UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

OR

o                                 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: 00-30747


FIRST COMMUNITY BANCORP

(Exact name of registrant as specified in its charter)

CALIFORNIA

 

33-0885320

(State or other jurisdiction
of incorporation or organization)

 

(I.R.S. Employer
Identification Number)

401 West “A’’ Street
San Diego, California

 

92101

(Address of principal executive offices)

 

(Zip Code)

 

(619) 233-5588

(Registrant’s telephone number, including area code)


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 o

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 o Non-accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

As of August 1, 2007 there were 29,418,792 shares of the registrant’s common stock outstanding, excluding 801,520 shares of unvested restricted stock.

 




TABLE OF CONTENTS

 

 

 

Page

 

PART I—FINANCIAL INFORMATION

 

 

3

 

 

ITEM 1.

 

Unaudited Condensed Consolidated Financial Statements

 

 

3

 

 

 

 

Unaudited Condensed Consolidated Balance Sheets

 

 

3

 

 

 

 

Unaudited Condensed Consolidated Statements of Earnings

 

 

4

 

 

 

 

Unaudited Condensed Consolidated Statements of Comprehensive Income

 

 

5

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows

 

 

6

 

 

 

 

Unaudited Condensed Consolidated Statement of Shareholders’ Equity

 

 

7

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

 

8

 

 

ITEM 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

21

 

 

ITEM 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

40

 

 

ITEM 4.

 

Controls and Procedures

 

 

40

 

 

PART II—OTHER INFORMATION

 

 

41

 

 

ITEM 1.

 

Legal Proceedings

 

 

41

 

 

ITEM 1A.

 

Risk Factors

 

 

41

 

 

ITEM 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

41

 

 

ITEM 4.

 

Submission of Matters to a Vote of Security Holders

 

 

42

 

 

ITEM 6.

 

Exhibits

 

 

43

 

 

SIGNATURES

 

 

44

 

 

 

2




PART I—FINANCIAL INFORMATION

ITEM 1.                Unaudited Condensed Consolidated Financial Statements

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

June 30,
2007

 

December 31, 
2006

 

 

 

(Dollars in thousands, except
share data)

 

Assets:

 

 

 

 

 

 

 

Cash and due from banks

 

$

132,727

 

 

$

128,910

 

 

Federal funds sold

 

9,900

 

 

22,000

 

 

Total cash and cash equivalents

 

142,627

 

 

150,910

 

 

Interest-bearing deposits in financial institutions

 

422

 

 

501

 

 

Investments:

 

 

 

 

 

 

 

Federal Home Loan Bank stock, at cost

 

17,324

 

 

28,747

 

 

Securities available-for-sale (amortized cost of $83,319 at June 30, 2007 and $91,675 at December 31, 2006)

 

82,724

 

 

91,381

 

 

Total investments

 

100,048

 

 

120,128

 

 

Loans, held for sale

 

116,834

 

 

173,319

 

 

Loans, net of fees

 

3,841,617

 

 

4,189,543

 

 

Allowance for loan losses

 

(52,431

)

 

(52,908

)

 

Net loans

 

3,789,186

 

 

4,136,635

 

 

Premises and equipment, net

 

36,841

 

 

37,102

 

 

Accrued interest receivable

 

18,687

 

 

21,388

 

 

Goodwill

 

770,665

 

 

738,083

 

 

Core deposit and customer relationship intangibles

 

46,290

 

 

50,427

 

 

Cash surrender value of life insurance

 

69,046

 

 

67,512

 

 

Other assets

 

53,129

 

 

57,318

 

 

Total assets

 

$

5,143,775

 

 

$

5,553,323

 

 

Liabilities and Shareholders’ Equity:

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

Noninterest-bearing

 

$

1,454,263

 

 

$

1,571,361

 

 

Interest-bearing

 

1,956,489

 

 

2,114,372

 

 

Total deposits

 

3,410,752

 

 

3,685,733

 

 

Accrued interest payable and other liabilities

 

66,542

 

 

51,043

 

 

Borrowings

 

302,684

 

 

499,000

 

 

Subordinated debentures

 

138,691

 

 

149,219

 

 

Total liabilities

 

3,918,669

 

 

4,384,995

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

Preferred stock, no par value; Authorized 5,000,000 shares; none issued and outstanding

 

 

 

 

 

Common stock, no par value; Authorized 50,000,000 shares; issued and outstanding 30,214,738 at June 30, 2007 and 29,635,957 at December 31, 2006 (includes 843,255 and 750,014 shares of unvested restricted stock, respectively)

 

1,044,941

 

 

1,020,132

 

 

Retained earnings

 

180,510

 

 

148,367

 

 

Accumulated other comprehensive loss—unrealized losses on securities available-for-sale, net

 

(345

)

 

(171

)

 

Total shareholders’ equity

 

1,225,106

 

 

1,168,328

 

 

Total liabilities and shareholders’ equity

 

$

5,143,775

 

 

$

5,553,323

 

 

 

See “Notes to Unaudited Condensed Consolidated Financial Statements.”

3




UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

 

 

Quarter Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(In thousands, except per share data)

 

Interest income:

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

84,277

 

$

68,330

 

$

175,226

 

$

128,279

 

Interest on federal funds sold

 

909

 

66

 

1,123

 

130

 

Interest on deposits in financial institutions

 

6

 

5

 

12

 

20

 

Interest on investment securities

 

1,362

 

2,588

 

2,738

 

4,754

 

Total interest income

 

86,554

 

70,989

 

179,099

 

133,183

 

Interest expense:

 

 

 

 

 

 

 

 

 

Deposits

 

13,731

 

7,136

 

27,156

 

12,765

 

Borrowings

 

3,414

 

3,118

 

10,166

 

5,281

 

Subordinated debentures

 

2,955

 

2,697

 

5,888

 

5,147

 

Total interest expense

 

20,100

 

12,951

 

43,210

 

23,193

 

Net interest income

 

66,454

 

58,038

 

135,889

 

109,990

 

Provision for credit losses

 

 

9,500

 

 

9,600

 

Net interest income after provision for credit losses

 

66,454

 

48,538

 

135,889

 

100,390

 

Noninterest income:

 

 

 

 

 

 

 

 

 

Service charges and fees on deposit accounts

 

2,850

 

1,986

 

5,667

 

3,545

 

Other commissions and fees

 

1,976

 

1,596

 

3,299

 

3,078

 

Gain on sale of loans, net

 

1,779

 

 

9,304

 

 

Increase in cash surrender value of life insurance

 

627

 

531

 

1,243

 

952

 

Other income

 

297

 

178

 

2,367

 

349

 

Total noninterest income

 

7,529

 

4,291

 

21,880

 

7,924

 

Noninterest expense:

 

 

 

 

 

 

 

 

 

Compensation

 

18,267

 

14,865

 

37,189

 

30,095

 

Occupancy

 

4,725

 

3,905

 

9,486

 

7,050

 

Furniture and equipment

 

1,195

 

981

 

2,488

 

1,742

 

Data processing

 

1,467

 

1,719

 

3,025

 

3,054

 

Other professional services

 

1,795

 

1,016

 

3,232

 

2,136

 

Business development

 

849

 

353

 

1,556

 

700

 

Communications

 

841

 

749

 

1,673

 

1,375

 

Insurance and assessments

 

378

 

492

 

791

 

964

 

Intangible asset amortization

 

2,305

 

1,577

 

4,479

 

2,726

 

Reorganization charges

 

1,083

 

407

 

1,341

 

407

 

Other

 

3,092

 

2,380

 

6,130

 

4,366

 

Total noninterest expense

 

35,997

 

28,444

 

71,390

 

54,615

 

Earnings before income taxes and effect of accounting change

 

37,986

 

24,385

 

86,379

 

53,699

 

Income taxes

 

15,461

 

9,934

 

35,308

 

21,987

 

Net earnings before cumulative effect of accounting change

 

22,525

 

14,451

 

51,071

 

31,712

 

Cumulative effect on prior years (to December 31, 2005) of changing the method of
accounting for stock-based compensation forfeitures

 

 

 

 

142

 

Net earnings

 

$

22,525

 

$

14,451

 

$

51,071

 

$

31,854

 

Outstanding shares:

 

 

 

 

 

 

 

 

 

Number of shares (weighted average):

 

 

 

 

 

 

 

 

 

Basic

 

28,885.9

 

22,509.2

 

28,876.6

 

20,952.2

 

Diluted

 

29,015.8

 

22,736.9

 

29,007.4

 

21,208.5

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

Net earnings before accounting change

 

$

0.78

 

$

0.64

 

$

1.77

 

$

1.51

 

Accounting change

 

 

 

 

0.01

 

Basic earnings per share

 

$

0.78

 

$

0.64

 

$

1.77

 

$

1.52

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

Net earnings before accounting change

 

$

0.78

 

$

0.64

 

$

1.76

 

$

1.50

 

Accounting change(1)

 

 

 

 

 

Diluted earnings per share

 

$

0.78

 

$

0.64

 

$

1.76

 

$

1.50

 

Dividends declared per share

 

$

0.32

 

$

0.32

 

$

0.64

 

$

0.57

 


(1)                Less than $0.01 per diluted share for the six months ended June 30, 2006.

See “Notes to Unaudited Condensed Consolidated Financial Statements.”

4




UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

Quarter Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(Dollars in thousands)

 

Net earnings

 

$

22,525

 

$

14,451

 

$

51,071

 

$

31,854

 

Other comprehensive income, net of related income taxes:

 

 

 

 

 

 

 

 

 

Unrealized holding losses on securities arising during
the period

 

(343

)

(106

)

(174

)

(371

)

Comprehensive income

 

$

22,182

 

$

14,345

 

$

50,897

 

$

31,483

 

 

See “Notes to Unaudited Condensed Consolidated Financial Statements.”

5




UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

 

 

(Dollars in thousands)

 

Cash flows from operating activities:

 

 

 

 

 

Net earnings

 

$

51,071

 

$

31,854

 

Adjustments to reconcile net earnings to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

7,206

 

5,185

 

Provision for credit losses

 

 

9,600

 

Gain on sale of loans

 

(9,304

)

 

Proceeds from sale of loans held for sale

 

78,350

 

 

Originations of and principal advanced on loans held for sale

 

(13,430

)

 

Gain on sale of premises and equipment

 

(26

)

(6

)

Restricted stock amortization

 

4,582

 

3,236

 

Excess tax benefit from stock option exercises and restricted stock vesting

 

(1,951

)

(4,578

)

Decrease in accrued and deferred income taxes, net

 

10,333

 

7,974

 

Decrease in other assets

 

824

 

2,767

 

Increase (decrease) in accrued interest payable and other liabilities

 

7,654

 

(17,423

)

Dividends on FHLB stock

 

(746

)

(323

)

Net cash provided by operating activities

 

134,563

 

38,286

 

Cash flows from investing activities:

 

 

 

 

 

Net cash and cash equivalents paid in acquisitions

 

(1,566

)

(24,710

)

Net decrease (increase) in loans

 

77,102

 

(73,506

)

Proceeds from sale of loans

 

355,239

 

4,859

 

Net decrease in deposits in financial institutions

 

79

 

1,698

 

Collections on sales of acquired securities

 

 

32,050

 

Maturities and repayments of investment securities

 

29,412

 

31,892

 

Purchases of investment securities

 

(20,877

)

(1,851

)

Net redemptions (purchases) of FRB and FHLB stock

 

12,185

 

(7,533

)

Purchases of premises and equipment, net

 

(2,929

)

(3,683

)

Proceeds from sale of other real estate owned

 

479

 

37

 

Proceeds from sale of premises and equipment

 

110

 

6

 

Net cash provided by (used in) investing activities

 

449,234

 

(40,741

)

Cash flows from financing activities:

 

 

 

 

 

Net decrease in noninterest-bearing deposits

 

(117,098

)

(43,528

)

Net decrease in interest-bearing deposits

 

(157,883

)

(178,319

)

Redemption of subordinated debtentures

 

(10,310

)

 

Proceeds from issuance of common stock

 

 

109,456

 

Repurchase of common stock

 

(9,521

)

 

Net proceeds from exercise of stock options and vesting of restricted stock

 

109

 

6,302

 

Tax benefit of stock option exercises and restricted and performance stock vesting

 

1,951

 

4,578

 

Net (decrease) increase in borrowings

 

(196,700

)

163,800

 

Repayment of acquired debt

 

(83,700

)

 

Cash dividends paid

 

(18,928

)

(12,700

)

Net cash (used in) provided by financing activities

 

(592,080

)

49,589

 

Net (decrease) increase in cash and cash equivalents

 

(8,283

)

47,134

 

Cash and cash equivalents at beginning of period

 

150,910

 

105,262

 

Cash and cash equivalents at end of period

 

$

142,627

 

$

152,396

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid during period for interest

 

$

43,110

 

$

21,707

 

Cash paid during period for income taxes

 

25,073

 

14,061

 

Transfer of loans to other real estate owned

 

98

 

 

Transfer from loans held for sale to loans

 

24,944

 

 

Transfer from loans to loans held for sale

 

379,692

 

4,888

 

 

See “Notes to Unaudited Condensed Consolidated Financial Statements.”

6




UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

 

 

Common Stock

 

Retained

 

Accumulated
Other
Comprehensive

 

 

 

 

 

Shares

 

Amount

 

Earnings

 

Income (Loss)

 

Total

 

 

 

(Dollars in thousands, except share data)

 

Balance at December 31, 2006

 

29,635,957

 

$

1,020,132

 

$

148,367

 

 

$

(171

)

 

$

1,168,328

 

Net earnings

 

 

 

51,071

 

 

 

 

51,071

 

Exercise of stock options

 

87,090

 

1,508

 

 

 

 

 

1,508

 

Shares issued in acquisitions

 

494,606

 

27,688

 

 

 

 

 

27,688

 

Shares purchased and retired

 

(177,600

)

(9,521

)

 

 

 

 

(9,521

)

Tax benefits from exercise of options and vesting of restricted stock

 

 

1,951

 

 

 

 

 

1,951

 

Restricted stock awarded and earned stock compensation, net of shares forfeited

 

200,134

 

4,582

 

 

 

 

 

4,582

 

Restricted stock surrendered

 

(25,449

)

(1,399

)

 

 

 

 

(1,399

)

Cash dividends paid ($0.64 per share)

 

 

 

(18,928

)

 

 

 

(18,928

)

Other comprehensive income—net unrealized loss on securities available-for-sale, net of tax effect of $126 thousand

 

 

 

 

 

(174

)

 

(174

)

Balance at June 30, 2007

 

30,214,738

 

$

1,044,941

 

$

180,510

 

 

$

(345

)

 

$

1,225,106

 

 

See “Notes to Unaudited Condensed Consolidated Financial Statements.”

7




NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007

NOTE 1—BASIS OF PRESENTATION

We are a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Our principal business is to serve as a holding company for our banking subsidiary. As of June 30, 2007, our sole banking subsidiary was Pacific Western Bank, which we refer to as Pacific Western or the Bank. When we say “we”, “our” or the “Company”, we mean the Company on a consolidated basis with the Bank. When we refer to “First Community” or to the holding company, we are referring to the parent company on a stand-alone basis.

We have completed 19 acquisitions since May 2000 including the merger whereby the former Rancho Santa Fe National Bank and First Community Bank of the Desert became wholly-owned subsidiaries of the Company in a pooling-of-interests transaction. All other acquisitions have been accounted for using the purchase method of accounting and, accordingly, their operating results have been included in the consolidated financial statements from their respective dates of acquisition. Please see Notes 2 and 3 for more information about our acquisitions.

(a)   Basis of Presentation

The accounting and reporting policies of the Company are in accordance with U.S. generally accepted accounting principles. All significant intercompany balances and transactions have been eliminated.

Our financial statements reflect all adjustments that are, in the opinion of management, necessary to present a fair statement of the results for the interim periods presented. Certain information and note disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The interim operating results are not necessarily indicative of operating results for the full year.

(b)   Use of Estimates

Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period to prepare these consolidated financial statements in conformity with U.S. generally accepted accounting principles. Actual results could differ from those estimates. Material estimates subject to change in the near term include, among other items, the allowance for credit losses, the carrying values of intangible assets and the realization of deferred tax assets.

(c)   Reclassifications

Certain prior period amounts have been reclassified to conform to the current year’s presentation.

8




NOTE 2—ACQUISITIONS

During 2007 and 2006 we completed the following four acquisitions using the purchase method of accounting, and accordingly, the operating results of the acquired entities have been included in the consolidated financial statements from their respective dates of acquisition. The allocation of the purchase price of Business Finance Capital Corporation, which we refer to as the BFI acquisition, is preliminary and subject to change.

 

 

Cedars

 

Foothill
Independent

 

Community

 

BFI Business

 

 

 

Bank

 

Bancorp

 

Bancorp

 

Finance

 

Acquisition

 

January

 

May

 

October

 

June

 

Date Acquired

 

 

 

2006

 

2006

 

2006

 

       2007       

 

 

 

(Dollars in thousands)

 

Assets acquired:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

34,474

 

 

$

60,844

 

 

$

24,521

 

 

$

4,331

 

 

Interest-bearing deposits in other banks

 

1,796

 

 

99

 

 

1,019

 

 

 

 

Investment securities

 

3,355

 

 

50,406

 

 

11,498

 

 

 

 

Loans, net

 

355,167

 

 

535,975

 

 

598,739

 

 

84,499

 

 

Loans held for sale

 

 

 

 

 

127,449

 

 

 

 

Premises and equipment

 

1,234

 

 

6,838

 

 

7,371

 

 

80

 

 

Goodwill

 

71,182

 

 

165,899

 

 

206,176

 

 

31,636

 

 

Core deposit and customer relationship intangible assets

 

2,992

 

 

17,311

 

 

9,514

 

 

 

 

Other assets

 

19,075

 

 

54,618

 

 

21,369

 

 

2,293

 

 

 

 

489,275

 

 

891,990

 

 

1,007,656

 

 

122,839

 

 

Liabilities assumed:

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-interest bearing deposits

 

(92,216

)

 

(265,369

)

 

(167,939

)

 

 

 

Interest bearing deposits

 

(269,189

)

 

(369,216

)

 

(489,931

)

 

 

 

Accrued interest payable and other liabilities

 

(7,870

)

 

(16,697

)

 

(14,167

)

 

(5,171

)

 

Borrowings

 

 

 

 

 

(33,195

)

 

(84,084

)

 

Subordinated debt

 

 

 

(8,481

)

 

(39,829

)

 

 

 

Total liabilities assumed

 

(369,275

)

 

(659,763

)

 

(745,061

)

 

(89,255

)

 

Total consideration paid by First Community

 

$

120,000

 

 

$

232,227

 

 

$

262,595

 

 

$

33,584

 

 

Deal value:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash paid by First Community for either common stock, common stock options, or preferred stock of acquired company

 

$

120,000

 

 

$

30

 

 

$

27

 

 

$

5,897

 

 

Fair value of common stock issued

 

 

 

232,197

 

 

262,568

 

 

27,688

 

 

Total consideration paid by First Community

 

120,000

 

 

232,227

 

 

262,595

 

 

33,585

 

 

Cash paid for stock options by acquired company

 

 

 

10,232

 

 

6,089

 

 

1,415

 

 

Total deal value

 

$

120,000

 

 

$

242,459

 

 

$

268,684

 

 

$

35,000

 

 

 

Cedars Bank

On January 4, 2006, we acquired Cedars Bank, or Cedars, based in Los Angeles, California. We paid approximately $120.0 million in cash for all of the outstanding shares of common stock and options of Cedars. At the time of the merger, Cedars was merged into Pacific Western. We made this acquisition to expand our presence in Los Angeles, California. In January 2006, we issued 1,891,086 shares of common stock for net proceeds of $109.5 million. We used these proceeds to augment our regulatory capital in support of the Cedars acquisition.

9




NOTE 2—ACQUISITIONS (Continued)

Foothill Independent Bancorp

On May 9, 2006, we acquired Foothill Independent Bancorp, or Foothill, based in Glendora, California. We issued approximately 3,947,000 shares of our common stock to the Foothill shareholders and caused Foothill to pay $10.2 million in cash for all outstanding options to purchase Foothill common stock. The aggregate deal value was approximately $242.5 million. At the time of the acquisition, Foothill was merged with and into the Company and Foothill’s wholly-owned subsidiary, Foothill Independent Bank, was merged with and into Pacific Western. We made this acquisition to expand our presence in Los Angeles, Riverside and San Bernardino Counties of California.

Community Bancorp Inc.

On October 26, 2006, we acquired Community Bancorp Inc., or Community Bancorp, based in Escondido, California. We issued 4,677,908 shares of our common stock to the Community Bancorp shareholders and caused Community Bancorp to pay $6.1 million in cash for all outstanding options to purchase Community Bancorp common stock. At the time of the acquisition, Community Bancorp was merged with and into the Company and Community National Bank, a wholly-owned subsidiary of Community Bancorp, was merged with and into Pacific Western. We made this acquisition to expand our presence in the San Diego and Riverside Counties of California.

BFI Business Finance.

On June 25, 2007 we acquired Business Finance Capital Corporation, or BFCC, a commercial finance company based in San Jose, California, and parent company to BFI Business Finance, or BFI. We issued 494,606 shares of our common stock to the BFCC common shareholders, paid $5.9 million in cash to preferred shareholders of BFCC and caused BFCC to pay $1.4 million in cash for all outstanding options to purchase BFCC common stock. The aggregate deal value was approximately $35.0 million. BFI is an asset-based lender with 34 employees and approximately $87 million in loans as of the acquisition date. BFI lends primarily to growing business throughout California and the northwestern United States. At the time of the acquisition, BFCC was merged out of existence and BFI became a subsidiary of Pacific Western. BFI will continue to operate under its current name. We made this acquisition, which we refer to as the BFI acquisition, to expand our asset-based lending business and further diversify our loan portfolio.

Merger Related Liabilities.

All of the acquisitions consummated after December 31, 2000 were completed using the purchase method of accounting. Accordingly, we recorded the estimated merger-related charges associated with each acquisition as a liability at closing when allocating the related purchase price.

For each acquisition, we developed an integration plan for the Company that addressed, among other things, requirements for staffing, systems platforms, branch locations and other facilities. The established plans are evaluated regularly during the integration process and modified as required. Merger and integration expenses are summarized in the following primary categories: (i) severance and employee-related charges; (ii) system conversion and integration costs, including contract termination charges; (iii) asset write-downs, lease termination costs for abandoned space and other facilities-related costs; and (iv) other charges. Other charges include investment banking fees, legal fees, other professional fees relating to due diligence activities and shareholder expenses associated with preparation of securities filings, as appropriate. These costs were included in the allocation of the purchase price at the acquisition date based on our formal integration plans.

10




NOTE 2—ACQUISITIONS (Continued)

The following table presents the activity in the merger-related liability account for the six months ended June 30, 2007:

 

 

Severance
and
Employee-
related

 

System
Conversion
and
Integration

 

Asset Write-
downs, Lease
Terminations
and Other
Facilities-
related

 

Other

 

Total

 

 

 

(Dollars in thousands)

 

Balance at December 31, 2006

 

 

$

111

 

 

 

$

135

 

 

 

$

2,518

 

 

$

1,285

 

$

4,049

 

Additions related to acquisitions

 

 

 

 

 

 

 

 

 

 

1,372

 

1,372

 

Non-cash write-downs and other

 

 

 

 

 

66

 

 

 

 

 

(66

)

 

Reversals

 

 

 

 

 

 

 

 

 

 

(150

)

(150

)

Cash outlays

 

 

(27

)

 

 

(201

)

 

 

(604

)

 

(1,099

)

(1,931

)

Balance at June 30, 2007

 

 

$

84

 

 

 

$

 

 

 

$

1,914

 

 

$

1,342

 

$

3,340

 

 

Unaudited Pro Forma Information for Purchase Acquisitions

The following table presents our unaudited pro forma results of operations for the quarter and six month ended June 30, 2006 as if the Cedars, Foothill, and Community Bancorp acquisitions had been completed at the beginning of 2006. The unaudited pro forma results of operations include: (1) the historical accounts of the Company, Cedars, Foothill, and Community Bancorp; and (2) pro forma adjustments, as may be required, including the amortization of intangibles with definite lives and the amortization or accretion of any premiums or discounts arising from fair value adjustments for assets acquired and liabilities assumed. The unaudited pro forma information is intended for informational purposes only and is not necessarily indicative of our future operating results or operating results that would have occurred had these acquisitions been completed at the beginning of 2006. No assumptions have been applied to the pro forma results of operations regarding possible revenue enhancements, expense efficiencies or asset dispositions. As the BFI acquisition is immaterial, pro forma amounts related to that acquisition are not presented.

 

 

Quarter Ended
June 30, 2006

 

Six Months Ended
June 30, 2006

 

 

 

(Dollar in thousands, except per
share data)

 

Revenues (net interest income plus noninterest
income)

 

 

$

80,029

 

 

 

$

161,037

 

 

Net earnings

 

 

$

17,791

 

 

 

$

40,500

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

 

$

0.62

 

 

 

$

1.42

 

 

Diluted

 

 

$

0.61

 

 

 

$

1.40

 

 

 

NOTE 3—GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and intangible assets arise from purchase business combinations. Goodwill and other intangible assets deemed to have indefinite lives generated from purchase business combinations are not subject to amortization and are instead tested for impairment no less than annually. Our annual impairment tests of goodwill have resulted in no impact on our results of operations and financial condition.

11




NOTE 3—GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)

The goodwill recorded has been assigned to our one reporting segment, banking, and none of the goodwill is deductible for income tax purposes. The following table presents the changes in goodwill for the six months ended June 30, 2007:

 

 

Six Months Ended

 

 

 

June 30, 2007

 

 

 

(Dollars in thousands)

 

Balance as of January 1, 2007

 

 

$

738,083

 

 

Additions

 

 

31,636

 

 

Adjustments related to 2006 acquisitions

 

 

946

 

 

Balance as of June 30, 2007

 

 

$

770,665

 

 

 

Intangible assets with definite lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment annually. The amortization expense represents the estimated decline in the value of the underlying deposits or loan customers acquired. The estimated aggregate amortization expense related to the intangible assets is expected to be $9.0 million for 2007. It is also estimated to range from $5.1 million to $8.0 million for each of the next five years and is expected to total $32.6 million over this time horizon. All of these estimates exclude the effect of amortization expense arising from identifying any intangible assets with definite lives from the BFI acquisition.

The following table presents the changes in the gross amounts of core deposit and customer relationship intangibles and the related accumulated amortization for the six months ended June 30, 2007 and 2006. As the purchase price allocation for BFI is not yet complete, the amount applicable to BFI’s customer relationship intangible asset is not included in the table.

 

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

 

 

(Dollars in thousands)

 

Gross amount:

 

 

 

 

 

Balance as of January 1,

 

$

67,773

 

$

37,956

 

Additions

 

342

 

20,302

 

Balance as of June 30,

 

68,115

 

58,258

 

Accumulated amortization:

 

 

 

 

 

Balance as of January 1,

 

(17,346

)

(10,658

)

Amortization

 

(4,479

)

(2,726

)

Balance as of June 30,

 

(21,825

)

(13,384

)

Net balance as of June 30,

 

$

46,290

 

$

44,874

 

 

12




NOTE 4—INVESTMENT SECURITIES

The amortized cost, gross unrealized gains and losses and fair value of securities available-for-sale as of June 30, 2007 are as follows:

 

 

June 30, 2007

 

 

 

Amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Fair value

 

 

 

(Dollars in thousands)

 

U.S. Treasury securities

 

 

$

998

 

 

 

$

 

 

 

$

1

 

 

 

$

997

 

 

Government-sponsored entity securities

 

 

40,007

 

 

 

30

 

 

 

67

 

 

 

39,970

 

 

Municipal securities

 

 

7,600

 

 

 

24

 

 

 

62

 

 

 

7,562

 

 

Mortgage-backed and other securities

 

 

34,714

 

 

 

52

 

 

 

571

 

 

 

34,195

 

 

Total

 

 

$

83,319

 

 

 

$

106

 

 

 

$

701

 

 

 

$

82,724

 

 

 

The contractual maturity distribution based on amortized cost and fair value as of June 30, 2007, is shown below. Mortgage-backed securities have contractual terms to maturity, but require periodic payments to reduce principal. In addition, expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

Maturity distribution as of
June 30, 2007

 

 

 

Amortized cost

 

Fair value

 

 

 

(Dollars in thousands)

 

Due in one year or less

 

 

$

25,708

 

 

 

$

25,665

 

 

Due after one year through five years

 

 

21,611

 

 

 

21,605

 

 

Due after five years through ten years

 

 

7,638

 

 

 

7,589

 

 

Due after ten years

 

 

28,362

 

 

 

27,865

 

 

Total

 

 

$

83,319

 

 

 

$

82,724

 

 

 

The following table presents the fair value and unrealized losses on securities that were temporarily impaired as of June 30, 2007:

 

 

Impairment Period

 

 

 

 

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

Descriptions of securities

 

 

 

Fair Value

 

Unrealized
Losses

 

Fair Value

 

Unrealized
Losses

 

Fair Value

 

Unrealized
Losses

 

 

 

(Dollars in thousands)

 

U.S. Treasury securities

 

 

$

 

 

 

$

 

 

 

$

997

 

 

 

$

1

 

 

 

$

997

 

 

 

$

1

 

 

Government-sponsored entity
securities

 

 

15,910

 

 

 

26

 

 

 

14,800

 

 

 

41

 

 

 

30,710

 

 

 

67

 

 

Municipal securities

 

 

4,239

 

 

 

28

 

 

 

935

 

 

 

34

 

 

 

5,174

 

 

 

62

 

 

Mortgage-backed and other securities

 

 

15,883

 

 

 

213

 

 

 

8,675

 

 

 

358

 

 

 

24,558

 

 

 

571

 

 

Total temporarily impaired
securities

 

 

$

36,032

 

 

 

$

267

 

 

 

$

25,407

 

 

 

$

434

 

 

 

$

61,439

 

 

 

$

701

 

 

 

All individual securities that have been in a continuous unrealized loss position for 12 months or longer at June 30, 2007 were securities that have been issued by the U.S. Treasury or municipalities and government-sponsored entities which have a AAA credit rating as determined by various rating agencies. These securities have fluctuated in value since their purchase dates because of changes in market interest rates. We concluded that the continuous unrealized loss position for the past 12 months on our securities is

13




NOTE 4—INVESTMENT SECURITIES (Continued)

a result of the level of market interest rates and not a result of the underlying issuers’ ability to repay and are, therefore, temporarily impaired. In addition, we have the intent and ability to hold these securities until their fair value recovers to their cost. Accordingly, we have not recognized the temporary impairment in our consolidated statement of earnings.

NOTE 5—NET EARNINGS PER SHARE

The following is a summary of the calculation of basic and diluted net earnings per share for the quarter and six months ended June 30, 2007 and 2006:

 

 

Quarter Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(In thousands, except per share data)

 

Net earnings before cumulative effect of accounting change

 

$

22,525

 

$

14,451

 

$

51,071

 

$

31,712

 

Accounting change

 

 

 

 

142

 

Net earnings

 

$

22,525

 

$

14,451

 

$

51,071

 

$

31,854

 

Weighted average shares outstanding used for basic net earnings per share

 

28,885.9

 

22,509.2

 

28,876.6

 

20,952.2

 

Effect of restricted stock and dilutive stock options

 

129.9

 

227.7

 

130.8

 

256.3

 

Diluted weighted average shares outstanding

 

29,015.8

 

22,736.9

 

29,007.4

 

21,208.5

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

Net earnings before accounting change

 

$

0.78

 

$

0.64

 

$

1.77

 

$

1.51

 

Accounting change

 

 

 

 

0.01

 

Basic earnings per share

 

$

0.78

 

$

0.64

 

$

1.77

 

$

1.52

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

Net earnings before accounting change

 

$

0.78

 

$

0.64

 

$

1.76

 

$

1.50

 

Accounting change(1)

 

 

 

 

 

Diluted earnings per share

 

$

0.78

 

$

0.64

 

$

1.76

 

$

1.50

 


(1)          Less than $0.01 per diluted share for the six months ended June 30, 2006.

In calculating the common stock equivalents for purposes of diluted earnings per share, we selected the transition method provided by FASB Staff Position FAS123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. Diluted earnings per share do not include all potentially dilutive shares that may result from outstanding stock options and restricted stock awards that may eventually vest. The number of common shares underlying stock options and shares of restricted stock which were outstanding but not included in the calculation of diluted net earnings per share were 761,627 and 637,900 for the quarters ended June 30, 2007 and 2006 and 760,735 and 609,313 for the six months ended June 30, 2007 and 2006.

NOTE 6—STOCK COMPENSATION

Accounting Change

We adopted SFAS No. 123 (revised 2004), Share Based Payment (“SFAS 123R”) on January 1, 2006. SFAS 123R applies to all stock-based compensation transactions in which an entity acquires employee or director services by either issuing stock or other equity instruments, such as stock options, restricted and performance stock, and/or stock appreciation rights, or incurring liabilities that are based on an entity’s

14




NOTE 6—STOCK COMPENSATION (Continued)

stock price, and requires entities that engage in these transactions to recognize compensation expense based on the fair value of the stock or other equity instrument either issued, modified, or settled. We adopted SFAS 123R using the modified prospective approach. Under this approach, compensation expense is recognized for (1) new share-based payment awards (e.g., stock options and restricted stock), (2) awards that are modified, repurchased, or cancelled after December 31, 2005, and (3) the remaining portion of the requisite service under previously granted unvested stock awards as of December 31, 2005.

As permitted under formerly effective accounting rules, we did not consider estimated forfeitures of stock awards during the amortization period and recognized the effect of forfeitures as they occurred. As required by SFAS 123R we recognized the cumulative effect of estimated forfeitures for unvested restricted stock awards as of December 31, 2005, by increasing our first quarter 2006 earnings by $242,000. The after tax effect of this adjustment was to increase net earnings by $142,000, or less than $0.01 per diluted share. SFAS 123R also requires us to use estimated forfeitures in recognizing stock compensation expense beginning January 1, 2006, and to true-up such expense when forfeitures occur. Amortization expense for all restricted stock awards is estimated to be $8.6 million for 2007 and includes an estimate for forfeitures. As of June 30, 2007, unrecognized stock-based compensation expense was $36.2 million. When we made restricted stock awards prior to January 1, 2006, we established an unearned equity compensation contra account within our shareholders’ equity equal to the market value of our common stock underlying the award on the award date. SFAS 123R required us to eliminate the unearned equity compensation account on January 1, 2006, by reclassifying it to common stock. Such reclassification had no effect on the amount of the Company’s shareholders’ equity.

Time-based and Performance-based Restricted Stock.

At June 30, 2007, there were outstanding 323,255 shares of unvested time-based restricted common stock and 520,000 shares of unvested performance-based restricted common stock. The awarded shares of time-based restricted common stock vest over a service period of three to four years from the date of grant. The awarded shares of performance-based restricted common stock vest in full on the date the Compensation, Nominating and Governance (“CNG”) Committee of the Board of Directors, as Administrator of the Company’s 2003 Stock Incentive Plan (the “Plan”), determines that the Company achieved certain financial goals established by the CNG Committee and set forth in the grant documents. The 315,000 shares of unvested performance-based restricted stock awarded in 2006 expire in 2013 and are currently expected to vest in the first quarter of 2013. The 205,000 shares of unvested performance-based restricted stock awarded in 2007 expire in 2017 and are currently expected to vest in the first quarter of 2017. Performance-based restricted stock is forfeited if financial goals are not met during their term. All restricted common stock vests immediately upon a change in control of the Company as defined in the Plan. Restricted stock amortization totaled $2.4 million and $1.9 million for the quarters ended June 30, 2007 and 2006, and $4.6 million and $3.2 million for the six months ended June 30, 2007 and 2006.

The Plan permits stock-based compensation awards to officers, directors, key employees and consultants. The Plan authorizes grants of stock-based compensation instruments to purchase or issue up to 3,500,000 shares of authorized but unissued Company common stock, subject to adjustments provided by the Plan. As of August 1, 2007, there were 716,062 shares available for grant under the Plan.

15




NOTE 7—BORROWINGS AND SUBORDINATED DEBENTURES

Borrowings.

At June 30, 2007, we had $302.7 million of borrowings outstanding composed of $384,000 of borrowings acquired in the BFI acquisition and $302.3 million of borrowings from the Federal Home Loan Bank of San Francisco (the “FHLB”) with an aggregate weighted average cost of 4.96%. The FHLB secured advances include overnight borrowings of $57.3 million and term advances of $245.0 million, of which $45.0 million will mature in December 2008. The weighted average cost of the FHLB term advances is 4.85%. The remaining $200 million is composed of two $100 million fixed-rate two year term advances, each with an option to be called by the FHLB on the first year anniversary dates of November and December 2007. If market interest rates are higher than the advances’ stated rates at that time, the advances will be called by the FHLB and the Bank will be required to repay the FHLB. If market interest rates are lower at their one year anniversary date, then the advances will not be called by the FHLB. If the advances are not called by the FHLB they will mature in November and December 2008. We may repay the advances with a prepayment penalty at any time. If the advances are called by the FHLB, there is no prepayment penalty. Our aggregate remaining secured borrowing capacity from the FHLB was $705.8 million at June 30, 2007. Additionally, the Bank maintains unsecured lines of credit in the aggregate of $120.0 million with three correspondent banks for the purchase of overnight funds. These lines are subject to availability of funds.

The Company has a revolving credit line with U.S. Bank, N.A. for $70.0 million. On August 2, 2007 we extended the maturity date of the credit line from August 2, 2007 to August 31, 2007. We expect to renew this line of credit for a one year period. This line is secured by a pledge of all of the outstanding capital stock of Pacific Western. The credit agreement requires the Company to maintain certain financial and capital ratios, among other covenants and conditions. Such covenants include minimum net worth ratios, maximum debt ratios, a minimum return on average assets, minimum and maximum credit quality ratios, and dividend payment limitations. As of June 30, 2007, we, and where applicable, Pacific Western, were in compliance with all covenants covering the agreement. We pay a quarterly fee of 25 basis points on the unused amounts. There were no amounts outstanding under the revolving credit line at June 30, 2007.

Subordinated Debentures.

The Company had an aggregate of $138.7 million subordinated debentures outstanding at June 30, 2007. During the second quarter of 2007 we redeemed for cash $10.3 million of subordinated debentures. The remaining subordinated debentures were issued in eight separate series. Each issuance has a maturity of thirty years from its date of issue. The subordinated debentures were issued to trusts established by us or entities we have acquired, which in turn issued trust preferred securities, which totaled $131.0 million at June 30, 2007. These trust preferred securities are presently considered Tier 1 capital for regulatory purposes. With the exception of Trust I and Trust CI, the subordinated debentures are callable at par, only by the issuer, five years from the date of issuance, subject to certain exceptions. We are permitted to call the debentures in the first five years if the prepayment election relates to one of the following three events: (i) a change in the tax treatment of the debentures stemming from a change in the IRS laws; (ii) a change in the regulatory treatment of the underlying trust preferred securities as Tier 1 capital; and (iii) a requirement to register the underlying trust as a registered investment company. Trust I and Trust CI may not be called for 10 years from the date of issuance unless one of the three events described above has occurred and then a prepayment penalty applies. In addition, there is a prepayment penalty if either of these debentures is called 10 to 20 years from the date of their issuance and they may be called at par after 20 years. The proceeds of the subordinated debentures were used primarily to fund several of our

16




NOTE 7—BORROWINGS AND SUBORDINATED DEBENTURES (Continued)

acquisitions and to augment regulatory capital. The following table summarizes the terms of each issuance of the subordinated debentures outstanding June 30, 2007:

Series

 

 

 

Date issued

 

Amount

 

Maturity

 

Earliest
Call Date
without
Penalty(1)

 

Fixed or
Variable
Rate

 

Rate Index

 

Current
Rate(2)

 

Next Reset
Date

 

 

 

 

(Dollars in thousands)

 

 

Trust CI(4)

 

 

3/23/2000

 

 

$

10,310

 

3/8/2030

 

3/8/2020

 

Fixed

 

N/A

 

 

11.00

%

 

 

N/A

 

 

 

Trust I

 

 

9/7/2000

 

 

8,248

 

9/7/2030

 

9/7/2020

 

Fixed

 

N/A

 

 

10.60

%

 

 

N/A

 

 

 

Trust F(3)

 

 

12/19/2002

 

 

8,248

 

12/26/2032

 

12/19/2007

 

Variable

 

3-month LIBOR +3.25

 

 

8.61

%

 

 

9/24/2007

 

 

 

Trust V

 

 

8/15/2003

 

 

10,310

 

9/17/2033

 

9/17/2008

 

Variable

 

3-month LIBOR +3.10

 

 

8.46

%

 

 

9/13/2007

 

 

 

Trust VI

 

 

9/3/2003

 

 

10,310

 

9/15/2033

 

9/15/2008

 

Variable

 

3-month LIBOR +3.05

 

 

8.41

%

 

 

9/13/2007

 

 

 

Trust CII(4)

 

 

9/17/2003

 

 

5,155

 

9/17/2033

 

9/17/2009

 

Variable

 

3-month LIBOR +2.95

 

 

8.31

%

 

 

9/13/2007

 

 

 

Trust VII

 

 

2/5/2004

 

 

61,856

 

4/23/2034

 

4/23/2009

 

Variable

 

3-month LIBOR +2.75

 

 

8.11

%

 

 

9/26/2007

 

 

 

Trust CIII(4)

 

 

8/15/2005

 

 

20,619

 

9/15/2035

 

9/15/2010

 

Fixed

(5)

N/A

 

 

5.85

%

 

 

9/15/2010

 

 

 

Unamortized premium(6)

 

 

 

 

 

3,635

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

$

138,691

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


(1)                As described above, certain issuances may be called earlier without penalty upon the occurrence of certain events.

(2)                As of July 26, 2007; excludes debt issuance costs.

(3)                Acquired in the Foothill acquisition.

(4)                Acquired in the Community Bancorp acquisition.

(5)                Interest rate is fixed until 9/15/2010 and then is variable at a rate of 3-month LIBOR + 1.69%.

(6)                This amount represents the fair value adjustment to the four trusts that we acquired during 2006.

As previously mentioned, the subordinated debentures were issued to trusts established by us, or entities we acquired, which in turn issued $131.0 million of trust preferred securities. These securities are currently included in our Tier I capital for purposes of determining the Company’s Tier I and total risk-based capital ratios. The Board of Governors of the Federal Reserve System, which is the holding company’s banking regulator, has promulgated a modification of the capital regulations affecting trust preferred securities. Under this modification, beginning March 31, 2009, the Company will be required to use a more restrictive formula to determine the amount of trust preferred securities that can be included in regulatory Tier I capital. At that time, the Company will be allowed to include in Tier I capital an amount of trust preferred securities equal to no more than 25% of the sum of all core capital elements, which is generally defined as shareholders’ equity less certain intangibles, including goodwill, core deposit intangibles and customer relationship intangibles, net of any related deferred income tax liability. The regulations currently in effect through December 31, 2008, limit the amount of trust preferred securities that can be included in Tier I capital to 25% of the sum of core capital elements without a deduction for permitted intangibles. We have determined that our Tier I capital ratios would remain above the well-capitalized level had the modification of the capital regulations been in effect at June 30, 2007. We expect that our Tier I capital ratios will be at or above the existing well-capitalized levels on March 31, 2009, the first date on which the modified capital regulations must be applied.

NOTE 8—COMMITMENTS AND CONTINGENCES

Lending Commitments.

Pacific Western is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of their customers. Such financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of such instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

17




NOTE 8—COMMITMENTS AND CONTINGENCES (Continued)

Commitments to extend credit amounting to $1.2 billion were outstanding at both June 30, 2007 and December 31, 2006. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since most commitments are never fully drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Standby letters of credit and financial guarantees amounting to $75.7 million and $67.9 million were outstanding as of June 30, 2007 and December 31, 2006. Standby letters of credit and financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. Most guarantees expire within one year from the date of issuance. The Company generally requires collateral or other security to support financial instruments with credit risk. Management does not anticipate that any material loss will result from the outstanding commitments to extend credit, standby letters of credit or financial guarantees.

The Company has investments in several small business investment companies and in low income housing project partnerships which provide the Company income tax credits. As of June 30, 2007 the Company had commitments to contribute capital to these entities totaling $933,000.

Legal Matters.

On June 8, 2004, the Company was served with an amended complaint naming First Community and Pacific Western as defendants in a class action lawsuit filed in Los Angeles Superior Court pending as Gilbert et. al v. Cohn et al, Case No. BC310846 (the “Gilbert Litigation”). A former officer of First Charter Bank, N.A. (“First Charter”), which the Company acquired in October 2001, was also named as a defendant. That former officer left First Charter in May of 1997 and later became a principal of Four Star Financial Services, LLC (“Four Star”), an affiliate of 900 Capital Services, Inc. (“900 Capital”).

On April 18, 2005, the plaintiffs filed the second amended class action complaint. The second amended complaint alleged that the former officer of First Charter improperly induced several First Charter customers to invest in 900 Capital or affiliates of 900 Capital and further alleges that Four Star, 900 Capital and some of their affiliated entities perpetuated their fraud upon investors through various accounts at First Charter, First Community and Pacific Western with those banks’ purported knowing participation in and/or willful ignorance of the scheme. The key allegations in the second amended complaint dated back to the mid-1990s and the second amended complaint alleged several counts for relief including aiding and abetting, conspiracy, fraud, breach of fiduciary duty, relief pursuant to the California Business and Professions Code, negligence and relief under the California Securities Act stemming from an alleged fraudulent scheme and sale of securities issued by 900 Capital and Four Star. In disclosures provided to the parties, plaintiffs have asserted that the named plaintiffs have suffered losses well in excess of $3.85 million, and plaintiffs have asserted that “losses to the class total many tens of millions of dollars.” On June 15, 2005, we filed a demurrer to the second amended complaint, and on August 22, 2005, the Court sustained our demurrer as to each of the counts therein, granting plaintiffs leave to amend on four of the six counts, and dismissing the other counts outright.

On August 12, 2005, the Company was notified by Progressive Casualty Insurance Company (“Progressive”), its primary insurance carrier with respect to the Gilbert Litigation that Progressive had determined that, based upon the allegations in the second amended complaint filed in the Gilbert Litigation, there was no coverage with respect to the Gilbert Litigation under the Company’s insurance policy with Progressive. Progressive also notified the Company that it was withdrawing its agreement to fund defense costs for the Gilbert Litigation and reserving its right to seek reimbursement from the

18




NOTE 8—COMMITMENTS AND CONTINGENCES (Continued)

Company for any defense costs advanced pursuant to the insurance policy. Through December 31, 2005, Progressive had advanced to the Company approximately $690,000 of defense costs with respect to the Gilbert Litigation.

On August 12, 2005, Progressive filed an action in federal district court for declaratory relief, currently pending as Progressive Casualty Insurance Company, etc., v. First Community Bancorp, etc., et al., Case No. 05-5900 SVW (MAWx) (the “Progressive Litigation”), seeking a declaratory judgment with respect to the parties’ rights and obligations under Progressive’s policy with the Company. On October 11, 2005, the Company filed in federal court a motion to dismiss or stay the Progressive Litigation.

In November 2005, along with certain other defendants, we reached an agreement in principle with respect to the Gilbert Litigation. That agreement is reflected in a written Stipulation of Settlement dated February 9, 2007, which has been executed by all the parties to that settlement. The settlement is subject to approval by the Los Angeles Superior Court and a certain level of participation in the settlement by class members. Assuming all conditions to final consummation of the settlement are met, the Company’s contribution to the settlement will be $775,000, which was accrued in 2005.

While we believe that this settlement, if finalized, will end our exposure to the underlying claims by participating class members, we cannot be certain that all conditions to the settlement will be satisfied or that we will not be subject to further claims by parties related to the same claims who did not participate in the settlement.

In connection with the Gilbert Litigation settlement, we also reached a settlement with Progressive Casualty Insurance Co. in the Progressive Litigation. The settlement with Progressive, which includes an additional contribution by Progressive under the Company’s policy toward the settlement of the Gilbert Litigation and a dismissal by Progressive of any claims against First Community for reimbursement, is contingent upon the consummation of the Gilbert Litigation settlement.

In the ordinary course of our business, we are party to various other legal actions, which we believe are incidental to the operation of our business. Although the ultimate outcome and amount of liability, if any, with respect to these other legal actions to which we are currently a party cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to us, any resulting liability is not likely to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

NOTE 9—INCOME TAXES

We adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (“FIN 48”), on January 1, 2007. FIN 48 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. FIN 48 prescribes a threshold and a measurement process for recognizing in the financial statements a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We have determined that there are no significant uncertain tax positions requiring recognition in our financial statements.

Our evaluation was performed for those tax years which remain open to audit. Open tax years subject to examination are 2003 through 2006 for federal purposes and 2002 through 2006 for state purposes. The IRS is currently examining Foothill’s 2004 income tax return.

19




NOTE 9—INCOME TAXES (Continued)

We may from time to time be assessed interest or penalties by taxing authorities, although any such assessments historically have been minimal and immaterial to our financial results. In the event we are assessed for interest and/or penalties, such amount will be classified in the financial statements as income tax expense.

NOTE 10—RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined as a market-based measurement and should be determined based on assumptions that a market participant would use when pricing an asset or liability. The market participant’s assumptions should include assumptions about risk as well as the effect of a restriction on the sale or use of an asset. Additionally, this statement establishes a fair value hierarchy that provides the highest priority to quoted prices in active markets and the lowest priority to unobservable data. This statement is effective for us on January 1, 2008. We are presently reviewing the standard to determine what effect, if any, it will have on our financial condition and results of operations.

The FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, (“SFAS 159”) in February 2007. This statement permits companies to choose to measure many financial instruments and certain other items at fair value. Once a company chooses to report an item at fair value, changes in fair value would be reported in earnings at each reporting date. SFAS No. 159 is effective for us on January 1, 2008. We are presently evaluating this Statement and have not yet decided whether we will or will not elect the fair value option for eligible items at the date of adoption.

NOTE 11—DIVIDEND AND SHARE REPURCHASE PROGRAM APPROVAL

On August 2, 2007, our Board of Directors (a) declared a quarterly cash dividend of $0.32 per common share payable on payable on August 31, 2007, to shareholders of record at the close of business on August 16, 2007 and (b) authorized the repurchase of shares of First Community common stock worth up to $150.0 million over the next twelve months.  The stock repurchase program may be limited or terminated at any time without prior notice.

20




ITEM 2.                Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Information

This Quarterly Report on Form 10-Q contains certain forward-looking information about the Company and its subsidiaries, which statements are intended to be covered by the safe harbor for “forward-looking statements” provided by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact are forward-looking statements. Such statements involve inherent risks and uncertainties, many of which are difficult to predict and are generally beyond the control of the Company. We caution readers that a number of important factors could cause actual results to differ materially from those expressed in, implied or projected by, such forward-looking statements. Risks and uncertainties include, but are not limited to:

·       planned acquisitions and related cost savings cannot be realized or realized within the expected time frame;

·       lower than expected revenues;

·       credit quality deterioration which could cause an increase in the allowance for credit losses and a reduction in net earnings;

·       increased competitive pressure among depository institutions;

·       the Company’s ability to complete announced acquisitions, to successfully integrate acquired entities, or to achieve expected synergies and operating efficiencies within expected time-frames or at all;

·       the integration of acquired businesses costs more, takes longer or is less successful than expected;

·       the possibility that personnel changes will not proceed as planned;

·       the cost of additional capital is more than expected;

·       a change in the interest rate environment reduces interest margins;

·       asset/liability repricing risks and liquidity risks;

·       pending legal matters may take longer or cost more to resolve or may be resolved adversely to the Company;

·       general economic conditions, either nationally or in the market areas in which the Company does or anticipates doing business, are less favorable than expected;

·       the economic and regulatory effects of the continuing war on terrorism and other events of war, including the war in Iraq;

·       legislative or regulatory requirements or changes adversely affecting the Company’s business;

·       changes in the securities markets; and

·       regulatory approvals for any acquisitions cannot be obtained on the terms expected or on the anticipated schedule.

If any of these risks or uncertainties materializes, or if any of the assumptions underlying such forward-looking statements proves to be incorrect, our results could differ materially from those expressed in, implied or projected by, such forward-looking statements. The Company assumes no obligation to update such forward-looking statements.

21




Overview

We are a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Our principal business is to serve as the holding company for our subsidiary bank, Pacific Western Bank, which we refer to as Pacific Western or the Bank.

Pacific Western is a full-service community bank offering a broad range of banking products and services including: accepting time and demand deposits; originating commercial loans, including asset-based lending and factoring, real estate and construction loans, Small Business Administration guaranteed loans, or SBA loans, consumer loans, mortgage loans and international loans for trade finance; providing tax free real estate exchange accommodation services; and providing other business-oriented products. At June 30, 2007, our gross loans totaled $4.0 billion of which 22% consisted of commercial loans, 75% consisted of commercial real estate loans, including construction loans, and 1% consisted of consumer and other loans. These percentages also include some foreign loans, primarily to individuals or entities with business in Mexico, representing approximately 2% of total loans. Our portfolio’s value and credit quality is affected in large part by real estate trends in Southern California.

Pacific Western competes actively for deposits, and emphasizes solicitation of noninterest-bearing deposits. In managing the top line of our business, we focus on loan growth and loan yield, deposit cost, and net interest margin, as net interest income, on a year-to-date basis, accounts for 90% of our net revenues (net interest income plus noninterest income).

Key Performance Indicators

Among other factors, our operating results depend generally on the following:

The Level of Our Net Interest Income

Net interest income is the excess of interest earned on our interest-earning assets over the interest paid on our interest-bearing liabilities. Our primary interest-earning asset is loans. Our interest-bearing liabilities include deposits, borrowings, and subordinated debentures. We attempt to increase our net interest income by maintaining a high level of noninterest-bearing deposits. At June 30, 2007, approximately 43% of our deposits were noninterest-bearing. We use our borrowing capacity under various credit lines for short-term liquidity needs such as funding loan demand, managing deposit flows and interim acquisition financing. Net proceeds from our other long-term borrowings, consisting of subordinated debentures, were used to fund certain of our acquisitions. Our general policy is to price our deposits in the bottom half or third-quartile of our competitive peer group, resulting in deposit products that bear somewhat lower interest rates. While our deposit balances will fluctuate depending on deposit holders’ perceptions of alternative yields available in the market, we attempt to minimize these variances by attracting a high percentage of noninterest-bearing deposits.

Loan Growth

We generally seek new lending opportunities in the $1 million to $10 million range, try to limit loan maturities for commercial loans to one year, for construction loans up to 18 months, and for commercial real estate loans up to ten years, and to price lending products so as to preserve our interest spread and net interest margin. We sometimes encounter strong competition in pursuing lending opportunities such that potential borrowers obtain loans elsewhere at lower rates than those we offer.

The Magnitude of Credit Losses

We stress credit quality in originating and monitoring the loans we make and measure our success by the level of our nonperforming assets and the corresponding level of our allowance for credit losses. Our

22




allowance for credit losses is the sum of our allowance for loan losses and our reserve for unfunded loan commitments. Provisions for credit losses are charged to operations as and when needed for both on and off balance sheet credit exposure. Loans which are deemed uncollectible are charged off and deducted from the allowance for loan losses. Recoveries on loans previously charged off are added to the allowance for loan losses. Changes in economic conditions, however, such as increases in the general level of interest rates, could negatively impact our customers and lead to increased provisions for credit losses.

The Level of Our Noninterest Expense

Our noninterest expense includes fixed and controllable overhead, the major components of which are compensation, occupancy, data processing, professional fees and communications. We measure success in controlling such costs through monitoring of the efficiency ratio. We calculate the efficiency ratio by dividing noninterest expense by the sum of net interest income and noninterest income. Accordingly, a lower percentage reflects lower expenses relative to income. The consolidated efficiency ratios have been as follows:

Quarterly Period

 

 

 

Ratio

 

Second quarter 2007

 

 

48.7

%

 

First quarter 2007

 

 

42.2

%

 

Fourth quarter 2006

 

 

49.5

%

 

Third quarter 2006

 

 

45.4

%

 

Second quarter 2006

 

 

45.6

%

 

 

The efficiency ratios for each of the quarters presented were affected by several items. The second quarter of 2007 efficiency ratio is impacted by $1.1 million in reorganization charges which increased the efficiency ratio by 146 basis points. The first quarter of 2007 includes a $6.6 million gain on the sale of a participating interest in commercial real estate loans, $1.9 million from the recognition of an unearned discount on the payoff of an acquired loan, and reorganization charges of $258,000, which together reduced the efficiency ratio by 446 basis points. The fourth quarter of 2006 efficiency ratio is impacted by securities losses and reorganization charges, which increased the ratio by 336 basis points. Reorganization charges in the second quarter of 2006 increased the efficiency ratio by 7 basis points. Additionally, the level of our noninterest expense has been influenced significantly by acquisitions; the four acquisitions we completed since the beginning of 2006 added $2.5 billion in assets and almost doubled the size of the Company.

Critical Accounting Policies

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for credit losses and the carrying values of goodwill, other intangible assets and deferred income tax assets. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2006.

Results of Operations

Earnings Performance

We analyze our performance based on net earnings determined in accordance with U.S. generally accepted accounting principles. The comparability of financial information is affected by our acquisitions.

23




Operating results include the operations of acquired entities from the dates of acquisition. See Note 2 of the Notes to Unaudited Condensed Consolidated Financial Statements contained in “Item 1. Unaudited Condensed Consolidated Financial Statements.” The following table presents net earnings and summarizes per share data and key financial ratios:

 

 

Quarter Ended

 

Six Months Ended
June 30,

 

 

 

6/30/07

 

3/31/07

 

6/30/06

 

2007

 

2006

 

 

 

(In thousands, except per share data)

 

Net interest income

 

$

66,454

 

$

69,435

 

$

58,038

 

$

135,889

 

$

109,990

 

Noninterest income

 

7,529

 

14,351

 

4,291

 

21,880

 

7,924

 

Net revenues

 

73,983

 

83,786

 

62,329

 

157,769

 

117,914

 

Provision for credit losses

 

 

 

9,500

 

 

9,600

 

Noninterest expense

 

35,997

 

35,393

 

28,444

 

71,390

 

54,615

 

Income taxes

 

15,461

 

19,847

 

9,934

 

35,308

 

21,987

 

Net earnings before accounting change

 

$

22,525

 

$

28,546

 

$

14,451

 

$

51,071

 

$

31,712

 

Accounting change

 

 

 

 

 

142

 

Net earnings

 

$

22,525

 

$

28,546

 

$

14,451

 

$

51,071

 

$

31,854

 

Average interest-earning assets

 

$

4,119,662

 

$

4,446,620

 

$

3,430,264

 

$

4,282,238

 

$

3,261,186

 

Profitability measures:

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

 

 

Net earnings before accounting change

 

$

0.78

 

$

0.99

 

$

0.64

 

$

1.77

 

$

1.51

 

Accounting change

 

 

 

 

 

0.01

 

Basic earnings per share

 

$

0.78

 

$

0.99

 

$

0.64

 

$

1.77

 

$

1.52

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

 

 

Net earnings before accounting change

 

$

0.78

 

$

0.98

 

$

0.64

 

$

1.76

 

$

1.50

 

Accounting change(1)

 

 

 

 

 

 

Diluted earnings per share

 

$

0.78

 

$

0.98

 

$

0.64

 

$

1.76

 

$

1.50

 

Net interest margin

 

6.47

%

6.33

%

6.79

%

6.40

%

6.80

%

Return on average assets

 

1.75

%

2.10

%

1.39

%

1.93

%

1.64

%

Return on average equity

 

7.6

%

9.9

%

7.5

%

8.8

%

9.5

%

Efficiency ratio

 

48.7

%

42.2

%

45.6

%

45.3

%

46.3

%


(1)          Less than $0.01 per diluted share for the six months ended June 30, 2006.

The decrease in net earnings and diluted earnings per share for the second quarter of 2007 compared to the first quarter of 2007 is attributed mostly to lower net interest income, lower noninterest income, and higher reorganization charges. The decrease in both net interest income and noninterest income relates to the sale of a participating interest of approximately $353 million in commercial real estate mortgage loans at the end of the first quarter of 2007; this sale generated an after-tax gain of $3.9 million and a portion of the proceeds were used to repay overnight borrowings. In addition, noninterest income decreased due to the gain from an unearned discount of $1.1 million (after tax) on a loan payoff recognized in the first quarter. The increases in net earnings and diluted earnings per share for both the second quarter and six months ended June 30, 2007 compared to the same periods of 2006 were driven by increased average loans, gain on sale of loans and a lower credit loss provision.

Net Interest Income.   Net interest income, which is our principal source of revenue, represents the difference between interest earned on assets and interest paid on liabilities. Net interest margin is net interest income expressed as a percentage of average interest-earning assets. Net interest income is affected by changes in both interest rates and the volume of average interest-earning assets and

24




interest-bearing liabilities. The following table presents, for the periods indicated, the distribution of average assets, liabilities and shareholders’ equity, as well as interest income and yields earned on average interest-earning assets and interest expense and costs on average interest-bearing liabilities:

 

 

Quarter Ended

 

 

 

6/30/07

 

3/31/07

 

6/30/06

 

 

 

Average
Balance

 

Interest
Income or
Expense

 

Average
Yield or
Cost

 

Average
Balance

 

Interest
Income or
Expense

 

Average
Yield or
Cost

 

Average
Balance

 

Interest
Income or
Expense