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, 2004.
[ ] 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
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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
of incorporation or ID Number)
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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(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 -- 6,530,002 shares as of August 5, 2004.
INDEX
NORTH VALLEY BANCORP AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets--June 30, 2004 and December 31,
2003
Condensed Consolidated Statements of Income--For the Six months Ended
June 30, 2004 and 2003
Condensed Consolidated Statements of Cash Flows--For the Six months
Ended June 30, 2004 and 2003
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
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2
PART I. FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
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NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands except share amounts)
June 30, December 31,
2004 2003
--------- ------------
ASSETS
Cash and due from banks $ 35,718 $ 28,013
Federal funds sold 18,665 31,510
--------- ------------
Total cash and cash equivalents 54,383 59,523
Interest-bearing deposits in other financial institutions 500 123
Investment securities:
Available for sale, at fair value 212,241 191,045
Held to maturity, at amortized cost 1,455 1,455
Loans and leases, net of allowance for loan and lease
losses of $6,177 and $6,493 at June 30, 2004 and
December 31, 2003 409,988 372,660
Premises and equipment, net of accumulated
depreciation and amortization 12,636 12,699
Other real estate 465
FHLB and FRB stock and other securities 3,496 2,991
Core deposit and other intangibles, net 2,019 2,272
Accrued interest receivable & other assets 37,200 34,925
--------- ------------
TOTAL ASSETS $ 734,383 $ 677,693
========= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing demand $ 135,954 $ 118,678
Interest-bearing 480,710 479,636
--------- ------------
Total deposits 616,664 598,314
Other borrowed funds 42,263 9,459
Accrued interest and other liabilities 7,199 7,371
Subordinated debentures 21,651 16,496
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Total liabilities 687,777 631,640
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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 6,527,435 and 6,488,073 at
June 30, 2004 and December 31, 2003 23,969 23,406
Retained earnings 25,545 22,795
Accumulated other comprehensive loss, net of tax (2,908) (148)
--------- ------------
Total stockholders' equity 46,606 46,053
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 734,383 $ 677,693
========= ============
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 For the three
months ended months ended
June 30, June 30,
----------------- -----------------
2004 2003 2004 2003
------- ------- ------- -------
INTEREST INCOME:
Loans and leases including fees $13,238 $15,149 $ 6,745 $ 7,465
Securities:
Taxable 3,637 1,948 1,754 902
Exempt from federal taxes 968 668 561 314
Federal funds sold 78 279 15 171
------- ------- ------- -------
Total interest income 17,921 18,044 9,075 8,852
------- ------- ------- -------
INTEREST EXPENSE:
Deposits 2,228 2,994 1,087 1,398
Subordinated debentures 740 613 386 357
Other borrowings 655 419 348 189
------- ------- ------- -------
Total interest expense 3,623 4,026 1,821 1,944
------- ------- ------- -------
NET INTEREST INCOME 14,298 14,018 7,254 6,908
PROVISION FOR LOAN AND LEASE LOSSES -- -- -- --
------- ------- ------- -------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 14,298 14,018 7,254 6,908
NONINTEREST INCOME:
Service charges on deposit accounts 2,566 2,426 1,194 1,136
Other fees and charges 1,099 1,062 564 607
Gain on sale of loans 4 1,072 4 868
Gain on sales or calls of securities 22 156 14 5
Other 1,020 1,158 474 538
------- ------- ------- -------
Total noninterest income 4,711 5,874 2,250 3,154
------- ------- ------- -------
NONINTEREST EXPENSES:
Salaries and employee benefits 6,893 6,677 3,472 3,365
Occupancy 884 836 454 434
Equipment 1,084 1,360 512 611
Other 4,389 4,772 2,222 2,539
------- ------- ------- -------
Total noninterest expenses 13,250 13,645 6,660 6,949
------- ------- ------- -------
INCOME BEFORE PROVISION FOR INCOME TAXES 5,759 6,247 2,844 3,113
PROVISION FOR INCOME TAXES 1,703 2,016 862 977
------- ------- ------- -------
NET INCOME $ 4,056 $ 4,231 $ 1,982 $ 2,136
======= ======= ======= =======
EARNINGS PER SHARE:
Basic $ 0.62 $ 0.62 $ 0.30 $ 0.31
======= ======= ======= =======
Diluted $ 0.59 $ 0.59 $ 0.29 $ 0.30
======= ======= ======= =======
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,
----------------------
2004 2003
--------- ---------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 4,056 $ 4,232
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 939 1,171
Amortization of premium on securities 41 265
Amortization of core deposit and other intangibles 253 248
Gain on sale of premises and equipment (13)
Gain on sale or calls of securities (22) (156)
Gain on sale of loans (4) (1,072)
Effect of changes in:
Accrued interest receivable (158) 273
Other assets (192) (446)
Accrued interest and other liabilities (84) (762)
--------- ---------
Net cash provided by operating activities 4,816 3,753
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CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of other real estate owned 27
Net changes in FHLB and FRB stock and other securities (505) (50)
Purchases of available for sale securities (54,752) (77,021)
Proceeds from sales of available for sale securities 4,344
Proceeds from maturities/calls of available for sale securities 28,852 41,465
Net (increase) decrease in interest-bearing deposits at
financial institutions (377) 220
Proceeds from sales of loans 52,932
Net (increase) decrease in loans and leases (37,789) 5,306
Purchases of premises and equipment, net (863) (645)
--------- ---------
Net cash (used in) provided by investing activities (65,434) 26,578
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 18,350 32,654
Proceeds from issuance of subordinated debentures 5,155 6,186
Net increase (decrease) in Federal funds purchased and
other borrowed funds 32,804 (12,402)
Cash dividends paid (1,306) (1,363)
Repurchase of common stock (4,321)
Cash received for stock options exercised 400 232
Compensation expense on stock options/grants 75 100
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Net cash provided by financing activities 55,478 21,086
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(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (5,140) 51,417
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 59,523 55,300
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 54,383 $ 106,717
========= =========
ADDITIONAL INFORMATION:
Cash paid during the period for:
Interest $ 3,161 $ 4,163
========= =========
Income taxes $ 2,025 $ 2,190
========= =========
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 the instructions to Form 10-Q and Article 10 of Regulation S-X of the
Securities and Exchange Commission. Accordingly, certain information and notes
required by accounting principles generally accepted in the United States for
annual financial statements are not included herein. 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. 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, 2003.
Operating results for the six months ended June 30, 2004 are not necessarily
indicative of the results that may be expected for any subsequent period or for
the year ended December 31, 2004.
The condensed consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries (North Valley Bank ("NVB"),
including Six Rivers Bank ("SRB"), a division of North Valley Bank, North Valley
Trading Company, which is inactive, and Bank Processing, Inc. ("BPI").
Significant intercompany items and transactions have been eliminated in
consolidation. North Valley Capital Trust I, North Valley Capital Trust II and
North Valley Capital Trust III are unconsolidated subsidiaries formed solely for
the purpose of issuing trust preferred securities.
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 - INVESTMENT SECURITIES
At June 30, 2004 and December 31, 2003, 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, 2004
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Securities of U.S. government
agencies and corporations $ 10,458 $ 3 $ (113) $ 10,348
Obligations of states and political
subdivisions 25,891 581 (691) 25,781
Mortgage backed securities 164,782 143 (4,189) 160,736
Corporate securities 3,013 169 3,182
Other securities 13,128 42 (976) 12,194
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$ 217,272 $ 938 $ (5,969) $ 212,241
========================================================
December 31, 2003
- -----------------
Securities of U.S. government
agencies and corporations $ 12,574 $ 73 $ (14) $ 12,633
Obligations of states and political
subdivisions 25,903 1,133 (94) 26,942
Mortgage backed securities 133,760 424 (1,408) 132,776
Corporate securities 6,027 273 (26) 6,274
Other securities 13,127 27 (734) 12,420
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$ 191,391 $ 1,930 $ (2,276) $ 191,045
========================================================
6
Carrying
Amount Gross Gross
(Amortized Unrealized Unrealized
Held to maturity securities: Cost) Gains Losses Fair Value
- --------------------------- ---------- ---------- ----------- ----------
June 30, 2004
- -------------
Obligation of states and political
Subdivisions $ 1,455 $ 286 $ -- $ 1,741
========= ========== ======== ==========
Carrying
Amount Gross Gross
(Amortized Unrealized Unrealized
Held to maturity securities: Cost) Gains Losses Fair Value
- ---------------------------- ---------- ---------- ----------- ----------
December 31, 2003
- -----------------
Obligation of states and political
Subdivisions $ 1,455 $ 376 $ -- $ 1,831
========= ========== ========== ==========
Gross realized gains on sales or calls of available for sale securities
were $22,000 and $170,000 for the six months ended June 30, 2004 and 2003. There
were no gross realized losses on sales or calls of available for sale securities
for the six months ended June 30, 2004. Gross realized losses on sales or calls
of available for sale securities were $14,000 for the six months ended June 30,
2003.
There were no sales or transfers of held to maturity securities for the
six months ended June 30, 2004 and 2003.
At June 30, 2004 and December 31, 2003, securities having fair value
amounts of approximately $131,164,000 and $65,031,000 were pledged to secure
public deposits, short-term borrowings, treasury, tax and loan balances and for
other purposes required by law or contract.
NOTE C - STOCK-BASED COMPENSATION
At June 30, 2004, 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 plans under the recognition and measurement principles of APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based compensation cost is reflected in net income
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
Director Plans for the difference between the fair value of the options at the
date of the grant and the exercise price at 85% of the fair value.
7
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 Three months ended
June 30, June 30,
------------------ --------------------
(in thousands except per share data) 2004 2003 2004 2003
------- ------- ------- -------
Net income, as reported $ 4,056 $ 4,231 $ 1,982 $ 2,136
Add: total stock-based compensation expense included in net
Income, net of tax 44 60 23 30
Deduct: total stock-based compensation expense
Determined under the fair value based method for all
awards, net of related tax effects (139) (182) (70) (92)
------- ------- ------- -------
Net income, pro forma $ 3,961 $ 4,109 $ 1,935 $ 2,074
Basic earnings per common share:
As reported $ 0.62 $ 0.62 $ 0.30 $ 0.31
Pro forma $ 0.61 $ 0.60 $ 0.30 $ 0.30
Diluted earnings per common and equivalent share:
As reported $ 0.59 $ 0.59 $ 0.29 $ 0.30
Pro forma $ 0.58 $ 0.57 $ 0.28 $ 0.29
- -----------------------------------------------------------------------------------------------------------
The fair value of each option granted during the periods presented is
estimated on the date of grant using an option-pricing model with the following
assumptions:
Six months ended June 30,
-------------------------
2004 2003
------ -------
Dividend yield 2.74% 3.10%
Expected volatility 16.21% 17.15%
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 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 Three months ended
June 30, June 30,
------------------ --------------------
(in thousands) 2004 2003 2004 2003
------- ------- ------- -------
Net income $ 4,056 $ 4,231 $ 1,982 $ 2,136
Other comprehensive income:
Holding loss arising during period (2,772) (656) (4,468) (35)
Reclassification adjustment, net of tax 12 112 9 4
------- ------- ------- -------
(2,760) (544) (4,459) (31)
Total comprehensive income (loss) $ 1,296 $ 3,687 $ (2,477) $ 2,105
======== ======= ======== =======
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 six month and three month period ended June 30, 2004
and 2003 is reconciled as follows:
Six months Three months
ended June 30, ended June 30,
--------------- ---------------
(In thousands except earnings per share) 2004 2003 2004 2003
------ ------ ------ ------
Calculation of Basic Earnings Per Share
Numerator - net income $4,056 $4,231 $1,982 $2,136
Denominator - weighted average common
shares outstanding 6,519 6,872 6,525 6,807
------ ------ ------ ------
Basic Earnings Per Share $ 0.62 $ 0.62 $ 0.30 $ 0.31
====== ====== ====== ======
Calculation of Diluted Earnings Per Share
Numerator - net income $4,056 $4,231 $1,982 $2,136
Denominator - weighted average common
shares outstanding 6,519 6,872 6,525 6,807
Dilutive effect of outstanding options 259 347 382 392
------ ------ ------ ------
6,778 7,219 6,907 7,199
------ ------ ------ ------
Diluted Earnings Per Share $ 0.59 $ 0.59 $ 0.29 $ 0.30
====== ====== ====== ======
9
NOTE F - PENSION PLAN BENEFITS
The Company has a supplemental retirement plan for key executives and a
supplemental retirement plan for certain retired key executives and directors.
These plans are nonqualified defined benefit plans and are unsecured and
unfunded. Components of net periodic benefit cost for the Company's supplemental
nonqualified defined benefit plans for the six and three months ended June 30,
2004 and 2003 are presented in the following table.
Pension Benefits
- ----------------
Six months ended Three months ended
June 30, June 30,
----------------------- ----------------------
(in thousands except per share amounts) 2004 2003 2004 2003
------- ------- ------ ------
Components of Net Periodic Cost:
Service cost $ 130 $ 114 $ 59 $ 65
Interest cost 86 82 43 41
Amortization of unrecognized net transition
obligation 12 12 6 6
Amortization of prior service cost 16 16 8 8
Recognized net actuarial gain (4) (2)
------- ------- ------- -------
Total Components of Net Periodic Cost $ 244 $ 220 $ 116 $ 118
======= ======= ======= =======
NOTE G - SUBSIDIARY MERGER
On January 1, 2004, the Company consummated the merger of its two
subsidiary banks. Six Rivers Bank was merged with and into North Valley Bank
with North Valley Bank as the surviving institution. The transaction was
accounted for as a combination of entities under common control similar to a
pooling of interests. Accordingly, all amounts related solely to North Valley
Bank have been restated to reflect the combination as if it had occurred at the
beginning of the periods presented. Former branches of Six Rivers Bank continue
to operate as Six Rivers Bank, a division of North Valley Bank. (For purposes
herein, "NVB" shall refer to North Valley Bank including the former branches of
SRB and "SRB" will refer to the former branches and operations of SRB.) As a
result of the reorganization, management no longer makes operating decisions or
assesses performance based on the separate results and activities of North
Valley Bank and its division, Six Rivers Bank. Therefore, information previously
disclosed on the operating performance of the Company's operating segments is no
longer meaningful.
NOTE H - AGREEMENT AND PLAN OF REORGANIZATION AND MERGER
On April 26, 2004, the Company and Woodland, California-based Yolo
Community Bank announced jointly the signing of an Agreement and Plan of
Reorganization and Merger on April 23, 2004 whereby North Valley Bancorp will
acquire Yolo Community Bank. Under the terms of the merger agreement, Yolo
Community Bank shareholders will receive $9.5 million in cash and 741,700 shares
of NOVB common stock in exchange for their Yolo shares. Based upon NOVB's
closing price of $16.18 as of August 5, 2004, the transaction is currently
valued at approximately $22.7million for the $105 million-asset Yolo Community
Bank. The definitive agreement was unanimously approved by the Board of
Directors of both companies, and by the shareholders of Yolo Community Bank on
July 27, 2004. Approval of the transaction by the California Commissioner of
Financial Institutions, the Federal Reserve Bank of San Francisco and the
Federal Deposit Insurance Corporation have been granted. The transaction is
expected to close on August 31, 2004.
NOTE I - SUBORDINATED DEBENTURES
On May 5, 2004, the Company, through its newly formed subsidiary, North
Valley Capital Trust III, issued 5,000 Trust Preferred Securities with a
liquidation value of $1,000 per share for gross proceeds of $5,000,000. The
entire proceeds of the issuance will be invested by North Valley Capital Trust
III in $5,000,000 aggregate principal amount of 3.97% subordinated debentures
due in 2034 issued by the Company. The Subordinated Debentures III mature in
2034, bear an initial interest rate of 3.97%, payable quarterly, and are
redeemable by the Company at par beginning on or after May 5, 2009, plus any
accrued and unpaid interest to the redemption date.
Under applicable regulatory guidelines, substantially all of the 5,000
Trust Preferred Securities are expected to qualify as Tier I capital.
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 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 the Northern California region; volatility
of rate sensitive deposits; operational risks including data processing system
failures or fraud; asset/liability matching risks and liquidity risks; the
California power crises; the U.S. "war on terrorism" and military action by the
U.S. in the Middle East, and changes in the securities markets.
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 our financial 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. We use historical loss factors as one factor in determining the
inherent loss that may be present in our loan and lease portfolio. Actual losses
could differ significantly from the historical factors that we use. 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 may be sustained in our loan and lease 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 on impaired loans (as defined) based on the differences
between the 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 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.
Stock Based Compensation
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, which are described more fully in Notes
1 and 14 to the Consolidated Financial Statements included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2003. The Company
accounts for these plans under the recognition and measurement principles of APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related
11
interpretations. No stock-based employee 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 Director Plans over the vesting period for the difference between the
fair value of the shares at the date of the grant and the exercise price, which
is equal to 85% of the fair value at the date of the grant.
Overview
- --------
North Valley Bancorp (the "Company") is a bank holding company for
North Valley Bank ("NVB"), a state-chartered bank. NVB operates out of its main
office located at 300 Park Marina Circle, Redding, CA 96001, with twenty-one
branches, which includes the former branches of SRB and two supermarket branches
in Northern California. The Company's principal business consists of attracting
deposits from the general public and using the funds to originate commercial,
real estate and installment loans to customers, who are predominately small and
middle market businesses and middle income individuals. 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
ten percent of its revenues.
Earnings Summary
- ----------------
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
(in thousands except per share amounts) 2004 2003 2004 2003
--------- -------- --------- ---------
Net interest income $ 14,298 $ 14,018 $ 7,254 $ 6,908
Provision for loan and lease losses -- -- -- --
Noninterest income 4,711 5,874 2,250 3,154
Noninterest expense 13,250 13,645 6,660 6,949
Provision for income taxes 1,703 2,016 862 977
--------- -------- --------- ---------
Net income $ 4,056 $ 4,231 $ 1,982 $ 2,136
========= ======== ========= =========
Earnings Per Share
Basic $ 0.62 $ 0.62 $ 0.30 $ 0.31
Diluted $ 0.59 $ 0.59 $ 0.29 $ 0.30
Annualized Return on Average Assets 1.13% 1.28% 1.09% 1.29%
Annualized Return on Average Equity 17.24% 16.84% 16.83% 17.06%
The Company's consolidated net income for the six months ended June 30,
2004 was $4,056,000, or $0.59 per diluted share, compared to $4,231,000, or
$0.59 diluted earnings per share for the same period in 2003. Return on average
assets was 1.13% and return on average equity was 17.24% for the six months
ended June 30, 2004 compared to the 1.28% and 16.84% achieved, respectively, for
the same period in 2003.
For the six months ended June 30, 2004 and 2003, the Company took no
provision for loan and lease losses. The fact that no provision has been taken
in either period is due to the results of the Company's analysis for measuring
the adequacy of the allowance for loan and lease losses. Factors include size
and mix of loan portfolio, non-performing loan levels, charge-off/recovery
activity and other qualitative factors including economic activity. Management
believes that the current level of allowance for loan and lease losses as of
June 30, 2004 of $6,177,000 or 1.48% of total loans and leases is adequate at
this time. The allowance for loan and lease losses was 6,493,000 or 1.71% of
total loans and leases at December 31, 2003. For further information regarding
our allowance for loan and lease losses, see "Allowance for Loan and Lease
Losses" on page 16.
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.
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:
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
(in thousands) 2004 2003 2004 2003
--------- -------- --------- ---------
Interest income $ 17,921 $ 18,044 $ 9,075 $ 8,852
Less: Interest expense 3,623 4,026 1,821 1,944
FTE adjustment 453 367 219 174
--------- -------- --------- ---------
Net interest income (FTE) $ 14,751 $ 14,385 $ 7,473 $ 7,082
========= ======== ========= =========
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 six-month period ended June 30, 2004
resulted primarily from higher average earning assets coupled with 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
resulted in a decrease in the net interest margin in the short term but for the
long-term has positioned the Company well for any further changes in interest
rates. Management made the strategic decision late in 2002 to sell all fixed
rate mortgages originated by the Company due to the overall low level of
interest rates and the additional interest rate risk the Company would take on
by maintaining these loans within the loan portfolio. In light of slightly
higher mortgage loan rates and decreased production, at the end of 2003, the
Company reverted back to holding all loans originated in the loan portfolio.
While average interest earning assets for the six months ended June 30,
2004 increased by $60,317,000 or 10.3% from the same period last year, yields on
average earning assets decreased 63 basis points from 6.35% to 5.72%. Most of
the yield decrease is due to the change in the mix of earning assets from loans
to lower-yielding investments and fed funds. Average interest bearing
liabilities increased by $45,448,000 or 9.2% for the six months ended June 30,
2004 compared to the same period in 2003 while the average rate paid on those
liabilities decreased 29 basis points from 1.64% to 1.35%. The Company's net
interest margin (FTE) decreased from 4.96% for the six month period ended June
30, 2003 to 4.60% for the same period ended June 30, 2004.
The following table is a summary of the Company's net interest margin
(FTE) for the periods indicated:
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
2004 2003 2004 2003
--------- -------- --------- ---------
Yield on earning assets 5.73% 6.35% 5.71% 6.17%
Rate paid on interest-bearing
liabilities 1.35% 1.64% 1.34% 1.57%
---- ---- ---- ----
Net interest spread 4.38% 4.71% 4.37% 4.60%
==== ==== ==== ====
Net interest margin 4.60% 4.96% 4.59% 4.84%
==== ==== ==== ====
Noninterest Income
- ------------------
The following table is a summary of the Company's noninterest income
for the periods indicated:
Six months ended June 30, Three months ended June 30,
Noninterest Income ------------------------- ---------------------------
(In thousands) 2004 2003 2004 2003
--------- --------- -------- --------
Service charges on deposit accounts $ 2,566 $ 2,426 $ 1,194 $ 1,136
Other fees and charges 1,099 1,062 564 607
Gain on sale of loans 4 1,072 4 868
Gain on sale or calls of securities 22 156 14 5
Other 1,020 1,158 474 538
--------- --------- -------- --------
Total noninterest income $ 4,711 $ 5,874 $ 2,250 $ 3,154
========= ========= ======== ========
Non-interest income decreased from $5,874,000 for the six months ended
June 30, 2003 to $4,711,000 for the same period in 2004. Service charges on
deposits increased $140,000 from the six months ended June 30, 2003 to the same
period in 2004. Other fees and charges also increased from $1,062,000 in the
second quarter ending June 30, 2003 to $1,099,000 for the same period in 2004.
These increases were due to normal growth in deposit accounts. The Company
recorded $1,072,000 in gains on sales of mortgages and $156,000 in gains on
sales of securities for the six months ended June 30, 2003 compared to $4,000 in
gains on sale of loans and $22,000 in gains on calls of securities for the same
period in 2004. Please see the paragraph below for a discussion of mortgage loan
sales. Other income decreased from $1,158,000 for the six months ended June 30,
2003 to $1,020,000 for the same period in 2004. The decrease in other income was
13
primarily due to a decrease on the rate of earnings on the cash surrender value
of life insurance holdings.
During the fourth quarter of 2002, the Company began to sell new
production fixed-rate conforming first trust deed mortgage loans into the
secondary market and retaining the servicing on these loans. This was 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 has reduced 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. Since December 31, 2003, the Company
has held all mortgage loans originated within the loan portfolio.
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) 2004 2003 2004 2003
-------- -------- -------- --------
Salaries & employee benefits $ 6,893 $ 6,677 $ 3,472 $ 3,365
Equipment expense 1,084 1,360 512 611
Occupancy expense 884 836 454 434
Marketing 384 551 173 353
Data processing expense 365 80 227 43
ATM expense 408 497 205 248
Printing & supplies 264 281 139 118
Postage 255 264 129 134
Messenger expense 180 165 95 96
Professional services 406 485 200 243
Other 2,127 2,449 1,054 1,304
-------- -------- -------- --------
Total Noninterest expense $ 13,250 $ 13,645 $ 6,660 $ 6,949
======== ======== ======== ========
Noninterest expense totaled $13,250,000 for the six months ended June
30, 2004, compared to $13,645,000 for the same period in 2003. This represents a
reduction of $395,000 or 2.9% from 2003 levels. Salaries and benefits increased
by $216,000 or 3.2% to $6,893,000 for the six months ended June 30, 2004
compared to $6,677,000 for the same period in 2003. The increase in salary
expense was due to merit increases partially offset by selective staff
reductions. Equipment expense decreased from $1,360,000 in 2003 to $1,084,000 in
2004 primarily due to additional expenses associated with the Company's new core
operating system immediately after the system conversion in late 2002. Most
other expense categories for the six months ended June 30, 2004 experienced
relatively small decreases or increases from the same respective periods in 2003
with the exception of other expense. The Company's ratio of noninterest expense
to average assets was 3.69% for the six months ended June 30, 2004 compared to
4.15% for the same period in 2003.
Income Taxes
- ------------
The provision for income taxes for the six months ended June 30, 2004
was $1,703,000 as compared to $2,016,000 for the same period in 2003. The
effective income tax rate for state and federal income taxes was 29.6% for the
six months ended June 30, 2004 compared to 32.3% for the same period in 2003.
The decrease in the effective rate for 2004 is due to a slightly lower revenue
base as well as an increase in investments that are exempt from federal taxes.
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, FNMA Preferred Stock, and life insurance policies whose
income is exempt from Federal taxes. In addition, the Company receives special
tax benefits from the State of California Franchise Tax Board for operating and
providing loans in designated `Enterprise Zones'.
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 June 30, 2004, the recorded investment in loans and leases for which
impairment had been recognized was approximately $978,796. Of the 2004 balance,
approximately $325,000 has a related valuation allowance of $163,000. For the
year ended December 31, 2003, the average recorded investment in loans and
leases for which impairment had been recognized was approximately $1,247,000.
During the portion of the year that the loans and leases were impaired, the
Company recognized interest income of approximately $5,000 for cash payments
received in 2004.
At December 31, 2003, the recorded investment in loans and leases for
which impairment had been recognized was approximately $1,636,000. Of the 2003
balance, approximately $535,000 has a related valuation allowance of $267,000.
For the year ended December 31, 2003, the average recorded investment in loans
and leases for which impairment had been recognized was approximately
$1,515,000. During the portion of the year that the loans and leases were
impaired, the Company recognized interest income of approximately $51,000 for
cash payments received in 2003.
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 June 30, 2004, and December 31, 2003, are
summarized as follows:
June 30, December 31,
2004 2003
------- ------------
Nonaccrual loans and leases $ 979 $ 1,615
Loans and leases 90 days past due and still accruing interest 2,811 1,395
------- --------
Total nonperforming loans and leases 3,790 3,010
Other real estate 465
------- --------
Total nonperforming assets $ 4,255 $ 3,010
======= ========
Nonaccrual loans and leases to total gross loans and leases 0.24% 0.43%
Nonperforming loans and leases to total gross loans and leases 0.91% 0.79%
Total nonperforming assets to total assets 0.58% 0.44%
15
Allowance for Loan and Lease Losses
- -----------------------------------
A summary of the allowance for loan and lease losses at June 30, 2004
and June 30, 2003 is as follows:
June 30, June 30,
(In thousands) 2004 2003
-------- --------
Balance beginning of period $ 6,493 $ 6,723
Provision for loan and lease losses
Net charge-offs (recoveries) 316 (33)
-------- --------
Balance end of period $ 6,177 $ 6,756
======== ========
Allowance for loan and lease losses to nonperforming
loans and leases 162.98% 231.29%
Allowance for loan and lease losses to total gross
loans and leases 1.48% 1.74%
Ratio of net charge-offs to average loans and leases
outstanding (annualized) 0.16% (0.02)%
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 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, 2004 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
16
o Model imprecision
2. Specific Allowance
Specific allowances are established in cases where management has
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".
The $6,177,000 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. In management's opinion, the level of
formula allowance is consistent from 2003 to 2004.
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 $23,000,000 as of June 30, 2004 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, 2004. In addition, NVB is a
member of the Federal Home Loan Bank ("FHLB") System providing additional
borrowing capacity of $85,019,000 secured by certain loans and investment
securities as of June 30, 2004. The Company also has a line of credit with
Federal Reserve Bank of San Francisco ("FRB") of $3,906,000 secured by first
deeds of trust on eligible commercial real estate loans and leases. As of June
30, 2004, borrowings consisted of $4,647,000 in medium-term FHLB advances,
long-term borrowings of $37,500,000 were outstanding with the FHLB, $116,000 was
outstanding with the FRB under the Treasury, Tax, and Loan program and
$21,651,000 was outstanding in the form of subordinated debt issued by the
Company.
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 $268,579,000 and
$252,146,000 (or 36.6% and 37.2% of total assets) at June 30, 2004 and December
31, 2003, respectively. The increase in liquid assets is due to growth in
deposits and a decrease in total loans outstanding.
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 $570,119,000 and $546,866,000 at June 30, 2004
and December 31, 2003, 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
17
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 six 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.
18
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 make 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, 2003.
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.
Financial Condition as of June 30, 2004 As Compared to December 31, 2003
- ------------------------------------------------------------------------
Total assets at June 30, 2004, were $734,383,000, compared to December
31, 2003 assets of $677,693,000. Investment securities and federal funds sold
grew to $232,361,000 at June 30, 2004, compared to $224,010,000 at December 31,
2003. These changes were the result of management's decision in January 2004 to
leverage the Company's capital. Specifically, the Company took out $37.5 million
in Federal Home Loan Bank advances with varying maturity dates and invested the
proceeds in a combination of ten- and fifteen-year mortgage backed securities.
The transaction is designed to increase net interest income while not adding any
significant interest rate risk and was also executed while the U.S. Treasury
yield curve was historically quite steep which makes this transaction more
attractive.
Net loans and leases, the Company's major component of earning assets,
increased during the first six months of 2004 to $409,988,000 at June 30, 2004
from $372,660,000 at December 31, 2003. The Company's average loan to deposit
ratio was 65.3% for the year ended December 31, 2003 and 58.6% for the six
months ended June 30, 2004.
Total deposits increased to $616,664,000 at June 30, 2004 compared to
$598,314,000 at December 31, 2003 driven by an increase in noninterest-bearing
checking, interest-bearing checking, and savings collectively, of $31,990,000
and a decrease in time deposits of $13,640,000. The decrease in time deposits is
mainly due to the low interest 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, 2003 has had a positive effect on the Company's cost of
funds (excluding non-interest checking), which was reduced from 1.64% for the
six months ended June 30, 2003 to 1.35% for the same period in 2004.
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
positive because it limits the Company's ability to earn a high rate of return
on stockholders' equity (ROE). Stockholders' equity increased to $46,606,000 as
of June 30, 2004, as compared to $46,053,000 at December 31, 2003. The increase
19
was primarily due to net income of $4,056,000 offset by cash dividends paid out
in the amount of $1,306,000. Under current regulations, management believes that
the Company meets all capital adequacy requirements and North Valley Bank was
considered well capitalized at June 30, 2004.
The Company's and North Valley Bank's capital amounts and risk-based
capital ratios are presented below.
To Be Well Capitalized
(In thousands) For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------------- ---------------------- -----------------------
Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
--------- ------ ---------- ------- ---------- -------
Company
As of June 30, 2004:
Total capital
(to risk weighted assets) $ 73,667 14.58% $ 40,408 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 62,683 12.41% $ 20,204 4.00% N/A N/A
Tier I capital
(to average assets) $ 62,683 8.57% $ 29,243 4.00% N/A N/A
As of December 31, 2003:
Total capital
(to risk weighted assets) $ 65,059 13.77% $ 37,797 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 58,310 12.34% $ 18,899 4.00% N/A N/A
Tier I capital
(to average assets) $ 58,310 8.49% $ 27,471 4.00% N/A N/A
North Valley Bank
As of June 30, 2004:
Total capital
(to risk weighted assets) $ 65,562 13.06% $ 40,158 8.00% $ 50,197 10.00%
Tier I capital
(to risk weighted assets) $ 59,385 11.83% $ 20,079 4.00% $ 30,118 6.00%
Tier I capital
(to average assets) $ 59,385 8.06% $ 29,488 4.00% $ 36,860 5.00%
As of December 31, 2003:
Total capital
(to risk weighted assets) $ 63,694 13.58% $ 37,523 8.00% $ 46,904 10.00%
Tier I capital
(to risk weighted assets) $ 58,135 12.39% $ 18,761 4.00% $ 28,142 6.00%
Tier I capital
(to average assets) $ 58,135 8.50% $ 27,359 4.00% $ 34,199 5.00%
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, 2004 compared to
December 31, 2003. Please see discussion under the caption "Interest Rate
Sensitivity" on page 17.
ITEM 4. CONTROLS AND PROCEDURES
-----------------------
Disclosure Controls and Procedures. Disclosure controls and procedures
are designed with the objective of ensuring that information required to be
disclosed in reports filed by the Company under the Exchange Act, such as this
Quarterly Report, is recorded, processed, summarized and reported within the
time periods specified in the rules and forms of the Securities and Exchange
Commission. Disclosure controls and procedures are also designed with the
objective of ensuring that such information is accumulated and communicated to
management, including the Chief Executive Officer and the Chief Financial
Officer, as appropriate to allow timely decisions regarding required disclosure.
Evaluation of Disclosure Controls and Procedures and Internal Control
over Financial Reporting. The Company's management, including the Chief
Executive Officer and the Chief Financial Officer, evaluated the Company's
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Exchange Act) as of June 30, 2004. Based on this evaluation, the Chief Executive
Officer and the Chief Financial Officer concluded that the Company's disclosure
20
controls and procedures are effective. There was no change in the Company's
internal control over financial reporting that occurred during the quarter ended
June 30, 2004 that 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, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
----------------------------------------------------------------------
Issuer Purchases of Equity Securities
Maximum number
Number of Shares of Shares that
Purchased as Part May Yet Be
of Publicly Purchased Under
Total Number of Average Price Paid Announced Plans the Plans or
Period Shares Purchased per Share or Programs Programs
- ------ ---------------- ------------------ ----------------- ---------------
April 1 thru April 30, 2004 0 0 0 10,454
May 1 thru May 31, 2004 0 0 0 10,454
June 1 thru June 30, 2004 0 0 0 10,454
The above repurchase program - announced on July 28, 2003 - is the
seventh such plan announced by the Company since May of 2001. The program calls
for the repurchase of up to 3.0% of the Company's outstanding shares, or 199,154
shares. The repurchases will be made from time to time by the Company in the
open market as conditions allow. All such transactions will be structured to
comply with Securities and Exchange Commission Rule 10b-18 and all shares
repurchased under this program will be retired. The number, price and timing of
the repurchases shall be at the Company's sole discretion and the program may be
re-evaluated depending on market conditions, liquidity needs or other factors.
The Board of Directors, based on such re-evaluations, may suspend, terminate,
modify or cancel the program at any time without notice. No shares were
repurchased during the second quarter of 2004.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
Not applicable
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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 27, 2004. Shareholders of the Company approved the following
proposals:
1. To elect the following one (1) nominee as Director of the
Corporation, for a term of one year:
Royce L. Friesen
The term of office of the following directors continued after the
Annual Meeting: Michael J. Cushman, William W. Cox, Dan W.
Ghidinelli, Kevin D. Hartwick, Thomas J. Ludden, Dolores M.
Vellutini, J.M. Wells, Jr.
2. To ratify the appointment of Perry-Smith LLP as Independent
Auditor for the Corporation for 2004.
Results of the election are presented below:
Annual Meeting of Shareholders
Thursday May 27, 2004
Total Shares Outstanding: 6,522,298
Total Shares Voted: 5,112,659 78.39%
Proposal 1: % of % of % of
Quorum Quorum Quroum
------ -------------------- -------------------
Nominees For Percent Withheld Percent Abstain Percent
Royce L. Friesen 5,068,768 77.71% 43,891 .67% 0 0
Proposal 2:
Perry-Smith LLP 5,047,738 77.39% 32,942 .51% 31,979 .49%
ITEM 5. OTHER INFORMATION
-----------------
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits:
Exhibit 3(c): Bylaws, as amended, of North Valley Bancorp
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, 2004
(b) Reports on Form 8-K during the quarter ended June 30, 2004:
Filed April 20, 2004 - First Quarter Earnings Announcement
Filed April 26, 2004 - Agreement and Plan of Reorganization and
Merger dated April 23, 2004 with Yolo Community Bank
Filed May 28, 2004 - Press Release announcing the retirement of
the Chairman of the Board, Rudy V. Balma and the appointment of
J.M. (Mike) Wells, Jr. as the new Chairman of the Board.
Filed June 2, 2004 - Cash Dividend Announcement
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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 9, 2004
--------------
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
23