% for 2002. The decline in net interest margin reflects the growth in lower margin investment securities and the lag-time in the repricing of assets versus liabilities.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table sets forth, for the periods indicated, information regarding (i) the total dollar amount of interest income from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rate; (iii) net interest income; (iv) interest rate spread; and (v) net interest margin. No tax equivalent adjustments were made during the periods presented. Information is based on average daily balances during the indicated periods, except noninterest-bearing deposits information is based on average balances for all periods.
(1)
Includes non-accrual loans. Interest income includes fees earned on loans originated.
(2)
Consists of securities classified as available for sale and held to maturity and trading account assets.
(3)
Consists of cash and due from banks and federal funds sold.
(4)
Interest on FHLB advances is net of hedging costs. We use interest rate swaps to hedge the short-term repricing characteristics of our floating-rate FHLB advances. See “-Asset and Liability Management.”
(5)
Consists of a note payable under a revolving line of credit and the capital trust offering.
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on our net interest income. Information is provided with respect to (i) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume); (ii) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); and (iii) changes in rate/volume (change in rate multiplied by change in volume).
(1)
Consists of securities classified as available for sale and held to maturity and trading account assets.
(2)
Consists of cash and due from banks and federal funds sold.
(3)
Interest on FHLB advances is net of cash flow hedging costs. We use interest rate swaps to hedge the short-term repricing characteristics of our floating-rate FHLB advances. See “-Asset and Liability Management.”
(4)
Consists of a note payable under a revolving line of credit and the capital trust offering.
Interest Income. Total interest income increased by $5.8 million or 12.6% for 2004 over 2003 from $46.4 million to $52.3 million. The increase in the average balance of earning assets offset a decline in the average yield earned on our loan portfolio and securities portfolio (including trading account assets), which declined by 32 and 10 basis points, respectively, over the period, to 6.44% and 3.68%, respectively. Total interest income increased by $2.9 million or 6.8% from $43.5 million to $46.4 million in 2003 over 2002. The increase in the average balance of earning assets more than offset a decline in the average yield earned on our loan portfolio and securities portfolio (including trading account assets), which declined by 56 and 108 basis points, respectively, over the period, to 6.76% and 3.78%, respectively. The Federal Reserve Board maintained a low federal funds rate during 2003, and since a substantial portion of our earning assets reprice with the general level of interest rates, our average yield on earning assets declined.
Interest Expense. Total interest expense increased by $2.4 million or 11.9% during the year ended December 31, 2004 over 2003, from $20.3 million to $22.7 million. During 2004, our average interest-bearing liabilities increased by $145.7 million or 18.3%, due primarily to the increase in borrowings and repurchase agreements to support our growth and the growth in deposits in new offices in Ventura, California and Overland Park, Kansas which collected $45.4 million in deposits during 2004 while the other offices lost $17.9 million in deposits. The average cost of interest bearing liabilities declined from 2.55% to 2.41% as deposits continued to reprice lower.
Total interest expense decreased by $1.6 million or 7.4% from $21.9 million to $20.3 million in 2003 over 2002. During 2003, our average interest-bearing liabilities increased by $142.5 million or 21.8%, due primarily to the increase in borrowings to support our growth and the new deposits in our office in Scottsdale, Arizona, which collected $31.3 million in deposits during 2003 while the other offices gained $14.1 million in deposits. The cost of interest bearing liabilities declined from 3.36% to 2.55% as market interest rates declined markedly in 2003.
Provision for Loan Losses. We established provisions for loan losses of $650,000, $790,000, and $391,000 during the years ended December 31, 2004, 2003, and 2002, respectively. Provisions for loan losses are charged to income to bring our allowance for loan losses to a level deemed appropriate by management. For more detailed information regarding the methodology used to maintain the allowance for loan losses, refer to the Asset Quality section in Item 1 - Business. Our provision for 2004 was affected by higher levels of commercial real estate and commercial and industrial loans.
Other Income. Total other income has fluctuated over the periods presented, due to our management of our securities portfolio, which is intended to enhance both net interest income as well as other income by capitalizing on changes in option-adjusted spreads. Other income includes net gains and losses from our trading activities, extinguishment of debt and other gains and losses plus banking fee income.
The following table sets forth information regarding other income for the periods shown.
(1)
Consists primarily of banking fee income such as service charges and fees on deposit accounts, fees from our trust and investment management services, and other miscellaneous fees.
For the year ended December 31, 2004, total other income amounted to $4.2 million, a decrease of $1.0 million or 19.6% over the prior year. The decrease in other income in 2004 was due primarily to the decline in banking fee income related to mortgage brokerage fees of $942,000 and a decrease of prepayment penalties on commercial and multi-family loans of $334,000. Prepayment penalties and refinancings were lower in 2004 as rates increased over the lows in 2003, and refinancing activity slowed markedly. Banking fee income did improve for the collection of deposit fees, which increased by $155,000 or 18.0%, and HWM fees increased by $158,000 or 34.6% when comparing 2004 to 2003. The $1.3 million of trading gains in 2004 were due to the gains on the CMBS and asset-backed total return swaps of $603,000 and the realized gain on sale of mortgage securities of $690,000, which was partially offset by losses of $189,000 related to early extinguishment of long-term, high-interest FHLB debt with a similar duration to the securities sold.
For the year ended December 31, 2003, total other income amounted to $5.2 million, an increase of $3.0 million or 140.7% over the prior year. The increase in other income was due primarily to the increase in banking fee income related to mortgage brokerage fees of $2.0 million and prepayment penalties on commercial and multi-family loans of $591,000. Banking fee income also improved in the collection of deposit fees, which increased by $251,000 or 41.0%, and HWM fees increased by $44,000 or 10.7%, when comparing 2003 to 2002. The $2.6 million of net trading gain in 2003 were due to the gains on the CMBS total return swaps and fixed-rate mortgage securities, which was partially offset by losses of $1.6 million related to early extinguishment of long-term, high-interest FHLB debt with a similar duration of the securities sold.
Other Expenses. The following table sets forth certain information regarding other expenses for the periods shown.
(1)
Consists primarily of professional fees, and other miscellaneous expenses.
Total other expenses increased by $1.6 million or 8.8% to 19.4 million during the year ended December 31, 2004 over the prior year ended December 31, 2003, and increased by $3.1 million to $17.8 million or 21.0% during the year ended December 31, 2003 over 2002. The growth in other operating expenses has been largely attributed to the expenses required to support the growth of our banking offices. Over the last year, we have opened banking offices in Ventura, California and in Overland Park, Kansas. We have also made expenditures in administration and systems to support its growth and have increased consulting and internal support to implement new corporate governance regulations, such as the Sarbanes Oxley Act (SOA). Included in other expenses for 2004 $185,000 of additional consulting expenses related to the implementation of SOA.
The principal category of our other expenses is salaries and employee benefits, which increased by $436,000 or 4.3% during the year ended December 31, 2004, as compared to the prior year. Salaries and employee benefits increased by $2.2 million or 28.5% during 2003. The increases during periods ended December 31, 2004 and 2003 over the prior years were primarily due to the hiring of additional employees in connection with the opening of new branch offices in Overland Park, Kansas in the end of 2003 and the Ventura, California location in the middle of 2004, together with our general growth in operations. In 2003, commission expense to loan officers increased by $746,000 or 66.2% in 2003 over 2002 due to the strong loan origination volumes in 2003.
Premises and equipment expenses increased by $431,000 or 15.8% during the year ended December 31, 2004, as compared to the prior year, and increased by $525,000 or 23.9% during 2003. The increase in premises and equipment expense during the year ended December 31, 2004 and 2003 was primarily due to the banking office openings and general growth in operations.
We have contracted with Smith Breeden to provide investment advisory services and interest rate risk analysis. Certain of our directors are also principals of Smith Breeden. The consulting fees paid by us to Smith Breeden during the years ended December 31, 2004, 2003 and 2002, amounted to $412,000, $365,000 and $325,000.
The increases in miscellaneous other expenses since 2002, primarily reflects our growth in our number of offices over the periods as well as expenses associated with our public company status and new corporate governance regulations.
Income Taxes. We incurred income tax expense of $5.4 million, $5.3 million and $3.5 million during the years ended December 31, 2004, 2003 and 2002. The amount of our income tax expense is a function of the amount of our income before income taxes during the periods presented. Our effective tax rate amounted to 39.8%, 41.5% and 41. 2%, the years ended December 31, 2004, 2003 and 2002. The company’s overall tax rate declined in 2004 due to the apportioning of state income tax to states with lower income tax rates.
Changes in Financial Condition
General. At December 31, 2004, our total assets amounted to $1.1 billion, compared to $974.8 million at December 31, 2003. The increase in total assets was primarily attributable to an increase in net loans receivable and securities classified as available for sale. At December 31, 2004, our total liabilities amounted to $1.0 billion, compared to $926.7 million at December 31, 2003.
Cash and Cash Equivalents. Cash and cash equivalents, consisting of cash and due from banks and federal funds sold, amounted to $13.2 million at December 31, 2004, and $22.9 million at December 31, 2003. We manage our cash and cash equivalents based upon our operating, investing and financing activities. We generally attempt to invest our excess liquidity into higher yielding assets such as loans or securities. See “Liquidity and Capital Resources.”
Securities. In order to limit our credit risk exposure and to earn an incremental income, we maintain a significant portion of our assets in various types of securities, consisting primarily of investment grade mortgage-backed securities and CMOs, and REMICs, which we collectively refer to as “mortgage-backed and related securities.” Our securities portfolio also includes, to a lesser extent, U.S. Government securities. At December 31, 2004, our securities portfolio, which is comprised of securities classified as available for sale and held to maturity, amounted to $431.3 million or 39.9% of our total assets. Mortgage-backed and related securities, which are the principal components of our securities portfolio, often carry lower yields than traditional mortgage loans. These types of securities, however, generally increase the quality of our assets by virtue of the securities’ underlying insurance or guarantees, require less capital under risk-based regulatory capital requirements than non-insured or non-guaranteed mortgage loans, are more liquid than individual mortgage loans, which enhances our ability to actively manage our portfolio, and may be used to collateralize borrowings or other obligations we incur.
Securities classified as available for sale, which consist of mortgage-backed and related securities, amounted to $431.2 million at December 31, 2004 and $398.7 million at December 31, 2003. The $32.5 million or 8.2% increase during the year ended December 31, 2004 was primarily due to favorable market opportunities for these securities. Securities classified as held to maturity, consisting of mortgage-backed and U.S. Government and agency securities, remained relatively stable at the end of the periods presented, amounting to $93,000 at December 31, 2004 and $222,000 at December 31, 2003. The decrease of $129,000 was due primarily to the maturity of a government security.
Trading Account Assets. We also classify certain mortgage-backed and related securities and equity securities as trading securities in accordance with SFAS No. 115 and enter into interest rate contracts that do not qualify for hedge accounting treatment. These assets are collectively referred to as trading account assets. Trading account assets amounted to $1.0 million at December 31, 2004 and $2.1 million at December 31, 2003. At December 31, 2004, of the $1.0 million of trading account assets, $388,000 consisted of mortgage- backed securities, $581,000 consisted of equity securities and $77,000 of unrealized gains associated with the $120.0 million notional amount of CMBS total return swaps. At December 31, 2003, of the $2.1 million of
trading account assets, $1.5 million consisted of mortgage-backed and related securities, $450,000 consisted of equity securities and $166,000 of unrealized gains associated with the $100.0 million notional amount of CMBS total return swaps.
Loans Receivable. At December 31, 2004, loans receivable, net of our allowance for loan losses, amounted to $598.4 million or 55.3% of total assets, as compared to $518.5 million or 53.2% of total assets at December 31, 2003. The $79.9 million or 15.4% increase in the loan portfolio during 2004, and the related loan mix change to higher spread earning loans was due to our emphasis on commercial real estate, commercial and industrial, and multifamily mortgage loans and Los Padres Bank’s strategy to broker for third parties substantially all new single-family mortgage originations in order to generate fee income.
Allowance for Loan Losses. At December 31, 2004, our allowance for loan losses totaled $5.2 million, compared to $4.6 million at December 31, 2003. At December 31, 2004, our allowance for loan losses represented approximately 0.87% of the total loan portfolio as compared to 0.88% at December 31, 2003. The increase in our allowance for loan losses during the periods reflects the growth of our loan portfolio and the mix change to business and commercial mortgage loans. We establish reserves for loan losses based on the nature of the risk of the comparable historical loss exposure.
Prepaid expenses and other assets. At December 31, 2004, prepaid expenses and other assets amounted to $3.7 million, as compared to $1.9 million as of December 31, 2003. The $1.9 million or 100.6% increase in prepaid expenses and other assets since December 31, 2003 reflected the increase in accounts receivable and prepaid expenses due to the additional banking office locations and expanded operations of the Company.
Deposits. At December 31, 2004, deposits totaled $598.2 million, as compared to $570.7 million as of December 31, 2003. The $27.5 million or 4.8% increase in total deposits during the year ended December 31, 2003 was due to the deposit growth of $45.3 million in our new banking offices in Ventura, California and Overland Park, Kansas, while we lost deposits in other offices as we decided not to match competition on high cost, rate sensitive deposits above our borrowing cost. We attempt to manage our overall funding costs by evaluating all potential sources of funds, including retail deposits and short and long-term borrowings, and identifying which particular source will result in an all-in cost to us that meets our funding benchmark. At the same time, Los Padres Bank has attempted to price the deposits offered through its branch system in order to promote retail deposit growth and offer a wide array of deposit products to satisfy its customers. In addition to providing a cost-efficient funding source, these retail deposits provide a source of fee income and the ability to cross-sell other products or services.
Borrowings. Advances from the FHLB of San Francisco amounted to $316.0 million at December 31, 2004 and $262.5 million at December 31, 2003. The increase in FHLB advances in 2004 was due to our increased utilization of such borrowings to fund our growth in loans and securities. At December 31, 2004, our FHLB advances had a weighted average interest rate of 2.54%, as compared to 1.49% at December 31, 2003. Our outstanding FHLB advances have maturities ranging from 2005 to 2010.
Trust preferred securities amounted to $25.8 at December 31, 2004 compared to $15.5 million at December 31, 2003. In September 2004, our newly created special purpose business trust, Harrington West Capital Trust II, issued $10.3 million of trust-preferred securities. The trust preferred securities bear an interest rate of three month LIBOR plus 1.90%, will mature on October 7, 2034 and have a five-year call feature. A portion of the proceeds from the offering were used to downstream capital to Los Padres Bank to support its growth in operations and the remaining funds will be used to support future expansion opportunities. In September 2003, we created a special purpose business trust, Harrington West Capital Trust I and issued $15.5 million of trust-preferred securities. The trust preferred securities issued in September 2003 bear an interest rate of three month LIBOR plus 2.85%, will mature on October 8, 2033 and have a five-
year call feature. A portion of the proceeds from the offering were used to pay down our outstanding line of credit.
Stockholders’ Equity. Our stockholders’ equity amounted to $52.7 million at December 31, 2004, an increase of $4.6 million from December 31, 2003. Net income earned during 2004 largely contributed to the increase in stockholder’s equity. Moreover, our stockholders’ equity was also affected by unrealized gains and losses on securities and interest rate contracts, dividends paid on our common stock, and the exercise of stock options.
Asset and Liability Management
In general, savings institutions are negatively affected by an increase in interest rates to the extent that interest-bearing liabilities mature or reprice more rapidly than interest-earning assets. The lending activities of savings institutions have historically emphasized the origination of long-term, fixed-rate loans secured by single-family residences, and the primary source of funds of such institutions has been deposits, which largely mature or are subject to repricing within a shorter period of time. This factor has historically caused the income and market value of portfolio equity (“MVPE”) of savings institutions to be more volatile than other financial institutions.
MVPE is defined as the net present value of the cash flows from an institution’s existing assets, liabilities and off-balance sheet instruments. The MVPE is estimated by valuing our assets, liabilities and off-balance sheet instruments under various interest rate scenarios. The extent to which assets gain or lose value in relation to the gains or losses of liabilities determines the appreciation or depreciation in equity on a market value basis. MVPE analysis is intended to evaluate the impact of immediate and sustained interest rate shifts of the current yield curve upon the market value of the current balance sheet. While having liabilities that reprice more frequently than assets is generally beneficial to net interest income and MVPE in times of declining interest rates, such an asset/liability mismatch is generally detrimental during periods of rising interest rates.
Our management believes that its asset and liability management strategy, as discussed below, provides us with a competitive advantage over other financial institutions. We believe that our ability to hedge our interest rate exposure through the use of various interest rate contracts provides us with the flexibility to acquire loans structured to meet our customer’s preferences and investments that provide attractive net risk-adjusted spreads, regardless of whether the customer’s loan or our investment is fixed-rate or adjustable-rate or short-term or long-term. Similarly, we can choose a cost-effective source of funds and subsequently engage in an interest rate swap or other hedging transaction so that the interest rate sensitivities of our interest-earning assets and interest-bearing liabilities are more closely matched.
Our asset and liability management strategy is formulated and monitored by the board of directors of Los Padres Bank. The board of director’s written policies and procedures are implemented by the Asset and Liability Committee of Los Padres Bank (“ALCO”), which is comprised of Los Padres Bank’s chief executive officer, president/chief financial officer, principal accounting officer, director of financial reporting and four non-employee directors of Los Padres Bank. The ALCO meets at least eight times a year to review the sensitivity of Los Padres Bank’s assets and liabilities to interest rate changes, investment opportunities, the performance of the investment portfolios, and prior purchase and sale activity of securities. The ALCO also provides guidance to management on reducing interest rate risk and on investment strategy and retail pricing and funding decisions with respect to Los Padres Bank’s overall asset and liability composition. The ALCO reviews Los Padres Bank’s liquidity, cash flow needs, interest rate sensitivity of investments, deposits and borrowings, core deposit activity, current market conditions and interest rates on both a local and national level in connection with fulfilling its responsibilities.
Smith Breeden provides consulting services to us regarding, among other things, the selection of our investments and borrowings, the pricing of loans and deposits, and the use of various interest rate contracts to reduce interest rate risk. Smith Breeden is a consulting firm, which renders investment advice and asset and liability management service to financial institutions and management services to corporations, endowments and funds. Two of our directors are minority stockholders in and one is an officer of Smith Breeden.
The ALCO regularly reviews interest rate risk by utilizing analyses prepared by Smith Breeden with respect to the impact of alternative interest rate scenarios on net interest income and on Los Padres Bank’s MVPE. The ALCO also reviews analyses prepared by Smith Breeden concerning the impact of changing market volatility, prepayment forecast error, and changes in option-adjusted spreads and non-parallel yield curve shifts.
In the absence of our hedging activities, our MVPE would decline as a result of a general increase in market rates of interest. This decline would be due to the market values of our assets being more sensitive to interest rate fluctuations than are the market values of our liabilities due to our investment in and origination of generally longer-term assets which are funded with shorter-term liabilities. Consequently, the elasticity (i.e., the change in the market value of an asset or liability as a result of a change in interest rates) of our assets is greater than the elasticity of our liabilities.
Accordingly, the primary goal of our asset and liability management policy is to effectively increase the elasticity of our liabilities and/or effectively contract the elasticity of our assets so that the respective elasticities are matched as closely as possible. This elasticity adjustment can be accomplished internally by restructuring our balance sheet or externally by adjusting the elasticities of our assets and/or liabilities through the use of interest rate contracts. Our strategy is to hedge either internally through the use of longer-term certificates of deposit or less sensitive transaction deposits and FHLB advances or externally through the use of various interest rate contracts.
External hedging generally involves the use of interest rate swaps, caps, floors, options and futures. The notional amount of interest rate contracts represents the underlying amount on which periodic cash flows are calculated and exchanged between counterparties. However, this notional amount does not necessarily represent the principal amount of securities, which would effectively be hedged by that interest rate contract.
In selecting the type and amount of interest rate contract to utilize, we compare the elasticity of a particular contract to that of the securities to be hedged. An interest rate contract with the appropriate offsetting elasticity could have a notional amount much greater than the face amount of the securities being hedged.
We adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, on January 1, 2001. SFAS No. 133 requires that an entity recognize all interest rate contracts as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. If certain conditions are met, an interest rate contract may be specifically designated as a fair value hedge, a cash flow hedge, or a hedge of foreign currency exposure. The accounting for changes in the fair value of an interest rate contract (that is, gains and losses) depends on the intended use of the interest rate contract and the resulting designation. To qualify for hedge accounting, we must show that, at the inception of the interest rate contracts and on an ongoing basis, the changes in the fair value of the interest rate contracts are expected to be highly effective in offsetting related changes in the cash flows of the hedged liabilities. We have entered into various interest rate swaps for the purpose of hedging certain of our short-term liabilities. These interest rate swaps qualify for hedge accounting. Accordingly, the effective portion of the accumulated change in the fair value of the cash flow hedges is recorded in a separate component of stockholders’ equity, net of tax, while the ineffective portion is recognized in earnings immediately. We have also entered into various interest rate swaps which hedge a portion of our securities portfolio. These swaps do not qualify for hedge accounting
treatment and are included in the trading account assets and are reported at fair value with realized and unrealized gains and losses on these instruments recognized in income (loss) from trading account assets.
An interest rate swap is an agreement where one party agrees to pay a fixed rate of interest on a notional principal amount to a second party in exchange for receiving from the second party a variable rate of interest on the same notional amount for a predetermined period of time. No actual assets are exchanged in a swap of this type and interest payments are generally netted. These swaps are generally utilized by us to synthetically convert floating-rate deposits and borrowings into fixed-rate liabilities or convert fixed-rate assets into adjustable-rate instruments, in either case without having to sell or transfer the underlying liabilities or assets.
At December 31, 2004, we held interest rate swaps, which are utilized to hedge liabilities and which qualify for hedge accounting pursuant to SFAS No. 133 and are included in other assets or other liabilities. These swap agreements had an aggregate notional amount of $152.0 million and maturities from January 2006 to October 2014. With respect to these agreements, we make fixed-rate payments ranging from 2.7% to 6.3% and receive payments based upon three-month LIBOR. These fixed-pay swaps are used to effectively modify the interest rate sensitivity of a portion of Los Padres Bank’s short-term LIBOR correlated borrowings which include short-term deposits, securities sold under agreements to repurchase and FHLB advances.
The interest expense relating to these swaps was $4.1 million, $3.7 million, and $2.0 million during the years ended December 31, 2004, 2003 and 2002, respectively. This expense is included in interest expense on FHLB advances in our consolidated statements of earnings. The approximate market value of these interest rate swaps was an unrealized loss of $4.3 million and $5.9 million as of December 31, 2004 and 2003, respectively. Effective as of January 1, 2001, these gains and losses are reflected as a separate component in stockholders’ equity. Prior to such date, these gains and losses were not reflected on our statement of financial condition.
At December 31, 2004, we did not hold any interest rate swaps as trading account assets, except for certain interest rate swaps that we utilize in order to enhance our returns and not for the purpose of interest rate risk management.
An interest rate cap or an interest rate floor consists of a guarantee given by the issuer (i.e., a broker) to the purchaser (i.e., us), in exchange for the payment of a premium. This guarantee states that if interest rates rise above (in the case of a cap) or fall below (in the case of a floor) a specified rate on a specified interest rate index, the issuer will pay to the purchaser the difference between the then current market rate and the specified rate on a notional principal amount. No funds are actually borrowed or repaid.
At December 31, 2004, we did not have any interest rate caps or floors which qualify for hedge accounting pursuant to SFAS No. 133. Such caps are sometimes used to effectively modify the interest rate sensitivity of a portion of Los Padres Bank’s short-term LIBOR correlated liabilities, which include short-term deposits, securities sold under agreements to repurchase and FHLB advances.
Interest rate futures are commitments to either purchase or sell designated instruments at a future date for a specified price. Futures contracts are generally traded on an exchange are marked-to-market daily and are subject to initial and maintenance margin requirements. We generally use 91-day Eurodollar certificates of deposit contracts (“Eurodollar futures contracts”) which are priced off LIBOR as well as Treasury Note and Bond futures contracts. We will from time to time agree to sell a specified number of contracts at a specified date. To close out a contract, we will enter into an offsetting position to the original transaction.
If interest rates rise, the value of our short futures positions increase. Consequently, sales of futures contracts serve as a hedge against rising interest rates. At December 31, 2004 and 2003, we did not have any
futures contracts. We had total losses on our futures contracts of $97,000 for the year ended December 31, 2002.
Options are contracts, which grant the purchaser the right to buy or sell the underlying asset by a certain date for a specified price. Generally, we will purchase options on financial futures to hedge the changing elasticity exhibited by mortgage loans and mortgage-backed securities. The changing elasticity results from the ability of a borrower to prepay a mortgage or caps and floors on the underlying loans. As market interest rates decline, borrowers are more likely to prepay their mortgages, shortening the elasticity of the mortgages. Consequently, where interest rates are declining, the value of mortgage loans or mortgage-backed securities will increase at a slower rate than would be expected if borrowers did not have the ability to prepay their mortgage.
We are subject to the risk that our counterparties with respect to various interest rate contracts may default at or prior to maturity of a particular instrument. In such a case, we might be unable to recover any unrealized gains with respect to a particular contract. To reduce this potential risk, we generally deal with large, established investment brokerage firms when entering into these transactions. In addition, we have a policy whereby we limit our unsecured exposure to any one counterparty to 25% of Los Padres Bank’s equity during any two-month period and 35% of Los Padres Bank’s equity during any one-month period.
The OTS requires each thrift institution to calculate the estimated change in the institution’s MVPE assuming an instantaneous, parallel shift in the Treasury yield curve of 100 to 300 basis points either up or down in 100 basis point increments. The OTS permits institutions to perform this MVPE analysis using their own internal model based upon reasonable assumptions. Smith Breeden assists us in performing the required calculation of the sensitivity of our market value to changes in interest rates.
In estimating the market value of mortgage loans and mortgage-backed securities, we utilize various prepayment assumptions, which vary, in accordance with historical experience, based upon the term, interest rate and other factors with respect to the underlying loans. At December 31, 2004, these prepayment assumptions varied from 7.2% to 54.3% for fixed-rate mortgages and mortgage-backed securities and varied from 6.9 to 33.0% for adjustable-rate mortgages and mortgage-backed securities.
The following table sets forth at December 31, 2004, the estimated sensitivity of Los Padres Bank’s MVPE to parallel yield curve shifts using our internal market value calculation. The table demonstrates the sensitivity of our assets and liabilities both before and after the inclusion of our interest rate contracts.
The table set forth above does not purport to show the impact of interest rate changes on our equity under generally accepted accounting principles. Market value changes only impact our income statement or the balance sheet to the extent the affected instruments are marked to market, and over the life of the instruments, as an impact on recorded yields.
Liquidity and Capital Resources
Liquidity. The liquidity of Los Padres Bank, a consolidated subsidiary of the Company is monitored closely for regulatory purposes at the Bank level by calculating the ratio of cash, cash equivalents (not committed, pledged or required to liquidate specific liabilities), investments and qualifying mortgage-backed securities to the sum of total deposits plus borrowings payable within one year, was 26.3% at December 31, 2004. At December 31, 2004, Los Padres Bank’s “liquid” assets totaled approximately $161.2 million.
In general, the Bank’s liquidity, represented by cash and cash equivalents, is a product of our operating, investing and financing activities. The Company’s primary sources of internal liquidity consist of deposits, prepayments and maturities of outstanding loans and mortgage-backed and related securities, maturities of short-term investments, sales of mortgage-backed and related securities and funds provided from operations. While scheduled loan and mortgage-backed and related securities amortization and maturing short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Company’s external sources of liquidity consist of borrowings, primarily advances from the FHLB of San Francisco and a revolving line of credit loan facility, which we maintain with two banks. At December 31, 2004, we had $316.0 million in FHLB advances and we had $27.1 million of additional borrowing capacity with the FHLB of San Francisco. At December 31, 2004, our note payable under our revolving line of credit amounted to $0.0 million and we had $15.0 million of additional borrowing capacity under this loan facility.
On September 16, 2004, we entered into an amendment to our credit agreement, which reduced the LIBOR margin range from 2.0% to 3.0% to 1.75% to 2.75%. We pay interest on the outstanding amount of our borrowings from time to time under the credit agreement at an interest rate that adjusts based upon our compliance with certain financial criteria and our selection of an interest rate formula. At our option, the
interest rates per annum applicable to any particular borrowing under the credit agreement is either (1) adjusted LIBOR plus a margin ranging from 1.75% to 2.75% or (2) the prime rate announced from time to time by Harris Trust and Savings Bank minus a margin ranging from 0.5% to 0.0%. The factors that determine the amount of the margin include our core profitability and our non-performing asset ratio. We are currently at the most favorable pricing level under the credit agreement. In each year, we also pay a commitment fee to the lenders equal to 0.25% of the average daily un-drawn portion of the borrowings available to us under the credit agreement for that year. All of the covenants remain in place and are unchanged. Management believes that as of December 31, 2004, it was in compliance with all of such covenants and restrictions and does not anticipate that such covenants and restrictions will limit our operations.
Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally used to pay down short-term borrowings. On a longer-term basis, we maintain a strategy of investing in various mortgage-backed and related securities and loans. We use our sources of funds primarily to meet our ongoing commitments, to pay maturing savings certificates and savings withdrawals, fund loan commitments and maintain a portfolio of mortgage-backed and related securities as well as certain other investments. At December 31, 2004, the total approved loan commitments outstanding amounted to $130.8 million. Certificates of deposit scheduled to mature in one year or less at December 31, 2004 totaled $381.1 million and FHLB borrowings and repurchase agreements that are scheduled to mature within the same period amounted to $317.0 million. Management believes that we have adequate resources to fund all of our commitments and the Company could either adjust the rate of certificates of deposit in order to retain deposits in changing interest rate environments or replace such deposits with advances from the FHLB of San Francisco if it proved to be cost-effective to do so.
A substantial source of our income from which we service our debt, pay our obligations and from which we can pay dividends is the receipt of dividends from Los Padres Bank. The availability of dividends from Los Padres Bank is limited by various statutes and regulations. At December 31, 2004, Los Padres Bank was permitted to pay up to $6.0 million of dividends to us. In order to make such dividend payment, Los Padres Bank is required to provide 30 days advance notice to the OTS, during which time the OTS may object to such dividend payment. It is possible, depending upon the financial condition of Los Padres Bank, and other factors, that the OTS could object to the payment of dividends by Los Padres Bank on the basis that the payment of such dividends is an unsafe or unsound practice. In addition, we are also subject to restrictions on our ability to pay dividends under our revolving loan facility and capital securities financings. In the event Los Padres Bank is unable to pay dividends to us, we may not be able to service our debt, pay our obligations or pay dividends on our common stock.
The Company has a revolving line of credit with a maximum borrowing capacity of $15.0 million with a maturity of September 30, 2007. We anticipate to utilize this line of credit as growth opportunities develop and to provide working capital. At December 31, 2004 and 2003, the Company was not indebted under its revolving line of credit. The Company also has the ability to enter into Trust Preferred Securities to provide working capital to fund our continued expansion.
Capital Resources. Federally insured savings institutions such as Los Padres Bank are required to maintain minimum levels of regulatory capital. Los Padres Bank’s failure to comply could also impact its overall assessment by the OTS in future regulatory examinations, which, if adverse, could also impact its FDIC insurance assessment.
The following table reflects as of December 31, 2004, Los Padres Bank’s actual levels of regulatory capital and the applicable regulatory capital requirements.
Contractual Obligations and Commercial Commitments
The following tables present our contractual obligations and commercial commitments as of December 31, 2004.
(1)
Includes interest expense associated with the commitments for our FHLB Advances, Reverse Repurchase Agreements and Other Debt at the current interest rate.
(1)
Lines of credit with no stated maturity date are included in commitments for less than one year.
Off-Balance Sheet Arrangements
As discussed in the Asset and Liability Management section above, we utilize external hedging transactions to effectively increase the elasticity of our liabilities and/or effectively contract the elasticity of our assets so that the respective elasticities are matched as closely as possible with the use of external hedging. External hedging generally involves the use of interest rate swaps, caps, floors, options and futures, which are off-balance sheet arrangements. We use interest rate swap instruments to effectuate our external hedging strategy. At December 31, 2004, we held interest rate swaps, which are utilized to hedge liabilities and which qualify for hedge accounting pursuant to SFAS No. 133 and are included in other assets or other
liabilities. These swap agreements had an aggregate notional amount of $152.0 million and maturities from January 2006 to October 2014. The notional amount of interest rate contracts represents the underlying amount on which periodic cash flows are calculated and exchanged between counterparties. However, this notional amount does not necessarily represent the principal amount of securities, which would effectively be hedged by that interest rate contract. Our interest rate swap instruments require that we make fixed-rate payments ranging from 2.7% to 6.3% and receive payments based upon three-month LIBOR. These fixed-pay swaps are used to effectively modify the interest rate sensitivity of a portion of Los Padres Bank’s short-term LIBOR correlated borrowings which include short-term deposits, securities sold under agreements to repurchase and FHLB advances.
At December 31, 2004 and 2003, the interest rate swaps listed below are hedging the interest rate risk of cash flows associated with short-term FHLB advances and certificates of deposit with terms between six and twelve months. These swaps qualify as cash flow hedges.
The following table sets forth the maturity distribution and weighted-average interest rates of the interest rate swaps used to limit the repricing risk of deposits and short-term borrowings as of December 31, 2004:
At December 31, 2004, we did not hold any interest rate swaps as trading account assets, except for certain interest rate swaps that we utilize in order to enhance our returns and not for the purpose of interest rate risk management.
The following table sets forth the interest rate swaps held to enhance our returns.
The Interest Rate Agreements used have an active secondary market and are included in trading account assets at fair value. The realized and unrealized gains and losses on these instruments are recognized immediately in other income.
Los Padres Bank’s exposure to credit risk from derivative financial instruments is represented by the fair value of the instruments. Credit risk amounts represent the replacement cost Los Padres Bank could incur should counterparties with contracts in a gain position completely fail to perform under the terms of those contracts. Counterparties are subject to the credit approval and credit monitoring policies and procedures of Los Padres Bank. Los Padres Bank limits its credit exposure by entering into International Swap Dealer Association (“ISDA”) Master Agreements with each counterparty. ISDA Master Agreements set the legal framework for transactions with counterparties in over the counter derivative markets. Los Padres Bank only deals with counterparties that are investment grade.
Los Padres Bank has unfunded loan commitments and letters of credit which are also considered off-balance sheet arrangements. A summary of these commitments is presented in the Contractual Obligations and Commercial Commitments section above.
Inflation and Changing Prices
Our consolidated financial statements and related data presented in this prospectus have been prepared in accordance with accounting principles generally accepted in the U.S., which require the measurement of financial position and operating results in terms of historical dollars (except with respect to securities which are carried at market value), without considering changes in the relative purchasing power of
money over time due to inflation. Unlike most industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services.
Recent Accounting Pronouncements
In December 2003, the FASB issued FASB Interpretation No. 46R (“FIN 46R”) which revised the January 2003 Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. The revision clarifies how variable interest entities should be identified and evaluated for consolidation purposes. The Company adopted FIN46R to its interests in special purpose entities (“SPEs”) as of December 31, 2003. Adoption of this new method of accounting for SPEs did not and is not expected to have a material impact on the Company’s consolidated results of operation and financial position.
In December 2003, the Accounting Standards Executive Committee of the AICPA issued Statement of Position No. 03-3 (“SOP 03-3”), Accounting for Certain Loans of Debt Securities Acquired in a Transfer. SOP 03-3 addresses the accounting for differences between contractual cash flows and the cash flows expected to be collected from purchased loans or debt securities if those differences are attributable, in part, to credit quality, SOP 03-3 requires purchased loans and debt securities to be recorded initially at fair value based on the present value of the cash flows expected to be collected with no carryover of any valuation allowance previously recognized by the seller. Interest income should be recognized based on the effective yield from the cash flows to be collected. To the extent that the purchased loans or debt securities experience subsequent deterioration in credit quality, a valuation allowance would be established for any additional cash flows that are not expected to be received. However, if more cash flows subsequently are expected to be received than originally estimated, the effective yield would be adjusted on a prospective basis. SOP 03-3 will be effective for loans and debt securities acquired after December 31, 2004. Management does not expect the adoption of this statement to have a material impact on the Company’s consolidated results of operation and financial position.
In March 2004, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 105 (“SAB 105”) was issued, which provides guidance regarding loan commitments that are accounted for as derivative instruments under FASB No. 133 (as amended), Accounting for Derivative Instruments and Hedging Activities. In SAB 105, the SEC ruled that the amount of the expected servicing rights should not be included when determining the fair value of derivative interest rate lock commitments. This guidance must be applied to rate locks initiated after March 31, 2004. Management does not anticipate the issuance of this Bulletin to have a material impact on the Company’s consolidated results of operation and financial position.
In March 2004, the Emerging Issues Task Force (“EITF”) reached consensus on the guidance provided in EITF Issue No. 03-1, The Meaning of Other Than Temporary Impairment and its Application to Certain Investments (“EITF 03-1”), as applicable to debt and equity securities that are within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and equity securities that are accounted for using the cost method specified in Accounting Policy Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. An investment is impaired if the fair value of the investment is less than its cost. EITF 03-1 outlines that an impairment would be considered other-than-temporary unless: a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment, and b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. Although not presumptive, a pattern of selling investments prior to the forecasted recovery of fair value may call into question the investor’s intent. In addition, the severity and duration of the impairment should also be considered in determining whether the impairment is other-than-temporary.
In September 2004, the FASB issued a proposed Board-directed FASB Staff Position, FSP EITF Issue 03-1-a, Implementation Guidance of the Application of Paragraph 16 of EITF Issue No. 03-1. The proposed FSP would provide implementation guidance with respect to debt securities that are impaired solely due to interest rates and/or sector spreads and analyzed for other-than-temporary impairment under paragraph 16 of Issue 03-1. The Board also issued FSP EITF Issue 03-1-b which delays the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-1. The delay does not suspend the requirement to recognize other-than temporary impairments as required by existing authoritative literature. Adoption of this standard may cause the Company to recognize under current guidance or to recognize such losses in earlier periods, especially those due to increases in interest rates. Since fluctuations in fair value for available-for-sale securities are already recorded in accumulative other comprehensive (income) loss, adoption of this standard is not expected to have a significant impact on stockholder’s equity.
In December 2004, the FASB revised SFAS No. 123 (R) (“SFAS 123 (R)”), Share Based Payment. SFAS 123 (R) replaced existing requirements under SFAS No. 123 and APB 25. SFAS 123 (R) requires companies to measure and recognize compensation expense equal to the fair value of stock options or other shares based payments. SFAS 123 (R)is effective for all interim and annual periods beginning after June 15, 2005 and, thus, will be effective for the Company beginning with the third quarter and calendar year 2005. The Company is in the process of evaluating the impact of this standard on its consolidated results of operation and financial position.
In December 2004, the FASB issued SFAS No. 153 (“SFAS 153”), Exchanges of Nonmonetary Assets, an amendment of APB 29, Accounting for Nonmonetary Transactions. This statement amends the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and more broadly provides for exceptions regarding exchanges of nonmonetary assets that do not have commercial substance. This Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Management does not anticipate the issuance of this standard to have a material impact on the Company’s consolidated results of operation and financial position.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management” in Item 7 hereof.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Audited consolidated financial statements and related documents required by this item are included in this Annual Report on Form 10-K on the pages indicated:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Harrington West Financial Group, Inc.
Solvang, California
We have audited the accompanying consolidated statements of financial condition of Harrington West Financial Group, Inc. (the “Company”) as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Harrington West Financial Group, Inc. as of December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.
/s/ DELOITTE & TOUCHE LLP
Los Angeles, California
March 25, 2005
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share data)
See notes to consolidated financial statements.
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(Dollars in thousands, except share and per share data)
See notes to consolidated financial statements.
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Dollars in thousands)
(Continued)
See notes to consolidated financial statements.
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Dollars in thousands)
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Continued)
HARRINGTON WEST FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
See notes to consolidated financial statements
(Concluded)
HARRINGTON WEST FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business of the Company - Harrington West Financial Group, Inc. (the “Company”) is a savings and loan holding company incorporated on August 29, 1995 to acquire and hold all of the outstanding common stock of Los Padres Bank (the “Bank”), a federally chartered savings bank which operates 13 branches serving individuals and small to medium-sized businesses. Ten banking facilities are operated on the California Central Coast, two banking facilities are located in Kansas, and operated as a division under the Harrington Bank brand, and one banking facility is located in Scottsdale, Arizona.
On February 1, 1999, the Bank purchased a 49% interest in Harrington Wealth Management Company (“HWMC”). HWMC offers trust and investment management services to the customers of the Bank. On October 31, 2001, the Bank purchased the remaining 51% interest in HWMC. Beginning in November 2001, HWMC became a wholly owned subsidiary of the Bank and is consolidated into the Bank.
On November 3, 2001, the Bank purchased from Harrington Bank, FSB, its $75 million bank located in Shawnee Mission, Kansas, in the heart of the Kansas City metropolis.
On November 12, 2002, the Company completed its initial public offering. An aggregate of 1,344,000 shares of common stock were sold to the public at $10.00 per share, comprised of 1,168,338 shares sold by the company and 175,662 shares sold by certain stockholders. In connection with the initial public offering, the Company raised approximately $10.2 million.
On September 25, 2003, we completed a $15.5 million capital trust offering. The capital securities were issued through a newly formed trust, Harrington West Capital Trust I, in a private transaction. The capital trust securities bear an interest rate of three-month LIBOR plus 2.85% and will mature on October 8, 2033 and have a five-year call feature. We used $11.3 million to pay off the secured line of credit with Harris Trust and Savings Bank and US Bank, N.A. The remainder of the proceeds were used to expand the Los Padres Bank operations in Overland park, Kansas, Ventura, California and Scottsdale, Arizona.
On September 30, 2004, HWFG decided to terminate its joint venture with Resource Marketing, Los Padres Mortgage Company, LLC (“LPMC”) because the penetration levels with the RE/MAX Achievers’ clientele were below the expected levels and HWFG believed that it could broaden loan originations on the Bank’s platform. LPMC. was organized in August 2002 and was brokering single-family residential and commercial real estate loans to third party investors. This strategy is also expected to provide economies by eliminating duplication of loan administration at LPMC and at the Bank. The Bank retained selected LPMC loan origination staff and loan officers to continue its loan origination expansion in the Scottsdale, Arizona market.
On September 27, 2004, we completed a $10.3 million capital trust offering that was completed with a newly formed trust, Harrington West Capital Trust II, in a private transaction. The capital trust securities bear an interest rate of three-month LIBOR plus 1.90% and will mature on October
7, 2034 and have a five-year call feature. We used a portion of the proceeds to downstream capital to Los Padres Bank for the continued expansion of their operations.
Basis of Presentation - The consolidated financial statements include the accounts of the Company, the Bank and its subsidiaries since their acquisition dates. All significant inter-company accounts and transactions have been eliminated.
Use of Estimates - The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and with prevailing practices in the banking industry. In preparing such financial statements, management is required to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses.
Segments - The Company has a single operating segment, banking operations.
Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
Securities Sold under Agreements to Repurchase - Transactions involving sales of securities under agreements to repurchase are accounted for as collateralized financings except where the Bank does not have an arrangement to purchase the same or substantially the same securities before maturity at a fixed or determinable price.
Trading Securities - Trading securities are debt and equity securities that are bought and held principally for the purpose of active management. These securities are reported at fair value and included in trading account assets on the balance sheet. Realized and unrealized gains and losses are included in income from trading account assets.
Available for Sale Securities - Debt and equity securities not classified as either held to maturity or trading securities are classified as securities available for sale and recorded at fair value, with unrealized gains and losses, after applicable taxes, excluded from earnings and reported as a separate component of stockholders’ equity. Declines in the value of debt securities and marketable equity securities that are considered to be other than temporary are recorded as a permanent impairment of securities available for sale in the statement of earnings. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Held to Maturity Securities - Held to maturity securities represent investments that the Bank has the positive intent and ability to hold to maturity and are reported at amortized cost.
Loans Receivable - Loans receivable are carried at the principal amount outstanding, net of deferred loan fees, costs, premiums and allowance for loan losses.
Loan Interest Income and Fees - Interest on loans is accrued as earned, except non-accrual loans on which interest is normally discontinued whenever the payment of principal or interest is considered to be in doubt. When a loan is placed on non-accrual, all previously accrued but uncollected interest is reversed against current period income. Interest income is subsequently recognized only to the extent cash payments are received.
Loan origination fees and certain direct loan origination costs are deferred and recognized over the lives of the related loans as an adjustment to yield using a method that approximates the level-yield method. Calculation of the yield is done on a loan-by-loan basis. Unamortized fees are recognized in income in the year the related loans are sold or paid off. Other loan fees and charges representing service costs for the repayment of loans, delinquent payments or miscellaneous loan services are recorded as income when collected.
Discounts and premiums on loans are amortized into interest income, using a method that approximates the level-yield method over the estimated life of the related loans.
Allowance for Loan Losses - Allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries).
The allowance is maintained at a level believed by management to be sufficient to absorb estimated probable credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the credit portfolio and other relevant factors. This evaluation is inherently subjective, as it requires material estimates, including, among others, the amounts and timing of expected future cash flows on impaired loans, estimated losses on consumer loans and residential mortgages, and general amounts for historical loss experience, economic conditions, uncertainties in estimating losses and inherent risks in the various credit portfolios, all of which may be susceptible to significant change.
In determining the adequacy of the allowance for loan losses, the Company makes specific allocations to impaired loans in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 114, Accounting by Creditors for Impairment of a Loan. Loans are identified as impaired when it is deemed probable that the borrower will be unable to meet the scheduled principal and interest payments under the terms of the loan agreement. Impairment is based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.
Allocations to non-homogenous loan pools are developed by loan type and risk factor and are based on historical loss trends and management’s judgment concerning those trends and other relevant factors. These factors may include, among others, trends in criticized assets, regional and national economic conditions, changes in lending policies and procedures, trends in local real estate values and changes in volumes and terms of the loan portfolio.
Homogenous (consumer and residential mortgage) loan allocations are made at a total portfolio level based on historical loss experience adjusted for portfolio activity and economic conditions.
Management believes the level of the allowance as of December 31, 2004 is adequate to absorb losses inherent in the loan portfolio.
Servicing - Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. Capitalized servicing rights are reported in prepaid expenses and other assets and are amortized into other income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is
Real Estate Acquired through Foreclosure - Real estate acquired through foreclosure is carried at estimated fair value at the time of foreclosure. Any subsequent operating expense or income, reduction in estimated values, and gains or losses on disposition of such properties are included in current operations.
Income Taxes - Deferred tax assets or liabilities shown on the balance sheet are adjusted to reflect differences between the tax bases of assets and liabilities and their reported amounts in the financial statements.
Premises and Equipment - Premises and equipment are stated at cost less accumulated depreciation. Depreciation and amortization are computed on the straight-line method over the estimated useful lives of the assets. The depreciable lives range from 3 to 20 years for leasehold improvements, 5 to 20 years for furniture, fixtures and equipment and 30 years for the office building.
Impairment of Long Lived Assets - The Bank reviews its long-lived assets for impairment annually or when events or circumstances indicate that the carrying amount of these assets may not be recoverable. An asset is considered impaired when the expected undiscounted cash flows over the remaining useful life is less than the net book value. When impairment is indicated for an asset, the amount of impairment loss is the excess of the net book value over its fair value.
Core Deposit Intangibles - Core deposit intangibles are established in connection with purchase business combinations of banking or thrift institutions. The intangible asset represents the fair
market value of acquiring the long-term depositor relationship. Core deposit intangibles have a finite useful life and it is the Company’s policy to amortize the intangible on a straight-line basis over the estimated useful life of the deposit base acquired, currently 10 years. At December 31, 2004 and 2003, the gross balance of core deposit intangibles was $1,937, and the accumulated amortization was $1,014 and $820, respectively. The amortization expense was $194 for each of the years ended December 31, 2004 and 2003, respectively. Estimated future amortization of core deposit intangibles is $194 for December 31, 2005 and 2006 and, $177 for December 31, 2007 and $94 for December 31, 2008 and 2009. Thereafter December 31, 2009, there will be an estimated future amortization of $172.
Goodwill - Goodwill is no longer amortized in accordance with SFAS No. 142 but, instead is tested for impairment at least annually. A goodwill impairment test was completed on September 30, 2004. No impairment loss was recorded by the Company.
Derivatives Held for Asset and Liability Management Purposes - The Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended which establishes accounting and reporting standards for derivative instruments and for hedging activities. They require that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a fair value hedge, a cash flow hedge or a hedge of foreign currency exposure. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation.
In accordance with the standards, the Company has identified certain types of short-term interest-bearing liabilities as a source of interest rate risk to be hedged in connection with the Company’s overall asset-liability management process. Although these liabilities have contractually fixed rates of interest, their short-term maturities, together with the expectation that they will be continually refinanced or replaced with similar products, give rise to the risk of fluctuations in interest expense as interest rates rise and fall in future periods. In response to this identified risk, the Company uses interest rate swaps as cash flow hedges to hedge the interest rate risk associated with the cash flows of the specifically identified short-term liabilities.
To qualify for hedge accounting, the Company must show that, at the inception of the hedges and on an ongoing basis, the changes in the fair value of the hedging instruments are expected to be highly effective in offsetting related changes in the cash flows of the hedged liabilities. These interest rate swaps have been shown to be effective in hedging the exposure to the short-term liability variability in cash flows and, therefore, qualify for hedge accounting. Accordingly, the effective portion of the accumulated change in the fair value of the cash flow hedges is recorded in a separate component of stockholders’ equity, net of tax, while the ineffective portion is recognized in earnings immediately. During the next twelve months, the Company expects to expense $1,488, net of tax, from the amount recorded in the separate component of stockholders’ equity.
Stock-Based Compensation - The Company issues stock-based compensation to certain employees, officers, and Directors. SFAS No. 123, Accounting for Stock-based Compensation, encourages, but does not require, companies to account for stock-based compensation using the fair value method, which generally results in compensation expense recognition. As permitted by SFAS No. 123, the Company continues to account for its fixed stock options using the intrinsic-value method, prescribed in APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretations, which generally does not result in compensation expense recognition. Under the intrinsic value method, compensation cost for stock options is measured at the date of grant as the
excess, if any, of the quoted market price of our stock over the exercise price of the options. Had compensation cost for these plans been determined based on the fair value at the grant dates of options consistent with the method defined in SFAS No. 123, the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below for the years ended December 31, 2004, 2003 and 2002:
Recent Accounting Pronouncements - In December 2003, the FASB issued FASB Interpretation No. 46R (“FIN 46R”) which revised the January 2003 Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. The revision clarifies how variable interest entities should be identified and evaluated for consolidation purposes. The Company adopted FIN46R to its interests in special purpose entities (“SPEs”) as of December 31, 2003. Adoption of this new method of accounting for SPEs did not and is not expected to have a material impact on the Company’s consolidated results of operation and financial position.
In December 2003, the Accounting Standards Executive Committee of the AICPA issued Statement of Position No. 03-3 (“SOP 03-3”), Accounting for Certain Loans of Debt Securities Acquired in a Transfer. SOP 03-3 addresses the accounting for differences between contractual cash flows and the cash flows expected to be collected from purchased loans or debt securities if those differences are attributable, in part, to credit quality, SOP 03-3 requires purchased loans and debt securities to be recorded initially at fair value based on the present value of the cash flows expected to be collected with no carryover of any valuation allowance previously recognized by the seller. Interest income should be recognized based on the effective yield from the cash flows to be collected. To the extent that the purchased loans or debt securities experience subsequent deterioration in credit quality, a valuation allowance would be established for any additional cash flows that are not expected to be received. However, if more cash flows subsequently are expected to be received than originally estimated, the effective yield would be adjusted on a prospective basis. SOP 03-3 will be effective for loans and debt securities acquired after December 31, 2004. Management does not expect the adoption of this statement to have a material impact on the Company’s consolidated results of operation and financial position.
In March 2004, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 105 (“SAB 105”) was issued, which provides guidance regarding loan commitments that are accounted for as derivative instruments under FASB No. 133 (as amended), Accounting for Derivative Instruments and Hedging Activities. In SAB 105, the SEC ruled that the amount of the expected servicing rights should not be included when determining the fair value of derivative interest rate lock commitments. This guidance must be applied to rate locks initiated after March 31, 2004. Management does not anticipate the issuance of this Bulletin to have a material impact on the Company’s consolidated results of operation and financial position.
In March 2004, the Emerging Issues Task Force (“EITF”) reached consensus on the guidance provided in EITF Issue No. 03-1, The Meaning of Other Than Temporary Impairment and its Application to Certain Investments (“EITF 03-1”), as applicable to debt and equity securities that are within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and equity securities that are accounted for using the cost method specified in Accounting Policy Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. An investment is impaired if the fair value of the investment is less than its cost. EITF 03-1 outlines that an impairment would be considered other-than-temporary unless: a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment, and b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. Although not presumptive, a pattern of selling investments prior to the forecasted recovery of fair value may call into question the investor’s intent. In addition, the severity and duration of the impairment should also be considered in determining whether the impairment is other-than-temporary. In September 2004, the FASB issued a proposed Board-directed FASB Staff Position, FSP EITF Issue 03-1-a, Implementation Guidance of the Application of Paragraph 16 of EITF Issue No. 03-1. The proposed FSP would provide implementation guidance with respect to debt securities that are impaired solely due to interest rates and/or sector spreads and analyzed for other-than-temporary impairment under paragraph 16 of Issue 03-1. The Board also issued FSP EITF Issue 03-1-b which delays the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-1. The delay does not suspend the requirement to recognize other-than temporary impairments as required by existing authoritative literature. Adoption of this standard may cause the Company to recognize under current guidance or to recognize such losses in earlier periods, especially those due to increases in interest rates. Since fluctuations in fair value for available-for-sale securities are already recorded in accumulative other comprehensive (income) loss, adoption of this standard is not expected to have a significant impact on stockholder’s equity.
In December 2004, the FASB revised SFAS No. 123 (R) (“SFAS 123 (R)”), Share Based Payment. SFAS 123 (R) replaced existing requirements under SFAS No. 123 and APB 25. SFAS 123 (R) requires companies to measure and recognize compensation expense equal to the fair value of stock options or other shares based payments. SFAS 123 (R)is effective for all interim and annual periods beginning after June 15, 2005 and, thus, will be effective for the Company beginning with the third quarter and calendar year 2005. The Company is in the process of evaluating the impact of this standard on its consolidated results of operation and financial position.
In December 2004, the FASB issued SFAS No. 153 (“SFAS 153”), Exchanges of Nonmonetary Assets, an amendment of APB 29, Accounting for Nonmonetary Transactions. This statement amends the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and more broadly provides for exceptions regarding exchanges of nonmonetary assets that do not have commercial substance. This Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Management does not anticipate the issuance of this standard to have a material impact on the Company’s consolidated results of operation and financial position.
Reclassifications - Certain reclassifications have been made to the prior financial statements to conform to the current year presentation.
Stock Split - The accompanying consolidated financial statements of the Company reflect the 6 for 5 stock split in the form of a stock dividend payable on March 11, 2004 to holders of record on
2. LOANS RECEIVABLE
The Bank’s loan portfolio as of December 31 is summarized as follows:
The Bank’s lending is concentrated in California’s Central Coast, Kansas City and the Scottsdale, Arizona metropolitan area. A deterioration in the economic conditions of these markets could adversely affect our business, financial condition and profitability. Such deterioration could give rise to increased loan delinquencies, increased problem asset and foreclosures, decreased loan demand and a decline in real estate values.
At December 31, 2004, Los Padres Bank’s regulatory limit on loans-to-one borrower was $11.6 million and its five largest loans or groups of loans-to-one borrower, including related entities, aggregated $9.6 million, $9.2 million, $9.1 million, $8.8 million and $8.6 million. These five largest loans or loan concentrations were secured by commercial real estate and development of single family residences. All of these loans or loan concentrations were performing in accordance with their payment terms at December 31, 2004.
Activity in the allowance for loan losses is summarized as follows for the years ended December 31:
Loans for which impairment has been recognized are as follows at December 31:
Unfunded Loan Commitments as of December 31,
(In Thousands)
3. SECURITIES
The amortized cost and estimated fair values of securities available for sale are summarized as follows:
Securities Available for Sale:
The fair values and unrealized losses of the securities classified as available-for-sale or held-to-maturity with unrealized losses as of December 31, 2004 and 2003 segregated by investments that have been in a continuous unrealized loss position for less than 12 months and investments that have been in a continuous unrealized loss position for 12 months or longer are summarized below:
Our mortgage-backed securities are issued by U.S. Government agencies and government sponsored enterprise, which primarily include Freddie Mac, Fannie Mae and the Government National Mortgage Association (“Ginnie Mae”). As of December 31, 2004, there are 58 mortgage-backed securities that are in an unrealized loss position with 25 of the mortgage-backed securities in an unrealized loss position for over twelve months. In December 31, 2003, there were 26 mortgage-backed securities in a unrealized loss position and no securities in a loss position for over twelve months. Management believes that the unrealized losses associated with these investments are attributable to changes in interest rates and spreads, and accordingly, the unrealized losses are not “other-than-temporary impairments”. Management intends to hold these securities until recovery.
Our collateralized mortgage obligations are issued by private entities or trusts and, as of December 31, 2004, are all rated AAA by a nationally recognized rating agency. As of December 31, 2004 and December 31, 2003, there are nine and eight, respectively collateralized mortgage obligation securities that are in an unrealized loss position. Of the nine securities in an unrealized loss position as of December 31, 2004, four of the securities have been in an unrealized loss position for over twelve months and in December 31, 2003 there were no securities in an unrealized loss position for over twelve months. Due to the AAA ratings noted above, Management believes that the unrealized losses associated with these investments are attributable to changes in interest rates and spreads, and accordingly, the unrealized
losses are not “other-than-temporary impairments”. Management intends to hold these securities until recovery.
Our commercial mortgaged-backed securities are issued by various entities or trusts and, as of December 31, 2004, all are rated as investment grade by a nationally recognized rating agency. As of December 31, 2004, there are four commercial mortgage-backed securities that are in an unrealized loss position with one security in an unrealized loss position for over twelve months. As of December 31, 2003, there were three commercial mortgage-backed securities that were in an unrealized loss position with no securities in an unrealized loss position for over twelve months. Due to the investment grade ratings noted above, management believes that the unrealized losses associated with these investments are attributable to changes in interest rates and spreads, and accordingly, the unrealized losses are not “other-than-temporary impairments”. Management intends to hold these securities until recovery.
All but one of our asset-backed securities are issued by private entities or trusts and, as of December 31, 2004, are all rated as investment grade by a nationally recognized rating agency. With the exception of the security discussed in the next paragraph, the underlying collateral of these investments are single-family mortgages. As of December 31, 2004, there are seven asset-backed securities that are in an unrealized loss position and as of December 31, 2003, there are nine asset-backed securities that are in an unrealized loss position, for both periods, there are no securities in an unrealized loss position for over twelve months. As to the mortgage-related asset backed securities, management believes that the unrealized losses associated with these investments are attributable to changes in interest rates and spreads, and accordingly, the unrealized losses are not “other-than-temporary impairments”. Management intends to hold these securities until recovery.
The asset-backed securities are collateralized by a pool of loans and leases on medical equipment and medical business loans and they have a fair value of $5,143 and $4,961 as of December 31, 2004 and 2003, respectively. The securities are of the senior tranches with priority cash flow rights. This medical equipment, asset-backed security is rated CCC by Moody’s and B1 by Fitch, as of December 31, 2004. Management believes the improvement in the unrealized loss from $952,000 as of December 31, 2003 to $351,000 as of December 31, 2004 is attributed to the decrease in delinquencies and default rates of the underlying loans. The delinquencies on the underlying loans of these securities have dropped from 28.1% as of the December 2003 servicer’s report to 13.4% per the December 2004 servicer report. Furthermore, management performs a stress test of the cash flows based on conservative delinquency, default and recovery rates on the underlying loans. Based on this analysis, all payments can be made on our DVI security and, as such, the current unrealized loss associated with this investment is not an “other-than-temporary impairment”. Management intends to hold these securities until recovery.
Proceeds from sales of available for sale securities were $28,316, $34,033 and $2,378, with related gross realized gains of $690,000, $1.5 million and $145,000 for 2004, 2003 and 2002, respectively.
Securities Held to Maturity:
The amortized cost and fair value of held to maturity debt securities by contractual maturity at December 31, 2004 are as follows:
4. PREMISES AND EQUIPMENT
Premises and equipment consist of the following at December 31:
5. DEPOSITS
A summary of deposits by type of account as of December 31 is as follows:
As of December 31, 2004, certificates of deposits are scheduled to mature as follows:
7. NOTE PAYABLE
At December 31, 2004 and 2003, the Company has a loan facility from two banks consisting of a revolving line of credit of $15.0 million, and we have not made any draws on the line of credit since we paid off the outstanding balance of $11.3 million in 2003.
On September 16, 2004, we entered into an amendment to our credit agreement, which reduced the LIBOR margin range from 2.0% to 3.0% to 1.75% to 2.75%. Under the new terms, interest is payable quarterly and the rate is based on three defined performance-based levels determined from quarterly operating results related to core profitability and nonperforming asset ratios: Level 1 allows for the choice of London Interbank Offered Rate (“LIBOR”) plus 175 basis points (in maturities of 30, 60 or 90 days) or prime rate less 50 basis points; Level 2 allows for the choice of LIBOR plus 225 basis points or prime rate less 50 basis points; Level 3 allows for the choice of LIBOR plus 275 basis points or prime rate. At December 31, 2004, the Company qualified for Level 1 loan pricing. A .25% commitment fee on the unused portion of the line is payable quarterly.
The credit agreement contains a number of significant covenants that restrict our ability to dispose of assets, incur additional indebtedness, invest in mortgage derivative securities above certain thresholds, create liens on assets, engage in mergers or consolidations or a change-of control, engage in certain transactions with affiliates, pay cash dividends or repurchase common stock. The credit agreement also requires us to comply with specified financial ratios and tests, including causing Los Padres Bank to maintain a ratio of non-performing assets to the sum of Tier 1 risk-based capital plus loan loss reserves of not more than 0.20 to 1, maintaining a ratio of outstanding loans under the credit agreement to the stockholders’ equity of Los Padres Bank of less than 0.50 to 1, maintaining the Los Padres Bank status as a “well capitalized” institution and complying with minimum core profitability requirements. The covenant that restricts payment of cash dividends in an aggregate amount not to exceed the greater of (a) $450,000 during any fiscal quarter, or (b) 40% of our consolidated net income during any fiscal quarter or declare dividends at any time an event of default has occurred under the revolving line of credit. Los Padres Bank’s status as a “well capitalized” institution and complying with minimum core profitability requirements is also a covenant associated with the credit agreement. Management believes that as of December 31, 2004, it was in compliance with all of such covenants and restrictions and does not anticipate that such covenants and restrictions will significantly limit its operations.
8. OTHER DEBT
On September 27, 2004, the Company completed a $10.3 million capital trust offering. The capital trust securities bear interest at LIBOR plus 1.90% and will mature on October 7, 2034. The capital securities were issued through a newly formed trust, Harrington West Capital Trust II, in a private transaction. Interest is payable quarterly.
On September 25, 2003, the Company completed a $15.5 million capital trust offering. The capital trust securities bear interest at LIBOR plus 2.85% and will mature on October 8, 2033. The capital securities were issued through a newly formed trust, Harrington West Capital Trust I, in a private transaction. Interest is payable quarterly.
The actual tax rates differed from the statutory rates as follows for the years ended December 31:
The following is a summary of the components of the net deferred tax asset at December 31:
A summary of the status of the Company’s stock options as of December 31 and changes during the years are presented below:
12. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures that have been established by regulation to ensure capital adequacy require the Bank to maintain minimum capital amounts and ratios (set forth in the table below). The Bank’s primary regulatory agency, the Office of Thrift Supervision (“OTS”), currently requires that the Bank maintain minimum ratios of tangible capital (as defined in the regulations) to tangible assets of 1.5%, core capital (as defined) to adjusted tangible assets of 4%, and total capital (as defined) to risk-weighted assets of 8%. These capital requirements are viewed as minimum standards by the OTS, and most institutions are expected to maintain capital levels well above the minimum. Minimum capital levels higher than those provided in the regulations may be established by the OTS for individual savings associations, upon a determination that the savings association’s capital is or may become inadequate in view of its circumstances.
During 2002, due to our business strategy which was concentrated on growth, a shift in our lending focus to more commercial lending and the size of our securities portfolios, we agreed with the OTS that we would maintain a total risk-based capital ratio and a leverage capital ratio of at least 11.0% and 6.0%, respectively, which was in excess of the OTS’ minimum requirements. During 2003, the OTS agreed to remove the 11.0% and 6.0% requirement noted above.
As of December 31, 2004 and 2003, the most recent notification from the OTS categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective 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. There are no conditions or events since that notification which management believes have changed the institution’s category.
Federal regulations place certain restrictions on dividends paid by the Bank to the Company. The total amount of dividends that may be paid at any date is generally limited to the retained earnings of the Bank. At December 31, 2004, the Bank’s retained earnings available for the payment of dividends were $12,694. Accordingly, $39,966 of the Company’s equity in the net assets of the Bank was restricted at December 31, 2004. In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements.
REGULATORY CAPITAL
FINANCIAL STATEMENT FOOTNOTE
13. EARNINGS PER SHARE
The following tables represent the calculations of earnings per share (“EPS”) for the periods presented.
14. COMMITMENTS AND CONTINGENCIES
Aggregate minimum lease commitments under long-term operating leases as of December 31, 2004 are as follows:
Minimum lease payments for the Bank’s premises are adjusted annually based upon the Consumer Price Index. The leases also provide for option renewal periods. Rental expense was $1,164, $1,055 and $840 for the years ended December 31, 2004, 2003 and 2002, respectively.
15. TRADING ACCOUNT ASSETS
Derivative Instruments Not Receiving Hedge Treatment - The Bank is a party to a variety of interest rate contracts such as interest rate swaps, caps, floors, futures, options and total return swaps (“Interest Rate Agreements”), which are recorded in the financial statements at fair value with changes in fair value and periodic payments recorded in earnings.
Interest rate swaps are contracts in which the parties agree to exchange fixed and floating rate payments for a specified period of time on a specified (“notional”) amount. The notional amount is only used to calculate the amount of the periodic interest payments to be exchanged and does not represent the amount at risk. As of December 31, 2004 the Bank held $95.0 million notional amount of Commercial Mortgage Backed Securities (“CMBS”) swaps and $25.0 million notional amount of Asset Backed Securities (“ABS”) swaps whereby the Bank receives the spread on the Lehman Brothers CMBS Index and specific ABS securities plus a constant spread and receives or pays the market value change of the index.
Interest rate futures contracts are commitments to either purchase or sell designated instruments at a future date for a specified price. Initial margin requirements are met in cash or other instruments, and changes in the contract values are settled in cash daily. The Bank maintained $0 at December 31, 2004 and 2003, respectively, in agency securities as a deposit with a broker for its futures activities. The Company did not have any interest rate futures contracts outstanding at December 31, 2004 and 2003.
The following is a summary of the Interest Rate Agreements as of December 31:
The Interest Rate Agreements used have an active secondary market and are included in trading account assets at fair value with realized and unrealized gains and losses on these instruments recognized immediately in other income.
The Bank’s exposure to credit risk from derivative financial instruments is represented by the fair value of the instruments. Credit risk amounts represent the replacement cost the Bank could incur should counterparties with contracts in a gain position completely fail to perform under the terms of those contracts. Counterparties are subject to the credit approval and credit monitoring policies and procedures of the Bank. The Bank limits its credit exposure by entering into International Swap Dealer Association (“ISDA”) Master Agreements with each counterparty. ISDA Master Agreements set the legal framework for transactions with counterparties in over the counter derivative markets. The Bank only deals with counterparties that are investment grade.
The following table shows the various components of the Company’s recorded net gain (loss) on its trading assets for the years ended December 31.
The following table shows the Company’s trading securities included in trading account assets as of December 31:
Securities Held for Trading:
16. DERIVATIVES HELD FOR ASSET AND LIABILITY MANAGEMENT
At December 31, 2004, the swaps listed below are hedging the interest rate risk of cash flows associated with short-term FHLB advances and certificates of deposit with terms between six and twelve months. These swaps qualify as cash flow hedges. During 2004, the ineffective portion of the change in fair value of the cash flow hedges was $155.
The following table sets forth the maturity distribution and weighted-average interest rates of the interest rate swaps used to limit the repricing risk of deposits and short-term borrowings as of December 31, 2004:
The Bank is dedicated to managing credit risks associated with investment and interest rate risk management activities. The Bank maintains positions with a variety of counterparties or obligors (“counterparties”). To limit credit exposure arising from such transactions, the Bank evaluates the credit standing of counterparties, establishes limits for the total exposure to any one counterparty, monitors exposure against the established limits, and monitors investment portfolio composition to manage concentrations.
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires that the Bank disclose estimated fair values for its financial instruments. The estimated fair value amounts have been determined by the Bank using available market information and appropriate valuation methodologies; however, considerable judgment is required to interpret market data to develop estimates of fair value.
Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Bank 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 at December 31:
The methods and assumptions used to estimate the fair value of each class of financial statements for which it is practicable to estimate that value are explained below:
Cash and Cash Equivalents - The carrying amounts approximate fair values due to the short-term nature of these instruments.
Securities - The fair values of securities are generally obtained from market bids for similar or identical securities or are obtained from independent security brokers or dealers.
Securities Sold under Repurchase Agreements - The carrying amounts approximate fair values due to the short-term nature of these instruments.
Trading Account Assets - The fair values of trading securities included in trading account assets are obtained from market bids or from independent securities brokers or dealers. Fair values of interest rate contracts are based on quoted market price or dealer quotes.
Loans - Fair values are estimated for portfolios of loans with similar financial characteristics, primarily fixed and adjustable rate interest terms. The fair values of mortgage loans are based upon discounted cash flows utilizing applicable risk-adjusted discount rates relative to available mortgage-backed securities having similar rate and repricing characteristics, as well as anticipated
prepayment schedules. No adjustments have been made for changes in credit within the loan portfolio. It is management’s opinion that the allowance for estimated loan losses pertaining to performing and nonperforming loans results in a fair valuation of such loans.
FHLB Stock - The carrying amounts approximate fair values, as the stock may be sold back to the FHLB at cost.
Deposits - The fair values of deposits are estimated based upon the type of deposit product. Demand accounts, which include passbooks and transaction accounts, are presumed to have equal book and fair values, since the interest rates paid on these accounts are based on prevailing market rates and the amounts are payable upon demand. The estimated fair values of time deposits are determined by discounting the cash flows of settlements of deposits having similar maturities and current rates, utilizing a LIBOR swap curve adjusted for Federal Deposit Insurance Corporation (“FDIC”) insurance that approximates the prevailing rates offered on the Company’s term borrowings less the cost of FDIC insurance as of the reporting date.
FHLB Advances - The fair values of FHLB advances are based upon discounted cash flows utilizing applicable risk-adjusted spreads relative to the current pricing for similar advances.
Notes Payable - The carrying amount approximates fair value, as the rate is based on current market rates.
Hedging instruments consist of interest rate swaps used to modify the interest rate sensitivity of certain short-term certificates of deposit, a portion of the Bank’s securities sold under agreements to repurchase and the short-term FHLB advances. Fair values are based on quoted market prices or dealer quotes. Where such quotes are not available, fair value is estimated by using quoted market prices for similar securities or by discounting future cash flows at a risk-adjusted spread to the LIBOR-based swap curve.
Commitments to Extend Credit, and Standby and Commercial Letters of Credit - The fair values of commitments to extend credit and standby letters of credit were not significant at either December 31, 2004 or 2003, as these instruments predominantly have adjustable terms and are of a short-term nature.
The fair value estimates presented herein are based on pertinent information available to management as of each reporting date. 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.
18. RELATED-PARTY TRANSACTIONS
The Bank has contracted with Smith Breeden Associates (SBA) to provide investment advisory services and interest rate risk analysis. A principal of SBA is a director for the Company and the Bank. Several principals and employees of SBA are stockholders of the Company. The amount of consulting expense relating to SBA for the years ended December 31, 2004, 2003 and 2002 was $412,000, $365,000 and $325,000, respectively.
In the ordinary course of business, the Bank has granted loans to principal officers and directors and their affiliates amounting to $0 and $891 at December 31, 2004 and 2003, respectively. The following table is a rollforward of the related party loan activity.
19. EMPLOYEE BENEFIT PLAN
The Company sponsors a defined contribution plan for the benefit of its employees. The Company’s contributions to the plan are determined annually by the Board of Directors in accordance with plan requirements. For tax purposes, eligible participants may contribute up to a maximum of 15% of their compensation, not to exceed the dollar limit imposed by the Internal Revenue Service. The expense associated with the employee benefit plan is included in salary and employee benefits in the consolidated statements of earnings. For the plan years ended December 31, 2004, 2003 and 2002, the Company contributed $473,000, $405,000 and $332,000, respectively.
20. PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed Statements of Financial Condition
Condensed Statements of Earnings
Condensed Statements of Cash Flows
21. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
22. SUBSEQUENT EVENTS
On February 2, 2005, Los Padres Bank entered into an agreement with Western Financial Bank for the purchase and assumption of their office in Thousand Oaks, California. In the purchase agreement, Los Padres Bank has agreed to purchase approximately $51.9 million in deposits and their associated overdraft protection accounts or line of credits, all furniture and fixtures and assume the lease for the building. This transaction is subject to regulatory approval and the Bank has submitted its application to the Office of Thrift Supervision and is awaiting final approval.
******
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9a.
Item 9a. Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer along with our Senior Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to the Exchange Act Rule 13a-15(b). Based upon that evaluation, our Chief Executive Officer along with the our Senior Vice President and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting us to material information relating to us (including our consolidated subsidiaries) required to be included in our periodic SEC filings. There have been no significant changes in our internal control over financial reporting during our most recent quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Item 9B.
Item 9B. Other Information
Not applicable.
PART III
Item 10.
Item 10. Directors and Executive Officer of the Registrant.
This information is incorporated by reference from our definitive proxy statement for our 2005 Annual Meeting of Stockholders (“Proxy Statement”) which will be filed pursuant to Regulation 14A.
As of March 10, 2004, our board of directors formally adopted the Company’s Code of Ethics, a copy of which was filed as Exhibit 14 to the 2003 Annual Report on Form 10-K.
Item 11.
Item 11. Executive Compensation.
This information is incorporated by reference from our Proxy Statement which will be filed pursuant to Regulation 14A.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
This information with respect to beneficial ownership by beneficial owners and management is incorporated by reference from our Proxy Statement which will be filed pursuant to Regulation 14A.
EQUITY COMPENSATION PLAN INFORMATION
The following table presents information for all equity compensation plans with individual compensation arrangements (whether with employees or non-employees such as directors), in effect as of December 31, 2004.
Item 13.
Item 13. Certain Relationships and Related Transactions.
This information is incorporated by reference from our Proxy Statement which will be filed pursuant to Regulation 14A.
Item 14.
Item 14. Principal Accountant Fees and Services
The information is incorporated by reference from our Proxy Statement which will be filed pursuant to Regulation 14A.
Part IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a) Documents filed as part of this report.
(1) The following documents are filed as part of this Annual Report on Form 10-K and are incorporated herein by reference to Item 8 hereof:
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition as of December 31, 2004 and 2003.
Consolidated Statements of Earnings for the Years Ended December 31, 2004, 2003 and 2002.
Consolidated Statements of Stockholder’s Equity for the Years Ended December 31, 2004, 2003 and 2002.
Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002.
Notes to Consolidated Financial Statements.
(2) All schedules for which provision is made in the applicable accounting regulation of the SEC are omitted because they are not applicable or the required information is included in the Consolidated Financial Statements or notes thereto.
(b) The following exhibits are filed as part of this Form 10-K, and this list includes the Exhibit Index.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.