UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
Commission File Number: 000-31929
-------------------------
SONOMA VALLEY BANCORP
(Name of registrant at as specific in its charter)
CALIFORNIA 68-0454068
(State of incorporation) (I.R.S. Employer Identification No.)
202 West Napa Street
Sonoma, California 95476
(707) 935-3200
(Address, including zip code, and telephone number,
including area code, of principal executive offices)
------------------------
Securities to be registered under section 12(b) of the Exchange Act: None
Securities to be registered under section 12(g) of the Exchange Act:
Name of each exchange
Title of each class on which registered
Common Stock, No Par Value None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (229.405 of this chapter) is 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 of 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 [ X ] No
Aggregate market value of Common Stock held by non-affiliates of Sonoma Valley
Bancorp as of March 16, 2004 based on the current market price of the stock:
$36,317,984
The number of shares of registrant's common stock outstanding as of March 15,
2004 was 1,484,823.
DOCUMENTS INCORPORATE BY REFERENCE
None.
With the exception of historical facts stated herein, the matters discussed
in this Form 10-K are "forward looking" statements that involve risks and
uncertainties that could cause actual results to differ materially from
projected results. Such "forward looking" statements include, but are not
necessarily limited to statements regarding anticipated levels of future
revenues and earnings from the operation of Sonoma Valley Bancorp's wholly owned
subsidiary, Sonoma Valley Bank, projected costs and expenses related to
operations of the bank's liquidity, capital resources, and the availability of
future equity capital on commercially reasonable terms. Factors that could cause
actual results to differ materially include, in addition to the other factors
identified in this Form 10-K, the following: (i) increased competition from
other banks, savings and loan associations, thrift and loan associations,
finance companies, credit unions, offerors of money market funds, and other
financial institutions; (ii) the risks and uncertainties relating to general
economic and political conditions, both domestically and internationally,
including, but not limited to, inflation, or natural disasters affecting the
primary service area of the Bank or its major industries; or (iii) changes in
the laws and regulations governing the Bank's activities at either the state or
federal level. Readers of this Form 10-K are cautioned not to put undue reliance
on "forward looking" statements which, by their nature, are uncertain as
reliable indicators of future performance. Sonoma Valley Bancorp disclaims any
obligation to publicly update these "forward looking" statements, whether as a
result of new information, future events, or otherwise.
PART I
ITEM 1. BUSINESS
General
Sonoma Valley Bancorp ("Company") was incorporated under California law on
March 9, 2000 at the direction of Sonoma Valley Bank for the purpose of forming
a single-bank holding company structure pursuant to a plan of reorganization.
The reorganization became effective November 1, 2000, after obtaining all
required regulatory approvals and permits, shares of the Company's common stock
were issued to shareholders of Sonoma Valley Bank in exchange for their Sonoma
Valley Bank stock. Previously, Sonoma Valley Bank filed its periodic reports and
current reports under the Securities Exchange Act of 1934 with the Federal
Deposit Insurance Corporation. Following the reorganization, periodic and
current reports are now filed with the Securities and Exchange Commission.
The business operations of the Company continue to be conducted through its
wholly-owned subsidiary, Sonoma Valley Bank ("Bank"), which began commercial
lending operations on June 3, 1988. In addition to its main branch located in
Sonoma, California, the Bank also operates a second branch office located in
Glen Ellen, California. In March 2004, the Bank opened a branch, Banco de
Sonoma, located in Boyes Hot Springs, California. The following discussion,
therefore, although presented on a consolidated basis, analyzes the financial
condition and results of operations of the Bank for the twelve month period
ended December 31, 2003.
Primary Services
The Bank emphasizes the banking needs of small to medium-sized commercial
businesses, professionals and upper middle to high income individuals and
families in its primary service area of Sonoma, California and the immediate
surrounding area.
2
The Bank offers depository and lending services keyed to the needs of its
business and professional clientele. These services include a variety of demand
deposit, savings and time deposit account alternatives, all insured by the FDIC
up to its applicable limits. Special merchant and business services, such as
coin, night depository, courier, on line cash management and merchant teller are
available. The Bank offers bank by mail service, drive-up ATM service, extended
hours including Saturday banking, drive-up windows and telephone voice response.
In 2003, the bank began offering Internet Banking to its customer base. The
initial customers using the product were existing Cash Management Commercial
customers and by mid-year the bank offered Internet Banking to its entire
customer base with products for both commercial and individual customers. The
Bank's lending activities are directed primarily towards granting short and
medium-term commercial loans, augmented by customized lines of credit, for such
purposes as operating capital, business and professional start-ups, inventory,
equipment, accounts receivable, credit cards, and interim construction
financing, personal loans and loans secured by residential real estate.
With the opening of our third Branch office, Banco de Sonoma Office in
March 2004, the bank is offering additional services to the Latino community in
our market place. In 2003, the Bank installed a bilingual ATM machine, and has
bilingual officers and customer service employees. All of the employees at the
Banco de Sonoma Office are bilingual.
The business of the Bank is not seasonal. The Bank intends to continue with
the same basic commercial banking activities it has operated with since
beginning operations June 3, 1988. Retail deposit gathering activities at the
branches comprise the bulk of sources for lending. The bank has approved
borrowing levels at the Federal Home Bank for temporary funding needs.
Competition
In general, the banking business in California and in the market areas,
which the Bank serves, is highly competitive with respect to both loans and
deposits, and is dominated by a relatively small number of major banks, which
have many offices operating over a wide geographic area. The Bank competes for
loans and deposits with these and other regional banks, including several which
are much larger than the Bank, as well as savings and loan associations, thrift
and loan associations, finance companies, credit unions, offerors of money
market funds and other financial institutions.
The Bank's primary service area is currently served by branches of eight
other banks (including three major banks: Citigroup, Bank of America and Wells
Fargo Bank). In order to compete with the major financial institutions in its
primary service area, the Bank uses its flexibility as an independent bank. This
includes emphasis on specialized services and personalized attention.
In the event there are customers whose loan demands exceed the Bank's
lending limit, the Bank seeks to arrange for such loans on a participation basis
with other financial institutions and intermediaries. The Bank also is able to
assist those customers requiring other services not offered by the Bank by
obtaining those services through its correspondent banks.
3
Concentration of Credit Risk
The majority of the Bank's loan activity is with customers located within
the county of Sonoma. While the Bank has a diversified loan portfolio,
approximately 84% of these loans are secured by real estate in its service area.
This concentration for the year ending December 31, 2003 is presented below:
(in thousands of dollars)
Secured by real estate:
Construction/land development $ 19,421
Farmland 3,784
1-4 family residences 15,919
Commercial/multi-family 63,691
Employees
As of December 31, 2003, the Company employed 49 full-time equivalent
employees. In anticipation of opening the Banco de Sonoma branch in 2004 the
bank began hiring additional employees in the 4th quarter of 2003.
Supervision and Regulation
The Company is a registered bank holding company under the Bank Holding
Company Act, regulated, supervised and examined by the Federal Reserve Bank. As
such, it must file with the Federal Reserve Bank an annual report and additional
reports as the Federal Reserve Board may require. The Company is also subject to
periodic examination by the Federal Reserve Board.
In addition, both the Company and the Bank are extensively regulated under
both federal and state laws and regulations. These laws and regulations are
primarily intended to protect depositors, not shareholders. To the extent that
the following information describes statutory or regulatory provisions, it is
qualified in its entirety by reference to the particular statutory and
regulatory provisions at issue.
As a California state-licensed bank, the Bank is subject to regulation,
supervision and periodic examination by the California Department of Financial
Institutions. The Bank is also subject to regulation, supervision, and periodic
examination by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank
is not a member of the Federal Reserve System, but is nevertheless subject to
certain regulations of the Board of Governors of the Federal Reserve System. As
a state bank, the Bank's deposits are insured by the FDIC to the maximum amount
permitted by law, which is currently $100,000 per depositor in most cases. For
this protection, the Bank pays a semi-annual assessment.
The regulations of these state and federal bank regulatory agencies govern
most aspects of the Company's and the Bank's business and operations, including
but not limited to, requiring the maintenance of non-interest bearing reserves
on deposits, limiting the nature and amount of investments and loans which may
be made, regulating the issuance of securities, restricting the payment of
dividends, regulating bank expansion and bank activities, including real estate
development activities. The Federal Reserve Board, the Federal Deposit Insurance
Corporation, and the California Department of Financial Institutions have broad
enforcement powers over depository institutions, including the power to prohibit
a bank from engaging in business practices which are considered to be unsafe or
unsound, to impose substantial fines and other civil and criminal penalties, to
terminate deposit insurance, and to appoint a conservator or receiver under a
4
variety of circumstances. The Federal Reserve Board also has broad enforcement
powers over bank holding companies, including the power to impose substantial
fines and other civil and criminal penalties.
Regulation of Bank Holding Companies
As a bank holding company, the Company's activities are subject to
extensive regulation by the Federal Reserve Board. The Bank Holding Company Act
requires us to obtain the prior approval of the Federal Reserve Board before (i)
directly or indirectly acquiring ownership or control of any voting shares of
another bank or bank holding company if, after such acquisition, we would own or
control more than 5% of the shares of the other bank or bank holding company
(unless the acquiring company already owns or controls a majority of such
shares); (ii) acquiring all or substantially all of the assets of another bank
or bank holding company; or (iii) merging or consolidating with another bank
holding company. The Federal Reserve Board will not approve any acquisition,
merger or consolidation that would have a substantially anticompetitive result,
unless the anticompetitive effects of the proposed transaction are clearly
outweighed by a greater public interest in meeting the convenience and needs of
the community to be served. The Federal Reserve Board also considers capital
adequacy and other financial and managerial factors in its review of
acquisitions and mergers.
With certain exceptions, the Bank Holding Company Act also prohibits us
from acquiring or retaining direct or indirect ownership or control of more than
5% of the voting shares of any company that is not a bank or bank holding
company, or from engaging directly or indirectly in activities other than those
of banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
non-bank activities that, by statute or by Federal Reserve Board regulation or
order, have been determined to be activities closely related to the business of
banking or of managing or controlling banks.
Federal Deposit Insurance
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines that the institution has engaged or is
engaging in unsafe or unsound practices, is in an unsafe or unsound condition to
continue operations or has violated any applicable law, regulation, order or any
condition imposed in writing by, or pursuant to written agreement with, the
FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing
process for a permanent termination of insurance if the institution has no
tangible capital.
Impact of Economic Conditions and Monetary Policies
The earnings and growth of the Bank are and will be affected by general
economic conditions, both domestic and international, and by the monetary and
fiscal policies of the United States Government and its agencies, particularly
the Federal Reserve Bank (FRB). One function of the FRB is to regulate the money
supply and the national supply of bank credit in order to mitigate recessionary
and inflationary pressures. Among the instruments of monetary policy used to
implement these objects are open market transactions in United States Government
securities, changes in the discount rate on member bank borrowings, and changes
in reserve requirement held by depository institutions. The monetary policies of
the FRB have had a significant effect on the operating results of commercial
banks in the past and are expected to continue to do so in the future. However,
the effect of such policies on the future business and earnings of the Bank
cannot be accurately predicted.
5
Recent and Proposed Legislation
From time to time, legislation is enacted which has the effect of
increasing the cost of doing business, limiting or expanding permissible
activities, or affecting the competitive balance between banks and other
financial institutions. Proposals to change the laws and regulations governing
the operations and taxation of banks and other financial institutions are
frequently made in Congress, in the California legislature, and by various bank
regulatory agencies. No prediction can be made as to the likelihood of any major
changes or the impact such changes might have on the Bank. Certain changes of
potential significance to the Bank which have been enacted recently or others
which are currently under consideration by Congress or various regulatory or
professional agencies are discussed below.
The Financial Services Modernization Act of 1999 (also known as the
"Gramm-Leach-Bliley Act" after its Congressional sponsors) substantially
eliminates most of the separations between banks, brokerage firms, and insurers
enacted by the Glass-Steagall Act of 1933. The reform legislation permits
securities firms and insurers to buy banks, and banks to underwrite insurance
and securities. States retain regulatory authority over insurers. The Treasury
Department's Office of the Comptroller of the Currency has authority to regulate
bank subsidiaries that underwrite securities and the Federal Reserve has
authority over bank affiliates for activities such as insurance underwriting and
real-estate development.
In January 2001, the Basel Committee on Banking Supervision issued a
proposal for a "New Capital Accord." The New Capital Accord incorporates a
three-part framework of minimum capital requirements, supervisory review of an
institution's capital adequacy and internal assessment process, and market
discipline through effective disclosure to encourage safe and sound banking
practices. The New Capital Accord is scheduled for implementation by the end of
2006. The federal banking agencies are required to take "prompt corrective
action" in respect of depository institutions and their bank holding companies
that do not meet minimum capital requirements. FDIC established five capital
tiers: "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" and "critically undercapitalized." A depository
institution's capital tier, or that of its bank holding company, depends upon
where its capital levels are in relation to various relevant capital measures,
including a risk-based capital measure and a leverage ratio capital measure, and
certain other factors.
Under the implementing regulations adopted by the federal banking agencies,
a bank holding company or bank is considered "well capitalized" if it has (i) a
total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based
capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv)
is not subject to any order or written directive to meet and maintain a specific
capital level for any capital measure. An "adequately capitalized" bank holding
company or bank is defined as one that has (i) a total risk-based capital ratio
of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% or greater and
(iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank
with a composite CAMELS rating of 1). A bank holding company or bank is
considered (A) "undercapitalized" if it has (i) a total risk-based capital ratio
of less than 8%, (ii) a Tier 1 risk-based capital ratio of less than 4% or (iii)
a leverage ratio of less than 4% (or 3% in the case of a bank with a composite
CAMELS rating of 1); (B) "significantly undercapitalized" if the bank has (i) a
total risk-based capital ratio of less than 6%, or (ii) a Tier 1 risk-based
capital ratio of less than 3% or (iii) a leverage ratio of less than 3% and
(C)"critically undercapitalized" if the bank has a ratio of tangible equity to
total assets equal to or less than 2%. The Federal Reserve Board may reclassify
a "well capitalized" bank holding company or bank as "adequately capitalized" or
subject an "adequately capitalized" or "undercapitalized" institution to the
supervisory actions applicable to the next lower capital category if it
determines that the bank holding company or bank is in an unsafe or unsound
condition or deems the bank holding company or bank to be engaged in an unsafe
or unsound practice and not to have corrected the deficiency. The Company and
Bank currently meet the definition of "well capitalized" institutions.
6
"Undercapitalized" depository institutions, among other things, are subject to
growth limitations, are prohibited, with certain exceptions, from making capital
distributions, are limited in their ability to obtain funding from a Federal
Reserve Bank and are required to submit a capital restoration plan. The federal
banking agencies may not accept a capital plan without determining, among other
things, that the plan is based on realistic assumptions and is likely to succeed
in restoring the depository institution's capital. In addition, for a capital
restoration plan to be acceptable, the depository institution's parent holding
company must guarantee that the institution will comply with such capital
restoration plan and provide appropriate assurances of performance. If a
depository institution fails to submit an acceptable plan, including if the
holding company refuses or is unable to make the guarantee described in the
previous sentence, it is treated as if it is "significantly undercapitalized".
Failure to submit or implement an acceptable capital plan also is grounds for
the appointment of a conservator or a receiver. "Significantly undercapitalized"
depository institutions may be subject to a number of additional requirements
and restrictions, including orders to sell sufficient voting stock to become
"adequately capitalized," requirements to reduce total assets and cessation of
receipt of deposits from correspondent banks. Moreover, the parent holding
company of a "significantly undercapitalized" depository institution may be
ordered to divest itself of the institution or of nonbank subsidiaries of the
holding company. "Critically undercapitalized" institutions, among other things,
are prohibited from making any payments of principal and interest on
subordinated debt, and are subject to the appointment of a receiver or
conservator. Each federal banking agency prescribes standards for depository
institutions and depository institution holding companies relating to internal
controls, information systems, internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, compensation, a
maximum ratio of classified assets to capital, minimum earnings sufficient to
absorb losses, a minimum ratio of market value to book value for publicly traded
shares and other standards as they deem appropriate. The Federal Reserve Board
and OCC have adopted such standards. Depository institutions that are not "well
capitalized" or "adequately capitalized" and have not received a waiver from the
FDIC are prohibited from accepting or renewing brokered deposits. As of December
31, 2003, the Company and Bank had no brokered deposits.
The USA Patriot Act of 2001 ("USA Patriot Act") imposes additional
obligations on U.S. financial institutions, including banks and broker dealer
subsidiaries, to implement policies, procedures and controls which are
reasonably designed to detect and report instances of money laundering and the
financing of terrorism. In addition, provisions of the USA Patriot Act require
the federal financial institution regulatory agencies to consider the
effectiveness of a financial institution's anti-money laundering activities when
reviewing bank mergers and bank holding company acquisitions.
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") intended to address
corporate and accounting fraud. Sarbanes-Oxley applies to publicly reporting
companies. In addition to the establishment of a new accounting oversight board,
which will enforce auditing, quality control and independence standards and will
be funded by fees from all publicly traded companies, the bill restricts
provision of both auditing and consulting services by accounting firms. To
maintain auditor independence, any non-audit services being provided to an audit
client will require pre-approval by the Company's audit committee members. In
addition, the audit partners must be rotated.
Sarbanes-Oxley also requires chief executive officers and chief financial
officers to certify to the accuracy of periodic reports filed with the
Securities Exchange Commission (the "SEC"), subject to civil and criminal
penalties if they knowingly or willfully violate this certification requirement.
In addition, under Sarbanes-Oxley, legal counsel will be required to report
evidence of a material violation of the securities laws or a breach of fiduciary
duty by a company to its chief executive officer or its chief legal officer,
7
and, if such officer does not appropriately respond, to report such evidence to
the audit committee or other similar committee of the board of directors or the
board itself.
Longer prison terms and increased penalties will also be applied to
corporate executives who violate federal securities laws, the period during
which certain types of suits can be brought against a company or its officers
has been extended, and bonuses issued to top executives prior to restatement of
a company's financial statements are now subject to disgorgement if such
restatement was due to corporate misconduct. Executives are also prohibited from
insider trading during retirement plan "blackout" periods, and loans to company
executives are restricted. Sarbanes-Oxley accelerates the time frame for
disclosures by public companies, as they must immediately disclose any material
changes in their financial condition or operations. Directors and executive
officers must also provide information for most changes in ownership in a
company's securities within two business days of the change.
Sarbanes-Oxley also prohibits any officer or director of a company or any
other person acting under their direction from taking any action to fraudulently
influence, coerce, manipulate or mislead any independent public or certified
accountant engaged in the audit of the company's financial statements for the
purpose of rendering the financial statements materially misleading.
Sarbanes-Oxley also requires the SEC to prescribe rules requiring inclusion of
an internal control report and assessment by management in the annual report to
shareholders. In addition, the Sarbanes-Oxley requires that each financial
report required to be prepared in accordance with (or reconciled to) accounting
principles generally accepted in the United States of America and filed with the
SEC reflect all material correcting adjustments that are identified by a
"registered public accounting firm" in accordance with accounting principles
generally accepted in the United States of America and the rules and regulations
of the SEC.
Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". The Statement is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. This Statement had no impact on
the Company's financial condition or results of operations.
In May 2003, the Financial Accounting Standards Board issued SFAS No. 150,
"Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity". SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both a liability and equity. It requires that an issuer classify certain
financial instruments as a liability, although the financial instrument may
previously have been classified as equity. This Statement is effective for
financial instruments entered into or modified after May 31, 2003 and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. This Statement had no impact on the Company's financial condition or
results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"), which covers guarantees such
as standby letters of credit, performance guarantees, and direct or indirect
guarantees of the indebtedness of others, but not guarantees of funding. FIN 45
requires a guarantor to recognize, at the inception of a guarantee, a liability
8
in an amount equal to the fair value of the obligation undertaken in issuing the
guarantee, and requires disclosure about the maximum potential payments that
might be required, as well as the collateral or other recourse obtainable. The
recognition and measurement provisions of FIN 45 were effective on a prospective
basis after December 31, 2002, and its adoption by the Company on January 1,
2003 has not had a significant effect on the Company's consolidated financial
statements.
In December 2003, the FASB revised Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which explains identification of
variable interest entities and the assessment of whether to consolidate these
entities. FIN 46 requires existing unconsolidated variable interest entities to
be consolidated by their primary beneficiaries if the entities do not
effectively disperse risks among the involved parties. The provisions of FIN 46
are effective for all financial statements issued after January 1, 2003. The
Company has no variable interests in any entities which would require disclosure
or consolidation.
In December 2002, FASB issued SFAS No. 148, which provides three
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based compensation. In addition, this Statement
amends the disclosure requirements of SFAS No. 123 to require more prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the impact on reported
financial results. Finally, this Statement amends APB Opinion No. 28, Interim
Financial Reporting, to require disclosure about those effects in interim
financial information. This Statement is effective for fiscal and interim
periods ending after December 15, 2003. The Company has elected to adopt the
prospective transition method effective January 1, 2003 and, accordingly,
compensation expense was recognized for any stock options granted on or after
that date. The unvested portion of stock options granted prior to January 1,
2003 will continue to be accounted for under the provisions of APB Opinion No.
28. This Statement did not have an impact on the Company's financial condition
or results of operations in 2003 since no stock options were granted. Since the
method of determining the value of stock options prescribed under SFAS No. 123
is based on a valuation model that relies upon factors that are beyond the
Company's control, such as stock price volatility and market interest rates,
Management is not able to accurately predict the cost of options that may be
granted in the future and the resulting impact on the Company's financial
condition and results of operations. Additional information regarding stock
options is contained in Notes A and M of the Notes to the Consolidated Financial
Statements.
9
Statistical Data
The following information is required by the Industry Guide 3, "Statistical
Disclosure by Bank Holding Companies". The averages shown have been calculated
using the average daily balance.
Sequential Page
Number
I. Distribution of Assets, Liabilities and Share-
holders' Equity; Interest Rates and Differential
A. Average balance sheets 19
B. Analysis of net interest earnings 19
C. Rate/volume analysis 20
II. Investment Portfolio
A. Book value (Amortized Cost) of investments 42
B. Weighted average yield and maturity 19, 23, 28 and 43
C. Securities of issuer exceeding
ten percent of equity: None
III. Loan Portfolio
A. Types of loans 19 and 44
B. Maturities and sensitivities of loans
to change in interest rates 28 and 45
C. Risk elements
1. Non-accrual, past due,
and restructured loans 24 and 44
2. Potential problem loans: None
3. Foreign outstandings: None
4. Loan concentrations 23 and 44
D. Other Interest Bearing Assets: None
IV. Summary of Loan Loss Experience 21, 24 and 45
V. Deposits
A. Average balances and average rates paid 19
B. Other categories of deposits None
C. Foreign outstandings None
D. Maturity of time deposits greater than $100,000 28
E. Maturity of foreign time deposits
greater than 100,000 None
VI. Return on Equity and Assets 17
VII. Short-term Borrowings: None
10
ITEM 2. PROPERTIES
The Company is headquartered in Sonoma, California. At the present time the
Company's Bank has two branch offices with a third branch opening first quarter
2004. In 1995 the Bank leased additional office space adjacent to the Sonoma
Branch and in September 1997 the Bank purchased property across the street from
the Sonoma Branch. The Sonoma Branch is located at 202 W. Napa Street, Sonoma.
The building contains approximately 6800 square feet and has been subleased on a
long-term basis (the initial term expires in 2009, with option to extend for two
additional five-year terms). The office is considered by management to be well
maintained and adequate for the purpose intended. Lease payments made in 2003
totaled $224,979 compared to the $216,326 paid in 2002. The lease provides for
future annual rents to be adjusted for changes in the Consumer Price Index
("CPI"), with a minimum annual increase of 4%, effective each March 1st.
In July, 1995, the Bank leased a building at 463 Second Street West. The
building contains approximately 2400 square feet and has been leased on a long
term basis to coincide with the Sonoma Branch lease. The initial term expired in
2000, with the first option exercised to expire in 2005, with an option to
extend for three additional five year terms and one additional four year term.
At present the Bank utilizes all of the units. Lease payments made in 2003
totaled $37,006 compared with the $36,376 paid in 2002. The lease provides for
future annual rents to be adjusted for changes in the Consumer Price Index
("CPI") effective each July 1st.
In September, 1997 the Bank purchased a building at 472 Second St. West.
The building contains approximately 1013 square feet. The Bank paid $246,943 for
the property. At present the Bank is utilizing the parking area for additional
parking for Bank employees and the Bank is renting out the building premises.
Rental income in 2003 was $17,406 compared to $16,521 in 2002.
The Glen Ellen Branch is located at 13751 Arnold Drive, Glen Ellen. The
facility is approximately 600 square feet. The facility is leased for a five
year term expiring in 2008 with the option to extend for two additional five
year terms. Lease payments made in 2003 totaled $12,889 compared to $12,172 in
2002. The lease provides for future annual rents to be adjusted for changes in
the CPI, with a minimum annual increase of 4% effective April 1st of each year.
The Banco de Sonoma Branch, opened in March 2004, is located at 18615
Sonoma Hwy #108, Boyes Hot Springs. The facility is approximately 1200 square
feet. The facility is leased for a five year term expiring in 2009 with an
option to extend for two additional five year terms. The lease provides for
future annual rents to be adjusted for changes in the CPI effective January 1st
of each year.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of operations, the Company and /or its Bank may have
disagreements or disputes with vendors, borrowers, or employees, which may or
may not result in litigation. These disputes are seen by the Company's
management as a normal part of business. There are no pending actions reported
and no threatened actions that management believes would have a significant
material impact on the Company's financial position, results of operations or
cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
The Company did not submit any matters to security holders during the
fourth quarter of its last fiscal year ended December 31, 2003.
11
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED
SECURITY HOLDER MATTERS
Following the reorganization the Company's common stock began trading on
the Over the Counter Bulletin Board ("OTC BB") under the symbol "SBNK", and the
Bank's stock ceased to be traded. The Company is not listed on any exchange or
on the National Association of Securities Dealers Automated Quotation System
("NASDAQ").
Several brokers act as facilitators in the trades of Sonoma Valley Bancorp
stock. They are:
A.G. Edwards Hoefer and Arnett
703 2nd Street, Suite 100 555 Market Street, 18th floor
Santa Rosa, CA 95409 San Francisco, CA 94105
Denise Gilseth Lisa Gallo
(800) 972-4800 (800) 346-5544
Paine Webber Monroe Securities
6570 Oakmont Drive 47 State Street
Santa Rosa, CA 95409 Rochester, NY 14614
John Rector Helen Rubeins
(707) 539-1500 (888)995-5560
Edward Jones Sutro & Co.
515 First Street East P.O. Box 2859
Sonoma, CA 95476 Big Bear Lake, CA 92315
Gary Scott Troy Norlander
(707) 935-1856 (800) 288-2811
Wedbush Morgan Securities
1300 S.W. Fifth Avenue, Suite 2000.
Portland, OR 97201-5667
Joey Warmenhoven
(503) 224-0480
12
The table below summarizes those trades of the common stock as reported by
OTC BB, setting forth the high and low prices for the periods shown. The stock
prices have been adjusted for stock dividends.
Quarter Ended: High Low
March 31, 2002 $ 21.32 $ 19.27
June 30, 2002 27.62 20.51
September 30, 2002 27.62 25.00
December 31, 2002 29.47 25.48
March 31, 2003 $ 29.52 $ 26.10
June 30, 2003 29.00 26.67
September 30, 2003 30.00 27.60
December 31, 2003 31.00 28.25
As of March 9, 2004, there were 1,661 holders of record of the Company's
common stock.
Payment of Dividends
Under state law, the Board of Directors of a California state-licensed bank
may declare a cash dividend, subject to the restriction that the amount
available for the payment of cash dividends shall be the lesser of retained
earnings of the bank or the bank's net income for its last three fiscal years
(less the amount of any distributions to shareholders made during such period).
However, under the Financial Institutions Supervisory Act, the FDIC has
broad authority to prohibit a bank from engaging in banking practices which it
considers to be unsafe or unsound. It is possible, depending upon the financial
condition of the bank in question and other factors, that the FDIC may assert
that the payment of dividends or other payments by a bank is considered an
unsafe and unsound banking practice and therefore, implement corrective action
to address such a practice.
The Bank paid cash dividends of $300,000 on December 29, 2000, $500,000 on
April 18, 2001, $500,000 on February 26, 2003 and $1,000,000 on June 18, 2003 to
the Company. Future dividend payments from the Bank to the Company will depend
on the Bank's future earnings and on the Bank's ability to meeting certain
capital requirements and having an adequate allowance for loan losses.
The Company paid a cash dividend of $0.25 cent per share to shareholders of
record as of March 1, 2004 with payment made on March 15, 2004. The Board of
Directors of the Company is currently reviewing our strategic plan to utilize
our capital assets in order to enhance shareholder value. One of the initiatives
includes review of the declaration of future cash dividends. No plan has yet
been finalized.
13
Historically, the Company and the Bank have declared ten stock dividends of
5% each, two stock dividends of 10% in May 1996 and June 1997, one 2 for 1 stock
split in March 1998 and a cash dividend in February 2004 as detailed below:
Dividends Paid by the Bank
--------------------------
Date Declared Record Date Date Paid
---------------------- ---------------------- ---------------------
May 13, 1992 May 31, 1992 June 15, 1992
June 26, 1993 July 15, 1993 July 31, 1993
July 20, 1994 August 1, 1994 August 15, 1994
January 18, 1995 February 5, 1995 February 20, 1995
August 16, 1995 September 11, 1995 September 29, 1995
May 22, 1996 June 14, 1996 June 28, 1996
June 18, 1997 July 15, 1997 August 1, 1997
March 18, 1998 April 15, 1998 April 30, 1998
July 21, 1999 August 16, 1999 August 31, 1999
August 16, 2000 September 8, 2000 September 25, 2000
Dividends Paid by the Company
-----------------------------
Date Declared Record Date Date Paid
---------------------- ---------------------- ---------------------
July 18, 2001 August 3, 2001 August 17, 2001
June 17, 2002 July 2, 2002 July 16, 2002
June 18, 2003 July 2, 2003 July 16, 2003
February 18, 2004 March 1, 2004 March 15, 2004
14
ITEM 6. SELECTED FINANCIAL DATA
SONOMA VALLEY BANCORP
Selected Consolidated Financial Data
dollars in thousands, except share
and per share data
For the years ended:
2003 2002 2001 2000 1999 1998
---- ---- ---- ---- ---- ----
RESULTS OF OPERATIONS:
Net interest income $ 8,906 $ 8,633 $ 8,236 $ 7,870 $ 6,699 $ 5,987
Provision for loan losses 20 393 342 335 240 335
Non-interest income 1,715 1,646 1,309 893 941 878
Non-interest expense 6,244 5,862 5,224 5,061 4614 4,100
Provision for income tax 1,446 1,275 1,379 1,160 976 843
-------- -------- -------- -------- -------- --------
$ 2,911 $ 2,744 $ 2,600 $ 2,207 $ 1,810 $ 1,587
======== ======== ======== ======== ======== ========
SELECTED AVERAGE BALANCES:
Assets $195,177 $164,200 $147,807 $135,924 $123,202 $107,202
Loans, net of unearned 123,044 116,867 100,605 86,547 73,222 70,838
Deposits 171,620 143,228 129,534 120,135 109,801 95,819
Shareholders' equity 20,232 17,964 15,121 12,984 11,490 9,976
PER SHARE DATA:
Basic net income $2.00 $1.87 $1.77 $1.49 $1.21 $1.06
Fully diluted net income $1.83 $1.72 $1.66 $1.45 $1.19 $1.05
Period end book value $14.73 $13.09 $11.36 $9.67 $8.10 $7.16
Weighted average shares
outstanding 1,457,431 1,464,344 1,473,151 1,478,573 1,497,447 1,502,803
FINANCIAL RATIOS:
Return on average assets 1.49% 1.67% 1.76% 1.62% 1.47% 1.48%
Return on average
shareholders' equity 14.39% 15.27% 17.19% 17.00% 15.75% 15.91%
Net yield on earning
assets 5.24% 6.06% 6.25% 6.49% 6.04% 6.22%
Cost Control ratio 56.95% 55.07% 52.72% 55.06% 58.52% 57.97%
Average shareholders'
equity to average assets 10.37% 10.94% 10.23% 9.55% 9.33% 9.31%
CAPITAL RATIOS:
Risk-based capital:
Tier I 12.81% 12.31% 11.81% 12.78% 12.36% 12.57%
Total 14.07% 13.57% 13.07% 14.04% 13.62% 13.83%
Leverage ratio 10.50% 10.62% 10.38% 10.11% 9.54% 9.55%
CREDIT QUALITY:
Net charge-offs to
average loans 0.14% 0.02% 0.05% -0.04% 0.04% 0.09%
Allowance for possible
loan losses to period
end loans 2.15% 2.17% 2.25% 2.29% 2.19% 2.12%
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Year Ended December 31, 2003 versus December 31, 2002
The business operations of the Company continue to be conducted through its
wholly-owned subsidiary, Sonoma Valley Bank ("Bank"), which began commercial
lending operations on June 3, 1988. Accordingly, the following discussion and
analysis of the financial condition and the results of operations should be read
in conjunction with the financial statements and notes included elsewhere in
this annual report. Per share amounts for prior years have been adjusted for the
Bank's prior 2 for 1 stock split declared March 18, 1998, 10% stock dividends
declared June 18, 1997 and May 22, 1996 and 5% stock dividends declared in June
2003, June 2002, July 2001, August 2000, July 1999, January and August, 1995,
July 1994, June 1993 and May, 1992. The continual growth and success of the
company is dependent upon a stable economy, an increasing deposit base in the
valley and economically viable technology to enhance customer service. Expansion
of services in the valley such as the opening of a new branch, the placement of
remote ATM in the local hospital, and the deployment of wire transfer services
through an international network are some of the strategies for our continual
successful performance. We continue to believe that community banking, through
providing useful services in niche markets will prosper in spite of the
consolidation taking place in the industry.
Critical Accounting Policies
The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States and general practices within
the financial services industry. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. A summary of the Company's most significant accounting policies is
contained in Note A to the consolidated financial statements. The Company
considers its most critical accounting policies to consist of the allowance for
loan and lease losses and the estimation of fair value, which are separately
discussed below.
Allowance for Loan and Lease Losses. The allowance for loan and lease
losses represents management's best estimate of inherent losses in the existing
loan portfolio. The allowance for loan and lease losses is increased by the
provision for losses on loans and leases charged to expense and reduced by loans
and leases charged off, net of recoveries. The provision for loan and lease
losses is determined based on management assessment of several factors: reviews
and evaluations of specific loans and leases, changes in the nature and volume
of the loan portfolio, current economic conditions and the related impact on
specific borrowers and industry groups, historical loan and lease loss
experience, the level of classified and nonperforming loans and the results of
regulatory examinations.
The Company's Audit Committee engage experienced independent loan portfolio
review professionals many of which are former bank examiners. The Audit
Committee determines the scope of such reviews and will provide the report of
findings to the Board's Loan Committee after they have accepted it. These
reviews are supplemented with periodic reviews by the Company's credit review
function, as well as periodic examination of both selected credits and the
credit review process by the applicable regulatory agencies. The information
from these reviews assists management in the timely identification of problems
and potential problems and provides a basis for deciding whether the credit
represents a probable loss or risk that should be recognized.
Changes in the financial condition of individual borrowers, in economic
conditions, in historical loss experience and in the conditions of the various
markets in which collateral may be sold may all affect the required level of the
16
allowance for loan and lease losses and the associated provision for loan and
lease losses.
Estimation of Fair Value. Accounting principles generally accepted in the
United States require that certain assets and liabilities be carried on the
Consolidated Balance Sheet at fair value or at the lower of cost or fair value.
Furthermore, the fair value of financial instruments is required to be disclosed
as a part of the notes to the consolidated financial statements for other assets
and liabilities. Fair values are volatile and may be influenced by a number of
factors, including market interest rates, prepayment speeds, discount rates, the
shape of yield curves and the credit worthiness of counterparties.
Fair values for the majority of the Company's available for sale investment
securities are based on quoted market prices. In instances where quoted market
prices are not available, fair values are based on the quoted prices of similar
instruments with adjustment for relevant distinctions. For trading account
assets, fair value is estimated giving consideration to the contractual interest
rates, weighted average maturities and anticipated prepayment speeds of the
underlying instruments and market interest rates.
Overview
Net income for 2003 was $2,911,007 compared with earnings of $2,744,333 in
2002. Basic earnings per share for 2003 was $2.00 compared with $1.87 in 2002.
Return on average shareholders' equity declined to 14.39% in 2003 compared to
15.27% in 2002. Return on average total assets for 2003, 2002 and 2001 were
1.49%, 1.67% and 1.76%, respectively.
While the bank continues to enjoy increased earnings over the last three
years, the banks growth in assets has exceeded the earnings growth. Earning
growth has been impacted by the decline in net interest margins, which is a
combination of increased rate competition for loans and the lower market rates
for investment securities. Retaining all of the banks earnings in its capital
accounts has resulted in the decline in the return on equity, as the capital
accounts increase at a faster growth rate than the increase in net income. The
capital planning strategy going forward will deploy both a repurchase of share
strategy with a cash dividend policy intended to better manage an adequate
capital level.
At December 31, 2003, total assets were $205.1 million, a 12.3% increase
over the $182.6 million at December 31, 2002. The Company showed loans of $122.5
million in 2003, compared with $128.1 million at year-end 2002, a decline of
4.4%. Deposits increased, growing 12.6%, from $160.0 million at year-end 2002 to
$180.1 million at year-end 2003. The loan-to-deposit ratio declined to 68.0% in
2003 from 80.0% in 2002. The decline in loans and the loan-to-deposit ratio is
reflective of management's attention to the risk associated with making long
term fixed rate loans at low interest rates and increased attention to loan
quality due to concern about the economy.
The company has acquired additional software to accommodate maintaining a
portfolio of adjustable rate residential loans, which was not an option
previously. Additionally, the bank has enhanced its ability to engage in
mortgage origination for the secondary market, and will be using the increased
liquidity for warehousing product available for sale. This activity is expected
to enhance earnings for the company.
Net Interest Income
Net interest income is the difference between total interest income and
total interest expense. Net interest income, adjusted to a fully taxable
equivalent basis, increased $250,000 to $9.3 million, up 2.8% from 2002 net
interest income of $9.0 million. Net interest income on a fully taxable
equivalent basis, as shown on the table - Average Balances, Yields and Rates
Paid (page 19), is higher than net interest income on the statements of
operations because it reflects adjustments applicable to tax-exempt income from
17
certain securities and loans ($343,000 in 2003 and $366,000 in 2002, based on a
34% federal income tax rate).
The increase in net interest income (stated on a fully taxable equivalent
basis) was the net effect of a small increase of $13,000 in interest income and
a $237,000 decrease in interest expense, which is a result of deposit rates
declining faster than loan rates. Declining rates influenced net interest income
in spite of the growth in earning assets. The decline in interest expense is
expected to plateau as the effective interest cost for the bank is not expected
to decline further. This combination of increased rate competition for loans and
investments with an inability to lower interest costs will likely result in a
flat earnings environment.
Net interest income (stated on a fully taxable equivalent basis) expressed
as a percentage of average earning assets, is referred to as net interest
margin. The Company's net interest margin declined 82 basis points to 5.24% in
2003 from 6.06% in 2002.
Interest Income
As previously stated, interest income (stated on a fully taxable equivalent
basis) increased by $13,000 to $11.0 million in 2003, a .12% increase over the
$10.9 million realized in 2002.
The $13,000 increase was the net effect of an 11.0% increase in average
earning assets to $176.6 million offset by a 117 basis point decline in average
yield for the year.
18
SONOMA VALLEY BANCORP
AVERAGE BALANCES/YIELDS AND RATES PAID
Rate/Volume
ASSETS Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield
Balance Expense Rate Balance Expense Rate Rate Expense Rate
- ------------------------- ------- ------- ------ -------- ------- ------ ------- ------- -----
Interest-earning assets:
Loans(2):
Commercial $85,965 $6,493 7.55% $75,696 $ 5,978 7.90% 61,888 $5,582 9.02%
Consumer 11,632 889 7.64% 13,186 1,098 8.33% 14,583 1,370 9.39%
Real estate construction 18,781 1,530 8.15% 19,040 1,689 8.87% 12,393 1,279 10.32%
Real estate mortgage 3,820 333 8.72% 5,732 481 8.39% 8,983 823 9.16%
Tax exempt loans (1) 3,147 263 8.36% 3,367 285 8.46% 2,566 220 8.57%
Leases 67 22 32.84% 164 27 16.46% 409 42 10.27%
Tax exempt leases (1) 47 10 21.28% 106 15 14.15% 165 15 9.09%
Unearned loan fees (416) (424) (382)
----- ----- -----
Total loans 123,043 9,540 7.75% 116,867 9,573 8.19% 100,605 9,331 9.27%
Investment securities
Available for sale:
Taxable 11,093 352 3.17% 6,029 365 6.05% 16,420 1,001 6.10%
Tax exempt(1) 0 0 0.00% 0 0 0.00% 0 0 0.00%
Hold to maturity:
Taxable 392 13 3.32% 201 13 6.47% 203 13 6.40%
Tax exempt (1) 11,270 736 6.53% 10,904 777 7.13% 11,779 837 7.11%
------ ----- ------ ----- ------ -----
Total investment 22,755 1,101 4.84% 17,134 1,155 6.74% 28,402 1,851 6.51%
securities
Federal funds sold 30,318 318 1.05% 14,053 216 1.54% 8,219 286 3.48%
FHLB Stock 288 13 4.51% 275 15 5.45% 261 15 5.75%
Total due from
banks/Interest bearing 202 1 0.50% 73 1 1.37% 11 0 2.73%
------- ------ ------- ------ ------- ------
Total interest earning 176,606 10,973 6.21% 148,402 10,960 7.39% 137,498 11,483 8.35%
assets ======= ====== ======= ====== ======= ======
Noninterest-bearing
assets:
Reserve for loan losses (2,772) (2,547) (2,263)
Cash and due from banks 9,090 7,600 6,620
Premises and equipment 1,120 705 620
Other assets 11,133 10,040 5,332
-------- -------- --------
Total assets $195,177 $164,200 $147,807
======== ======== ========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Interest bearing deposits
Interest bearing 29,819 $51 0.17% $23,794 $ 84 0.35% $21,940 $ 149 0.68%
transaction
Savings deposits 59,266 466 0.79% 48,052 656 1.37% 42,074 997 2.37%
Time deposits 19,794 477 2.41% 18,362 547 2.98% 16,739 845 5.05%
over $100,000
Other time deposits 25,209 730 2.90% 20,155 674 3.34% 18,913 885 4.68%
deposits ------ --- ------ --- ------ ---
Total interest bearing
Deposits 134,088 1,724 1.28% 110,363 1,961 1.78% 99,666 2,876 2.89%
Federal Funds purchased 0 0 0.00% 0 0 0.00% 0 0 0%
Other short term 3 0 0.00% 0 0 0.00% 174 7 4.02%
borrowings ------- ----- ------- ----- ------ -----
Total interest bearing
liabilities 134,091 1,724 1.28% 110,363 $ 1,961 1.78% 99,840 $ 2,883 2.89%
===== ======= =======
Non interest bearing
liabilities:
Non interest bearing 37,531 32,865 29,868
demand deposits
Other liabilities 3,323 3,008 2,978
Shareholders' equity 20,232 17,964 15,121
------- ------- ------
Total liabilities and
shareholders' equity 195,177 $164,200 $147,807
======= ======== ========
shareholders' equity
Interest rate spread 4.93% 5.61% 5.46%
Interest income $10,973 6.21% $10,960 7.39% $11,483 8.35%
Interest expense 1,724 0.98% 1,961 1.32% 2,883 2.10%
------- ------- -------
Net interest income/margin $9,249 5.24% $8,999 6.06% $8,600 6.25%
======= ======= =======
(1) Fully tax equivalent adjustments are based on a federal income tax
rate of 34% in 2003, 2002 and 2001.
(2) Non accrual loans have been included in loans for the purposes of the
above presentation. Loan fees of approximately $405,000, $343,000 and $334,000
for the twelve months ended December 31, 2003, 2002 and 2001, respectively,
were amortized to the appropriate interest income categories.
19
SONOMA VALLEY BANCORP
Rate/Volume Analysis
2003 over 2002 2002 over 2001
--------------- ---------------
Volume Rate Vol/Rate Total Volume Rate Vol/Rate Total
ASSETS
Interest-earning assets:
Loans:
Commercial 811 (261) (35) 515 1,245 (694) (155) 396
Consumer (129) (90) 11 (209) (131) (156) 15 (272)
Real estate (23) (138) 2 (159) 686 (180) (96) 410
construction
Real estate mortgage (160) 19 (6) (148) (298) (69) 25 (342)
Tax exempt loans (19) (4) 0 (22) 69 (3) (1) 65
Leases (16) 27 (16) (5) (25) 25 (15) (15)
Tax exempt leases (8) 8 (4) (5) (5) 8 (3) 0
Unearned fee income 0 0 0 0 0 0 0 0
---- ----- ---- ---- ----- ------- ----- ----
Total loans 456 (439) (48) (33) 1,541 (1,069) (230) 242
Investment securities:
Available for sale:
Taxable 307 (174) (146) (13) (633) (7) 4 (636)
Tax-exempt 0 0 0 0 0 0 0 0
Held to maturity:
Taxable 12 (6) (6) 0 0 0 0 0
Tax-exempt 26 (65) (2) (41) (62) 2 0 (60)
---- ----- ---- ---- ----- ------- ----- ----
Total investment
securities 345 (245) (154) (54) (695) (5) 4 (696)
Federal funds sold 250 (69) (79) 102 203 (160) (113) (70)
FHLB Stock 1 (3) (0) (2) 1 (1) 0 0
Due from banks-int bearing 2 (1) (1) 0 2 0 (1) 1
---- ----- ---- ---- ----- ------- ----- ----
Total interest-earning
assets 1,054 (757) (282) 13 1,052 (1,235) (340) (523)
===== ===== ===== ==== ===== ======= ===== =====
LIABILITIES
Interest-bearing liabilities:
Interest-bearing deposits:
Savings deposits 21 (44) (11) (34) 13 (72) (6) (65)
Interest-bearing demand
deposits 153 (277) (65) (189) 142 (423) (60) (341)
Time less than $100,000 43 (105) (8) (70) (26) (321) 9 (338)
Time $100,000 and over 169 (90) (23) 56 172 (285) (58) (171)
---- ----- ---- ---- ----- ------- ----- ----
Total interest-bearing
deposits 386 (516) (107) (237) 301 (1,101) (115) (915)
Federal funds purchased 0 0 0 0 0 0 0 0
Other borrowings 0 0 0 0 (7) (7) 7 (7)
---- ----- ---- ---- ----- ------- ----- ----
Total interest-bearing
liabilities 386 (516) (107) (237) 294 (1,108) (108) 922
Interest differential 668 (241) (175) 250 758 (127) (232) 399
===== ===== ===== ==== ===== ======= ===== =====
Volume/Rate variances were allocated in the following manner:
a. Changes affected by volume (change in volume times old rate)
b. Changes affected by rates (change in rates times old volume)
c. Changes affected by rate/volume (change in volume times change in rates)
The total for each category was arrived at by totaling the individual items
in their respective categories.
20
Interest Expense
Total interest expense declined by $237,000 to $1.7 million. The average
rate paid on all interest-bearing liabilities was 1.28%, compared to 1.78% in
2002. Average balances increased from $110.4 million to $134.1 million, a 21.5%
gain.
The gain in volume of average balances was responsible for a $279,000
increase in interest expense offset by a $516,000 decrease related to lower
interest rates paid for a net decrease of $237,000. The lower rates paid on
interest-bearing liabilities is a result of a declining interest rate
environment.
Individual components of interest income and interest expense are provided
in the table - Average Balances, Yields and Rates Paid on page 19.
Provision for Loan Losses
The provision for loan losses charged to operations is based on the Bank's
monthly evaluations of the loan portfolio and the adequacy of the allowance for
loan losses in relation to total loans outstanding. The provisions to the
allowance for loan losses amounted to $20,000 in 2003 and $393,000 in 2002. The
decrease in the provision is the result management's evaluation and assessment
of the loan portfolio and decline in the loan growth.
Loans charged-off, net of recoveries, resulted in losses totaling $167,000
in 2003 and $27,000 in 2002. The increase in charge offs reflects loan problems
related to the economic downturn. Refer to page 45, Note D for an analysis of
the changes in the allowance for loan and lease losses.
Non-interest Income
Non-interest income of $1.7 million increased 4.5% in comparison with the
$1.6 million recorded in 2002. The increase was primarily due to a $70,000
increase in service charges on deposit accounts.
Non-interest Expense
Total non-interest expense increased 6.5% to $6.2 million in 2003 from $5.9
million in 2002. Non-interest expense represented 3.2% of average total assets
in 2003 and 3.6% in 2001. The expense/asset ratio is a standard industry
measurement of a bank's ability to control its overhead or non-interest costs.
During 2004, the Company will continue to emphasize cost controls. Certain costs
are not controllable by management. Refer to Note I, page 49, for a detailed
description of Non-Interest Income and Other Non-Interest Expense.
Salaries and Benefits
Salaries and benefits increased 1.5% from $3.4 million in 2002 to $3.5
million in 2003. The 2003 increase reflects normal merit increases and employee
incentives paid as a result of the Company's earnings in 2003. Additionally,
there continues to be significant increases in workers compensation and employee
medical benefits. At December 31, 2003 and 2002 total full-time equivalent
employees were 49 and 44 respectively. Year-end assets per employee were $4.2
million in 2003 and 2002 compared to $3.3 million in 2001.
21
Premises and Equipment
Expenses related to premises and equipment increased by 24.4% to $769,000
in 2003 from $618,000 in 2002. Building lease expense on three locations and
storage units increased to $289,000 in 2003 from $278,000 in 2002. Lease income
for 2003 totaled $17,000 compared to lease income of $17,000 in 2002. The
increase in premises and equipment expense is the result renovation and
remodeling of the Operations Center and Sonoma Main Office facility.
Other Non-interest Expense
Other non-interest expense increased by 9.9% to $2.0 million in 2003 from
$1.8 million in 2002. The increase was the result of a 22.2% increase in
professional fees. Professional fees is the largest category of other
non-interest expense, primarily comprised of accounting, legal and other
professional fees. These services increased by $210,000 to $1,153,000 in 2003
from $944,000 in 2002. This increase is the result of the additional regulatory
requirements as a result of Sarbanes-Oxley and the U.S. Patriot Act. Increases
in other categories reflect the increased growth and volume of business in
general.
Provision for Income Taxes
The provision for income taxes increased to an effective tax rate of 33.2%
in 2003 compared with 31.7% in 2002.
Balance Sheet Analysis
Investment Securities
Securities are classified as held to maturity if the Company has both the
intent and the ability to hold these securities to maturity. As of December 31,
2003, the Company had securities totaling $16.6 million with a market value of
$17.0 million categorized as held to maturity. Decisions to acquire municipal
securities, which are generally placed in this category, are based on tax
planning needs and pledge requirements.
Securities are classified as available for sale if the Company intends to
hold these debt securities for an indefinite period of time, but not necessarily
to maturity. Investment securities which are categorized as available for sale
are acquired as part of the overall asset and liability management function and
serve as a primary source of liquidity. Decisions to acquire or dispose of
different investments are based on an assessment of various economic and
financial factors, including, but not limited to, interest rate risk, liquidity
and capital adequacy. Securities held in the available for sale category are
recorded at market value, which is $20.1 million compared to an amortized cost
of $20.1 million as of December 31, 2003.
At year end 2003 the overall portfolio had a market value of $37.2 million
compared with an amortized cost of $36.6 million. Investment securities
increased 166.8% to $36.7 million from $13.7 million in 2002. The Company
purchases securities rated A or higher by Standard and Poor's and/or Moody's
Investors Service. At year end the Company had two securities totaling $656,000
with ratings below A, both mature in 2004. Tax-exempt bonds are occasionally
purchased without an A rating. In the opinion of management, there was no
investment in securities at December 31, 2003 that would constitute a material
credit risk to the Company.
22
The table below shows the components of the investment portfolio and
average yields. For further information concerning the Company's total
securities portfolio, including market values and unrealized gains and losses,
refer to Note C of the Notes to Consolidated Financial Statements on pages 42
and 43.
Twelve months ended 12/31/03 Twelve months ended 12/31/02
Average Average Average Average
Balance Yield Balance Yield
------- ------- ------- -------
U.S. Treasury securities $ 780 1.8% $ 2,529 6.0%
U.S. federal agency issues 9,263 2.9% 1,596 6.1%
State, county and municipal issues 11,662 6.4% 11,105 7.1%
Corporate securities 1,050 6.4% 1,904 6.1%
-------- --------
Total investment securities $ 22,755 4.8% $ 17,134 6.7%
======== ========
Loans
A comparative schedule of average loan balances is presented in the table
on page 19; year-end balances are presented in Note D to the Consolidated
Financial Statements pages 44 and 45.
Loan balances, net of deferred loan fees at December 31, 2003, were $122.5
million, a decrease of 4.4% over 2002. Commercial loans, comprising 75.0% of the
portfolio, increased $2.7 million, or 3.0% over 2002. This increase represents
the only category of loans showing growth in 2003. Included in commercial loans
are loans made for commercial purposes and secured by real estate.
Real Estate Construction loans declined $2.8 million, or 14.7% over 2002
balances. Consumer loans, including home equity loans, decreased $1.6 million or
12.1% over 2002 balances while real estate mortgage loans declined $3.7 million
or 62.3%. In 1997 the Company began offering leasing opportunities to small
businesses. Lease financing receivables for year end 2003 decreased $94,000 or
54.0%.
Risk Elements
The majority of the Company's loan activity is with customers located
within Sonoma County. Approximately 84% of the total loan portfolio is secured
by real estate located in the Company's service area (see Note P, on page 57 of
the Consolidated Financial Statements, Concentration of Credit Risk).
Significant concentrations of credit risk may exist if a number of loan
customers are engaged in similar activities and have similar economic
characteristics. The Company believes that it has policies in place to identify
problem loans and to monitor concentration of credits of loan customers engaged
in similar activities.
Commitments and Letters of Credit
Loan commitments are written agreements to lend to customers at agreed upon
terms provided there are no violations of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses. Loan commitments may have variable interest rates and terms that
reflect current market conditions at the date of commitment. Because many of the
commitments are expected to expire without being drawn upon, the amount of total
commitments does not necessarily represent the Company's anticipated future
funding requirements. Unfunded loan commitments were $35.3 million at December
31, 2003 and $30.4 million at December 31, 2002.
23
Standby letters of credit commit the Company to make payments on behalf of
customers when certain specified events occur. Standby letters of credit are
primarily issued to support customers' financing requirements of twelve months
or less and must meet the Company's normal policies and collateral requirements.
Standby letters of credit outstanding were $725,000 at December 31, 2003 and
$589,000 at December 31, 2002.
Nonperforming Assets
Management classifies all loans as non-accrual loans when they become more
than 90 days past due as to principal or interest, or when the timely collection
of interest or principal becomes uncertain, if earlier, unless they are
adequately secured and in the process of collection.
A loan remains in a non-accrual status until both principal and interest
have been current for six months and meets cash flow or collateral criteria or
when the loan is determined to be uncollectible and is charged off against the
allowance for loan losses, or in the case of real estate loans, is transferred
to other real estate owned. A loan is classified as a restructured loan when the
interest rate is materially reduced, when the term is extended beyond the
original maturity date or other concessions are made by the Company because of
the inability of the borrower to repay the loan under the original terms.
The Company had $1.2 million in non-accrual status at December 31, 2003 and
$897,000 at December 31, 2002. There were $1.2 million in loans 90 days or more
past due at December 31, 2003 and $796,000 in loans 90 days or more past due at
December 31, 2002.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level considered adequate
to provide for losses that can be reasonably anticipated. The allowance is
increased by provisions charged to operating expense and reduced by charge-offs,
net of recoveries. The allowance is based on estimates, and ultimate losses may
vary from the current estimates. These estimates are reviewed monthly and, as
adjustments become necessary, they are reported in earnings in the periods in
which they become known.
The review process is intended to identify loan customers who may be
experiencing financial difficulties. In these circumstances, a specific reserve
allocation or charge-off may be recommended. Other factors considered by
management in evaluating the adequacy of the allowance include: loan volume,
historical net loan loss experience, the condition of industries and geographic
areas experiencing or expected to experience economic adversities, credit
evaluations, and current economic conditions. The allowance for loan losses is
not a precise amount, but based on the factors above, represents management's
best estimate of losses that may be ultimately realized from the current loan
portfolio.
Worsening conditions in certain economic sectors and geographic areas could
adversely affect the loan portfolio, necessitating larger provisions for loan
losses than currently estimated. However, as of December 31, 2003, the Company
believes its overall allowance for loan losses is adequate based on its analysis
of conditions at that time.
At December 31, 2003, the allowance for loan losses was $2.6 million, or
2.2% of year end loans, compared with $2.8 million or 2.2% of year end loans at
December 31, 2002. Net charge-offs to average loans increased when compared with
the prior year. The Company recorded net losses of $167,000 or .14% of average
loans in 2003 compared to $27,000 or .02% of average loans in 2002. The
continued low level of charge-offs in 2003 reflects the Company's attention and
effort in managing and collecting past due loans by encouraging the customer to
bring them to a current status or to pay them off.
24
Deposits
A comparative schedule of average deposit balances is presented in the
table on page 19; year-end deposit balances are presented in the table below.
Total deposits increased $20.1 million (12.6%) in 2003, to $180.1 million.
Demand deposits declined $813,000, or 2.1% in 2003. Savings deposits increased
by $11.9 million, or 22.9% and interest bearing checking increased $7.8 million
or 31.8% during 2003. Other time deposits of less than $100,000 decreased
$325,000, or 1.6% and time deposits over $100,000 increased $1.5 million, for an
increase of 6.2% over 2002 balances.
The composition of deposits for the years ending December 31, 2003 and 2002
are as follows:
December 31, Percentage December 31, Percentage
2003 of Total 2002 of Total
------------ ---------- ------------ ----------
Interest bearing transaction deposits $32,467,678 18.0% $24,627,589 15.4%
Savings deposits 63,680,697 35.4% 51,802,714 32.4%
Time deposits, $100,000 and over 26,565,347 14.7% 25,018,603 15.6%
Other time deposits 19,453,317 10.8% 19,778,540 12.4%
------------ ------------ ------
Total interest bearing deposits 142,167,039 78.9% 121,227,446 75.8%
Noninterest-bearing deposits 37,947,577 21.1% 38,760,806 24.2%
------------ ------------ ------
Total deposits $180,114,616 100.0% $159,988,252 100.0%
============ ============ ======
Capital
The Bank is subject to FDIC regulations governing capital adequacy. The
FDIC has adopted risk-based capital guidelines which establish a risk-adjusted
ratio relating capital to different categories of assets and off-balance sheet
exposures. Under the current guidelines, as of December 31, 2003, the Bank was
required to have minimum Tier I and total risk-based capital ratios of 4% and 8%
respectively. To be well capitalized under Prompt Corrective Action Provisions
requires minimum Tier I and total risk-based capital ratios should be 6% and 10%
respectively.
The FDIC has also adopted minimum leverage ratio guidelines for compliance
by banking organizations. The guidelines require a minimum leverage ratio of 4
percent of Tier 1 capital to total average assets. Banks experiencing high
growth rates are expected to maintain capital positions well above the minimum
levels. The leverage ratio in conjunction with the risk-based capital ratio
constitute the basis for determining the capital adequacy of banking
organizations.
Based on the FDIC's guidelines, the Bank's total risk-based capital ratio
at December 31, 2003 was 13.44% and its Tier 1 risk-based capital ratio was
12.18%. The Bank's leverage ratio was 10.00%. All the ratios exceed the minimum
guidelines of 8.00%, 4.00% and 4.00%, respectively. The ratios for the Holding
Company at December 31, 2002, were 13.57%, 12.31% and 10.62%, respectively. The
capital ratios for the Holding Company at December 31, 2003, were 14.07%, 12.81%
and 10.49%, respectively.
In February 2001, the Company approved a program to repurchase Sonoma
Valley Bancorp stock up to $1 million and in August 2002 the Company approved
the repurchase of an additional $1 million Sonoma Valley Bancorp stock. As of
December 31, 2003, $1,448,737 was repurchased and retired, net of options which
were exercised and then subsequently repurchased and retired. The Company is
continuing to repurchase Sonoma Valley Bancorp stock up to the authorized
amount.
25
Management believes that the Bank's current capital position, which exceeds
guidelines established by industry regulators, is adequate to support its
business.
Off Balance Sheet Commitments
The Company's off balance sheet commitments consist of commitments to
extend credit and standby letters of credit. These commitments are extended to
customers in the normal course of business and are described in Note O to the
Consolidated Financial Statements on page 55. The Company also has contractual
obligations consisting of operating leases for various facilities and payments
to participants under the Company's supplemental executive retirement plan and
deferred compensation plan, which are described in Note H.
The following table summarizes the Company's contractual obligations as of
December 31, 2003.
Payments due by period
Less than 1 More than 5
Contractual Obligations Total year 1-3 years 3-5 Years years
- ----------------------------------------------------------------------------------------------------
Operating Lease Obligations 1,623,625 302,802 582,837 594,949 143,037
Executive Officer Supplemental
Retirement 1,733,623 5,000 29,502 186,543 1,512,578
Deferred Compensation 989,788 12,819 16,844 106,504 853,621
Liquidity Management
The Company's liquidity is determined by the level of assets (such as cash,
federal funds sold and available-for-sale securities) that are readily
convertible to cash to meet customer withdrawal and borrowing needs. Deposit
growth also contributes to the Company's liquidity needs. The Company's
liquidity position is reviewed by management on a regular basis to verify that
it is adequate to meet projected loan funding and potential withdrawal of
deposits. The Company has a comprehensive Asset and Liability Policy which it
uses to monitor and determine adequate levels of liquidity. At year end 2003,
the Company's liquidity ratio (adjusted liquid assets to deposits and short term
liabilities) was 29.03% compared to 20.39% and 21.08% at year end 2002 and 2001,
respectively. Management expects that liquidity will remain adequate throughout
2004, as loans are not expected to grow significantly more than deposits, and
excess funds will continue to be invested in quality liquid assets.
Market Risk Management
Overview. Market risk is the risk of loss from adverse changes in market
prices and rates. The Company's market risk arises primarily from interest rate
risk inherent in its loan and deposit functions. The goal for managing the
assets and liabilities of the Company is to maximize shareholder value and
earnings while maintaining a high quality balance sheet without exposing the
Company to undue interest rate risk. The Board of Directors has overall
responsibility for the interest rate risk management policies. Sonoma Valley
Bank has an Asset and Liability Management Committee (ALCO) that establishes and
monitors guidelines to control the sensitivity of earnings to changes in
interest rates.
Asset/Liability Management. Activities involved in asset/liability
management include but are not limited to lending, accepting and placing
deposits and investing in securities. Interest rate risk is the primary market
risk associated with asset/liability management. Sensitivity of earnings to
interest rate changes arises when yields on assets change in a different time
period or in a different amount from that of interest costs on liabilities. To
26
mitigate interest rate risk, the structure of the balance sheet is managed with
the goal that movements of interest rates on assets and liabilities are
correlated and contribute to earnings even in periods of volatile interest
rates. The asset/liability management policy sets limits on the acceptable
amount of variance in net interest margin and market value of equity under
changing interest environments. The Company uses simulation models to forecast
earnings, net interest margin and market value of equity.
Simulation of earnings is the primary tool used to measure the sensitivity
of earnings to interest rate changes. Using computer-modeling techniques, the
Company is able to estimate the potential impact of changing interest rates on
earnings. A balance sheet forecast is prepared quarterly using inputs of actual
loans, securities and interest bearing liabilities (i.e. depositis/borrowings)
positions as the beginning base. The forecast balance sheet is processed against
four interest rate scenarios. The scenarios include a 100 and 200 basis point
rising rate forecasts, a flat rate forecast and a 100 basis point falling rate
forecast which take place within a one year time frame. The net interest income
is measured during the year assuming a gradual change in rates over the
twelve-month horizon. The Company's 2004 net interest income, as forecast below,
was modeled utilizing a forecast balance sheet projected from year-end 2002
balances. The following table summarizes the effect on net interest income (NII)
of a +/-100 and +200 basis point change in interest rates as measured against a
constant rate (no change) scenario.
Interest Rate Risk Simulation of Net Interest Income as of December 31, 2003
(In thousands)
Variation from a constant rate scenario Change in NII
+200bp $948
+100bp $434
-100bp ($328)
The simulations of earnings do not incorporate any management actions,
which might moderate the negative consequences of interest rate deviations.
Therefore, they do not reflect likely actual results, but serve as conservative
estimates of interest rate risk.
Interest Rate Sensitivity Analysis. Interest rate sensitivity is a function
of the repricing characteristics of the portfolio of assets and liabilities.
These repricing characteristics are the time frames within which the
interest-bearing assets and liabilities are subject to change in interest rates
either at replacement, repricing or maturity. Interest rate sensitivity
management focuses on the maturity of assets and liabilities and their repricing
during periods of changes in market interest rates. Interest rate sensitivity is
measured as the difference between the volumes of assets and liabilities in the
current portfolio that are subject to repricing at various time horizons. The
differences are known as interest sensitivity gaps.
A positive cumulative gap may be equated to an asset sensitive position. An
asset sensitive position in a rising interest rate environment will cause a
bank's interest rate margin to expand. This results as floating or variable rate
loans reprice more rapidly than fixed rate certificates of deposit that reprice
as they mature over time. Conversely, a declining interest rate environment will
cause the opposite effect. A negative cumulative gap may be equated to a
liability sensitive position. A liability sensitive position in a rising
interest rate environment will cause a bank's interest rate margin to contract,
while a declining interest rate environment will have the opposite effect.
The following table sets forth the dollar amounts of maturing and/or
repricing assets and liabilities for various periods. This does not include the
impact of prepayments or other forms of convexity caused by changing interest
rates. Historically, this has been immaterial and estimates for them are not
included.
27
The Company has more liabilities than assets repricing during the next
year. However, because the Company's asset rates change more than deposit rates,
the Company's interest income will change more than the cost of funds when rates
change. Its net interest margin should therefore increase somewhat when rates
increase and shrink somewhat when rates fall.
The Company controls its long term interest rate risk by keeping long term
fixed rate assets (longer than 5 years) less than its long term fixed rate
funding, primarily demand deposit accounts and capital. The following table sets
forth cumulative maturity distributions as of December 31, 2003 for the
Company's interest-bearing assets and interest-bearing liabilities, and the
Company's interest rate sensitivity gap as a percentage of total
interest-earning assets. The table shows $72.5 million in fixed rate loans over
5 years. Many variable rate credit lines reached floors in 2003, and were
reclassified to the fixed rate category. As soon as interest rates increase, the
loans will no longer be at floors and will be reclassified back to the floating
rate category.
(dollars in thousands)
December 31, 2003 3 months 12 months 3 years 5 years 15 years >15 years Totals
- -------------------------------------------------------------------------------------------------
ASSETS:
Fixed rate investments $300 $3,977 $11,268 $4,858 $15,298 $977 $36,678
Variable rate investments 295 295
Fixed rate loans 11,452 12,844 11,686 30,199 39,608 2,696 108,485
Variable rate loans 13,191 0 0 0 0 0 13,191
Interest-bearing balances 35 35
Fed funds sold 25,220 25,220
------ ------
Interest bearing assets 50,198 16,821 22,954 35,057 54,906 3,968 183,904
====== ====== ====== ====== ====== ===== =======
LIABILITIES:
Interest bearing 32,468 32,468
transaction deposits
Savings deposits 63,681 63,681
Time deposits
Fixed rate >100m 5,933 13,199 5,251 2,254 26,637
Fixed rate <100m 5,437 8,743 4,114 1,043 19,337
Floating rate >100m 0
Floating rate <100m 44 44
Borrowings 0 0
----- ------
Interest Bearing $107,563 $21,942 $9,365 $3,297 $ 0 $0 $142,167
Liabilities ======== ======= ====== ====== === ===== ========
Rate Sensitivity Gap (57,365) (5,121) 13,589 31,760 54,906 3,968
Cumulative Rate (57,365)(62,486) (48,897) (17,137) 37,769 41,737
Sensitivity Gap
Cumulative Position to (27.97%)(30.47%) (23.84%) (8.36%) 18.41% 20.34%
Total Assets
Inflation
Assets and liabilities of a financial institution are principally monetary
in nature. Accordingly, interest rates, which generally move with the rate of
inflation, have potentially the most significant effect on the Company's net
interest income. The Company attempts to limit inflation's impact on rates and
net income margins by minimizing its effect on these margins through continuing
asset/liability management programs.
28
Management's Discussion and Analysis
The Year Ended December 31, 2002 versus December 31, 2001
Summary
Net income for 2002 was $2.7 million compared with $2.6 million in 2001.
Basic earnings per share for 2002 were $1.87 compared with $1.77 in 2001. Return
on average assets was 1.67% in 2002 compared with 1.76% the previous year, while
return on average equity was 15.27% in 2002 and 17.19% for the previous year.
Total assets reached $182.6 million in 2002, an 16.0% increase over the
$157.4 million at December 31, 2001. Loans increased 19.2% to $128.1 million,
compared with $107.4 million at year-end 2001. Deposits also increased, growing
16.2% from $137.7 million at year-end 2001 to $160.0 million at year-end 2002.
The loan-to-deposit ratio increased from 78.1% to 80.0%.
Net Interest Income
Net interest income on a fully tax equivalent basis increased by $399,000
to $9.0 million in 2002, up 4.6% from 2001 net interest income of $8.6 million.
The net interest margin for 2002 decreased to 6.06% from 6.25% for the previous
year. Individual components of interest income and interest expense are provided
in the table - Average Balances, Yields and Rates Paid on page 19.
Interest Income
Interest income decreased by $523,000 to $11.0 million for a 4.6% decline
over the $11.5 million realized in 2001. The volume of earning assets increased
by 7.9% to $148.4 million from $137.5 million in 2001, while the yield on
average earning assets declined 97 basis points.
Interest Expense
Interest expense decreased by $922,000 to $2.0 million in 2002 from $2.9
million in 2001. The average rate paid on all interest-bearing liabilities
decreased from 2.89% in 2001 to 1.78% in 2002 while average balances increased
from $99.8 million to $110.4 million, a 10.5% gain over 2001. The gain in volume
of average balances was responsible for a $186,000 increase in interest expense
and higher interest rates paid resulted in a decrease of $1,108,000 for a total
decrease of $922,000. The higher rates paid on interest bearing liabilities is
the result of a raising rate environment.
Provision for Loan Losses
The provision for loan losses was $393,000 in 2002 and $342,000 in 2001.
The increase in the provision is primarily the result of loan growth and
management's evaluation and assessment of the loan portfolio. Loans charged off,
net of recoveries, resulted in losses totaling $27,000 in 2002 and losses of
$47,000 in 2001. The increase in charge-offs reflects current economic
conditions.
Non-interest Income
Non-interest income increased by 25.4% to $1.6 million from $1.3 million
the previous year. The increase was due to increases in all categories of non
interest income with a 189.0% increase in other non interest income, a 3.7%
increase in service charge on deposit accounts and a 24.3% increase in other fee
income.
29
Non-interest Expense
Non-interest expenses increased 12.2% to $5.9 million in 2002 from $5.2
million in 2001. Non-interest expense represented 3.6% of average total assets
at December 31, 2002 and 3.5% at December 31, 2001.
Salaries and benefits increased by 9.3% from $3.1 million in 2001 to $3.4
million in 2002. The 2002 increase reflects normal merit increases, incentives
and other increases in employee benefits. At December 31, 2002, total full-time
equivalent employees were 44 compared to 47 at December 31, 2001. Year end
assets per employee were $4.2 million in 2002 compared to $3.3 million in 2001.
Expenses related to premises and equipment increased by 5.5% to $618,000 in
2002, from $586,000 in 2001. Building lease expense on three locations and
storage units increased to $278,000 in 2002 from $268,000 in 2001.
Other non-interest expenses increased by 21.0% to $1.8 million in 2002 from
$1.5 million in 2001. The increase was primarily the result of a 66.2% increase
in professional fees. Professional fees is the largest category of other
non-interest expense, primarily comprised of accounting, legal and other
professional fees. These services increased by $190,000 to $478,000 in 2002 from
$288,000 in 2001. Advertising and business development show an increase of 90.2%
or $95,000 to $200,848 in 2002 from $105,614 in 2001. Advertising/business
development includes advertising, customer relations, shareholder relations,
public relations, donations and civic dues and is a result of the bank's
community involvement. Increases in other categories reflect the increased
growth and volume of business in general.
Provision for Income Taxes
The provision for income taxes decreased to an effective tax rate of 31.72%
in 2002 compared with 34.66% in 2001.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding Quantitative and Qualitative Disclosures about Market
Risk appears on page 26 through 28 under the caption "Management's Discussion
and Analysis of Consolidated Financial Condition and Results of Operations -
Market Risk Management" and is incorporated herein by reference.
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Richardson & Company 550 Howe Avenue, Suite 210
Sacramento, California 95825
Telephone: (916) 564-8727
FAX: (916) 564-8728
REPORT OF RICHARDSON & COMPANY
INDEPENDENT AUDITORS
Board of Directors and Shareholders
Sonoma Valley Bancorp and Subsidiary
Sonoma, California
We have audited the accompanying consolidated balance sheets of Sonoma Valley
Bancorp and Subsidiary as of December 31, 2003 and 2002, and the related
consolidated statements of operations, changes in the shareholders' equity and
cash flows for each of the three years in the period ended December 31, 2003.
These financial statements are the responsibility of the Bancorp'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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Sonoma Valley
Bancorp and Subsidiary as of December 31, 2003 and 2002, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
January 29, 2004 /s/ Richardson & Company
31
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
ASSETS 2003 2002
----------- -----------
Cash and due from banks $ 9,803,272 $ 8,387,953
Federal funds sold 25,220,000 23,095,000
Interest-bearing due from banks 330,930 34,646
----------- -----------
Total cash and cash equivalents 35,354,202 31,517,599
Investment securities available-for-sale, at fair value 20,119,777 3,823,259
Investment securities held-to-maturity (fair value
of $17,042,186 and $10,440,453, respectively) 16,558,153 9,923,737
Loans and lease financing receivables, net 119,833,989 125,269,181
Premises and equipment, net 1,313,995 875,697
Accrued interest receivable 906,958 799,282
Cash surrender value of life insurance 7,730,600 7,387,712
Other assets 3,288,463 3,006,260
------------- -------------
Total assets $205,106,137 $182,602,727
============ ============
LIABILITIES
Noninterest-bearing demand deposits $ 37,947,577 $ 38,760,806
Interest-bearing transaction deposits 32,467,678 24,627,589
Savings and money market deposits 63,680,697 51,802,714
Time deposits, $100,000 and over 26,565,347 25,018,603
Other time deposits 19,453,317 19,778,540
------------ ------------
Total deposits 180,114,616 159,988,252
Accrued interest payable
and other liabilities 3,520,242 3,374,165
------------ ------------
Total liabilities 183,634,858 163,362,417
Commitments and contingencies ( see accompanying notes )
SHAREHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares
authorized; 1,457,594 shares in 2003 and 1,401,146 in
2002 issued and outstanding 15,061,636 12,936,225
Retained earnings 6,386,083 6,215,790
Accumulated other comprehensive income 23,560 88,295
------------ ------------
Total shareholders' equity 21,471,279 19,240,310
------------ ------------
Total liabilities and shareholders' equity $205,106,137 $182,602,727
============ ============
The accompanying notes are an integral part of these financial statements.
32
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001
---------------- --------------- ----------------
INTEREST INCOME
Loans and leases $ 9,446,841 $ 9,470,998 $ 9,251,314
Taxable securities 365,459 378,511 1,013,330
Tax-exempt securities 485,460 512,708 552,110
Federal funds sold and other 318,798 216,362 286,083
Dividends 13,269 15,227 15,812
----------- ----------- -----------
Total interest income 10,629,827 10,593,806 11,118,649
INTEREST EXPENSE
Interest-bearing transaction deposits 50,454 84,241 149,078
Savings and money market deposits 466,081 655,841 996,864
Time deposits, $100,000 and over 729,758 674,089 844,351
Other time deposits 477,061 546,543 885,322
Other
31 7,221
---------- ----------- -----------
Total interest expense 1,723,385 1,960,714 2,882,836
---------- ---------- -----------
NET INTEREST INCOME 8,906,442 8,633,092 8,235,813
Provision for loan and lease losses 20,000 393,000 342,000
---------- ---------- -----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN AND
LEASE LOSSES 8,886,442 8,240,092 7,893,813
NON-INTEREST INCOME 1,715,123 1,641,191 1,309,315
NON-INTEREST EXPENSE
Salaries and employee benefits 3,489,007 3,437,390 3,143,911
Premises and equipment 768,789 618,029 585,748
Other 1,986,365 1,806,954 1,494,285
---------- ---------- -----------
Total non-interest expense 6,244,161 5,862,373 5,223,944
Income before provision ---------- ---------- -----------
for income taxes 4,357,404 4,018,910 3,979,184
Provision for income taxes 1,446,397 1,274,577 1,378,940
---------- ---------- -----------
NET INCOME $2,911,007 $2,744,333 $ 2,600,244
========== ========== ===========
NET INCOME PER SHARE $ 2.00 $ 1.87 $ 1.77
NET INCOME PER SHARE ====== ====== ======
ASSUMING DILUTION $ 1.83 $ 1.72 $ 1.66
====== ====== ======
The accompanying notes are an integral part of these financial statements.
33
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the years ended December 31, 2003, 2002 and 2001
Accumulated
Other
Comprehensive Common Stock Retained Comprehensive
Income Shares Amount Earnings Income Total
------------- --------- ----------- ----------- ------------- ------------
BALANCE AT
JANUARY 1, 2001
1,281,680 $ 9,585,003 $ 4,641,551 $ 78,692 $ 14,305,246
5% stock dividend 63,104 1,381,976 (1,381,976)
Fractional shares (11,955) (11,955)
Redemption and retirement
of stock (27,717) (207,323) (364,085) (571,408)
Stock options exercised and 16,437 266,229 266,229
related tax benefits
Net income for the year $2,600,244 2,600,244 2,600,244
Other comprehensive
income,
net of tax:
Unrealized holding gains
on securities available-
for-sale arising during 82,706
the year, net of taxes -----------
of $57,842
Other comprehensive
income,
net of taxes 82,706 82,706 82,706
---------- ---------- --------- ------------ --------- ----------
Total comprehensive income $2,682,950
==========
BALANCE AT
DECEMBER 31, 2001 1,333,504 11,025,885 5,483,779 161,398 16,671,062
5% stock dividend 65,742 1,775,026 (1,775,026)
Fractional shares (13,951) (13,951)
Redemption and retirement
of stock (14,596) (121,257) (223,345) (344,602)
Stock options exercised and
related tax benefits 16,496 256,571 256,571
Net income for the year $ 2,744,333 2,744,333 2,744,333
Other comprehensive
income,
net of tax:
Unrealized holding gains
on securities available-
for-sale arising during (73,103)
the year, net of taxes -----------
of $51,125
Other comprehensive
income,
net of taxes (73,103) (73,103) (73,103)
----------- ---------- ----------- ------------ --------- ---------
Total comprehensive income $ 2,671,230
===========
(Continued)
34
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Continued)
For the years ended December 31, 2003, 2002 and 2001
Accumulated
Other
Comprehensive Common Stock Retained Comprehensive
Income Shares Amount Earnings Income Total
------------- --------- ----------- ----------- ------------- ------------
BALANCE AT
DECEMBER 31, 2002 1,401,146 $12,936,225 $ 6,215,790 $ 88,295 $19,240,310
5% stock dividend 68,665 1,997,422 (1,997,422)
Fractional shares (14,193) (14,193)
Redemption and retirement
of stock (38,987) (361,296) (729,099) (1,090,395)
Stock options exercised and
related tax benefits 26,770 489,285 489,285
Net income for the year $ 2,911,007 2,911,007 2,911,007
Other comprehensive income,
net of tax:
Unrealized holding losses
on securities available-
for-sale arising during
the year, net of taxes
of $45,274 (64,735)
------------
Other comprehensive income,
net of taxes (64,735) (64,735) (64,735)
------------ ----------- ------------- ------------ ------------- -----------
Total comprehensive income $ 2,846,272
===========
BALANCE AT
DECEMBER 31, 2003
1,457,594 $15,061,636 $ 6,386,083 $ 23,560 $21,471,279
========= =========== =========== ========== ===========
The accompanying notes are an integral part of these financial statements.
35
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001
----------- ----------- -----------
OPERATING ACTIVITIES
Net income $ 2,911,007 $ 2,744,333 $ 2,600,244
Adjustments to reconcile net income
to net cash provided by operating activities:
Provision for loan and lease losses 20,000 393,000 342,000
Depreciation 224,774 144,659 142,683
Loss on sale of securities 5,098
Loss on sale of equipment 23
Amortization and other 115,551 43,971 71,782
Net change in interest receivable (107,676) 152,779 199,863
Net change in cash surrender value
Of life insurance (342,888) (265,181) (113,227)
Net change in other assets (47,325) (63,800) (111,557)
Net change in interest payable
and other liabilities 146,078 50,001 69,505
--------- --------- ---------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 2,919,544 3,504,860 3,201,293
INVESTING ACTIVITIES
Purchases of securities held-to-maturity (10,718,156) (1,129,886)
Purchases of securities available-for-sale (17,216,738) (540,547)
Proceeds from maturing securities held-to-
Maturity 4,028,400 1,841,141 1,472,700
Proceeds from maturing securities available-
for-sale 750,000 7,000,000 10,550,000
Proceeds from sales of securities available-
for-sale 244,063
Net increase (decrease) in loans and leases 5,415,192 (20,629,972) (14,910,204)
Purchases of premises and equipment (663,645) (399,704) (156,037)
Purchases of life insurance (2,092,000) (3,000,000)
Proceeds from disposal of equipment
550
------------ ------------ -----------
NET CASH USED FOR
INVESTING ACTIVITIES (18,404,397) (14,577,019) (7,173,427)
(Continued)
36
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001
----------- ----------- -----------
FINANCING ACTIVITIES
Net change in demand, interest-bearing
transaction and savings deposits $ 18,904,842 $ 13,505,460 $ 13,692,323
Net change in time deposits 1,221,521 8,827,814 866,584
Stock repurchases (1,090,395) (344,602) (571,408)
Stock options exercised 299,681 214,375 214,858
Fractional shares purchased
(14,193) (13,951) (11,955)
------------ ----------- -----------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 19,321,456 22,189,096 14,190,402
------------ ----------- -----------
NET CHANGE IN CASH AND
CASH EQUIVALENTS 3,836,603 11,116,937 10,218,268
------------ ----------- -----------
Cash and cash equivalents
at beginning of year 31,517,599 20,400,662 10,182,394
------------ ----------- -----------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 35,354,202 $ 31,517,599 $ 20,400,662
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Cash paid during the year for:
Interest expense $1,731,256 $1,965,215 $2,920,348
Income taxes $1,375,000 $1,663,975 $1,556,000
SUPPLEMENTAL DISCLOSURES OF
NONCASH ACTIVITIES:
Stock dividend $1,997,422 $1,775,026 $1,381,976
Net change in unrealized gains and losses
on securities $ (110,009) $ (124,228) $ 140,548
Net change in deferred income taxes on unrealized
gains and losses on securities $ 45,274 $ 51,125 $ (57,842)
The accompanying notes are an integral part of these financial statements.
37
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
NOTE A--SIGNIFICANT ACCOUNTING POLICIES
Business: Sonoma Valley Bancorp (the Bancorp), formed in 2000, is a bank holding
company whose principal activity is the ownership and management of its
wholly-owned subsidiary, Sonoma Valley Bank. Sonoma Valley Bank was organized in
1987 and commenced operations on June 3, 1988 as a California state-chartered
bank. The Bank is subject to regulation, supervision and regular examination by
the State Department of Financial Institutions and Federal Deposit Insurance
Corporation. The regulations of these agencies govern most aspects of the Bank's
business.
Principles of Consolidation: The consolidated financial statements include the
accounts of the Bancorp and the Bank. All material intercompany accounts and
transactions have been eliminated.
Nature of Operations: The Bank provides a variety of banking services to
individuals and businesses in its primary service area of Sonoma, California and
the immediate surrounding area. The Bank offers depository and lending services
primarily to meet the needs of its business and professional clientele. These
services include a variety of demand deposit, savings and time deposit account
alternatives, and special merchant and business services. The Bank's lending
activities are directed primarily towards granting short and medium-term
commercial loans, customized lines of credit, for such purposes as operating
capital, business and professional start-ups, inventory, equipment and accounts
receivable, and interim construction financing.
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles 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.
Cash and Cash Equivalents: For the purposes of reporting cash flows, cash and
cash equivalents are defined as those amounts included in the balance sheet
captions "Cash and due from banks" and "Federal funds sold." Generally, federal
funds are sold or purchased for one-day periods.
Investment Securities: Securities are classified as held-to-maturity if the
Bancorp has both the intent and ability to hold those debt securities to
maturity regardless of changes in market conditions, liquidity needs or changes
in general economic conditions. These securities are carried at cost adjusted
for amortization of premium and accretion of discount, computed by the interest
method over their contractual lives.
Securities are classified as available-for-sale if the Bancorp intends to hold
those debt securities for an indefinite period of time, but not necessarily to
maturity. Any decision to sell a security classified as available-for-sale would
be based on various factors, including significant movements in interest rates,
changes in the maturity mix of the Bancorp's assets and liabilities, liquidity
needs, regulatory capital considerations and other similar factors. Securities
available-for-sale are carried at fair value. Unrealized holding gains or losses
are reported as increases or decreases in shareholders' equity, net of the
related deferred tax effect. Realized gains or losses, determined on the basis
of the cost of specific securities sold, are included in earnings.
38
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE A--SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loans and Lease Financing Receivables: Loans are stated at the amount of unpaid
principal, less the allowance for loan losses and net deferred loan fees.
Interest on loans is accrued and credited to income based on the principal
amount outstanding. Loan origination fees and certain direct loan origination
costs are capitalized and recognized as an adjustment of the yield on the
related loan. However, loan origination costs in excess of fees collected are
not deferred but this treatment has an immaterial impact on the financial
statements. Amortization of net deferred loan fees is discontinued when the loan
is placed on nonaccrual status.
All of the Bancorp's leases are classified and accounted for as direct financing
leases. Under the direct financing method of accounting for leases, the total
net rentals receivable under the lease contracts, net of unearned income, are
recorded as a net investment in direct financing leases, and the unearned income
is recognized each month as it is earned so as to produce a constant periodic
rate of return on the unrecovered investment.
Allowance for Loan and Lease Losses: The allowance is maintained at a level
which, in the opinion of management, is adequate to absorb probable losses
inherent in the loan and lease portfolio. Credit losses related to
off-balance-sheet instruments are included in the allowance for loan and lease
losses except if the loss meets the criteria for accrual under Statement of
Financial Accounting Standards (SFAS) No. 5, in which case the amount is accrued
and reported separately as a liability. Management determines the adequacy of
the allowance based upon reviews of individual loans and leases, recent loss
experience, current economic conditions, the risk characteristics of the various
categories of loans and leases and other pertinent factors. The allowance is
based on estimates, and ultimate losses may vary from the current estimates.
These estimates are reviewed monthly and, as adjustments become necessary, they
are reported in earnings in the periods in which they become known. Loans and
leases deemed uncollectible are charged to the allowance. Provisions for loan
and lease losses and recoveries on loans previously charged off are added to the
allowance.
Commercial loans are considered impaired, based on current information and
events, if it is probable that the Bancorp will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Allowances on impaired loans are
established based on the present value of expected future cash flows discounted
at the loan's historical effective interest rate or, for collateral-dependent
loans, on the fair value of the collateral. Cash receipts on impaired loans are
used to reduce principal.
Income Recognition on Impaired and Nonaccrual Loans and Leases: Loans and
leases, including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of principal or interest for a period of
more than 90 days, unless such loans are well-secured and in the process of
collection. If a loan or lease or a portion of a loan or lease is classified as
doubtful or is partially charged off, the loan or lease is classified as
nonaccrual. Loans and leases that are on a current payment status or past due
less than 90 days may also be classified as nonaccrual if repayment in full of
principal and/or interest is in doubt.
39
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE A--SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loans and leases may be returned to accrual status when all principal and
interest amounts contractually due (including arrearages) are reasonably assured
of repayment within an acceptable period of time, and there is a sustained
period of repayment performance by the borrower, in accordance with the
contractual terms of interest and principal.
While a loan or lease is classified as nonaccrual and the future collectibility
of the recorded balance is doubtful, collections of interest and principal are
generally applied as a reduction to principal outstanding. When the future
collectibility of the recorded balance is expected, interest income may be
recognized on a cash basis. In the case where a nonaccrual loan or lease had
been partially charged off, recognition of interest on a cash basis is limited
to that which would have been recognized on the recorded balance at the
contractual interest rate. Cash interest receipts in excess of that amount are
recorded as recoveries to the allowance for loan losses until prior charge-offs
have been fully recovered.
Premises and Equipment: Premises and equipment are stated at cost, less
accumulated depreciation. The provision for depreciation is computed principally
by the straight-line method over the estimated useful lives of the related
assets.
Income Taxes: Provisions for income taxes are based on amounts reported in the
statements of operations (after exclusion of non-taxable income such as interest
on state and municipal securities) and include deferred taxes on temporary
differences in the recognition of income and expense for tax and financial
statement purposes. Deferred taxes are computed using the asset and liability
method. Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. Deferred tax assets are recognized for
deductible temporary differences and tax credit carryforwards, and then a
valuation allowance is established to reduce that deferred tax asset if it is
"more likely than not" that the related tax benefits will not be realized.
Advertising: Advertising costs are charged to operations in the year incurred.
Net Income Per Share of Common Stock: Net income per share of common stock is
computed by dividing net income by the weighted average number of shares of
common stock outstanding during the year, after giving retroactive effect to the
stock dividends and splits. Net income per share--assuming dilution is computed
similar to net income per share except that the denominator is increased to
include the number of additional common shares that would have been outstanding
if the dilutive potential common shares had been issued. Included in the
denominator is the dilutive effect of stock options computed under the treasury
method.
40
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE A--SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock Option Accounting: At December 31, 2003, the Bancorp has two stock-based
employee and director compensation plans, which are described more fully in Note
M. The Bancorp adopted SFAS No. 148, Accounting for Stock-Based Compensation, an
Amendment of SFAS No. 123 effective January 1, 2003 using the prospective
application method. Under this method, the compensation expense and related tax
benefit associated with stock option grants issued on or after January 1, 2003
are recognized in the income statement. The Bancorp accounts for options granted
prior to January 1, 2003 under the recognition and measurement principles of APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based compensation cost is reflected in net income for
these options, as all options granted under those plans had an exercise price
equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
if the Bancorp had applied the fair value recognition provisions of SFAS
Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
compensation for options granted prior to January 1, 2003.
2003 2002 2001
----------- ----------- -----------
Net income, as reported $ 2,911,007 $ 2,744,333 $ 2,600,244
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (179,899) (185,919) (179,899)
----------- ----------- -----------
Pro forma net income $ 2,731,108 $ 2,558,414 $ 2,420,345
=========== =========== ===========
Earnings per share:
Basic--as reported $ 2.00 $ 1.87 $ 1.77
Basic--pro forma 1.87 1.75 1.64
Diluted--as reported 1.83 1.72 1.66
Diluted--pro forma 1.72 1.61 1.54
Off-Balance-Sheet Financial Instruments: In the ordinary course of business the
Bancorp has entered into off-balance-sheet financial instruments consisting of
commitments to extend credit and standby letters of credit. Such financial
instruments are recorded in the financial statements when they become payable.
Operating Segments: Reportable segments are based on products and services,
geography, legal structure, management structure and any other manner in which
management desegregates a company for making operating decisions and assessing
performance. The Bancorp has determined that its business is comprised of a
single operating segment.
41
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE B--RESTRICTIONS ON CASH AND DUE FROM BANKS
Cash and due from banks include amounts the Bank is required to maintain to meet
certain average reserve and compensating balance requirements of the Federal
Reserve. The total requirement at December 31, 2003 and 2002 was $3,400,000 and
$2,886,000, respectively.
NOTE C--INVESTMENT SECURITIES
The amortized cost and approximate fair value of investment securities are
summarized as follows:
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------- --------------- ---------------- --------------
December 31, 2003:
Securities Available-For-Sale
U.S. Treasury securities $ 515,928 $ 4,619 $ 520,547
U.S. Government agency
securities 18,672,992 72,126 $ (57,548) 18,687,570
Corporate securities
890,820 20,840 911,660
------------ --------- ---------- ------------
$ 20,079,740 $ 97,585 $ (57,548) $ 20,119,777
============ ========= ========= ============
Securities Held-to-Maturity
Municipal securities $ 16,558,153 $ 550,533 $ (66,500) $ 17,042,186
------------ --------- ---------- ------------
$ 16,558,153 $ 550,533 $ (66,500) $ 17,042,186
============ ========= ========= ============
December 31, 2002:
Securities Available-For-Sale
U.S. Treasury securities $ 533,848 $ 5,057 $ 538,905
U.S. Government agency
securities 1,497,398 115,417 1,612,815
Corporate securities 1,641,968 46,555 $ (16,984) 1,671,539
------------ --------- ---------- ------------
$3,673,214 $ 167,029 $ (16,984) $ 3,823,259
============ ========= ========= ============
Securities Held-to-Maturity
Municipal securities $ 9,923,737 $ 517,873 $ (1,157) $ 10,440,453
------------ --------- ---------- ------------
$ 9,923,737 $ 517,873 $ (1,157) $ 10,440,453
============ ========= ========= ============
42
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE C--INVESTMENT SECURITIES (Continued)
Contractual maturities of investment securities at December 31, 2003 were as
follows:
Securities Available-For-Sale Securities Held-To-Maturity
----------------------------- ------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
-------------- --------------- -------------- --------------
Due in one year or less $3,155,579 $ 3,234,107 $ 1,042,976 $ 1,060,505
Due after one year through
five years 13,886,939 13,837,497 2,288,096 2,345,770
Due after five years through
ten years 3,037,222 3,048,173 7,600,195 7,814,824
Due after ten years 5,626,886 5,821,087
--------------- --------------- --------------- ----------------
$ 20,079,740 $ 20,119,777 $ 16,558,153 $ 17,042,186
=============== =============== =============== ================
During 2002, the Bancorp sold securities available-for-sale for total proceeds
of approximately $244,062 resulting in gross realized losses of approximately
$5,098 and no gross realized gains. During 2003 and 2001, the Bancorp did not
sell any securities available-for-sale.
As of December 31, 2003, investment securities with a carrying amount of
$6,107,353 and an approximate fair value of $6,530,152 were pledged, in
accordance with federal and state requirements, as collateral for public
deposits. Investment securities with a carrying amount and fair value of
$1,655,647 at December 31, 2003 were pledged to meet the requirements of the
Federal Reserve and the U.S. Department of Justice.
The following table shows the investments' gross unrealized losses and fair
value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position, at December 31,
2003.
Less Than 12 Months
-----------------------
Fair Unrealized
Description of Securities Value Losses
- ------------------------- ------------ ----------
U.S. government agency securities $ 8,736,699 $ 57,548
Municipal securities 4,630,160 63,406
------------ ----------
Total temporarily impaired securities $ 13,366,859 $ 120,954
============ ==========
There were no securities as of December 31, 2003 that were in a continuous loss
position for 12 months or more. There were 9 Federal Home Loan Bank or Federal
Home Loan Mortgage Corporation securities and 14 municipal securities that were
temporarily impaired as of December 31, 2003. The primary cause of the
impairment of these securities is interest rate volatility. The unrealized
losses on these securities is expected to be short-term.
43
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE D--LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES
The composition of the loan and lease portfolio was as follows at December 31:
2003 2002
-------------------------- -----------------------
Commercial $ 92,197,984 75.0% $ 89,507,230 69.7%
Consumer 11,750,131 9.6% 13,374,774 10.4%
Real estate mortgage 2,231,244 1.8% 5,911,082 4.6%
Real estate construction 16,646,907 13.5% 19,507,906 15.2%
Lease financing receivables, net of
unearned income of $9,799 in
2003 and $33,781 in 2002 79,884 0.1% 174,409 0.1%
------------- ---- ----------- ----
122,906,150 100.0% 128,475,401 100.0%
===== =====
Deferred loan fees and costs, net (437,536) (424,258)
Allowance for loan and lease losses
(2,634,625) (2,781,962)
------------ ------------
$119,833,989 $125,269,181
============ ============
At December 31, 2003, the recorded investment in loans for which impairment has
been recognized in accordance with Statement of Financial Accounting Standards
(Statement) No. 114 totaled $1,145,000, with a corresponding valuation allowance
of $424,000. At December 31, 2002, the recorded investment in loans for which
impairment has been recognized in accordance with Statement No. 114 totaled
$164,000, with a corresponding valuation allowance of $17,000. For the years
ended December 31, 2003, 2002 and 2001, the average recorded investment in
impaired loans was approximately $843,000, $143,000 and $192,000, respectively.
During 2003 and 2002, $8,000 and $2,000 of interest was received and recognized
on impaired loans, respectively. No interest was recognized on impaired loans
during 2001.
In addition, at December 31, 2003 and 2002, the Bancorp had other nonaccrual
loans of approximately $115,300 and $801,700, respectively, for which impairment
had not been recognized.
The Bancorp has no commitments to loan additional funds to the borrowers of
impaired or nonaccrual loans.
44
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE D--LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
The maturity and repricing distribution of the loan and lease portfolio at
December 31:
2003 2002
----------- ----------
Fixed rate loan maturities
Three months or less $ 11,452,282 $ 11,069,375
Over three months to twelve months 12,843,967 16,759,422
Over one year to five years 41,884,458 25,717,999
Over five years 42,304,207 46,803,191
Floating rate loans repricing
Quarterly or more frequently 13,191,129 26,369,806
Quarterly to annual frequency 26,790
One to five years frequency 832,277
----------- -----------
121,676,043 127,578,860
Nonaccrual loans 1,230,107 896,541
----------- -----------
$122,906,150 $128,475,401
============ ============
An analysis of the changes in the allowance for loan and lease losses is as
follows for the years ended December 31:
2003 2002 2001
----------- ----------- -----------
Beginning balance $ 2,781,962 $ 2,415,555 $ 2,120,517
Provision for loan and lease losses 20,000 393,000 342,000
Loans charged off:
Commercial (142,572) (10,741) (44,345)
Consumer (41,161) (34,872) (31,680)
---------- ---------- ----------
(183,733) (45,613) (76,025)
Recoveries:
Commercial 8,320 9,474 10,363
Consumer 8,076 9,546 18,700
----------- ----------- -----------
16,396 19,020 29,063
----------- ----------- -----------
Ending balance $ 2,634,625 $ 2,781,962 $ 2,415,555
=========== =========== ===========
45
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE E--PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at December 31:
2003 2002
---------- ----------
Land $ 175,000 $ 175,000
Building 71,943 71,943
Leasehold improvements 660,272 418,802
Furniture, fixtures and equipment 1,688,809 1,306,225
---------- ---------
2,596,024 1,971,970
Less: Accumulated depreciation (1,282,029) (1,096,273)
---------- ----------
$1,313,995 $ 875,697
========== =========
NOTE F--TIME DEPOSITS
The maturities of time deposits at December 31, 2003 are as follows:
Maturing within one year $ 33,355,000
Maturing in one year to two years 8,443,000
Maturing two years through five years 2,550,000
Maturing after five years 1,671,000
-------------
$ 46,019,000
=============
NOTE G--FEDERAL FUNDS CREDIT LINES
The Bancorp has uncommitted federal funds lines of credit agreements with other
banks. The maximum borrowings available under these lines totaled $4,000,000 at
December 31, 2003. The Bancorp pledged loans totaling $25,913,127 as collateral
to secure advances from the Federal Home Loan Bank of up to $14,255,849. There
were no borrowings outstanding under the agreements at December 31, 2003 or
2002.
NOTE H--EMPLOYEE BENEFIT PLANS
The Bancorp has a 401(k) Employee Savings Plan (the Plan) in which the Bancorp
matches a portion of the employee's contribution each payday. All employees are
eligible for participation following three months of employment. Bancorp
contributions are 100% vested at all times. The Bancorp made contributions
totaling $92,012 in 2003, $77,913 in 2002 and $60,845 in 2001.
46
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE H--EMPLOYEE BENEFIT PLANS (Continued)
The Bancorp purchased single premium life insurance policies in connection with
the implementation of retirement plans for four key officers and for the Board
of Directors. The policies provide protection against the adverse financial
effects from the death of a key officer and provide income to offset expenses
associated with the plans. The officers are insured under the policies, but the
Bancorp is the owner and beneficiary. At December 31, 2003 and 2002, the cash
surrender value of these policies totaled $7,730,600 and $7,387,712,
respectively.
The retirement plans are unfunded and provide for the Bancorp to pay the
officers and directors specified amounts for specified periods after retirement
and allows them to defer a portion of current compensation in exchange for the
Bancorp's commitment to pay a deferred benefit at retirement. If death occurs
prior to or during retirement, the Bancorp will pay the officer's beneficiary or
estate the benefits set forth in the plans. Deferred compensation is vested as
to the amounts deferred. Liabilities are recorded for the estimated present
value of future salary continuation benefits and for the amounts deferred by the
officers and directors. At December 31, 2003 and 2002, the liability recorded
for the executive officer supplemental retirement plan totaled $1,439,970 and
$1,223,570, respectively. The amount of pension expense related to this plan for
2003 and 2002 was $216,400 and $325,365, respectively. At December 31, 2003 and
2002, the liability recorded for the director supplemental retirement plan
totaled $293,653 and $208,626, respectively. The amount of pension expense
related to this plan for 2003 and 2002 was $208,626 and $85,027, respectively.
At December 31, 2003 and 2002, the liability recorded for the deferred
compensation plan totaled $989,788 and $849,610, respectively. The amount of
expense related to this plan for 2003 and 2002 was $82,542 and $74,407,
respectively. The following are the components of the accumulated benefit
obligation related to the executive officer and director supplemental retirement
plans as of December 31:
Directors Officers
----------------------- -------------------------
2003 2002 2003 2002
--------- --------- ----------- -----------
Projected benefit obligation $ 293,653 $ 208,626 $ 1,235,077 $ 1,032,706
Unamortized net transition
obligation 204,893 190,864
--------- --------- ----------- -----------
Benefit obligation included in
other liabilities $ 293,653 $ 208,626 $ 1,439,970 $ 1,223,570
========= ========= =========== ===========
The weighted-average discount rate used in determining the actuarial present
value of the projected benefit obligation was 7.5% for 2003 and 2002. No
compensation increases were assumed. The entire accumulated benefit obligation
was fully vested at December 31, 2003 and 2002.
47
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE H--EMPLOYEE BENEFIT PLANS (Continued)
The following is a reconciliation of the beginning and ending balances of the
benefit obligation for the years ended December 31:
Directors Officers
----------------------- -------------------------
2003 2002 2003 2002
--------- --------- ----------- -----------
Benefit obligation at beginning of year $ 208,626 $ 1,223,570 $ 898,205
Net periodic pension cost:
Service cost 71,387 $ 76,182 319,856 302,632
Interest cost on projected benefit
obligation 13,640 8,845 122,265 66,189
Amortization of unrecognized (56,811) (43,456)
liability at transition
Amendments 123,599 (168,910)
-------- --------- ---------- --------
Net Periodic pension cost recognized 85,027 208,626 216,400 325,365
-------- --------- ----------- --------
Benefit obligation at end of year $ 293,653 $ 208,626 $ 1,439,970 $ 1,223,570
========= ========= =========== ===========
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid:
Directors Officers
--------- --------
2004 $ 5,000
2005 14,100
2006 15,402
2007 17,585
2008 23,562 $ 145,396
2009 to 2013 1,511,134 4,811,609
48
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE I--NON-INTEREST INCOME AND OTHER NON-INTEREST EXPENSE
Non-interest income is comprised of the following for the years ended December
31:
2003 2002 2001
----------- --------- ---------
Service charges on deposit accounts $ 1,033,990 $ 964,198 $ 930,171
Other fee income 323,780 312,121 251,042
Life insurance earnings 342,888 357,181 113,227
Investment securities gains (losses) (5,098)
Other ( none exceeding 1% of revenues ) 14,465 12,789 14,875
----------- --------- ---------
$ 1,715,123 $ 1,641,191 $ 1,309,315
=========== =========== ===========
Other non-interest expense is comprised of the following for the years ended
December 31:
2003 2002 2001
----------- --------- ---------
Professional and consulting fees $ 679,460 $ 477,830 $ 287,471
Data processing 473,932 465,946 469,750
Stationary and supplies 160,992 159,909 158,335
Staff related 175,801 158,707 104,092
Advertising and business development 165,142 200,848 105,614
Postage and telephone 123,269 122,408 116,879
Assessments and insurance 30,948 83,633 79,042
Other ( none exceeding 1% of revenues) 176,821 137,673 173,102
----------- ----------- -----------
$ 1,986,365 $ 1,806,954 $ 1,494,285
=========== =========== ===========
49
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE J--INCOME TAXES
The provision for income taxes is comprised of the following:
2003 2002 2001
------------ ----------- -----------
Current
Federal $ 827,960 $ 1,073,157 $ 1,008,534
State 403,346 426,600 409,376
--------- ----------- -----------
1,231,306 1,499,757 1,417,910
Deferred
Federal 180,039 (195,491) (50,778)
State 35,052 (29,689) 11,808
------------ ----------- -----------
215,091 (225,180) (38,970)
------------ ----------- -----------
$ 1,446,397 $ 1,274,577 $ 1,378,940
============ =========== ===========
The following is a reconciliation of income taxes computed at the Federal
statutory income tax rate of 34% to the effective income tax rate used for the
provision for income taxes:
2003 2002 2001
------------ ----------- -----------
Income tax at Federal statutory rate $ 1,481,517 $1,366,429 $ 1,352,923
State franchise tax, less Federal
income tax benefit 311,746 287,529 284,687
Interest on municipal obligations exempt
from Federal tax (217,541) (259,885) (221,062)
Life insurance earnings (141,113) (146,996) (46,598)
Meals and entertainment 8,175 7,412 7,283
Other differences 3,613 20,088 1,707
----------- ----------- -----------
Provision for income taxes $ 1,446,397 $ 1,274,577 $ 1,378,940
=========== =========== ===========
50
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE J--INCOME TAXES (Continued)
The tax effects of temporary differences that give rise to the components of the
net deferred tax asset recorded as an other asset as of December 31 were as
follows:
2003 2002 2001
------------ ----------- -----------
Deferred tax assets:
Nonqualified benefit plans $ 1,021,410 $ 884,446 $ 719,760
Allowance for loan losses 959,891 1,015,774 877,944
Accrued liabilities 227,840 233,575 280,367
State franchise taxes 137,138 145,316 139,188
Other 13,773 45,119 27,186
------------ ----------- -----------
Total deferred tax assets 2,360,052 2,324,230 2,044,445
Deferred tax liabilities:
Depreciation 89,220 36,366 19,308
Unrealized securities holding gains 16,477 61,750 112,876
Other 42,041 35,565 29,392
------------ ----------- -----------
Total deferred tax liabilities 147,738 133,681 161,576
------------ ----------- -----------
Net deferred tax asset $ 2,212,314 $ 2,190,549 $ 1,882,869
=========== =========== ===========
Amounts presented for the tax effects of temporary differences are based upon
estimates and assumptions and could vary from amounts ultimately reflected on
the Bancorp's tax returns. Accordingly, the variances from amounts reported for
prior years are primarily the result of adjustments to conform to the tax
returns as filed.
Refundable income taxes were $346,669 and $185,839 at December 31, 2003 and
2002, respectively. The income tax benefit related to net investment losses was
$2,098 during 2002. There were no net investment gains or losses in 2003 or
2001.
NOTE K--STOCK REPURCHASE
The Bancorp has in effect a program to repurchase Sonoma Valley Bancorp stock.
As of December 31, 2003, $2,006,404 was repurchased.
51
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE L--EARNINGS PER SHARE
The following is the computation of basic and diluted earnings per share for the
years ended December 31:
2003 2002 2001
------------ ----------- -----------
Basic:
Net income $ 2,911,007 $ 2,744,333 $ 2,600,244
=========== =========== ===========
Weighted-average common shares outstanding 1,457,431 1,464,344 1,473,151
=========== =========== ===========
Earnings per share $ 2.00 $ 1.87 $ 1.77
=========== =========== ===========
Diluted:
Net income $ 2,911,007 $ 2,744,333 $ 2,600,244
=========== =========== ===========
Weighted-average common shares outstanding 1,457,431 1,464,344 1,473,151
Net effect of dilutive stock options - based on the
treasury stock method using average market
price 132,911 128,321 94,899
----------- ----------- -----------
Weighted-average common shares outstanding
and common stock equivalents 1,590,342 1,592,665 1,568,050
=========== =========== ===========
Earnings per share- assuming dilution $ 1.83 $ 1.72 $ 1.66
=========== =========== ===========
NOTE M--STOCK OPTION PLAN
The Bancorp has a stock option plan (the Plan), effective March 31, 1996 and
terminating March 31, 2006, under which incentive and nonstatutory stock
options, as defined under the Internal Revenue Code, may be granted. The Plan is
administered by a Committee appointed by the Board. Options representing 454,024
shares of the Bancorp's authorized and unissued common stock may be granted
under the Plan by the Committee to directors, full-time officers, and full-time
employees of the Bancorp at a price to be determined by the Committee, but in
the case of incentive stock options shall not be less than 100% of the fair
market value of the shares on the date the incentive stock option is granted. In
addition, the Bancorp shall grant options to purchase 3,089 shares of common
stock to each Board member on March 1st of each year, provided the person was a
member of the Board for the entire preceding year ending December 31st, at an
option price equal to the fair market value as of the grant date. The options
may have an exercise period of no more than 10 years and are vested upon
granting, except for 63,943 of incentive options and 142,075 of nonstatutory
options granted in April 1999, which are subject to a graded vesting schedule of
20% per year. No options were granted in 2003 or 2001.
52
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE M--STOCK OPTION PLAN (Continued)
The Bancorp approved an equity incentive plan (the Plan), effective May, 2002
and terminating May, 2012, under which stock options, restricted stock, stock
appreciation rights and stock bonuses may be granted. The Plan is administered
by a Committee appointed by the Board. Options representing 82,370 shares of the
Bancorp's authorized and unissued common stock may be granted under the Plan by
the Committee to all employees of the Bancorp at a price to be determined by the
Committee but shall not be less than 100% of the fair market value of the shares
on the date the incentive stock option is granted. The options may have an
exercise period of no more than 10 years and vesting is at the discretion of the
Committee.
The fair value of options granted is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 2002; dividend yield of zero; expected volatility
of 33.36 percent; risk-free interest rate of 5.44 percent and expected life of
10 years.
A summary of stock option activity, adjusted to give effect to stock dividends
and stock splits follows for the years ended December 31:
Incentive Stock Options
--------------------------------------------------------------------------------
2003 2002 2001
------------------------- ------------------------ -------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Price Shares Exercise Price Shares Exercise Price
---------------- -------- -------------- -------- -------------- --------
Shares under option at
beginning of year $ 12.36 113,624 $ 12.27 132,500 $12.28 135,185
Options granted 21.77 1,103
Options exercised 12.10 (15,445) 12.31 (17,426) 12.82 (2,685)
Options cancelled 11.95 (2,553)
-------- -------
Shares under option at
end of year 12.40 98,179 12.36 113,624 12.27 132,500
======== ======= =======
Options exercisable at
end of year 95,090 94,683 92,602
Weighted-average fair value
of options granted during
the year $9.28
53
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE M--STOCK OPTION PLAN (Continued)
Nonstatutory Stock Options
------------------------------------------------------------------------------
2003 2002 2001
------------------------- ------------------------ -----------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Price Shares Exercise Price Shares Exercise Price Shares
---------------- -------- ------------- -------- -------------- --------
Shares under option at
beginning of year $11.84 225,465 $ 11.84 225,465 $ 11.83 240,906
Options exercised 10.07 (12,352) 11.69 (15,441)
------- ------- _______
Shares under option at
end of year 11.94 213,113 11.84 225,465 11.84 225,465
======= ======= =======
Options exercisable at
end of year 182,227 163,696 132,788
The following table summarizes information about fixed stock options outstanding
at December 31, 2003:
Options Outstanding
----------------------------------------------------
Weighted-Average
Range of Number Remaining Weighted-Average
Exercise Prices Outstanding Contractual Life Exercise Price
--------------- ----------- ---------------- ----------------
$8.19 to $9.79 31,448 3.27 years $ 8.69
$11.75 to $11.95 233,816 5.28 years 11.93
$14.59 to $16.16 44,925 4.18 years 15.08
$21.77 1,103 8.42 years 21.77
-------
$8.19 to $21.77 311,292 4.96 years 12.09
=======
Options Exercisable
------------------------------------
Range of Number Weighted-Average
Exercise Prices Exercisable Exercise Price
--------------- ----------- ----------------
$8.19 to $9.79 31,448 $ 8.69
$11.75 to $11.95 199,841 11.92
$14.59 to $16.16 44,925 15.08
$21.77 1,103 21.77
----------
$8.19 to $21.77 277,317 12.11
==========
54
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE N--RELATED PARTY TRANSACTIONS
The Bancorp has entered into transactions with its directors, executive officers
and their affiliates (related parties). Such transactions were made in the
ordinary course of business on substantially the same terms and conditions,
including interest rates and collateral, as those prevailing at the same time
for comparable transactions with other customers, and did not, in the opinion of
management, involve more than normal credit risk or present other unfavorable
features. The following is a summary of the aggregate activity involving related
party borrowers at December 31, 2003 and 2002:
2003 2002
----------- -----------
Loans outstanding at beginning of year $ 4,607,000 $ 2,236,000
Loans disbursements 690,000 2,723,000
Loan repayments (2,202,000) (352,000)
----------- -----------
Loans outstanding at end of year $ 3,095,000 $ 4,607,000
=========== ===========
At December 31, 2003, commitments to related parties of approximately $1,541,000
were undisbursed. Deposits received from directors and officers totaled
$6,471,000 and $5,360,000 at December 31, 2003 and 2002, respectively.
The Bancorp leases its Glen Ellen office from a director of the Bancorp under a
noncancellable operating lease. Lease expense for the years ended December 31,
2003 and 2002 was $12,889 and $12,172, respectively. The remaining lease
commitment is approximately $61,595 through March 2008 including a minimum
inflationary increase of 4% per year. The monthly lease payments will be
increased annually based upon the Consumer Price Index, but not less than 4%
annually. The term of the lease is 5 years with an option to extend the lease
term for an additional 5 years at the same Consumer Price Index limitations.
NOTE O--COMMITMENTS AND CONTINGENT LIABILITIES
Lease Commitments: The Bancorp leases its two Sonoma offices, the Glen Ellen
office and the Banco de Sonoma office under noncancelable operating leases with
remaining terms of approximately six years, two years, five years and five
years, respectively. All of the leases require adjustments to the base rent for
changing price indices and two have a minimum annual increase of four percent.
The Sonoma main office lease has an option to renew for two consecutive
five-year terms and the Sonoma annex office has an option to renew for two
five-year periods and one four-year period. The Glen Ellen office and the Banco
de Sonoma office lease each have an option to renew for two additional five-year
terms. The following table summarizes future minimum commitments under the
noncancelable operating leases.
55
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE O--COMMITMENTS AND CONTINGENT LIABILITIES (Continued)
Year ended December 31:
2004 $ 302,802
2005 295,621
2006 287,216
2007 297,927
2008 297,022
Thereafter 143,037
-----------
$ 1,623,625
===========
Rental expense was $289,000 in 2003, $278,000 in 2002 and $268,000 in 2001.
Financial Instruments with Off-Balance-Sheet Risk: The Bancorp's financial
statements do not reflect various commitments and contingent liabilities which
arise in the normal course of business and which involve elements of credit
risk, interest rate risk and liquidity risk. These commitments and contingent
liabilities are commitments to extend credit and standby letters of credit. A
summary of the Bancorp's commitments and contingent liabilities at December 31,
is as follows:
Contractual Amounts
2003 2002
------------ -------------
Commitments to extend credit $ 35,309,000 $ 30,359,000
Standby letters of credit 725,000 589,000
Commitments to extend credit and standby letters of credit include exposure to
some credit loss in the event of nonperformance of the customer. The Bancorp's
credit policies and procedures for credit commitments and financial guarantees
are the same as those for extension of credit that are recorded on the balance
sheet. Because these instruments have fixed maturity dates, and because many of
them expire without being drawn upon, they do not generally present any
significant liquidity risk to the Bancorp.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The Bancorp evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Bancorp upon extension of credit, is based on management's
credit evaluation of the customer. Collateral held varies but may include
accounts receivable, inventory, property, plant, and equipment, certificates of
deposits and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bancorp to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending facilities to customers.
56
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE O--COMMITMENTS AND CONTINGENT LIABILITIES (Continued)
The Bancorp has not incurred any losses on its commitments in 2003, 2002 or
2001.
As a guarantor of its customer's credit card accounts, the Bancorp is
contingently liable for credit card receivable balances held by another
financial institution should the customers default. The total amount guaranteed
as of December 31, 2003 and 2002 was $153,500 and $181,000, respectively.
NOTE P--CONCENTRATIONS OF CREDIT RISK
Most of the Bancorp's business activity is with customers located within the
State of California, primarily in Sonoma County. The economy of the Bancorp's
primary service area is heavily dependent on the area's major industries which
are tourism and agriculture, especially wineries, dairies, cheese producers and
turkey breeders. General economic conditions or natural disasters affecting the
primary service area or its major industries could affect the ability of
customers to repay loans and the value of real property used as collateral.
While the Bancorp has a diversified loan portfolio, approximately 84% of these
loans are secured by real estate in its service area.
The concentrations of credit by type of loan are set forth in Note D. The
distribution of commitments to extend credit approximates the distribution of
loans outstanding. In addition, the Bancorp has loan commitments in the
wine/agricultural industry, tourism industry and construction loans,
representing 8%, 13% and 23%, of outstanding loans, respectively. Standby
letters of credit were granted primarily to commercial borrowers. The Bancorp,
as a matter of policy, does not extend credit to any single borrower or group of
related borrowers on a secured basis in excess of 25% of its unimpaired capital
(shareholders' equity plus the allowance for credit losses) and on an unsecured
basis in excess of 15% of its unimpaired capital.
The concentrations of investments are set forth in Note C. The Bancorp places
its investments primarily in financial instruments backed by the U.S. Government
and its agencies or by high quality financial institutions, municipalities or
corporations. The Bancorp has significant funds deposited with four
correspondent banks. At December 31, 2003 the Bancorp had on deposit $7,500,000,
$7,500,000 and $5,500,000 in federal funds sold to three of these institutions,
which represented 35%, 35% and 26% of the Bancorp's net worth, respectively. In
addition, deposits with two correspondent banks were in excess of the federally
insured limit by $3,033,351 at December 31, 2003. While management recognizes
the inherent risks involved in such concentrations, this concentration provides
the Bancorp with an effective and cost efficient means of managing its liquidity
position and item processing needs. Management closely monitors the financial
condition of their correspondent banks on a continuous basis. The Bancorp also
maintains additional deposit accounts with other correspondent banks should
management determine that a change in its correspondent banking relationship
would be appropriate.
57
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE P--CONCENTRATIONS OF CREDIT RISK (Continued)
At December 31, 2003, the Bancorp had life insurance policies with cash
surrender values of $2,248,787, $1,847,274 and $1,646,283 with three insurance
companies, which represented 10%, 9% and 8%, respectively, of the Bancorp's net
worth. Management closely monitors the financial condition and rating of these
insurance companies on a regular basis.
NOTE Q--REGULATORY MATTERS
Banking regulations limit the amount of cash dividends that may be paid without
prior approval of the Bank's regulatory agency. Cash dividends are limited to
the lesser of retained earnings, if any, or net income for the last three years,
net of the amount of any other distributions made to shareholders during such
periods. As of December 31, 2003, $6,442,571 was available for cash dividend
distribution without prior approval.
The Bank is subject to various regulatory capital requirements administered by
its primary federal regulator, the Federal Deposit Insurance Corporation (FDIC).
Failure to meet minimum capital requirements can initiate certain
mandatory---and possibly additional discretionary---actions by regulators that,
if undertaken, could have a direct material effect on the Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classification are 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 Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2003, that the Bank
meets all capital adequacy requirements to which it is subject.
58
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE Q--REGULATORY MATTERS (Continued)
As of December 31, 2003, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Bank must maintain
minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set
forth in the table. There are no conditions or events since that notification
that management believes have changed the institution's category. The Bank's
actual capital amounts and ratios are also presented in the table.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------- ------------------ -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(in thousands)
As of December 31, 2003:
Total Capital
(to Risk Weighted Assets) $ 22,493 13.4% >$ 13,393 >8.0% >$16,742 >10.0%
Tier I Capital - - - -
(to Risk Weighted Assets) $ 20,394 12.2% >$ 6,697 >4.0% >$10,044 > 6.0%
Tier I Capital - - - -
(to Average Assets) $ 20,394 10.0% >$ 8,165 >4.0% >$10,206 > 5.0%
- - - -
As of December 31, 2002:
Total Capital
(to Risk Weighted Assets) $ 20,852 13.4% >$ 12,444 >8.0% >$15,555 >10.0%
Tier I Capital - - - -
(to Risk Weighted Assets) $ 18,897 12.2% >$ 6,222 >4.0% >$ 9,333 > 6.0%
Tier I Capital - - - -
(to Average Assets) $ 18,897 10.5% >$ 7,207 >4.0% >$ 9,009 > 5.0%
- - - -
NOTE R--CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY
A condensed balance sheet as of December 31, 2003 and 2002 and the related
condensed statement of operations and cash flows for the years ended December
31, 2003, 2002, and 2001 for Sonoma Valley Bancorp (parent company only) are
presented as follows:
59
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE R--CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY (Continued)
Condensed Balance Sheets
December 31, 2003 and 2002
2003 2002
------------ ------------
Assets
Cash $ 869,931 $ 249,432
Other assets 258,863 89,551
Investment in common stock of subsidiary 20,417,945 18,985,494
------------ ------------
$ 21,546,739 $ 19,324,477
============ ============
Liabilities
Accrued expenses $ 75,460 $ 84,167
Shareholders' equity
Common stock 15,061,636 12,936,225
Retained earnings 6,409,643 6,304,085
------------ ------------
$ 21,546,739 $ 19,324,477
============ ============
Condensed Statements of Operations
For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001
----------- --------- ----------
Dividend from subsidiary $ 1,500,000 $ 500,000
Expenses 145,553 $ 125,091 36,620
----------- --------- ----------
Income (loss) before income taxes and equity in
undistributed income of subsidiary 1,354,447 (125,091) 463,380
Equity in undistributed net income of subsidiary 1,497,186 2,824,941 2,120,445
Income tax benefit 59,374 44,483 16,419
----------- ----------- -----------
Net income $ 2,911,007 $ 2,744,333 $ 2,600,244
=========== =========== ===========
60
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE R--CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY (Continued)
Condensed Statements of Cash Flows
For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001
---------- ---------- ----------
Operating activities:
Net income $2,911,007 $2,744,333 $2,600,244
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net income of subsidiary (1,497,186) (2,824,941) (2,120,445)
Net change in other assets 20,292 40,345 (17,218)
Net change in accrued expenses (8,707) 84,167
--------- ---------- ----------
Net cash provided by operating activities 1,425,406 43,904 462,581
---------- ---------- ---------
Financing activities:
Stock repurchases (1,090,395) (344,602) (571,408)
Stock options exercised 299,681 214,375 214,858
Fractional shares purchased (14,193) (13,951) (11,955)
---------- ---------- ---------
Net cash used by financing activities (804,907) (144,178) (368,505)
Net change in cash and cash equivalents 620,499 (100,274) 94,076
Cash and cash equivalents at beginning of year 249,432 349,706 255,630
---------- ---------- ---------
Cash and cash equivalents at end of year $ 869,931 $ 249,432 $ 349,706
========== ========== =========
Supplemental Disclosures of Noncash Activities:
Stock Dividend $1,997,422 $1,775,026 $ 1,381,976
NOTE S--FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments, requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance sheet. In
cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. In that regard, the derived fair value
estimates cannot be substantiated by comparison to independent markets and, in
many cases, could not be realized in immediate settlement of the instruments.
Statement No. 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Bancorp as
a whole.
61
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE S--FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
The estimated fair values of the Bancorp and Subsidiary's financial instruments
are as follows at December 31:
2003 2002
---------------------- ------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ----------- ----------- -----------
Financial assets:
Cash and due from banks $9,803,272 $9,803,272 $ 8,387,953 $ 8,387,953
Interest-bearing due from banks 330,930 330,930 34,646 34,646
Federal funds sold 25,220,000 25,220,000 23,095,000 23,095,000
Investment securities
available- for-sale 20,119,777 20,119,777 3,823,259 3,823,259
Investment securities held-
to-maturity 16,558,153 17,042,186 9,923,737 10,440,453
Loans and lease financing
receivables, net 119,833,989 120,308,741 125,269,181 125,970,797
Accrued interest receivable 906,958 906,958 799,282 799,282
Cash surrender value of life
insurance 7,730,600 7,730,600 7,387,712 7,387,712
Financial liabilities:
Deposits 180,114,616 180,913,343 159,988,252 160,920,406
Accrued interest payable 52,052 52,052 59,923 59,923
The carrying amounts in the preceding table are included in the balance sheet
under the applicable captions.
The following methods and assumptions were used by the Bancorp in estimating its
fair value disclosures for financial instruments:
Cash, due from banks and federal funds sold: The carrying amount is a
reasonable estimate of fair value.
Investment securities: Fair values for investment securities are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments. The carrying amount of accrued interest receivable
approximates its fair value.
62
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 2003, 2002 and 2001
NOTE S--FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
Loans and lease financing receivables, net: For variable-rate loans and leases
that reprice frequently and fixed rate loans and leases that mature in the near
future, with no significant change in credit risk, fair values are based on
carrying amounts. The fair values for other fixed rate loans and leases are
estimated using discounted cash flow analysis, based on interest rates currently
being offered for loans or leases with similar terms to borrowers of similar
credit quality. Loan and lease fair value estimates include judgments regarding
future expected loss experience and risk characteristics and are adjusted for
the allowance for loan and lease losses. The carrying amount of accrued interest
receivable approximates its fair value.
Cash surrender value of life insurance: The carrying amount approximates its
fair value.
Deposits: The fair values disclosed for demand deposits (for example,
interest-bearing checking accounts and passbook accounts) are, by definition,
equal to the amount payable on demand at the reporting date (that is, their
carrying amounts). The fair values for certificates of deposit are estimated
using a discounted cash flow calculation that applies interest rates currently
being offered on certificates to a schedule of aggregated contractual maturities
on such time deposits. The carrying amount of accrued interest payable
approximates fair value.
Off-balance sheet instruments: Off-balance sheet commitments consist of
commitments to extend credit and standby letters of credit. The contract or
notional amounts of the Bancorp's financial instruments with off-balance-sheet
risk are disclosed in Note O. Estimating the fair value of these financial
instruments is not considered practicable due to the immateriality of the
amounts of fees collected, which are used as a basis for calculating the fair
value, on such instruments.
NOTE T--SUBSEQUENT EVENTS
The Bank will open a new branch office, called Banco de Sonoma, in March 2004. A
long-term lease has been entered into as of December 31, 2003, which is included
in Note O. The Bank has deferred $40,000 of costs related primarily to leasehold
improvements as of December 31, 2003.
In January 2004, the Bank authorized the granting of options to purchase 45,000
shares to officers of the Bank at $31.06, resulting in compensation expense of
approximately $50,000.
On February 18, 2004, the Board of Directors declared a cash dividend of $0.25
per share to shareholders of record on March 1, 2004 and payable on March 15,
2004.
63
ITEM 9. CHANGES ON AND DISAGREEMENT WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES.
We carried out an evaluation, under the supervision and with the
participation of the our management, including our Chief Executive Officer and
Chief Financial Officer, about the effectiveness of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation,
our Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures as of the end of the period covered by this
Form 10-K are effective in timely alerting them to material information required
to be included in this Form 10-K.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Position with the Bank and Principal
Director Age Occupations During the Past Five Years
- -------- --- --------------------------------------
Secretary since 2001 and Director of the Bank
Suzanne Brangham 61 since March, 1995; since 1975, president of
Classix, Inc. and since 1994, president of 400
West Spain Corp.
Director of the Bank since its formation in
Dale T. Downing 62 1988; proprietor, Sonoma Market, Inc. and Glen
Ellen Village Market, Inc., formerly Shone's
Country Store, Inc.
Director of the Bank since its formation in
Frederick H. Harland 57 1988; proprietor, Harland & Lely Corporation
since 1998, project manger, Lely Construction,
Inc. since 1990; former Director and Chief
Executive Officer of Sonoma Cheese Factory from
1969 to 1990.
Director of the Bank since its formation in
Robert B. Hitchcock 59 1988; Chairman of the Board 1988-1995 retired in
1992 as President, Nicholas Turkey Breeding
Farms, a position held since 1982.
Director of the Bank since its formation in
Gerald J. Marino 64 1988; retired president, Marino Distributing
Beer and Wine Company since 1968.
64
Director of the Bank since 1993; president of
Gary D. Nelson 66 Gary D. Nelson Associates, Inc. since 1970.
Chairman of the Board since 1995 and Director of
Robert J. Nicholas 61 the Bank since its formation in 1988; retired in
1992 as Chairman, Nicholas Turkey Breeding
Farms, a position held since 1982.
Director of the Bank since 1992; general manager
Angelo C. Sangiacomo 73 and partner, Sangiacomo Vineyards since 1950;
founding director, Carneros Quality
Alliance since 1959.
Director of the Bank since 1993; retired as
J. R. Stone 80 Chairman of World Products, Inc. in 1987.
..
President and Chief Executive Officer of the
Mel Switzer, Jr. 58 Bank since April 1990; director of the Bank
since he joined in 1990.
Director of the Bank since its formation in
Harry W. Weise 73 1988; Secretary 1995-2001; retired president,
North Bay Insurance Brokers, Inc. since 1968.
..
Position with the Bank and Principal
Officer Age Occupations During the Past Five Years
- ------- --- --------------------------------------
Mel Switzer, Jr. 58 President and Chief Executive Officer since
April 1990.
Mary Quade Dieter 55 Executive Vice President, Chief Operating
Officer, Chief Financial Officer and Assistant
Corporate Secretary since June 1997; Executive
Vice President, Chief Financial Officer and
Asst. Corporate Secretary since January 1993;
Vice President, Chief Financial Officer and
Assistant Corporate Secretary from June 1988 to
January 1993.
Senior Vice President and Chief Lending Officer
Sean Cutting, 34 since August 2003; VP and Loan Group Manager
Chief Lending Officer, since April 2003; VP and Commercial Loan Officer
Senior Vice President since June 2002; Corporate Banking Officer at
ABN AMRO Bank and Silicon Valley Bank from
1999-2001.
There are no family relationships between any of the directors or executive
officers.
65
Position with the Bank and Principal
Key Employee Age Occupations During the Past Five Years
- ------------ --- --------------------------------------
Bob Thomas,
CIO, Vice President 44 Vice President and Chief Information Officer
since January 2003; AVP and IT Manage since
January 2001; Information Technology Manager
since January 2000; Network Communications
Engineer at ReloAction from 1997-1999.
Audit Committee Financial Expert
The Board of Directors has not designated an Audit Committee Financial
Expert. All of the members of the Audit Committee are independent as determined
by the NASD listing standards.
Compliance with Section 16 of the Securities Exchange Act of 1934
Based solely upon a review of Forms 3, 4 and 5 delivered to the Company as
filed with the Securities and Exchange Commission ("Commission"), directors and
officers of the Company and persons who own more than 10% of the Company's
common stock timely filed all required reports pursuant to Section 16(a) of the
Securities Exchange Act of 1934, except Robert Nicholas, who was late reporting
one transaction.
Code of Ethics
We have adopted a code of ethics that applies to our principal executive
officer, principal financial officer, principal accounting officer, controller
and other persons performing similar functions. A copy of our code of ethics can
be found on our website at sonomavalleybank.com/svbethics.pdf. The Company will
report any amendment or wavier to the code of ethics on our website within five
(5) days.
66
ITEM. 11. EXECUTIVE COMPENSATION.
As to the Company's Chief Executive Officer and each other key employee of
the Company and Bank who received total remuneration in excess of $100,000 in
2003, the following table sets forth total remuneration received from the
Company for services performed in all capacities during the last three years.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG-TERM COMPENSATION
------------------- ----------------------
SECURITIES
NAME AND OTHER RESTRICTED UNDERLYING ALL
PRINCIPAL ANNUAL STOCK OPTIONS/ OTHER
POSITION YEAR SALARY BONUS COMP. AWARD(S) SARs COMP.
=================== ======== ============ ========== =========== ============== ================ ==========
Mel Switzer, Jr., 2001 $147,137(1) $104,032 $7,608(5) $ 0 0 $4,200(6)
CEO, President
2002 $154,250(2) $120,727 $ 0(5) $ 0 0 $4,800(6)
2003 $157,879(3) $ 72,159 $ 2,374(5) $ 0 0 $5,600(6)
=================== ======== ============ ========== =========== ============== ================ ==========
Mary Quade 2001 $97,592 $69,355 $8,633(5) $ 0 0 $4,200(6)
Dieter, COO, CFO,
Executive VP
2002 $ 102,472 $ 80,485 $2,759(5) $ 0 0 $4,800(6)
2003 $106,571 $48,106 $ 102(5) $ 0 0 $5,600(6)
=================== ======== ============ ========== =========== ============== ================ ==========
Sean C. Cutting
CLO, Senior VP 2002 $48,853(4) $ 4,890 $1,539(5) $ 0 0 $2,030(6)
2003 $ 108,567 $25,900 $ 820(5) $ 0 0 $4,800(6)
=================== ======== ============ ========== =========== ============== ================ ==========
Bob Thomas, 2001 $ 109,600 $ 10,631 $1,990(5) $ 0 0 $ 0
CIO, VP
2002 $ 117,880 $ 11,491 $1,720(5) $ 0 0 $ 0
2003 $137,750 $10,061 $2,484(5) $ 0 0 $ 0
=================== ======== ============ ========== =========== ============== ================ ==========
____________________________
(1) Includes $141,290 base salary and $5,847 in fringe benefits.
(2) Includes $148,354 base salary and $5,896 in fringe benefits.
(3) Includes $154,289 base salary and $3,590 in fringe benefits.
(4) Hire date 6/17/2002
(5) Represents accrued and unused vacation.
(6) Represents 401(k) employer's matching contributions.
67
Option Grants in 2003
The following table provides information relating to stock options granted
by us during the year ended December 31, 2003.
Option Grants in Last Fiscal Year
---------------------------------
Potential
Percent of Total Realizable Value at
Number of Options Granted Assumed Annual
Securities to Exercise Rates of Stock
Underlying Employees Price Price Appreciation
Options in Fiscal Year Per Expiration For Option Terms
Name Granted -------------- Share Date 5% 10%
---- ------- ----- ---- ------ -------
Mel Switzer, Jr. 0 - - - - -
Mary Quade Dieter 0 - - - - -
Sean C. Cutting 0 - - - - -
* Less than 1%
Fiscal Year End Option Values
The following table sets forth for each of our executive officers named in
the Summary Compensation Table the number and value of exercisable and
un-exercisable options for the year ended December 31, 2003.
Number of Securities
Shares Underlying Unsecured Value of Unexercised
Acquired Options In-The-Money Options
on Value at December 31, 2003 at December 31, 2003
Name Exercise Realized ($) Exercisable Un-exercisable Exercisable Un-exercisable
---- -------- ------------ ----------- -------------- ----------- --------------
Mel Switzer, Jr. 0 0 60,422 3,089 1,053,431 54,678
Mary Quade Dieter 0 0 27,058 0 327,953 0
Sean C. Cutting 0 0 0 0 0 0
Compensation of Directors
The directors of the Company are scheduled to meet at least quarterly and
receive $100 for each meeting. The directors of the Bank receive $800 for each
regular board meeting and $200 for each committee meeting attended of which they
are a member. The Chairman of the Board of the Bank receives $1,100 for each
meeting. The Chair of the Audit Committee receives $300 for each meeting
attended. The President and Chief Executive Officer does not receive any
director fees.
Severance Agreements
On October 21, 1998, the Bank entered into Severance Agreements with both
its Chief Executive Officer, Mel Switzer, and its Chief Operating Officer, Mary
Dieter. On March 17, 2004, the Bank entered into a Severance Agreement with its
Chief Lending Officer, Sean C. Cutting. The Severance Agreement with Mr. Switzer
provides for payment to him equal to two years of his base salary in the event
that he is terminated within 24 months following a change of control of the
68
Company. Similarly, the Severance Agreements with Ms. Dieter and Mr. Cutting
provides for payment to each equal to one year of their individual base salary
in the event either is terminated within 24 months following a change of control
of the Company. The Severance Agreements are not employment agreements and
provide for payment of the severance only in the event of the occurrence of the
specified circumstances. All Severance Agreements are effective through October
20, 2008, subject to extension by mutual agreement of the Company and each
executive. The Company has assumed the obligations under these agreements.
Aggregated Option Exercises in Last Fiscal Year and Ten-Year Options/SAR
Repricings
There was no re-pricing of options for the fiscal year ended December 31,
2003.
Compensation Committee Interlocks and Insider Participation
Directors, Robert J. Nicholas, Chairman, Dale T. Downing, Robert B.
Hitchcock, Gary D. Nelson and Harry W. Weise serve on the Personnel and Policies
Committee (the board committee performing equivalent functions of a compensation
committee). There are no compensation committee interlocks or insider
participation on our personnel and policies committee.
Personnel and Policies Committee Report
Compensation Philosophy
The Committee continues to emphasize the important link between the
Company's performance, which ultimately benefits all shareholders, and the
compensation of its executives. Therefore, the primary goal of the Company's
executive compensation policy is to closely align the interests of the
shareholders with the interest of the executive officers, In order to achieve
this goal, the Company attempts to (i) offer compensation opportunities that
attract and retain executives whose abilities and skills are critical to the
long-term success of the Company and reward them for their efforts in ensuring
the success of the Company and (ii) encourage executives to manage from the
perspective of owners with an equity stake in the Company. The Company currently
uses three integrated components - Base Salary, Incentive Compensation and Stock
Options - to achieve these goals.
Base Salary
The Base Salary component of total compensation is designed to compensate
executives competitively within the industry and the marketplace. Base Salaries
of the executive officers are established by the committee based upon Committee
compensation data, the executives' job responsibilities, level of experience,
individual performance and contribution to the business. In making base salary
decisions, the Committee exercised its discretion and judgment based upon
regional and personal knowledge of industry practice and did not apply and
specific formula to determine the weight of any one factor.
Incentive Bonuses
The Incentive Bonus component of executive compensation is designed to
reflect the Committee's belief that a portion of the compensation of each
executive officer should be contingent upon the performance of the Company, as
well as the individual contribution of each executive officer. The Incentive
Bonus is intended to motivate and reward executive officers by allowing the
executive officers to directly benefit from the success of the Company. The plan
is weighted heavily towards achieving profitability before any bonus
compensation would be earned and is presently based upon increasing returns on
beginning equity.
69
Long Term Incentives
The Committee provides the Company's executive officers with long-term
incentive compensation in the form of stock option grants under the Company's
1996 Stock Option Plan and 2001 Equity Incentive Plan. The Committee believes
that stock options provide the Company's executive officers with the opportunity
to purchase and maintain an equity interest in the Company and t share in the
appreciation of the value of the Company's Common Stock. The Committee believes
that stock options directly motivate an executive officers to date have been
granted at the fair market value of the Company's common stock on the date of
grant. The committee considers each option subjectively, considering factors
such as the individual performance of the executive officer and the anticipated
contribution for the executive officer to the attainment of the Company's long
term strategic performance goals. The number of stock options granted in prior
years is also taken into consideration.
In conclusion, the Committee believes that the company's current
compensation levels are consistent with Company goals.
Respectfully Submitted,
Sonoma Valley Bancorp
Personnel and Policies Committee,
/s/ Robert J. Nicholas, Chairman
/s/ Dale T. Downing
/s/ Robert B. Hitchcock
/s/ Gary D. Nelson
/s/ Harry W. Weise
70
Comparison of Cumulative Total Return on Investment
There can be no assurance that our stock performance will continue into the
future with the same or similar trends depicted in the graph below. The market
price of our common stock in recent years has fluctuated significantly and it is
likely that the price of the stock will fluctuate in the future. We do not
endorse any predictions of future stock performance. Furthermore, the stock
performance chart is not considered by us to be (i) soliciting material, (ii)
deemed filed with the Securities and Exchange Commission, or (iii) to be
incorporated by reference in any filings by us under the Securities Act, or the
Exchange Act.
[OBJECT OMITTED]
71
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Equity Compensation Plan Information
Compensation Plan Table
The following table provides aggregate information as of the end of the
fiscal year ended December 31, 2003 with respect to all compensation plans
(including individual compensation arrangements) under which equity securities
are authorized for issuance.
Plan category Number of securities Weighted-average Number of securities
to be issued upon exercise price of remaining available
exercise of outstanding options, for future issuance
outstanding options, warrants and rights under equity
warrants and rights compensation plans
(excluding securities
reflected in column (a))
(a) (b) (c)
-------------------- ---------------------- -------------------- -----------------------
Equity compensation
plans approved by
security holders 311,292 $ 12.09 82,370
Equity compensation
plans not approved by 0 0 0
security holders
Total 311,292 $ 12.09 82,370
Principal Shareholders
The following table sets forth certain information as of March 15, 2004,
with respect to the beneficial ownership of our common stock for (i) each
director, (ii) all of our directors and officers as a group, and (iii) each
person known to us to own beneficially five percent (5%) or more of the
outstanding shares of our common stock.
The address for each listed shareholder is Sonoma Valley Bancorp, 202 W.
Napa Street, Sonoma, California 95476. To our knowledge, except as indicated in
the footnotes to this table or pursuant to applicable community property laws,
the persons named in the table have sole voting and investment power with
respect to the shares of common stock indicated.
Common Stock Amount
Name, Principal and Nature of
Occupation and Address Beneficial Ownership Percent of
- ---------------------- -------------------- Class(1)
----------
Suzanne Brangham 26,574 (2) 1.76%
Dale T. Downing 77,873 (3)(7) 5.17%
Frederick H. Harland 13,007 (4)(8) *
72
Common Stock Amount
Name, Principal and Nature of
Occupation and Address Beneficial Ownership Percent of
- ---------------------- -------------------- Class(1)
----------
Robert B. Hitchcock 85,219 (3)(9) 5.66%
Gerald J. Marino 72,002 (2) 4.77%
Gary D. Nelson 73,063 (5)(10) 4.91%
Robert J. Nicholas 80,732 (4) 5.40%
Angelo C. Sangiacomo 28,892 (2)(11) 1.91%
J. R. Stone 63,801 (2)(12) 4.23%
Mel Switzer, Jr. 80,275 (6)(13) 5.18%
Harry W. Weise 58,148 (3) 3.86%
Directors and Executive
Officers as a Group (13 695,566 (14) 39.50%
persons including the above)
* Less than 1% of outstanding shares of common stock.
(1) Percentages are based on a total of 1,484,823 shares outstanding as
of March 15, 2004.
(2) Includes 24,709 shares subject to options exercisable within 60 days.
(3) Includes 21,620 shares subject to options exercisable within 60 days.
(4) Includes 9,266 shares subject to options exercisable within 60 days.
(5) Includes 3,089 shares subject to options exercisable within 60 days.
(6) Includes 63,511 shares subject to options exercisable within 60 days.
(7) Includes 7,944 shares held by wife in an IRA account.
(8) Includes 403 shares held by wife and 487 shares held by wife in an IRA
account.
(9) Includes 7,280 shares held by wife in an IRA account.
(10) Includes 178 shares held in a Trust Account of which his wife is a
Trustee and 21 shares held by son.
(11) Includes 1,305 shares held by wife as a custodian of Uniform Transfer
to Minors Act.
(12) Includes 12,754 shares held by wife in an IRA account.
(13) Includes 1,438 shares held by wife in an IRA account.
(14) Includes a total of 278,884 shares subject ot options exercisable
within 60 days.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Certain Relationships and Related Transactions
We have and expect to have in the future to have banking transactions in
the ordinary course of its business with its directors, officers, principal
shareholders and their affiliates. These loans are granted on substantially the
same terms, including interest rates, collateral, and repayment terms, as those
prevailing at the same time for comparable transactions with others and, in the
opinion of management, do not involve more than the normal risk of
collectibility. The aggregate loan disbursements and loan payments made in
connection with loans to directors, officers, principal shareholders, and
affiliates, are as follows:
73
2003 2002
---- ----
Balance, beginning of year $4,607,000 $2,236,000
Loan disbursements 690,000 2,723,000
Loan payments (2,202,000) (352,000)
Balance, end of year $3,095,000 $4,607,000
During 2003, the highest amount of aggregate indebtedness of directors,
officers, principal shareholders, and affiliates, was $ 3,113,688 as of July 31,
2003, which represented 15.45% of the Bank's equity capital as of such date.
The Bank leases its Glen Ellen branch office from Sonoma Market Partnership
in which director Dale Downing is a partner. Lease expense for the years ended
December 31, 2003 and 2002 was $12,889 and $12,172, respectively. The remaining
lease commitment is approximately $61,595 through March 2008 including a minimum
inflationary increase of 4% per year. The monthly lease payments will be
increased annually based upon the Consumer Price Index, but not less than 4%
annually. The term of the lease is 5 years with an option to extend the lease
term for two additional 5 year terms at the same Consumer Price Index
limitations.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Relationship with Independent Auditors
The Company retained the firm of Richardson & Co. as independent auditors
of the Company for the fiscal year ending December 31, 2003.
Audit Fees
The aggregate fees billed for professional services rendered for the audit
of the Company's annual financial statements on Form 10-K and the review of the
financial statements included in the Company's quarterly reports on Form 10-Q
for the fiscal year ended December 31, 2002 was $ 41,720 and December 31, 2003
was $ 41,720.
Audit-Related Fees
The aggregate fees billed for assurance and related services by the
principal accountant that are reasonably related to the performance of the audit
or review of the Company's financial statements for the year ended December 31,
2002 was $ 4,695 and December 31, 2003 was $ 8,547.
Tax Fees
The aggregate fees billed for tax compliance, tax advice and tax planning
rendered by our independent auditors for the fiscal year ended December 31, 2002
was $ 9,470 and December 31, 2003 was $ 9,470. The services comprising these
fees include federal and state income tax returns, quarterly tax estimates and
business property tax statements.
All Other Fees
There were no aggregate fees billed for any other professional services
rendered by the Company's independent auditors for the fiscal year ended
December 31, 2002 and 2003.
74
The Audit Committee approved 100% of the fees paid to the principal
accountant for audit-related, tax and other fees. The Audit Committee
pre-approves all non-audit services to be performed by the auditor in accordance
with the Audit Committee Charter. The percentage of hours expended on the
principal accountant's engagement to audit the Company's financial statements
for the most recent fiscal year that were attributed to work performed by
persons other than the principal accountant's full-time, permanent employees was
0%.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
Financial Statements
The following financial statements of the Company are filed as part of this
Annual Report:
Number Page
1. Independent Auditor's Report..................................... 31
2. Consolidated Balance Sheets as of December 31, 2003 and 2002..... 32
3. Consolidated Statements of Operations for the three years ended
December 31, 2003, 2002 and 2001................................. 33
4. Consolidated Statements of Changes in Shareholders' Equity
for the three years ended December 31, 2003, 2002 and 2001....... 34 and 35
5. Consolidated Statements of Cash Flows for the three years ended
December 31, 2003, 2002 and 2001................................. 36 and 37
6. Notes to Consolidated Financial Statements....................... 38
Financial Statement Schedules
All other schedules have been omitted since the required information is not
present or is not present in sufficient amounts to require submission of the
schedules or because the information is included in the financial statements or
the notes thereto.
75
Exhibits
- --------
The following Exhibits are attached or incorporated herein by reference:
3.1 Sonoma Valley Bancorp Articles of Incorporation, filed as Exhibit 3.1 to
the Registrant's Registration Statement on Form S-8 filed on June 5, 2001.
3.3 Sonoma Valley Bancorp By-laws, filed as Exhibit 3.2 to the Registrant's
Registration Statement on Form S-8 filed on June 5, 2001.
4.2 Agreement for the sale of Sonoma Valley Bank Stock dated September 23,
1992, filed as Exhibit 4.2 (formerly A-1) to the Form F-2 for the year
ended December 31, 1992.
10.1 Lease for Sonoma branch office, filed as Exhibit 10.1 (formerly 7.1) to the
Registrant's Registration Statement on Form F-1 filed on May 1, 1989.
10.2 Sonoma Valley Bank Chief Executive Officer Severance Agreement dated
January 4, 1995, filed as Exhibit 10.2 to the Form 10-KSB for the year
ended December 31, 1997.
10.3 Sonoma Valley Bank Supplemental Executive Retirement Plan, as amended on
March 20, 1996, filed as Exhibit 10.3 to the Form 10-KSB for the year ended
December 31, 1997.
10.4 Sonoma Valley Bank Deferred Compensation Plan, filed as Exhibit 10.4 to the
Form 10-KSB for the year ended December 31, 1997.
10.5 Sonoma Valley Bank Master Trust Agreement for Executive Deferral Plans,
filed as Exhibit 10.5 to the Form 10-KSB for the year ended December 31,
1997.
10.6 Sonoma Valley Bank 1996 Stock Option Plan, filed as Exhibit 10.6 to the
Form 10-KSB for the year ended December 31, 1997.
10.7 Sonoma Valley Bank Severance Agreement with Mel Switzer, Jr. dated October
21, 1998, filed as Exhibit 10.7 to the From 10-KSB for the year ended
December 31, 1998.
10.8 Sonoma Valley Bank Severance Agreement with Mary Dieter dated October 21,
1998, filed as Exhibit 10.8 to the From 10-KSB for the year ended December
31, 1998.
10.10 Sonoma Valley Bancorp Assumption of Severance Agreement [Form of], filed
as Exhibit 10.1 to the Form 10-KSB for the year ended December 31, 2001.
10.11 Sonoma Valley Bancorp 2002 Equity Incentive Plan, filed as Exhibit A to
the Company's Proxy Statement for the Annual Meeting held on May 14, 2002.
10.12 Sonoma Valley Bank Severance Agreement with Sean Cuttings dated
March 18, 2004.
23.1 Consent of Richardson and Co., Independent Auditors.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act
76
(b) Reports on Form 8-K
The following reports on Form 8-K were filed during the last quarter of the
period covered by this report:
Date of Event Reported Item Reported
---------------------- -------------
February 18, 2004 Announcing Cash Dividend
February 15, 2004 Announcing Fiscal Year End 2003 Results
77
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
SONOMA VALLEY BANCORP,
A California corporation
/S/ MEL SWITZER, JR. March 23, 2004
- ---------------------------------
Mel Switzer, Jr.
President and
Chief Executive Officer
(Principal Executive Officer)
/S/ MARY QUADE DIETER March 23, 2004
- ---------------------------------
Mary Quade Dieter
Executive Vice President and
Chief Operating Officer
(Principal Finance and Accounting Officer)
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
/S/ SUZANNE BRANGHAM March 23, 2004
- ---------------------------------
uzanne Brangham, Secretary
of the Board and Director
/S/ DALE T. DOWNING March 23, 2004
- ---------------------------------
Dale T. Downing, Director
/S/ FREDERICK H. HARLAND March 23, 2004
- ---------------------------------
Frederick H. Harland, Director
/S/ ROBERT B. HITCHCOCK March 23, 2004
- ---------------------------------
Robert B. Hitchcock, Director
/S/ GERALD J. MARINO March 23, 2004
- ---------------------------------
Gerald J. Marino, Director
78
/S/ GARY D. NELSON March 23, 2004
- ---------------------------------
Gary D. Nelson, Director
/S/ ROBERT J. NICHOLAS March 23, 2004
- ---------------------------------
Robert J. Nicholas, Chairman
of the Board and Director
/S/ ANGELO C. SANGIACOMO March 23, 2004
- ---------------------------------
Angelo C. Sangiacomo, Director
/S/ JESSE R. STONE March 23, 2004
- ---------------------------------
Jesse R. Stone, Director
/S/ MEL SWITZER, JR. March 23, 2004
- ---------------------------------
Mel Switzer, Jr., President,
Chief Executive Officer and
Director (Principal Executive
Officer)
/S/ HARRY WEISE March 23, 2004
- ---------------------------------
Harry Weise, Director
/S/ MARY QUADE DIETER March 23, 2004
- ---------------------------------
Mary Quade Dieter, Executive
Vice President, Chief Operating
Officer and Chief Financial
Officer (Principal Finance and
Accounting Officer)
79