================================================================================
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 September 30, 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 November 1, 2003, there were 4,951,631 shares of the Registrant's common
stock outstanding.
This page is page 1 of 44 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, 2003 and 2002.......................3
Consolidated Balance Sheets
September 30, 2003 and December 31, 2002......................................5
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2003 and 2002.................................6
Notes to Consolidated Financial Statements....................................8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations.............................14
Item 3. Quantitative and Qualitative Disclosures
About Market Risk............................................................38
Item 4. Controls and Procedures......................................................41
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.............................................42
SIGNATURES.....................................................................................43
INDEX TO EXHIBITS..............................................................................44
This page is page 2 of 44 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,
2003 2002 2003 2002
--------------------------------------------------
Interest income:
Interest and fees on loans $6,815 $6,542 $19,951 $19,245
Interest on investment securities 712 1,105 2,703 3,321
Interest on federal funds sold 11 159 34 383
--------------------------------------------------
Total interest income 7,538 7,806 22,688 22,949
Interest expense:
Interest on deposits 1,368 2,265 4,749 6,559
Interest on other borrowings 387 270 948 807
--------------------------------------------------
Total interest expense 1,755 2,535 5,697 7,366
--------------------------------------------------
Net interest income 5,783 5,271 16,991 15,583
Provision for loan losses --- --- --- ---
--------------------------------------------------
Net interest income after provision for loan losses 5,783 5,271 16,991 15,583
Noninterest income:
Service charges on deposit accounts 260 288 782 910
Merchant draft processing, net 1,187 1,322 3,404 3,698
Loan servicing income 32 66 110 201
Net realized gains on
investment securities available for sale --- 259 86 294
Other income 187 220 562 663
--------------------------------------------------
Total noninterest income 1,666 2,155 4,944 5,766
Noninterest expense:
Salaries and employee benefits 2,466 2,346 7,008 6,694
Occupancy and equipment expense 475 531 1,567 1,588
Other 1,198 1,426 3,551 3,663
--------------------------------------------------
Total noninterest expense 4,139 4,303 12,126 11,945
--------------------------------------------------
Income before income taxes 3,310 3,123 9,809 9,404
Provision for income taxes 1,225 1,165 3,527 3,474
--------------------------------------------------
Net income $2,085 $1,958 $6,282 $5,930
==================================================
Total comprehensive income $1,779 $2,018 $5,724 $6,427
==================================================
(Continued)
This page is page 3 of 44 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,
2003 2002 2003 2002
--------------------------------------------------------
Basic earnings per common share:
Net income $.42 $.37 $1.24 $1.13
Weighted average shares - basic 4,987,000 5,214,000 5,049,000 5,234,000
Diluted earnings per common share:
Net income $.41 $.36 $1.21 $1.09
Weighted average shares - diluted 5,141,000 5,400,000 5,171,000 5,424,000
See Notes to Consolidated Financial Statements.
(Concluded)
This page is page 4 of 44 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands)
September 30, December 31,
2003 2002
---------------------------------
(unaudited)
Assets:
Cash and due from banks $22,349 $21,837
Federal funds sold 5,000 17,500
---------------------------------
Cash and cash equivalents 27,349 39,337
Investment securities:
Held to maturity (fair value of $18,326 and $17,268) 17,933 16,764
Available for sale, at fair value (amortized cost of $47,833 and
$81,092) 49,112 83,157
---------------------------------
Total investment securities 67,045 99,921
Mortgage loans held for sale 455 ---
Loans:
Residential real estate mortgage 113,380 87,764
Commercial real estate mortgage 182,119 158,018
Commercial 56,554 62,958
Real estate construction 45,525 42,749
Installment and other 14,578 14,260
Less net deferred loan fees (231) (673)
---------------------------------
Total portfolio loans 411,925 365,076
Less allowance for loan losses (7,545) (7,400)
---------------------------------
Net loans 404,380 357,676
Premises and equipment, net 2,409 2,760
Cash surrender value of life insurance 3,744 3,620
Other assets and interest receivable 9,920 9,867
---------------------------------
Total assets $515,302 $513,181
=================================
Liabilities and Shareholders' equity:
Deposits:
Noninterest bearing demand deposits $104,951 $103,484
Interest-bearing transaction accounts 152,487 128,292
Time deposits one hundred thousand and over 76,983 69,000
Other time deposits 120,466 152,317
---------------------------------
Total deposits 454,887 453,093
Short-term borrowings 4,199 12,356
Trust preferred securities 20,000 10,000
Other liabilities and interest payable 9,154 8,925
---------------------------------
Total liabilities 488,240 484,374
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: 4,951,631 and 3,404,890 shares 10,498 10,853
Retained earnings 15,822 16,654
Accumulated other comprehensive income, net of tax 742 1,300
---------------------------------
Total shareholders' equity 27,062 28,807
---------------------------------
Total liabilities and shareholders' equity $515,302 $513,181
=================================
See Notes to Consolidated Financial Statements.
This page is page 5 of 44 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Nine Months Ended
September 30,
2003 2002
-------------------------
Cash flows from operating activities:
Net income $6,282 $5,930
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization, net 416 192
Loans originated for sale (3,268) (1,807)
Proceeds from sale of loans held for sale 2,806 1,170
Net realized gains on securities available for sale (86) (294)
Net realized (gain) loss on sale of loans held for sale 7 (13)
Change in other assets and interest receivable 164 (1,033)
Change in other liabilities and interest payable 229 2,790
-------------------------
Total adjustments 268 1,005
-------------------------
Net cash from operating activities 6,550 6,935
Cash flows from investing activities:
Net change in loans (46,285) (15,892)
Purchases of investment securities available for sale (5,004) (33,816)
Purchases of investment securities held to maturity (4,215) (2,499)
Proceeds from sales of investment securities available for sale 9,812 9,319
Maturities of investment securities available for sale 28,336 12,292
Maturities or calls of investment securities held to maturity 2,968 2,332
Purchases of premises and equipment, net (189) (723)
-------------------------
Net cash from investing activities (14,577) (28,987)
Cash flows from financing activities:
Net change in noninterest bearing demand deposits 1,467 13,325
Net change in interest bearing transaction accounts 24,195 283
Net change in time deposits (23,868) 40,994
Net change in short-term borrowings (8,157) 1,605
Issuance of trust preferred securities 10,000 ---
Repurchases of common stock (5,711) (2,201)
Issuance of common stock 661 ---
Cash dividends paid (2,548) (2,102)
-------------------------
Net cash from financing activities (3,961) 51,904
-------------------------
Net change in cash and cash equivalents (11,988) 29,852
Cash and cash equivalents at beginning of period 39,337 24,249
-------------------------
Cash and cash equivalents at end of period $27,349 $54,101
=========================
(Continued)
This page is page 6 of 44 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
(Continued)
Nine Months Ended
September 30,
2003 2002
------------------------
Supplemental Disclosures:
Cash paid during the period for:
Interest expense $6,550 $7,594
Income taxes 3,145 3,743
See Notes to Consolidated Financial Statements.
(Concluded)
This page is page 7 of 44 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, Redwood Statutory Trust I ("RSTI") and Redwood Statutory
Trust II ("RSTII"). 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 for the three and nine
months ended September 30, 2003 and cash flows for the nine months ended
September 30, 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.
On July 16, 2003, the Company announced a three-for-two stock split of
its outstanding shares of common stock payable on August 13, 2003 to common
shareholders of record on July 28, 2003. Earnings per share information for all
periods presented give effect to the stock split.
This page is page 8 of 44 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 the fair value recognition provisions of FASB Statement No.
123, Accounting for Stock-Based Compensation.
Three months ended Nine months ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
----------------------------------------- -----------------------------------------
(dollars in thousands, except per share data)
Net income as reported $2,085 $1,958 $6,282 $5,930
Deduct: Stock-based compensation expense
determined under fair value based method (22) (45) (61) (121)
----------------------------------------- -----------------------------------------
Pro forma net income $2,063 $1,913 $6,221 $5,809
========================================= =========================================
Basic earnings per share as reported $.42 $.37 $1.24 $1.13
Pro forma basic earnings per share .41 .37 1.23 1.11
Diluted earnings per share as reported $.41 $.36 $1.21 $1.09
Pro forma diluted earnings per share .40 .35 1.20 1.07
Pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date. There were no options
granted during the three-month periods ended September 30, 2003 and 2002.
Nine months ended
September 30, 2003 September 30, 2002
-----------------------------------------
Risk-free interest rate 3.53% 5.41%
Expected option life in years 10 10
Expected stock price volatility 31.71% 33.12%
Dividend yield 3.5% 2.8%
This page is page 9 of 44 pages.
The following table reflects the Company's earnings per share data.
Three Months Ended
September 30,
2003 2002
---------------------------- ----------------------------
Basic Diluted Basic Diluted
---------------------------- ----------------------------
(in thousands, except per share data)
Earnings per common share:
Net income $2,085 $2,085 $1,958 $1,958
Earnings per share .42 .41 .37 .36
Weighted average common shares outstanding 4,987,000 5,141,000(1) 5,214,000 5,400,000(1)
1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 154,000 and 186,000 for the three months ended
September 30, 2003 and September 30, 2002, as adjusted for the
three-for-two stock split announced July 16, 2003.
Nine Months Ended
September 30,
2003 2002
---------------------------- ----------------------------
Basic Diluted Basic Diluted
---------------------------- ----------------------------
(in thousands, except per share data)
Earnings per common share:
Net income $6,282 $6,282 $5,930 $5,930
Earnings per share 1.24 1.21 1.13 1.09
Weighted average common shares outstanding 5,049,000 5,171,000(1) 5,234,000 5,424,000(1)
1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 122,000 and 190,000 for the nine months ended
September 30, 2003 and September 30, 2002, as adjusted for the
three-for-two stock split announced July 16, 2003.
4. Comprehensive Income
The Company's total comprehensive earnings presentation is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
------------------------- ------------------------
(in thousands)
Net income as reported $2,085 $1,958 $6,282 $5,930
Other comprehensive income/(loss) (net
of tax):
Change in unrealized holding gain
on available for sale securities (306) 223 (508) 682
Reclassification adjustment --- (163) (50) (185)
------------------------- ------------------------
Total comprehensive income $1,779 $2,018 $5,724 $6,427
========================= ========================
This page is page 10 of 44 pages.
5. Subsequent Events - Common Stock Cash Dividend
On October 6, 2003, the Board of Directors declared a quarterly cash
dividend of 17 cents per share on the Company's Common Stock. The dividend was
paid on October 29, 2003 to shareholders of record on October 15, 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 35,000 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, 2003
-------------------------------------------------
Merchant
Community Card Total
Banking Services Company
-------------------------------------------------
(in thousands)
Total interest income $7,538 $ --- $7,538
Total interest expense 1,747 8 1,755
Interest income/(expense) allocation (183) 183 ---
-------------------------------------------------
Net interest income 5,608 175 5,783
Provision for loan losses --- --- ---
Total other operating income 479 1,187 1,666
Total other operating expense 3,409 730 4,139
-------------------------------------------------
Income before income taxes 2,678 632 3,310
Provision for income taxes 990 235 1,225
-------------------------------------------------
Net income $1,688 $397 $2,085
=================================================
Total Average Assets $489,604 $28,485 $518,089
=================================================
This page is page 11 of 44 pages.
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 nine months ended September 30, 2003
-------------------------------------------------
Merchant
Community Card Total
Banking Services Company
-------------------------------------------------
(in thousands)
Total interest income $22,688 $ --- $22,688
Total interest expense 5,667 30 5,697
Interest income/(expense) allocation (598) 598 ---
-------------------------------------------------
Net interest income 16,423 568 16,991
Provision for loan losses --- --- ---
Total other operating income 1,540 3,404 4,944
Total other operating expense 9,994 2,132 12,126
-------------------------------------------------
Income before income taxes 7,969 1,840 9,809
Provision for income taxes 2,866 661 3,527
-------------------------------------------------
Net income $5,103 $1,179 $6,282
=================================================
Total Average Assets $486,899 $30,097 $516,996
=================================================
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 12 of 44 pages.
7. Common Stock Repurchases
The Company has announced authorizations to repurchase up to 533,250
common shares. To date, 525,900 shares have been repurchased. In the quarter
ended September 30, 2003, the Company purchased 170,395 shares under the program
at an average price per share of $25.76. For the nine months ended September 30,
2003, the Company purchased 239,946 shares under the program at an average price
per share of $23.80. Under the repurchase program, the Company plans to purchase
shares from time to time on the open market and/or in privately negotiated
transactions. All share and average price per share numbers herein have been
adjusted for the three-for-two stock splits announced September 20, 2001 and
July 16, 2003.
8. New Accounting Pronouncements
The Financial Accounting Standards Board ("FASB") recently issued two
new accounting standards, Statement of Financial Accounting Standards ("SFAS")
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities", and SFAS No. 150, "Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity", both of which generally
became effective in the quarter beginning July 1, 2003. Management has
determined that the adoption of these standards did not have a material impact
on the Company's operating results or financial condition. However, the Federal
Reserve is reviewing the regulatory capital implications of the requirements to
report trust preferred securities with liabilities. If trust preferred
securities were to be disallowed for Tier 1 regulatory capital treatment, the
regulatory capital amount may be materially impacted.
This page is page 13 of 44 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, 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.
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
This page is page 14 of 44 pages.
long-term impact of the California energy crisis, the
decline in the technology sector and any negative effect of the
substantial budget deficit, gubernatorial recall and budgetary crisis
and continuing fiscal difficulties of the State of California.
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.
The following sections discuss significant changes and trends in
financial condition, capital resources and liquidity of the Company from
December 31, 2002 to September 30, 2003. Significant changes and trends in the
Company's results of operations for the three and nine months ended September
30, 2003, compared to the same period in 2002, are also discussed.
Summary of Financial Results
The Company reported net income of $2,085,000 ($.41 per diluted share)
for the three months ended September 30, 2003 as compared to $1,958,000 ($.36
per diluted share) for the same period in 2002, an increase of $127,000 in net
income or 6%. This increase is due to an increase of $512,000 in net interest
income and a decrease in noninterest expense of $164,000, partially offset by a
decrease of $489,000 in noninterest income.
Net income for the nine months ended September 30, 2003 was $6,282,000
($1.21 per diluted share), as compared to $5,930,000 ($1.09 per diluted share)
for the same period in 2002, an increase of $352,000 or 6%. This increase is due
to an increase of $1,408,000 in net interest income, partially offset by a
decrease of $822,000 in noninterest income and an increase of $181,000 in
noninterest expense.
On July 16, 2003, the Company announced a three-for-two stock split of
its outstanding shares of common stock payable on August 13, 2003 to common
shareholders of record on July 28, 2003. Earnings per share information for all
periods presented give effect to the stock split.
This page is page 15 of 44 pages.
Net Interest Income
Net interest income increased from $5,271,000 in the third quarter of
2002 to $5,783,000 in the third quarter of 2003, which represents an increase of
$512,000 or 10%. The increase in net interest income was driven by an increase
in average earning assets of $12,175,000 from $476,552,000 for the quarter ended
September 30, 2002 to $488,727,000 for the quarter ended September 30, 2003. The
largest component of the increase in earning assets was growth in the Company's
loan portfolio. Average portfolio loans increased $50,233,000 or 14%, 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
$30,754,000 or 21%, average real estate mortgage loans increased $23,991,000 or
26% and average installment and other loans increased $2,600,000 or 17%, offset
by a decline of $12,021,000, or 18% in average commercial loans for the three
months ended September 30, 2003 as compared to the three months ended September
30, 2002.
Net interest income for the nine months ended September 30, 2003 was
$16,991,000, which represents an increase of $1,408,000 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 $31,613,000 from $457,472,000 at September
30, 2002 to $489,085,000 at September 30, 2003. For the nine months ended
September 30, 2003, average portfolio loans increased $46,559,000 or 13%, when
compared to the same period in 2002.
For the three months ended September 30, 2003, net interest margin
increased to 4.69% from 4.39% for the same period one year ago. For the nine
months ended September 30, 2003, net interest margin increased to 4.64% from
4.55% one year ago. Yield on earning assets decreased to 6.12% for the three
months ended September 30, 2003 from 6.50% for the same period one year ago. For
the nine months ended September 30, 2003, yield on earning assets decreased to
6.20% from 6.71% for the same period one year ago. The decrease in the yield on
earning assets for the three-and nine-month periods during 2003 is due to a
decline in the general interest rate environment. Yield paid on interest bearing
liabilities decreased to 1.85% for the three-month period ended September 30,
2003 from 2.79% for the same period one year ago. For the nine-month period
ended September 30, 2003, yield paid on interest bearing liabilities decreased
to 2.02% from 2.81% for the same period one year ago. The decrease in interest
rates on interest bearing liabilities occurred as the Company lowered its
deposit product pricing in response to lower short-term rates quoted in the
national markets. The largest decrease was experienced in time deposits. For the
three and nine months ended September 30, 2003, such expense decreased $816,000
or 45% and $1,523,000 or 29% as compared to the same periods one year ago.
This page is page 16 of 44 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, 2003 September 30, 2002
------------------------------------- -----------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
------------------------------------- -----------------------------------
Real estate-mortgage loans $117,030 $1,741 5.90% $93,039 $1,645 7.01%
Real estate-commercial loans 176,093 3,127 7.05 145,339 2,679 7.31
Commercial loans 55,125 907 6.53 67,146 1,187 7.01
Real estate construction loans 46,464 866 7.39 41,988 841 7.95
Installment and other 17,911 165 3.65 15,311 179 4.64
Deferred loan fees (268) --- --- (702) --- ---
----------------------- ----------------------
Portfolio loans 412,354 6,806 6.55 362,121 6,531 7.16
Mortgage loans held for sale 549 8 5.78 467 11 9.35
Investments 70,737 712 3.99 77,158 1,105 5.68
Federal funds sold 5,087 12 0.94 36,806 159 1.71
----------------------- ----------------------
Total earning assets (1) $488,727 7,538 6.12 $476,552 7,806 6.50
============= ============
Interest bearing transaction
accounts $152,262 354 0.92 $119,070 436 1.45
Time deposits 201,742 1,013 1.99 226,124 1,829 3.21
Other borrowings 22,689 388 6.78 14,901 270 7.19
----------------------- ----------------------
Total interest-bearing
liabilities $376,693 1,755 1.85% $360,095 2,535 2.79%
============= ============
----------- -----------
Net interest income $5,783 $5,271
=========== ===========
Net interest income to
earning assets 4.69% 4.39%
(1) Nonaccrual loans are included in the calculation of the average balance
of earning assets (interest not accrued is excluded).
This page is page 17 of 44 pages.
Nine months ended Nine months ended
September 30, 2003 September 30, 2002
------------------------------------- -------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
------------------------------------- -------------------------------------
Real estate-mortgage loans $110,513 $5,125 6.20% $94,391 $5,026 7.12%
Real estate-commercial loans 167,252 8,917 7.13 133,314 7,515 7.54
Commercial loans 59,109 2,783 6.29 68,929 3,589 6.96
Real estate construction loans 47,383 2,621 7.40 43,681 2,606 7.98
Installment and other 16,600 490 3.95 14,246 495 4.65
Deferred loan fees (366) --- --- (629) --- ---
---------------------- ------------------------
Portfolio loans 400,491 19,936 6.66 353,932 19,231 7.26
Mortgage loans held for sale 356 15 5.63 219 14 8.55
Investments 84,107 2,703 4.30 74,077 3,321 5.99
Federal funds sold 4,131 34 1.10 29,244 383 1.75
---------------------- ------------------------
Total earning assets (1) $489,085 22,688 6.20 $457,472 22,949 6.71
============= ===============
Interest bearing transaction
accounts $147,643 1,016 0.92 $121,906 1,303 1.43
Time deposits 210,061 3,733 2.38 213,988 5,256 3.28
Other borrowings 19,625 948 6.46 14,347 807 7.52
---------------------- ------------------------
Total interest-bearing
liabilities $377,329 5,697 2.02% $350,241 7,366 2.81%
============= ===============
---------- ----------
Net interest income $16,991 $15,583
========== ==========
Net interest income to
earning assets 4.64% 4.55%
(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 44 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, 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
September 30, 2003 compared to the
three months ended September 30, 2002
------------------------------------------
Volume Rate Total
------------------------------------------
(in thousands)
Increase/(decrease) in interest income:
Real estate-mortgage loans $383 ($287) $96
Real estate-commercial loans 549 (101) 448
Commercial loans (202) (78) (280)
Real estate construction loans 86 (61) 25
Installment and other 28 (42) (14)
Mortgage loans held for sale 2 (5) (3)
Investments (86) (307) (393)
Federal funds sold (96) (51) (147)
------------------------------------------
Total increase/(decrease) 664 (932) (268)
------------------------------------------
Increase/(decrease) in interest expense:
Interest-bearing transaction accounts 102 (184) (82)
Time deposits (181) (635) (816)
Other borrowings 134 (16) 118
------------------------------------------
Total increase/(decrease) 55 (835) (780)
------------------------------------------
Increase/(decrease) in net interest income $609 ($97) $512
==========================================
Nine months ended
September 30, 2003 compared to the
nine months ended September 30, 2002
-----------------------------------------
Volume Rate Total
-----------------------------------------
(in thousands)
Increase/(decrease) in interest income:
Real estate-mortgage loans $795 ($696) $99
Real estate-commercial loans 1,828 (426) 1,402
Commercial loans (482) (324) (806)
Real estate construction loans 212 (197) 15
Installment and other 75 (80) (5)
Mortgage loans held for sale 7 (6) 1
Investments 408 (1,026) (618)
Federal funds sold (244) (105) (349)
-----------------------------------------
Total increase/(decrease) 2,599 (2,860) (261)
-----------------------------------------
Increase/ (decrease) in interest expense:
Interest-bearing transaction accounts 239 (526) (287)
Time deposits (95) (1,428) (1,523)
Other borrowings 267 (126) 141
-----------------------------------------
Total increase/ (decrease) 411 (2,080) (1,669)
-----------------------------------------
Increase/(decrease) in net interest income $2,188 ($780) $1,408
=========================================
This page is page 19 of 44 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, 2003 and 2002. For further information, see "Allowance for
Loan Losses" and "Nonperforming Assets" in this section.
Noninterest Income and Expense
Noninterest Income
The following tables set forth the components of the Company's
noninterest income for the three and nine months ended September 30, 2003, as
compared to the same period in 2002.
Three Months Ended
September 30,
--------------------------- $ %
2003 2002 Change Change
--------------------------- ----------------------
(dollars in thousands)
Service charges on deposit accounts $260 $288 ($28) (10)%
Merchant draft processing, net 1,187 1,322 (135) (10)
Loan servicing income 32 66 (34) (52)
Net realized gains on investment securities available
for sale --- 259 (259) (100)
Other income 187 220 (33) (15)
----------------------------------------
Total noninterest income $1,666 $2,155 ($489) (23)%
=========================== ============
Noninterest income decreased $489,000, or 23%, to $1,666,000 for the
three months ended September 30, 2003 when compared to $2,155,000 for the same
period in 2002. During this period, such decrease was primarily due to a
decrease in net realized gains on investment securities available for sale of
$259,000, a decrease of $135,000 in merchant card net revenue, a $28,000
decrease in service charges on deposit accounts, and a decrease in loan
servicing income of $34,000. The decrease in merchant card net revenue is due to
the absence of income posted in the third quarter of 2002, that was the result
of the Company's renegotiation of the processing contract with First Data
Resources. Such income amounted to $120,000. The decrease in loan servicing
income is due to a decline in loans serviced by the Company. The decrease in
service charges on deposit accounts is due to a decline in the fees charged
customers for certain products and services. The net realized gains on
investment securities available for sale decreased due to the absence of sales
of investment securities available for sale during the third quarter of 2003.
This page is page 20 of 44 pages.
Nine Months Ended
September 30,
--------------------------- $ %
2003 2002 Change Change
------------------------------------------------
(dollars in thousands)
Service charges on deposit accounts $782 $910 ($128) (14)%
Merchant draft processing, net 3,404 3,698 (294) (8)
Loan servicing income 110 201 (91) (45)
Net realized gains on investment securities available
for sale 86 294 (208) (71)
Other income 562 663 (101) (15)
--------------------------------------
Total noninterest income $4,944 $5,766 ($822) (14)%
======================================
Noninterest income decreased $822,000 or 14% to $4,944,000 for the nine
months ended September 30, 2003 when compared to $5,766,000 for the same period
in 2002. During this period, such decrease was primarily due to a decrease of
$294,000 in merchant card net revenue, a decrease of $208,000 in net realized
gains on investment securities available for sale, a decrease in service charges
on deposit accounts of $128,000, and a decrease in loan servicing income of
$91,000, 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, 2003,
as compared to the same period in 2002.
Three Months Ended
September 30,
--------------------------- $ %
2003 2002 Change Change
------------- --------------------------------------
(dollars in thousands)
Salaries and employee benefits $2,466 $2,346 $120 5 %
Occupancy and equipment expense 475 531 (56) (11)
Other 1,198 1,426 (228) (16)
--------------------------------------
Total noninterest expense $4,139 $4,303 ($164) (4)%
======================================
Noninterest expense decreased by $164,000, or 4%, to $4,139,000 during
the third quarter of 2003 as compared to $4,303,000 for the third quarter of
2002. The decrease in noninterest expense for the three-month period ended
September 30, 2003, as compared to the same period ended September 30, 2002, is
attributable to a decrease in occupancy and equipment expense of $56,000, and a
decrease in other expense of $228,000, partially offset by an increase in
salaries and employee benefits of $120,000. The decrease in occupancy and
equipment expense was due to the February 2003 move of the Company's operations
center. Such move resulted in a decrease in the Company's monthly rent expense
by approximately $11,000. The decrease in other expense is primarily due to
costs incurred in the third quarter of 2002 for legal and consulting fees
associated with certain corporate activities, which included exploring strategic
options for the Company and its Merchant Bankcard segment. The increase in
salaries and employee benefits was primarily due to expenses associated with the
Company's executive
This page is page 21 of 44 pages.
search process and the impact of normal annual salary increases.
Nine Months Ended
September 30,
------------------------ $ %
2003 2002 Change Change
------------------------ ---------------------
(dollars in thousands)
Salaries and employee benefits $7,008 $6,694 $314 5 %
Occupancy and equipment expense 1,567 1,588 (21) (1)
Other 3,551 3,663 (112) (3)
------------------------------------
Total noninterest expense $12,126 $11,945 $181 2 %
====================================
Noninterest expense increased by $181,000 or 2%, to $12,126,000 during
the nine months ended September 30, 2003 as compared to $11,945,000 for the same
period one year ago. The increase in noninterest expense was due to an increase
in salaries and employee benefits of $314,000, partially offset by a decrease in
occupancy and equipment expense of $21,000 and a decrease in other expense of
$112,000, as discussed above.
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% and 36% for the three and nine months ended September 30, 2003, as
compared to 37% and 37% for the same periods 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 35,000 merchants
throughout the United States.
This page is page 22 of 44 pages.
Summary financial data by business segment for the indicated periods is
as follows:
For the quarter ended September 30, 2003
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $7,538 $ --- $7,538
Total interest expense 1,747 8 1,755
Interest income/(expense) allocation (183) 183 ---
-----------------------------------------------
Net interest income 5,608 175 5,783
Provision for loan losses --- --- ---
Total other operating income 479 1,187 1,666
Total other operating expense 3,409 730 4,139
-----------------------------------------------
Income before income taxes 2,678 632 3,310
Provision for income taxes 990 235 1,225
-----------------------------------------------
Net income $1,688 $397 $2,085
===============================================
Total Average Assets $489,604 $28,485 $518,089
===============================================
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 nine months ended September 30, 2003
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $22,688 $ --- $22,688
Total interest expense 5,667 30 5,697
Interest income/(expense) allocation (598) 598 ---
-----------------------------------------------
Net interest income 16,423 568 16,991
Provision for loan losses --- --- ---
Total other operating income 1,540 3,404 4,944
Total other operating expense 9,994 2,132 12,126
-----------------------------------------------
Income before income taxes 7,969 1,840 9,809
Provision for income taxes 2,866 661 3,527
-----------------------------------------------
Net income $5,103 $1,179 $6,282
===============================================
Total Average Assets $486,899 $30,097 $516,996
===============================================
This page is page 23 of 44 pages.
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
===============================================
Community Banking
The Community Banking segment's income before income tax increased for
the three and nine months ended September 30, 2003 when compared to the same
periods in 2002. The increase was primarily due to an increase in net interest
income. Net interest income increased $478,000 and $1,295,000 for the three and
nine months ended September 30, 2003, principally due to an increase in earning
assets. The Company increased its loan portfolio during the first nine months of
2003 through marketing efforts. For the nine months ended September 30, 2003,
total average portfolio loans were $400,491,000, up 13% from $353,932,000 for
the nine months ended September 30, 2002.
Merchant Card Services
The Company's merchant credit card segment earned $397,000 and
$1,179,000 for the three and nine months ended September 30, 2003 compared to
$468,000 and $1,353,000 for the same period in 2002. The decrease in the unit's
net income for the three and nine months ended September 30, 2003 is primarily
due to a decrease in merchant processing revenue and an increase in salaries and
benefits expenses. The decrease in merchant processing revenue is partially due
to $120,000 in income recorded during the third quarter of 2002, as a result of
the renegotiation of the Company's processing contract with First Data
Resources. Additionally, in the first and second quarters of 2002, the Company
recorded an additional $160,000 in revenue associated with a portfolio sale. The
increase in the unit's salaries and employee benefits expense is due to a
build-up in sales development personnel. The merchant credit card segment's net
income comprised approximately 19% of the Company's consolidated net income for
the three and nine months ended September 30, 2003 as compared to 24% 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
This page is page 24 of 44 pages.
its merchant credit card processing business. Accordingly, NBR has established a
reserve to provide for losses associated with charge-backs. Such reserve, which
totaled $1,296,000 and $1,265,000 as of September 30, 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 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 $47,000 and $195,000 for
the three and nine months ended September 30, 2003, as compared to $75,000 and
$183,000 for the three and nine months ended September 30, 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 Nine months ended
September 30, September 30,
2003 2002 2003 2002
---------------------------------------------------
(in thousands)
Beginning allowance $1,314 $1,251 $1,261 $1,212
Provision for losses 47 75 195 183
Recoveries --- 19 3 30
Charge-offs (65) (80) (163) (160)
------------------------- -------------------------
Ending allowance $1,296 $1,265 $1,296 $1,265
========================= =========================
Investment Securities
Total investment securities decreased to $67,045,000, as of September
30, 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 and the second
quarter sale of mortgage backed securities of $9,812,000. Such mortgage-backed
securities portfolio amounted to $79,794,000 as of December 31, 2002 as compared
to 44,629,000 as of September 30, 2003. The average federal funds sold balance
for the nine months ended September 30, 2003 of $4,131,000 was substantially
lower than $29,244,000 for the nine months ended September 30, 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 $411,925,000 at September 30, 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 $24,101,000 to $182,119,000, at September 30, 2003, compared to
$158,018,000 at December 31, 2002. Residential real estate mortgage loans
This page is page 25 of 44 pages.
also increased $25,616,000 to $113,380,000 at September 30, 2003, compared to
$87,764,000 at December 31, 2002.
The following table summarizes the composition of the loan portfolio at
September 30, 2003 and December 31, 2002:
September 30, 2003 December 31, 2002
---------------------------- ----------------------------
Amount % Amount %
---------------------------- ----------------------------
(dollars in thousands)
Residential real estate
mortgage $113,380 28% $87,764 24%
Commercial real estate
mortgage 182,119 43 158,018 43
Commercial 56,554 14 62,958 17
Real estate construction 45,525 11 42,749 12
Installment and other 14,578 4 14,260 4
Less net deferred loan fees (231) --- (673) ---
----------------- -----------------
Total portfolio loans 411,925 100% 365,076 100%
=========== ============
Less allowance for loan
losses (7,545) (7,400)
----------------- -----------------
Net loans $404,380 $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 26 of 44 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,
--------------------------------- ------------------------------
2003 2002 2003 2002
--------------------------------- ------------------------------
(dollars in thousands)
Beginning allowance for loan losses $7,492 $7,586 $7,400 $7,580
Provision for loan losses --- --- --- ---
Charge-offs --- (23) (79) (68)
Recoveries 53 15 224 66
--------------------------------- ------------------------------
Ending allowance for loan losses $7,545 $7,578 $7,545 $7,578
================================= ==============================
Net (charge-offs) recoveries to average
loans (annualized) 0.05% (0.01%) 0.05% 0.00%
The allowance for loan losses as a percentage of total loans decreased
from 2.03%, at December 31, 2002, to 1.83% at September 30, 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:
September 30, December 31,
2003 2002
---------------- ---------------
(dollars in thousands)
Nonaccrual loans $2,415 $2,516
Accruing loans past due 90 days or more --- 6
Restructured loans 267 272
---------------- ---------------
Total nonperforming loans 2,682 2,794
Other real estate owned --- ---
---------------- ---------------
Total nonperforming assets $2,682 $2,794
================ ===============
Nonperforming assets to total assets 0.52% 0.54%
This page is page 27 of 44 pages.
Nonperforming assets have decreased from $2,794,000 or .54% of total
assets, as of December 31, 2002, to $2,682,000 or .52% of total assets as of
September 30, 2003. The decrease was primarily attributable to a decrease of
$101,000 in nonaccrual loans during this period.
At September 30, 2003, nonperforming loans consisted of loans to 11
borrowers, 7 of which have balances in excess of $100,000. The two largest have
recorded balances of $1,171,000 and $332,000. Both loans are secured by
industrial equipment or various other 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 September 30, 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 five loan relationships which total
approximately $4,125,000 as of September 30, 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 September 30, 2003, the Company's total recorded investment in
impaired loans (as defined by SFAS No. 114 and No. 118) was $2,682,000, of which
$2,415,000 relates to the recorded investment in loans for which there is a
related allowance for loan losses allocation of $976,000. The remaining $267,000
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, 2003 and 2002 was $2,875,000 and $1,263,000. The
increase of $1,612,000 in the average recorded investment in impaired loans
during the nine months ending September 30, 2003 compared to the same period one
year ago was primarily due to the increase in average nonperforming loans. There
was $13,000 and $35,000 of interest income recognized during the periods that
such loans were impaired for the three and nine months ended September 30, 2003
as compared to $32,000 and $38,000 for the same periods one year ago.
As of September 30, 2003, there was $2,415,000 of loans on which the
accrual of interest had been discontinued as compared to $2,516,000 at December
31, 2002. During the three and nine months ended September 30, 2003, interest
due but excluded from interest income on loans placed on nonaccrual status was
$60,000 and $173,000, as compared to $11,000 and $42,000 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, 2003 and 2002.
This page is page 28 of 44 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 and nine 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 indexed 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 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 September 30, 2003 balances are as follows:
Original September 30, 2003
Certificate Certificate
Face Value Face Value
-----------------------------------
Class A $73,199,448 $1,038,107
Class B 3,249,067 3,196,478
Class C 100 100
-----------------------------------
Total pool $76,448,615 $4,234,685
===================================
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 44 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, 2003
-------------------------------------------------------------------------
Less Than One Through Four Through After Five
One Year Three Years Five Years Years Total
-------------------------------------------------------------------------
(in thousands)
Trust preferred securities $ --- $ --- $ --- $20,000 $20,000
Operating leases (premises) 1,576 3,223 2,991 5,487 13,277
-------------------------------------------------------------------------
Total long-term debt
and operating leases $1,576 $3,223 $2,991 $25,487 $33,277
===========================================================
Commitments to extend credit 93,281
Standby letters of credit 5,381
---------------
Total contractual obligations
and commitments $131,939
===============
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 September 30, 2003, Redwood held $3,086,000 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 September 30, 2003, there was no outstanding balance
under this line of credit.
This page is page 30 of 44 pages.
Redwood's current cash dividend to its common shareholders is $.17 per
common share per quarter, as adjusted for the three-for-two stock split
announced July 16, 2003. 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 and quarterly payments of interest at the
rate of 6.35% for the first five years then at the three month LIBOR plus 3.1%
per annum on $10,000,000 of trust preferred financing issued in July 2003.
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 nine months of 2003, NBR declared a dividend payable
to Redwood of $3,300,000. Management believes that as of September 30, 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 nine months ended
September 30, 2003, the Company received cash of $6,550,000 from operating
activities, while using $14,577,000 in investing activities and $3,961,000 from
financing 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 31 of 44 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 September 30, 2003 and December 31,
2002.
September 30, 2003 December 31, 2002
------------------------------------- -------------------------------------
Well- Minimum Well- Minimum
Actual Capitalized Requirement Actual Capitalized Requirement
------------------------------------- -------------------------------------
Company
Leverage 6.58% 5.00% 4.00% 6.96% 5.00% 4.00%
Tier 1 risk-based 8.24 6.00 4.00 9.18 6.00 4.00
Total risk-based 12.28 10.00 8.00 10.72 10.00 8.00
NBR
Leverage 8.01% 5.00% 4.00% 7.35% 5.00% 4.00%
Tier 1 risk-based 10.03 6.00 4.00 9.68 6.00 4.00
Total risk-based 11.29 10.00 8.00 10.94 10.00 8.00
The Company has announced authorizations to repurchase up to 533,250 of
common shares. To date, 525,900 shares have been repurchased. In the quarter
ended September 30, 2003, the Company purchased 170,395 shares under the program
at an average price per share of $25.76. For the nine months ended September 30,
2003, the Company has purchased 239,946 shares under the program at an average
price per share of $23.80. Under the repurchase program, the Company plans to
purchase shares from time to time on the open market and/or in privately
negotiated transactions. All share and average price per share numbers herein
have been adjusted for the three-for-two stock splits announced September 20,
2001 and July 16, 2003.
This page is page 32 of 44 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 RSTI 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 RSTI Capital Securities. Distributions on the
RSTI 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, 2003, the
outstanding principal balance of the RSTI Capital Securities was $10,000,000.
The junior subordinated debentures are subject to mandatory redemption,
in whole or in part, upon repayment of the RSTI 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 RSTI 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; 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 RSTI Capital Securities from time to time for a period not to exceed 10
consecutive semi-annual periods.
On July 22, 2003, Redwood Statutory Trust II ("RSTII"), a wholly owned
subsidiary of the Company, closed a financing of 10,000 Capital Securities with
a liquidation amount of $1,000 per security. The proceeds of the financing were
loaned to the Company in exchange for junior subordinated debentures with terms
similar to the RSTII Capital Securities. The sole assets of RSTII 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 RSTII under the RSTII Capital Securities. Distributions on the RSTII Capital
Securities, which are payable quarterly at the annual rate of 6.35% for the
first five years and then reset to the three month LIBOR plus 3.1% per annum,
will be included in interest expense in the consolidated financial statements.
While these securities can be considered Tier I capital under current regulatory
guidelines, as a result of certain limitations applicable, they currently
qualify as Tier II regulatory capital. As of September 30, 2003, the outstanding
principal balance of the RSTII Capital Securities was $10,000,000.
The junior subordinated debentures are subject to mandatory redemption,
in whole or in part, upon repayment of the RSTII 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 RSTII Capital
Securities are redeemable prior to the maturity date of July 22, 2033, at the
option of the Company; on or after July 22, 2008 at par; or upon occurrence of
specific events defined within the trust indenture. The Company has the option
to defer distributions on the RSTII Capital Securities from time to time for a
period not to exceed 10 consecutive semi-annual periods.
This page is page 33 of 44 pages.
The principal balance of the RSTI Capital Securities and the RSTII
Capital Securities constitutes the trust preferred securities in the Company's
financial statements.
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 34 of 44 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 September
30, 2003 (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,
2003, the Company's total Visa transactions within these certain high-risk
categories were 1.63% 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
September 30, 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 6.30% of tangible equity capital and the aggregate charge-backs for the
quarter were .26% of the interchange count and .29% 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 September 30, 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.
In 1996, Wal-Mart Stores, Inc. and several other retailers sued Visa
and Mastercard in cases now pending in federal court in New York, asserting that
Visa and Mastercard's rules regarding uniform acceptance of all Visa and
Mastercard credit and debit cards were an illegal tying arrangement. Prior to
trial, Visa and Mastercard agreed to settle these cases. The settlements
reportedly remain subject to court approval. Neither the Company nor NBR are a
party to these suits, and neither will be directly liable for these settlements.
However, Visa or Mastercard may seek to assess, or assert claims against, their
members to fund the settlements. The merchant credit card segment's net income
comprised approximately 19% of the Company's consolidated net income for the
three and nine months ended September 30, 2003. We cannot predict the effect
that the settlements or any direct claim asserted against members will have on
the competitive environment or our future earnings from merchant bankcard
operations.
This page is page 35 of 44 pages.
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, 2003, approximately 83% of the dollar value 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, 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, floods or wildfires, 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, the decline in the technology
sector in Northern California and the recent budgetary crisis and gubernatorial
recall and continuing fiscal difficulties in the California state government 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.
California Energy and Governmental Fiscal 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. In addition, economic conditions in California are subject to
uncertainties resulting from the California state government's recent budgetary
crisis and gubernatorial recall and continuing fiscal difficulties. These events
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.
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, contributed to the downturn in U.S. economic conditions experienced
recently, have resulted in increased uncertainty regarding the economic outlook
and could further adversely affect business and economic conditions in the U.S.
generally and in our principal markets. 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.
Deterioration in either the U.S. or the California economy could adversely
affect the Company's financial condition and results of operations.
This page is page 36 of 44 pages.
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, and (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.
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 as 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.
This page is page 37 of 44 pages.
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.
As of September 30, 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 NBR'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 NBR (or in its
wholly owned subsidiary), all of the Company's interest rate risk exposure lies
at the NBR level. As a result, all significant interest rate risk management
procedures are performed at the NBR level. Based upon the nature of its
operations, NBR is not subject to foreign currency exchange or commodity price
risk. NBR'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.
This page is page 38 of 44 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. NBR'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. NBR, 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. NBR 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.
NBR 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. NBR has adopted formal policies and practices to
monitor and manage interest rate risk exposure. As part of this effort, NBR
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 39 of 44 pages.
The following table sets forth, as of September 30, 2003, the
distribution of repricing opportunities for NBR'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 $5,000 $ --- $ --- $ --- $ --- $5,000
Investment securities and other 2,609 2,652 12,894 27,173 21,717 67,045
Mortgage loans held for sale 455 --- --- --- --- 455
Loans 85,004 33,700 38,700 153,482 101,039 411,925
-----------------------------------------------------------------------
Total interest-earning assets 93,068 36,352 51,594 180,655 122,756 484,425
-----------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing transaction accounts 152,487 --- --- --- --- 152,487
Time deposits 51,988 38,740 94,717 12,004 --- 197,449
Trust preferred securities --- --- --- --- 20,000 20,000
Short-term borrowings 4,199 --- --- --- --- 4,199
-----------------------------------------------------------------------
Total interest-bearing liabilities 208,674 38,740 94,717 12,004 20,000 374,135
-----------------------------------------------------------------------
Interest rate sensitivity gap ($115,606) ($2,388) ($43,123) $168,651 $102,756
===========================================================
Cumulative interest rate sensitivity gap (115,606) (117,994) (161,117) 7,534 110,290
Interest rate sensitivity gap ratio 0.45 0.94 0.54 15.05 6.14
Cumulative interest rate sensitivity
gap ratio 0.45 0.52 0.53 1.02 1.29
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 NBR's net
interest margin.
Management expects that, in a declining interest rate environment,
NBR's net interest margin would be expected to decline, and, in an increasing
interest rate environment, NBR's net interest margin would tend to increase. NBR
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
NBR will experience the described relationships to declining or increasing
interest rates.
This page is page 40 of 44 pages.
On a quarterly basis, NBR'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 NBR'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 NBR's equity. This theoretical market value
of NBR's equity is calculated by discounting cash flows associated with NBR's
assets and liabilities. The following is a summary of interest rate risk
exposure as of September 30, 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.
September 30, 2003
------------------
Change in Annual Change in
Change in Interest Rate Net Interest Income Market Value of Equity
----------------------- ------------------- ----------------------
+200 $396,000 ($14,347,000)
+100 $96,000 ($7,920,000)
-100 ($15,000) $5,740,000
-200 ($817,000) $12,627,000
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 September 30, 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-15(e) and 15d-15(e) 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
over financial reporting during the fiscal quarter to which this report
relates that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial
reporting.
This page is page 41 of 44 pages.
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits.
31.1 Certification of the Chief Executive Officer Under Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer Under Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer Under Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 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 July 9, 2003 reporting under Item 5
thereof, announcement of declaration of quarterly dividend.
2. Form 8-K filing dated July 21, 2003 reporting under Item 7 and
9 thereof, announcement of financial results for the second
quarter of 2003 and announcement of 3-for 2 stock split.
3. Form 8-K filing dated July 28, 2003 reporting under Item 5 thereof,
announcement of completion of trust preferred financing.
4. Form 8-K filing dated August 5, 2003, reporting under Item 5 thereof,
announcement of partial completion of stock repurchase program and
authorization of an additional 331,000 share repurchase program.
5. Form 8-K filing dated August 26, 2003, reporting under Item 5
thereof, announcement of senior executive officer resignation.
This page is page 42 of 44 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: 11/13/03 By: /s/ Kim C. McClaran
-------- -------------------------------------
Kim C. McClaran
Vice President and
Interim Chief Financial Officer
This page is page 43 of 44 pages.
Index of Exhibits
Exhibit Number
31.1 Certification of the Chief Executive Officer under Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer under Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer under Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer under Section 906 of the
Sarbanes-Oxley Act of 2002.
This page is page 44 of 44 pages.