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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 June 30, 2004
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 Identification No.)
of incorporation or organization)
801 Fourth Street, Santa Rosa, California 95404
-------------------------------------------------------
(Address of principal executive offices) (Zip code)
707-579-2265
---------------------------------------------------
(Registrant(s 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
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
July 15, 2004: 9,870,567
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(dollars in thousands)
ASSETS June 30, 2004 December 31, 2003
------------- -----------------
Cash and equivalents:
Cash and due from banks $ 25,573 $ 20,078
Federal funds sold 85,849 74,496
-------- --------
Total cash and equivalents 111,422 94,574
Investment securities available-for-sale 1,080 632
Federal Home Loan Bank (FHLB) stock, at cost 7,342 5,961
Federal Reserve Bank stock, at cost 192 165
Loans receivable, net of discounts and
allowance for loan losses 824,350 733,857
Leasehold improvements and equipment, net 2,411 1,586
Accrued interest receivable and other assets 12,974 11,451
-------- --------
Total assets $959,771 $848,226
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $720,884 $658,320
Accrued interest payable and
other liabilities 3,717 3,162
FHLB Advances 156,195 119,211
-------- --------
Total liabilities 880,796 780,693
-------- --------
Shareholders' equity:
Common stock, no par value; authorized,
20,000,000 shares; shares issued and
outstanding, 9,870,567 at June 30, 2004
and 9,491,422 at December 31, 2003
(retroactively stated for 5% stock
dividend) 47,395 34,653
Additional paid-in-capital 3,775 1,702
Accumulated other comprehensive
(loss)/income (10) 2
Retained earnings 27,815 31,176
-------- --------
Total shareholders' equity 78,975 67,533
-------- --------
Total liabilities and shareholders'
Equity $959,771 $848,226
======== ========
See Notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
for the three and six months ended June 30, 2004 and 2003
(Unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
(dollars in thousands,
except per share data) 2004 2003 2004 2003
------------- --------------
Interest income:
Loans $12,870 $10,817 $24,912 $21,203
Federal funds sold and
investment securities 297 260 546 474
------- ------- ------- -------
Total interest income 13,167 11,077 25,458 21,677
Interest expense 3,475 3,615 6,807 7,189
------- ------- ------- -------
Net interest income before
provision for loan losses 9,692 7,462 18,651 14,488
Provision for loan losses 325 300 550 600
------- ------- ------- -------
Net interest income after
provision for loan losses 9,367 7,162 18,101 13,888
------- ------- ------- -------
Other income:
Service charges on deposits 180 153 251 309
Gain on sale of loans 248 343 700 700
Other 179 203 631 410
------- ------- ------- -------
Total other income 607 699 1,582 1,419
------- ------- ------- -------
Other expenses:
Salaries and employee benefits 2,362 2,100 4,775 4,061
Occupancy 337 310 643 609
Equipment 215 178 416 354
Advertising and business
development 161 139 303 272
Outside customer services 80 82 174 166
Director and shareholder expenses 105 114 163 208
Deposit and other insurance 112 91 224 182
Professional fees 89 115 194 217
Other 279 308 600 601
------- ------- ------- -------
Total other expenses 3,740 3,437 7,492 6,670
------- ------- ------- -------
Income before provision for
income taxes 6,234 4,424 12,191 8,637
Provision for income taxes 2,585 1,789 4,961 3,446
------- ------- ------- -------
Net income $ 3,649 $ 2,635 $ 7,230 $ 5,191
======= ======= ======= =======
Basic earnings per common share $0.37 $0.30 $0.75 $0.56
======= ======= ======= =======
Diluted earnings per common share $0.33 $0.26 $0.65 $0.49
======= ======= ======= =======
See notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended June 30,
(dollars in thousands) 2004 2003
------------------------
Cash flows from operating activities:
Net income $ 7,230 $ 5,191
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses 550 600
Depreciation and amortization 281 251
FHLB Stock dividends (108) (78)
Tax benefit from stock option exercised 2,073
Gain on sale of loans (700) (700)
Change in deferred income taxes (467) (102)
Change in operating assets and liabilities
Change in deferred loan fees and discounts 119 (164)
Change in interest receivable and other assets (1,055) (259)
Change in accrued interest payable and other
liabilities 555 321
-------- --------
Net cash provided by operating activities 8,478 5,060
-------- --------
Cash flows from investing activities:
Purchases of investment securities (1,100)
Proceeds from the sale of investment securities 638
Purchase of restricted stock (1,301) (1,139)
Net increase in loans receivable (90,462) (52,586)
Purchase of leasehold improvements and
equipment, net (1,106) (360)
-------- ---------
Net cash used by investing activities (93,331) (54,085)
-------- ---------
Cash flows from financing activities:
Net increase in deposits 62,564 37,455
Net increase in FHLB advances 36,984 24,451
Payment of cash dividends (6) (7)
Stock options exercised 2,158 98
-------- --------
Net cash provided by financing activities 101,700 61,997
-------- --------
Net change in cash and cash equivalents 16,847 12,972
Cash and cash equivalents, at beginning of year 94,575 87,463
-------- --------
Cash and cash equivalents, at end of period $111,422 $100,435
======== ========
Supplemental cash-flows information from:
Interest paid 6,646 7,264
======== ========
Income taxes paid 3,345 3,332
======== ========
See Notes to Consolidated Financial Statements
Northern Empire Bancshares and Subsidiary
Notes to Consolidated Financial Statements
June 30, 2004
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 June 30, 2004 and the results of operations for the six
months then ended. The results of operations for the six months ended
June 30, 2004 are not necessarily indicative of the operating results to
be anticipated for the year ended December 31, 2004.
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.
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 2003 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 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 March 16, 2004 and the two for one stock split to shareholders
of record on December 1, 2003. The Corporation's pertinent EPS data is as
follows:
For the three months ended For the three months ended
June 30, 2004 June 30, 2003
-------------------------- --------------------------
Per Per
Income/ Shares/ Share Income/ Shares/ Share
Numerator Denominator Amount Numerator Denominator Amount
--------- ----------- ------ --------- ----------- ------
Net Income $3,649,000 $2,635,000
========== ==========
EPS - Income available
to common stockholders $3,649,000 9,802,059 $0.37 $2,635,000 8,787,792 $0.30
========== ===== ========== =====
Effect of dilutive
Securities - Stock
Options 1,368,325 1,236,267
--------- ---------
EPS assuming dilution -
Income available to
common stockholders plus
assumed conversion $3,649,000 11,170,384 $0.33 $2,635,000 10,024,059 $0.26
========== ========== ===== ========== ========== =====
For the six months ended For the six months ended
June 30, 2004 June 30, 2003
------------------------ ------------------------
Per Per
Income/ Shares/ Share Income/ Shares/ Share
Numerator Denominator Amount Numerator Denominator Amount
--------- ----------- ------ --------- ----------- ------
Net Income $7,230,000 $5,191,000
========== ==========
EPS - Income available
to common stockholders $7,230,000 9,678,450 $0.75 $5,191,000 9,222,795 $0.56
========== ==========
Effect of dilutive
Securities - Stock
Options 1,401,896 1,298,080
EPS assuming dilution -
Income available to
common stockholders
plus assumed conversion $7,230,000 11,080,346 $0.65 $5,191,000 10,520,875 $0.49
========== ==========
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 December 31, 2002 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 six months ended
June 30, June 30,
2004 2003 2004 2003
-------------------------- ------------------------
Net income for the period $3,649,000 $2,635,000 $7,230,000 $5,191,000
Compensation expense, net of
tax effect 18,000 38,000 37,000 75,000
----------- ---------- ---------- ----------
Pro-forma net income $3,631,000 $2,597,000 $7,193,000 $5,116,000
========== ========== ========== ==========
Pro-forma earnings per common
share $0.37 $0.30 $0.74 $0.55
Pro-forma earnings per common
share, assuming dilution $0.33 $0.26 $0.65 $0.49
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 were granted in 2003):
2004
----
Dividends 5%
Expected volatility 26.8%
Risk-free interest rate 2.57%
Expected life 3 years
Note 4 - Comprehensive Income
The Corporation's total comprehensive earnings presentation is as follows:
(in thousands) For the three For the six
months ended months ended
June 30, June 30,
2004 2003 2004 2003
------ ------ ------ ------
Net Income $3,649 $2,635 $7,230 $5,191
Other Comprehensive income (loss):
Change in unrealized holding
gain (losses) during the period (20) (2) (23) (5)
Income tax benefit (expense) 10 0 10 2
(10) (2) (13) (3)
------ ------ ------ ------
Comprehensive income $3,639 $2,633 $7,217 $5,188
====== ====== ====== ======
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Northern Empire Bancshares (the "Corporation") is the bank 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 our outside accountants, and assessment of economic conditions
The allocated and unallocated components represent the total allowance for
loan losses that management estimates is adequate to 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 make assumptions which are highly uncertain, and requires a
high degree of judgment; and is impacted by regional, national and global
economic trends. 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
The discussion of certain matters in this report may constitute "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 accounting standards by the Financial Accounting Standards
Board, the Securities and Exchange Commission (SEC) or other standard-
setting bodies.
Such changes could affect the manner in which the Corporation and the
Bank are required to account for and report income, expenses,
reserves, or a merger or acquisition, if any, and could materially
affect the Corporation's business and financial statements.
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.
Changes in Federal Home Loan Bank (FHLB) borrowing policies.
The Bank relies upon the FHLB for a large portion of the funding which
is collateralized by loan assets. Based upon the current policies of
the FHLB we believe the advances are renewable. Changes in the
requirements of the FHLB could materially affect the Bank's business
and financial statements.
Investors are cautioned to consider these and other risks and
uncertainties.
The Corporation specifically disclaims any obligation to update any such
factors or to publicly announce the results of any revisions to any
forward-looking statements in this report to reflect future events or
developments.
Summary of Financial Results
Total consolidated assets equaled $959,771,000 at June 30, 2004 compared
to $848,226,000 at December 31, 2003. Net loans increased $90.5 million
since year-end with $55.3 million occurring in the second quarter. Cash
and equivalents increased $5.5 million during the second quarter.
Deposits increased $32.7 million and FHLB advances increased $17.0 million
during the second quarter.
The net income after tax for the first six months of 2004 equaled
$7,230,000 compared to $5,191,000 for the comparable period of 2003, an
increase of 39.3%. The net income for the second quarter of $3,649,000
increased 38.5% over the second quarter of 2003 when net income equaled
$2,635,000. Increased profit resulted from growth in net interest income
due to loan growth and the lower cost of funds resulting from the decision
to borrow on its credit line with the Federal Home Loan Bank.
Net Interest Income
Net interest income (before the provision for loan losses) of $9,692,000
for the second quarter of 2004 increased 29.9% from $7,462,000 for the
comparable period last year. This increase in net interest income
resulted primarily from volume increases of $200.3 million in average
earning assets for the current quarter compared to the second quarter of
2003. The Bank experienced a $182.8 million increase in average loans
outstanding, which have the highest yields. Average investments, interest-
bearing cash balances and Fed Funds investments increased $17.5 million.
Average interest bearing deposits for the second quarter increased
$107.1 million over the same period last year and average borrowings with
the Federal Home Loan Bank increased $73.0 million.
The net interest margin equaled 4.30% during the second quarter of 2004
compared to an average margin for the second quarter of 2003 of 4.24% and
4.25%for the year ended December 31, 2003. The yield on average loans
equaled 6.36% in the second quarter compared to 6.87% for the same period
last year, while the Bank's cost of funds decreased to 1.77% for the
second quarter of 2004 from 2.38% for the second quarter of 2003.
Several factors impact the Bank's 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 conditions and actions of the 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 2003 prime rate equaled 4.25% until June 30, 2003
when it declined to 4.00%, a 40 year low, where it remained through
June 30, 2004. Prime rate increased to 4.25% on July 1, 2004. Prime rate
has remained fairly stable during the last few years following 2001 when
Fed Funds and Prime rates declined 11 times with Prime declining from
9.50% to 4.00%. The majority of SBA loans are tied to prime rate and
reprice on a quarterly basis, based on the published prime rate on the
last day of the preceding calendar quarter. Therefore the increase in
prime rate on June 30, 2004 will impact SBA 7(a) loans on October 1, 2004.
Other loan indexes generally move with, precede or lag changes in prime
rate. 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.
As of June 30, 2004, the Bank has $203.5 million in SBA 7(a) loans which
reprice based upon the prime rate on the first day of the calendar
quarter. The Bank also has $232.6 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
1.71% for May 2004 (latest available) and 1.90% for December 2003 compared
to 2.38% for December 2002. The Bank also has a fixed rate loan portfolio
which generally reduces net interest margin as interest rates rise and
benefits net interest margin as rates decline. The rate of loan
prepayments continues at an increased rate as borrowers refinance to
indexes which bear lower rates than loans tied to COFI which are at floors
or fixed rates.
Of the Bank's loan portfolio totaling $833.0 million at June 30, 2004,
$317.2million or 38.0% of total loans are adjustable rate loans which have
not reached a floor or ceiling rate. Of that total approximately $226.3
million are prime-based loans, of which $22.2 million reprice immediately
and $204.1 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 make 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 COFI or loans at floors
or fixed rates.
Interest rates offered on certificates of deposits have increased with the
recent increase in market rates, yet they remain at low levels
historically. The Bank has $135.7 million in Sonoma Investor Reserve
accounts (money market rate deposit accounts). The cost of these deposits
equaled 1.08% during the second quarter of 2004 compared to 1.25% for the
second quarter last year.
The Bank has $463.3 million in time certificates of deposits. These
accounts reprice at a slower pace. The cost of time deposits equaled
2.27% for the second quarter of 2004 compared to 3.12% in the second
quarter of the preceding year. The benefit of lower rates of time
deposits will continue to occur until they mature and are renewed at the
market rates offered on their maturity dates. The Bank continues to offer
competitive market rates for deposits when compared to financial
institutions in our area.
Level of Loans Relative to Deposits
-----------------------------------
The Bank's ratio of loans-to-deposits increased to an average of 115.2% in
second quarter of 2004 compared to 107.0% for the same period last year.
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 net interest margin.
The largest loan growth occurred in real estate mortgage loans growing to
$571.9 million at this quarter end from $495.5 million at December 31,
2003. 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
increased as a result of these new products and the Bank's competitive
rate structure. Total COFI loans have declined; however, they remain a
popular index in our market especially in a raising rate environment since
the index lags from other indexes like prime rate and LIBOR.
Construction loans increased to $32.0 million at the end of this quarter
from $26.3 million at year end. Construction loans generally have higher
yields than other real estate loans. General economic conditions greatly
influence the demand for construction loans and the Bank has experienced
an increase in activity during this quarter.
SBA loans, which generally are secured by real estate, are classified as
commercial loans. Commercial loans totaled $223.0 million at June 30,
2004 compared to $214.0 million at December 31, 2003, of which $203.5
million and $ 162.7 million, respectively, were 7(a) SBA loans. SBA
loans continue to be a popular loan product; however, the SBA loan program
was impacted by federal government budgetary issues during the first
quarter of 2004. On April 5, 2004 government funding was restored for the
SBA's 2004 fiscal year, the loan cap was lifted and the program was
increased to allow for guaranteed loans up to $2 million which provides a
better loan product for borrowers. Additional government actions may
further alter the SBA program, which could have a negative impact on the
Bank's profits.
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 yields. The Bank is currently offering loan products tied
to prime rate, U.S. Treasury rates or LIBOR which have lower interest
rates but reprice at a faster rate than COFI loans. Construction loans
have some seasonality and generally rise when economic conditions improve.
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 June 30, 2004 the Bank had $720,000 in non-accrual loans compared to
$1,274,000 million at December 31, 2003. 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. 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 (other banks of
comparable asset size). 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 impact of changes in interest rates. Sonoma Investor Reserve
accounts can be repriced weekly; and therefore, the benefit of falling
interest rates and the negative impact of rising rates is more immediate.
Competition also is a factor in the repricing of certain deposit products.
While prime rate changes have a more immediate impact on loans it may take
longer for the impact in repricing market rate deposits due to competition
for these deposits 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. Based on the present terms
and conditions of the FHLB line of credit, 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 our cost of funds. As of June 30,
2004 the Bank had increased borrowed funds from the FHLB to $156.7 million
as compared to 79.2 million at June 30, 2003, an increase of $77.0
million. The cost of borrowing was more than 100 basis points below the
current offering rate on deposits of similar term.
Interest expense decreased to $3,475,000 in the second quarter of 2004
from $3,615,000 in the second quarter of 2003. The major factor was the
decrease in the average cost of interest bearing liabilities which
declined to 1.77% from 2.38% when comparing the second quarter of this
year to the second quarter of last year. In addition, the increase in the
funds borrowed from the FHLB to fund loan growth at an average rate of
1.24% had a positive impact rather than attracting new deposits at market
rates.
The following are analyses of the net interest margin:
Three months ended June 30, 2004 Three months ended June 30, 2003
-------------------------------- --------------------------------
(dollars in thousands) Average Average
Balance Interest Yield Balance Interest Yield
------- -------- ----- ------- -------- -----
Earning assets (1) $906,814 $13,167 5.84% $706,470 $11,077 6.29%
Interest bearing liabilities 788,892 3,475 1.77% 608,829 3,615 2.38%
------- -------
Net interest income $ 9,692 $ 7,462
======= =======
Net Interest income to earning
Assets 4.30% 4.24%
===== =====
(1) Non-accrual loans are included in the calculation of average balance of earning assets, and interest not
accrued is excluded.
Six months ended June 30, 2004 Six months ended June 30, 2003
------------------------------ ------------------------------
Average Average
(dollars in thousands) Balance Interest Yield Balance Interest Yield
------- -------- ----- ------- -------- -----
Earning assets (1) $877,513 $25,458 5.83% $686,046 $21,677 6.37%
Interest bearing liabilities 761,780 6,807 1.80% 591,288 7,189 2.45%
Net interest income $18,651 $14,488
======= =======
Net Interest income to earning assets 4.27% 4.26%
===== =====
(1) Non-accrual loans are included in the calculation of average balance of earning assets, and interest not
accrued is excluded.
The following tables 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 six months ended June 30, 2004 and 2003.
Changes not solely attributable to rate or volume have been allocated to
rate.
For the three months ended
June 30, 2004
over June 30, 2003
--------------------------------
(dollars in thousands) Volume Yield/Rate Total
------ ---------- -----
Increase (decrease) in interest income:
Portfolio loans $6,387 ($4,334) $2,053
Other earning assets 174 (137) 37
------ ------ ------
Total increase (decrease) 6,561 (4,471) 2,090
------ ------ ------
Increase (decrease) in interest expense
Interest-bearing transaction accounts 46 (97) (51)
Time deposits 1,445 (1,704) (259)
Other borrowings 554 (384) 170
------ ------ ------
Total increase (decrease) 2,045 (2,185) (140)
------ ------ ------
Increase (decrease) in net interest
Income $4,516 ($2,286) $2,230
====== ====== ======
For the six months ended
June 30, 2004
over June 30, 2003
-------------------------------
(dollars in thousands) Volume Yield/Rate Total
------ ---------- -----
Increase (decrease) in interest income:
Portfolio loans $12,262 ($8,553) $3,709
Other earning assets 321 (249) 72
------- ------ ------
Total increase (decrease) 12,583 (8,802) 3,781
------- ------ ------
Increase (decrease) in interest expense
Interest-bearing transaction accounts 91 (211) (120)
Time deposits 2,837 (3,437) (600)
Other borrowings 1,078 (740) 338
------- ------ ------
Total increase (decrease) 4,006 (4,388) (382)
------- ------ ------
Increase (decrease) in net
interest income $ 8,577 ($4,414) $4,163
======= ====== ======
Provision for Loan Losses
The provision for loan losses equaled $325,000 for the three months ended
June 30, 2004 and $550,000 for the first six months of 2004 compared to
$300,000 and $600,000 for the same periods in 2003. The provision was
based upon the overall growth in loans at the end of the current quarter.
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
decreased to $607,000 from $699,000 when comparing the second quarter of
2004 to the same period last year primarily as a result of a lower volume
of SBA loan sales this quarter.
Service Charges
---------------
Service charges on deposit accounts equaled $180,000 in the second quarter
of 2004 compared to $153,000 for the same period last year. The increase
relates to charges on analysis customers and general growth in deposit
accounts. The earnings credit rate has remained at low rates due to the
current interest rate environment. Analysis customers earn less on their
average balances to cover the cost of services provided to them. If the
earnings credits earned do not cover the cost of services, the customer is
charged a service fee. Analysis customers can increase their average
balances to reduce the charges or alter the services provided to reduce
their service charges. The Bank also receives fees for safe deposit, Visa,
and other services.
SBA Loan Sales and Loan Participations
--------------------------------------
In the second quarter of this year, the Bank sold the guaranteed portion
of SBA loans totaling $2.2 million with no loan participations and
recognized gains on those sales of $248,000. During the second quarter of
last year, the Bank sold the guaranteed portion of SBA loans totaling
$4.0 million with no participations and recognized gains on those sales of
$343,000. 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 average percentage gain on loan sales received in the
second quarter of 2004 remained strong equaling 11.3% in the second
quarter of 2004 compared to 8.6% in the second quarter of 2003. Premiums
on loan sales are market driven based upon factors such as rate of
prepayments of SBA loans experienced throughout the country and there is
no guarantee that premiums will continue at the current level.
SBA Loan Servicing
------------------
SBA servicing fees totaled $91,000 during the second quarter of 2004,
compared to fees of $75,000 recorded in the second quarter of last year.
The income varies since the fee income is calculated based upon the
payments received during the period and the size of the portfolio
serviced. The serviced portfolio equaled $52.4 million at June 30, 2004
compared to $46.3 million at June 30, 2003.
Sales of Other Real Estate Owned
--------------------------------
There were no sales of other real estate owned (OREO) during the second
quarter of 2004 and there was a gain of $183,000 recorded on the sale of
foreclosed property during the first quarter of 2004. There were no sales
of OREO during the first half of 2003.
Non-Interest Expenses
The Bank's non-interest expenses totaling $3,740,000 in the second quarter
of 2004 increased 8.8% from $3,437,000 for the second quarter of last
year. It was expected that non-interest expenses would increase in the
second quarter of 2004 as a result of the new branch in San Rafael,
expansion of the Bank's operations center and the relocation of the
lending functions to larger premises. These changes had a small impact on
non-interest expenses in the second quarter and the full impact of these
additions is expected to commence in the third quarter.
Salaries and Employee Benefits
------------------------------
The Bank's largest expense category is salaries and benefits which
increased 12.5% to $2,362,000 in the second quarter of 2004 from
$2,100,000 during the second quarter of 2003. The Bank's full time
equivalent (FTE) staff level has increased to 147 in June 2004 compared to
129 at June 2003. Increased staff included a new regional loan officer in
Sacramento plus additional staff in the Loan, Branch Administration,
Finance Departments, Internal Audit and Compliance. Personnel costs are
also affected by annual salary increases, incentives based upon production
goals and changes in benefit costs. Incentive payments remained high due
to the increased level of loan production during the second quarter of
2004.
Occupancy and Equipment
-----------------------
Occupancy expenses increased to $337,000 in the second quarter of 2004
from $310,000 in the second quarter of 2003. This increase results from
several changes in premises. The Loan Department and several
administrative functions were relocated to Fountaingrove Business Center
in northern Santa Rosa in May. This space was designed to provide
operational efficiencies and to provide for expansion. The operations
center also completed its expansion and the new San Rafael Branch opened
on July 28. Many of the occupancy costs associated with this expansion
will commence during the third quarter of this year. It is expected that
occupancy expenses will continue to increase as and if the Bank continues
to expand. Equipment costs of $215,000 increased 20.8% over $178,000 for
the second quarter last year. The Bank has upgraded the mainframe and
added imaging equipment to meet the needs of our customers.
Deposit and Other Insurance
---------------------------
Deposit and other insurance of $112,000 increased $21,000 over the second
quarter of last year. Regulatory assessments and FDIC insurance cost grew
due to the increase in deposits. There is no assurance that regulatory
assessments will continue at the current low level. The cost of other
insurance has increased when three year policies expired and renewed with
higher rates and increased insurance coverage.
Professional Services
---------------------
Professional fees of $89,000 decreased from $115,000 for the second
quarter of 2003. Included in this category are legal, accounting and
consulting fees which tend to vary depending upon the timing and need for
services. There continues to be increased legal and accounting costs in
connection with SEC reporting and the new regulations resulting from the
Sarbanes Oxley Act. Legal activity on problem loans was minimal during
this quarter due to the low level of problem loans (see discussion on
Allowance for Loan Losses). Audit or review services are contracted by
the Audit Committee and are performed on a varying schedule with little
activity in the second quarter. It is expected that Audit fees will
continue to increase as a result of SEC changes which include new
requirements on internal controls. The Bank has hired an independent
consultant to assist in the evaluation and testing of the Bank's internal
controls and operating procedures as called for under the new rules.
Advertising and Business Development
------------------------------------
Advertising and business development costs, which vary depending on loan
and deposit promotions, increased to $161,000 from $139,000 in the second
quarter of 2003.
Outside Customer Services
-------------------------
Outside customer services were $80,000 down from $82,000 in the second
quarter of 2003. The Bank pays for certain direct costs (i.e.: payroll
services, escrow fees, etc.) which are expensed. These costs are based
upon depositor's use of 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 rate environment the earnings credit rate is low and as a
result our customers are either paying for more of the covered services or
increasing their average balances to increase the earnings on their
accounts.
Shareholder and Director Expenses
---------------------------------
Second quarter expenses for shareholder and director expenses equaled
$105,000 compared to $114,000 for the second quarter of last year.
Included in this category are directors' fees for attending Board, Loan
Committee, ALCO, Executive Committee, Audit and special director meetings.
There have been changes to the Board of Directors with the resignation of
one director who served on several committees. Two directors were added
to the Board and it is expected that fees will increase as a result. The
cost of the Corporation's annual report, transfer agent fees and other
costs of communicating with shareholders is also included in this expense
category.
Other Expenses
--------------
Other expenses, which include stationery and supplies, telephone, postage,
armored car and courier costs, loan expenses, dues and subscriptions and
automobile costs decreased to $279,000 from $308,000 in the second quarter
of 2003. These expenses for the year to date equaled $600,000 compared to
$601,000 for the same period last year. Some of these expenses vary which
accounts for the decline in costs this quarter. Miscellaneous loan
expenses can vary significantly depending on the level of problem loans
which was very low during the second quarter. It is expected that these
costs will increase as a result of the Bank's expansion.
Income Taxes
The effective tax rate was 41.5% for the second quarter of 2004. The
provision for the second quarter of 2004 was $2,585,000 versus $1,789,000
for the same period last year. A portion of this increase resulted from
increases in pre-tax income during the comparable quarters. The effective
tax rate is affected by several factors which include apportionment ratios
between states, the enterprise zone deduction and applicable tax rates.
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 $111.4 million or 11.6% of total assets at June 30, 2004, compared
to $94.6 million or 11.1% of total assets at December 31, 2003. The Bank
sold $2.2 million in SBA loans during the second quarter of 2004 which
increased the Bank's liquidity. The Bank also increased borrowings from
the Federal Home Loan Bank by $17.0 million during the second quarter of
2004. Bank deposits increased $29.9 million during the second quarter of
2004 as a result of deposit promotions. The funds provided by all of
these actions were used to fund 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 June 30, 2004,
the Bank held $139.3 million in SBA guaranteed loans which could be sold
for additional liquidity.
At June 30, 2004, the Bank had unused federal funds lines of credit
totaling $26,000,000. The Bank also has a credit line with the Federal
Home Loan Bank which is based upon the value of collateral (investments
and loans). As of June 30, 2004 the Bank has collateral pledged which
would allow the Bank to borrow up to $223.2 million. The Bank could
borrow an amount equal to 25% of our assets, assuming that collateral
values would support that level of borrowings. At June 30, 2004, the Bank
had borrowed $156.2 million with $67.0 million available to borrow with
the FHLB. 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
June 30, 2004, the Corporation had non-interest and interest bearing cash
balances of $4.0 million, 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 second quarter of 2004, deposits increased to $720.9 million
compared to $658.3 million at the end of the year.
Money market deposits totaling $139.7 increased $133.4 million from
December 31, 2003. This is a limited transaction account with a
discretionary rate which is set by management. The rate offered on this
account has been relatively unchanged during this quarter even though
there is strong competition in our market area for these types of funds.
The Bank's customers continue to hold funds in this deposit product rather
than locking into a specific maturity during this time of low interest
rates. These funds are also more volatile and fluctuate during various
business cycles.
Certificates of deposits totaling $463.3 million at June 30, 2004
increased 14.7% from $404.0 million at December 31, 2003. The Bank
offered time deposit promotions during this quarter which were successful
in attracting new depositors.
As of June 30, 2004, non-interest bearing deposits equaled $67.0 million
compared to $61.4 million at December 31, 2003. The Bank's transaction
accounts have significant changes in daily balances, mainly due to
deposits held by large businesses' accounts.
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 $824.4 million at
June 30, 2004 compared to $733.9 million at December 31, 2003, increasing
12.3% over year end and 29.0% over the June 30, 2003 balance of
$639.3 million. The following is an analysis of the loan portfolio.
Type of Loan (in thousands) June 30, December 31,
2004 2003
-------- -----------
Real estate-mortgage $571,903 $495,538
Real estate- construction 31,967 26,271
Commercial 222,956 214,000
Consumer installment 6,200 6,185
-------- --------
833,026 741,994
Deferred loan fees and discounts (957) (838)
Allowance for loan losses (7,719) (7,299)
-------- --------
Total $824,350 $733,857
======== ========
The SBA loan program continues to be a popular program; however,
competition remains very strong in our market areas. At June 30, 2004,
total SBA (7a) guaranteed loans equaled $203.5 million, net of
$52.4 million in SBA loans sold and being serviced by the Bank. The
majority of the Bank's SBA loans are secured by real estate; however,
they are reported as commercial loans. SBA loans have the same
underwriting requirements as the Bank's other loans, except 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 government program could affect the Bank's
profitability and future SBA loan growth. The guaranteed portion of SBA
loans which could be sold in the secondary market was $139.3 million at
June 30, 2004 compared to $108.0 million at June 30, 2003.
The Bank continues to emphasize commercial and real estate lending. At
June 30, 2004, 26.8% of the loans held for investment were commercial
loans and 72.5% were real estate and construction loans, compared to 28.8%
and 70.3% respectively at December 31, 2003. The Bank has continued to
grow its commercial and commercial real estate portfolio through its
reputation as an experienced business and real estate lender which
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, a worsening of economic conditions or a natural disaster could
potentially have an adverse impact on the value of collateral, on the loan
portfolio, and on the financial condition of the Bank.
Construction loans increased to $32.0 million at June 30, 2004 from $26.3
million at December 31, 2003 due to the improved 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 0.7% of the total loan
portfolio at June 30, 2004 and 0.8% of the total loan portfolio at
December 31, 2003
Allowance for Loan Losses
The allowance for loan losses equaled $7,719,000 at June 30, 2004,
compared to $7,299,000 at December 31, 2003 At June 30, 2004, the
allowance for loan losses equaled 1.1% 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 June 30, 2004, there were five borrowers on non-accrual totaling
$720,000 with $690,000 of that amount collateralized by real estate and
$61,000 of it also guaranteed by the SBA. There was one loan past due 90
days or more totaling $153,000 and still accruing interest. Loans past
due 30 to 89 days totaled $3,152,000, with $2,750,000 of that amount
collateralized by real estate and $709,000 guaranteed by the SBA. At
December 31, 2003, the Bank had $1,274,000 in non-accrual loans and no
loans past due 90 or more days and still accruing interest. Past due 30 to
89 days totaled $1,950,000 at December 31, 2003.
During the second quarter of 2004, there were no loans charged off and
$2,000 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 second quarter and the first six months of 2004:
Three months ended Six months ended
(in thousands) June 30, 2004 June 30, 2004
------------------ ----------------
Balance - Beginning of period $7,392 $7,299
Provision for loan losses 325 550
Charge offs - 135
Recoveries 2 5
------ ------
Balance - End of period $7,719 $7,719
====== ======
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 June 30, 2003, the
Bank was considered "well capitalized." The total risk-based capital
ratios were 11.5% for the Bank and 12.1% for the Corporation.
The Corporation declared a 5% stock dividend on March 16, 2004 with a
record date of May 3, 2004.
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 of 100 and 200 basis
points. 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 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 next twelve months, 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) (in thousands) (in thousands)
-------------- ------------------- -------------------
+200 $37,141 $496
+100 37,027 382
Base Scenario 36,645 0
(100) 36,521 (124)
(200) 36,140 (505)
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 are 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
June 30, 2004 of assets, liabilities and shareholders' equity classified
by earliest possible repricing opportunity or maturity date.
Over 3 months Over 1 year Non rate
Balance Sheet Through 3 through through 5 Sensitive or Total
(in thousands) months 1 year years Over 5 years
--------- ------------- ---------- ------------ ------
Assets
Fed funds sold & certificates of
deposit $ 85,849 $ 85,849
Investment securities $ 1,080 $ 7,534 8,614
Loans (net of discounts) 387,500 $209,913 151,110 83,546 832,069
Non interest-earning assets
(net of allowance for loan losses) 33,239 33,239
-------- -------- -------- -------- --------
$473,349 $209,913 $152,190 $124,319 $959,771
======== ======== ======== ======== ========
Liabilities & Shareholders( Equity
Time Deposits $100,000 and over $ 39,692 $146,280 $ 18,689 $204,661
All other interest-bearing
liabilities 238,715 324,060 42,480 $ 197 605,452
Non interest bearing liabilities 66,966 66,966
Other Liabilities & Shareholders'
Equity 82,692 82,692
-------- -------- -------- -------- --------
$278,407 $470,340 $ 61,169 $149,855 $959,771
======== ======== ======== ======== ========
Interest Rate Sensitivity (1) $194,942 ($260,427) $ 91,021 $25,536
Cumulative Interest Rate
Sensitivity $194,942 ($65,485) $ 25,536 $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 (e). 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.
No change in internal control over financial reporting, as defined in
Securities and Exchange Act Rule 15d-15(f), occurred during the fiscal
quarter ended June 30, 2004 that has materially affected or is reasonably
likely to materially affect the Corporation's internal control over
financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None other than in the ordinary course of business.
Item 2. Changes in securities, use of proceeds and issue of purchases of
equity securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders of the Corporation was held on
May 18, 2004. The following candidates received the votes
indicated.
Withheld/Abstained/
For Broker Non-Votes
--------- -------------------
Clement C. Carinalli 8,223,074 115,935
Patrick R. Gallaher 8,219,920 119,089
William E. Geary 8,222,520 116,489
James B. Keegan, Jr. 8,223,074 115,935
Dennis R. Hunter 8,223,074 115,935
Robert V. Pauley 8,206,366 132,643
All candidates were re-elected, constituting the full board of
directors of the Corporation.
No other matters were voted on at the meeting
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).
(31)Rule 13 a - 14 (a)/ 15d - 14(a) Certifications
(32)Section 1350 Certification
(b) Reports on Form 8-K
Form 8-K, filed on July 15, 2004, reporting, under Items 7 and 12,
second quarter of 2004 results.
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: August 2, 2004
/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