UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the period ended September 30, 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
- --------------------------------- ------------------------
(State or other jurisdiction (IRS Employer ID Number)
of incorporation or organization)
300 Park Marina Circle, Redding, CA 96002
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (530) 226-2900
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- --------------------------------------------------------------------------------
(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 - 7,302,726 shares as of November 8, 2004.
INDEX
NORTH VALLEY BANCORP AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION 3
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Item 1. Financial Statements (Unaudited) 3
Condensed Consolidated Balance Sheets--September 30, 2004 and
December 31, 2003 3
Condensed Consolidated Statements of Income--For the Nine
months Ended September 30, 2004 and 2003 4
Condensed Consolidated Statements of Cash Flows--For the Nine
months Ended September 30, 2004 and 2003 5
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION 23
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Item 1. Legal Proceedings 23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits 24
SIGNATURES 25
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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)
September 30, 2004 December 31, 2003
------------------ -----------------
ASSETS
Cash and due from banks $ 37,865 $ 28,013
Federal funds sold 27,000 31,510
----------- -----------
Total cash and cash equivalents 64,865 59,523
Interest-bearing deposits in other financial institutions 500 123
Investment securities:
Available for sale, at fair value 223,775 191,045
Held to maturity, at amortized cost 144 1,455
Loans and leases, net of allowance for loan and lease
losses of $7,269 and $6,493 at September 30, 2004 and
December 31, 2003 500,532 372,660
Premises and equipment, net of accumulated
depreciation and amortization 13,226 12,699
Other real estate 465
FHLB and FRB stock and other securities 3,716 2,991
Core deposit and other intangibles, net 5,290 2,272
Goodwill 14,348 --
Accrued interest receivable & other assets 36,882 34,925
----------- -----------
TOTAL ASSETS $ 863,743 $ 677,693
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing demand $ 167,284 $ 118,678
Interest-bearing 563,088 479,636
----------- -----------
Total deposits 730,372 598,314
Other borrowed funds 39,120 9,459
Accrued interest and other liabilities 8,239 7,371
Subordinated debentures 21,650 16,496
----------- -----------
Total liabilities 799,381 631,640
----------- -----------
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 7,302,726 and 6,488,073 at
September 30, 2004 and December 31, 2003 37,841 23,406
Retained earnings 26,879 22,795
Accumulated other comprehensive loss, net of tax (358) (148)
----------- -----------
Total stockholders' equity 64,362 46,053
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 863,743 $ 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 nine months ended For the three months ended
September 30, September 30,
------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
INTEREST INCOME:
Loans and leases including fees $ 20,621 $ 22,019 $ 7,383 $ 6,870
Securities:
Taxable 5,714 3,142 1,718 1,194
Exempt from federal taxes 1,079 975 470 307
Federal funds sold 226 458 148 179
----------- ----------- ----------- -----------
Total interest income 27,640 26,594 9,719 8,550
----------- ----------- ----------- -----------
INTEREST EXPENSE:
Deposits 3,403 4,306 1,175 1,313
Subordinated debentures 1,151 960 411 358
Other borrowings 987 579 332 150
----------- ----------- ----------- -----------
Total interest expense 5,541 5,845 1,918 1,821
----------- ----------- ----------- -----------
NET INTEREST INCOME 22,099 20,749 7,801 6,729
PROVISION FOR LOAN AND LEASE LOSSES 216 -- 216 --
----------- ----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 21,883 20,749 7,585 6,729
NONINTEREST INCOME:
Service charges on deposit accounts 3,933 3,575 1,367 1,149
Other fees and charges 1,680 1,591 581 529
Gain on sale of loans 9 1,442 5 370
Gain on sales or calls of securities 22 201 -- 45
Other 1,466 1,732 446 574
----------- ----------- ----------- -----------
Total noninterest income 7,110 8,541 2,399 2,667
----------- ----------- ----------- -----------
NONINTEREST EXPENSES:
Salaries and employee benefits 10,504 10,122 3,611 3,445
Occupancy 1,365 1,303 481 467
Equipment 1,601 1,954 517 594
Other 6,784 7,165 2,395 2,393
----------- ----------- ----------- -----------
Total noninterest expenses 20,254 20,544 7,004 6,899
----------- ----------- ----------- -----------
INCOME BEFORE PROVISION FOR INCOME TAXES 8,739 8,746 2,980 2,497
PROVISION FOR INCOME TAXES 2,615 2,696 912 680
----------- ----------- ----------- -----------
NET INCOME $ 6,124 $ 6,050 $ 2,068 $ 1,817
=========== =========== =========== ===========
EARNINGS PER SHARE:
Basic $ 0.93 $ 0.89 $ 0.31 $ 0.28
=========== =========== =========== ===========
Diluted $ 0.88 $ 0.85 $ 0.29 $ 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 nine months ended
September 30,
--------------------------
2004 2003
----------- -----------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 6,124 $ 6,050
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,407 1,707
Amortization of premium on securities 24 346
Amortization of core deposit and other intangibles 379 374
Provision for loan and lease losses 216 --
Gain on sale or calls of securities (22) (201)
Gain on sale of loans (9) (1,442)
Loan originations from loan sales -- (72,456)
Proceeds from loan sales -- 73,898
Stock-based compensation expense 113 --
Effect of changes in:
Accrued interest receivable (305) 378
Other assets (1,181) (49)
Accrued interest and other liabilities 317 (1,242)
----------- -----------
Net cash provided by operating activities 7,063 7,363
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CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash paid in acquisition (4,441) --
Proceeds from sale of other real estate owned -- 55
Net changes in FHLB and FRB stock and other
securities (196) (50)
Purchases of available for sale securities (50,755) (110,299)
Proceeds from sales of available for sale securities -- 18,221
Proceeds from maturities/calls of available for sale
securities 41,687 60,498
Proceeds from maturities/calls of held to maturity
securities 1,455 --
Net (increase) decrease in interest-bearing deposits at
financial institutions (377) 418
Net (increase) decrease in loans and leases (46,622) 72,679
Purchases of premises and equipment, net (1,514) (1,181)
Proceeds from sale of premises and equipment 29 --
----------- -----------
Net cash used in investing activities (61,734) (40,341)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 35,699 40,331
Proceeds from issuance of subordinated debentures 5,155 --
Net increase (decrease) in Federal funds purchased and
other borrowed funds 19,561 (17,468)
Cash dividends paid (2,040) (2,020)
Repurchase of common stock -- (6,660)
Cash received for stock options exercised 458 368
Compensation expense on stock options/grants 180 173
----------- -----------
Net cash provided by financing activities 59,013 14,724
----------- -----------
INCREASE IN CASH AND CASH EQUIVALENTS 5,342 62,428
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 59,523 55,300
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 64,865 $ 117,728
=========== ===========
5
For the nine months ended
September 30,
--------------------------
2004 2003
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ADDITIONAL INFORMATION:
Cash paid during the period for:
Interest $ 5,233 $ 6,161
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Income taxes $ 2,025 $ 2,190
=========== ===========
Supplemental schedule related to acquisition (Note H)
Deposits $ 96,359
Overnight borrowings 10,100
Other liabilities 549
Available-for-sale investment securities (23,316)
Held-to-maturity investment securities (144)
Loans, net (81,922)
FHLB stock (644)
Premises and equipment, net (449)
Intangibles (17,061)
Other assets (1,597)
Compensation expense on stock options assumed 1,008
Stock issued 12,676
-----------
$ (4,441)
===========
See notes to condensed consolidated financial statements (unaudited).
6
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 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 nine months ended September 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, Yolo
Community 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 September 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)
- ----------------------------- ----------- ----------- ----------- ------------
September 30, 2004
- ------------------
Securities of U.S. government
agencies and corporations $ 20,147 $ 41 $ (91) $ 20,097
Obligations of states and political
subdivisions 29,638 1,186 (42) 30,782
Mortgage backed securities 158,566 343 (1,460) 157,449
Corporate securities 3,007 145 -- 3,152
Other securities 13,240 31 (976) 12,295
----------- ----------- ---------- -----------
$ 224,598 $ 1,746 $ (2,569) $ 223,775
=========== =========== ========== ===========
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
----------- ----------- ---------- -----------
$ 191,391 $ 1,930 $ (2,276) $ 191,045
=========== =========== ========== ===========
7
Carrying
Amount Gross Gross
(Amortized Unrealized Unrealized
Held to maturity securities: Cost) Gains Losses Fair Value
- --------------------------- ----------- ----------- ----------- -----------
September 30, 2004
- ------------------
Obligation of states and political
subdivisions $ 144 $ -- $ -- $ 144
=========== =========== ========== ===========
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 $245,000 for the nine months ended September 30, 2004 and 2003.
There were no gross realized losses on sales or calls of available for sale
securities for the nine months ended September 30, 2004. Gross realized losses
on sales or calls of available for sale securities were $44,000 for the nine
months ended September 30, 2003.
There were no sales or transfers of held to maturity securities for the
nine months ended September 30, 2004 and 2003.
At September 30, 2004 and December 31, 2003, securities having fair
value amounts of approximately $145,150,000 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.
Management periodically evaluates each investment security relying
primarily on industry analyst reports, observation of market conditions and
interest rate fluctuations. Management believes it will be able to collect all
amounts due according to the contractual terms of the underlying investment
securities and that the noted decline in fair value is due only to interest
rate fluctuations.
NOTE C - STOCK-BASED COMPENSATION
At September 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.
8
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.
Nine months ended Three months ended
September 30, September 30,
------------------------- --------------------------
(in thousands except per share data) 2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income, as reported $ 6,124 $ 6,050 $ 2,068 $ 1,817
Add: total stock-based compensation
expense included in net income,
net of tax 66 103 22 44
Deduct: total stock-based compensation
expense determined under the
fair value based method for all
awards, net of related tax effects (194) (275) (66) (91)
----------- ----------- ----------- -----------
Net income, pro forma $ 5,996 $ 5,878 $ 2,024 $ 1,770
Basic earnings per common share:
As reported $ 0.93 $ 0.89 $ 0.31 $ 0.28
Pro forma $ 0.91 $ 0.87 $ 0.30 $ 0.27
Diluted earnings per common and
equivalent share:
As reported $ 0.88 $ 0.85 $ 0.29 $ 0.26
Pro forma $ 0.87 $ 0.83 $ 0.29 $ 0.25
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:
Nine months ended
September 30,
-------------------------
2004 2003
----------- -----------
Dividend yield 2.47% 2.87%
Expected volatility 16.30% 18.97%
Risk-Free interest rate 3.58% 5.00%
Expected option life 7 years 7 years
9
NOTE D - COMPREHENSIVE INCOME
Comprehensive income includes net income and other comprehensive income
or loss. The Company's only sources of other comprehensive (loss) 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:
Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
(in thousands) 2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income $ 6,124 $ 6,050 $ 2,068 $ 1,817
Other comprehensive (loss) income,
net of tax:
Holding (loss) income arising during
period (223) (1,604) 2,550 (947)
Reclassification adjustment 13 145 0 32
----------- ----------- ----------- -----------
(210) (1,459) 2,550 (915)
----------- ----------- ----------- -----------
Total comprehensive income $ 5,914 $ 4,591 $ 4,618 $ 902
=========== =========== =========== ===========
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 nine month and three month period ended September 30,
2004 and 2003 is reconciled as follows:
Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
(In thousands except earnings per share) 2004 2003 2004 2003
----------- ----------- ----------- -----------
Calculation of Basic Earnings Per Share
Numerator - net income $ 6,124 $ 6,050 $ 2,068 $ 1,817
Denominator - weighted average common
shares outstanding 6,601 6,781 6,773 6,599
----------- ----------- ----------- -----------
Basic Earnings Per Share $ 0.93 $ 0.89 $ 0.31 $ 0.28
=========== =========== =========== ===========
Calculation of Diluted Earnings Per Share
Numerator - net income $ 6,124 $ 6,050 $ 2,068 $ 1,817
Denominator - weighted average common
shares outstanding 6,601 6,781 6,773 6,599
Dilutive effect of outstanding options 353 358 352 388
----------- ----------- ----------- -----------
6,954 7,139 7,125 6,987
----------- ----------- ----------- -----------
Diluted Earnings Per Share $ 0.88 $ 0.85 $ 0.29 $ 0.26
=========== =========== =========== ===========
10
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 nine and three months ended September
30, 2004 and 2003 are presented in the following table.
Pension Benefits
- ----------------
Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
(in thousands) 2004 2003 2004 2003
----------- ----------- ----------- -----------
Components of Net Periodic Cost:
Service cost $ 189 $ 166 $ 59 $ 45
Interest cost 129 123 43 41
Amortization of unrecognized net
transition obligation 18 19 6 7
Amortization of prior service cost 24 23 8 14
Recognized net actuarial gain -- (8) -- (4)
----------- ----------- ----------- -----------
Total Components of Net Periodic Cost $ 360 $ 323 $ 116 $ 103
=========== =========== =========== ===========
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 - ACQUISITION
On August 31, 2004, pursuant to the Agreement and Plan of
Reorganization dated April 23, 2004, the Company completed its acquisition of
Woodland, California-based Yolo Community Bank ("YCB") through a merger and
tax-free reorganization whereby YCB became a wholly-owned subsidiary. As of the
date of the acquisition, YCB had total assets of $115.4 million comprised of
$5.6 million in cash and due from banks, $24.1 million in investment securities,
$82.6 million in net loans and $3.1 million in other assets. Total liabilities
acquired included $96.4 million in deposits under the terms of the agreement.
Under the terms of the agreement, Yolo Community Bank shareholders received a
combination of $9.5 million in cash and 741,697 shares of NOVB common stock in
exchange for their YCB shares.
The excess of the purchase price over the estimated fair value of the
net assets acquired was $14.3 million, which was recorded as goodwill. Assets
acquired also included a core deposit intangible of $2.7 million that is being
amortized on a straight-line basis over ten years. Other estimated fair value
adjustments were not significant. The accompanying unaudited consolidated
financial statements include the accounts of YCB since September 1, 2004.
11
The following supplemental pro forma information discloses the selected
financial information for the periods indicated as though the YCB merger had
been completed as of the beginning of each of the periods being reported.
Dollars are in thousands except per share data.
(in thousands) Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Revenue $ 38,875 $ 39,658 $ 13,216 $ 12,720
Net Income $ 6,417 $ 6,341 $ 2,163 $ 1,889
Diluted Earnings per share $ 0.84 $ 0.80 $ 0.28 $ 0.25
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.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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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
13
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") and, since September 1, 2004, Yolo Community Bank
("YCB"), both state-chartered banks. NVB operates out of its main office located
at 300 Park Marina Circle, Redding, CA 96001, with twenty-one branches, which
include the former branches of SRB and two supermarket branches in Northern
California. YCB, acquired in a business combination more fully described in Note
H to the interim financial statements contained herein, operates out of its main
office located at 624 Court Street in Woodland, California with three branches.
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. As the result of a consumer compliance examination in the second
quarter of 2004, North Valley Bank entered into an informal agreement with the
Federal Reserve Bank of San Francisco to improve its oversight, policies, and
procedures related to consumer protection laws and regulations. This is in
response to examination issues that arose during the course of examination and
does not involve any safety and soundness issues. The Bank has strengthened its
risk management by hiring a Chief Risk Officer who is responsible for
compliance, internal controls (SOX 404) and training specific to these areas.
Earnings Summary
- ----------------
Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
(in thousands except per share amounts) 2004 2003 2004 2003
----------- ----------- ----------- -----------
Net interest income $ 22,099 $ 20,749 $ 7,801 $ 6,729
Provision for loan and lease losses 216 -- 216 --
Noninterest income 7,110 8,541 2,399 2,667
Noninterest expense 20,254 20,544 7,004 6,899
Provision for income taxes 2,615 2,696 912 680
----------- ----------- ----------- -----------
Net income $ 6,124 $ 6,050 $ 2,068 $ 1,817
=========== =========== =========== ===========
Earnings Per Share
Basic $ 0.93 $ 0.89 $ 0.31 $ 0.28
Diluted $ 0.88 $ 0.85 $ 0.29 $ 0.26
Annualized Return on Average Assets 1.09% 1.21% 1.03% 1.07%
Annualized Return on Average Equity 16.35% 16.61% 15.04% 15.82%
The Company's consolidated net income for the nine months ended
September 30, 2004 was $6,124,000, or $0.88 per diluted share, compared to
$6,050,000, or $0.85 diluted earnings per share for the same period in 2003.
Return on average assets was 1.09% and return on average equity was 16.35% for
the nine months ended September 30, 2004 compared to the 1.21% and 16.61%
achieved, respectively, for the same period in 2003.
For the nine months ended September 30, 2004 and 2003, the Company
recognized a $216,000 provision for loan and lease losses compared to no
provision recorded in the same period in 2003. The process for determining
allowance adequacy includes a comprehensive analysis of the loan portfolio.
Factors in the analysis 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 September 30, 2004 of $7,269,000 or
1.43% 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 18.
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.
14
The following table is a summary of the Company's net interest income,
presented on a fully taxable equivalent (FTE) basis for tax-exempt investments
included in earning assets, for the periods indicated:
Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
(In thousands) 2004 2003 2004 2003
----------- ----------- ----------- -----------
Interest income $ 27,640 $ 26,594 $ 9,719 $ 8,550
Less: Interest expense 5,541 5,845 1,918 1,821
FTE adjustment 654 564 201 197
----------- ----------- ----------- -----------
Net interest income (FTE) $ 22,753 $ 21,313 $ 8,002 $ 6,926
=========== =========== =========== ===========
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 nine-month period ended September 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. While this strategy has
decreased the current net interest margin of the Company, it has also positioned
the Company to take advantage of future changes in interest rates. 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 nine months ended
September 30, 2004 increased by $71,638,000 or 12.1% from the same period last
year, yields on average earning assets decreased 42 basis points from 6.13% to
5.71%. Most of the yield decrease is due to yields on loans which decreased from
7.23% for the nine months ended September 30, 2003 compared to 6.69% for the
same period in 2004. Average interest bearing liabilities increased by
$62,443,000 or 12.6% for the nine months ended September 30, 2004 compared to
the same period in 2003 while the average rate paid on those liabilities
decreased 24 basis points from 1.57% to 1.33%. The Company's net interest margin
(FTE) decreased from 4.81% for the nine month period ended September 30, 2003 to
4.59% for the same period ended September 30, 2004. The Company's net interest
margin (FTE) for the third quarter of 2004 was 4.55%, flat compared to the same
period a year ago. On a sequential-quarter basis, the Company's net interest
margin decreased from 4.59% for the second quarter of 2004 compared to the 4.55%
achieved in the third quarter of 2004.
The following table is a summary of the Company's net interest margin
(FTE) for the periods indicated:
Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Yield on earning assets 5.71% 6.13% 5.64% 5.75%
Rate paid on interest-bearing
liabilities 1.33% 1.57% 1.28% 1.44%
---- ---- ---- ----
Net interest spread 4.39% 4.56% 4.36% 4.31%
==== ==== ==== ====
Net interest margin 4.59% 4.81% 4.55% 4.55%
==== ==== ==== ====
Noninterest Income
- ------------------
The following table is a summary of the Company's noninterest income
for the periods indicated:
Nine months ended Three months ended
Noninterest Income September 30, September 30,
-------------------------- --------------------------
(In thousands) 2004 2003 2004 2003
----------- ----------- ----------- -----------
Service charges on deposit accounts $ 3,933 $ 3,575 $ 1,367 $ 1,149
Other fees and charges 1,680 1,591 581 529
Gain on sale of loans 9 1,442 5 370
Gain on sale or calls of securities 22 201 -- 45
Other 1,466 1,732 446 574
----------- ----------- ----------- -----------
Total noninterest income $ 7,110 $ 8,541 $ 2,399 $ 2,667
=========== =========== =========== ===========
Non-interest income decreased from $8,541,000 for the nine months ended
September 30, 2003 to $7,110,000 for the same period in 2004. Service charges on
deposits increased $358,000 from the nine months ended September 30, 2003 to the
same period in 2004. Other fees and charges also increased from $1,591,000 for
the nine months ended September 30, 2003 to $1,680,000 for the same period in
2004 due to normal growth. The Company recorded $1,442,000 in gains on sales of
mortgages and $201,000 in gains on sales of securities for the nine months ended
15
September 30, 2003 compared to $9,000 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 $1,732,000 for the nine months ended September 30, 2003 to $1,466,000 for
the same period in 2004. The decrease in other income was primarily due to a
decrease on the market 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. As of December 31, 2003, the Company
reverted back to holding all loans originated within the loan portfolio.
Noninterest Expense
- -------------------
The following table is a summary of the Company's noninterest expense
for the periods indicated:
Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
(In thousands) 2004 2003 2004 2003
----------- ----------- ----------- -----------
Salaries & employee benefits $ 10,504 $ 10,122 $ 3,611 $ 3,445
Equipment expense 1,601 1,954 517 594
Occupancy expense 1,365 1,303 481 467
Marketing 584 805 200 254
Data processing expense 716 126 351 46
ATM expense 578 729 170 231
Printing & supplies 410 399 146 118
Postage 331 384 76 120
Messenger expense 287 250 107 85
Professional services 597 740 191 255
Other 3,281 3,732 1,154 1,284
----------- ----------- ----------- -----------
Total Noninterest expense $ 20,254 $ 20,544 $ 7,004 $ 6,899
=========== =========== =========== ===========
Noninterest expense totaled $20,254,000 for the nine months ended
September 30, 2004, compared to $20,544,000 for the same period in 2003. This
represents a reduction of $290,000 or 1.4% from 2003 levels. Salaries and
benefits increased by $382,000 or 3.8% to $10,504,000 for the nine months ended
September 30, 2004 compared to $10,122,000 for the same period in 2003. The
increase in salary expense was due to merit increases and the effect of one
month of operations of YCB partially offset by selective staff reductions.
Equipment expense decreased from $1,954,000 in 2003 to $1,601,000 in 2004
primarily due to additional expenses in 2003 associated with the Company's new
core operating system after the system conversion in late 2002. Data processing
expenses increased from $126,000 in 2003 to $716,000 in 2004 due to the
outsourcing in early 2004 of the Company's local area network administration.
Most other expense categories for the nine months ended September 30, 2004
experienced relatively small decreases or increases from the same respective
periods in 2003. The Company's ratio of noninterest expense to average assets
was 3.59% for the nine months ended September 30, 2004 compared to 4.11% for the
same period in 2003.
Income Taxes
- ------------
The provision for income taxes for the nine months ended September 30,
2004 was $2,615,000 as compared to $2,696,000 for the same period in 2003. The
effective income tax rate for state and federal income taxes was 29.9% for the
nine months ended September 30, 2004 compared to 30.8% for the same period in
2003. 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'.
16
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 September 30, 2004, the recorded investment in loans and leases for
which impairment had been recognized was approximately $850,480. Of the 2004
balance, approximately $288,795 has a related valuation allowance of $144,397.
For the year ended December 31, 2003, the average recorded investment in loans
and leases for which impairment had been recognized was approximately
$1,114,539. During the portion of the year that the loans and leases were
impaired, the Company recognized interest income of approximately $8,000 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.
Non-performing assets at September 30, 2004, and December 31, 2003, are
summarized as follows:
September 30, December 31,
2004 2003
----------- -----------
Nonaccrual loans and leases $ 837 $ 1,615
Loans and leases 90 days past due and still
accruing interest 1,349 1,395
----------- -----------
Total nonperforming loans and leases 2,186 3,010
Other real estate 465 --
----------- -----------
Total nonperforming assets $ 2,651 $ 3,010
=========== ===========
Nonaccrual loans and leases to total gross
loans and leases 0.16% 0.43%
Nonperforming loans and leases to total
gross loans and leases 0.43% 0.79%
Total nonperforming assets to total assets 0.32% 0.44%
17
Allowance for Loan and Lease Losses
- -----------------------------------
A summary of the allowance for loan and lease losses at September 30,
2004 and September 30, 2003 is as follows:
September 30, September 30,
(In thousands) 2004 2003
------------- -------------
Balance beginning of period $ 6,493 $ 6,723
Provision for loan and lease losses 216 --
Net charge-offs 459 81
Adjustments (YCB) 1,019 --
------------ ------------
Balance end of period $ 7,269 $ 6,642
============ ============
Allowance for loan and lease losses to nonperforming
loans and leases 332.53% 200.60%
Allowance for loan and lease losses to total gross
loans and leases 1.43% 1.79%
Ratio of net charge-offs to average loans and leases
outstanding (annualized) 0.14% 0.03%
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
allowance. 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 to determine the adjustment to the formula
allowance at September 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
18
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 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 $7,269,000 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.
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 September 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 September 30, 2004. In addition, NVB
is a member of the Federal Home Loan Bank ("FHLB") System providing additional
borrowing capacity of $93,040,000 secured by certain loans and investment
securities as of September 30, 2004. The Company also has a line of credit with
Federal Reserve Bank of San Francisco ("FRB") of $4,204,000 secured by first
deeds of trust on eligible commercial real estate loans and leases. As of
September 30, 2004, borrowings consisted of $1,620,000 in medium-term FHLB
advances, long-term borrowings of $37,500,000 were outstanding with the FHLB,
and $21,650,000 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 $289,470,000 and
$252,146,000 (or 33.5% and 37.2% of total assets) at September 30, 2004 and
December 31, 2003, respectively. The increase in liquid assets is due to growth
in deposits and the addition of YCB although total liquid assets as a percentage
of total assets decreased also due to the YCB acquisition and an increase in
total loans.
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 $677,114,000 and $546,866,000 at September 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.
19
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 nine 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.
20
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 September 30, 2004 As Compared to December 31, 2003
- -----------------------------------------------------------------------------
Total assets at September 30, 2004, were $863,743,000, compared to
$677,693,000 at December 31, 2003. Investment securities and federal funds sold
grew to $251,105,000 at September 30, 2004, compared to $224,010,000 at December
31, 2003. Of the $186,050,000 increase in total assets, $130,734,000 was a
result of the YCB acquisition on August 31, 2004. Of the remaining $55,316,000
increase in total assets, $37,500,000 was as a result of management's decision
in January 2004 to leverage the Company's capital. Specifically, the Company
took out $37.5 million in fixed rate Federal Home Loan Bank advances with
varying maturity dates and invested the proceeds in a combination of ten- and
fifteen-year fixed rate 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
steep which makes this transaction more attractive. This leverage strategy was
carefully analyzed in multiple interest-rate scenarios in order to ensure that
fluctuations in interest rates would not significantly impair the earnings
stream of this strategy.
Net loans and leases, the Company's major component of earning assets,
increased during the first nine months of 2004 to $500,532,000 at September 30,
2004 from $372,660,000 at December 31, 2003. Of the $127,872,000 increase,
$81,922,000 was due to the YCB acquisition and the remainder was organic growth
primarily in the commercial real estate sector. The Company's average loan to
deposit ratio was 68.5% for the year ended December 31, 2003 and 65.9% for the
nine months ended September 30, 2004.
Total deposits increased to $730,372,000 at September 30, 2004 compared
to $598,314,000 at December 31, 2003 of which $96,359,000 was due to the YCB
acquisition and the remaining $35,699,000 increase was primarily organic growth
in noninterest-bearing checking accounts. This change in the deposit mix from
December 31, 2003 has had a positive effect on the Company's interest expense
and has enabled the Company to maintain its net interest margin as rates have
decreased.
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 $64,362,000 as
21
of September 30, 2004, as compared to $46,053,000 at December 31, 2003. The
increase was primarily due to the YCB acquisition which increased common stock
and surplus by $12,676,000 due to the issuance of 741,697 shares of the
Company's common stock. Stockholders' equity also increased due to net income of
$6,124,000 partially offset by cash dividends paid out in the amount of
$2,040,000. Under current regulations, management believes that the Company
meets all capital adequacy requirements and North Valley Bank was considered
well capitalized at September 30, 2004. On October 26, 2004 the Company made a
$2.5 million capital contribution to YCB to fund YCB's continued internal growth
and to maintain YCB's capital ratios at internal policy levels. With this
additional capital, YCB's pro forma capital ratios as of September 30, 2004 were
as follows; Tier 1 Capital to risk-weighted assets, 9.55%, total capital to risk
weighted assets: 10.62% and leverage ratio: 9.28%.
The Company's, North Valley Bank's and Yolo Community 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 September 30, 2004:
Total capital
(to risk weighted assets) $ 73,280 12.17% $ 48,160 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 66,011 10.97% $ 24,080 4.00% N/A N/A
Tier I capital
(to average assets) $ 66,011 8.48% $ 31,151 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 September 30, 2004:
Total capital
(to risk weighted assets) $ 60,879 12.02% $ 40,508 8.00% $ 50,635 10.00%
Tier I capital
(to risk weighted assets) $ 54,644 10.79% $ 20,254 4.00% $ 30,381 6.00%
Tier I capital
(to average assets) $ 54,644 7.36% $ 29,688 4.00% $ 37,110 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%
Yolo Community Bank
As of September 30, 2004:
Total capital
(to risk weighted assets) $ 7,751 8.03% $ 7,721 8.00% $ 9,651 10.00%
Tier I capital
(to risk weighted assets) $ 6,716 6.96% $ 3,861 4.00% $ 5,791 6.00%
Tier I capital
(to average assets) $ 6,716 6.76% $ 3,972 4.00% $ 4,965 5.00%
As of December 31, 2003:
Total capital
(to risk weighted assets) $ 9,688 12.20% $ 6,357 8.00% $ 7,947 10.00%
Tier I capital
(to risk weighted assets) $ 8,773 11.00% $ 3,179 4.00% $ 4,768 6.00%
Tier I capital
(to average assets) $ 8,773 9.1% $ 3,875 4.00% $ 4,844 5.00%
22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
In Management's opinion there has not been a material change in the
Company's market risk profile for the nine months ended September 30, 2004
compared to December 31, 2003. Please see discussion under the caption "Interest
Rate Sensitivity" on page 20.
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 September 30, 2004. Based on this evaluation, the Chief
Executive Officer and the Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective. There was no change in the
Company's internal control over financial reporting that occurred during the
quarter ended September 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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-----------------------------------------------------------
Issuer Purchases of Equity Securities
Period Maximum number
Number of Shares of Shares that
Purchased as Part May Yet Be
of Publicly Purchased Under
Total Number of Average Price Announced Plans the Plans or
Period Shares Purchased Paid per Share or Programs Programs
- ------ ---------------- -------------- ----------------- ---------------
July 1 thru September 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 third quarter of 2004.
23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
Not applicable
ITEM 5. OTHER INFORMATION
-----------------
Not applicable
ITEM 6. EXHIBITS
--------
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
September 30, 2004
Exhibit 99.71 Form of Employment Agreement executed in
August 2004 between Yolo Community Bank
and John DiMichele
24
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NORTH VALLEY BANCORP
- --------------------
(Registrant)
Date: November 9, 2004
----------------
By: /s/ MICHAEL J. CUSHMAN
-----------------------------------
Michael J. Cushman
President & Chief Executive Officer
By: /s/ EDWARD J. CZAJKA
-----------------------------------
Edward J. Czajka
Executive Vice President &
Chief Financial Officer
25