<PAGE>
SECURITIES AND EXCHANGE COMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
VALLEY NATIONAL CORPORATION
----------------------------------------------
(Name of small business issuer in its charter)
IRS Employer ID. NO. 33-0825336
1234 East Main Street, El Cajon, California 92021
-------------------------------------------------
(Address of principal executive offices)
Issuer's telephone number, including area code: (619) 593-3330
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months and (2) has been
subject to such filing requirements for the past 90 days. Yes X No
As of August 10, 1999, there were 2,782,635 shares of Common Stock ($0.0001 par
value) outstanding.
Transitional Small Business Disclosure Format: Yes No X
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
ASSETS 1999 1998
------------- ------------
<S> <C> <C>
Cash and due from banks $ 12,168,000 $ 11,704,000
Federal funds sold 10,950,000 11,890,000
Interest-earning deposits 6,002,000 6,396,000
Securities:
Available-for-sale 22,815,000 23,609,000
Held-to-maturity 23,117,000 22,953,000
Federal Reserve Bank stock 447,000 445,000
Loans, net 161,655,000 149,708,000
Premises and equipment, net 4,776,000 4,978,000
Other real estate owned, net 1,050,000 1,103,000
Accrued interest receivable 1,647,000 1,617,000
Other assets 3,045,000 2,397,000
------------- ------------
Total assets $ 247,672,000 $236,800,000
------------- ------------
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 48,545,000 $ 44,015,000
Savings 110,246,000 115,940,000
Time deposits under $100,000 44,504,000 37,891,000
Time deposits of $100,000 or more 23,011,000 18,547,000
------------- ------------
Total deposits 226,306,000 216,393,000
Long-term debt 35,000 52,000
Accrued expenses and other liabilities 1,061,000 945,000
------------- ------------
Total liabilities 227,402,000 217,390,000
------------- ------------
Stockholders' equity:
Common stock, $.0001 par value; authorized 10,000,000 shares;
issued and outstanding 2,783,000 and 2,778,000 shares as of
June 30, 1999 and December 31, 1998, respectively 17,140,000 17,121,000
Accumulated other comprehensive income - unrealized gains
(losses) on securities available-for-sale, net (241,000) 142,000
Retained earnings 3,371,000 2,147,000
------------- ------------
Total stockholders' equity 20,270,000 19,410,000
------------- ------------
Total liabilities and stockholders' equity $ 247,672,000 $236,800,000
------------- ------------
------------- ------------
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Earnings
(Unaudited)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $3,865,000 $3,539,000 $7,554,000 $7,050,000
Interest on securities
Taxable 429,000 322,000 857,000 679,000
Exempt from federal income taxes 206,000 175,000 411,000 338,000
Interest on federal funds sold 89,000 325,000 253,000 523,000
Interest on interest-earning deposits 84,000 67,000 171,000 133,000
---------- ---------- ---------- ----------
4,673,000 4,428,000 9,246,000 8,723,000
---------- ---------- ---------- ----------
Interest expense:
Time deposits of $100,000 or more 234,000 192,000 443,000 386,000
Other deposits 1,161,000 1,373,000 2,346,000 2,736,000
---------- ---------- ---------- ----------
1,395,000 1,565,000 2,789,000 3,122,000
---------- ---------- ---------- ----------
Net interest income before provision for
loan losses 3,278,000 2,863,000 6,457,000 5,601,000
Provision for loan losses 110,000 168,000 260,000 349,000
---------- ---------- ---------- ----------
Net interest income after
provision for loan losses 3,168,000 2,695,000 6,197,000 5,252,000
---------- ---------- ---------- ----------
Other operating income:
Service charges on deposit accounts 419,000 387,000 831,000 787,000
Merchant processing fees 181,000 134,000 332,000 243,000
Mortgage brokerage fees 72,000 60,000 136,000 104,000
Gain on sale of loans 29,000 36,000 59,000 36,000
Other 216,000 156,000 361,000 253,000
---------- ---------- ---------- ----------
917,000 773,000 1,719,000 1,423,000
---------- ---------- ---------- ----------
Other operating expenses:
Compensation and employee benefits 1,380,000 1,278,000 2,744,000 2,605,000
Occupancy expense 287,000 276,000 592,000 560,000
Furniture and equipment 187,000 169,000 370,000 323,000
Other 1,061,000 812,000 2,049,000 1,574,000
---------- ---------- ---------- ----------
2,915,000 2,535,000 5,755,000 5,062,000
---------- ---------- ---------- ----------
Income before income taxes 1,170,000 933,000 2,161,000 1,613,000
Income tax expense 420,000 333,000 767,000 565,000
---------- ---------- ---------- ----------
Net earnings $ 750,000 $ 600,000 $1,394,000 $1,048,000
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Basic earnings per share $ 0.27 $ 0.22 $ 0.50 $ 0.38
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted earnings per share $ 0.25 $ 0.20 $ 0.46 $ 0.35
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the six months ended
June 30,
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net earnings $ 1,394,000 $ 1,048,000
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Gain on sale of loans (59,000) (36,000)
Depreciation and amortization 516,000 463,000
Gain on sale of other real estate owned (8,000) (23,000)
Provision for loan losses 260,000 349,000
Provision for losses on other real estate owned 30,000 30,000
Increase in accrued interest receivable and
other assets (423,000) (791,000)
Increase in accrued expenses and other liabilities 142,000 271,000
------------ ------------
Net cash provided by operating activities 1,852,000 1,311,000
------------ ------------
Cash flows from investing activities:
Purchases of securities held-to-maturity (202,000) (1,567,000)
Maturities of securities available-for-sale 1,945,000 5,480,000
Purchases of securities available-for-sale (1,827,000) (2,099,000)
Net (increase) decrease in interest-earning deposits 394,000 2,000
Purchases of Federal Reserve Bank stock (2,000) (59,000)
Net increase in loans outstanding (12,894,000) (4,439,000)
Purchases of premises and equipment (238,000) (271,000)
Proceeds from sale of loans 746,000 --
Proceeds from sale of other real estate owned 31,000 132,000
------------ ------------
Net cash used in investing activities (12,047,000) (2,821,000)
------------ ------------
Cash flows from financing activities:
Net increase in deposits 9,913,000 19,321,000
Payments on long-term debt (17,000) (15,000)
Proceeds from exercise of stock options 19,000 213,000
Cash in lieu of fractional shares (6,000) (17,000)
Cash dividends paid (190,000) (154,000)
------------ ------------
Net cash provided by financing activities 9,719,000 19,348,000
------------ ------------
Net increase (decrease) in cash and cash equivalents (476,000) 17,838,000
Cash and cash equivalents at beginning of period 23,594,000 19,293,000
------------ ------------
Cash and cash equivalents at end of period $ 23,118,000 $ 37,131,000
------------ ------------
------------ ------------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 2,767,000 $ 3,140,000
Cash paid during the period for income taxes $ 758,000 $ 489,000
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
ITEM 1. (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) NATURE OF OPERATIONS
The interim financial statements included herein have been
prepared by Valley National Corporation (the Company) without
audit, pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC"). The Company is a bank holding
company, which does substantially all of its business through its
wholly owned subsidiary Valle de Oro Bank, N.A. (the "Bank"). A
discussion of the Company is a discussion of the Bank. Certain
information and footnote disclosures, normally included in the
consolidated financial statements prepared in accordance with
generally accepted accounting principles have been condensed or
omitted pursuant to such SEC rules and regulations. These
consolidated financial statements should be read in conjunction
with the audited financial statements and notes thereto included
in the Company's latest Annual Report. In the opinion of
management, all adjustments, including normal recurring
adjustments necessary to present fairly the financial position of
the Company with respect to the interim financial statements and
the results of its operations for the interim period ended June
30, 1999, have been included. Certain reclassifications may have
been made to prior year amounts to conform to the 1998
presentation. The results of operations for interim periods are
not necessarily indicative of results for the full year.
The Company operates six offices in San Diego County, California.
The Company's primary source of revenue is interest from real
estate and commercial loans to individuals and small to
middle-market businesses. The accounting and reporting policies of
the Company conform to generally accepted accounting principles
and to general practices within the banking industry. The
following is a description of the more significant policies.
(B) CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, cash and cash
equivalents consist of cash, due from banks and Federal funds
sold. Generally, Federal funds are sold for one-day periods. The
Bank keeps $350,000 on deposit at the Federal Reserve Bank in
accordance with a compensating balance arrangement in addition to
required reserve balances.
(C) SECURITIES
Management determines the appropriate classification of securities
at the time of purchase. If management has the intent and the
Company has the ability at the time of purchase to hold securities
until maturity, they are classified as held-to-maturity.
Securities held-to-maturity are stated at cost, adjusted for
amortization of premiums and accretion of discounts over the
period to call or maturity of the related security using the
interest method. Securities to be held for indefinite periods of
time, but not necessarily to be held-to-maturity or on a long-term
basis, are classified as available-for-sale and carried at fair
value with unrealized gains or losses, net of tax, reported as a
separate component of other comprehensive income until realized.
Realized gains or losses on the sale of securities
available-for-sale, if any, are determined using the amortized
cost of the specific securities sold. Securities
available-for-sale include securities that
5
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
management intends to use as part of its asset/liability
management strategy and that may be sold in response to changes in
interest rates, prepayment risk and other related factors.
Securities are individually evaluated for appropriate
classification, when acquired; consequently, similar types of
securities may be classified differently depending on factors
existing at the time of purchase.
When a security is sold, the realized gain or loss, determined on
a specific-identification basis, is included in earnings. To the
extent a security has a decline in fair value, which is determined
by the Company as other than temporary, the adjusted cost basis is
written down to fair value and the amount of the write-down is
charged to earnings.
(D) LOANS AND LOAN FEES
Loans are stated at the amount of principal outstanding. Interest
income is accrued daily on the outstanding loan balances using the
simple-interest method. Loans are generally placed on nonaccrual
status when the borrowers are past due 90 days and when payment in
full of principal or interest is not expected. At the time a loan
is placed on nonaccrual status, any interest income previously
accrued but not collected is reversed against current period
interest income. Income on nonaccrual loans is subsequently
recognized only to the extent cash is received and the loan's
principal balance is deemed collectible. Loans are restored to
accrual status when the loans become both well secured and are in
process of collection.
Nonrefundable fees and related direct costs associated with the
origination of loans are deferred and netted against outstanding
loan balances. Net deferred fees and costs are recognized in
interest income over the terms of the loans using the interest
method. The amortization of loan fees is discontinued on
nonaccrual loans.
(E) ALLOWANCE FOR LOAN LOSSES
An allowance for loan losses is maintained at a level deemed
appropriate by management to adequately provide for known and
inherent risks in the loan portfolio and other extensions of
credit, including off-balance sheet credit extensions. The
allowance is based upon a continuing review of the portfolio, past
loan loss experience, current economic conditions that may affect
the borrowers' ability to pay, and the underlying collateral value
of the loans. When a loan or portion of a loan is determined to be
uncollectible, the portion deemed uncollectible is charged off and
deducted from the allowance. The provision for loan losses and
recoveries on loans previously charged off are added to the
allowance.
A loan is considered impaired when it is probable that a creditor
will be unable to collect all amounts due according to the
original contractual terms of the loan agreement. If the measure
of the impaired loan is less than the recorded investment in the
loan, a valuation allowance is established with a corresponding
charge to the provision for loan losses. Since substantially all
of the Company's loans are collateral dependent, the calculation
of the allowance for losses on impaired loans is generally based
on the fair value of the collateral, less estimated costs of
disposal.
The allowance for loan losses is subjective and may be adjusted in
the future because of changes
6
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
in economic conditions and the repayment abilities of the
borrowers. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review
the Company's allowance. These agencies may require the Company to
recognize additions to the allowance based on their judgments
related to information available to them at the time of their
examinations.
(F) PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated
depreciation. Depreciation is charged to operating expense using
the straight-line method over the estimated useful lives of
depreciable assets, which range from 3 to 30 years. Leasehold
improvements are capitalized and amortized to operating expense
over the term of the respective lease or the estimated useful life
of the improvement, whichever is shorter.
(G) OTHER REAL ESTATE OWNED
Real estate properties acquired through loan foreclosure or
through acceptance of a deed-in-lieu of foreclosure are initially
recorded at fair value, less estimated selling costs at the date
of foreclosure. Once real estate properties are acquired,
valuations are periodically obtained by management and an
allowance for losses is established by a charge to operations if
the carrying value of a property exceeds its fair value, less
estimated costs of disposal. Real estate properties held for sale
are carried at the lower of cost, including the cost of
improvements and amenities incurred subsequent to acquisition, or
fair value, less estimated selling costs. Costs related to
development and improvement of properties are capitalized, whereas
costs relating to holding the properties are expensed.
(H) INCOME TAXES
Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in earnings in the period that includes the enactment
date.
(I) EARNINGS PER SHARE
Basic earnings per share is computed by dividing net earnings by
the weighted-average number of shares of common stock outstanding
during the period. Diluted earnings per share is computed by
dividing net earnings by the weighted-average number of shares of
common stock, common stock equivalents and other potentially
dilutive securities outstanding during the period.
7
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
The weighted-average number of shares used for the earnings per
share calculations was:
<TABLE>
<CAPTION>
For the three months ended For the six months ended
June 30, June 30,
1999 1998 1999 1998
------------------------ -------------------------
<S> <C> <C> <C> <C>
Basic 2,783,000 2,755,000 2,782,000 2,755,000
Diluted 3,029,000 3,002,000 3,023,000 2,977,000
</TABLE>
These calculations reflect the 5% stock dividend paid on May 28,
1999.
(J) USE OF ESTIMATES
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities
and the disclosure of contingent assets and liabilities at the
date of the consolidated financial statements and the reported
amounts of revenue and expenses during the reporting period to
prepare these financial statements in conformity with generally
accepted accounting principles. Actual results could differ from
those estimates.
(K) COMPREHENSIVE INCOME
Comprehensive income for the periods indicated is as follows:
<TABLE>
<CAPTION>
For the three months ended For the six months ended
June 30, June 30,
1999 1998 1999 1998
------------------------------- ---------------------------------
<S> <C> <C> <C> <C>
Net earnings $750,000 $600,000 $1,394,000 $1,048,000
Change in unrealized gains
(losses) on securities
available for sale (444,000) (7,000) (638,000) 23,000
Income tax benefit (expense) 178,000 3,000 255,000 (10,000)
------------------------------- ---------------------------------
Comprehensive net income $484,000 $596,000 $1,011,000 $1,061,000
------------------------------- ---------------------------------
------------------------------- ---------------------------------
</TABLE>
(L) YEAR 2000
The Company has developed a remediation plan and is in the process
of converting computer systems and applications for the Year 2000.
Expenditures related to Year 2000 issues are expensed as incurred.
(M) RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to
the current year's presentation.
8
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(2) SECURITIES AVAILABLE-FOR-SALE
The amortized cost, gross unrealized gains and losses and fair value of
securities available-for-sale as of June 30, 1999 and December 31, 1998
are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------- ---------- ----------- -------------
<S> <C> <C> <C> <C>
JUNE 30, 1999:
U.S. Treasury notes and U.S.
agency securities $ 14,211,000 $ 22,000 $ (215,000) $ 14,018,000
Obligations of states and
political subdivisions 8,705,000 26,000 (230,000) 8,501,000
Corporate obligations 301,000 -- (5,000) 296,000
------------- ---------- ----------- -------------
$ 23,217,000 $ 48,000 $ (450,000) $ 22,815,000
------------- ---------- ----------- -------------
------------- ---------- ----------- -------------
</TABLE>
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------- ---------- ----------- -------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1998:
U.S. Treasury notes and U.S.
agency securities $ 14,655,000 $ 155,000 $ (55,000) $ 14,755,000
Obligations of states and
political subdivisions 8,417,000 162,000 (23,000) 8,556,000
Corporate obligations 301,000 -- (3,000) 298,000
------------- ---------- ----------- -------------
$ 23,373,000 $ 317,000 $ (81,000) $ 23,609,000
------------- ---------- ----------- -------------
------------- ---------- ----------- -------------
</TABLE>
The maturity distribution based on amortized cost and fair value as of
June 30, 1999, by contractual maturity, is shown below. Expected
maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
----------- -----------
<S> <C> <C>
Due in one year or less $ 2,858,000 $ 2,858,000
Due after one year through five years 13,615,000 13,376,000
Due after five years through ten years 6,365,000 6,209,000
Due after ten years 379,000 372,000
----------- -----------
$23,217,000 $22,815,000
----------- -----------
----------- -----------
</TABLE>
As of June 30, 1999, securities held-to-maturity with an amortized cost
of $3,404,000 and securities
9
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
available-for-sale with a fair value of $2,776,000 totaling $6,180,000
were pledged as security for public deposits and other purposes as
required by various statutes and agreements.
(3) SECURITIES HELD-TO-MATURITY
The amortized cost, gross unrealized gains and losses and fair value of
securities held-to-maturity as of June 30, 1999 and December 31, 1998 are
as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- --------- ------------ -----------
<S> <C> <C> <C> <C>
JUNE 30, 1999:
U.S. Treasury notes and U.S.
government agencies $ 7,495,000 $ 11,000 $ (169,000) $ 7,337,000
Obligations of states and
political subdivisions 15,158,000 156,000 (134,000) 15,180,000
Corporate obligations 464,000 -- -- 464,000
----------- --------- ------------ -----------
$23,117,000 $ 167,000 $ (303,000) $22,981,000
----------- --------- ------------ -----------
----------- --------- ------------ -----------
</TABLE>
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- --------- ------------ -----------
<S> <C> <C> <C> <C>
DECEMBER 31, 1998:
U.S. Treasury notes and U.S.
government agencies $ 7,499,000 $ 85,000 $ (17,000) $ 7,567,000
Obligations of states and
political subdivisions 14,986,000 609,000 -- 15,595,000
Corporate obligations 468,000 2,000 -- 470,000
----------- --------- ------------ -----------
$22,953,000 $ 696,000 $ (17,000) $23,632,000
----------- --------- ------------ -----------
----------- --------- ------------ -----------
</TABLE>
The maturity distribution based on amortized cost and fair value as of
June 30, 1999, by contractual maturity, is shown below. Expected
maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
----------- -----------
<S> <C> <C>
Due in one year or less $ 1,675,000 $ 1,680,000
Due after one year through five years 9,802,000 9,680,000
Due after five years through ten years 9,423,000 9,343,000
Due after ten years 2,217,000 2,278,000
----------- -----------
$23,117,000 $22,981,000
----------- -----------
----------- -----------
</TABLE>
10
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(4) LOANS
The composition of the Company's loan portfolio is as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
------------- -------------
<S> <C> <C>
Construction $ 10,094,000 $ 7,960,000
Real estate 80,757,000 66,850,000
Commercial and industrial loans 58,123,000 62,341,000
Installment 15,132,000 14,754,000
All other loans (including overdrafts) 350,000 308,000
164,456,000 152,213,000
Less allowance for loan losses (1,949,000) (1,687,000)
Less deferred loan fees (852,000) (818,000)
------------- -------------
$ 161,655,000 $ 149,708,000
------------- -------------
------------- -------------
</TABLE>
Although the Company seeks to avoid undue concentrations of loans to a
single industry or based upon a single class of collateral, the Company's
loan portfolio consists primarily of loans to borrowers within San Diego
County and, as a result, the Company's loan and collateral portfolios are
to some degree concentrated. The portfolio is well diversified in both
project type and area within the San Diego County region. The Company
evaluates each credit on an individual basis and determines collateral
requirements accordingly. When real estate is taken as collateral,
advances are generally limited to a certain percentage of the appraised
value of the collateral at the time the loan is made, depending on the
type of loan, the underlying property and other factors.
The Company has established a monitoring system for its loans in order to
identify potential problem loans and to permit the periodic evaluation of
impairment and the adequacy of the allowance for loan losses in a timely
manner. Impaired loans included in the Company's loan portfolio as of
June 30, 1999 and December 31, 1998 were $140,000 and $92,000,
respectively, which have aggregate specific related allowance amounts of
$35,000 and $9,000, respectively. For the six months ended June 30, 1999,
the average balance of impaired loans was $142,000. For the six months
ended June 30, 1999, interest income of $5,000 was recognized on these
loans during the period of impairment.
11
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
A summary of the activity in the allowance for loan losses for the six
months ended June 30, is as follows:
<TABLE>
<CAPTION>
JUNE 30,
1999 1998
----------- -----------
<S> <C> <C>
Balance, beginning of period $ 1,687,000 $ 1,342,000
Provision for loan losses charged to expense 260,000 349,000
Loans charged off to the allowance (16,000) (154,000)
Recoveries credited to the allowance 18,000 43,000
----------- -----------
Balance, end of period $ 1,949,000 $ 1,580,000
----------- -----------
----------- -----------
</TABLE>
Loans on nonaccrual amounted to $535,000, and $92,000 as of June 30, 1999
and December 31, 1998, respectively. Interest income of $23,000 would
have been recorded for the six months ended June 30, 1999 if nonaccrual
loans had been on a current basis, in accordance with their original
terms. Interest income of $2,000 was recognized on loans subsequently
transferred to nonaccrual status during the six months ended June 30,
1999. Loans contractually past due greater than 90 days and still
accruing interest totaled approximately $53,000 and $437,000, as of June
30, 1999 and December 31, 1998, respectively.
In the normal course of business, the Company has granted loans to
certain directors and their affiliates under terms which Company
management believes are consistent with the Company's general lending
policies. An analysis of this activity for the six months ended June 30,
1999 is as follows:
<TABLE>
<CAPTION>
JUNE 30,
1999
-----------
<S> <C>
Balance, beginning of period $ 1,113,000
Loans granted, including renewals 49,000
Repayments (120,000)
-----------
Balance, end of period $ 1,042,000
-----------
-----------
</TABLE>
The Company had additional commitments for loans of $1,930,000 to these
individuals as of June 30, 1999.
12
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(5) PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
----------- -----------
<S> <C> <C>
Land $ 746,000 $ 746,000
Buildings 1,540,000 1,500,000
Leasehold improvements 3,335,000 3,318,000
Furniture, fixtures and equipment 4,058,000 3,888,000
9,679,000 9,452,000
Less accumulated depreciation and amortization (4,903,000) (4,474,000)
----------- -----------
$ 4,776,000 $ 4,978,000
----------- -----------
----------- -----------
</TABLE>
(6) OTHER REAL ESTATE OWNED
A summary of the changes in the allowance for possible losses on other
real estate owned is as follows:
<TABLE>
<CAPTION>
JUNE 30,
1999 1998
-------- --------
<S> <C> <C>
Balance, beginning of period $300,000 $240,000
Provision charged to expense 30,000 30,000
Charge-offs -- --
-------- --------
Balance, end of period $330,000 $270,000
-------- --------
-------- --------
</TABLE>
(7) DEPOSITS
The maturity distribution of time deposits as of June 30, 1999 is as
follows:
<TABLE>
<S> <C>
Three months or less $23,001,000
Over three through six months 14,000,000
Over six through twelve months 22,122,000
Over twelve months 8,392,000
-----------
Total $67,515,000
-----------
-----------
</TABLE>
13
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(8) LONG-TERM DEBT
Long-term debt of $35,000 and $52,000 at June 30, 1999 and December 31,
1998, respectively, consisted of a mortgage note payable in monthly
installments of $3,100 through July 2000, including interest at a fixed
rate of 8.5%. Future maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1999 $ 17,000
2000 18,000
--------
$ 35,000
--------
--------
</TABLE>
(9) COMMITMENTS AND CONTINGENCIES
The Company is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of
its customers and to reduce its own exposure to fluctuations in
interest rates. These financial instruments include commitments to
extend credit and standby letters of credit. Those instruments involve,
to varying degrees, elements of credit and interest rate risk in excess
of the amount recognized in the balance sheets. The contract or
notional amounts of those instruments reflect the extent of involvement
the Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by
the counterparty to the financial instrument for commitments to extend
credit and standby letters of credit is represented by the contractual
amount of those instruments. The Company uses the same credit policies
in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
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 many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash
requirements. Commitments to extend credit amounting to $45,616,000 and
$43,138,000 were outstanding as of June 30, 1999 and December 31, 1998,
respectively. Of these commitments to extend credit, $7,693,000 and
$7,747,000 represent home equity lines of credit at June 30, 1999 and
December 31, 1998, respectively, which will be repaid over a ten year
period if drawn upon. The Company evaluates each customer's
credit-worthiness on a case-by-case basis. The amount of collateral
obtained by the Company, if deemed necessary upon extension of credit,
is based on management's credit evaluation of the counterparty.
Collateral held varies but may include certificates of deposit,
accounts receivable, inventory, property, plant and equipment,
residential real estate and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support public and private
borrowing arrangements, including commercial paper, bond financing and
similar transactions. The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan
facilities to customers. The Company holds various types of collateral
14
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(primarily certificates of deposit) to support those commitments for
which collateral is deemed necessary. The Company had approximately
$588,000 and $488,000 in standby letters of credit outstanding as of
June 30, 1999 and December 31, 1998, respectively.
Most of the letters of credit expire within twelve months.
Management does not anticipate any material losses will arise from
additional fundings of the aforementioned lines of credit or letters of
credit.
As of June 30, 1999, the Company had lines of credit in the amount of
$11,500,000 from correspondent banks, of which no amounts were
outstanding. These lines are renewable annually. The availability of
the lines of credit, as well as adjustments in deposit programs,
provides for liquidity in the event that the level of deposits should
fall abnormally low. These sources provide that funding thereof may be
withdrawn depending upon the financial strength of the Company.
Because of the nature of its activities, the Company is at all times
subject to pending and threatened legal actions that arise out of the
normal course of its business. In the opinion of management, the
disposition of these matters will not have a material adverse effect on
the Company's financial position or results of operations.
(10) REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital
requirements administered by the Federal banking agencies. Under capital
adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve
quantitative measures of the Bank's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital
(as defined) to average assets (as defined). Management believes, as of
June 30, 1999, that the Bank meets all capital adequacy requirements to
which it is subject.
As of June 30, 1999, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well capitalized the Bank must maintain minimum total
risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in
the table. There are no conditions or events since that notification that
management believes have changed the Bank's category.
15
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
The Bank's actual capital amounts and ratios are also presented in the
following table.
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED
FOR CAPITAL UNDER PROMPT
ADEQUACY CORRECTIVE ACTION
ACTUAL PURPOSES PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1999:
Total Capital (to
Risk- Weighted Assets) $22,459,000 12.35% $14,548,000 8.0% $18,186,000 10.0%
Tier I Capital (to
Risk- Weighted Assets) $20,510,000 11.28% $ 7,274,000 4.0% $10,911,000 6.0%
Tier I Capital (to
Average Assets) $20,510,000 8.42% $ 9,740,000 4.0% $12,176,000 5.0%
</TABLE>
Under Federal banking law, dividends declared by the Bank in any
calendar year may not, without the approval of the Comptroller of the
Currency (OCC), exceed its net earnings for that year combined with its
retained income from the preceding two years. However, the OCC has
previously issued a bulletin to all national banks outlining new
guidelines limiting the circumstances under which national banks may
pay dividends even if the banks are otherwise statutorily authorized to
pay dividends. The limitations impose a requirement or in some cases
suggest that prior approval of the OCC should be obtained before a
dividend is paid if a national bank is the subject of administrative
action or if the payment could be viewed by the OCC as unsafe or
unusual.
16
<PAGE>
VALLEY NATIONAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(11) OTHER EXPENSES
Other expenses are as follows for the six months ended June 30:
<TABLE>
<CAPTION>
JUNE 30,
------------------------------
1999 1998
---------- ----------
<S> <C> <C>
Stationery and supplies $ 136,000 $ 118,000
Telephone, courier and postage 194,000 171,000
Data processing 296,000 275,000
Merchant processing expense 243,000 173,000
Promotional expenses 180,000 179,000
Professional services 238,000 64,000
Insurance 94,000 96,000
FDIC and regulatory assessments 45,000 38,000
Other real estate owned expenses 26,000 21,000
Other 597,000 439,000
---------- ----------
$2,049,000 $1,574,000
---------- ----------
---------- ----------
</TABLE>
(12) PENDING MERGER
On May 10, 1999, the Company announced that a definitive agreement has
been signed under which the Company will merge with Community First
Bankshares, Inc. The Company's principal subsidiary, Valle de Oro Bank,
N.A. will merge into Community First Bankshares, Inc. The agreement is
subject to regulatory and other approvals and is expected to close in
the fourth quarter of 1999. The merger is structured to be tax-free and
is intended to be accounted for as a pooling of interests.
Shares of Valley National Corporation stock will be exchanged for
shares of Community First using an exchange rate between 0.775 and
1.119 shares of Community First for each share of Valley National
Corporation. The exact exchange rate will be determined by first
calculating the total number of Community First shares to be used in
the exchange by dividing $65 million by the average trading value of
Community First for the 20 trading days ending with the fourth
trading day before the close of the transaction. Second, the
exchange rate will be determined by dividing the total number of
Valley National Corporation shares outstanding or subject to
options, warrants or other rights, which is currently calculated to
be 3,226,029, by the number of Community First shares as calculated
above. The exchange rate is also subject to certain minimum and
maximum number of shares to be issued by Community First.
17
<PAGE>
ITEM 2. Management's Discussion and Analysis or Plan of Operation
Statements made in this report that state the intentions, beliefs, expectations
or predictions of the future by the Company or its management are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company's actual results could differ
materially from those projected in such forward-looking statements.
LIQUIDITY
Cash and cash equivalents at June 30, 1999 totaled $23.1 million, or 9.3% of
total assets, compared to $23.6 million at December 31, 1998. This decrease was
the result of loans increasing during the period at a faster rate than deposits.
Net loans increased $11.9 million during the first six months of 1999 as a
result of improved loan demand, especially in commercial real estate and
construction lending. Total deposits, by comparison, increased $9.9 million
during this same period, primarily in time deposits.
By comparison, cash and cash equivalents was $37.1 million at June 30, 1998.
During the first six months of 1998 deposits increased at a greater rate than
loans with the excess funds being initially invested in federal funds sold.
A secondary source of liquidity is securities classified available-for-sale,
which at June 30, 1999 had a fair value of $22.8 million or 9.2% of total
assets. Of this amount, $2.9 million mature in one year or less. In addition,
the Company invests in interest-earning deposits with other financial
institutions totaling $6.0 million at June 30, 1999. A majority of these
interest-earning deposits mature in one year or less. Both securities
available-for-sale and interest-earning deposits act as secondary sources of
liquidity, if needed.
The Company also maintains lines of credit with correspondent banks for the
purchase of overnight funds in amounts up to $11.5 million, subject to
availability. The Company also has the ability to borrow funds from the Federal
Reserve Bank's discount window. Historically, the Company has used these
facilities infrequently.
The ability of the Company to obtain funds for the payment of dividends and for
other cash requirements is largely dependent upon the amount of dividends that
may be declared and paid by Valle de Oro Bank (the Bank). Dividends paid by a
national bank, like Valle de Oro Bank, are regulated by the Office of the
Comptroller of the Currency under its general supervisory authority as it
relates to a bank's requirement to maintain adequate capital. A national banking
association may declare a dividend without the approval of the Office of the
Comptroller of the Currency as long as the total of dividends declared in a
calendar year does not exceed the total of net profits for that year combined
with the retained profits for the preceding two years.
CAPITAL RESOURCES
Valle de Oro Bank continues to be classified under the federal banking agencies'
regulatory requirements as "well" capitalized. The Bank maintains a margin of
capital in excess of the minimum requirements, which will allow for future
growth (see Note 10 to the unaudited consolidated financial statements).
Historically, the Bank has increased capital primarily through the generation
and retention of net earnings.
The Company's quarterly cash dividend was increased in the third quarter of 1998
to $0.035 per share from $0.03 per share, adjusting for the two-for-one stock
split on April 1, 1999. This increase reflected the
18
<PAGE>
Company's continuing rise in net earnings, and is not expected to adversely
affect the Company's level of capital.
RESULTS OF OPERATIONS
Net earnings for the six months ended June 30, 1999 was $1,394,000 compared to
$1,048,000 for the same period in 1998. Basic earnings per share for the six
month period ended June 30, 1999 was $0.50 compared to $0.38 per share for the
same period in 1998. Diluted earnings per share for the six month period ended
June 30, 1999 was $0.46 compared to $0.35 per share for the same period in 1998.
The increase in net earnings was primarily the result of higher net interest
income, lower provision for loan losses, and higher other operating income.
Net earnings for the three months ended June 30, 1999 was $750,000 compared to
$600,000 for the same period in 1998. Basic earnings per share for the quarter
ended June 30, 1999 was $0.27 compared to $0.22 per share for the same period in
1998. Diluted earnings per share for the three month period ended June 30, 1999
was $0.25 compared to $0.20 per share for the same period in 1998. The increase
in net earnings for the second quarter of 1999 compared to the second quarter of
1998 was also the result of higher net interest income due to the growth of
earning assets and lower interest expense, lower provision for loan losses, and
higher other operating income.
<TABLE>
<CAPTION>
For the six months ended June 30,
1999 1998
----------- ----------
Average Int Earned/ Average Int Earned/
(In thousands) Amount Paid Yield Amount Paid Yield
------------- ------------ -------- ------------ ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Loans, net $ 153,366 $ 7,554 9.85% $ 134,127 $ 7,050 10.51%
Investment securities:
Taxable 29,636 857 5.78% 22,190 679 6.12%
Exempt from federal income taxes 17,517 411 7.81% 13,836 338 8.14%
Federal funds sold 10,875 253 4.66% 19,493 523 5.37%
Deposits with financial institutions 6,214 171 5.51% 4,482 133 5.92%
--------- ------- ---- --------- ------- ----
Total earning assets 217,608 $ 9,246 8.50% $ 194,128 $ 8,723 8.99%
Non-earning assets 24,531 21,040
--------- ---------
Total assets $ 242,139 $ 215,168
--------- ---------
--------- ---------
Time deposits of $100,000 or more $ 18,870 $ 443 4.70% $ 14,619 $ 386 5.28%
All other interest-bearing deposits 154,374 2,346 3.04% 142,837 2,736 3.83%
------- ------- ---- --------- ------- ----
Total interest-bearing deposits 173,244 $ 2,789 3.22% 157,456 $ 3,122 3.97%
Noninterest-bearing deposits 47,695 39,246
Other liabilities 1,157 906
Stockholders' equity 20,043 17,560
--------- ---------
Total liabilities and
stockholders'
Equity $ 242,139 $ 215,168
--------- ---------
--------- ---------
Interest income/earning assets $ 9,246 8.50% $ 8,723 8.99%
Interest expense/earning assets 2,789 2.57% 3,122 3.22%
------- ---- ------- ----
------- ---- ------- ----
Net interest income $ 6,457 5.93% $ 5,601 5.77%
------- --------
------- --------
</TABLE>
Yields on tax-exempt securities are stated on a fully tax-equivalent basis using
a rate of 40%.
19
<PAGE>
Net interest income for the six month and three month periods ended June 30,
1999 increased due to the growth of earning assets and lower cost of funds.
Average earning assets grew to $217.6 million at June 30, 1999 compared to
$194.1 million at June 30, 1998.
Since the beginning of 1999, loan demand has improved for the company.
Commercial real estate and construction lending activity has been strong,
followed by increases in multi-family real estate and home equity credit lines.
In addition, average taxable and tax-exempt securities increased as well as
interest-earning deposits with other financial institutions. Average federal
funds sold have declined over the past 12 months. Short-term interest rates
declined in the fourth quarter of 1998 prompting the decrease in federal funds
sold and the increase in securities. Recently, with upward pressure on
short-term interest rates, the Company is reversing this strategy and not
increasing securities as much as federal funds sold.
As a result of the decline in short-term interest rates over the past year,
interest expense decreased in both the six month and three month periods ended
June 30, 1999 compared to the same periods in 1998. The average yield on
interest-bearing deposits decreased to 3.22% for the six month period ended June
30, 1999 from 3.97% for the same period in 1998. In addition to the growth of
earning assets, this decline in average yield on interest-bearing deposits
helped to further increase net interest margin in both the six months and three
months ended June 30, 1999.
Changes Due to Volume and Rate
<TABLE>
<CAPTION>
1999 Change due to 1998 Change due to
(In thousands) Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
<S> <C> <C> <C> <C> <C> <C>
Loans, net $ 948 $(444) $ 504 $ 891 $(161) $ 730
Investment securities
Taxable 215 (37) 178 (60) (9) (69)
Exempt from federal income taxes 86 (13) 73 81 1 82
Federal funds sold (201) (69) (270) 89 15 104
Deposits with financial institutions 47 (9) 38 10 -- 10
------- ----- ----- ------- ----- -----
Total $ 1,095 $(572) $ 523 $ 1,011 $(154) $ 857
Time deposits of $100,000 or more $ 100 $ (43) $ 57 $ 4 $ (6) $ (2)
All other deposits 175 (565) (390) 290 12 302
------- ----- ----- ------- ----- -----
Total $ 275 $(608) $(333) $ 294 $ 6 $ 300
------- ----- ----- ------- ----- -----
$ 820 $ 36 $ 856 $ 717 $(160) $ 557
------- ----- ----- ------- ----- -----
------- ----- ----- ------- ----- -----
</TABLE>
Net interest income for the six month period ended June 30, 1998 increased to
$5.6 million compared to the same period of 1997 as a result of the growth of
earning assets. Between June 1998 and 1997, average earning assets increased
$22.0 million, or 12.8%, to $194.1 million with the largest increases in loans
and federal funds sold. During the six month period ended June 30, 1998, the
overall yield on earning assets declined as a result of decreases in yields on
loans and taxable securities. Loan yields declined during this period due to
lower demand for loans and aggressive competition from both bank and non-bank
competitors.
PROVISION FOR LOAN LOSSES
When determining the provision for loan losses, management considers such
factors as loan growth, historical
20
<PAGE>
loan losses, delinquencies, current economic factors, collateral values, and
potential risks identified in the portfolio. Due to lower net loan losses,
the provision for loan losses declined in the first six months and second
quarter of 1999 compared to the same period in 1998. Loans charged off to the
allowance for loan losses totaled $16,000 for the six month period ended June
30, 1999 with loan recoveries totaling $18,000. By comparison, loans charged
off to the allowance for loan losses for the same period in 1998 totaled
$154,000 and recoveries totaled $43,000. Loans on nonaccrual status were
$535,000 as of June 30, 1999 compared to $92,000 as of December 31, 1998.
OTHER OPERATING INCOME
Service charges on deposit accounts increased to $831,000 in the first six
months of 1999 compared to $787,000 in the same period in 1998 and increased to
$419,000 in the second quarter of 1999 compared to $387,000 for the second
quarter of 1998. These increases were the result of the growth in Company
deposits and the increased number of accounts subject to charge. The Company did
not change its service charge fees between June 30, 1998 and 1999.
Merchant processing fees increased to $332,000 for the six month period ended
June 30, 1999 compared to $243,000 for the same period in 1998 and increased to
$181,000 for the three month period ended June 30, 1999 compared to $134,000 for
the same period in 1998 as a result of an increase in merchant transaction fees
and the growth of the merchant program.
Mortgage brokerage fees have increased due to low mortgage rates and the
resulting increased real estate sales and refinancing activity.
Gain on sale of loans is the result of sales of the guaranteed portion of SBA
loans, which the Company has done more frequently in 1999 than 1998. Other
income increased primarily as a result of increased commissions earned on the
sale of mutual funds, annuities and other nondeposit investment products.
OTHER OPERATING EXPENSE
Compensation and employee benefits increased to $2,744,000 or 5.3% in the first
six months of 1999 compared to the same period in 1998 and increased to
$1,380,000 in the second quarter of 1999 compared to $1,278,000 in the second
quarter of 1998. This increase is primarily the result of pay increases and
promotions granted to staff members for improved performance in their assigned
duties. Staffing levels have remained fairly steady over the past year and
expense controls have been effective.
Occupancy expense increased $32,000 to $592,000 and furniture and equipment
expense increased $47,000 to $370,000 in the first six months of 1999 compared
to the same period in 1998 primarily as a result of increases in the operating
and maintenance costs of premises and equipment and higher depreciation expense
resulting from acquisitions of additional equipment.
Other operating expense increased $475,000 in the six month period ended June
30, 1999 compared to the same period in 1998 and increased $249,000 in the
second quarter of 1999 compared to the second quarter of 1998. For the six month
period ended June 30, 1999 compared to the same period in 1998, professional
services increased $174,000 largely due to the cost of forming Valley National
Corporation. Data processing, merchant processing expense, stationery,
telephone, postage and other expenses increased primarily as a result of the
growth of the Company, and to a lesser degree, price increases.
21
<PAGE>
INFLATION
There were no adverse effects on the operations of the Company as a result of
inflation during the six month period ended June 30, 1999. Inflation, in the
form of substantially higher interest rates or operating costs, has not been a
significant factor in the operations of the Company.
YEAR 2000
The Year 2000 ("Y2K") issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a variety
of system miscalculations, operating problems and system failures.
The Company is addressing its year 2000 ("Y2K") issues using a five phase
program. The five phases are awareness, assessment, renovation, validation, and
implementation. A brief description of each phase and the Company's progress
toward completing each phase follows.
The awareness phase identifies potential Y2K problems, develops an overall
strategy for addressing the issues, obtains support from the board of directors
and management, appoints a project team of employees to direct the Company's
activities, and implements an internal and external communication program to
raise awareness of the problems and issues. The Company completed this phase as
of June 30, 1998.
The assessment phase identifies all information technology systems i.e.,
hardware, software, networks, ATMs, etc., and non-information technology systems
such as alarm and security systems, and environmental controls, etc. This phase
also develops a system to evaluate and assess borrower and vendor preparedness,
including a tracking and monitoring system to identify potential problems.
The Company's program to assess borrower preparedness includes commercial, real
estate and consumer borrowers. The program is designed to evaluate each
borrower's exposure to Y2K issues, the borrower's preparedness in addressing
this exposure, and an assessment of the borrower's ability to meet its
obligations under a worst case Y2K scenario. Based on this assessment,
additional amounts are specifically allocated, as necessary, to cover potential
losses for borrowers considered having a high Y2K risk rating. In addition,
funds have been allocated to cover potential Y2K related losses, in general,
without regard to specific borrowers.
The Company has completed all of its information and non-information technology
system assessments. In addition, it has communicated with borrowers and vendors,
established a monitoring system, logged responses, and assigned risk factors.
The Company has assigned Y2K risk factors associated with its borrowers and made
an allocation of the allowance for loan losses for Y2K risk. This allocation
process will be reviewed and revised on a quarterly basis through, at least, the
first quarter of 2000. Accordingly, monitoring and communication with borrowers
and vendors is ongoing.
The Company has also made initial assessments of its liquidity position in
relation to the Y2K impact on large depositors and the deposit base, in general.
At this time, the Company does not see a high level of concern by customers
regarding their ability to conduct normal banking activities. However, the
Company has made an initial assessment of its projected level of cash and
cash-equivalents for the upcoming 1999 year-end, and is taking appropriate steps
to ensure adequate funds will be available to meet customer needs, should the
need arise. Such steps include adjusting the maturity date of certain assets to
fall in the latter part
22
<PAGE>
of the fourth quarter of 1999 and offering attractive rates on time deposits
that mature beyond 2000. The Company is currently monitoring its liquidity
position on a monthly basis.
The renovation phase involves making the necessary information technology and
non-information technology changes and upgrades necessary to be Y2K compliant.
The Company has installed new item processing equipment, new voice response
hardware and software, and new local area network servers. It has upgraded its
communication system, purchased new security and alarm systems, and installed
six new automated teller machines. The Company considers the renovation phase on
all mission critical systems to be complete.
The validation phase is the testing phase. The Company uses a third party data
processing vendor whose software is Y2K compliant. During the first quarter of
1999, proxy testing was completed with no significant Y2K issues found.
The Company has finished testing its other internal specialized systems.
The implementation phase introduces system changes into its operating
environment. Once tested, Y2K compliant systems are ready to be introduced into
the Company's operating environment. The target date for implementation of all
systems is September 30, 1999.
Contingency planning has begun. The board of directors has appointed business
resumption contingency planning project manager. A business resumption
contingency plan has been completed and testing of the plan is underway.
Complete testing and validation of the business resumption contingency plan is
scheduled to be completed by September 30, 1999.
With respect to the cost of preparing for Y2K, the Company's use of a
third-party data processor and its policy of periodically upgrading in-house
hardware and software systems have mitigated its direct expenses for Y2K. In
1998 the Company spent approximately $30,000, not including the cost of a
significant amount of Company staff time, on assessing, renovating and testing
its various systems. For the first six months of 1999, the Company has spent
approximately $13,000 on its Y2K efforts. The Company's operating budget related
to Y2K matters is $50,500 in 1999 and $13,500 in 2000. With respect to the
operating budget, a majority of the expenditures are related to testing and
customer communications planned for the third and fourth quarters of 1999. For
the year 1999, its capital budget related to Y2K matters is $100,000, including
the cost of a generator at $51,000 that was approved and installed in the second
quarter of 1999.
Although significant steps are being taken to alleviate many of the Y2K
concerns, management still considers the most likely worst case Y2K scenario
will involve the inability of the Company's utility and telephone service
providers to furnish consistent, uninterrupted power and telecommunication
services to the Company in the early weeks of 2000. This view continues to be
based solely on a lack of meaningful disclosure provided to the Company by these
companies. The correspondence the Company has received to date has been somewhat
general in nature, and lacking the specific steps they have taken and still need
to take to become fully compliant. Due to the complexity of today's power and
telecommunication systems, management feels that there may be a good chance of
occasional power outages, or loss of telephone service that may last for several
hours or even several days. The purchase of a generator, cellular telephones and
battery-operated equipment is in response to these concerns.
23
<PAGE>
PART II-OTHER INFORMATION
ITEM 1. Legal Proceedings
None.
ITEM 2. Changes in Securities
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 and Reports on Form 8-K
The Company filed a report on Form 8-K dated May 19, 1999
under Item 5 stating that on May 10, 1999 Valley National Corporation
entered into a definitive agreement to merge with Community First
Bankshares, Inc., a $5.9 billion bank holding company in Fargo, North
Dakota.
24
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Valley National Corporation
- ---------------------------
Registrant
Date: August 13, 1999
- ----------------------
/s/ Paul M. Cable
- ---------------------------------
Paul M. Cable,
Senior Vice President and Chief Financial Officer
25
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