10-Q 1 d10q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------- FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 ------------------------------------------------ OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------------- ------------------- Commission file number 0-30777 --------- PACIFIC MERCANTILE BANCORP ------------------------------------------------------ (Exact name of Registrant as specified in its charter) California 33-0898238 -------------------------------------------------------------------------------- (State or other jurisdiction (I.R.S. Employer Identification of incorporation or organization) Number) 949 South Coast Drive, Suite 300, Costa Mesa, California 92626 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (714) 438-2500 ------------------------ (Registrant's telephone number, including area code) ---------------------------------------------- (Former name, former address and former fiscal year, if changed, since last year) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. YES X . NO . --- --- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 6,344,828 shares of Common Stock as of October 31, 2001 PACIFIC MERCANTILE BANCORP QUARTERLY REPORT ON FORM 10Q FOR THE QUARTER ENDED SEPTEMBER 30, 2001 TABLE OF CONTENTS
Page No. -------- Part I. Financial Information Item 1. Financial Statements Consolidated Statements of Financial Condition September 30, 2001 and December 31, 2000............................................... 3 Consolidated Statements of Operations Three months and nine months ended September 30, 2001 and 2000......................... 4 Consolidated Statements of Comprehensive Income (Loss) Three months and nine months ended September 30, 2001 and 2000......................... 5 Consolidated Statements of Cash Flows Three months and nine months ended September 30, 2001 and 2000......................... 6 Notes to Consolidated Financial Statements............................................. 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 10 Item 3. Market Risk............................................................................ 19 Part II. Other Information Item 6. Exhibits and Reports on Form 8-K....................................................... 19 Signatures Exhibit Index
PART I. ITEM 1. FINANCIAL STATEMENTS PACIFIC MERCANTILE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, December 31, 2001 2000 ------------ ------------ (Unaudited) ASSETS Cash and due from banks $ 11,673,800 $ 9,023,300 Federal funds sold 15,240,000 38,565,000 ------------ ------------ Cash and cash equivalents 26,913,800 47,588,300 Interest bearing deposits with financial institutions 1,387,000 1,188,000 Securities available for sale, at fair value ($8,310,900 pledged as collateral for repurchase agreements at September 30, 2001) 9,161,000 12,987,900 Loans held for sale, at lower of cost or market 39,580,500 11,084,400 Loans (net of allowances of $1,445,500 and $1,145,500, respectively) 123,944,100 87,260,800 Accrued interest receivable 884,100 782,400 Premises and equipment, net 2,487,700 1,336,300 Other assets 1,279,500 388,800 ------------ ------------ Total assets $205,637,700 $162,616,900 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Noninterest bearing $ 57,774,600 $ 48,553,100 Interest bearing 107,422,900 75,733,400 ------------ ------------ Total deposits 165,197,500 124,286,500 Securities sold under agreements to repurchase 2,933,500 2,679,800 Accrued interest payable 117,800 94,300 Other liabilities 1,120,300 867,700 ------------ ------------ Total liabilities 169,369,100 127,928,300 ------------ ------------ Commitments and contingencies -- -- Stockholders' equity: Preferred stock, no par value, 2,000,000 shares authorized; none issued -- -- Common stock, no par value, 10,000,000 shares authorized; 6,344,828 shares issued and outstanding at September 30, 2001 and December 31, 2000 37,607,900 37,547,400 Accumulated deficit (1,441,500) (2,865,700) Accumulated other comprehensive income 102,200 6,900 ------------ ------------ Total stockholders' equity 36,268,600 34,688,600 ------------ ------------ Total liabilities and stockholders' equity $205,637,700 $162,616,900 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 3 Part I. Item 1. (continued) PACIFIC MERCANTILE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, -------------------------- --------------------------- 2001 2000 2001 2000 ---------- ---------- ---------- ---------- Interest income: Loans, including fees $2,687,700 $1,974,500 $7,181,700 $4,929,400 Federal funds sold 264,800 656,100 1,232,700 1,491,900 Securities available for sale 121,000 82,200 378,900 169,100 Interest earning deposits with financial institutions 17,600 19,000 50,400 57,300 ---------- ---------- ---------- ---------- Total interest income 3,091,100 2,731,800 8,843,700 6,647,700 Interest expense: Deposits 829,400 906,300 2,656,600 2,479,000 Other borrowings 34,300 14,800 106,400 14,800 ---------- ---------- ---------- ---------- Total interest expense 863,700 921,100 2,763,000 2,493,800 Net interest income 2,227,400 1,810,700 6,080,700 4,153,900 Provision for loan losses (100,000) (100,000) (300,000) (300,000) ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 2,127,400 1,710,700 5,780,700 3,853,900 Noninterest income 1,019,600 224,200 2,261,800 679,700 Noninterest expense 2,712,300 1,717,800 6,718,300 4,794,200 ---------- ---------- ---------- ---------- Income (loss) before income taxes 434,700 217,100 1,324,200 (260,600) Income tax benefit 100,000 -- 100,000 -- ---------- ---------- ---------- ---------- Net income (loss) $ 534,700 $ 217,100 $1,424,200 $ (260,600) ========== ========== ========== ========== Weighted average number of shares outstanding 6,339,816 6,321,102 6,334,647 4,684,720 ========= ========= ========= ========= Basic and fully diluted income (loss) per share $ 0.08 $ 0.03 $ 0.22 $ (0.06) ========== ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. 4 Part I. Item 1. (continued) PACIFIC MERCANTILE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, --------------------------- ----------------------------- 2001 2000 2001 2000 -------- -------- ---------- --------- Net income (loss) $534,700 $217,100 $1,424,200 $(260,600) Other comprehensive gain, net of tax: Change in unrealized gain on securities available for sale, net of tax effect 89,300 6,700 95,300 5,100 -------- -------- ---------- --------- Total comprehensive income (loss) $624,000 $223,800 $1,519,500 $(255,500) ======== ======== ========== =========
The accompanying notes are an integral part of these consolidated financial statements. 5 Part I. Item 1. (continued) PACIFIC MERCANTILE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine months ended September 30, ---------------------------------- 2001 2000 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ 1,424,200 $ (260,600) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 445,500 304,100 Provision for loan losses 300,000 300,000 Net amortization (accretion) of premiums (discounts) on securities (120,500) 3,900 Net gains on sales of loans held for sale (795,700) (211,000) Net loss on sale of equipment -- 2,200 Mark to market loans held for sale 3,600 -- Proceeds from sales of loans held for sale 240,609,000 61,239,300 Originations and purchases of loans held for sale (268,313,000) (66,790,200) Net change in accrued interest receivable (101,700) (441,200) Net change in other assets (890,700) (244,100) Net change in accrued interest payable 23,500 23,500 Net change in other liabilities 252,600 120,700 ------------ ------------ Net cash provided by (used in) operating activities (27,163,200) (5,953,400) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Net (increase) decrease in interest bearing deposits with financial institutions (199,000) 198,000 Proceeds from maturities of securities available for sale 19,250,700 750,000 Purchase of securities available for sale (15,208,000) (2,605,300) Net increase in loans (36,983,300) (37,922,800) Proceeds from sale of premises and equipment -- 10,300 Purchase of premises and equipment (1,596,900) (458,800) ------------ ------------ Net cash used in investing activities (34,736,500) (40,028,600) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 40,911,000 40,218,200 Proceeds from sale of common stock, net of offering expenses -- 18,555,200 Proceeds from exercise of stock options 60,500 1,000 Net increase in security sold under agreement to repurchase 253,700 1,296,500 ------------ ------------ Net cash provided by financing activities 41,225,200 60,070,900 ------------ ------------ Decrease in cash and cash equivalents (20,674,500) 14,088,900 Cash and cash equivalents, beginning of period 47,588,300 38,498,200 ------------ ------------ Cash and cash equivalents, end of period $ 26,913,800 $ 52,587,100 ============ ============ SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS Cash paid for interest on deposits and other borrowings $ 2,739,500 $ 2,538,000 Cash paid for income taxes $ 33,900 $ 2,400
The accompanying notes are an integral part of these consolidated financial statements. 6 Part I. Item 1. (continued) PACIFIC MERCANTILE BANCORP AND SUBSIDIARY Notes to Consolidated Financial Statements (Unaudited) 1. Nature of Business and Significant Accounting Policies Organization The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all footnotes as would be necessary for a fair presentation of financial position, results of operations, changes in cash flows and comprehensive income (loss) in conformity with generally accepted accounting principles. However, these interim financial statements reflect all adjustments (consisting of normal recurring adjustments and accruals) which, in the opinion of the management, are necessary for a fair presentation of the results for the interim periods presented. These unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles on a basis consistent with, and should be read in conjunction with the Company's audited financial statements as of and for the year ended December 31, 2000 and the notes thereto included in the Company's Form 10-K filed under the Securities Act of 1934. The financial position at September 30, 2001, and the results of operations for the nine month period ended September 30, 2001 are not necessarily indicative of the results of operations that may be expected for any other interim period or for the full year ending December 31, 2001. The consolidated financial statements include the accounts of Pacific Mercantile Bancorp and its wholly owned subsidiary Pacific Mercantile Bank (which together shall be referred to as the "Company"). The Company is a bank holding company which was incorporated on January 7, 2000 in the State of California. Pacific Mercantile Bank (the "Bank") is a banking company which was formed on May 29, 1998, incorporated November 18, 1998 in the State of California and commenced operations on March 1, 1999. The Bank is chartered by the California Department of Financial Institutions (the "DFI") and is a member of the Federal Reserve Bank of San Francisco ("FRB"). In addition, its customers' deposit accounts are insured by the Federal Deposit Insurance Corporation ("FDIC") up to the maximum amount allowed by Federal Regulations. Pacific Mercantile Bancorp was organized to acquire all of the outstanding shares of the Bank and, on June 12, 2000, it consummated that acquisition by means of a merger as a result of which the Bank became a wholly-owned subsidiary of the Company and the Bank's shareholders became the Company's shareholders, owning the same number and percentage of the Company's shares as they had owned in the Bank (the "Reorganization"). Prior to the Reorganization, the Company had only nominal assets and had not conducted any business. All financial information included herein has been restated as if the Reorganization was effective for all periods presented. Additionally, the number of common shares outstanding gives retroactive effect to a two-for-one stock split of the Bank's outstanding shares that became effective on April 14, 2000. Use of Estimates The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Loans At September 30, 2001, the Company had no nonaccrual, impaired, or restructured loans and had no loans with principal more than 90 days past due that were still accruing interest. 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-) Income (Loss) Per Share Basic income (loss) per share for each of the periods presented was computed by dividing the net income (loss) by the weighted average number of shares of common stock outstanding during each such period. The weighted average numbers of shares used in the basic income (loss) per share computations for the nine month periods ended September 30, 2001 and 2000 were 6,334,647 and 4,684,720, respectively. The weighted average numbers of shares used in the basic income per share computations for the three month periods ended September 30, 2001 and 2000 were 6,339,816 and 6,321,102, respectively. The weighted average numbers of shares used in the fully diluted income (loss) per share computations for the three and nine months ended September 30, 2001 were 6,525,145 and 6,488,435, respectively. The weighted average numbers of shares used in the fully diluted income per share computations for the three months ended September 30, 2000 was 6,497,085. The Company's common stock equivalents are anti-dilutive for the nine months ended September 30, 2000 and are therefore not included in the income (loss) per share calculation. Comprehensive Income (Loss) Components of comprehensive income (loss) include non-ownership related revenues, expenses, gains, and losses that under generally accepted accounting principles are included in equity but excluded from net income. Recent Accounting Pronouncements SFAS 133: In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" which was subsequently amended by SFAS No. 137 and SFAS No. 138. SFAS No. 137 and SFAS No. 138 deferred the effective date of the pronouncement from fiscal years that began June 15, 1999 to fiscal years that began June 30, 2000 and amended the reporting and accounting standards for derivative instruments and for hedging activities. SFAS No. 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives are accounted for depending on the purpose of the derivative and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. The adoption of SFAS No. 133, SFAS No. 137, and SFAS No. 138 has not had a material impact on the Company's results of operations or financial condition. SFAS 140: Effective April 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140"). SFAS 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain additional disclosures. Adoption of SFAS 140 did not have a material impact to the Company's consolidated financial statements. 8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-) SFAS 141 and SFAS 142: Recently, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141") and No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 and SFAS 142 eliminate the "pooling of interests" method of accounting for business combination initiated after June 30, 2001. They require that the acquirer's cost for an acquisition be allocated among the various assets acquired, in proportion to their relative fair market values, and any unallocated cost is assigned to the "residue," or goodwill. Certain intangible assets that are determined to have an indefinite useful life shall not be amortized. Additionally, goodwill shall no longer be amortized, but will be tested for impairment at least annually. These two statements must be adopted in fiscal years beginning after December 15, 2001. The Company is currently analyzing the potential impact of the implementation of SFAS 141 and SFAS 142 to its financial statements upon adoption on January 1, 2002. Adoption of these two pronouncements is not expected to have a material impact to the Company's consolidated financial statements. 2. Commitments and Contingencies In order to meet the financing needs of its customers in the normal course of business, the Company is party to financial instruments with off-balance sheet risk, which consist of commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. At September 30, 2001, we were committed to fund certain loans amounting to approximately $122,313,100. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Commitments generally have fixed expiration dates; however, since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon an extension of credit, is based on management's credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, residential real estate and income-producing commercial properties. We are subject to legal actions normally associated with financial institutions. At September 30, 2001, we did not have any pending contingencies that would be material to the consolidated financial condition or results of operations of the Company. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Background. The following discussion presents information about our consolidated results of operations, financial condition, liquidity and capital resources. Substantially all of our operations are conducted by the Bank and the Bank accounts for substantially all of our revenues and expenses. This information should be read in conjunction with the Company's quarterly unaudited consolidated financial statements, and the notes thereto, contained earlier in this Report. Forward-Looking Information. This discussion contains information regarding operating trends and expectations regarding our future performance (which is referred to as "forward-looking information"). That information is subject to the uncertainties and risks described below in the Section of this Report entitled "Forward Looking Information and Uncertainties Regarding Future Financial Performance" and readers of this Report are urged to read that Section in its entirety. Recent Operating Results. We generated net income of $534,700, or $0.08 per share, for the third quarter of 2001 as compared to net income of $217,100, or $0.03 per share, for the third quarter of 2000. For the nine months ended September 30, 2001 we generated net income of $1,424,200, or $0.22 per share, as compared to a net loss of $260,600, or $0.06 per share, for the same period of 2000. These improvements were due largely to increases in (i) interest income that were primarily attributable to the increases in the volume of our loans and other interest earning assets, and (ii) noninterest income that were primarily attributable to the expansion of our mortgage banking division. Per share income (loss) is based on weighted average shares outstanding of 6,339,816 for the third quarter of 2001 as compared to 6,321,102 for the third quarter of 2000 and 6,334,647 for the first nine months of 2001 as compared to 4,684,720 for the first nine months of 2000. The increase in the weighted average shares outstanding for the nine months ended September 30, 2001 was the result of our completion of a public offering in June 2000 in which we sold a total of 2,611,608 shares of our common stock. Also contributing to the improvement in our operating results was an income tax benefit of $100,000 arising from the recognition of a portion of the Bank's deferred tax asset. Set forth below are key financial performance ratios for the periods indicated:
Three months ended Nine months ended September 30, September 30, ------------------ ----------------- 2001 2000 2001 2000 ------ ------ ------ -------- Return on average assets (1) 1.07% 0.59% 1.04% (0.28)% Return on average shareholders' equity (1) 5.90% 2.52% 5.42% (1.58)% Net interest margin 4.70% 4.91% 4.69% 4.75% Basic and fully diluted income (loss) per share $0.08 $0.03 $0.22 $(0.06)
-------------- (1) Annualized Results of Operations Net Interest Income. Net interest income, the primary determinant of our operating income, represents the difference between interest earned on interest earning assets and the interest paid on interest bearing liabilities. Net interest income, when expressed as a percentage of total average interest earning assets, is referred to as "net interest margin." We generated net interest income of $2,227,400 and $6,080,700, respectively, in the quarter and nine months ended September 30, 2001 as compared to net interest income of $1,810,700 and $4,153,900, respectively, for the corresponding quarter and nine months of 2000. These increases in net interest income were largely attributable to increases in interest income of $359,300 and $2,196,000, respectively, in the quarter and nine months ended September 30, 2001, as well as a $57,400 decrease in our interest expense in the quarter ended 10 September 30,2000 and offset by a $269,200 increase in interest expense for the nine months ended September 30, 2000. The increases in interest income were largely attributable to an increase of approximately $57,872,900 and $49,639,600, respectively, in our average loans outstanding for those two periods which generated $713,200 and $2,252,300, respectively, of additional interest and fee income in the quarter and nine months ended September 30, 2001 as compared to the same periods of 2000, which more than offset the effect of declining interest rates on loans and other interest earning assets due to declining market rates of interest. The decrease in interest expense for the quarter ended September 30, 2001 was due to declining market rates of interest. The increase in interest expense for the nine months ended September 30, 2001 was primarily attributable to an increase of approximately $22,607,900 in average interest bearing deposits outstanding during that nine month period compared to the corresponding period of 2000, which more than offset the effects on interest expense of declining market rates of interest. Our ratio of net interest income to average earning assets ("net interest margin") for the quarter and nine months ended September 30, 2001 declined to 4.70% and 4.69%, respectively, as compared to 4.91% and 4.75%, respectively, for the corresponding periods of 2000. These declines were attributable to declines in the average prime lending rate for the quarter and nine months ended September 30, 2001 of 0.14% and 1.98%, respectively and an increase in the average prime lending rate for the nine months ended September 30, 2000 of .65%. The prime lending rate did not change during the third quarter of 2000. As described below in the Subsection entitled "Asset/Liability Management," our balance sheet was shown to be in a positive gap position at September 30, 2001. This implies that our earnings would increase in the short-term if interest rates rise and would decline in the short-term if interest rates were to fall. Noninterest income The following table sets forth the major components of noninterest income for the periods indicated:
Three Months Ended Nine Months Ended September 30, September 30, ----------------------------------------------------------------------------- 2001 2000 2001 2000 ---- ---- ---- ---- Service charges and fees $ 57,400 $ 44,700 $ 169,900 $ 97,100 Net gains on sales of loans held for sale 420,100 96,700 795,700 211,000 Mortgage banking 445,600 54,100 1,008,500 261,100 Merchant income 81,100 25,500 205,600 89,200 Other 15,400 3,200 82,100 21,300 ----------------------------------------------------------------------------- Total noninterest income $1,019,600 $224,200 $2,261,800 $679,700 =============================================================================
Noninterest Income. Noninterest income consists of service charges and fees on deposit accounts, net gains on sales of loans held for sale, mortgage banking income, merchant income, and other noninterest income. Noninterest income for the quarter ended September 30, 2001 consisted primarily of loan origination and processing fees and yield spread premium generated by the mortgage banking division, which originates conforming and non-conforming, agency quality, residential first and home equity mortgage loans. Mortgage banking income, including net gains on sales of loans held for sale, increased to $865,700 and $1,804,200, respectively for the quarter and nine months ended September 30, 2001 from $150,800 and $472,100, respectively, for the corresponding quarter and nine months of 2000. Those increases were attributable to increases of $84 million and $186 million, respectively, in mortgage loan volume from the corresponding periods of 2000. Noninterest Expense. The following table provides detail of the Company's noninterest expense by category for the periods indicated: 11
Three Months Ended Nine Months Ended September 30, September 30 --------------------------------------------- 2001 2000 2001 2000 ---------- ---------- ---------- ---------- Salaries and employee benefits $1,393,000 $ 880,100 $3,457,100 $2,647,600 Occupancy 382,600 128,300 740,900 361,700 Depreciation 189,200 108,400 445,500 304,100 Equipment 59,900 17,300 124,700 69,900 Data processing 74,900 72,900 220,200 184,500 Professional fees 94,000 79,500 291,300 201,500 Other loan related 107,300 41,700 270,500 95,100 Stationery and supplies 71,000 52,800 161,200 114,300 Courier 68,600 41,000 159,200 87,600 Advertising, promotion, and development 14,900 62,900 161,300 189,300 Correspondent bank service charges 39,400 31,300 107,600 91,500 Other operating expense (1) 217,500 201,600 578,800 447,100 ---------- ---------- ---------- ---------- Total noninterest expense $2,712,300 $1,717,800 $6,718,300 $4,794,200 ========== ========== ========== ==========
(1) Other operating expense primarily consists of telephone expense, check charges for customers, and insurance expense. Noninterest Expense. Total noninterest expense for the quarter and nine months ended September 30, 2001 was $2,712,300 and $6,718,300, respectively, as compared to $1,717,800 and $4,794,200, respectively, for the corresponding periods of 2000. Salaries and employee benefits constitute the largest components of noninterest expense. The increases in noninterest expense in the first nine months of 2001 were attributable primarily to increased staffing, occupancy and equipment costs in connection with the opening of two new banking centers, one in Costa Mesa and the other in Beverly Hills, California, and a new headquarters also in Costa Mesa. Loan-related expenses increased as a result of the increase in our mortgage banking operations noted above. Noninterest expense as a percentage of net revenue (the "efficiency ratio") improved to 83.5% for the quarter ended September 30, 2001 from 84.4% for the corresponding period of 2000. This improvement indicated that a proportionately smaller amount of net revenue was required to provide for noninterest expenses. This improvement was attributable to the increases in interest income and noninterest income, which more than offset the increases in noninterest expense in the quarter ended September 30, 2001. Noninterest expense as a percentage of average assets for the three months ended September 30, 2001 and 2000 was 5.42% and 4.65%, respectively. Asset/Liability Management The objective of asset/liability management is to reduce our exposure to interest rate fluctuations, which can affect our net interest margins and, therefore, also our net interest income and net earnings. We seek to achieve this objective by matching interest-rate sensitive assets and liabilities, and maintaining the maturity and repricing of these assets and liabilities at appropriate levels given the interest rate environment. Generally, if rate sensitive assets exceed rate sensitive liabilities, the net interest income will be positively impacted during a rising rate environment and negatively impacted during a declining rate environment. When rate sensitive liabilities exceed rate sensitive assets, the net interest income will generally be positively impacted during a declining rate environment and negatively impacted during a rising rate environment. However, because interest rates for different asset and liability products offered by depository institutions respond differently to changes in the interest rate environment, the gap is only a general indicator of interest rate sensitivity. The table below sets forth information concerning our rate sensitive assets and rate sensitive liabilities as of September 30, 2001. The assets and liabilities are classified by the earlier of maturity or repricing date in accordance with their contractual terms. Certain shortcomings are inherent in the method of analysis presented in the following table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees and at different times to changes in market interest rates. Rates on some assets and liabilities change in advance of changes in market rates of interest, while rates on other assets or 12 liabilities may lag behind changes in market rates of interest. Also, loan prepayments and early withdrawals of certificates of deposit could cause the interest sensitivities to vary from those which appear in the table.
Over Three Over One Three Through Year Over Non- Months Twelve Through Five Interest Or Less Months Five Years Years Bearing Total ------------ ----------- ----------- ----------- ------------ ------------ Assets ------ Interest-bearing deposits in Other financial institutions $ 99,000 $ 1,288,000 $ -- $ -- $ -- $ 1,387,000 Securities available for sale 1,057,500 152,200 5,433,500 1,667,700 -- 8,310,900 Federal Reserve Bank stock -- -- -- 850,100 -- 850,100 Federal Funds Sold 15,240,000 -- -- -- -- 15,240,000 Loans, gross 128,607,500 18,410,200 12,984,900 4,967,500 -- 164,970,100 Non-interest earning assets -- -- -- -- 14,879,600 14,879,600 ------------ ----------- ----------- ----------- ------------ ------------ Total assets $145,004,000 $19,850,400 $18,418,400 $ 7,485,300 $ 14,879,600 $205,637,700 ============ =========== =========== =========== ============ ============ Liabilities and Stockholders' Equity: ------------------------------------- Noninterest-bearing deposits $ 41,863,500 $ -- $ -- $ -- $ 15,911,100 $ 57,774,600 Interest-bearing deposits 90,960,300 14,928,800 1,533,800 -- -- 107,422,900 Repurchase agreements 2,933,500 -- -- -- -- 2,933,500 Other liabilities -- -- -- -- 1,238,100 1,238,100 Stockholders' equity -- -- -- -- 36,268,600 36,268,600 ------------ ----------- ----------- ------------ ------------ ------------ Total liabilities and Stockholders equity $135,757,300 $14,928,800 $ 1,533,800 $ -- $ 53,417,800 $205,637,700 ------------ ----------- ------------ ------------ ------------ Interest rate sensitivity gap $ 9,246,700 $ 4,921,600 $16,884,600 $ 7,485,300 $(38,538,200) $ -- ============ =========== =========== =========== ============ ============= Cumulative interest rate Sensitivity gap $ 9,246,700 $14,168,300 $31,052,900 $38,538,200 $ -- $ -- ============ =========== =========== =========== ============= ============= Cumulative % of rate sensitive assets in maturity period 70.51% 80.17% 89.12% 92.76% 100.00% ====== ====== ====== ====== ======= Rate sensitive assets to rate Sensitive liabilities 1.07 1.33 12.01 N/A N/A ====== ====== ====== ====== ======= Cumulative ratio 1.07 1.09 1.20 1.25 N/A ====== ====== ====== ====== =======
At September 30, 2001, our rate sensitive balance sheet was shown to be in a positive gap position. This implies that our net interest margin would increase in the short-term if interest rates rise and would decline in the short-term if interest rates were to fall. And, during the quarter ended September 30, 2001, our net interest margin was lower than in the same quarter of 2000, due to a decline in prevailing market rates of interest. However, as noted above, the extent to which our net interest margin will be impacted by changes in prevailing interests rates will depend on a number of factors, including how quickly rate sensitive assets and liabilities react to interest rate changes. Financial Condition Assets. Total assets increased to $205,637,700 at September 30, 2001 from $162,616,900 at December 31, 2000, due primarily to increases in loans and loans held for sale. Loans Held for Sale. Loans intended for sale in the secondary market totaled $39,580,500 at September 30, 2001 and $11,084,400 at December 31, 2000. This increase was attributable primarily to the increase in outstanding loans originated or purchased by our mortgage banking division. Purchased loans are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Loans. Loans outstanding at December 31, 2000 and September 30, 2001 (exclusive of loans held for sale) were made to customers in Southern California, the primary market areas being Orange and Los Angeles Counties. The greatest concentration of our loans are in real estate loans and commercial loans, which represented 50% and 41%, respectively, of the loan portfolio at September 30, 2001 and 53% and 38%, respectively at December 31, 2000. 13 The loan portfolio consisted of the following at September 30, 2001 and December 31, 2000: September 30, December 31, 2001 Percent 2000 Percent ------------ --------- ----------- ---------- Real estate loans $ 62,780,000 50.1% $46,882,000 53.1% Commercial loans 50,804,900 40.6% 33,732,400 38.2% Construction loans 5,976,800 4.8% 3,238,900 3.7% Consumer loans 5,703,000 4.5% 4,393,700 5.0% ------------ --------- ----------- ---------- Gross loans 125,264,700 100.0% 88,247,000 100.0% ========= ========== Deferred loan origination costs, net 124,900 159,300 Allowance for loan losses (1,445,500) (1,145,500) ------------ ----------- Loans, net $123,944,100 $87,260,800 ============ ===========
Commercial loans are loans to businesses to finance capital purchases or improvements, or to provide cash flow for operations. Real estate loans are loans secured by trust deeds on real property, including property under construction, commercial property and single family and multifamily residences. Consumer loans include installment loans to consumers as well as home equity loans and other loans secured by junior liens on real property. The following table sets forth the maturity distribution of the Bank's loan portfolio (excluding consumer loans) at September 30, 2001:
Over One Year One Year Through Over Five Or Less Five Years Years Total ------- ---------- ----- ----- Real estate loans Floating rate $ 3,231,300 $ 4,383,000 $49,445,900 $ 57,060,200 Fixed rate 926,600 423,100 4,370,100 5,719,800 Commercial loans Floating rate 32,198,300 9,038,300 1,916,100 43,152,700 Fixed rate 1,646,500 4,118,700 1,887,000 7,652,200 Construction loans Floating rate 3,728,400 -- -- 3,728,400 Fixed rate 428,900 -- 1,819,500 2,248,400 -------------- ----------- ----------- ------------ Total $ 42,160,000 $17,963,100 $59,438,600 $119,561,700 ============== =========== =========== ============
Allowance for Loan Losses. The risk that borrowers will fail or be unable to repay their loans is an inherent part of the banking business. In order to recognize on a timely basis, to the extent practicable, losses that can result from such failures, banks establish an allowance for loan losses by means of periodic charges to income known as "provisions for loan losses." Loans are charged against the allowance for loan losses when management believes that collection of the carrying amount of the loan, either in whole or in part, has become unlikely. Periodic additions are made to the allowance (i) to replenish and thereby maintain the adequacy of the allowance following the occurrence of loan losses, and (ii) to increase the allowance in response to increases in the volume of outstanding loans and deterioration in economic conditions or in the financial condition of borrowers. The Bank evaluates the adequacy of and makes provisions in order to maintain or increase the allowance for loan losses on a quarterly basis. As a result, provisions for loan losses will normally represent a recurring expense. 14 The allowance for loan losses at December 31, 2000 was $1,145,500, which represented 1.3% of outstanding loans at that date. At September 30, 2001, the allowance had been increased to $1,445,500, in order to maintain the allowance at approximately 1.2% of outstanding loans. The Bank carefully monitors changing economic conditions, the loan portfolio by category, borrowers' financial condition and the history of the portfolio in determining the adequacy of the allowance for loan losses. We are not currently aware of any information indicating that there will be material deterioration in our loan portfolio, and we believe that the allowance for loan losses at September 30, 2001 is adequate to provide for losses inherent in the portfolio. However, the allowance was established on the basis of estimates developed primarily from historical industry loan loss data because the Bank commenced operations in March 1999 and lacks any long-term historical data relating to the performance of loans in its loan portfolio. As a result, ultimate losses may vary from the estimates used to establish the allowance. As the volume of loans increases, additional provisions for loan losses will be required to maintain the allowance at adequate levels. Additionally, if economic conditions were to deteriorate, it would become necessary to increase the allowance by means of additional provisions for loan losses. We also measure and reserve for impairment on a loan by loan basis using either the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if the loan is collateral dependent. As of September 30, 2001, we had no loans classified as impaired. We exclude from our impairment calculations smaller, homogeneous loans such as consumer installment loans and lines of credit. Also, loans that experience insignificant payment delays or payment shortfalls are generally not considered impaired. A summary of the transactions in the allowance for loan losses for the nine months ended September 30, 2001 and the year ended December 31, 2000 is as follows:
September 30, 2001 December 31, 2000 ------------------ ----------------- Balance, beginning of period $1,145,500 $ 750,000 Provision for loan losses 300,000 400,000 Recoveries -- -- Amounts charged off -- (4,500) ---------- ---------- Balance, end of period $1,445,500 $1,145,500 ========== ==========
Nonperforming Assets. There were no nonaccrual loans, restructured loans or loans which were considered impaired at September 30, 2001 or December 31, 2000. Deposits. At September 30, 2001 deposits totaled $165,197,500, which included $32,894,900 of certificates of deposits of $100,000 or more. By comparison, deposits at December 31, 2000, totaled $124,286,500, which included $17,212,900 of certificates of deposit of $100,000 or more. Noninterest bearing demand deposits totaled $57,774,600, or 35.0% of total deposits at September 30, 2001. By comparison noninterest bearing demand deposits totaled $48,553,100, or 39.1% of total deposits, at December 31, 2000. Set forth below is maturity schedule of domestic time certificates of deposits outstanding at September 30, 2001:
Certificates of Deposit Certificates of Deposit of Maturities Under $100,000 $100,000 or more ------------------------------------------ -------------- ---------------- Three Months or Less $2,206,000 $22,719,800 Over Three and though Six Months 2,079,500 6,955,600 Over Six through Twelve Months 2,633,100 3,010,600 Over Twelve Months 1,324,900 208,900 ---------- ----------- $8,243,500 $32,894,900 ========== ===========
15 Liquidity Our liquidity needs are actively managed to insure sufficient funds are available to meet the ongoing needs of the Bank's customers. We project the future sources and uses of funds and maintain sufficient liquid funds for unanticipated events. The primary sources of funds include payments on loans, the sale or maturity of investments and growth in deposits. The primary uses of funds includes funding new loans, making advances on existing lines of credit, purchasing investments, funding deposit withdrawals and paying operating expenses. The Bank maintains funds in overnight federal funds and other short- term investments to provide for short-term liquidity needs. Cash flow provided by financing activities, primarily representing increases in deposits, totaled $41,225,200 for the nine months ended September 30, 2001. Cash flow used in operating activities, primarily representing the net increase in loans held for sale, totaled $27,163,200. Cash flow used in investing activities, primarily representing increases in loans and purchases of securities available for sale, offset by proceeds from the maturities of securities available for sale, totaled $34,736,500 for the nine months ended September 30, 2001. At September 30, 2001, liquid assets, which included cash and due from banks, federal funds sold, interest earning deposits with financial institutions and unpledged securities available for sale (excluding Federal Reserve Bank stock) totaled $28,300,800 or 14% of total assets. Our primary uses of funds are loans and our primary sources of the funds that we use to make loans are deposits. Accordingly, the relationship between gross loans and total deposits provides a useful measure of our liquidity. Since repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loan to deposit ratio the less liquid are our assets. On the other hand, since we realize greater yields and higher interest income on loans than it does on investments, a lower loan to deposit ratio can adversely affect interest income and the earnings of the Bank. As a result, management's goal is to achieve a loan to deposit ratio that appropriately balances the requirements of liquidity and the need to generate a fair return on assets. At September 30, 2001, the loan to deposit ratio was 97.2%, compared to 80.0% at December 31, 2000. As of September 30, 2001, the Company had $2.9 million in securities sold under agreements to repurchase which are classified as secured borrowings and mature within one day from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. The Bank monitors the fair value of the underlying securities to ensure that sufficient collateral exists. Investments and Investment Policy Our investment policy is to provide for our liquidity needs to generate a favorable return on investments without undue interest rate risk, credit risk or asset concentrations. Our investment policy authorizes us to invest in obligations issued or fully guaranteed by the United States government, certain federal agency obligations, certain time deposits, certain municipal securities and federal funds sold. It is our policy that there will be no trading account. The weighted average maturity of U.S. government obligations, federal agency securities and municipal obligations cannot exceed five years. Time deposits must be placed with federally insured financial institutions, cannot exceed $100,000 in any one institution and may not have a maturity exceeding twenty- four months. Securities available for sale are those that we intend to hold for an indefinite period of time, but that may be sold in response to changes in liquidity needs, changes in interest rates, changes in prepayment risks or other similar factors. The securities are recorded at fair value. Any unrealized gains and losses are reported as "Other Comprehensive Income (Loss)" rather than included in or deducted from earnings. 16 The following is a summary of the major components of securities available for sale and a comparison of the amortized cost, estimated fair values and gross unrealized gains and losses as of September 30, 2001 and December 31, 2000:
Gross Gross Estimated Amortized Unrealized Unrealized Fair September 30, 2001 Cost Gains (Losses) Value ------------------------------------------ ----------- ----------- ----------- ------------ Available-For-Sale: U.S. Agency Securities less than one year $5,220,700 $34,200 $ -- $5,255,400 Collateralized mortgage obligations 2,988,000 67,500 -- 3,055,500 Federal Reserve Bank Stock 850,100 -- -- 850,100 ----------- ------- ------- ---------- Total $9,058,800 $102,200 $ -- $9,161,000 =========== ======== ======= ========== Gross Gross Estimated Amortized Unrealized Unrealized Fair December 31, 2000 Cost Gains (Losses) Value -------------------------------------------- ----------- ----------- ---------- ----------- Available-For-Sale: U.S. Treasury Securities less than one year $ 2,204,300 $ -- $ -- $ 2,204,300 U.S. Agency Securities less than one year 9,955,000 6,900 -- 9,961,900 Federal Reserve Bank Stock 821,700 -- -- 821,700 ----------- ------ ------- ----------- Total $12,981,000 $6,900 $ -- $12,987,900 =========== ====== ======= ===========
At September 30, 2001, we had U.S. government agency securities and collateralized mortgage obligations with a carrying value of $8,310,900 that were pledged to secure repurchase agreements. The contractual maturities of the U.S. government agency securities at September 30, 2001 were between one and seventy-eight months. Although the collateral mortgage obligations have contractual maturities through 2027, expected maturities will differ from contractual maturities because borrowers may have the right to prepay such obligations without penalty. The weighted average yield is 5.05% for U.S. government agency securities, 5.70% for collateral mortgage obligations and 6.0% for Federal Reserve Bank stock. Capital Resources The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can lead to certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's operating results or financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action that apply to all bank holding companies and FDIC insured banks in the United States, the Company (on a consolidated basis) and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company (on a consolidated basis) and the Bank to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes that, as of September 30, 2001, the Company (on a consolidated basis) and the Bank met all capital adequacy requirements to which they are subject. 17 As of September 30, 2001, based on applicable capital regulations, the Company (on a consolidated basis) and the Bank are categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table which contains a comparison of the Company and Bank's capital and capital ratios at September 30, 2001 to the regulatory requirements applicable to them.
To be Well Capitalized Under Prompt For Capital Corrective Action Actual Adequacy Purposes Provisions ------ ----------------- ---------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- Total Capital to Risk Weighted Assets: Bank $30,667,600 14.6% $16,793,600 greater than equal to 8.0% $20,992,000 greater than equal to 10.0% Company 37,612,000 17.9% 16,798,700 greater than equal to 8.0% 20,998,300 greater than equal to 10.0% Tier I Capital to Risk Weighted Assets: Bank 29,222,100 13.9% 8,396,800 greater than equal to 4.0% 12,595,200 greater than equal to 6.0% Company 36,166,500 17.2% 8,399,300 greater than equal to 4.0% 12,599,000 greater than equal to 6.0% Tier I Capital to Average Assets: Bank 29,222,100 14.7% 7,932,600 greater than equal to 4.0% 9,915,700 greater than equal to 5.0% Company 36,166,500 18.2% 7,930,800 greater than equal to 4.0% 9,913,600 greater than equal to 5.0%
The Company intends to retain earnings to support future growth and, therefore, does not intend to pay dividends for at least the foreseeable future. In addition, the Bank has agreed with the FDIC to maintain a Tier 1 Capital to Average Assets ratio of at least eight percent until February 28, 2002. Forward Looking Information and Uncertainties Regarding Future Financial Performance This Report, including management's discussion above concerning our results of operation and financial condition, contains "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. Forward- looking statements are estimates of or statements about our expectations or beliefs regarding our future financial performance or anticipated future financial condition that are based on current information and that are subject to a number of risks and uncertainties that could cause our actual operating results in the future to differ significantly from those expected at the current time. Those risks and uncertainties include, although they are not limited to, the following: Increased Competition. Increased competition from other banks and financial service businesses, mutual funds and securities brokerage and investment banking firms that offer competitive loan and investment products could require us to reduce interest rates and loan fees to attract new loans or to increase interest rates that we offer on time deposits, either or both of which could, in turn, reduce interest income and net interest margins. Possible Adverse Changes in Economic Conditions. Adverse changes in national or local economic conditions could (i) reduce loan demand which could, in turn, reduce interest income and net interest margins; (ii) adversely affect the financial capability of borrowers to meet their loan obligations which, in turn, could result in increases in loan losses and require increases in provisions made for possible loan losses, thereby adversely affecting operating results; and (iii) lead to reductions in real property values that, due to our reliance on real property to secure many of our loans, could make it more difficult for us to prevent losses from being incurred on non-performing loans through the sale of such real properties. Possible Adverse Changes in National Economic Conditions and FRB Monetary Policies. Changes in national economic conditions, such as increases in inflation or declines in economic output often prompt changes in Federal Reserve Board monetary policies that could reduce interest income or increase the cost of funds to us, either of which could result in reduced earnings. In the past few months there has been a slowing in economic growth nationally, the duration and severity of which are difficult to predict at this time. The Federal Reserve Board has recently reduced interest rates to stimulate the economy and those reductions could result in a decline in interest 18 income as compared to prior periods. If, on the other hand, there is a continuing downturn in the economy, loan losses could increase thereby adversely affecting operating results. Changes in Regulatory Policies. Changes in federal and state bank regulatory policies, such as increases in capital requirements or in loan loss reserve or asset/liability ratio requirements, could adversely affect earnings by reducing yields on earning assets or increasing operating costs. Effects of Growth. It is our intention to take advantage of opportunities to increase our business, either through acquisitions of other banks or the establishment of new banking offices. In particular, we have opened two new banking offices during the second and third quarters of 2001, which has increased our noninterest expense and if we open additional offices or acquire any other banks, we are likely to incur additional operating costs until those offices achieve profitability or the acquired banks are integrated into our operations. Other risks that could affect our future financial performance are described in the Section entitled "Risk Factors" in the Prospectus dated June 14, 2000, included in our S-1 Registration Statement filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended, and our Annual Report on Form 10-K for the fiscal year ended December 31, 2000 filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. Readers of this Report are urged to review the discussion of those risks as well contained in that Prospectus and that Annual Report. Due to these and other possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements contained in this Report, which speak only as of the date of this Quarterly Report, or to make predictions based solely on historical financial performance. We also disclaim any obligation to update forward-looking statements contained in this Report, in our Prospectus or in our Annual Report. ITEM 3. MARKET RISK Market risk is the risk of loss to future earnings, to fair values of assets or to future cash flows that may result from changes in the price or value of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates and other market conditions. Market risk is attributed to all market risk sensitive financial instruments, including loans, investment securities, deposits and borrowings. We do not engage in trading activities or participate in foreign currency transactions for our own account. Accordingly, our exposure to market risk is primarily a function of our asset and liability management activities and of changes in market rates of interest. Changes in rates can cause or require increases in the rates we pay on deposits that may take effect more rapidly or may be greater than the increases in the interest rates we are able to charge on loans and the yields that we can realize on our investments. The extent of that market risk depends on a number of variables including the sensitivity to changes in market interest rates and the maturities of our interest earning assets and our deposits. See "Asset/Liability Management." PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. None (b) Reports on Form 8-K: None 19 SIGNATURES Pursuant to the requirements 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. DATE: November 13, 2001 PACIFIC MERCANTILE BANCORP By: /s/ DANIEL L. ERICKSON ------------------------------------- Daniel L. Erickson, Executive Vice President and Chief Financial Officer S-1