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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2004
Commission File Number: 000-31929
SONOMA VALLEY BANCORP
(Exact name of Registrant as specified in its charter)
California 68-0454068
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
202 West Napa Street Sonoma, California 95476
(Address of principal executive offices) (Zip Code)
(707) 935-3200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by a check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares outstanding of the registrant's Common Stock, no par value,
as of November, 1, 2004 was 2,142,104.
--------------------------------
INDEX
Part 1 Financial Information Page Number
Item 1. Financial Statements (Unaudited):
Consolidated Balance Sheets at September 30, 2004,
December 31, 2003 and September 30, 2003..............................3
Consolidated Statements of Operations for the
three months and nine months ended September 30, 2004 and 2003........4
Consolidated Statements of Changes in Shareholders Equity
for the nine months ended September 30, 2004,
and the years ended December 31, 2003 and 2002........................5
Consolidated Statements of Cash Flows for the
nine months ended September 30, 2004 and 2003.........................7
Notes to Consolidated Financial Statements............................8
Average Balances, Yields and Rates Paid
for the nine months ended September 30, 2004 and 2003................11
Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations....................12
Item 3. Quantitative and Qualitative Disclosure about Market Risk........26
Item 4. Controls and Procedures..........................................26
Part II Other Information
Item 1. Legal Proceedings................................................26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds......26
Item 3. Default Upon Senior Securities...................................27
Item 4. Submission of Matters to a Vote of Security Holders..............27
Item 5. Other Information................................................27
Item 6. Exhibits.........................................................27
Signatures...............................................................28
Certifications...........................................................29
The information furnished in these interim statements reflects all adjustments
and accruals which are, in the opinion of management, necessary for a fair
statement of the results for such periods. The results of operations in the
interim statements are not necessarily indicative of the results that may be
expected for the full year.
Page 2
Part I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
The information furnished in these interim statements reflects all adjustments
and accruals which are, in the opinion of management, necessary for a fair
statement of the results for such periods. The results of operations in the
interim statements are not necessarily indicative of the results that may be
expected for the full year.
FINANCIAL STATEMENTS
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
September 30, 2004 (Unaudited) and December 31, 2003 (Audited) and September 30,
2003 (Unaudited)
September 30 December 31 September 30
2004 2003 2003
ASSETS ------------ ----------- ------------
Cash and due from banks $ 8,292,339 $ 9,803,272 $ 8,481,664
Federal funds sold 1,685,000 25,220,000 31,190,000
Interest-bearing due from banks 35,406 330,930 330,764
------------ ----------- ------------
Total cash and cash equivalents 10,012,745 35,354,202 40,002,428
Investment securities available-for-sale at fair value 23,518,575 20,119,777 13,834,148
Investment securities held-to-maturity (fair
value of $18,394,000, $17,042,000 and
$14,011,000, respectively) 17,794,884 16,558,153 13,620,606
Loans and lease financing receivables, net 144,537,306 119,833,989 119,040,732
Premises and equipment, net 1,369,688 1,313,995 1,296,242
Accrued interest receivable 1,159,065 906,958 931,593
Cash surrender value of life insurance 8,851,899 7,730,600 7,644,878
Other assets 3,457,580 3,288,463 3,303,338
------------ ----------- ------------
Total assets $210,701,742 $205,106,137 $199,673,965
============ =========== ============
LIABILITIES
Non interest-bearing demand deposits $ 45,379,582 $ 37,947,577 $ 36,491,921
Interest-bearing transaction deposits 31,214,138 32,467,678 28,124,429
Savings and money market deposits 65,398,770 63,680,697 65,414,882
Time deposits, $100,000 and over 26,505,608 26,565,347 26,000,588
Other time deposits 18,562,732 19,453,317 19,539,327
------------ ----------- ------------
Total deposits 187,060,830 180,114,616 175,571,147
Accrued interest payable and other liabilities 3,756,149 3,520,242 3,489,366
------------ ----------- ------------
Total liabilities 190,816,979 183,634,858 179,060,513
SHAREHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares
authorized; 2,142,104 shares at September 30, 2004,
1,457,594 shares at December 31, 2003 and 1,451,486
shares at September 30, 2003 issued & outstanding. 15,497,836 15,061,636 14,950,486
Retained earnings 4,470,003 6,386,083 5,619,396
Accumulated other comprehensive income (loss) (83,076) 23,560 43,570
------------ ----------- ------------
Total shareholders' equity 19,884,763 21,471,279 20,613,452
------------ ----------- ------------
Total liabilities and shareholders' equity $210,701,742 $205,106,137 $199,673,965
============ =========== ============
Page 3
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2004 2003 2004 2003
------------ ------------ ------------ -----------
INTEREST INCOME
Loans and leases $ 2,600,528 $ 2,479,394 $ 7,232,583 $ 7,198,098
Taxable securities 199,716 106,046 626,080 247,874
Tax-exempt securities 167,272 122,076 493,306 340,169
Federal funds sold 12,663 74,023 77,231 243,578
Dividends 8,093 3,111 13,849 10,206
------------ ------------ ------------- ------------
Total interest income 2,988,272 2,784,650 8,443,049 8,039,925
INTEREST EXPENSE
Interest-bearing transaction deposits 13,397 10,908 37,354 38,889
Savings and money market deposits 109,155 113,500 312,162 359,771
Time deposits, $100,000 and over 164,582 174,004 498,011 554,444
Other time deposits 97,424 115,390 296,439 368,272
Other borrowings 0 29 0 29
------------ ------------ ------------- ------------
Total interest expense 384,558 413,831 1,143,966 1,321,405
------------ ------------ ------------- ------------
NET INTEREST INCOME 2,603,714 2,370,819 7,299,083 6,718,520
Provision for loan and lease losses 40,000 0 70,000 20,000
------------ ------------ ------------- ------------
NET INTEREST INCOME
AFTER PROVISION FOR
LOAN AND LEASE
LOSSES 2,563,714 2,370,819 7,229,083 6,698,520
NON-INTEREST INCOME 452,131 455,301 1,264,243 1,296,322
NON-INTEREST EXPENSE
Salaries and employee benefits 1,102,331 914,569 3,113,135 2,574,209
Premises and equipment 230,840 203,696 662,949 568,717
Other 533,372 593,362 1,629,757 1,638,893
------------ ------------ ------------- ------------
Total non-interest expense 1,866,543 1,711,627 5,405,841 4,781,819
------------ ------------ ------------- ------------
Income before provision
for income taxes 1,149,302 1,114,493 3,087,485 3,213,023
Provision for income taxes 404,574 372,151 1,005,594 1,070,074
------------ ------------ ------------- ------------
NET INCOME $ 744,728 $ 742,342 $ 2,081,891 $ 2,142,949
============ ============ ============= ============
NET INCOME PER SHARE $ .34 $ .34 $ .96 $ .99
===== ===== ===== ======
NET INCOME PER SHARE-
ASSUMING DILUTION $ .32 $ .31 $ .88 $ .91
===== ===== ===== ======
Page 4
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the nine months ended September 30, 2004 (Unaudited), and the years ended
December 31, 2003 (Audited) and 2002 (Audited)
Accumulated
Other
Comprehensive Common Stock Retained Comprehensive
Income Shares Amount Earnings Income Total
------------- ---------- ----------- ----------- ------------- -------------
BALANCE AT
JANUARY 1, 2002 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 loss,
net of tax:
Unrealized holding losses
on securities available-
for-sale arising during
the year, net of taxes
of $51,125 (73,103)
-------------
Other comprehensive loss,
net of taxes (73,103) (73,103) (73,103)
------------- ---------- ----------- ----------- ------------- --------------
Total comprehensive income $ 2,671,230
=============
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 loss,
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 loss,
net of taxes (64,735) (64,735) (64,735)
------------- ---------- ----------- ----------- ------------- --------------
Total comprehensive income $ 2,846,272
=============
Page 5
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Continued)
For the nine months ended September 30, 2004 (Unaudited), and the years ended
December 31, 2003 (Audited) and 2002 (Audited)
Accumulated
Other
Comprehensive Common Stock Retained Comprehensive
Income Shares Amount Earnings Income Total
------------- --------- ------------ ----------- ------------- ----------------
BALANCE AT
DECEMBER 31, 2003 1,457,594 $ 15,061,636 $ 6,386,083 $ 23,560 $ 21,471,279
Redemption and retirement
of stock (601) (6,218) (11,839) (18,057)
Cash dividends (906,732) (906,732)
Fractional shares (7,497) (7,497)
Stock options granted 72,576 72,576
Stock options exercised and
related tax benefits 97,494 1,786,065 1,786,065
Redemption of stock
under tender offer (126,208) (1,416,223) (3,071,903) (4,488,126)
3 for 2 stock split 713,825
Net income for the period $ 2,081,891 2,081,891 2,081,891
Other comprehensive loss,
net of tax:
Unrealized holding losses
on securities available-
for-sale arising during
the year, net of taxes
of $ 74,577 (106,636)
-------------
Other comprehensive loss,
net of taxes (106,636) (106,636) (106,636)
------------- --------- ------------ ----------- ------------- ----------------
Total comprehensive income $ 1,975,255
=============
BALANCE AT
September 30, 2004 2,142,104 $ 15,497,836 $ 4,470,003 $ (83,076) $ 19,884,763
========= ============ =========== ============= ================
Page 6
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the nine months ended September 30, 2004 and 2003
2004 2003
- ------ ---------------- ---------------
OPERATING ACTIVITIES
Net income $ 2,081,891 $ 2,142,949
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 70,000 20,000
Depreciation 227,462 166,568
Gain on sale of premise and equipment (366) 0
Amortization and other 105,667 72,808
Stock options granted 72,576 0
Net change in interest receivable (252,107) (132,311)
Net change in other assets (94,540) (265,799)
Net change in cash surrender value of life insurance (1,121,299) (257,166)
Net change in interest payable and other liabilities 235,907 115,201
---------------- ---------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,325,191 1,862,250
INVESTING ACTIVITIES
Purchases of securities held-to-maturity (2,519,972) (6,812,829)
Purchases of securities available-for sale (8,154,336) (10,877,142)
Proceeds from maturing securities held-to-maturity 1,201,900 3,083,400
Proceeds from maturing securities available-for sale 4,550,000 750,000
Net change in loans (24,773,318) 6,208,450
Purchases of life insurance 0 0
Purchases of premises and equipment (282,789) (587,113)
---------------- ---------------
NET CASH USED FOR INVESTING ACTIVITIES (29,978,515) (8,235,234)
FINANCING ACTIVITIES
Net change in demand, interest-bearing transaction and savings deposits 7,896,538 14,840,123
Net change in time deposits (950,324) 742,772
Cash dividend paid (906,732) 0
Exercise of stock options 1,786,065 377,484
Stock repurchases (4,506,183) (1,088,373)
Fractional shares purchased (7,497) (14,193)
---------------- ---------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 3,311,867 14,857,813
---------------- ---------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (25,341,457) 8,484,829
Cash and cash equivalents at beginning of period 35,354,202 31,517,599
---------------- ---------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $10,012,745 $ 40,002,428
================ ===============
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest $1,145,990 $ 1,330,180
Income taxes 115,000 1,025,000
Stock dividend 0 1,997,422
Change in unrealized gains and losses
on securities available-for-sale (181,212) (76,004)
Change in deferred income taxes on
unrealized holding gains and losses on securities 74,577 31,279
Page 7
SONOMA VALLEY BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
(Unaudited)
Note 1 - Basis of Presentation
In the opinion of Management, the unaudited interim consolidated financial
statements contain all adjustments of a normal recurring nature, which are
necessary to present fairly the financial condition of Sonoma Valley Bancorp
(the "Company") and Subsidiary at September 30, 2004 and results of operations
for the three and nine months then ended.
Certain information and footnote disclosures presented in the Company's annual
financial statements are not included in these interim financial statements.
Accordingly, the accompanying unaudited interim consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's 2003 Annual Report on
Form 10-K. The results of operations for the three and nine months ended
September 30, 2004 are not necessarily indicative of the operating results
through December 31, 2004.
Note 2 - Consolidation
The consolidated financial statements include the accounts of Sonoma Valley
Bancorp and its wholly owned subsidiary Sonoma Valley Bank. All material
intercompany accounts and transactions have been eliminated in consolidation.
Note 3 - Commitments
The Company has no outstanding performance letters of credit at September 30,
2004 and September 30, 2003.
Note 4 - Net Income Per Common Share
Net income per share is calculated by using the weighted average common shares
outstanding. The weighted average number of common shares used in computing the
net income per common share for the period ending September 30, 2004 was
2,173,330 and for the period ending September 30, 2003 was 2,167,662.
Net income per share (diluted) is calculated by using the weighted average
common shares (diluted) outstanding. The weighted average number of common
shares (diluted) used in computing the net income per common share (diluted) for
the period ending September 30, 2004 was 2,360,731 and for the period ending
September 30, 2003 was 2,366,643.
Prior year shares have been adjusted to reflect 3 for 2 stock split on July 21,
2004.
Page 8
Note 5 - Stock Option Accounting
The Company has two stock-based employee and director compensation plans. In
December 2002 the Financial Accounting Standards Board issued SFAS No. 148,
Accounting for Stock-Based Compensation, an Amendment of SFAS No. 123 ("SFAS No.
123") in an effort to encourage the recognition of compensation expense for the
issuance of stock options. The Company adopted SFAS No. 148 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 will be recognized in the income statement.
Prior to January 1, 2003, the Company accounted for those plans 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 stock options granted prior to
January 1, 2003, 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 Company had applied the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
compensation on stock options granted prior to January 1, 2003.
For the Three Months For the Nine Months
Ended September 30 Ended September 30
2004 2003 2004 2003
---------------- ------------- -------------- -------------
Net Income, as reported $ 744,728 $ 742,342 $ 2,081,891 $2,142,949
Deduct: Total stock-based
compensation expense determined
under fair value based method for all
awards, net of related tax effects (44,978) (44,975) (134,934) (134,925)
---------------- ------------- -------------- -------------
Pro forma net income $ 699,750 $ 697,367 $ 1,946,957 $ 2,008,024
================ ============= ============== =============
Net income per share:
Basic - As reported $ .34 $ .34 $ .96 $ .99
====== ====== ====== =====
Basic - Pro forma $ .32 $ .32 $ .90 $ .93
====== ====== ====== =====
Diluted - As reported $ .32 $ .31 $ .88 $ .91
====== ====== ====== =====
Diluted - Pro forma $ .30 $ .29 $ .82 $ .85
====== ====== ====== =====
Page 9
Note 6 - Employee Benefit Plans
The Bancorp provides retirement plans to its key officers and directors. The
plans are unfunded and provide for the Bancorp to pay the officers and directors
specified amounts for specified periods after retirement. The amount of pension
expense related to this plan, and the components of pension expense for the nine
months ended September 30, 2004 and 2003 are as follows:
Directors Officers
------------------------- ------------------------
2004 2003 2004 2003
------------ ----------- ------------ ----------
Service cost $ 47,407 $ 53,541 $ 138,276 $ 147,065
Interest cost on projected benefit obligation 16,363 10,229 51,853 56,214
Amortization of unrecognized liability at (22,644) (26,114)
------------ ----------- ------------ ----------
transition
Net periodic pension cost recognized $ 63,770 $ 63,770 $ 167,485 $ 177,165
============ =========== ============ ==========
Page 10
SONOMA VALLEY BANCORP
AVERAGE BALANCES/YIELDS AND RATES PAID
For the nine months ended September 30, 2004 and 2003
(dollars in thousands)
2004 2003
---- ----
Average Income/ Yield/ Average Income/ Yield/
ASSETS Balance Expense Rate Balance Expense Rate
Interest-earning assets:
Loans(2):
Commercial 95,539 5,089 7.12% 85,155 4,932 7.74%
Consumer 13,667 681 6.66% 11,809 666 7.54%
Real estate construction 18,756 1,085 7.73% 19,532 1,176 8.05%
Real estate mortgage 4,439 245 7.37% 4,154 270 8.69%
Tax exempt loans (1) 3,055 192 8.39% 3,171 199 8.39%
Leases 33 6 24.29% 73 17 31.14%
Tax exempt leases (1) 1 0 0.00% 52 8 20.57%
Unearned loan fees (447) (414)
-------- ------- -------- ------
Total loans 135,043 7,298 7.22% 123,532 7,268 7.87%
Investment securities
Available for sale:
Taxable 23,626 614 3.47% 9,658 237 3.28%
Tax exempt(1) 0 0 0.00% 0 0 0.00%
Hold to maturity:
Taxable 393 8 2.72% 388 10 3.45%
Tax exempt (1) 17,155 747 5.82% 10,147 517 6.80%
-------- ------- -------- ------
Total investment securities 41,174 1,369 4.44% 20,193 764 5.05%
Federal funds sold 10,640 77 .97% 29,803 244 1.09%
Federal Home Loan Bank stock 564 14 3.32% 287 10 4.66%
Total due from banks/Interest bearing 194 4 2.75% 158 0 0.00%
-------- ------- -------- ------
Total interest earning assets 187,615 8,762 6.24% 173,973 8,286 6.37%
======= ======
Noninterest-bearing assets:
Reserve for loan losses (2,444) (2,781)
Cash and due from banks 9,652 8,859
Premises and equipment 1,364 1,057
Other assets 12,038 10,971
-------- --------
Total assets $208,225 $192,079
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Interest bearing deposits
Interest bearing transaction 32,924 37 0.15% 29,096 39 0.18%
Savings deposits 66,394 312 0.63% 57,659 360 0.83%
Time deposits over $100,000 25,446 498 2.61% 24,886 554 2.98%
Other time deposits 18,750 297 2.12% 19,843 368 2.48%
-------- ------ -------- ------
Total interest bearing Deposits 143,514 1,144 1.06% 131,484 1,321 1.34%
Federal Funds purchased 0 0 0.00% 0 0 0.00%
Other short term borrowings 0 0 0.00% 4 0 0.00%
-------- ------ -------- ------
Total interest bearing liabilities 143,514 $1,144 1.06% 131,488 $1,321 1.34%
====== ======
Non interest bearing liabilities:
Non interest bearing demand deposits 40,293 37,395
Other liabilities 3,468 3,236
Shareholders' equity 20,950 19,960
-------- --------
Total liabilities and shareholders' equity $208,225 $192,079
======== ========
Interest rate spread 5.18% 5.03%
===== =====
Interest income $8,762 6.24% $8,286 6.37%
Interest expense 1,144 .81% 1,321 1.02%
------- ----- ------ -----
Net interest income/margin $7,618 5.43% $6,965 5.35%
======= ===== ======= =====
(1) Fully tax equivalent adjustments are based on a federal income tax rate of
34% in 2004 and 2003
(2) Non accrual loans have been included in loans for the purposes of the above
presentation. Loan fees of approximately $224,508 and $319,370 for the nine
months ended September 30, 2004 and September 30, 2003, respectively, were
amortized to the appropriate interest income categories.
Page 11
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward Looking Statements
With the exception of historical facts stated herein, the matters discussed in
this Form 10-Q 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 (the
"Company") wholly owned subsidiary, Sonoma Valley Bank (the "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-Q, 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-Q 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.
For the Nine Month Periods
Ended September 30, 2004 and 2003
Overview
The Company continues to be profitable, however, net income decreased by $61,058
from $2,142,949 for the nine months ended September 30, 2003 to $2,081,891 for
the nine months ended September 30, 2004. The decrease in net income is a result
of the expenses associated with the opening of a new branch, Banco de Sonoma,
during the first quarter of 2004 and the recognition of expense for stock
options granted during January 2004. Additionally, the Company experienced a
decline in income associated with loan referral fees. The Company now originates
most of the mortgage loans previously outsourced to a vendor. The net effect of
these items combined to lower net income. On a per share basis, net income
equaled $.96 compared with $.99 per share during the same period in 2003.
Return on average total assets on an annualized basis for the nine-month period
was 1.34% in 2004 and 1.49% in 2003. Return on average shareholders' equity on
an annualized basis for the same periods was 13.27% and 14.35%, respectively.
The decline in the return on average assets in 2004 is the result of the
increase in average assets from $192.1 million in 2003 to $208.2 million in 2004
and the lower income generated during the period. The lower return on equity is
the result of the decline in income for the nine month period of 2004 and the
$990,000 increase in average equity from $20.0 million in 2003 to $21.0 million
in 2004.
Page 12
Income for the nine month period ending September 30, 2004 is lower than 2003
due to the 65 basis point decline in the yield on loans (see the table-Average
Balances, Yields and Rates Paid on page 11), the significant decline in loan
referral income, the increase in operating expense due to the new Banco de
Sonoma Branch and the expensing of stock options. The Company has experienced
pressure to refinance loans for customers and a portion of the loans are tied to
the prime lending rate and have repriced downward accordingly.
The most significant event affecting the Company's growth is the opening of the
Banco de Sonoma branch in Boyes Hot Springs. Initially, this will have a
negative effect on the Income Statement by creating in excess of $200,000 in
additional expense for the Company. The branch is offering services to the
Latino community in our market place. Management identified this as a niche
which was under-served and an opportunity for future growth and profitability.
All employees at the branch are bilingual and able to offer full service
banking. An additional product which has been added is the ability for the
customer to effect an immediate transfer of funds to Mexico. Management
anticipates that the growth in the branch will be slow and steady and profitable
within three or four years.
Total shareholders' equity declined by $1.6 million or 7.39% for the nine months
ended September 30, 2004. On May 21, 2004, the Company closed the tender offer
purchasing 126,208 shares of stock at $35.00 per share for a total of $4,488,126
including expenses associated with the offering, lowering equity. In addition to
the tender offer, the Company repurchased and retired 601 shares of stock for
$18,000. For the nine months ending September 30, 2004 the Company reported net
income of $2,082,000 and paid out cash dividends of $371,000 in March, 2004 and
$536,000 in August, 2004. An additional $7,000 was paid for fractional shares in
August, 2004 as a result of the three for two stock split. The directors and
officers exercised 97,494 options which added $1.2 million to the capital
accounts. The tax benefit on these options exercised was $617,000, which also
increases equity. See page 6 for detail of "Changes in Shareholder Equity."
RESULTS OF OPERATIONS
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, as shown on the table- Average Balance, Yields and Rates Paid, on page
11, is higher than net interest income on the statement of income because it
reflects adjustments applicable to tax-exempt income from certain securities and
loans ($319,000 in 2004 and $246,000 in 2003, based on a 34% federal income tax
rate).
The improvement in net interest income for the nine months ended September 30,
2004 (stated on a fully taxable equivalent basis) is a result of the net effect
of a $477,000 increase in interest income offset by a decline in interest
expense of $177,000, resulting in an increase of $654,000. The increase in
interest income is a result of the growth in the loan portfolio offset by the
low rates paid on deposit accounts. In 2004 there has been three increases in
the target fed funds rate and prime lending rate. A 25 basis point increase
occurred July 1, 2004, another August 11, 2004 and most recently 25 basis points
as of September 22, 2004.
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 for 2004 increased to 5.43% from 5.35% for the
Page 13
same period in 2003. The increase in the net interest margin is the result of
the 75 basis point increase in the prime lending rate, growth in loan volume and
the transition of assets from fed funds sold to loan products.
Interest Income
As previously stated, interest income (stated on a fully taxable equivalent
basis) increased by $477,000 to $8.8 million in the nine months of 2004, a 5.76%
increase over the $8.3 million realized during the same period in 2003. The
$13.6 million increase in volume of average balances was responsible for a $1.2
million increase in interest income offset by a $725,000 decrease in income
related to lower interest rates. The yield on earning assets was 6.24% as of
September, 2004 compared to 6.37% as of the same period in 2003, a 13 basis
point decline. The decline is primarily a result of maturing loans at higher
yields being replaced by lower yielding loans and existing loans refinancing at
lower rates due to the lower market rates. The net effect was an increase in
interest income of $477,000.
Interest Expense
Total interest expense decreased by $177,000 to $1.1 million for the 2004 period
ending September compared to $1.3 million during the same period of 2003. The
average rate paid on all interest-bearing liabilities decreased from 1.34% in
2003 to 1.06% in 2004. Average balances increased from $131.5 million to $143.5
million, a 9.15% gain in deposits. The increase in volume of average balances
was responsible for a $52,000 increase in interest expense offset by a $229,000
decrease in expense related to lower interest rates resulting in lower interest
expense of $177,000.
Individual components of interest income and interest expense are provided in
the table-Average Balances, Yields and Rates Paid on page 11.
Provision for Loan Losses
The provision for loan losses charged to operations is based on the Company's
monthly evaluation of the loan portfolio and the adequacy of the allowance for
loan losses in relation to total loans outstanding. Due to managements'
evaluation and assessment of the loan portfolio as a result of loan growth, a
provision of $70,000 was made during the nine months of 2004 compared to $20,000
during the same period of 2003. Management anticipates that loan growth will
continue in the fourth quarter which could necessitate an additional provision
to the reserve for loan losses. The provision for loan losses at year end 2003
was $20,000.
The economic climate continues to slowly improve and the non-accrual portfolio
dropped to less than 1% of total loans during the nine months of 2004, down
40.4% or $733,000 from the level of non-accrual loans as of September, 2003.
Loans charged-off were $336,000 (one loan represented over 80.3% of this figure)
and recoveries were $13,000 for the nine months of 2004 compared with $44,000 in
charge-offs and $13,000 in recoveries for the same period in 2003. See page 18
for an analysis in the changes in allowance for loan losses including charge
offs and recoveries.
Page 14
Non-interest Income
Non-interest income of $1.26 million decreased 2.5% from the $1.30 million
recorded in the comparable period in 2003. The Company has experienced a decline
in loan referral income which is a result of the decline in loan refinancings
and new purchase loans, offset by an increase in service charge income.
Non-interest Expense
Total non-interest expense increased 13.1% to $5.4 million during the nine
months of 2004 from $4.8 million for the same period in 2003. Non-interest
expense on an annualized basis represented 3.47% of average total assets in 2004
compared with 3.33% in the comparable period in 2003. The increase in the 2004
expense ratio largely reflects expenses incurred with the opening of our new
branch, Banco de Sonoma and the expensing of stock options.
The expenses for salaries and benefits increased 20.9% from $2.6 million in 2003
to $3.1 million in 2004. The $539,000 increase in 2004 is largely the result of
the additional staffing and benefits required for the Banco de Sonoma branch
which opened during the first quarter; and the effect of a 79.03% increase in
the cost of Workers Compensation insurance when comparing the nine months ended
September 30, 2004 with the same period of 2003. Additionally, the Company began
expensing stock options awarded in 2004. At September 30, 2004, total full time
equivalent employees were 56 compared to 47 in 2003.
Expense related to premises and equipment increased 16.6% to $663,000 in 2004
from $569,000 in 2003. The $94,000 increase in expense in 2004 is a result of
the amortization of expenses from the remodel of the Sonoma Branch and the
opening of the Banco de Sonoma branch. The bank continues to emphasize security
in its computer operations and equipment and software are monitored and upgraded
as appropriate to ensure confidentiality of customer and company data. The
company continues to emphasize the utilization of technology to accommodate
customer and market demands.
Other operating expenses declined by .56% in 2004 to $1.63 million from $1.64
million in 2003. The Company showed a 20% decline in other miscellaneous
expense. The most significant decline was in correspondent bank service charges.
Provision for Income Taxes
The provision for income taxes declined to an effective tax rate of 32.6% for
the nine months of 2004 compared with 33.3% for the nine months of 2003. The
lower effective tax rate is a reflection of the increase of municipal securities
in the investment portfolio. Income taxes reported in the financial statements
include deferred taxes resulting from timing differences in the recognition of
items for tax and financial reporting purposes.
BALANCE SHEET ANALYSIS
Investments
Investment securities were $41.3 million at September 30, 2004, a 12.7% increase
from the $36.7 million at December 31, 2003 and a 50.5% increase from $27.5
Page 15
million at September 30, 2003. The significant increase in the portfolio is
management's attempt to generate higher earnings by moving funds from Fed Funds
Sold to higher yielding investments. The Company purchases securities rated A or
higher by Standard and Poor's and or Moody's Investors Service. In the event a
security is downgraded, the Company will monitor the investment more closely or
sell if appropriate. Local tax-exempt bonds are occasionally purchased without
an A rating.
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 September 30,
2004, the Company had securities totaling $17.8 million with a market value of
$18.4 million categorized as held to maturity. Decisions to acquire municipal
securities, which are generally placed in this category, are based on tax
planning needs, pledge requirements and earnings.
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 $23.5 million compared to an amortized cost
of $23.7 million as of September 30, 2004.
There was one Federal Home Loan Mortgage Agency security of $1.0 million and two
Federal Home Loan Bank securities of $1.3 million in the AFS portfolio and
$879,000 in municipal securities in the HTM portfolio that have been in a
continuous loss position for 12 months or more as of September 30, 2004. There
were seventeen Federal Home Loan Bank, Federal Home Loan Mortgage Corporation or
Federal National Mortgage Association securities of $17.6 million in the AFS
portfolio and six municipal securities of $1.6 million in the HTM portfolio that
have been temporarily impaired as of September 30, 2004. The primary cause of
the impairment of these securities is interest rate volatility inherent in a
rising rate environment which causes the market value of the security to
decline. Management understood the potential market risks at the time of
acquisition and determined the benefit to the Company of the higher interest
rates received was a good business decision. It is the Company's intent to carry
the securities to maturity date, at which time the Company will receive face
value for the securities at no loss.
Although the quoted market values fluctuate, investment securities are generally
held to maturity, and accordingly, gains and losses to the income statement are
recognized upon sale, or at such time as management determines that a permanent
decline in value exists.
Loans
The Company's loan portfolio was $146.9 million at September 30, 2004, or 78.5%
of total deposits. This compares with $122.5 million, or 68.0% of total
deposits, at December 31, 2003 and $121.8 million, or 69.4% of total deposits,
at September 30, 2003. A comparative schedule of average loan balances is
presented in the table on page 11; period-end and year-end balances are
presented in the following table.
Page 16
September 30, Percentage December 31, Percentage September 30, Percentage
2004 of Total 2003 of Total 2003 of Total
---- -------- ---- -------- ---- --------
Commercial $107,850,150 73.1% $92,197,984 75.0% $89,465,014 73.2%
Consumer 15,147,103 10.3% 11,750,131 9.6% 11,096,839 9.1%
Real estate construction 17,483,054 11.9% 16,646,907 13.5% 18,606,701 15.2%
Real estate mortgage 6,857,318 4.7% 2,231,244 1.8% 2,987,397 2.4%
Leases 20,714 0.0% 79,884 0.1% 71,060 0.1%
------------ ------------ ------------
147,358,339 100.0% 122,906,150 100.0% 122,227,011 100.0%
===== ===== =====
Deferred loan fees
and costs, net (439,618) (437,536) (414,889)
Allowance for loan
and lease losses (2,381,415) (2,634,625) (2,771,390)
------------ ------------ ------------
$144,537,306 $119,833,989 $119,040,732
============ ============ ============
Risk Elements
The majority of the Company's loan activity is with customers located within
Sonoma County. Approximately 86.5% of the total loan portfolio is secured by
real estate located in the Company's service area. 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 it
has policies in place to identify problem loans and to monitor concentrations of
credits.
Based on its risk management review and a review of its loan portfolio,
management believes that its allowance for losses for the quarter ending
September 30, 2004, is sufficient to absorb losses inherent in the loan
portfolio. This assessment is based upon the best available information and does
involve uncertainty and matters of judgment. Accordingly, the adequacy of the
loan loss reserve cannot be determined with precision and could be susceptible
to significant change in future periods.
Non Performing 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 6 months and when other criteria are met 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 bank because of the inability of the
borrower to repay the loan under the original terms.
There were $1.1 million of non accrual loans and no loans 90 days or more past
due and still accruing at September 30, 2004. There were $1.8 million of non
accrual loans and no loans 90 days or more past due and still accruing at
September 30, 2003. The decline in non accrual loans is management's attempt to
recognize and handle problems early.
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,
Page 17
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 September 30, 2004 the Company
believes its overall allowance for loan losses is adequate based on its analysis
of conditions at that time.
At September 30, 2004, the allowance for loan losses was $2.4 million, or 1.62%
of period-end loans, compared with $2.6 million, or 2.15% at December 31, 2003
and $2.8 million, or 2.28% at September 30, 2003. This reduction in the
allowance is consistent with the improved quality of the loan portfolio.
An analysis of the changes in the allowance for loan losses, including
charge-offs and recoveries by loan categories, is presented below.
For the Nine Months For the Year For the Nine Months
Ended Ended Ended
9/30/04 12/31/03 9/30/03
Balance beginning of year $ 2,634,625 $ 2,781,962 $ 2,781,962
Charge-offs:
Commercial (290,000) (142,572) ( 4,955)
Consumer ( 46,369) ( 41,161) (38,675)
------------ ------------- -------------
Total charge-offs (336,369) (183,733) (43,630)
Recoveries:
Commercial 11,621 8,320 6,400
Consumer 1,538 8,076 6,658
------------ ------------- --------------
Total recoveries 13,159 16,396 13,058
Net (chargeoffs) recoveries (323,210) (167,337) (30,572)
Provision charged to operations 70,000 20,000 20,000
------------ ------------- --------------
Balance end of period $ 2,381,415 $ 2,634,625 $ 2,771,390
============ ============= ==============
Ratio of net charge-offs
annualized to average loans 0.32% 0.14% 0.03%
Balance in allowance as a percentage
of loans outstanding at period end 1.62% 2.15% 2.28%
YTD AVG LOANS 135,043,182 123,043,664 123,531,714
PERIOD END LOANS 146,918,721 122,468,614 121,812,123
Page 18
Deposits
A comparative schedule of average deposit balances is presented in the table on
page 11; period end and year-end deposit balances are presented in the following
table.
September 30, Percentage December 31, Percentage September 30, Percentage
2004 of Total 2003 of Total 2003 of Total
---- -------- ---- -------- ---- --------
Interest bearing
transaction deposits $31,214,138 16.7% $32,467,678 18.0% $28,124,429 16.0%
Savings deposits 65,398,770 35.0% 63,680,697 35.4% 65,414,882 37.3%
Time deposits, $100,000
and over 26,505,608 14.2% 26,565,347 14.7% 26,000,588 14.8%
Other time deposits 18,562,732 9.9% 19,453,317 10.8% 19,539,327 11.1%
----------- -------- ----------- ------ ----------- ------
Total interest bearing
deposits 141,681,248 75.8% 142,167,039 78.9% 139,079,226 79.2%
Demand deposits 45,379,582 24.2% 37,947,577 21.1% 36,491,921 20.8%
----------- ------ ----------- ------ ----------- ------
Total deposits $187,060,830 100.0% $180,114,616 100.0% $175,571,147 100.0%
=========== ====== =========== ====== =========== ======
Total deposits increased by $6.9 million, during the nine months of 2004, to
$187.1 million from $180.1 million at December 31, 2003. Non interest bearing
demand deposits showed the greatest increase of $7.4 million or 19.6% to $45.4
million at September 30, 2004 from $37.9 million as of December 31, 2003 and an
increase of $8.9 million or 24.4% increase from $36.5 million as of September
30, 2003. Savings deposits increased $1.7 million or 2.7% to $65.4 million from
$63.7 million as of December 31, 2003 and a minimal decline of $16,000 or .02%
from $65.4 million as of September 30, 2003.
When compared to December 31, 2003, the Company showed declines in all other
categories of deposits. Time deposits greater than $100,000, other time deposits
and interest bearing checking declined by .22%, 4.6% and 3.9% to $26.5 million,
$18.6 million and $31.2 million, respectively. Of those three, interest bearing
checking and time deposits greater than $100,000 show increases over September
30, 2003 of 11.0% and 1.9% from $28.1 million and $26.0 million, respectively.
In addition to savings accounts mentioned above, the category of other time
deposits declined by 5.0% from $19.5 million at September 30, 2003 to $18.6
million as of September 30, 2004. Customers may be allowing funds to accumulate
in demand and savings accounts rather than time deposits to more readily take
advantage of future investment opportunities.
With the future of interest rates uncertain the Company cannot predict how
quickly rates may change on deposit accounts in a rising rate environment which
could cause the net interest margin to decline, resulting in lower net income.
Risk-Based Capital
The Federal Deposit Insurance Corporation (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 current guidelines,
Page 19
as of September 30, 2004, 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 new minimum leverage ratio guidelines for compliance
by banking organizations. The guidelines require a minimum leverage ratio of 4%
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.
The table below presents Tier 1 capital, total capital and total risk-weighted
assets at September 30, 2004, along with the related risk-based capital ratio
and leverage ratio.
(dollars in thousands)
Total
Risked-based TIER 1 TOTAL Leverage
Assets Capital Ratio Capital Ratio Ratio
------ ------- ----- ------- ----- -----
$186,271 $17,384 9.59% $20,949 11.25% 8.78%
Off Balance Sheet Commitments
The Company's off balance sheet commitments consist of commitments to extend
credit of $34.8 million and standby letters of credit of $310,000. These
commitments are extended to customers in the normal course of business. 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.
The following table summarizes the Company's contractual obligations as of
September 30, 2004.
- --------------------------------------------------------------------------------------------------------------------
Payments due by period
-------------------------------------------------------------------------------
Contractual Obligations
- --------------------------------------------------------------------------------------------------------------------
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
- --------------------------------------------------------------------------------------------------------------------
Operating Lease Obligations 1,396,914 293,450 855,329 248,135 -
- --------------------------------------------------------------------------------------------------------------------
Executive Officer and
Director Supplemental
Retirement 1,952,193 5,661 33,187 210,056 1,703,289
- --------------------------------------------------------------------------------------------------------------------
Deferred Compensation 1,096,711 3,180 18,644 110,086 964,801
- --------------------------------------------------------------------------------------------------------------------
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
Page 20
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
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. deposits/borrowings)
positions as the beginning base. The forecast balance sheet is processed against
four interest rate scenarios. The scenarios include 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 2003
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 September 30, 2004
(In thousands)
Variation from a constant rate scenario $ Change in NII
+200bp $ 373
+100bp 180
-100bp (398)
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
Page 21
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.
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 September 30, 2004 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 $34.2 million in fixed rate loans over
5 years. Some variable rate credit lines came off of floors in 2004, and were
reclassified from the fixed rate to the variable rate category. As interest
rates increase, more loans will come off floors and will reclass back to the
variable rate category.
SEPTEMBER 30, 2004 3 months 12 months 3 years 5 years 15 years >15 years Totals
-------- --------- -------- ------- -------- --------- --------
(in thousands)
ASSETS:
Fixed rate investments $ 1,748 $ 757 $ 15,995 $ 7,376 $ 14,459 $ 978 $ 41,313
Variable rate investments 0 0 0 0 0 705 705
Fixed rate loans 9,428 7,884 15,507 39,929 31,613 2,606 106,967
Variable rate loans 36,287 1,414 0 1,610 0 0 39,311
Interest-bearing balances due from banks 35 35
Fed funds sold 1,685 1,685
-------- --------- -------- ------- -------- --------- --------
Interest bearing assets 49,183 10,055 31,502 48,915 46,072 4,289 190,016
-------- --------- -------- ------- -------- --------- --------
LIABILITIES:
Interest bearing transaction deposits 31,214 31,214
Savings deposits 65,399 65,399
Time Deposits
Fixed rate >100m 4,936 14,298 5,721 1,550 26,505
Fixed rate <100m 4,528 9,441 3,717 854 18,540
Floating rate >100m 0
Floating rate <100m 23 23
Borrowings 0
-------- -------- -------- ------- -------- --------- --------
Interest Bearing Liabilities $ 106,100 $ 23,739 $ 9,438 $ 2,404 $ 0 $ 0 $141,681
-------- -------- -------- ------- -------- --------- --------
Rate Sensitivity Gap (56,917) (13,684) 22,064 46,511 46,072 4,289
-------- -------- -------- ------- ------- ---------
Cumulative Rate Sensitivity Gap (56,917) (70,601) (48,537) (2,026) 44,046 48,335
-------- -------- -------- ------- ------- ---------
Cumulative Position to Total Assets -27.01% -33.51% -23.04% -0.96% 20.90% 22.94%
======== ======== ======== ======= ======= =========
Page 22
For the Three Month Periods
Ended September 30, 2004 and 2003
Overview
The Company reported net income of $745,000 for the third quarter of 2004
compared with $742,000 for the third quarter of 2003. On a per share basis, net
income for the three months ended September 30, 2004 equaled $.34 per share
compared with $.34 per share during the same period in 2003.
Return on average total assets on an annualized basis for the three months ended
September 30, 2004 and 2003 was 1.40% and 1.50%, respectively. The decline in
the return on assets is because assets are growing faster than earnings. Return
on average shareholders' equity on an annualized basis for the three months
ended September 30, 2004 and 2003 was 15.14% and 14.57%, respectively. The
increase in the return on equity is a result of the decline in the equity
accounts. This decline is a result of the completion of the tender offer in May,
2004 and the payment of a cash dividend in August, 2004. Together they lowered
capital by $5.0 million which was partially offset by the exercise of stock
options by directors and officers which increased capital by $1.8 million.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income, adjusted to a fully taxable equivalent basis, increased
$255,000 to $2.7 million for the three months ended September 30, 2004, from
$2.5 million during the comparable period of 2003. Net interest income on a
fully taxable equivalent basis, as shown on the table -Average Balances, Yields
and Rates Paid on page 25, is higher than net interest income on the statements
of income because it reflects adjustments applicable to tax-exempt income from
certain securities and loans ($108,000 in 2004 and $86,000 in 2003, based on a
34% federal income tax rate).
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 for the third quarter of 2004 increased to 5.64%
from 5.42% for the comparable period in 2003. The increase in the net interest
margin is the result of the movement of funds from lower yielding fed funds to
higher yielding investments and loans, the repricing of time deposits to lower
interest rates and the 75 basis point increase in the fed funds target rate and
the prime lending rate in 2004.
Interest Income
Interest income for the three months ended September 30, 2004 increased by
$225,000 to $3.1 million, a 7.84% increase over the $2.9 million realized during
the same period in 2003. The gain in volume of average balances was responsible
for a $571,000 increase in interest income offset by a $346,000 decrease in
income related to lower interest rates. The net effect was a decline in interest
income of $225,000.
Interest Expense
Total interest expense for the three months ended September 30, 2004 declined by
$30,000 to $384,000 compared with $414,000 in the same period of 2003. The
Page 23
average rate paid on all interest-bearing liabilities for the third quarter of
2004 declined to 1.06% from 1.20% in the third quarter of 2003, and average
balances for the third quarter of 2004 increased to $144.7 million from $136.4
million in the same period of 2003, a 6.08% gain.
The gain in volume of average balances accounted for a $5,000 increase in
interest expense offset by a $35,000 decline related to lower interest rates
paid resulting in a $30,000 decrease in interest expense for the third quarter
of 2004.
Individual components of interest income and interest expense are provided in
the table - Average Balances, Yields and Rates Paid on page 25.
Provision for Loan Losses
There was no provision for loan losses during the third quarter of 2003 compared
to the $40,000 provision for the third quarter of 2004. The increase in the
provision is the result of managements' evaluation and assessment of the loan
portfolio and the loan growth the Company has experienced.
Non-interest Income
Non-interest income of $452,000 for the third quarter of 2004 represented a
decrease of $3,000, or .66%, from the $455,000 for the comparable period in
2003.
Non-interest Expense
For the third quarter of 2004, non-interest expense was $1.9 million compared
with $1.7 million for the same period in 2003, representing an increase of
$155,000, or 9.05%. The largest increase of non interest expense was salaries
and benefits, which increased $187,000, or 20.4%, compared with the three months
ended September 30, 2003. The increase is largely a result of additional salary
and benefit costs associated with our new branch, Banco de Sonoma. The full time
equivalent employees at September 30, 2004 was 56 compared with 47 at September
30, 2003.
Premises and equipment expense increased $27,000, or 13.2%, to $231,000 for the
third quarter of 2004 from $204,000 for the third quarter of 2003. The increase
is tied to depreciation expense for the remodel of the Sonoma Branch and the
premises and equipment for the new branch, Banco de Sonoma.
Other non interest expense for the three months ended September 30, 2004
declined by 9.95% to $534,000 compared to $593,000 in the same period in 2003.
The largest component of the decline is a result of lower charges by
correspondent banks for their check processing services.
Provision for Income Taxes
The provision for income taxes increased to an effective tax rate of 35.2% in
the third quarter of 2004 compared with 33.4% for the comparable period in 2003.
Income taxes reported in the financial statements include deferred taxes
resulting from timing differences in the recognition of items for tax and
financial reporting purposes.
Page 24
SONOMA VALLEY BANCORP
AVERAGE BALANCES/YIELDS AND RATES PAID
For the three months ended September 30, 2004 and 2003
(dollars in thousands)
2004 2003
==== ====
Average Income/ Yield/ Average Income/ Yield/
ASSETS Balance Expense Rate Balance Expense Rate
Interest-earning assets:
Loans(2):
Commercial 101,190 1,822 7.16% 86,411 1,771 8.13%
Consumer 14,382 223 6.17% 11,088 202 7.23%
Real estate construction 20,159 399 7.87% 18,422 381 8.21%
Real estate mortgage 6,593 113 6.82% 3,450 77 8.85%
Tax exempt loans (1) 3,031 64 8.40% 3,148 67 8.44%
Leases 25 1 15.91% 50 4 31.74%
Tax exempt leases (1) 0 0 0.00% 31 1 12.80%
Unearned loan fees (461) (412)
-------- ------ ------ -------- ------- -------
Total loans 144,919 2,622 7.20% 122,188 2,503 8.12%
Investment securities
Available for sale:
Taxable 23,728 197 3.30% 14,266 103 2.86%
Tax exempt(1) 0 0 0.00% 0 0 0.00%
Hold to maturity:
Taxable 388 3 3.08% 408 2 1.94%
Tax exempt (1) 17,572 253 5.73% 11,345 186 6.50%
======== ====== ======== ========
Total investment securities 41,688 453 4.32% 26,019 291 4.44%
Federal funds sold 3,908 13 1.32% 31,039 74 0.95%
Federal Home Loan Bank stock 700 8 4.55% 291 3 4.09%
Total due from banks/Interest bearing 35 0 0.00% 331 0 0.00%
-------- ------ ------- --------
Total interest earning assets 191,250 3,096 6.44% 179,868 2,871 6.33%
====== ========
Noninterest-bearing assets:
Reserve for loan losses (2,384) (2,773)
Cash and due from banks 9,890 9,005
Premises and equipment 1,382 1,226
Other assets 12,388 11,078
-------- --------
Total assets $212,526 $198,404
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Interest bearing deposits
Interest bearing transaction 32,898 $ 13 0.16% 29,282 $ 11 0.15%
Savings deposits 68,513 109 0.63% 62,577 114 0.72%
Time deposits over $100,000 24,853 164 2.64% 24,808 174 2.77%
Other time deposits 18,447 98 2.11% 19,735 115 2.31%
-------- ------ -------- --------
Total interest bearing
Deposits 144,711 384 1.06% 136,402 414 1.20%
Federal funds purchased 0 0 0.00% 0 0 0.00%
Other short term borrowings 0 0 00.0% 11 0 00.0%
-------- ------ -------- --------
Total interest bearing
liabilities 144,711 $ 384 1.06% 136,413 $ 414 1.20%
====== ========
Non interest bearing liabilities:
Non interest bearing demand deposits 44,529 38,268
Other liabilities 3,609 3,349
Shareholders' equity 19,677 20,374
-------- --------
Total liabilities and shareholders'
equity $212,526 $198,404
======== ========
Interest rate spread 5.38% 5.13%
===== =====
Interest income 3,096 6.44% 2,871 6.33%
Interest expense 384 0.80% 414 0.91%
------ ----- -------- -----
Net interest income/margin $2,712 5.64% $2,457 5.42%
====== ===== ======== =====
(1) Fully tax equivalent adjustments are based on a federal income tax rate of
34% in 2004 and 2003
(2) Non accrual loans have been included in loans for the purposes of the
above presentation. Loan fees of approximately $84,700 and $130,500 for
the nine months ended September 30, 2004 and September 30, 2003,
respectively, were amortized to the appropriate interest income categories.
Page 25
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Information regarding Quantitative and Qualitative Disclosures about Market Risk
appears on page 20 through 22 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.
Item 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer along with the Company's Chief Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation,
the Company's Chief Executive Officer along with the Company's Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company required to be included in this Form 10-Q.
Part II
Item 1. LEGAL PROCEEDINGS
From time to time the Company may be a party to legal proceedings arising in the
ordinary course of business. The Company is not currently a party to, nor is any
of its properties the subject of, any material pending legal proceedings.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following chart summarizes the Company repurchases of the Company's common
shares as part of the Company's publicly announced repurchase plan.
---------------------------------------------------------------------------------------------------------------
(a) (b) (c) (d)
Maximum Number
(or Approximate
Total Number of Dollar Value) of
Shares (or Units) Shares (or Units)
Purchased as Part that May Yet be
Total Number of of Publicly Purchased Under
Shares (or Units) Average Price paid Announced Plans or the Plans or
Period Purchased per Share (or Unit) Programs Programs
---------------------------------------------------------------------------------------------------------------
Month #7: 0 0 0 $0
7/1/04 - 7/31/04
---------------------------------------------------------------------------------------------------------------
Month #8: 0 0 0 $0
8/1/04 - 8/31/04
---------------------------------------------------------------------------------------------------------------
Month #9: 0 0 0 $0
9/1/04 - 9/30/04
---------------------------------------------------------------------------------------------------------------
Total 0 0 0 $0
---------------------------------------------------------------------------------------------------------------
Page 26
Item 3. DEFAULTS UPON SENIOR SECURITIES
None
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
Item 5. OTHER INFORMATION
None
Item 6. EXHIBITS
Exhibits
31.1 Certification of CEO pursuant to Section 302 of the Sarbanes-
Oxley Act
31.2 Certification of CFO pursuant to Section 302 of the Sarbanes-
Oxley Act
32 Certification of CEO and CFO pursuant to Section 906 of the
Sarbanes-Oxley Act
Page 27
SIGNATURES
Under the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
SONOMA VALLEY BANCORP
Registrant
Date: November 10, 2004 /s/ Mel Switzer, Jr.
------------------- -------------------------------------
Mel Switzer, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 10, 2004 /s/ Mary Dieter Smith
------------------- -------------------------------------
Mary Dieter Smith
Executive Vice President,
Chief Operating Officer and Chief
Financial Officer
(Principal Financial and Accounting
Officer)
Page 28