FORM 10-QSB
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 2-91196
NORTHERN EMPIRE BANCSHARES
---------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
California 94-2830529
- ------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
801 Fourth Street, Santa Rosa, California 95404
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(Address of principal executive offices) (Zip code)
issuer's telephone number 707-579-2265
NONE
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) has filed all reports required to be filed
by Section 13 or 15 (d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.
Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date.
Title of class: Common Stock, no par value Outstanding shares as of
October 15, 1998:
3,303,412
Transitional Small Business Disclosure Format (check one): Yes No X
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(dollars in thousands)
ASSETS
September 30, December 31,
1998 1997
------------- -----------
Cash and equivalents:
Cash and due from banks $ 8,984 $ 7,412
Federal funds sold 38,375 8,770
-------- --------
Total cash and equivalents 47,359 16,182
Investment securities
Held-to-maturity 1,500
Available-for-sale 2,003 3,951
Restricted 1,708 1,639
Loans receivable, net 249,527 204,408
Leasehold improvements and
equipment, net 789 683
Accrued interest receivable
and other assets 5,777 5,374
-------- --------
Total assets $307,163 $233,737
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $284,444 $214,747
Accrued interest payable
and other liabilities 1,364 1,281
-------- --------
Total liabilities 285,808 216,028
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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,
in 1998 and in 1997 12,347 9,778
Unrealized gain (loss)
on available for sale securities 2 0
Retained earnings 9,006 7,931
-------- --------
Total shareholders' equity 21,355 17,709
-------- --------
Total liabilities and
shareholders' equity $307,163 $233,737
======== ========
See Notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
for the three and nine months ended September 30, 1998 and 1997
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
(dollars in thousands,
except per share data) 1998 1997 1998 1997
---- ---- ---- ----
Interest income:
Loans $ 6,151 $ 4,981 $17,238 $13,968
Federal funds sold and
investment securities 490 436 1,262 1,175
------- ------- ------- -------
Total interest income 6,641 5,417 18,500 15,143
Interest expense 2,897 2,417 8,135 6,788
------- ------- ------- -------
Net interest income before
provision for loan losses 3,744 3,000 10,365 8,355
Provision for loan losses 120 120 360 360
------- ------- ------- -------
Net interest income after
provision for loan losses 3,624 2,880 10,005 7,995
------- ------- ------- -------
Other income:
Service charges on deposits 93 80 269 260
Gain on sale of loans 235 0 567 130
Other 177 214 536 602
------- ------- ------- -------
Total other income 505 294 1,372 992
------- ------- ------- -------
Other expenses:
Salaries and employee benefits 998 961 3,041 2,702
Occupancy 176 179 541 523
Equipment 181 94 409 261
Advertising 102 94 266 268
Outside customer services 79 65 202 188
Shareholder and
director expenses 73 45 204 167
Deposit and other insurance 50 45 144 131
Professional fees 41 27 120 105
Other 193 181 562 556
------- ------- ------- -------
Total other expenses 1,893 1,691 5,489 4,901
------- ------- ------- -------
Income before income taxes 2,236 1,483 5,888 4,086
Provision for income taxes 890 580 2,356 1,636
------- ------- ------- -------
Net income $ 1,346 $ 903 $ 3,532 $ 2,450
======= ======= ======= =======
Earnings per common share $ 0.41 $ 0.28 $ 1.07 $ 0.76
======= ======= ======= =======
Earnings per common share
assuming dilution $ 0.40 $ 0.27 $ 1.03 $ 0.73
======= ======= ======= =======
See Notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the nine months ended September 30, 1998 and 1997
(Unaudited)
(dollars in thousands) 1998 1997
--------- ---------
Cash flows from operating activities:
Net income $ 3,532 $ 2,450
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses and OREO losses 360 360
Depreciation, amortization and accretion 276 228
Net increase (decrease) in deferred loan
fees and discounts 168 (264)
Decrease (increase) in interest receivable
and other assets (533) 294
Increase (decrease) in accrued interest
payable and other liabilities 83 139
--------- ---------
Net cash provided by in operating activities 3,886 3,207
--------- ---------
Cash flows from investing activities:
Purchase of: Held to maturity securities 0 (13,982)
Available for sale securities (2,026) (3,974)
Restricted securities (69) (1,506)
Maturities of: Held to maturity securities 1,500 20,995
Available for sale securities 3,977 3,340
Proceeds from sale of available for sale securities 0 5,006
Net decrease in deposits in other
financial institutions 0 3,269
Net decrease (increase) in loans receivable (45,517) (29,914)
Purchase of leasehold improvements and
equipment, net (382) (206)
--------- ---------
Net cash used in investing activities (42,517) (16,972)
--------- ---------
Cash flows from financing activities:
Net increase (decrease) in deposits 69,698 15,617
Payment of cash dividends (5) (3)
Stock options exercised 115 89
--------- ---------
Net cash provided by financing activities 69,809 15,703
--------- ---------
Net increase (decrease) in cash and
cash equivalents 31,178 1,938
Cash and cash equivalents at beginning of year 16,182 33,790
--------- ---------
Cash and cash equivalents at end of period $ 47,360 $ 35,728
========= =========
Other cash flow information
Interest paid $ 8,043 $ 6,790
Income taxes paid $ 2,333 $ 1,685
Additions to other real estate owned $ 0 $ 227
See Notes to Consolidated Financial Statements
Northern Empire Bancshares and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1998
NOTE 1 - BASIS OF PRESENTATION
In the opinion of Management, the unaudited interim consolidated
financial statements contain all adjustments of a normal recurring
nature, which are necessary to present fairly the financial condition of
Northern Empire Bancshares (the "Corporation") and Subsidiary at
September 30, 1998 and the results of operations for the three and nine
months then ended.
Certain information and footnote disclosures presented in the
Corporation's annual consolidated financial statements are not included
in these interim financial statements. Accordingly, the accompanying
unaudited interim consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Corporation's 1997 Annual Report on Form 10-KSB. The
results of operations for the three and nine months ended September 30,
1998 are not necessarily indicative of the operating results through
December 31, 1998.
NOTE 2 - NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
Earnings per share (EPS) are shown in accordance with SFAS No. 128
"Earnings per Share" which was effective for fiscal years ended after
December 31, 1997 and requires restatement of prior period EPS. Basic
EPS is computed by dividing income available to common shareholders by
the weighted average number of common shares outstanding during the
period. Diluted EPS is computed by dividing diluted income available to
shareholders by the weighted average number of common shares and common
equivalent shares outstanding which include dilutive stock options. The
computation of common stock equivalent shares is based on the weighted
average market price of the Bank's common stock throughout the period.
<TABLE>
<CAPTION>
For the three For the nine
months ended months ended
September 30, September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Weighted average number of common
shares outstanding - Basic 3,303,175 3,260,521 3,300,191 3,241,274
Effect of dilutive securities:
Stock options 89,324 135,479 133,594 126,990
Weighted average number of common
shares outstanding - diluted 3,392,499 3,396,000 3,433,785 3,368,264
Net income $1,346,000 $903,000 $3,532,000 $2,450,000
Basic earnings per share $0.41 $0.28 $1.07 $0.76
Diluted earnings per share $0.40 $0.27 $1.03 $0.73
</TABLE>
NOTE 3 - NEW AND PENDING ACCOUNTING STANDARDS
See the Corporation's 1997 Annual Report on Form 10-KSB for a discussion
of new and pending accounting standards.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
Northern Empire Bancshares is the bank holding company of Sonoma
National Bank (the "Bank"). Since the principal business of the
Corporation is the Bank, the following discussion pertains mainly to the
Bank.
This report contains "forward-looking statements" as defined in section
27A of the Securities Act of 1933, 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.
Total consolidated assets equaled $307,163,000 at September 30, 1998
compared to $233,737,000 at December 31, 1997. Cash and cash
equivalents increased $31.2 million since year end. Net loans increased
$45.1 million since year end with $15.4 million occurring in the third
quarter. The growth in cash and cash equivalents and loans was funded by
new deposits.
Net income for the first nine months of 1998 equaled $3,532,000 compared
to $2,450,000 for the comparable period last year, an increase of 44.2%.
The third quarter's net income of $1,346,000 increased 49.1% over the
third quarter of 1997 when net income equaled $903,000. The higher
profit resulted from increases in net interest income due to loan growth
(a larger volume of higher yielding earning assets)and increased sales
of Small Business Administration (SBA) loans.
NET INTEREST INCOME
Net interest income of $3,744,000 for the third quarter of 1998
increased 24.8% from $3,000,000 for the comparable period last year.
This increase in net interest income resulted from volume increases of
$54.9 million in average earning assets for the third quarter of 1998
compared to the third quarter of 1997. $50.4 million of that increase
was in average loans outstanding, which have the highest yield of
interest earning assets. Average interest bearing deposits for the third
quarter increased $43.3 million over the same period last year.
The net interest margin equaled 5.25% during the third quarter of 1998
compared to an average margin for the year of 1997 of 5.22%. The yield
on average loans equaled 9.87% in the third quarter compared to 9.98%
for the year of 1997, while the Bank's cost of funds was 4.91% in the
third quarter compared to 5.00% during the year of 1997.
Several factors impact the Bank's interest margin. The Bank's ratio of
loans to deposits increased from an average of 90.6% in 1997 to 91.5%
during the third quarter of 1998. The mix of loans influence the
overall yield on loans. During the third quarter of 1998, there
was significant growth in all loan categories: however, an increase of
$15.0 million in average construction loan balances over September 30,
1997 balances had a positive effect since that loan category has the
highest loan yield. Recently, the Bank has experienced increased competition
from financial institutions which has resulted in lower pricing on certain
types of loan products offered by the Bank.
The Bank is considered asset sensitive and benefits from rate increases,
since its assets reprice at a faster rate than deposits. The Prime
lending rate was 8.25% from December 31, 1996 through March 26, 1997
when it increased to 8.5%, where it remained until September 30, 1998
when it declined to 8.25%. On October 16, 1998 the Bank lowered prime
rate to 8.00%. Of the Bank's loan portfolio totaling $254.4 million at
September 30, 1998, $187.9 million or 73.9% of the loans are adjustable
rate loans which have not reached a floor or ceiling rate.
Approximately $117.7 million are prime-based loans, of which $24.0
million reprice immediately and $92.2 million reprice on a quarterly
basis. Approximately $83.3 million of the Bank's loan portfolio is
periodically adjustable (generally every six months) based upon the
Eleventh District's cost of funds index. This index was 4.90% in
September 1998 and September 1997.
Interest expense increased from $2,417,000 in the third quarter of 1997
to $2,897,000 in 1998. The major factor was the increase of $43.3
million in average interest bearing deposits when comparing the third
quarter of 1997 to 1998. The average cost of interest bearing deposits
was 4.91% during the third quarter of 1998 compared to 5.02% in the
third quarter of 1997. Interest rates on deposits have also declined
due to the actions of the Federal Reserve by lowering the fed funds
interest rates and discount rate. At September 30, 1998 the Bank had
$81.0 million in deposits which reprice weekly based upon the 23 week
treasury bill less a margin of 50 basis points. The cost on this
account was 4.58% on June 30, 1998 and has declined to 4.00% on
September 30, 1998. Rates offered on certificates of deposits have also
declined; however, these accounts reprice only on the certificate's
maturity date.
OTHER INCOME
Other income is derived primarily from service charges on deposit
accounts, discount brokerage income, earnings on life insurance, SBA
loan servicing, SBA loan sales and sales of other real estate owned.
Other income increased to $505,000 from $294,000 when comparing the
third quarter of 1998 to the same period last year. The majority of
this increase resulted from gains on SBA sales totaling $235,000 during
the third quarter while there were no SBA loans sales during the third
quarter of 1997. SBA servicing fees, which totaled $81,000 during the
quarter, decreased from $102,000 for the same period of 1997. This
change reflects the decrease in the pool of loans serviced, on which the
Bank receives a servicing fee. The serviced portfolio equaled $31.2 at
September 30, 1998 compared to $35.0 million at the end of the third
quarter of 1997.
Service charges during the quarter increased to $93,000 from $80,000
during the third quarter last year. Service charges vary depending on
the services to customer and earnings credits provided from balances
maintained by analysis customers.
There were $2,873,000 in sales of SBA loans during the third quarter of
1998, compared to no sales in the third quarter of 1997. The 1998 sales
resulted in gains totaling $235,000 during the third quarter of 1998.
The Bank has been retaining the majority of the guaranteed portion of
SBA loans to realize the interest yield, rather than selling the
guaranteed portion for a one time gain and then servicing the loan for a
fee. Management considers the Bank's liquidity needs and the estimated
loans and deposit growth as a part of the decision to hold SBA
guaranteed loans versus selling them. There is an established
market for SBA guaranteed loans which the Bank can access to sell
qualifying SBA guaranteed loans.
The Bank sold other real estate owned (OREO) valued at $130,000 at a
gain of $1,000 during the third quarter of 1998. During the first nine
months of 1997, the Bank sold five OREO properties realizing book gains
totaling $42,000 ($19,000 in the third quarter).
NON-INTEREST EXPENSES
The Bank's non-interest expenses increased from $1,691,000 in the third
quarter of 1997 to $1,893,000 in the third quarter of 1998. This
increase was anticipated since the Bank has continued to grow at a rapid
rate with minimal increases in non-interest expenses for the last few
years.
The Bank's largest expense category is salaries and benefits which
increased 3.9% from $961,000 to $998,000 when comparing third quarter of
1997 to same period of 1998. The Bank has been hiring Branch staff in
preparation for the opening of the West College Branch scheduled for
this November. Personnel costs were also affected by annual salary
increases, changes in benefit costs and incentive compensation based
upon loan and deposit growth.
Occupancy expenses decreased 1.7% when comparing the third quarter of
1997 to 1998; however, occupancy expenses have increased 3.4% when
comparing the first nine months of 1997 to 1998. Occupancy expenses
fluctuate in part due to repairs. The milder weather during the summer
also resulted in lower utility bills. In June 1998, the lending and loan
administrative staff was relocated to a new building, which is expected
to improve work flow and provide space for future growth. Occupancy
expenses are expected to increase with the opening of the West College
Branch.
Equipment costs equaled $181,000 during the third quarter of 1998
compared to $94,000 for the comparable quarter last year. During the
second and third quarters of 1998, a computer network was installed,
which required upgrading existing computer equipment and the purchasing
of new computers and peripheral equipment. Equipment costs are expected
to continue to increase during 1998 and 1999 as additional networks are
installed throughout the branches. Equipment costs include costs
associated with the year 2000 readiness. These costs include
replacement of noncompliant software and equipment and software testing
charges.
Deposit and other insurance of $50,000 increased $5,000 over the third
quarter of last year. Regulatory assessments and FDIC insurance costs
grew due to the increase in the deposit assessment base for Financing
Corporation (FICO) assessment which became effective January 1, 1997.
There is no assurance that the current FDIC assessment will continue at
such a low level. Other insurance costs increased due to Bank growth
and additions to the Bank's insurance coverage which resulted in higher
premiums.
Advertising and business development costs increased to $102,000 up from
$94,000 in the third quarter of 1997. Professional fees increased by
$14,000 from the third quarter of 1997 to $41,000. Professional fees
included the cost of specialized computer training for the loan
department staff. Legal costs were higher during 1998 due to the legal
cost associated with the new stock option plan. Both the advertising and
professional fee categories vary significantly based on activity
throughout the year. Other expenses, which include stationery &
supplies, telephone, postage, courier, customer expenses, loan
expenses, dues and subscriptions and automobile costs, increased 6.6% over the
third quarter of 1997's expense level due to growth of the Bank.
Total non-interest expenses for the SBA lending department for the third
quarter were approximately $349,000 ($176,000 in personnel costs,
$60,000 in occupancy and equipment expenses, $20,000 in
marketing/business development) compared to $372,000 for the third
quarter of 1997. At September 30, 1998, the SBA loan portfolio
(serviced portion and Bank's portion) equaled $121.9 million, of which
$31.2 million has been sold and is being serviced.
INCOME TAXES
The effective tax rate was 39.8% for the third quarter of 1998. The
provision for the third quarter of 1998 was $890,000 versus $580,000 for
the same period last year. The increase resulted from the increase in
pre-tax income during the comparable quarters.
LIQUIDITY AND INVESTMENT PORTFOLIO
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.
Cash and due from banks and federal funds sold totaled $47.4 million or
15.4% of total assets at September 30, 1998, compared to $16.2 million
or 6.9% of total assets at December 31, 1997. Liquid assets were lower
than normal at year end due to the rapid growth in loans at the end of
the year. During the first quarter of 1998 the Bank offered special
time deposits at slightly higher then market rates to attract new
deposits and sold loans in order to restore liquidity to normal levels.
At the end of the first quarter, total cash and equivalents equaled $33
million or 12.3% of total assets.
The Bank has several ways of providing additional liquidity. Special
deposit campaigns, which offer slightly higher than market rates,
continue to attract new deposits to the Bank. The Bank also has the
option of selling SBA guaranteed loans to provide liquidity.
As of September 30, 1998, the Bank held $55.9 million in SBA guaranteed
loans which could be sold if liquidity was needed.
At September 30, 1998, the Bank had unused federal funds lines of credit
totaling $9,000,000. The Bank also has a credit line with the Federal
Home Loan Bank which is based upon the value of collateral (investments
and loans). Management believes this amount of secondary liquidity is
adequate to meet any cash demands that may arise.
At present, the Corporation's primary sources of liquidity are from
interest on deposits, 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 Comptroller of the Currency.
At September 30, 1998, the Corporation had non-interest and interest
bearing cash balances of $299,000, which management believes is adequate
to meet the Corporation's operational expenses.
The Corporation and the Bank do not engage in hedging transactions
(interest rate futures, caps, swap agreements, etc.).
DEPOSITS
During the third quarter of 1998 total deposits increased$23.4 million
to $284.4 million at September 30, 1998.
Money market rate deposits grew from $64.8 million at year end to $81.0
million at September 30, 1998. This is a limited transaction account
which pays a floating rate equal to the 13 week treasury bill less a
margin of 50 basis points. The rate offered on this account has been
very attractive and many of the Bank's customers have held their funds
in this deposit product rather than locking a specific maturity. New
customers continue to find this deposit account attractive due to the
immediate availability of the funds versus a time certificate bearing a
future maturity.
Certificates of deposits increased from $102.9 million at December 31,
1997 to $145.6 million as of September 30, 1998. The Bank has increased
certificates of deposit by offering attractive rates on certificates for
specific terms. The Bank has been successful in retaining the majority
of funds received through certificate campaigns.
As of September 30, 1998, non-interest bearing deposits equaled $40.9
million compared to $30.1 million at December 31, 1997. The Bank's
transaction accounts have significant changes in daily balances, mainly
due to deposits held by title companies. This type of deposit account
has greater balance fluctuations than other types of deposits based upon
their business activity; however, they carry average daily balances in
excess of $3 million.
The low interest rate environment over the past few years and the
increased competition from the financial services industry has made it
more difficult to attract new deposits at favorable rates. The Bank
continually monitors competitors' rates, strives to be competitive in
pricing deposits, and has offered attractive time deposit rates to raise
funds during periods of high loan growth.
LOANS
Loans, net of discounts and reserves, equaled $249.5 million at September 30,
1998 compared to $204.4 million at December 31, 1997, increasing 22.1%.
The SBA department continues to experience strong loan demand with SBA
loans (net of $3.8 million in SBA loan sales) growing $3.2 million
during the third quarter to $90.7 million on September 30, 1998. The
majority of the Bank's SBA loans are secured by real estate; however,
these loans are reported as commercial loans. SBA loans have the same
underwriting requirements as the Bank's other loans, they are sometimes
for longer terms (7 to 25 years) and have higher loan-to-value ratios
than the Bank typically accepts. The SBA loan program remains subject to
budget considerations at the Federal government level. Major changes to
the program could affect profitability and future SBA loan growth. The
guaranteed portion of SBA loans currently held by the Bank but which
could be sold in the secondary market increased 33.7% from $41.8 million
to $55.9 million when comparing September 30, 1997 to September 30,
1998.
The Bank continues to emphasize commercial and real estate lending. At
September 30, 1998, 46.5% of the loans held for investment were
commercial loans and 52.9% were real estate and construction loans,
compared to 48.0% and 51.0% respectively at December 31, 1997.
The Bank has increased the commercial and commercial real estate
portfolio through its reputation, in Sonoma and Marin Counties, as an
experienced business and real estate lender that facilitates the
successful negotiation of complex commercial loans. The Bank
maintains high credit qualifications with most real estate loans having
60-70% loan to value ratios. Management is aware of the risk factors in
making commercial and real estate loans and is continually monitoring
the local market place. A decline in real estate values and/or demand
could potentially have an adverse impact on the loan portfolio, and
on the financial condition of the Bank.
During the third quarter of 1997, the Bank added a residential
construction loan group. As a result, construction loan balances have
increased from $7.7 million at September 30, 1997 to $11.0 million at
year end to $20.7 million at September 30, 1998. The Bank offers
residential mortgages on a limited basis.
The Bank has a small portfolio of consumer loans which equaled 0.6% of
the total loan portfolio at September 30, 1998.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses equaled $2.9 million at September 30,
1998, compared to $2.5 million at December 31, 1997. At September 30,
1998, the allowance for loan losses equaled 1.5% of loans, net of the
guaranteed portion of SBA loans . The allowance for loan losses is
reviewed on a monthly basis, based upon an allocation for each loan
category, plus an allocation for any outstanding loans which have been
classified by regulators or internally for the "Watch List". Each loan
that has been classified is individually analyzed for the risk involved
with a specific reserve allocation assigned according to the risk
assessment.
At September 30, 1998, there were two loans on non-accrual for a total
of $155,000 of which $129,000 was collateralized by real estate and
$140,000 was guaranteed by the SBA. There were no loans past due 90 days
or more and still accruing interest. Loans past due 30 to 89 days
totaled $1,634,000 of which $1,566,000 was secured by real
estate and $354,000 was guaranteed by the SBA. On December 31, 1997,
the Bank had $318,000 in non-accrual loans, and $150,000 in loans past
due 90 or more days and still accruing interest.
There have been no loan charge offs and no loan recoveries during the
first nine months of 1998. The Bank has experienced very low credit
losses since its inception.
CAPITAL RESOURCES
Pursuant to regulations under the FDIC Improvement Act of 1991 (FDICIA),
five capital levels were prescribed as applicable for banks, ranging
from well-capitalized to critically under-capitalized. At September 30,
1998, the Bank was considered "well capitalized." The total risk-based
capital ratios were 10.7% for the Bank and 10.9% for the Corporation.
The Corporation declared a 2 for 1 stock split during August 1998. The
record date was September 30, 1998 and the new shares were distributed
on October 15, 1998. In March 1998 the Corporation declared a 5% stock
dividend with a record date of May 1, 1998 and distributed on May 15,
1998. This report has been adjusted to reflect the stock split and
stock dividend. During 1997 the Bank issued a 5% stock dividend to
shareholders of record on March 31, 1997.
YEAR 2000 COMPLIANCE
State of Readiness: The Bank is working to identify and mitigate the
potential impact of the Year 2000 on its computer systems. Year 2000
Readiness is defined as hardware, software and other date-sensitive
systems which execute correctly, regardless of the date on which they
are processing or the contents of the files that are being utilized.
The Bank uses a great number of such systems across its entire
operation. All of the Corporation's data processing is performed using
the Bank's computer systems.
Specifically, the Bank has undertaken a major project to ensure that its
systems will be capable of processing after the century date change.
There is a formal Year 2000 Project Plan in place. This project is
overseen by the Y2K Committee, which reports monthly progress to the
Board of Directors.
The initial phase of the project was to identify hardware, software,
vendors and correspondents. The Bank then decided which ones required
renovation or replacement and developed time frames to complete these
tasks. This process was largely completed by mid-1998. By the end of
1998, the Bank will have substantially completed the renovation phase
and begin Year 2000 testing by simulating certain key dates identified
by regulatory agencies. Testing and implementation should be completed
by the second quarter of 1999.
The Bank has started the testing phase of its Year 2000 Project, with
particular emphasis on systems determined Mission Critical. As part of
this phase, the Bank is working with external vendors to test their
systems as Year 2000 Ready. The testing phase also includes a new
release of the main bank software package by the end of 1998. In
addition, the Bank plans to test certain systems such as environmental,
vault doors and security systems by the end of 1998.
The Bank relies on third-party software and service providers for
substantially all of its Data Processing and does not use any
proprietary programs which are critical to operations. Therefore, it is
of primary importance that the Bank closely monitor the progress of its
primary software vendors toward Year 2000 Readiness.
The Bank has also contacted its major suppliers regarding their Year
2000 readiness. At this time, the Committee has not identified any
significant issues with identified suppliers.
The Bank has also identified customers with material loan and/or deposit
balances. They have been contacted personally and it has been requested
that they fill out a standard survey regarding their Year 2000 planning.
The Bank will then assess the overall risk to the company and include
the information in its Contingency Planning.
Costs to Address the Year 2000 Issue: The Bank has budgeted
anticipated expenditures of $50,000 in 1998 and 1999. The Bank estimates
that it has spent $3,000 to date during 1998 in connection with Year
2000 issues. These expenses may total $20,000 by the end of the
year. In addition, the Bank has had to reallocate internal resources to
address Year 2000 issues. The Bank does not anticipate that cost for
repair or replacement of non-compliant systems will be material. The
Bank also sees this as an opportunity to replace older technology with
systems that are more current.
The Bank has not completed the testing phase of its Plan, but currently
believes that costs of addressing it will not have a material adverse
impact of the Bank's financial position. However, if the Bank and third
party vendors on which it relies are unable to resolve any significant
issues that could arise during the testing phase in a timely manner, it
could result in a material financial risk to the Bank. To reduce that
risk as much as possible, the Bank plans to devote additional resources
if required to resolve any significant Year 2000 issues.
Risks Presented by the Year 2000 Issue: As testing continues and new
information is obtained, other systems may be identified as Year 2000
risks. If any critical third-party software vendors or service providers
fail to adequately address their Year 2000 issues, such failure could
have a material adverse effect on the Bank's business, financial
condition and operating results. Such adverse impacts could include the
requirement that the Bank pay significant overtime to employees to
centralizing operations and performing a limited number of transactions.
There is also a risk that the repairs made by the third party vendor
could render it incompatible with the Bank's operations and require that
a new vendor be identified, which could have a material adverse effect.
Contingency Plans: The Year 2000 Committee is currently in the process
of developing a Year 2000 Contingency Plan. The Bank completed a
Business Impact Analysis during the third quarter 1998 and the
Contingency Plan is expected to be completed by the end of the fourth
quarter 1998. The Bank will test the Contingency Plan as much as
possible without interrupting normal operations during 1999.
Despite the Bank's activities regarding the Year 2000 issue, there can
be no assurance that partial or total systems interruptions and/or costs
to update the necessary hardware and software would not have a material
adverse effect on the Bank's business, financial condition, results of
operations or business prospects. Moreover, due to conditions beyond
the Bank's control, such as power and telecommunications, there can be
no assurance that the Contingency Plans will be successful.
SCHEDULES
LOANS HELD FOR INVESTMENT
(In thousands)
September 30, 1998 December 31, 1997
Commercial Loans $118,230 $100,283
Real Estate Loans-Construction 20,700 10,982
Real Estate Loans-Other 113,873 95,513
Installment Loans 1,633 2,012
-------- --------
Total $254,436 $208,790
======== ========
Of the total loans due in more than one year, $42.3 million were at
fixed interest rates or had reached the loan's floor or ceiling rates
and $171.3 million were at adjustable interest rates at September 30,
1998. The loan portfolio has no foreign balances.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(In thousands)
Quarter Ended Nine Months Ended
September 30, 1998 September 30, 1998
Balance - Beginning of Period $2,779 $2,539
Provision for Loan Losses 120 360
Charge Offs 0 0
Recoveries 0 0
------ ------
Balance - End of the Period $2,899 $2,899
====== ======
There were two loans on non-accrual at September 30, 1998, totaling to
$155,000 of which $140,000 was guaranteed by the U.S. Government and
$129,000 was secured by real estate. There were no loans past due 90
days or more and still accruing interest.
GAP ANALYSIS
The following schedule represents interest rate sensitivity profile as
of September 30, 1998 of assets, liabilities and shareholder's equity
classified by earliest possible repricing opportunity or maturity date.
Non-rate
Over 3 Over 1 Sensitive
months year or
Through 3 through through 5 Over 5
Balance Sheet months 1 year years years Total
(in thousands)
-------- -------- -------- -------- -------
Assets
Fed funds sold $38,375 $38,375
Investment securities $2,003 $1,708 3,711
Loans (net of discounts) 133,538 $70,182 14,647 34,058 252,425
Non-interest-earning assets
(net of allowance for loan
losses) 12,601 12,601
-------- -------- -------- -------- -------
171,913 70,182 16,650 48,367 307,112
======== ======== ======== ======== =======
Liabilities & Shareholders
Equity
Time Deposits $100,000
and over $7,514 $27,390 $8,066 $2,759 $45,729
All other interest-bearing
deposits 107,605 72,715 15,220 2,585 198,125
Non-interest bearing deposits 40,890 40,890
Other Liabilities &
Shareholders' Equity 22,368 22,368
-------- -------- -------- -------- --------
115,119 100,105 23,286 68,602 307,112
======== ======== ======== ======== ========
Interest Rate
Sensitivity (1) 56,794 (29,923) (6,636) (20,235)
Cumulative Interest Rate
Sensitivity 56,794 26,923 20,235 0
-------- -------- -------- -------- -------
(1) Interest rate sensitivity is the difference between interest rate
sensitive assets and interest rate sensitive liabilities within the
above time frames.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None other than in the ordinary course of business.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits:
(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).
(27) (a) Financial Data Schedule
b. Reports on Form 8-K - None
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
NORTHERN EMPIRE BANCSHARES
Date: November 10, 1998
- ------------------------
/s/ Dennis R. Hunter /s/ Patrick R. Gallaher
- -------------------- -----------------------
Dennis R. Hunter Patrick R. Gallaher
Chairman of the Board Director & Chief Accounting Officer
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