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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 2-91196
NORTHERN EMPIRE BANCSHARES
------------------------------------------------------
(Exact name of registrant as specified in its charter)
California 94-2830529
- --------------------------------- ------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
801 Fourth Street, Santa Rosa, California 95404
------------------------------------------ ----------
(Address of principal executive offices) (Zip code)
707-579-2265
-------------------------------------------------
(Registrants telephone number, including area code)
NONE
(Former name, former address and former fiscal year, if changed since
last report)
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 whether the registrant is an accelerated filer
(as defined in rule 12b-2 of the Exchange Act). Yes X No ____
(NOTE: The accelerated filer status determination as of 12/31/02
governs the quarterly reports to be filed for the subsequent fiscal
year.)
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Title of class: Common Stock, no par value. Outstanding shares as of
October 15, 2003: 4,401,323
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(dollars in thousands)
ASSETS
September 30, December 31,
ASSETS 2003 2002
Cash and equivalents:
Cash and due from banks $ 19,476 $ 14,717
Federal funds sold 72,228 72,746
--------- ---------
Total cash and equivalents 91,704 87,463
--------- ---------
Interest-bearing deposits in banks 198
Investment securities available-for-sale 637 652
Federal Home Loan Bank stock, at cost 4,003 2,740
Federal Reserve Bank stock, at cost 165 165
Loans receivable, net 668,120 586,461
Leasehold improvements and equipment, net 1,563 1,361
Accrued interest receivable and other assets 10,807 10,340
--------- ---------
Total assets $ 776,999 $ 689,380
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $ 631,777 $ 577,585
Accrued interest payable and
other liabilities 3,950 3,281
FHLB advances 79,219 54,776
--------- ---------
Total liabilities 714,946 635,642
--------- ---------
Shareholders' equity:
Preferred stock, no par value;
authorized, 10,000,000 shares;
none issued or outstanding
Common stock, no par value; authorized,
20,000,000 shares; shares issued
and outstanding, 4,401,323 at
September 30,2003 and 4,389,960
at December 31, 2002 (retroactively
stated for 5% stock dividend) as
stated prior to 2 for 1 stock split to be
distributed to shareholders of record as
of December 1, 2003. See notes 1 and 5. 33,147 27,529
Additional paid-in capital 786 786
Accumulated other comprehensive income (loss) 5 10
Retained earnings 28,115 25,413
--------- ---------
Total shareholders' equity 62,053 53,738
--------- ---------
Total liabilities and
shareholders' equity $776,999 $689,380
======== ========
See Notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the three and nine months ended September 30, 2003 and 2002
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
Interest income:
Loans $ 11,096 $ 10,219 $ 32,299 $ 29,610
Federal funds sold, investment
securities and other 296 343 770 863
------- ------- ------- -------
Total interest income 11,392 10,562 33,069 30,473
Interest expense 3,423 4,224 10,612 11,707
------- ------- ------- -------
Net interest income before
provision for loan losses 7,969 6,338 22,457 18,766
Provision for loan losses 150 240 750 540
------- ------- ------- -------
Net interest income after
provision for loan losses 7,819 6,098 21,707 18,226
------- ------- ------- -------
Other income:
Service charges on deposits 138 131 447 390
Gain on sale of loans 352 328 1,052 791
Other 268 216 678 544
------- ------- ------- -------
Total other income 758 675 2,177 1,725
------- ------- ------- -------
Other expenses:
Salaries and employee benefits 2,289 1,827 6,350 5,000
Occupancy 312 280 921 802
Equipment 208 148 562 446
Advertising and
business development 155 108 427 355
Outside customer services 89 91 255 293
Director and shareholder expenses 100 89 308 266
Deposit and other insurance 93 84 276 244
Professional fees 62 110 279 239
Other 304 237 904 713
------- ------- ------- -------
Total other expenses 3,612 2,974 10,282 8,358
------- ------- ------- -------
Income before income taxes 4,965 3,799 13,602 11,593
Provision for income taxes 1,945 1,527 5,391 4,691
------- ------- ------- -------
Net income $ 3,020 $ 2,272 $ 8,211 $ 6,902
======= ======= ======= =======
Earnings per common share $ 0.69 $ 0.52 $ 1.87 $ 1.57
======= ======= ======= =======
Earnings per common share
assuming dilution $ 0.60 $ 0.45 $ 1.64 $ 1.39
======= ======= ======= =======
See notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2003 and 2002
(Unaudited)
2003 2002
(dollars in thousands)
Cash flows from operating activities:
Net income $ 8,211 $ 6,902
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 750 540
Depreciation, amortization and accretion 385 324
FHLB stock dividends (118) (38)
Net decrease in deferred loan fees and discounts (494) (438)
Change in deferred income taxes (104) 36
Change in interest receivable and other assets (363) (629)
Change in accrued interest payable and
other liabilities 669 176
-------- --------
Net cash provided by in operating activities 8,936 6,873
-------- --------
Cash flows from investing activities:
Purchase of restricted securities (1,145) (1,704)
Maturities of available for sale securities 10 354
Redemption of restricted securities
Net decrease in interest bearing deposits 198 100
Net increase in loans receivable (81,915) (103,279)
Purchase of leasehold improvements and
equipment, net (587) (223)
-------- --------
Net cash used in investing activities (83,439) (104,752)
-------- --------
Cash flows from financing activities:
Net increase in deposits 54,192 65,955
Net increase in FHLB advances 24,443 34,977
Payment of cash dividends (7) (6)
Stock options exercised 116 73
-------- --------
Net cash provided by financing activities 78,744 100,999
-------- --------
Net increase in cash and cash equivalents 4,241 3,120
Cash and cash equivalents at beginning of year 87,463 82,242
-------- --------
Cash and cash equivalents at end of period $ 91,704 $ 85,362
======== ========
Supplemental cash flow information:
Interest paid $ 10,737 $ 11,672
======== ========
Income taxes paid $ 5,402 $ 4,536
======== ========
Other real estate owned acquired
through foreclosure $ - $ 110
======== ========
See notes to Consolidated Financial Statements
Northern Empire Bancshares and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2003
Note 1 - Basis of Presentation
The unaudited financial information contained in this report reflects
all adjustments which, in the opinion of Management, are necessary to
present fairly the financial condition of Northern Empire Bancshares and
Subsidiary at September 30, 2003 and the results of operations for the
three and nine months then ended. The results of operations for the
three-months and nine-months ended September 30, 2003 are not
necessarily indicative of the results to be anticipated for the year
ended December 31, 2003.
The preparation of the consolidated financial statements in conformity
with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect
amounts reported in the consolidated financial statements. Changes in
these estimates and assumptions are considered reasonably possible and
may have a material impact on the consolidated financial statements and
thus actual results could differ from the amounts reported and disclosed
herein. The Company considers the allowance for loan loss a critical
accounting policy subject to estimate.
Except where it is otherwise stated, the information in this report does
not reflect the two for one stock split in the Common Stock of the
Corporation to be distributed to shareholders of record as of December
31, 2003 approved by the Board of Directors on October 21, 2003.
Certain information and footnote disclosures presented in the
Corporation's annual consolidated financial statements are not included
in these interim financial statements. Accordingly, the accompanying
unaudited interim consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Corporation's 2002 Annual Report on Form 10-K.
Note 2 - Net Income per Common and Common Equivalent Share
Basic earnings per share (EPS) is computed by dividing income available
to common shareholders by the weighted average number of common shares
outstanding during the period. Diluted EPS is computed by dividing
diluted income available to shareholders by the weighted average number
of common shares and common equivalent shares outstanding which include
dilutive stock options. The computation of common stock equivalent
shares is based on the weighted average market price of the
Corporation's common stock throughout the period adjusted for the impact
of the 5% stock dividend declared on April 1, 2003. The Corporation's
pertinent EPS data is as follows:
For the three months ended For the three months ended
September 30, 2003 September 30, 2002
Weighted Weighted
Average Per Average Per
Income/ Shares/ Share Income/ Shares/ Share
Numerator Denominator Amount Numerator Denominator Amount
Net Income $3,020,000 $2,272,000
========== ==========
EPS - Income available
to common stockholders $3,020,000 4,395,126 $0.69 $2,272,000 4,383,223 $0.52
========== ==========
Effect of Dilutive
Securities - Stock Options 598,481 624,158
--------- ---------
EPS assuming dilution-Income
available to common
stockholders plus assumed
conversion $3,020,000 4,993,607 $0.60 $2,272,000 5,007,381 $0.45
========== ========= ===== ========== ========= =====
For the nine months ended For the nine months ended
September 30, 2003 September 30, 2002
Weighted Weighted
Average Per Average Per
Income/ Shares/ Share Income/ Shares/ Share
Numerator Denominator Amount Numerator Denominator Amount
Net Income $8,211,000 $6,902,000
========== ==========
EPS - Income available to
common stockholders $8,211,000 4,394,867 $1.87 $6,902,000 4,383,084 $1.57
========== ==========
Effect of Dilutive
Securities - Stock Options 611,499 586,704
------- -------
EPS assuming dilution-Income
available to common
stockholder plus assumed
conversion $8,211,000 5,006,366 $1.64 $6,902,000 4,969,788 $1.39
========== ========= ===== ========== ========= =====
Note 3 - Stock Based Compensation
The Company accounts for stock-based employee compensation arrangements
using the intrinsic value method 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.
As of January 1, 2003 the Company adopted the disclosure requirements of
SFAS 148, Accounting for Stock Based Compensation, which amends
accounting principals Board ("APB") No. 28 by adding to the list of
disclosures to be made for interim periods.
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. For purposes of pro forma disclosures, the
estimated fair value of the options is amortized over the options'
vesting period. Stock options issued to non-employees are valued under
the provisions of SFAS No. 123. 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:
For the three months ended For the nine months ended
September 30, September 30,
(In thousands) 2003 2002 2003 2002
Net Income for the period $3,020 $2,272 $8,211 $6,902
Compensation expense,
net of tax effect 38 88 113 265
------ ------ ------ ------
Proforma net income $2,982 $2,184 $8,098 $6,637
====== ====== ====== ======
Proforma earnings per
common share $0.68 $0.50 $1.84 $1.51
Proforma earnings per
common share, assuming
dilution $0.60 $0.44 $1.62 $1.34
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 (no options have been granted in 2003):
2002
----
Dividends 5%
Expected volatility 16.51%
Risk-free interest rate 4.94%
Expected life 10 years
Note 4 - Comprehensive Income
The Corporation's total comprehensive earnings presentation is as
follows:
(dollars in thousands)
For the three For the nine
months ended months ended
September 30, September 30,
2003 2002 2003 2002
Net Income $3,020 $2,272 $8,211 $6,902
Other Comprehensive income (loss):
Change in unrealized holding
gain (losses) arising during
the period (4) 9 (8) 19
Income tax benefit (expense) 2 (3) 3 (9)
------ ------ ------ ------
Comprehensive income $3,018 $2,278 $8,206 $6,912
====== ====== ====== ======
Note 5 - Stock Split
On October 21, 2003, the Board of Directors of the Corporation declared
a two for one stock split to shareholders of record on December 1, 2003
payable on December 15, 2003.
Note 6 - Commitments
In October 2003, the Bank entered into an operating lease agreement for
office facilities for the Bank's executive officer, all of the lending
functions located in Santa Rosa and certain administrative personnel.
The facilities are located at 3558 Round Barn Boulevard, Santa Rosa,
California. The initial rent is $32,415.90 per month. The lease
commences June 1, 2004 and expires on August 31, 2014 and has two five
year options to extend the term.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Northern Empire Bancshares (the "Corporation") is the financial holding
company of Sonoma National Bank (the "Bank"). Since the principal
business of the Corporation is the Bank, the following discussion
pertains mainly to the Bank.
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. 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 the 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), 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 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 which are highly uncertain and
require a high degree of judgment; the process 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.
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, which includes statements such as projections, plans,
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 such
assumptions will be correct, or that such 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.
Summary of Financial Results
Total consolidated assets equaled $776,999,000 at September 30, 2003
compared to $689,380,000 at December 31, 2002 and $669,090,000 at
September 30, 2002. Net loans increased $81.7 million since year-end
with $28.8 million occurring in the third quarter. Cash and equivalents
increased $4.2 million to $91.7 million at September 31, 2003 compared
to $87.5 million at December 31, 2002 and $85.4 million at September 30,
2002.
Net income after tax for the first nine months of 2003 equaled
$8,211,000 compared to $6,902,000 for the comparable of 2002, an
increase of 19.0%. The net income for the third quarter of $3,020,000
increased 32.9% over the third quarter of 2002 when net income equaled
$2,272,000. The higher profit resulted mainly from increases in net
interest income due to loan growth.
Net Interest Income
Net interest income (before the provision for loan losses) of $7,969,000
for the third quarter of 2003 increased 25.7% from $6,338,000 for the
comparable period last year. This increase in net interest income
resulted primarily from volume increases of $113.4 million in average
earning assets for the current quarter compared to the third quarter of
2002. The Bank experienced a $113.4 million increase in average loans
outstanding, which have the highest yields. Average investments,
certificates of deposits and fed funds sold increased $8.0 million.
Average interest bearing deposits for the third quarter increased $56.6
million over the same period last year and average borrowings with the
Federal Home Loan Bank increased $43.2 million. Net interest income
(before the provision for loan losses) of $22,457,000 for the nine
months ended September 30, 2003 increased 19.7% from $18,766,000 for the
comparable period last year.
Net interest margin equaled 4.24% during the third quarter of 2003
compared to an average margin for the third quarter of 2002 of 3.98% and
4.23% for the year ended December 31, 2002. The yield on average loans
equaled 6.69% in the third quarter compared to 7.34% for the same period
last year, while the Bank's cost of funds decreased to 2.12% in the
current quarter from 3.10% for the third quarter of 2002.
Several factors impact the Bank's interest margin. These include changes
in market interest rates, level of loans relative to deposits, mix of
loans 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
Banks net interest margin since prime rate generally moves with Federal
Reserve Board changes. During 2002 the prime rate equaled 4.75% until
November 7 when it declined to 4.25% (40 year low) where it remained
until June 30, 2003 when it declined to 4.00%. 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 full impact of rate changes on the Bank's earnings is not realized
for several months, since not all loans or deposits reprice immediately.
The Bank has $175.8 million in SBA section 7(a) loans which reprice
based upon the prime rate on the first day of the calendar quarter. The
Bank has $187.1 million adjustable rate loans, mainly commercial real
estate loans that are tied to the Eleventh District Cost of Funds Index
(COFI) which adjust at a slower pace. The COFI index was 1.95% for
August 2003 (latest available) and 2.38% for December 2002 compared to
3.07% for December 2001. 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. The rate of loan prepayments
has increased as borrowers refinance to indexes which bear lower rates
than loans tied to COFI or fixed rates.
Of the Bank's loan portfolio totaling $676.2 million at September 30,
2003, $281.9 million or 41.7% of total loans are adjustable rate loans,
which have not reached a floor or ceiling rate. Approximately
$221.1million are prime-based loans, of which $44.1 million reprice
immediately and $177.0 million reprice on a quarterly basis.
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.
While interest rates offered on deposits have stabilized, they remain at
historically low levels. The Bank had $141.2 million in Sonoma Investor
Reserve accounts (money market rate deposit accounts). The cost of
these deposits equaled 1.08% during the third quarter of 2003 compared
to 1.81% for the third quarter last year.
The Bank had $384.7 million in time certificates of deposits at
September 30, 2003. These accounts reprice at a slower pace. The cost
of time deposits equaled 2.79% for the third quarter of 2003 compared to
3.83% in the third quarter of the preceding year. The benefit of lower
rates on time deposits will continue to occur as certificates of
deposits mature and are renewed at the lower rates offered on their
maturity dates. The Bank has offered competitive market rates for
deposits when compared to other financial institutions in our area.
Level of Loans Relative to Deposits
The Bank's ratio of loans to deposits averaged 105.8% in the third
quarter of 2003 compared to 98.8% for the same period last year. A
higher loan to deposit ratio generally results in an increase in net
interest margin.
Mix of Loan and Earning Assets
The mix of loans influences the overall yield on loans. The largest
loan growth occurred in real estate loans, which grew $63.7 million
since December 31, 2002 to $676.2 million at this quarter's end. This
category has a lower yield than other types of loans. The Bank has
developed new loan products tied to US Treasury and LIBOR index with
other favorable terms to attract new loan volume. Loan volume has been
strong as a result of these products. Total COFI loans have continued
to decline during this quarter as borrowers move to other indexes which
have lower rates.
Construction loans decreased to $25.3 million at the end of this quarter
from $32.4 million at year-end. Due to risks associated with
construction loans they generally have higher yields than other real
estate loans. General economic conditions greatly influence the demand
for construction loans and the Bank has continued to experience less
demand during this quarter.
SBA loans, which generally are secured by real estate, are classified as
commercial loans. Commercial loans totaled $198.8 million at September
30, 2003 compared to $173.3 million at December 31, 2002. SBA loans
continue to be a popular loan product; however, the rate of growth has
declined as borrowers move to more fixed rate or indexes which are less
volatile than prime rate.
Economic conditions and competition have impacted the mix of loans.
Refinancing of COFI loans due to the higher floor rate than current
rates has reduced loan yield. The Bank is currently offering loan
products tied to prime rate, US Treasury rates or LIBOR which have lower
interest rates but reprice at a faster rate than COFI loans.
Construction loans generally decline when economic conditions worsen.
The Bank continues to experience strong competition for loans, which has
resulted in lower loan pricing in the market place, which impacts the
Bank's offering rates on new loans and negatively impacts the Bank's net
interest margin.
Non-Accrual Loan Balances
Loans, which have been placed on non-accrual status also impact the net
interest margin. At the time a loan is placed on non-accrual, the
unpaid interest is reversed and interest accruals are discontinued until
the credit quality of the loan justifies returning it to accrual status.
As of September 30, 2003 the Bank had $469,000 in non-accrual loans
compared to $3.0 million at December 31, 2002. When a non-accrual loan
pays off or is reinstated to accrual status the interest income is
reinstated to income which has a positive effect on loan yields. At
September 30, 2003 non-accrual loans and loans past due 90 days or more
equaled 0.07% of total loans. The current level of non-accrual loans is
considered by management to be a low level of non-accrual loans based
upon comparisons to our peer group. See Allowance for Loan Losses for
additional information.
Mix of Deposits and Other Funding Sources
The mix of funding sources determines the cost of funds for the Bank.
Certificates of deposit reprice at the time the certificate matures
which delays the benefit to the Bank's cost of funds in a downward
interest market. Sonoma Investor Reserve accounts can be repriced
weekly; and therefore, the benefit of falling interest rates is more
immediate. Competition also is a factor in the repricing of certain
deposit products. While prime rate drops immediately on loans it often
takes longer to receive the same benefit when repricing market rate
deposits due to competitive rates in our market area.
The Bank also has a borrowing line with the Federal Home Loan Bank
(FHLB) which has been used, as a source of liquidity. The borrowing
rates are below rates offered on certificates of deposits and the Bank
has increased the use of this line as a way to reduce its cost of funds.
As of September 30, 2003 the Bank had borrowed $79.2 million from the
FHLB. The cost of FHLB loans is approximately 100 basis points below
current offering rates on deposits of similar term.
Interest expense decreased to $3,423,000 in the third quarter of 2003
from $4,224,000 in the third quarter of 2002. The major factor was the
decrease in the average cost of interest bearing liabilities which
declined to 2.12% from 3.10% when comparing the third quarter of this
year to the third quarter of last year. In addition, the increase in
the funds borrowed from the FHLB to fund loan growth at an average rate
of 1.47% had a positive impact rather than attracting new deposits at
market rates.
The following is an analysis of the net interest margin:
(dollars in thousands)
Three months ended Three months ended
September 30, 2003 September 30, 2002
Average Average
Balance Interest Yield Balance Interest Yield
Earning assets(1) $745,590 $11,392 6.06% $632,229 $10,562 6.63%
Interest bearing liabilities 641,090 3,423 2.12% 541,307 4,224 3.10%
Net interest income $7,969 $6,338
====== ======
Net Interest income
to earning assets 4.24% 3.98%
==== ====
(1) Non-accrual loans are included in the calculation of average balance
of earning assets, and interest not accrued is excluded.
(dollars in thousands)
Nine months ended Nine months ended
September 30, 2003 September 30, 2002
Balance Interest Yield Balance Interest Yield
Earning assets (1) $706,112 $33,069 6.26% $584,936 $30,473 6.97%
Interest bearing liabilities 608,044 10,612 2.33% 492,183 11,707 3.18%
Net interest income $22,457 $18,766
======= =======
Net Interest income
to earning assets 4.24% 4.29%
==== ====
(1) Non-accrual loans are included in the calculation of average balance
of earning assets, and interest not accrued is excluded.
The following table sets forth changes in interest income and interest
expense for each major category of interest-earning asset and
interest-bearing liability, and the amount of change attributable to
volume and rate changes for the three and nine months ended September
30, 2003 and 2002. Changes not solely attributable to rate or volume
have been allocated to rate.
(dollars in thousands)
For the three months
ended September 30, 2003
over September 30, 2002
Volume Yield/Rate Total
Increase (decrease) in interest income:
Portfolio loans $7,599 ($6,722) $877
Other earning assets 174 (221) (47)
------ ------ ------
Total increase (decrease) 7,773 (6,943) 830
Increase (decrease) in interest expense
Interest-bearing transaction accounts 289 (510) (221)
Time deposits 1,371 (2,033) (662)
Other borrowings 1,007 (925) 82
------ ------ ------
Total increase (decrease) 2,667 (3,468) (801)
------ ------ ------
Increase (decrease) in
net interest income $5,106 ($3,475) $1,631
====== ====== ======
(dollars in thousands)
For the nine months
ended September 30, 2003
over September 30, 2002
Volume Yield/Rate Total
Increase (decrease) in interest income:
Portfolio loans $8,327 $5,638) $2,689
Other earning assets 197 (290) (93)
------ ------ ------
Total increase (decrease) 8,524 (5,928) 2,596
------ ------ ------
Increase (decrease) in interest expense
Interest-bearing transaction accounts 133 (710) (577)
Time deposits 2,416 (3,253) (837)
Other borrowings 1,151 (832) 319
------ ------ ------
Total increase (decrease) 3,700 (4,795) (1,095)
------ ------ ------
Increase (decrease) in
net interest income $4,824 ($1,133) $3,691
====== ====== ======
Provision for Loan Losses
The provision for loan losses equaled $150,000 for the three months
ended September 30, 2003 and $750,000 for the nine months ended
September 30, 2003 compared to $240,000 and $540,000 for the same
periods in 2002. The provision is intended to maintain the Allowance
for Loan Losses given the overall growth in loans and the level of
non-accrual loans. For further discussion see Allowance for Loan Losses
Other Income
Other income is derived primarily from service charges, SBA loan sales,
SBA loan servicing and sales of other real estate owned. Other income
increased to $758,000 from $675,000 when comparing the third quarter of
2003 to the same period last year. Other income equaled $2,177,000 for
the nine months ended September 30, 2003 compared to $1,725,000 for the
comparable period last year.
Service Charges
Service charges on deposit accounts equaled $138,000 in the third
quarter of 2003 compared to $131,000 for the same period last year and
$447,000 for the nine months ended September 30, 2003 compared to
$390,000 for the nine months ended September 30, 2002. The increase
relates to charges on analysis customers. The earnings credit rate has
remained at a low level due to the declining interest rate environment.
Analysis customers earn less on their average balance to cover the cost
of services provided to them. If the earnings credits do not cover the
cost of services customers are charged a service fee. In addition, the
Bank has added more businesses to the analysis program. The Bank also
receives fees for safe deposit, visa, and other services.
SBA Loan Sales and Loan Participations
In the third quarter of this year, the Bank sold the guaranteed portion
of SBA loans totaling $3.5 million. The SBA loan sales resulted in
$352,000 in gains on sale of SBA loans. During the third quarter of last
year, the Bank sold the guaranteed portion of SBA loans totaling $4.7
million and recognized gains on those sales of $328,000. The Bank has
sold $14,621,000 in guaranteed portion of SBA loans during the nine
months ended September 30, 2003 compared to $11,466,000 for the same
period last year recognizing gains on those sales of $1,052,000 in 2003
and $791 in 2002.
The Bank continues to retain the majority of the SBA loans it makes, in
order to realize the interest yield, rather than selling the guaranteed
portion for a one time gain and servicing fees. Management considers the
Bank's liquidity needs and anticipates loan and deposit growth as a part
of the decision to hold SBA guaranteed loans versus selling them. The
premiums on loan sales in the third quarter remained at higher levels
over those received in earlier during 2002. The average premium on
sales in the third quarter of 2003 equaled 10.2%, compared to 7.0% in
the third quarter of 2002. Premiums are market driven based upon
factors such as rate of prepayment of SBA loans experienced throughout
the country. There is no guarantee that premiums will continue at the
current level. The Bank did not participate commercial real estate loans
to other California financial institutions during the third quarter of
2003. Management considers the Bank's liquidity needs and anticipates
loan and deposit growth as a part of the decision to participate loans.
SBA Loan Servicing
SBA servicing fees totaled $98,000 during the third quarter of 2003,
compared to fees of $73,000 recorded in the third quarter of last year.
The income varies depending on the fee income calculated based upon the
payments received during the period and the size of the portfolio
serviced. The serviced portfolio equaled $47.5 million at September 30,
2003 compared to $37.8 million at September 30, 2002.
Sales of Other Real Estate Owned
There were no sales of OREO during the third quarter of 2003. During
the third quarter of 2002, the Bank foreclosed on real estate located in
Phoenix, Arizona which secured an SBA loan. This property was purchased
by the Bank at the foreclosure sale amount of $110,000 and a small
charge off was taken at the time of foreclosure. In the fourth quarter
of last year this property was sold with a gain to the Bank of $36,000.
Non-Interest Expenses
The Bank's non-interest expenses increased to $3,612,000 for the third
quarter of this year and $10,282,000 for the year-to-date compared to
$2,974,000 and $8,358,000 for the same period last year. This increase
was anticipated since the Bank has continued to grow at a rapid rate.
Salaries and Employee Benefits
The Bank's largest expense category is salaries and benefits which
increased 25.3% to $2,289,000 up from $1,827,000 for the third quarter
of 2002. The Bank's full time equivalent (FTE) staff level has increased
to 129 in September 2003 from 113 in September 30, 2002. The Bank hired
a Senior Vice President in charge of Audit and Risk Management, a new
administrator in charge of the Branch system and several new loan
support employees to manage the high loan volume. Incentive payments
continue at a high level since they are based on growth in the loan
portfolio. The Bank continues to experience increases in worker
compensation insurance costs which increased 48% when comparing the
third quarter of this year to the same period last year. Health
insurance costs are also expected to continue to increase due the
condition of the health care industry. Personnel costs are also affected
by annual salary and promotional increases within the existing staff.
Occupancy and Equipment
Occupancy expenses increased 11.4%, in the third quarter in the amount
of $520,000, mainly due to the new branch located in Sonoma, the new
loan office in San Rafael and rent increases on existing facilities.
Occupancy costs are expected to increase with additional expansion of
the Branch network and the relocation of the Bank's loan department and
administrative offices to a larger facility in Santa Rosa. Equipment
costs increased 40.5% to $208,000 from $148,000 for the third quarter
last year. Recently the Bank upgraded the mainframe computer and
replaced the proof machine which positions the Bank for future
expansion. It is expected that equipment costs will continue to
increase as the Bank grows.
Deposit and Other Insurance
Deposit and other insurance of $93,000 increased in the third quarter
from $84,000 for the same period of last year. The increase results
from growth of the Bank, which determines the regulatory assessments.
There is no assurance that regulatory assessments will continue at the
current low level. The cost of other insurance is included in this
category. It is expected that the cost of other insurance will increase
in 2004 when a three year policy Banker Bond expires and is replaced at
market rates.
Professional Services
Professional fees decreased to $62,000 for the third quarter of 2003
down from $110,000 for the same period last year. The majority of the
decrease results from reimbursements of legal costs (that the Bank had
previously expensed) on problem loans from the SBA and the borrower.
Legal expenses vary depending upon the level of problem loans. (See
discussion on Allowance for Loan Losses). There has been an increase in
legal and accounting costs as a result of SEC reporting and the new
regulations due to the Sarbanes Oxley Act. It is expected that these
costs will continue to increase. Other professional services vary
depending upon the scheduling of other contracted services such as loan
reviews, tax services, and other consulting services. The Bank has
increased the use of consultants to assist in special projects where
additional expertise or resources are needed. It is expected that this
trend will continue.
Advertising and Business Development
Advertising and business development costs, which vary depending on the
timing of loan and deposit promotions, increased to $155,000 from
$108,000 for the third quarter of 2002.
Outside Customer Services
Outside customer services declined 2.2% to $89,000 when comparing this
quarter to second quarter of 2002. The Bank pays for certain direct
costs (i.e. payroll services, escrow fees, etc.) which are expensed.
These costs are based upon the depositor using the analysis system. The
analysis customer receives earnings credits based upon their deposit
account balances which can be used to offset these charges. The customer
is charged a bank service fee if their earnings credits do not cover the
costs. With the lower interest environment the earnings credit rate is
low and as a result our customers are paying for more of the covered
services directly rather than paying service charges.
Shareholder and Director Expenses
Third quarter expenses for shareholder and director expenses equaled
$100,000 compared to $89,000 in the previous third quarter. Included in
this category are directors' fees for attending Board, Loan Committee,
Asset Liability Committee (ALCO), Executive Committee, Audit Committee
and Executive Compensation Committee meetings. It was expected that
these expenses will increase due to the increased responsibilities of
directors due to recent regulatory changes. The Bank has increased the
frequency of ALCO and Audit Committee meetings. The cost of the
Corporation's annual report, transfer agent fees and other costs of
communicating with shareholders is included in this expense category.
Other Expenses
Other expenses (including stationery and supplies, telephone, postage,
loan expenses, dues and subscriptions and automobile costs) increased
28.3% to $304,000 in the third quarter from $237,000 in the third
quarter of 2002. These costs increase with the overall growth of the
Bank. The Bank continues to closely monitor operating expenses as part
of the Bank's overall cost controls.
Total non-interest expenses for the SBA lending department for the third
quarter of 2003 was approximately $557,000 ($371,000 in personnel costs,
$71,000 in occupancy and equipment expenses, $40,000 in
marketing/business development and $75,000 in other expenses) compared
to $549,000 for the third quarter of 2002. The SBA department's loan
portfolio includes $223.3 million of SBA section 7(a) loans and $247.9
of commercial real estate and other loans of which $47.5 million has
been sold and is being serviced. The expenses of the SBA lending
department are included in the totals for the Bank in corresponding
expense categories.
Income Taxes
The effective tax rate was 39.2% for the third quarter of 2003 compared
to 40.2% for the comparable quarter last year. The reduction in the
effective tax rate results from projected tax savings associated with
the favorable tax treatment of interest on loans in enterprise zones.
The provision for the third quarter of 2003 was $1,945,000 versus
$1,527,000 for the same period last year. The increase resulted from
the increase in pre-tax income during the comparable quarters.
Liquidity and Investment Portfolio
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.
Cash and due from banks, federal funds sold and certificates of deposit
totaled $91.7 million or 11.8% of total assets at September 30, 2003,
compared to $87.7 million or 12.7% of total assets at December 31, 2002.
The Bank sold $3.5 million in SBA loans during the third quarter of
2003 which increased the Bank's liquidity. The Bank's level of
borrowings from the FHLB in the amount of $79,219 was relatively
unchanged during the third quarter of 2003. Bank deposits increased
$16.7 million during the third quarter of 2003 as a result of deposit
promotions to fund the projected loan growth.
The Bank considers the unsold guaranteed portion of 7(a) SBA loans as a
secondary source of liquidity. There is an established market for these
loans and a sale can be completed within a few weeks. As of September
30, 2003, the Bank held $117.5 million in SBA guaranteed loans which
could be sold for additional liquidity.
At September 30, 2003, the Bank had unused federal funds lines of credit
totaling $14 million. The Bank also has a credit line with the Federal
Home Loan Bank (FHLB) which is based upon the value of collateral
(investments and loans). As of September 30, 2003 the Bank has
collateral pledged which would allow the Bank to borrow up to $148.6
million. As of September 30, 2003, the Bank had borrowed $79.2 million
which leaves $69.4 million available to borrow. The Bank could borrow an
amount equal to 25% of our assets, assuming that collateral values would
support that level of borrowings. Management believes this amount of
secondary liquidity is adequate to meet any cash demands that may arise.
At present, the Corporation's primary sources of liquidity are from
interest on deposits, 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 Comptroller of the Currency. At
September 30, 2003, the Corporation had non-interest and interest
bearing cash balances of $402,000, which management believes is adequate
to meet the Corporation's operational expenses.
The Corporation and the Bank do not engage in hedging transactions
(interest rate futures, caps, swap agreements, etc.).
Deposits
During the third quarter of 2003 total deposits increased by $16.8
million to $631.8 million at September 30, 2003 as compared to deposits
of $577.6 million at December 31, 2002 and $568.1 million at September
30, 2002.
Money market deposits totaling $141.2 million at September 30, 2003 have
declined from $144.6 at December 31, 2002. This is a limited transaction
account with a discretionary rate which is set by management. The rate
offered on this account was unchanged during this quarter.. There is
strong competition in our market area for these types of funds. The
Bank's customers have their funds in this deposit product rather than
locking into a specific maturity during this time of low interest rates.
There has been some movement into other investments with signs of the
stock market improving. These funds are also more volatile and
fluctuate during various business cycles.
Certificates of deposits totaling $384.7 million at September 30, 2003
increased $32.6 million from $352.1 million as of September 30, 2002 and
$352.1 million at December 31, 2002. The Bank offered time deposit
promotions during this quarter which was successful in attracting new
depositors.
As of September 30, 2003, non-interest-bearing deposits equaled $70.8
million compared to $50.6 million at December 31, 2002 and $54.7 million
at September 30, 2002. The Bank's transaction accounts have significant
changes in daily balances, mainly due to deposits held by large
businesses.
The interest rate environment and the increased competition from the
financial services industry has made it more difficult to attract new
deposits at favorable rates. The Bank continually monitors competitors'
rates, strives to be competitive in pricing deposits, and has offered
attractive time deposit rates to raise funds during periods of high loan
growth.
Loans
Loans, net of discounts and reserves, equaled $668.1 million at
September 30, 2003 compared to $586.5 million at December 31, 2002,
increasing 13.9% over year-end and 17.3% over the September 30, 2002
balance of $569.6 million.
The following is an analysis of the loan portfolio.
Type of Loan
(in thousands) September 30, December 31,
2003 2002
Commercial $198,761 $173,325
Real Estate Construction 25,332 32,412
Real Estate Other 445,865 382,134
Installment Loans to Individuals 6,280 6,445
-------- --------
676,238 594,316
Deferred loan fees and discount (971) (1,466)
Allowance for loan losses (7,147) (6,389)
-------- --------
TOTAL $668,120 $586,461
======== ========
The SBA loan program continued to be a popular program with strong
competition in our market area. At September 30, 2003, loans with SBA
guarantees equaled $223.3 million, net of $47.5 million in SBA loans
sold and being serviced by the Bank compared to $209.1 million, net of
$46.3 million in SBA loans sold at September 30, 2002. The majority of
the Bank's SBA loans are secured by real estate; however, these loans
are reported as commercial loans. SBA loans have the same underwriting
requirements, as the Bank' other loans. They are sometimes for longer
terms (7 to 25 years) and have higher loan-to-value ratios than the Bank
typically accepts. The SBA loan program remains subject to budget
considerations at the Federal government level. Major changes to the
federal program could affect the Bank's profitability and future SBA
loan growth. The guaranteed portion of SBA loans currently held by the
Bank which could be sold in the secondary market increased to $117.5
million at September 30, 2003 from $94.8 million at September 30, 2002.
The Bank continues to emphasize commercial and real estate lending. At
September 30, 2003, 29.4% of the loans held for investment were
commercial loans and 69.7% were real estate and construction loans,
compared to 29.2% and 69.7% respectively at December 31, 2002 and 28.9%
and 69.9% at September 30, 2002. The Bank has continued to grow its
commercial and commercial real estate portfolio through its reputation
as an experienced business and real estate lender that facilitates the
successful negotiation of complex commercial loans. The Bank maintains
high credit qualifications with most real estate loans having 60-70%
loan-to-value ratios. Management is aware of the risk factors in making
commercial and real estate loans and is continually monitoring the local
market place. A decline in real estate values and/or demand could
potentially have an adverse impact on the loan portfolio, and on the
financial condition of the Bank.
Construction loans decreased to $25.3 million at September 30, 2003 from
$32.4 million at December 31, 2002 and $35.8 million at September 30,
2002 due to the reduced demand caused by general economic conditions.
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. 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 offers residential mortgages on a limited basis. The Bank has
a small portfolio of consumer loans, which equaled 0.9% of the total
loan portfolio at September 30, 2003 and 1.1% of the total loan
portfolio at December 31,2002.
Allowance for Loan Losses
The allowance for loan losses equaled $7,147,000 at September 30, 2003,
compared to $6,389,000 at December 31, 2002 and $6,088,000 at September
30, 2002. At September 30, 2003 the allowance for loan
losses equaled 1.3% of loans, net of the guaranteed portion of SBA
loans. The allowance for loan losses is reviewed on a monthly basis,
based upon an allocation for each loan category, 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 with a specific reserve
allocation assigned according to the risk assessment.
At September 30, 2003, there were three borrowers on non-accrual status
totaling $469,000 of which $439,000 was collateralized by real estate
and the SBA guaranteed $75,000. There were no loans that were past due
90 days or more and still accruing interest. At September 30, 2003,
loans past due 30 to 89 days totaled $2,788,000 all of which were
collateralized by real estate and $75,000 was guaranteed by the SBA. On
December 31, 2002, the Bank had $3,035,000 in non-accrual loans, and no
loans past due 90 or more days and still accruing interest. Loans past
due 30 to 89 days totaled $6,358,000 at December 31, 2002.
During the third quarter of 2003 there were no loans charged off and
$3,000 in loan recoveries. The Bank continues to have a low charge off
experience compared to industry standards, but there can be no
assurances that this will continue or that the Bank will not experience
loan losses. The following is an analysis of the activity in the
allowance for loan losses during the quarter and year-to-date.
(dollars in thousands)
Quarter ended Nine months ended
September 30, 2003 September 30, 2003
Balance - Beginning of period $6,994 $6,390
Provision for loan losses 150 750
Charge offs - -
Recoveries 3 7
------ ------
Balance - End of period $7,147 $7,147
====== ======
Capital Resources
Pursuant to regulations under the FDIC Improvement Act of 1991 (FDICIA),
five capital levels were prescribed as applicable for banks, ranging
from well-capitalized to critically under-capitalized. At September 30,
2003, the Bank was considered "well capitalized." The total risk-based
capital ratios were 11.8% for the Bank and 11.9% for the Corporation, as
compared to 11.5% and 11.6% at December 31, 2002 and 11.2% and 11.3% at
September 30, 2002.
The Corporation declared a 5% stock dividend On April 1, 2003 with a
record date of May 9, 2003.
ITEM 3. 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 and sustained increases and decreases in market
interest rates. The Bank has no trading securities.
Management expects that, in a declining rate environment, the Bank's net
interest margin would tend to decline, and, in an increasing rate
environment, the Banks 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 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 Banks assets and liabilities.
The following table summarizes the simulated change in net interest
income based on the next twelve months, given a change in general
interest rates of 200 basis points up or 100 basis points down.
Change in Interest Estimated Estimated Change in
Rate in basis points Net Interest Income Net Interest Income
+200 $35,276,000 $2,937,000
+100 33,766,000 1,427,000
Base Scenario 32,339,000 -0-
-100 31,536,000 (803,000)
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 schedule represents interest rate sensitivity profile as
of September 30, 2003 of assets, liabilities and shareholders' equity
classified by earliest possible repricing opportunity or maturity date.
Balance Sheet
(dollars in thousands)
Over 3 Over Non-rate
months 1 year Sensitive
Through through through or Over
3 months 1 year 5 years 5 years Total
Assets
Fed funds sold
& certificates of deposit $72,228 $72,228
Investment securities $637 $4,168 4,805
Loans (net of discounts) 245,028 46,605 $47,917 335,717 675,267
Non-interest-earning assets (net
of allowance for loan losses) 24,699 24,699
-------- -------- -------- -------- --------
$317,256 $47,242 $47,917 $364,584 $776,999
======== ======== ======== ======== ========
Liabilities &
Shareholders' Equity
Time Deposits $100,000 and over $50,540 $78,428 $35,661 $164,629
All other interest-bearing
liabilities 238,433 167,481 67,693 $1,953 475,560
Non-interest
bearing liabilities 70,807 70,807
Other Liabilities &
Shareholders' Equity 66,003 66,003
-------- -------- -------- -------- --------
$288,973 $245,909 $103,354 $138,763 $776,999
======== ======== ======== ======== ========
Interest Rate Sensitivity (1) $28,283 ($198,667) ($55,437) $225,821
Cumulative Interest
Rate Sensitivity $28,283 ($170,384) ($225,821) $ -0-
(1) Interest rate sensitivity is the difference between interest rate
sensitive assets and interest rate sensitive liabilities within the
above time frames.
Item 4. Controls and Procedures
As of the end of the period covered by 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, as defined in Securities 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 Corporation's 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 II - OTHER INFORMATION
Item 1. Legal Proceedings - None other than in the ordinary course of
business.
Item 2. Changes in Securities and Use of Proceeds
On October 21, 2003, the Board of Directors of the Corporation
approved a two for one stock split whereby holders of shares of Common
Stock of the Corporation, as of the record date on December 1, 2003,
shall receive two shares of Common Stock for each share of Common Stock
held on the record date. The stock split will be effective by the filing
of an amendment to the Corporation's Articles of Incorporation with
California Secretary of State.
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(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 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 and incorporated herein by this
reference).
(c) Bylaws of the Corporation, as amended (filed as
Exhibit 3.2 to the Corporation's S-2 Registration Statement,
File No. 33-51906 filed September 11, 1992 and incorporated
herein by this reference).
(d) 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 and incorporated herein by this reference).
(e) 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 and incorporated herein by this
reference).
(f) The Section 302 Certifications of the Chief Executive
Officer and Chief Financial Officer are filed herewith
collectively as Exhibit 31.
(g) The Section 906 Certifications of the Chief Executive
Officer and Chief Financial Officer are filed herewith as
Exhibit 32.
(10)(bb) Lease for Administrative Offices and the Loan Department
at 3558 Round Barn Boulevard, Santa Rosa, California, dated
October 14, 2003.
(b) Reports on Form 8-K
Form 8-K, filed on October 14, 2003, reporting, under Item 9,
third quarter of 2003 financial results.
Form 8-K, filed on October 23, 2003, reporting, under
Item 5 (a) resignation of William P. Gallaher as a director
and (b) approval by the Board of Directors of the Corporation
of a two for one stock split in the Common Stock of the
Corporation on October 21, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NORTHERN EMPIRE BANCSHARES
Date: November 05, 2003
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/s/ Deborah A. Meekins /s/ Jane M. Baker
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Deborah A. Meekins Jane M. Baker
President and Chief Executive Officer Chief Financial Officer
Exhibit 31
Section 302 Certification
I, Deborah A. Meekins, certify that:
1. I have reviewed this quarterly report on Form 10-Q Northern Empire
Bancshares;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this 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 quarterly 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-15(e) and 15d-1(e)) for the
registrant and have:
a. designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, 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 quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure
controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
c. disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter that
has materially affected, or is reasonably likely to
materially affect, the registrant's internal control
over financial reporting; and
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting,, 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 and material weaknesses in the
design or operation of internal controls over financial
reporting which are reasonably likely to adversely affect
the registrant's ability to record, process, summarize and
report financial data; 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 over financial reporting.
Date: November 4, 2003
Signature /s/ Deborah A. Meekins
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Deborah A. Meekins, President and Chief
Executive Officer
Section 302 Certification
I, Jane M. Baker, certify that:
1. I have reviewed this quarterly report on Form 10-Q Northern Empire
Bancshares;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this 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 quarterly 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-15(e) and 15d-1(e)) for the
registrant and have:
a. designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, 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 quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure
controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
c. disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter that
has materially affected, or is reasonably likely to
materially affect, the registrant's internal control
over financial reporting; and
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting,, 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 and material weaknesses in the
design or operation of internal controls over financial
reporting which are reasonably likely to adversely affect
the registrant's ability to record, process, summarize and
report financial data; 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 over financial reporting.
Date: November 4, 2003
Signature /s/ Jane M. Baker
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Jane M. Baker, Chief Financial Officer
Exhibit 32
SECTION 906 CERTIFICATION
The undersigned each certify that:
They are the duly appointed Chief Executive Officer and Chief
Financial Officer, respectively, of Northern Empire Bancshares, a
California Corporation ("the Company"); and
To their best knowledge and belief, the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30, 2003, and to which the
Certification is attached as Exhibit 99(i), fully complies with the
requirements of Sections 13(a) or 15(d) of the Securities 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: November 4, 2003
/s/ Deborah A. Meekins /s/ Jane M. Baker
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Deborah A. Meekins Jane M. Baker
President and Chief Chief Financial Officer
Executive Officer