10-Q 1 e10-q.txt FORM 10-Q FOR QUARTERLY PERIOD ENDED JUNE 30, 2000 1 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 June 30, 2000 ------------------------------------------------- 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 0-11337 ----------- FOOTHILL INDEPENDENT BANCORP ----------------------------------------------------------- (Exact name of Registrant as specified in its charter) DELAWARE 95-3815805 -------------------------------------------------------------------------------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 510 SOUTH GRAND AVENUE, GLENDORA, CALIFORNIA 91741 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (626) 963-8551 or (909) 599-9351 ------------------------------------------ (Registrant's telephone number, including area code) Not Applicable ----------------------------------- (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. 5,343,697 shares of Common Stock as of August 4, 2000 2 PART I - FINANCIAL STATEMENTS FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (dollars in thousands)
June 30, December 31, 2000 1999 --------- ------------ ASSETS Cash and due from banks $ 30,683 $ 23,262 Federal funds sold 8,100 3,600 --------- --------- Total Cash and Cash Equivalents 38,783 26,862 --------- --------- Interest-bearing deposits in other financial institutions 1,979 7,919 --------- --------- Investment Securities Held-To-Maturity (approximate market value $20,114 in 2000 and $7,245 in 1999 U.S. Treasury 998 2,997 U.S. Government Agencies 16,370 1,000 Municipal Agencies 922 1,062 Other Securities 2,250 2,250 --------- --------- Total Investment Securities Held-To-Maturity 20,540 7,309 --------- --------- Investment Securities Available-For-Sale 46,499 56,015 --------- --------- Loans, net of unearned discount and prepaid points and fees 358,309 343,294 Direct lease financing 1,301 2,341 Less reserve for possible loan and lease losses (3,702) (6,102) --------- --------- Total Loans & Leases, net 355,908 339,533 --------- --------- Bank premises and equipment 6,854 6,779 Accrued interest 2,758 2,928 Other real estate owned, net of allowance for possible losses of $0 in 2000 and $42 in 1999 2,421 1,714 Cash surrender value of life insurance 5,329 4,997 Prepaid expenses 1,075 1,618 Deferred tax asset 2,277 2,412 Other assets 570 590 --------- --------- Total Assets $ 484,993 $ 458,676 ========= ========= LIABILITIES AND Deposits STOCKHOLDERS' EQUITY Demand deposits $ 144,197 $ 133,115 Savings and NOW deposits 103,562 101,839 Money market deposits 73,671 72,400 Time deposits in denominations of $100,000 or more 46,253 40,408 Other time deposits 67,850 49,502 --------- --------- Total deposits 435,533 397,264 --------- --------- Accrued employee benefits 1,967 2,002 Accrued interest and other liabilities 1,452 2,152 Short-term debt 8,800 Long-term debt 19 --------- --------- Total Liabilities 438,952 410,237 --------- --------- Stockholders' Equity Common Stock par value $.001 per share - authorized: 25,000,000 shares; issued outstanding: 5,337,861 shares in 2000 and 5,772,614 in 1999 36,581 36,415 Additional Paid-in Capital 963 963 Retained Earnings 9,042 11,898 Accumulated Other Comprehensive Income (545) (837) --------- --------- Total Stockholders' Equity 46,041 48,439 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 484,993 $ 458,676 ========= =========
See accompanying notes to financial statements 2 3 FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (dollars in thousands)
Six Months Ended Three Months Ended June 30, June 30, ---------------------- ---------------------- 2000 1999 2000 1999 -------- -------- -------- -------- INTEREST INCOME Interest and fees on loans $ 16,677 $ 14,444 $ 8,255 $ 7,464 Interest on investment securities U.S. Treasury 48 282 13 121 Obligations of other U.S. government agencies 1,250 1,312 609 620 Municipal agencies 161 177 79 89 Other securities 485 664 316 308 Interest on deposits 94 408 34 208 Interest on Federal funds sold 274 291 163 139 Lease financing income 46 92 19 44 -------------------------------------------------- Total Interest Income 19,035 17,670 9,488 8,993 -------------------------------------------------- INTEREST EXPENSE Interest on savings & NOW deposits 777 768 389 386 Interest on money market deposits 1,473 1,352 757 693 Interest on time deposits in denominations of $100,000 or more 1,212 814 657 362 Interest on other time deposits 1,586 1,249 909 618 Interest on borrowings 48 3 4 1 -------------------------------------------------- Total Interest Expense 5,096 4,186 2,716 2,060 -------------------------------------------------- Net Interest Income 13,939 13,484 6,772 6,933 PROVISION FOR LOAN AND LEASE LOSSES 475 280 455 124 -------------------------------------------------- Net Interest Income After Provisions for Loan and Lease Losses 13,464 13,204 6,317 6,809 -------------------------------------------------- OTHER INCOME Fees and service charges 2,140 2,215 1,139 1,154 Gain on sale SBA loans 6 100 4 72 Other 56 23 29 23 -------------------------------------------------- Total other income 2,202 2,338 1,172 1,249 -------------------------------------------------- OTHER EXPENSES Salaries and benefits 5,026 4,790 2,331 2,441 Occupancy expenses, net of revenue of $94 in 2000 and $86 in 1999 1,114 1,036 571 526 Furniture and equipment expenses 777 825 390 420 Other expenses (Note 2) 3,639 4,064 1,618 2,219 -------------------------------------------------- Total Other Expenses 10,556 10,715 4,910 5,606 -------------------------------------------------- INCOME BEFORE INCOME TAXES 5,110 4,827 2,579 2,452 -------------------------------------------------- PROVISION FOR INCOME TAXES 1,888 1,762 953 895 -------------------------------------------------- NET INCOME $ 3,222 $ 3,065 $ 1,626 $ 1,557 ================================================== EARNINGS PER SHARE (Note 3) Basic $ 0.58 $ 0.52 $ 0.30 $ 0.26 -------------------------------------------------- Diluted $ 0.55 $ 0.49 $ 0.29 $ 0.25 --------------------------------------------------
See accompanying notes to financial statements 3 4 FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (dollars in thousands) SIX MONTHS ENDED JUNE 30, 2000 AND 1999
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2000 1999 ----------- ----------- Cash Flows From Operating Activities: Interest and fees received $ 19,097 $ 17,753 Service fees and other income received 1,872 2,084 Financing revenue received under leases 46 92 Interest paid (4,861) (4,335) Cash paid to suppliers and employees (10,126) (11,406) Income taxes paid (1,891) (1,344) ----------- ----------- Net Cash Provided by (Used in) Operating Activities 4,137 2,844 ----------- ----------- Cash Flows From Investing Activities: 832,832 1,057,405 Proceeds from maturity of investment securities (AFS) Purchase of investment securities (AFS) (838,198) (1,041,015) Proceeds from maturity of investment securities (HTM) 2,140 5,005 Purchase of investment securities (HTM) (1) (4,003) Proceeds from maturity of deposits in other financial institutions 9,902 15,830 Purchase of deposits in other financial institutions (3,962) (18,113) Net (increase) decrease in credit card and revolving credit receivables 8 93 Recoveries on loans previously written off (25) 119 Net (increase) decrease in loans (18,106) (19,046) Net (increase) decrease in leases 1,040 953 Proceeds from property, plant and equipment 20 20 Capital expenditures (1,420) (589) Proceeds from sale of other real estate owned -- 99 Stock repurchased and retired (5,226) (1,820) ----------- ----------- Net Cash Provided by (Used in) Investing Activities (20,996) (5,062) =========== =========== Cash Flows From Financing Activities: Net increase in demand deposits, NOW accounts, 14,092 8,702 savings accounts, and money market deposits Net increase in certificates of deposit with maturities of three months or less 2,257 3,393 Net increase (decrease) in certificates of deposit with maturities of more than three months 21,936 (11,606) Net increase (decrease) in short term borrowing (8,800) -- Proceeds from exercise of stock options 24 95 Proceeds from stock issued under employee benefit and dividend reinvestment plans 142 159 Principal payment on long term debt (19) (27) Dividends paid (852) (1,481) ----------- ----------- Net Cash Provided by Financing Activities 28,780 (765) ----------- ----------- Net Increase (Decrease) in Cash and Cash Equivalents 11,921 (2,983) Cash and Cash Equivalents at Beginning of Year 26,862 37,482 ----------- ----------- Cash and Cash Equivalents at June 30, 2000 and 1999 $ 38,783 $ 34,499 =========== ===========
See accompanying notes to financial statements 4 5 FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (dollars in thousands) SIX MONTHS ENDED JUNE 30, 2000 AND 1999 RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
2000 1999 -------- -------- Net Income $ 3,222 $ 3,065 ======== ======== Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities Depreciation and amortization 657 640 Provision for possible credit losses 475 280 Provision for possible OREO losses 42 (41) (Gain)/loss on sale of equipment 2 3 Provision for deferred taxes 135 136 Increase/(decrease) in taxes payable (138) 282 (Increase)/decrease in other assets 30 (128) (Increase)/decrease in interest receivable 170 106 Increase/(decrease) in discounts and premiums (62) 69 Increase/(decrease) in interest payable 235 (149) (Increase)/decrease in prepaid expenses 543 (984) Increase/(decrease) in accrued expenses and other liabilities (842) (178) Increase in cash surrender value of life insurance (332) (257) -------- -------- Total Adjustments 915 (221) -------- -------- Net Cash Provided (Used) by Operating Activities $ 4,137 $ 2,844 ======== ========
DISCLOSURE OF ACCOUNTING POLICY 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. See accompanying notes to financial statements 5 6 FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) (dollars in thousands) SIX MONTHS ENDED JUNE 30, 2000 AND 1999
Accumulated Number of Additional Other Shares Capital Paid-In Comprehensive Retained Comprehensive Outstanding Stock Capital Income Earnings Income Total ----------- ---------- ---------- ------------- ---------- -------------- ---------- BALANCE - January 1, 1999 5,985,244 $ 36,057 $ 963 $ 11,516 $ (157) $ 48,379 Cash dividend (1,481) (1,481) Exercise of stock options 13,869 95 95 Common stock issued under employee benefit and dividend reinvestment plans 10,872 159 159 Common stock repurchased, cancelled and retired (121,950) (1,820) (1,820) Comprehensive Income 3,065 3,065 3,065 Net Income Unrealized security holding losses (Net of taxes $54) (410) (410) (410) ---------- Total Comprehensive Income $ 2,655 ---------- ---------- ---------- ========== ---------- ---------- ---------- BALANCE - June 30, 1999 5,888,035 $ 36,111 $ 963 $ 11,280 $ (567) $ 47,987 ========== ========== ========== ========== ========== ========== BALANCE - January 1, 2000 5,772,614 36,415 963 11,898 (837) 48,439 Cash dividend (852) (852) Exercise of stock options 4,048 24 24 Common stock issued under employee benefit and dividend reinvestment plans 14,678 142 142 Common stock repurchased, cancelled and retired (453,479) (5,226) (5,226) Comprehensive Income Net Income 3,222 3,222 3,222 Unrealized security holding gains (Net of taxes $134) 292 292 292 ---------- Total Comprehensive Income $ 3,514 ========== ---------- ---------- ---------- ---------- ---------- ---------- BALANCE - June 30, 2000 5,337,861 $ 36,581 $ 963 $ 9,042 $ (545) $ 46,041 ========== ========== ========== ========== ========== ==========
See accompanying notes to financial statements 6 7 FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (dollars in thousands) JUNE 30, 2000 AND 1999 NOTE #1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of the results for the interim periods presented have been included. For further information, refer to the financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1999. NOTE #2 - OTHER EXPENSES The following is a breakdown of other expenses for the six and three month periods ended June 30, 2000 and June 30, 1999, respectively.
Six Months Ended Three Months Ended June 30, June 30, -------------------- -------------------- 2000 1999 2000 1999 ------- ------- ------- ------- Data processing $ 533 $ 468 $ 280 $ 243 Marketing expenses 564 603 290 323 Office supplies, postage and telephone 509 582 240 276 Bank Insurance 239 282 101 125 Supervisory Assessments 62 41 31 20 Professional Expenses 765 1,079 433 706 Provision for OREO Loss -- 46 -- 1 Provision for Y2K Expense (285) -- (285) -- Other Expenses 1,252 963 528 525 ------- ------- ------- ------- Total Other Expenses $ 3,639 $ 4,064 $ 1,618 $ 2,219 ======= ======= ======= =======
NOTE #3 - EARNINGS PER SHARE The following is a reconciliation of net income and shares outstanding to the income and number of shares used to compute earnings per share (amounts in thousands):
Six Months Ended June 30, Three Months Ended June 30, --------------------------------------- ---------------------------------------- 2000 1999 2000 1999 ----------------- ----------------- ----------------- ----------------- Income Shares Income Shares Income Shares Income Shares ------ ------ ------ ------ ------ ------ ------ ------ Net income as reported $3,222 $3,065 $1,626 $1,557 Shares outstanding at period end 5,338 5,888 5,338 5,888 Impact of weighting shares purchased during the period 209 42 (6) 9 ------ ------ ------ ------ ------ ------ ------ ------ Used in Basic EPS 3,222 5,547 3,065 5,930 1,626 5,332 1,557 5,897 Dilutive effect of outstanding stock options 369 362 356 362 ------ ------ ------ ------ ------ ------ ------ ------ Used in Dilutive EPS $3,222 5,916 $3,065 6,292 $1,626 5,688 $1,557 6,259 ====== ====== ====== ====== ====== ====== ====== ======
7 8 Notes to Condensed Consolidated Financial Statements (continued) NOTE #4 - INCOME TAXES The Bank adopted Statement No. 109 of the Financial Accounting Standards Board, Accounting for Income Taxes, commencing January 1, 1993. This new statement supersedes Statement No. 96 and among other things, changes the criteria for the recognition and measurement of deferred tax assets. This adoption does not create a material change in the financial statements of the Bank or the Company. NOTE #5 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS Financial Accounting Standards Board Statement 107 is effective for financial statements for fiscal years ending after December 15, 1992. The Statement considers the fair value of financial instruments for both assets and liabilities. The following methods and assumptions were used to estimate the fair value of financial instruments. Investment Securities For U.S. Government and U.S. Agency securities, fair values are based on market prices. For other investment securities, fair value equals quoted market price if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities as the basis for a pricing matrix. Loans The fair value for loans with variable interest rates is the carrying amount. The fair value of fixed rate loans is derived by calculating the discounted value of the future cash flows expected to be received by the various homogeneous categories of loans. All loans have been adjusted to reflect changes in credit risk. Deposits The fair value of demand deposits, savings deposits, savings accounts and NOW accounts is defined as the amounts payable on demand at June 30, 2000. The fair value of fixed maturity certificates of deposit is estimated based on the discounted value of the future cash flows expected to be paid on the deposits. Notes Payable Rates currently available to the Bank for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt. Commitments to Extend Credit and Standby Letter of Credit The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the parties involved. For fixed-rate loan commitments, fair value also considered the difference between current levels of interest rates and committed rates. The fair value of guarantees and letters of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with parties involved at June 30, 2000. 8 9 Notes to Condensed Consolidated Financial Statements (continued) The estimated fair values of the Bank's financial instruments are as follows:
June 30, 2000 ------------------------ Carrying Fair Amount Value -------- -------- (dollars in thousands) Financial Assets Cash and Cash equivalents $ 38,783 $ 38,783 Investment securities and deposits 69,018 66,315 Loans 358,501 355,227 Direct lease financing 1,301 1,291 Financial Liabilities Deposits 435,533 435,740 Long term debt 0 0 Unrecognized Financial Instruments Commitments to extend credit 50,484 50,484 Standby letters of credit 884 884
NOTE # 6 - NON-PERFORMING LOANS The following table sets forth information regarding the Bank's non-performing loans at June 30, 2000 and December 31, 1999.
June 30, December 31, 2000 1999 -------- ------------ (dollars in thousands) Accruing Loans More Than 90 Days Past Due(1) Aggregate Loan Amounts Commercial, financial and agricultural $ -- $ 148 Real Estate 465 50 Installment loans to individuals 1 4 Aggregate Leases -- -- Total Loans Past Due More Than 90 Days 466 202 Troubled Debt Restructurings(2) 1,769 1,780 Non-accrual loans(3) 3,271 6,068 -------- -------- Total Non-Performing Loans $ 5,506 $ 8,050 ======== ========
---------- (1) Reflects loans for which there has been no payment of interest and/or principal for 90 days of more. Ordinarily, loans are placed on non-accrual status (accrual of interest is discontinued) when the Bank has reason to believe that continued payment of interest and principal is unlikely. (2) Renegotiated loans are those which have been renegotiated to provide a deferral of interest or principal. (3) There were 8 loans on non-accrual status totaling approximately $3,271,000 at June 30, 2000 and 14 loans totaling approximately $6,068,000 at December 31, 1999. 9 10 Notes to Condensed Consolidated Financial Statements (continued) The policy of the Company is to review each loan in the loan portfolio to identify problem credits. In addition, as an integral part of its review process of the Bank, the Federal Reserve Bank and the California Department of Financial Institutions also classifies problem credits. There are three classifications for problem loans: "substandard", "doubtful", and "loss". Substandard loans have one defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Doubtful loans have the weaknesses of substandard loans with the additional characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, questionable. A loan classified as "loss" is considered uncollectible and of such little value that the continuance as an asset of the institution is not warranted. Another category designated "special mention" is maintained for loans which do not currently expose the Bank to a significant degree of risk to warrant classification as substandard, doubtful or loss, but do possess credit deficiencies or potential weaknesses deserving management's close attention. As of June 30, 2000, the Bank's classified loans consisted of approximately $11,376,885 of loans classified as substandard. There were no loans classified as doubtful. The Bank's $11,376,885 of loans classified as substandard consisted of approximately $8,105,701 of performing and accruing loans and approximately $3,271,184 of non-accrual loans. NOTE # 7 - RESERVE FOR LOAN AND LEASE LOSSES The reserve for loan and lease losses is a general reserve established by Management to absorb potential losses inherent in the entire portfolio. The level of and ratio of additions to the reserve are based on a continuous analysis of the loan and lease portfolio and, at June 30, 2000, reflected an amount which, in Management's judgement, was adequate to provide for known and inherent loan losses. In evaluating the adequacy of the reserve, Management gives consideration to the composition of the loan portfolio, the performance of loans in the portfolio, evaluations of loan collateral, prior loss experience, current economic conditions and the prospects or worth of respective borrowers or guarantors. In addition, the Federal Reserve Bank or Department of Financial Institutions, as an integral part of their examination process, periodically reviews the Bank's allowance for possible loan and lease losses. The examiners may require the Bank to recognize additions to the allowance based upon their judgement of the information available to it at the time of its examination. The Bank was most recently examined by the Federal Reserve Bank as of March 31, 2000. The reserve for loan and lease losses at June 30, 2000, was $3,702,000 or 1.03% of total loans and leases. Additions to the reserve are effected through the provision for loan losses which is an operating expense of the Company. The following table provides certain information with respect to the Company's allowance for loan losses as well as charge-off and recovery activity. 10 11 Notes to Condensed Consolidated Financial Statements (continued)
June 30, December 31, 2000 1999 -------- ------------ (dollars in thousands) Allowance for Loan Losses Balance, Beginning of period $ 6,102 $ 5,576 -------- -------- Charge-Offs Commercial, financial and agricultural (3,066) (112) Real estate - construction -- -- Real estate - mortgage -- (45) Consumer Loans (6) (39) Lease Financing -- -- Other -- -- -------- -------- Total Charge-Offs (3,072) (196) -------- -------- Recoveries Commercial, financial and agricultural 21 44 Real estate - construction -- -- Real estate - mortgage 169 188 Consumer loans 7 5 Lease Financing -- -- Other -- -- -------- -------- Total Recoveries 197 237 -------- -------- Net Recoveries (Charge-Offs) (2,875) 41 Provision Charged to Operations 475 485 -------- -------- Balance, End of period $ 3,702 $ 6,102 ======== ======== Net Charge-Offs During the Period to Average Loans Outstanding During the Period Ended 0.81% -0.01% ======== ======== Allowance for Loan Losses to Total Loans 1.03% 1.76% ======== ========
For additional information regarding the loan charge-offs in the quarter ended June 30, 2000, see "MANAGEMENT'S DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --RESULTS OF OPERATIONS -- Provision for Loan and Lease Losses." In accordance with SFAS No. 114 (as amended by SFAS No. 118), "Accounting by Creditors for Impairment of a Loan," loans identified as "impaired" are measured 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. A loan is impaired when it is probable the creditor will not be able to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Loan impairment is evaluated on a loan-by-loan basis as part of normal loan review procedures of the Bank. 11 12 Notes to Condensed Consolidated Financial Statements (continued) NOTE # 8 - MARKET RISK The Company's management utilizes the results of a dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. The simulation model estimates the impact of changing interest rates on the interest income from all interest earning assets and the interest expense paid on all interest bearing liabilities reflected on the Company's balance sheet. This sensitivity analysis is compared to policy limits which specify maximum tolerance level for net interest income exposure over a one year horizon assuming no balance sheet growth, given both a 200 basis point upward and downward shift in interest rates. A parallel and pro rata shift in rates over a 12-month period is assumed. The Company does not engage in any hedging activities and does not have any derivative securities in its portfolio. The following reflects the Company's net interest income sensitivity analysis as of June 30, 2000:
(Dollars in Thousands) Estimated Net Market Value Interest ------------------------------ Simulated Rate Changes Income Sensitivity Assets Liabilities ------------------------ -------------------- ----------- ----------- +200 basis points -9.43% $ 469,397 $ 435,599 -200 basis points 7.57% $ 502,764 $ 437,583
12 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Our principal operating subsidiary, Foothill Independent Bank, which is a California state chartered bank (the "Bank"), accounts for substantially all of our revenues and income. Accordingly, the following discussion focuses primarily on its operations and financial condition. RESULTS OF OPERATIONS OVERVIEW. During the first half of 2000, we generated net earnings of $3,222,000, which represented an increase of $157,000, or 5%, over net earnings in the first half of 1999. That increase was due primarily to a reduction in non-interest expense, and, to a lesser extent, an increase in interest income, which was partially offset by an increase in interest expense. Net earnings for the six months ended June 30, 2000 represented an annualized return on average assets of 1.37% and an annualized return on average equity of 13.85%, compared to 1.32% and 12.94%, respectively, for the same six months of 1999. NET INTEREST INCOME. Net interest income is a principal determinant of a bank's income. Net interest income represents the difference or "spread" between the interest earned on interest-earning assets, such as loans and investment securities, and the interest paid on interest-bearing liabilities, principally deposits. Net interest income increased by $455,000, or 3.4%, in the six month period ended June 30, 2000, as compared to the same period of 1999, primarily as a result of a $1,365,000, or 7.7%, increase in interest income that more than offset an increase in interest expense of $910,000, or 21.7%. The increase in interest income was attributable primarily to increases in the volume of outstanding loans, and, to a lesser extent, increases in interest charged on loans in response to increases in market rates of interest. The increase in interest expense was due primarily to increases in the volume of time certificates of deposits ("time deposits"), including those in denominations of $100,000 or more ("TCD's") on which the Bank pays its highest rates of interest. Primarily as a result of that increase in the volume of time deposits in the second quarter of 2000, interest expense increased by $656,000, or 31.8%, which more than offset an increase of 495,000, or 5.5%, in interest income. As a result, net interest income for the second quarter of 2000 declined by $161,000, or 2.3%, compared to the second quarter of 1999. RATE SENSITIVITY, MARKET RISK AND NET INTEREST MARGINS. RATE SENSITIVITY. Like other banks and bank holding companies, our margins (that is, the difference between yields we are able to realize on loans and other interest earning assets and the interest we pay on deposits) are affected by a number of factors including the relative percentages or the "mix" of (i) our assets, between loans, on the one hand, on which we are able to obtain higher rates of interest, and investment securities, federal funds sold and funds held in interest-bearing deposits with other financial institutions, on the other hand, on which yields generally are lower; (ii) variable and fixed rate loans in its loan portfolio; and (iii) demand and savings deposits, on the one hand, and time deposits, on the other hand. As a general rule, a bank with a relatively high percentage of fixed-rate loans will experience a decline in interest income during a period of increasing market rates of interest, because it will be unable to "reprice" its fixed rate loans to fully offset the increase in the rates of interest it must offer to retain maturing time deposits and attract new deposits. Similarly, a bank with a high percentage of time deposits generally will experience greater increases in interest expense, and therefore, a decrease in net interest income, during a period of increasing market rates of interest than a bank with a greater percentage of demand and savings deposits which are less sensitive to changes in market rates of interest. By contrast, during a period of declining market rates of interest, a bank with a higher percentage of variable loans, as a general rule, will experience a decline in net interest income because such loans usually contain automatic repricing provisions that are "triggered" by declines in market rates of interest; whereas offsetting reductions in the rates of interest paid on time deposits cannot be implemented until they mature, at which time a bank can seek their renewal at lower rates of interest or allow such deposits to be withdrawn in order to reduce interest expense. NET INTEREST MARGIN. We attempt to reduce our exposure to interest rate changes and, thereby, at least to maintain and, if possible, to increase, our net interest margin or spread by seeking (i) to attract and maintain a significant volume of demand and savings deposits that are not as sensitive to interest rate fluctuations as are TCD's 13 14 and other time deposits, and (ii) to match opportunities to "reprice" earning assets, particularly loans, in response to changes in market rates of interest which require or cause repricing of deposits. At the end of 1999, we made the decision to offer programs designed to bring more time deposits into the Bank, after two years of allowing those deposits to "run off". As a result, demand and savings (including money market) deposits represented 74% of average total deposits at June 30, 2000, with time deposits representing 26%, as compared to 79% and 21%, respectively, at December 31, 1999, and 73% and 27%, respectively, at June 30, 1999. As a result, in the quarter and six months ended June 30, 2000, our net interest margin (i.e., tax-adjusted net interest income stated as a percentage of average interest-earning assets) was 6.30% and 6.55%, respectively, compared to 6.74% and 6.56% for the corresponding periods of 1999. However, our net interest margin continues to exceed the average net interest margin for California-based, publicly traded banks and bank holding companies with assets ranging from $250-to-$750 million (the "Peer Group Banks"). The ability to maintain our net interest margin is not entirely within our control because the interest rates we are able to charge on loans and the interest rates we must offer to maintain and attract deposits are affected by national monetary policies established and implemented by the Federal Reserve Board and by competitive conditions in our service areas. In addition, the effect on a bank's net interest margins of changes in market rates of interest will depend on the types and maturities of its deposits and earning assets. For example, a change in interest rates paid on deposits in response to changes in market rates of interest can be implemented more quickly in the case of savings deposits and money market accounts than with respect to time deposits as to which a change in interest rates generally cannot be implemented until such deposits mature. In addition, a change in rates of interest paid on deposits can and often does lead consumers to move their deposits from one type of deposit to another or to shift funds from deposits to non-bank investments or from such investments to bank deposit accounts or instruments, which also will affect a bank's net interest margin. 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 rate and other market conditions. Market risk is attributed to all market risk sensitive financial instruments, including loan and 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 that 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 "Rate Sensitivity" above. We use a dynamic simulation model to forecast the anticipated impact of changes in market interest rates on our net interest income. That model is used to assist management in evaluating, and in determining and adjusting strategies designed to reduce, our exposure to these market risks, which may include, for example, changing the mix of earning assets or interest-bearing deposits. See Note 8 to our Condensed Consolidated Financial Statements contained in Part I of this Report for further information with respect to that dynamic simulation model that, based on certain assumptions, attempts to quantify the impact that simulated upward and downward interest rate changes would have on our net interest income. PROVISION FOR LOAN AND LEASE LOSSES. We follow the practice of maintaining a reserve for possible losses on loans and leases that occur from time to time as an incidental part of the banking business. Write-offs of loans (essentially reductions in the carrying values of non-performing loans due to possible losses on their ultimate recovery) are charged against this reserve (the "Loan Loss Reserve"), which is adjusted periodically to reflect changes in (i) the volume of outstanding loans, and (ii) the risk of potential losses due to a deterioration in the condition of borrowers or in the value of property securing non-performing loans or changes in economic conditions. During the second quarter of 2000, we charged off $3.055 million of non-accrual loans to their net realizable value, due to the bankruptcy of a large corporate borrower. These losses had had been fully reserved for in our Loan Loss Reserve by means of provisions for loan losses that we made in previous years and, as a result, these charge-offs had no effect on our operating results during the six months or 14 15 quarter ended June 20, 2000. The charge off of those non-accrual loans resulted in an overall improvement in the quality of our loan portfolio, as is indicated by the following: the ratio of non-performing loans-to-total loans improved to 1.04% at June 30, 2000 from 2.08% at June 30, 1999; the ratio of non-performing assets-to-total assets improved to 1.27% at June 30, 2000 compared to 1.94% at June 30, 1999; and the ratio of non-performing loans-to-total loan loss reserve improved to 1.49% at June 30, 2000 from 1.39% at June 30, 1999. Excluding the above-mentioned loan charge-offs, recoveries of previously "charged-off" loans exceeded loan charge-offs by $181,000 in the first six months of 2000. By comparison, in the same six months of 1999, recoveries of previously charged-off loans exceeded loan charge-offs by $99,000. See Note 7 to our Condensed Consolidated Financial Statements contained in Part I of this Report for further information with respect to an analysis of the Bank's loan and lease loss experience for the first half of 2000 compared to the experience for 1999. Additions to the Loan Loss Reserve are made through a charge against income referred to as the "provision for loan and lease losses." We made provisions for potential loan and lease losses of $455,000 and $475,000, respectively, in the three and six-month periods ended June 30, 2000, as compared to $124,000 and $280,000 for the corresponding periods of 1999; and, at June 30, 2000, the Loan Loss Reserve was approximately $3,702,000 or 1.03% of total loans and leases outstanding, compared to approximately $5,955,000 or 1.91% of total loans and leases outstanding at June 30, 1999. OTHER INCOME. Other income decreased by $77,000 or 6.2%, and $136,000 or 5.8%, in the quarter and six-month periods ended June 30, 2000, compared to the same periods of 1999, because other income in the in the first half of 1999 included a one-time gain on the sale of SBA loans. Decreases in transaction fees and service charges collected on deposits and other banking transactions also contributed, to a lesser extent, to this decline in other income. OTHER EXPENSE. Other expense (also often referred to as "non-interest expense"), consists primarily of (i) salaries and other employee expenses, (ii) occupancy and furniture and equipment expenses, and (iii) other operating and miscellaneous expenses that include insurance premiums, marketing expenses, data processing costs, professional expenses, and charges that are periodically made against income to establish reserves for possible losses on the disposition or declines in market values of real properties acquired on or in lieu of foreclosure of defaulted loans (commonly referred to as "other real estate owned" or "OREO"). In order to attract a higher volume of non-interest bearing demand and lower cost savings and money market deposits and, thereby, improve the Bank's net interest margin, it has been our policy to provide a much higher level of personal service to our customers than the level of services that are provided by many of our competitors. As a result, our net interest margin has usually exceeded the average net interest margin of the Peer Group Banks. Nevertheless, during the 1999 and continuing into 2000, we implemented a number of cost reduction programs designed to reduce non-interest expenses and, thereby increase operating efficiencies, without adversely affecting the quality of service we provide to our customers. As a result of those programs, during the three and six month periods ended June 30, 2000, we reduced our operating expenses by $159,000 and $696,000, respectively, compared to the same periods of 1999. Those expense reductions resulted in improvements in our efficiency ratio (that is, basically, the ratio of non-interest expense to the sum of our net interest income and other income) to 64.7% and 65.3%, respectively, in the three and six month periods ended June 30, 2000, from 68.5% % and 67.7%, respectively, for the same three and six month periods of 1999. INCOME TAXES. Income taxes increased by approximately $58,000 or 6.5% and $126,000 or 7.2%, respectively, during the three and six month periods ended June 30, 2000 compared to the same periods of 1999, primarily as a result of the increases in pre-tax income. FINANCIAL CONDITION Our total assets increased during the six months ended June 30, 2000 by $26,317,000 or 5.7%, when compared to total assets at December 31, 1999. Average assets at June 30, 2000 were $10,898,000 or 2.3%, higher than total average assets at December 31, 1999. As mentioned above, in the latter part of 1999 we implemented programs designed to attract additional time deposits primarily to fund increases in the volume of our loans. As a 15 16 result the volume of time deposits grew at a greater rate than did the volume of demand, savings and money market deposits during the six months ended June 30, 2000. However, despite that growth, the volume of demand, savings and money market deposits at the Bank represented 73.8% of total deposits at June 30, 2000, as compared to only 26.2% for time deposits, and time deposits in denominations of $100,000 or more increased to only 10.6% of total deposits at June 30, 2000 from 10.2% of total deposits at December 31, 1999. LIQUIDITY MANAGEMENT. Liquidity management policies attempt to achieve a matching of sources and uses of funds in order to enable us to fund our customers' requirements for loans and for deposit withdrawals. In conformity with those policies, we maintain a number of short-term sources of funds to meet periodic increases in loan demand and deposit withdrawals and maturities. At June 30, 2000, the principal sources of liquidity consisted of $30,683,000 of cash and demand balances due from other banks; $8,100,000 in Federal funds sold; $9,534,000 in short-term (maturities of 45 days or less) commercial paper; and $4,000,000 in an overnight repurchase agreement, which, together, totaled $52,317,000, as compared to $27,862,000 at December 31, 1999. Other sources of liquidity include $46,499,000 in securities available-for-sale, of which approximately $12,015,000 mature within one year; and $1,979,000 in interest bearing deposits at other financial institutions, which mature in 6 months or less. We also have established facilities enabling us to borrow up to $10,100,000 of Federal funds from other banks and we have an unused $6,447,000 line of credit with the Federal Home Loan Bank. During the third quarter of 1999 we also received approval from the Federal Reserve Bank of San Francisco to establish an account that will also allow us to borrow at their discount window should the need arise. Additionally, substantially all of our installment loans and leases, the amount of which aggregated $7,312,000 at June 30, 2000, require regular installment payments from customers, providing us with a steady flow of cash funds. Accordingly, we believe that we have adequate cash and cash equivalent resources to meet any increases in demand for loans-and leases and any increase in deposit withdrawals that might occur in the foreseeable future. CAPITAL RESOURCES. The increases in earnings achieved since January 1, 1997 caused our capital ratios to increase in relation to regulatory capital requirements. However, those increases in capital also caused our return on average equity to remain relatively fixed despite the increases in earnings. As a result, in 1998, our Board of Directors authorized an open market stock repurchase program to be funded out of earnings. Between the commencement of that program in late 1998 and March 31, 2000, we purchased a total of 709,721 shares of common stock for an aggregate price of approximately $8,818,000 and, in June of 2000, the Board of Directors authorized the continuation of that repurchase program for an additional 5% of the outstanding shares. In September of 1999, the Board of Directors adopted a new cash dividend policy which provides for the Company to pay quarterly cash dividends of $0.08 per share. Pursuant to that policy, quarterly cash dividends of $0.08 per share were paid in January 2000, and May 2000, and a third such dividend was declared in June 2000, which will be paid on August 22, 2000 to shareholders of record as of August 7, 2000. It has been and continues to be the objective of our Board of Directors to retain earnings to meet capital requirements under applicable government regulations and to support our growth. As a result, the Board may change the amount or frequency of cash dividends to the extent that it deems necessary or appropriate to achieve these objectives. For example the retention of earnings in previous years enabled the Bank to fund the opening of four new banking offices and extend the Bank's market areas, all of which have contributed to our increased profitability and the maintenance of our capital adequacy ratios well above regulatory requirements. We continue to evaluate and explore opportunities to expand our market into areas such as eastern Los Angeles County, western San Bernardino County, north Orange County and northern Riverside County, all of which are contiguous to our existing markets. We believe that the mergers and consolidations of a number of independent banks that have occurred since 1997 have created opportunities for us to increase our market share in those areas. We took advantage of those opportunities within our existing market areas in 1998 and 1999, during which we established a substantial number of new customer relationships and increased the volume of our demand, savings and money market deposit balances obtained largely from customers of the merged banks who we disaffected by the quality of services they were receiving. We believe that there are still expansion and growth opportunities within and adjacent to our existing market areas and in furtherance of our strategic plans designed to take advantage of those opportunities, we plan to open our 12th banking office, in the city of Temecula, California. 16 17 At June 30, 2000, the Bank's Tier 1 leverage ratio and Tier 1 risk-based capital ratio were 9.58% and 11.48%, respectively, which were in excess of minimum bank regulatory requirements. Our consolidated Tier 1 risk-based capital ratio was 11.52%. The risk-based capital ratio is determined by weighting our assets in accordance with certain risk factors and, the higher the risk profile of the assets, the greater is the amount of capital that is required to maintain an adequate risk-based capital ratio, which generally is at least 8%. The Tier 1 capital and Tier 1 risk-based capital ratios of the Bank compare favorably with those of the Peer Group Banks. Under accounting principles that address the financial reporting requirements for investments in certain equity and debt securities held by financial institutions, any unrealized gain on such securities is required to be credited to, and any unrealized losses are required to be charged against, stockholders' equity. At June 30, 2000, we recorded a valuation reserve for unrealized losses on such securities aggregating approximately $545,000. A substantial portion of this amount is related to certain investments in mutual funds, which are classified as investments in marketable equity securities, but which we have held for several years and intend to continue to hold for the foreseeable future. FORWARD LOOKING INFORMATION AND UNCERTAINTIES REGARDING FUTURE PERFORMANCE This Report, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains certain forward-looking information, which reflects management's current views of future financial performance. The forward-looking information is subject to certain risks and uncertainties, including but not limited to the following: INCREASED COMPETITION. Increased competition from other financial institutions, 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 LOCAL ECONOMIC CONDITIONS. Adverse changes in 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 reserves for possible loan losses, thereby adversely affecting earnings; 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 increase the cost of funds to us and reduce net interest margins, particularly if we are unable, due to competitive pressures or the rate insensitivity of earning assets, to effectuate commensurate increases in the rates we are able to charge on existing or new loans. CHANGES IN REGULATORY POLICIES. Changes of federal and state bank regulatory policies, such as increases in capital requirements or in loan loss reserves, or changes in asset/liability ratios, 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. If we do acquire any other banks or open any additional banking offices we are likely to incur additional operating costs that may adversely affect our operating results, at least on an interim basis, until any acquired bank is integrated into our operations or the new banking offices are able to achieve profitability. Due to these and other possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report, or to make predictions based solely on historical financial performance. 17 18 PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS A Special Meeting of Shareholders of the Company was held on April 25, 2000. Set forth below is a description of, and the outcome of the vote, on each matter presented for a vote of the shareholders.
--------------------------------------------------------------------------------------------------------------------- VOTES SHARES BROKER OUTCOME MATTER VOTES FOR AGAINST ABSTAINING NON-VOTES OF VOTE ------ --------- ------- ---------- --------- ------- --------------------------------------------------------------------------------------------------------------------- 1. Change in State of Incorporation from California to Delaware 3,171,128 1,315,027 29,430 630,804 Approved --------------------------------------------------------------------------------------------------------------------- 2. Classification of Board of Directors into three classes 3,083,407 1,308,761 89,346 664,875 Approved --------------------------------------------------------------------------------------------------------------------- 3. Elimination of Cumulative Voting in Election of Directors 3,278,467 1,103,289 99,756 664,405 Approved --------------------------------------------------------------------------------------------------------------------- 4. Requiring a Two-Third's Vote of Shareholders to Amend the 3,307,605 1,426,436 53,629 358,719 Approved Bylaws --------------------------------------------------------------------------------------------------------------------- 5. Requirement of Board Approval for Shareholder Action to be taken by Written Consent 2,994,719 1,420,790 104,945 625,935 Approved --------------------------------------------------------------------------------------------------------------------- 6. Restricting the Ability of Shareholders to Call Special Not Shareholder Meetings 2,845,265 1,539,677 135,470 625,977 Approved* --------------------------------------------------------------------------------------------------------------------- 7. An increase in the Authorized Number of Shares of Common Stock to 25 Million Shares 3,753,410 1,341,285 51,694 0 Approved --------------------------------------------------------------------------------------------------------------------- 8. Authorization of a new class Not of 10 million Preferred Shares 2,871,259 1,543,285 109,739 622,106 Approved* ---------------------------------------------------------------------------------------------------------------------
---------- * The votes cast for approval of these two matters was less than a majority of the number of shares outstanding, which was the vote required to approve these matters. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) Exhibits: 27 -- Financial Data Schedule (b) Reports on Form 8-K: There were no Reports on Form 8-K for events occurring in the quarter ended June 30, 2000. 18 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: August 10, 2000 FOOTHILL INDEPENDENT BANCORP By: /s/ CAROL ANN GRAF ------------------------------------- Carol Ann Graf Senior Vice President and Chief Financial Officer and Assistant Secretary S-1 20 INDEX TO EXHIBITS
EXHIBIT SEQUENTIALLY NUMBER DESCRIPTION NUMBERED PAGE ------ ----------- ------------- 27 Financial Data Schedule
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