CENTRAL VALLEY COMMUNITY BANCORP - Quarter Report: 2006 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006

 

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

 

FOR THE TRANSITION PERIOD FROM                        TO                        

 

COMMISSION FILE NUMBER: 000—31977

 

CENTRAL VALLEY COMMUNITY BANCORP

(Exact name of registrant as specified in its charter)

 

 

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 past 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  ý   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act).

 

Large accelerated filer  o

Accelerated filer  o

Non-accelerated filer  ý

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes  o   No  ý

 

As of May 10, 2006 there were 5,974,400 shares of the registrant’s common stock outstanding

 

 

CENTRAL VALLEY COMMUNITY BANCORP

 

2005 QUARTERLY REPORT ON FORM 10-Q

 

TABLE OF CONTENTS

 

PART 1: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
ITEM 1A RISK FACTORS
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5 OTHER INFORMATION
ITEM 6 EXHIBITS
SIGNATURES

 

2

 

PART 1: FINANCIAL INFORMATION

 

ITEM 1: FINANCIAL STATEMENTS

 

CENTRAL VALLEY COMMUNITY BANCORP

CONDENSED CONSOLIDATED BALANCE SHEET

(Unaudited)

 

(In thousands, except share amounts)		March 31, 2006			December 31, 2005
ASSETS
Cash and due from banks		$	18,560		$	22,165
Federal funds sold		31,315			29,830
Total cash and cash equivalents		49,875			51,995
Interest bearing deposits in other banks		918			918
Available-for-sale investment securities (Amortized cost of $107,250 at March 31, 2006 and $106,437 at December 31, 2005)		106,116			105,592
Loans, less allowance for credit losses of $3,195 at March 31, 2006 and $3,339 at December 31, 2005		290,423			298,463
Bank premises and equipment, net		3,078			2,912
Bank owned Life Insurance		6,782			6,725
Federal Home Loan Bank stock		1,679			1,659
Goodwill and intangible assets		10,166			10,241
Accrued interest receivable and other assets		5,114			5,172
Total assets		$	474,151		$	483,677
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Non-interest bearing		$	131,534		$	153,004
Interest bearing		288,567			277,985
Total deposits		420,101			430,989
Short-term borrowings		3,250			3,250
Long-term debt		938			3,250
Accrued interest payable and other liabilities		6,848			4,665
Total liabilities		431,137			442,154
Shareholders’ equity:
Preferred stock, no par value: 10,000,000 shares authorized, no shares issued or outstanding		—			—
Common stock, no par value; 80,000,000 shares authorized; outstanding 5,923,540 at March 31, 2006 and 5,891,820 at December 31, 2005		13,287			13,053
Retained earnings		30,407			28,977
Accumulated other comprehensive loss, net of tax		(680		)	(507		)
Total shareholders’ equity		43,014			41,523
Total liabilities and shareholders’ equity		$	474,151		$	483,677

 

See notes to unaudited condensed consolidated financial statements.

 

3

 

CENTRAL VALLEY COMMUNITY BANCORP

CONDENSED CONSOLIDATED STATEMENT OF INCOME

(Unaudited)

 

		For the Three Months
		Ended March 31,
(In thousands except per share amounts)		2006			2005
INTEREST INCOME:
Interest and fees on loans		$	5,995		$	4,545
Interest on Federal funds sold		270			142
Interest and dividends on investment securities:
Taxable		720			843
Exempt from Federal income taxes		306			328
Total interest income		7,291			5,858
INTEREST EXPENSE:
Interest on deposits		1,262			761
Other		64			60
Total interest expense		1,326			821
Net interest income before provision for credit losses		5,965			5,037
PROVISION FOR CREDIT LOSSES		400			—
Net interest income after provision for credit losses		5,565			5,037
NON-INTEREST INCOME:
Service charges		555			578
Net realized gains on sales of investment securities		125			—
Appreciation in cash surrender value of bank owned life insurance		57			46
Loan placement fees		51			91
Federal Home Loan Bank stock dividends		19			16
Other income		173			124
Total non-interest income		980			855
NON-INTEREST EXPENSES:
Salaries and employee benefits		2,508			2,390
Occupancy and equipment		555			510
Other expenses		1,257			1,151
Total non-interest expenses		4,320			4,051
Income before provision for income taxes		2,225			1,841
PROVISION FOR INCOME TAXES		795			647
Net income		$	1,430		$	1,194
Basic earnings per share		$	0.24		$	0.21
Diluted earnings per share		$	0.22		$	0.19

 

See notes to unaudited condensed consolidated financial statements

 

4

 

CENTRAL VALLEY COMMUNITY BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE YEAR ENDED DECEMBER 31, 2005

AND THE THREE MONTH PERIOD ENDED MARCH 31, 2006

(Unaudited)

 

										Accumulated
										Other
										Comprehensive			Total			Total
(In thousands, except share and per share		Common Stock					Retained			Income (Loss)			Shareholders’			Comprehensive
amounts)		Shares		Amount			Earnings			(Net of Taxes)			Equity			Income
Balance, January 1, 2005		5,257,734		$	6,343		$	22,933		$	330		$	29,606
Comprehensive income
Net income							6,044						6,044			$	6,044
Other comprehensive loss, net of tax:
Net change in unrealized gains on available-for-sale investment securities										(837		)	(837		)	(837		)
Total comprehensive income																$	5,207
Stock issued for acquisition		522,106		6,079									6,079
Stock options exercised and related tax benefit		111,980		631									631
Balance, December 31, 2005		5,891,820		13,053			28,977			(507		)	41,523
Comprehensive income
Net income							1,430						1,430			$	1,430
Other comprehensive loss, net of tax:
Net change in unrealized loss on available-for-sale investment securities										(173		)	(173		)	(173		)
Total comprehensive income																$	1,257
Stock options exercised and related tax benefit		31,720		165									165
Stock-based compensation expense				69									69
Balance, March 31, 2006		5,923,540		$	13,287		$	30,407		$	(680	)	$	43,014

 

See notes to unaudited condensed consolidated financial statements.

 

5

 

CENTRAL VALLEY COMMUNITY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31, 2006 and 2005

(Unaudited)

 

(In thousands)		2006			2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	1,430		$	1,194
Adjustments to reconcile net income to net cash provided by operating activities:
Net increase in deferred loan fees		28			58
Depreciation, amortization and accretion, net		494			561
Stock-based compensation		69			—
Provision for loan losses		400			—
Net realized gains on sales of available-for-sale investment securities		(125		)	—
Increase in bank owned life insurance, net of expenses		(56		)	(46		)
FHLB stock dividends		(19		)	(14		)
Net decrease in accrued interest receivable and other assets		183			1,888
Net increase in accrued interest payable and other liabilities		2,208			43
Net cash provided by operating activities		4,612			3,684
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash and cash equivalents acquired in acquisitions		21			13,844
Purchases of available for sale investment securities		(15,208		)	(25,801		)
Proceeds from sales or calls of available-for-sale investment securities		9,834			—
Proceeds from principal repayments of available for sale investment securities		4,480			4,051
Net decrease in interest bearing deposits in other banks		—			6
Net decrease (increase) in loans		7,612			(8,215		)
Purchases of premises and equipment		(401		)	(210		)
Purchases of bank owned life insurance		—			(350		)
Net cash provided by (used in) in investing activities		6,338			(16,675		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in demand, interest bearing and savings deposits		(16,762		)	6,260
Net increase in time deposits		5,874			6,515
Repayments to Federal Home Loan Bank		(2,000		)	(2,000		)
Repayments of borrowings from other financial institutions		(312		)	—
Proceeds from exercise of stock options		130			8
Net cash provided by (used in) financing activities		(13,070		)	10,783
Decrease in cash and cash equivalents		(2,120		)	(2,208		)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR		51,995			43,814
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	49,875		$	41,606
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest expense		$	1,310		$	780
Income taxes					$	683
Non-Cash Investing Activities:
Net change in unrealized losses on available-for-sale investment securities		$	(289	)	$	(1,519	)
Non-Cash Financing Activities:
Tax Benefit from stock options exercised		$	35		$	7
Supplemental schedules related to acquisition:
Acquisition of Bank of Madera County:
Deposits					$	63,769
Other liabilities					439
Loans, net					(45,028		)
Intangibles		$	21		(10,455		)
Premises and equipment					(390		)
Federal Home Loan Bank stock					(172		)
Other assets					(398		)
Stock Issued					6,079
Cash acquired, net of cash paid to Bank of Madera County shareholders		$	21		$	13,844

 

See notes to unaudited condensed consolidated financial statements

 

6

 

CENTRAL VALLEY COMMUNITY BANCORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Basis of Presentation

 

The interim unaudited condensed consolidated financial statements of Central Valley Community Bancorp and subsidiary have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). These interim condensed consolidated financial statements include the accounts of Central Valley Community Bancorp and its wholly owned subsidiary Central Valley Community Bank (the “Bank”) (collectively, the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The Company believes that the disclosures are adequate to make the information presented not misleading. These interim condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s 2005 Annual Report to Shareholders on Form 10-K. In the opinion of management, all adjustments, including normal recurring adjustments necessary to present fairly the Company’s financial position and shareholders’ equity at March 31, 2006 and December 31, 2005, and the results of its operations and its cash flows for the 3 month interim period ended March 31, 2006 and March 31, 2005, have been included. Certain reclassifications have been made to prior year amounts to conform to the 2006 presentation. The results of operations for interim periods are not necessarily indicative of results for the full year.

 

The preparation of these condensed consolidated 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 those estimates.

 

Management has determined that since 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.

 

Note 2. Stock-Based Compensation

 

The Company has three stock-based compensation plans, which are described in Note 3. Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share Based Payment (“SFAS 123(R)”), using the modified prospective application transition method, which requires recognizing expense for options granted prior to the adoption date equal to the fair value of the unvested amounts over their remaining vesting period, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 Accounting for Stock Based Compensation, and compensation cost for all share based payments granted subsequent to January 1, 2006, based on the grant date fair values estimated in accordance with the provisions of SFAS 123(R). There were no grants made in the first quarter of 2006 or 2005. Results for prior periods have not been restated. Prior to January 1, 2006, The Company accounted for these plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations (“APB 25”). No stock-based compensation cost is reflected in net income prior to January 1, 2006, as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

 

As a result of adopting SFAS 123(R), the Company’s income before provision for income taxes and net income for the three months ended March 31, 2006 was $69,000 and $59,000, respectively, lower than if we had continued to account for share-based compensation under APB 25. Basic and diluted earnings per share for the quarter ended March 31, 2006

 

7

 

would have been $0.25 and $0.23, respectively, without the adoption of SFAS 123(R) compared to $0.24 and $0.22, respectively, as reported.

 

SFAS 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as a cash flow from financing in the statement of cash flows. These excess tax benefits were not significant for the Company.

 

In February 2005 the Company accelerated the vesting of 186,000 options previously granted to certain directors and executive officers as reflected in the table below. No stock based compensation is reflected in net income for the quarter ended March 31, 2005 as a result of the acceleration of the vesting as it is expected that generally all of the directors and executive management whose options were accelerated will remain with the Company through the original vesting period.

 

The following table illustrates the pro forma effect on net income and earnings per share if the fair value recognition provisions of SFAS 123 had been applied to the Company’s stock option plans for the quarter ended March 31, 2005.

 

		For the Quarter Ended March 31,
		2005
		(In thousands, except per share amounts)
Net earnings as reported			$	1,194
Add: Share-based compensation cost, net of related tax effects, included in net income as reported			—
Deduct: Total stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects			(375		)
Pro forma net income			$	819
Basic earnings per share - as reported			$	0.21
Basic earnings per share - pro forma			$	0.14
Diluted earnings per share - as reported			$	0.19
Diluted earnings per share - pro forma			$	0.13

 

Note 3. Stock Option Plans

 

During 1992, the Bank established a Stock Option Plan for which shares are reserved for issuance to employees and directors under incentive and nonstatutory agreements. The Company assumed all obligations under this plan as of November 15, 2000, and options to purchase shares of the Company’s common stock were substituted for options to purchase shares of common stock of the Bank. Outstanding options under this plan are exercisable until their expiration, however, no new options will be granted under this plan.

 

On November 15, 2000, the Company adopted, and subsequently amended on December 20, 2000, the Central Valley Community Bancorp 2000 Stock Option Plan for which 1,030,870 shares remain reserved for issuance for options already granted to employees and directors under incentive and nonstatutory agreements and 82,726 remain reserved for future grants. The plan requires that the option price may not be less than the fair market value of the stock at the date the option is granted, and that the option price must be paid in full at the time it is exercised. The options under the plan expire on dates determined by the Board of Directors, but not later than ten years from the date of grant. The vesting period is determined by the Board of Directors and is generally over five years.

 

In March 2005, the Company adopted the Central Valley Community Bancorp 2005 Omnibus Incentive Plan. The plan provides for awards in the form of incentive stock options, non-statutory stock options, stock appreciation rights, and restricted stock. The plan also allows for performance awards that may be in the form of cash or shares of the Company, including restricted stock. The maximum number of shares that can be issued with respect to all awards under the plan is 476,000. The plan requires that the exercise price may not be less than 100% of the fair market value of the stock at the date the option is granted, and that the option price must be paid in full at the time it is exercised. The options and awards under the plan expire on dates determined by the Board of Directors, but not later than ten years

 

8

 

from the date of grant. The vesting period for the options and option related stock appreciation rights is determined by the Board of Directors and is generally over five years. There are no grants under this plan.

 

A summary of the combined activity of the plans follows:

 

		Three Months ended March 31, 2006
				Weighted			Weighted
				Average			Average Remaining		Average
				Exercise			Contractual		Intrinsic
		Shares		Price			Term		Value
Options outstanding, beginning of period		1,085,290		$	5.97
Options granted		—		—
Options exercised		(31,720	)	$	4.10
Options canceled		(22,700	)	$	4.76
Options outstanding, end of period		1,030,870		$	6.06		5.47		$	9,631
Options vested or expected to vest at March 31, 2006		993,453		$	5.98		6.85		$	9,125
Options exercisable, end of period		796,950		$	4.65		5.41		$	8,550

 

There were no options granted in the quarters ended March 31, 2006 and 2005. The total intrinsic value of options exercised during the quarter ended March 31, 2006 was $345,000. The Company bases the fair value of the options previously granted on the date of grant using a Black-Scholes option pricing model that uses assumptions based on expected option life and the level of estimated forfeitures, expected stock volatility, risk free interest rate, and dividend yield. The Company uses historical data to estimate expected option life. 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 for the periods within the contractual life of the options in effect at the time of grant.

 

As of March 31, 2006, there was $434,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 1992 Plan and 2000 Plan. The cost is expected to be realized over a weighted average period of 4.25 years. Total fair value of shares vested during the quarter ended March 31, 2006 was $17,052.

 

Note 4. Earnings per share

 

Basic earnings 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. There was no difference in the net income used in the calculation of basic earnings per share and diluted earnings per share.

 

A reconciliation of the numerators and denominators of the basic and diluted EPS computations is as follows:

 

		Three Months Ended
		March 31,
(In thousands except share and per share amounts)		2006			2005
Basic Earnings Per Share:
Net income		$	1,430		$	1,194
Weighted average shares outstanding		5,912,967			5,781,326
Net income per share		$	0.24		$	0.21
Diluted Earnings Per Share:
Net income		$	1,430		$	1,194
Weighted average shares outstanding		5,912,967			5,781,326
Effect of dilutive stock options		530,104			595,316
Weighted average shares of common stock and common stock equivalents		6,443,071			6,376,642
Net income per diluted share		$	0.22		$	0.19

9

 

Note 5. Comprehensive Income

 

Total comprehensive income is comprised of net earnings and net unrealized gains and losses on available-for-sale securities, which is the Company’s only source of other comprehensive income. Total comprehensive income for the three-month periods ended March 31, 2006 and 2005 was $1,257,000 and $290,000.

 

Note 6. Commitments and Contingencies

 

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for loans.

 

Commitments to extend credit amounting to $140,103,000 and $133,956,000 were outstanding at March 31, 2006 and December 31, 2005, respectively. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.

 

Undisbursed lines of credit amounting to $67,248,000 and $64,374,000 were outstanding at March 31, 2006 and December 31, 2005, respectively. Undisbursed lines of credit are revolving lines of credit whereby customers can repay principal and advance principal during the term of the loan at their discretion and most expire between one and twelve months.

 

The Company has undisbursed portions of construction loans totaling $16,747,000 and $20,636,000 as of March 31, 2006 and December 31, 2005, respectively. These commitments are agreements to lend to a customer, subject to meeting certain construction progress requirements. The underlying construction loans have fixed expiration dates.

 

Standby letters of credit and financial guarantees amounting to $69,000 and $80,000 were outstanding at March 31, 2006 and December 31, 2005, respectively. Standby letters of credit and financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. Most guarantees carry a one year term or less. The fair value of the liability related to these standby letters of credit, which represents the fees received for issuing the guarantees, was not significant at March 31, 2006 and December 31, 2005. The Company recognizes these fees as revenue over the term of the commitment or when the commitment is used.

 

The Company generally requires collateral or other security to support financial instruments with credit risk. Management does not anticipate any material loss will result from the outstanding commitments to extend credit, standby letters of credit and financial guarantees.

 

10

 

The Company is subject to legal proceedings and claims which arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to such actions will not materially affect the consolidated financial position or consolidated results of operations of the Company.

 

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Certain matters discussed in this report constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained herein that are not historical facts, such as statements regarding the Company’s current business strategy and the Company’s plans for future development and operations, are based upon current expectations. These statements are forward-looking in nature and involve a number of risks and uncertainties. Such risks and uncertainties include, but are not limited to (1) significant increases in competitive pressure in the banking industry; (2) the impact of changes in interest rates, a decline in economic conditions at the international, national or local level on the Company’s results of operations, the Company’s ability to continue its internal growth at historical rates, the Company’s ability to maintain its net interest margin, and the quality of the Company’s earning assets; (3) changes in the regulatory environment; (4) fluctuations in the real estate market; (5) changes in business conditions and inflation; (6) changes in securities markets; and (7) risks associated with acquisitions, relating to difficulty in integrating combined operations and related negative impact on earnings, and incurrence of substantial expenses. Therefore, the information set forth in such forward-looking statements should be carefully considered when evaluating the business prospects of the Company.

 

When the Company uses in this Quarterly Report on Form 10-Q the words “anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similar expressions, the Company intends to identify forward-looking statements. Such statements are not guarantees of performance and are subject to certain risks, uncertainties and assumptions, including those described in this Quarterly Report on Form 10-Q. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. The future results and shareholder values of the Company may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (R), Share Based Payment (“SFAS 123(R)”) using the modified prospective transition method. Prior to adoption of this statement, the Company accounted for its share-based employee compensation plans under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock-Based Compensation. See Note 2 and 3 to the Condensed Consolidated Financial Statements for additional information related to implementation of SFAS 123(R) and for further information on the Company’s stock-based compensation plans. In March 2005 the Company adopted the Central Valley Community Bancorp Incentive Plan. Under this plan, the Company can award stock appreciation rights and restricted stock in addition to the incentive and non-statutory stock options.

 

There have been no other changes to the Company’s critical accounting policies from those discussed in the Company’s 2005 Annual Report to Shareholders’ on Form 10-K.

 

This discussion should be read in conjunction with our unaudited condensed consolidated financial statements, including the notes thereto, appearing elsewhere in this report.

 

OVERVIEW

 

First Three Months of 2006

 

In the first three months of 2006, our results exceeded those of the first quarter of 2005 by 19.8%. Net income was  $1,430,000 for the first three months of 2006 compared to net income of $1,194,000 for the first three months of 2005. Results for the first three months of 2006 included a $240,000 after tax addition to the allowance for credit losses,

 

11

 

compared to no provision for credit losses in the first quarter of 2005. Diluted EPS for the first three months of 2006 was $0.22 compared to $0.19 for the first three months of 2005.

 

Annualized return on average equity for the first three months of 2006 was 13.40% compared to 13.22% for the same period of 2005. Total equity was $43,014,000 at March 31, 2006 compared to $35,990,000 at March 31, 2005.

 

In comparing first quarter 2006 to first quarter 2005, total loans continued to grow at a double digit pace. Average total loans increased $38,477,000 or 14.9% in the first three months of 2006 compared to the first three months of 2005. Asset quality continues to be strong. The Bank had one non-accrual loan at March 31, 2006 totaling $591,000 compared to three loans totaling $1,308,000 at March 31, 2005 and had no other real estate owned at March 31, 2006 or 2005. In the first quarter of 2006, we recorded a charge-off which consisted of a $527,000 commercial relationship in the Sacramento area. The addition of $400,000 to the allowance for credit losses was to restore the allowance to the level of estimated reserves for probable losses in the portfolio. Refer to Provision for Credit Loss and Allowance for Credit Losses for further discussion.

 

Central Valley Community Bancorp  (Company)

 

We are a central California-based bank holding company for a one-bank subsidiary, Central Valley Community Bank (the “Bank”). We provide traditional commercial banking services to small and medium-sized businesses and individuals in the communities along the Highway 99 corridor in the Fresno and Madera Counties of central California. Additionally, we have a private banking office in Sacramento County. As a holding company, the Company is subject to supervision, examination and regulations of the Federal Reserve Bank.

 

At March 31, 2006, we had total loans of $293,618,000, total assets of $474,151,000, total deposits of $420,101,000 and stockholders’ equity of $43,014,000.

 

Central Valley Community Bank  (Bank)

 

The Bank commenced operations in January 1980 as a state-chartered bank. As a state-chartered bank, the Bank is subject to primary supervision, examination and regulation by the Department of Financial Institutions. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation up to the applicable limits thereof, and the Bank is subject to supervision, examination and regulations of the FDIC.

 

In February 2006, we opened our newest branch in downtown Fresno bringing the total number of branches to ten (10) full service branches which serve the communities of Fresno, Clovis, Kerman, Prather, Oakhurst, Madera, and Sacramento. Additionally the Bank operates Real Estate, Agribusiness and SBA departments that originate loans in California. According to the June 30, 2005 FDIC data, the Bank’s seven (7) branches in Fresno County (Clovis, Fresno, Kerman, and Prather) had a 5.0% combined deposit market share of all banks and 4.0% of all depositories including credit unions, thrifts, and savings banks.

 

The Bank anticipates additional branch openings to meet the growing service needs of its customers. We have been approved by FDIC and the California Department of Financial Institutions (DFI) for a new branch site in the Sunnyside area of Fresno and anticipate the branch opening in the third quarter of 2006. The branch expansions provide the Company with opportunities to expand its loan and deposit base; however, based on past experience, management expects these new offices will initially have a negative impact on earnings until the volume of business grows to cover fixed overhead expenses.

 

Key Factors in Evaluating Financial Condition and Operating Performance

 

As a publicly traded community bank holding company, we focus on several key factors including:

 

• Return to our stockholders;

• Return on average assets;

• Development of core revenue streams, including net interest income and non-interest income;

• Asset quality;

• Asset growth; and

• Operating efficiency.

 

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Return to Our Stockholders.

 

Our return to our stockholders is measured in the form of return on average equity (“ROE”). Our net income for the three months ended March 31, 2006 increased $236,000 or 19.8% to $1,430,000 compared to $1,194,000 for the three months ended March 31, 2005. Net income increased mainly due to an increase in net interest income provided by the continued increase in interest rates, management of deposit interest expense, and our own organic growth. Non-interest income also increased and was partially offset by an increase in interest expenses and operating expenses. Basic EPS increased to $0.24 for the three months ended March 31, 2006 compared to $0.21 for the three months ended March 31, 2005. Diluted EPS increased to $0.22 for the three months ended March 31, 2006 compared to $0.19 for the three months ended March 31, 2005. The increase in EPS was due primarily to the increase in net income, partially offset by an increase in average shares outstanding as a result of the exercise of stock options. Our annualized ROE was 13.40% for the three months ended March 31, 2006 compared to 15.63% for the year ended December 31, 2005 and 13.22% for the three months ended March 31, 2005.

 

Return on Average Assets

 

Our return on average assets (“ROA”) is a measure we use to compare our performance with other banks and bank holding companies. Our annualized ROA for the three months ended March 31, 2006 was 1.22% compared to 1.33% for the year ended December 31, 2005 and 1.08% for the three months ended March 31, 2005. The decrease in ROA compared to December 2005 is due to the decrease in net income relative to our increase in average assets. Average assets March 31, 2005 were $468,689,000 compared $455,680,000 December 31, 2005. ROA for our peer group was 1.54% at December 31, 2005. Peer group from SNL Financial data includes all holding companies in California with assets from $300M to $500M and not subchapter S.

 

Development of Core Earnings

 

 Over the past several years, we have focused on not only improving net income, but improving the consistency of our revenue streams in order to create more predictable future earnings and reduce the effect of changes in our operating environment on our net income. Specifically, we have focused on net interest income through a variety of processes, including increases in average interest earning assets as a result of loan generation and retention and improved net interest margin by focusing on core deposits and managing the cost of funds. As a result, our net interest income before provision for credit losses increased $928,000 or 18.4% to $5,965,000 for the three months ended March 31, 2006 compared to $5,037,000 for the three months ended March 31, 2005. Another measurement of those efforts is our net interest margin which improved 55 basis points to 5.74% for the three months ended March 31, 2006 compared to 5.19% for the three months ended March 31, 2005.

 

Our non-interest income is generally made up of service charges and fees on deposit accounts, fee income from loan placements and gains on sale from investment securities. Non-interest income for the first three months of 2006 increased $125,000 or 14.6% to $980,000 compared to $855,000 for the first three months of 2005 mainly due to the gains from sales of investment securities. Customer service charges decreased slightly to $555,000 for the first three months of 2006 compared to $578,000 for the same period in 2005. Further detail of non-interest income is provided below.

 

Asset Quality

 

For all banks and bank holding companies, asset quality has a significant impact on the overall financial condition and results of operations. Asset quality is measured in terms of percentage of total loans and total assets, and is a key element in estimating the future earnings of a company. The Company had one non-performing loan for $591,000 as of March 31, 2006 compared to two non-performing loans totaling $616,000 as of December 31, 2005. Management maintains certain loans that have been brought current by the borrower (less than 30 days delinquent) on non-accrual status until such time as management has determined that the loans are likely to remain current in future periods. Non-performing loans as a percentage of total loans was 0.2% as of March 31, 2006 compared to 0.2% at December 31, 2005, and 0.5% at March 31, 2005. The Company did not have any other real estate owned at March 31, 2006 or December 31, 2005, or March 31, 2005.

 

Asset Growth

 

As revenues from both net interest income and non-interest income are a function of asset size, the continued growth in assets has a direct impact in increasing net income and therefore ROE and ROA. The majority of our assets are loans and investment securities, and the majority of our liabilities are deposits, and therefore the ability to generate deposits as a funding source for loans and investments is fundamental to our asset growth.

 

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The influence of our agricultural portfolio, particularly for raisins and nuts, is reflected in the differences in loan and deposit volumes from December 31, 2005 to March 31, 2006. Generally, agricultural processors sell the crops harvested in the fourth quarter of each year and hold the funds to be disbursed to the farmers until the first quarter of the following year creating a temporary increase in deposits. In the first quarter of each year, the farmers then pay down their agricultural loans with their crop proceeds. This trend is reflected in our first quarter loan and deposit numbers. Total assets decreased 2.0% during the first three months of 2006 from $483,677,000 as of December 31, 2005 to $474,151,000 as of March 31, 2006. Total gross loans decreased 2.7% to $293,618,000 as of March 31, 2006 compared to $301,802,000 as of December 31, 2005. Total deposits decreased 2.5% to $420,101,000 as of March 31, 2006 compared to $430,989,000 as of December 31, 2005. We expect the agricultural borrowings will begin to increase as the farmers begin their new crop year. We continue to under perform in our loan to deposit ratio compared to our peers. Our loan to deposit ratio at March 31, 2006 was 69.9% compared to 70.0% at December 31, 2005. The loan to deposit ratio of our peers was 94.7% at December 31, 2005. Further discussion of loans and deposits is below.

 

Operating Efficiency

 

Operating efficiency is the measure of how efficiently earnings before taxes are generated as a percentage of revenue. The Bank’s efficiency ratio (operating expenses, excluding amortization of intangibles, divided by net interest income plus non-interest income, excluding gains from sales of securities) improved to 60.1% for the first three months of 2006 compared to 64.1% for the first three months of 2005. The improvement in the efficiency ratio is due to the increase in revenues exceeding the increase in operating expenses. The Bank’s net interest income before provision for credit losses plus non-interest income increased 15.9% to $6,866,000 for the three months ended March 31, 2006 compared to $5,925,000 for the same period in 2005, while operating expenses, excluding amortization of intangibles, increased 8.5% to $4,123,000 from $3,799,000 for the same period in 2005.

 

RESULTS OF OPERATIONS

 

Net Income for the First Three Months of 2006 Compared to the First Three Months of 2005:

 

Net income increased to $1,430,000 for the three months ended March 31, 2006 compared to $1,194,000 for the three months ended March 31, 2005. Basic earnings per share were $0.24 and $0.21 for the three months ended March 31, 2006 and 2005, respectively. Diluted earnings per share were $0.22 and $0.19 for the three months ended March 31, 2006 and 2005, respectively. ROE was 13.40% for the three months ended March 31, 2006 compared to 13.22% for the three months ended March 31, 2005. ROA for the three months ended March 31, 2006 was 1.22% compared to 1.08% for the three months ended March 31, 2005.

 

The increase in net income and profitability for the three months ended March 31, 2006 compared to the same period in the prior year was mainly due to the increases in net interest income and non-interest income and was partially offset by the increases in the provision for credit losses and increases in non-interest expenses. Net interest income increased due to an increase in average interest earning assets provided by our organic growth, and the positive effect of our asset sensitive position and our ability to attract non-interest bearing deposits. The eight increases in the Federal funds interest rate from March 31, 2005 to March 31, 2006 also contributed to the increase in net interest income. Non-interest expenses increased primarily due to salaries and benefits and occupancy and equipment expenses. Further discussion of salary and occupancy expenses is below.

 

Interest Income and Expense

 

Net interest income is the most significant component of our income from operations. Net interest income (the “interest rate spread”) is the difference between the gross interest and fees earned on the loan and investment portfolios and the interest paid on deposits and other borrowings. Net interest income depends on the volume of and interest rate earned on interest earning assets and the volume of and interest rate paid on interest bearing liabilities.

 

The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield and cost information for the periods presented. Average balances are derived from daily balances, and non-accrual loans are not included as interest earning assets for purposes of this table.

 

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CENTRAL VALLEY COMMUNITY BANCORP

SCHEDULE OF AVERAGE BALANCES AND AVERAGE YIELDS AND RATES

 

		FOR THE THREE MONTHS ENDED								FOR THE THREE MONTHS ENDED
		MARCH 31, 2006								MARCH 31, 2005
(Unaudited)		Average						Yield/		Average						Yield/
(Dollars in thousands)		Balance			Interest			Rate		Balance			Interest			Rate
ASSETS
Interest-earning deposits in other banks		$	918		$	8		3.49	%	$	2,621		$	11		1.68	%
Securities
Taxable securities		75,598			712			3.77	%	96,455			832			3.45	%
Non-taxable securities (1)		30,145			471			6.25	%	21,858			497			9.10	%
Total investment securities		105,743			1,183			4.47	%	118,313			1,329			4.49	%
Federal funds sold		24,701			270			4.37	%	23,354			142			2.43	%
Total		131,362			1,461			4.45	%	144,288			1,482			4.11	%
Loans (2) (3)		295,361			5,995			8.12	%	256,376			4,545			7.09	%
Federal Home Loan Bank stock		1,663			19			4.57	%	1,588			16			4.03	%
Total interest-earning assets		428,386			7,475			6.98	%	402,252			6,043			6.01	%
Allowance for credit losses		(3,373		)						(3,428		)
Non-accrual loans		603								1,111
Cash and due from banks		18,760								17,874
Bank premises and equipment		3,076								3,134
Other non-earning assets		21,237								21,932
Total average assets		$	468,689		$	7,475				$	442,875		$	6,043
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Savings and NOW accounts		$	84,541		$	36		0.17	%	$	85,955		$	37		0.17	%
Money market accounts		108,583			512			1.89	%	105,570			278			1.05	%
Time certificates of deposit, under $100,000		43,512			303			2.79	%	44,766			225			2.01	%
Time certificates of deposit, $100,000 and over		48,128			411			3.42	%	40,239			221			2.20	%
Total interest-bearing deposits		284,764			1,262			1.77	%	276,530			761			1.10	%
Other borrowed funds		5,456			64			4.69	%	7,411			60			3.24	%
Total interest-bearing liabilities		290,220			1,326			1.83	%	283,941			821			1.16	%
Non-interest bearing demand deposits		132,791								119,310
Other liabilities		2,992								3,485
Shareholders’ equity		42,686								36,139
Total average liabilities and shareholders’ equity		$	468,689		$	1,326				$	442,875		$	821
Interest income and rate earned on average earning assets					7,475			6.98	%				6,043			6.01	%
Interest expense and interest cost related to average interest-bearing liabilities					1,326			1.83	%				821			1.16	%
Net interest income and net interest margin (4)					$	6,149		5.74	%				$	5,222		5.19	%

 

	(1)  Calculated on a fully tax equivalent basis, which includes Federal tax benefits relating to income earned on municipal bonds totaling $165 and $169 in 2006 and 2005, respectively.
	(2)  Loan interest income includes loan fees of $262 in 2006 and $237 in 2005.
	(3)  Average loans do not include non-accrual loans.
	(4)  Net interest margin is computed by dividing annualized net interest income by total average interest-earning assets.

 

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Interest and fee income from loans increased 31.9% in the first three months of 2006 compared to the same period of 2005. Focusing on building relationships, which resulted in an increase in loan volume and eight interest rate increases that have occurred since March 31, 2005, were the major components of the $1,450,000 increase. Average total loans for the first three months of 2006 increased 15.2% to $295,964,000 compared to $257,487,000 for the same period in 2005. Competition for loans is strong in the Central Valley. We have seen an increase in the number of regional and community banks opening branches and loan centers. This competition is often reflected in aggressive loan pricing. We are committed to providing our customers with the best price, however we are also committed to increase our value to shareholders. We believe we were able to meet the challenge and reported an increase in the yield on loans of 103 basis points for the first three months of 2006 to 8.12% compared to 7.09% for the same period of 2005.

 

Interest income from total investments, (total investments include investment securities, Federal funds, interest bearing deposits with other banks, and other securities) decreased $17,000 in the first three months of 2006 compared to the same period of 2005, mainly due to the 9.0% decrease in average balances of total investments partially offset by the eight interest rate increases that have occurred since March 31, 2005. Income from investments represents 21.7% of net interest income.

 

In the first quarter of 2006, we repositioned our holdings in municipal securities and sold several municipal securities that were less than five years from maturity or call. The result of the approximate $4,139,000 repositioning was a net realized gain on sale of investments of $111,000. We believe this repositioning provided the best return for the short term municipals and will provide future reinvestment opportunities to increase yields.

 

In an effort to increase yields, without accepting unreasonable risk, a significant portion of the investment purchases have been in high quality mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMOs”). At March 31, 2006, we held $47,899,000 or 45.1% of the total market value of the investment portfolio in MBS and CMOs with an average yield of 4.36%. We understand the interest rate risks and prepayment risks associated with MBS and CMOs. In a declining interest rate environment, prepayments from MBS and CMOs could be expected to increase and the expected life of the investment could be expected to shorten. Conversely, if interest rates increase, prepayments could be expected to decline and the average life of the MBS and CMOs could be expected to extend. Additionally, changes in interest rates are reflected in the market value of the investment portfolio. During declining interest rates, the investment portfolio could be expected to have market value gains and in increasing rate environments, the market value could be expected to be negative. The change in market value, net of tax-effect, of the available-for-sale investment portfolio is also reflected in the Company’s equity. At March 31, 2006, the average life of the investment portfolio was 4.9 years and the market value reflected a pre-tax loss of $1,134,000.

 

A component of the Company’s strategic plan has been to use its investment portfolio to offset, in part, its interest rate risk relating to variable rate loans. At March 31, 2006, an immediate rate increase of 200 basis points would result in an estimated decrease in the market value of the investment portfolio by approximately $8,180,000. Conversely, with an immediate rate decrease of 200 basis points, the estimated increase in the market value of the investment portfolio is $7,596,000. The modeling environment assumes management would take no action during an immediate shock of 200 basis points. The likelihood of immediate changes of 200 basis points is contrary to expectation, as evidenced by the fifteen changes in interest rates since June 30, 2004 which were in 25 basis point increments. However, the Company uses those increments to measure its interest rate risk in accordance with regulatory requirements and to measure the possible future risk in the investment portfolio. For further discussion of the Company’s market risk, refer to Item 3 - Quantitative and Qualitative Disclosures about Market Risk.

 

Management’s review of all investments before purchase includes an analysis of how the security will perform under several interest rate scenarios to monitor whether investments are consistent with our investment policy. The policy addresses issues of average life, duration, and concentration guidelines, prohibited investments, impairment, and prohibited practices.

 

Total interest income for the first three months of 2006 increased  $1,433,000, to $7,291,000 compared to $5,858,000 for the three months ended March 31, 2005. The increase was due to the 6.5% increase in the average balance of interest earning assets, combined with the 97 basis point increase in the yield on those assets. Average interest earning assets increased to $428,386,000 for the three months ended March 31, 2006 compared to $402,252,000 for the three months ended March 31, 2005. The yield on interest earning assets increased to 6.98% for the three months ended March 31, 2006 compared to 6.01% for the three months ended March 31, 2005. The $26,134,000 increase in average earning assets can be attributed to our own organic growth.

 

Interest expense on deposits for the three months ended March 31, 2006 increased $501,000 or 65.8% to $1,262,000 compared to $761,000 for the three months ended March 31, 2005. This increase was due to the repricing of interest bearing deposits as a result of the increasing rate environment and the $8,234,000 increase in volume of average interest

 

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bearing deposits. Average interest-bearing deposits were $284,764,000 for the three months ended March 31, 2006 compared to $276,530,000 for the same period ended March 31, 2005. The 3.0% increase was the result of our own internal growth.

 

Average other borrowings decreased to $5,456,000 with an effective rate of 4.69% for the three months ended March 31, 2006 compared to $7,411,000 with an effective rate of 3.24% for the three months ended March 31, 2005. Included in other borrowings are advances from the Federal Home Loan Bank (FHLB) and a loan from a major bank, primarily to provide additional capital for the Bank in conjunction with the merger of Bank of Madera County in 2005. This bank loan is indexed to prime rate or to the three-month LIBOR and reprices quarterly. The FHLB advances are fixed rate borrowings.

 

In partial offset to the increase in the cost of interest bearing deposits and other borrowings, the increase in non-interest bearing demand deposits has contributed significantly to the lowered cost of funds. Average demand deposits increased 11.3% from an average $119,310,000 for the three months ended March 31, 2005 to $132,791,000 for the three months ended March 31, 2006. The cost of all of our interest bearing liabilities increased 67 basis points to 1.83% for the three months ended March 31, 2006 compared to 1.16% for the three months ended March 31, 2005. Average transaction accounts (including interest bearing checking, money market accounts and non interest bearing demand deposits) increased 5.5% to $300,457,000 for the three months ended March 31, 2006 compared to $284,699,000 for the three months ended March 31, 2005.

 

Net Interest Income before Provision for Credit Losses

 

Net interest income before provision for credit losses for the three months ended March 31, 2006 increased $928,000 or 18.4% to $5,965,000 compared to $5,037,000 for the three months ended March 31, 2005. This increase was primarily due to the increase in the net interest margin, combined with an increase in average interest earning assets which were partially offset by the increase in average interest bearing liabilities. Average interest earning assets were $428,386,000 for the three months ended March 31, 2006 with a net interest margin of 6.98% compared to $402,252,000 with a net interest margin of 6.01% for the three months ended March 31, 2005. For a discussion of the repricing of our assets and liabilities, see “Item 3 - Quantitative and Qualitative Disclosure about Market Risk.”

 

Provision for Credit Losses

 

We provide for possible credit losses by a charge to operating income based upon the composition of the loan portfolio, past delinquency levels, losses and non-performing assets, economic and environmental conditions and other factors which, in management’s judgement, deserve recognition in estimating credit losses. Loans are charged off when they are considered uncollectible or of such little value that continuance as an active earning bank asset is not warranted.

 

The establishment of an adequate credit allowance is based on both an accurate risk rating system and loan portfolio management tools. The Board has established initial responsibility for the accuracy of credit risk grades with the individual credit officer. The grading is then submitted to the Chief Credit Administrator (“CCA”), who reviews the grades for accuracy and makes recommendations to Credit Review who gives final approval. The risk grading and reserve allocation is analyzed annually by a third party credit reviewer and by various regulatory agencies.

 

Quarterly, the CCA sets the specific reserve for all adversely risk-graded credits. This process includes the utilization of loan delinquency reports, classified asset reports, and portfolio concentration reports to assist in accurately assessing credit risk and establishing appropriate reserves. Reserves are also allocated to credits that are not adversely graded. Historical loss experience within the portfolio along with peer bank loss experiences are used in determining the level of the reserves held.

 

The allowance for credit losses is reviewed at least quarterly by the Board’s Audit/Compliance Committee and by the Board of Directors. Reserves are allocated to loan portfolio categories using percentages which are based on both historical risk elements such as delinquencies and losses and predictive risk elements such as economic, competitive and environmental factors. We have adopted the specific reserve approach to allocate reserves to each adversely graded asset, as well as to each impaired asset for the purpose of estimating potential loss exposure. Although the allowance for credit losses is allocated to various portfolio categories, it is general in nature and available for the loan portfolio in its entirety. Additions may be required based on the results of independent loan portfolio examinations, regulatory agency examinations, or our own internal review process. Additions are also required when, in management’s judgement, the allowance does not properly reflect the portfolio’s potential loss exposure.

 

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The allocation of the allowance for credit losses is set forth below:

 

Loan Type(Dollars in thousands)		March 31, 2006 Amount			Percent of Loans in Each Category to Total Loans		December 31, 2005 Amount			Percent of Loans in Each Category to Total Loans
Commercial & Industrial		$	1,372		28.7	%	$	1,325		27.5	%
Real Estate		1,127			44.3	%	1,138			41.0	%
Real Estate - construction, land development and other land loans		294			14.2	%	378			15.4	%
Equity Lines of Credit		148			7.3	%	175			7.8	%
Agricultural		86			3.0	%	120			2.5	%
Consumer & Installment		139			2.5	%	198			5.8	%
Other		1			0.0	%	1			0.0	%
Non-specific reserve		28					4
		$	3,195				$	3,339

 

Managing credits identified through the risk evaluation methodology includes developing a business strategy with the customer to mitigate our potential losses. Management continues to monitor these credits with a view to identifying as early as possible when, and to what extent, additional provisions may be necessary.

 

Additions to the allowance for credit losses in the first three months of 2006 were $400,000. There was no addition to the allowance for the first three months of 2005. The increase in 2006 is due in part to the increase in the volume of outstanding loans and our assessment of the overall adequacy of the allowance for credit losses after the first quarter charge off of one commercial relationship. Recovery potential of approximately $152,000 is anticipated on this $527,000 charge off. The amount and timing of any recovery is subject to many factors and may or may not be realized.

 

Non-performing loans as a percentage of loans was 0.2% as of March 31, 2006 compared to 0.2% as of December 31, 2005 and 0.5% at March 31, 2005. Non-performing loans as of March 31 2006 totaled $591,000 and were comprised of one SBA loan which is secured by real estate. We do not anticipate a loss on this loan. The Company did not have any other real estate owned at March 31, 2006, December 31, 2005 or March 31, 2005.

 

The net charge off ratio, which reflects net charge-offs to average loans for the three months ended March 31, 2006 was 0.184% compared to a net recovery ratio of 0.003% for the same period in 2005. The historical ratios for the past three years were a net charge off ratio of 0.223% for 2005, a net recovery ratio of 0.139% for 2004, and a net charge-off ratio of 0.005% for 2003. Refer to the allowance for credit losses section for further discussion of credit quality.

 

Based on information currently available, management believes that the allowance for credit losses should be adequate to absorb estimated probable losses in the portfolio. However, no assurance can be given that we may not sustain charge-offs which are in excess of the allowance in any given period. Refer to “Allowance for Credit Losses” below for further information of the allowance for credit losses.

 

Non-Interest Income

 

Non-interest income is comprised of customer service charges, loan placement fees, gain on sales of investments and other income. Non-interest income was $980,000 for the three months ended March 31, 2006 compared to $855,000 for the same period ended March 31, 2005. The $125,000 increase in non-interest income comparing the three months ended March 31, 2006 to the same period in 2005 was primarily due to the gain on sales of investments.

 

Customer service charges decreased $23,000 to $555,000 for the first three months of 2006 compared to $578,000 for the same period in 2005, mainly due to reduced NSF fees and transaction account service charges. The decrease in fees can be partially attributed to the success of our new Free Checking Account. This product has become the product of choice of our existing customers as well as new customers and offers a basic account with no average balance requirements, no monthly service charge, and pays no interest. Comparing March 2006 to March 2005, the number of accounts in this product increased 31% and the average balance per account in the Free Checking product was $2 ,300.

 

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