10-Q 1 e-7310.txt QUARTERLY REPORT FOR THE QTR ENDED 6/30/01 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 OR [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT For the transition period from ____________ to ____________ Commission file number 000-26191 SUN COMMUNITY BANCORP LIMITED (Exact name of registrant as specified in its charter) ARIZONA 86-0878747 (State or other jurisdiction (I.R.S. Employer of incorporation or Identification organization) Number) 2777 EAST CAMELBACK ROAD, SUITE 375 PHOENIX, ARIZONA (Address of principal executive offices) 85016 (Zip Code) (602) 955-6100 (Registrant's telephone number) Not Applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common stock, No par value: 6,090,849 shares outstanding as of July 31, 2001. Page 1 of 19 INDEX PART I. FINANCIAL INFORMATION FORWARD-LOOKING STATEMENTS Certain of the statements contained in this document, including Sun's interim consolidated financial statements, Management's Discussion and Analysis of Financial Condition and Results of Operations and in documents incorporated into this document by reference that are not historical facts, including, without limitation, statements of future expectations, projections of results of operations and financial condition, statements of future economic performance and other forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, are subject to known and unknown risks, uncertainties and other factors which may cause the actual future results, performance or achievements of Sun and/or its subsidiaries and other operating units to differ materially from those contemplated in such forward-looking statements. The words "intend", "expect", "project", "estimate", "predict", "anticipate", "should", "believe", and similar expressions also are intended to identify forward-looking statements. Important factors which may cause actual results to differ from those contemplated in such forward-looking statements include, but are not limited to: (i) the results of Sun's efforts to implement its business strategy, (ii) changes in interest rates, (iii) legislation or regulatory requirements adversely impacting Sun's banking business and/or expansion strategy, (iv) adverse changes in business conditions or inflation, (v) general economic conditions, either nationally or regionally, which are less favorable than expected and that result in, among other things, a deterioration in credit quality and/or loan performance and collectability, (vi) competitive pressures among financial institutions, (vii) changes in securities markets, (viii) actions of competitors of Sun's banks and their ability to respond to such actions, (ix) the cost of capital, which may depend in part on Sun's asset quality, prospects and outlook, (x) changes in governmental regulation, tax rates and similar matters, and (xi) other risks detailed in Sun's other filings with the Securities and Exchange Commission. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated. All subsequent written or oral forward-looking statements attributable to Sun or persons acting on its behalf are expressly qualified in their entirety by the foregoing factors. Investors and other interested parties are cautioned not to place undue reliance on such statements, which speak as of the date of such statements. Sun undertakes no obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of unanticipated events. Page ---- Item 1. Financial Statements: Consolidated sheets - June 30, 2001 and December 31, 2000. 3 Consolidated statements of income - Three months and six months ended June 30, 2001 and 2000. 4 Consolidated statements of changes in stockholders' equity - Six months ended June 30, 2001 and 2000. 5 Consolidated statements of cash flows - Six months ended June 30, 2001 and 2000. 6 Notes to consolidated financial statements. 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 10 PART II. OTHER INFORMATION Item 1. Legal Proceedings. 18 Item 2. Changes in Securities and Use of Proceeds. 18 Item 3. Defaults Upon Senior Securities. 18 Item 4. Submission of Matters to a Vote of Security Holders. 18 Item 5. Other Information. 18 Item 6. Exhibits and Reports on Form 8-K. 18 SIGNATURES 19 Page 2 of 19 PART I, ITEM 1 SUN COMMUNITY BANCORP LIMITED Consolidated Balance Sheets As of June 30, 2001 and December 31, 2000

Page 3 of 19 SUN COMMUNITY BANCORP LIMITED Consolidated Statements of Income For the Three Months and Six Months Ended June 30, 2001 and 2000

NET INCOME PER SHARE - Note D Page 4 of 19 SUN COMMUNITY BANCORP LIMITED Consolidated Statements of Changes in Stockholders' Equity For the Six Months Ended June 30, 2000 and 2001

Page 5 of 19 SUN COMMUNITY BANCORP LIMITED Consolidated Statements of Cash Flows For the Six Months Ended June 30, 2001 and 2000

Page 6 of 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUN COMMUNITY BANCORP LIMITED NOTE A - BASIS OF PRESENTATION The accompanying condensed consolidated financial statements of Sun Community Bancorp Limited (Sun) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q. Accordingly, they do not include all information and footnotes necessary for a fair presentation of consolidated financial position, results of operations and cash flows in conformity with generally accepted accounting principles. The statements do, however, include all adjustments of a normal recurring nature (in accordance with Rule 10-01(b)(8) of Regulation S-X) which Sun considers necessary for a fair presentation of the interim periods. The results of operations for the six-month period ended June 30, 2001 are not necessarily indicative of the results to be expected for the year ending December 31, 2001. The consolidated balance sheet as of December 31, 2000 was derived from audited consolidated financial statements as of that date. Certain 2000 amounts have been reclassified to conform to the 2001 presentation. NOTE B - NEW BANKS AND PENDING BANK APPLICATIONS Sunrise Bank of San Diego, located in San Diego, California, opened in January 2001. It is majority-owned by Sunrise Capital Corporation, which is majority-owned by Sun. As of June 30, 2001, efforts were underway for the formation of additional banks in California and Nevada. NOTE C - ACQUISITION OF MINORITY INTEREST IN BANK Effective June 30, 2001, Camelback Community Bank (previously a majority-owned subsidiary of Sun) became a wholly-owned subsidiary resulting from the minority shareholders of Camelback exchanging their Camelback shares for shares of Sun. The exchange ratio was based on 150% of Camelback's adjusted book value. As a result of the share exchange, the minority owners of Camelback became shareholders of Sun. About 280,500 new shares of Sun's common stock were issued in this transaction. Page 7 of 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUN COMMUNITY BANCORP LIMITED - CONTINUED NOTE D - NET INCOME PER SHARE The computations of basic and diluted earnings per share were as follows:

NOTE E - IMPACT OF NEW ACCOUNTING STANDARDS Financial Accounting Standards Board (FASB) Statement No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, requires all derivatives to be recognized in financial statements and to be measured at fair value. Gains and losses resulting from changes in fair value are included in income, or in comprehensive income, depending on whether the instrument qualifies for hedge accounting and the type of hedging instrument involved. This new standard became effective January 1, 2001 and had no effect on Sun's financial statements. In early July 2001, the Securities and Exchange Commission, American Institute of Certified Public Accountants and Federal Financial Institutions Examination Council each issued new guidance (some of which remains to be finalized) on accounting for loan loss reserves (also known as allowances for loan losses). While the new guidance does not change prior accounting rules in this area, it provides additional clarification and guidance on how such reserves and allowances may be documented by management. In July 2001, the FASB issued Statement No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets". Statement No. 141 requires that all business combinations be accounted for under a prior standard of purchase accounting, eliminating the so-called pooling-method which was used to account for some business combinations. Statement No. 141 requires that the purchase method be used for business combinations initiated after June 30, 2001. This new standard is not expected to have a material effect on Sun's consolidated financial statements. Page 8 of 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUN COMMUNITY BANCORP LIMITED - CONTINUED NOTE E - IMPACT OF NEW ACCOUNTING STANDARDS (CONTINUED) Statement No. 142 requires that goodwill no longer be amortized and charged against earnings, but instead to be reviewed for impairment. Amortization of goodwill ceases upon adoption of the Statement, which for most companies, will be January 1, 2002. This new standard requires that goodwill be reviewed periodically for impairment and, accordingly, impairment adjustments of goodwill be charged against earnings, when determined. Management has not completed its analysis of this new standard, however, its preliminary review has concluded that, upon implementation, future amortization of goodwill will be reduced or eliminated. A variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to Sun's financial statements. [The remainder of this page intentionally left blank] Page 9 of 19 PART I, ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Financial Condition Total assets approximated $677.2 million at June 30, 2001, an increase of $150.4 million from the December 31, 2000 level of $526.8 million. The balance sheets include Sun and its consolidated subsidiaries. In January 2001, Sunrise Bank of San Diego located in San Diego, California, commenced operations and was added to the consolidated group as a majority-owned subsidiary of Sunrise Capital Corporation, a majority-owned subsidiary of Sun. Portfolio loans increased during the six-month period by approximately $123.1 million. Loan growth was funded primarily by higher levels of time deposits. The majority of portfolio loan growth occurred in commercial loans, which increased approximately $120 million, consistent with the banks' emphasis on commercial lending activities. Loans at June 30, 2001 include $3.5 million advanced to Capitol Bancorp, Sun's principal shareholder, on a short-term basis. The allowance for loan losses at June 30, 2001 approximated $7.3 million or 1.33% of total portfolio loans, an increase from the year-end 2000 ratio of 1.29%. The allowance for loan losses is maintained at a level believed adequate by management to absorb potential losses inherent in the loan portfolio at the balance sheet date. Management's determination of the adequacy of the allowance is based on evaluation of the portfolio (including volume, amount and composition, potential impairment of individual loans and concentrations of credit), past loss experience, current economic conditions, loan commitments outstanding and other factors. [The remainder of this page intentionally left blank] Page 10 of 19 The table below summarizes portfolio loan balances and activity in the allowance for loan losses for the six-month periods (in thousands): 2001 2000 ------- ------- Allowance for loan losses at January 1 $ 5,440 $ 2,371 Loans charged-off (76) (417) Recoveries 44 16 ------- ------- Net charge-offs (32) (401) Additions to allowance charged to expense 1,862 1,702 ------- ------- Allowance for loan losses at June 30 $ 7,270 $ 3,672 ======= ======= For internal purposes, management allocates the allowance to all loan classifications. The amounts allocated in the following table (in thousands), include all loans for which management has concerns based on Sun's loan rating system, should not be interpreted as an indication of future charge-offs. In addition, amounts allocated are not intended to reflect the amount that may be available for future losses.

Impaired loans (i.e., loans for which there is a reasonable probability that borrowers would be unable to repay all principal and interest due under the contractual terms of the loan documents) were not material in 2000 and through June 30, 2001. Page 11 of 19 Nonperforming loans (i.e., loans which are 90 days or more past due and loans on nonaccrual status) are summarized below (in thousands): June 30 December 31 2001 2000 ------ ------ Nonaccrual loans: Commercial $2,272 $1,793 Real estate 14 Installment ------ ------ Total nonaccrual loans 2,272 1,807 Past due (>90 days) loans: Commercial 11 Real estate Installment ------ ------ Total past due loans 11 -- ------ ------ Total nonperforming loans $2,283 $1,807 ====== ====== Nonperforming loans increased $476,000 during the first half of 2001, however, continued at a low level in relation to total loans. These consist of a small number of loans, in various stages of resolution, which management believes to be adequately collateralized or otherwise appropriately considered in its determination of the adequacy of the allowance for loan losses. The following comparative analysis summarizes each bank's total portfolio loans, allowance for loan losses, nonperforming loans and allowance ratios (dollars in thousands):

---------- (1) As a condition of charter approval, bank is required to maintain an allowance for loan losses of not less than 1% for the first three years of operations. Page 12 of 19 RESULTS OF OPERATIONS Net income for the six months ended June 30, 2001 approximated $795,000 ($0.14 per share), compared to $261,000 ($0.05 per share) during the corresponding period of 2000. Net income of $479,000 ($.08 per share) for the three months ended June 30, 2001 significantly surpassed the corresponding 2000 period results of $146,000 ($.03 per share). Operating results and total assets (in thousands) were as follows:

---------- n/a Not applicable (1) Commenced operations as DE NOVO banks in 2000. (2) Commenced operations as a DE NOVO bank in 2001. Net interest income increased to $17.3 million during the six-month 2001 period versus $11.1 million in the corresponding period of 2000 primarily due to growth in total assets and the number of banks within the consolidated group. Noninterest income increased to $705,000 for the 2001 six-month period, as compared with $457,000 in 2000. Service charge revenue nearly doubled in the 2001 period compared to the same period in 2000. This increase is primarily related to higher transaction volume and the larger number of customers resulting from the addition of new banks in 1999 and 2000. Provisions for loan losses approximated $1.9 million for the six months ended June 30, 2001 compared to $1.7 million during the 2000 period. The increase is primarily related to loan growth. The provisions for loan losses are based upon management's analysis of the allowance for loan losses, as previously discussed. Noninterest expense for the six months ended June 30, 2001 was $14.9 million compared with $9.9 million in 2000. The increase in noninterest expense is associated with newly formed banks, growth and increases in general operating costs. Increases in employee compensation and occupancy mostly relate to the growth in number of banks within the consolidated group and the larger number of data processing and other administrative support staff necessary for the increased number and size of banks. Page 13 of 19 LIQUIDITY AND CAPITAL RESOURCES The principal funding source for asset growth and loan origination activities is deposits. Total deposits increased $142.1 million for the six-month 2001 period, compared to $121.2 million in 2000. Such growth occurred in all deposit categories, with the majority from time deposits. The Corporation's banks generally do not rely on brokered deposits as a key funding source. Noninterest-bearing deposits approximated 18.2% of total deposits at June 30, 2001, a slight decrease from the December 31, 2000 level of 19.4%. Levels of noninterest-bearing deposits fluctuate based on customers' transaction activity. Deposit growth in 2001 has been deployed primarily into commercial loans, consistent with the banks' emphasis on commercial lending activities. Cash and cash equivalents amounted to $98 million or 14.5% of total assets at June 30, 2001 as compared with $73.4 million or 13.9% of total assets at December 31, 2000. As liquidity levels vary continuously based on customer activities, amounts of cash and cash equivalents can vary widely at any given point in time. Management believes the banks' liquidity position at June 30, 2001 is adequate to fund loan demand and meet depositor needs. In addition to cash and cash equivalents, a source of long-term liquidity is the banks' marketable investment securities. Sun's liquidity requirements have not historically necessitated the sale of investments in order to meet liquidity needs. It also has not engaged in active trading of its investments and has no intention of doing so in the foreseeable future. At June 30, 2001 Sun and its banks had approximately $12.1 million of investment securities classified as available for sale which can be utilized to meet various liquidity needs as they arise. Sun and its banks are subject to complex regulatory capital requirements, which require maintaining certain minimum capital ratios. These ratio measurements, in addition to certain other requirements, are used by regulatory agencies to determine the level of regulatory intervention and enforcement applied to financial institutions. Sun and each of its banks are in compliance with the regulatory requirements and management expects to maintain such compliance. [The remainder of this page intentionally left blank] Page 14 of 19 Stockholders' equity, as a percentage of total assets, approximated 8.3% at June 30, 2001, a decrease from the beginning of the year ratio of 10.0%. Total capital funds (stockholders' equity, plus minority interests in consolidated subsidiaries) aggregated $84.3 million or 12.4% of total assets at June 30, 2001. The following table summarizes the amounts (in thousands) and related ratios of individually significant subsidiaries (assets of $50 million or more at the beginning of 2001) and consolidated regulatory capital position at June 30, 2001:

---------- (1) The minimum required ratio of Tier I capital to risk-weighted assets is 4%. (2) The minimum required ratio of Tier I and Tier II capital to risk-weighted assets is 8%. (3) In order to be classified as a "well-capitalized" institution, the ratio of Tier I and Tier II capital to risk-weighted assets must be 10% or more. Sun's operating strategy continues to be focused on the ongoing growth and maturity of its existing banks, coupled with new bank expansion in selected markets as opportunities arise. Accordingly, Sun may invest in or otherwise add additional banks in future periods, subject to economic conditions and other factors, although the timing of such additional banking units, if any, is uncertain. Such future new banks and/or additions of other operating units could be either wholly-owned, majority-owned or otherwise controlled by Sun. At June 30, 2001, plans were underway for the formation of additional banks in California and Nevada. In April 2000, Sun announced plans to purchase up to $3 million of its common stock in open market purchases. The shares repurchased in this manner may be retained as treasury shares, retired, used for implementation of an employee stock ownership plan or for other business purposes. To the extent such share purchases are made, they will have the impact of increasing the percentage ownership of Sun by Capitol Bancorp Ltd., Sun's principal shareholder. The share purchase program will be funded from Sun's existing resources, principally short-term loans and investments. Through June 30, 2001, total purchases approximated $1.3 million. Page 15 of 19 Camelback Community Bank reached its 36th month of operation in May 2001. In June 2001, Sun offered the minority owners of Camelback an opportunity to exchange their Camelback shares for shares of Sun. The exchange ratio was based on 150% of Camelback's adjusted book value and was completed effective June 30, 2001. As a result of the share exchange, the minority owners of Camelback became shareholders of Sun. About 280,500 new shares of Sun's common stock were issued in this transaction. Effective June 30, 2000, Sun entered into a similar share exchange transaction with the shareholders of Valley First Community Bank (previously a majority-owned subsidiary of Sun), issuing about 298,000 shares of Sun's common stock. TRENDS AFFECTING OPERATIONS The most significant trends which can impact the financial condition and results of operations of financial institutions are changes in market rates of interest and changes in general economic conditions. Changes in interest rates, either up or down, have an impact on net interest income (plus or minus), depending on the direction and timing of such changes. At any point in time, there is an imbalance between interest rate-sensitive assets and interest rate-sensitive liabilities. This means that when interest rates change, the timing and magnitude of the effect of such interest rate changes can alter the relationship between asset yields and the cost of funds. In January 2001, the Open Market Committee of the Federal Reserve Board decreased interbank interest rates on two separate dates, for a total decrease of 100 basis points. In March 2001, another 50 basis points decrease was initiated by the Federal Reserve, followed by decreases of 50 basis points in both April and May 2001 and 25 basis points in June 2001. Because variable rate loans reprice more rapidly than interest-bearing deposits, such market interest rate decreases compressed net interest margins at Sun's banks in 2001. As the Open Market Committee continues to influence interest rates and other economic policy in 2001, including the potential of additional rate decreases, net interest margins may become more compressed (having an adverse impact on earnings) as the year progresses. Start-up banks generally incur operating losses during their early periods of operations. Recently-formed start-up banks are expected to detract from consolidated earnings performance and additional start-up banks formed in 2001 and beyond will similarly negatively impact short-term profitability. Sun's Board of Directors has determined to reduce the rate of start-ups in the near term in contrast to the previous three years. General economic conditions also have a significant impact on both the results of operations and the financial condition of financial institutions. Widespread media reports of concerns about the health of the domestic economy have continued in 2001. While local economic conditions appear to indicate a weakening environment, loan losses in this initial period of 2001 have remained approximately level with the prior year's period. In the first half of 2001, however, nonperforming loans have increased and it is anticipated that levels of nonperforming loans and related loan losses may trend upward as economic conditions, locally and nationally, evolve. Page 16 of 19 IMPACT OF NEW ACCOUNTING STANDARDS Financial Accounting Standards Board (FASB) Statement No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, requires all derivatives to be recognized in financial statements and to be measured at fair value. Gains and losses resulting from changes in fair value are included in income, or in comprehensive income, depending on whether the instrument qualifies for hedge accounting and the type of hedging instrument involved. This new standard became effective January 1, 2001 and had no effect on Sun's financial statements. In early July 2001, the Securities and Exchange Commission, American Institute of Certified Public Accountants and Federal Financial Institutions Examination Council each issued new guidance (some of which remains to be finalized) on accounting for loan loss reserves (also known as allowances for loan losses). While the new guidance does not change prior accounting rules in this area, it provides additional clarification and guidance on how such reserves and allowances may be documented by management. In July 2001, the FASB issued Statement No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets". Statement No. 141 requires that all business combinations be accounted for under a prior standard of purchase accounting, eliminating the so-called pooling-method which was used to account for some business combinations. Statement No. 141 requires that the purchase method be used for business combinations initiated after June 30, 2001. This new standard is not expected to have a material effect on Sun's consolidated financial statements. Statement No. 142 requires that goodwill no longer be amortized and charged against earnings, but instead to be reviewed for impairment. Amortization of goodwill ceases upon adoption of the Statement, which for most companies, will be January 1, 2002. This new standard requires that goodwill be reviewed periodically for impairment and, accordingly, impairment adjustments of goodwill be charged against earnings, when determined. Management has not completed its analysis of this new standard, however, its preliminary review has concluded that, upon implementation, future amortization of goodwill will be reduced or eliminated. A variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to Sun's financial statements. Page 17 of 19 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. Sun and its subsidiaries are parties to certain ordinary, routine litigation incidental to their business. In the opinion of management, liabilities arising from such litigation would not have a material effect on Sun's consolidated financial position or results of operations. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. ITEM 5. OTHER INFORMATION. None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: None. (b) Reports on Form 8-K: No reports on Form 8-K were filed during the quarter ended June 30, 2001. Page 18 of 19 SIGNATURES Pursuant to the requirements 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. SUN COMMUNITY BANCORP LIMITED (Registrant) /s/ Joseph D. Reid ---------------------------------------- Joseph D. Reid Chairman, President and Chief Executive Officer (duly authorized to sign on behalf of the registrant) /s/ Lee W. Hendrickson ---------------------------------------- Lee W. Hendrickson Executive Vice President and Chief Financial Officer Date: August 14, 2001 Page 19 of 19

SUN COMMUNITY BANCORP LTD 10-Q