UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2005
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from               to               

 

Commission file number 0-25979

 

WESTERN SIERRA BANCORP

(Exact name of Registrant as specified in its charter)

 

California		68-0390121
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
4080 Plaza Goldorado Circle Cameron Park, California		95682
(Address of principal executive offices)		(Zip code)

 

Registrant’s telephone number, including area code: (530) 677-5600

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value per share

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes ý No o

 

As of May 4, 2005 there were approximately 7,702,000 shares outstanding of the Registrant’s common stock.

 

 

WESTERN SIERRA BANCORP & SUBSIDIARIES

Index to Form 10-Q

 

PART I. Financial Information
	Item 1. Consolidated Financial Statements (unaudited)
	Consolidated Balance Sheet March 31, 2005 and December 31, 2004
	Consolidated Statement of Income Three months ended March 31, 2005 and 2004
	Consolidated Statement of Cash Flows Three months ended March 31, 2005 and 2004
	Notes to Consolidated Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosure about Market Risk
	Item 4. Controls and Procedures
PART II. Other Information
	Item 1. Legal proceedings
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
	Item 3. Defaults Upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits
SIGNATURES

 

2

 

PART I. FINANCIAL INFORMATION

 

Western Sierra Bancorp and Subsidiaries

Consolidated Balance Sheet

(dollars in thousands)

 

(Unaudited)		March 31, 2005			December 31, 2004
ASSETS:
Cash and due from banks		$	40,863		$	29,975
Federal funds sold		47,100			74,630
Cash and cash equivalents		87,963			104,605
Interest-bearing deposits		—			1,200
Loans held for sale		1,484			2,685
Investment securities:
Trading		36			42
Available for sale (amortized cost $79,539 in 2005 and $81,106 in 2004)		80,065			82,521
Held to maturity (market value of $3,129 in 2005 and $3,202 in 2004)		3,017			3,067
Total investments		83,118			85,630
Portfolio loans and leases:
Real estate mortgage		639,929			600,108
Real estate construction		193,390			199,140
Commercial		119,099			119,823
Agricultural		11,162			11,514
Installment		3,904			4,160
Lease financing		1,904			1,768
Total gross loans and leases		969,388			936,513
Deferred loan and lease fees, net		(2,953		)	(3,008		)
Allowance for loan and lease losses		(14,288		)	(13,786		)
Net portfolio loans and leases		952,147			919,719
Premises and equipment, net		21,153			20,808
Goodwill and other intangible assets		33,722			33,913
Other assets		38,819			29,530
Total Assets		$	1,218,406		$	1,198,090
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Non-interest bearing deposits		$	280,062		$	272,250
Interest bearing deposits:
NOW, money market and savings		389,389			405,967
Time, over $100,000		205,810			185,935
Other time		154,557			158,814
Total deposits		1,029,818			1,022,966
Borrowed funds		30,500			21,500
Subordinated debentures		36,496			36,496
Other liabilities		7,085			6,977
Total liabilities		1,103,899			1,087,939
Shareholders’ equity:
Preferred stock- no par value; 15,000,000 shares authorized; none issued		—			—
Common stock- no par value; 15,000,000 shares authorized; issued - 7,679,934 shares in 2005 and 7,629,762 shares in 2004		69,037			68,125
Retained earnings		45,132			41,109
Accumulated other comprehensive income		338			917
Total shareholders’ equity		114,507			110,151
Total Liabilities and Shareholders’ Equity		$	1,218,406		$	1,198,090

 

See notes to the unaudited consolidated financial statements.

 

3

 

Western Sierra Bancorp and Subsidiaries

Consolidated Statement of Income

(dollars in thousands, except per share data)

 

		Three Months Ended March 31, 2005
(Unaudited)		2005			2004
Interest income:
Interest and fees on loans		$	16,113		$	14,036
Interest on investment securities:
Taxable		398			369
Exempt from federal taxes		409			387
Interest on Federal funds sold		312			53
Total interest income		17,232			14,844
Interest expense:
Interest on deposits		2,671			2,004
Interest on borrowed funds		716			557
Total interest expense		3,387			2,562
Net interest income		13,845			12,282
Provision for loan and lease losses (LLP)		450			710
Net interest income after LLP		13,395			11,572
Non-interest income:
Service charges and fees		1,186			1,195
Investment service fee income		130			291
Net gain on sale and packaging of residential mortgage loans		933			855
Gain on sale of government-guaranteed loans		112			—
Loss on sale of investment securities		(3		)	—
Other income		251			227
Total non-interest income		2,609			2,568
Non-interest expenses:
Salaries and benefits		5,403			4,887
Occupancy and equipment		1,611			1,352
Other expenses		2,621			2,309
Amortization of core deposit intangibles		180			180
Total other expenses		9,815			8,728
Income before income tax		6,189			5,412
Income taxes		2,166			1,947
Net income		$	4,023		$	3,465
Basic earnings per share		$	0.53		$	0.46
Fully diluted earnings per share		$	0.51		$	0.44

 

See notes to the unaudited consolidated financial statements.

 

4

 

Western Sierra Bancorp and Subsidiaries

Consolidated Statement of Cash Flows

(dollars in thousands)

 

		Three Months Ended
(Unaudited)		March 31, 2005			March 31, 2004
Cash flows from operating activities:
Net income		$	4,023		$	3,465
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses		450			710
Depreciation and amortization		851			762
Deferred loan and lease origination fees, net		(55		)	(239		)
Amortization of investment security premiums, net of accretion of discount		127			241
Decrease (increase) in trading securities		6			(3		)
Loss on sale of premises and equipment		(3		)	—
Increase in cash surrender value of life insurance policies		(198		)	(165		)
Decrease (increase) in loans held for sale		(1,326		)	(789		)
Increase in other assets		(2,013		)	(550		)
Decrease (increase) in other liabilities		108			(2,167		)
Decrease (increase) in deferred taxes		(20		)	(20		)
Net cash provided by operating activities		5,492			1,245
Cash flows from investing activities:
Proceeds from sale and call of available-for-sale investment securities		3,000			4
Purchases of available-for-sale investment securities		(5,412		)	(385		)
Principal repayments received from available-for-sale SBA pools and mortgage-backed securities		3,851			2,649
Principal repayments received from held-to-maturity mortgage-backed securities		50			243
Net decrease in interest-bearing deposits in banks		1,200			198
Net increase in loans and leases		(32,823		)	(37,050		)
Proceeds from the sale of premises and equipment		15			—
Purchases of premises and equipment		(1,028		)	(534		)
Purchase of life insurance policies		(7,300		)	—
Net cash used in investing activities		(38,447		)	(34,875		)
Cash flows from financing activities:
Net (decrease) increase in demand, interest-bearing and savings deposits		$	(8,766	)	$	12,127
Net increase in time deposits		15,618			33,034
Net increase in borrowings		9,000			12,100
Proceeds from the exercise of stock options		461			153
Net cash provided by financing activities		16,313			57,414
(Decrease) increase in cash and cash equivalents		(16,642		)	23,784
Cash and cash equivalents at beginning of year		104,605			55,964
Cash and cash equivalents at end of period		$	87,963		$	79,748
Non-cash investing activities:
Net change in unrealized gain on available-for-sale investment securities		$	(890	)	$	698

 

See notes to the unaudited consolidated financial statements.

 

5

 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1.  Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of Western Sierra 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 condensed consolidated financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s 2004 Annual Report to Shareholders.

 

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Western Sierra National Bank (WSNB) and its subsidiary WSNB Investment Trust (a Real Estate Investment Trust (“REIT”), Lake Community Bank (LCB), Central California Bank (CCB) and Auburn Community Bank (ACB).  All significant inter-company balances and transactions have been eliminated.  Western Sierra Statutory Trusts I, II, III, and IV are unconsolidated subsidiaries formed solely for the purpose of issuing trust preferred securities.  Operating results for the three months ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. Certain amounts in the consolidated financial statements for the year ended December 31, 2004 and the three-month period ended March 31, 2004 may have been reclassified to conform to the presentation of the consolidated financial statements in 2005.

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires Management to make estimates and assumptions.  These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from these estimates.

 

2.  Stock-based Compensation

 

At March 31, 2004, the Company has four stock-based compensation 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 as if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation.

 

Pro forma adjustments to the Company’s consolidated net earnings and earnings per share are disclosed during the years in which the options become vested (dollars in thousands, except per share data).

 

		Three Months Ended March 31,
		2005			2004
Net earnings as reported		$	4,023		$	3,465
Deduct: Total stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects		(220		)	(375		)
Pro forma net income		$	3,803		$	3,090
Basic earnings per share - as reported		$	0.53		$	0.46
Basic earnings per share - pro forma		$	0.50		$	0.41
Diluted earnings per share - as reported		$	0.51		$	0.44
Diluted earnings per share - pro forma		$	0.48		$	0.40

 

6

---

 

3.  Earnings per Share

 

Basic earnings per share (EPS), which excludes dilution, is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options, result in the issuance of common stock, which shares in the earnings of the Company. Earnings per share is retroactively adjusted for stock dividends and splits for all periods presented. A reconciliation of the numerators and denominators of the basic and diluted EPS computations is as follows (dollars in thousands, except share data).

 

		Three Months Ended
		March 31, 2005			March 31, 2004
Basic EPS Computation:
Numerator—net income		$	4,023		$	3,465
Denominator— weighted average number of shares outstanding		7,645,511			7,457,544
Basic earnings per share		$	0.53		$	0.46
Diluted EPS Computation:
Numerator—net income		$	4,023		$	3,465
Denominator— weighted average number of shares outstanding		7,645,511			7,457,544
Effect of dilutive stock options		310,563			406,798
		7,956,074			7,864,342
Diluted earnings per share		$	0.51		$	0.44

 

4.  Stock Repurchase Plan

 

On January 16, 2004 the Company announced that the Board of Directors approved a plan to utilize up to $2 million (or approximately 1% of the total outstanding shares) to repurchase the Company’s common stock.  As of March 31, 2005, the Company had repurchased 3,000 shares at an average price of approximately $28.27.

 

5.  Commitments and Contingencies

 

Leases

 

In April 2005, the Company signed a contract for an office lease that will be the headquarters and a branch of Western Sierra National Bank located at One Capital Mall Suite 600, Sacramento, CA  95814.  The term is for 7 years and the monthly rent expense begins in October 2005 at approximately $17,000 per month or $2.50 Per foot.

 

Financial Instruments With Off-Balance-Sheet Risk

 

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business in order to meet the financing needs of its customers and to reduce its exposure to fluctuations in interest rates.  These financial instruments include commitments to extend credit, letters of credit and commitments to sell loans.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the consolidated balance sheet.

 

The Company’s exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments.  The Company uses the same credit policies in making commitments and letters of credit as they do for loans and leases included on the consolidated balance sheet.

 

7

 

The following financial instruments represent off-balance-sheet credit risk (dollars in thousands):

 

		March 31, 2005			December 31, 2004
Commitments to extend credit:
Revolving lines of credit secured by 1-4 family residences		$	33,249		$	33,019
Commercial real estate, construction and land development commitments:
Secured by real estate		194,711			211,737
Not secured by real estate		674			1,105
Other commercial commitments not secured by real estate		54,955			53,099
Agricultural commitments		2,496			3,261
Other commitments		3,843			3,872
		$	289,928		$	306,093
Letters of credit		$	23,431		$	22,866

 

Real estate commitments are generally secured by property with loan-to-value ratios not to exceed 80%.  In addition, the majority of the Company’s commitments have variable interest rates.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  Each customer’s creditworthiness is evaluated on a case-by-case basis.  The amount of collateral obtained, if deemed necessary upon extension of credit, is based on Management’s credit evaluation of the borrower.  Collateral held varies, but may include deposits, accounts receivable, inventory, equipment, income-producing commercial properties and residential real estate.

 

Letters of credit are conditional commitments to guarantee the performance or financial obligation of a customer to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

 

Commitments to sell loans are agreements to sell to another party loans originated by the Company.  The Company only sells loans to third parties without recourse.  The Company is not exposed to credit loss if the borrower fails to perform according to the promissory note as long as the Company has fulfilled its obligations stated in the sales commitment.

 

6.  Comprehensive Income

 

Comprehensive income includes net income and other comprehensive income.  The Company’s only source of other comprehensive income is derived from unrealized gains and losses on investment securities available-for-sale.  Reclassification adjustments resulting from gains or losses on investment securities that were realized and included in net income of the current period that also had been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose are excluded from comprehensive income of the current period.  The Company’s total comprehensive income was as follows:

 

		Three Months Ended March 31,
(In thousands)		2005			2004
Net income		$	4,023		$	3,465
Other comprehensive (loss) income:
Holding (losses) gains arising during period, net of tax		(581		)	458
Re-classification adjustment, net of tax		2			—
Total other comprehensive (loss) income		(579		)	458
Total comprehensive income		$	3,444		$	3,923

 

8

 

7.  Subsequent Events

 

In November 2004, the Company entered into a definitive merger agreement to acquire Gold Country Financial Services, the holding company for Gold Country Bank, headquartered in Marysville, California. Under the terms of the agreement, Gold Country Bank will merge into WSNB in a stock and cash deal valued at approximately $23.1 million.  Shareholders of Gold Country on March 7, 2005 approved the merger.  The transaction, which was originally expected to close by April 2005 and has been delayed subject to OCC final approval.  Management expects the transaction will be completed by June 30, 2005.  The combination of Gold Country Bank, with over $140 million in assets and five branch locations will result in consolidated assets of over $1.3 billion for the Company, which will then have 35 branch locations.

 

8.  New Accounting Pronouncements

 

In April 2005, the SEC announced that FAS 123R requirements for stock option expensing will be deferred until January 1, 2006 and will be reflected on the Company’s first interim report thereafter.  As originally issued by the FASB, public companies subject to SEC oversight were required to implement Statement 123R as of the beginning of the first reporting period that begins after June 15, 2005.

 

9

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.

 

Private securities litigation reform act safe harbor statement

 

This quarterly report on Form 10-Q includes forward-looking information, which is subject to the “safe harbor” created by the Securities Act of 1933 and Securities Act of 1934. These forward-looking statements (which involve the Company’s plans, beliefs and goals) involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors:

 

1.               Competitive pressure in the banking industry and changes in the regulatory environment.

 

2.               Changes in the interest rate environment and volatility of rate sensitive deposits.

 

3.               Decline in the health of the economy nationally or regionally which could reduce the demand for loans or reduce the value of real estate collateral securing most of the Company’s loans.

 

4.               Credit quality deterioration that could cause an increase in the provision for loan losses.

 

5.               The Company’s exposure to real estate values in the markets that it serves, as over 80% of the Company’s loans are secured by real estate.

 

6.               Asset/Liability matching risks and liquidity risks.

 

7.               Volatility and devaluation in the securities markets.

 

8.               With respect to the merger with Gold Country Financial Services, these forward-looking statements describe the Company's expectations regarding future events, including all conditions to close the merger will be met.

 

 

For additional information concerning risks and uncertainties related to the Company and its operations, please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 under the heading “Forward-Looking Information”.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

The following sections discuss significant changes and trends in financial condition, capital resources and liquidity of the Company from December 31, 2004 to March 31, 2005. Also discussed are significant trends and changes in the Company’s results of operations for the three months ended March 31, 2005 compared to the same period in 2004. The consolidated financial statements and related notes appearing elsewhere in this report are condensed and unaudited.

 

10

 

General

 

The Company was incorporated under the laws of the State of California on July 11, 1996. The Company was organized pursuant to a plan of reorganization for the purpose of becoming the parent corporation of Western Sierra National Bank, and on December 31, 1996, the reorganization was effected and shares of the Company’s common stock were exchanged for the common shares held by Western Sierra National Bank’s shareholders.

 

In April 1999, the Company acquired Roseville 1st National Bank and Lake Community Bank in a stock for stock exchange. In May of 2000, the Company acquired Sentinel Community Bank in a stock for stock exchange. Each of these mergers was accounted for as a pooling of interests and, accordingly, all prior period financial statements have been restated to reflect the combined operations of the Company, Roseville 1st National Bank, Lake Community Bank and Sentinel Community Bank. Sentinel Community Bank at the time of its acquisition was immediately merged into Western Sierra National Bank. In May of 2000, Roseville 1st National Bank was also merged into Western Sierra National Bank.

 

In April 2002, the Company acquired Central California Bank for $3.7 million in cash and 252,181 shares of the Company’s stock.  This transaction was accounted for using purchase accounting, which resulted in a purchase price allocation of $2.3 million to goodwill and $1.9 million to core deposit intangible assets.  In July 2002, the Sentinel Community Bank branches were transferred from Western Sierra National Bank to Central California Bank.

 

In July 2003, the Company acquired Central Sierra Bank for $10.7 million in cash and 404,173 shares of the Company’s stock.  This transaction was accounted for using purchase accounting, which resulted in a purchase price allocation of $11.6 million to goodwill and $2.9 million to core deposit intangible assets.  Central Sierra Bank operates as a division of Central California Bank.

 

In December 2003, the Company acquired Auburn Community Bank for $6.5 million in cash and 349,976 shares of the Company’s stock.  This transaction was accounted for using purchase accounting, which resulted in a purchase price allocation of $14.5 million to goodwill and $1.8 million to core deposit intangible assets.

 

In November 2004, the Company entered into a definitive merger agreement to acquire Gold Country Financial Services, the holding company for Gold Country Bank, headquartered in Marysville, California. Under the terms of the agreement, Gold Country Bank will merge into WSNB in a stock and cash deal valued at approximately $23.1 million.  Shareholders of Gold Country on March 7, 2005 approved the merger.  The transaction, which was originally expected to close by April 2005 and has been delayed subject to OCC final approval.  Management expects the transaction will be completed by June 30, 2005.  The combination of Gold Country Bank, with over $140 million in assets and five branch locations will result in consolidated assets of over $1.3 billion for the Company, which will then have 35 branch locations.

 

The Company is a registered bank holding company under the Bank Holding Company Act. The Company conducts its operations at 4080 Plaza Goldorado Circle, Cameron Park, California 95682.

 

Western Sierra National Bank was organized under national banking laws and commenced operations as a national bank on January 4, 1984. Western Sierra National Bank is a member of the Federal Reserve System, and the FDIC insures its deposits to the maximum amount permitted by law. Western Sierra National Bank’s head office is located at 4080 Plaza Goldorado Circle, Cameron Park, and its branch offices are located at 4011 Plaza Goldorado, Cameron Park, CA, 2661 Sanders Drive, Pollock Pines, CA, 3970 J Missouri Flat Road, Placerville, CA, 1450 Broadway, Placerville, CA, 3880 El Dorado Hills Blvd., El Dorado Hills, CA, 571 5th Street, Lincoln, CA, 1545 River Park Dr. #101 & #200, Sacramento, CA, 1801 Douglas Blvd., Roseville, CA, 6951 Douglas Blvd., Granite Bay, CA, 9050 Fairway Drive, Roseville, CA, 2779 East Bidwell, Folsom, CA, 9610 Bruceville Rd. #100, Elk Grove, CA  and 2761 Del Paso Road, Sacramento, CA.  Western Sierra National Bank does not have any other subsidiaries other than Sentinel Associates, Inc., an inactive entity formed by Sentinel Bank in 1983 to develop single-family residential real estate.

 

Lake Community Bank was incorporated as a banking corporation under the laws of the State of California on March 9, 1984 and commenced operations as a California state-chartered bank on November 15, 1984. Lake Community Bank is an insured bank under the Federal Deposit Insurance Act and is a member of the Federal Reserve System. Lake Community Bank engages in the general commercial banking business in Lake County from its headquarters banking office located at 805 Eleventh Street, Lakeport, CA, and its branch located at 4280 Main Street, Kelseyville, CA. Lake Community Bank does not have any affiliates or subsidiaries.

 

Central California Bank was incorporated under the laws of the State of California on January 13, 1997 and commenced operations on April 24, 1998. Central California Bank is an insured bank under the Federal Deposit Insurance Act and became a

 

11

 

member of the Federal Reserve System in January 2003. In July 2003, Central Sierra Bank merged into Central California Bank.  Central California Bank engages in the general commercial banking business in Tuolumne and Stanislaus counties from its headquarters banking office located at 13753-A Mono Way, Sonora, CA, and its branches located at 400 E. Olive Ave, Turlock, CA, 3700 Lone Tree Way, Antioch, CA, 229 South Washington Street, Sonora, CA, 18711 Tiffeni Drive, Twain Harte, CA, 22712 Main Street, Columbia, CA, 373 West St. Charles Street, San Andreas, CA, 1239 South Main Street, Angels Camp, CA, 18281 Main Street, Jamestown, CA, 89 Lakewood Mall, Lodi, CA, 11 Ridge Road, Sutter Creek, CA, 87 Highway 26, Valley Springs, CA, 3505 Spangler Lane, Suite 300, Copperopolis, CA and 2525-A McHenry Ave, Modesto, CA and a loan production office located at 1111 Dunbar Road, Arnold, CA.  Central California Bank does not have any affiliates or subsidiaries.

 

Auburn Community Bank, a state non-member bank, was originally operating under the name of Auburn National Bank which was incorporated under the laws of the State of California on July 28, 1997, and commenced operations on February 2, 1998.  On July 29, 1999, Auburn National Bank converted from national bank to a state non-member bank and was renamed Auburn Community Bank.  Auburn Community Bank is an insured bank under the Federal Deposit Insurance Act and operates its headquarters banking office located at 500 Auburn-Folsom Road Suite 200, Auburn, CA and its branch located at 11795 Atwood Road, Auburn, CA.  Auburn Community Bank does not have any affiliates or subsidiaries.

 

Employees.  At March 31, 2005, the Company and its subsidiaries employed 373 persons on a full-time equivalent basis. The Company believes its employee relations are satisfactory.

 

Financial Condition

 

The Company increased total assets from $1.20 billion at December 31, 2004 to $1.22 billion at March 31, 2005, an increase of $20 million or 1.7%. The primary components of asset growth was portfolio loans, which grew $110.9 million or 12.9%.  Asset growth was funded by growth in deposits of $111.5 million or 12.1%.

 

The Company increased total assets from $1.2 billion at December 31, 2004 to $1.22 billion at March 31, 2005, an increase of $20 million or 1.7%. The two primary components of asset growth were portfolio loans, which grew $32 million, and other assets, which increased $9 million.  Growth in other assets was primarily a result of purchasing approximately $7.3 million in Bank Owned Life Insurance, or “BOLI”, which was purchased to generate income to offset rising benefit costs.  The policies yiled are subject to change annually by the respective insurance companies and are expected to yield approximately 4.5% on a tax deffered basis over the next twelve months. These increases in total assets were offset by a reduction in cash and cash equivalents of $17 million.  Asset growth was primarily funded by growth in borrowed funds of $9 million and growth in deposits of $7 million.

 

During the first three months of 2005, non-interest bearing deposits increased from $272 million at year-end 2004 to $280 million at March 31, 2005.  Included in non-interest deposits are local title company deposits, which have increased $9 million from $36 million at December 31, 2004 to $45 million at March 31, 2005.  These funds do not receive interest but do result in an assessment of service fees by the title company’s service bureau to the Company.  During the first three months of 2004, the service fees on title company deposits incurred by the Company were less than 1% of the average title company deposits outstanding.

 

Results of Operations

 

The Company reported net income of $4.02 million for the three months ended March 31, 2005 (or $0.51 per share, diluted) compared to $3.47 million (or $0.44 per share, diluted) for the same period in 2004. The quarterly earnings represent an increase of $558,000 or a 16.1% increase in net income and diluted earnings per share.

 

The primary factors contributing to the increase in operating results during the three-month period ended March 31, 2005 as compared to the same period in 2004 include:

 

1.               An increase in net interest income of $1.56 million or 12.7% in the first quarter over the same period in 2004.  The net increase is due to an overall increase in average earning assets and the benefit of recent rate increases applied to the Company’s asset sensitive balance sheet.

 

2.               A decrease in loan and lease loss provisions of $260,000 for the first quarter ended March 31, 2005 as compared to the same period in 2004.  During the period nonperforming assets fell to .09% at March 31, 2005 from .17% at March 31, 2004.  The percentage of loan and lease loss reserves to gross loans and leases was 1.47% at March 31, 2005 as compared to 1.47% at December 31, 2004 and 1.42% at March 31, 2004.

 

3.               An increase in non-interest income of $41,000, which includes a $112,000 gain from the sale of government-guaranteed loans.

 

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4.               An effective tax rate of 35.0% as compared to 36.0% in the first quarter of the previous year.

 

The above factors were offset in part by:

 

1.               Total other expenses increased $1.09 million or 12% over the first quarter in the previous year.

 

Return on Average Assets and Average Equity

 

Return on average assets (“ROA”) was 1.36% for the first quarter of 2005 as compared to 1.32% for the first quarter of 2004.  Return on equity (“ROE”) was 14.66% for the first of 2005 as compared to 14.74% for the first quarter of 2004.

 

Net Interest Income (Tax Equivalent Yield Basis)

 

Net interest income is the primary source of income for the Company and represents the excess of interest and fees earned on interest-earning assets (loans, investments and Federal funds sold) over the interest paid on deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets.

 

For the three months ended March 31, 2005, interest income on a tax equivalent basis increased by $2.4 million to $17.5 million or 16% over the same period in 2004. Interest expense on deposit accounts and borrowings increased $825,000 or 32% over the same three-month period ended March 31, 2004. Average earning assets yielded (on a fully tax equivalent basis) 6.55% versus 6.41% a year ago, the effect of which was partially offset by an increase in the cost of funds where the average cost of funds increased to 1.69% from 1.41% a year ago. Net interest income (on a tax equivalent basis) increased $1.6 million or 13% to $14.1 million. The net interest margin decreased 4 basis points to 5.28% from 5.32% for the same three-month period a year ago.

 

Overall, yields trended up from the prior year as a result of market interest rates. The Company’s cost of funds increased to 1.69% from 1.41% which was substantially offset by an increase in return on average earning assets which increased to 6.55% from 6.41%.  This increase was primarily driven by yields on loans, which increased from 6.75% to 6.92%.

 

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The following table presents, for the periods indicated, the distribution of consolidated average assets, liabilities and shareholders’ equity, as well as the total dollar amounts of interest income from average earning assets and the resultant yields and the dollar amounts of interest expense and average interest-bearing liabilities, expressed both in dollars and in rates. Non-accrual loans, which are not considered material, are included in the calculation of the average balances of loans.  Savings deposits include NOW and money market accounts. To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pre-tax equivalents based on the marginal corporate federal tax rate of 35 percent (dollars in thousands).

 

Average Balances, Interest Income/Expense and Yields/Rates Paid

 

		Three Months Ended
		March 31, 2005								March 31, 2004
		Average Balance			Interest			Yield/ Rate		Average Balance			Interest			Yield/ Rate
Earning assets:
Portfolio loans		$	945,555		$	16,124		6.92%		$	837,635		$	14,049		6.75%
Tax-exempt investment securities		36,937			629			6.90%		34,063			595			7.02%
Taxable investment securities		46,190			387			3.40%		48,927			359			2.95%
Federal funds sold		51,731			312			2.44%		21,730			53			0.98%
Interest-bearing deposits in banks		1,187			12			3.96%		2,179			10			1.79%
Average earning assets		1,081,599			17,463			6.55%		944,534			15,064			6.41%
Other assets		131,233								119,325
Less ALLL		(14,033		)						(11,856		)
Average total assets		$	1,198,799							$	1,052,003
Interest-bearing liabilities:
Savings deposits		$	399,710		$	862		0.87%		$	335,767		$	544		0.65%
Time deposits		349,903			1,809			2.10%		328,601			1,461			1.79%
Other borrowings (1)		62,182			717			4.67%		66,832			557			3.35%
Average interest-bearing liabilities		811,794			3,387			1.69%		731,200			2,562			1.41%
Non-interest bearing liabilities		267,844								214,849
Other liabilities		7,846								11,371
Shareholders’ equity		111,315								94,582
Average total liabilities and shareholders’ equity		$	1,198,799							$	1,052,003
Net interest income and net interest margin (2)					$	14,076		5.28%					$	12,503		5.32%

 

(1) For the purpose of this schedule the Company’s subordinated debentures are included in other borrowings.

(2) Net interest margin is calculated by dividing net interest income by average earning assets.

 

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The following tables set forth changes in interest income and expense for each major category of earning assets and interest-bearing liabilities, and the amount of change attributable to volume and rate changes for the periods indicated. Changes not specifically attributable to rate or volume have been allocated to rate changes (dollars in thousands).

 

Analysis of Changes in Net Interest Income

 

		Three Months Ended March 31, 2005 over 2004
		Volume			Rate			Total
Increase (decrease) in interest income:
Portfolio loans		$	1,794		$	281		$	2,075
Tax-exempt investment securities		50			(16		)	34
Taxable investment securities		(20		)	48			28
Federal funds sold		72			187			259
Interest-bearing deposits		(4		)	6			2
Net increase (decrease)		1,892			506			2,398
Increase (decrease) in interest expense:
Interest-bearing accounts		103			215			318
Time deposits		94			254			348
Other borrowings (1)		(38		)	198			159
Net increase (decrease)		158			667			825
Total net increase (decrease)		$	1,734		$	(161	)	$	1,573

 

(1) For the purpose of this schedule the interest on the Company’s subordinated debentures is included in other borrowings.

 

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Non-interest Income

 

The Company’s non-interest income consists primarily of service charges on deposit accounts, investment service fee income, other service fees, and mortgage loan origination and processing fees.

 

For the three months ended March 31, 2005, total non-interest income increased $41,000 or 2% over the same period in 2004.  This increase is primarily due to the gain on sale of government-guaranteed loans of $112,000 and an increase in mortgage loan origination and packaging fees of $78,000.  This growth was offset by a decrease of $161,000 in investment service fee income.

 

Non-interest Expense

 

Non-interest expenses consist of salaries and related employee benefits, occupancy and equipment expenses, data processing fees, professional fees, directors’ fees, and other operating expenses. Non-interest expense increased $1.09 million or 12% over the same three-month period of 2004.  Approximately $363,000 or 33% of this increase relates to three new branches that were opened during the fourth quarter of 2004.  Salaries and benefits increased $516,000 million or 11% over the same three-month period of last year.  Other expenses increased $312,000 or 14% over the same period in 2004, partially due to a $100,000 reserve for an operational loss that occurred in March 2005.

 

The following tables set forth a summary of non-interest expense for the periods indicated (dollars in thousands, percentages are annualized):

 

		Three Months Ended March 31,
		2005					2004
		Expense			% of Avg Assets		Expense			% of Avg Assets
Salaries and benefits		$	5,403		1.83%		$	4,887		2.07%
Occupancy and equipment		1,611			0.54%		1,352			0.57%
Other expenses		2,621			0.89%		2,309			0.98%
Amortization of core deposit and other intangibles		180			0.06%		180			0.08%
Total non-interest expense		$	9,815		3.32%		$	8,728		3.72%

 

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Efficiency Ratio

 

The Company uses a widely accepted banking operating ratio as a measure of its progress in improving operating efficiency.  The efficiency ratio is derived by dividing total non-interest expenses by the sum of tax adjusted net interest income and non-interest income.  Simply put, this ratio describes the operating expense necessary to generate $1 in tax equivalent total revenue.  The Company’s efficiency ratio increased modestly in the first quarter of 2005 driven by the expense increases outlined above in the “Non-interest Expense” discussion.

 

The following table sets forth the Company’s tax adjusted efficiency ratio for the periods indicated (dollars in thousands):

 

		Three Months Ended March 31,
		2005			2004
Non-interest expense		$	9,815		$	8,728
Amortization of core deposit and other intangibles		(180		)	(180		)
Investment in limited partnership		(108		)	(56		)
Net non-interest expense		$	9,527		$	8,492
Fully tax equivalent income:
Net interest income		$	13,845		$	12,282
Non-interest income		2,609			2,568
Tax benefit adjustment for tax-exempt income		330			313
Total fully tax equivalent Income		$	16,783		$	15,163
Efficiency Ratio		56.8%			56.0%

 

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Income Taxes

 

The following table reflects the Company’s tax provision and the related effective tax rate for the periods indicated (dollars in thousands):

 

		Three Months Ended March 31,
		2005			2004
Tax provision		$	2,166		$	1,947
Effective tax rate		35.0%			36.0%

 

The Company’s effective tax rate varies with changes in the relative amounts of its non-taxable income and non-deductible expenses. The increase in the Company’s tax provision is attributable to increases in the Company’s net income and the relative amount of tax-exempt income.

 

Asset Quality

 

The Company concentrates its lending activities primarily within areas directly serviced by its branches as previously discussed.

 

The Company manages its credit risk through diversification of its loan portfolio, the application of underwriting policies and procedures and credit monitoring practices. Although the Company has a diversified loan portfolio, a significant portion of its borrowers’ ability to repay their loans is dependent upon the professional services and residential real estate development industry sectors. Generally, loans are secured by real estate or other assets and are expected to be repaid from the cash flows of the borrower or proceeds from the sale of collateral.

 

The following table sets forth the amounts of loans outstanding by category as of the dates indicated (dollars in thousands):

 

		March 31, 2005			% of Total		December 31, 2004			% of Total
Commercial and residential real estate mortgage		$	639,929		66.01%		$	600,108		64.08%
Commercial and residential real estate construction		193,390			19.95%		199,140			21.26%
Commercial		119,099			12.29%		119,823			12.79%
Agricultural		11,162			1.15%		11,514			1.23%
Installment and other		3,904			0.60%		4,160			0.71%
Lease financing		1,904			0.20%		1,768			0.19%
Total		969,388			100.00%		936,513			100.00%
Deferred loan fees and costs, net		(2,953		)	-0.29%		(3,008		)	-0.33%
Less allowance for loan and lease losses		(14,288		)	-1.47%		(13,786		)	-1.47%
Total net loans and leases		$	952,147				$	919,719

 

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The following table sets forth a summary of the Company’s non-performing assets as of the dates indicated (dollars in thousands):

 

		March 31,			December 31,
		2005			2004
Non-accrual loans		$	1,045		$	889
Non-performing assets as a % of total assets		0.09%			0.07%
Non-accrual loans as a % of gross loans		0.11%			0.10%
Ratio of allowance for loan and lease losses to non-accrual loans		13.67			15.51

 

The Company’s non-accrual loans increased from $889,000 to $1,045,000 in the first three months of 2005. The Company’s “coverage ratio” or the ratio of allowance for loan and lease losses to non-accrual loans decreased from 15.51 to 13.67 during the first three months of 2005.  The Company carried no other real estate as of March 31, 2005 or December 31, 2004.

 

Allowance for Loan and Lease Losses

 

The allowance for loan and lease losses is established through charges to earnings in the form of the provision for loan and lease losses. Loan and lease losses are charged to, and recoveries are credited to, the allowance for loan and lease losses. The provision for loan and lease losses is determined after considering various factors such as loan and lease loss experience, current economic conditions, maturity of the portfolio, size of the portfolio, industry concentrations, borrower credit history, the existing allowance for loan and lease losses, independent loan reviews, current charges to and recoveries within the allowance for loan and lease losses and the overall quality of the portfolio as determined by management, regulatory agencies, and independent credit review consultants retained by the Company.

 

The adequacy of the Company’s allowance for loan and lease losses is based on specific and formula allocations to the Company’s loan and lease portfolio. Specific allocations are made for impaired loans and leases. The specific allocations are increased or decreased through management’s reevaluation of the status of the particular problem loans and leases. Loans and leases which do not receive a specific allocation receive an allowance allocation based on a formula represented by a percentage factor based on underlying collateral, type of loan and lease, historical charge-offs and general economic conditions which is applied against the general portfolio segments.

 

It is the policy of management to make additions to the allowance for loan and lease losses so that it remains adequate to cover anticipated charge-offs and management believes that the allowance at March 31, 2005 is adequate. However, the determination of the amount of the allowance is judgmental and subject to economic conditions which cannot be predicted with certainty. Accordingly, the Company cannot predict whether charge-offs of loans and leases in excess of the allowance may be required in future periods. The provision for loan and lease losses reflects an accrual sufficient to cover projected potential charge-offs.  The table below sets forth the allocation of the allowance for loan and lease losses by loan type as of the dates specified. The allocation of individual categories of loans includes amounts applicable to specifically identified, as well as unidentified, losses inherent in that segment of the loan and lease portfolio and will necessarily change whenever management determines that the risk characteristics of the loan portfolio have changed.

 

Management believes that any breakdown or allocation of the allowance for loan and lease losses into loan categories lends an appearance of exactness which does not exist, in that the allowance is utilized as a single unallocated allowance available for all loans and undisbursed commitments.

 

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The following table summarizes the activity in the allowance for loan and lease losses for the periods indicated (dollars in thousands):

 

		Three Months Ended March 31,
		2005			2004
Beginning balance for allowance for loan and lease losses		$	13,786		$	11,529
Provision for loan and lease losses		450			710
Charge offs:
Commercial		45			25
Real estate		—			—
Agricultural		—			—
Other		8			19
Total charge offs		53			44
Recoveries:
Commercial		103			13
Real estate		—			—
Agricultural		—			—
Other		2			1
Total recoveries		105			14
Net recoveries (charge offs)		52			(30		)
Undisbursed amount transferred out		—			(44		)
Ending balance		$	14,288		$	12,165
Allowance for loan and lease losses to total loans		1.47%			1.42%
Annualized net recoveries (charge offs) to average loans		0.02%			-0.01%

 

Liquidity

 

A Funds Management Policy has been developed by the Company’s Management and approved by the Company’s Board of Directors that establishes guidelines for the investments and liquidity of the Company. The goals of this policy are to provide liquidity to meet the financial requirements of the Company’s customers, maintain adequate reserves as required by regulatory agencies and maximize earnings of the Company. The Company’s liquidity ratio at March 31, 2005 was 10.7% and was 12.7% at December 31, 2004.  The reduction in the liquidity ratio at March 31, 2005 is due to a decrease in cash and cash equivalents of  $17 million which can primarily be attributed to growth in gross loans of $32 million offset by growth in deposits and borrowings of $17 million.  Liquidity is computed by dividing liquid assets (consisting of cash and due from banks, available-for-sale investments not pledged, federal funds sold and loans held for sale) by total liabilities. The Company’s Management believes it maintains adequate liquidity levels.

 

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Capital Adequacy

 

Overall capital adequacy is monitored on a day-to-day basis by the Company’s Management and reported to the Company’s Board of Directors on a monthly basis. The Company’s and subsidiary banks’ regulators measure capital adequacy by using a risk-based capital framework and by monitoring compliance with minimum risk-based and leverage ratio guidelines. Under the risk-based capital standards, assets reported on the Company’s balance sheet and certain off-balance sheet items are assigned to risk categories, each of which is assigned a risk weight.

 

This standard characterizes an institution’s capital as being “Tier 1” capital (defined as principally comprising shareholders’ equity and qualifying subordinated debentures) and “Tier 2” capital (defined as principally comprising the qualifying portion of the allowance for loan and lease losses and any remaining subordinated debentures).

 

The minimum ratio of total risk-based capital to risk-weighted assets, including certain off-balance sheet items, is 8% (10% to be considered well-capitalized).  The minimum ratio of Tier 1 capital to average assets (leverage ratio) is 4.0% (5.0% to be considered well-capitalized).  The minimum ratio of Tier 1 capital to risk-weighted assets is 4.0% (6.0% to be considered well-capitalized).  At least one-half (4%) of the total risk-based capital (Tier 1) is to be comprised of common equity; the balance may consist of debt securities and a limited portion of the allowance for loan and lease losses.  Subordinated debentures in the amount of $36 million are included in the Company’s Tier 1 capital as of March 31, 2005 and December 31, 2004, respectively, as allowed by Federal Reserve regulations, in the consolidated totals below.

 

The following table sets forth the Company’s and its banking subsidiaries’ capital ratios as of the dates indicated.

 

		March 31, 2005										December 31, 2004
		ACB		CCB		LCB		WSNB		Company		ACB		CCB		LCB		WSNB		Company
Total risk-based capital to risk-weighted assets		11.0%		12.3%		10.6%		11.5%		12.7%		10.3%		12.3%		11.8%		11.2%		12.6%
Tier 1 capital to risk-weighted assets		9.8%		11.0%		9.3%		10.3%		11.5%		9.0%		11.0%		10.5%		9.9%		11.3%
Tier 1 capital to average assets (leverage ratio)		8.1%		8.6%		8.7%		9.0%		9.7%		7.3%		8.5%		9.6%		8.6%		9.5%

 

The Company and its bank subsidiaries continue to meet all regulatory capital requirements at March 31, 2005.

 

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