UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended December 31, 2009
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___TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934. For the transition period from __________ to __________
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Commission file number:
000-49892
PACIFIC STATE BANCORP
(Exact name of Registrant as specified in its charter)
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California
(State or other jurisdiction of incorporation or organization)
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61-1407606
(I.R.S. Employer Identification No.)
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1899 W. March Lane
Stockton, CA
(Address of principal executive offices)
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95207
(Zip Code)
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Registrant’s telephone number, including area code: (209) 870-3214
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name
of each exchange on which registered:
Common Stock, no par value The
NASDAQ Stock Market, LLC
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [ ]
No [X]
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes []
No [X]
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference to Part III of this Form 10-K or any amendment to this
Form 10-K. []
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated
filer (Do not check if a smaller reporting company.) [] Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act).
Yes [ ]
No [X]
The aggregate market value of voting and non-voting stock held by non-affiliates of the Registrant was approximately $4,615,525 as of June 30, 2009 which was calculated based on the last reported sale of the Company's Common Stock on June 30, 2009. This calculation does not reflect a determination that certain persons are affiliates
of the Registrant for any other purpose.
Common stock, no par value 3,722,198 shares outstanding as of March 31, 2010.
DOCUMENTS INCORPORATED BY REFERENCE
Annual Report to Shareholders for Fiscal Year Ended December 31, 2009 (Part II)
TABLE OF CONTENTS
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PART 1.
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Page
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Item 1.
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Business
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3
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Item 1A.
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Risk Factors
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17
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Item 1B.
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Unresolved Staff Comments
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25
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Item 2.
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Properties
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25
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Item 3.
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Legal Proceedings
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25
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Item 4.
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Submission of Matters to a Vote of Security Holders
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25
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PART II.
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Item 5.
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Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
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26
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Item 6.
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Selected Financial Data
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26
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Item 7.
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Management’s Discussion and Analysis of Financial Condition and Results of Operation
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26
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Item 7A.
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Quantitative and Qualitative Disclosures about Market Risk
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26
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Item 8.
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Financial Statements and Supplementary Data
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26
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Item 9.
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Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
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26
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Item 9A
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Controls and Procedures
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27
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Item 9 B
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Other Information
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27
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PART III.
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Item 10.
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Directors, Executive Officers and Corporate Governance
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28
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Item 11.
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Executive Compensation
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28
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Item 12.
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Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
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28
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Item 13.
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Certain Relationships and Related Transactions and Director Independence
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28
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Item 14.
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Principal Accountant Fees and Services
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28
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PART IV.
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Item 15.
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Exhibits, Financial Statement Schedules
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28
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Signatures
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29
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Index of Exhibits
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30
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PACIFIC STATE BANCORP
STOCKTON, CALIFORNIA
FORM 10-K
FISCAL YEAR ENDED DECEMBER 31, 2009
PART I
ITEM 1.
BUSINESS
FORWARD LOOKING STATEMENTS
Certain statements discussed or incorporated by reference in this Annual Report including, but not limited to, information concerning possible or assumed future results of operations of the Company set forth in the Management's Discussion and Analysis of Financial Condition and Results of Operation, are forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements include statements in which words such as "expect," "anticipate," "intend," "plan," "believe," "estimate," "consider" or similar expressions are used. The Company’s actual future results and shareholder values may differ materially from those anticipated and expressed in these forward-looking statements, which are based on management's beliefs and assumptions and on information
currently available to management, and are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include, among others, (1) competitive pressures in the banking industry; (2) changes in the interest rate environment; (3) general economic conditions, either nationally or regionally; (4) changes in the regulatory environment; (5) changes in business conditions and inflation; and (6) changes in securities markets. Many of these
factors are beyond the Company’s ability to control or predict. Investors are cautioned not to put undue reliance on any forward-looking statements. In addition, the Company does not have any intention or obligation to update forward-looking statements contained in this Annual Report, even if new information, future events or other circumstances have made them incorrect or misleading. Except as specifically noted herein all references to the "Company" refer to Pacific State Bancorp,
a California corporation
GENERAL DESCRIPTION OF BUSINESS
Pacific State Bancorp (the “Company”) is a holding company with one bank subsidiary, Pacific State Bank, (the “Bank”), and two unconsolidated subsidiary grantor trusts, Pacific State Statutory Trusts II and III. Pacific State Bancorp commenced operations on June 24, 2002 after acquiring all of the outstanding
shares of Pacific State Bank. The Bank is a California state chartered bank formed November 2, 1987. The Bank is a member of the Federal Reserve System. The Bank’s primary source of revenue is interest on loans to customers who are predominantly small to middle-market businesses and middle-income individuals. Pacific State Statutory Trusts II and III are unconsolidated, wholly owned statutory business trusts formed in March 2004 and June 2007, respectively for the exclusive purpose
of issuing trust preferred securities.
The Bank conducts a general commercial banking business, primarily in the five county regions that comprises Alameda, Calaveras, San Joaquin, Stanislaus and Tuolumne counties. The Bank offers commercial banking services to residents and employers of businesses in the Bank’s service area, including professional firms and
small to medium sized retail and wholesale businesses and manufacturers. The Company as of March 31, 2010 had 89 employees, including 41 officers. The Bank does not engage in any non-bank lines of business. The business of the Bank is not to any significant degree seasonal in nature. The Bank has no operations outside California and has no material amount of loans or deposits concentrated among any one or few persons, groups or industries. The Bank operates nine branches with
its Administrative Office and one branch located at 1899 W. March Lane, in Stockton, California; additional branches are located in Stockton and in the communities of Angels Camp, Arnold, Groveland, Lodi, Modesto, Tracy and Hayward, California.
Pacific State Bancorp common stock trades on the NASDAQ Capital Market under the symbol of “PSBC”.
RECENT DEVELOPMENTS
The Company has been adversely impacted by the continuing deterioration in the California real estate market. The Company incurred a net loss of $22.4 million for the year ended December 31, 2009 and $5.2 million for the year ended December 31, 2008. Shareholders’ equity has decreased from $27.3 million
or 6.47% of total assets at December 31, 2008 to $5.7 million or 1.54% of total assets at December 31, 2009. The net losses in 2009 were due primarily to a provision for loan losses of $15.4 million, a valuation allowance for deferred taxes of $8.4 million for the year ended December 31, 2009 and an increase in nonperforming assets which has reduced the Company’s net interest income.
Further, the Company’s financial condition has adversely affected funding sources during the past quarter and caused withdrawals of deposits and reductions in borrowing arrangements. As a result of the losses, the Company is deemed to be “under capitalized” as of December 31, 2009. These conditions create an uncertainty
about the Company’s ability to continue as a going concern. The consolidated financial statements set forth in the Annual Report have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result from
the outcome of the Company’s inability to repay the outstanding principal balance of its debt or from any regulatory action, either of which would affect its ability to continue as a going concern.
On November 10, 2009, the Company received a notice from the Nasdaq Global Market stating that the Company no longer met the $1.00 per share requirement for continued listing on the Nasdaq Global Select Market under Listing Rule 5450 (a)(1). This notice did not result in an immediate delisting of the Company’s common stock from the
Nasdaq Global Select Market, as a grace period of 180 calendar days or until May 10, 2010, is provided under the listing rules. However, we elected to apply to transfer listing to the NASDAQ Capital Market as set forth in Listing Rule 5505. As a result of such transfer, the Company became eligible for an additional 180 calendar day grace period. The requirements for initial listing on the Nasdaq Capital Market include a minimum market value of publicly held shares of $15 million, which the Company
does not currently meet. We are working diligently to attempt to retain listing of the Company’s common stock on Nasdaq. We believe that improved financial performance that results in an increased stock price, much closer to the Company’s tangible book value, is the best potential solution for regaining compliance with the minimum bid requirement. However, there can be no assurance that our financial performance will improve during the 180 day grace period. If at any time during this grace period
the bid price of the Company’s common stock closes at $1.00 per share or more for a minimum of ten consecutive business days, Nasdaq will provide us written confirmation of compliance. Also, see “Risk Factors” below.
On February 18, 2010, the Company and the Bank consented to enter into a written agreement with the Federal Reserve Bank of San Francisco (the “FRBSF”) and the State of California Department of Financial Institutions (the “CDFI”) as follow-up to an examination of the Bank (the “Written Agreement”).
A copy of the Written Agreement is filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K dated February 22, 2010, and is incorporated herein by this reference. The description provided below of the Written Agreement is a summary and does not purport to be a complete description of all of the terms of such
Written Agreement and is qualified in its entirety by reference to the Written Agreement filed with this Current Report.
Among other things, the Written Agreement provides that the Company and the Bank shall submit to the FRBSF and the CDFI their continuing plans to enhance lending and credit administration functions, to maintain policies and procedures for the maintenance of an adequate allocation for loan and lease losses, to improve the Bank’s earnings
and overall condition, improve management of the Bank’s liquidity position and funds management practices and update its capital plan in order to maintain sufficient capital at the Company and the Bank. The Written Agreement also restricts the Company and the Bank from making the payment of dividends, any payments on trust preferred securities, any reduction in capital or the purchase or redemption of stock without the prior approval of the FRBSF. Progress reports detailing the form and manner
of all actions taken to secure compliance with the Written Agreement must be submitted to the FRBSF at least quarterly.
The Directors of the Company and the Bank have recognized and agree with the goal of financial soundness represented by the Written Agreement and have confirmed the intent of the Directors and senior management of the Company and the Bank to diligently seek to comply with all requirements (including timelines) specified in the Written Agreement.
We believe that making the improvements in our operations required by the Written Agreement will enhance our financial performance. However, there can be no assurance that these results will follow as a result of our actions, or that we will be able to make the changes required by the Written Agreement. Among other things, compliance
with the Written Agreement may be more time consuming or expensive than anticipated, the objectives set forth in the Written Agreement may take longer to achieve than we would hope or expect and we may not be able to increase our capital consistent with the revised capital plan to be submitted. Our efforts to comply with the Written Agreement may have adverse effects on our operations and financial condition for reasons we cannot currently anticipate. Also, the conditions of the economy nationally
and in California, the capital markets and the real estate markets may impair the likelihood of success of the remedial actions we are attempting to take.
As a result of being undercapitalized under the prompt corrective action rules, the Bank is subject to certain regulatory restrictions. These include, among others, that the Bank may not make any capital distributions, must submit an acceptable capital restoration plan to the FDIC, may not increase its average total assets during a calendar
quarter to exceed its average total assets during the preceding calendar quarter and may not acquire a business, establish or acquire a branch office or engage in a new line of business.
As a result of the Written Agreement, we are actively seeking additional capital either directly through the sale of securities or indirectly through the merger with another bank or financial institution (which could be accompanied by a financing). We expect that any sale of securities would most likely be through a private placement to institutional
investors. While we have had discussions with various financing sources and potential merger partners, at the date of this Report we have no agreements for any such transaction. Any merger or financing could involve a change of control of the Company.
Management of the Company has taken certain steps in an effort to continue with safe and sound banking practices exercising the contractual right to defer the interest on the junior subordinated debentures, taking a number of actions to contain costs, continuing to reduce its lending exposure, and increasing the borrowing line at the Federal
Reserve Bank’s discount window in an amount up to approximately $38 million.
If the Bank is not successful in raising additional capital, it will not be able to become fully compliant with the provisions of the Written Agreement discussed above. As a result, the FRBSF, CDFI or the FDIC may take further enforcement action, including placing the Bank into receivership. If the Bank is placed into FDIC receivership,
it is likely that the Bank would be required to cease operations and liquidate. If the Bank were to liquidate it is unlikely that there would be any assets available to the holders of the common shareholders of the Company. See Risk Factors below.
BUSINESS PLAN
The focus of the Company’s business plan is to attract “Business Relationship” small, medium and large accounts, but not to the exclusion of any other business which the Company can reasonably and profitably attract. In order to provide a level of service to attract such customers, the Company has structured
its specific services and charges on a basis which management believes to be profitable, taking into consideration other aspects of the account relationship. The Company offers a full range of banking services to its customers intended to attract the following specific types of accounts: relatively large consumer accounts; professional group and association accounts, including the accounts of groups or firms of physicians, dentists, attorneys and accountants; and accounts of small to medium-sized businesses
engaged in retail, wholesale, light industrial, manufacturing, agricultural and service activities.
In order to realize our objectives, we have taken and will continue to take steps to improve our capital accounts. Since mid-2009, we have taken actions to bolster our capital ratios, in an effort to protect the Bank and the Company. The actions taken include, among others, the exercise of our right to defer payment of interest on our junior
subordinated debentures in September, 2009, a significant reduction in loan growth and cost cutting to the extent possible as we seek to achieve compliance with regulatory requirements (see “Recent Developments” below). In addition, we are focused on reductions in certain non-interest expenses and improvement in non-interest income, in an effort to increase profitability. Although we do not believe we currently have the ability to raise new capital through a public offering at an acceptable price,
we continue to evaluate alternative capital strengthening strategies, and are currently working on initiatives to strengthen our capital position including the possibility of entering into a business combination with a strategic partner, significantly reducing asset size through loan sales or entering into a transaction with a private equity group. However, there can be no assurance that our pursuit of such strategic alternatives will result in the Company pursuing any particular transaction or strategy, or if
it pursues any
such transaction or strategy, that it will be completed or be successful.
TRUST SUBSIDIARIES
The Company during 2004 and 2007 established two subsidiary grantor trusts. Pacific State Statutory Trusts II and III (the “Trusts”). The Trusts were established for the sole purpose of issuing capital securities (“Capital Securities”) pursuant to declarations of trust (the “Declarations”). The
proceeds from the sale of the Capital Securities were loaned to the Company as subordinated debentures (the “Debentures”) issued to the Trusts pursuant to indentures (the “Indentures”). Interest payments on the Debentures will flow through the Trusts to the Pooling Vehicles, which are the holders of the Capital Securities and similar securities issued by other financial institutions. Payments of distributions by the Trusts to the Pooling Vehicle are guaranteed by
the Company. See Note 8 to the Company’s consolidated financial statements included with this report.
Proceeds from the issuance of the 2004 subordinated debentures were used to provide the Bank with an additional $3.5 million in capital in order to support the continued growth of the Bank. Proceeds from the issuance of the 2007 subordinated debentures were used to retire subordinated debenture issued in 2002 at a more favorable
rate of interest.
PRODUCT LINES AND SERVICES
The Bank currently offers the following general banking services at all of its branches: commercial, construction, agricultural and real estate loans and personal credit lines, interest on checking, U.S. Savings bond services, domestic and foreign drafts, banking by appointment, automatic transfer of funds between savings and checking accounts,
business courier services, checking and savings accounts for personal and business purposes, domestic letters of credit, a depository for MasterCard and Visa drafts, federal depository services, cash management assistance, wire and telephone transfers, Individual Retirement Accounts, time certificates of deposit, courier service for non-cash deposits, Visa and MasterCard, revolving lines of credit to consumers secured by deeds of trust on private residences, unsecured overdraft protection credit lines attached
to checking accounts, ATM cards and MasterMoney debit cards via the Star, Cirrus, Plus, MasterCard and Visa networks.
The Bank is not authorized to offer trust services. The Federal Reserve Bank of San Francisco is the Company’s primary correspondent relationship. The Bank currently also has correspondent relationships with City National Bank in Beverly Hills, California, First Tennessee Bank in Memphis, Tennessee, Wells Fargo
Bank, San Francisco, California and Pacific Coast Bankers Bank, San Francisco, California.
The Bank recognizes that, in order to be competitive, it must attract a certain number of consumer accounts. Individual Retirement Accounts, Visa and MasterCard, revolving lines of credit to consumers secured by deeds of trust on private residences, and unsecured overdraft protection credit lines attached to checking accounts
currently offered by the Bank are designed to appeal particularly to consumers. Moreover, participation in large-scale ATM networks assists the Company in competing for consumer accounts.
The Bank is an approved Small Business Administration and 504 lender, FSA, USDA Business and Industry, USDA Part-time Farmer Program and FHA and VA lender. The Bank is a national leader in the underwriting of U.S. Department of Agriculture business and industry loans, as well as a Preferred Lender for this program.
MARKETING
The basic marketing strategy of the Bank is to retain the Bank’s initial market share and to increase the Bank’s penetration of the market over the long term via expansion east and west of Stockton, California in small to medium sized communities. The Bank attempts to accomplish this by providing a full range of personalized
banking services to small and medium size businesses, professionals and individuals within Alameda, Calaveras, San Joaquin, Stanislaus and Tuolumne Counties.
The Bank’s marketing plan aims to provide for strong continuity in banker-customer relationships, a high degree of convenience for customers, prompt response in the handling of loan requests, and personal attention to needs of individual customers. The marketing plan also includes a commitment to lend the Bank’s
deposits back into the areas from which they are derived, thereby assisting in the building activity, population growth and other changes, which are occurring in the market area. By focusing the Bank’s relationship toward its community the Bank attempts to establish strong continuity with its customers.
The Directors of the Company are active in business development through personal contacts and personal participation in local activities. The Directors of the Company have a strong commitment to community banking. They believe in business development by actively participating in community events.
Local advertising and publicity in local papers also are used to attract business and to acquaint potential customers with the Bank’s services.
COMPETITION
The Bank’s service area consists of Alameda, Calaveras, San Joaquin, Stanislaus and Tuolumne Counties. The banking business in California generally, and specifically in the Bank’s primary market area, is highly competitive with respect to both loans and deposits. The banking business is dominated by a relatively
small number of major banks, which have many offices operating over wide geographic areas. Many of the major commercial banks offer certain services (such as international, trust and securities brokerage services), which are not offered directly by the Bank. By virtue of their greater total capitalization, such banks have substantially higher lending limits than the bank and substantial advertising and promotional budgets.
In the past, an independent bank’s principal competitors for deposits and loans have been other banks (particularly major banks), savings and loan associations and credit unions. To a lesser extent, competition was also provided by thrift and loans, mortgage brokerage companies and insurance companies. Other
institutions, such as brokerage houses, credit card companies, and even retail establishments have offered new investment vehicles, such as money-market funds, which also compete with banks. The direction of federal legislation in recent years seems to favor competition between different types of financial institutions and to foster new entrants into the financial services market, and it is anticipated that this trend will continue.
To compete with major financial institutions in its service area, the Bank relies upon specialized services, responsive handling of customer needs, local promotional activity, and personal contacts by its officers, directors and staff, as opposed to large multi-branch banks, which compete primarily by interest rates and multiple branch
locations. For customers whose loan demands exceed the Bank’s lending limits, the Bank seeks to arrange funding for such loans on a participation basis with its correspondent banks or other independent commercial banks.
SUPERVISION AND REGULATION
The Company is principally regulated by the Federal Reserve Board (“FRB”). The Bank is principally regulated by the California Commissioner of Financial Institutions (“Commissioner”), but is also subject to regulation by the Federal Deposit Insurance Corporation (“FDIC”) and by its primary federal regulator,
the FRB. These agencies govern most of the Company’s and the Bank’s business, including capital requirements, loans, investments, mergers and acquisitions, borrowings, dividends, branch locations and other similar matters. In addition, the Bank’s business is affected by general economic conditions and by the monetary and fiscal policies of the United States government. These policies influence, for example, the Federal Reserve’s open market operations in U.S. Government
securities, the reserve requirements imposed upon commercial banks, the discount rates applicable to borrowings from the Federal Reserve by banks, and other similar matters which impact the growth of the Bank’s loans, investments and deposits and the interest rates which the Bank charges and pays.
Proposals to change the laws and regulations governing the operations and taxation of financial institutions are frequently made in Congress, in the California legislature and before various regulatory and professional agencies. Major changes and the impact such changes might have are difficult to predict with accuracy. Certain
significant recently proposed or enacted laws and regulations are discussed below.
The Company may make capital distributions (dividends in cash or property, or repurchases of capital stock) subject to the California General Corporation Law and the policies, rules and regulations of the FRB. Under the California General Corporation Law, the Company may not pay dividends in cash or property except (i) out of positive
retained earnings or (ii) if, after giving effect to the distribution, the Company’s assets would be at least 1.25 times its liabilities and its current assets would exceed its current liabilities (determined on a consolidated basis under generally accepted accounting principles). The FRB has stated that, as a matter of prudent banking, a bank holding company generally should not pay cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends,
and that the prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition.
The ability of the Company to pay dividends will depend upon its cash resources. The Company’s principal source of income consists of dividends and cash distributions from the Bank. As a California-chartered bank, without the approval of the California DFI, the Bank may pay dividends in an amount that does not exceed the lesser of its
retained earnings or its net income for the last three fiscal years. Under regulations of the FDIC, the Bank may not make a capital distribution without prior approval of the FDIC if it would be undercapitalized, significantly undercapitalized or critically undercapitalized under the Prompt Corrective Action Rules. Additionally, as a result of entering into the Written Agreement, the Company may not make a capital distribution without the prior approval of the FRBSF and the CDFI. See “Recent
Developments” below.
INTERSTATE BANKING
Since 1995, initial entry into California by merger or acquisition involving an out-of state institution must be accomplished by acquisition of or merger with an existing whole bank which has been in existence for at least five years.
CAPITAL REQUIREMENTS
The Company and the Bank are subject to certain regulatory capital requirements administered by the FRB and the FDIC. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities
and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about the components, risk weightings and other factors.
The Uniform Financial Institutions Rating System classifies and evaluates the soundness of financial institutions according to the so-called “CAMELS” criteria, an acronym for capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk, (including changes in interest rates, foreign exchange
rates, commodity prices or equity prices which may adversely affect an institution’s earnings and capital).
Prompt Corrective Action regulations (the “PCA Regulations”) of the federal bank regulatory agencies establish five capital categories in descending order (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized), assignment to which depends upon the institution’s
total risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage ratio. Institutions classified in one of the three undercapitalized categories are subject to certain mandatory and discretionary supervisory actions, which include increased monitoring and review, implementation of capital restoration plans, asset growth restrictions, limitations upon expansion and new business activities, requirements to augment capital, restrictions upon deposit gathering and interest rates, replacement
of senior executive officers and directors, and requiring divestiture or sale of the institution. The Bank is currently classified as an “under capitalized” bank pursuant to the PCA regulations. As of December 31, 2009, the Bank’s total risk-based capital ratio (approximately 6.7%) and its leverage ratio (approximately 4.1%) are considered undercapitalized by PCA Regulations.
Holding Company Liability.
Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to its banking subsidiaries and commit resources to their support. This support may be required by the Federal Reserve Board at times when, absent this Federal Reserve policy, we may not be inclined to provide it. As discussed above,
under the “Prompt Corrective Action” rules, a bank holding company in certain circumstances also could be required to guarantee the capital plan of an undercapitalized banking subsidiary. In addition, any capital loans by a bank holding company to any of its depository institution subsidiaries are subordinate in right of payment to deposits and to certain other indebtedness of the banks. In the event of a bank holding company’s bankruptcy under Chapter 11 of the U.S. Bankruptcy Code,
the trustee will be deemed to have assumed and is required to cure immediately any deficit under any commitment by the debtor holding company to any of the federal banking agencies to maintain the capital of an insured depository institution, and any claim for breach of such obligation will generally have priority over most other unsecured claims.
FEDERAL DEPOSIT INSURANCE
The deposits of the Bank have historically been insured by the FDIC up to $100,000 per insured depositor, except certain types of retirement accounts, which are insured up to $250,000 per insured depositor. On October 3, 2008, the maximum amount insured under FDIC deposit insurance was temporarily increased from $100,000 to $250,000 per
insured depositor through December 31, 2013. Additionally, the Bank has elected to participate in those provisions of the FDIC’s Transaction Account Guarantee Program that provide additional insurance coverage on non-interest bearing deposit transaction accounts. Under this program, through December 31, 2010, all noninterest-bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account and the Bank is assessed an annual fee of 25 basis points
for all deposit amounts exceeding the existing deposit insurance limit of $250,000. Coverage under the Transaction Account Guarantee Program is in addition to and separate from the coverage available under the FDIC's general deposit insurance rules. See information under the caption “Liquidity and Market” in the Company’s 2009 Annual Report to Shareholders, which information is incorporated herein by this reference.
On February 27, 2009, the FDIC issued a press release with attached final rule dated February 26, 2009, which established increased assessment rates effective as of April 1, 2009 and included adjustments to improve differentiation of risk profiles among institutions. Based upon the announced increase in assessments for insured
financial institutions in 2009 as described above and the continuing adverse economic conditions impacting financial institutions generally which may necessitate further increases in assessments, the Bank anticipates that such assessments will have a significantly greater impact upon operating expenses in 2010 compared to 2009.
COMMUNITY REINVESTMENT ACT
Community Reinvestment Act (“CRA”) regulations evaluate the Bank’s lending to low and moderate income individuals and businesses across a four-point scale from “outstanding” to “substantial noncompliance,” and are a factor in regulatory review of applications to merge, or establish new branches.
In addition, any Bank rated in “substantial noncompliance” with the CRA regulations may be subject to enforcement proceedings. The Bank has a current rating of “satisfactory” CRA compliance.
SAFETY AND SOUNDNESS STANDARDS
Federal bank regulations for insured financial institutions establish safety and soundness standards for (1) internal controls, information systems and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset growth; (6) compensation, fees and benefits; and (7) excessive compensation.
If an agency determines that an institution fails to meet any standard established by the guidelines, the agency may require the financial institution to submit to the agency an acceptable plan to achieve compliance with the standard. Agencies may elect to initiate enforcement action in certain cases where failure to meet one or more of the standards could threaten the safe and sound operation of the institution.
SARBANES-OXLEY ACT OF 2002
The Sarbanes-Oxley Act of 2002 (the “SOA”) was enacted to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.
The SOA is the most far-reaching U.S. securities legislation enacted in many years. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission, (“the SEC”), under the Securities Exchange Act of 1934. Since the enactment
of the SOA, the SEC has issued numerous new and proposed regulations to implement SOA requirements.
The SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
The SOA addresses the following, among other matters:
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Duties, responsibilities and qualifications of the audit committee;
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Certification of financial statements by the Principal Executive Officer and the Chief Financial Officer;
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The forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
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A prohibition on insider trading during pension plan black out periods;
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Disclosure of off-balance sheet transactions;
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A prohibition on certain personal loans to directors and officers;
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Expedited filing requirements for forms which disclose transactions by officers and directors in Company stock ;
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Disclosure of a code of ethics and of any change or waiver of such code;
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New requirements for auditing and reporting on Company internal controls;
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“Real time” filing of periodic reports;
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The formation of a public company accounting oversight board (the “PCAOB”) with authority to set auditing, quality control and independence standards and investigate and discipline public accounting firms;
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Auditor independence; and
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Various increased criminal penalties for violations of securities laws.
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Although we have incurred additional expense in complying with the provisions of the SOA, such compliance did not have a material impact on our results of operation or financial condition.
FINANCIAL SERVICES MODERNIZATION LEGISLATION
On November 12, 1999, the Gramm- Leach-Bliley Act of 1999 (the "Financial Services Modernization Act") was signed into law. The Financial Services Modernization Act is intended to modernize the banking industry by removing barriers to affiliation among banks, insurance companies, the securities industry and other financial service providers.
It provides financial organizations with the flexibility of structuring such affiliations through a holding company structure or through a financial subsidiary of a bank, subject to certain limitations. The Financial Services Modernization Act establishes a new type of bank holding company, known as a financial holding company, which may engage in an expanded list of activities that are "financial in nature," which include securities and insurance brokerage, securities underwriting, insurance underwriting and
merchant banking. The Company has not sought “financial holding company” status and has no present plans to do so.
The Financial Services Modernization Act also sets forth a system of functional regulation that makes the Federal Reserve Board the "umbrella supervisor" for holding companies, while providing for the supervision of the holding company's subsidiaries by other federal and state agencies.
In addition, the Bank is subject to other provisions of the Financial Services Modernization Act, including those relating to CRA, privacy and safe-guarding confidential customer information, regardless of whether the Company elects to become a financial holding company or to conduct activities through a financial subsidiary of the Bank.
The Company does not, however, currently intend to file notice with the Federal Reserve Board to become a financial holding company or to engage in expanded financial activities through a financial subsidiary of the Bank.
The Financial Services Modernization Act did not have a material adverse effect on their operations in the near-term. However, to the extent that it permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. The Financial Services Modernization Act is intended
to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the amount of competition that the Company faces from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company.
USA PATRIOT ACT OF 2001
On October 26, 2001, President Bush signed the USA Patriot Act (the "Patriot Act"), which includes provisions pertaining to domestic security, surveillance procedures, border protection, and terrorism laws to be administered by the Secretary of the Treasury. Title III of the Patriot Act entitled, "International Money
Laundering Abatement and Anti-Terrorist Financing Act of 2001" includes amendments to the Bank Secrecy Act which expand the responsibilities of financial institutions in regard to anti-money laundering activities with particular emphasis upon international money laundering and terrorism financing activities through designated correspondent and private banking accounts. Certain surveillance provisions of the Patriot Act were scheduled to expire on December 31, 2005, but the deadline
was postponed to allow time for evaluation of such provisions, and on March 9, 2006, President Bush signed legislation to reauthorize the Patriot Act, incorporating certain civil liberty protections approved by Congress.
Section 313(a) of the Patriot Act prohibits any insured financial institution such as Pacific State Bancorp from providing correspondent accounts to foreign banks which do not have a physical presence in any country (designated as "shell banks"), subject to certain exceptions for regulated affiliates of foreign banks.
Section 313(a) also requires financial institutions to take reasonable steps to ensure that foreign bank correspondent accounts are not being used to indirectly provide banking services to foreign shell banks, and Section 319(b) requires financial institutions to maintain records of the owners and agent for service of process of any such foreign banks with whom correspondent accounts have been established.
Section 312 of the Patriot Act creates a requirement for special due diligence for correspondent accounts and private banking accounts. Under Section 312, each financial institution that establishes, maintains, administers, or manages a private banking account or a correspondent account in the United States for a non-United
States person, including a foreign individual visiting the United States, or a representative of a non-United States person, shall establish appropriate, specific, and, where necessary, enhanced, due diligence policies, procedures, and controls that are reasonably designed to detect and record instances of money laundering through those accounts.
The Company and its subsidiaries are not currently aware of any account relationships between the Company and its banking subsidiaries and any foreign bank or other person or entity as described above under Sections 313(a) or 312 of the Patriot Act. The terrorist attacks on September 11, 2001 have realigned national
security priorities of the United States and it is reasonable to anticipate that the United States Congress may enact additional legislation in the future to combat terrorism including modifications to existing laws such as the Patriot Act to expand powers as deemed necessary. The effects which the Patriot Act and any additional legislation enacted by Congress may have upon financial institutions is uncertain; however, such legislation would likely increase compliance costs and thereby
potentially have an adverse effect upon the Company's results of operations.
RECENT REGULATORY DEVELOPMENTS
In response to global credit and liquidity issues involving a number of financial institutions, the United States government, particularly the United States Department of the Treasury (the “U.S. Treasury”) and the Federal financial institution regulatory agencies, have taken a variety of extraordinary measures designed to restore
confidence in the financial markets and to strengthen financial institutions, including capital injections, guarantees of bank liabilities and the acquisition of illiquid assets from banks.
Emergency Economic Stabilization Act
. On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Pursuant to the EESA, the U.S. Treasury was granted the authority to take a range of actions for the purpose of stabilizing
and providing liquidity to the U.S. financial markets and has implemented several programs, including the purchase by the U.S. Treasury of certain troubled assets from financial institutions under the Troubled Asset Relief Program” (the “TARP”) and the direct purchase by the U.S. Treasury of equity securities of financial institutions under the Capital Purchase Program (the “CPP”).
Capital Purchase Program
. On October 24, 2008, the U.S. Treasury announced plans to direct $250 billion of the TARP funding into the CPP to acquire preferred stock investments in bank holding companies and banks. Requirements for bank holding companies and banks eligible to
participate as a Qualifying Financial Institution (“QFI”) in the CPP include:
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Submission of an application prior to November 14, 2008 to the QFI’s Federal banking regulator to obtain preliminary approval to participate in the CPP;
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If the QFI receives preliminary approval, it will have 30 days within which to submit final documentation and fulfill any outstanding requirements;
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The minimum amount of capital eligible for purchase by the U.S. Treasury under the CPP is 1 percent of the Total Risk-Weighted Assets of the QFI and the maximum is the lesser of (i) an amount equal to 3 percent of the Total Risk-Weighted Assets of the QFI or (ii) $25 billion;
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Capital acquired by a QFI under the CPP will be accorded Tier 1 capital treatment;
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The preferred stock issued to the U.S. Treasury will be non-voting (except in the case of class votes), senior perpetual preferred stock that ranks senior to common stock and pari passu with existing preferred stock (except junior preferred stock);
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In addition to the preferred stock, the U.S. Treasury will be issued warrants to acquire shares of the QFI’s common stock equal in value to 15 percent of the amount of capital purchased by the QFI;
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Dividends are payable to the U.S. Treasury at the rate of 5% per annum for the first 5 years and 9% per annum thereafter;
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Subject to certain exceptions and other requirements, no redemption of the preferred stock is permitted during the first 3 years;
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Certain restrictions on the payment of dividends to shareholders of the QFI shall remain in effect while the preferred stock purchased by the U.S. Treasury is outstanding;
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Repurchase of the QFI’s stock requires consent of the U.S. Treasury, subject to certain exceptions;
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The preferred shares are not subject to any contractual restrictions on transfer by the U.S. Treasury; and
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The QFI must agree to be bound by certain executive compensation and corporate governance requirements and senior executive officers must agree to certain compensation restrictions.
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Temporary Liquidity Guarantee Program
. Among other programs and actions taken by the U.S. Treasury and other regulatory agencies, the FDIC implemented the Temporary Liquidity Guarantee Program (the “TLGP”) to strengthen confidence and encourage liquidity in the financial
system. The TLGP is comprised of the Debt Guarantee Program (the “DGP”) and the Transaction Account Guarantee Program (the “TAGP”). The DGP guarantees all newly issued senior unsecured debt (e.g., promissory notes, unsubordinated unsecured notes and commercial paper) up to prescribed limits issued by participating entities beginning on October 14, 2008 and continuing through October 31, 2009. For eligible debt issued by that date, the FDIC will provide the guarantee coverage
until the earlier of the maturity date of the debt or June 30, 2012. The TAGP offers full guarantee for noninterest-bearing transaction accounts held at FDIC-insured depository institutions. The unlimited deposit coverage was voluntary for eligible institutions and was in addition to the $250,000 FDIC deposit insurance per account that was included as part of the EESA. The insured deposit limits are currently scheduled to return to $100,000 on January 1, 2014, except for certain retirement accounts.
The TAGP coverage became effective on October 14, 2008 and is scheduled to continue for participating institutions until December 31, 2010. The Bank opted to participate in the TAGP.
Initially, the TLGP programs, the DGP and TAGP, were provided at no cost for the first 30 days. On November 3, 2008, the FDIC extended the opt-out period to December 5, 2008 to provide eligible institutions additional time to consider the terms before making a final decision regarding participation in the program. Participants
in the DGP are charged an annualized fee ranging from 50 basis points to 100 basis points (depending on the maturity of the debt issued) multiplied by the amount of debt issued, and calculated for the maturity period of that debt, or through June 30, 2012, whichever is earlier. The Bank is authorized to participate in the DGP and can apply to issue approximately $ 1,700,000 of qualifying senior debt securities covered by the DGP. As of December 31, 2009, the Bank has no senior unsecured debt outstanding.
In addition to the existing risk-based deposit insurance premium paid on such deposits, TAGP participants will be assessed, on a quarterly basis, an annualized 10 basis points fee on balances in noninterest-bearing transaction accounts that exceed the existing deposit insurance limit of $250,000.
Financial Stability Plan
. On February 10, 2009, the U.S. Treasury announced a Financial Stability Plan (the “FSP”) as a comprehensive approach to strengthening the financial system and credit crisis. The Plan includes a Capital Assistance Program (the “CAP”)
that is intended to serve as a bridge to raising private capital and to ensure sufficient capital to preserve or increase lending in a worse-than-expected economic deterioration. Eligibility to participate in the CAP will be consistent with the criteria for QFI’s under the CPP. Eligible institutions with consolidated assets in excess of $100 billion will be able to obtain capital under the CAP, subject to a supervisory review process and comprehensive stress test assessment of the losses that could occur
over a two year period in the future across a range of economic scenarios, including conditions more severe than anticipated or as typically used in capital planning processes. Eligible institutions with consolidated assets below $100 billion will be able to obtain capital under the CAP after a supervisory review. As announced, the CAP includes issuance of a convertible preferred security to the U.S. Treasury at a discount to the participating institution’s stock price as of February 9, 2009, subject
to a dividend to be determined. The security instrument will be designed to incentivize institutions to replace the CAP capital with private capital or redeem it. Institutions participating in the CPP under TARP may also be permitted to exchange their CPP preferred stock for the convertible preferred CAP security. Among the other elements of the FSP, is a temporary extension by the FDIC of the TLGP for enhancing financial institution liquidity to October 31, 2009.
American Recovery and Reinvestment Act
. On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (the “ARRA”) was signed into law. Section 7001 of the ARRA amended Section 111 of the EESA in its entirety. While the U.S. Treasury must promulgate
regulations to implement the restrictions and standards set forth in Section 7001, the ARRA, among other things, significantly expands the executive compensation restrictions previously imposed by the EESA. Such restrictions apply to any entity that has received or will receive financial assistance under the TARP, and shall generally continue to apply for as long as any obligation arising from financial assistance provided under the TARP, including preferred stock issued under the CPP, remains outstanding.
These ARRA restrictions do not apply to any TARP recipient during such time when the Federal government (i) only holds any warrants to purchase common stock of such recipient or (ii) holds no preferred stock or warrants to purchase common stock of such recipient. Since the Bank determined not to participate in the CPP, the restrictions and standards set forth in Section 7001 of the ARRA are not applicable to the Bank.
Term Asset-Backed Securities Loan Facility
. On March 3, 2009, the U.S, Treasury and the Board of Governors announced the Term Asset-Backed Securities Loan Facility (the “TALF”). The TALF is one of the programs under the Financial Stability Plan announced by the U.S. Treasury
on February 10, 2009. The TALF is intended to help stimulate the economy by facilitating securitization activities which allow lenders to increase the availability of credit to consumers and businesses. Under the TALF, the Federal Reserve Bank of New York (“FRBNY”) will lend up to $200 billion to provide financing to investors as support for purchases of certain AAA-rated asset-backed securities (“ABS”) initially for newly and recently originated auto loans, credit card loans, student
loans, and SBA-guaranteed small business loans anticipated to be funded on March 25, 2009, and rental, commercial, and government vehicle fleet leases, small ticket equipment, heavy equipment, and agricultural equipment loans and leases proposed to be funded in April.
ABS fundings will be held monthly beginning on March 25, 2009 through March 2010, or longer if the TALF is extended. The loan asset classes may be expanded in the future to include commercial mortgages, non-Agency residential mortgages, and/or other asset classes. Credit extensions under the TALF will be non-recourse loans to eligible
borrowers secured by eligible collateral for a three-year term with interest paid monthly. Any U.S. company that owns eligible collateral may borrow from the TALF, provided the company maintains an account with a primary dealer who will act as agent for the borrower and deliver eligible collateral to the FRBNY custodian in connection with the loan funding. The FRBYN will create a special purpose vehicle (“SPV”) to purchase and manage any assets received by the FRBYN in connection with the TALF loans.
The U.S. Treasury will provide $20 billion of credit protection to the FRBNY in connection with the TALF through the Troubled Assets Relief Program (the “TARP”) by purchasing subordinated debt issued by the SPV to finance the first $20 billion of asset purchases. If more than $20 billion in assets are purchased by the SPV,
the FRBNY will lend additional funds to the SPV to finance such additional purchases. The FRBNY’s loan to the SPV will be senior to the TARP subordinated loan and secured by all of the assets of the SPV.
TRANSACTIONS BETWEEN AFFILIATES
Transactions between a bank and its "affiliates" are quantitatively and qualitatively restricted under the Federal Reserve Act. The Federal Reserve Board issued Regulation W on October 31, 2002, which comprehensively implements Sections 23A and 23B of the Federal Reserve Act. Sections 23A and 23B and Regulation W restrict loans by
a depository institution to its affiliates, asset purchases by a depository institution from its affiliates, and other transactions between a depository institution and its affiliates. Regulation W unifies in one public document the Federal Reserve Board’s interpretations of Section 23A and 23B. Regulation W had an effective date of April 1, 2003.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Pacific State Bancorp and its subsidiary (collectively, the "Company") conform with accounting principles generally accepted in the United States and prevailing practice within the banking industry. The more significant of these policies applied in the preparation of the accompanying consolidated
financial statements are discussed below.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Pacific State Bank. Significant intercompany transactions and balances have been eliminated in consolidation. For financial reporting purposes, the Company's investment in Pacific State Statutory
Trusts II and III ("Trusts") are accounted for under the equity method and are included in accrued interest receivable and other assets in the consolidated balance sheet. The subordinated debentures issued and guaranteed by the Company and held by the Trusts are included as subordinated debentures in the consolidated balance sheet.
SEGMENT INFORMATION
Management has determined that because all of the banking products and services offered by the Company are available in each branch of the Bank, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate
to aggregate the Bank branches and report them as a single operating segment. No customer accounts for more than 10 percent of revenues for the Company or the Bank.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
RECLASSIFICATIONS
Certain reclassifications have been made to prior years' balances to conform to classifications used in 2009.
CASH AND CASH EQUIVALENTS
For the purpose of the statement of cash flows, cash, due from banks and Federal funds sold are considered to be cash equivalents. Generally, Federal funds are sold for one-day periods.
INVESTMENT SECURITIES
Investment securities are classified into the following categories:
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Available-for-sale securities, reported at fair value, with unrealized gains and losses excluded from earnings and reported, net of taxes, as accumulated other comprehensive income (loss) within shareholders' equity.
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Held-to-maturity securities, which management has the positive intent and ability to hold to maturity, reported at amortized cost, adjusted for the accretion of discounts and amortization of premiums.
Management determines the appropriate classification of its investments at the time of purchase and may only change the classification in certain limited circumstances. The Company did not have any investments classified as trading at December 31, 2009 or 2008. All transfers between categories are accounted for at
fair value. There were no transfers between categories in 2009 or 2008.
Gains or losses on the sale of investment securities are computed on the specific identification method. Interest earned on investment securities is reported in interest income, net of applicable adjustments for accretion of discounts and amortization of premiums.
Investment securities are evaluated for impairment on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline and the intent
and ability of the Company to retain its investment in the securities for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term "other than temporary" is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support
a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.
As a member of the Federal Reserve System, the Federal Home Loan Bank System and the Farmer Mac Home Administration System, the Bank is required to maintain an investment in restricted capital stock of each system. These investments are carried at cost and are redeemable at par and are included in accrued interest receivable
and other assets in the consolidated balance sheet.
LOANS
Loans are stated at principal balances outstanding. Interest is accrued daily based upon outstanding loan balances. However, when, in the opinion of management, loans are considered to be impaired and the future collectability of interest and principal is in serious doubt, loans are placed on nonaccrual status and
the accrual of interest income is suspended. Any interest accrued but unpaid is charged against income. Payments received are applied to reduce principal to the extent necessary to ensure collection. Subsequent payments on these loans, or payments received on nonaccrual loans for which the ultimate collectability of principal is not in doubt, are applied first to earned but unpaid interest and then to principal.
An impaired loan is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical matter, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. A loan is considered impaired when, based on current information
and events, it is probable that the Company will be unable to collect all amounts due (including both principal and interest) in accordance with the contractual terms of the loan agreement. Interest income on impaired loans, if appropriate, is recognized on a cash basis.
Loan origination fees, commitment fees, direct loan origination costs and purchase premiums and discounts on loans are deferred and recognized as an adjustment of yield, and amortized to interest income over the contractual term of the loan. The unamortized balance of deferred fees and costs is reported as a component of net
loans.
The Company may purchase loans or acquire loans through a business combination for which differences exist between the contractual cash flows and the cash flows expected to be collected due, at least in part, to credit quality. When the Company acquires such loans, the yield that may be accreted (accretable yield) is limited
to the excess of the Company’s estimate of undiscounted cash flows expected to be collected over the Company’s initial investment in the loan. The excess of contractual cash flows over cash flows expected to be collected may not be recognized as an adjustment to yield, loss, or a valuation allowance. Subsequent increases in cash flows expected to be collected generally should be recognized prospectively through adjustment of the loan’s yield over its remaining life. Decreases
in cash flows expected to be collected should be recognized as an impairment. The Company may not "carry over" or create a valuation allowance in the initial accounting for loans acquired under these circumstances. At December 31, 2009 and 2008, there were no such loans being accounted for under this policy.
LOAN SALES AND SERVICING
The Company accounts for the transfer and servicing of financial assets based on the financial and servicing assets it controls and liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished.
Government Guaranteed Loans
Included in the loan portfolio are loans which are 75% to 90% guaranteed by the Small Business Administration (SBA), Farmer Mac and USDA Business and Industry. The guaranteed portion of these loans may be sold to a third party, with the Company retaining the unguaranteed portion. The Company generally receives a premium
in excess of the adjusted carrying value of the loan at the time of sale. The Company may be required to refund a portion of the sales premium if the borrower defaults or prepays within ninety days of the settlement date. At December 31, 2009, there were no premiums subject to these recourse provisions.
The Company's investment in the loan is allocated between the retained portion of the loan, the servicing asset (liability) and the sold portion of the loan based on their relative fair values on the date the loan is sold. The gain on the sold portion of the loan is recognized as income at the time of sale. The carrying
value of the retained portion of the loan is discounted based on the estimated value of a comparable non-guaranteed loan. The servicing asset (liability) is recognized and amortized over the estimated life of the related loan. Significant future prepayments of these loans will result in the recognition of additional amortization of related servicing assets (liabilities).
The Company serviced government-guaranteed loans for others totaling $48,327,000 and $53,112,000 as of December 31, 2009 and 2008 respectively.
Servicing Rights
Servicing rights acquired through 1) a purchase or 2) the origination of loans which are sold with servicing rights retained are recognized as separate assets or liabilities. Servicing assets or liabilities are recorded at the difference between the contractual servicing fees and adequate compensation for performing the servicing,
and are subsequently amortized in proportion to and over the period of the related net servicing income or expense. Servicing assets are periodically evaluated for impairment. Servicing rights were not significant at December 31, 2009 and 2008.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained to provide for losses related to impaired loans and other losses that can be expected to occur in the normal course of business. The determination of the allowance is based on estimates made by management, to include consideration of the character of the loan portfolio, specifically
identified problem loans, potential losses inherent in the portfolio taken as whole and economic conditions in the Company's service area.
Classified loans and loans determined to be impaired are individually evaluated by management for specific risk of loss. In addition, reserve factors are assigned to currently performing loans based on management's assessment of the following for each identified loan type: (1) inherent credit risk, (2) historical losses
and, (3) where the Company has not experienced losses, the loss experience of peer banks. These estimates are particularly susceptible to changes in the economic environment and market conditions.
The Bank's Loan Committee reviews the adequacy of the allowance for loan losses at least quarterly, to include consideration of the relative risks in the portfolio and current economic conditions and other factors. The allowance is adjusted based on that review if, in the judgment of the Loan Committee and management, changes
are warranted.
While management uses the best information available on which to base estimates, future adjustments to the allowance for credit losses may be necessary if the economic conditions, particularly in the Stockton Markets and San Joaquin County, differ substantially from the assumptions used by management. In addition, regulatory agencies,
as an integral part of their examination process, periodically review the Company’s allowance for loan losses, and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examination.
This allowance is established through a provision for loan losses which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after net charge-offs and loan growth. The allowance for loan losses at December 31, 2009 and 2008, respectively, reflects management's
estimate of probable losses in the portfolio.
Allowance for Losses Related to Undisbursed Loan and Lease Commitments
The Bank maintains a separate allowance for losses related to undisbursed loan and lease commitments. Management estimates the amount of probable losses by applying the loss factors used in the allowance for loan and lease loss methodology to an estimate of the expected usage of undisbursed commitments for each loan or lease type. The allowance
totaled $67,000 and $222,000 at December 31, 2009 and 2008, respectively, and is included in accrued interest payable and other liabilities on the consolidated balance sheet.
OTHER REAL ESTATE
Other real estate includes real estate acquired in full or partial settlement of loan obligations. When property is acquired, any excess of the Company's recorded investment in the loan balance and accrued interest income over the estimated fair market value of the property is charged against the allowance for loan losses. A
valuation allowance for selling and administration costs associated with the liquidation of the property is recorded and maintained subsequent to foreclosure of the property. The allowance is established through a provision for losses on other real estate which is included in other expenses. Subsequent gains or losses on sales or permanent impairment charges are recorded in other income or expenses as incurred. At December 31, 2009 the Company has $10,934,000 in other real estate
and $2,029,000 in other real estate at December 31 2008.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost. Depreciation is determined using the straight-line method over the estimated useful lives of the related assets. The useful lives of premises are estimated to be ten to thirty-nine years. The useful lives of furniture, fixtures and equipment are estimated to be
three to fifteen years. Leasehold improvements are amortized over the life of the asset or the life of the related lease, whichever is shorter. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation and amortization are removed from the accounts, and any resulting gain or loss is recognized in income for the period. The cost of maintenance and repairs is charged to expense as incurred.
The Company evaluates premises and equipment for financial impairment as events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable.
GOODWILL AND INTANGIBLE ASSETS
As a result of the Company's 2002 acquisition of the Stockton branch of California Bank & Trust, the Company recognized a core deposit intangible asset of $448,000 and goodwill of $718,000. The core deposit intangible has been fully amortized and will no longer impact the Company’s financial statements. Goodwill
is not amortized, but is measured for impairment on an annual basis. At December 31, 2009 management has determined that the goodwill previously recorded can no longer be supported and has recognized an impairment charge of $718,000, or the entire balance of the goodwill. As of December 31, 2008 the Company had a balance of $718,000 of goodwill recorded.
INCOME TAXES
The Company and its subsidiaries file consolidated tax returns. The Company accounts for income taxes in accordance with FASB ASC 740, Income Taxes, resulting in two components of income tax expense: current and deferred. Current income tax expense approximates taxes to be paid or refunded for the current period. The Company determines
deferred income taxes using the balance sheet method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and recognizes enacted changes in tax rates and laws in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized subject to Management’s judgment that realization is more likely
than not. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize. The tax position is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon settlement. Interest and penalties are recognized as a component of income tax expense.
On the consolidated balance sheet, net deferred tax assets are included in accrued interest receivable and other assets.
Management continually evaluates the ability of the Company to ultimately realize deferred tax assets currently recorded. If management determines that it is more likely than not that the deferred tax assets can ultimately be realized, no valuation allowance is recorded. If management determines that it is not more
likely than not that the deferred tax assets will be realized, a valuation allowance is recorded against the future tax benefits that management believes will not be realized. As of December 31, 2009, the Company has recorded a valuation allowance of $8,404,000 against deferred tax assets. As of December 31, 2008 and December 31, 2007 the Company did not record a valuation allowance against deferred tax assets.
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share (EPS), which excludes dilution, is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as
stock options, result in the issuance of common stock which shares in the earnings of the Company. The Company had a net loss for 2009 and 2008; therefore all stock options are antidilutive. All data with respect to computing earnings per share is retroactively adjusted to reflect stock splits and dividends and the treasury stock method is applied to determine the dilutive effect of stock options in computing diluted EPS.
STOCK-BASED COMPENSATION
At December 31, 2009, the Company had one shareholder approved stock-based compensation plan which is described more fully in Note 11. The Company accounts for its stock based compensation plan in accordance with FASB ASC 718,
Stock Compensation
, using the modified
prospective transition method. Under that transition method, compensation cost recognized in fiscal years 2006, 2007, 2008 and 2009 includes: (a) compensation cost for all share-based payments vesting during 2006, 2007, 2008 and 2009 that were granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of ASC 718, and (b) compensation cost for all share-based payments vesting during 2006, 2007, 2008 and 2009 that
were granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of ASC 718. For further information on grants and vesting please refer to Note 11. Compensation cost is recognized net of estimated forfeitures. Results for prior periods have not been restated.
As a result of applying ASC 718, the Company recorded an expense of $56,000 in 2009, $270,000 in 2008 and $309,000 in 2007.
Determining Fair Value
The Company bases the fair value of the options previously granted on the date of grant using a Black-Scholes-Merton option pricing model that uses assumptions based on expected option life, the level of expected stock volatility and the risk-free interest rate. Stock volatility is based on the historical volatility of the Company's
stock. The risk-free rate is based on the U.S. Treasury yield curve and the expected term of the options. The expected term of the options represents the period that the Company's share-based awards are expected to be outstanding based on the terms of the optionee’s employment agreement and position within the Company, previous option activity, the number of shares currently owned and the expected time of when those options would be exercised. The Company has not paid cash dividends. The Company estimates
the forfeiture rate in calculating the compensation expense to be insignificant. The Company did not grant any stock options in 2009 or 2008. In 2007 the Company granted 30,000 stock options using a risk free rate of 4.98%, volatility rate of 34.79% and forfeiture rate of 2%. This resulted in a fair market value under the Black-Scholes-Merton model of $9.22 per option.
WHERE YOU CAN FIND MORE INFORMATION
Under the Securities Exchange Act of 1934 Sections 13 and 15(d), periodic and current reports must be filed with the SEC. The Company electronically files the following reports with the SEC: Form 10-K (Annual Report), Form 10-Q (Quarterly Report), Form 8-K (Current Report), insider ownership reports and Form DEF 14A (Proxy Statement). The
Company may file additional forms. The SEC maintains an Internet site, www.sec.gov, in which all forms filed electronically may be accessed free of charge.
The Company links these reports to its website (
www.pacificstatebank.com
) as soon as reasonably practicable after filing them with the SEC. None of the information on or hyperlinked from the Company’s website is incorporated into this Annual Report on Form 10-K.
ITEM 1A.
RISK FACTORS
The Company and its subsidiary, Pacific State Bank, conduct business in an environment that includes certain risks described below which could have a material adverse effect on the Company's business, results of operations, financial condition, future prospects and stock price. You are also referred to the matters described
under the heading "Cautionary Statements Regarding Forward-Looking Statements," for additional information regarding factors that may affect the Company's business.
Going Concern Uncertainty
The consolidated financial statements contained in the Company’s Annual Report to Shareholders for 2009, which information is incorporated herein by this reference, have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business. As a result,
the consolidated financial statements do not include any adjustments that may result from the outcome of any regulatory action or the Company’s or the Bank’s inability to meet its existing debt obligations. The Bank has recently incurred significant operating losses, experienced a significant deterioration in the quality of its assets and become subject to enhanced regulatory scrutiny. These factors, among others, were deemed to cast significant doubt on the Company’s and the Bank’s
ability to continue as a going concern. If the Company cannot continue to operate as a going concern, it is likely that shareholders will lose all or substantially all of their investment in the Company.
The Company is actively pursuing a broad range of strategic alternatives, including a capital infusion or a merger, in order to address any doubt related to the Company’s ability to continue as a going concern. There can be no assurance that the pursuit of strategic alternatives will result in any transaction, or that any such transaction
will allow the Company’s shareholders to avoid a loss of all or substantially all of their investment in the Company. The pursuit of strategic alternatives may also involve significant expenses and management time and attention.
Additional Capital
The Company needs to raise additional capital to meet the higher minimum capital levels that the Bank and Company are obligated to maintain under the Consent with the CDFI. As of December 31, 2009, the Bank was considered “under capitalized” under the prompt corrective action rules of the Federal Deposit Insurance Corporation
(“FDIC”). In addition, should the Company’s current rate of operating losses continue or should the Company’s asset quality erode and require significant additional provision for credit losses, resulting in additional net operating losses, the Company’s capital levels will decline further and it will need to raise more capital to satisfy its regulatory capital requirements. The Company’s ability to raise additional capital depends on conditions in the capital
markets, which are outside the Company’s control, and on the Company’s financial performance. Accordingly, the Company cannot be certain of its ability to raise additional capital on acceptable terms, or at all. If the Company cannot raise additional capital, its results of operations and financial condition could be materially and adversely affected, and it may be subject to further supervisory action. See “Regulatory Risk.” In addition, if the Company were to raise additional
capital through the issuance of additional shares, its stock price could be adversely affected, depending on the terms of any shares it were to issue.
Regulatory Risk
During the fourth quarter of 2009, the Company and the Bank entered into the Written Agreement with the FRB and the CDFI. See “Recent Developments” for the discussion of the terms of the Written Agreement. Additionally, on April 15, 2010, the Bank executed a Waiver and Consent to
an Order of the CDFI (the “Consent”) requiring the Bank, within 90 days of the effective date of the Order, to increase and to maintain tangible capital at a level equal to 10% of assets. The effective date will be the date that the CDFI executes the Order per se. As of December 31, 2009, the Bank had a ratio of tangible capital to assets of 3.9%, which was not sufficient to meet the higher level that the Bank would
be obligated to maintain under the Consent. As a result, if within 90 days of the effective date of the Order the Bank cannot comply with the Consent provisions, the Bank may be subject to further supervisory action, which could have a material adverse effect on its results of operations, financial condition and business.
In addition, due to the ongoing economic downturn and the resultant deterioration in the Central California commercial real estate and commercial business markets and adverse impact on the Bank’s loan portfolio and financial results, the Company and
the Bank’s
conduct of their business may be the subject of additional regulatory actions and face further limitations on their business. Bank regulatory authorities have the authority to bring enforcement actions against banks and bank holding companies for unsafe or unsound practices in
businesses or for violations of any law, rule or regulation, any condition imposed in writing by the appropriate bank regulatory agency or any written agreement with
the authority. Possible enforcement actions against the Company and Bank could include the issuance of a cease-and-desist order, the issuance of directives to increase capital or to enter into a strategic transaction, whether by merger or otherwise, with a third party, the appointment of a conservator or receiver for the Bank, the termination of insurance of deposits, the issuance of removal and prohibition orders against institution- affiliated parties, and the enforcement of such actions through injunctions
or restraining orders. The imposition of any such enforcement actions would likely have an adverse effect on the Company’s and the Bank’s results of operations, financial condition and business.
No Assurance of Profitability
The Company incurred a net loss of $22.4 million, or $6.02 per diluted common share, for the year ended December 31, 2009, primarily due to a $15.4 million provision for loan losses, a $718 thousand charge for goodwill impairment and the establishment of a $8.4 million net deferred tax asset valuation allowance. Although the Company
has taken a significant number of steps to reduce its credit exposure, the Company likely will continue to incur credit costs throughout 2010, which Management anticipates will continue to adversely impact the Company’s overall financial performance and results of operations. There can be no assurance that the Company will achieve profitability in the future.
Change in Capital Classification
As of December 31, 2009, the Company and the Bank were no longer classified as “well capitalized” under generally applicable
regulatory guidelines. In addition, the Company and the Bank do not presently meet this standard and there is a substantial risk
that the Company and the Bank will fail to meet such requirements in future periods unless the Company is successful in executing on its three-year capital and strategic plan. The Bank’s regulatory capital position has reduced such that it was classified as ”under capitalized,” thereby causing it to be unable to renew the use of brokered deposits as a source of funds. A “well capitalized” institution may accept brokered deposits without restriction. An “adequately
capitalized” institution must obtain a waiver from the FDIC in order to accept, renew or roll over brokered deposits. In addition, certain interest-rate limits apply to the financial institution’s brokered and solicited deposits. Although an institution could seek permission from the FDIC to accept brokered deposits if it were no longer considered to be “well capitalized,” the FDIC may deny permission, or may permit the institution to accept fewer brokered deposits than the level
considered desirable. Since the Bank’s level of deposits are being reduced, due to the lack of a full brokered deposit waiver and by the interest rate limits on brokered or solicited deposits, Management anticipates that the Bank will reduce its assets and, most likely, curtail its lending activities. Other possible
consequences of classification as an “under capitalized” institution include the potential for increases in borrowing
costs and terms from the Federal Home Loan Bank (“FHLB”) and other financial institutions and increases in FDIC insurance premiums. Such changes could have a material adverse effect on the Company’s results of operations, financial condition and business.
Dividends from the Bank
The principal source of funds from which the Company services its debt and pays its obligations and dividends is the receipt of dividends from the Bank. The availability of dividends from the Bank is limited by various statutes and regulations. As a result of entering into the Written Agreement, it is also restricted, without prior
approval from the FRB and the CDFI, from paying dividends to the Company.
Deferral of Interest on Trust Preferred Securities
In the third quarter of 2009, the Company elected to defer regularly scheduled interest payments on its outstanding $8.5 million of junior subordinated notes relating to its trust preferred securities. During the deferral period, interest will continue to accrue on the junior subordinated notes at the stated coupon rate, including the
deferred interest, and the Company may not, among other things and with limited exceptions, pay cash dividends on or repurchase its common stock nor make any payment on outstanding debt obligations that rank equally with or are junior to the junior subordinated notes. As a result of the Company’s deferral of interest on the junior subordinated notes, it is likely that the Company will not be able to raise funds through the offering of debt securities until the
Company
becomes current on those obligations or those obligations are restructured. This deferral may also adversely affect the Company’s ability to obtain debt financing on commercially reasonable terms, or at all. As a result, the Company will likely have greater difficulty in obtaining financing and, thus, will have fewer sources to enhance its capital and liquidity position. In addition, if the Company defers interest payments on the junior subordinated notes for more than 20 consecutive quarters,
the Company would be in default under the indenture agreements governing such notes and the amount due under such agreements would be immediately due and payable.
Continued Listing on The NASDAQ Global Select Market
The Company’s common stock is listed on The NASDAQ National Market. The listing standards of The NASDAQ Capital Market provide, among other things, that a company may be delisted if its market value of its publicly held share do not equal $15 million and the bid price of its stock drops below $1.00 for a period of 30 consecutive business
days, the shares may be delisted. The market value of the Company’s shares do not equal $15 million and the closing price of the Company’s common stock was $0.37 per share on March 31, 2010 and $0.51 on February 28, 2010. If the Company fails to comply with the listing standards applicable to issuers listed on the NASDAQ Capital Market, the Company’s common stock may be delisted from the NASDAQ Capital Market. The delisting of the Company’s common stock would significantly affect
the ability of investors to trade the Company’s securities and would likely reduce the liquidity and market price of the Company’s common stock. In addition, the delisting of the Company’s common stock could also materially adversely affect the Company’s ability to raise capital on terms acceptable to the Company or at all. Delisting from the NASDAQ Capital Market could also have other negative results, including the potential loss of confidence by customers and employees and the loss
of institutional investor interest in the Company’s common stock.
Liquidity Risk
Liquidity is essential to the Company’s business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on the Company’s liquidity. The Company’s access to funding sources in amounts adequate to finance the Company’s activities could be impaired
by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact the Company’s access to liquidity sources include a decrease in the level of the Bank’s business activity due to a market downturn, adverse regulatory action against the Company or the Bank, an increase in costs of capital in financial capital markets, or a decrease in depositor or investor confidence in the Bank.
The
Bank’s ability to acquire deposits or borrow could also be impaired by factors that are not specific to the Company, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole as the recent turmoil faced by financial institutions in the domestic and worldwide credit markets deteriorates.
The expiration of the FDIC’S TAG program in December may cause depositors to reduce the size of their deposits with us.
In October 2008, the FDIC announced its TAG Program as part of the TLG Program. The TAG Program guarantees full deposit insurance coverage of non-interest bearing transaction accounts until December 31, 2010, regardless of the dollar amount and in addition to the standard FDIC insurance. The current expiration of the TAG Program is anticipated
to be the Bank’s most significant liquidity risk in the near term and mitigating the liquidity impact of such an event remains a priority. As of December 31, 2009, the Company had 49 deposit accounts with balances greater than $250,000 participating in the TAG Program providing unlimited insurance coverage for a total of $26 million in deposits. The TAG Program is due to expire December 31, 2010. If the TAG Program is not extended again by the FDIC, we could experience withdrawals by account
holders of any amounts they have on deposit in excess of the amount then insured by the FDIC. Even if the FDIC decides to extend the TAG Program again, it could do so on terms that makes the program unavailable to us or on terms that make the program less attractive for us to participate. Based on current liquidity sources, we anticipate that we will have adequate collateral and other sources of liquidity to meet those potential needs. However, it could require us to utilize the majority of our available
liquidity and potentially utilize a portion of our borrowing capacity at the discount window. A significant decline in our deposits and/or an increase in collateral requirements could adversely affect our liquidity and financial position, and could adversely affect our business, results of operations, and prospects.
FDIC Premiums
FDIC insurance premiums increased substantially in 2009, and the Bank expects to pay significantly higher FDIC premiums in the future. The FDIC has recently been considering different methodologies by which it may increase premium amounts, because the costs associated with bank resolutions or failures have substantially depleted the Deposit
Insurance Fund. In November 2009, the FDIC voted to require insured depository institutions to prepay slightly over three years of estimated insurance assessments. While the Bank was exempted from prepaying three years assessments, the increase in premiums significantly increased the Bank’s non-interest expense in 2009, and may continue to do so for the foreseeable future.
Reputation Risk
Reputation risk, or the risk to the Company’s earnings and capital from negative publicity or public opinion, is inherent in Company’s business. Negative publicity or public opinion could adversely affect the Bank’s ability to keep and attract customers and expose the Company to adverse legal and regulatory consequences.
Negative public opinion could result from the Company’s actual or perceived conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by
government regulators and community organizations in response to that conduct.
Increased Likelihood of Class Action Litigation and Additional Regulatory Enforcement
The market price of the Company’s common stock has declined substantially over the past year. This decline could result in shareholder class action lawsuits, even if the activities subject to complaint are not unlawful, and even if the lawsuits are ultimately unsuccessful. Recent events in financial markets and negative publicity may
result in more regulation and legislative scrutiny of the Company’s industry practices and may cause additional exposure to increased shareholder litigation and additional regulatory enforcement actions, which would adversely affect the Company’s business.
The Company’s business is subject to interest rate risk, and variations in interest rates may negatively affect its financial performance.
Changes in the interest rate environment may reduce the Company's net interest income. It is expected that the Company will continue to realize income from the differential or "spread" between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other
interest-bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. We cannot assure you that we can minimize the Company's interest rate risk. In addition, an increase in the general
level of interest rates may adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially and adversely affect the Company's net interest spread, asset quality, loan origination volume and overall profitability.
The Company faces strong competition from financial service companies and other companies that offer banking services, which can hurt Pacific State Bancorp' business.
The Company's subsidiary, Pacific State Bank, conducts banking operations principally in Stockton California and San Joaquin County. Increased competition in the Bank's market may result in reduced loans and deposits. Ultimately, it may not be able to compete successfully against current and future competitors. Many competitors
offer the banking services that are offered by the Bank in its service area. These competitors include national and super-regional banks, finance companies, investment banking and brokerage firms, credit unions, government-assisted farm credit programs, other community banks and technology-oriented financial institutions offering online services. In particular, the Bank's competitors include several major financial companies whose greater resources may afford them a marketplace advantage
by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits, and range and quality
of products and services provided, including new technology-driven products and services. Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances, such as Internet-based banking services that cross traditional geographic bounds, enable more companies to provide financial services. If the Bank is unable to attract and retain banking customers, it may be unable to continue its loan growth
and level of deposits, which may adversely affect its and the Company's results of operations, financial condition and future prospects.
Changes in economic conditions could result in an economic downturn in Northern California which could adversely affect the Company’s business.
The Company's business is directly affected by factors such as economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government monetary and fiscal policies and inflation, all of which are beyond the Company's control. A deterioration in economic conditions
locally, regionally or nationally including as the result of terrorist activities within and outside California could result in an economic downturn in Northern California and trigger the following consequences, any of which could adversely affect the Company's business:
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·
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loan delinquencies and defaults may increase;
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·
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problem assets and foreclosures may increase;
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·
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demand for the Company's products and services may decline;
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·
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low cost or non-interest bearing deposits may decrease; and
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·
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collateral for loans may decline in value, in turn reducing customers' borrowing power, and reducing the value of assets and collateral as sources of repayment of existing loans.
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·
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The Company has a concentration risk in real estate related loans.
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At December 31, 2009, approximately 6.5% of the Company's loan portfolio consisted of real estate related loans. Substantially all of the Company's real property collateral is located in its operating markets in Stockton, California and San Joaquin County. The Company has experienced a substantial decline in real estate
values in the Company's primary market areas as a result of an economic downturn. The Company’s management has been proactive in working with borrowers having problems repaying loans that have become delinquent or have the potential to become delinquent. In most cases, collateral values are sufficient to repay outstanding principal and interest. In the cases where collateral values have fallen short of the principle and interest owed on the loans, management has reserved
for the estimated potential loss. Other events including natural disasters such as earthquakes, fires, and floods could materially effect real estate values in the Company’s primary market areas. Such a decline in values could have an adverse impact on the Company by limiting repayment of defaulted loans through sale of the real estate collateral and by likely increasing the number of defaulted loans to the extent that the financial condition of its borrowers is adversely
affected by such a decline in values. Those events could necessitate a significant increase in the provision for loan and lease losses which could adversely affect the Company's results of operations, financial condition, and future prospects.
The Company's allowance for loan losses may not be adequate to cover actual losses.
Like all financial institutions, the Company maintains an allowance for loan losses to provide for loan defaults and non-performance, but its allowance for loan losses may not be adequate to cover actual loan losses. In addition, future provisions for loan losses could materially and adversely affect the Company's operating
results. The Company’s allowance for loan losses is based on prior experience, as well as an evaluation of the risks in the current portfolio. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond the Company’s control, and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review the Company’s
loans and allowance for loan losses. Although we believe that the Company’s allowance for loan losses is adequate to cover current losses, we cannot assure you that it will not further increase the allowance for loan losses or that regulators will not require it to increase this allowance. Either of these occurrences could materially and adversely affect the Company's earnings.
ITEM 1B.
UNRESOLVED STAFF COMMENTS.
Not applicable
ITEM 2.
PROPERTIES
The Company owns its West March Lane and East March Lane facilities in Stockton, and branches located in Modesto, Groveland, Angels Camp, Arnold and Hayward. The Company purchased the West March Lane office for $867,000 in 1992. The Company’s executive officers and support staff were located in the West
March Lane building from 1997 to 2004. During 2001 the Company purchased an adjacent building to the West March Lane office, for $747,000, in order to expand its administrative functions. The executive offices, finance department, central operations and data processing were moved into these offices in 2004. The Company repossessed a Modesto building and converted it to a banking branch in 1996. The Modesto land was purchased in 1999 for $524,000. The Company purchased
the Arnold branch for $600,000 as part of its 1997 expansion into branches acquired from Valliwide Bank. During 2000 the Company purchased a lot in Groveland and purchased a lot in Angels Camp in order to build and relocate the current branch offices. These sites offer the Company better visibility and demonstrate commitment to the communities we serve. The Groveland property was purchased for $148,000 and construction was completed in January 2003. The Angels Camp
property was purchased for $200,000 and was completed in the third quarter of 2003. The Company purchased the building in Hayward for $1,800,000 in July 2006 and purchased land on East March Lane in Stockton for $728,000 in June of 2007 and constructed a branch that was placed into service January 2, 2009 in order to replace the downtown Stockton office, which was closed when its lease expired December 31, 2008.
The Company holds additional premises under lease which are presented below:
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·
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In 2010, the Company entered into a 5-year lease for the building in Tracy.
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In 2005, the Company entered into a 10-year lease with four options to extend for an additional 5 years each for the building in Lodi. The annual rent commenced in 2006 upon completion of the building and occupation by Pacific State Bank.
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ITEM 3.
LEGAL PROCEEDINGS
.
There are no material pending legal proceedings, other than ordinary routine litigation incidental to its business, to which the Company is a party or of which any of its property is the subject.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to vote of the security holders during the fourth quarter of the period covered by this report.
Item (*)
Executive Officers of the Registrant.
The following table presents certain information regarding the executive officers of the Company:
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NAME
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AGE
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POSITION(S)
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SINCE
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Rick Simas
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49
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Principal Executive Officer
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2008
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Gary A. Stewart
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60
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Executive VP/CCO/Director
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1996
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Justin Garner
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28
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Vice President/CFO
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2008
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(*) Included pursuant to General Instruction (G)(3).
PART II
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
See information under the caption “Market Price for Registrant’s Common Equity, Dividends and Related Stockholder Matters” in the Company’s 2009 Annual Report to Shareholders, which information is incorporated here by reference.
ITEM 6.
SELECTED FINANCIAL DATA
See information under the caption “Selected Financial Data” in the Company’s 2009 Annual Report to Shareholders, which information is incorporated here by reference.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
See information under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operation” in the Company’s 2009 Annual Report to Shareholders which information is incorporated here by reference.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISLOSURES ABOUT MARKET RISK.
See information under the caption “Liquidity and Market Risk” and “Net Interest Income Simulation” in the Company’s 2009 Annual Report to Shareholders which information is incorporated here by reference.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Report of Independent Registered Public Accounting Firm, Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Changes in Shareholders’ Equity, Consolidated Statement of Cash Flows and Notes to Consolidated Financial Statements, all contained in the Company’s 2009 Annual Report to Shareholders,
which information is incorporated here by reference.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
ITEM 9A.
CONTROLS AND PROCEDURES
The management of Pacific State Bancorp, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The Company’s internal control over financial reporting
is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that
could have a material effect on the financial statements.
The Principal Executive Officer and Chief Financial Officer of the Company have concluded, based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company
in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including the Company’s Principal Executive Officer and Chief Financial
Officer, as appropriate to allow timely decisions regarding required disclosure. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
There were no significant changes in the Company’s internal controls or in other factors during the last quarter of 2009 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls.
Accordingly, even an effective system of internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that degree of compliance with the policies or procedures may deteriorate.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to the rules of the
Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Management has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework.
Based on that assessment, management concludes that, as of December 31, 2009, the Company’s internal control over financial reporting is effective.
ITEM 9B.
OTHER INFORMATION
None
PART III
Certain information required by Part III, Items 10, 11, 12, 13 and 14 (identified below) will be provided by amendment to this Form 10-K no later than April 30, 2010. The Company’s definitive Proxy Statement is intended to be filed with the Securities and Exchange Commission
in May, 2010 in connection with the solicitation of proxies for the Company’s 2010 Annual Meeting of Shareholders (the "Proxy Statement").
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
.
ITEM 11.
EXECUTIVE COMPENSATION
.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
.
PART IV
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ITEM 15.
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EXHIBITS, FINANCIAL STATEMENT SCHEDULES
.
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(a)(1)
The following financial statements of the Company included in the Annual Report to Shareholders for the year ended December 31, 2009, are filed and incorporated by reference in Item 8 of this report
.
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(i)
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Report of Independent Registered Public Accounting Firm, dated April 15, 2010.
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(ii)
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Consolidated Balance Sheet, December 31, 2009 and 2008.
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(iii)
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Consolidated Statement of Operations: Years ended December 31, 2009, 2008 and 2007.
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(iv)
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Consolidated Statement of Changes in Shareholders’ Equity: Years ended December 31, 2009, 2008 and 2007.
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(v)
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Consolidated Statement of Cash Flows: Years ended December 31, 2009, 2008 and 2007.
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(vi)
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Notes to Consolidated Financial Statements.
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(2)
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All Schedules have been omitted because they are not applicable or not required or because the information is included in the financial statements or the notes thereto or is not material.
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(3)
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Exhibits filed with this report are listed in the Index to Exhibits below, which is incorporated herein by reference.
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(b) The Exhibits listed on the Index of Exhibits are filed and incorporated here by reference.
(c) All Schedules have been omitted because they are not applicable or not required or because the information is included in the financial statements or the notes thereto or is not material.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: April 15, 2010 PACIFIC
STATE BANCORP
By:
/s/ Rick Simas
Rick Simas
Chief Executive Officer/President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: April 15, 2010 By:
/s/
Rick Simas
Rick Simas
Chief Executive Officer/President
Date: April 15, 2010 By
:/s/
Justin Garner
Justin Garner
Vice President/Chief Financial Officer
Date: April 15, 2010 By:
/s/
Michael L. Dalton
Michael L. Dalton
Director and Chairman of the Audit Committee
Date: April 15, 2010 By:
/s/
Maxwell Freeman
Maxwell Freeman
Director
Date: April 15, 2010 By:
/s/
Harold Hand
Harold Hand
Director and Chairman of the Board
Date: April 15, 2010 By:
/s/
Patricia A. Hatton
Patricia A. Hatton
Director and Chairperson of the Director Loan Committee
Date: April 15, 2010 By:
/s/
Yoshikazu Mataga
Yoshikazu Mataga
Director
Date: April 15, 2010 By:
/s/
George M. Schofield
George M. Schofield
Director
Date: April 15, 2010 By:
/s/
Gary A. Stewart
Gary A. Stewart
Executive Vice President/Chief Credit Officer
Director
LIST OF EXHIBITS
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3.1
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Articles of Incorporation, as amended. Incorporated by reference from Exhibit 3.1 filed with the Company's Form 10-K for the year ended December 31, 2004.
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3.2
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Bylaws. Incorporated by reference from Exhibit 3.2 filed with the Company’s Registration Statement No. 333-84908 on Form S-4EF (the “S-4”).
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4.1
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Agreement to file copy of Indenture for the Company’s $3.5 Million of Floating Rate Junior Subordinated Deferrable Interest Debentures due 2034 issued to Pacific State Statutory Trust II. Incorporated by reference from the Company’s Form 10-K for the year ended December 31, 2003.
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4.2
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Agreement to file copy of Indenture for the Company’s $5.0 Million of Floating Rate Junior Subordinated Deferrable Interest Debentures due 2037 issued to Pacific State Statutory Trust III. Incorporated by reference from the Company’s Form 10-K for the year ended December 31, 2007
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10.1
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Lease Agreement for Main Office. Incorporated by reference from Exhibit 10.1 filed with the S-4.
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10.2
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Lease Agreement for Lodi Office. Incorporated by reference from Exhibit 10.2 to the Company’s Form 10-K for the year ended December 31, 2005 (the “2005 10-K”).
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10.3
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Lease Agreement, Tracy Branch Office. Incorporated by reference from Exhibit 10.3 filed with the S-4.
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104.1
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Form of Salary Continuation Agreement. Incorporated by reference from Exhibit 10.5.1 to the 2005 10-K .
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10.4.2
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Form of Split Dollar Agreement. Incorporated by reference from Exhibit 10.5.2 to the 2005 10-K .
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10.5
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1997 Stock Option Plan. Incorporated by reference from Exhibit 10.6 filed with the Company’s Quarterly Report on Form 10-Q for the quarterly period ending September 30, 2003.
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13
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21
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23
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31.1
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31.2
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32.1
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32.2
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*
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Denotes management contract or compensatory arrangement
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