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 March 31, 2005.
[ ] 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
- ---------------------------------------- ----------
(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 -7,415,825 shares as of May 9, 2005.
INDEX
NORTH VALLEY BANCORP AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets--
March 31, 2005 and December 31, 2004 3
Condensed Consolidated Statements of Income--
For the Three months Ended March 31, 2005 and 2004 4
Condensed Consolidated Statements of Cash Flows--
For the Three months Ended March 31, 2005 and 2004 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 24
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings 24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits 25
SIGNATURES
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands except share amounts)
March 31, December 31,
ASSETS 2005 2004
------------ ------------
Cash and due from banks $ 36,207 $ 23,575
Federal funds sold 21,850 640
------------ ------------
Total cash and cash equivalents 58,057 24,215
Interest-bearing deposits in other financial institutions -- 500
Investment securities:
Available for sale, at fair value 188,787 218,961
Held to maturity, at amortized cost 132 133
Loans and leases, net of allowance for loan and
lease losses of $7,367 at March 31, 2005 and
$7,217 at December 31, 2004 566,024 546,128
Premises and equipment, net of accumulated
depreciation and amortization 15,169 13,927
Other real estate 32 --
FHLB and FRB stock and other securities 5,080 4,826
Core deposit intangibles, net 3,025 3,188
Goodwill 15,611 15,281
Cash surrender of life insurance 27,805 27,541
Accrued interest receivable & other assets 12,457 11,531
------------ ------------
TOTAL ASSETS $ 892,179 $ 866,231
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing demand $ 177,850 $ 165,595
Interest-bearing:
Demand deposits 196,648 187,738
Savings and money market 214,756 200,628
Certificates of deposit 155,742 157,693
------------ ------------
Total deposits 744,996 711,654
Other borrowed funds 50,166 57,594
Accrued interest and other liabilities 8,943 9,884
Subordinated debentures 21,651 21,651
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Total liabilities 825,756 800,783
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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 7,415,825 and 7,311,726 at
March 31, 2005 and December 31, 2004 38,765 37,917
Retained earnings 29,922 28,403
Accumulated other comprehensive loss, net of tax (2,264) (872)
------------ ------------
Total stockholders' equity 66,423 65,448
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 892,179 $ 866,231
============ ============
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 three months ended
March 31,
---------------------------
2005 2004
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INTEREST INCOME:
Loans and leases including fees $ 9,457 $ 6,493
Securities:
Taxable 1,688 1,883
Exempt from federal taxes 311 407
Federal funds sold 171 63
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Total interest income 11,627 8,846
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INTEREST EXPENSE:
Deposits 1,252 1,141
Subordinated debentures 411 354
Other borrowings 366 307
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Total interest expense 2,029 1,802
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NET INTEREST INCOME 9,598 7,044
PROVISION FOR LOAN AND LEASE LOSSES 270 --
------------ ------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 9,328 7,044
NONINTEREST INCOME:
Service charges on deposit accounts 1,133 1,372
Other fees and charges 568 535
Earnings on cash surrender value of life insurance policies 277 323
Gain on sale of loans 47 --
Gain on sales or calls of securities 93 8
Other 332 223
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Total noninterest income 2,450 2,461
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NONINTEREST EXPENSES:
Salaries and employee benefits 4,682 3,421
Occupancy 627 430
Equipment 561 572
Other 2,564 2,167
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Total noninterest expenses 8,434 6,590
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INCOME BEFORE PROVISION FOR INCOME
TAXES 3,344 2,915
PROVISION FOR INCOME TAXES 1,085 841
------------ ------------
NET INCOME $ 2,259 $ 2,074
============ ============
EARNINGS PER SHARE:
Basic $ 0.31 $ 0.32
============ ============
Diluted $ 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 three months ended
March 31,
---------------------------
2005 2004
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CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 2,259 $ 2,074
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 530 469
Amortization of premium on securities 51 4
Amortization of core deposit intangible 163 126
Provision for loan and lease losses 270
Gain on sale or calls of securities (93) (8)
Gain on sale of loans (47)
Stock-based compensation expense 53 130
Effect of changes in:
Accrued interest receivable 600 (228)
Other assets (1,451) 129
Accrued interest and other liabilities (1,324) 106
------------ ------------
Net cash provided by operating activities 1,011 2,802
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CASH FLOWS FROM INVESTING ACTIVITIES:
Net changes in FHLB and FRB stock and
other securities 43 (876)
Purchases of available for sale securities (50,755)
Proceeds from sales of available for sale securities 20,033
Proceeds from maturities/calls of available for
sale securities 7,826 6,000
Net decrease in interest-bearing deposits
at financial institutions 500 123
Net increase in loans and leases (20,151) (27,716)
Purchases of premises and equipment, net (1,772) (217)
Proceeds from sale of premises and equipment -- --
------------ ------------
Net cash used in investing activities 6,479 (73,441)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 33,342 10,324
Proceeds from issuance of subordinated debentures
Net (decrease) increase in Federal funds purchased
and other borrowed funds (7,428) 37,924
Cash dividends paid (653)
Cash received for stock options exercised 438 289
------------ ------------
Net cash provided by financing activities 26,352 47,884
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH 33,842 (22,755)
EQUIVALENTS
CASH AND CASH EQUIVALENTS, BEGINNING
OF YEAR 24,215 59,523
------------ ------------
CASH AND CASH EQUIVALENTS, END OF
PERIOD $ 58,057 $ 36,768
============ ============
5
ADDITIONAL INFORMATION:
Cash paid during the period for:
Interest $ 1,469 $ 1,906
============ ============
Income taxes $ 1,313 $ 825
============ ============
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, 2004.
Operating results for the three months ended March 31, 2005 are not necessarily
indicative of the results that may be expected for any subsequent period or for
the year ended December 31, 2005.
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, NVB Business
Bank ("NVBBB") formerly known as 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 March 31, 2005 and December 31, 2004, 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)
- ----------------------------- ------------ ------------ ------------ ------------
March 31, 2005
- --------------
Securities of U.S. government
agencies and corporations $ 16,123 $ 3 $ (301) $ 15,825
Obligations of states and political
subdivisions 24,363 643 (125) 24,881
Mortgage backed securities 129,162 97 (3,355) 125,904
Corporate securities 7,990 82 (8) 8,064
Other securities 15,088 26 (1,001) 14,113
------------ ------------ ------------ ------------
$ 192,726 $ 851 $ (4,790) $ 188,787
============ ============ ============ ============
December 31, 2004
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Securities of U.S. government
agencies and corporations $ 19,118 $ 17 $ (211) $ 18,924
Obligations of states and political
subdivisions 30,147 1,035 (46) 31,136
Mortgage backed securities 148,160 206 (1,812) 146,554
Corporate securities 7,989 104 8,093
Other securities 15,127 34 (907) 14,254
------------ ------------ ------------ ------------
$ 220,541 $ 1,396 $ (2,976) $ 218,961
============ ============ ============ ============
7
Carrying
Amount Gross Gross
(Amortized Unrealized Unrealized
Held to maturity securities: Cost) Gains Losses Fair Value
- --------------------------- ------------ ------------ ------------ ------------
March 31, 2005
- --------------
Obligation of states and political
subdivisions $ 132 $ -- $ (2) $ 130
============ ============ ============ ============
Carrying
Amount Gross Gross
(Amortized Unrealized Unrealized
Cost) Gains Losses Fair Value
------------ ------------ ------------ ------------
December 31, 2004
- -----------------
Obligation of states and political
subdivisions $ 133 $ -- $ (2) $ 131
============ ============ ============ ============
Gross realized gains on sales or calls of available for sale securities
were $273,000 and $8,000 for the three months ended March 31, 2005 and 2004.
Gross realized losses on sales or calls of available for sale securities for the
three months ended March 31, 2005 were $180,000. There were no gross realized
losses on sales or calls of available for sale securities for the three months
ended March 31, 2004.
There were no sales or transfers of held to maturity securities for the
three months ended March 31, 2005 and 2004.
At March 31, 2005 and December 31, 2004, securities having fair value
amounts of approximately $145,150,000 and $100,973,000 were pledged to secure
public deposits, short-term borrowings, treasury, tax and loan balances and for
other purposes required by law or contract.
Investment securities are evaluated for other-than-temporary impairment
on at least a quarterly basis and more frequently when economic or market
conditions warrant such an evaluation to determine whether a decline in their
value below amortized cost is other than temporary. Management utilizes criteria
such as the magnitude and duration of the decline and the intent and ability of
the Bank to retain its investment in the issues for a period of time sufficient
to allow for an anticipated recovery in fair value, in addition to the reasons
underlying the decline, to determine whether the loss in value is other than
temporary. The term "other than temporary" is not intended to indicate that the
decline is permanent, but indicates that the prospects for a near-term recovery
of value is not necessarily favorable, or that there is a lack of evidence to
support a realizable value equal to or greater than the carrying value of the
investment. Once a decline in value is determined to be other than temporary,
the value of the security is reduced and a corresponding charge to earnings is
recognized.
At March 31, 2005, the Company held $155,131,000 of available for sale
investment securities in an unrealized loss position of which $76,115,000 were
in a loss position for less than twelve months and $79,016,000 were in a loss
position and had been in a loss position for twelve months or more. Management
periodically evaluates each investment security for other than temporary
impairment, 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 considered
temporary and due only to interest rate fluctuations.
Included in the above securities at March 31, 2005 were 100,000 shares
of FNMA, Series M perpetual preferred stock. The coupon rate is fixed at 4.75%
with a taxable-equivalent yield of 5.38%. The securities are owned at par, or
$50.00 per share, for a total investment of $5,000,000 and an unrealized loss of
$910,000 at March 31, 2005. The securities are callable at par on June 1, 2008.
The market value per share as of March 31, 2005 was $42.15 per share.
Management carefully evaluated the FNMA preferred stock to determine
whether the decline in fair value below book value of these securities is
other-than-temporary. Among other items, management reviewed relevant accounting
literature which included SFAS No. 115, Statement of Auditing Standard ("SAS")
92, and Staff Accounting Bulletin ("SAB") No. 59. In conducting this assessment,
management evaluated a number of factors including, but not limited to:
8
o How far fair value has declined below book value
o How long the decline in fair value has existed
o The financial condition of the issuer
o Rating agency changes on the issuer
o Management's intent and ability to hold the security for a period of
time sufficient to allow for any anticipated recovery in fair value
Based on this evaluation, management concluded that these securities
were deemed to be temporarily impaired. Management's assessment weighed heavily
on the duration of the loss, normal market fluctuations during this holding
period, FNMA's response to its weaker financial condition, analysis of FNMA by
rating agencies and investment bankers and the prospects for changes in
long-term interest rates.
NOTE C - STOCK-BASED COMPENSATION
At March 31, 2005, 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.
9
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.
Three months ended March 31,
---------------------------
(in thousands except per share data) 2005 2004
------------ ------------
Net income, as reported $ 2,259 $ 2,074
Add: total stock-based compensation expense included in net
Income, net of tax 31 22
Deduct: total stock-based compensation expense
determined under the fair value based method for all
awards, net of related tax effects (78) (70)
------------ ------------
Net income, pro forma $ 2,212 $ 2,026
Basic earnings per common share:
As reported $ 0.31 $ 0.32
Pro forma $ 0.30 $ 0.31
Diluted earnings per common and equivalent share:
As reported $ 0.29 $ 0.30
Pro forma $ 0.28 $ 0.30
- --------------------------------------------------------------------------------
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:
Three months ended March 31,
---------------------------
2005 2004
------------ ------------
Dividend yield 2.28% 2.74%
Expected volatility 15.29% 16.21%
Risk-Free interest rate 3.58% 5.00%
Expected option life 7 years 7 years
10
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 (loss) 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:
Three months ended March 31,
---------------------------
(in thousands) 2005 2004
------------ ------------
Net income $ 2,259 $ 2,074
Other comprehensive (loss) income, net of tax:
Holding (loss) income arising during period (1,337) 1,704
Reclassification adjustment (55) (5)
------------ ------------
(1,392) 1,699
------------ ------------
Total comprehensive income $ 867 $ 3,773
============ ============
NOTE E - EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income by the
weighted average common shares outstanding for the period. Diluted earnings per
share reflect the potential dilution that could occur if options or other
contracts to issue common stock were exercised and converted into common stock.
There was no difference in the numerator, net income, used in the
calculation of basic earnings per share and diluted earnings per share. The
denominator used in the calculation of basic earnings per share and diluted
earnings per share for the three month periods ended March 31, 2005 and 2004 is
reconciled as follows:
Three months ended March 31,
---------------------------
(In thousands except earnings per share) 2005 2004
------------ ------------
Calculation of Basic Earnings Per Share
Numerator - net income $ 2,259 $ 2,074
Denominator - weighted average common
shares outstanding 7,339 6,504
------------ ------------
Basic Earnings Per Share $ 0.31 $ 0.32
============ ============
Calculation of Diluted Earnings Per Share
Numerator - net income $ 2,259 $ 2,074
Denominator - weighted average common
shares outstanding 7,339 6,504
Dilutive effect of outstanding options 463 393
------------ ------------
7,802 6,897
------------ ------------
Diluted Earnings Per Share $ 0.29 $ 0.30
============ ============
11
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 March 31,
2005 and 2004 are presented in the following table.
Three months ended March 31,
---------------------------
(in thousands) 2005 2004
------------ ------------
Components of Net Periodic Cost:
Service cost $ 66 $ 71
Interest cost 48 43
Amortization of unrecognized net transition
obligation 7 6
Amortization of prior service cost 9 8
Recognized net actuarial gain -- --
------------ ------------
Total Components of Net Periodic Cost $ 130 $ 128
============ ============
NOTE G - ACCOUNTING FOR CERTAIN LOANS OR DEBT SECURITIES ACQUIRED IN A TRANSFER
In December 2003, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
03-03, Accounting for Certain Loans or Debt Securities Acquired in a Transfer
(the "SOP"). This SOP addresses accounting for differences between contractual
cash flows and cash flows expected to be collected from an investor's initial
investment in loans or debt securities (loans) acquired in a transfer if those
differences are attributable, at least in part, to credit quality. It also
includes such loans acquired in purchase business combinations. This SOP does
not apply to loans originated by the entity. This SOP limits the yield that may
be accreted and requires that the excess of contractual cash flows over cash
flows expected to be collected not be recognized as an adjustment of yield, loss
accrual, or valuation allowance.
This SOP prohibits "carrying over" or creation of valuation allowances
in the initial accounting for loans acquired in a transfer that are within the
scope of this SOP. The prohibition of the valuation allowance carryover applies
to the purchase of an individual loan, a pool of loans, a group of loans, and
loans acquired in a purchase business combination. This SOP was adopted by the
Company on January 1, 2005 for loans acquired in a transfer thereafter. In
management's opinion, the adoption of this pronouncement did not have a material
impact on the Company's financial position or results of operations.
NOTE H: - SHARE-BASED PAYMENTS
In December 2004, the Financial Accounting Standards Board issued
Statement Number 123 (revised 2004) ("FAS 123 (R)"), Share-Based Payments. FAS
123 (R) requires all entities to recognize compensation expense in an amount
equal to the fair value of share-based payments such as stock options granted to
employees. In April 2005, the Securities and Exchange Commission adopted a rule
deferring compliance with the effective date of FAS 123(R) from the first
reporting period after June 15, 2005 to the first fiscal year beginning after
June 15, 2005, effectively January 1, 2006, for the Company. Management believes
that the effect of FAS 123 (R) will be consistent with its pro forma disclosures
included in Note C to these Unaudited Consolidated Financial Statements.
12
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.
Share Based Payments
At December 31, 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, which are
described more fully in Note 14 to the Consolidated Financial Statements
included herein in Item 15 - Financial Statements and Supplementary Data. 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 employee compensation cost is reflected
13
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. For
further information regarding the proforma effect on reported net income and
earnings per share as if the Company had elected to recognize compensation cost
based on the fair value of the options granted at the date of grant as
prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation", see Note
1 to the Consolidated Financial Statements in Item 15 - Financial Statements and
Supplementary Data.
In December 2004, the Financial Accounting Standards Board issued
Statement Number 123 (revised 2004) ("FAS 123 (R)"), Share-Based Payments. FAS
123 (R) requires all entities to recognize compensation expense in an amount
equal to the fair value of share-based payments such as stock options granted to
employees. In April 2005, the Securities and Exchange Commission adopted a rule
amending the effective date of FAS 123(R) from the first reporting period after
June 15, 2005 to the first fiscal year beginning after June 15, 2005,
effectively January 1, 2006, for the Company. Management believes that the
effect of FAS 123 (R) will be consistent with its pro forma disclosures included
in Note C to these Unaudited Consolidated Financial Statements.
Critical assumptions that are assessed in computing the fair value of
share-based payments include stock price volatility, expected dividend rates,
forfeiture rates and the expected lives of such options.
Goodwill
Business combinations involving the Company's acquisition of the equity
interests or net assets of another enterprise may give rise to goodwill.
Goodwill represents the excess of the cost of an acquired entity over the net of
the amounts assigned to assets acquired and liabilities assumed in transactions
accounted for under the purchase method of accounting. Goodwill of $15,281,000
was recorded in the Company's acquisition of NVBBB. The value of goodwill is
ultimately derived from the Company's ability to generate net earnings after the
acquisition. A decline in net earnings could be indicative of a decline in the
fair value of goodwill and result in impairment. For that reason, goodwill will
be assessed for impairment at a reporting unit level at least annually.
Management will conduct its first assessment of impairment during the third
quarter of 2005 or earlier if events and circumstances warrant such an
assessment.
Impairment of Investment Securities
Investment securities are evaluated for other-than-temporary impairment
on at least a quarterly basis and more frequently when economic or market
conditions warrant such an evaluation to determine whether a decline in their
value below amortized cost is other than temporary. Management utilizes criteria
such as the magnitude and duration of the decline, the financial condition of
the issuer, rating agency changes related to the issuer's securities and the
intent and ability of the Bank to retain its investment in the issues for a
period of time sufficient to allow for an anticipated recovery in fair value, in
addition to the reasons underlying the decline, to determine whether the loss in
value is other than temporary. The term "other than temporary" is not intended
to indicate that the decline is permanent, but indicates that the prospects for
a near-term recovery of value is not necessarily favorable, or that there is a
lack of evidence to support a realizable value equal to or greater than the
carrying value of the investment. Once a decline in value is determined to be
other than temporary, the value of the security is reduced and a corresponding
charge to earnings equal is recognized.
Overview
- --------
North Valley Bancorp (the "Company") is a bank holding company for
North Valley Bank ("NVB") and, since September 1, 2004, NVB Business Bank
("NVBBB"), formerly known as Yolo Community Bank. both state-chartered banks.
NVB operates out of its main office located at 300 Park Marina Circle, Redding,
CA 96001, with twenty-one branches, including two supermarket branches in
Northern California. NVBBB, acquired in a business combination more fully
described in Note 2 to the financial statements contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 2004, 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.
14
Earnings Summary
- ----------------
Three months ended March 31,
---------------------------
(in thousands except per share amounts) 2005 2004
------------ ------------
Net interest income $ 9,598 $ 7,044
Provision for loan and lease losses 270 --
Noninterest income 2,450 2,461
Noninterest expense 8,434 6,590
Provision for income taxes 1,085 841
------------ ------------
Net income $ 2,259 $ 2,074
============ ============
Earnings Per Share
Basic $ 0.31 $ 0.32
Diluted $ 0.29 $ 0.30
Annualized Return on Average Assets 1.00% 1.17%
Annualized Return on Average Equity 13.74% 17.75%
For the three months ended March 31, 2005, the Company recognized a
$270,000 provision for loan and lease losses compared to no provision recorded
in the same period in 2004. 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 March 31, 2005 of $7,367,000 or 1.28% of total loans and
leases is adequate at this time. The allowance for loan and lease losses was
$7,217,000 or 1.30% of total loans and leases at December 31, 2004. For further
information regarding our allowance for loan and lease losses, see "Allowance
for Loan and Lease Losses" on page 19.
Net Interest Income
- -------------------
Net interest income is the principal source of the Company's operating
earnings and represents the difference between interest earned on loans and
leases and other investments and interest paid on deposits and other borrowings.
The amount of interest income and expense is affected by changes in the volume
and mix of earning assets and interest-bearing deposits, along with changes in
interest rates.
The following table is a summary of the Company's net interest income,
presented on a fully taxable equivalent (FTE) basis for tax-exempt investments
included in earning assets, for the periods indicated:
Three months ended March 31,
---------------------------
(In thousands) 2005 2004
------------ ------------
Interest income $ 11,627 $ 8,846
Less: Interest expense 2,029 1,802
FTE adjustment 198 165
------------ ------------
Net interest income (FTE) $ 9,796 $ 7,209
============ ============
Net interest income has been adjusted to a fully taxable equivalent
basis (FTE) for tax-exempt investments included in earning assets. The increase
in net interest income (FTE) for the three-month period ended March 31, 2005
resulted primarily from a much larger average interest-earning asset base due
mostly to the NVBBB acquisition. Management is 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. In the latter
part of 2004 and into the first quarter of 2005, the Company's net interest
margin has expanded. This is in large part due to the loan growth that has taken
place during that same time frame in addition to the NVBBB acquisition on August
31,2004. Currently the Company is selling all fixed-rate 15-and 30-year
residential mortgages in order to minimize the Company's interest rate risk and
to generate consistent mortgage fee income.
While average interest earning assets for the three months ended March
31, 2005 increased by $152,718,000 or 23.5% from the same period last year,
yields on average earning assets also increased 42 basis points from 5.59% to
6.01%. Yields in the first quarter of 2005 increased by 1.33% on fed funds sold,
0.14% on investment securities, and 0.25% on loans compared to the same period
15
in 2004. Average interest bearing liabilities increased by $109,766,000 or 20.6%
for the three months ended March 31, 2005 compared to the same period in 2004
while the average rate paid on those liabilities decreased by 4 basis points
from 1.36% to 1.32%. The Company's net interest margin (FTE) increased from
4.47% for the three month period ended March 31,2004 to 4.96% for the same
period in 2005.
The following table is a summary of the Company's net interest margin
(FTE) for the periods indicated:
Three months ended March 31,
---------------------------
2005 2004
------------ ------------
Yield on earning assets 6.01% 5.59%
Rate paid on interest-bearing liabilities 1.32% 1.36%
------------ ------------
Net interest spread 4.69% 4.23%
============ ============
Net interest margin 4.96% 4.47%
============ ============
Noninterest Income
- ------------------
The following table is a summary of the Company's noninterest income
for the periods indicated:
Three months ended March 31,
Noninterest Income ---------------------------
(In thousands) 2005 2004
------------ ------------
Service charges on deposit accounts $ 1,133 $ 1,372
Other fees and charges 568 535
Earnings on cash surrender value of life
insurance policies 277 323
Gain on sale of loans 47 --
Gain on sale or calls of securities 93 8
Other 332 223
------------ ------------
Total noninterest income $ 2,450 $ 2,461
============ ============
Non-interest income decreased slightly from $2,461,000 for the three
months ended March 31, 2004 to $2,450,000 for the same period in 2005. Service
charges on deposits decreased $239,000 from the three months ended March 31,
2004 to the same period in 2005. This decrease was due mainly to management's
decision to discontinue the annual ATM card fee. Historically, North Valley Bank
has imposed an annual $12 charge per ATM card issued. This fee was typically
assessed in January of each year and in 2004 this fee totaled $257,000 in income
to the Company. Other fees and charges increased from $535,000 for the three
months ended March 31, 2004 to $568,000 for the same period in 2005 due to
organic growth. Earnings on cash surrender value of life insurance policies
decreased to $277,000 for the first quarter of 2005 compared to $323,000 for the
same period in 2004 due to lower earnings rates. The Company recorded $47,000 in
gains on sales of mortgages and $93,000 in gains on sales of securities for the
three months ended March 31, 2005 compared to $8,000 in gains on calls of
securities for the same period in 2004. Other income increased to $332,000 for
the three months ended March 31, 2005 from $223,000 for the same period in 2004.
The increase in other income was primarily due to an increase in fees earned
associated with the Company's investment sales.
Noninterest Expense
- -------------------
The following table is a summary of the Company's noninterest expense
for the periods indicated:
Three months Ended March 31,
---------------------------
(In thousands) 2005 2004
------------ ------------
Salaries & employee benefits $ 4,682 $ 3,421
Equipment expense 561 572
Occupancy expense 627 430
Marketing 198 211
Data processing expenses 319 138
ATM expense 202 203
Printing & supplies 160 125
Postage 111 126
Messenger expense 92 85
Professional services 314 206
Other 1,168 1,073
------------ ------------
Total Noninterest expense $ 8,434 $ 6,590
============ ============
Noninterest expense totaled $8,434,000 for the three months ended March
31, 2005, compared to $6,590,000 for the same period in 2004. This represents an
increase of $1,844,000 or 28.0% from 2004 levels. Salaries and benefits
16
increased by $1,261,000 or 36.9% to $4,682,000 for the three months ended March
31, 2005 compared to $3,421,000 for the same period in 2004. The increase is due
in large part to the additional operations of NVBBB as well as the additional
branches in Santa Rosa and Ukiah that commenced operations in April of 2005. In
addition, $286,000 of salary expense was due to severance costs associated with
a former Company executive and are of a nonrecurring nature. Equipment expense
decreased slightly as core system efficiencies continue to be gained. Data
processing expenses increased from $138,000 in 2004 to $319,000 in 2005 due to
the outsourcing in early 2004 of the Company's local area network
administration. Professional services expense increased as the Company engaged a
new internal audit firm as well as ongoing Sarbanes-Oxley Section 404 testing
costs. Most other expense categories for the three months ended March 31, 2005
experienced relatively small decreases or increases from the same respective
periods in 2004. The Company's ratio of noninterest expense to average assets
was 3.73% for the three months ended March 31, 2005 compared to 3.71% for the
same period in 2004.
Income Taxes
- ------------
The provision for income taxes for the three months ended March 31,
2005 was $1,085,000 as compared to $841,000 for the same period in 2004. The
effective income tax rate for state and federal income taxes was 32.4% for the
three months ended March 31, 2005 compared to 28.9% for the same period in 2004.
The increase in the effective tax rate is due to higher overall revenues in the
Company but the same or slightly lower level of revenues that are exempt from
federal taxes in the first quarter of 2005 compared to the same period in 2004.
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.
At March 31, 2005, the recorded investment in loans and leases for
which impairment had been recognized was approximately $1,088,000. Of the 2005
balance, approximately $309,000 has a related valuation allowance of $154,000.
For the three months ended March 31, 2005, the average recorded investment in
loans and leases for which impairment had been recognized was approximately
$1,088,000. During the portion of the year that the loans and leases were
impaired, the Company recognized interest income of approximately $1,700 for
cash payments received in 2005.
At December 31, 2004, the recorded investment in loans and leases for
which impairment had been recognized was approximately $1,202,000. Of the 2004
balance, approximately $403,000 has a related valuation allowance of $202,000.
For the year ended December 31, 2004, the average recorded investment in loans
and leases for which impairment had been recognized was approximately
$1,136,000. During the portion of the year that the loans and leases were
impaired, the Company recognized interest income of approximately $18,000 for
cash payments received in 2004.
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 March 31, 2005, and December 31, 2004, are
summarized as follows:
17
March 31, December 31,
2005 2004
------------ ------------
Nonaccrual loans and leases $ 1,079 $ 1,155
Loans and leases 90 days past due and still accruing
interest 374 1,015
------------ ------------
Total nonperforming loans and leases 1,453 2,170
Other real estate 32 --
------------ ------------
Total nonperforming assets $ 1,485 $ 2,170
============ ============
Nonaccrual loans and leases to total gross loans and 0.19% 0.15%
leases
Nonperforming loans and leases to total gross loans and 0.25% 0.39%
leases
Total nonperforming assets to total assets 0.17% 0.21%
18
Allowance for Loan and Lease Losses
- -----------------------------------
A summary of the allowance for loan and lease losses at March 31, 2005
and March 31, 2004 is as follows:
March 31, March 31,
2005 2004
------------ ------------
(In thousands)
Balance beginning of period $ 7,217 $ 6,493
Provision for loan and lease losses 270
Net charge-offs 120 74
------------ ------------
Balance end of period $ 7,367 $ 6,419
============ ============
Allowance for loan and lease losses to nonperforming
loans and leases 507.02% 196.66%
Allowance for loan and lease losses to total gross
loans and leases 1.28% 1.58%
Ratio of net charge-offs to average loans and leases
outstanding (annualized) 0.09% 0.08%
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 March 31, 2005 included
the following, which existed at the balance sheet date:
o General business and economic conditions effecting
the Company's key lending areas
o Real estate values in Northern California
o Loan volumes and concentrations, including trends in
past due and nonperforming loans
o Seasoning of the loan portfolio
o Status of the current business cycle
o Specific industry or market conditions within
portfolio segments
o Model imprecision
19
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 $7,367,000 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 of $23,000,000 as of March 31, 2005 were available to
provide liquidity. The Company has a revolving, unsecured line of credit for
$8,000,000 with a correspondent bank as of March 31, 2005. In addition, NVB is a
member of the Federal Home Loan Bank ("FHLB") System providing additional unused
borrowing capacity of $73,627,000 secured by certain loans and investment
securities as of March 31, 2005. The Company also has a line of credit with
Federal Reserve Bank of San Francisco ("FRB") of $3,003,000 secured by first
deeds of trust on eligible commercial real estate loans and leases. As of March
31, 2005, borrowings consisted of $12,666,000 in medium-term FHLB advances,
long-term borrowings of $37,500,000 were outstanding with the FHLB, 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 $247,273,000 and
$243,809,000 (or 27.7% and 28.1% of total assets) at March 31, 2005 and December
31, 2004, respectively.
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 $693,741,000 and $661,926,000 at March 31, 2005
and December 31, 2004, respectively.
In assessing liquidity, historical information such as seasonal loan
demand, local economic cycles and the economy in general are considered along
with current ratios, management goals and unique characteristics of the Company.
Management believes the Company is in compliance with its policies relating to
liquidity.
Interest Rate Sensitivity
- -------------------------
The Company constantly monitors earning asset and deposit levels,
developments and trends in interest rates, liquidity, capital adequacy and
marketplace opportunities. Management responds to all of these to protect and
possibly enhance net interest income while managing risks within acceptable
levels as set forth in the Company's policies. In addition, alternative business
plans and contemplated transactions are also analyzed for their impact. This
process, known as asset/liability management, is carried out by changing the
maturities and relative proportions of the various types of loans, investments,
deposits and other borrowings in the ways prescribed above.
20
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.
21
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, 2004.
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 March 31, 2005 As Compared to December 31, 2004
- -------------------------------------------------------------------------
Total assets at March 31, 2005, were $892,179,000, compared to
$866,231,000 at December 31, 2004. Investment securities, interest-bearing
deposits in other financial institutions, and federal funds decreased to
$210,769,000 at March 31, 2005, compared to $220,234,000 at December 31, 2004.
The $25,948,000 increase in total assets was driven by a $33,342,000 increase in
total deposits which allowed the Company to pay down $7,428,000 in borrowings.
In addition, the Company sold approximately $20 million in investment securities
to continue to fund the Company's loan growth.
Net loans and leases, the Company's major component of earning assets,
increased during the first three months of 2005 to $566,024,000 at March 31,
2005 from $546,128,000 at December 31, 2004. This represents an annualized
growth rate of 14.6% but Management believes that loan demand and loan growth
will increase over first quarter growth levels during the remainder of 2005. The
Company's average loan to deposit ratio was 75.4% for the quarter ended March
31, 2005 compared to 63.8% for the same period in 2004.
Total deposits increased to $744,996,000 at March 31, 2005 compared to
$711,654,000 at December 31, 2004. Savings and money market accounts increased
$14,128,000 or 7.0% and noninterest-bearing demand deposits increased
$12,255,000 or 7.4% from December 31, 2004 levels. This growth along with a
slight decrease in certificates of deposits have continued to have a favorable
effect on the Company's interest expense and has enabled the Company to expand
the net interest margin as rates have increased.
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 $66,423,000 as
of March 31, 2005, as compared to $65,448,000 at December 31, 2004. The increase
was primarily due to net income of $2,259,000 partially offset by cash dividends
paid out in the amount of $740,000. Under current regulations, management
believes that the Company meets all capital adequacy requirements and North
Valley Bank was considered well capitalized at March 31, 2005.
22
The Company's, North Valley Bank's and NVB Business 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 March 31, 2005:
Total capital
(to risk weighted assets) $ 77,350 11.61% $ 53,320 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 69,984 10.50% $ 26,660 4.00% N/A N/A
Tier I capital
(to average assets) $ 69,984 7.91% $ 35,395 4.00% N/A N/A
As of December 31, 2004:
Total capital
(to risk weighted assets) $ 74,859 11.73% $ 51,036 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 67,642 10.60% $ 25,518 4.00% N/A N/A
Tier I capital
(to average assets) $ 67,642 7.89% $ 34,274 4.00% N/A N/A
North Valley Bank
As of March 31, 2005:
Total capital
(to risk weighted assets) $ 62,524 11.13% $ 44,960 8.00% $ 56,200 10.00%
Tier I capital
(to risk weighted assets) $ 56,248 10.01% $ 22,480 4.00% $ 33,720 6.00%
Tier I capital
(to average assets) $ 56,248 7.39% $ 30,446 4.00% $ 38,057 5.00%
As of December 31, 2004:
Total capital
(to risk weighted assets) $ 62,201 11.59% $ 42,942 8.00% $ 53,678 10.00%
Tier I capital
(to risk weighted assets) $ 56,074 10.45% $ 21,471 4.00% $ 32,207 6.00%
Tier I capital
(to average assets) $ 56,074 7.49% $ 29,953 4.00% $ 37,442 5.00%
NVB Business Bank
As of March 31, 2005:
Total capital
(to risk weighted assets) $ 10,507 10.20% $ 8,242 8.00% $ 10,303 10.00%
Tier I capital
(to risk weighted assets) $ 9,417 9.14% $ 4,121 4.00% $ 6,181 6.00%
Tier I capital
(to average assets) $ 9,417 7.71% $ 4,883 4.00% $ 6,104 5.00%
As of December 31, 2004:
Total capital
(to risk weighted assets) $ 10,521 10.38% $ 8,108 8.00% $ 10,134 10.00%
Tier I capital
(to risk weighted assets) $ 9,431 9.31% $ 4,054 4.00% $ 6,081 6.00%
Tier I capital
(to average assets) $ 9,431 8.73% $ 4,321 4.00% $ 5,401 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 three months ended March 31, 2005 compared
to December 31, 2004. Please see discussion under the caption "Interest Rate
Sensitivity" on page 20.
23
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 March 31, 2005. 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 March 31, 2005 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 or the Plans or
Shares Purchased Paid per Share Programs Programs
---------------- -------------- ------------------- ----------------
January 1 thru March 31, 2005 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 first quarter of 2005.
Item 3. Defaults Upon Senior Securities
Not applicable
24
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits
(a) Exhibits:
Exhibit 31 - Rule 13a-14(a)/15d-14(a) Certifications
Exhibit 31.1 - CEO Rule 13a-14(a)/15d-14(a) Certifications
Exhibit 31.2 - CFO Rule 13a-14(a)/15d-14(a) Certifications
Exhibit 32 - Section 1350 Certifications - Certification
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 with
Respect to the North Valley Bancorp Quarterly Report on Form
10-Q for the Quarter ended March 31, 2005
Exhibit 4(h) - Amended and Restated Declaration of Trust
(North Valley Capital Trust III) dated May 5, 2004
Exhibit 4(i) - Indenture (North Valley Capital Trust III)
dated May 5, 2004
Exhibit 4(j) - Guarantee Agreement for North Valley Capital
Trust III (North Valley Bancorp) dated May 5, 2004
Exhibit 10(aaa) - Fourth Amendment to North Valley Bancorp
Employee Stock Ownership Plan, effective
Exhibit 10(bbb) - Lease for 100 B Street, Suite 360,
Santa Rosa, California, dated April 15, 2005,
between North Valley Bank and Sonja Valentina LLC.
Exhibit 10(ccc) - Lease for 2515 Park Marina Drive, Suite 102,
Redding, California dated March 15, 2005, between The
McConnell Foundation and North Valley Bancorp.
25
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 May 9, 2005
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