UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2004
[ ] TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from___________to__________
Commission File Number 2-91196(1)
NORTHERN EMPIRE BANCSHARES
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(Exact name of registrant as specified in its charter)
CALIFORNIA 94-2830529
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
801 Fourth Street
Santa Rosa, California 95404
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(Address of principal executive offices)
(707) 579-2265
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Exchange Act:
NONE
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes
X No_____.
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Act). Yes X No ___
State the aggregate market value of the voting and non-voting
common equity held by non-affiliates computed by reference to the price
at which the common equity was last sold, or the average bid and asked
price of such common equity, as of the last business day of the
registrant's most recently completed second fiscal quarter: $173,209,000
as of June 30, 2004. Shares held by directors and executive officers
have been excluded from the foregoing calculation in that such persons
may be deemed to be "affiliates". Such determination of affiliate
status is not necessarily a conclusive determination for other purposes.
Indicate the number of shares outstanding of each of the
registrant's classes of common stock, as of the latest practicable date.
9,854,067 shares, as of February 15, 2005.
DOCUMENTS INCORPORATED BY REFERENCE:
Not Applicable.
(1) Registrant filed a registration statement, on Form S-1, under File
Number 2-91196, and the Post Effective Amendment No. 8 to the
registration statement was declared effective on November 23, 1988.
TABLE OF CONTENTS
Part I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
Item 9 A. Controls and Procedures
Item 9 B. Other Information
Part III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accounting Fees and Services
Part IV
Item 15. Exhibits, Financial Statement Schedules
PART 1
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 of 1934,
which includes statements such as projections, plans and objectives and
assumptions about the future, and such forward looking statements are
subject to the safe harbor created by these sections. Although the
Corporation and the Bank have based their plans and projections on
certain assumptions, there can be no assurances that such assumptions
will be correct, or that their 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 substantially all 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 (SBA) 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, such changes are a
possibility because of current budget constraints at the SBA.
* 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, and changes in the rates or duration of
advances could make them less advantageous to the Bank.
* Uncertainty regarding the economic outlook resulting from the
continuing war on terrorism and foreign hostilities, as well as
actions taken or to be taken by the U.S. or other governments as a
result of further acts or threats of terrorism.
* 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.
* Operational risks including data processing system failures or fraud.
ITEM 1. Business
* Available Information
The Corporation electronically files the following reports with the SEC:
Form 10-K (annual report), Form 10-Q (quarterly report), and Form 8-K
(current report). The Corporation may also file additional reports
and/or forms with the SEC. The SEC maintains an internet website,
www.sec.gov., at which all electronic filings can be accessed.
Information regarding the Corporation and the Bank may be found at the
Bank's website, www.snbank.com. A direct link to Northern Empire
Bancshares' reports filed with the SEC is located under "Investor Info"
section on the website. Paper copies of the reports filed with the SEC
may also be obtained free of charge by contacting Jane M. Baker at the
Corporation at 3558 Round Barn Blvd., Suite 300, Santa Rosa, California
95403 or by telephone (707) 591-9000.
* History and General
Northern Empire Bancshares (the "Corporation") was incorporated as a
California corporation on June 8, 1982 for the purpose of becoming a
bank holding company of Sonoma National Bank (the "Bank"). On April 27,
2000, the Corporation made an election to become a financial holding
company pursuant to the Gramm-Leach-Bliley Act of 1999. The
Corporation's executive offices are located at 3558 Round Barn Blvd.,
Santa Rosa, California, and its telephone number is (707) 591-9000.
The Corporation's sole subsidiary is the Bank and its activities are the
commercial banking activities engaged in through the Bank and some
lending through loan participations with the Bank. As a financial
holding company, the Corporation may in the future invest in
subsidiaries which are permissible for a financial holding company,
subject to the required approvals of the Federal Reserve Board. However,
the Corporation has no present plans to make any such additional
investments and there can be no assurance that it will do so in the
future.
The Bank was organized as a national banking association on March 27,
1984 and commenced operations on January 25, 1985. It currently has the
following eight banking offices operating in Sonoma and Marin Counties,
California:
1. Main Office located at 801 Fourth Street, in the central business
district of Santa Rosa, California,
2. Oakmont Branch located in the Oakmont area of Santa Rosa,
approximately 7 miles east of the main office,
3. West College Branch office in west Santa Rosa, approximately 2 miles
west of the main office
4. Windsor Branch located in Windsor, approximately 10 miles north of
the main office,
5. Sebastopol Branch office located in Sebastopol, approximately 8 miles
west of the main office,
6. Petaluma Branch located in Petaluma, approximately 16 miles south of
the main office,
7. Sonoma Branch located in Sonoma, approximately 20 miles east of the
main office, and
8. San Rafael Branch located in San Rafael, approximately 38 miles south
of the main office.
In the spring of 2005, the Bank will open branches in downtown Walnut
Creek, approximately 70 miles from the main office, and in downtown
Petaluma, approximately 17 miles from the main office. Another branch
is planned to open this summer in Concord approximately 65 miles from
the main office.
The Bank also has loan production offices in the following locations:
1. Santa Rosa Loan Center located at 3558 Round Barn Blvd., Suite 300,
Santa Rosa, California,
2. Sacramento Office located at 1851 Heritage Lane, Suite 128,
Sacramento, California,
3. San Rafael Office located at 1447 Fourth Street, San Rafael,
California,
4. Walnut Creek Office located at 2910 Camino Diablo, Suite 215C, Walnut
Creek, California, and
5. Phoenix Office located in the Biltmore Financial Center at 2398 East
Camelback Road, Suite 615, Phoenix, Arizona.
As a national bank, the Bank is subject to supervision, regulation and
regular examination by the Comptroller of the Currency ("Comptroller").
The deposits of the Bank are insured by the Bank Insurance Fund, which
is administered by the Federal Deposit Insurance Corporation. The Bank
is a member of the Federal Reserve System and, as such, is subject to
applicable provisions of the Federal Reserve Act and the regulations
thereunder. See, "Supervision and Regulation."
The Bank engages in the general commercial banking business. It accepts
checking and savings deposits, offers money market deposit accounts and
certificates of deposit, makes secured and unsecured commercial,
construction, other installment and term loans, and offers other
customary banking services. The Bank makes commercial loans guaranteed
by the Small Business Administration (SBA), which may be sold in the
secondary market. The Bank does not offer trust services directly, and
does not presently intend to do so, but offers such services, when
requested, through its correspondent banks.
Within the Loan Department are groups of lenders which specialize in
commercial, construction and SBA lending. SBA loans are funded by the
Bank and then the Bank may, at its option, sell the portion of the loan
guaranteed by the SBA (generally 75% to 85% of the total loan amount,
depending on the purpose and term of the loan). When a SBA loan is
sold, the Bank retains the unguaranteed portion of that loan and the
right to service the loan. Income from loan sales is recorded in
non-interest income. The SBA program is subject to budgetary
restrictions and other revisions by the government which could have a
negative impact on the Bank's profit. See, "Management's Discussion and
Analysis of Financial Condition and results of Operation, Non-Interest
Income." The Bank is designated as a "Preferred Lender" by the SBA.
This means that it may fund a loan without credit review and
underwriting performed by the SBA.
* Market Area
The Bank's primary market area and source of most of its loan business
is Sonoma County and the greater Bay Area in California and Arizona
(mainly in the surrounding area of Phoenix). The Bank has expanded its
lending territory for construction loans, commercial real estate loans
and loans made under the programs of the SBA. The Bank has loan
production facilities in Phoenix, Arizona and San Rafael, Sacramento,
and Walnut Creek, California. The primary market area for deposit
business is Sonoma County, and there has been recent expansion into
Marin County.
* Competition
The banking business in California generally, and specifically in the
market area served by the Bank, is highly competitive with respect to
both loans and deposits, and is dominated by major banks which have
offices operating throughout California. Among the advantages such
major banks have over the Bank are their ability to finance wide-ranging
advertising campaigns and to allocate their investment assets to regions
of highest yield and demand. In addition, many of the major banks
operating in the Bank's service area offer specialized services, such as
trust and international banking services, which the Bank does not offer
directly. By virtue of their greater total capitalization, the major
banks also have substantially higher lending limits than the Bank has.
The Bank competes for loans and deposits with these major banks, as well
as with other independent banks, savings and loan associations, credit
unions, mortgage companies, insurance companies and other lending
institutions. There are approximately nine independent banks with
operations in Sonoma County. The entry of other independent banks or the
expansion of major banks in the Bank's service area may adversely affect
the Bank's ability to compete.
Savings and loans, credit unions and money market funds have provided
significant competition for banks with respect to deposits. Other
entities, both governmental and private, seeking to raise capital
through the issuance and sale of debt or equity securities, also provide
competition for the Bank in the acquisition of deposits. The trend of
federal and state legislation has significantly increased competition
between banks and other financial institutions for both loans and
deposits and is expected to continue to do so in the future. In
particular, the Gramm-Leach-Bliley Act enacted in 1999 authorizes
affiliations among banks, insurance companies and securities firms and
has increased competition among financial institutions with respect to
all types of financial products and services.
The earnings and growth of the Bank are affected not only by local
market conditions and general economic conditions, but also by
government monetary and fiscal policies. Such policies influence the
growth of loans, investments and deposits and also affect interest rates
charged on loans and paid on deposits. The nature and impact of future
changes in such policies on the business and earnings of the Bank cannot
be predicted.
At present, there are approximately 136 banking offices and offices of
savings and loan associations in the Sonoma County market area and a
substantially greater number of such offices in the greater Bay Area,
including offices of major chain banks, of smaller independent banks and
savings and loan associations. The Bank attempts to compete by offering
personalized and specialized services to its customers. In the Sonoma
County market area, the Bank's promotional activities emphasize the
advantages of doing business with a locally owned, independent
institution attuned to the particular needs of the community.
The Bank experiences strong competition from major banks and local
community banks in making SBA loans, especially in California. Most of
our local SBA competitors also have Preferred Lender status from the
SBA, and they often offer more attractive rates on SBA loans than the
Bank can. We expect this trend to continue. There can be no assurance
that the Bank will continue to increase its SBA loan portfolio or
continue to make a significant number of SBA loans.
Further information, including certain statistical information,
concerning the Bank and the Corporation is provided at "Item
7-Management's Discussion and Analysis of Financial Condition and
Results of Operation".
Employees
At December 31, 2004 the Bank had 127 full-time and 34 part-time
employees.
Supervision and Regulation
Banks and bank holding companies are subject to extensive supervision
and regulation under both federal and state laws and regulations. The
primary purpose of these laws and regulations is the protection of
depositors, consumers and the federal deposit insurance fund, and not
the protection of shareholders. The following description summarizes the
regulatory environment and some of the laws to which the Corporation and
the Bank are subject. The summary is not intended to be a discussion of
all applicable laws and regulations and is qualified in its entirety by
reference to specific statutes and regulations. The laws and
regulations applicable to banks and bank holding companies are
constantly changing and evolving and new laws and regulations are
frequently introduced. The banking business is also affected by the
policies and interpretations of regulatory authorities. It is not
possible to predict the impact of future changes in the regulatory
environment on the business and operations of the Corporation and the
Bank.
The Corporation
The Corporation is a bank holding company registered under the Bank
Holding Company Act of 1956 and is subject to supervision by the Board
of Governors of the Federal Reserve System ("Board"). As a bank holding
company, the Corporation must obtain the approval of the Board before it
may acquire all or substantially all of the assets of any bank, or
ownership or control of the voting shares of any bank if, after giving
effect to such acquisition of shares, the Corporation would own or
control more than 5% of the voting shares of such bank. Prior approval
of the Board is also required for the merger or consolidation of the
Corporation and another bank holding company. Effective April 27, 2000,
the Corporation made an election to become a "financial holding company"
pursuant to the Gramm-Leach-Bliley Act. See "Financial Services
Modernization," below.
The Board has the authority to examine the Corporation and the Bank
periodically. The Board has a policy for risk-focused supervision of
small bank holding companies that do not engage in significant
non-banking activities. The focus of examinations under the policy is
on whether the Corporation has in place systems to manage the risks it
takes on in its business. In analyzing risk, the Board looks at the
financial condition of the Corporation and the Bank, management,
compliance with laws and regulations, inter-company transactions and any
new or contemplated activities.
The Corporation and any subsidiary which it may acquire or organize in
the future are deemed to be affiliates of the Bank within the meaning
set forth in the Federal Reserve Act and are subject to that Act. This
means, for example, that there are limitations on loans by the Bank to
affiliates, on investments by the Bank in any affiliate's stock and on
the Bank's taking any affiliate's stock as collateral for loans to any
borrower. All affiliate transactions must satisfy certain limitations
and otherwise be on terms and conditions that are consistent with safe
and sound banking practices. In this regard, the Bank generally may not
purchase from any affiliate a low-quality asset (as that term is defined
in the Federal Reserve Act). Also, transactions by the Bank with an
affiliate must be on substantially the same terms as would be available
for non-affiliates.
The Corporation and the Bank are prohibited from engaging in certain
tie-in arrangements in connection with the extension of credit. For
example, the Bank generally may not extend credit on the condition that
the customer obtain some additional service from the Bank or the
Corporation, or refrain from obtaining such service from a competitor.
The Corporation is subject to the periodic reporting requirements of the
Securities Exchange Act of 1934 ("Exchange Act"), and it files annual,
quarterly and current reports with the Securities and Exchange
Commission. At this time the Corporation's common shares are not
registered under the Exchange Act, and it is therefore not subject to
the proxy and tender offer rules or the director, executive officer and
principal shareholder reporting requirements of the Exchange Act.
(a) Sarbanes-Oxley Act of 2002. President Bush signed the
Sarbanes-Oxley Act of 2002 into law on July 30, 2002. This new
legislation establishes a comprehensive framework that affects the
corporate governance and reporting requirements of companies that file
reports with the Securities and Exchange Commission and provides
accounting oversight of the accounting firms that audit them. Among
other things, the Sarbanes-Oxley Act
* limits the scope of consulting services that auditors can offer their
reporting company audit clients;
* imposes a range of new criminal penalties for fraud and other wrongful
acts and extends the period during which certain types of lawsuits
can be brought against a company or its insiders;
* expands certain disclosure requirements for reporting companies and
requires the maintenance of internal controls and procedures and
disclosures regarding those controls and procedures;
* requires officer certifications of a reporting company's financial
statements in quarterly, annual and other reports to the Securities
and Exchange Commission; and
* creates an accounting oversight board that is empowered to set
auditing quality control and ethics standards.
The Sarbanes-Oxley Act requires the Securities and Exchange Commission
to adopt regulations to implement certain of its requirements. Numerous
regulations have been adopted to date and others are expected to be
adopted in the future.
(b) USA Patriot Act of 2001. The USA Patriot Act of 2001 contains new
anti-money laundering and financial transparency laws, in addition to
the laws and regulations theretofore in effect. The USA Patriot Act
requires, among other things, certain additional due diligence and
record keeping practices for financial institutions that administer or
maintain private bank accounts for non-U.S. persons and imposes
standards for verifying customer identification at account opening. The
statutory requirements are implemented by regulations issued by the U.S.
Department of the Treasury.
(c) Financial Services Modernization. Major financial services
modernization legislation was enacted in 1999, known as the
Gramm-Leach-Bliley Act ("1999 Act"). This legislation removed barriers
that theretofore separated banks, securities firms and other types of
financial institutions. Effective March 11, 2000, the 1999 Act
established a new type of holding company, a "financial holding
company," that may engage in "financial activities" not permitted to
bank holding companies and that have the authority to affiliate with
companies engaged in such activities. "Financial activities" are to be
determined by the Board in coordination with the Secretary of the
Treasury, and may include activities that are financial in nature,
incidental to an activity that is financial in nature, or complimentary
to a financial activity and that do not pose a safety and soundness
risk. The 1999 Act enumerates activities considered financial in nature
(in addition to those already permitted to bank holding companies),
including underwriting insurance or annuities, or acting as an insurance
or annuity principal, agent or broker; providing investment or financial
advice; underwriting, dealing in or making markets in securities; and
merchant banking (subject to certain limitations).
A holding company may elect to be treated as a financial holding
company, and engage in these activities, provided that its subsidiary
depository institutions are well-capitalized, well-managed and have
received at least a satisfactory rating in the last Community
Reinvestment Act examination. National banks may also engage in many of
these activities through a new structure, the "financial subsidiary,"
subject to substantially the same capital, management and CRA
requirements, and state-chartered banks are given similar authority.
The Act also provides for functional regulation of financial services
firms, which means that securities activities are to be regulated by the
Securities and Exchange Commission, insurance activities by state
insurance regulators, and banking activities by the appropriate bank
regulatory agencies.
The 1999 Act has resulted or is expected to result in new or revised
regulations for such matters as (1) newly authorized activities for bank
holding companies and financial holding companies, (2) financial
privacy, (3) customer protections for bank insurance sales, (4) the
Community Reinvestment Act, (5) overseas activities of bank holding
companies, (6) bank derivatives transactions and intra-day credit, (7)
activities allowed in national bank operating subsidiaries, and (8)
broker-dealer registration requirements for bank sales of new hybrid
products.
(d) Dividends Payable by the Corporation Holders of Common Stock of
the Corporation are entitled to receive dividends as and when declared
by the Board of Directors out of funds legally available therefore under
the laws of the State of California. Under California law, the
Corporation is prohibited from paying dividends unless: (a) the amount
of its retained earnings immediately prior to the dividend payment
equals or exceeds the amount of the dividend; or (b) immediately after
giving effect to the dividend (i) the sum of its assets would be at
least equal to 125 percent of its liabilities and (ii) its current
assets would be at least equal to its current liabilities, or, if the
average of its earnings before taxes on income and before interest
expense for the two preceding fiscal years was less than the average of
its interest expense for the two preceding fiscal years, at least equal
to 125 percent of its current liabilities.
The Board of Governors has advised bank holding companies that it
believes that payment of cash dividends in excess of current earnings
from operations is inappropriate and may be cause for supervisory
action. As a result of this policy, banks and their holding companies
may find it difficult to pay dividends out of retained earnings from
historical periods prior to the most recent fiscal year or to take
advantage of earnings generated by extraordinary items such as sales of
buildings or other large assets in order to generate profits to enable
payment of future dividends. Further, the Board of Governors' position
that holding companies are expected to provide a source of managerial
and financial strength to their subsidiary banks potentially restricts a
bank holding company's ability to pay dividends.
The Corporation's ability to pay dividends on its Common Stock is
subject to the rights of senior security holders and lenders, which will
include the holders of preferred stock in the future if preferred stock
is issued. Dividend payments will also be dependent upon its separate
liquidity needs. See Item 7, "Management's Discussion and Analysis of
Financial Condition." In that regard, Federal and state statutes,
regulations and policies impose restrictions on the payment of
management fees and cash dividends by the Bank to the Corporation.
The Bank
As a national banking association, the Bank is subject to the National
Bank Act and to supervision, regulation and regular examination by the
Comptroller of the Currency ("Comptroller"). It is also a member of the
Federal Reserve System and, as such, is subject to applicable provisions
of the Federal Reserve Act and regulations issued pursuant thereto. The
deposits of the Bank are insured up to the maximum legal limits by the
Bank Insurance Fund ("BIF"), which is managed by the Federal Deposit
Insurance Corporation ("FDIC"), and the Bank is therefore subject to
applicable provisions of the Federal Deposit Insurance Act and
regulations of the FDIC. The Bank is also subject to applicable
provisions of California law, insofar as they do not conflict with or
are not pre-empted by Federal law. The statutes and regulations
administered by these agencies govern most aspects of the Bank's
business, including required reserves against deposits, loans,
investments, dividends, deposit insurance premiums mergers and
acquisitions, the establishment of new branches and other banking
facilities, disclosure obligations to depositors and borrower and
customer privacy.
(a) Supervision and Examinations. Federal law mandates frequent
examinations of all banks, with the costs of examinations to be assessed
against the bank being examined. In the case of the Bank, its primary
regulator is the Comptroller.
The Comptroller has a community bank risk-assessment system, which
consists of examination procedures that focus on the various types of
risks that national banks face. The Comptroller measures each
individual bank's exposure to certain risks, assesses the controls the
bank has adopted in response to the risks it faces and the measures it
takes to monitor those risks. The Comptroller evaluates nine categories
of risk: credit, interest rate, liquidity, price, foreign exchange,
transaction, compliance, strategic and reputation. These nine risks are
measured and the direction of the risk is also analyzed.
The FDIC has "back up" enforcement power over the Bank under Federal
law. The FDIC is authorized to conduct examinations of insured
institutions that represent a heightened risk to the deposit insurance
funds when the FDIC determines that such an examination is necessary.
By agreement with other federal regulatory agencies, the FDIC is also
given access to supervisory information held by the federal agencies and
the right to participate in examinations.
The Federal banking regulatory agencies have substantial enforcement
powers over the depository institutions that they regulate. Civil and
criminal penalties may be imposed on such institutions and persons
associated with those institutions for violations of any law or
regulation. The amount of the penalty depends on whether the violation
is part of a pattern or causes a loss to the financial institution.
Enforcement powers also include the power to enjoin "unsafe or unsound
practices," the issuance of a cease-and-desist order that can be
judicially enforced, the issuance of directives to increase capital and
the issuance of formal and informal agreements.
(b) Prompt Corrective Action. The Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA") requires the banking
agencies to take corrective action against certain financial
institutions, based upon the financial institutions' compliance with the
various capital measurements. The capital requirements and the
definitions of the various measures of capital are described below under
the heading "Capital Regulations and Dividends." The following chart
sets forth the various categories of capital compliance. In order to be
considered in the well or adequately capitalized categories, a financial
institution must meet all the requirements for that category. An
institution will be considered undercapitalized or significantly or
critically undercapitalized if it meets any of the requirements for that
category.
Ratio Category Total Risk-Based Tier 1 Risk-Based Leverage
Well Capitalized* 10% or above 6% or above 5% or above
Adequately Capitalized 8% or above 4% or above 4% or above**
Undercapitalized Less than 8% Less than 4% Less than 4%
Significantly
Undercapitalized Less than 6% Less than 3% Less than 3%
Critically
Undercapitalized - - 2% or less
* In addition, the institution must not be subject to any written
capital order or directive to meet and maintain a specific capital
level.
** 3% instead of 4% if the institution has the highest rating under
the CAMEL rating system.
FDICIA also permits the banking agencies essentially to downgrade an
institution to the next lower category (but not into the category of
critically undercapitalized) if it determines that the institution is in
an unsafe or unsound condition, or is engaging in an unsafe or unsound
practice. An institution that has received a less-than-satisfactory
rating in its most recent examination report for assets, management,
earnings or liquidity may be deemed to be engaged in an unsafe and
unsound practice. Except for a finding based on a
less-than-satisfactory rating, the institution is entitled to prior
written notice and an opportunity to respond to its regulator's finding
that it is in an unsafe or unsound condition or is engaging in such
practices.
Based on its capital position at December 31, 2004, the Bank is
considered well capitalized.
As noted above, an undercapitalized financial institution is subject to
certain corrective action by the appropriate agency, depending on the
category it falls into. All undercapitalized institutions are required
to submit a capital plan within 45 days after the institution becomes
undercapitalized. Also, such an institution's asset growth is
restricted and it must obtain the prior approval of its federal
regulator before it acquires any company, sets up any new branch or
engages in any new line of business. The banking agency is required to
monitor closely the condition of the bank and its compliance with its
plan, and to review periodically the plan and the supervisory
restrictions on the bank to assure they are appropriate. In addition,
the regulator is authorized by statute to take the certain corrective
actions and order certain limitations on the bank's activities if
necessary to carry out the purposes of the statute.
If an institution is categorized as being significantly
undercapitalized, or is undercapitalized and fails to submit a capital
plan, its banking regulator is required to take increasingly severe
enforcement actions against such institution. The regulator must
require recapitalization through a sale of stock or a merger, restrict
affiliate transactions and restrict the interest rates the bank may
offer on deposits, (unless it finds that doing so would not further the
purpose of the section). In addition, such an institution may not pay a
bonus to a senior executive officer or increase the pay of any executive
officer without the prior written approval of its federal regulator.
An institution that is critically undercapitalized is subject to
mandatory restrictions that are even more severe, and seizure within
time limits designated by statute. In general, the federal regulator is
required to seize an institution within 90 days of its becoming
critically undercapitalized, unless the regulator can document that
another course of action will better achieve the purposes of this
section. The FDIC is required to restrict the activities of a
critically undercapitalized institution, beyond the degree of
limitations specified above for institutions that are significantly
undercapitalized.
(c) Brokered Deposits. FDICIA places limits on brokered deposits and
extends the limits to any bank that is not "well capitalized" or is
notified that it is in "troubled condition." Previously, the
limitations applied only to troubled banks. A well capitalized
institution (which generally includes an institution that is considered
well capitalized for purposes of the prompt corrective action
regulations discussed above) may still accept brokered deposits without
restriction, unless it has been informed by its appropriate Federal
regulatory agency that it is in "troubled condition." All other insured
depository institutions are prohibited from accepting brokered deposits
unless a waiver is obtained from the FDIC. If a waiver is obtained, the
interest paid on such deposits may not exceed the rate paid for deposits
in its normal market area, or the national rate as determined in the
FDIC's regulation.
If a depository institution solicits deposits by offering interest rates
significantly higher than rates being offered in its market area, it is
deemed under FDICIA to be a deposit broker. Therefore, depending on its
capital category, it may be prohibited from such practice, or need a
prior waiver from the FDIC in order to offer such rates. The FDIC's
regulations specify that an institution that is not well capitalized may
offer rates that exceed the prevailing effective rates offered in the
normal market area only if the institution obtains a waiver, but the
institution may not offer rates more than 75 basis points above such
prevailing rates.
The Bank is at this time considered well capitalized and not in a
"troubled condition," and it is not, therefore, subject to the brokered
deposit limitations.
(d) Risk-Based Deposit Insurance Assessments. In addition, FDICIA
requires the FDIC to develop and implement a system to account for risks
attributable to different categories and concentrations of assets and
liabilities in assessing deposit insurance premiums. Under this system,
each bank's deposit insurance premium assessment is calculated based on
a risk-based assessment program and the FDIC may increase or decrease
the assessment rate schedule on a semi-annual basis.
Capital Regulations and Dividends
The Board requires member banks and bank holding companies to maintain
adequate capital and has adopted capital leverage guidelines for
evaluating the capital adequacy of bank holding companies. The
Comptroller has also adopted a similar minimum leverage regulation,
requiring national banks to maintain at least a minimum capital to asset
ratio. The Board's guidelines and the Comptroller's regulations require
the banks and bank holding companies subject to them to achieve and
maintain a Tier 1 capital to total asset ratio of at least three percent
(3.0%) to five percent (5.0%), depending on the condition and rate of
growth of the bank or holding company. Tier 1 or core capital is
defined to consist primarily of common equity, retained earnings, and
certain qualified perpetual preferred stock. These minimum leverage
ratio requirements limit the ability of the banking industry, including
the Corporation and the Bank, to leverage assets.
The Federal Reserve Board also uses risk-based capital guidelines to
evaluate the capital adequacy of member banks and bank holding
companies. Under these guidelines, assets are categorized according to
risk and the various categories are assigned risk weightings. Assets
considered to present less risk than others require allocation of less
capital. In addition, off-balance sheet and contingent liabilities and
commitments must be categorized and included as assets for this purpose.
Under these guidelines, the Corporation is required to maintain total
capital of at least 8.00% of risk-adjusted assets, and half of that
minimum total capital must consist of Tier 1 capital as defined above.
The Comptroller has also adopted risk-based capital guidelines
applicable to national banks, such as the Bank, that are similar to the
Federal Reserve's risk-based capital guidelines. At this time, the Bank
is required to maintain total capital of at least 8.00% of risk-adjusted
assets.
The capital totals of the Corporation and the Bank, as of December 31,
2004, exceeded the amounts of capital required under the regulatory
guidelines to be well capitalized as shown in Footnote 13 to the
Financial Statements, entitled Regulatory Capital Requirements, Item 8.
Under the risk-based capital rules, when the agencies assess the capital
adequacy of a bank, they must take into account the effect on that
bank's capital that would occur if interest rates moved up or down. The
purpose of this requirement is to ensure that banks with high levels of
interest rate risk have enough capital to cover the loss exposure.
The risk-based guidelines and the leverage ratio do not have a
significant effect on the Corporation and the Bank at this time because
both the Corporation and the Bank meet their respective required ratios.
The effect the requirements may have in the future is uncertain. The
risk-based capital guidelines may affect the allocation of the Bank's
assets between various types of loans and investments. If the Bank
continues to grow with its present asset composition, it may be required
to raise additional capital.
The required capital ratios have increased in significance under FDICIA,
as described above. The ratios now affect a bank's ability to utilize
brokered deposits and its deposit insurance premium rates, and they can
result in regulatory enforcement action. See, above, "The Bank."
As required by FDICIA, the Federal banking agencies now take credit risk
concentrations and an individual institution's ability to manage such
concentrations into account when they assess a bank's capital adequacy.
Non-traditional investments and activities, such as the use of
derivatives, are also taken into account in assessing capital
requirements. The agencies can adjust the standards for risk-based
capital on a case by case basis to take such risks into account, but
there is no formula that a bank can use prior to evaluation by the
agency to determine how credit concentration or nontraditional
activities will affect its capital requirements.
Regulatory restrictions and other information guidelines with respect to
the payment of dividends by the Bank are contained in Item 5, "Market
for Registrant's Common Equity and Related Stockholder Matters.", below.
Impact of Monetary Policies
Banking is a business in which profitability depends on rate
differentials. In general, the difference between the interest rate
received by the Bank on loans extended to its customers and securities
held in the Bank's investment portfolio and the interest rate paid by
the Bank on its deposits and its other borrowings comprise the major
portion of the Bank's earnings. To the extent that the Bank is not able
to compensate for increases in the cost of deposits and other borrowings
with greater income from loans, securities and fees, the net earnings of
the Bank will be reduced. The interest rates paid and received by the
Bank are highly sensitive to many factors which are beyond the control
of the Bank, including the influence of domestic and foreign economic
conditions.
The earnings and growth of the Bank are also affected by the monetary
and fiscal policy of the United States government and its agencies,
particularly the Board. These agencies can and do implement national
monetary policy, which is used in part to curb inflation and combat
recession. Among the instruments of monetary policy used by these
agencies are open market transactions in United States Government
securities, changes in the discount rates of member bank borrowings and
changes in reserve requirements. The actions of the Board have had a
significant effect on lending by banks, investments and deposits, and
such actions are expected to continue to have a substantial effect in
the future. However, the nature and timing of any further changes in
such polices and their impact on the Bank cannot be predicted.
Public Interest Laws, Consumer and Lending Laws
In addition to the other laws and regulations discussed herein, the Bank
is subject to numerous consumer and public interest laws and regulations
that are designed to protect customers in transactions with banks.
While the list set forth below is not exhaustive, these laws and
regulations include the Community Reinvestment Act, Truth in Lending
Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the
Expedited Funds Availability Act, the Equal Credit Opportunity Act, the
Fair Housing Act, the Real Estate Settlement Procedures Act, the Home
Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt
Collection Practices Act, the Bank Secrecy Act, the Right to Financial
Privacy Act and the Americans with Disabilities Act.
These laws and regulations mandate certain disclosure requirements and
regulate the manner in which financial institutions must deal with
customers when taking deposits, making loans, collecting loans and
providing other services. The Bank must comply with the applicable
provisions of these laws and regulations as part of its ongoing customer
relations. Failure to comply with these laws and regulations can
subject the Bank to various penalties, including but not limited to
enforcement actions, injunctions, fines or criminal penalties, punitive
damages to consumers and the loss of certain contractual rights.
Environmental Regulation
Federal, state and local regulations regarding the discharge of
materials into the environment may have an impact on the Corporation and
the Bank. Under Federal law, liability for environmental damage and the
cost of cleanup may be imposed upon any person or entity who is an owner
or operator of contaminated property. State law provisions, which were
modeled after Federal law, impose substantially similar requirements.
Both Federal and state laws were amended in 1996 to provide generally
that a lender who is not actively involved in operating the contaminated
property will not be liable to clean up the
property, even if the lender has a security interest in the property or
becomes an owner of the property through foreclosure.
The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the
"Economic Growth Act"), discussed in more detail below, includes
protection for lenders from liability under the Comprehensive
Environmental Response, Compensation and Liability Act of 1980
("CERCLA"). The Economic Growth Act adds a new section to CERCLA to
specify the actions a lender may take with respect to lending and
foreclosure activities without incurring environmental clean-up
liability or responsibility. Typical contractual provisions regarding
environmental issues in the loan documentation and due diligence
inspections will not lead to lender liability for clean-up, and a lender
may foreclose on contaminated property, so long as it merely maintains
the property and moves to divest it at the earliest possible time.
Under California law, a lender generally will not be liable to the State
Attorney General for the cost associated with cleaning up contaminated
property unless the lender realized some benefit from the property,
failed to divest the property promptly, caused or contributed to the
release of the hazardous materials or made the loan primarily for
investment purposes.
The extent of the protection provided by both the Federal and state
lender protection statutes will depend on their interpretation by the
administrative agencies and courts, and the Corporation cannot predict
whether it will be adequately protected for the types of loans made by
the Bank.
In addition, the Corporation and the Bank are still subject to the risks
that a borrower's financial position will be impaired by liability under
the environmental laws and that property securing a loan made by the
Bank may be environmentally impaired and not provide adequate security
for the Bank. California law provides some protection against the
second risk, by establishing certain additional, alternative remedies
for a lender in the situation where the property securing a loan is
later found to be environmentally impaired. Primarily, the law permits
the lender in such a case to pursue remedies against the borrower other
than foreclosure under the deed of trust.
The Bank attempts to protect its position against the remaining
environmental risks by performing prudent due diligence. Environmental
questionnaires and information on use of toxic substances are requested
as part of its underwriting procedures. The Bank lends based upon its
evaluation of the collateral, net worth of the borrower and the
borrower's capacity for unforeseen business interruptions or risks.
New and Pending Legislation
Certain legislative and regulatory proposals that could affect the
Corporation, the Bank and the banking business in general are pending or
have been introduced, before the United States Congress, the California
State Legislature, and Federal, state and local government agencies.
Such legislative and regulatory proposals include proposals regarding
expansion of consumer protection, privacy and disclosure requirements,
increases in the premiums for deposit insurance, restructuring of the
bank regulatory agencies, and expansion of the powers of other financial
institutions that compete with banks, among others.
It is not known to what extent, if any, these proposals will be enacted
or remain in force or what effect such legislation would have on the
structure, regulation and competitive relationship of financial
institutions. It is likely, however, that many of these proposals would
subject the Corporation and the Bank to increased regulation, disclosure
and reporting requirements and would increase competition to the Bank
and its cost of doing business.
In addition to pending legislative changes, the various banking
regulatory agencies frequently propose rules and regulations to
implement and enforce already existing legislation. It cannot be
predicted whether or in what form any such legislation or regulations
will be enacted or the effect that such legislation or regulations may
have on the Bank's business. It is likely, however, that many of these
proposals would subject the Corporation and the Bank to increased
regulation, disclosure and reporting requirements and would increase
competition to the Bank and its cost of doing business.
ITEM 2. Properties
The Corporation and the Bank share common quarters at 801 Fourth Street,
in the central business district of Santa Rosa. The Bank leases a total
of approximately 9,335 square feet of ground floor and second floor
office space at that location.
The Commercial, Construction and SBA Lending, Loan Administration and
Executive offices are located in north Santa Rosa at 3558 Round Barn
Blvd., Suite 300. The Bank leases 17,061 square feet at that location
The Bank's data processing, client services and personnel departments
are located at 1650 Northpoint Parkway, Santa Rosa. The Bank currently
occupies 12,334 square feet at that location.
The Bank leases facilities for its eight branch offices and the new
branches which are in process of completion (both stand alone offices
and supermarket branches) in Sonoma, Marin and Contra Costa Counties
under various leases which expire under various dates, including options
to renew, through the year 2044.
The Bank also leases other properties for its loan production offices in
California and Arizona.
Management believes that the Bank's existing facilities will accommodate
current operations and planned growth in the lending and operations
areas of the Bank for the next few years. Additional facilities may be
needed depending upon the rate of Bank growth.
The Bank has invested in loans secured by real property collateral. The
Bank's policies with respect to such loans are described under the
caption "Loan Portfolio" in Item 7, Management's Discussion and Analysis
of Financial Condition and Results of Operation.
ITEM 3. Legal Proceedings
Neither the Corporation nor the Bank is a party to any material pending
legal proceedings, other than proceedings arising in the ordinary course
of the Bank's business. None of these are expected to have a material
adverse impact on the financial position or results of operations of the
Corporation or Bank.
ITEM 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of shareholders during the
fourth quarter of 2004.
Part II
ITEM 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
On December 31, 2004, the Corporation had 9,854,067 shares of common
stock outstanding, held by approximately 252 shareholders of record.
At December 31, 2004, the directors and executive officers of the
Corporation and the Bank beneficially held 1,864,853 shares, or 18.9% of
the outstanding shares. These shares do not include shares that may be
acquired upon the exercise of outstanding stock options. See "Item 12,
Security Ownership of Certain Beneficial Owners and Management," herein.
Under SEC rules, the directors and officers are restricted in the amount
of securities they may sell without registration under the Securities
Act of 1933, as amended. In general, directors and officers each may
offer up to 98,540 shares in any three month period without such
registration.
As of December 31, 2004, the directors, officers and staff have the
right to acquire 742,891 additional shares upon the exercise of options
granted pursuant to the Corporation's Stock Option Plan. Should several
directors and officers choose to exercise options and sell their shares
on the market, such that a large number of shares are offered at one
time, the price of the common stock could be adversely affected.
The Corporation's common stock is not listed on any securities exchange
or on the National Association of Securities Dealers Automated
Quotations (NASDAQ) System. The firms SmithBarney and Brookstreet
Securities, located in Santa Rosa, and Hoefer & Arnett, located in San
Francisco, are presently making a market in the stock. The Corporation's
trading symbol is NREB.
On February 25, 2005, the board of directors announced its intent to
file an application for the listing of the Corporation's common shares
on NASDAQ by the end of March 2005. According to NASDAQ, processing the
application and reaching a final determination as to whether the
Corporation meets all the requirements for listing can take up to eight
weeks. There is no guarantee that NASDAQ will approve the listing
application or, if approved, any assurance as to the effect, if any,
that listing the common shares on NASDAQ may have on the volume of
trading in the shares or on the price at which the shares are traded.
The following chart shows the high and low bid quotations and the volume
of transactions in the Corporation's stock for the periods indicated.
The price and volume information set forth below does not reflect
privately-negotiated transactions, if any. The trading volume was
obtained from the OTC bulletin board web site. The prices were obtained
from the business section of the Press Democrat (the local newspaper in
Santa Rosa, California). The bid prices and numbers of shares in this
table have been adjusted for the impact of the stock dividends issued
during 2004 and 2003 and the two for one stock split in December 2003.
Bid Quotations for the Corporation's Common Stock
Approximate
Quarter Ended High Low Trading Volume
- ------------- ---- -- ---------------
March 31, 2003 $12.70 $11.36 270,591
June 30, 2003 12.24 11.36 244,951
September 30, 2003 13.38 11.14 742,447
December 31, 2003 17.62 13.33 486,621
March 31, 2004 20.52 16.28 226,041
June 30, 2004 21.90 19.75 202,727
September 30, 2004 22.25 19.55 313,661
December 31, 2004 23.25 20.25 439,400
Due to the lack of any significant trading and no established public
market, the prices indicated above should not be considered an
indication of the market value of the shares. There is no assurance
that any significant trading market for the shares will develop in the
future and there are no assurances as to the price at which shares may
be traded in the future. The bid and asked prices of the Corporation's
common stock were $22.35 and $22.40, respectively, on December 31, 2004.
Dividends and Stock Split
On March 16, 2004 the Board of Directors declared a 5% stock dividend
payable on May 31, 2004 to shareholders of record on May 3, 2004. On
October 21, 2003, the Corporation declared a two for one stock split to
shareholders of record on December 1, 2003. On April 1, 2003, the
Corporation declared a 5% stock dividend to shareholders of record on
May 9, 2003.
The Corporation has not paid any cash dividends since 1995. There is no
assurance that dividends will be paid, or, if paid, what the amount of
any such dividends will be. The future dividend policy of the
Corporation is subject to the discretion of the Board of Directors and
will depend upon a number of factors, including earnings, financial
condition, cash needs and general business conditions. In addition, the
Board of Directors may declare dividends only out of funds legally
available therefore. See "Supervision and Regulation - Dividends Payable
by the Corporation."
The Corporation's primary source of income (other than interest income
earned on the Corporation's other investments) is the receipt of
dividends from the Bank. The Bank's ability to pay dividends is subject
to the restrictions of the national banking laws and, under certain
circumstances, the approval of the Comptroller of the Currency. A
national bank may not pay dividends from its capital. All dividends
must be paid out of net profits then on hand, after deducting for
expenses, including losses and bad debts. A national bank is also
prohibited from declaring a dividend until its surplus fund equals the
amount of its capital stock or, if the surplus fund does not equal the
amount of its capital stock, until one-tenth of the bank's net profits
for the preceding half year, in the case of quarterly or semiannual
dividends, or the preceding two consecutive half-year periods, in the
case of an annual dividend, are transferred to the surplus fund each
time dividends are declared.
The approval of the Comptroller is required if the total of all
dividends declared by a bank in any calendar year will exceed the total
of its net profits of that year combined with its retained net profits
of the two preceding years, less any required transfers to surplus or a
fund for the retirement of any preferred stock which may be outstanding.
Moreover, the Comptroller may prohibit the payment of dividends which
would constitute an unsafe and unsound banking practice. As of December
31, 2004, $35,060,000 of retained earnings of the Bank was available for
the payment of dividends to the parent company under this requirement.
Securities Authorized for Issuance under Equity Compensation Plans
The Corporation's 1997 Stock Option Plan ("1997 Plan") was approved by
the Corporation's shareholders at the May 19, 1998 annual shareholders'
meeting. The 1997 Plan was adopted by the Board of Directors to replace
the Corporation's earlier stock option plan (the "1984 Plan") which was
approved by the Corporation's shareholders on June 4, 1995 and expired
by its terms on February 26, 1994. No options to purchase shares are
still outstanding under the 1984 Plan since the final options were
exercised in January 2004 and no new options may be granted under the
1984 Plan. Other than options outstanding under its 1997 stock option
plan, the Corporation does not have any outstanding rights or warrants
to purchase shares of its common stock.
The purpose of the 1997 Plan is to provide a means whereby employees and
directors of the Corporation and the Bank and any other corporation that
may become a subsidiary of the Corporation, may be given an opportunity
to purchase shares of common stock of the Corporation. The Plan is
intended to advance the interests of the Corporation and the Bank by
enhancing their ability to attract and retain the best available
personnel for positions of substantial responsibility and to attract and
retain the best available persons to serve as directors of the
Corporation and the Bank, to provide additional incentive to employees
and directors, and to promote the success of the Corporation's business.
The Plan provides for the grant of both non-statutory options and
options which are intended to qualify as "incentive stock options" as
defined in Section 422 of the Internal Revenue Code (the "Code").
Shares for which options have been granted under the Plan may be
purchased at a price not less than the fair market value of the shares
on the date the option was granted. Options vest immediately up to a
maximum of five years and expire not more than ten years from the date
of grant.
The following table shows the number of shares that may be issued upon
the exercise of options outstanding as of December 31, 2004, the
weighted average exercise price of such options and the number of shares
remaining for option grants under the 1997 Plan. The numbers of shares
and the exercise prices have been adjusted, pursuant to the terms of the
1997 Plan, for stock dividends and the 2003 two-for-one stock split.
Equity Compensation Plan Information
Number of securities
remaining available
for future issuance
Number of securities Weighted-average under equity
to be issued upon exercise price compensation plans
exercise of of outstanding (excluding securities
outstanding options, options, warrants reflected in
warrants and rights and rights column (a)
------------------- ----------------- ---------------------
Equity compensation
plans approved by
security holders 742,891 $10.60 1,647,604
Equity compensation
plans not approved
by security holders 0 0 0
------------------- ----------------- ---------------------
Total 742,891 $10.60 1,647,604
=================== ================= =====================
Purchases of Equity Securities by the Issuer
In 2004 the Board of Directors reviewed the status of option grants for
non-officer directors. While the Board believes these grants have
served their purpose of aligning the directors' interests with those of
the Company's other shareholders, the strong performance of the
Company's stock since 2001 (the last time options were granted to
directors) has resulted in options having a higher dilutive impact than
originally anticipated. As of November 5, 2004, each non-officer
director canceled their outstanding options totaling 1,371,624 and
non-officer directors who exercised options earlier in 2004 either
rescinded the exercise or contributed additional capital by paying the
difference between the market price at the time the options were
exercised and the exercise price. As a part of this transaction 29,500
shares were repurchased at the exercise price that the director had paid
for the shares when issued. For additional information see discussion
under the caption "Stock Option Plan" in Item 11, Executive
Compensation.
(c) Total
Number of
Shares (d) Maximum Number
(or Units) (or Approximate
Purchased Dollar Value)
(a) Total as Part of of Shares
number of (b) Average Publicly (or Units) that
Shares Price Paid Announced May Yet Be
(or units) per Share Plans or Purchased Under the
Period purchased (or unit) Programs Plans or Programs
- ------- --------- --------- --------- ------------------
November 2004 29,500 5.57 None None
Total 29,500 5.57 None None
ITEM 6. Selected Financial Data
(Dollars in thousands)
Year ended December 31: 2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ---------
Interest income $54,402 $44,732 $41,456 $44,345 $39,894
Interest expense 15,286 13,924 15,841 20,803 19,495
Net interest income 39,116 30,808 25,615 23,542 20,399
Provision for loan losses 1,550 900 840 960 960
Non-interest income 2,862 2,894 2,334 1,677 1,456
Non-interest expense 16,640 14,165 11,678 10,521 9,530
Income before income taxes 23,788 18,637 15,431 13,738 11,365
Provision for income taxes 9,468 7,366 6,096 5,651 4,513
Net Income 14,320 11,271 9,335 8,087 6,852
Earnings per share:
Basic* $1.46 $1.22 $1.01 $0.88 $0.75
Diluted* $1.30 $1.06 $0.89 $0.81 $0.72
Per Share:
Cash Dividends paid $0.00 $0.00 $0.00 $0.00 $0.00
Book value at
December 31*: $9.12 $7.12 $5.83 $5.06 $4.35
Average common
shares outstanding* 9,777,906 9,253,526 9,206,997 9,183,333 9,141,167
Average diluted common
shares outstanding* 11,049,306 10,586,680 10,461,931 10,006,114 9,519,459
Shares outstanding at
December 31 (Actual) 9,854,067 9,491,423 9,218,915 8,761,045 8,304,872
At December 31
Loans, net 938,104 733,857 586,461 466,529 432,446
Total assets 1,080,924 848,226 689,380 561,004 494,390
Total deposits 791,025 658,320 577,585 502,137 453,437
Borrowed funds 191,912 119,211 54,776 11,802 1,828
Shareholders' equity 89,878 67,533 53,738 44,297 36,103
* Prior years have been adjusted for stock split and stock dividends
issued.
Financial Ratios: 2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ---------
For the year:
Return on average assets 1.49% 1.52% 1.50% 1.54% 1.54%
Return on average equity 18.16% 18.80% 18.86% 19.83% 20.87%
Net interest margin 4.20% 4.25% 4.23% 4.61% 4.71%
Net loan losses to
average loans 0.03% 0.00% 0.01% 0.01% 0.02%
Efficiency ratio (1) 39.64% 42.03% 41.78% 41.72% 43.60%
At December 31:
Equity to assets 8.31% 7.80% 7.80% 7.90% 7.30%
Total capital to
risk adjusted assets 12.13% 11.74% 11.56% 12.14% 10.69%
Nonperforming assets to
total loans & OREO 0.11% 0.17% 0.51% 0.45% 0.51%
Nonperforming assets to
total assets 0.10% 0.15% 0.44% 0.38% 0.46%
Allowance for loan losses
to total loans 0.92% 0.98% 1.07% 1.18% 1.06%
Allowance for loan losses
to non-performing assets 700.5% 572.9% 210.5% 260.48% 207.58%
(1) Efficiency ratio is the percentage of noninterest expenses to the
sum of net interest income plus noninterest income.
In 2004 the Board of Directors reviewed the status of option grants for
non-officer directors. While the Board believes these grants have
served their purpose of aligning the directors' interests with those of
the Company's other shareholders, the strong performance of the
Company's stock since 2001 (the last time options were granted to
directors) has resulted in options having a higher dilutive impact than
originally anticipated. As of November 5, 2004, each non-officer
director canceled their outstanding options totaling 1,371,624 and
non-officer directors who exercised options earlier in 2004 either
rescinded the exercise or contributed additional capital by paying the
difference between the market price at the time the options were
exercised and the exercise price. The Board unanimously decided that
this action would benefit all shareholders and would best position the
Company to take advantage of the opportunities that lie ahead. Although
he is no longer a board member, William Gallaher, who resigned as a
director on October 13, 2003, has also participated in this action by
paying the difference between the market price at the time the options
were exercised and the option price. The effect of these actions was to
(1)reduce the number of fully diluted shares of the Company used to
calculate diluted earnings per share and (2)increase our shareholders'
equity by $6.0 million ($6.9 million in cash payments less the tax
impact of $872,000) as the result of the payment of the market price
differential net of the repayment for shares returned to the Company and
the tax impact. Per share book value and shareholders equity increased
significantly during 2004 due to this nonrecurring event concerning
outside director stock options. See discussion in Section III, Item 11
Executive Compensation - Stock Option Plan and Compensation of Outside
Directors. See also discussion in Item 5, Purchases of Equity Securities
by the Issuer.
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation
Critical Accounting Policies
The Corporation and Bank's accounting policies are fundamental to
understanding management's discussion and analysis of results of
operations and financial condition. Accounting policies are described
in detail in Note 1 of the Notes to Consolidated Financial Statements
presented in Item 8. One policy, Allowance for Loan Losses, has been
identified as being critical because it requires management to make
difficult and subjective judgments about matters that are inherently
uncertain and because of the likelihood that materially different
amounts might be reported under different conditions or using different
assumptions. This policy is reviewed by Loan Committee and approved by
the Board of Directors.
The Allowance for Loan Losses represents management's estimate of
probable losses inherent in the loan portfolio at the balance sheet
date. The allowance for loan losses is reviewed monthly and is based on
allocations for each loan category (e.g. Real Estate, Commercial), 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 other
consultants, and assessment of economic conditions. The allocated and
unallocated components represent the total allowance for loan losses
which management believes 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 regarding the inherent losses which are
highly uncertain, 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
may have had a material impact on the provision for loan losses and on
the consolidated results of operations.
Balance Sheet - Summary
The Corporation's sole subsidiary is the Bank, and its primary
activities are the commercial banking activities engaged in through the
Bank. The following discussion of financial condition as of December
31, 2004 and 2003 and results of operations for the years ended December
31, 2004, 2003 and 2002 focuses primarily on the Bank.
During 2004, total consolidated assets grew 27.4% to $1,080,924,000 at
December 31, 2004. Total consolidated assets grew 23.0% during 2003 to
$848,226,000 at December 31, 2003. The growth in 2004 results from
continued strong loan demand. During the year the Bank developed new
loan products which better served the market, has seasoned group of loan
officers with substantial connections within their community and
expanded broker network and has a higher lending limit which all
contributed to the loan growth. See "Loan Portfolio."
Total deposits increased 20.2% to $791,025,000 when comparing December
31, 2004 to December 31, 2003. For the year ended December 31, 2003,
total deposits increased 14.0% to $658,320,000. Deposits and FHLB
advances increased to fund the loan growth mentioned above. See
"Deposits."
Federal Home Loan Bank Advance increased very substantially to
$191,912,000 at December 31, 2004 from $119,211,000 at December 31,
2003. Advances increased to fund loan growth at a lower cost than term
deposits. See "Mix of Deposits and Other Funding Sources" and "FHLB
Advances."
Results of Operations - Summary
The Corporation's consolidated net income for the year ended December
31, 2004 was $14,320,000 as compared to $11,271,000 for the year ended
December 31, 2003, an increase of 27.1%. The Corporation's consolidated
net income for the year ended December 31, 2003, increased 20.7% over
the year ended December 31, 2002.
Net interest income before provision for loan losses increased
$8,308,000 or 27.0%, when comparing the year of 2004 to 2003. This
increase results from the growth in the volume of loans on which the
Bank earns a net interest margin and the lower cost of advances from
FHLB versus term deposits. The interest margin for 2004 equaled 4.20%
compared to 4.25% in 2003 and 4.23% in 2002. See, "Net Interest Income."
The provision for loan losses of $1,550,000 in 2004 compared to $900,000
in 2003. See, "Allowance for Loan Losses." Non-interest income
decreased $32,000 primarily due to the reduced volume of SBA loan sales,
less loan referral fee income and reduced charges on deposit accounts.
See, "Non-Interest Income." Operating expenses increased by $2,475,000
primarily because of growth of the Bank. It was the first full year of
operation of the Bank's new branch office in San Rafael, California and
costs increased due to the consolidation of the Loan Department and
certain administrative functions into a larger office facility and the
expansion of the existing operations center.
When comparing 2003 to 2002 the provision for loan losses was increased
to $900,000 in 2003 from $840,000 in 2002 and other income increased
$560,000 to $2,894,000 in 2003 from $2,334,000 in 2002. Operating
expenses increased $2,487,000 during 2003 primarily due to increases in
personnel costs, resulting from a new Sonoma Branch.
Net Interest Income
The primary source of the Bank's income is the difference between (1)
the interest earned on its loan and investment portfolios, interest
bearing deposits with other banks, and federal funds sold, and (2) the
interest paid on deposits and other borrowed funds. This difference is
referred to as net interest income, and it is one of the primary factors
that affect the Corporation's profitability. Interest income earned on
loans, which includes loan fee income, is primarily a function of the
amount of loans outstanding and the rates prevailing on these loans.
Interest paid on deposits depends on the composition of the deposit base
and the rates paid to attract deposits. See, "Deposits."
For the year ended December 31, 2004, net interest income before the
provision for loan losses totaled $39,116,000 as compared to $30,808,000
for the year ended December 31, 2003, representing an increase of 27.0%.
The majority of this increase results from the net interest margin
earned on growth in the loan portfolio, largely as a result of the
increase in real estate loans as discussed above. See, "Loan
Portfolio." During 2003, net interest income before the provision for
loan losses totaled $30,808,000 as compared to $25,615,000 in 2002
representing an increase of 20.3%. The majority of this increase
resulted from the net interest margin earned on growth in the loan
portfolio.
The Bank's net interest margin (expressed as a percentage, the interest
income less interest expense divided by average interest earning assets)
equaled 4.20% in 2004 compared to 4.25% in 2003 and 4.23% in 2002.
Several factors impact the Bank's net interest margin. These include
changes in market interest rates, the level of loans relative to
deposits, the mix of loans and earning assets, non-accrual loan balances
and the mix of deposits and other funding sources.
* Changes in Market Interest Rates
Changes in economic conditions and the actions of the Federal Reserve
Board to increase or decrease the Fed Funds and Discount rates have a
direct impact on the Bank's net interest margin since prime rate and
other market interest rates and indices generally move in response to
Federal Reserve Board actions. During 2004 prime rate increased to
5.25% at year end, an increase of 125 basis points from its low of
4.00%. During 2003 prime rate equaled 4.25% until June when it declined
to 4.00% where it remained until June 2004. During 2002 prime rate
equaled 4.75% until November 7 when it declined to 4.25%. 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 market-interest rate changes on the Bank's earnings
are not realized immediately, since not all loans or deposits reprice
immediately. The majority of SBA loans is tied to the prime rate and
reprice on a calendar quarter basis. The Bank also has adjustable rate
loans, mainly commercial real estate loans, which are tied to a variety
of loan indices including the Eleventh District Cost of Funds Index
(COFI), LIBOR, the six-month constant maturity Treasury (CMT) and the
five-year CMT. Each of these indices react to changes in market interest
rates at different speeds and magnitudes. 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.
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 continued to experience a
steady rate of loan payoffs as borrowers have refinanced to other loans
at fixed rates or tied to indexes which bear lower rates.
* Level of Loans Relative to Deposits
The net interest margin is also affected by the level of loans relative
to deposits. The Bank's ratio of loans-to-deposits increased during
2004, when it averaged 114.5%, as compared to 107.5% in 2003 and 99.6%
in 2002. 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 Bank grew average loans by $185.9 million in 2004 and $112.8 million
in 2003. In both those years, the majority of the growth in average
loans occurred in commercial real estate loans. There were increases of
$149.4 million and $89.1 million in average real estate loans,
respectively, which bear a lower average interest yield of 6.55% in 2004
and 7.21% in 2003 and 8.03% in 2002. The majority of commercial real
estate loan rates is tied to COFI and generally adjusts every six
months. There is a significant lag in the repricing of these loans
since first the COFI index needs to reflect the change in the cost of
funds for the 11th District before it is factored into the repricing
rate on the COFI loans. The COFI index moved to 2.12% for December 2004
from 1.90% for December 2003 and 2.38% for December 2002. In a
declining rate environment, COFI based loans help interest margin;
however, in an increasing rate environment they lag other indexes and
have a negative impact on net interest margin.
Average commercial loan yields (the majority of these loans are SBA
loans) for 2004 increased 6 basis points and decreased 63 basis points
in 2003. Most of these loans reprice to prime rate on a quarterly
repricing schedule. This average increase was impacted by the quarterly
repricing of SBA loans to reflect the increase in prime rate of 25 basis
points to 4.25% on July 1, 2004 and 50 basis points to 4.75% on October
1, 2004. In 2003 the SBA rates were 4.25% through June and then
declined to 4.00% on July 1 through the end of the year. In 2002 the SBA
rate was unchanged at 4.75% until November 2002 when it declined to
4.25%.
Average construction loans increased $3.9 million during 2004. The
average yield was 7.83% during 2004 compared to 8.50% in 2003. These
loans have short maturity dates (approximately one year). Economic
conditions and rate competition for construction loans have a direct
impact on the volume in construction loans and the Bank experienced a
higher volume of construction loans during 2004. The Bank has been in
this market for several years and is well recognized by the broker
network as providing high quality construction loan products and good
service which has resulted in more referrals and larger volume.
Interest income increased to $54.4 million in 2004 from $44.7 million in
2003 and $41.5 million in 2002. The increases in 2004 and 2003 resulted
primarily from increases in the average balance of loans outstanding
during those years. Average loans increased to $834.5 million in 2004
from $648.7 million in 2003 and $535.9 million in 2002. The yield on
loans equaled 6.34% in 2004, 6.74% in 2003 and 7.52% in 2002. The 40
basis point decline during 2004 resulted primarily from the impact of
rate changes, the indexes used, the timing of rate adjustments and the
Bank's competitive loan pricing. The lag in repricing COFI loans and
the volume of COFI loans at floor rates offset the benefit of the
increasing market rates.
Economic conditions and competition have impacted the mix of loans.
COFI loans were less attractive to borrowers when rates were rapidly
declining since loan products tied to prime rate, U.S. Treasury rates or
LIBOR had lower interest rates. As a result many COFI loans were
refinanced resulting in higher loan prepayments. Construction loans
generally increase when economic conditions improve and the Bank did
experience higher demand for construction loans during 2004. The Bank
continues to experience significant competition for loans, which has
resulted in pricing pressure for new loan originations.
Overall loan portfolio yields are affected by deferred loan fees and
discounts on loans which equaled $853,000 at December 31, 2004 and
$838,000 at December 31, 2003. This balance is netted against total
loans in the balance sheet. These fees and discounts are amortized to
income over the life, or estimated life, of the loan with which they are
associated and serve to increase loan portfolio yields. Interest income
on loans includes loan fee income and income from amortization of
discounts of $1,179,000 for the year ended December 31, 2004, $1,346,000
for the year ended December 31, 2003 and $1,537,000 for the year ended
December 31, 2002. This fee income and amortization of discounts
increased yields on average loans by 14 basis points in 2004, as
compared to 18 basis points in 2003 and 22 basis points in 2002.
Deferred loan fees are a product of origination and commitment fees net
of certain direct loan origination costs. The asset balance of net
deferred fee amounts equaled $400,000 at December 31, 2004 and $293,000
at December 31, 2003. The decline in fee income and the deferred fee
balance in 2004 results from loan pricing on some products which did not
include charging fees ("par pricing") due to competition in the area.
SBA 7(a) loans do not have loan fees; however, cost recovery is recorded
on all loans. Discounts on the unguaranteed portion of SBA loans are
recorded when the guaranteed portion of the SBA loan is sold. These
discounts are amortized as an adjustment to the loan yields over the
estimated life of the SBA loan. As of December 31, 2004, $1,253,000 was
recorded as discounts compared to $1,414,000 at December 31, 2003. The
decrease results from lower volume of loan sales during 2004 and the
structure of the loans sales, which includes premium and servicing
values.
* Non-Accrual Loan Balances
Loans carried as non-accrual reduce the portfolio yield, since the
balance of a non-accrual loan is maintained in the loan total but no
interest is accrued. Non-accrual loans are included in the loan amounts
in the average balance sheets below. Interest foregone on non-accrual
loans equaled $18,000 during 2004 compared to $154,000 during 2003 and
$228,000 during 2002 which had a negative impact on net interest margin.
The allowance for loan losses has no direct effect on yield. For further
discussion see "Allowance for Loan Losses."
* Mix of Deposits and Other Funding Sources
In 2004, interest expense increased to $15.3 million compared to $13.9
million in 2003 and $15.8 million in 2002. The increase in interest
expense in 2004 was a result of an increase in interest bearing
deposits, offset by a decrease in the average interest rates paid for
deposits. Average interest bearing deposits increased $111.6 million
during 2004; however, the average cost of interest paid on interest
bearing deposits for the year ended December 31, 2004 was 1.97% versus
2.34% for the year ended December 31, 2003 and 3.14% for the year ended
December 31, 2002. Deposit costs decreased 37 basis points during 2004
and 80 basis points during 2003.
The Bank's money market rate account, the Sonoma Investors Reserve
Account, declined during 2004 as a result of increased competition for
money market accounts. Balances held in Sonoma Investors Reserve
accounts equaled $ 115.5 at December 31, 2004 moving from $142.6 million
at December 31, 2003. Average balances for savings and money market
accounts at the Bank were $149.6 million for 2004, $145.7 million for
2003 and $138.1 million for 2002. In September 2004, the Bank increased
the rates on savings accounts to a highly competitive rate and heavily
advertised the savings rate. The savings account was very popular since
the funds are immediately available and as a result of the savings
account balances increased to $55.4 million at December 31, 2004 from
$8.4 million at December 31, 2003. The rate offered on the Sonoma
Investors Reserve account and the savings account reprices on a weekly
basis. The rates on Savings and Sonoma Investor Reserve accounts are
discretionary which provides management with flexibility in controlling
interest costs and reacting to changes in market rates. Due to the
weekly repricing, changes in rates on the Sonoma Investors Reserve
Account and Savings accounts have a more immediate impact on the Bank's
cost of funds than changes in offering rates on time certificates. The
cost of funds on savings and money market accounts equaled 1.14% in
2004, 1.17% in 2003 compared to 1.75% in 2002.
Time deposits reprice at a slower pace, since certificates of deposits
usually do not reprice until their maturity dates, which generally range
from six to twenty-four months. Time deposits have increased to $507.9
million at December 31, 2004 from $404.0 million at December 31, 2003.
During both 2004 and 2003, the Bank ran several time deposit campaigns
at rates slightly higher than its local competitors. These higher
priced deposits were used to fund loan growth. The cost of time
deposits averaged 2.35% in 2004 and 2.94% in 2003 compared to savings
and money market rate accounts which averaged 1.14% in 2004 and 1.17% in
2003. Growth in time deposits which bear the highest cost, has a
negative impact on the Bank's cost of funds and net interest margin.
Average non-interest bearing deposits increased to $69.5 million in 2004
compared to $56.7 million in 2003. Growth in non-interest bearing
deposits has a positive impact on the interest margin.
The majority of the Bank's growth was funded by time certificates,
savings accounts and advances from the Federal Home Loan Bank (FHLB).
The Bank has the ability to borrow from the FHLB at a cost and/or terms
that may be more favorable than deposits accounts. During 2004, the
FHLB increased the Bank's maximum financing availability, with
acceptable collateral, to 35 percent of assets from 25 percent of
assets. During 2004, the Bank increased the funds borrowed to $191.9
million compared to $119.2 million at December 31, 2003. The borrowings
during 2004 are generally for a term of one year and are at fixed or
variable rates. Previously, the Bank has also borrowed from the FHLB at
terms which match longer term loans totaling $1.9 million. The Bank has
used this line as a both a contingency source of funds and a source of
funds for future loan growth. At December 31, 2004, the Bank had pledged
loan collateral to the FHLB totaling $434.2 million which increased our
borrowing capacity to $269.7 million, and had borrowed $191.9 million
against that line. FHLB advances are offered in a wide variety of costs,
terms and structures, which can be less expensive than raising new
deposits through the Bank's branch systems, having a positive impact
on net interest margins. However, changes in the terms and conditions
of FHLB advances may affect the Bank's ability to borrow from the FHLB
and/or the advantages to the Bank from such borrowings.
The tables on the following pages (i) summarize the distribution, by
amount, of the average assets, liabilities and shareholders' equity of
the Corporation for the periods indicated and (ii) set forth the yields
on earning assets and the rates paid for interest bearing liabilities
during the periods indicated. Non-accrual loans are included in the
average loan balances even though they are no longer accruing interest.
Averages are computed primarily from daily balances.
AVERAGE BALANCE SHEET
Year Ended
December 31, 2004
(dollars in thousands)
Interest Average
Average Income/ Yield
Balance Expense /Rate
-------- ------- ------
Interest bearing deposits
with other banks $456 $4 0.93%
Investments 8,842 360 4.25%
Federal funds sold 88,028 1,120 1.27%
Loans:
Commercial (including
SBA loans) 233,241 13,211 5.66%
Installment loans
to individuals 6,181 330 5.36%
Real estate -Construction 32,053 2,504 7.83%
Real estate -Other 563,050 36,873 6.55%
-------- ------- ------
Total Loans 834,525 52,918 6.34%
-------- ------- ------
Total earning assets 931,851 54,402 5.84%
-------
Non-earning assets:
Allowance for loan losses (7,772)
Deferred Loan Fees & Discounts (860)
Cash and due from banks 21,607
Other assets 14,245
--------
TOTAL ASSETS $959,071
========
Deposits:
Demand - interest bearing $34,893 $119 0.34%
Savings & money market 149,611 1,712 1.14%
Time certificates 473,740 11,153 2.35%
-------- ------- ------
Total interest
bearing deposits 658,244 12,984 1.97%
Other Interest bearing
liabilities 147,197 2,302 1.56%
-------- ------- ------
Total Interest bearing deposits
& liabilities 805,441 15,286 1.90%
-------
Non-interest bearing liabilities:
Non-interest bearing deposits 69,456
Other liabilities 5,314
Shareholders' equity 78,860
--------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $959,071
========
Net interest income $39,116
=======
Net interest margin 4.25%
=======
AVERAGE BALANCE SHEET
Year Ended
December 31, 2003
(dollars in thousands)
Interest Average
Average Income/ Yield
Balance Expense /Rate
-------- ------- ------
Certificates of deposit
with other banks $546 $7 1.28%
Investments 4,704 196 4.18%
Federal funds sold 70,564 779 1.10%
Loans:
Commercial (including
SBA loans) 200,518 11,172 5.57%
Installment loans
to individuals 6,330 341 5.38%
Real estate -Construction 28,135 2,392 8.50%
Real estate -Other 413,667 29,845 7.21%
-------- ------- ------
Total Loans 648,650 43,750 6.74%
-------- ------- ------
Total earning assets 724,464 44,732 6.17%
-------
Non-earning assets:
Allowance for loan losses (6,894)
Deferred Loan Fees & Discounts (1,142)
Cash and due from banks 15,789
Other assets 11,850
--------
TOTAL ASSETS $744,067
========
Deposits:
Demand -interest bearing $27,377 $105 0.38%
Savings & money market 145,717 1,699 1.17%
Time certificates 373,546 10,983 2.94%
-------- ------- ------
Total interest bearing deposits 546,640 12,787 2.34%
Other Interest bearing liabilities 76,720 1,137 1.48%
-------- ------- ------
Total Interest bearing
deposits & liabilities 623,360 13,924 2.23%
-------
Non-interest bearing liabilities:
Non-interest bearing deposits 56,708
Other liabilities 4,051
Shareholders' equity 59,948
--------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $744,067
========
Net interest income $30,808
=======
Net interest margin 4.25%
=======
AVERAGE BALANCE SHEET
Year Ended
December 31, 2002
(dollars in thousands)
Interest Average
Average Income/ Yield
Balance Expense /Rate
-------- ------- ------
Certificates of deposit
with other banks $849 $17 2.01%
Investments 2,475 95 3.84%
Federal funds sold 65,926 1,029 1.56%
Loans:
Commercial (including
SBA loans) 167,841 10,403 6.20%
Installment loans to individuals 3,341 229 6.85%
Real estate -Construction 40,117 3,615 9.01%
Real estate -Other 324,595 26,068 8.03%
-------- ------- ------
Total Loans 535,894 40,315 7.52%
-------- ------- ------
Total earning assets 605,144 41,456 6.85%
-------
Non-earning assets:
Allowance for loan losses (5,913)
Deferred Loan Fees & Discounts (1,688)
Cash and due from banks 15,028
--------
Other assets 10,175
--------
TOTAL ASSETS $622,746
========
Deposits:
Demand -interest bearing $21,979 $130 0.59%
Savings & money market 138,105 2,414 1.75%
Time certificates 320,333 12,557 3.92%
-------- ------- ------
Total interest bearing deposits 480,417 15,101 3.14%
Other Interest bearing liabilities 31,906 740 2.32%
-------- ------- ------
Total Interest bearing
deposits & liabilities 512,323 15,841 3.09%
-------
Non-interest bearing liabilities:
Non-interest bearing deposits 57,642
Other liabilities 3,280
Shareholders' equity 49,501
--------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $622,746
========
Net interest income $25,615
=======
Net interest margin 4.23%
=======
The following tables set forth the changes in net interest income due to
changes in interest rates and the volume of assets and liabilities
between years. Variances attributable to simultaneous rate and volume
changes are all allocated to volume change amount.
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST INCOME AND EXPENSE
2004 OVER 2003
(dollars in thousands) Yield
Volume /Rate Total
------- ------ ------
Increase/(decrease) in interest income:
Interest bearing deposit
with other banks $(1) $(2) $(3)
Investments 172 (8) 164
Federal funds sold 193 148 341
Loans:
Commercial (incl. SBA loans) 1,823 216 2,039
Installment loans to individuals (8) (3) (11)
Real estate -Construction 333 (221) 112
Real estate -Other 10,778 (3,750) 7,028
------- ------ ------
Total 13,290 (3,620) 9,670
------- ------ ------
Increase/(decrease) in interest expense:
Deposits & other interest
bearing liabilities:
Demand -interest bearing 29 (15) 14
Savings & money market 45 (32) 13
Time certificates 2,946 (2,776) 170
Other interest bearing liabilities 1,045 120 1,165
------- ------ ------
Total 4,065 (2,703) 1,362
------- ------ ------
Increase/(decrease) in net interest income $9,225 $(917) 8,308
======= ====== ======
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST INCOME AND EXPENSE
2003 OVER 2002
(dollars in thousands) Yield
Volume /Rate Total
------- ------ ------
Increase/(decrease) in interest income:
Certificates of deposit with other banks $(6) $(4) $(10)
Investments 86 15 101
Federal funds sold 72 (322) (250)
Loans:
Commercial (incl. SBA loans) 2,025 (1,256) 769
Installment loans to individuals 205 (93) 112
Real estate -Construction (1,080) (143) (1,223)
Real estate -Other 7,153 (3,376) 3,777
------- ------ ------
Total 8,455 (5,179) 3,276
------- ------ ------
Increase/(decrease) in interest expense:
Deposits & other interest
bearing liabilities:
Demand -interest bearing 32 (57) (25)
Savings & money market 133 (848) (715)
Time certificates 2,086 (3,660) (1,574)
Other interest bearing liabilities 1,039 (642) 397
------- ------ ------
Total 3,290 (5,207) (1,917)
------- ------ ------
Increase/(decrease) in net interest income $5,165 $28 $5,193
======= ====== ======
Provision for Loan Losses
The provision for loan losses was $1,550,000 for 2004, compared to
$900,000 for 2003 and $840,000 for 2002. The provision reflects
continued growth in loans and the level of non-accrual and watch list
loans during this year, and current economic conditions. For further
discussion see "Allowance for Loan Losses."
Non-Interest Income
The following table sets forth non-interest income by category for the
years indicated.
Percentage
Year ended December 31, Change
----------------------- -----------
2004/ 2003/
(in thousands) 2004 2003 2002 2003 2002
---- ---- ---- ---- ----
Gain on loan sales $1,294 $1,387 $1,015 (6.7)% 36.7%
Service charges on deposits 471 556 546 (15.3) 1.8
Loan servicing fees 384 326 298 17.8 9.4
Merchant and other service fees 213 184 189 15.8 (2.6)
Referral fees 112 227 72 (50.7) 315.3
Income on insurance policies 116 133 119 (12.8) 11.8
Gain on OREO sales 183 0 36 - -
Other 89 81 59 9.9 37.3
------ ------ ------
Total Other Income $2,862 $2,894 $2,334 (1.1)% 24.0%
====== ====== ======
The decrease in gains on the sale of the guaranteed portion of SBA loans
resulted from lower volume of loan sales of $11.3 million in 2004
compared to $14.1 million sold in 2003 and $14,790,000 sold in 2002. The
Bank's income from gains on sales averaged 11.4% in 2004 compared to
9.9% in 2003 and 6.6% in 2002. The Bank experienced higher premiums and
lower prepayment rates on SBA 7(a) loans. The SBA implemented a
prepayment penalty on SBA 7(a) loans in 2000 which has also had a
positive impact on the rate of prepayments which is a part of the
premium determination.
Loan servicing fees are based on loan payments and payoffs received on
the sold portion of SBA loans, and therefore, vary from year to year.
During 2004, the Bank's average SBA loan portfolio serviced was $51.7
million versus $43.9 million in 2003 and $35.2 million in 2002. The
serviced portfolio reflects SBA loan payoffs and volume of new sales
during the period.
There can be no assurance that the SBA program will continue to generate
significant amounts of other non-interest income in the future. The
Bank continues to experience additional competition with more financial
institutions making SBA loans. The governmental actions may alter the
SBA program at any time, which could have a negative impact on the
Bank's profit. See, "Item 1, The Corporation, Business of the Bank."
Service Charges on Deposits vary depending upon the type of account.
Fees charged to "analysis customers'" vary depending upon the customers'
use of various Bank services. Analysis customers' charges are reduced by
an earnings credit which is calculated by applying an interest rate
(earnings credit rate) to the average balance maintained by the
customer. In 2004 the earnings credit rate was increased to make the
analysis product more marketable. The result was that more of the
analysis charges were covered by earnings credit and the analysis income
was lower. Before this rate change account holders' earnings were lower,
and therefore, service charges were higher. While the earnings credit
rate does impact the service charges, our business account holders
continue to manage their accounts activity to minimize their service
charges. With the higher earnings credit rate, the Bank had a more
competitive deposit product in this market and was able to attract new
business accounts.
A Gain on Other Real Estate Owned (OREO) Sale resulted from the sale of
property that the Bank took possession of during the first quarter as a
result of a loan foreclosure. This property was sold at a gain of
$183,000 during the first quarter of 2004. The Bank did not have any
other real estate owned during 2003. In 2002 there was one OREO sold
for a gain of $36,000 on the only OREO property held by the Bank during
the year. See, "Other Real Estate Owned."
When comparing the year ended December 31, 2003 to December 31, 2002,
non-interest income increased 24.0% which primarily resulted from higher
volume of SBA loan sales and increased loan referral fees.
Non-Interest Expense
Non-interest expenses include salaries and employee benefits, occupancy,
equipment and the general expenses required for the operation of the
Corporation and the Bank. For the year ended December 31, 2004,
non-interest expenses totaled $16,640,000, an increase of 17.5% over the
previous year. The following table outlines the components of
non-interest expense for the periods indicated:
Percentage
Year ended December 31, Change
----------------------- -----------
(in thousands) 2004/ 2003/
Expense Item 2004 2003 2002 2003 2002
---- ---- ---- ---- ----
Salaries & Employee Benefits $10,464 $8,837 $6,981 18.4% 26.6%
Occupancy 1,422 1,223 1,114 16.3 9.8
Equipment 948 760 606 24.7 25.4
Advertising/Business
Development/Donations 706 619 519 14.1 19.3
Outside Customer Services 368 342 399 7.6 (14.3)
Director & Shareholder expenses 380 382 360 (0.5) 6.1
Deposit and Other Insurance 467 352 329 32.7 7.0
Postage & courier expenses 331 304 271 8.9 11.1
Professional Fees 582 394 360 47.7 9.4
Stationery & Supplies 304 248 228 22.6 8.8
Telephone expense 200 184 158 8.7 16.5
Loan expenses 69 168 93 (58.9) 80.6
Other 399 352 260 13.4 35.4
------- ------- -------
TOTAL $16,640 $14,165 $11,678 17.5% 21.3%
======= ======= =======
The increase in salaries and employee benefits results primarily from an
increase in staff with the Bank's full time equivalent (FTE) staff
positions averaging 147 in 2004, 130 in 2003 and 114 in 2002, increases
for performance and promotions, higher incentives due to higher level of
production and increases in the of cost of group insurance and other
benefits. The majority of the increase in staff resulted from the new
branch office in San Rafael and new support staff to process the
increased loan and deposit volume. It is expected that staff will
continue to increase in 2005 due to the projected opening of the new
branches in Walnut Creek, Petaluma and Concord and additional support
staff to manage the growth within the Bank.
The increase in occupancy was planned due to the consolidated the Loan
Department and other administrative functions in a larger building which
would accommodate the current staff and provide for additional
expansion. The Bank also added approximately 5,000 square feet to the
operations center and added a new branch office in San Rafael. The
majority of existing properties has annual increases as called for in
the lease agreements. Occupancy expenses are expected to increase in
2005 with a full year of operation in the new facilities and the
addition of the three branches planned to opening in 2005. For further
discussion see Item 2 "Properties."
Equipment expenses increased as a result of the expansion of facilities
and staff additions. During 2004, the Bank continued to upgrade and
expand our technology. The Bank's central processing system which was
replaced with new equipment in 2003 increased the depreciation expenses
this year. The relocation to new facilities resulted in upgrading
outdated furniture and equipment and enhancing systems. Equipment costs
are expected to continue to increase during 2005 with the planned
expansion referred to above.
Included in Deposit and Other Insurance are regulatory assessments which
have been increasing over the last several years due to asset and
deposit growth. See, "Description of Business-Supervision and
Regulation." In addition the Bank had a significant increase in
liability insurance which resulted from the expiration of three year
policies in January 2004 and replacing them with premiums at current
market rates.
Professional fees increased in 2004 as a result of additional costs
associated with consulting and audit fees to perform the review of
internal control reporting and audit requirements of Section 404 of the
Sarbanes-Oxley Act. Due to the low level of problem loans during 2004,
legal costs on problem loans were at a low level. Fees for reviews of
data processing functions, intrusion testing, loan review services, SBA
audit and other consulting services are also included in this category.
Loan expenses vary depending upon the level of problem loans and the use
of contracted loan services to assist staff during periods of high loan
production. The Bank generally charges for direct costs associated with
loan originations. Broker fees are included as a part of cost recovery
and recorded in deferred fees on loans and amortized as an adjustment to
interest income in accordance with generally accepted accounting
principles. Due to the low level of problem loans during 2004 these
costs were minimal. The Bank contracts loan inspections and appraisal
review services during peaks in loan activity.
When comparing 2003 to 2002, the increase in total non-interest expenses
of 21.3% was due primarily to increased salary expenses resulting from
increases in branch, lending and other staff additions throughout the
Bank, salary increases and staff incentives associated with increased
volume of loan and deposit activity. In addition, costs associated with
occupancy and equipment also increased due to branch expansion. Most
expense categories were higher as a result of the loan and deposit
growth and the new facilities.
Loan Portfolio
In 2004 the Bank's real estate loans continued to experience strong loan
demand. This growth results from many factors which includes the
following. The Bank continued to respond to the rapidly changing needs
of our borrowers by offering new products and/or pricing options. An
example of one new product is the 40 year amortization on certain
commercial real estate loans. The Bank also has more experienced loan
officers than in past years with an established referral network which
results in more loan applications. The Bank's lending limit has also
increased which allows the Bank to process larger loans than in the
past. Competition also impacts loan volume and the announcement of the
merger of a local community bank competitor had a positive impact on
loan volume during the year. The Bank does not anticipate that the past
rate of growth will continue.
The following table shows the composition of the loan portfolio, by type
of loan, as of the dates indicated.
(In thousands) December 31,
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Type of Loan
Real Estate -Mortgage $663,620 $495,538 $382,134 $284,782 $273,298
Real Estate -Construction 41,145 26,271 32,412 49,604 46,244
Commercial 236,718 214,000 173,325 137,711 118,134
Consumer Installment 6,193 6,185 6,445 2,052 2,412
-------- -------- -------- -------- --------
Total, gross 947,676 741,994 594,316 474,149 440,088
Deferred fees and
discounts, net (853) (838) (1,466) (2,004) (2,961)
-------- -------- -------- -------- --------
Total loans net of deferred
fees and discounts 946,823 741,156 592,850 472,145 437,127
Allowance for loan losses (8,719) (7,299) (6,389) (5,616) (4,681)
-------- -------- -------- -------- --------
TOTAL LOANS, NET $938,104 $733,857 $586,461 $466,529 $432,446
======== ======== ======== ======== ========
The table above illustrates the Bank's emphasis on commercial and real
estate lending. At December 31, 2004 and 2003 commercial loans
comprised 25.0% and 28.8%, respectively, of the Bank's total loan
portfolio. Construction and other real estate loans (combined) comprised
74.4% and 70.3% on those same dates. Management is aware of the risk
factors in making commercial and real estate loans and is continuously
monitoring the local marketplace as well as performing annual reviews of
this portfolio.
Commercial real estate mortgage and construction lending contains
potential risks which are not inherent in other types of portfolio
loans. With respect to construction lending, the potential risks
include declines in market values of underlying real property collateral
and delays or cost overruns, which could expose the Bank to loss. Risks
in commercial real estate lending include declines in commercial real
estate values, general economic conditions surrounding the commercial
real estate properties and vacancy rates. Management attempts to
mitigate lending risks through established underwriting procedures as
discussed below, periodic reviews of the underlying collateral and
monitoring real estate values and vacancy rates in our market areas. A
decline in general economic conditions or real estate values within the
Company's market area could have a negative impact on the performance of
the loan portfolio or value of the collateral.
The Bank makes commercial loans primarily to small and medium sized
businesses and to professionals located within Northern California and
Arizona. While the Bank emphasizes commercial lending, management does
not believe that there is any significant concentration of commercial
loans to any specific type of business or industry.
At December 31, 2004, 98.0% or $928.3 million of the Bank's loans,
including real estate loans and a majority of the Bank's SBA loans, were
secured by real estate as the principal source of collateral. A
worsening of economic conditions, a decline of real estate values and/or
rising interest rates could have an effect on the value of real estate
securing these loans and could have an adverse impact on the financial
condition of the Bank.
Most of the real estate collateral for the Bank's loans is located in
the Northern California and Arizona where the loan is generated. A
significant natural disaster impacting those locations, such as a severe
earthquake or widespread flooding, could disrupt the business of these
borrowers and impair the security for the Bank's loans. Although some of
the Bank's borrowers carry insurance to cover some of the losses that
might arise from such an event, the Bank does not require all its
borrowers to carry earthquake insurance coverage since such insurance
typically provides a large deductible amount. If a large earthquake
occurs in the Bank's market area, the Bank would probably have to
restructure some of its loans and may suffer loan losses related to the
earthquake.
The Bank originates loans guaranteed in large part by the U.S. Small
Business Administration ("SBA"). The guaranteed portion of each loan
may be sold to outside investors, usually at a price in excess of par.
SBA 7(a) loans typically have SBA guarantees ranging from 75% to 85%
with a maximum guarantee amount. During the first quarter of 2004 the
SBA program was impacted by federal government budgetary issues and a
lower loan cap was imposed. 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
(previously $1,333,000) which provided a better loan product for
borrowers. Additional governmental actions may further alter the SBA
program, which could have a negative impact on the Bank's profits.
During the first quarter the Bank converted the SBA loan requests which
exceeded the temporary $750,000 loan cap to loans under the SBA's 504
program. Under the 504 program 55% of the loan is funded by the Bank
compared to 100% of the loan amount under the 7(a) program. The 504
loans carry additional risks since the Bank's loan amount is not
guaranteed by the SBA; however, this is mitigated by the lower
loan-to-collateral value ratio of approximately 50%. There is an
established market to sell the guaranteed portion of 7(a) loans, whereas
504 loans are also saleable but generally at less favorable terms. The
Bank has sold some 504 loans, but has generally held the majority of the
504 loans in the Bank's loan portfolio.
The SBA requires a prepayment penalty, which is remitted to the SBA, of
5% in the first year, 3% in the second year and 1% in the third year, on
all 7(a) loans. The impact of the prepayment penalty has been to slow
the rate of payoff on SBA loans. The Bank follows the same internal
credit approval process when approving an SBA loan as when approving
other loans. The majority of the Bank's SBA loans are secured by real
estate. All SBA loans are reported in the chart above as Commercial
Loans.
While SBA loans generally have the same underwriting requirements as the
Bank's other loans, they are sometimes for longer terms (7 to 25 years)
and have a higher loan-to-value ratio than the Bank typically accepts.
This risk is mitigated by the majority of the loans being secured by
real estate. If a default on a SBA loan occurs the Bank shares
proportionally in the collateral supporting the loan with the SBA which
guarantees the loan. At December 31, 2004, the Bank held $217.7 million
in 7(a) loans of which $148.1 million was guaranteed by the SBA. At
December 31, 2003, the Bank held $192.4 million in 7(a) loans of which
$129.4 was guaranteed by the SBA. At December 31, 2004 there no SBA
loans were past due 90 days and still accruing interest. There was one
SBA loan totaling $264,000 of which $198,000 was guaranteed by the SBA,
on non-accrual status. At December 31, 2003 there was one SBA
guaranteed loans totaling $96,000, of which $72,000 was guaranteed by
the SBA, on non-accrual status. There were no charge offs on SBA loans
during 2004 and 2003, and two charge offs totaling $26,000 on SBA
guaranteed loans in 2002.
The category entitled "Real Estate-Other" includes loans which are
secured by real estate and not classified as construction or commercial
loans. The majority of these loans are secured by commercial real
estate. The Bank offers residential mortgage loans on a limited basis.
Home equity lines of credit, included in Real Estate - Other, equaled
1.1% of the total loan portfolio at December 31, 2004 compared to 1.0%
at December 31, 2003. These loans are secured primarily by second trust
deeds on single family residences. The Bank typically requires a
loan-to-value ratio of no more than 80% for home equity loans. The
rates are adjustable monthly based on the Bank's internal reference
rate, and terms do not exceed ten years.
Real estate construction loans increased to $41,145,000 from $26,271,000
in 2003 and $32,412,000 in 2002. The Bank construction loan group
focuses on construction loans primarily for single family residences
valued at under $4,000,000 located in Northern California. Construction
loans are made to "owner/occupied" and "owner/users" of the properties
and occasionally to developers with a successful history of developing
projects in the Bank's market area. Loan-to-value ratios on
construction loans depend upon the nature of the property. The Bank's
policy is to require that the loan-to-value ratio ranges from 65% to 80%
and that the borrower have a cash equity interest in the land ranging
from 25%-50% or alternative collateral. The construction lending
business is subject to, among other things, the volatility of interest
rates, real estate prices in the area and the market availability of
conventional real estate financing to repay such construction loans. A
decline in real estate values and/or demand could potentially have an
adverse impact on this portion of the loan portfolio, and on the
earnings and financial condition of the Bank.
The Bank has a small portfolio of consumer loans, equaling 0.7% of the
total loan portfolio at December 31, 2004. Personal lines of credit and
overdraft protection are offered to customers. Regular underwriting
procedures are followed depending upon the type of loans. Revolving
lines are reviewed every two years. It is the Bank's policy to
collateralize all loans unless, in management's estimation, the credit
worthiness, cash flow and character of the borrower justify extension of
credit on an unsecured basis. Management recognizes the inherent risk in
making unsecured loans, but in management's judgment, such unsecured
loans are justified based on the credit worthiness and financial
strength of the borrowers. Management believes that its secured loans
are adequately collateralized to minimize loss in the event of default
in payment of interest or principal or decline in collateral values. In
making collateralized loans, the Bank's policy establishes a maximum
loan-to-collateral value ratio of from 50% to 100%, depending on the
type of collateral and the other factors supporting the loan.
The following table summarizes the Bank's loan maturities, by loan type,
at December 31, 2004. Loans are categorized by the maturity of the
final installment.
(In thousands)
Real Real
Estate Estate
-Other Construction Commercial Installment Total
------ ------------ ---------- ----------- ------
Loans Maturing in:
One Year or less:
Fixed rate $24,477 $27,013 $685 34 $52,209
Variable rate 2,915 11,340 6,090 5,844 26,189
One to five years:
Fixed rate 11,781 1,740 1,357 168 15,046
Variable rate 16,808 1,052 7,212 0 25,072
After five years:
Fixed rate 405 0 0 147 552
Variable rate 607,234 0 221,374 0 828,608
-------- ------- -------- ------ --------
TOTAL $663,620 $41,145 $236,718 $6,193 $947,676
======== ======= ======== ====== ========
Interest Rate Sensitivity
The Bank attempts to lend at competitive interest rates and to reduce
exposure to interest rate fluctuations by making most of its loans at
adjustable interest rates.
The following table summarizes the Bank's loan portfolio by contractual
repricing frequency and by loan type, at December 31, 2004. SBA loans
are considered commercial loans for this analysis. Most of the SBA
loans are secured by real estate. The Bank has approximately $398.4
million in adjustable loans which are priced at floor rate and are
considered fixed rate loans, deemed to reprice at their maturity date
for the purpose of this analysis.
Over 3 Over
3 Months 1 Year
Months through through Over 5
(In thousands) or less 1 Year 5 Years Years Total
------- ------- ------- ------ -----
Real Estate -
Other $181,487 $192,325 $243,789 $46,019 $663,620
Real Estate -
Construction 22,562 16,842 1,741 0 41,145
Commercial 230,407 1,350 4,797 164 236,718
Installment Loans 5,863 15 139 176 6,193
-------- -------- -------- ------- --------
TOTAL $440,319 $210,532 $250,466 $46,359 $947,676
======== ======== ======== ======= ========
Interest rate risk is reduced through the practice of making variable
interest rate loans which are tied to an outside rate index. These
loans "float", or adjust their rate as the interest rate environment
changes. As of December 31, 2004 and 2003 approximately 50.7% and
46.6%, respectively, of the Bank's loan portfolio was comprised of loans
with adjustable rates (excluding those which had reached their floors).
Allowance for Loan Losses
In accordance with its policy, the Bank maintains an allowance for loan
losses to provide for losses in the loan portfolio. The allowance for
loan losses is reviewed monthly and is based on an allocation for each
loan category (e.g. Real Estate, Commercial), plus an allocation for any
outstanding loans which have been classified by regulators or internally
for the "Watch List." Each loan that has been classified is
individually analyzed for the risk involved and an allowance provided
according to the risk assessment. In addition, management considers
such factors as known loan problems, historical loan loss experience,
loan concentrations, experience of loan losses in the banking industry,
evaluations made by bank regulatory agencies, assessment of economic
conditions and other appropriate data to identify risks in the loan
portfolio. Based upon this analysis of the allowance for loan losses
(which incorporates the growth in the loan portfolio during the year),
the Bank has, as of December 31, 2004, increased the allowance by 19.5%
to $8,719,000 compared to $7,299,000 at December 31, 2003. The provision
for loan losses for the year ended December 31, 2004 was $1,550,000. The
increase in the allowance was based upon the growth in the loan
portfolio during the year, the level of non-accrual loans and watch list
loans and current economic conditions. The ratio of allowance to total
loans outstanding (net of SBA loan guarantees) equaled 1.1% at December
31, 2004 and 1.2% at December 31, 2003.
Depending on future evaluations of the allowance in connection with
regulatory examinations, any changes in the factors management reviews,
as described above, and the amount of any loan losses that may be
incurred, further increases may be made in accordance with the Bank's
policy, and such increases will have an adverse effect on earnings.
The following table sets forth the changes in the allowance for loan
losses over the last five years and the relationship to loans
outstanding, net of the SBA guaranteed portion, at the end of those
periods.
(dollars in thousands)
Year Ended December 31,
ALLOWANCE FOR
LOAN LOSSES: 2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
Balance at Beginning
of Period $7,299 $6,389 $5,616 $4,681 $3,787
Provision for Loan
Losses Charged
to Expense 1,550 900 840 960 960
Less Charge-Offs:
Commercial 0 0 26 0 0
Real Estate-Other 135 0 0 25 66
Real Estate-
Construction 0 0 18 0 0
Consumer Installment 0 0 26 0 0
-------- -------- -------- -------- --------
Total Charge-offs 135 0 70 25 66
-------- -------- -------- -------- --------
Recoveries:
Commercial 0 0 0 0 0
Real Estate-Other 0 0 0 0 0
Real Estate-
Construction 5 10 3 0 0
Consumer Installment 0 0 0 0 0
-------- -------- -------- -------- --------
Total Recoveries 5 10 3 0 0
Net Charge-offs/
(Recoveries) 130 (10) 67 25 66
-------- -------- -------- -------- --------
Balance at the End
of the Period $8,719 $7,299 $6,389 $5,616 $4,681
======== ======== ======== ======== ========
Total Loans Outstanding
at End of Period-Net
of SBA Guarantees $799,620 $612,596 $493,305 $397,693 $378,141
-------- -------- -------- -------- --------
Ratio of Ending Allowance
to Ending Loans
Outstanding-Net of SBA
Loan Guarantees 1.1% 1.2% 1.3% 1.4% 1.2%
-------- -------- -------- -------- --------
AVERAGE TOTAL LOANS $834,525 $705,617 $535,894 $463,530 $399,170
-------- -------- -------- -------- --------
Ratio of Net Charge-offs/
(Recoveries) to Average
Loans Outstanding
during the Period (0.000)% (0.001)% 0.013% 0.005% 0.017%
-------- -------- -------- -------- --------
During 2004 there was one loan charged off for $135,000 and $5,000 was
recovered on a loan charge-off from 2002. During 2003 there were no
charge-offs on loans and $10,000 was recovered on a loan charge-off from
the previous year.
The following tables set forth the allocation of the allowance for loan
losses by loan type at the end of those periods indicated. The
allocation of the allowance will necessarily change whenever management
determines that the risk characteristics of the loan portfolio have
changed. It should not be construed that the amount allocated to a
particular segment is the only amount available for future charge-offs
that might occur within that segment, since the allowance is a general
reserve. In addition, the amounts allocated by segment may not be
indicative of future charge-off trends. The percentage of loans shown
in these schedules represents the percentage of loans in each loan
category to total loans.
(dollars in thousands)
December 31, December 31, December 31,
2004 2003 2002
------------- --------------- ---------------
% of % of % of
Category Amount Loans Amount Loans Amount Loans
- -------- ------ ----- ------ ----- ------ -----
Commercial $1,989 25.0% $2,089 28.9% $1,681 29.2%
Real Estate-
Construction 1,043 4.3 760 3.5 1,148 5.4
Real Estate-
Other 5,622 70.0 4,389 66.8 3,491 64.3
Consumer
Installment 65 0.7 61 0.8 69 1.1
------ ----- ------ ----- ------ -----
TOTAL $8,719 100.0% $7,299 100.0% $6,389 100.0%
====== ===== ====== ===== ====== =====
(dollars in thousands)
December 31, 2001 December 31, 2000
Category Amount % of Loans Amount % of Loans
Commercial $1,832 29.0% $1,194 26.8%
Real Estate-
Construction 1,216 10.5 1,057 10.5
Real Estate-
Other 2,533 60.1 2,383 62.1
Consumer
Installment 35 0.4 47 0.6
------ ----- ------ -----
TOTAL $5,616 100.0% $4,681 100.0%
====== ===== ====== =====
Non-Performing and Impaired Loans
Loans are generally placed on non-accrual status when the borrowers are
past due 90 days or when payment in full of principal or interest is not
expected. At the time a loan is placed on non-accrual status, any
interest income previously accrued but not collected is reversed.
Interest accruals are resumed on such loans only when they are brought
fully current with respect to interest and principal and when, in the
judgment of management, the loans are estimated to be fully collectible
as to both principal and interest. The Bank considers a loan impaired
when, based upon current information and events, it is probable that the
Bank will be unable to collect all amounts due according to the
contractual terms of the loan agreement.
The following table sets forth information regarding nonperforming
assets at the dates indicated.
December 31, 2004 2003 2002 2001 2000
------ ------ ------ ------ ------
(In thousands)
Nonperforming loans:
Non-accrual loans $312 $1,274 $3,035 $2,156 $2,097
Accruing loans past
due 90 days 777 0 0 0 158
Restructured loans 0 0 0 0 0
------ ------ ------ ------ ------
Total nonperforming loans 1,089 1,274 3,035 2,156 2,255
------ ------ ------ ------ ------
Other real estate owed 0 0 0 0 0
Total nonperforming/
impaired assets $1,089 $1,274 $3,035 $2,156 $2,255
====== ====== ====== ====== ======
Nonperforming assets to
total loans and other
real estate owned 0.11% 0.17% 0.51% 0.45% 0.51%
Nonperforming assets
to total assets 0.08% 0.15% 0.44% 0.38% 0.46%
The following table sets forth the classified loans at the end of each
of the last five years.
(In thousands) 2004 2003 2002 2001 2000
------ ------ ------ ------ ------
Substandard $6,842 $7,224 $8,460 $2,269 $3,071
Doubtful 47 0 1,043 705 0
Loss 0 0 0 0 0
Other real estate owned 0 0 0 0 0
------ ------ ------ ------ ------
Total classified assets $6,889 $7,224 $9,503 $2,974 $3,071
Classified to total loans and
other real estate owned 0.7% 1.0% 1.6% 0.6% 0.7%
Allowance for loan losses to
total classified 126.6% 101.0% 67.2% 188.8% 152.4%
The amount of interest foregone on the loans on non-accrual at December
31, 2004 totaled approximately $18,000 in 2004 and $11,000 in interest
was earned on those loans (prior to those loans being placed on
non-accrual) during the year. The amount of interest foregone on loans
on non-accrual at December 31, 2003 was $154,000 for 2003 and $70,000 in
interest was earned on those loans (prior to those loans being placed on
non-accrual) during the year.
On December 31, 2004, the Bank had $312,000 in non-accrual loans, of
which $264,000 was collateralized by real estate and $198,000 was
guaranteed by the SBA. As of December 31, 2003, the Bank had $1,274,000
in non-accrual loans, of which $1,244,000 was collateralized by real
estate and $72,000 was guaranteed by the SBA.
Potential non-performing loans are identified by management as part of
its ongoing evaluation and review of the loan portfolio. Based on such
reviews as of December 31, 2004, management has no knowledge or
information about any loan which has not been included in the preceding
tables which causes management to have doubts about the borrowers'
ability to comply with present repayment terms, such that the loan might
subsequently be classified as non-performing.
Other Real Estate Owned
In January 2004 the Bank took possession of a motel located in Arizona
through a foreclosure proceeding. This OREO was valued at $676,000 and
a charge-off of $135,000 was recorded against the allowance for loan
losses. This property was sold during the first quarter and a gain of
$183,000 was recorded. During 2003, the Bank did not hold any property
as Other Real Estate Owned (OREO).
Deposits
The Bank obtains deposits primarily from local businesses, loan
customers, shareholders and personal contacts by its business
development staff, officers and directors. The Bank does not have any
brokered deposits. At December 31, 2004, deposits totaled $791,025,000,
which was an increase of 20.2% from $658,320,000 at December 31, 2003.
Non-interest bearing demand deposits totaled $72,156,000 at December 31,
2004 as compared to $61,436,000 at December 31, 2003. Although these
deposits do not bear interest, some of the account holders utilize the
Bank's analysis system which gives earnings credits for their collected
average balances based on an internal index. The customer may then use
those earnings credits towards various account services such as escrow
accounting fees, courier services, payroll, and check printing paid to
third party vendors. The balances in this type of account tend to vary
since many of the accounts are business accounts with large dollar
transactions. The average balance for demand deposits increased to
$69,456,000 during 2004 from $59,311,000 during 2003.
Time deposits increased by $103.9 million or 25.7% in 2004. During 2004
and 2003, the Bank continued to offer highly competitive rates on time
deposits in order to fund growth in loans. Time deposits increased to
$507,910,000 at December 31, 2004 from $404,010,000 at December 31, 2003
and $352,073000 at December 31, 2002. Time deposits bear a higher
interest rate than other types of deposits and increase the Bank's
overall cost of funds. See, "Net Interest Income."
Money market deposits decreased by $27.1 million or 19.0% in 2004. The
balances maintained in these accounts also tend to vary. The Bank's
Sonoma Investor Reserve account is tied to a discretionary index which
reprices on a weekly basis. The Sonoma Investors Reserve accounts
generally offer rates which are competitive, and therefore, this account
has been very popular with depositors. However, due to the lower
interest rate environment, competition for this type of deposit has
increased and our balances have declined
Savings deposits increased by $46.9 million to $55,361,000 at December
31, 2004 due to the aggressive pricing on this product during the last
quarter of 2004. These deposits are liquid accounts but do not allow
for withdrawal by checks. Competitor's pricing was less competitive and
the savings account was very popular.
Management attempts to reduce risks from fluctuating interest rates by
limiting the maturities on certificates of deposit. The following table
sets forth, by time remaining to maturity, the Bank's time certificates
of deposit as of December 31, 2004.
(dollars in thousands) $100,000 and Over Less than $100,000
Amount Pct Amount Pct
Three Months or Less $72,294 31.6% $78,188 28.1%
3 to 6 months 71,789 31.4 83,671 30.0
6 months to 1 year 75,527 33.0 99,582 35.7
Over 1 year 9,228 4.0 17,631 6.2
-------- ----- -------- -----
Total $228,838 100.0% $279,072 100.0%
======== ===== ======== =====
At December 31, 2004 certificates of deposit of $100,000 or more
constituted approximately 28.9% of total deposits. The holders of these
deposits are primarily local customers of the Bank; however, during 2004
and 2003 the Bank did utilize an internet rate listing service for
financial institutions and did attract new funds to the Bank at rates
which approximated local consumer rates. At December 31, 2004 the
deposits obtained through the rate listing service totaled $49.5million
compared to $28.6 million at December 31, 2003.
While time deposits are rate sensitive, the Bank believes they are
relatively stable deposits, as they are obtained primarily from
customers with other banking relationships with the Bank.
Investment Portfolio
The following table shows the fair market value of the Bank's investment
portfolio at December 31, 2004, 2003 and 2002.
December 31, 2004 2003 2002
- ------------ ---- ---- ----
(In thousands)
Other Securities $100 $0 $0
U.S. Government-Sponsored Agencies 982 632 652
Federal Home Loan Bank Stock 9,020 5,961 2,740
Federal Reserve Stock 254 165 165
------- ------ ------
Total $10,356 $6,758 $3,557
======= ====== ======
Securities Pledged $1,000 $625 $625
The following table shows the yield of investments (at amortized cost)
by maturity ranges as of December 31, 2004. Federal Home Loan Bank and
Federal Reserve stock are excluded from this table.
(In thousands) Amount Yield
- -------------- ------ -----
One year or less $0 0.00%
Over one year through 5 years 1,100 3.05
Over 5 years through 10 years 0 0.00
Over 10 years 0 0.00
------ ----
Total $1,100 3.05%
====== ====
The yield on average investments (including Federal Home Loan Bank and
Federal Reserve Bank stock) equaled 4.25% during 2004 compared to 4.18%
in 2003. See, "Net Interest Income."
The Bank is required to own Federal Home Loan Bank ("FHLB") stock to
maintain its borrowing relationship. See, "Liquidity." The Bank
receives stock dividends quarterly based upon the earnings of the
Federal Home Loan Bank Stock. The Bank received an annualized yield of
4.33% during 2004 and 4.21% during 2003. The Federal Reserve Bank stock
had a yield of 6.00% during 2004.
Investments are carried at amortized cost or market value, depending on
whether they are held to maturity or available for sale. At December
31, 2004, $1,082,000 was classified as available for sale per accounting
definitions. At December 31, 2003, $632,000 was classified as available
for sale. The market value of securities equaled $1,082,000 and
$632,000 at December 31, 2004 and December 31, 2003, respectively.
Federal Home Loan Bank Advances
The Bank has a borrowing agreement with the Federal Home Loan Bank
(FHLB). The terms and conditions of the advances are negotiated at the
time of the advance. The majority of the advances have been for a term
of one year at rates tied to Prime. The FHLB will permit the Bank to
borrow up to 35% of the Bank's total assets provided that adequate
collateral has been pledge to the FHLB. The borrowing rates on FHLB
advances have been below the cost of attracting term deposits of similar
maturities; therefore, the Bank has borrowed from the FHLB to fund a
large portion of the loan growth during 2004. At December 31, 2004 the
Bank had pledged loans with an outstanding principal balance of $434.2
million which results in a borrowing capacity of $269.7 million. As of
December 31, 2004 the balance of advances from FHLB equaled $191.9
million up from $119.2 million at December 31, 2003. The Bank expects
to continue to use the line at the FHLB to fund growth in the future.
However, changes in the terms and conditions of FHLB advances may affect
the Bank's ability to borrow from the FHLB and/or the advantages to the
Bank from such borrowings.
Contractual Obligations
The following table shows the Company's significant fixed and
determinable contractual obligations as of December 31, 2004 by payment
date:
Payments due by period in thousands
Less More
than 1 to 3 to than
Total 1 year 3 years 5 years 5 years
----- ------ ------- ------- -------
Contractual Obligation
- ----------------------
Certificates of
Deposit Note 5* $507,910 $481,051 $26,811 $48 0
Federal Home Loan
Bank Note 6* 191,912 165,000 25,000 1,717 195
Capital Lease
Obligations 0 0 0 0 0
Operating Lease
Obligations Note 12* 11,731 1,360 2,596 2,524 5,251
Other Long term
Liabilities 0 0 0 0 0
-------- -------- ------- ------ ------
$711,553 $647,411 $54,407 $4,289 $5,446
======== ======== ======= ====== ======
* See notes to Financial Statements
Off-Balance Sheet Commitments
As of December 31, 2004 commitments to extend credit were the Bank's
only financial instruments with off-balance sheet risk. The Bank has
not entered into any contracts for financial derivative instruments such
as futures, swaps, etc. Loan commitments increased to $69.4 million at
December 31, 2004 from $56.5 million at December 31, 2003.
Standby letters of credit and commercial letters of credit are
conditional commitments issued by the Bank to guarantee the performance
of a customer to a third party or payment by a customer to a third
party. Those guarantees are primarily issued in international trade or
to support public and private borrowings arrangements, including bond
financing, equipment purchases and similar transactions. Except for
certain long-term guarantees, the majority of guarantees expire in one
to two years. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to
customers. Collateral supporting those commitments varies depending
upon the credit standing of the borrowers. The Bank routinely charges a
fee for these credit facilities.
Amount of Commitment Expiration Per Period
(in thousands)
Less
than 1 to 3 3 to 5
Total 1 year years years Thereafter
Commitments to
extend credit $69,431 $35,970 $33,461 $0 $0
Commercial and standby
letters of credit 633 333 300 0 0
------- ------- ------- - --
$70,064 $36,303 $33,761 $0 $0
======= ======= ======= == ==
Liquidity - Consolidated
Liquidity is a bank's ability to meet possible deposit withdrawals, to
meet loan commitments and increased loan demand, and to take advantage
of other investment opportunities as they arise. The Bank's liquidity
practices are defined in both the Asset and Liability Policy and the
Investment Policy. These policies define acceptable liquidity measures
in terms of ratios to total assets, deposits, liabilities and capital.
In addition, these policies include acceptable ranges for the Bank's
loans-to-deposits ratio. The Bank also compares its liquidity position
and ratios to those of its peer group.
The Bank is required to maintain specific reserve balances with the
Federal Reserve Bank. This is monitored on a daily basis to assure
compliance with regulatory requirements. The Office of the Comptroller
of the Currency ("OCC") also requires the Bank to establish adequate
liquidity policies and practices. Although defined liquidity
percentages are not specified in the OCC's regulations, they have been
incorporated in the Bank's policies and procedures.
The consolidated cash flows can be divided into three distinct areas:
operating, investing and financing. For the year ended December 31,
2004, the Company received $17.2 million from operating activities.
Investing activities used $209.6 million of which $204.5 million was
invested in loans. Financing activities provided $214,315,000 in funds.
The growth of the Bank was financed through short-term borrowings with
the Federal Home Loan Bank which provided $72.7 million and deposit
growth which provided $132.7 million in new funds.
Option exercises by directors and employees totaled $2.2 million in
2004. Additional-paid-in capital due to the payment by certain directors
of the difference between the option prices and the market value on date
of exercise of director options provided $6.9 million (not including the
tax effect of this transaction $872,000) in liquid funds during 2004.
See the Consolidated Statement of Cash Flows in the Consolidated
Financial Statement and Item 11, Executive Compensation, Stock Option
Plan for additional details.
Cash and due from banks, interest bearing deposits in banks and federal
funds sold totaled $116,504,000 or 10.8% of total assets at December 31,
2004 compared to $94,574,000 or 11.1% of total assets at December 31,
2003.
At December 31, 2004 and 2003, the Bank's ratio of loans-to-deposits was
114.5% and 112.7% respectively which were in compliance with its
internal guideline of 125%. This ratio is higher than peers. The large
portfolio of SBA 7(a) loans, which is readily saleable within a two week
period, allows the Bank to maintain a higher loan-to-deposit ratio.
The Bank has two federal funds lines of credit totaling $26,000,000 with
two financial institutions. These lines are available on a short term
basis to meet cash demands that may arise. The Bank also has a
borrowing relationship with the Federal Home Loan Bank, which has
provided a source of funds for loan growth and liquidity purposes. For
further discussion see "Federal Home Loan Bank".
The Bank funded loan growth during 2004 and 2003 through increased
interest-bearing deposits (mainly time deposits) and borrowing from the
Federal Home Loan Bank. A portion of the FHLB line has been set aside
as a contingency source of liquidity and is not available for normal
operations. Deposits increased during 2004 and 2003 largely due to
deposit campaigns which offered higher rates to attract new time
deposits. This trend is expected to continue, although there can be no
assurance that deposits will continue to grow at the current rate in the
existing market areas.
Liquidity - Parent Company Only
At present, the Corporation's primary sources of liquidity are from
short term investments on its capital, proceeds from exercise of stock
options, and dividends from the Bank. The Bank's ability to pay
dividends to the Corporation is subject to the restrictions of the
national banking laws and, under certain circumstances, the approval of
the OCC. See Item 5, "Dividends." In addition, the Federal Reserve Act
prohibits the Bank from making loans to its "affiliates", including the
Corporation, unless certain collateral requirements are met.
At December 31, 2004, the Corporation had non-interest and interest
bearing cash balances of $10,698,000, which management believes is
adequate to meet the Corporation's foreseeable operational expenses.
Return on Equity and Assets
The following table shows key financial ratios for the years ended
December 31, 2004 and 2003.
Year Ended December 31,
2004 2003
Return on Average Assets 1.5% 1.5%
Return on Average
Shareholders' Equity 18.2% 18.8%
Average Shareholders' Equity
as a Percent of Average Assets 8.2% 8.1%
Dividend Payout Ratio N/A N/A
Effects of Inflation
Inflation affects the Bank and the banking business generally because of
its effect on interest rates and loan demand. To offset inflation and
the resulting changes in interest rates and market demands, the Bank
attempts to maintain liquid interest bearing assets and to manage its
assets and liabilities such that they can be repriced within a short
period of time. In addition to its effect on market conditions and
interest rates, inflation increases the Corporation's cost of
operations. The rate of inflation has maintained a very low annual rate
during the last few years.
Capital
The Corporation and the Bank are required by the Federal Reserve Board
and the Comptroller of the Currency to maintain adequate capital. The
Board of Governors of the Federal Reserve System has adopted risk-based
capital guidelines for member banks and bank holding companies which
provide minimum uniform capital adequacy requirements for bank holding
companies. The OCC has also adopted additional capital requirements
which are applicable to national banks, such as the Bank. See "Item 1,
Description of Business, Supervision and Regulation-Capital Regulations
and Item 8, Consolidated Financial Statements, Note 13."
The Bank and the Corporation are considered "Well-Capitalized" under the
"risk-based" capital methodology. The Bank's leverage capital ratio was
7.6% of its total assets at December 31, 2004. The Bank's total
risk-based capital ratio was 10.8% at December 31, 2004; the minimum
acceptable level at December 31, 2003 was 8.0%. The Corporation's
leverage capital ratio was 8.6%, with total risk-based capital equaling
12.1%, at December 31, 2004.
Income Taxes
The 2004 provision for income tax equaled $9,468,000 versus $7,366,000
in 2003 and $6,096,000 in 2002. The increase in taxes results from
higher pretax income and an application of a higher Federal tax rate
associated with the income level. The overall effective tax rate was
39.8% during 2004 compared to 39.5% in 2003 and 39.5% in 2002. See,
"Item 8, Consolidated Financial Statements, Note 7."
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Bank's financial performance is impacted by, among other factors,
interest rate risk and credit risk. The Bank utilizes no derivatives to
mitigate its credit risk, relying instead on loan review and adequate
loan loss reserves. See Allowance for Loan Losses.
Interest rate risk is the risk of loss in value due to changes in
interest rates. Since virtually all of the Corporation's interest rate
risk exposure lies at the Bank level, this risk is addressed by the
Bank's Asset Liability Committee ("ALCO"), which includes members of the
Board of Directors and senior officers of the Bank. ALCO attempts to
manage the various components of the Corporation's balance sheet to
minimize the impact of sudden and sustained changes in interest rates on
portfolio values and net interest income.
A fundamental objective is to manage its assets and liabilities to
maximize the economic value of the Bank while maintaining adequate
liquidity and minimizing exposure to interest rate risk. Management
believes an acceptable degree of exposure to interest rate risk results
from the management of assets and liabilities through maturity, pricing
and mix with the goal of limiting the Bank's exposure to interest rate
risk. The Bank's profitability is dependent to a large extent upon its
net interest income. The Bank is subject to interest rate risk to the
degree that its interest-earning assets reprice differently than its
interest-bearing liabilities.
Interest rate sensitivity analysis is used to measure the Bank's
interest rate risk by computing estimated changes in the net present
value ("NPV") of its cash flows from assets, liabilities and off-balance
sheet items in the event of a range of assumed changes in market
interest rates. NPV represents the market value of portfolio equity and
is equal to the market value of assets minus the market value of
liabilities, with adjustments made for off-balance sheet items. This
analysis assesses the risk of loss in market rate sensitive instruments
in the event of sudden or sustained increases and decreases in market
interest rates of 100 basis points or more. The Bank has no trading
securities.
On a monthly basis, management prepares an analysis of interest rate
risk exposure. Such analysis calculates the change in net interest
income given a change in general interest rates of 100 and 200 basis
points up or down. All changes are measured in dollars and are compared
to projected net interest income, and the value of the Bank's equity is
calculated by discounting cash flows associated with the Bank's assets
and liabilities. The following table summarizes the simulated change in
net interest income based on the twelve months ending December 31, 2004,
given a change in general interest rates of 100 and 200 basis points up
or down.
Change in Estimated Estimated Change in
Interest Rate Net Interest Income Net Interest Income
(basis points) (000) (000)
+200 $40,324 $(564)
+100 40,776 (112)
Base Scenario 40,888 0
- -100 41,024 136
- -200 41,440 552
The model utilized by management to create the report presented above
makes numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit runoff and should not be relied upon
as indicative of actual future results. Computations do not contemplate
any actions that ALCO could undertake in response to changes in interest
rates. Actual results could differ significantly from those estimates,
which would result in significant differences in the calculated
projected change.
Interest rate risk management is a function of the repricing
characteristics of the portfolio of assets and liabilities. Interest
rate risk management focuses on the maturity structure of assets and
liabilities and their repricing characteristics during periods of
changes in market interest rates. Effective interest rate risk
management seeks to ensure that both assets and liabilities respond to
changes in interest rates within an acceptable time frame, thereby
minimizing the effect of interest rate movements on net interest income.
Interest rate sensitivity is measured as the difference between the
volume of assets and liabilities in the current portfolio that is
subject to repricing at various time horizons. The differences are known
as interest rate sensitivity gaps.
The following table represents the Corporation's interest rate
sensitivity profile as of December 31, 2004. Assets, liabilities and
shareholders' equity are classified by the earliest possible repricing
opportunity or maturity date, whichever first occurs.
Balance Sheet
Over 3 Over Non-rate
months 1 year sensitive
Through through through or over
(in thousands) 3 months 1 year 5 years 5 years Total
-------- ------- ------- ------- ------
Assets
Fed Funds sold $95,498 $95,498
Investment securities $1,082 $9,274 10,356
Loans 440,319 $210,532 250,466 45,506 946,823
Non-interest-earning
assets (net of allowance
for loan losses 28,247 28,247
-------- -------- -------- ------- ----------
$535,817 $210,532 $251,548 $83,027 $1,080,924
-------- -------- -------- ------- ----------
Liabilities &
Shareholders' Equity
Time deposits $100,000
and over $72,294 $147,316 $9,228 $228,838
Other interest-bearing
deposits and liabilities 454,147 183,253 44,300 $243 681,943
Non-interest bearing
liabilities 72,156 72,156
Other Liabilities &
Shareholders' Equity 97,987 97,987
-------- -------- -------- ------- ----------
$526,441 $330,569 $53,528 $170,386 $1,080,924
-------- -------- -------- ------- ----------
Interest Rate
Sensitivity (1) $9,376 $(120,037) $198,020 $(87,359)
Cumulative Interest
Rate Sensitivity $9,376 $(110,661) $87,359 0
(1) Interest rate sensitivity is the difference between interest rate
sensitive assets and interest rate sensitive liabilities within the
above time frames.
Management believes that the Bank is fairly well balanced in terms of
repricing schedule. Prime based loans approximate money market accounts
with both repricing relatively quickly. Time deposits and loans tied to
COFI reprice on a similar schedule with approximately the same balances
repricing. In the past the Bank was more asset sensitive; however, with
the increase in variable rate advances from the FHLB the Bank has become
more liability sensitive in the short term. When a Bank is considered
asset sensitive it means that in a declining interest rate environment
there usually is an immediate negative impact on the Bank's net interest
margin, since assets reprice to lower rates more quickly than
liabilities. In a raising interest rate environment, the earnings are
positively affected immediately and the converse is true of a liability
sensitive Bank. The Bank continually monitors its interest rate
sensitivity as part of the Bank's planning process.
The Corporation and the Bank do not at this time engage in hedging
transactions (interest rate futures, caps, swap agreements, etc.).
ITEM 8. Financial Statements and Supplementary Data
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2004, 2003 and 2002
AND
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2003
(in thousands, except share amounts)
2004 2003
------------ ---------
ASSETS
Cash and cash equivalents
Cash and due from banks $ 21,006 $ 20,078
Federal funds sold 95,498 74,496
------------ ---------
116,504 94,574
Investment securities available-for-sale 1,082 632
Federal Home Loan Bank (FHLB) stock, at cost 9,020 5,961
Federal Reserve Bank stock, at cost 254 165
Loans, net 938,104 733,857
Premises and equipment 2,709 1,586
Accrued interest receivable and other assets 13,251 11,451
------------ ---------
Total assets $ 1,080,924 $ 848,226
============ =========
LIABILITIES
Deposits $ 791,025 $ 658,320
FHLB advances 191,912 119,211
Accrued interest payable and other liabilities 8,109 3,162
------------ ---------
Total liabilities 991,046 780,693
------------ ---------
STOCKHOLDERS' EQUITY
Preferred stock, no par value; 10,000,000
shares authorized; none issued or outstanding - -
Common stock, no par value; 40,000,000 shares
authorized;9,854,067 and 9,039,450 shares issued
and outstanding in 2004 and 2003 47,302 34,653
Additional paid-in capital 7,681 1,702
Accumulated other comprehensive (loss) income (10) 2
Retained earnings 34,905 31,176
----------- ---------
Total stockholders' equity 89,878 67,533
----------- ---------
Total liabilities and stockholders' equity $ 1,080,924 $ 848,226
=========== =========
See accompanying notes.
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2004, 2003 and 2002
(in thousands, except earnings per share)
2004 2003 2002
-------- -------- --------
INTEREST INCOME
Loans $ 52,918 $ 43,750 $ 40,315
Federal funds sold and investment
securities 1,484 982 1,141
-------- -------- --------
Total interest income 54,402 44,732 41,456
-------- -------- --------
INTEREST EXPENSE
Interest on deposits 12,984 12,787 15,101
Interest on borrowings 2,302 1,137 740
-------- -------- --------
Total interest expense 15,286 13,924 15,841
-------- -------- --------
NET INTEREST INCOME 39,116 30,808 25,615
PROVISION FOR LOAN LOSSES 1,550 900 840
-------- -------- --------
Net interest income after provision
for loan losses 37,566 29,908 24,775
-------- -------- --------
NONINTEREST INCOME
Service charges on deposits 471 556 546
Gain on sale of loans 1,294 1,387 1,015
Gain on sale of OREO 183 - -
Other 914 951 773
-------- -------- --------
Total noninterest income 2,862 2,894 2,334
-------- -------- --------
NONINTEREST EXPENSES
Salaries and benefits 10,464 8,837 6,981
Occupancy 1,422 1,223 1,114
Equipment 948 760 606
Outside customer services 368 342 399
Deposit and other insurance 467 352 329
Professional fees 582 394 360
Advertising 342 296 268
Other administrative 2,047 1,961 1,621
-------- -------- --------
Total noninterest expenses 16,640 14,165 11,678
-------- -------- --------
INCOME BEFORE PROVISION FOR INCOME TAXES 23,788 18,637 15,431
PROVISION FOR INCOME TAXES 9,468 7,366 6,096
-------- -------- --------
NET INCOME $ 14,320 $ 11,271 $ 9,335
======== ======== ========
EARNINGS PER COMMON SHARE $ 1.46 $ 1.22 $ 1.01
======== ======== ========
EARNINGS PER COMMON SHARE, ASSUMING DILUTION $ 1.30 $ 1.06 $ 0.89
======== ======== ========
See accompanying notes.
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2004, 2003 and 2002
(in thousands, except share amounts)
Accumulated
Common Stock Additional Other
------------------- Paid-in Comprehensive Retained Comprehensive
Shares Amount Capital Income (Loss) Earnings Total Income
--------- ------- ---------- ------------- -------- ------- -------------
Balance, December 31, 2001 3,973,263 $21,946 $ 786 $ (1) $ 21,566 $44,297
Net income - - - - 9,335 9,335 $ 9,335
Unrealized holding gains
(losses) arising during
period - - - 18 - 18 18
Income tax impact on
Unrealized holding
gains (losses) - - - (7) - (7) (7)
5% stock dividend 198,447 5,482 - - (5,482) - -
Stock options exercised 9,204 101 - - - 101 -
Payout of fractional
Shares - - - - (6) (6) -
--------- ------- ---------- ------------ -------- ------- ------------
Balance, December 31, 2002 4,180,914 $27,529 $ 786 $ 10 $ 25,413 $53,738 $ 9,346
--------- ------- ---------- ------------ -------- ------- =============
Net income - - - - 11,271 11,271 $ 11,271
Unrealized holding gains
(losses) arising during
period - - - (12) - (12) (12)
Income tax impact on
Unrealized holding
gains (losses) - - - 4 - 4 4
5% stock dividend 208,781 5,501 - - (5,501) - -
Stock options exercised
including related tax
benefit 247,922 1,623 916 - - 2,539 -
Payout of fractional shares - - - - (7) (7) -
Effect of two for one
stock split 4,401,833 - - - - - -
--------- ------- ---------- ------------ -------- ------- ------------
Balance, December 31, 2003 9,039,450 $34,653 $ 1,702 $ 2 $ 31,176 $67,533 $ 11,263
--------- ------- ---------- ------------ -------- ------- ============
Net income - - - - 14,320 14,320 $ 14,320
Unrealized holding gains
(losses) arising during
period - - - (22) - (22) (22)
Income tax impact on
Unrealized holding gains
(losses) - - - 10 - 10 10
5% stock dividend 468,759 10,585 - - (10,585) - -
Stock options exercised 375,358 2,228 - - - 2,228 -
Additional capital
contributed by
non-officer directors,
net of tax impact - - 5,979 - - 5,979 -
Shares repurchased and
cancelled (29,500) (164) - - - (164) -
Payout of fractional
shares - - - - - (6) (6)
--------- ------- ---------- ------------ -------- ------- ------------
Balance, December 31, 2004 9,854,067 $47,302 $ 7,681 $ (10) $ 34,905 $89,878 $ 14,308
========= ======= ========== ============ ======== ======= ============
See accompanying notes.
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2004, 2003 and 2002
in thousands)
2004 2003 2002
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 14,320 $ 11,271 $ 9,335
Adjustments to reconcile net
income to net cash from
operating activities:
Depreciation and
amortization 643 524 437
FHLB stock dividend (317) (165) (64)
Change in deferred income taxes (197) (476) (152)
Provision for loan losses 1,550 900 840
Gain on sales of loans (1,294) (1,387) (1,015)
Tax impact from stock options
exercised (872) 916 -
Changes in operating assets and
liabilities:
Net change in deferred loan
fees and discounts 15 (626) (538)
Change in interest receivable
and other assets (1,603) (635) (1,050)
Change in accrued interest
payable and other liabilities 4,947 (120) 513
--------- --------- ---------
Net cash from operating
activities 17,192 10,202 8,306
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of
available-for-sale securities 631 13 1,000
Net change in interest bearing
deposits - 198 100
Net increase in loans (204,518) (146,282) (119,219)
Purchase of leasehold improvements
and equipment, net (1,766) (750) (765)
Purchase of Federal Reserve
Bank stock (89) - (2)
Purchases of FHLB stock (2,742) (3,057) (2,077)
Purchase of available-for-sale
securities (1,093) - (639)
--------- --------- ---------
Net cash from investing
activities (209,577) (149,878) (121,602)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 132,705 80,736 75,448
Net change in FHLB advances 72,701 64,435 42,974
Payout of fractional shares (6) (7) (6)
Repurchase of common stock (164) - -
Contributed capital 6,851 - -
Proceeds from exercise of stock
options 2,228 1,623 101
--------- --------- ---------
Net cash from financing
activities 214,315 146,787 118,517
--------- --------- ---------
NET CHANGE IN CASH AND CASH
EQUIVALENTS 21,930 7,111 5,221
CASH AND CASH EQUIVALENTS,
beginning of year 94,574 87,463 82,242
--------- --------- ---------
CASH AND CASH EQUIVALENTS,
end of year $ 116,504 $ 94,574 $ 87,463
========= ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 14,754 $ 13,984 $ 15,806
Income taxes $ 6,580 $ 7,438 $ 6,190
See accompanying notes.
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Description of operations - Northern Empire Bancshares (the Company) is a
bank holding company that conducts its business through its wholly-owned
subsidiary, Sonoma National Bank (the Bank). The Bank is headquartered in
Santa Rosa, California, and operates eight branches in communities located
in Sonoma and Marin Counties in California. Its primary source of revenues
is derived from providing commercial and real estate loans to
predominantly small and middle-market businesses located in Northern
California and Arizona. The Bank is a Preferred Lender under the Small
Business Administration's (SBA) Loan Guarantee Program.
Principles of consolidation - All significant, intercompany transactions
and accounts between Northern Empire Bancshares and its wholly-owned
subsidiary, Sonoma National Bank, have been eliminated in consolidation.
Use of estimates - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenues and expenses and the
disclosure of contingent assets and liabilities. The amounts estimated
could differ from actual results.
Cash and cash equivalents - For purposes of reporting cash flows, cash and
cash equivalents consist of cash on hand, amounts due from banks and
federal funds sold with. Generally, federal funds are sold overnight.
Substantially all cash and cash equivalents held in other financial
institutions exceed existing deposit insurance coverage.
Investment securities - Unrealized losses on individual available-for-sale
securities that are deemed to be other than temporary are recorded in
earnings as realized losses. There have been no investments that have been
other than temporary impaired during the last three years. The Bank
classifies and accounts for debt and equity securities as follows:
Available-for-sale: Debt and equity securities that will be held for
indefinite periods of time, including securities that may be sold in
response to changes in market interest or prepayment rates, needs for
liquidity and changes in the availability of and the yield of
alternative investments, are classified as available-for-sale. After
amortization or accretion of any premiums or discounts, these assets
are carried at fair value. Fair value is determined using published
quotes as of the close of business. Unrealized gains and losses are
excluded from earnings and reported net of tax as a separate component
of stockholders' equity.
Premises and equipment - Premises and equipment are stated at cost and
depreciated or amortized using the straight-line method over the shorter
of the estimated useful lives of the assets, which are three to seven
years, or the term of the applicable lease. Depreciation and amortization
expenses for the years ended December 31, 2004, 2003 and 2002, were
$643,000, $524,000 and $437,000.
Advertising - Advertising costs are charged to expense during the year in
which they are incurred.
Stock-based compensation - The Company accounts for stock-based employee
compensation arrangements in accordance with the provisions of Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees
(APB No. 25) and complies with the disclosure provisions of Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123). Under APB No. 25, compensation expense is the
excess, if any, of the fair value of the Company's stock at a measurement
date over the amount that must be paid to acquire the stock. SFAS No. 123
requires a fair value method to be used when determining compensation
expense for stock options and similar equity instruments. SFAS No. 123
permits a company to continue to use APB No. 25 to account for stock-based
compensation to employees, but pro forma disclosures of net income and
earnings per share must be made as if SFAS No. 123 had been adopted in its
entirety.Stock options issued to non-employees are valued under the
provisions of SFAS No. 123.
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:
(dollars in thousands, except per 2004 2003 2002
share amounts) -------- -------- --------
Net income for the year $ 14,320 $ 11,271 $ 9,335
Compensation expense, net of tax effect 1,347 698 1,052
-------- -------- --------
Pro forma net income $ 12,973 $ 10,573 $ 8,283
======== ======== ========
Earnings per share as reported $ 1.46 $ 1.22 $ 1.01
Pro forma earnings per common share $ 1.33 $ 1.14 $ 0.90
Earnings per share, assuming dilution
as reported $ 1.30 $ 1.06 $ 0.89
Pro forma earnings per common share,
assuming dilution $ 1.17 $ 1.00 $ 0.79
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 2002
------------- ---------
Dividends 0% 0%
Expected volatility 26.82% - 38.21% 16.51%
Risk-free interest rate 2.57% - 4.31% 4.94%
Expected life 3 - 10 years 10 years
Income taxes - The Company and the Bank file consolidated federal income
tax returns and combined state tax returns for California and Arizona.
Income taxes are recognized under the asset and liability method using
enacted tax rates and are composed of taxes on financial accounting income
that is adjusted for requirements of current tax law and deferred taxes.
Deferred taxes are the expected future tax consequences of temporary
differences between the financial statement carrying amounts and tax bases
of existing assets and liabilities.
Recent accounting pronouncements - In December 2004, the Financial
Accounting Standard Board ("FASB") issued "Statement of Financial
Accounting Standards ("SFAS") No. 123 (revised 2004), Accounting for
Stock Based Compensation. This statement supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and its related implementation
guidance. This Statement requires a public entity to measure the cost of
employee services received in exchange for an award of equity instruments
based on the grant-date fair value of the award. The grant-date fair value
of employee share options and similar instruments will be estimated using
option-pricing models adjusted for the unique characteristics of those
instruments. That cost will be recognized over the period during which an
employee is required to provide service in exchange for the award-the
requisite service period (usually the vesting period). SFAS 123R requires
the Company to adopt the new accounting provisions beginning in the third
quarter of 2005. Management estimates that the effect of adopting this
Statement can not be determined at this time.
Loans - Loans are carried at amortized cost. The Bank's portfolio consists
primarily of commercial and real estate loans generally collateralized by
first and second deeds of trust on real estate, as well as business assets
and personal property. Interest income is accrued daily on the outstanding
loan balances using the simple interest method. Loans are generally placed
on nonaccrual status when the borrowers are past due 90 days and when full
payment of principal or interest is not expected. At the time a loan is
placed on nonaccrual status, any interest income previously accrued but
not collected is reversed against interest income. Interest accruals are
resumed on such loans only when they are brought fully current with
respect to interest and principal and when, in the judgment of management,
the loans are estimated to be fully collectible as to both principal and
interest.
The Bank charges loan origination and commitment fees. Loan origination
fees are deferred and amortized to interest income using the interest
method. Loan commitment fees are amortized to interest income over the
commitment period. The Bank incurs loan costs when originating some loans.
These costs are deferred and expensed over the life of the loan. The
deferred costs and fees are reported as net on the balance sheet.
Sales and servicing of Small Business Administration (SBA) loans - The
Bank originates loans to customers under SBA's 7(a) and 504 programs. The
7(a) program generally provide for SBA guarantees of 75% to 85% of each
loan and the Bank has the option to sell the guaranteed portion of each
loan and retain the unguaranteed portion in its own portfolio. Under the
504 program the bank funds approximately 55% of the loan.
Periodically a few SBA 7(a) loans are sold in the secondary market. Gains
on these sales are earned through the sale of the guaranteed portion of
the loan for an amount in excess of the adjusted carrying value of the
portion of the loan sold. The Bank allocates the carrying value of such
loans between the portion sold, the portion retained and a value assigned
to the right to service the loan. The difference between the adjusted
carrying value of the portion retained and the face amount of the portion
retained is amortized to interest income over the life of the related loan
using a method that approximates the interest method.
Servicing assets are recognized as separate assets when rights are
acquired through sale of loans. The amount assigned to the right to
service the loan is based on its fair value. Fair value is determined by
a valuation model that calculates the present value of estimated net
servicing income. The valuation model incorporates assumptions that market
participants would use in estimated future net servicing income, such as
the cost to service, a discount rate, an earnings rate, ancillary income
and prepayment speeds. Capitalized servicing rights are reported in other
assets and are amortized into non-interest income in proportion to, and
over the period of, the estimated future net servicing income of the
underlying loans. Management periodically evaluates the servicing assets
for impairment and does not believe any impairment exists at December 31,
2004 and 2003.
Servicing fee income is recorded for fees earned for servicing loans. The
fees are based on a contractual percentage of the outstanding principal;
or a fixed amount per loan and are recorded as income when earned. The
amortization of mortgage servicing rights is netted against loan servicing
fee income.
Allowance for loan losses - The allowance for loan losses is established
as losses are estimated through a provision for loan losses charged to
earnings. Loan losses are charged against the allowance when management
believes the uncollectibility of a loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by
management and is based upon management's periodic review of the
collectibility of the loans in light of historical experience, the nature
and volume of the loan portfolio, adverse situations that may affect the
borrower's ability to repay, estimated value of any underlying collateral
and prevailing economic conditions. This evaluation is inherently
subjective as it requires estimates that are susceptible to significant
revision as more information becomes available.
The allowance consists of specific, general and unallocated components.
The specific component relates to loans that are classified as either:
doubtful, substandard or special mention. For such loans that are also
classified as impaired, an allowance is established when the collateral
value of the impaired loan is lower than the carrying value of that loan.
The general component covers non-classified loans and is based on
historical loss experience adjusted for qualitative factors. An
unallocated component is maintained to cover uncertainties that could
affect management's estimate of probable losses. The unallocated component
of the allowance reflects the margin of imprecision inherent in the
underlying assumptions used in the methodologies for estimating specific
and general losses in the portfolio.
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by management
in determining impairment include payment status, collateral value, and
the probability of collecting scheduled principal and interest payments
when due. Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Management determines
the significance of payment delays and payment shortfalls on a case-by-
case basis, taking into consideration all of the circumstances surrounding
the loan and the borrower, including the length of the delay, the reasons
for the delay, the borrower's prior payment record, and the amount of the
shortfall in relation to the principal and interest owed. Impairment is
measured on a loan by loan basis for commercial and construction loans by
either the present value of expected future cash flows discounted at the
loan's effective interest rate, the loan's obtainable market price, or the
fair value of the collateral if the loan is collateral dependent.
Earnings per share - Earnings per share (EPS) are computed using the
weighted average number of common shares outstanding during the year.
Diluted earnings per share are computed by adjusting the common shares
outstanding for the assumed conversion of all potentially dilutive stock
options under the treasury stock method. The computation of basic and
dilutive earnings per share is retroactively adjusted for all periods
presented to reflect the change in the capital structure resulting from
a two for one stock split and stock dividends.
The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations dollars in
thousands, except share date:
(dollars in thousands, except Year Ended December 31,
share data) ---------------------------------------
2004 2003 2002
----------- ----------- -----------
Basic:
Net income $ 14,320 $ 11,271 $ 9,335
=========== =========== ===========
Weighted average common shares
outstanding 9,777,906 9,253,526 9,206,997
=========== =========== ===========
Earnings per common share $ 1.46 $ 1.22 $ 1.01
=========== =========== ===========
Assuming dilution:
Weighted average common shares
outstanding 9,777,906 9,253,526 9,206,997
Stock options 1,271,400 1,333,153 1,254,934
----------- ----------- -----------
11,049,306 10,586,679 10,461,931
=========== =========== ===========
Diluted earnings per common share $ 1.30 $ 1.06 $ 0.89
=========== =========== ===========
Comprehensive income - Comprehensive income is composed of net income and
changes in equity from non-stockholder sources. These non-stockholder
sources are reported net of tax and include unrealized gains and losses on
certain investments in debt and equity securities. Accumulated balances of
these non-stockholder sources are reflected as a separate item in the
equity section of the balance sheet.
Federal Home Loan Bank system - As a member of the Federal Home Loan Bank
(FHLB), the Company is required to maintain an investment in the FHLB's
capital stock. The investment is carried at cost. Interest rates on the
advances from the FHLB currently range from 2.31% to 5.63% and mature
through 2033. To collateralize these advances, the Bank has pledged loans
to FHLB with outstanding principal balances of $423,437,000, which results
in a borrowing capacity of $269,729,000.
Significant Group Concentration of Credit Risk - Most of the Company's
activities are with customers located in Northern California and Arizona.
Note 2 discusses the types of securities that the Company invests in. Note
3 discusses the types of lending the Company engages in. The Company does
not have any significant concentrations to any one industry or customer.
Derivatives and hedging - The Bank's investment policy does not allow
derivatives, interest swaps, caps, collars, or hedging investments.
Off-Balance Sheet Credit Related Financial Instruments - In the ordinary
course of business, the Company has entered into commitments to extend
credit, including commitments under commercial letters of credit and
standby letters of credit. Such financial instruments are recorded when
they are funded.
Reclassifications - Certain reclassifications were made to prior year's
presentations to conform to the current year.
NOTE 2 - INVESTMENT SECURITIES AVAILABLE FOR SALE
As required by law, investment securities with a par value of $1,000,000
were pledged to secure deposits and borrowings. The securities held at
December 31, 2004, mature in 2007.
Gross Unrealized Market
(dollars in thousands) Cost (Losses)/Gains Value
------- ---------------- -------
At December 31, 2004:
Other Securities $ 100 - $ 100
U.S. Government Agency Securities 1,000 (18) 982
------- ------- -------
Total Investment Securities
- December 31, 2004 $ 1,100 $ (18) $ 1,082
======= ======= =======
At December 31, 2003:
U.S. Government Agency Securities $ 628 $ 4 $ 632
======= ======= =======
There were no securities with unrealized losses for twelve consecutive
months or more at December 31, 2004.
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES
The Bank's lending activities are concentrated primarily in Northern
California and in Arizona. There were no industry or borrower group
concentrations at December 31, 2004 and 2003.
(dollars in thousands) 2004 2003
--------- ---------
Real estate loans - mortgage $ 663,620 $ 495,538
Real estate loans - construction 41,145 26,271
Commercial loans 236,718 214,000
Consumer installment loans including overdrafts 6,193 6,185
--------- ---------
947,676 741,994
Deferred loan fees and discount (853) (838)
Allowance for loan losses (8,719) (7,299)
--------- ---------
$ 938,104 $ 733,857
========= =========
A summary of activity in the allowance for loan losses is as follows:
(dollars in thousands) 2004 2003 2002
------- ------- -------
Balance, beginning of year $ 7,299 $ 6,389 $ 5,616
Provision for loan losses 1,550 900 840
Recoveries of previously charged-off loans 5 10 -
Loans charged-off (135) - (67)
------- ------- -------
$ 8,719 $ 7,299 $ 6,389
======= ======= =======
At December 31, 2004, there were two loans totaling $311,000 in nonaccrual
status, and there were nine loans totaling $1,274,000 in nonaccrual status
at December 31, 2003. The averaged recoded investment in impaired loans
was $511,000, $1,152,000 and $1,755,000 for the years ended December 31,
2004, 2003 and 2002. Interest foregone on these loans totaled $18,000,
$154,000 and $228,000, respectively. Interest income recognized on
impaired loans was $11,000, $5,000 and $65,000 for the years ended
December 31, 2004, 2002 and 2001, respectively. That portion of the
allowance for loan losses associated with these nonaccrual loans was
$46,000 and $64,000, respectively. At December 31, 2004 there was one
loan of $777,000 past due 90 days and still accruing interest. This loan
was guaranteed by the SBA and was paid in full subsequent to year end.
There were no loans past due 90 or more days and still accruing interest
at December 31, 2003.
The Bank has the option to sell to outside investors the guaranteed
portion of SBA loans while retaining the unguaranteed portion in its loan
portfolio. The SBA guarantee is transferred to the buyer and the Bank
retains the loan's servicing function. Loans serviced for others are not
included in the accompanying consolidated balance sheets. The unpaid
principal balances of SBA loans serviced for others were $52,469,000 and
$49,505,000 guaranteed by the SBA at December 31, 2004 and 2003, of which
the Bank's retained interests in those loans ranged from 10% to 54%. The
balance of capitalized servicing rights included in other assets at
December 31, 2004 and 2003, was $1,406,000 and $1,255,000. The fair value
of these rights was determined using discount rates of 6.0% to 6.50% in
2004 and 6.5% to 7% in 2003, and prepayment speeds ranging from 6% to 15%
depending upon the stratification of the specific right. The amortized
servicing rights for the years ended December 31, 2004, 2003 and 2002,
totaled $380,000, $159,000 and $77,000. Losses on these loans are shared
between the Bank and the SBA on a pro rata basis. SBA guaranteed loans
that could be sold in the future totaled $148,057,000 at December 31,
2004.
The Bank serviced non-SBA loans for others totaling $20,769,000 and
$22,703,000 in unpaid principal balances at December 31, 2004 and 2003.
These loans are not included in the accompanying consolidated balance
sheet, and there are no servicing assets associated with these loans.
NOTE 4 - PREMISES AND EQUIPMENT
(dollars in thousands) 2004 2003
--------- ---------
Leasehold improvements $ 2,080 $ 1,590
Furniture and equipment 4,524 3,422
--------- ---------
6,604 5,012
Less accumulated depreciation and amortization 3,895 3,426
--------- ---------
$ 2,709 $ 1,586
========= =========
NOTE 5 - DEPOSITS
Certificates of deposit with balances of $100,000 or more totaled
$228,838,000 and $172,555,000 at December 31, 2004 and 2003. Deposits in
thousands of dollars consist of the following:
(dollars in thousands) 2004 2003
--------- ---------
Noninterest-bearing $ 72,156 $ 61,436
Interest-bearing:
Money market 115,505 142,611
Savings 55,361 8,428
Demand 40,093 41,835
Certificates of deposit 507,910 404,010
--------- ---------
$ 791,025 $ 658,320
========= =========
Certificates of deposit are scheduled to mature as follows:
(dollars in thousands)
Year Ending December 31,
------------------------
2005 $481,051
2006 26,450
2007 361
2008 -
2009 -
Thereafter 48
--------
$507,910
========
NOTE 6 - FEDERAL HOME LOAN BANK (FHLB) ADVANCES
Contractual maturities and balances outstanding of FHLB advances are
reflected in the following schedules. Advances from the FHLB are
collateralized by qualifying first mortgage loans and government agency
securities. FHLB advances at variable rates were $165,000,000 and
$60,000,000, in 2004 and 2003, respectively.
(dollars in thousands)
2004 2003
---------------------- ----------------------
Interest Interest
Maturities Amount Rates Amount Rates
- ---------- --------- ---------- --------- ----------
Within one year $ 165,000 2.31-2.43% $ 87,266 1.18-1.36%
Two years 25,000 3.06% 30,000 1.18-1.22%
Five years 1,717 5.56-5.63% 1,747 5.56-5.63%
Over five years 195 4.67% 198 4.67%
--------- ---------
$ 191,912 $ 119,211
========= =========
2004 2003
--------- ---------
Maximum balance outstanding at any month end $ 191,912 $ 119,211
Average outstanding balance 147,197 76,680
Weighted average interest rate 1.56% 1.48%
NOTE 7 - INCOME TAXES
The components of the provision for federal and state income taxes are as
follows:
(dollars in thousands)
2004 2003 2002
--------- --------- ---------
Provision for income taxes
Federal $ 8,772 $ 5,186 $ 4,803
State 2,626 1,740 1,445
--------- --------- ---------
11,398 6,926 6,248
Change in deferred income taxes (197) (476) (152)
Change in tax method for deferred
fees (861) - -
Tax impact from options exercised (872) 916 -
--------- --------- ---------
$ 9,468 $ 7,366 $ 6,096
========= ========= =========
A reconciliation of the statutory tax rates to the effective tax rates is
as follows:
2004 2003 2002
---------- ---------- ----------
Federal income tax at statutory rate 35.0 % 34.4 % 34.0 %
State taxes, net of federal income
tax benefit 6.6 6.1 6.7
Other, net (1.8) (1.0) (1.2)
---------- ---------- ----------
39.8 % 39.5 % 39.5 %
========== ========== ==========
The components of net deferred tax assets in thousands of dollars are as
follows:
(dollars in thousands) 2004 2003
--------- ----------
Loan loss reserves $ 3,626 $ 2,929
State taxes 728 553
Deferred fees (861) -
Deferred compensation 708 450
All others 74 146
--------- ----------
$ 4,275 $ 4,078
========= ==========
NOTE 8 - STOCK OPTIONS
The Company's stock option plan provides for granting of nonqualified and
qualified incentive stock options to directors, officers and employees to
purchase shares of the Company's stock. The option plan provides that
shares may be purchased upon exercise of options at a price not less than
the fair-market value on the date the option was granted. Options vest
immediately up to a maximum of five years and expire not more than ten
years from the date of grant. In accordance with the Plan, the number of
shares subject to outstanding options is adjusted to prevent the dilutive
effect of stock dividends and the two for one stock split during 2003. The
exercise price is reduced accordingly. The Company granted stock options
for 182,000 shares during the year ended December 31, 2004.
In 2004 the Board of Directors reviewed the status of option grants for
non-officer directors. While the Board believes these grants served their
purpose of aligning the directors' interest with those of the Company's
other shareholders, the strong performance of the Company's stock since
2001 (the last time options were granted to directors) resulted in options
having a higher dilutive impact than originally anticipated. Accordingly,
on November 5, 2004, each non-officer director canceled their outstanding
options totaling 1,371,624 and non-officer directors who exercised options
earlier in 2004 either rescinded the exercise or contributed additional
capital by paying the difference between market price at the time options
were exercised and the exercise price. A former director also participated
in this action by paying the difference between market price at the time
the options were exercised and the exercise price. The effect of these
actions was to (1) reduce the number of fully diluted shares of the
Company and (2) increase shareholders' equity by $6.0 million (net of tax
impact) as a result of the payment of the market price differential net of
the repayment for shares returned to the Company.
The following tables summarize the number of options granted and
exercisable and the weighted average exercise prices and remaining
contractual lives of the options:
2004 2003 2002
----------------------- ----------------------- ---------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- --------- --------- --------- --------- ---------
Outstanding at beginning of year 2,213,202 $ 6.57 1,193,237 $ 13.79 1,133,840 $ 14.27
Granted 182,000 $ 22.26 - $ - 15,000 $ 28.25
Options granted attributable to the
stock dividend 94,671 $ 6.53 59,580 $ 13.13 56,525 $ 13.59
Options granted attributable to the
stock split - - 1,224,493 $ 6.55 - -
Options canceled by outside
directors (1,371,624) $ 6.19 -
Forfeited - (16,186) $ 8.97 (2,924) $ 17.57
Exercised (375,358) $ 5.94 (247,922) $ 6.54 (9,204) $ 11.00
---------- --------- ---------
Outstanding at end of year 742,891 $ 10.60 2,213,202 $ 6.57 1,193,237 $ 13.79
========== ========= =========
The weighted average fair value of options (using the Black-Scholes model)
granted during 2004 was $5.54.
Weighted-
Weighted- Average Weighted-
Options Average Remaining Options Average
Outstanding at Exercise Contractual Exercisable at Exercise
December 31, 2004 Price Life December 31, 2004 Price
- ----------------- --------- ----------- ----------------- ---------
199,373 $ 5.48 3.8 199,373 $ 5.48
113,502 5.22 3.6 113,502 5.22
24,304 6.81 5.8 19,443 6.81
189,537 8.18 6.1 113,722 8.18
33,075 12.81 7.5 13,230 12.81
160,000 22.30 10.0 160,000 22.30
23,100 20.95 9.3 - N/A
- ----------------- -----------------
742,891 10.60 $ 619,270 $ 10.47
================= =================
NOTE 9 - DEFERRED COMPENSATION
The Company has deferred compensation agreements with two key officers and
three Board members. The agreements require the Company to provide annual
benefits ranging from $75,000 to $100,000 for the officers and $13,000 to
$46,000 for some Board members for 15 years after retirement or
disability. In the event of death, the beneficiaries are to receive the
benefits. The estimated present value of future benefits to be paid is
being accrued over the period from the effective date of the agreements
until the expected retirement dates of the participants. The expense
incurred for the years ended December 31, 2004, 2003 and 2002, totaled
$251,000, $326,000 and $336,000. The Company is the beneficiary of life
insurance policies that have been purchased as a method of financing the
benefits under the agreements. At December 31, 2004 and 2003, the cash
surrender value of these policies, which is included on the balance sheet
in other assets, was $2,663,000 and $2,545,000, respectively.
NOTE 10 - EMPLOYEE BENEFIT PLAN
The Company has a 401(k) savings plan covering substantially all employees
of the Company and the Bank. Employees who elect to participate are able
to defer up to 15% of their annual salary, subject to limitations imposed
by federal tax law. The Company makes matching contributions equal to 100%
of each participant's elective deferral, up to a maximum of $1,200 per
employee. Contributions by the Company for the years ended December 31,
2004, 2003 and 2002, were $117,000, $96,000 and $91,000.
NOTE 11 - RELATED-PARTY TRANSACTIONS
The Company had an operating lease with a major stockholder of the Company
for office facilities. The lease expired in August 2004. Rental payments
under this lease were $108,000, $185,000 and $181,000 for the years ended
December 31, 2004, 2003 and 2002.
The Company has, and expects to have in the future, banking transactions
in the ordinary course of business with directors, executive officers and
their associates.
An analysis of the loans to directors and executive officers follows:
(dollars in thousands) 2004 2003
--------- ---------
Balance, beginning of year $ 7,277 $ 10,757
Additions 20,364 4,279
Principal reductions (19,082) (7,759)
--------- ---------
$ 8,559 $ 7,277
========= =========
During 2004, the Bank implemented a program to assist employees in
financing their primary residences, as of December 31, 2004 the program
had $5,680,000 in these loans, at interest rates from 3.25% to 5.25%.
Deposits held by directors and officers totaled $15,961,000 and
$11,573,000 at the years ending December 31, 2004 and 2003.
A firm, of which a director is a partner, has acted as leasing agent for
leased premises of the Bank. Real estate commissions or referral fees that
were paid by the lessor's totaled $32,000 during 2004 and $145,000 in
2003. During 2004 the firm also, acted as a contractor for leasehold
improvements of the Bank which totaled $420,000, of which $245,000 was
paid by the lessor. There were no construction services performed in 2003.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
The Bank is required by federal regulations to maintain certain minimum
average balances with the Federal Reserve, based primarily on the Bank's
daily demand deposit balances. Required deposits held with the Federal
Reserve at December 31, 2004 and 2003, were $7,065,000 and $5,623,000.
The Company and the Bank have entered into operating leases for branches
and office facilities that expire through June 2024. The majority of the
lease agreements have options to extend the lease terms. Total rental
expense for the years ended December 31, 2004, 2003 and 2002 was
$1,101,000, $916,000 and $836,000, respectively.
Future minimum non-cancelable lease payments are as follows:
(dollars in thousands)
Year Ending December 31,
------------------------
2005 $ 1,360
2006 1,335
2007 1,261
2008 1,262
2009 1,262
Thereafter 5,251
---------
$ 11,731
=========
NOTE 13 - REGULATORY CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on the Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Company and the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's
assets, liabilities and certain off-balance sheet items as calculated
under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors. Prompt corrective
action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios
(set forth in the following table) of total and Tier 1 capital (as defined
in the regulations) to risk-weighted assets (as defined) and of Tier 1
capital (as defined) to average assets (as defined). Management believes
the Company and the Bank meet all capital adequacy requirements to which
they are subject.
As of December 31, 2004, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, an institution must maintain minimum
total risk-based., Tier 1 risk based and Tier 1 leverage ratios as set
forth in the following table. There are no conditions or events since the
notification that management believes have changed the Bank's category.
The Company's and the Bank's actual capital amounts and ratios as of
December 31, 2004 and 2003 are also presented in the following table.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------------- ------------------- --------------------
(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
---------- ------- ---------- ------ ---------- -------
At December 31, 2004:
Total Capital to Risk-Weighted Assets
Consolidated $ 98,466 12.1% $ 64,926 8.0% $ 81,158 10.0%
Bank $ 87,719 10.8% $ 64,922 8.0% $ 81,152 10.0%
Tier 1 Capital to Risk-Weighted Assets
Consolidated $ 89,747 11.1% $ 32,463 4.0% $ 48,695 6.0%
Bank $ 79,000 9.7% $ 32,461 4.0% $ 48,691 6.0%
Tier 1 Capital to Average Assets
Consolidated $ 89,747 8.6% $ 31,215 3.0% $ 52,026 5.0%
Bank $ 79,000 7.6% $ 31,214 3.0% $ 52,023 5.0%
At December 31, 2003:
Total Capital to Risk-Weighted Assets
Consolidated $ 74,707 11.7% $ 50,909 8.0% $ 63,637 10.0%
Bank $ 72,765 11.4% $ 50,905 8.0% $ 63,632 10.0%
Tier 1 Capital to Risk-Weighted Assets
Consolidated $ 67,405 10.6% $ 25,455 4.0% $ 38,182 6.0%
Bank $ 65,466 10.3% $ 25,453 4.0% $ 38,179 6.0%
Tier 1 Capital to Average Assets
Consolidated $ 67,405 8.4% $ 24,021 3.0% $ 31,818 5.0%
Bank $ 65,466 8.2% $ 24,019 3.0% $ 40,032 5.0%
Payment of dividends by the Bank is limited under regulation. The amount
that can be paid in any calendar year without prior approval of the Office
of the Comptroller of the Currency cannot exceed the lesser of net profits
(as defined) for that year, plus the net profits for the preceding two
calendar years, or retained earnings.
NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair value estimates are determined as of a specific date in time
utilizing quoted market prices, where available, or various assumptions
and estimates. As the assumptions underlying these estimates change, the
fair value of the financial instruments will change. The use of
assumptions and various valuation techniques, as well as the absence of
secondary markets for certain financial instruments, will likely reduce
the comparability of fair value disclosures between financial
institutions. Additionally, the Bank has not disclosed highly subjective
values of other non-financial instruments. Accordingly, the aggregate fair
value amounts presented do not represent, and should not be construed to
represent, the full underlying value of the Company. The methods and
assumptions used to estimate the fair values of each class of financial
instruments are as follows:
Cash and cash equivalents - The carrying value of cash and cash
equivalents approximates fair value due to the relatively short-term
nature of these instruments.
Investment securities - The fair value of investment securities is based
on quoted market prices. If quoted market prices are not available, then
fair values are based on quoted market prices of comparable instruments.
Included in investment securities are Federal Home Loan Bank and Federal
Reserve Bank stock, which are carried at cost. The carrying amount is a
reasonable estimate of fair market value.
Loans - In order to determine the fair values for loans, the loan
portfolio was segmented based on loan type, credit quality and repricing
characteristics. For certain variable rate loans with no significant
credit concerns and frequent repricings, estimated fair values are based
on the carrying values. The fair values of other loans are estimated using
discounted cash flow analyses. Discount rates used in these analyses are
generally based on origination rates for similar loans of comparable
credit quality. Maturity estimates of installment loans are based on
historical experience with prepayments.
Deposits - The fair values for deposits subject to immediate withdrawal,
such as interest and noninterest bearing and savings deposit accounts, are
equal to the amount payable on demand at the reporting date (i.e., their
carrying amount on the balance sheet). Fair values for fixed-rate
certificates of deposits are estimated by discounting future cash flows
using interest rates currently offered on time deposits with similar
remaining maturities.
FHLB Advances - The fair value is determined by discounting future cash
flows using rates currently available for debt with similar terms and
remaining maturities.
Off-balance sheet instruments - The fair value of commitments to extend
credit and standby letters of credit is estimated using the fees currently
charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
counter parties.
December 31, 2003 December 31, 2004
------------------------- ---------------------
(dollars in thousands) Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- --------- ---------
Financial assets:
Cash and cash
equivalents $ 116,504 $ 116,504 $ 94,574 $ 94,574
Investment
securities 10,356 10,356 6,758 6,758
Loans, net 938,104 941,567 733,857 759,308
----------- ----------- --------- ---------
$ 1,064,964 $ 1,068,427 $ 835,189 $ 860,640
=========== =========== ========= =========
Financial liabilities:
Deposits $ 791,025 $ 791,944 $ 658,320 $ 660,933
FHLB advances 191,913 191,536 119,211 118,975
----------- ----------- --------- ---------
$ 982,938 $ 983,480 $ 777,531 $ 779,908
=========== =========== ========= =========
Off-balance sheet financial
instruments:
Commitments to extend
credit $ - $ 70,064 $ - $ 56,811
NOTE 15 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its
customers. To date, these financial instruments include commitments to
extend credit and standby letters of credit that involve elements of
credit and interest rate risk in excess of the amount recognized in the
statement of financial position.
The Company's exposure to credit loss is represented by the contractual
amount of these commitments. The Company follows the same credit policies
in making commitments as it does for on-balance-sheet instruments
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments
are expected to expire without being drawn upon, the total commitment
amounts do not necessarily represent future cash requirements. The Bank
evaluates each customer's creditworthiness on a case-by-case basis and
generally requires collateral or other security to support commitments to
extend credit.
Standby letters of credit are performance assurances made on behalf of
customers who have a contractual obligation to produce or deliver goods
or services or otherwise perform. Credit risk in these transactions arises
from the possibility that a customer may not be able to repay the Bank if
the letter of credit is drawn upon. As with commitments to extend credit,
the Bank evaluates each customer's creditworthiness on a case-by-case
basis. The amount of collateral obtained, if any, is based on management's
credit evaluation of the counter-party.
Unfunded commitments under commercial lines-of-credit, revolving credit
lines and overdraft protection agreements are commitments for possible
future extensions of credit to existing customers. These lines-of-credit
are either secured or unsecured and usually contain a specified maturity
date and may or may not be drawn upon to the total extent to which the
Company is committed.
At December 31, 2004 and 2003, loan commitments totaled $69,431,000 and
$56,507,000 and standby letters of credit totaled $633,000 and $304,000.
NOTE 16 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
The condensed balance sheet of Northern Empire Bancshares (parent company
only) as of December 31, 2004 and 2003, and statements of income and cash
flows for each of the three years ended December 31, 2004, are as follows:
BALANCE SHEETS
(dollars in thousands,
except share amount) December 31,
2004 2003
-------- --------
Assets
Cash and cash equivalents $ 10,698 $ 1,898
Investment in Sonoma National Bank 79,131 65,594
Other assets 51 51
-------- --------
Total assets $ 89,880 $ 67,543
======== ========
Liabilities and Stockholders' Equity
Other liabilities $ 2 $ 10
-------- --------
Preferred stock, no par value; 10,000,000 shares
authorized; none issued or outstanding - -
Common stock, no par value; 40,000,000 shares
authorized; 9,854,067 and 9,039,450 shares
issued and outstanding in 2004 and 2003 47,302 34,653
Additional paid-in-capital 7,681 1,702
Accumulated other comprehensive income (10) 2
Retained earnings 34,905 31,176
-------- --------
Total stockholders' equity 89,878 67,533
-------- --------
Total liabilities and stockholders' equity $ 89,880 $ 67,543
======== ========
STATEMENTS OF INCOME
(dollars in thousands) Years Ended December 31,
2004 2003 2002
-------- -------- -------
Interest and other income $ 52 $ 5 $ 5
Administrative expenses (153) (47) (39)
Income tax expense (1) (1) 44
Equity in undistributed earnings
of Sonoma National Bank 14,422 11,313 9,325
-------- -------- -------
Net income $ 14,320 $ 11,270 $ 9,335
======== ======== =======
STATEMENTS OF CASH FLOWS
(dollars in thousands) Years Ended December 31,
2004 2003 2002
-------- -------- -------
Cash flows from operating activities:
Net income $ 14,320 $ 11,270 $ 9,335
Adjustments to reconcile net income
to net cash from operating activities:
Changes in other assets - 4 (3)
Change in other liabilities (8) 9 (41)
Equity in undistributed earnings (14,422) (11,313) (9,325)
-------- -------- -------
Net cash from operating
activities (110) (30) (34)
-------- -------- -------
Cash flows from financing activities:
Payout of fractional shares (6) (7) (6)
Repurchase of common stock (164) - -
Contributed capital 6,851 - -
Proceeds from exercise of stock
options 2,229 1,623 101
-------- -------- -------
Net cash from financing
activities 8,910 1,616 95
-------- -------- -------
Net change in cash and cash
equivalents 8,800 1,586 61
Cash and cash equivalents, beginning
of year 1,898 312 251
-------- -------- -------
Cash and cash equivalents, end of year $ 10,698 $ 1,898 $ 312
======== ======== =======
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Northern Empire Bancshares
We have audited the accompanying consolidated balance sheets of Northern
Empire Bancshares as of December 31, 2004 and 2003, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years ended December 31, 2004. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audits to obtain reasonable assurance
about whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Northern Empire Bancshares as of December 31, 2004 and 2003, and the
results of their operations and cash flows for each of the three years
ended December 31, 2004, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Moss Adams LLP
Santa Rosa, California
January 21, 2005
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None.
ITEM 9 A. Controls and Procedures
Evaluation of Disclosure 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-15(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.
Management Report on Internal Control over Financial Reporting
As permitted by the Securities and Exchange Commission's exemptive order
of November 30, 2004, applicable to certain accelerated filers,
management's report on internal control over financial reporting will be
included in an amendment to this report.
Attestation Report of Registered Public Accounting Firm
As permitted by the Securities and Exchange Commission's exemptive order
of November 30, 2004, applicable to certain accelerated filers, the
attestation report of the Company's auditors regarding management's
report on internal control over financial reporting will be included in
an amendment to this report.
Changes in Internal Control over Financial Reporting
No change in internal control over financial reporting, as defined in
Securities Exchange Act Rule 15d-15(f), occurred during the fiscal
quarter ended December 31, 2004 that has materially affected, or is
reasonably likely to materially affect the Corporation's internal
control over financial reporting.
ITEM 9 B. Other Information
None
Part III
ITEM 10. Directors and Executive Officers of the Registrant
The following are the directors and executive officers of the
Corporation and the Bank:
Name and Positions with the Principal Occupation
Corporation and the Bank Age During the Past 5 Years
- --------------------------- -- ---------------------------
Deborah A. Meekins, 52 President and Chief Executive
President & Chief Executive Officer of the Bank since
Officer and of the Bank and of the February 1991. President
Corporation, Director of the Bank and Chief Executive Officer
of the Corporation since
December 2002.
Clement C. Carinalli 59 Retired CPA, local
Director of the Corporation businessman, rancher and
and the Bank real estate investor.
Kevin Carinalli 32 Owner of Carco Investments,
Director of the Bank general contractor, real
estate developer and
property manager.
Patrick R. Gallaher, 59 Retired CPA and local
Secretary of the Corporation businessman; major shareholder
and Director of the Corporation in Oakmont Developers, a
and the Bank Santa Rosa development
company.
William E. Geary, 76 Senior Partner in Geary,
Director of the Corporation Shea & O'Donnell, a
and the Bank Santa Rosa law firm.
Dennis R. Hunter, 62 Real estate investor and
Chairman of the Board of the developer in Santa Rosa;
Corporation and Vice Chairman principal in Investment
of the Board of the Bank Development Fund, a venture
capital fund, a director of
Energy Exploration
Technologies, director of
North Bay Corp.
James B. Keegan, Jr., 56 Partner in Keegan & Coppin
Vice-Chairman & Director of the Company, Inc. a Santa Rosa
Corporation and Chairman of the real estate brokerage and
Board of the Bank development firm, since 1976.
Michael J. Wright, 49 Co-owner of Wright Contracting,
Director of the Bank Inc., serves as Chief Financial
Officer, Secretary/Treasurer
of his company.
David F. Titus 52 Executive Vice President &
Executive Vice President & Senior Loan Officer of the
Senior Loan Officer and Bank since January, 1995.
Director of the Bank Senior Vice President &
Senior Loan Officer of the
Bank from August 1991 to
January, 1995.
Larry V. Sorensen, 45 Executive Vice President of
Executive Vice President & Corporate Development of the
Corporate Development Bank since May 2002; Finance
Officer of the Bank Director of Corrigo Inc.;
and , Vice President of
Corporate Development of Golden
West Financial Corporation
JoAnn Barton, 51 Senior Vice President and
Senior Vice President & Senior Senior Operations Administrator
Operations Officer of the Bank of the Bank since March 1992;
from November 1985 Vice
President and Senior Operations
Administrator of the Bank.
Jane M. Baker 58 Senior Vice President and
Senior Vice President & Chief Chief Financial Officer of
Financial Officer of the Bank the Bank since August 1995;
and Chief Financial Officer Vice President and Chief
of the Corporation Financial Officer of the Bank
since August 1992. Chief
Financial Officer of the
Corporation since December
2002.
Each of the directors of the Corporation has served as a director since
the initial organization of the Corporation in 1982, except for Patrick
R. Gallaher who was elected on May 19, 1992 and Clement C. Carinalli who
served from 1982 until 1992 and from 1996 to date.
William E. Geary, Dennis R. Hunter and James B. Keegan, Jr. have served
as directors of the Bank since the initial organization of the Bank in
1984. Clement C. Carinalli served from 1984 to 1992 and from 1996 to
date. Deborah A. Meekins was appointed in August 1990; Patrick R.
Gallaher was appointed in December 1991, David F. Titus was appointed in
June 2001, and Kevin Carinalli and Michael Wright were appointed in
March 2004. Kevin Carinalli is the son of Clement C. Carinalli. As the
sole shareholder of the Bank, the Corporation elects the directors of
the Bank.
The board of directors of the Corporation has determined that the joint
Audit Committee of the Corporation and the Bank does not have a
"financial expert," as that term is defined in the SEC's regulations.
The board has not actively sought a person whose qualifications and
experience meet the SEC's definition of a "financial expert," but the
board believes that several of its members are qualified in financial
matters as a result of training and experience in accountancy and
business and numerous years of service on the boards of the Corporation
and the Bank.
Patrick Gallaher is the Chairman of the Audit Committee of the
Corporation and the Bank. Mr. Gallaher is a retired businessman and
certified public accountant. Michael Wright and William Geary also
serve on the joint Audit Committee of the Corporation and the Bank.
Director Nomination Process
Director nominees to be elected by the shareholders of the Corporation,
and any directors to be appointed by the board of directors to fill a
vacancy on the board are selected each year by a majority of the
independent directors of the Corporation. In carrying out its
responsibilities regarding director nominations, the board takes into
account the factors it deems appropriate to assist in developing a board
of directors and board committees that are comprised of experienced
advisors with skills relevant to the business of the Bank and the
Corporation.
Code of Ethics
The Corporation and the Bank have adopted a financial code of ethics for
senior financial officers. A paper copy of the financial code of ethics
may be obtained free of charge by contacting Jane M. Baker at the
Corporation at 3558 Round Barn Blvd., Suite 300, Santa Rosa, CA 95403 or
by telephone (707)591-9000.
ITEM 11. Executive Compensation
The following table sets forth the cash compensation paid to or accrued
for the executive officers of the Bank for services rendered for the
periods indicated. The executive officers of the Corporation, including
the President, do not receive compensation for their services as such.
The Vice Chairman of the Corporation, James B. Keegan, Jr., also serves
as the Chairman of the Board of the Bank and receives $2,000 per month
from the Bank for his services in that capacity. See, "Compensation of
Directors," below.
Summary Compensation Table
(dollars in thousands) Annual Compensation Long-term Compensation
----------------------------- --------------------------------------------
Other Long-term
Annual Restricted Options Incentive
Name and Principal Compen- stock (No.of Plan All
Position Year Salary Bonus sation award Shares (2) payouts Other(1)
- -------------------- ---- ------ ----- ------ -------- -------- ------- -----
Deborah A. Meekins, 2002 $182 $155 $6 $103
President, Chief 2003 243 135 6 122
Executive Officer of 2004 264 162 5 103
the Corporation and
Bank and Director
of the Bank
David F. Titus, 2002 160 86 6 85
Executive Vice 2003 177 99 6 99
President, Senior Loan 2004 193 120 6 85
Officer and
Director of the Bank
Larry V. Sorensen, 2002 89 17 4 33,075 0
Executive Vice President 2003 154 51 6 1
Corporate Development 2004 166 63 6 1
Officer of the Bank
JoAnn Barton, 2002 99 19 4 1
Senior Vice President, 2003 84 16 4 1
Senior Operations 2004 91 19 4 1
Officer of the Bank
Jane M. Baker, 2002 106 21 4 1
Senior Vice President, 2003 110 28 4 1
Chief Financial Officer 2004 120 34 4 1
of the Bank and Chief
Financial Officer of
the Corporation
(1) Includes contribution by the Bank for the benefit of the named
officer pursuant to the Bank's 401(k) plan, auto allowances and
accrued expenses incurred with respect to the Salary Continuation
Agreement for Ms. Meekins and Mr. Titus, as described below.
(2) Adjusted for stock dividends and two for one split.
Salary Continuation Agreements
The Bank has deferred compensation agreements with Deborah A. Meekins,
President and Chief Executive Officer, and David F. Titus, Executive
Vice President and Senior Loan Officer. Under these agreements, the
Bank is obligated to provide for them or their beneficiaries, during a
period of 15 years after the employee's death, disability, or
retirement, annual benefits ranging from $75,000 to $100,000. Benefits
are also provided to the officer if he/she resigns following a change in
control or if he/she voluntarily resigns after June 1, 1995. The
estimated present value of future benefits to be paid is being accrued
over the period from the effective date of the agreements until their
expected retirement dates. The accrued expense is included in Other
Liabilities in the financial statements. The Bank is the beneficiary of
life insurance policies that have been purchased as a method of
financing the benefits under the agreements. At December 31, 2004, the
total cash surrender value of these policies was $1,240,000, which is
included in other assets.
Stock Option Plan
Neither the Corporation nor the Bank award restricted stock or have long
term incentive plans, other than the Corporation's 1984 and 1997 Stock
Option Plans. The 1984 Plan expired in February 1994 with the last of
the options exercised in January 2004 and no options are outstanding at
December 31, 2004. Options for a total of 742,891 shares (160,000 to all
directors of the Corporation and 582,891 shares to forty-six officers
and employees of the Bank) are outstanding under the 1997 Plan as of
December 31, 2004.
In 2004 the Board of Directors reviewed the status of option grants for
non-officer directors. While the Board believes these grants have
served their purpose of aligning the directors' interests with those of
the Company's other shareholders, the strong performance of the
Company's stock since 2001 (the last time options were granted to
directors) has resulted in options having a higher dilutive impact than
originally anticipated. As of November 5,2004, each non-officer
director canceled their outstanding options totaling 1,371,624 and
non-officer directors who exercised options earlier in 2004 either
rescinded the exercise or contributed additional capital by paying the
difference between the market price at the time the options were
exercised and the exercise price. The Board unanimously decided that
this action would benefit all shareholders and would best position the
Company to take advantage of the opportunities that lie ahead. Although
he is no longer a board member, William Gallaher, who resigned as a
director on October 13, 2003, has also participated in this action by
paying the difference between the market price at the time the options
were exercised and the option price. The effect of these actions was to
(1) reduce the number of fully diluted shares of the Company used to
calculate diluted earnings per share and (2)increase our shareholders'
equity by $6.0 million ($6.9 million in cash payments less the tax
impact of $872,000) as the result of the payment of the market price
differential net of the repayment for shares returned to the Company and
the tax impact. See discussion in Item 5, Purchases of Equity Securities
by Issuer.
The Corporation granted 182,000 options (160,000 to all directors of the
Corporation and 22,000 to seven employees of the Bank) in 2004.
The following sets forth information regarding all options held by the
named executive officers as of December 31, 2004 and options exercised
during 2004:
Aggregated Year-End Option Exercises and Values
December 31, 2004
------------------------------------------------
Number of
Securities Underlying
Shares Value Unexercised Options Value of
acquired on realized (No. of Shares)(1) Unexercised Options (2)
Name exercise (#) $ Exercisable/Unexercisable Exercisable/Unexercisable
- ------------------ ------------ -------- ------------------------- -------------------------
Deborah A. Meekins 23,000 318,000 230,002 / 20,419 $3,798,000 / $289,000
David F. Titus 5,000 62,000 56,825 / 14,585 $909,000 / $207,000
Larry V. Sorensen 0 0 13,230 / 19,845 $126,000 / $189,000
JoAnn Barton 6,000 80,000 16,817 / 2,430 $273,000 / $38,000
Jane M. Baker 2,730 44,000 23,117 / 2,430 $380,000 / $38,000
(1) Adjusted for stock dividends issued since date of the option grant.
(2) Calculated based on the difference between the fair market value
of the stock and the exercise price of the options at
December 31, 2004.
Compensation of Outside Directors
During 2004 outside directors of the Bank (including directors who serve
as executive officers of the Corporation) received director fees of
$1,500 for each monthly board meeting attended and $500 per executive
committee, Audit committee and ALCO meetings. Loan committee was paid
$500 per meeting for four months and $250 per meeting for six months.
The Chairman of the Board of the Bank receives a fee of $2,000 per month
in addition to the committee fees described above. The Corporation does
not pay directors' fees at this time, and does not plan to in the near
future.
Outside directors were eligible to receive options under the
Corporation's 1984 Stock Option Plan and are also eligible to receive
options under the 1997 Stock Option Plan. See "Item 12, Security
Ownership of Certain Beneficial Owners and Management."
In 2004 the Board of Directors reviewed the status of option grants for
non-officer directors. While the Board believes these grants have
served their purpose of aligning the directors' interests with those of
the Company's other shareholders, the strong performance of the
Company's stock since 2001 (the last time options were granted to
directors) has resulted in options having a higher dilutive impact than
originally anticipated. Accordingly, as of November 5,2004, each
non-officer director canceled their outstanding options totaling
1,371,624 and non-officer directors who exercised options earlier in
2004 either rescinded the exercise or contributed additional capital by
paying the difference between the market price at the time the options
were exercised and the exercise price. The Board unanimously decided
that this action would benefit all shareholders and would best position
the Company to take advantage of the opportunities that lie ahead.
Although he is no longer a board member, William Gallaher, who resigned
as a director on October 13, 2003, has also participated in this action
by paying the difference between the market price at the time the
options were exercised and the option price. The effect of these actions
was to (1) reduce the number of fully diluted shares of the Company used
to calculated diluted earnings per share and (2) increase our
shareholders' equity by $6.0 million (net of tax impact of $872,000)
as the result of the payment of the market price differential net of the
repayment for shares returned to the Company and the tax impact. See
discussion in Item 5, Purchases of Equity Securities by Issuer.
In December 2004 the Board of Directors granted 160,000 options to all
directors of the Corporation which were the only options outstanding to
Directors of the Corporation at December 31, 2004. These options were
granted subject to the approval of the Corporations shareholders to be
considered at the 2005 shareholders meeting. The outstanding options at
December 31, 2004 had an estimated value of $8,000 based on the
difference between the fair market value of the stock as of December 31,
2004 and the exercise price of the options.
During 2003 there were no options granted to directors. Directors of the
Corporation exercised options for 241,860 shares during 2003. During
2004 William Gallaher, a former director who had exercised 233,860
shares in December of 2003, participated in the Board action discussed
above by contributing additional capital by paying the difference
between the market price at the date of exercise and the option price.
The Corporation has deferred compensation agreements with directors
Patrick R. Gallaher, William Geary, and James B. Keegan, Jr. Under each
of these agreements, the Corporation is obligated to provide for the
director or his beneficiaries, for a period of 15 years after the
director's death, disability or retirement, annual benefits ranging from
$13,000 to $46,000. The estimated present value of future benefits to be
paid is being accrued over the period from the effective date of the
agreements until the expected retirement dates. The Corporation is
beneficiary of life insurance policies that have been purchased as a
method of financing the benefits. At December 31, 2004, the total cash
surrender value of these policies was $1,423,000, which is included in
other assets.
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
Other than as set forth below, the Corporation knows of no person who is
the beneficial owner of more than 5.0% of the Corporation's outstanding
shares as of December 31, 2004.
The following sets forth the numbers of shares of common stock
beneficially owned by each director of the Corporation and the Bank and
by the directors and executive officers of the Corporation and the Bank
as a group, as of December 31, 2004. The numbers of shares beneficially
owned include the numbers of shares which each person has the right to
acquire within 60 days upon exercise of stock options granted pursuant
to the Corporation's Stock Option Plan. The percentages of shares owned
beneficially are calculated, pursuant to SEC Rule 13d-3(d) (1), based on
the number of shares presently outstanding plus the number of shares
which the person or group has the right to acquire within 60 days.
Number of Shares
Name Beneficially Owned Pct
Clement C. Carinalli 171,525 (1) 1.7%
Kevin Carinalli 258,964 (2) 2.5
Patrick R. Gallaher 179,817 (3) 1.7
William E. Geary 385,444 (4) 3.7
Dennis R. Hunter 292,862 (5) 2.9
James B. Keegan, Jr. 179,624 (6) 1.7
Deborah A. Meekins 359,348 (7) 3.5
Robert V. Pauley * 311,237 (8) 3.0
David Titus 69,586 (9) 0.7
Michael Wright 6,300 (10) 0.1
JoAnn Barton 72,751 (11) 0.7
Jane M. Baker 32,590 (12) 0.3
Larry V. Sorensen 13,546 (13) 0.1
Directors and Executive
Officers as a group
(13 persons) 2,333,594 22.6%
* Mr. Pauley passed away on February 18, 2005
(1) Does not include options for 25,000 shares which were assigned by
Mr. Carinalli in 2004 to family members.
(2) Including 6,250 shares issuable to Mr. Carinalli upon the exercise
of stock options exercisable within 60 days and 8,122 shares held
as custodian for his minor children.
(3) Including 25,000 shares issuable to Mr. Gallaher upon the exercise
of stock options exercisable within 60 days and 154,817 shares
held in Mr. & Mrs. Gallaher's trust.
(4) Including 25,000 shares issuable to Mr. Geary upon the exercise of
stock options exercisable within 60 days, 76,573 shares held in
Mr. Geary's profit sharing plan, 261,653 shares held in Mr. & Mrs.
Geary's trusts and 22,218 shares held in a trust account for which
Mr. Geary serves as trustee but does not have a beneficial
interest.
(5) Including 92,694 shares held in trust accounts for which Mr. Hunter
serves as trustee but does not have a beneficial interest and
117,717 shares held by Redwood Equities, LLC. Does not include
options for 30,000 shares which were assigned by Mr. Hunter to a
family member.
(6) Including 30,000 shares issuable to Mr. Keegan upon the exercise
of stock options exercisable within 60 days, 18,382 shares in
Mr. & Mrs. Keegan's trust, 110,992 shares held by Keegan & Coppin
Company, Inc., 20,204 shares held by the Keegan & Coppin Profit
Sharing Plan.
(7) Including 240,211 shares issuable to Ms. Meekins upon the exercise
of stock options exercisable within 60 days and 119,137 held in
Ms. Meekins' trust.
(8) Including 25,000 shares issuable to Mr. Pauley upon the exercise
of stock options exercisable within 60 days.
(9) Including 64,117 shares issuable to Mr. Titus upon the exercise of
stock options exercisable within 60 days and 5,469 shares held in
Mr. & Mrs. Titus' trust.
(10) Includes 6,300 held by Wright Contracting, Inc.
(11) Including 16,816 shares issuable to Ms. Barton upon the exercise
of stock options exercisable within 60 days.
(12) Including 23,117 shares issuable to Ms. Baker upon the exercise of
stock options exercisable within 60 days and 7,797 held in
Ms. Baker's trust account and 1,676 held in Ms. Baker's 401k
account.
(13) Including 13,230 shares issuable to Mr. Sorensen upon the exercise
of stock options exercisable within 60 days and 316 shares held
in Mr. Sorensen's 401k account.
The business address of each of the above individuals is c/o Northern
Empire Bancshares, 3558 Round Barn Boulevard, Suite 300, Santa Rosa, CA
95403.
ITEM 13. Certain Relationships and Related Transactions
The Company had an operating lease with a major stockholder of the
Company for office facilities. That lease expired in August 2004.
Rental payments under that lease were $185,000, $181,000 and $168,000
for the years ended December 31, 2004, 2003 and 2002.
The Company has, and expects to have in the future, transactions in the
ordinary course of business with directors, officers and their
associates.
The transactions involving loans have been and will be entered into with
such persons in the ordinary course of business, on substantially the
same terms, including interest rates and collateral, as those prevailing
at the time for comparable transactions with other persons, and on terms
not involving more than the normal risk of collectibility or
representing other unfavorable features. At December 31, 2004, loans by
the Bank to directors, officers and their associates totaled
approximately $8,559,000, constituting 0.9% of total loans, 10.8% of the
Bank's shareholders' equity and 9.5% of the consolidated shareholders'
equity of the Corporation. Loans to insiders, such as officers,
directors, and certain other persons are subject to the limitations and
requirements of the Financial Institutions Regulatory and Interest Rate
Control Act of 1978 and regulations thereunder.
Deposits held by directors and officers totaled $15,961,000 and
11,573,000 at the years ending December 31, 2004 and 2003.
During 2004, the Bank implemented a special loan program to assist
employees (not available to executive officers and directors) in
financing their primary residence at competitive terms. As of December
31, 2004 the Bank had $5,680,000 outstanding to employees at interest
rates ranging from 3.25% to 5.25% under this special loan program. Other
types of loans, such as construction financing and consumer loans, have
been provided to employees in the normal course of business. As of
December 31, 2004 total loans outstanding to employees totaled
$5,994,000 at rates ranging from 3.25% to 10.25%.
The firm of Keegan & Coppin Company, Inc. of which James B. Keegan, Jr.
a director, is a partner, has acted and may in the future act as leasing
agent in transactions for leased premises of the Bank. Real estate
commissions and referral fees have been paid by the lessor of Bank
facilities to Keegan & Coppin Company, Inc. in the amount of $32,000 in
2004 and $145,000 in 2003. Keegan & Coppin Company, Inc. has also acted
as a contractor for the Bank's leasehold improvements which totaled
$420,000 in 2004, of which $245,000 paid by the lesser and $175,000 was
paid by the Bank for the construction of the leasehold improvements.
There were no constructions services performed in 2003. Keegan & Coppin
Company, Inc. is currently in the process of constructing leasehold
improvements in the branch in Petaluma, California, for which $197,000
will be paid by the Bank. Real estate commissions and referral fees paid
to Keegan & Coppin Company, Inc. were in the amounts customarily paid in
the real estate industry for those areas. Construction contracts are
awarded using a bidding process.
Item 14. Principal Accounting Fees and Services
The following schedule summarizes the amounts billed by the
Corporation's auditors for accounting services as of the end of the
last two years.
(in thousands) 2004 2003
---- ----
Audit fees $131 $121
Audit related fees 0 0
Tax fees 47 35
All other fees 0 0
---- ----
$178 $156
==== ====
The Corporation and Bank's Audit Committee met in 2004 with our
independent auditors, Moss Adams, LLP, and approved their engagement to
perform audit and tax services before the accountant was engaged to
render audit and non-audit services. The aggregate amount of all
non-audit services, which were tax services, performed by the accountant
during 2004 amounted to 26.4% of the total fees paid by the Corporation
and Bank to the accountant for the year.
Part IV
ITEM 15. Exhibits, Financial Statement Schedules
(1) 1. All Financial Statements.
See item 8.
(2) 2 Financial Statement Schedules.
None required
(3) 3. Exhibits
The following is a list of the exhibits to this Form 10-K.
(3) (a) Restated Articles of Incorporation, as amended through
December 1, 2003 (filed as Exhibit (3)(d) to the
Corporation's Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 1988, file number 2-91196, and
incorporated herein by this reference).
(b) Secretary's certificate of Amendment to the Bylaws of the
Corporation and revised Bylaws
(10) (a)* Stock Option Plan (filed as Exhibit 10.2 to the Corporation's
S-1 Registration Statement, filed May 18, 1984, file number
2-91196, and incorporated herein by this reference).
(b)* Amendment No. 1 to Stock Option Plan (filed as
Exhibit (10)(d) to the Corporation's Annual Report on Form
10-K for the Fiscal Year ended December 31, 1989, file
number 2-91196, and incorporated herein by this reference).
(c)* Amendment No. 2 to Stock Option Plan (filed as
Exhibit (10)(f) to the Corporation's Annual Report on Form
10-K for the Fiscal Year Ended December 31, 1991,
file number 2-91196, and incorporated herein by this
reference).
(d) Amendment No. 3 to Stock Option Plan.
(e) Form of Non-statutory Stock Option Agreement
(f)* Indemnification Agreements between James B. Keegan, Jr. and
Northern Empire Bancshares and Sonoma National Bank (filed as
Exhibit (10)(h) to the Corporation's Annual Report on Form
10-KSB for the Fiscal Year Ended December 31,1992, file
number 2-91196, and incorporated herein by this reference).
(g)* Indemnification Agreements between Dennis R. Hunter and
Northern Empire Bancshares and Sonoma National Bank (filed
as Exhibit (10)(i) to the Corporation's Annual Report on Form
10-KSB for the Fiscal Year Ended December 31,1992, file
number 2-91196, and incorporated herein by this reference).
(h)* Indemnification Agreements between Robert V. Pauley and
Northern Empire Bancshares and Sonoma National Bank (filed
as Exhibit (10)(j) to the Corporation's Annual Report on Form
10-KSB for the Fiscal Year Ended December 31,1992, file
number 2-91196, and incorporated herein by this reference).
(i)* Indemnification Agreements between William E. Geary and
Northern Empire Bancshares and Sonoma National Bank (filed
as Exhibit (10)(k) to the Corporation's Annual Report on
Form 10-KSB for the Fiscal Year Ended December 31,1992,
file number 2-91196, and incorporated herein by this
reference).
(j)* Indemnification Agreements between Patrick R. Gallaher and
Northern Empire Bancshares and Sonoma National Bank (filed as
Exhibit (10)(l) to the Corporation's Annual Report on Form
10-KSB for the Fiscal Year Ended December 31,1992, file
number 2-91196, and incorporated herein by this reference).
(k)* Indemnification Agreement between William P. Gallaher and
Sonoma National Bank (filed as Exhibit (10)(m) to the
Corporation's Annual Report on Form 10-KSB for the Fiscal
Year Ended December 31,1992, file number 2-91196, and
incorporated herein by this reference).
(l)* Indemnification Agreement between Deborah A. Meekins and
Sonoma National Bank (filed as Exhibit (10)(p) to the
Corporation's Annual Report on Form 10-KSB for the Fiscal
Year Ended December 31,1992, file number 2-91196, and
incorporated herein by this reference).
(m)* Executive Salary Continuation Agreement between Deborah A.
Meekins and Sonoma National Bank (filed as Exhibit (10)(O)
to the Corporation's Annual Report on Form 10-KSB for the
Fiscal Year Ended December 31,1993, file number 2-91196,
and incorporated herein by this reference).
(n)* Executive Salary Continuation Agreement between David F. Titus
and Sonoma National Bank (filed as Exhibit (10)(p) to the
Corporation's Annual Report on Form 10-KSB for the Fiscal Year
Ended December 31,1993, file number 2-91196, and incorporated
herein by this reference).
(o) Lease for premises in Lakeside Village Shopping Center,
Windsor, California, dated March 1,1993 (filed as Exhibit
(10.15) to the Corporation's Amendment No. 1 to Form S-2
Registration Statement, File No. 33-60566, filed May 13, 1993,
file number 33-60566, and incorporated herein by this
reference).
(p)* Director's Deferred Compensation Plan between Patrick R.
Gallaher and Sonoma National Bank (filed as Exhibit (10)(r)
to the Corporation's Annual Report on Form 10-KSB for the
Fiscal Year Ended December 31,1994, file number 2-91196, and
incorporated herein by this reference).
(q)* Director's Deferred Compensation Plan between
James B. Keegan, Jr. and Sonoma National Bank (filed as
Exhibit (10)(t) to the Corporation's Annual Report on Form
10-KSB for the Fiscal Year Ended December 31,1994, file
number 2-91196, and incorporated herein by this reference).
(r)* Director's Deferred Compensation Plan between William E. Geary
and Sonoma National Bank (filed as Exhibit (10)(u) to the
Corporation's Annual Report on Form 10-KSB for the Fiscal
Year Ended December 31,1994, file number 2-91196, and
incorporated herein by this reference).
(s) Lease for Bank Premises at 6641 Oakmont Drive, Santa Rosa,
California, dated October 1, 1996 (filed as Exhibit (10)(w)
to the Corporation's Quarterly Report on Form 10-QSB for the
Quarter ended September 30, 1996, file number 2-91196, and
incorporated herein by this reference).
(t)* Indemnification Agreements between William P. Gallaher and
Northern Empire Bancshares (filed as Exhibit (10)(a) to the
Corporation's Quarterly Report on Form 10-QSB for the Quarter
Ended June 30,1998, file number 2-91196, and incorporated
herein by this reference).
(u)* Indemnification Agreements between Clement C. Carinalli and
Northern Empire Bancshares and Sonoma National Bank (filed as
Exhibit (10)(b) to the Corporation's Quarterly Report on Form
10-QSB for the Quarter Year Ended June 30, 1998, file number
2-91196, and incorporated herein by this reference).
(v)* 1997 Stock Option Plan, as amended, and Stock Option Agreement
(filed as Exhibit (10)(b) to the Corporation's Quarterly
Report on Form 10-QSB for the Quarter Year Ended June 30,
1998, file number 2-91196, and incorporated herein by this
reference).
(w) Lease for West College Branch in G & G Market at 1211A West
College Avenue, Santa Rosa, California, dated June 30, 1998
(filed as Exhibit (10)(y) to the Corporation's Annual Report
on Form 10-KSB for the Fiscal Year Ended December 31, 1998,
file number 2-91196, and incorporated herein by this
reference).
(x) Lease for Petaluma College Branch in G & G Market at 701-B,
Petaluma, California, dated November 1, 2000 (filed as
Exhibit (10)(z) to the Corporation's Annual Report on Form
10-K for the Fiscal Year Ended December 31, 2000, file number
2-91196, and incorporated herein by this reference).
(y) Lease for Sonoma Branch at 135 West Napa Street, Sonoma,
California, dated April 5, 2002. (filed as Exhibit (10)(a)
to the Corporation's Quarterly Report on Form 10-Q for the\
Quarter Year Ended March 31, 2002, file number 2-91196, and
incorporated herein by this reference).
(z) Lease for Operations Center at 1650 Northpoint Parkway, Santa
Rosa, California, dated February 1, 2001. (filed as Exhibit
(10)(aa) to the Corporation's Annual Report on Form 10-K for
the Fiscal Year Ended December 31, 2000, file number 2-91196,
and incorporated herein by this reference).
(aa) Lease for Administrative Offices and the Loan Department at
3558 Round Barn Boulevard, Santa Rosa, California, dated
October 14, 2003 (filed as Exhibit (10)(bb) to the
Corporation's Quarterly Report on Form 10-Q for the
Quarter Year Ended September 30, 2003, file number 2-91196
and incorporated herein by this reference.
(bb) Lease for the Main Branch at 801 Fourth Street, Santa Rosa,
California, dated December 17, 2003 (filed as
Exhibit (10)(dd) to the Corporation's Annual Report on Form
10-K for the Fiscal Year Ended December 31, 2003, file number
2-91196, and incorporated herein by this reference).
(cc) Letter agreement dated November 5, 2004. Confidential
treatment has been requested for certain commercial and
financial information, omitted from this Exhibit and filed
separately, pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.
(dd) Letter agreement dated November 5, 2004. Confidential
treatment has been requested for certain commercial and
financial information, omitted from this Exhibit and filed
separately, pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.
(ee) Letter agreement dated November 5, 2004. Confidential
treatment has been requested for certain commercial and
financial information, omitted from this Exhibit and filed
separately, pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.
(ff) Letter agreement dated November 5, 2004. Confidential
treatment has been requested for certain commercial and
financial information, omitted from this Exhibit and filed
separately, pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.
(gg) Letter agreement dated November 5, 2004. Confidential
treatment has been requested for certain commercial and
financial information, omitted from this Exhibit and filed
separately, pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.
(hh) Letter agreement dated November 5, 2004. Confidential
treatment has been requested for certain commercial and
financial information, omitted from this Exhibit and filed
separately, pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.
(ii) Letter agreement dated November 5, 2004. Confidential
treatment has been requested for certain commercial and
financial information, omitted from this Exhibit and filed
separately, pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.
*Management contract or compensation plan or arrangement.
(14) Code of Ethics (filed as Exhibit 14 to the
Corporation's Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 2003, file number 2-91196, and
incorporated herein by this reference).
(21) Subsidiaries of the Corporation (filed as Exhibit 22 to Post
Effective Amendment No. 5 to the Corporation's S-1
Registration Statement, filed May 29, 1987, File No 2-91196
and incorporated herein by this reference).
(23) Consent Independent Registered Public Accounting Firm
(31) Rule 13a-14(a)/15d-14(a) Certifications
(32) Section 1350 Certifications
(b) Reports on Form 8-K
Form 8-K, filed on January 26, 2005, reporting, under
Item 7 and 12, 2004 financial results.
Supplemental Information to be Furnished With Reports Filed Pursuant to
Section 15(d) of the Exchange Act by Non Reporting Issuers.
Four copies of the Registrant's 2004 Annual Report to Security Holders
will be furnished to the Commission for its information when it is sent
to the security holders.
The Registrant's Proxy Materials for the 2005 Shareholders' Meeting have
not yet been sent to the Security Holders. Copies of the Proxy
materials will be furnished to the Commission for its information when
they are sent to the security holders.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Northern Empire Bancshares
By /s/ Deborah A. Meekins
-------------------------
Deborah A. Meekins
President & Chief Executive Officer
Date: March 8, 2005
By /s/ Jane M. Baker
---------------------
Jane M. Baker
Chief Financial Officer
Date: March 8, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
/s/ Dennis R. Hunter Date March 8,2005
- --------------------
Dennis R. Hunter
Chairman of the Board of Directors
/s/ James B. Keegan, Jr. Date March 8,2005
- ------------------------
James B. Keegan, Jr.
Vice Chairman of the Board of Directors
/s/ Patrick R. Gallaher Date March 8,2005
- -------------------------
Patrick R. Gallaher,
Secretary and Director
/s/ Clement C. Carinalli Date March 8, 2005
- ------------------------
Clement C. Carinalli,
Director
/s/ William E. Geary Date March 8, 2005
- --------------------
William E. Geary,
Director
Exhibit 31.1
Certification
I, Deborah A. Meekins, certify that:
1. I have reviewed this annual report on Form 10K of Northern Empire
Bancshares;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(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 annual 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 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.
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: March 8,2005
Signature /s/ Deborah A. Meekins
-----------------------
Deborah A. Meekins
President & Chief Executive Officer
Exhibit 31.2
Certification
I, Jane M. Baker, certify that:
1. I have reviewed this annual report on Form 10K of Northern Empire
Bancshares;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(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 annual 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 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.
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: March 8, 2005
Signature /s/ Jane M. Baker
-------------------
Jane M. Baker
Chief Financial Officer
Exhibit 32
CERTIFICATION
The undersigned each certify that:
1. They are the duly appointed Chief Executive Officer and Chief
Financial Officer, respectively, of Northern Empire Bancshares, a
California Corporation ("the Company"); and
2. To her best knowledge and belief, the Company's Annual Report on Form
10-K for the year ended December 31, 2004, and to which the
Certification is attached as Exhibit 32, fully complies with the
requirements of Sections 13(a) or 15(d) of the Securities and
Exchange Act of 1934 and that the information contained in the
Report fairly presents, in all material respects, the Financial
condition and results of operations of Northern Empire Bancshares.
Date: March 8, 2005
/s/ Deborah A. Meekins /s/ Jane M. Baker
- ---------------------- --------------------
Deborah A. Meekins Jane M. Baker
President & Chief Executive Officer Chief Financial Officer