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, 1996
[ ] 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. $18,043,000
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. $18,426,000, as of February 28, 1997.
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 1,465,374 shares of common
stock as of February 28, 1997.
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.
1
<PAGE>
TABLE OF CONTENTS
Part I
Item 1. Description of Business 1
Business of the Bank 2
Employees 5
Supervision and Regulation 5
Item 2. Description of Properties 17
Item 3. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Part II
Item 5. Market for Common Equity and Related Stockholder Matters 18
Item 6. Management's Discussion and Analysis or Plan of Operations 20
Item 7. Financial Statements 44
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 66
Part III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act 67
Item 10. Executive Compensation 68
Item 11. Security Ownership of Certain Beneficial Owners and
Management 69
Item 12. Certain Relationships and Related Transactions 71
Item 13. Exhibits, Financial and Reports on Form 8-K 72
2
<PAGE>
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 commercial
loans guaranteed by the SBA, which may be sold in the secondary market. The Bank
offers investment services through PrimeVest Financial Services, Inc. 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). When a
SBA loan is sold, the Bank retains the unguaranteed portion of that 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." The Bank is designated as a "Preferred
Lender" by the SBA. This means that it may fund a loan without the prior
approval of the SBA for that loan. Certification as a Preferred
3
<PAGE>
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 PrimeVest Financial Services, Inc ("PrimeVest"). 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 PrimeVest. 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 business is
Sonoma and Marin Counties. The Bank has increased its lending territory for
loans made under the programs of the Small Business Administration ("SBA"). The
Bank has SBA loan production facilities in Phoenix, Arizona and San Francisco
and Sacramento, California. The primary market area for deposit business is
Sonoma County.
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. Savings and loans, credit unions and money market
funds 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 101 banking offices and offices of savings
and loan associations in the Sonoma County market area, including offices of
major chain banks, of smaller independent banks and savings and loan
associations. The Bank attempts to compete by offering 30personalized 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.
The Bank has experienced increased competition from major banks and local
community banks in making SBA loans, especially in California. Most of our local
SBA competitors also have Preferred Lender status from the SBA, and they often
offer more attractive rates on SBA loans than the Bank can. We expect this trend
to continue. There can be no assurance that the Bank will continue to increase
its SBA loan portfolio or continue to make a significant number of SBA loans.
4
<PAGE>
Forward-Looking Statements
This report contains "forward-looking statements" as defined in section 27A of
the Securities Act of 1993, as amended, and section 21E of the Securities
Exchange Act of 1934, as amended, which includes statements such as projections,
plans and objectives and assumptions about the future, and such forward looking
statements are subject to the safe harbor created by these sections. Many
factors could cause the actual results, amounts or events to differ materially
from those the Corporation expects to achieve or occur, such as changes in
competition, market interest rates, economic conditions and regulations.
Although the Corporation has based its plans and projections on certain
assumptions, there can be no assurances that its assumptions will be correct, or
that its plans and projections can be achieved.
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, 1996 the Bank had 68 full-time and 9 part-time employees.
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 and are subject to that 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
5
<PAGE>
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 ("BIF"), 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 to qualify, and
that some banks having between $100 million to $1 billion in assets will also be
considered small and noncomplex. During 1996, the Bank was considered
"non-complex" and was examined under the streamlined procedures.
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 and the definitions
of the various measures of capital are described below under the heading
"Capital Regulations and Dividends." 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.
6
<PAGE>
<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, 1996, 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 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 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
7
<PAGE>
specified above for institutions that are significantly undercapitalized.
(c) Brokered Deposits.
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.
(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 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
8
<PAGE>
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, 1996,
exceeded the amounts of capital required under the regulatory guidelines. The
following table shows the capital of the Corporation 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, 1996:
<TABLE>
<CAPTION>
Corporation Bank
<S> <C> <C>
Leverage capital ratio 7.1 6.9
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 9.2 8.9
Required tier 1 risk-based capital ratio 4.0 4.0
<FN>
* Determined based on the regulators' evaluations.
</FN>
</TABLE>
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 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 growth of the Bank exceeds projected levels, it
may be required to raise additional capital.
The Bank's capital ratios have increased in significance under 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 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,
which the Bank does not use, 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.
9
<PAGE>
The Corporation and the Bank are also subject to regulatory restrictions and
guidelines with respect to the payment of dividends. See Item 5, "Market for
Common Equity and Related Stockholder Matters."
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 contaminated
property. State law provisions, which were modeled after Federal law, impose
substantially similar requirements. Both Federal and state laws were amended in
1996 to provide generally that a lender who is not actively involved in
operating the contaminated property will not be liable to clean up the property,
even if the lender has a security interest in the property or becomes an owner
of the property through foreclosure.
The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the
"Economic Growth Act"), discussed in more detail below, includes protection for
lenders from liability under the Comprehensive Environmental Response,
Compensation and Liability Act of 1980 ("CERCLA"). The Economic Growth Act adds
a new section to CERCLA to specify the actions a lender may take with respect to
lending and foreclosure activities without incurring environmental clean-up
liability or responsibility. Typical contractual provisions regarding
environmental issues in the loan documentation and due diligence inspections
will not lead to lender liability for clean-up, and a lender may foreclose on
contaminated property, so long as it merely maintains the property and moves to
divest it at the earliest possible time.
Under California law, a lender generally will not be liable to the State
Attorney General for the cost associated with cleaning up contaminated property
unless the lender realized some benefit from the property, failed to divest the
property promptly, caused or contributed to the release of the hazardous
materials or made the loan primarily for investment purposes. This amendment to
10
<PAGE>
California law became effective with respect to judicial proceedings filed and
orders issued after January 1, 1997.
The extent of the protection provided by both the Federal and state lender
protection statutes will depend on their interpretation by the administrative
agencies and courts, and the Corporation cannot predict whether it will be
adequately protected for the types of loans made by the Bank.
In addition, the Corporation and the Bank are still subject to the risks that a
borrower's financial position will be impaired by liability under the
environmental laws and that property securing a loan made by the Bank may be
environmentally impaired and not provide adequate security for the Bank.
California law provides some protection against the second 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.
The Bank attempts to protect its position against the remaining environmental
risks by performing prudent due diligence. Environmental questionaires and
information on use of toxic substances is requested as part of its underwriting
procedures. The Bank lends based upon its evaluation of the collateral, net
worth of the borrower and the borrower's capacity for unforeseen business
interruptions or risks.
Americans With Disabilities Act
(a) Economic Growth and Regulatory Paperwork Reduction Act of 1996
The Americans With Disabilities Act ("ADA") enacted by Congress, in conjunction
with similar California legislation, is having an impact on banks and increasing
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) Economic Growth and Regulatory Paperwork Reduction Act of 1996 The Economic
Growth and Regulatory Paperwork Reduction Act of 1996 (the "Economic Growth
Act"), enacted on September 30, 1996, addresses the problems that arose from the
disparity between the deposit insurance premiums payable by banks and savings
associations, and includes a wide variety of regulatory relief measures for
banks.
The crisis in the savings and loan industry during the late 1980s resulted in
the dissolution of the Federal Savings and Loan Insurance Corporation and the
insurance of thrift deposits through a separate fund of the FDIC called the
Saving Association Insurance Fund ("SAIF") and the issuance of bonds by the
Financing Corporation ("FICO") to cover some of the losses incurred by the
failed savings association. As the banking industry in general has become more
healthy since 1990, deposit insurance premiums for well-managed and
strongly-capitalized BIF insured institutions have decreased to very low levels.
However, because of the cost of carrying the FICO bonds and because the SAIF
still needed to build reserves, deposit insurance premiums for SAIF insured
institutions have not decreased. This created a large disparity between the cost
of deposit
11
<PAGE>
insurance for healthy banks and similarly situated thrifts over the last several
years. Many healthy thrifts have sought ways either to convert to BIF insurance
or to obtain BIF insurance for some portions of their deposits, in order to
remain competitive with banks. The migration of deposits increased the pressure
on the remaining thrifts to build up reserves at the SAIF and pay the cost of
servicing the FICO bonds.
Subtitle G of the Economic Growth Act required all remaining SAIF institutions
(subject to certain exceptions) to pay a one-time deposit assessment of $.657
per $100 of insured deposits in 1996, in order to recapitalize the SAIF fund.
The banking agencies are now required by law to take actions to prevent the
migration of deposits from the SAIF to the BIF funds, until the year 2000. In
addition, the cost of carrying the FICO bonds will now be allocated between BIF
insurance institutions and SAIF insured institutions, with BIF insured
institutions paying 1/5 the amount paid by SAIF insured institutions. The FDIC
recently estimated that BIF institutions will pay an assessment of approximately
$.0128 annually per $100 of insured deposits and SAIF institutions will pay
approximately $.0644 annually per $100 of insured deposits. Starting in the year
2000, BIF and SAIF institutions will share the FICO bond costs equally, with an
estimated assessment of $.0243 annually per $100 of insured deposits.
This legislation will increase the Bank's premiums, as it will now be required
to share in the cost of carrying the FICO bonds. The increase will be slight
until the year 2000, at which time it will increase.
The Economic Growth Act also included many regulatory relief provisions
applicable to the Corporation and the Bank. National banks no longer need to
submit branch applications with respect to ATM machines. Application procedures
for the Corporation to engage in certain non-banking activities will be
steamlined, so long as the Corporation maintains an adequate financial position
and is considered well managed. The lending restrictions on directors and
officers have been relaxed to permit loans having favorable terms under employee
benefit plans. The Federal Reserve Board and the Department of Housing and Urban
Development ("HUD") are required to simplify and improve their regulations with
respect to disclosures relating to certain mortgage loans, and certain
exemptions from the disclosure requirements were added.
The Economic Growth Act also provides protection for lenders who self-test for
compliance with the Equal Credit Opportunity Act (the "ECOA") and the Fair
Housing Act ("FHA"). The ECOA now provides that the results or report generated
or obtained by a bank from a self-test may not be obtained by an agency,
department or applicant to be used with respect to any proceeding or civil
action alleging a violation of the ECOA. This change in the law protects the
Bank against liability based on the results of internal tests done to enhance
compliance with the law and encourages the Bank to use self-testing to evaluate
its compliance with the ECOA and the FHA.
(b) Increased Permitted Activities
During 1996, the Federal banking agencies, especially the OCC and the Federal
Reserve, took steps to increase the types of activities in which national banks
and bank holding companies can engage, and to make it easier to engage in such
activities. The Federal Reserve adopted interim regulations on November 1, 1996
to implement Section 2208 of the Economic Growth Act, as discussed above, which
permits certain well-capitalized bank holding companies to engage (de novo or by
acquisition) in activities previously approved by regulation without submitting
a prior application. Under the new procedures, a bank holding company that
qualifies may engage in new permitted activities after providing advance notice
to the Federal Reserve at least 12 business days in advance of engaging in the
activity. In order to qualify, a bank holding company must be well-capitalized
12
<PAGE>
and have received a sufficiently high composite rating and management rating at
its last examination.
Since the Federal Reserve did not have a regulatory definition of
well-capitalized, as applicable to a bank holding company, the interim rule
defines well-capitalized for purposes of the new procedures. In general, in
order for a bank holding company to be considered well capitalized, it must (1)
have a total risk-based capital ratio of 10% or more, (2) have a Tier 1
risk-based capital ratio of 6% or more, (3) have either i) a Tier 1 leverage
ratio of 4% or more or ii) a composite rating of 1 or uses a market risk
adjustment to its risk-based capital ratio, and has a Tier 1 leverage ratio of
3% or more, and (4) not be subject to any written agreement, order or capital
directive issued by the Federal Reserve. This change in the law provides an
advantage to a well-capitalized bank holding company, since such a bank holding
company can engage in new activities more freely and quickly. The Corporation is
considered well-capitalized under this rule.
On November 20, 1996, the OCC issued final regulations permitting national banks
to engage in a wider range of activities through subsidiaries. "Eligible
institutions" (those national banks that are well capitalized, have a high
overall rating and a satisfactory CRA rating, and are not subject to an
enforcement order) may engage in activities related to banking though operating
subsidiaries after going through a new expedited application process. In
addition, the new regulations include a provision whereby a national bank may
apply to the OCC to engage in an activity through a subsidiary in which the bank
itself may not engage. In determining whether to permit the subsidiary to engage
in the activity, the OCC will evaluate why the bank itself is not permitted to
engage in the activity and whether a Congressional purpose will be frustrated if
the OCC permits the subsidiary to engage in the activity.
Although the Bank is not currently intending to enter into any new type of
business, either relating to banking or that is not currently permitted for a
bank, this regulation could help the Bank if it determines to expand its
operations in the future. The amount of the benefit to the Bank depends on the
extent to which the OCC permits banks to engage in new lines of business, and
whether the Bank qualifies as an "eligible institution" at such time as it might
decide to expand.
(c) New OCC Corporate Activities and Transaction Regulations
On November 26, 1996, the OCC completely revised its rules to simplify and
streamline corporate applications and notices by national banks, including such
diverse issues as branch applications, fiduciary powers applications, change in
bank control, and changes in capital. The amendments became effective on
December 31, 1996. The Bank is not currently anticipating filing any corporate
applications with the OCC, but the new rules could have an effect on the Bank is
such an application is required.
(d) ATM Fee Legislation
In April of 1996, two of the larger ATM networks lifted their prior restriction
prohibiting ATM operators from directly surcharging the users of the ATMs, which
triggered a series of legislative proposals and hearings with respect to whether
the fees charged by the operators of ATM machines should be regulated. The
lifting of the prior restriction on surcharges was controversial in part because
customers may be required to pay two charges for a single transaction,one to the
bank issuing the ATM card and another to the operator of the ATM being used.
Currently, Federal law requires a bank at which a depositor has an account to
disclose to its own customers the amount of fees it charges, and California law
requires an ATM operator to disclose to users of the ATM machine who are using
an ATM card issued by someone other than the ATM operator that a fee will be
charged. California law was amended in 1996, effective July 1, 1997, to
13
<PAGE>
require the operators of ATMs in California to disclose to customers any
surcharge or fee that the operator of the machine will charge, including charges
for mini-statements and other services.
Although the Bank does not own or operate ATMs, it issues ATM cards to its
customers. This legislation will not have a significant effect on the Bank as it
is currently stated, but other proposed changes could affect the Bank by
limiting ATM charges to customers.
(e) 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. Although the Bank has not experienced a significant
impact to date, there may be increased competition from larger interstate banks.
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.
(f) New Community Reinvestment Act Regulations.
The Federal banking agencies amended substantially their Community Reinvestment
Act ("CRA") regulations in 1995, and issued guidelines and explanations of the
new regulations in 1996. CRA requires banks to help meet the credit needs of
their entire communities, including minorities and low and moderate income
groups.
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, 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.
14
<PAGE>
Small institutions (with less than $250 million in assets) are now being
examined on a "streamlined assessment method." The streamlined method focuses 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. The Federal regulators who are implementing the new
regulations have reported that the time spent at the banks during CRA
examination is reduced under the new regulations, and the banks spend less time
on paperwork evidencing compliance. The Bank was examined under the new
guidelines as of June 30, 1996.
On March 8, 1996, the Federal banking agencies issued joint examination
procedures applicable to compliance examination under the new CRA regulations.
On October 21, 1996, the Consumer Compliance Task Force of the Federal Financial
Institutions Examination Council issued additional guidelines for CRA
compliance. Starting on July 1, 1997, the new procedures and guidelines will
apply to larger institutions.
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 is currently considered a small institution under the CRA regulations
and it will be 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 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. At this time, the new regulations have increased the
uncertainty of the Bank's business, both as the rating and examination
procedures changes and as the Bank grows and may no longer qualify as a small
institution.
(g) 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. In 1996, the agencies
adopted guidelines for asset quality and earnings. The effect of the guidelines
is to require 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,
compensation, asset quality and earnings. 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.
The effect of these guidelines on the Bank 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. The new
guidelines, in the areas of monitoring asset quality and the quality and
quantity of earnings, require the Bank to document that certain reports have
been made, and that it is monitoring the required items at the required times.
(h) 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,
15
<PAGE>
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.
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.
16
<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 these
premises from Ann Marie Carinalli and Clement C. Carinalli, a director of the
Corporation and the Bank. See Item 12, "Certain Relationships and Related
Transactions".
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 also leases approximately 390 square feet of space within the Safeway
grocery store in Windsor for a branch and approximately 7,500 square feet of
space in a two story office building at 755 Fourth Street. The 755 Fourth Street
premises are located across the street from the Bank's main office and is
utilized for SBA and commercial lending and 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
1996.
17
<PAGE>
Part II
ITEM 5.
Market for Common Equity and Related Stockholder Matters
On February 28, 1997, the Corporation had 1,465,374 shares of common stock
outstanding, held by approximately 317 shareholders of record.
The directors and officers of the Corporation and the Bank hold 15.9% and
beneficially own 33.3% 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 14,653 shares in any three
month period without such registration.
As of February 28, 1997, the directors and officers also have the right to
acquire 91,518 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 Hoefer & Arnet and First
Associated Securities Group, Inc., the Corporation'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. The bid prices and numbers of shares in this table have been
adjusted for the impact of stock dividends declared in 1997 and issued in 1996
and 1995.
<TABLE>
<CAPTION>
Bid Quotations for the Corporation's Approximate
Common Stock Trading Volume
=======================
Quarter Ended High Low
===================================== =================== ====================
<S> <C> <C> <C>
March 31, 1995 $8.12 $7.47 27,783
June 30, 1995 8.12 7.38 31,255
September 30, 1995 7.79 7.26 61353
December 31, 1995 8.34 7.38 75,823
March 31, 1996 10.38 8.23 102,160
June 30, 1996 11.50 10.15 83,349
September 30, 1996 12.00 11.16 105,315
December 31, 1996 15.44 11.76 173,250
===================================== =================== ==================== =======================
</TABLE>
18
<PAGE>
There has been large increase in the trading volume over the last year; however,
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
which shares may be traded in the future. The bid and asked prices of the
Corporation's common stock were $18.00 and $19.00, respectively, on February 28,
1997.
Dividends
On February 19, 1997, the Corporation declared a 5% stock dividend to
shareholders of record on March 31, 1997.
On May 14, 1996, the Corporation declared a 5% stock dividend to shareholders of
record on June 14, 1996.
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.
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, 1996, $3,975,000 of retained earnings of the Bank
was available for the payment of dividends under this requirement.
19
<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, 1995 and 1996.
During 1996, total consolidated assets grew 34.6% to $224,793,000 at December
31, 1996. Total consolidated assets grew 37.1% during 1995 to $166,962,000 at
December 31, 1995.
Total deposits increased 35.7% to $209,235,000 when comparing December 31, 1996
to December 31, 1995. For the year ended December 31, 1995, total deposits
increased 38.8% to $154,221,000.
Results of Operations
The Corporation's consolidated net income for the year ended December 31, 1996
was $2,306,000 as compared to $1,720,000 for the year ended December 31, 1995,
an increase of 34.1%. The Corporation's consolidated net income for the year
ended December 31, 1995, increased 27.8% over the year ended December 31, 1994.
Net interest income before provision for loan losses increased 22.0%, or
$1,667,000, when comparing the year of 1996 to 1995. This increase results from
the growth in the volume of loans on which the Bank earns a net interest margin.
The Bank's interest margin for 1996 declined slightly to 5.31% from 5.64% in
1995 and 5.70% in 1994. See, "Net Interest Income."
The provision for loan losses increased $170,000 in 1996 over 1995. See,
"Allowance for Loan Losses." Other income increased $18,000. See, "Non-Interest
Income." Operating expenses increased by $548,000 primarily because of increases
in personnel costs and cost associated with foreclosed property and problem
loans.
When comparing 1995 to 1994 the provision for loan losses decreased $30,000.
Other income decreased $544,000 due to reduced volume of SBA sales. Operating
expenses increased during 1995 primarily due to increases in personnel costs.
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, 1996, net interest income before the provision
for loan losses totalled $9,232,000 as compared to $7,565,000 for the year ended
December 31, 1995, representing an increase of 22.0%. The majority of this
increase results from the net margin earned on growth in the loan portfolio,
largely from the increase in SBA loans and commercial real estate loans. See,
"Loan Portfolio." During 1995, net interest income before the provision for loan
losses increased $1,446,000
20
<PAGE>
or 23.6%, from $6,119,000 to $7,565,000, primarily due to the net margin earned
on growth in the loan portfolio.
Interest income increased from $9.2 million in 1994 to $13.0 million in 1995 to
$16.4 million in 1996. This is a direct result of growth in loans. Average loans
increased from $114.8 million in 1995 to $148.0 million in 1996. However, the
yield on loans declined to 10.14% in 1996 from 10.39% in 1995. The 25 basis
point decline during 1996 results from several factors; however, the decline in
prime rate in February 1996 of 25 basis points had a significant impact. In
addition, the SBA started imposing a basis point 50 charge on the guaranteed
portion of all SBA loans originated after October 1995. This charge applied
through all of 1996, and was accounted yield for as an adjustment to the yield
on the loans to which the charge applied. The decline of 50 basis points on SBA
loans was a change mandated by the SBA which became effective in October of
1995. The mix of loans also impacts the overall yield on loans. During 1996, the
Bank experienced growth in real estate loans which have a lower yield than other
types of loans such as SBA loans which also impacted the overall portfolio
yield.
The Bank's net interest margin, the yield on interest earning assets less the
rate paid on average interest bearing liabilities, declined from 5.70% in 1994
to 5.64% in 1995 to 5.31% in 1996. Changes in market interest rates were the
primary reason for the decline. The Federal Reserve Board lowered the discount
rate in February of 1996 where it remained for the balance for the year. During
1995 the Federal Reserve increased the discount rate in February 1995 by 50
basis points and then lowered the rate in July 1995 by 25 basis points and again
in December 1995 by 25 basis points. Commercial banks generally adjusted their
prime lending rates immediately following changes in the discount rate. Prime
rate was 8.25% at December 31, 1996 compared to 8.5% at end of 1995 and 1994.
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 full impact of rate changes on the Bank's earnings are not realized for
several months, since not all loans or deposits reprice immediately. The
majority of SBA loans are tied to the prime rate and reprice on a calendar
quarterly basis. Additionally, the Bank has some fixed rate loans and adjustable
rate loans, mainly commercial real estate 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 and declined to 4.84% in December 1996. There can be no assurances that
earnings will not be adversely impacted by future actions of the Federal Reserve
Board and changes in market interest rates.
The net interest margin is also affected by the level of loans relative to
deposits. The Bank's ratio of loans to deposits has remained consistent over the
last two years, averaging 87.9% in 1996 as compared to 88.2% in 1995.
Interest expense increased 31% when comparing 1995 to 1996, due to increases in
interest bearing deposits, particularly in time deposits which bear the highest
cost. The average cost of interest paid on interest bearing deposits for the
year ended December 31, 1996 was 4.96% versus 4.94% for the year ended December
31, 1995. Average non-interest bearing deposits increased slightly in 1996, with
most of the Bank's growth being funded by money market deposits and time
deposits. In 1995, the Bank's growth also was funded by time certificates and
money market accounts.
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. Time deposits have
increased from $28.3 million at December 1994 to $66.5 million at the end of
1995 to $94.0 million at December 31, 1996. During both 1995 and 1996, the Bank
ran several time deposit campaigns at rates slightly higher than our local
competitors. These higher priced deposits
21
<PAGE>
were used to fund the rapid growth in loans. The cost of time deposits averaged
5.92% in 1996 compared to savings and money market rate accounts which averaged
4.35%. This increase in time deposits has had a negative impact on the Bank's
net interest margin.
The Bank's money market rate account, the Sonoma Investors Reserve Account,
which offers rates tied to US Treasury rates, also remained competitive during
1996. Balances held in Sonoma Investors Reserve accounts increased from $44.0
million at the end of 1994 to $49.9 million at December 31, 1995 and $71.1
million at year end 1996. In late December 1996, the Bank received short term
deposits of approximately $16 million, which were held in Sonoma Investors
Reserve accounts for approximately 30 days. This accounted for the majority of
the increase in money market rate accounts in 1996. The rate offered on the
Sonoma Investors Reserve account is repriced on a weekly basis. During 1995 and
1996 the cost of these funds has declined based upon the movement with the 90
day treasury. Due to the weekly repricing, changes in rates on the Sonoma
Investors Reserve Account have 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 was 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 increased only 1.13%. The greater increase in the Bank's
interest expense rate negatively impacts income. The Bank's average
loans-to-deposits ratio improved from 85.8% in 1994 to 88.2% in 1995 which had a
positive impact on the net interest margin.
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 $740,000 for the year ended December 31, 1996 and $602,000 for the
year ended December 31, 1995. Deferred loan fees are a product of origination
and commitment fees and certain direct loan origination costs. The deferred fee
amounts are as follows: $1,138,000 as of December 31, 1996, and $999,000 as of
December 31, 1995. Deferred fees are netted against total loans in the balance
sheet.
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, 1996, $867,000 was recorded as discounts compared to $778,000 at
December 31, 1995. These discounts are netted against total loans in the balance
sheet.
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 equaled $32,000 in 1996 compared to $30,000 in
1995.
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.
22
<PAGE>
<TABLE>
<CAPTION>
AVERAGE BALANCE SHEET
Year Ended
December 31, 1996
- ---------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Average Interest Average
Balance Income/Expense Yield/Rate
------------------ ------------------ ------------------
<S> <C> <C> <C>
Certificates of deposit
with other banks $4,872 $265 5.44%
Investments 6,163 341 5.53%
Federal funds sold 14,883 812 5.46%
Loans:
Commercial (incl. SBA loans &
loans held for sale) 71,523 7,588 10.61%
Installment loans to individuals 2,337 274 11.72%
Real estate - Construction 2,500 235 9.40%
Real estate - Other 71,665 6,907 9.64%
------------------ ------------------ ------------------
Total Loans 148,025 15,004 10.14%
------------------ ------------------ ------------------
Total earning assets 173,943 16,423 9.44%
------------------
Non-earning assets:
Allowance for loan losses (1,837)
Deferred Loan Fees & Discounts (1,868)
Cash and due from banks 6,850
Other assets 5,339
------------------
TOTAL ASSETS $182,427
==================
Deposits:
Demand - interest bearing 9,730 103 1.06%
Savings & money market 58,383 2,540 4.35%
Time certificates 76,844 4,548 5.92%
------------------ ------------------ ------------------
Total interest bearing deposits 144,957 7,191 4.96%
------------------
Demand - non-interest bearing 23,356
Other liabilities:
Other liabilities 991
Shareholders' equity 13,123
------------------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $182,427
==================
Net interest income $9,232
==================
Net interest margin 5.31%
==================
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
AVERAGE BALANCE SHEET
Year Ended
December 31, 1995
- ---------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Average Interest Average
Balance Income/Expense Yield/Rate
------------------ ------------------ ------------------
<S> <C> <C> <C>
Certificates of deposit
with other banks $5,880 $354 6.02%
Investments 2,450 134 5.47%
Federal funds sold 10,503 599 5.70%
Bankers acceptances 572 34 5.94%
Loans:
Commercial (incl. SBA loans &
loans held for sale) 52,361 5,844 11.16%
Installment loans to individuals 2,924 348 11.90%
Real estate - Construction 2,528 294 11.63%
Real estate - Other 57,006 5,439 9.54%
------------------ ------------------ ------------------
Total Loans 114,819 11,925 10.39%
------------------ ------------------ ------------------
Total earning assets 134,224 13,046 9.72%
------------------
Non-earning assets:
Allowance for loan losses (1,508)
Deferred Loan Fees & Discounts (1,628)
Cash and due from banks 6,155
Other assets 4,663
------------------
TOTAL ASSETS $141,906
==================
Deposits:
Demand - interest bearing 9,042 95 1.05%
Savings & money market 54,925 2,832 5.16%
Time certificates 47,089 2,554 5.42%
------------------ ------------------ ------------------
Total interest bearing deposits 111,056 5,481 4.94%
------------------
Demand - non-interest bearing 19,095
Other liabilities:
Other liabilities 588
Shareholders' equity 11,167
------------------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $141,906
==================
Net interest income $7,565
==================
Net interest margin 5.64%
==================
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
AVERAGE BALANCE SHEET
Year Ended
December 31, 1994
- ---------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Average Interest Average
Balance Income/Expense Yield/Rate
------------------ ------------------ ------------------
<S> <C> <C> <C>
Certificates of deposit
with other banks $4,342 $187 4.31%
Investments 1,518 78 5.14%
Federal funds sold 9,805 392 4.00%
Bankers acceptances 1,375 63 4.58%
Loans:
Commercial (incl. SBA loans &
loans held for sale) 39,207 3,776 9.63%
Installment loans to individuals 3,049 313 10.27%
Real estate - Construction 2,552 282 11.05%
Real estate - Other 45,533 4,129 9.07%
------------------ ------------------ ------------------
Total Loans 90,341 8,500 9.41%
------------------ ------------------ ------------------
Total earning assets 107,381 9,220 8.59%
------------------
Non-earning assets:
Allowance for loan losses (1,292)
Deferred Loan Fees & Discounts (1,048)
Cash and due from banks 6,174
Other assets 4,056
------------------
TOTAL ASSETS $115,271
==================
Deposits:
Demand - interest bearing 9,101 $99 1.09%
Savings & money market 43,363 1,638 3.78%
Time certificates 32,990 1,364 4.13%
------------------ ------------------ ------------------
Total interest bearing deposits 85,454 3,101 3.63%
------------------
Demand - non-interest bearing 19,801
Other liabilities:
Other liabilities 510
Shareholders' equity 9,506
------------------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $115,271
==================
Net interest income $6,119
==================
Net interest margin 5.70%
==================
</TABLE>
25
<PAGE>
The following tables set 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, 1996 as compared to the year ended December 31, 1995, and for
the year ended December 31, 1995, as compared to the year ended December 31,
1994. Variances attributable to simultaneous rate and volume changes are all
allocated to volume change amount.
<TABLE>
<CAPTION>
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST INCOME AND EXPENSE
1996 OVER 1995
- ---------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Volume Yield Total
--------- ----------- ---------
<S> <C> <C> <C>
Increase/(decrease) in interest income:
Certificates of deposit
with other banks $(55) $(34) $(89)
Investments 205 2 207
Federal funds sold 239 (26) 213
Bankers acceptances (34) (34)
Loans:
Commercial 2,033 (289) 1,744
Installment loans to individuals (69) (5) (74)
Real estate - Construction (3) (55) (58)
Real estate - Other 1,413 55 1,468
------------------ ------------------ ------------------
Total 3,729 (352) $3,377
------------------ ------------------ ------------------
Increase/(decrease) in interest expense:
Deposits:
Demand - interest bearing 7 1 8
Savings & money market 150 (442) (292)
Time certificates 1,761 233 1,994
------------------ ------------------ ------------------
Total 1,918 (208) 1,710
------------------ ------------------ ------------------
Increase/(decrease) in net interest income 1,811 (144) 1,667
================== ================== ==================
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST INCOME AND EXPENSE
1995 OVER 1994
- ---------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Volume Yield/Rate Total
------------------ ------------------ ------------------
<S> <C> <C> <C>
Increase/(decrease) in interest income:
Certificates of deposit
with other banks $93 $74 167
Investments 51 5 56
Federal funds sold 40 167 207
Bankers acceptances (48) 19 (29)
Loans:
Commercial (incl. SBA loans &
loans held for sale) 1,468 600 2,068
Installment loans to individuals (15) 50 35
Real estate - Construction (3) 15 12
Real estate - Other 1,096 214 1,310
------------------ ------------------ ------------------
Total 2,682 1,144 $3,826
------------------ ------------------ ------------------
Increase/(decrease) in interest expense:
Deposits:
Demand - interest bearing (4) (4)
Savings & money market 596 598 1,194
Time certificates 764 426 1,190
------------------ ------------------ ------------------
Total 1,360 1,020 2,380
------------------ ------------------ ------------------
Increase/(decrease) in net interest income 1,322 124 1,446
================== ================== ==================
</TABLE>
27
<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, discount
brokerage income, earnings on life insurance and SBA loan servicing fees. When
comparing the year ended December 31, 1996 to December 31, 1995, other
non-interest income totaled $1,620,000, slightly higher than 1995's total of
$1,602,000.
Gains on the sale of the guaranteed portion of SBA loans totaled $567,000 in
1996 versus $715,000 in 1995. This decline in gains on sales resulted from
management's decision to retain a larger portion of these loans, earning
interest income, rather than selling them immediately. During 1996 the Bank sold
SBA loans totaling $6,390,000, compared to $9,837,000 in 1995.
SBA servicing fees increased during 1996 to $379,000 for the year compared to
$362,000 for 1995. Servicing revenues will continue to grow as long as the SBA
servicing portfolio increases. During 1996, the Bank's average SBA loan
portfolio serviced was $43 million compared to $41 million in 1995.
There can be no assurance that the SBA program will continue to generate
significant amounts of other non-interest income in the future. During 1995 and
1996, the Bank experienced additional competition with more financial
institutions making SBA loans. The government may also revise the SBA program at
any time, 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 1996,
service charges totaled $337,000 versus $306,000 in 1995. Service charges vary
depending upon the customers' uses of various Bank services. With the growth in
deposit customers the fee income also increased. In addition, the Bank adjusted
its rates for various services during the first quarter of 1996 after several
years of no changes, thereby increasing service fee income.
Non-interest income also includes earnings on life insurance held for directors
and senior officers which totaled $104,000 in 1996 as compared to $100,000 in
1995. During 1996, the Bank sold US Treasuries which were classified as held for
sale at a gain of $7,000. There were no sales in 1995. Discount brokerage
services generated $47,000 in revenue during its first full year of operation.
The cost of offering discount services totaled $63,000.
There were no gains on the sale of other real estate owned (OREO) in 1996 or
1995. See, "Other Real Estate Owned."
Other non-interest income for 1995 totaled $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 portions of SBA loans, which totaled
$715,000 in 1995 compared to $1,287,000 in 1994. This decline in gains on sales
resulted from managements decision to retain a larger portion of these loans,
earning interest income, rather than sell them immediately. During 1995, the
Bank sold SBA loans totaling $9,837,000 compared to $18,957,000 in 1994. SBA
servicing fees increased during 1995 to $362,000 compared to $264,000 in 1994
due to the increase in loans serviced.
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, 1996, non-interest expenses
totaled $6,407,000, an increase of 9.4% over the previous year.
28
<PAGE>
Non-interest expenses increased 3.4% from $5,666,000 in 1994 to $5,859,000 in
1995.
Salaries and benefits increased 10.5% in 1996 to $3,521,000. A large portion of
the increase resulted from larger incentive payments since they are tied to loan
production and deposit growth, which were at higher than anticipated levels
during 1996. Salaries included increases for performance and promotions during
the year. The Bank also experienced staff growth in 1996 with the Bank's full
time equivalent (FTE) staff positions averaging 68 persons in 1996, from 66 in
1995.
Occupancy costs were $699,000 in 1996 compared to $698,000 in 1995. Effective in
October 1996, the Oakmont lease payment was reduced from $10,000 per month to
$6,000. This reduction in rent resulted from the renegotiation of our lease
agreement. This savings offset the increases in rents based on indexes in the
various lease agreements and increases in property taxes, utilities and
maintenance expenses.
Equipment expenses equaled $315,000 in 1996 compared to $283,000 last year. The
Bank has continued to upgrade computer technology. During the last quarter of
1995, the Bank's mainframe and proof machine, which had been fully depreciated,
were replaced with new equipment. In addition, Bank staff continues to upgrade
from terminals to individual personal computers. As a result, the costs
associated with computer technology has increased from $187,000 in 1995 to
$224,000 in 1996.
Advertising and business development cost increased $28,000 to $336,000 for
1996. The growth in these expenses was consistent with the overall growth in the
Bank. These costs include promotion of various products (Telebanc, SBA lending,
Commercial lending and Deposit campaigns).
Outside customer services increased from $218,000 in 1995 to $245,000 in 1996.
Analysis charges are a major expense included in this category. Since the Bank
continues to attract new business accounts which use our analysis system, this
expense category has grown. Analysis charges are customer expenses for title and
escrow services, check charges, courier and payroll services incurred 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.
Professional fees increased from $130,000 in 1995 to $185,000. The Bank's legal
costs increased 39.6% during 1996 mainly due to legal costs associated with
problem loans and foreclosure activity. See "Other Real Estate Owned. During
1996, the Bank also hired outside professionals to conduct special operational
audits of Data Processing Operations and Investment Services and to conduct a
strategic planning session with the Bank's directors.
The FDIC insurance costs declined by $98,000 or 40.8% due to the
over-capitalization of the Bank Insurance Fund (BIF). The FDIC deposit insurance
premiums for 1996 equaled the minimum of $2,000 compared to $129,000 in 1995.
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 and then fell in the first half of 1996 to 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. Effective in
1997, the Bank will be charged a "Financing Corporation" (FICO) assessment at
the annual rate of 0.000648 of the Bank's assessment base. See, "Description of
Business-Supervision and Regulation-New and Pending Legislation."
Other expenses increased 22.6% to $803,000 during 1996. Included in this
category are expenses related to loan costs (broker fees, appraisals, etc.),
foreclosure and OREO expense, shareholder and
29
<PAGE>
director fees, seminars and travel costs. During 1995, other expenses of
$655,000 remained at the same level as 1994.
Non-interest expenses are expected to increase in 1997 due to the planned growth
in the Bank.
The increase in non-interest expenses of 3.4% from the 1994 total of $5,666,000
to $5,859,000 in 1995 was due primarily to staff incentives associated with
increased volume of loan and deposit activity, higher occupancy costs which were
partially offset by FDIC insurance savings, and reduced problem loan costs.
The SBA department's direct operating expenses equaled $1,547,000, $1,382,000
and $1,156,000 for the years ended December 1996, 1995 and 1994 respectively.
The following table outlines the components of non-interest expense for the
periods indicated:
<TABLE>
<CAPTION>
(In thousands) Year Ended December 31,
Expense Item 1996 1995
<S> <C> <C>
Salaries & Employee Benefits $3,521 $3,186
Occupancy 699 698
Equipment 315 283
Advertising/Business Development 336 308
Outside Customer Services 245 218
Professional Fees 185 130
Stationery & Supplies 161 141
Deposit and Other Insurance 142 240
Other 803 655
TOTAL $6,407 $5,859
================================================= ==================== =====================
</TABLE>
Loan Portfolio
The following table shows the composition of the Corporation's loan portfolio,
by type of loan, as of the dates indicated.
30
<PAGE>
<TABLE>
<CAPTION>
(In thousands) December 31,
Type of Loan 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Commercial $84,969 $62,062 $38,688 $31,315 $30,989
Real Estate Construction 1,533 3,556 1,701 5,113 2,399
Real Estate Other 81,008 64,720 49,601 44,048 39,571
Installment Loans to
Individuals 2,218 2,702 2,965 3,147 2,026
TOTAL $169,728 $133,040 $92,955 $83,623 $74,985
============================= =============== =============== ================ ================ ===============
</TABLE>
The table above illustrates the Bank's emphasis on commercial and real estate
lending. At December 31, 1996 and 1995 commercial loans comprised 50.1% and
46.6%, respectively, of the Bank's total loan portfolio. Construction and other
real estate loans (combined) comprised 48.6% and 51.3% 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 and Marin Counties. 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.
Most of the Bank's loans are made to borrowers located in Sonoma or Marin County
and most of the security for the Bank's loans is located in those counties. A
significant natural disaster impacting those counties, such as a severe
earthquake or widespread flooding, could disrupt the business of these borrowers
and impair the security for the Bank's loans. Although some of the Bank's
borrowers carry insurance to cover some of the losses that might arise from such
an event, the Bank does not require all its borrowers to carry earthquake
insurance coverage since such insurance typically provides a large deductible
amount. If a large earthquake occurs in the Bank's market area, the Bank would
probably have to restructure some of its loans and may suffer loan losses
related to the earthquake.
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
unguaranteed portion on sold loans is generally 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. All SBA 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 which guarantees the loan. At
December 31, 1996, the Bank held $69,232,000 in loans generated by the SBA
department, of which $28,256,000 was guaranteed by the SBA. At December 31,
1995, the Bank held $46,083,000 in loans generated by the SBA department, of
which $16,195,000 was guaranteed by SBA. There were no SBA loans more than 90
days past due and still accruing interest: there were two SBA loan totaling
$126,000, of which $114,000 was guaranteed by the SBA, on nonaccrual status, as
of December 31, 1996.
31
<PAGE>
Other real estate includes loans which are secured by real estate and not
classified as a construction or commercial loan. The majority of these loans are
secured by commercial real estate. The Bank offers residential mortgage loans on
a limited basis.
Home equity lines of credit, included in real estate - other, equaled 2.9% of
the total loan portfolio at December 31, 1996 compared to 5.0% 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.
Real estate construction loans are made primarily for single family residences
and commercial properties valued at under $2,500,000 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.
The Bank has a small portfolio of consumer loans, equaling 1.3% of the total
loan portfolio at December 31, 1996 and 2.3% 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 had averaged $350,000 in balances
during the preceding twelve month period. 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
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, 1996. Loans are categorized by the maturity of the final
installment.
32
<PAGE>
<TABLE>
<CAPTION>
Over 1 Year
1 year through Over 5
(In thousands) or Less 5 Years Years Total
<S> <C> <C> <C> <C>
Commercial $10,406 $17,938 $56,625 $84,969
Real Estate -Construction 1,227 306 0 1,533
Real Estate -Other 5,072 19,843 56,093 81,008
Installment Loans 777 1,109 332 2,218
TOTAL $17,482 $39,196 $113,050 $169,728
============================ =================== =================== ================== =====================
</TABLE>
Of the total loans due in more than one year at December 31, 1996, $45,648,000
were at fixed interest rates, which includes loan currently at their floor rate,
and $106,598,000 were at adjustable interest rates.
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 by contractual
repricing frequency and by loan type, at December 31, 1996. SBA loans are
considered commercial loans for this analysis. Most of the SBA loans are secured
by real estate. The Bank has approximately $21 million in adjustable loans which
are priced at floor rate and are considered fixed rate loans, deemed to reprice
at their maturity date for the purpose of this analysis.
<TABLE>
<CAPTION>
Over 3 Months Over 1 Year
3 Months or through through Over 5
(In thousands) Less 1 Year 5 Years Years Total
<S> <C> <C> <C> <C> <C>
Commercial $72,256 $2,577 $2,561 $7,575 $84,969
Real Estate -Construction 81 1,452 0 0 1,533
Real Estate -Other 11,466 35,457 11,207 22,878 81,008
Installment Loans 2,218 0 0 0 2,218
TOTAL $86,021 $39,486 $13,768 $30,453 $169,728
============================ ================ =================== ================= ================= ===================
</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,
1996 and 1995 approximately 72% and 76% respectively of the Bank's loan
portfolio was comprised of loans with adjustable rates (excluding those which
had reached their floors, at which time they are considered fixed loans).
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
33
<PAGE>
"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 bank regulatory agencies, assessment of economic
conditions and other appropriate data to identify risks in the loan portfolio.
Based upon this analysis of the allowance for loan losses (which incorporates
the growth in the loan portfolio during the year), the Bank has increased the
allowance by 21.8% to $2,042,000 at December 31, 1996 compared to $1,676,000 in
1995. The provision for loan losses for the year ended December 31, 1996 was
$420,000 as compared to $250,000 for the year ended December 31, 1995.
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.
During 1996, the Bank charged-off six loans (4 commercial and 2 consumer)
totalling $62,000 and recovered $8,000 on commercial loans. 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.
The following table sets forth the changes in the allowance for loan losses over
the last five years and the relationship to loans outstanding at the end of
those periods.
34
<PAGE>
<TABLE>
<CAPTION>
(dollars in thousands) Year Ended December 31
ALLOWANCE FOR LOAN LOSSES: 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Balance at beginning of Period $1,676 $1,421 $1,113 $1,144 $883
Provision for Loan Losses Charged to Expense 420 250 280 174 355
Less Charge-Offs:
Commercial 38 0 0 204 69
Real Estate-Other 0 72 0 0 0
Consumer loans 24 30 16 8 26
Total Charge-offs 62 102, 16 212 95
Recoveries:
Commercial 8 79 20 3 1
Real Estate - Other 0 24 24 1 0
Consumer 0 4 0 3 0
Total Recoveries 8 107 44 7 1
Net Charge-offs/(Recoveries) 54 (5) (28) 205 94
Balance at the End of the Period $2,042 $1,676 $1,421 $1,113 $1,144
Total Loans Outstanding at End of Period Net of
SBA guarantees $141,472 $118,716 $89,124 $82,263 $71,604
Ratio of Ending Allowance to Ending Loans 1.4% 1.4% 1.6% 1.4% 1.6%
Outstanding Net
of SBA loan guarantees
AVERAGE TOTAL LOANS $148,025 $114,819 $90,341 $77,295 $75,591
Ratio of Net Charge-offs to Average
Loans Outstanding During the Period 0.036% (0.004)% (0.031)% 0.365% 0.124%
============================================================= ============== ============== ============== ==============
</TABLE>
The following tables set forth the allocation of the allowance for loan losses
by loan type at the end of those periods indicated. 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. The percentage of loans shown in these
schedules represent the percentage of loans in each loan category to total
loans.
35
<PAGE>
<TABLE>
<CAPTION>
(dollars in thousands) December 31, 1996 December 31, 1995
Category Amount % of Loans Amount % of Loans
<S> <C> <C> <C> <C>
Commercial $1,081 50.0% $788 46.7%
Real Estate -Construction 66 1 166 2.7
Real Estate -Other 744 48 682 48.6
Installment Loans 151 1 40 2.0
TOTAL $2,042 100.0% $1,676 100.0%
===================================== ================= =============== ================= =================
</TABLE>
<TABLE>
<CAPTION>
(dollars in thousands) December 31, 1994 December 31, 1993 December 31, 1992
Category Amount % of Amount % of Amount % of
Loans Loans Loans
<S> <C> <C> <C> <C> <C> <C>
Commercial $524 39.1% $385 37.4% $236 38.6%
Real Estate -Construction 117 1.9 189 6.1 123 3.4
Real Estate -Other 683 55.7 449 52.7 602 55.2
Installment Loans 97 3.3 90 3.8 183 2.8
TOTAL $1,421 100.0% $1,113 100.0% $1,144 100.0%
================================ ============= ============================ ============ ================ ===============
</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. These loans are considered impaired loans.
36
<PAGE>
<TABLE>
<CAPTION>
(dollars in thousands) December 31,
1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Past due 90 days or more $0 $0 $0 $0 $0
Non-accrual 438 398 201 438 925
Total $438 $398 $201 $438 $925
Percent of Total Loans 0.3% 0.3% 0.2% 0.5% 1.2%
Impaired Loans $438 $398 $201 $438 $925
================================================= =============== =============== ================ =================
</TABLE>
The amount of interest that would have been recorded for the loans on
non-accrual at December 31, 1996 totaled approximately $32,000 in 1996 and
$36,000 in interest was collected on those loans during the year.
On December 31, 1996, the Bank had $438,000 in non-accrual loans of which
$100,000 was collateralized by real estate and $114,000 was guaranteed by the
SBA on loans not secured by real estate. As of December 31, 1995, the Bank had
$398,000 in non-accrual loans of which $329,000 was collateralized by real
estate.
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, 1996, 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 foreclosed with respect to real estate collateral securing four loans
during 1996. These properties were recorded at the lessor of cost or fair market
value and totaled $359,000 at December 31, 1996.
On January 2, 1997, one of these properties was sold realizing a small gain. The
other real estate owned balance after the January 2 sale was $161,000 consisting
of three commercial buildings. These properties were collateral for SBA loans in
which the Bank held a 25% interest. The book value of $161,000 represents the
Bank's share of the property value net of the portion due to the SBA. The Bank
has entered into agreements to sell two of these commercial properties.
The Bank held no other real estate owned during 1995.
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, 1996, deposits totalled $209,235,000, which was an increase of
35.7% from December 31, 1995. Non-interest bearing demand deposits totalled
$28,612,000 at December 31,
37
<PAGE>
1996 as compared to $23,017,000 at December 31, 1995. 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.
A title company maintains deposits at the Bank representing $2,878,000 in
average balances during the fourth quarter of 1996 in accounts utilizing the
analysis system. For this title company, the Bank paid out $11,000 to third
party vendors for escrow, courier and related services during the fourth quarter
of 1996. See, "Non-Interest Expense." This equates to a 1.5% annual cost of
funds, which can be compared to the Bank's overall annual cost of funds of 5.0%
for 1996.
Most of the deposit growth at the Bank in 1996 was in the time deposit and money
market deposit categories. Time deposits increased $27.4 million or 41.2% in
1996, while money market deposits increased $21.2 million or 42.4% from December
31, 1995 to December 31, 1996. The increase in money market deposits at the end
of 1996 included approximately $16 million which was deposited for approximately
30 days with the Bank.
During both 1995 and 1996, the Bank has offered highly competitive rates on time
deposits in order to fund loan demand. Time deposits increased from $28,348,000
at December 31, 1994 to $66,533,000 at December 31 1995 to $93,973,000 at the
year end of 1996. 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 money market rate accounts increased from $54,925,000
in 1995 to $58,383,000 during 1996. The Bank's Sonoma Investor Reserve account
has been and continues to be very popular, since it was tied to the 90-day
Treasury Bill and reprices on a weekly basis. During 1994, the rate on the
Sonoma Investor Reserve exceeded the rates offered on time deposits; however,
since then the rates offered on longer term time deposit have become more
attractive to depositors and there has been movement into time deposit unless
immediate access to funds is needed. During 1996 the Sonoma Investors Reserve
accounts offered rates which were competitive with rates offered on 30 to 90 day
time certificates, and therefore, this account continues to be a very popular
with depositors.
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, 1996.
<TABLE>
<CAPTION>
$100,000 and Over Less than $100,000
Amount Pct Amount Pct
(in 000's) (in 000's)
======================================================================================================
<S> <C> <C> <C> <C>
Three Months or Less $7,224 28.2% $15,631 22.9%
3 to 6 months 7,260 28.3 18,075 26.4
6 months to 1 year 10,262 40.1 27,707 40.5
Over 1 year 875 3.4 6,939 10.2
Total $25,621 100.0% $68,352 100.0%
======================================================================================================
</TABLE>
38
<PAGE>
At December 31, 1996, certificates of deposit of $100,000 or more constituted
approximately 12.2% 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.
Investment Portfolio
At December 31, 1996 and 1995 the Bank held the following investments:
<TABLE>
<CAPTION>
December 31,
(in thousands) 1996 1995 1994
========================================================================
<S> <C> <C> <C>
U.S. Treasury Securities $16,009 $10,756 $1,970
Fannie Mae Discount Note 0 0 985
Federal Reserve Stock 123 123 117
Total $16,132 $10,879 $3,072
Securities Pledged $500 $500 $500
========================================================================
</TABLE>
The Bank's investments in U.S. Treasury securities totaled $16,009,000 at
December 31, 1996, with a total par value of $16,000,000. Due to the excess
liquidity at the end of 1996, $10 million was invested in U.S. Treasury
securities with a maturity of January 2, 1997 at a yield of 4.16%. The funds
were then reinvested in Fed Funds Sold. The excess liquidity at year end was
caused by the receipt of a large short term deposit. The remaining treasury
investments of $6 million mature in late January 1997 through May 1997. The
yield on average investments equaled 5.53% during 1996 compared to 5.47% in
1995. See, "Net Interest Income."
The Federal Reserve Bank stock has a yield of 6.0%.
Investments are carried at amortized cost. All debt securities, at December 31,
1996 and 1995 were categorized as held-to-maturity per accounting definitions.
The market value of securities equaled $16,132,000 at December 31, 1996 and
$10,882,000 at December 31, 1995.
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, 1996 and 1995, the Bank had
no balances in bankers' acceptances but there were balances during 1995.
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 include 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
39
<PAGE>
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
totaled $37,158,000 or 16.5% of total assets at December 31, 1996. If the $10
million invested in U.S. Treasuries for one week over year end is included, the
ratio increases to 21.0%, which is higher than the Bank's liquidity position
over the last several years.
Cash and due from banks, federal funds sold and time certificates of deposit
totaled $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 years, and comparable to other financial institutions in its asset
size range.
At December 31, 1996 and 1995 the Bank's ratio of loans-to-deposits was 86.9%
and 84.0% respectively.
The Bank has two federal funds lines of credit totaling $9,000,000 with two
institutions. These lines are available on a short term basis to meet cash
demands that may arise.
The Bank funded loan growth during 1996 through increased interest-bearing
deposits. Deposits increased during 1996 and 1995 largely due to deposit
campaigns which offered higher rates to attract new time deposits. This trend is
expected to continue in 1997. The Bank is currently in the process of
establishing a borrowing relationship with the Federal Home Loan Bank which will
provide a new source of funds for loan growth and liquidity purposes.
The following table represents the Corporation's interest rate sensitivity
profile as of December 31, 1996. Assets, liabilities and shareholders' equity
are classified by the earliest possible repricing opportunity or maturity date,
whichever first occurs.
40
<PAGE>
<TABLE>
<CAPTION>
Over 3 Over 1 year Non-rate
Balance Sheet Through 3 months through 5 Sensitive Total
(in thousands) months through years or
1 year Over 5
years
- ------------------------------------------ --------------- -------------- -------------- -------------- ----------------
Assets
<S> <C> <C> <C> <C> <C>
Time Deposits-other financial institutions $594 $2,774 $3,368
Fed funds sold 22,724 22,724
Investment securities 12,121 4,011 16,132
Loans 86,021 39,486 $13,768 $30,453 169,728
Non-interest-earning assets 12,841 12,841
(net of allowance for loan losses)
$121,460 $46,271 $13,768 $43,294 $224,793
=============== ============== ============== ============== ================
Liabilities & Shareholders Equity
Time Deposits $100,000 and over $7,224 $17,522 $875 $25,621
All other interest-bearing deposits 102,281 45,782 6,935 $4 155,002
Non-interest bearing liabilities 29,832 29,832
Other Liabilities & Shareholders' Equity 14,338 14,338
$109,505 $63,304 $7,810 $44,174 $224,793
=============== ============== ============== ============== ================
Interest Rate Sensitivity (1) $11,955 ($17,033) $5,958 ($880)
Cumulative Interest Rate Sensitivity $11,955 ($5,078) $880 $0
========================================== =============== ============== ============== ============== ================
</TABLE>
(1) Interest rate sensitivity is the difference between interest rate sensitive
assets and interest rate sensitive liabilities within the above time frames.
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 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.
41
<PAGE>
At December 31, 1996, the Corporation had non-interest and interest bearing cash
balances of $196,000, 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,
1996 1995 1994
<S> <C> <C> <C>
Return on Average Assets 1.3% 1.2% 1.2%
Return on Average
Shareholders' Equity 17.6% 15.4% 15.4%
Average Shareholders' Equity
as a Percent of Average Assets 7.2% 7.9% 7.9%
Dividend Payout Ratio N/A 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 1996.
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 6.9% of its total assets, exceeding the
amount of capital required under the minimum capital requirements. Under the
"risk-based" capital methodology, the Bank's total risk-based capital ratio was
10.2% at December 31, 1996. The minimum acceptable level at December 31, 1996
was 8.0%. The Corporations leverage capital ratio was 7.1% with total risk-based
capital equaling 10.4% at December 31, 1996.
Income Taxes
The 1996 provision for income tax equaled $1,719,000, which included a state tax
provision of $468,000. The overall effective tax rate was 42.7% during 1996.
See, "Item 7, Consolidated Financial Statements, Note 6." The provision for
federal income taxes for 1995 was $1,338,000, and the state provision was
$373,000. The overall effective tax rate for 1995 was 43.7%.
42
<PAGE>
New and Pending Accounting Standards
In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities." The FASB subsequently amended SFAS No. 125 in
December 1996. As amended, this statement provides accounting and reporting
standards for transfers and servicing of financial assets and extinguishment of
liabilities. This statement provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings. A transfer of financial assets in which the transferor surrenders
control over those assets is accounted for as a sale to the extent that
consideration other than beneficial interest in the transferred assets is
received in exchange. This statement also requires that liabilities and
derivatives incurred or obtained by transferors as a part of a transfer of
financial assets be initially measured at fair value, if practicable. It also
requires that servicing assets and other retained interest in the transferred
assets be measured by allocating the previous carrying amount between the assets
sold, if any, and retained interest, if any, based on their relative fair value
at the date of the transfer. Furthermore, this statement required that debtors
reclassify financial assets pledged as collateral, and that secured parties
recognize those assets and their obligation to return them in certain
circumstances in which the secured party has taken control of those assets. In
addition, the statement requires that a liability be derecognized if and only if
either (a) the debtor pays the creditor and is relieved of its obligation for
the liability or (b) the debtor is legally released from being the primary
obligor under the liability either judicially or by the creditor. Accordingly, a
liability is not considered extinguished by an in-subtance defeasance. SFAS No.
125 applies to securities lending, repurchase agreements, dollar rolls, and
other similar secured financing transactions occurring after December 31, 1997
and to all other transfers and servicing of financial assets occurring after
December 31, 1996 and is to be applied prospectively. Management does not
believe that the application of this statement will have a material impact on
the Company's financial statements.
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share". This
statement established standards for computing and presenting earnings per share
(EPS) and applies to entities with publicly held common stock. This statement
simplifies the standards for computing EPS previously found in APB Opinion No.
15, "Earnings per Share," and makes them comparable to international EPS
standards. It replaces the presentation of primary EPS with a presentation of
basic EPS. It also requires dual presentation of basic and diluted EPS on the
face of the income statement for all entities with complex capital structures
and requires a reconciliation of the numerator and denominator of the basic EPS
computation to the numerator and denominator of the diluted EPS computation.
This statement is effective for financial statements issued for periods ending
after December 15, 1997; earlier application is not permitted. Management does
not believe that the application of this statement will have a material impact
on the company's financial statements
43
<PAGE>
ITEM 7.
Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
REPORT ON AUDITS OF CONSOLIDATED FINANCIAL
STATEMENTS for the years ended December 31,
1996 and 1995
44
<PAGE>
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, 1996 and 1995, 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, 1996 and 1995, and the results of its operations and its cash flows
for the years then ended, in conformity with generally accepted accounting
principles.
/s/Coopers & Lybrand L.L.P.
San Francisco, California
January 31, 1997 (except for Note 15, as to which the date is February 19, 1997)
45
<PAGE>
<TABLE>
<CAPTION>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
as of December 31, 1996 and 1995
(dollars in thousands)
ASSETS 1996 1995
<S> <C> <C>
Cash and equivalents:
Cash and due from banks $ $11,066 $ $11,288
Federal funds sold 22,724 5,000
- ----------------- -- ------------------
Total cash and equivalents 33,790 16,288
Certificates of deposits in other financial institutions 3,368 5,139
Investment securities 16,132 10,879
Loans receivable, net 165,681 129,587
Leasehold improvements and equipment, net 620 747
Accrued interest receivable and other assets 5,202 4,322
- ----------------- -- ------------------
Total assets $ 224,793 $ 166,962
= ================= == ==================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $ 209,235 $ 154,221
Accrued interest payable and other liabilities 1,220 759
- ----------------- -- ------------------
Total liabilities 210,455 154,980
- ----------------- -- ------------------
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, 1,534,470 in 1996 and 1,388,355 in 1995 9,607 7,433
Retained earnings 4,731 4,549
- ----------------- -- ------------------
Total shareholders' equity 14,338 11,982
- ----------------- -- ------------------
Total liabilities and shareholders' equity $ 224,793 $ 166,962
= ================= == ==================
</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, 1996 and 1995
(dollars in thousands, except per share data) 1996 1995
<S> <C> <C>
Interest income:
Loans $ 15,005 $ 11,925
Certificates of deposits in other financial institutions 265 354
Federal funds sold and investment securities 1,153 767
-- ------------------ - ------------------
Total interest income 16,423 13,046
Interest expense 7,191 5,481
-- ------------------ - ------------------
Net interest income before provision for loan losses 9,232 7,565
Provision for loan losses 420 250
-- ------------------ - ------------------
Net interest income after provision for loan losses 8,812 7,315
-- ------------------ - ------------------
Other income:
Service charges on deposits 337 306
Gain on sale of loans 567 715
Other 716 581
-- ------------------ - ------------------
Total other income 1,620 1,602
-- ------------------ - ------------------
Other expenses:
Salaries and employee benefits 3,521 3,186
Occupancy 699 698
Equipment 315 283
Outside customer services 245 218
Deposit and other insurance 142 240
Professional fees 185 130
Advertising 150 165
Other 1,150 939
-- ------------------ - ------------------
Total other expenses 6,407 5,859
-- ------------------ - ------------------
Income before income taxes 4,025 3,058
Provision for income taxes 1,719 1,338
-- ------------------ - ------------------
Net income $ 2,306 $ 1,720
== ================== = ==================
Common stock earnings per share $ 1.46 $ 1.16
== ================== = ==================
Average common shares outstanding for net income per share calculation 1,578,757 1,488,157
== ================== = ==================
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
<TABLE>
<CAPTION>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended December 31, 1996 and 1995
(dollars in thousands) Common Stock Retained
Earnings
----------------------------------- ---------------
Shares Amount Total
- ----------- -- ----------- --------
<S> <C> <C> <C> <C>
Balance, December 31, 1994 1,253,350 $ 6,489 $ 3,710 $ 10,199
Cash dividend paid ($.20 per share) (266) (266)
Stock options exercised 69,015 329 329
Stock dividend 65,990 615 (615)
Net income 1,720 1,720
----------- -- ----------- -- ------------ -- --------
Balance, December 31, 1995 1,388,355 7,433 4,549 11,982
Stock options exercised 3,578 52 52
Payout of fractional shares (2) (2)
Stock dividend 142,537 2,122 (2,122)
Net income 2,306 2,306
----------- -- ----------- -- ------------ -----------
Balance, December 31, 1996 1,461,400 $ 9,607 $ 4,731 $ 14,338
=========== == =========== == ============ == =======
</TABLE>
The accompanying notes are an integral part of these
financial statements.
47
<PAGE>
<TABLE>
<CAPTION>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1996 and 1995
(dollars in thousands) 1996 1995
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,306 $ 1,720
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 420 250
Depreciation, amortization and accretion 290 113
Net increase in deferred loan fees and discounts 228 359
Deferred income taxes (28) (185)
Increase in interest receivable and other assets (492) (424)
Increase in accrued interest payable and other liabilities 460 265
-- ------------- - -------------
Net cash provided by in operating activities 3,184 2,098
-- ------------- - -------------
Cash flows from investing activities:
Purchase of investment securities (21,003) (24,191)
Maturities of investment securities 15,750 16,500
Net decrease in deposits in other financial institutions 1,771 1,092
Net increase in loans receivable (37,102) (40,081)
Purchase of leasehold improvements and equipment, net (163) (297)
-- ------------- - -------------
Net cash used in investing activities (40,747) (46,977)
-- ------------- - -------------
Cash flows from financing activities:
Net increase in deposits 55,015 43,138
Payment of cash dividend (2) (266)
Stock options exercised 52 329
-- ------------- - -------------
Net cash provided by financing activities 55,065 43,201
-- ------------- - -------------
Net increase (decrease) in cash and cash equivalents 17,502 (1,678)
Cash and cash equivalents at beginning of year 16,288 17,966
-- ------------- - -------------
Cash and cash equivalents at end of year $ 33,790 $ 16,288
== ============= = =============
Other cash flow information:
Interest paid $ 7,150 $ 5,265
== ============= = =============
Income taxes paid $ 1,860 $ 1,515
== ============= = =============
Additions to Other Real Estate Owned $ 359 $ -
== ============= = =============
</TABLE>
The accompanying notes are an integral part of these
financial statements.
48
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL 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:
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.
49
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, continued:
Loans Receivable:
Loans held for investment are carried at amortized cost and all loans
held for sale are carried at the lower of cost or market. 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 has the option to sell the guaranteed portion of each loan to
an investor and retain 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.
50
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, continued:
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.
51
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, continued:
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, (1,503,579 and 1,417,293 shares in 1996
and 1995, respectively).
Reclassifications:
Certain amounts in the 1995 financial statements have been reclassified
to conform with 1996 classifications.
2. Investment Securities:
The amortized cost and estimated market values of investment securities at
December 31, 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
1996
----------------------------------------------------
Unrealized Unrealized Market
Gains Losses Value
(dollars in thousands) Cost
---------------- ---------------- ---------------- --------------
<S> <C> <C> <C> <C>
Held to maturity - U.S. Treasury securities
$ 16,009 $ 1 $ (1) $ 16,009
Other securities - Federal Reserve Bank stock
123 - - 123
--------------- ------------- ------------ ---------
$ 16,132 $ 1 $ (1) $ 16,132
=============== ============== =========== ========
</TABLE>
52
<PAGE>
<TABLE>
<CAPTION>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Investment Securities, continued:
1995
--------------------------------------------------------------------------
Unrealized Unrealized Market
(dollars in thousands) Cost Gains Losses Value
------------------- --------------- -------------- -----------
<S> <C> <C> <C> <C>
Held to maturity - U.S. Treasury securities
$ 10,756 $ 4 $ (1) $ 10,759
Other securities - Federal Reserve Bank stock
123 - - 123
-- ---------------- -- ------------ - ------------ - --------
$ 10,879 $ 4 $ (1) $ 10,882
== ================ == ============ = ============ = ========
Investment securities totaling $500,000 at December 31, 1996 and 1995,
were pledged to secure certain deposits.
All investment securities held at December 31, 1996 have a contractual maturity
of one year or less.
During the year ended December 31, 1996, the bank sold one
security classified as available for sale for proceeds of $1,002,000 and
recognized a gain of $7,000. There were no sales in 1995.
3. Loans and Allowance
for Loan Losses: Loans at December 31, 1996 and 1995 consisted of the following:
</TABLE>
<TABLE>
<CAPTION>
1996 1995
(dollars in thousands)
<S> <C> <C>
Commercial loans $ 84,969 $ 62,062
Consumer installment loans 2,218 2,702
Real estate loans:
Construction 1,533 3,556
Other 81,008 64,720
-- --------------- - ---------------
169,728 133,040
Deferred loan fees and discounts (2,005) (1,777)
Allowance for loan losses (2,042) (1,676)
-- --------------- - ---------------
$ 165,681 $ 129,587
== =============== = ===============
</TABLE>
The Company's lending activities are concentrated primarily in Sonoma County;
however, the Company makes loans under the Small Business Administration
primarily in Northern California and Arizona. There were no industry or borrower
group concentrations at December 31, 1996.
53
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Loans and Allowance for Loan Losses, continued:
A summary of activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
1996 1995
(dollars in thousands)
<S> <C> <C>
Balance, beginning of year $ 1,676 $ 1,421
Provision for loan losses 420 250
Charge-offs (62) (102)
Recoveries 8 107
- -------------- - ------------
Balance, end of year $ 2,042 $ 1,676
= ============ = ============
</TABLE>
There were six loans totaling $438,000 and five loans totaling $398,000 on
nonaccrual status as of December 31, 1996 and 1995, respectively. Interest
foregone on such loans totaled $32,000 in 1996 and $30,000 in 1995.
At December 31, 1996 and 1995, the recorded investment in loans for which
impairment has been recognized in accordance with SFAS No. 114 totaled $438,000
and $398,000, with a corresponding valuation allowance of $201,000 and $64,000,
respectively. The average recorded investment in impaired loans in 1996 and 1995
was $418,000 and $179,000, respectively. No interest income was recognized on
impaired loans in 1996 and 1995.
As discussed in Note 1, the Company originates loans guaranteed by the U.S.
Small Business Administration (SBA). The Company has the option to sell to
outside investors, usually at a price in excess of par, the guaranteed portion
of these loans and retain 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, 1996 and 1995, the Company serviced $44,110,000 and $44,019,000 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. In addition, at December 31, 1996 and 1995, loans
receivable included $28,256,000 and $14,324,000 of SBA loans which could be sold
in the future.
At December 31, 1996 and 1995, the Company serviced additional loans for others
totaling $10,494,000 and $11,666,000, respectively.
54
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Leasehold Improvements and Equipment:
Leasehold improvements and equipment consisted of the following at
December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
(dollars in thousands)
<S> <C> <C>
Leasehold improvements $ 942 $ 938
Furniture and equipment 1,513 1,502
- ------------ - ------------
Total 2,455 2,440
Less accumulated depreciation and amortization (1,835) (1,693)
- ------------ - ------------
Total $ 620 $ 747
= ============ = ============
</TABLE>
Depreciation and amortization of approximately $290,000 and $226,000 were
charged to expense for the years ended December 31, 1996 and 1995, respectively.
5. Deposits:
<TABLE>
<CAPTION>
Deposits consisted of the following at December 31, 1996 and 1995:
(dollars in thousands) 1996 1995
Deposits:
<S> <C> <C>
Noninterest-bearing $ 28,612 $ 23,017
Interest-bearing:
Money market rate 71,087 49,913
Savings 4,095 5,086
Demand 11,468 9,672
Certificates of deposit 93,973 66,533
--------------- ----------------
$ 209,235 $ 154,221
=============== ===============
</TABLE>
Certificates of deposits with balances of $100,000 or more totaled $25,621,000
and $19,331,000 at December 31, 1996 and 1995, respectively.
Certificates of deposit have remaining maturities at December 31, 1996 and 1995
as follows:
<TABLE>
<CAPTION>
(dollars in thousands) 1996 1995
<S> <C> <C>
Three months or less $ 22,855 $ 12,386
Over three through six months 25,335 11,686
Over six through twelve months 37,969 21,888
Over twelve months 7,814 20,573
-------------- --------------
Total certificates of deposit $ 93,973 $ 66,533
=============== ==============
</TABLE>
<PAGE>
6. Income Taxes:
The components of the provision for federal and state income taxes are as
follows:
<TABLE>
<CAPTION>
1996 1995
(dollars in thousands)
<S> <C> <C>
Currently payable:
Federal $ 1,219 $ 1,136
State 528 387
--------------- --------------
Total 1,747 1,523
--------------- ---------------
Deferred:
Federal 45 (171)
State (73) (14)
--------------- ---------------
Total (28) (185)
-------------- ---------------
Total $ 1,719 $ 1,338
=============== ===============
</TABLE>
A reconciliation of the statutory tax rates to the effective tax rates is
as follows:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Statutory federal tax rate 35.0% 35.0%
State tax, net of federal income tax effect 7.2 7.9
Other, net 0.5 0.8
-------- -------
42.7% 43.7%
======== ========
</TABLE>
The components of deferred income tax assets net of liabilities as of
December 31, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
Deferred Deferred
(dollars in thousands) Tax Assets Tax Assets
------------ ------------
<S> <C> <C>
Loan loss reserves $ 650 $ 508
Deferred loan fees 61 103
State taxes, net of federal effect 370 297
All others (18) 127
------------- -------------
Total $ 1,063 $ 1,035
============= =============
</TABLE>
55
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 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
Exercised (3,578) 4.31 - 7.36
Effect of 5% stock dividend 4,576 4.31 - 7.36
--------- ---------------
Outstanding, December 31, 1996 96,185 $4.31 - $7.36
======== ===============
</TABLE>
In the aggregate, options to 96,185 and 95,187 shares were exercisable at
December 31, 1996 and 1995, respectively. In 1994, the stock option plan
expired, therefore at December 31, 1996 and 1995, there were no options to
purchase shares available for future grants. 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, 1996 and 1995 totaled $104,000 and $89,000,
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, 1996 and 1995, the cash surrender value of these policies was
1,778,000 and $1,671,000, respectively, which is included in other assets.
56
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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>
1996 1995
(dollars in thousands)
<S> <C> <C>
Balance, beginning of year $ 4,581 $ 2,490
Additions 2,997 2,470
Principal reductions (1,510) (379)
-- -------- -- ------------
Balance, end of year $ 6,068 $ 4,581
== ======== == ============
</TABLE>
The Company has entered into three operating leases for branch and office
facilities with A Director or partnerships owned by Directors of the Company.
Rental payments made under these leases were $331,000 and $304,000 for the years
ended December 31, 1996 and 1995, respectively. Two of the leases require that
rental payments will increase each year based on the consumer price index.
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 at December
31, 1996 were $1,156,000.
The future minimum noncancelable lease payments as of December 31, 1996
are as follows:
<TABLE>
<CAPTION>
(dollars in thousands)
<C> <C>
1997 $ 482
1998 383
1999 331
2000 341
Thereafter 1,482
- ------------
Total $ 3,019
=============
</TABLE>
Total rental expense for the years ended December 31, 1996 and 1995 was
$481,000 and $478,000, respectively.
57
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Regulatory Capital Requirements:
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material affect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1996, that the Bank
meets all capital adequacy requirements to which it is subject.
<TABLE>
<CAPTION>
Actual For Capital Adequacy To Be Well Capitalized Under
Purposes Prompt Corrective Action
Provisions
(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
As of 12/31/96
<S> <C> <C> <C> <C> <C> <C>
Total Capital (To Risk Weighted $15,920 10.2% > $12,524 > 8.0% > $15,655 > 10.0%
Assets)
Tier 1 Capital (To Risk Weighted $13,962 8.9% > $ 6,262 > 4.0% > $9,393 > 6.0%
Assets)
Tier 1 Capital (To Average Assets) $13,962 6.9% > $ 6,049 > 3.0% > $10,082 > 5.0%
</TABLE>
As of December 31, 1996, the Bank was categorized as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as
well-capitalized, the Bank must maintain minimum total risk-based, Tier I
risk-based, Tier I leverage ratio as set forth in the table, and not subject to
a capital directive.
Payment of dividends by the Bank is limited under regulation. The amount that
can be paid in any calendar year without prior approval of the Office of the
Comptroller of the Currency cannot exceed the lesser of net profits (as defined)
for that year plus the net profits for the preceding two calendar years, or
retained earnings. Therefore, the payment of dividends by the Company may also
be limited.
58
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
59
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Fair Values of Financial Instruments, continued:
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.
<TABLE>
<CAPTION>
December 31, 1996
--------------------------------------------
Carrying
(dollars in thousands) Fair
Amount Value
-- -------------- --- ---------------
<S> <C> <C>
Financial assets:
Cash equivalents and certificates of deposits $ 37,158 $ 37,159
Investments securities 16,009 16,009
Loans receivable, net 165,681 168,577
-- -------------- --- ---------------
218,848 221,745
-- -------------- --- ---------------
Financial liabilities:
Deposits $ 209,431 $ 209,597
-- -------------- --- ---------------
Off-balance sheet financial instruments:
Commitments to extend credit - 166
Standby letters of credit - 4
-- -------------- --- ---------------
- $ 170
== ============== === ===============
</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.
60
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. Financial Instruments with Off-Balance Sheet Risk, continued:
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, 1996 and 1995, loan commitments totaled $16,590,000 and
$12,952,000, respectively and standby letters of credit totaled $377,000 and
$1,486,000, respectively.
14. Parent Company Only Condensed Financial Information:
The condensed financial statements of Northern Empire Bancshares (parent company
only) as of December 31, 1996 and 1995, and for each of the two years in the
period ended December 31, 1996, are presented below:
<TABLE>
<CAPTION>
(dollars in thousands) 1996 1995
<S> <C> <C>
Balance Sheets
Assets:
Cash and cash equivalents $ 196 $ 180
Investment in Sonoma National Bank 14,060 11,752
Other assets 91 51
--------------- --------------
Total assets $ 14,347 $ 11,983
============== ==============
Liabilities and shareholders' equity:
Other liabilities $ 9 $ 1
--------------- --------------
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
outstanding 1,461,400 in 1996 and 1,388,355 in 1995 8,310 7,433
Retained earnings 6,028 4,549
--------------- --------------
Total shareholders' equity 14,338 11,982
--------------- --------------
Total liabilities and shareholders' equity $ 14,347 $ 11,983
=============== ==============
</TABLE>
61
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Parent Company Only Condensed Financial Information, continued:
<TABLE>
<CAPTION>
(dollars in thousands) 1996 1995
Statements of Income
<S> <C> <C>
Interest and other income $ 8 $ 18
Administrative expenses (9) (10)
Income taxes expense (1) (3)
Equity in undistributed earnings of Sonoma National Bank 2,308 1,715
--------------- --------------
Net income $ 2,306 $ 1,720
=============== ==============
</TABLE>
<TABLE>
<CAPTION>
(dollars in thousands) 1996 1995
Statements of Cash Flows Cash flows from operating activities:
<S> <C> <C>
Net income $ 2,306 $ 1,720
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Change in other assets (40) 92
Change in other liabilities 8 (3)
--------------- --------------
Total 2,274 1,809
Less equity in undistributed earnings of Sonoma National Bank (2,308) (1,715)
-------------- --------------
Net cash provided by (used in) operating activities (34) 94
--------------- --------------
Cash flows from investing activities:
Capital contributed to Sonoma National Bank (200)
--------------- --------------
Net cash used in investing activities - (200)
--------------- --------------
Cash flows from financing activities:
Cash dividend paid (2) (266)
Stock options exercised 52 329
--------------- --------------
Net cash provided by financing activities 50 63
--------------- --------------
Net increase (decrease) in cash and cash equivalents 16 (43)
Cash and cash equivalents:
Beginning of year 180 223
--------------- --------------
End of year $ 196 $ 180
=============== ==============
</TABLE>
62
<PAGE>
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Subsequent Event
The Company's Board of Directors declared a 5% stock dividend on February 19,
1997 to shareholders of record on March 31, 1997. Fractional shares will be paid
in cash based upon the closing price as of the record date. The numbers of
common shares issued and outstanding and the balances of common stock,
additional paid in capital and retained earnings have been restated at December
31, 1996 to reflect the shares which will be issued in connection with the 5%
common stock dividend. All weighted average shares outstanding and per share
amounts have been retroactively restated.
63
<PAGE>
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, 44 President and Chief Executive Officer of the Bank since February
President & Chief Executive Officer and 1991.
Director of the Bank
Clement C. Carinalli 51 Retired CPA, local businessman, rancher and real estate investor.
Director of the Corporation and the Bank
Certified Public Accountant and local businessman; major
Patrick R. Gallaher 51 shareholder in Oakmont Developers, a Santa Rosa development
Chief Accounting Officer of the Corporation company.
and Director of the Corporation and the Bank
William P. Gallaher, 46 Real Estate developer and investor; President of Oakmont
Director of the Corporation and the Bank Developers; President of Gallaher Construction Company.
William E. Geary, 68 Senior Partner in Geary, Shea & O'Donnell, a Santa Rosa law firm.
Director of the Corporation and the Bank
Dennis R. Hunter, 54 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., 48 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, 52 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
Director of the Bank manager; trader of futures options contrats in Chicago and
other international market exchanges
David F. Titus, 44 Executive Vice President & Senior Loan Officer of the Bank since
Executive Vice President and Senior Loan January, 1995. Senior Vice President & Senior Loan Officer of the
Officer of the Bank Bank from August 1991 to January, 1995.
Officer of the Bank
JoAnn Barton, 43 Senior Vice President and Senior Operations Administrator of the
Senior Vice President & Senior Operations Bank since March 1992; from November 1985 Vice President and
Officer of the Bank Senior Operations Administrator of the Bank.
Jane M. Baker 50 Senior Vice President and Chief Financial Officer of the Bank since
Senior Vice Presient & August 1995; Vice President and Chief Financial Officer of the
Chief Financial Officer of the Bank Bank since August 1992; from 1990 to 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, William P. Gallaher who was elected on June 21,
1994 and Clement C. Carinalli who was reappointed in May 1996. William P.
Gallaher and Patrick R. Gallaher are brothers.
65
<PAGE>
William E. Geary, Dennis R. Hunter, James B. Keegan, Jr. and Robert V. Pauley
have served as directors of the Bank since the initial organization of the Bank.
Clement C. 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. 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 $1,500 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
(dollars in thousands) Long Term
Compensation
Annual Compensation
Options All Other
(1)
Name and Principal Position Year Salary Bonus (No. of Shares)
==================================== =========== ================ =============== ==============================
<S> <C> <C> <C> <C> <C>
Deborah A. Meekins, 1994 $122 $69 $24
President and Chief Executive Officer 1995 128 69 27
and Director of the Bank
1996 133 81 39
David F. Titus, Executive Vice 1994 83 44 1,157(2) 25
President and Senior Loan Officer of
the Bank 1995 91 44 23
1996 96 54 34
==================================== =========== ================ =============== ==============================
<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 stock dividends issued since date of the option grant, but not
the 1997 stock dividend that has been declared but not issued.
</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, 1996, 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 1996 or 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 1996.
<TABLE>
<CAPTION>
Aggregated Year-End Option Values
December 31, 1996
Number of Unexercised Securities Value of Unexercised Options (2)
Underling Options (No. of Shares)(1) Exercisable/Unexercisable
Name Exercisable/Unexercisable
<S> <C> <C>
Deborah A. Meekins 21,464 / 0 $219,000 / $0
David F. Titus 1,157 / 0 10,000 / 0
=================================== ====================================== ======================================
<FN>
(1) Adjusted for stock dividends issued since date of the option grant, but not
the 1997 stock dividend that has been declared but not issued.
(2) Calculated based on the difference between the fair market value of the
stock and the exercise price of the options, as of December 31, 1996.
</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: $1,000 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 $1,500 per month in addition to the
committee fees described above. 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 1996, 600 options were exercised by directors, realizing a
value of approximately $2,000. Outside directors held on December 31, 1996
options for 64,517 shares, which options had an estimated value of $568,000
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, 1995 and 1996, 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 $13,000 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, 1996, the cash surrender value of these
policies was $974,000, which is included in other assets.
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 28, 1997.
67
<PAGE>
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 28, 1997. 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. The
number of shares have not been adjusted for the stock dividend declared in 1997.
<TABLE>
<CAPTION>
Number of
SharesBeneficially
Name Owned Pct
==============================================================================================
<S> <C> <C>
Clement C. Carinalli 59,344(1) 4.0%
Patrick R. Gallaher 67,512(2),(3) 4.6
William P. Gallaher 49,335(2),(4) 3.4
William E. Geary 59,058(5) 4.0
Dennis R. Hunter 54,597(6) 3.7
James B. Keegan, Jr. 46,158(7) 3.2
Deborah A. Meekins 22,042(8) 1.5
Robert V. Pauley 112,531(9) 7.7
All other officers as a group (8 people) 17,714(10) 1.2
Directors and Officers as a group (15 persons) 488,291 33.3%
==============================================================================================
<FN>
(1) Including 19,306 shares which Mr. Carinalli has the right to purchase upon
exercise of outstanding options.
(2) Including 400 shares held by Gallaher Construction Inc., Pension & Profit
Sharing Plan.
(3) Including 23,731 shares held in Mr. P. Gallaher's IRA.
(4) Including 6,945 shares which Mr. W. Gallaher has the right to purchase upon
exercise of outstanding options and 31,715 shares held in Mr. W. Gallaher's IRA.
(5) Including 9,261 shares which Mr. Geary has the right to purchase upon
exercise of outstanding options and 28,471 shares held for Geary Shea &
O'Donnell, employee pension and profit sharing plan.
(6) Including 10,187 shares which Mr. Hunter has the right to purchase upon
exercise of outstanding options and 38,738 shares held in the name of Kathrine
Hunter, as to which Mr. Hunter has voting rights.
(7) Including 6,857 shares which Mr. Keegan has the right to purchase upon
exercise of outstanding options.
(8) Including 21,464 shares which Ms. Meekins has the right to purchase upon
exercise of outstanding options.
(9) Including 9,261 shares which Mr. Pauley has the right to purchase upon
exercise of outstanding options.
(10) Including 8,237 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.
Robert V. Pauley, 120 "D" Street, Santa Rosa, CA 95404
68
<PAGE>
As of February 28, 1997, Mr. James Ratto, P.O. Box 768, Novato, CA 94948, owned
73,516 shares or 5.0% of the total shares outstanding.
ITEM 12.
Certain Relationships and Related Transactions
The Corporation leases the main premises of the Bank from Clement C. Carinalli,
a director of the Corporation and the Bank, and Ann Marie Carinalli. The
Corporation subleases the premises to the Bank. During 1996, the building was
sold and Mr. and Mrs Carinalli assigned the lease obligation to the new owners.
The monthly lease payment was $15,957 per month in 1996. The total rental
expenses on this lease for the year ended December 31, 1996 was $187,000.
The Corporation leases the Oakmont Branch premises from Oakmont Investments of
which Patrick Gallaher, a director of the Corporation and Bank, is a partner.
Monthly payments were $6,300 with annual increases based on increases in the
Consumer Price Index commencing in October 1997. The monthly rental for the
Oakmont Branch was $6,300 at December 31, 1996. Total rental expense on this
lease for years ended December 31, 1996 and 1995 was $106,000 and $104,000.
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, 1996, loans by the Bank to
directors, officers and their associates totaled approximately $6,068,000,
constituting 3.6% of total loans, 43.2% of the Bank's shareholder's equity and
42.3% 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 10.2 to the
Corporation's S-2 Registration Statement, filed
September 11, 1992, 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)* 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).
(f)* 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).
(g)* 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).
(h)* 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).
70
<PAGE>
(i)* 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).
(j)* 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).
(k)* 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).
(l)* 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).
(m)* 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).
(n)* 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).
(o) 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).
(p)* Director's Deferred Compensation Plan between Patrick
R. Gallaher and Sonoma 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).
(q)* 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).
(r)* 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).
(s)* 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).
(t)* Director's Deferred Compensation Plan between William
P. Gallaher and Sonoma National Bank (filed as
Exhibit (10)(v) to the Corporation's Quarterly Report
on Form 10-QSB for the Quarter Ended June 30,1996 and
incorporated herein by this reference).
(u) Lease for Bank Premises at 6641 Oakmont Drive, Santa
Rosa, California, dated October 1, 1996 (filed as
Exhibit (10)(w) to the Corporation's Quarterly Report
on
71
<PAGE>
Form 10-QSB for the Quarter ended September 30, 1996
and incorporated herein by this reference).
(v) Lease for Loan and Administration Offices at 751 and
755 Fourth Street, Santa Rosa, California, dated June
1, 1996 (filed as Exhibit (10)(w) to the
Corporation's Quarterly Report on Form 10-QSB for the
Quarter ended September 30, 1996 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 1996 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 1997 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 Hunter
Dennis R. Hunter,
Chairman of the Board of Directors
Date: March 26, 1997
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 26, 1997
Chairman of the Board of Directors
James B. Keegan, Jr. Date: March 26, 1997
President/Director
Patrick R. Gallaher, Date: March 26, 1997
Chief Accounting Officer/Director
Robert V. Pauley, Date: March 26, 1997
Secretary and Treasurer/Director
Clement C. Carinalli, Date: March 26, 1997
Director
William P. Gallaher, Date: March 26, 1997
Director
William E. Geary, Date: March 26, 1997
Director
73
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This Schedule contains summary financial inforamtion extracted from the Balance
Sheet and Statement of Income and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 11,066
<INT-BEARING-DEPOSITS> 3,368
<FED-FUNDS-SOLD> 22,724
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 16,132
<INVESTMENTS-MARKET> 16,132
<LOANS> 167,723
<ALLOWANCE> 2,042
<TOTAL-ASSETS> 224,793
<DEPOSITS> 209,235
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,220
<LONG-TERM> 0
0
0
<COMMON> 9,607
<OTHER-SE> 4,731
<TOTAL-LIABILITIES-AND-EQUITY> 14,338
<INTEREST-LOAN> 15,005
<INTEREST-INVEST> 1,153
<INTEREST-OTHER> 256
<INTEREST-TOTAL> 16,423
<INTEREST-DEPOSIT> 7,191
<INTEREST-EXPENSE> 7,191
<INTEREST-INCOME-NET> 9,232
<LOAN-LOSSES> 62
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 6,407
<INCOME-PRETAX> 4,025
<INCOME-PRE-EXTRAORDINARY> 4,025
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,306
<EPS-PRIMARY> 1.46
<EPS-DILUTED> 1.46
<YIELD-ACTUAL> 5.31
<LOANS-NON> 438
<LOANS-PAST> 623
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 438
<ALLOWANCE-OPEN> 1,676
<CHARGE-OFFS> 62
<RECOVERIES> 8
<ALLOWANCE-CLOSE> 2,042
<ALLOWANCE-DOMESTIC> 2,042
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 236
</TABLE>
