HANMI FINANCIAL CORP - Quarter Report: 2004 June (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

Hanmi Financial Corporation

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes (x)           No (  )

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b.2 of the Exchange Act.).

Yes (x)           No (  )

As of August 6, 2004, there were 24,469,854 outstanding shares of the issuer’s Common Stock.

FORM 10-Q

INDEX

HANMI FINANCIAL CORPORATION

HANMI FINANCIAL CORPORATION AND SUBSIDIARIES

See accompanying notes to consolidated financial statements.

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HANMI FINANCIAL CORPORATION AND SUBSIDIARIES

See accompanying notes to consolidated financial statements.

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HANMI FINANCIAL CORPORATION AND SUBSIDIARIES

See accompanying notes to consolidated financial statements.

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Notes to Consolidated Financial Statements

Note 1. Hanmi Financial Corporation

     Hanmi Financial Corporation (“Hanmi Financial” or the “Company”) is a Delaware corporation that is the holding company for Hanmi Bank (the “Bank”) and is subject to the Bank Holding Company Act of 1956, as amended.

     Hanmi Bank, the primary subsidiary of the Company, is a commercial bank licensed by the California Department of Financial Institutions. Hanmi Bank’s deposit accounts are insured under the Federal Deposit Insurance Act up to applicable limits thereof, and the Bank is a member of the Federal Reserve System.

     Hanmi Bank is a community bank conducting general business banking with its primary market encompassing the multi-ethnic population of the Los Angeles, Orange, San Diego and Santa Clara counties. Hanmi Bank’s full-service offices are located in business areas where many of the businesses are run by immigrants and other minority groups, and its client base reflects the multi-ethnic composition of these communities. On April 30, 2004, the Company completed its acquisition of Pacific Union Bank (“PUB”), a $1.2 billion (assets) commercial bank headquartered in Los Angeles that, like Hanmi, serves primarily the Korean-American community. Hanmi Bank currently has twenty-seven full-service branch offices located in Los Angeles, Orange, Santa Clara and San Diego counties. Of the twenty-seven offices, Hanmi Bank opened twelve as de novo branches and acquired fifteen through acquisition. On June 17, 2004, the Company announced it would close seven branches.

Note 2. Basis of Presentation

     In the opinion of management, the consolidated financial statements of Hanmi Financial Corporation and its subsidiaries reflect all the material adjustments necessary for a fair presentation of the results for the interim period ended June 30, 2004, but are not necessarily indicative of the results which will be reported for the entire year. In the opinion of management, the aforementioned consolidated financial statements are in conformity with accounting principles generally accepted in the United States of America. The interim information should be read in conjunction with the Company’s 2003 Annual Report on Form 10-K.

     Descriptions of the Company’s significant accounting policies are included in Note 1, Summary of Significant Accounting Policies, in the Company’s 2003 Form 10-K. Certain reclassifications were made to the prior period presentation to conform to the current period’s presentation.

Note 3. Investment Securities

     The following table presents the fair value and the unrealized loss on securities that were temporarily impaired at June 30, 2004.

     The temporary impairment is a result of the change in market interest rates and is not a result of the underlying issuer's ability to repay. Accordingly, we have not recognized the temporary impairment in our results of operations.

Note 4. Employee Stock-Based Compensation

     The Company measures its employee stock-based compensation arrangements under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation expense has been recognized for the stock option plan, as stock options were granted at fair value at the date of grant. Had compensation expense for the Company’s stock option plan been determined based on the fair values estimated using the Black-Scholes model at the grant dates for previous awards, the Company’s net income and income per share would have been reduced to the pro forma amounts indicated for the periods as follows:

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Note 5. Earnings Per Share

     Earnings per share (“EPS”) is calculated on both a basic and diluted basis. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted from the issuance of common stock that then shared in earnings, excluding common shares in treasury.

     The following table presents a reconciliation of the components used to derive basic and diluted earnings per share for the periods indicated.

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Note 6. Derivative Financial Instruments

     The Company has entered into interest rate swaps to hedge the interest rate risk associated with the cash flows of specifically identified variable-rate loans. As of June 30, 2004, the Company had five interest rate swap agreements with a total notional amount of $70 million, wherein the Company receives a fixed rate of 5.77% and 6.37% at quarterly intervals for each $20 million notional amount and a fixed rate of 6.51%, 6.76%, and 7.29% for each $10 million notional amount, respectively. The swaps expire over the period March 14, 2008 through May 17, 2009. The Company pays a floating rate at quarterly intervals based on The Wall Street Journal published prime rate.

     At June 30, 2004, the fair value of the interest rate swaps was in an unfavorable position of $893,000. A total of $544,000, net of tax, is included in other comprehensive loss. The fair value of the interest rate swaps is included in other liabilities in the accompanying consolidated statements of financial condition. Expenses of $23,000 related to swap ineffectiveness were recorded in the Company’s income statement for the quarter ended June 30, 2004.

Note 7. Current Accounting Matters

     In accordance with Statement of Financial Accounting Standards No. 149, “Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities” (“SFAS No. 149”), interest rate lock commitments on mortgage loans that will be held for sale must be accounted for as derivatives and marked to market in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”). All other interest rate lock commitments are excluded from SFAS No. 133, pursuant to SFAS No. 149.

     The Securities and Exchange Commission (“SEC”) issued guidance in Staff Accounting Bulletin No. 105 (“SAB No. 105”) that requires that fair-value measurements include only differences between the guaranteed interest rates in loan commitments and a market interest rate, excluding any expected future cash flows related to the customer relationship or loan servicing. Servicing assets are to be recognized only after the servicing asset has been contractually separated from the underlying loan by sale or securitization of the loan with servicing retained. The guidance in SAB No. 105 must be applied to interest rate locks initiated after March 31, 2004 and is to be applied prospectively. The application of SAB No. 105 did not have a material effect on the Company.

Note 8. Business Combinations

     On April 30, 2004, the Company completed its acquisition of Pacific Union Bank (“PUB”) and merged PUB with Hanmi Bank. The Company paid $164.5 million in cash to acquire 5,537,431 of the PUB shares owned by Korea Exchange Bank. All of the remaining PUB shares were converted in the acquisition into shares of the Company’s common stock based on an exchange ratio of 1.156 Hanmi shares for each PUB share.

     Immediately prior to the completion of the acquisition, the Company issued a total of 3,947,369 shares of its common stock pursuant to a private placement for total proceeds of $75,000,000 before expenses and placement fees. As a result of the issuance of shares in the merger and the private placement, as well as normal stock option activity, the number of outstanding Company shares has increased to 24,438,017.

     In addition, all outstanding PUB employee stock options were converted into 68,707 options to purchase Hanmi stock valued at $1.1 million in total. Based on Hanmi’s average price of $25.06 for the five-day trading period from April 28 through May 4, 2004, the total consideration paid for PUB was $324.7 million and resulted in the recognition of goodwill aggregating approximately $207.2 million. This amount, as well as the fair values of assets and liabilities recorded, may change as certain estimates are finalized.

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     As of April 30, 2004, the fair value of PUB net assets acquired was as follows:

     The core deposit intangible is being amortized over its estimated useful life of five years. None of the goodwill balance is expected to be deductible for income tax purposes.

     The Company incurred the following merger-related costs:

     Immediately following the acquisition of PUB, management initiated and approved plans to restructure the operations of the existing Hanmi and PUB branch networks and corporate headquarters to eliminate duplicative facilities, streamline operations, and reduce costs. Management anticipates that these actions, including the termination of approximately 100 management, headquarters, and branch employees, will be substantially complete by December 31, 2004. Through June 30, 2004, 13 employees had been terminated. On a pro forma basis, combined employee headcount of Hanmi and PUB decreased from 671 as of December 31, 2003 to 611 as of June 30, 2004, primarily as a result of attrition and the hiring freeze instituted January 2, 2004.

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     Restructuring costs recognized as expenses during the second quarter of 2004 consisted primarily of employee severance and retention bonuses, data processing contract termination costs, the costs of vacating duplicative branches within Hanmi’s existing network, and the impairment of fixed assets (primarily leasehold improvements) associated with such branches. Of the $1,728,000 of total restructuring expenses provided, $54,000 was utilized and charged against the related liability in the second quarter of 2004.

     Certain restructuring costs (primarily PUB employee severance, data processing contract termination costs, and the costs of vacating duplicative branches within PUB’s network) were recognized as liabilities assumed in the business combination or impairments of fixed assets associated with such branches. Accordingly, they have been considered part of the purchase price of PUB and recorded as an increase in the balance of goodwill. Of the $4,512,000 of total restructuring costs that have been treated as part of the purchase price, $1,112,000 was utilized and charged against the related liability in the second quarter of 2004.

Unaudited Pro Forma Combined Financial Data Reflecting the PUB Acquisition

     The unaudited pro forma combined income statements presented below give effect to the acquisition of PUB as if it had been consummated as of January 1, 2003. The unaudited pro forma information is not necessarily indicative of the results of operations that would have resulted had the acquisition been completed as of January 1, 2003, nor is it necessarily indicative of future results of operations.

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Note 9. Junior Subordinated Debentures

     On April 28, 2004, the Company formed Hanmi Capital Trust III (the “Trust”) to issue trust preferred securities. On April 28, 2004, the Trust issued $20 million of trust preferred securities pursuant to a private placement underwritten by Trapeza Funding V, LLC and included in a pool of trust preferred securities assembled by Trapeza. In addition, it issued to the Company $619,000 of trust common securities. The Trust used the proceeds to purchase $20.6 million of the Company’s junior subordinated debt due April 30, 2009, bearing interest at the three-month LIBOR plus 2.63%. These notes are the sole assets of the Trust and are subordinate to all of the Company’s existing and future obligations.

     The Company treats the trust preferred securities as Tier 1 capital. The debt, the common securities issued by the Trust, and the related income effects are eliminated within the Company’s consolidated financial statements.

     The notes have a 30-year maturity, and they are callable after five years. Upon repayment of the debentures at their stated maturity or following their earlier redemption, the Trust will use the proceeds of such repayment to redeem an equivalent amount of outstanding trust preferred securities and trust common securities.

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

     The following is management’s discussion and analysis of the major factors that influenced the Company’s results of operations and financial condition for the three months and six months ended June 30, 2004. This analysis should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and with the unaudited financial statements and notes thereto set forth in this report.

Critical Accounting Policies

     We have established various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. Certain accounting policies require us to make significant estimates and assumptions which have a material impact on the carrying value of certain assets and liabilities, and we consider these to be critical accounting policies. The estimates and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods. Management has discussed the development and selection of these critical accounting policies with the Audit Committee of our Board of Directors.

     We believe the allowance for loan losses is the critical accounting policy that requires the most significant estimates and assumptions, which are particularly susceptible to significant change in the preparation of our financial statements. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Allowance and Provision for Loan Losses” for a description of the Company’s methodology for determining the allowance for loan losses.

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Selected Financial Data

     The following table sets forth certain selected financial data concerning the Company for the periods indicated:

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Forward-Looking Information

     Certain matters discussed under this caption may constitute forward-looking statements under Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward looking statements relate to, among other things, expectations of the environment in which the Company operates and projection of future performance. There can be no assurance that the results described or implied in such forward-looking statements will, in fact, be achieved and actual results, performance, and achievements could differ materially because the business of the Company involves inherent risks and uncertainties. Risks and uncertainties include possible future deteriorating economic conditions in the Company’s areas of operation; interest-rate risk associated with volatile interest rates and related asset-liability matching risk; liquidity risks; risk of significant non-earning assets, and net credit losses that could occur, particularly in times of weak economic conditions or times of rising interest rates; risks of available-for-sale securities declining significantly in value as interest rates rise; difficulties in integrating the operations of acquired companies; and regulatory risks associated with the variety of current and future regulations to which the Company is subject. For additional information concerning these factors, see the Company’s filings with the Securities and Exchange Commission, and in particular, the Company’s Form 10-K under the heading “Factors That May Affect Future Results of Operation,” “Interest Rate Risk Management,” and “Liquidity and Capital Resources.”

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Results of Operations

Overview

     The Company’s net income for the three months ended June 30, 2004 was $7.5 million, or $0.35 per diluted share, compared to $5.0 million, or $0.35 per diluted share, for the three months ended June 30, 2003. The 52.3% increase in net income for 2004 as compared to 2003 was primarily due to the acquisition of interest-earning assets totaling $1.1 billion as part of the merger with PUB. Hanmi’s results of operations include revenues and expenses derived from the assets acquired and liabilities assumed via the combination with PUB for the months of May and June 2004. Net interest income before provision for loan losses increased $10.3 million, or 74.6%, due to ongoing growth in loan production as well as the newly acquired interest-earning assets. Non-interest income increased by $1.2 million, or 20.6%, mainly due to an increase in service charges on deposit accounts. Non-interest expenses increased by $7.5 million, or 72.7%, including $1.7 million of non-recurring restructuring expenses. This increase was primarily attributable to the additional salaries and employee benefits, occupancy, professional fees, and data processing expenses incurred during the post-merger integration period. The annualized return on average assets was 1.13% for the three months ended June 30, 2004, compared to a return on average assets of 1.26% for the same period of 2003, a decrease of 13 basis points. The annualized return on average equity was 9.97%, and return on tangible equity was 19.72%, compared to 15.21% and 15.47%, respectively, in the three-month period a year ago.

     The Company’s net income for the six months ended June 30, 2004 was $13.9 million, or $0.78 per diluted share, compared to $9.2 million, or $0.64 per diluted share, for the six months ended June 30, 2003. Net interest income before provision for loan losses increased $15.1 million, or 58.2%, to $41.1 million, and non-interest income increased by $1.5 million, or 14.7%, to $11.6 million. Non-interest expenses increased by $8.9 million, or 46.5%, including $1.7 million of non-recurring restructuring expenses. The annualized return on average assets was 1.26% for the six months ended June 30, 2004, compared to a return on average assets of 1.21% for the same period of 2003, an increase of five basis points. The annualized return on average equity was 12.41%, and return on tangible equity was 18.75%, compared to 14.48% and 14.76%, respectively, in the six-month period a year ago.

Net Interest Income before Provision for Loan Losses

     The principal component of the Company’s earnings is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid on deposits and other borrowed funds. When net interest income is expressed as a percentage of average interest-earning assets, the result is the net interest margin. The net interest spread is the yield on average interest-earning assets less the average cost of interest-bearing deposits and borrowed funds.

     For the three months ended June 30, 2004, the Company’s net interest income before provision for loan losses was $24.2 million. This represented an increase of $10.3 million, or 74.6%, over net interest income before provision for loan losses of $13.9 million for the three months ended June 30, 2003. The net interest spread increased to 3.57% for the three months ended June 30, 2004, from 3.12% for the same period in 2003. The change was mainly due to an increase in rates received on loans and investments as the Company emphasized spread income and disposed of certain low-yielding investments in the first quarter of 2004. The net interest margin also increased 36 basis point to 4.10% for the three months ended June 30, 2004, from 3.74% for the same period in 2003, due to an increase in the volume of interest-earning assets with higher interest rates.

     For the six months ended June 30, 2004, the Company’s net interest income before provision for loan losses was $41.1 million. This represented an increase of $15.1 million, or 58.2%, over net interest income before provision for loan losses of $26.0 million for the six months

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ended June 30, 2003. The interest rate spread increased to 3.56% for the six months ended June 30, 2004, from 2.97% for the same period in 2003. The change was mainly due to an increase in rates received on loans and investments. The net interest margin also increased 46 basis point to 4.08% for the six months ended June 30, 2004, from 3.62% for the same period in 2003 due to an increase in the volume of interest earning assets with higher interest rates.

     Total interest income increased $12.6 million, or 65.8%, to $31.7 million for the three months ended June 30, 2004, from $19.1 million for the three months ended June 30, 2003. Total interest income increased $17.2 million, or 47.1%, to $53.8 million for the six months ended June 30, 2004, from $36.6 million for the six months ended June 30, 2003. The increase was mainly the result of an increase in the volume of interest-earning assets attributable to the acquisition of PUB. For the second quarter of 2004, average interest-earning assets increased by $882.1 million, or 59.6%, to $1.89 billion, compared to $1.06  billion a year ago. For the first half of 2004, average interest-earning assets increased by $579 million, or 40.3%, to $2.02 billion, compared to $1.44 billion a year ago.

     The Company’s interest expense on deposits and other borrowed funds for the three months ended June 30, 2004 increased by $2.2 million, or 42.5%, to $7.5 million, from $5.3 million for the three months ended June 30, 2003. The Company’s interest expense on deposits and other borrowed funds for the six months ended June 30, 2004 increased by $2.1 million, or 19.8%, to $12.7 million, from $10.6 million for the six months ended June 30, 2003. The increases reflected an increase in interest-bearing liabilities related to the acquisition of PUB; however, a decrease in interest rates paid to depositors offset the increase in the volume of interest-bearing deposits and borrowings.

     Average interest-bearing liabilities were $1.67 billion and $1.42 billion for the three months and six months ended June 30, 2004, respectively, which represented increases of $644.3 million, or 62.7%, and $424 million, or 42.4%, respectively, from average interest-bearing liabilities of $1.03 billion and $1.0 billion for the same periods a year ago. The cost of average interest-bearing liabilities decreased to 1.79% and 1.78% for the three months and six months ended June 30, 2004, respectively, compared to costs of 2.04% and 2.11% for the same periods of 2003. Overall, interest on deposits decreased mainly due to repricing of interest rates on long-term certificates of deposit to lower interest rates as the deposits matured and the acquisition of PUB’s deposits, which had a lower average interest rate compared to Hanmi’s deposits portfolio.

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     The table below presents the average yield on each category of interest-earning assets, average rate paid on each category of interest-bearing liabilities, and the resulting net interest spread and net interest margin for the periods indicated. All average balances are daily average balances.

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     The table below shows changes in interest income and interest expense and the amounts attributable to variations in interest rates and volumes for the periods indicated. The variances attributable to simultaneous volume and rate changes have been allocated to the change due to volume and the change due to rate categories in proportion to the relationship of the absolute dollar amount attributable solely to the change in volume and to the change in rate.