SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

ý   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended   June 30, 2003

 

o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File No. 0-31525

 

COMMUNITY VALLEY BANCORP

(Exact name of registrant as specified in its charter)

 

 

(530) 899-2344

(Registrant’s telephone number,
including area code)

 

not applicable

(Former name, former address and former fiscal year, if changed
since last report.)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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  ý     No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12-b-2)

 

Yes  o     No  ý

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

No par value Common Stock – 2,706,864 shares outstanding at July 31, 2003.

 

 

PART 1-FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

 

COMMUNITY VALLEY BANCORP

CONSOLIDATED BALANCE SHEET (Unaudited)

 

(In thousands)		June 30, 2003			December 31, 2002
ASSETS
Cash and due from banks		$	18,565		$	15,621
Federal funds sold		74,300			57,410
Interest-bearing deposits in banks		6,638			4,061
Investment securities (market value of $2,461 at June 30, 2003 and $3,438 at December 31, 2002)		2,410			3,387
Loans held for sale		4,611			7,912
Loans, less allowance for loan losses of $3,277 at June 30, 2003 and $3,007 at December 31, 2002		241,716			229,699
Bank premises and equipment, net		6,860			6,653
Accrued interest receivable and other assets		13,982			12,492
		$	369,082		$	337,235
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Non-interest bearing		$	68,951		$	62,889
Interest bearing		260,062			235,092
Total deposits		329,013			297,981
Employee stock ownership plan note payable		742			732
Mandatorily redeemable cumulative trust preferred securities of subsidiary grantor trust		8,000			8,000
Accrued interest payable and other liabilities		4,125			5,141
Total liabilities		341,880			311,854
Commitments and contingencies
Shareholders’ equity:
Common stock – no par value; 20,000,000 shares authorized; issued and outstanding – 2,692,278 shares at June 30, 2003 and 2,700,339 shares at December 31, 2002		6,935			6,660
Unearned ESOP shares (65,458 shares at June 30, 2003 and 65,437 shares at December 31, 2002, at cost)		(906		)	(852		)
Retained earnings		21,173			19,559
Accumulated other comprehensive income (Note 3)		0			14
Total shareholders’ equity		27,202			25,381
		$	369,082		$	337,235

 

See Notes to Unaudited Consolidated Financial Statements

 

2

 

COMMUNITY VALLEY BANCORP

CONSOLIDATED STATEMENT OF INCOME

(Unaudited)

 

		For the periods ended June 30,
		Three months						Six Months
(In thousands, except per share data)		2003			2002			2003			2002
Interest income:
Interest and fees on loans		$	4,871		$	4,170		$	9,645		$	8,394
Interest on Federal funds sold		199			148			381			288
Interest on deposits in banks		49			14			90			24
Interest and dividends on investment securities:
Taxable		26			20			62			36
Exempt from Federal income taxes		19			26			38			54
Dividends					1
Total interest income		5,164			4,379			10,216			8,796
Interest expense:
Interest on deposits		1,019			1,157			2,032			2,487
Interest on long-term debt		112			10			250			20
Total interest expense		1,131			1,167			2,282			2,507
Net interest income		4,033			3,212			7,934			6,289
Provision for loan losses		120			150			270			253
Net interest income after provision for loan losses		3,913			3,062			7,664			6,036
Non-interest income		1,383			1,256			2,566			3,315
Non-interest expense:
Salaries and employee benefits		1,945			1,362			3,886			2,823
Occupancy		204			169			376			306
Furniture and equipment		233			238			473			411
Other expense		950			954			1,816			2,947
Total non-interest expense		3,332			2,723			6,551			6,487
Income before income taxes		1,964			1,634			3,679			2,864
Income taxes		848			662			1,526			639
Net income		$	1,116		$	972		$	2,153		$	2,225
Basic earnings per share (Note 2)		$	.42		$	.38		$	.81		$	.87
Diluted earnings per share (Note 2)		$	.40		$	.36		$	.78		$	.82
Cash dividends per share of issued and outstanding common stock		$	.10		$	.075		$	.10		$	.075

 

See Notes to Unaudited Consolidated Financial Statements

 

3

 

COMMUNITY VALLEY BANCORP

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(In thousands except number of shares)

 

		Common Stock					Unearned ESOP Shares			Retained Earnings			Accumulated Other Comprehensive Income			Total Shareholders’ Equity			Comprehensive Income
		Shares		Amount
Balance, January 1, 2002		2,648,389		$	6,131		$	(902	)	$	15,592					$	20,821
Comprehensive income (Note 3):
Net income										4,849						4,849			$	4,849
Other comprehensive gain except unrealized gain													$	14		14			14
Total comprehensive income																			$	4,863
Exercise of stock options and related tax benefit		36,962		426												426
Earned ESOP shares				108			50									158
Cash dividends- $.33 per share										(882		)				(882		)
Cash in lieu of fractional shares in four-for-three stock split				(5		)										(5		)
Balance, December 31, 2002		2,685,351		6,660			(852		)	19,559			14			25,381
Comprehensive income (Note 3):
Net income										2,153						2,153			$	2,153
Other comprehensive loss, net of tax:
Unrealized loss on available-for-sale investment securities													(14		)				(14		)
Total comprehensive income																			$	2,139
Exercise of stock options and related tax benefit		14,988		216												216
Earned ESOP shares				59			24									83
Shares acquired by ESOP							(78		)							(78		)
Cash dividends declared										(539		)				(539		)
Balance, June 30, 2003		2,700,339		$	6,935		$	(906	)	$	21,173		$	0		$	27,202

 

See Notes to Unaudited Consolidated Financial Statements

 

4

 

COMMUNITY VALLEY BANCORP

CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)

 

(In thousands)
For the six months ended June 30,		2003			2002
Cash flows from operating activities:
Net income		$	2,153		$	2,225
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		270			253
Deferred loan origination costs, net		(50		)	(62		)
Depreciation and amortization		497			311
Net decrease in loans held for sale		3,301			2,208
(Increase) decrease in cash surrender value of life insurance		(1,705		)	102
Compensation expense on cashless exchange of stock options					79
Loss on sale of other real estate					13
Deferred Taxes					977
Non-cash compensation expense associated with the ESOP		83
Decrease (increase) in accrued interest receivable and other assets		367			(1,707		)
Decrease in accrued interest payable and other liabilities		(1,017		)	(523		)
Gain on disposition of Bank premises and equipment		(1		)	(160		)
Net cash provided by operating activities		3,898			3,716
Cash flows from investing activities:
Increase in interest-bearing deposits in banks		(2,577		)	(792		)
Proceeds from called held-to-maturity investment securities		2,200			250
Purchase of held-to-maturity investment securities		(1,311		)	(562		)
Purchases of bank premises and equipment		(748		)	(1,184		)
Proceeds from sale of bank premises and equipment		32
Net increase in loans		(12,237		)	(16,039		)
Net cash (used in) provided by investing activities		(14,641		)	(18,327		)
Cash flows from financing activities:
Net increase in demand, interest-bearing and savings deposits		$	27,720		$	25,216
Net (increase) decrease in time deposits		3,312			(17,103		)
Proceeds from repayment of ESOP loan, net		10			(59		)
Payment of cash dividends		(538		)	(398		)
Exercise of stock options		151			86
Purchase of unearned ESOP shares		(78		)
Net cash provided by financing activities		30,577			7,742
Increase (decrease) in cash and cash equivalents		19,834			(6,869		)
Cash and cash equivalents at beginning of year		73,031			49,672
Cash and cash equivalents at end of period		$	92,865		$	42,803

 

See Notes to Unaudited Consolidated Financial Statements

 

5

 

Community Valley Bancorp and Subsidiaries

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1.   BASIS OF PRESENTATION

 

In May 2002, shareholders of Butte Community Bank (the “Bank”) approved a plan of reorganization and merger whereby the Bank became a wholly owned subsidiary of a newly formed bank holding company, Community Valley Bancorp.  Management expects that the holding company structure will facilitate growth within the banking field and in areas related to banking, either by the creation of new subsidiaries or the acquisition of existing companies and banks.

 

The accompanying unaudited consolidated financial statements of Community Valley Bancorp and subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  In the opinion of management, all adjustments (which consist solely of normal recurring accruals) considered necessary for a fair presentation of the results for the interim periods presented have been included.  These interim consolidated financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s 2002 Annual Report to Shareholders on Form 10-K.

 

In December 2002, the Company issued to CVB Trust I subordinated deferrable interest debentures due December 31, 2032.  Simultaneously, CVB Trust I issued 8,000 floating rate capital securities, with liquidation values of $1,000 per security, for gross proceeds of $8,000,000.  The subordinated debentures represent the sole assets of CVB Trust I.  The subordinated debentures are redeemable by the Company, subject to the receipt by the Company of prior approval from the Federal Reserve Bank (FRB), if then required under applicable capital guidelines or policies of the FRB.  The Company may redeem the subordinated debentures on any December 31st on or after December 31, 2007.  The redemption price shall be par plus accrued and unpaid interest, except in the case of redemption under a special event which is defined in the debenture.  The floating rate capital securities are subject to mandatory redemption to the extent of any early redemption of the subordinated debentures and upon maturity of the subordinated debentures on December 31, 2032.

 

Holders of the securities are entitled to cumulative cash distributions on the liquidation amount of $1,000 per security.  Interest rates on the capital securities and debentures are computed on a 360-day basis.  The stated interest rate is the three-month London Interbank Offered Rate (LIBOR) plus 3.3%, with a maximum rate of 12.5% annually, adjustable quarterly.

 

The consolidated financial statements include the accounts of the Company and its wholly owned bank subsidiary, Butte Community Bank, and CVB Trust I. All significant inter-company balances and transactions have been eliminated in consolidation.  The results of operations for the three and six month periods ended June 30, 2003 may not necessarily be indicative of the operating results for the full year 2003.

 

2.  EARNINGS PER SHARE COMPUTATION

 

Basic earnings per share are computed by dividing net income by the weighted average common shares outstanding for the period (2,628,336 and 2,626,803 shares for the three and six month periods ended June 30, 2003 and 2,588,869 and 2,584,083 shares for the three and six month periods ended June 30, 2002).  Diluted earnings per share reflect the potential dilution that could occur if outstanding stock options were exercised using the treasury stock method.   Diluted earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period plus the dilutive effect of options (146,415 and 139,796 shares for the three and six month periods ended June 30, 2003 and 139,957 and 135,688 shares for the three and six

 

6

 

month periods ended June 30, 2002).  Earnings per share are retroactively adjusted for stock splits and dividends for all periods presented.

 

3. COMPREHENSIVE INCOME

 

Comprehensive income is reported in addition to net income for all periods presented.  Comprehensive income is made up of net income plus other comprehensive income or loss.  Other comprehensive income or loss, net of taxes, is comprised of changes in unrealized gains or losses, net of taxes, on available-for-sale securities, adjusted for the effect of realized gains or losses on available-for-sale securities, net of taxes.

 

4.  STOCK –BASED COMPENSATION

 

The Company issues stock options under three stock-based compensation plans, the Community Valley Bancorp 1991, 1997 and 2000 Stock Option Plans.  The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations.  No stock-based compensation cost is reflected in net income, as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant.  In accordance with Financial Accounting Standards Board (“FASB”) No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of FASB No. 12, the following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

 

Pro forma adjustments to the Company’s consolidated net earnings and earnings per share are disclosed during the periods in which the options become vested.

 

		Three Months Ended
		June 30, 2003			June 30, 2002
Net earnings as reported		$	1,116,709		$	972,415
Deduct:  Total stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects		(64,512		)	(68,467		)
Pro forma net income		$	1,052,197		$	903,948
Basic earnings per share - as reported		$	0.42		$	0.38
Basic earnings per share - pro forma		$	0.40		$	0.35
Diluted earnings per share - as reported		$	0.40		$	0.36
Diluted earnings per share - pro forma		$	0.38		$	0.34

 

7

 

		Six Months Ended
		June 30, 2003			June 30, 2002
Net earnings as reported		$	2,153,484		$	2,225,549
Deduct:  Total stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects		(129,024		)	(136,934		)
Pro forma net income		$	2,024,461		$	2,088,615
Basic earnings per share - as reported		$	0.82		$	0.86
Basic earnings per share - pro forma		$	0.77		$	0.81
Diluted earnings per share - as reported		$	0.78		$	0.82
Diluted earnings per share - pro forma		$	0.74		$	0.78

 

5.  ACCOUNTING PRONOUNCEMENTS

 

In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123.  This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002.  The interim disclosure provisions are effective for financial reporting containing financial statements for interim periods beginning after December 15, 2002.  Because the Company accounts for the compensation cost associated with its stock option plan under the intrinsic value method, the alternative methods of transition will not apply to the Company.  In management’s opinion, the adoption of this Statement did not have a material impact on the Company’s consolidated financial position or results of operations.

 

On April 30, 2003, the Financial Accounting Standards Board issued Statement No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”  This Statement amends and clarifies the accounting for derivative instruments by providing guidance related to circumstances under which a contract with a net investment meets the characteristics of a derivative as discussed in Statement 133.  The Statement also clarifies when a derivative contains a financing component.   The Statement is intended to result in more consistent reporting for derivative contracts and must be applied prospectively for contracts entered into or modified after June 30, 2003, except for hedging relationships designated after June 30, 2003.   In management’s opinion, adoption of this Statement is not expected to have a material effect on the Company’s consolidated financial position or results of operations.

 

8

 

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.  This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances).  Some of the provisions of this Statement are consistent with the current definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements.  The remaining provisions of this Statement incorporate the FASB’s intention to revise the definition to encompass certain obligations that a reporting entity can or must settle by issuing its own equity shares, depending on the nature of the relationship established between the holder and the issuer. This Statement concludes the first phase of the FASB’s redeliberations of the Exposure Draft, Accounting for Financial Instruments with Characteristics of Liabilities, Equity, or Both.   This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities.  In management’s opinion, adoption of this statement did not have a material effect on the Company’s consolidated financial position or results of operations.

 

9

 

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF COMMUNITY VALLEY BANCORP

 

The following is Community Valley Bancorp’s (the “Company”) management’s discussion and analysis of the significant changes in balance sheet accounts for June 30, 2003 and December 31, 2002 and income and expense accounts for the three and six month periods ended June 30, 2003 and 2002. The discussion is designed to provide a better understanding of significant trends related to the Company’s financial condition, results of operations, liquidity, capital resources and interest rate sensitivity.

 

In addition to the historical information contained herein, this report on Form 10-Q contains certain forward-looking statements.  The reader of this report should understand that all such forward-looking statements are subject to various uncertainties and risks that could affect their outcome.   The Company’s actual results could differ materially from those suggested by such forward-looking statements.  Factors that could cause or contribute to such differences include, but are not limited to, variances in the actual versus projected growth in assets, return on assets, loan losses, expenses, rates charged on loans and earned on securities investments, rates paid on deposits, competition effects, fee and other noninterest income earned, general economic conditions, nationally, regionally and in the operating market areas of the Company and its subsidiaries, changes in the regulatory environment, changes in business conditions and inflation, changes in securities markets, data processing problems, a decline in real estate values in the Company’s market area,  the effects of terrorism, including the events of September 11, 2001 and thereafter, and the conduct of the war on terrorism by the United States and its allies, as well as other factors. This entire report should be read putting such forward-looking statements in context.

 

General Development of Business

 

The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was incorporated under the laws of the State of California in 2002.  As a bank holding company, the Company is authorized to engage in the activities permitted under the Bank Holding Company Act of 1956, as amended, and regulations thereunder.  Its principal office is located at 2041 Forest Avenue, Chico, California 95928 and its telephone number is (530) 899-2344.

 

The Company owns 100% of the issued and outstanding common shares of Butte Community Bank and CVB Trust I.  Butte Community Bank was incorporated and commenced business in Paradise and Oroville, California in 1990.  Butte Community Bank operates seven full service offices within its primary service areas of Butte and Sutter Counties.  The Bank also maintains a Loan Production Office in Roseville. Butte Community Bank’s primary business is serving the commercial banking needs of small to mid-sized businesses and consumers within those counties.  Butte Community Bank accepts checking and savings deposits, offers money market deposit accounts and certificates of deposit, makes secured and unsecured commercial, secured real estate, and other installment and term loans and offers other customary banking services.

 

Overview

 

The Company recorded net income of $1,116,000 for the quarter ended June 30, 2003, which was a 15% increase from the $972,000 reported for the same period of 2002.  Diluted earnings per share for the second quarter of 2003 were $0.40, compared to the $0.36 recorded in the second quarter of 2002.  The annualized return on average equity (ROAE) and the return on average assets (ROA) for the second quarter of 2003 were 16.62% and 1.25%, respectively, as compared to 17.19% and 1.41%, respectively, for the same period in 2002.

 

10

 

Net income for the six months ended June 30, 2003 was $2,153,000 (down 3.2%) compared to the $2,225,000 recorded in the first six months of 2002. The primary reason for the decline in net income is the net increase in tax expense of $887,000.  The Company realized a net credit of $23,000 for the first quarter of 2002 due to the tax-free proceeds from key man insurance policies the Bank received in March of 2002 as a result of the death of the Company’s Chief Operating Officer.

 

Total assets of the Company increased by $31,874,000 or (9.4%) from December 31, 2002 to $369,082,000 at June 30, 2003.  Net loans totaled $241,716,000, up $12,017,000 (5.2%) from the ending balances on December 31, 2002.  Deposit balances at June 30, 2003 totaled $329,013,000, up $31,032,000 (10.4%) from December 31, 2002.

 

Table One below provides a summary of the components of net income for the periods indicated:

 

Table One:  Components of Net Income

 

		Three months ended June 30,						Six months ended June 30,
(In thousands, except percentages)		2003			2002			2003			2002
Net interest income		$	4,033		$	3,212		$	7,934		$	6,289
Provision for loan losses		(120		)	(150		)	(270		)	(253		)
Non-interest income		1,383			1,295			2,566			3,315
Non-interest expense		(3,332		)	(2,723		)	(6,551		)	(6,487		)
(Provision for) benefit from income taxes		(848		)	(662		)	(1,526		)	(639		)
Net income		$	1,116		$	972		$	2,153		$	2,225
Average total assets (In millions)		$	360.9		$	275.6		$	346.3		$	271.4
Net income (annualized) as a percentage of average total assets		1.25		%	1.41		%	1.24		%	1.64		%

 

Results of Operations

 

Net Interest Income and Net Interest Margin

 

Net interest income represents the excess of interest and fees earned on interest earning assets (loans, securities, federal funds sold and investments in time deposits) over the interest paid on deposits and borrowed funds.  Net interest margin is net interest income expressed as a percentage of average earning assets.

 

The Company’s net interest margin was 5.01% for the three months ended June 30, 2003 and 5.08% for the six months ended June 30, 2003.  Net interest income increased $820,000 (25.6%) for the second quarter of 2003 compared to the same period in 2002.  Net interest income increased $1,645,000 (26.2%) for the six months ended June 30, 2003 over the same period in 2002.   The primary reason for this increase was the loan growth and the resulting interest income and fees associated with that growth together with the decrease in the interest rates paid on deposits.

 

11

 

Interest expense was $36,000 (3.1%) lower in the second quarter of 2003 versus the prior year period. The average balances of interest bearing liabilities were $59,466,000 (20.6%) higher in the second quarter of 2003 versus the same quarter in 2002. Even though the interest bearing balances increased, rates paid on these liabilities decreased 57 basis points on a quarter over quarter basis.     Interest expense was $225,000 (9.6%) lower in the six month period ended June 30, 2003 versus the prior year period.  The average balances of interest bearing liabilities were $54,433,000 (26.8%) higher in the six-month period ended June 30, 2003 versus the same period in 2002.  Rates paid on interest bearing liabilities decreased 70 basis points on a year over year basis.  The reason for this decrease was the ability of management to change the mix of the deposits away from higher interest rate certificates of deposit to lower rate demand deposits and to lower the average cost of certificates of deposit as higher cost deposits were re-priced in a lower rate environment.

 

Table Two, Analysis of Net Interest Margin on Earning Assets, and Table Three, Analysis of Volume and Rate Changes on Net Interest Income and Expenses, are provided to enable the reader to understand the components and past trends of the Company’s interest income and expense.  Table Two provides an analysis of net interest margin on earning assets setting forth average assets, liabilities and shareholders’ equity; interest income earned and interest expense paid and average rates earned and paid; and the net interest margin on earning assets.

 

Table Two:  Analysis of Net Interest Margin on Earning Assets (Unaudited)

 

Three Months Ended June 30,		2003								2002
(In thousands, except percentages)		Avg Balance			Interest			Avg Yield (4)		Avg Balance			Interest			Avg Yield (4)
Assets:
Earning assets
Loans (1)		$	246,939		$	4,871		7.91	%	$	207,092		$	4,170		8.08	%
Taxable investment securities		1,812			26			5.76	%	1,232			20			6.51	%
Tax-exempt investment securities (2)		975			19			7.82	%	2,083			27			5.20	%
Federal funds sold		67,480			199			1.18	%	34,760			148			1.71	%
Investments in time deposits		5,884			49			3.34	%	948			14			5.93	%
Total earning assets		323,090			5,164			6.41	%	246,115			4,379			7.14	%
Cash & due from banks		14,681								12,807
Other assets		23,112								16,729
		$	360,884							$	275,651
Liabilities & Shareholders’ Equity
Interest bearing liabilities:
NOW & MMDA		$	145,708		370			1.03	%	$	95,691		296			1.24	%
Savings		21,678			26			.49	%	19,533			50			1.03	%
Time deposits		87,836			623			2.88	%	88,485			811			3.68	%
Other borrowings		8,756			112			5.19	%	803			10			4.99	%
Total interest bearing liabilities		263,978			1,131			1.72	%	204,512			1,167			2.29	%
Demand deposits		61,715								44,232
Other liabilities		8,265								4,228
Total liabilities		333,958								252,972
Shareholders’ equity		26,926								22,679
		$	360,884							$	275,651
Net interest income & margin (3)					$	4,033		5.01	%				$	3,212		5.23	%

 

(1)   Loan interest includes loan fees of $437,000 and $527,000 during the three months ended June 30, 2003 and June 30, 2002, respectively.

(2)   Does not include taxable-equivalent adjustments that primarily relate to income on certain securities that are exempt from federal income taxes.

 

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(3)   Net interest margin is computed by dividing net interest income by total average earning assets.

(4)   Average yield is calculated based on actual days in quarter (91 for June 30, 2003 and June 30, 2002) and annualized to actual days in year (365 for 2003 and 2002).

 

 

Six Months Ended June 30,		2003								2002
(In thousands, except percentages)		Avg Balance			Interest			Avg Yield (4)		Avg Balance			Interest			Avg Yield (4)
Assets:
Earning assets
Loans (1)		$	243,065		$	9,645		8.00	%	$	205,283		$	8,328		8.18	%
Taxable investment securities		2,041			61			6.03	%	1,137			34			6.03	%
Tax-exempt investment securities (2)		1,027			38			7.46	%	2,085			52			5.03	%
Federal funds sold		63,689			381			1.21	%	33,704			288			1.72	%
Investments in time deposits		5,284			90			3.43	%	795			24			6.09	%
Total earning assets		315,106			10,215			6.54	%	243,004			8,726			7.24	%
Cash & due from banks		14,297								12,368
Other assets		22,169								15,918
		$	351,572							$	271,290
Liabilities & Shareholders’ Equity
Interest bearing liabilities:
NOW & MMDA		$	141,325		728			1.04	%	$	90,237		551			1.23	%
Savings		21,108			63			.60	%	18,448			90			.98	%
Time deposits		86,177			1,242			2.91	%	93,462			1,846			3.98	%
Other borrowings		8,745			250			5.76	%	775			20			5.20	%
Total interest bearing liabilities		257,355			2,283			1.79	%	202,922			2,507			2.49	%
Demand deposits		62,163								43,011
Other liabilities		5,561								3,271
Total liabilities		325,079								249,204
Shareholders’ equity		26,493								22,086
		$	351,572							$	271,290
Net interest income & margin (3)					$	7,932		5.08	%				$	6,912		5.16	%

 

(1)          Loan interest includes loan fees of $917,000 and $878,000 during the six months ended June 30, 2003 and June 30, 2002, respectively.

(2)          Does not include taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes.

(3)          Net interest margin is computed by dividing net interest income by total average earning assets.

(4)          Average yield is calculated based on actual days in period (181 for June 30, 2003 and June 30, 2002) and annualized to actual days in year (365 for 2003 and 2002).

 

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Table Three sets forth a summary of the changes in interest income and interest expense from changes in average asset and liability balances (volume) and changes in average interest rates.  On a quarter over quarter basis for the period ending June 30, 2003 net interest income has increased $821,000 over the same time period in 2002.  Interest income from earning assets has increased by $785,000. Changes in the volume of earning assets, primarily loans, have resulted in an increase in interest income of $1,009,000 while interest income from changes in rates has decreased by $224,000.  Interest expense for the second quarter of 2003 was $36,000 less than the same time period in 2002.  Changes in the volume of interest bearing liabilities, primarily the increase in balances of demand deposits, as well as the addition of interest expense related to the trust preferred securities, have resulted in a net increase of interest expense of $253,000.  Decreases in average rates paid, primarily on certificates of deposit and demand deposits have resulted in an interest expense reduction of $289,000.   On a year-to-date basis through June 30, 2003, net interest income has increased $1,713,000 over the same time period in 2002.  Interest income from earning assets has increased by $1,489,000.  Changes in the volume of earning assets, primarily loans, have resulted in an increase in interest income of $1,926,000 while interest income from changes in rates has decreased by $437,000.  Interest expense for the six month period was $224,000 less than the same time period in 2002.  Changes in the volume of interest bearing liabilities, primarily the increase in balances of demand deposits, as well as the addition of interest expense related to the trust preferred securities, have resulted in a net increase of interest expense of $387,000.  Decreases in average rates paid, primarily on certificates of deposit and demand deposits have resulted in an interest expense reduction of $611,000.

 

Table Three:  Analysis of Volume and Rate Changes on Net Interest Income and Expenses (Unaudited)

 

(In thousands) Three Months Ended June 30, 2003 over 2002
Increase (decrease) due to change in:		Volume			Rate (3)			Net Change
Interest-earning assets:
Net loans (1)		$	802		$	(101	)	$	701
Taxable investment securities		9			(3		)	6
Tax exempt investment securities (2)		(14		)	6			(8		)
Federal funds sold		139			(88		)	51
Investment in time deposits		73			(38		)	35
Total		1,009			(224		)	785
Interest-bearing liabilities:
Demand deposits		155			(81		)	74
Savings deposits		5			(29		)	(24		)
Time deposits		(6		)	(182		)	(188		)
Other borrowings		99			3			102
Total		253			(289		)	(36		)
Interest differential		$	756		$	65		$	821

 

(1)   The average balance of non-accruing loans is immaterial as a percentage of total loans and, as such, has been included in net loans.

(2)   Does not include taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes.

(3)   The rate/volume variance has been included in the rate variance.

 

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(In thousands) Six Months Ended June 30, 2003 over 2002
Increase (decrease) due to change in:		Volume			Rate (3)			Net Change
Interest-earning assets:
Net loans (1)		$	1,533		$	(216	)	$	1,317
Taxable investment securities		27			0			27
Tax exempt investment securities (2)		(26		)	12			(14		)
Federal funds sold		256			(163		)	93
Investment in time deposits		136			(70		)	66
Total		1,926			(437		)	1,489
Interest-bearing liabilities:
Demand deposits		312			(135		)	177
Savings deposits		13			(40		)	(27		)
Time deposits		(144		)	(460		)	(604		)
Other borrowings		206			24			230
Total		387			(611		)	(224		)
Interest differential		$	1,539		$	174		$	1,713

 

(1)          The average balance of non-accruing loans is immaterial as a percentage of total loans and, as such, has been included in net loans.

(2)          Does not include taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes.

(3)          The rate/volume variance has been included in the rate variance.

 

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Non-interest Income

 

Table Four below provides a summary of the components of noninterest income for the periods indicated (dollars in thousands) (percent of assets annualized):

 

Table Four:  Components of Noninterest Income (Unaudited)

 

Three Months Ended June 30,		2003			% of Avg. Assets		2002			% of Avg. Assets
Service charges on deposit accounts		$	264		.28		$	250		.27
Loan servicing fees		374			.40		145			.20
Fees - alternative investment sales		61			.08		76			.12
Merchant fee income		45			.04		72			.12
Gain on the sale of loans		472			.52		217			.32
Other		167			.20		535			.80
Total non-interest income		$	1,383		1.52		$	1,295		1.83

 

Six Months Ended June 30,		2003			% of Avg. Assets		2002			% of Avg. Assets
Service charges on deposit accounts		$	522		.30		$	494		.36
Loan servicing fees		713			.41		266			.20
Fees - alternative investment sales		81			.05		85			.06
Merchant fee income		151			.09		134			.10
Gain on the sale of loans		766			.44		442			.33
Other		333			.19		1,894			1.40
Total non-interest income		$	2,566		1.48		$	3,315		2.45

 

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Non-interest income was up $88,000 (6.8%) to $1,383,000 for the three months ended June 30, 2003 as compared to $1,295,000 for the three months ended June 30, 2002.    Increases in non-interest income were realized in fees from service charges (up 5.6%), loan servicing fees (up 158%), and gain on sale of loans (up 118%).  The increase in service charge income was the result of additional deposit accounts opened during the second quarter.  The loan servicing income and the gain recognized on the sale of loans increased as a result of more loans being sold on the secondary market through FNMA (Fannie Mae) as many customers of the Company took advantage of low levels in mortgage financing rates.  Servicing fee increases were also realized in SBA (Small Business Administration) and FHMA (Farmers Home Administration) through their USDA (United States Department of Agriculture) Business and Industry program.  The Company retains the servicing of loans sold through these programs, which generates fee income.

 

For the six months ended June 30, 2003, non-interest income was down $749,000 (29%) to $2,566,000 as compared to the $3,315,000 total for the six months ended June 30, 2002.   The major reason for the decrease in non-interest income for this period can be attributed to the tax-free net proceeds from key man insurance policies the Bank received in March 2002 as a result of the death of the Company’s Chief Operating Officer.  All of the other components of the non-interest income showed gains with the exception of fees from alternative investment sales which was down 5%.  Increases were realized in service charges on deposit accounts (up 5.7%), loan servicing fees (up 168%), merchant fee income (up 12.7%), and gain on sale of loans (up 73%).

 

Non-interest Expense

 

Non-interest expense increased $608,000 (22.3%) to $3,331,000 in the second quarter of 2003 versus $2,723,000 in the second quarter of 2002.  On a quarter over quarter basis, full time equivalent employees increased by 16.  Salary and employee benefits increased $583,000 (42.8%) resulting from normal cost of living raises, commissions paid to Butte Community Bank’s Real Estate Loan agents and staffing additions made during the year as the Company continues to grow and implement the new technology acquired during the year.  Benefit costs and employer taxes increased commensurate with the salaries.    On a quarter over quarter basis, occupancy expenses were higher by $35,000 (20.7%).  This increase in costs is associated with the opening of the North Paradise office and the move of the Magalia office into the Holiday Quality Foods market, and is related to building depreciation, utilities, janitorial services and property taxes.   Fixed asset expense was $233,000 in the second quarter of 2003 compared to $238,000 in the same period of 2002, representing a 2.1% decrease.   Other expenses decreased $4,000 (.4%) in the second quarter of 2003 versus the second quarter of 2002.

 

Non-interest expense for the six month period ended June 30, 2003 was $6,551,000 versus $6,487,000 for the same period in 2002.  Salaries and benefits increased by $1,063,000 (37.7%) due to cost of living raises added benefit costs and employer taxes associated with the staffing additions made during the year as the Company continues to grow and implement the new technology acquired during the year.  On a year over year basis, full time equivalent employees increased by 31.   Premises expense was up $70,000 (22.9%) from the first six months of 2002 to the first six months of 2003.  Fixed asset expense was up 62,000 (15.1%).  A portion of this increase relates to technology upgrades made to our core banking system such as the digital image processing system introduced in the first quarter of this year.  As with the quarter-to-quarter comparison, much of the increase in premise expense is related to the opening of the new North Paradise office and the move of the Magalia office to the Holiday Quality Foods market.  Other expenses decreased by $1,131,000 (38.4%).   As discussed in the non-interest income section, most of this decrease was attributable to the accelerated accrual of salary continuation plan benefits, in March 2002, associated with the death of the Company’s Chief Operating Officer that will be subsequently paid to his beneficiary.

 

Provision for Loan Losses

 

The Company provided $120,000 for loan and lease losses for the second quarter of 2003 as compared to $150,000 for the second quarter of 2002.  Net loan recoveries for the three months ended June 30, 2003 were $3,000 as compared to $1,000 in charge-offs for the three months ended June 30, 2002.   For the first six months of 2003, the Company made provisions for loan losses of $270,000.   This compares to the provision for loan losses of $253,000 for the first six months of 2002.

 

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Provision for Income Taxes

 

The effective tax rate for the second quarter and first six months of 2003 was 43.2% and 41.4%, versus 40.5% and 22.3%, for the same period in 2002.  The lower effective tax rate for the first six months of 2002 was attributable to the tax-free net proceeds from key man insurance policies received as the result of the death of one of the Company’s executives.

 

Balance Sheet Analysis

 

The Company’s total assets were $369,082,000 at June 30, 2003 as compared to $337,235,000 at December 31, 2002, representing an increase of 9.4%.  The average balance of total assets for the six months ended June 30, 2003 was $351,572,000, which represents an increase of $80,137,000 (29.5%) over the $271,435,000 during the six-month period ended June 30, 2002.

 

Loans

 

The Company concentrates its lending activities in the following principal areas: 1) commercial; 2) real estate; 3) residential real estate and real estate construction (both commercial and residential); 4) agriculture; and 5) consumer loans.  Commercial and residential real estate loans are generally secured by improved property, with original maturities of 3-10 years.  At June 30, 2003, these principal areas accounted for approximately 22%, 29%, 31%, 10% and 8%, respectively, of the Company’s loan portfolio.    The mix at December 31, 2002 was 21%, 35%, 28%, 8% and 8%.  These changes are consistent with the Company’s history of increased real estate construction activity during the summer months.  Continuing strong economic activity in the Company’s market area, new borrowers developed through the Company’s marketing efforts and credit extensions expanded to existing borrowers, offset by normal loan pay-downs and payoffs, resulted in net increases in loan balances for commercial loans ($4,815,000 or 9.9%), real estate construction ($11,944,000 or 18.5%) agricultural loans ($4,996,000 or 26.4%),and consumer ($723,000 or 3.7%) and a decrease in residential real estate ($10,243,000 or 14.2%).  Table Five below summarizes the composition of the loan portfolio as of June 30, 2003 and December 31, 2002.

 

Table Five: Loan Portfolio Composition (Unaudited)

 

(In thousands)		June 30, 2003			December 31, 2002
Commercial		$	53,476		$	48,661
Real estate:
Mortgage		71,814			82,057
Construction		76,509			64,565
Agriculture		23,931			18,935
Consumer		20,048			19,325
Total loans		245,778			233,543
Allowance for loan losses		(3,277		)	(3,007		)
Deferred loan fees, net		(786		)	(837		)
Total net loans		$	241,715		$	229,699

 

The majority of the Company’s loans are direct loans made to individuals and local businesses.  The Company relies substantially on local promotional activity and personal contacts by bank officers, directors and employees to compete with other financial institutions.  The Company makes loans to borrowers whose applications include a sound purpose and a viable primary repayment source, generally supported by a secondary source of repayment.

 

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Commercial loans consist of credit lines for operating needs, loans for equipment purchases, working capital, and various other business loan products.  Consumer loans include a range of traditional consumer loan products such as personal lines of credit and loans to finance purchases of autos, boats, recreational vehicles, mobile homes and various other consumer items.  Construction loans are generally composed of commitments to customers within the Company’s service area for construction of both commercial properties and custom and semi-custom single-family residences.  Other real estate loans consist primarily of loans secured by first trust deeds on commercial and residential properties typically with maturities from 3 to 10 years and original loan to value ratios generally from 65% to 80%.  Agriculture loans consist primarily of crop loans to farmers of peaches, prunes, walnuts, and almonds.  In general, except in the case of loans with SBA or FMHA guarantees, the Company does not make long-term mortgage loans; however, Butte Community Bank has a residential lending division to assist customers in securing most forms of longer term single-family mortgage financing.

 

Risk Elements

 

The Company assesses and manages credit risk on an ongoing basis through a total credit culture that emphasizes excellent credit quality, extensive internal monitoring and established formal lending policies.  Additionally, the Company contracts with an outside loan review consultant to periodically review the existing loan portfolio.  Management believes its ability to identify and assess risk and return characteristics of the Company’s loan portfolio is critical for profitability and growth.  Management strives to continue its emphasis on credit quality in the loan approval process, active credit administration and regular monitoring.  With this in mind, management has designed and implemented a comprehensive loan review and grading system that functions to continually assess the credit risk inherent in the loan portfolio.

 

Ultimately, underlying trends in economic and business cycles may influence credit quality.  The Company’s business is concentrated in the Butte and Sutter County Area. The economy of these two counties is diversified with professional services, manufacturing, agriculture and real estate investment and construction.

 

Special emphasis is placed within the communities in which the Company has offices (Chico, Paradise, Magalia, Oroville and Yuba City).  The Company also maintains loan production offices in the cities of Roseville and Redding.  Single-family residential construction is the primary lending product from the Roseville location serving the greater Sacramento area.  The primary focus of the loan production office in Redding is commercial loans with an emphasis on SBA and other government loan programs.

 

The Company has significant extensions of credit and commitments to extend credit that are secured by real estate.  The ultimate repayment of these loans is generally dependent on personal or business cash flows or the sale or refinancing of the real estate.  The Company monitors the effects of current and expected market conditions and other factors on the collectability of real estate loans.  The more significant factors management considers involve the following:  lease, absorption and sale rates; real estate values and rates of return; operating expenses; inflation; and sufficiency of collateral independent of the real estate including, in limited instances, personal guarantees.

 

In extending credit and commitments to borrowers, the Company generally requires collateral and/or guarantees as security.  The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrowers.  The Company’s requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management’s evaluation of the creditworthiness of the borrower.  Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property.  The Company secures its collateral by perfecting its security interest in business assets, obtaining deeds of trust, or outright possession among other means.

 

In management’s judgment, a concentration exists in real estate loans, which represented approximately 60% of the Company’s loan portfolio at June 30, 2003, which reflects an improvement from the 62.8% concentration level at December 31, 2002.  Management believes the concentration to have no more than the normal risk of collectability; however, a substantial decline in the economy in general, or a decline in real estate

 

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values in the Company’s primary market areas in particular, could have an adverse impact on the collectability of these loans and require an increase in the provision for loan losses which could adversely affect the Company’s future prospects, results of operations, profitability and stock price.  Management believes that its lending policies and underwriting standards will tend to minimize losses in an economic downturn; however, there is no assurance that losses will not occur under such circumstances.  The Company’s loan policies and underwriting standards include, but are not limited to, the following: (1) maintaining a thorough understanding of the Company’s service area and originating a significant majority of its loans within that area, (2) maintaining a thorough understanding of borrowers’ knowledge, capacity, and market position in their field of expertise, (3) basing real estate loan approvals not only on market demand for the project, but also on the borrowers’ capacity to support the project financially in the event it does not perform to expectations (whether sale or income performance), and (4) maintaining conforming and prudent loan to value and loan to cost ratios based on independent outside appraisals and ongoing inspection and analysis by the Company’s lending officers.

 

Nonaccrual, Past Due and Restructured Loans

 

Management generally places loans on nonaccrual status when they become 90 days past due, unless the loan is well secured and in the process of collection.  Loans are charged off when, in the opinion of management, collection appears unlikely.

 

Table Six below sets forth nonaccrual loans as of June 30, 2003 and December 31, 2002.  There were no loans past due 90 days or more and still accruing interest at June 30, 2003 or December 31, 2002.

 

 

Table Six:  Non-Performing Loans (Unaudited)

 

(In thousands)		June 30, 2003			December 31, 2002
Nonaccrual:
Commercial		67			134
Real estate		460			460
Consumer and other		75			—
Total non-performing loans		$	835		$	594

 

At June 30, 2003, non-performing loans and leases were .34% of total loans and leases.  The recorded investments in loans that were considered to be impaired totaled six loans with balances of $835,000 at June 30, 2003 and two loans with balances of $594,000 at December 31, 2002.  One of the seven impaired loans shown for June 30, 2003 had a U.S. Government guarantee for 90% of the loan balance which was $440,000.  On July 11, 2003 the entire balance of this loan was paid in full.  The remaining six loans have a very low potential for loss.  There were no loan concentrations in excess of 10% of total loans not otherwise disclosed as a category of loans as of June 30, 2003 or December 31, 2002.  Management is not aware of any potential problem loans, which were accruing and current at June 30, 2003, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms.

 

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Allowance for Loan Losses Activity

 

The provision for loan losses is based upon management’s evaluation of the adequacy of the existing allowance for loans outstanding. This allowance is increased by provisions charged to expense and recoveries and is reduced by loan charge-offs. Management determines an appropriate provision based upon the interaction of three primary factors: (1) loan portfolio growth, (2) a comprehensive grading and review formula for total loans outstanding, and (3) estimated inherent credit risk in the portfolio.

 

Management establishes general reserve factors for loans based upon an assessment of a credit risk by loan type and loan grade. These reserve factors, which are based on historical loss information, may be adjusted for significant commercial and real estate loans that are individually evaluated by management for specific risk of loss.  In addition, reserve factors ranging from 0.25% to 2.50% are assigned to currently performing loans that are not otherwise graded as Special Mention, Substandard or Doubtful.  These factors are assigned based on management’s assessment of the following for each identified loan type: (1) inherent credit risk, (2) historical losses and, (3) where the Company has not experienced losses, historical losses experienced by peer banks.    Finally, a residual component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  This residual component of the allowance reflects a margin of imprecision inherent in the underlying assumptions used to estimate losses in specifically graded loans and expected losses in the performing portfolio.

 

The Loan Committee of the Bank reviews the adequacy of the allowance for loan losses at least quarterly to include consideration of the relative risks in the portfolio and current economic conditions.  The allowance is adjusted based on that review if, in the judgment of the loan committee and management, changes are warranted.  The allowance for loan losses totaled $3,277,000 or 1.34% of total loans at June 30, 2003 and $3,007,000 or 1.29% at December 31, 2002.  Net charge-offs to average loans for the second quarter and year to date through June 30, 2003 are zero.

 

Table Seven below summarizes, for the periods indicated, the activity in the allowance for loan losses.

 

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Table Seven: Allowance for Loan Losses (Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
(In thousands, except for percentages)		2003			2002			2003			2002
Average loans outstanding		$	239,661		$	215,108		$	236,876		$	210,515
Allowance for possible loan losses at beginning of period		$	3,154		$	2,496		$	3,007		$	2,397
Loans charged off:
Commercial		—
Real estate		—			—						(4		)
Consumer		(1		)	—			(4		)
Total		(1		)				(4		)	(4		)
Recoveries of loans previously charged off:
Commercial		—			1						1
Real estate		—			—
Consumer		4						4
Total		4			1			4			1
Net loan charge offs		3			1			—			(3		)
Additions to allowance charged to operating expenses		120			150			270			253
Allowance for loan losses at end of period		$	3,277		$	2,647		3,277			2,647
Ratio of net charge-offs to average loans outstanding		.00		%	.00		%	.00		%	.00		%
Provision for possible loan losses to average loans outstanding		.05		%	.07		%	.11		%	.12		%
Allowance for loan  losses to loans net of deferred fees at end of period		1.34		%	1.20		%	1.34		%	1.20		%

 

It is the policy of management to maintain the allowance for loan losses at a level adequate for known and inherent risks in the portfolio.  Based on information currently available to analyze inherent credit risk, including economic factors, overall credit quality, historical delinquencies and a history of actual charge-offs, management believes that the provision for loan losses and the allowance are prudent and adequate.  The Company generally makes monthly allocations to the allowance for loan losses.  The budgeted allocation is based on estimates of loss risk and loan growth.  Adjustments may be made based on differences from estimated loan growth, the types of loans constituting this growth, changes in risk ratings within the portfolio, and general economic conditions.  However, no prediction of the ultimate level of loans charged off in future years can be made with any certainty.

 

Other Real Estate

 

At June 30, 2003 and December 31, 2002, the Company did not have any other real estate (“ORE”) properties.

 

22

 

Deposits

 

At June 30, 2003, total deposits were $329,013,000 representing an increase of $31,032,000 (10.4%) over the December 31, 2002 balance of $297,981,000.

 

Capital Resources

 

The current and projected capital position of the Company and the impact of capital plans and long-term strategies are reviewed regularly by management. The Company’s capital position represents the level of capital available to support continued operations and expansion.

 

The Board of Directors of the Company authorized the payment of a cash dividend of $.075 per share on January 28, 2002, April 25, 2002, and July 26, 2002, $.08 per share on October 25, 2002, $.10 per share on January 23, 2003, and $.10 per share on April 24, 2003.  The payment of dividends in the future is subject to the discretion of the Board of Directors of the Company and will depend on earnings, the financial condition of the Company and other relevant factors.  The per share amounts have been retroactively restated for the Company’s 4 for 3 stock split approved by the Board of Directors on August 20, 2002.

 

The Company and its subsidiary Bank are subject to certain regulations issued by the Board of Governors of the Federal Reserve System and the FDIC which require maintenance of certain levels of capital.  At June 30, 2003, shareholders’ equity was $27,202,000, representing an increase of $1,821,000 (7.2%) from $25,381,000 at December 31, 2002.  The Bank’s ratio of total risk-based capital to risk adjusted assets was 12.6% at June 30, 2003 compared to 10.9% at December 31, 2002.  Tier 1 risk-based capital to risk-adjusted assets was 11.4% at June 30, 2003 and 9.7% at December 31, 2002.

 

Table Eight below lists the Company and the Bank capital ratios at June 30, 2003 and December 31, 2002, as well as the minimum ratios required under regulatory definitions of capital adequacy.

 

Table Eight:  Capital Ratios (Unaudited)

 

Capital to Risk-Adjusted Assets		At June 30, 2003		At December 31, 2002		Minimum Regulatory Requirement
Company
Leverage ratio		10.1	%	10.4	%	4.0	%
Tier 1 Risk-Based Capital		12.6	%	12.8	%	4.0	%
Total Risk-Based Capital		13.8	%	14.0	%	8.0	%
Bank
Leverage ratio		9.22	%	7.9	%	4.0	%
Tier 1 Risk-Based Capital		11.4	%	9.7	%	4.0	%
Total Risk-Based Capital		12.6	%	10.9	%	8.0	%

 

Capital ratios are reviewed on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet future needs.  All ratios are in excess of the regulatory definition of “Minimum” at June 30, 2003 and December 31, 2002.  The Bank was considered “well-capitalized” by regulatory standards, at June 30, 2003 and December 31, 2002.

 

23

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

Market Risk Management

 

Overview.  Market risk is the risk of loss from adverse changes in market prices and rates.  The Company’s market risk arises primarily from interest rate risk inherent in its loan, investment and deposit portfolios.  The goal for managing the assets and liabilities of the Company is to maximize shareholder value and earnings while maintaining a high quality balance sheet without exposing the Company to undue interest rate risk.

 

The Board of Directors has overall responsibility for the interest rate risk management policies.  The Bank has an Asset and Liability Management Committee (ALCO) that establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates.

 

Asset/Liability Management.  Activities involved in asset/liability management include, but are not limited to, lending, accepting and placing deposits, investing in securities, using trust preferred securities and borrowings.  Interest rate risk is the primary market risk associated with asset/liability management.  Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities.  To mitigate interest rate risk, the structure of the balance sheet is managed with the goal that movements of interest rates on assets and liabilities are correlated and contributes to earnings even in periods of volatile interest rates.  The asset/liability management policy sets limits on the acceptable amount of variance in net interest margin and market value of equity under changing interest environments.  The Company uses simulation models to forecast earnings, net interest margin and market value of equity.

 

Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes.  Using computer-modeling techniques, the Company is able to estimate the potential impact of changing interest rates on earnings.  A balance sheet forecast is prepared monthly using inputs of actual loans, securities and interest bearing liability (i.e. deposits/borrowings) positions as the beginning base.  The forecast balance sheet is processed against seven interest rate scenarios.  These scenarios include a 100, 200 and 300 basis point rising rate forecast, a flat rate forecast and a 100, 200 and 300 basis point falling rate forecast which take place within a one year time frame.  The net interest income is measured during the year assuming a gradual change in rates over the twelve-month horizon.  The Company’s net interest income, as forecast below, was modeled utilizing a forecast balance sheet projected from balances as of the date indicated.

 

Table Nine below summarizes the effect on net interest income (NII) of a ±200 basis point change in interest rates as measured against a constant rate (no change) scenario.  The results shown in Table nine for the two periods, fall within the parameters of the Bank’s policy for interest rate risk.

 

Table Nine:  Interest Rate Risk Simulation of Net Interest as of June 30, 2003 and December 31, 2002 (Unaudited)

 

(In thousands)		$ Change in NII from Current 12 Month Horizon June 30, 2003			$ Change in NII from Current 12 Month Horizon December 31, 2002
Variation from a constant rate scenario
+200bp		$	379		$	111
- 200bp		$	(1,752	)	$	(1,262	)

 

The simulations of earnings do not incorporate any management actions which might moderate the negative consequences of interest rate deviations.  Therefore, they do not reflect likely actual results, but serve as estimates of interest rate risk.  In this simulation, the exposure to net interest income has increased due to a larger volume of assets maturing than liabilities and re-pricing at lower rates.

 

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Inflation

 

The impact of inflation on a financial institution differs significantly from that exerted on manufacturing, or other commercial concerns, primarily because its assets and liabilities are largely monetary.  In general, inflation primarily affects the Company and it subsidiaries through its effect on market rates of interest, which affects the Company’s ability to attract loan customers.  Inflation affects the growth of total assets by increasing the level of loan demand, and potentially adversely affects capital adequacy because loan growth in inflationary periods can increase at rates higher than the rate that capital grows through retention of earnings, which may be generated in the future.  In addition to its effects on interest rates, inflation increases overall operating expenses.  Inflation has not had a material effect upon the results of operations of the Company and its subsidiaries during the periods ended June 30, 2003, and 2002.

 

Liquidity

 

Liquidity management refers to the Company’s ability to provide funds on an ongoing basis to meet fluctuations in deposit levels as well as the credit needs and requirements of its clients.  Both assets and liabilities contribute to the Company’s liquidity position.  Federal funds lines, short-term investments and securities, and loan repayments contribute to liquidity, along with deposit increases, while loan funding and deposit withdrawals decrease liquidity.  The Company assesses the likelihood of projected funding requirements by reviewing historical funding patterns, current and forecasted economic conditions and individual client funding needs.  Commitments to fund loans at June 30, 2003 and December 31, 2002 were approximately $111,762,000 and $105,835,000, respectively.  Such loans relate primarily to revolving lines of credit and other commercial loans, and to real estate construction loans.

 

The Company’s sources of liquidity consist of cash and due from correspondent banks, overnight funds sold to correspondent banks, unpledged marketable investments and loans held for sale.  On June 30, 2003, consolidated liquid assets totaled $106 million or 28.7% of total assets compared to $81.4 million or 24.1% of total assets on December 31, 2002.  In addition to liquid assets, the Company maintains short-term lines of credit in the amount of $6,000,000 with correspondent banks.  There were no borrowings outstanding under these arrangements at June 30, 2003.    The Bank also has informal agreements with various other banks to sell participations in loans, if necessary.  The Company serves primarily a business and professional customer base and, as such, its deposit base is susceptible to economic fluctuations.  Accordingly, management strives to maintain a balanced position of liquid assets to volatile and cyclical deposits.

 

Liquidity is also affected by portfolio maturities and the effect of interest rate fluctuations on the marketability of both assets and liabilities.  The Company can sell any of its unpledged securities held in the available-for-sale category to meet liquidity needs.

 

Off-Balance Sheet Items

 

The Company has certain ongoing commitments under operating leases.  These commitments do not significantly impact operating results. As of June 30, 2003 and December 31, 2002, commitments to extend credit and letters of credit were the only financial instruments with off-balance sheet risk.  The Company has not entered into any contracts for financial derivative instruments such as futures, swaps, options or similar instruments.  Loan commitments and letters of credit were $111,762,000 and $105,835,000 at June 30, 2003 and December 31, 2002, respectively.  As a percentage of net loans, these off-balance sheet items represent 45.3% and 46.1%, respectively.

 

Other Matters

 

Effects of Terrorism The terrorist actions on September 11, 2001 and thereafter have had significant adverse effects upon the United States economy.  Whether the terrorist activities in the future and the actions of the United States and its allies in combating terrorism on a worldwide basis will adversely impact the Company and the extent of such impact is uncertain.  However, such events have had and may continue to have an adverse effect

 

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on the economy in the Company’s market areas.  Such continued economic deterioration could adversely affect the Company’s future results of operations by, among other matters, reducing the demand for loans and other products and services offered by the Company, increasing nonperforming loans and the amounts reserved for loan losses, and causing a decline in the Company’s stock price.

 

Item 4. Controls and Procedures

 

The Company’s Chief Executive Officer and Chief Financial Officer, based on their evaluation within 90 days prior to the date of this report of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a—14(c)), have concluded that the Company’s disclosure controls and procedures are adequate and effective for purposes of Rule 13a—14(c) in timely alerting them to material information relating to the Company required to be included in the Company’s filings with the SEC under the Securities Exchange Act of 1934. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.

 

PART II – OTHER INFORMATION

 

Item 1.  Legal Proceedings.

 

None.

 

Item 2.  Changes in Securities and Use of Proceeds.

 

None.

 

Item 3.  Defaults Upon Senior Securities.

 

None.

 

Item 4.  Submission of Matters to a Vote of Security Holders.

 

None.

 

Item 5.  Other Information.

 

None

 

Item 6.  Exhibits

 

(a)  Exhibits

 

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Exhibit Number		Document Description
31.1		Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)  Reports on Form 8-K

 

On March 21, 2003, the Company filed a Report on form 8-K announcing a ten cent per share cash dividend for shareholders of record on April 2, 2003, payable April 24, 2003.

 

On June 24, 2003, the Company filed a Report on form 8-k announcing a ten cent per share Stock Dividend for shareholders of record on July 1, 2003, payable July 25, 2003.

 

On July 10, 2003, the Company filed a Report on form 8-k announcing the approval by the Board of Directors of the Company of a stock repurchase plan.

 

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SIGNATURES

 

Pursuant to the requirements 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.

 

 

		COMMUNITY VALLEY BANCORP
August 11, 2003		By: /s/ Keith C. Robbins
		Keith C. Robbins
		President, Chief Executive Officer
August 11, 2003		By: /s/ John F. Coger
		John F. Coger
		Executive Vice President, CFO

 

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