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  September 30, 2004

 

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)

 

 

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    3,636,291 shares outstanding at October 31, 2004.

 

 

PART 1-FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)

 

(In thousands except per share data)		September 30, 2004			December 31, 2003
ASSETS
Cash and due from banks		$	25,677		$	26,205
Federal funds sold		14,425			50,605
Interest-bearing deposits in banks		9,607			7,925
Investment securities (market value of $7,133 at September 30, 2004 and $4,325 at December 31, 2003)		7,128			4,325
Loans held for sale		1,569			2,279
Loans, less allowance for loan losses of $4,233 at September 30, 2004 and $3,587 at December 31, 2003		339,852			270,231
Bank premises and equipment, net		9,045			8,554
Accrued interest receivable and other assets		15,874			16,599
		$	423,177		$	386,723
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Non-interest bearing		$	76,987		$	68,463
Interest bearing		297,830			274,048
Total deposits		374,817			342,511
Employee stock ownership plan note payable		722			832
Subordinated debentures		8,248			8,248
Accrued interest payable and other liabilities		6,012			5,183
Total liabilities		389,799			356,774
Commitments and contingencies
Shareholders’ equity:
Common stock – no par value; 20,000,000 shares authorized; issued and outstanding – 3,632,391 shares at September 30, 2004 and 3,621,824 shares at December 31, 2003		7,773			7,271
Unearned ESOP shares (85,691 shares at September 30, 2004 and 90,909 shares at December 31, 2003, at cost)		(1,014		)	(1,070		)
Retained earnings		26,612			23,746
Accumulated other comprehensive income, net (Note 3)		7			2
Total shareholders’ equity		33,378			29,949
		$	423,177		$	386,723

 

See Notes to Unaudited Consolidated Financial Statements

 

2

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENT OF INCOME

(Unaudited)

 

		For the periods ended September 30,
		Three months						Nine Months
(In thousands, except per share data)		2004			2003			2004			2003
Interest income:
Interest and fees on loans		$	6,306		$	5,308		$	17,278		$	14,493
Interest on Federal funds sold		86			152			329			533
Interest on deposits in banks		64			55			180			145
Interest and dividends on investment securities:
Taxable		47			9			108			70
Exempt from Federal income taxes		16			0			36			38
Dividends		0			1			3			1
Total interest income		6,519			5,525			17,934			15,740
Interest expense:
Interest on deposits		878			964			2,605			2,996
Interest on subordinated debentures		112			103			315			336
Interest on note payable		8			8			25			25
Total interest expense		998			1,075			2,945			3,357
Net interest income		5,521			4,449			14,989			12,383
Provision for loan losses		225			210			640			480
Net interest income after provision for loan losses		5,296			4,239			14,349			11,903
Non-interest income		1,366			1,519			4,150			4,085
Non-interest expense:
Salaries and employee benefits		2,243			2,005			6,623			5,891
Occupancy		283			236			767			612
Furniture and equipment		399			284			1,103			757
Other expense		1,107			910			3,076			2,726
Total non-interest expense		4,032			3,435			11,569			9,986
Income before income taxes		2,630			2,323			6,930			6,002
Income taxes		1,036			889			2,783			2,415
Net income		$	1,594		$	1,434		$	4,147		$	3,587
Basic earnings per share		$	.45		$	.41		$	1.17		$	1.02
Diluted earnings per share		$	.42		$	.39		$	1.09		$	.97
Cash dividends per share		$	.075		$	.056		$	.225		$	.17

 

See Notes to Unaudited Consolidated Financial Statements

 

3

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(In thousands except share data)

 

													Accumulated Other Comprehensive Income
							Unearned ESOP Shares									Total Shareholders’ Equity
		Common Stock								Retained Earnings									Comprehensive Income
		Shares		Amount
Balance, January 1, 2003		3,580,468		$	6,660		$	(852	)	$	19,559		$	14		$	25,381
Comprehensive income (Note 3):
Net income										5,269						5,269			$	5,269
Other comprehensive loss, net of tax
Unrealized loss on available-for-sale investment securities													(12		)	(12		)	(12		)
																			$	5,257
Exercise of stock options and related tax benefit		41,356		462												462
Earned ESOP shares				150			102									252
Shares acquired or redeemed by ESOP							(321		)							(321		)
Cash dividends- $.30 per share										(1,082		)				(1,082		)
Balance, December 31, 2003		3,621,824		7,272			(1,071		)	23,746			2			29,949
Comprehensive income (Note 3):
Net income										4,146						4,146			$	4,146
Other comprehensive loss, net of tax:
Unrealized gain on available-for-sale investment securities													5			5			5
Total comprehensive income																			$	4,151
Purchase of common stock		(19,015	)	(40		)				(462		)				(502		)
Exercise of stock options and related tax benefit		29,582		470												470
Fractional shares				(6		)										(6		)
Earned ESOP shares				77			57									134
Cash dividends declared - $.225 per share										(818		)				(818		)
Balance, September 30, 2004		3,632,391		$	7,773		$	(1,014	)	$	26,612		$	7		$	33,378

 

See Notes to Unaudited Condensed Consolidated Financial Statements

 

4

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS                  (Unaudited)

 

(In thousands) For the nine months ended September 30,		2004			2003
Cash flows from operating activities:
Net income		$	4,146		$	3,587
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		640			480
Deferred loan origination costs, net		59			224
Depreciation and amortization		999			671
Gain on disposition of Bank premises and equipment					(3		)
Net decrease in loans held for sale		711			2,252
Increase in cash surrender value of bank-owned life insurance		(335		)	(166		)
Non-cash compensation expense associated with the ESOP		135			116
Decrease in accrued interest receivable and other assets		1,259			47
Increase (decrease) in accrued interest payable and other liabilities		829			(1,005		)
Net cash provided by operating activities		8,443			6,203
Cash flows from investing activities:
Increase in interest-bearing deposits in banks		(1,682		)	(3,666		)
Proceeds from called available-for-sale investment securities		300
Proceeds from called held-to-maturity investment securities		1,598			2,200
Proceeds from matured held-to-maturity investment securities		130
Proceeds from principal payments of held-to-maturity investment securities		310
Purchase of held-to-maturity investment securities		(1,012		)	(2,030		)
Purchase of available-for-sale investment securities		(4,148		)
Purchases of premises and equipment		(1,454		)	(1,857		)
Proceeds from sale of premises and equipment					155
Purchase of bank-owned life insurance					(1,608		)
Investment in ATM program					(9,989		)
Net increase in loans		(70,319		)	(38,454		)
Net cash used in investing activities		(76,277		)	(55,249		)
Cash flows from financing activities:
Net increase in demand, interest-bearing and savings deposits		$	21,109		$	36,254
Net increase in time deposits		11,195			2,549
Repayment of ESOP loan, net		(110		)	92
Payment of cash dividends		(817		)	(810		)
Cash paid for fractional shares		(6		)
Exercise of stock options		259			236
Purchase of unearned ESOP shares					(186		)
Repurchase of common stock		(502		)
Net cash provided by financing activities		31,128			38,135
Decrease in cash and cash equivalents		(36,708		)	(10,911		)
Cash and cash equivalents at beginning of year		76,810			73,031
Cash and cash equivalents at end of period		$	40,102		$	62,120

 

See Notes to Unaudited Consolidated Financial Statements

 

5

 

Community Valley Bancorp and Subsidiaries

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1.  BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements of Community Valley Bancorp and subsidiaries (the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, certain information and notes required by accounting principles generally accepted in the United States for annual financial statements are not included herein.  In the opinion of management, all adjustments (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 2003 Annual Report to Shareholders on Form 10-K.

 

The condensed consolidated financial statements include the accounts of the Company and its wholly owned bank subsidiary, Butte Community Bank.  Community Valley Statutory Trust is not consolidated into the Company’s consolidated financial statements and, accordingly, is accounted for under the equity method.  All significant inter-company balances and transactions have been eliminated in consolidation.  The results of operations for the three and nine month periods ended September 30, 2004 may not necessarily be indicative of the operating results for the full year 2004.

 

On February 20, 2004, the Board of Directors declared a four-for-three stock split effective March 26, 2004 for shareholders of record on March 2, 2004.  All share and per share data has been retroactively adjusted to reflect the stock split.

 

Management has determined that since all of the commercial banking products and services offered by the Company are available in each branch of the bank, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate the Bank branches and report them as a single operating segment.

 

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 financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from these estimates.

 

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 (3,560,903 and 3,552,469 shares for the three and nine month periods ended September 30, 2004 and 3,518,621 and 3,507,809 shares for the three and nine month periods ended September 30, 2003).  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 (230,192 and 247,793 shares for the three and nine month periods ended September 30, 2004 and 194,245 and 189,644 shares for the three and  nine month periods ended September 30, 2003).  Earnings per share are retroactively adjusted for stock splits and dividends for all periods presented.  During the periods covered the Company had no stock options that were considered anti-dilutive.

 

6

 

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.  The Company’s only source of  comprehensive income or loss, 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. 123, 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.

 

(In thousands, except per share data)

 

		Three Months Ended
		September 30, 2004			September 30, 2003
Net income as reported		$	1,594		$	1,434
Deduct: Total stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects		(71		)	(65		)
Pro forma net income		$	1,523		$	1,369
Basic earnings per share - as reported		$	0.45		$	0.41
Basic earnings per share - pro forma		$	0.43		$	0.39
Diluted earnings per share - as reported		$	0.42		$	0.39
Diluted earnings per share - pro forma		$	0.40		$	0.38

 

7

 

		Nine Months Ended
		September 30, 2004			September 30, 2003
Net earnings as reported		$	4,147		$	3,588
Deduct: Total stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects		(214		)	(194		)
Pro forma net income		$	3,933		$	3,393
Basic earnings per share - as reported		$	1.17		$	1.02
Basic earnings per share - pro forma		$	1.11		$	0.97
Diluted earnings per share - as reported		$	1.09		$	0.97
Diluted earnings per share - pro forma		$	1.04		$	0.93

 

		Nine Months Ended
		September 30, 2004			September 30, 2003
Dividend yield (not applicable)
Expected volatility		79.07 – 92.26		%	95.16		%
Risk-free interest rate		4.02 – 4.12		%	4.52		%
Expected option life		10 years			10 years
Weighted average fair value of options granted during the year		$	9.51		$	9.86

 

8

 

5.  COMMITMENTS AND CONTINGENCIES

 

The Company has certain ongoing commitments under operating leases.  These commitments do not significantly impact operating results. As of September 30, 2004 and December 31, 2003, 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 $153,673,000 and $141,308,000 at September 30, 2004 and December 31, 2003, respectively.  As a percentage of net loans, these off-balance sheet items represent 45.0% and 52.3%, respectively.

 

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 September 30, 2004 and December 31, 2003 and income and expense accounts for the three and nine month periods ended September 30, 2004 and 2003. 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.  Butte Community Bank was incorporated and commenced business in Paradise and Oroville, California in 1990.  Butte Community Bank operates ten full service offices within its primary service areas of Butte, Sutter, Yuba and Tehama Counties.  The Bank also maintains Loan Production Offices in Citrus Heights and Redding. 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.

 

9

 

Critical Accounting Policies

 

General

 

The Company’s significant accounting principles are described in Note 1 of the consolidated financial statements in the Company’s 2003 Annual Report to Shareholders on Form 10-K and are essential to understanding Management’s Discussion and Analysis of Results of Operations and Financial Condition. Community Valley Bancorp’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. Some of the Company’s accounting principles require significant judgement to estimate values of assets or liabilities. In addition, certain accounting principles require significant judgment in applying the complex accounting principles to transactions to determine the most appropriate treatment. The following is a summary of the more judgmental and complex accounting estimates and principles.

 

Allowance for Loan Losses (ALL)

 

The allowance for loan losses is management’s best estimate of the probable losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting:  (1) SFAS No.5 which requires that losses be accrued when they are probable of occurring and estimable and (2) SFAS No. 114, which requires that losses be accrued on impaired loans based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The Company performs periodic and systematic detailed evaluations of its lending portfolio to identify and estimate the inherent risks and assess the overall collectibility. These evaluations include general conditions such as the portfolio composition, size and maturities of various segmented portions of the portfolio such as secured, unsecured, construction, and Small Business Administration (“SBA”).

 

Additional factors include concentrations of borrowers, industries, geographical sectors, loan product, loan classes and collateral types, volume and trends of loan delinquencies and non-accrual, criticized and classified assets and trends in the aggregate in significant credits identified as watch list items. There are several components to the determination of the adequacy of the ALL. Each of these components is determined based upon estimates that can and do change when the actual events occur. The Company estimates the SFAS No. 5 portion of the ALL based on the segmentation of its portfolio. For those segments that require an ALL, the Company estimates loan losses on a monthly basis based upon its ongoing loan review process and analysis of loan performance. The Company follows a systematic and consistently applied approach to select the most appropriate loss measurement methods and support its conclusions and rationale with written documentation. One method of estimating loan losses for groups of loans is through the application of loss rates to the groups’ aggregate loan balances. Such rates typically reflect historical loss experience for each group of loans, adjusted for relevant economic factors over a defined period of time. The Company evaluates and modifies its loss estimation model as needed to ensure that the resulting loss estimate is consistent with GAAP.

 

For individually impaired loans, SFAS No. 114 provides guidance on the acceptable methods to measure impairment. Specifically, SFAS No. 114 states that when a loan is impaired, the Company should measure impairment based on the present value of expected future principal and interest cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price or the fair value of collateral, if the loan is collateral dependent. When developing the estimate of future cash flows for a loan, the Company considers all available information reflecting past events and current conditions, including the effect of existing environmental factors.

 

10

 

Loan Sales and Servicing

 

The Company originates government guaranteed loans and mortgage loans that may be sold in the secondary market.  The amounts of gains recorded on sales of loans and the initial recording of servicing assets and interest only (I/O) strips is based on the estimated fair values of the respective components.  In recording the initial value of the servicing assets and the fair value of the I/O strips receivable, the Company uses estimates which are based on management’s expectations of future prepayments and discount rates.  Servicing assets are amortized over the estimated life of the related loan.  I/O strips are not significant at September 30, 2004.  These prepayment and discount rates were based on current market conditions and historical performance of the various pools of serviced loans.  If actual prepayments with respect to sold loans occur more quickly than projected the carrying value of the servicing assets may have to be adjusted through a charge to earnings.

 

Stock-Based Compensation

 

The Company uses the intrinsic value based method for measuring compensation cost related to stock options. Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date over the amount an employee must pay to acquire the stock. This cost is amortized on a straight-line basis over the vesting period of the options granted. The Company applies Accounting Principles Board Opinion (“APB”) No. 25 Accounting for Stock Issued to Employees and related interpretations in accounting for stock options.  No compensation cost has been recorded in the accompanying financial statements because all options have been granted at an exercise price of no less than the fair market value at date of grant.

 

Revenue recognition

 

The Company’s primary source of revenue is interest income, which is the difference between the interest income it receives on interest-earning assets and the interest expense it pays on interest-bearing liabilities, and (ii) fee income, which includes fees earned on deposit services, income from SBA lending, electronic-based cash management services, mortgage brokerage fee income and merchant credit card processing services. Interest income is recorded on an accrual basis. Note 1 to the Consolidated Financial Statements in the Company’s 2003 Annual Report to Shareholders on Form 10-K offers an explanation of the process for determining when the accrual of interest income is discontinued on an impaired loan.

 

Overview

 

The Company recorded net income of $1,594,000 for the quarter ended September 30, 2004, which was an 11% increase from the $1,434,000 reported for the same period of 2003.  Diluted earnings per share for the third quarter of 2004 were $0.42, compared to the $0.39 recorded in the third quarter of 2003.  The annualized return on average equity (ROAE) and the return on average assets (ROA) for the third quarter of 2004 were 17.34% and 1.36%, respectively, as compared to 17.80% and 1.34%, respectively, for the same period in 2003.

 

Net income for the nine months ended September 30, 2004 was $4,147,000 (up 15.6%) compared to the $3,587,000 recorded in the first nine months of 2003.   The primary reasons for the increase in net income were the growth in earning assets the company experienced as well as decreases in average rates paid, primarily on certificates of deposit and demand deposits.

 

Total assets of the Company increased by $36,454,000 or (9.4%) from December 31, 2003 to $423,177,000 at September 30, 2004.  Net loans totaled $341,421,000, up $71,190,000 (26.3%) from the ending balances on December 31, 2003.  Deposit balances at September 30, 2004 totaled $374,817,000, up $32,306,000 (9.4%) from December 31, 2003.

 

11

 

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 September 30,						Nine months ended September 30,
(In thousands, except percentages)		2004			2003			2004			2003
Net interest income		$	5,521		$	4,449		$	14,989		$	12,383
Provision for loan losses		(225		)	(210		)	(640		)	(480		)
Non-interest income		1,366			1,519			4,150			4,085
Non-interest expense		(4,032		)	(3,435		)	(11,569		)	(9,986		)
Provision for income taxes		(1,036		)	(889		)	(2,783		)	(2,415		)
Net income		$	1,594		$	1,434		$	4,147		$	3,587
Average total assets (In millions)		$	421.1		$	381.1		$	408.1		$	363.2
Net income (annualized) as a percentage of average total assets		1.51		%	1.53		%	1.36		%	1.34		%

 

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 5.86% for the three months ended September 30, 2004 and 5.58% for the nine month period ending September 30, 2004.  Net interest income increased $1,071,000 (24%) for the third quarter of 2004 compared to the same period in 2003.  Net interest income increased $2,604,000 (21%) for the nine months ended September 30, 2004 over the same period in 2003.   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.

 

The average balances of interest bearing liabilities were $27,748,000 (10%) higher in the third quarter of 2004 versus the same quarter in 2003. Even though the interest bearing balances increased, rates paid on these liabilities decreased 23 basis points on a quarter over quarter basis.   As a result, interest expense was $77,000 (7.7%) lower in the third quarter of 2004 versus the prior year period.  The average balances of interest bearing liabilities were $32,585,000 (12.4%) higher in the nine-month period ended September 30, 2004 versus the same period in 2003.  Rates paid on interest bearing liabilities decreased 38 basis points on a year over year basis.  The reason for this decrease was the ability of management to channel the growth 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.  As a result, interest expense was $412,000 (12.3%) lower in the nine month period ended September 30, 2004 versus the prior year period.

 

Table Two, Analysis of Net Interest Margin, 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 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.

 

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Table Two:  Analysis of Net Interest Margin

 

		Three Months Ended September 30,
		2004								2003
		Avg						Avg		Avg						Avg
(In thousands, except percentages)		Balance			Interest			Yield (4)		Balance			Interest			Yield (4)
Assets:
Earning assets
Loans (1)		$	334,154		$	6,306		7.51	%	$	268,306		$	5,308		7.85	%
Taxable investment securities		5,529			47			3.31	%	2,061			10			1.73	%
Tax-exempt investment securities (2)		1,219			16			5.22	%	817						0	%
Federal funds sold		24,784			86			1.38	%	60,593			152			1.00	%
Interest bearing deposits in banks		9,305			64			2.74	%	7,298			55			2.99	%
Total earning assets		374,991			6,519			6.91	%	339,075			5,525			6.46	%
Cash & due from banks		27,040								17,151
Other assets		19,118								24,883
		$	421,149							$	381,109
Liabilities & Shareholders’ Equity
Interest bearing liabilities:
NOW & MMDA		$	175,330		262			0.59	%	$	157,307		348			0.88	%
Savings		31,172			37			0.47	%	23,329			28			0.47	%
Time deposits		88,377			579			2.61	%	86,644			588			2.69	%
Other borrowings		8,984			120			5.31	%	8,772			111			5.02	%
Total interest bearing liabilities		303,863			998			1.31	%	276,115			1,075			1.54	%
Demand deposits		77,711								70,082
Other liabilities		6,512								6,923
Total liabilities		388,086								353,120
Shareholders’ equity		33,063								27,989
		$	421,129							$	381,109
Net interest income & margin (3)					$	5,521		5.86	%				$	4,449		5.21	%

 

(1)  Loan interest includes loan fees of $628,000 and $497,000 during the three months ended September 30, 2004 and September 30, 2003 respectively.

(2)  Does not include taxable-equivalent adjustments that primarily relate to income on certain securities that are 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 quarter (92 for September 30, 2004 and September 30, 2003) and annualized to actual days in year (366 for 2004 and 365 for 2003).

 

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