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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
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 (IRS Employer
incorporation or organization) Identification No.)
111 Santa Rosa Avenue, Santa Rosa, California 95404-4905
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (707) 573-4800
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 __
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes __ No X
At May 5, 2003, there were 3,375,323 shares of the Registrant's common stock
outstanding.
This page is page 1 of 40 pages.
REDWOOD EMPIRE BANCORP
AND
SUBSIDIARIES
Index
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Operations
Three Months Ended March 31, 2003 and 2002....................................3
Consolidated Balance Sheets
March 31, 2003 and December 31, 2002..........................................5
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2003 and 2002....................................6
Notes to Consolidated Financial Statements....................................8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations.............................12
Item 3. Quantitative and Qualitative Disclosures
About Market Risk............................................................32
Item 4. Controls and Procedures......................................................34
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.............................................35
SIGNATURES.....................................................................................36
CERTIFICATIONS.................................................................................37
This page is page 2 of 40 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
March 31,
2003 2002
--------------------------------
Interest income:
Interest and fees on loans $6,406 $6,217
Interest on investment securities 1,123 1,088
Interest on federal funds sold 13 104
--------------------------------
Total interest income 7,542 7,409
Interest expense:
Interest on deposits 1,744 2,162
Interest on other borrowings 268 258
--------------------------------
Total interest expense 2,012 2,420
--------------------------------
Net interest income 5,530 4,989
Provision for loan losses --- ---
--------------------------------
Net interest income after provision for loan losses 5,530 4,989
Noninterest income:
Service charges on deposit accounts 268 314
Merchant draft processing, net 1,129 1,179
Loan servicing income 35 54
Net realized gains on
investment securities available for sale --- 35
Other income 197 236
--------------------------------
Total noninterest income 1,629 1,818
Noninterest expense:
Salaries and employee benefits 2,284 2,046
Occupancy and equipment expense 614 524
Other 1,188 1,168
--------------------------------
Total noninterest expense 4,086 3,738
--------------------------------
Income before income taxes 3,073 3,069
Provision for income taxes 1,057 1,122
--------------------------------
Net income $2,016 $1,947
================================
Total comprehensive income $1,997 $1,910
================================
(Continued)
This page is page 3 of 40 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
(Continued)
Three Months Ended
March 31,
2003 2002
----------------------------------
Basic earnings per common share:
Net income $.60 $.56
Weighted average shares - basic 3,385,000 3,499,000
Diluted earnings per common share:
Net income $.57 $.54
Weighted average shares - diluted 3,507,000 3,632,000
See Notes to Consolidated Financial Statements.
(Concluded)
This page is page 4 of 40 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands)
March 31, December 31,
2003 2002
-----------------------------------
(unaudited)
Assets:
Cash and due from banks $22,286 $21,837
Federal funds sold 19,221 17,500
-----------------------------------
Cash and cash equivalents 41,507 39,337
Investment securities:
Held to maturity (fair value of $16,155 and $17,268) 15,648 16,764
Available for sale, at fair value (amortized cost of $75,047 and $81,092) 76,910 83,157
-----------------------------------
Total investment securities 92,558 99,921
Mortgage loans held for sale 322 ---
Loans:
Residential real estate mortgage 109,210 87,764
Commercial real estate mortgage 166,378 158,018
Commercial 60,443 62,958
Real estate construction 49,307 42,749
Installment and other 12,538 14,260
Less net deferred loan fees (362) (673)
-----------------------------------
Total portfolio loans 397,514 365,076
Less allowance for loan losses (7,355) (7,400)
-----------------------------------
Net loans 390,159 357,676
Premises and equipment, net 2,765 2,760
Cash surrender value of life insurance 3,662 3,620
Other assets and interest receivable 9,643 9,867
-----------------------------------
Total assets $540,616 $513,181
===================================
Liabilities and Shareholders' equity:
Deposits:
Noninterest bearing demand deposits $109,502 $103,484
Interest-bearing transaction accounts 160,351 128,292
Time deposits one hundred thousand and over 68,385 69,000
Other time deposits 144,123 152,317
-----------------------------------
Total deposits 482,361 453,093
Short-term borrowings 4,621 12,356
Trust preferred securities 10,000 10,000
Other liabilities and interest payable 14,928 8,925
-----------------------------------
Total liabilities 511,910 484,374
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: 3,373,523 and 3,404,890 shares 10,751 10,853
Retained earnings 16,763 16,654
Accumulated other comprehensive income, net of tax 1,192 1,300
-----------------------------------
Total shareholders' equity 28,706 28,807
-----------------------------------
Total liabilities and shareholders' equity $540,616 $513,181
===================================
See Notes to Consolidated Financial Statements.
This page is page 5 of 40 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Three Months Ended
March 31,
2003 2002
----------------------------------
Cash flows from operating activities:
Net income $2,016 $1,947
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization, net 122 50
Loans originated for sale (1,296) ---
Proceeds from sale of loans held for sale 971 ---
Net realized gains on securities available for sale --- (35)
Net realized loss on sale of loans held for sale 3 ---
Change in other assets and interest receivable 274 (628)
Change in other liabilities and interest payable 6,003 865
----------------------------------
Total adjustments 6,077 252
----------------------------------
Net cash from operating activities 8,093 2,199
Cash flows from investing activities:
Net change in loans (32,319) 77
Purchases of investment securities available for sale (3,081) (14,279)
Purchases of investment securities held to maturity (21) ---
Proceeds from sales of investment securities available for sale --- 5,079
Maturities of investment securities available for sale 9,057 5,681
Maturities or calls of investment securities held to maturity 1,112 931
Purchases of premises and equipment, net (193) (361)
----------------------------------
Net cash from investing activities (25,445) (2,872)
Cash flows from financing activities:
Net change in noninterest bearing demand deposits 6,018 13,550
Net change in interest bearing transaction accounts 32,059 2,894
Net change in time deposits (8,809) 23,100
Net change in short-term borrowings (7,735) 155
Repurchases of common stock (1,322) (1,206)
Issuance of common stock 162 ---
Cash dividends paid (851) (705)
----------------------------------
Net cash from financing activities 19,522 37,788
----------------------------------
Net change in cash and cash equivalents 2,170 37,115
Cash and cash equivalents at beginning of period 39,337 24,249
----------------------------------
Cash and cash equivalents at end of period $41,507 $61,364
==================================
(Continued)
This page is page 6 of 40 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
(Continued)
Three Months Ended
March 31,
2003 2002
---------------- ---------------
Supplemental Disclosures:
Cash paid during the period for:
Interest expense $1,968 $2,807
Income taxes 650 614
See Notes to Consolidated Financial Statements.
(Concluded)
This page is pae 7 of 40 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 2002 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 and Redwood Statutory Trust I ("RSTI"). In 2002, National
Bank of the Redwoods (and with its subsidiary, "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. 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 three months ended March 31, 2003 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2003.
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.
This page is page 8 of 40 pages.
3. Stock-Based Compensation
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in net
income, as all options granted had an exercise price equal to or greater than
the market price of the underlying common stock at date of grant. The following
table illustrates the effect on net income using earnings per share if expense
was measured using fair value recognition provisions of FASB Statement No. 123,
Accounting of Stock-Based Compensation.
March 31, 2003 March 31, 2002
--------------------------------------
(dollars in thousands,
except per share data)
Net income as reported $2,016 $1,947
Deduct: Stock-based compensation expense
determined under fair value based method (19) (37)
------------------ ------------------
Pro forma net income $1,997 $1,910
================== ==================
Basic earnings per share as reported $.60 $.56
Pro forma basic earnings per share .59 .55
Diluted earnings per share as reported $.57 $.54
Pro forma diluted earnings per share .57 .53
Pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
March 31, 2003 March 31, 2002
------------------------------------
Risk-free interest rate 3.82% 5.41%
Expected option life in years 10 10
Expected stock price volatility 32.44% 33.25%
Dividend yield 2.8% 2.1%
This page is page 9 of 40 pages.
The following table reflects the Company's earnings per share data.
Three Months Ended
March 31,
2003 2002
-------------------------- -------------------------
Basic Diluted Basic Diluted
-------------------------- -------------------------
(in thousands, except per share data)
Earnings per common share:
Net income $2,016 $2,016 $1,947 $1,947
Earnings per share .60 .57 .56 .54
Weighted average common shares outstanding 3,385,000 3,507,000(1) 3,499,000 3,632,000(1)
1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 122,000 and 133,000 for the three months ended
March 31, 2003 and March 31, 2002.
4. Comprehensive Income
The Company's total comprehensive earnings presentation is as follows:
Three Months Ended
March 31,
2003 2002
-------------------------
(in thousands)
Net income as reported $2,016 $1,947
Other comprehensive income (net of tax):
Change in unrealized holding gain
on available for sale securities (108) (215)
Reclassification adjustment --- (20)
-------------------------
Total comprehensive income $1,908 $1,712
=========================
5. Subsequent Event - Common Stock Cash Dividend
On April 4, 2003, the Board of Directors declared a quarterly cash dividend
of 25 cents per share on the Company's Common Stock. The dividend was payable on
April 29, 2003 to shareholders of record on April 17, 2003.
6. 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 37,000 merchants throughout the United States.
This page is page 10 of 40 pages.
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 March 31, 2003
-------------------------------------------
Merchant
Community Card Total
Banking Services Company
-------------------------------------------
(in thousands)
Total interest income $7,542 $ --- $7,542
Total interest expense 2,007 5 2,012
Interest income/(expense) allocation (170) 170 ---
-------------------------------------------
Net interest income 5,365 165 5,530
Provision for loan losses --- --- ---
Total other operating income 500 1,129 1,629
Total other operating expense 3,395 691 4,086
-------------------------------------------
Income before income taxes 2,470 603 3,073
Provision for income taxes 850 207 1,057
-------------------------------------------
Net income $1,620 $396 $2,016
===========================================
Total Average Assets $484,888 $25,723 $510,611
===========================================
For the quarter ended March 31, 2002
---------------------------------------------
Merchant
Community Card Total
Banking Services Company
---------------------------------------------
(in thousands)
Total interest income $7,409 $ --- $7,409
Total interest expense 2,418 2 2,420
Interest income/(expense) allocation (156) 156 ---
---------------------------------------------
Net interest income 4,835 154 4,989
Provision for loan losses --- --- ---
Total other operating income 639 1,179 1,818
Total other operating expense 3,088 650 3,738
---------------------------------------------
Income before income taxes 2,386 683 3,069
Provision for income taxes 874 248 1,122
--------------------------------------------
Net income $1,512 $435 $1,947
=============================================
Total Average Assets $443,027 $26,714 $469,741
=============================================
This page is page 11 of 40 pages.
7. Common Stock Repurchases and Trust Preferred Issuance
In August 2001, the Company announced an authorization to repurchase
355,500 common shares, as adjusted for the three-for-two stock split announced
September 20, 2001. To date, 237,003 shares have been repurchased, as adjusted
for the three-for-two stock split announced September 20, 2001. In the quarter
ended March 31, 2003, the Company purchased 46,367 shares at an average cost of
$28.52 under the program. Under the repurchase program, the Company plans to
purchase shares from time to time on the open market and/or in privately
negotiated transactions.
8. 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 information see "Income Taxes".
9. New Accounting Pronouncements
New accounting standards for asset retirement obligations, restructuring
activities and exit costs, operating leases, and early extinguishment of debt
were adopted as of January 1, 2003. Management has determined that the adoption
of these new accounting standards did not have a material impact on the
Company's financial condition or results of operations.
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, among other things,
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 banking or
other laws and regulations or governmental fiscal or monetary
policies.
o Changes in the interest rate environment (including possible further
declines in interest rates) and volatility of rate sensitive loans and
deposits.
This page is pae 12 of 40 pages.
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
continuing war on terrorism, as well as actions taken or to be taken
by the U.S. or other governments as a result of further acts or
threats of terrorism.
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.
o A continuing 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 update these
forward-looking statements to reflect facts, circumstances, assumptions or
events that occur after the date the forward-looking statements are made or to
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, 2002 and "Certain Important
Considerations for Investors" herein.
This page is page 13 of 40 pages.
The following sections discuss significant changes and trends in financial
condition, capital resources and liquidity of the Company from December 31, 2002
to March 31, 2003. Significant changes and trends in the Company's results of
operations for the three months ended March 31, 2003, compared to the same
period in 2002, are also discussed.
Summary of Financial Results
The Company reported net income of $2,016,000 ($.57 per diluted share) for
the three months ended March 31, 2003 as compared to $1,947,000 ($.54 per
diluted share) for the same period in 2002, an increase of $69,000 in net income
or 4%. This increase is due to an increase of $541,000 in net interest income,
partially offset by an increase of $348,000 in noninterest expense and a
decrease of $189,000 in other noninterest income. In addition, net income
increased due to a decline in the Company's effective tax rate from 36.6% for
the quarter ended March 31,2002 to 34.4% for the quarter ended March 31, 2003.
For further information, see "Income Taxes" in this section.
Net Interest Income
Net interest income increased from $4,989,000 in the first quarter of 2002
to $5,530,000 in the first quarter of 2003, which represents an increase of
$541,000 or 11%. The increase in net interest income was driven by a substantial
increase in average earning assets of $43,529,000 from $441,641,000 for the
quarter ended March 31, 2002 to $485,170,000 for the quarter ended March 31,
2003. The largest component of the increase in earning assets was growth in the
Company's loan portfolio. Average portfolio loans increased $32,689,000 or 9%,
when compared to the same quarter in 2002. The Company continues to focus on
growth in the overall loan portfolio, and in particular the commercial real
estate portfolio, through marketing efforts and a general expansion of
businesses within the Company's market area. Average commercial real estate
loans increased $36,784,000 or 30% and average installment and other loans
increased $3,085,000 or 23%, offset by a decline of $7,211,000, or 10% in
average commercial loans for the three months ended March 31, 2003 as compared
to the three months ended March 31, 2002.
The Company's net interest margin also increased slightly to 4.62% from
4.58% one year ago. For the three months ended March 31, 2003, yield on earning
assets decreased to 6.30% from 6.80% 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. Yield paid on interest bearing liabilities decreased to 2.19%
for the three months ended March 31, 2003 as compared to 2.86% for the same
period one year ago. This decline is attributable to a lower interest rate
environment and the downward repricing of interest bearing deposits.
This page is page 14 of 40 pages.
The following is an analysis of the Company's net interest margin for the
indicated periods:
Three months ended Three months ended
March 31, 2003 March 31, 2002
------------------------------------- ------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
------------------------------------- ------------------------------------
Real estate-mortgage loans $98,156 $1,621 6.70% $97,077 $1,722 7.19%
Real estate-commercial loans 159,915 2,855 7.24 123,131 2,282 7.52
Commercial loans 62,133 956 6.24 69,344 1,197 7.00
Real estate construction loans 44,593 807 7.34 45,620 863 7.67
Installment and other 16,707 163 3.96 13,622 153 4.56
Deferred loan fees (544) --- --- (523) --- ---
----------------------- ----------------------
Portfolio loans 380,960 6,402 6.82 348,271 6,217 7.24
Mortgage loans held for sale 220 4 7.37 --- --- ---
Investments 99,764 1,123 4.57 68,941 1,088 6.40
Federal funds sold 4,226 13 1.25 24,429 104 1.73
----------------------- ----------
Total earning assets (1) $485,170 7,542 6.30 $441,641 7,409 6.80
============= =============
Interest bearing transaction accounts $137,760 304 0.89 $124,386 423 1.38
Time deposits 217,091 1,440 2.69 204,335 1,739 3.45
Other borrowings 17,606 268 6.17 14,174 258 7.38
----------------------- ----------
Total interest-bearing liabilities $372,457 2,012 2.19% $342,895 2,420 2.86%
============= =============
----------- ----------
Net interest income $5,530 $4,989
=========== ==========
Net interest income to
earning assets 4.62% 4.58%
(1) Nonaccrual loans are included in the calculation of the average balance
of earning assets (interest not accrued is excluded).
Tis page is page 15 of 40 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 months ended March 31, 2003 and 2002. 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
March 31, 2003 compared to the
three months ended March 31, 2002
----------------------------------------
Volume Rate Total
----------------------------------------
(in thousands)
Increase/(decrease) in interest income:
Real estate-mortgage loans $19 ($120) ($101)
Real estate-commercial loans 659 (86) 573
Commercial loans (118) (123) (241)
Real estate construction loans (19) (37) (56)
Installment and other 32 (22) 10
Mortgage loans held for sale 4 --- 4
Investments 401 (366) 35
Federal funds sold (68) (23) (91)
----------------------------------------
Total increase/(decrease) 910 (777) 133
----------------------------------------
Increase/(decrease) in interest expense:
Interest-bearing transaction accounts 42 (161) (119)
Time deposits 103 (402) (299)
Other borrowings 56 (46) 10
----------------------------------------
Total increase/(decrease) 201 (609) (408)
----------------------------------------
Increase/(decrease) in net interest income $709 ($168) $541
========================================
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 months ended March 31, 2003
and 2002. For further information, see "Allowance for Loan Losses" and
"Nonperforming Assets" in this section.
This page is page 16 of 40 pages.
Noninterest Income and Expense
Noninterest Income
The following table sets forth the components of the Company's noninterest
income for the three months ended March 31, 2003, as compared to the same period
in 2002.
Three Months Ended
March 31, $ %
--------------------------
2003 2002 Change Change
------------- ----------- ----------------------
(dollars in thousands)
Service charges on deposit accounts $268 $314 ($46) (15)%
Merchant draft processing, net 1,129 1,179 (50) (4)
Loan servicing income 35 54 (19) (35)
Net realized gains on investment securities
available for sale --- 35 (35) (100)
Other income 197 236 (39) (17)
------------- ----------- ------------
Total noninterest income $1,629 $1,818 ($189) (10)%
============= =========== ============
Noninterest income decreased $189,000, or 10%, to $1,629,000 for the three
months ended March 31, 2003 when compared to $1,818,000 for the same period in
2002. During this period, such decrease was primarily due to a decrease of
$50,000 in merchant card net revenue, a $46,000 decrease in service charges on
deposit accounts and a decrease in net realized gains on investment securities
available for sale of $35,000. The decrease in merchant card net revenue is due
to a decrease in processing revenue. The decrease in net realized gains on
investment securities available for sale is the result of the sale of $5,079,000
of corporate debt securities during 2002. Such securities were sold to improve
the risk profile of the Company's investment portfolio.
Noninterest Expense
The following table sets forth the components of the Company's noninterest
expense during the three months ended March 31, 2003, as compared to the same
period in 2002.
Three Months Ended
March 31, $ %
---------------------------
2003 2002 Change Change
-----------------------------------------------
(dollars in thousands)
Salaries and employee benefits $2,284 $2,046 $238 12 %
Occupancy and equipment expense 614 524 90 17
Other 1,188 1,168 20 2
-------------------------------------
Total noninterest expense $4,086 $3,738 $348 9 %
=====================================
Noninterest expense increased by $348,000, or 9%, to $4,086,000 during
the first quarter of 2003 as compared to $3,738,000 for the first quarter of
2002. The increase in noninterest
This page is page 17 of 40 pages
expense for the three-month period ended March 31, 2003, as compared to the same
period ended March 31, 2002, was primarily attributable to an increase in
salaries and employee benefits of $238,000. The increase in salaries and
employee benefits was primarily due to an increase in sales personnel. At March
31, 2003, the number of full time equivalent employees totaled 156 as compared
to 154 at March 31, 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 34.4% for the three months ended March 31, 2003, as compared to 36.6%
for the same period in 2002. The primary reason for the Company's effective tax
rate being significantly lower than the statutory rate of 41% is due to the
January 15, 2002 formation of 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 37,000 merchants
throughout the United States.
Summary financial data by business segment for the indicated periods is as
follows:
For the quarter ended March 31, 2003
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $7,542 $ --- $7,542
Total interest expense 2,007 5 2,012
Interest income/(expense) allocation (170) 170 ---
-----------------------------------------------
Net interest income 5,365 165 5,530
Provision for loan losses --- --- ---
Total other operating income 500 1,129 1,629
Total other operating expense 3,395 691 4,086
-----------------------------------------------
Income before income taxes 2,470 603 3,073
Provision for income taxes 850 207 1,057
-----------------------------------------------
Net income $1,620 $396 $2,016
===============================================
Total Average Assets $484,888 $25,723 $510,611
===============================================
This page is page 18 of 40 pages.
For the quarter ended March 31, 2002
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $7,409 $ --- $7,409
Total interest expense 2,418 2 2,420
Interest income/(expense) allocation (156) 156 ---
-----------------------------------------------
Net interest income 4,835 154 4,989
Provision for loan losses --- --- ---
Total other operating income 639 1,179 1,818
Total other operating expense 3,088 650 3,738
-----------------------------------------------
Income before income taxes 2,386 683 3,069
Provision for income taxes 874 248 1,122
-----------------------------------------------
Net income $1,512 $435 $1,947
===============================================
Total Average Assets $443,027 $26,714 $469,741
===============================================
Community Banking
The Community Banking segment's income before income tax increased for the
three months ended March 31, 2003 when compared to the same period in 2002. The
increase was primarily due to an increase in net interest income. Net interest
income increased $530,000 for the three months ended March 31, 2003, principally
due to an increase in earning assets, offset partially by a decline in the
general interest rate environment. The Company increased its loan portfolio
during the first three months of 2003 through marketing efforts. For the quarter
ended March 31, 2003, total average portfolio loans were $380,960,000, up 9%
from $348,271,000 for the quarter ended March 31, 2002.
Merchant Card Services
The Company's merchant credit card segment earned $396,000 for the three
months ended March 31, 2003 compared to $435,000 for the same period in 2002.
The decrease in the unit's net income was due to a decrease in processing
revenue and an increase in salary and benefits expenses. The merchant credit
card segment's net income comprised approximately 20% of the Company's
consolidated net income for the three months ended March 31, 2003 as compared to
22% for the same period 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 $1,263,000 and $1,233,000 as of March 31, 2003 and 2002, 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 (Independent Sales
This page is page 19 of 40 pages.
Organization) 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 $44,000 for the three months ended March 31, 2003, as compared to $58,000
for the three months ended March 31, 2002. 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
March 31,
2003 2002
--------------------------
(in thousands)
Beginning allowance $1,261 $1,212
Provision for losses 44 58
Recoveries 3 8
Charge-offs (45) (45)
--------------------------
Ending allowance $1,263 $1,233
==========================
Investment Securities
Total investment securities decreased to $92,558,000, as of March 31, 2003,
compared to $99,921,000 as of December 31, 2002. The decrease in the investment
securities portfolio from December 31, 2002 was primarily due to prepayments of
the Company's mortgage backed securities portfolio. Such portfolio amounted to
$79,794,000 as of December 31, 2002 as compared to $74,450,000 as of March 31,
2003. The average federal funds sold balance for the quarter ended March 31,
2003 of $4,226,000 was substantially lower than $24,429,000 for the quarter
ended March 31, 2002. This decrease was due to the Company's increased focus on
greater growth in the Company's loan portfolio.
Loans
Total loans increased to $397,514,000 at March 31, 2003 compared to
$365,076,000 at December 31, 2002. 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 $8,360,000 to $166,378,000, at March 31, 2003, compared to
$158,018,000 at December 31, 2002. Residential real estate mortgage loans also
increased $21,446,000 to $109,210,000 at March 31, 2003, compared to $87,764,000
at December 31, 2002.
This page is page 20 of 40 pages.
The following table summarizes the composition of the loan portfolio at
March 31, 2003 and December 31, 2002:
March 31, 2003 December 31, 2002
---------------------------- -----------------------------
Amount % Amount %
---------------------------- -----------------------------
(dollars in thousands)
Residential real estate mortgage $109,210 27% $87,764 24%
Commercial real estate mortgage 166,378 43 158,018 43
Commercial 60,443 15 62,958 17
Real estate construction 49,307 12 42,749 12
Installment and other 12,538 3 14,260 4
Less net deferred loan fees (362) --- (673) ---
---------------------------- -----------------------------
Total portfolio loans 397,514 100% 365,076 100%
========== ============
Less allowance for loan losses (7,355) (7,400)
------------------- ------------------
Net loans $390,159 $357,676
=================== ==================
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 indicate 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 21 of 40 pages.
The following table summarizes changes in the Company's allowance for loan
losses for the indicated periods:
Three months ended
March 31,
--------------------------
2003 2002
------------- ------------
(dollars in thousands)
Beginning allowance for loan losses $7,400 $7,580
Provision for loan losses --- ---
Charge-offs (79) (45)
Recoveries 34 14
------------- ------------
Ending allowance for loan losses $7,355 $7,549
============= ============
Net charge-offs to average
loans (annualized) 0.05% 0.04%
The allowance for loan losses as a percentage of total loans decreased from
2.03%, at December 31, 2002, to 1.85% at March 31, 2003. The growth in the
Company's loan portfolio resulted primarily from commercial real estate loans
and residential 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:
March 31, December 31,
2003 2002
---------------- ---------------
(dollars in thousands)
Nonaccrual loans $2,983 $2,516
Accruing loans past due 90 days or more --- 6
Restructured loans 272 272
---------------- ---------------
Total nonperforming loans 3,255 2,794
Other real estate owned --- ---
---------------- ---------------
Total nonperforming assets $3,255 $2,794
================ ===============
Nonperforming assets to total assets 0.60% 0.54%
This page is page 22 of 40 pages.
Nonperforming assets have increased from $2,794,000 or .54% of total
assets, as of December 31, 2002, to $3,255,000 or .60% of total assets as of
March 31, 2003. The increase was attributable to an increase of $467,000 in
nonaccrual loans during this period.
At March 31, 2003, nonperforming loans consist of loans to 17 borrowers, 9
of which have balances in excess of $100,000. The two largest have recorded
balances of $1,355,000 and $378,000. Both loans are secured by industrial
equipment or various business assets. 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 March 31, 2003, 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 three loan relationships which total
approximately $2,500,000 as of March 31, 2003, compared to eight loan
relationships totaling approximately $1,244,000 at December 31, 2002, about
which management has serious doubts as to the ability of the borrowers to comply
with the present repayment terms. These loans may become nonperforming assets
based on the information presently known about possible credit problems of the
borrower.
At March 31, 2003, the Company's total recorded investment in impaired
loans (as defined by SFAS No. 114 and No. 118) was $3,255,000, of which
$2,983,000 relates to the recorded investment in loans for which there is a
related allowance for loan losses allocation of $825,000. The remaining $272,000
in impaired loans did not require a specific allowance for loan losses
allocation.
The Company's average recorded investment in impaired loans during the
three months ended March 31, 2003 and 2002 was $2,968,000 and $3,220,000. The
decrease of $252,000 in the average recorded investment in impaired loans during
the three months ending March 31, 2003 compared to the same period one year ago
was primarily due to the decrease in nonperforming loans. There was no interest
income recognized during the periods that such loans were impaired for the three
months ended March 31, 2003 and March 31, 2002.
As of March 31, 2003, there was $2,983,000 of loans on which the accrual of
interest had been discontinued as compared to $2,516,000 at December 31, 2002.
During the three months ended March 31, 2003, interest due but excluded from
interest income on loans placed on nonaccrual status was $76,000, as compared to
$36,000 for the same period one year ago. There was no interest income received
on nonaccrual loans during the three months ended March 31, 2003 and March 31,
2002.
This page is page 23 of 40 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, legal status of borrower nature of the
collateral and other matters. The Company expects that it may be required to
repurchase loans in the future. In the first three months of 2003, the Company
was not required to repurchase any such loans. During the first quarter of 2002,
the Company paid $33,000 for a settlement related to disputed title issues.
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 its 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 March 31, 2003 balances are as follows:
Original March 31, 2003
Certificate Certificate
Face Value Face Value
------------------------------
Class A $73,199,448 $2,264,009
Class B 3,249,067 3,196,478
Class C 100 100
------------------------------
Total pool $76,448,615 $5,460,587
==============================
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 24 of 40 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.
March 31, 2003
----------------------------------------------------------------------
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) 1,345 1,655 1,134 523 4,657
----------------------------------------------------------------------
Total long-term debt
and operating leases $1,345 $1,655 $1,134 $10,523 $14,657
==========================================================
Commitments to extend credit 74,305
Standby letters of credit 5,414
-------------
Total contractual obligations
and commitments $94,376
=============
Liquidity
Redwood's primary source of liquidity is dividends from NBR. Redwood's
primary uses of liquidity have historically been common stock repurchases,
dividend payments made to common shareholders, 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 March 31, 2003, Redwood held $21,000 in deposits at NBR. In
addition, the Company has a $2,500,000 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 March 31, 2003, there was $2,000,000 outstanding under
this line of credit.
This page is page 25 of 40 pages.
Redwood's current cash dividend to its common shareholders is $.25 per
common share per quarter. Further, Redwood is required to make semi-annual
payments of interest at the rate of 10.2% per annum 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 2003 dividend plan from the OCC in January 2003.
During the first three months of 2003, NBR declared a dividend payable to
Redwood of $1,600,000. Management believes that as of March 31, 2003, 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 three months ended
March 31, 2003, the Company received cash of $8,093,000 from operating
activities and $19,522,000 from financing activities, while using $25,445,000 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 (the "FRB") 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.
This page is page 26 of 40 pages.
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).
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 of the
Company and the capital ratios of NBR at March 31, 2003 and December 31, 2002.
March 31, 2003 December 31, 2002
-------------------------------------- -----------------------------------
Well- Minimum Well- Minimum
Actual Capitalized Requirement Actual Capitalized Requirement
-------------------------------------- -----------------------------------
Company
Leverage 6.99% 5.00% 4.00% 6.96% 5.00% 4.00%
Tier 1 risk-based 8.61 6.00 4.00 9.18 6.00 4.00
Total risk-based 10.13 10.00 8.00 10.72 10.00 8.00
NBR
Leverage 7.50% 5.00% 4.00% 7.35% 5.00% 4.00%
Tier 1 risk-based 9.24 6.00 4.00 9.68 6.00 4.00
Total risk-based 10.50 10.00 8.00 10.94 10.00 8.00
In August 2001, the Company announced an additional authorization to
repurchase 355,500 of common shares, as adjusted for the three-for-two stock
split announced September 20, 2001. To date, 237,003 shares have been
repurchased. Under the repurchase program, the Company plans to purchase shares
from time to time on the open market and/or in privately negotiated
transactions.
This page is page 27 of 40 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 March 31, 2003, 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 Company's 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 FRB, 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 one of the Company's merchant credit card customers
be unable to pay on charge-backs from cardholders. Due to contractual
obligations between the Company 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 growing proprietary accounts.
This page is page 28 of 40 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 affected 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 December
31, 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 March 31, 2003,
the Company's total Visa transactions within these certain high-risk categories
were 1.70% of its 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 March
31, 2003, the Company's weekly Visa volume was 55% of the Company's tangible
equity capital, and aggregate charge-backs for the previous six months were
6.39% of tangible equity capital and the aggregate charge-backs for the quarter
were .41% of the interchange count and .44% of the interchange amount. Merchant
bankcard participants, such as the Company, must comply with these Visa rules by
filing a compliance plan with Visa. At March 31, 2003, 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 rules, 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 March 31, 2003,
approximately 82% of the dollar value of the Company's loans were secured by
real estate, of which 50% 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,
construction and other 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 or floods,
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 in California, such events
could have a significant adverse impact on the value of such collateral or the
Company's earnings.
This page is page 29 of 40 pages.
War on Terrorism. The terrorist attacks on the World Trade Center and the
Pentagon on September 11, 2001, ongoing acts or threats of terrorism and actions
taken by the U.S. or other governments as a result of such acts or threats, have
contributed to the continuing downturn in U.S. economic conditions and 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. Continued 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. 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. The long-term impact of the energy crisis in
California on the Company's markets and business cannot be predicted, but could
result in a sustained period of economic difficulties. 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 FRB, which regulates the supply of money and
credit in the U.S. Among the instruments of monetary policy available to the FRB
are (a) conducting open market operations in U.S. 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 30 of 40 pages.
Competition from Other Financial Institutions. NBR 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, mutual funds 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. Banks, securities firms and insurance companies can
also now combine in a new type of financial services firm, called a "financial
holding company". Financial holding companies can offer virtually any type of
financial service, including banking, securities underwriting, insurance (both
agency and underwriting), and merchant banking. 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, such large financial institutions may
have greater access to capital at a lower cost than NBR, which may adversely
affect NBR's ability to compete effectively.
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. Accounting standards and interpretations currently
affecting the Company and its subsidiaries may change at any time, and the
Company's financial condition and results of operations may be adversely
affected.
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.
This page is page 31 of 40 pages.
As of March 31, 2003, other than NBR Real Estate Investment Trust and the
REMIC, (discussed elsewhere in this report), 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.
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), 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 al 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 and Central California, is subject to risks associated
with the local economy. The Company does not own any trading assets.
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 32 of 40 pages.
The following table sets forth, as of March 31, 2003, the distribution of
repricing opportunities for the Bank'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 $19,221 $ --- $ --- $ --- $ --- $19,221
Investment securities 7,237 6,171 15,778 47,769 15,603 92,558
Mortgage loans held for sale 322 --- --- --- --- 322
Loans 121,169 36,701 40,910 157,146 41,588 397,514
-----------------------------------------------------------------------
Total interest-earning assets 147,949 42,872 56,688 204,915 57,191 509,615
-----------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing transaction accounts 160,351 --- --- --- --- 160,351
Time deposits 72,657 95,817 35,530 8,504 --- 212,508
Trust preferred securities --- --- --- --- 10,000 10,000
Short-term borrowings 4,621 --- --- --- --- 4,621
-----------------------------------------------------------------------
Total interest-bearing liabilities 237,629 95,817 35,530 8,504 10,000 387,480
-----------------------------------------------------------------------
Interest rate sensitivity gap ($89,680) ($52,945) $21,158 $196,411 $47,191
===========================================================
Cumulative interest rate sensitivity gap (89,680) (142,625) (121,467) 74,944 122,135
Interest rate sensitivity gap ratio 0.62 0.45 1.60 24.10 5.72
Cumulative interest rate sensitivity gap ratio 0.62 0.57 0.67 1.20 1.32
The Bank'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 Bank's net interest margin.
Management expects that, in a declining interest rate environment, the
Bank's net interest margin would be expected to decline, and, in an increasing
interest rate environment, the Bank's net interest margin would tend to
increase. The Bank 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 Bank will experience the described relationships to declining
or increasing interest rates.
This page is page 33 of 40 pages.
On a quarterly basis, the Bank's 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 Bank's assets and liabilities. The following is a
summary of interest rate risk exposure as of March 31, 2003 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.
March 31, 2003
--------------
Change in Annual Change in
Change in Interest Rate Net Interest Income Market Value of Equity
----------------------- ------------------- ----------------------
+200 $479,000 ($12,964,000)
+100 $362,000 ($5,662,000)
-100 ($1,594,000) $1,387,000
-200 ($3,665,000) $3,564,000
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 March 31, 2003, the Company's principal executive
officer and 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. Such officers have also concluded that
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 the most recent evaluation and there were no
significant deficiencies or material weaknesses, and therefore no
corrective actions needed to be taken.
This page is page 34 of 40 pages.
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits.
99.1 Certification of the Chief Executive Officer Under Section 906 of
the Sarbanes-Oxley Act of 2002.
99.2 Certification of the Chief Financial Officer Under Section 906 of
the Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K
1. Form 8-K filing dated January 7, 2003 reporting under Item 5
thereof, an increase in quarterly cash dividend.
2. Form 8-K filing dated January 22, 2003 reporting under Item 5
thereof, fourth quarter and full year 2002 results.
This page is page 35 of 40 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: 5/13/2003 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 36 of 40 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 37 of 40 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: May 6, 2003
/s/ Patrick Kilkenny
- --------------------------------------------
Patrick Kilkenny, President/CEO
This page is page 38 of 40 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 39 of 40 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: May 6, 2003
/s/ James Beckwith
- --------------------------------------------
James Beckwith, EVP/COO/CFO
This page is page 40 of 40 pages.