FORM 10-KSB
U.S. Securities and Exchange Commission
Washington, D.C. 20549
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [Fee Required]
For the Fiscal Year Ended December 31, 1995
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from___________to__________
Commission File Number 2-91196(1)
NORTHERN EMPIRE BANCSHARES
(Name of small business issuer in its charter)
CALIFORNIA 94-2830529
(State of Incorporation) (I.R.S. Employer Identification Number)
801 Fourth Street
Santa Rosa, California 95404
(Address of principal executive offices)
(707) 579-2265
(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act: NONE
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 (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No____.
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year. $14,648,000
State the aggregate market value of the voting stock held by
non-affiliates computed by reference to the price at which the stock was sold,
or the average bid and asked prices of such stock, as of a specified date within
the past 60 days. $13,104,000, as of February 29, 1996.
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 1,388,579 shares of common
stock as of February 29, 1996.
DOCUMENTS INCORPORATED BY REFERENCE:
Not Applicable.
Transitional Small Business Disclosure Format: Yes No X
(1) Registrant filed a registration statement, on Form S-1, under File Number
2-91196, and the Post Effective Amendment No. 8 to the registration statement
was declared effective on November 23, 1988.
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PART 1
ITEM 1.
Description of Business
Northern Empire Bancshares (the "Corporation") was incorporated as a California
corporation on June 8, 1982 for the purpose of becoming a bank holding company
of Sonoma National Bank (the "Bank"). The Corporation's executive offices are
located at 801 Fourth Street, Santa Rosa, California, and its telephone number
is (707) 579-2265.
The Corporation's sole subsidiary is the Bank and its activities are the
commercial banking activities engaged in through the Bank and some lending. As a
bank holding company, the Corporation may in the future invest in additional
banking subsidiaries or in those non-banking subsidiaries which are permissible
for a bank holding company, subject to the required approvals of the Federal
Reserve Board. See, "Supervision and Regulation." However, the Corporation has
no present plans to make any such additional investments and there can be no
assurance that it will do so in the future.
Business of the Bank
The Bank was organized as a national banking association on March 27, 1984 and
commenced operations on January 25, 1985. It currently has three banking
offices: the main office located at 801 Fourth Street, in the central business
district of Santa Rosa, California, a branch office located in the Oakmont area
of Santa Rosa, approximately 5 miles east of the main office, and a branch in
Windsor, approximately 5 miles north of the main office.
As a national bank, the Bank is subject to supervision, regulation and regular
examination by the Comptroller of the Currency ("Comptroller"). The deposits of
the Bank are insured by the Bank Insurance Fund, which is administered by the
Federal Deposit Insurance Corporation. The Bank is a member of the Federal
Reserve System and, as such, is subject to applicable provisions of the Federal
Reserve Act and the regulations thereunder. See, "Supervision and Regulation."
Description of Business
The Bank engages in the general commercial banking business. It accepts checking
and savings deposits, offers money market deposit accounts and certificates of
deposit, makes secured and unsecured commercial and other installment and term
loans, and offers other customary banking services. The Bank makes mortgage
loans and commercial loans guaranteed by the SBA, which may be sold in the
secondary market. The Bank does not offer trust services directly, and does not
presently intend to do so, but offers such services, where requested, through
its correspondent banks.
The Bank devotes several individuals in the Loan Department to the origination
of SBA guaranteed loans. SBA loans are funded by the Bank and then the Bank may,
at its option, sell the portion of the loan guaranteed by the SBA (70% to 90% of
the total loan amount, depending on the purpose and term of the loan). The Bank
retains the unguaranteed portion of the loan and the right to service the loan.
Income from loan sales is an important portion of the Bank's non-interest
income. See, "Management's Discussion and Analysis or Plan of Operations,
Non-Interest Income." During 1995, the Bank discontinued marketing mortgage
loans which were interim funded and sold in their entirety within 30 days.
The Bank is designated as a "Preferred Lender" by the SBA. This means that it
may fund a loan without
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the prior approval of the SBA for that loan. Certification as a Preferred Lender
gives the Bank a competitive advantage, as it is able to provide a quick
response to loan applications.
During the last quarter of 1995, the Bank began offering investment services
through Prime Vest Financial Services, Inc. PrimeVest provides full-service
stock and bond brokerage services. The Bank's investment program is administered
by a Bank employee who is also a licensed registered representative with Prime
Vest. This new program has been well received by our customers and has brought
new customers to the Bank.
Market Area
The Bank's primary market area and the source of most of its loan and deposit
business is Sonoma County. The Bank has increased its lending territory for
loans made under the programs of the Small Business Administration ("SBA"). The
geographic area serviced by the Santa Rosa office was expanded in 1993 to
include the greater San Francisco Bay Area. The Bank has SBA loan production
facilities in Phoenix and Tucson, Arizona.
Competition
The banking business in California generally, and specifically in the market
area served by the Bank, is highly competitive with respect to both loans and
deposits, and is dominated by major banks which have offices operating
throughout California. Among the advantages such major banks have over the Bank
are their ability to finance wide-ranging advertising campaigns and to allocate
their investment assets to regions of highest yield and demand. In addition,
many of the major banks operating in the Bank's service area offer specialized
services, such as trust and international banking services, which the Bank does
not offer directly. By virtue of their greater total capitalization, the major
banks also have substantially higher lending limits than the Bank has. The Bank
competes for loans and deposits with these major banks, as well as with other
independent banks, savings and loan associations, credit unions, mortgage
companies, insurance companies and other lending institutions. The entry of
other independent banks in the Bank's service area may adversely affect the
Bank's ability to compete. The Bank also competes with savings and loans, credit
unions and money market funds, which have provided significant competition for
banks with respect to deposits. Other entities, both governmental and private,
seeking to raise capital through the issuance and sale of debt or equity
securities, also provide competition for the Bank in the acquisition of
deposits. The trend of federal and state legislation has significantly increased
competition between banks and other financial institutions for both loans and
deposits and is expected to continue to do so in the future.
At present, there are approximately 80 banking offices and offices of savings
and loan associations in the Bank's primary market area, including offices of
major chain banks, of smaller independent banks and savings and loan
associations. The Bank attempts to compete by offering personalized and
specialized services to its customers. The Bank's promotional activities
emphasize the advantages of doing business with a locally owned, independent
institution attuned to the particular needs of the community.
Statistical Information
Certain statistical information concerning the Bank and the Corporation is
provided at "Item 6- Management's Discussion and Analysis or Plan of Operation".
Employees
At December 31, 1995 the Bank had 64 full-time and 7 part-time employees.
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Supervision and Regulation
The Corporation
The Corporation is a bank holding company registered under the Bank Holding
Company Act of 1956 and is subject to the supervision of the Board of Governors
of the Federal Reserve System ("Board"). As a bank holding company, the
Corporation must obtain the approval of the Board before it may acquire all or
substantially all of the assets of any bank, or ownership or control of the
voting shares of any bank if, after giving effect to such acquisition of shares,
the Corporation would own or control more than 5% of the voting shares of such
bank. With certain limited exceptions, the Corporation is prohibited from
engaging in or acquiring direct or indirect ownership or control of more than 5%
of the voting shares of any company engaged in non-banking activities, unless
the Federal Reserve Board determines that such activities are so closely related
to banking as to be a proper incident thereof.
The Corporation and any subsidiary which it may acquire or organize in the
future are deemed to be affiliates of the Bank within the meaning set forth in
the Federal Reserve Act. This means, for example, that there are limitations on
loans by the Bank to affiliates, on investments by the Bank in any affiliate's
stock and on the Bank's taking any affiliate's stock as collateral for loans to
any borrower. All affiliate transactions must satisfy certain limitations and
otherwise be on terms and conditions that are consistent with safe and sound
banking practices. In this regard, the Bank generally may not purchase from any
affiliate a low-quality asset (as that term is defined in the Federal Reserve
Act). Also, transactions by the Bank with an affiliate must be on substantially
the same terms as would be available for non-affiliates.
The Corporation and its subsidiary are also subject to certain restrictions with
respect to engaging in the underwriting, public sale and distribution of
securities.
The Corporation and the Bank are prohibited from engaging in certain tie-in
arrangements in connection with the extension of credit. For example, the Bank
generally may not extend credit on the condition that the customer obtain some
additional service from the Bank or the Corporation, or refrain from obtaining
such service from a competitor.
The Bank
As a national banking association, the Bank is subject to the National Bank Act
and to supervision, regulation and regular examination by the Comptroller of the
Currency ("Comptroller"). It is also a member of the Federal Reserve System and,
as such, is subject to applicable provisions of the Federal Reserve Act and
regulations issued pursuant thereto. The deposits of the Bank are insured up to
the maximum legal limits by the Bank Insurance Fund, which is managed by the
Federal Deposit Insurance Corporation ("FDIC"), and the Bank is therefore
subject to applicable provisions of the Federal Deposit Insurance Act and
regulations of the FDIC. The statutes and regulations administered by these
agencies govern most aspects of the Bank's business, including required reserves
against deposits, loans, investments, dividends, and the establishment of new
branches and other banking facilities.
(a) Supervision and Examinations.
Federal law mandates frequent examinations of all banks, with the costs of
examinations to be assessed against the bank being examined. In the case of the
Bank, its primary regulator is the Comptroller. In 1994, the Comptroller started
using streamlined examination procedures for small community banks that are
considered by the regulators to be "noncomplex". The Comptroller has indicated
that it expects most banks with under $100 million in assets and well managed to
qualify, and that some banks having between $100 million to $1 billion in assets
will also be considered small and noncomplex. During 1995, the Bank was
considered "non-complex" and was examined under the streamlined procedures.
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The FDIC has "back up" enforcement power over the Bank under Federal law. The
FDIC may recommend and, in the absence of response by an institution's primary
regulator, undertake enforcement action against any insured financial
institution. Such "back up" enforcement action is permissible if ordered by the
Board of Directors of the FDIC only upon a showing that an insured financial
institution's conduct poses a risk to its insurance fund.
The Federal banking regulatory agencies have substantial enforcement powers over
the depository institutions that they regulate. Civil and criminal penalties may
be imposed on such institutions and persons associated with those institutions
for violations of any law or regulation. The penalties can be up to $ 5,000 per
day that a violation continues when the violation is unintentional, or up to $1
million per day that a violation continues when the violation is willful. The
amount of the penalty also depends on whether the violation is part of a pattern
or causes a loss to the financial institution.
(b) Prompt Corrective Action.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
requires the banking agencies to take corrective action against certain
financial institutions, based upon the financial institutions' compliance with
the various capital measurements. The capital requirements are described below
under the heading "Capital Requirements." The following chart sets forth the
various categories of capital compliance. In order to be considered in the well
or adequately capitalized categories, a financial institution must meet all the
requirements for that category. An institution will be considered
undercapitalized or significantly or critically undercapitalized if it meets any
of the requirements for that category.
<TABLE>
<CAPTION>
Tier 1
Ratio Category Total Risk-Based Risk-Based Leverage
- -------------- ---------------- ---------- --------
<S> <C> <C> <C>
Well Capitalized* 10% or above 6% or above 5% or above
Adequately Capitalized 8% or above 4% or above 4% or above**
Undercapitalized Less than 8% Less than 4% Less than 4%
Significantly
Undercapitalized Less than 6% Less than 3% Less than 3%
Critically
Undercapitalized - - 2% or less
<FN>
* In addition, the institution must not be subject to any written capital
order or directive to meet and maintain a specific capital level.
** 3% instead of 4% if the institution has the highest rating under the CAMEL rating system.
</FN>
</TABLE>
FDICIA also permits the banking agencies essentially to downgrade an institution
to the next lower category (but not into the category of critically
undercapitalized) if it determines that the institution is in an unsafe or
unsound condition, or is engaging in an unsafe or unsound practice. An
institution that has received a less-than-satisfactory rating in its most recent
examination report for assets, management, earnings or liquidity may be deemed
to be engaged in an unsafe and unsound practice. Except for a finding based on a
less-than-satisfactory rating, the institution is entitled to prior written
notice and an opportunity to respond to its regulator's finding that it is in an
unsafe or unsound condition or is engaging in such practices.
Based on its capital position at December 31, 1995, the Bank is considered well
capitalized.
As noted above, an undercapitalized financial institution is subject to certain
corrective action by the appropriate agency, depending on the category it falls
into. All undercapitalized institutions are required to submit a capital plan
within 45 days after the institution becomes undercapitalized. Also, such an
institution's asset growth is restricted and it must obtain the prior approval
of its federal regulator before it
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acquires any company, sets up any new branch or engages in any new line of
business. The banking agency is required to monitor closely the condition of the
bank and its compliance with its plan, and to review periodically the plan and
the supervisory restrictions on the bank to assure they are appropriate. In
addition, the regulator is authorized by statute to take the certain corrective
actions and order certain limitations on the bank's activities if necessary to
carry out the purposes of the statute.
If an institution is categorized as being significantly undercapitalized, or is
undercapitalized and fails to submit a capital plan, its banking regulator is
required to take increasingly severe enforcement actions against such
institution. The regulator must require recapitalization through a sale of stock
or a merger, restrict affiliate transactions and restrict the interest rates the
bank may offer on deposits, (unless it finds that doing so would not further the
purpose of the section). In addition, such an institution may not pay a bonus to
a senior executive officer or increase the pay of any executive officer without
the prior written approval of its federal regulator.
An institution that is critically undercapitalized is subject to mandatory
restrictions that are even more severe, and seizure within time limits
designated by statute. In general, the federal regulator is required to seize an
institution within 90 days of its becoming critically undercapitalized, unless
the regulator can document that another course of action will better achieve the
purposes of this section. The FDIC is required to restrict the activities of a
critically undercapitalized institution, beyond the degree of limitations
specified above for institutions that are significantly undercapitalized.
(c) Brokered Deposits.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
places limits on brokered deposits and extends the limits to any bank that is
not "well capitalized" or is notified that it is in "troubled condition."
Previously, the limitations applied only to troubled banks. A well capitalized
institution (which generally includes an institution that is considered well
capitalized for purposes of the prompt corrective action regulations discussed
above) may still accept brokered deposits without restriction, unless it has
been informed by its appropriate Federal regulatory agency that it is in
"troubled condition." All other insured depository institutions are prohibited
from accepting brokered deposits unless a waiver is obtained from the FDIC. If a
waiver is obtained, the interest paid on such deposits may not exceed the rate
paid for deposits in its normal market area, or the national rate as determined
in the FDIC's regulation.
If a depository institution solicits deposits by offering interest rates
significantly higher than rates being offered in its market area, it is deemed
under FDICIA to be a deposit broker. Therefore, depending on its capital
category, it may be prohibited from such practice, or need a prior waiver from
the FDIC in order to offer such rates. The FDIC's regulations specify that an
institution that is not well capitalized may offer rates that exceed the
prevailing effective rates offered in the normal market area only if the
institution obtains a waiver, but the institution may not offer rates more than
75 basis points above such prevailing rates.
The Bank is at this time considered well capitalized and not in a "troubled
condition," and it is not, therefore, subject to the brokered deposit
limitations. If the Bank's status changes in the future, these regulations could
restrict the ability to attract such deposits.
(d) Risk-Based Deposit Insurance Assessments.
In addition, FDICIA required the FDIC to develop and implement a system to
account for risks attributable to different categories and concentrations of
assets and liabilities in assessing deposit insurance premiums. The FDIC adopted
a risk-assessment system effective January 1, 1994. Under this system, each
bank's deposit insurance premium assessment is calculated based on the level of
risk that the Bank Insurance Fund will incur a loss if that bank fails and the
amount of the loss if such failure occurs. This requirement, along with the
increased emphasis on exceeding capital measures, may cause banks such
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as the Bank to adjust their asset mix in order to affect their deposit insurance
premium and their ability to engage in activities.
Capital Regulations and Dividends
The Board requires member banks and bank holding companies to maintain adequate
capital and has adopted capital leverage guidelines for evaluating the capital
adequacy of bank holding companies. The Comptroller has also adopted a similar
minimum leverage regulation, requiring national banks to maintain at least a
minimum capital to asset ratio. The Board's guidelines and the Comptroller's
regulations require the banks and bank holding companies subject to them to
achieve and maintain a Tier 1 capital to total asset ratio of at least three
percent (3.0%) to five percent (5.0%), depending on the condition and rate of
growth of the bank or holding company. Tier 1 or core capital is defined to
consist primarily of common equity, retained earnings, and certain qualified
perpetual preferred stock. These minimum leverage ratio requirements limit the
ability of the banking industry, including the Corporation and the Bank, to
leverage assets.
The Federal Reserve Board also uses risk-based capital guidelines to evaluate
the capital adequacy of member banks and bank holding companies. Under these
guidelines, assets are categorized according to risk and the various categories
are assigned risk weightings. Assets considered to present less risk than others
require allocation of less capital. In addition, off-balance sheet and
contingent liabilities and commitments must be categorized and included as
assets for this purpose. Under these guidelines, the Corporation is required to
maintain total capital of at least 8.00% of risk-adjusted assets, and half of
that minimum total capital must consist of Tier 1 capital as defined above.
The Comptroller has also adopted risk-based capital guidelines applicable to
national banks, such as the Bank, that are similar to the Federal Reserve's
risk-based capital guidelines. At this time, the Bank is required to maintain
total capital of at least 8.00% of risk-adjusted assets.
The capital totals of the Corporation and the Bank, as of December 31, 1995,
exceeded the amounts of capital required under the regulatory guidelines. The
following table shows the capital of the Company and the Bank, as a percentage
of assets, and the capital which they are required to maintain under the capital
regulations, as of December 31, 1995:
<TABLE>
<CAPTION>
Company Bank
<S> <C> <C>
Leverage capital ratio 7.6 7.4
Required leverage capital ratio 3.0 - 5.0* 3.0 - 5.0*
Total risk-based capital ratio 10.4 10.2
Required total risk-based capital ratio 8.0 8.0
Tier 1 risk-based capital ratio 9.1 8.9
Required tier 1 risk-based capital ratio 4.0 4.0
* Determined based on the regulators' evaluations.
</TABLE>
The risk-based guidelines and the leverage ratio do not have a significant
effect on the Corporation and the Bank at this time because both the Corporation
and the Bank meet their respective required ratios. The effect the requirements
may have in the future is uncertain, but management does not believe they will
have an adverse effect on the Corporation or the Bank. The risk-based capital
guidelines may affect the allocation of the Bank's assets between various types
of loans and investments. If the Bank continues to grow with its present asset
composition, it may be required to raise additional capital.
The Bank's capital ratios have increased in significance under the Federal
Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), as described
above. The ratios now affect the Bank's ability to utilize brokered deposits and
its deposit insurance premium rates, and they can result in regulatory
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enforcement action. See, above, "The Bank."
As required by FDICIA, the Federal banking agencies now take credit risk
concentrations and an individual institution's ability to manage such
concentrations into account when they assess a bank's capital adequacy.
Non-traditional investments and activities, such as the use of derivatives, are
also taken into account in assessing capital requirements. The agencies can
adjust the standards for risk-based capital on a case by case basis to take such
risks into account, but there is no formula that a bank can use prior to
evaluation by the agency to determine how credit concentration or nontraditional
activities will affect its capital requirements.
The banking agencies adopted amendments to the risk-based capital rules in 1995
to take interest rate risk into account. Now, when the agencies assess the
capital adequacy of a bank, they must take into account the effect on that
bank's capital that would occur if interest rates moved up or down. The purpose
of the amendment is to ensure that banks with high levels of interest rate risk
have enough capital to cover the loss exposure.
The amendments to the capital rules do not specify how interest rate risks will
be measured. The agencies proposed a measurement framework in 1995 to measure
the interest rate risk to a particular bank. However, the agencies later
announced in December of 1995 that they need more time to analyze the risk
measurement proposal. It is not known whether the final measurement framework
will affect the Bank's capital requirements.
The Corporation and the Bank are also subject to regulatory restrictions and
guidelines with respect to the payment of dividends. See of Item 5, "Market for
Common Equity and Related Stockholder Matters," below.
Impact of Monetary Policies
Banking is a business in which profitability depends on rate differentials. In
general, the difference between the interest rate received by the Bank on loans
extended to its customers and securities held in the Bank's investment portfolio
and the interest rate paid by the Bank on its deposits and its other borrowings
comprise the major portion of the Bank's earnings. To the extent that the Bank
is not able to compensate for increases in the cost of deposits and other
borrowings with greater income from loans, securities and fees, the net earnings
of the Bank will be reduced. The interest rates paid and received by the Bank
are highly sensitive to many factors which are beyond the control of the Bank,
including the influence of domestic and foreign economic conditions.
The earnings and growth of the Bank are also affected by the monetary and fiscal
policy of the United States government and its agencies, particularly the Board.
These agencies can and do implement national monetary policy, which is used in
part to curb inflation and combat recession. Among the instruments of monetary
policy used by these agencies are open market transactions in United States
Government securities, changes in the discount rates of member bank borrowings
and changes in reserve requirements. The actions of the Board have had a
significant effect on lending by banks, investments and deposits, and such
actions are expected to continue to have a substantial effect in the future.
However, the nature and timing of any further changes in such polices and their
impact on the Bank cannot be predicted.
Environmental Regulation
Federal, state and local regulations regarding the discharge of materials into
the environment may have an impact on the Corporation and the Bank. Under
Federal law, liability for environmental damage and the cost of cleanup may be
imposed upon any person or entity who is an owner or operator of
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contaminated property. State law provisions, which were modeled after Federal
law, impose substantially similar requirements. A resulting risk to the
Corporation and the Bank is the possibility that property securing a loan made
by the Bank may be environmentally impaired and not provide adequate security
for the Bank. In addition, these statutes subject the Bank to a risk that it
might be considered to be an owner or operator of such property and therefore
liable for the costs associated with cleaning up the environmental damage.
California law provides some protection against the first risk, by establishing
certain additional, alternative remedies for a lender in the situation where the
property securing a loan is later found to be environmentally impaired.
Primarily, the law permits the lender in such a case to pursue remedies against
the borrower other than foreclosure under the deed of trust. Additional
legislation is now pending in California to protect lenders against the second
risk, but there can be no assurance that such legislation will be adopted.
The Environmental Protection Agency had adopted a rule that limited the
environmental clean-up liability of a lender with limited interest in and
control over contaminated property. In 1994, however, that rule was struck down
by the Federal courts, on the ground that the rule was not authorized by the
statutory law. In spite of this, the EPA has continued to follow the rule's
provisions in its enforcement policy. Although legislation to give lenders
similar protection is pending in Congress, there can be no assurance that it
will pass or that it will provide similar protection to lenders if it is
enacted.
Americans With Disabilities Act
The Americans With Disabilities Act ("ADA") enacted by Congress, in conjunction
with recently adopted California legislation, is having an impact on banks and
their cost of doing business. The legislation requires employers with 15 of more
employees and all businesses operating "commercial facilities" or "public
accommodations" to accommodate disabled employees and customers. The ADA has two
major objectives (1) to prevent discrimination against disabled job applicants,
job candidates and employees and (2) to provide disabled persons with ready
access to commercial facilities and public accommodations. Commercial
facilities, such as the Bank, must ensure all new facilities are accessible to
disabled persons, and in some instances may be required to adapt existing
facilities to make them accessible, such as ATM's and bank premises.
New and Pending Legislation
(a) Interstate Banking and Branching.
The Caldera, Weggeland and Killea California Interstate Banking and Branching
Act of 1995 ("Interstate Banking Act") became effective October 2, 1995. The
Interstate Banking Act implements in California a limited form of interstate
branching. A bank from outside of California may now acquire a whole bank in
California and merge the California bank into the out-of-state bank. The effect
of such merger is that the out-of-state bank will have full branch offices in
California. Federal law authorizing these mergers was passed in 1994 and became
effective September 30, 1995.
Out of state banks may not establish branch offices in California by opening a
new branch or acquiring one or more (but less than all) of the branches of a
California bank. They may only acquire a whole bank that has been in existence
for at least five years. As a result of the Interstate Banking Act, California
banks may now be permitted to branch into other states that have also adopted
early opt-in legislation.
There may be a gradual increase in the number of offices of foreign banks in
California, and a possible decrease in banks headquartered in California, as
such banks are acquired by out-of-state entities. It is too early to predict the
specific effect of the Interstate Banking Act on the Bank and its particular
market.
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The Interstate Banking Act also authorizes California state-chartered banks to
appoint unaffiliated banks in other states to act as an agent of the California
state-chartered bank. The agent can accept deposits and evaluate loan
applications on behalf of the principal bank. National banks may establish
agency relationships only with affiliated banks. This expanded authority for
state-chartered banks may place national banks in California at a disadvantage
if many state-chartered bank use agency relationships with unaffiliated entities
to increase their business.
(b) New Community Reinvestment Act Regulations.
The Federal banking agencies amended substantially their Community Reinvestment
Act ("CRA") regulations in 1995. CRA requires banks to help meet the credit
needs of their entire communities, including minorities and low and moderate
income groups. Prior regulations required banks to adopt a CRA statement and
prove to the regulators that the bank has engaged in activities to determine and
meet the credit needs of minority and low and moderate income groups. Those
regulations had been criticized on the ground that regulatory examinations to
determine compliance focused on the processes a bank goes through rather than
the results of the effort or actual performance.
Under the revised CRA regulations, the agencies determine a bank's rating under
the CRA by evaluating its performance on lending, service and investment tests,
with the lending test as the most important. The tests are to be applied in an
"assessment context" that is developed by the agency for the particular
institution. The assessment context takes into account demographic data about
the community, the community's characteristics and needs, the institution's
capacities and constraints, the institution's product offerings and business
strategy, the institution's prior performance, and data on similarly situated
lenders. Since the assessment context is developed by the regulatory agencies,
there is substantial concern that a particular bank will not know until it is
examined whether its CRA programs and efforts have been sufficient.
Larger institutions are required under the revised regulations to compile and
report certain data on their lending activities in order to measure performance.
Some of this data is already required under other laws, such as the Equal Credit
Opportunity Act.
Small institutions (with less than $250 million in assets) will be examined on a
"streamlined assessment method". The streamlined method will focus on the
institution's loan to deposit ratio, degree of local lending, record of lending
to borrowers and neighborhoods of differing income levels, and record of
responding to complaints.
Large and small institutions have the option of being evaluated for CRA purposes
in relation to their own pre-approved strategic plan. Such a strategic plan must
be submitted to the institution's regulator three months before its effective
date and be published for public comment.
The Bank will be considered a small institution until it has assets of greater
than $250 million at the ends of two years in a row. The initial impact of this
amendment on the business of the Bank will be less than the impact when the Bank
has $250 million in assets and no longer qualifies as a small institution. At
that time, the new regulations will increase the amount of reports the Bank is
required to prepare and submit, and it could cause the Bank to change its asset
mix, in order to meet the performance standards. The new regulations will
increase the uncertainty of the Bank's business as the rating and examination
procedures change.
(c) The Private Securities Litigation Reform Act of 1995
The Private Securities Litigation Reform Act of 1995 was enacted near the end of
1995 to implement procedural protections to discourage frivolous securities
litigation. The Reform Act now requires certain specific pleadings to be made in
connection with litigation involving securities fraud, and limits plaintiffs'
rights of recovery against certain defendants. The Reform Act also provides a
legislative safe harbor against liability for the release of certain
"forward-looking" statements, such as projections.
19
<PAGE>
This legislation should have several indirect effects on all publicly held
companies, including the Corporation and the Bank. First, such companies should
face less risk of being sued by investors over issues relating to disclosures
and/or stock price. Second, companies may find that it is now easier to obtain
the services of highly qualified persons to serve as officers and directors, as
this legislation should reduce the risks such individuals face of being named in
frivolous litigation. Finally, this should reduce, over time, insurance premiums
for director and officer liability insurance.
(d) Safety and Soundness Guidelines.
The Federal banking agencies issued final safety and soundness guidelines in
1995, as required by FDICIA. The guidelines contain operational and managerial
standards and prohibit certain compensation practices. The effect of the
guidelines is to require on general standards of safe and sound business and
banking practices with respect to internal controls and information systems,
internal audit systems, loan documentation, credit underwriting, interest rate
exposure and compensation. The banking agencies have indicated that the
standards are the same as the agencies previously applied in their examinations
of institutions, so the adoption should not affect individual institutions that
comply with the regulations. If an agency determines that an institution is not
in compliance with the guidelines, the institution must submit a plan to come
into compliance to the regulator within 30 days of notification.
In addition, the agencies re-proposed guidelines for asset quality and earnings.
If adopted, the proposal would set forth similar guidelines for institutions in
the areas of monitoring asset quality and the quality and quantity of earnings
that are similar to the operational and managerial standards.
The effect of these guidelines on the Bank, as adopted and re-proposed, depends
on how they are implemented by the Bank's primary regulator, the Comptroller.
The Bank expects that the guidelines may increase the Bank's cost of doing
business, since it now must document its compliance with all the requirements in
the guidelines.
(e) Truth in Lending Act Amendments
Amendments to the Truth in Lending Act were enacted in 1995. The amendments
increase the tolerances for errors and reduce the potential liability of lenders
for errors in disclosure. The legislation also places limitations on borrowers'
rights to rescind consumer credit transactions based on the disclosures provided
to the borrower by the lender. The amendments provide relief to banks and other
consumer lenders generally from some of the uncertainty and potential liability
that accompanies consumer lending.
(f) Reduced Deposit Insurance Premiums.
During 1995 the FDIC reduced substantially the deposit insurance premiums paid
by most banks. The Bank's premium was reduced, effective June 1, 1995, from 23
cents per $100 to 4 cents per $100 of insured deposits. The premium assessment
was further reduced for the first half of 1996 to zero cents per $100 of insured
deposits for most healthy banks. Banks must still pay the legal minimum annual
premium of $2,000. This has reduced and will reduce the Bank's cost of doing
business by the amount of the reductions. The second reduction to the legal
minimum premium has been criticized substantially by other governmental
representatives and quasi-governmental groups, however, and there can be no
assurance that the Bank will continue to pay such a small deposit insurance
premium.
(g) Proposed Legislation and Regulation.
Certain legislative and regulatory proposals that could affect the Corporation,
the Bank and the banking business in general are pending or may be introduced,
before the United States Congress, the California State Legislature, and Federal
and state government agencies. The United States Congress is considering
numerous bills that could reform the banking laws substantially. Bills are also
pending that would reduce the banking industry's regulatory burden, in areas
such as Truth in Lending, Truth in Savings, and Real Estate Settlement
Procedures Act disclosure requirements, and in various reporting
20
<PAGE>
requirements.
In addition, various legislative proposals to merge the Bank Insurance Fund
("BIF") with the Savings Association Insurance Fund ("SAIF"), and to address the
current deposit insurance premium discrepancy between banks and savings
associations, are currently under consideration. Banks insured by the BIF fund
now pay substantially lower deposit insurance premiums than institutions insured
by the SAIF fund. Should the funds be merged, the premiums paid by banks such as
the Bank may increase substantially, which would increase the Bank's expenses.
Other proposals to permit banks to engage in related financial services, and to
permit other financial services companies to offer banking-related services are
pending and, if adopted, would increase competition to the Bank.
It is not known to what extent, if any, these proposals will be enacted and what
effect such legislation would have on the structure, regulation and competitive
relationship of financial institutions. It is likely, however, that many of
these proposals would subject the Corporation and the Bank to increased
regulation, disclosure and reporting requirements and would increase competition
to the Bank and its cost of doing business.
In addition to pending legislative changes, the various banking regulatory
agencies frequently propose rules and regulations to implement and enforce
already existing legislation. It cannot be predicted whether or in what form any
such legislation or regulations will be enacted or the effect that such
legislation may have on the Bank's business.
21
<PAGE>
ITEM 2.
Description of Properties
The Corporation and the Bank share common quarters at 801 Fourth Street, in the
central business district of Santa Rosa. The Corporation leases a total of
approximately 9,335 square feet of ground floor and second floor office space at
that location and sublets this area to the Bank.
The Corporation leases approximately 3,692 square feet of office space at 6641
Oakmont Drive, Santa Rosa, where Highway 12 intersects with Oakmont Drive, for a
branch office of the Bank opened in 1989. The Corporation leases these premises
from Oakmont Investments, of which Patrick Gallaher, a director of the
Corporation and the Bank, is a partner. See Item 12, "Certain Relationships and
Related Transactions".
The Bank leases approximately 390 square feet of space within the Safeway
grocery store which is located in Windsor, near the exit from Highway 101. The
branch opened on July 2, 1993. The bank leases these premises from LVI Partners,
of which William Gallaher, a director of the Corporation and the Bank, is a
partner. See Item 12, "Certain Relationships and Related Transactions".
The Bank leases, on a month-to-month basis, approximately 7,500 square feet of
space in a two story office building at 755 Fourth Street. This office is
located across the street from the main office and is utilized for SBA and
commercial lending and loan administration.
The Bank has invested in loans secured by real property collateral. The Bank's
policies with respect to such loans are described under the caption "Item 7,
Management's Discussion and Analysis or Plan of Operation - Loan Portfolio." The
Bank's policies on real estate secured loans may be changed without a vote of
security holders.
ITEM 3.
Legal Proceedings
Neither the Corporation nor the Bank is a party to any pending legal
proceedings, other than proceedings arising in the ordinary course of the Bank's
business. None of these are expected to have a material impact on the financial
position or results of operations of the Registrant.
ITEM 4.
Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of shareholders in the fourth quarter of
1995.
22
<PAGE>
Part II
ITEM 5.
Market for Common Equity and Related Stockholder Matters
On February 29, 1996, the Corporation had 1,388,579 shares of common stock
outstanding, held by approximately 341 shareholders of record.
The directors and officers of the Corporation and the Bank hold 24.3% and
beneficially own 34.7% of the outstanding shares. See "Item 11, Security
Ownership of Certain Beneficial Owners and Management," herein. Under SEC rules,
the directors and officers are restricted in the amount of securities they may
sell without registration under the Securities Act of 1933, as amended. In
general, directors and officers each may offer up to 13,883 shares in any three
month period without such registration.
As of February 29, 1996, the directors and officers also have the right to
acquire 95,187 additional shares upon the exercise of options granted pursuant
to the Corporation's Stock Option Plan. Should several directors and officers
choose to exercise options and sell their shares on the market, such that a
large number of shares are offered at one time, the price of the common stock
could be adversely affected.
The firms Everen Securities, Inc. and First Associated Securities Group, Inc.,
located in Santa Rosa, and Hoefer & Arnett, located in San Francisco are
presently making a market in the stock.
The following chart shows the high and low bid quotations and the volume of
transactions in the Corporation's stock for the periods indicated. This
information has been provided to the Corporation by First Associated Securities
Group, Inc., one of the Bank's market makers, and does not include privately
negotiated transactions that were not conducted through them. The prices
indicated below are inter-dealer prices, do not necessarily represent actual
transactions and do not include retail mark-ups, mark-downs or commissions.
<TABLE>
<CAPTION>
Bid Quotations for the Corporation's Approximate
Common Stock Trading Volume
=======================
Quarter Ended High Low
===================================== ================== ====================
<S> <C> <C> <C>
March 31, 1994 $9.00 8.00 35,000
June 30, 1994 9.50 8.25 59,000
September 30, 1994 9.50 8.50 13,500
December 31, 1994 9.75 8.75 29,000
March 31, 1995 9.50 8.75 24,000
June 30, 1995 9.50 8.63 27,000
September 30, 1995 9.13 8.50 53,000
December 31, 1995 9.75 8.63 65,500
===================================== =================== ==================== =======================
</TABLE>
Due to the lack of any significant trading and no established public market,
this information should not be considered an indication of the market value of
the shares. There is no assurance that any significant trading market for the
shares will develop in the future and there are no assurances as to the price at
23
<PAGE>
which shares may be traded in the future. The bid and asked prices of the
Corporation's common stock was $9.25 and $9.63, respectively, on February 29,
1996.
Dividends
On March 30, 1995, the Corporation declared a cash dividend of $0.20 per share
of stock. In September 1995, the Corporation declared a 5% stock dividend to
shareholders of record on October 31, 1995.
In 1994, the Corporation declared and paid two cash dividends totalling $0.36
per share of stock. In July of 1994, the Corporation declared a 5% stock
dividend to shareholders of record as of July 29, 1994.
There is no assurance that dividends will be paid again, or, if paid, what the
amount of any such dividends will be. The future dividend policy of the
Corporation is subject to the discretion of the Board of Directors and will
depend upon a number of factors, including earnings, financial condition, cash
needs and general business conditions.
In addition, the Board of Directors may declare dividends only out of funds
legally available therefor. The Corporation's primary source of income (other
than interest income earned on the Corporation's other investments) is the
receipt of dividends from the Bank. The Bank's ability to pay dividends is
subject to the restrictions of the national banking laws and, under certain
circumstances, the approval of the Comptroller of the Currency.
A national bank may not pay dividends from its capital. All dividends must be
paid out of net profits then on hand, after deducting for expenses, including
losses and bad debts. A national bank is also prohibited from declaring a
dividend until its surplus fund equals the amount of its capital stock or, if
the surplus fund does not equal the amount of its capital stock, until one-tenth
of the bank's net profits for the preceding half year, in the case of quarterly
or semiannual dividends, or the preceding two consecutive half-year periods, in
the case of an annual dividend, are transferred to the surplus fund each time
dividends are declared.
The approval of the Comptroller is required if the total of all dividends
declared by a bank in any calendar year will exceed the total of its net profits
of that year combined with its retained net profits of the two preceding years,
less any required transfers to surplus or a fund for the retirement of any
preferred stock which may be outstanding. Moreover, the Comptroller may prohibit
the payment of dividends which would constitute an unsafe and unsound banking
practice. As of December 31, 1995, $3,957,000 of retained earnings of the Bank
was available for the payment of dividends under this requirement.
24
<PAGE>
ITEM 6.
Management's Discussion and Analysis or Plan of Operations
The Corporation's sole subsidiary is Sonoma National Bank ("Bank"), and its
primary activities are the commercial banking activities engaged in through the
Bank. The following discussion of financial condition and results of operations
focuses primarily on the Bank, for the years ended December 31, 1994 and 1995.
During 1995, total consolidated assets grew 37.1% to $166,962,000 at December
31, 1995. Total consolidated assets grew 14.3% during 1994 to $121,776,000 at
December 31, 1994.
Total deposits increased 38.8% to $154,221,000 when comparing December 31, 1995
to December 31, 1994. For the year ended December 31, 1994, total deposits
increased 14.1% to $111,083,000. Results of Operations
The Corporation's consolidated net income for the year ended December 31, 1995
was $1,720,000 as compared to $1,346,000 for the year ended December 31, 1994,
an increase of 27.8%. The Corporation's consolidated net income for the year
ended December 31, 1994, increased 3.6% over the year ended December 31, 1993.
Net interest income before provision for loan losses increased 23.6%, or
$1,446,000, when comparing the year of 1995 to 1994. This is largely due to the
increase in loan volume, which added $2,682,000 to interest income. The Bank's
interest margin for 1995 was 5.64%, which was slightly lower than the 1994
margin of 5.70%. The interest margin for 1994 was 5.70% compared to 5.74% in
1993.
Net interest income after provision for loan losses increased $1,476,000 in 1995
over 1994 and other income decreased $544,000, due to the reduced volume of SBA
loan sales. See, "Non-Interest Income." Operating expenses increased by $193,000
primarily because of increases in personnel costs. Income tax expense rose
$365,000 in 1995 compared to 1994, as a result of increased income and the
slightly higher effective tax rate.
When comparing 1994 to 1993 net interest income after provision for loan losses
increased $830,000. Other income increased $248,000 due to increased volume of
SBA sales and servicing income and the gain on an OREO sale. Operating expenses
increased during 1994 due to expansion of the SBA department and the first full
year of operation at the Windsor branch.
Net Interest Income
The primary source of the Bank's income is the difference between (1) the
interest earned on its loan and investment portfolios, interest bearing deposits
with other banks, and federal funds sold, and (2) the interest paid on deposits
and other borrowed funds. This difference is referred to as net interest income,
and it is one of the primary factors that affect the Corporation's
profitability. Interest income earned on loans, which includes loan fee income,
is primarily a function of the amount of loans outstanding and the rates
prevailing on these loans. Interest paid on deposits depends on the composition
of the deposit base and the rates paid to attract deposits. See, "Deposits."
For the year ended December 31, 1995, net interest income before the provision
for loan losses totalled $7,565,000 as compared to $6,119,000 for the year ended
December 31, 1994, representing an increase of 23.6%. The majority of this
increase results from growth in the loan portfolio, largely from the increase in
SBA loans and commercial real estate loans. See, "Loan Portfolio." During 1994,
net interest income before the provision for loan losses increased $936,000 or
18.1%, from $5,183,000 to $6,119,000, primarily due to the growth in the loan
portfolio and the increasing rate environment.
25
<PAGE>
Interest expense increased 76.7% when comparing 1994 to 1995, due to increases
in interest bearing deposits, particularly in time deposits which bear the
highest cost, and the higher interest rate in 1995 as compared to 1994. The
average cost of interest paid on interest bearing deposits for the year ended
December 31, 1995 was 4.9% versus 3.6% for the year ended December 31, 1994.
Average non-interest bearing deposits decreased slightly in 1995, so all of the
Bank's growth was funded by money market deposits and time deposits. During
1994, deposits shifted from time deposits to money market and savings accounts;
however, in 1995, there was growth in both time certificates and money market
accounts.
In 1995, the net interest margin was affected by rate changes. The Federal
Reserve Board increased the discount rate several times in 1994 and once in
February 1995 and since then the rate has declined. Commercial banks generally
adjusted their prime lending rates immediately following changes in the discount
rate. During 1995, prime rate was increased from 8.5% to 9% in February and
since then decreased to 8.5% at year end. During 1994, prime rate increased from
6% at the beginning of the year to 8.5% at year end. Since the Bank is asset
sensitive, meaning more assets are immediately adjustable than liabilities, the
net interest margin tends to increase when rates increase and tends to decrease
in a declining rate environment. The net effect of the change in interest rates
on earning assets and cost of funds was an increase of $124,000 in net interest
income in 1995 and an increase of $37,000 in net interest income in 1994.
The full impact of rate changes on the Bank's assets are not realized for
several months, since not all loans reprice immediately. The majority of SBA
loans are tied to the prime rate and reprice on a calendar quarter basis.
Additionally, the Bank has fixed rate loans and loans that are tied to indexes
which adjust at a slower pace, such as the Eleventh District Cost of Funds Index
(COFI). The COFI rate increased from 4.6% in December 1994 to 5.1% in December
1995.
The Bank's deposits reprice at a slower pace than loans, primarily since
certificates of deposits usually do not reprice until their maturity dates,
which generally range from six months to eighteen months. During 1995, time
deposits increased from $28.3 million to $66.5 million. This growth was possible
due to the more favorable rates on time certificates versus other money market
rate accounts (Sonoma Investors Reserve Account) which are tied to US Treasury
rates. The rate on the Sonoma Investors Reserve account is repriced on a weekly
basis and has declined during 1995, and therefore, has a more immediate impact
on the Bank's cost of funds than changes in rates on time certificates.
The Bank's net interest margin declined to 5.64% in 1995 from 5.70% in 1994.
This modest decline is caused by the decline in interest rates since February
1995, changes in the mix of loans and deposit and changes in the ratio of loans
to deposits. See, "Loan Portfolio" and "Deposits." During 1995, the Bank's cost
of funds increased 1.31%, while the increase in the rate earned on
interest-earning assets equalled 1.13% which negatively impacts income. The
Bank's average loans to deposits ratio improved from 85.8% in 1994 to 88.2% in
1995, which partially offset the larger increase in the cost of funds.
Overall loan portfolio yields are affected by deferred loan fees and discounts
on loans. These fees and discounts are amortized to income over the life, or
estimated life, of the loan with which they are associated and serve to increase
loan portfolio yields. Interest income on loans includes amortization of loan
fee income of $602,000 for the year ended December 31, 1995 and $492,000 for the
year ended December 31, 1994. Deferred loan fees are a product of origination
and commitment fees and certain direct loan origination costs. These fees are
amortized as an adjustment of the related loan's yield over the contractual life
of the loan. The deferred fee balances are as follows: $999,000 as of December
31, 1995, and $820,000 as of December 31, 1994.
Discounts on the unguaranteed portion of SBA loans are recorded when the
guaranteed portion of the SBA loan is sold. These discounts are amortized as an
adjustment to the loan yields over the estimated life of the SBA loan. As of
December 31, 1995 $778,000 was recorded as discounts compared to $599,000 at
December 31, 1994. These discounts are netted against total loans in the balance
sheet.
26
<PAGE>
Construction loans are generally short term loans and fees associated with them
amortize to income over a much shorter term. The average balance in construction
loans was $2.5 million in 1995 versus $2.6 million in 1994. Interest income and
fee amortization on construction loans equalled $294,000 in 1995 versus $282,000
in 1994.
The allowance for loan losses has no direct effect on yield. Loans carried as
non-accrual reduce the portfolio yield, since the balance of a non-accrual loan
is maintained in the loan total but no interest is accrued. Nonaccrual loans are
included in the loan amounts in the following average balance sheets. Interest
foregone on non-accrual loans equalled $30,000 in 1995 compared to $21,000 in
1994.
The tables on the following pages (i) summarize the distribution, by amount, of
the average assets, liabilities and shareholders' equity of the Corporation for
the periods indicated and (ii) set forth the yields on earning assets and the
rates paid for interest bearing liabilities during the periods indicated.
Averages are computed primarily from daily balances.
27
<PAGE>
<TABLE>
<CAPTION>
AVERAGE BALANCE SHEET
- ----------------------------------------------------------------------------------------------------------------------
Year Ended
December 31, 1995
Average Interest/Income Average
Balance Expense Yield/Rate
<S> <C> <C> <C>
------------------ ------------------ -----------------
Certificates of deposit
with other banks $5,880,000 $354,000 6.02%
Investments 2,450,000 134,000 5.47%
Federal funds sold 10,503,000 599,000 5.70%
Bankers acceptances 572,000 34,000 5.94%
Loans:
Commercial (incl. SBA loans &
loans held for sale) 52,361,000 5,844,000 11.16%
Installment loans to individuals 2,924,000 348,000 11.90%
Real estate - Construction 2,528,000 294,000 11.63%
Real estate - Other 57,006,000 5,439,000 9.54%
------------------ ------------------ -----------------
Total Loans 114,819,000 11,925,000 10.39%
------------------ ------------------ -----------------
Total earning assets 134,224,000 13,046,000 9.72%
Non-earning assets:
Allowance for loan losses (1,508,000)
Deferred Loan Fees & Discounts (1,628,000)
Cash and due from banks 6,155,000
Other assets 4,663,000
------------------
TOTAL ASSETS $141,906,000
==================
Deposits:
Demand - interest bearing 9,042,000 95,000 1.05%
Savings & money market 54,925,000 2,832,000 5.16%
Time certificates 47,089,000 2,554,000 5.42%
------------------ ------------------ -----------------
Total interest bearing deposits 111,056,000 5,481,000 4.94%
Demand - non-interest bearing 19,095,000
Other liabilities:
Other liabilities 588,000
Shareholders' equity 11,167,000
------------------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $141,906,000 $5,481,000
================== ==================
Net interest income $7,565,000
==================
Net interest margin 5.64%
==================
28
<PAGE>
<CAPTION>
AVERAGE BALANCE SHEET
- ----------------------------------------------------------------------------------------------------------------------
Year Ended
December 31, 1994
Average Interest/Income Average
Balance Expense Yield/Rate
<S> <C> <C> <C>
----------------- ------------------ -----------------
Certificates of deposit
with other banks $4,342,000 $187,000 4.31%
Investments 1,518,000 78,000 5.14%
Federal funds sold 9,805,000 392,000 4.00%
Bankers acceptances 1,375,000 63,000 4.58%
Loans:
Commercial (incl. SBA loans &
loans held for sale) 39,207,000 3,776,000 9.63%
Installment loans to individuals 3,049,000 313,000 10.27%
Real estate - Construction 2,552,000 282,000 11.05%
Real estate - Other 45,533,000 4,129,000 9.07%
------------------ ------------------ -----------------
Total Loans 90,341,000 8,500,000 9.41%
------------------ ------------------ -----------------
Total earning assets 107,381,000 9,220,000 8.59%
Non-earning assets:
Allowance for loan losses (1,292,000)
Deferred Loan Fees & Discounts (1,048,000)
Cash and due from banks 6,174,000
Other assets 4,056,000
------------------
TOTAL ASSETS $115,271,000
==================
Deposits:
Demand - interest bearing 9,101,000 99,000 1.09%
Savings & money market 43,363,000 1,638,000 3.78%
Time certificates 32,990,000 1,364,000 4.13%
------------------ ------------------ -----------------
Total interest bearing deposits 85,454,000 3,101,000 3.63%
Demand - non-interest bearing 19,801,000
Other liabilities:
Other liabilities 510,000
Shareholders' equity 9,506,000
------------------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $115,271,000 $3,101,000
================== ==================
Net interest income $6,119,000
==================
Net interest margin 5.70%
==================
29
</TABLE>
<PAGE>
The following table sets forth the changes in net interest income due to changes
in interest rates and the volume of assets and liabilities from the year
ended December 31, 1995 as compared to the year ended December 31, 1994.
<TABLE>
<CAPTION>
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST IN COME AND EXPENSE
- ----------------------------------------------------------------------------------------------------------------------
1995 over 1994
- ----------------------------------------------------------------------------------------------------------------------
Volume Yield/Rate Total
<S> <C> <C> <C>
------------------ ------------------ -----------------
Increase (decrease)
in interest income:
Certificates of deposit
with other banks $92,752 $74,248 167,000
Investments 50,991 5,009 56,000
Federal funds sold 39,335 167,666 207,000
Bankers acceptances (47,700) 18,700 (29,000)
Loans:
Commercial (incl. SBA loans &
loans held for sale) 1,468,133 599,867 2,068,000
Installment loans to individuals (15,004) 50,004 35,000
Real estate - Construction (2,802) 14,802 12,000
Real estate - Other 1,095,995 214,005 1,310,000
------------------ ------------------ -----------------
Total 2,681,700 1,144,301 $3,826,000
------------------ ------------------ -----------------
Increase (decrease)
in interest expense:
Deposits:
Demand - interest bearing (360) (3,640) (4,000)
Savings & money market 595,591 598,409 1,194,000
Time certificates 764,429 425,571 1,190,000
------------------ ------------------ -----------------
Total 1,359,660 1,020,340 2,380,000
------------------ ------------------ -----------------
Increase (decrease) in
net interest income 1,322,040 123,961 1,446,000
================== ================== =================
<FN>
Note: Variances attributable to simultaneous rate and volume changes are all allocated to volume change
amount.
</FN>
</TABLE>
30
<PAGE>
The following table sets forth the changes in net interest income due to changes
in interest rates and the volume of assets and liabilities from the year
ended December 31, 1994 as compared to the year ended December 31, 1993.
<TABLE>
<CAPTION>
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST IN COME AND EXPENSE
- ----------------------------------------------------------------------------------------------------------------------
1994 over 1993
- ----------------------------------------------------------------------------------------------------------------------
Volume Yield/Rate Total
<S> <C> <C> <C>
------------------ ------------------ -----------------
Increase (decrease)
in interest income:
Certificates of deposit
with other banks $36,150 $10,850 47,000
Investments 6,594 21,406 28,000
Federal funds sold 67,650 101,350 169,000
Bankers acceptances 40,866 6,134 47,000
Loans:
Mortgage loans helds for sale (41,236) 5,236 (36,000)
Commercial 893,383 173,617 1,067,000
Installment loans to individuals 46,734 7,266 54,000
Real estate - Construction (72,848) (100,152) (173,000)
Real estate - Other 440,224 (97,224) 343,000
------------------ ------------------ -----------------
Total 1,417,517 128,483 $1,546,000
------------------ ------------------ -----------------
Increase (decrease)
in interest expense:
Deposits:
Demand - interest bearing $14,245 ($70,245) ($56,000)
Savings & money market 576,219 230,781 807,000
Time certificates (71,636) (69,364) (141,000)
------------------ ------------------ -----------------
Total $518,828 $91,172 $610,000
------------------ ------------------ -----------------
Increase (decrease) in
net interest income $898,689 $37,311 $936,000
================== ================== =================
<FN>
Note: Variances attributable to simultaneous rate and volume changes are all allocated to volume change
amount.
</FN>
</TABLE>
31
<PAGE>
Non-Interest Income
Non-interest income is derived primarily from gains on sales of SBA (Small
Business Administration) loans, service charges on deposit accounts and SBA loan
servicing fees.
When comparing the year ended December 31, 1995 to December 31, 1994, other
non-interest income totalled $1,602,000, decreasing 25.3% over the 1994 total of
$2,146,000. This decrease was largely due to the 44.4% decline in gains on the
sale of the guaranteed portion of SBA loans, which totalled $715,000 in 1995
versus $1,287,000 in 1994. This decline in gains on sales resulted from
management's decision to retain a larger portion of these loans, earning
interest income, rather than sell them immediately. During 1995 the Bank sold
SBA loans totalling $9,837,000, compared to $18,957,000 in 1994.
SBA servicing fees increased during 1995 to $362,000 for the year compared to
$260,000 for 1994. Servicing revenues will continue to grow as long as the SBA
servicing portfolio increases. During 1995, the Bank's average SBA loan
portfolio serviced was $41 million compared to $26 million in 1994.
There can be no assurance that the SBA program will continue to generate
significant amounts of other non-interest income in the future. During 1994 and
1995, the Bank experienced additional competition with more financial
institutions making SBA loans. The SBA program, being a government program, is
also subject to revision by the government which could have a negative impact on
the Bank's profit. See, "Item 1, The Corporation, Business of the Bank."
Non-interest income includes service charges on deposit accounts. During 1995,
service charges totalled $306,000 versus $296,000 in 1994. Service charges vary
depending upon the customers' uses of various Bank services. During the first
quarter of 1996 rates for varies services were adjusted after several years of
no changes. This is expected to result in a modest increase in service charge
income during 1996.
There were no gains on sale of other real estate owned (OREO) in 1995; however,
in 1994, non-interest income included a gain of $98,000 on the sale of OREO. At
this time, it is not expected that the Corporation will have any significant
gains from the sale of OREO during 1996. See, "Other Real Estate Owned."
Other non-interest income for 1994 totalled $2,146,000, increasing 13.1% over
the 1993 total of $1,898,000. This increase was due to gains on the sale of the
guaranteed portions of SBA loans, which totalled $1,287,000 in 1994, an increase
of 21.0% compared to $1,064,000 in 1993. SBA servicing fees also doubled during
1994 to $260,000 for the year.
Approximately $2,000 in mortgage loan sale income was recognized in 1995, versus
$56,000 in 1994, $167,000 in 1993 and $226,000 in 1992. The decline in income
during 1994 was attributable to the decline in residential mortgage loan
refinance activity, caused by increases in mortgage loan interest rates which
followed 20-year lows in mortgage rates in 1993. During the first quarter of
1995, the Bank stopped marketing its residential mortgage product. The
residential mortgage loan staff was laid off or reassigned to other job duties.
At this time, the Bank has no plans to actively re-enter this market.
Non-Interest Expense
Non-interest expenses include salaries and employee benefits, occupancy,
equipment and the general expenses required for the operation of the Corporation
and the Bank. For the year ended December 31, 1995, non-interest expenses
totalled $5,859,000, an increase of 3.4% over the previous year. Non-interest
expenses increased 16.7% from $4,857,000 in 1993 to $5,666,000 in 1994.
Non-interest expenses include salaries and benefits, which increased 14.8% in
1995. The majority of the increase resulted from larger incentive payments. Most
incentives are tied to loan production and deposit
32
<PAGE>
growth, which were at higher than anticipated levels during 1995. During 1994
the Bank added 8 employees, ending with 70 full time equivalent (FTE) staff
positions. During 1995, the Bank's FTE declined to 67 persons due to SBA staff
reduction in regional locations (Fresno, Hollister and Ukiah offices were
closed).
Occupancy costs increased 9.5% from $637,000 in 1994 to $698,000 in 1995. The
increase in occupancy costs was due to SBA lease commitments (which added
$14,000) and scheduled increases as required in branch lease agreement (which
added $17,000). There were also increases in property taxes, utilities and
maintenance expenses.
The other expense categories decreased 12.0% in 1995. The Bank computer system
was fully depreciated in the first quarter of 1995, which accounted for the
24.5% decline in equipment costs. The FDIC insurance costs declined by $94,000
or 34.7% due to the over-capitalization of the Bank Insurance Fund (BIF).
Business development expenses and advertising costs declined due cutbacks in SBA
regional offices' activities. Professional expenses also declined in 1995 due to
the low level of legal fees associated with problem loans. During 1994, other
expense categories increased 12.0% mainly in FDIC insurance, advertising and
business development expenses and office expenses associated with the SBA
growth.
The FDIC deposit insurance premiums for 1995 equalled $129,000 compared to
$223,000 paid in 1994. The Bank's deposit insurance premium is currently in the
lowest cost category. The Bank's cost per $100 of insurance deposits fell from
$0.23 to $0.04 during 1995. The assessment rate for the first half of 1996 is
zero cents per $100 of insured deposits with an annual minimum payment of
$2,000. There can be no assurance that the deposit insurance rates will remain
at this low level. See, "Description of Business-Supervision and Regulation-New
and Pending Legislation, (f) Reduced Deposit Insurance Premiums."
Analysis charges are customer expenses for title and escrow services, check
charges, courier and payroll services on behalf of customers who maintain
deposit balances sufficient to compensate for these costs. See, "Deposits."
While some non-interest expense is incurred, management feels the contribution
of the non-interest bearing demand accounts toward lowering overall cost of
funds more than offsets this cost.
Non-interest expenses are expected to increase in 1996 due to the planned growth
in the Bank.
The increase in non-interest expenses of 16.7% from the 1993 total of $4,857,000
to $5,666,000 in 1994 was due primarily to the operation of the Windsor branch
office, which opened in July, 1993, and the expansion of the SBA department
during 1994. The SBA department's direct operating expenses equalled $
1,382,000, $1,156,000 and $573,000 for the years ended December 1995, 1994 and
1993 respectively. Total direct operating expenses associated with the Windsor
office were $230,000, $217,000, and $139,000 for the same periods.
The following table outlines the components of non-interest expense for the
periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
Expense Item 1995 1994
<S> <C> <C>
Salaries & Employee Benefits $3,186,000 $2,776,000
Occupancy 698,000 637,000
Equipment 283,000 375,000
33
<PAGE>
Advertising/Business Development 308,000 382,000
Outside Customer Services 218,000 208,000
Professional Fees 130,000 163,000
Stationery & Supplies 141,000 125,000
Deposit and Other Insurance 240,000 335,000
Other 655,000 665,000
------- -------
TOTAL $5,859,000 $5,666,000
========== ==========
================================================= ==================== =====================
</TABLE>
Loan Portfolio
The following table shows the composition of the Corporation's loan portfolio,
by type of loan, as of the dates indicated. Loans held for sale are excluded.
<TABLE>
<CAPTION>
December 31,
Type of Loan 1995 1994
<S> <C> <C>
Commercial $47,745,000 $34,857,000
Real Estate Construction 3,556,000 1,701,000
Real Estate Other 64,713,000 49,601,000
Installment Loans to Individuals 2,702,000 2,965,000
--------- ---------
TOTAL $118,716,000 $89,124,000
=========== ===========
================================================= ====================== ======================
</TABLE>
The above table illustrates the Bank's emphasis on commercial and real estate
lending. At December 31, 1995 and 1994 commercial loans comprised 40.2% and
39.1%, respectively, of the Bank's total loan portfolio. Construction and other
real estate loans (combined) comprised 57.5% and 57.6% on those same dates.
Management is aware of the risk factors in making commercial and real estate
loans and is continuously monitoring the local marketplace as well as performing
annual reviews of this portfolio.
The Bank makes commercial loans primarily to small and medium sized businesses
and to professionals located within Sonoma County. While the Bank emphasizes
commercial lending, management does not believe that there is any significant
concentration of commercial loans to any specific type of business or industry.
The Bank originates loans guaranteed by the U.S. Small Business Administration
("SBA"). The guaranteed portion of each loan, typically ranging from 70% to 90%,
may be sold to outside investors, usually at a price in excess of par. The
remaining unguaranteed portion is retained in the Bank's loan portfolio. The
Bank follows the same internal credit approval process when approving an SBA
loan as when approving other loans. The majority of the Bank's SBA loans are
secured by real estate. These loans are reported in the chart above as
Commercial Loans.
While SBA loans generally have the same underwriting requirements as the Bank's
other loans, they are sometimes for longer terms (7 to 25 years) and have a
higher loan-to-value ratio than the Bank typically accepts. This risk is
mitigated by the majority of the loans being secured by real estate. If a
default on a SBA loan were to occur, the Bank would share proportionally in the
collateral supporting the loan with the SBA
34
<PAGE>
which guarantees the loan. At December 31, 1995, the Bank held $35,413,000 in
SBA loans of which $19,218,000 represented the unguaranteed portions of the SBA
loans and $16,195,000 was guaranteed by the SBA. At December 31, 1994, the Bank
held $16,459,000 in SBA loans of which $12,620,000 represented the unguaranteed
portion of the SBA loans and $3,831,000 was guaranteed by SBA. There were four
SBA loans totalling $213,000 (Bank's unguaranteed portion) more than 90 days
past due, all of which had been placed on nonaccrual status, as of December 31,
1995. The unguaranteed portions are analyzed separately when reviewing the
adequacy of the allowance for loan losses.
Real estate construction loans are made primarily for single family residences
and commercial properties valued at under $1,500,000 located within Sonoma
County. Construction loans are made to "owner/occupied" and "owner/users" of the
properties and occasionally to developers with a successful history of
developing projects in the Bank's market area. Loan-to-value ratios on
construction loans depend upon the nature of the property. The Banks's policy is
to require that the loan-to-value ratio ranges from 65% to 75% and that the
borrower have a cash equity interest in the land ranging from 25%-50%. The
construction lending business is subject to, among other things, the volatility
of interest rates, real estate prices in the area and the market availability of
conventional real estate financing to repay such construction loans. The Bank
mitigates much of this risk by requiring the borrower to procure take-out
financing prior to funding the loan. A decline in real estate values and/or
demand could potentially have an adverse impact on this portion of the loan
portfolio, and on the earnings and financial condition of the Bank.
Other real estate includes loans which are secured by real estate and not
classified as a construction loan or SBA loan. The majority of these loans are
secured by commercial real estate.
Prior to early 1995, the Bank originated residential mortgage loans with the
intent to sell them to the Federal Home Loan Mortgage Corporation (FHLMC) or
outside investors at a price approximating par value. These loans were sold
without recourse to the Bank. The Bank either sold these loans on a servicing
released basis or retained the servicing function. The Bank sold approximately
$6,389,000 in real estate mortgages during 1994. During 1995, this market was no
longer active and the Bank discontinued marketing residential mortgage loans
with the intention of selling them. The Bank did originated $1.5 million in
residential mortgage loans in 1995 and $2.2 million in mortgage loans in 1994
which were held as portfolio loans at year end (Real Estate - Other).
Home equity lines of credit, included in real estate - other, equalled 5.0% of
the total loan portfolio at December 31, 1995. These loans are secured primarily
by second trust deeds on single family residences. The Bank typically requires a
loan-to-value ratio of no more than 80% for home equity loans. The rates are
adjustable monthly based on the Bank's internal reference rate, and terms do not
exceed ten years.
The Bank has a small portfolio of consumer loans, equaling 2.3% of the total
loan portfolio at December 31, 1995. Personal lines of credit and overdraft
protection are offered to customers. During 1995 the Bank sold its credit card
portfolio which averaged $350,000 in balances in 1994. Regular underwriting
procedures are followed depending upon the type of loans. Revolving lines are
reviewed every two years.
It is the Bank's policy to collateralize all loans unless, in management's
estimation, the credit worthiness, cash flow and character of the borrower
justify extension of credit on an unsecured basis. Management recognizes the
inherent risk in making unsecured loans, but in management's judgement, such
35
<PAGE>
unsecured loans are justified based on the credit worthiness and financial
strength of the borrowers. Management believes that its secured loans are
adequately collateralized to minimize loss in the event of default in payment of
interest or principal or decline in collateral values. In making collateralized
loans, the Bank's policy establishes a maximum loan to collateral value ratio of
from 50% to 100%, depending on the type of collateral and the other factors
supporting the loan.
The following table summarizes the Bank's loan maturities, by loan type, at
December 31, 1995. The loans, which includes loans held for sale, are
categorized by the maturity of the final installment.
<TABLE>
<CAPTION>
Over 1 Year
1 year through Over 5
or Less 5 Years Years Total
<S> <C> <C> <C> <C>
Commercial $12,551,000 $13,447,000 $36,071,000 $62,069,000
Real Estate -Construction 2,845,000 711,000 0 3,556,000
Real Estate -Other 5,595,000 12,674,000 46,444,000 64,713,000
Installment Loans 946,000 1,351,000 405,000 2,702,000
------- --------- ------- ---------
TOTAL $21,937,000 $28,183,000 $82,920,000 $133,040,000
=========== =========== =========== ============
============================ ================ ================ ================== ==================
</TABLE>
Of the total loans due in more than one year, $8,754,000 were at fixed interest
rates and $102,349,000 were at adjustable interest rates at December 31, 1995.
Interest Rate Sensitivity
The Bank attempts to lend at competitive interest rates and to reduce exposure
to interest rate fluctuations by making most of its loans at adjustable interest
rates.
The following table summarizes the Bank's loan portfolio, including SBA loans
held for sale, by contractual repricing frequency, by loan type, at December 31,
1995. SBA loans held for sale are considered commercial loans for this analysis.
Most of the SBA loans are secured by real estate.
<TABLE>
<CAPTION>
Over 3 Months Over 1 Year
3 Months or through through Over 5
Less 1 Year 5 Years Years Total
<S> <C> <C> <C> <C> <C>
Commercial $58,858,000 $2,241,000 $505,000 $465,000 $62,069,000
Real Estate -Construction 350,000 3,206,000 0 0 3,556,000
Real Estate -Other 16,350,000 38,508,000 7,653,000 2,202,000 64,713,000
Installment Loans 2,702,000 0 0 0 2,702,000
--------- - - - ---------
TOTAL $78,260,000 $43,955,000 $8,158,000 $2,667,000 $133,040,000
=========== =========== ========== ========== ============
============================ ================ =================== ================= ================= ===================
</TABLE>
Interest rate risk is reduced through the practice of making variable interest
rate loans which are tied to an outside rate index. These loans "float", or
adjust their rate as the interest rate environment changes. As of December 31,
1995 and 1994 approximately 90% and 87% respectively of the Bank's loan
portfolio was comprised of loans with adjustable rates.
Allowance for Loan Losses
In accordance with its policy, the Bank maintains an allowance for loan losses
to provide for losses in the loan portfolio. The allowance for loan losses is
reviewed monthly and is based on an allocation for each loan category (e.g. Real
Estate, Commercial), an allocation of undisbursed commitments, plus an
allocation for any outstanding loans which have been classified by regulators or
internally for the "Watch List." Each loan that has been classified is
individually analyzed for the risk involved and an allowance provided according
to the risk assessment. In addition, management considers such factors as known
loan problems, historical loan loss experience, loan concentrations, loan loss
experience in the banking industry, evaluations made by
36
<PAGE>
bank regulatory agencies, assessment of economic conditions and other
appropriate data to identify risks in the loan portfolio. Based upon the
analysis of the allowance for loan losses, the Bank has increased the allowance
by 17.9% to $1,676,000 at December 31, 1995 compared to $1,421,000 in 1994. The
provision for loan losses for the year ended December 31, 1995 was $250,000 as
compared to $280,000 in 1994.
Depending on future evaluations of the allowance in connection with regulatory
examinations, any changes in the factors management reviews as described above,
and the amount of any loan losses that may be incurred, further increases may be
made in accordance with the Bank's policy, and such increases will have an
adverse effect on earnings. Management attempts to reduce exposure to loss from
adverse economic conditions through portfolio diversification among businesses
and types of borrowers. In 1995 nine loans totalling $102,000 were charged-off
and $107,000 was recovered during the year on loans which had been previously
charged-off. During 1994 the Bank charged-off seven consumer loans totalling
$16,000, and recovered $44,000 on commercial and real estate-other loans. In
1993 the Bank charged-off five loans totalling $212,000, including three
commercial loans aggregating $204,000.
The following table sets forth the changes in the allowance for loan losses and
the relationship to loans outstanding at the end of those periods.
<TABLE>
<CAPTION>
Year Ended December 31
1995 1994
ALLOWANCE FOR LOAN LOSSES:
<S> <C> <C>
Balance at beginning of Period $1,421,000 $1,113,000
Provision for Loan Losses Charged to Operating Expense 250,000 280,000
Less Charge-Offs
Real Estate - Other 72,000 0
Consumer loans 30,000 16,000
------ ------
Total Charge-offs 102,000 16,000
------- ------
Recoveries
Commercial 79,000 20,000
Real Estate - Other 24,000 24,000
Consumer 4,000 0
-------- -----
Total Recoveries 107,000 44,000
------- ------
Net Charge-offs/(Recoveries) (5,000) (28,000)
------- --------
Balance at the End of the Period $1,676,000 $1,421,000
========== ==========
Total Loans Outstanding at End of Period $118,716,000 $89,124,000
============ ===========
Ratio of Ending Allowance to Ending Loans Outstanding 1.4% 1.6%
==== ====
AVERAGE TOTAL LOANS $114,819,000 $90,341,000
============ ===========
Ratio of Net Charge-offs to Average
Loans Outstanding During the Period (0.00004) (0.00031)
========= =========
=============================================================== ==========================================
</TABLE>
The following table sets forth the allocation of the allowance for loan losses
by loan type as of December 31, 1995 and 1994. The allocation of the allowance
will necessarily change whenever management determines that the risk
characteristics of the loan portfolio have changed. It should not be construed
that the amount allocated to a particular segment is the only amount available
for future charge-offs that might occur within that segment, since the allowance
is a general reserve. In addition, the amounts allocated by segment may not be
indicative of future charge-off trends.
37
<PAGE>
<TABLE>
<CAPTION>
December 31, 1995 December 31, 1994
% of Loans % of Loans
Category Amount in each Amount in each
Category to Category to
Total Total
<S> <C> <C> <C> <C>
Commercial $ 788,000 46.7% $524,000 39.1%
Real Estate -Construction 166,000 2.7 117,000 1.9
Real Estate -Other 682,000 48.6 683,000 55.7
Installment Loans 40,000 2.0 97,000 3.3
------ --------- ------ -------
TOTAL $1,676,000 100.0% $1,421,000 100.0%
========== ====== ========== ======
====================================== =============== ================= ================ =================
</TABLE>
Non-Performing and Impaired Loans
Loans are generally placed on nonaccrual status when the borrowers are past due
90 days or 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. Interest accruals are resumed on such
loans only when they are brought fully current with respect to interest and
principal and when, in the judgement of management, the loans are estimated to
be fully collectible as to both principal and interest. The Bank considers a
loan impaired when, based upon current information and events, it is probable
that the Bank will be unable to collect all amounts due according to the
contractual terms of the loan agreement. This policy is generally consistent
with the Bank's nonaccrual loan policy as described above.
The following table sets forth loans past due 90 days or more and non-accrual
loans as of the dates indicated.
<TABLE>
<CAPTION>
December 31,
Days Past Due 1995 1994
<S> <C> <C>
90 and over $0 $0
Non-accrual 398,000 201,000
------- -------
Total $398,000 $201,000
======== ========
Percent of Total Loans 0.3% 0.2%
==== ====
Impaired Loans $398,000 N/A
============================================ ======================= =======================
</TABLE>
The amount of interest that would have been recorded for the loans on
non-accrual at December 31 of the year totaled approximately $30,000 in 1995 and
$21,000 in 1994.
On December 31, 1995, the Bank had $398,000 in non-accrual loans of which
$329,000 was collateralized by real estate. The unsecured loan was an SBA loan
for $69,000 of which $62,000 is guaranteed by the SBA. As of December 31, 1994,
the $201,000 of non-accrual loans consisted of one commercial loan totalling
$31,000 and four real estate-other loans totalling $170,000
Potential non-performing loans are identified by management as part of its
ongoing evaluation and review of the loan portfolio. Based on such reviews as of
December 31, 1994, management has no knowledge of information about any loan
which causes management to have doubts about the borrowers' ability to comply
with present repayment terms, such that the loan might subsequently be
classified as non-performing.
Other Real Estate Owned
The Bank held no other real estate owned during 1995. In late January 1996, the
Bank obtained title to commercial real estate property located in Moraga,
California. This real estate supported a SBA loan in which the Bank held a 25%
interest. The Bank's recorded $77,000 as the OREO fair market value of the
Bank's interest in the property.
The Corporation and Bank acquired title to approximately 42 acres of land in
March of 1992 through foreclosure proceedings on one loan. The amount of the
loan at the time of foreclosure was $780,000. Improvement costs totalling
$64,000 were capitalized. In 1994, this property was sold resulting in a gain of
$98,000, which was recorded as other income in the financial statements.
38
<PAGE>
Deposits
The Bank obtains deposits primarily from shareholders, local businesses, loan
customers and personal contacts by its business development staff, officers and
directors. The Bank does not have any brokered deposits.
At December 31, 1995, deposits totalled $154,221,000, which was an increase of
38.8% from December 31, 1994. Non-interest bearing demand deposits totalled
$23,017,000 at December 31, 1995 as compared to $21,197,000 at December 31,
1994. Although these deposits do not bear interest, some of the account holders
utilize the Bank's analysis system which gives earnings credits for their
collected average balances based on 100% of the 91-Day T-Bill rate. The customer
may then use those earnings credits towards various account services such as
escrow accounting fees, courier services, payroll, and check printing paid to
third party vendors. Two title companies maintain deposits at the Bank
representing $2,985,000 in average balances during the fourth quarter of 1995 in
accounts utilizing the analysis system. For these title companies, the Bank paid
out $8,000 to third party vendors for escrow, courier and related services
during the fourth quarter of 1995. See, "Non-Interest Expense." This equates to
a 1.1% annual cost of funds, which can be compared to the Bank's overall annual
cost of funds of 4.9% for 1995.
Most of the deposit growth at the Bank in 1995 was in the time deposit category,
and, to a lesser extent in money market deposits. Time deposits increased $38.2
million or 135% in 1995, while money market deposits increased $5.9 million or
13% from December 31, 1994 to December 31, 1995. In early 1995, the Bank offered
higher rates on time deposits in order to fund loan demand. The growth in
deposits occurred mainly in this category with time deposits increasing from
$28,348,000 at December 31, 1994 to $66,533,000 at year end 1995. This shift to
time deposits bearing a higher rate than other types of deposits increased the
Bank's overall cost of funds. See, "Net Interest Income."
Average balances held in savings and money market rate accounts increased from
$43,363,000 to $54,925,000 during 1995. The Bank's Sonoma Investor Reserve
account has been very popular, since it was tied to the 90-day Treasury Bill and
repriced on a weekly basis. During 1994, when the rate on the Sonoma Investor
Reserve exceeded the rates offered on time deposits, depositors moved funds to
this account. It provided immediate access to their funds and yielded a higher
return.
Management attempts to reduce risks from fluctuating interest rates by limiting
the maturities on certificates of deposit. The following table sets forth, by
time remaining to maturity, the Bank's time certificates of deposit as of
December 31, 1995:
<TABLE>
<CAPTION>
$100,000 and Over Less than $100,000
Amount Pct Amount Pct
======================================================================================================
<S> <C> <C> <C> <C>
Three Months or Less $3,912,000 20.2 $8,474000 18.0
3 to 6 months 3,506,000 18.1 8,180,000 17.3
6 months to 1 year 5,712,000 30.0 16,176,000 34.3
Over 1 year 6,201,000 32.1 14,372,000 30.4
---------- ---- ---------- ----
Total $19,331,000 100.0 $47,202,000 100.0
=========== ===== =========== =====
======================================================================================================
</TABLE>
At December 31, 1995, certificates of deposit of $100,000 or more months
constituted approximately 12.5% of total deposits. The holders of these deposits
are primarily local customers of the Bank. While these deposits are rate
sensitive, the Bank believes they are stable deposits, as they are obtained
primarily from customers with other banking relationships with the Bank.
39
<PAGE>
Investment Portfolio
At December 31, 1995 and 1994 the Bank held the following investments:
<TABLE>
<CAPTION>
December 31,
1995 1994
===========================================================================================
<S> <C> <C>
U.S. Treasury Securities $10,756,000 $1,970,000
Fannie Mae Discount Note 0 985,000
Federal Reserve Stock 123,000 117,000
------- -------
Total $10,879,000 $3,072,000
=========== ==========
Securities Pledged $500,000 $500,000
-------- --------
===========================================================================================
</TABLE>
The Bank's investments in U.S. Treasury securities totalled $10,756,000 at
December 31, 1995, which investment had a total par value of $10,750,000. On
December 28, 1995, $10 million was invested in U.S. Treasury securities with a
maturity of January 4, 1996 at a yield of 3.7%. The funds were then reinvested
in Fed Funds Sold. The remaining treasury investment of $750,000 matures on
November 30, 1996 and yields 5.9% to the Bank. The yield on average investments
equalled 5.47% during 1995 compared to 5.1% in 1994.
See, "Net Interest Income."
The Federal Reserve Bank stock has a yield of 6.0%.
Investments are carried at amortized cost. All debt securities are held to
maturity. The market value of securities equalled $10,882,000 at December 31,
1995 and $3,060,000 at December 31, 1994.
Bankers' acceptances are considered investments for financial statement
purposes. These are short term instruments purchased through correspondent banks
and the rates are typically higher than federal funds rates. Maturities vary
from one to six months. For regulatory purposes, bankers' acceptances are
classified in the loan portfolio. As of December 31, 1995 and 1994, the Bank had
no balances in bankers' acceptances but there were balances during both years.
Liquidity - Consolidated
Liquidity is a bank's ability to meet possible deposit withdrawals, to meet loan
commitments and increased loan demand, and to take advantage of other investment
opportunities as they arise. The Bank's liquidity practices are defined in both
the Asset and Liability Policy and the Investment Policy. These policies define
acceptable liquidity measures in terms of ratios to total assets, deposits,
liabilities and capital. In addition, these policies includes acceptable ranges
for the bank's loans-to-deposits ratio. The Bank also compares its liquidity
position and ratios to its peer group.
The Bank is required to maintain specific reserve balances with the Federal
Reserve Bank. This is monitored on a daily basis to assure compliance with
regulatory requirements. The Office of the Comptroller of the Currency ("OCC")
also requires the Bank to establish adequate liquidity policies and practices.
Although defined liquidity percentages are not specified in the OCC's
regulations, they have been incorporated in the Bank's policies and procedures.
Cash and due from banks, federal funds sold and time certificates of deposit
totalled $21,427,000 or 12.8% of total assets at December 31, 1995. If the one
week U.S. Treasury for $10,000,000 recorded at year end is included, the ratio
increases to 18.8%, which is similar to the Bank's liquidity position over the
last several
40
<PAGE>
years, and comparable to other financial institutions in its asset size range.
At December 31, 1994, cash and due from banks, interest bearing deposits in
other banks and federal funds sold totaled $24,197,00, constituting 19.9% (21.8%
including short term investments) of the total assets at that date. At December
31, 1995 and 1994 the Bank's ratio of loans-to-deposits (including loans held
for sale) was 84.0% and 81.1% respectively.
The Bank has three federal funds lines of credit totalling $9,000,000 with three
institutions ($3,000,000 each). These lines are available on a short term basis
to meet any cash demands that may arise.
The Bank funded loan growth during 1995 through increased interest-bearing
deposits. The cost of funds has been negatively impacted by economic factors in
both 1995 and 1994. Deposits increased during both years largely due to deposit
campaigns which offered higher rates. During 1994, the deposit growth occurred
in money market accounts which had a higher yield than time certificates, and
the funds were also readily accessible to the depositor. During 1995 rates on
time deposits increased and the Bank was able to attract new time deposits.
The following table represents the Corporation's interest rate sensitivity
profile as of December 31, 1995. Assets, liabilities and shareholders' equity
are classified by the earliest possible repricing opportunity or maturity date,
whichever first occurs.
<TABLE>
<CAPTION>
Over 3 months Over 1 year Non-rate
Balance Sheet Through 3 through through 5 Sensitive or Total
(In 000's) months 1 year years Over 5 years
- ------------------------------------------ --------------- -------------- -------------- -------------- ----------------
Assets
<S> <C> <C> <C> <C> <C>
Time Deposits-other financial institutions $387 $4,752 $5,139
Fed funds sold 5,000 5,000
Investment securities 9,996 760 $123 10,879
Loans and loans held for sale 78,260 43,955 $8,158 2,667 133,040
Non-interest-earning assets (net of allowance for 12,904 12,904
loan losses)
$93,643 $49,467 $8,158 $15,694 $166,962
=============== ============== ============== ============== ================
Liabilities & Shareholders Equity
Time Deposits $100,000 and over $3,912 $9,218 $6,201 $19,331
All other interest-bearing deposits 73,531 24,356 13,986 111,873
Non-interest bearing liabilities $23,017 23,017
Other Liabilities & Shareholders' Equity 12,741 12,741
$77,443 $33,574 $20,187 $35,758 $166,962
=============== ============== ============== ============== ================
Interest Rate Sensitivity (1) $16,200 $15,893 ($12,029) ($20,064)
Cumulative Interest Rate Sensitivity $16,200 $32,093 $20,064 $0
========================================== =============== ============== ============== ============== ================
<FN>
(1) Interest rate sensitivity is the difference between interest rate sensitive
assets and interest rate sensitive liabilities within the above time frames.
</FN>
</TABLE>
The Bank is asset sensitive. In a declining interest rate environment there is
an immediate negative impact on the Bank's net interest margin, since assets
reprice to lower rates more quickly than liabilities. In a raising interest rate
environment, the Bank's earnings are positively affected immediately. The Bank
continually
41
<PAGE>
monitors its interest rate sensitivity as part of the Bank's planning process.
The Corporation and the Bank do not at this time engage in hedging transactions
(interest rate futures, caps, swap agreements, etc.).
Liquidity - Parent Company Only
At present, the Corporation's primary sources of liquidity are from short term
investments on its capital, proceeds from exercise of stock options, and
dividends from the Bank. The Bank's ability to pay dividends to the Corporation
is subject to the restrictions of the national banking laws and, under certain
circumstances, the approval of the OCC. Under such restrictions, the Bank may
not presently pay dividends to the Corporation without notification to the OCC.
In addition, the Federal Reserve Act prohibits the Bank from making loans to its
"affiliates", including the Corporation, unless certain collateral requirements
are met.
At December 31, 1995, the Corporation had non-interest and interest bearing cash
balances of $180,000, which management believes is adequate to meet the
Corporation's foreseeable operational expenses.
Return on Equity and Assets
The following table shows key financial ratios for the years ended December 31,
1995 and 1994:
<TABLE>
<CAPTION>
Year Ended December 31,
1995 1994
<S> <C> <C>
Return on Average Assets 1.2% 1.2%
Return on Average
Shareholders' Equity 15.4% 14.2%
Average Shareholders' Equity
as a Percent of Average Assets 7.9% 8.2%
Dividend Payout Ratio 15.7% 33.3%
================================================== =================== ===================
</TABLE>
Effects of Inflation
Inflation affects the Bank and the banking business generally because of its
effect on interest rates and loan demand. To offset inflation and the resulting
changes in interest rates and market demands, the Bank attempts to maintain
liquid interest bearing assets and to manage its assets and liabilities such
that they can be repriced within a short period of time. In addition to its
effect on market conditions and interest rates, inflation increases the
Corporation's cost of operations. The rate of inflation fell dramatically during
1991 and has maintained a very low annual rate through 1995.
Capital
The Corporation and the Bank are required by the Federal Reserve Board and the
Comptroller of the Currency to maintain adequate capital. The Board of Governors
of the Federal Reserve Bank has adopted risk-based capital guidelines for member
banks and bank holding companies which provide minimum uniform capital adequacy
requirements for bank holding companies. The OCC has also adopted additional
capital requirements which are applicable to national banks, such as the
Bank. See "Item 1, Description of Business, Supervision and
Regulation-Capital Regulations."
The Bank's leverage capital ratio was 7.4% of its total assets, exceeding the
amount of capital required under
42
<PAGE>
the minimum capital requirements. Under the "risk-based" capital methodology,
the Bank's total risk-based capital ratio was 10.2% at December 31, 1995. The
minimum acceptable level at December 31, 1995 was 8.0%.
Income Taxes
The 1995 provision for income tax equalled $1,338,000, which included a state
tax provision of $373,000. The overall effective tax rate was 43.7% during 1995.
See, "Item 7, Consolidated Financial Statements, Note 6." The provision for
federal income taxes for 1994 was $973,000, and the state provision was
$271,000. The overall effective tax rate for 1994 was 42.0%.
43
<PAGE>
ITEM 7.
Financial Statements
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Northern Empire Bancshares and Subsidiary:
We have audited the consolidated balance sheets of Northern Empire Bancshares
and Subsidiary (the Company) as of December 31, 1995 and 1994, and the related
consolidated statements of income, shareholders' equity and cash flows for the
years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Company at
December 31, 1995 and 1994, and the results of its operations and its cash flows
for the years then ended, in conformity with generally accepted accounting
principles.
/Coopers & Lybrand L.L.P./
San Francisco, California
January 19, 1996
44
<PAGE>
<TABLE>
<CAPTION>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
as of December 31, 1995 and 1994
ASSETS 1995 1994
<S> <C> <C>
Cash and equivalents:
Cash and due from banks $ 11,288,000 $ 6,042,000
Federal funds sold 5,000,000 11,924,000
--- ---------------- --- ---------------
Total cash and equivalents 16,288,000 17,966,000
Certificates of deposits in other financial institutions 5,139,000 6,231,000
Investment securities (market value: 1995 - $10,882,000; 1994 - $3,060,000) 10,879,000 3,072,000
Loans held for sale 14,324,000 3,831,000
Loans receivable, net 115,263,000 86,285,000
Leasehold improvements and equipment, net 747,000 677,000
Accrued interest receivable and other assets 4,322,000 3,714,000
--- ---------------- --- ---------------
Total assets $ 166,962,000 $ 121,776,000
=== ================ === ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $ 154,221,000 $ 111,083,000
Accrued interest payable and other liabilities 759,000 494,000
--- ---------------- --- ---------------
Total liabilities 154,980,000 111,577,000
--- ---------------- --- ---------------
45
<PAGE>
--- ---------------- --- ---------------
Commitments and contingencies (Note 10).
Shareholders' equity:
Preferred stock, no par value; authorized, 10,000,000 shares;
none issued or outstanding - -
Common stock, no par value; authorized, 20,000,000 shares; shares issued and
outstanding, 1,388,355 in 1995 and 1,253,350 in 1994 7,433,000 6,489,000
Retained earnings 4,549,000 3,710,000
--- ---------------- --- ---------------
Total shareholders' equity 11,982,000 10,199,000
--- ---------------- --- ---------------
Total liabilities and shareholders' equity $ 166,962,000 $ 121,776,000
=== ================ === ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
46
<PAGE>
<TABLE>
<CAPTION>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
for the years ended December 31, 1995 and 1994
1995 1994
Interest income:
<S> <C> <C>
Loans $ 11,925,000 $ 8,500,000
Certificates of deposits in other financial institutions 354,000 187,000
Federal funds sold and investment securities 767,000 533,000
-- --------------- --- ------------
Total interest income 13,046,000 9,220,000
Interest expense 5,481,000 3,101,000
-- --------------- --- ------------
Net interest income before provision for loan losses 7,565,000 6,119,000
Provision for loan losses 250,000 280,000
-- --------------- --- ------------
Net interest income after provision for loan losses 7,315,000 5,839,000
-- --------------- --- ------------
Other income:
Service charges on deposits 306,000 296,000
Gain on sale of loans 715,000 1,287,000
Other 581,000 563,000
-- --------------- --- ------------
Total other income 1,602,000 2,146,000
-- --------------- --- ------------
Other expenses:
Salaries and employee benefits 3,186,000 2,776,000
Occupancy 698,000 637,000
Equipment 283,000 375,000
Outside customer services 218,000 208,000
Deposit and other insurance 240,000 335,000
Professional fees 130,000 163,000
Advertising 165,000 235,000
47
<PAGE>
Other 939,000 937,000
-- --------------- --- ------------
Total other expenses 5,859,000 5,666,000
-- --------------- --- ------------
Income before income taxes 3,058,000 2,319,000
Provision for income taxes 1,338,000 973,000
-- --------------- --- ------------
Net income $ 1,720,000 $ 1,346,000
== =============== === ============
Common stock earnings per share $ 1.27 $ 1.08
== =============== === ============
Average common shares outstanding for net income per share calculation 1,349,803 1,245,735
== =============== === ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
48
<PAGE>
<TABLE>
<CAPTION>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended December 31, 1995 and 1994
Common Stock
Retained
Earnings
------------------------------------- ----------------
Shares Amount Total
- ------------ -- ------------- ------
<S> <C> <C> <C> <C>
Balance, December 31, 1993 1,136,108 $ 5,563,000 $ 3,334,000 $8,897,000
Cash dividend paid ($.36 per share) - - (430,000) (430,000)
Stock options exercised 58,260 386,000 - 386,000
Stock dividend 58,982 540,000 (540,000) -
Net income 1,346,000 1,346,000
------------ -- ------------- -- ------------- -------------
Balance, December 31, 1994 1,253,350 6,489,000 3,710,000 10,199,000
Cash dividend paid ($.20 per share) - - (266,000) (266,000)
Stock options exercised 69,015 329,000 - 329,000
Stock dividend 65,990 615,000 (615,000) -
Net income 1,720,000 1,720,000
------------ -- ------------- -- ------------- -------------
Balance, December 31, 1995 1,388,355 $ 7,433,000 $ 4,549,000 $11,982,000
============ == ============= == ============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
49
<PAGE>
<TABLE>
<CAPTION>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1995 and 1994
1995 1994
Cash flows from operating activities:
<S> <C> <C>
Net income $ 1,720,000 $ 1,346,000
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Gain on sale of other real estate owned - (98,000)
Provision for loan losses 250,000 280,000
Depreciation, amortization and accretion 113,000 228,000
Net increase in deferred loan fees and discounts 359,000 540,000
Deferred income taxes (185,000) 28,000
Loans originated for sale (20,330,000) (28,759,000)
Cost of loans sold 9,837,000 26,288,000
Increase in interest receivable and other assets (424,000) (1,328,000)
Increase in accrued interest payable and other liabilities 265,000 163,000
----- --------------- --- --------------
Net cash used in operating activities (8,395,000) (1,312,000)
----- --------------- --- --------------
Cash flows from investing activities:
Purchase of investment securities (24,191,000) (2,854,000)
Maturities of investment securities 16,500,000 500,000
Net decrease (increase) in deposits in other financial institutions 1,092,000 (2,486,000)
Net increase in loans receivable (29,588,000) (6,833,000)
Purchase of leasehold improvements and equipment, net (297,000) (143,000)
Proceeds on sale of other real estate owned - 1,001,000
Investment in other real estate owned - (21,000)
----- --------------- --- --------------
Net cash used in investing activities (36,484,000) (10,836,000)
----- --------------- --- --------------
Cash flows from financing activities:
Net increase in deposits 43,138,000 13,751,000
Payment of cash dividend (266,000) (430,000)
50
<PAGE>
Stock options exercised 329,000 386,000
----- --------------- --- --------------
Net cash provided by financing activities 43,201,000 13,707,000
----- --------------- --- --------------
Net (decrease) increase in cash and cash equivalents (1,678,000) 1,559,000
Cash and cash equivalents at beginning of year 17,966,000 16,407,000
----- --------------- --- --------------
Cash and cash equivalents at end of year $ 16,288,000 $ 17,966,000
===== =============== === ==============
Other cash flow information:
Interest paid $ 5,265,000 $ 3,093,000
===== =============== === ==============
Income taxes paid $ 1,515,000 $ 1,074,000
===== =============== === ==============
</TABLE>
The accompanying notes are an integral part of these finanical statements.
1. Summary of Significant Accounting Policies:
Organization:
Northern Empire Bancshares (the Company) is a bank holding company which
conducts its primary business through its wholly owned subsidiary, Sonoma
National Bank (the Bank), a commercial bank located in Sonoma County,
California. All significant intercompany transactions and accounts have been
eliminated in consolidation.
Nature of Operations:
The Company primarily operates three branches in suburban communities in
Sonoma County. The company's primary source of revenue is providing
commercial and real estate loans to customers, who are predominantly small
and middle-market businesses. The cost of funds relate to various deposit
products offered to these same businesses and individuals.
Use of Estimates in the Preparation of Financial Statements:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Cash and Equivalents:
For the purposes of reporting cash flows, cash and equivalents include cash
on hand, amounts due from banks and federal funds sold. Generally, federal funds
are sold overnight. Substantially all cash and cash equivalents held in other
financial institutions exceed existing deposit insurance coverage.
Investment Securities:
In accordance with Statement of Financial Accounting Standard ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" which was
adopted by the Company on January 1, 1994, all investment securities are
classified as held-to-maturity because management has the positive intent and
ability to hold all of the debt securities until maturity. Accordingly, these
securities are carried at their remaining unpaid principal balances, net of
unamortized premiums or unaccreted discounts. Premiums are amortized and
discounts are accreted using the level yield method over the estimated remaining
term of the underlying security.
51
<PAGE>
1. Summary of Significant Accounting Policies, continued:
Loans Receivable:
Loans held for investment are carried at amortized cost. The Company's loan
portfolio consists primarily of commercial and installment loans generally
collateralized by first and second deeds of trust on real estate as well as
business assets and personal property.
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
full payment 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. Interest accruals are resumed on such loans only when
they are brought fully current with respect to interest and principal and when,
in the judgment of management, the loans are estimated to be fully collectible
as to both principal and interest.
The Company charges loan origination and
commitment fees. Net loan origination fees are deferred and amortized to
interest income over the life of the loan. Loan commitment fees are amortized to
interest income over the commitment period.
Sales and Servicing of Small Business Administration (SBA) Loans:
The Company originates loans to customers under SBA programs that generally
provide for SBA guarantees of 70% to 90% of each loan. The Company generally
sells the guaranteed portion of each loan to an investor and retains the
unguaranteed portion in its own portfolio. Funding for the SBA programs depend
on annual appropriations by the U.S. Congress.
Gains on these sales are earned through the sale of the guaranteed portion of
the loan for an amount in excess of the adjusted carrying value of the portion
of the loan sold. The Company allocates the carrying value of such loans between
the portion sold, the portion retained and a value assigned to the right to
service the loan. The difference between the adjusted carrying value of the
portion retained and the face amount of the portion retained is amortized to
interest income over the life of the related loan using a method which
approximates the interest method. The value assigned to the right to service the
loan is also amortized over the estimated life of the loan.
Allowance for Loan Losses:
The Company adopted SFAS No. 114, Accounting by Creditors for Impairment of a
Loan, as amended by FAS 118, on January 1, 1995. Under these new standards, a
loan is considered impaired if it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. Any allowance for losses on
impaired loans are to be measured under one of three methods. Since almost all
of the Company's loans are collateral dependent, the calculation of the impaired
loans is generally based on the fair value of the collateral. The adoption of
SFAS No. 114 did not result in any additional provision for credit losses at
January 1, 1995. Income recognition on impaired loans conforms to the method the
Company uses for income recognition on nonaccrual loans.
An allowance for loan losses is maintained at a level deemed appropriate by
management to provide for known losses as well as unidentified losses in the
loan portfolio. The allowance is based upon management's assessment of various
factors affecting the collectibility of the loans including current and
projected economic conditions, past credit experience, delinquency status, the
value of the underlying collateral, if any, and continuing review of the
portfolio of loans and commitments. The allowance is increased by provisions
charged to income and reduced by net charge-offs. The allowance for loan losses
is based on estimates, and ultimate losses may vary from the current estimates.
Other Real Estate Owned:
Other real estate owned (OREO) consists of properties acquired through
foreclosure and is stated at the lower of cost or fair value less estimated
costs to sell. Development and improvement costs relating to the property are
capitalized. Estimated losses that result from the ongoing periodic valuation of
these properties are charged to current earnings with a provision for losses on
foreclosed property in the period in which they are identified. The resulting
allowance for OREO losses is decreased when the property is sold. Operating
expenses of such properties, net of related income, are included in other
expenses. Gains and losses on disposition of OREO are included in other income.
Leasehold Improvements and Equipment:
Leasehold improvements and equipment are
stated at cost less accumulated depreciation and amortization. Depreciation and
amortization are computed on the straight-line basis over the shorter of the
estimated useful lives of the assets or the term of the lease.
52
<PAGE>
Income Taxes:
The Company and the Bank file consolidated federal income tax returns and
combined state tax returns for California and Arizona. Deferred income taxes
reflect the estimated future tax effects of temporary differences between the
amount of assets and liabilities for financial reporting purposes and such
amounts as measured by tax laws and regulations.
Net Income Per Common and Common Equivalent Share:
Net income per common and common equivalent share, adjusted for stock dividends,
is calculated using the weighted average number of shares outstanding during the
period, (1,349,803 and 1,245,735 shares in 1995 and 1994, respectively).
Reclassifications:
Certain amounts in the 1994 financial statements have been reclassified to
conform with 1995 classifications.
2. Investment Securities:
The amortized cost and estimated market values of investment securities at
December 31, 1995 and 1994 were as follows:
<TABLE>
<CAPTION>
1995
----------------------------------------------------------------------------------
Unrealized Unrealized Market
Gains Losses Value
Cost
----------------- -------------- --------------- ------------------
<S> <C> <C> <C> <C>
Held to maturity - U.S. Treasury
securities $ 10,756,000 $ 4,000 $ 1,000 $ 10,759,000
Other securities - Federal Reserve Bank
stock 123,000 - - 123,000
-- ------------- --- ---------- -- ----------- -- --------------
$ 10,879,000 $ 4,000 $ 1,000 $ 10,882,000
== ============= === ========== == =========== == ==============
Held-to-maturity:
U.S. Government Agency Securities $ 985,000 - $ 1,000 $ 984,000
U.S. Treasury Securities 1,970,000 - 11,000 1,959,000
Other securities:
Federal Reserve Bank stock 117,000 - 117,000
-- ------------- --- ---------- -- ----------- -- --------------
$ 3,072,000 - $ 12,000 $ 3,060,000
== ============= === ========== == =========== == ==============
</TABLE>
Investment securities totaling $500,000 at December 31, 1995 and 1994,
respectively, were pledged to secure certain deposits.
All investment securities held at December 31, 1995 have a contractual maturity
of one year or less. There were no sales of investment securities in 1995 or
1994.
53
<PAGE>
3. Loans and Allowance for Loan Losses:
Loans at December 31, 1995 and 1994 consisted of the following:
<TABLE>
<CAPTION>
1995 1994
<S> <C> <C>
Commercial loans $ 47,745,000 $ 34,857,000
Consumer installment loans 2,702,000 2,965,000
Real estate loans:
Construction 3,556,000 1,701,000
Other 64,713,000 49,601,000
---- --------------- --- ---------------
118,716,000 89,124,000
Deferred loan fees and discounts (1,777,000) (1,418,000)
Allowance for loan losses (1,676,000) (1,421,000)
---- --------------- --- ---------------
$ 115,263,000 $ 86,285,000
==== =============== === ===============
</TABLE>
The Company's lending activities are concentrated primarily in Sonoma County.
There were no industry or borrower group concentrations at December 31, 1995.
54
<PAGE>
3. Loans and Allowance for Loan Losses, continued:
A summary of activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
1995 1994
<S> <C> <C>
Balance, beginning of year $ 1,421,000 $ 1,113,000
Provision for loan losses 250,000 280,000
Charge-offs (102,000) (16,000)
Recoveries 107,000 44,000
-- ------------- --- --------------
Balance, end of year $ 1,676,000 $ 1,421,000
== ============= === ==============
</TABLE>
There were six loans totaling $398,000 and five loans totaling $201,000 on
nonaccrual status as of December 31, 1995 and 1994, respectively. Interest
foregone on such loans totaled $30,000 in 1995 and $21,000 in 1994.
At December 31, 1995, the recorded investment in loans for which impairment has
been recognized in accordance with SFAS No. 114 totaled $398,000, with a
corresponding valuation allowance of $64,000. The average recorded investment in
impaired loans in 1995 was $179,000. No interest income was recognized on
impaired loans in 1995.
As discussed in Note 1, the Company originates loans
guaranteed by the U.S. Small Business Administration (SBA). The Company sells to
outside investors, usually at a price in excess of par, the guaranteed portion
of these loans and retains the remaining unguaranteed portion in its loan
portfolio. When the Company sells the guaranteed portion of such loans, it
transfers the SBA guarantee to the buyer and retains the servicing function. At
December 31, 1995 and 1994, the Company serviced $45,209,000 and $38,967,000 in
loans guaranteed by the SBA of which the Company's retained interest in these
loans range from 10% to 35%. The Company and the SBA share losses on these loans
on a pro rata basis.
At December 31, 1995 and 1994, the Company serviced
additional loans for others totaling $11,209,000 and $11,290,000, respectively.
4. Leasehold Improvements and Equipment:
Leasehold improvements and equipment consisted of the following at December
31, 1995 and 1994:
<TABLE>
<CAPTION>
1995 1994
<S> <C> <C>
Leasehold improvements $ 938,000 $ 938,000
Furniture and equipment 1,502,000 1,638,000
---- -------------- --- --------------
Total 2,440,000 2,576,000
Less accumulated depreciation and amortization (1,693,000) (1,899,000)
---- -------------- --- --------------
Total $ 747,000 $ 677,000
==== ============== === ==============
</TABLE>
Depreciation and amortization of approximately $226,000 and $336,000 were
charged to expense for the years ended December 31, 1995 and 1994, respectively.
55
<PAGE>
5. Deposits:
Deposits consisted of the following at December 31, 1995 and 1994:
<TABLE>
<CAPTION>
1995 1994
Deposits:
<S> <C> <C>
Noninterest-bearing $ 23,017,000 $ 21,197,000
Interest-bearing:
Money market rate 49,913,000 44,005,000
Savings 5,086,000 8,614,000
Demand 9,672,000 8,919,000
Certificates of deposit 66,533,000 28,348,000
--- --------------- --- ---------------
$ 154,221,000 $ 111,083,000
=== =============== === ===============
</TABLE>
Certificates of deposits with balances of $100,000 or more totaled $19,331,000
and $8,616,000 at December 31, 1995 and 1994, respectively.
Certificates of deposit have remaining maturities at December 31, 1995 and 1994
as follows:
<TABLE>
<CAPTION>
1995 1994
<S> <C> <C>
Three months or less $ 12,386,000 $ 5,189,000
Over three through six months 11,686,000 9,579,000
Over six through twelve months 21,888,000 12,209,000
Over twelve months 20,573,000 1,371,000
-- -------------- --- -------------
Total certificates of deposit $ 66,533,000 $ 28,348,000
== ============== === =============
</TABLE>
56
<PAGE>
6. Income Taxes:
The components of the provision for federal and state income taxes are as
follows:
<TABLE>
<CAPTION>
1995 1994
Currently payable:
<S> <C> <C>
Federal $ 1,136,000 $ 698,000
State 387,000 247,000
---- ------------- --- ----------
Total 1,523,000 945,000
---- ------------- --- ----------
Deferred:
Federal (171,000) 4,000
State (14,000) 24,000
---- ------------- --- ----------
Total (185,000) 28,000
---- ------------- --- ----------
Total $ 1,338,000 $ 973,000
==== ============= === ==========
</TABLE>
A reconciliation of the statutory tax rates to the effective tax rates is as
follows:
<TABLE>
<CAPTION>
1995 1994
<S> <C> <C>
Statutory federal tax rate 35.0% 34.0%
State tax, net of federal income tax effect 7.9 8.3
Other, net 0.8 (0.3)
--- ------------ --- -----------
43.7% 42.0%
=== ============ === ===========
</TABLE>
The components of deferred income tax assets net of liabilities as of December
31, 1995 and 1994 are as follows:
<TABLE>
<CAPTION>
1995 1994
Deferred Deferred
Tax Tax
Assets Assets
---- ------------ ------------
<S> <C> <C>
Loan loss reserves $ 508,000 $ 423,000
Deferred loan fees 103,000 105,000
State taxes, net of federal effect 297,000 138,000
57
<PAGE>
All others 127,000 184,000
---- ------------ --- ------------
Total $ 1,035,000 $ 850,000
==== ============ === ============
</TABLE>
7. Stock Option Plan:
The Company's nonqualifying stock option plan provides for granting of stock
options (up to 311,380 shares) to directors and officers to purchase shares of
the Company's stock at a price not less than the fair market value on the date
the option is granted. Options to outside directors vest at the time of grant.
Options to officers and directors who are also officers vest over five years
from the date of grant.
All options expire ten years from the date of grant. A summary of all stock
option activity is as follows:
<TABLE>
<CAPTION>
Number Option
of Price
Shares Per Share
------------ ----------------
<S> <C> <C>
Outstanding, December 31, 1993 210,008 $ 5.00 -
$8.53
Granted 3,000 8.38
Effect of 5% stock dividend 8,428 4.76 -
8.12
Expired (3,500) 7.00 -
7.38
Exercised (58,260) 4.76 -
7.75
------------ --- ------------
Outstanding, December 31, 1994 159,676 4.76 -
8.12
Effect of 5% stock dividend 4,526 4.53 -
7.73
Exercised (69,015) 4.76 -
6.66
------------ --- ------------
Outstanding, December 31, 1995 95,187 $ 4.53 -
7.73
============ === ============
</TABLE>
In the aggregate, options to 95,187 and 159,676 shares were exercisable at
December 31, 1995 and 1994, respectively. At December 31, 1995 and 1994, there
were no options to purchase shares available for future grants.
In October 1995, the Financial Accounting Standards Board (FASB) issued
financial Accounting Standards (SFAS) No. 123 "Accounting for Stock-Based
Compensation." Under the provisions of SFAS No. 123, the Company is encouraged,
but not required, to measure compensation costs related to its employee stock
compensation plans under the fair value method. Under this method, compensation
cost is measured at the grant date based on the value of the award and is
recognized over the service period, which is usually the
58
<PAGE>
vesting period. If the Company elects not to recognize compensation expense
under this method, it is required to disclose the pro forma net income and
earnings per share effects based on the SFAS No. 123 fair value methodology.
SFAS No. 123 applies to financial statements for fiscal years beginning after
December 15, 1995. Earlier implementation is permitted. The Company will
implement the requirements of SFAS No. 123 in 1996 and will only adopt the
disclosures provisions of this statement.
8. Deferred Compensation:
The Company has entered into deferred compensation agreements with two key
officers and four board members. Under these agreements, the Company is
obligated to provide for each such employee/director or their beneficiaries,
during a period of 15 years after the employee's/director's death, disability,
or retirement, annual benefits ranging from $75,000 to $100,000 for the
employees and $13,000 to $55,000 for the directors. The estimated present value
of future benefits to be paid is being accrued over the period from the
effective date of the agreements until the expected retirement dates of the
participants. The expense incurred and amount accrued for this plan for the
years ended December 31, 1995 and 1994 totaled $89,000 and $58,000,
respectively. The Company is the beneficiary of life insurance policies that
have been purchased as a method of financing the benefits under the agreements.
At December 31, 1995, the cash surrender value of these policies was $1,671,000,
which is included in other assets.
9. Related Party Transactions:
The Company has and expects to have, in the future, banking
transactions in the ordinary course of business with directors, officers and
their associates. An analysis of the loans to related parties is as follows:
<TABLE>
<CAPTION>
1995 1994
<S> <C> <C>
Balance, beginning of year $ 2,490,000 $ 2,968,000
Additions 2,470,000 1,236,000
Principal reductions (379,000) (1,714,000)
---- ------------- --- --------------
Balance, end of year $ 4,581,000 $ 2,490,000
==== ============= === ==============
</TABLE>
The Company has entered into three operating leases for branch and office
facilities with a shareholder or partnerships partially owned by Directors of
the Company. Rental payments made under these leases were $304,000 and $287,000
for the years ended December 31, 1995 and 1994, respectively. Two of the leases
require that rental payments will increase each year based on the consumer price
index, and under certain circumstances, average deposits at the branch.
10. Commitments and Contingencies:
The Bank is required by federal regulations to
maintain certain minimum average balances with the Federal Reserve, based
primarily on the Bank's daily demand deposit balances. Required deposits held
with the Federal Reserve averaged approximately $1,009,000 in 1995.
59
<PAGE>
10. Commitments and Contingencies, continued:
The future minimum noncancelable lease payments as of December 31, 1995 are as
follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1996 $ 324,000
1997 316,000
1998 295,000
1999 202,000
Thereafter 945,000
---- ------------
Total $ 2,082,000
==== ============
</TABLE>
Total rental expense for the years ended December 31, 1995 and 1994 was $478,000
and $447,000, respectively.
11. Regulatory Capital Requirements:
The Bank is required by Office of the Comptroller of the Currency (OCC) and
Federal Deposit Insurance Corporation (FDIC) guidelines to maintain various
minimum capital ratios. At December 31, 1995, the Bank exceeded all applicable
regulatory capital ratios.
The FDIC Improvement Act of 1991 (FDICIA) requires each federal banking agency
to implement regulations governing "prompt corrective" actions for institutions
that it regulates. In response to this requirement, the FDIC adopted final
rules, effective December 19, 1992, based upon FDICIA's five capital tiers: well
capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. Under FDICIA, the FDIC is
required to take supervisory action against institutions that are not deemed
either "well capitalized" or "adequately capitalized." At December 31, 1995, the
Bank was considered "well capitalized."
Payment of dividends by the Bank is limited under regulations for national
banks. The amount that can be paid in any calendar year without prior approval
of the OCC cannot exceed the lesser of net profits (as defined) for that year
plus the net profits for the preceding two calendar years, or undivided profits.
Therefore, the payment of dividends by the Company may also be limited.
60
<PAGE>
11. Regulatory Capital Requirements, continued:
The Bank is required to report certain financial information to its regulators.
Differences can arise between the Bank's financial statements and the regulatory
financial information reported because regulatory reporting requirements differ
from generally accepted accounting principals (GAAP). A reconciliation of the
Bank's GAAP net income and shareholder's equity to the amounts reported for
regulatory purposes as of December 31, 1995 is as follows:
<TABLE>
<CAPTION>
Bank Only
----------------------------------------------
Net Shareholder's
Income Equity
----------------- ------------------------
<S> <C> <C>
GAAP financial statement amounts $ 1,715,000 $ 11,752,000
Regulatory accounting adjustment, net of income tax impact 206,000 (41,000)
---- ------------ ---- --------------
Amounts reported for regulatory purposes (unaudited) $ 1,921,000 $ 11,711,000
==== ============ ==== ==============
</TABLE>
12. Fair Values of Financial Instruments:
Fair value estimates are determined as of a specific date in time utilizing
quoted market prices, where available, or various assumptions and estimates. As
the assumptions underlying these estimates change, the fair value of the
financial instruments will change. The use of assumptions and various valuation
techniques, as well as the absence of secondary markets for certain financial
instruments, will likely reduce the comparability of fair value disclosures
between financial institutions. Additionally, the Bank has not disclosed highly
subjective values of other non-financial instruments. Accordingly, the aggregate
fair value amounts presented do not represent and should not be construed to
represent the full underlying value of the Company. The methods and assumptions
used to estimate the fair values of each class of financial instruments are as
follows:
Cash and Cash Equivalents:
The carrying value of cash and cash
equivalents approximates fair value due to the relatively short-term nature of
these instruments.
Investment Securities, Held to Maturity:
Fair value of securities and investments is based on quoted market prices. If
quoted market prices are not available, fair values are based on quoted market
prices of comparable instruments.
Loans Receivable:
In order to determine the fair values for loans, the loan portfolio was
segmented based on loan type, credit quality and repricing characteristics. For
certain variable rate loans with no significant credit concerns and frequent
repricings, estimated fair values are based on the carrying values. The fair
values of other loans are estimated using discounted cash flow analyses. The
discount rates used in these analyses are generally based on origination rates
for similar loans of comparable credit quality. Maturity estimates of
installment loans are based on historical experience with prepayments.
Deposits:
The fair values for deposits, subject to immediate withdrawal such as interest
and noninterest bearing, and savings deposit accounts, are equal to the amount
payable on demand at the reporting date (i.e., their carrying amount on the
balance sheet). Fair values for fixed-rate certificates of deposits are
estimated by discounting future cash flows using interest rates currently
offered on time deposits with similar remaining maturities.
Off-Balance Sheet Instruments:
The fair value of commitments to extend credit and standby letters of credit is
estimated using the fees currently charged to enter into similar agreements,
taking into account the remaining terms of the agreements and the present
creditworthiness of the counter parties.
61
<PAGE>
<TABLE>
<CAPTION>
December 31, 1995
----------------------------------------
Carrying Fair
Amount Value
- -------------- -- --------------
<S> <C> <C>
Financial assets:
Cash equivalents and certificates of deposits $ 21,427,000 $ 21,440,000
Investments securities 10,879,000 10,882,000
Loans held for sale 14,324,000 15,685,000
Loans receivable, net 115,263,000 116,184,000
- -------------- -- --------------
161,893,000 164,191,000
- -------------- -- --------------
Financial liabilities:
Deposits $ 154,221,000 $ 154,577,000
- -------------- -- --------------
Off-balance sheet financial instruments:
Commitments to extend credit - 130,000
Standby letters of credit - 15,000
- -------------- -- --------------
- $ 145,000
- -------------- -- --------------
</TABLE>
13. 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 to meet the financing needs of its customers. To
date, these financial instruments include commitments to extend credit and
standby letters of credit which involve elements of credit and interest rate
risk in excess of the amount recognized in the statement of financial position.
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. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The Company generally requires
collateral or other security to support commitments to extend credit.
Standby letters of credit are performance assurances made on behalf of customers
who have a contractual obligation to produce or deliver goods or services or
otherwise perform. Credit risk in these transactions arises from the possibility
that a customer may not be able to repay the Bank if the letter of credit is
drawn upon. As with commitments to extend credit, the Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if any, is based on management's credit evaluation of the
counter-party.
At December 31, 1995 and 1994, loan commitments totaled $12,951,000 and
$14,012,000, respectively and standby letters of credit totaled $1,486,000 and
$823,000, respectively.
62
<PAGE>
14. Parent Company Only Condensed Financial Information:
The condensed financial statements of Northern Empire Bancshares (parent company
only) as of December 31, 1995 and 1994, and for each of the two years in the
period ended December 31, 1995, are presented below:
<TABLE>
<CAPTION>
1995 1994
<S> <C> <C>
Balance Sheets
Assets:
Cash and cash equivalents $ 180,000 $ 223,000
Investment in Sonoma National Bank 11,752,000 9,837,000
Other assets 51,000 143,000
---- ------------- --- --------------
Total assets $ 11,983,000 $ 10,203,000
==== ============= === ==============
Liabilities and shareholders' equity:
Other liabilities $ 1,000 $ 4,000
---- ------------- --- --------------
Preferred stock, no par value; authorized, 10,000,000 shares; none
issued or outstanding
Common stock, no par value; authorized,
20,000,000 shares; issued and outstanding 1,388,355 in 1995 and
1,253,350 in 1994 7,433,000 6,489,000
Retained earnings 4,549,000 3,710,000
---- ------------- --- --------------
Total shareholders' equity 11,982,000 10,199,000
---- ------------- --- --------------
Total liabilities and shareholders' equity $ 11,983,000 $ 10,203,000
==== ============= === ==============
Statements of Income
Dividend income - $ 100,000
Interest and other income $ 18,000 9,000
Administrative expenses (10,000) (15,000)
Income taxes benefit (expense) (3,000) 2,000
Equity in undistributed earnings of Sonoma National Bank 1,715,000 1,250,000
---- ------------- --- --------------
Net income $ 1,720,000 $ 1,346,000
==== ============= === ==============
1995 1994
Statements of Cash Flows
Cash flows from operating activities:
Net income $ 1,720,000 $ 1,346,000
63
<PAGE>
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Decrease (Increase) in other assets 92,000 (92,000)
Decrease in other liabilities (3,000) (20,000)
---- ------------- --- --------------
Total 1,809,000 1,234,000
Less equity in undistributed earnings of Sonoma National Bank (1,715,000) (1,250,000)
---- ------------- --- --------------
Net cash provided by (used in) operating activities 94,000 (16,000)
---- ------------- --- --------------
Cash flows from investing activities:
Proceeds on sale of OREO - 200,000
Capital contributed to Sonoma National Bank (200,000) -
---- ------------- --- --------------
Net cash (used in) provided by investing activities (200,000) 200,000
---- ------------- --- --------------
Cash flows from financing activities:
Cash dividend paid (266,000) (430,000)
Stock options exercised 329,000 386,000
---- ------------- --- --------------
Net cash provided by (used in) financing activities 63,000 (44,000)
---- ------------- --- --------------
Net increase (decrease) in cash and cash equivalents (43,000) 140,000
Cash and cash equivalents:
Beginning of year 223,000 83,000
---- ------------- --- --------------
End of year $ 180,000 $ 223,000
==== ============= === ==============
</TABLE>
ITEM 8.
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
Not applicable.
64
<PAGE>
Part III
ITEM 9.
Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
The following are the directors and executive officers of the Corporation and
the Bank:
<TABLE>
<CAPTION>
Name and Positions with the Principal Occupation
Corporation and the Bank Age During the Past 5 Years
=========================================== ======= =================================================================
<S> <C> <C>
Deborah A. Meekins, 43 President and Chief Executive Officer of the Bank since February
President & Chief Executive Officer and 1991; Acting President from August 1990 to February 1991.
Director of the Bank
Clement C. Carinalli 50 Retired CPA, local businessman, rancher and real estate investor
Director of the Bank
Patrick R. Gallaher, 50 Certified Public Accountant and local businessman. Secretary/Treasurer
Chief Accounting Officer of the Corporation for Oakmont Developers from September 1986 to the present.
and Director of the Corporation and the Bank
William P. Gallaher, 45 Real Estate developer and investor; President of Oakmont Developers, a
Director of the Corporation and the Bank Santa Rosa development company; President of Gallaher Construction
Company since 1979.
William E. Geary, 67 Senior Partner in Geary, Shea & O'Donnell, a Santa Rosa law firm.
Director of the Corporation and the Bank
Dennis R. Hunter, 53 Real estate investor and developer in Santa Rosa; principal in
Chairman of the Board of the Corporation and Investment Development Fund, a venture capital fund.
Vice Chairman of the Board of the Bank
James B. Keegan, Jr., 47 Partner in Keegan & Coppin Company, a Santa Rosa real estate
President & Director of the Corporation and brokerage and development firm, since 1976.
Chairman of the Board of the Bank
Robert V. "Buzz" Pauley, 51 Owner of Pauley Exports, Ltd., an exporter of California food and
Secretary/Treasurer of the Corporation and beverage products to the Pacific Rim. Commercial properties manager;
Director of the Bank trader of futures and options contracts in Chicago and other international
market exchanges.
David F. Titus, 43 Executive Vice President & Senior Loan Officer since January, 1995.
Executive Vice President and Senior Loan Senior Vice President & Senior Loan Officer from August 1991 to
Officer of the Bank January, 1995; Vice President & Senior Commercial Lending Officer from
February 1990 until August 1991.
JoAnn Barton, 42 Senior Vice President and Senior Operations Administrator of the Bank
Senior Vice President & Senior Operations since March 1992; from November 1985 Vice President and Senior
Officer of the Bank Operations Administrator.
Jane M. Baker 49 Senior Vice President and Chief Financial Officer since August 1995.
Senior Vice President & Vice President and Chief Financial Officer of the Bank since August
Chief Financial Officer of the Bank 1992; from 1990 to 1992, Controller of Redwood Bank.
</TABLE>
Each of the directors of the Corporation has served as a director since the
initial organization of the Corporation in 1982, except for Patrick R. Gallaher
who was elected on May 19, 1992 and William P. Gallaher who was elected on June
21, 1994.
William E. Geary, Dennis R. Hunter, James B. Keegan, Jr. and Robert V. Pauley
have served as directors of the
65
<PAGE>
Bank since the initial organization of the Bank. Mr. Carinalli was reappointed
to the Bank board in February 1996. Deborah A. Meekins was appointed as Bank
director in August 1990; William P. Gallaher was appointed in November 1988; and
Patrick R. Gallaher was appointed in December 1991. William P. Gallaher and
Patrick R. Gallaher are brothers. As the sole shareholder of the Bank, the
Corporation elects the directors of the Bank.
The Corporations's common stock is not registered pursuant to section 12 of the
Exchange Act, therefore Item 405 of Regulation S-B is not applicable.
ITEM 10.
Executive Compensation
The following table sets forth the cash compensation paid to or accrued for the
officers of the Bank whose cash compensation exceeded $100,000, for services
rendered for periods indicated. The executive officers of the Corporation,
including the President, do not receive compensation for their services as such.
The President of the Corporation, James B. Keegan, Jr., serves as the Chairman
of the Board of the Bank and receives $1,000 per month from the Bank for his
services in that capacity. All other executive officers of the Corporation are
considered outside directors of the Bank and, as such, they receive directors
fees. See, "Compensation of Directors," below.
<TABLE>
<CAPTION>
Summary Compensation Table
Long Term
Annual Compensation Compensation
Name and Principal Position Options All Other (1)
Year Salary Bonus (No. of Shares)
============================= ========== ============ ============ ================== ===================
<S> <C> <C> <C> <C> <C>
Deborah A. Meekins, 1993 $115,000 $10,000 $20,000
President and Chief 1994 122,000 69,000 24,000
Executive Officer and 1995 128,000 69,000 27,000
Director of the Bank
David F. Titus, Executive Vice 1993 80,000 8,000 17,000
President and Senior Loan 1994 83,000 44,000 1,102(2) 25,000
Officer of the Bank 1995 91,000 44,000 23,000
============================= ========== ============ ============ ================== ===================
<FN>
(1) Includes contribution by the Bank for the benefit of the named officer
pursuant to the Bank's 401(k) plan and expenses incurred with respect to the
Salary Continuation Agreement for the named officer, as described below.
(2) Adjusted for the 5% stock dividend in July 1994 and the 5% stock
dividend in November 1995.
</FN>
</TABLE>
Salary Continuation Agreements
During 1993, the Bank entered into deferred compensation agreements with Deborah
A. Meekins, President & Chief Executive Officer, and David F. Titus, Executive
Vice President & Senior Loan Officer. Under these agreements, the Bank is
obligated to provide for them or their beneficiaries, during a period of 15
years after the employee's death, disability, or retirement, annual benefits
ranging from $75,000 to $100,000. Benefits are also provided to the officer if
he/she resigns following a change in control or if he/she voluntarily resigns
after June 1, 1995. The estimated present value of future benefits to be paid is
being accrued over the period from the effective date of the agreements until
their expected retirement dates. The accrued expense is included in Other
Liabilities in the financial statements. The Bank is the beneficiary of life
insurance policies that have been purchased as a method of financing the
benefits under the agreements. At December 31, 1995, the cash surrender value of
these policies were $791,000, which is included in other assets.
66
<PAGE>
Stock Option Plan
Neither the Corporation nor the Bank award restricted stock or have long term
incentive plans, other than the Corporation's Stock Option Plan. No stock
options were granted to officers in 1995, since the stock option plan expired on
February 26, 1994. Stock options granted under the Stock Option Plan remain
outstanding even though the Plan has terminated. None of the listed executive
officers exercised any stock options in 1995.
<TABLE>
Aggregated Year-End Option Values
<CAPTION>
December 31, 1995
Number of Unexercised Securities
Underling Options
(No. of Shares) Value of Unexercised Options (1)
Name Exercisable/Unexercisable Exercisable/Unexercisable
<S> <C> <C> <C> <C>
Deborah A. Meekins 18,972 / 1,472 $71,000 / $4,000
David F. Titus 440 / 662 1,000 / 1,000
=================================== ====================================== ======================================
<FN>
(1) Calculated based on the difference between the fair market value of the
stock and the exercise price of the options, as of December 31, 1995.
</FN>
</TABLE>
Compensation of Directors
Outside Directors of the Bank (including directors who serve as executive
officers of the Corporation) receive director fees as follows: $600 for each
monthly board meeting attended, $200 per executive or loan committee meeting
attended and $125 per all other committee meetings attended. The Chairman of the
Board of the Bank receives a fee of $1,000 per month in addition to the
committee fees described above. Effective January 1996, the board fee was
increased to $1,000 per meeting attended and the Chairman of the Board of the
Bank's fee was increased to $1,500 per month. The Corporation does not pay
director's fees at this time, and does not plan to in the near future.
Directors also were eligible to receive options under the Corporation's Stock
Option Plan. See "Item 11, Security Ownership of Certain Beneficial Owners and
Management." During 1995, 54,200 options were exercised by directors, realizing
a value of approximately $178,000. Outside directors held on December 31, 1995
options for 82,491 shares, which options had an estimated value of $160,000
based on the difference between the fair market value of the stock as of that
date and the exercise price of the options.
During 1994 and early 1995, the Corporation entered into deferred compensation
agreements with Patrick R. Gallaher, William P. Gallaher, William Geary, and
James B. Keegan, Jr. Under each of these agreements, the Corporation is
obligated to provide for the director or his beneficiaries, during a period of
between 10 to 15 years after the director's death, disability or retirement,
annual benefits ranging from $12,000 to $55,000. The estimated present value of
future benefits to be paid is being accrued over the period from the effective
date of the agreements until the expected retirement dates. The Corporation is
beneficiary of life insurance policies that have been purchased as a method of
financing the benefits. At December 31, 1995, the cash surrender value of these
policies was $883,000, which is included in other assets.
67
<PAGE>
ITEM 11.
Security Ownership of Certain Beneficial Owners and Management
Other than as set forth below, the Corporation knows of no person who is the
beneficial owner of more than 5.0% of the Corporation's outstanding shares as of
February 29, 1996.
The following sets forth the numbers of shares of common stock beneficially
owned by each director of the Corporation and the Bank and by the directors and
officers (including vice presidents and above) of the Corporation and the Bank
as a group, as of February 29, 1996. The numbers of shares beneficially owned
include the numbers of shares which each person has the right to acquire upon
exercise of stock options granted pursuant to the Corporation's Stock Option
Plan. The percentages of shares owned beneficially are calculated, pursuant to
SEC Rule 13d-3(d) (1), based on the number of shares presently outstanding plus
the number of shares which the person or group has the right to acquire.
<TABLE>
<CAPTION>
Number of Shares
Name Beneficially Owned Pct
====================================================================================================
<S> <C> <C>
Clement C. Carinalli 56,640 (1) 3.8%
Patrick R. Gallaher 93,437 (2) 6.3
William P. Gallaher 65,694 (2),(3) 4.4
William E. Geary 74,617 (4) 5.0
Dennis R. Hunter 61,518 (5) 4.1
James B. Keegan, Jr. 44,322 (6) 3.0
Deborah A. Meekins 20,995 (7) 1.4
Robert V. Pauley 123,435 (8) 8.3
All other officers as a group (8 people) 18,040 (9) 1.2
Directors and Officers as a group (15 persons) 514,743 34.7%
====================================================================================================
<FN>
(1) Including 18,388 share which Mr. Carinalli has the right to purchase upon exercise of outstanding
options.
(2) Including 43,955 shares held by Gallaher Construction Inc., Pension & Profit Sharing Plan.
(3) Including 6,615 shares which Mr. Gallaher has the right to purchase upon exercise of outstanding
options.
(4) Including 8,820 shares which Mr. Geary has the right to purchase upon
exercise of outstanding options and 6,890 shares held for Geary Shea &
O'Donnell, employee pension and profit sharing plan.
(5) Including 9,702 shares which Mr. Hunter has the right to purchase upon
exercise of outstanding options and 46,414 shares held in the name of
Kathrine Hunter, as to which Mr. Hunter has voting rights.
68
<PAGE>
(6) Including 9,602 shares which Mr. Keegan has the right to purchase upon exercise of outstanding
options.
(7) Including 20,444 shares which Ms. Meekins has the right to purchase upon exercise of outstanding
options.
(8) Including 8,820 shares which Mr. Pauley has the right to purchase upon
exercise of outstanding options and 1,145 shares held as custodian for
a minor child.
(9) Including 11,308 shares which officers have the right to purchase upon exercise of outstanding
options.
</FN>
</TABLE>
The following are the business addresses of the directors having beneficial
ownership of more than 5% of the Corporation's outstanding shares.
Patrick R. Gallaher, 6637 Oakmont Drive, Santa Rosa, CA 95409
William E. Geary, 37 Old Courthouse Square, Santa Rosa, CA 95404
Robert V. Pauley, 120 "D" Street, Santa Rosa, CA 95404
ITEM 12.
Certain Relationships and Related Transactions
The Corporation leases the Oakmont Branch premises from Oakmont Investments of
which Patrick Gallaher, a director of the Corporation and Bank, is a partner.
Initial monthly lease payments were a minimum of $5,538 with monthly increases
of $.25 per square foot or $923, at each of the following average deposit
thresholds: $17,500,000, $30,000,000 and $50,000,000. In addition, these lease
payments are subject to annual increases based on increases in the Consumer
Price Index. The Oakmont Branch had deposits at December 31, 1995 totalling
$50,600,000; however, the average deposits did not exceed $50,000,000 until
January 1996. The monthly rental for the Oakmont Branch was $9,000 at December
31, 1995. Total rental expense on this lease for years ended December 31, 1995
and 1994 was $104,000 and $97,000.
The Bank signed a lease dated March 1, 1993 for branch premises in Windsor
with LVI Partners of which William Gallaher, a director of the Corporation and
Bank, is a partner. Initial monthly lease payments are $1,250 for the first 12
months and then increased to $1,667 for the remaining 48 months. Total rental
expenses on this lease for the year ended December 31, 1995 was $20,000.
The Bank has had in the ordinary course of business, and expects to have in
the future, banking transactions with its directors, officers and their
associates, including transactions with corporations of which such persons are
directors, officers or controlling shareholders. The transactions involving
loans have been and will be entered into with such persons in the ordinary
course of business, on substantially the same terms, including interest rates
and collateral, as those prevailing at the time for comparable transactions
with other persons, and on terms not involving more than the normal risk of
collectibility or presenting other unfavorable features. At December 31, 1995,
loans by the Bank to directors, officers and their associates totaled
approximately $4,581,000, constituting 3.5% of total loans, 39.0% of the
Bank's shareholder's equity and 38.2% of the consolidated shareholders' equity
of the Corporation.
Loans to insiders, such as officers, directors, and certain other persons are
subject to the limitations and requirements of the Financial Institutions
Regulatory and Interest Rate Control Act of 1978 and regulations thereunder.
69
<PAGE>
PART IV
ITEM 13.
Exhibits, Financial and Reports on Form 8-K
(a) Exhibits
The following is a list of the exhibits to this Form
10-KSB.
(3) (a) Articles of Incorporation of the Corporation
(filed as Exhibit 3.1 to the Corporation's S-1
Registration Statement, filed May 18, 1984 and
incorporated herein by this reference).
(b) Certificate of Amendment to Articles of
Incorporation, filed January 17, 1989 (filed as
exhibit (3)(b) to the Corporation's Annual Report on
Form 10-K for the Fiscal Year Ended December 31, 1988
and incorporated herein by this reference).
(c) Bylaws of the Corporation, as amended (filed as
Exhibit 3.2 to the Corporation's S-2 Registration
Statement, File No. 33-51906 filed September 11, 1992
and incorporated herein by this reference).
(d) Amendment to the Bylaws of the Corporation and
revised Bylaws (filed as Exhibit (3)(d) to the
Corporation's Annual Report on Form 10-KSB for the
Fiscal Year Ended December 31,1994 and incorporated
herein by this reference).
(10) (a) Lease for Bank Premises at 801 Fourth Street,
Santa Rosa, California (filed as Exhibit 10.1 to
Amendment No. 1 to the Corporation's S-1 Registration
Statement, filed June 23, 1984, and incorporated
herein by this reference).
(b)* Stock Option Plan (filed as Exhibit 10.2 to the
Corporation's S-1 Registration Statement, filed May
18, 1984, and incorporated herein by this reference).
(c) Lease for Bank Premises at 6641 Oakmont Drive, Santa
Rosa, California, dated February 1, 1989 (filed as
Exhibit (10)(c) to the Corporation's Annual Report on
Form 10-K for the Fiscal Year ended December 31, 1988
and incorporated herein by this reference).
(d)* Amendment No. 1 to Stock Option Plan (filed as
Exhibit (10)(d) to the Corporation's
Annual Report on Form 10-K for the Fiscal Year ended
December 31, 1989 and
incorporated herein by this reference).
(e) Lease for Administrative Office at 755 Fourth Street,
Santa Rosa, California, dated January 10, 1990 (filed
as Exhibit (10)(e) to the Corporation's Annual Report
on Form 10-K for the Fiscal Year ended December 31,
1989 and incorporated herein by this reference).
(f)* Amendment No. 2 to Stock Option Plan (filed as
Exhibit (10)(f) to the Corporation's
Annual Report on Form 10-K for the Fiscal Year Ended
December 31, 1991 and
incorporated herein by this reference).
(g) Lease for second floor at 755 Fourth Street, Santa
Rosa, California, Dated November 12, 1992 (filed as
Exhibit (10)(g) to the Corporation's Annual Report on
Form 10-KSB
70
<PAGE>
for the Fiscal Year Ended December 31,1992 and
incorporated herein by this
reference).
(h)* Indemnification Agreements between James B. Keegan,
Jr. and Northern Empire Bancshares and Sonoma
National Bank (filed as Exhibit (10)(h) to the
Corporation's Annual Report on Form 10-KSB for the
Fiscal Year Ended December 31,1992 and
incorporated herein by this reference).
(i)* Indemnification Agreements between Dennis R. Hunter
and Northern Empire Bancshares and Sonoma National
Bank (filed as Exhibit (10)(i) to the Corporation's
Annual Report on Form 10-KSB for the Fiscal Year
Ended December 31,1992 and incorporated herein by
this reference).
(j)* Indemnification Agreements between Robert V. Pauley
and Northern Empire Bancshares and Sonoma National
Bank (filed as Exhibit (10)(j) to the Corporation's
Annual Report on Form 10-KSB for the Fiscal Year
Ended December 31,1992 and incorporated herein by
this reference).
(k)* Indemnification Agreements between William E. Geary
and Northern Empire Bancshares and Sonoma National
Bank (filed as Exhibit (10)(k) to the Corporation's
Annual Report on Form 10-KSB for the Fiscal Year
Ended December 31,1992 and incorporated herein by
this reference).
(l)* Indemnification Agreements between Patrick R.
Gallaher and Northern Empire Bancshares and Sonoma
National Bank (filed as Exhibit (10)(l) to the
Corporation's Annual Report on Form 10-KSB for the
Fiscal Year Ended December 31,1992 and incorporated
herein by this reference).
(m)* Indemnification Agreement between William P. Gallaher
and Sonoma National Bank (filed as Exhibit (10)(m) to
the Corporation's Annual Report on Form 10-KSB for
the Fiscal Year Ended December 31,1992 and
incorporated herein by this reference).
(n)* Indemnification Agreement between Deborah A. Meekins
and Sonoma National Bank (filed as Exhibit (10)(p) to
the Corporation's Annual Report on Form 10-KSB for
the Fiscal Year Ended December 31,1992 and
incorporated herein by this reference).
(o)* Executive Salary Continuation Agreement between
Deborah A. Meekins and Sonoma National Bank (filed as
Exhibit (10)(O) to the Corporation's Annual Report on
Form 10-KSB for the Fiscal Year Ended December
31,1993 and incorporated herein by this reference).
(p)* Executive Salary Continuation Agreement between David
F. Titus and Sonoma National Bank (filed as Exhibit
(10)(p) to the Corporation's Annual Report on Form
10-KSB for the Fiscal Year Ended December 31,1993 and
incorporated herein by this reference).
.
(q) Lease for premises in Lakeside Village Shopping
Center, Windsor, California, dated
March 1,1993 (filed as Exhibit (10.15) to the
Corporation's Amendment No. 1 to Form
S-2 Registration Statement, File No. 33-60566,
filed May 13, 1993 and incorporated
herein by this reference).
(r)* Director's Deferred Compensation Plan between
Patrick R. Gallaher and Sonoma
71
<PAGE>
National Bank (filed as Exhibit (10)(r) to the
Corporation's Annual Report on Form 10- KSB for the
Fiscal Year Ended December 31,1994 and incorporated
herein by this reference).
(s)* Director's Deferred Compensation Plan between William
P. Gallaher and Sonoma National Bank (filed as
Exhibit (10)(s) to the Corporation's Annual Report on
Form 10- KSB for the Fiscal Year Ended December
31,1994 and incorporated herein by this reference).
(t)* Director's Deferred Compensation Plan between James
B. Keegan, Jr. and Sonoma
National Bank (filed as Exhibit (10)(t) to the
Corporation's Annual Report on Form 10-
KSB for the Fiscal Year Ended December 31,1994
and incorporated herein by this reference).
(u)* Director's Deferred Compensation Plan between William
E. Geary and Sonoma National Bank (filed as Exhibit
(10)(u) to the Corporation's Annual Report on Form
10-KSB for the Fiscal Year Ended December 31,1994 and
incorporated herein by this reference).
*Management contract or compensation plan or arrangement.
(22) Subsidiaries of the Corporation (filed as Exhibit 22
to Post Effective Amendment No. 5 to the
Corporation's S-1 Registration Statement, filed May
29, 1987, File No. 2-91196 and
incorporated herein by this reference).
(27) Financial Data Schedule.
(b) Reports on Form 8-K
Not Applicable
Supplemental Information to be Furnished With Reports Filed Pursuant to
Section 15(d) of the Exchange Act by Non Reporting Issuers.
Four copies of the Registrant's 1995 Annual Report to Security Holders will be
furnished to the Commission for its information when it is sent to the
security holders.
The Registrant's Proxy Materials for the 1996 Shareholders' Meeting have not
yet been sent to the Security Holders. Copies of the Proxy materials will be
furnished to the Commission for its information when they are sent to the
security holders.
72
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Northern Empire Bancshares
By_/Dennis R. Hunter/____
Dennis R. Hunter,
Chairman of the Board of Directors
March 19, 1996 Date
-------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in capacities on the dates indicated.
/Dennis R. Hunter/ Date: March 19, 1996
Dennis R. Hunter
Chairman of the Board of Directors
/James B. Keegan/ Date: March 19, 1996
James B. Keegan, Jr.
President/Director
/Patrick R. Gallaher/ Date: March 19, 1996
Patrick R. Gallaher,
Chief Accounting Officer/Director
/Robert V. Pauley/ Date: March 19, 1996
Robert V. Pauley,
Secretary and Treasurer/Director
/William P. Gallaher/ Date: March 19, 1996
William P. Gallaher,
Director
/William E. Geary/ Date: March 19, 1996
William E. Geary,
Director
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<LEGEND>
This Schedule contains summary financial inforamtion extracted from the Balance
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</LEGEND>
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<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> DEC-31-1995
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