UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the period ended September 30, 2002
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition Period
From to
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Commission file number 0-10652
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NORTH VALLEY BANCORP
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(Exact name of registrant as specified in its charter)
California 94-2751350
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State or other jurisdiction (IRS Employer ID Number)
of incorporation or organization)
300 Park Marina Circle, Redding, CA 96002
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (530) 226-2900
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880 East Cypress Avenue, Redding, CA
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the
preceding 12 months (or for such shorter periods 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock -4,666,444 shares as of November 13, 2002.
INDEX
NORTH VALLEY BANCORP AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets--September 30, 2002
and December 31, 2001 3
Condensed Consolidated Statements of Income--For the Three
and Nine Months Ended September 30, 2002 and 2001 4
Condensed Consolidated Statement of Cash Flows--For the
Nine months Ended September 30, 2002 and 2001 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
Item 4. Controls and Procedures 21
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings 21
Item 2. Changes in Securities 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 22
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2
PART I. FINANCIAL INFORMATION
Item 1.Financial Statements
NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands except share amounts)
ASSETS September 30, December 31,
2002 2001
------------ ------------
Cash and due from banks $ 31,798 $ 26,575
Federal funds sold 12,000 19,800
------------ ------------
Total cash and cash equivalents 43,798 46,375
Interest-bearing deposits in other financial institutions 693 2,289
Securities:
Available for sale, at fair value 115,191 111,626
Held to maturity, at amortized cost (fair value of $1,912
at September 30, 2002 and $1,941 at December 31, 2001) 1,455 1,455
Loans and leases net of allowance for loan and lease
losses of $6,466 and $5,786 at September 30, 2002 and
December 31, 2001 431,470 391,022
Premises and equipment, net of accumulated
Depreciation and amortization 12,207 10,294
Other real estate owned 105 287
FHLB, FRB stock and other securities 3,242 2,213
Core deposit and other intangibles, net 2,892 3,252
Accrued interest receivable & other assets 28,915 26,160
------------ ------------
TOTAL ASSETS $ 639,968 $ 594,973
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing demand $ 106,282 $ 94,719
Interest-bearing 432,379 419,559
------------ ------------
Total deposits 538,661 514,278
Other borrowed funds 32,831 20,647
Accrued interest and other liabilities 8,387 6,370
Company obligated mandatorily redeemable cumulative
trust preferred securities of subsidiary grantor trust 10,000 10,000
------------ ------------
Total liabilities 589,879 551,295
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STOCKHOLDERS' EQUITY:
Preferred stock, no par value: authorized 5,000,000
Shares; none outstanding
Common stock, no par value: authorized 20,000,000
Shares, outstanding 4,672,046 and 4,651,056 at
September 30, 2002 and December 31, 2001 25,052 24,538
Retained Earnings 22,215 18,383
Accumulated other comprehensive income, net of tax 2,822 757
------------ ------------
Total stockholders' equity 50,089 43,678
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 639,968 $ 594,973
============ ============
See notes to condensed consolidated financial statements (unaudited).
3
NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In thousands except per share amounts)
For the nine months ended For the three months ended
September 30, September 30,
------------------------- -------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
INTEREST INCOME
Loans and leases including fees $ 24,400 $ 24,721 $ 8,319 $ 8,317
Securities
Taxable 3,380 3,438 1,049 1,289
Exempt from federal taxes 1,194 1,257 398 409
Federal funds sold 265 521 87 178
----------- ----------- ----------- -----------
Total interest income 29,239 29,937 9,853 10,193
----------- ----------- ----------- -----------
INTEREST EXPENSE
Deposits 6,079 11,571 1,795 3,508
Company obligated mandatorily redeemable cumulative
trust preferred securities of subsidiary grantor trust 787 211 275 211
Other borrowings 654 252 189 121
----------- ----------- ----------- -----------
Total interest expense 7,521 12,034 2,259 3,840
----------- ----------- ----------- -----------
NET INTEREST INCOME 21,718 17,903 7,594 6,353
PROVISION FOR LOAN AND LEASE LOSSES 1,375 940 380 420
----------- ----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 20,343 16,963 7,214 5,933
NONINTEREST INCOME:
Service charges on deposit accounts 4,643 4,237 1,622 1,398
Other fees and charges 469 756 42 210
Gain on sale of loans 202 4 202
Gain on sales or calls of securities 27 13 14 11
Other 1,308 1,060 337 436
----------- ----------- ----------- -----------
Total noninterest income 6,649 6,070 2,217 2,055
----------- ----------- ----------- -----------
NONINTEREST EXPENSES:
Salaries and employee benefits 9,289 8,279 3,074 2,960
Occupancy 1,142 928 361 295
Equipment 1,330 1,007 485 334
Merger & integration -- 358 --
Other 6,495 5,567 2,234 1,937
----------- ----------- ----------- -----------
Total noninterest expenses 18,256 16,139 6,154 5,526
----------- ----------- ----------- -----------
INCOME BEFORE PROVISION FOR INCOME
TAXES 8,736 6,894 3,277 2,462
PROVISION FOR INCOME TAXES 2,954 2,135 1,151 773
----------- ----------- ----------- -----------
NET INCOME $ 5,782 $ 4,759 $ 2,126 $ 1,689
=========== =========== =========== ===========
EARNINGS PER SHARE:
Basic $ 1.24 $ 0.86 $ 0.46 $ 0.33
=========== =========== =========== ===========
Diluted $ 1.20 $ 0.84 $ 0.44 $ 0.33
=========== =========== =========== ===========
See notes to condensed consolidated financial statements (unaudited).
4
NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)
(In thousands)
For the nine months ended
September 30,
--------------------------
2002 2001
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CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 5,782 $ 4,759
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,007 875
Amortization of premium on securities 173 (19)
Amortization of core deposit and other intangibles 360 148
Provision for loan and lease losses 1,375 940
Gain on sale or calls of securities (27) (13)
Gain on sale of loans (202) (4)
Effect of changes in:
Accrued interest receivable 142 500
Other assets (4,280) (1,986)
Accrued interest and other liabilities 2,017 (387)
----------- -----------
Net cash provided by operating activities 6,347 4,813
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of other real estate owned 250 307
Net changes in FHLB, FRB and other securities (1,029) 65
Purchases of available for sale securities (39,119) (53,647)
Proceeds from sales of available for sale securities 12,722 15,854
Proceeds from maturities/calls of available for sale securities 26,134 32,921
Proceeds from sales of loans 24,827 219
Net change in interest-bearing deposits at financial institutions 1,596 (669)
Net changes in loans and leases (66,516) (22,063)
Purchases of premises and equipment, net (2,920) (1,576)
----------- -----------
Net cash (used in) provided by investing activities (44,055) (28,589)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 24,383 42,344
Net change in Federal funds purchased and other borrowed funds 12,184 3,710
Cash dividends paid (1,680) (2,227)
Repurchase of common stock (395) (15,821)
Cash received for stock options exercised 328 247
Proceeds from Company obligated mandatorily redeemable cumulative
preferred securities of subsidiary grantor trusts 10,000
Compensation expense on stock options/grants 311 85
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Net cash provided by financing activities 35,131 38,338
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INCREASE IN CASH AND CASH EQUIVALENTS (2,577) 14,562
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 46,375 28,728
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 43,798 $ 43,290
=========== ===========
ADDITIONAL INFORMATION:
Cash paid during the period for:
Interest $ 7,999 $ 11,899
=========== ===========
Income taxes $ 4,706 $ 3,431
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Transfer of foreclosed loans and leases from loans and leases receivable
To other real estate owned $ 68 $ 274
=========== ===========
Noncash investing and financing activities
Transfer of investment securities from held to maturity to
available for Sale $ -- $ 25,471
=========== ===========
See notes to condensed consolidated financial statements (unaudited).
5
NORTH VALLEY BANCORP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
of North Valley Bancorp and subsidiaries (the "Company") have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form 10-Q
and Article 10 of Regulation S-X. In the opinion of management, all adjustments
(consisting solely of normal recurring accruals) considered necessary for a fair
presentation of the results for the interim periods presented have been
included. They do not, however, include all the information and footnotes
required by accounting principles generally accepted in the United States of
America for annual financial statements. For further information, refer to the
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
Operating results for the nine months ended September 30, 2002 are not
necessarily indicative of the results that may be expected for any subsequent
period or for the year ended December 31, 2002.
The condensed consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries (North Valley Bank ("NVB"), Six
Rivers Bank ("SRB"), North Valley Capital Trust 1, North Valley Trading Company,
which is inactive, and Bank Processing, Inc. ("BPI") a California corporation).
Significant intercompany items and transactions have been eliminated in
consolidation.
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions. These estimates and assumptions affect the reported amounts of
assets and liabilities at the date of the consolidated financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates.
NOTE B - SECURITIES
At September 30, 2002 and December 31, 2001, the amortized cost of securities
and their approximate fair value were as follows:
(in thousands) Gross Gross Carrying
Amortized Unrealized Unrealized Amount
Available for sale securities: Cost Gains Losses (Fair Value)
------------ ------------ ------------ ------------
September 30, 2002
Securities of U.S. government
Agencies and corporations $ 1,997 $ 24 $ 2,021
Obligations of states and political
Subdivisions 24,398 2,183 26,581
Mortgage backed securities 75,078 1,596 $ (231) 76,443
Corporate securities 8,982 1,081 10,063
Other securities 88 (5) 83
------------ ------------ ------------ ------------
$ 110,543 $ 4,884 $ (236) $ 115,191
============ ============ ============ ============
December 31, 2001
Securities of U.S. government
Agencies and corporations $ 1,991 $ 78 $ 2,069
Obligations of states and political
Subdivisions 28,085 1,074 $ (254) 28,905
Mortgage backed securities 70,331 601 (81) 70,851
Corporate securities 9,946 20 (241) 9,725
Other securities 88 (12) 76
------------ ------------ ------------ ------------
$ 110,441 $ 1,773 $ (588) $ 111,626
============ ============ ============ ============
6
Carrying
Amount Gross Gross
(Amortized Unrealized Unrealized
Held to maturity securities: Cost) Gains Losses Fair Value
------------ ------------ ------------ ------------
September 30, 2002
------------------
Obligation of states and political
Subdivisions $ 1,455 $ 457 $ -- $ 1,912
============ ============ ============ ============
Carrying
Amount Gross Gross
(Amortized Unrealized Unrealized
Held to maturity securities: Cost) Gains Losses Fair Value
------------ ------------ ------------ ------------
December 31, 2001
-----------------
Obligation of states and political
Subdivisions $ 1,455 $ 486 $ -- $ 1,941
============ ============ ============ ============
Gross realized gains on sales or calls of available-for-sale securities
were $43,000 for the three months ended September 30, 2002 and $11,000 for the
three and nine months ended September 30, 2001. Gross realized losses on sales
or calls of available-for-sale securities were $29,000 for the three months
ended September 30, 2002. There were no gross realized losses on sale of
available for sale securities for the three months ended September 30, 2002.
There were no gross realized gains or losses on calls of held to
maturity securities for the three and nine months ended September 30, 2002 and
2001.
Scheduled maturities of held to maturity and available for sale
securities (other than equity securities with an amortized cost of approximately
$88,000 and a fair value of approximately $83,000) at September 30, 2002, are
shown below (in thousands). The Company invests in mortgage backed securities
("MBSs") issued by the Federal National Mortgage Association, the Federal Home
Loan Mortgage Corporation and Government National Mortgage Association. Actual
maturities of MBSs and other securities may differ from contractual maturities
because borrowers have the right to prepay mortgages without penalty or call
obligations with or without call penalties. The Company uses the "Wall Street"
consensus average life at the time the security is purchased to schedule
maturities of these MBSs and adjusts scheduled maturities periodically based
upon changes in the Wall Street estimates.
Held to Maturity Available for Sale
Securities Securities
------------------------- -------------------------
Amortized
Cost Fair Value
(Carrying Amortized (Carrying
Amount) Fair Value Cost Amount)
----------- ----------- ----------- -----------
Due in 1 year or less $ 19,289 $ 19,985
Due after 1 year through 5 years 34,192 36,307
Due after 5 years through 10 years 13,360 14,220
Due after 10 years $ 1,455 $ 1,912 43,614 44,596
----------- ----------- ----------- -----------
$ 1,455 $ 1,912 $ 110,455 $ 115,108
=========== =========== =========== ===========
At September 30, 2002 and December 31, 2001 securities having fair
value amounts of approximately $53,701,000 and $39,185,000 were pledged to
secure public deposits, short-term borrowings, treasury, tax and loan balances
and for other purposes required by law or contract.
7
NOTE C - COMPREHENSIVE INCOME
Comprehensive income includes net income and other comprehensive
income. The Company's only sources of other comprehensive income are derived
from unrealized gains and losses on investment securities available-for-sale and
adjustments to the minimum pension liability. Reclassification adjustments
resulting from gains or losses on investment securities that were realized and
included in net income of the current period that also had been included in
other comprehensive income as unrealized holding gains or losses in the period
in which they arose are excluded from comprehensive income of the current
period. The Company's total comprehensive income was as follows:
Nine months ended Three months ended
September 30, September 30,
------------------------- -------------------------
(in thousands) 2002 2001 2002 2001
----------- ----------- ----------- -----------
Net income $ 5,782 $ 4,759 $ 2,126 $ 1,689
Other comprehensive income:
Holding gain (loss) arising during period, net
of reclassification adjustment and tax 2,065 1,761 1,302 811
----------- ----------- ----------- -----------
Total comprehensive income $ 7,847 $ 6,520 $ 3,428 $ 2,500
=========== =========== =========== ===========
NOTE D - EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income by the
weighted average common shares outstanding for the period. Diluted earnings per
share reflect the potential dilution that could occur if options or other
contracts to issue common stock were exercised and converted into common stock.
There was no difference in the numerator, net income, used in the
calculation of basic earnings per share and diluted earnings per share. The
denominator used in the calculation of basic earnings per share and diluted
earnings per share for the nine and three month periods ended September 30, 2002
and 2001 is reconciled as follows:
Nine months ended Three months ended
September 30, September 30,
------------------------- -------------------------
(In thousands except earnings per share) 2002 2001 2002 2001
----------- ----------- ----------- -----------
Calculation of Basic Earnings Per Share
Numerator - net income $ 5,782 $ 4,759 $ 2,126 $ 1,689
Denominator - weighted average common
Shares outstanding 4,670 5,537 4,622 5,054
----------- ----------- ----------- -----------
Basic Earnings Per Share $ 1.24 $ 0.86 $ 0.46 $ 0.33
=========== =========== =========== ===========
Calculation of Diluted Earnings Per Share
Numerator - net income $ 5,782 $ 4,759 $ 2,126 $ 1,689
Denominator - weighted average common
Shares outstanding 4,670 5,537 4,622 5,054
Dilutive effect of outstanding options 133 112 210 123
----------- ----------- ----------- -----------
4,803 5,649 4,832 5,177
----------- ----------- ----------- -----------
Diluted Earnings Per Share $ 1.20 $ 0.84 $ 0.44 $ 0.33
=========== =========== =========== ===========
8
NOTE E - SEGMENT DISCLOSURE
The Company operates as three business segments: North Valley Bank, Six
Rivers Bank and Other. Management analyzes the operations of NVB, SRB and Other
separately. Other consists of North Valley Bancorp a multi-bank holding company
registered with and subject to regulation and supervision by the Board of
Governors of the Federal Reserve System and Bank Processing Inc, a California
corporation, both of which provide services to NVB and SRB. Management allocates
the costs of Bancorp and BPI to NVB and SRB based primarily on usage through a
variety of statistical data. NVB and SRB are separately chartered institutions
each with its own Board of Directors and regulated independently of each other.
The accounting policies of the segments are the same as those described
in Note 1 to the Consolidated Financial Statements included in the Company's
annual report on Form 10-K for the fiscal year ended December 31, 2001. The
Company evaluates performance based on operating results before income taxes not
including nonrecurring gains or losses.
The Company derives a majority of its revenues from interest income and
the chief operating decision maker relies primarily on net interest income and
non-interest income to assess the performance of the segments and make decisions
about resources to be allocated to the segment. Therefore, the total revenues
for the segments reported below consists of net interest income plus noninterest
income for the nine months ended September 30, 2002 and 2001.
The Company does not have operating segments other than those reported.
Parent company financial information is included in the Other category in the
disclosures below along with the activity of BPI and North Valley Trading Co.
and represents the Company's Other operating segment.
The Company does not have a single external customer from which it
derives 10 percent or more of its revenues and operates in one geographical
area.
Information about reportable segments, and reconciliation of such
information to the condensed consolidated financial statements as of and for the
nine month periods ended September 30, follows:
Nine months ended: NVB SRB Other Total
---------- ---------- ---------- ----------
September 30, 2002:
Total revenues $ 24,942 $ 10,598 $ 348 $ 35,888
Net income (loss) $ 5,251 $ 1,097 $ (566) $ 5,782
Interest income $ 20,194 $ 9,044 $ -- $ 29,238
Interest expense $ 4,243 $ 2,516 $ 762 $ 7,521
Depreciation and amortization $ 712 $ 646 $ 55 $ 1,413
Provision for loan and lease losses $ 1,215 $ 160 $ -- $ 1,375
Total assets $ 422,374 $ 215,529 $ 2,065 $ 639,968
September 30, 2001:
Total revenues $ 24,045 $ 11,683 $ 279 $ 36,007
Net income (loss) $ 4,312 $ 943 $ (496) $ 4,759
Interest income $ 19,644 $ 10,266 $ 27 $ 29,937
Interest expense $ 7,630 $ 4,193 $ 211 $ 12,034
Depreciation and amortization $ 642 $ 350 $ 12 $ 1,004
Provision for loan and lease losses $ 660 $ 280 $ -- $ 940
Total assets $ 381,196 $ 200,772 $ 2,724 $ 584,692
NOTE F - STOCK REPURCHASE PROGRAM
The Board of Directors of the Company has authorized a stock repurchase
program under which repurchases will be made from time to time by the Company,
in compliance with Securities and Exchange Commission rules, to a level as
authorized by the Board. On July 31, 2002, the Board of Directors authorized a
new common stock repurchase program. The program calls for the repurchase of up
to 3.0% of the Company's outstanding shares, or approximately 140,000 shares,
based on approximately 4,665,000 shares outstanding as of the date of the
announcement. Under this latest program, a total of 10,600 shares have been
repurchased for total consideration of $176,545. This repurchase program is the
fifth such plan announced since May of 2001. Pursuant to these five repurchase
plans, a total of 1,218,100 shares of common stock were repurchased by the
Company.
9
NOTE G - NEW ACCOUNTING PRONOUNCEMENTS
Effective June 2001 the Financial Accounting Standards Board ("FASB")
approved for issuance he Statement of Financial Accounting Standards (SFAS) No.
141, "Business Combinations" which addresses the elimination of pooling
accounting treatment in business combinations and the financial accounting and
reporting for acquired goodwill and other intangible assets at acquisition and
SFAS No. 142, "Goodwill and Other Intangible Assets" which addresses financial
accounting and reporting for acquired goodwill and other intangible assets at
acquisition in transactions other than business combinations covered by SFAS No.
141, and the accounting treatment of goodwill and other intangible assets after
acquisition and initial recognition in the financial statements effective
January 1, 2002 the Company adopted SFAS No. 142. The adoption of this statement
did not have any impact on the Company's consolidated financial position,
results of operations, or cash flows as the Company had no goodwill as of
January 1, 2002 and all of the Company's intangible assets have finite lives and
are continuing to be amortized.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This Statement rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, SFAS No. 64,
Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This
Statement also rescinds SFAS No. 44, Accounting for Intangible Assets of Motor
Carriers. This Statement amends SFAS No. 13, Accounting for Leases, to eliminate
an inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. This Statement also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. This Statement is effective for fiscal years beginning after May 15,
2002. Adoption of this statement is not expected to have a material effect on
the Company's consolidated financial statements.
The FASB issued Statement No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, in July, 2002. The standard requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity.
Previous accounting guidance was provided by Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." Statement 146 replaces Issue 94-3 and is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
In management's opinion, the adoption of this statement will not have a material
impact on the Company's financial position or results of its operations.
On October 1, 2002, the FASB issued FASB Statement No. 147, Acquisitions of
Certain Financial Institutions. This statement, which provides guidance on the
accounting for the acquisition of a financial institution, applies to all
acquisitions except those between two or more mutual enterprises (the Board has
a separate project on its agenda that will provide guidance on the accounting
for transactions between mutual enterprises).
The provisions of Statement 147 reflect the following conclusions:
The excess of the fair value of liabilities assumed over the fair value
of tangible and identifiable intangible assets acquired in a business
combination represents goodwill that should be accounted for under FASB
Statement No. 142, Goodwill and Other Intangible Assets. Thus, the
specialized accounting guidance in paragraph 5 of FASB Statement No.
72, Accounting for Certain Acquisitions of Banking or Thrift
Institutions, will not apply after September 30, 2002. If certain
criteria in Statement 147 are met, the amount of the unidentifiable
intangible asset will be reclassified to goodwill upon adoption of that
Statement.
Financial institutions meeting conditions outlined in Statement 147
will be required to restate previously issued financial statements. The
objective of that restatement requirement is to present the balance
sheet and income statement as if the amount accounted for under
Statement 72 as an unidentifiable intangible asset had been
reclassified to goodwill as of the date Statement 142 was initially
applied. (For example, a financial institution that adopted Statement
142 on January 1, 2002, would retroactively reclassify the
unidentifiable intangible asset to goodwill as of that date and restate
previously issued income statements to remove the amortization expense
recognized in 2002). Those transition provisions are effective on
October 1, 2002; however, early application is permitted.
The scope of FASB Statement No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, is amended to include long-term
customer-relationship intangible assets such as depositor- and
borrower-relationship intangible assets and credit cardholder
intangible assets.
The adoption of Statement No. 147 is not expected to have a material effect on
the Company's consolidated financial statements.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Certain statements in this Form 10-Q (excluding statements of fact or
historical financial information) involve forward-looking information within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, and are subject to the
"safe harbor" created by those sections. These forward-looking statements
involve certain risks and uncertainties that could cause actual results to
differ materially from those in the forward-looking statements. Such risks and
uncertainties include, but are not limited to, the following factors:
competitive pressure in the banking industry increases significantly; changes in
the interest rate environment reduce margins; general economic conditions,
either nationally or regionally, are less favorable than expected, resulting in,
among other things, a deterioration in credit quality and an increase in the
provision for possible loan losses; changes in the regulatory environment;
changes in business conditions, particularly in Shasta and Humboldt Counties;
volatility of rate sensitive deposits; operational risks including data
processing system failures or fraud; asset/liability matching risks and
liquidity risks; and changes in the securities markets. In additions, recent
events, including those of September 11, 2001, have increased the uncertainty
related to the national and California economic outlook and could have an effect
on the future operations of the Company or its customers, including borrowers.
Critical Accounting Policies
- ----------------------------
General
North Valley Bancorp's financial statements are prepared in accordance
with accounting principles generally accepted in the United States of America
(GAAP). The financial information contained within its statements is, to a
significant extent, financial information that is based on measures of the
financial effects of transactions and events that have already occurred. A
variety of factors could affect the ultimate value that is obtained either when
earning income, recognizing an expense, recovering an asset or relieving a
liability. North Valley Bancorp uses historical loss factors as one factor in
determining the inherent loss that may be present in its loan portfolio. Actual
losses could differ significantly from the historical factors that are used.
Other estimates that we use are related to the expected useful lives of our
depreciable assets. In addition, GAAP itself may change from one previously
acceptable method to another method. Although the economics of our transactions
would be the same, the timing of events that would impact our transactions could
change.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses is an estimate of the losses
that are inherent in our loan portfolio. The allowance is based on two basic
principles of accounting: (1) Statement of Financial Accountings Standards
(SFAS) No. 5 "Accounting for Contingencies", which requires that losses be
accrued when they are probable of occurring and estimable and (2) SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan", which requires that losses
be accrued for impaired loans based on the differences between that value of
collateral, present value of future cash flows or values that are observable in
the secondary market and the loan balance.
Our allowance for loan and lease losses has three basic components: the
formula allowance, the specific allowance and the unallocated allowance. Each of
these components is determined based upon estimates that can and do change when
the actual events occur. The formula allowance uses a historical loss view as an
indicator of future losses and therefore this estimate could differ from the
loss incurred in the future. However, since this history is updated with the
most recent loss information, the errors that might otherwise occur are
mitigated. The specific allowance uses various techniques to arrive at an
estimate of loss. Historical loss information, expected cash flows and fair
market value of collateral are used to estimate those losses. The use of these
values is inherently subjective and our actual losses could be greater or less
than the estimates. The unallocated allowance captures losses that are
attributable to various economic events, industry or geographic sectors whose
impact on the portfolio have occurred but have yet to be recognized in either
the formula or specific allowances including model imprecision. For further
information regarding our allowance for credit losses, see "Allowance for Loan
and Lease Losses" on page 15.
Corporate Reform Legislation
President George W. Bush signed the Sarbanes-Oxley Act of 2002 (the
"Act") on July 30, 2002, which responds to recent issues in corporate governance
and accountability. Among other matters, key provisions of the Act provide for:
o Expanded oversight of the accounting profession by creating a new
independent oversight board to be monitored by the SEC.
o Revised rules on auditor independence to restrict the nature of
non-audit services provided to audit clients and to require such
services to be pre-approved by the audit committee.
o Improved corporate responsibility through mandatory listing standards
relating to audit committees, certifications of periodic reports by
the CEO and CFO, and makes it a crime for an issuer to interfere with
an audit.
o Enhanced financial disclosures, including periodic reviews for the
largest issuers and real time disclosure of material company
information.
o Enhanced criminal penalties for a broad array of white collar crimes
and increases in the statute of limitations for securities fraud
lawsuits.
The effect of the Act upon corporations is uncertain; however, it is likely
that compliance costs may increase as corporations modify procedures if required
to conform to the provisions of the Act. The Company does not currently
anticipate that compliance with the Act will have a material effect upon its
financial position or results of its operations or its cash flows.
11
Overview
- --------
North Valley Bancorp (the "Company") is a multi-bank holding company
registered with and subject to regulation and supervision by the Board of
Governors of the Federal Reserve System (the "Board of Governors"). The Company
was incorporated in 1980 in the State of California. The Company wholly owns its
principal subsidiaries, North Valley Bank ("NVB"), Six Rivers Bank ("SRB"),
North Valley Capital Trust 1, North Valley Trading Company, which is inactive,
and Bank Processing, Inc. ("BPI"), a California corporation. The sole subsidiary
of NVB, which is inactive, is North Valley Basic Securities (the "Securities
Company").
The Company conducts a commercial and retail banking business with NVB
operating eleven full service banking offices, including two supermarket
branches, in Shasta and Trinity Counties and with SRB operating seven full
service banking offices in Humboldt, Del Norte and Mendocino counties. The
Company operates as three business segments - NVB, SRB, and Other - providing
demand, savings, money market rate deposit accounts, and time deposits, and
making commercial, real estate and consumer loans. The Company also offers
installment note collections, issues cashier's checks and money orders, sells
travelers' checks and provides safe deposit boxes and other customary banking
services. The Company's primary source of revenues is interest income from its
loan and investment securities portfolios. The Company is not dependent on any
single customer for more than 10% of the Company's revenues.
Earnings Summary
- ----------------
Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
(in thousands except per share amounts 2002 2001 2002 2001
----------- ----------- ----------- -----------
Net interest income $ 21,718 $ 17,903 $ 7,594 $ 6,353
Provision for loan and lease losses 1,375 940 380 420
Noninterest income 6,649 6,070 2,217 2,055
Noninterest expense 18,256 16,139 6,154 5,526
Provision for income taxes 2,954 2,135 1,151 773
----------- ----------- ----------- -----------
Net income $ 5,782 $ 4,759 $ 2,126 $ 1,689
=========== =========== =========== ===========
Earnings Per Share
Basic $ 1.24 $ 0.86 $ 0.46 $ 0.33
Diluted $ 1.20 $ 0.84 $ 0.44 $ 0.33
Annualized Return on Average Assets 1.27% 1.16% 1.36% 1.17%
Annualized Return on Average Equity 17.06% 11.91% 17.90% 13.75%
The Company's consolidated net income for the nine months ended
September 30, 2002 was $5,782,000, or $1.20 per diluted share, compared to
$4,759,000, or $0.84 diluted earnings per share for the same period in 2001.
Return on average assets was 1.27% and return on average equity was 17.06% for
the nine months ended September 30, 2002 improving over the 1.16% and 11.91% for
the same period in 2001. Net income for the three months ended September 30,
2002 was $2,126,000 or $0.44 per diluted share, compared to $1,689,000 or $0.33
per diluted share for the same period in 2001. Return on average assets was
1.36% and return on average equity was 17.90% for the three months ended
September 30, 2002 improving from 1.17% and 13.75% for the same period in 2001.
There were no merger and integration expenses for the nine months ended
September 30, 2002. Merger and integration expenses were $358,000 on a pre-tax
basis and $245,000 on an after-tax basis for the nine months ended September 30,
2001. Excluding this nonrecurring item, core net income, which represents net
income excluding merger and integration charges and other non-recurring income,
on a tax effected basis, for the nine months ended September 30, 2001 was
$5,004,000 or $0.89 per diluted share.
For the nine months ended September 30, 2002, the Company added to its
allowance for loan and lease losses through a provision charged to earnings of
$1,375,000. This compares to $940,000 for the same period in 2001. The increased
level of provision is due primarily to recent loan growth in the portfolio as
well as an increase in the level of non-performing loans. Management believes
that the current level of allowance for loan and lease losses as of September
30, 2002 of $6,466,000 or 1.48% of total loans and leases is adequate at this
time. The allowance for loan and lease losses was $5,786,000 or 1.46% of total
loans and leases at December 31, 2001. For further information regarding our
allowance for loan and lease losses, see "Allowance for Loan and Lease Losses"
on page 15.
Net Interest Income
- -------------------
Net interest income is the principal source of the Company's operating
earnings and represents the difference between interest earned on loans and
leases and other investments and interest paid on deposits and other borrowings.
The amount of interest income and expense is affected by changes in volume and
mix of earning assets and interest-bearing deposits, along with changes in
interest rates.
12
The following table is a summary of the Company's net interest income
presented on a fully taxable equivalent (FTE) basis, for tax-exempt investments
included in earning assets, for the periods indicated:
Nine months ended Three months ended
September 30, September 30,
------------------------- -------------------------
(In thousands) 2002 2001 2002 2001
----------- ----------- ----------- -----------
Interest income $ 29,239 $ 29,937 $ 9,853 $ 10,193
Less: Interest expense 7,521 12,034 2,259 3,840
FTE adjustment 589 620 196 202
----------- ----------- ----------- -----------
Net interest income (FTE) $ 22,306 $ 18,523 $ 7,790 $ 6,555
=========== =========== =========== ===========
Net interest income has been adjusted to a fully taxable equivalent
basis (FTE) for tax-exempt investments included in earning assets. The increase
in net interest income (FTE) for the three-and nine month periods ended
September 30, 2002 resulted primarily from the decreasing rates paid on
interest-bearing liabilities as well as the growth in average earning assets,
which was offset by lower yields on those assets. During 2001, the Federal
Reserve Bank Board reduced short-term interest rates by 475 basis points.
Management has thus far been able to effectively manage the net interest margin
during the dramatic change in rates due to its diversified balance sheet and
proactive management of the investment portfolio. While average interest earning
assets for the nine months ended September 30, 2002 increased by $51,540,000 or
10.4% from the same period last year, yields on average earning assets decreased
94 basis points from 8.24% to 7.30%. Average interest bearing liabilities
increased by $43,527,000 for the nine months ended September 30, 2002 compared
to the same period in 2001 while the average rate paid on those liabilities
decreased 168 basis points from 3.88% to 2.20%. Although significant reductions
occurred in short term interest rates from 2001 which have been maintained
through 2002, the Company's net interest margin (FTE) expanded from 4.99% for
the nine month period ended September 30, 2001 to 5.46% for the same period
ended September 30, 2002. As a result the net interest spread increased 75 basis
points from 4.36% to 5.11%. During the third quarter of 2002, average interest
earning assets increased by $69,616,000 from the same period last year, however
yields on earning assets decreased by 84 basis points. During the third quarter
of 2002, average interest bearing liabilities increased to $460,589,000 from
$435,688,000 for the same period in 2001 while the average rate paid on those
liabilities decreased by 155 basis points. The effect of the above resulted in
an increase in the net interest margins for both the three and nine months
periods ended September 30, 2002 of 51 basis points and 46 basis points,
respectively, compared to 2001 as shown below.
The following table is a summary of the Company's net interest margin
(FTE) for the periods indicated:
Nine Months Ended Three Months Ended
September 30, September 30,
--------------------- ---------------------
2002 2001 2002 2001
------ ------ ------ ------
Yield on earning assets 7.30% 8.24% 7.16% 8.00%
Rate paid on interest-bearing liabilities 2.20% 3.88% 1.95% 3.50%
------ ------ ------ ------
Net interest spread 5.10% 4.36% 5.21% 4.50%
====== ====== ====== ======
Net interest margin 5.46% 4.99% 5.55% 5.04%
====== ====== ====== ======
Noninterest Income
- ------------------
The following table is a summary of the Company's noninterest income
for the periods indicated:
Noninterest Income Nine Months Ended Three Months Ended
September 30, September 30,
------------------------- -------------------------
(In thousands) 2002 2001 2002 2001
----------- ----------- ----------- -----------
Service charges on deposit accounts 4,643 4,237 1,622 1,398
Other fees and charges 469 756 42 210
Gain (loss) on sale of loans 202 4 202 --
Gain on sale or calls of securities 27 13 14 11
Other 1,308 1,060 337 436
----------- ----------- ----------- -----------
Total noninterest income $ 6,649 $ 6,070 $ 2,217 $ 2,055
=========== =========== =========== ===========
Non-interest income increased from $6,070,000 for the nine months ended
September 30, 2001 to $6,649,000 for the same period in 2002. Service charges on
deposits increased to $4,643,000 for the nine months ended September 30, 2002
from $4,237,000 for the same period in 2001, an increase of $406,000 or 9.6%.
The increase in service charges was due to the continued success of the
Company's "Positively Free Checking" program, a Company-wide deposit-gathering
promotion that began in March of 2000 at NVB and in October of 2000 at SRB. The
increase in service charge income was offset by a decrease in other fees and
charges of $287,000 offset by an increase in other income of $248,000. The
decrease in other fees was due to the termination of a data processing contract
between BPI and a local financial institution in addition to a decrease in
mortgage servicing income. The increase in other income was primarily due to the
increase of $133,000 over the same period in 2001 in earnings on life insurance
holdings which were purchased to fund the Company's salary continuation plan.
13
During the third quarter of 2002, the Company began to sell new
production conforming first trust deed mortgage loans into the secondary market
and retaining the servicing on these loans. This is part of a strategy to
maintain a consistent, beneficial mix within the loan portfolio while also
maintaining a relatively shorter duration within the loan portfolio due to the
current low interest rate environment. While this strategy may serve to slightly
reduce the overall yield on earning assets, the benefit is that when rates do
start to move back up, the Company will be in a better position to respond to
rate changes and maintain a consistent net interest margin. This strategy also
provided $202,000 in gains on loan sales for the three- and nine month periods
ended September 30, 2002 as compared $4,000 and $0 in the same periods in 2001.
For the quarter ended September 30, 2002, noninterest income increased
to $2,217,000 compared to $2,055,000 for the same period in 2001. Service
charges on deposits, other fees and other income all experienced the same trends
as those described above in the changes in the nine month period ended September
30, 2002 and 2001.
Noninterest Expense
- -------------------
The following table is a summary of the Company's noninterest expense
for the periods indicated:
Noninterest Expense Nine Months Ended Three Months Ended
September 30, September 30,
------------------------- -------------------------
(In thousands) 2002 2001 2002 2001
----------- ----------- ----------- -----------
Salaries & employee benefits $ 9,289 $ 8,279 $ 3,082 $ 2,960
Merger & acquisition expense -- 358 -- --
Equipment expense 1,330 1,007 485 334
Occupancy expense 1,142 928 361 295
Marketing 806 901 259 291
Data processing expenses 178 277 35 85
ATM expense 678 420 240 133
Printing & supplies 447 415 173 130
Postage 418 372 151 127
Messenger expense 278 206 77 68
Professional services 698 499 220 193
Other 2,992 2,477 1,071 910
----------- ----------- ----------- -----------
Total Noninterest expense $ 18,256 $ 16,139 $ 6,154 $ 5,526
=========== =========== =========== ===========
Noninterest expense totaled $18,256,000 for the nine-month period ended
September 30, 2002, compared to $16,139,000 for the same period in 2001.
Salaries and benefits increased by $1,010,000 or 12.2% to $9,289,000 for the
nine months ended September 30, 2002 compared to $8,279,000 for the same period
in 2001. The increase in salary expense was due to regular merit increases, new
employees associated with two new branch facilities, and an increase in
compensation expense of $225,000 related to stock options granted to Directors
at below market value. Equipment expense and occupancy expense increased for
both three- and nine month periods ended September 30, 2002 due to the opening
of two new branches, one in August of 2001 and the new Churn Creek branch of NVB
which opened in August of 2002. All other expense categories combined totaled
$6,495,000 for the nine months ended September 30, 2002 compared to $5,925,000
for the same period in 2001, an increase of $570,000 or 10.8%. Other significant
changes were ATM expense and professional services which increased for both the
three- and nine month periods ended September 30, 2002 compared to the same
periods in 2001. The Company's efficiency ratio for the first nine months of
2002 was 64.4%, slightly better than the 67.3% efficiency ratio achieved for the
first nine months of 2001. For the quarter ended September 30, 2002 the
Company's efficiency ratio was 62.7% compared to 65.7% achieved in the third
quarter of 2001.
Income Taxes
- ------------
The provision for income taxes for the nine months ended September 30,
2002 was $2,954,000 as compared to $2,136,000 for the same period in 2001. The
effective income tax rate for state and federal income taxes was 33.8% for the
nine months ended September 30, 2002 compared to 31.0 % for the same period in
2001. The increase in the effective tax rate was due to a decrease in the
Company's tax-exempt income relative to total revenues. The difference in the
effective tax rate compared to the statutory tax rate (approximately 42.05%) is
primarily the result of the Company's investment in municipal securities and
life insurance policies whose income is exempt from Federal taxes.
Impaired, Nonaccrual, Past Due and Restructured Loans and Leases and Other
Nonperforming Assets
- --------------------------------------------------------------------------
The Company considers a loan or lease impaired if, based on current
information and events, it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. The measurement of impaired loans
and leases is generally based on the present value of expected future cash flows
discounted at the historical effective interest rate, except that all
collateral-dependent loans and leases are measured for impairment based on the
fair value of the collateral.
14
At September 30, 2002, the recorded investment in loans and leases for
which impairment has been recognized was approximately $1,437,000 with a related
valuation allowance which is included in the specific allowance of $284,000. For
the period ended September 30, 2002 the average recorded investment in loans and
leases for which impairment has been recognized was approximately $963,000.
During the portion of the year that the loans and leases were impaired, the
Company recognized interest income of approximately $22,000 for cash payments
received in 2002.
At December 31, 2001, the recorded investment in loans and leases for
which impairment had been recognized was approximately $867,000 with a related
valuation allowance of $218,000. For the year ended December 31 2001, the
average recorded investment in loans and leases for which impairment had been
recognized was approximately $613,000. During the portion of the year that the
loans and leases were impaired, the Company recognized interest income of
approximately $76,000 for cash payments received in 2001.
Loans on which the accrual of interest has been discontinued are
designated as nonaccrual loans. Accrual of interest on loans is discontinued
either when reasonable doubt exists as to the full and timely collection of
interest or principal, or when a loan becomes contractually past due by 90 days
or more with respect to interest or principal (except that when management
believes a loan is well secured and in the process of collection, interest
accruals are continued on loans deemed by management to be fully collectible).
When a loan is placed on nonaccrual status, all interest previously accrued but
not collected is reversed against current period interest income. Income on such
loans is then recognized only to the extent that cash is received and where the
future collection of principal is probable. Interest accruals are resumed on
such loans when, in the judgment of management, the loans are estimated to be
fully collectible as to both principal and interest. The increase in
nonperforming loans was primarily due to the addition of four nonperforming
single-family residential loans, which are all in the process of collection.
Non-performing assets at September 30, 2002, and December 31, 2001, are
summarized as follows:
September 30, December 31,
2002 2001
----------- -----------
Nonaccrual loans and leases $ 1,437 $ 867
Loans and leases 90 days past due and still accruing
interest 1,158 848
----------- -----------
Total nonperforming loans and leases 2,595 1,715
Other real estate owned 105 287
----------- -----------
Total nonperforming assets $ 2,700 $ 2,002
=========== ===========
Nonaccrual loans and leases to total gross loans and
leases 0.33% 0.22%
Nonperforming loans and leases to total gross loans
and leases 0.59% 0.43%
Total nonperforming assets to total assets 0.42% 0.34%
15
Allowance for Loan and Lease Losses
- -----------------------------------
A summary of the allowance for loan and lease losses at September 30,
2002, September 30, 2001 and December 31, 2001, is as follows:
September 30, September 30,
(In thousands) 2002 2001
------------ ------------
Balance beginning of period $ 5,786 $ 4,964
Provision for loan and lease losses 1,375 940
Net charge offs 695 375
------------ ------------
Balance end of period $ 6,466 $ 5,529
============ ============
Allowance for loan and lease losses to nonaccrual loans and
leases 449.97% 1,082.00%
Allowance for loan and lease losses to nonperforming loans
and leases 249.17% 404.76%
Allowance for loan and lease losses to total gross loans and
leases 1.48% 1.46%
Ratio of net charge-offs to average loans and leases
outstanding (annualized) .22% 0.13%
The allowance for loan and lease losses is established through a
provision for loan and lease losses based on management's evaluation of the
risks inherent in the loan and lease portfolio. In determining levels of risk,
management considers a variety of factors, including, but not limited to, asset
classifications, economic trends, industry experience and trends, geographic
concentrations, estimated collateral values, historical loan and lease loss
experience, and the Company's underwriting policies. The allowance for loan and
lease losses is maintained at an amount management considers adequate to cover
losses in loans and leases receivable, which are considered probable and
estimable. While management uses the best information available to make these
estimates, future adjustments to allowances may be necessary due to economic,
operating, regulatory, and other conditions that may be beyond the Company's
control. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan and
lease losses. Such agencies may require the Company to recognize additions to
the allowance based on judgments different from those of management.
The allowance for loan and lease losses is comprised of three primary
types of allowances:
1. Formula Allowance
Formula allowances are based upon loan and lease loss factors that
reflect management's estimate of the inherent loss in various segments of or
pools within the loan and lease portfolio. The loss factor is multiplied by the
portfolio segment (e.g. multifamily permanent mortgages) balance to derive the
formula allowance amount. The loss factors are updated periodically by the
Company to reflect current information that has an effect on the amount of loss
inherent in each segment.
2. Specific Allowance
Specific allowances are established in cases where management had
identified significant conditions or circumstances related to an individually
impaired credit. In other words, these allowances are specific to the loss
inherent in a particular loan. The amount for a specific allowance is calculated
in accordance with SFAS No. 114, "Accounting By Creditors For Impairment Of A
Loan".
3. Unallocated Allowance
The Company maintains an unallocated loan and lease loss allowance that
is based upon management's evaluation of conditions that are not directly
measured in the determination of the formula and specific allowances. The
evaluation of inherent loss with respect to these conditions is subject to a
higher degree of uncertainty because they are not identified with specific
problem credits or historical performance of loan and lease portfolio segments.
The conditions evaluated in connection with the unallocated allowance at
September 30, 2002 included the following, which existed at the balance sheet
date:
General Factors:
o General business and economic conditions effecting the Company's
key lending areas
o Real estate values in Northern California
o Loan volumes and concentrations, including trends in past due and
nonperforming loans
16
o Seasoning of the loan portfolio
o Status of the current business cycle
o Specific industry or market conditions within portfolio segments
o Model imprecision
At September 30, 2002, the allowance for loan losses was comprised of
$5,553,000 in formula and specific allowances and $913,000 in unallocated
allowance. The $5,553,000 in formula and specific allowances reflects
management's estimate of the inherent loss in various pools or segments in the
portfolio, and includes adjustments for general economic conditions, trends in
the portfolio, changes in the mix of the portfolio and the level of formula
allowance is consistent from 2001 to 2002.
The $913,000 in unallocated allowance at September 30, 2002, reflects a
decrease from $1,216,000 at December 31, 2001 due to the Company's consideration
of the following factors, as well as more general factors including the slowing
economy, increased layoffs and unemployment, and consumer and business reactions
to the events of September 11, 2001:
o The recent potential adverse effects of a decline in tourism impacting the
hospitality industry that is a significant component of the economies
within our service area;
o Slight increases in local unemployment and personal bankruptcies;
o Continued changes in the mix of our loan portfolio toward increased
emphasis on commercial business and real estate lending.
Management anticipates that as the Company continues to implement its strategic
plan the Company will:
o generate further growth in loans receivable held for investment
o emphasize the origination and purchase of income property real estate loans
o continue expansion of commercial business lending
As a result, future provisions will be required and the ratio of the
allowance for loan and lease losses to loans outstanding may increase.
Experience across the financial services industry indicates that commercial
business and income property loans may present greater risks than residential
real estate loans, and therefore should be accompanied by suitably high levels
of reserves.
Liquidity
- ---------
The objective of liquidity management is to ensure the continuous
availability of funds to meet the demands of depositors and borrowers.
Collection of principal and interest on loans and leases, the liquidations and
maturities of investment securities, deposits with other banks, customer
deposits and short term borrowing, when needed, are primary sources of funds
that contribute to liquidity. Unused lines of credit from correspondent banks to
provide federal funds for $13,500,000 as of September 30, 2002 were available to
provide liquidity. In addition, NVB and SRB are both members of the Federal Home
Loan Bank ("FHLB") System providing additional borrowing capacity of $82,652,000
secured by certain loans and investment securities as of September 30, 2002. The
Company also has a line of credit with Federal Reserve Bank ("FRB") of
$7,924,000 secured by first deeds of trust on eligible commercial real estate
loans and leases. As of September 30, 2002, borrowings consisted of $32,500,000
in medium-term FHLB advances, long-term borrowings of $331,000 were outstanding
with the FHLB, $363,000 was outstanding with the FRB under the Treasury, Tax,
and Loan program and $10,000,000 was outstanding in the form of Company
obligated mandatorily redeemable cumulative trust preferred securities.
The Company manages both assets and liabilities by monitoring asset and
liability mixes, volumes, maturities, yields and rates in order to preserve
liquidity and earnings stability. Total liquid assets (cash and due from banks,
federal funds sold, and investment securities) totaled $161,337,000 and
$161,745,000 (or 25.2% and 27.1% of total assets) at September 30, 2002 and
December 31, 2001, respectively. Total liquid assets for September 30, 2002 and
December 31, 2001 include investment securities of $1,455,000 classified as held
to maturity based on the Company's intent and ability to hold such securities to
maturity.
Core deposits, defined as demand deposits, interest bearing demand
deposits, regular savings, money market deposit accounts and time deposits of
less than $100,000, continue to provide a relatively stable and low cost source
of funds. Core deposits totaled $489,711,000 and $460,054,000 at September 30,
2002 and December 31, 2001, respectively.
In assessing liquidity, historical information such as seasonal loan
demand, local economic cycles and the economy in general are considered along
with current ratios, management goals and unique characteristics of the Company.
Management believes the Company is in compliance with its policies relating to
liquidity.
17
Interest Rate Sensitivity
- -------------------------
The Company constantly monitors earning asset and deposit levels,
developments and trends in interest rates, liquidity, capital adequacy and
marketplace opportunities. Management responds to all of these to protect and
possibly enhance net interest income while managing risks within acceptable
levels as set forth in the Company's policies. In addition, alternative business
plans and contemplated transactions are also analyzed for their impact. This
process, known as asset/liability management is carried out by changing the
maturities and relative proportions of the various types of loans, investments,
deposits and other borrowings in the ways prescribed above.
The tool used to manage and analyze the interest rate sensitivity of a
financial institution is known as a simulation model and is performed with
specialized software built for this specific purpose for financial institutions.
This model allows management to analyze three specific types of risks: market
risk, mismatch risk, and basis risk.
Market Risk
Market risk results from the fact that the market values of assets or
liabilities on which the interest rate is fixed will increase or decrease with
changes in market interest rates. If the Company invests in a fixed-rate, long
term security and then interest rates rise, the security is worth less than a
comparable security just issued because the older security pays less interest
than the newly issued security. If the security had to be sold before maturity,
then the Company would incur a loss on the sale. Conversely, if interest rates
fall after a fixed-rate security is purchased, its value increases, because it
is paying at a higher rate than newly issued securities. The fixed rate
liabilities of the Company, like certificates of deposit and fixed-rate
borrowings, also change in value with changes in interest rates. As rates drop,
they become more valuable to the depositor and hence more costly to the Company.
As rates rise, they become more valuable to the Company. Therefore, while the
value changes when rates move in either direction, the adverse impacts of market
risk to the Company's fixed-rate assets are due to rising rates and for the
Company's fixed-rate liabilities, they are due to falling rates. In general, the
change in market value due to changes in interest rates is greater in financial
instruments that have longer remaining maturities. Therefore, the exposure to
market risk of assets is lessened by managing the amount of fixed-rate assets
and by keeping maturities relatively short. These steps, however, must be
balanced against the need for adequate interest income because variable-rate and
shorter-term assets generally yield less interest than longer-term or fixed-rate
assets.
Mismatch Risk
The second interest-related risk, mismatch risk, arises from the fact
that when interest rates change, the changes do not occur equally in the rates
of interest earned and paid because of differences in the contractual terms of
the assets and liabilities held. A difference in the contractual terms, a
mismatch, can cause adverse impacts on net interest income.
The Company has a certain portion of its loan portfolio tied to the
national prime rate. If these rates are lowered because of general market
conditions, e.g., the prime rate decreases in response to a rate decrease by the
Federal Reserve Open Market Committee ("FOMC"), these loans will be repriced. If
the Company were at the same time to have a large proportion of its deposits in
long-term fixed-rate certificates, interest earned on loans would decline while
interest paid on the certificates would remain at higher levels for a period of
time until they mature. Therefore net interest income would decrease
immediately. A decrease in net interest income could also occur with rising
interest rates if the Company had a large portfolio of fixed-rate loans and
securities that was funded by deposit accounts on which the rate is steadily
rising.
This exposure to mismatch risk is managed by attempting to match the
maturities and repricing opportunities of assets and liabilities. This may be
done by varying the terms and conditions of the products that are offered to
depositors and borrowers. For example, if many depositors want shorter-term
certificates while most borrowers are requesting longer-term fixed rate loans,
the Company will adjust the interest rates on the certificates and loans to try
to match up demand for similar maturities. The Company can then partially fill
in mismatches by purchasing securities or borrowing funds from the FHLB with the
appropriate maturity or repricing characteristics.
Basis Risk
The third interest-related risk, basis risk, arises from the fact that
interest rates rarely change in a parallel or equal manner. The interest rates
associated with the various assets and liabilities differ in how often they
change, the extent to which they change, and whether they change sooner or later
than other interest rates. For example, while the repricing of a specific asset
and a specific liability may occur at roughly the same time, the interest rate
on the liability may rise one percent in response to rising market rates while
the asset increases only one-half percent. While the Company would appear to be
evenly matched with respect to mismatch risk, it would suffer a decrease in net
interest income. This exposure to basis risk is the type of interest risk least
able to be managed, but is also the least dramatic. Avoiding concentration in
only a few types of assets or liabilities is the best means of increasing the
chance that the average interest received and paid will move in tandem. The
wider diversification means that many different rates, each with their own
volatility characteristics, will come into play.
18
Net Interest Income and Net Economic Value Simulations
To quantify the extent of all of these risks both in its current
position and in transactions it might take in the future, the Company uses
computer modeling to simulate the impact of different interest rate scenarios on
net interest income and on net economic value. Net economic value or the market
value of portfolio equity is defined as the difference between the market value
of financial assets and liabilities. These hypothetical scenarios include both
sudden and gradual interest rate changes, and interest rate changes in both
directions. This modeling is the primary means the Company uses for interest
rate risk management decisions.
The hypothetical impact of sudden interest rate shocks applied to the
Company's asset and liability balances are modeled quarterly. The results of
this modeling indicate how much of the Company's net interest income and net
economic value are "at risk" (deviation from the base level) from various sudden
rate changes. This exercise is valuable in identifying risk exposures. The
results for the Company's most recent simulation analysis indicate that the
Company's net interest income at risk over a one-year period and net economic
value at risk from 2% shocks are within normal expectations for sudden changes
and do not materially differ from those of December 31, 2001.
For this simulation analysis, the Company has made certain assumptions
about the duration of its non-maturity deposits that are important to
determining net economic value at risk.
Segment Discussion
- ------------------
Management recognizes that each of the subsidiary banks operate in a
different market and also have unique operating challenges. NVB operates more
profitably than does SRB. This is due to the operating history and
infrastructure of SRB. Since the merger with SRB in October 2000, management has
been focused on making SRB a more efficient organization and has had some
success in making SRB more profitable. Although total revenues at SRB are down
for the first nine months of 2002 as compared to the same period in 2001, net
income is up from $943,000 in 2001 to $1,097,000 in 2002, a 16.3% increase.
Financial Condition as of September 30, 2002 As Compared to December 31, 2001
- -----------------------------------------------------------------------------
Total assets at September 30, 2002, were $639,968,000, compared to
December 31, 2001 assets of $594,973,000. Investment securities and federal
funds sold totaled $128,846,000 at September 30, 2002, compared to $132,881,000
at December 31, 2001.
Net loans and leases, the Company's major component of earning assets
increased during the first nine months of 2002 to $431,470,000 at September 30,
2002 from $391,022,000 at December 31, 2001. The Company's average loan to
deposit ratio was 80.0% for the nine months ended September 30, 2001 and 77.8%
for the nine months ended September 30, 2002.
Total deposits increased to $538,661,000 at September 30, 2002 compared
to $514,278,000 at December 31, 2001 with an increase in noninterest-bearing
deposits of $11,563,000, an increase in interest-bearing checking of
$11,157,000, an increase in savings of $24,481,000 and a decrease in time
deposits of $22,813,000. The decrease in time certificates is primarily due to
the low rate environment in which customers are more inclined to keep their
deposits in shorter duration instruments. The increase in demand and interest
bearing demand balances is attributed to the success of the "Positively Free
Checking" program. This change in the deposit mix from December 31, 2001 had a
positive effect on the Company's cost of funds, which was reduced from 3.88% for
the nine months ended September 30, 2001 to 2.20% for the nine months ended
September 30, 2002.
The Company maintains capital to support future growth and dividend
payouts while trying to effectively manage the capital on hand. From the
depositor standpoint, a greater amount of capital on hand relative to total
assets is generally viewed as positive. At the same time, from the standpoint of
the shareholder, a greater amount of capital on hand may not be viewed as very
positive because it limits the Company's ability to earn a high rate of return
on shareholders equity (ROE). Stockholders' equity increased to $50,089,000 as
of September 30, 2002, as compared to $43,678,000 at December 31, 2001. The
increase was primarily as a result of the net income of $5,782,000, an increase
in the unrealized gain on available for sale of securities of $2,065,000, the
effect of stock options exercised of $328,000, and compensation expenses
recorded on stock options and grants of $311,000 offset by cash dividends of
$1,680,000, and the stock repurchase of $125,000. Under current regulations, the
management believes that the Company meets all capital adequacy requirements and
both of the Company's subsidiary banks were considered well capitalized at
September 30, 2002 and December 31, 2001.
19
The Company's and the Bank's capital amounts (in thousands) risk-based capital
ratios are presented below.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------------- ----------------------- -----------------------
Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
Company ----------- --------- ----------- --------- ----------- ---------
As of September 30, 2002:
Total capital
(to risk weighted assets) $ 60,191 12.67% $ 37,995 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 54,248 11.42% $ 18,997 4.00% N/A N/A
Tier I capital
(to average assets) $ 54,248 8.81% $ 24,632 4.00% N/A N/A
As of December 31, 2001:
Total capital
(to risk weighted assets) $ 54,959 12.82% $ 34,285 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 49,587 11.57% $ 17,142 4.00% N/A N/A
Tier I capital
(to average assets) $ 49,587 8.37% $ 23,701 4.00% N/A N/A
North Valley Bank
As of September 30, 2002:
Total capital
(to risk weighted assets) $ 39,691 12.05% $ 26,351 8.00% $ 32,939 10.00%
Tier I capital
(to risk weighted assets) $ 35,867 10.89% $ 13,175 4.00% $ 19,763 6.00%
Tier I capital
(to average assets) $ 35,867 8.59% $ 16,695 4.00% $ 20,868 5.00%
As of December 31, 2001:
Total capital
(to risk weighted assets) $ 35,140 11.75% $ 23,920 8.00% $ 29,900 10.00%
Tier I capital
(to risk weighted assets) $ 31,913 10.67% $ 11,960 4.00% $ 17,940 6.00%
Tier I capital
(to average assets) $ 31,913 8.13% $ 15,698 4.00% $ 19,622 5.00%
Six Rivers Bank
As of September 30, 2002:
Total capital
(to risk weighted assets) $ 19,110 13.36 $ 11,447 8.00% $ 14,308 10.00%
Tier I capital
(to risk weighted assets) $ 17,311 12.10% $ 5,723 4.00% $ 8,585 6.00%
Tier I capital
(to average assets) $ 17,311 8.84% $ 7,832 4.00% $ 9,790 5.00%
As of December 31, 2001:
Total capital
(to risk weighted assets) $ 18,166 14.17% $ 10,258 8.00% $ 12,822 10.00%
Tier I capital
(to risk weighted assets) $ 16,551 12.91% $ 5,129 4.00% $ 7,693 6.00%
Tier I capital
(to average assets) $ 16,551 8.35% $ 7,932 4.00% $ 9,914 5.00%
20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
In Management's opinion there has not been a material change in the
Company's market risk profile for the nine months ended September 30, 2002
compared to December 31, 2001.
ITEM 4. CONTROLS AND PROCEDURES
- --------------------------------
Within the 90 days prior to the date of filing this report, an
evaluation was carried out under the supervision and with the participation of
our management, including the Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design of our disclosure controls and
procedures (as defined in Rule 13(a)-14(c)) of the Securities Exchange Act of
1934. Based on that evaluation, our Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and procedures are effective
in ensuring that the information required to be disclosed by the Registrant in
the reports it files or submits under the Act is (i) accumulated and
communicated to the Registrant's management (including the Chief Executive
Officer and Chief Financial Officer) in a timely manner, and (ii) recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms.
There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation described above in Item 4.
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings
There are no material legal proceedings pending against the Company or
against any of its property. The Company, because of the nature of its business,
is generally subject to various legal actions, threatened or filed, which
involve ordinary, routine litigation incidental to its business. Some of the
pending cases seek punitive damages in addition to other relief. Although the
amount of the ultimate exposure, if any, cannot be determined at this time, the
Company does not expect that the final outcome of threatened or filed suits will
have a materially adverse effect on its consolidated financial position.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
21
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits -
Exhibit 99.34 - Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 with Respect to the North Valley
Bancorp Quarterly Report on Form 10-Q for the Quarter ended
September 30, 2002
(b) Reports on Form 8-K during the quarter ended September 30, 2002:
Filed July 19, 2002 - Second Quarter Earnings Announcement
Filed August 1, 2002 -Stock Repurchase Plan Announcement
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NORTH VALLEY BANCORP
- --------------------
(Registrant)
Date November 14, 2002
-----------------
By: /s/ MICHAEL J. CUSHMAN
--------------------------------------------------
Michael J. Cushman
President & Chief Executive Officer
/s/ EDWARD J. CZAJKA
--------------------------------------------------
Edward J. Czajka
Executive Vice President & Chief Financial Officer
22
CERTIFICATIONS*
I, Michael J. Cushman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of North Valley Bancorp
(the Registrant);
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ MICHAEL J. CUSHMAN
- ----------------------------------
Michael J. Cushman
President, Chief Executive Officer
(Principal Financial Officer)
23
CERTIFICATIONS*
I, Edward J. Czajka, certify that:
1. I have reviewed this quarterly report on Form 10-Q of North Valley Bancorp
(the Registrant);
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ EDWARD J. CZAJKA
- --------------------------------------------------
Edward J. Czajka
Executive Vice President, Chief Financial Officer
(Principal Financial Officer)
24