ITEM 1. BUSINESS
California First National Bancorp, a California corporation (the "Company"), is a bank holding company headquartered in Orange County, California with leasing and bank subsidiaries. The Company has two leasing subsidiaries, California First Leasing Corporation ("CalFirst Leasing") and Amplicon, Inc. ("Amplicon"), collectively the "Leasing Companies" and a bank subsidiary, California First National Bank ("CalFirst Bank" or the "Bank"), which is an FDIC-insured national bank.
The Leasing Companies and CalFirst Bank focus on leasing and financing capital assets, primarily computer systems and networks and other technology-based assets, through centralized marketing programs designed to offer cost-effective leasing alternatives. Leased assets are re-marketed at lease expiration through sale or re-lease. CalFirst Bank also purchases finance receivables from the Leasing Companies and other third parties, and is expanding into commercial loans. CalFirst Bank gathers deposits from a centralized location primarily through posting rates on the Internet.
Forward-Looking Statements
This Form 10-K contains forward-looking statements. Forward-looking statements include, among other things, information concerning our possible future consolidated results of operations, business and growth strategies, financing plans, our competitive position and the effects of competition. Forward-looking statements include all statements that are not historical facts and can be identified by forward-looking words such as "anticipate", "believe", "could", "estimate", "expect", "intend", "plan", "may", "should", "will", "would", "project" and similar expressions. These forward-looking statements are based on information currently available to us and are subject to inherent risks and uncertainties, and certain factors could cause actual results to differ materially from those anticipated. Some of the risks and uncertainties that may cause our actual results or performance to differ materially from such forward-looking statements are included in "Item 1A.
ITEM 1A. RISK FACTORS
There are a number of factors, including those specified below, that may adversely affect the Company's business, financial results or stock price. Additional risks that the Company currently does not know about or currently views as immaterial may also affect the Company's business or adversely impact its financial results or stock price.
Industry Risk Factors
The Company's business and financial results are subject to general business and economic conditions. The Company's business activities and earnings are affected by general business conditions in the United States. An economic downturn could result in a deterioration of credit quality of lessees, a change in the allowance for lease losses, or reduced demand for leasing capital assets. Changes in the financial performance and condition of lessees could negatively affect the repayment of receivables. In addition, changes in securities markets and monetary fluctuations could adversely affect the availability and terms of funding necessary to meet the Company's liquidity needs.
Changes in the domestic interest rate environment could reduce the Company's net direct finance and interest income. The Company's net direct finance and interest income, which is the difference between income earned on leases and investments and interest expense paid on deposits, is affected by market rates of interest, which in turn are affected by prevailing economic conditions, by the fiscal and monetary policies of the federal government and by the policies of various regulatory agencies.
California First National Bancorp and Subsidiaries
Disruptions in the domestic credit markets and interest rate environment, including changes in interest spreads and the yield curve, could reduce net interest income. Higher interest rates and the inability to access capital markets could negatively affect certain customers and result in increased lease losses.
Changes in the laws, regulations and policies governing financial services companies could alter the Company's business environment and adversely affect operations. The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its fiscal and monetary policies determine in a large part the Company's cost of funds and the return that can be earned on leases and investments, both of which affect the Company's net direct finance and interest income.
The Company and the Bank are regulated by governmental entities. This regulation is to protect depositors, federal deposit insurance funds and the banking system as a whole. Changes in statutes, regulations or policies could affect the Company in substantial and unpredictable ways. The Company cannot predict whether any potential legislation will be enacted, and if enacted, the effect that it or any regulations would have on the Company's financial condition or results of operations.
The financial services industry is highly competitive, and competitive pressures could intensify and adversely affect the Company's financial results. The Company operates in a highly competitive industry that could become even more competitive as a result of legislative, regulatory and technological changes. The Company competes with other commercial banks, savings and lease associations, mutual savings banks, finance companies, credit unions and investment companies, many of which have greater resources than the Company.
Acts or threats of terrorism and political or military actions taken by the United States or other governments could adversely affect general economic or industry conditions.
Company Risk Factors
The Company's allowance for lease losses may not be adequate to cover actual losses. The Company's subsidiaries have retained over 90% of lease transactions in their own portfolios, which has increased the exposure to credit risk. The Company maintains an allowance for lease losses to provide for probable and estimatable losses in the portfolio. The Company's allowance for lease losses is based on its historical experience as well as an evaluation of the risks associated with its lease portfolio, including the size and composition of the lease portfolio, current economic conditions and concentrations within the portfolio. The allowance for lease losses may not be adequate to cover losses resulting from unanticipated adverse changes in the economy or the financial markets. If the credit quality of the customer base materially decreases, or if the reserve for lease losses is not adequate, future provisions for lease losses could materially and adversely affect financial results.
The Company may suffer losses in its lease portfolio despite its underwriting practices. The Company seeks to mitigate the risks inherent in its lease portfolio by adhering to specific credit practices. Although the Company believes that its criteria are appropriate for the various kinds of leases it makes, the Company may incur losses on leases that meet these criteria.
The Company may be adversely affected by significant changes in interest rates. CalFirst Bank has grown to represent 50% of the Company's assets, and bank deposits now exceed $100 million As a result, the Company's sensitivity to changes in interest rates has increased from historical levels. Although the Bank employs a matched funding strategy designed to correlate the repricing characteristics of assets with liabilities, the impact of interest rates movements is not always consistent during different market cycles, and changes in the costs for deposits and yields on assets may not coincide.
The change in residual value of leased assets may have an adverse impact on the Company's financial results. A portion of the Company's leases is subject to the risk that the residual value of the property under lease will be less than the Company's recorded value. Adverse changes in the residual value of leased assets can have a negative impact on the Company's financial results. The risk of changes in the realized value of the leased assets compared to recorded residual values depends on many factors outside of the Company's control.
California First National Bancorp and Subsidiaries
The financial services business involves significant operational risks. Operational risk is the risk of loss resulting from the Company's operations, including, but not limited to, the risk of fraud by employees or persons outside of the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, the Company could suffer financial loss, face regulatory action and suffer damage to its reputation.
Quarterly operating results may fluctuate significantly. Operating results may differ from quarter to quarter due to a variety of factors, including the volume and profitability of leased property being remarketed, the size and credit quality of the lease portfolio, the interest rate environment, the volume of new lease originations, including variations in the property mix and funding of such originations and economic conditions in general. The results of any quarter may not be indicative of results in the future.
Negative publicity could damage the Company's reputation and adversely impact its business and financial results. Reputation risk, or the risk to the Company's business from negative publicity, is inherent in the Company's business. Negative publicity can result from the Company's actual or alleged conduct in any number of activities, including leasing practices, corporate governance, and actions taken by government regulators in response to those activities. Negative publicity can adversely affect the Company's ability to keep and attract customers and can expose the Company to litigation and regulatory action.
The Company's reported financial results are subject to certain assumptions and estimates and management's selection of accounting method. The Company's management must exercise judgment in selecting and applying many accounting policies and methods so they comply with generally accepted accounting principles and reflect management's judgment of the most appropriate manner to report the Company's financial condition and results. In some cases, management may select an accounting policy which might be reasonable under the circumstances yet might result in the Company's reporting different results than would have been reported under a different alternative.
Certain accounting policies are critical to presenting the Company's financial condition and results. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These critical accounting policies include the estimate of residual values, the allowance for lease losses, and income taxes. For more information, refer to "Critical Accounting Policies and Estimates".
Changes in accounting standards could materially impact the Company's financial statements. The Financial Accounting Standards Board (FASB) may change the financial accounting and reporting standards that govern the preparation of the Company's financial statements. These changes can be hard to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the Company's restating prior period financial statements.
Loss of certain key officers would adversely affect the Company's business.The Company's business and operating results are substantially dependent on the certain key employees, including the Chief Executive Officer, Chief Operating Officer, Senior Vice President of Credit, Chief Financial Officer, the President and Chief Credit Officer of the Bank and certain key sales managers. The loss of the services of these individuals, particularly the Chief Executive Officer, would have a negative impact on the business because of their expertise and years of industry experience.
California First National Bancorp and Subsidiaries
The Company's business could suffer if the Company fails to attract and retain qualified people. The Company's success depends, in large part, on its ability to attract and retain key people. Competition for personnel in most activities the Company engages in can be intense. The Company may not be able to hire the best people or to keep them.
The Company relies on other companies to provide components of the Company's business infrastructure. Third party vendors provide certain components of the Company's business infrastructure, such as the Bank's core processing and electronic banking systems, item processing, and Internet connections. While the Company has selected these third party vendors carefully, it does not control their actions. Any problems caused by these third parties not providing the Company their services for any reason or their performing their services poorly, could adversely affect the Company's ability to deliver products and services to the Company's customers and otherwise to conduct its business. Replacing these third party vendors could also entail significant delay and expense.
A natural disaster could harm the Company's business. Natural disasters could harm the Company's operations directly through interference with communications, including the interruption or loss of the Company's websites, which would prevent the Company from gathering deposits, originating leases and processing and controlling its flow of business, as well as through the destruction of facilities and the Company's operational, financial and management information systems.
The Company faces systems failure risks as well as security risks, including "hacking" and "identity theft." The computer systems and network infrastructure the Company and others use could be vulnerable to unforeseen problems. These problems may arise in both our internally developed systems and the systems of our third-party service providers. Our operations are dependent upon our ability to protect computer equipment against damage from fire, power loss or telecommunication failure. Any damage or failure that causes an interruption in our operations could adversely affect our business and financial results. In addition, our computer systems and network infrastructure present security risks, and could be susceptible to hacking or identity theft.
The Company relies on dividends from its subsidiaries for its liquidity needs. The Company is a separate and distinct legal entity from the Leasing Companies and the Bank. The Company receives substantially all of its cash from dividends paid by the Leasing Companies. These dividends are the principal source of funds to pay dividends on the Company's stock. Various regulations limit the amount of dividends that the Bank may pay to the Company.
The Company's stock price can be volatile. The Company's stock price can fluctuate widely in response to a variety of factors, including: actual or anticipated variations in the Company's quarterly operating results; operating and stock price performance of other companies that investors deem comparable to the Company; news reports relating to trends, concerns and other issues in the financial services industry, and changes in government regulations. General market fluctuations, industry factors and general economic and political conditions and events, including terrorist attacks, economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations, could also cause the Company's stock price to decrease regardless of the Company's operating results. In addition, the volume of trading in the Company's stock is very limited and can result in fluctuations in prices between trades.
The Company is a "controlled company" as defined by NASDAQ, with over 50% of the stock held by the Chief Executive Officer, over 65% held by two senior executives and fewer than 100 shareholders of record.As a result, senior management has the ability to exercise significant influence over the Company's policies and business, and determine the outcome of corporate actions requiring stockholder approval. These actions may include, for example, the election of directors, the adoption of amendments to corporate documents, the approval of mergers, sales of assets and the continuation of the Company as a registered company with obligations to file periodic reports and other filings with the SEC.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
California First National Bancorp and Subsidiaries
ITEM 2.
ITEM 2. PROPERTIES
At June 30, 2007, the Company and its subsidiaries occupied approximately 49,000 square feet of office space in Irvine, California leased from an unaffiliated party. The lease provides for monthly rental payments that average $92,708 from July 2007 through August 2008.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is sometimes named as a defendant in litigation relating to its business operations. Management does not expect the outcome of any existing suit to have a material adverse effect on the Company's financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The common stock of California First National Bancorp trades on the NASDAQ Global Market System under the symbol CFNB. The following high and low closing sale prices for the periods shown reflect inter-dealer prices without retail markup, markdown or commissions and may not necessarily reflect actual transactions.
The Company had approximately 29 stockholders of record and in excess of 400 beneficial owners as of September 3, 2007.
The Board of Directors of the Company has adopted a policy of paying regular quarterly cash dividends, subject to an ongoing review of the Company's profitability, liquidity and future operating cash requirements. On December 15, 2004, the Company paid a special dividend of $2.00 per outstanding common share, which totaled $22.2 million, to stockholders of record on December 1, 2004. The Board of Directors approved an increase in the quarterly dividend from $.10 to $.11 per share in January 2006, and in January 2007, approved an increase in the quarterly dividend to $.12 per share. For the fiscal years ended June 30, 2007, 2006, and 2005, the Company declared cash dividends totaling $.46, $.42 and $2.30, respectively, per common share.
California First National Bancorp and Subsidiaries
Common Stock Performance Graph
The graph below shows a comparison of the five-year cumulative return among the Company, the NASDAQ Composite Index and the Russell 2000. As required by Securities and Exchange Commission rules, total return in each case assumes the reinvestment of dividends paid.
California First National Bancorp and Subsidiaries
In April 2001, the Board of Directors authorized management, at its discretion, to repurchase up to 1,000,000 shares of common stock. Since this authorization has no termination date, the Board of Directors reviews the authorization to repurchase common stock from time to time. During the year ended June 30, 2007, the Company repurchased 108,621 shares of common stock. During the years ended June 30, 2006 and 2005, the Company did not repurchase any common stock. As of September 3, 2007, 504,335 shares remain available under this authorization. The following table summarizes share repurchase activity for the quarter ended June 30, 2007:
Equity Compensation Plan Information
The following table provides information about shares of the Company's Common Stock that may be issued upon the exercise of options under all of our existing equity compensation plans as of June 30, 2007.
(1)
The maximum number of shares that may be issued under the equity compensation plan increases each year by an amount equal to 1% of the total number of issued and outstanding shares of Common Stock as of June 30 of the fiscal year immediately preceding such fiscal year.
California First National Bancorp and Subsidiaries
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data and operating information of the Company and its subsidiaries. The selected financial data should be read in conjunction with the Financial Statements and notes thereto and Management's Discussion and Analysis of Results of Operations and Financial Condition contained herein.
California First National Bancorp and Subsidiaries
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Company's results include the operations of CalFirst Leasing, Amplicon, and CalFirst Bank. The Company's direct finance income includes interest income earned on the Company's investment in lease receivables and residuals. Other income primarily includes gains realized on the sale of leased property, income from sales-type and operating leases and gains realized on the sale of leases, and other fee income. Income from sales-type leases relates to the re-lease of off-lease property ("lease extensions") and new lease transactions that qualify as sales-type leases, generally where the fair value of the property subject to the lease differs from the Company's carrying cost. Income from operating leases generally involves lease extensions that are booked as operating leases rather than as a sales-type leases.
The Company's operating results are subject to quarterly fluctuations resulting from a variety of factors, including the volume and profitability of leased property being re-marketed through re-lease or sale, the size and credit quality of the lease portfolio, the interest rate environment, the volume of new lease originations, including variations in the mix and funding of such originations, and economic conditions in general. The Company's principal market risk exposure is interest rate risk, which is the exposure due to differences in the repricing characteristics of interest-earning assets and interest-bearing liabilities. The Company's interest-bearing liabilities represent about 34% of earning assets, and therefore, changes in interest rates in general have a greater impact on the income earned on the investment in lease receivables, securities and other interest earning assets, with less impact from higher or lower interest expense. Distortions in the yield curve can result in some impact on earnings due to the compression or widening of the difference between earning asset yields and funding costs.
The Company conducts its business in a manner designed to mitigate risks. However, the assumption of risk is a key source of earnings in the leasing and banking industries and the Company is subject to risks through its investment in lease receivables held in its own portfolio, lease transactions in process, and residual investments. The Company takes steps to manage risks through the implementation of strict credit management processes and on-going risk management review procedures.
Critical Accounting Policies and Estimates
The preparation of the Company's financial statements requires management to make certain critical accounting estimates that impact the stated amount of assets and liabilities at a financial statement date and the reported amount of income and expenses during a reporting period. These accounting estimates are based on management's judgment and are considered to be critical because of their significance to the financial statements and the possibility that future events may differ from current judgments, or that the use of different assumptions could result in materially different estimates. The following is a description of the most critical accounting policies management applies, all of which require the use of accounting estimates and management's judgment, based on the relevant information available at the end of each period.
Allowance for Lease Losses -- The allowance for lease losses provides coverage for probable and estimatable losses in the Company's lease portfolios. The allowance recorded is based on a quarterly review of all leases outstanding and transactions in process. The determination of the appropriate amount of any provision is based on management's judgment at that time and takes into consideration all known relevant internal and external factors that may affect the lease portfolio, including levels of non-performing leases, lessees' financial condition, leased property values as well as general economic conditions and credit quality indicators. The Company's allowance includes an estimate of reserves needed to cover specifically identified lease losses and certain unidentified but inherent risks in the portfolio.
Residual Values -- For capital leases that qualify as direct financing leases, the aggregate lease payments receivable and estimated residual value, if any, are recorded on the balance sheet, net of unearned income and allowances, as net investment in capital leases. Of the volume of capital leases booked during the fiscal years ended June 30, 2007, 2006 and 2005, approximately 25.3%, 30.4% and 30.1%, respectively, were structured such that the Company owns the leased asset at the end of the term and therefore, the Company recorded a residual value. The residual value is an estimate for accounting purposes of the fair value of the leased property at lease termination and is determined at the inception of the lease based on the property leased and the terms and conditions of the underlying lease contract. The realizability of any estimated residual value depends on future collateral values, contractual options available to the lessee, the credit of the lessee, market conditions and other subjective and qualitative factors. The estimated residual values established at lease inception are periodically reviewed to determine if values are realizable and any identified losses are recognized at such time.
California First National Bancorp and Subsidiaries
Deferred Income Taxes and Valuation Allowance -- Deferred tax assets and liabilities result from temporary differences between the time income or expense items are recognized for financial statement purposes and for tax reporting. Such amounts are calculated using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. The determination of current and deferred income taxes is based on complex analyses of many factors including interpretation of Federal and state income tax laws, the difference between tax and financial reporting basis of assets and liabilities (temporary differences), estimates of amounts due or owed such as the timing of reversals of temporary differences and current financial accounting standards. A valuation allowance is established if, based upon the relevant facts and circumstances, management believes that some or all of certain tax assets will not be realized. The Company has open tax years that may in the future be subject to examination by federal and state taxing authorities. Management periodically evaluates the adequacy of related valuation allowances, taking into account our open tax return positions, tax assessments received and tax law changes. The process of evaluating allowance accounts involves the use of estimates and a high degree of management judgment. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities and reserves.
The Company's estimates are reviewed continuously to ensure reasonableness. However, the amounts the Company may ultimately realize could differ from such estimated amounts.
Overview of Results, Trends and Outlook
Net earnings for the year ended June 30, 2007 of $9.9 million were down 7.8% from the $10.7 million from the prior year. The decline was due to over a 45% reduction in income from end of term transactions, partially offset by a 30.4% increase in net direct finance and interest income after provision for lease losses. Selling, general and administrative expenses ("SG&A") remained relatively flat for fiscal 2007 compared to fiscal 2006. For the year ended June 30, 2007, new lease bookings of $155.4 million were below the $163.8 million booked in the prior year. Of the new leases booked during fiscal 2007, approximately 97% were retained in the Company's own portfolios, compared to 91% in fiscal 2006. Consequently, the net investment in capital leases of $231.8 million at June 30, 2007 increased 8% from June 30, 2006. The Bank accounted for almost all of the growth in assets, with the Bank's investment in capital leases of $127.5 million at June 30, 2007 representing 55% of the Company's consolidated investment. To fund this portfolio, the Bank's demand, money market and time deposits increased by 18% to $105.5 million from $89.2 million at June 30, 2006.
During fiscal 2007, the Company benefited from a rising interest rate environment, with the average yield on leases held in its own portfolio increasing by about 160 basis points. In addition, yields on cash and other interest-earning investments improved by 100 basis points. However, part of these gains was offset by the growth in deposits at the Bank and an increase in average interest rates paid by 100 basis points.
New lease transactions approved ("lease originations") of approximately $171 million during fiscal 2007 were down 8.2% from $187 million in fiscal 2006. However, the backlog of approved but un-booked leases at June 30, 2007 is about 4% above the level of a year ago. Property acquired for transactions in process of $35 million was down 17% from to the level at June 30, 2006.
Looking forward to fiscal 2008, management will continue to focus efforts on expanding the volume of lease originations, but any such achievement is dependent upon economic and other circumstances that are beyond management's control. In addition, attention is being focused on the development of a commercial loan business, which is not expected to contribute meaningfully to asset growth during fiscal 2008. Based on the net investment in capital leases at June 30, 2007 and the current backlog of approved leases, the volume of leases estimated to be booked in 2008 should be in line with 2007. As a result, direct finance income should increase from the 2007 level, but the rate of growth is expected to be substantially below the rate experienced in fiscal 2007. The Company's estimated residual values maturing over the next 12 months is $2.9 million at June 30, 2007, 15% below the $3.4 million at June 30, 2006 and compared to $5.6 million at June 30, 2005. As a result, management expects the decline in other income to be substantially less than in 2007. The ultimate growth in direct finance income or outcome with respect to the investment in residual values is subject to a variety of factors including the impact of credit markets, interest rates, lessee's financial condition and choices. All these factors are beyond management's control and therefore any expectations are subject to change.
California First National Bancorp and Subsidiaries
Consolidated Statement of Earnings Analysis
Summary -- For the fiscal year ended June 30, 2007, net earnings decreased 7.8% to $9.9 million, compared to $10.7 million for fiscal 2006. Diluted earnings per share decreased 8.4% to $0.86 for fiscal year ended June 30, 2007, compared to $0.94 per share for fiscal 2006. Net earnings reflect an increase in direct finance income and a reduction in the provision for lease losses offset by higher interest expense on deposits, and lower profits from end of term transactions. SG&A expense levels remained flat.
Net Direct Finance and Interest Income -- Net direct finance and interest income is the difference between interest earned on the investment in capital leases, securities and other interest earning investments and interest paid on deposits or other borrowings. Net direct finance and interest income is affected by changes in the volume and mix of interest earning assets and liabilities, the movement of interest rates, and funding and pricing strategies.
Net direct finance and interest income was $22.2 million for the fiscal year ended June 30, 2007 compared to $17.6 million for fiscal 2006 and $15.5 million in fiscal 2005. The 26.1% increase in fiscal 2007 from fiscal 2006 was due to an increase of $6.0 million in direct finance income and $728,000 in interest income on cash and investments, offset by a $2.1 million increase in interest expense on deposits. The increase in direct finance income reflects a 13.2% increase in the average investment in capital leases directly held by the Company, and a 160 basis point improvement in average yields on such investment. The increase in interest income on cash and investments resulted from a 100 basis point increase in average yield and an 18% increase in the average balances.
The increase in net direct finance income in fiscal 2006 was due to an increase of $3.4 million in direct finance income and a $320,000 increase in interest income earned on cash and investments, offset by a $1.5 million increase in interest expense on deposits. The increase in direct finance income reflected an 18.3% increase in the average investment in capital leases directly held by the Company and a 20 basis point increase in average yields on such investment. The increase in interest income on cash and investments resulted from the increase in interest rates earned offset by a decrease in the level of average balances.
The following table presents the components of the increases (decreases) in net direct finance and interest income by volume and rate:
California First National Bancorp and Subsidiaries
The following table presents the Company's average balance sheets, direct finance income and interest earned or interest paid, the related yields and rates on major categories of the Company's interest-earning assets and interest-bearing liabilities:
(1)
Direct finance income and interest expense on average discounted lease rentals and non-recourse debt of $7.4 million, $7.2 million and $11.7 million at June 30, 2007, 2006 and 2005, respectively, offset each other and do not contribute to the Company's net interest and finance income. Average balance is based on month-end balances, includes non-accrual leases, and is presented net of unearned income.
California First National Bancorp and Subsidiaries
Provision for Lease Losses -- The Company recorded a negative provision for lease losses of $120,000 in fiscal 2007 due to a recovery of $633,000 received early in the year. Separate from this recovery, the deterioration in the credit quality of certain leases during the first nine months of the year required a provision of $513,000. The net recovery of $120,000 compared to a provision of $482,000 in fiscal 2006 and $359,000 in fiscal 2005. The provisions made in fiscal 2005 and fiscal 2006 primarily related to 14% growth in the net investment in capital leases in fiscal 2006 and 22% growth in fiscal 2005, along with some increase in the risk profile of the portfolio during fiscal 2005.
Other Income -- Other income accounted for 29% of the Company's gross profit during the year ended June 30, 2007, compared to 48% during 2006 and 49% during 2005. Total other income of $9.2 million for the year ended June 30, 2007 decreased $6.5 million, or 42%, from $15.7 million in 2006 and $5.3 million, or 37%, below the level earned in 2005. The decrease in other income in fiscal 2007 compared to fiscal 2006 primarily reflects a decrease of $6.8 million in gain on sale of leases and leased property as a significantly lower volume of leases came to the end of term during the period. Operating and sales-type lease income declined $68,000, reflecting only a slight decrease in lease extensions when compared to the prior year. Other fee income increased $391,000 to $1.2 million.
The increase in other income in fiscal 2006 compared to fiscal 2005 primarily reflected an increase of $1.4 million in gain on sale of leases and leased property as the volume of leased property sold on leases coming to end of term increased during the period. Operating and sales-type lease income increased by $119,000, reflecting only a slight increase in lease extensions when compared to the prior year. Other fee income decreased $311,000 to $780,000.
Selling, General, and Administrative Expenses -- The Company's selling, general and administrative expenses ("SG&A") increased $188,000, or 1%, to $15.5 million recognized for the year ended June 30, 2007. This compared to SG&A expenses in fiscal 2006 of $15.3 million, which had decreased by $761,000, or 5%, from $16.0 million in fiscal 2005. The increase in SG&A expenses during fiscal 2007 is due to higher costs resulting from the growth in the sales force, which offset the benefit from lower variable costs resulting from efforts to control costs.
The decrease in SG&A expenses during fiscal 2006 compared to fiscal 2005 is due to lower costs resulting from a slightly smaller sales force and lower variable costs resulting from efforts to control costs. SG&A expenses in fiscal 2006 also reflect a lower deferral of initial direct costs of $3.6 million, compared to $4.0 million in fiscal 2005.
Income Taxes -- Income taxes were accrued at a tax rate of 38.25% for the fiscal year ended June 30, 2007 compared to 38.75% for fiscal year ended June 30, 2006, and 38.5% for fiscal year ended June 30, 2005 representing the Company's estimated annual tax rates for each respective year. The income tax rate decreased in fiscal 2007 due in part to an increased volume of leases where interest earned is exempt from certain taxes. Tax-exempt leases represented approximately 8.1% of new lease bookings in fiscal 2007, compared to 7.7% during fiscal 2006 and 13% in fiscal 2005.
Financial Condition Analysis
Lease Portfolio Analysis
The Company currently funds a high percentage of new lease transactions internally, while only a small portion of leases are assigned to financial institutions. During the fiscal year ended June 30, 2007, approximately 97% of the total dollar amount of new leases booked by the Company were held in its own portfolio, compared to 91% during fiscal 2006 and 93% during fiscal 2005. During the fiscal year ended June 30, 2007, the Company's net investment in capital leases increased by $17.9 million. This increase includes a $17.8 million increase in the Company's investment in lease receivables, and a $108,000 increase in the investment in estimated residual values. The increase in the investment in capital leases is primarily due to the higher volume of new lease transactions retained by the Company, while the increase in investment in residual values is due to a slightly higher volume of residual values being booked on new leases on which the Company retains a residual investment than the volume of residual values being recognized at end of term.
California First National Bancorp and Subsidiaries
The Company often makes payments to purchase leased property prior to the commencement of the lease. The disbursements for these lease transactions in process are generally made to facilitate the lessees' property implementation schedule. The lessee generally is contractually obligated by the lease to make rental payments directly to the Company during the period that the transaction is in process, and obligated to reimburse the Company for all disbursements under certain circumstances. Income is not recognized while a transaction is in process and prior to the commencement of the lease. At June 30, 2007, the Company's investment in property acquired for transactions in process was $34.7 million, down from $41.7 million at June 30, 2006, but even with $34.1 million at June 30, 2005.
The Company's risk assets are comprised almost exclusively of leases for capital assets to businesses and other commercial or non-profit organizations. All leases are secured by the underlying property being leased. The Company's strategy is to develop lease portfolios with risk/reward profiles that meet its objectives. Through the use of non-recourse financing, the Company avoids risks that do not meet these requirements. The strategy emphasizes diversification on both a geographic and customer level, and spreading the Company's risk across a breadth of leases while minimizing the risk to any one customer. At June 30, 2007, no lessee accounted for more than 3% of the Company's net investment in capital leases, and two lessees combined represented less than 5% of the Company's net investment in capital leases. The investment in capital leases is diversified by geographic regions, with the Company's portfolio spread across all fifty states. At June 30, 2007, California (16%) was the only state that represented more than 10% of the Company's net investment in capital leases. The Company has no exposure to foreign lessees. The Company's leases are with lessees in a wide spectrum of industries; however, at June 30, 2007 approximately 35% of the Company's net investment in capital leases was with public and private colleges, universities, elementary and secondary schools located throughout the United States. No other industry sector represented more than 10%. The educational portfolio includes over 698 leases with over 343 different lessees. One university represented approximately 2% of the Company's net investment in capital leases. The Company believes the exposure to this sector is warranted based on the historically good credit profile of this group.
The Company monitors the performance of all leases held in its own portfolio, transactions in process, as well as lease transactions assigned to lenders, if the Company retains a residual investment in the leased property subject to those leases. An ongoing review of all leases ten or more days delinquent is conducted. Lessees who are delinquent with the Company or an assignee are coded in the Company's accounting and tracking systems in order to provide management visibility, periodic reporting, and appropriate reserves. The accrual of interest income on leases will be discontinued when the lessee becomes ninety days or more past due on its lease payments with the Company, unless the Company believes the investment is otherwise recoverable. Leases may be placed on non-accrual earlier if the Company has significant doubt about the ability of the lessee to meet its lease obligations, as evidenced by consistent delinquency, deterioration in the lessee's financial condition or other relevant factors.
The following table summarizes the Company's non-performing capital leases.
Non-performing assets decreased during fiscal 2007 due primarily to write-offs taken and payments received. The restructured lease balance continues to be influenced by Hurricane Katrina vicinity leases, which are characterized as restructured due to accommodations provided to the lessees affected in that area. Direct finance income that would have been recorded had non-accrual leases at each respective fiscal year end been current in accordance with their original terms would have been $148,655, $46,395 and $96,429 during fiscal 2007, 2006 and 2005, respectively. The amount of direct finance income actually recorded on non-performing capital leases was $173,620, $60,961 and $71,297 during fiscal 2007, 2006 and 2005, respectively.
California First National Bancorp and Subsidiaries
In addition to the non-performing capital leases identified above, there were $733,000 of investment in capital leases at June 30, 2007 for which management has concerns regarding the ability of the lessees to continue to meet existing lease obligations, compared with $1.8 million at June 30, 2006. This amount consists of leases classified as substandard or doubtful, or with lessees that currently are experiencing financial difficulties or that management believes may experience financial difficulties in the future. Although these leases have been identified as potential problem leases, they may never become non-performing. These potential problem leases are considered in the determination of the allowance for lease losses. The decrease in amount at June 30, 2007 reflects the pay-off of special mention credits from the prior year, which offset the addition of other substandard leases.
Allowance for Lease Losses
The allowance for lease losses and the residual valuation allowance provide coverage for probable and estimatable losses in the Company's lease portfolios. The allowance recorded is based on a quarterly review of all leases outstanding and transactions in process. Lease receivables or residuals are charged off when they are deemed completely uncollectible. The determination of the appropriate amount of any provision is based on management's judgment at that time and takes into consideration all known relevant internal and external factors that may affect the lease portfolio.
The allowance for lease losses decreased to $3.34 million (1.4% of net investment in capital leases) at June 30, 2007 from $3.64 million (1.7% of net investment in capital leases) at June 30, 2006. The allowance at June 30, 2007 consisted of $912,900 allocated to specific accounts that were considered impaired and $2.43 million that was available to cover losses inherent in the portfolio. This compared to $752,900 allocated to specific impaired accounts at June 30, 2006 and $2.88 million that was available to cover losses inherent in the portfolio at such date. The allowance allocated to specific accounts increased $160,000 while the unallocated allowance decreased $455,000 during fiscal 2007. The decrease in the 2007 unallocated allowance reflects higher specific reserves provided for at the Leasing Companies, while most growth in lease portfolio has occurred within CalFirst Bank, which tends to be of higher credit quality, and therefore includes lower inherent losses. At June 30, 2007, the volume of transactions in process was down 17% from the end of the prior year, however the volume of unfunded lease commitments increased 19%. Based on the above factors, the Company considers the allowance for doubtful accounts of $3.3 million at June 30, 2007 adequate to cover losses specifically identified as well as inherent in the lease portfolios. However, no assurance can be given that the Company will not, in any particular period, sustain lease losses that are sizeable in relation to the amount reserved, or that subsequent evaluations of the lease portfolio, in light of factors then prevailing, including economic conditions and the on-going credit review process, will not require significant increases in the allowance for lease losses. Among other factors, a continued economic slowdown may have an adverse impact on the adequacy of the allowance for lease losses by increasing credit risk and the risk of potential loss even further. As the Company has retained a significantly greater percentage of leases in its own portfolio, this creates increased exposure to delinquencies, repossessions, foreclosures and losses than the Company has historically experienced.
California First National Bancorp and Subsidiaries
Liquidity and Capital Resources
The Company funds its operating activities through internally generated funds, bank deposits, non-recourse debt, and as necessary, through access to credit facilities. At June 30, 2007 and 2006, the Company's cash and cash equivalents were $46.1 million and $40.7 million, respectively. Stockholders' equity at June 30, 2007 was $197.7 million, or 60% of total assets, compared to $193.5 million, or 62% of total assets, at June 30, 2006. At June 30, 2007, the Company and the Bank exceed their regulatory capital requirements and are considered "well-capitalized" under guidelines established by the FRB and the OCC.
Deposits at CalFirst Bank totaled $105.5 million at June 30, 2007, compared to $89.2 million at June 30, 2006. The $16.3 million increase was used to fund leases and maintain liquidity at the Bank. Average deposit balances have risen steadily over the past three years commensurate with the growth in the Bank's lease portfolio. The Bank is competitive with major institutions in terms of its structure of interest rates, and generally offers interest rates on deposit accounts that are higher than the national average. Rates paid by the Bank on deposits have risen in varying degrees in response to the general increase in market rates. The following table presents average balances and average rates paid on deposits for years ended June 30, 2007, 2006 and 2005:
The following table shows the maturities of certificates of deposits at the dates indicated:
The Leasing Companies' capital expenditures for leased property purchases are sometimes financed by assigning certain base lease term payments to banks or other financial institutions, including CalFirst Bank. The assigned lease payments are discounted at fixed rates such that the lease payments are sufficient to fully amortize the aggregate outstanding debt. At June 30, 2007, the Company had outstanding non-recourse debt aggregating $6.2 million relating to property under capital leases assigned to unaffiliated parties. In the past, the Company has been able to obtain adequate non-recourse funding commitments, and the Company believes it will be able to do so in the future.
California First National Bancorp and Subsidiaries
The Leasing Companies also have access to a $25 million line of credit with a bank ("Lender"). The purpose of the line is to provide resources as needed for investment in transactions in process and capital leases. The agreement provides for borrowings based on the Lender's prime rate or LIBOR, at the Leasing Companies' option, requires a commitment fee on the unused line balance and allows for advances through March 31, 2008. The agreement is unsecured; however, the Leasing Companies' obligations are guaranteed by the Company. Under the provisions of the agreement, the Leasing Companies must maintain a minimum net worth and profitability. Pursuant to the agreement, the Leasing Companies are prohibited from repaying any indebtedness owed by them to the Company. A repayment of principle to the Company was made during fiscal 2007, and the Lender waived compliance with the covenant for the period in which it occurred. No borrowings have been made under this line of credit as of August 31, 2007.
Contractual Obligations and Commitments
The following table summarizes various contractual obligations to make and receive future payments at June 30, 2007. Commitments to purchase property for unfunded leases are binding and generally have fixed expiration dates or other termination clauses. Since the Company expects some of the commitments to expire without being funded, the total commitment amounts do not necessarily represent the Company's future liquidity requirements.
(1)
Disbursements to purchase property on approved leases are estimated to be completed within one year, but it is likely that some portion could be deferred to fiscal 2009.
(2)
Does not include amounts to be received related to transactions-in-process already funded and the unfunded lease property purchases included above, which together aggregate to $122.7 million at June 30, 2007. The timing and amount of repayment cannot be determined until a lease commences.
(3)
Based upon contractual cash flows; amounts could differ due to prepayments, lease restructures, charge-offs and other factors.
The need for cash for operating activities will increase as the Company expands. The Company believes that existing cash balances, cash flow from operations, cash flows from its financing and investing activities, and assignments (on a non-recourse basis) of lease payments will be sufficient to meet its foreseeable financing needs.
Inflation has not had a significant impact upon the operations of the Company.
Recent Accounting Pronouncements
See Note 1, "Summary of Significant Accounting Policies," of the Company's consolidated financial statements for disclosure of recent accounting pronouncements.
California First National Bancorp and Subsidiaries
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising from changes in market indices such as interest rates and equity prices. The Company's principal market risk exposure is interest rate risk, which is the exposure due to differences in the repricing characteristics of interest-earning assets and interest-bearing liabilities. The Company's balance sheet structure is primarily short-term in nature, with a greater portion of assets that reprice or mature within one year. As a result, the Company's exposure to interest rate risk largely results from declines in interest rates and the impact on net direct finance and interest income.
At June 30, 2007, the Company had $46.1 million invested in securities of very short duration, including $24.4 million in federal funds sold and securities purchased under agreements to resell. The Company's gross investment in lease payments receivable of $253.8 million consists of leases with fixed rates, however, $109.5 million of such investment is due within one year of June 30, 2007. This compares to the Bank's interest bearing deposit liabilities of $105.5 million, 75% of which mature within one year. The Leasing Companies have no interest-bearing debt, and non-recourse debt does not represent an interest rate risk to the Company because it is fully amortized through direct payments from lessees to the purchaser of the lease receivable. Based on the foregoing, at June 30, 2007, the Company had assets of $155.6 million subject to changes in interest rates over the next twelve months, compared to repricing liabilities of $79.1 million. Given the current structure of the consolidated balance sheet, if interest rates decrease, interest income on the Company's short-term investment position decreases, and future lease rates from direct financing leases, which often are based on United States Treasury rates, will tend to be lower. Conversely, as interest rates rise, the Company's earnings will benefit as yields on cash investments and lease investments improve, with less offsetting impact from rising interest expense.
As the banking operations of the Company have grown and the Bank's deposits represent a greater portion of the Company's assets, the Company is subject to increased interest rate risk. The Bank has an Asset/Liability Management Committee and policies established to manage its interest rate risk. The Bank measures its asset/liability position through duration measures and sensitivity analysis, and calculates the potential effect on earnings using maturity gap analysis. The interest rate sensitivity modeling includes the creation of prospective twelve month "baseline" and "rate shocked" net interest income simulations. After a "baseline" net interest income is determined, using assumptions that the Bank deems reasonable, market interest rates are raised or lowered by 100 to 300 basis points instantaneously, parallel across the entire yield curve, and a "rate shocked" simulation is run. Interest rate sensitivity is then measured as the difference between calculated "baseline" and "rate shocked" net interest income.
California First National Bancorp and Subsidiaries
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements and supplementary financial information are included herein at the pages indicated below:
California First National Bancorp and Subsidiaries
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of California First National Bancorp
We have audited the accompanying consolidated balance sheets of California First National Bancorp and Subsidiaries as of June 30, 2007 and 2006 and the related consolidated statements of earnings, changes in stockholders' equity, and cash flows for each of the three years in the period ended June 30, 2007. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of California First National Bancorp and Subsidiaries as of June 30, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2007, in conformity with accounting principles generally accepted in the United States of America.
Vavrinek, Trine, Day & Co., LLP
Laguna Hills, California
September 4,
California First National Bancorp and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
The accompanying notes are an integral
part of these consolidated financial statements.
California First National Bancorp and Subsidiaries
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands, except share and per share amounts)
The accompanying notes are an integral
part of these consolidated financial statements.
California First National Bancorp and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except for share amounts)
The accompanying notes are an integral
part of these consolidated financial statements.
California First National Bancorp and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral
part of these consolidated financial statements.
California First National Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies:
Nature of Operations
California First National Bancorp, a California corporation (the "Company") and its subsidiaries have two principal lines of business, leasing and banking. The Company leases high-technology and other capital assets to customers located throughout the United States. The Company is also engaged in the re-marketing of leased assets at lease expiration. The Company's banking subsidiary, California First National Bank ("CalFirst Bank") is an FDIC-insured national bank that gathers deposits using the telephone, the Internet, and direct mail from a centralized location and leases capital assets to businesses and organizations and provides business loans to fund the purchase of assets leased by third parties.
Basis of Presentation
The consolidated financial statements include the accounts of California First National Bancorp and its wholly owned subsidiaries, California First Leasing Corporation and Amplicon, Inc., (collectively, the "Leasing Companies"), and CalFirst Bank. All intercompany balances and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent 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.
Cash and Cash Equivalents
For purposes of these statements, cash and cash equivalents include cash in banks, cash in demand deposit accounts, money market accounts and federal funds sold, all of which have initial maturities of less than ninety days. Included in cash and cash equivalents at June 30, 2007 and 2006 was $25,954,581 and $18,789,000, respectively, that was held by the Bank and was only available to fund the Bank's operations.
Investment Securities
Investment securities that the Company has the intent and ability to hold until maturity are classified as "held-to-maturity" and are stated at cost adjusted for amortization of premium or accretion of discount under criteria established with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." All other securities are classified as available for sale and reported at fair value. Changes in unrealized gains and losses, net of related deferred taxes, for available-for-sale securities are recorded in comprehensive income. The Company did not have any "available for sale" securities at June 30, 2006.
Leases
Capital Leases
New lease transactions are generally structured as direct financing leases. The re-lease of property that has come off lease may be accounted for as a sales-type lease or as an operating lease, depending on the terms of the re-lease. Leased property that comes off lease and is re-marketed through a sale to the lessee or a third party is accounted for as sale of leased property.
For leases that qualify as direct financing leases, the aggregate lease payments receivable and estimated residual value, if any, are recorded on the balance sheet net of unearned income as net investment in capital leases. The unearned income is recognized as direct finance income on an internal rate of return method calculated to achieve a level yield on the Company's investment over the lease term. There are no costs or expenses related to direct financing leases since lease income is recorded on a net basis.
California First National Bancorp and Subsidiaries
For capital leases that qualify as sales-type leases, the Company recognizes profit or loss at lease inception to the extent the fair value of the property leased differs from the Company's carrying value. The difference between the discounted value of the aggregate lease payments receivable and the property cost, less the discounted value of the residual, if any, and any initial direct costs is recorded as sales-type lease income. For balance sheet purposes, the aggregate lease payments receivable, and estimated residual value, if any, are recorded on the balance sheet net of unearned income as net investment in capital leases. Unearned income is recognized as direct finance income over the lease term on an internal rate of return method.
The residual value is an estimate for accounting purposes of the fair value of the lease property at lease termination. The estimates are reviewed periodically to ensure reasonableness, however, the amounts the Company may ultimately realize could differ from the estimated amounts.
The Company assigns, on a non-recourse basis, the minimum lease payments receivable related to certain leases to financial institutions at fixed interest rates. When leases are assigned to unaffiliated financial institutions without recourse, the discounted value of the minimum lease payments receivable is recategorized on the balance sheet as discounted lease rentals assigned to lenders. The related obligations resulting from the discounting of the leases are recorded as non-recourse debt. The unearned income related to the lease is reduced by the interest expense from the non-recourse debt. In the event of default by a lessee, the lender has a first lien against the underlying leased property with no further recourse against the Company. If this occurs, the Company may not realize its residual investment in the leased property.
A portion of the Company's selling, general and administrative ("S,G&A") costs directly related to originating direct financing lease transactions is deferred through a reduction to SG&A expenses recognized in the period, with the deferred costs amortized over the lease term as a reduction to direct finance income utilizing the effective interest method.
Operating Leases
Lease contracts, which do not meet the criteria of capital leases, are accounted for as operating leases. Property on operating leases is recorded at the lower of cost or fair value and depreciated on a straight-line basis over the lease term to the estimated residual value at the termination of the lease. Most operating leases involve the re-lease of off-lease property and the associated cost is the Company's estimated residual. Rental income is recorded monthly or quarterly when due.
Allowance for Lease Losses
The allowance for lease losses and residual valuation allowance is periodically reviewed for adequacy considering levels of past due leases and non-performing assets, lessees' financial condition, leased property values as well as general economic conditions and credit quality indicators. The need for reserves is subject to future events, which by their nature are uncertain. Therefore, changes in economic conditions or other events affecting specific lessees or industries may necessitate additions or deductions to the allowance for lease losses or the residual valuation allowance.
Property Acquired for Transactions in Process
Property acquired for transactions in process represents partial deliveries of property which the lessee has accepted on in-process lease transactions. Such amounts are stated at cost, net of any lessee payments related to the property. Income is not recognized while a transaction is in process and prior to the commencement of the lease. At lease commencement, any pre-commencement payments are included in minimum lease payments receivable and the unearned income is recognized as direct finance income over the lease term.
California First National Bancorp and Subsidiaries
Earnings Per Share
Basic net income per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted net income per share includes the effect of the potential shares outstanding, including dilutive stock options, using the treasury stock method.
The following table reconciles the components of the basic net income per share calculation to diluted net income per share.
The Company did not include the following number of antidilutive stock options in its calculation of diluted earnings per share:
Recent Accounting Pronouncements
In June 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes." This Interpretation clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Guidance is also provided on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for the Company as of July 1, 2007. Based on the current assessment, the adoption of FIN No. 48 is expected to increase beginning retained earnings by $750,000 to $1.25 million upon adoption.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" ("SAB 108"). This guidance was issued to resolve diversity in current practice among registrants. The bulletin establishes that registrants must quantify the impact of correcting all misstatements on the financial statements by using both the rollover and iron curtain approaches to evaluate the errors. The rollover approach quantifies the misstatement based on the amount of the error originating in the current year income statement and the iron curtain approach quantifies a misstatement based on the amount of the error existing in the balance sheet at the end of the fiscal year. The bulletin contains guidance on correcting errors under the dual approach and transition guidance. The adoption of SAB 108 did not have a material impact on our financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." The statement defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The statement also establishes a framework for measuring fair value by creating a three-level fair value hierarchy that ranks the quality and reliability of information used to determine fair value, and requires new disclosures of assets and liabilities measured at fair value based on their level in the hierarchy. We do not expect the adoption of this statement to have a material impact on our financial position or results of operations.
California First National Bancorp and Subsidiaries
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities; including an Amendment of FASB Statement No. 115" ("FAS 159"). FAS 159 permits entities with an irrevocable option to report most financial assets and liabilities at fair value, with subsequent changes in fair value reported in earnings. The election can be applied on an instrument-by-instrument basis. The statement establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. The provisions of FAS 159 are effective for the fiscal year beginning July 1, 2008. The Company is currently evaluating the impact of the provisions of FAS 159.
Note 2 - Restatement:
Subsequent to the issuance of the Company's June 30, 2005 financial statements, the Company determined that (1) a restatement of prior period results needed to be made to correctly account for certain lease extensions as operating leases instead of as sales-type leases, and (2) certain information in the Consolidated Statements of Cash Flows should be restated to comply with the guidance under Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows" ("SFAS No. 95").
Accounting for Lease Extensions
A review of the accounting for lease extensions accounted for as sales-type leases identified that certain lease extensions classified as sales-type leases should have been classified as operating leases. The difference in lease classification results in different timing of income recognition within the extension term and a change in classification of such leases on the balance sheet from net investment in capital leases to property on operating leases.
The effect of the restatement on the Company's previously reported Consolidated Statement of Earnings for the year ended June 30, 2005 is as follows:
Consolidated Statement of Cash Flows
Certain reclassifications have been made to the Consolidated Statement of Cash Flows for the year ended June 30, 2005 in order to a) recognize cash flows related to the gain on sale of leased property and sales-type lease income as investing activities rather than operating activities, b) recognize cash flows related to property acquired for transactions in process as investing activities rather than as operating cash flows, and c) separately present cash outflows and inflows related to lease investments. The restatement solely affected the classification of these activities and the subtotals of cash flows from operating and investing activities presented in the Consolidated Statements of Cash Flows, but they had no impact on the net increase (decrease) in cash and cash equivalents set forth in such statement for any previously reported periods.
California First National Bancorp and Subsidiaries
The effect of the restatement on the Company's previously reported Consolidated Statement of Cash Flows for the year ended June 30, 2005 is as follows:
California First National Bancorp and Subsidiaries
Note 3 - Investment Securities:
The amortized cost, fair value, and carrying value of investment securities held at June 30, 2007 were as follows:
The unrealized loss on the Company's investment in the mortgaged-backed securities was caused by changes in interest rates. The contractual cash flows are guaranteed by an agency of the U. S. government, and accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company's investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and the Company has the ability and intent to hold those investments to maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2007.
There was no decline in the fair value of the investment available-for-sale below the cost that was deemed to be other than temporary at June 30, 2007.
The amortized cost, fair value, and carrying value of investment securities held at June 30, 2006 were as follows:
The amortized cost and estimated fair value of investment securities at June 30, 2007, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
California First National Bancorp and Subsidiaries
Note 4 - Receivables:
The Company's receivables consist of the following:
Note 5 - Capital Leases:
The Company's net investment in capital leases consists of the following:
The minimum lease payments receivable and estimated residual value are discounted using the internal rate of return method related to each specific capital lease. Unearned income includes the offset of initial direct costs of $4,609,693 and $4,275,670 at June 30, 2007 and 2006, respectively.
At June 30, 2007, a summary of the installments due on minimum lease payments receivable and the expected maturity of the Company's estimated residual value are as follows:
California First National Bancorp and Subsidiaries
A summary of the allowance for lease losses and selected statistics is as follows:
The allowance for lease losses set forth above does not include a valuation allowance of $68,000 that is recorded as an offset to Property acquired for transactions in process.
Non-recourse debt, which relates to the discounting of capital lease receivables, bears interest at rates ranging from 6.74% to 8.13%. Maturities of such obligations at June 30, 2007 are as follows:
Deferred interest expense of $555,000 at June 30, 2007 will be amortized against direct finance income related to the Company's discounted lease rentals assigned to lenders of $6,239,000 using the effective yield method over the applicable lease term.
Note 6 - Credit Facilities:
In March 2007, the Leasing Companies entered into amendment 1 to the $25 million line of credit with a bank ("Lender"). The agreement provides for borrowings based on the Lender's prime rate or LIBOR, at the Leasing Companies' option, requires a commitment fee on the unused line balance and allows for advances through March 31, 2008. The agreement is unsecured, however, the Leasing Companies' obligations are guaranteed by the Company. Under the provisions of the agreement, the Leasing Companies must maintain a minimum net worth and profitability. Pursuant to the agreement, the Leasing Companies are prohibited from repaying any indebtedness owed by them to the Company. A repayment of principle to the Company was made during fiscal 2007, and the Lender waived compliance with the covenant for the period in which it occurred. No borrowings have been made on this line of credit as of August 31, 2007.
Note 7 - Fair Value of Financial Instruments:
The Company has estimated the fair value of its financial instruments in compliance with Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments" ("SFAS No. 107"). For cash and cash equivalents and demand and savings deposits the estimated fair value is based on respective market prices, which was equal to book value for all periods presented. For investment securities, the fair values were based on quoted market prices when available. For securities, which had no quoted market prices, fair values were estimated by discounting cash flows using current rates on similar securities. For time certificates of deposits, the fair values were estimated by discounting cash flows using interest rates currently offered for like liabilities with similar terms. The fair value of the Company's net investment in capital leases is not a required disclosure under SFAS No. 107.
California First National Bancorp and Subsidiaries
The estimated fair values of financial instruments were as follows:
Note 8 - Income Taxes:
The Company accounts for its income taxes under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Among other provisions, this standard requires deferred tax balances to be determined using the enacted income tax rate for the years in which taxes will be paid or refunds received. From time to time, various governmental taxing authorities audit the Company. The Company believes that its accrual for income taxes is adequate for adjustments, if any, which may result from these examinations.
The provision for income taxes is summarized as follows:
California First National Bancorp and Subsidiaries
Deferred taxes result principally from the method of recording lease income on capital leases and depreciation methods for tax reporting, which differ from financial statement reporting. Deferred income tax liabilities (assets) are comprised of the following:
The differences between the federal statutory income tax rate and the Company's effective tax rate are as follows:
At June 30, 2007 and 2006, the Company had an income taxes receivable balance of $4,331,000 and $4,744,000, respectively.
Note 9 - Capital Structure and Stock-based Compensation:
At June 30, 2007, the Company has 20,000,000 authorized shares of common stock and is authorized to issue 2,500,000 shares of preferred stock, from time to time, in one or more series and to fix the voting powers, designations, preferences and the relative participating, optional or other rights, if any, of any wholly unissued series of preferred stock.
In November 1995, the Company's stockholders approved the 1995 Equity Participation Plan (the "1995 Plan"), which replaced a previous plan. The 1995 Plan provides for the granting of options, restricted stock and stock appreciation rights ("SARs") to key employees, directors and consultants of the Company. Under the 1995 Plan, the maximum number of shares of common stock that can be issued upon the exercise of options or SARs, or upon the vesting of restricted stock awards, was initially 1,000,000, but the maximum number of available shares of common stock could increase by an amount equal to 1% of the total number of issued and outstanding shares of common stock as of June 30 of the fiscal year immediately preceding such fiscal year. Each grant or issuance under the 1995 Plan is set forth in a separate agreement and indicates, as determined by the stock option committee, the type, terms, vesting period and conditions of the award.
On December 15, 2004, the Company paid a special dividend of $2.00 per outstanding common share, which totaled $22.2 million, to stockholders of record on December 1, 2004. In connection with the distribution, stock options under the Company's two stock option plans held by employees and directors of the Company that were not exercised prior to the distribution date were re-priced to preserve the economic benefit of the stock options at such time. The re-pricing was implemented in accordance with the provisions for an equity restructuring under FASB Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation -- an Interpretation of APB Opinion No. 25." Accordingly, no compensation expense resulted from the re-pricing of the options. However, because FIN 44 limited the re-pricing adjustments, an additional 136,618 options were granted in order to preserve the economic benefit of the stock options. The exercise price of the re-priced options range from $5.20 to $15.27.
California First National Bancorp and Subsidiaries
On July 1, 2005, the Company implemented Statement of Financial Accounting Standards 123(R), "Share-Based Payments" ("SFAS 123R") which replaced SFAS 123 and supercedes APB Opinion No. 25 and the related implementation guidance. SFAS 123R addresses accounting for equity-based compensation arrangements, including employee stock options. The Company adopted the "modified prospective method" where stock-based compensation expense is recorded beginning on the adoption date and prior periods are not restated. Under this method, compensation expense is recognized using the fair-value based method for all new awards granted after July 1, 2005. Additionally, compensation expense for unvested stock options that are outstanding at July 1, 2005 is recognized over the requisite service period based on the fair value of those options as previously calculated at the grant date under the pro-forma disclosures of SFAS 123. The fair value of each grant is estimated using the Black-Scholes option-pricing model.
During the years ended June 30, 2007 and 2006, the Company recognized pre-tax stock-based compensation expense of $132,108 and $187,348, respectively, as a result of adopting SFAS 123R. Such expense related to options granted during the fiscal years 2002 through 2004. The Company has not awarded any new grants since fiscal 2004 and has calculated the stock-based compensation expense based upon the original grant date fair value as allowed under SFAS 123R.
The following table summarizes activity related to stock options for the periods indicated:
(1)
All 2005 option grants were the result of the special dividend in December 2004, which resulted in all unexercised options as of the record date being re-priced under FIN 44 to preserve the economic benefit of the stock options at such time.
California First National Bancorp and Subsidiaries
At June 30, 2007, the aggregate intrinsic value of options outstanding and options exercisable were $4,890,000 and $4,706,000, respectively. The total intrinsic value of options exercised during the year ended June 30, 2007 was $340,000. As of June 30, 2007, approximately $75,000 of total unrecognized compensation expense related to unvested shares is expected to be recognized over a weighted average period of approximately 16 months.
Prior to the adoption to SFAS 123R on July 1, 2005, the Company accounted for stock-based awards using the intrinsic value method in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees. In accordance with Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), as amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," (SFAS No. 148), the Company adopted the disclosure requirements of SFAS No. 123 as amended by SFAS No. 148 through June 30, 2005.
The following table illustrates the effect on the year ended June 30, 2005 on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123, as amended by SFAS No. 148:
Note 10 - Regulatory Capital Requirements:
The Company and CalFirst Bank are subject to regulatory capital adequacy guidelines administered by federal banking agencies. Failure to meet minimum capital requirements can result in the initiation of certain actions by the federal agencies that, if undertaken, could have a material effect on the Company's financial statements. The Company currently is required to maintain (i) Tier 1 risked-based capital equal to at least six percent (6%) of its risk-weighted assets; (ii) total risked-based capital (the sum of Tier 1 and Tier 2 capital) equal to ten percent (10%) of risk-weighted assets; and (iii) a minimum Tier 1 "leverage ratio" (measuring Tier 1 risked-based capital as a percentage of adjusted total assets) of at least five percent (5%). CalFirst Bank is subject to risk-based and leverage capital requirements mandated by the Office of the Comptroller of the Currency. The Bank is required to maintain (i) a minimum ratio of Tier 1 risked-based capital to risk-adjusted assets of four percent (4%); (ii) a minimum ratio of qualifying total capital to risk-adjusted assets of eight percent (8%) and (iii) for the first three years of operations, a minimum ratio of Tier 1 risked-based capital to adjusted total assets, leverage ratio, of 5%.
California First National Bancorp and Subsidiaries
The following table presents capital and capital ratio information for the Company and its banking subsidiary as of June 30, 2007 and 2006. At June 30, 2007, the Company and CalFirst Bank exceeded all capital requirements by significant amounts.
Note 11 - Commitments and Contingencies:
Leases
The Company leases its corporate offices under an operating lease that expires in fiscal 2009. Rent expense was $1,117,486 (2007), $1,063,521 (2006) and $979,637, (2005).
Litigation
From time to time, the Company is party to legal actions and administrative proceedings and subject to various claims arising out of the Company's normal business activities. Management does not expect the outcome of any of these matters, individually and in the aggregate, to have a material adverse effect on the financial condition and results of operations of the Company.
401(k) Plan
Employees of the Company may participate in a voluntary defined contribution plan (the "401K Plan") qualified under Section 401(k) of the Internal Revenue Code of 1986. Under the 401K Plan, employees who have met certain age and service requirements may contribute up to a certain percentage of their compensation. The Company has made contributions of $133,015 (2007), $122,924 (2006) and $135,056 (2005).
Note 12 - Segment Reporting:
The Company has two leasing subsidiaries, Amplicon and CalFirst Leasing ("Leasing Companies"), involved in leasing and financing capital assets, and re-marketing leased assets at lease expiration.
The Company's banking subsidiary, CalFirst Bank, is an FDIC-insured national bank that gathers deposits from a centralized location and is involved in leasing and remarketing capital assets in a manner similar to the Leasing Companies. CalFirst Bank also provides business loans to fund the purchase of assets leased by the Leasing Companies and other third parties.
California First National Bancorp and Subsidiaries
The accounting policies of each segment are the same as those described in “Summary of Significant Accounting Policies” (see Note 1). Below is a summary of each segment’s financial results for 2007, 2006 and 2005:
California First National Bancorp and Subsidiaries
Note 13 - California First National Bancorp (Parent Only) Financial Information:
The condensed financial statements of California First National Bancorp as of June 30, 2007, and 2006 and for the years ended June 30, 2007 and 2006 are presented below:
California First National Bancorp and Subsidiaries
Note 14 - Selected Quarterly Financial Data (Unaudited):
Summarized quarterly financial data for the fiscal years ended June 30, 2007 and 2006 is as follows:
California First National Bancorp and Subsidiaries
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. As of the end of the period covered by this report, the Company's management, including its principal executive officer and its principal financial officer, evaluated the effectiveness of the Company's disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended and have concluded that the Company's disclosure controls and procedures are adequate and effective for the purposes set forth in the definition in Exchange Act rules. There were no significant changes made during the most recent fiscal quarter to the Company's internal controls or other factors that could significantly affect the Company's internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
California First National Bancorp and Subsidiaries
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is incorporated herein by reference to the Company's definitive proxy statement to be filed not later than October 28, 2007 with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
We have a Code of Business Conduct and Ethics within the meaning of Item 406 of Regulation S-K adopted by the SEC under the Exchange Act that applies to our principal executive officer, principal accounting officer and principal financial officer. Our Code of Business Conduct and Ethics is available on the Company's website (www.calfirstbancorp.com), and we intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding any amendment to, or waiver from, a provision of our code of ethics by posting such information on our website. The information contained on the Company's website is not part of this or any other report we file with or furnish to the SEC and is incorporated by reference herein.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the Company's definitive proxy statement to be filed not later than October 28, 2007 with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated herein by reference to the Company's definitive proxy statement to be filed not later than October 28, 2007 with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated herein by reference to the Company's definitive proxy statement to be filed not later than October 28, 2007 with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated herein by reference to the Company's definitive proxy statement to be filed not later than October 28, 2007 with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
California First National Bancorp and Subsidiaries
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Schedules
All financial statements are set forth under Item 8 of this annual report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.
(b) Exhibits:
Exhibit No.
Description of Exhibit
Page No.
2.1
Agreement of Merger dated as of May 22, 2001 among Amplicon, Inc., California First National Bancorp and CFNB Merger Sub (incorporated by reference to Exhibit 2.1 to Registrant's Statement on Form 8-K dated May 25, 2001)
3.1
Articles of Incorporation of California First National Bancorp (incorporated by reference to Exhibit 3.1 to Registrant's Statement on Form 8-K dated May 25, 2001)
3.2
Bylaws of California First National Bancorp (incorporated by reference to Exhibit 3.2 to Registrant's Statement on Form 8-K dated May 25, 2001)
10.1
1995 Equity Participation Plan, as amended to date (incorporated by reference to Exhibit 10.1 to Registrant’s Statement on Form S-8 File No. 333-15683)
10.2
Capital Assurances and Liquidity Maintenance Agreement between California First National Bancorp and California First National Bank, effective as of May 23, 2001 (incorporated by reference to Exhibit 10.1 to Registrant's Statement on Form 8-K dated May 25, 2001)
10.3
Agreement by and between California First National Bank and the Office of the Comptroller of the Currency dated as of May 23, 2001 (incorporated by reference to Exhibit 10.2 to Registrant's Statement on Form 8-K dated May 25, 2001)
10.4
Office Lease dated January 30, 2003, between California First National Bancorp and World Trade Center Building, Inc. (incorporated by reference to Exhibit 10.8 to the Registrant’s March 31, 2003 Form 10-Q)
10.5
Business Loan Agreement dated as of January 20, 2006 between California First Leasing Corporation and Amplicon, Inc. and Bank of America (incorporated by reference to Exhibit 10.6 to the Registrant’s December 31, 2005 Form 10-Q).
10.6
Amendment 1 to the Business Loan Agreement between California First Leasing Corporation and Amplicon, Inc. and Bank of America dated as of March 29, 2007 (incorporated by reference to Exhibit 10.7 to Registrant's Statement on Form 8-K dated April 2, 2007)
31.1
Rule 13a-14(a)/15d-14(a) Certifications of Principal Executive Officer
31.2
Rule 13a-14(a)/15d-14(a) Certifications of Principal Financial Officer
Section 1350 Certifications by Principal Executive Officer and Principal Financial Officer
California First National Bancorp and Subsidiaries
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CALIFORNIA FIRST NATIONAL BANCORP
By: /s/ S. Leslie Jewett
Date: September 14, 2007
S. Leslie Jewett
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes each of Patrick E. Paddon, S. Leslie Jewett and Glen T. Tsuma as attorney-in-fact to sign on his behalf, individually in each capacity stated below, and to file all amendments and/or supplements to this Annual Report on Form 10-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Patrick E. Paddon
President, Chief Executive
September 14, 2007
Patrick E. Paddon
Officer and Director
/s/ Glen T. Tsuma
Vice President, Chief Operating
September 14, 2007
Glen T. Tsuma
Officer and Director
/s/ S. Leslie Jewett
Chief Financial Officer
September 14, 2007
S. Leslie Jewett
/s/ Michael H. Lowry
Director
September 14, 2007
Michael H. Lowry
/s/ Harris Ravine
Director
September 15, 2007
Harris Ravine
/s/ Danilo Cacciamatta
Director
September 14, 2007
Danilo Cacciamatta