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| PACW > SEC Filings for PACW > Form 10-Q on 6-Nov-2008 | All Recent SEC Filings |
6-Nov-2008
Quarterly Report
Forward-Looking Information
This Quarterly Report on Form 10-Q contains certain forward-looking information about the Company and its subsidiaries, which statements are intended to be covered by the safe harbor for "forward-looking statements" provided by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact are forward-looking statements. Such statements involve inherent risks and uncertainties, many of which are difficult to predict and are generally beyond the control of the Company. We caution readers that a number of important factors could cause actual results to differ materially from those expressed in, implied or projected by, such forward-looking statements. Risks and uncertainties include, but are not limited to:
º •
º lower than expected revenues;
º •
º credit quality deterioration or pronounced and sustained reduction in
real estate market values could cause an increase in the allowance for
credit losses and a reduction in earnings;
º •
º increased competitive pressure among depository institutions;
º •
º the Company's ability to complete future acquisitions and to
successfully integrate such acquired entities or achieve expected
benefits, synergies and/or operating efficiencies within expected
time-frames or at all;
º •
º the possibility that personnel changes will not proceed as planned;
º •
º the cost of additional capital is more than expected;
º •
º a change in the interest rate environment reduces interest margins;
º •
º asset/liability repricing risks and liquidity risks;
º •
º pending legal matters may take longer or cost more to resolve or may
be resolved adversely to the Company;
º •
º general economic conditions, either nationally or in the market areas
in which the Company does or anticipates doing business, are less
favorable than expected;
º •
º environmental conditions, including natural disasters, may disrupt our
business, impede our operations, negatively impact the values of
collateral securing the Company's loans or impair the ability of our
borrowers to support their debt obligations;
º •
º the economic and regulatory effects of the continuing war on terrorism
and other events of war, including the war in Iraq;
º •
º legislative or regulatory requirements or changes adversely affecting
the Company's business;
º •
º changes in the securities markets; and
º •
º regulatory approvals for any capital activities cannot be obtained on
the terms expected or on the anticipated schedule.
If any of these risks or uncertainties materializes, or if any of the assumptions underlying such forward-looking statements proves to be incorrect, our results could differ materially from those expressed in, implied or projected by, such forward-looking statements. The Company assumes no obligation to update such forward-looking statements.
We are a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Our principal business is to serve as the holding company for our subsidiary bank, Pacific Western Bank, which we refer to as Pacific Western or the Bank.
Pacific Western is a full-service community bank offering a broad range of banking products and services including: accepting time and demand deposits; originating loans, including commercial, real estate construction, SBA guaranteed, consumer, and international loans; and providing other business-oriented products. Our operations are primarily located in Southern California and the Bank focuses on conducting business with small to medium size businesses and the owners and employees of those businesses in our marketplace. Through our asset-based lending operation we also operate in Arizona, Northern California, the Pacific Northwest, and Texas. At September 30, 2008, our assets totaled $4.4 billion, of which gross loans totaled $3.9 billion. At this date approximately 22% were commercial loans, 56% were commercial real estate loans, 9% were commercial real estate construction loans, 7% were residential real estate construction loans, 6% were residential real estate loans, and 1% were consumer and other loans. These percentages include some foreign loans, primarily to individuals or entities with business in Mexico, representing 1% of total loans. Our portfolio's value and credit quality is affected in large part by real estate trends in Southern California.
Pacific Western competes actively for deposits, and emphasizes solicitation of noninterest-bearing deposits. In managing the top line of our business, we focus on loan growth and loan yield, deposit cost, and net interest margin, as net interest income, on a year-to-date basis, accounts for 90% of our net revenues (net interest income plus noninterest income).
Key Performance Indicators
Among other factors, our operating results depend generally on the following:
Net interest income is the excess of interest earned on our interest-earning assets over the interest paid on our interest-bearing liabilities. The recent decline in market interest rates and fierce competition for liquidity has compressed our net interest margin. Further reductions in market interest rates combined with tight liquidity and low loan growth could negatively impact both our net interest income and net interest margin going forward. Our primary interest-earning asset is loans. Our interest-bearing liabilities include deposits, borrowings, and subordinated debentures. We attempt to increase our net interest income by maintaining a high loan-to-deposit ratio and high level of transactional deposit accounts, which includes noninterest-bearing deposits and interest-bearing checking accounts. While our deposit balances fluctuate depending on deposit holders' perceptions of alternative yields available in the market, we attempt to minimize these variances by attracting a high percentage of noninterest-bearing deposits, which have no expectation of yield. At September 30, 2008, approximately 38% of our total deposits were noninterest-bearing deposits. The recent disruptions in the financial credit and liquidity markets have resulted in increased competition from financial institutions seeking to maintain liquidity and this has placed upward pressure on the rates paid on certain deposit accounts. In addition to deposits, we have borrowing capacity under various credit lines which we use for liquidity needs such as funding loan demand, managing deposit flows and interim acquisition financing. While this borrowing capacity is relatively flexible, it tends to be more expensive than core deposits.
We generally seek new lending opportunities in the $1 million to $10 million range, try to limit loan maturities for commercial loans to one year, for construction loans up to 18 months, and for commercial real estate loans up to ten years, and to price lending products so as to preserve our
We stress credit quality in originating loans and monitor our success by the level of our nonperforming assets, the amount of credit loss provisions recorded, and the resultant level of our allowance for credit losses. Our allowance for credit losses is the sum of our allowance for loan losses and our reserve for unfunded loan commitments. Provisions for credit losses are charged to operations as and when needed for both on and off balance sheet credit exposure. Loans which are deemed uncollectible are charged against the allowance for loan losses. Recoveries on loans previously charged off are added to the allowance for loan losses. During the nine months ended September 30, 2008, we made a provision for credit losses totaling $37.0 million based upon our reserve methodology and considered, among other factors, the level of net charge-offs, the level and trends of classified, criticized, and nonaccrual loans, general market conditions and portfolio concentrations.
We continually review our loans to determine whether there has been any deterioration in credit quality stemming from economic conditions or other factors which may affect collectibility of our loans. Changes in economic conditions, such as inflation, unemployment, increases in the general level of interest rates and negative conditions in borrowers' businesses, could negatively impact our customers and cause us to adversely classify loans and increase portfolio loss factors. An increase in classified loans generally results in increased provisions for credit losses. Any deterioration in the real estate market may lead to increased provisions for credit losses because of our concentration in real estate loans.
Our operating noninterest expense (noninterest expense excluding goodwill write-offs, a legal settlement and reorganization costs) includes fixed and controllable overhead, the major components of which are compensation, occupancy, data processing, professional fees and communications expense. We measure success in controlling such costs through monitoring of the efficiency ratio. We calculate the operating efficiency ratio by dividing operating noninterest expense by the sum of net interest income and noninterest income. Accordingly, a lower percentage reflects lower expenses relative to income. The consolidated operating efficiency ratios have been as follows:
Quarterly Period Ratio
Third quarter of 2008 62.0 %
Second quarter 2008 59.4 %
First quarter 2008 54.8 %
Fourth quarter 2007 52.6 %
Third quarter 2007 48.0 %
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The increase in the operating efficiency ratio for the 2008 quarterly periods compared to the 2007 periods presented is due mostly to a decline in net interest income relative to noninterest expense. Certain reporting periods include income or expense items that were significant to specific quarters' results and also influenced the efficiency ratio. In particular, during the fourth quarter of 2007 we incurred $1.4 million in prepayment penalties and made a charitable contribution of $1.0 million; these items increased the fourth quarter operating efficiency ratio from 49.1% to 52.6%. See also Results of Operations-Earnings Performance for further information on non-GAAP financial measures.
The Company's accounting policies are fundamental to understanding management's discussion and analysis of results of operations and financial condition. The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for credit losses and the carrying values of intangible assets and deferred income tax assets. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2007.
Results of Operations
The discussion in this Form 10-Q of net earnings, earnings per share, performance ratios and comparisons to prior periods is based on net operating earnings as shown in the following table and described below. The Company uses certain non-GAAP financial measures to provide meaningful supplemental information regarding the Company's operational performance and to enhance investors' overall understanding of such financial performance. These non-GAAP financial measures are presented for supplemental informational purposes only for understanding the Company's operating results and should not be considered a substitute for financial information presented in accordance with GAAP. These non-GAAP financial measures presented by the Company may be different from non-GAAP financial measures used by other companies. The following table presents a reconciliation of the non-GAAP financial measurements to the GAAP financial measurements and certain performance ratios.
Non-GAAP Measurements (Unaudited)
Nine Months Ended
Quarter Ended September 30,
In thousands, except
per share data September 30, 2008 June 30, 2008 September 30, 2007 2008 2007
Net earnings (loss)
as reported $ 9,551 $ (474,514 ) $ 22,196 $ (737,686 ) $ 73,267
Legal settlement,
net of tax - 452 - 452 -
Reorganization
costs, net of tax - 150 - 150 778
Goodwill write-off - 486,701 - 761,701 -
Net operating
earnings $ 9,551 $ 12,789 $ 22,196 $ 24,617 $ 74,045
GAAP basic shares
outstanding 27,191.1 27,166.8 28,899.3 27,167.8 28,884.2
Effect of restricted
stock and dilutive
stock options(a) 12.7 - 88.7 - 117.7
GAAP diluted shares
outstanding 27,203.8 27,166.8 28,988.0 27,167.8 29,001.9
Operating earnings
basic shares
outstanding 27,191.1 27,166.8 28,899.3 27,167.8 28,884.2
Effect of restricted
stock and dilutive
stock options 12.7 11.5 88.7 38.4 117.7
Operating earnings
diluted shares
outstanding 27,203.8 27,178.3 28,988.0 27,206.2 29,001.9
GAAP basic and
diluted earnings
(loss) per share $ 0.35 $ (17.47 ) $ 0.77 $ (27.15 ) $ 2.53
Net operating
diluted earnings per
share $ 0.35 $ 0.47 $ 0.77 $ 0.90 $ 2.55
GAAP return on
average assets 0.88 % (39.18 )% 1.72 % (20.58 )% 1.86 %
Net operating return
on average assets 0.88 % 1.06 % 1.72 % 0.69 % 1.88 %
GAAP return on
average equity 10.10 % (223.19 )% 7.31 % (124.98 )% 8.25 %
Net operating return
on average equity 10.10 % 6.02 % 7.31 % 4.17 % 8.34 %
Noninterest expense
as reported $ 37,848 $ 524,084 $ 34,524 $ 872,242 $ 105,914
Legal settlement - (780 ) - (780 ) -
Reorganization costs - (258 ) - (258 ) (1,341 )
Goodwill write-off - (486,701 ) - (761,701 ) -
Operating
noninterest expense $ 37,848 $ 36,345 $ 34,524 $ 109,503 $ 104,573
GAAP efficiency
ratio 62.0 % 856.7 % 48.0 % 467.4 % 46.1 %
Net operating
efficiency ratio 62.0 % 59.4 % 48.0 % 58.7 % 45.5 %
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The net loss for the 2008 periods is due to goodwill write-offs. In response to the volatility in the banking industry and the effect such volatility has had on banking stocks since the beginning of 2008, including PacWest Bancorp's common stock, we wrote-off $275.0 million of goodwill in the first quarter of 2008 and the remaining balance of our goodwill totaling $486.7 million in the second quarter of 2008. Such charges had no effect on the Company's or the Bank's cash balances, liquidity or well-capitalized regulatory capital ratios.
Net operating earnings (defined as net earnings excluding goodwill write-offs, reorganization costs, and the second quarter of 2008 legal settlement), totaled $9.6 million, or $0.35 per diluted share, for the quarter ended September 30, 2008, compared to $12.8 million, or $0.47 per diluted share, for the quarter ended June 30, 2008, and $22.2 million, or $0.77 per diluted share, for the quarter ended September 30, 2007. The decrease in net operating earnings for the third quarter of 2008 compared to the prior quarter is attributed mostly to a higher provision for credit losses. The decrease in net
operating earnings for the third quarter of 2008 compared to the same quarter in 2007 is attributed to lower net interest income, a higher provision for credit losses and higher noninterest expense.
Net operating earnings total $24.6 million, or $0.90 per diluted share, for the nine months ended September 30, 2008 compared to $74.0 million, or $2.55 per diluted share, for the nine months ended September 30, 2007. The decrease in net operating earnings for the year-to-date period is attributed to lower net interest income, a higher provision for credit losses, lower noninterest income and higher noninterest expense. The decrease in net interest income relates mostly to the decline in market interest rates and lower loan balances resulted mostly from the sale of a participating interest in approximately $353 million in commercial real estate mortgage loans in March 2007 combined with our effort to reduce our nonowner-occupied residential loan exposure. The decrease in noninterest income is due mostly to lower gain on sale of loans and lower income related to discounts recognized on acquired loans that have since been repaid.
Net Interest Income. Net interest income, which is our principal source of revenue, represents the difference between interest earned on assets and interest paid on liabilities. Net interest margin is net interest income expressed as a percentage of average interest-earning assets. Net interest income is affected by changes in both interest rates and the volume of average interest-earning assets and interest-bearing liabilities. The following tables present, for the periods indicated, the distribution of
average assets, liabilities and stockholders' equity, as well as interest income and yields earned on average interest-earning assets and interest expense and costs on average interest-bearing liabilities:
Quarter Ended
September 30, 2008 June 30, 2008 September 30, 2007
Interest Yields Interest Yields Interest Yields
Average Income/ and Average Income/ and Average Income/ and
Balance Expense Rates Balance Expense Rates Balance Expense Rates
(Dollars in thousands)
ASSETS
Loans, net of
deferred fees and
costs(1)(2) $ 3,893,836 $ 68,712 7.02 % $ 3,970,704 $ 69,536 7.04 % $ 3,938,511 $ 85,649 8.63 %
Investment
securities(2) 136,383 1,808 5.27 % 146,840 1,861 5.10 % 96,672 1,268 5.20 %
Federal funds sold 4,837 23 1.89 % 4,549 23 2.03 % 47,931 605 5.01 %
Other earning assets 235 1 1.69 % 326 2 2.47 % 436 5 4.55 %
Total
interest-earning
assets 4,035,291 70,544 6.95 % 4,122,419 71,422 6.97 % 4,083,550 87,527 8.50 %
Noninterest-earning
assets:
Other assets 267,643 748,146 1,042,212
Total assets $ 4,302,934 $ 4,870,565 $ 5,125,762
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LIABILITIES AND STOCKHOLDERS' EQUITY Interest checking $ 351,863 $ 666 0.75 % $ 373,382 $ 690 0.74 % $ 355,303 $ 857 0.96 % Money market 995,617 4,384 1.75 % 1,085,945 4,875 1.81 % 1,136,201 9,290 3.24 % Savings 100,720 41 0.16 % 100,779 41 0.16 % 120,484 59 0.19 % Time certificates of deposit 502,456 3,910 3.10 % 426,654 3,313 3.12 % 451,900 4,718 4.14 % Total interest-bearing deposits 1,950,656 9,001 1.84 % 1,986,760 8,919 1.81 % 2,063,888 14,924 2.87 % Other interest-bearing liabilities 696,131 6,568 3.75 % 723,115 6,731 3.74 % 418,432 6,320 5.99 % Total interest-bearing liabilities 2,646,787 15,569 2.34 % 2,709,875 15,650 2.32 % 2,482,320 21,244 3.40 % Noninterest-bearing liabilities: Demand deposits 1,232,660 1,256,794 1,383,407 Other liabilities 47,233 48,801 55,386 Total liabilities 3,926,680 4,015,470 3,921,113 Stockholders' equity 376,254 855,095 1,204,649 Total liabilities and stockholders' equity $ 4,302,934 $ 4,870,565 $ 5,125,762 Net interest income $ 54,975 $ 55,772 $ 66,283 Net interest spread 4.61 % 4.65 % 5.10 % Net interest margin 5.42 % 5.44 % 6.44 % |
º (2)
º Yields on loans and securities have not been adjusted to a tax-equivalent
basis because the impact is not material.
Third quarter of 2008 compared to second quarter of 2008
Interest income declined $878,000 due mainly to lower average construction and commercial loan balances. On the funding side, interest expense decreased $81,000 compared to the second quarter of 2008 due to lower average borrowings.
Our net interest margin for the third quarter of 2008 was 5.42%, a decrease of 2 basis points when compared to the second quarter of 2008. There was virtually no effect from nonaccrual loans on the third quarter net interest margin and the net interest margin for the month of September was 5.39%. The yield on average loans was 7.02% for the third quarter of 2008 compared to 7.04% for the second quarter of 2008; the loan yield for the month of September was 7.05%. The yield on average earning assets was 6.95% for the third quarter of 2008 compared to 6.97% for the second quarter of 2008.
Third quarter of 2008 compared to the third quarter of 2007
The $11.3 million decrease in net interest income for the third quarter of 2008 compared to the same quarter of 2007 was mainly a result of lower loan yields. Loan interest income decreased $16.9 million as our average loan yields declined in line with the general decline in market interest rates which began in September 2007. Interest expense decreased $5.7 million for the third quarter of 2008 compared to the same quarter of 2007 due to a combination of lower funding costs and higher average FHLB borrowings. We continue to use FHLB advances to fund loan growth and deposit flows.
Our net interest margin for the third quarter of 2008 declined 102 basis points when compared to the third quarter of 2007. This decrease is due to a combination of lower loan yields, lower average
demand deposits and lower overall funding costs. The lower loan yield and cost of funds are due to the decline in market interest rates.
Nine Months Ended September 30,
2008 2007
Interest Yields Interest Yields
Average Income/ and Average Income/ and
Balance Expense Rates Balance Expense Rates
(Dollars in thousands)
ASSETS
Loans, net of deferred
fees and costs(1)(2) $ 3,961,008 $ 213,901 7.21 % $ 4,065,400 $ 260,875 8.58 %
Investment securities(2) 142,179 5,370 5.05 % 104,591 4,006 5.12 %
Federal funds sold 4,806 86 2.39 % 44,817 1,728 5.16 %
Other earning assets 295 6 2.72 % 473 17 4.81 %
Total
interest-earning
assets 4,108,288 219,363 7.13 % 4,215,281 266,626 8.46 %
Noninterest-earning
. . .
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