Notes to Condensed Consolidated Financial Statements

(unaudited)

 

NOTE 1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Operations

 

First Choice Bancorp, also known as First Choice or the Holding Company, a California corporation, was organized on September 1, 2017 to become the holding company for First Choice Bank (the "Bank"), collectively with First Choice, the Company. In December 2017 , the Bank received requisite shareholder and regulatory approval necessary for the reorganization of First Choice Bank into the Holding Company form of ownership pursuant to which First Choice Bank became a wholly-owned subsidiary of First Choice. The reorganization was completed as of the close of business on December 21, 2017 .

 

The Bank was incorporated under the laws of the State of California in March 2005 , and commenced banking operations in August 2005 and has been organized as a single operating segment operating with five full-service branches in Cerritos, Rowland Heights, Alhambra, Anaheim and Carlsbad, California. The Bank’s primary source of revenue is providing loans to customers, who are predominately small and middle-market businesses and individuals within its principal market area of Los Angeles County, Orange County and San Diego County.

Basis of Presentation

 

The accompanying condensed consolidated financial statements include the accounts of First Choice, and its wholly-owned subsidiary, First Choice Bank, a California state-chartered bank and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments considered necessary for a fair presentation, have been included. Operating results for the three and six months ended June 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018 . These interim period condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements as of and for the years ended December 31, 2017 and 2016, which are included in the Company’s Form S-4, dated April 25, 2018 (the “Form S-4”), with the United States Securities and Exchange Commission (“SEC”).

All significant intercompany balances and transactions have been eliminated in consolidation.

Certain reclassifications have been made to the December 31, 2017 condensed consolidated balance sheet to conform to the presentation as of June 30, 2018 . These reclassifications, which consisted of a $2.9 million increase to "Gross loans" and "Discounts and unearned fees, net", had no impact on the Company’s previously reported "Loans receivable, net".

 

Accounting Policies

Our accounting policies are described in Note 1. Summary of Significant Accounting Policies of the Company’s audited consolidated financial statements as of and for the years ended December 31, 2017 and 2016 included in the Form S-4 filed with the SEC.

Use of Estimates in the Preparation of Consolidated Financial Statements

 

The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses and fair value of financial instruments are particularly subject to change in the near term.

 

Accounting Standards Adopted in 2018

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, Revenue from Contracts with Customers (Topic606) (“ASU 2014-09”). ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2015-14, Revenue from Contracts with Customers (Topic 606) (“ASU 2015-14”) was issued in August 2015 and deferred adoption to annual reporting periods beginning after December 15, 2017. The adoption of ASU 2014-09 on January 1, 2018 did not have a material impact on the Company’s consolidated financial statements. The timing of the Company’s revenue recognition did not materially change. The Company’s largest portions of revenue, interest and fees on loans and gain on sales of loans, are specifically excluded from the scope of the guidance, and the Company currently recognizes the majority of the remaining revenue sources in a manner that management believes is consistent with the new guidance. Because of this, management believes that revenue recognized under the new guidance will generally approximate revenue recognized under current GAAP. See Note 16 - Revenue Recognition .

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). This guidance changes how entities account for equity investments that do not result in consolidation and are not accounted for under the equity method of accounting. Entities will be required to measure these investments at fair value at the end of each reporting period and recognize changes in fair value in net income. A practicability exception will be available for equity investments that do not have readily determinable fair values; however, the exception requires the Company to adjust the carrying amount for impairment and observable price changes in orderly transactions for the identical or a similar investment of the same issuer. This guidance also changes certain disclosure requirements and other aspects of current US GAAP. This guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within the fiscal year. Early adoption is permitted for only one of the six amendments. In addition, this update also changes the presentation and disclosure requirements for financial instruments, including a requirement that public business entities us the exit price when measuring the fair value of financial instruments measured at amortized cost for disclosure purposes. The Company measures the fair value of financial instruments reported at amortized cost in the balance sheet using the exit price notion (refer to Note 15 - Fair Value of Financial Instruments for further discussion) . The Company has evaluated its applicable equity investments and determined that other bank stocks qualify for the measurement exception, which allows those investments to be measured at cost less any impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Any impairment will be recorded prospectively through earnings, with related disclosures to be made. Upon adoption on January 1, 2018, the Company recognized a net $24 thousand reclassification from accumulated other comprehensive income to retained earnings relating to equity securities with a readily determinable fair value.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) (“ASU 2016-15”). This guidance clarifies and provides guidance on several cash receipt and cash payment classification issues, including debt prepayment and extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle. The amendments in this guidance are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The adoption of this guidance on January 1, 2018 did not have a significant impact on the Company’s consolidated financial statements.

 

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) (“ASU 2016-18”). This guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this guidance are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The adoption of this guidance on January 1, 2018 did not have a significant impact on the Company’s consolidated financial statements.

In March 2018, the FASB issued ASU 2018-4, Investments-Debt Securities (Topic 320) and Regulated Operations (Topic 980): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273 (ASU 2018-04) which incorporate into the Accounting Standards Codification recent SEC guidance which was issued in order to make the relevant interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The amendments were effective upon issuance. The adoption of these amendments did not have a material effect on the Company's consolidated financial statements.

 

In March 2018, the FASB issued ASU 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (ASU 2018-05). The amendments incorporate into the Accounting Standards Codification recent SEC guidance related to the income tax accounting implications of the Tax Cuts and Jobs Act. The amendments were effective upon issuance. The adoption of these amendments did not have a material effect on the Company's consolidated financial statements.

In May 2018, FASB issued ASU 2018-06, Codification Improvements to Topic 942, Depository and Lending - Income Taxes . The amendments in this ASU supersede the guidance within Subtopic 942-741 that has been rescinded by the OCC and no longer relevant. A cross-reference between Subtopic 740-30, Income Taxes-Other Considerations or Special Areas, and Subtopic 942-740 is being added to the remaining guidance in Subtopic 740-30 to improve the usefulness of the codification. The amendments in this update are effective upon issuance, as no accounting requirements are affected. The adoption of these amendments did not have a material impact on the Company’s consolidated financial statements.

Recent Accounting Guidance Not Yet Effective

  

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). The new guidance establishes the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. Entities will be required to recognize the lease assets and lease liabilities that arise from leases in the statement of financial position and to disclose qualitative and quantitative information about lease transactions, such as information about variable lease payments and options to renew and terminate leases. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within the fiscal year. The Company is currently evaluating the impact of the adoption of ASU 2016-02 to determine the potential impact it will have on its consolidated financial statements. The Company’s assets and liabilities will increase based on the present value of the remaining lease payments for leases in place at the adoption date; however, this is not expected to be material to the Company’s consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326) (“ASU 2016-13”). This guidance is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this guidance replace the incurred loss impairment methodology in current US GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to credit loss estimates. This ASU will be effective for fiscal years beginning after December 15, 2019. Early adoption is available as of the fiscal year beginning after December 15, 2018. The Company is evaluating the provisions of the guidance, and will closely monitor developments and additional guidance to determine the potential impact on the Company’s consolidated financial statements. Management is in the process of identifying the methodologies and the additional data requirements necessary to implement the guidance and has engaged an existing third-party service provider to assist in implementation.

In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments provide targeted improvements to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Specifically, the amendments include clarifications related to: measurement elections, transition requirements, and adjustments associated with equity securities without readily determinable fair values; fair value measurement requirements for forward contracts and purchased options on equity securities; presentation requirements for hybrid financial liabilities for which the fair value option has been elected; and measurement requirements for liabilities denominated in a foreign currency for which the fair value option has been elected. The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-03 to have a material impact on its consolidated financial statements.

 

NOTE 2.    RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

 

On February 5, 2018, the Company announced that the Audit Committee of the Board of Directors of the Company, after consultation with management and its independent registered accounting firm, determined that the Company’s consolidated financial statements for the fiscal year ended December 31, 2016, and for each of the first three quarters of 2017, were not in compliance with generally accepted accounting principles and would be restated.

 

The decision to restate these consolidated financial statements was based on the Company’s conclusion that it had been overly conservative in its earnings calculations, primarily as a result of the complex accounting treatment for the Company’s equity compensation plan. In addition, the Company had provided accruals for expenses in years 2014, 2015 and 2016 in anticipation of incurring certain expenses, which expenses, for a number of different reasons, were never incurred. The result was that the Company had over-accrued for expenses. The net after-tax result of the restatement was that the Company earned approximately $1.06 million more in income after taxes than was reported in the consolidated financial statements for the years ended December 31, 2014 through 2016. In each of the quarters ended March 31, 2017, June 30, 2017 and September 30, 2017, the Company had incorrectly accrued for certain expenses resulting in $156 thousand less in income after taxes for the nine months ended September 30, 2017. The restatement for the years ended 2014 through 2016 and the nine months ended September 30, 2017 are reflected in the Company's audited consolidated financial statements as of and for the years ended December 31, 2017 and 2016, which are included in the Company's Form S-4, dated April 25, 2018, filed with the United States Securities and Exchange Commission.

The net after-tax impact on net income for the three months ended June 30, 2017 was an increase of $47 thousand . The primary components of the impact on noninterest expense were a $66 thousand decrease in professional fees and $44 thousand decrease in customer service expense partially offset by a $29 thousand increase in deposit insurance and regulatory assessments and a $33 thousand increase in income taxes. The net after-tax impact on net income for the six months ended June 30, 2017 was an increase of $38 thousand . The primary components of the impact on noninterest expense were a $146 thousand decrease in professional fees offset by a $55 thousand increase in deposit insurance and regulatory assessments, a $39 thousand increase in other expenses and a $27 thousand increase in income taxes. As of June 30, 2017, the restatement resulted in an increase in other assets and total assets of $134 thousand , an increase in other liabilities and total liabilities of $172 thousand and a $38 thousand increase in retained earnings and total equity.

 

NOTE 3.    BUSINESS COMBINATION

On February 26, 2018, the Company announced that it entered into an Agreement and Plan of Reorganization and Merger, dated February 23, 2018 (the "merger agreement"), by which Pacific Commerce Bancorp ("PCB") will be merged with and into First Choice Bancorp; and Pacific Commerce Bancorp’s bank subsidiary, Pacific Commerce Bank, will be merged with and into First Choice Bancorp’s bank subsidiary, First Choice Bank (collectively, the “Merger”). Following receipt of all necessary regulatory and shareholder approvals, on July 31, 2018, the Company completed its acquisition of PCB. The Merger was an all stock transaction valued at approximately $133.5 million , or $13.69 per share, based on a closing price of $28.70 for First Choice’s common stock as of July 31, 2018 .

At the effective time of the Merger, each share of PCB common stock was converted into the right to receive 0.47689 shares (referred to as the exchange ratio) of the Company's common stock, with cash paid in lieu of any fractional shares. The final exchange ratio of the stock-to-stock transaction is 0.47689 , which is higher than the ratio of 0.46531 announced at the time of the acquisition, as the ratio was subject to certain adjustments as previously described in the joint proxy statement. The higher exchange ratio was primarily due to adjustments resulting from an increase in PCB’s capital from the exercise of stock options, lower than budgeted merger transaction costs and higher than projected net income during the first six months of 2018. 

In the aggregate, the Company issued 4,386,798 shares of First Choice common stock in exchange for the outstanding shares of PCB common stock. In addition, in connection with the Merger each outstanding stock option issued by First Choice to those PCB directors, officers and employees that are continuing with First Choice were converted into a rollover stock options exercisable into 134,564 shares of First Choice common stock. Those PCB directors, officers and employees that are not continuing with First Choice had the option to receive either a rollover stock option or cash equal to the value of their PCB stock option, and after such elections were made, 285,829 rollover stock options were issued and exercisable into shares of First Choice common stock, and no cash was issued.

PCB was headquartered in Los Angeles, California, with $553.2 million in total assets, $401.2 million in gross loans and $476.6 million in total deposits as of June 30, 2018 . PCB had six full-service branches in Los Angeles and San Diego Counties, including its operating division, ProAmérica Bank, in Downtown Los Angeles. The transaction increases First Choice’s total assets to approximately $1.6 billion on a pro forma basis as of June 30, 2018 . At June 30, 2018 , the Company's interest checking deposits included a $5.0 million balance from Pacific Commerce Bancorp.

The amortized cost and estimated fair value of all investment securities held-to-maturity and available-for-sale at June 30, 2018 , by contractual maturities are shown below. Contractual maturities may differ from expected maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

There were no sales of any investment securities available-for-sale or held-to-maturity during the three and six months ended June 30, 2018 . There were $4.4 million and $4.4 million in sales of investment securities available-for-sale for the three and six months ended June 30, 2017 . There were no maturities or calls of investment securities during the three and six months ended June 30, 2018 and 2017 .

At June 30, 2018 securities held-to-maturity with a carrying amount of $5.3 million were pledged to the Federal Reserve Bank as discussed in Note 8 – Borrowing Arrangements.

 

As of June 30, 2018 and December 31, 2017 , unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are summarized as follows: