SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 2-91196
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NORTHERN EMPIRE BANCSHARES
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(Exact name of registrant as specified in its charter)
California 94-2830529
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(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation
or organization)
801 Fourth Street, Santa Rosa, California 95404
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(Address of principal executive offices) (Zip code)
707-579-2265
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(Registrant's telephone number, including area code)
NONE
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(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Title of class: Common Stock, no par value. Outstanding shares as of
October 15, 2000: 3,766,162
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (Unaudited)
(dollars in thousands)
ASSETS September 30, 2000 December 31, 1999
Cash and equivalents:
Cash and due from banks $ 14,764 $ 11,030
Federal funds sold 32,029 17,029
-------- --------
Total cash and equivalents 46,793 28,059
Investment securities available-for-sale 2,992 2,970
Federal Home Loan Bank stock, at cost 552 1,165
Federal Reserve Bank stock, at cost 160 129
Loans receivable, net 421,124 357,225
Leasehold improvements and equipment, net 824 792
Accrued interest receivable
and other assets 8,429 7,588
-------- --------
Total assets $480,874 $397,928
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $437,340 $357,867
FHLB Advances 6,834 9,050
Accrued interest payable and
other liabilities 2,595 1,949
-------- --------
Total liabilities 446,769 368,866
-------- --------
Shareholders' equity:
Preferred stock, no par value;
authorized, 10,000,000 shares;
none issued or outstanding - -
Common stock, no par value;
authorized, 20,000,000 shares;
shares issued and outstanding,
3,766,162 in 2000 and
3,737,751 in 1999 18,265 15,561
Additional paid-in capital 741 646
Accumulated other comprehensive
income (loss) (5) (17)
Retained earnings 15,104 12,872
-------- --------
Total shareholders' equity 34,105 29,062
-------- --------
Total liabilities and
shareholders' equity $480,874 $397,928
======== ========
See Notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
for the three and nine months ended September 30, 2000 and 1999
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
(dollars in thousands,
except per share data)
Interest income:
Loans $ 9,960 $ 7,298 $27,154 $20,490
Federal funds sold and
investment securities 510 372 1,566 1,064
------- ------- ------- -------
Total interest income 10,470 7,670 28,720 21,554
Interest expense 5,149 3,298 13,858 9,115
------- ------- ------- -------
Net interest income before
provision for loan losses 5,321 4,372 14,862 12,439
Provision for loan losses 240 240 720 560
------- ------- ------- -------
Net interest income after
provision for loan losses 5,081 4,132 14,142 11,879
------- ------- ------- -------
Other income:
Service charges on deposits 79 106 254 341
Gain on sale of loans 36 83 289 403
Other 152 156 522 507
------- ------- ------- -------
Total other income 267 345 1,065 1,251
------- ------- ------- -------
Other expenses:
Salaries and employee
benefits 1,410 1,242 4,001 3,519
Occupancy 213 197 627 580
Equipment 130 105 393 351
Advertising and
business development 108 108 352 301
Outside customer services 104 85 310 259
Director and shareholder
expenses 88 70 231 220
Deposit and other insurance 70 54 201 159
Professional fees 55 48 179 113
Other 233 213 684 640
------- ------- ------- -------
Total other expenses 2,411 2,122 6,978 6,142
------- ------- ------- -------
Income before income taxes 2,937 2,355 8,229 6,988
Provision for income taxes 1,205 953 3,364 2,823
------- ------- ------- -------
Net income $ 1,732 $ 1,402 $ 4,865 $ 4,165
======= ======= ======= =======
Earnings per common share $ 0.46 $ 0.38 $ 1.29 $ 1.12
======= ======= ======= =======
Earnings per common share
assuming dilution $ 0.45 $ 0.37 $ 1.27 $ 1.10
======= ======= ======= =======
See notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the nine months ended September 30, 2000 and 1999
(Unaudited)
(dollars in thousands)
2000 1999
------- --------
Cash flows from operating activities:
Net income $ 4,865 $ 4,165
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses and OREO losses 720 560
Depreciation, amortization and accretion 289 265
FHLB stock dividends 52 54
Net increase in deferred loan fees and discounts 165 530
Change in deferred income taxes 251 (86)
Tax benefit from stock options exercised 96 -
Increase in interest receivable and other assets (1,092) (296)
Increase in accrued interest payable and
other liabilities 646 2
------- --------
Net cash provided by in operating activities 5,992 5,194
------- --------
Cash flows from investing activities:
Purchase of restricted securities (39) (113)
Purchase of available for sale securities (22) -
Maturities of available for sale securities - 4,011
Redemption of restricted securities 582 512
Net increase in loans receivable (64,784) (60,866)
Purchase of leasehold improvements and
equipment, net (321) (138)
------- --------
Net cash used in investing activities (64,584) (56,594)
------- --------
Cash flows from financing activities:
Net increase in deposits 79,473 45,120
Net decrease FHLB advances (2,216) (16)
Payment of cash dividends (2) (4)
Stock options exercised 71 253
------- --------
Net cash provided by financing activities 77,326 45,353
------- --------
Net increase (decrease) in cash and
cash equivalents 18,734 (6,047)
Cash and cash equivalents at beginning of year 28,059 39,333
------- --------
Cash and cash equivalents at end of period $46,793 $33,286
======= ========
Supplemental cash flow information:
Interest paid $13,776 $ 9,192
======= ========
Income taxes paid $ 2,743 $ 2,892
======= ========
Additions to other real estate owned $ 940 $ 238
======= ========
See notes to Consolidated Financial Statements
Northern Empire Bancshares and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2000
Note 1 - Basis of Presentation
In the opinion of Management, the unaudited interim consolidated
financial statements contain all adjustments of a normal recurring
nature, which are necessary to present fairly the financial condition of
Northern Empire Bancshares (the "Corporation") and Subsidiary at
September 30, 2000 and the results of operations for the three and nine
months then ended.
Certain information and footnote disclosures presented in the
Corporation's annual consolidated financial statements are not included
in these interim financial statements. Accordingly, the accompanying
unaudited interim consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Corporation's 1999 Annual Report on Form 10-KSB. The
results of operations for the three and nine months ended September 30,
2000 are not necessarily indicative of the operating results through
December 31, 2000.
Note 2 - Net Income per Common and Common Equivalent Share
Basic earnings per share (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
Corporation's common stock throughout the period. The Corporation's
pertinent EPS data is as follows:
For the three months ended
September 30, 2000
------------------
Income/ Shares/ Per Share
Numerator Denominator Amount
--------- ----------- ---------
Net Income $1,732,000
==========
EPS - Income available to
common stockholders 3,765,662 $0.46
Effect of Dilutive Securities-
Stock Options 56,048
---------
EPS assuming dilution-
Income available to common
stockholders plus assumed
conversion 3,821,710 $0.45
========= =====
For the three months ended
September 30, 1999
------------------
Income/ Shares/ Per Share
Numerator Denominator Amount
--------- ----------- --------
Net Income $1,402,000
==========
EPS - Income available to
common stockholders 3,737,751 $0.38
Effect of Dilutive Securities-
Stock Options 88,116
---------
EPS assuming dilution-
Income available to common
stockholders plus assumed
conversion 3,825,867 $0.37
========= =====
For the nine months ended
September 30, 2000
------------------
Income/ Shares/ Per Share
Numerator Denominator Amount
--------- ----------- ---------
Net Income $4,865,000
==========
EPS - Income available to
common stockholders 3,758,185 $1.29
Effect of Dilutive Securities-
Stock Options 60,612
---------
EPS assuming dilution-
Income available to common
stockholders plus assumed
conversion 3,818,797 $1.27
========= =====
For the nine months ended
September 30, 1999
------------------
Income/ Shares/ Per Share
Numerator Denominator Amount
--------- ----------- ----------
Net Income $4,165,000
==========
EPS - Income available to
common stockholders 3,712,733 $1.12
Effect of Dilutive Securities-
Stock Options 85,921
---------
EPS assuming dilution-
Income available to common
stockholders plus assumed
conversion 3,798,654 $1.10
========= =====
Note 3 - Comprehensive Income
The Corporation's total comprehensive earnings presentation is as follows:
For the three For the nine
months ended months ended
September 30, September 30,
------------ ------------
(In thousands) 2000 1999 2000 1999
---- ---- ---- ----
Net Income $1,732 $1,402 $4,865 $4,165
Other Comprehensive income (loss):
Change in unrealized holding gain
(losses) arising during the period 10 (5) 22 (21)
Reclassification adjustment for
gains included in net income - - - (4)
Income tax benefit (expense) (5) 2 (9) 10
------ ------ ------ ------
5 (3) 13 (15)
------ ------ ------ ------
Comprehensive income $1,737 $1,399 $4,878 $4,150
====== ====== ====== ======
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Northern Empire Bancshares (the "Corporation") is the financial holding
company of Sonoma National Bank (the "Bank"). Since the principal
business of the Corporation is the Bank, the following discussion
pertains mainly to the Bank.
This report contains "forward-looking statements" as defined in section
27A of the Securities Act of 1933, as amended, and section 21E of the
Securities Exchange Act of 1934, as amended, which includes statements
such as projections, plans and objectives and assumptions about the
future, and such forward looking statements are subject to the safe
harbor created by these sections. Many factors could cause the actual
results, amounts or events to differ materially from those the
Corporation expects to achieve or occur, such as changes in competition,
market interest rates, economic conditions and regulations. Although the
Corporation has based its plans and projections on certain assumptions,
there can be no assurances that its assumptions will be correct, or that
its plans and projections can be achieved.
Summary of Financial Results
Total consolidated assets equaled $480,874,000 at September 30, 2000
compared to $397,928,000 at December 31, 1999. Cash and cash
equivalents increased $18.7 million since year end. Net loans increased
$63.9 million since year end with $28.2 million occurring in the second
quarter.
Net income after tax for the first nine months of 2000 equaled
$4,865,000 compared to $4,165,000 for the comparable period last year,
an increase of 16.8%. The third quarter's net income of $1,732,000
increased 23.5% over the third quarter of 1999 when net income equaled
$1,402,000. The higher profit resulted from increases in net interest
income due to loan growth (a larger volume of higher yielding earning
assets).
Net Interest Income
Net interest income (before the provision for loan losses) of $5,321,000
for the third quarter of 2000 increased 21.7% from $3,298,000 for the
comparable period last year. This increase in net interest income
resulted from volume increases of $98.5 million in average earning
assets for the third quarter of 2000 compared to the third quarter of
1999. Average loans outstanding increased $97.2 million over the third
quarter of 1999 while investments and fed funds sold increased $1.3
million. Average interest bearing deposits for the third quarter
increased $81.8 million over the same period last year.
The net interest margin equaled 4.76% during the third quarter of 2000
compared to an average margin of 5.03% for the full year of 1999. The
yield on average loans equaled 9.58% in the third quarter of 2000
compared to 9.20% for the year of 1999. The change in loan yields
results from increases in prime rates since July 1999. The Bank's cost
of interest bearing deposits increased from 4.62% for 1999 to 5.53%
during the third quarter of 2000 which also results from increasing
deposit rates during the past year.
Mix of Loans The mix of loans influences the overall yield on loans.
During the third quarter of 2000, there was significant growth of $12.9
million in real estate loans. Real estate loans have a lower yield than
other types of loans which negatively impacts net interest margin.
Construction loans which have a higher yield were increased $5.4
million. Net interest margin is also affected by the level of loans
relative to deposits. The Bank's ratio of loans to deposits increased
from an average of 96.4% during the third quarter of 1999 to 98.6% for
the same period this year, this increase has a positive impact on net
interest margin.
Interest Rate Environment The Bank benefits from rate increases, since
more of its assets reprice at a faster rate than deposits. The Prime
lending rate was 9.5% on September 30, 2000 compared to 8.25% at
September 30, 1999. Prime rate started to increase in July 1999 and
raised 75 basis points by the end of last year. This year, prime rate
has increased 100 basis points. However, the Bank experiences a delay
in the benefit of prime rate changes, since SBA guaranteed loans reprice
on a calendar quarter basis. On July 1, SBA guaranteed loans repriced
for the 50 basis point change that occurred on May 16. Of the Bank's
loan portfolio totaling $428.4 million at September 30, 2000, $344.7
million or 80.5% of the loans are adjustable rate loans which have not
reached a floor or ceiling rate. Approximately $150.0 million are
prime-based loans, of which $53.4 million reprice immediately and $96.6
million reprice on a quarterly basis. Approximately $187.8 million of
the Bank's loan portfolio is periodically adjustable (generally every
six months) based upon the Eleventh District's Cost of Funds Index
(COFI) in effect 45 days before the change date. This COFI index for
September 30, 1999 was 4.61% compared to 5.51% reported for the month of
August, 2000. This index adjusts at a much slower pace than prime rate
which has resulted in a significant lag in increasing the yield on loans
tied to this index. The Bank has just started to benefit from the
increase in the index on COFI loans. This lag in repricing on such a
large portion of the loan portfolio has slows the rate of change on the
net interest margin.
Non-accrual loans Loans which have been placed on non-accrual status
also impact net interest margin. At the time a loan is placed on
non-accrual, the unpaid interest is reversed and interest accruals are
discontinued until the credit quality of the loan justifies returning it
to accrual status. As of September 30, 1999 the Bank had $1,109,000
classified as non-accrual loans compared to $750,000 at the end of this
quarter. Non-accrual loans negatively impact net interest margin.
Management continually monitors the loan portfolio for potential problem
loans and expects to have non-accrual loans with a loan portfolio of our
size. The current level of non-accrual loans is considered by
management to be a low level of non-accrual loans based upon comparisons
to our peer group (other banks of comparable asset size). See comments
under "Allowance for Loan Losses".
Cost of Deposits Interest expense increased from $3,298,000 in the
third quarter of 1999 to $5,149,000 in 2000. The major factor was the
increase of $85.9 million in average interest bearing liabilities when
comparing the third quarter of 1999 to 2000. The average cost of
interest bearing liabilities increased from 4.60% to 5.52% when
comparing the third quarter of last year to the third quarter of this
year. This increase had a negative impact on net interest margin. The
Bank has a money market rate deposit account which is tied to the 13
week U.S. Treasury bill. Money market accounts comprise 29.6% of total
deposits. The rate on this account increased from an average of 3.99%
in the third quarter of 1999 to 5.23% this quarter which was a major
factor in the increase in overall deposit costs. The Bank's rapid
growth and local competition for deposits has had a negative impact on
the interest margin as reflected in the increase in the cost of
deposits.
Yield Analyses The following schedules set forth yield on earning
assets, cost of funds and net interest margin for the periods indicated.
Three months ended Three months ended
September 30, 2000 September 30, 1999
------------------ ------------------
Average Average
Balance Interest Yield Balance Interest Yield
------- -------- ----- ------- -------- -----
(dollars in thousands)
Earning assets (1) 444,642 10,470 9.37% 346,173 7,670 8.79%
Interest bearing
liabilities 370,521 5,149 5.52% 284,660 3,298 4.60%
Net interest income 5,321 4,372
====== =====
Net Interest income
to earning assets 4.76% 5.01%
==== ====
(1) Non-accrual loans are included in the calculation of average
balance of earning assets, and interest not accrued is excluded.
Nine months ended Nine months ended
September 30, 2000 September 30, 1999
------------------ ------------------
Average Average
Balance Interest Yield Balance Interest Yield
------- -------- ----- ------- -------- -----
(dollars in thousands)
Earning assets (1) 420,827 28,720 9.12% 325,604 21,554 8.85%
Interest bearing
liabilities 351,196 13,858 5.27% 266,874 9,115 4.57%
Net interest income 14,862 12,439
====== ======
Net Interest income
to earning assets 4.72% 5.11%
==== ====
(1) Non-accrual loans are included in the calculation of average
balance of earning assets, and interest not accrued is excluded.
The following table sets forth changes in interest income and interest
expense for each major category of interest-earning asset and
interest-bearing liability, and the amount of change attributable to
volume and rate changes for the three and nine months ended September
30, 2000 and 1999. Changes not solely attributable to rate or volume
have been allocated to rate.
For the three months ended September 30, 2000 over September 30, 1999
---------------------------------------------------------------------
(dollars in thousands)
Volume Yield/Rate Total
------ ---------- -----
Increase (decrease) in interest income:
Portfolio loans $2,236 $426 $2,662
Other earning assets 15 123 138
------ ------ ------
Total increase (decrease) 2,251 549 2,800
------ ------ ------
Increase in interest expense:
Interest-bearing transaction accounts 323 365 688
Time deposits 659 502 1,161
Other borrowings 1 1 2
------ ------ ------
Total increase 983 868 1,851
------ ------ ------
Increase (decrease) in net interest income $1,268 ($319) $949
====== ====== ======
For the nine months ended September 30, 2000 over September 30, 1999
--------------------------------------------------------------------
(dollars in thousands)
Volume Yield/Rate Total
------ ---------- -----
Increase (decrease)in interest income:
Portfolio loans $6,296 $368 $6,664
Other earning assets 172 330 502
------ ------ ------
Total increase (decrease) 6,468 698 7,166
------ ------ ------
Increase in interest expense:
Interest-bearing transaction accounts 711 1,500 2,211
Time deposits 2,174 243 2,417
Other borrowings 103 12 115
------ ------ ------
Total increase 2,988 1,755 4,743
------ ------ ------
Increase (decrease) in net interest income $3,480 ($1,057) $2,423
====== ====== ======
Provision for Loan Losses
The provision for loan losses equaled $240,000 for the three months
ended September 30, 2000 and $720,000 for the first nine months of 2000
compared to $240,000 and $560,000 for the same periods last year. The
increase in the provision reflects the overall growth in loans and the
increase in non-accrual loans during this year. For further discussion
see Allowance for Loan Losses
Other Income
Other income is derived primarily from service charges on deposit
accounts, earnings on life insurance, SBA loan servicing, SBA loan sales
and sales of other real estate owned. Other income equaled $267,000 for
the third quarter of this year compared to $345,000 for the same period
last year.
Service charges on deposit accounts decreased from $106,000 during the
third quarter of 1999 to $79,000 during the third quarter of 2000. A
portion of this fluctuation is due to the increase in the earnings
credit rate (average 13 week US Treasury Bill for the month). This rate
is applied to the average balances held by analysis customers and this
income is used to offset the cost of services provided. When the cost
of services exceed the income, the customer is billed a service charge.
Analysis customers have also been maintaining higher average balances
and the Bank has lost a few accounts, which had analysis charges on a
regular basis. This has negatively impacted income from service charges
on deposit accounts. In addition, there was a decline in overdraft
charges when comparing this income to last year.
In the third quarter of 2000, the Bank sold the guaranteed portion of
one SBA loan totaling $747,000 and recognized gains on that sale of
$36,000. During the third quarter of 1999, the Bank sold the guaranteed
portion of SBA loans totaling $2.2 million and the Bank recognized gains
on those sales of $83,000. The Bank has been retaining the majority of
the guaranteed portion of SBA loans to realize the interest yield,
rather than selling the guaranteed portion for a one time gain and
servicing fees. Management considers the Bank's liquidity needs and
anticipates loan and deposit growth as a part of the decision to hold
SBA guaranteed loans versus selling them.
SBA servicing fees, which totaled $76,000 during the third quarter of
2000, was slightly above last year's level of $72,000 for the same
period. The serviced portfolio equaled $30.1 million at September 30,
2000 compared to $25.3 million at the end of the third quarter of 1999.
The Bank had no sales of other real estate owned (OREO) during this
quarter and no properties were classified as OREO at the end of this
quarter or the third quarter of 1999. During the third quarter of 1999
there was one sale of OREO totaling $284,000 which was sold at a loss of
$2,000.
Non-Interest Expenses
The Bank's non-interest expenses increased from $2,122,000 in the third
quarter of last year to $2,411,000 for the third quarter of 2000. This
increase was anticipated since the Bank has continued to grow at a rapid
rate.
The Bank's largest expense category is salaries and benefits which
increased 13.5% from $1,242,000 to $1,410,000 in the third quarter of
this year. The Bank's full time equivalent staff positions increased by
13 since September of 1999. The addition of a new branch in Sebastopol
and a loan production office in Walnut Creek added five new staff
positions and the Bank has hired four employees for the Petaluma Branch
which is scheduled to open late this year. There were also other staff
increases throughout the Bank to accommodate growth in Bank operations.
The record level of loan and deposit growth has resulted in higher
incentive payments during this quarter. Personnel costs were also
affected by salary increases and changes in benefit costs.
Occupancy expenses increased 8.1%, mainly due to the new branch and loan
production office plus the impact of programed rental increases in our
existing lease agreements. Equipment costs increased 23.8% over the
comparable quarter last year. This significant increase results from
the Bank's commitment to provide excellent computer services to our
customers and staff. Last year the Bank replaced several systems which
were not year 2000 compliant, with that cost now being amortized to
expense over their estimated life. In addition, the Bank recently
installed a new teller system and is currently in the process of
implementing an internet banking system.
Deposit and other insurance of $70,000 includes an increase of $16,000
over the third quarter of last year. Regulatory assessments and FDIC
insurance cost grew $16,000 due to the increase in deposit assessment
base for Financing Corporation (FICO) assessment which became effective
January 1, 1997. The increase is caused by deposit growth. There is no
assurance that the current FDIC assessment rate will continue at such a
low level. Other insurance costs were comparable to the third quarter
of last year even though the Bank has grown and increased insurance
coverage in many areas.
Professional fees increased by $7,000 from the third quarter of 1999 to
$55,000 in the third quarter of 2000. Legal expenses continued at a
higher level due to services provided on non-accrual and other problem
loans. Even though the Bank has experienced an increase in problem loan
activity this year, problem loans still remain at a low level when
compared to the Bank's peer group. See "Allowance for Loan Losses."
Advertising and business development costs were comparable to the previous
third quarter at $108,000. This expense category can vary significantly
based on activity during the period and the need to promote loan and
deposit products.
Outside customer services continues to increase due to new customers
using the Bank's analysis system and an increase in other costs
associated with customers' accounts. The increase in director and
shareholder expenses was mainly due to the increase in costs by our
transfer agent. Other expenses, which includes stationery & supplies,
telephone, postage, loan expenses, dues and subscriptions and automobile
costs, have increased due to Bank growth.
Non-interest expenses directly allocated to the SBA lending department
for the third quarter approximated $512,000 (including $287,000 in
personnel costs, $66,000 in occupancy and equipment expenses, $46,000 in
marketing/business development) compared to $533,000 for the third
quarter of 1999. The SBA department's expenses vary depending upon loan
activity. In addition, there has been an increase in staff levels. At
September 30, 2000, the SBA loan portfolio (serviced portion and Bank's
portion) equaled $126.2 million, of which $30.1 million has been sold
and is being serviced.
Income Taxes
The effective tax rate was 41.0% for the third quarter of 2000. The
provision for the third quarter of 2000 was $1,205,000 versus $953,000
for the same period last year. The increase resulted from the increase
in pre-tax income during the comparable quarters.
Liquidity and Investment Portfolio
Liquidity is a bank's ability to meet possible deposit withdrawals, to
meet loan commitments and increased loan demand, and to take advantage
of other investment opportunities as they arise. The Bank's liquidity
practices are defined in both the Asset and Liability Policy and the
Investment Policy. These policies define acceptable liquidity measures
in terms of ratios to total assets, deposits, liabilities and capital.
Cash and due from banks and federal funds sold totaled $46.8 million or
9.7% of total assets at September 30, 2000, compared to $28.1 million or
7.1% of total assets at December 31, 1999. At year end, the level of
liquid assets was lower than normal due to a large volume of loans
recorded during the month of December. Since year end the Bank has sold
SBA loans and participated loans to restore liquidity to a higher level.
In addition, the Bank has offered special time deposits at slightly
higher than market rates to attract new deposits. As of September 30,
2000 the Bank held $63.8 million in SBA guaranteed loans which could be
sold if additional liquidity was needed.
At September 30, 2000, the Bank had unused federal funds lines of credit
totaling $11 million. The Bank also has a credit line with the Federal
Home Loan Bank (FHLB) which is based upon the value of collateral
(investments and loans). Currently the Bank has pledged loans as
collateral which would allow the Bank to borrow up to $15.5 million. As
of September 30, 2000 the Bank had borrowed $6.8 million which left $8.7
in additional borrowing capacity. The FHLB is in the process of
changing its lending requirements which may increase the Bank's
borrowing limit. Management believes this amount of secondary liquidity
is adequate to meet any cash demands that may arise.
At present, the Corporation's primary sources of liquidity are from
interest on deposits, exercise of stock options and dividends from the
Bank. The Bank's ability to pay dividends to the Corporation is subject
to the restrictions of the national banking laws and, under certain
circumstances, the approval of the Comptroller of the Currency.
At September 30, 2000, the Corporation had non-interest and interest
bearing cash balances of $220,000, which management believes is adequate
to meet the Corporation's operational expenses.
The Corporation and the Bank do not engage in hedging transactions
(interest rate futures, caps, swap agreements, etc.).
Deposits
During the third quarter of 2000 total deposits increased by $26.0
million to $437.3 million at September 30, 2000.
Money market rate deposits equaled $129.6 million at September 30, 2000.
This is a limited transaction account paid a floating rate based on the
13 week treasury bill less a margin of 75 basis points. The rate
offered on this account has been very attractive and many of the Bank's
customers have held their funds in this deposit product rather than
locking into a specific maturity. New customers continue to find this
deposit account attractive due to the immediate availability of the
funds versus a time certificate bearing a future maturity.
Certificates of deposits increased from $197.4 million at December 31,
1999 to $235.2 million as of September 30, 2000. The Bank has increased
certificates of deposit by offering attractive rates on certificates for
specific terms. The Bank has been successful in retaining the majority
of funds received through certificate campaigns.
As of September 30, 2000, non-interest bearing deposits equaled $52.5
million compared to $40.4 million at December 31, 1999 and $46.9 million
on September 30, 1999. The Bank's transaction accounts have significant
changes in daily balances, mainly due to deposits held by title
companies. This type of deposit account has greater balance
fluctuations than other types of accounts based upon their business
activity.
The low interest rate environment over the past few years and the
increased competition from the financial services industry has made it
more difficult to attract new deposits at favorable rates. During the
last year deposit rates have been increasing. Higher yields on deposit
accounts may make them a more competitive investment option. The Bank
continually monitors competitors' rates, strives to be competitive in
pricing deposits, and has offered attractive time deposit rates to raise
funds during periods of high loan growth.
Loans
Loans, net of discounts and reserves, equaled $421.1 million at
September 30, 2000 compared to $357.2 million at December 31, 1999,
increasing 17.9% over year end and 28.9% over the September 30,1999
balance of $326.8. The following is an analysis of the loan portfolio.
Type of Loan September 30, 2000 December 31, 2000
------------------ -----------------
(in thousands)
Commercial $136,991 $130,924
Real Estate Construction 39,686 39,523
Real Estate Other 249,680 191,472
Installment Loans to Individuals 2,062 1,783
-------- --------
428,419 363,702
Deferred loan fees and discount (2,854) (2,690)
Allowance for loan losses (4,441) (3,787)
-------- --------
TOTAL $421,124 $357,225
======== ========
The SBA loan program continued to be a popular program; however,
competition continues to be strong in our market area. At September 30,
2000, SBA loans equaled $96.1 million, net of $30.1 million in SBA loans
sold and being serviced by the Bank. The majority of the Bank's SBA
loans are secured by real estate; however, these loans are reported as
commercial loans. SBA loans have the same underwriting requirements as
the Bank's other loans, they are sometimes for longer terms (7 to 25
years) and have higher loan-to-value ratios than the Bank typically
accepts. The SBA loan program remains subject to budget considerations
at the Federal government level. Major changes to the federal program
could affect the Bank's profitability and future SBA loan growth. The
guaranteed portion of SBA loans currently held by the Bank but which
could be sold in the secondary market increased from $58.5 million to
$63.8 million when comparing September 30, 1999 to September 30, 2000.
The Bank continues to emphasize commercial and real estate lending. At
September 30, 2000, 32.0% of the loans held for investment were
commercial loans and 67.5% were real estate and construction loans,
compared to 36.0% and 63.5% respectively at December 31, 1999. The Bank
has increased the commercial and commercial real estate portfolio
through its reputation, in Sonoma and surrounding counties, as an
experienced business and real estate lender that facilitates the
successful negotiation of complex commercial loans. The Bank maintains
high credit qualifications with most real estate loans having 60-70%
loan-to-value ratios. Management is aware of the risk factors in making
commercial and real estate loans and is continually monitoring the local
market place. A decline in real estate values and/or demand could
potentially have an adverse impact on the loan portfolio, and on the
financial condition of the Bank.
The Bank's residential construction loan group was expanded in mid 1997
and has continued to grow since then. Construction loan balances have
increased from $20.7 million at September 30, 1998 to $33.6 million at
September 30, 1999 to its September 30, 2000 balance of $39.7 million.
Due to the shorter life of construction loans, the Bank does not expect
this rate of growth to continue. The Bank offers residential mortgages
on a limited basis.
The Bank has a small portfolio of consumer loans which equaled 0.5% of
the total loan portfolio at September 30, 2000 and 0.5% at December 31,
1999.
Allowance for Loan Losses
The allowance for loan losses equaled $4.4 million at September 30,
2000, compared to $3.8 million at December 31, 1999. At September 30,
2000, the allowance for loan losses equaled 1.2% of loans, net of the
guaranteed portion of SBA loans . The allowance for loan losses is
reviewed on a monthly basis, based upon an allocation for each loan
category, plus an allocation for any outstanding loans which have been
classified by regulators or internally for the "Watch List". Each loan
that has been classified is individually analyzed for the risk involved
with a specific reserve allocation assigned according to the risk
assessment.
At September 30, 2000, there were three loans on non-accrual totaling
$750,000 were collateralized by real estate and $440,000 was guaranteed
by the SBA. There were no loans past due 90 days or more and still
accruing interest. Loans past due 30 to 89 days totaled $5,333,000 of
which $4,805,000 was collateralized by real estate and $2,026,000 was
guaranteed by the SBA. On December 31, 1999, the Bank had $1,888,000 in
non-accrual loans, and no loans past due 90 or more days and still
accruing interest.
During the third quarter of 2000 there were $36,000 in loan charge offs
and there have been $67,000 in charge offs year to date. During the
1999 there was $19,000 in charge offs and no recoveries during the nine
months ended September 30, 1999. The Bank continues to have a low charge
off experience compared to industry standards. The following is an
analysis of the activity in the allowance for loan losses during the
quarter and year-to-date.
(In thousands)
Quarter ended Nine months ended
September 30, 2000 September 30, 2000
------------------ ------------------
Balance - Beginning of period $4,237 $3,787
Provision for loan losses 240 720
Charge offs 36 66
Recoveries 0 0
------ ------
Balance - End of period $4,441 $4,441
====== ======
Capital Resources
Pursuant to regulations under the FDIC Improvement Act of 1991 (FDICIA),
five capital levels were prescribed as applicable for banks, ranging
from well-capitalized to critically under-capitalized. At September 30,
2000, the Bank was considered "well capitalized." The total risk-based
capital ratios were 10.33% for the Bank and 10.39% for the Corporation.
The Company issued a 5% stock dividend to shareholders of record on May
3, 2000.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
The Bank's financial performance is impacted by, among other factors,
interest rate risk and credit risk. The Bank utilizes no derivatives to
mitigate its credit risk, relying instead on loan review and adequate
loan loss reserves. See Allowance for Loan Losses.
Interest rate risk is the risk of loss in value due to changes in
interest rates. Since virtually all of the Corporation's interest rate
risk exposure lies at the Bank level, this risk is addressed by the
Bank's Asset Liability Committee ("ALCO"), which includes members of the
Board of Directors and senior officers of the Bank. ALCO attempts to
manage the various components of the Corporation's balance sheet to
minimize the impact of sudden and sustained changes in interest rates on
portfolio values and net interest income.
A fundamental objective is to manage its assets and liabilities to
maximize the economic value of the Bank while maintaining adequate
liquidity and minimizing exposure to interest rate risk. Management
believes an acceptable degree of exposure to interest rate risk results
from the management of assets and liabilities through maturity, pricing
and mix with the goal of limiting its exposure to interest rate risk.
The Bank's profitability is dependent to a large extent upon its net
interest income. The Bank is subject to interest rate risk to the degree
that its interest-earning assets reprice differently than its
interest-bearing liabilities.
Interest rate sensitivity analysis is used to measure the Bank's
interest rate risk by computing estimated changes in the net present
value (NPV) of its cash flows from assets, liabilities and off-balance
sheet items in the event of a range of assumed changes in market
interest rates. NPV represents the market value of portfolio equity and
is equal to the market value of assets minus the market value of
liabilities, with adjustments made for off-balance sheet items. This
analysis assesses the risk of loss in market rate sensitive instruments
in the event of sudden or sustained increases and decreases in market
interest rates of 100 basis points or more. The Bank has no trading
securities.
Management expects that, in a declining rate environment, the Bank's net
interest margin would be expected to decline, and, in an increasing rate
environment, the Bank's net interest margin would tend to increase. On
a monthly basis, management prepares an analysis of interest rate risk
exposure. Such analysis calculates the change in net interest income
given a change in general interest rates of 200 basis points up or down.
All changes are measured in dollars and are compared to projected net
interest income and the value of the Bank's equity is calculated by
discounting cash flows associated with the Bank's assets and
liabilities. The following table summarizes the simulated change in net
interest income based on the twelve months ending December 31, 2000,
given a change in general interest rates of 200 basis points up or down.
Change in Estimated Estimated Change in
Interest Rate Net Interest Income Net Interest Income
+200 18,911 93
+100 18,858 40
Base Scenario 18,818 -
-100 18,698 (120)
-200 18,575 (243)
The model utilized by management to create the report presented above
makes numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit runoff and should not be relied upon
as indicative of actual future results. Computations do not contemplate
any actions that ALCO could undertake in response to changes in interest
rates. Actual results could differ significantly from those estimates,
which would result in significant differences in the calculated
projected change.
Interest rate risk management is a function of the repricing
characteristics of the portfolio of assets and liabilities. Interest
rate risk management focuses on the maturity structure of assets and
liabilities and their repricing characteristics during periods of
changes in market interest rates. Effective interest rate risk
management seeks to ensure that both assets and liabilities respond to
changes in interest rates within an acceptable time frame, thereby
minimizing the effect of interest rate movements on net interest income.
Interest rate sensitivity is measured as the difference between the
volume of assets and liabilities in the current portfolio that are
subject to repricing at various time horizons. The differences are known
as interest rate sensitivity gaps.
The following schedule represents the Corporation's interest rate
sensitivity profile as of September 30, 2000 of assets, liabilities and
shareholders' equity classified by earliest possible repricing
opportunity or maturity date.
<TABLE>
Balance Sheet
(in thousands)
<CAPTION>
Over 3 Over 1 Non-rate
months year Sensitive
Through 3 through through 5 or Over 5
months 1 year years years Total
-------- -------- --------- -------- -------
<S> <C> <C> <C> <C> <C>
Assets
Fed funds sold &
certificates of deposit $32,029 $6,930 $32,722
Investment securities 2,992 $712 3,704
Loans (net of discounts) 178,335 182,481 $56,080 8,669 425,565
Non-interest-earning assets
(net of allowance for
loan losses) 18,883 18,883
-------- -------- -------- -------- --------
$213,356 $183,174 $56,080 $28,264 $480,874
======== ======== ======== ======== ========
Liabilities & Shareholders'
Equity
Time Deposits $100,000
and over $32,264 $27,103 $16,261 $75,628
All other interest-bearing
liabilities 208,404 65,914 33,318 $8,401 316,037
Non-interest bearing
liabilities 52,509 52,509
Other Liabilities &
Shareholders' Equity 36,700 36,700
-------- -------- -------- -------- --------
$240,668 $93,017 $49,579 $97,610 $480,874
======== ======== ======== ======== ========
Interest Rate Sensitivity (1) ($27,312) $90,157 $6,501 ($69,346)
Cumulative Interest
Rate Sensitivity ($27,312) $62,845 $69,346 -
</TABLE>
(1) Interest rate sensitivity is the difference between interest rate sensitive
assets and interest rate sensitive liabilities within the above time
frames.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings -
None other than in the ordinary course of business.
Item 2. Changes in Securities and Use of Proceeds - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits:
(3)(a) Articles of Incorporation of the Corporation (filed as Exhibit
3.1 to the Corporation's S-1 Registration Statement, filed May
18, 1984 and incorporated herein by this reference).
(b) Certificate of Amendment to Articles of Incorporation, filed
January 17, 1989 (filed as exhibit (3)(b) to the Corporation's
Annual Report on Form 10-K for the Fiscal Year Ended December
31, 1988 and incorporated herein by this reference).
(c) Bylaws of the Corporation, as amended (filed as Exhibit 3.2 to
the Corporation's S-2 Registration Statement, File No. 33-51906
filed September 11, 1992 and incorporated herein by this
reference).
(d) Amendment to the Bylaws of the Corporation and revised Bylaws
(filed as Exhibit (3)(d) to the Corporation's Annual Report on
Form 10-KSB for the Fiscal Year Ended December 31, 1994 and
incorporated herein by this reference).
(e) Secretary's certificate of Amendment to the Bylaws of the
Corporation and revised Bylaws ((filed as Exhibit (3)(e) to the
Corporation's Annual Report on Form 10-KSB for the Fiscal Year
Ended December 31, 1997 and incorporated herein by this
reference).
(27)(a) Financial Data Schedule - see attached
b. Reports on Form 8-K - None
SIGNATURES
Pursuant to the requirements of the Securities 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
Date: November 7, 2000
/s/ Dennis R. Hunter /s/ Patrick R. Gallaher
------------------------- ------------------------
Dennis R. Hunter Patrick R. Gallaher
Chairman of the Board Chief Accounting Officer
