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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 June 30, 2003.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition Period From ____________ to ____________
Commission file number 0-10652
NORTH VALLEY BANCORP
------------------------------------------------------
(Exact name of registrant as specified in its charter)
California 94-2751350
- --------------------------------- ------------------------
State or other jurisdiction (IRS Employer ID Number)
of incorporation or organization)
300 Park Marina Circle, Redding, CA 96002
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (530) 226-2900
--------------
---------------------------------------------------------------
(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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). 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 - 6,563,823 shares as of August 12, 2003.
INDEX
NORTH VALLEY BANCORP AND SUBSIDIARIES
Page
----
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets--June 30, 2003 and
December 31, 2002 ............................................. 3
Condensed Consolidated Statements of Income--For the
Three and Six months Ended June 30, 2003 and 2002 ............. 4
Condensed Consolidated Statements of Cash Flows--For the
Six months Ended June 30, 2003 and 2002 ....................... 5
Notes to Condensed Consolidated Financial Statements .......... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................ 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk ....... 22
Item 4. Controls and Procedures .......................................... 22
PART II. OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings ................................................ 22
Item 2. Changes in Securities ............................................ 22
Item 3. Defaults Upon Senior Securities .................................. 22
Item 4. Submission of Matters to a Vote of Security Holders .............. 23
Item 5. Other Information ................................................ 23
Item 6. Exhibits and Reports on Form 8-K ................................. 24
SIGNATURES ................................................................ 24
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands except share amounts)
June 30, 2003 December 31, 2002
------------- -----------------
ASSETS
Cash and due from banks $ 34,567 $ 33,900
Federal funds sold 72,150 21,400
---------- ----------
Total cash and cash equivalents 106,717 55,300
Interest-bearing deposits in other financial institutions 297 517
Investment securities:
Available for sale, at fair value 140,762 110,475
Held to maturity, at amortized cost (fair value of $1,980 at
June 30, 2003 and $1,843 at December 31, 2002) 1,455 1,455
Loans and leases, net of allowance for loan and lease losses of
$6,756 and $6,723 at June 30, 2003 and
December 31, 2002 380,677 437,843
Premises and equipment, net of accumulated
depreciation and amortization 12,630 13,156
Other real estate 28 55
FHLB and FRB stock and other securities 3,370 3,258
Core deposit and other intangibles, net 2,524 2,772
Accrued interest receivable & other assets 31,322 30,939
---------- ----------
TOTAL ASSETS $ 679,782 $ 655,770
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing demand $ 131,631 $ 108,140
Interest-bearing 456,076 446,913
---------- ----------
Total deposits 587,707 555,053
Other borrowed funds 20,672 32,888
Accrued interest and other liabilities 7,038 7,800
Company obligated mandatorily redeemable cumulative
trust preferred securities of subsidiary grantor trust 16,000 10,000
---------- ----------
Total liabilities 631,417 605,741
---------- ----------
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 6,697,632 and 6,951,141 at
June 30, 2003 and December 31, 2002 24,270 25,112
Retained earnings 22,982 23,260
Accumulated other comprehensive income, net of tax 1,113 1,657
---------- ----------
Total stockholders' equity 48,365 50,029
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 679,782 $ 655,770
========== ==========
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 six months ended For the three months ended
------------------------- --------------------------
June 30, June 30,
-------- --------
2003 2002 2003 2002
-------- -------- -------- --------
INTEREST INCOME:
Loans and leases including fees $ 15,149 $ 16,081 $ 7,465 $ 8,281
Securities:
Taxable 1,948 2,331 902 1,144
Exempt from federal taxes 668 796 314 392
Federal funds sold 279 178 171 78
-------- -------- -------- --------
Total interest income 18,044 19,386 8,852 9,895
-------- -------- -------- --------
INTEREST EXPENSE:
Deposits 2,994 4,284 1,398 1,982
Company obligated mandatorily redeemable cumulative trust
preferred securities of subsidiary grantor trust 613 513 357 256
Other borrowings 419 465 189 250
-------- -------- -------- --------
Total interest expense 4,026 5,262 1,944 2,488
-------- -------- -------- --------
NET INTEREST INCOME 14,018 14,124 6,908 7,407
PROVISION FOR LOAN AND LEASE LOSSES -- 995 -- 575
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 14,018 13,129 6,908 6,832
NONINTEREST INCOME:
Service charges on deposit accounts 2,426 2,533 1,136 1,020
Other fees and charges 1,062 915 607 696
Gain on sale of loans 1,072 -- 868 --
Gain on sales or calls of securities 156 13 5 13
Other 1,158 971 538 433
-------- -------- -------- --------
Total noninterest income 5,874 4,432 3,154 2,162
-------- -------- -------- --------
NONINTEREST EXPENSES:
Salaries and employee benefits 6,677 6,207 3,365 3,026
Occupancy 836 781 434 394
Equipment 1,360 845 611 430
Other 4,772 4,269 2,539 2,216
-------- -------- -------- --------
Total noninterest expenses 13,645 12,102 6,949 6,066
-------- -------- -------- --------
INCOME BEFORE PROVISION FOR INCOME
TAXES 6,247 5,459 3,113 2,928
PROVISION FOR INCOME TAXES 2,016 1,803 977 1,020
-------- -------- -------- --------
NET INCOME $ 4,231 $ 3,656 $ 2,136 $ 1,908
======== ======== ======== ========
EARNINGS PER SHARE:
Basic $ 0.62 $ 0.52 $ 0.31 $ 0.27
======== ======== ======== ========
Diluted $ 0.59 $ 0.51 $ 0.30 $ 0.26
======== ======== ======== ========
See notes to condensed consolidated financial statements (unaudited).
4
NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
For the six months
------------------
ended June 30,
--------------
2003 2002
---------- ----------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 4,232 $ 3,656
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,171 701
Amortization of premium on securities 265 264
Amortization of core deposit and other intangibles 248 240
Provision for loan and lease losses -- 995
Gain on sale or calls of securities (156) (13)
Gain on sale of loans (1,072)
Effect of changes in:
Accrued interest receivable 273 12
Other assets (446) (3,178)
Accrued interest and other liabilities (762) 837
---------- ----------
Net cash provided by operating activities 3,753 3,514
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of other real estate owned 27 250
Net changes in FHLB, FRB and other securities (50) (1,108)
Purchases of available for sale securities (77,021) (6,603)
Proceeds from sales of available for sale securities 4,344 6,870
Proceeds from maturities/calls of available for sale securities 41,465 21,173
Proceeds from sales of loans 52,932 10,777
Net decrease (increase) in interest-bearing deposits at financial institutions 220 1,583
Net decrease(increase) in loans and leases 5,306 (44,218)
Purchases of premises and equipment, net (645) (1,003)
---------- ----------
Net cash (used in) provided by investing activities 26,578 (12,279)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 32,654 9,595
Net (decrease)increase in Federal funds purchased and other borrowed funds (6,216) 3,094
Cash dividends paid (1,363) (1,118)
Repurchase of common stock (4,321) (313)
Cash received for stock options exercised 232 326
Compensation expense on stock options/grants 100 198
---------- ----------
Net cash provided by financing activities 21,086 11,782
---------- ----------
INCREASE IN CASH AND CASH EQUIVALENTS 51,417 3,017
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 55,300 46,375
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 106,717 $ 49,392
========== ==========
ADDITIONAL INFORMATION:
Cash paid during the period for:
Interest $ 4,163 $ 5,391
========== ==========
Income taxes $ 2,190 $ 835
========== ==========
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 of the Securities and Exchange Commission. 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, 2002. Operating results for the six
months ended June 30, 2003 are not necessarily indicative of the results that
may be expected for any subsequent period or for the year ended December 31,
2003.
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 I, North Valley Capital Trust
II, 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 June 30, 2003 and December 31, 2002, 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)
------------ ------------ ------------ ------------
June 30, 2003
Securities of U.S. government
agencies and corporations $ 12,676 $ 88 $ 12,764
Obligations of states and political
subdivisions 21,672 1,614 $ (22) 23,264
Mortgage backed securities 86,494 1,260 (1,536) 86,218
Corporate securities 6,039 380 6,419
Other securities 12,127 76 (106) 12,097
------------ ------------ ------------ ------------
$ 139,008 $ 3,418 $ (1,664) $ 140,762
============ ============ ============ ============
December 31, 2002
Securities of U.S. government
agencies and corporations $ 11,220 $ 9 $ 11,229
Obligations of states and political
subdivisions 23,580 1,138 $ (67) 24,651
Mortgage backed securities 59,915 1,108 (4) 61,019
Corporate securities 8,976 520 9,496
Other securities 4,088 (8) 4,080
------------ ------------ ------------ ------------
$ 107,779 $ 2,775 $ (79) $ 110,475
============ ============ ============ ============
6
Carrying
Amount Gross Gross
(Amortized Unrealized Unrealized
Held to maturity securities: Cost) Gains Losses Fair Value
------------ ------------ ------------ ------------
June 30, 2003
-------------
Obligation of states and political
subdivisions $ 1,455 $ 525 $ -- $ 1,980
============ ============ ============ ============
Carrying
Amount Gross Gross
(Amortized Unrealized Unrealized
Held to maturity securities: Cost) Gains Losses Fair Value
------------ ------------ ------------ ------------
December 31, 2002
-----------------
Obligation of states and political
subdivisions $ 1,455 $ 388 $ -- $ 1,843
============ ============ ============ ============
Gross realized gains on sales or calls of available-for-sale securities
were $170,000 and $42,000 for the six months ended June 30, 2003 and 2002. Gross
realized losses on sales or calls of available-for-sale securities were $14,000
and $29,000 for the six months ended June 30, 2003 and 2002.
There were no sales or transfers of held-to-maturity securities for the
six months ended June 30, 2003 and 2002.
Scheduled maturities of held-to-maturity and available-for-sale
securities (other than equity securities with an amortized cost of approximately
$12,127,000 and a fair value of approximately $12,097,000) at June 30, 2003, 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 Securities Available for Sale Securities
Amortized
Cost Fair Value
(Carrying Amortized (Carrying
Amount) Fair Value Cost Amount)
------------ ------------ ------------ ------------
Due in 1 year or less $ 35,040 $ 36,222
Due after 1 year through 5 years 38,867 40,319
Due after 5 years through 10 years 2,329 2,634
Due after 10 years $ 1,455 $ 1,980 50,645 49,490
------------ ------------ ------------ ------------
$ 1,455 $ 1,980 $ 126,881 $ 128,665
============ ============ ============ ============
At June 30, 2003 and December 31, 2002 securities having fair value
amounts of approximately $53,850,000 and $65,052,000 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 - STOCK-BASED COMPENSATION
At June 30, 2003, the Company has three stock-based compensation plans,
the North Valley Bancorp 1989 Director Stock Option Plan, the 1998 Employee
Stock Incentive Plan and the 1999 Director Stock Option Plan. The Company
accounts for these plan 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
under the Employee Plan, as all options granted under this plan had an exercise
price equal to the market value of the underlying common stock on the date of
grant. Compensation expense is recognized in the financial statements for the
differences between the fair value of the options at the date of the grant and
the exercise price at 85% of the fair value for the Director Plans.
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. Pro forma adjustments to the Company's net earnings and earnings
per share are disclosed during the years in which the options become vested.
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
(In thousands) 2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income, as reported $ 4,231 $ 3,656 $ 2,136 $ 1,908
Add: total stock-based compensation expense included in net
income, net of tax 60 119 30
Deduct: total stock-based compensation expense
Determined under the fair value based method for all
awards, net of related tax effects (182) (199) (92) (100)
---------- ---------- ---------- ----------
Net income, pro forma $ 2,033 $ 3,576 $ 2,074 $ 1,809
Basic earnings per common share:
As reported $ 0.62 $ 0.52 $ 0.31 $ 0.27
Pro forma $ 0.60 $ 0.51 $ 0.30 $ 0.26
Diluted earnings per common and equivalent share:
As reported $ 0.59 $ 0.51 $ 0.30 $ 0.26
Pro forma $ 0.57 $ 0.50 $ 0.29 $ 0.25
- --------------------------------------------------------------------------------
The fair value of each option granted during period presented is
estimated on the date of grant using an option-pricing model with the following
assumptions:
Six months ended June 30,
-------------------------
2003 2002
---- ----
Dividend yield 3.10% 3.184%
Expected volatility 17.15% 20.52%
Risk-Free interest rate 5.00% 5.00%
Expected option life 7 years 7 years
- --------------------------------------------------------------------------------
8
NOTE D - COMPREHENSIVE INCOME
Comprehensive income includes net income and other comprehensive income
or loss. The Company's only sources of other comprehensive income are derived
from unrealized gains and losses on available-for-sale investment securities 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:
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
(In thousands) 2003 2002 2003 2002
-------- -------- -------- --------
Net income $ 4,231 $ 3,656 $ 2,136 $ 1,908
Other comprehensive income:
Holding (loss) gain arising during period (656) 754 (35) 1,029
Reclassification adjustment, net of tax 112 9 4 9
-------- -------- -------- --------
(544) 763 (31) 1,038
Total comprehensive income $ 3,687 $ 4,419 $ 2,105 $ 2,946
======== ======== ======== ========
NOTE E - 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 three and six month period ended June 30, 2003 and
2002 is reconciled as follows:
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
(In thousands except earnings per share) 2003 2002 2003 2002
-------- -------- -------- --------
Calculation of Basic Earnings Per Share
Numerator - net income $ 4,231 $ 3,656 $ 2,136 $ 1,908
Denominator - weighted average common
shares outstanding 6,872 6,999 6,807 7,001
-------- -------- -------- --------
Basic Earnings Per Share $ 0.62 $ 0.52 $ 0.31 $ 0.27
======== ======== ======== ========
Calculation of Diluted Earnings Per Share
Numerator - net income $ 4,231 $ 3,656 $ 2,136 $ 1,908
Denominator - weighted average common
shares outstanding 6,872 6,999 6,807 7,001
Dilutive effect of outstanding options 347 186 392 209
-------- -------- -------- --------
7,219 7,185 7,199 7,210
-------- -------- -------- --------
Diluted Earnings Per Share $ 0.59 $ 0.51 $ 0.30 $ 0.26
======== ======== ======== ========
NOTE F - 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.
9
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, 2002. 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 six months ended June 30, 2003 and 2002.
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, North Valley Trading Co, North
Valley Capital Trust I and North Valley Capital Trust II 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
six month period ended June 30, follows:
Six months ended: NVB SRB Other Total
--------- --------- --------- ---------
June 30, 2003:
Total revenues $ 14,465 $ 5,843 $ (416) $ 19,892
Net income (loss) $ 3,878 $ 890 $ (537) $ 4,231
Interest income $ 12,482 $ 5,562 $ -- $ 18,044
Interest expense $ 2,049 $ 1,376 $ 601 $ 4,026
Depreciation and amortization $ 1,093 $ 471 $ 119 $ 1,684
Provision for loan and lease losses $ -- $ -- $ -- $ --
Total assets $ 465,996 $ 207,890 $ 5,896 $ 679,782
June 30, 2002:
Total revenues $ 13,361 $ 5,462 $ (267) $ 18,556
Net income (loss) $ 3,260 $ 734 $ (338) $ 3,656
Interest income $ 13,265 $ 6,098 $ 23 $ 19,386
Interest expense $ 2,991 $ 1,764 $ 507 $ 5,262
Depreciation and amortization $ 556 $ 566 $ 83 $ 1,205
Provision for loan and lease losses $ 875 $ 120 $ -- $ 995
Total assets $ 411,512 $ 198,751 $ 1,748 $ 612,011
NOTE G - STOCK REPURCHASE PLAN
On April 28, 2003, 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 204,000 shares based on
approximately 6,833,000 shares outstanding at April 28, 2003 after giving effect
to the 3 for 2 stock split payable on May 15, 2003 to holders of record on April
15, 2003. Under this program, a total of 205,368 shares were repurchased and
retired as of July 25, 2003 for total consideration of $3,186,184.
10
NOTE H - STOCK SPLIT
On March 12, 2003, The Company announced a 3 for 2 stock split in the
form of a dividend payable to holders of common stock on April 15, 2003, the
record date. The stock dividend was distributed on May 15, 2003 with each
shareholder receiving one additional share for every two shares held on the
record date. Partial shares were paid in cash based upon the market price on the
record date. All share and earnings per share figures in this report have been
adjusted retroactively to reflect the 3-for-2 stock split.
NOTE I - NEW ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation--Transition and Disclosure--an amendment of FASB
Statement No. 123. This Statement amends SFAS No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
compensation. In addition, this Statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based compensation
and the effect of the method used on reported results. The transition guidance
and annual disclosure provisions of SFAS No. 148 are effective for fiscal years
ending after December 15, 2002. The interim disclosure provisions are effective
for financial reporting containing financial statements for interim periods
beginning after December 15, 2002. Because the Company accounts for the
compensation cost associated with its stock option plans under the intrinsic
value method, the alternative methods of transition will not apply to the
Company. The additional interim disclosure requirements of the Statement are
included in these financial statements. In management's opinion, the adoption of
this Statement did not have a material impact on the Company's consolidated
financial position or results of its operations or its cash flows.
On April 30, 2003, the FASB issued Statement No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging Activities. This Statement
amends and clarifies the accounting for derivative instruments by providing
guidance related to circumstances under which a contract with a net investment
meets the characteristics of a derivative as discussed in Statement 133. The
Statement also clarifies when a derivative contains a financing component. The
Statement is intended to result in more consistent reporting for derivative
contracts and must be applied prospectively for contracts entered into or
modified after June 30, 2003, except for hedging relationships designated after
June 30, 2003. In management's opinion, adoption of this statement is not
expected to have a material effect on the Company's consolidated financial
position or results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). This
Statement is effective for financial instruments entered into or modified by the
Company after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. The Company has previously
accounted for its mandatorily redeemable cumulative trust preferred securities
in a manner consistent with the Statement and, in management's opinion, adoption
of this Statement did not have a material effect on the Company's consolidated
financial position or results of operations.
NOTE J - COMPANY OBLIGATED MANDATORILY REDEEMABLE CUMULATIVE TRUST PREFERRED
SECURITIES OF SUBSIDIARY GRANTOR TRUST
During the first quarter of 2003, the Company formed North Valley
Capital Trust II as a special purpose entity ("SPE") which is consolidated into
the Company's financial statements. North Valley Capital Trust II is a Delaware
business trust wholly owned by the Company and formed for the purpose of issuing
Company obligated mandatorily redeemable cumulative trust preferred securities
of Subsidiary Grantor Trust holding solely junior subordinated debentures.
On April 10, 2003, North Valley Capital Trust II issued 6,000 Trust
Preferred Securities with a liquidation value of $1,000 for gross proceeds of
$6,000,000. The entire proceeds of the issuance were invested by North Valley
Capital Trust II in $6,000,000 aggregate principal amount of 6.448% subordinated
debentures due in 2033 (the Subordinated Debentures) issued by the Company. The
Subordinated Debentures represent the sole assets of North Valley Capital Trust
II.
Holders of the trust preferred securities are entitled to cumulative
cash distributions at an annual rate of 6.448% of the liquidation amount of
$1,000 per security. The Company has the option to defer payment of the
distributions for a period of up to five years, as long as the Company is not in
default in the payment of interest on the Subordinated Debentures. The Company
has guaranteed, on a subordinated basis, distributions and other payments due on
the trust preferred securities (the Guarantee). The Guarantee, when taken
together with the Company's obligations under the Subordinated Debentures, the
Indenture Agreement pursuant to which the subordinated Debentures were issued
and the Company's obligations under the Trust Agreement governing the subsidiary
trust, provide a full and unconditional guarantee of amounts due on the Trust
Preferred Securities. Under applicable regulatory guidelines, all of the Trust
Preferred Securities currently qualify as Tier I Capital.
NOTE K - SUBSEQUENT EVENTS
On July 28, 2003, the Board of Directors of the Company authorized a
new stock repurchase program under which repurchases will be made from time to
time by the Company, in compliance with Securities and Exchange Commission
11
rules. The program calls for the repurchase of up to 3.0% of the Company's
outstanding shares, or approximately 199,000 shares, based on approximately
6,638,000 shares outstanding as of the date of the announcement. Under this
latest program, a total of 90,000 shares have been repurchased through August
12, 2003 for total consideration of $1,419,500.
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 addition, recent
events, including those of September 11, 2001, and efforts of the U.S.
Government to combat terrorism, 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 these 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. Certain amounts in 2002 have been reclassified to conform with the 2003
financial statement presentation.
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.
The allowance for loan and lease losses has two basic components: the
formula allowance and the specific 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, adjusted for
qualitative factors, as an indicator of future losses and therefore this
estimate could differ from losses that occur 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 for specific loans. 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 qualitative factors
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 historical or specific allowances including model
imprecision. For further information regarding our allowance for credit losses,
see "Allowance for Loan and Lease Losses" on page 17.
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
12
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.
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 I, North Valley Capital Trust II, 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 fourteen 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.
13
Earnings Summary
- ----------------
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
(In thousands except per share amounts) 2003 2002 2003 2002
-------- -------- -------- --------
Net interest income 14,018 14,124 6,908 7,407
Provision for loan and lease losses -- 995 -- 575
Noninterest income 5,874 4,432 3,154 2,162
Noninterest expense 13,645 12,102 6,949 6,066
Provision for income taxes 2,016 1,803 977 1,020
-------- -------- -------- --------
Net income $ 4,231 $ 3,656 $ 2,136 $ 1,908
======== ======== ======== ========
Earnings Per Share
Basic $ 0.62 $ 0.52 $ 0.31 $ 0.27
Diluted $ 0.59 $ 0.51 $ 0.30 $ 0.26
Annualized Return on Average Assets 1.28% 1.21% 1.29% 1.25%
Annualized Return on Average Equity 16.84% 16.27% 17.06% 16.77%
The Company's consolidated net income for the six months ended June 30,
2003 was $4,231,000, or $0.59 per diluted share, compared to $3,656,000, or
$0.51 diluted earnings per share for the same period in 2002. Return on average
assets was 1.28% and return on average equity was 16.84% for the six months
ended June 30, 2003 improving over the 1.21% and 16.27% for the same period in
2002.
For the six months ended June 30, 2003, the Company took no provision
for loan losses. This compares to $995,000 for the same period in 2002. The
decreased level of provision is due to the results of the Company's methodology
for measuring the adequacy of the allowance for loan losses. Factors include
size and mix of loan portfolio, non-performing loan levels, charge-off/recovery
activity and other factors including economic activity. Management believes that
the current level of allowance for loan and lease losses as of June 30, 2003 of
$6,756,000 or 1.74% of total loans and leases is adequate at this time. The
allowance for loan and lease losses was $6,723,000 or 1.52% of total loans and
leases at December 31, 2002. For further information regarding our allowance for
loan and lease losses, see "Allowance for Loan and Lease Losses" on page 17.
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 the volume
and mix of earning assets and interest-bearing deposits, along with changes in
interest rates.
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:
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
(In thousands) 2003 2002 2003 2002
-------- -------- -------- --------
Interest income $ 18,044 $ 19,386 $ 8,852 $ 9,895
Less: Interest expense 4,026 5,262 1,944 2,488
FTE adjustment 367 393 174 193
-------- -------- -------- --------
Net interest income (FTE) $ 14,385 $ 14,517 $ 7,082 $ 7,600
======== ======== ======== ========
Net interest income has been adjusted to a fully taxable equivalent
basis (FTE) for tax-exempt investments included in earning assets. The decrease
in net interest income (FTE) for the six month period ended June 30, 2003
resulted primarily from lower average total loan volumes coupled with lower
overall yields on earning assets partially offset by a decrease in interest
expense. Management has been proactive in attempting to manage the Company's net
interest margin, that is, trying to maximize current net interest income without
placing an undue risk on future earnings. This has thus far been accomplished by
the Company's diversified balance sheet, strong core deposit base and proactive
management of the investment portfolio and borrowings. While average interest
earning assets for the six months ended June 30, 2003 increased by $42,063,000
or 7.7% from the same period last year, yields on average earning assets
decreased 100 basis points from 7.35% to 6.35%. Average interest bearing
liabilities increased by $37,475,000 or 8.2% for the six months ended June 30,
2003 compared to the same period in 2002 while the average rate paid on those
liabilities decreased 69 basis points from 2.33% to 1.64%. The Company's net
interest margin (FTE) decreased from 5.39% for the six month period ended June
30, 2002 to 4.96% for the same period ended June 30, 2003.
The following table is a summary of the Company's net interest margin
(FTE) for the periods indicated:
14
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
2003 2002 2003 2002
---- ---- ---- ----
Yield on earning assets 6.35% 7.35% 6.17% 7.40%
Rate paid on interest-bearing liabilities 1.64% 2.33% 1.57% 2.18%
---- ---- ---- ----
Net interest spread 4.71% 5.02% 4.60% 5.22%
==== ==== ==== ====
Net interest margin 4.96% 5.39% 4.84% 5.57%
==== ==== ==== ====
Noninterest Income
- ------------------
The following table is a summary of the Company's noninterest income
for the periods indicated:
Noninterest Income Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
(In thousands) 2003 2002 2003 2002
-------- -------- -------- --------
Service charges on deposit accounts $ 2,426 $ 2,533 $ 1,136 $ 1,020
Other fees and charges 1,062 915 607 696
Gain on sale of loans 1,072 -- 868 --
Gain on sale or calls of securities 156 13 5 13
Other 1,158 971 538 433
-------- -------- -------- --------
Total noninterest income $ 5,874 $ 4,432 $ 3,154 $ 2,162
======== ======== ======== ========
Non-interest income increased from $4,432,000 for the six months ended
June 30, 2002 to $5,874,000 for the same period in 2003. Service charges on
deposits decreased slightly to $2,426,000 for the six months ended June 30, 2003
from $2,533,000 for the same period in 2002. This was due in large part to
waivers on service charges that occurred in the first quarter of 2003 due to
service disruption associated with the system conversion in late 2002. Other
fees and charges increased from $915,000 during the first six months of 2002 to
$1,062,000 for the same period in 2003. This increase was primarily due to an
increase in ATM service charge income. The Company recorded $1,072,000 in gains
on sales of mortgages and $156,000 in gains on sales and calls of investment
securities. Please see the paragraph below for a discussion of mortgage loan
sales. Other income increased from $971,000 for the six months ended June 30,
2002 to $1,158,000 for the same period in 2003. The increase in other income was
primarily due to an increase on earnings on life insurance holdings which were
purchased to fund the Company's salary continuation plan.
During the fourth 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 shorter duration within the loan portfolio due to the historically
low interest rate environment and maintain a diverse product mix within the loan
portfolio. While this strategy may serve to reduce the overall yield on earning
assets in the near-term, 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. Management will continue to monitor
this strategy and may change it in light of any significant interest rate
movements or other factors.
15
Noninterest Expense
- -------------------
The following table is a summary of the Company's noninterest expense
for the periods indicated:
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
(In thousands) 2003 2002 2003 2002
-------- -------- -------- --------
Salaries & employee benefits $ 6,677 $ 6,207 $ 3,365 $ 3,026
Equipment expense 1,360 845 611 430
Occupancy expense 836 781 434 394
Marketing 551 547 353 280
Data processing expenses 80 143 43 70
ATM expense 497 438 248 282
Printing & supplies 281 274 118 141
Postage 264 267 134 95
Messenger expense 165 201 96 86
Professional services 485 478 243 285
Other 2,449 1,921 1,304 977
-------- -------- -------- --------
Total Noninterest expense $ 13,645 $ 12,102 $ 6,949 $ 6,066
======== ======== ======== ========
Noninterest expense totaled $13,645,000 for the six months ended June
30, 2003, compared to $12,102,000 for the same period in 2002. Salaries and
benefits increased by $470,000 or 7.6% to $6,677,000 for the six months ended
June 30, 2003 compared to $6,207,000 for the same period in 2002. The increase
in salary expense was due to regular merit increases and new employees
associated with a new branch facility but was partially offset by a reduction in
employees in BPI due to the change in core operating system which requires less
personnel. Equipment expense increased for the six months ended June 30, 2003
due to the opening of one new branch in August of 2002 and an increase in
depreciation expense associated with the Company's new core operating system.
Most other expense categories for the three and six months ended June 30, 2003
experienced relatively small increases or decreases from the same respective
periods in 2002 with the exception of other expense. Other expense totaled
$2,449,000 for the six months ended June 30, 2003, an increase of $528,000 or
27.5%. This was mainly due to increased communication costs associated with the
new core operating system as well as normal internal growth. The Company's
efficiency ratio for the first six months of 2003 was 68.6%, an increase over
the 65.2% efficiency ratio achieved for the first six months of 2002.
Income Taxes
- ------------
The provision for income taxes for the six months ended June 30, 2003
was $2,016,000 as compared to $1,803,000 for the same period in 2002. The
effective income tax rate for state and federal income taxes was 32.3% for the
six months ended June 30, 2003 compared to 33.0 % for the same period in 2002.
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.
At June 30, 2003, the recorded investment in loans and leases for which
impairment has been recognized was approximately $1,306,000 with a related
valuation allowance, which is included in the specific allowance of $568,000.
For the period ended June 30, 2003 the average recorded investment in loans and
leases for which impairment has been recognized was approximately $1,336,500.
During the portion of the year that the loans and leases were impaired, the
Company recognized interest income of approximately $46,000 for cash payments
received in 2003.
At December 31, 2002, the recorded investment in loans and leases for
which impairment had been recognized was approximately $1,452,000 with a related
valuation allowance of $365,000. For the year ended December 31, 2002, the
average recorded investment in loans and leases for which impairment had been
recognized was approximately $948,000. During the portion of the year that the
loans and leases were impaired, the Company recognized interest income of
approximately $63,000 for cash payments received in 2002.
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
16
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 June 30, 2003, and December 31, 2002, are
summarized as follows:
June 30, December 31,
------------ ------------
2003 2002
------------ ------------
Nonaccrual loans and leases $ 1,201 $ 1,452
Loans and leases 90 days past due and still accruing interest 1,720 864
------------ ------------
Total nonperforming loans and leases 2,921 2,316
Other real estate 28 55
------------ ------------
Total nonperforming assets $ 2,949 $ 2,371
============ ============
Nonaccrual loans and leases to total gross loans and leases 0.31% 0.33%
Nonperforming loans and leases to total gross loans and leases 0.75% 0.52%
Total nonperforming assets to total assets 0.43% 0.36%
Allowance for Loan and Lease Losses
- -----------------------------------
A summary of the allowance for loan and lease losses at June 30, 2003
and June 30, 2002 is as follows:
June 30, June 30,
-------- --------
(In thousands) 2003 2002
-------- --------
Balance beginning of period $ 6,723 $ 5,786
Provision for loan and lease losses -- 995
Net (recoveries) charge-offs (33) 430
-------- --------
Balance end of period $ 6,756 $ 6,351
======== ========
Allowance for loan and lease losses to nonaccrual loans and leases 562.53% 963.02%
Allowance for loan and lease losses to nonperforming loans and leases 231.29% 356.03%
Allowance for loan and lease losses to total gross loans and leases 1.74% 1.38%
Ratio of net charge-offs to average loans and leases outstanding (annualized) (0.02%) 0.11%
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 two 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.
The formula allowance is adjusted for qualitative factors that
are 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 June 30, 2003 included the
following, which existed at the balance sheet date:
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
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
2. Specific Allowance
Specific allowances are established in cases where management
has identified significant conditions or circumstances related
17
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".
At June 30, 2003, the allowance for loan losses was comprised of
$5,468,000 in formula and specific allowances and $1,288,000 in unallocated
allowance. The $5,468,000 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 and changes in the mix of the portfolio. The level of formula
allowance is consistent from 2002 to 2003.
The $1,288,000 in unallocated allowance at June 30, 2003, is nearly
flat compared with the $1,098,000 in unallocated allowance as of December 31,
2002. The Company's analysis of general factors in determining the appropriate
level of unallocated reserves has not significantly changed from December 31,
2002.
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 higher 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 $20,500,000 as of June 30, 2003 were available to
provide liquidity. The Company has a revolving, unsecured line of credit for
$3,000,000 with a correspondent bank as of June 30, 2003. In addition, NVB and
SRB are both members of the Federal Home Loan Bank ("FHLB") System providing
additional borrowing capacity of $56,522,000 secured by certain loans and
investment securities as of June 30, 2003. The Company also has a line of credit
with Federal Reserve Bank ("FRB") of $4,433,000 secured by first deeds of trust
on eligible commercial real estate loans and leases. As of June 30, 2003,
borrowings consisted of $20,000,000 in medium-term FHLB advances, long-term
borrowings of $251,000 were outstanding with the FHLB, $421,000 was outstanding
with the FRB under the Treasury, Tax, and Loan program and $16,000,000 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 $249,231,000 and
$167,747,000 (or 36.7% and 25.6% of total assets) at June 30, 2003 and December
31, 2002, respectively. The increase in liquid assets is due to growth in
deposits and a decrease in total loans outstanding. Management believes that the
increase in liquid assets will put more pressure on the Company's net interest
margin in the short-term but will favorably position the Company when interest
rates begin to rise. Total liquid assets for June 30, 2003 and December 31, 2002
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 $540,343,000 and $506,162,000 at June 30, 2003
and December 31, 2002, 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.
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.
18
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 first 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.
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, 2002.
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.
19
Segment Discussion
- ------------------
Management recognizes that each of the subsidiary banks operate in a
different market and also have unique operating challenges. NVB has historically
operated in a more efficient and profitable manner than does SRB. This is
primarily 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. For the six months ended June 30, 2003, total revenues at NVB and
SRB increased 8.3% and 7.0%, respectively while net income increased by 19.0%
and 21.3%.
Financial Condition as of June 30, 2003 As Compared to December 31, 2002
- ------------------------------------------------------------------------
Total assets at June 30, 2003, were $679,782,000, compared to December
31, 2002 assets of $655,770,000. Investment securities and federal funds sold
grew to $214,367,000 at June 30, 2003, compared to $133,330,000 at December 31,
2002.
Net loans and leases, the Company's major component of earning assets,
decreased during the first six months of 2003 to $380,677,000 at June 30, 2003
from $437,843,000 at December 31, 2002. The Company's average loan to deposit
ratio was 80.2% for the year ended nine month December 31, 2002 and 74.3% for
the six months ended June 30, 2003. The decrease in loans outstanding is
primarily due to the continued selling of the Company's fixed-rate single-family
mortgage production as discussed on page 15 of this report.
Total deposits increased to $587,707,000 at June 30, 2003 compared to
$555,053,000 at December 31, 2002 with an increase in noninterest-bearing
checking, interest-bearing checking, and savings collectively, of $39,708,000
and a decrease in time deposits of $7,054,000. The decrease in time certificates
is mainly due to the low rate environment in which customers are more inclined
to keep their deposits in shorter duration deposit products. 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, 2002 has had a positive effect on the Company's cost of funds (excluding
non-interest checking), which was reduced from 2.33% for the six months ended
June 30, 2002 to 1.64% for the same period in 2003.
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 stockholders' equity (ROE). Stockholders' equity decreased to $48,365,000 as
of June 30, 2003, as compared to $50,029,000 at December 31, 2002. The decrease
was primarily due to the repurchase of NOVB common stock in the amount of
$4,321,000, cash dividends paid out in the amount of $1,363,000, partially
offset by net income of $4,231,000. Under current regulations, management
believes that the Company meets all capital adequacy requirements and both of
the Company's subsidiary banks were considered well capitalized at June 30, 2003
and December 31, 2002.
20
The Company's and the Bank's capital amounts (In thousands) and
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 June 30, 2003:
Total capital
(to risk weighted assets) $ 66,435 14.28% $ 37,221 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 60,608 13.03% $ 18,611 4.00% N/A N/A
Tier I capital
(to average assets) $ 60,608 9.21% $ 26,316 4.00% N/A N/A
As of December 31, 2002:
Total capital
(to risk weighted assets) $ 61,581 12.58% $ 39,157 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 55,455 11.33% $ 19,578 4.00% N/A N/A
Tier I capital
(to average assets) $ 55,455 8.59% $ 25,815 4.00% N/A N/A
North Valley Bank
As of June 30, 2003:
Total capital
(to risk weighted assets) $ 42,181 12.86% $ 26,233 8.00% $ 32,791 10.00%
Tier I capital
(to risk weighted assets) $ 38,082 11.61% $ 13,116 4.00% $ 19,675 6.00%
Tier I capital
(to average assets) $ 38,082 8.48% $ 17,970 4.00% $ 22,462 5.00%
As of December 31, 2002:
Total capital
(to risk weighted assets) $ 41,380 12.12% $ 27,316 8.00% $ 34,146 10.00%
Tier I capital
(to risk weighted assets) $ 37,192 10.89% $ 13,658 4.00% $ 20,487 6.00%
Tier I capital
(to average assets) $ 37,192 8.61% $ 17,279 4.00% $ 21,598 5.00%
Six Rivers Bank
As of June 30, 2003:
Total capital
(to risk weighted assets) $ 19,930 14.70% $ 10,846 8.00% $ 13,557 10.00%
Tier I capital
(to risk weighted assets) $ 18,224 13.44% $ 5,423 4.00% $ 8,134 6.00%
Tier I capital
(to average assets) $ 18,224 8.92% $ 8,174 4.00% $ 10,217 5.00%
As of December 31, 2002:
Total capital
(to risk weighted assets) $ 18,958 13.03% $ 11,641 8.00% $ 14,551 10.00%
Tier I capital
(to risk weighted assets) $ 17,130 11.77% $ 5,821 4.00% $ 8,731 6.00%
Tier I capital
(to average assets) $ 17,130 8.24% $ 8,316 4.00% $ 10,394 5.00%
21
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 six months ended June 30, 2003 compared to
December 31, 2002. Please see page 20 for discussion on Interest Rate
Sensitivity.
ITEM 4. CONTROLS AND PROCEDURES
- --------------------------------
Disclosure Controls and Procedures: An evaluation of the Company's
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)) was carried out under the supervision and with the participation
of the Company's Chief Executive Officer, Chief Financial Officer and other
members of the Company's senior management as of the end of the Company's fiscal
quarter ended June 30, 2003. The Company's Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures as currently in effect are effective in ensuring that the information
required to be disclosed by the Company in the reports it files or submits under
the Exchange Act is (i) accumulated and communicated to the Company's management
(including the Chief Executive Officer and Chief Financial Officer) to allow
timely decisions regarding required disclosure, and (ii) recorded, processed,
summarized and reported within the time periods specified in the Commission's
rules and forms.
Internal Control Over Financial Reporting: An evaluation of any changes
in the Company's internal control over financial reporting (as defined in
Exchange Act Rules 13a-15(f) and 15d-15(f)), that occurred during the Company's
fiscal quarter ended June 30, 2003, was carried out under the supervision and
with the participation of the Company's Chief Executive Officer, Chief Financial
Officer and other members of the Company's senior management. The Company's
Chief Executive Officer and Chief Financial Officer concluded that no change
identified in connection with such evaluation has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
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
22
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders of North Valley Bancorp was held on
Thursday May 22, 2003. Shareholders of the Company approved the following
proposals:
1. To elect the following four (4) nominees as Directors of the
Corporation, each for a term of three years:
Michael J. Cushman
Dan W. Ghidinelli
J. M. Wells, Jr.
Kevin D. Hartwick
The term of office of the following directors continued after the
Annual Meeting: Rudy V. Balma, William W. Cox, Royce L. Friesen, Thomas
J. Ludden, Douglas M. Treadway, Dolores M. Vellutini.
2. To ratify the appointment of Perry-Smith LLP as Independent Auditor for
the Corporation for 2003.
Results of the election are presented below:
Annual Meeting of Shareholders
Thursday May 22, 2003
Total Shares Outstanding: 6,908,292
Total Shares Voted: 5,920,434 85.70%
Proposal 1: % of % of % of
Quorum Quorum Quorum
--------------------------------------------------------
Nominees For Percent Withheld Percent Abstain Percent
Michael J. Cushman 5,514,914 93.15% 405,519 6.85% 0 0
Dan W. Ghidinelli 5,908,630 99.80% 11,803 .20% 0 0
J. M. Wells, Jr. 5,838,680 98.62% 81,753 1.38% 0 0
Kevin D. Hartwick 5,910,934 99.84% 9,499 .16% 0 0
Proposal 2:
Perry-Smith LLP 5,902,953 99.70% 300 .01% 17,181 .29%
Item 5. Other Information
Not applicable
23
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 31 - Rule 13a-14(a)/15d-14(a) Certifications
Exhibit 31.1 - CEO Rule 13a-14(a)/15d-14(a) Certifications
Exhibit 31.2 - CFO Rule 13a-14(a)/15d-14(a) Certifications
Exhibit 32 - Section 1350 Certifications - 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 June 30, 2003
(b) Reports on Form 8-K during the quarter ended June 30, 2003:
Filed April 18, 2003 - 2002 First Quarter Earnings Announcement
Filed April 29, 2003 - Stock Repurchase Plan Announcement
Filed June 16, 2003 - Cash Dividend 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 August 12, 2003
---------------
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
24