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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2002
[ ] TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from___________to__________
Commission File Number 2-91196(1)
NORTHERN EMPIRE BANCSHARES
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(Exact name of registrant as specified in its charter)
CALIFORNIA 94-2830529
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
801 Fourth Street
Santa Rosa, California 95404
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(Address of principal executive offices)
(707) 579-2265
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Exchange Act: NONE
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes X
No_____.
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Act). Yes X No ___
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which
the common equity was last sold, or the average bid and asked price of such
common equity, as of the last business day of the registrant's most
recently completed second fiscal quarter. $91,572,445 as of June 28, 2002.
Shares held by directors and executive officers have been excluded in that
such persons may be deemed to be "affiliates." Such determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
Indicate the number of shares outstanding of each of the
registrant's classes of common stock, as of the latest practicable date.
4,180,914 shares, as of February 28, 2003.
DOCUMENTS INCORPORATED BY REFERENCE:
Not Applicable.
(1) Registrant filed a registration statement, on Form S-1, under File
Number 2-91196, and the Post Effective Amendment No. 8 to the registration
statement was declared effective on November 23, 1988.
TABLE OF CONTENTS
Part I
Item 1. Business 3
Item 2. Properties 15
Item 3. Legal Proceedings 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 16
Item 6. Selected Financial Data 19
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation 21
Item 7A. Quantitative and Qualitative Disclosures
about Market Risk 45
Item 8. Financial Statements and Supplementary Data 47
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 48
Part III
Item 10. Directors and Executive Officers of the Registrant 48
Item 11. Executive Compensation 49
Item 12. Security Ownership of Certain Beneficial Owners and
Management 51
Item 13. Certain Relationships and Related Transactions 53
Item 14. Controls and Procedures 53
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 54
PART 1
Forward-Looking Statements
This report contains "forward-looking statements" as defined in section 27A
of the Securities Act of 1933, and section 21E of the Securities Exchange
Act of 1934, which includes statements such as projections, plans and
objectives and assumptions about the future, and such forward looking
statements are subject to the safe harbor created by these sections.
Although the Corporation and the Bank have based their plans and
projections on certain assumptions, there can be no assurances that its
assumptions will be correct, or that its plans and projections can be
achieved. Many factors, risks and uncertainties could cause the actual
results, amounts or events to differ materially from those the Corporation
and the Bank expect to achieve or occur. Such factors, risks and
uncertainties include, but are not limited to the following:
Changes in the market interest rates and volatility of rate
sensitive loans and deposits. Changes in interest rates impact
the demand for new loans, the rates received on loans and
securities and the rates paid on deposits and borrowings.
Significant fluctuations in interest rates may have an adverse
effect on the business, financial condition and results of
operations of the Corporation and the Bank.
Competitive pressures in the banking industry. The banking
business is highly competitive, and competition among
financial institutions for all types of financial products
and services is expected to increase. The ability of the
Bank to compete in the future will depend on the nature
and level of future competition.
Changes in the legislative and regulatory environment.
Banks and bank holding companies are subject to extensive
supervision and regulation. The banking business is also
affected by the monetary and fiscal policies of the United
States government and the Federal Reserve Board. The future
regulatory environment may significantly affect the Bank's
business.
Declines in the national or regional economy. A worsening of
economic conditions could reduce the demand for loans, cause
credit quality deterioration and/or result in a decline in
the value of real estate collateral securing a substantial
portion of the Bank's loans. Any of these factors could have an
adverse impact on the Bank's financial condition.
Changes in the U.S. Small Business Administration program.
The Bank makes a significant portion of its commercial loans
through the U.S. Small Business Administration program, which
guarantees a portion of such loans, and the Bank generates
income through the sale of such loans. Changes in the Small
Business Administration program could have an adverse effect on
the Bank's business.
ITEM 1. Business
General
Northern Empire Bancshares (the "Corporation") was incorporated as a
California corporation on June 8, 1982 for the purpose of becoming a bank
holding company of Sonoma National Bank (the "Bank"). On April 27, 2000,
the Corporation made an election to become a financial holding company
pursuant to the Gramm-Leach-Bliley Act of 1999. The Corporation's
executive offices are located at 801 Fourth Street, Santa Rosa,
California, and its telephone number is (707)579-2265.
Due to technical difficulties the Form 10-K is not available on the web
site for Sonoma National Bank. A copy may be obtained by contacting Jane
M. Baker at Northern Empire Bancshares at 801 Fourth Street, Santa Rosa,
California 95404 or by telephone (707) 579-2265.
The Corporation's sole subsidiary is the Bank and its activities are the
commercial banking activities engaged in through the Bank and some lending
through loan participations with the Bank. As a financial holding company,
the Corporation may in the future invest in subsidiaries which are
permissible for a financial holding company, subject to the required
approvals of the Federal Reserve Board. However, the Corporation has no
present plans to make any such additional investments and there can be no
assurance that it will do so in the future.
The Bank was organized as a national banking association on March 27, 1984
and commenced operations on January 25,1985. It currently has seven
banking offices in California:
1. Main Office located at 801 Fourth Street, in the central
business district of Santa Rosa, California,
2. Oakmont Branch located in the Oakmont area of Santa Rosa,
approximately 5 miles east of the main office,
3. West College Branch office in west Santa Rosa,
4. Windsor Branch located in Windsor,approximately 5 miles
north of the main office,
5. Sebastopol Branch office located in Sebastopol,approximately 5
miles west of the main office,
6. Petaluma Branch located in Petaluma, approximately 15 miles
south of the main office, and
7. Sonoma Branch located in Sonoma, approximately 20 miles east
of the main office.
The Bank also has loan production offices in the following locations:
1. Santa Rosa Loan Center located at 815 Fifth Street, in
the central business district of Santa Rosa, California,
2. Sacramento Office located at 1851 Heritage Lane, Suite 128,
Sacramento, California,
3. Sacramento Office located at 7311 Greenhaven Drive,
Suite 180, Sacramento, California,
4. San Rafael Office located at 901 Tamalpais Avenue,
Suite 200, San Rafael, California,
5. Walnut Creek Office located at 2910 Camino Diablo,
Suite 215C, Walnut Creek, California, and
6. Phoenix Office located in the Biltmore Financial Center
at 2398 East Camelback Road, Suite 615,Phoenix, Arizona.
As a national bank, the Bank is subject to supervision, regulation and
regular examination by the Comptroller of the Currency ("Comptroller").
The deposits of the Bank are insured by the Bank Insurance Fund, which
is administered by the Federal Deposit Insurance Corporation. The Bank
is a member of the Federal Reserve System and, as such, is subject to
applicable provisions of the Federal Reserve Act and the regulations
thereunder. See, "Supervision and Regulation."
The Bank engages in the general commercial banking business. It accepts
checking and savings deposits, offers money market deposit accounts and
certificates of deposit, makes secured and unsecured commercial,
construction, other installment and term loans, and offers other customary
banking services. The Bank makes commercial loans guaranteed by the Small
Business Administration (SBA), which may be sold in the secondary market.
The Bank does not offer trust services directly, and does not presently
intend to do so, but offers such services, when requested, through its
correspondent banks.
Within the Loan Department are groups of lenders which specialize in
commercial, construction and SBA lending. SBA loans are funded by the
Bank and then the Bank may, at its option, sell the portion of the loan
guaranteed by the SBA (generally 70% to 85% of the total loan amount,
depending on the purpose and term of the loan). When a SBA loan is
sold, the Bank retains the unguaranteed portion of that loan and the right
to service the loan. Income from loan sales is recorded in non-interest
income. The SBA program is subject to budgetary restrictions and other
revisions by the government which could have a negative impact on the
Bank's profit. See,"Management's Discussion and Analysis of
Financial Condition and results of Operation, Non-Interest Income." The
Bank is designated as a "Preferred Lender" by the SBA. This means that
it may fund a loan without credit review and underwriting performed by
the SBA. Certification as a Preferred Lender means that the Bank has a
competitive advantage by being able to provide a quick response to loan
applications.
Market Area
The Bank's primary market area and source of most of its loan business,
except for SBA lending, is Sonoma County and the greater Bay Area.
During 2002, SBA loans were generated throughout California and in
Arizona. The Bank has expanded its lending territory for construction
loans, commercial real estate loans and loans made under the programs of
the SBA. The Bank has SBA loan production facilities in Phoenix, Arizona
and San Rafael, Sacramento, and Walnut Creek, California. The primary
market area for deposit business is Sonoma County.
Competition
The banking business in California generally, and specifically in the
market area served by the Bank, is highly competitive with respect to
both loans and deposits, and is dominated by major banks which have
offices operating throughout California. Among the advantages such
major banks have over the Bank are their ability to finance wide-ranging
advertising campaigns and to allocate their investment assets to regions
of highest yield and demand. In addition, many of the major banks
operating in the Bank's service area offer specialized services, such as
trust and international banking services, which the Bank does not offer
directly. By virtue of their greater total capitalization, the major
banks also have substantially higher lending limits than the Bank has.
The Bank competes for loans and deposits with these major banks,
as well as with other independent banks, savings and loan associations,
credit unions, mortgage companies, insurance companies and other lending
institutions. The entry of other independent banks in the Bank's service
area may adversely affect the Bank's ability to compete.
Savings and loans, credit unions and money market funds have provided
significant competition for banks with respect to deposits. Other
entities, both governmental and private, seeking to raise capital through
the issuance and sale of debt or equity securities, also provide
competition for the Bank in the acquisition of deposits. The trend of
federal and state legislation has significantly increased competition
between banks and other financial institutions for both loans and
deposits and is expected to continue to do so in the future. In
particular, the Gramm-Leach-Bliley Act enacted in November, 1999
authorizes affiliations among banks, insurance companies and
securities firms and is expected to significantly increase competition
among financial institutions with respect to all types of financial
products and services.
The earnings and growth of the Bank are affected not only by local market
conditions and general economic conditions,but also by government monetary
and fiscal policies. Such policies influence the growth of loans,
investments and deposits and also affect interest rates charged on loans
and paid on deposits. The nature and impact of future changes in
such policies on the business and earnings of the Bank cannot be predicted.
At present, there are approximately 108 banking offices and offices of
savings and loan associations in the Sonoma County market area and a
substantially greater number of such offices in the greater Bay Area,
including offices of major chain banks, of smaller independent banks and
savings and loan associations. The Bank attempts to compete by offering
personalized and specialized services to its customers. In the Sonoma
County market area, the Bank's promotional activities emphasize the
advantages of doing business with a locally owned, independent institution
attuned to the particular needs of the community.
The Bank has experienced increased competition from major banks and local
community banks in making SBA loans,especially in California. Most of our
local SBA competitors also have Preferred Lender status from the SBA, and
they often offer more attractive rates on SBA loans than the Bank can. We
expect this trend to continue. There can be no assurance that the Bank
will continue to increase its SBA loan portfolio or continue to make a
significant number of SBA loans.
Certain statistical information concerning the Bank and the Corporation is
provided at "Item 7-Management's Discussion and Analysis of Financial
Condition and Results of Operation".
Employees
At December 31, 2002 the Bank had 108 full-time and 19 part-time employees.
Supervision and Regulation
Banks and bank holding companies are subject to extensive supervision and
regulation under both federal and state laws and regulations. The primary
purpose of these laws and regulations is the protection of depositors,
consumers and the federal deposit insurance fund, and not the protection
of shareholders. The following description summarizes the regulatory
environment and some of the laws to which the Corporation and the Bank
are subject. The summary is not intended to be a discussion of all
applicable laws and regulations and is qualified in its entirety by
reference to specific statutes and regulations. The laws and regulations
applicable to banks and bank holding companies are constantly changing
and evolving and new laws and regulations are frequently introduced.
The banking business is also affected by the policies and interpretations
of regulatory authorities. It is not possible to predict the impact of
future changes in the regulatory environment on the business and
operations of the Corporation and the Bank.
The Corporation
The Corporation is a bank holding company registered under the Bank
Holding Company Act of 1956 and is subject to the supervision by the
Board of Governors of the Federal Reserve System ("Board"). As a bank
holding company, the Corporation must obtain the approval of the Board
before it may acquire all or substantially all of the assets of any bank,
or ownership or control of the voting shares of any bank if, after giving
effect to such acquisition of shares, the Corporation would own or control
more than 5% of the voting shares of such bank. Prior approval of the
Board is also required for the merger or consolidation of the
Corporation and another bank holding company. Effective April 27, 2000,
the Corporation made an election to become a "financial holding company"
pursuant to the Gramm-Leach-Bliley Act. See "Financial Services
Modernization," below.
The Board has the authority to examine the Corporation periodically. The
Board has a policy for risk-focused supervision of small bank holding
companies that do not engage in significant non-banking activities. The
focus of examinations under the policy is on whether the Corporation has
in place systems to manage the risks it takes on in its business. In
analyzing risk, the Board looks at the financial condition of the
Corporation and the Bank, management, compliance with laws and
regulations, inter-company transactions and any new or contemplated
activities.
The Corporation and any subsidiary which it may acquire or organize in the
future are deemed to be affiliates of the Bank within the meaning set
forth in the Federal Reserve Act and are subject to that Act. This means,
for example, that there are limitations on loans by the Bank to affiliates,
on investments by the Bank in any affiliate's stock and on the Bank's
taking any affiliate's stock as collateral for loans to any borrower. All
affiliate transactions must satisfy certain limitations and otherwise be
on terms and conditions that are consistent with safe and sound banking
practices. In this regard, the Bank generally may not purchase from any
affiliate a low-quality asset (as that term is defined in the Federal
Reserve Act). Also, transactions by the Bank with an affiliate must be on
substantially the same terms as would be available for non-affiliates.
The Corporation and the Bank are prohibited from engaging in certain tie-in
arrangements in connection with the extension of credit. For example, the
Bank generally may not extend credit on the condition that the customer
obtain some additional service from the Bank or the Corporation, or
refrain from obtaining such service from a competitor.
(a) Sarbanes-Oxley Act of 2002. President Bush signed the Sarbanes-Oxley
Act of 2002 into law on July 30,2002. This new legislation establishes a
comprehensive framework that affects the corporate governance and reporting
requirements of companies that file reports with the Securities and
Exchange Commission and provides accounting oversight of the accounting
firms that audit them. Among other things, the Sarbanes-Oxley Act
limits the scope of consulting services that auditors can offer
their reporting company audit clients;
imposes a range of new criminal penalties for fraud and other
wrongful acts and extends the period during which certain
types of lawsuits can be brought against a company or its
insiders;
expands certain disclosure requirements for reporting companies
and requires the maintenance of internal controls and
procedures and disclosures regarding those controls and
procedures;
requires officer certifications of a reporting company's
financial statements in quarterly, annual and other
reports to the Securities and Exchange Commission; and
creates an accounting oversight board that is empowered
to set auditing quality control and ethics standards.
The Sarbanes-Oxley Act requires the Securities and Exchange Commission to
adopt regulations to implement certain of its requirements. Numerous
regulations have been adopted to date and others are expected to be
adopted in the future.
(b) USA Patriot Act of 2001. The USA Patriot Act of 2001 contains new
anti-money laundering and financial transparency laws, in addition to the
laws and regulations theretofore in effect. The USA Patriot Act requires,
among other things, certain additional due diligence and record keeping
practices for financial institutions that administer or maintain
private bank accounts for non-U.S. persons and imposes standards for
verifying customer identification at account opening. The statutory
requirements are to be implemented by regulations issued by the U.S.
Department of the Treasury.
(c) Financial Services Modernization. Major financial services
modernization legislation was enacted in November 1999, known as the
Gramm-Leach-Bliley Act ("1999 Act"). This legislation removed barriers
that theretofore separated banks, securities firms and other types of
financial institutions. Effective March 11, 2000, the 1999 Act
established a new type of holding company, a "financial holding company,"
that may engage in "financial activities" not permitted to bank
holding companies and that have the authority to affiliate with companies
engaged in such activities. "Financial activities" are to be determined
by the Board in coordination with the Secretary of the Treasury, and may
include activities that are financial in nature, incidental to an activity
that is financial in nature, or complimentary to a financial activity and
that do not pose a safety and soundness risk. The 1999 Act enumerates
activities considered financial in nature (in addition to those
already permitted to bank holding companies), including underwriting
insurance or annuities, or acting as an insurance or annuity principal,
agent or broker; providing investment or financial advice; underwriting,
dealing in or making markets in securities; and merchant banking (subject
to certain limitations).
A holding company may elect to be treated as a financial holding company,
and engage in these activities, provided that its subsidiary depository
institutions are well-capitalized, well-managed and have received at
least a satisfactory rating in the last Community Reinvestment Act
examination. National banks may also engage in many of these activities
through a new structure, the "financial subsidiary," subject to
substantially the same capital, management and CRA requirements,
and state-chartered banks are given similar authority.
The Act also provides for functional regulation of financial services
firms, which means that securities activities are to be regulated by the
Securities and Exchange Commission, insurance activities by state
insurance regulators, and banking activities by the appropriate bank
regulatory agencies.
The 1999 Act has resulted or is expected to result in new or revised
regulations for such matters as (1) newly authorized activities for bank
holding companies and financial holding companies, (2)financial privacy,
(3) customer protections for bank insurance sales, (4) the Community
Reinvestment Act, (5) overseas activities of bank holding companies, (6)
bank derivatives transactions and intra-day credit, (7) activities allowed
in national bank operating subsidiaries, and (8) broker-dealer
registration requirements for bank sales of new hybrid products.
(d) Dividends Payable by the Corporation Holders of Common Stock of the
Corporation are entitled to receive dividends as and when declared by the
Board of Directors out of funds legally available therefore under the laws
of the State of California. Under California law, the Corporation is
prohibited from paying dividends unless: (a) the amount of its
retained earnings immediately prior to the dividend payment equals or
exceeds the amount of the dividend; or (b) immediately after giving effect
to the dividend (i) the sum of its assets would be at least equal to 125
percent of its liabilities and (ii) its current assets would be at least
equal to its current liabilities, or, if the average of its earnings
before taxes on income and before interest expense for the two preceding
fiscal years was less than the average of its interest expense for
the two preceding fiscal years, at least equal to 125 percent of its
current liabilities.
The Board of Governors has advised bank holding companies that it believes
that payment of cash dividends in excess of current earnings from
operations is inappropriate and may be cause for supervisory action.
As a result of this policy, banks and their holding companies may find it
difficult to pay dividends out of retained earnings from historical periods
prior to the most recent fiscal year or to take advantage of earnings
generated by extraordinary items such as sales of buildings or other large
assets in order to generate profits to enable payment of future dividends.
Further, the Board of Governors' position that holding companies are
expected to provide a source of managerial and financial strength to their
subsidiary banks potentially restricts a bank holding company's ability to
pay dividends.
The Corporation's ability to pay dividends on its Common Stock is subject
to the rights of senior security holders and lenders, which will include
the holders of preferred stock in the future if preferred stock is issued.
Dividend payments will also be dependent upon its separate liquidity needs.
See Item 7,"Management's Discussion and Analysis of Financial
Condition." In that regard, Federal and state statutes, regulations and
policies impose restrictions on the payment of management fees and cash
dividends by the Bank to the Corporation.
The Bank
As a national banking association, the Bank is subject to the National Bank
Act and to supervision, regulation and regular examination by the
Comptroller of the Currency ("Comptroller"). It is also a member of the
Federal Reserve System and, as such, is subject to applicable provisions of
the Federal Reserve Act and regulations issued pursuant thereto. The
deposits of the Bank are insured up to the maximum legal limits by the Bank
Insurance Fund ("BIF"), which is managed by the Federal Deposit Insurance
Corporation ("FDIC"), and the Bank is therefore subject to applicable
provisions of the Federal Deposit Insurance Act and regulations of the
FDIC. The statutes and regulations administered by these agencies
govern most aspects of the Bank's business, including required reserves
against deposits, loans, investments, dividends, and the establishment of
new branches and other banking facilities.
(a) Supervision and Examinations. Federal law mandates frequent
examinations of all banks, with the costs of examinations to be assessed
against the bank being examined. In the case of the Bank, its primary
regulator is the Comptroller.
The Comptroller has a community bank risk-assessment system, which consists
of examination procedures that focus on the various types of risks that
national banks face. The Comptroller measures each individual bank's
exposure to certain risks, assesses the controls the bank has adopted in
response to the risks it faces and the measures it takes to monitor
those risks. The Comptroller evaluates nine categories of risk: credit,
interest rate, liquidity, price, foreign exchange, transaction, compliance,
strategic and reputation. These nine risks are measured and the direction
of the risk is also analyzed.
The FDIC has "back up" enforcement power over the Bank under Federal law.
The FDIC is authorized to conduct examinations of insured institutions that
represent a heightened risk to the deposit insurance funds when the FDIC
determines that such an examination is necessary. By agreement with other
federal regulatory agencies, the FDIC is also given access to supervisory
information held by the federal agencies and the right to participate in
examinations.
The Federal banking regulatory agencies have substantial enforcement powers
over the depository institutions that they regulate. Civil and criminal
penalties may be imposed on such institutions and persons associated with
those institutions for violations of any law or regulation. The penalties
can be up to $ 5,000 per day that a violation continues when the
violation is unintentional, or up to $1 million per day that a violation
continues when the violation is willful. The amount of the penalty also
depends on whether the violation is part of a pattern or causes a loss to
the financial institution.
(b) Prompt Corrective Action. The Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") requires the banking agencies to take
corrective action against certain financial institutions, based upon the
financial institutions' compliance with the various capital measurements.
The capital requirements and the definitions of the various measures of
capital are described below under the heading "Capital Regulations and
Dividends." The following chart sets forth the various categories of
capital compliance. In order to be considered in the well or adequately
capitalized categories, a financial institution must meet all the
requirements for that category. An institution will be considered
undercapitalized or significantly or critically undercapitalized if it
meets any of the requirements for that category.
Ratio Category Total Risk-Based Tier 1 Risk-Based Leverage
- --------------- ---------------- ----------------- --------
Well Capitalized* 10% or above 6% or above 5% or above
Adequately Capitalized 8% or above 4% or above 4% or above**
Undercapitalized Less than 8% Less than 4% Less than 4%
Significantly Undercapitalized Less than 6% Less than 3% Less than 3%
Critically Undercapitalized - - 2% or less
* In addition, the institution must not be subject to any written
capital order or directive to meet and maintain a specific
capital level.
** 3% instead of 4% if the institution has the highest rating
under the CAMEL rating system.
FDICIA also permits the banking agencies essentially to downgrade an
institution to the next lower category (but not into the category of
critically undercapitalized) if it determines that the institution is in an
unsafe or unsound condition, or is engaging in an unsafe or unsound
practice. An institution that has received a less- than-satisfactory
rating in its most recent examination report for assets, management,
earnings or liquidity may be deemed to be engaged in an unsafe and unsound
practice. Except for a finding based on a less-than-satisfactory rating,
the institution is entitled to prior written notice and an opportunity to
respond to its regulator's finding that it is in an unsafe or unsound
condition or is engaging in such practices.
Based on its capital position at December 31, 2002, the Bank is considered
well capitalized.
As noted above, an undercapitalized financial institution is subject to
certain corrective action by the appropriate agency, depending on the
category it falls into. All undercapitalized institutions are required to
submit a capital plan within 45 days after the institution becomes
undercapitalized. Also, such an institution's asset growth is restricted
and it must obtain the prior approval of its federal regulator before it
acquires any company, sets up any new branch or engages in any new line of
business. The banking agency is required to monitor closely the condition
of the bank and its compliance with its plan, and to review periodically
the plan and the supervisory restrictions on the bank to assure they are
appropriate. In addition, the regulator is authorized by statute to take
the certain corrective actions and order certain limitations on the bank's
activities if necessary to carry out the purposes of the statute.
If an institution is categorized as being significantly undercapitalized,
or is undercapitalized and fails to submit a capital plan, its banking
regulator is required to take increasingly severe enforcement actions
against such institution. The regulator must require recapitalization
through a sale of stock or a merger, restrict affiliate transactions and
restrict the interest rates the bank may offer on deposits, (unless it
finds that doing so would not further the purpose of the section). In
addition, such an institution may not pay a bonus to a senior
executive officer or increase the pay of any executive officer without the
prior written approval of its federal regulator.
An institution that is critically undercapitalized is subject to mandatory
restrictions that are even more severe,and seizure within time limits
designated by statute. In general, the federal regulator is required to
seize an institution within 90 days of its becoming critically
undercapitalized,unless the regulator can document that another course of
action will better achieve the purposes of this section. The FDIC is
required to restrict the activities of a critically undercapitalized
institution, beyond the degree of limitations specified above for
institutions that are significantly undercapitalized.
(c) Brokered Deposits. FDICIA places limits on brokered deposits and
extends the limits to any bank that is not "well capitalized" or is
notified that it is in "troubled condition." Previously, the limitations
applied only to troubled banks. A well capitalized institution (which
generally includes an institution that is considered well capitalized for
purposes of the prompt corrective action regulations discussed above) may
still accept brokered deposits without restriction, unless it has been
informed by its appropriate Federal regulatory agency that it is in
"troubled condition." All other insured depository institutions are
prohibited from accepting brokered deposits unless a waiver is obtained
from the FDIC. If a waiver is obtained, the interest paid on such deposits
may not exceed the rate paid for deposits in its normal market area, or the
national rate as determined in the FDIC's regulation.
If a depository institution solicits deposits by offering interest rates
significantly higher than rates being offered in its market area, it is
deemed under FDICIA to be a deposit broker. Therefore, depending on its
capital category, it may be prohibited from such practice, or need a prior
waiver from the FDIC in order to offer such rates. The FDIC's regulations
specify that an institution that is not well capitalized may offer rates
that exceed the prevailing effective rates offered in the normal market
area only if the institution obtains a waiver, but the institution may not
offer rates more than 75 basis points above such prevailing rates.
The Bank is at this time considered well capitalized and not in a "troubled
condition," and it is not, therefore,subject to the brokered deposit
limitations.
(d) Risk-Based Deposit Insurance Assessments. In addition, FDICIA
requires the FDIC to develop and implement a system to account for risks
attributable to different categories and concentrations of assets and
liabilities in assessing deposit insurance premiums. Under this system,
each bank's deposit insurance premium assessment is calculated based on a
risk-based assessment program.
Capital Regulations and Dividends
The Board requires member banks and bank holding companies to maintain
adequate capital and has adopted capital leverage guidelines for evaluating
the capital adequacy of bank holding companies. The Comptroller has also
adopted a similar minimum leverage regulation, requiring national banks to
maintain at least a minimum capital to asset ratio. The Board's guidelines
and the Comptroller's regulations require the banks and bank holding
companies subject to them to achieve and maintain a Tier 1 capital to total
asset ratio of at least three percent (3.0%) to five percent (5.0%),
depending on the condition and rate of growth of the bank or holding
company. Tier 1 or core capital is defined to consist primarily of
common equity, retained earnings, and certain qualified perpetual preferred
stock. These minimum leverage ratio requirements limit the ability of
the banking industry, including the Corporation and the Bank, to leverage
assets.
The Federal Reserve Board also uses risk-based capital guidelines to
evaluate the capital adequacy of member banks and bank holding companies.
Under these guidelines, assets are categorized according to risk and the
various categories are assigned risk weightings. Assets considered to
present less risk than others require allocation of less capital. In
addition, off-balance sheet and contingent liabilities and commitments must
be categorized and included as assets for this purpose. Under these
guidelines, the Corporation is required to maintain total capital of at
least 8.00% of risk-adjusted assets, and half of that minimum total capital
must consist of Tier 1 capital as defined above.
The Comptroller has also adopted risk-based capital guidelines applicable
to national banks, such as the Bank, that are similar to the Federal
Reserve's risk-based capital guidelines. At this time, the Bank is
required to maintain total capital of at least 8.00% of risk-adjusted
assets.
The capital totals of the Corporation and the Bank, as of December 31,
2002, exceeded the amounts of capital required under the regulatory
guidelines to be well capitalized as shown in Footnote 13 of the Financial
Statements, entitled Regulatory Capital Requirements, Item 8.
Under the risk-based capital rules, when the agencies assess the capital
adequacy of a bank, they must take into account the effect on that bank's
capital that would occur if interest rates moved up or down. The purpose
of this requirement is to ensure that banks with high levels of interest
rate risk have enough capital to cover the loss exposure.
The risk-based guidelines and the leverage ratio do not have a significant
effect on the Corporation and the Bank at this time because both the
Corporation and the Bank meet their respective required ratios. The effect
the requirements may have in the future is uncertain, but management does
not believe they will have an adverse effect on the Corporation or the
Bank. The risk-based capital guidelines may affect the allocation of
the Bank's assets between various types of loans and investments. If the
Bank continues to grow with its present asset composition, it may be
required to raise additional capital.
The required capital ratios have increased in significance under FDICIA, as
described above. The ratios now affect the Bank's ability to utilize
brokered deposits and its deposit insurance premium rates, and they can
result in regulatory enforcement action. See, above, "The Bank."
As required by FDICIA, the Federal banking agencies now take credit risk
concentrations and an individual institution's ability to manage such
concentrations into account when they assess a bank's capital adequacy.
Non-traditional investments and activities, such as the use of derivatives,
are also taken into account in assessing capital requirements. The
agencies can adjust the standards for risk-based capital on a case by
case basis to take such risks into account, but there is no formula that a
bank can use prior to evaluation by the agency to determine how credit
concentration or nontraditional activities will affect its capital
requirements.
Regulatory restrictions and other information guidelines with respect to
the payment of dividends by the Bank are contained in Item 5, "Market for
Registrant's Common Equity and Related Stockholder Matters.", below.
Impact of Monetary Policies
Banking is a business in which profitability depends on rate differentials.
In general, the difference between the interest rate received by the Bank
on loans extended to its customers and securities held in the Bank's
investment portfolio and the interest rate paid by the Bank on its deposits
and its other borrowings comprise the major portion of the Bank's earnings.
To the extent that the Bank is not able to compensate for increases in the
cost of deposits and other borrowings with greater income from loans,
securities and fees, the net earnings of the Bank will be reduced. The
interest rates paid and received by the Bank are highly sensitive to many
factors which are beyond the control of the Bank, including the influence
of domestic and foreign economic conditions.
The earnings and growth of the Bank are also affected by the monetary and
fiscal policy of the United States government and its agencies,
particularly the Board. These agencies can and do implement national
monetary policy, which is used in part to curb inflation and combat
recession. Among the instruments of monetary policy used by these agencies
are open market transactions in United States Government securities,
changes in the discount rates of member bank borrowings and changes in
reserve requirements. The actions of the Board have had a significant
effect on lending by banks, investments and deposits, and such actions are
expected to continue to have a substantial effect in the future. However,
the nature and timing of any further changes in such polices and their
impact on the Bank cannot be predicted.
Public Interest Laws, Consumer and Lending Laws
In addition to the other laws and regulations discussed herein, the Bank is
subject to certain consumer and public interest laws and regulations that
are designed to protect customers in transactions with banks. While
the list set forth below is not exhaustive, these laws and regulations
include the Community Reinvestment Act, Truth in Lending Act, the Truth in
Savings Act, the Electronic Funds Transfer Act, the Expedited Funds
Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act,
the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure
Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act,
the Bank Secrecy Act and the Right to Financial Privacy Act.
These laws and regulations mandate certain disclosure requirements and
regulate the manner in which financial institutions must deal with
customers when taking deposits, making loans, collecting loans and
providing other services. The Bank must comply with the applicable
provisions of these laws and regulations as part of its ongoing customer
relations. Failure to comply with these laws and regulations can subject
the Bank to various penalties, including but not limited to enforcement
actions, injunctions, fines or criminal penalties, punitive damages to
consumers and the loss of certain contractual rights.
Environmental Regulation
Federal, state and local regulations regarding the discharge of materials
into the environment may have an impact on the Corporation and the Bank.
Under Federal law, liability for environmental damage and the cost of
cleanup may be imposed upon any person or entity who is an owner or
operator of contaminated property. State law provisions, which were
modeled after Federal law, impose substantially similar requirements. Both
Federal and state laws were amended in 1996 to provide generally that a
lender who is not actively involved in operating the contaminated property
will not be liable to clean up the property, even if the lender has a
security interest in the property or becomes an owner of the property
through foreclosure.
The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the
"Economic Growth Act"), discussed in more detail below, includes protection
for lenders from liability under the Comprehensive Environmental Response,
Compensation and Liability Act of 1980 (ACERCLA"). The Economic Growth Act
adds a new section to CERCLA to specify the actions a lender may take with
respect to lending and foreclosure activities without incurring
environmental clean-up liability or responsibility. Typical contractual
provisions regarding environmental issues in the loan documentation and due
diligence inspections will not lead to lender liability for clean-up, and a
lender may foreclose on contaminated property, so long as it merely
maintains the property and moves to divest it at the earliest possible
time.
Under California law, a lender generally will not be liable to the State
Attorney General for the cost associated with cleaning up contaminated
property unless the lender realized some benefit from the property, failed
to divest the property promptly, caused or contributed to the release of
the hazardous materials or made the loan primarily for investment
purposes. This amendment to California law became effective with respect
to judicial proceedings filed and orders issued after January 1, 1997.
The extent of the protection provided by both the Federal and state lender
protection statutes will depend on their interpretation by the
administrative agencies and courts, and the Corporation cannot predict
whether it will be adequately protected for the types of loans made by the
Bank.
In addition, the Corporation and the Bank are still subject to the risks
that a borrower's financial position will be impaired by liability under
the environmental laws and that property securing a loan made by the Bank
may be environmentally impaired and not provide adequate security for the
Bank. California law provides some protection against the second risk, by
establishing certain additional, alternative remedies for a lender in the
situation where the property securing a loan is later found to be
environmentally impaired. Primarily, the law permits the lender in such a
case to pursue remedies against the borrower other than foreclosure under
the deed of trust.
The Bank attempts to protect its position against the remaining
environmental risks by performing prudent due diligence. Environmental
questionnaires and information on use of toxic substances are requested as
part of its underwriting procedures. The Bank lends based upon its
evaluation of the collateral, net worth of the borrower and the borrower's
capacity for unforeseen business interruptions or risks.
Americans With Disabilities Act
The Americans With Disabilities Act ("ADA") enacted by Congress, in
conjunction with similar California legislation, may have an impact on
banks and their cost of doing business. The legislation requires employers
with 15 of more employees and all businesses operating "commercial
facilities" or "public accommodations" to accommodate disabled employees
and customers. The ADA has two major objectives (1) to prevent
discrimination against disabled job applicants, job candidates and
employees and (2) to provide disabled persons with ready access to
commercial facilities and public accommodations. Commercial facilities,
such as the Bank, must ensure all new facilities are accessible to
disabled persons, and in some instances may be required to adapt existing
facilities to make them accessible, such as ATM's and bank premises.
New and Pending Legislation
Certain legislative and regulatory proposals that could affect the
Corporation, the Bank and the banking business in general are pending or
have been introduced, before the United States Congress, the California
State Legislature, and Federal, state and local government agencies.
(a) ATM Fees. Legislation has been proposed in the past in the Congress
and the California legislature and measures are currently being proposed in
local jurisdictions to regulate the amount of ATM fees that operators of
ATMs may charge, and to further regulate the disclosure of such fees. The
Gramm-Leach-Bliley Act of 1999 also requires ATM operators who impose a
fee for use of an ATM by a non-customer to disclose such fees. The Bank
does not own or operate ATM machines.
(b) Expansion in Credit Union Membership. A broad rule adopted by the
National Credit Union Administration ('NCUA'), relaxes limits of credit
union membership. The new rule took effect January 1, 1999.
The NCUA will now approve credit unions with membership of more than
300,000 residents with proof that they function as a community. The effect
is to substantially expand credit union membership and make credit
unions as tax exempt entities, serving credit needs of large communities,
more competitive to banks. Litigation attacking the new rule is pending.
(c) Privacy. The 1996 Amendments to the Fair Credit Reporting Act allow
a bank to share customer information with its affiliates providing the
bank's customers are given the opportunity to 'opt out' by way of
language contained in a bank's loan applications, loan agreements and other
forms.
The Gramm-Leach-Bliley Act of 1999 requires financial institutions to
provide further customer protections regarding the sharing or selling of
nonpublic personal information, including disclosure by an institution of
its policies regarding confidentiality and security of such personal
information and further requirements regarding notices to customers and the
customer's opportunity to exercise a non-disclosure option. Disclosure of
the Bank's policies and practices regarding disclosure is to be made at
the time a customer relationship is established and not less than annually
during the continuation of the relationship. Effective July 1, 2001,
federal banking agencies have established standards and guidelines for
financial institutions to follow relating to administrative, technical and
physical safeguards for customer records and information. Financial
institutions are required to establish an information security program to
assess and control risks to customer information, including overseeing
their service provider arrangements to protect the security of customer
information maintained or processed by service providers.
Existing California state law provides protection against furnishing
customer information to third parties and law enforcement officials. There
is new legislation introduced in California from time to time which would
require financial institutions to provide additional notices or
information to customers or take additional steps to protect customer
information. The Gramm-Leach-Bliley Act permits states to adopt privacy
laws which are more strict and to provide greater privacy protection than
its own provisions in protecting customer information.
(d) Deposit Insurance Reform. Legislation has been introduced
before Congress from time to time to raise deposit insurance from its
current amount of $100,000. In one proposed bill deposit insurance would
be increased to $130,000 per account with higher amounts for individual
retirement accounts and other retirement accounts. Other proposals include
eliminating or reducing the requirement under current law for mandatory
increases in premium payments by depository institutions for deposit
insurance when the ratio of federal reserves in the insurance funds to
insured deposits is less than 1.25%. At the end of the fourth quarter of
2002 the ratio was 1.27%. Other proposals include merging the Bank
Insurance Fund and the Savings Association Insurance Fund and restructuring
the federal banking agencies.
It is not known to what extent, if any, these proposals will be enacted or
remain in force or what effect such legislation would have on the
structure, regulation and competitive relationship of financial
institutions. It is likely, however, that many of these proposals would
subject the Corporation and the Bank to increased regulation, disclosure
and reporting requirements and would increase competition to the Bank and
its cost of doing business.
In addition to pending legislative changes, the various banking regulatory
agencies frequently propose rules and regulations to implement and enforce
already existing legislation. It cannot be predicted whether or in what
form any such legislation or regulations will be enacted or the effect that
such legislation or regulations may have on the Bank's business. It is
likely, however, that many of these proposals would subject the
Corporation and the Bank to increased regulation, disclosure and reporting
requirements and would increase competition to the Bank and its cost of
doing business.
ITEM 2. Properties
The Corporation and the Bank share common quarters at 801 Fourth Street, in
the central business district of Santa Rosa. The Corporation leases a
total of approximately 9,335 square feet of ground floor and second
floor office space at that location and sublets this area to the Bank.
The SBA and Commercial Lending and Loan Administration offices are located
less than a block away from the main office at 815 Fifth Street, Santa
Rosa. The Bank leases 8,047 square feet from Mr. James Ratto, a major
shareholder of the Corporation.
The Bank's data processing, client services and personnel departments are
located at 1650 Northpoint Parkway, Santa Rosa. The Bank leases 7,122
square feet.
The Corporation leases facilities for its six branch offices (both stand
alone offices and supermarket branches)in Sonoma County under various
leases which expire under various dates, including options to renew through
the year 2025.
The Bank also leases other properties for its loan production offices in
California and Arizona.
Management believes that its facilities are adequate for its present needs,
but additional facilities may be needed as and when the Bank continues to
grow.
The Bank has invested in loans secured by real property collateral. The
Bank's policies with respect to such loans are described under the caption
"Item 7, Management's Discussion and Analysis of Financial Condition
and Results of Operation - Loan Portfolio."
ITEM 3. Legal Proceedings
Neither the Corporation nor the Bank is a party to any material pending
legal proceedings, other than proceedings arising in the ordinary course of
the Bank's business. None of these are expected to have a material
adverse impact on the financial position or results of operations of the
Corporation or Bank.
ITEM 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of shareholders during the fourth
quarter of 2002.
Part II
ITEM 5. Market for Registrant's Common Equity and
Related Stockholder Matters
On January 31, 2003, the Corporation had 4,180,914 shares of common stock
outstanding, held by approximately 297 shareholders of record.
At January 31, 2003, the directors and officers of the Corporation and the
Bank hold 8.7% and beneficially own 35.0% of the outstanding shares. See
"Item 12, Security Ownership of Certain Beneficial Owners and
Management," herein. Under SEC rules, the directors and officers are
restricted in the amount of securities they may sell without registration
under the Securities Act of 1933, as amended. In general, directors and
officers each may offer up to 41,809 shares in any three month period
without such registration.
As of January 31, 2002, the directors, officers and staff have the right to
acquire 1,193,237 additional shares upon the exercise of options granted
pursuant to the Corporation's Stock Option Plans. Should several
directors and officers choose to exercise options and sell their shares on
the market, such that a large number of shares are offered at one time, the
price of the common stock could be adversely affected.
The Corporation's common stock is not listed on any securities exchange or
on the National Association of Securities Dealers Automated Quotations
(NASDAQ) System. The firms First Union Securities, Inc. and Mutual
Securities, located in Santa Rosa, and Hoefer & Arnett and First Security
Van Kasper, located in San Francisco, are presently making a market in the
stock. The Corporation's trading symbol is NREB. The following chart
shows the high and low bid quotations and the volume of transactions in
the Corporation's stock for the periods indicated. The trading volume was
obtained from the OTC bulletin board web site and does not include
privately negotiated transactions. The prices were obtained the from the
business section of the Press Democrat in Santa Rosa, California. The bid
prices and numbers of shares in this table have been adjusted for
the impact of the stock dividends issued during 2001 and 2002.
Bid Quotations for the Corporation's
Common Stock
Approximate
Quarter Ended High Low Trading Volume
March 31, 2001 19.72 17.34 264,533
June 30, 2001 18.57 17.38 77,458
September 30, 2001 21.29 17.19 394,475
December 31, 2001 21.48 20.57 173,188
March 31, 2002 25.05 21.48 96,192
June 30, 2002 29.25 26.15 208,545
September 30, 2002 28.15 26.00 104,979
December 31, 2002 27.05 25.55 93,891
Due to the lack of any significant trading and no established public
market, the prices indicated above should not be considered an indication
of the market value of the shares. There is no assurance that any
significant trading market for the shares will develop in the future and
there are no assurances as to the price at which shares may be traded in
the future. The bid and asked prices of the Corporation's common stock
were $27.10 and $28.25, respectively, on January 31, 2003.
Dividends
On March 26, 2002, the Corporation declared a 5% stock dividend to
shareholders of record on April 30, 2002. On March 27, 2001, the
Corporation declared a 5% stock dividend to shareholders of record on May
4,2001.
The Corporation has not paid any cash dividends since 1995. There is no
assurance that dividends will be paid, or, if paid, what the amount of any
such dividends will be. The future dividend policy of the Corporation
is subject to the discretion of the Board of Directors and will depend upon
a number of factors, including earnings, financial condition, cash needs
and general business conditions. In addition, the Board of Directors
may declare dividends only out of funds legally available therefore. See
"Supervision and Regulation - Dividends Payable by the Corporation."
The Corporation's primary source of income (other than interest income
earned on the Corporation's other investments) is the receipt of dividends
from the Bank. The Bank's ability to pay dividends is subject to the
restrictions of the national banking laws and, under certain circumstances,
the approval of the Comptroller of the Currency. A national bank may not
pay dividends from its capital. All dividends must be paid out of net
profits then on hand, after deducting for expenses, including losses and
bad debts. A national bank is also prohibited from declaring a dividend
until its surplus fund equals the amount of its capital stock or, if the
surplus fund does not equal the amount of its capital stock, until
one-tenth of the bank's net profits for the preceding half year, in the
case of quarterly or semiannual dividends, or the preceding two
consecutive half- year periods, in the case of an annual dividend, are
transferred to the surplus fund each time dividends are declared.
The approval of the Comptroller is required if the total of all dividends
declared by a bank in any calendar year will exceed the total of its net
profits of that year combined with its retained net profits of the two
preceding years, less any required transfers to surplus or a fund for the
retirement of any preferred stock which may be outstanding. Moreover, the
Comptroller may prohibit the payment of dividends which would constitute
an unsafe and unsound banking practice. As of December 31, 2002,
$24,321,000 of retained earnings of the Bank was available for the payment
of dividends to the parent company under this requirement.
Securities Authorized for issuance under equity compensation plans
The Corporation's 1997 Stock Option Plan ("1997 Plan") was approved by the
Corporation's shareholders at the May 19, 1998 annual shareholders'
meeting. The 1997 Plan was adopted by the Board of Directors to
replace the Corporation's earlier stock option plan (the A1984 Plan@) which
was approved by the Corporation's shareholders on June 4, 1995 and expired
by its terms on February 26, 1994. Options to purchase shares are still
outstanding under the 1984 Plan, and these options will remain outstanding
until they are exercised or expire. However, no new options may be
granted under the 1984 Plan. Other than options outstanding under its
stock option plans, the Corporation does not have any outstanding rights
or warrants to purchase shares of its common stock.
The purpose of the 1997 Plan is to provide a means whereby employees and
directors of the Corporation and the Bank and any other corporation that
may become a subsidiary of the Corporation, may be given an opportunity to
purchase shares of common stock of the Corporation. The Plan is intended
to advance the interests of the Corporation and the Bank by enhancing
their ability to attract and retain the best available personnel for
positions of substantial responsibility and to attract and retain the best
available persons to serve as directors of the Corporation and the Bank,
to provide additional incentive to employees and directors, and to promote
the success of the Corporation's business.
The Plan provides for the grant of both non-statutory options and options
which are intended to qualify as
"incentive stock options" as defined in Section 422 of the Internal Revenue
Code (the "Code").
Equity Compensation Plan Information
Number of securities
remaining available for future
Number of securities to be issuance under equity
issued upon exercise of Weighted-average exercise compensation plans
outstanding options, price of outstanding options, (excluding securities reflected
warrants and rights warrants and rights in column (a))
----------------------- ----------------------------- -------------------------------
Equity compensation
plans approved by
security holders 1,193,237 $13.78 64,382
Equity compensation
plans not approved
by security holders 0 0 0
--------- ------ ------
Total 1,193,237 $13.78 64,382
========= ====== ======
ITEM 6. Selected Financial Data
(Dollars in thousands)
2002 2001 2000 1999 1998
Year ended December 31,
Interest income $41,456 $44,345 $39,894 $29,824 $25,399
Interest expense 15,841 20,803 19,495 12,836 11,103
Net interest income 25,615 23,542 20,399 16,988 14,296
Provision for loan losses 840 960 960 800 480
Non-interest income 2,334 1,677 1,456 1,572 1,702
Non-interest expense 11,678 10,521 9,530 8,428 7,582
Income before income taxes 15,431 13,738 11,365 9,332 7,936
Provision for income taxes 6,096 5,651 4,513 3,754 3,171
Net Income 9,335 8,087 6,852 5,578 4,765
Earnings per share:
Basic* $2.24 $1.94 $1.65 $1.36 $1.19
Diluted* $1.97 $1.78 $1.59 $1.28 $1.15
Per Share:
Cash Dividends paid $0.00 $0.00 $0.00 $0.00 $0.00
Book value at
December 31* $12.85 $10.62 $8.69 $7.04 $5.67
Average common
shares outstanding* 4,175,509 4,164,777 4,145,654 4,100,365 4,012,941
Average diluted common
shares outstanding* 4,744,640 4,537,920 4,317,215 4,356,891 4,156,739
Shares outstanding at
December 31 (Actual) 4,180,914 3,973,263 3,766,382 3,560,296 3,309,712
At December 31
Loans, net 586,461 466,529 432,446 357,225 267,029
Total assets 689,380 561,004 494,390 397,928 322,253
Total deposits 577,585 502,137 453,437 357,867 295,969
Borrowed funds 54,776 11,802 1,828 9,050 1,872
Shareholders equity 53,738 44,297 36,103 29,062 22,810
Financial Ratios:
For the year:
Return on average assets 1.50% 1.54% 1.54% 1.59% 1.69%
Return on average equity 18.86% 19.83% 20.87% 21.62% 23.39%
Net interest margin 4.23% 4.61% 4.71% 5.03% 5.23%
Net loan losses to
average loans 0.01% 0.01% 0.02% 0.01% 0.00%
Efficiency ratio 41.78% 41.72% 43.60% 45.41% 47.39%
At December 31:
Equity to assets 7.80% 7.90% 7.30% 7.30% 7.08%
Total capital to risk
adjusted assets 11.56% 12.14% 10.69% 10.54% 10.63%
Nonperforming assets to
total loans & OREO 0.51% 0.45% 0.51% 0.52% 0.02%
Nonperforming assets to
total assets 0.44% 0.38% 0.46% 0.47% 0.02%
Allowance for loan losses
to total loans 1.07% 1.18% 1.06% 1.04% 1.11%
Allowance for loan losses to
non-performing assets 210.5% 260.48% 207.58% 200.58% 4869.35%
* Prior years have been adjusted for stock dividends issued.
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operation
Critical Accounting Policies
The Corporation and Bank's accounting policies are fundamental to
understanding management's discussion and analysis of results of operations
and financial condition. Accounting policies are described in detail in
Note 1 of the Notes to Consolidated Financial Statements presented in Item
8. One policy, Allowance for Loan Losses, has been identified as being
critical because it requires management to make difficult and subjective
judgments about matters that are inherently uncertain and because of the
likelihood that materially different amounts would be reported under
different conditions or using different assumptions. This policy is
reviewed by Loan Committee and approved by the Board of Directors.
The Allowance for Loan Losses represents management's estimate of probable
losses inherent in the loan portfolio at the balance sheet date. The
allowance for loan losses is reviewed monthly and is based on allocations
for each loan category (e.g. Real Estate, Commercial), an allocation for
undisbursed commitments, plus an allocation for any outstanding loans which
have been classified and are on the "Watch List." Each loan that has been
classified is individually analyzed for the risk involved and an allowance
provided according to the risk assessment. In addition to the allocated
component there is an unallocated component. The unallocated component
incorporates management's judgment of the inherent risks in the portfolio
based on: historical loan loss experience, loan concentrations,
evaluations made by regulatory agencies and our outside accountants, and
assessment of economic conditions The allocated and unallocated components
represent the total allowance for loan losses to adequately cover losses
inherent in the loan portfolio.
Changes in the estimate related to the allowance for loan losses can
materially affect net income. The process of determining the allowance
requires us to forecast losses on loans in the future which are
highly uncertain and require a high degree of judgment; and is impacted by
regional, national and global economic trends and different assumptions
regarding possible future economic conditions could have been used and
would have had a material impact on the provision for loan losses and on
the consolidated results of operations.
Balance Sheet - Summary
The Corporation's sole subsidiary is Sonoma National Bank ("Bank"), and its
primary activities are the commercial banking activities engaged in through
the Bank. The following discussion of financial condition as of December
31, 2002 and 2001 and results of operations for the years ended December
31, 2002, 2001 and 2000 focuses primarily on the Bank.
During 2002, total consolidated assets grew 22.9% to $689,380,000 at
December 31, 2002. Total consolidated assets grew 13.5% during 2001 to
$561,004,000 at December 31, 2001. The growth in 2002 results from strong
loan demand during the second and third quarters of 2002. See discussion
on Loan Portfolio.
Total deposits increased 15.0% to $577,585,000 when comparing December 31,
2002 to December 31, 2001. For the year ended December 31, 2001, total
deposits increased 10.7% to $502,137,000. Deposits increased to fund the
loan growth mentioned above. See discussion on Deposits.
Results of Operations - Summary
The Corporation's consolidated net income for the year ended December 31,
2002 was $9,335,000 as compared to $8,087,000 for the year ended December
31, 2001, an increase of 15.4%. The Corporation's consolidated net income
for the year ended December 31, 2001, increased 18.0% over the year ended
December 31, 2000.
Net interest income before provision for loan losses increased $2,073,000,
or 8.8%, when comparing the year of 2002 to 2001. This increase results
from the growth in the volume of loans on which the Bank earns a net
interest margin. The interest margin for 2002 equaled 4.23% compared to
4.61% in 2001 and 4.71% in 2000. See, "Net Interest Income."
The provision for loan losses of $840,000 in 2002 compared to $960,000 in
2001. See, "Allowance for Loan Losses." Non-interest income increased
$657,000 primarily due to higher premiums on SBA loan sales and an
increase in the volume of SBA loans sold which increased gains on SBA loan
sales by $470,000. See, "Non-Interest Income." Operating expenses
increased by $1,157,000 primarily because of rapid growth of the Bank. A
new branch office was opened in Sonoma, California in October 2002 and a
new loan production office was opened in San Rafael during the fourth
quarter of 2002.
When comparing 2001 to 2000 the provision for loan losses was unchanged at
$960,000 in 2001 and other income increased $221,000 to $1,677,000 in 2001
from $1,456,000 in 2000. Operating expenses increased $991,000 during
2001 primarily due to increases in personnel costs, a new branch office
and the move of central services to a new location.
Net Interest Income
The primary source of the Bank's income is the difference between (1) the
interest earned on its loan and investment portfolios, interest bearing
deposits with other banks, and federal funds sold, and (2) the interest
paid on deposits and other borrowed funds. This difference is referred to
as net interest income, and it is one of the primary factors that affect
the Corporation's profitability. Interest income earned on loans, which
includes loan fee income, is primarily a function of the amount of loans
outstanding and the rates prevailing on these loans. Interest paid on
deposits depends on the composition of the deposit base and the rates paid
to attract deposits. See, "Deposits."
For the year ended December 31, 2002, net interest income before the
provision for loan losses totaled $25,615,000 as compared to $23,542,000
for the year ended December 31, 2001, representing an increase of 8.8%.
The majority of this increase results from the net interest margin earned
on growth in the loan portfolio, largely as a result of the increase in
real estate loans. See, "Loan Portfolio." During 2001, net interest
income before the provision for loan losses totaled $23,542,000 as
compared to $20,399,000 in 2000 representing an increase of 15.4%. The
majority of this increase resulted from the net interest margin earned
on growth in the loan portfolio.
The Bank's net interest margin (expressed as a percentage, the yield on
average interest earning assets less the rate paid on average interest
bearing liabilities) moved to 4.23% in 2002 from 4.61% in 2001 and 4.71%
in 2000. Several factors impact the Bank's net interest margin. These
include changes in market interest rates, level of loans relative to
deposits, mix of loan and earning assets, non-accrual loan balances and
mix of deposits and other funding sources.
Changes in Market Interest Rates
Changes in economic condition and actions of Federal Reserve Board to
reduce the Fed Funds and Discount rates have a direct impact on the Bank's
net interest margin since prime rate generally moves with Federal
Reserve Board changes. During 2002 prime rate equaled 4.75% until November
7 when it declined to 4.25%(40 year lows). During 2001, The Federal
Reserve Board lowered the discount rate and Fed Funds rates 11
times with prime rate also declining 11 times following the Federal Reserve
Board's actions. Prime rate declined to 4.75% at December 31, 2001 from
9.50% at December 31, 2000. The majority of SBA loans are tied to prime
rate and reprice on a quarterly basis. Other loan indexes also declined;
however, not as immediately as prime rate. The rapid decline in market
rates in 2001 has continued to have a negative impact on the Bank's
interest margin during 2002 and will impact loan yield as loans reprice
based upon their repricing schedule and index. There are no assurances
that earnings will not be adversely impacted by future actions of the
Federal Reserve Board and changes in market interest rates.
The Bank is considered asset sensitive, meaning more assets are immediately
adjustable than liabilities. The Bank's net interest margin tends to
increase when interest rates increase and tends to decrease in a
declining rate environment.
The full impact of rate changes on the Bank's earnings are not realized for
several months, since not all loans or deposits reprice immediately. The
majority of SBA loans are tied to the prime rate and reprice on a calendar
quarter basis. The Bank has adjustable rate loans, mainly commercial real
estate loans that are tied to indexes which adjust at a slower pace, such
as the Eleventh District Cost of Funds Index (COFI). The COFI index moved
to 2.38% for December 2002 from 3.07% for December 2001 and 5.62% for
December 2000. The Bank also has a fixed rate loan portfolio which
generally reduces net interest margin as interest rates rise and benefits
interest margin as rates decline.
Market rates also impact the Bank's ability to attract deposits and grow
the loan portfolio. The current low rates offered on deposits makes them
less attractive to depositors. The Bank has also experienced an increase
in loan payoffs as borrowers have refinanced to other loans tied to
indexes which bear lower rates than loans tied to the COFI index.
Level of Loans Relative to Deposits
The net interest margin is also affected by the level of loans relative to
deposits. The Bank's ratio of loans-to- deposits increased during 2002,
when it averaged 99.6%, as compared to 97.3% in 2001. This ratio equaled
98.2% in 2000. An increase in the loan-to-deposit ratio generally results
in an increase in net interest margin.
Mix of Loan and Earning Assets
Changes in the mix of loans also impact the Bank's interest margin. The
Bank grew average loans by $72.4 million in 2002 and $64.4 million in 2001.
In both those years the majority of the growth in average loans
occurred in commercial real estate loans. There were increases of $55.2
million and $33.3 million in average commercial real estate loans,
respectively, which bear a lower average interest yield of 8.03% in 2002
and 9.25% in 2001. The majority of commercial real estate loan rates is
tied to COFI and generally adjusts every six months. There is a
significant lag in the repricing of these loans since first the COFI index
need to reflect the decline in the cost of funds in the 11th District
before it is factored into the repricing rate on the COFI loans. In a
declining rate environment, COFI based loans help interest margin;
however, in an increasing rate environment they lag other indexes and have
a negative impact on net interest margin.
Average commercial loans yields (the majority of these loans are SBA loans)
for 2002 decreased 259 basis points from 2001. Most of these loans reprice
to prime rate on a quarterly repricing schedule. This average decline
results from the quarterly repricing of SBA loans to reflect the drop in
prime rate during 2001 when prime rate fells from 9.5% on January 1, 2001
to 4.75% at December 31, 2001 where it remained until November 2002 when
it declined to 4.25%. On January 1, 2003, SBA loans rates declined 50
basis points as a result of the prime rate decline in November 2002, which
will have a negative impact on net interest margin.
Average Construction loans declined $11.9 million during 2002. The average
yield was 9.01% during 2002 compared to 9.95% in 2001. These loans have
short maturity dates (approximately one year). Economic conditions and
rate competition for construction loans resulted in less volume in
construction loans during2002.
Interest income declined to $41.5 million in 2002 from $44.3 million in
2001 and $39.9 million in 2000. This decline is a direct result of the
lower interest rate environment. Average loans increased to $535.9 million
from $463.5 million in 2001 and $399.2 million in 2000. The yield on loans
equaled 7.52% in 2002, 9.20% in 2001 and 9.47% in 2000. The 168 basis
point decline during 2002 resulted primarily from the impact of declining
rates in 2001. The lag in repricing COFI loans did mitigate the
impact of the rapidly declining market rates during 2001; however, during
2002 COFI loan yields have declined with the majority of COFI loans
currently at rate floors.
The economic conditions and competition have impacted the mix of loans.
COFI loans were less attractive to borrowers when rates were rapidly
declining since loan products tied to prime rate, U.S. Treasury rates or
LIBOR had lower interest rates. As a result many COFI loans were refinanced
resulting in higher loan prepayments. Construction loans generally decline
when economic conditions worsen and the Bank has experienced less demand
for constructions loans during the last quarter of 2002. The Bank has
continues to experience increased competition for loans, which has
resulted in lower loan pricing.
Overall loan portfolio yields are affected by deferred loan fees and
discounts on loans. These fees and discounts are amortized to income over
the life, or estimated life, of the loan with which they are associated
and serve to increase loan portfolio yields. Interest income on loans
includes loan fee income of $1,537,000 for the year ended December 31,
2002, $1,658,000 for the year ended December 31, 2001 and $1,403,000
for the year ended December 31, 2000. This fee income increased yields on
average loans by 22 basis points in 2002, as compared to 36 basis points in
2001. Deferred loan fees are a product of origination and commitment fees
net of certain direct loan origination costs. The deferred fee amounts
equaled $1,464,000 at December 31, 2002 and $2,004,000 at December 31,
2001. The decline in fee income and the deferred fee balance in 2002
results from new loan pricing on some products which did not include
charging fees ("par pricing") due to competition in the area. Deferred
fees are netted against total loans in the balance sheet.
Discounts on the unguaranteed portion of SBA loans are recorded as an asset
when the guaranteed portion of the SBA loan is sold. These discounts are
amortized as an adjustment to the loan yields over the estimated life of
the SBA loan. As of December 31, 2002, $933,000 was recorded as discounts
compared to $639,000 at December 31, 2001. These discounts are netted
against total loans in the balance sheet.
Non-Accrual Loan Balances
Loans carried as non-accrual reduce the portfolio yield, since the balance
of a non-accrual loan is maintained in the loan total but no interest is
accrued. Non-accrual loans are included in the loan amounts in the average
balance sheets below. Interest foregone on non-accrual loans equaled
$228,000 during 2002 compared to $143,000 during 2001 and $186,000 during
2000 which had a negative impact on the net interest margin. The
allowance for loan losses has no direct effect on yield. For further
discussion see "Allowance for Loan Losses."
Mix of Deposits and Other Funding Sources
Interest expense decreased to $15.8 million compared to $20.8 million in
2001 and $19.5 million in 2000. This decline results from the current low
interest rate environment. Interest bearing deposits increased $58.3
million during 2002. The average cost of interest paid on interest bearing
deposits for the year ended December 31, 2002 was 3.14% versus 4.88% for
the year ended December 31, 2001 and 5.39% for the year ended December 31,
2000. Deposit costs decreased 174 basis points during 2002 and 51 basis
points during 2001.
The Bank's money market rate account, the Sonoma Investors Reserve Account
remained competitive and average balances grew $6.8 million during 2002.
Balances held in Sonoma Investors Reserve accounts
increased to $144.6 million at December 31, 2002 from $137.8 million at
December 31, 2001 and $126.4 million December 31, 2000. Average balances
for savings and money market accounts at the Bank were
$138.1 million for 2002, $129.7 million for 2001 and $118.9 million for
2000. The rate offered on the Sonoma Investors Reserve account is repriced
on a weekly basis. Effective in November 2000, the rate became a
discretionary rate which provides management more flexibility in
controlling interest costs and management believes that the Bank remains
competitive in its market area. Previously the rate was indexed to the
U.S. Treasury Bill which was very volatile. Due to the weekly repricing,
changes in rates on the Sonoma Investors Reserve Account have a more
immediate impact on the Bank's cost of funds than changes in offering
rates on time certificates. The cost of funds on savings and money market
accounts equaled 1.75% in 2002 compared to 3.23% in 2001, representing a
decline of 143 basis points.
Time deposits reprice at a slower pace, since certificates of deposits
usually do not reprice until their maturity dates, which generally range
from six to twenty-four months. Time deposits have increased to $352.3
million at December 31, 2002 from $276.7 million at December 31, 2001 and
$254.0 million at December 31, 2000. During both 2002 and 2001, the Bank
ran several time deposit campaigns at rates slightly higher than its local
competitors. These higher priced deposits were used to fund loan growth.
The cost of time deposits averaged 3.92% in 2002 and 5.93% in 2001 compared
to savings and money market rate accounts which averaged 1.75% in 2002 and
3.23% in 2001. Growth in time deposits which bear the highest cost, has a
negative impact on the Bank's cost of funds and net interest margin.
Average non-interest bearing deposits increased 6.1% in 2002 to $57.6
million in 2002 compared to $54.3 in 2001 compared and $48.7 million in
2000. Growth in non-interest bearing deposits has a positive impact on
the interest margin.
The majority of the Bank's growth has been and continues to be funded by
time certificates and money market accounts. The Bank has the ability to
borrow from the Federal Home Loan Bank (FHLB) at a cost which is lower
than market rates on deposits. Due to the restructuring of the FHLB, the
Bank's borrowing capacity has been significantly increased (maximum of 25%
of total assets with acceptable collateral). During 2002, the Bank
increased the funds borrowed to $54.8 million at December 31, 2002
compared to $11.8 million in 2002. The borrowings are generally for a
term of one year and are at fixed or variable rates. The Bank has also
borrowed from the FHLB to match fund two long term loans totaling $1.8
million. The Bank has used this line as a both a contingency source of
funds and a source of funds for future loan growth. At December 31, 2002,
the Bank had pledged loan collateral to the FHLB totaling $208.2 million
which increased our borrowing capacity to $120.5 million and had borrowed
$54.8 million against that line. Borrowing costs with the FHLB are lower
than the cost of attracting new deposits of similar duration. Therefore,
expanding the Bank borrowings at the FHLB has had a positive impact on net
interest margins.
The tables on the following pages (i) summarize the distribution, by
amount, of the average assets, liabilities and shareholders' equity of the
Corporation for the periods indicated and (ii) set forth the yields on
earning assets and the rates paid for interest bearing liabilities during
the periods indicated. Non-accrual loans are included in the average loan
balances even though they are no longer accruing interest. Averages are
computed primarily from daily balances.
AVERAGE BALANCE SHEET
Year Ended
December 31, 2002
(dollars in thousands)
Average Interest Average
Balance Income/Expense Yield/Rate
Certificates of deposit
with other banks $849 $17 2.01%
Investments 2,475 95 3.84%
Federal funds sold 65,926 1,029 1.56%
Loans:
Commercial (including SBA loans) 167,841 10,403 6.20%
Installment loans to individuals 3,341 229 6.85%
Real estate - Construction 40,117 3,615 9.01%
Real estate - Other 324,595 26,068 8.03%
-------- ------- -----
Total Loans 535,894 40,315 7.52%
-------- ------- -----
Total earning assets 605,144 41,456 6.85%
-------
Non-earning assets:
Allowance for loan losses (5,913)
Deferred Loan Fees & Discounts (1,688)
Cash and due from banks 15,028
--------
Other assets 10,175
--------
TOTAL ASSETS $622,746
========
Deposits:
Demand - interest bearing $21,979 $130 0.59%
Savings & money market 138.105 2,414 1.75%
Time certificates 320,333 12,557 3.92%
-------- ------- -----
Total interest bearing deposits 480,417 15,101 3.14%
-------- ------- -----
Other Interest bearing liabilities 31,906 740 2.32%
-------
Total Interest bearing
deposits & liabilities 512,323 15,841 3.09%
-------
Non-interest bearing liabilities:
Non-interest bearing deposits 57,642
Other liabilities 3,280
Shareholders' equity 49,501
--------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $622,746
========
Net interest income $25,615
=======
Net interest margin 4.23%
=======
AVERAGE BALANCE SHEET
Year Ended
December 31, 2001
(dollars in thousands)
Average Interest Average
Balance Income/Expense Yield/Rate
Certificates of deposit
with other banks $490 $22 4.39%
Investments 2,073 123 5.95%
Federal funds sold 44,285 1,556 3.51%
Loans:
Commercial (including SBA loans) 139,902 12,300 8.79%
Installment loans to individuals 2,239 229 10.20%
Real estate - Construction 52,031 5,175 9.95%
Real estate - Other 269,358 24,940 9.25%
-------- ------- -----
Total Loans 463,530 42,644 9.20%
-------- ------- -----
Total earning assets 510,378 44,345 8.69%
-------
Non-earning assets:
Allowance for loan losses (5,135)
Deferred Loan Fees & Discounts (2,490)
Cash and due from banks 12,663
Other assets 9,481
--------
TOTAL ASSETS $524,897
========
Deposits:
Demand - interest bearing $18,861 $192 1.02%
Savings & money market 129,696 4,194 3.23%
Time certificates 273,550 16,232 5.93%
-------- ------- -----
Total interest bearing deposits 422,107 20,618 4.88%
-------- ------- -----
Other Interest bearing
liabilities 4,729 185 3.91%
-------
Total Interest bearing deposits
& liabilities 426,836 20,803 4.87%
-------
Non-interest bearing liabilities:
Non-interest bearing deposits 54,302
Other liabilities 3,071
Shareholders' equity 40,688
--------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $524,897
========
Net interest income $23,543
=======
Net interest margin 4.61%
=======
AVERAGE BALANCE SHEET
Year Ended
December 31, 2000
(dollars in thousands)
Average Interest Average
Balance Income/Expense Yield/Rate
Certificates of deposit
with other banks $498 $35 6.95%
Investments 3,908 229 5.85%
Federal funds sold 29,382 1,814 6.18%
Loans:
Commercial (including SBA loans) 124,131 12,694 10.23%
Installment loans to individuals 1,701 178 10.45%
Real estate - Construction 37,215 3,850 10.35%
Real estate - Other 236,123 21,094 8.93%
-------- ------- -----
Total Loans 399,170 37,816 9.47%
-------- ------- -----
Total earning assets 432,958 39,894 9.21%
-------
Non-earning assets:
Allowance for loan losses (4,227)
Deferred Loan Fees & Discounts (2,780)
Cash and due from banks 11,322
Other assets 8,466
--------
TOTAL ASSETS $445,739
========
Deposits:
Demand - interest bearing $17,012 178 1.04%
Savings & money market 118,942 5,981 5.03%
Time certificates 221,797 13,116 5.91%
-------- ------- -----
Total interest bearing deposits 357,751 19,275 5.39%
-------- ------- -----
Other Interest bearing liabilities 3,736 220 5.88%
Total Interest bearing
deposits & liabilities 361,487 19,495 5.39%
-------
Non-interest bearing liabilities:
Non-interest bearing deposits 48,655
Other liabilities 2,758
Shareholders' equity 32,839
--------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $445,739
========
Net interest income $20,399
=======
Net interest margin 4.71%
=======
The following tables set forth the changes in net interest income due to
changes in interest rates and the volume of assets and liabilities between
years. Variances attributable to simultaneous rate and volume changes are
all allocated to volume change amount.
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST INCOME AND EXPENSE
2002 OVER 2001
(dollars in thousands)
Volume Yield/Rate Total
---------- ---------- ----------
Increase/(decrease) in interest income:
Certificates of deposit
with other banks $16 $(21) $(5)
Investments 24 (52) (28)
Federal funds sold 760 (1,287) (527)
Loans:
Commercial (incl. SBA loans) 2,456 (4,353) (1,897)
Installment loans to individuals 113 (113) 0
Real estate - Construction (1,185) (375) (1,560)
Real estate - Other 5,115 (3,987) 1,128
---------- ---------- ----------
Total 7,299 (10,188) (2,889)
---------- ---------- ----------
Deposits & other interest
bearing liabilities:
Demand - interest bearing 32 (94) (62)
Savings & money market 272 (2,052) (1,780)
Time certificates 2,776 (6,451) (3,675)
Other interest bearing liabilities 1,063 (508) 555
---------- ---------- ----------
Total 4,143 (9,105) (4,962)
---------- ---------- ----------
Increase/(decrease) in net
interest income $3,156 $(1,083) $2,073
========== ========== ==========
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST INCOME AND EXPENSE
2001 OVER 2000
(dollars in thousands)
Volume Yield/Rate Total
---------- ---------- ----------
Increase/(decrease) in interest income:
Certificates of deposit with
other banks $(1) $(12) $(13)
Investments (108) 2 (106)
Federal funds sold 920 (1,178) (258)
Loans:
Commercial (incl. SBA loans) 1,613 (2,007) (394)
Installment loans to individuals 56 (5) 51
Real estate - Construction 1,533 (208) 1,325
Real estate - Other 2,969 877 3,846
---------- ---------- ----------
Total 6,982 (2,531) 4,451
---------- ---------- ----------
Increase/(decrease) in
interest expense:
Deposits & other interest
bearing liabilities:
Demand - interest bearing 19 (5) 14
Savings & money market 541 (2,328) (1,787)
Time certificates 3,060 55 3,115
Other interest bearing liabilities 59 (93) (34)
---------- ---------- ----------
Total 3,679 (2,371) 1,308
---------- ---------- ----------
Increase/(decrease) in net
interest income $3,303 $(160) $3,143
========== ========== ==========
Provision for Loan Losses
The provision for loan losses was $840,000 for 2002 compared to $960,000
for 2001and $960,000 for 2000. The provision reflects continued growth in
loans and the level of non-accrual loans during this year. For further
discussion see "Allowance for Loan Losses."
Non-Interest Income
Non-interest income equaled $2,334,000 in 2002, an increase of 39.2% over
the previous year. The following table sets forth income by category for
the years indicated.
Years ended December 31,
(Dollars in thousands) 2002 2001 2000
Gain on loan sales $1,015 $545 $451
Service charges on deposits 546 430 332
Loan servicing fees 298 288 285
Merchant and other service fees 189 181 137
Income on insurance policies 119 123 128
Gain on OREO sales 36 0 39
Other 131 110 84
------ ------ ------
Total Other Income $2,334 $1,677 $1,456
====== ====== ======
Non-interest income is derived primarily from gains on sales of SBA loans,
service charges on deposit accounts, earnings on life insurance and SBA
loan servicing fees. Non-interest income increased 39.2% to $2,334,000
when comparing the year ended December 31, 2002 to the previous year,
which resulted mainly from increased gains on sale of SBA loans due to the
higher volume of SBA loan sales. When comparing the year ended December
31, 2001 to December 31, 2000, non-interest income increased 15.2% to
$1,677,000 compared to $1,456,000 last year. This increase results mostly
from higher premiums on SBA loan sales and increased service charges on
deposit accounts.
Gains on SBA Loan Sales
Gains on the sale of the guaranteed portion of SBA loans increased to
$1,015,000 in 2002 compared to $545,000 in 2001 and $451,000 in 2000.
This increase in gains on sales resulted from increased volume of
SBA loans sold with $14,790,000 sold in 2002 compared to $8,514,000 in 2001
and $11,004,000 in 2000. The Bank's premiums averaged 6.6% in 2002 compared
to 5.7% in 2001 and 4.10% in 2000. The higher premiums are reflective of
lower prepayment rates on SBA 7(a) loans due to the lower prime rate
during 2002 and 2001. The SBA implemented a prepayment penalty on SBA
7(a) loans in 2000 which has also had a positive impact on rate of
prepayments.
Service Charges on Deposits
Non-interest income includes service charges on deposit accounts. During
2002, service charges totaled $546,000 versus $430,000 in 2001 and $332,000
in 2000. Service charges vary depending upon the customers' uses of
various Bank services. During 2002 and 2001, the earnings credit rate
declined due the lower interest rate environment. This means that account
holders' earnings were lower to cover the cost of services, and therefore,
service charges were higher than previous years. While the earnings credit
rate does impact the service charges, our business account holders
continue to manage their accounts activity to minimize their service
charges. In addition to the lower earnings credit rate, the Bank has
continued to market this deposit product and has added new business
accounts which have increased revenues.
Loan Servicing Fees
SBA servicing fees equaled $298,000 compared to $288,000 in 2001 and
$285,000 in 2000. Service fee income is based on loan payments and payoffs
received on the sold portion of SBA loans, and therefore, vary from year
to year. During 2002, the Bank's average SBA loan portfolio serviced was
$35.2 million versus $31.6 million in 2001 and $30.3 million in 2000. The
fluctuation in the serviced portfolio is caused by timing of SBA loan
payoffs and volume of new sales.
There can be no assurance that the SBA program will continue to generate
significant amounts of other non-interest income in the future. The Bank
continues to experience additional competition with more financial
institutions making SBA loans. The government may also revise the SBA
program at any time, which could have a negative impact on the Bank's
profit. See, "Item 1, The Corporation, Business of the Bank."
Income on Insurance Policies
Non-interest income also includes earnings on life insurance policies held
for certain directors and senior officers which totaled $119,000 versus
$123,000 in 2001 and $128,000 in 2000.
Gain on Other Real Estate Owned (OREO) Sales
In 2002 there was one OREO sold for a gain of $36,000 on the only OREO
property held by the Bank during the year. During 2001 the Bank had no OREO
or OREO sales. In 2000, $39,000 was recorded as a gain on sale of OREO.
See, "Other Real Estate Owned."
Non-Interest Expense
Non-interest expenses include salaries and employee benefits, occupancy,
equipment and the general expenses required for the operation of the
Corporation and the Bank. For the year ended December 31, 2002,
non-interest expenses totaled $11,678,000, an increase of 11.0% over
the previous year. The following table outlines the components of
non-interest expense for the periods indicated:
(In thousands)
Year Ended December 31,
Expense Item 2002 2001 2000
Salaries & Employee Benefits $6,981 $6,154 $5,468
Occupancy 1,114 957 855
Equipment 606 604 535
Advertising/Business Development/Donations 519 487 493
Outside Customer Services 399 469 420
Director & Shareholder expenses 360 295 296
Deposit and Other Insurance 329 299 270
Postage & courier expenses 271 244 222
Professional Fees 360 247 245
Stationery & Supplies 228 196 193
Telephone expense 158 174 163
Loan expenses 93 94 82
Other 260 301 288
------- ------- ------
TOTAL $11,678 $10,521 $9,530
======= ======= ======
Salaries and Employee Benefits
A portion of the 13.4% increase in salaries and benefits resulted from
staff increases associated with the opening of the Sonoma Branch in October
2002 and the addition of loan officers in San Rafael and Sacramento, CA
and new support staff to process the increased loan volume. During 2002
incentive compensation increased due to higher level of loan production.
Salaries also included pay increases for performance and promotions
during the year. The Bank's full time equivalent (FTE) staff positions
averaged 114 in 2002, 105 in 2001 and 96 in 2000.
Occupancy
Occupancy costs increased 16.4% due to the new Sonoma Branch, new loan
office in San Rafael and the first full year of occupancy at the operations
center (opened in August 2001). In addition, there were annual increases
in the rents charged on most facilities as called for in the lease
agreements. Occupancy costs are expected to increase when and if the Bank
expands into new market areas.
Equipment
Equipment expenses increased to $606,000 compared to $604,000 in 2001.
During 2002, the Bank continued to upgrade and expand our technology. In
2002, the Bank implemented "I Banc" internet banking for businesses.
Equipment costs are expected to continue to increase during 2002 as the
Bank grows, expands its usage of technology and replaces obsolete
equipment.
Advertising/Business Development/Donations
Advertising and business development costs vary from year to year depending
on the various promotions that have occurred during the year. These costs
include promotion of various Bank services (I Banc, Telebanc,
SBA, commercial and construction lending and deposit campaigns) and
promoting new locations. The Bank continued its strong support of the
local community through contributions to local charitable agencies.
Outside Customer Services
Outside customer services decreased to $399,000 in 2002 from $469,000 in
2001. Analysis charges are a major expense included in this category.
Analysis charges are customer expenses for title and escrow services,
check charges, courier and payroll services incurred on behalf of customers
who maintain non- interest bearing deposit balances sufficient to
compensate for these costs. During 2002, a large analysis account changed
their deposit activity which resulted in less services being provided.
See, "Deposits." While some non-interest expense is incurred, management
feels the contribution of the non-interest bearing demand accounts toward
lowering the overall cost of funds more than offsets this cost.
Director and Shareholder Expenses
Director and shareholder expenses equaled $360,000 in 2002 compared to
$295,000 in 2001. See "Compensation of Directors." Director fees vary
depending upon the number of meetings during the year and director
attendance at those meetings. During 2002 there were additional
meetings. In addition, shareholder costs have increased due to regulatory
reporting changes and are expected to continue to increase due to new and
expanded regulatory requirements.
Deposit and Other Insurance
Included in Deposit and Other Insurance are regulatory assessments which
have been increasing over the last several years to $225,000 compared to
$200,000 in 2001. The Bank's deposit insurance premium is currently based
upon the lowest cost category of zero cents per $100 of insured deposits.
There can be no assurance that the deposit insurance rates will remain at
this low level; a rate increase is expected because of the low ratio of
federal reserves to insured deposits. The Bank is also charged a
"Financing Corporation" (FICO) assessment. The annual rate varies and is
calculated per $100 of insured deposits. This cost equaled $87,000 in
2002 compared to $85,000 in 2001. Also included is the fee (based upon
total assets)assessed by the Office of the Comptroller of the Currency
which equaled $138,000 in 2002 and $115,000 in 2001. See, "Description of
Business-Supervision and Regulation."
Professional Fees
Professional fees increased to $360,000 in 2002 from $247,000 in 2001. The
Bank's legal costs vary depending upon the volume of past due and
non-accrual loans and OREO which required legal assistance. Professional
fees have also increased due to implementing changes in financial
reporting requirements. Other professional fees include accounting
services, outside data processing review, loan review services, SBA audit
fees and other consulting services.
Loan Expenses
Loan expenses of $93,000 were relatively unchanged from 2001. These costs
can vary; however, problem loan expenses have the biggest impact since the
borrower generally does not reimburse the Bank for the costs. Included in
this category are credit reports, appraisals, foreclosure expenses,
inspection costs and other loan related expenses. The Bank generally
charges for direct costs associated with loan originations.
Broker fees are included in cost recovery and recorded as part of deferred
fees on loans and amortized as an adjustment to interest income in
accordance with generally accepted accounting principles.
The other expense categories decreased to $260,000 from $301,000. While
non-interest expenses decreased in 2002 due to cost controls, they are
expected to increase in 2002 due to the anticipated growth in the Bank.
When comparing 2001 to 2000, the increase in non-interest expenses of 10.4%
to $10,521,000 from $9,530,000 was due primarily to increased salary
expenses attributable to the full year of operation of the Petaluma Branch
staff and other new staff additions, salary increases and staff incentives
associated with increased volume of loan and deposit activity. In
addition, cost associated with occupancy and equipment also increased due
to the branch expansion and general growth with the new operations center
opening in August of 2001. Most expense categories were higher as a result
of the loan and deposit growth and the new facilities (Petaluma Branch and
Operations Center).
Loan Portfolio
The following table shows the composition of the loan portfolio, by type of
loan, as of the dates indicated.
(In thousands) December 31,
Type of Loan 2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Commercial $173,325 $137,711 $118,134 $112,277 $110,468
Real Estate
Construction 32,412 49,604 46,244 39,523 28,177
Real Estate
Other 382,134 284,782 273,298 210,119 131,661
Installment Loans
to Individuals 6,445 2,052 2,412 1,783 1,749
-------- -------- -------- -------- --------
Total, gross 594,316 474,149 440,088 363,702 272,055
Deferred fees and
discounts, net (1,466) (2,004) (2,961) (2,690) (2,007)
-------- -------- -------- -------- --------
Total loans net of
deferred fees and discounts 592,850 472,145 437,126 361,012 270,048
Allowance for loan losses (6,389) (5,616) (4,681) (3,787) (3,019)
TOTAL LOANS, NET $586,461 $466,529 $432,446 $357,225 $267,029
======== ======== ======== ======== ========
The table above illustrates the Bank's emphasis on commercial and real
estate lending. At December 31, 2002 and 2001 commercial loans comprised
29.2% and 29.4%, respectively, of the Bank's total loan portfolio.
Construction and other real estate loans (combined) comprised 69.8% and
70.5% on those same dates. Management is aware of the risk factors in
making commercial and real estate loans and is continuously monitoring the
local marketplace as well as performing annual reviews of this portfolio.
The Bank makes commercial loans primarily to small and medium sized
businesses and to professionals located within Sonoma County with SBA loans
also being generated in California and Arizona. While the Bank emphasizes
commercial lending, management does not believe that there is any
significant concentration of commercial loans to any specific type of
business or industry.
At December 31, 2002, 95.5% or $567.5 million of the Bank's loans were
secured by real estate as the principal source of collateral. A worsening
of economic conditions, a decline of real estate values and/or rising
interest rates could have an effect on the value of real estate securing
these loans and could have an adverse impact on the financial condition of
the Bank.
Most of the security for the Bank's loans is located in the area where the
loan is generated. A significant natural disaster impacting those
locations, such as a severe earthquake or widespread flooding, could
disrupt the business of these borrowers and impair the security for the
Bank's loans. Although some of the Bank's borrowers carry insurance to
cover some of the losses that might arise from such an event, the Bank
does not require all its borrowers to carry earthquake insurance coverage
since such insurance typically provides a large deductible amount. If a
large earthquake occurs in the Bank's market area, the Bank would probably
have to restructure some of its loans and may suffer loan losses related to
the earthquake.
The Bank originates loans guaranteed by the U.S. Small Business
Administration ("SBA"). The guaranteed portion of each loan, typically
ranging from 70% to 85%, may be sold to outside investors, usually at a
price in excess of par. Under the new rules the SBA 7(a) guarantees range
from 75% to 85% with a maximum of $1,000,000. The unguaranteed portion on
sold loans is generally retained in the Bank's loan portfolio. In
2000, the SBA began requiring a prepayment penalty of 5% in first year, 3%
in second year and 1% in the third year, on all 7(a) loans. The Bank
follows the same internal credit approval process when approving an
SBA loan as when approving other loans. The majority of the Bank's SBA
loans are secured by real estate. All SBA loans are reported in the chart
above as Commercial Loans.
While SBA loans generally have the same underwriting requirements as the
Bank's other loans, they are sometimes for longer terms (7 to 25 years) and
have a higher loan-to-value ratio than the Bank typically accepts. This
risk is mitigated by the majority of the loans being secured by real
estate. If a default on a SBA loan occurs the Bank shares proportionally
in the collateral supporting the loan with the SBA which guarantees the
loan. The SBA department also generates commercial and construction loans
which are not SBA loans. At December 31, 2002, the Bank held $339,782,000
in loans generated by the SBA department, of which $191,694,000 were 7(a)
loans of which $101,010,000 was guaranteed by the SBA. At December 31,
2001, the Bank held $232,268,000 in loans generated by the SBA department,
of which $145,478,000 were 7(a) loans of which $76,458,000 was guaranteed
by the SBA. At December 31, 2002 and 2001 there were no SBA guaranteed
loans more than 90 days past due and still accruing interest. At December
31, 2002 there was one SBA guaranteed loans totaling $94,000, of which
$71,000 was guaranteed by the SBA, on non-accrual status and three SBA
guaranteed loans totaling $1,639,000 of which $1,220,000 was guaranteed
by the SBA at December 31, 2001. There were two charge offs totaling
$26,000 on SBA guaranteed loans in 2002; no charge-offs on SBA loans during
2001 and a total of $36,000 in charge offs on loans with SBA guarantees
during 2000.
The category entitled "Real Estate-Other" includes loans which are secured
by real estate and not classified as construction or commercial loans. The
majority of these loans are secured by commercial real estate. The Bank
offers residential mortgage loans on a limited basis. Home equity lines
of credit, included in Real Estate - Other, equaled 1.4% of the total loan
portfolio at December 31, 2002 compared to 1.5% at December 31, 2001.
These loans are secured primarily by second trust deeds on single family
residences. The Bank typically requires a loan-to-value ratio of no more
than 80% for home equity loans. The rates are adjustable monthly based on
the Bank's internal reference rate, and terms do not exceed ten years.
Real estate construction loans declined to $32,412,000 in 2002 from
$49,604,000 in 2001 as a result of depressed economic conditions. The Bank
created a construction loan group during 1997 to focus on construction
loans primarily for single family residences valued at under $4,000,000
located in Northern California. Construction loans are made to
"owner/occupied" and "owner/users" of the properties and occasionally to
developers with a successful history of developing projects in the Bank's
market area. Loan-to-value ratios on construction loans depend upon the
nature of the property. The Bank's policy is to require that the
loan-to-value ratio ranges from 65% to 80% and that the borrower
have a cash equity interest in the land ranging from 25%-50% or alternative
collateral. The construction lending business is subject to, among
other things, the volatility of interest rates, real estate prices in the
area and the market availability of conventional real estate financing to
repay such construction loans. A decline in real estate values and/or
demand could potentially have an adverse impact on this portion of the loan
portfolio, and on the earnings and financial condition of the Bank.
The Bank has a small portfolio of consumer loans, equaling 1.1% of the
total loan portfolio at December 31, 2002. Personal lines of credit and
overdraft protection are offered to customers. Regular underwriting
procedures are followed depending upon the type of loans. Revolving lines
are reviewed every two years.
It is the Bank's policy to collateralize all loans unless, in management's
estimation, the credit worthiness, cash flow and character of the borrower
justify extension of credit on an unsecured basis. Management recognizes
the inherent risk in making unsecured loans, but in management's judgment,
such unsecured loans are justified based on the credit worthiness and
financial strength of the borrowers. Management believes that its secured
loans are adequately collateralized to minimize loss in the event of
default in payment of interest or principal or decline in collateral
values. In making collateralized loans, the Bank's policy establishes a
maximum loan-to-collateral value ratio of from 50% to 100%, depending on
the type of collateral and the other factors supporting the loan.
The following table summarizes the Bank's loan maturities, by loan type, at
December 31, 2002. Loans are categorized by the maturity of the final
installment.
(In thousands)
Real Estate- Other Real
Commercial Construction Estate Installment Total
Loans Maturing in:
One year or less:
Fixed rate $2,131 $23,121 $21,208 $229 $46,689
Variable rate 1,080 4,713 7,611 36 13,440
One to five years
Fixed rate 1,842 1,651 6,536 537 10,566
Variable rate 12,212 0 11,772 5,003 28,987
After five years
Fixed rate 813 0 25,295 216 26,324
Variable rate 155,247 2,927 309,712 423 468,309
-------- -------- ------- ------- --------
TOTAL $173,325 $32,412 $382,134 $6,444 $594,315
======== ======= ======== ====== ========
Of the total loans due in more than one year at December 31, 2002, $259.4
million were at fixed interest rates, which include loans currently at
their floor rate, and $274.8 million were at adjustable interest rates.
Interest Rate Sensitivity
The Bank attempts to lend at competitive interest rates and to reduce
exposure to interest rate fluctuations by making most of its loans at
adjustable interest rates.
The following table summarizes the Bank's loan portfolio by contractual
repricing frequency and by loan type, at December 31, 2002. SBA loans are
considered commercial loans for this analysis. Most of the SBA loans
are secured by real estate. The Bank has approximately $252.3 million in
adjustable loans which are priced at floor rate and are considered fixed
rate loans, deemed to reprice at their maturity date for the purpose of
this analysis.
(In thousands)
Over 3 Over
Months 1 Year
3 Months through through Over 5
or less 1 Year 5 Years Years Total
Commercial $169,413 $1,256 $1,843 $813 $173,325
Real Estate -
Construction 20,059 10,702 1,651 0 32,412
Real Estate -Other 51,888 35,608 40,519 254,119 382,134
Installment Loans 5,229 458 545 212 6,444
-------- ------- ------- -------- --------
TOTAL $246,589 $48,024 $44,558 $255,144 $594,315
======== ======= ======= ======== ========
Interest rate risk is reduced through the practice of making variable
interest rate loans which are tied to an outside rate index. These
loans "float", or adjust their rate as the interest rate environment
changes. As of December 31, 2002 and 2001 approximately 48% and 74%,
respectively, of the Bank's loan portfolio was comprised of loans with
adjustable rates (excluding those which had reached their floors).
Allowance for Loan Losses
In accordance with its policy, the Bank maintains an allowance for loan
losses to provide for losses in the loan portfolio. The allowance for
loan losses is reviewed monthly and is based on an allocation for each
loan category (e.g. Real Estate, Commercial), an allocation for
undisbursed commitments, plus an allocation for any outstanding loans
which have been classified by regulators or internally for the "Watch
List." Each loan that has been classified is individually analyzed for
the risk involved and an allowance provided according to the risk
assessment. In addition, management considers such factors as known
loan problems, historical loan loss experience, loan concentrations,
loan loss experience in the banking industry, evaluations made by bank
regulatory agencies, assessment of economic conditions and other
appropriate data to identify risks in the loan portfolio. Based upon
this analysis of the allowance for loan losses (which incorporates the
growth in the loan portfolio during the year), the Bank has, as of
December 31, 2002, increased the allowance by 13.8% to $6,389,000
compared to $5,616,000 at December 31, 2001. The provision for loan
losses for the year ended December 31, 2002 was $840,000. The increase
in the allowance was based upon the growth in the loan portfolio during
the year, level of non-accrual loans and watch list loans and current
economic conditions. The ratio of allowance to total loans outstanding
(net of SBA loan guarantees) equaled 1.3% at December 31, 2002 and 1.4%
at December 31, 2001.
Depending on future evaluations of the allowance in connection with
regulatory examinations, any changes in the factors management reviews
as described above, and the amount of any loan losses that may be
incurred, further increases may be made in accordance with the Bank's
policy, and such increases will have an adverse effect on earnings.
Management attempts to reduce exposure to loss from adverse economic
conditions through portfolio diversification among businesses and types
of borrowers.
The following table sets forth the changes in the allowance for loan
losses over the last five years and the relationship to loans
outstanding, net of the SBA guaranteed portion, at the end of those
periods.
(dollars in thousands)
Year Ended December 31,
ALLOWANCE FOR LOAN LOSSES: 2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Balance at Beginning of Period $5,616 $4,681 $3,787 $3,019 $2,539
Provision for Loan Losses
Charged to Expense 840 960 960 800 480
Less Charge-Offs:
Commercial 26 0 0 13 0
Real Estate-Other 0 25 66 0 0
Construction 18 0 0 0 0
Consumer loans 26 0 0 19 0
-------- -------- -------- -------- --------
Total Charge-offs 70 25 66 32 0
-------- -------- -------- -------- --------
Recoveries:
Commercial 0 0 0 0 0
Real Estate - Other 0 0 0 0 0
Real Estate - Construction 3 0 0 0 0
Consumer 0 0 0 0 0
Total Recoveries 3 0 0 0 0
-------- -------- -------- -------- --------
Net Charge-offs/(Recoveries) 67 25 66 32 0
-------- -------- -------- -------- --------
Balance at the End of the Period $6,389 $5,616 $4,681 $3,787 $3,019
======== ======== ======== ======== ========
Total Loans Outstanding at End of
Period-Net of SBA Guarantees $493,305 $397,693 $378,141 $302,665 $213,034
-------- -------- -------- -------- --------
Ratio of Ending Allowance to
Ending Loans Outstanding-Net
of SBA Loan Guarantees 1.3% 1.4% 1.2% 1.3% 1.4%
AVERAGE TOTAL LOANS $535,894 $463,530 $399,170 $308,013 $239,549
-------- -------- -------- -------- --------
Ratio of Net Charge-offs to
Average Loans Outstanding
During the Period 0.013% 0.005% 0.017% 0.010% 0.000%
-------- -------- -------- -------- --------
During 2002 there were charged-offs on two real estate loans, one
construction loan and four consumer loans, totaling $70,000, and $3,000
in loan recoveries on construction loans.
The following tables set forth the allocation of the allowance for loan
losses by loan type at the end of those periods indicated. The
allocation of the allowance will necessarily change whenever management
determines that the risk characteristics of the loan portfolio have
changed. It should not be construed that the amount allocated to a
particular segment is the only amount available for future charge-offs
that might occur within that segment, since the allowance is a general
reserve. In addition, the amounts allocated by segment may not be
indicative of future charge-off trends. The percentage of loans shown
in these schedules represents the percentage of loans in each loan
category to total loans.
(dollars in thousands)
December 31, December 31, December 31,
2002 2001 2000
%of %of %of
Category Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
Commercial $1,681 29.2% $1,832 29.0% $1,194 26.8%
Real Estate -
Construction 1,148 5.4 1,216 10.5 1,057 10.5
Real Estate -Other 3,491 64.3 2,533 60.1 2,383 62.1
Installment Loans 69 1.1 35 0.4 47 0.6
------ ----- ------ ----- ------ -----
TOTAL $6,389 100.0% $5,616 100.0% $4,681 100.0%
====== ===== ====== ===== ====== =====
(dollars in thousands)
December 31, 1999 December 31, 1998
Category
Amount % of Loans Amount % of Loans
------ ----- ------ ------
Commercial $1,269 30.8% $1,565 40.6%
Real Estate -Construction 776 10.9 444 10.4
Real Estate -Other 1,700 57.8 959 48.4
Installment Loans 42 0.5 51 0.6
------ ----- ------ ------
TOTAL $3,787 100.0% $3,019 100.0%
====== ===== ====== ======
Non-Performing and Impaired Loans
Loans are generally placed on non-accrual status when the borrowers are
past due 90 days or when payment in full of principal or interest is not
expected. At the time a loan is placed on non-accrual status, any
interest income previously accrued but not collected is reversed.
Interest accruals are resumed on such loans only when they are brought
fully current with respect to interest and principal and when, in the
judgment of management, the loans are estimated to be fully collectible
as to both principal and interest. The Bank considers a loan impaired
when, based upon current information and events, it is probable that the
Bank will be unable to collect all amounts due according to the
contractual terms of the loan agreement.
The following table sets forth information regarding nonperforming
assets at the dates indicated.
(In thousands)
2002 2001 2000 1999 1998
Nonperforming loans:
Non-accrual loans $3,035 $2,156 $2,097 $1,888 $62
Accruing loans past
due 90 days 0 0 158 0 0
Restructured loans 0 0 0 0 0
Total nonperforming loans 3,035 2,156 2,255 1,888 62
------- ------ ------ ------ ----
Other real estate owed 0 0 0 0 0
Total nonperforming/
impaired assets $3,035 $2,156 $2,255 $1,888 $62
====== ====== ====== ====== ====
Nonperforming assets to
total loans and other
real estate owned 0.51% 0.45% 0.51% 0.52% 0.02%
Nonperforming assets
to total assets 0.44% 0.38% 0.46% 0.47% 0.02%
The following table sets forth the classified loans at the end of the
last five years.
(In thousands)
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
Substandard $8,368 $2,269 $3,071 $3,607 $2,679
Doubtful 303 705 0 2 18
Loss 0 0 0 0 0
Other real estate owned 0 0 0 0 0
------ ------ ------ ------ ------
Total classified assets $8,671 $2,974 $3,071 $3,609 $2,697
====== ====== ====== ====== ======
Classified to total
loans and other real
estate owned 1.45% 0.63% 0.70% 0.99% 0.99%
Allowance for loan losses
to total classified 73.68% 188.84% 152.43% 119.54% 106.22%
The amount of interest foregone on the loans on non-accrual at December
31, 2002 totaled approximately $228,000 for 2002 and $39,000 in interest
was earned on those loans (prior to those loans being placed on
non-accrual) during the year. The amount of interest foregone on the
loans on non-accrual at December 31, 2001 totaled approximately $143,000
for 2001 and $43,000 in interest was earned on those loans (prior to
those loans being placed on non-accrual) during the year.
As of December 31, 2002, the Bank had $3,035,000 in non-accrual loans,
of which $2,732,000 was collateralized by real estate and $94,000 was
guaranteed by the SBA. On December 31, 2001, the Bank had $2,156,000 in
non-accrual loans, of which $1,639,000 was collateralized by real estate
and $1,220,000 was guaranteed by the SBA.
Potential non-performing loans are identified by management as part of
its ongoing evaluation and review of the loan portfolio. Based on such
reviews as of December 31, 2002, management has no knowledge of
information about any loan which has not been included in the preceding
tables which causes management to have doubts about the borrowers'
ability to comply with present repayment terms, such that the loan might
subsequently be classified as non-performing.
Other Real Estate Owned
During 2002, the Bank foreclosed on one industrial building and sold the
property for a gain of $36,000. The Bank had no OREO properties during
2001.
Deposits
The Bank obtains deposits primarily from shareholders, local businesses,
loan customers and personal contacts by its business development staff,
officers and directors. The Bank does not have any brokered deposits.
At December 31, 2002, deposits totaled $577,585,000, which was an
increase of 15.0% from $502,137,000 at December 31, 2001.
Non-interest bearing demand deposits totaled $50,632,000 at December 31,
2002 as compared to $59,413,000 at December 31, 2001. Although these
deposits do not bear interest, some of the account holders utilize the
Bank's analysis system which gives earnings credits for their collected
average balances based on an internal index. The customer may then use
those earnings credits towards various account services such as escrow
accounting fees, courier services, payroll, and check printing paid to
third party vendors. The balances in this type of account tend to vary
and were lower than normal at the end of the year. The average balance
for demand deposits increased to $57,642,000 during 2002 from
$54,302,000 during 2001.
Time deposits increased $75.4 million or 27.3% in 2002. During 2002 and
2001, the Bank continued to offer highly competitive rates on time
deposits in order to fund growth in loans. Time deposits increased to
$352,073,000 at December 31, 2002 from $276,704,000 at December 31, 2001
and $253,959,000 at December 31, 2000. Time deposits bear a higher
interest rate than other types of deposits and increase the Bank's
overall cost of funds. See, "Net Interest Income."
Money market deposits increased $6.8 million or 4.9% in 2002. The
Bank's Sonoma Investor Reserve account, which was previously tied to the
90-day U.S. Treasury Bill and is now tied to a discretionary index,
reprices on a weekly basis. The Sonoma Investors Reserve accounts
generally offers rates which were competitive with rates offered on 30
to 90 day time certificates, and therefore, this account has been very
popular with depositors. However, due to the lower interest rate
environment competition for this type of deposit has increased.
Management attempts to reduce risks from fluctuating interest rates by
limiting the maturities on certificates of deposit. The following table
sets forth, by time remaining to maturity, the Bank's time certificates
of deposit as of December 31, 2002.
(dollars in thousands) $100,000 and Over Less than $100,000
Amount Pct Amount Pct
-------- ----- -------- -----
Three Months or Less $36,304 24.3% $38,436 19.0%
3 to 6 months 41,995 28.0 55,380 27.4
6 months to 1 year 55,058 36.7 79,363 39.3
Over 1 year 16,540 11.0 28,997 14.3
-------- ----- -------- -----
Total $149,897 100.0% $202,176 100.0%
======== ===== ======== =====
At December 31, 2002, certificates of deposit of $100,000 or more
constituted approximately 26.0% of total deposits. The holders of these
deposits are primarily local customers of the Bank. While these
deposits are rate sensitive, the Bank believes they are stable deposits,
as they are obtained primarily from customers with other banking
relationships with the Bank.
Investment Portfolio
The following table shows the fair market value of the Bank's investment
portfolio at December 31, 2002, 2001 and 2000.
December 31,
(In thousands) 2002 2001
------ ------
U.S. Treasury Securities $0 $0
U.S. Government-Sponsored Agencies 652 998
Federal Home Loan Bank Stock 2,740 599
Federal Reserve Stock 165 163
------ ------
Total $3,557 $1,760
====== ======
Securities Pledged $625 $625
The following table shows the yield of investments (at amortized cost)
by maturity ranges as of December 31, 2002. Federal Home Loan Bank and
Federal Reserve stock are excluded from this table.
(In thousands) Amount Yield
------ -----
One year or less $0 0.00%
Over one year through 5 years 636 3.45
Over 5 years through 10 years 0 0.00
Over 10 years 0 0.00
------ -----
Total $636 3.45%
====== =====
The yield on average investments (including Federal Home Loan Bank and
Federal Reserve Bank stock) equaled 3.84% during 2002 compared to 5.95%
in 2001. See, "Net Interest Income."
The Bank is required to own Federal Home Loan Bank ("FHLB") stock to
maintain its borrowing relationship. See, "Liquidity." The Bank
receives stock dividends quarterly based upon the earnings of the
Federal Home Loan Bank Stock. The Bank received an annualized yield of
3.80% during 2002 and 5.88% during 2001. The Federal Reserve Bank stock
had a yield of 5.93% during 2002.
Investments are carried at amortized cost or market value, depending on
whether they are held to maturity or available for sale. At December
31, 2002, $652,000 was classified as available for sale per accounting
definitions. At December 31, 2001, $998,000 was classified as available
for sale. The market value of securities equaled $652,000 and $998,000
at December 31, 2002 and December 31, 2001, respectively.
Liquidity - Consolidated
Liquidity is a bank's ability to meet possible deposit withdrawals, to
meet loan commitments and increased loan demand, and to take advantage
of other investment opportunities as they arise. The Bank's liquidity
practices are defined in both the Asset and Liability Policy and the
Investment Policy. These policies define acceptable liquidity measures
in terms of ratios to total assets, deposits, liabilities and capital.
In addition, these policies include acceptable ranges for the Bank's
loans-to-deposits ratio. The Bank also compares its liquidity position
and ratios to those of its peer group.
The Bank is required to maintain specific reserve balances with the
Federal Reserve Bank. This is monitored on a daily basis to assure
compliance with regulatory requirements. The Office of the Comptroller
of the Currency ("OCC") also requires the Bank to establish adequate
liquidity policies and practices. Although defined liquidity
percentages are not specified in the OCC's regulations, they have been
incorporated in the Bank's policies and procedures.
Cash and due from banks, interest bearing deposits in banks and federal
funds sold totaled $87,661,000 or 12.7% of total assets at December 31,
2002 compared to $82,540,000 or 14.7% of total assets at December 31,
2001. The liquidity level at December 31, 2002 exceeded the Bank's
policy guideline of 10%.
At December 31, 2002 and 2001, the Bank's ratio of loans-to-deposits was
102.8% and 94.4% respectively which were in compliance with its internal
guideline.
The Bank has two federal funds lines of credit totaling $14,000,000 with
two financial institutions. These lines are available on a short term
basis to meet cash demands that may arise. The Bank also has a
borrowing relationship with the Federal Home Loan Bank, which has
provided a new source of funds for loan growth and liquidity purposes.
Due to restructuring at the Federal Home Loan Bank, the Bank has the
ability to borrow at significantly higher levels depending upon the
collateral available for pledging. At December 31, 2002 the Bank had
$208,172,000 in loans pledged which provided a borrowing capacity of
$120,526,000. As of December 31, 2002, the Bank had borrowed
$54,776,000 compared to $11,802,000 at December 31, 2001.
The Bank funded loan growth during 2002 and 2001 through increased
interest-bearing deposits (mainly time deposits), borrowing from the
Federal Home Loan Bank and liquidity. Deposits increased during 2002
and 2001 largely due to deposit campaigns which offered higher rates to
attract new time deposits. While this trend is expected to continue,
the Bank also plans to expand the use of the Federal Home Loan Bank
lending program to fund loan growth in the future.
Liquidity - Parent Company Only
At present, the Corporation's primary sources of liquidity are from
short term investments on its capital, proceeds from exercise of stock
options, and dividends from the Bank. The Bank's ability to pay
dividends to the Corporation is subject to the restrictions of the
national banking laws and, under certain circumstances, the approval of
the OCC. See Item 5, "Dividends." In addition, the Federal Reserve Act
prohibits the Bank from making loans to its "affiliates", including the
Corporation, unless certain collateral requirements are met.
At December 31, 2002, the Corporation had non-interest and interest
bearing cash balances of $312,000, which management believes is adequate
to meet the Corporation's foreseeable operational expenses.
Return on Equity and Assets
The following table shows key financial ratios for the years ended
December 31, 2002 and 2001.
Year Ended December 31,
2002 2001
---- ----
Return on Average Assets 1.5% 1.5%
Return on Average Shareholders' Equity 18.9% 19.8%
Average Shareholders' Equity
as a Percent of Average Assets 7.9% 7.8%
Dividend Payout Ratio N/A N/A
Effects of Inflation
Inflation affects the Bank and the banking business generally because of
its effect on interest rates and loan demand. To offset inflation and
the resulting changes in interest rates and market demands, the Bank
attempts to maintain liquid interest bearing assets and to manage its
assets and liabilities such that they can be repriced within a short
period of time. In addition to its effect on market conditions and
interest rates, inflation increases the Corporation's cost of
operations. The rate of inflation has maintained a very low annual rate
during the last few years.
Capital
The Corporation and the Bank are required by the Federal Reserve Board
and the Comptroller of the Currency to maintain adequate capital. The
Board of Governors of the Federal Reserve System has adopted risk-based
capital guidelines for member banks and bank holding companies which
provide minimum uniform capital adequacy requirements for bank holding
companies. The OCC has also adopted additional capital requirements
which are applicable to national banks, such as the Bank. See "Item 1,
Description of Business, Supervision and Regulation-Capital Regulations
and Item 8, Consolidated Financial Statements, Note 13."
The Bank and the Corporation are considered "Well-Capitalized" under the
"risk-based" capital methodology. The Bank's leverage capital ratio was
7.8% of its total assets. The Bank's total risk-based capital ratio was
11.5% at December 31, 2002; the minimum acceptable level at December 31,
2002 was 8.0%. The Corporation's leverage capital ratio was 7.9%, with
total risk-based capital equaling 11.6%, at December 31, 2002.
Income Taxes
The 2002 provision for income tax equaled $6,096,000. The overall
effective tax rate was 39.5% during 2002. See, "Item 7, Consolidated
Financial Statements, Note 7." The provision for federal income taxes
for 2001 was $5,651,000. The overall effective tax rate for 2001 and
2000 was 41.1% and 39.7%, respectively.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Bank's financial performance is impacted by, among other factors,
interest rate risk and credit risk. The Bank utilizes no derivatives to
mitigate its credit risk, relying instead on loan review and adequate
loan loss reserves. See Allowance for Loan Losses.
Interest rate risk is the risk of loss in value due to changes in
interest rates. Since virtually all of the Corporation's interest rate
risk exposure lies at the Bank level, this risk is addressed by the
Bank's Asset Liability Committee ("ALCO"), which includes members of the
Board of Directors and senior officers of the Bank. ALCO attempts to
manage the various components of the Corporation's balance sheet to
minimize the impact of sudden and sustained changes in interest rates on
portfolio values and net interest income.
A fundamental objective is to manage its assets and liabilities to
maximize the economic value of the Bank while maintaining adequate
liquidity and minimizing exposure to interest rate risk. Management
believes an acceptable degree of exposure to interest rate risk results
from the management of assets and liabilities through maturity, pricing
and mix with the goal of limiting its exposure to interest rate risk.
The Bank's profitability is dependent to a large extent upon its net
interest income. The Bank is subject to interest rate risk to the degree
that its interest-earning assets reprice differently than its
interest-bearing liabilities.
Interest rate sensitivity analysis is used to measure the Bank's
interest rate risk by computing estimated changes in the net present
value (NPV) of its cash flows from assets, liabilities and off-balance
sheet items in the event of a range of assumed changes in market
interest rates. NPV represents the market value of portfolio equity and
is equal to the market value of assets minus the market value of
liabilities, with adjustments made for off-balance sheet items. This
analysis assesses the risk of loss in market rate sensitive instruments
in the event of sudden or sustained increases and decreases in market
interest rates of 100 basis points or more. The Bank has no trading
securities.
Management expects that, in a declining rate environment, the Bank's net
interest margin would be expected to decline, and, in an increasing rate
environment, the Bank's net interest margin would tend to increase. On
a monthly basis, management prepares an analysis of interest rate risk
exposure. Such analysis calculates the change in net interest income
given a change in general interest rates of 100 and 200 basis points up
or down. All changes are measured in dollars and are compared to
projected net interest income and the value of the Bank's equity is
calculated by discounting cash flows associated with the Bank's assets
and liabilities. The following table summarizes the simulated change in
net interest income based on the twelve months ending December 31, 2002,
given a change in general interest rates of 100 and 200 basis points up
or down.
Change in Estimated Estimated Change in
Interest Rate Net Interest Income Net Interest Income
(basis points) (000) (000)
+200 30,320 2,577
+100 28,979 1,236
Base Scenario 27,743 0
-100 26,922 (821)
-200 26,396 (1,347)
The model utilized by management to create the report presented above
makes numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit runoff and should not be relied upon
as indicative of actual future results. Computations do not contemplate
any actions that ALCO could undertake in response to changes in interest
rates. Actual results could differ significantly from those estimates,
which would result in significant differences in the calculated
projected change.
Interest rate risk management is a function of the repricing
characteristics of the portfolio of assets and liabilities. Interest
rate risk management focuses on the maturity structure of assets and
liabilities and their repricing characteristics during periods of
changes in market interest rates. Effective interest rate risk
management seeks to ensure that both assets and liabilities respond to
changes in interest rates within an acceptable time frame, thereby
minimizing the effect of interest rate movements on net interest income.
Interest rate sensitivity is measured as the difference between the
volume of assets and liabilities in the current portfolio that is
subject to repricing at various time horizons. The differences are known
as interest rate sensitivity gaps.
The following table represents the Corporation's interest rate
sensitivity profile as of December 31, 2002. Assets, liabilities and
shareholders' equity are classified by the earliest possible repricing
opportunity or maturity date, whichever first occurs.
Balance Sheet
(in thousands)
Over 1 Non-rate
Over 3 year Sensitive
Through months through or
3 through 5 Over 5
months 1 year years years Total
-------- -------- ------- -------- --------
Assets
Fed Funds sold and
Time Deposits $72,746 $198 $72,944
Investment securities $652 $2,904 3,556
Loans 246,589 48,024 44,558 255,144 594,315
Non-interest-earning assets
(net of allowance for
loan losses) 18,565 18,565
-------- -------- ------- -------- --------
$319,335 $48,222 $45,210 $276,613 $689,380
-------- -------- ------- -------- --------
Liabilities & Shareholders
Equity
Time Deposits $100,000
and over $36,304 $41,995 $54,855 $16,540 $149,694
Other interest-bearing
deposits and liabilities 223,316 154,946 51,997 1,776 432,035
Non-interest bearing liabilities 50,632 50,632
Other Liabilities &
Shareholders' Equity 57,019 57,019
-------- -------- ------- -------- --------
$259,620 $196,941 $106,852 $125,967 $689,380
-------- -------- ------- -------- --------
Interest Rate Sensitivity (1) $59,715 ($148,719) ($61,642) $150,646
Cumulative Interest
Rate Sensitivity $59,715 ($89,004)($150,646) 0
(1) Interest rate sensitivity is the difference between interest rate
sensitive assets and interest rate sensitive liabilities within the
above time frames.
Management believes that the Bank is fairly well balanced in terms of
repricing schedule. Prime based loans approximate money market accounts
with both repricing relatively quickly. Time deposits and loans tied to
COFI reprice on a similar schedule with approximately the same balances
repricing. In the past the Bank was more asset sensitive which meant
that in a declining interest rate environment there usually is an
immediate negative impact on the Bank's net interest margin, since
assets reprice to lower rates more quickly than liabilities. In a
raising interest rate environment, the Bank's earnings were positively
affected immediately. The Bank continually monitors its interest rate
sensitivity as part of the Bank's planning process.
The Corporation and the Bank do not at this time engage in hedging
transactions (interest rate futures, caps, swap agreements, etc.).
ITEM 8. Financial Statements and Supplementary Data
CONTENTS
INDEPENDENT AUDITOR'S REPORT
FINANCIAL STATEMENTS
Consolidated balance sheets
Consolidated statements of income
Consolidated statements of comprehensive income
Consolidated statements of changes in stockholders' equity
Consolidated statements of cash flows
Notes to consolidated financial statements.
Page F-1
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
Northern Empire Bancshares
We have audited the accompanying consolidated balance sheets of
Northern Empire Bancshares as of December 31, 2002 and
2001, and the related consolidated statements of income,
comprehensive income, changes in stockholders' equity and cash flows
for each of the three years ended December 31, 2002. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those
standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in
the 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 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 Northern Empire Bancshares as of December 31, 2002 and
2001, and the results of its operations and cash flows for
each of the three years ended December 31, 2002, in conformity with
accounting principles generally accepted in the United States of
America.
/s/ MOSS ADAMS LLP
Santa Rosa, California
January 17, 2003
NORTHERN EMPIRE BANCSHARES
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
2002 2001
------------ ------------
ASSETS
Cash and cash equivalents
Cash and due from banks $ 14,717,000 $ 16,726,000
Federal funds sold 72,746,000 65,516,000
------------ ------------
87,463,000 82,242,000
Interest-bearing deposits in banks 198,000 298,000
Investment securities available-for-sale 652,000 998,000
Federal Home Loan Bank (FHLB)
stock, at cost 2,740,000 599,000
Federal Reserve Bank stock, at cost 165,000 163,000
Loans, net 586,461,000 466,529,000
Premises and equipment 1,361,000 1,037,000
Accrued interest receivable and
other assets 10,340,000 9,138,000
------------ ------------
Total assets $689,380,000 $561,004,000
============ ============
LIABILITIES
Deposits $577,585,000 $502,137,000
Accrued interest payable and
other liabilities 3,281,000 2,768,000
FHLB advances 54,776,000 11,802,000
------------ ------------
Total liabilities 635,642,000 516,707,000
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, no par value;
20,000,000 shares authorized;
4,180,914 and 3,973,263 shares issued
and outstanding in 2002 and 2001 27,529,000 21,946,000
Additional paid-in capital 786,000 786,000
Accumulated other comprehensive
income (loss) 10,000 (1,000)
Retained earnings 25,413,000 21,566,000
------------ ------------
Total stockholders' equity 53,738,000 44,297,000
------------ ------------
Total liabilities and
stockholders' equity $689,380,000 $561,004,000
============ ============
See accompanying notes
NORTHERN EMPIRE BANCSHARES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
----------- ----------- -----------
INTEREST INCOME
Loans $ 40,315,000 $ 42,644,000 $ 37,816,000
Federal funds sold and investment
securities 1,141,000 1,701,000 2,078,000
----------- ----------- -----------
Total interest income 41,456,000 44,345,000 39,894,000
----------- ----------- -----------
INTEREST EXPENSE
Interest on deposits 15,101,000 20,618,000 19,275,000
Interest on borrowings 740,000 185,000 220,000
----------- ----------- -----------
Total interest expense 15,841,000 20,803,000 19,495,000
----------- ----------- -----------
NET INTEREST INCOME 25,615,000 23,542,000 20,399,000
PROVISION FOR LOAN LOSSES 840,000 960,000 960,000
----------- ----------- -----------
Net interest income after provision
for loan losses 24,775,000 22,582,000 19,439,000
----------- ----------- -----------
NONINTEREST INCOME
Service charge on deposits 546,000 430,000 332,000
Gain on sale of loans 1,015,000 545,000 451,000
Other 773,000 702,000 673,000
----------- ----------- -----------
Total noninterest income 2,334,000 1,677,000 1,456,000
----------- ----------- -----------
NONINTEREST EXPENSES
Salaries and benefits 6,981,000 6,154,000 5,468,000
Occupancy 1,114,000 957,000 855,000
Equipment 606,000 604,000 535,000
Outside customer services 399,000 469,000 420,000
Deposit and other insurance 329,000 299,000 270,000
Professional fees 360,000 247,000 245,000
Advertising 268,000 243,000 248,000
Other administrative 1,621,000 1,548,000 1,489,000
----------- ----------- -----------
Total noninterest expenses 11,678,000 10,521,000 9,530,000
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 15,431,000 13,738,000 11,365,000
PROVISION FOR INCOME TAXES 6,096,000 5,651,000 4,513,000
----------- ----------- -----------
NET INCOME $ 9,335,000 $ 8,087,000 $ 6,852,000
=========== =========== ===========
EARNINGS PER COMMON SHARE $ 2.24 $ 1.94 $ 1.65
=========== =========== ===========
EARNINGS PER COMMON SHARE,
ASSUMING DILUTION $ 1.97 $ 1.78 $ 1.59
=========== =========== ===========
See accompanying notes.
Page F-4
NORTHERN EMPIRE BANCSHARES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
----------- ----------- -----------
NET INCOME $ 9,335,000 $ 8,087,000 $ 6,852,000
----------- ----------- -----------
OTHER COMPREHENSIVE INCOME (LOSS)
Unrealized holding gains (losses)
arising during period 16,000 (2,000) 7,000
Reclassification adjustment for (gains)
losses included in net income 2,000 (7,000) 30,000
----------- ----------- -----------
18,000 (9,000) 37,000
Income tax benefit (expense) (7,000) 4,000 (16,000)
----------- ----------- -----------
11,000 (5,000) 21,000
----------- ----------- -----------
COMPREHENSIVE INCOME $9,346,000 $ 8,082,000 $ 6,873,000
=========== =========== ===========
See accompanying notes.
Page F-5
NORTHERN EMPIRE BANCSHARES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2002, 2001 and 2000
Accumulated
Additional Other
Common Stock Paid-in Comprehensive Retained
Shares Amount Capital Income (Loss) Earnings Total
--------- ---------- --------- -------- ----------- ------------
Balance, December 31, 1999 3,560,296 15,561,000 $ 646,000 $ (17,000) $ 12,872,000 $ 29,062,000
5% stock dividend 179,157 2,632,000 - - (2,632,000) -
Stock options exercised 26,929 74,000 96,000 - - 170,000
Payout of fractional shares - - - - (2,000) (2,000)
Unrealized gain on securities,
net of tax - - - 21,000 - 21,000
Net income - - - - 6,852,000 6,852,000
--------- ---------- --------- -------- ----------- ------------
Balance, December 31, 2000 3,766,382 18,267,000 742,000 4,000 17,090,000 36,103,000
5% stock dividend 188,641 3,608,000 - - (3,608,000) -
Stock options exercised 18,240 71,000 44,000 - - 115,000
Payout of fractional shares - - - - (3,000) (3,000)
Unrealized loss on securities,
net of tax - - - (5,000) - (5,000)
Net income - - - - 8,087,000 8,087,000
--------- ---------- --------- -------- ----------- ------------
Balance, December 31, 2001 3,973,263 21,946,000 786,000 (1,000) 21,566,000 44,297,000
5% stock dividend 198,447 5,482,000 - - (5,482,000) -
Stock options exercised 9,204 101,000 - - - 101,000
Payout of fractional shares - - - - (6,000) (6,000)
Unrealized gain on securities,
net of tax - - - 11,000 - 11,000
Net income - - - - 9,335,000 9,335,000
--------- ---------- --------- -------- ----------- ------------
Balance, December 31, 2002 4,180,914 27,529,000 $ 786,000 $ 10,000 $25,413,000 $ 53,738,000
========= ========== ========= ======== =========== ============
See accompanying notes.
Page F-6
NORTHERN EMPIRE BANCSHARES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
------------ ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 9,335,000 $ 8,087,000 $ 6,852,000
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation and amortization 437,000 423,000 396,000
FHLB stock dividend (64,000) (35,000) (63,000)
Change in deferred income taxes (152,000) (437,000) (642,000)
Provision for loan losses 840,000 960,000 960,000
Tax benefit from stock options exercised - 44,000 96,000
Gain on sale of fixed assets - - (9,000)
Changes in operating assets and liabilities
Net change in deferred loan fees and discounts (538,000) (957,000) 271,000
Change in interest receivable and other assets (1,050,000) 72,000 (543,000)
Change in accrued interest payable and
other liabilities 513,000 (252,000) 1,073,000
------------ ----------- -----------
Net cash from operating activities 9,321,000 7,905,000 8,391,000
------------ ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of
available-for-sale securities 1,000,000 3,650,000 2,984,000
Net change in interest bearing deposits 100,000 395,000 (693,000)
Net increase in loans (120,234,000) (34,086,000) (76,452,000)
Purchase of leasehold improvements
and equipment, net (765,000) (524,000) (543,000)
Purchase of Federal Reserve Bank stock (2,000) (3,000) (32,000)
Purchases of FHLB stock (2,077,000) - -
Proceeds from FHLB stock redemptions - - 667,000
Proceeds from sale of fixed assets - - 11,000
Purchase of available-for-sale securities (639,000) (2,669,000) (1,978,000)
------------ ----------- -----------
Net cash from investing activities (122,617,000) (33,237,000) (76,036,000)
------------ ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 75,448,000 48,698,000 95,570,000
Net change in FHLB advances 42,974,000 9,974,000 (7,222,000)
Payout of fractional shares (6,000) (3,000) (2,000)
Proceeds from exercise of stock options 101,000 71,000 74,000
------------ ----------- -----------
Net cash from financing activities 118,517,000 58,740,000 88,420,000
------------ ----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS 5,221,000 33,408,000 20,775,000
CASH AND CASH EQUIVALENTS, beginning of year 82,242,000 48,834,000 28,059,000
------------ ----------- -----------
CASH AND CASH EQUIVALENTS, end of year $ 87,463,000 $ 82,242,000 $ 48,834,000
============ =========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 15,806,000 $ 21,098,000 $ 19,200,000
Income taxes 6,190,000 $ 6,061,000 $ 4,652,000
Page F-7
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Description of operations - Northern Empire Bancshares (the Company)
is a bank holding company that conducts its business through its
wholly-owned subsidiary, Sonoma National Bank (the Bank). The Bank is
headquartered in Santa Rosa, California, and operates six branches in
suburban communities located throughout Sonoma County, California.
Its primary source of revenues is derived from providing commercial
and real estate loans to predominantly small and middle-market
businesses. The Bank is a Preferred Lender under the Small Business
Administration's (SBA) Loan Guarantee Program.
Principles of consolidation - All significant, intercompany
transactions and accounts between Northern Empire Bancshares
and its wholly-owned subsidiary, Sonoma National Bank, have been
eliminated in consolidation.
Use of estimates - The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses and the disclosure of contingent
assets and liabilities. The amounts estimated could differ from
actual results.
Cash and cash equivalents - For purposes of reporting cash flows, cash
and cash equivalents consist of cash on hand, amounts due from banks
and federal funds sold. Generally, federal funds are sold overnight.
Substantially all cash and cash equivalents held in other financial
institutions exceed existing deposit insurance coverage.
Interest-bearing deposits in banks - Interest bearing deposits in
banks mature within one year and are carried at cost. The
amounts held in other banks do not exceed the FDIC insurance
threshold.
Investment securities - Unrealized losses on individual held-to-
maturity and available-for-sale securities that are deemed to
be other than temporary are recorded in earnings as realized losses.
The Bank classifies and accounts for debt and equity securities as
follows:
Held-to-maturity: Debt securities that management has the
positive intent and ability to hold until maturity are
classified as held-to-maturity and are carried at their
remaining unpaid principal balance, net of unamortized premiums
or nonaccreted discounts. Premiums are amortized and discounts
are accreted using the level interest yield method over
the estimated term of the underlying security.
Available-for-sale: Debt and equity securities that will be
held for indefinite periods of time, including securities that
may be sold in response to changes in market interest or
prepayment rates, needs for liquidity and changes in the
availability of and the yield of alternative investments, are
classified as available-for-sale. After amortization or
accretion of any premiums or discounts, these assets are
carried at market value. Market value is determined using
published quotes as of the close of business. Unrealized gains
and losses are excluded from earnings and reported net of
tax as a separate component of stockholders' equity.
Trading securities: Debt and equity securities that are
bought and held principally for the purposes of selling
them in the near term are classified as trading securities
and reported at market value, with unrealized gains and
losses included in earnings.
Stock-based compensation - The Company accounts for stock-based
employee compensation arrangements in accordance with the provisions
of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB No. 25) and complies with the disclosure
provisions of Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation (SFAS No. 123). Under APB No.
25, compensation expense is the excess, if any, of the fair value of
the Company's stock at a measurement date over the amount that must
be paid to acquire the stock. SFAS No. 123 requires a fair value
method to be used when determining compensation expense for stock
options and similar equity instruments. SFAS No. 123 permits a
company to continue to use APB No. 25 to account for stock-based
compensation to employees, but pro forma disclosures of net income
and earnings per share must be made as if SFAS No. 123 had been
adopted in its entirety. Stock options issued to non-employees are
valued under the provisions of SFAS No. 123.
Page F-8
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Had compensation cost for the Company's options been determined based on the
methodology prescribed under SFAS No. 123, the Company's net income and
income per share would have been as follows:
2002 2001 2000
----------- ---------- -----------
Net income for the year $ 9,335,000 $ 8,087,000 $ 6,852,000
Compensation expense, net of tax effect 354,000 347,000 287,000
----------- ---------- -----------
Proforma net income $ 8,981,000 $ 7,740,000 $ 6,565,000
----------- ---------- -----------
Proforma earnings per common share $ 2.15 $ 1.95 $ 1.66
Proforma earnings per common share,
assuming dilution $ 1.89 $ 1.79 $ 1.60
The fair value of each option is estimated on date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
2002 2001 2000
----------- ---------- -----------
Dividends 5% 5% 5%
Expected volatility 16.51% 14.80% 15.13%
Risk-free interest rate 4.94 4.86 5.9% - 6.35%
Expected life 10 years 10 years 10 years
Premises and equipment - Premises and equipment are stated at cost and
depreciated or amortized using the straight-line method over the shorter
of the estimated useful lives of the assets, which are three to seven years,
or the term of the applicable lease. Depreciation expense for the years
ended December 31, 2002, 2001 and 2000, was $437,000, $423,000 and $396,000.
Advertising - Advertising costs are charged to expense during the year in
which they are incurred.
Income taxes - The Company and the Bank file consolidated federal income tax
returns and combined state tax returns for California and Arizona. Income taxes
are recognized using enacted tax rates and are composed of taxes on financial
accounting income that is adjusted for requirements of current tax law and
deferred taxes. Deferred taxes are the expected future tax consequences of
temporary differences between the financial statement carrying amounts and tax
bases of existing assets and liabilities.
Recent accounting pronouncements - The Financial Accounting Standards Board
(FASB) has issued the following accounting pronouncements:
SFAS No.145. Rescission of FASB Statements No. 4, 44 and 64, Amendment of
FASB Statement No. 13 and Technical Corrections. This Statement rescinds FASB
Statement No. 4, Reporting Gains and Losses from Extinguishment of Debt, and
an amendment of that Statement, FASB Statement No. 64, Extinguishments of
Debt Made to Satisfy Sinking-Fund Requirements. This Statement also rescinds
FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers.
This Statement amends FASB Statement No. 13, Accounting for Leases, to
eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback transactions. This
Statement also amends other existing authoritative pronouncements to make
various technical corrections, clarify meanings, or describe their
applicability under changed conditions. The adoption of SFAS No. 145 is not
expected to have a material effect on the Company's consolidated financial
statements.
Page F-9
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SFAS No.146, Accounting for Costs Associated with Exit or Disposal
Activities. This Statement addresses financial accounting and
reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a
Restructuring). The provisions of this Statement are effective for
exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. The adoption of SFAS No. 146
is not expected to have a material effect on the Company's
consolidated financial statements.
SFAS No.147, Accounting for Certain Acquisitions of Banking or Thrift
Institutions and FASB Interpretation No. 9, Applying APB Opinions No.
16 and 17 When a Savings and Loan Association or a Similar
Institution is Acquired in a Business Combination Accounted for by
the Purchase Method. This Statement provides guidance on the
application of the purchase method to acquisitions of financial
institutions. Except for transactions between two or more mutual
enterprises, this Statement removes acquisitions of financial
institutions from the scope of both Statement 72 and Interpretation 9
and requires that those transactions be accounted for in accordance
with FASB Statements No. 141, Business Combinations and No. 142,
Goodwill and Other Intangible Assets. This Statement is effective for
acquisitions made on or after October 1, 2002. The adoption of SFAS
No. 147 is not expected to have a material effect on the Company's
consolidated financial statements.
SFAS No.148, Accounting for Stock-Based Compensation. This Statement
addresses alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation. This statement permits two additional transition
methods that avoid the ramp-up effect arising from prospective
application of the fair value based method addresses alternative. In
addition, it amends the disclosure requirements of Statement 123 to
require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results.
As of December 31, 2002, the Company has adopted the disclosure
requirements of the Statement and continues to follow the intrinsic
value method to account for stock-based employee compensation.
Financial Accounting Standards Board Interpretation (FASBI) No. 45,
Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. The
Interpretation clarifies that a guarantor is required to recognize,
at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. It also
significantly expands the disclosures guarantors must include in
their financial statements. While the Interpretation's accounting
provisions are effective prospectively to guarantees issued or
modified after December 31, 2002, its disclosure requirements
generally apply to all guarantees and must be included in financial
statements of interim and annual periods ending after December 15,
2002. The adoption of Interpretation No. 45 is not expected to have
a material effect on the Company's consolidated financial statements.
Loans - Loans are carried at amortized cost. The Bank's portfolio
consists primarily of commercial and real estate loans
generally\collateralized by first and second deeds of trust on real
estate, as well as business assets and personal property.
Interest income is accrued daily on the outstanding loan balances
using the simple interest method. Loans are generally placed on
nonaccrual status when the borrowers are past due 90 days and when
full payment of principal or interest is not expected. At the time a
loan is placed on nonaccrual status, any interest income previously
accrued but not collected is reversed against interest income.
Interest accruals are resumed on such loans only when they are
brought fully current with respect to interest and principal and
when, in the judgment of management, the loans are estimated to be
fully collectible as to both principal and interest.
The Bank charges loan origination and commitment fees. Loan
origination fees are deferred and amortized to interest income
using the interest method. Loan commitment fees are amortized to
interest income over the commitment period. The Bank incurs loan
costs when originating some SBA loans. These costs are deferred and
expensed over the life of the loan. The deferred costs and fees are
reported as net on the balance sheet.
Page F-10
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Sales and servicing of Small Business Administration (SBA) loans -
The Bank originates loans to customers under SBA programs that
generally provide for SBA guarantees of 70% to 90% of each loan. The
Bank has the option to sell the guaranteed portion of each loan and
retain the unguaranteed portion in its own portfolio. Funding for
the SBA programs depends on appropriations by the U.S. Congress.
Gains on these sales are earned through the sale of the guaranteed
portion of the loan for an amount in excess of the adjusted
carrying value of the portion of the loan sold. The Bank allocates
the carrying value of such loans between the portion sold,
the portion retained and a value assigned to the right to service the
loan. The difference between the adjusted carrying value
of the portion retained and the face amount of the portion retained
is amortized to interest income over the life of the related
loan using a method that approximates the interest method.
The amount assigned to the right to service the loan is based on its
fair value relative to the loan as a whole. To determine the
fair value of servicing rights, the Bank uses models that incorporate
assumptions that market participants would use in estimating future
net servicing income, which includes estimating the cost of servicing
per loan, the discount rate and loan prepayment estimates. The Bank
amortizes the servicing rights using the effective interest methods.
The balance of the servicing asset is included in other assets.
Allowance for loan losses - An allowance for loan losses is
maintained at a level deemed appropriate by management to
provide for both known and unidentified losses in the loan portfolio,
including loan commitments and standby letters of credit. The
allowance is based upon management's assessment of various factors
affecting the collectibility of the loans, including current and
projected economic conditions, past credit experience, delinquency
status, the value of the underlying collateral, if any, and
continuing review of the portfolio of loans and commitments. A loan
is considered impaired if it is probable the Bank will be unable
to collect the scheduled payments of principal or interest according
to the contractual terms of the loan agreement. Since nearly all of
the Bank's loans are collateral dependent, the allowance of the
impaired loans is generally based on the fair value of the collateral.
The allowance for loan losses is an estimate and actual losses may vary
from these estimates. The estimate is reviewed periodically and
adjustments, if necessary, are reported in earnings in the periods in
which the adjustment becomes known.
Earnings per share - Earnings per share (EPS) are computed using the
weighted average number of common shares outstanding during the year.
Diluted earnings per share are computed by adjusting the common
shares outstanding for the assumed conversion of all potentially
dilutive stock options. The computation of basic and dilutive
earnings per share is retroactively adjusted for all periods
presented to reflect the change in the capital structure resulting
from stock dividends.
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations:
Year Ended December 31,
2002 2001 2000
----------- ----------- -----------
Basic:
Net income $ 9,335,000 $ 8,087,000 $ 6,852,000
=========== =========== ===========
Weighted average common
shares outstanding 4,175,509 4,164,777 4,145,654
=========== =========== ===========
Earnings per common share $ 2.24 $ 1.94 $ 1.65
=========== =========== ===========
Assuming dilution:
Weighted average common
shares outstanding 4,175,509 4,164,777 4,145,654
Stock options 569,131 373,143 171,561
----------- ----------- -----------
4,744,640 4,537,920 4,317,215
=========== =========== ===========
Diluted earnings per
common share $ 1.97 $ 1.78 $ 1.59
=========== =========== ===========
Page F-11
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Comprehensive income - Comprehensive income is composed of net income
and changes in equity from non-stockholder sources. These non-stockholder
sources are reported net of tax and include unrealized
gains and losses on certain investments in debt and equity
securities. Accumulated balances of these non-stockholder sources
are reflected as a separate item in the equity section of the balance
sheet.
Federal Home Loan Bank system - As a member of the Federal Home Loan Bank
(FHLB), the Company is required to maintain an investment in
the FHLB's capital stock. The investment is carried at cost. Interest
rates on the advances from the FHLB currently range from 1.36% to
5.63% and mature through 2008. To collateralize these advances, the
Bank has pledged loans to FHLB with outstanding principal balances of
$208,172,000, which results in a borrowing capacity of $120,526,000.
Derivatives and hedging - The Bank's investment policy does not allow
derivatives, interest swaps, caps, collars, or hedging investments.
NOTE 2 - INVESTMENT SECURITIES AVAILABLE FOR SALE
As required by law, investment securities with a par value of
$625,000 were pledged to secure deposits and borrowings. The
securities held at December 31, 2002, mature April 2004.
Unrealized Market
Cost Gains (Losses) Value
---------- -------- ---------
U.S. Government Agency Securities
- December 31, 2002 $ 636,000 $ 16,000 $ 652,000
---------- -------- ---------
U.S. Government Agency Securities
- December 31, 2001 $ 1,000,000 $ (2,000) $ 998,000
---------- -------- ---------
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES
The Bank's lending activities are concentrated primarily in Sonoma
County, California, with SBA loans also being generated in other
counties in Northern California and in Arizona. There were no
industry or borrower group concentrations at December 31, 2002 and
2001.
2002 2001
------------- -------------
Commercial loans $ 173,325,000 $ 137,711,000
Consumer installment loans 6,445,000 2,052,000
Real estate loans - construction 32,412,000 49,604,000
Real estate loans - mortgage 382,134,000 284,782,000
594,316,000 474,149,000
Deferred loan fees and discount (1,466,000) (2,004,000)
Allowance for loan losses (6,389,000) (5,616,000)
------------- -------------
$ 586,461,000 $ 466,529,000
============= =============
Page F-12
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of activity in the allowance for loan losses is as follows:
2002 2001 2000
----------- ----------- -----------
Balance, beginning of year $ 5,616,000 $ 4,681,000 $ 3,787,000
Provision for loan losses 840,000 960,000 960,000
Loans charged-off (67,000) (25,000) (66,000)
----------- ----------- -----------
$ 6,389,000 $ 5,616,000 $ 4,681,000
=========== =========== ===========
At December 31, 2002, there were nine loans totaling $3,035,000 in
nonaccrual status, and there were nine loans totaling $2,156,000
in nonaccrual status at December 31, 2001. Interest foregone on these
loans totaled $228,000 and $143,000, respectively. That portion of
the allowance for loan losses associated with these nonaccrual loans
was $256,000 and $282,000, respectively.
The Bank has the option to sell to outside investors the guaranteed
portion of SBA loans while retaining the unguaranteed portion in its
loan portfolio. The SBA guarantee is transferred to the buyer and the
Bank retains the loan's servicing function. Loans serviced for others
are not included in the accompanying consolidated balance sheets. The
unpaid principal balances of SBA loans serviced for others were
$40,256,000 and $31,649,000 guaranteed by the SBA at December 31,
2002 and 2001, of which the Bank's retained interests in those loans
ranged from 10% to 54%. The balance of capitalized servicing rights
included in other assets at December 31, 2002 and 2001, was $933,000
and $639,000. The fair value of these rights was determined using
discount rates of 7% in 2002 and 10% in 2001 and prepayment speeds
ranging from 6% to 15% depending upon the stratification of the
specific right. The amortized servicing rights for the years ended
December 31, 2002, 2001 and 2000, totaled $77,000, $65,000 and
$61,000. Losses on these loans are shared between the Bank and the
SBA on a pro rata basis. SBA guaranteed loans that could be sold in
the future totaled $101,010,000 at December 31, 2002.
The Bank serviced non-SBA loans for others totaling $31,199,000 and
$25,683,000 in unpaid principal balances at December 31, 2002 and
2001. These loans are not included in the accompanying consolidated
balance sheet, and there are no servicing assets associated with
these loans.
NOTE 4 - PREMISES AND EQUIPMENT
2002 2001
----------- -----------
Leasehold improvements $ 1,565,000 $ 1,269,000
Furniture and equipment 3,599,000 3,158,000
----------- -----------
5,164,000 4,427,000
Less accumulated depreciation
and amortization 3,803,000 3,390,000
----------- -----------
$ 1,361,000 $ 1,037,000
=========== ===========
Page F-13
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - DEPOSITS
Certificates of deposit with balances of $100,000 or more totaled
$149,897,000 and $114,107,000 at December 31, 2002 and 2001.
Deposits consist of the following:
2002 2001
------------- -------------
Noninterest-bearing $ 50,632,000 $ 59,413,000
Interest-bearing:
Money market 144,594,000 137,826,000
Savings 6,503,000 5,904,000
Demand 23,783,000 22,290,000
Certificates of deposit 352,073,000 276,704,000
------------- -------------
$ 577,585,000 $ 502,137,000
============= =============
Certificates of deposit are scheduled to mature as follows:
Year Ending December 31,
-----------------------
2003 $ 306,535,000
2004 45,079,000
2005 97,000
2006 -
2007 362,000
-------------
$ 352,073,000
=============
NOTE 6 - FEDERAL HOME LOAN BANK (FHLB) ADVANCES
Contractual maturities and balances outstanding of FHLB advances are
reflected in the following schedules. Advances from the FHLB are
collateralized by qualifying first mortgage loans and government
agency securities.
2002 2001
------------------------- ------------------------
Interest Interest
Maturities Amount Rates Amount Rates
----------- ----------- ----------- -----------
Within one year $30,000,000 1.54 - 2.92% $10,000,000 2.92%
Two years 23,000,000 1.36 - 1.94% - -
Six years 1,776,000 5.56 - 5.63% 1,802,000 5.56 - 5.63%
----------- -----------
$54,776,000 $11,802,000
=========== ===========
2002 2001
----------- -----------
Maximum balance outstanding at any month end $54,776,000 $11,802,000
Average outstanding balance 27,009,000 4,651,000
Weighted average interest rate 2.48% 3.96%
Page F-14
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - INCOME TAXES
The components of the provision for federal and state income taxes
are as follows:
2002 2001 2000
----------- ----------- -----------
Provision for income taxes
Federal $ 4,803,000 $ 4,553,000 $ 3,752,000
State 1,445,000 1,491,000 1,307,000
----------- ----------- -----------
6,248,000 6,044,000 5,059,000
Change in deferred income taxes (152,000) (437,000) (642,000)
Tax benefit from options exercised - 44,000 96,000
----------- ----------- -----------
$ 6,096,000 $ 5,651,000 $ 4,513,000
=========== =========== ===========
A reconciliation of the statutory tax rates to the effective tax rates is
as follows:
2002 2001 2000
----------- ----------- -----------
Federal income tax at statutory rate 34.0% 34.0% 34.0%
State taxes, net of federal
income tax benefit 6.7 6.7 7.6
Other, net (1.2) 0.4 (1.9)
----------- ----------- -----------
39.5% 41.1% 39.7%
=========== =========== ===========
The components of net deferred tax assets are as follows:
2002 2001
----------- -----------
Loan loss reserves $ 2,508,000 $ 2,311,000
State taxes 531,000 487,000
Deferred compensation 545,000 432,000
All others 18,000 220,000
----------- -----------
$ 3,602,000 $ 3,450,000
=========== ===========
NOTE 8 - STOCK OPTIONS
The Company's nonqualifying stock option plans provide for granting
of stock options to directors and officers to purchase shares of
the Company's stock. All shares covered by the options granted to
date may be purchased at a price not less than the fair-market value
on the date the option was granted. Options vest over three to five
years and expire ten years from the date of grant. In accordance
with the Plan, options are granted to prevent the antidilutive
effect of a 5% stock dividend during the year. The exercise price is
reduced accordingly.
The Company granted 15,000 nonqualifying stock options to an
employee during the year ended December 31, 2002.
Page F-15
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables summarize the number of options granted and
exercisable and the weighted average exercise prices and remaining
contractual lives of the options:
2002 2001 2001
------------------- ---------------- -----------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- ----- --------- ----- ------- -----
Outstanding at beginning of year 1,133,840 $14.27 861,225 $13.38 839,020 $13.33
Granted 15,000 28.25 242,350 19.88 299,406 14.33
Options granted attributable to the
stock dividend 56,525 13.59 54,458 19.13 40,606 13.02
Forfeited (2,924) 17.57 (5,953) 14.90 (290,878) 13.32
Exercised (9,204) 11.00 (18,240) 3.89 (26,929) 2.78
--------- --------- -------
Outstanding at end of year 1,193,237 13.78 1,133,840 14.27 861,225 13.38
--------- --------- -------
Options exercisable at end of year 782,080 526,448 352,200
========= ========= =======
Weighted-
Weighted Average Weighted-
Options Average Remaining Options Average
Outstanding at Exercise Contractual Exercisable at Exercse
December 31, 2002 Price Life December 31, 2002 Price
- ---------------- ------ --------- ----------------- -------
3,345 $2.70 1.2 3,345 $2.70
522,270 12.08 5.8 417,816 12.08
61,248 11.52 5.6 48,998 11.52
319,068 12.92 5.6 255,255 12.92
11,024 15.02 7.8 4,410 15.02
261,282 18.03 8.0 52,256 18.03
15,000 28.25 9.5 -
---------- --------
1,193,237 $13.78 782,080 $13.78
========== ========
Note 9 - DEFERRED COMPENSATION
The Company has deferred compensation agreements with two key
officers and four Board members. The agreements require the Company
to provide annual benefits ranging from $75,000 to $100,000 for the
officers and $13,000 to $55,000 for the Board members for 15 years
after retirement or disability. In the event of death, the beneficiaries
are to receive the benefits. The estimated present
value of future benefits to be paid is being accrued over the period
from the effective date of the agreements until the expected
retirement dates of the participants. The expense incurred for the
years ended December 31, 2002, 2001 and 2000, totaled $196,000,
$182,000 and $174,000. The Company is the beneficiary of life insurance
policies that have been purchased as a method of financing
the benefits under the agreements. At December 31, 2002 and
2001, the cash surrender value of these policies, which is included
on the balance sheet in other assets, was $2,396,000 and $2,287,000.
Page F-16
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - EMPLOYEE BENEFIT PLAN
The Company has a 401(k) savings plan covering substantially all
employees of the Company and the Bank. Employees who elect to
participate are able to defer up to 15% of their annual salary,
subject to limitations imposed by federal tax law. The Company makes
matching contributions equal to 100% of each participant's elective
deferral, up to a maximum of $1,200 per employee. Contributions by
the Company for the years ended December 31, 2002, 2001 and 2000,
were $96,000, $91,000 and $75,000.
NOTE 11 - RELATED-PARTY TRANSACTIONS
The Company has an operating lease with a major stockholder of the
Company for office facilities. The lease expires in August 2004, with
an option to extend the lease for an additional five years. Rental
payments under this lease were $181,000, $168,000 and $168,000 for
the years ended December 31, 2002, 2001 and 2000.
The Company has, and expects to have in the future, banking
transactions in the ordinary course of business with directors,
officers and their associates. An analysis of the loans to related
parties is as follows:
2002 2001
----------- -----------
Balance, beginning of year $ 8,572,000 $ 7,273,000
Additions 18,828,000 16,616,000
Principal reductions (16,643,000) (15,317,000)
----------- -----------
$10,757,000 $ 8,572,000
=========== ===========
NOTE 12 - COMMITMENTS AND CONTINGENCIES
The Bank is required by federal regulations to maintain certain minimum
average balances with the Federal Reserve, based
primarily on the Bank's daily demand deposit balances. Required
deposits held with the Federal Reserve at December 31, 2002 and
2001, were $4,767,000 and $4,098,000.
The Company and the Bank have entered into operating leases for branches
and office facilities that expire through May 2022. Two of
the leases have options to extend the term for two additional five-
year terms, and one lease has an option to extend the term for three
additional five-year terms. Rental payments under these various
leases were $656,000, $530,000 and $482,000 for the years ended
December 31, 2002, 2001 and 2000. Total rental expense was $836,000,
$706,000 and $650,000, respectively.
Future minimum non-cancelable lease payments are as follows:
Year Ending December 31,
2003 $ 897,000
2004 679,000
2005 339,000
2006 309,000
Thereafter 953,000
-----------
$ 3,177,000
===========
Page F-17
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - REGULATORY CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on the Bank's financial
statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company and
the Bank must meet specific capital guidelines that involve
quantitative measures of the Bank's assets, liabilities and certain
off-balance sheet items as calculated under regulatory accounting
practices. The capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts
and ratios (set forth in the table below) of total and Tier 1 capital
(as defined in the regulations) to risk-weighted assets (as defined)
and of Tier 1 capital (as defined) to average assets (as defined).
Management believes the Company and the Bank meet all capital
adequacy requirements to which it is subject.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------- ------------------- -------------------
Amount Amount Amount
(in thousands) Ratio (in thousands) Ratio (in thousands) Ratio
------------- ----- ------------ ----- ------------- -----
At December 31, 2002:
Total Capital to
Risk-Weighted Assets
Consolidated $ 60,027 11.6% $ 41,541 8.0% $ 51,927 10.0%
Bank 59,661 11.5% 41,532 8.0% 51,916 10.0%
Tier 1 Capital to Risk-
Weighted Assets
Consolidated 53,638 10.3% 20,771 4.0% 31,156 6.0%
Bank 53,272 10.3% 20,766 4.0% 31,149 6.0%
Tier 1 Capital to
Average Assets
Consolidated 53,638 7.9% 20,509 3.0% 34,181 5.0%
Bank 53,272 7.8% 20,496 3.0% 34,160 5.0%
At December 31, 2001:
Total Capital to
Risk-Weighted Assets
Consolidated 49,321 12.1% 32,491 8.0% 40,614 10.0%
Bank 49,060 12.1% 32,487 8.0% 40,609 10.0%
Tier 1 Capital to Risk-
Weighted Assets
Consolidated 44,238 10.9% 16,246 4.0% 24,368 6.0%
Bank 43,977 10.8% 16,243 4.0% 24,365 6.0%
Tier 1 Capital to
Average Assets
Consolidated 44,238 8.0% 16,555 3.0% 27,592 5.0%
Bank 43,977 8.0% 16,554 3.0% 27,591 5.0%
At December 31, 2002, the Bank was categorized as well capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, the Bank must maintain minimum
Total risk-based, Tier 1 risk-based and Tier 1 average ratios as set
forth in the table above.
Payment of dividends by the Bank is limited under regulation. The
amount that can be paid in any calendar year without prior approval
of the Office of the Comptroller of the Currency cannot exceed the
lesser of net profits (as defined) for that year, plus the net
profits for the preceding two calendar years, or retained earnings.
Page F-18
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLDATED FINANCIAL STATEMENTS
NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair value estimates are determined as of a specific date in time
utilizing quoted market prices, where available, or various
assumptions and estimates. As the assumptions underlying these
estimates change, the fair value of the financial instruments
will change. The use of assumptions and various valuation techniques,
as well as the absence of secondary markets for certain financial
instruments, will likely reduce the comparability of fair value
disclosures between financial institutions.
Additionally, the Bank has not disclosed highly subjective values of
other non-financial instruments. Accordingly, the aggregate fair
value amounts presented do not represent, and should not be construed
to represent, the full underlying value of the Company. The methods
and assumptions used to estimate the fair values of each class of
financial instruments are as follows:
Cash and cash equivalents - The carrying value of cash and cash
equivalents approximates fair value due to the relatively short-term
nature of these instruments.
Interest-bearing deposits in banks - The fair value of interest-
bearing deposits are estimated using discounted cash flow analysis
based on current rates for similar types of deposits.
Investment securities - The fair value of investment securities is
based on quoted market prices. If quoted market prices are not
available, then fair values are based on quoted market prices of
comparable instruments. Included in investment securities are Federal
Home Loan Bank and Federal Reserve Bank stock, which are carried at
cost. The carrying amount is areasonable estimate of fair market
value.
Loans - In order to determine the fair values for loans, the loan
portfolio was segmented based on loan type, credit quality and
repricing characteristics. For certain variable rate loans with no
significant credit concerns and frequent repricings, estimated fair
values are based on the carrying values. The fair values of other
loans are estimated using discounted cash flow analyses. Discount
rates used in these analyses are generally based on origination rates
for similar loans of comparable credit quality. Maturity estimates of
installment loans are based on historical experience with prepayments.
Deposits - The fair values for deposits subject to immediate
withdrawal, such as interest and noninterest bearing and savings
deposit accounts, are equal to the amount payable on demand at the
reporting date (i.e., their carrying amount on the balance sheet).
Fair values for fixed-rate certificates of deposits are estimated by
discounting future cash flows using interest rates currently offered
on time deposits with similar remaining maturities.
Off-balance sheet instruments - The fair value of commitments to
extend credit and standby letters of credit is estimated using the
fees currently charged to enter into similar agreements, taking into
account the remaining terms of the agreements and the present
creditworthiness of the counter parties.
December 31, 2002 December 31, 2001
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------- ------------- -------------
Financial assets:
Cash and cash equivalents $ 87,463,000 $ 87,463,000 $ 82,242,000 $ 82,242,000
Interest-bearing deposits
in banks 198,000 199,000 298,000 299,000
Investment securities 3,557,000 3,557,000 1,760,000 1,760,000
Loans, net 586,461,000 599,521,000 466,529,000 473,833,000
------------ ------------- ------------- -------------
$677,679,000 $ 690,740,000 $ 550,829,000 $ 558,134,000
============ ============= ============= =============
Financial liabilities -
deposits $577,585,000 $ 578,201,000 $ 502,137,000 $ 505,814,000
============ ============= ============= =============
Off-balance sheet
financial instruments:
Commitments to extend
credit - $ 50,112,000 $ - $ 50,923,000
Page F-19
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of
its customers. To date, these financial instruments include
commitments to extend credit and standby letters of credit that
involve elements of credit and interest rate risk in excess of the
amount recognized in the statement of financial position.
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements. The Bank evaluates each customer's creditworthiness on
a case-by-case basis and generally requires collateral or other
security to support commitments to extend credit.
Standby letters of credit are performance assurances made on behalf
of customers who have a contractual obligation to produce or deliver
goods or services or otherwise perform. Credit risk in these transactions
arises from the possibility that a customer may not be
able to repay the Bank if the letter of credit is drawn upon. As
with commitments to extend credit, the Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral
obtained, if any, is based on management's credit evaluation of the
counter-party.
At December 31, 2002 and 2001, loan commitments totaled $48,035,000
and $47,451,000 and standby letters of credit totaled $2,077,000 and
$3,472,000.
NOTE 16 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
The condensed balance sheet of Northern Empire Bancshares (parent
company only) as of December 31, 2002 and 2001, and statements of
income and cash flow for each of the three years ended December 31,
2002, are as follows:
ASSETS
2002 2001
------------ ------------
Cash and cash equivalents 312,000 $ 251,000
Investment in Sonoma National Bank 53,372,000 44,036,000
Other assets 55,000 52,000
------------ ------------
Total assets $ 53,739,000 $ 44,339,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 1,000 $ 42,000
Preferred stock, no par value;
10,000,000 shares authorized;
none issued or outstanding - -
Common stock, no par value;
20,000,000 shares authorized;
4,180,914 and 3,973,263 shares
issued and outstanding in
2002 and 2001 27,529,000 21,946,000
Additional paid-in-capital 786,000 786,000
Accumulated other comprehensive
income (loss) 10,000 (1,000)
Retained earnings 25,413,000 21,566,000
------------ ------------
Total stockholders' equity 53,738,000 44,297,000
------------ ------------
Total liabilities and
stockholders' equity $ 53,739,000 $ 44,339,000
============ ============
Page F-20
NORTHERN EMPIRE BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2002 2001 2000
---------- ---------- ---------
STATEMENTS OF INCOME
Interest and other income $ 5,000 $ 9,000 $13,000
Administrative expenses (39,000) (38,000) (37,000)
Income tax expense 44,000 (1,000) (1,000)
Equity in undistributed earnings of
Sonoma National Bank $ 9,325,000 $ 8,117,000 $ 6,877,000
---------- ---------- ---------
Net income $ 9,335,000 $ 8,087,000 $ 6,852,000
=========== ========== ==========
STATEMENTS OF CASH FLOWS
2002 2001 2000
---------- ----------- ------------
Cash flows from operating activities:
Net income $ 9,335,000 $ 8,087,000 $ 6,852,000
Adjustments to reconcile net income to net
cash from operating activities:
Changes in other assets (3,000) - 1,000
Change in other liabilities (41,000) - -
Equity in undistributed earnings (9,325,000) (8,117,000) (6,877,000)
---------- ---------- ---------
Net cash from operating activities (34,000) (30,000) (24,000)
---------- ---------- ---------
Cash flows from investing activities:
Net change in loans receivable - - 149,000
---------- ---------- ---------
Net cash from investing activities - - 149,000
---------- ---------- ---------
Cash flows from financing activities:
Payout of fractional shares (6,000) (3,000) (2,000)
Proceeds from exercise of stock options 101,000 71,000 74,000
---------- ---------- ---------
Net cash from financing activities 95,000 68,000 72,000
---------- ---------- ---------
Net change in cash and cash equivalents 61,000 38,000 197,000
Cash and cash equivalents, beginning of year 251,000 213,000 16,000
---------- ---------- ---------
Cash and cash equivalents, end of year $ 312,000 $ 251,000 $ 213,000
========== ========== =========
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None.
Part III
ITEM 10. Directors and Executive Officers of the Registrant
The following are the directors and executive officers of the
Corporation and the Bank:
Name and Positions with the Principal Occupation
Corporation and the Bank Age During the Past 5 Years
Deborah A. Meekins, 50 President and Chief Executive
President & Chief Executive Officer of the Bank
Officer and Director of the since February 1991.
Bank and Chief Executive Officer
of the Corporation
Clement C. Carinalli 57 Retired CPA, local businessman,
Director of the Corporation rancher and real estate
and the Bank investor.
Patrick R. Gallaher, 57 Certified Public Accountant
Chief Accounting Officer of and local businessman;
the Corporation and Director major shareholder in
of the Corporation and the Bank Oakmont Developers, a Santa
Rosa development company.
William P. Gallaher, 52 Real Estate developer and
Director of the Corporation investor; President of
and the Bank Oakmont Developers; President
of Gallaher Construction
Company.
William E. Geary, 74 Senior Partner in Geary,
Director of the Corporation Shea & O'Donnell, a Santa
and the Bank Rosa law firm.
Dennis R. Hunter, 60 Real estate investor and
Chairman of the Board of the developer in Santa Rosa;
Corporation and Vice Chairman principal in Investment
of the Board of the Bank Development Fund, a venture
capital fund, a director of
Pinnacle Oil International, Inc.
James B. Keegan, Jr., 54 Partner in Keegan & Coppin
Vice-Chairman & Director of the Company, a Santa Rosa real
Corporation and Chairman of the estate brokerage and
Board of the Bank development firm, since 1976.
Robert V. "Buzz" Pauley, 58 A commercial properties manager;
Secretary/Treasurer and Director trader of futures and options
of the Corporation and Director contracts in Chicago and other
of the Bank international market exchanges.
David F. Titus, 50 Executive Vice President &
Executive Vice President & Senior Loan Officer of the
Senior Loan Officer and Bank since January, 1995.
Director of the Bank Senior Vice President & Senior
Loan Officer of the Bank from
August 1991 to January, 1995.
Larry V. Sorensen, 43 Executive Vice President of
Executive Vice President & Corporate Development of the
Corporate Development Officer Bank since May 2002; Finance
of the Bank Director of Corrigo Inc.; and ,
Vice President of Corporate
Development of Golden West
Financial Corporation
JoAnn Barton, 49 Senior Vice President and
Senior Vice President & Senior Operations Administrator
Senior Operations Officer of the Bank since March 1992;
of the Bank from November 1985 Vice
President and Senior Operations
Administrator of the Bank.
Jane M. Baker 56 Senior Vice President and
Senior Vice President & Chief Financial Officer of the
Chief Financial Officer Bank since August 1995;
of the Bank and Chief Vice President and Chief
Financial Officer of the Financial Officer of the
Corporation Bank since August 1992.
Each of the directors of the Corporation has served as a director since
the initial organization of the Corporation in 1982, except for Patrick
R. Gallaher who was elected on May 19, 1992, William P. Gallaher who was
elected on June 21, 1994 and Clement C. Carinalli who served from 1982
until 1992 and from 1996 to date. William P. Gallaher and Patrick R.
Gallaher are brothers.
William E. Geary, Dennis R. Hunter, James B. Keegan, Jr. and Robert V.
Pauley have served as directors of the Bank since the initial
organization of the Bank in 1984. Clement C. Carinalli served from 1984
to 1992 and from 1996 to date. William P. Gallaher was appointed as
Bank director in November 1988; Deborah A. Meekins was appointed in
August 1990; Patrick R. Gallaher was appointed in December 1991 and
David F. Titus was appointed in June 2001. As the sole shareholder of
the Bank, the Corporation elects the directors of the Bank.
The Corporation's common stock is not registered pursuant to section 12
of the Exchange Act, therefore Item 405 of Regulation S-K is not
applicable.
ITEM 11. Executive Compensation
The following table sets forth the cash compensation paid to or accrued
for the executive officers of the Bank for services rendered for the
periods indicated. The executive officers of the Corporation, including
the President, do not receive compensation for their services as such.
The Vice Chairman of the Corporation, James B. Keegan, Jr., serves as
the Chairman of the Board of the Bank and receives $2,000 per month from
the Bank for his services in that capacity. See, "Compensation of
Directors," below.
Summary Compensation Table
(dollars in thousands)
Long Term
Annual Compensation Compensation
------------------- -------------
Options
Name and Principal Position Year Salary Bonus (No. of Shares) All Other (1)
Deborah A. Meekins, 2000 $173 $152 $51
President and Chief Executive 2001 181 152 21,000 67
Officer and Director of 2002 182 155 139
the Bank
David F. Titus, Executive Vice 2000 118 106 39
President and Senior Loan 2001 123 106 15,000 55
Officer and 2002 160 86 113
Director of the Bank
Larry V. Sorensen, Executive
Vice President and Corporate
Development Officer of the 2002 89 0 15,000 4
Bank
JoAnn Barton, Senior Vice 2000 99 20 5,000 4
President and Senior Operations 2001 103 20 5
Officer of the Bank 2002 99 19 5
Jane M. Baker, Senior Vice 2000 98 20 5,000 4
President and Chief Financial 2001 103 20 5
Officer of the Bank 2002 106 21 5
(1) Includes contribution by the Bank for the benefit of the named
officer pursuant to the Bank's 401(k) plan, auto allowances and accrued
expenses incurred with respect to the Salary Continuation Agreement for
Ms. Meekins and Mr. Titus, as described below.
Salary Continuation Agreements
The Bank has deferred compensation agreements with Deborah A. Meekins,
President and Chief Executive Officer, and David F. Titus, Executive
Vice President and Senior Loan Officer. Under these agreements, the
Bank is obligated to provide for them or their beneficiaries, during a
period of 15 years after the employee's death, disability, or
retirement, annual benefits ranging from $75,000 to $100,000. Benefits
are also provided to the officer if he/she resigns following a change in
control or if he/she voluntarily resigns after June 1, 1995. The
estimated present value of future benefits to be paid is being accrued
over the period from the effective date of the agreements until their
expected retirement dates. The accrued expense is included in Other
Liabilities in the financial statements. The Bank is the beneficiary of
life insurance policies that have been purchased as a method of
financing the benefits under the agreements. At December 31, 2002, the
total cash surrender value of these policies was $1,113,000, which is
included in other assets.
Stock Option Plan
Neither the Corporation nor the Bank award restricted stock or have long
term incentive plans, other than the Corporation's 1984 and 1997 Stock
Option Plans. The 1984 Plan expired in February 1994. Options for a
total of 3,345 shares (to officers of the Bank) granted under the 1984
Plan remain outstanding and will expire in February 2004. Options for a
total of 1,189,892 shares (913,328 to all directors of the Corporation
and 276,564 shares to forty-four officers and employees of the Bank) are
outstanding under the 1997 Plan as of December 31, 2002. As of January
31, 2002 options for a total of 1,193,237 shares (913,328 to all
directors of the Corporation and 279,909 shares to forty-four officers
and employees of the Bank) were outstanding.
The following sets forth information regarding all stock options granted
to executive officers during 2002.
Option Grants Table
Potential realizable value
at assumed annual rates of
stock price appreciation
Individual Grants for option term
Percent
Number of of total Exercise
Securities options of
underlying granted to base 5% 10%
options employees in price Expiration ($) ($)
Name granted (1) fiscal year ($/Sh) Date $ $
Larry V. Sorensen 15,000 100% $28.25 6/13/2012 $266,400 $675,300
(1) Adjusted for stock dividends issued since date of the option grant.
The following sets forth information regarding all options held by the
named executive officers as of December 31, 2002 and options exercised
during 2002:
Aggregated Year-End Option Exercises and Values
December 31, 2002
Number of Securities
Shares Value Underlying Unexercised Value of Unexercised
acquired on realized Options (No. of Shares)(1) Options (2)
Name exercise(#) ($) Exercisable/Unexercisable Exercisable/Unexercisable
- ------------------ ---------- -------- -------------------------- -------------------------
Deborah A. Meekins 1,000 $13,467 85,510 / 38,742 $1,123,991 / $411,546
David F. Titus 0 0 19,937 / 16,876 $276,254 / $150,628
Larry V. Sorensen 0 0 0 / 15,000 $0 / ($40,500)
JoAnn Barton 0 0 7,066 / 4,522 $91,417 / $51,866
Jane M. Baker 1,285 $30,199 8,366 / 4,522 $121,124 / $51,866
(1) Adjusted for stock dividends issued since date of the option grant.
(2) Calculated based on the difference between the fair market value of
the stock and the exercise price of the options, as of December 31,
2002.
Compensation of Outside Directors
During 2002 outside directors of the Bank (including directors who serve
as executive officers of the Corporation) receive director fees as
follows: $1,500 for each monthly board meeting attended, $500 per
executive committee and ALCO and $250 per all other committee meetings
attended. The Chairman of the Board of the Bank receives a fee of
$2,000 per month in addition to the committee fees described above. The
Corporation does not pay directors' fees at this time, and does not plan
to in the near future.
Outside directors were eligible to receive options under the
Corporation's 1984 Stock Option Plan and are also eligible to receive
options under the 1997 Stock Option Plan. See "Item 12, Security
Ownership of Certain Beneficial Owners and Management." During 2000,
stock options for 17,885 shares were exercised by directors, realizing a
value of approximately $213,000. During 2001, options for 157,000 were
granted to outside directors. During 2002 there were no options granted
to directors and none were exercised during the year. During 2000,
options to several outside directors were canceled and reissued. At the
time the options were canceled, their exercise price was less than the
fair market value of the shares, the directors were 40% vested, and the
remaining life of the options was eight years. The directors were
granted options for the same number of shares at an exercise price that
exceeds the exercise price of the canceled options and equal to the fair
market value at the time of the grant. The new options contain an
accelerated vesting period, to match the vesting of the canceled
options, and have a ten year life. Outside directors held on December
31, 2002 options for 913,328 shares, which options had an estimated
value of $11,001,000 based on the difference between the fair market
value of the stock as of that date and the exercise price of the
options.
The Corporation has deferred compensation agreements with directors
Patrick R. Gallaher, William P. Gallaher, William Geary, and James B.
Keegan, Jr. Under each of these agreements, the Corporation is
obligated to provide for the director or his beneficiaries, during a
period of between 10 to 15 years after the director's death, disability
or retirement, annual benefits ranging from $13,000 to $55,000. The
estimated present value of future benefits to be paid is being accrued
over the period from the effective date of the agreements until the
expected retirement dates. The Corporation is beneficiary of life
insurance policies that have been purchased as a method of financing the
benefits. At December 31, 2002, the total cash surrender value of these
policies was $1,282,000, which is included in other assets.
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management
Other than as set forth below, the Corporation knows of no person who is
the beneficial owner of more than 5.0% of the Corporation's outstanding
shares as of January 31, 2003.
The following sets forth the numbers of shares of common stock
beneficially owned by each director of the Corporation and the Bank and
by the directors and officers (including vice presidents and above) of
the Corporation and the Bank as a group, as of January 31, 2003. The
numbers of shares beneficially owned include the numbers of shares which
each person has the right to acquire within 60 days upon exercise of
stock options granted pursuant to the Corporation's Stock Option Plans.
The percentages of shares owned beneficially are calculated, pursuant to
SEC Rule 13d-3(d) (1), based on the number of shares presently
outstanding plus the number of shares which the person or group has the
right to acquire within 60 days.
Name Number of Shares
Beneficially Owned Pct
Clement C. Carinalli 168,732 (1) 3.4%
Patrick R. Gallaher 181,699 (2) 3.6
William P. Gallaher 162,238 (3) 3.3
William E. Geary 267,448 (4) 5.4
Dennis R. Hunter 312,568 (5) 6.3
James B. Keegan, Jr. 185,969 (6) 3.7
Deborah A. Meekins 144,049 (7) 2.9
Robert V. Pauley 247,678 (8) 5.0
David Titus 24,295 (9) 0.5
JoAnn Barton 34,115(10) 0.7
Jane M. Baker 10,851(11) 0.2
Larry V. Sorensen 0 0.0
Directors and Executive
Officers as a group
(10 persons) 1,739,642 35.0%
(1) Including 90,942 shares issuable to Mr. Carinalli upon the exercise
of stock options exercisable within 60 days.
(2) Including 90,942 shares issuable to Mr. Gallaher upon the exercise
of stock options exercisable within 60 days, 90,515 shares held in Mr.
& Mrs. Gallaher's trust and 242 shares owned by a child living at
home.
(3) Including 90,942 shares issuable to Mr. Gallaher upon the exercise
of stock options exercisable within 60 days and 22,493 held in an IRA
account.
(4) Including 90,942 shares issuable to Mr. Geary upon the exercise of
stock options exercisable within 60 days, 38,945 shares held in Mr.
Geary's profit sharing plan, 118,665 shares held in Mr. & Mrs. Geary's
trust, 18,896 shares held by Geary, Shea, O'Donnell, Grattan's profit
sharing account and 10,077 shares held in a trust account for which
Mr.Geary serves as trustee but does not have a beneficial interest.
(5) Including 103,357 shares issuable to Mr. Hunter upon the exercise
of stock options exercisable within 60 days and 194,521 shares held in
trust accounts for which Mr. Hunter serves as trustee but does not
have a beneficial interest.
(6) Including 103,357 shares issuable to Mr. Keegan upon the exercise
of stock options exercisable within 60 days, 62,189 shares held by
Keegan & Coppin Company, Inc., 9,163 shares held by the Keegan &
Coppin Profit Sharing Plan and 11,238 held in trust accounts for
which Mr. Keegan is trustee or held in accounts for the benefit of his
children.
(7) Including 90,141 shares issuable to Ms. Meekins upon the exercise
of stock options exercisable within 60 days.
(8) Including 90,942 shares issuable to Mr. Pauley upon the exercise of
stock options exercisable within 60 days and 15,755 shares held by
Mrs. Pauley.
(9) Including 23,245 shares issuable to Mr. Titus upon the exercise of
stock options exercisable within 60 days.
(10) Including 7,066 shares issuable to Ms. Barton upon the
exercise of stock options exercisable within 60 days.
(11) Including 8,366 shares issuable to Ms. Baker upon the exercise
of stock options exercisable within 60 days and 2,485 held in Ms.
Baker's trust account.
The business addresses of each of the above individuals is c/o Northern
Empire Bancshares, 801 Fourth Street, Santa Rosa, CA 95404
ITEM 13. Certain Relationships and Related Transactions
The Bank leases facilities for the loan department and some
administrative offices from Mr. James Ratto, a major shareholder of the
Corporation. Total rental expense on this lease for the year ended
December 31, 2002, 2001 and 2000 was $181,000, $168,000 and 168,000
respectively.
The Bank has had in the ordinary course of business, and expects to have
in the future, banking transactions with its directors, officers and
their associates, including transactions with corporations of which such
persons are directors, officers or controlling shareholders. The
transactions involving loans have been and will be entered into with
such persons in the ordinary course of business, on substantially the
same terms, including interest rates and collateral, as those prevailing
at the time for comparable transactions with other persons, and on terms
not involving more than the normal risk of collectibility or presenting
other unfavorable features. At December 31, 2002, loans by the Bank to
directors, officers and their associates totaled approximately
$10,757,000, constituting 1.8% of total loans, 20.2% of the Bank's
shareholders' equity and 20.0% of the consolidated shareholders' equity
of the Corporation.
Loans to insiders, such as officers, directors, and certain other
persons are subject to the limitations and requirements of the Financial
Institutions Regulatory and Interest Rate Control Act of 1978 and
regulations thereunder.
Item 14. Controls and Procedures
Within the 90 day period prior to the date of this report, the
Corporation carried out an evaluation, under the supervision and with
the participation of the Corporation's management, including its Chief
Executive Officer and Chief Financial Officer, of the effectiveness of
the design and operation of the Corporation's disclosure controls and
procedures pursuant to Exchange Act Rule 15d-14(c). Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Corporation's disclosure controls and procedures are
effective in a timely manner to alert them to material information
relating to the Corporation which is required to be included in the
Corporations periodic Securities and Exchange Commission filings.
There have been no significant changes in the Corporation's internal
controls or in other factors that could significantly affect these
controls subsequent to the evaluation date.
Part IV
ITEM 15. Exhibits, Financial Statement Schedules, and Reports on
Form 10-K
(1) 1. All Financial Statements.
See item 8.
(2) 2 Financial Statement Schedules.
None required
(3) 3. Exhibits
The following is a list of the exhibits to this Form 10-K.
(3) (a) Articles of Incorporation of the Corporation (filed as Exhibit
3.1 to the Corporation's S-1 Registration Statement, filed May
18, 1984, file number 2-91196, and incorporated herein by this
reference).
(b) Certificate of Amendment to Articles of Incorporation, filed
January 17, 1989 (filed as exhibit (3)(b) to the Corporation's
Annual Report on Form 10-K for the Fiscal Year Ended
December 31, 1988, file number 2-91196, and incorporated
herein by this reference).
(c) Amendment to the Bylaws of the Corporation and revised Bylaws
(filed as Exhibit (3)(d) to the Corporation's Annual Report on
Form 10-KSB for the Fiscal Year Ended December 31,1994, file
number 2-91196, and incorporated herein by this reference).
(d) Secretary's certificate of Amendment to the Bylaws of the
Corporation and revised Bylaws (filed as exhibit (3)(e) to the
Corporation's Annual Report on Form 10-KSB for the Fiscal Year
Ended December 31, 1997, file number 2-91196, and incorporated
herein by this reference).
(10) (a) Lease for Bank Premises at 801 Fourth Street, Santa Rosa,
California (filed as Exhibit 10.2 to the Corporation's S-2
Registration Statement, filed September 11, 1992, file number
2-91196, and incorporated herein by this reference).
(b)* Stock Option Plan (filed as Exhibit 10.2 to the Corporation's
S-1 Registration Statement, filed May 18, 1984, file number
2-91196, and incorporated herein by this reference).
(c)* Amendment No. 1 to Stock Option Plan (filed as Exhibit (10)(d)
to the Corporation's Annual Report on Form 10-K for the Fiscal
Year ended December 31, 1989, file number 2-91196, and
incorporated herein by this reference).
(d)* Amendment No. 2 to Stock Option Plan (filed as Exhibit (10)(f)
to the Corporation's Annual Report on Form 10-K for the Fiscal
Year Ended December 31, 1991, file number 2-91196, and
incorporated herein by this reference).
(e)* Indemnification Agreements between James B. Keegan, Jr. and
Northern Empire Bancshares and Sonoma National Bank (filed as
Exhibit (10)(h) to the Corporation's Annual Report on Form
10-KSB for the Fiscal Year Ended December 31,1992, file number
2-91196, and incorporated herein by this reference).
(f)* Indemnification Agreements between Dennis R. Hunter and Northern
Empire Bancshares and Sonoma National Bank (filed as Exhibit
(10)(i) to the Corporation's Annual Report on Form 10-KSB for the
Fiscal Year Ended December 31,1992, file number 2-91196, and
incorporated herein by this reference).
(g)* Indemnification Agreements between Robert V. Pauley and Northern
Empire Bancshares and Sonoma National Bank (filed as Exhibit
(10)(j) to the Corporation's Annual Report on Form 10-KSB for the
Fiscal Year Ended December 31,1992, file number 2-91196, and
incorporated herein by this reference).
(h)* Indemnification Agreements between William E. Geary and Northern
Empire Bancshares and Sonoma National Bank (filed as Exhibit
(10)(k) to the Corporation's Annual Report on Form 10-KSB for the
Fiscal Year Ended December 31,1992, file number 2-91196, and
incorporated herein by this reference).
(i)* Indemnification Agreements between Patrick R. Gallaher and
Northern Empire Bancshares and Sonoma National Bank (filed as
Exhibit (10)(l) to the Corporation's Annual Report on Form
10-KSB for the Fiscal Year Ended December 31,1992, file number
2-91196, and incorporated herein by this reference).
(j)* Indemnification Agreement between William P. Gallaher and Sonoma
National Bank (filed as Exhibit (10)(m) to the Corporation's
Annual Report on Form 10-KSB for the Fiscal Year Ended December
31,1992, file number 2-91196, and incorporated herein by this
reference).
(k)* Indemnification Agreement between Deborah A. Meekins and Sonoma
National Bank (filed as Exhibit (10)(p) to the Corporation's
Annual Report on Form 10-KSB for the Fiscal Year Ended December
31,1992, file number 2-91196, and incorporated herein by this
reference).
(l)* Executive Salary Continuation Agreement between Deborah A.
Meekins and Sonoma National Bank (filed as Exhibit (10)(O) to
the Corporation's Annual Report on Form 10-KSB for the Fiscal
Year Ended December 31,1993, file number 2-91196, and
incorporated herein by this reference).
(m)* Executive Salary Continuation Agreement between David F. Titus
and Sonoma National Bank (filed as Exhibit (10)(p) to the
Corporation's Annual Report on Form 10-KSB for the Fiscal Year
Ended December 31,1993, file number 2-91196, and incorporated
herein by this reference).
(n) Lease for premises in Lakeside Village Shopping Center, Windsor,
California, dated March 1,1993 (filed as Exhibit (10.15) to the
Corporation's Amendment No. 1 to Form S-2 Registration Statement,
File No. 33-60566, filed May 13, 1993, file number 33-60566, and
incorporated herein by this reference).
(o)* Director's Deferred Compensation Plan between Patrick R.
Gallaher and Sonoma National Bank (filed as Exhibit (10)(r) to
the Corporation's Annual Report on Form 10-KSB for the Fiscal
Year Ended December 31,1994, file number 2-91196, and
incorporated herein by this reference).
(p)* Director's Deferred Compensation Plan between William P.
Gallaher and Sonoma National Bank (filed as Exhibit (10)(s) to
the Corporation's Annual Report on Form 10-KSB for the Fiscal
Year Ended December 31,1994, file number 2-91196, and
incorporated herein by this reference).
(q)* Director's Deferred Compensation Plan between James B. Keegan,
Jr. and Sonoma National Bank (filed as Exhibit (10)(t) to the
Corporation's Annual Report on Form 10-KSB for the Fiscal Year
Ended December 31,1994, file number 2-91196, and incorporated
herein by this reference).
(r)* Director's Deferred Compensation Plan between William E. Geary
and Sonoma National Bank (filed as Exhibit (10)(u) to the
Corporation's Annual Report on Form 10-KSB for the Fiscal Year
Ended December 31,1994, file number 2-91196, and incorporated
herein by this reference).
(s)* Director's Deferred Compensation Plan between William P.
Gallaher and Sonoma National Bank (filed as Exhibit (10)(v) to
the Corporation's Quarterly Report on Form 10-QSB for the Quarter
Ended June 30,1996, file number 2-91196, and incorporated herein
by this reference).
(t) Lease for Bank Premises at 6641 Oakmont Drive, Santa Rosa,
California, dated October 1, 1996 (filed as Exhibit (10)(w) to
the Corporation's Quarterly Report on Form 10-QSB for the
Quarter ended September 30, 1996, file number 2-91196, and
incorporated herein by this reference).
(u) Lease for Loan and Administration Offices at 815 Fifth Street,
Santa Rosa, California, dated February 24, 1998 (filed as Exhibit
(10)(w) to the Corporation's Annual Report on Form 10-KSB for
the Fiscal Year Ended December 31,1997, file number 2-91196, and
incorporated herein by this reference).
(v)* Indemnification Agreements between William P. Gallaher and
Northern Empire Bancshares (filed as Exhibit (10)(a) to the
Corporation's Quarterly Report on Form 10-QSB for the Quarter
Ended June 30,1998, file number 2-91196, and incorporated herein
by this reference).
(w)* Indemnification Agreements between Clement C. Carinalli and
Northern Empire Bancshares and Sonoma National Bank (filed as
Exhibit (10)(b) to the Corporation's Quarterly Report on Form
10-QSB for the Quarter Year Ended June 30, 1998, file number
2-91196, and incorporated herein by this reference).
(x)* 1997 Stock Option Plan, as amended, and Stock Option Agreement
(filed as Exhibit (10)(b) to the Corporation's Quarterly Report
on Form 10-QSB for the Quarter Year Ended June 30, 1998, file
number 2-91196, and incorporated herein by this reference).
(y) Lease for West College Branch in G & G Market at 1211A West
College Avenue, Santa Rosa, California, dated June 30, 1998
(filed as Exhibit (10)(y) to the Corporation's Annual Report on
Form 10-KSB for the Fiscal Year Ended December 31, 1998, file
number 2-91196, and incorporated herein by this reference).
(y) Lease for Petaluma College Branch in G & G Market at 701-B,
Petaluma, California, dated November 1, 2000 (filed as Exhibit
(10)(z) to the Corporation's Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 2000, file number 2-91196, and
incorporated herein by this reference).
(aa) Lease for Operations Center at 1650 Northpoint Parkway, Santa
Rosa, California, dated February 1, 2001. (filed as Exhibit
(10)(aa) to the Corporation's Annual Report on Form 10-K for
the Fiscal Year Ended December 31, 2000, file number 2-91196,
and incorporated herein by this reference).
*Management contract or compensation plan or arrangement.
(21) Subsidiaries of the Corporation (filed as Exhibit 22 to Post
Effective Amendment No. 5 to the Corporation's S-1 Registration
Statement, filed May 29, 1987, File No 2-91196 and incorporated
herein by this reference).
(23) Consent of Moss Adams, LLP
(99(a)) Section 906 Certification
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of
the period covered by this report.
Supplemental Information to be Furnished With Reports Filed Pursuant to
Section 15(d) of the Exchange Act by Non Reporting Issuers.
Four copies of the Registrant's 2001 Annual Report to Security Holders
will be furnished to the Commission for its information when it is sent
to the security holders.
The Registrant's Proxy Materials for the 2002 Shareholders' Meeting have
not yet been sent to the Security Holders. Copies of the Proxy
materials will be furnished to the Commission for its information when
they are sent to the security holders.
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.
Northern Empire Bancshares
By /s/ Deborah A. Meekins
------------------------
Deborah A. Meekins, Chief Executive Officer
Date March 25, 2003
-------------------
By /s/ Jane M Baker
-------------------
Jane M. Baker, Chief Financial Officer
Date March 25, 2003
-------------------
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 and in the capacities and on the dates indicated.
/s/ Dennis R. Hunter Date March 25, 2003
- ---------------------------------- --------------
Dennis R. Hunter
Chairman of the Board of Directors
/s/ James B. Keegan, Jr. Date March 25, 2003
- ---------------------------------- --------------
James B. Keegan, Jr.
Vice Chairman of the Board of Director
/s/ Patrick R. Gallaher Date March 26, 2003
- ---------------------------------- --------------
Patrick R. Gallaher,
Chief Accounting Officer/Director
Date
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Robert V. Pauley,
Secretary and Treasurer/Director
/s/ Clement C. Carinalli Date March 18, 2003
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Clement C. Carinalli,
Director
/s/ William P. Gallaher Date March 25, 2003
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William P. Gallaher,
Director
/s/ William E. Geary Date March 25, 2003
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William E. Geary,
Director
Exhibit 23
CONSENT OF INDEPENDENT AUDITOR
We consent to the incorporation by reference in Northern Empire
Bancshares' Registration Statement on Form S-8 (No. 333-33076) of our
report on the audit of the consolidated financial statements of
Northern Empire Bancshares as of December 31, 2002 and 2001, and for
the three years ended December 31, 2002. Our report, which is dated
January 17, 2003, appears in the Annual Report on Form 10-K of
Northern Empire Bancshares for the year ended December 31, 2002.
/s/ MOSS ADAMS LLP
Santa Rosa, California
March 20, 2003
Section 302 Certification
I, Deborah A. Meekins, certify that:
1. I have reviewed this annual report on Form 10K Northern Empire
Bancshares;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for,
the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in
which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation
Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's
auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions);
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.
Date: March 25, 2003
Signature /s/ Deborah A. Meekins
------------------------
Deborah A. Meekins
President & Chief Executive Officer
Section 302 Certification
I, Jane M. Baker, certify that:
7. I have reviewed this annual report on Form 10K Northern Empire
Bancshares;
8. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
9. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for,
the periods presented in this annual report;
10. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and have:
d. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made
known to us by others within those entities, particularly
during the period in which this annual report is being
prepared;
e. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation
Date"); and
f. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
11. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's
auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions);
c. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
d. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
12. The registrant's other certifying officers and I have indicated
in this annual report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.
Date: March 25, 2003
Signature /s/ Jane M. Baker
-------------------
Jane M. Baker
Chief Financial Officer
Exhibit 99(a)
SECTION 906 CERTIFICATION
The undersigned each certify that:
1. They are the duly appointed Chief Executive Officer and Chief
Financial Officer, respectively, of Northern Empire Bancshares, a
California Corporation ("the Company"); and
2. To her best knowledge and belief, the Company's Annual Report on
Form 10-K for the year ended December 31, 2002, and to which the
Certification is attached as Exhibit 1, fully complies with the
requirements of Sections 13(a) or 15(d) of the Securities and
Exchange Act of 1934 and that the information contained in the
Report fairly presents, in all material respects, the Financial
condition and results of operations of Northern Empire
Bancshares.
Date: March 25, 2003
/s/ Deborah A. Meekins /s/ Jane M. Baker
- ---------------------- ---------------------
Deborah A. Meekins Jane M. Baker
President & Chief Executive Officer Chief Financial Officer