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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2003
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to __________
Commission file number: 0-19231
REDWOOD EMPIRE BANCORP
(Exact Name of Registrant as Specified in Its Charter)
California 68-0166366
----------------------------------- -----------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
111 Santa Rosa Avenue, Santa Rosa, California 95404-4905
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (707) 573-4800
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par
value.
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes No X
The aggregate market value of the Registrant's common stock held by
non-affiliates on June 30, 2003 (based on the closing sale price of the Common
Stock) was $45,983,175.
As of March 8, 2004 there were 4,939,045 shares outstanding of the Registrant's
common stock.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated by reference in this
Form 10-K:
DOCUMENT FORM 10-K REFERENCE
Redwood's Definitive Proxy Statement Part III
For the 2004 Annual Meeting of Shareholders
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TABLE OF CONTENTS
Page
PART I
Forward-Looking Information............................................................................................. 4
Item 1. Business.............................................................................................. 5
Item 2. Properties........................................................................................... 22
Item 3. Legal Proceedings.................................................................................... 22
Item 4. Submission of Matters to a Vote of Security Holders.................................................. 22
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............................ 23
Item 6. Selected Financial Data.............................................................................. 24
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operation................................................................................. 25
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........................................... 51
Item 8. Financial Statements and Supplementary Data.......................................................... 55
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure........................................................................................... 92
Item 9A. Controls and Procedures.............................................................................. 92
PART III
Item 10. Directors and Executive Officers of the Registrant................................................... 92
Item 11. Executive Compensation................................................................................92
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters........93
Item 13. Certain Relationships and Related Transactions........................................................94
Item 14. Principal Accountant Fees and Services................................................................94
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................... 94
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PART I
Forward-Looking Information
This Annual Report on Form 10-K 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 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:
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 and foreign hostilities, as well as
actions taken or to be taken by the U.S. or other governments as a
result of further acts or threats of terrorism.
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 decline in the health of the Northern California economy, including
the decline in the technology sector and any negative effect of the
budgetary crisis and continuing fiscal difficulties of the State of
California.
o Certain operational risks involving data processing systems or fraud.
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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.
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. For additional
information concerning risks and uncertainties related to the Company and its
operations, please refer to "Certain Important Considerations for Investors" in
Item 1, "Management's Discussion and Analysis of Financial Condition and Results
of Operation" in Item 7 and other information in this Report.
Item 1. Business
Redwood Empire Bancorp ("Redwood," and with its subsidiaries, the
"Company") is a bank holding company headquartered in Santa Rosa, California,
and operating in Northern California with three wholly-owned subsidiaries,
National Bank of the Redwoods, a national bank ("NBR" or the "Bank"), Redwood
Statutory Trust I and Redwood Statutory Trust II, both Connecticut statutory
trusts. A previously owned subsidiary of the Company, Allied Bank, F.S.B., a
federal savings bank ("Allied"), merged with its sister subsidiary, NBR, in
March 1997.
(a) General Development of Business.
Redwood is a California corporation, headquartered in Santa Rosa,
California. One of its wholly-owned subsidiaries is NBR, a national bank which
was chartered in 1985. In addition, NBR has three wholly-owned California
chartered subsidiaries, Valley Mortgage Corporation, Allied Diversified Credit,
and Redwood Merchant Services, Inc., all of which are currently inactive.
Redwood was created by NBR in August 1988, in order to become a bank holding
company through the acquisition of all of NBR's outstanding shares. That
transaction was consummated in January 1989. Redwood acquired Allied in
September 1990, through a tax-free reorganization in which Redwood exchanged
shares of its stock for all of the outstanding shares of Allied. The acquisition
of Allied was accounted for as a pooling of interests for financial reporting
purposes.
On October 31, 1992, Lake Savings and Loan Association, a one-branch
California chartered savings and loan based in Lakeport, California ("Lake"),
was purchased for approximately $2,300,000 in cash, and merged into Allied. At
the time of its acquisition, Lake had total assets of approximately $41 million.
The acquisition was accounted for as a purchase.
On November 4, 1994, Codding Bank, a multiple-branch California
chartered bank based in Rohnert Park, California ("Codding"), with total assets
of approximately $42 million, was purchased for $7,028,000 in cash, including
merger related expenses, and merged into NBR.
On March 24, 1997, Allied was merged into NBR.
In September 1999, the Company divested its sub prime mortgage
brokerage and mortgage banking units, Valley Financial and Allied Diversified
Credit. The divestiture took the form of an
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asset sale and employee transfer to Valley Financial Funding, Inc., whose
shareholders included senior management of Valley Financial and Allied
Diversified Credit. The Company disclosed the operations of these units as well
as the after tax loss on disposition as discontinued operations. Accordingly,
historical financial information has been recast to present the operating
results of Valley Financial and Allied Diversified Credit as discontinued
operations.
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.
The subordinated debentures are considered Tier 1 capital (with certain
limitations applicable) under current regulatory guidelines. As of December 31,
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 Federal Reserve Board ("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; or on or after February 22, 2011 at a premium; or upon the
occurrence of specific events set forth in 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 January 15, 2002, NBR formed NBR Real Estate Investment Trust, a
Maryland Real Estate Investment Trust. The entity was formed to provide an
additional vehicle to raise capital and to better organize and market the
origination of real estate secured loans.
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,
are included in interest expense in the consolidated financial statements. While
the subordinated debentures can be considered Tier 1 capital under current
regulatory guidelines, as a result of certain limitations applicable, they
currently only qualify as Tier 2 regulatory capital. As of December 31, 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
6
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 set forth in 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.
Prior to 2003, RSTI was consolidated in the Company's financial
statements with the trust preferred securities issued by the trust reported in
liabilities as "trust preferred securities" and the subordinated debentures
eliminated in consolidation. Under new accounting guidance, FASB Interpretation
No. 46, as revised in December 2003, RSTI and RSTII are not consolidated with
the Company. Accordingly, the amounts previously reported as "trust preferred
securities" in liabilities have been recaptioned "subordinated debentures" and
continue to be presented in liabilities on the balance sheet. At December 31,
2003 and 2002, the amount of the subordinated debentures and trust preferred
securities were the same. The effect of no longer consolidating the trusts does
not change the amounts reported as the Company's assets, liabilities, equity or
interest expense.
Further, as a result of FASB's Interpretation No. 46, questions were
raised about whether trust preferred securities would still qualify for
treatment as Tier 1 capital. In July of 2003, the FRB instructed bank holding
companies to continue to include trust preferred securities in Tier 1 capital
for regulatory capital purposes, until notice is given to the contrary. At
December 31, 2003, due to certain limitations applicable under current
regulatory guidelines, the Company had outstanding $8,710,000 of trust preferred
securities associated with RSTI that was considered Tier 1 capital. The Company
does not expect the final rules, when implemented, will result in the immediate
elimination of these securities as Tier 1 capital. These securities comprised
25% of the Company's Tier 1 capital as of December 31, 2003. If it were
determined that these securities do not qualify as Tier 1 capital, the Company
would still meet the requirements for well-capitalized institutions as of
December 31, 2003.
(b) Financial Information About Industry Segments.
The Company operates in two principal industry segments: core community
banking and merchant card services. The Company's core community banking
industry segment includes commercial, commercial real estate, construction, and
permanent residential lending along with all depository activities. As of
December 31, 2003, the Company's merchant card services industry group provided
credit card settlement services for approximately 35,000 merchants located
throughout the United States. For additional information concerning financial
information about industry segments, please refer to "Management's Discussion
and Analysis of Financial Condition and Results of Operation" in Item 7, under
the caption "Business Segments".
(c) Narrative Description of Business.
The Company's business strategy involves two principal business
activities which are conducted through NBR: community banking and merchant card
services.
NBR provides its core community banking services through five retail
branches located in Sonoma County, California, one retail branch located in
Mendocino County, California, and one retail branch located in Lake County,
California. NBR generally extends commercial loans to professionals and
businesses with annual revenues of less than $20 million. These commercial loans
are primarily for working capital and asset acquisitions. NBR emphasizes the
origination of commercial real estate loans within its primary market area. Such
loans are either owner-occupied
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or investor owned and are usually supported by long-term leases. Properties
which secure loans within the Company's commercial real estate portfolio include
office buildings, retail centers and industrial buildings. NBR also originates
commercial and residential construction loans for its portfolio along with
permanent single family and multi-family residential loans. NBR's primary
targeted lending market area includes the California counties north of San
Francisco.
The primary sources of funds for NBR's commercial and residential
lending programs are local deposits, proceeds from loan sales, loan payments,
and other borrowings. NBR attracts deposits primarily from local businesses,
professionals and retail customers. NBR's primary deposit market areas include
the counties of Sonoma, Mendocino and Lake. Sonoma, Mendocino and Lake Counties
have benefited from the migration of population and businesses into the area, as
well as growth in established firms and industries. These counties have
generally exceeded the growth in population and economic activity of California
as a whole. NBR generally does not purchase deposits through deposit brokers and
had no brokered deposits at December 31, 2003. In addition to deposits, NBR may
obtain other borrowed funds through its membership in the Federal Home Loan Bank
of San Francisco (the "FHLB") and its retention of treasury, tax and loan funds
at the Federal Reserve Bank of San Francisco.
As of December 31, 2003, the Company provided VISA and Mastercard
credit card processing and settlement services for approximately 35,000
merchants located throughout the United States. In 2003, the Company's
processing volume exceeded $1.8 billion. The Company's merchant card services
customer base is made up of merchants located in its primary market area and
merchants who have been acquired by the Company through the use of independent
sales agents and independent sales organizations (individually an "ISO" and
collectively "ISOs").
The Company is regulated by various government agencies, with the
primary regulators being the FRB, the Office of the Comptroller of the Currency
(the "OCC") and the Federal Deposit Insurance Corporation (the "FDIC").
The Company and its subsidiaries had 159 full-time-equivalent employees
at December 31, 2003. Redwood's headquarters are located at 111 Santa Rosa
Avenue, Santa Rosa, California 95404-4905, and its telephone number is (707)
573-4800.
Regulation and Supervision
The Effect of Government Policy on Banking
The earnings and growth of the Company are affected not only by local
market area factors and general economic conditions, but also by government
monetary and fiscal policies. For example, the FRB influences the supply of
money through its open market operations in U.S. Government securities and
adjustments to the discount rates applicable to borrowings by depository
institutions and others. Such actions influence the growth of loans, investments
and deposits and also affect interest rates charged on loans and paid on
deposits. The nature and impact of future changes in such policies on the
business and earnings of the Company cannot be predicted. Additionally, state
and federal tax policies can impact banking organizations.
8
As a consequence of the extensive regulation of commercial banking
activities in the United States, the business of the Company is particularly
susceptible to being affected by the enactment of federal and state legislation
which may have the effect of increasing or decreasing the cost of doing
business, modifying permissible activities or enhancing the competitive position
of other financial institutions. Any change in applicable laws or regulations
may have a material adverse effect on the business and prospects of the Company.
Regulation and Supervision of Bank Holding Companies
The Company is a bank holding company subject to the Bank Holding
Company Act of 1956, as amended ("BHCA"). The Company reports to, registers
with, and is examined by the FRB. The FRB also has the authority to examine the
Company's subsidiaries.
The FRB has significant supervisory and regulatory authority over the
Company and its affiliates. The FRB requires the Company to maintain certain
levels of capital. See "Capital Standards." The FRB also has the authority to
take enforcement action against any bank holding company that commits any unsafe
or unsound practice, or violates certain laws, regulations or conditions imposed
in writing by the FRB. According to FRB policy, bank holding companies are
expected to act as a source of financial strength to subsidiary banks, and to
commit resources to support subsidiary banks. This support may be required at
times when a bank holding company may not be able to provide such support.
Under the BHCA, a company generally must obtain the prior approval of
the FRB before it exercises a controlling influence over a bank, or acquires
directly or indirectly, more than 5% of the voting shares or substantially all
of the assets of any bank or bank holding company. Thus, the Company is required
to obtain the prior approval of the FRB before it acquires, merges or
consolidates with any bank or bank holding company; any company seeking to
acquire, merge or consolidate with the Company also would be required to obtain
the prior approval of the FRB.
The Company is generally prohibited under the BHCA from acquiring
ownership or control of more than 5% of the voting shares of any company that is
not a bank or bank holding company and from engaging directly or indirectly in
activities other than banking, managing banks or providing services to
affiliates of the holding company. However, a bank holding company, with the
approval of the FRB, may engage in, or acquire the voting shares of companies
engaged in, activities that the FRB has determined to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto. A
bank holding company must demonstrate that the benefits to the public of the
proposed activity will outweigh the possible adverse effects associated with
such activity.
The Gramm-Leach-Bliley Act of 1999 (GLBA) eliminated many of the
restrictions placed on the activities of bank holding companies that become
financial holding companies. Among other things, GLBA repealed certain
Glass-Steagall Act restrictions on affiliations between banks and securities
firms, and amended the BHCA to permit bank holding companies that are financial
holding companies to engage in activities, and acquire companies engaged in
activities, that are: financial in nature (including insurance underwriting,
insurance company portfolio investment, financial advisory, securities
underwriting, dealing and market-making, and merchant banking activities);
incidental to financial activities; or complementary to financial activities if
the FRB
9
determines that they pose no substantial risk to the safety or soundness of
depository institutions or the financial system in general. The Company has not
become a financial holding company. GLBA also permits national banks, such as
NBR, to engage in activities considered financial in nature through a financial
subsidiary, subject to certain conditions and limitations and with the approval
of the OCC.
A bank holding company may acquire banks in states other than its home
state without regard to the permissibility of such acquisitions under state law,
but subject to any state requirement that the acquired bank has been organized
and operating for the minimum period of time and providing that the bank holding
company, prior to or following the proposed acquisition, controls no more than
10% of the total amount of deposits of insured depository institutions in the
United States and no more than 30% of such deposits in that state (or such
lesser or greater amount set by state law). Banks may also merge across state
lines, creating interstate branches. Furthermore, a bank may open new branches
in a state in which it does not already have banking operations, if the laws of
such state permit such de novo branching.
Under California law, (a) out-of-state banks that wish to establish a
California branch office to conduct core banking business must first acquire by
merger or purchase a California bank or industrial loan company which is not
less than five years old; (b) California state-chartered banks are empowered to
conduct various authorized branch-like activities on an agency basis through
affiliated and unaffiliated insured depository institutions in California and
other states; and (c) the California Commissioner of Financial Institutions is
authorized to approve an interstate acquisition or merger which would result in
a deposit concentration exceeding 30% if the Commissioner finds that the
transaction is consistent with public convenience and advantage. However, a
state bank chartered in a state other than California may not enter California
by purchasing a California branch office of a California bank or industrial loan
company without purchasing the entire entity or by establishing a de novo
California bank.
The FRB generally prohibits a bank holding company from declaring or
paying a cash dividend which would impose undue pressure on the capital of
subsidiary banks or would be funded only through borrowing or other arrangements
that might adversely affect a bank holding company's financial position. The
FRB's policy is that a bank holding company should not continue its existing
rate of cash dividends on its common stock unless its net income is sufficient
to fully fund each dividend and its prospective rate of earnings retention
appears consistent with its capital needs, asset quality and overall financial
condition. See the section entitled "Restrictions on Dividends and Other
Distributions" for information regarding additional restrictions on the ability
of the Company and NBR to pay dividends.
Transactions between the Company and NBR are subject to a number of
other restrictions. FRB policies forbid the payment by bank subsidiaries of
management fees which are unreasonable in amount or exceed the fair market value
of the services rendered (or, if no market exists, actual costs plus a
reasonable profit). Subject to certain limitations, depository institution
subsidiaries of bank holding companies may extend credit to, invest in the
securities of, purchase assets from, or issue a guarantee, acceptance, or letter
of credit on behalf of, an affiliate, provided that the aggregate of such
transactions with a single affiliate may not exceed 10% of the capital stock and
surplus of the institution, and the aggregate of such transactions with all
affiliates may not exceed 20% of the capital stock and surplus of such
institution. The Company may only borrow from depository institution
subsidiaries if the loan is secured by marketable obligations with a value of a
designated
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amount in excess of the loan. Further, the Company may not sell a low-quality
asset to a depository institution subsidiary.
Bank Regulation and Supervision
As a national bank, NBR is regulated, supervised and regularly examined
by the OCC. Deposit accounts at NBR are insured by the Bank Insurance Fund
("BIF") and the Savings Institution Insurance Fund ("SAIF"), as administered by
the FDIC, to the maximum amount permitted by law. The Bank is also subject to
applicable provisions of California law, insofar as such provisions are not in
conflict with or preempted by federal banking law. The Bank is a member of the
Federal Reserve System, and is also subject to certain regulations of the FRB
dealing primarily with check clearing activities, establishment of banking
reserves, Truth-in-Lending (Regulation Z), Truth-in-Savings (Regulation DD), and
Equal Credit Opportunity (Regulation B).
The OCC may approve, on a case-by-case basis, the entry of bank
operating subsidiaries into a business incidental to banking, including
activities in which the parent bank is not permitted to engage. A national bank
is permitted to engage in activities approved for a bank holding company through
a bank operating subsidiary, such as acting as an investment or financial
advisor, leasing personal property and providing financial advice to customers.
In general, these activities are permitted only for well-capitalized or
adequately capitalized national banks.
The USA Patriot Act
Title III of the United and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 ("USA
Patriot Act") includes numerous provisions for fighting international money
laundering and blocking terrorist access to the U.S. financial system. The
provisions of Title III of the USA Patriot Act which affect banking
organizations, including NBR, relate principally to U.S. banking organizations'
relationships with foreign banks and with persons who are resident outside the
United States. The USA Patriot Act does not immediately impose any new filing or
reporting obligations for banking organizations, but does require certain
additional due diligence and record keeping practices.
Part of the USA Patriot Act is the International Money Laundering
Abatement and Financial Anti-Terrorism Act of 2001 (IMLAFATA). Among its
provisions, IMLAFATA requires each financial institution to: (i) establish an
anti-money laundering program; (ii) establish due diligence policies, procedures
and controls with respect to its private banking accounts and correspondent
banking accounts involving foreign individuals and certain foreign banks; and
(iii) avoid establishing, maintaining, administering, or managing correspondent
accounts in the United States for, or on behalf of, a foreign bank that does not
have a physical presence in any country. In addition, IMLAFATA contains a
provision encouraging cooperation among financial institutions, regulatory
authorities and law enforcement authorities with respect to individuals,
entities and organizations engaged in, or reasonably suspected of engaging in,
terrorist acts or money laundering activities. IMLAFATA expands the
circumstances under which funds in a bank account may be forfeited and requires
covered financial institutions to respond under certain circumstances to
requests for information from federal banking agencies within 120 hours.
IMLAFATA also amends the BHCA and the Bank Merger Act to require the federal
banking agencies to consider the effectiveness of a financial institution's
anti-money laundering activities when reviewing an application under these acts.
11
Pursuant to IMLAFATA, the Secretary of the Treasury, in consultation
with the heads of other government agencies, has adopted and proposed special
measures applicable to banks, bank holding companies, and/or other financial
institutions. These measures include enhanced record keeping and reporting
requirements for certain financial transactions that are of primary money
laundering concern, due diligence requirements concerning the beneficial
ownership of certain types of accounts, and restrictions or prohibitions on
certain types of accounts with foreign financial institutions.
Privacy Restrictions
The GLBA, in addition to the previously described changes in
permissible non-banking activities permitted to banks, bank holding companies
and financial holding companies, also required the federal banking agencies,
among others federal regulatory agencies, to adopt regulations governing the
privacy of consumer financial information. The OCC adopted such regulations with
an effective date of November 13, 2000, and a date of full compliance with the
regulations of July 1, 2001. The Bank is subject to the OCC's regulations.
The regulations impose three main requirements established by the GLBA.
First, a banking organization must provide initial notices to customers about
their privacy policies, describing the conditions under which they may disclose
nonpublic personal information to nonaffiliated third parties and affiliates.
Second, banking organizations must provide annual notices of their privacy
policies to their customers. Third, banking organizations must provide a
reasonable method for customers to "opt-out" of disclosures to nonaffiliated
third parties.
In connection with the regulations governing the privacy of consumer
financial information, the federal banking agencies, including the OCC, adopted
guidelines for safeguarding confidential customer information, effective on July
1, 2001. The guidelines require banking organizations to establish an
information security program to: (1) identify and assess the risks that may
threaten customer information; (2) develop a written plan containing policies
and procedures to manage and control these risks; (3) implement and test the
plan; and (4) adjust the plan on a continuing basis to account for changes in
technology, the sensitivity of customer information, and internal or external
threats. The guidelines also outline the responsibilities of directors of
banking organizations in overseeing the protection of customer information.
The Company believes that it complies with all provisions of the GLBA
and all implementing regulations, and NBR has developed appropriate policies and
procedures designed to meet its responsibilities in connection with the privacy
provisions of GLBA.
Capital Standards
The federal banking agencies have risk-based capital adequacy
guidelines intended to provide a measure of capital adequacy that reflects the
degree of risk associated with a banking organization's operations for both
transactions reported on the balance sheet as assets and transactions, such as
letters of credit and recourse arrangements, which are recorded as off balance
sheet items. Under these guidelines, nominal dollar amounts of assets and credit
equivalent amounts of off balance sheet items are multiplied by one of several
risk adjustment percentages,
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which range from 0% for assets with low credit risk, such as certain U.S.
government securities, to 100% for assets with relatively higher credit risk,
such as certain loans.
In determining the capital level the Company and NBR are required to
maintain, the federal banking agencies do not, in all respects, follow
accounting principles generally accepted in the United States of America
("GAAP") and have special rules which have the effect of reducing the amount of
capital they will recognize for purposes of determining the capital adequacy of
NBR.
A banking organization's risk-based capital ratios are obtained by
dividing its qualifying capital by its total risk-adjusted assets and off
balance sheet items. The regulators measure risk-adjusted assets and off balance
sheet items against both total qualifying capital (the sum of Tier 1 capital and
limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists
of common stock, retained earnings, noncumulative perpetual preferred stock,
subordinated debentures (for up to 25% of total Tier 1 capital), other types of
qualifying preferred stock and minority interests in certain subsidiaries, less
most other intangible assets and other adjustments. Net unrealized losses on
available-for-sale equity securities with readily determinable fair value must
be deducted in determining Tier 1 capital. For Tier 1 capital purposes, deferred
tax assets that can only be realized if an institution earns sufficient taxable
income in the future are limited to the amount that the institution is expected
to realize within one year, or 10% of Tier 1 capital, whichever is less. Tier 2
capital may consist of a limited amount of the allowance for possible loan and
lease losses, term preferred stock and other types of preferred stock and
subordinated debentures not qualifying as Tier 1 capital, term subordinated debt
and certain other instruments with some characteristics of equity. The inclusion
of elements of Tier 2 capital are subject to certain other requirements and
limitations of the federal banking agencies. The federal banking agencies
require a minimum ratio of qualifying total capital to risk-adjusted assets and
off-balance-sheet items of 8%, and a minimum ratio of Tier 1 capital to adjusted
average risk-adjusted assets and off balance sheet items of 4%.
Under OCC regulations, there are also two rules governing minimum
capital levels that OCC-supervised banks, such as NBR, must maintain against the
risks to which they are exposed. The first rule makes risk-based capital
standards consistent for two types of credit enhancements (i.e., recourse
arrangements and direct credit substitutes) and requires different amounts of
capital for different risk positions in asset securitization transactions. The
second rule permits limited amounts of unrealized gains on debt and equity
securities to be recognized for risk-based capital purposes as of September 1,
1998. The OCC rules also provide that a qualifying institution that sells small
business loans and leases with recourse must hold capital only against the
amount of recourse retained. In general, a qualifying institution is one that is
well-capitalized under the OCC's prompt corrective action rules. The amount of
recourse that can receive the preferential capital treatment cannot exceed 15%
of the institution's total risk-based capital.
Effective January 1, 2002, the federal banking agencies, including the
OCC, adopted new regulations to change their regulatory capital standards to
address the treatment of recourse obligations, residual interests and direct
credit substitutes in asset securitizations that expose banks primarily to
credit risk. Capital requirements for positions in securitization transactions
are varied according to their relative risk exposures, while limited use is
permitted of credit ratings from rating agencies, a banking organization's
qualifying internal risk rating system or qualifying software. The regulation
requires a bank to deduct from Tier 1 capital, and from assets, all
credit-enhancing interest-only strips, whether retained or purchased, that
exceed 25% of Tier 1 capital. Additionally, a bank must maintain
dollar-for-dollar risk-based capital for any remaining credit-enhancing
13
interest-only strips and any residual interests that do not qualify for a
ratings-based approach. The regulation specifically reserves the right to modify
any risk-weight, credit conversion factor or credit equivalent amount, on a
case-by-case basis, to take into account any novel transactions that do not fit
well into the currently defined categories.
In addition to the risked-based guidelines, the federal banking
agencies require banking organizations to maintain a minimum amount of Tier 1
capital to adjusted average total assets, referred to as the leverage capital
ratio. For a banking organization rated in the highest of the five categories
used to rate banking organizations, the minimum leverage ratio of Tier 1 capital
to total assets must be 3%. It is improbable, however, that an institution with
a 3% leverage ratio would receive the highest rating since a strong capital
position is a significant part of the regulators' rating. Bank holding companies
not rated in the highest category must have a minimum leverage ratio of 4%. For
all banks not rated in the highest category, the minimum leverage ratio must be
at least 100 to 200 basis points above the 3% minimum. Thus, the effective
minimum leverage ratio, for all practical purposes, must be at least 4% or 5%
for banks. In addition to these uniform risk-based capital guidelines and
leverage ratios that apply across the industry, the regulators have the
discretion to set individual minimum capital requirements for specific
institutions at rates significantly above the minimum guidelines and ratios.
As of December 31, 2003, NBR's capital ratios exceeded applicable
regulatory requirements. The following tables present the capital ratios for the
Company and NBR, compared to the standards for "well-capitalized" bank holding
companies and depository institutions, as of December 31, 2003 (amounts in
thousands except percentage amounts).
The Company
---------------------------------------------------------------------
Actual Well Minimum
------------------------ Capitalized Capital
Capital Ratio Ratio Requirement
------- ----- ----- -----------
Leverage..................................... $33,449 6.47% 5.00% 4.00%
Tier 1 Risk-Based............................ 33,449 7.93 6.00 4.00
Total Risk-Based............................. 50,383 11.94 10.00 8.00
The Bank
---------------------------------------------------------------------
Actual Well Minimum
------------------------ Capitalized Capital
Capital Ratio Ratio Requirement
------- ----- ----- -----------
Leverage..................................... $39,013 7.59% 5.00% 4.00%
Tier 1 Risk-Based............................ 39,013 9.29 6.00 4.00
Total Risk-Based............................. 44,286 10.55 10.00 8.00
The federal banking agencies must take into consideration
concentrations of credit risk and risks from non-traditional activities, as well
as an institution's ability to manage those risks, when determining the adequacy
of an institution's capital. This evaluation will be made as a part of the
institution's regular safety and soundness examination. The federal banking
agencies must also consider interest rate risk (when the interest rate
sensitivity of an institution's assets does not match the sensitivity of its
liabilities or its off-balance-sheet position) in evaluation of a bank's capital
adequacy.
14
Prompt Corrective Action and Other Enforcement Mechanisms
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") requires each federal banking agency to take prompt corrective action
to resolve the problems of insured depository institutions, including but not
limited to those that fall below one or more prescribed minimum capital ratios.
The law required each federal banking agency to promulgate regulations defining
the following five categories in which an insured depository institution will be
placed, based on the level of its capital ratios: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized.
Under the prompt corrective action provisions of FDICIA, an insured
depository institution generally will be classified in the following categories
based on the capital measures indicated below:
"Well capitalized" "Adequately capitalized"
------------------ ------------------------
Total risk-based capital of 10%; Total risk-based capital of 8%;
Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and
Leverage ratio of 5%. Leverage ratio of 4%.
"Undercapitalized" "Significantly undercapitalized"
------------------ --------------------------------
Total risk-based capital less than 8%; Total risk-based capital less than 6%;
Tier 1 risk-based capital less than Tier 1 risk-based capital less than 3%;
4%; or or
Leverage ratio less than 4%. Leverage ratio less than 3%.
"Critically undercapitalized"
-----------------------------
Tangible equity to total assets equal
to or less than 2%.
An institution that, based upon its capital levels, is classified as
"well capitalized," "adequately capitalized" or "undercapitalized" may be
treated as though it were in the next lower capital category if the appropriate
federal banking agency, after notice and opportunity for hearing, determines
that an unsafe or unsound condition or an unsafe or unsound practice warrants
such treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions.
In addition to measures taken under the prompt corrective action
provisions, commercial banking organizations may be subject to potential
enforcement actions by the federal banking agencies for unsafe or unsound
practices in conducting their businesses or for violations of any law, rule,
regulation or any condition imposed in writing by the agency or any written
agreement with the agency. Enforcement actions may include the imposition of a
conservator or receiver, the issuance of a cease-and-desist order that can be
judicially enforced, the termination of insurance of deposits (in the case of a
depository institution), the imposition of civil money penalties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the issuance of removal and prohibition orders against
institution-affiliated parties and the enforcement of such actions through
injunctions or restraining orders based upon a judicial determination that the
agency would be harmed if such equitable relief was not granted. Additionally, a
holding company's
15
inability to serve as a source of strength to its subsidiary banking
organizations could serve as an additional basis for a regulatory action against
the holding company.
Safety and Soundness Standards
FDICIA also implemented certain specific restrictions on transactions
and required federal banking regulators to adopt overall safety and soundness
standards for depository institutions related to internal control, loan
underwriting and documentation and asset growth. Among other things, FDICIA
limits the interest rates paid on deposits by undercapitalized institutions,
restricts the use of brokered deposits, limits the aggregate extensions of
credit by a depository institution to an executive officer, director, principal
shareholder or related interest, and reduces deposit insurance coverage for
deposits offered by undercapitalized institutions for deposits by certain
employee benefits accounts.
The federal banking agencies may require an institution to submit to an
acceptable compliance plan as well as have the flexibility to pursue other more
appropriate or effective courses of action given the specific circumstances and
severity of an institution's noncompliance with one or more standards.
Restrictions on Dividends and Other Distributions
The power of the board of directors of an insured depository
institution to declare a cash dividend or other distribution with respect to
capital is subject to statutory and regulatory restrictions which limit the
amount available for such distribution depending upon the earnings, financial
condition and cash needs of the institution, as well as general business
conditions. FDICIA prohibits insured depository institutions from paying
management fees to any controlling persons or, with certain limited exceptions,
making capital distributions, including dividends, if, after such transaction,
the institution would be undercapitalized.
The payment of dividends by a national bank is further restricted by
additional provisions of federal law, which prohibit a national bank from
declaring a dividend on its shares of common stock unless its surplus fund
exceeds the amount of its common capital (total outstanding common shares times
the par value per share). Additionally, if losses have at any time been
sustained equal to or exceeding a bank's undivided profits then on hand, no
dividend may be paid. Moreover, even if a bank's surplus exceeded its common
capital and its undivided profits exceed its losses, the approval of the 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. A national bank must consider other business factors in
determining the payment of dividends. The payment of dividends by NBR is
governed by NBR's ability to maintain minimum required capital levels and an
adequate allowance for loan losses.
Regulators also have authority to prohibit a depository institution
from engaging in business practices which are considered to be unsafe or
unsound, possibly including payment of dividends or other payments under certain
circumstances even if such payments are not expressly prohibited by statute.
16
In February 2004, NBR received approval from the OCC for its 2004
dividend plan. In 2003, 2002 and 2001, NBR declared dividends payable to Redwood
of $6,700,000, $6,600,000 and $5,900,000.
Premiums for Deposit Insurance and Assessments for Examinations
FDICIA established several mechanisms to increase funds to protect
deposits insured by the BIF and SAIF administered by the FDIC. The FDIC is
authorized to borrow up to $30 billion from the United States Treasury; up to
90% of the fair market value of assets of institutions acquired by the FDIC as
receiver from the Federal Financing Bank; and from depository institutions that
are members of the BIF and SAIF. Any borrowings not repaid by asset sales are to
be repaid through insurance premiums assessed to member institutions. Such
premiums must be sufficient to repay any borrowed funds within 15 years and
provide insurance fund reserves of $1.25 for each $100 of insured deposits.
FDICIA also provides authority for special assessments against insured deposits.
No assurance can be given at this time as to what the future level of premiums
will be.
Community Reinvestment Act and Fair Lending
The Bank is subject to certain fair lending requirements and reporting
obligations involving home mortgage lending operations and Community
Reinvestment Act ("CRA") activities. The CRA generally requires the federal
banking agencies to evaluate the record of a financial institution in meeting
the credit needs of its local communities, including low and moderate income
neighborhoods. In addition to substantive penalties and corrective measures that
may be required for a violation of certain fair lending laws, the federal
banking agencies may take compliance with such laws and CRA into account when
regulating and supervising other activities.
Corporate Governance Reforms
On July 30, 2002, President Bush signed into law The Sarbanes-Oxley Act
of 2002. This legislation addresses accounting oversight and corporate
governance matters, including:
o the creation of a five-member oversight board with investigative and
disciplinary powers to set standards for accountants;
o the prohibition of accounting firms from providing various types of
consulting services to public clients and requiring accounting firms
to rotate partners among public client assignments every five years;
o increased penalties for financial crimes;
o expanded disclosure of corporate operations and internal controls and
certification of financial statements;
o enhanced controls on, and reporting of, insider trading; and
o prohibition on lending to officers and directors of public companies,
although NBR may still make these loans within the constraints of
existing banking regulators.
The Nasdaq National Market has enacted additional corporate governance
rules that have been approved by the Securities and Exchange Commission. These
rules are intended to allow shareholders to more easily and effectively monitor
the performance of companies and directors.
17
The Company has implemented procedures designed to comply with these new
corporate governance rules. The Company continues to evaluate what impact this
law, its implementing regulations and the amended Nasdaq rules will have upon
our operations, including a likely increase in certain outside professional
costs.
Pending Legislation and Regulations and Accounting Guidance
Additional proposals to change the laws and regulations governing the
banking and financial services industry are frequently introduced in Congress,
in the state legislatures and before the various bank regulatory agencies.
Accounting standards and interpretations currently affecting the Company and its
subsidiaries may also change at any time. The likelihood and timing of any such
changes and the impact such changes might have on the Company and its financial
condition and results of operations cannot be determined at this time.
Competition
In the past, an independent bank's principal competitors for deposits
and loans have been other banks (particularly major banks), savings and loan
associations and credit unions. To a lesser extent, competition was also
provided by thrift and loans, mortgage brokerage companies and insurance
companies. Other institutions, such as brokerage houses, mutual fund companies,
credit card companies, and even retail establishments have offered new
investment vehicles, which also compete with banks for deposit business. The
direction of federal legislation in recent years, especially the GLBA, favors
competition among different types of financial institutions. Using the financial
holding company structure, insurance companies and securities firms may compete
more directly with banks and bank holding companies.
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. Chargeback 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 growing proprietary accounts.
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
18
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 of
..1%. At December 31, 2003 the Company's overall fraud ratio was .2% compared to
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 December 31, 2003, the Company's total
VISA transactions within these certain high-risk categories were 3.3% 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 the aggregate charge-backs for the quarter be less than .59% of the
interchange count and .95% of the interchange amount. At December 31, 2003, the
Company's weekly VISA volume was 47.5% of the Company's tangible equity capital
and aggregate charge-backs for the previous six months were 3.31% of tangible
equity capita,l and the aggregate charge-backs for the quarter were .18% of the
interchange count and .24% 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 December 31, 2003, the Company is in compliance
with all rule changes that went into effect on March 31, 2001, based on VISA's
acceptance of the Company's compliance plan. Should the Company be unable to
comply with these rules, VISA will require collateral of one to four times the
short fall.
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. On January 23, 2004,
the Federal District Court for the Eastern District of New York approved this
settlement, which became effective January 1, 2004. 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
segments' net income comprised approximately 20% of the Company's consolidated
net income at December 31, 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.
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 December
31, 2003, approximately 84% of the Company's loans were secured by real estate,
of which 54% 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 within Northern and Central
California. The ability of the Company to continue to originate mortgage,
construction and other loans may be impaired by adverse changes in local or
regional economic conditions, adverse changes in the real estate market,
increasing interest rates, or acts of nature (including earthquakes or floods,
which may cause uninsured damage and other loss of value to real estate that
secures the Company's loans). 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.
19
California Economic Conditions and Governmental Fiscal Crisis. A
substantial majority of our assets, deposits and fee income are generated in
California. As a result, poor economic conditions in California may cause us to
incur losses associated with higher default rates and decreased collateral
values in our loan portfolio. Economic conditions in California are subject to
various uncertainties at this time, including the decline in the technology
sector, and the California state government's budgetary crisis and continuing
fiscal difficulties. If economic conditions in California decline, we expect
that our level of problem assets could increase. California's state government
has undergone serious fiscal and budget crises in the recent past. The State of
California is also a customer of the Company and NBR. While the California
electorate on March 2, 2004, approved various ballot measures aimed at
addressing this situation, including a $15 billion bond issue, the long-term
impact of this situation on the California economy and the Company's markets
cannot be predicted. 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; Foreign Hostilities. Acts or threats of terrorism and
actions taken by the U.S. or other governments as a result of such acts or
threats, may result in a downturn in U.S. economic conditions and could
adversely affect business and economic conditions in the U.S. generally and in
our principal markets. The recent war in Iraq has also generated various
political and economic uncertainties affecting the global and U.S. economies.
Deterioration in either the U.S. or the California economy could adversely
affect the Company's financial condition and results of operations.
Government Regulation. Redwood and its subsidiaries are subject to
extensive federal and state governmental supervision, regulation and control,
and 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, WorldCom, Inc. and other major U.S. corporate bankruptcies and
reports of accounting irregularities at public companies, including various
large and publicly traded 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 by 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.
20
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 NBR conducts operations. Among the advantages possessed by the larger of
these institutions are their ability to make larger loans, finance extensive
advertising campaigns, access international money markets and generally allocate
their investment assets to regions of highest yield and demand. In addition,
such large financial institutions may have greater access to capital at a lower
cost than NBR, which may adversely affect NBR's ability to compete effectively.
In addition, the market in which the Company competes for merchant
credit card processing is intensely competitive and, in recent years, has been
characterized by increased consolidation. This consolidation has enabled certain
of the Company's competitors to have access to significant capital, management,
marketing and technological resources that are equal to or greater than those of
the Company, and there can be no assurance that the Company will be able to
continue to compete successfully with such other processors.
Critical Accounting Policies. The Company's financial statements are
presented in accordance with accounting principles generally accepted in the
United States of America (US GAAP). The financial information contained within
our financial statements is, to a significant extent, financial information that
is based on approximate measures of the financial effects of transactions and
events that have already occurred. A variety of factors could affect the
ultimate value that is obtained either when earning income, recognizing an
expense, recovering an asset or relieving a liability.
The Company's accounting policies are fundamental to understanding
management's discussion and analysis of financial condition and results of
operations. The most significant accounting policies followed by the Company are
presented in Note B to the Consolidated Financial Statements. The Company has
identified its policy on the allowance for loan losses to be critical because
management has to make subjective and/or complex judgments about matters that
are inherently uncertain and could be subject to revision as new information
becomes available. 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 loses could differ significantly from the historical loss factors that we
use. The loan portfolio represents the largest asset type on the Consolidated
Statement of Condition. Note B to the Consolidated Financial Statements
describes the methodology used to determine the allowance for loan losses and a
discussion of the factors driving changes in the amount of the allowance for
loan losses is included in this "Management's Discussion and Analysis of
Financial Condition and Results of Operation" in Item 7.
21
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 December 31, 2003, other than NBR Real Estate Investment Trust
and the REMIC (discussed elsewhere in this Report), we have not created any
special purpose entities to securitize assets or to obtain off-balance sheet
funding. Although we have sold a number of loans in the past two years, those
loans have been sold to third parties without recourse, subject to customary
representations and warranties. For more information regarding contractual
obligations and commitments, please see "Mortgage Repurchase Commitments",
"Investment in REMIC" and "Contractual Obligations and Commitments" in
"Management's Discussion and Analysis of Financial Condition and Results of
Operation" in Item 7.
Item 2. Properties
The Company owns one depository branch and leases seven other locations
used in the normal course of business. In addition, the Company leases certain
equipment. There are no contingent rental payments and the Company has three
sublease arrangements. Total rental expenses under all leases, including
premises, totaled $1,317,000, $1,326,000 and $1,282,000, in 2003, 2002 and 2001.
The expiration dates of the leases vary, with the first such lease expiring
during 2004 and the last such lease expiring during 2014. The lease expiring
during 2004 is currently in the process of being renegotiated and is expected to
be extended for an additional term. The Company maintains insurance coverage on
its premises, leaseholds and equipment, including business interruption and
record reconstruction coverage.
Item 3. Legal Proceedings
Certain lawsuits and claims arising in the ordinary course of business
have been filed or are pending against the Company or its subsidiaries. Based
upon information available to the Company, its review of such lawsuits and
claims and consultation with its counsel, the Company believes the liability
relating to these actions, if any, would not have a material adverse effect on
the Company's financial condition and results of operations.
Item 4. Submission of Matters to a Vote of Securities Holders
No matters were submitted to a vote of the Company's shareholders
during the fourth quarter of 2003.
22
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company's Common Stock is publicly traded on the NASDAQ National
Market under the symbol "REBC". On September 20, 2001 and July 15, 2003, the
Company announced three-for-two stock splits of its outstanding shares of common
stock. All common stock prices and dividends per share have been restated for
the stock splits. As of December 31, 2003, the Company believes, based upon
information it has obtained from its transfer agent, there are 1,099
shareholders of record of its Common Stock.
There are regulatory limitations on cash dividends that may be paid by
the Company as well as regulatory limitations on cash dividends that may be paid
by NBR to Redwood which could limit the Company's ability to pay dividends.
Federal regulatory agencies also have the authority to prohibit the payment of
dividends by NBR if a finding is made that such payment would constitute an
unsafe or unsound practice, or if NBR became critically undercapitalized. See
"Liquidity" in Item 7, "Regulation and Supervision" in Item 1 and Note N to the
Company's Consolidated Financial Statements in this Report.
Redwood Empire Bancorp
Common Stock Prices
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4
2002 2002 2002 2002 2003 2003 2003 2003
----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------
High $19.20 $21.83 $18.67 $19.55 $20.50 $20.71 $24.95 $26.50
Low 16.27 17.44 16.80 17.17 17.67 18.50 19.01 23.50
Close 18.83 18.27 18.00 17.73 20.50 19.01 24.48 26.12
Dividends
Declared per share $.133 $.133 $.133 $.133 $.167 $.167 $.167 $.170
The Company currently expects that it will continue to pay comparable
cash dividends, however, future dividends are subject to approval by our Board
of Directors and will depend upon a number of factors, including future
earnings, financial condition, regulatory restrictions, cash needs and general
business conditions.
23
Item 6. Selected Financial Data
Summary of Consolidated Financial Data and Performance Ratios
At or for the Year ended December 31,
2003 2002 2001 2000 1999 (2)
(dollars in thousands, except per share data)
Statements of Operations:
Total interest income $30,134 $30,536 $33,555 $35,163 $30,633
Net interest income 22,766 20,866 20,104 20,844 19,687
Provision for loan losses --- --- --- 150 750
Noninterest income 6,833 7,615 6,599 6,106 5,197
Income from continuing operations 7,649 7,961 7,307 6,466 4,599
Loss from discontinued operations --- --- --- --- (437)
Net income 7,649 7,961 7,307 6,466 4,162
Net income available to common stock shareholders 7,649 7,961 7,307 6,466 4,162
Balance Sheets:
Total assets $528,900 $513,181 $448,742 $453,439 $423,046
Total loans 414,521 365,076 351,649 315,101 314,445
Allowance for loan losses 7,162 7,400 7,580 7,674 7,931
Total deposits 454,782 453,093 397,412 405,333 369,509
Shareholders' equity 27,680 28,807 26,687 35,459 37,444
Performance and Financial Ratios:
Return on average assets from continuing operations 1.48% 1.62% 1.63% 1.47% 1.13%
Return on average common equity from continuing operations 27.25% 28.98% 26.41% 17.75% 11.70%
Common dividend payout ratio 44.34% 35.08% 18.09% 25.29% 19.51%
Average equity to average assets from continuing operations 5.43% 5.58% 6.17% 8.30% 9.66%
Leverage ratio 6.47% 6.59% 7.46% 7.72% 8.66%
Tier 1 risk-based capital ratio 7.93% 8.69% 9.52% 9.99% 11.74%
Total risk-based capital ratio 11.94% 10.36% 11.16% 11.25% 13.01%
Net interest margin from continuing operations 4.66% 4.49% 4.78% 5.08% 5.30%
Noninterest expense from continuing operations to net
interest income and other noninterest income from
continuing operations 55.41% 56.20% 54.12% 59.18% 66.07%
Average earning assets to average total assets from
continuing operations 94.44% 94.34% 93.72% 93.50% 91.20%
Nonperforming assets to total assets 0.24% 0.54% 0.71% 0.43% 1.52%
Net loan charge-offs to average loans 0.06% 0.05% 0.03% 0.12% 0.29%
Allowance for loan losses to total loans 1.73% 2.03% 2.16% 2.44% 2.52%
Allowance for loan losses to nonperforming loans 565.72% 264.85% 238.66% 637.91% 194.34%
Share Data (1):
Common shares outstanding (000) 4,951 5,108 5,295 6,431 7,266
Book value per common share $5.59 $5.64 $5.04 $5.51 $5.15
Basic earnings per common share:
Income from continuing operations 1.52 1.53 1.32 .94 .61
Loss from discontinued operations --- --- --- --- (.06)
Net income available for common stock shareholders 1.52 1.53 1.32 .94 .55
Weighted average shares outstanding (000) 5,026 5,211 5,555 6,866 7,569
Diluted earnings per common share:
Income from continuing operations 1.48 1.47 1.27 .92 .59
Loss from discontinued operations --- --- --- --- (.06)
Net income available for common stock shareholders 1.48 1.47 1.27 .92 .54
Weighted average shares outstanding (000) 5,184 5,400 5,738 6,996 7,776
Cash dividends per common share $.67 $.53 $.25 $.25 $.11
(1) Restated for 2001 and 2003 3-for-2 stock splits.
(2) Amounts previously reported as an extraordinary loss for the year ended
December 31, 1999 have been reclassified to other expense in order to
comply with FASB Statement No. 145. The related ratios and per share
data have been restated to give effect to this reclassification.
24
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation
Overview
Forward-Looking Information
This Annual Report on Form 10-K 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 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:
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 and foreign hostilities, as well as
actions taken or to be taken by the U.S. or other governments as a
result of further acts or threats of terrorism.
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.
25
o A decline in the health of the Northern California economy, including
the decline in the technology sector and any negative effect of the
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.
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. For additional
information concerning risks and uncertainties related to the Company and its
operations, please refer to "Certain Important Considerations for Investors" in
Item 1 and other information in this Report.
Executive Summary
The Company derives its income from two principal sources: (1) net
interest income, which is the difference between the interest income it receives
on interest-earning assets and the interest expense it pays on interest-bearing
liabilities; and (2) non interest income or fee income, which includes fees
earned on deposit services, fees earned from servicing loans for investors, fees
from processing services, electronic-based cash management services and merchant
credit card processing.
The following analysis of the Company's financial condition and results
of operations should be read in conjunction with the Consolidated Financial
Statements of Redwood Empire Bancorp and related notes thereto included in this
Report. Average balances, including such balances used in calculating financial
and performance ratios, are generally daily averages for NBR, which management
believes are representative of the operations of the Company.
In 2003, the Company reported net income of $7,649,000, or $1.48
diluted per share, as compared to 2002 and 2001 net income of $7,961,000, or
$1.47 diluted per share, and $7,307,000, or $1.27 diluted per share.
Return on average assets for the year ended December 31, 2003 was 1.48%
as compared to 1.62% and 1.63% for the years ended December 31, 2002 and 2001.
Return on average common equity was 27.25% for the year ended December 31, 2003,
as compared to 28.98% and 26.41% for the years ended December 31, 2002 and 2001.
The Company's results in 2003 decreased from 2002. During the fourth
quarter of 2003, the Company charged $767,000 to income tax expense related to
the reversal of certain previously recognized net state tax benefits related to
the Company's Real Estate Investment Trust (REIT). As a result of this tax
benefit reversal, the Company's effective tax rate increased from 36.2% in 2002
to 42.0% in 2003. Despite this charge, net income before income taxes increased
$723,000 or 6% to $13,199,000 in 2003 as compared to $12,476,000 in 2002. For
further information, see "Results of Operations - Income Taxes" in this section.
26
The Company's results in 2002 improved from 2001. Improvement was shown
in noninterest income, which increased $1,016,000 to $7,615,000 in 2002 as
compared to $6,599,000 in 2001, and net interest income, which increased
$762,000 to $20,866,000 in 2002 as compared to $20,104,000 in 2001. In addition,
net income increased due to a decline in the Company's effective tax rate from
40.4% in 2001 to 36.2% in 2002. For further information, see "Results of
Operations - Income Taxes" in this section.
Significant Accounting Policies and Significant Estimates
The Notes to the Consolidated Financial Statements contain a summary of
the Company's significant accounting policies, including a discussion of
recently issued accounting pronouncements. Certain of these policies as well as
estimates made by management are considered to be important to the portrayal of
the Company's financial condition, since they require management to make
difficult, complex or subjective judgments and estimates, some of which may
relate to matters that are inherently uncertain. Additional information about
these policies can be found in Note B to the Consolidated Financial Statements.
Results of Operations
Net Interest Income. For 2003, the Company's net interest income
amounted to $22,766,000 as compared to $20,866,000 in 2002 and $20,104,000 in
2001. This represents an increase of $1,900,000 or 9% in 2003, an increase of
$762,000 or 4% in 2002 and a decrease of $740,000 or 4% in 2001, in each case as
compared to prior year. The increase in 2003 as compared to 2002 is due to an
increase in average earning assets of $24,021,000 from $464,613,000 in 2002 to
$488,634,000 in 2003. The increase in 2002 as compared to 2001 is also due to an
increase in average earning assets of $44,273,000 from $420,340,000 in 2001 to
$464,613,000 in 2002, offset by a decline in the net interest margin from 4.78%
in 2001 to 4.49% in 2002. Such decline in the net interest margin is primarily
due to the lower interest rate environment and the Company carrying $29,948,000
in lower yielding overnight investments during 2002 as compared to $17,552,000
in 2001.
27
The following table presents for the years indicated the distribution
of consolidated average assets, liabilities and shareholders' equity, as well as
the total dollar amounts of interest income from average earning assets and the
resultant yields, and the dollar amounts of interest expense and average
interest-bearing liabilities, expressed both in dollars and in rates. Nonaccrual
loans are included in the calculation of the average balances of loans, and
interest not accrued is excluded.
2003 2002 2001
---------------------------- --------------------------------------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
---------------------------- --------------------------------------------------------------
(dollars in thousands)
Assets:
Portfolio loans $404,510 $26,613 6.58% $356,953 $25,678 7.19% $327,913 $27,904 8.51%
Mortgage loans held for sale 403 23 5.71 307 24 7.82 --- --- ---
Investment securities (1) 79,672 3,455 4.34 77,405 4,335 5.60 74,875 4,879 6.52
Federal funds sold 4,049 43 1.06 29,948 499 1.67 17,552 772 4.40
-------------------- ---------------------- ----------------------
Total earning assets 488,634 30,134 6.17 464,613 30,536 6.57 420,340 33,555 7.98
------- ------- -------
Other non-earning assets 36,241 35,396 35,841
Allowance for loan losses (7,492) (7,543) (7,673)
------------ ------------- -------------
Total average assets $517,383 $492,466 $448,508
============ ============= =============
Liabilities and Shareholders' Equity:
Interest bearing transaction
accounts $149,036 1,396 0.94 $123,068 1,618 1.31 $123,537 2,762 2.24
Time deposits 205,855 4,600 2.23 217,332 6,961 3.20 186,011 9,668 5.20
Subordinated debentures 14,914 1,283 8.60 10,000 1,003 10.03 8,700 882 10.14
Other borrowings 6,313 89 1.41 4,169 88 2.11 3,360 139 4.14
-------------------- ---------------------- ----------------------
Total interest bearing
liabilities 376,118 7,368 1.96 354,569 9,670 2.73 321,608 13,451 4.18
------------ -------------- ---------------
Non-interest bearing demand deposits 101,091 99,148 88,909
Other non-interest bearing liabilities 12,101 11,274 10,322
Shareholders' equity 28,073 27,475 27,669
------------ ------------- -------------
Total average liabilities and
shareholders' equity $517,383 $492,466 $448,508
============ ============= =============
Net interest spread 4.21 3.84 3.80
======== ========== ==========
Net interest income and
net interest margin $22,766 4.66% $20,866 4.49% $20,104 4.78%
================= =================== ===================
(1) Investment securities are shown with the fair value adjustment included.
The Company's average earning assets for 2003 increased approximately
5%, or $24,021,000, to $488,634,000, as compared to $464,613,000 for 2002.
Average earning assets increased approximately 11%, or $44,273,000, in 2002 as
compared to 2001. During 2003 and 2002, the increase in average earning assets
was driven by strong deposit growth. The increase in earning assets during 2003
and 2002 resulted primarily from an increase of $32,896,000 and $33,347,000 in
average outstanding commercial real estate loans.
With the increase in average earning assets in 2003 discussed above,
the Company's funding levels also increased. The average balance of interest
bearing transaction accounts increased $25,968,000 during 2003, which partially
offset a decrease in higher cost time deposits of $11,477,000. Time deposits
increased $31,321,000 in 2002 compared to an increase of $5,881,000 in 2001. The
growth in time deposits in 2002 was a result of the successful introduction of
the Company's liquid CD product. Additionally, average other borrowings
increased $2,144,000 in 2003 and $809,000 in 2002.
The following table sets forth changes in interest income and interest
expense for each major category of average earning asset and average
interest-bearing liability, and the amount of change attributable to volume and
rate changes for the years indicated. Changes not solely attributable to
28
rate or volume have been allocated proportionately to the change due to volume
and the change due to rate.
2003 over 2002 2002 over 2001
------------------------------- --------------------------------
Volume Rate Total Volume Rate Total
------------------------------- --------------------------------
(in thousands)
Increase (decrease) in interest income:
Portfolio loans (1), (2) $3,243 ($2,308) $935 $2,332 ($4,558) ($2,226)
Mortgage loans held for sale 6 (7) (1) 24 --- 24
Investment securities 124 (1,004) (880) 160 (704) (544)
Federal funds sold (321) (135) (456) 365 (638) (273)
------------------------------- --------------------------------
Total increase (decrease) 3,052 (3,454) (402) 2,881 (5,900) (3,019)
------------------------------- --------------------------------
Increase (decrease) in interest expense:
Interest bearing transaction accounts 300 (522) (222) (10) (1,134) (1,144)
Time deposits (351) (2,010) (2,361) 1,437 (4,144) (2,707)
Trust preferred 438 (158) 280 130 (9) 121
Other borrowings 36 (35) 1 28 (79) (51)
------------------------------- --------------------------------
Total increase (decrease) 423 (2,725) (2,302) 1,585 (5,366) (3,781)
------------------------------- --------------------------------
Increase (decrease) in net interest income $2,629 ($729) $1,900 $1,296 ($534) $762
=============================== ================================
(1) Does not include interest income which would have been earned on nonaccrual
loans had such loans performed in accordance with their terms.
(2) Amortized loan fees of $571,000, $377,000 and $584,000 are included in
interest income for 2003, 2002 and 2001.
The net interest margin increased to 4.66% for the year ended December
31, 2003, as compared to 4.49% and 4.78% for the years ended December 31, 2002
and 2001. During 2003, the improvement in the Company's net interest margin was
attributable to an improvement in the earning asset mix. During 2002 and 2001,
the Company's net interest margin was negatively impacted by sluggish loan
growth and the decline in the general interest rate environment. In addition,
the pooled trust preferred debt financing which funded the Company's stock
repurchase plans had a negative impact on the net interest margin of 26 basis
points in 2003, 22 basis points in 2002 and 21 basis points in 2001. The yield
on average earning assets decreased to 6.17% in 2003 compared to 6.57% in 2002
and 7.98% in 2001.
The effective rates on average interest-bearing liabilities decreased
to 1.96% for 2003 as compared to 2.73% for 2002 and 4.18% for 2001. The decrease
in 2003, 2002 and 2001 is attributable to a lower interest rate environment, as
discussed above, offset by the impact of the Company's pooled trust preferred
debt financing.
Provision for Loan Losses. Annual fluctuations in the provision for
loan losses result from management's regular assessment of the adequacy of the
allowance for loan losses. There was no provision for loan losses for the years
ended December 31, 2003, 2002 and 2001. The absence of the provision for loan
losses was due to the minimal level of loan charge-offs, little change in loan
portfolio asset quality and management's assessment of the level of risk in the
portfolio. See "Asset Quality" in this section.
29
Noninterest Income. During 2003, noninterest income from continuing
operations decreased 10%, or $782,000, to $6,833,000 as compared to $7,615,000,
for 2002. The Company's noninterest income from continuing operations for 2002
increased by $1,016,000 or 15% from the $6,599,000 it received during 2001. The
following table sets forth the sources of noninterest income from continuing
operations for the years ended December 31, 2003, 2002 and 2001.
Year Ended December 31,
2003 2002 2001
--------------------------------------
(in thousands)
Service charges on deposit accounts $1,045 $1,188 $1,116
Merchant draft processing, net 4,824 5,009 4,240
Loan servicing income 158 268 295
Net realized gains on
securities available for sale 86 294 112
Gain (loss) on sale of loans (9) 13 ---
Other income 729 843 836
---------- ----------- ---------
$6,833 $7,615 $6,599
========== =========== =========
Merchant draft processing net revenue amounted to $4,824,000 in 2003,
as compared to $5,009,000 in 2002 and $4,240,000 in 2001. The decrease of
$185,000 during 2003 as compared to 2002 was due to approximately $120,000 in
additional income associated with the recognition of the Company's processing
contract with First Data Resources during the third quarter of 2002 and the
recognition of an additional $160,000 in revenue associated with a portfolio
sale which occurred in the first and second quarters of 2002. The increase of
$769,000 during 2002 when compared to 2001 is a result of the Company achieving
success in building its overall merchant draft processing business through
direct marketing efforts and new independent sales organization (ISO) business.
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 is unable to pay charge-backs from cardholders. As a result of this
obligation, NBR may incur losses associated with its merchant credit card
processing business. Accordingly, NBR has established a reserve to provide for
losses associated with charge-back losses. Such reserve, which totaled
$1,310,000 and $1,261,000 as of December 31, 2003 and 2002, was estimated based
upon industry loss data as a percentage of transaction volume throughout each
year, the historical losses incurred by NBR and management's assumptions
regarding merchant and ISO risk. For additional information, please refer to
"Certain Important Considerations for Investors" in Item 1 in this Report.
Loan servicing revenues decreased to $158,000 for the year ended
December 31, 2003, compared to $268,000 in 2002, and $295,000 in 2001. The
decrease in 2003 and 2002 was due to a decrease in the Company's servicing
portfolio. Future loan servicing income will be dependent, in part, on
prepayments of loans held in the Company's servicing portfolio.
During 2003, the Company sold $9,812,000 in investment securities
available for sale, and recorded a gain on such sales of $86,000. See Note D to
the Consolidated Financial Statements. During 2002, the Company sold $9,025,000
in investment securities available for sale, and recorded a gain on such sales
of $294,000.
30
Noninterest Expense. Noninterest expense amounted to $16,400,000 in
2003, $16,005,000 in 2002 and $14,451,000 in 2001. This represents an increase
of $395,000 or 2% in 2003 when compared to 2002 and an increase of $1,554,000 or
11% in 2002 when compared to 2001.
Salaries and employee benefits expense for 2003 increased $468,000, or
5%, to $9,435,000, as compared to $8,967,000 for 2002. During 2002 salaries and
employee benefits increased $631,000, or 8%, to $8,967,000, as compared to
$8,336,000 for 2001. The increase in 2003 is the result of expenses associated
with the Company's executive search process, the impact of normal annual salary
increases and the increased costs associated with health care and workers'
compensation insurance. The increase during 2002 is a result of an increase in
the average number of full-time-equivalent staff employed by the Company. The
decrease in 2001 is a result of the Company's emphasis on improving efficiency
through process improvement and job function consolidation. The Company's
full-time-equivalent staff levels were 159, 151, and 148 at December 31, 2003,
2002 and 2001.
Occupancy and equipment expense was $2,105,000 in 2003, $2,126,000 in
2002, and $2,026,000 in 2001. During 2003 occupancy and equipment expenses
declined slightly by $21,000, as compared to an increase of $100,000 in 2002
resulting from normal operating cost increases.
The following table describes the components of other noninterest
expense for the years ended December 31, 2003, 2002 and 2001.
Year Ended December 31,
2003 2002 2001
---------------------------------------
(in thousands)
Professional fees $808 $1,119 $360
Regulatory expense and insurance 465 420 396
Postage and office supplies 516 531 529
Shareholder expenses and director fees 463 379 377
Advertising 475 400 484
Telephone 384 395 389
Electronic data processing 1,170 1,113 944
Other 579 555 610
---------------------------------------
$4,860 $4,912 $4,089
=======================================
Other noninterest expenses were $4,860,000 during 2003, a decrease of
$52,000, or 1%, when compared to 2002 expenses of $4,912,000. Other noninterest
expense increased $823,000 or 20% in 2002 when compared to 2001. The increase
during 2002 is in part due to legal and consulting fees of $415,000 associated
with certain corporate activities, including exploring strategic options for the
Company and its Merchant Card Services segment and $163,000 in expenses incurred
in association with the formation of NBR Real Estate Investment Trust.
31
Income Taxes. The Company's effective tax rate varies with changes in
the relative amounts of its non-taxable income and nondeductible expenses. The
Company's effective tax rate on continuing operations was 42.0% in 2003, 36.2%
in 2002 and 40.4% in 2001. The primary reason for the reduction in the Company's
effective tax rate in 2002 was the January 15, 2002 formation of NBR Real Estate
Investment Trust, a Maryland Real Estate Investment Trust ("REIT"). This entity
was formed as a subsidiary of NBR to provide an additional vehicle to raise
capital and to better organize NBR's marketing and origination of real estate
secured lending. As a result of the formation and funding of this entity, along
with the one-time benefit associated with the 2002 recapture of only 50% of the
Company's California state bad debt reserve, and the allowed permanent deduction
of the other 50% of the Company's California state bad debt reserve, the
Company's effective tax rate was reduced to 36.2% in 2002. In December 2003, the
California Franchise Tax Board announced that it has taken the position that
certain tax transactions related to REITs and regulated investment companies
(RICs) will be disallowed. Additionally, there are indications that the State of
California may aggressively challenge certain strategies such as REITs, and
California is encouraging voluntary compliance with their announced positions
with regard to REITs through the passage of Senate Bill 614 and Assembly Bill
1601, which were signed into law in the fourth quarter of 2003. Therefore, in
the fourth quarter of 2003 the Company reversed certain previously recognized
net state tax benefits related to the REIT and the Company did not recognize any
state tax benefit related to the REIT for 2003. As a result, the Company's
effective tax rate increased to 42.0% in 2003. The Company believes it is
appropriately reserved for REIT tax benefits previously recognized.
Business Segments
The Company operates in two principal industry segments: core community
banking and merchant credit card services. The Company's core community banking
industry segment includes commercial, commercial real estate, construction, and
permanent residential lending along with treasury and depository activities. As
of December 31, 2003, the Company's merchant card services industry group
provided credit card settlement services for approximately 35,000 merchants
throughout the United States.
32
Summary financial data by industry segment follows:
For the Year Ended,
December 31,
-----------------------------------------------
2003 2002 2001
-----------------------------------------------
(in thousands)
Community Banking:
Revenue $24,070 $22,876 $21,421
Expenses 13,502 13,327 12,222
-----------------------------------------------
Income before income taxes $10,568 $9,549 $9,199
===============================================
Average assets $488,297 $465,678 $422,134
===============================================
Merchant Credit Card Services:
Revenue $5,529 $5,605 $5,282
Expenses 2,898 2,678 2,229
-----------------------------------------------
Income before income taxes $2,631 $2,927 $3,053
===============================================
Average assets $29,086 $26,788 $26,374
===============================================
Total Company:
Revenue $29,599 $28,481 $26,703
Expenses 16,400 16,005 14,451
-----------------------------------------------
Income before income taxes $13,199 $12,476 $12,252
===============================================
Average assets $517,383 $492,466 $448,508
===============================================
Community Banking
The Community Banking segment's income before income taxes amounted to
$10,568,000 in 2003 as compared to $9,549,000 in 2002 and $9,199,000 in 2001.
The Community Banking segment's revenues increased in 2003 and 2002 as a result
of an increase in net interest income. Net interest income increased due to an
increase in earning assets, offset by a decline in the general interest rate
environment and the issuance of pooled trust preferred debt securities, which
have been fully allocated to the Community Banking segment. Additionally, during
2003 and 2002, the Company increased its loan portfolio through marketing
efforts. Total average portfolio loans were $404,510,000 in 2003, up from
$356,953,000 in 2002.
Merchant Card Services
As of December 31, 2003, the Merchant Card Services segment provided
VISA and Mastercard credit card processing and settlement services for
approximately 35,000 merchants located throughout the United States. In 2003,
processing volume exceeded $1.8 billion. The Company's merchant card services
customer base is made up of merchants located in its primary market area and
merchants who have been acquired by the Company through the use of ISOs.
During 2003, the Merchant Card Services segment's net income decreased
due to a decrease in merchant draft processing net revenues and increases in
salary and employee benefits expenses. The increase in the segment's salary and
employee benefits expense is due to a build-up in sales development personnel.
During 2002, the Merchant Card Services segment's net income decreased
33
due to an increase in salaries and employee benefits expenses. The increase in
expenses was partially offset by an increase in processing revenue brought about
by the Company's efforts to build its overall merchant card services business
through direct marketing efforts, new ISO relationships and an increase in the
realization in deferred processing revenue associated with certain merchants.
During 2001, the Merchant Card Services segment's net income declined due to a
decline in processing revenue, which is directly attributable to the expiration
of a large merchant credit card processing contract in the fourth quarter of
2000.
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 is unable to pay charge-backs from cardholders. As a result of this
obligation, NBR may incur losses associated with its merchant credit card
processing business. Accordingly, NBR has established a reserve to provide for
losses associated with charge-back losses. Such reserve, which totaled
$1,310,000 and $1,261,000 as of December 31, 2003 and 2002, was estimated based
upon industry loss data as a percentage of transaction volume throughout each
year, historical losses incurred by NBR, and management's assumptions regarding
merchant and ISO risk. The provision for charge-back losses, which is included
in the financial statements as a reduction in merchant draft processing income,
was $280,000, $246,000 and $138,000 in 2003, 2002 and 2001. For additional
information, please refer to "Certain Important Considerations for Investors" in
Item 1 in this Report.
The following table summarizes the Company's merchant card allowance
for charge-back losses for the periods indicated:
For the Year Ended
December 31,
2003 2002 2001
--------------------------------------
(in thousands)
Beginning allowance $1,261 $1,212 $1,277
Provision for losses 280 246 138
Recoveries 7 37 105
Charge-offs (238) (234) (308)
--------------------------------------
Ending allowance $1,310 $1,261 $1,212
======================================
Investment Portfolio
The Company classifies its investment securities as held to maturity or
available for sale. The Company's intent is to hold all securities held to
maturity until maturity and management believes that the Company has the ability
to do so. Securities available for sale may be sold to implement the Company's
asset/liability management strategies and in response to changes in interest
rates, prepayment rates and similar factors. The following table summarizes the
maturities of the Company's debt securities at their carrying value and their
weighted average yields at December 31, 2003. In the following table, yields on
tax-exempt securities have been presented on a tax-equivalent basis.
34
Available for Sale
After One After Five
Through Through After
Within One Year Five Years Ten Years Ten Years Total
------------------ ------------------ ------------------ ------------------ ------------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------------------ ------------------ ------------------ ------------------ ------------------
U.S. Government
obligations $15,549 1.68 % $2,153 5.60 % $ --- --- $ --- --- $17,702 2.16 %
Mortgage-backed --- --- --- --- 4,442 5.32 % 33,400 5.86% 37,842 5.79 %
--------- ----------- ---------- ----------- ---------
Total $15,549 1.68 % $2,153 5.60 % $4,442 5.32 % $33,400 5.86 % $55,544 4.64 %
========= =========== ========== =========== =========
Held to Maturity
After Five
After One Through Through After
Within One Year Five Years Ten Years Ten Years Total
------------------------------------------------------------------------------------------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------------------------------------------------------------------------------------------------
(dollars in thousands)
Mortgage-backed $ --- --- $ --- --- $149 6.50 % $5,110 5.49 % $5,259 5.52 %
Other securities --- --- 1,184 4.93 % 3,512 4.31 % 7,611 4.36 % 12,307 4.38 %
----------- ----------- ----------- ----------- ------------
Total $ --- --- $1,184 4.93 % $3,661 4.40 % $12,721 4.81 % $17,566 4.72 %
=========== =========== =========== =========== ============
The following table summarizes the book value of the Company's investment
securities held on the dates indicated:
Available for Sale
December 31,
2003 2002 2001
-----------------------------------------------------
(in thousands)
U.S. Government obligations $17,702 $9,372 $10,360
Mortgage-backed securities 37,842 71,183 25,390
Other securities --- --- 9,308
FHLB and FRB Stock 2,685 2,602 2,515
-----------------------------------------------------
Total $58,229 $83,157 $47,573
=====================================================
Held to Maturity
December 31,
2003 2002 2001
-----------------------------------------------------
(in thousands)
U.S. Government obligations $ --- $ --- $2,000
Mortgage-backed securities 5,259 8,611 9,066
Other securities 12,307 8,153 6,336
-----------------------------------------------------
Total $17,566 $16,764 $17,402
=====================================================
35
Loan Portfolio
The Company concentrates its lending activities in three principal
areas: real estate mortgage loans (residential and commercial loans), real
estate construction loans and commercial loans. At December 31, 2003, these
three categories accounted for approximately 71%, 12% and 13% of the Company's
loan portfolio. The interest rates charged for the loans made by the Company
vary with the degree of risk, the size and maturity of the loans, the borrowers'
depository relationships with the Company and prevailing money market rates
indicative of the Company's cost of funds.
Concentration of the Company's lending activities in the real estate
sector 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. The
ability of the Company to continue to originate mortgage, construction and other
loans may be impaired by adverse changes in local or regional economic
conditions, adverse changes in the real estate market, increasing interest
rates, or acts of nature (including earthquakes or floods, which may cause
uninsured damage and other loss of value to real estate that secures the
Company's loans). 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.
The following table sets forth the amounts of loans outstanding by
category as of the dates indicated. There were no concentrations of loans
exceeding 10% of total loans which are not otherwise disclosed as a category of
loans in the table below.
December 31,
---------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---------------------------------------------------------------------------------------
(in thousands)
Residential real estate mortgage $108,851 $87,764 $101,175 $98,914 $130,504
Commercial real estate mortgage 186,185 158,018 121,456 93,091 79,476
Commercial 55,473 62,958 70,438 66,645 61,165
Real estate construction 51,154 42,749 46,501 49,460 40,059
Installment and other 13,025 14,260 12,567 7,900 4,624
Net deferred fees (167) (673) (488) (909) (1,383)
---------------------------------------------------------------------------------------
Total loans 414,521 365,076 351,649 315,101 314,445
Allowance for loan losses (7,162) (7,400) (7,580) (7,674) (7,931)
---------------------------------------------------------------------------------------
Net loans $407,359 $357,676 $344,069 $307,427 $306,514
=======================================================================================
Real Estate Mortgage Loans. As of December 31, 2003, the Company's
residential mortgage loans totaled $108,851,000, or 26%, of its total loans.
These loans were predominantly originated in Sonoma and Mendocino Counties.
Total residential loans increased $21,087,000 during 2003 due to normal
origination activity. Total residential loans decreased $13,411,000 during 2002
primarily as the result of substantial paydown activity, and increased
$2,261,000 during 2001, primarily as the result of normal loan origination
activity. During 2000, total residential loans decreased due to the Company's
sale of $21,205,000 in single family residential loans and the securitization of
another $17,949,000 as part of an asset repositioning strategy. The funds
received from the loan sale were used to fund growth in higher yielding
relationship-based commercial and commercial real estate loans.
36
At December 31, 2003, $66,406,000, or 61%, of the Company's residential
real estate mortgage loans were fixed-rate mortgage loans having original terms
ranging from one to 30 years. Another $17,874,000, or 16%, were held as
adjustable-rate mortgages. The balance of these loans, $24,571,000, or 23%,
consisted of multifamily loans and loans on improved single-family lots. The
majority of the Company's residential mortgage loans have been underwritten for
the Company's portfolio and do not necessarily meet standard underwriting
criteria for sale in the secondary market. Approximately 71% of the total amount
outstanding had principal balances that were less than $300,000. The Company's
residential real estate mortgage loans predominately have loan-to-value ratios
of 80% or less, using current loan balances and appraised values as of the time
of origination. The Company's general policy is not to exceed an 80%
loan-to-value ratio on residential mortgage loans without mortgage insurance.
As of December 31, 2003, the Company had outstanding $186,185,000 in
commercial mortgage loans, which constituted 45% of total loans. Of these loans,
43% were secured by owner-occupied commercial properties and have 5- to 15-year
maturities based upon 25- to 30-year amortization periods. The ratio of the loan
principal amount to appraised values is generally 75% or less, using appraised
values at the time of loan origination, and the loans are for owner-occupied
small office buildings or office/warehouses. The Company originates commercial
mortgage loans that are guaranteed by the SBA up to 75% of the loan balance and
up to 90% of the loan to value. The SBA guaranteed portion of such loans can be
sold into the secondary market with the unguaranteed principal balance retained.
The aggregate retained unguaranteed principal balance of such loans was $8
million at December 31, 2003. Approximately 29% of the total amount outstanding
of commercial mortgage loans had principal balances that were less than
$250,000.
Real Estate Construction Loans. The Company's primary market focus
emphasizes individual borrowers and small residential and commercial projects.
The economic viability of the project and the borrower's past development record
and creditworthiness are primary considerations in the loan underwriting
decision. The Company had $51,154,000 in construction loans outstanding at
December 31, 2003, comprising 12% of its total loans. These loans were
principally located in Northern California. This represents an increase of
$8,405,000 or 20% from 2002. During 2002 and 2001, construction loans decreased
$3,752,000 or 8% and $2,959,000 or 6% from 2001 and 2000. In 2000 construction
loans increased $9,401,000 or 23%. As of December 31, 2003, approximately $15
million of these loans consisted of 31 single-family individual-borrower
construction loans, and the remaining loans included 12 subdivision projects, 22
land development projects and 7 commercial projects. At December 31, 2003, the
largest single-family construction loan commitment was $3,250,000, and the
average commitment was less than $882,000. The largest commitment for a
subdivision project was $5,900,000 and the average subdivision commitment was
less than $2,500,000. The average commitment for a commercial project was
approximately $649,000.
Construction loans are funded on a line-item, percentage of completion
basis. As the builder completes various line items (foundation, framing,
electrical, etc.) of the project, or portions of those line items, the work is
reviewed by one of several independent inspectors hired by the Company. Upon
approval from the inspector, the Company funds the draw request according to the
percentage completion of the line items that have been approved. Actual funding
checks must be signed by an officer of the Company, and that officer must also
initial the line-item worksheet used to support the draw request. In addition,
Company personnel or agents routinely inspect the various construction projects,
all of which are located in the Company's lending area.
37
Commercial real estate mortgage and construction lending contains
potential risks which are not inherent in other types of portfolio loans. These
potential risks include declines in market values of underlying real property
collateral and, with respect to construction lending, delays or cost overruns,
which could expose the Company to loss. In addition, risks in commercial real
estate lending include declines in commercial real estate values, general
economic conditions surrounding the commercial real estate properties and
vacancy rates. A decline in general economic conditions or real estate values
within the Company's market area could have a negative impact on the performance
of the loan portfolio or value of the collateral. Because the Company lends
primarily within its market area, the real property collateral for its loans is
similarly concentrated, rather than diversified over a broader geographic area.
The Company could therefore be adversely affected by a decline in real estate
values in its primary market area even if real estate values elsewhere in
California remain stable or increase.
Commercial Loans. Commercial loans consist primarily of short-term
financing for businesses and professionals located in Sonoma and Mendocino
Counties. At December 31, 2003, these loans totaled $55,473,000, or 13%, of the
Company's total loans. This represents a decrease of $7,485,000 or 12%, as
compared to a decrease of $7,480,000 or 11% from 2002 and 2001. The decline in
commercial loans during 2003 and 2002 is due to normal loan payoffs and the
competitive banking environment. The increase in commercial loans of $3,793,000
during 2001 was due to the Company's marketing efforts and a general expansion
of businesses within the Company's market area. The commercial loans are
diversified as to industries and types of businesses, with no significant
industry concentrations. Commercial loan borrowers generally have deposit
relationships with the Company. The commercial loans can be unsecured or secured
by various assets, including equipment, receivables, deposits and other assets.
Commercial loans may be secured by commercial or residential property; however,
they are not classified as mortgage loans since these loans are not typically
taken out for the purpose of acquiring real estate and the loans are short-term.
In these cases, the mortgage collateral is often taken as additional collateral.
As of December 31, 2003, the size of individual commercial loans varied widely,
with 92% having principal balances less than $350,000. At December 31, 2003, the
Company had 10 commercial borrowers whose aggregate individual liability
exceeded $2,000,000.
Loan Commitments. In the normal course of business, there are various
commitments outstanding to extend credit that are not reflected in the financial
statements. Annual review of the commercial credit lines and ongoing monitoring
of outstanding balances reduces the risk of loss associated with these
commitments. There were $85,659,000 in undisbursed loan commitments and
$5,375,000 in standby letters of credit at December 31, 2003.
38
Maturity Distribution. The following table shows the maturity
distribution of the Company's commercial and real estate construction loans
outstanding as of December 31, 2003, which, based on remaining scheduled
repayments of principal, were due within the periods indicated.
After One
Within Through After Five
One Year Five Years Years Total
-------------------------------------------------
(in thousands)
Commercial $18,280 $18,288 $18,905 $55,473
Real estate construction 39,456 10,036 1,662 51,154
-------------------------------------------------
Total $57,736 $28,324 $20,567 $106,627
=================================================
Loans with fixed interest rates $11,934 $4,323 $288 $16,545
Loans with variable interest rates 45,802 24,001 20,279 90,082
-------------------------------------------------
Total $57,736 $28,324 $20,567 $106,627
=================================================
Deposit Structure
The Company's time deposits of $100,000 or more had the following
schedule of maturities at December 31, 2003 (in thousands):
Remaining Maturity:
Three months or less $31,379
Over three months to six months 15,824
Over six months to 12 months 20,375
Over 12 months 5,684
-------
Total $73,262
=======
Time deposits of $100,000 or more are generally from the Company's
local business and professional customer base. The Company primarily attracts
deposits from local businesses and professionals, as well as through retail
certificates of deposits, savings and checking accounts. In addition to the
Company's local depository offices, it attracts certificates of deposit,
primarily from financial institutions throughout the nation, by publishing rates
in national publications. These certificates of deposit have often been set at
interest rates at local market retail deposit rates to attract deposits. The
national deposit market is utilized to supplement the Company's liquidity needs.
There can be no assurance that this funding practice will continue to provide
deposits at attractive rates or that applicable federal regulations will not
limit the Company's ability to attract deposits in this manner. The amount of
such deposits was $199,000 and $399,000 as of December 31, 2003 and 2002. The
Company generally does not purchase brokered deposits and had no brokered
deposits at December 31, 2003. The Company also accepts certificates of deposit
from the State of California. Such certificates of deposit amounted to
$20,000,000 and $10,000,000 as of December 31, 2003 and 2002. In order to accept
deposits from the State of California, the Company is required to pledge
investment securities. The carrying amount of such securities amounted to
$23,293,000 and $13,016,000 as of December 31, 2003 and 2002.
39
The following table sets forth the distribution of the Company's
average daily deposits for the periods indicated.
Year Ended December 31,
--------------------------------------------------------------------
2003 2002 2001
--------------------------------------------------------------------
Amount Rate Amount Rate Amount Rate
--------------------------------------------------------------------
(dollars in thousands)
Transaction accounts:
Savings & Money Market $118,438 1.11% $93,166 1.56% $95,773 2.59%
NOW 30,598 0.27 29,902 0.55 27,764 1.00
Noninterest bearing 101,091 --- 99,148 --- 88,909 ---
Time deposits $100,000 and over 73,218 2.08 91,705 3.27 102,185 5.28
Other time deposits 132,637 2.32 125,627 3.16 83,826 5.09
The potential impact on the Company's liquidity from the withdrawal of
these deposits is considered in the Company's asset and liability management
policies, which attempt to anticipate adequate liquidity needs through its
management of investments, federal funds sold, or by generating additional
deposits.
Other Borrowings
NBR has a short term borrowing agreement with the Federal Home Loan
Bank of San Francisco (FHLB). This agreement is collateralized by approximately
$69,000,000 in residential mortgage loans. Available credit under this line at
December 31, 2003 was $38,000,000. Advances can be made on a long-term and
short-term basis with a rolling maturity date. On occasion, a borrowing is made
on a fixed maturity basis. In such instances, maturities do not extend beyond
one year. As of December 31, 2003, there was an outstanding balance of
$13,500,000 under this line. Redwood also maintains a $2,500,000 unsecured line
of credit with a major financial institution. As of December 31, 2003, there was
no outstanding balance under this line. In addition, the Company enters into
various short-term borrowing agreements, which include Treasury, Tax and Loan
borrowings. These borrowings have maturities of one day and are collateralized
by investments or loans.
The following table summarizes the balances outstanding at year end,
the highest amount of borrowings outstanding for a month-end during the year,
the average balance of borrowings and the weighted average interest rate for the
years ended December 31, 2003, 2002 and 2001 (in thousands).
2003 2002 2001
-------------------------------------------
Balance, December 31 $16,265 $12,356 $3,870
Average balance during the year 6,313 4,169 3,360
Weighted average interest rate during the year 1.41% 2.11% 4.14%
Maximum month-end balance during year $16,265 $12,356 $6,000
Date of maximum month-end balance December December September
40
Subordinated Debentures/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.
The subordinated debentures are considered Tier 1 capital (with certain
limitations applicable) under current regulatory guidelines. As of December 31,
2003 and 2002, 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 set forth
in 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,
are included in interest expense in the consolidated financial statements. While
the subordinated debentures can be considered Tier 1 capital under current
regulatory guidelines, as a result of certain limitations applicable, they
currently only qualify as Tier 2 regulatory capital. As of December 31, 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 set forth in 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.
41
Prior to 2003, RSTI was consolidated in the Company's financial
statements with the trust preferred securities issued by the trust reported in
liabilities as "trust preferred securities" and the subordinated debentures
eliminated in consolidation. Under new accounting guidance, FASB Interpretation
No. 46, as revised in December 2003, RSTI and RSTII are not consolidated with
the Company. Accordingly, the amounts previously reported as "trust preferred
securities" in liabilities have been recaptioned "subordinated debentures" and
continue to be presented in liabilities on the balance sheet. At December 31,
2003 and 2002, the amount of the subordinated debentures and trust preferred
securities were the same. The effect of no longer consolidating the trusts does
not change the amounts reported as the Company's assets, liabilities, equity or
interest expense.
Further, as a result of FASB's Interpretation No. 46, questions were
raised about whether trust preferred securities would still qualify for
treatment as Tier 1 capital. In July of 2003, the FRB instructed bank holding
companies to continue to include trust preferred securities in Tier 1 capital
for regulatory capital purposes, until notice is given to the contrary. At
December 31, 2003, due to certain limitations applicable under current
regulatory guidelines, the Company had outstanding $8,710,000 of trust preferred
securities associated with RSTI that was considered Tier 1 capital. The Company
does not expect the final rules, when implemented, will result in the immediate
elimination of these securities as Tier 1 capital. These securities comprised
25% of the Company's Tier 1 capital as of December 31, 2003. If it were
determined that these securities do not qualify as Tier 1 capital, the Company
would still meet the requirements for well-capitalized institutions as of
December 31, 2003.
Asset Quality
The Company attempts to minimize credit risk through its underwriting
and credit review policies. The Company conducts its own internal credit review
processes and, in addition, contracts with an independent loan reviewer who
performs semi-annual reviews of new loans and potential problem loans that fall
within predetermined parameters. The Board of Directors of NBR has an internal
asset review committee which reviews the asset quality of new and problem loans
on a quarterly basis and reports the findings to the full Board. In management's
opinion, this loan review system facilitates the early identification of
potential problem loans.
The performance of the Company's loan portfolio is evaluated regularly
by management. The Company places a loan on nonaccrual status when one of the
following events occurs: (1) any installment of principal or interest is 90 days
or more past due (unless, in management's opinion, the loan is well secured and
in the process of collection); (2) management determines the ultimate collection
of principal of or interest on a loan to be unlikely; or (3) the terms of a loan
have been renegotiated to less than market rates due to a serious weakening of
the borrower's financial condition.
42
With respect to the Company's policy of placing loans 90 days or more
past due on nonaccrual status unless the loan is well secured and in the process
of collection, a loan is considered to be in the process of collection if, based
on a probable specific event, it is expected that the loan will be repaid or
brought current. Generally, this collection period would not exceed 30 days.
When a loan is placed on nonaccrual status, the Company's general policy is to
reverse and charge against current income previously accrued but unpaid
interest. Interest income on such loans is subsequently recognized only to the
extent that cash is received and future collection of principal is deemed by
management to be probable. Where the collectability of principal or interest on
a loan is considered to be doubtful by management, it is placed on nonaccrual
status prior to becoming 90 days delinquent.
Interest income is recognized on impaired loans in a manner similar to
that of all loans. It is the Company's policy to place loans that are delinquent
90 days or more as to principal or interest on nonaccrual status unless well
secured and in the process of collection, and to reverse from current income
accrued but uncollected interest. Cash payments subsequently received on
nonaccrual loans are recognized as income only when the future collection of
principal is considered by management to be probable.
At December 31, 2003 and 2002, the Company's total recorded investment
in impaired loans was $1,266,000 and $2,794,000 of which $1,266,000 and
$2,493,000 related to the recorded investment for which there is a related
allowance for credit losses of $164,000 and $670,000. The amount of that
recorded investment for which there is no related allowance for credit losses
was $0 and $301,000 at December 31, 2003 and 2002. At December 31, 2003 and
2002, substantially all of the impaired loan balance was measured based on the
fair value of the collateral, with the remainder measured by the estimated
present value of cash flows.
The average recorded investment in impaired loans during the years
ended December 31, 2003, 2002 and 2001 was $1,798,000, $1,866,000 and
$2,973,000. The related amount of interest income recognized during the periods
that such loans were impaired during such year was $0, $65,000 and $49,000.
As of December 31, 2003 and 2002, there were $1,266,000 and $2,516,000
of loans on which the accrual of interest had been discontinued. Interest due
but excluded from interest income on loans placed on nonaccrual status was
$189,000, $66,000 and $88,000 for the years ended December 31, 2003, 2002 and
2001. Interest income received on nonaccrual loans was $0, $0 and $1,000 for the
years ended December 31, 2003, 2002 and 2001.
43
The following table sets forth the amount of the Company's
nonperforming assets as of the dates indicated.
December 31,
---------------------------------------------------------
2003 2002 2001 2000 1999
---------------------------------------------------------
(dollars in thousands)
Nonaccrual loans $1,266 $2,516 $2,892 $908 $3,063
Accruing loans past due 90 days or more --- 6 --- --- ---
Restructured loans (in compliance with
modified terms) --- 272 284 295 1,018
---------------------------------------------------------
Total nonperforming loans 1,266 2,794 3,176 1,203 4,081
Other real estate owned --- --- --- 757 2,363
---------------------------------------------------------
Total nonperforming assets $1,266 $2,794 $3,176 $1,960 $6,444
=========================================================
Nonperforming loans to total loans 0.31% 0.77% 0.90% 0.38% 1.30%
Nonperforming assets to total assets 0.24 0.54 0.71 0.43 1.52
Allowance for loan losses to nonperforming assets 565.72 264.85 238.66 391.53 123.08
Allowance for loan losses to nonperforming loans 565.72 264.85 238.66 637.91 194.34
Nonperforming loans totaled $1,266,000 at December 31, 2003, consisting
of $362,000 that were secured by residential real estate with the remaining
$904,000 either unsecured or collateralized by various business assets other
than real estate.
At December 31, 2003, the Company did not carry any assets classified
as other real estate owned.
In addition to the above mentioned assets, as of December 31, 2003
management of the Company has identified three lending relationships which in
aggregate amount to approximately $2,984,000 in potential nonperforming loans,
as to which it has serious doubts as to the ability of the borrowers to comply
with the present repayment terms and which may become nonperforming assets,
based on known information about possible credit problems of the borrower. These
loans are secured by real estate and by business assets.
44
The following table provides certain information for the years
indicated with respect to the Company's allowance for loan losses as well as
charge-off and recovery activity.
Year Ended December 31,
-----------------------------------------------------------------
2003 2002 2001 2000 1999
-----------------------------------------------------------------
(dollars in thousands)
Balance at beginning of period $7,400 $7,580 $7,674 $7,931 $8,041
-----------------------------------------------------------------
Charge-offs:
Residential real estate mortgage 60 --- --- 111 21
Commercial real estate mortgage --- --- --- --- 612
Commercial 549 264 177 461 769
Real estate construction --- 22 --- 90 100
Installment and other --- 12 8 39 13
-----------------------------------------------------------------
Total charge-offs 609 298 185 701 1,515
-----------------------------------------------------------------
Recoveries:
Residential real estate mortgage 10 --- 4 69 42
Commercial real estate mortgage 75 --- --- 22 45
Commercial 228 99 75 169 498
Real estate construction 6 2 --- 3 53
Installment and other 52 17 12 31 17
-----------------------------------------------------------------
Total recoveries 371 118 91 294 655
-----------------------------------------------------------------
Net charge-offs 238 180 94 407 860
-----------------------------------------------------------------
Provision for loan losses --- --- --- 150 750
-----------------------------------------------------------------
Balance at end of period $7,162 $7,400 $7,580 $7,674 $7,931
=================================================================
Net charge-offs during the period
to average loans 0.06% 0.05% 0.03% 0.12% 0.29 %
Allowance for loan losses to total
loans 1.73 2.03 2.16 2.44 2.52
Allowance for loan losses
to nonperforming loans 565.72 264.85 238.66 637.91 194.34
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.
45
The adequacy of the Company's allowance for loan losses is based on
specific and formula allocations to the Company's loan portfolio. Specific
allocations of the allowance for loan losses are made to identified problem
loans where management has identified significant conditions or circumstances
related to a given loan, which management believes indicates the probability
that a loss may occur. The specific allocations are increased or decreased
through management's reevaluation on a quarterly basis of the status of the
particular problem loans. Loans which do not receive a specific allocation
receive an allowance allocation based on a formula, represented by a percentage
factor based on underlying collateral, type of loan, historical charge-offs and
general economic conditions and other qualitative factors.
It is the policy of management to make additions to the allowance for
loan losses so that it remains adequate to cover probable incurred losses, and
management believes that the allowance at December 31, 2003 was adequate.
However, the determination of the amount of the allowance is judgmental and
subject to economic conditions which cannot be predicted with certainty.
Accordingly, the Company cannot predict whether charge-offs of loans in excess
of the allowance may be required in future periods.
The table below sets forth the allocation of the allowance for loan
losses by loan type as of the dates specified. The allocation of individual
categories of loans includes amounts applicable to specifically identified as
well as estimated losses inherent in that segment of the loan portfolio and will
necessarily change whenever management determines that the risk characteristics
of the loan portfolio have changed.
Management believes that any breakdown or allocation of the allowance
for loan losses into loan categories lends an appearance of exactness, which
does not exist, in that the allowance is utilized as a single amount available
for all loans. The allocation below should not be interpreted as an indication
of the specific amounts or loan categories in which future charge-offs will
occur.
December 31,
---------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---------------------------------------------------------------------------------------------
Allowance % of Allowance % of Allowance % of Allowance % of Allowance % of
for Losses Loans For Losses Loans for Losses Loans for Losses Loans for Losses Loans
---------------------------------------------------------------------------------------------
(dollars in thousands)
Residential real
estate mortgage $517 26% $1,322 24% $1,283 29% $1,194 32% $2,258 42%
Commercial real
estate mortgage 1,786 46 2,386 43 1,839 34 1,549 29 947 25
Commercial 2,149 13 2,341 17 2,198 20 2,187 21 2,088 19
Real estate construction 679 12 871 12 1,433 13 1,416 16 1,064 13
Installment and other 406 3 447 4 427 4 257 2 130 1
Unallocated 1,625 --- 33 --- 400 --- 1,071 --- 1,444 ---
--------------- ----------------- ----------------- ----------------- -----------------
Total $7,162 100% $7,400 100% $7,580 100% $7,674 100% $7,931 100%
=============== ================= ================= ================= =================
During 2003, the Company performed an analysis around the methodology
and factors used to determine the allocation of the allowance for loan losses.
As shown in the table above, such analysis resulted in an increase of $1,592,000
in the unallocated portion of the allowance for loan
46
losses at December 31, 2003 to $1,625,000 as compared to $33,000 at December 31,
2002. The analysis included such factors as the historical charge off experience
for NBR, the application of specific and general reserves to the entire loan
portfolio and the establishment of a minimum and maximum loan loss reserve range
based on the historical charge off experience for NBR. The OCC and an
independent credit review consulting company were consulted prior to the
implementation of this methodology.
Mortgage Repurchase Commitments
From time to time the Company may be required to repurchase mortgage
loans from mortgage loan investors as a result of breaches of representations
and warranties in the purchase agreement between the investor and the Company.
The Company may also be required to reimburse a mortgage loan investor for
losses incurred as a result of liquidating collateral, which had secured a
mortgage loan sold by the Company. Such representations and warranties include
the existence of a valid appraisal, status of borrower or fraud. The Company
expects that it may be required to repurchase loans in the future. During 2003
and 2001, the Company was not required to repurchase any loans, as compared to
2002, during which the Company was required to repurchase one mortgage loan for
$72,000.
Investment in REMIC
In 1995, Allied, formally a wholly owned subsidiary of Redwood which
was merged into NBR in 1997, sold a COFI ARM mortgage pool whose carrying value
was approximately $73.9 million 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 100% interest in the COFI
indexed ARM mortgage pool in exchange for cash of $71.5 million 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 the Class "B" certificate shall only receive
principal payments after all Class "A" certificates are retired.
The composition of the original certificate balances along with their
respective December 31, 2003 balances is as follows:
Original December 31, 2003
Certificate Certificate
Face Value Face Value
-------------------- --------------------
Class A $73,199,448 $276,339
Class B 3,249,067 3,196,477
Class C 100 100
-------------------- --------------------
$76,448,615 $3,472,916
==================== ====================
47
Since inception the pool has realized losses of $52,590 which reduced
the original face value of the Class "B" certificate.
Contractual Obligations and Commitments
The following table presents our longer term, non-deposit related,
contractual obligations and our commitments to extend credit to our borrowers,
in aggregate and by payment due dates:
December 31, 2003
------------------------------------------------------------------
Less Than One Through Four To After Five
One Year Three Years Five Years Years Total
------------------------------------------------------------------
(in thousands)
Subordinated debentures $ --- $ --- $ --- $20,000 $20,000
Operating leases (premises) 1,625 3,131 2,969 5,145 12,870
------------------------------------------------------------------
Total long-term debt
and operating leases $1,625 $3,131 $2,969 $25,145 $32,870
========================================================
Commitments to extend credit 85,659
Standby letters of credit 5,375
-----------
Total contractual obligations and commitments $123,904
===========
Liquidity
Redwood's primary source of liquidity is dividends from NBR. Redwood's
primary uses of liquidity are associated with common stock repurchases, dividend
payments made to the shareholders, interest payments relating to Redwood's trust
preferred debt and operating expenses. It is the Company's policy to maintain
liquidity levels at the parent company which management believes to be
consistent with the safety and soundness of the Company as a whole. As of
December 31, 2003, Redwood held $5,270,000 in deposits at NBR. In addition,
Redwood 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 December 31, 2003, there was no outstanding balance under this line
of credit.
Payment of dividends by Redwood 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 be
undercapitalized as a result. If NBR is restricted from paying dividends,
Redwood might be unable to pay the above obligations. No assurance can be given
as to the ability of NBR to pay dividends to Redwood. The aggregate amount of
dividends which may be declared by NBR to be paid to Redwood in 2004 without
prior regulatory approval approximates $4,599,000 plus current 2004 net profits.
The approval of the 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. In February 2004, NBR received approval
from the OCC for its 2004 dividend plan. In 2003, 2002
48
and 2001, NBR declared dividends payable to Redwood of $6,700,000, $6,600,000
and $5,900,000. For additional information, please see "Regulation and
Supervision" in Item 1 of this Report and Note N to the Consolidated Financial
Statements included in this Report.
Although each entity within the consolidated group manages its own
liquidity, the Company's consolidated cash flows can be divided into three
distinct areas; operating, investing and financing. For the year ended December
31, 2003, the Company received $7,796,000 and $7,155,000 in cash flows from
operations and financing activities while using $26,429,000 in investing
activities.
The principal source of asset liquidity is federal funds sold.
Secondary sources of liquidity are loan repayments, investment securities
available for sale, maturing investment securities held to maturity, and loans
and investments that can be used as collateral for other borrowings. At December
31, 2003, the Company had $8,600,000 in federal funds sold. Total investment
securities were $75,795,000, of which $43,165,000 were pledged.
Liability-based liquidity includes interest-bearing and noninterest
bearing retail deposits, which are a relatively stable source of funds, time
deposits from financial institutions throughout the United States, federal funds
purchased, and other short-term and long-term borrowings, some of which are
collateralized. As required by the Federal Home Loan Bank, NBR collateralizes
its advances from the FHLB with residential mortgage loans. Management uses FHLB
advances as part of its funding strategy because the rates paid for those
advances are generally in line with the rates paid on time deposits. At December
31, 2003, approximately $69,000,000 of residential mortgage loans were pledged
to secure any funds the Company may borrow from the FHLB in the future. NBR's
FHLB borrowing limitation at December 31, 2003 was $38,000,000. At December 31,
2003 and 2002, NBR had outstanding FHLB advances of $13,500,000 and $5,000,000.
At December 31, 2001, NBR had paid off all FHLB advances. Management believes
that at December 31, 2003 the Company's liquidity position was adequate for the
operations of Redwood and its subsidiaries for the foreseeable future.
Capital
A strong capital base is essential to the Company's continued ability
to service the needs of its customers. Capital protects depositors and the
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 each required to maintain minimum capital
ratios defined by various federal government regulatory agencies. The FRB and
the OCC have each established capital guidelines, which include minimum capital
requirements. The regulations impose two sets of standards: "risk-based" and
"leverage".
49
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, subordinated debentures, 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). At December 31, 2003, 2002 and 2001, the Company and its
subsidiaries were required to maintain a total risk-based capital ratio of at
least 8% and a Tier 1 capital ratio of at least 4%.
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% for other than the highest rated institutions. The
minimum leverage ratio for the Company and NBR is based on average assets for
the quarter.
NBR maintains insurance on its customer deposits with the Federal
Deposit Insurance Corporation ("FDIC"). The FDIC manages the Bank Insurance Fund
("BIF"), which insures deposits of commercial banks such as NBR, and the Savings
Association Insurance Fund ("SAIF"), which insures deposits of savings
associations. FDICIA mandated that the two funds maintain reserves at 1.25% of
their respective federally insured deposits.
The table below shows the capital ratios for the Company and NBR at
December 31, 2003.
Company NBR
------------------------------
Total capital to risk weighted assets 11.94% 10.55%
Tier 1 capital to risk weighted assets 7.93 9.29
Leverage ratio 6.47 7.59
Under the most stringent capital requirement, the Company has
approximately $12,777,000 in capital above the level at which it would become
under-capitalized. Similarly, NBR has $10,689,000 in capital in excess of that
level.
Common Stock Repurchase
During the years ended December 31, 2003, 2002 and 2001, the Company
repurchased common stock of the Company. The number of shares and the average
cost per share of such repurchases is as follows:
2003 2002 2001
----------------------------------------
Common shares repurchased 255,093 205,992 1,299,462
Average price paid $22.39 $18.37 $12.61
The above table reflects the three-for-two common stock splits, which
were announced on September 20, 2001 and July 16, 2003.
50
As of the date of this filing, the Company has current common stock
repurchase authorizations outstanding of 1,029,750 shares, of which 541,048 have
been purchased at an average cost of $19.86.
Off-Balance Sheet Arrangements
The following table shows the amounts and expected maturities of
significant commitments as of December 31, 2003. Further discussion on these
commitments is included in Note Q to the Consolidated Financial Statements
included in this Report.
After One
Within Through After Five
One Year Five Years Years Total
------------------------------------------
(in thousands)
Commitments to extend credit $55,515 $16,818 $12,526 $84,859
Standby letters of credit 300 5,075 --- 5,375
------------------------------------------
$55,815 $21,893 $12,526 $90,234
==========================================
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
As a financial institution, the Company's primary component of market
risk is interest rate volatility. Fluctuation in interest rates will ultimately
impact both the level of income and expense recorded on a large portion of the
Bank's assets and liabilities and the market value of all interest earning
assets and interest bearing liabilities, other than those which possess a short
term to maturity. Since virtually all of the Company's interest bearing
liabilities and all of the Company's interest earning assets are located at the
Bank, virtually all of the Company's interest rate risk exposure lies at the
Bank level. As a result, all significant interest rate risk management
procedures are performed at the Bank level. Based upon the nature of its
operations, the Bank is not subject to foreign currency exchange or commodity
price risk. The Bank's real estate loan portfolio, concentrated primarily within
Northern California, is subject to risks associated with the local economy. The
Company does not own any trading assets. See "Asset Quality" in Item 7 of this
Report.
51
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.
52
The following table sets forth, as of December 31, 2003, the
distribution of repricing opportunities for the Company's earning assets and
interest-bearing liabilities, the interest rate sensitivity gap, the cumulative
interest rate sensitivity gap, the interest rate sensitivity gap ratio (i.e.,
earning assets divided by interest-bearing liabilities) and the cumulative
interest rate sensitivity gap ratio.
After Three After Six After One
Within Months But Months But Year But
Three Within Six Within Within After Five
Months Months One year Five Years Years Total
--------------------------------------------------------------------------
(dollars in thousands)
Earning assets:
Federal funds sold $8,600 $ --- $ --- $ --- $ --- $8,600
Investment securities 15,703 2,237 12,147 24,477 21,231 75,795
Loans 95,312 34,797 43,542 127,021 113,849 414,521
--------------------------------------------------------------------------
Total earning assets 119,615 37,034 55,689 151,498 135,080 498,916
--------------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing transaction accounts 154,640 --- --- --- --- 154,640
Time deposits 57,835 54,132 70,159 10,657 --- 192,783
Other borrowings 16,265 --- --- --- --- 16,265
Subordinated debentures --- --- --- --- 20,000 20,000
--------------------------------------------------------------------------
Total interest-bearing liabilities 228,740 54,132 70,159 10,657 20,000 383,688
--------------------------------------------------------------------------
Interest rate sensitivity gap ($109,125) ($17,098) ($14,470) $140,841 $115,080 $115,228
==========================================================================
Cumulative interest rate sensitivity gap ($109,125) ($126,223) ($140,693) $148 $115,228
===============================================================
Interest rate sensitivity gap ratio 0.52% 0.68% 0.79% 14.22% 6.75%
Cumulative interest rate sensitivity gap ratio 0.52% 0.55% 0.60% 1.00% 1.30%
Interest-bearing transaction accounts, which consist of money market
and savings deposit accounts, are classified as repricing within three months.
Some of these deposits may be repriced at management's option, and therefore a
decision not to reprice such deposits could significantly alter the Company's
net interest margin.
Even though the Company's gap position is liability sensitive within
the one year time horizon, management expects that, in a declining rate
environment, the Company's net interest margin would be expected to decline,
and, in an increasing rate environment, the Company's net interest margin would
tend to increase. The Company has experienced greater mortgage lending activity
through mortgage refinancing as rates declined, and may increase its net
interest margins in an increasing rate environment if more traditional
commercial bank lending becomes a higher percentage of the overall earning
assets mix. There can be no assurance, however, that under such circumstances
the Company will experience the described relationships to declining or
increasing interest rates.
53
On a quarterly basis, NBR management prepares an analysis of interest
rate risk exposure. Such analysis calculates the change in net interest income
and the theoretical market value of the Bank's equity given a change in general
interest rates of 200 basis points up and 200 basis points down. All changes are
measured in dollars and are compared to projected net interest income and the
current theoretical market value of the Bank's equity. This theoretical market
value of the Bank's equity is calculated by discounting cash flows associated
with the Company's assets and liabilities. The following is a December 31, 2003
and 2002 summary of interest rate risk exposure as measured on a net interest
income basis and a market value of equity basis, given a change in general
interest rates of 200 basis points up and 200 basis points down.
Change in Annual Change in
Change in Interest Rate Net Interest Income Market Value of Equity
2003
----
+200 $449,000 ($13,855,000)
+100 79,000 (7,789,000)
-100 128,000 5,737,000
-200 (745,000) 11,931,000
2002
----
+200 $546,000 ($10,255,000)
+100 412,000 (4,324,000)
-100 (1,541,000) 1,363,000
-200 (3,371,000) 3,807,000
The Company's interest rate risk exposure to a rising rate environment
remained relatively stable in 2003 compared to 2002, while exposure to a falling
interest rate environment decreased in 2003 compared to 2002. This decrease was
principally due to the current low rate environment which limits the Company
from lowering its funding costs at a rate consistent with potential 100 or 200
basis point declines in yields on earning assets.
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 of 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
the current market rate. Actual results could differ significantly from those
estimates which would result in significant differences in the calculated
projected change.
54
Item 8. Financial Statements and Supplementary Data
Financial Statements
The following consolidated financial statements of Redwood and its
subsidiaries and the report of independent auditors are included in this
section:
Page
Report of Independent Auditors.......................................................................56
Consolidated Financial Statements of Redwood Empire Bancorp and Subsidiaries
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001..............................................................57
Consolidated Balance Sheets as of December 31, 2003 and 2002.......................................58
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2003, 2002 and 2001..............................................................59
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001..............................................................60
Notes to Consolidated Financial Statements.........................................................62
55
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
Redwood Empire Bancorp
Santa Rosa, California
We have audited the accompanying consolidated balance sheets of Redwood
Empire Bancorp and subsidiaries (Company) as of December 31, 2003 and 2002 and
the related consolidated statements of operations, shareholders' equity and cash
flows for the years ended December 31, 2003, 2002 and 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Redwood
Empire Bancorp and subsidiaries as of December 31, 2003 and 2002 and the results
of their operations and their cash flows for the years ended December 31, 2003,
2002 and 2001 in conformity with accounting principles generally accepted in the
United States of America.
Crowe Chizek and Company LLC
South Bend, Indiana
January 9, 2004
56
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except share and per share data)
Year Ended December 31,
------------------------------------------------
2003 2002 2001
--------------- --------------- ----------------
Interest income:
Interest and fees on loans $26,636 $25,702 $27,904
Interest on investment securities 3,455 4,335 4,879
Interest on federal funds sold 43 499 772
--------------- --------------- ----------------
Total interest income 30,134 30,536 33,555
Interest expense:
Interest on deposits 5,996 8,579 12,430
Interest on other borrowings 89 88 139
Interest on subordinated debentures 1,283 1,003 882
--------------- --------------- ----------------
Total interest expense 7,368 9,670 13,451
--------------- --------------- ----------------
Net interest income 22,766 20,866 20,104
Provision for loan losses --- --- ---
--------------- --------------- ----------------
Net interest income after provision for loan losses 22,766 20,866 20,104
--------------- --------------- ----------------
Noninterest income:
Service charges on deposit accounts 1,045 1,188 1,116
Merchant draft processing, net 4,824 5,009 4,240
Loan servicing income 158 268 295
Net realized gains on securities
available for sale 86 294 112
Gain/(loss) on sale of loans (9) 13 ---
Other income 729 843 836
--------------- --------------- ----------------
Total noninterest income 6,833 7,615 6,599
--------------- --------------- ----------------
Noninterest expense:
Salaries and employee benefits 9,435 8,967 8,336
Occupancy and equipment expense 2,105 2,126 2,026
Other 4,860 4,912 4,089
--------------- --------------- ----------------
Total noninterest expense 16,400 16,005 14,451
--------------- --------------- ----------------
Income before income taxes 13,199 12,476 12,252
Provision for income taxes 5,550 4,515 4,945
--------------- --------------- ----------------
Net income $7,649 $7,961 $7,307
=============== =============== ================
Basic earnings per common share:
Net income $1.52 $1.53 $1.32
Weighted average shares 5,026,000 5,211,000 5,554,500
Diluted earnings per common share:
Net income $1.48 $1.47 $1.27
Weighted average shares 5,184,000 5,400,000 5,737,500
See Notes to Consolidated Financial Statements.
57
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share data)
December 31, December 31,
2003 2002
-------------------------------------
Cash and due from banks $19,259 $21,837
Federal funds sold 8,600 17,500
-------------------------------------
Cash and cash equivalents 27,859 39,337
Investment securities:
Held to maturity, at cost (fair value: 2003 - $18,041; 2002 - $17,268) 17,566 16,764
Available for sale, at fair value (amortized cost: 2003 - $56,921; 2002 - $81,092) 58,229 83,157
-------------------------------------
Total investment securities 75,795 99,921
Mortgage loans held for sale 192 ---
Loans:
Portfolio loans 414,521 365,076
Allowance for loan losses (7,162) (7,400)
-------------------------------------
Net loans 407,359 357,676
Premises and equipment, net 2,489 2,760
Cash surrender value of life insurance 3,782 3,620
Other assets and interest receivable 11,424 9,867
-------------------------------------
Total Assets $528,900 $513,181
=====================================
Liabilities and Shareholders' Equity:
Deposits:
Noninterest bearing demand deposits $107,359 $103,484
Interest bearing transaction accounts 154,640 128,292
Time deposits one hundred thousand and over 73,262 69,000
Other time deposits 119,521 152,317
-------------------------------------
Total deposits 454,782 453,093
Other borrowings 16,265 12,356
Subordinated debentures 20,000 10,000
Other liabilities and interest payable 10,173 8,925
-------------------------------------
Total Liabilities 501,220 484,374
-------------------------------------
Shareholders' Equity:
Preferred stock, no par value; authorized 2,000,000 shares;
issued and outstanding: no shares --- ---
Common stock, no par value; authorized 10,000,000 shares; issued
and outstanding: 2003 - 4,950,984 shares, 2002 - 3,404,890 shares 10,577 10,853
Retained earnings 16,344 16,654
Accumulated other comprehensive income, net of tax 759 1,300
-------------------------------------
Total Shareholders' Equity 27,680 28,807
-------------------------------------
Total Liabilities and Shareholders' Equity $528,900 $513,181
=====================================
See Notes to Consolidated Financial Statements.
58
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Years ended December 31, 2003, 2002 and 2001
(in thousands, except per share data)
Accumulated
Other
Comprehensive Common Retained Comprehensive
Income Shares Stock Earnings Income (loss), Net Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balances, January 1, 2001 2,858 $14,601 $20,781 $77 $35,459
Comprehensive income:
Net income $7,307 7,307 7,307
Other comprehensive income:
Unrealized holding gains arising
during period, net of tax of $468 651
Add: reclassification adjustment
net of tax of ($45) (67)
---------------
Other comprehensive income 584 584 584
---------------
Comprehensive income $7,891
===============
Common stock repurchased (595) (3,278) (13,113) (16,391)
Stock split - 3 for 2 1,193
Stock options exercised, net of tax effect and shares
redeemed 74 1,050 1,050
Cash dividends declared - common ($0.25 per share) (1,322) (1,322)
-------------------------------------------------------------
Balances, December 31, 2001 3,530 12,373 13,653 661 26,687
Comprehensive income:
Net income $7,961 7,961 7,961
Other comprehensive income:
Unrealized holding gains arising
during period, net of tax of $395 824
Less: reclassification adjustment
net of tax of ($109) (185)
---------------
Other comprehensive income 639 639 639
---------------
Comprehensive income $8,600
===============
Common stock repurchased (137) (1,616) (2,167) (3,783)
Stock options exercised, net of tax effect 12 96 96
Cash dividends declared - common ($0.53 per share) (2,793) (2,793)
-------------------------------------------------------------
Balances, December 31, 2002 3,405 10,853 16,654 1,300 28,807
Comprehensive income:
Net income $7,649 7,649 7,649
Other comprehensive loss:
Unrealized holding gains (losses) arising
during period, net of tax of ($182) (489)
Less: reclassification adjustment
net of tax of ($34) (52)
---------------
Other comprehensive loss (541) (541) (541)
---------------
Comprehensive income $7,108
===============
Common stock repurchased (255) (1,145) (4,567) (5,712)
Stock split - 3 for 2 1,702
Stock options exercised, net of tax effect 99 869 869
Cash dividends declared - common ($0.67 per share) (3,392) (3,392)
-------------------------------------------------------------
Balances, December 31, 2003 4,951 $10,577 $16,344 $759 $27,680
=============================================================
See Notes to Consolidated Financial Statements.
59
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
Year ended December 31,
2003 2002 2001
------------------------------------------
Cash flows from operating activities:
Net income $7,649 $7,961 $7,307
------------------------------------------
Adjustments to reconcile net income to net cash
from operating activities:
Depreciation and amortization, net 487 456 130
Net realized gains on securities available for sale (86) (294) (112)
Loans originated for sale (4,316) (1,807) ---
Proceeds from sale of loans held for sale 4,115 1,820 ---
(Gain) loss on sale of loans 9 (13) ---
Change in cash surrender value of life insurance (162) (177) (168)
Change in other assets and interest receivable (1,148) (837) 706
Change in other liabilities and interest payable 1,248 (1,848) 2,084
------------------------------------------
Total adjustments 147 (2,700) 2,640
------------------------------------------
Net cash from operating activities 7,796 5,261 9,947
------------------------------------------
Cash flows from investing activities:
Net change in loans (49,111) (13,230) (36,058)
Purchases of investment securities available for sale (18,508) (64,436) (24,832)
Purchases of investment securities held to maturity (4,234) (4,840) (1,326)
Sales of investment securities available for sale 9,812 9,319 5,918
Maturities of investment securities available for sale 32,734 20,569 27,883
Maturities of investment securities held to maturity 3,327 5,623 13,866
Purchase of premises and equipment, net of retirements (449) (865) (884)
Proceeds from sale of other real estate owned --- --- 757
------------------------------------------
Net cash from investing activities (26,429) (47,860) (14,676)
------------------------------------------
Cash flows from financing activities:
Net change in noninterest bearing transaction accounts 3,875 16,515 (4,758)
Net change in interest bearing transaction accounts 26,348 6,835 (5,884)
Net change in time deposits (28,534) 32,331 2,721
Net change in other borrowings 3,909 8,486 342
Issuance of subordinated debentures 10,000 --- 10,000
Repurchases of common stock (5,712) (3,783) (16,391)
Issuance of common stock 661 96 773
Cash dividends paid (3,392) (2,793) (1,752)
------------------------------------------
Net cash from financing activities 7,155 57,687 (14,949)
------------------------------------------
Net change in cash and cash equivalents (11,478) 15,088 (19,678)
Cash and cash equivalents at beginning of year 39,337 24,249 43,927
------------------------------------------
Cash and cash equivalents at end of year $27,859 $39,337 $24,249
==========================================
(Continued)
60
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Continued)
Year ended December 31,
2003 2002 2001
-----------------------------------------
Supplemental Disclosures:
Cash paid during the year for:
Income taxes $4,645 $5,193 $5,155
Interest 8,013 9,311 13,618
See Notes to Consolidated Financial Statements.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - DESCRIPTION OF BUSINESS
Redwood Empire Bancorp ("Redwood," and with its subsidiaries, the
"Company") is a financial institution holding company headquartered in Santa
Rosa, California, and operating in Northern California with three wholly-owned
subsidiaries, National Bank of the Redwoods (NBR), a national bank chartered in
1985, and Redwood Statutory Trust I (RSTI) and Redwood Statutory Trust II
(RSTII), both Connecticut statutory trusts. 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 provide
an additional vehicle to raise capital and to better organize and market the
origination of real estate secured loans. The Company's business strategy
involves two principal business activities, core community banking services and
merchant card services, which are conducted through NBR.
NBR provides its core community banking services through five retail
branches located in Sonoma County, California, one retail branch located in
Mendocino County, California, and one retail branch located in Lake County,
California. Loan services at NBR are generally extended to professionals and to
businesses with annual revenues of less than $20 million. Commercial loans are
primarily for working capital, asset acquisition and commercial real estate.
NBR's targeted commercial banking market area includes the California counties
north of San Francisco. NBR generates noninterest income through merchant draft
processing by virtue of its status as a Principal Member of VISA/MasterCard. In
addition, NBR originates both commercial and residential construction loans for
its portfolio.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States of America and
general practices within the banking industry. The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. The estimates of allowance for
loan losses, allowance for merchant card charge-back losses and fair values of
securities and other financial instruments are particularly subject to change. A
summary of the more significant policies follows:
Basis of Presentation
The consolidated financial statements include the accounts of Redwood
Empire Bancorp and NBR. As discussed in Note M, RSTI and RSTII are not
consolidated in the financial statements. All material inter-company
transactions and accounts have been eliminated.
62
For the purpose of the statements of cash flows, cash and cash
equivalents have been defined as cash on hand, demand deposits with
correspondent banks, cash items in transit and federal funds sold.
Investment Securities
Securities held to maturity are carried at cost adjusted by the
accretion of discounts and amortization of premiums. The Company has the ability
and intent to hold these investment securities to maturity. Securities available
for sale may be sold to implement the Company's asset/liability management
strategies and in response to changes in interest rates, prepayment rates and
similar factors. Available for sale securities are recorded at market value and
unrealized gains or losses, net of income taxes, are included in accumulated
other comprehensive income or loss, as a separate component of shareholders'
equity. Federal Reserve Bank (FRB) stock and Federal Home Loan Bank (FHLB) stock
are restricted equity securities and are carried at cost. Gain or loss on sale
of investment securities is based on the specific identification method.
Interest income includes amortization of purchased premium or discount.
Securities are written down to fair value when a decline in fair value is not
temporary.
Loans and the Allowance for Loan Losses
Loans are stated at the principal balance outstanding net of the
allowance for loan losses and net deferred loan fees or costs. Loan fees net of
certain related direct costs to originate loans are deferred and amortized over
the contractual life of the loan using a method approximating the interest
method. Loan fees and direct costs related to the origination of loans held for
sale are recognized as a component of gain or loss on sale of mortgage loans
when the related loans are sold.
The allowance for loan losses is maintained at a level considered
adequate for probable incurred credit losses that can be reasonably anticipated
and is based on management's quarterly evaluation of the economic climate and
other factors related to the collectability of loan balances.
The factors considered by management include growth and composition of
the loan portfolio, overall portfolio quality, review of specific problem loans,
historical loss rates, regulatory reviews, trends and concentrations in
delinquencies and current economic conditions that may affect the borrower's
ability to pay. The actual results could differ significantly from management's
estimates. The allowance for loan losses is increased by provisions charged to
operations and reduced by loan charge-offs net of recoveries. A loan charge-off
is recorded when a loan has been determined by management to be uncollectable.
A loan is impaired when, based upon current information and events, it
is probable that NBR will be unable to collect all amounts due according to the
contractual terms of the loan agreement. This standard is applicable to all
loans, uncollateralized as well as collateralized, except loans that are
measured at the lower of cost or fair value. Impairment is measured based on the
present value of expected future cash flows discounted at the loan's effective
interest rate, the loan's observable market price, or the fair value of the
collateral if the loan is collateral dependent.
63
Interest income is recognized on impaired loans in a manner similar to
that of all loans. It is the Company's policy to place loans that are delinquent
90 days or more as to principal or interest on nonaccrual status unless well
secured and in the process of collection, and to reverse from current income
accrued but uncollected interest. Cash payments subsequently received on
nonaccrual loans are recognized as income only where the future collection of
all principal is considered by management to be probable.
Other Real Estate Owned
Property acquired by the Company through foreclosure is recorded at the
lower of estimated fair value less estimated selling costs (fair value) or the
carrying value of the related loan at the date of foreclosure. At the time the
property is acquired, if the fair value is less than the loan amounts
outstanding, any difference is charged against the allowance for loan losses.
After acquisition, valuations are periodically performed and, if the carrying
value of the property exceeds the fair value, a valuation allowance is
established by a charge to operations. Subsequent increases in the fair value
may reduce or eliminate this allowance.
Operating costs on foreclosed real estate are expensed as incurred.
Costs incurred for physical improvements to foreclosed real estate are
capitalized if the value is recoverable through future sale.
Company Owned Life Insurance
The Company has purchased life insurance policies on certain key
executives. Company owned life insurance is recorded at its cash surrender
value, or the amount that can be realized.
Loans Held for Sale
The Bank originates loans held for sale in the secondary market. Loans
held for sale are carried at the lower of cost or market in the aggregate.
Off-Balance-Sheet Risk
The Company is party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet. The contract or notional amounts of those instruments reflect the extent
of involvement the Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments.
64
Loan commitments are typically contingent upon the borrower meeting
certain financial and other covenants, and such commitments typically have fixed
expiration dates and require payment of a fee. As many of these commitments are
expected to expire without being drawn upon, the total commitments do not
necessarily represent future cash requirements. The Company evaluates each
potential borrower and the necessary collateral on an individual basis.
Collateral varies, but may include real property, bank deposits, debt
securities, equity securities, or business assets.
Standby letters of credit are conditional commitments written by the
Company to guarantee the performance of a customer to a third party. These
guarantees relate primarily to inventory purchases by the Company's commercial
customers, and such guarantees are typically short-term. Credit risk is similar
to that involved in extending loan commitments to customers and the Company
accordingly uses evaluation and collateral requirements similar to those of loan
commitments. Virtually all such commitments are collateralized.
Premises and Equipment
Premises and equipment consist of building, leasehold improvements,
furniture and equipment and are stated at cost, less accumulated depreciation
and amortization. Depreciation is computed using the straight-line method over
the estimated useful lives for financial reporting purposes, and an accelerated
method for income tax reporting. The estimated useful life of furniture and
equipment is between five and ten years. Leasehold improvements are amortized
over the terms of the lease or their estimated useful lives, whichever is
shorter.
Income Taxes
The Company accounts for income taxes using an asset and liability
approach, which requires the recognition of deferred tax assets and liabilities.
Future tax benefits attributable to temporary differences are recognized
currently to the extent that realization of such benefits is more likely than
not. These future tax benefits are measured by applying currently enacted tax
rates. A valuation allowance, if needed, reduces deferred tax assets to the
amount expected to be realized.
Earnings per Common Share
Basic earnings per common 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 common 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
entity.
On September 20, 2001 and July 15, 2003, the Company announced
three-for-two stock splits of its outstanding shares of common stock. Earnings
per share information for all periods presented give effect to the stock splits.
65
The following table reconciles the numerator and denominator used in
computing both basic earnings per common share and diluted earnings per common
share for the periods indicated. The weighted average shares outstanding have
been restated to give effect for the 2001 and 2003 three-for-two stock splits.
Twelve Months Ended
December 31,
---------------------------------------------------------------------
2003 2002 2001
--------------------- --------------------- ---------------------
Basic Diluted Basic Diluted Basic Diluted
(2) (2) (2)
--------- ----------- --------------------- ---------------------
(in thousands, except per share data)
Earnings per common share:
Net income $7,649 $7,649 $7,961 $7,961 $7,307 $7,307
Net income per share $1.52 $1.48 $1.53 $1.47 $1.32 $1.27
Weighted average common shares
outstanding 5,026 5,184(1) 5,211 5,400(1) 5,555 5,738(1)
Notes to earnings per common share table:
(1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 158, 189 and 183 for 2003, 2002 and 2001.
(2) Stock options of 0, 27 and 0 shares of common stock were not considered in
computing earnings per common share for 2003, 2002 or 2001 because they
were not dilutive.
66
Stock-Based Compensation
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in net
income, as all options granted had an exercise price equal to or greater than
the market price of the underlying common stock at date of grant. The following
table illustrates the effect on net income using earnings per share if expense
was measured using fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation.
2003 2002 2001
-----------------------------------------------
(dollars in thousands, except per share data)
Net income as reported $7,649 $7,961 $7,307
Deduct: Stock-based compensation expense
determined under fair value based method (121) (166) (166)
-----------------------------------------------
Pro forma net income $7,528 $7,795 $7,141
===============================================
Basic earnings per share as reported $1.52 $1.53 $1.32
Pro forma basic earnings per share 1.50 1.50 1.29
Diluted earnings per share as reported $1.48 $1.47 $1.27
Pro forma diluted earnings per share 1.45 1.44 1.24
Pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
The fair value of the options granted during 2003, 2002 and 2001 is
estimated as $417,000, $155,000 and $375,000 on the date of grant using the
Black-Scholes option-pricing model with the following assumptions:
2003 2002 2001
-----------------------------------------------
Risk-free interest rate 4.03% 4.06% 4.88%
Expected option life in years 7 10 10
Expected stock price volatility 31.82% 32.44% 33.25%
Dividend yield 3.1% 3.7% 2.9%
The weighted average per share fair value of the 2003, 2002 and 2001 awards was
$6.95, $5.34 and $4.17.
67
Business Segments
Internal financial information is primarily reported and aggregated in
two lines of business, community banking and bankcard services.
Comprehensive Income
Comprehensive income includes net income and other comprehensive income
or loss. The Company's only source of other comprehensive income or loss is
derived from unrealized gains and losses on investment securities
available-for-sale. Reclassification adjustments result from gains or losses on
investment securities available-for-sale that were realized and included in net
income of the current period that also had been included in other comprehensive
income or loss as unrealized holding gains or losses in the period in which they
arose. They are excluded from other comprehensive income or loss of the current
period to avoid double counting.
Adoption of New Accounting Standards
During 2003, the Company adopted FASB Statement 143, "Accounting for
Asset Retirement Obligations", FASB Statement 145, regarding extinguishment of
debt and accounting for leases, FASB Statement 146, "Accounting for Costs
Associated with Exit or Disposal Activities", FASB Statement 148, "Accounting
for Stock-Based Compensation - Transaction and Disclosure - an amendment to FASB
Statement No. 123", FASB Statement 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities", FASB Statement 150, "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equities", FASB Statement 132 (revised 2003), "Employers' Disclosures about
Pensions and Other Postretirement Benefits", FASB Interpretation 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees", and FASB
Interpretation 46, "Consolidation of Variable Interest Entities". Adoption of
the new standards did not materially affect the Company's operating results or
financial condition.
NOTE C - CASH AND DUE FROM BANKS
NBR is required to maintain average reserve and clearing balances
including cash on hand or on deposit with the Federal Reserve Bank. The required
reserve balance included in cash and due from banks was approximately $1,200,000
at December 31, 2003 and 2002. These balances do not earn interest.
68
NOTE D - INVESTMENT SECURITIES
An analysis of the investment securities portfolio follows:
Gross Gross
Fair Unrealized Unrealized
Value Gains Losses
------------------------------------------------
(in thousands)
December 31, 2003:
Available for sale:
U.S. Government obligations $17,702 $190 $ ---
Mortgage-backed 37,842 1,118 ---
------------------------------------------------
Total debt securities 55,544 1,308 ---
FRB and FHLB stock 2,685 --- ---
------------------------------------------------
Total available for sale $58,229 $1,308 $ ---
================================================
Carrying Unrecognized Unrecognized Fair
Amount Gains Losses (1) Value
------------------------------------------------------------
(in thousands)
Held to maturity:
Mortgage-backed $5,259 $112 $ --- $5,371
Other securities 12,307 400 (37) 12,670
------------------------------------------------------------
Total held to maturity $17,566 $512 ($37) $18,041
============================================================
(1) Unrecognized losses are less than twelve months as continuing unrecognized
losses.
Fair Unrealized Unrealized
Value Gains Losses
(in thousands)
------------------------------------------------
December 31, 2002:
Available for sale:
U.S. Government obligations $9,372 $371 $---
Mortgage-backed 71,183 1,694 ---
------------------------------------------------
Total debt securities 80,555 2,065 ---
FRB and FHLB stock 2,602 --- ---
------------------------------------------------
Total available for sale $83,157 $2,065 $---
================================================
69
Gross Gross
Carrying Unrecognized Unrecognized Fair
Amount Gains Losses Value
------------------------------------------------------------
(in thousands)
Held to maturity:
Mortgage-backed $8,611 $274 $ --- $8,885
Other securities 8,153 239 (9) 8,383
------------------------------------------------------------
Total held to maturity $16,764 $513 ($9) $17,268
============================================================
Debt securities by contractual maturity at December 31, 2003 were due
as follows. Securities not due at single maturity date, primarily
mortgage-backed securities, are shown separately.
Fair
Value
-------------------
(in thousands)
Available for sale:
One year or less $15,549
After one year through five years 2,153
After five years through ten years ---
After ten years ---
Mortgage-backed 37,842
-------------------
$55,544
===================
Carrying Fair
Amount Value
------------------- ------------------
(in thousands)
Held to maturity:
One year or less $ --- $ ---
After one year through five years 1,184 1,235
After five years through ten years 3,512 3,655
After ten years 7,611 7,780
Mortgage-backed 5,259 5,371
------------------- ------------------
$17,566 $18,041
=================== ==================
70
The following table summarizes securities with unrealized losses at December 31,
2003:
Description Less than 12 Months 12 Months or More Total
of Securities Fair Value Unrealized Loss Fair Value Unrealized Loss Value Unrealized Loss
- -------------------------------------------------------------------------------------------------------------------
US Government obligations $ --- $ --- $ --- $ --- $ --- $ ---
Mortgage-backed --- --- --- --- --- ---
Other securities 2,268 37 --- --- 2,268 37
--------------------------------------------------------------------------------------
Total temporarily impaired $2,268 $37 $ --- $ --- $2,268 $37
======================================================================================
The unrealized losses on other securities have not been recognized into
income because the issuers' bonds are of high credit quality (rated AA or
higher), management has the intent and ability to hold for the foreseeable
future, and the decline in fair value is largely due to increases in market
interest rates. The fair value is expected to recover as the bonds approach
their maturity date.
Proceeds from sales of available for sale investments in debt
securities during 2003, 2002 and 2001 were $9,812,000, $9,319,000, and
$5,918,000. These sales resulted in the realization of gross gains of $86,000,
$294,000 and $112,000 for 2003, 2002 and 2001.
Securities carried at approximately $30,148,000 and $34,402,000 at
December 31, 2003 and 2002 were pledged to secure public deposits, bankruptcy
deposits, and treasury tax and loan borrowings.
NOTE E - MORTGAGE LOAN SERVICING
The Company services mortgage loans and participating interests in
mortgage loans owned by investors. The unpaid principal balances of mortgage
loans serviced for others are as follows:
December 31,
2003 2002
--------------------------------------
(in thousands)
Mortgage loan portfolios serviced for:
Freddie Mac $162 $347
Fannie Mae 300 610
Other investors 4,310 7,421
------------------ ------------------
$4,772 $8,378
================== ==================
71
NOTE F - LOANS AND THE ALLOWANCE FOR LOAN LOSSES
The Company primarily makes permanent and construction residential real
estate loans in California, and loans to individuals and small businesses
primarily in Sonoma and Mendocino Counties, California. There are no major
industry segments in the loan portfolio. Outstanding loans by type were:
December 31,
2003 2002
-----------------------------------
(in thousands)
Residential real estate mortgage $108,851 $87,764
Commercial real estate mortgage 186,185 158,018
Commercial 55,473 62,958
Real estate construction 51,154 42,749
Installment and other 13,025 14,260
Less net deferred fees (167) (673)
----------------- -----------------
Total loans 414,521 365,076
Less allowance for loan losses (7,162) (7,400)
----------------- -----------------
Net loans $407,359 $357,676
================= =================
Activity in the allowance for loan losses is summarized as follows:
2003 2002 2001
---------------------------------------
(in thousands)
Balance, beginning of year $7,400 $7,580 $7,674
Provision for loan losses --- --- ---
Loans charged off (609) (298) (185)
Recoveries 371 118 91
----------- ----------- -----------
Balance, end of year $7,162 $7,400 $7,580
=========== =========== ===========
At December 31, 2003 and 2002, the Company's total recorded investment
in impaired loans was $1,266,000 and $2,794,000 of which $1,266,000 and
$2,493,000 related to the recorded investment for which there is a related
allowance for loan losses of $164,000 and $670,000, and $0 and $301,000 relates
to the amount of that recorded investment for which there is no related
allowance for loan losses. At December 31, 2003 and 2002, substantially all of
the impaired loan balance was measured based on the fair value of the
collateral, with the remainder measured by estimated present value of cash
flows.
72
The average recorded investment in impaired loans during the years
ended December 31, 2003, 2002 and 2001 was $1,798,000, $1,866,000 and
$2,973,000. The related amount of interest income recognized on an accrual and
cash basis during the periods that such loans were impaired was $0, $65,000 and
$49,000.
As of December 31, 2003 and 2002, there were $1,266,000 and $2,516,000
of loans on nonaccrual. Interest due but excluded from interest income on these
nonaccrual loans was $189,000, $66,000, and $88,000 for the years ended December
31, 2003, 2002 and 2001. Interest income received on nonaccrual loans was $0, $0
and $1,000 for the years ended December 31, 2003, 2002 and 2001.
At December 31, 2003 and 2002, there was $0 and $6,000 in loans past
due 90 days or more as to interest or principal and still accruing interest
The Company originates SBA loans for sale to investors. A summary of
the activity in SBA loans is as follows:
December 31,
2003 2002 2001
----------------------------------------
(in thousands)
SBA guaranteed portion of loans serviced for others $3,794 $4,389 $8,389
SBA loans, net of sold portion 8,209 7,938 8,163
From time to time the Company may extend credit to executive officers,
directors and related parties. There were no such balances outstanding at
December 31, 2003 and 2002.
NOTE G - PREMISES, EQUIPMENT AND LEASES
A summary of premises and equipment is as follows:
December 31,
2003 2002
---------------------------
(in thousands)
Land $85 $187
Building and leasehold improvements 2,864 3,352
Furniture and equipment 9,916 9,258
---------------------------
Total premises and equipment 12,865 12,797
Less accumulated depreciation and amortization (10,376) (10,037)
---------------------------
Premises and equipment, net $2,489 $2,760
===========================
Depreciation expense for the years ended December 31, 2003, 2002, and
2001 was $720,000, $741,000, and $736,000.
73
The Company leases certain premises and equipment used in the normal
course of business. There are no contingent rental payments and the Company has
three subleased properties. Total rental expense under all leases, including
premises, totaled $1,317,000, $1,326,000, and $1,282,000 in 2003, 2002 and 2001.
Minimum future lease commitments total $12,870,000. Lease commitments are as
follows: 2004 - $1,625,000; 2005 - $1,565,000; 2006 - $1,566,000; 2007 -
$1,516,000; 2008 - $1,453,000; and thereafter - $5,145,000. Minimum future
sublease receivables are as follows: 2004 - $132,000; 2005 - $132,000; 2006 -
$132,000; 2007 - $132,000; and 2008 - $132,000; and thereafter - $126,000. All
subleases expire by 2009.
NOTE H - DEPOSITS
Interest expense on time certificates of deposit of $100,000 or more
was $1,526,000, $2,996,000, and $5,398,000 during 2003, 2002 and 2001.
At December 31, 2003 the scheduled maturities for all time deposits are
as follows:
Year ending
December 31, (in thousands)
- --------------------- --------------------
2004 $182,126
2005 8,371
2006 363
2007 1,031
2008 892
--------------------
$192,783
====================
74
NOTE I - INCOME TAXES
The provision (benefit) for income taxes consists of the following:
Year Ended December 31,
2003 2002 2001
----------------------------------------
(in thousands)
Current:
Federal $3,844 $4,402 $4,268
State 1,230 257 1,080
------------- ------------ -------------
5,074 4,659 5,348
------------- ------------ -------------
Deferred:
Federal 376 139 (300)
State 100 (283) (103)
------------- ------------ -------------
476 (144) (403)
------------- ------------ -------------
$5,550 $4,515 $4,945
============= ============ =============
A reconciliation of the statutory income tax rate to the effective
income tax rate attributable to continuing operations of the Company is as
follows:
2003 2002 2001
------------------------------------------
Income tax at federal statutory rate 35.0% 35.0 % 35.0 %
State franchise tax, net of federal benefit 6.5 (.1) 5.2
Other .5 1.3 .2
----------- ----------- -----------
42.0% 36.2 % 40.4 %
=========== =========== ===========
The Company's effective tax rate varies with changes in the relative
amounts of its non-taxable income and nondeductible expenses. The Company's
effective tax rate on continuing operations was 42.0% in 2003, 36.2% in 2002 and
40.4% in 2001. The primary reason for the reduction in the Company's effective
tax rate in 2002 was the January 15, 2002 formation of NBR Real Estate
Investment Trust, a Maryland Real Estate Investment Trust ("REIT"). This entity
was formed as a subsidiary of NBR to provide an additional vehicle to raise
capital and to better organize NBR's marketing and origination of real estate
secured lending. As a result of the formation and funding of this entity, along
with the one-time benefit associated with the 2002 recapture of only 50% of the
Company's California state bad debt reserve, and the allowed permanent deduction
of the other 50% of the Company's California state bad debt reserve, the
Company's effective tax rate was reduced to 36.2% in 2002. In December 2003, the
California Franchise Tax Board announced that it has taken the position that
certain tax transactions related to REITs and regulated investment companies
(RICs) will be disallowed. Additionally, there are indications that the State of
California may aggressively challenge certain strategies such as REITs, and
California is encouraging voluntary compliance with their announced positions
with regard to REITs through the passage of Senate Bill 614 and Assembly Bill
1601, which were signed into law in the fourth quarter of 2003. Therefore, in
the fourth quarter of 2003 the Company reversed certain previously recognized
net state tax benefits related to the REIT and the Company did not recognize
75
any state tax benefit related to the REIT for 2003. As a result, the Company's
effective tax rate increased to 42.0% in 2003. The Company believes it is
appropriately reserved for REIT tax benefits previously recognized.
Deferred income taxes, included in other assets and interest
receivable, reflect the tax effect of temporary differences existing between the
financial statement basis and tax basis of the Company's assets and liabilities.
Deferred tax benefits attributable to temporary differences are recognized to
the extent that realization of such benefits is more likely than not. The
Company believes it is more likely than not that the net deferred tax assets at
December 31, 2003 and 2002 will be utilized to reduce future taxable income.
Accordingly, there was no valuation allowance associated with deferred tax
assets at December 31, 2003 and 2002. The tax effect of the principal temporary
items creating the Company's net deferred tax asset included in other assets and
interest receivable are:
December 31,
2003 2002
-------------------------
(in thousands)
Deferred tax assets:
Allowance for loan losses $3,283 $3,392
Restructuring costs 10 ---
Accrued expenses not yet deductible 797 746
Depreciation 400 482
Securities marked to market for
tax purposes 549 765
Other 81 261
------------ ------------
Total deferred tax assets 5,120 5,646
------------ ------------
Deferred tax liabilities:
Unrealized gain on securities
available for sale (549) (765)
FHLB stock dividends (399) (361)
State taxes (332) (420)
------------ ------------
Total deferred tax liabilities (1,280) (1,546)
------------ ------------
Net deferred tax asset $3,840 $4,100
============ ============
76
NOTE J - OTHER BORROWINGS
Other borrowings consist of the following:
December 31,
2003 2002
--------------------------
(in thousands)
Treasury, tax and loan note $2,757 $3,870
Advances from the FHLB 13,500 5,000
Advance from Wells Fargo --- 1,150
Security repurchase agreement 8 2,336
--------------------------
$16,265 $12,356
==========================
Treasury, Tax and Loan Note
The Company enters into various short-term borrowing agreements, which
include Treasury, Tax and Loan borrowings. These borrowings have maturities of
one day and are collateralized by investments or loans.
Advances from the FHLB
The Company has a short-term borrowing agreement with the Federal Home
Loan Bank of San Francisco (FHLB). These borrowings have maturities of one day.
During 2003, 2002 and 2001, the highest month-end balance during the year was
$13,500,000, $5,000,000 and $6,000,000. At December 31, 2003 and 2002 there was
an outstanding balance of $13,500,000 and $5,000,000. During 2003, 2002 and 2001
the average balance was $5,545,000, $3,891,000 and $2,802,000 at average
interest rates of 1.2%, 2.0% and 3.9%. All borrowings from the FHLB must be
collateralized, and the Company pledged approximately $69,000,000 and
$42,000,000 of residential mortgage loans as of December 31, 2003 and 2002, to
the FHLB to secure any funds it may borrow. The available credit under this
agreement at December 31, 2003 and 2002 was $38,000,000 and $37,000,000.
Advances from UBOC
During 1999, Redwood entered into an agreement with Union Bank of
California (UBOC) to obtain a $3,000,000 unsecured line of credit for short-term
borrowing purposes. At December 31, 2003 and 2002 the line had been paid off.
During 2003 and 2002, there were no advances under this line of credit. During
2001 the highest month-end balance was $1,279,000 and the average balance was
$35,000 at an average interest rate of 9.02%.
77
Advances from Wells Fargo
During 2001, Redwood entered into an agreement with Wells Fargo Bank to
obtain a $2,500,000 unsecured line of credit for short-term borrowing purposes.
At December 31, 2002 there was an outstanding balance of $1,150,000 as compared
to the line having been paid off as of December 31, 2003. The available credit
under this line at December 31, 2003 and 2002 was $2,500,000 and $1,350,000. The
average balance of advances was $768,000, $298,000 and $523,000 for 2003, 2002
and 2001 at an average interest rate of 2.70%, 3.41% and 5.12%. The highest
month-end balance during 2003, 2002 and 2001 was $2,000,000, $1,150,000 and
$1,500,000. This agreement has a maturity date of October 15, 2004.
NOTE K - NONINTEREST EXPENSE - OTHER
The major components of noninterest expense - other are as follows:
Year Ended December 31,
2003 2002 2001
----------------------------------------
(in thousands)
Professional fees $808 $1,119 $360
Regulatory expense and insurance 465 420 396
Postage and office supplies 516 531 529
Shareholder expenses and director fees 463 379 377
Advertising 475 400 484
Telephone 384 395 389
Electronic data processing 1,170 1,113 944
Other 579 555 610
------------- ------------ -------------
$4,860 $4,912 $4,089
============= ============ =============
NOTE L - STOCK OPTIONS AND BENEFIT PLANS
The Company's 1991 stock option plan, which was amended in 1992,
provides for the granting of both incentive stock options and nonqualified stock
options to directors and key employees. Generally, options outstanding under the
stock option plan are granted at prices equal to the market value of the stock
at the date of grant, vest ratably over a four year service period and expire
ten years subsequent to the award. During 2001, all shares remaining in this
plan were granted.
During 2001, the Company's 2001 stock option plan was adopted. Similar
to the 1991 stock option plan, incentive stock options and nonqualified stock
options may be granted to key employees and directors. Options outstanding under
the stock option plan are granted at prices equal to the market value of the
stock at the date of grant, vest ratably over a four year service period and
expire ten years subsequent to the award.
78
Outstanding common stock options at December 31, 2003, are exercisable
at various dates through 2013. The following table summarizes option activity.
The following information has been restated to give effect of the three-for-two
stock splits announced September 20, 2001 and July 15,2003.
Weighted Average
Number Option Price
of Shares per Share
----------------------------------------
(in thousands)
Balance at January 1, 2001 483 $5.87
Options granted 90 12.11
Options exercised, net of shares redeemed (178) 5.30
----------------------------------------
Options cancelled (5) 9.11
Balance at December 31, 2001 390 7.52
Options granted 29 20.03
Options exercised (18) 4.93
----------------------------------------
Balance at December 31, 2002 401 8.54
Options granted 60 24.82
Options exercised (99) 6.66
----------------------------------------
Balance at December 31, 2003 362 11.75
==================
At December 31, 2003, 216,000 shares were available for future grants
under the 2001 plan.
Additional information regarding options outstanding as of December 31,
2003 is as follows:
Options Outstanding Options Exercisable
-------------------------------------------------------------------
Weighted Avg.
Range of Remaining
Exercise Number Contractual Weighted Avg. Number Weighted Avg.
Prices Outstanding Life (yrs) Exercise Price Exercisable Exercise Price
- -----------------------------------------------------------------------------------------------------
(in thousands) (in thousands)
$3.00 - $4.99 79 2 $4.25 79 $4.25
5.00 - 6.99 33 2 5.80 33 5.80
7.00 - 8.99 10 5 7.61 10 7.61
9.00 - 10.99 80 5 9.15 79 9.13
11.00 - 12.99 35 7 11.44 18 11.44
13.00 - 14.99 33 7 13.23 16 13.23
19.00 - 20.99 42 8 19.87 20 19.95
25.00 - 26.99 50 10 25.41 --- ---
----------------- -----------------
362 11.75 255 8.40
================= =================
79
In 1991 the Company established a 401(K) savings plan for employees
over age 21 who have at least 90 days of continuous service. The Company's
matching contributions are based on a sliding scale for a maximum contribution
per employee of $4,000 for 2003, 2002 and 2001. Company contributions totaled
$239,000, $221,000, and $228,000 in 2003, 2002 and 2001.
In December 1993 the Company established a supplemental benefit plan
(Plan) to provide death benefits and supplemental income payments during
retirement for selected officers. The Plan is a nonqualified defined benefit
plan and is unsecured. Benefits under the Plan are fixed for each participant
and are payable over a specific period following the participant's retirement or
at such earlier date as termination or death occurs. Participants vest in the
plan based on their years of service subsequent to being covered by the Plan. As
of December 31, 2003, 2002 and 2001, there is only one participant in the plan.
The Company has purchased insurance policies to provide for its obligations
under the Plan in the event a participant dies prior to retirement. The cash
surrender value of such policies was $3,782,000 at December 31, 2003 and
$3,620,000 at December 31, 2002. Under this Plan, the Company recognized expense
of $101,000, $81,000, and $70,000 in 2003, 2002 and 2001. The aggregate
liability of the Plan was approximately $398,000 and $324,000 at December 31,
2003 and 2002.
NOTE M - SUBORDINATED DEBENTURES AND 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.
The subordinated debentures are considered Tier 1 capital (with certain
limitations applicable) under current regulatory guidelines. As of December 31,
2003 and 2002, 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.
80
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,
are included in interest expense in the consolidated financial statements. While
the subordinated debentures can be considered Tier 1 capital under current
regulatory guidelines, as a result of certain limitations applicable, they
currently only qualify as Tier 2 regulatory capital. As of December 31, 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 set forth in 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.
Prior to 2003, RSTI was consolidated in the Company's financial
statements with the trust preferred securities issued by the trust reported in
liabilities as "trust preferred securities" and the subordinated debentures
eliminated in consolidation. Under new accounting guidance, FASB Interpretation
No. 46, as revised in December 2003, RSTI and RSTII are not consolidated with
the Company. Accordingly, the amounts previously reported as "trust preferred
securities" in liabilities have been recaptioned "subordinated debentures" and
continue to be presented in liabilities on the balance sheet. At December 31,
2003 and 2002, the amount of the subordinated debentures and trust preferred
securities were the same. The effect of no longer consolidating the trusts does
not change the amounts reported as the Company's assets, liabilities, equity or
interest expense.
NOTE N - REGULATORY MATTERS
One of the principal sources of cash for Redwood is dividends from NBR.
Total dividends which may be declared by subsidiary financial institutions
depend on the regulations which govern them. In addition, regulatory agencies
can place dividend restrictions on the subsidiaries based on their evaluation of
the financial condition of the subsidiaries. No restrictions are currently
imposed by regulatory agencies on the subsidiaries other than the limitations
found in the regulations which govern the respective subsidiaries. The approval
of the 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. The aggregate amount of dividends which
may be declared by NBR to be paid to Redwood in 2004 without prior regulatory
approval, approximates $4,599,000 plus current 2004 net profits.
81
NBR is subject to certain restrictions under the Federal Reserve Act,
including restrictions on the extension of credit to affiliates. In particular,
it is prohibited from lending to an affiliated company unless the loans are
secured by specific types of collateral. Such secured loans and other advances
from the subsidiaries are limited to 10 percent of the subsidiary's equity. No
such loans or advances were outstanding during 2003 or 2002.
Redwood and NBR are subject to various regulatory capital requirements
administered by the federal banking agencies. In addition to these capital
guidelines, the Federal Deposit Insurance Corporation Improvement Act of 1991
(FDICIA) required each federal banking agency to implement a regulatory
framework for prompt corrective actions for insured depository institutions that
are not adequately capitalized. The FRB, FDIC, OCC and OTS have adopted such a
system which became effective on December 19, 1992. Failure to meet minimum
capital requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. The regulations require
the Company to meet specific capital adequacy guidelines that involve
quantitative measures of the Company's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
NBR's capital classification is also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company to maintain a minimum leverage ratio of Tier 1
capital (as defined in the regulations) to adjusted assets (as defined), and
minimum ratios of Tier 1 and total capital (as defined) to risk-weighted assets
(as defined). As of December 31, 2003 and 2002, the most recent notification
from the OCC categorized NBR as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized, NBR must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed NBR's category. The Company
is also considered to be well capitalized as of December 31, 2003 and 2002.
There are no conditions or events since the most recent regulatory notifications
that management believes have changed NBR's or the Company's capital categories.
82
To Be Categorized as
For Capital Well-Capitalized Under
Actual Adequacy Purposes Prompt Corrective Action
------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
------------------------------------------------------------------------------
(in thousands) (in thousands) (in thousands)
At December 31, 2003:
Company
Leverage Capital (to Average Assets) $33,449 6.47% $20,672 4.00% $25,841 5.00%
Tier 1 Capital (to Risk-weighted Assets) 33,449 7.93% 16,872 4.00% 25,308 6.00%
Total Capital (to Risk-weighted Assets) 50,383 11.94% 33,744 8.00% 42,180 10.00%
NBR
Leverage Capital (to Average Assets) 39,013 7.59% 20,554 4.00% $25,692 5.00%
Tier 1 Capital (to Risk-weighted Assets) 39,013 9.29% 16,798 4.00% 25,197 6.00%
Total Capital (to Risk-weighted Assets) 44,286 10.55% 33,597 8.00% 41,996 10.00%
At December 31, 2002:
Company
Leverage Capital (to Average Assets) $33,597 6.59% $20,396 4.00% $25,495 5.00%
Tier 1 Capital (to Risk-weighted Assets) 33,597 8.69% 15,461 4.00% 23,191 6.00%
Total Capital (to Risk-weighted Assets) 40,061 10.36% 30,922 8.00% 38,652 10.00%
NBR
Leverage Capital (to Average Assets) $36,261 7.12% $20,362 4.00% $25,452 5.00%
Tier 1 Capital (to Risk-weighted Assets) 36,261 9.39% 15,439 4.00% 23,158 6.00%
Total Capital (to Risk-weighted Assets) 41,117 10.65% 30,877 8.00% 38,596 10.00%
Management believes that as of December 31, 2003, the Company and NBR
met all capital requirements to which they were subject. Under the most
stringent capital requirement, NBR has approximately $10,689,000 in excess
capital before it becomes "undercapitalized" under the regulatory framework for
prompt corrective action.
The prompt corrective action regulations impose restrictions upon all
financial institutions to refrain from certain actions which would cause an
institution to be classified as "undercapitalized", such as the declaration of
dividends or other capital distributions or payment of management fees, if
following the distribution or payment the institution would be classified as
"undercapitalized". In addition, financial institutions which are classified as
"undercapitalized" are subject to certain mandatory and discretionary
supervisory actions.
83
NOTE O - BUSINESS SEGMENTS
The Company operates in two principal industry segments: core community
banking, and merchant card services. The Company's core community banking
industry segment includes commercial, commercial real estate, construction, and
permanent residential lending along with all depository activities. As of
December 31, 2003, the Company's merchant card services industry group provided
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 includes indirect costs, such as overhead and operations
and technology expense, which 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.
84
For the year ended December 31, 2003
Community Total
Banking Bankcard Company
--------------------------------------
(in thousands)
Total interest income $30,134 $ --- $30,134
Total interest expense 7,337 31 7,368
Interest income (expense) allocation (736) 736 ---
--------------------------------------
Net interest income 22,061 705 22,766
Provision for loan losses --- --- ---
Total other operating income 2,009 4,824 6,833
Total other operating expense 13,502 2,898 16,400
--------------------------------------
Income before income taxes 10,568 2,631 13,199
Provision for income taxes 4,445 1,105 5,550
--------------------------------------
Net income $6,123 $1,526 $7,649
======================================
Total Average Assets $488,297 $29,086 $517,383
======================================
For the year ended December 31, 2002
Community Total
Banking Bankcard Company
--------------------------------------
(in thousands)
Total interest income $30,536 $ --- $30,536
Total interest expense 9,641 29 9,670
Interest income (expense) allocation (625) 625 ---
--------------------------------------
Net interest income 20,270 596 20,866
Provision for loan losses --- --- ---
Total other operating income 2,606 5,009 7,615
Total other operating expense 13,327 2,678 16,005
--------------------------------------
Income before income taxes 9,549 2,927 12,476
Provision for income taxes 3,469 1,046 4,515
--------------------------------------
Net income $6,080 $1,881 $7,961
======================================
Total Average Assets $465,678 $26,788 $492,466
======================================
85
For the year ended December 31, 2001
Community Total
Banking Bankcard Company
--------------------------------------
(in thousands)
Total interest income $33,555 $ --- $33,555
Total interest expense 13,441 10 13,451
Interest income (expense) allocation (1,052) 1,052 ---
--------------------------------------
Net interest income 19,062 1,042 20,104
Provision for loan losses --- --- ---
Total other operating income 2,359 4,240 6,599
Total other operating expense 12,222 2,229 14,451
--------------------------------------
Income before income taxes 9,199 3,053 12,252
Provision for income taxes 3,714 1,231 4,945
--------------------------------------
Net income $5,485 $1,822 $7,307
======================================
Total Average Assets $422,134 $26,374 $448,508
======================================
NOTE P - FAIR VALUES OF FINANCIAL INSTRUMENTS
The Company discloses the fair values of financial instruments for
which it is practicable to estimate their value. Although management uses its
best judgment in assessing fair values, there are inherent weaknesses in any
estimating technique that may be reflected in the fair values disclosed. The
fair value estimates are made at a discrete point in time based on relevant
market data, information about the financial instruments, and other factors.
Estimates of fair value of financial instruments without quoted market prices
are subjective in nature and involve various assumptions and estimates that are
matters of judgment. Changes in the assumptions used could significantly affect
these estimates. The fair values have not been adjusted to reflect changes in
market conditions for the period subsequent to the valuation dates of December
31, 2003 and 2002, and therefore, estimates presented herein are not necessarily
indicative of amounts which could be realized in a current transaction.
The following estimates and assumptions were used on December 31, 2003
and 2002 to estimate the fair value of each class of financial instruments for
which it is practicable to estimate that value.
(a) Cash and Cash Equivalents
For cash and cash equivalents, the carrying amount is a reasonable
estimate of fair value.
86
(b) Investment Securities
Fair value equals quoted market price, if available. If a quoted market
price is not available, fair value is estimated using quoted market prices for
similar securities. For investments in unregistered mortgage-backed securities
with recourse, fair value was estimated based on the expected future cash flows
to be received adjusted for prepayments, foreclosures, losses and other
significant factors impacting fair value. U.S. Government agency stock has no
trading market but is required as part of membership, and therefore it is
carried at cost.
(c) Loans, net
To estimate fair value of loans held for investment, including
commercial loans, mortgages, construction and other loans, each loan category is
segmented by fixed and adjustable rate interest terms, by estimated credit risk,
by maturity, and by performing and nonperforming categories.
The fair value of performing loans is estimated by discounting
contractual cash flows using the current interest rates at which similar loans
would be made to borrowers with similar credit ratings and for the same
remaining maturities. Assumptions regarding credit risk, cash flow, and discount
rates are judgmentally determined using available market information.
The fair value of nonperforming loans and loans delinquent more than 30
days is estimated by discounting estimated future cash flows using current
interest rates with an additional risk adjustment reflecting the individual
characteristics of the loans.
(d) Interest Receivable and Payable
For interest receivable and payable, the carrying amount is a
reasonable estimate of fair value.
(e) Deposits
The fair value of deposits with no stated maturity, such as noninterest
bearing demand deposits, savings and money market accounts, is equal to the
amount payable on demand on December 31, 2003 and 2002. The fair value of time
deposits is based on the discounted value of contractual cash flows. The
discount rate is based on rates currently offered for deposits of similar size
and remaining maturities.
(f) Other Borrowings and Subordinated Debentures
The discounted value of contractual cash flows at market interest rates
for debt with similar terms and remaining maturities are used to estimate the
fair value of existing debt.
87
(g) Commitments to Fund Other Loans
The fair value of commitments to fund other loans represents fees
currently charged to enter into similar agreements with similar remaining
maturities. The fair value of these instruments is not material to the financial
statements.
The estimated fair values of the Company's financial instruments are as
follows:
December 31,
2003 2002
----------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------------------------------------------------
(in thousands)
Assets:
Cash and cash equivalents $27,859 $27,859 $39,337 $39,337
Investment securities 75,795 76,270 99,921 100,425
Loans, net 407,359 412,759 357,676 359,533
Interest receivable 2,137 2,137 2,325 2,325
Liabilities:
Deposits (454,782) (455,546) (453,093) (455,169)
Other borrowings (16,265) (16,265) (12,356) (12,356)
Subordinated debentures (20,000) (21,162) (10,000) (10,678)
Interest payable (1,152) (1,152) (1,797) (1,797)
NOTE Q - COMMITMENTS AND CONTINGENCIES
Certain lawsuits and claims arising in the ordinary course of business
have been filed or are pending against the Company or its subsidiaries. Based
upon information available to the Company, its review of such lawsuits and
claims and consultation with its counsel, the Company believes the liability
relating to these actions, if any, would not have a material adverse effect on
its consolidated financial statements.
88
A listing of financial instruments whose contract amounts represent
credit risk is as follows:
December 31, 2003 December 31, 2002
Fixed Rate Variable Rate Fixed Rate Variable Rate
------------------------------ ------------------------------
(in thousands)
Commitments to extend credit $8,802 $76,857 $13,746 $62,213
Standby letters of credit 5,375 --- 307 ---
Commitments to make loans are generally made for periods of 60 days or
less. The fixed rate loan commitments have interest rates ranging from 3.30%
to 8.75% and maturities ranging from one month to 120 months.
NOTE R - CONDENSED FINANCIAL INFORMATION OF
REDWOOD EMPIRE BANCORP (PARENT ONLY)
CONDENSED BALANCE SHEETS
December 31,
2003 2002
--------------------------
(in thousands)
Assets
Cash and cash equivalents $5,270 $46
Investment in NBR 41,050 39,604
Investment in RSTI and RSTII 620 310
Other assets 1,823 816
------------- ------------
Total assets $48,763 $40,776
============= ============
Liabilities and Shareholders' Equity
Subordinated debentures $20,000 $10,000
Short term borrowings --- 1,150
Borrowings from RSTI and RSTII 620 310
Other liabilities 463 509
Shareholders' equity 27,680 28,807
------------- ------------
Total liabilities and shareholders' equity $48,763 $40,776
============= ============
89
CONDENSED STATEMENTS OF OPERATIONS
Year Ended December 31,
2003 2002 2001
-------------------------------------
(in thousands)
Dividends from NBR $6,700 $6,600 $5,900
Interest expense 1,304 1,013 910
Operating expenses 454 979 585
------------ ------------------------
Income before equity in undistributed income of NBR 4,942 4,608 4,405
------------ ------------------------
Equity in undistributed income of NBR 1,987 2,612 2,299
------------ ------------------------
Income before income taxes 6,929 7,220 6,704
Income tax benefit (720) (741) (603)
------------ ------------------------
Net income $7,649 $7,961 $7,307
============ ========================
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31,
2003 2002 2001
---------------------------------------------------
(in thousands)
Cash flows from operating activities:
Net income $7,649 $7,961 $7,307
---------------------------------------------------
Adjustments:
Equity in undistributed excess distributed
income of NBR (1,987) (2,612) (2,299)
Change in other assets (1,109) (125) 642
Change in other liabilities (46) (50) 274
---------------------------------------------------
Total adjustments (3,142) (2,787) (1,383)
---------------------------------------------------
Net cash from operating activities 4,507 5,174 5,924
---------------------------------------------------
Cash flows from investing activities:
Capital investment into RSTI --- --- (310)
---------------------------------------------------
Net cash from investing activities --- --- (310)
---------------------------------------------------
Cash flows from financing activities:
Net change in other borrowings (1,150) 1,150 ---
Issuance of common stock 661 96 773
Issuance of subrodinated debentures 10,000 --- 10,000
Net proceeds from borrowings from RSTII 310 --- ---
Net proceeds from borrowings from RSTI --- --- 310
Repurchases of common stock (5,712) (3,783) (16,391)
Cash dividends paid (3,392) (2,793) (1,752)
---------------------------------------------------
Net cash from financing activities 717 (5,330) (7,060)
---------------------------------------------------
Net change in cash and cash equivalents 5,224 (156) (1,446)
Cash and cash equivalents at beginning of year 46 202 1,648
---------------------------------------------------
Cash and cash equivalents at end of year $5,270 $46 $202
===================================================
90
NOTE S- QUARTERLY RESULTS (UNAUDITED)
The following table summarizes the Company's quarterly results. All
earnings per share data and common stock prices have been restated to give
effect of the Company's three-for-two stock splits announced September 20, 2001
and July 15, 2003.
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
2002 2002 2002 2002 2003 2003 2003 2003 *
------------------------------------- -------------------------------------
Interest income $7,409 $7,734 $7,806 $7,587 $7,542 $7,608 $7,538 $7,446
Net interest income 4,989 5,323 5,271 5,283 5,530 5,678 5,783 5,775
Provision for loan losses --- --- --- --- --- --- --- ---
Other operating income 1,818 1,793 2,155 1,849 1,629 1,649 1,666 1,889
Other operating expenses 3,738 3,904 4,303 4,060 4,086 3,901 4,139 4,274
------------------------------------- -------------------------------------
Income before income taxes 3,069 3,212 3,123 3,072 3,073 3,426 3,310 3,390
Provision for income taxes 1,122 1,187 1,165 1,041 1,057 1,245 1,225 2,023
------------------------------------- -------------------------------------
Net income $1,947 $2,025 $1,958 $2,031 $2,016 $2,181 $2,085 $1,367
===================================== =====================================
Earnings per common share:
Basic earnings per common share: .37 .39 .37 .39 .40 .43 .42 .28
Diluted earnings per common share: .36 .37 .36 .38 .38 .42 .41 .27
Common Stock Prices:
High $19.20 $21.83 $18.67 $19.55 $20.50 $20.71 $24.95 $26.50
Low 16.27 17.44 16.80 17.17 17.67 18.50 19.01 23.50
Close 18.83 18.27 18.00 17.73 20.50 19.01 24.48 26.12
* Net income for the fourth quarter of 2003 was negatively impacted by provision
for income taxes totaling $2,023,000. The provision for income taxes included
$767,000 of expense related to the reversal of certain previously recognized net
state tax benefits related to the Company's REIT.
91
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9A. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures.
Our Chief Executive Officer (principal executive officer) and Chief
Financial Officer (principal financial officer) have concluded that the design
and operation of our disclosure controls and procedures are effective as of
December 31, 2003. This conclusion is based on an evaluation conducted under the
supervision and with the participation of management. Disclosure controls and
procedures are those controls and procedures which ensure that information
required to be disclosed in this filing is accumulated and communicated to
management and is recorded, processed, summarized and reported in a timely
manner and in accordance with Securities and Exchange Commission rules and
regulations.
(b) Changes in Internal Controls.
During the quarter ended December 31, 2003, there were no changes in
our internal control over financial reporting that materially affected, or are
reasonably likely to affect, our internal control over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant
Reference is made to the information contained in the Sections
entitled "Committees and Meetings of the Board of Directors", "Nominees",
"Executive Officers" and "Section 16(a) Beneficial Ownership Reporting
Compliance" of Redwood's Proxy Statement for the May 18, 2004 Annual Meeting of
Shareholders, to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934, as amended, and by this reference incorporated herein.
The Company has adopted a Code of Ethics applicable to all officers
(including senior financial officers, such as our Chief Executive Officer, Chief
Financial Officer and Controller), directors and employees of the Company. A
copy is posted on our website, www.nbronline.com. The Company intends to
disclose any amendment to, or waiver from any provision of, the Code of Ethics
that applies to its senior financial officers on its website.
Item 11. Executive Compensation
Reference is made to the information contained in the Sections entitled
"Performance Graph", "Board Compensation Committee Report on Executive
Compensation", "Compensation of Directors", "Executive Compensation" and
"Supplemental Benefit Plans" of Redwood's Proxy
92
Statement for the May 18, 2004 Annual Meeting of Shareholders, to be filed
pursuant to Regulation 14A under the Securities Exchange Act of 1934, as
amended, and by this reference incorporated herein.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Information concerning ownership of the equity stock of Redwood by
certain beneficial owners and management is contained in the Sections entitled
"Security Ownership of Certain Beneficial Owners" and "Security Ownership of
Management" of Redwood's Proxy Statement for the May 18, 2004 Annual Meeting of
Shareholders, to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934, as amended, and is by this reference incorporated herein.
The following table provides information relating to the Company's
equity compensation plans as of December 31, 2003:
(a)
Number of (c)
securities to Number of securities
be issued upon (b) remaining available for
exercise of Weighted-average future issuance under
outstanding exercise price of equity compensation
options warrants outstanding options plans (excluding
and rights warrants and rights securities reflect in
column (a))
--------------------- ------------------------ ---------------------------
Plan Category:
Equity compensation plans 330,000 $10.43
approved by shareholders 216,000
Equity compensation plans 32,000 25.41 ---
not approved by shareholders
--------------------- ---------------------------
Total 362,000 $11.75 216,000
===================== ===========================
At December 31, 2003, there were 216,000 shares of common stock
available for future issuance under the Company's 2001 stock option plan. For
additional information concerning the Company's equity compensation plans, see
Note L to our Consolidated Financial Statements included in this Report.
The Company awarded the President and Chief Executive Officer of NBR
options to purchase 32,000 shares of Common Stock in connection with the
commencement of his employment in December 2003. These options were awarded
outside of the 2001 Stock Option Plan. The exercise price of these options is
the market value of the Common Stock on the date of the award. These options
vest ratably over a four-year period.
93
Item 13. Certain Relationships and Related Transactions
Reference is made to the information contained in the Section entitled
"Certain Transactions" of Redwood's Proxy Statement for the May 18, 2004 Annual
Meeting of Shareholders to be filed pursuant to Regulation 14A under the
Securities Exchange Act of 1934, as amended, and by this reference incorporated
herein.
Item 14. Principal Accountant Fees and Services
Reference is made to the information contained in the Section entitled
"Ratification of Independent Auditors" of Redwood's Proxy Statement for the May
18, 2004 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A
under the Securities Exchange Act of 1934, as amended, and by this reference
incorporated herein.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) 1. Financial Statements.
The following consolidated financial statements of Redwood and its
subsidiaries and independent auditors' report are included in Part III
(Item 8) of this Form 10-K:
Page
Report of Independent Auditors.........................................56
Consolidated Financial Statements of Redwood Empire Bancorp
and Subsidiaries
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001..................................57
Consolidated Balance Sheets as of December 31, 2003 and 2002...........58
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2003, 2002 and 2001..................................59
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001..................................60
Notes to Consolidated Financial Statements.............................62
2. Financial Statement Schedules.
All financial statement schedules have been omitted, as
inapplicable.
3. Exhibits.
The following documents are filed herewith or incorporated by
reference in this Annual Report on Form 10-K.
94
Exhibit
Number Description
- ------- -----------
3.1 Amended Articles of Incorporation of Redwood filed as Exhibit 3.1
to our Amended Annual Report on Form 10-K for the year ended
December 31, 2002 and by this reference incorporated herein.
3.2 Amended and Restated By-Laws of Redwood dated May 18, 1999 filed
as Exhibit 3.2 to our Annual Report on Form 10-K for the year
ended December 31, 2001 and by this reference incorporated
herein.
4. Indenture, dated February 22, 2001, between Redwood and State
Street Bank and Trust Company of Connecticut, National
Association, filed as Exhibit 4 to our Annual Report on Form 10-K
for the year ended December 31, 2000 and by this reference
incorporated herein.
4.1 Amended and Restated Declaration of Trust, dated February 22,
2001, by and among State Street Bank and Trust Company of
Connecticut, National Association, Redwood and the Administrators
named therein filed as Exhibit 4.1 to our Annual Report on Form
10-K for the year ended December 31, 2000 and by this reference
incorporated herein.
4.2 Certificate of Amendment of Certificate of Determination of
Rights, Preferences, Privileges and Restrictions of the
Registrant's 7.80% Noncumulative Convertible Perpetual Preferred
Stock, Series A dated August 11, 1998 filed as Exhibit 4.2 to our
Annual Report on Form 10-K for the year ended December 31, 2001
and by this reference incorporated herein.
4.3 Indenture, dated July 22, 2003, between Redwood and US Bank
National Association of Connecticut. **
4.4 Amended and Restated Declaration of Trust, dated July 22, 2003,
by and among US Bank National Association of Connecticut, Redwood
and the Administrators named therein. **
10. Executive Salary Continuation Agreement between Patrick W.
Kilkenny and Redwood dated November 1, 1993, Amendment 1 dated
April 25, 1996, Amendment 2 dated November 16, 1999, and
Amendment 3 dated March 21, 2001, filed as Exhibit 10 to our
Annual Report on Form 10-K for the year ended December 31, 2001
and by this reference incorporated herein. *
10.1 Executive Severance Agreement between Patrick W. Kilkenny and
Redwood, filed as Exhibit 10.1 to our Annual Report on Form 10-K
for the year ended December 31, 1999 and by this reference
incorporated herein. *
95
10.4 Redwood's 401(k) Profit Sharing Plan, filed as Exhibit 28.1 to
our Registration Statement on Form S-8 dated June 12, 1990
(Registration No. 33-35377), and by this reference incorporated
herein. *
10.5 Redwood's Amended and Restated 1991 Stock Option Plan, filed as
Exhibit 4.1 to our Registration Statement on Form S-8 filed on
July 8, 1992 (Registration No. 33-49372), and by this reference
incorporated herein. *
10.6 Redwood's 2001 Stock Option Plan, filed as Appendix A to our
Definitive Proxy Statement on Form 14A filed with the SEC on
April 13, 2001, and by this reference incorporated herein. *
10.7 Redwood's Executive Salary Continuation Plan, filed as Exhibit
10.9 to our Registration Statement on Form S-2 dated December 13,
1993 (Registration No. 33-71324), and by this reference
incorporated herein. *
10.8 Redwood's Dividend Reinvestment and Stock Purchase Plan filed as
Exhibit 4.1 to our Registration Statement on Form S-3 dated April
28, 1993 (Registration No. 33-61750), and by this reference
incorporated herein.
10.9 Lease, dated June 1, 1999, between National Bank of the Redwoods
and Advanced Development & Investments, filed as Exhibit 10.8 to
our Annual Report on Form 10-K for the year ended December 31,
1999 and by this reference incorporated herein.
10.12 Guarantee Agreement, dated February 22, 2001, by and between
Redwood and State Street Bank and Trust Company of Connecticut,
National Association filed as Exhibit 10.11 to our Annual Report
on Form 10-K for the year ended December 31, 2000 and by this
reference incorporated herein.
10.13 NBR REIT Declaration of Trust, dated February 5, 2002 filed as
Exhibit 10.13 to our Annual Report on Form 10-K for the year
ended December 31, 2001 and by this reference incorporated
herein.
10.14 NBR REIT Bylaws dated February 5, 2002 filed as Exhibit 10.14 to
our Annual Report on Form 10-K for the year ended December 31,
2001 and by this reference incorporated herein.
10.15 Lease, dated August 22, 2002, between National Bank of the
Redwoods and Santa Rosa Northpoint Associates filed as Exhibit
10.15 to our Annual Report on Form 10-K for the year ended
December 31, 2002 and by this reference incorporated herein.
10.16 Lease amendment dated September 2, 2003 between National Bank of
the Redwoods and Upway Properties, LLC. **
10.17 Placement Agreement, dated July 17, 2003, between Redwood, First
Tennessee Capital Markets and Keefe, Bruyette & Woods, Inc.. **
96
10.18 Subscription Agreement, dated July 22, 2003, between Redwood
Statutory Trust II, Redwood and Preferred Term Securities II,
Ltd. **
10.19 Guarantee Agreement, dated July 22, 2003, by and between Redwood
and US Bank National Association of Connecticut. **
10.20 Employment Agreement, effective December 1, 2003, between
National Bank of the Redwoods and Stephen A. Fleming. **
11. Statement re Computation of Per Share Earnings. **
21. Subsidiaries of the Registrant. **
23.1 Consent of Crowe Chizek and Company LLC. **
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act, as adopted pursuant to
Section 302 of the Sarbanes- Oxley Act of 2002. **
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act, as adopted pursuant to
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. **
* Management contract or compensatory plan, contract or arrangement.
** Provided herewith.
97
(b) Reports on Form 8-K.
A report on Form 8-K was filed on October 9, 2003 to report under Item 5
the approval of a quarterly cash dividend.
A report on Form 8-K was filed on October 24, 2003 to report under Item 7
the press release of earnings for the third quarter of 2003 and to furnish
information under Item 9 in connection therewith.
A report on Form 8-K was filed on December 2, 2003 to report under Item 5
the announcement of the hiring of a new President and CEO of NBR.
(c) Exhibits Required by Item 601 of Regulation S-K
Reference is made to the exhibits under Item 15(a)(3) of this report.
(d) Additional Financial Statements
Not applicable.
98
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to be signed
on its behalf by the undersigned, thereunto duly authorized.
REDWOOD EMPIRE BANCORP
By: /S/ Patrick W. Kilkenny Dated: March 18, 2004
------------------------
Patrick W. Kilkenny
President, Chief Executive Officer and Director
(Principal Executive Officer)
And By: /S/ Kim C. McClaran Dated: March 18, 2004
------------------------
Kim C. McClaran
Vice President and
Chief Financial Officer
99
Pursuant to the requirements of the Securities Exchange Act of 1934, this
amendment has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
/S/ John H. Brenengen Dated: March 18, 2004
- --------------------------------------------
John H. Brenengen, Director
/S/ Dana R. Johnson Dated: March 18, 2004
- --------------------------------------------
Dana R. Johnson, Director
Chairman of the Board
/S/ Patrick W. Kilkenny Dated: March 18, 2004
- -----------------------------------
Patrick W. Kilkenny, Director
/S/ Gregory J. Smith Dated: March 18, 2004
- --------------------------------------------
Gregory J. Smith, Director
/S/ Mark H. Rodebaugh Dated: March 18, 2004
- -----------------------------------
Mark H. Rodebaugh, Director
/S/ William B. Stevenson Dated: March 18, 2004
- -----------------------------------
William B. Stevenson, Director
100