HANMI FINANCIAL CORP - Quarter Report: 2005 March (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the Quarterly Period Ended March 31, 2005

or

For the Transition Period From _________ To _________

Commission File Number: 000-30421

HANMI FINANCIAL CORPORATION

(213) 382-2200

Not Applicable

     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 þ No o

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No o

     As of May 6, 2005, there were 49,629,807 outstanding shares of the issuer’s Common Stock.

HANMI FINANCIAL CORPORATION

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HANMI FINANCIAL CORPORATION AND SUBSIDIARY

See Accompanying Notes to Consolidated Financial Statements

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HANMI FINANCIAL CORPORATION AND SUBSIDIARY

See Accompanying Notes to Consolidated Financial Statements

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HANMI FINANCIAL CORPORATION AND SUBSIDIARY

See Accompanying Notes to Consolidated Financial Statements

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HANMI FINANCIAL CORPORATION AND SUBSIDIARY

NOTE 1 — HANMI FINANCIAL CORPORATION

     Hanmi Financial Corporation (“Hanmi Financial”, “we” or “our”) 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, our primary subsidiary, is a commercial bank licensed by the California Department of Financial Institutions. The Bank’s deposit accounts are insured under the Federal Deposit Insurance Act, up to applicable limits thereof. The Bank is a member of the Federal Reserve System.

     Our primary operations are related to traditional banking activities, including the acceptance of deposits and the lending and investing of money through operation of the Bank. Hanmi Bank is a community bank conducting general business banking with its primary market encompassing the multi-ethnic population of Los Angeles, Orange, San Diego, San Francisco 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. Hanmi Bank’s client base reflects the multi-ethnic composition of these communities. The Bank is a California state-chartered, FDIC-insured financial institution.

     On April 30, 2004, we completed the acquisition of Pacific Union Bank (“PUB”), a $1.2 billion (assets) commercial bank headquartered in Los Angeles that also served primarily the Korean-American community. As of March 31, 2005, the Bank maintained a branch network of 22 locations, serving individuals and small-sized to medium-sized businesses in Los Angeles and surrounding areas.

NOTE 2 — BASIS OF PRESENTATION

     In the opinion of management, the consolidated financial statements of Hanmi Financial Corporation and subsidiary reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim period ended March 31, 2005, but are not necessarily indicative of the results that 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 our 2004 Annual Report on Form 10-K.

     Descriptions of our significant accounting policies are included in “Note 1 — Summary of Significant Accounting Policies” in our 2004 Annual Report on Form 10-K. Certain reclassifications were made to the prior period’s presentation to conform to the current period’s presentation.

     On January 20, 2005, our Board of Directors declared a two-for-one stock split, to be effected in the form of a 100 percent common stock dividend. The new shares were distributed on February 15, 2005 to shareholders of record on the close of business on January 31, 2005. All share and per share amounts for the prior period have been restated to reflect the stock dividend.

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HANMI FINANCIAL CORPORATION AND SUBSIDIARY

NOTE 3 — EMPLOYEE STOCK-BASED COMPENSATION

     Our employee stock-based compensation arrangements are measured 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 stock option plan been determined based on the fair values estimated using the Black-Scholes model at the grant dates for previous awards, our net income and earnings per share would have been reduced to the pro forma amounts indicated below:

     In February 2005, 100,000 shares of restricted stock were granted to Dr. Sung Won Sohn, our Chief Executive Officer. 20,000 of these shares vested immediately, and an additional 20,000 shares will vest each year over the next four years on the anniversary date of the grant provided that Dr. Sohn is still employed by us. The market value of the shares awarded totaled $1,815,000 and has been recorded as a separate component of shareholders’ equity. Unearned compensation is being amortized against income over the four-year vesting period. For the three months ended March 31, 2005, $393,000 of compensation expense was recognized in the consolidated statements of income.

NOTE 4 — EARNINGS PER SHARE

     Earnings per share (“EPS”) is calculated on both a basic and a diluted basis. Basic EPS 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 EPS 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.

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HANMI FINANCIAL CORPORATION AND SUBSIDIARY

NOTE 4 — EARNINGS PER SHARE (Continued)

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

     As of March 31, 2005, there were 125,554 options outstanding that were not included in the computation of diluted EPS because their exercise price was greater than the quarterly average market price of the common shares and, therefore, the effect would be anti-dilutive. There were no anti-dilutive options as of March 31, 2004.

NOTE 5 — OFF-BALANCE SHEET COMMITMENTS

     As part of the service to our small-sized and medium-sized business customers, Hanmi Bank issues formal loan commitments and lines of credit. These commitments can be either secured or unsecured. They may be in the form of revolving lines of credit for seasonal working capital needs or may take the form of commercial letters of credit and standby letters of credit. Commercial letters of credit facilitate import trade. Standby letters of credit are conditional commitments issued by Hanmi Bank to guarantee the performance of a customer to a third party.

     The following table shows the distribution of the Hanmi Bank’s undisbursed loan commitments as of the dates indicated.

NOTE 6 — CURRENT ACCOUNTING MATTERS

     In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using the intrinsic method that is currently used and requires that such transactions be accounted for using a fair value-based method and recognized as expense in the Consolidated Statement of Income. SFAS No. 123R was to be effective as of the beginning of the third quarter of 2005; however, on April 14, 2005, the Securities and Exchange Commission adopted a new rule that deferred the required adoption date to the beginning of the first quarter of 2006. We have provided pro forma disclosures under SFAS No. 123 in “Note 3 — Employee Stock-Based Compensation.”

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     The following is management’s discussion and analysis of the major factors that influenced our results of operations and financial condition for the three months ended March 31, 2005. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2004 and with the unaudited consolidated financial statements and notes thereto set forth in this Report.

CRITICAL ACCOUNTING POLICIES

     We have established various accounting policies that 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 our Annual Report on Form 10-K for the year ended December 31, 2004. Certain accounting policies require us to make significant estimates and assumptions that 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 that 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 and reserve for unfunded loan commitments are critical accounting policies that require significant estimates and assumptions that are particularly susceptible to significant change in the preparation of our financial statements. See “Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition — Financial Condition — Allowance for Loan Losses and Reserve for Unfunded Loan Commitments” for a description of the methodology used to determine the allowance for loan losses and reserve for unfunded loan commitments.

     During the year ended December 31, 2004, the application of Statement of Financial Accounting Standards No. 141, “Business Combinations,” to the purchase of Pacific Union Bank required significant estimates and assumptions. We engaged outside experts including appraisers to assist in estimating the fair values of certain assets acquired, particularly the loan portfolio, core deposit intangible asset, and fixed assets. The fair values of financial assets, including the investments portfolio, deposits and borrowings, were estimated by the Bank, using market data regarding securities market prices and interest rates. We also evaluated long-lived assets for impairment and recorded any necessary adjustments. In accordance with Emerging Issues Task Force Issue No. 95-3, “Recognition of Liabilities in Connection With a Purchase Business Combination,” we recognized liabilities assumed for costs to involuntarily terminate employees of PUB and costs to exit activities of PUB under an exit plan approved by Hanmi Bank’s board of directors.

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SELECTED FINANCIAL DATA

     The following table sets forth certain selected financial data for the periods indicated.

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FORWARD-LOOKING STATEMENTS

     Some of the statements under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-Q constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of such terms and other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ from those expressed or implied by the forward-looking statement. For additional information concerning these factors, see our Form 10-K filed with the Securities and Exchange Commission on March 16, 2005 under the headings “Factors That May Affect Future Results of Operations,” “Interest Rate Risk Management” and “Liquidity and Capital Resources.” We undertake no obligation to update these forward-looking statements to reflect events or circumstances that occur after the date on which such statements were made.

RESULTS OF OPERATIONS

Overview

     For the three months ended March 31, 2005, net income was $13.3 million, or $0.27 per diluted share, compared to $6.4 million, or $0.22 per diluted share, for the three months ended March 31, 2004. The 108.8 percent increase in net income for 2005 as compared to 2004 was primarily due to the acquisition of PUB. Net interest income before provision for credit losses increased $14.9 million, or 88.4 percent, due to ongoing growth in the loan portfolio as well as the newly acquired interest-earning assets from PUB. Non-interest income increased by $2.6 million, or 53.1 percent, mainly due to an increase in service charges on deposit accounts. Non-interest expenses increased by $7.0 million, or 67.9 percent, due 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 1.74 percent for the three months ended March 31, 2005, compared to a return on average assets of 1.44 percent for the same period of 2004, an increase of 30 basis points. The annualized return on average shareholders’ equity was 13.32 percent for the three months ended March 31, 2005, and return on average tangible equity was 29.19 percent, compared to 17.99 percent and 18.01 percent, respectively, for the same period in 2004.

Net Interest Income Before Provision for Credit Losses

     Our earnings depend largely upon the difference between the interest income received from the loan portfolio and other interest-earning assets and the interest paid on deposits and borrowings. The difference is “net interest income.” Net interest income, when expressed as a percentage of average total interest-earning assets, is referred to as the net interest margin. Net interest income is affected by the change in the level and mix of interest-earning assets and interest-bearing liabilities, referred to as volume changes. Net interest income is also affected by changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes. Interest rates charged on loans are affected principally by the demand for such loans, the supply of money available for lending purposes and competitive factors. Those factors are, in turn, affected by general economic conditions and other factors beyond our control, such as Federal economic policies, the general supply of money in the economy, income tax policies, governmental budgetary matters and the actions of the Federal Reserve Bank.

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     For the three months ended March 31, 2005, net interest income before provision for credit losses was $31.7 million. This represented an increase of $14.9 million, or 88.4 percent, over net interest income before provision for credit losses of $16.8 million for the three months ended March 31, 2004. The interest rate spread increased to 3.99 percent for the three months ended March 31, 2005, from 3.45 percent for the same period in 2004. The change was mainly due to an increase in rates received on loans and investments as we increased our prime rate by a total of 50 basis points during the first quarter. Approximately 88.9 percent of our loan portfolio is tied to our prime rate. We also emphasized spread income and disposed of certain low yielding assets in the first and second quarters of 2004 and reinvested the proceeds from the amortization of our investment portfolio into loan production. Average loans outstanding increased from 75.8 percent of average interest-earning assets in the first quarter of 2004 to 81.8 percent of average interest-earning assets in the first quarter of 2005. The net interest margin also increased by 68 basis points to 4.70 percent for the three months ended March 31, 2005, from 4.02 percent for the same period in 2004, due to an increase in the volume of interest-earning assets with higher interest rates.

     Total interest income increased $21.1 million, or 95.7 percent, to $43.1 million for the three months ended March 31, 2005, from $22.0 million for the three months ended March 31, 2004. The increase was mainly the result of an increase in the volume of interest-earning assets obtained through the acquisition of PUB. For the first quarter of 2005, average interest-earning assets increased by $1.0 billion, or 62.5 percent, to $2.7 billion, compared to $1.7 billion a year ago.

     Total interest expense increased $6.1 million, or 119.5 percent, to $11.3 million for the three months ended March 31, 2005, from $5.2 million for the three months ended March 31, 2004. The increase reflects an increase in interest-bearing liabilities related to the acquisition of PUB and higher interest rates paid to depositors. Average interest-bearing liabilities increased by $770.7 million, or 66.7 percent, to $1.9 billion, compared to $1.2 billion a year ago. The cost of average interest-bearing liabilities increased to 2.39 percent for the three months ended March 31, 2005, compared to 1.80 percent for the same period in 2004.

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     The following table presents the average balances of assets, liabilities and shareholders’ equity; the amount of interest income or interest expense; the average yield or rate for each category of interest-earning assets and interest-bearing liabilities; and the net interest spread and the 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.

Provision for Credit Losses

     Provisions to the allowance for loan losses and reserve for unfunded loan commitments are made quarterly, in anticipation of probable loan losses. The quarterly provision is based on the allowance need, which is calculated using a formula designed to provide adequate allowances for anticipated losses and reserves for unfunded loan commitments. The formula is composed of various components. The allowance is determined by assigning specific allowances for all classified loans. All loans that are not classified are then given certain allocations according to type with larger percentages applied to loans deemed to be of a higher risk. These percentages are determined based on the prior loss history by type of loan, adjusted for current economic factors. For the three months ended March 31, 2005, the provision for credit losses was $136,000, compared to $900,000 for the three months ended March 31, 2004, a decrease of 84.9 percent. The decrease in the provision for credit losses in the first quarter of 2005 resulted primarily from the low net charge-offs experienced in the first quarter of 2005, which caused historical loss percentages to decrease. As of March 31, 2005, total net charge-offs were $81,000, compared to $605,000 total net charge-offs in the fourth quarter of 2004 and $1.9 million in the first quarter of 2004.

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Non-Interest Income

     The following table sets forth the various components of non-interest income for the periods indicated:

     Non-interest income is earned from four major sources: service charges on deposit accounts, fees generated from international trade finance, gain on sales of loans, and gain on sales of securities available for sale. For the three months ended March 31, 2005, non-interest income was $7.5 million, an increase of 53.1 percent from $4.9 million for the three months ended March 31, 2004. The overall increase in non-interest income is due to the PUB merger, which closed on April 30, 2004.

     Service charges on deposit accounts increased by $1.1 million, or 39.9 percent, from $2.7 million for the three months ended March 31, 2004 to $3.7 million for three months ended March 31, 2005. Service charge income on deposit accounts increased with the higher deposit volume and number of accounts as a result of the PUB merger. Average deposits increased by 72.9 percent from $1.5 billion in 2004 to $2.5 billion in 2005. Service charges are constantly reviewed to maximize service charge income while still maintaining a competitive position.

     Fees generated from international trade finance increased by $140,000, or 17.4 percent, from $805,000 for the three months ended March 31, 2004 to $945,000 for the three months ended March 31, 2005. The increase was due to the PUB merger. Average trade finance loans increased by $22.7 million, or 39.0 percent, from $58.2 million in 2004 to $80.9 million in 2005.

     Gain on sales of loans decreased by $161,000, or 34.3 percent, from $469,000 for the three months ended March 31, 2004 to $308,000 for the three months ended March 31, 2005. The decrease in gain on sales of loans resulted from the decreased sales activity in SBA loans due to more loans being held in portfolio. The guaranteed portion of SBA loans is sold in the secondary markets with servicing rights retained.

     Other income increased by $372,000, or 149.4 percent, from $249,000 for the three months ended March 31, 2004 to $621,000 for the three months ended March 31, 2005 due to increases in credit card fee income and sales commissions from mutual funds and insurance products.

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Non-Interest Expenses

     The following table sets forth the breakdown of non-interest expenses for the periods indicated:

     For the three months ended March 31, 2005, non-interest expenses were $17.4 million, an increase of $7.0 million, or 67.9 percent, from $10.4 million for the three months ended March 31, 2004. This increase was primarily due to the PUB merger, which closed on April 30, 2004.

     Salaries and employee benefits expenses for the three months ended March 31, 2005 increased $3.5 million, or 62.2 percent, to $9.2 million from $5.7 million for the three months ended March 31, 2004. The increase was due to a 41.6 percent increase in the number of employees following the acquisition of PUB and a $1.3 million increase in bonus accruals.

     Occupancy and equipment expenses for the three months ended March 31, 2005 increased $846,000, or 61.1 percent, to $2.2 million from $1.4 million for the three months ended March 31, 2004, due to the acquisition of twelve former PUB branches.

     Data processing expense for the three months ended March 31, 2005 increased $345,000, or 42.1 percent, to $1.2 million from $0.8 million for the three months ended March 31, 2004. Additional expense was incurred mainly due to an increase in loans and deposits volume related to the acquisition.

     Core deposit premium amortization for the three months ended March 31, 2005 increased $702,000 to $732,000 from $30,000 for the three months ended March 31, 2004. The increase is attributable to the core deposits acquired from PUB.

     Other operating expenses for the three months ended March 31, 2005 increased $458,000, or 34.5 percent, to $1.8 million from $1.3 million for the three months ended March 31, 2004. The increases are primarily attributable to the increase in the number of employees following the acquisition of PUB.

Provision for Income Taxes

     For the three months ended March 31, 2005, we recognized provisions for income taxes of $8.3 million on net income before tax of $21.7 million, representing an effective tax rate of 38.5 percent.

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FINANCIAL CONDITION

Summary of Changes in Balance Sheets — March 31, 2005 Compared to December 31, 2004

     As of March 31, 2005, total assets were $3.14 billion, an increase of $35.2 million, or 1.1 percent, from the December 31, 2004 balance of $3.10 billion. The increase in assets was mainly funded by deposits, which increased by $16.1 million, or 0.6 percent, to $2.54 billion at March 31, 2005 from $2.53 billion at December 31, 2004. Loans remained relatively unchanged during the quarter. At March 31, 2005 and December 31, 2004, loans, net of unearned fees, allowance for loan losses and loans held for sale, totaled $2.23 billion. Investment securities increased $4.9 million, or 1.2 percent, to $423.9 million at March 31, 2005 from $419.0 million at December 31, 2004.

Investment Securities

     Securities are classified as held to maturity or available for sale in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Those securities that we have the ability and intent to hold to maturity are classified as “held to maturity securities.” All other securities are classified as “available for sale.” There were no trading securities at March 31, 2005. Securities classified as held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts, and available for sale securities are stated at fair value. The securities currently held consist primarily of U.S. agency securities, mortgage-backed securities, collateralized mortgage obligations and municipal bonds.

     As of March 31, 2005, held to maturity securities totaled $1.1 million and available for sale securities totaled $422.8 million, compared to $1.1 million and $417.9 million, respectively, at December 31, 2004.

     The amortized cost and estimated fair value of investment securities at March 31, 2005, by contractual maturity, are shown below. Although mortgage-backed securities and collateralized mortgage obligations have contractual maturities through 2035, expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

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Loan Portfolio

     All loans are carried at face amount, less principal repayments collected, net of deferred loan origination fees and costs, and the allowance for loan losses. Interest on all loans is accrued daily on a simple interest basis. Once a loan is placed on non-accrual status, the accrual of interest is discontinued and previously accrued interest is reversed. Loans are placed on non-accrual status when principal and interest on a loan is past due 90 days or more, unless a loan is both well secured and in the process of collection.

     The following table shows the loan composition by type, including loans held for sale, as of the dates indicated.

     At March 31, 2005 and December 31, 2004, loans, net of unearned fees, allowance for loan losses and loans held for sale, totaled $2.23 billion. Real estate loans, composed of commercial property, residential property and construction loans, decreased $32.3 million, or 3.4%, to $924.5 million at March 31, 2005 from $956.8 million at December 31, 2004. The decrease in the real estate loan portfolio reflects management’s emphasis on controlling exposure to an excessive concentration in commercial real estate loans.

     Total commercial and industrial loans, composed of domestic commercial property and lines of credit, trade financing and SBA loans, were $1.25 billion at March 31, 2005, which represented an increase of $30.0 million, or 2.5%, from $1.22 billion at December 31, 2004. The increase was primarily due to growth in commercial term loans, commercial lines of credit and SBA loans, partly offset by a decrease of $30.0 million in international loans that was due to normal seasonal fluctuations as these loans have historically decreased during the first quarter.

     Consumer loans decreased $3.0 million, or 3.4%, to $84.5 million at March 31, 2005 from $87.5 million at December 31, 2004.

     At March 31, 2005, accruing loans 90 days past due or more were $500,000, an increase of $292,000 from $208,000 at December 31, 2004. Non-accrual loans were $6.4 million at March 31, 2005, a $0.6 million increase compared to $5.8 million at December 31, 2004. The increase was due to $3.3 million of loans migrating to non-performing status, partially offset by $2.7 million loans returned to performing status.

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     The table below shows the composition of non-performing assets as of the dates indicated.