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, 1999
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
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(Exact name of small business issuer as specified in its charter)
California 94-2830529
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(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)
(707)579-2265
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(Issuer's telephone number)
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 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
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 31, 1999: 3,559,763
Transitional Small Business Disclosure Format (check one): Yes No X
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (Unaudited)
(dollars in thousands)
September 30, December 31,
1999 1998
ASSETS
Cash and equivalents:
Cash and due from banks $ 10,413 $ 9,613
Federal funds sold 22,873 29,720
--------- ----------
Total cash and equivalents 33,286 39,333
--------- ----------
Investment securities
Available-for-sale 2,975 7,005
Restricted 1,278 1,731
Loans receivable, net 326,805 267,029
Leasehold improvements and equipment, net 732 859
Accrued interest receivable and other assets 6,549 6,167
--------- ---------
Total assets $ 371,625 $ 322,124
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $ 341,089 $ 295,969
Accrued interest payable and other liabilities 1,677 1,675
FHLB Advances 1,856 1,872
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Total liabilities 344,622 299,516
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Shareholders' equity:
Preferred stock, no par value;
authorized, 10,000,000 shares;
none issued or outstanding 0 0
Common stock, no par value;
authorized, 20,000,000 shares;
shares issued and outstanding,
3,559,763 on September 30,1999
and 3,475,197 on December 31, 1998 15,559 12,365
Accumulated after comprehensive income/(loss) (15) 4
Retained earnings 11,459 10,239
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Total shareholders' equity 27,003 22,608
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Total liabilities and shareholders' equity $ 371,625 $ 322,124
========= =========
See Notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1999 1998 1999 1998
---- ---- ---- ----
(dollars in thousands, except per share data)
Interest income:
Loans $7,298 $6,151 $20,490 $17,238
Federal funds sold and
investment securities 372 490 1,064 1,262
------ ------ ------- -------
Total interest income 7,670 6,641 21,554 18,500
------ ------ ------- -------
Interest expense 3,298 2,897 9,115 8,135
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Net interest income before
provision for loan losses 4,372 3,744 12,439 10,365
Provision for loan losses 240 120 560 360
------ ------ ------- -------
Net interest income after
provision for loan losses 4,132 3,624 11,879 10,005
Other income:
Service charges on deposits 106 93 341 269
Gain on sale of loans 83 235 403 567
Other 156 177 507 536
------ ------ ------- -------
Total other income 345 505 1,251 1,372
------ ------ ------- -------
Other expenses:
Salaries and employee benefits 1,242 998 3,519 3,041
Occupancy 197 176 580 541
Equipment 105 181 351 409
Advertising 108 102 301 266
Outside customer services 85 79 259 202
Shareholder and director expenses 70 73 220 204
Deposit and other insurance 54 50 159 144
Professional fees 48 41 113 120
Other 213 193 640 562
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Total other expenses 2,122 1,893 6,142 5,489
------ ------ ------- -------
Income before income taxes 2,355 2,236 6,988 5,888
Provision for income taxes 953 890 2,823 2,356
------ ------ ------- -------
Net income $1,402 $1,346 $ 4,165 $ 3,532
====== ====== ======= =======
Earnings per common share $ 0.39 $ 0.39 $ 1.18 $ 1.02
====== ====== ======= =======
Earnings per common share
assuming dilution $ 0.37 $ 0.38 $ 1.11 $ 0.98
====== ====== ======= =======
See Notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended September 30,
1999 1998
(dollars in thousands)
Cash flows from operating activities:
Net income $ 4,165 $ 3,532
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses and OREO losses 560 360
Depreciation, amortization and accretion 265 276
Net increase (decrease) in deferred loan
fees and discounts 530 168
Decrease (increase) in interest receivable
and other assets (382) (533)
Increase (decrease) in accrued interest
payable and other liabilities (14) 83
-------- --------
Net cash provided by in operating activities 5,124 3,886
-------- --------
Cash flows from investing activities:
Purchase of: Available for sale securities 0 (2,026)
Restricted securities (59) (69)
Maturities of: Held to maturity securities 0 1,500
Available for sale securities 4,011 3,977
Restricted securities 512 0
Net decrease (increase) in loans receivable (60,866) (45,517)
Purchase of leasehold improvements
and equipment, net (138) (382)
-------- --------
Net cash used in investing activities (56,540) (42,517)
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Cash flows from financing activities:
Net increase (decrease) in deposits 45,120 69,698
Payment of cash dividends (4) (5)
Stock options exercised 253 115
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Net cash provided by financing activities 45,369 69,809
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Net increase (decrease) in cash and
cash equivalents (6,047) 31,178
Cash and cash equivalents at beginning of year 39,333 16,182
-------- --------
Cash and cash equivalents at end of period $ 33,286 $ 47,360
======== ========
Other cash flow information
Interest paid $ 9,192 $ 8,043
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Income taxes paid $ 2,892 $ 2,333
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Additions to other real estate owned $ 238 $ 0
======== ========
See Notes to Consolidated Financial Statements
Northern Empire Bancshares and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1999
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, 1999 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 1998 Annual Report on Form 10-KSB. The results of operations
for the three and nine months ended September 30, 1999 are not necessarily
indicative of the operating results through December 31, 1999.
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.
For the three For the nine
months ended months ended
September 30, September 30,
1999 1998 1999 1998
Weighted average number of common
shares outstanding - Basic 3,559,763 3,468,333 3,535,936 3,465,201
Effect of dilutive securities:
Stock options 222,060 93,790 211,439 140,273
Weighted average number of common
shares outstanding - diluted 3,781,823 3,562,123 3,747,375 3,605,474
Net income $1,402,000 $1,346,000 $4,165,000 $3,532,000
Basic earnings per share $0.39 $0.39 $1.18 $1.02
Diluted earnings per share $0.37 $0.38 $1.11 $0.98
Note 3 - New and Pending Accounting Standards
See the Corporation's 1998 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 $371,625,000 at September 30, 1999 compared
to $322,124,000 at December 31, 1998. Cash and cash equivalents decreased $6.0
million since year end. Net loans increased $59.8 million since year end with
$24.2 million occurring in the third quarter. Deposits increased $45.1 million
since year end with $22.4 million occurring in the third quarter.
Net income for the first nine months of 1999 equaled $4,165,000 compared to
$3,532,000 for the comparable period last year, an increase of 17.9%. The third
quarter's net income of $1,402,000 increased 4.2% over the third quarter of
1998 when net income equaled $1,346,000. The higher profit resulted from
increases in net interest income due to loan growth (a larger volume of higher
yielding earning assets).
Net Interest Income
Net interest income of $4,372,000 for the third quarter of 1999 increased 16.8%
from $3,744,000 for the comparable period last year. This increase in net
interest income resulted from volume increases of $63.9 million in average
earning assets for the third quarter of 1999 compared to the third quarter of
1998. Average loans outstanding during that same period increased $69.1
million. Loans have the highest yield of interest earning assets. Average
interest bearing deposits for the third quarter increased $48.4 million over
the same period last year.
The net interest margin equaled 5.00% during the third quarter of 1999 compared
to an average margin for the year of 1998 of 5.23%. The yield on average loans
equaled 9.15% in the third quarter compared to 9.85% for the year of 1998. The
Bank's cost of funds declined from 4.89% for 1998 to 4.60% during the third
quarter of 1999. The decline in loan yields was caused by reductions in Prime
rate during September, October and November 1998 which totaled 75 basis points.
In July and August prime rate increased a total of 50 basis points. The SBA
loan portfolio totaling $91.0 million increased 25 basis points on July 1, 1999
and will increase 25 basis points on October 1, 1999.
Several factors impact the Bank's interest margin. The mix of loans influences
the overall yield on loans. During the third quarter of 1999, there was
significant growth in some loan categories. Average commercial real estate
loans increased $13.7 million, while SBA loans declined $300,000. Commercial
real estate loans have lower yield than SBA loans. The increase of $3.1 million
in average construction loan balances had a more favorable effect since that
loan category has the highest loan yield. Net interest margin is also affected
by the level of loans relative to deposits. The Bank's ratio of loans to
deposits increased from an average of 91.8% in 1998 to 96.4% during the third
quarter of 1999 which had a positive impact on net interest margin.
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
8.50% from March 26, 1997 where it remained until September 30, 1998 when rates
started to decline, falling to 7.75% on November 18, 1998. On July 1, 1999 and
on August 25, 1999 rates increased 25 basis points to 8.25%. Of the Bank's
loan portfolio totaling $332.8 million at September 30, 1999, $237.4 million or
71.3% of the loans are adjustable rate loans which have not reached a floor or
ceiling rate. Approximately $114.7 million are prime-based loans, of which
$22.2 million reprice immediately and $92.5 million reprice on a quarterly
basis. Approximately $140.1 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 4.56% on September 1999
compared to 4.90% on September 1998.
Interest expense increased from $2,897,000 in the third quarter of 1998 to
$3,298,000 in 1999. The major factor was the increase of $48.4 million in
average interest bearing deposits when comparing the third quarter of 1998 to
1999. The average cost of interest bearing deposits decreased from 4.91% to
4.60% when comparing the third quarter of last year to the third quarter of
this year.
Other Income
Other income is derived primarily from service charges on deposit accounts,
earnings on life insurance, SBA loan servicing, SBA loan sales and sales of
other real estate owned. Other income decreased to $345,000 from $505,000 when
comparing the third quarter of 1999 to the same period last year.
During the third quarter of this year, the Bank sold the guaranteed portion of
SBA loans totaling $2.2 million and recognized gains on those sales of $83,000.
During the third quarter of last year, the Bank sold the guaranteed portion of
SBA loans totaling $2.9 million and recognized gains on those sales of
$235,000. The premium income, which is market driven, has declined during
1999. The rate of SBA loan payoffs has shortened the average life of SBA loans,
and this negatively impacted the premiums offered. 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
servicing fees. Management considers the Bank's liquidity needs and
anticipates loan and deposit growth as a part of the decision to hold SBA
guaranteed loans versus selling them.
SBA servicing fees, which totaled $72,000 during the quarter, decreased from
$81,000 for the same period of 1998. This change reflects the decrease in the
pool of loans serviced, on which the Bank receives a servicing fee. The
serviced portfolio equaled $25.3 at September 30, 1999 compared to $31.2
million at the end of the third quarter of 1998.
Service charges during the quarter increased from $93,000 during the third
quarter of last year to $106,000 during the third quarter of this year. This
fluctuation is not unusual since service charges vary depending on the services
to customer and earnings credits provided from balances maintained by analysis
customers.
During 1999 there was one sale of other real estate owned (OREO) valued at
$284,000 at a loss of $2,000 recorded in September of 1999. During the third
quarter of 1998, the Bank sold OREO valued at $130,000 at a gain of $1,000.
Non-Interest Expenses
The Bank's non-interest expenses increased from $1,893,000 in the third quarter
of 1998 to $2,122,000 in the third quarter of 1999. This increase was
anticipated since the Bank has continued to grow at a rapid rate.
The Bank's largest expense category is salaries and benefits which increased
24.4% from $998,000 to $1,242,000 when comparing third quarter of 1998 to same
period of 1999. A new branch location was opened in October 1998 which added
five new staff positions. The record rate of loan and deposit growth has
resulted in higher incentive payments over the third quarter of 1998. The Bank
has also added staff to serve the needs of the larger volume of loan and
deposit customers. Personnel costs were also affected by annual salary
increases, changes in benefit costs and incentive compensation based upon loan
and deposit growth.
Occupancy expenses increased 11.9% when comparing the third quarter of 1998 to
1999; however, occupancy expenses have only increased 7.2% when comparing the
first nine months of 1998 to 1999. Occupancy expenses fluctuate in part due to
repairs. Occupancy expenses are expected to increase with the opening of the
new branch planned to open in Sebastopol, California in the fourth quarter.
Equipment costs equaled $105,000 during the third quarter of 1999 compared to
$181,000 for the comparable quarter last year. During the third quarter of
1998, the Bank incurred the majority of the costs associated with year 2000
readiness. These costs included the replacement of noncompliant software and
equipment and software testing charges.
Deposit and other insurance of $54,000 was comparable to the third quarter of
last year which equaled $53,000. Regulatory assessments and FDIC insurance
costs are expected grow 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 are expected to increase due to Bank growth
and additions to the Bank's insurance coverage.
Advertising which includes business development costs, varies depending on loan
and deposit promotions, and increased to $108,000 up from $102,000 in the third
quarter of 1998. Professional fees increased by $7,000 from the third quarter
of 1998 to $48,000 this quarter. Professional fees included the cost of a
third party review of our data processing functions. Both the advertising and
professional fee categories vary significantly based on activity throughout the
year. Outside customer services increased due to new customers using the Bank's
analysis system which added expense charges. Other expenses, which include
stationery & supplies, telephone, postage, courier, customer expenses, loan
expenses, dues and subscriptions and automobile costs, have increased due to
Bank growth.
Total non-interest expenses for the SBA lending department for the third
quarter were approximately $553,000 ($309,000 in personnel costs, $64,000 in
occupancy and equipment expenses, $38,000 in marketing/business development)
compared to $349,000 for the third quarter of 1998. At September 30, 1999, the
SBA loan portfolio (serviced portion and Bank's portion) equaled $116.3
million, of which $25.3 million has been sold and is being serviced. During
1999, the SBA lending staff played a significant role in increasing the Bank's
portfolio of commercial loans that are not guaranteed by the SBA.
Income Taxes
The effective tax rate was 40.5% for the third quarter of 1999. The provision
for the third quarter of 1999 was $953,000 versus $890,000 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 $33.3 million or 9.0% of
total assets at September 30, 1999, compared to $39.3 million or 12.2% of total
assets at December 31, 1998. Liquid assets were lower than normal at September
30, 1999 due to the rapid growth in loans at the end of the quarter. The Bank
has been and continues to offer special time deposits at slightly higher than
market rates to attract new deposits. The Bank also sold SBA loans and
participated loans in order to restore liquidity to normal levels. The Bank
sold SBA loans totaling $2.2 million, which will closed in October.
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, 1999, the Bank held
$58.5 million in SBA guaranteed loans which could be sold if liquidity was
needed.
At September 30, 1999, the Bank had unused federal funds lines of credit
totaling $11,000,000. 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 and loans, 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, 1999, the Corporation had non-interest and interest bearing
cash balances of $411,000, 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 1999 total deposits increased $22.4 million to
$341.1 million at September 30, 1999.
Money market rate deposits equaled $93.7 million at September 30, 1999. 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 into 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 $146.6 million at December 31, 1998 to
$179.5 million as of September 30, 1999. 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, 1999, non-interest bearing deposits equaled $46.9 million
compared to $42.4 million at December 31, 1998. 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.
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 $326.8 million at September 30,
1999 compared to $267.0 million at December 31, 1998, increasing 22.4%.
The SBA department continues to grow. SBA loans (gross loans which include the
portion which is guaranteed), net of loans sold and payoffs, increased $1.3
million during the third quarter to $91.0 million on September 30, 1999. 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 4.7% from $55.9 million to $58.5 million when comparing September 30,
1998 to September 30, 1999.
The Bank continues to emphasize commercial and real estate lending. At
September 30, 1999, 37.9% of the loans held for investment were commercial
loans and 61.6% were real estate and construction loans, compared to 43.4% and
55.9% respectively at December 31, 1998. The Bank has increased the commercial
and commercial real estate portfolio through its reputation, in Sonoma County
and the greater bay area of San Francisco, 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 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 $20.7 million at September 30, 1998 to $33.6 million at
September 30, 1999. The Bank offers residential mortgages on a limited basis.
The Bank has a small portfolio of consumer loans which equaled 0.5% of the
total loan portfolio at September 30, 1999.
Allowance for Loan Losses
The allowance for loan losses equaled $3.6 million at September 30, 1999,
compared to $3.0 million at December 31, 1998. At September 30, 1999, the
allowance for loan losses equaled 1.3% 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, 1999, there were four loans on non-accrual for a total of
$1,109,000 of which $195,000 was collateralized by real estate and $384,000 was
guaranteed by the SBA. There was one loan totaling $13,000 past due 90 days or
more and still accruing interest.
Loans past due 30 to 89 days totaled $1,146,000 of which $1,109,000 was secured
by real estate and $530,000 was guaranteed by the SBA. On December 31, 1998,
the Bank had $62,000 in non-accrual loans, and no loans past due 90 or more
days and still accruing interest.
During the third quarter there have been no loan charge offs or recoveries.
The Bank has charged off $19,000 during 1999. There were no loans charged off
and no loan recoveries during 1998. The Bank continues to have a low charge off
experience compared to industry standards.
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, 1999, the
Bank was considered "well capitalized." The total risk-based capital ratios
were 10.4% for the Bank and 10.5% for the Corporation.
The Corporation declared a 5% stock dividend on April 6, 1999 with a record
date of May 18, 1999. The financial statements have been adjusted to reflect
the impact of this stock dividend.
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Year 2000
The Bank has an ongoing program designed to ensure that its operational and
financial systems will not be adversely affected by year 2000 computer
programming problems. The Bank performs no in-house computer programming and
its computer systems and programs are designed and supported by companies
specifically in the business of providing such products and services. The
Bank's plan includes: evaluating existing hardware, software, vaults, alarm
systems, communication systems and other electrical devices; testing critical
application programs and systems, both internally and externally; establishing
a contingency plan and upgrading hardware and software as necessary. The Bank
has developed a Customer Awareness Plan to monitor and guide relationships with
depositors and borrowers. A Material Customer plan has been implemented to
assess the Y2K readiness among larger depositors and borrowers.
The initial phase was to assess and identify all internal business processes
requiring modification and to develop renovation plans as needed. This phase
was largely completed in mid-1998. The second phase was to begin testing
critical systems by simulating year 2000 data conditions. The Bank
implemented a formal testing plan, which set forth the specific testing
methodology guidelines and types of testing to be used, and set dates for which
accuracy testing is to be conducted. This phase has been completed and reviewed
by an independent third party. Testing will continue due to upgrades, program
patches to correct problems detected during testing and other system changes
during the year.
The Bank's primary focus had been to become Y2K ready in the following areas:
deposit data processing, wire transfer processing, loan data processing and
documentation, ACH and ATM processing, network communications, accounting and
various internal systems (voicemail, electronic mail, HVAC and office
equipment).
The Bank's Year 2000 strategy contains detailed steps for assessment of the
complexity of becoming Y2K compliant, including determining (1) the effect of
Y2K on the Bank's main computer system and on each sub-product used by each
department that interfaces with the main computer system, (2) hardware
requirements for all significant applications and whether new hardware needs
to be purchased, (3) whether the internal environmental systems are Y2K ready
and(4) whether the services provided by outside vendors with respect to the
payment system functions are Y2K compliant.
The Bank's primary data processing system (which consists of software that
manages loans, deposits and accounting) is provided to the Bank by ITI, a third
party vendor specializing in bank software. ITI upgrades their software with
the most recent upgrade occurring in December 1998. ITI has focused on Y2k and
has not had as many new software upgrade as they have had in previous years.
The Bank utilizes Unisys equipment which has proprietary software which has
been upgraded to be Y2K ready. The Bank upgraded its central processor, which
was Y2K compliant, in 1997 to prepare for the implementation of a computer
network which was installed in June 1998.
The Bank will incur certain costs associated with the testing and deemed
necessary to address Y2K compliance. These costs include the cost of the
internal testing that is being done, and the costs of any outside auditors or
other personnel that will be necessary to evaluate the results of the tests as
well as hardware and software replacement. The Bank currently estimates that
the cost of its Y2K compliance program will be approximately $85,000. The
expenditures are not expected to have a material impact on the Bank's results
of operations.
The Bank has developed contingency plans for year 2000 readiness. The
contingency plan addresses business resumption plans which respond to any
failures of core business processes at critical dates due to the Y2K problem.
This plan also includes liquidity contingency planning during the turn of the
century. The purpose of the plan is to establish a course of action to help it
resume core business processes in an orderly way in the event of a system
failure. This business resumption contingency planning is necessary because,
notwithstanding successful efforts to thoroughly implement Y2K ready systems,
the potential exists that systems will not operate as expected. The plan has
been developed in order to be implemented in a timely manner; however, there
can be no assurance that such contingency plans will be successful.
Based on the due diligence that the Bank has conducted to date, the Bank does
not expect that any of its major corporate customers will have Y2K problems
that will result in significant loan losses or a material reduction in deposits
to the Bank from those customers. The Bank will continue to monitor whether
any of its customers may encounter problems from the century date change.
Despite the Company's activities regarding the Y2K issue, there can be no
assurances that partial or total system interruptions and costs to update the
necessary hardware and software would not have a material adverse effect on the
Company.
SCHEDULES
LOANS HELD FOR INVESTMENT
(In thousands)
September 30, 1999 December 31, 1998
Commercial Loans $126,192 $118,395
Real Estate Loans-Construction 33,640 28,177
Real Estate Loans-Other 171,372 123,839
Installment Loans 1,626 1,644
-------- --------
Total $332,830 $272,055
======== ========
Of the total loans due in more than one year, $95.4 million were at fixed
interest rates or had reached the loan's floor or ceiling rates and $237.4
million were at adjustable interest rates at September 30, 1999. The loan
portfolio has no foreign balances.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(In thousands)
Quarter Ended Nine Months Ended
September 30, 1999 September 30, 1999
Balance - Beginning of Period $3,320 $3,019
Provision for Loan Losses 240 560
Charge Offs 0 19
Recoveries 0 0
------ ------
Balance - End of the Period $3,560 $3,560
====== ======
There were four loans on non-accrual at September 30, 1999, totaling
to $1,109,000 of which $384,000 was guaranteed by the U.S. Government and
$195,000 was secured by real estate. There was one loan for $13,000 which
was past due 90 days or more and still accruing interest.
GAP ANALYSIS
The following schedule represents interest rate sensitivity profile as of
September 30, 1999 of assets, liabilities and shareholder's equity classified
by earliest possible repricing opportunity or maturity date.
<TABLE>
<CAPTION>
Over 3 Non-rate
Months Over 1 year Sensitive or
Through 3 through through 5 Over 5
Months 1 year years years Total
<S> <C> <C> <C> <C> <C>
Balance Sheet
(in thousands)
Assets
Fed funds sold $22,873 $22,873
Investment securities $2,975 $1,278 4,253
Loans (net of discounts) 145,893 $132,351 21,762 30,358 330,364
Non-interest-earning assets
(net of allowance for loan losses) 14,135 14,135
-------- -------- -------- -------- --------
$168,766 $132,351 $24,737 $45,771 $371,625
======== ======== ======== ======== ========
Liabilities & Shareholders Equity
Time Deposits $100,000 and over $15,042 $32,273 $11,388 $58,703
All other interest-bearing deposits 118,914 73,666 26,652 $16,287 235,519
Non-interest bearing deposits 46,870 46,870
Other Liabilities &
Shareholders' Equity 30,533 30,533
-------- -------- -------- -------- --------
$133,956 $105,939 $38,040 $93,690 $371,625
======== ======== ======== ======== ========
Interest Rate Sensitivity (1) $34,810 $26,412 $(13,303) $(47,919)
Cumulative Interest Rate Sensitivity $34,810 $61,222 $47,919 0
</TABLE>
(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).
(e) Secretary's certificate of Amendment to the Bylaws of the Corporation
and revised Bylaws (filed as Exhibit (3)(e) to the Corporation's
Annual Report on Form 10-KSB for the Fiscal Year Ended December 31,
1997 and incorporated herein by this reference).
(27) (a) Financial Data Schedule
b. Reports on Form 8-K
Registrant filed a current report on Form 8-k on October 4, 1999, and filed
amendment number 1 to such report on October 7, 1999 with respect to the
change in registrant's certifying accountants.
SIGNATURES
In accordance with the requirements of the 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 12, 1999
- -----------------------
/s/ Dennis R. Hunter /s/ Patrick R. Gallaher
- -------------------- -----------------------
Dennis R. Hunter Patrick R. Gallaher
Chairman of the Board Director & Chief Accounting Officer
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 10413
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 22873
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 2975
<INVESTMENTS-CARRYING> 4253
<INVESTMENTS-MARKET> 4253
<LOANS> 330364
<ALLOWANCE> 3560
<TOTAL-ASSETS> 371625
<DEPOSITS> 341089
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1677
<LONG-TERM> 1856
15559
0
<COMMON> 0
<OTHER-SE> 11444
<TOTAL-LIABILITIES-AND-EQUITY> 371625
<INTEREST-LOAN> 20490
<INTEREST-INVEST> 1064
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 21554
<INTEREST-DEPOSIT> 9037
<INTEREST-EXPENSE> 9115
<INTEREST-INCOME-NET> 12439
<LOAN-LOSSES> 540
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 6142
<INCOME-PRETAX> 6988
<INCOME-PRE-EXTRAORDINARY> 6988
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4165
<EPS-BASIC> 1.18
<EPS-DILUTED> 1.11
<YIELD-ACTUAL> 5.13
<LOANS-NON> 1109
<LOANS-PAST> 1159
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 2268
<ALLOWANCE-OPEN> 3320
<CHARGE-OFFS> 19
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 3560
<ALLOWANCE-DOMESTIC> 3560
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 333
</TABLE>
