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, 1998
[ ] 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.
$27,101,000
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. $65,871,000, as of February
26, 1999.
State the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date: 3,335,244
shares of common stock as of February 26, 1999.
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.
TABLE OF CONTENTS
Part I
Item 1. Description of Business
Business of the Bank
Employees
Supervision and Regulation
Item 2. Description of Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Part II
Item 5. Market for Common Equity and Related Stockholder Matters
Item 6. Management's Discussion and Analysis or Plan of Operations
Item 7. Financial Statements
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
Part III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
Item 10. Executive Compensation
Item 11. Security Ownership of Certain Beneficial Owners and
Management
Item 12. Certain Relationships and Related Transactions
Item 13. Exhibits, Financial and Reports on Form 8-K
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
four 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, a branch office in west side of Santa Rosa 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
("Small Business Administration"), which may be sold in the secondary
market. The Bank does not offer trust services directly, and does not
presently intend to do so, but offers such services, where requested,
through its correspondent banks.
Within the Loan Department is a specialized group of SBA lenders. 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 (generally 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
recorded in 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. Certification as a
Preferred Lender gives the Bank a competitive advantage, as it is able
to provide a quick response to loan applications.
The Bank offered investment services through PrimeVest Financial
Services, Inc ("PrimeVest"). PrimeVest provides full-service stock and
bond brokerage services. The Bank's investment program was
administered by a Bank employee who is also a licensed registered
representative with PrimeVest. The Bank recently decided to discontinue
this service on Bank premises. Existing PrimeVest customers
will transact investment services directly with PrimeVest headquartered
in St. Cloud, MN via the telephone.
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, San Francisco, California 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 91 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
personalized and specialized services to its customers. The Bank's
promotional activities emphasize the advantages of doing business with a
locally owned, independent institution attuned to the particular needs
of the community.
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.
Forward-Looking Statements
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.
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, 1998 the Bank had 65 full-time and 15 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 Board has the authority to examine the Corporation periodically.
During 1997, the Board adopted a policy for risk-focused supervision of
small bank holding companies that do not engage in significant
non-banking activities. The focus of examinations under the new policy
will focus on whether the Corporation has in place systems to manage the
risks it takes on in its business. In analyzing risk, the Board will
look at the financial condition of the Corporation and the Bank,
management, compliance with laws and regulations, inter-company
transactions and any new or contemplated activities.
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 the condition that
the customer obtain some additional service from the Bank or the
Corporation, or refrain from obtaining such service from a competitor.
(a) Dividends Payable by the Corporation Holders of Common Stock of
the Corporation are entitled to receive dividends as and when declared
by the Board of Directors out of funds legally available therefor under
the laws of the State of California. Under California law, the
Corporation is prohibited from paying dividends unless: (a) the amount
of its retained earnings immediately prior to the dividend payment
equals or exceeds the amount of the dividend; or (b) immediately after
giving effect to the dividend (i) the sum of its assets would be at
least equal to 125 percent of its liabilities and (ii) its current
assets would be at least equal to its current liabilities, or, if the
average of its earnings before taxes on income and before interest
expense for the two preceding fiscal years was less than the average of
its interest expense for the two preceding fiscal years, at least equal
to 125 percent of its current liabilities.
The Board of Governors has advised bank holding companies that it
believes that payment of cash dividends in excess of current earnings
from operations is inappropriate and may be cause for supervisory
action. As a result of this policy, banks and their holding companies
may find it difficult to pay dividends out of retained earnings from
historical periods prior to the most recent fiscal year or to take
advantage of earnings generated by extraordinary items such as sales of
buildings or other large assets in order to generate profits to enable
payment of future dividends. Further, the Board of Governors' position
that holding companies are expected to provide a source of managerial
and financial strength to their subsidiary banks potentially restricts a
bank holding company's ability to pay dividends.
The Corporation's ability to pay dividends on its Common Stock is
subject to the rights of senior security holders and lenders, which will
include the holders of preferred stock in the future if preferred stock
is again issued. Dividend payments will also be dependent upon its
separate liquidity needs. See Item 6, "Management's Discussion and
Analysis of Financial Condition." In that regard, Federal and state
statutes, regulations and policies impose restrictions on the payment of
management fees and cash dividends by the Bank to the Corporation.
Information regarding the Company's cash dividend payment history can be
found in Item 5, "Market for Common Equity and Related Stockholder
Matters."
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.
In 1996, the OCC issued a community bank risk-assessment system, which
consists of examination procedures that focus on the various types of
risks that national banks face. The OCC now measures each individual
bank's exposure to certain risks, assesses the controls the bank has
adopted in response to the risks it faces and the measures it takes to
monitor those risks. The OCC evaluates nine categories of risk: credit,
interest rate, liquidity, price, foreign exchange, transaction,
compliance, strategic and reputation. These nine risks are measured and
the direction of the risk is also analyzed.
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.
Total Tier 1
Ratio Category Risk-Based Risk-Based Leverage
- -------------- ---------- ---------- --------
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
* 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.
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, 1998, 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 the certain corrective
actions and order certain limitations on the bank's activities if
necessary to carry out the purposes of the statute.
If an institution is categorized as being significantly
undercapitalized, or is undercapitalized and fails to submit a capital
plan, its banking regulator is required to take increasingly severe
enforcement actions against such institution. The regulator must
require recapitalization through a sale of stock or a merger, restrict
affiliate transactions and restrict the interest rates the bank may
offer on deposits, (unless it finds that doing so would not further the
purpose of the section). In addition, such an institution may not pay a
bonus to a senior executive officer or increase the pay of any executive
officer without the prior written approval of its federal regulator.
An institution that is critically undercapitalized is subject to
mandatory restrictions that are even more severe, and seizure within
time limits designated by statute. In general, the federal regulator is
required to seize an institution within 90 days of its becoming
critically undercapitalized, unless the regulator can document that
another course of action will better achieve the purposes of this
section. The FDIC is required to restrict the activities of a
critically undercapitalized institution, beyond the degree of
limitations specified above for institutions that are significantly
undercapitalized.
(c) Brokered Deposits. 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 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,
1998, 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,
1998:
Corporation Bank
Leverage capital ratio 7.2% 7.1%
Required leverage capital ratio 3.0% - 5.0%* 3.0% - 5%*
Total risk-based capital ratio 10.6% 10.5%
Required total risk-based capital ratio 8.0% 8.0%
Tier 1 risk-based capital ratio 9.4% 9.3%
Required tier 1 risk-based capital ratio 4.0% 4.0%
* Determined based on the regulators' evaluations.
Under the risk-based capital rules, 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 this requirement 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 Bank continues to grow with its present asset
composition, it may be required to raise additional capital.
The required 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, 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.
Regulatory restrictions and other information guidelines with respect to
the payment of dividends by the Bank are contained in Item 5, "Market
for Common Equity and Related Stockholder Matters.", below.
Impact of Monetary Policies
Banking is a business in which profitability depends on rate
differentials. In general, the difference between the interest rate
received by the Bank on loans extended to its customers and securities
held in the Bank's investment portfolio and the interest rate paid by
the Bank on its deposits and its other borrowings comprise the major
portion of the Bank's earnings. To the extent that the Bank is not able
to compensate for increases in the cost of deposits and other borrowings
with greater income from loans, securities and fees, the net earnings of
the Bank will be reduced. The interest rates paid and received by the
Bank are highly sensitive to many factors which are beyond the control
of the Bank, including the influence of domestic and foreign economic
conditions.
The earnings and growth of the Bank are also affected by the monetary
and fiscal policy of the United States government and its agencies,
particularly the Board. These agencies can and do implement national
monetary policy, which is used in part to curb inflation and combat
recession. Among the instruments of monetary policy used by these
agencies are open market transactions in United States Government
securities, changes in the discount rates of member bank borrowings and
changes in reserve requirements. The actions of the Board have had a
significant effect on lending by banks, investments and deposits, and
such actions are expected to continue to have a substantial effect in
the future. However, the nature and timing of any further changes in
such polices and their impact on the Bank cannot be predicted.
Public Interest Laws, Consumer and Lending Laws
In addition to the other laws and regulations discussed herein, the Bank
is subject to certain consumer and public interest laws and regulations
that are designed to protect customers in transactions with banks.
While the list set forth below is not exhaustive, these laws and
regulations include the Community Reinvestment Act, Truth in Lending
Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the
Expedited Funds Availability Act, the Equal Credit Opportunity Act, the
Fair Housing Act, the Real Estate Settlement Procedures Act, the Home
Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt
Collection Practices Act and the Right to Financial Privacy Act.
These laws and regulations mandate certain disclosure requirements and
regulate the manner in which financial institutions must deal with
customers when taking deposits, making loans, collecting loans and
providing other services. The Bank must comply with the applicable
provisions of these laws and regulations as part of its ongoing customer
relations. Failure to comply with these laws and regulations can
subject the Bank to various penalties, including but not limited to
enforcement actions, injunctions, fines or criminal penalties, punitive
damages to consumers and the loss of certain contractual rights.
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 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
questionnaires and information on use of toxic substances are 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
The Americans With Disabilities Act ("ADA") enacted by Congress, in
conjunction with similar California legislation, is having an impact on
banks and their cost of doing business. The legislation requires
employers with 15 of more employees and all businesses operating
"commercial facilities" or "public accommodations" to accommodate
disabled employees and customers. The ADA has two major objectives (1)
to prevent discrimination against disabled job applicants, job
candidates and employees and (2) to provide disabled persons with ready
access to commercial facilities and public accommodations. Commercial
facilities, such as the Bank, must ensure all new facilities are
accessible to disabled persons, and in some instances may be required to
adapt existing facilities to make them accessible, such as ATM's and
bank premises.
New and Pending Legislation
Certain legislative and regulatory proposals that could affect the
Corporation, the Bank and the banking business in general are pending or
have been introduced, before the United States Congress, the California
State Legislature, and Federal, state and local government agencies.
(a) ATM Fees. Legislation has been proposed in the past in the
Congress and the California legislature and measures are currently being
proposed in local jurisdictions to regulate the amount of ATM fees that
operators of ATMs may charge, and to further regulate the disclosure of
such fees. The Bank does not own or operate ATM machines.
(b) Banking Reform Bills. A new financial service reform bill was
introduced early in the 1999 session of the House of Representatives,
patterned on the Senate version which was considered last year but not
passed. A similar bill passed the House in 1998. The new Bill, H.R.
10, would repeal the Glass Steagall Act prohibitions on bank affiliation
with securities firms. It would allow bank affiliates to engage in
certain securities underwritings and dealing and distributions of mutual
funds. It expands bank powers by allowing them to engage in activities
'financial in nature' rather than be limited by the current standard,
'closely related to banking'. It would allow banks to underwrite and
broker insurance products, and requires the Federal Reserve to defer to
the State and Federal agencies on securities and insurance law issues.
It also requires a satisfactory CRA rating for a bank to be eligible for
new powers, and expands compliance with CRA requirements to other
financial companies created by H.R. 10. Similar legislation permitting
cross ownership of banks and commercial businesses and continuation of
the thrift charter is expected to be introduced in the Senate for
consideration this year.
(c) Expansion in Credit Union Membership. A broad rule has been
adopted by the National Credit Union Administration ('NCUA'), relaxing
limits of credit union membership. The new rule takes effect January 1,
1999. The NCUA will now approve credit unions with membership of more
than 300,000 residents with proof that they function as a community.
The effect is to substantially expand credit union membership and make
credit unions as tax exempt entities, serving credit needs of large
communities, more competitive to banks. Litigation attacking the new
rule is pending.
(d) Office of Thrift Supervision ('OTS') Expansion of Charters to
Insurance Industry. In 1998 the OTS granted its ninth charter for an
insurance company to operate a thrift or savings and loan subsidiary.
In this case the OTS approved the application of State Farm Mutual Auto
Insurance Co. to operate a savings and loan business at some 16,000
sites where State Farm has insurance agents. State Farm will offer
auto, home equity and mortgage loans both directly through agents and
through the mail. There have been 41 new thrifts approved by the OTS
since 1994 with 54 charter applications pending which is expected to
result in yet more competition for banks.
(e) Proposed 'Know Your Customer Rule'; Privacy. The 'Know Your
Customer' rule was proposed by the Federal Reserve to enforce the Bank
Secrecy Act, and requires bank management to determine the identity of
their customers and their customers' source of funds and then monitor
the accounts for unusual events. Suspicious events are then to be
reported to law enforcement authorities by the banks. The rule has been
widely criticized as requiring an additional expenditure of resources by
banks as well as requiring invasion of the privacy of customers. At the
same time, other regulators such as the OCC are proposing privacy rules
to prevent such information from being provided.
The 1996 Amendments to the Fair Credit Reporting Act allow a bank to
share customer information with its affiliates providing the bank's
customers are given the opportunity to 'opt out' by way of language
contained in a bank's loan applications, loan agreements and other
forms. California state law provides protection against furnishing
customer information to third parties (other than law enforcement
officials). It is not known whether the 'know your customer rule'
will be finally adopted, but it is expected that banks will be required
by bank regulators, including the OCC, as well as customers and
consumers to adhere to existing laws on privacy and to adopt privacy
policies.
(f) Interest on Business Checking. Legislation has again been
introduced during 1999 to lift the current ban on the payment of
interest on business checking accounts. Legislation lifting the ban on
paying interest on business checking accounts is expected to the
considered in 1999 in the Shelby-Mack Regulatory Relief Bill. The
adoption of this legislation would permit the Bank to compete more
directly for commercial deposits, but increase its costs of funds.
It is not known to what extent, if any, these proposals will be enacted
or remain in force or 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 or regulations may
have on the Bank's business. 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.
ITEM 2. Description of Properties
The Corporation and the Bank share common quarters at 801 Fourth Street,
in the central business district of Santa Rosa. The Corporation leases
a total of approximately 9,335 square feet of ground floor and second
floor office space at that location and sublets this area to the Bank.
The Corporation leases approximately 3,692 square feet of office space
at 6641 Oakmont Drive, Santa Rosa, where Highway 12 intersects with
Oakmont Drive, for a branch office of the Bank opened in 1989.
In May 1998, SBA and Commercial Lending and Loan Administration offices
were relocated to a building which is located less than a block away
from the main office at 815 Fifth Street, Santa Rosa. The Bank leases
8,047 square feet from Mr. James Ratto, a major shareholder of the
Corporation.
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."
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 1998.
Part II
ITEM 5. Market for Common Equity and Related Stockholder Matters
On February 26, 1999, the Corporation had 3,335,244 shares of common
stock outstanding, held by approximately 325 shareholders of record.
The directors and officers of the Corporation and the Bank hold 12.7%
and beneficially own 31.1% 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 33,352 shares in any three month period without such
registration.
As of February 26, 1999, the directors, officers and staff also have the
right to acquire 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 Mutual Securities, located in
Santa Rosa, and Van Kasper & Company, 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.
The volume information has been provided to the Corporation by Hoefer &
Arnet of transactions reported to NASDAQ and does not include privately
negotiated transactions. The prices provided by Mutual Securities 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 the stock split and stock dividends issued during 1998 and
stock dividend in 1997.
Bid Quotations for the Corporation's Common Stock
Quarter Ended Approximate
High Low Trading Volume
March 31, 1997 $9.63 $7.69 357,420
June 30, 1997 12.75 9.00 214,620
September 30, 1997 13.19 11.69 124,110
December 31, 1997 16.14 13.13 190,890
March 31, 1998 17.13 16.19 265,860
June 30, 1998 18.00 17.22 226,420
September 30, 1998 15.88 14.44 46,100
December 31, 1998 15.25 14.38 273,400
There has been an increase in the trading volume over the last two
years; 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 $19.50 and $20.00, respectively, on February 26,
1999.
Dividends
On August 25, 1998, the Corporation declared a two for one stock split
to shareholders of record on September 30, 1998. On March 31, 1998, the
Corporation declared a 5% stock dividend to shareholders of record on
May 1, 1998. On February 19, 1997, the Corporation declared a 5% stock
dividend to shareholders of record on March 31, 1997.
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, 1998, $10,327,000 of retained earnings of the Bank was available for
the payment of dividends under this requirement.
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, 1997 and
1998.
During 1998, total consolidated assets grew 37.8% to $322,124,000 at
December 31, 1998. Total consolidated assets grew 4.0% during 1997 to
$233,737,000 at December 31, 1997.
Total deposits increased 37.8% to $295,969,000 when comparing December
31, 1998 to December 31, 1997. For the year ended December 31, 1997,
total deposits increased 2.6% to $214,747,000.
Results of Operations
The Corporation's consolidated net income for the year ended December
31, 1998 was $4,765,000 as compared to $3,273,000 for the year ended
December 31, 1997, an increase of 45.6%. The Corporation's consolidated
net income for the year ended December 31, 1997, increased 41.9% over
the year ended December 31, 1996.
Net interest income before provision for loan losses increased 24.8%, or
$2,842,000, when comparing the year of 1998 to 1997. 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 1998 equaled 5.23%
compared to 5.22% in 1997. The interest margin equaled 5.31% in 1996.
See, "Net Interest Income."
The provision for loan losses decreased $170,000 in 1998 over 1997.
See, "Allowance for Loan Losses." Other income increased $299,000
primarily due to SBA loan sales. See, "Non-Interest Income." Operating
expenses increased by $866,000 primarily because of growth of the Bank.
A new branch office was opened, the lending staff moved to larger space
and a new computer network was installed during 1998.
When comparing 1997 to 1996 the provision for loan losses increased
$230,000 and other income decreased $217,000. Operating expenses
increased $309,000 during 1997 primarily due to increases in personnel
costs and the cost associated with foreclosed property and problem
loans.
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, 1998, net interest income before the
provision for loan losses totaled $14,296,000 as compared to $11,454,000
for the year ended December 31, 1997, representing an increase of 24.8%.
The majority of this increase results from the net margin earned on
growth in the loan portfolio, largely from the increase in SBA loans,
commercial real estate loans and construction loans. See, "Loan
Portfolio." During 1997, net interest income before the provision for
loan losses increased $2,222,000 or 24.1%, from $9,232,000 to
$11,454,000, primarily due to the net margin earned on growth in the
loan portfolio.
The Bank's net interest margin (expressed as a percentage, the yield on
average interest earning assets less the rate paid on average interest
bearing liabilities) moved from 5.31% in 1996 to 5.22% in 1997 and to
5.23% in 1998. Changes in market interest rates impact the Bank's net
interest margin. The Federal Reserve Board had held the Fed Funds and
Discount rate at the same level since February 1996; however, in
September, October and November of 1998, the Federal Reserve Bank
lowered rates reducing the Fed Funds rate to 4.75% and this discount
rate to 4.5%. The prime rate generally follows rate adjustments by the
Federal Reserve Bank and the prime rate declined from 8.25% on September
29, 1998 to 7.75% on November 18, 1998 where is has remained. The prime
rate was 8.25% at December 31, 1997 and 1996. 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 quarter 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 4.84% in December 1996 to 4.95% in December 1997 and decreased to
4.69% in December 1998. 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 increased during
1998, when it averaged 94.9%, as compared to 90.6% in 1997 and 87.9% in
1996. Changes in the mix of loans also impacts the Bank's interest
margin.
Interest income increased from $16.4 million in 1996 to $20.6 million in
1997 to $25.4 million in 1998. This is a direct result of growth in
loans. Average loans increased from $148.0 million in 1996 to $191.3
million in 1997 to $239.5 million in 1998. However, the yield on loans
declined to 9.85% in 1998 from 9.98% in 1997. The 13 basis point
decline during 1998 results primarily from the drop in prime rate during
the last quarter of 1998. The mix of loans also impacts the overall
yield on loans. During 1998, average balances of real estate loans,
which have a lower yield than other types of loans such as SBA loans,
increased $17.2 million thereby impacting the overall portfolio yield.
The Bank continues to experience increased competition for loans, which
has resulted in lower loan pricing in the market place, which may impact
the Bank's offering rates on new loans in the future.
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 loan fee income of $1,095,000 for the year ended
December 31, 1998 and $923,000 for the year ended December 31, 1997.
This fee income increased yields on average loans by 45 basis points in
1998 as compared to 48 basis points in 1997. Deferred loan fees are a
product of origination and commitment fees net of certain direct loan
origination costs. The deferred fee amounts are as follows: $1,353,000
as of December 31, 1998, and $1,143,000 as of December 31, 1997.
Deferred fees are netted against total loans in the balance sheet.
Discounts on the unguaranteed portion of SBA loans are recorded as an
asset 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, 1998, $654,000 was
recorded as discounts compared to $700,000 at December 31, 1997. 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 $12,000 in 1998 compared to $12,000 in 1997.
Interest expense increased 20.8% when comparing 1997 to 1998, 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, 1998 was
4.89%, versus 4.98% for the year ended December 31, 1997. Average
non-interest bearing deposits increased 27.2% in 1998, with most of the
Bank's growth being funded by time deposits. In 1997, 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 $94.0 million at the end of 1996 to $102.9
million at December 31, 1997 to $146.6 million at December 31, 1998.
During both 1997 and 1998, the Bank ran several time deposit campaigns
at rates slightly higher than its local competitors. These higher
priced deposits were used to fund the rapid growth in loans. The cost
of time deposits averaged 5.69% in 1998 compared to savings and money
market rate accounts which averaged 4.17%. Growth in time deposits
(highest cost), has a negative impact on the Bank's cost of funds and
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 1998. Balances held in Sonoma Investors Reserve
accounts fluctuated from $71.1 million at December 31, 1996 to $64.8
million at December 31, 1997 to $87.0 million at year end 1998. In
December 1996, the Bank received a short term deposit of approximately
$16 million, which were held in Sonoma Investors Reserve accounts for
approximately 30 days. This deposit increased the 1996 balance at year
end and the withdrawal of this deposit in 1997 was greater than other
increases during 1997. Average balances for all money market accounts at
the Bank were $59.2 million for 1996, $66.7 million for 1997 and $77.5
million for 1998. The rate offered on the Sonoma Investors Reserve
account is repriced on a weekly basis. During 1997 and 1998 the cost of
these funds has declined based upon the movement of the 90 day U.S.
Treasury Bill. 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
cost of funds on savings and money market accounts equaled 4.17% in 1998
compared to 4.41% in 1997.
The Bank's margin has been relatively stable during 1996, 1997 and 1998.
Changes in the mix of loans and deposits, changes in the ratio of
loans-to-deposits and market rates all impact the Bank's margin. During
1997, the Bank's cost of funds increased 0.02%, while the rate earned on
loans decreased 0.16% which negatively impacted income. The Bank's
average loans-to-deposits ratio increased from 87.9% in 1996 to 90.6% in
1997, this had a positive impact on net interest margin.
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.
AVERAGE BALANCE SHEET
Year Ended
December 31, 1998
(dollars in thousands)
Average Interest Average
Balance Income/Expense Yield/Rate
Certificates of deposit
with other banks $ 0 $ 0
Investments 5,660 332 5.87%
Federal funds sold 28,047 1,466 5.23%
Loans:
Commercial (including SBA loans) 113,108 11,357 10.04%
Installment loans to individuals 1,761 193 10.99%
Real estate - Construction 18,473 2,142 11.59%
Real estate - Other 106,207 9,909 9.32%
-------- ------- ------
Total Loans 239,549 23,601 9.85%
-------- ------- ------
Total earning assets 273,256 25,399 9.29%
-------
Non-earning assets:
Allowance for loan losses (2,765)
Deferred Loan Fees & Discounts (1,992)
Cash and due from banks 8,072
Other assets 6,181
--------
TOTAL ASSETS $282,752
========
Deposits:
Demand - interest bearing $12,608 $134 1.06%
Savings & money market 81,359 3,395 4.17%
Time certificates 132,938 7,568 5.69%
-------- ------- ----
Total interest bearing deposits 226,905 11,097 4.89%
Other Interest bearing liabilities 130 6 4.61%
-------- ------- ----
Total Interest bearing deposits &
liabilities 227,035 11,103 4.89%
-------
Non-interest bearing liabilities:
Non-interest bearing deposits 33,917
Other liabilities 1,426
Shareholders' equity 20,374
--------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $282,752
========
Net interest income $14,296
=======
Net interest margin 5.23%
=====
AVERAGE BALANCE SHEET
Year Ended
December 31, 1997
(dollars in thousands)
Average Interest Average
Balance Income/Expense Yield/Rate
Certificates of deposit
with other banks $1,292 $75 5.80%
Investments 7,360 422 5.73%
Federal funds sold 19,514 1,064 5.45%
Loans:
Commercial (including SBA loans) 95,682 9,894 10.34%
Installment loans to individuals 1,833 202 11.02%
Real estate - Construction 4,766 585 12.27%
Real estate - Other 89,011 8,403 9.44%
-------- ------- -----
Total Loans 191,292 19,084 9.98%
-------- ------- -----
Total earning assets 219,458 20,645 9.41%
-------
Non-earning assets:
Allowance for loan losses (2,146)
Deferred Loan Fees & Discounts (1,868)
Cash and due from banks 7,458
Other assets 5,547
--------
TOTAL ASSETS $228,449
========
Deposits:
Demand - interest bearing $11,258 $120 1.07%
Savings & money market 67,949 2,999 4.41%
Time certificates 105,207 6,072 5.77%
-------- ------- -----
Total interest bearing deposits 184,414 9,191 4.98%
Non-interest bearing liabilities:
Demand - non-interest bearing 26,649
Other liabilities 1,262
Shareholders' equity 16,124
--------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $228,449
========
Net interest income $11,454
========
Net interest margin 5.22%
=====
AVERAGE BALANCE SHEET
Year Ended
December 31, 1996
(dollars in thousands)
Average Interest Average
Balance Income/Expense Yield/Rate
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 (including SBA loans) 71,523 7,589 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 15,005 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%
Non-interest bearing liabilities
Demand - non-interest bearing 23,356
Other liabilities 991
Shareholders' equity 13,123
--------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $182,427
========
Net interest income $9,232
======
Net interest margin 5.31%
======
The following tables set forth the changes in net interest income due to
changes in interest rates and the volume of assets and liabilities
between years. Variances attributable to simultaneous rate and volume
changes are all allocated to volume change amount.
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST INCOME AND EXPENSE
1998 OVER 1997
(dollars in thousands)
Volume Yield/Rate Total
Increase/(decrease)in interest income:
Certificates of deposit
with other banks $(75) $ - $(75)
Investments (97) 7 (90)
Federal funds sold 465 (63) 402
Loans:
Commercial (incl. SBA loans) 1,802 (339) 1,463
Installment loans to individuals (8) (1) (9)
Real estate - Construction 1,682 (125) 1,557
Real estate - Other 1,623 (117) 1,506
------ ---- ------
Total 5,392 (638) 4,754
------ ---- ------
Increase/(decrease) in interest expense:
Deposits & other interest bearing liabilities:
Demand - interest bearing 14 - 14
Savings & money market 591 (195) 396
Time certificates 1,600 (104) 1,496
Other interest bearing liabilities - 6 6
------ ----- ------
Total 2,205 (293) 1,912
------ ----- ------
Increase/(decrease) in
net interest income $3,187 $(345) $2,842
====== ===== ======
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST INCOME AND EXPENSE
1997 OVER 1996
(dollars in thousands)
Volume Yield/Rate Total
Increase/(decrease) in interest income:
Certificates of deposit
with other banks $(208) $18 $(190)
Investments 69 12 81
Federal funds sold 253 (1) 252
Loans:
Commercial (incl. SBA loans) 2,498 (192) 2,306
Installment loans to individuals (56) (16) (72)
Real estate - Construction 278 71 349
Real estate - Other 1,638 (142) 1,496
------ ---- ------
Total 4,472 (250) 4,222
------ ---- ------
Increase/(decrease) in interest expense:
Deposits:
Demand - interest bearing 16 1 17
Savings & money market 422 37 459
Time certificates 1,637 (113) 1,524
------ ---- ------
Total 2,075 (75) 2,000
------ ---- ------
Increase/(decrease) in
net interest income $2,397 $(175) $2,222
====== ===== ======
<PAGE>
Non-Interest Income
Non-interest income is derived primarily from gains on sales of SBA
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, 1998 to December 31, 1997, non-interest
income increased 21.3% to $1,702,000, compared to $1,403,000 in 1997.
Gains on the sale of the guaranteed portion of SBA loans increased to
$619,000 in 1998 versus $265,000 in 1997. This increase in gains on
sales resulted from management's decision to sell a larger portion of
SBA loans. During 1998 the Bank sold SBA loans totaling $7,144,000,
compared to $3,959,000 in 1997.
SBA servicing fees decreased to $339,000 for 1998 compared to $392,000
for 1997. Service fee income is based on payments received, and
therefore, vary from year to year. During 1998, the Bank's average SBA
loan portfolio serviced was $31.5 million compared to $39.1 million in
1997, which reflects the impact of SBA loan payoffs. If the serviced
portfolio continues to decline, SBA servicing revenue will continue to
be negatively impacted.
There can be no assurance that the SBA program will continue to generate
significant amounts of other non-interest income in the future. The
Bank continues to experience 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 1998, service charges totaled $367,000 versus $346,000 in 1997.
Service charges vary depending upon the customers' uses of various Bank
services. With the growth in deposit customers the fee income also
increased.
Non-interest income also includes earnings on life insurance held for
directors and senior officers which totaled $105,000 in 1998 as compared
to $135,000 in 1997. The decline in income reflects adjustment to
interest accrual during 1998.
Discount brokerage services generated $72,000 in 1998 compared to
$67,000 in 1997. The costs associated with this service have
consistently exceeded the revenue generated. This service was well
received by Bank customers; however, due to the risk associated with
discount brokerage services it was determined that the Bank would no
longer offer this service effective January 1999.
During 1998, $1,000 in gain on sale of other real estate owned (OREO)
was recorded compared to $42,000 in 1997. See, "Other Real Estate
Owned."
Other non-interest income for 1997 totaled $1,403,000, compared to
$1,620,000 in 1996. The decline in gains on the sale of the guaranteed
portions of SBA loans, which totaled $265,000 in 1997 compared to
$567,000 in 1996 negatively impacted non-interest income, on SBA loan
sales totaling $3,959,000 in 1997 and $6,390,000 in 1996. SBA servicing
fees increased during 1997 to $392,000 compared to $379,000 in 1996.
Discount brokerage services added $67,000, before expenses, during its
second full year of operation. Service charges also increased $9,000
during 1997.
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, 1998,
non-interest expenses totaled $7,582,000, an increase of 12.9% over the
previous year. The following table outlines the components of
non-interest expense for the periods indicated:
(In thousands)
Year Ended December 31, 1998 1997 1996
Expense Item
Salaries & Employee Benefits $4,284 $3,762 $3,521
Occupancy 747 713 699
Equipment 521 368 315
Advertising/Business Development 299 318 336
Outside Customer Services 278 249 245
Director & Shareholder expenses 274 204 205
Deposit and Other Insurance 198 173 142
Professional Fees 151 147 185
Stationery & Supplies 148 146 161
Other 682 636 598
------ ------ ------
TOTAL $7,582 $6,716 $6,407
====== ====== ======
A portion of the 13.9% increase in salaries and benefits resulted from
staff increases associated with the opening of the new West College
Branch in the last quarter of 1998. During 1998 incentive compensation
increased due to increased loan production and deposit growth. Salaries
included increases for performance and promotions during the year. The
Bank also experienced staff growth in 1998 with the Bank's full time
equivalent (FTE) staff positions averaging 76 persons in 1998, compared
to 73 in 1997.
Occupancy costs were $747,000 in 1998 compared to $713,000 in 1997.
During May 1998 the Loan Administration personnel was relocated to a
larger space at 815 Fifth Street in Santa Rosa. In addition to the
moving costs, the Bank experiences annual increases in the rents charged
on most of their facilities.
Equipment expenses increased to $521,000 in 1998 as the Bank has
continued to upgrade computer technology by installing a network in the
Loan Administration and Finance Departments. This project required
purchasing personal computers for terminal users in the loan department.
The Bank installed a new mainframe in February 1998. In January 1999
the Bank expanded its computer network to the Windsor and Oakmont branch
offices and will add the Main branch during the first half of 1999. In
addition, the Bank provided for known expenses and costs associated with
Year 2000 project by accruing $50,000. Equipment costs are expected to
continue to increase during 1999.
Advertising and business development costs vary from year to year
depending on the various promotions that have occurred during the year.
These costs include promotion of various products (Telebanc, SBA
lending, Commercial lending and Deposit campaigns).
Outside customer services increased from $249,000 in 1997 to $278,000 in
1998. Analysis charges are a major expense included in this category.
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 $147,000 in 1997 to $151,000 in 1998.
The Bank's legal costs vary depending on the need to retain legal
assistance on problem loans, OREO, compliance issue and other issues.
During 1998 a new stock option plan was approved which increased legal
expenses. Other professional fees include accounting services, loan
review services, SBA audit fees and computer training.
Regulatory assessments have varied from $129,000 in 1995 to $55,000 in
1996 to $88,000 in 1997 to $97,000. 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 was charged a "Financing Corporation" (FICO) assessment
at the annual rate of $0.0128 per $100 of insured deposits. This cost
equaled $25,000 in 1997 and $26,000 in 1998. See, "Description of
Business-Supervision and Regulation-New and Pending Legislation."
Director and shareholder expenses increased from $204,000 in 1997 to
$274,000 in 1998. Director fees were increased effective January 1,
1998. See "Compensation of Directors." Shareholder services have also
increased and the Company's transfer agent has increased charges from
$8,000 in 1997 to $22,000 in 1998.
Other expenses increased 7.2% to $682,000 during 1998. Included in this
category are expenses related to loan costs (broker fees, appraisals,
etc.), problem loan and OREO expenses, charitable donations, seminars
and travel costs. During 1997, other expenses of $636,000 increased
6.4% over 1996.
Non-interest expenses are expected to increase in 1999 due to the
planned growth in the Bank.
The increase in non-interest expenses of 4.8% from the 1996 total of
$6,407,000 to $6,716,000 in 1997 was due primarily to staff incentives
associated with increased volume of loan and deposit activity. The
Bank's equipment cost were increasing due to adding and upgrading
personal computers within the Bank.
Loan Portfolio
The following table shows the composition of the Corporation's loan
portfolio, by type of loan, as of the dates indicated.
(In thousands)
December 31,
Type of Loan 1998 1997 1996 1995 1994
Commercial $118,395 $100,283 $84,969 $62,062 $38,688
Real Estate Construction 28,177 10,982 1,533 3,556 1,701
Real Estate Other 123,839 95,513 81,008 64,720 49,601
Installment Loans
to Individuals 1,644 2,012 2,218 2,702 2,965
-------- -------- -------- -------- -------
TOTAL $272,055 $208,790 $169,728 $133,040 $92,955
======== ======== ======== ======== =======
The table above illustrates the Bank's emphasis on commercial and real
estate lending. At December 31, 1998 and 1997 commercial loans
comprised 43.5% and 48.0%, respectively, of the Bank's total loan
portfolio. Construction and other real estate loans (combined)
comprised 55.9% and 51.0% 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 occurs the Bank shares
proportionally in the collateral supporting the loan with the SBA which
guarantees the loan. At December 31, 1998, the Bank held $125,108,000
in loans generated by the SBA department, of which $59,020,000 was
guaranteed by the SBA. At December 31, 1997, the Bank held $92,188,000
in loans generated by the SBA department, of which $46,712,000 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 $62,000,
of which $56,000 was guaranteed by the SBA, on nonaccrual status, as of
December 31, 1998. There were no SBA loan charge offs during 1998 or
1997.
The category entitled "Real Estate-Other" 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
1.1% of the total loan portfolio at December 31, 1998 compared to 2.1%
at December 31, 1997. 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 grew from $1,533,000 in 1996 to
$10,982,000 in 1997 to $28,177,000 in 1998. The Bank created a
construction loan group during 1997 to focus on construction loans
primarily for single family residences and commercial properties valued
at under $2,500,000 located in Northern California. 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 Bank'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. 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 1.0% of the
total loan portfolio at December 31, 1997 and 0.6% at December 31, 1998.
Personal lines of credit and overdraft protection are offered to
customers. 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, 1998. Loans are categorized by the maturity of the
final installment.
(In thousands)
Over 1 Year
1 year through Over 5
Or less 5 years Years Total
Commercial $13,182 $11,441 $93,772 $118,395
Real Estate -Construction 24,612 446 3,119 28,177
Real Estate -Other 9,260 17,788 96,791 123,839
Installment Loans 1,166 478 0 1,644
------- ------- -------- --------
TOTAL $48,220 $30,153 $193,682 $272,055
======= ======= ======== =========
Of the total loans due in more than one year at December 31, 1998,
$46,655,000 were at fixed interest rates, which includes loans currently
at their floor rate, and $177,180,000 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, 1998. SBA loans
are considered commercial loans for this analysis. Most of the SBA
loans are secured by real estate. The Bank has approximately $22.9
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.
(In thousands)
Over Over 1
3 Months Year
3 Months through through Over 5
or Less 1 Year 5 Years Years Total
Commercial $112,969 $2,378 $2,125 $923 $118,395
Real Estate -Construction 18,802 8,281 1,094 0 28,177
Real Estate -Other 59,047 1,724 3,517 59,551 123,839
Installment Loans 1,176 92 258 118 1,644
-------- ------- ------ ------- --------
TOTAL $191,994 $12,475 $6,994 $60,592 $272,055
======== ======= ====== ======= ========
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, 1998 and 1997 approximately 70% of the
Bank's loan portfolio was comprised of loans with adjustable rates
(excluding those which had reached their floors).
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 for
undisbursed commitments, plus an allocation for any outstanding loans
which have been classified by regulators or internally for the "Watch
List." Each loan that has been classified is individually analyzed for
the risk involved and an allowance provided according to the risk
assessment. In addition, management considers such factors as known
loan problems, historical loan loss experience, loan concentrations,
loan loss experience in the banking industry, evaluations made by 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 18.9% to $3,019,000 at December 31, 1998 compared to
$2,539,000 in 1997. The provision for loan losses for the year ended
December 31, 1998 was $480,000 as compared to $650,000 for the year
ended December 31, 1997. The increase in the allowance was based upon
the growth in the loan portfolio during the year. The ratio of
allowance to loans outstanding equaled 1.4% compared to 1.6% at December
31, 1997 and 1.4% at December 31, 1996.
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 1998 there were no loans charged-off and no loan recoveries.
During 1997, the Bank charged-off five loans (1 commercial, 2 real
estate and 2 consumer) totaling $222,000 and recovered $69,000 on real
estate loans.
The following table sets forth the changes in the allowance for loan
losses over the last five years and the relationship to loans
outstanding, net of the SBA guaranteed portion, at the end of those
periods.
<TABLE>
<CAPTION>
(dollars in thousands)
Year Ended December 31
ALLOWANCE FOR LOAN LOSSES: 1998 1997 1996 1995 1993
<S> <C> <C> <C> <C> <C>
Balance at Beginning
of Period $2,539 $2,042 $1,676 $1,421 $1,113
Provision for Loan Losses
Charged to Expense 480 650 420 250 280
Less Charge-Offs:
Commercial 0 48 38 0 0
Real Estate-Other 0 140 0 72 0
Consumer loans 0 34 24 30 16
Total Charge-offs 0 222 62 102 16
Recoveries:
Commercial 0 69 8 79 20
Real Estate - Other 0 0 0 24 24
Consumer 0 0 0 4 0
Total Recoveries 0 69 8 107 44
Net Charge-offs/(Recoveries) 0 153 54 (5) (28)
-------- -------- -------- -------- -------
Balance at the End
of the Period $3,019 $2,539 $2,042 $1,676 $1,421
======== ======== ======== ======== =======
Total Loans Outstanding at End of
Period-Net of SBA Guarantees $213,034 $162,077 $141,472 $118,716 $89,124
======== ======== ======== ======== =======
Ratio of Ending Allowance
to Ending Loans Outstanding-Net
of SBA Loan Guarantees 1.4% 1.6% 1.4% 1.4% 1.6%
======== ======== ======== ======== =======
AVERAGE TOTAL LOANS $239,549 $191,292 $148,025 $114,819 $90,341
======== ======== ======== ======== =======
Ratio of Net Charge-offs
to Average Loans Outstanding
During the Period 0.0% 0.079% 0.036% (0.004)% (0.031)%
========= ======== ======== ======== =======
</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.
(dollars in thousands) December 31, 1998 December 31, 1997
Category Amount % of Loans Amount % of Loans
Commercial $1,565 43.5% $1,312 48.0%
Real Estate -Construction 444 10.4 133 5.3
Real Estate -Other 959 45.5 1,021 45.7
Installment Loans 51 0.6 73 1.0
------ ----- ------ -----
TOTAL $3,019 100.0% $2,539 100.0%
====== ===== ====== =====
<TABLE>
<CAPTION>
(dollars in thousands) December 31, 1996 December 31, 1995 December 31, 1994
Category Amount % of Loans Amount % of Loans Amount % of Loans
<S> <C> <C> <C> <C> <C> <C>
Commercial $1,081 50.1% $788 46.7% $524 39.1%
Real Estate -Construction 66 0.9 166 2.7 117 1.9
Real Estate -Other 744 47.7 682 48.6 683 55.7
Installment Loans 151 1.3 40 2.0 97 3.3
------ ----- ------ ----- ------ -----
TOTAL $2,042 100.0% $1,676 100.0% $1,421 100.0%
====== ===== ====== ===== ====== =====
</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.
The following table sets forth accruing loans past due 90 days or more
and non-accrual loans as of the dates indicated. In 1997, the $150,000
in past due over 90 days was one loan which had matured and was in the
process of being renewed.
(dollars in thousands) December 31,
1998 1997 1996 1995 1994
Past due 90 days or more $0 $150 $0 $0 $0
Non-accrual 62 318 438 398 201
---- ---- ---- ---- ----
Total $62 $468 $438 $398 $201
==== ==== ==== ==== ====
Percent of Total Loans 0.0% 0.2% 0.3% 0.3% 0.2%
==== ==== ==== ==== ====
Impaired Loans $62 $468 $438 $398 $201
==== ==== ==== ==== ====
The amount of interest foregone on the loans on non-accrual at December
31, 1998 totaled approximately $12,000 for 1998 and $4,000 in interest
was collected on those loans (prior to those loans being placed on
nonaccrual) during the year.
On December 31, 1998, the Bank had $62,000 in non-accrual loans, of
which $62,000 was collateralized by real estate and $56,000 was
guaranteed by the SBA. As of December 31, 1997, the Bank had $318,000
in non-accrual loans, of which $294,000 was collateralized by real
estate and $40,000 was guaranteed by the SBA.
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, 1998, 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
During 1998, there were no foreclosures resulting in OREO properties.
The property held at December 31, 1997 was sold during 1998 at a gain of
$1,000.
The Bank held one property recorded at a fair market value of $130,000
at December 31, 1997. The Bank foreclosed with respect to real estate
collateral securing three loans and sold six OREO properties during
1997. The OREO sales resulted in gains totaling $42,000 during the
year.
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, 1998, deposits totaled $295,969,000, which was an
increase of 37.8% from December 31, 1997.
Non-interest bearing demand deposits totaled $42,413,000 at December 31,
1998 as compared to $30,092,000 at December 31, 1997. 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. The balances in this type of
account seem to vary and were higher than normal at the end of the year.
During 1998 the average balance for demand deposits was $33,917,000.
Time deposits increased $43.7 million or 42.4% in 1998. During both
1997 and 1998, the Bank offered highly competitive rates on time
deposits in order to fund growth in loans. Time deposits increased from
$93,973,000 at December 31, 1996 to $102,904,000 at December 31, 1997 to
$146,584,000 at December 31, 1998. This shift to time deposits which
bear a higher rate than other types of deposits, increased the Bank's
overall cost of funds. See, "Net Interest Income."
Money market deposits increased $22.2 million or 34.2% from December 31,
1997 to December 31, 1998. The Bank's Sonoma Investor Reserve account
is tied to the 90-day Treasury Bill and reprices on a weekly basis.
During 1994 through 1996 the rates offered on longer term time deposit
have exceeded the rate offered on the Sonoma Investors Reserve account,
and there was movement into time deposit unless immediate access to
funds was needed. During 1997 and 1998 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, 1998.
$100,000 and Over Less than $100,000
Amount Amount
(in 000's) Pct (in 000's) Pct
------------------ -------------------
Three Months or Less $15,027 31.1% $28,903 29.4%
3 to 6 months 10,173 21.1 28,218 28.7
6 months to 1 year 20,151 41.8 37,036 37.6
Over 1 year 2,891 6.0 4,185 4.3
------- ----- ------- -----
Total $48,242 100.0% $98,342 100.0%
======= ===== ======= =====
At December 31, 1998, certificates of deposit of $100,000 or more
constituted approximately 16.3% 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
The following table shows the book value of the Bank's investment
portfolio at December 31, 1998, 1997 and 1996.
December 31,
(in thousands) 1998 1997 1996
---- ---- ----
U.S. Treasury Securities $0 $1,499 $16,009
U.S. Government-Sponsored Agencies 7,005 3,498 0
Mortgage-Backed Securities 0 453 0
Federal Home Loan Bank Stock 1,602 1,511 0
Federal Reserve Stock 129 129 123
------ ------ -------
Total $8,736 $7,090 $16,132
====== ====== =======
Securities Pledged $625 $500 $500
====== ====== =======
The following table shows the yield of investments (at amortized cost)
by maturity ranges as of December 31, 1998. Federal Home Loan Bank and
Federal Reserve stock are excluded from this table.
(in thousands) Amount Yield
------ -----
One year or less $2,000 5.15 %
Over one year through 5 years 5,000 5.54
Over 5 years through 10 years 0
Over 10 years 0
------ ----
Total $7,000 5.42 %
====== ====
The Bank's investments in U.S. Treasury securities declined from
$16,009,000 at December 31, 1996 to $1,499,000 at the end of 1997 and
the Bank held no U.S. Treasury securities at the end of 1998. The Bank
had excess liquidity at the end of 1996 when the Bank received of a
large short term deposit of approximately $16 million. $10 million of
the funds from that deposit were invested in U.S. Treasury securities
with a maturity of January 2, 1997 at a yield of 4.16%. At maturity,
the funds were reinvested in Fed Funds Sold. The yield on average
investments equaled 5.73% during 1997 compared to 5.87% in 1998. See,
"Net Interest Income."
The Federal Home Loan Bank ("FHLB") stock was purchased during 1997.
Stock purchase is a requirement of establishing a borrowing
relationship. See, "Liquidity." The Bank receives stock dividends
quarterly based upon the earnings of the Federal Home Loan Bank Stock.
The Bank received an annualized yield of 6.2% during 1997 and 5.8%
during 1998. The Bank invested in mortgage-backed securities to qualify
for participation with the FHLB since there is a requirement that
participating Banks have a minimum percentage of its loan outstandings
in residential loan products. Since year end these securities have
matured. The Federal Reserve Bank stock has a yield of 6.0%.
Investments are carried at amortized cost or market value, depending on
whether they are held to maturity or available for sale. At December
31, 1998, $7,005,000 was classified as available for sale. At December
31, 1997, $1,499,000 was held as held-to-maturity and $3,951,000 as held
as available-for-sale per accounting definitions. The market value of
securities equaled $8,736,000 at December 31, 1998 and $7,090,000 at
December 31, 1997.
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 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 $39,333,000 or 12.2% of total assets at December 31,
1998 compared to $16,182,000 or 6.9% of total assets at December 31,
1997. During the third quarter of 1997, the Bank entered into an
arrangement with the Federal Home Loan Bank ("FHLB") for short term
secured borrowings. This additional source of liquidity justified
reducing the level of liquidity held in Cash and Fed Funds and the
Bank's liquidity guidelines were reduced. The liquidity level at
December of 1997 was below policy guidelines which was caused by a large
increase in the loan portfolio of $7.3 million at the end of the year.
During December of 1997, a deposit campaign was implemented to raise
liquidity and the ALCO committee approved the sale of $2 million in SBA
loans in January 1998. As a result of these actions the liquidity
position improved during January and came within policy guidelines by
January 5, 1998.
At December 31, 1998 and 1997 the Bank's ratio of loans-to-deposits was
91.8% and 97.2% respectively. Due to the high loan growth in December
1997, the loan-to-deposit ratio exceeded the policy guideline of 95% at
1997 year end. During January of 1998 the ratio of loans-to-deposits
declined and came within policy guidelines.
The Bank has two federal funds lines of credit totaling $9,000,000 with
two financial institutions. These lines are available on a short term
basis to meet cash demands that may arise. The Bank has also
established a borrowing relationship with the Federal Home Loan Bank, as
discussed above, which will provide a new source of funds for loan
growth and liquidity purposes. As of December 31, 1998, the Bank had
borrowed $1,872,000 from the FHLB to match fund fixed rate real estate
loans. At the end of 1997, the Bank had no advances outstanding from
the FHLB.
The Bank funded loan growth during 1998 and 1997 through increased
interest-bearing deposits (mainly time deposits) and liquidity.
Deposits increased during 1998 and 1997 largely due to deposit campaigns
which offered higher rates to attract new time deposits. This trend is
expected to continue in 1999.
The following table represents the Corporation's interest rate
sensitivity profile as of December 31, 1998. Assets, liabilities and
shareholders' equity are classified by the earliest possible repricing
opportunity or maturity date, whichever first occurs.
<TABLE>
Balance Sheet
(in thousands)
<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>
Assets
Fed funds sold $29,720 $29,720
Investment securities 0 2,001 5,004 1,731 8,736
Loans 191,994 12,475 6,994 60,592 272,055
Non-interest-earning
assets (net of allowance
for loan losses) 0 0 0 11,613 11,613
-------- ------- -------- -------- --------
$221,714 $14,476 $11,998 $73,936 $322,124
======== ======= ======== ======== ========
Liabilities & Shareholders Equity
Time Deposits $100,000
and over $15,027 $30,324 $434 $2,457 $48,242
Other interest-bearing
deposits and liabilities 130,486 65,254 4,161 7,285 207,186
Non-interest bearing
liabilities 0 0 0 42,413 42,413
Other Liabilities &
Shareholders' Equity 0 0 0 24,283 24,283
-------- ------- ------- -------- --------
$145,513 $95,578 $4,595 $76,438 $322,124
======== ======= ======= ======== ========
Interest Rate
Sensitivity(F1) $76,201 $(81,102) $7,403 $(2,502)
Cumulative Interest
Rate Sensitivity $76,201 $(4,901) $2,502 0
<FN>
<F1>
(1) Interest rate sensitivity is the difference between interest rate
sensitive assets and interest rate sensitive liabilities within the
above time frames.
</FN>
</TABLE>
The Bank is asset sensitive. In a declining interest rate environment
there is an immediate negative impact on the Bank's net interest margin,
since assets reprice to lower rates more quickly than liabilities. In a
raising interest rate environment, the Bank's earnings are positively
affected immediately. The Bank continually 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. In addition, the Federal Reserve Act prohibits the Bank from
making loans to its "affiliates", including the Corporation, unless
certain collateral requirements are met.
At December 31, 1998, the Corporation had non-interest and interest
bearing cash balances of $313,000, 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, 1998, 1997 and 1996:
Year Ended December 31, 1998 1997 1996
Return on Average Assets 1.7% 1.4% 1.3%
Return on Average
Shareholders' Equity 23.4% 20.3% 17.6%
Average Shareholders' Equity
as a Percent of Average Assets 7.2% 7.1% 7.2%
Dividend Payout Ratio N/A N/A N/A
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 has maintained a very low annual rate
during 1998 and 1997.
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 and the Corporation are considered "Well-Capitalized" under the
"risk-based" capital methodology. The Bank's leverage capital ratio was
7.1% of its total assets. The Bank's total risk-based capital ratio was
10.5% at December 31, 1998. The minimum acceptable level at December
31, 1998 was 8.0%. The Corporations leverage capital ratio was 7.2%,
with total risk-based capital equaling 10.6%, at December 31, 1998.
Income Taxes
The 1998 provision for income tax equaled $3,171,000. The overall
effective tax rate was 40.0% during 1998. See, "Item 7, Consolidated
Financial Statements, Note 6." The provision for federal income taxes
for 1997 was $2,218,000. The overall effective tax rate for 1997 was
40.4%.
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 also
developed a Customer Awareness Plan to monitor and guide relationships
with depositors and borrowers. In addition, 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 largely completed; however, testing will continue
due to upgrades and changes in systems 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 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
continually upgrades their software with the most recent upgrade
occurring in December 1998. 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
determinations 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. The Bank currently estimates that the
cost of its Y2K compliance program will be approximately $70,000. The
expenditures are not expected to have a material impact on the Bank's
results of operations.
Currently, the Bank is developing contingency plans for year 2000
readiness. The contingency plan will be completed by June 30, 1999 and
will address business resumption plans which respond to any failures of
core business processes at critical dates due to the Y2K problem. 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 being done
because, notwithstanding successful efforts to thoroughly implement Y2K
ready systems the potential exists that systems will not operate as
expected. The plan is being 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 incur 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.
ITEM 7. Financial Statements
Report of Independent Accountants
Financial Statements:
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Shareholders' Equity
and Comprehensive Income
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Northern Empire
Bancshares and Subsidiary
Report on Audits of Consolidated
Financial Statements
For the Years Ended December 31,
1998 and 1997
Report of Independent Accountants
February 11, 1999
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, 1998 and
1997, and the related consolidated statements of income, shareholders'
equity and comprehensive income 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, 1998 and 1997, and the results of its
operations and its cash flows for the years then ended, in conformity
with generally accepted accounting principles.
PricewaterhouseCoopers LLP
Northern Empire Bancshares and Subsidiary
Consolidated Balance Sheets
As of Decembe 31, 1998 and 1997
ASSETS 1998 1997
Cash and cash equivalents:
Cash and due from banks $9,613,000 $7,412,000
Federal funds sold 29,720,000 8,770,000
------------ ------------
Total cash and cash equivalents 39,333,000 16,182,000
------------ ------------
Investment securities:
Held-to-maturity 0 1,499,000
Available-for-sale 7,005,000 3,951,000
Federal Home Loan Bank stock, at cost 1,602,000 1,511,000
Federal Reserve Bank stock, at cost 129,000 129,000
Loans receivable, net 267,029,000 204,408,000
Leasehold improvements and equipment, net 859,000 683,000
Accrued interest receivable and other assets 6,167,000 5,374,000
------------ ------------
Total assets $322,124,000 $233,737,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $295,969,000 $214,747,000
Accrued interest payable and other liabilities 1,675,000 1,281,000
FHLB advances 1,872,000 0
------------ ------------
Total liabilities 299,516,000 216,028,000
------------ ------------
Commitments and contingencies (Note 10).
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,3,309,712 in 1998 and 3,110,138 in 1997
(retroactively stated for 2- for -1 stock split 12,365,000 9,778,000
Accumulated other comprehensive income(loss) 4,000 (1,000)
Retained earnings 10,239,000 7,932,000
------------ ------------
Total shareholders' equity 22,608,000 17,709,000
------------ ------------
Total liabilities and shareholders' equity $322,124,000 $233,737,000
============ ============
The accompanying notes are an integral part of these financial
statements.
<TABLE>
Northern Empire Bancshares and Subsidiary
Consolidated Statements of Income
As of December 31, 1998 and 1997
<CAPTION>
1998 1997
<S> <C> <C>
Interest income:
Loans $23,601,000 $19,084,000
Certificates of deposits in other financial institutions 0 75,000
Federal funds sold and investment securities 1,798,000 1,486,000
----------- -----------
Total interest income 25,399,000 20,645,000
Interest expense 11,103,000 9,191,000
----------- -----------
Net interest income before provision for loan losses 14,296,000 11,454,000
Provision for loan losses 480,000 650,000
----------- -----------
Net interest income after provision for loan losses 13,816,000 10,804,000
----------- -----------
Other income:
Service charges on deposits 367,000 346,000
Gain on sale of loans 619,000 265,000
Other 716,000 792,000
----------- -----------
Total other income 1,702,000 1,403,000
----------- -----------
Other expenses:
Salaries and employee benefits 4,284,000 3,762,000
Occupancy 747,000 713,000
Equipment 521,000 368,000
Outside customer services 278,000 249,000
Deposit and other insurance 198,000 173,000
Professional fees 151,000 147,000
Advertising 187,000 184,000
Other 1,216,000 1,120,000
----------- -----------
Total other expenses 7,582,000 6,716,000
----------- -----------
Income before income taxes 7,936,000 5,491,000
Provision for income taxes 3,171,000 2,218,000
----------- -----------
Net income $4,765,000 $3,273,000
========== ==========
Earnings per common share $1.44 $1.01
========== ==========
Earnings per common share assuming dilution $1.39 $0.98
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<TABLE>
Northern Empire Bancshares and Subsidiary
Consolidated Statements of Shareholders' Equity and Comprehensive Income
As of December 31, 1998 and 1997
<CAPTION>
Accumulated
Other
Common Stock Comprehensive Retained Comprehensive
Shares Amount Income Earnings Income Total
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 3,069,046 $9,677,000 $0 $4,661,000 $14,338,000
Comprehensive income:
Net income 3,273,000 $ [3,273,00 3,273,000
Other comprehensive income,
net of tax:
Unrealized losses on
securities net taxes
of $(677) ($1,000) (1,000)
-----------
Other comprehensive loss (1,000) (1,000)
-----------
Comprehensive income $ [3,272,000]
===========
Options exercised 41,092 101,000 101,000
Payout of fractional shares (2,000) (2,000)
----------- ----------- ----------- ----------- -----------
Balance, December 31, 1997 3,110,138 9,778,000 (1,000) 7,932,000 17,709,000
Comprehensive income:
Net income 4,765,000 $ [4,765,00 4,765,000
Other comprehensive income,
net of tax:
Unrealized gain
on securities net
taxes of $(3,475) 5,000 5,000
-----------
Other comprehensive income 5,000 5,000
-----------
Comprehensive income [4,770,000]
5% stock dividend 156,976 2,453,000 (2,453,000) 0
Options exercised 42,598 134,000 134,000
Payout of fractional shares (5,000) (5,000)
----------- ----------- ----------- ----------- -----------
Balance, December 31, 1998 3,309,712 $12,365,000 $4,000 $10,239,000 $22,608,000
=========== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial
statements.
<TABLE>
Northern Empire Bancshares and Subsidiary
Consolidated Statements of Cash Flows
As of December 31, 1998 and 1997
<CAPTION>
1998 1997
<S> <C> <C>
Cash flows from operating activities:
Net income $4,765,000 $3,273,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 480,000 650,000
Depreciation, amortization and accretion 380,000 320,000
FHLB stock dividend (90,000) (11,000)
Gain on sale of OREO (1,000) 0
Net increase (decrease) in deferred loan fees and discounts 164,000 (162,000)
Deferred income taxes (448,000) (216,000)
Increase in interest receivable and other assets (475,000) (184,000)
Increase in accrued interest payable and other liabilities 394,000 61,000
------------ ------------
Net cash provided by operating activities 5,169,000 3,731,000
------------ ------------
Cash flows from investing activities:
Purchase of:
Held-to-maturity securities 0 (16,343,000)
Available-for-sale securities (6,998,000) (6,977,000)
Proceeds from:
Maturities of held-to-maturity securities 1,499,000 24,500,000
Maturities of available-for-sale securities 3,953,000 3,043,000
Sale of available-for-sale securities 0 5,006,000
Proceeds from the sale of OREO 131,000 0
Net decrease in deposits in other financial institutions 0 3,368,000
Net increase in loans receivable (63,265,000) (39,164,000)
Purchase of leasehold improvements and equipment, net (561,000) (383,000)
------------ ------------
Net cash used in investing activities (65,241,000) (26,950,000)
------------ ------------
Cash flows from financing activities:
Net increase in deposits 81,222,000 5,512,000
Net increase in FHLB advances 1,872,000 0
Payment of cash dividends (5,000) (2,000)
Stock options exercised 134,000 101,000
------------ ------------
Net cash provided by financing activities 83,223,000 5,611,000
------------ ------------
Net increase (decrease) in cash and cash equivalents 23,151,000 (17,608,000)
Cash and cash equivalents at beginning of year 16,182,000 33,790,000
------------ ------------
Cash and cash equivalents at end of year 39,333,000 $16,182,000
============ ============
Other cash flow information:
Interest paid $10,994,981 $9,178,000
============ ============
Income taxes paid $2,852,500 $2,394,000
============ ============
Addition to other real estate owned 0 $227,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial
statements.
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 four 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
The Bank classifies and accounts for debt and equity securities as
follows:
HELD-TO-MATURITY - Debt securities that management has the positive
intent and ability to hold until maturity are classified as
held-to-maturity are carried at their remaining unpaid principal
balance, net of unamortized premiums or unaccreted discounts. Premiums
are amortized and discounts are accreted using the level interest yield
method over the estimated remaining term of the underlying security.
TRADING SECURITIES - Debt and equity securities that are bought and held
principally for the purpose of selling them in the near term are
classified as trading securities and reported at market value, with
unrealized gains and losses included in earnings. The Bank
held no trading securities during 1998.
AVAILABLE-FOR-SALE - Debt and equity securities that will be held for
indefinite periods of time, including securities that may be sold in
response to changes in market interest or prepayment rates, needs for
liquidity and changes in the availability of and the
yield of alternative investments are classified available-for-sale.
After amortization or accretion of any premiums or discounts, these
assets are carried at market value. Market value is determined using
published quotes as of the close of business. Unrealized gains and
losses are excluded from earnings and reported net of tax as a separate
component of stockholders' equity until realized.
Realized gains and losses on held-to-maturity and available-for-sale
securities are computed using the specific identification method using
amortized cost.
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 real estate 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.
In accordance with Statement of Financial Accounting Standards (SFAS)
No. 125, Accounting for Transfers and Services of Financial Assets and
Extinguishment of Liabilities, the value assigned to the right to
service the loan is based on its fair value relative to the loan as a
whole. To determine the fair value of servicing rights, the Company
used models which incorporated assumptions that market participants
would use in estimating future net servicing
income which included estimates of the cost of servicing per loan, the
discount rate and loan prepayment estimates. The Company amortizes the
servicing rights using the effective interest methods. The balance of
the servicing asset is included in other assets.
Allowance for Loan Losses
An allowance for loan losses is maintained at a level deemed appropriate
by management to provide for known 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.
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 is measured under one of three
prescribed 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.
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.
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.
Earnings Per Share
Earnings per share (EPS) amounts for the years ended December 31, 1998
and 1997 are shown in accordance with SFAS No. 128 Earnings per Share
which was effective for fiscal years ended after December 15, 1998 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.
The following is a reconciliation of the numerators and denominators of
the basic and diluted EPS computations for the years ended December 31,
1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
------------------------------------ ----------------------------------
Per Per
Income Shares Share Income Shares Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amounts
----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net income $4,765,000 $3,273,000
========== ==========
Basic EPS
Income available to
common stockholder $4,765,000 3,301,457 $1.44 $3,273,000 3,246,031 $1.01
========== ===== ========== =====
Effective of Dilutive
Securities
Stock options 118,302 138,004
---------- ----------
Diluted EPS
Income available to
common stockholders
plus assumed
conversion $4,765,000 3,419,759 $1.39 $3,273,000 3,384,035 $0.98
========== ========== ===== ========== ========== =====
</TABLE>
Comprehensive Income
On January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". This statement requires companies to classify
items of other comprehensive income by their nature in the financial
statements and display the accumulated other comprehensive income
separately from retained earnings and additional paid-in capital in the
equity section of the balance sheet.
Federal Home Loan Bank System
As a member of the Federal Home Loan Bank (FHLB), the Company is
required to maintain an investment in the capital stock of the FHLB.
The investment is carried at cost.
At December 31, 1998, the Company had advances from the FHLB in the
amount of $1,872,000. The advances have interest rates ranging from
5.56% to 5.63% and mature in 2008. The FHLB has a blanket lien based on
residential mortgage loans of approximately $9,000,000 at December 31,
1998 to collateralize these advances. At December 31, 1997, the
Company had no advances outstanding from FHLB.
Reclassifications
Certain amounts in the 1997 financial statements have been reclassified
to conform with 1998 classifications.
2. Investment Securities
The amortized cost and estimated market values of investment securities
at December 31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
1998
-----------------------------------------------
Unrealized Unrealized Market
Cost Gains Losses Value
------- ------- ------- -------
<S> <C> <C> <C> <C>
Available for sale:
U.S. Government Agency Securities $7,000,000 5,000 0 $7,005,000
---------- ---------- ---------- ----------
$7,000,000 5,000 $0 $7,005,000
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
1997
-----------------------------------------------
Unrealized Unrealized Market
Cost Gains Losses Value
------ ------ ------ ------
<C> <C> <C> <C> <C>
Available for sale:
U.S. Government Agency Securities $3,952,000 0 (1,000) $3,951,000
Held to maturity:
U.S. Treasury Securities 1,499,000 0 0 1,499,000
---------- ---------- ---------- ----------
$5,451,000 0 ($1,000) $5,450,000
========== ========== ========== ==========
</TABLE>
Investment securities with carrying value of $625,000 and $500,000 were
pledged to secure deposits and borrowings, as required by law at
December 31, 1998 and 1997, respectively.
During the year ended December 31, 1998, the bank did not sale
securities classified as available-for-sale. During the year ended
December 31, 1997, the bank sold one security, classified as available-
for-sale, for proceeds of $5,006,000 and recognized no gain or loss.
The amortized cost and estimated market value of investment securities
at December 31, 1998 by contractual maturity is as follows:
Amortized Market
Cost Value
Available-for-sale:
One year or less 2,000,000 2,001,000
Over one through five years 5,000,000 5,004,000
---------- ----------
$7,000,000 $7,005,000
========== ==========
3. Loans and Allowance for Loan Losses
Loans at December 31, 1998 and 1997 consisted of the following:
1998 1997
Commercial loans $118,395,000 $100,283,000
Consumer installment loans 1,644,000 2,012,000
Real estate loans:
Construction 28,177,000 10,982,000
Other 123,839,000 95,513,000
------------ ------------
272,055,000 208,790,000
Deferred loan fees and discounts (2,007,000) (1,843,000)
Allowance for loan losses (3,019,000) (2,539,000)
------------ ------------
$267,029,000 $204,408,000
============ ============
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, 1998.
A summary of activity in the allowance for loan losses is as follows:
1998 1997
Balance, beginning of year $2,539,000 $2,042,000
Provision for loan losses 480,000 650,000
Charge-offs 0 (222,000)
Recoveries 0 69,000
---------- ----------
Balance, end of year $3,019,000 $2,539,000
========== ==========
There were two loans totaling $62,000 and four loans totaling $318,000
on nonaccrual status as of December 31, 1998 and 1997, respectively.
Interest foregone on such loans totaled $12,000 in 1998 and $12,000 in
1997.
At December 31, 1998 and 1997, the recorded investment in loans for
which impairment has been recognized in accordance with SFAS No. 114, as
amended by SFAS No. 118, totaled $62,000 and $318,000, with a
corresponding valuation allowance of $4,000 and $54,000, respectively.
The average recorded investment in impaired loans in 1998 and 1997 was
$190,000 and $378,000, respectively. No interest income was recognized
on impaired loans in 1998 and 1997.
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, 1998 and 1997, the
Company serviced $28,699,000 and $33,893,000 in loans guaranteed by the
SBA of which the Company's retained interests 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, 1998 and 1997, loans
receivable included $54,654,000 and $43,988,000 of SBA loans which could
be sold in the future.
At December 31, 1998 and 1997 the Company serviced additional loans for
others totaling $6,850,000 and $8,395,000, respectively.
4. Leasehold Improvements and Equipment
Leasehold improvements and equipment consisted of the following at
December 31, 1998 and 1997:
1998 1997
Leasehold improvements $1,386,000 $963,000
Furniture and equipment 1,779,000 1,752,000
---------- ----------
Total 3,165,000 2,715,000
Less accumulated depreciation (2,306,000) (2,032,000)
and amortization
---------- ----------
Total $859,000 $683,000
========== ==========
Depreciation and amortization of approximately $375,000 and $320,000
were charged to expense for the years ended December 31, 1998 and 1997,
respectively.
5. Deposits
Deposits consisted of the following at December 31, 1998 and 1997:
1998 1997
Deposits:
Noninterest-bearing $42,413,000 $30,092,000
Interest-bearing:
Money market rate 87,035,000 64,842,000
Savings 5,389,000 3,823,000
Demand 14,548,000 13,086,000
Certificates of deposit 146,584,000 102,904,000
------------ ------------
$295,969,000 $214,747,000
============ ============
Certificates of deposits with balances of $100,000 or more totaled
$48,242,000 and $29,104,000 at December 31, 1998 and 1997, respectively.
Certificates of deposit have remaining maturities at December 31, 1998
and 1997 as follows:
1998 1997
Three months or less $43,931,000 $25,572,000
Over three through six months 38,393,000 22,721,000
Over six through twelve months 57,189,000 34,082,000
Over twelve months 7,071,000 20,529,000
------------ ------------
Total certificates of deposit $146,584,000 $102,904,000
============ ============
6. Income Taxes
The components of the provision for federal and state income taxes are
as follows:
1998 1997
Currently payable:
Federal $2,692,000 $1,784,000
State 927,000 650,000
---------- ----------
3,619,000 2,434,000
Deferred:
Federal (378,000) (132,000)
State (70,000) (84,000)
---------- ----------
(448,000) (216,000)
---------- ----------
Total $3,171,000 $2,218,000
========== ==========
A reconciliation of the statutory tax rates to the effective tax rates
is as follows:
1998 1997
Statutory federal tax rate 34.0 % 35.0 %
State tax, net of federal income tax effect 7.1 7.2
Other, net -1.1 -1.8
---- ----
40.0 % 40.4 %
==== ====
The components of deferred income tax assets net of liabilities as of
December 31, 1998 and 1997 are
as follows:
1998 1997
Deferred Deferred
Tax Assets Tax Assets
(Liabilities(Liabilities
Loan loss reserves $981,000 $810,000
Deferred compensation 198,000 140,000
Deferred loan fees 20,000 41,000
State taxes, net of federal effect 601,000 454,000
All others (73,000) (166,000)
---------- ----------
Total $1,727,000 $1,279,000
========== ==========
7. Stock Option Plan
The Company's nonqualifying stock option plans provide for granting of
stock options (up to 911,380 shares) to directors and officers to
purchase shares of the Company's stock. All options granted to
date may be purchased at a price not less than the fair market value on
the date the option was granted. Options vest over five years from the
date of grant. All options expire ten years from the
date of grant.
Statement of Financial Accounting Standards No. 123 (SFAS No. 123),
Accounting for Stock Based Compensation, is effective for transactions
entered into for fiscal years beginning after December 31, 1995, and
applies to awards made in fiscal years beginning after December 31,
1994. This statement defines a fair-value method of accounting for
stock-based compensation. As permitted by SFAS No.123, the Company
accounts for stock options under APB Opinion No. 25, under which no
compensation cost has been recognized. Prior to 1998, the Company made
no awards under its stock plans for which SFAS No. 123 was applicable.
As of December 31, 1998, the awards granted during the year remain
unvested, as such, pro forma net income and earnings per share data as
of if compensation cost for these plans had been determined consistent
with SFAS No. 123 would not differ from the reported amounts in the
Company's income statement.
A summary of the status of the Plan as of December 31, 1998 and 1997,
and changes during the years ending on those dates is presented below:
1998 1997
--------------------- ---------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
Outstanding at beginning of year $166,676 $3.02 $209,823 $3.01
Granted 757,500 14.63 0
Exercised (42,598) 3.02 (43,147) 2.35
-------- ------ -------- ------
Outstanding at end of year $881,578 $12.99 $166,676 $3.18
======== ====== ======== ======
Options exercisable at year-end $124,078 $166,676
======== ========
Weighted-average fair value of
options granted during the year $2.25 $0
======== ========
The following table summarizes information about the Plan's stock
options at December 31, 1998:
Options Outstanding Options Exercised
- ---------------------------------- ---------------------
Weighted-
Average Weighted- Weighted-
Number Remaining Average Number Average
Outstanding Contractual Exercise Exercisable Exercise
at 12/31/98 Life Price at 12/31/98 Price
38,702 2.7 years $2.73 38,702 $2.73
55,168 0.4 years 3.03 55,168 3.03
4,676 5.2 years 3.28 4,676 3.28
25,532 0.4 years 3.34 25,532 3.34
64,500 9.8 years 14.00 0 0.00
693,000 9.6 years 14.69 0 0.00
------- -------
881,578 8.9 years $13.01 124,078 $3.01
======= =======
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 for this plan for the years ended December 31, 1998
and 1997 totaled $186,000 and $157,000, 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,
1998 and 1997, the cash surrender value of these policies was
$1,990,000 and $1,900,000, respectively, which is included in other
assets.
9. Employee Benefit Plan
The Company has a 401(k) savings plan covering substantially all
employees of the Company. Under the provisions of the plan, employees
who elect to participate are allowed to make "deferred contributions"
(as defined in the Plan Agreement) of up to 15% of their annual salary
with a maximum of $9,500. In addition, the Company will make matching
contributions equal to 100% of each employee's elective deferral with a
maximum of $1,000 per employee. Contributions by the Company for the
year ended December 31, 1998 and 1997 amounted to $53,000 and $52,000,
respectively.
10. 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:
1998 1997
Balance, beginning of year $7,015,000 $6,075,000
Additions 4,914,000 10,336,000
Principal reductions (5,598,000) (9,396,000)
---------- ----------
6,331,000 7,015,000
========== ==========
The Company has entered into an operating lease for branch and office
facilities with a Director of the Company. Rental payments made under
this lease were $199,872 and $194,000 for the years ended December 31,
1998 and 1997, respectively. The Company has also entered into an
operating lease with a major shareholder of the Company for office
facilities. Rental payments made under this lease were $115,875 and $0
for the years ended December 31, 1998 and December 31, 1997,
respectively.
11. 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, 1998 were $1,396,000.
The future minimum noncancelable lease payments as of December 31, 1998
are as follows:
1999 $560,000
2000 547,000
2001 530,000
2002 540,000
2003 537,000
Thereafter 575,000
----------
$3,289,000
==========
Total rental expense for the years ended December 31, 1998 and 1997 was
$520,000 and $480,000, respectively.
12. Regulatory Capital Requirements
The Company and the Bank are 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 Company and 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 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 Company and 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, 1998, that the
Company and the Bank meet all capital adequacy requirements to which it
is subject.
<TABLE>
<CAPTION>
To be Well Capitalized
For Capital Under Prompt
Actual Adequancy Purposes Corrective Action Provisions
--------------------- ----------------------- ------------------------------
Amount Ratio Amount Ratio Amount Ratio
As of December 31, 1998(in thousands) (in thousands) (in thousands)
<S> <C> <C> <C> <C> <C> <C>
Total Capital (to Risk Weighted
Assets):
Consolidated $25,567 10.6%> $19,246 > 8.0%> $24,057 > 10.0%
Bank $25,239 10.5%> 19,223 > 8.0%> 24,029 > 10.0%
Tier 1 Capital (to Risk Weighted
Assets):
Consolidated $22,560 9.4%> 9,623 > 4.0%> 14,434 > 6.0%
Bank $22,234 9.3%> 9,612 > 4.0%> 14,417 > 6.0%
Tier 1 Capital (to Average Assets):
Consolidated $22,560 7.2%> 12,580 > 4.0%> 15,725 > 5.0%
Bank $22,234 7.1%> 12,580 > 4.0%> 15,725 > 5.0%
</TABLE>
As of December 31, 1998, 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.
13. Fair Values of Financial Instruments
Fair value estimates are determined as of a specific date in time
utilizing quoted market prices, where available, or various assumptions
and estimates. As the assumptions underlying these estimates change,
the fair value of the financial instruments will change. The use of
assumptions and various valuation techniques, as well as the absence of
secondary markets for certain financial instruments, will likely reduce
the comparability of fair value disclosures between financial
institutions. Additionally, the Bank has not disclosed highly
subjective values of other non-financial instruments. Accordingly, the
aggregate fair value amounts presented do not represent and should not
be construed to represent the full underlying value of the Company.
The methods and assumptions used to estimate the fair values of each
class of financial instruments are as follows:
Cash and Cash Equivalents
The carrying value of cash and cash equivalents approximates fair value
due to the relatively short-term nature of these instruments.
Investment Securities, Held to Maturity
Fair value of securities and investments is based on quoted market
prices. If quoted market prices are not available, fair values are
based on quoted market prices of comparable instruments.
Loans Receivable
In order to determine the fair values for loans, the loan portfolio was
segmented based on loan type, credit quality and repricing
characteristics. For certain variable rate loans with no
significant credit concerns and frequent repricings, estimated fair
values are based on the carrying values. The fair values of other loans
are estimated using discounted cash flow analyses. The discount rates
used in these analyses are generally based on origination rates for
similar loans of comparable credit quality. Maturity estimates of
installment loans are based on historical experience with prepayments.
Deposits
The fair values for deposits, subject to immediate withdrawal such as
interest and noninterest bearing, and savings deposit accounts, are
equal to the amount payable on demand at the reporting date (i.e., their
carrying amount on the balance sheet). Fair values for fixed-rate
certificates of deposits are estimated by discounting future cash flows
using interest rates currently offered on time deposits with similar
remaining maturities.
Off-Balance Sheet Instruments
The fair value of commitments to extend credit and standby letters of
credit is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counter parties.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
---------------------------- ----------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ------ ------ ------
<S> <C> <C> <C> <C>
Financial assets:
Cash equivalents and certificates
of deposits $39,333,000 $39,333,000 $16,182,000 $16,182,000
Investments securities 8,736,000 8,729,000 7,091,000 7,090,000
Loans receivable, net 267,029,000 268,326,000 204,408,000 212,002,000
------------ ------------ ------------ ------------
$315,098,000 $316,388,000 $227,681,000 $235,274,000
============ ============ ============ ============
Financial liabilities:
Deposits $295,969,000 $296,163,000 $214,747,000 $214,761,000
============ ============ ============ ============
Off-balance sheet financial instruments:
Commitments to extend credit 0 168,000 0 231,000
Standby letters of credit 0 0 0 0
============ ============ ============ ============
0 168,000 0 231,000
============ ============ ============ ============
</TABLE>
14. Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. To date, these financial instruments include commitments to
extend credit and standby letters of credit which involve elements of
credit and interest rate risk in excess of the amount recognized in the
statement of financial position.
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since many
of the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on
a case-by-case basis. The Company generally requires collateral or
other security to support commitments to extend credit.
Standby letters of credit are performance assurances made on behalf of
customers who have a contractual obligation to produce or deliver goods
or services or otherwise perform. Credit risk in these transactions
arises from the possibility that a customer may not be able to repay the
Bank if the letter of credit is drawn upon. As with commitments to
extend credit, the Bank evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if any, is
based on management's credit evaluation of the counter-party.
At December 31, 1998 and 1997 loan commitments totaled $30,658,000 and
$23,123,000, respectively and standby letters of credit totaled $168,000
and $80,000, respectively.
15. Comprehensive Income
The changes in the balances of accumulated other comprehensive income,
net of tax, are as follows:
Unrealized
Gain/Loss Accumulated
on Securities Other
Available- Comprehensive
For-Sale Income
Balance, December 31, 1996 $0 $0
Current period change (1,000) (1,000)
------ ------
Balance, December 31, 1997 (1,000) (1,000)
Current period change 5,000 5,000
------ ------
Balance, December 31, 1998 $4,000 $4,000
====== ======
16. Parent Company Only Condensed Financial Information
The condensed financial statements of Northern Empire Bancshares (parent
company only) as of December 31, 1998 and 1997, and for each of the two
years in the period ended December 31, 1998, are presented below:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Balance Sheets
Assets:
Cash and cash equivalents $313,000 $162,000
Investment in Sonoma National Bank 22,284,000 17,501,000
Other assets 51,000 86,000
----------- -----------
Total assets 22,648,000 17,749,000
=========== ===========
Liabilities and shareholders' equity:
Other liabilities 40,000 40,000
----------- -----------
Preferred stock, no par value; authorized, 10,000,000 shares;
none issued or outstanding
Common stock, no par value; authorized, 20,000,000 shares;
issued and outstanding 3,307,712 in 1998 and 3,110,138 in 1997
(retroactively stated for stock split) 12,365,000 9,778,000
Accumulated other comprehensive income (loss) 4,000 (1,000)
Retained earnings 10,239,000 7,932,000
----------- -----------
Total shareholders' equity 22,608,000 17,709,000
----------- -----------
Total liabilities and shareholders' equity $22,648,000 $17,749,000
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Statements of Income
Interest and other income $12,000 $16,000
Administrative expenses (24,000) (9,000)
Income taxes expense (1,000) 25,000
Equity in undistributed earnings of Sonoma National Bank 4,778,000 3,241,000
---------- ----------
Net income $4,765,000 $3,273,000
========== ==========
</TABLE>
<TABLE>
<CAPTION>
Statements of Cash Flows 1998 1997
<S> <C> <C>
Cash flows from operating activities:
Net income $4,765,000 $3,273,000
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Change in other assets 35,000 5,000
Change in other liabilities 31,000
---------- ----------
Total 4,800,000 3,309,000
Less equity in undistributed earnings of Sonoma National Bank (4,778,000) (3,241,000)
---------- ----------
Net cash provided by (used in) operating activities 22,000 68,000
---------- ----------
Cash flows from investing activities:
Capital contributed to Sonoma National Bank 0 (200,000)
---------- ----------
Net cash (used in) provided by investing activities 0 (200,000)
---------- ----------
Cash flows from financing activities:
Cash dividend paid (5,000) (3,000)
Stock options exercised 134,000 101,000
---------- ----------
Net cash provided by financing activities 129,000 98,000
Net increase (decrease) in cash and cash equivalents 151,000 (34,000)
Cash and cash equivalents:
Beginning of year 162,000 196,000
---------- ----------
End of year $313,000 $162,000
========== ==========
</TABLE>
ITEM 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
Not applicable.
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, 46
President & Chief Executive Officer President and Chief Executive Officer
and Director of the Bank of the Bank since February 1991.
Clement C. Carinalli 53
Director of the Corporation Retired CPA, local businessman,
and the bank rancher and real estate investor.
Patrick R. Gallaher, 53
Chief Accounting Officer of the
Corporation and Director of the Certified Public Accountant and local
Corporation and the Bank businessman; major shareholder in Oakmont
Developers, a Santa Rosa development
company.
William P. Gallaher, 48
Director of the Corporation Real Estate developer and investor;
and the Bank President of Oakmont Developers;
President of Gallaher Construction Company.
William E. Geary, 70
Director of the Corporation Senior Partner in Geary, Shea &
and the Bank O'Donnell, a Santa Rosa law firm.
Dennis R. Hunter, 56
Chairman of the Board of the Real estate investor and developer in
Corporation and Vice Chairman of Santa Rosa; principal in Investment
the Board of the Bank Development Fund, a venture capital fund.
James B. Keegan, Jr., 50
President & Director of the Partner in Keegan & Coppin Company,
Corporation and Chairman of the a Santa Rosa real estate brokerage
Board of the Bank and development firm, since 1976.
Robert V. "Buzz" Pauley, 54
Secretary/Treasurer of the Owner of Pauley Exports, Ltd.,
Corporation and Director of the Bank an exporter of California food and beverage
products to the Pacific Rim; commercial
properties manager; trader of futures and
options contracts in Chicago and other
international market exchanges.
David F. Titus, 46
Executive Vice President Executive Vice President & Senior Loan
Senior Loan Officer of the Bank Officer of the Bank since January, 1995.
Senior Vice President & Senior Loan
Officer of the Bank from August 1991 to
January, 1995.
JoAnn Barton, 45
Senior Vice President & Senior Senior Vice President and Senior
Operations Officer of the Bank Operations Administrator of the Bank since
March 1992; from November 1985 Vice
President and Senior Operations
Administrator of the bank.
Jane M. Baker 52
Senior Vice President & Senior Vice President and Chief Financial
Chief Financial Officer of the Bank Officer of the Bank since August 1995;
Vice President and Chief Financial
Officer of the Bank since August 1992.
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.
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 Corporation'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 executive officers of the Bank whose cash compensation exceeded
$100,000, for services rendered for the 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 $2,000 per month from the Bank for his services
in that capacity. All other executive officers of the Corporation are
considered outside directors of the Bank and, as such, they receive
directors' fees. See, "Compensation of Directors," below.
</TABLE>
<TABLE>
Summary Compensation Table
(dollars in thousands)
<CAPTION>
Long Term
Annual Compensation Compensation
Options All Other
Name and Principal Position Year Salary Bonus (No. of Shares) (1)
<S> <C> <C> <C> <C> <C>
Deborah A. Meekins, 1996 $133 $81 $39
President and Chief Executive 1997 141 110 51
Officer and Director of 1998 149 132 84,000 46
the Bank
David F. Titus, 1996 96 54 34
Executive Vice President and 1997 100 73 46
Senior Loan Officer of 1998 107 88 15,000 37
JoAnn Barton,
Senior Vice President and 1996 80 10 0
Senior Operations Officer of 1997 84 14 1
the Bank 1998 90 17 5,000 1
Jane Baker,
Senior Vice President and 1996 79 10 0
Chief Financial Officer of 1997 84 14 1
(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.
</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, 1998, the cash surrender value of these policies were $920,000,
which is included in other assets.
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 1997 or 1996, 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.
The Corporation's Board of Directors adopted a new stock option plan
which was approved by the shareholders at the May 19, 1998 shareholders
meeting. Options totaling 757,500 have been granted under this plan to
all directors of the Corporation and forty-one officers and employees of
the Bank. 148,500 of the options were granted to officers and employees
of the Bank, including the following senior officers:
Aggregated Year-End Option Values
December 31, 1998
Number of Unexercised
Securities Underlying Value of Unexercised
Options (No. of Shares)(1) Options (2)
Name Exercisable/Unexercisable Exercisable/Unexercisable
Deborah A. Meekins 24,688 / 84,000 $269,804 / ($75,750)
David F. Titus 2,548 / 15,000 $26,678 / ($3,750)
JoAnn Barton 4,974 / 5,000 $53,496 / ($1,250)
Jane Baker 2,128 / 5,000 $22,238 / ($1,250)
(1) Adjusted for stock dividends issued since date of the option grant.
(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,
1998.
Compensation of Directors
Outside Directors of the Bank (including directors who serve as
executive officers of the Corporation) receive director fees as follows:
$1,500 for each monthly board meeting attended, $500 per executive and
$250 per all other committee meetings attended. The Chairman of the
Board of the Bank receives a fee of $2,000 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.
Outside 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 1998, stock options
for 17,895 shares were exercised by directors, realizing a value of
approximately $452,000. Outside directors held on December 31, 1998
options for 703,516 shares, which options had an estimated value of
$441,000 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, 1998, the cash
surrender value of these policies was $1,072,000, 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, 1999.
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, 1999. 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.
Number of Shares
Name Beneficially Owned Pct
Clement C. Carinalli 147,012 (1) 4.4%
Patrick R. Gallaher 97,343 (2) 2.9
William P. Gallaher 66,670 (3) 2.0
William E. Geary 108,156 (4) 3.2
Dennis R. Hunter 255,588 (5) 7.7
James B. Keegan, Jr. 99,516 (6) 3.0
Deborah A. Meekins 45,256 (7) 1.4
Robert V. Pauley 177,850 (8) 5.3
All other officers as a group (17 people) 39,940 (9) 1.2
--------- ----
Directors and Officers as a group (25 persons) 1,037,331 31.1%
========= ====
(1) Including 17,034 shares which Mr. Carinalli has the right to
purchase upon exercise of outstanding options and 49,902 shares
held by members of his immediate family residing at his home.
(2) Including 14,115 shares held in Mr. P. Gallaher's IRA and 200
shares owned by a child living at home.
(3) Including 15,310 shares which Mr. W. Gallaher has the right to
purchase upon exercise of outstanding options, 18,506 shares held
in Mr. W. Gallaher's IRA and 10,200 shares which Mr. W. Gallaher
has the right to acquire.
(4) Including 16,220 shares which Mr. Geary has the right to purchase
upon exercise of outstanding options, 38,150 shares held in Mr.
Geary's profit sharing plan, 16,326 shares held in employee
pension and profit sharing plan of Geary, Shea & O'Donnell and
8,292 shares held in a trust account for which Mr. Geary serves as
trustee but does not have a beneficial interest.
(5) Including 75,000 shares held in the name of Kathrine Hunter, as
to which Mr. Hunter has voting rights, 20,000 shares owned with
Lois Rust and 160,588 shares held in trust accounts for which Mr.
Hunter serves as trustee but does not have a beneficial interest.
(6) Including 71,853 shares held by Keegan & Coppin Company, Inc.,
7,540 shares held by the Keegan & Coppin Profit Sharing Plan and
7,242 held in trust accounts for which Mr. Keegan is trustee or
held in accounts for the benefit of his minor children.
(7) Including 18,388 shares which Ms. Meekins has the right to
purchase upon exercise of outstanding options.
(8) Including 20,420 shares which Mr. Pauley has the right to purchase
upon exercise of outstanding options and 18,230 shares held by Mrs.
Pauley.
(9) Including 10,666 shares which officers have the right to purchase
upon exercise of outstanding options.
The following are the business addresses of the directors having
beneficial ownership of more than 5% of the Corporation's outstanding
shares.
Dennis R. Hunter, 2455 Bennett Valley Road, Santa Rosa, CA 95404
Robert V. Pauley, 120 "D" Street, Santa Rosa, CA 95404
ITEM 12. Certain Relationships and Related Transactions
The Corporation leased 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 $16,596 per
month in 1998. The total rental expenses on this lease for the year
ended December 31, 1998 was $200,000.
The Corporation leased the Oakmont Branch premises from Oakmont
Investments of which Patrick Gallaher, a director of the Corporation and
Bank, is a partner. During 1997, Oakmont Investments sold the building
and assigned the lease obligation to the new owner. The monthly rental
for the Oakmont Branch was $8,619 at December 31, 1998. Total rental
expense on this lease for the year ended December 31, 1998 was $103,000.
The Bank leased facilities for the loan department and some
administrative offices from Mr. James Ratto, a major shareholder of the
Corporation. The monthly rent was $12,875 per month at December 31,
1998. Total rental expense on this lease for the year ended December 31,
1998 was $116,000.
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, 1998, loans by the Bank to
directors, officers and their associates totaled approximately
$6,331,000, constituting 2.8% of total loans, 34.4% of the Bank's
shareholder's equity and 34.0% 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.
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) 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).
(d) 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).
(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)* 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).
(d)* 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).
(e)* 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).
(f)* 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).
(g)* 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).
(h)* 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).
(i)* 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).
(j)* 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).
(k)* 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).
(l)* 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).
(m)* 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).
(n) 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).
(o)* 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).
(p)* 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).
(q)* 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).
(r)* 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).
(s)* 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).
(t) 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 Form 10-QSB for the
Quarter ended September 30, 1996 and incorporated herein by
this reference).
(u) Lease for Loan and Administration Offices at 815 Fifth Street,
Santa Rosa, California, dated February 24, 1998 (filed as
Exhibit (10)(w) to the Corporation's Annual Report on Form
10-KSB for the Fiscal Year Ended December 31,1997 and
incorporated herein by this reference).
(v)* Indemnification Agreements between William P. Gallaher and
Northern Empire Bancshares (filed as Exhibit (10)(a) to the
Corporation's Quarterly Report on Form 10-QSB for the Quarter
Ended June 30,1998 and incorporated herein by this
reference).
(w)* Indemnification Agreements between Clement C. Carinalli and
Northern Empire Bancshares and Sonoma National Bank (filed as
Exhibit (10)(b) to the Corporation's Quarterly Report on Form
10-QSB for the Quarter Year Ended June 30, 1998 and
incorporated herein by this reference).
(x)* 1997 Stock Option Plan, as amended, and Stock Option Agreement
(filed as Exhibit (10)(b) to the Corporation's Quarterly Report
on Form 10-QSB for the Quarter Year Ended June 30, 1998 and
incorporated herein by this reference).
(y) Lease for West College Branch in G & G Market at 1211A West
College Avenue, Santa Rosa, California, dated June 30, 1998.
*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 1998 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 1999 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.
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 /s/ Dennis R. Hunter
------------------------------------
Dennis R. Hunter,
Chairman of the Board of Directors
Date March 22, 1999
By /s/ Patrick R. Gallaher
------------------------------------
Patrick R. Gallaher
Chief Accounting Officer/Director
Date March 22, 1999
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.
/s/ Dennis R. Hunter March 22, 1999
- ---------------------------------- Date-----------------------
Dennis R. Hunter
Chairman of the Board of Directors
/s/ James B. Keegan, Jr. March 22, 1999
- ---------------------------------- Date-----------------------
James B. Keegan, Jr.
President/Director
/s/ Patrick R. Gallaher March 22, 1999
- ----------------------------------- Date-----------------------
Patrick R. Gallaher,
Chief Accounting Officer/Director
/s/ Robert V. Pauley March 22, 1999
- ----------------------------------- Date-----------------------
Robert V. Pauley,
Secretary and Treasurer/Director
/s/ Clement C. Carinalli March 22, 1999
- ----------------------------------- Date-----------------------
Clement C. Carinalli,
Director
/s/ William P. Gallaher March 22, 1999
- ----------------------------------- Date-----------------------
William P. Gallaher,
Director
/s/ William E. Geary March 22, 1999
- ----------------------------------- Date-----------------------
William E. Geary,
Director
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 9613
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 29720
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 7005
<INVESTMENTS-CARRYING> 1731
<INVESTMENTS-MARKET> 8736
<LOANS> 270048
<ALLOWANCE> 3019
<TOTAL-ASSETS> 322124
<DEPOSITS> 295969
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1675
<LONG-TERM> 1872
0
0
<COMMON> 12365
<OTHER-SE> 10239
<TOTAL-LIABILITIES-AND-EQUITY> 322124
<INTEREST-LOAN> 23601
<INTEREST-INVEST> 322
<INTEREST-OTHER> 1466
<INTEREST-TOTAL> 25399
<INTEREST-DEPOSIT> 11103
<INTEREST-EXPENSE> 11103
<INTEREST-INCOME-NET> 14296
<LOAN-LOSSES> 480
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 7582
<INCOME-PRETAX> 4765
<INCOME-PRE-EXTRAORDINARY> 4765
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4765
<EPS-PRIMARY> 1.44
<EPS-DILUTED> 1.39
<YIELD-ACTUAL> 5.23
<LOANS-NON> 62
<LOANS-PAST> 1695
<LOANS-TROUBLED> 1695
<LOANS-PROBLEM> 1695
<ALLOWANCE-OPEN> 2539
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 3019
<ALLOWANCE-DOMESTIC> 3019
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 428
</TABLE>
G & G PROPERTIES
G & G CENTER
COMMERCIAL LEASE
1. PARTIES. This lease, dated as of this 30th day of June 1998 is
made by and between G & G Properties, a General Partnership (herein
called "Landlord") and Sonoma National Bank (herein called "Tenant").
2. PREMISES. Landlord does hereby lease to Tenant and Tenant hereby
leases from Landlord that certain space (herein called "Premises"),
having dimensions of approximately approx. 500 square feet of floor
area. The location of said Premises are delineated on Exhibit "A"
attached hereto and incorporated by reference herein. Said Premises are
located in the G & G Supermarket 1211 W. College Ave., City of Santa
Rosa, County of Sonoma, State of California. This Lease is subject to
the terms, convenants and conditions herein set forth and the Tenant
convenants as a material part of the consideration for this Lease to
keep and perform each and all of the said terms, convenants and
conditions by it to be kept and performed.
3. USE. Tenant shall use the Premises for full service banking and
related services and shall not use or permit the Premises to be used for
any other purpose without the prior written consent of the Landlord.
Tenant to have shared access of G & G Markets existing public address
system.
3A. Tenant to install a Sonoma National Bank sign on the front of
the G & G Market. The sign size and location subject to City and
Landlords approval prior to installation.
4. MINIMUM RENT.
4A. Tenant agrees to pay Landlord as Minimum Rent, without notice
or demand, the monthly sum of ($1,500.00 ) One-Thousand Five-Hundred &
no/100 Dollars, in advance on or before the first day of each and every
successive month during the specified term. The Rental shall commence
on the 1st day of September, 19 98 . The Premises are being leased as
subject to such incidental work as is to be performed by Tenant prior to
said date (this work, if any to be set forth in the attached Addendum
and in this latter event, the rental shall commence on said date only if
Tenant shall have completed said work.) Rent for any period which is
less than one month (1) shall be a prorated portion of the month of the
monthly installment herein based upon a thirty (30) day month. Said
rental shall be paid to Landlord, without deduction or offset, in lawful
money of the United States of America and at such place as Landlord may
from time to time designate in writing.
Rent shall be mailed to: G&G Properties phone 707 546-6877
Attn: Jodie Lau message 707 573-5905
1211 W. College Ave. Fax 707 575-5921
Santa Rosa, CA 95401
4B. MINIMUM RENTAL INCREASES. No CPI increases will be in effect
for the first 3 years of the lease. As set forth in 4A above shall be
increased if the Consumer Price Index--San Francisco Bay Area
Average--All Items (Index)--as published by the United States Department
of Labor's Statistics, increases over the base period index. The base
period Index shall be the Index for the calendar month which is four
months prior to the month in which rentals commence. The base period
Index shall be compared with the Index; the same calendar month for each
subsequent year (Comparison Month). In no event shall the Minimum Rent
be less than that set forth in 4A above. Should the Bureau discontinue
the publication of the above Index, or publish same less frequently, or
alter same in some other manner which reasonably reflects and monitors
consumer prices.
5. TERM. The lease term shall be TEN full years with three 5 year
options. The parties hereto acknowledges that certain obligations under
various articles hereof may commence prior to the Lease term, i.e.,
construction, hold harmless, liability insurance, etc,; and the parties
agree to be bound by these articles prior to commencement of the lease
term.
6. SECURITY DEPOSIT. Concurrently with Tenant's execution of this
lease, Tenant has deposited with the Landlord a sum of $1,500.00 as
security deposit. Said sum shall held by Landlord as security for the
faithful performance by Tenant of all the terms, convenants, and
conditions of this Lease to be kept and performed by Tenant during the
term thereof. If Tenant defaults with respect to any provisions of this
Lease, including, but not limited to the provisions relating to the
payment of rent, Landlord may (but shall not be required to) use, apply
or retain all or any part of this security deposit for the payment of
any rent or any other sum in default, or for the payment of any amount
which Landlord may spend or become obligated to spend by reason on
Tenant's default, or to compensate Landlord for any other loss or damage
which Landlord may suffer by reason of Tenant's default. If any portion
of said deposit is so used or applied Tenant shall, within five (5) days
after written demand therefor, deposit cash with Landlord in an amount
sufficient to restore the security deposit to its original amount and
Tenants failure to do so shall be a default under this Lease. Landlord
shall not be required to keep this security deposit separate from its
general funds, and Tenant shall not be entitled to interest on such
deposit. If Tenant shall fully and faithfully perform every provision
of this Lease to be performed by it, the security deposit or any balance
thereof shall be returned to Tenant (or, at Landlord's option, the last
assignee of Tenant's interest hereunder) within ten (10) days following
expiration of the Lease term. In the event of termination of Landlord's
interest in this Lease, Landlord shall transfer said deposit to
Landlord's successor in interest.
7. ADJUSTMENTS. COMMON AREAS.
I. In addition to the Minimum Rent provided in Article 4 hereinabove,
and commencing at the same time as any rental commences under this Lease
Tenant shall pay to Landlord the following items, herein called
Adjustments/Common Areas:
(a) All real estate taxes and insurance premiums on the
Premises, including and, building, and improvements thereon.
Said real estate taxes shall include all real estate taxes and
assessments that are levied upon and/or assessed against the
Premises, including any taxes which may be levied on rents. Said
insurance shall include all insurance premiums for fire, extended
coverage, liability, and any other insurance that Landlord deems
necessary on the Premises. Said taxes and insurance premiums
for purposes of this provision shall be reasonably apportioned
in accordance with the total floor area of the Premises as it
relates to the total floor area of the Shopping Center which is
from time to time completed as of the first day of each
calendar quarter (provided, however, that if any tenants in said
building or buildings pay taxes directly to any taxing authority
or carry their own insurance, as may be provided in their leases,
their square footage shall not be deemed a part of the floor
area).
(b)Tenant's portion of maintenance of the landscaping,
upkeep of the structures, painting, parking lot maintenance, and
other maintenance procedures essential to maintaining the center.
Common area charges are included in the minimum rent stated in
section 4A. above.
8. USES PROHIBITED. Tenant shall not do or permit anything to be done
in or about the Premises nor bring or keep anything therein which is not
within the permitted use of the premises which will in any way increase
the existing rate of or affect any fire or other insurance upon the
Building or any of its contents or cause a cancellation of any insurance
policy covering said Building or any part thereof or any of its
contents. Tenant shall not do or permit anything to be done in or about
the Premises which will in any way obstruct or interfere with the rights
of other tenants or occupants of the Building or injure or annoy them or
use or allow the Premises to be used for any improper, immoral, unlawful
or objectionable purpose; nor shall Tenant cause, maintain or permit any
nuisance in, or about the Premises. Tenant shall not commit or allow to
be committed any waste in or upon the Premises.
9. COMPLIANCE WITH LAW. Tenant shall not use the Premises, or permit
anything to be done in or about the Premises, which will in any way
conflict with any law, statute, ordinance or governmental rule or
regulation now in force or which may hereafter be enacted or
promulgated. Tenant shall, at its sole cost and expense, promptly
comply with all laws, statutes, ordinances and governmental rules,
regulations now in force or which may hereafter be in force and with the
requirements of any board of fire underwriters or other similar bodies
now or hereafter constituted relating to or affecting the condition, use
or occupancy of the Premises, excluding structural changes not related
to or affected by Tenant's improvements or acts. The judgment of any
court of competent jurisdiction or the admission of Tenant in any action
against Tenant, whether Landlord be a party thereto or not, that Tenant
has violated any law, statute, ordinance or governmental rule,
regulation or requirement, shall be conclusive of that fact as between
Landlord and Tenant.
10. ALTERATIONS AND ADDITIONS. Tenant shall not make or allow to be
made any alterations, additions or improvements to or of the Premises or
any part thereof without first obtaining the written consent of Landlord
and any alterations, additions or improvements to or of said Premises,
including, but not limited to, wall covering, paneling and built-in
cabinet work, but excepting movable furniture and trade fixtures, shall
at once become a part of the realty and belong to the Landlord and
shall be surrendered with the Premises. In the event Landlord consents
to the making of any alterations, additions or improvements to the
Premises by Tenant, the same shall be made by tenant at Tenant's sole
cost and expense. Upon the expiration or sooner termination of the term
hereof, Tenant shall, upon written demand by Landlord, given at least
thirty (30) days prior to the end of the term, at Tenant's sole cost and
expense, forthwith and with all due diligence, remove any alterations,
additions, or improvements made by Tenant, designated by Landlord to be
removed, and Tenant shall, forthwith and with all due diligence, at its
sole cost and expense, repair any damage to the premises caused by such
removal.
11. REPAIRS.
11A. By entry hereunder, Tenant shall be deemed to have accepted
the Premises as being in good sanitary order, condition and repair.
Tenant shall, at Tenant's sole cost and expense, keep the Premises and
every part thereof in good condition and repair including without
limitation, the maintenance, replacement and repair of any storefront,
doors, windows casements, glazing, heating and air-conditioning system
(when there is an air-conditioning system). Tenant shall obtain a
service contract for repairs and maintenance of said system, said
maintenance contract to conform to the requirements under the warranty,
if any, on said system), plumbing, pipes, electrical wiring and
conduits. Tenant shall, upon the expiration or sooner termination of
this Lease hereof, surrender the Premises to the Landlord in good
condition, broom clean, ordinary wear and tear and damage from causes
beyond the reasonable control of Tenant excepted. Any damage to
adjacent premises caused by Tenant's use of the Premises shall be
repaired at the sole cost and expense of Tenant.
11B. Notwithstanding the provisions of Article 11A herein- above,
Landlord shall repair and maintain the structural portions of the
Building, including the exterior walls and roof, unless such maintenance
and repairs are caused in part or in whole by the act, neglect, fault or
omission of any duty by the Tenant, its agents, servants, employees,
invitee, or any damage caused by breaking and entering, in which case
Tenant shall pay to Landlord the actual cost of such maintenance and
repairs. Landlord shall not be liable for any failure to make such
repairs or to perform any maintenance unless such failure shall persist
for an unreasonable time after written notice of the need of such
repairs or maintenance is given to Landlord by Tenant. Except as
provided in Article 25 hereof, there shall be no abatement of rent and
no liability of Landlord by reason of any injury to or interference with
Tenant's business arising from the making of any repairs, alterations or
improvements in or to any portion of the Building or the Premises or in
or to fixtures, appurtenances and equipment therein. Tenant waives the
right to make repairs at Landlord's expense under any law, statute or
ordinance now or hereafter in effect.
12. LIENS. Tenant shall keep the Premises and the property in which
the Premises are situated free from any liens arising out of any work
performed, materials furnished or obligations incurred by or on behalf
of Tenant. Landlord may require, at Landlord's sole option, that Tenant
shall provide to Landlord, at Tenant's sole cost and expense, a lien and
completion bond in an amount equal to one and on-half (1 1/2) times the
estimated cost of any improvements, additions, or alterations in the
Premises which the Tenant desires to make, to insure Landlord against
any liability for mechanics' and materialman's liens and to insure
completion of the work.
13. ASSIGNMENT AND SUBLETTING. Tenant shall not either voluntarily, or
by operation or law, assign, transfer, mortgage, pledge, hypothecate or
encumber this Lease or any interest therein, and shall not sublet the
said Premises or any part thereof, or any right or privilege appurtenant
thereto, or allow any other person (the employees, agents, servants and
invitees, of Tenant excepted) to occupy or use the said Premises, or any
portion thereof, without first obtaining the written consent of
Landlord, which consent shall not be unreasonably withheld. A consent
to one assignment subletting, occupation or use by any other person
shall not be deemed to be a consent to any subsequent assignment,
subletting, occupation or use by another person. Consent to any such
assignment or subletting shall in no way relieve Tenant of any liability
under this Lease. Any such assignment or subletting without such shall
be void, and shall, at the option of the Landlord, constitute a default
under the terms of this Lease.
In the event that Landlord shall consent to a sublease or
assignment here under, Tenant shall pay Landlord reasonable fees, not to
exceed One Hundred and No/100ths ($100.00) Dollars, incurred in
connection with the processing of documents necessary to giving of such
consent.
14. HOLD HARMLESS. Tenant shall indemnity and hold harmless Landlord
against and from any and all claims arising from Tenant's use of the
Premises or from the conduct of its business or from any activity, work,
or other things done, permitted or suffered by the Tenant in or about
the Premises, and shall further indemnify and hold harmless Landlord
against and from any and all claims arising from any breach or default
in the performance of any obligation on Tenant's part to be performed
under the terms of this Lease, or arising from any act or negligence of
the Tenant, or any officer, agent, employee, guest, or invitee of
Tenant, and from all costs, attorney's fees, and liabilities incurred in
or about the defense of any such claim or any action or proceeding
brought thereon and in any case any action or proceeding be brought
against Landlord by reason of such claim, Tenant upon notice from
Landlord shall defend the same at Tenant's expense by counsel reasonably
satisfactory to Landlord. Tenant, as a material part of the
consideration to Landlord, hereby assumes all risk of damage to property
or injury to persons in, upon or about the Premises, from any cause
other than Landlord's negligence; and Tenant hereby waives all claims in
respect thereof against Landlord. Tenant shall give prompt notice to
Landlord in case of casualty or accidents in the Premises. Landlord or
its agents shall not be liable for any loss or damage to persons or
property resulting from fire, explosion, falling plaster, steam, gas,
electricity, water or rain which may leak from any part of the building
or from the pipes, appliances or plumbing works therein or from the
roof, street or subsurface or from any place resulting from dampness or
any other cause whatsoever, unless caused by or due to the negligence of
the Landlord or its agents, servants or employees. Landlord or its
agents shall not be liable for interference with the light, air, or any
latent defect in the Premises.
15. SUBROGATION. As long as their respective insurers so permit,
Landlord and Tenant hereby mutually waive their respective rights of
recovery against each other for any loss insured by fire, extended
coverage and other property insurance policies existing for the benefit
of the respective parties. Each party shall apply to their insurers to
obtain said waivers. Each party shall obtain any special endorsements,
if required by their insurer to evidence compliance with the
aforementioned waiver.
16. LIABILITY INSURANCE. Tenant shall, at Tenant's expense, obtain and
keep in force during the term of this Lease a policy of comprehensive
public liability insurance insuring Landlord and Tenant against any
liability arising out of the ownership, use, occupancy or maintenance of
the premises and all areas appurtenant thereto. Such insurance shall be
in the amount of not less than $1,000,000.00 for injury or death of one
person in any one accident or occurrence and in the amount of not less
than $1,000,000.00 for injury or death of more than one person in any
one accident or occurrence. Such insurance shall further insure
Landlord and Tenant against liability for property damage of at least
$1,000.000.00. The limit of any such insurance shall not, however,
limit the liability of the Tenant hereunder. Tenant may provide this
insurance under a blanket policy, provided that said insurance shall
have a Landlord's protective liability endorsement attached thereto. If
Tenant shall fail to procure and maintain said insurance, Landlord may,
but shall not be required to, procure and maintain same, but at the
expense of Tenant. Insurance required hereunder shall be in companies
rated a+, AAA or better in "Best's Insurance Guide". Tenant shall
deliver to Landlord, prior to right of entry, copies of policies of
liability insurance required herein or certificates evidencing the
existence and amounts of such insurance with loss payable clauses
satisfactory to Landlord. No policy shall be cancellable or subject to
reduction of coverage. All such policies shall be written as primary
policies not contributing with and not in excess of coverage which
Landlord may carry.
17. UTILITIES. Landlord shall pay for all gas, heat, light, and power
charges. Tenant shall be responsible for telephone service, alarm
service and other services necessary for bank operations, together with
any applicable taxes.
18. PERSONAL PROPERTY TAXES. Tenant shall pay, or cause to be paid,
before delinquency any and all taxes levied or assessed and which become
payable during the term hereof upon all Tenant's leasehold improvements,
equipment, furniture, fixtures, and any other personal property located
in the Premises. In the event any or all of the Tenant's leasehold
improvements, equipment, furniture, fixtures and other personal property
shall be assessed and taxed with the real property, Tenant shall pay to
Landlord its share of such taxes within ten (10) days after delivery to
Tenant by Landlord of a statement in writing setting forth the amount of
such taxes applicable to Tenant's property.
19. RULES AND REGULATIONS. Tenant shall faithfully observe and comply
with the rules and regulations that Landlord shall from time to time
promulgate and/or modify. The rules and regulations shall be binding
upon the Tenant upon delivery of a copy of them to Tenant. Landlord
shall not be responsible to Tenant for the nonperformance of any said
rules and regulations by any other tenants or occupants.
20. HOLDING OVER. If Tenant remains in possession of the Premises or
any part thereof after the expiration of the term hereof with the
express written consent of Landlord, such occupancy shall be a tenancy
from month to month at a rental in the amount of the last Monthly
Minimum Rent, plus all other charges payable hereunder, and upon all the
terms hereof applicable to a month-to-month tenancy.
21. ENTRY BY LANDLORD. Landlord reserves, and shall during Banks
operating hours, have the right to enter the Premises to inspect the
same, to submit said Premises to prospective purchasers or tenants, to
repair the Premises and any portion of the Building of which the
Premises are a part that Landlord may deem necessary or desirable,
without abatement of rent, and may for that purpose erect scaffolding
and other necessary structures where reasonably required by the
character of the work to be performed, always providing that the
entrance to the Premises shall not be unreasonably blocked thereby, and
further providing that the business of the Tenant shall not be
interfered with unreasonably. Tenant hereby waives any claim for
damages or for any injury or inconvenience to or interference with
Tenant's business, any loss of occupancy or quiet enjoyment of the
Premises, and any other loss occasioned thereby. Access by Landlord
before and after Banks normal open hours will be provided by arrangement
with Tenant Management. A list of Tenant personnel and telephone
numbers will be provided to Landlord in case of emergency.
22. TENANT'S DEFAULT. The occurrence of any one or more of the
following events shall constitute a default and breach of this Lease by
Tenant.
22A. The vacating or abandonment of the Premises by Tenant.
22B. The failure of Tenant to make any payment of rent or any other
payment required to be made by Tenant hereunder, as and when due, where
such failure shall continue for a period of three (3) days after
written notice thereof by Landlord to Tenant. 22C. The failure
by Tenant to observe or perform any of the covenants, conditions or
provisions of this Lease to be observed or performed by Tenant, other
than described in Article 22B, above, where such failure shall continue
for a period of thirty (30) days after written notice hereof by
Landlord to Tenant; provided, however, that if the nature of
Tenant's default is such that more than thirty (30) days period and
thereafter diligently prosecutes such cure to completion.
22D. The making by Tenant of any general assignment or general
arrangement for the benefit of creditors; or the filing by or against
Tenant of a petition to have Tenant adjudged a bankrupt, or a petition
or reorganization or arrangement under any law relating to bankruptcy
(unless in the case of a petition filed against Tenant, the same is
dismissed within sixty (60) days; or the appointment of a trustee or a
receiver to take possession of substantially all of Tenant's assets
located at the Premises or of Tenant's interest in this Lease, where
possession is not restored to Tenant within thirty (30) days; or the
attachment, execution or other judicial seizure of substantially all of
Tenant's assets located at the Premises or of Tenant's interest in this
Lease, where such seizure is not discharged in thirty (30) days.
23. REMEDIES IN DEFAULT. In the event of any such default or breach by
Tenant, Landlord may at any time thereafter, in his sole discretion,
with or without notice or demand and without limiting Landlord in the
exercise of a right or remedy which Landlord may have by reason of such
default or breach:
23A. Terminate Tenant's right to possession of the Premises by
any lawful means, in which case this Lease shall terminate and
Tenant shall immediately surrender possession of the Premises to
Landlord. In such event Landlord shall be entitled to recover from
Tenant all damages incurred by Landlord by reason of Tenant's default
including, but not limited to, the cost of recovering possession of the
Premises; expenses of reletting, including necessary renovation and
alteration of the Premises; reasonable attorney's fees; the worth at the
time of award by the court having jurisdiction thereof of the amount by
which the unpaid rent and other charges and Adjustments called for
herein for the balance of the term after the time of such award exceeds
the amount of such loss for the same period that Tenant proves could be
reasonably avoided; and that portion of any leasing commission paid by
Landlord and applicable to the unexpired term of this Lease. Unpaid
installments of rent or other sums shall bear interest from the date due
at the maximum legal rate; or
23B. Maintain Tenant's right to possession, in which case this
Lease shall continue in effect whether or not Tenant shall have
abandoned the Premises. In such event Landlord shall be entitled to
enforce all of Landlord's rights and remedies under this Lease,
including the right to recover the rent and any other charges and
Adjustments as may become due hereunder; or
23C. Pursue any other remedy now or hereafter available
to Landlord under the laws or judicial decisions of the State in
which the Premises are located.
24. DEFAULT BY LANDLORD. Landlord shall not be in default unless
Landlord fails to perform obligations required of Landlord within a
reasonable time, but in no event later than thirty (30) days after
written notice by Tenant to Landlord and to the holder of any first
mortgage or deed of trust covering the Premises whose name and address
shall have theretofore been furnished to Tenant in writing, specifying
wherein Landlord has failed to perform such obligation; provided,
however, that if the nature of Landlord's obligation is such that more
than thirty (30) days are required for performance then Landlord shall
not be in default if Landlord commences performance within such thirty
(30) day period and thereafter diligently prosecutes the same to
completion. In no event shall Tenant have the right to terminate this
Lease as a result of Landlord's default and Tenant's remedies shall be
limited to damages and/or an injunction.
25. RECONSTRUCTION. In the event the Premises are damaged by fire or
other perils covered by extended coverage insurance, Landlord agrees to
forthwith repair same, and this Lease shall remain in full force and
effect, except that Tenant shall be entitled to a proportionate
reduction of the Minimum Rent from the date of damage and while such
repairs are being made, such proportionate reduction to be based upon
the extent to which the damage and making of such repairs shall
reasonably interfere with the business carried on by the Tenant in the
Premises. If the damage is due to the fault or neglect of Tenant or its
employees, there shall be no abatement of rent.
In the event the Premises are damaged as a result of any cause
other than the perils covered by fire and extended coverage insurance,
then Landlord shall forthwith repair the same, provided the extent of
the destruction be less than ten (10%) percent of the then full
replacement cost of the Premises. In the event the destruction of the
Premises is to an extent of ten (10%) percent or more of the full
replacement cost then Landlord shall have the option; (1) to repair or
restore such damage, this Lease continuing in full force and effect, but
the Minimum Rent to be proportionately reduced as hereinabove in this
Article provided; or (2) give notice to Tenant at any time within sixty
(60) days after such damage, terminating this Lease as of the date
specified in such notice, which date shall be no more than thirty (30)
days after the giving of such notice. In the event of giving such
notice, this Lease shall expire and all interest of the Tenant in the
Premises shall terminate on the date so specified in such notice and the
Minimum Rent, reduced by a proportionate reduction, based upon the
extent, if any, to which such damage interfered with the business
carried on by the Tenant in the Premises, shall be paid up to date of
said such termination.
Not withstanding anything to the contrary contained in this
Article, Landlord shall not have any obligation whatsoever to repair,
reconstruct or restore the Premises when the damage resulting from any
casualty covered under this Article occurs during the last twenty-four
months of the term of this Lease or any extension thereof.
Landlord shall not be required to repair any injury or damage by
fire or other cause, or to make any repairs or replacements of any
leasehold improvements, fixture, or other personal property of Tenant.
26. EMINENT DOMAIN. If more than twenty-five (25%) percent of the
Premises shall be taken or appropriated by any public or quasi-public
authority under the power of eminent domain, either party hereto shall
have the right, at its option, within sixty (60) days after said taking,
to terminate this Lease upon thirty (30) days written notice. If
either less than or more than twenty-five (25%) percent of the Premises
are taken (and neither party elects to terminate as herein provided),
the Minimum Rent thereafter to be paid shall be equitably reduced. If
any part of the Shopping Center other than the Premises may be so taken
or appropriated, Landlord shall within sixty (60) days of said taking
have the right at its option to terminate this Lease upon written notice
to Tenant. In the event of any taking or appropriation whatsoever
Landlord shall be entitled to any and all awards and/or settlements
which may be given and Tenant shall have no claim against Landlord for
the value of any unexpired term of this Lease.
27. GENERAL PROVISIONS.
I. Plats and Riders. Clauses, plats, riders and addendums, if any
affixed to this Lease are a part hereof.
II. Waiver. The waiver by Landlord of any term covenant or
condition herein contained shall not be deemed to be a waiver of such
term, covenant or any other subsequent breach of the same or any other
term, covenant or condition herein contained. The subsequent acceptance
of rent hereunder by Landlord shall not be deemed to be a waiver of any
preceding default by Tenant of any term, covenant or condition of this
Lease, other than the failure of the Tenant to pay the particular rental
so accepted, regardless of Landlord's knowledge of such preceding
default at the time of the acceptance of such rent.
III. Joint Obligation. If there be more than one Tenant the
obligations hereunder imposed shall be joint and several.
IV. Marginal Headings. The marginal headings and article titles
to the articles of this Lease are not a part of the Lease and shall have
no effect upon the construction or interpretation of any part hereof.
V. Time. Time is of the essence of this Lease and each and all of
its provisions in which performance is a factor.
VI. Successors and Assigns. The covenants and conditions herein
contained, subject to the provisions as to assignment, apply to and bind
the heirs, successors, executors, administrators and assigns of the
parties hereto.
VII. Recordation. Neither Landlord nor Tenant shall record this
Lease, but a short form memorandum hereof may be recorded at the request
of Landlord.
VIII. Quiet Possession. Upon Tenant paying the rent reserved
hereunder and observing and performing all the covenants, conditions and
provisions on Tenant's part to be observed and performed hereunder,
Tenant shall have quiet possession of the Premises for the entire term
hereof, subject to all the provisions of this Lease.
IX. Late Charges. Tenant hereby acknowledges that late payment by
Tenant to Landlord of rent or other sums due hereunder will cause
Landlord to incur costs not contemplated by this Lease, the exact amount
of which will be extremely difficult to ascertain. Such costs include,
but are not limited to, processing and accounting charges, and late
charges which may be imposed upon Landlord by terms of any mortgage or
trust deed covering the Premises. Accordingly, if any installments of
rent or any sum due from Tenant shall not be received by Landlord or
Landlord's designee within ten (10) days after written notice that said
amount is past due, then Tenant shall pay to Landlord a late charge
equal to the maximum amount permitted by law (and in the absence of any
governing law, ten (10%) percent of such overdue amount), plus any
attorneys' fees incurred by Landlord by reason of Tenant's failure to
pay rent and/or other charges when due hereunder. The parties hereby
agree that such late charges represent a fair and reasonable estimate of
the cost that Landlord will incur by reason of the late payment by
Tenant. Acceptance of such late charges by the Landlord shall in no
event constitute a waiver of Tenant's default with respect to such
overdue amount, nor prevent Landlord from exercising any of the rights
and remedies granted hereunder.
X. Prior Agreements. This Lease contains all of the agreements of
the parties hereto with respect to any matter covered or mentioned in
this Lease, and no prior agreements or understanding pertaining to any
such matters shall be effective for any purpose. No provision of this
Lease may be amended or added to except by an agreement in writing
signed by the parties hereto or the respective successors in interest.
This Lease shall not be effective or binding on any party until fully
executed by both parties hereto. XI. Inability to Perform. This
Lease and the obligations of the Tenant hereunder shall not be affected
or impaired because the Landlord is unable to fulfill any of its
obligations hereunder or is delayed in doing so, if such inability or
delay is caused by reason of strike, labor troubles, acts of God, or any
other cause beyond the reasonable control of the Landlord.
XII. Partial Invalidity. Any provision of this Lease which shall
prove to be invalid, void, or illegal shall in no way affect, impair or
invalidate any other provision hereof and such other provision shall
remain in full force and effect.
XIII. Cumulative Remedies. No remedy or election hereunder shall
be deemed exclusive but shall, whenever possible, be cumulative with all
other remedies at law or in equity.
XlV. Choice of Law. This Lease shall be governed by the laws of
the State in which the Premises are located.
XV. Attorneys' Fees. In the event any action or proceeding
brought by either party against the other under this Lease the
prevailing party shall be entitled to recover for the fees of its
attorneys in such action or proceeding, including costs of appeal, if
any, in such amount as the court may adjudge reasonable as attorneys'
fees. In addition, should it be necessary for Landlord to employ legal
counsel to enforce any of the provisions herein contained, Tenant agrees
to pay all attorneys' fees and court costs reasonably incurred.
XVI. Sale of Premises by Landlord. In the event of any sale of the
Premises by Landlord, Landlord shall be and is hereby entirely freed and
relieved of all liability under any and all of its covenants and
obligations contained in or derived from this Lease arising out of any
act, occurrence or omission occurring after the consummation of such
sale; and the purchaser, at such sale or any subsequent sale of the
Premises shall be deemed, without any further agreement between the
parties or the successors in interest or between the parties and any
such purchaser, to have assumed and agreed to carry out any and all of
the covenants and obligations of the Landlord under this Lease.
XVII. Subordination, Attornment. At Landlord's option, Tenant
shall subordinate its interest in this Lease to any mortgage, deed of
trust or any other hypothecation for security subsequently placed upon
the real property of which the Building and Premises are a part and to
any and all advances made on the security thereof and to all renewals,
modifications, consolidations, replacements and extensions thereof. In
the event of the termination of any ground lease or the sale of the real
property of which the Building and Premises are a part (pursuant to
foreclosure or the exercise of a power of sale under any such mortgage,
deed of trust or other security instrument) Tenant shall attorn to the
ground lessor or the purchaser, as the case may be, and recognize such
person as Landlord under this Lease. Notwithstanding such
subordination, Tenant's right to quiet possession of the Premises shall
not be disturbed if Tenant is not in default at the time of any
termination or sale.
XVIII. Notices. All notices and demands which may or are to be
required or permitted to be given by either party on the other hereunder
shall be in writing. All notices and demands by the Landlord to the
Tenant shall be sent by United States Mail, postage prepaid, addressed
to the Tenant at the Premises, and to the address hereinbelow, or to
such other place as Tenant may from time to time designate in a notice
to the Landlord. All rent, notices and demands by the Tenant to the
Landlord shall be sent by United States Mail, postage prepaid, addressed
to the Landlord at the address set forth herein, and to such other
person or place as the Landlord may from time to time designate in a
notice to the Tenant .
To Landlord at: G&G Properties
Attention: Jodie Lau
1211 W. College Ave.
Santa Rosa, CA 95401
707-546-6877
XX. Authority of Tenant. If Tenant is a corporation, each
individual executing this Lease on behalf of said corporation in
accordance with the bylaws of said corporation will be bound by the
terms of this Lease.
28. BROKERS. Tenant warrants that it has had no dealings with any real
estate broker or agents in connection with the negotiation of this
Lease, and it knows of no other real estate broker or agent who is
entitled to a commission in connection with this Lease.
Signed and accepted this 8 day of July , 1998.
Robert Gong Sonoma National Bank
Deborah A. Meekins
(Landlords) (Tenants)
G & G Properties
Commercial Lease Addendum
Addendum to lease between G & G Properties and Sonoma National Bank
dated June 30, 1998.
1. The term of this lease shall commence on the commencement date (as
defined in item #4A) and provided Sonoma National Bank has received
final OCC approval.
2. G & G Properties agrees to grant Sonoma National Bank first right
of refusal to provide a full service banking facility at any new G & G
Supermarket locations.
