Page 1
UNITED STATES
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, 2006
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: 001-9383
WESTAMERICA BANCORPORATION
(Exact Name of Registrant as Specified in its Charter)
CALIFORNIA 94,2156203
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1108 Fifth Avenue, San Rafael, California 94901
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code (707) 863-6000
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 [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer [ X ] Accelerated Filer [ ] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [ ]
Indicate the number of shares outstanding of each of the registrant's classes
Title of Class Shares Outstanding as of August 1, 2006
Common Stock, 31,186,948
No Par Value
Page 2
TABLE OF CONTENTS
Page
-------------
Forward Looking Statements 2
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements 3
Notes to Unaudited Condensed Consolidated Financial Statements 7
Financial Summary 12
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 3 - Quantitative and Qualitative Disclosures about Market Risk 27
Item 4 - Controls and Procedures 27
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 28
Item 1A - Risk Factors 28
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 28
Item 3 - Defaults upon Senior Securities 28
Item 4 - Submission of Matters to a Vote of Security Holders 29
Item 5 - Other Information 29
Item 6 - Exhibits 29
Exhibit 11 - Computation of Earnings Per Share 32
Exhibit 31.1 - Certification of Chief Executive Officer pursuant to
Securities Exchange Act Rule 13a-14(a)/15d-14(a) 33
Exhibit 31.2 - Certification of Chief Financial Officer pursuant to
Securities Exchange Act Rule 13a-14(a)/15d-14(a) 34
Exhibit 32.1 - Certification of Chief Executive Officer Required by 18 U.S.C. Section 1350 35
Exhibit 32.2 - Certification of Chief Financial Officer Required by 18 U.S.C. Section 1350 36
FORWARD-LOOKING STATEMENTS
This report on Form 10-Q contains forward-looking statements about Westamerica
Bancorporation for which it claims the protection of the safe harbor
provisions contained in the Private Securities Litigation Reform Act of 1995.
These forward-looking statements are based on Management's current knowledge
and belief and include information concerning the Company's possible or
assumed future financial condition and results of operations. A number of
factors, some of which are beyond the Company's ability to predict or control,
could cause future results to differ materially from those contemplated. These
factors include but are not limited to (1) a slowdown in the national and
California economies; (2) fluctuations in asset prices including, but not
limited to, stocks, bonds, real estate, and commodities; (3) economic
uncertainty created by terrorist threats and attacks on the United States, the
actions taken in response, and the uncertain effect of these events on the
national and regional economies; (4) changes in the interest rate environment;
(5) changes in the regulatory environment; (6) significantly increasing
competitive pressure in the banking industry; (7) operational risks including
data processing system failures or fraud; (8) the effect of acquisitions and
integration of acquired businesses; (9) volatility of rate sensitive deposits
and investments; (10) asset/liability management risks and liquidity risks;
(11) changes in liquidity levels in capital markets; and (12) changes in the
securities markets. The reader is directed to the Company's annual report on
Form 10-K for the year ended December 31, 2005, for further discussion of
factors which could affect the Company's business and cause actual results to
differ materially from those expressed in any forward-looking statement made
in this report. The Company undertakes no obligation to update any
forward-looking statements in this report.
Page 3
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
WESTAMERICA BANCORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands)
(unaudited)
At June 30, At
--------------------------December 31,
2006 2005* 2005*
---------------------------------------
Assets:
Cash and cash equivalents $188,670 $194,749 $209,273
Money market assets 534 540 534
Investment securities available for sale 620,294 691,609 662,388
Investment securities held to maturity,
with market values of:
$1,210,561 at June 30, 2006 1,243,936
$1,358,083 at June 30, 2005 1,349,555
$1,323,782 at December 31, 2005 1,337,216
Loans, gross 2,580,612 2,687,566 2,672,221
Allowance for loan losses (55,684) (59,862) (55,849)
---------------------------------------
Loans, net of allowance for loan losses 2,524,928 2,627,704 2,616,372
Other real estate owned 656 40 0
Premises and equipment, net 31,785 34,864 33,221
Identifiable intangibles 24,114 28,297 26,170
Goodwill 121,719 124,122 121,907
Interest receivable and other assets 150,250 147,924 150,478
---------------------------------------
Total Assets $4,906,886 $5,199,404 $5,157,559
=======================================
Liabilities:
Deposits:
Noninterest bearing $1,330,280 $1,377,680 $1,419,313
Interest bearing:
Transaction 606,633 614,246 658,667
Savings 951,819 1,114,631 1,022,645
Time 758,315 726,283 745,476
---------------------------------------
Total deposits 3,647,047 3,832,840 3,846,101
Short-term borrowed funds 746,517 828,280 775,173
Debt financing and notes payable 36,993 40,354 40,281
Liability for interest, taxes and
other expenses 54,598 50,002 60,940
---------------------------------------
Total Liabilities 4,485,155 4,751,476 4,722,495
---------------------------------------
Shareholders' Equity:
Authorized - 150,000 shares of common stock
Issued and outstanding:
31,201 at June 30, 2006 343,490
32,593 at June 30, 2005 344,932
31,882 at December 31, 2005 343,035
Deferred compensation 2,734 2,423 2,423
Accumulated other comprehensive income:
Unrealized (loss) gain on securities
available for sale, net (4,771) 8,185 1,882
Retained earnings 80,278 92,388 87,724
---------------------------------------
Total Shareholders' Equity 421,731 447,928 435,064
---------------------------------------
Total Liabilities and
Shareholders' Equity $4,906,886 $5,199,404 $5,157,559
=======================================
See accompanying notes to unaudited condensed consolidated financial
statements.
* Adjusted to adopt Financial Accounting Standard 123 (revised 2004), "Share-
Based Payment." See Note 4.
Page 4
WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In thousands, except per share data)
unaudited)
Three months ended Six months ended
June 30, June 30,
2006 2005* 2006 2005*
----------------------------------------------------
Interest Income:
Loans $41,160 $39,941 $82,266 $74,874
Money market assets and funds sold 2 1 2 1
Investment securities available for sale
Taxable 4,227 4,760 8,631 10,878
Tax-exempt 3,150 3,313 6,321 6,665
Investment securities held to maturity
Taxable 7,407 7,264 15,236 14,553
Tax-exempt 5,931 6,177 11,888 11,788
----------------------------------------------------
Total interest income 61,877 61,456 124,344 118,759
----------------------------------------------------
Interest Expense:
Transaction deposits 427 340 855 602
Savings deposits 924 970 1,822 1,834
Time deposits 6,661 4,144 12,577 7,375
Short-term borrowed funds 7,695 4,655 14,366 8,224
Notes payable 578 637 1,176 1,067
----------------------------------------------------
Total interest expense 16,285 10,746 30,796 19,102
----------------------------------------------------
Net Interest Income 45,592 50,710 93,548 99,657
----------------------------------------------------
Provision for credit losses 150 300 300 600
----------------------------------------------------
Net Interest Income After
Provision For Credit Losses 45,442 50,410 93,248 99,057
----------------------------------------------------
Noninterest Income:
Service charges on deposit accounts 7,186 7,542 14,269 14,469
Merchant credit card 2,392 2,417 4,778 3,715
Debit card 876 811 1,704 1,509
Financial services commissions 363 339 661 619
Trust fees 287 309 569 583
Mortgage banking 49 67 99 167
Securities losses 0 0 0 (4,903)
Other 2,908 3,994 5,621 6,515
----------------------------------------------------
Total Noninterest Income 14,061 15,479 27,701 22,674
----------------------------------------------------
Noninterest Expense:
Salaries and related benefits 13,559 13,956 26,816 27,839
Occupancy 3,267 3,230 6,499 6,181
Data processing 1,531 1,539 3,065 3,087
Equipment 1,315 1,313 2,581 2,544
Amortization of intangibles 1,016 1,092 2,056 1,497
Courier service 909 964 1,831 1,890
Professional fees 833 604 1,291 1,324
Other 3,915 4,391 7,690 8,591
----------------------------------------------------
Total Noninterest Expense 26,345 27,089 51,829 52,953
----------------------------------------------------
Income Before Income Taxes 33,158 38,800 69,120 68,778
Provision for income taxes 8,664 11,080 18,509 18,747
----------------------------------------------------
Net Income $24,494 $27,720 $50,611 $50,031
====================================================
Comprehensive Income:
Unrealized (loss) gain on securities
available for sale, net (3,941) 4,674 (6,653) (4,321)
Securities losses/impairment losses
included in net income 0 0 0 2,868
----------------------------------------------------
Comprehensive Income $20,553 $32,394 $43,958 $48,578
====================================================
Average Shares Outstanding 31,364 32,759 31,525 32,393
Diluted Average Shares Outstanding 31,932 33,364 32,103 33,024
Per Share Data:
Basic Earnings $0.78 $0.85 $1.61 $1.54
Diluted Earnings 0.77 0.83 1.58 1.51
Dividends Paid 0.32 0.30 0.64 0.60
See accompanying notes to unaudited condensed consolidated financial
statements.
* Adjusted to adopt Financial Accounting Standard 123 (revised 2004), "Share-
Based Payment." See Note 4.
Page 5
WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands)
(unaudited)
Accumulated
Compre-
Common Deferred hensive Retained
Shares Stock Compensation Income Earnings Total
------------------------------------------------------------------------------
Balance, December 31, 2004* 31,640 $255,205 $2,146 $9,638 $99,672 $366,661
Net income for the period 50,031 50,031
Stock issued and stock options
assumed for acquisition of
Redwood Empire Bancorp 1,639 89,538 89,538
Stock issued for stock options 156 4,700 4,700
Stock option tax benefits 1,114 1,114
Restricted stock activity 21 797 277 1,074
Stock based compensation 1,055 1,055
Purchase and retirement of stock (863) (7,477) (38,022) (45,499)
Dividends (19,293) (19,293)
Unrealized loss on securities
available for sale, net (1,453) (1,453)
------------------------------------------------------------------------------
Balance, June 30, 2005* 32,593 $344,932 $2,423 $8,185 $92,388 $447,928
==============================================================================
Balance, December 31, 2005* 31,882 $343,035 $2,423 $1,882 $87,724 $435,064
Net income for the period 50,611 50,611
Stock issued for stock options 219 7,881 7,881
Stock option tax benefits 617 617
Restricted stock activity 20 727 311 1,038
Stock based compensation 1,274 1,274
Purchase and retirement of stock (920) (10,043) (37,770) (47,813)
Dividends (20,287) (20,287)
Unrealized loss on securities
available for sale, net (6,653) (6,653)
------------------------------------------------------------------------------
Balance, June 30, 2006 31,201 $343,491 $2,734 ($4,771) $80,278 $421,732
==============================================================================
See accompanying notes to unaudited condensed consolidated financial
statements.
* Adjusted to adopt Financial Accounting Standard 123 (revised 2004), "Share-
Based Payment." See Note 4.
Page 6
WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
For the six months
ended June 30,
--------------------------
2006 2005*
--------------------------
Operating Activities:
Net income $50,611 $50,031
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation of fixed assets 1,956 2,067
Amortization of intangibles and other assets 3,196 2,414
Credit loss provision 300 600
Net (amortization) deferral of loan fees, net of cost (258) 23
Decrease (increase) in interest income receivable 2,284 (617)
Increase in other assets (3,928) (6,405)
(Decrease) increase in income taxes payable (1,655) 512
Increase in interest expense payable 1,384 1,251
Increase (decrease) in other liabilities 1,571 (5,659)
Stock option compensation expense 1,274 1,055
Excess tax benefits from stock-based compensation (617) (141)
Gain on sales of investment securities 0 4,903
Writedown of equipment 186 6
Gain on sale of real estate 0 (1,331)
Gain on sales of other assets 0 (800)
Originations of loans for resale (500) (425)
Proceeds from sale of loans originated for resale 505 426
--------------------------
Net Cash Provided by Operating Activities 56,309 47,910
--------------------------
Investing Activities:
Net cash used in mergers and acquisitions 0 (35,210)
Net repayments of loans 90,740 52,145
Purchases of investment securities available for sale (5,020) 0
Proceeds from maturity of securities available for sale 35,448 67,386
Proceeds from sale of securities available for sale 0 196,109
Purchases of investment securities held to maturity 0 (147,085)
Proceeds from maturity of securities held to maturity 93,281 67,990
Purchases of FRB/FHLB stock (67) (2,943)
Proceeds from sales of FRB/FHLB stock 139 0
Purchases of property, plant and equipment (706) (793)
Proceeds from sale of real estate 0 1,752
--------------------------
Net Cash Provided by Investing Activities 213,815 199,351
--------------------------
Financing Activities:
Net decrease in deposits (199,054) (120,760)
Net (decrease) increase in short-term borrowings (28,656) 5,459
Repayments of notes payable (3,288) (3,264)
Exercise of stock options 7,754 4,551
Tax benefit from stock-based compensation 617 141
Purchase and retirement of stock (47,813) (45,499)
Dividends paid (20,287) (19,293)
--------------------------
Net Cash Used in Financing Activities (290,727) (178,665)
--------------------------
Net (Decrease) Increase In Cash and Cash Equivalents (20,603) 68,596
Cash and Cash Equivalents at Beginning of Period 209,273 126,153
--------------------------
Cash and Cash Equivalents at End of Period $188,670 $194,749
==========================
Supplemental Disclosure of Noncash Activities:
Loans transferred to other real estate owned $656 $40
Supplemental Disclosure of Cash Flow Activity:
Unrealized loss on securities available for sale, net ($3,941) ($1,453)
Interest paid for the period 32,181 20,962
Income tax payments for the period 20,860 18,788
The acquisition of Redwood Empire Bancorp involved
the following:
Cash issued -- 57,128
Common stock issued -- 89,538
Liabilities assumed -- 504,901
Fair value of assets acquired, other than cash and cash equivalents -- (495,596)
Core deposit intangible -- (16,600)
Customer based intangible - merchant draft processing -- (10,300)
Goodwill -- (107,153)
Net cash and cash equivalent received -- 21,919
See accompanying notes to unaudited condensed consolidated financial
statements.
* Adjusted to adopt Financial Accounting Standard 123 (revised 2004), "Share-
Based Payment." See Note 4.
Page 7
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and pursuant to the rules and regulations of the
Securities and Exchange Commission. The results of operations reflect interim
adjustments, all of which are of a normal recurring nature and which, in the
opinion of Management, are necessary for a fair presentation of the results for
the interim periods presented. The interim results for the six months ended
June 30, 2006 and 2005 are not necessarily indicative of the results expected
for the full year. These unaudited consolidated financial statements should
be read in conjunction with the audited consolidated financial statements and
accompanying notes as well as other information included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2005.
Note 2: Significant Accounting Policies.
Certain accounting policies underlying the preparation of these financial
statements require Management to make estimates and judgments. These estimates
and judgments may affect reported amounts of assets and liabilities, revenues
and expenses, and disclosures of contingent assets and liabilities. The most
significant of these involve the Allowance for Credit Losses, which is
discussed in Note 1 to the audited consolidated financial statements included
in the Company's Annual Report on Form 10-K for the year ended December 31,
2005.
Effective March 1, 2005, the Company acquired Redwood Empire Bancorp ("REBC"),
parent company of National Bank of the Redwoods. The REBC acquisition was
accounted for using the "purchase method" of accounting for business
combinations which requires valuing assets and liabilities which do not have
quoted market prices. In determining fair values for assets and liabilities
without quoted market prices for the REBC acquisition, management engaged an
independent consultant to determine such fair values. Critical assumptions used
in the valuation included prevailing market interest rates on similar financial
products, future cash flows, maturity structures and durations of similar
financial products, the cost of processing deposit products, the interest rate
structure for similar funding sources over the estimated duration of acquired
deposits, the duration of customer relationships, and other critical
assumptions.
On March 17, 2006, the Financial Accounting Standards Board (FASB) issued FASB
Statement of Financial Accounting Standards No. 156 (SFAS 156), "Accounting for
Servicing of Financial Assets an amendment of FASB No. 140". This Statement
amends FASB Statement No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" (SFAS 140). The new
Standard addresses the recognition and measurement of separately recognized
servicing assets and liabilities and provides an approach to simplify efforts
to obtain hedge-like (offset) accounting. The standard requires that a
separately recognized servicing asset or servicing liability be initially
measured at fair value, if practicable, and permits an entity with a separately
recognized servicing asset or servicing liability to choose either the
amortization method or the fair value method for subsequent measurement. The
Company currently has approximately $100 thousand in mortgage servicing rights
which are currently amortized over the period of estimated mortgage income.
This method is consistent with the SFAS 140 requirements. The Company does not
currently hedge its mortgage servicing rights as the risks to earnings from
fluctuating values is not significant. SFAS 156 is effective for fiscal years
beginning after September 15, 2006. The Company will be adopting this new
Standard beginning January 1, 2007.
In June 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No.48 (FIN 48), "Accounting Uncertainty in Income Taxes". This
Interpretation clarifies the accounting for uncertainty in income taxes
recognized in an enterprise's financial statements in accordance with FASB
Statement No.109, Accounting for Income Taxes. This Interpretation prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in
a tax return and also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition. The evaluation of a tax position in accordance with this
Interpretation is a two-step process. The first step is recognition: The
enterprise determines whether it is more likely than not that a tax position
will be sustained. The second step is measurement: A tax position that
meets the more-likely-than-not recognition threshold is measured to determine
the amount of benefit to recognize in the financial statements. The tax
position is measured at the largest amount of benefit that is greater than 50
percent likely of being realized upon ultimate settlement. Differences between
tax positions taken in a tax return and amounts recognized in the financial
statements will generally result in: a) An increase in a liability for income
taxes payable (or a reduction of an income tax refund receivable) or b) A
reduction in a deferred tax asset or an increase in a deferred tax liability c)
Both (a) and (b). FIN 48 is effective fiscal years beginning after December 15,
2006. The Company does not expect the adoption of this new standard to have a
material impact on its results of operations.
Note 3: Goodwill and Other Intangible Assets
The Company has recorded goodwill and other identifiable intangibles
associated with purchase business combinations. Goodwill is not amortized, but
is periodically evaluated for impairment. The Company did not recognize
impairment during the six months ended June 30, 2006. Identifiable intangibles
are amortized to their estimated residual values over their expected useful
lives. Such lives and residual values are also periodically reassessed to
determine if any amortization period adjustments are indicated. During the
second quarter of 2006, no such adjustments were recorded.
Page 8
In connection with the acquisition of Redwood Empire Bancorp ("REBC") in the
first quarter of 2005, the Company recorded goodwill and identifiable
intangibles of $109 million and $27 million, respectively, in accordance with
the purchase method of accounting. The following table summarizes the
Company's goodwill and identifiable intangible assets, as of January 1 and
June 30 for 2006 and 2005 (dollars in thousands). In the first quarter of 2006
goodwill relating to the REBC acquisition was reduced by $193 related to stock
options issued in connection with the acquisition and increased $5 related to
accrued expenses. In the second quarter of 2005 goodwill relating to the REBC
acquisition was reduced by $3,381, of which $2,027 represents the premium
received on the required divestiture of a former REBC branch office in Lake
County. The balance of the adjustment related to stock options issued in
connection with the acquisition.
At At
January 1, June 30,
2006 Additions Reductions 2006
----------------------------------------------------
Goodwill $125,879 $5 ($193) $125,691
Accumulated Amortization (3,972) 0 0 (3,972)
----------------------------------------------------
Net $121,907 $5 ($193) $121,719
====================================================
Core Deposit Intangibles $24,383 $0 $0 $24,383
Accumulated Amortization (6,972) 0 (1,148) (8,120)
Merchant Draft Processing Intangible 10,300 0 0 10,300
Accumulated Amortization (1,541) 0 (908) (2,449)
----------------------------------------------------
Net $26,170 $0 ($2,056) $24,114
====================================================
At At
January 1, June 30,
2005 Additions Reductions 2005
----------------------------------------------------
Goodwill $22,968 $108,507 ($3,381) $128,094
Accumulated Amortization (3,972) 0 0 (3,972)
----------------------------------------------------
Net $18,996 $108,507 ($3,381) $124,122
====================================================
Core Deposit Intangibles $7,783 $16,600 $0 $24,383
Accumulated Amortization (4,889) 0 (880) (5,769)
Merchant Draft Processing Intangible 0 10,300 0 10,300
Accumulated Amortization 0 0 (617) (617)
----------------------------------------------------
Net $2,894 $26,900 ($1,497) $28,297
====================================================
At June 30, 2006, the estimated aggregate amortization of core deposit
intangibles, in thousands of dollars, for the remainder of 2006 and annually
through 2011 is $1,132, $2,153, $2,021, $1,859, $1,636, and $1,386,
respectively. The weighted average amortization period for core deposit
intangibles is 12.12 years.
At June 30, 2006, the estimated aggregate amortization of merchant draft
processing intangible, in thousands of dollars, for the remainder of 2006 and
annually through 2011 is $900, $1,500, $1,200, $962, $774, and $624,
respectively. The weighted average amortization period for merchant draft
processing intangibles is 11.67 years.
Page 9
Note 4: Stock Options
The Company grants stock options and restricted performance shares (RPSs) to
employees in exchange for employee services, pursuant to the shareholder-
approved 1995 Stock Option Plan, which was amended and restated in 2003. Stock
options are granted with an exercise price equal to the fair market value of
the related common stock and generally became exercisable in equal annual
installments over a three-year period with each installment vesting on the
anniversary date of the grant. Each stock option has a maximum ten-year term.
A restricted performance share grant becomes vested after three years of being
awarded, provided the Company has attained its performance goals for such
three-year period.
Effective January 1, 2006, the Company adopted FASB Statement No.123(revised
2004), Share-Based Payment (SFAS No. 123(R)) on a modified retrospective
basis. SFAS No. 123(R) requires the Company to begin using the fair value
method to account for stock based awards granted to employees in exchange for
their services. Prior to the adoption of SFAS No. 123(R), the Company
accounted for stock option plans using the intrinsic value method, as
permitted by SFAS No. 123, "Accounting for Stock-Based Compensation." Under
the prior intrinsic value method, compensation expense was recorded for stock
options only if the price of the underlying stock on the date of grant
exceeded the exercise price of the option. The Company's historical stock
option grants were awarded with exercise prices equal to the prevailing price
of the underlying stock on the dates of grant; therefore, no compensation
expense was recorded using the intrinsic value method. The Company's
recognition of compensation expense for restricted performance share grants
has not changed with the adoption of SFAS No. 123(R). The Company has
recognized compensation expense for historical restricted performance share
grants over the relevant attribution period. Restricted performance share
grants have no exercise price, therefore, the intrinsic value is measured
using an estimated per share price at the vesting date for each restricted
performance share. The estimated per share price is adjusted during the
attribution period to reflect actual stock price performance. The Company's
obligation for unvested outstanding restricted performance share grants is
classified as a liability until the vesting date, at which time the issued
shares become classified as shareholders' equity.
The scope of SFAS 123(R) includes a wide range of stock-based compensation
arrangements including stock options, restricted stock plans,
performance-based awards, stock appreciation rights, and employee stock
purchase plans. SFAS 123(R) requires that the Company measure the cost of
employee services received in exchange for an award of equity instruments
based on the fair value of the award on the grant date. That cost must be
recognized in the income statement over the vesting period of the award. In
applying the "modified retrospective" method to implement SFAS No. 123 (R),
the Company adjusted the financial statements for prior periods to give effect
to the fair-value-based method of accounting for awards that were granted,
modified or settled in the fiscal years beginning after December 15, 1994 on a
basis consistent with the pro forma disclosures required by Statement 123.
Accordingly, compensation costs and the related tax effects are recognized in
those financial statements as though awards for those periods before the
effective date of Statement 123(R) had been accounted for under Statement 123.
In addition, the opening balances of common stock, deferred taxes and retained
earnings for the earliest year presented are adjusted to reflect the
cumulative effect of the modified retrospective application on earlier
periods.
The following table summarizes information about stock options granted under
the Plans as of June 30, 2006. The intrinsic value is calculated as the
difference between the market value as of June 30, 2006 and the exercise price
of the shares. The market value as of June 30, 2006 was $48.97 as reported by
the NASDAQ Global Market:
Options Outstanding Options Exercisable
---------------------------------------------------------------------------------------------------------------------
Range of Shares Aggregate Weighted Weighted Shares Aggregate Weighted Weighted
Exercise (in Intrinsic Average Average (in Intrinsic Average Average
Price thousands) Value Remaining Exercise thousands) Value Remaining Exercise
(in Contractual Price (in Contractual Price
thousands) Life thousands) Life
(years) (years)
---------------------------------------------------------------------------------------------------------------------
$10 - 15 11 $394 1.9 $13.09 11 $394 1.9 $13.09
15 - 19 1 24 1.9 16.76 1 24 1.9 16.76
19 - 20 104 3,079 0.6 19.25 104 3,079 0.6 19.25
20 - 25 408 10,188 3.6 24.00 408 10,188 3.6 24.00
32 - 33 226 3,656 1.6 32.79 226 3,656 1.6 32.79
33 - 35 260 3,747 2.6 34.56 260 3,747 2.6 34.56
35 - 40 653 6,504 5.1 39.02 653 6,504 5.1 39.02
40 - 45 451 3,705 6.6 40.75 451 3,705 6.6 40.75
45 - 50 449 0 7.6 49.61 298 0 7.6 49.61
50 - 55 724 0 8.9 52.55 159 0 8.5 52.54
---------------------------------------------------------------------------------------------------------------------
$10 - 55 3,287 $31,297 5.7 40.32 2,571 $31,297 4.9 37.06
=====================================================================================================================
Page 10
The Company applies the Roll-Geske option pricing model (Modified Roll) to
determine grant date fair value of stock option grants. This model modifies
the Black-Scholes Model to take into account dividends and American options.
During the six months ended June 30, 2006 and 2005, the Company granted 258
thousand and 560 thousand stock options, respectively. The following weighted
average assumptions were used in the option pricing to value stock options
granted in the periods indicated:
For the
Six months ended
June 30,
2006 2005
--------------------------
Expected volatility*1 16% 15%
Expected life in years*2 4.0 7.0
Risk-free interest rate*3 4.41% 3.91%
Expected dividend yield 2.63% 2.47%
Fair value per award $6.54 $6.61
*1 Measured using daily price changes of Company's stock over respective
expected term of the option and the implied volatility derived from the market
prices of the Company's stock and traded options.
*2 the expected life is the number of years that the Company estimates that
the options will be outstanding prior to exercise
*3 the risk-free rate for periods within the contractual term of the option is
based on the US Treasury yield curve in effect at the time of the grant
Employee stock option grants are being expensed by the Company over the
grants' three year vesting period. The Company issues new shares upon the
exercise of options. The Company estimates it will issue approximately 275
thousand shares during 2006 related to stock-based compensation programs. The
number of shares authorized to be issued for options is 2.2 million.
The impact of adopting SFAS 123(R) for the three months and six months ended
June 30, 2006 and 2005 and at June 30, 2006 and 2005 is summarized in the
following tables (in thousands, except per share data):
For the three months ended June 30,
----------------------------------------------------
2006 2005
----------------------------------------------------
Intrinsic Fair Intrinsic Fair
Value Value Value Value
Method Method Method Method
----------------------------------------------------
Income before income taxes $33,798 $33,158 $39,132 $38,800
Net income 24,868 24,494 27,914 27,720
Net earnings per share - basic $0.80 $0.78 $0.85 $0.85
Net earnings per share - diluted share 0.78 0.77 0.84 0.83
Cash flow provided by operations $23,131 $22,797 $15,498 $15,380
Cash flow used in financing activities (160,449) (160,115) (19,849) (19,731)
For the six months ended June 30,
----------------------------------------------------
2006 2005
----------------------------------------------------
Intrinsic Fair Intrinsic Fair
Value Value Value Value
Method Method Method Method
----------------------------------------------------
Income before income taxes $70,394 $69,120 $69,833 $68,778
Net income 51,356 50,611 50,648 50,031
Net earnings per share - basic $1.63 $1.61 $1.56 $1.54
Net earnings per share - diluted share 1.60 1.58 1.53 1.51
Cash flow provided by operations $56,925 $56,310 $48,051 $47,910
Cash flow used in financing activities (291,343) (290,728) (178,806) (178,665)
A summary of option activity during the six months ended June 30, 2006 is
presented below:
Shares Weighted Weighted
Average Average
Exercise Remaining
Price Contractual
Term
---------------------------------------
Outstanding at January 1, 2006 3,269,086 $39.13
Granted 258,000 52.56
Exercised (217,386) 35.69
Forfeited or expired (22,408) 52.03
-------------
Outstanding at June 30, 2006 3,287,292 40.32 5.7
=============
Exercisable at June 30, 2006 2,570,743 37.09 4.9 years
=============
Page 11
A summary of the Company's nonvested share activity during the six months
ended June 30, 2006 is presented below.
Shares Weighted
Average
Grant
Date
Fair Value
--------------------------
Nonvested at January 1, 2006 967,947
Granted 258,000
Vested (486,990)
Forfeited (22,408)
-------------
Nonvested at June 30, 2006 716,549 $6.65
=============
The weighted average estimated grant date fair value, as defined by SFAS
123(R), for options granted under the Company's stock option plan during the
six months ended June 30, 2006 and 2005 was $6.54 and $6.61 per share,
respectively. The total remaining unrecognized compensation cost related to
nonvested awards as of June 30, 2006 is $3.3 million and the weighted average
period over which the cost is expected to be recognized is 1.7 years.
The total intrinsic value of options exercised during first half 2006 and 2005
was $3.6 million and $3.3 million, respectively. The total fair value of RPSs
that vested during first half 2006 and 2005 was $1.0 million and $905
thousand, respectively. The actual tax benefit realized for the tax deductions
from the exercise of options totaled $615 thousand and $141 thousand,
respectively, for first half 2006 and 2005.
A summary of the status of the Company's restricted performance shares as of
June 30, 2006 and 2005 and changes during the quarters ended on those dates,
follows:
2006 2005
--------------------------
Outstanding at January 1, 43,582 57,750
Granted 15,084 20,740
Exercised (19,946) (20,637)
Forfeited 0 (7,983)
--------------------------
Outstanding at June 30, 38,720 49,870
==========================
As of June 30, 2006 and 2005, the restricted performance shares had a
weighted-average contractual life of 1.78 and 1.72 years, respectively. The
compensation cost that was charged against income for the Company's restricted
performance shares granted was $372 thousand and $600 thousand for the six
month ended June 30, 2006 and 2005, respectively. There were no stock
appreciation rights or incentive stock options granted in the first half of
2006 and 2005.
Note 5: Post Retirement Benefits
The Company uses an actuarial-based accrual method of accounting for
post-retirement benefits. The Company offers a continuation of group insurance
coverage to employees electing early retirement until age 65. The Company pays
a portion of these early retirees' insurance premium which are determined at
their date of retirement. The Company reimburses a portion of Medicare Part B
premiums for all retirees and spouses over 65.
In accordance with SFAS No.132 "Employers' Disclosures about Pensions and
Other Post-Retirement Benefits", the Company provides the following interim
disclosure related to its post-retirement benefit plan.
The following table sets forth the net periodic post retirement benefit costs
for the six months ended June 30.
For the six months ended
June 30,
--------------------------
2006 2005
--------------------------
(In thousands)
Service cost $94 $139
Interest cost 106 105
Amortization of unrecognized
transition obligation 30 31
--------------------------
Net periodic cost $230 $275
==========================
The Company does not contribute to any post-retirement benefit plans.
Page 12
WESTAMERICA BANCORPORATION
Financial Summary
(Dollars in thousands, except per share data)
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
2006 2005* 2006 2005*
----------------------------------------------------
Net Interest Income (FTE)*** $51,503 $57,023 $105,477 $112,043
Provision for Loan Losses (150) (300) (300) (600)
Noninterest Income:
Securities losses 0 0 0 (4,903)
Deposit service charges and other 14,061 15,479 27,701 27,577
Total noninterest income 14,061 15,479 27,701 22,674
Noninterest Expense (26,345) (27,089) (51,829) (52,953)
Provision for income taxes (FTE)*** (14,575) (17,393) (30,438) (31,133)
----------------------------------------------------
Net Income $24,494 $27,720 $50,611 $50,031
====================================================
Average Shares Outstanding 31,364 32,759 31,525 32,393
Diluted Average Shares Outstanding 31,932 33,364 32,103 33,024
Shares Outstanding at Period End 31,201 32,593 31,201 32,593
As Reported:
Basic Earnings Per Share $0.78 $0.85 $1.61 $1.54
Diluted Earnings Per Share $0.77 $0.83 $1.58 $1.51
Return On Assets 1.99% 2.15% 2.04% 2.01%
Return On Equity 23.12% 25.81% 24.02% 25.08%
Net Interest Margin (FTE)*** 4.58% 4.84% 4.65% 4.87%
Net Loan (Recoveries) Losses to Average Loans 0.04% 0.04% 0.04% 0.01%
Efficiency Ratio** 40.2% 37.4% 38.9% 39.3%
Average Balances:
Total Assets $4,948,443 $5,170,029 $5,001,349 $5,017,331
Earning Assets 4,515,728 4,719,635 4,560,953 4,619,282
Total Gross Loans 2,588,220 2,670,663 2,602,084 2,522,686
Total Deposits 3,652,030 3,906,875 3,718,233 3,811,714
Shareholders' Equity 424,999 430,796 424,916 402,212
Balances at Period End:
Total Assets $4,906,886 $5,199,404
Earning Assets 4,445,376 4,729,270
Total Gross Loans 2,580,612 2,687,566
Total Deposits 3,647,047 3,832,840
Shareholders' Equity 421,731 447,928
Financial Ratios at Period End:
Allowance for Loan Losses to Loans 2.16% 2.23%
Book Value Per Share $13.52 $13.74
Equity to Assets 8.59% 8.61%
Total Capital to Risk Adjusted Assets 10.93% 10.37%
Dividends Paid Per Share $0.32 $0.30 $0.64 $0.60
Dividend Payout Ratio 42% 36% 41% 40%
The above financial summary has been derived from the Company's unaudited
consolidated financial statements. This information should be read in
conjunction with those statements, notes and the other information included
elsewhere herein.
* Adjusted to adopt Financial Accounting Standard 123 (revised 2004),
"Share-Based Payment." See Note 4.
** The efficiency ratio is defined as noninterest expense divided by total
revenue (net interest income on a tax-equivalent basis and noninterest
income).
*** Yields on securities and certain loans have been adjusted upward to a
"fully taxable equivalent" ("FTE") basis in order to reflect the effect of
income which is exempt from federal income taxation at the current statutory
tax rate.
Page 13
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Westamerica Bancorporation and subsidiaries (the "Company") reported second
quarter 2006 net income of $24.5 million or $.77 diluted earnings per share.
These results compare to net income of $27.7 million or $0.83 per share for
the same period of 2005.
On a year-to-date basis, the Company reported net income for the six months
ended June 30, 2006 of $50.6 million or diluted earnings per share of $1.58,
compared with $50.0 million or $1.51 per share for the same period of 2005.
The second quarter of 2005 represents the first full quarter of operations
following the March 1, 2005 acquisition of Redwood Empire Bancorp ("REBC").
Following is a summary of the components of net income for the periods
indicated (dollars in thousands):
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
2006 2005* 2006 2005*
----------------------------------------------------
Net interest income (FTE) $51,503 $57,023 $105,477 $112,043
Provision for loan losses (150) (300) (300) (600)
Noninterest income 14,061 15,479 27,701 22,674
Noninterest expense (26,345) (27,089) (51,829) (52,953)
Provision for income taxes (FTE) (14,575) (17,393) (30,438) (31,133)
----------------------------------------------------
Net income $24,494 $27,720 $50,611 $50,031
====================================================
Average diluted shares 31,932 33,364 32,103 33,024
Diluted earnings per share $0.77 $0.83 $1.58 $1.51
Average total assets 4,948,443 5,170,029 5,001,349 5,017,331
Net income (annualized) to average total assets 1.99% 2.15% 2.04% 2.01%
* Adjusted to adopt SFAS 123(R)
Net income for the second quarter of 2006 was $3.2 million or 11.6% less than
the same quarter of 2005, primarily attributable to lower net interest income
(FTE) and noninterest income, partially offset by decreases in provision for
loan losses, noninterest expense and income tax provision (FTE). The decrease
in net interest income (FTE) (down $5.5 million or 9.7%) was the net result of
lower average interest-earning assets and higher funding costs, partially
offset by higher yields on earning assets and higher loan fee income. The loan
loss provision decreased $150 thousand or 50.0% from a year ago, reflecting
Management's assessment of credit risk for the loan portfolio. Noninterest
income decreased $1.4 million or 9.2% mainly because the prior year period
included a $1.3 million gain on sale of real estate. Noninterest expense
decreased $744 thousand or 2.7%. The provision for income taxes (FTE)
decreased $2.8 million or 16.2% primarily due to lower profitability, a higher
proportion of interest revenue attributable to tax-exempt municipal loans and
securities, higher tax credits and refunds, and other tax preference items.
Comparing the first six months of 2006 to the prior year, net income increased
$580 thousand or 1.2%, mostly due to lower loan loss provision, higher
noninterest income, lower noninterest expense and lower tax provision (FTE),
partly offset by a decrease in net interest income (FTE). The lower net
interest income (FTE) was mainly caused by a lower volume of average
interest-earning assets and higher funding costs, partially offset by higher
yields on earnings assets and higher loan fee income. The loan loss provision
decreased $300 thousand or 50.0% to reflect Management's view on credit risk.
Noninterest income rose mostly because the 2005 period included $4.9 million
in losses on sales of securities, which were realized in managing the
Company's interest rate risk position following the REBC acquisition.
Noninterest expense declined $1.1 million or 2.1%. The income tax provision
(FTE) decreased $695 thousand or 2.2% primarily due to a higher proportion of
interest revenue attributable to tax-exempt municipal loans and securities,
higher tax credits and refunds, and other tax preference items.
Page 14
Net Interest Income
Following is a summary of the components of net interest income for the
periods indicated (dollars in thousands):
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
2006 2005 2006 2005
----------------------------------------------------
Interest and fee income $61,877 $61,456 $124,344 $118,759
Interest expense (16,285) (10,746) (30,796) (19,102)
FTE adjustment 5,911 6,313 11,929 12,386
----------------------------------------------------
Net interest income (FTE) $51,503 $57,023 $105,477 $112,043
====================================================
Average earning assets $4,515,728 $4,719,635 $4,560,953 $4,619,282
Net interest margin (FTE) 4.58% 4.84% 4.65% 4.87%
The Company's primary source of revenue is net interest income, or the
difference between interest income earned on loans and investments and
interest expense paid on interest-bearing deposits and borrowings. Net
interest income (FTE) decreased during the second quarter of 2006
by $5.5 million or 9.7% from the same period in 2005 to $51.5 million, mainly
due to lower average earning assets (down $204 million) and higher rates paid
on interest-bearing liabilities (up 77 basis points "bp"), partially offset by
higher yields on earning assets excluding loan fees (up 24 bp), a lower volume
of interest-bearing liabilities (down $166 million) and higher loan fee
income.
Comparing the first six months of 2006 with the same period of 2005, net
interest income (FTE) decreased $6.6 million or 5.9%, primarily due to lower
average earning assets and higher rates paid on interest-bearing liabilities,
partially offset by higher yields on earning assets excluding loan fees and
higher loan fee income.
Interest and Fee Income
Interest and fee income (FTE) for the second quarter of 2006 increased $19
thousand from the same period in 2005. The increase was caused by higher
yields on earning assets and increased loan fee income (up $243 thousand),
offset by lower average earning assets.
The average earning asset decrease of $204 million for the second quarter of
2006 compared to the same period in 2005 was due to declines in most earning
asset categories except for growth in residential real estate loans (up $15
million) and indirect consumer loans (up $9 million). The loan portfolio
declined $82 million mostly due to decreases in commercial real estate loans
(down $43 million), commercial loans (down $42 million) and personal credit
lines (down $15 million). Competitive loan pricing and loosened underwriting
standards in the banking industry are limiting the opportunity to originate
commercial loans which will remain profitable throughout the duration of the
loans, in Management's opinion. Current interest rate spreads between loan
origination yields and the rates paid on deposits and other funding sources
are very narrow. Such interest rate spreads could be pressured in the
near-term as funding costs rise while many loan yields are generally fixed in
nature. As a result, the Company has not take an aggressive posture relative
to current loan and investment portfolio growth.
Average total investments decreased $121 million for the second quarter of
2006 compared with the same period in 2005 primarily due to paydowns, calls,
and maturities of mortgage backed securities and collateralized mortgage
obligations (down $51 million), municipal securities (down $37 million) and
U.S. government sponsored entity obligations (down $27 million).
The average yield on the Company's earning assets, excluding loan fee income,
increased from 5.71% in the second quarter of 2005 to 5.95% in the same period
in 2006 (up 24 bp). The composite yield on loans, excluding loan fees, rose 33
bp to 6.48% primarily due to increases in construction loans (up 163 bp),
commercial loans (up 75 bp) and personal credit lines (up 188 bp).
The investment portfolio yield rose 9 bp to 5.25%, mainly attributable to
increases in the yield on U.S. government sponsored entity obligations (up 26
bp) and mortgage backed securities and collateralized mortgage obligations (up
21 bp), partially offset by declines in the yields on corporate securities and
municipal securities (down 9 bp).
Comparing the first two quarters of 2006 with the corresponding period a year
ago, interest and fee income (FTE) was up $5.1 million or 3.9%. The increase
largely resulted from higher yields on earning assets and increased loan fee
income (up $74 thousand), partially offset by lower average earning assets.
The average yield on earning assets excluding loan fees for the first half of
2006 was 5.96% compared with 5.66% in the corresponding period of 2005. The
loan portfolio yield excluding loan fees for the first half of 2006 compared
with the same period of 2005 was higher by 37 bp, due to increases in personal
credit lines (up 175 bp), construction loans (up 158 bp) and commercial loans
(up 88 bp).
The investment portfolio yield rose by 30 bp. The increase resulted mostly
from higher yields on U.S. government sponsored obligation (up 24 bp) and
mortgage backed securities and collateralized mortgage obligations (up 22 bp),
net of decreases in yields on corporate securities and municipal securities
(down 11 bp).
Page 15
Average earning assets decreased $58 million or 1.3% for the first half of
2006 compared with the same period of 2005, due to a lower volume of the
investment portfolio, offset by loan growth mostly as a result of the REBC
acquisition. In the first six months of 2005, the Company sold approximately
$196 million in securities available for sale to manage its interest rate risk
position in light of the REBC acquisition. Average investments declined $138
million mainly due to decreases in U.S. government sponsored entity
obligations (down $83 million) and mortgage backed securities and
collateralized mortgage obligations (down $40 million). The loan portfolio
grew $79 million, the net result of increases in residential real estate loans
(up $51 million), commercial real estate loans (up $35 million) and
construction loans (up $15 million), partially offset by declines in
commercial loans (down $13 million) and personal credit lines (down $10
million).
Interest Expense
Interest expense in the second quarter of 2006 increased $5.5 million or 51.5%
compared with the same period in 2005. The increase was attributable to higher
rates paid on the interest-bearing liabilities, partially offset by a decrease
in those liabilities.
The average rate paid on interest-bearing liabilities increased from 1.30% in
the second quarter of 2005 to 2.07% in the same quarter of 2006. Rates paid on
most liabilities moved with general market conditions. The average rate on
federal funds purchased rose 197 bp. Rates on deposits increased as well,
including those on CDs over $100 thousand, which rose 172 bp; and on retail
CDs, which went up by 60 bp.
Interest-bearing liabilities declined $166 million or 5.0% for the second
quarter of 2006 over the same period of 2005. Most categories of deposits
declined including money market savings (down $147 million), retail CDs (down
$64 million), partially offset by a $55 million increase in CDs over $100
thousand. Federal funds purchased and long term debt declined $36 million and
$3 million, respectively. The decline was more than offset by a $58 million
increase in other short-term borrowings, which represent customer balances in
sweep and repurchase facilities.
Comparing the first half of 2006 to the corresponding period of 2005, interest
expense rose $11.7 million or 61.2%, due to higher rates paid on
interest-bearing liabilities, partially offset by a decline in such
liabilities.
Rates paid on liabilities averaged 1.94% during the first six months of 2006
compared to 1.19% in the first six months of 2005. Rates on most
interest-bearing liabilities moved up with the general trend in the market.
The average rate paid on federal funds purchased rose 196 bp. Rates on most
deposits were also higher. CDs over $100 thousand rose 166 bp and retail CDs
increased by 53 bp.
Interest-bearing liabilities declined $46.4 million or 1.4% over the first
half of 2005. Money market savings and retail CDs decreased $118 million and
$41 million, respectively. Federal funds decreased $20 million. The decline
was partially offset by increases in CDs over $100 thousand (up $75 million),
other short-term borrowings, which represent customer balances in sweep and
repurchase facilities (up $48 million), and long-term debt (up $4 million).
In all periods, the Company has attempted to continue increasing the balances
of more profitable, lower-cost transaction accounts in order to minimize the
cost of funds.
Net Interest Margin (FTE)
The following summarizes the components of the Company's net interest margin
for the periods indicated:
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
2006 2005 2006 2005
----------------------------------------------------
Yield on earning assets 6.01% 5.75% 6.00% 5.70%
Rate paid on interest-bearing
liabilities 2.07% 1.30% 1.94% 1.19%
----------------------------------------------------
Net interest spread 3.94% 4.45% 4.06% 4.51%
Impact of all other net
noninterest bearing funds 0.64% 0.39% 0.59% 0.36%
----------------------------------------------------
Net interest margin 4.58% 4.84% 4.65% 4.87%
====================================================
During the second quarter of 2006, the net interest margin declined 26 bp
compared to the same period in 2005. Rates paid on interest-bearing
liabilities climbed faster than yields on earning assets, resulting in a 51 bp
decline in net interest spread. The decline in the net interest spread was
partially mitigated by the higher value of noninterest bearing funding
sources. While the average balance of these sources decreased $71 million or
5.1%, their value increased 25 bp because of the higher market rates of
interest at which they could be invested.
The net interest margin in the first half of 2006 declined by 22 bp when
compared with the corresponding period of 2005. Earning asset yields increased
30 bp and the cost of interest-bearing liabilities rose by 75 bp, resulting in
a 45 bp decrease in the interest spread. Noninterest bearing funding sources
declined $15 million or 1.1%, their margin contribution increased by 23 bp.
Page 16
Summary of Average Balances, Yields/Rates and Interest Differential
The following tables present, for the periods indicated, information regarding
the Company's consolidated average assets, liabilities and shareholders'
equity, the amount of interest income from average earning assets and the
resulting yields, and the amount of interest expense paid on interest-bearing
liabilities and the resulting rates paid. Average loan balances include
nonperforming loans. Interest income includes proceeds from loans on
nonaccrual status only to the extent cash payments have been received and
applied as interest income. Yields on securities and certain loans have been
adjusted upward to reflect the effect of income which is exempt from federal
income taxation at the current statutory tax rate (dollars in thousands).
For the three months ended
June 30, 2006
---------------------------------------
Interest Rates
Average Income/ Earned/
Balance Expense Paid
---------------------------------------
Assets:
Money market assets and funds sold $848 $2 0.95%
Investment securities:
Available for sale
Taxable 398,032 4,227 4.25%
Tax-exempt 252,617 4,605 7.29%
Held to maturity
Taxable 691,209 7,407 4.29%
Tax-exempt 584,802 9,057 6.19%
Loans:
Commercial:
Taxable 355,136 7,386 8.34%
Tax-exempt 247,225 3,978 6.45%
Commercial real estate 914,373 16,590 7.28%
Real estate construction 77,151 1,674 8.70%
Real estate residential 511,521 5,898 4.61%
Consumer 482,814 6,964 5.79%
--------------------------
Total loans 2,588,220 42,490 6.58%
--------------------------
Total earning assets 4,515,728 67,788 6.01%
Other assets 432,715
-------------
Total assets $4,948,443
=============
Liabilities and shareholders' equity
Deposits:
Noninterest bearing demand $1,316,927 $-- --
Savings and interest-bearing
transaction 1,588,822 1,351 0.34%
Time less than $100,000 242,793 1,581 2.61%
Time $100,000 or more 503,488 5,080 4.05%
--------------------------
Total interest-bearing deposits 2,335,103 8,012 1.38%
Short-term borrowed funds 766,936 7,695 3.97%
Debt financing and notes payable 37,015 578 6.25%
--------------------------
Total interest-bearing liabilities 3,139,054 16,285 2.07%
Other liabilities 67,463
Shareholders' equity 424,999
-------------
Total liabilities and shareholders' equity $4,948,443
=============
Net interest spread (1) 3.94%
Net interest income and interest margin (2) $51,503 4.58%
==========================
(1) Net interest spread represents the average yield earned on earning assets
minus the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by calculating the difference between
interest income and expense (annualized), divided by the average balance of
earning assets.
Page 17
For the three months ended
June 30, 2005
---------------------------------------
Interest Rates
Average Income/ Earned/
Balance Expense Paid
---------------------------------------
Assets:
Money market assets and funds sold $664 $1 0.60%
Investment securities:
Available for sale
Taxable 444,661 4,760 4.28%
Tax-exempt 266,299 4,873 7.32%
Held to maturity
Taxable 731,214 7,264 3.97%
Tax-exempt 606,134 9,523 6.28%
Loans:
Commercial:
Taxable 394,956 6,921 7.03%
Tax-exempt 249,472 4,132 6.64%
Commercial real estate 956,931 16,905 7.09%
Real estate construction 80,254 1,446 7.23%
Real estate residential 496,133 5,589 4.51%
Consumer 492,917 6,355 5.17%
--------------------------
Total loans 2,670,663 41,348 6.21%
--------------------------
Total earning assets 4,719,635 67,769 5.75%
Other assets 450,394
-------------
Total assets $5,170,029
=============
Liabilities and shareholders' equity:
Deposits:
Noninterest bearing demand $1,387,984 $-- --
Savings and interest-bearing
transaction 1,763,669 1,310 0.30%
Time less than $100,000 307,118 1,542 2.01%
Time $100,000 or more 448,104 2,602 2.33%
--------------------------
Total interest-bearing deposits 2,518,891 5,454 0.87%
Short-term borrowed funds 745,499 4,655 2.47%
Debt financing and notes payable 40,377 637 6.31%
--------------------------
Total interest-bearing liabilities 3,304,767 10,746 1.30%
Other liabilities 46,482
Shareholders' equity 430,796
-------------
Total liabilities and shareholders' equity $5,170,029
=============
Net interest spread (1) 4.45%
Net interest income and interest margin (2) $57,023 4.84%
==========================
(1) Net interest spread represents the average yield earned on earning assets
minus the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by calculating the difference between
interest income and expense (annualized), divided by the average balance of
earning assets.
Page 18
For the six months ended
June 30, 2006
---------------------------------------
Interest Rates
Average Income/ Earned/
Balance Expense Paid
---------------------------------------
Assets:
Money market assets and funds sold $835 $2 0.48%
Investment securities:
Available for sale
Taxable 404,534 8,631 4.27%
Tax-exempt 253,722 9,249 7.29%
Held to maturity
Taxable 713,479 15,236 4.27%
Tax-exempt 586,298 18,182 6.20%
Loans:
Commercial:
Taxable 357,142 14,757 8.33%
Tax-exempt 250,250 8,073 6.51%
Commercial real estate 918,606 33,404 7.33%
Real estate construction 77,750 3,361 8.72%
Real estate residential 510,279 11,793 4.62%
Consumer 488,058 13,585 5.61%
--------------------------
Total loans 2,602,085 84,973 6.58%
--------------------------
Total earning assets 4,560,953 136,273 6.00%
Other assets 440,396
-------------
Total assets $5,001,349
=============
Liabilities and shareholders' equity:
Deposits:
Noninterest bearing demand $1,336,214 $-- --
Savings and interest-bearing
transaction 1,631,228 2,677 0.33%
Time less than $100,000 248,398 3,041 2.47%
Time $100,000 or more 502,393 9,536 3.83%
--------------------------
Total interest-bearing deposits 2,382,019 15,254 1.29%
Short-term borrowed funds 752,622 14,366 3.80%
Debt financing and notes payable 37,569 1,176 6.26%
--------------------------
Total interest-bearing liabilities 3,172,210 30,796 1.94%
Other liabilities 68,009
Shareholders' equity 424,916
-------------
Total liabilities and shareholders' equity $5,001,349
=============
Net interest spread (1) 4.06%
Net interest income and interest margin (2) $105,477 4.65%
==========================
(1) Net interest spread represents the average yield earned on earning assets
minus the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by calculating the difference between
interest income and expense (annualized), divided by the average balance of
earning assets.
Page 19
For the six months ended
June 30, 2005
---------------------------------------
Interest Rates
Average Income/ Earned/
Balance Expense Paid
---------------------------------------
Assets:
Money market assets and funds sold $686 $1 0.29%
Investment securities:
Available for sale
Taxable 514,031 10,878 4.23%
Tax-exempt 268,344 9,822 7.32%
Held to maturity
Taxable 735,800 14,553 3.96%
Tax-exempt 577,735 18,207 6.30%
Loans:
Commercial
Taxable 372,063 12,622 6.84%
Tax-exempt 248,513 8,232 6.68%
Commercial real estate 883,369 31,659 7.23%
Real estate construction 62,995 2,256 7.22%
Real estate residential 458,928 10,195 4.44%
Consumer 496,818 12,720 5.16%
--------------------------
Total loans 2,522,686 77,684 6.20%
--------------------------
Total earning assets 4,619,282 131,145 5.70%
Other assets 398,049
-------------
Total assets $5,017,331
=============
Liabilities and shareholders' equity:
Deposits:
Noninterest bearing demand $1,351,234 $-- --
Savings and interest-bearing
transaction 1,744,122 2,436 0.28%
Time less than $100,000 289,290 2,780 1.94%
Time $100,000 or more 427,068 4,595 2.17%
--------------------------
Total interest-bearing deposits 2,460,480 9,811 0.80%
Short-term borrowed funds 724,483 8,224 2.26%
Debt financing and notes payable 33,629 1,067 6.35%
--------------------------
Total interest-bearing liabilities 3,218,592 19,102 1.19%
Other liabilities 45,293
Shareholders' equity 402,212
-------------
Total liabilities and shareholders' equity $5,017,331
=============
Net interest spread (1) 4.51%
Net interest income and interest margin (2) $112,043 4.87%
==========================
(1) Net interest spread represents the average yield earned on earning assets
minus the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by calculating the difference between
interest income and expense (annualized), divided by the average balance of
earning assets.
Page 20
Summary of Changes in Interest Income and Expense due to Changes in
Average Asset & Liability Balances and Yields Earned & Rates Paid
-------------------------------------------------------------------
The following tables set forth a summary of the changes in interest income and
interest expense due to changes in average asset and liability balances
(volume) and changes in average interest rates for the periods indicated.
Changes not solely attributable to volume or rates have been allocated in
proportion to the respective volume and rate components (dollars in
thousands).
Three months ended June 30, 2006
compared with three months
ended June 30, 2005
---------------------------------------
Volume Rate Total
---------------------------------------
Interest and fee income:
Money market assets and funds sold $0 $1 $1
Investment securities:
Available for sale
Taxable (495) (38) (533)
Tax-exempt (249) (19) (268)
Held to maturity
Taxable (410) 553 143
Tax-exempt (332) (134) (466)
Loans:
Commercial:
Taxable (743) 1,208 465
Tax-exempt (37) (117) (154)
Commercial real estate (764) 449 (315)
Real estate construction (58) 286 228
Real estate residential 176 133 309
Consumer (133) 742 609
---------------------------------------
Total loans (1,559) 2,701 1,142
---------------------------------------
Total earning assets (3,045) 3,064 19
---------------------------------------
Interest expense:
Deposits:
Savings and interest-bearing
transaction (138) 179 41
Time less than $100,000 (363) 402 39
Time $100,000 or more 356 2,122 2,478
---------------------------------------
Total interest-bearing deposits (145) 2,703 2,558
---------------------------------------
Short-term borrowed funds 138 2,902 3,040
Debt financing and notes payable (53) (6) (59)
---------------------------------------
Total interest-bearing liabilities (60) 5,599 5,539
---------------------------------------
Increase (decrease) in Net Interest Income ($2,985) ($2,535) ($5,520)
=======================================
Page 21
Six months ended June 30, 2006
compared with six months
ended June 30, 2005
---------------------------------------
Volume Rate Total
---------------------------------------
Interest and fee income:
Money market assets and funds sold $0 $1 $1
Investment securities:
Available for sale
Taxable (2,335) 88 ($2,247)
Tax-exempt (533) (40) ($573)
Held to maturity
Taxable (451) 1,134 $683
Tax-exempt 265 (290) ($25)
Loans:
Commercial:
Taxable (523) 2,658 $2,135
Tax-exempt 57 (216) ($159)
Commercial real estate 1,276 469 $1,745
Real estate construction 586 519 $1,105
Real estate residential 1,175 423 $1,598
Consumer (228) 1,093 $865
---------------------------------------
Total loans 2,343 4,946 7,289
---------------------------------------
Total earning assets (711) 5,839 5,128
---------------------------------------
Interest expense:
Deposits:
Savings and interest-bearing
transaction (165) 406 $241
Time less than $100,000 (430) 691 $261
Time $100,000 or more 927 4,014 $4,941
---------------------------------------
Total interest-bearing deposits 332 5,111 5,443
---------------------------------------
Short-term borrowed funds 331 5,811 $6,142
Debt financing and notes payable 124 (15) $109
---------------------------------------
Total interest-bearing liabilities 787 10,907 11,694
---------------------------------------
Increase (decrease) in Net Interest Income ($1,498) ($5,068) ($6,566)
=======================================
Page 22
Provision for Credit Losses
The level of the provision for credit losses during each of the periods
presented reflects the Company's continued efforts to manage credit costs by
enforcing underwriting and administration procedures and aggressively pursuing
collection efforts with troubled debtors. The Company provided $150 thousand
for loan losses in the second quarter of 2006, compared with $300 thousand in
the second quarter of 2005. For the first six months of 2006 and 2005, $300
thousand and $600 thousand were provided in each respective period. The
provision reflects management's assessment of credit risk in the loan
portfolio for each of the periods presented. For further information regarding
net credit losses and the allowance for credit losses, see the "Classified
Assets" section of this report.
Noninterest Income
The following table summarizes the components of noninterest income for the
periods indicated (dollars in thousands).
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
2006 2005 2006 2005
----------------------------------------------------
Service charges on deposit accounts $7,186 $7,542 $14,269 $14,469
Merchant credit card fees 2,392 2,417 4,778 3,715
ATM fees and interchange 717 709 1,395 1,333
Debit card fees 876 811 1,704 1,509
Other service fees 488 429 934 834
Financial services commissions 363 339 661 619
Trust fees 287 309 569 583
Official check issuance income 373 267 706 492
Mortgage banking income 49 67 99 167
Securities losses 0 0 0 (4,903)
Gain on sale of real estate 0 1,331 0 1,331
Other noninterest income 1,330 1,258 2,586 2,525
----------------------------------------------------
Total $14,061 $15,479 $27,701 $22,674
====================================================
Noninterest income for the second quarter of 2006 decreased by $1.4 million or
9.2% from the same period in 2005 primarily because 2005 included a $1.3
million gain on sale of real estate. Service charges on deposits declined $356
thousand or 4.7% mainly due to decreases in deficit fees charged on analyzed
accounts (down $207 thousand or 12.0%) resulting primarily from the higher
earnings credit rate allocated to customers' compensating balances. Decreases
in return item charges (down $108 thousand or 15.9%) and DDA activity also
contributed to reducing service charges on deposits. Official check issuance
income contributed to increasing noninterest income mostly due to the higher
earnings credit rate received on outstanding items.
In the first half of 2006, noninterest income increased $5.0 million or 22.2%
compared with the same period of the previous year primarily because 2005
included $4.9 million in losses on sales of securities, which were realized in
managing the Company's interest rate risk position following the REBC
acquisition. The previous year also included a $1.3 million gain on sale of
real estate. Merchant credit card fees increased $1.1 million or 28.6%
attributable to the acquisition of REBC's merchant card processing unit in
March of 2005. Official check issuance income increased $214 thousand or 43.5%
due to the higher earnings credit rate. Debit card fees increased $195
thousand or 12.9% mainly due to increased usage. Other service fees rose $100
thousand or 12.0% largely due to higher internet banking income. Service
charges on deposits declined $200 thousand or 1.4% largely due to a decrease
in deficit fees charged on analyzed accounts (down $224 thousand or 6.8%) as a
result of the higher earnings credit rate, lower returned item charges and DDA
activity, partially offset by an increase in overdraft fees (up $205 thousand
or 3.1%).
Page 23
Noninterest Expense
The following table summarizes the components of noninterest expense for the
periods indicated (dollars in thousands).
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
2006 2005 2006 2005
----------------------------------------------------
Salaries and related benefits $13,559 $13,956 $26,816 $27,839
Occupancy 3,267 3,230 6,499 6,181
Data processing services 1,531 1,539 3,065 3,087
Equipment 1,315 1,313 2,581 2,544
Amortization of deposit intangibles 1,016 1,092 2,056 1,497
Courier service 909 964 1,831 1,890
Professional fees 833 604 1,291 1,324
Telephone 466 553 898 1,081
Postage 397 376 807 797
Stationery and supplies 272 304 542 652
Customer checks 263 240 553 472
Operational losses 255 200 443 390
Loan expense 236 232 430 436
Advertising/public relations 219 275 453 481
Correspondent Service Charges 207 264 390 514
Other noninterest expense 1,600 1,947 3,174 3,768
----------------------------------------------------
Total $26,345 $27,089 $51,829 $52,953
====================================================
Average full time equivalent staff 904 974 922 969
Noninterest expense to revenues (FTE) 40.18% 37.36% 38.92% 39.31%
Noninterest expense decreased $744 thousand or 2.7% in the second quarter of
2006 compared to the same period in 2005. Salaries and related benefits
decreased $397 thousand or 2.8%, the net result of a $607 thousand decrease in
salaries and a $210 thousand increase in incentive and other benefit plans.
The decrease in regular salaries was attributable to the effect of a smaller
workforce through attrition and payment made in 2005 to non-continuing REBC
employees, partially offset by annual merit increases to continuing staff.
Other noninterest expense declined $348 thousand or 17.9% mostly due to lower
cost of corporate insurance, declines in travel expense and other operating
expenses. Professional fees rose $229 thousand or 37.9% mostly due to a $277
thousand increase in legal fees.
In the first six months of 2006, noninterest expense declined $1.1 million or
2.1% compared with the corresponding period of 2005. Salaries and related
benefits declined $1.0 million or 3.7% mostly due to a $820 thousand decrease
in regular salary as a result of fewer employees, partially offset by annual
merit increases, and a decline in the cost of benefit programs. Other
noninterest expense decreased $594 thousand or 15.8% primarily due to a $353
thousand decrease in corporate insurance costs, and declines in travel expense
and other operating expenses. The $183 thousand or 16.9% decline in telephone
expense was largely attributable to savings from changing providers.
Correspondent service charges and stationery and supplies expense decreased
$124 thousand or 24.1% and $110 thousand or 16.9%, respectively. The $559
thousand or 37.3% increase in amortization of identifiable intangibles
resulted from the REBC acquisition. Occupancy expense rose $318 thousand, or
5.1%, also due to the REBC acquisition.
Provision for Income Tax
During the second quarter of 2006, the Company recorded income tax expense
(FTE) of $14.6 million, $2.8 million or 16.2% lower than the second quarter of
2005. The current quarter provision represents an effective tax rate of 37.3%,
compared to 38.3% for the second quarter of 2005. On a year-to-date basis, the
income tax provision (FTE) was $30.4 million for 2006 compared with $31.1
million for 2005. The effective tax rate of 37.6% for the first half of 2006
is lower than the 37.9% for the same period of 2005. The lower tax rates in
2006 are due to tax credits and other benefits realized from additional
investments in low income housing projects, a higher proportion of tax-exempt
income from municipal bonds and loans, tax refunds and other tax items.
Classified Assets
The Company closely monitors the markets in which it conducts its lending
operations and continues its strategy to control exposure to loans with high
credit risk and to increase diversification of earning assets. Loan reviews
are performed using grading standards and criteria similar to those employed
by bank regulatory agencies. Loans receiving lesser grades fall under the
"classified" category, which includes all nonperforming and potential problem
loans, and receive an elevated level of attention to ensure collection. Other
real estate owned is recorded at the lower of cost or market value less
estimated disposition costs.
Page 24
The following is a summary of classified loans and other real estate owned on
the dates indicated (dollars in thousands):
At June 30, At
--------------------------December 31,
2006 2005 2005
---------------------------------------
Classified loans $25,682 $37,615 $29,997
Other real estate owned 656 40 0
---------------------------------------
Classified loans and other real estate owned $26,338 $37,655 $29,997
=======================================
Allowance for loan losses /
classified loans 217% 159% 186%
Classified loans at June 30, 2006, decreased $11.9 million or 31.7% from a
year ago mainly due to 14 loan payoffs totaling $22.1 million, a transfer to
other real estate owned and upgrades, partially offset by nine loan downgrades
totaling $9.1 million. Classified loans at June 30, 2006, declined $4.3
million or 14.4% from December 31, 2005 mostly due to seven loan payoffs
totaling $16.3 million, a transfer to other real estate owned and upgrades,
partially offset by eight loan downgrades totaling $7.9 million.
Other real estate owned increased $616 thousand from a year ago and rose $656
thousand from December 31, 2005 because collateral for one commercial real
estate loan was foreclosed in the second quarter of 2006.
Nonperforming Loans and Other Real Estate Owned
Nonperforming loans include nonaccrual loans and loans 90 days past due as to
principal or interest and still accruing. Loans are placed on nonaccrual
status when they become 90 days or more delinquent, unless the loan is well
secured and in the process of collection. Interest previously accrued on loans
placed on nonaccrual status is charged against interest income. In addition,
loans secured by real estate with temporarily impaired values and commercial
loans to borrowers experiencing financial difficulties are placed on
nonaccrual status even though the borrowers continue to repay the loans as
scheduled. Such loans are classified as "performing nonaccrual" and are
included in total nonperforming assets. When the ability to fully collect
nonaccrual loan principal is in doubt, cash payments received are applied
against the principal balance of the loan until such time as full collection
of the remaining recorded balance is expected. Any subsequent interest
received is recorded as interest income on a cash basis.
The following is a summary of nonperforming loans and other real estate owned
on the dates indicated (dollars in thousands):
At June 30, At
--------------------------December 31,
2006 2005 2005
---------------------------------------
Performing nonaccrual loans $3,899 $6,072 $4,256
Nonperforming nonaccrual loans 1,613 1,560 2,068
---------------------------------------
Total nonaccrual loans 5,512 7,632 6,324
Loans 90 days past due and
still accruing 114 84 162
---------------------------------------
Total nonperforming loans 5,626 7,716 6,486
Other real estate owned 656 40 0
---------------------------------------
Total $6,282 $7,756 $6,486
=======================================
As a percentage of total loans 0.24% 0.29% 0.24%
Performing nonaccrual loans at June 30, 2006 decreased $2.2 million or 35.8%
and $357 thousand or 8.4% from a year ago and December 31, 2005, respectively,
as a result of loans being returned to accrual status, payoffs, loans being
placed on nonperforming nonaccrual, chargeoffs and new loans being placed on
nonaccrual.
Nonperforming nonaccrual loans at June 30, 2006 increased $53 thousand or 3.4%
from a year ago and declined $455 thousand or 22.0% from December 31, 2005.
The change was the net result of loans being returned to accrual status or
being charged off or paid off, and others being added to nonperforming
nonaccrual.
Changes in other real estate owned are discussed above under "Classified
Assets".
The Company had no restructured loans as of June 30, 2006, June 30, 2005 and
December 31, 2005.
The amount of gross interest income that would have been recorded for
nonaccrual loans for the three and six month periods ended June 30, 2006, if
all such loans had performed in accordance with their original terms, was $143
thousand and $262 thousand, respectively, compared to $150 thousand and $274
thousand, respectively, for the second quarter and the first half of 2005.
Page 25
The amount of interest income that was recognized on nonaccrual loans from all
cash payments, including those related to interest owed from prior years, made
during the three and six months ended June 30, 2006, totaled $93 thousand and
$153 thousand, respectively, compared to $120 thousand and $285 thousand,
respectively, for the comparable periods in 2005. These cash payments
represent annualized yields of 5.78% and 5.01%, respectively, for the second
quarter and the first six months of 2006 compared to 6.02% and 7.88%,
respectively, for the second quarter and the first half of 2005.
Total cash payments received during the second quarter of 2006 which were
applied against the book balance of nonaccrual loans outstanding at June 30,
2006, totaled approximately $15 thousand compared with $77 thousand for the
same period in 2005. Cash payments received totaled $47 thousand for the six
months ended June 30, 2006 compared with $228 thousand for the corresponding
period in 2005.
Management believes the overall credit quality of the loan portfolio continues
to be sound; however, nonperforming assets could fluctuate from period to
period. The performance of any individual loan can be affected by external
factors such as the interest rate environment, economic conditions or factors
particular to the borrower. No assurance can be given that additional
increases in nonperforming loans and other real estate owned will not occur in
the future.
Allowance for Credit Losses
The Company's allowance for credit losses is maintained at a level considered
adequate to provide for losses that can be estimated based upon specific and
general conditions. These include conditions unique to individual borrowers,
as well as overall credit loss experience, the amount of past due,
nonperforming loans and classified loans, recommendations of regulatory
authorities, prevailing economic conditions and other factors. A portion of
the allowance is specifically allocated to impaired and other identified loans
whose full collectibility is uncertain. Such allocations are determined by
Management based on loan-by-loan analyses. A second allocation is based in
part on quantitative analyses of historical credit loss experience, in which
criticized and classified credit balances identified through an internal
credit review process are analyzed using a linear regression model to
determine standard loss rates. The results of this analysis are applied to
current criticized and classified loan balances to allocate the reserve to the
respective segments of the loan portfolio. In addition, loans with similar
characteristics not usually criticized using regulatory guidelines are
analyzed based on the historical loss rates and delinquency trends, grouped by
the number of days the payments on these loans are delinquent. Last,
allocations are made to general loan categories based on commercial office
vacancy rates, mortgage loan foreclosure trends, agriculture commodity prices,
and levels of government funding. The remainder of the reserve is considered
to be unallocated and is established at a level considered necessary based on
relevant economic conditions and available data, including unemployment
statistics, unidentified economic and business conditions, the quality of
lending management and staff, credit quality trends, concentrations of credit,
and changing underwriting standards due to external competitive factors.
Management considers the $59.4 million allowance for credit losses to be
adequate as a reserve against losses as of June 30, 2006.
The following table summarizes the credit loss provision, net credit losses
and allowance for credit losses for the periods indicated (dollars in
thousands):
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
2006 2005 2006 2005
Balance, beginning of period $59,456 $59,859 $59,536 $54,152
Credit loss provision 150 300 300 600
Allowance acquired through merger 0 0 0 5,213
Loans charged off (645) (754) (1,763) (1,353)
Recoveries of previously
charged off loans 411 457 1,299 1,250
----------------------------------------------------
Net credit losses (234) (297) (464) (103)
----------------------------------------------------
Balance, end of period $59,372 $59,862 $59,372 $59,862
====================================================
Components:
Allowance for loan losses $55,684 $59,862 $55,684 $59,862
Reserve for unfunded credit commitments (1) 3,688 -- 3,688 --
----------------------------------------------------
Allowance for credit losses $59,372 $59,862 $59,372 $59,862
====================================================
Allowance for loan losses /
loans outstanding 2.16% 2.23%
(1) Effective December 31, 2005, the Company transferred the portion of the
allowance for credit losses related to lending commitments and letters of
credit to other liabilities.
Asset and Liability Management
The fundamental objective of the Company's management of assets and
liabilities is to maximize its economic value while maintaining adequate
liquidity and a conservative level of interest rate risk.
Interest rate risk is the most significant market risk affecting the Company.
Interest rate risk results from many factors. Assets and liabilities may
mature or reprice at different times. Assets and liabilities may reprice at
the same time but by different amounts. Short-term and long-term market
interest rates may change by different amounts. The remaining maturity of
various assets or liabilities may shorten or lengthen as interest rates
change. In addition, interest rates may have an indirect impact on loan
demand, credit losses, and other sources of earnings such as account analysis
fees on commercial deposit accounts, official check fees and correspondent
bank service charges.
Page 26
Rising short-term interest rates are slowing growth of lower-costing deposit
products, placing more reliance on higher-cost certificates of deposit and
wholesale funding. Competitive loan pricing and loosened underwriting
standards in the banking industry are limiting the opportunity to originate
commercial loans which will remain profitable throughout the duration of the
loans, in Management's opinion. Current interest rate spreads between loan
origination yields and the rates paid on deposits and other funding sources
are very narrow. Such interest rate spreads could be pressured in the
near-term as funding costs rise while many loan yields are generally fixed in
nature. As a result, the Company has not take an aggressive posture relative
to current loan growth. The interest rate spread is also very narrow in regard
to bond investments. As such, Westamerica has not been making additional
investments in bonds. The Company's exposure to interest rate risk has
declined during the first six months of 2006. Lower loan volumes, particularly
commercial real estate, and a seasoning investment portfolio have reduced the
duration of the Company's earning assets, while the duration of its funding
has not changed by a meaningful amount. Management continues to monitor the
interest rate environment as well as economic conditions and other conditions
it deems relevant in managing the Company's exposure to interest rate risk.
In adjusting the Company's asset/liability position, Management attempts to
manage interest rate risk while enhancing net interest margin and net interest
income. At times, depending on expected increases or decreases in general
interest rates, the relationship between long and short term interest rates,
market conditions and competitive factors, Management may adjust the Company's
interest rate risk position in order to manage its net interest margin and net
interest income. The Company's results of operations and net portfolio values
remain subject to changes in interest rates and to fluctuations in the
difference between long and short term interest rates.
Management assesses interest rate risk by comparing the Company's most likely
earnings plan with various earnings models using many interest rate scenarios
that differ in the direction of interest rate changes, the degree of change
over time, the speed of change and the projected shape of the yield curve. For
example, assuming an increase of 50 bp in the federal funds rate and an
increase of 15 bp in the 10 year Constant Maturity Treasury Bond yield during
the same period, estimated earnings at risk would be approximately 1.5% of the
Company's most likely net income plan over the next twelve months. Simulation
estimates depend on, and will change with, the size and mix of the actual and
projected balance sheet at the time of each simulation.
The Company does not currently engage in trading activities or use derivative
instruments to control interest rate risk, even though such activities may be
permitted with the approval of the Company's Board of Directors.
Liquidity
The Company's principal source of asset liquidity is investment securities
available for sale and principal payments from consumer loans. At June 30,
2006, investment securities available for sale totaled $620 million,
representing a decrease of $42 million from December 31, 2005. At June 30,
2006, indirect auto loans totaled $409.5 million, which were experiencing
stable monthly principal payments of approximately $20 million. In addition,
at June 30, 2006, the Company had customary lines for overnight borrowings
from other financial institutions in excess of $700 million and a $35 million
line of credit, under which $22.8 million was outstanding. Additionally, as a
member of the Federal Reserve System, the Company has access to borrowing from
the Federal Reserve. The Company's short-term debt rating from Fitch Ratings
is F1. Management expects the Company can access short-term debt financing if
desired. The Company's long-term debt rating from Fitch Ratings is A with a
stable outlook. Management is confident the Company could access additional
long-term debt financing if desired.
The Company generates significant liquidity from its operating activities. The
Company's profitability during the first six months of 2006 and 2005
contributed to substantial operating cash flows of $56.3 million and $47.9
million, respectively. In the first half of 2006, operating activities and
retained earnings from prior years provided cash for $47.8 million of Company
stock repurchases, $20.3 million in shareholder dividends and $3.3 million for
repayment of long term debt. Similarly, in 2005, operating activities and
retained earnings from prior years provided cash for $19.3 million in
shareholder dividends, $3.3 million for repayment of long term debt and $45.5
million utilized to repurchase common stock.
The Company's investing activities were also a net source of cash in the first
six months of 2006. Proceeds from maturing investment securities of $128.7
million were only partially reinvested, for a net increase in cash of $123.7
million. Other investing activities included net loan repayments of $90.7
million. This cash inflow offset a $199 million decrease in customers'
deposits and a $28.7 million reduction in short-term borrowings.
In the first six months of 2005, the Company's primary investment was the REBC
acquisition. The Company paid cash of $35.2 million and issued 1.6 million
shares of its common stock to REBC shareholders in exchange for $435 million
loans, $47 million investment securities, $370 million deposits, a merchant
card processing business, and other assets and liabilities. In the first six
months of 2005, the Company also sold approximately $196 million in securities
available for sale to manage its interest rate risk position in light of the
REBC acquisition. The Company also divested approximately $34 million in
deposits in a branch sale required by regulators in approving the REBC
acquisition.
Page 27
The Company anticipates maintaining its cash levels in 2006 mainly through
profitability and retained earnings. It is anticipated that loan demand will
be moderate during the remainder of 2006, although such demand will be
dictated by economic conditions. A highly competitive environment for deposits
has developed as short-term interest rates have steadily increased. The
Company aggressively solicits non-interest bearing demand deposits and money
market checking deposits, which are the least sensitive to interest rates.
However, higher costing products, including money market savings and
certificates of deposit, have been less stable during the recent period of
rising short-term interest rates. The growth of deposit balances is subject to
heightened competition and the success of the Company's sales efforts and
delivery of superior customer service. Depending on economic conditions,
interest rate levels, and a variety of other conditions, deposit growth may be
used to fund loans, purchase investment securities or to reduce short-term
borrowings. However, due to concerns regarding uncertainty in the general
economic environment, competition, possible terrorist attacks and political
uncertainty, loan demand and levels of customer deposits are not certain.
Shareholder dividends and share repurchases are expected to continue subject
to the Board's discretion and continuing evaluation of capital levels,
earnings, asset quality and other factors.
Westamerica Bancorporation ("the Parent Company") is a separate entity and
apart from Westamerica Bank ("the Bank") and must provide for its own
liquidity. In addition to its operating expenses, the Parent Company is
responsible for the payment of dividends to its shareholders, and interest and
principal on outstanding debt. Substantially all of the Parent Company's
revenues are obtained from subsidiary service fees and dividends. Payment of
such dividends to the Parent Company by the Bank is limited under regulations
for Federal Reserve member banks and California law. The amount that can be
paid in any calendar year, without prior approval from federal and state
regulatory agencies, cannot exceed the net profits (as defined) for that year
plus the net profits of the preceding two calendar years less dividends paid.
The Company believes that such restrictions will not have an impact on the
Parent Company's ability to meet its ongoing cash obligations.
Capital Resources
The current and projected capital position of the Company and the impact of
capital plans and long-term strategies are reviewed regularly by Management.
The Company repurchases shares of its common stock in the open market pursuant
to stock repurchase plans approved by the Board with the intention of
lessening the dilutive impact of issuing new shares under stock option plans,
returning excess capital to shareholders, and other ongoing requirements.
These programs have been implemented to optimize the Company's use of equity
capital and enhance shareholder value. Pursuant to these programs, the Company
collectively repurchased 920 thousand shares and 863 thousand shares in the
first half of 2006 and 2005, respectively.
The Company's capital position represents the level of capital available to
support continued operations and expansion. The Company's primary capital
resource is shareholders' equity, which was $421.7 million at June 31, 2006, a
decrease of $26.2 million or 5.9% from a year ago, and a decrease of $13.3
million or 3.1% from December 31, 2005. These decreases are reflective of the
effect of the generation of earnings and stock issuance in connection with
employee stock option exercises, offset by common stock repurchases, dividends
paid to shareholders and a change in unrealized gain(loss) on securities
available for sale. The Company's ratio of equity to total assets rose to
8.59% at June 30, 2006, from 8.47% a year ago and 8.44% on December 31, 2005,
because total assets decreased relatively more than shareholders' equity.
The following summarizes the ratios of capital to risk-adjusted assets for the
periods indicated:
At June 30, At Minimum
--------------------------December 31, Regulatory
2006 2005 2005 Requirement
----------------------------------------------------
Tier I Capital 9.61% 9.04% 9.08% 4.00%
Total Capital 10.93% 10.37% 10.40% 8.00%
Leverage ratio 6.26% 5.96% 6.01% 4.00%
The risk-based capital ratios rose at June 30, 2006, compared with June 30 and
December 31 of 2005, primarily due to lower risk-adjusted assets.
Capital ratios are reviewed by Management on a regular basis to ensure that
capital exceeds the prescribed regulatory minimums and is adequate to meet the
Company's anticipated future needs. All ratios as shown in the table above are
in excess of the regulatory definition of "well capitalized".
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company does not currently engage in trading activities or use derivative
instruments to control interest rate risk, even though such activities may be
permitted with the approval of the Company's Board of Directors.
Interest rate risk as discussed above is the most significant market risk
affecting the Company. Other types of market risk, such as foreign currency
exchange risk, equity price risk and commodity price risk, are not significant
in the normal course of the Company's business activities.
Item 4. Controls and Procedures
The Company's principal executive officer and principal financial officer have
evaluated the effectiveness of the Company's "disclosure controls and
procedures," as such term is defined in Rule 13a-15(e) of the Securities
Exchange Act of 1934, as amended, as of June 30, 2006. Based upon their
evaluation, the principal executive officer and principal financial officer
concluded that the Company's disclosure controls and procedures are effective.
The evaluation did not identify any change in the Company's internal control
over financial reporting that occurred during the quarter ended June 30, 2006
that has materially affected, or is reasonably likely to materially affect,
the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Due to the nature of the banking business, the Bank is at
times party to various legal actions; all such actions are of a
routine nature and arise in the normal course of business of the
Subsidiary Bank.
Page 28
Item 1A. Risk Factors
There are no material changes to the risk factors disclosed in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) None
(b) None
(c) Issuer Purchases of Equity Securities
The table below sets forth the information with respect to purchases made by
or on behalf of Westamerica Bancorporation or any "affiliated purchaser" (as
defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of
common stock during the quarter ended June 30, 2006 (in thousands, except per
share data).
(c) (d)
Total Maximum
Number Number
of Shares of Shares
(b) Purchased that May
(a) Average as Part of Yet Be
Total Price Publicly Purchased
Number of Paid Announced Under the
Shares per Plans Plans or
Period Purchased Share or Programs* Programs
-----------------------------------------------------------------
April 1
through
April 30 143 $51.12 143 909
-----------------------------------------------------------------
May 1
through
May 31 252 50.83 252 657
-----------------------------------------------------------------
June 1
through
June 30 96 48.57 96 561
-----------------------------------------------------------------
Total 491 $50.48 491 561
=================================================================
* Includes 14, 7 and 6 shares purchased in April, May and June,
respectively, by the Company in private transactions with the independent
administrator of the Company's Tax Deferred Savings/Retirement Plan (ESOP).
The Company includes the shares purchased in such transactions within the
total number of shares authorized for purchase pursuant to the currently
existing publicly announced program.
The Company repurchases shares of its common stock in the open market to
optimize the Company's use of equity capital and enhance shareholder value and
with the intention of lessening the dilutive impact of issuing new shares to
meet stock performance, option plans, and other ongoing requirements.
Shares were repurchased during the second quarter of 2006 pursuant to a
program approved by the Board of Directors on August 25, 2005 authorizing the
purchase of up to 2,000,000 shares of the Company's common stock from time to
time prior to September 1, 2006. At June 30, 2006, 561,000 shares remain
available to purchase under this authorization.
Page 29
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
Proxies for the Annual Meeting of shareholders held on April 27,
2006, were solicited pursuant Regulation 14A of the Securities
Exchange Act of 1934. The Report of Inspector of election
indicates that 27,094,988 shares of the Common Stock of the
Company, out of 31,648,838 shares outstanding on February 27,
2006 the record date, were present, in person or by proxy, at the
meeting. There were no "broker non-votes" because the election of
directors is considered "routine" under applicable exchange rules
and therefore, on this matter, brokers were able to vote shares
for which no direction was provided by the beneficial owner. The
following matter was submitted to a vote of the shareholders:
1. - Election of directors:
For Withheld
------- ---------
Etta Allen 26,561,230 533,759
Louis E. Bartolini 26,375,284 719,705
E.Joseph Bowler 26,858,668 236,320
Arthur C. Latno, Jr. 26,258,382 836,606
Patrick D. Lynch 26,484,883 610,106
Catherine C. MacMillan 26,536,941 558,047
Ronald A. Nelson 26,260,194 834,794
Carl R. Otto 26,519,980 575,008
David L. Payne 26,651,749 443,239
Edward B. Sylvester 26,600,097 494,891
Shareholders were to cast their vote for or to withhold their vote.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) The exhibit list required by this item is incorporated by reference
to the Exhibit Index filed with this report.
Page 30
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 hereunto duly
authorized.
WESTAMERICA BANCORPORATION
(Registrant)
August 4, 2006 /s/ John "Robert" Thorson
--------------- --------------------------
Date John "Robert" Thorson
Senior Vice President
and Chief Financial Officer
(Chief Financial and Accounting Officer)
Page 31
Exhibit Index
Exhibit 11: Computation of Earnings Per Share on Common
and Common Equivalent Shares and on Common
Shares Assuming Full Dilution
Exhibit 31.1: Certification of Chief Executive
Officer pursuant to Securities
Exchange Act Rule 13a-14(a)/15d-14(a)
Exhibit 31.2: Certification of Chief Financial
Officer pursuant to Securities
Exchange Act Rule 13a-14(a)/15d-14(a)
Exhibit 32.1: Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
Exhibit 32.2: Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002