UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSAUNT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 0-19231
REDWOOD EMPIRE BANCORP
(Exact name of registrant as specified in its charter)
California 68-0166366
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
111 Santa Rosa Avenue, Santa Rosa, California 95404-4905
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code: (707) 537-4800
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 [ ]
At November 4, 2002, there were 3,449,890 shares of the Registrant's common
stock outstanding.
This page is page 1 of 46 pages.
REDWOOD EMPIRE BANCORP
AND
SUBSIDIARIES
Index
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2002 and 2001.......................3
Consolidated Balance Sheets
September 30, 2002 and December 31, 2001......................................5
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2002 and 2001.................................6
Notes to Consolidated Financial Statements....................................8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations.............................13
Item 3. Quantitative and Qualitative Disclosures
About Market Risk............................................................37
Item 4. Controls and Procedures......................................................40
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds....................................41
Item 6. Exhibits and Reports on Form 8-K.............................................41
SIGNATURES.....................................................................................42
CERTIFICATIONS.................................................................................43
This page is page 2 of 46 pages.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
--------------------------------------------------------
Interest income:
Interest and fees on loans $6,542 $6,954 $19,245 $21,310
Interest on investment securities 1,105 1,192 3,321 3,791
Interest on federal funds sold 159 171 383 711
--------------------------------------------------------
Total interest income 7,806 8,317 22,949 25,812
Interest expense:
Interest on deposits 2,265 3,018 6,559 9,951
Interest on other borrowings 270 308 807 743
--------------------------------------------------------
Total interest expense 2,535 3,326 7,366 10,694
--------------------------------------------------------
Net interest income 5,271 4,991 15,583 15,118
Provision for loan losses --- --- --- ---
--------------------------------------------------------
Net interest income after provision for loan losses 5,271 4,991 15,583 15,118
Noninterest income:
Service charges on deposit accounts 288 284 910 819
Merchant draft processing, net 1,322 1,098 3,698 2,930
Loan servicing income 66 69 201 226
Net realized gains on
investment securities available for sale 259 22 294 22
Other income 220 221 663 614
--------------------------------------------------------
Total noninterest income 2,155 1,694 5,766 4,611
Noninterest expense:
Salaries and employee benefits 2,346 2,066 6,694 6,287
Occupancy and equipment expense 531 511 1,588 1,503
Other 1,426 1,052 3,663 2,921
--------------------------------------------------------
Total noninterest expense 4,303 3,629 11,945 10,711
--------------------------------------------------------
Income before income taxes 3,123 3,056 9,404 9,018
Provision for income taxes 1,165 1,224 3,474 3,631
--------------------------------------------------------
Net income $1,958 $1,832 $5,930 $5,387
========================================================
Total comprehensive income $2,018 $2,256 $6,427 $6,266
========================================================
(Continued)
This page is page 3 of 46 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
(Continued)
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
----------------------------------------------------------------
Basic earnings per common share:
Net income $.56 $.51 $1.70 $1.43
Weighted average shares - basic 3,476,000 3,564,000 3,489,000 3,755,000
Diluted earnings per common share:
Net income $.54 $.50 $1.64 $1.39
Weighted average shares - diluted 3,600,000 3,697,000 3,616,000 3,877,000
See Notes to Consolidated Financial Statements.
(Concluded)
This page is page 4 of 46 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands)
September 30, December 31,
2002 2001
----------------------------------
(unaudited)
Assets:
Cash and due from banks $16,672 $19,596
Federal funds sold 37,429 4,653
----------------------------------
Cash and cash equivalents 54,101 24,249
Investment securities:
Held to maturity (fair value of $18,351 and $17,635) 17,731 17,402
Available for sale, at fair value (amortized cost of $58,838 and $46,433) 60,676 47,573
----------------------------------
Total investment securities 78,407 64,975
Mortgage loans held for sale 654 ---
Loans:
Residential real estate mortgage 92,711 101,175
Commercial real estate mortgage 149,234 121,456
Commercial 68,302 70,438
Real estate construction 45,403 46,501
Installment and other 12,960 12,567
Less net deferred loan fees (736) (488)
----------------------------------
Total portfolio loans 367,874 351,649
Less allowance for loan losses (7,578) (7,580)
----------------------------------
Net loans 360,296 344,069
Premises and equipment, net 2,812 2,636
Mortgage servicing rights, net 4 4
Cash surrender value of life insurance 3,576 3,443
Other assets and interest receivable 10,013 9,366
----------------------------------
Total assets $509,863 $448,742
==================================
Liabilities and Shareholders' equity:
Deposits:
Noninterest bearing demand deposits $100,294 $86,969
Interest-bearing transaction accounts 121,740 121,457
Time deposits one hundred thousand and over 77,660 112,638
Other time deposits 152,320 76,348
----------------------------------
Total deposits 452,014 397,412
Short-term borrowings 5,475 3,870
Trust preferred securities 10,000 10,000
Other liabilities and interest payable 13,563 10,773
----------------------------------
Total liabilities 481,052 422,055
Shareholders' equity:
Preferred stock, no par value; authorized 2,000,000 shares;
none issued and outstanding --- ---
Common stock, no par value; authorized 10,000,000 shares;
issued and outstanding: 3,455,390 and 3,530,135 shares 11,136 12,373
Retained earnings 16,517 13,653
Accumulated other comprehensive income, net of tax 1,158 661
----------------------------------
Total shareholders' equity 28,811 26,687
----------------------------------
Total liabilities and shareholders' equity $509,863 $448,742
==================================
See Notes to Consolidated Financial Statements.
This page is page 5 of 46 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Nine Months Ended
September 30,
2002 2001
--------------------------
Cash flows from operating activities:
Net income $5,930 $5,387
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization, net 192 14
Loans originated for sale (1,807) ---
Proceeds from sale of loans held for sale 1,170 ---
Net realized gains on securities available for sale (294) (22)
Net realized gains on sale of loans held for sale (13) ---
Change in other assets and interest receivable (1,033) 293
Change in other liabilities and interest payable 2,790 630
Other, net --- 30
--------------------------
Total adjustments 1,005 945
--------------------------
Net cash from operating activities 6,935 6,332
Cash flows from investing activities:
Net change in loans (15,892) (27,159)
Purchases of investment securities available for sale (33,816) (24,818)
Purchases of investment securities held to maturity (2,499) (1,326)
Proceeds from sales of investment securities available for sale 9,319 1,022
Maturities of investment securities available for sale 12,292 24,058
Maturities or calls of investment securities held to maturity 2,332 12,886
Purchases of premises and equipment, net (723) (651)
Proceeds from sale of other real estate owned --- 512
--------------------------
Net cash from investing activities (28,987) (15,476)
Cash flows from financing activities:
Net change in noninterest bearing demand deposits 13,325 2,539
Net change in interest bearing transaction accounts 283 (4,774)
Net change in time deposits 40,994 (2,890)
Net change in short-term borrowings 1,605 (113)
Issuance of trust preferred securities --- 10,000
Repurchases of common stock (2,201) (14,634)
Cash dividends paid (2,102) (1,274)
--------------------------
Net cash from financing activities 51,904 (11,146)
--------------------------
Net change in cash and cash equivalents 29,852 (20,290)
Cash and cash equivalents at beginning of period 24,249 43,927
--------------------------
Cash and cash equivalents at end of period $54,101 $23,637
==========================
(Continued)
This page is page 6 of 46 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
(Continued)
Nine Months Ended
September 30,
2002 2001
-------------------------------
Supplemental Disclosures:
Cash paid during the period for:
Interest expense $7,594 $10,759
Income taxes 3,743 2,925
See Notes to Consolidated Financial Statements.
(Concluded)
This page is page 7 of 46 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements should be
read in conjunction with the consolidated financial statements and related notes
contained in Redwood Empire Bancorp's 2001 Annual Report to Shareholders. The
statements include the accounts of Redwood Empire Bancorp ("Redwood," and with
its subsidiaries, the "Company"), and its wholly owned subsidiaries, National
Bank of the Redwoods ("NBR" or the "Bank") and Redwood Statutory Trust I
("RSTI"). All significant inter-company balances and transactions have been
eliminated. The financial information contained in this report reflects all
adjustments, which, in the opinion of management, are necessary for a fair
presentation of the results of the interim periods. All such adjustments are of
a normal recurring nature. The results of operations and cash flows for the nine
months ended September 30, 2002 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2002.
Certain reclassifications were made to prior period financial
statements to conform to current period presentations.
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, federal funds sold and repurchase
agreements with original maturities of 90 days or less. Federal funds sold and
repurchase agreements are generally for one day periods.
2. Earnings per Share
Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the Company.
On September 20, 2001, the Company announced a three-for-two stock
split of its outstanding shares of common stock. Earnings per share information
for all periods presented give effect to the stock split.
This page is page 8 of 46 pages.
The following table reflects the Company's pertinent earnings per share
data.
Three Months Ended
September 30,
2002 2001
------------------------------- -------------------------------
Basic Diluted Basic Diluted
--------------- ------------- -------------- --------------
(in thousands, except per share data)
Earnings per common share:
Net income $1,958 $1,958 $1,832 $1,832
Earnings per share .56 .54 .51 .50
Weighted average common shares outstanding 3,476,000 3,600,000(1) 3,564,000 3,697,000(1)
1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 124,000 and 133,000 for the three months ended
September 30, 2002 and September 30, 2001.
Nine Months Ended
September 30,
2002 2001
------------------------------- -------------------------------
Basic Diluted Basic Diluted
--------------- ------------- -------------- --------------
(in thousands, except per share data)
Earnings per common share:
Net income $5,930 $5,930 $5,387 $5,387
Earnings per share 1.70 .1.64 .1.43 1.39
Weighted average common shares outstanding 3,489,000 3,616,000(1) 3,755,000 3,877,000(1)
1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 127,000 and 122,000 for the nine months ended
September 30, 2002 and September 30, 2001.
3. Comprehensive Income
The Company's total comprehensive earnings presentation is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
---------------------------------------------
(in thousands)
Net income as reported $1,958 $1,832 $5,930 $5,387
Other comprehensive income (net of
tax):
Change in unrealized holding gain
on available for sale securities 223 437 682 892
Reclassification adjustment (163) (13) (185) (13)
---------------------------------------------
Total comprehensive income $2,018 $2,256 $6,427 $6,266
=============================================
This page is page 9 of 46 pages.
4. Subsequent Event - Common Stock Cash Dividend
On October 8, 2002, the Board of Directors declared a quarterly cash
dividend of 20 cents per share on the Company's Common Stock. The dividend was
payable on October 30, 2002 to shareholders of record on October 18, 2002.
5. Business Segments
The Company operates in two principal business segments: core community
banking and merchant card services. The Company's core community banking segment
includes commercial, commercial real estate, construction and permanent
residential lending along with all treasury and depository activities. The
Company's merchant card services industry group provides credit card settlement
services for approximately 44,000 merchants throughout the United States.
The condensed income statements and average assets of the individual
segments are set forth in the table below. The information in this table is
derived from the internal management reporting system used by management to
measure the performance of the segments and the Company. The management
reporting system assigns balance sheet and income statement items to each
segment based on internal management accounting policies. Net interest income is
determined by the Company's internal funds transfer pricing system, which
assigns a cost of funds or credit for funds to assets or liabilities based on
their type, maturity or repricing characteristics. Noninterest income and
expense directly attributable to a segment are assigned to that business. Total
other operating expense, including indirect costs, such as overhead, operations
and technology expense, are allocated to the segments based on an evaluation of
costs for product or data processing. All amounts other than allocations of
interest and indirect costs are derived from third parties. The provision for
credit losses is allocated based on the required reserves and the net
charge-offs for each respective segment. The Company allocates depreciation
expense without allocating the related depreciable asset to that segment.
Summary financial data by business segment for the indicated periods is
as follows:
For the quarter ended September 30, 2002
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $7,806 $ --- $7,806
Total interest expense 2,529 6 2,535
Interest income/(expense) allocation (147) 147 ---
-----------------------------------------------
Net interest income 5,130 141 5,271
Provision for loan losses --- --- ---
Total other operating income 833 1,322 2,155
Total other operating expense 3,587 716 4,303
-----------------------------------------------
Income before income taxes 2,376 747 3,123
Provision for income taxes 886 279 1,165
-----------------------------------------------
Net income $1,490 $468 $1,958
===============================================
Total Average Assets $477,257 $26,638 $503,895
===============================================
This page is page 10 of 46 pages.
For the quarter ended September 30, 2001
-------------------------------------------------
Merchant
Community Card Total
Banking Services Company
-------------------------------------------------
(in thousands)
Total interest income $8,317 $ --- $8,317
Total interest expense 3,323 3 3,326
Interest income/(expense) allocation (266) 266 ---
-------------------------------------------------
Net interest income 4,728 263 4,991
Provision for loan losses --- --- ---
Total other operating income 596 1,098 1,694
Total other operating expense 3,062 567 3,629
-------------------------------------------------
Income before income taxes 2,262 794 3,056
Provision for income taxes 906 318 1,224
-------------------------------------------------
Net income $1,356 $476 $1,832
=================================================
Total Average Assets $422,976 $27,589 $450,565
=================================================
For the nine months ended September 30, 2002
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $22,949 $ --- $22,949
Total interest expense 7,342 24 7,366
Interest income/(expense) allocation (479) 479 ---
-----------------------------------------------
Net interest income 15,128 455 15,583
Provision for loan losses --- --- ---
Total other operating income 2,068 3,698 5,766
Total other operating expense 9,936 2,009 11,945
-----------------------------------------------
Income before income taxes 7,260 2,144 9,404
Provision for income taxes 2,683 791 3,474
-----------------------------------------------
Net income $4,577 $1,353 $5,930
===============================================
Total Average Assets $458,776 $27,086 $485,862
===============================================
For the nine months ended September 30, 2001
----------------------------------------------
Merchant
Community Card Total
Banking Services Company
----------------------------------------------
(in thousands)
Total interest income $25,812 $ --- $25,812
Total interest expense 10,686 8 10,694
Interest income/(expense) allocation (840) 840 ---
----------------------------------------------
Net interest income 14,286 832 15,118
Provision for loan losses --- --- ---
Total other operating income 1,681 2,930 4,611
Total other operating expense 9,061 1,650 10,711
----------------------------------------------
Income before income taxes 6,906 2,112 9,018
Provision for income taxes 2,781 850 3,631
----------------------------------------------
Net income $4,125 $1,262 $5,387
==============================================
Total Average Assets $420,341 $25,952 $446,293
==============================================
This page is page 11 of 46 pages.
6. Common Stock Repurchases and Trust Preferred Issuance
In January and February 2001, the Company's Board of Directors
authorized the repurchase of up to 10% of the Company's total shares
outstanding, or 427,500 shares in January 2001 and 385,500 shares in February
2001, as adjusted for the three-for-two stock split announced September 20,
2001, of which all shares have been repurchased. In August 2001, the Company
announced a third authorization to repurchase an additional 355,500 shares, as
adjusted for the three-for-two stock split announced September 20, 2001. To
date, 138,636 shares have been repurchased, as adjusted for the three-for-two
stock split announced September 20, 2001. Under the repurchase program, the
Company plans to purchase shares from time to time on the open market and/or in
privately negotiated transactions. The first two repurchase authorizations were
funded in part with proceeds received from a $10,000,000 pooled trust preferred
securities offering concluded on February 22, 2001. The financing, which
qualifies for tier 1 capital treatment, for up to 25% of total tier 1 capital,
bears an interest rate of 10.2% and is due in 30 years. Debt issuance costs,
which amounted to approximately $300,000, are being amortized over the life of
the offering.
7. Real Estate Investment Trust
On January 15, 2002, NBR formed NBR Real Estate Investment Trust, a
Maryland Real Estate Investment Trust. The entity was formed to hold NBR's real
estate secured loans and to better organize NBR's marketing and origination of
real estate secured lending. For further discussion see "Income Taxes".
8. New Accounting Pronouncements
On October 1, 2002, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 147,
"Acquisitions of Certain Financial Institutions." SFAS No. 147 is effective
October 1, 2002, and may be early applied. SFAS No. 147 Supersedes SFAS No. 72,
"Accounting for Certain Acquisitions of Banking or Thrift Institutions". SFAS No
147 provides guidance on the accounting for the acquisition of a financial
institution, and applies to all such acquisitions except those between two or
more mutual enterprises. Under SFAS No. 147, the excess of the fair value of
liabilities assumed over the fair value of tangible and identifiable intangible
assets acquired in a financial institution business combination represents
goodwill that should be accounted for under SFAS No. 142, "Goodwill and Other
Intangible Assets". If certain criteria are met, the amount of the
unidentifiable intangible asset resulting from prior financial institutions
acquisitions is to be reclassified to goodwill upon adoption of this Statement.
Financial institutions meeting conditions outlined in SFAS No. 147 are required
to restate previously issued financial statements. The objective of the
restatement is to present the balance sheet and income statement as if the
amount accounted for under SFAS No. 72 as an unidentifiable intangible asset had
been reclassified to goodwill as of the date the Company adopted SFAS No. 142.
Adoption of SFAS No. 147 on October 1, 2002 did not have a material effect on
the Company's consolidated financial position or results of operation.
This page is page 12 of 46 pages.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Forward-Looking Information
This Quarterly Report on Form 10-Q includes forward-looking information
which is subject to the "safe harbor" created by Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements (which involve the Company's plans,
beliefs and goals, refer to estimates, projections or expectations or use
similar terms) involve certain risks and uncertainties that could cause actual
results to differ materially from those in the forward-looking statements. Such
risks and uncertainties include, but are not limited to, the following factors
(many of which are beyond the Company's ability to control):
o Competitive pressure in the banking industry and changes in the
regulatory and legislative environment.
o Changes in the interest rate environment and volatility of rate
sensitive loans and deposits.
o A decline in the health of the economy nationally or regionally which
could reduce the demand for loans or reduce the value of real estate
collateral securing most of the Company's loans or reduce the volume
of the Company's merchant credit card processing business.
o Uncertainty regarding the economic outlook resulting from the
terrorist attacks on September 11, 2001, as well as actions taken or
to be taken by the U.S. or other governments as a result of such
attacks or further acts or threats of terrorism.
o Credit quality deterioration, which could cause an increase in the
provision for loan losses.
o Dividend restrictions.
o Regulatory discretion.
o Material losses in the Company's merchant credit card processing
business from merchant or card holder fraud or merchant business
failure and the ability of the Company to comply with the rules and
regulations of the major credit card associations, such as Visa and
Mastercard, as described under "Certain Important Considerations for
Investors" in this report.
o Asset/liability repricing risks and liquidity risks.
o Changes in the securities markets.
This page is page 13 of 46 pages.
o A decline in the health of the Northern California economy, including
the long-term impact of the California energy crisis and the decline
in the technology sector.
o Certain operational risks involving data processing systems or fraud.
o The proposal or adoption of changes in accounting standards by the
Financial Accounting Standards Board, the Securities and Exchange
Commission or other standard setting bodies.
Any forward-looking statements made by the Company are intended to
provide investors with additional information with which they may assess the
Company's future potential. All forward-looking statements are based on
assumptions about an uncertain future and are based on information available at
the date such statements are issued. The Company undertakes no obligation to
revise or publicly release the results of any revision to these forward-looking
statements. For additional information concerning risks and uncertainties
related to the Company and its operations, please refer to the Company's Annual
Report on Form 10-K for the year ended December 31, 2001 and "Certain Important
Considerations for Investors" herein.
The following sections discuss significant changes and trends in
financial condition, capital resources and liquidity of the Company from
December 31, 2001 to September 30, 2002. Significant changes and trends in the
Company's results of operations for the three and nine months ended September
30, 2002, compared to the same period in 2001, are also discussed.
Summary of Financial Results
The Company reported net income of $1,958,000 ($.54 per diluted share)
for the three months ended September 30, 2002 as compared to $1,832,000 ($.50
per diluted share) for the same period in 2001, an increase of $126,000 in net
income or 7%. This increase is due to an increase of $461,000 in noninterest
income and an increase of $280,000 in net interest income, partially offset by
an increase of $674,000 in noninterest expense. In addition, net income
increased due to a decline in the Company's effective tax rate from 40.05% for
the quarter ended September 30, 2001 to 37.30% for the quarter ended September
30, 2002. For further information, see "Income Taxes" in this section.
Net income for the nine months ended September 30, 2002 was $5,930,000
($1.64 per diluted share) as compared to $5,387,000 ($1.39 per diluted share)
for the same period in 2001, an increase of $543,000 in net income or 10%. This
increase is due to an increase of $1,155,000 in noninterest income and an
increase of $465,000 in net interest income, partially offset by an increase of
$1,234,000 in noninterest expense. In addition, net income increased due to a
decline in the Company's effective tax rate from 40.26% for the nine months
ended September 30, 2001 to 36.94% for the nine months ended September 30, 2002.
For further information, see "Income Taxes" in this section.
This page is page 14 of 46 pages.
On September 20, 2001, the Company announced a three-for-two stock
split of its outstanding shares of common stock. Earnings per share information
for all periods presented give effect to the stock split.
Net Interest Income
Net interest income increased from $4,991,000 in the third quarter of
2001 to $5,271,000 in the third quarter of 2002, which represents an increase of
$280,000 or 6%. The increase in net interest income was driven by an increase in
average earning assets of $53,960,000 from $422,592,000 for the quarter ended
September 30, 2001 to $476,552,000 for the quarter ended September 30, 2002,
offset by a decline of the net interest margin from 4.69% for the quarter ended
September 30, 2001 to 4.39% for the quarter ended September 30, 2002. Such
decline in the net interest margin is primarily due to the lower interest rate
environment and the Company carrying $36,806,000 in lower yielding average
overnight investments for the quarter ended September 30, 2002 as compared to
$19,149,000 in such investments for the quarter ended September 30, 2001.
Net interest income for the nine months ended September 30, 2002 was
$15,583,000, which represents an increase of $465,000 when compared to the same
period one year ago. The increase in net interest income was driven by an
increase in average earning assets of $39,218,000 from $418,254,000 at September
30, 2001 to $457,472,000 for the nine months ended September 30, 2002. The
Company's net interest margin decreased to 4.55% for the nine months ended
September 30, 2002, as compared to 4.83% for the nine months ended September 30,
2001. The decline in net interest margin during the nine-month period of 2002 is
due to the lower interest rate environment, the Company carrying $29,244,000 in
lower yielding average overnight investments for the nine months ended September
30, 2002 as compared to $20,464,000 one year ago and the full nine-month impact
of the Company's February 22, 2001 trust preferred debt financing. For further
discussion of this matter, see "Trust Preferred Securities" in this section.
For the three months ended September 30, 2002, yield on earning assets
decreased to 6.50% from 7.81% for the same period one year ago. The decrease in
yield on earning assets is due to a decline in the general interest rate
environment. Despite the decline in interest rates, average portfolio loans
increased $35,008,000 or 11%, when compared to the same quarter in 2001. Average
commercial real estate loans increased $38,673,000 or 36% and average
installment and other loans increased $4,273,000 or 39%, offset by a decline of
$7,570,000, or 10% in average commercial loans for the three months ended
September 30, 2002 as compared to the three months ended September 30, 2001.
This page is page 15 of 46 pages.
For the nine months ended September 30, 2002, yield on earning assets
decreased to 6.71% as compared to 8.25% for the nine months ended September 30,
2001. While the Company has seen average earning assets grow to $457,472,000 for
the nine months ended September 30, 2002, as compared to $418,254,000 for the
nine months ended September 30, 2001, the decline in yield on earning assets is
attributable to the decline in the general interest rate environment. Average
portfolio loans increased $32,409,000 or 10% when compared to the same period in
2001. Average commercial real estate loans increased $30,891,000 or 30% and
average installment and other loans increased $4,265,000 or 43% for the nine
months ended September 30, 2002 as compared to the nine months ended September
30, 2001.
Yield paid on interest bearing liabilities decreased to 2.79% and 2.81%
for the three and nine months ended September 30, 2002 as compared to 4.09% and
4.46% for the same periods one year ago. This decline is attributable to a lower
interest rate environment as discussed above.
With the increase in average earning assets in the first nine months of
2002, the Company's funding levels also increased as average interest bearing
liabilities increased $29,428,000 or 9% as compared to the same period one year
ago. The average balance of time deposits increased $28,486,000 during the nine
months ended September 30, 2002 as compared to the same period one year ago. The
growth in time deposits during 2002 is a result of the Company's efforts to fund
earning asset growth and build its deposit portfolio. In addition to growth in
interest bearing deposits, average non interest bearing demand deposits
increased $11,441,000 or 12% for the quarter ended September 30, 2002 when
compared to the same quarter one year ago.
This page is page 16 of 46 pages.
The following is an analysis of the Company's net interest margin for
the indicated periods:
Three months ended Three months ended
September 30, 2002 September 30, 2001
-------------------------------------- -------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
-------------------------------------- -------------------------------------
Real estate-mortgage loans $93,039 $1,645 7.01% $93,952 $1,864 7.87%
Real estate-commercial loans 145,339 2,679 7.31 106,666 2,280 8.48
Commercial loans 67,146 1,187 7.01 74,716 1,697 9.01
Real estate construction loans 41,988 841 7.95 41,353 940 9.02
Installment and other 15,311 179 4.64 11,038 173 6.22
Deferred loan fees (702) --- --- (612) --- ---
------------------------ -----------------------
Portfolio loans 362,121 6,531 7.16 327,113 6,954 8.43
Mortgage loans held for sale 467 11 9.34 --- --- ---
Investments 77,158 1,105 5.68 76,330 1,192 6.20
Federal funds sold 36,806 159 1.71 19,149 171 3.54
------------------------ -----------------------
Total earning assets (1) $476,552 7,806 6.50 $422,592 8,317 7.81
============== =============
Interest bearing transaction accounts $119,070 $436 1.45 $123,410 674 2.17
Time deposits 226,124 1,829 3.21 184,415 2,344 5.04
Other borrowings 14,901 270 7.19 14,875 308 8.21
------------------------ ------------------------
Total interest-bearing liabilities $360,095 2,535 2.79% $322,700 3,326 4.09%
============== =============
----------- -----------
Net interest income $5,271 $4,991
=========== ===========
Net interest income to
earning assets 4.39% 4.69%
This page is page 17 of 46 pages.
Nine months ended Nine months ended
September 30, 2002 September 30, 2001
-------------------------------------- ------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
-------------------------------------- ------------------------------------
Real estate-mortgage loans $94,391 $5,026 7.12% $95,185 $5,796 8.14%
Real estate-commercial loans 133,314 7,515 7.54 102,423 6,732 8.79
Commercial loans 68,929 3,589 6.96 72,092 5,106 9.47
Real estate construction loans 43,681 2,606 7.98 42,643 3,142 9.85
Installment and other 14,246 495 4.65 9,981 534 7.15
Deferred loan fees (629) --- --- (801) --- ---
------------------------ -------------------------
Portfolio loans 353,932 19,231 7.26 321,523 21,310 8.86
Mortgage loans held for sale 219 14 8.55 --- --- ---
Investments 74,077 3,321 5.99 76,267 3,791 6.65
Federal funds sold 29,244 383 1.75 20,464 711 4.65
------------------------ -------------------------
Total earning assets (1) $457,472 22,949 6.71 $418,254 25,812 8.25
============== ==============
Interest bearing transaction accounts $121,906 1,303 1.43 $123,730 2,304 2.49
Time deposits 213,988 5,256 3.28 185,502 7,647 5.51
Other borrowings 14,347 807 7.52 11,581 743 8.58
------------------------ -------------------------
Total interest-bearing liabilities $350,241 7,366 2.81% $320,813 10,694 4.46%
============== ==============
----------- ------------
Net interest income $15,583 $15,118
=========== ============
Net interest income to
earning assets 4.55% 4.83%
(1) Nonaccrual loans are included in the calculation of the average balance of
earning assets (interest not accrued is excluded).
This page is page 18 of 46 pages.
The following table sets forth changes in interest income and interest
expense for each major category of interest-earning asset and interest-bearing
liability, and the amount of change attributable to volume and rate changes for
the three and nine months ended September 30, 2002 and 2001. Changes not solely
attributable to rate or volume have been allocated proportionately to the change
due to volume and the change due to rate.
Three months ended
September 30, 2002 compared to the
three months ended September 30, 2001
-------------------------------------
Volume Rate Total
-------------------------------------
(in thousands)
Increase/(decrease) in interest income:
Real estate-mortgage loans ($18) ($201) ($219)
Real estate-commercial loans 744 (345) 399
Commercial loans (160) (350) (510)
Real estate construction loans 14 (113) (99)
Installment and other 57 (51) 6
Mortgage loans held for sale 11 --- 11
Investments 13 (100) (87)
Federal funds sold 105 (117) (12)
-------------------------------------
Total increase/(decrease) 766 (1,277) (511)
-------------------------------------
Increase/(decrease) in interest expense:
Interest-bearing transaction accounts (23) (215) (238)
Time deposits 456 (971) (515)
Other borrowings 1 (39) (38)
-------------------------------------
Total increase/(decrease) 434 (1,225) (791)
-------------------------------------
Increase/(decrease) in net interest income $332 ($52) $280
=====================================
Nine months ended
September 30, 2002 compared to the
nine months ended September 30, 2001
-----------------------------------------
Volume Rate Total
-----------------------------------------
(in thousands)
Increase/(decrease) in interest income:
Real estate-mortgage loans ($48) ($722) ($770)
Real estate-commercial loans 1,834 (1,051) 783
Commercial loans (216) (1,301) (1,517)
Real estate construction loans 75 (611) (536)
Installment and other 184 (223) (39)
Mortgage loans held for sale 14 --- 14
Investments (106) (364) (470)
Federal funds sold 228 (556) (328)
-----------------------------------------
Total increase/(decrease) 1,965 (4,828) (2,863)
-----------------------------------------
Increase/ (decrease) in interest expense:
Interest-bearing transaction accounts (33) (968) (1,001)
Time deposits 1,044 (3,435) (2,391)
Other borrowings 163 (99) 64
-----------------------------------------
Total increase/ (decrease) 1,174 (4,502) (3,328)
-----------------------------------------
Increase/(decrease) in net interest income $791 ($326) $465
=========================================
This page is page 19 of 46 pages.
Provision for Loan Losses
Due to the absence of significant net loan charge-offs, little change
in loan portfolio asset quality and the balance in the allowance for loan
losses, there was no provision for loan losses for the three and nine months
ended September 30, 2002 and 2001. For further information, see "Allowance for
Loan Losses" and "Nonperforming Assets" in this section.
Noninterest Income and Expense and Income Taxes
Noninterest Income
The following tables set forth the components of the Company's
noninterest income for the three and nine months ended September 30, 2002, as
compared to the same period in 2001.
Three Months Ended
September 30, $ %
--------------------------------
2002 2001 Change Change
------------- ------------- ----------------------------
(dollars in thousands)
Service charges on deposit accounts $288 $284 $4 1%
Merchant draft processing, net 1,322 1,098 224 20
Loan servicing income 66 69 (3) (4)
Net realized gains on investment securities
available for sale 259 22 237 1,077
Other income 220 221 (1) (0)
------------- ------------- --------------
Total noninterest income $2,155 $1,694 $461 27%
============= ============= ==============
Noninterest income increased $461,000, or 27%, to $2,155,000 for the
three months ended September 30, 2002 when compared to $1,694,000 for the same
period in 2001. During this period, such increase was primarily due to an
increase of $224,000 in merchant card net revenue, and an increase in net
realized gains on investment securities available for sale of $237,000. The
increase in merchant card net revenue is due to an increase in processing
revenue brought about by the Company's efforts to build its overall merchant
card services business through direct marketing efforts and new independent
sales organization (ISO) relationships. The increase in net realized gains on
investment securities available for sale is the result of the sale of $4,000,000
of corporate debt securities. Such securities were sold to improve the risk
profile of the Company's investment portfolio.
Nine Months Ended
September 30, $ %
------------------------------
2002 2001 Change Change
------------ ------------ ----------------------------
(dollars in thousands)
Service charges on deposit accounts $910 $819 $91 11%
Merchant draft processing, net 3,698 2,930 768 26
Loan servicing income 201 226 (25) (11)
Net realized gains on investment securities
available for sale 294 22 272 1,236
Other income 663 614 49 8
------------ ------------ --------------
Total noninterest income $5,766 $4,611 $1,155 25%
============ ============ ==============
This page is page 20 of 46 pages.
Noninterest income increased $1,155,000, or 25%, to $5,766,000 for the
nine months ended September 30, 2002 when compared to $4,611,000 for the same
period in 2001. During this period, such increase was primarily due to an
increase of $768,000 in merchant card net revenue, an increase in service
charges on deposit accounts of $91,000 and an increase in net realized gains on
investment securities available for sale of $272,000. The increase in merchant
card net revenue is due to an increase in processing revenue and the increase in
net realized gains on investment securities available for sale is due to the
sale of corporate debt securities, as discussed above.
Noninterest Expense
The following tables set forth the components of the Company's
noninterest expense during the three and nine months ended September 30, 2002,
as compared to the same period in 2001.
Three Months Ended
September 30, $ %
---------------------------
2002 2001 Change Change
------------------------------------------------
(dollars in thousands)
Salaries and employee benefits $2,346 $2,066 $280 14 %
Occupancy and equipment expense 531 511 20 4
Other 1,426 1,052 374 36
-------------------------------------
Total noninterest expense $4,303 $3,629 $674 19 %
=====================================
Noninterest expense increased by $674,000, or 19%, to $4,303,000 during
the third quarter of 2002 as compared to $3,629,000 for the third quarter of
2001. The increase in noninterest expense for the three-month period ended
September 30, 2002, as compared to the same period ended September 30, 2001, was
primarily attributable to an increase in salaries and employee benefits of
$280,000 and an increase in other expense of $374,000. The increase in salaries
and employee benefits was primarily due to an increase in the number of full
time equivalent employees employed by the Company. At September 30, 2002, the
number of full time equivalent employees totaled 155 as compared to 148 at
September 30, 2001. During the third quarter the Company incurred $331,000 in
legal and consulting fees associated with certain corporate activities,
including exploring strategic options for the Company and its Merchant Bankcard
segment. Expenses incurred in association with the formation of the NBR Real
Estate Trust amounted to $49,000 for the quarter ended September 30, 2002.
This page is page 21 of 46 pages.
Nine Months Ended
September 30, $ %
-----------------------
2002 2001 Change Change
----------------------- ----------------------
(dollars in thousands)
Salaries and employee benefits $6,694 $6,287 $407 6 %
Occupancy and equipment expense 1,588 1,503 85 6
Other 3,663 2,921 742 25
----------- ------------ -----------
Total noninterest expense $11,945 $10,711 $1,234 12 %
=========== ============ ===========
Noninterest expense increased by $1,234,000, or 12%, to $11,945,000
during the nine months ended September 30, 2002 as compared to $10,711,000 for
the same period one year ago. The increase in noninterest expense was due to an
increase in salaries and employee benefits of $407,000 and an increase in other
expense of $742,000. The increase in salaries and employee benefits was
primarily due to the increase in the number of full time equivalent employees,
as described above. During the nine months ended September 30, 2002, the Company
incurred $386,000 in legal and consulting fees associated with certain corporate
activities, including exploring strategic options for the Company and its
Merchant Bankcard segment. Expenses incurred in association with the formation
of NBR Real Estate Investment Trust amounted to $101,000 for the nine months
ended September 30, 2002.
Income Taxes
The Company's effective tax rate varies with changes in the relative
amounts of its non-taxable income and nondeductible expenses. The effective tax
rate was 37.30% and 36.94% for the three and nine months ended September 30,
2002, as compared to 40.05% and 40.26% for the same periods in 2001. The primary
reason for the reduction in the Company's effective tax rate is due to the
January 15, 2002 formation of the NBR Real Estate Investment Trust, a Maryland
Real Estate Investment Trust. The entity was formed to hold NBR's real estate
secured loans and to better organize NBR's marketing and origination of real
estate secured lending.
Business Segments
The Company operates in two principal product and service lines: core
community banking and merchant credit card services. The Company's core
community banking segment includes commercial, commercial real estate,
construction and permanent residential lending along with treasury and
depository activities. The Company's merchant card services industry group
provides credit card settlement services for approximately 44,000 merchants
throughout the United States.
This page is page 22 of 46 pages.
Summary financial data by business segment for the indicated periods is as
follows:
For the quarter ended September 30, 2002
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $7,806 $ --- $7,806
Total interest expense 2,529 6 2,535
Interest income/(expense) allocation (147) 147 ---
-----------------------------------------------
Net interest income 5,130 141 5,271
Provision for loan losses --- --- ---
Total other operating income 833 1,322 2,155
Total other operating expense 3,587 716 4,303
-----------------------------------------------
Income before income taxes 2,376 747 3,123
Provision for income taxes 886 279 1,165
-----------------------------------------------
Net income $1,490 $468 $1,958
===============================================
Total Average Assets $477,257 $26,638 $503,895
===============================================
For the quarter ended September 30, 2001
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $8,317 $ --- $8,317
Total interest expense 3,323 3 3,326
Interest income/(expense) allocation (266) 266 ---
-----------------------------------------------
Net interest income 4,728 263 4,991
Provision for loan losses --- --- ---
Total other operating income 596 1,098 1,694
Total other operating expense 3,062 567 3,629
-----------------------------------------------
Income before income taxes 2,262 794 3,056
Provision for income taxes 906 318 1,224
-----------------------------------------------
Net income $1,356 $476 $1,832
===============================================
Total Average Assets $422,976 $27,589 $450,565
===============================================
For the nine months ended September 30, 2002
----------------------------------------------
Merchant
Community Card Total
Banking Services Company
----------------------------------------------
(in thousands)
Total interest income $22,949 $ --- $22,949
Total interest expense 7,342 24 7,366
Interest income/(expense) allocation (479) 479 ---
----------------------------------------------
Net interest income 15,128 455 15,583
Provision for loan losses --- --- ---
Total other operating income 2,068 3,698 5,766
Total other operating expense 9,936 2,009 11,945
----------------------------------------------
Income before income taxes 7,260 2,144 9,404
Provision for income taxes 2,683 791 3,474
----------------------------------------------
Net income $4,577 $1,353 $5,930
==============================================
Total Average Assets $458,776 $27,086 $485,862
==============================================
This page is page 23 of 46 pages.
For the nine months ended September 30, 2001
-------------------------------------------
Merchant
Community Card Total
Banking Services Company
-------------------------------------------
(in thousands)
Total interest income $25,812 $ --- $25,812
Total interest expense 10,686 8 10,694
Interest income/(expense) allocation (840) 840 ---
-------------------------------------------
Net interest income 14,286 832 15,118
Provision for loan losses --- --- ---
Total other operating income 1,681 2,930 4,611
Total other operating expense 9,061 1,650 10,711
-------------------------------------------
Income before income taxes 6,906 2,112 9,018
Provision for income taxes 2,781 850 3,631
-------------------------------------------
Net income $4,125 $1,262 $5,387
===========================================
Total Average Assets $420,341 $25,952 $446,293
===========================================
Community Banking
The Community Banking segment's income before income tax increased for
the three and nine months ended September 30, 2002 when compared to the same
period in 2001. The increase was primarily due to an increase in net interest
income. Net interest income increased $402,000 and $842,000 for the three and
nine months ended September 30, 2002, principally due to an increase in earning
assets, offset by a decline in the general interest rate environment and the
issuance of pooled trust preferred debt securities, which have been fully
allocated to the Community Banking segment. The Company increased its loan
portfolio during the first nine months of 2002 through marketing efforts. For
the quarter ended September 30, 2002, total average portfolio loans were
$362,120,000, up 11% from $327,113,000 for the quarter ended September 30, 2001.
Merchant Card Services
The Company's merchant credit card segment earned $468,000 and
$1,353,000 for the three and nine months ended September 30, 2002 compared to
$476,000 and $1,262,000 for the same periods in 2001. The increase in the unit's
net income was due to an increase in processing revenue brought about by the
Company's efforts to build its overall merchant card services business through
direct marketing efforts, and new independent sales organization (ISO)
relationships and an increase in the realization in deferred processing revenue
associated with certain merchants. The merchant credit card segment's net income
comprised approximately 24% and 23% of the Company's consolidated net income for
the three and nine months ended September 30, 2002 as compared to 26% and 23%
for the same periods one year ago.
The Company bears certain risks associated with its merchant credit
card processing business. Due to a contractual obligation between NBR and Visa
and MasterCard, NBR stands in the place of the merchant in the event that a
merchant refuses or is unable to pay on charge-backs from cardholders.
Charge-back exposure can also result from fraudulent credit card transactions
initiated by merchant customers. As a result, NBR may incur losses associated
with its merchant credit card processing business. Accordingly, NBR has
established a reserve to provide for losses associated with charge-back losses.
Such reserve, which totaled $1,265,000
This page is page 24 of 46 pages.
and $1,213,000 as of September 30, 2002 and 2001, was estimated based upon
industry loss data as a percentage of transaction volume throughout each year,
historical losses incurred by the Company and management's evaluation regarding
merchant and ISO risk. The Company utilizes the services of ISOs to acquire
merchants as customers. The provision for charge-back losses, which is included
in the financial statements as a reduction in merchant draft processing income,
was $75,000 and $183,000 for the three and nine months ended September 30, 2002,
as compared to $0 and $74,000 for the three and nine months ended September 30,
2001. For further discussion, see "Certain Important Considerations for
Investors" in this section.
The following table summarizes the Company's merchant card allowance
for charge-back losses for the periods indicated:
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
--------------------------------------------------
(in thousands)
Beginning allowance $1,251 $1,240 $1,212 $1,276
Provision for losses 75 --- 183 74
Recoveries 19 25 30 104
Charge-offs (80) (52) (160) (241)
------------------------- ------------------------
Ending allowance $1,265 $1,213 $1,265 $1,213
========================= ========================
Investment Securities
Total investment securities increased to $78,407,000, as of September
30, 2002, compared to $64,975,000 as of December 31, 2001. The Company's average
federal funds sold position was $29,244,000 for the nine months ended September
30, 2002 as compared to $20,464,000 for the same period in 2001. Growth of the
investment securities portfolio and the Company's overnight investment position
was driven by the need to invest proceeds from the Company's deposit growth.
Loans
Total loans increased to $367,874,000 at September 30, 2002 compared to
$351,649,000 at December 31, 2001. The Company's residential loan portfolio has
experienced substantial paydown activity during the first nine months of 2002.
Despite this paydown activity, the Company continues to focus on growth in the
overall loan portfolio through marketing efforts and a general expansion of
businesses within the Company's market area. Commercial real estate loans
increased $27,778,000 to $149,234,000, at September 30, 2002, compared to
$121,456,000 at December 31, 2001.
This is page 25 of 46 pages.
The following table summarizes the composition of the loan portfolio at
September 30, 2002 and December 31, 2001:
September 30, 2002 December 31, 2001
---------------------------- -----------------------------
Amount % Amount %
---------------------------- -----------------------------
(dollars in thousands)
Residential real estate mortgage $92,711 25% $101,175 29%
Commercial real estate mortgage 149,234 40 121,456 34
Commercial 68,302 19 70,438 20
Real estate construction 45,403 12 46,501 13
Installment and other 12,960 4 12,567 4
Less net deferred loan fees (736) --- (488) ---
---------------------------- ---------------------------
Total portfolio loans 367,874 100% 351,649 100%
========== ==========
Less allowance for loan losses (7,578) (7,580)
------------------- ------------------
Net loans $360,296 $344,069
=================== ==================
Allowance for Loan Losses
The allowance for loan losses is established through charges to
earnings in the form of the provision for loan losses. Loan losses are charged
to, and recoveries are credited to, the allowance for loan losses. The provision
for loan losses is determined after considering various factors such as loan
loss experience, current economic conditions, maturity of the portfolio, size of
the portfolio, industry concentrations, borrower credit history, the existing
allowance for loan losses, independent loan reviews, current charges and
recoveries to the allowance for loan losses and the overall quality of the
portfolio, as determined by management, regulatory agencies and independent
credit review consultants retained by the Company.
The Company's allowance for loan losses is based on specific and
formula allocations to the Company's loan portfolio. Specific allocations of the
allowance for loan losses are made to identified problem loans where management
has identified significant conditions or circumstances related to a given loan,
which management believes indicates the probability that a loss may occur. The
specific allocations are increased or decreased through management's
reevaluation on a quarterly basis of the status of the particular problem loans.
Loans which do not receive a specific allocation receive an allowance allocation
based on a formula, represented by a percentage factor based on underlying
collateral, type of loan, historical charge-offs, general economic conditions
and other qualitative factors.
This page is page 26 of 46 pages.
The following table summarizes changes in the Company's allowance for
loan losses for the indicated periods:
Three months ended Nine months ended
September 30, September 30
------------------------- --------------------------
2002 2001 2002 2001
------------------------- --------------------------
(dollars in thousands)
Beginning allowance for loan losses $7,586 $7,704 $7,580 $7,674
Provision for loan losses --- --- --- ---
Charge-offs (23) (127) (68) (129)
Recoveries 15 32 66 64
------------------------- --------------------------
Ending allowance for loan losses $7,578 $7,609 $7,578 $7,609
========================= ==========================
Net charge-offs to average
loans (annualized) 0.01% 0.12% 0.00% 0.03%
The allowance for loan losses as a percentage of total loans decreased
slightly from 2.16%, at December 31, 2001, to 2.06% at September 30, 2002. The
growth in the Company's loan portfolio resulted primarily from commercial real
estate loans that generally bear a lower credit risk than construction or
commercial loans. Accordingly, under the Company's loan loss reserve
methodology, such loans generally receive a lower loan loss reserve allocation
as compared to commercial or construction loans.
Nonperforming Assets
The following table summarizes the Company's nonperforming assets at
the dates indicated:
September 30, December 31,
2002 2001
---------------- ---------------
(dollars in thousands)
Nonaccrual loans $556 $2,892
Accruing loans past due 90 days or more 586 ---
Restructured loans 277 284
---------------- ---------------
Total nonperforming loans 1,419 3,176
Other real estate owned --- ---
---------------- ---------------
Total nonperforming assets $1,419 $3,176
================ ===============
Nonperforming assets to total assets 0.28% 0.71%
This page is page 27 of 46 pages.
Nonperforming assets have decreased from $3,176,000 or .71% of total
assets, as of December 31, 2001, to $1,419,000 or .28% of total assets as of
September 30, 2002. The decrease was attributable to a decrease of $2,336,000 in
nonaccrual loans during this period.
At September 30, 2002, nonperforming loans consist of loans to 11
borrowers, 4 of which have balances in excess of $100,000. The two largest have
recorded balances of $586,000 and $277,000. One property is secured by
commercial property, the other by industrial equipment. Based on information
currently available, management believes that adequate allocations are included
in the allowance for loan losses to cover the estimated loss exposure that may
result from these loans.
At September 30, 2002, the Company did not have any properties
classified as other real estate owned.
Although the volume of nonperforming assets will depend in part on the
future economic environment, there are eight loan relationships which totals
approximately $2,476,000 as of September 30, 2002, compared to three loan
relationships totaling approximately $1,921,000 at December 31, 2001, about
which management has serious doubts as to the ability of the borrowers to comply
with the present repayment terms. These loans may become a nonperforming asset
based on the information presently known about possible credit problems of the
borrower.
At September 30, 2002, the Company's total recorded investment in
impaired loans (as defined by SFAS No. 114 and No. 118) was $1,419,000, of which
$1,142,000 relates to the recorded investment in loans for which there is a
related allowance for loan losses allocation of $106,000. The remaining $277,000
in impaired loans did not require a specific allowance for loan losses
allocation.
The Company's average recorded investment in impaired loans during the
nine months ended September 30, 2002 and 2001 was $1,263,000 and $2,127,000. The
decrease of $864,000 in the average recorded investment in impaired loans during
the nine months ending September 30, 2002 compared to the same period one year
ago was primarily due to the decrease in nonperforming loans. Interest income
recognized during the periods that such loans were impaired for the three and
nine months ended September 30, 2002 was $32,000 and $38,000, as compared to
$30,000 and $75,000 for the three and nine months ended September 30, 2001.
As of September 30, 2002, there was $556,000 of loans on which the
accrual of interest had been discontinued as compared to $2,892,000 at December
31, 2001. During the three and nine months ended September 30, 2002, interest
due but excluded from interest income on loans placed on nonaccrual status was
$11,000 and $42,000, as compared to $3,000 and $43,000 for the same periods one
year ago. There was no interest income received on nonaccrual loans during the
three and nine months ended September 30, 2002, as compared to $119,000 and
$124,000 during the three and nine months ended September 30, 2001.
This page is page 28 of 46 pages.
Mortgage Repurchase Commitments
From time to time the Company may be required to repurchase mortgage
loans from mortgage loan investors as a result of breaches of representations
and warranties in the purchase agreement between the investor and the Company.
The Company may also be required to reimburse a mortgage loan investor for
losses incurred as a result of liquidating collateral, which had secured a
mortgage loan sold by the Company. Such representations and warranties include
the existence of a valid appraisal, status of borrower or fraud. In the first
nine months of 2002, the Company was not required to repurchase any such loans.
The Company maintains a reserve for management's estimate of potential losses
associated with the repurchase of previously sold mortgage loans. Reserves for
such losses totaled $60,000 as of September 30, 2002 and $93,000 as of December
31, 2001. During the first quarter of 2002, the Company paid $33,000 for a
settlement related to disputed title issues. The Company expects that it may be
required to repurchase loans in the future.
Investment in REMIC
In 1995, Allied Savings Bank ("Allied"), formerly a wholly owned
subsidiary of the Company which merged into NBR in 1997, sold a COFI ARM
mortgage pool whose carrying value was approximately $73,900,000 as part of a
transaction that resulted in creating a Real Estate Mortgage Investment Conduit
("REMIC"). The REMIC issued three classes of mortgage pass-through mortgage
certificates: A, B and C. The sale transaction took place as a result of Allied
selling 100% interest in the COFI indexed ARM mortgage pool in exchange for cash
of $71,500,000 and a Class B certificate which represented the first loss
position with respect to any ultimate losses realized upon the liquidation of
defaulted mortgage loans in the pool. As part of the sale transaction, Allied
retained the servicing of the pool. The Class A and Class B certificates have
sequential rights to principal payments, such that Class B certificates shall
only receive principal payments after all Class A certificates are retired.
The composition of the original certificate balances along with their
respective September 30, 2002 balances are as follows:
Original September 30, 2002
Certificate Certificate
Face Value Face Value
-------------------------------------------
Class A $73,199,448 $2,855,840
Class B 3,249,067 3,196,478
Class C 100 100
-------------------------------------------
Total pool $76,448,615 $6,052,418
===========================================
Since inception the pool has realized losses of $52,590, which reduced
the original face value of the Class B certificate.
This page is page 29 of 46 pages.
Contractual Obligations and Commitments
The following table presents the Company's longer term, non-deposit
related, contractual obligations and commitments to extend credit to our
borrowers, in aggregate and by payment due dates.
September 30, 2002
----------------------------------------------------------------------
Less Than One Through Four Through After Five
One Year Three Years Five Years Years Total
----------------------------------------------------------------------
(in thousands)
Trust preferred securities $ --- $ --- $ --- $10,000 $10,000
Operating leases (premises) 1,503 1,490 440 150 3,583
----------------------------------------------------------------------
Total long-term debt
and operating leases $1,503 $1,490 $440 $10,150 $13,583
=========================================================
Commitments to extend credit 79,508
Standby letters of credit 423
Total contractual
obligations
--------------
and commitments $93,514
==============
Liquidity
Redwood's primary source of liquidity is dividends from NBR. Redwood's
primary uses of liquidity have historically been associated with common stock
repurchases, dividend payments made to common stock holders, interest payments
relating to Redwood's trust preferred securities and operating expenses. It is
Redwood's general policy to maintain liquidity at the parent level which
management believes to be consistent with the safety and soundness of the
Company as a whole. As of September 30, 2002, Redwood held $46,000 in deposits
at NBR. In addition, the Company has a $3,500,000 unsecured line of credit with
a major financial institution, which bears an interest rate equal to the federal
funds rate plus 1.50%. As of September 30, 2002, there was $460,000 outstanding
under this line of credit.
This page is page 30 of 46 pages.
Redwood's current cash dividend to its common shareholders is $.20 per
common share per quarter. Further, Redwood is required to make semi-annual
payments of interest at 10.2% on $10,000,000 of trust preferred securities
issued in 2001. Payment of these obligations is ultimately dependent on
dividends from NBR to Redwood. Federal regulatory agencies have the authority to
prohibit the payment of dividends by NBR to Redwood if a finding is made that
such payment would constitute an unsafe or unsound practice or if NBR would
become undercapitalized as a result. If NBR is restricted from paying dividends,
Redwood might be unable to pay dividends to its common shareholders. No
assurance can be given as to the ability of NBR to pay dividends to Redwood in
the future. The approval of the Office of the Comptroller of the Currency
("OCC"), is required for the payment of dividends if the total of all dividends
declared by a national bank in any calendar year would 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. Due to this requirement, NBR obtained such
approval for its 2002 dividend plan from the OCC in January 2002.
During the first nine months of 2002, NBR declared a dividend payable
to Redwood of $5,100,000. Management believes that as of September 30, 2002, the
Company's liquidity position was adequate for the operations of Redwood and NBR.
Although each entity within the consolidated Company manages its own
liquidity, the Company's consolidated cash flow can be divided into three
distinct areas: operating, investing and financing. For the nine months ended
September 30, 2002, the Company received cash of $6,935,000 from operating
activities and $51,904,000 from financing activities, while using $28,987,000 in
investing activities.
Capital Resources
A strong capital base is essential to the Company's continued ability
to service the needs of its customers. Capital protects depositors and the FDIC
deposit insurance fund from potential losses and is a source of funds for the
substantial investments necessary for the Company to remain competitive. In
addition, adequate capital and earnings enable the Company to gain access to the
capital markets to supplement its internal growth of capital. Capital is
generated internally primarily through earnings retention.
The Company and NBR are required to maintain minimum capital ratios
defined by various federal government regulatory agencies. The Board of
Governors of the Federal Reserve System and the OCC have each established
capital guidelines, which include minimum capital requirements. These
regulations impose three sets of standards: "risk-based", "leverage" and
"tangible" capital.
Under the risk-based capital standard, assets reported on an
institution's balance sheet and certain off-balance sheet items are assigned to
risk categories, each of which is assigned a risk weight. This standard
characterizes an institution's capital as being "Tier 1" capital (defined as
principally comprising shareholders' equity, trust preferred securities, for up
to 25% of total tier 1 capital, and noncumulative preferred stock) and "Tier 2"
capital (defined as principally comprising the allowance for loan losses and
subordinated debt).
This page is page 31 of 46 pages.
Under the leverage capital standard, an institution must maintain a
specified minimum ratio of Tier 1 capital to total assets, with the minimum
ratio ranging from 4% to 6%. The leverage ratio for the Company and NBR is based
on average assets for the quarter.
The following table summarizes the consolidated capital ratios and the
capital ratios of the principal subsidiary at September 30, 2002 and December
31, 2001.
September 30, 2002 December 31, 2001
-------------------------------------- -----------------------------------
Well- Minimum Well- Minimum
Capitalized Actual
Actual Requirement CapitalizedRequirement
-------------------------------------- -----------------------------------
Company
Leverage 7.17% 5.00% 4.00% 7.46% 5.00% 4.00%
Tier 1 risk-based 9.22 6.00 4.00 9.52 6.00 4.00
Total risk-based 10.68 10.00 8.00 11.16 10.00 8.00
NBR
Leverage 7.32% 5.00% 4.00% 7.69% 5.00% 4.00%
Tier 1 risk-based 9.41 6.00 4.00 9.82 6.00 4.00
Total risk-based 10.67 10.00 8.00 11.08 10.00 8.00
In January and February 2001, the Company's Board of Directors
authorized the repurchase of up to 10% of the Company's total shares
outstanding, or 427,500 shares in January 2001 and 385,500 shares in February
2001, as adjusted for the three-for-two stock split announced September 20,
2001, of which all shares have been repurchased. In August 2001, the Company
announced a third authorization to repurchase an additional 355,500 shares, as
adjusted for the three-for-two stock split announced September 20, 2001. To
date, 138,636 shares have been repurchased, as adjusted for the three-for-two
stock split announced September 20, 2001. Under the repurchase program, the
Company plans to purchase shares from time to time on the open market and/or in
privately negotiated transactions. The first two repurchase authorizations were
funded in part with proceeds received from a $10,000,000 pooled trust preferred
securities offering which concluded on February 22, 2001.
This page is page 32 of 46 pages.
Trust Preferred Securities
On February 22, 2001, Redwood Statutory Trust I ("RSTI"), a wholly
owned subsidiary of the Company, closed a pooled offering of 10,000 Capital
Securities with a liquidation amount of $1,000 per security. The proceeds of the
offering were loaned to the Company in exchange for junior subordinated
debentures with terms similar to the Capital Securities. The sole assets of RSTI
are the junior subordinated debentures of the Company and payments thereunder.
The junior subordinated debentures and the back-up obligations, in the
aggregate, constitute a full and unconditional guarantee by the Company of the
obligations of RSTI under the Capital Securities. Distributions on the Capital
Securities are payable semi-annually at the annual rate of 10.2% and are
included in interest expense in the consolidated financial statements. These
securities are considered Tier 1 capital (with certain limitations applicable)
under current regulatory guidelines. As of September 30, 2002, the outstanding
principal balance of the Capital Securities was $10,000,000. The principal
balance of the Capital Securities constitutes the trust preferred securities in
the financial statements.
The junior subordinated debentures are subject to mandatory redemption,
in whole or in part, upon repayment of the Capital Securities at maturity or
their earlier redemption at the liquidation amount. Subject to the Company
having received prior approval of the Federal Reserve, if then required, the
Capital Securities are redeemable prior to the maturity date of February 22,
2031, at the option of the Company; on or after February 22, 2021 at par; or on
or after February 22, 2011 at a premium; or upon occurrence of specific events
defined within the trust indenture. The Company has the option to defer
distributions on the Capital Securities from time to time for a period not to
exceed 10 consecutive semi-annual periods.
Certain Important Considerations for Investors
Merchant Credit Card Processing. The Company's profitability can be
negatively impacted should any of the Company's merchant credit card customers
be unable to pay on charge-backs from cardholders. Due to a contractual
obligation between NBR and Visa and Mastercard, NBR stands in the place of the
merchant in the event that a merchant refuses, or is unable due to bankruptcy or
other reasons, to pay on charge-backs from cardholders. Management has taken
certain actions to decrease the risk of merchant bankruptcy associated with its
merchant credit card business. These steps include the discontinuance of
high-risk accounts. Charge-back exposure can also result from fraudulent credit
card transactions initiated by merchant customers. To mitigate merchant fraud
risk, the Company employs certain underwriting standards when accepting a new
merchant. Further, the Company monitors merchant activity for unusual
transactions. In addition, the Company bears the risk of merchant nonpayment of
applicable interchange, assessment and other fees. Failure by the merchants to
pay such fees may adversely affect the Company's revenues. The Company utilizes
ISOs to acquire merchant credit card customers. The Company's ability to
maintain and grow net revenue from its merchant credit card processing operation
is dependent upon maintaining and adding to these ISO relationships.
This page is page 33 of 46 pages.
Merchant credit card processing services are highly regulated by credit
card associations such as Visa. In order to participate in the credit card
programs, the Company must comply with the credit card association's rules and
regulations that may change from time to time. If the Company fails to comply
with these credit card association standards, the Company's status as a member
service provider and as a certified processor could be suspended or terminated.
During November 1999, Visa adopted several rule changes to reduce risks in
high-risk merchant credit card programs and these rule changes affect the
Company's merchant credit card business. The rule changes went into effect on
March 31, 2001. These changes included a requirement that a processor's reported
fraud ratios be no greater than three times the national average. At June 30,
2002 (the most recent period available from Visa), the Company's overall fraud
ratio was less than the Visa requirement. Other Visa changes included the
requirement that total processing volume in certain high-risk categories (as
defined by Visa) be less than 20% of total processing volume. At September 30,
2002, the Company's total Visa transactions within these certain high-risk
categories were 1.3% of total Visa processing volume. Other changes Visa
announced included a requirement that weekly Visa volumes be less than 60% of an
institution's tangible equity capital, as well as a requirement that aggregate
charge-backs for the previous six months be less than 5% of the institution's
tangible equity capital or that aggregate charge-backs for the quarter be less
than .59% of the interchange count and .95% of the interchange amount. At
September 30, 2002, the Company's weekly Visa volume was 56% of the Company's
tangible equity capital, and aggregate charge-backs for the previous six months
were 5.9% of tangible equity capital and the aggregate charge-backs for the
quarter were .43% of the interchange count and .35% of the interchange amount.
Merchant credit card participants, such as the Company, must comply with these
new Visa rules by filing a compliance plan with Visa. At September 30, 2002, the
Company is in compliance with all rule changes that went into effect on March
31, 2001, based on Visa's acceptance of the Company's compliance plan. Should
the Company be unable to comply with these rule changes, Visa will require
collateral of one to four times the shortfall.
Concentration of Lending Activities. Concentration of the Company's
lending activities in the real estate sector, including construction loans,
could have the effect of intensifying the impact on the Company of adverse
changes in the real estate market in the Company's lending areas. At September
30, 2002, approximately 78% of the Company's loans were secured by real estate,
of which 52% were secured by commercial real estate, including small office
buildings, owner-user office/warehouses, mixed use residential and commercial
properties and retail properties. Substantially all of the properties that
secure the Company's present loans are located in Northern and Central
California. The ability of the Company to continue to originate mortgage or
construction loans may be impaired by adverse changes in local or regional
economic conditions, adverse changes in the real estate market, increasing
interest rates, or acts of nature (including earthquakes, which may cause
uninsured damage and other loss of value to real estate that secures the
Company's loans). In addition, the long-term impact of the California energy
crisis and the decline in the technology sector in Northern California may cause
adverse changes in the Company's local economy. Due to the concentration of the
Company's real estate collateral, such events could have a significant adverse
impact on the value of such collateral and the Company's earnings.
This page is page 34 of 46 pages.
Events of September 11. The terrorist attacks on the World Trade Center
and the Pentagon on September 11, 2001, as well as actions taken or to be taken
by the U.S. or other governments as a result of such attacks or further acts or
threats of terrorism, have resulted in increased uncertainty regarding the
economic outlook. Past experience suggests that shocks to American society of
far less severity have resulted in a temporary loss of consumer and business
confidence and a reduction in the rate of economic growth. It is not possible at
this time to project the ultimate economic impact of these events. However, any
deterioration in either the U.S. or the California economy could adversely
affect the Company's financial condition and results of operations.
California Energy Crisis. Due to problems associated with the
deregulation of the electrical power industry in California, California
utilities and other energy industry participants have experienced difficulties
with the supply and price of electricity and natural gas. As a consequence of
this situation, a major California public utility in the gas and power business
became the subject of a voluntary bankruptcy proceeding. The California energy
situation continues to be fluid and subject to many uncertainties and a number
of lawsuits and regulatory proceedings have been commenced concerning various
aspects of the current energy situation. Although the situation has stabilized
recently, customers of the utilities were faced at times in 2001 with increased
gas and electric prices, power shortages and, in some cases, rolling blackouts.
The long-term impact of the energy crisis in California on the Company's markets
and business cannot be predicted, but could result in an economic slow-down.
This could have an adverse effect on the demand for new loans, the ability of
borrowers to repay outstanding loans, the value of real estate and other
collateral securing loans and, as a result, on the Company's financial condition
and results of operations.
Government Regulation. The Company and its subsidiaries are subject to
extensive federal and state governmental supervision, regulation and control.
Future legislation and government policy could adversely affect the financial
industry. Although the full impact of such legislation and regulation cannot be
predicted, future changes may alter the structure of, and competitive
relationship among, financial institutions. The Company's business may be
adversely affected by any future changes in laws, regulations, policies or
interpretations, including legislative and regulatory reactions to the terrorist
attack on September 11, 2001, and future acts of terrorism, and the Enron
Corporation and WorldCom Inc. bankruptcies and recent reports of accounting
irregularities at public companies, including various large and seemingly
well-regarded companies. Additionally, the Company's business is affected
significantly by the fiscal and monetary policies of the federal government and
its agencies, particularly the Federal Reserve Board (the "FRB"), which
regulates the supply of money and credit in the US. Among the instruments of
monetary policy available to the FRB are (a) conducting open market operations
in US government securities, (b) changing the discount rates of borrowings of
depository institutions, (c) imposing or changing reserve requirements against
certain borrowings by banks and their affiliates. These methods are used in
varying degrees and combinations to directly affect the availability of bank
loans and deposits, as well as the interest rates charged on loans and paid on
deposits. The policies of the FRB may have a material effect on our business,
financial condition and results of operations.
This page is page 35 of 46 pages.
Competition from Other Financial Institutions. The Company competes for
deposits and loans principally with major commercial banks, other independent
banks, savings and loan associations, savings banks, thrift and loan
associations, credit unions, mortgage companies, insurance companies and other
lending institutions. With respect to deposits, additional significant
competition arises from corporate and governmental debt securities, as well as
money market mutual funds. The Company also depends for its origination of
mortgage loans on independent mortgage brokers who are not contractually
obligated to do business with the Company and are regularly solicited by the
Company's competitors. Aggressive policies of such competitors have in the past
resulted, and may in the future result, in a decrease in the Company's volume of
mortgage loan originations and/or a decrease in the profitability of such
originations, especially during periods of declining mortgage loan origination
volumes. Several of the nation's largest savings and loan associations and
commercial banks have a significant number of branch offices in the areas in
which the Company conducts operations. Among the advantages possessed by the
larger of these institutions are their ability to make larger loans, finance
extensive advertising campaigns, access international money markets and
generally allocate their investment assets to regions of highest yield and
demand.
In addition, the market in which the Company competes for merchant
credit card processing is intensely competitive and, in recent years, has been
characterized by increased consolidation. This consolidation has enabled certain
of the Company's competitors to have access to significant capital, management,
marketing and technological resources that are equal to or greater than those of
the Company, and there can be no assurance that the Company will be able to
continue to compete successfully with such other processors.
Critical Accounting Policies. The Company's financial statements are
presented in accordance with accounting principles generally accepted in the
United States of America (US GAAP). The financial information contained within
our financial statements is, to a significant extent, financial information that
is based on approximate measures of the financial effects of transactions and
events that have already occurred. A variety of factors could affect the
ultimate value that is obtained either when earning income, recognizing an
expense, recovering an asset or relieving a liability. Along with other factors,
we use historical loss factors to determine the inherent loss that may be
present in our loan and lease portfolio. Actual losses could differ
significantly from the historical loss factors that we use. Other estimates that
we use are fair value of our securities and expected useful lives of our
depreciable assets. We have not entered into derivative contracts for our
customers or for ourselves, which relate to interest rate, credit, equity,
commodity, energy, or weather-related indices. US GAAP itself may change from
one previously acceptable method to another method. Although the economics of
our transactions would be the same, the timing of events that would impact our
transactions could change.
Our most significant estimates are approved by our Management team,
which is comprised of our most senior officers. At each financial reporting
period, a review of these estimates is then presented to our Board of Directors.
As of September 30, 2002, other than previously disclosed on pages 22,
29 and 30, we have not created any special purpose entities to securitize assets
or to obtain off-balance sheet funding. Although we have sold a number of loans
in the past two years, those loans have been sold to third parties without
recourse, subject to customary representations and warranties.
This page is page 36 of 46 pages.
Impact of New Accounting Standards. On October 1, 2002, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 147, "Acquisitions of Certain Financial Institutions."
SFAS No.147 is effective October 1, 2002, and may be early applied. SFAS No.
147 Supersedes SFAS No. 72, "Accounting for Certain Acquisitions of Banking or
Thrift Institutions". SFAS No 147 provides guidance on the accounting for the
acquisition of a financial institution, and applies to all such acquisitions
except those between two or more mutual enterprises. Under SFAS No. 147, the
excess of the fair value of liabilities assumed over the fair value of tangible
and identifiable intangible assets acquired in a financial institution business
combination represents goodwill that should be accounted for under SFAS No. 142,
"Goodwill and Other Intangible Assets". If certain criteria are met, the amount
of the unidentifiable intangible asset resulting from prior financial
institutions acquisitions is to be reclassified to goodwill upon adoption of
this Statement. Financial institutions meeting conditions outlined in SFAS No.
147 are required to restate previously issued financial statements. The
objective of the restatement is to present the balance sheet and income
statement as if the amount accounted for under SFAS No. 72 as an unidentifiable
intangible asset had been reclassified to goodwill as of the date the Company
adopted SFAS No. 142. Adoption of SFAS No. 147 on October 1, 2002 did not have a
material effect on the Company's consolidated financial position or results of
operation.
Certifications Under Section 906 of the Sarbanes-Oxley Act of 2002
The certification by the Company's chief executive officer and chief
financial officer of this report on Form 10-Q, as required by section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350), has been submitted to the
Securities and Exchange Commission as additional correspondence accompanying
this report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As a financial institution, the Company's primary component of market
risk is interest rate volatility. Fluctuation in interest rates will ultimately
impact both the level of income and expense recorded on a large portion of the
Bank's assets and liabilities, and the market value of all interest earning
assets and interest bearing liabilities, other than those which possess a short
term to maturity. Since virtually all of the Company's interest bearing
liabilities and all of the Company's interest earning assets are located at the
Bank (or in its wholly-owned subsidiary), virtually all of the Company's
interest rate risk exposure lies at the Bank level. As a result, all significant
interest rate risk management procedures are performed at the Bank level. Based
upon the nature of its operations, the Bank is not subject to foreign currency
exchange or commodity price risk. The Bank's real estate loan portfolio,
concentrated primarily within Northern California, is subject to risks
associated with the local economy. The Company does not own any trading assets.
This page is page 37 of 46 pages.
The fundamental objective of the Company's management of its assets and
liabilities is to maximize the economic value of the Company while maintaining
adequate liquidity and an exposure to interest rate risk deemed by management to
be acceptable. Management believes an acceptable degree of exposure to interest
rate risk results from the management of assets and liabilities through
maturities, pricing and mix to attempt to neutralize the potential impact of
changes in market interest rates. The Bank's profitability is dependent to a
large extent upon its net interest income, which is the difference between its
interest income on interest-earning assets, such as loans and securities, and
its interest expense on interest-bearing liabilities, such as deposits and
borrowings. The Bank, like other financial institutions, is subject to interest
rate risk to the degree that its interest-earning assets reprice differently
than its interest-bearing liabilities. The Bank manages its mix of assets and
liabilities with the goals of limiting its exposure to interest rate risk,
ensuring adequate liquidity, and coordinating its sources and uses of funds.
The Bank seeks to control its interest rate risk exposure in a manner
that will allow for adequate levels of earnings and capital over a range of
possible interest rate environments. The Bank has adopted formal policies and
practices to monitor and manage interest rate risk exposure. As part of this
effort, the Bank measures risk in three ways: repricing of earning assets and
interest bearing liabilities; changes in net interest income for interest rate
shocks up and down 200 basis points; and changes in the market value of equity
for interest rate shocks up and down 200 basis points.
This page is page 38 of 46 pages.
The following table sets forth, as of September 30, 2002, the distribution of
repricing opportunities for the Company's earning assets and interest-bearing
liabilities, the interest rate sensitivity gap, the cumulative interest rate
sensitivity gap, the interest rate sensitivity gap ratio (i.e., earning assets
divided by interest-bearing liabilities) and the cumulative interest rate
sensitivity gap ratio.
After Three After Six After One
Within Months but Months but Year But
Three Within Six Within One Within After Five
Months Months Year Five Years Years Total
--------------------------------------------------------------------------
(Dollars in thousands)
Interest earning assets:
Federal funds sold $37,429 $ --- $ --- $ --- $ --- $37,429
Investment securities and other 10,220 6,820 15,719 37,406 9,265 79,430
Mortgage loans held for sale 654 --- --- --- --- 654
Loans 112,628 51,358 38,926 130,468 34,494 367,874
-------------------------------------------------------------------------
Total interest-earning assets 160,931 58,178 54,645 167,874 43,759 485,387
-------------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing transaction accounts 121,740 --- --- --- --- 121,740
Time deposits 60,150 54,910 105,433 9,487 --- 229,980
Trust preferred securities --- --- --- --- 10,000 10,000
Short-term borrowings 5,475 --- --- --- --- 5,475
-------------------------------------------------------------------------
Total interest-bearing liabilities 187,365 54,910 105,433 9,487 10,000 367,195
-------------------------------------------------------------------------
Interest rate sensitivity gap ($26,434) $3,268 ($50,788) $158,387 $33,759
==============================================================
Cumulative interest rate sensitivity gap (26,434) (23,166) (73,954) 84,433 118,192
Interest rate sensitivity gap ratio 0.86 1.06 0.52 17.70 4.38
Cumulative interest rate sensitivity gap ratio 0.86 0.90 0.79 1.24 1.32
The Company's gap position is substantially dependent upon the volume
of mortgage loans held in the portfolio. These loans generally have maturities
greater than five years; however, these loans have a repricing frequency of at
least quarterly and therefore are classified in the above table as repricing
within three months. Additionally, interest-bearing transaction accounts, which
consist of money market and savings deposit accounts, are classified as
repricing within three months. Some of these deposits may be repriced at
management's option, and therefore a decision not to reprice such deposits could
significantly alter the Company's net interest margin.
Management expects that, in a declining interest rate environment, the
Company's net interest margin would be expected to decline, and, in an
increasing interest rate environment, the Company's net interest margin would
tend to increase. The Company has experienced greater mortgage lending activity
through mortgage refinancings and financing new home purchases as rates
declined, and may increase its net interest margins in an increasing rate
environment if more traditional commercial bank lending becomes a higher
percentage of the overall earning assets mix. There can be no assurance,
however, that under such circumstances the Company will experience the described
relationships to declining or increasing interest rates.
This page is page 39 of 46 pages.
On a quarterly basis, NBR management prepares an analysis of interest
rate risk exposure. Such analysis calculates the change in net interest income
and the theoretical market value of the Bank's equity given a change in general
interest rates of 200 basis points up and 200 basis points down. All changes are
measured in dollars and are compared to projected net interest income and the
current theoretical market value of the Bank's equity. This theoretical market
value of the Bank's equity is calculated by discounting cash flows associated
with the Company's assets and liabilities. The following is a summary of
interest rate risk exposure as of September 30, 2002 as measured on a net
interest income basis and a market value of equity basis, given a change in
general interest rates of up to 200 basis points up and 200 basis points down.
September 30, 2002
------------------ Change in Annual Change in
Change in Interest Rate Net Interest Income Market Value of Equity
----------------------- ------------------- ----------------------
+200 $1,490,000 ($7,261,000)
+100 $902,000 ($2,797,000)
-100 ($1,098,000) $846,000
-200 ($3,079,000) $2,224,000
The model utilized by management to create the report presented above
makes various estimates at each level of interest rate change regarding cash
flows from principal repayments on loans and mortgage-backed securities and/or
call activity on investment securities. In addition, repricing these earning
assets and matured liabilities can occur in one of three ways: (1) the rate of
interest to be paid on an asset or liability may adjust periodically based on an
index; (2) an asset, such as a mortgage loan, may amortize, permitting
reinvestment of cash flows at the then-prevailing interest rates; or (3) an
asset or liability may mature, at which time the proceeds can be reinvested at
current market rate. Actual results could differ significantly from those
estimates, which would result in significant differences in the calculated
projected change.
Item 4. Controls and Procedures
a) Evaluation of Disclosure Controls and Procedures. Based on their
evaluation as of a date within 90 days of the filing date of this
Quarterly Report on Form 10-Q, the Company's principal executive
officer and the principal financial officer have concluded that the
Company's disclosure controls and procedures (as defined in Rules
13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the
"Exchange Act")) are effective to ensure that information required to
be disclosed by the Company in reports that it files or submits under
the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in Securities and Exchange Commission rules
and forms.
b) Changes in Internal Controls. There were no significant changes in the
Company's internal controls or in other factors that could
significantly affect those controls subsequent to the date of their
most recent evaluation. There were no significant deficiencies or
material weaknesses, and therefore there were no corrective actions
taken.
This page is page 40 of 46 pages.
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
On February 22, 2001, the Company completed its $10,000,000
participation in a pooled trust preferred securities offering. Issuance costs
amounted to approximately $300,000 and are being amortized over the 30-year life
of the securities. The Company, relying on Section 4(2), Rule 506 and Rule 903
of the Securities Act of 1933, as amended, sold the securities directly to
Preferred Term Securities, Ltd. II, a Cayman Islands corporation. The proceeds
have been, and will continue to be, used for share repurchases and general
corporate purposes.
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits.
None.
b) Reports on Form 8-K
1. Form 8-K filing dated July 18, 2002 reporting under
Item 5 thereof, second quarter 2002 results.
2. Form 8-K filing dated July 10, 2002 reporting, under
Item 5 thereof, the declaration of quarterly dividend.
This page is page 41 of 46 pages.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
REDWOOD EMPIRE BANCORP
----------------------
(Registrant)
Date: 11/13/02 By: /s/ James E. Beckwith
------------ -----------------------------
James E. Beckwith
Executive Vice President,
Chief Financial Officer and
Chief Operating Officer
(Principal Financial Officer and
Duly Authorized Officer)
This page is page 42 of 46 pages.
CERTIFICATION
I, Patrick Kilkenny, certify that:
1) I have reviewed this quarterly report on Form 10-Q of Redwood Empire
Bancorp;
2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
This page is page 43 of 46 pages.
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
/s/ Patrick Kilkenny
- ------------------------------
Patrick Kilkenny, President/CEO
This page is page 44 of 46 pages.
CERTIFICATION
I, James Beckwith, certify that:
1) I have reviewed this quarterly report on Form 10-Q of Redwood Empire
Bancorp;
2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
This page is page 45 of 46 pages.
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
/s/ James Beckwith
- ---------------------------
James Beckwith, EVP/COO/CFO
This page is page 46 of 46 pages.