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UNITED STATES
SECURITIES AND EXCHANGE COMISSION
Washington, D.C. 20006
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FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2001
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SIERRA BANCORP
(Exact name of registrant as specified in its charter)
California 94-2431437
State of incorporation I.R.S. Employer Identification Number
86 North Main Street 93257
Porterville, California Zip Code
Address of principal executive offices
(559) 782-4900
Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
No Par Value
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period 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
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Check if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of
Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this form 10-K.______
As of February 15, 2002, the aggregate market value of the voting stock
held by non-affiliates of the Registrant was approximately $49.4 million, based
on the closing price reported to the Registrant on that date of $9.90 per share.
Shares of Common Stock held by each officer and director and each person
owning more than five percent of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This
determination of the affiliate status is not necessarily a conclusive
determination for other purposes.
The number of shares of Common Stock of the registrant outstanding as of
February 15, 2002 was 9,212,280.
Documents Incorporated by Reference: Portions of the definitive proxy
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statement for the 2002 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission pursuant to SEC Regulation 14A are
incorporated by reference in Part III, Items 10-13.
This Form 10-K consists of a total of 285 pages. The Exhibit Index
appears on page 92.
TABLE OF CONTENTS
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ITEM PAGE
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PARTI................................................................................... 3
Item 1. Business.................................................................. 3
Item 2. Properties................................................................ 20
Item 3. Legal Proceedings......................................................... 22
Item 4. Submission of Matters to a Vote of Security Holders....................... 22
PART II................................................................................. 23
Item 5. Market for Common Equity and Related Shareholder Matters.................. 23
Item 6. Selected Financial Data................................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................ 27
Item 7A. Quantitative and Qualitative Disclosures about Market Risk................ 52
Item 8. Consolidated Financial Statements and Supplementary Data.................. 52
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...................................... 52
PART III................................................................................ 54
Item 10. Directors and Executive Officers of the Registrant........................ 54
Item 11. Executive Compensation.................................................... 54
Item 12. Security Ownership of Certain Beneficial
Owners and Management..................................................... 54
Item 13. Certain Relationships and Related Transactions............................ 54
PART IV................................................................................. 55
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K................................................... 55
SIGNATURES.............................................................................. 91
2
PART I
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ITEM 1. BUSINESS
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GENERAL
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THE COMPANY
Sierra Bancorp (the "Company") is a California corporation registered as a bank
holding company under the Bank Holding Company Act of 1956, as amended (the "BHC
Act"), and is headquartered in Porterville, California. The Company was
incorporated in November, 2000 and acquired all of the outstanding shares of
Bank of the Sierra (the "Bank") in August, 2001. The Company's principal
subsidiary is the Bank. The Company's only other subsidiary is Sierra Capital
Trust I, which was formed in November, 2001 solely to facilitate the issuance of
capital trust pass-through securities. The Company exists primarily for the
purpose of holding the stock of the Bank and of such other subsidiaries as it
may acquire or establish.
The Company's principal source of income is currently dividends from the Bank,
but the Company intends to explore supplemental sources of income in the future.
The expenditures of the Company, including (but not limited to) the payment of
dividends to shareholders, if and when declared by the Board of Directors, and
the cost of servicing debt, will generally be paid from such payments made to
the Company by the Bank.
At December 31, 2001, the Company had consolidated assets of $650.4 million,
deposits of $521.3 million and shareholders' equity of $46.1 million. The
Company's liabilities include $15 million in capital trust pass-through
securities issued by Sierra Capital Trust I (see "Recent Developments" for
further details).
The Company's Administrative Offices are located at 86 North Main Street,
Porterville, California and its telephone number is (559) 782-4900. References
herein to the "Company" include the Company and the Bank, unless the context
indicates otherwise.
THE BANK
Bank of the Sierra was incorporated under the laws of the State of California on
September 14, 1977, and commenced operations as a California state-chartered
commercial bank on January 19, 1978. The Bank's Administrative Office is located
at 86 North Main Street, Porterville, California. The Bank is an insured bank
under the Federal Deposit Insurance Act up to the maximum limits thereof. The
Bank is not a member of the Federal Reserve System. At December 31, 2001, the
Bank had approximately $649.0 million in assets, $486.1 million in loans and
$521.3 million in deposits.
We operate nine full-service branch offices in seven Tulare County communities,
five full-service branch offices in Kern County, and one full-service branch
office each in Kings County and Fresno County. We offer a full range of banking
services to individuals and various-size businesses in the communities we serve.
The locations of those offices are:
Porterville: Main Office Bakersfield: Bakersfield California Office
90 North Main Street 5060 California Avenue
Administrative Headquarters Bakersfield Ming Office
86 North Main Street 1621 Mill Rock Way
West Olive Branch
1498 West Olive Avenue
Lindsay: Lindsay Office Tulare: Tulare Office
142 South Mirage Avenue 246 East Tulare Avenue
Exeter: Exeter Office Hanford: Hanford Office
1103 West Visalia Road 427 West Lacey Boulevard
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Visalia: Visalia Mooney Office Tehachapi: Tehachapi Downtown Office
2515 South Mooney Boulevard 224 West "F" Street
Visalia Downtown Office Tehachapi Old Town Office
128 East Main Street 21000 Mission Street
Three Rivers: Three Rivers Office Fresno: Fresno Office
40884 Sierra Drive 636 East Shaw Avenue
Dinuba: Dinuba Office California City: California City Office
401 East Tulare Street 8031 California City
In addition, our Bank Card Center is located at 80 North Main Street,
Porterville, California. We also have specialized credit centers for
agricultural lending and construction and real estate lending within a number of
these branch offices. These facilities are located in the cities of Porterville
and Visalia in Tulare County, the city of Fresno in Fresno County, the city of
Bakersfield in Kern County, and the city of Hanford in Kings County.
Prior to 1997, Bank of the Sierra had grown exclusively by establishing de novo
full-service branch offices and credit centers in various locations in
California's South Central San Joaquin Valley. In February 1997 we made our
first branch purchase of the Dinuba Office of Wells Fargo Bank. Between February
1997 and September, 1999 we opened three additional de novo offices, in Tulare,
Hanford, and Fresno. In May 2000 we added four new branches by the acquisition
of Sierra National Bank ("SNB"). These branches stretch from California City, in
the high desert, westerly to Bakersfield along the Highway 58 corridor, a
distance of approximately 81 miles.
With a predominant focus on personal service, Bank of the Sierra has positioned
itself as a multi-community independent bank serving the financial needs of
individuals and businesses, including agricultural and real estate customers in
Tulare and other surrounding counties. We are currently the largest independent
bank headquartered in Tulare County. Our principal retail lending services
include home equity and consumer loans. In addition, we have three other
significant dimensions which surround this core of retail community banking:
agricultural lending, credit card loans, and real estate financing (both
construction and long term).
The Agricultural Credit Centers located in Fresno, Porterville, and Bakersfield
provide a complete line of credit services in support of the agricultural
activities which are key to the continued economic development of the
communities we serve. "Ag lending" clients include a full range of individual
farming customers, small business farming organizations and major corporate
farming units.
The Bank Card Center, headquartered in Porterville, provides a range of credit,
debit and ATM card services, which are made available to each of the customers
served by the branch banking offices. In addition, we staff our Fresno, Visalia,
Porterville, and Bakersfield offices with real estate lending specialists. These
officers are responsible for a complete line of land acquisition and development
loans, construction loans for residential and commercial development, and
multifamily credit facilities. Secondary market services are provided though the
Bank's affiliations with Freddie Mac, Fannie Mae and various non-governmental
programs. Until recently, the Bank also had a group dedicated to originating
residential mortgage loans. However, in an effort to improve customer service
and reduce overhead expense, the real estate lending area was restructured and
this group's focus was shifted to other products. In early 2002 the Bank entered
into an agreement with Moneyline Lending Services, Inc. ("Moneyline"), whereby
Moneyline underwrites single family mortgage loans for qualifying Bank customers
referred to them via Bank-branded delivery channels (i.e., Bank branches, the
Bank's internet site, and a dedicated telephone line).
We also engage in Small Business Administration lending and have been designated
as a Preferred Lender since 1999. The Bank's SBA program generated approximately
$13 million in loans during the past year. It is anticipated that loans under
this program will be an increasing segment of our loan portfolio over the next
few years.
4
As of December 31, 2001, the principal areas in which we directed our lending
activities, and the percentage of our total loan portfolio for which each of
these areas was responsible, were as follows: (i) agricultural loans (2.97%);
(ii) commercial and industrial (including SBA) loans (18.25%); (iii) real estate
loans (66.02%); (iv) consumer loans (10.42%); and (v) credit cards (2.33%).
In addition to the lending activities noted above, we offer a wide range of
deposit products for the retail banking market including checking, interest
bearing transaction, savings, time certificates of deposit and retirement
accounts, as well as telephone banking and internet banking with bill pay
options. As of December 31, 2001, we had 47,661 deposit accounts with balances
totaling approximately $521.3 million, compared to 47,262 deposit accounts with
balances totaling approximately $527.8 million at December 31, 2000. Bank of the
Sierra attracts deposits through its customer-oriented product mix, competitive
pricing, convenient locations, extended hours and drive-up banking, all provided
with the highest level of customer service.
Most of the Bank's deposits are attracted from individuals, business-related
sources and smaller municipal entities. This results in a relatively modest
average deposit balance of approximately $11,000 at December 31, 2001, but makes
the Bank less subject to adverse effects from the loss of a substantial
depositor who may be seeking higher yields in other markets or who may have need
of money otherwise on deposit with the Bank, especially during periods of
inflation or conservative monetary policies.
We also offer other products and services to our customers, which complement the
lending and deposit services previously reviewed. These include installment note
collection, cashier's checks, traveler's checks, bank-by-mail, ATM, night
depository, safe deposit boxes, direct deposit, automated payroll services and
other customary banking services. Shared ATM and Point of Sale (POS) networks
allow customers access to the national and international funds transfer
networks. In 1997, as part of our continuing efforts to meet the needs of our
various communities, we added a Spanish language option to our network of ATMs
throughout our service area. During the past three years we have substantially
enhanced our ATM locations to include off-site areas not previously served by
cash or deposit facilities. We now have a total of nine such remote ATM's at
eight different locations, including a hospital, county offices, a college
campus, a grocery store, and a restaurant parking lot. These locations
facilitate cash advances and deposits which would not otherwise be available to
consumers at non-branch locations, thereby increasing consumer convenience. We
also have a mobile ATM unit which is transportable and is used at fairs,
exhibitions, and various other community functions within our market area. In
addition to such specifically oriented customer applications, we provide safe
deposit, wire transfer capabilities and a convenient customer service group to
answer questions and assure a high level of customer satisfaction with the level
of services and products we provide.
For non-deposit services, we have a strategic alliance with Investment Centers
of America, Inc. of Bismarck, North Dakota ("ICA"). Through this arrangement,
registered and licensed representatives of ICA provide Bank customers with
convenient access to annuities, insurance products, mutual funds, and a full
range of investment products. They conduct business from offices located in our
Porterville, Visalia, Tulare and Tehachapi branches.
We do not believe there is a significant demand for additional trust services in
our service areas, and we do not operate or have any present intention to seek
authority to operate a Trust Department. We believe that the cost of
establishing and operating such a department would not be justified by the
potential income to be gained therefrom. However, we occasionally make
arrangements with correspondent institutions to offer trust services to our
customers upon request.
The Bank currently has one wholly-owned subsidiary, Sierra Phoenix, Inc., whose
sole function is to hold certain investments which the Bank is not permitted to
hold directly but which can now be held directly by the Company. This subsidiary
currently holds two investments, one of which is stock in Sphinx International,
Inc. ("Sphinx"). Sphinx was formerly known as Phoenix International Ltd., Inc.,
a computer software company which specialized in the production and marketing of
client user software for financial institutions. In 2001,
5
Sphinx sold substantially all of its assets (including all of its operating
business) and certain of its liabilities to London Bridge Phoenix Software,
Inc., and a partial distribution of the sale proceeds has been remitted to
Sphinx shareholders. The remainder of the cash will be distributed subsequent
to the resolution of the remaining contingent liabilities, at which time Sphinx
will conclude operations. The other investment held by Sierra Phoenix is an
equity position in California Banker's Insurance Agency ("CBIA"), an entity
which was formed to facilitate insurance product sales after enabling
legislation under the Gramm-Leach-Bliley Financial Services Modernization Act
was passed. Bank of the Sierra is currently a passive investor, through Sierra
Phoenix, Inc., in CBIA. It is expected that during 2002 the Bank's investment
in Sierra Phoenix will be transferred via a dividend to Sierra Bancorp, at
which time the aforementioned investments would be placed under the direct
ownership of Sierra Bancorp and Sierra Phoenix would be dissolved. This would
not have a material impact on the operations of the Bank or Company.
During the year ended December 31, 2001, one class of products or services
accounted for more than 15% of the Bank's consolidated revenues. Our real estate
lending, loan sales, and loan servicing activities (including gains from the
sale of loan servicing) generated approximately 17.62% of consolidated revenue
for 2001. During 2000, this area accounted for 16.66% of the Bank's consolidated
revenues. Real estate lending activities are generated by real estate loan
officers who are not responsible for branch deposit gathering activities but who
are solely dedicated to the Bank's real property secured lending activities.
This class of services includes a complete line of land acquisition and
development loans, construction loans for residential and commercial
development, and multifamily credit facilities. In addition, secondary market
services are provided though this group and its affiliations with Freddie Mac,
Fannie Mae and various non-governmental programs. Real estate lending and
related activities generated total revenue of $9.3 million and $8.7 million for
2001 and 2000, respectively.
We have not engaged in any material research activities relating to the
development of new products or services or the improvement of existing banking
services during the last two fiscal years. However, the officers and employees
of the Bank are continually engaged in marketing activities, including the
evaluation and development of new products and services, which enable the Bank
to retain and improve its competitive position in its service area. Our decision
to introduce "Sierra Access" internet banking in October of 1999 was the result
of such evaluation. This product includes electronic bill paying capabilities
for enhanced customer value, and Sierra Access has been actively marketed for
the last two years. Another example is "Sierra Loan Access", a consumer loan
application process made available through the Bank's internet site during the
year 2001. This function allows a consumer to gain an answer within fifteen to
thirty minutes on a request for any number of consumer loans, including auto,
personal revolving lines, credit card, or home equity/home improvement loans.
The initiation of our partnership with Moneyline has enabled similar
improvements in the consumer mortgage lending process. We also rolled out
"Sierra Web Cash Manager" in 2001, a commercial checking account cash management
system which functions through the Bank's internet web site. During 2001, the
Bank further expanded its off-site ATM locations by installing an ATM at the
Town & Country market in Porterville. This facility is an in-store ATM, and has
substantially enhanced convenience for Bank customers who patronize that market.
All of these developments are meant to increase public convenience in the Bank's
service area and enhance public access to the electronic payments system. The
cost to the Bank for these development, implementation, and marketing activities
cannot expressly be calculated with any degree of certainty.
The Bank holds no patents or licenses (other than licenses required by
appropriate bank regulatory agencies), franchises, or concessions. The Bank's
business has a modest seasonal component due to the heavy agricultural
orientation of the Central Valley. As our branches in more metropolitan areas
such as Fresno and Bakersfield have expanded, however, the agriculturally
related economic base has become less important. The Bank is not dependent on a
single customer or group of related customers for a material portion of its
deposits, nor is a material portion of the Bank's loans concentrated within a
single industry or group of related industries. There has been no material
effect upon the Bank's capital expenditures, earnings, or competitive position
as a result of Federal, state, or local environmental regulation.
6
RECENT DEVELOPMENTS
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On November 16, 2000, Sierra Bancorp was incorporated as a bank holding company,
for the purpose of acquiring the Bank in a one bank holding company
reorganization. Shortly after the incorporation, Sierra Bancorp filed a
registration statement on Form S-4 with the Securities and Exchange Commission
in order to register its common stock which was issued pursuant to the terms of
a Plan of Reorganization and Agreement of Merger dated December 14, 2000. The
Plan of Reorganization and Agreement of Merger provided for the exchange of
shares of the Bank for shares of Sierra Bancorp on a share-for-share basis (the
"Reorganization"). The registration statement was declared effective on April
27, 2001. The Reorganization was approved by the Company's shareholders on May
23, 2001, and all required regulatory approvals or non-disapprovals with respect
to the Reorganization were obtained. The Reorganization was consummated on
August 10, 2001, subsequent to which the Bank continued its operations as
previously conducted but as a wholly-owned subsidiary of Sierra Bancorp. The new
corporate structure is intended to give Sierra Bancorp and the Bank greater
flexibility in terms of operation, expansion and diversification.
On November 28, 2001, Sierra Capital Trust I, a newly formed Delaware statutory
business trust and a wholly-owned subsidiary of the Company (the "Trust"),
issued an aggregate of $15,000,000 of principal amount of Floating Rate TRUPS(R)
(Capital Trust Pass-through Securities of the Trust) (the "Trust Preferred
Securities"). Salomon Smith Barney, Inc. acted as placement agent in connection
with the offering of the trust securities. The securities issued by the Trust
are fully guaranteed by the Company with respect to distributions and amounts
payable upon liquidation, redemption or repayment. The entire proceeds to the
Trust from the sale of the Trust Preferred Securities were used by the Trust in
order to purchase $15,000,000 in principal amount of the Fixed Rate Junior
Subordinated Deferrable Interest Debentures due 2031 issued by the Company (the
"Subordinated Debt Securities"). Subject to a maximum of 25% of Tier 1 capital
for all cumulative preferred stock, the Trust Preferred Securities are included
as Tier 1 capital for purposes of calculating the Company's regulatory capital
ratios under the Prompt Corrective Action guidelines issued by the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"). The
Company used $10 million of the proceeds it ultimately received to increase its
equity investment in the Bank. A portion of the proceeds was also used to retire
debt incurred during 2001 to pay for the formation of the holding company, and
the remainder has been placed in a demand deposit account at the Bank. On a
consolidated basis, the Company should be able to leverage its increased
regulatory capital to generate additional loan growth, although there can be no
guarantee that this expected loan growth will indeed occur.
RECENT ACCOUNTING PRONOUNCEMENTS
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In September 2000, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 140, Accounting for
Transfers and Servicing of Financial Assets and Liabilities. This Statement
replaces SFAS No. 125. It revised the standards for securitizations and other
transfers of financial assets and collateral after March 2001 and requires
certain additional disclosures, but it carries over most of SFAS No. 125's
provisions without reconsideration. Management does not believe there was a
material effect on the Bank's consolidated financial statements upon the
adoption of SFAS No. 140.
In June 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS
No.142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all
business combinations initiated after June 30, 2001 be accounted for under the
purchase method and addresses the initial recognition and measurement of
goodwill and other intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement of intangible assets
acquired outside of a business combination and the accounting for goodwill and
other intangible assets subsequent to their acquisition. SFAS No. 142 provides
that intangible assets with finite useful lives be amortized and that goodwill
and intangible assets with indefinite lives will not be amortized, but will
rather be tested at least annually for impairment. The Company has adopted SFAS
No. 142 for its fiscal year beginning January 1, 2002. At December 31, 2001, the
Company had approximately $5.5
7
million in goodwill which has an indefinite life that management will now
evaluate periodically for impairment. Previously, the Company reflected charges
of $332,000 and $214,000 in its income statement for the years ended 2001 and
2000, respectively, as amortization relating to that goodwill.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, that replaces FASB Statement No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of. The accounting model for long-lived assets to be disposed of by sale applies
to all long-lived assets, including discontinued operations, and replaces the
provisions of APB Opinion No. 30, Reporting Results of Operations-Reporting the
Effects of Disposal of a Segment of a Business, for the disposal of segments of
a business. SFAS No. 144 requires that those long-lived assets be measured at
the lower of carrying amount or fair value less cost to sell, whether reported
in continuing operations or in discontinued operations. Therefore, discontinued
operations will no longer be measured at net realizable value or include amounts
for operating losses that have not yet occurred.
SFAS No. 144 also broadens the reporting of discontinued operations to include
all components of an entity with operations that can be distinguished from the
rest of the entity and that will be eliminated from the ongoing operations of
the entity in a disposal transaction. The provisions of SFAS No. 144 are
effective for financial statements issued for fiscal years beginning after
December 15, 2001 and, generally, are to be applied prospectively. In
management's opinion, the adoption of this statement will not have a material
impact on the Company's current financial position or results of operations.
COMPETITION
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The banking business in California generally, and specifically in our market
areas, is highly competitive with respect to virtually all products and services
and has become increasingly more so in recent years. The industry continues to
consolidate and strong, unregulated competitors have entered banking markets
with focused products targeted at highly profitable customer segments. Many
largely unregulated competitors are able to compete across geographic boundaries
and provide customers increasing access to meaningful alternatives to banking
services in nearly all significant products. These competitive trends are likely
to continue.
With respect to commercial bank competitors, the business is largely dominated
by a relatively small number of major banks with many offices operating over a
wide geographical area, which banks have, among other advantages, the ability to
finance wide-ranging and effective advertising campaigns and to allocate their
investment resources to regions of highest yield and demand. Many of the major
banks operating in the area offer certain services which we do not offer
directly but may offer indirectly through correspondent institutions. By virtue
of their greater total capitalization, such banks also have substantially higher
lending limits than we do.
In addition to other banks, competitors include savings institutions, credit
unions, and numerous non-banking institutions such as finance companies, leasing
companies, insurance companies, brokerage firms, and investment banking firms.
In recent years, increased competition has also developed from specialized
finance and non-finance companies that offer wholesale finance, credit card, and
other consumer finance services, including on-line banking services and personal
finance software. Strong competition for deposit and loan products affects the
rates of those products as well as the terms on which they are offered to
customers. Mergers between financial institutions have placed additional
pressure on banks within the industry to streamline their operations, reduce
expenses, and increase revenues to remain competitive. Competition has also
intensified due to federal and state interstate banking laws enacted in the
mid-1990's, which permit banking organizations to expand into other states, and
the California market has been particularly attractive to out-of-state
institutions. The recently enacted Financial Modernization Act, which, effective
March 11, 2000, has made it possible for full affiliations to occur between
banks and securities firms, insurance companies, and other financial companies,
is also expected to intensify competitive conditions.
8
Technological innovation has also resulted in increased competition in financial
services markets. Such innovation has, for example, made it possible for
non-depository institutions to offer customers automated transfer payment
services that previously have been considered traditional banking products. In
addition, many customers now expect a choice of several delivery systems and
channels, including telephone, mail, home computer, ATMs, self-service branches,
and/or in-store branches. In addition to other banks, the sources of competition
for such products include savings associations, credit unions, brokerage firms,
money market and other mutual funds, asset management groups, finance and
insurance companies, internet-only financial intermediaries, and mortgage
banking firms.
For many years, we have countered this increasing competition by providing our
own style of community-oriented, personalized service. We rely upon local
promotional activity, personal contacts by our officers, directors, employees,
and shareholders, automated 24-hour banking, and the individualized service
which we can provide through our flexible policies. This appears to be
well-received by the populace of the San Joaquin Valley, who appreciate a more
personal and customer-oriented environment in which to conduct their financial
transactions. In addition, however, to meet the needs of customers with
electronic access requirements, the Company has embraced the electronic age and
installed telephone banking and personal computer and internet banking with bill
payment capabilities. This high tech and high touch approach allows the
individual to customize the Bank's contact methodologies to their particular
preference. Moreover, for customers whose loan demands exceed our legal lending
limit, we attempt to arrange for such loans on a participation basis with
correspondent banks. We also assist our customers in obtaining from our
correspondent banks other services that the Bank may not offer.
Our credit card business is subject to an even higher level of competitive
pressure than our general banking business. There are a number of major banks
and credit card issuers that are able to finance often highly successful
advertising campaigns with which community banks generally do not have the
resources to compete. As a result, our credit card outstandings are much more
likely to increase at a slower rate than that which might be seen in nationwide
issuers' year-end statistics. Additional competition comes from many
non-financial institutions, such as providers of various retail products, which
offer many types of credit cards.
EMPLOYEES
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As of December 31, 2001 the Company had 217 full-time and 88 part-time
employees. On a full time equivalent basis, the Company's staff level was 287 at
December 31, 2001, as compared to 323 at December 31, 2000. None of our
employees is concurrently represented by a union or covered by a collective
bargaining agreement. Management of the Company believes its employee relations
are satisfactory.
REGULATION AND SUPERVISION
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The Company and the Bank are subject to significant regulation by federal and
state regulatory agencies. The following discussion of statutes and regulations
is only a brief summary and does not purport to be complete. This discussion is
qualified in its entirety by reference to such statutes and regulations. No
assurance can be given that such statutes or regulations will not change in the
future.
THE COMPANY
The Company is subject to the periodic reporting requirements of Section 13 of
the Securities Exchange Act of 1934 (the "Exchange Act") which requires the
Company to file annual, quarterly and other current reports with the Securities
and Exchange Commission (the "SEC"). The Company is also subject to additional
regulations including, but not limited to, the proxy and tender offer rules
promulgated by the SEC under Sections 13 and 14 of the Exchange Act; the
reporting requirements of directors, executive officers and principal
shareholders regarding transactions in the Company's Common Stock and
short-swing profits rules promulgated by the SEC under Section 16 of the
Exchange Act; and certain additional reporting requirements by principal
shareholders of
9
the Company promulgated by the SEC under Section 13 of the Exchange Act.
The Company is a bank holding company within the meaning of the Bank Holding
Company Act of 1956 and is registered as such with the Federal Reserve Board. A
bank holding company is required to file with the Federal Reserve Board annual
reports and other information regarding its business operations and those of its
subsidiaries. It is also subject to examination by the Federal Reserve Board and
is required to obtain Federal Reserve Board approval before acquiring, directly
or indirectly, ownership or control of any voting shares of any bank if, after
such acquisition, it would directly or indirectly own or control more than 5% of
the voting stock of that bank, unless it already owns a majority of the voting
stock of that bank.
The Federal Reserve Board has by regulation determined certain activities in
which a bank holding company may or may not conduct business. A bank holding
company must engage, with certain exceptions, in the business of banking or
managing or controlling banks or furnishing services to or performing services
for its subsidiary banks. The permissible activities and affiliations of certain
bank holding companies have recently been expanded. (See "Financial
Modernization Act" below.)
The Company and the Bank are deemed to be affiliates of each other within the
meaning set forth in the Federal Reserve Act and are subject to Sections 23A and
23B of the Federal Reserve Act . This means, for example, that there are
limitations on loans by the Bank to affiliates, and that all affiliate
transactions must satisfy certain limitations and otherwise be on terms and
conditions at least as favorable to the Bank as would be available for
non-affiliates.
The Federal Reserve Board has a policy that bank holding companies must serve as
a source of financial and managerial strength to their subsidiary banks. It is
the Federal Reserve Bank's position that bank holding companies should stand
ready to use their available resources to provide adequate capital to their
subsidiary banks during periods of financial stress or adversity. Bank holding
companies should also maintain the financial flexibility and capital-raising
capacity to obtain additional resources for assisting their subsidiary banks.
The Federal Reserve Board also has the authority to regulate bank holding
company debt, including the authority to impose interest rate ceilings and
reserve requirements on such debt. Under certain circumstances, the Federal
Reserve Board may require The Company to file written notice and obtain its
approval prior to purchasing or redeeming The Company's equity securities.
THE BANK
As a California state-chartered bank whose accounts are insured by the FDIC up
to a maximum of $100,000 per depositor, the Bank is subject to regulation,
supervision and regular examination by the Department of Financial Institutions
(the "DFI") and the FDIC. In addition, while the Bank is not a member of the
Federal Reserve System, it is subject to certain regulations of the Federal
Reserve Board. The regulations of these agencies govern most aspects of the
Bank's business, including the making of periodic reports by the Bank, and the
Bank's activities relating to dividends, investments, loans, borrowings, capital
requirements, certain check-clearing activities, branching, mergers and
acquisitions, reserves against deposits and numerous other areas. Supervision,
legal action and examination of the Bank by the FDIC is generally intended to
protect depositors and is not intended for the protection of shareholders.
The earnings and growth of the Bank are largely dependent on its ability to
maintain a favorable differential or "spread" between the yield on its
interest-earning assets and the rate paid on its deposits and other
interest-bearing liabilities. As a result, the Bank's performance is influenced
by general economic conditions, both domestic and foreign, the monetary and
fiscal policies of the federal government, and the policies of the regulatory
agencies, particularly the Federal Reserve Board. The Federal Reserve Board
implements national monetary policies (such as seeking to curb inflation and
combat recession) by its open-market operations in United States Government
securities, by adjusting the required level of reserves for financial
institutions subject
10
to its reserve requirements and by varying the discount rate applicable to
borrowings by banks which are members of the Federal Reserve System. The actions
of the Federal Reserve Board in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates charged on loans and
deposits. The nature and impact of any future changes in monetary policies
cannot be predicted.
CAPITAL ADEQUACY REQUIREMENTS
The Company and the Bank are subject to the regulations of the Federal Reserve
Board and the FDIC, respectively, governing capital adequacy. Those regulations
incorporate both risk-based and leverage capital requirements. Each of the
federal regulators has established risk-based and leverage capital guidelines
for the banks or bank holding companies it regulates, which set total capital
requirements and define capital in terms of "core capital elements," or Tier 1
capital; and "supplemental capital elements," or Tier 2 capital. Tier 1 capital
is generally defined as the sum of the core capital elements less goodwill and
certain other deductions, notably the unrealized net gains or losses (after tax
adjustments) on available for sale investment securities carried at fair market
value. The following items are defined as core capital elements: (i) common
shareholders' equity; (ii) qualifying non-cumulative perpetual preferred stock
and related surplus (not to exceed 25% of tier 1 capital); and (iii) minority
interests in the equity accounts of consolidated subsidiaries. Supplementary
capital elements include: (i) allowance for loan and lease losses (but not more
than 1.25% of an institution's risk-weighted assets); (ii) perpetual preferred
stock and related surplus not qualifying as core capital; (iii) hybrid capital
instruments, perpetual debt and mandatory convertible debt instruments; and (iv)
term subordinated debt and intermediate-term preferred stock and related
surplus. The maximum amount of supplemental capital elements which qualifies as
Tier 2 capital is limited to 100% of Tier 1 capital, net of goodwill.
The minimum required ratio of qualifying total capital to total risk-weighted
assets is 8.0% ("Total Risk-Based Capital Ratio"), at least one-half of which
must be in the form of Tier 1 capital, and the minimum required ratio of Tier 1
capital to total risk-weighted assets is 4.0% ("Tier 1 Risk-Based Capital
Ratio"). Risk-based capital ratios are calculated to provide a measure of
capital that reflects the degree of risk associated with a banking
organization's operations for both transactions reported on the balance sheet as
assets, and transactions, such as letters of credit and recourse arrangements,
which are recorded as off-balance sheet items. Under the risk-based capital
guidelines, the nominal dollar amounts of assets and credit-equivalent amounts
of off-balance sheet items are multiplied by one of several risk adjustment
percentages, which range from 0% for assets with low credit risk, such as
certain U. S. Treasury securities, to 100% for assets with relatively high
credit risk, such as business loans. As of December 31, 2001 and 2000, the
Bank's Total Risk-Based Capital Ratios were 11.17% and 9.00%, respectively and
its Tier 1 Risk-Based Capital Ratios were 10.01% and 7.76%, respectively. As of
December 31, 2001, the Company's Total Risk-Based Capital was 12.18% and its
Tier 1 Risk-Based Capital Ratio was 11.03%.
The risk-based capital requirements also take into account concentrations of
credit (i.e., relatively large proportions of loans involving one borrower,
industry, location, collateral or loan type) and the risks of "non-traditional"
activities (those that have not customarily been part of the banking business).
The regulations require institutions with high or inordinate levels of risk to
operate with higher minimum capital standards, and authorize the regulators to
review an institution's management of such risks in assessing an institution's
capital adequacy.
The risk-based capital regulations also include exposure to interest rate risk
as a factor that the regulators will consider in evaluating a bank's capital
adequacy. Interest rate risk is the exposure of a bank's current and future
earnings and equity capital arising from adverse movements in interest rates.
While interest risk is inherent in a bank's role as financial intermediary, it
introduces volatility to earnings and to the economic value of the bank.
The FDIC and the Federal Reserve Board also require the maintenance of a
leverage capital ratio designed to supplement the risk-based capital guidelines.
Banks and bank holding companies that have received the highest rating of the
five categories used by regulators to rate banks and are not anticipating or
experiencing any
11
significant growth must maintain a ratio of Tier 1 capital (net of all
intangibles) to adjusted total assets ("Leverage Capital Ratio") of at
least 3%. All other institutions are required to maintain a leverage ratio of at
least 100 to 200 basis points above the 3% minimum, for a minimum of 4% to 5%.
Pursuant to federal regulations, banks must maintain capital levels commensurate
with the level of risk to which they are exposed, including the volume and
severity of problem loans, and federal regulators may, however, set higher
capital requirements when a bank's particular circumstances warrant. As of
December 31, 2001 and 2000, the Bank's Leverage Capital Ratios were 8.17% and
5.64%, respectively. As of December 31, 2001, the Company's leverage capital
ratio was 9.02%, exceeding regulatory minimums. See Part II, Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operation - Capital Resources.
PROMPT CORRECTIVE ACTION PROVISIONS
Federal law requires each federal banking agency to take prompt corrective
action to resolve the problems of insured financial institutions, including but
not limited to those that fall below one or more prescribed minimum capital
ratios. The federal banking agencies have by regulation defined the following
five capital categories: "well capitalized" (Total Risk-Based Capital Ratio of
10%; Tier 1 Risk-Based Capital Ratio of 6%; and Leverage Ratio of 5%);
"adequately capitalized" (Total Risk-Based Capital Ratio of 8%; Tier 1
Risk-Based Capital Ratio of 4%; and Leverage Ratio of 4%) (or 3% if the
institution receives the highest rating from its primary regulator);
"undercapitalized" (Total Risk-Based Capital Ratio of less than 8%; Tier 1
Risk-Based Capital Ratio of less than 4%; or Leverage Ratio of less than 4%) (or
3% if the institution receives the highest rating from its primary regulator);
"significantly undercapitalized" (Total Risk-Based Capital Ratio of less than
6%; Tier 1 Risk-Based Capital Ratio of less than 3%; or Leverage Ratio less than
3%); and "critically undercapitalized" (tangible equity to total assets less
than 2%). A bank may be treated as though it were in the next lower capital
category if after notice and the opportunity for a hearing, the appropriate
federal agency finds an unsafe or unsound condition or practice so warrants, but
no bank may be treated as "critically undercapitalized" unless its actual
capital ratio warrants such treatment.
At each successively lower capital category, an insured bank is subject to
increased restrictions on its operations. For example, a bank is generally
prohibited from paying management fees to any controlling persons or from making
capital distributions if to do so would make the bank "undercapitalized." Asset
growth and branching restrictions apply to undercapitalized banks, which are
required to submit written capital restoration plans meeting specified
requirements (including a guarantee by the parent holding company, if any).
"Significantly undercapitalized" banks are subject to broad regulatory
authority, including among other things, capital directives, forced mergers,
restrictions on the rates of interest they may pay on deposits, restrictions on
asset growth and activities, and prohibitions on paying certain bonuses without
FDIC approval. Even more severe restrictions apply to critically
undercapitalized banks. Most importantly, except under limited circumstances,
not later than 90 days after an insured bank becomes critically
undercapitalized, the appropriate federal banking agency is required to appoint
a conservator or receiver for the bank.
In addition to measures taken under the prompt corrective action provisions,
insured banks may be subject to potential actions by the federal regulators for
unsafe or unsound practices in conducting their businesses or for violations of
any law, rule, regulation or any condition imposed in writing by the agency or
any written agreement with the agency. Enforcement actions may include the
issuance of cease and desist orders, termination of insurance of deposits (in
the case of a bank), the imposition of civil money penalties, the issuance of
directives to increase capital, formal and informal agreements, or removal and
prohibition orders against "institution-affiliated" parties.
12
SAFETY AND SOUNDNESS STANDARDS
The federal banking agencies have also adopted guidelines establishing safety
and soundness standards for all insured depository institutions. Those
guidelines relate to internal controls, information systems, internal audit
systems, loan underwriting and documentation, compensation and interest rate
exposure. In general, the standards are designed to assist the federal banking
agencies in identifying and addressing problems at insured depository
institutions before capital becomes impaired. If an institution fails to meet
these standards, the appropriate federal banking agency may require the
institution to submit a compliance plan and institute enforcement proceedings if
an acceptable compliance plan is not submitted.
PREMIUMS FOR DEPOSIT INSURANCE
The FDIC regulations also implement a risk-based premium system, whereby insured
depository institutions are required to pay insurance premiums depending on
their risk classification. Under this system, institutions such as the Bank
which are insured by the Bank Insurance Fund ("BIF"), are categorized into one
of three capital categories (well capitalized, adequately capitalized, and
undercapitalized) and one of three supervisory categories based on federal
regulatory evaluations. The three supervisory categories are: financially sound
with only a few minor weaknesses (Group A), demonstrates weaknesses that could
result in significant deterioration (Group B), and poses a substantial
probability of loss (Group C). The capital ratios used by the FDIC to define
well capitalized, adequately capitalized and undercapitalized are the same in
the FDIC's prompt corrective action regulations. The current BIF base assessment
rates (expressed as cents per $100 of deposits) are summarized as follows:
Group A Group B Group C
------- ------- -------
Well Capitalized.................. 0 3 17
Adequately Capitalized............ 3 10 24
Undercapitalized.................. 10 24 27
In addition, BIF member banks (such as the Bank) must pay an amount toward the
retirement of the Financing Corporation bonds issued in the 1980's to assist in
the recovery of the savings and loan industry. This amount fluctuates but for
the first quarter of 2002 is 1.82 basis points (cents per $100 of insured
deposits).
COMMUNITY REINVESTMENT ACT
The Bank is subject to certain requirements and reporting obligations involving
Community Reinvestment Act ("CRA") activities. The CRA generally requires the
federal banking agencies to evaluate the record of a financial institution in
meeting the credit needs of its local communities, including low and moderate
income neighborhoods. The CRA further requires the agencies to take a financial
institution's record of meeting its community credit needs into account when
evaluating applications for, among other things, domestic branches, consummating
mergers or acquisitions, or holding company formations. In measuring a bank's
compliance with its CRA obligations, the regulators utilize a performance-based
evaluation system which bases CRA ratings on the bank's actual lending service
and investment performance, rather than on the extent to which the institution
conducts needs assessments, documents community outreach activities or complies
with other procedural requirements. In connection with its assessment of CRA
performance, the FDIC assigns a rating of "outstanding," "satisfactory," "needs
to improve" or "substantial noncompliance." The Bank was last examined for CRA
compliance in June, 2001 and received a "satisfactory" CRA Assessment Rating.
13
OTHER CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are increasingly focusing attention on compliance
with consumer protection laws and regulations. Examination and enforcement has
become intense, and banks have been advised to carefully monitor compliance with
various consumer protection laws and their implementing regulations. The federal
Interagency Task Force on Fair Lending issued a policy statement on
discrimination in home mortgage lending describing three methods that federal
agencies will use to prove discrimination: overt evidence of discrimination,
evidence of disparate treatment, and evidence of disparate impact. In addition
to CRA and fair lending requirements, the Bank is subject to numerous other
federal consumer protection statutes and regulations. Due to heightened
regulatory concern related to compliance with consumer protection laws and
regulations generally, the Bank may incur additional compliance costs or be
required to expend additional funds for investments in the local communities it
serves.
INTERSTATE BANKING AND BRANCHING
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Interstate Banking Act") regulates the interstate activities of banks and bank
holding companies and establishes a framework for nationwide interstate banking
and branching. Since June 1, 1997, a bank in one state has generally been
permitted to merge with a bank in another state without the need for explicit
state law authorization. However, states were given the ability to prohibit
interstate mergers with banks in their own state by "opting-out" (enacting state
legislation applying equality to all out-of-state banks prohibiting such mergers
) prior to June 1, 1997.
Since 1995, adequately capitalized and managed bank holding companies have been
permitted to acquire banks located in any state, subject to two exceptions:
first, any state may still prohibit bank holding companies from acquiring a bank
which is less than five years old; and second, no interstate acquisition can be
consummated by a bank holding company if the acquiror would control more than
10% of the deposits held by insured depository institutions nationwide or 30%
percent or more of the deposits held by insured depository institutions in any
state in which the target bank has branches.
A bank may establish and operate de novo branches in any state in which the bank
does not maintain a branch if that state has enacted legislation to expressly
permit all out-of-state banks to establish branches in that state.
In 1995 California enacted legislation to implement important provisions of the
Interstate Banking Act discussed above and to repeal California's previous
interstate banking laws, which were largely preempted by the Interstate Banking
Act.
The changes effected by Interstate Banking Act and California laws have
increased competition in the environment in which the Bank operates to the
extent that out-of-state financial institutions directly or indirectly enter the
Bank's market areas. It appears that the Interstate Banking Act has contributed
to the accelerated consolidation of the banking industry. While many large
out-of-state banks have already entered the California market as a result of
this legislation, it is not possible to predict the precise impact of this
legislation on the Bank and the Company and the competitive environment in which
they operate.
FINANCIAL MODERNIZATION ACT
Effective March 11, 2000 the Gramm-Leach-Bliley Act eliminated most barriers to
affiliations among banks and securities firms, insurance companies, and other
financial service providers, and enabled full affiliations to occur between such
entities. This legislation permits bank holding companies to become "financial
holding companies" and thereby acquire securities firms and insurance companies
and engage in other activities that are financial in nature. A bank holding
company may become a financial holding company if each of its subsidiary banks
is well capitalized under the FDICIA prompt corrective action provisions, is
well managed, and has at least a satisfactory rating under the CRA by filing a
declaration that the bank holding company wishes to
14
become a financial holding company. No regulatory approval will be required
for a financial holding company to acquire a company, other than a bank or
savings association, engaged in activities that are financial in nature or
incidental to activities that are financial in nature, as determined by the
Federal Reserve Board. The Company has no current intention of becoming a
financial holding company, but may do at some point in the future if deemed
appropriate in view of opportunities or circumstances at the time.
The Gramm-Leach-Bliley Act defines "financial in nature" to include securities
underwriting, dealing and market making; sponsoring mutual funds and investment
companies; insurance underwriting and agency; merchant banking activities; and
activities that the Board has determined to be closely related to banking. A
national bank (and therefore, a state bank as well) may also engage, subject to
limitations on investment, in activities that are financial in nature, other
than insurance underwriting, insurance company portfolio investment, real estate
development and real estate investment, through a financial subsidiary of the
bank, if the bank is well capitalized, well managed and has at least a
satisfactory CRA rating. Subsidiary banks of a financial holding company or
national banks with financial subsidiaries must continue to be well capitalized
and well managed in order to continue to engage in activities that are financial
in nature without regulatory actions or restrictions, which could include
divestiture of the financial in nature subsidiary or subsidiaries. In addition,
a financial holding company or a bank may not acquire a company that is engaged
in activities that are financial in nature unless each of the subsidiary banks
of the financial holding company or the bank has a CRA rating of satisfactory or
better.
The Gramm-Leach-Bliley Act also imposes significant new requirements on
financial institutions with respect to the privacy of customer information, and
modifies other existing laws, including those related to community reinvestment.
USA PATRIOT ACT OF 2001
On October 26, 2001, President Bush signed the USA Patriot Act of 2001 (the
"Patriot Act"). Enacted in response to the terrorist attacks in New York,
Pennsylvania and Washington, D.C. on September 11, 2001, the Patriot Act is
intended to strengthen U.S. law enforcement's and the intelligence communities'
ability to work cohesively to combat terrorism on a variety of fronts. The
potential impact of the Act on financial institutions of all kinds is
significant and wide ranging. The Act contains sweeping anti-money laundering
and financial transparency laws and requires various regulations, including:
. due diligence requirements for financial institutions that
administer, maintain, or manage private bank accounts or correspondent
accounts for non-U.S. persons;
. standards for verifying customer identification at account opening;
. rules to promote cooperation among financial institutions, regulators,
and law enforcement entities in identifying parties that may be
involved in terrorism or money laundering;
. reports by nonfinancial trades and business filed with the Treasury
Department's Financial Crimes Enforcement Network for transactions
exceeding $10,000 and;
. filing of suspicious activities reports securities by brokers and
dealers if they believe a customer may be violating U.S. laws and
regulations.
The Company is not able to predict the impact of such law on its financial
condition or results of operations at this time.
15
OTHER PENDING AND PROPOSED LEGISLATION
Other legislative and regulatory initiatives which could affect the Company, the
Bank and the banking industry in general are pending, and additional initiatives
may be proposed or introduced before the United States Congress, the California
legislature and other governmental bodies in the future. Such proposals, if
enacted, may further alter the structure, regulation and competitive
relationship among financial institutions, and may subject the Bank to increased
regulation, disclosure and reporting requirements. In addition, the various
banking regulatory agencies often adopt new rules and regulations to implement
and enforce existing legislation. It cannot be predicted whether, or in what
form, any such legislation or regulations may be enacted or the extent to which
the business of the Company or the Bank would be affected thereby.
RISK FACTORS
Statements and financial discussion and analysis by management contained
throughout this report that are not historical facts are forward-looking
statements made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements involve a number of
risks and uncertainties. The important factors that could cause actual results
to differ materially from the forward-looking statements herein include, without
limitation, the factors set forth below.
Poor Economic Conditions May Cause Us to Incur Losses. A substantial majority of
- ------------------------------------------------------
our assets and deposits are generated in the San Joaquin Valley in central
California. As a result, poor economic conditions in the San Joaquin Valley may
cause us to incur losses associated with higher default rates and decreased
collateral values in our loan portfolio. The San Joaquin Valley has not
experienced the same type of growth that has occurred in other areas of
California, especially those where high-tech industries have taken hold.
Unemployment levels remain relatively high, especially in Tulare County, which
is our geographic center and the base of our agriculturally oriented
communities. The United States entered into an economic recession in 2001, and
California's Silicon Valley and other high-tech areas have been particularly
impacted. While the current National recession has not necessarily worsened
economic conditions in the San Joaquin Valley, the Company's level of
non-performing assets increased in 2001 anyway due mainly to lingering
agricultural difficulties. Because of increased global competition and other
factors, excess supply and low prices characterize the markets for many
agricultural products. If current recessionary conditions continue or
deteriorate, we expect that our level of non-performing assets could increase
further.
Poor Economic Conditions Affecting Particular Industries Could Have an Adverse
- ------------------------------------------------------------------------------
Effect on Our Customers and Their Ability to Make Payments to Us. We are also
- -----------------------------------------------------------------
affected by certain industry-specific economic factors. For example, a
significant portion of our total loan portfolio is related to real estate
obligations, particularly commercial real estate loans. A downturn in the
commercial real estate industry in California could have an adverse effect on
our operations. Similarly, a sizable portion of our total loan portfolio is to
borrowers either directly or indirectly involved in the agricultural industry.
While a great number of our borrowers may not be individually involved in
agriculture, many of the jobs in the San Joaquin Valley are ancillary to the
regular production, processing, marketing and sales of agricultural commodities.
The ripple effect of lower commodity prices for milk, olives, grapes, tree fruit
and oranges has a tendency to spread to lower land prices, lower borrower
income, and lower collateral values. In addition, weather patterns are of
critical importance to row crop, tree fruit, and orange production. A
degenerative cycle of weather and commodity prices can impact consumer
purchasing power, which has the potential to create further unemployment
throughout the San Joaquin Valley. Such conditions have affected and may
continue to adversely affect our borrower base and negatively impact our
business.
The California Energy Crisis May Adversely Impact Our Customers. California
- ----------------------------------------------------------------
experienced severe energy shortages in 2001, which resulted in rolling blackouts
in certain instances in portions of the state. Poor economic conditions as a
result of energy shortages in the areas where our customers are located could
adversely
16
affect our borrower base, and consequently, may negatively impact our
business. The issue of energy shortages has been resolved, to some extent, but
the prices paid by consumers and businesses for energy have increased
significantly in many cases. While the full impact has not yet been determined,
these price increases could cause customers of the Bank to experience losses or
go out of business, which could result in delinquencies and losses on loans made
to our borrowers and in turn have a material adverse effect on our business.
We May Incur Risks As a Result of Our Growth. Our Company's/1/ total assets
- ---------------------------------------------
increased from $607 million at December 31, 2000, to $650 million at December
31, 2001, with most of the growth occurring in the fourth quarter of the year.
Management's intention is to leverage the Company's current infrastructure to
sustain the momentum achieved in latter part of 2001, although no assurance can
be provided that this strategy will result in significant growth.
Our ability to manage growth will depend primarily on our ability to:
. monitor operations;
. control funding costs and operating expenses;
. maintain positive customer relations; and
. attract, assimilate and retain qualified personnel.
If we fail to achieve those objectives in an efficient and timely manner we may
experience disruptions in our business plans, and our financial condition and
results of operations could be adversely affected.
Changing Interest Rates May Reduce Our Net Interest Income. Banking companies'
- -----------------------------------------------------------
earnings depend largely on the relationship between the cost of funds, primarily
deposits and borrowings, and the yield on earning assets such as loans and
investment securities. This relationship, known as the interest rate spread, is
subject to fluctuation and is affected by economic, regulatory and competitive
factors which influence interest rates, the volume and mix of interest-earning
assets and interest-bearing liabilities, and the level of nonperforming assets.
Many of these factors are beyond our control. Fluctuations in interest rates
affect the demand of customers for our products and services. The Bank is
subject to interest rate risk to the degree that our interest-bearing
liabilities reprice or mature more slowly or more rapidly or on a different
basis than our interest-earning assets. Given our current volume and mix of
interest-bearing liabilities and interest-earning assets, our interest rate
spread could be expected to decline during times of falling interest rates, but
could also be adversely impacted if interest rates increase. Therefore,
significant fluctuations in interest rates may have a negative effect on our
results of operations.
Intense Competition Exists for Loans and Deposits. The banking and financial
- --------------------------------------------------
services business in California generally, and in our market area specifically,
is highly competitive. The increasingly competitive environment is a result
primarily of changes in regulation, changes in technology and product delivery
systems and the accelerating pace of consolidation among financial service
providers. We compete for loan, deposit, and financial services customers with
other commercial banks, savings and loan associations, securities and brokerage
companies, mortgage companies, insurance companies, finance companies, money
market funds, credit unions and other non-bank financial service providers. Many
of these competitors are much larger in total assets and capitalization, have
greater access to capital markets and offer a broader array of financial
services than we do, which creates certain competitive disadvantages for the
Company.
You May Have Difficulty Selling Your Shares in the Future If a More Active
- --------------------------------------------------------------------------
Trading Market for Our Stock Does Not Develop. Although Sierra Bancorp's Common
- ----------------------------------------------
Stock has been listed on the Nasdaq National Market since August 10, 2001 (the
effective date of the holding company reorganization) and Bank of the Sierra's
Common Stock was previously listed on the Nasdaq National Market since June 10,
1999, trading in our stock has not been extensive and cannot be characterized as
amounting to an active trading market.
- -------------------------
/1/ Inasmuch as the Company did not acquire the outstanding shares of the Bank
until August, 2001, the financial information contained throughout this Annual
Report for 2000 and earlier is for the Bank only. Information for 2001 is for
the Company on a consolidated basis unless otherwise stated.
17
Because the Price of Our Common Stock May Vary Widely, When You Decide to Sell
- ------------------------------------------------------------------------------
It, You May Encounter a Delay or Have to Accept a Reduced Price. The price of
- ----------------------------------------------------------------
our common stock may fluctuate widely, depending on many factors. Some of these
factors have little to do with our operating results or the intrinsic worth of
our Company. For example, the market value of our common stock may be affected
by the trading volume of the shares, announcements of expanded services by us
or our competitors, operating results of our competitors, general trends in the
banking industry, general price and volume fluctuations in the stock market,
acquisition of related companies, or variations in quarterly operating results.
Also, if the trading market for our common stock remains limited, that may
exaggerate changes in market value, leading to more price volatility than would
occur in a more active trading market. As a result, if you want to sell your
common stock, you may encounter a delay or have to accept a reduced price.
Adverse Effects of Banking Regulations or Changes in Banking Regulations Could
- ------------------------------------------------------------------------------
Adversely Affect Our Business. We are governed by significant federal and state
- ------------------------------
regulation and supervision, which is primarily for the benefit and protection
of our customers and not for the benefit of our investors. In the past, our
business has been materially affected by these regulations, and our business
may be adversely affected by any future changes in laws, regulations, policies
or interpretations. Laws, regulations or policies currently affecting us and
our subsidiaries may change at any time, and regulatory authorities may also
change their interpretation of these statutes and regulations.
The Allowance for Loan Losses May Not Cover Actual Loan Losses. We try to limit
- ---------------------------------------------------------------
the risk that borrowers will fail to repay loans by carefully underwriting the
loans, nevertheless losses can and do occur. We create an allowance for
estimated loan losses in our accounting records, based on estimates of the
following:
. industry standards;
. historical experience with our loans;
. evaluation of economic conditions;
. regular reviews of the quality mix and size of the overall loan portfolio;
. regular reviews of delinquencies; and
. the quality of the collateral underlying our loans.
We maintain an allowance for loan losses at a level which we believe is
adequate to absorb any specifically identified losses as well as any other
losses inherent in our loan portfolio. However, changes in economic, operating
and other conditions, including changes in interest rates, that are beyond our
control, may cause our actual loan losses to exceed our current allowance
estimates. If the actual loan losses exceed the amount reserved, it will hurt
our business. In addition, the FDIC and the Department of Financial
Institutions, as part of their supervisory functions, periodically review our
allowance for loan losses. Such agencies may require us to increase our
provision for loan losses or to recognize further loan losses, based on their
judgments, which may be different from those of our management. Any increase in
the allowance required by the FDIC or the Department of Financial Institutions
could also hurt our business.
Our Directors and Executive Officers Control Almost a Majority of Our Stock,
- ----------------------------------------------------------------------------
and Your Interests May Not Always be the Same as Those of the Board and
- -----------------------------------------------------------------------
Management. As of December 31, 2001, our directors and executive officers
- ----------
together with their affiliates, beneficially owned approximately_45.9% of the
Bank's outstanding voting stock (not including vested option shares). As a
result, if all of these shareholders were to take a common position, they could
most likely control the outcome of most corporate actions, such as:
. approval of mergers or other business combinations;
. sales of all or substantially all of our assets;
. any matters submitted to a vote of our shareholders;
. issuance of any additional common stock or other equity securities;
18
. incurrence of debt other than in the ordinary course of business;
. the selection and tenure of our Chief Executive Officer; and
. payment of dividends on common stock or other equity securities.
In some situations, the interests of our directors and executive officers may
be different from yours. However, our Board of Directors and executive officers
have a fiduciary duty to act in the best interests of the shareholders, rather
than in their own best interests, when considering a proposed business
combination or any of these types of matters.
Provisions in Our Articles of Incorporation Will Delay or Prevent Changes in
- ----------------------------------------------------------------------------
Control of Our Corporation or Our Management. These provisions make it more
- ---------------------------------------------
difficult for another company to acquire us, which could reduce the market
price of our common stock and the price that you receive if you sell your
shares in the future. These provisions include the following:
. a requirement that certain business combinations not approved by our Board of
Directors receive the approval of two-thirds of the outstanding shares;
. staggered terms of office for members of the board of directors;
. the elimination of cumulative voting in the election of directors; and
. a requirement that our Board of Directors consider the potential social and
economic effects on the our employees, depositors, customers and the
communities we serve as well as certain other factors, when evaluating a
possible tender offer, merger or other acquisition of the Company.
19
ITEM 2. PROPERTIES
- -------------------
The following properties (real properties and/or improvements thereon) are
owned by the Company/(1)/ and are unencumbered. In the opinion of Management,
all properties are adequately covered by insurance.
Square Feet of Land and
Location Use of Facilities Office Space Building Cost
- -------- ----------------- ------------ -------------
90 North Main Street Main Office 8,500 $324,560
Porterville, California
(Opened January 1978)
1498 West Olive Avenue Branch Office 5,000 $803,380
Porterville, California
(Opened January 1980)
142 South Mirage Branch Office 5,500 $816,366
Lindsay, California
(Opened December 1980)
1103 West Visalia Street Branch Office 4,500 $609,337
Exeter, California
(Opened November 18, 1988)
40884 Sierra Drive Branch Office 2,500 $496,251
Three Rivers, California
(Opened March 4, 1994)
401 East Tulare Street Branch Office 2,300 $500,793
Dinuba, California
(Opened February 14, 1997)
246 East Tulare Avenue Branch Office 7,800 $1,189,607
Tulare, California
(Opened May 2, 1998)
427 West Lacey Boulevard Branch Office 4,500 $1,271,189
Hanford, California
(Opened January 16, 1999)
636 E. Shaw Avenue Branch Office 12,000 $1,498,445
Fresno, California
(Opened September 27, 1999)
224 West "F" Street Branch Office 7,749 $330,000
Tehachapi, California
(Opened May 22, 2000)
- -----------------------
/1/ As used throughout this Annual Report, the term "Company" includes, where
appropriate, both Sierra Bancorp and its consolidated subsidiary, Bank of the
Sierra.
20
Square feet of Land and
Location Use of Facilities Office Space Building Cost
- -------- ----------------- ------------ -------------
21000 Mission Street Branch Office 1,479 $250,000
Tehachapi, California
(Opened May 22, 2000)
8031 California City Boulevard Branch Office 2,182 $285,000
California City, California
(Opened May 22, 2000)
1621 Mill Rock Way Branch Office 3,920 $1,160,000
Bakersfield, California
(Opened May 22, 2000)
The following facilities are leased by the Bank:
Square Feet of Monthly Rent Term of
Location Use of Facilities Office Space as of 12/31/01 Lease
- -------- ----------------- ------------ -------------- -----
80-86 North Main Street Administrative 37,000 $10,225 4/26/14/1/
Porterville, California Headquarters Office
128 East Main Street Branch Office 8,000 $7,650 6/30/05/2/
Visalia, California
(Opened September 5, 1995)
2515 South Mooney Blvd. Branch Office 3,300 $4,705 6/18/06
Visalia, California
(Opened June, 1991)
5060 California Avenue Branch Office 7,410 $11,292 7/31/08
Bakersfield, California
(Opened May, 2, 1997)
Additionally, the Bank has eight remote ATM locations. The amount of monthly
rent at these locations is minimal.
Management believes that the Company's existing facilities are adequate to
accommodate the Company's operations for the immediately foreseeable future.
- -----------------------
/1/ This is the termination date of the original 20-year lease; the Company has
the right, however, to terminate the lease with 90 days advance notice on the
10th and 15th anniversary dates of the lease commencement.
/2/ This is the termination date of the original lease; the Company also has
three renewal options for five years each under this lease agreement.
21
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
From time to time, the Company is a party to claims and legal proceedings
arising in the ordinary course of business. After taking into consideration
information furnished by counsel to the Company as to the current status of
these claims or proceedings to which the Company is a party, management is of
the opinion that the ultimate aggregate liability represented thereby, if any,
will not have a material adverse affect on the financial condition of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
Not applicable.
22
PART II
-------
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
- -----------------------------------------------------------------
(a) Market Information
Sierra Bancorp's Common Stock has been listed on the Nasdaq National Market
since August 10, 2001 (the effective date of the holding company
reorganization), and Bank of the Sierra's Common Stock was previously listed on
the Nasdaq National Market since June 10, 1999. Our Common Stock trades on the
Nasdaq Stock Market(R) under the symbol BSRR and the CUSIP number for such
common stock is #064860109. Trading in the Common Stock of the Company has not
been extensive and such trades cannot be characterized as amounting to an
active trading market. Management is aware of the following securities dealers
who make a market in the Company's stock: Hoefer & Arnett, San Francisco,
California; J. Alexander Securities, Inc., Los Angeles, California; Morgan
Stanley Dean Witter, Bakersfield, California Sutro & Co., Los Angeles,
California, and Wedbush Morgan Securities, Portland, Oregon (the "Securities
Dealers").
The following table summarizes trades of the Company's /1/ Common Stock, setting
forth the approximate high and low sales prices and volume of trading for the
periods indicated, based upon information provided by public sources. The
information in the following table does not include trading activity between
dealers.
Calendar Sale Price of the Company's /1/ Approximate
Quarter Ended Common Stock Trading Volume
High Low Shares
---- --- ------
March 31, 2000.......... 9.50 7.50 183,200
June 30, 2000........... 8.25 7.13 94,800
September 30, 2000...... 8.00 5.68 89,200
December 31, 2000....... 7.50 5.75 137,700
March 31, 2001.......... 8.13 6.25 96,100
June 30, 2001........... 7.30 6.00 126,400
September 30, 2001...... 7.25 6.00 122,000
December 31, 2001....... 7.30 6.00 167,300
(b) Holders
On February 15, 2002 there were approximately 739 shareholders of record of the
Company's Common Stock.
(c) Dividends
As a bank holding company which currently has no significant assets other than
its equity interest in the Bank, the Company's ability to declare dividends
depends primarily upon dividends it receives from the Bank. The Bank's dividend
practices in turn depend upon the Bank's earnings, financial position, current
and anticipated cash requirements and other factors deemed relevant by the
Bank's Board of Directors at that time.
The Company paid quarterly cash dividends totaling $1.66 million or $0.18 per
share in 2001 and $2.12 million or $0.23 per share in 2000, representing 24%
and 38%, respectively of the prior year's earnings. (As the holding company
reorganization became effective on August 10, 2001, all of the dividends paid
prior to that date were paid by the Bank, rather than the Company.) Since 1999,
the Bank (or the Company, as applicable) has
- -----------------------
/1/ Inasmuch as the Company did not acquire the outstanding shares of the Bank
until August, 2001, the information contained herein for 2000 and part of 2001
is for the Bank's stock. As of the effective date of the holding company
reorganization (August 10, 2001), each outstanding share of common stock of the
Bank was converted into one outstanding share of common stock of the Company.
23
generally adhered to a policy of paying quarterly cash dividends totaling about
35% of the prior year's net earnings to the extent consistent with general
considerations of safety and soundness, provided that such payments do not
adversely affect the Bank's or the Company's financial condition and are not
overly restrictive to its growth capacity. However, the Bank experienced
significant growth in 2000, due mainly to its acquisition of Sierra National
Bank in May of that year, and also had a slight contraction in earnings in the
2000 calendar year. In light of these events, the Board of Directors declared
dividends in 2001 totaling only approximately 24% of the prior year earnings.
The Company anticipates paying dividends in the future consistent with the
general dividend policy as described above. However, no assurance can be given
that the Bank's and the Company's future earnings and/or growth expectations in
any given year will justify the payment of such a dividend.
The power of the Bank's Board of Directors to declare cash dividends is also
limited by statutory and regulatory restrictions which restrict the amount
available for cash dividends depending upon the earnings, financial condition
and cash needs of the Bank, as well as general business conditions. Under
California banking law, the Bank may declare dividends in an amount not
exceeding the lesser of its retained earnings or its net income for the last
three years (reduced by dividends paid during such period) or, with the prior
approval of the California Commissioner of Financial Institutions, in an amount
not exceeding the greatest of (i) the retained earnings of the Bank, (ii) the
net income of the Bank for its last fiscal year, or (iii) the net income of the
Bank for its current fiscal year. The payment of any cash dividends by the Bank
will depend not only upon the Bank's earnings during a specified period, but
also on the Bank meeting certain regulatory capital requirements.
The Company's ability to pay dividends is also limited by state corporation
law. The California General Corporation Law prohibits the Company from paying
dividends on the Common Stock unless: (i) its retained earnings, immediately
prior to the dividend payment, equals or exceeds the amount of the dividend or
(ii) immediately after giving effect to the dividend the sum of the Company's
assets (exclusive of goodwill and deferred charges) would be at least equal to
125% of its liabilities (not including deferred taxes, deferred income and
other deferred liabilities) and the current assets of the Company would be at
least equal to its current liabilities, or, if the average of its earnings
before taxes on income and before interest expense for the two preceding fiscal
years was less than the average of its interest expense for the two preceding
fiscal years, at least equal to 125% of its current liabilities.
(d) Recent Sales of Unregistered Securities
On November 28, 2001, the Company issued an aggregate of $15,000,000 in
principal amount of its Floating Rate Junior Subordinated Deferrable Interest
Debentures due 2031 (the "Subordinated Debt Securities"). All of the
Subordinated Debt Securities were issued to Sierra Capital Trust I, a Delaware
statutory business trust and a wholly-owned subsidiary of the Company (the
"Trust"). The Subordinated Debt Securities were not registered under the
Securities Act in reliance on the exemption set forth in Section 4(2) thereof.
The Subordinated Debt Securities were issued to the Trust in consideration for
the receipt of the net proceeds (approximately $14.5 million) raised by the
Trust from the sale of $15,000,000 in principal amount of the Trust's Floating
Rate Capital Trust Pass-through Securities (the "Trust Preferred Securities").
Salomon Smith Barney, Inc. ("SSB") acted as the placement agent in connection
with the offering of the Trust Preferred Securities for aggregate commissions
of $450,000 payable by the Trust. The sale of the Trust Preferred Securities
was part of a larger transaction arranged by SSB pursuant to which the Trust
Preferred Securities were deposited into a special purpose vehicle along with
similar securities issued by a number of other banks and the special purpose
vehicle then issued its securities to the public (the "Pooled TRUPS"). The
Pooled TRUPS were sold by SSB only (i) to those entities SSB reasonably
believed were qualified institutional buyers (as defined in Rule 144A under the
Securities Act), (ii) to "accredited investors" (as defined in Rule 501(a)(1),
(2), (3) or (7) or Regulation D promulgated under the Securities Act) or (iii)
in offshore transactions in compliance with Rule 903 of Regulation S under the
Securities Act. The Trust Preferred Securities were not registered under the
Securities Act in reliance on exemptions set forth in Rule 144A, Regulation D
and Regulation S, as applicable.
24
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
The "selected financial data" for 2001 which follows is derived from the
audited Consolidated Financial Statements of the Company and other data from
our internal accounting system. The selected financial data should be read in
conjunction with the audited Consolidated Financial Statements and Notes
thereto, and Management's Discussion and Analysis of Financial Condition and
Results of Operations in Item 7 below. Statistical information below is
generally based on average daily amounts.
25
Selected Financial Data
As of December 31,
(Dollars in thousands, except per share data)
Income Statement Summary 2001 2000/1/ 1999 1998 1997
------------- ------------- ------------- ------------- ------------
Interest income $ 43,338 $ 45,528 $ 33,864 $ 33,652 $ 30,011
Interest expense $ 15,892 $ 18,677 $ 11,721 $ 12,378 $ 9,846
Net interest income before provision for
loan losses $ 27,446 $ 26,851 $ 22,143 $ 21,274 $ 20,165
Provision for loan losses $ 1,300 $ 2,760 $ 2,118 $ 2,800 $ 2,013
Non interest income $ 9,663 $ 6,436 $ 5,346 $ 6,076 $ 4,389
Non-interest expense $ 25,309 $ 22,304 $ 16,984 $ 16,383 $ 15,463
Income before provision for income taxes $ 10,500 $ 8,223 $ 8,387 $ 8,167 $ 7,078
Provision for income taxes $ 3,622 $ 2,742 $ 2,775 $ 2,943 $ 2,536
Net Income $ 6,878 $ 5,481 $ 5,612 $ 5,224 $ 4,542
Balance Sheet Summary
Total loans, net $ 480,393 $ 416,392 $ 314,474 $ 270,920 $ 258,142
Allowance for loan losses $ (5,675) $ (5,362) $ (3,319) $ (4,394) $ (3,034)
Securities held to maturity $ - $ - $ 64,886 $ 53,096 $ 37,033
Securities available for sale $ 92,689 $ 110,752 $ 26,528 $ 30,656 $ 23,082
Cash and due from banks $ 39,835 $ 43,433 $ 31,413 $ 24,545 $ 26,774
Federal funds sold $ - $ 246 $ - $ 9,800 $ 5,300
Other real estate owned $ 769 $ 1,530 $ 2,553 $ 1,273 $ 2,285
Premises and equipment, net $ 14,304 $ 14,477 $ 11,597 $ 9,491 $ 7,540
Total Interest-Earning assets $ 579,480 $ 535,689 $ 408,924 $ 369,216 $ 327,264
Total Assets $ 650,410 $ 606,726 $ 458,384 $ 404,064 $ 365,333
Total Interest-Bearing liabilities $ 454,216 $ 431,468 $ 327,835 $ 283,464 $ 260,373
Total Deposits $ 521,317 $ 527,776 $ 385,818 $ 355,881 $ 321,113
Total Liabilities $ 604,269 $ 565,944 $ 421,685 $ 369,046 $ 334,882
Total Shareholders' Equity $ 46,141 $ 40,782 $ 36,699 $ 35,018 $ 30,451
Per Share Data /(2)/
Net Income $ 0.75 $ 0.60 $ 0.61 $ 0.57 $ 0.49
Book Value $ 5.01 $ 4.43 $ 3.98 $ 3.80 $ 3.31
Cash Dividends $ 0.18 $ 0.23 $ 0.22 $ 0.15 $ 0.05
Weighted Average Common Shares Outstanding, Basic 9,212,280 9,212,280 9,212,280 9,212,280 9,212,280
Weighted Average Common Shares Outstanding, Diluted 9,221,480 9,212,280 9,252,193 9,212,280 9,212,280
Key Operating Ratios:
Performance Ratios:
Return on Average Equity /(3)/ 15.94% 14.30% 16.24% 15.81% 15.74%
Return on Average Assets /(4)/ 1.15% 0.96% 1.33% 1.33% 1.37%
Net Interest Spread /(5)/ 4.25% 4.60% 5.10% 4.97% 5.68%
Net Interest Margin 5.07% 5.48% 5.97% 5.92% 6.68%
Dividend Payout Ratio /(6)/ 24.11% 38.33% 36.07% 26.32% 10.20%
Equity to Assets Ratio /(7)/ 7.21% 6.69% 8.22% 8.42% 8.71%
Net Loans to Total Deposits at Period End 92.15% 78.90% 81.51% 76.13% 80.39%
Asset Quality Ratios:
Non Performing Loans to Total Loans 2.01% 0.73% 0.29% 1.43% 0.55%
Nonperforming Assets to Total Loans and
Other Real Estate Owned 2.17% 1.05% 1.08% 1.88% 1.41%
Net Charge-offs (recoveries) to Average Loans 0.23% 0.43% 1.11% 0.55% 0.78%
Allowance for Loan Losses to
Net Loans at Period End 1.18% 1.29% 1.06% 1.62% 1.18%
Allowance for Loan Losses to Non-Performing Loans 58.00% 173.87% 363.13% 111.58% 211.13%
Capital Ratios:
Tier 1 Capital to Adjusted Total Assets 9.02% 5.64% 8.13% 8.16% 8.10%
Tier 1 Capital to Total Risk-weighted Assets 11.03% 7.76% 10.30% 11.54% 10.50%
Total Capital to Total Risk-weighted Assets 12.18% 9.00% 11.32% 12.79% 11.61%
/(1)/ On May 19, 2000, Bank of the Sierra acquired the net assets of Sierra
National Bank. The transaction was accounted for using the purchase method of
accounting. Bank of the Sierra paid $9,563,000 in cash (including
acquisition-related costs of $463,000) for net assets of $3,694,000. The
resulting purchase price in excess of net assets acquired (intangibles) is
$5,869,000. The allocation of the purchase price is preliminary as not all
estimations have been finalized.
/(2)/ All per share data and the average number of shares outstanding have been
retroactively restated on a split adjusted basis.
/(3)/ Net income divided by average shareholders' equity.
/(4)/ Net income divided by average total assets.
/(5)/ Represents the average rate earned on interest-earning assets less the
average rate paid on interest-bearing liabilities.
/(6)/ Dividends declared per share divided by net income per share.
/(7)/ Average equity divided by average total assets.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
-------------
This discussion presents Management's analysis of the financial condition and
results of operations of the Company as of and for each of the years in the
three-year period ended December 31, 2001./(1)/ The Company also wholly owns
Sierra Capital Trust I, a Delaware statutory business trust (see "Part II, Item
5 -- Market for Common Equity and Related Shareholder Matters -- Recent Sales
of Unregistered Securities"). The discussion should be read in conjunction with
the Consolidated Financial Statements of the Company and the Notes related
thereto presented elsewhere in this Form 10-K Annual Report (see Item 8 below).
Statements contained in this report that are not purely historical are forward
looking statements within the meaning of Section 21E of the Securities Exchange
Act of 1934 as amended, including the Company's expectations, intentions,
beliefs, or strategies regarding the future. All forward-looking statements
concerning economic conditions, rates of growth, rates of income or values as
may be included in this document are based on information available to the
Company on the date noted, and the Company assumes no obligation to update any
such forward-looking statements. It is important to note that the Company's
actual results could materially differ from those in such forward-looking
statements. Factors that could cause actual results to differ materially from
those in such forward-looking statements are fluctuations in interest rates,
inflation, government regulations, economic conditions, customer
disintermediation and competitive product and pricing pressures in the
geographic and business areas in which the Company conducts its operations.
SUMMARY OF PERFORMANCE
- ----------------------
After a slight dip in earnings in 2000, the Company regained its footing in
2001 and increased net earnings by more than 25% despite only a 4.7% increase
in average earning assets and a slight decline in the Company's net interest
margin. Net income in 2000 declined primarily due to increased operating costs
associated with the May 2000 acquisition of Sierra National Bank ("SNB"), a
Tehachapi-based, four branch financial institution with approximately $87
million in total assets. The purchase of SNB was a strategic decision meant to
improve the Company's long-term potential. Gains on the sale of investment
securities were responsible for approximately half of the increase in net
income in 2001. The increase in net earnings in 2001 was also achieved through
increased net interest income, gains from the sale of loans and loan servicing,
a reduction in the loan loss provision (which occurred in spite of an increase
in the level of non-performing loans - see "Non-performing Assets"), and the
implementation of expense controls during the course of the year. For 2001, net
income was $6.88 million, compared to the $5.48 million earned in 2000 and net
income of $5.61 million in 1999. Net income per share was $0.75 for 2001, as
compared to $0.60 during 2000 and $0.61 in 1999. The Company's Return on
Average Assets ("ROA") was 1.15% and Return on Average Equity ("ROE") was
15.94% in 2001, as compared to .96% and 14.30%, respectively in 2000, and 1.33%
and 16.24%, respectively for 1999.
Perhaps the most significant single factor impacting the Company's performance
in 2001 was the Federal Reserve Board's record reduction in the target
overnight fed funds rate and discount rate, although this negative factor was
more than offset by the combination of positive factors discussed elsewhere in
this section. The Federal Reserve Board's rate reductions injected liquidity
into the banking system, which forced other market interest rates to decline in
response. As is typical in many other community banks, the Company's net
interest margin was negatively impacted as market rates fell. The rate-related
decline in net interest income, however, was mitigated by the increased income
generated by a higher level of average earning assets and favorable changes in
the Company's deposit mix, and net interest income increased by $595,000 from
2000 to 2001. Moreover, the decline in market rates boosted the Company's
volume of mortgage loans, some of which we were able to sell at a substantial
gain, and increased the value of the Bank's investment portfolio, a portion of
which was also sold with realized gains.
- -----------------------
/1/ As the holding company reorganization pursuant to which the Company became
the sole shareholder of the Bank was effective in August, 2001, all financial
information as of and for the years ended December 31, 2000 and any earlier
years or periods relates to the Bank rather than the Company. Information as of
and for the year ended December 31, 2001 is provided for the Bank and the
Company on a consolidated basis.
27
The Company's lower loan loss provision is, on the surface, inconsistent with
the increase in non-performing assets and higher aggregate loan balances, and
the Company's allowance for loan losses fell as a percentage of loans and as a
percentage of non-performing loans. Actual loan losses, however, declined in
2001, and management's detailed analysis of the adequacy of the allowance
provides justification for the amounts added to the allowance by means of the
loan loss provision during the year.
Due in part to an increase in operating expenses associated with the SNB
acquisition, the Company undertook a thorough review of its major expenses in
early 2001. As a result of this effort, certain cost-cutting measures were
implemented during the year, including a staff reduction program. The Company
also decided to sell its mortgage servicing to reduce associated expenses and
realize non-recurring gains. It is anticipated that these expense controls will
continue to enhance the Company's profitability in subsequent years, although no
absolute assurance can be given that this, in fact, will occur.
On November 28, 2001, Sierra Capital Trust I, a newly formed Delaware statutory
business trust and a wholly-owned subsidiary of the Company (the "Trust"),
issued an aggregate of $15,000,000 of principal amount of Floating Rate
TRUPS(R) (Capital Trust Pass-through Securities of the Trust) , which in turn
were used to purchase the same amount of Subordinated Debt Securities issued by
the Company. These Trust Preferred Securities currently qualify as Tier 1
capital when calculating regulatory risk-based capital ratios. The issuance of
the Trust Preferred Securities in the fourth quarter of 2001, coupled with
relatively slow asset growth during most of 2001, resulted in substantial
improvement in the Company's capital ratios. Proceeds from the issuance of Trust
Preferred Securities were used to increase the capital of the Bank and for
general corporate purposes. The Bank is now considered to be "well capitalized"
pursuant to the FDIC's prompt corrective action guidelines. We anticipate that
this increase in capital will provide a springboard for future asset growth,
while allowing the Bank to maintain its well capitalized position. There can be
no absolute assurance given that this in fact will occur, however, as numerous
local market, general economic and regulatory changes could impact capital
ratios going forward.
RESULTS OF OPERATIONS
- ---------------------
NET INTEREST INCOME AND NET INTEREST MARGIN
- -------------------------------------------
During 2001 the Company generated net income of $6.88 million as compared to
$5.48 million in 2000 and $5.61 million in 1999. The Company earns income from
two primary sources. The first is net interest income brought about by income
from the successful deployment of earning assets less the costs of
interest-bearing liabilities. The second is non-interest income, which generally
comes from customer service charges and fees, but can also result from
non-customer sources such as gains on loan sales and gains on sales from the
Company's investment portfolio. The majority of the Company's expenses are
operating costs which relate to providing a full range of banking services to
our customers.
Net interest income, which is simply total interest income (including fees) less
total interest expense, was $27.45 million in 2001 compared to $26.85 million
and $22.14 million in 2000 and 1999, respectively. This represents an increase
of 2.2% in 2001 over 2000 and an increase of 21.3% in 2000 over 1999. Going
forward, the $15 million in Trust Preferred Securities, which currently bear an
interest rate of 6.007%, are expected to add approximately $900,000 per year to
the Company's interest expense, although the rate adjusts every six months and
this amount will likely vary somewhat. The Company will be able to maintain a
positive interest spread on these funds, however, by leveraging this additional
regulatory capital to increase loan balances.
The amount by which total interest income exceeds total interest expense depends
on several factors. Among those factors are yields on earning assets, the cost
of interest-bearing liabilities, the relative volume of total earning assets and
total interest-bearing liabilities, and the mix of products which comprise the
Company's earning assets, deposits, and other interest-bearing liabilities.
Change in the amount and mix of interest-earning
28
assets and interest-bearing liabilities is referred to as "volume change."
Change in interest rates earned on assets and rates paid on deposits and other
borrowed funds is referred to as "rate change."
The Volume and Rate Variances table which follows sets forth the dollar amount
of changes in interest earned and paid for each major category of
interest-earning assets and interest-bearing liabilities and the amount of
change attributable to changes in average balances (volume) or changes in
average interest rates. The calculation is as follows: the change due to
increase or decrease in volume is equal to the increase or decrease in the
average balance times the prior period's rate. The change due to an increase or
decrease in the rate is equal to the increase or decrease in the average rate
times the current period's balance. The variances attributable to both the
volume and rate changes have been allocated to the change in rate.
===========================================================================================================
Volume & Rate Variances Years Ended December 31,
- -----------------------
(dollars in thousands) 2001 over 2000 2000 over 1999
----------------------------- -------------------------------
Increase(decrease) due to Increase(decrease) due to
Assets: Volume Rate Net Volume Rate Net
----------------------------- -------------------------------
Investments:
- -----------
Federal funds sold / Due from time $ 334 $ (180) $ 154 $ 105 $ (103) $ 2
Taxable $ (447) $ (207) $ (654) $ 809 $ 609 $ 1,418
Non-taxable/(1)/ $ 111 $ (133) $ (22) $ 284 $ (74) $ 210
Equity $ (7) $ 67 $ 60 $ (19) $ 30 $ 11
----------------------------- -------------------------------
Total Investments $ (9) $ (453) $ (462) $ 1,179 $ 462 $ 1,641
----------------------------- -------------------------------
Loans:
- -----
Agricultural $ (490) $ (331) $ (821) $ 7 $ 251 $ 258
Commercial $ 1,456 $ (1,137) $ 319 $ 1,824 $ (412) $ 1,412
Real Estate $ 101 $ (1,680) $(1,579) $ 8,881 $(1,078) $ 7,803
Consumer $ 694 $ (439) $ 255 $ 566 $ 58 $ 624
Credit Cards $ 101 $ (3) $ 98 $ 15 $ (89) $ (74)
----------------------------- -------------------------------
Total Loans $ 1,862 $ (3,590) $(1,728) $ 11,293 $(1,270) $10,023
----------------------------- -------------------------------
Total Earning Assets $ 1,853 $ (4,043) $(2,190) $ 12,472 $ (808) $11,664
----------------------------- -------------------------------
Liabilities
Interest Bearing Deposits:
- -------------------------
NOW $ (16) $ (180) $ (196) $ 115 $ (41) $ 74
Savings Accounts $ 51 $ (255) $ (204) $ 156 $ 61 $ 217
Money Market $ 862 $ 510 $ 1,372 $ 334 $ 34 $ 368
TDOA's & IRA's $ 27 $ 4 $ 31 $ 266 $ (12) $ 254
Certificates of Deposit * $100,000 $ (767) $ (884) $(1,651) $ 1,863 $ 741 $ 2,604
Certificates of Deposit ** $100,000 $ (240) $ (1,062) $(1,302) $ 1,491 $ 1,040 $ 2,531
----------------------------- -------------------------------
Total Interest Bearing Deposits $ (83) $ (1,867) $(1,950) $ 4,225 $ 1,823 $ 6,048
----------------------------- -------------------------------
Borrowed Funds:
- --------------
Federal Funds Purchased $ 189 $ (103) $ 86 $ 2 $ 23 $ 25
Repurchase Agreements $ 95 $ (264) $ (169) $ 116 $ 117 $ 233
Other Borrowings $ (840) $ 3 $ (837) $ 531 $ 119 $ 650
TRUPS $ 85 $ - $ 85 $ - $ - $ -
----------------------------- -------------------------------
Total Borrowed Funds $ (471) $ (364) $ (835) $ 649 $ 259 $ 908
----------------------------- -------------------------------
Total Interest Bearing Liabilities $ (554) $ (2,231) $(2,785) $ 4,874 $ 2,082 $ 6,956
----------------------------- -------------------------------
Net Interest Margin/Income $ 2,407 $ (1,812) $ 595 $ 7,598 $(2,890) $ 4,708
============================= ===============================
/(1)/ Yields on tax exempt income have not been computed on a tax equivalent basis.
===========================================================================================================
The Company's net interest margin is its net interest income expressed as a
percentage of average earning assets. The Company's net interest margin for 2001
was 5.07%, a decline of 12 basis points from the 5.19% reported for 2000. For
the year 1999, this margin was 5.80%. The following Distribution, Rate and Yield
table shows, for each of the past three years, the rates earned on each
component of the Company's investment and loan portfolio, the rates paid on each
segment of the Company's interest bearing liabilities, and the Company's net
interest margin. That same table also shows the Company's average daily balances
for each principal category of assets, liabilities and shareholders' equity, the
amount of interest income or interest expense, and the average
29
yield or rate for each category of interest-earning asset and interest-bearing
liability along with the net interest margin for each of the reported periods.
Distribution, Rate & Yield Year Ended December 31,
(dollars in thousands)
2001(a) 2000(a)
------------------------------ ------------------------------
Average Income/ Average Average Income/ Average
Assets Balance Expense Rate Balance Expense Rate
Investments:
Federal Funds Sold/Due from Time $ 9,395 $ 398 4.24% $ 3,959 $ 243 6.14%
Taxable $ 60,057 $ 3,662 6.10% $ 66,993 $ 4,316 6.44%
Non-taxable/(1)/ $ 42,427 $ 2,000 4.71% $ 40,211 $ 2,022 5.03%
Equity $ 2,391 $ 94 3.93% $ 2,680 $ 34 1.27%
------------------ --------------------
Total Investments $114,270 $ 6,154 5.39% $ 113,843 $ 6,615 5.81%
------------------ --------------------
Loans:/(2)/
- -----
Agricultural $ 11,344 $ 885 7.80% $ 15,921 $ 1,706 10.72%
Commercial $ 76,341 $ 6,525 8.55% $ 61,830 $ 6,206 10.04%
Real Estate $284,239 $24,715 8.70% $ 283,147 $26,294 9.29%
Consumer $ 37,264 $ 3,561 9.56% $ 30,795 $ 3,306 10.74%
Credit Cards $ 11,781 $ 1,499 12.72% $ 10,987 $ 1,401 12.75%
Other $ 5,999 $ - 0.00% $ 610 $ - 0.00%
------------------ --------------------
Total Loans $426,968 $37,185 8.71% $ 403,290 $38,913 9.65%
------------------ --------------------
Total Earning Assets/(4)/ $541,238 $43,339 8.01% $ 517,133 $45,528 8.80%
------- -------
Non-Earning Assets $ 57,318 $ 56,093
-------- ----------
Total Assets $598,556 $ 573,226
======== ==========
Liabilities and Shareholders Equity
Interest-Bearing Deposits:
- -------------------------
NOW $ 45,668 $ 216 0.47% $ 47,498 $ 412 0.87%
Savings $ 30,170 $ 370 1.23% $ 27,698 $ 574 2.07%
Money Market $ 83,925 $ 2,911 3.47% $ 53,784 $ 1,539 2.86%
TDOA's, and IRA's $ 20,526 $ 918 4.47% $ 19,924 $ 887 4.45%
Certificates of Deposit * $100,000 $120,434 $ 5,829 4.84% $ 134,199 $ 7,480 5.57%
Certificates of Deposit ** $100,000 $101,944 $ 5,008 4.91% $ 105,970 $ 6,310 5.95%
------------------ --------------------
Total Interest-Bearing Deposits $402,667 $15,252 3.79% $ 389,073 $17,202 4.42%
Borrowed Funds:
Federal Funds Purchased $ 2,608 $ 116 4.45% $ 439 $ 30 6.83%
Repurchase Agreements $ 15,728 $ 432 2.75% $ 13,573 $ 601 4.43%
Other Borrowings $ 63 $ 7 11.11% $ 13,017 $ 844 6.48%
TRUPS $ 1,397 $ 85 6.08% $ - $ - 0.00%
------------------ --------------------
Total Borrowed Funds $ 19,796 $ 640 3.23% $ 27,029 $ 1,475 5.46%
------------------ --------------------
Total Interest Bearing Liabilities $422,463 $15,892 3.76% $ 416,102 $18,677 4.49%
Demand Deposits $125,833 $ 113,757
Other Liabilities $ 7,118 $ 5,029
Shareholders' Equity $ 43,142 $ 38,338
-------- ----------
Total Liabilities and Shareholders' Equity $598,556 $ 573,226
======== ==========
Interest Income/Earning Assets 8.01% 8.80%
Interest Expense/Earning Assets 2.94% 3.61%
------- -------
Net Interest Margin/(3)/ $27,447 5.07% $26,851 5.19%
================== =================
1999(a)
-----------------------------
Average Income/ Average
Balance Expense Rate
Investments:
Federal Funds Sold/Due from Time $ 2,468 $ 174 7.05%
Taxable $ 52,371 $ 2,898 5.53%
Non-taxable/(1)/ $ 34,759 $ 1,812 5.21%
Equity $ 3,391 $ 90 2.65%
-------------------
Total Investments $ 92,989 $ 4,974 5.35%
-------------------
Loans:/(2)/
- -----
Agricultural $ 15,847 $ 1,448 9.14%
Commercial $ 44,786 $ 4,794 10.70%
Real Estate $191,281 $ 18,491 9.67%
Consumer $ 25,429 $ 2,682 10.55%
Credit Cards $ 10,879 $ 1,475 13.56%
Other $ 507 $ - 0.00%
-------------------
Total Loans $288,729 $ 28,890 10.01%
-------------------
Total Earning Assets/(4)/ $381,718 $ 33,864 8.87%
--------
Non-Earning Assets $ 38,953
--------
Total Assets $420,671
========
Liabilities and Shareholders Equity
Interest-Bearing Deposits:
- -------------------------
NOW $ 35,413 $ 338 0.95%
Savings $ 19,262 $ 357 1.85%
Money Market $ 41,841 $ 1,171 2.80%
TDOA's, and IRA's $ 14,021 $ 633 4.51%
Certificates of Deposit * $100,000 $ 97,095 $ 4,876 5.02%
Certificates of Deposit ** $100,000 $ 75,974 $ 3,779 4.97%
-------------------
Total Interest-Bearing Deposits $283,606 $ 11,154 3.93%
Borrowed Funds:
Federal Funds Purchased $ 281 $ 5 1.78%
Repurchase Agreements $ 10,321 $ 368 3.57%
Other Borrowings $ 3,480 $ 194 5.57%
TRUPS $ - $ - 0.00%
-------------------
Total Borrowed Funds $ 14,082 $ 567 4.03%
-------------------
Total Interest Bearing Liabilities $297,688 $ 11,721 3.94%
Demand Deposits $ 83,766
Other Liabilities $ 4,655
Shareholders' Equity $ 34,562
--------
Total Liabilities and Shareholders' Equity $420,671
========
Interest Income/Earning Assets 8.87%
Interest Expense/Earning Assets 3.07%
-------
Net Interest Margin/(3)/ $ 22,143 5.80%
===================
* means less than
** means greater than
(a) Average balances are obtained from the best available daily or monthly
data.
/(1)/ Yields on tax exempt income have not been computed on a tax equivalent
basis.
/(2)/ Loan fees have been included in the calcualtion of interest income.
Loan Fees were approximately $(85,500), $667,000, and $1,753,000 for the
years ended December 31, 2001, 2000, and 1999 respectively. Loans are
gross of the allowance for possible loan losses, deferred fees and related
direct cost.
/(3)/ Represents net interest income as a percentage of average interest-earning
assets.
/(4)/ Non-accrual loans have been included in total loans for purposes of total
earning assets.
During 2001, the Company's net interest margin was impacted by two primary
factors, one negative and one positive. The main negative factor was the overall
decline in interest rates which caused net interest income to fall by $1.8
million. A large portion of the Bank's loans carry variable rates and re-price
immediately, versus a
30
large base of core deposits which are generally slower to re-price, creating
timing differences as interest income fell more rapidly than interest expense.
Exacerbating the timing effect was the narrowing of the relative spread between
loan and deposit rates as market rates moved significantly lower. The Company's
net interest margin actually showed improvement toward year-end, however, as
floors on loan rates kicked in and deposit rates were lowered to match similar
decreases in competitor rates. Demand for deposits has proven to be relatively
inelastic, possibly because insured bank deposits are currently viewed as a
safe haven relative to alternative investment products. However, as depositors
feel more secure with alternative investments the Company could be forced to pay
increasingly more for deposits to avoid potential run-off, even if other
interest rates remain static.
The primary positive factor impacting the Company's net interest margin was the
favorable shift in the mix of the Company's deposits and other interest-bearing
liabilities. The Company ran an advertising campaign targeting variable-rate
money market deposits early in 2001, which not only attracted new depositors but
also enticed some existing customers with maturing time deposits to roll their
money into money market accounts. Average time deposit balances fell by nearly
$18 million from 2000 to 2001, while money market account balances increased by
$30 million. Although a relatively high promotional rate was initially paid on
money market deposits, that rate fell as market interest rates dropped during
the course of the year. Even more significantly, though, average demand deposit
balances increased by $12 million, or 10.6%, from 2000 to 2001, which had a
substantial positive impact on the Company's net interest margin.
From 2000 to 2001, the Company's average loan portfolio grew by approximately
$24 million, or 5.87%, with earnings on that growth, net of associated funding
costs, contributing to net interest income. The increase in the annual average
balance is lower than the $64 million increase in ending balances, since most of
the growth in 2001 occurred in the last two months of the year. This growth
spurt should provide a solid base for earnings growth in 2002, however, although
no assurance can be given that this will prove to be the case. Additionally,
loan balances, which are the highest yielding component of the Company's earning
assets, have become an increasingly larger portion of the Company's average
asset base over the past three years. During 2001 the loan portfolio averaged
71.3% of total assets, while for 2000 and 1999 such balances represented 70.4%
and 68.6%, respectively, of average assets. The reverse of this trend is that
average investment balances have declined relative to total assets, from 22.1%
in 1999, to 19.9% in 2000 and 19.1% in 2001. Despite their decline relative to
total assets, a shifting of investment balances into higher-yielding
mortgage-backed securities and municipal bonds during 2001 has also helped
support the Company's net interest margin.
There were three major items having a negative impact on the Company's net
interest margin in 2000, which fell by more than 60 basis points relative to
1999. First was the fact that interest-bearing liabilities increased in
proportion to interest-earning assets, while other liabilities and equity both
declined relative to average earning assets. The second was the general market
and competitive conditions which caused an approximate 75 basis point increase
in the cost of time deposits, which comprised a significant portion (58%) of
interest-bearing liabilities in 2000. The third was the decline in the yield on
the loan portfolio, which was caused primarily by a disproportionate increase in
real estate loans, the lowest-yielding segment of the Company's portfolio in
2000.
Based on current economic conditions, the Company expects moderate changes in
the rates paid on interest-bearing liabilities and rates earned on both the
investment and loan portfolio during 2002. The Company's net interest margin is
anticipated to stay approximately the same as in 2001, and net interest income
should increase if loans grow as planned and the loan growth is funded by
reasonably priced deposits. However, no assurance can be given that this will,
in fact, occur.
NON-INTEREST INCOME AND NON-INTEREST EXPENSE
- --------------------------------------------
The primary traditional sources of non-interest income for the Company are
service charges on deposit accounts, gains on the sale of loans, loan servicing
income, and credit card fees. During 2001, the Company also realized substantial
gains on the sale of investment securities and the sale of loan servicing
rights. Service charges on
31
deposit accounts and loan sales income in 2001 accounted for 49.2% and 9.3%,
respectively, of total non-interest income, as compared to 63.5% and 7.9%,
respectively, for 2000. This decrease was due to the significant increase in
gains from the sale of loan servicing, and gains from the sale of investment
securities. Loan servicing income (including gains on servicing sales) and
credit card fees for 2001 were 12.1% and 5.0% respectively, as compared to 8.1%
and 7.3%, respectively, during 2000. Non-recurring gains on the sale of
investment securities increased from 1.9% to 11.5% of total non-interest income
from 2000 to 2001, but are expected to diminish significantly in 2002.
The primary source of non-interest income continues to be service charges on
deposit accounts. The Company's ratio of service charge income on deposit
accounts to average transaction accounts (demand and interest-bearing NOW
accounts) increased to 2.77% in 2001, as compared to 2.53% for 2000 and 2.55% in
1999. This increase is indicative of operational changes enacted in recent years
to generate additional non-sufficient funds charges, a higher level of collected
versus waived activity charges, and a lower number of service charge free
accounts.
Loan sales income increased proportionate to total non-interest income due to
the high volume of mortgage loans booked and sold during 2001. Mortgage loan
activity increased presumably as a result of the relatively low rates available
on such loans, and it is not expected that this level of loan sales income will
be sustained in 2002. Loan servicing income increased as well, as non-recurring
gains were realized on the sale of the bulk of the Company's servicing rights.
Pursuant to a detailed analysis of the loan servicing area, management
determined that loan servicing revenue was not sufficient to cover associated
costs and maintain a reasonable profit margin, and decided to sell the servicing
rights on its residential loan servicing portfolio. We expect that loan
servicing revenues will drop off substantially in 2002, although associated
expenses will also decline.
Credit card fees increased slightly from 2000 to 2001, but were approximately
the same percentage of average earning assets. With no plans for significant
growth in credit card receivables, it is expected that credit card fees will
stay at about the same level in 2002.
The decline in market interest rates had the effect of increasing the market
value of the Company's investment portfolio, which is substantially comprised of
fixed-rate bonds, and the Company was able to realize some of those gains as
bonds were sold during the year. Management had determined at the beginning of
2001 that the portfolio should be repositioned to improve its total return, by
moving balances from lower-yielding treasuries and agencies into municipal bonds
and mortgage-backed securities to the greatest extent possible. As bonds were
sold during the year in pursuit of this strategy, the Company realized gains on
those sales totaling approximately $1.1 million, compared to $119,000 and $6,000
in 2000 and 1999, respectively. Not all of the proceeds from investment
portfolio sales and maturities were reinvested in bonds, as evidenced by the $18
million decline in the total investment portfolio balance during 2001.
The Company is increasingly focused on enhancing its fee income to mitigate the
effects of a declining net interest margin. Based on the Company's efficiency
ratio of 68% for 2001, 67% for 2000, and 62% for 1999 as compared to the 55% and
lower ratios of certain major financial institutions, it is expected that this
activity will continue for the foreseeable future.
The Company's total non-interest expense increased to $25.3 million in 2001, as
compared to $22.3 million in 2001 and $17.0 million in 1999. The overall
increase in non-interest expenses is due in large part to the Company's
acquisition of SNB in May of 2000. In 2001 a full year of the post-acquisition
increase in operating expenses is reflected in the Company's income statement,
whereas in 2000 only those expenses subsequent to the acquisition date are
included.
The largest dollar increase in non-interest expenses was in professional
services costs, which more than doubled from $1.1 million to $2.3 million.
Included in professional services costs are about $200,000 in costs associated
with forming the holding company in 2001. This category also includes payments
to consultants for compliance, loan, and operations reviews, which increased by
$182,000 due to the increased size and complexity of the
32
Company. The Bank's FDIC assessment also increased by $170,000 from 2000 to
2001, due to the increase in the Bank's assessable deposit base as well as the
lower capital ratios that resulted from the SNB acquisition. It is expected that
the FDIC assessment will decline in 2002, since financial reports filed with
regulators at the end of 2001 reflect improvement in the Company's capital
position. However, assessment rates are subject to change and there is no
guaranty that the anticipated reduction will indeed occur.
The second largest dollar increase in non-interest expense was in salaries and
employee benefits, which increased by $854,000, or 8.5%, from 2000 to 2001. The
main reason for this increase is that 2001 reflects a full year of the
additional expense associated with staffing the four offices added through the
SNB acquisition. Based on market analysis and peer comparisons, it is
management's opinion that the Company can achieve significant growth in loans
and deposits with only minimal increases in staff. Thus, it is expected that
salaries and employee benefits will decline as a percentage of earning assets
over the next few years, although there is no guaranty that this will actually
occur. In addition, pursuant to a comprehensive analysis of various operating
units, staff reductions were implemented in mid-2001 and full-time equivalent
employees declined from 323 at the end of 2000 to 286 at the end of 2001. This
decline portends a much more modest increase in salaries and benefits in 2002,
although no assurance can be given that this, in fact, will occur.
Rent and occupancy expense increased by $548,000, or 15.1%, from 2000 to 2001.
The main reason for this increase is that 2001 reflects a full year of the
additional depreciation and other occupancy expenses associated with the four
offices added through the SNB acquisition, as well as the renovation and
maintenance expenses incurred to bring those offices up to Company standards.
Other operating costs increased by nearly $400,000, or 27%, the second largest
percentage increase for non-interest expense categories. Most of the increase
was in telephone and data communications costs, which increased subsequent to
the SNB acquisition but have also increased as the Company has upgraded its
communications technology. These costs are currently being reviewed in detail,
and telephone and data line configurations are expected to be restructured to
increase efficiencies and decrease costs, although no assurance can be given
that this will, in fact, occur.
Data processing costs also experienced a significant increase from 2000 to 2001,
climbing from $1.54 million to $1.88 million. This 22% increase was centered in
item processing costs, which grew by $279,000 due to the additional number of
items processed in 2001 versus 2000. Item processing costs as a percentage of
total non-interest expense have increased from 1.5% in 1999, to 4.9% in 2000, to
5.4% in 2001. Management has researched various alternatives in order to reduce
item processing costs, and plans to implement an in-house item processing
solution in the latter part of 2002. It is expected that, all else being equal,
this solution will significantly reduce item processing costs starting in 2003,
however there can be no assurance that this expense reduction will actually
occur.
The following table sets forth the various components of the Company's
non-interest income and non-interest expense for the years indicated:
33
=================================================================================================================
Non Interest Income/Expense
(dollars in thousands, unaudited)
OTHER OPERATING INCOME: 2001 % of Total 2000 % of Total 1999 % of Total
- ---------------------- ------------------- -------------------- -------------------
Service charges on deposit accounts $ 4,754 49.20% $ 4,085 63.47% $ 3,038 56.83%
Credit Card Fees $ 482 4.99% $ 472 7.33% $ 423 7.91%
Other service charges, commissions & fees $ 926 9.58% $ 391 6.08% $ 325 6.08%
Gains on sales of loans $ 899 9.30% $ 505 7.85% $ 836 15.64%
Loan servicing income $ 1,168 12.09% $ 520 8.08% $ 560 10.48%
Gains on sale of investment securities $ 1,108 11.47% $ 119 1.85% $ 6 0.11%
Other $ 326 3.37% $ 344 5.34% $ 158 2.96%
------------------- -------------------- -------------------
Total non-interest income $ 9,663 100.00% $ 6,436 100.00% $ 5,346 100.00%
As a percentage of average earning assets 1.79% 1.24% 1.40%
OTHER OPERATING EXPENSES:
- ------------------------
Salaries and employee benefits $10,908 43.10% $10,054 45.08% $ 8,195 48.25%
Occupancy costs
Furniture & Equipment $ 1,987 7.85% $ 1,964 8.81% $ 1,554 9.15%
Premises $ 2,187 8.64% $ 1,662 7.45% $ 1,391 8.19%
Advertising and Marketing Costs $ 829 3.28% $ 925 4.15% $ 711 4.19%
Data Processing Costs
Item processing costs $ 1,375 5.43% $ 1,096 4.91% $ 253 1.49%
Other data processing $ 506 2.00% $ 441 1.98% $ 536 3.16%
Deposit Services Costs $ 1,418 5.60% $ 1,304 5.85% $ 686 4.04%
Loan Services Costs
Loan Processing $ 445 1.76% $ 428 1.92% $ 384 2.26%
ORE Owned $ 129 0.51% $ 462 2.07% $ 167 0.98%
Credit Card $ 566 2.24% $ 532 2.39% $ 489 2.88%
Other loan services $ 32 0.13% $ 39 0.17% $ 71 0.42%
Other Operating Costs
Telephone & data communications $ 1,041 4.11% $ 797 3.57% $ 531 3.13%
Postage & mail $ 426 1.68% $ 309 1.39% $ 285 1.68%
Other $ 415 1.64% $ 371 1.66% $ 431 2.54%
Professional Services Costs
Legal & Accounting $ 1,457 5.76% $ 709 3.18% $ 302 1.78%
Other professional service $ 853 3.37% $ 428 1.92% $ 392 2.31%
Stationery & Supply Costs $ 615 2.43% $ 605 2.71% $ 499 2.94%
Sundry & Tellers $ 120 0.47% $ 178 0.80% $ 107 0.63%
------------------- -------------------- -------------------
Total non-interest Expense $25,309 100.00% $22,304 100.00% $16,984 100.00%
As a % of average earning assets 4.68% 4.31% 4.45%
Net non-interest income as a % of earning assets -2.89% -3.07% -3.05%
=================================================================================================================
PROVISION FOR LOAN LOSSES
- -------------------------
Credit risk is inherent in the business of making loans. The Company sets aside
an allowance or reserve for loan losses through charges to earnings. The charges
are shown in the income statements as provisions for loan losses, and
specifically identifiable and quantifiable losses are immediately charged off
against the allowance.
The Company's provisions in 2001, 2000, and 1999 were $1.3 million, $2.8
million, and $2.1 million, respectively. The provision was reduced by $1.5
million in 2001 despite an increase in non-performing loans. A lower amount was
added to the Company's allowance for loan losses in 2001 because net charge-offs
also fell by $748,000, and the allowance was maintained at a level determined to
be appropriate subsequent to a thorough management review of the allowance
relative to the Company's current loan portfolio. The loan loss provision is
determined by a conducting a monthly evaluation of the adequacy of the Company's
allowance for loan losses, and charging the shortfall, if any, to the current
month's expense. This has the effect of creating
34
variability in the amount and frequency of charges to the Company's earnings.
The procedures for monitoring the adequacy of the allowance, as well as
detailed information concerning the allowance itself, are included below under
"Allowance for Loan Losses".
INCOME TAXES
- ------------
As indicated in Note 9 in the Notes to the Consolidated Financial Statements,
income tax expense is the sum of two components, current tax expense and
deferred tax expense. Current tax expense results from applying the current tax
rate to taxable income, and is in essence the actual current income tax
liability. Some items of income and expense are recognized in different years
for tax purposes than when applying generally accepted accounting principles,
however, leading to differences between the Company's actual tax liability and
the amount accrued for this liability based on book income. These temporary
timing differences comprise the deferred portion of the Company's tax expense.
Most of the Company's temporary differences involve recognizing more expenses in
its financial statements than it has been allowed to deduct for taxes, and
therefore the Company normally carries a net deferred tax asset on its books. At
December 31, 2001 the Company's $1.6 net deferred tax asset was primarily due to
temporary differences in the reported allowance for loan losses, deferred
compensation, and depreciation.
The Company's income tax expense is also affected by the extent of tax-exempt
securities income, which arises primarily from the Company's investments in
state, county and municipal bonds. This portion of the portfolio averaged 36% of
the total in 2001, and provided $2.0 million in tax-exempt income. In 2001 the
Company also committed to an approximate $2.9 million investment in WNC
Institutional Tax Credit Fund X, a low-income housing partnership, which should
result in approximately $3.0 million in net total tax credits over its 15 year
life. About $140,000 of those tax credits should be realized in 2001, although
all of the credits are dependent upon the occupancy level of the housing
projects and income of the tenants and cannot be projected with complete
certainty. In addition, in 2001 the Company reevaluated the interest income
earned on its loans to companies whose operations are located in areas
designated as "enterprise zones" by the State of California. This interest
income is partially exempt from California income taxes, and the Company expects
to reduce its tax liability by taking advantage of this exemption. However,
changes in state law could preclude this exemption and there is no guaranty that
it can or will be sustained going forward.
FINANCIAL CONDITION
- -------------------
A comparison between the summary year-end balance sheets for 2001 through 1997
was presented previously in the table of Selected Financial Data (see Item 6
above). As indicated in that table, the Company's total assets, loans, deposits,
and shareholders' equity have grown each year for the past four years, with
asset growth most pronounced in 2000 as a result of the acquisition of SNB. The
four branches acquired with SNB currently have $42.4 million in loans and $94.4
million in deposits, which comprise 8.8% and 18.1%, respectively, of the
Company's total loans and total deposits at December 31, 2001. Growth in the
Company's total assets over the past year approximated $44 million, or 7.2%, as
compared to growth in 2000 of $148 million, or 32.4%.
Also of importance is the fact that total loan balances, which are typically
higher-earning assets than investment securities, have increased relative to
total interest-earning assets every year since 1998 and currently stand at 84.0%
of interest earning assets. Moreover, interest-earning assets increased from
88.3% of total assets at year-end 2000 to 89.1% at year-end 2001. These trends
signify more efficient deployment of assets.
On the liability side, the deposit mix changed significantly in 2001 and the
increased weighting of lower-cost funding sources had an obvious positive impact
on the Bank's cost of interest-bearing liabilities. The Company had also
increased its reliance on wholesale funding sources at year-end, although this
was an intentional asset/liability management strategy and should be a temporary
condition. Rather than build deposit
35
balances in anticipation of loan growth, the Company funded loan growth with
short-term brokered deposits and borrowings from the Federal Home Loan Bank. We
are now focusing on increasing customer deposits to replace wholesale
borrowings.
LOAN PORTFOLIO
- --------------
The Company's loan portfolio represents the single largest portion of invested
assets, substantially greater than the investment portfolio or any other asset
category. At December 31, 2001, gross loans represented 74.8% of total assets,
as compared to 69.5% and 69.3% at December 31, 2000 and 1999, respectively. The
quality and diversification of the Company's loan portfolio are important
considerations when reviewing the Company's results of operations.
The Selected Financial Data table in Item 6 above reflects the net amount of
loans outstanding at December 31st for each year between 1997 and 2001. The Loan
Distribution table which follows sets forth the amount of the Company's total
loans outstanding and the percentage distribution in each category at the dates
indicated. The amounts shown in the table are gross figures and do not include
net deferred loan fees or net deferred loan origination costs for all periods
presented.
=============================================================================================================
Loan Distribution
- -----------------
As of December 31,
(dollars in thousands) 2001 2000 1999 1998 1997
--------- --------- --------- -------- ----------
Agricultural $ 14,471 $ 16,306 $ 15,096 $ 19,249 $ 16,147
Commercial and Industrial $ 71,857 $ 59,554 $ 41,817 $ 38,459 $ 36,644
Real Estate
Secured by Commercial/Professional Office
Properties including construction and development $196,455 $165,759 $114,038 $ 79,749 $ 72,920
Secured by Residential Properties $106,772 $102,594 $ 74,052 $ 74,359 $ 70,751
Secured by Farmland $ 16,998 $ 17,575 $ 16,250 $ 14,913 $ 19,353
Held for Sale $ 1,048 $ 2,128 $ 10,957 $ 8,108 $ 4,287
--------- --------- --------- -------- ---------
Total Real Estate $321,273 $288,056 $215,297 $177,129 $167,311
Small Business Administration loans $ 16,942 $ 10,883 $ 7,185 $ 4,618 $ 2,918
Consumer Loans $ 50,714 $ 35,416 $ 27,449 $ 24,564 $ 21,879
Credit Cards $ 11,344 $ 11,481 $ 10,666 $ 11,645 $ 16,950
--------- --------- --------- -------- ---------
Total Loans $486,601 $421,696 $317,510 $275,664 $261,849
========= ========= ========= ======== =========
Percentage of Total Loans
Agricultural 2.97% 3.87% 4.75% 6.98% 6.17%
Commercial and Industrial 14.77% 14.12% 13.17% 13.95% 13.99%
Real Estate:
Secured by Commercial/Professional Office
Properties including construction and development 40.37% 39.31% 35.93% 28.93% 27.85%
Secured by Residential Properties 21.94% 24.33% 23.32% 26.97% 27.02%
Secured by Farmland 3.49% 4.17% 5.12% 5.41% 7.39%
Held for Sale 0.22% 0.50% 3.45% 2.94% 1.64%
--------- --------- --------- -------- ---------
Total Real Estate 66.02% 68.31% 67.81% 64.26% 63.90%
Small Business Administration loans 3.48% 2.58% 2.26% 1.68% 1.11%
Consumer Loans 10.42% 8.40% 8.65% 8.91% 8.36%
Credit Cards 2.34% 2.72% 3.36% 4.22% 6.47%
--------- --------- --------- -------- ---------
100.00% 100.00% 100.00% 100.00% 100.00%
========= ========= ========= ======== =========
=============================================================================================================
As reflected in the Loan Distribution table, aggregate loan balances have
increased nearly $225 million, or 85.8%, over the last five years, with a major
portion of the increase occurring in the past two years. All of the Company's
$65 million in loan growth in 2001 was generated by existing business units,
however only about two-thirds of the Company's total $104 million loan growth
during 2000 was from then-existing branches, while the remainder was due to the
acquisition of four branches of SNB. The largest percentage growth during 2001
came in commercial loans (including SBA loans), while the largest dollar volume
increase was in loans secured by real estate.
36
Loan growth in the Company's immediate market has been oriented toward
commercial loans, including SBA loans, as well as loans secured by real estate,
including commercial and professional buildings and single family dwellings. As
a result, these areas have comprised the major portion of the Company's loan
growth over the past few years. Loans secured by real estate grew by $33
million, or 11.5%, and commercial loans grew by $18 million, or 26.1%, during
2001, although most of this growth occurred in the last quarter of the year.
Loans secured by real estate and commercial loans comprised 66.0% and 18.3%,
respectively, of the Bank's total loan portfolio at the end of 2001.
The Company's commercial loans are centered in locally oriented commercial
activities in the markets where the Company has a presence. Additionally, the
Company has a business unit dedicated to its SBA product and is very active in
specific SBA program lending, and also sells a number of the SBA loans it
originates. During 2001, the Company generated over $13 million in SBA loans.
Further, the Company is designated an SBA Preferred Lender, which allows greater
flexibility to meet small business loan requests with a more timely credit
approval process. On September 9, 1998, Bank of the Sierra was named #1 Small
Business Friendly Lender in California for 1997 by the Office of Advocacy of the
Small Business Administration. This award is made to financial institutions
whose loan portfolio shows a propensity of lending to small businesses (defined
as a commercial loan under $1 million, with a focus on small business loans
under $250,000). This award lends credence to the Company's success in meeting
the needs of smaller business owners in the communities in which the Company
conducts its banking activities. This dedication to SBA lending was recently
reaffirmed when Bank of the Sierra was named the top SBA lender in the Fresno
District in the last quarter of 2001, and tied for first in the number of loans
for the Fresno District during the SBA's 2001 fiscal year.
The most significant shift in the loan portfolio mix over the past five years
has been in loans secured by commercial properties, which increased from 27.9%
of total loans at the end of 1997 to 40.4% of total loans at the end of 2001.
Real estate lending is an increasingly important part of the Company's focus,
and is likely to remain so for the immediate future. Real estate loans secured
by farmland, however, declined to just 3.5% of total loan balances by the end of
2001 from 7.4% at the end of 1997, and agricultural loans dropped during the
same period to 3.0% of the Company's total loan balances from 6.2%. The decline
in agricultural loans over the last few years has been due in part to the
December 1998 freeze, along with reduced local plantings due to foreign
competition. However, the Company has also withdrawn from financing production
lines, where year-to-year cash flow variations can impede the ability of
borrowers to meet contractual repayment terms. With uncertain commodity prices,
our borrowers have faced declining equity in farming operations, and some are
removing themselves from farming by selling land for housing and other
development.
Consumer loans represented 10.4% of total loans at December 31, 2001 and 8.4% of
total loans outstanding at December 31, 2000. The $15.3 million, or 43.2% growth
in these balances came primarily from the purchase of $10 million in balances
outstanding on unsecured lines of credit to high net-worth individuals. The
purchase, from a Los Angeles area financial institution, was consummated in
December of 2001. The remaining balances consist primarily of automobile and
unsecured lines of credit, which have gained popularity due to their ease of
use. The Company has encountered a great deal of competition for consumer
lending products, and has developed a program for lending to people rather than
lending on property. As a result, relationship lending has increased as a
portion of overall consumer credit, and is exemplified by home equity lines,
other revolving consumer credit facilities and credit card lines. However, a
great deal of consumer credit is now granted in the form of home equity lines,
which allow a more favorable treatment of interest costs. As a result, consumer
credit separately reported is only for term debt and unsecured lines, not
inclusive of home equity lines, a more growth-oriented category. Such
consumer-oriented debt, secured by home equity, is captured within the total
reported for real estate loans secured by residential property.
Credit card loans represented 2.3% of total loans outstanding at December 31,
2001, having declined from 6.5% of total loans at December 31, 1997. During
1998, the Company sold its agent program participant loans to another servicing
entity and discontinued issuing cards for other banks. The fifteen-bank agent
program had represented about 30% of total credit card loans outstanding.
Despite this decrease, the credit card segment of the Company's loan product
group remains an important part of the Company's overall customer relationship
37
lending strategy.
Another important aspect of the Company's loan business has been that of
residential real estate loans which have been generated internally by the real
estate mortgage loan department and then sold in the secondary market to
government sponsored enterprises or other long-term lenders. The Company has
consistently been among the largest real estate mortgage lenders in Tulare
County for the past ten years. During 2001, the Company originated and sold
aggregate balances of approximately $41 million of such loans, an increase from
the $38 million originated and sold in 2000. This changed in March 2002, when
the Company began to earn referral fees for directing residential mortgage
customers to Moneyline but ceased originating and selling those loans itself.
The Company also originates and sells agricultural mortgage loans to certain
other investors, and the volume of these loans serviced totaled $54 million as
of December 31, 2001. Total loans serviced for others numbered 167 with an
aggregate balance of $59 million at December 31 2001, as compared to 1,480 loans
with an aggregate balance of $173 million at the end of 2000.
In the normal course of business, the Company makes commitments to extend credit
as long as there are no violations of any condition established in the
contractual arrangement. Total unused commitments to extend credit were $152
million at December 31, 2001 as compared to $138 million at December 31, 2000.
These commitments represented 23% of outstanding gross loans at December 31,
2001 and 2000, respectively, net of credit card lines available which were $43
million and $39 million, at December 31, 2001 and 2000, respectively. The
Company's stand-by letters of credit at December 31, 2001, and 2000 were $4.4
million and $7.9 million, respectively, which represented approximately 3% of
total commitments outstanding at the end of 2001 and 6% at the end of 2000.
Because the Company is not involved with chemicals or toxins that might have an
adverse effect on the environment, its primary exposure to environmental
legislation is through its lending activities. The Company's lending procedures
include steps to identify and monitor this exposure to avoid any significant
loss or liability related to environmental regulations.
LOAN MATURITIES
- ---------------
The following Loan Maturity table shows the amounts of total loans and leases
outstanding as of December 31, 2001, which, based on remaining scheduled
repayments of principal, are due within three months, after three months but
less than one year, after one but within five years, and in more than five
years. The principal balance of loans due after one year is indicated by both
fixed and floating rate categories. (Non-accrual loans are intermixed within
each category.)
===================================================================================================================================
Loan Maturity
- -------------
(dollars in thousands) As of December 31, 2001
Three Floating Fixed
Three months One Over rate: rate:
months thru twelve to five five due after due after
or less months years years Total one year one year
---------- ------------ ----------- ------------ ----------- ----------- ------------
Agricultural $ 4,963 $ 4,771 $ 3,670 $ 1,067 $ 14,471 $ 1,930 $ 2,807
Commercial and Industrial/(1)/ $ 14,114 $ 26,162 $ 26,315 $ 22,208 $ 88,799 $ 29,527 $ 18,996
Real Estate $ 24,148 $ 19,613 $ 47,268 $ 230,244 $ 321,273 $ 115,938 $ 161,574
Consumer Loans $ 927 $ 1,748 $ 22,815 $ 25,224 $ 50,714 $ 31,284 $ 16,755
Credit Cards $ 368 $ 4,286 $ 6,690 $ - $ 11,344 $ 6,690 $ -
---------- ------------ ----------- ------------ ----------- ----------- ------------
TOTAL $ 44,520 $ 56,580 $ 106,758 $ 278,743 $ 486,601 $ 185,369 $ 200,132
========== ============ =========== ============ =========== =========== ============
/(1)/ Includes Small Business Administration Loans
===================================================================================================================================
This schedule, which aggregates contractual principal repayments by time period,
can be used in combination with the Investment Maturities table in the
Investment Securities section and the Deposit Maturities table in the Deposits
section to identify time periods with potential liquidity exposure. The
referenced maturity schedules
38
do not convey a complete picture of the Company's re-pricing exposure or
interest rate risk, however. For details on the re-pricing characteristics
of the Company's balance sheet and a more comprehensive discussion of the
Company's sensitivity to changes in interest rates, see the "Liquidity and
Market Risk" section.
NON-PERFORMING ASSETS
- ---------------------
Banks have generally suffered their most severe earnings declines as a result of
customers' inability to generate sufficient cash flow to service their debts, or
as a result of the downturns in national and regional economies which have
brought about declines in overall property values. In addition, certain
investments which the Company may purchase have the potential of becoming less
valuable as the conditions change in the obligor's financial capacity to repay,
based on regional economies or industry downturns. As a result of these types of
failures, an institution may suffer asset quality risk, and may lose the ability
to obtain full repayment of an obligation to the Company. Since loans are the
most significant assets of the Company and generate the largest portion of
revenues, the Company's management of asset quality risk is focused primarily on
loan quality.
The Company achieves a certain level of loan quality by establishing a sound
credit plan, which includes defining goals and objectives and devising and
documenting credit policies and procedures. These policies and procedures
identify certain markets, set goals for portfolio growth or contraction, and
establish limits on industry and geographic concentrations. In addition, these
policies establish the Company's underwriting standards and the methods of
monitoring ongoing credit quality. Unfortunately, however, the Company's
asset-quality risk may be affected by external factors such as the level of
interest rates, employment, general economic conditions, real estate values and
trends in particular industries or more geographic markets. The Company's
internal factors for controlling risk are centered in underwriting practices,
credit granting procedures, training, risk management techniques, and
familiarity with our loan customers as well as the relative diversity and
geographic concentration of our loan portfolio.
As a multi-community, independent bank headquartered in and serving Tulare
County (with a smaller presence in each of Kern, Fresno and Kings counties), the
Company must contend with the attendant vagaries of the California and San
Joaquin Valley markets. The Company's asset quality has suffered during the last
several years due to the impact of a national economic recession, consumer
bankruptcies, weather-related agricultural loan losses, and depressed prices for
agricultural goods, however the San Joaquin Valley may be experiencing a slow
but sustained economic recovery. The Company is optimistic that the local
economy will continue to improve over time, but no assurance can be given that
such improvement will in fact continue.
Non-performing assets are comprised of loans on non-accrual status, loans 90
days or more past due and still accruing interest, loans restructured where the
terms of repayment have been renegotiated resulting in a deferral of interest or
principal and other real estate owned ("OREO"). Loans are generally placed on
non-accrual status when they become 90 days past due. Loans may be restructured
by management when a borrower has experienced some change in financial status
causing an inability to meet the original repayment terms and where the Company
believes the borrower will eventually overcome those circumstances and repay the
loan in full. OREO consists of properties acquired by foreclosure or similar
means that management intends to offer for sale.
Management's classification of a loan as non-accrual is an indication that there
is reasonable doubt as to the full collectibility of principal or interest on
the loan; at that point, the Company stops recognizing income from the interest
on the loan and reverses any uncollected interest that had been accrued but
unpaid. These loans may or may not be collateralized, but collection efforts are
continuously pursued.
The following table provides information with respect to components of the
Company's non-performing assets at the date indicated.
39
Non-performing Assets
(dollars in thousands) As of December 31,
Nonaccrual Loans:/(1)/ 2001 2000 1999 1998 1997
------------ --------- --------- --------- ---------
Agricultural $ 185 $ 652 $ - $ 635 $ -
Commercial and Industrial/(2)/ $ 1,022 $ 47 $ - $ 175 $ 570
Real Estate
Secured by Commercial/Professional Office
Properties including construction and development $ 503 $ - $ - $ - $ -
Secured by Residential Properties $ - $ - $ 130 $ 125 $ -
Secured by Farmland $ 4,945 $ 1,267 $ - $ - $ 270
Consumer Loans $ 22 $ 22 $ 38 $ 58 $ 57
Credit Cards $ 39 $ 132 $ 220 $ 125 $ 269
------------ --------- --------- --------- ---------
SUBTOTAL $ 6,716 $ 2,120 $ 388 $ 1,118 $ 1,166
Loans 90 days or more past due & still accruing:
(as to principal OR interest)
Agricultural $ 1,418 $ - $ 73 $ 1,637 $ -
Commercial and Industrial/(2)/ $ 867 $ 377 $ 27 $ 127 $ 63
Real Estate
Secured by Commercial/Professional Office
Properties including construction and development $ - $ 334 $ - $ 411 $ -
Secured by Residential Properties $ 640 $ 94 $ 382 $ - $ 149
Secured by Farmland $ - $ 106 $ - $ 545 $ -
Held for Sale $ - $ - $ - $ - $ -
Consumer Loans $ 126 $ 31 $ 4 $ 7 $ 1
Credit Cards $ 17 $ 22 $ 40 $ 93 $ 58
------------ --------- --------- --------- ---------
SUBTOTAL $ 3,068 $ 964 $ 526 $ 2,820 $ 271
------------ --------- --------- --------- ---------
TOTAL NON-PERFORMING LOANS $ 9,784 $ 3,084 $ 914 $ 3,938 $ 1,437
Other Real Estate Owned $ 769 $ 1,530 $ 2,553 $ 1,273 $ 2,285
------------ --------- --------- --------- ---------
Total nonperforming assets $ 10,553 $ 4,614 $ 3,467 $ 5,211 $ 3,722
============ ========= ========= ========= =========
Restructured Loans/(3)/ N/A N/A N/A N/A N/A
Nonperforming loans as % of total gross loans 2.01% 0.73% 0.29% 1.43% 0.55%
Nonperforming assets as a % of total gross
loans and other real estate owned 2.17% 1.05% 1.08% 1.88% 1.41%
/(1)/ Additional interest income of approximately $705,000 would have been
recorded for the year ended December 31, 2001 if these loans had been paid in
accordance with their original terms and had been outstanding throughout the
applicable period then ended or, if not outstanding throughout the applicable
period then ended, since origination.
/(2)/ Includes Small Business Administration Loans
/(3)/ A "restructured loan" is one where the terms were renegotiated to provide
a reduction or deferral of interest or principal because of a deterioration in
the financial position of the borrower.
Total non-performing balances stood at $10.5 million at the end of 2001, and
more than 60% of those balances are agriculture-related. Even though
non-performing loans have increased relative to total loans since 1999, the
Company's actual level of net loan losses has declined over the same period (see
"Allowance for Loan Losses"). Net Charge-offs to average loans fell from 1.11%
in 1999, to .43% in 2000 and .23% in 2001, although no assurance can be given
that this favorable trend will continue. The Company's non-performing assets
increased by $5.9 million during 2001, primarily due to the placement on
non-accrual status of approximately $4.5 million in loans to a single borrower.
Management considers those loans to be well-reserved (see Allowance for Loan
Losses below), and expects to resolve them during 2002. Another mitigating
factor when evaluating the Company's non-performing assets is the fact that over
$6 million (including $3 million of the $4.5 million in loans discussed above)
of the balances are secured by real estate, and an additional $1.5 million is
comprised of the guaranteed portion of loans which are backed by the U.S.
government. Although the Company's overall level of non-performing loans
increased substantially, the level of OREO was reduced during 2001 from $1.5
million to $800,000. This decrease was the result of aggressive sale activities
undertaken to dispose of OREO properties.
ALLOWANCE FOR LOAN LOSSES
- -------------------------
The allowance for loan losses is established through a provision for loan losses
based on management's evaluation of known and inherent risk in our loan
portfolio. The allowance is increased by provisions charged
40
against current earnings and reduced by net charge-offs. Loans are charged off
when they are deemed to be uncollectable; recoveries are generally recorded only
when cash payments are received subsequent to the charge off.
We employ a systematic methodology for determining the allowance for loan losses
that includes a monthly review process and monthly adjustment of the allowance.
Our process includes a periodic review of individual loans that have been
specifically identified as problem loans or have characteristics which could
lead to impairment, as well as detailed reviews of other loans (either
individually or in pools). While this methodology utilizes historical and other
objective information, the establishment of the allowance for loan losses and
the classification of loans is also to some extent based on management's
judgment and experience.
Our methodology incorporates a variety of risk considerations, both quantitative
and qualitative, in establishing an allowance for loan losses that management
believes is appropriate at each reporting date. Quantitative factors include our
historical loss experience, delinquency and charge-off trends, collateral
values, changes in non-performing loans, and other factors. Quantitative factors
also incorporate known information about individual loans, including borrowers'
sensitivity to interest rate movements and borrowers' sensitivity to
quantifiable external factors including commodity prices as well as acts of
nature (freezes, earthquakes, fires, etc.) that occur in a particular period.
Qualitative factors include the general economic environment in our markets and,
in particular, the state of the agriculture industry and other key industries in
the Central San Joaquin Valley. The way a particular loan might be structured,
the extent and nature of waivers of existing loan policies, and the rate of
portfolio growth are other qualitative factors that are considered.
The table which follows summarizes the activity in the allowance for loan losses
for the years indicated:
41
Allowance For Loan Losses
(dollars in thousands) As of December 31,
Balances: 2001 2000 1999 1998 1997
-----------------------------------------------------------
Average gross loans outstanding during period $ 426,968 $ 403,290 $ 288,729 $ 262,976 $ 242,760
=========== =========== =========== =========== ===========
Gross loans outstanding at end of period $ 486,601 $ 421,696 $ 317,510 $ 275,664 $ 261,849
=========== =========== =========== =========== ===========
Allowance for Loan Losses:
Balance at beginning of period $ 5,362 $ 3,319 $ 4,394 $ 3,034 $ 2,904
---------- --------- --------- --------- ----------
Adjustments/(1)/ $ - $ 1,018 $ - $ - $ -
---------- --------- --------- --------- ----------
Provision Charged to Expense $ 1,300 $ 2,760 $ 2,118 $ 2,800 $ 2,013
---------- --------- --------- --------- ----------
Loan Charge-offs
Agricultural $ 81 $ 324 $ 1,880 - -
Commercial & Industrial Loans/(2)/ $ 295 $ 705 $ 290 $ 236 $ 564
Real Estate loans $ - $ - - - $ 20
Consumer Loans $ 376 $ 253 $ 374 $ 398 $ 133
Credit Card Loans $ 587 $ 657 $ 729 $ 907 $ 1,277
---------- --------- --------- --------- ----------
Total $ 1,339 $ 1,939 $ 3,273 $ 1,541 $ 1,994
---------- --------- --------- --------- ----------
Recoveries
Agricultural $ 31 $ 27 $ 1 - -
Commercial & Industrial Loans/(2)/ $ 187 $ 44 $ 28 $ 42 $ 56
Real Estate loans $ - $ - - $ - $ 1
Consumer Loans $ 39 $ 66 $ 12 $ 18 $ 9
Credit Card Loans $ 95 $ 67 $ 39 $ 41 $ 45
---------- --------- --------- --------- ----------
Total $ 352 $ 204 $ 80 $ 101 $ 111
---------- --------- --------- --------- ----------
Net Loan Charge-offs $ 987 $ 1,735 $ 3,193 $ 1,440 $ 1,883
---------- --------- --------- --------- ----------
Balance at end of period $ 5,675 $ 5,362 $ 3,319 $ 4,394 $ 3,034
========== ========= ========= ========= ==========
Ratios:
Net Loan Charge-offs to Average Loans 0.23% 0.43% 1.11% 0.55% 0.78%
Allowance for Loan Losses to
Gross Loans at End of Period 1.17% 1.27% 1.05% 1.59% 1.16%
Allowance for Loan Losses to
Non-Performing Loans 58.00% 173.87% 363.13% 111.58% 211.13%
Net Loan Charge-offs to Allowance
for Loan Losses at End of Period 17.39% 32.36% 96.20% 32.77% 62.06%
Net Loan Charge-offs to
Provision for loan losses 75.92% 62.86% 150.76% 51.43% 93.53%
/(1)/ Allowance acquired from Sierra National Bank
/(2)/ Includes Small Business Administration Loans.
At December 31, 2001, the Company's allowance for loan losses was $5.7 million.
The loan loss provisions in 2001, 2000, and 1999 totaled $1.3 million, $2.8
million, and $2.1 million, respectively. Although the provision was lower, the
$987,000 in net loans charged off in 2001 was also $748,000 lower than in 2000,
thus the allowance for loan losses increased by $313,000 from the end of 2000 to
the end of 2001. The allowance did, however, decline from 1.27% to 1.17% of
total loans, despite the increase in the ratio of non-performing loans to total
loans from .73% to 2.01% (see "Non-performing Assets" above). The large increase
in non-performing loans also caused the allowance to fall from 173.9% of
non-performing loans at the end of 2000 to 58.0% at the end of 2001. If the $4.5
million in non-performing loans to a single borrower discussed in the previous
section are resolved in the manner expected by management, and if the $1.5
million in government guaranteed balances is excluded from the calculation, the
allowance to non-performing assets ratio should again exceed 130%. However, no
assurance can be given that this indeed will take place.
42
Our methodology for determining the adequacy of the Company's allowance for
loans losses is, and has been, consistently followed. However, as we add new
products, increase in complexity, and expand our geographic coverage, we expect
to enhance our methodology to keep pace with the size and complexity of the loan
portfolio. On an ongoing basis we engage outside firms to independently assess
our methodology, and to perform independent credit reviews of our loan
portfolio. The Company's external auditors, the FDIC, and the California
Department of Financial Institutions also review the allowance for loan losses
as an integral part of the examination processes. Management believes that our
current methodology is appropriate given our size and level of complexity.
Further, management believes that the allowance for loan losses is adequate as
of December 31, 2001 to cover known and inherent risks in the loan portfolio.
However, fluctuations in credit quality, or changes in economic conditions or
other factors could cause management to increase or decrease the allowance for
loan losses as necessary, and no assurance can be given that such factors may
not result in increased losses in the loan portfolio in the future.
The following table provides a summary of the allocation of the allowance for
loan losses for specific loan categories at the dates indicated. The allocation
presented should not be interpreted as an indication that charges to the
allowance for loan losses will be incurred in these amounts or proportions, or
that the portion of the allowance allocated to each loan category represents the
total amounts available for charge-offs that may occur within these categories.
The unallocated portion of the allowance for loan losses and the total allowance
is applicable to the entire loan portfolio.
- ----------------------------------------------------------------------------------------------------------------------------------
Allocation of Loan Loss Allowance As of December 31,
- ---------------------------------
(dollars in thousands) 2001 2000 1999 1998 1997
%Total/(1)/ %Total/(1)/ %Total/(1)/ %Total/(1)/ %Total/(1)/
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------------------ ----------------- ----------------- ----------------- -----------------
Agricultural $ 997 2.97% $ 574 3.87% $ 478 4.75% $ 982 6.98% $ 132 6.17%
Commercial and Industrial/(2)/ $1,573 18.25% $1,667 16.70% $ 764 15.43% $1,696 15.63% $1,087 15.11%
Real Estate $1,713 66.02% $2,112 68.31% $1,362 67.81% $1,038 64.26% $ 473 63.90%
Consumer Loans $ 681 10.42% $ 384 8.40% $ 285 8.65% $ 272 8.91% $ 305 8.36%
Credit Cards $ 711 2.34% $ 625 2.72% $ 430 3.36% $ 406 4.22% $1,037 6.47%
------------------ ----------------- ----------------- ----------------- -----------------
TOTAL $5,675 100.00% $5,362 100.00% $3,319 100.00% $4,394 100.00% $3,034 100.00%
================== ================= ================= ================= =================
/(1)/ Represents percentage of loans in category to total loans.
/(2)/ Includes Small Business Administration loans.
- ----------------------------------------------------------------------------------------------------------------------------------
The Company's year-end allowance consists of a $5.2 million specifically
allocated allowance and a $500,000 "unallocated" allowance which is pro-rated
among the categories shown in the previous table. The unallocated allowance
recognizes the model and estimation risk associated with the allocated
allowances, and management's evaluation of various conditions, the effects of
which are not directly measured in determining the allocated allowance. The
evaluation of the inherent loss under these conditions involves a higher degree
of uncertainty because they are not identified with specific problem credits or
portfolio segments. The conditions evaluated in connection with the unallocated
allowance include the following at the balance sheet date:
. The current business cycle and existing general economic and business
conditions affecting our key lending areas; economic and business
conditions affecting our key lending portfolios;
. Seasoning of the loan portfolio, growth in loan volumes and changes in
loan terms; and
. The results of bank regulatory examinations.
INVESTMENT PORTFOLIO
- --------------------
The investment securities portfolio, which had a book value of $93 million at
December 31, 2001, is the second largest component of the Company's earning
asset base, and the structure and composition of this portfolio is significant
to any analysis of the financial condition of the Company. Subsequent to
implementing Financial Accounting Standards Board Statement 115, "Accounting for
Certain Investments in Debt and Equity Securities"
43
(SFAS 115) on December 31, 1993, the Company classifies its investments into two
portfolios: "Held-to-maturity", and "Available-for-sale". While SFAS 115 also
provides for a trading portfolio classification, the Company has no investments
which are so classified. The held-to-maturity portfolio should consist only of
investments that the Company has both the intention and ability to hold until
maturity, to be sold only in the event of concerns with an issuer's credit
worthiness, a change in tax law that eliminates their tax exempt status or other
infrequent situations as permitted by SFAS 115.
Prior to 2000, the Company's long-term tax exempt obligations and certain
pledged treasury and agency issues were classified as held-to-maturity. During
the fourth quarter of 2000, however, the Company adopted Financial Accounting
Standards Board Statement 133, "Accounting for Derivative Instruments and
Hedging Activities" (SFAS 133). Upon adoption of this statement, the Company
reclassified substantially all of its investments from the held-to-maturity
portfolio to the available-for-sale portfolio. As a result, the Company's
unrecorded potential increase in market value net of tax effect was recorded on
the balance sheet as an increase in accumulated other comprehensive income. Such
reclassification was completed in order to allow the Company to more actively
manage this portfolio.
The investment portfolio serves the following purposes: 1) it provides liquidity
to even out cash flows from the loan and deposit activities of customers; 2) it
provides a source of pledged assets for securing public deposits and borrowed
funds; 3) it provides a large base of assets, the maturity and interest rate
characteristics of which can be changed more readily than the loan portfolio to
better match changes in the deposit base and other funding sources of the
Company; 4) it is an alternative interest-earning use of funds when loan demand
is weak; and 5) it can enhance the Company's tax position by providing partially
tax exempt income.
Securities pledged as collateral on repurchase agreements, public deposits and
for other purposes as required or permitted by law were $55.0 million and $62.3
million, for December 31, 2001 and 2000, respectively.
The investment portfolio was reduced in size in 2001, dropping to $93 million at
the end of the year from its starting balance of $113 million. The reduction was
due to bonds which were sold to realize income statement gains, and maturing
bonds and principal prepayments on mortgage-backed securities which were not
re-invested on a dollar for dollar basis. This $20 million reduction added to
the impact of increasing loan balances when viewing the weighting of both
categories relative to interest-earning assets. While loans are generally
higher-yielding instruments and their increased weighting enhances the Company's
yield on earning assets, management does not anticipate letting investment
balances drop further relative to total earning assets due to the investment
portfolio's preferential liquidity characteristics.
The Company's investment portfolio is composed primarily of: (1) U.S. Treasury
and Agency issues for liquidity and pledging; (2) mortgage-backed securities to
enhance the yield of the portfolio; (3) state, county and municipal obligations
which provide limited tax free income and pledging potential; and (3) other
equity investments. The relative distribution of these groups within the overall
portfolio changed significantly in 2001, with a shift out of treasuries and
agencies and into mortgage-backed securities and municipal obligations.
Municipal obligations remain the largest portion of the total portfolio at
48.9%, up from 37.8% at the end of 2000. Treasuries and agencies together
comprised 22.2% of total investments at the end of 2001, down from 48.7% at the
end of 2000, while mortgage-backed securities increased proportionate to total
investments in 2001, to 23.2% from 6.8%. This movement away from pure liquidity
instruments into higher-yielding bonds with a higher perceived risk and a longer
duration helped the company minimize the impact of declining interest rates on
the weighted average yield of the portfolio. The portfolio yield fell to 5.38%
in 2001 from 5.81% in 2000, a drop of only 43 basis points despite the Federal
Reserve's 475 basis point reduction in the fed funds rate during the year.
The Company's available-for-sale group also includes certain equity investments,
namely Sphinx common stock and Farmer Mac stock. The Farmer Mac investment is a
required element to allow the Company to sell certain agricultural loans to this
quasi-governmental agency, whereas the Company's Sphinx investment arose from
its
44
use of their integrated banking software. In addition, the Company holds certain
other equity investments which are not readily marketable securities and thus
are classified as "other assets" on the Company's balance sheet. These include
investments in Pacific Coast Bankers Bancshares ("PCBB"), Lender Services
Acquisition Corporation, WNC Institutional Tax Credit Fund X, California
Economic Development Lending Initiative, Community Bankers Insurance Agency,
LLC, and the Federal Home Loan Bank. The Company's $1 million investment in
Lender Services Acquisition Corporation ("LSAC") was made during 2001. LSAC is
owned primarily by a consortium of California bank holding companies, none of
which holds voting shares in excess of 5% of the total voting stock of LSAC.
LSAC is a holding company for certain title insurance companies which operate
mainly in California and which derive a portion of their revenues out of
referrals from the banks which own LSAC. The Company's investment in WNC
Institutional Tax Credit Fund X totals $2.9 million and is more fully described
in the Income Taxes section.
The following Investment Portfolio table reflects the amortized cost and fair
market values for the total portfolio for each of the categories of investments
for the past three years.
=================================================================================================================================
Investment Portfolio As of December 31,
(dollars in thousands) 2001 2000 1999
-------------------------- ----------------------- ---------------------------
Amortized Fair Market Amortized Fair Market Amortized Fair Market
Held to maturity Cost Value Cost Value Cost Value
---------- ---------- ---------- ----------- ---------- -----------
US Treasury Securities $ - $ - $ - $ - $ 7,582 $ 7,511
US Government Agencies & Corporations - - - - 21,045 20,501
State & political subdivisions - - - - 36,259 35,390
Equity securities - - - - - -
-------------------------- ----------------------- ---------------------------
Total held to maturity $ - $ - $ - $ - $ 64,886 $ 63,402
Available for sale
US Treasury Securities $ 1,002 $ 1,025 $ 13,540 $ 13,557 $ 17,538 $ 17,503
US Government Agencies & Corporations 18,824 19,548 40,705 41,204 2,487 2,475
Mortgage-backed securities 21,257 21,507 7,513 7,650 270 272
Corporate Bonds 4,996 5,210 4,985 5,039 4,974 4,930
State & political subdivisions 44,477 45,284 41,407 42,519 - -
Equity securities 100 115 787 783 671 1,348
-------------------------- ----------------------- ---------------------------
Total available for sale $ 90,656 $92,689 $ 108,937 $ 110,752 $25,940 $ 26,528
-------------------------- ----------------------- ---------------------------
Total Investment Securities $ 90,656 $92,689 $ 108,937 $ 110,752 $90,826 $ 89,930
========================== ======================= ==========================
=================================================================================================================================
The investment maturities table below summarizes the maturity of the Company's
investment securities and their weighted average yields at December 31, 2001.
Expected remaining maturities may differ from remaining contractual maturities
because obligors may have the right to repay certain obligations with or without
penalties.
45
===================================================================================================================================
Investment Maturities
- ---------------------
(dollars in thousands)
As of December 31, 2001
Within One After One But After Five Years But After Ten
Year Within Five Years Within Ten Year Years Total
--------------- ----------------- -------------------- --------------- --------------
Held to maturity Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
--------------- ----------------- -------------------- --------------- --------------
US Treasury securities $ - n/a $ - n/a $ - n/a $ - n/a $ - n/a
US Government agencies & corporations - n/a - n/a - n/a - n/a - n/a
State & political subdivisions/(1)/ - n/a - n/a - n/a - n/a - n/a
Equity securities - n/a - n/a - n/a - n/a - n/a
Total held to maturity $ - n/a $ - n/a $ - n/a $ - n/a $ - n/a
------- ------- --------- ------ -------
Available for sale
US Treasury securities $ 1,025 5.63% $ - 0.00% $ - n/a $ - n/a $ 1,025 5.63%
US Government agencies & corporations 6,093 6.06% 13,455 6.96% - n/a - 0.00% 19,548 6.67%
Mortgage-backed securities 10 4.23% 5,526 7.03% 14,404 5.04% 1,567 6.11% 21,507 5.63%
Corporate Bonds 504 7.06% 4,706 7.05% - n/a - n/a 5,210 7.05%
State & political subdivsions/(1)/ 4,228 8.24% 23,574 6.05% 13,084 7.07% 4,398 7.27% 45,284 6.67%
Equity securities/(2)/ - n/a - n/a - n/a 115 n/a 115 n/a
------- ------- --------- ------ -------
Total available for sale $11,860 6.83% $47,261 6.52% $ 27,488 6.01% $6,080 6.97% $92,689 6.44%
------- ------- --------- ------ -------
Total investment securities $11,860 $47,261 $ 27,488 $6,080 $92,689
======= ======= ========= ====== =======
/(1)/ Yields are not adjusted for the tax benefits of non taxable income
/(2)/ Equity securities have no stated maturity but have been added to the after
ten years, for ease of review.
===================================================================================================================================
CASH AND DUE FROM BANKS
- -----------------------
Cash on hand and balances due from correspondent banks represent the major
portion of the Company's non-earning assets. At December 31, 2001 these areas
comprised 6.1% of total assets, as compared to 7.2% of total assets at December
31, 2000. This decline is indicative of the Company's efforts to reduce
non-earning balances while increasing interest-earning assets.
These efforts will continue in 2002, with a focus on the reduction of vault cash
and required reserves at the Federal Reserve Bank. There are, however,
geographic limitations which limit our ability to reduce the number of cash
items in process of collection. The Company's operating branches lie at the
southern extremity of the Federal Reserve Bank (FRB) of San Francisco's
responsibility area of check clearing activities, while the Company's item
processing activities are performed in the Fresno and Walnut locales; Fresno
lies within the FRB's San Francisco region, while Walnut is within the FRB's Los
Angeles branch Office's responsibility area. As a result, a greater volume of
the Company's balances with correspondent banks have been uncollected funds, and
therefore due from bank balances have traditionally been greater than similar
size institutions in more metropolitan areas where collection activity is more
centralized. However, if and when the Federal Reserve Banks start accepting
electronic items (i.e., imaged checks) for collection, this geographic
disadvantage will be removed.
PREMISES AND EQUIPMENT
- ----------------------
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is charged to income over the estimated useful lives
of the assets and leasehold improvements are amortized over the terms of the
related lease, or the estimated useful lives of the improvements, whichever is
shorter. Depreciation expense was $1.9 million for the year ended December 31,
2001 as compared to $1.8 million during 2000. The following premises and
equipment table reflects the balances by major category of fixed assets:
46
==============================================================================================================================
Premises & Equipment As of December 31,
- --------------------
(dollars in thousands) 2001 2000 1999
------------------------------- --------------------------------- ----------------------------------
Accumulated Net Book Accumulated Net Book Accumulated Net Book
Cost Depreciation Value Cost Depreciation Value Cost Depreciation Value
------------------------------- --------------------------------- ----------------------------------
Land $ 2,025 $ - $ 2,025 $ 2,028 $ - $ 2,028 $ 1,309 $ - $ 1,309
Buildings $ 8,649 $ 2,078 $ 6,571 $ 8,013 $1,741 $ 6,272 $ 6,252 $1,443 $ 4,809
Leasehold Improvements $ 1,721 $ 817 $ 904 $ 1,696 $ 691 $ 1,005 $ 1,591 $ 581 $ 1,010
Construction in progress $ 367 $ - $ 367 $ 188 $ - $ 188 $ 40 $ - $ 40
Furniture and Equipment $13,417 $ 8,980 $ 4,437 $12,526 $7,542 $ 4,984 $10,655 $6,226 $ 4,429
------------------------------- --------------------------------- ----------------------------------
Total $26,179 $11,875 $14,304 $24,451 $9,974 $14,477 $19,847 $8,250 $11,597
=============================== ================================= ==================================
==============================================================================================================================
Although the net book value of the Company's premises and equipment declined
slightly in 2001, there was a $2.8 million increase in the level of investment
in premises and equipment during 2000. Land and buildings increased with the
addition of the four SNB branches, and additional computer hardware was placed
in service to accommodate the increase in locations. As a percentage of total
assets, however, the Company's premises and equipment have declined to 2.2%,
from 2.4% at the end of 2000 and 2.5% at the end of 1999.
DEPOSITS
- --------
Information concerning the average balance and average rates paid on deposits by
deposit type for the past three fiscal years is contained in the Distribution,
Rate, and Yield table located in the previous section on Results of Operations -
Net Interest Income and Net Interest Margin. The composition and cost of the
Company's deposit base are important components in analyzing the Company's net
interest margin and balance sheet liquidity characteristics, both of which are
discussed in greater detail in other sections herein. Net interest margin is
improved to the extent that growth in deposits can be concentrated in
historically lower-cost core deposits, namely non-interest-bearing demand, NOW
accounts, savings accounts and money market deposit accounts. Liquidity is
impacted by the volatility of deposits or other funding instruments, or in other
words their propensity to leave the institution for rate-related or other
reasons. Potentially, the most volatile deposits in a financial institution are
large certificates of deposits, which generally means time deposits with
balances exceeding $100,000. Because these deposits (particularly when
considered together with a customer's other specific deposits) may exceed FDIC
insurance limits, depositors may select shorter maturities to offset perceived
risk elements associated with deposits over $100,000. The Company's
community-oriented deposit gathering activities in the central San Joaquin
Valley, however, have engendered a less volatile than usual base of depositor
certificates over $100,000. The preponderance of maturities of jumbo deposits
are within the "three months or less" time frame, although most of the customers
with such time deposits have been with the Company for over two years.
The Company's total deposit volume actually declined slightly to $521 million at
the end of 2001, as compared to $528 million at the end of 2000. Deposit growth
of $142 million was achieved during 2000, however, both as a result of the
acquisition of four SNB branches and the growth of the other twelve branches
within the system. The Company is currently promoting higher rates on time
deposits in certain geographic locations to generate additional customer
deposits with longer maturities, and reduce reliance on borrowed funds.
Despite the overall drop in deposit balances, money market deposits increased by
nearly $50 million, or 112%, due in large part to a promotional campaign run
early in 2001. Total time deposits declined by $72 million, or 26.1% during the
year. Money market deposits and time deposits comprised 18.0% and 39.1%,
respectively, of total deposits at the end of 2001, versus 8.4% and 52.3%,
respectively, of total deposits at the end of 2000. With rates declining as they
did during 2001, this movement into variable-rate money market deposits had a
positive impact on the Company's net interest margin. Balances which might have
otherwise been locked in time deposits at higher rates were instead in money
market instruments which were re-priced downward frequently during the course of
the year. Rates paid on more liquid money market deposits are usually lower than
those paid on time deposits. However, interest rates changed to the point where,
by year-end 2001, the cost of time deposits with a maturity of less than one
year were equivalent to or less than rates on money market deposits. To take
advantage of current interest rate dynamics, the Company is conducting a
marketing campaign targeting time deposits. We expect that this promotion will
generate approximately $30 million in additional deposits with
47
an approximate one-year maturity, although no assurance can be given that this
will actually occur.
Another favorable volume variance came in non-interest demand deposits. Demand
deposits increased by $12 million, or 9.4%, and increased from 24.7% to 27.4%
of total deposits during 2001. Likewise, interest-bearing demand deposits, or
NOW accounts, increased by $3.8 million, or 8.3%, and grew from 8.7% to 9.5% of
total deposits. Our reliance on overnight fed funds purchased increased at the
end of 2001 as compared to 2000, as well, although this source of funds had
become inexpensive relative to traditional deposit sources by the end of the
year.
The scheduled maturity distribution of the Company's time deposits as of
December 31, 2000 was as follows:
- -----------------------------------------------------------------------------------------------------------------------
Deposit Maturity Distribution As of December 31, 2001
- -----------------------------
(dollars in thousands) Three Three Six One Over
months to six to twelve to three three
or less months months years Years Total
------------ ----------- ----------- ----------- ---------- ------------
Time Certificates of Deposits * $100,000 $ 58,823 $ 34,996 $ 20,776 $ 7,279 $ 1,637 $ 123,511
OTHER TIME DEPOSITS >$100,000 $ 52,632 $ 16,117 $ 8,606 $ 2,649 $ 407 $ 80,411
------------ ----------- ----------- ----------- ---------- ------------
TOTAL $ 111,455 $ 51,113 $ 29,382 $ 9,928 $ 2,044 $ 203,922
============ =========== =========== =========== ========== ============
- -----------------------------------------------------------------------------------------------------------------------
* = less than
In addition to the deposit liabilities available in the local market, the
Company provides a non-deposit cash management product to its commercial
business customers. This product group is categorized as a non-deposit "sweep
account," and at December 31, 2001, the Company's financial statements
reflected $22.3 million in repurchase agreements, which represent such "sweep
accounts." At December 31, 2000, the Company's financial statements reflected
approximately $13.6 million in repurchase agreements, secured by pledged
investments held segregated from the Company's own securities portfolio. As a
result of their overnight investment aspect, the cost of these "sweep accounts"
has generally been lower than the Company's interest expense for longer-term
funds. It is anticipated that while this product will remain an important
aspect of the Company's service capacity.
OTHER BORROWINGS
- ----------------
The Company utilizes other short-term borrowing to fund loan growth when
longer-term deposit growth has not kept pace with customer loan requests. In
addition, short-term borrowings may be used to purchase additional investments
when anticipated maturity dates are near term, or when additional liquidity is
required to support higher customer cash utilization levels, as was the case at
December 31, 1999 due to Y2K considerations.
Short-term borrowings principally include overnight fed funds purchased, which
at the end of 2001 consisted exclusively of advances from the Federal Home Loan
Bank of San Francisco (FHLB), and securities sold under repurchase agreements
which generally mature in one day. The details of these borrowings for the
years 2001, 2000, and 1999 are presented below:
48
- -------------------------------------------------------------------------------
Short-term Borrowings
- ---------------------
Fed funds purchased and 2001 2000 1999
----------- ----------- -----------
repurchase agreements
- ---------------------
(dollars in thousands)
Balance at December 31 $ 22,253 $ 13,584 $ 18,638
Average amount outstanding $ 15,728 $ 13,977 $ 10,602
Maximum amount outstanding
at any month end $ 22,253 $ 20,756 $ 20,766
Average interest rate for the year 2.74% 4.51% 3.52%
- ------------------------------------------------------------------------------
FHLB Advances
- -------------
(dollars in thousands)
Balance at December 31 $ 38,300 $ 20,700 $ 13,800
Average amount outstanding $ 3,162 $ 13,017 $ 3,480
Maximum amount outstanding
at any month end $ 38,300 $ 35,123 $ 17,300
Average interest rate for the year 3.67% 6.48% 5.57%
- ------------------------------------------------------------------------------
CAPITAL RESOURCES
- -----------------
At December 31, 2001, the Company had total shareholders equity of $46.1
million, comprised of $2.3 million in common stock, $42.6 million in retained
earnings, and $1.2 million in accumulated other comprehensive income. Total
shareholders equity at the end of 2000 was $40.8 million. Net income has
provided $18 million in capital over the last three years, of which $5.8
million or approximately 32% was distributed in dividends. The retention of
earnings has been the Company's main source of capital since 1982, however the
Company issued $15 million in Trust Preferred Securities in 2001, the proceeds
of which are considered to be Tier 1 capital for regulatory purposes but
long-term debt in accordance with generally accepted accounting principles.
The Company paid quarterly cash dividends totaling $1.66 million or $0.18 per
share in 2001 and $2.12 million or $0.23 per share in 2000, representing 24%
and 38%, respectively of the prior year's earnings. (As the holding company
reorganization became effective on August 10, 2001, all of the dividends paid
prior to that date were paid by the Bank, rather than the Company.) Since 1999,
the Bank (or the Company, as applicable) has generally adhered to a policy of
paying quarterly cash dividends totaling about 35% of the prior year's net
earnings to the extent consistent with general considerations of safety and
soundness, provided that such payments do not adversely affect the Bank's or
the Company's financial condition and are not overly restrictive to its growth
capacity. However, the Bank experienced significant growth in 2000, due mainly
to its acquisition of Sierra National Bank in May of that year, and also had a
slight contraction in earnings in the 2000 calendar year. In light of these
events, the Board of Directors declared dividends in 2001 totaling only
approximately 24% of the prior year earnings. The Company anticipates paying
dividends in the future consistent with the general dividend policy as
described above. However, no assurance can be given that the Bank's and the
Company's future earnings and/or growth expectations in any given year will
justify the payment of such a dividend.
The Company uses a variety of measures to evaluate capital adequacy. Management
reviews various capital measurements on a monthly basis and takes appropriate
action to ensure that such measurements are within
49
established internal and external guidelines. The external guidelines, which
are issued by the Federal Reserve Board and the FDIC, establish a risk-adjusted
ratio relating capital to different categories of assets and off balance sheet
exposures. There are two categories of capital under the Federal Reserve Board
and FDIC guidelines: Tier 1 and Tier 2 Capital. Tier 1 Capital includes common
shareholders' equity and the proceeds from the issuance of trust-preferred
securities (the Company's trust-preferred securities are currently at the
maximum includible limit of 25% of Tier 1 capital), less goodwill and certain
other deductions, notably the unrealized net gains or losses (after tax
adjustments) on securities available for sale, which are carried at fair market
value. Tier 2 Capital includes preferred stock and certain types of debt
equity, which the Company does not hold, as well as the allowance for loan
losses, subject to certain limitations. (For a more detailed definition, see
"Item 1, Business-Supervision and Regulation - Capital Adequacy Requirements"
herein.)
At December 31, 2001, the Company had a Tier 1 risk based capital ratio of
11.0%, a total capital to risk-weighted assets ratio of 12.2%, and a leverage
ratio of 9.0%. The Company had a Tier 1 risk-based capital ratio of 7.8%, a
total risk-based capital ratio of 9.0%, and a leverage ratio of 5.6% at
December 31, 2000. Note 13 of the Notes to Consolidated Financial Statements
provides more detailed information concerning the Company's capital amounts and
ratios as of December 31, 2001 and 2000.
The FDIC also places each financial institution it regulates into one of five
capital categories, depending on the institution's risk-based capital ratios
(For more detailed information, see "Item 1, Business-Supervision and
Regulation - Prompt Corrective Action Provisions" herein.). As of December 31,
2001, the Bank had a Total Risk-Based Capital Ratio of 11.17%, a Tier 1
Risk-Based Capital Ratio of 10.01%, and a Leverage Capital Ratio of 8.17%. The
Bank is currently "well capitalized" by regulatory standards, although it was
classified as "adequately capitalized" for much of the year. In 2000, with the
addition of SNB assets of about $87 million and additional growth of about $61
million, the Bank's growth far outstripped its rate of capital accumulation and
its regulatory capital rating fell. Additionally, with the purchase of SNB for
cash, the Bank created an intangible asset that is deducted from the Bank's
reported GAAP capital for regulatory purposes. However, with the accumulation
of retained earnings and the addition of regulatory capital via the issuance of
Trust Preferred Securities in 2001, the Bank's regulatory capital ratios
improved substantially. It is anticipated that the current level of capital
will allow the Bank to grow substantially and remain well capitalized, although
no assurance can be given that this will be the case.
LIQUIDITY AND MARKET RISK MANAGEMENT
- ------------------------------------
The Company must address on a daily basis the various and sundry factors which
impact its continuing operations. Three of these factors, the economic climate
which encompasses our business environment, the regulatory framework which
governs our practices and procedures, and credit risk have been previously
discussed. There are other risks specific to the operation of a financial
institution which also need to be managed, and this section will address
liquidity risk and market risk.
Liquidity refers to the Company's ability to maintain a cash flow adequate to
fund operations, and to meet obligations and other commitments in a timely and
cost-effective fashion. At various times the Company requires funds to meet
short-term cash requirements brought about by loan growth or deposit outflows,
the purchase of assets, or liability repayments. To manage liquidity needs
properly, cash inflows must be timed to coincide with anticipated outflows, or
sufficient liquidity resources must be available to meet varying demands. The
Company manages its own liquidity in such a fashion as to be able to meet
unexpected sudden changes in levels of its assets or deposit liabilities,
without maintaining excessive amounts of on-balance sheet liquidity. Excess
balance sheet liquidity can negatively impact the interest margin.
An integral part of the Company's ability to manage its liquidity position
appropriately is provided by the Company's large base of core deposits, which
were generated by offering traditional banking services in the communities in
its service area and which have, historically, been a very stable source of
funds. The Company's loan to deposit ratio jumped from 78.9% at the end of 2000
to 92.2% at the end of 2001, primarily due to the
50
surge in loan growth toward the end of 2001 which was funded with overnight
borrowings from other banks. The ratio has already shown improvement in early
2002 as overnight borrowings have been replaced by deposits, and was 88.5%
(unaudited) at the end of February 2002. At year-end 2001, the Company's
customers had also invested $22.3 million in the Company's sweep product, as
compared to $13.6 million at year-end 2000.
The Company's liquidity ratio, which is a measure of liquid assets to deposits
and short-term liabilities, showed some level of deterioration during 2001 due
to declining investment balances. The liquidity ratio was 23.7% at the end of
December 2000, but had dropped to 18.3% by the end of 2001. Management's goal
is to maintain this ratio at 20% or greater, and the investment portfolio is
budgeted to increase to help achieve that target, although no assurance can be
given that this will actually happen. However, management is also of the
opinion that the standby funding sources it has arranged are more than
sufficient to meet the Company's current and anticipated short-term liquidity
needs. Those sources include a formal borrowing line with the Federal Home Loan
Bank, which is secured by certain of its real estate loans, and informal
short-term liquidity lines for overnight fed funds with certain correspondent
banks. The Company also has the ability to raise deposits through various
deposit brokers, sell investment securities, or sell loans if required for
liquidity purposes. Although the Company's investment's are all classified as
"available for sale", not all could be used for liquidity should the need arise
since approximately $55 million of those balances are being pledged for various
purposes.
Because of the rapid pace of loan growth in the last quarter of 2001, the
Company lacked sufficient time to generate customer deposits to fund that
growth. Overnight borrowings from the Federal Home Loan Bank were used instead,
as evidenced by the $19 million increase in other borrowings at December 31,
2001 as compared to December 31, 2000. The Company anticipates the restoration
of balanced deposit growth both through the use of brokered deposits, which are
currently relatively inexpensive relative to traditional customer deposit
sources, and the current marketing campaign, which is targeting time deposits
in specific geographic areas.
Market risk arises from changes in interest rates, exchange rates, commodity
prices and equity prices. The Company's market risk exposure is primarily that
of interest rate risk, and it has risk management policies to monitor and limit
earnings and balance sheet exposure to changes in interest rates. The Company
does not engage in the trading of financial instruments.
The principal objective of interest rate risk management (often referred to as
"asset/liability management") is to manage the financial components of the
Company in a manner that will optimize the risk/reward equation for earnings
and capital in relation to changing interest rates. In order to identify areas
of potential exposure to rate changes, the Company calculates its re-pricing
gap on a monthly basis. It also performs an earnings simulation analysis and a
market value of portfolio equity calculation on a quarterly basis to identify
more dynamic interest rate risk exposures than those apparent in the standard
re-pricing gap analysis.
The Bancware modeling software is used by the Company for asset/liability
management in order to simulate the effects of potential interest rate changes
on the Company's net interest margin. These simulations can also provide both
static and dynamic information on the projected fair market values of the
Company's financial instruments under differing interest rate assumptions. The
simulation program utilizes specific individual loan and deposit maturities,
embedded options, rates and re-pricing characteristics to determine the effects
of a given interest rate change on the Company's interest income and interest
expense. Rate scenarios consisting of key rate and yield curve projections are
run against the Company's investment, loan, deposit and borrowed funds
portfolios. These rate projections can be shocked (an immediate and sustained
change in rates, up or down), ramped (an incremental increase or decrease in
rates over a specified time period), economic (based on current trends and
econometric models) or stable (unchanged from current actual levels). The
Company typically uses three standard interest rate scenarios in conducting the
simulation, namely stable, an upward shock of 200 basis points, and a downward
shock of 200 basis points.
51
The Company's policy is to limit the change in the Company's net interest
margin and economic value to plus or minus 10% upon application of interest
rate shocks of 200bp, as compared to a base rate scenario. As of December 31,
2001, the Company had the following estimated net interest margin sensitivity
profile:
Immediate Change in Rate
+200 bp -200 bp
-----------------------
Net Interest Income Change ($140,000) ($1,029,000)
The above profile illustrates that if there were an immediate increase of 200
basis points in interest rates, the Company's annual net interest income would
likely decrease by around $140,000, or approximately 0.4%. By the same token,
if there were an immediate downward adjustment of 200 basis points in interest
rates, the Company's net interest income would likely fall by approximately $1
million, or 2.94%, over the next year. The relationship between the change in
net interest income under rising and declining rate scenarios is typically
expected to be inversely proportionate, and in fact the Company has, in the
past, been exposed to declining rates while benefiting in a rising rate
environment. However, certain balance sheet characteristics (such as "floors"
on loan rates) and the current unusual interest rate environment have combined
to create the current situation where the Company's net interest income
actually declines from base in a rising rate environment as well as a declining
rate environment. The Company's interest rate risk profile has changed since
December 31, 2000, when it displayed the following characteristics:
Immediate Change in Rate
+200 bp -200 bp
-----------------------
Net Interest Income Change $926,000 ($904,000)
Short-term market interest rates fell by 475 basis points during the year and
the Company's net interest income fell by $1.8 million due to negative rate
variances, which provides a fairly good validation of the model's assessment of
the Company's exposure.
Further, the economic value of the Company's loan and deposit portfolios would
also change under the interest rate variances previously discussed. The amount
of change is based on the profiles of each loan and deposit class, which
include the rate, the likelihood of prepayment or repayment, whether its rate
is fixed or floating, the maturity of the instrument and the particular
circumstances of the customer. The quantification of the change in economic
value is somewhat apparent in Note 14, Fair Value of Financial Instruments, in
the Consolidated Financial Report, however such values change over time based
on certain assumptions about interest rates and likely changes in the yield
curve.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
The information concerning quantitative and qualitative disclosures about
market risk called for by Item 305 of Regulation S-K is included as part of
Item 7 above. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Market Risk Management".
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- -----------------------------------------------------------------
The financial statements begin on page 56 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
At its Board of Directors meeting on June 14, 2001, the Board of Directors of
the Company terminated the services of McGladrey & Pullen LLP ("M&P")). At the
same meeting, the Board of Directors selected the accounting firm of
Perry-Smith LLP as independent auditors for the remainder of the Bank's 2001
fiscal year.
52
The determination to replace M&P was recommended by the audit committee and
approved by the full board of directors of the Company.
M&P audited the consolidated financial statements of the Bank for the years
ended December 31, 2000 and 1999. M&P's report on the financial statements for
the last two fiscal years of the Company did not contain an adverse opinion or
disclaimer of opinion, nor were such reports qualified or modified as to
uncertainty, audit scope or accounting principles.
During the two fiscal years ended December 31, 2000 and 1999 and the subsequent
interim period January 1, 2001 through June 14, 2001, there were no
disagreements with M&P and the Company on any matter of accounting principles
or practices, financial statement disclosure or auditing scope or procedure,
which disagreements, if not resolved to the satisfaction of M&P, would have
caused it to make reference to the subject matter of the disagreements in
connection with its reports.
53
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by these items is contained in the Company's
definitive Proxy Statement for the Company's 2002 Annual Meeting of
Shareholders which the Company will file with the SEC within 120 days after the
close of the Company's 2001 fiscal year in accordance with SEC Regulation 14A
under the Securities Exchange Act of 1934. Such information is incorporated
herein by this reference.
54
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
- --------------------------------------------------------------------------
(a) List of documents filed as part of this report
(1) FINANCIAL STATEMENTS
The following financial statements and independent auditor's reports are
included in this Annual Report on Form 10-K immediately following.
Page
----
I a. Independent Auditor's Report from Perry-Smith LLP......................... 56
I b. Independent Auditor's Report from McGladrey & Pullen LLP.................. 57
II. Consolidated Balance Sheet - December 31, 2001 and 2000................... 58
III. Consolidated Statement of Income - Years Ended
December 31, 2001, 2000 and 1999....................................... 59
IV. Consolidated Statement of Changes in Shareholders' Equity - Years Ended
December 31, 2001, 2000 and 1999....................................... 60
V. Consolidated Statement of Cash Flows - Years Ended
December 31, 2001, 2000 and 1999....................................... 61
VI. Notes to the Consolidated Financial Statements............................ 63
(2) FINANCIAL STATEMENT SCHEDULES
Schedules to the financial statements are omitted because the required
information is not applicable or because the required information is presented
in the Company's Consolidated Financial Statements or related notes.
(3) EXHIBITS
See Index to Exhibits.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of the
Company's fiscal year ended December 31, 2001.
55
INDEPENDENT AUDITOR'S REPORT
----------------------------
The Shareholders
and Board of Directors
Sierra Bancorp and Subsidiaries
We have audited the accompanying consolidated balance sheet of Sierra
Bancorp and subsidiaries (the "Company") as of December 31, 2001 and the
related consolidated statements of income, changes in shareholders' equity and
cash flows for the year then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit. The consolidated financial statements of the Company for the years ended
December 31, 2000 and 1999 were audited by other auditors whose report, dated
February 2, 2001, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 2001 consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Sierra Bancorp and subsidiaries as of December 31, 2001 and the consolidated
results of their operations and their cash flows for the year then ended, in
conformity with accounting principles generally accepted in the United States
of America.
/s/ Perry-Smith LLP
Sacramento, California
January 25, 2002
56
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Bank of the Sierra
Porterville, California
We have audited the accompanying consolidated balance sheets of Bank of the
Sierra and subsidiary as of December 31, 2000, and the related consolidated
statements of income, comprehensive income, stockholders' equity and cash flows
for each of the two years in the period ended December 31, 2000. These
consolidated financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Bank of the Sierra
and subsidiary as of December 31, 2000 and the results of their operations and
their cash flows for each of the two years in the period ended December 31,
2000 in conformity with accounting principles generally accepted in the United
States of America.
/s/ McGladrey & Pullen, LLP
Pasadena, California
February 2, 2001
57
SIERRA BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, 2001 and 2000
(Dollars in thousands)
2001 2000
------------ -------------
ASSETS
Cash and due from banks $ 39,835 $ 43,433
Federal funds sold 246
Interest-bearing deposits in banks 190 1,231
Investment securities available-for-sale
(Note 3) 92,689 110,752
Loans, net of allowance for loan losses of
$5,675 in 2001 and $5,362 in 2000
(Notes 4, 10 and 15) 480,393 416,392
Premises and equipment, net (Note 5) 14,304 14,477
Other real estate 769 1,530
Intangible assets 5,546 5,878
Other assets (Notes 6 and 9) 16,684 12,787
------------ -------------
Total assets $ 650,410 $ 606,726
============ =============
LIABILITIES AND
SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 142,884 $ 130,592
Interest bearing (Note 7) 378,433 397,184
------------ -------------
Total deposits 521,317 527,776
Short-term borrowings (Note 8) 60,783 34,284
Other liabilities (Note 6) 7,169 3,884
------------ -------------
Total liabilities 589,269 565,944
------------ -------------
Mandatorily redeemable cumulative trust
preferred securities of subsidiary grantor
trust (Note 11) 15,000
Commitments and contingencies (Note 10)
Shareholders' equity (Notes 12 and 13):
Common stock, no par value; 24,000,000 shares
authorized; 9,212,280 shares issued and
outstanding 2,285 2,285
Retained earnings 42,651 37,430
Accumulated other comprehensive income (Notes 3
and 16) 1,205 1,067
------------ -------------
Total shareholders' equity 46,141 40,782
------------ -------------
Total liabilities and shareholders' equity $ 650,410 $ 606,726
============ =============
The accompanying notes are an integral
part of these consolidated financial statements.
58
SIERRA BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
For the Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
2001 2000 1999
------------- ------------- --------------
Interest income:
Interest and fees on loans $ 37,185 $ 38,913 $ 28,890
Interest on investment securities:
Taxable 3,755 4,350 2,988
Tax-exempt 2,000 2,022 1,812
Interest on Federal funds sold and interest-bearing
deposits 398 243 174
------------- ------------- --------------
Total interest income 43,338 45,528 33,864
------------- ------------- --------------
Interest expense:
Interest on deposits (Note 7) 15,252 17,202 11,154
Interest on borrowings (Note 8) 556 1,475 567
Interest on manditorily redeemable trust preferred
securities (Note 11) 84
------------- ------------- --------------
Total interest expense 15,892 18,677 11,721
------------- ------------- --------------
Net interest income 27,446 26,851 22,143
Provision for loan losses (Note 4) 1,300 2,760 2,118
------------- ------------- --------------
Net interest income after provision for loan losses 26,146 24,091 20,025
------------- ------------- --------------
Non-interest income:
Service charges on deposit accounts 4,754 4,085 3,038
Loan servicing income (Note 4) 1,168 520 560
Gain on sale of loans 899 505 836
Credit card fees 482 472 423
Gain on sale of investment securities available-for-
sale, net (Note 3) 1,108 119 6
Other income 1,252 735 483
------------- ------------- --------------
Total non-interest income 9,663 6,436 5,346
------------- ------------- --------------
Non-interest expense:
Salaries and employee benefits (Note 4) 10,908 10,054 8,195
Occupancy and equipment expense (Notes 5 and 10) 4,174 3,626 2,945
Other (Note 14) 10,227 8,624 5,844
------------- ------------- --------------
Total non-interest expense 25,309 22,304 16,984
------------- ------------- --------------
Income before income taxes 10,500 8,223 8,387
Provision for income taxes (Note 9) 3,622 2,742 2,775
------------- ------------- --------------
Net income $ 6,878 $ 5,481 $ 5,612
============= ============= ==============
Earnings per share (Note 12):
Basic $ .75 $ .60 $ .61
========== ========== ==========
Diluted $ .75 $ .60 $ .61
========== ========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
59
SIERRA BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands, except share data)
Accumu-
Common Stock lated Other
----------------------------- Compre- Share- Compre-
Retained hensive holders' hensive
Shares Amount Earnings Income Equity Income
------------- -------------- ------------- ------------- ------------- -------------
Balance, January 1, 1999 9,212,280 $ 2,285 $ 30,483 $ 2,250 $ 35,018
Comprehensive income (Note 16):
Net income 5,612 5,612 $ 5,612
Net change in unrealized gain on
securities available-for-sale,
net of tax (1,904) (1,904) (1,904)
-----------
Comprehensive income $ 3,708
===========
Cash dividends - $.22 per share (2,027) (2,027)
------------- -------------- ------------- ------------- -------------
Balance, December 31, 1999 9,212,280 2,285 34,068 346 36,699
Comprehensive income (Note 16):
Net income 5,481 5,481 $ 5,481
Net change in unrealized gain on
securities available-for-sale,
net of tax 721 721 721
------------
Comprehensive income $ 6,202
===========
Cash dividends - $.23 per share (2,119) (2,119)
------------- -------------- ------------- ------------- -------------
Balance, December 31, 2000 9,212,280 2,285 37,430 1,067 40,782
Comprehensive income (Note 16):
Net income 6,878 6,878 $ 6,878
Net change in unrealized gain on
securities available-for-sale,
net of tax (Note 3) 138 138 138
-----------
Comprehensive income $ 7,016
===========
Cash dividends - $.18 per share (1,657) (1,657)
------------- -------------- ------------- ------------- -------------
Balance, December 31, 2001 9,212,280 $ 2,285 $ 42,651 $ 1,205 $ 46,141
============= ============== ============= ============= =============
The accompanying notes are an integral
part of these consolidated financial statements.
60
SIERRA BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands)
2001 2000 1999
------------- ------------- --------------
Cash flows from operating activities:
Net income to reconcile net income to net cash
provided by operations $ 6,878 $ 5,481 $ 5,612
Adjustments:
Provision for loan losses 1,300 2,760 2,118
Amortization (accretion) of investment security
premiums/discounts, net 194 (103) 18
Amortization of intangibles 332 214 36
Net increase (decrease) in deferred loan fees, net 591 (152) (633)
Depreciation and amortization 1,946 1,746 1,585
Gain on sale of investment securities available-
for-sale, net (1,108) (119) (6)
(Gain) loss on sale of other real estate (154) 119 48
Net increase in cash surrender value of life
insurance policies (154)
Net decrease (increase) in loans held-for-sale 1,080 8,829 (2,849)
Net increase in other assets (812) (1,108) (691)
Net increase (decrease) in other liabilities 3,285 (824) 256
Deferred income tax (benefit) expense (389) (968) 533
------------- ------------- --------------
Net cash provided by operating activities 12,989 15,875 6,027
------------- ------------- --------------
Cash flows from investing activities:
Decrease in interest-bearing deposits in banks 1,041 763
Purchases of investment securities held-to-maturity (14,668) (21,616)
Purchases of investment securities available-for-sale (41,127) (16,755) (6,330)
Proceeds from sales of investment securities
available-for-sale 40,293 9,528
Proceeds from principal repayments of investment
securities available-for-sale 9,735 575
Proceeds from called and matured investment
securities held-to-maturity 4,296 9,781
Proceeds from called and matured investment
securities available-for-sale 10,294 14,804 5,965
Purchase of other investments (2,622)
Loan originations, net (67,948) (62,631) (43,033)
Purchases of premises and equipment, net (1,773) (2,600) (3,691)
Decrease in Fed funds sold 246 5,034 9,800
Proceeds from sale of other real estate 1,891 2,605 341
Acquisition of Sierra National Bank, net of cash
acquired (4,804)
Other (826)
------------- ------------- --------------
Net cash used in investing activities (49,970) (63,853) (49,609)
------------- ------------- --------------
(Continued)
61
SIERRA BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Continued)
For the Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands)
2001 2000 1999
------------- ------------- --------------
Cash flows from financing activities:
Net change in customer deposits $ (6,459) $ 60,271 $ 29,937
Net increase in short-term borrowings 26,499 1,846 22,540
Proceeds from issuance of manditorily redeemable
cumulative trust preferred securities of subsidiary
grantor trust 15,000
Dividends paid (1,657) (2,119) (2,027)
------------- ------------- --------------
Net cash provided by financing activities 33,383 59,998 50,450
------------- ------------- --------------
Net (decrease) increase in cash and cash equivalents (3,598) 12,020 6,868
Cash and cash equivalents, beginning of year 43,433 31,413 24,545
------------- ------------- --------------
Cash and cash equivalents, end of year $ 39,835 $ 43,433 $ 31,413
============= ============= ==============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 16,472 $ 17,332 $ 11,779
Income taxes $ 2,473 $ 4,128 $ 1,970
Non-cash investing and financing activities:
Real estate acquired through foreclosure $ 976 $ 1,492 $ 1,295
Loans made to finance the sale of other real estate $ 28 $ 355
Transfer of investment securities held-to-maturity
to investment securities available-for-sale $ 75,202
Net change in unrealized gains on investment
securities available-for-sale $ 218 $ 1,227 $ (3,068)
Acquisition of Sierra National Bank:
Fair value of assets acquired, net of fair value of
liabilities assumed:
Federal funds sold $ 5,280
Interest-bearing deposits in banks 1,994
Investment securities available-for-sale 14,843
Loans, net 53,320
Premises and equipment 2,026
Other real estate 614
Intangibles 6,032
Other assets 3,686
Deposits (81,687)
Other liabilities (1,304)
-------------
Net cash purchase price $ 4,804
=============
The accompanying notes are an integral part of these consolidated
financial statements.
62
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE BUSINESS OF SIERRA BANCORP
On November 16, 2000, Sierra Bancorp (the "Company") was incorporated
as a bank holding company for the purpose of acquiring Bank of the
Sierra (the "Bank") in a one bank holding company reorganization. The
new corporate structure gives the Company and the Bank greater
flexibility in terms of operation, expansion, and diversification. The
reorganization was approved by the Company's shareholders on May 23,
2001, and all required regulatory approvals or non-disapprovals with
respect to the reorganization were obtained. The reorganization was
consummated on August 10, 2001, subsequent to which the Bank continued
its operations as previously conducted but as a wholly owned subsidiary
of the Company.
The Company's subsidiaries include the Bank and Sierra Capital Trust I.
The Bank operates sixteen full service branch offices and eight credit
centers. The Bank's deposits are insured by the Federal Deposit
Insurance Corporation (FDIC) up to applicable legal limits. The Bank
maintains a diversified loan portfolio comprised of agricultural,
commercial, consumer, real estate construction and mortgage loans.
Loans are made primarily within the market areas of the South Central
San Joaquin Valley of California, specifically, Tulare, Fresno, Kern,
Kings, and Madera counties. These areas have diverse economies with
principal industries being agriculture, real estate and light
manufacturing. The Bank's wholly-owned subsidiary, Sierra Phoenix,
Inc., was formed to hold the stock of Phoenix International, Inc.,
which is currently in liquidation.
On May 19, 2000, the Bank acquired Sierra National Bank (SNB) for a
purchase price of $9,563,000 in cash and merged the operations of SNB
into those of the Bank. This acquisition has been accounted for using
the purchase method of accounting. Accordingly, operating results of
SNB are included in the consolidated statements of income from the date
of acquisition. The purchase price has been allocated to the assets
acquired and liabilities assumed based on the estimated fair values at
the date of acquisition. The excess of the purchase price over the
estimated fair values of the net assets acquired was $6,032,000 and has
been recorded as goodwill. The combined results of the companies are
derived from historical results of operations adjusted for amortization
of intangibles and additional depreciation on revalued assets acquired.
Unaudited pro forma results of operations for the years ended December
31, 2000 and 1999 were $4,775,000 and $5,937,000, or $.52 per share and
$.64 per share, respectively.
In November 2001, the Company formed a wholly-owned subsidiary, Sierra
Capital Trust I, a Delaware statutory business trust, for the exclusive
purpose of issuing and selling trust preferred securities.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation and Basis of Presentation
---------------------------------------
The consolidated financial statements include the accounts of the
Company and the consolidated accounts of its wholly-owned subsidiaries,
Bank of the Sierra and Sierra Capital Trust I. All significant
intercompany balances and transactions have been eliminated. Certain
reclassifications have been made to prior years' balances to conform to
classifications used in 2001. The accounting and reporting policies of
Sierra Bancorp conform with accounting principles generally accepted in
the United States of America and prevailing practices within the
banking industry.
Cash Equivalents
----------------
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand and amounts due from banks.
63
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Investment Securities
---------------------
Investments are classified into the following categories:
. Securities available-for-sale, reported at market
value, with unrealized gains and losses excluded from
earnings and reflected, net of tax, as a separate
component of shareholders' equity in accumulated
other comprehensive income.
. Securities held-to-maturity, which management has the
intent and the Company has the ability to hold to
maturity, are carried at cost, adjusted for
amortization of premiums and the accretion of
discounts.
Management determines the appropriate classification of its investments
at the time of purchase and may only change the classification in
certain limited circumstances. All transfers between categories are
accounted for at fair value.
The Bank adopted Statement of Financial Accounting Standards No. 133
(SFAS 133), Accounting for Derivative Instruments and Hedging
Activities, on October 1, 2000. Upon adoption, SFAS 133 allows the
transfer of investment securities held-to-maturity into the
available-for-sale category without calling into question an entity's
intent to hold other debt securities to maturity in the future. No
derivative instruments were held and, accordingly, there was no
transition adjustment reported in these consolidated financial
statements. However, all investment securities held-to-maturity were
transferred to the available-for-sale category and the unrealized
holding net gain at the date of transfer was included in accumulated
other comprehensive income.
Net gains or losses on the sale of investment securities, computed on
the specific identification method, are shown separately in
non-interest income in the consolidated statement of operations.
Interest earned on investment securities is included in interest
income, net of applicable adjustments for accretion of discounts and
amortization of premiums. In addition, unrealized losses that are other
than temporary are recognized in earnings for all investments.
Loans
-----
Loans are reported at the principal amounts outstanding, adjusted for
unearned income, deferred loan origination fees and costs, purchase
premiums and discounts, write-downs, and the allowance for loan losses.
Loan origination fees, net of certain deferred origination costs, and
purchase premiums and discounts are recognized as an adjustment to
yield of the related loans.
The accrual of interest on loans is discontinued when, in the opinion
of management, there is an indication that the borrower may be unable
to meet payments as they become due. Upon such discontinuance, all
unpaid accrued interest is reversed against current income unless the
loan is in the process of collection. Interest received on nonaccrual
loans generally is either applied against principal or reported as
interest income, according to management's judgment as to the
collectibility of principal. Generally, loans are restored to accrual
status when the obligation is brought current and has performed in
accordance with the contractual terms for a reasonable period of time
and the ultimate collectibility of the total contractual principal and
interest is no longer in doubt.
64
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan Losses
-------------------------
The allowance for loan losses is maintained at a level which, in
management's judgment, is adequate to absorb loan losses inherent in
the loan portfolio. The allowance for loan losses is increased by a
provision for loan losses, which is charged to expense, and reduced by
charge-offs, net of recoveries. The amount of the allowance is based on
management's evaluation of the collectibility of the loan portfolio,
changes in its risk profile, credit concentrations, historical trends,
and economic conditions. This evaluation also considers the balance of
impaired loans. A loan is impaired when it is probable that the Bank
will be unable to collect all contractual principal and interest
payments due in accordance with terms of the loan agreement. Losses on
individually identified impaired loans are measured based on the
present value of expected future cash flows discounted at each loan's
original effective market interest rate. As a practical expedient,
impairment may be measured based on the loan's observable market price
or the fair value of the collateral if the loan is collateral
dependent. The amount of impairment, if any, is recorded through the
provision added to the allowance for loan losses. One-to-four family
residential mortgages and consumer installment loans are subjected to a
collective evaluation for impairment, considering delinquency and
repossession statistics, historical loss experience, and other factors.
Though management believes the allowance for loan losses to be
adequate, ultimate losses may vary from their estimates. However,
estimates are reviewed periodically, and as adjustments become
necessary, they are reported in earnings during periods they become
known. In addition, the FDIC and the California Department of Financial
Institutions, as an integral part of their examination process, review
the allowance for loan losses. These agencies may require additions to
the allowance for loan losses based on their judgment about information
available at the time of their examinations.
Sale and Servicing of Loans
---------------------------
During the years ended December 31, 2000 and 1999, the Bank sold loans
or participating interests in loans to Freddie Mac, Fannie Mae and
other outside investors to provide funds for additional lending and to
generate servicing income. Under such agreements, the Bank serviced the
loans and the buyer received its share of principal collected together
with interest at an agreed-upon rate. This rate generally differed from
the loans' contractual interest rate. During 2001, the Bank modified
its strategy for selling loans to include the sale of servicing.
Gains and losses on sales of loans are recognized at the time of sale
and are calculated based on the difference between the selling price
and the allocated book value of loans sold. Book value allocations are
determined in accordance with Financial Accounting Standards Board
(FASB) Statement No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities. Any inherent risk
of loss on loans sold is transferred to the buyer at the date of sale.
The Bank has issued various representations and warranties associated
with the sale of loans. These representations and warranties may
require the Bank to repurchase loans with underwriting deficiencies as
defined per the applicable sales agreements and certain past due loans
within 90 days of the sale. The Bank experienced no losses during the
years ended December 31, 2001, 2000 and 1999 regarding these
representations and warranties.
65
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Premises and Equipment
----------------------
Premises and equipment are stated at cost less accumulated
depreciation. Depreciation is computed using the straight-line method
over the estimated useful lives of the assets. The useful lives of
premises are estimated to be thirty years. The useful lives of
furniture, fixtures and equipment are estimated to be three to twenty
years. Leasehold improvements are amortized over the life of the asset
or the term of the related lease, whichever is shorter. When assets are
sold or otherwise disposed of, the cost and related accumulated
depreciation are removed from the accounts, and any resulting gain or
loss is recognized in income for the period. The cost of maintenance
and repairs is charged to expense as incurred.
Impairment of long-lived assets is evaluated by management based upon
an event or changes in circumstances surrounding the underlying assets
which indicate long-lived assets may be impaired.
Other Real Estate
-----------------
Other real estate includes real estate acquired in full or partial
settlement of loan obligations. When property is acquired, any excess
of the recorded investment in the loan balance and accrued interest
income over the estimated fair market value of the property, net of
estimated selling costs, is charged against the allowance for loan
losses. A valuation allowance for losses on other real estate is
maintained to provide for temporary declines in value. The allowance is
established through a provision for losses on other real estate which
is included in other non-interest expense. Subsequent gains or losses
on sales or writedowns resulting from permanent impairments are
recorded in other income or expense as incurred.
Income Taxes
------------
The Company files its income taxes on a consolidated basis with its
subsidiaries. The allocation of income tax expense represents each
entity's proportionate share of the consolidated provision for income
taxes.
The Company accounts for income taxes through the use of the asset and
liability method. Under the asset and liability method, deferred taxes
are recognized for the tax consequences of temporary differences by
applying enacted statutory tax rates applicable to future years to
differences between the financial statement carrying amounts and the
bases of existing assets and liabilities. The effect on deferred taxes
of a change in tax rates would be recognized in income in the period
that includes the enactment date.
401(k) Savings Plan
-------------------
The 401(k) savings plan (the "Plan") allows participants to defer, on a
pre-tax basis, up to 15% of their salary (but in no event more than
$10,500 per participant in the 2001 calendar year) and accumulate
tax-deferred earnings as a retirement fund. The Bank may make a
discretionary contribution to match the participants' contributions
annually. The amount of the matching contribution may vary from year to
year. The matching contribution is discretionary and subject to the
approval of the Board of Directors. The Bank contributed $284,000,
$293,000 and $231,000 to the Plan in 2001, 2000 and 1999, respectively.
66
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock-Based Compensation
------------------------
Stock options are accounted for under the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees. Accordingly, compensation cost for stock
options is measured as the excess, if any, of the quoted market price
of the Company's stock at the date of grant over the exercise price.
However, if the fair value of stock-based compensation computed under a
fair value based method, as prescribed in Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation,
is material to the financial statements, pro forma net income and
earnings per share are disclosed as if the fair value method had been
applied.
Earnings Per Share
------------------
Basic earnings per share (EPS), which excludes dilution, is computed by
dividing income available to common shareholders by the
weighted-average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock, such as stock
options, result in the issuance of common stock which shares in the
earnings of the Company. The treasury stock method has been applied to
determine the dilutive effect of stock options in computing diluted
EPS.
Use of Estimates
----------------
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of
America 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.
Material estimates that are particularly susceptible to significant
changes in the near-term relate to the determination of the allowance
for loan losses and the valuation of real estate acquired in connection
with foreclosures or in satisfaction of loans. In connection with the
determination of the allowances for loan losses and other real estate,
management obtains independent appraisals for significant properties,
evaluates the overall loan portfolio characteristics and delinquencies
and monitors economic conditions.
Impact of New Financial Accounting Standards
--------------------------------------------
In September 2000, the Financial Accounting Standards Board (FASB)
issued SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, to replace SFAS
No. 125 which was issued in June 1996. The original statement addressed
issues related to transfers of financial assets in which the transferor
has some continuing involvement with the transferred assets or with the
transferee. SFAS No. 140 resolves implementation issues which arose as
a result of SFAS No. 125, but carries forward most of the provisions of
the original statement. SFAS 140 was effective for transfers occurring
after March 31, 2001 and for disclosures relating to securitization
transactions and collateral for fiscal years ending after December 15,
2000. Management does not believe the adoption of this statement has
had a significant impact on the Company's financial statement.
67
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Impact of New Financial Accounting Standards (Continued)
--------------------------------------------
In June 2001, the FASB issued SFAS No. 141, Business Combinations.
SFAS No. 141 addresses the financial accounting and reporting for
business combinations and requires the use of a single method to
account for business combinations, the purchase method of
accounting. In addition, SFAS No. 141 requires that intangible
assets be recognized as assets apart from goodwill if they meet
one of two criteria, the contractual-legal criterion or the
separability criterion. SFAS No. 141 applies to all business
combinations for which the date of acquisition is July 1, 2001 or
later.
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other
Intangible Assets. Pursuant to SFAS No. 142, goodwill and other
intangible assets that have indefinite useful lives will be evaluated
periodically for impairment rather than amortized. The provisions of
this statement apply to financial statements for fiscal years beginning
after December 15, 2001, except for goodwill or other intangible assets
acquired after June 30, 2001 for which SFAS No. 142 is immediately
effective. On January 1, 2002, the Company adopted these
pronouncements, replacing the amortization of goodwill with an annual
impairment test. Amortization of goodwill was $332,000 for the year
ended December 31, 2001.
In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which replaces SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. The accounting model for
long-lived assets to be disposed of by sale applies to all long-lived
assets, including discontinued operations, and replaces the provision
of Accounting Principles Board Opinion No. 30, Reporting Results of
Operations-Reporting the Effects of Disposal of a Segment of a
Business, for the disposal of segments of a business. SFAS No. 144
requires that those long-lived assets be measured at the lower of
carrying amount or fair value less costs to sell, whether reported in
continuing operations or in discontinued operations. Therefore,
discontinued operations will no longer be measured at net realizable
value or include amounts for operating losses that have not yet
occurred. The provisions of SFAS No. 144 are effective for financial
statements issued for fiscal years beginning after December 15, 2001
and, generally, are to be applied prospectively. Management does not
believe the adoption of this statement will have a significant impact
on the Company's financial position or results of operations.
68
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. INVESTMENT SECURITIES AVAILABLE-FOR-SALE
The amortized cost and estimated market value of investment securities
available-for-sale are as follows (dollars in thousands):
December 31, 2001
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------------- --------------- --------------- ----------------
U.S. Treasury securities $ 1,002 $ 23 $ 1,025
U.S. Government agencies 18,824 724 19,548
Obligations of states and
political subdivisions 44,477 962 $ (155) 45,284
U.S. Government agencies
collateralized by mortgage
obligations 21,257 250 21,507
Corporate bonds 4,996 214 5,210
Other securities 100 15 115
---------------- --------------- --------------- ----------------
$ 90,656 $ 2,188 $ (155) $ 92,689
================ =============== =============== ================
December 31, 2000
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------------- --------------- --------------- ----------------
U.S. Treasury securities $ 13,540 $ 19 $ (2) $ 13,557
U.S. Government agencies 40,705 573 (74) 41,204
Obligations of states and
political subdivisions 41,407 1,180 (68) 42,519
U.S. Government agencies
collateralized by mortgage
obligations 7,513 141 (4) 7,650
Corporate bonds 4,985 56 (2) 5,039
Other securities 787 6 (10) 783
---------------- --------------- --------------- ----------------
$ 108,937 $ 1,975 $ (160) $ 110,752
================ =============== =============== ================
Net unrealized gains on investment securities available-for-sale
totaling $2,033,000 and $1,815,000 are recorded net of $828,000 and
$748,000 in tax liabilities as accumulated other comprehensive income
within shareholders' equity at December 31, 2001 and 2000,
respectively.
Gross gains realized on the sale of investment securities
available-for-sale were $1,108,000, $119,000 and $6,000 for the years
ended December 31, 2001, 2000 and 1999, respectively.
On October 1, 2000, all investment securities held-to-maturity were
transferred to the available-for-sale category in accordance with the
provisions of SFAS 133. The amortized cost and estimated market value
of the transferred securities on the date of transfer were $75,202,000
and $74,971,000, respectively. Accordingly, gross unrealized gains of
$560,000 and gross unrealized losses of $791,000 were recorded, net of
tax benefits, in accumulated other comprehensive income within
shareholders' equity.
69
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. INVESTMENT SECURITIES AVAILABLE-FOR-SALE (Continued)
The amortized cost and estimated market value of investment securities
available-for-sale at December 31, 2001 by contractual maturity are
shown below. Expected maturities will differ from contractual
maturities because the issuers of the securities may have the right to
call or prepay obligations with or without call or prepayment
penalties.
Estimated
Amortized Market
Cost Value
--------------- ----------------
(Dollars in thousands)
Maturing within one year $ 11,854 $ 11,850
Maturing after one year through five years 40,357 41,735
Maturing after five years through ten years 12,732 13,084
Maturing after ten years 4,356 4,398
--------------- ----------------
69,299 71,067
Investment securities not due at a single maturity date:
U.S. Government agencies collateralized by
mortgage obligations 21,257 21,507
Other securities 100 115
--------------- ----------------
Total $ 90,656 $ 92,689
=============== ================
Investment securities available-for-sale with amortized costs totaling
$53,573,000 and $61,360,000 and estimated market values totaling
$54,698,000 and $62,364,000 were pledged to secure public deposits,
other contractual obligations and short-term borrowing arrangements at
December 31, 2001 and 2000, respectively.
4. LOANS
The composition of the loan portfolio is as follows (dollars in
thousands):
December 31,
---------------------------------
2001 2000
--------------- ----------------
Real estate loans:
Secured by commercial and professional office
properties, including construction and
development $ 196,455 $ 165,759
Secured by residential properties 106,772 102,594
Secured by farm land 16,998 17,575
Held for sale 1,048 2,128
--------------- ----------------
Total real estate 321,273 288,056
Commercial and industrial 71,857 59,554
Agricultural 14,471 16,306
Small Business Administration loans 16,942 10,883
Consumer 50,714 35,416
Credit cards 11,344 11,481
--------------- ----------------
486,601 421,696
Deferred loan (fees) costs, net (533) 58
Allowance for loan losses (5,675) (5,362)
--------------- ----------------
$ 480,393 $ 416,392
=============== ================
70
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4. LOANS (Continued)
A summary of the transactions in the allowance for loan losses follows
(dollars in thousands):
Year Ended December 31,
---------------------------------------------------
2001 2000 1999
--------------- --------------- ----------------
Balance, beginning of year $ 5,362 $ 3,319 $ 4,394
Provision charged to operations 1,300 2,760 2,118
Loans charged off (1,339) (1,939) (3,273)
Recoveries of loans previously charged off 352 204 80
Allowance acquired from SNB 1,018
--------------- --------------- ----------------
Balance, end of year $ 5,675 $ 5,362 $ 3,319
=============== =============== ================
The recorded investment in loans that were considered to be impaired
totaled $6,716,000 and $2,120,000 at December 31, 2001 and 2000,
respectively. The related allowance for loan losses on these impaired
loans at December 31, 2001 and 2000 was $1,389,000 and $675,000,
respectively. The average recorded investment in impaired loans during
2001, 2000 and 1999 was $5,282,000, $651,000 and $1,193,000,
respectively. Interest income on impaired loans is recognized on a cash
basis and was not significant for the years ended December 31, 2001,
2000 and 1999, respectively.
At December 31, 2001 and 2000, nonaccrual loans totaled $6,716,000 and
$2,120,000, respectively. Interest foregone on these nonaccrual loans
totaled $705,000, $52,000 and $14,000 for the years ended December 31,
2001, 2000 and 1999, respectively.
Certain loans have been pledged to secure borrowing arrangements (see
Note 8).
Salaries and employee benefits totaling $2,472,000, $1,701,000 and
$1,600,000 have been deferred as loan origination costs to be amortized
over the estimated lives of the related loans for the years ended
December 31, 2001, 2000 and 1999, respectively.
Loan Servicing
--------------
The Bank originates mortgage loans for sale to investors. During the
years ended December 31, 2000 and 1999, the Bank generally retained
servicing rights for the loans sold. During the year ended December 31,
2001, the Bank modified its strategy and did not retain servicing.
During the year ended December 31, 2001, the Bank sold the servicing
rights for approximately $114 million in mortgage loans. The total gain
on the sale of servicing rights was $789,000 and is included in loan
servicing income in the accompanying consolidated statement of income.
No servicing rights were sold during the year ended December 31, 2000.
During the year ended December 31, 1999, the Bank sold the servicing
rights for approximately $32 million in adjustable rate mortgage loans.
The total gain on the sale of servicing rights for 1999 was $331,000
and is included in loan servicing income in the accompanying
consolidated statement of income.
The Bank's servicing portfolio at December 31, 2001 and 2000 totaled
$54,180,000 and $176,261,000, respectively. At December 31, 2001, loans
were principally serviced for one investor. Mortgage servicing
fiduciary funds, which are segregated in special bank accounts, are
included as demand deposits in the accompanying consolidated balance
sheet. At December 31, 2001 and 2000, such funds totaled $96,000 and
$833,000, respectively.
71
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
5. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following (dollars in
thousands):
December 31,
---------------------------------
2001 2000
--------------- ----------------
Land $ 2,025 $ 2,028
Buildings and improvements 8,649 8,013
Furniture, fixtures and equipment 13,417 12,526
Leasehold improvements 1,721 1,696
Construction in progress 367 188
--------------- ----------------
26,179 24,451
Less accumulated depreciation
and amortization 11,875 9,974
--------------- ----------------
$ 14,304 $ 14,477
=============== ================
Depreciation and amortization included in occupancy and equipment
expense totaled $1,946,000, $1,754,000 and $1,580,000 for the years
ended December 31, 2001, 2000 and 1999, respectively.
6. OTHER ASSETS
Other assets consisted of the following (dollars in thousands):
December 31,
---------------------------------
2001 2000
--------------- ----------------
Accrued interest receivable $ 3,766 $ 4,902
Deferred tax assets (Note 9) 1,663 1,354
Investment in limited partnership 2,896
Federal Home Loan Bank stock 2,014 1,764
Other 6,345 4,767
--------------- ----------------
$ 16,684 $ 12,787
=============== ================
The Bank invested in a limited partnership that operates qualified
affordable housing projects to receive tax benefits in the form of tax
deductions from operating losses and tax credits. The Bank accounts for
the investment under the cost method and management analyzes the
investment annually for potential impairment. The Bank has remaining
capital commitments to this partnership at December 31, 2001 in the
amount of approximately $1,274,000. Such amounts are included in other
liabilities.
72
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
7. DEPOSITS
Interest-bearing deposits consisted of the following (dollars in
thousands):
December 31,
---------------------------------
2001 2000
--------------- ----------------
Savings $ 31,128 $ 31,343
Money market 93,928 44,238
NOW accounts 49,455 45,668
Time, $100,000 or more 80,412 131,502
Time, under $100,000 123,510 144,433
--------------- ----------------
$ 378,433 $ 397,184
=============== ================
Aggregate annual maturities of time deposits are as follows (dollars in
thousands):
Year Ending
December 31,
- --------------------
2002 $ 191,950
2003 8,022
2004 1,852
2005 1,751
2006 347
---------------
$ 203,922
===============
Interest expense recognized on interest-bearing deposits consisted of
the following (dollars in thousands):
Year Ended December 31,
---------------------------------------------------
2001 2000 1999
--------------- --------------- ----------------
Savings $ 370 $ 574 357
Money market 2,911 1,539 1,171
NOW accounts 216 412 338
Time, $100,000 or more 5,008 6,310 3,779
Time, under $100,000 6,747 8,367 5,509
--------------- --------------- ----------------
$ 15,252 $ 17,202 $ 11,154
=============== =============== ================
73
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
8. SHORT-TERM BORROWING ARRANGEMENTS
The following table shows information for short-term borrowings
(dollars in thousands).
2001 2000 1999
---------------------- ---------------------- ----------------------
Amount Rate Amount Rate Amount Rate
------------- ------ -------------- ------ ------------- -------
As of December 31:
Federal funds purchased and
repurchase agreements $ 22,253 1.39% $ 13,584 4.20% $ 18,638 4.95%
Federal Home Loan Bank
advances 38,300 1.56% 20,700 6.13% 13,800 3.53%
Other borrowings 230 4.75%
------------- -------------- -------------
Total $ 60,783 $ 34,284 $ 32,438
============= ============== =============
Year ended December 31
average balance:
Federal funds purchased and
repurchase agreements $ 15,728 2.74% $ 13,977 4.51% $ 10,602 3.52%
Federal Home Loan Bank
advances 3,162 3.67% 13,017 6.48% $ 3,480 5.57%
------------- -------------- -------------
Total $ 18,890 $ 26,994 $ 14,082
============= ============== =============
Maximum month-end balance:
Federal funds purchased and
repurchase agreements $ 22,253 $ 20,756 $ 20,766
Federal Home Loan Bank
advances $ 38,300 $ 35,123 $ 17,300
The Bank had unsecured lines of credit with its correspondent banks
which, in the aggregate, amounted to $13,000,000 and $16,000,000 at
December 31, 2001 and 2000, respectively, at interest rates which vary
with market conditions. There were no borrowings outstanding under
these lines of credit at December 31, 2001 and 2000. At December 31,
2001, the Company could borrow up to $48,509,000 from the Federal Home
Loan Bank, secured by qualifying first mortgage loans with a carrying
value of $76,731,000.
The Company enters into sales of securities under agreements to
repurchase which generally mature within one day. The dollar amount of
securities underlying the agreements are carried as investment
securities available-for-sale. At December 31, 2001 and 2000, these
securities had amortized costs of $22,045,000 and $16,510,000,
respectively, which approximated market value.
74
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9. INCOME TAXES
The provision for income taxes follows (dollars in thousands):
Year Ended December 31,
---------------------------------------------------
2001 2000 1999
--------------- --------------- ----------------
Federal:
Current $ 2,814 $ 2,620 $ 1,476
Deferred (266) (767) 176
--------------- --------------- ----------------
2,548 1,853 1,652
--------------- --------------- ----------------
State:
Current 1,197 1,090 766
Deferred (123) (201) 357
--------------- --------------- ----------------
1,074 889 1,123
--------------- --------------- ----------------
$ 3,622 $ 2,742 $ 2,775
=============== =============== ================
The effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are presented below
(dollars in thousands):
December 31,
---------------------------------
2001 2000
--------------- ----------------
Deferred tax assets:
Allowance for loan losses $ 1,842 $ 1,333
Deferred compensation 437 466
Future benefit of State tax deduction 167 357
Other real estate 388 430
Other 463 34
--------------- ----------------
Total deferred tax assets 3,297 2,620
--------------- ----------------
Deferred tax liabilities:
Premises and equipment (548) (414)
Unrealized gain on securities
available-for-sale (828) (748)
Other (258) (104)
--------------- ----------------
Total deferred tax liabilities (1,634) (1,266)
--------------- ----------------
Net deferred tax assets $ 1,663 $ 1,354
=============== ================
75
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9. INCOME TAXES (Continued)
The expense for income taxes differs from amounts computed by applying
the statutory Federal income tax rates to income before income taxes.
The significant items comprising these differences consisted of the
following (dollars in thousands):
Year Ended December 31,
---------------------------------------------------
2001 2000 1999
--------------- --------------- ----------------
Income tax expense at Federal
statutory rate $ 3,675 $ 2,878 $ 2,935
Increase (decrease) resulting from:
State franchise tax expense, net of
Federal tax effect 669 580 595
Tax exempt income (621) (615) (568)
Affordable housing tax credits (144)
Other 43 (101) (187)
--------------- --------------- ----------------
Total 3,622 2,742 2,775
=============== =============== ================
Effective tax rate 34.5% 33.3% 33.1%
=============== =============== ================
10. COMMITMENTS AND CONTINGENCIES
Leases
------
The Bank leases certain of its branch facilities, administrative
offices and equipment under noncancelable operating leases. Rental
expense included in occupancy and equipment and other expense totaled
$427,000, $432,000 and $399,000 for the years ended December 31, 2001,
2000 and 1999, respectively.
Future minimum lease payments on noncancelable operating leases are as
follows (dollars in thousands):
Year Ending
December 31,
- --------------------
2002 $ 411
2003 411
2004 411
2005 363
2006 286
2007 and Thereafter 1,197
-------------
$ 3,079
=============
Federal Reserve Requirements
----------------------------
Banks are required to maintain reserves with the Federal Reserve Bank
equal to a percentage of their reservable deposits less vault cash. The
reserve balances maintained at the Federal Reserve Bank at December 31,
2001 and 2000 were $3,807,000 and $450,000, respectively.
76
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10. COMMITMENTS AND CONTINGENCIES (Continued)
Financial Instruments With Off-Balance-Sheet Risk
-------------------------------------------------
The Bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business in order to meet the financing
needs of its customers. These financial instruments consist of
commitments to extend credit and standby letters of credit. These
instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance
sheet.
The Bank's exposure to credit loss in the event of nonperformance by
the other party for commitments to extend credit and letters of credit
is represented by the contractual amount of those instruments. The Bank
uses the same credit policies in making commitments and letters of
credit as it does for loans included on the balance sheet.
The following financial instruments represent off-balance-sheet credit
risk (dollars in thousands):
December 31,
---------------------------------
2001 2000
--------------- ----------------
Commitments to extend credit $ 105,736 $ 90,787
Standby letters of credit $ 4,413 $ 7,927
Credit card commitments $ 42,522 $ 39,280
Commitments to extend credit consist primarily of unfunded
single-family residential and commercial real estate construction loans
and commercial revolving lines of credit. Construction loans are
established under standard underwriting guidelines and policies and are
secured by deeds of trust, with disbursements made over the course of
construction. Commercial revolving lines of credit have a high degree
of industry diversification. Commitments generally have fixed
expiration dates or other termination clauses and may require payment
of a fee. Since many of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Standby letters of credit are
generally secured and are issued by the Bank to guarantee the
performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loans to customers. Credit card commitments are commitments
on credit cards and are unsecured.
Concentration in Real Estate Lending
------------------------------------
A substantial portion of the Company's loans are secured by real estate
in its primary market area. Accordingly, the ultimate collectibility of
a substantial portion of the Company's loan portfolio and the recovery
of a portion of the carrying amount of foreclosed real estate are
susceptible to changes in economic conditions and real estate
valuations in the Company's primary market.
Concentration by Geographic Location
------------------------------------
The Bank grants commercial, real estate mortgage, real estate
construction and consumer loans to customers primarily in the South
Central San Joaquin Valley of California, specifically Tulare, Fresno,
Kern, Kings and Madera counties. The ability of a substantial portion
of the Bank's customers to honor their contracts is dependent on the
economy in these areas. Although the Bank's loan portfolio is
diversified, there is a relationship in this region between the local
agricultural economy and the economic performance of loans made to
non-agricultural customers.
77
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10. COMMITMENTS AND CONTINGENCIES (Continued)
Concentration by Organization
-----------------------------
The Bank has undertaken an effort to market its credit card program
locally through the establishment of relationships with various
organizations, commonly referred to as affinity groups. The Bank has no
affinity group that individually accounts for more than 20% of the
credit card portfolio.
Contingencies
-------------
The Company is subject to legal proceedings and claims which arise in
the ordinary course of business. In the opinion of management, the
amount of ultimate liability with respect to such actions will not
materially affect the consolidated financial position or consolidated
results of operations of the Company.
11. MANDATORILY REDEEMABLE CUMULATIVE TRUST PREFERRED SECURITIES OF
SUBSIDIARY GRANTOR TRUST
Sierra Capital Trust I is a Delaware business trust formed by the
Company for the sole purpose of issuing trust preferred securities
fully and unconditionally guaranteed by the Company. During the fourth
quarter of 2001, Sierra Capital Trust I issued 15,000 Floating Rate
Capital Trust Pass-Through Securities (TRUPS), with a liquidation value
of $1,000 per security, to the Company for gross proceeds of
$15,000,000. The entire proceeds of the issuance were invested by
Sierra Capital Trust I in $15,000,000 of Floating Rate Junior
Subordinated Deferrable Interest Debentures (the "Subordinated
Debentures"), with identical maturity, repricing and payment terms as
the TRUPS issued by the Company. The Subordinated Debentures represent
the sole assets of Sierra Capital Trust I. The Subordinated Debentures
mature on December 8, 2031, bear an initial interest rate of 6.007%
(based on 6-month LIBOR plus 3.75%), with repricing and payments due
semi-annually. The Subordinated Debentures are redeemable by the
Company, subject to receipt by the Company of prior approval from the
Federal Reserve Bank, on any June 8th or December 8th on or after
December 8, 2006. The redemption price is par plus accrued and unpaid
interest, except in the case of redemption under a special event which
is defined in the debenture. The TRUPS are subject to mandatory
redemption to the extent of any early redemption of the Subordinated
Debentures and upon maturity of the Subordinated Debentures on July 31,
2031. The Subordinated Debentures bear the same terms and interest
rates as the TRUPS.
Holders of the TRUPS are entitled to a cumulative cash distribution on
the liquidation amount of $1,000 per security at an initial rate per
annum of 6.007%. For each successive period beginning on June 8 of each
year, the rate will be adjusted to equal the 6-month LIBOR plus 3.75%;
provided, however, that prior to December 8, 2006, such annual rate
does not exceed 11.00%. The distributions on the TRUPS are treated as
interest expense in the consolidated statement of income. The Company
has the option to defer payment of the distributions for a period of up
to five years, as long as the Company is not in default on the payment
of interest on the Subordinated Debentures. The TRUPS issued in the
offering were sold in private transactions pursuant to an exemption
from registration under the Securities Act of 1933, as amended. The
Company has guaranteed, on a subordinated basis, distributions and
other payments due on the TRUPS.
78
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11. MANDATORILY REDEEMABLE CUMULATIVE TRUST PREFERRED SECURITIES OF
SUBSIDIARY GRANTOR TRUST (Continued)
The Subordinated Debentures and related trust investments in the
Subordinated Debentures have been eliminated in consolidation and the
TRUPS are reflected as outstanding in the accompanying consolidated
financial statements. Under applicable regulatory guidelines, all of
the TRUPS currently qualify as Tier 1 capital.
12. SHAREHOLDERS' EQUITY
Earnings Per Share
------------------
A reconciliation of the numerators and denominators of the basic and
diluted earnings per share computations is as follows (dollars in
thousands):
2001 2000 1999
--------------- --------------- ----------------
Basic Earnings Per Share
- ------------------------
Net income $ 6,878 $ 5,481 $ 5,612
--------------- --------------- ----------------
Weighted average shares outstanding 9,212,280 9,212,280 9,212,280
--------------- --------------- ----------------
Basic earnings per share $ .75 $ .60 $ .61
=============== =============== ================
Diluted Earnings Per Share
- --------------------------
Net income $ 6,878 $ 5,481 $ 5,612
--------------- --------------- ----------------
Weighted average shares outstanding 9,212,280 9,212,280 9,212,280
Effect of dilutive stock options 9,200 39,913
--------------- --------------- ----------------
9,221,480 9,212,280 9,252,193
=============== =============== ================
Diluted earnings per share $ .75 .60 $ .61
=============== =============== ================
Stock Options
-------------
In June 1998, the Bank adopted the 1998 Stock Option Plan (the "Plan")
for which shares are reserved for issuance to employees and directors
under incentive and nonstatutory agreements. The Plan covers a total of
2,763,684 shares, of which two-thirds are reserved for the grant of
options to full-time salaried officers and employees of the Bank. The
remaining one-third of the shares available for grant may be granted to
anyone eligible to participate in the Plan, including directors,
officers and employees. The Company assumed all obligations under the
Plan as of August 10, 2001 and options to purchase shares of the
Company's common stock were substituted for options to purchase shares
of common stock of the Bank. The Plan requires that the option price
may not be less than the fair market value of the stock at the date the
option is granted, and that the option price must be paid in full at
the time it is exercised. The options under the Plan expire on dates
determined by the Board of Directors, but not later than ten years from
the date of grant. The vesting period is determined by the Board of
Directors and is generally five years. For participants with 10 years
of service at the date of grant, options vest immediately. Outstanding
options under the Plan are exercisable until their expiration.
79
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12. SHAREHOLDERS' EQUITY (Continued)
Stock Options (Continued)
-------------
A summary of the combined activity of the plans follows:
2001 2000 1999
------------------------ ------------------------ -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- ----------- ----------- ----------- ----------- -----------
Outstanding,
beginning of year 1,055,000 $ 9.00 1,090,000 $ 9.00 996,000 $ 9.00
Granted 1,097,000 $ 6.55 72,000 $ 9.00 132,000 $ 9.00
Canceled (160,800) $ 8.87 (107,000) $ 9.00 (38,000) $ 9.00
----------- ----------- -----------
Outstanding,
end of year 1,991,200 $ 7.66 1,055,000 $ 9.00 1,090,000 $ 9.00
=========== =========== ===========
Exercisable,
end of year 1,265,100 $ 7.92 699,000 $ 9.00 727,000 $ 9.00
=========== =========== ===========
Weighted average fair
value of options
granted $ 2.03 $ 2.45 $ 3.12
A summary of options outstanding at December 31, 2001 follows:
Weighted Number of
Outstanding Average Options
at Remaining Exercisable
December 31, Contractual December 31,
Exercise Price 2001 Life (Years) 2001
- -------------- --------------- --------------- ----------------
$ 6.43 1,036,000 9.8 532,500
$ 9.00 955,200 6.9 732,600
--------------- --------------- ----------------
1,991,200 8.4 1,265,100
=============== =============== ================
80
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12. SHAREHOLDERS' EQUITY (Continued)
Stock Options (Continued)
-------------
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation. Accordingly, no compensation expense has been recognized
under the above stock option plan. Had compensation cost been
determined based on the fair value at grant date for awards in 2001,
2000 and 1999 consistent with the provisions of SFAS 123, the Company's
consolidated net income and earnings per share for the years ended
December 31, 2001, 2000 and 1999 would have been adjusted to the pro
forma amounts indicated below. Pro forma adjustments to the Company's
consolidated net income and earnings per share are disclosed during the
years in which the options become vested.
2001 2000 1999
--------------- --------------- ----------------
(Dollars in thousands except per share data)
Net income - as reported $ 6,878 $ 5,481 $ 5,612
Net income - pro forma $ 6,689 $ 5,281 $ 5,402
Basic earnings per share - as reported $ .75 $ .60 $ .61
Basic earnings per share - pro forma .73 $ .57 $ .59
Diluted earnings per share - as reported $ .75 $ .60 $ .61
Diluted earnings per share - pro forma .73 $ .57 $ .59
The weighted average assumptions for determining compensation costs
under the fair value method include the following:
2001 2000 1999
--------------- --------------- ----------------
Dividend yield 2.57% 2.88% 2.46%
Expected volatility 26.45% 28.03% 30.85%
Risk-free interest rate 4.96% 6.13% 6.21%
Expected option life 6 years 10 years 7.5 years
13. REGULATORY MATTERS
The Company and the Bank are subject to certain regulatory requirements
administered by the Board of Governors of the Federal Reserve System
and the Federal Deposit Insurance Corporation (FDIC). Failure to meet
these minimum capital requirements can initiate certain mandatory, and
possibly additional discretionary, actions by regulators that, if
undertaken, could have a direct material effect on the Company's
consolidated financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting
practices. The Company's and the Bank's capital amounts and
classification are also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts
and ratios of total and Tier 1 capital to risk-weighted assets and of
Tier 1 capital to average assets. Each of these components is defined
in the regulations. Management believes that the Company and the Bank
meet all their capital adequacy requirements as of December 31, 2001
and 2000.
81
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
13. REGULATORY MATTERS (Continued)
In addition, the most recent notification from the FDIC categorized the
Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier 1 risk-based and leverage
capital and ratios as set forth below (dollars in thousands). There are
no conditions or events since that notification that management
believes have changed the Bank's category.
2001 2000
----------------------- ------------------------
Amount Ratio Amount Ratio
-------------- ------- -------------- -------
Leverage Ratio
- --------------
Sierra Bancorp and subsidiaries $ 54,389 9.0%
Minimum regulatory requirement $ 24,131 4.0%
Bank of the Sierra $ 49,210 8.2% $ 33,647 5.6%
Minimum requirement for "Well-Capitalized" institution $ 30,122 5.0% $ 30,150 5.0%
Minimum regulatory requirement $ 24,098 4.0% $ 24,120 4.0%
Tier 1 Risk-Based Capital Ratio
- -------------------------------
Sierra Bancorp and subsidiaries $ 54,389 11.0%
Minimum regulatory requirement $ 19,722 4.0%
Bank of the Sierra $ 49,213 10.0% $ 33,647 7.8%
Minimum requirement for "Well-Capitalized" institution $ 29,496 6.0% $ 26,027 6.0%
Minimum regulatory requirement $ 19,664 4.0% $ 17,532 4.0%
Total Risk-Based Capital Ratio
- ------------------------------
Sierra Bancorp and subsidiaries $ 60,071 12.2%
Minimum regulatory requirement $ 39,445 8.0%
Bank of the Sierra $ 54,895 11.2% $ 39,025 9.0%
Minimum requirement for "Well-Capitalized" institution $ 49,160 10.0% $ 43,379 10.0%
Minimum regulatory requirement $ 39,328 8.0% $ 34,703 8.0%
Dividend Restrictions
---------------------
The Company's ability to pay cash dividends is dependent on dividends
paid to it by the Bank and limited by state corporation law. Under
California law, the holders of common stock of the Company are entitled
to receive dividends when and as declared by the Board of Directors,
out of funds legally available, subject to certain restrictions. The
California general Corporation Law prohibits the Company from paying
dividends on the common stock unless: (1) its retained earnings,
immediately prior to the dividend payment, equals or exceeds the amount
of the dividend or (ii) immediately after giving effect to the
dividend, the sum of the Company's assets (exclusive of goodwill and
deferred charges) would be at least equal to 125% of its liabilities
(not including deferred taxes, deferred income and other deferred
liabilities) and the current assets of the Company would be at least
equal to its current liabilities, or, if the average of its earnings
before taxes on income and before interest expense for the two
preceding fiscal years was less than the average of its interest
expense for the two preceding fiscal years, at least equal to 125% of
its current liabilities.
82
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
13. REGULATORY MATTERS (Continued)
Dividend Restrictions Continued)
---------------------
Dividends from the Bank to the Company are restricted under California law
to the lesser of the Bank's retained earnings or the Bank's net income for
the latest three fiscal years, less dividends previously declared during
that period, or, with the approval of the Department of Financial
Institutions, to the greater of the retained earnings of the Bank, the
net income of the Bank for its last fiscal year, or the net income of the
Bank for its current fiscal year. As of December 31, 2001, the maximum
amounts available for dividend distribution under this restriction were
approximately $11,991,000.
14. OTHER EXPENSE
Other expense consisted of the following (dollars in thousands):
Year Ended December 31,
---------------------------------
2001 2000 1999
---------- --------- --------
Professional fees $ 2,310 $ 1,137 $ 694
Data processing 1,881 1,537 789
Advertising and promotion 829 925 711
Deposit services 1,086 1,090 686
Stationary and supplies 615 605 499
Telephone and data communication 1,041 797 531
Loan and credit card processing 1,172 960 873
Other 1,293 1,573 1,061
------- --------- --------
$ 10,227 $ 8,624 $ 5,844
========= ========= ========
15. LOANS TO RELATED PARTIES
During the normal course of business, the Bank enters into loans with
related parties, including executive officers and directors. These loans
are made with substantially the same terms, including rates and
collateral, as loans to unrelated parties. The following is a summary of
the aggregate activity involving related party borrowers (dollars in
thousands):
Balance, January 1, 2001 $ 1,366
Disbursements 14,046
Amounts repaid (12,749)
-----------
Balance, December 31, 2001 $ 2,663
===========
Undisbursed commitments to related parties,
December 31, 2001 $ 647
===========
16. COMPREHENSIVE INCOME
Comprehensive income is a more inclusive financial reporting methodology
that includes disclosure of other comprehensive income (loss) that
historically has not been recognized in the calculation of net income.
Unrealized gains and losses on the Company's available-for-sale investment
securities are included in other comprehensive income (loss). Total
comprehensive income and the components of accumulated other comprehensive
income (loss) are presented in the Consolidated Statement of Changes in
Shareholders' Equity.
83
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
16. COMPREHENSIVE INCOME (Continued)
The Company held securities classified as available-for-sale which had
unrealized gains or losses as follows (dollars in thousands):
Tax
Before (Expense) After
Tax Benefit Tax
--------- ----------- ----------
For the Year Ended December 31, 2001
- ------------------------------------
Other comprehensive income:
Unrealized holding gains $ 1,326 $ (525) $ 801
Less: reclassification adjustment for net
gains included in net income 1,108 (445) 663
--------- ----------- ----------
Total other comprehensive income $ 218 $ (80) $138
========= =========== ==========
For the Year Ended December 31, 2000
- ------------------------------------
Other comprehensive income:
Unrealized holding gains $ 1,346 $ (555) $ 791
Less: reclassification adjustment for net
gains included in net income 119 (49) 70
--------- ----------- ----------
Total other comprehensive income $ 1,227 $ (506) $ 721
========= =========== ==========
For the Year Ended December 31, 1999
- ------------------------------------
Other comprehensive loss:
Unrealized holding losses $ (3,062) $ 1,162 $ (1,900)
Less: reclassification adjustment for net
gains included in net income 6 (2) 4
--------- ----------- ----------
Total other comprehensive loss $ (3,068) $ 1,164 $ (1,904)
========= =========== ==========
17. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Disclosures include estimated fair values for financial instruments for
which it is practicable to estimate fair value. These estimates are made
at a specific point in time based on relevant market data and information
about the financial instruments. These estimates do not reflect any
premium or discount that could result from offering the Company's entire
holdings of a particular financial instrument for sale at one time, nor do
they attempt to estimate the value of anticipated future business related
to the instruments. In addition, the tax ramifications related to the
realization of unrealized gains and losses can have a significant effect
on fair value estimates and have not been considered in any of these
estimates.
Because no market exists for a significant portion of the Company's
financial instruments, fair value estimates are based on judgments
regarding current economic conditions, risk characteristics of various
financial instruments and other factors. These estimates are subjective in
nature and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions
could significantly affect the fair values presented.
84
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
17. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
The following methods and assumptions were used by the Company to
estimate the fair value of its financial instruments at December 31, 2001
and 2000:
Cash and cash equivalents, Federal funds sold and short-term borrowings:
-----------------------------------------------------------------------
For cash and cash equivalents, Federal funds sold and short-term
borrowings, the carrying amount is estimated to be fair value.
Interest-bearing deposits in banks: The fair values of interest-bearing
----------------------------------
deposits in banks are estimated by discounting their future cash flow
using rates at each reporting date for instruments with similar remaining
maturities offered by comparable financial institutions.
Investment securities: For investment securities, fair values are based on
---------------------
quoted market prices, where available. If quoted market prices are not
available, fair values are estimated using quoted market prices for
similar securities and indications of value provided by brokers.
Loans and loans held for sale: For variable-rate loans that reprice
-----------------------------
frequently with no significant change in credit risk, fair values are
based on carrying values. Fair values of loans held for sale are
estimated using quoted market prices for similar loans. Fair values for
other loans are estimated using discounted cash flow analyses, using
interest rates being offered at each reporting date for loans with
similar terms to borrowers of comparable creditworthiness. The carrying
amount of accrued interest receivable approximates its fair value.
Life insurance policies: The fair values of life insurance policies are
-----------------------
based on current cash surrender values at each reporting date provided by
the insurers.
Other Investments: Included in other assets are other long-term
-----------------
investments carried at cost, which approximates estimated fair value
Deposits: The fair values for demand deposits are, by definition, equal to
--------
the amount payable on demand at the reporting date represented by their
carrying amount. Fair values for fixed-rate certificates of deposit are
estimated using a discounted cash flow analysis using interest rates
being offered at each reporting date by the Bank for certificates with
similar remaining maturities. The carrying amount of accrued interest
payable approximates its fair value.
Mandatorily Redeemable Cumulative Trust Preferred Securities of Subsidiary
--------------------------------------------------------------------------
Grantor Trust: The fair value of mandatorily redeemable cumulative trust
-------------
preferred securities of subsidiary grantor trust was determined based on
the current market value for like kind instruments of a similar maturity
and structure.
Commitments to extend credit and letters of credit: Commitments to extend
--------------------------------------------------
credit are primarily for adjustable rate loans. For these commitments,
there are no differences between the committed amounts and their fair
values. Commitments to fund fixed rate loans and letters of credit are at
rates which approximate fair value at each reporting date.
85
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
17. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
December 31, 2001 December 31, 2000
---------------------------- -----------------------------
(Dollars in thousands)
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ -------------- ---------------- -----------
Financial assets:
Cash and due from banks $ 39,835 $ 39,835 $ 43,433 $ 43,433
Federal funds sold 246 246
Interest-bearing deposits
in banks 190 190 1,231 1,231
Investment securities 92,689 92,689 110,752 110,752
Loans 479,345 499,870 414,264 420,919
Loans held for sale 1,048 1,048 2,128 2,128
Cash surrender value of life
insurance policies 1,392 1,392 1,238 1,238
Other investments 5,910 5,910 1,764 1,764
Accrued interest receivable 3,766 3,766 4,902 4,902
Financial liabilities:
Deposits $ 521,317 $ 509,163 $ 527,776 $ 504,663
Short-term borrowings 60,783 60,783 34,284 34,284
Accrued interest payable 442 442 1,087 1,087
Mandatorily redeemable
cumulative trust preferred
securities 15,000 15,000
Off-balance-sheet financial
instruments:
Commitments to extend credit $ 105,736 $ 105,736 $ 90,787 $ 90,787
Standby letters of credit 4,413 4,413 7,927 7,927
Credit card commitments 42,522 42,522 39,280 39,280
86
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
18. PARENT ONLY CONDENSED FINANCIAL STATEMENTS
The Company commenced operations on August 10, 2001. As a result,
comparative financial information is not available. The information
below is presented as of December 31, 2001 and for the year then ended
as if the reorganization had taken place on January 1, 2001.
BALANCE SHEET
December 31, 2001
(Dollars in Thousands)
ASSETS
Cash and due from banks $ 3,957
Investment in bank subsidiary 55,965
Investment in Sierra Capital Trust I 464
Investment in other securities 1,000
Other assets 454
-----------
$ 61,840
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Short-term borrowings $ 150
Other liabilities 85
-----------
Total liabilities 235
-----------
Junior subordinated debentures due to
subsidiary grantor trust 15,464
Shareholders' equity:
Common stock 2,285
Retained earnings 42,651
Accumulated other comprehensive income 1,205
-----------
Total shareholders' equity 46,141
-----------
$ 61,840
===========
87
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
18. PARENT ONLY CONDENSED FINANCIAL STATEMENTS (Continued)
STATEMENT OF INCOME
For the Year Ended December 31, 2001
(Dollars in thousands)
Income:
Dividends declared by bank subsidiary $ 868
-----------
Expenses:
Interest on junior subordinated debentures due to
subsidiary grantor trust 84
Other expenses 240
-----------
Total expenses 324
-----------
Income before equity in undistributed
income of subsidiary 544
Equity in undistributed income of subsidiary 6,334
-----------
Net income $ 6,878
===========
88
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
18. PARENT ONLY CONDENSED FINANCIAL STATEMENTS (Continued)
STATEMENT OF CASH FLOWS
For the Year Ended December 31, 2001
(Dollars in thousands)
Cash flows from operating activities:
Net income $ 6,878
Adjustments to reconcile net income to net cash
provided by operating activities:
Undistributed net income of subsidiary (6,334)
Increase in other assets (454)
Increase in other liabilities 85
--------
Net cash provided by operating activities 175
Cash flows from investing activities:
Investment in bank subsidiary (10,000)
Investment in Sierra Capital Trust I (464)
Investment in other securities (1,000)
--------
Net cash used in investing activities (11,464)
--------
Cash flows from financing activities:
Proceeds from short-term borrowings 150
Proceeds from the issuance of junior subordinated debentures
due to subsidiary grantor trust 15,464
Dividends paid (368)
--------
Net cash provided by financing activities 15,246
--------
Cash and cash equivalents at end of year $ 3,957
========
Non-cash investing activities:
Issuance of common stock in exchange for the common
stock of the Bank $ 40,782
Net change in unrealized gain on investment securities
available-for-sale $ 218
89
SIERRA BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
19. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth the Company's results of operations for
the four quarters of 2001 and 2000 and is unaudited. In management's
opinion, the results of operations reflect all adjustments (which
include only recurring adjustments) necessary to present fairly the
condensed results for such periods.
2001 Quarter Ended
-------------------------------------------------------------
December 31, September 30, June 30, March 31,
------------- -------------- ----------- ----------
Interest income $ 10,384 $ 10,520 $ 10,980 $ 11,454
Interest expense 2,683 3,623 4,513 5,073
------------- -------------- ----------- ----------
Net interest income 7,701 6,897 6,467 6,381
Provision for loan losses 600 100 200 400
Non-interest income 2,213 2,514 2,813 2,123
Non-interest expense 6,205 6,147 6,588 6,369
------------- -------------- ----------- ----------
Net income before
taxes 3,109 3,164 2,492 1,735
Provision for taxes 945 1,155 897 625
------------- -------------- ----------- ----------
Net income $ 2,164 $ 2,009 $ 1,595 $ 1,110
============= ============== =========== ==========
Diluted earnings per
share $ .24 $ .22 $ .17 $ .12
Cash dividend per
share $ .04 $ .04 $ .06 $ .04
2001 Quarter Ended
-------------------------------------------------------------
December 31, September 30, June 30, March 31,
------------- -------------- ----------- ----------
Interest income $ 12,545 $ 12,703 $ 10,939 $ 9,341
Interest expense 5,357 5,189 4,431 3,700
------------- -------------- ----------- ----------
Net interest income 7,188 7,514 6,508 5,641
Provision for loan losses 690 690 690 690
Non-interest income 1,861 1,721 1,530 1,324
Non-interest expense 6,077 6,391 5,387 4,449
------------- -------------- ----------- ----------
Net income before
taxes 2,282 2,154 1,961 1,826
Provision for taxes 669 713 704 656
------------- -------------- ----------- ----------
Net income $ 1,613 $ 1,441 $ 1,257 $ 1,170
============= ============== =========== ==========
Diluted earnings per
share $ .18 $ .16 $ .14 $ .13
Cash dividend per
share $ .06 $ .06 $ .06 $ .05
90
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned thereunto duly authorized.
Dated: March 22, 2002 BANK OF THE SIERRA,
a California corporation
By: /s/ James C. Holly
--------------------------------------------------
James C. Holly
President
and Chief Executive Officer
By: /s/ Kenneth R. Taylor
--------------------------------------------------
Kenneth R. Taylor
Senior Vice President
and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Albert L. Berra Director March 22, 2002
- -----------------------------------------
Albert L. Berra
/s/ Gregory A. Childress Director March 22, 2002
- -----------------------------------------
Gregory A. Childress
/s/ Robert L. Fields Director March 22, 2002
- -----------------------------------------
Robert L. Fields
/s/ Vincent L. Jurkovich Director March 22, 2002
- -----------------------------------------
Vincent L. Jurkovich
/s/ Howard H. Smith Director March 22, 2002
- -----------------------------------------
Howard H. Smith
/s/ Morris A. Tharp Chairman of the Board March 22, 2002
- -----------------------------------------
Morris A. Tharp
/s/ Robert H. Tienken Director and March 22, 2002
- ----------------------------------------- Corporate Secretary
Robert H. Tienken
/s/ Gordon T. Woods Director March 22, 2002
- -----------------------------------------
Gordon T. Woods
/s/ Kenneth R. Taylor Senior Vice President March 22, 2002
- ----------------------------------------- & Chief Financial Officer
Kenneth R. Taylor
91
INDEX TO EXHIBITS
-----------------
- -------------------------------------------------------------------------------
Exhibit No. Description
- ----------- -----------
- -------------------------------------------------------------------------------
2 Plan of Reorganization and Agreement of
Merger dated December 14, 2000 by and
among Bank of the Sierra, Sierra
Bancorp and Sierra Merger Corporation
(effective August 10, 2001) (1)
- -------------------------------------------------------------------------------
3.1 Articles of Incorporation of Sierra
Bancorp (1)
- -------------------------------------------------------------------------------
3.2 Amendment to Articles of Incorporation
of Sierra Bancorp (1)
- -------------------------------------------------------------------------------
3.3 By-laws of Sierra Bancorp (1)
- -------------------------------------------------------------------------------
10.1 1998 Stock Option Plan (1)
- -------------------------------------------------------------------------------
10.2 Indenture dated as of November 28, 2001
between Wilmington Trust Company, as
Trustee, and Sierra Bancorp, as Issuer
(2)
- -------------------------------------------------------------------------------
10.3 Amended and Restated Declaration of
Trust of Sierra Capital Trust I, dated
as of November 28, 2001(2)
- -------------------------------------------------------------------------------
10.4 Guarantee Agreement between Sierra
Bancorp and Wilmington Trust Company
dated as of November 28, 2001(2)
- -------------------------------------------------------------------------------
11 Statement of Computation of Per Share
Earnings(3)
- -------------------------------------------------------------------------------
21 Subsidiaries of Sierra Bancorp (2)
- -------------------------------------------------------------------------------
23.1 Consent of McGladrey & Pullen, LLP (2)
- -------------------------------------------------------------------------------
23.2 Consent of Perry Smith, LLP (2)
- -------------------------------------------------------------------------------
- ------------------
(1) Filed as an Exhibit to the Registration Statement of Sierra Bancorp on
Form S-4 filed with the Securities and Exchange Commission (Registration No.
333-53178) on January 4, 2001 and incorporated herein by reference.
(2) Filed herewith.
(3) Computation of earnings per share is incorporated herein by reference
to Note 12 of the Financial Statements.
92