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 June 30, 2000
--------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 2-91196
------------------------------
NORTHERN EMPIRE BANCSHARES
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
California 94-2830529
--------------------------------------------- ------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
801 Fourth Street, Santa Rosa, California 95404
------------------------------------------ ---------
(Address of principal executive offices) (Zip code)
707-579-2265
--------------------------------------------------
Registrant's telephone number, including area code)
NONE
---------------------------------------------------
(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
July 15, 2000: 3,765,493
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(dollars in thousands)
ASSETS June 30, 2000 December 31, 1999
Cash and equivalents:
Cash and due from banks $ 13,915 $ 11,030
Federal funds sold 28,861 17,029
-------- --------
Total cash and equivalents 42,776 28,059
Investment securities available-for-sale 2,982 2,970
Federal Home Loan Bank stock, at cost 539 1,165
Federal Reserve Bank stock, at cost 161 129
Loans receivable, net 392,890 357,225
Leasehold improvements and
equipment, net 857 792
Accrued interest receivable and
other assets 7,798 7,588
-------- --------
Total assets $448,003 $397,928
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $411,261 $357,867
Accrued interest payable
and other liabilities 2,539 1,949
FHLB Advances 1,839 9,050
-------- --------
Total liabilities 415,639 368,866
-------- --------
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,
3,765,493 in 2000 and
3,737,751 in 1999 18,262 15,561
Additional paid-in capital 741 646
Accumulated other comprehensive
income (loss) (10) (17)
Retained earnings 13,371 12,872
-------- --------
Total shareholders' equity 32,364 29,062
-------- --------
Total liabilities and
shareholders' equity $448,003 $397,928
======== ========
See Notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
for the three and six months ended June 30, 2000 and 1999
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
------- ------ ------- -------
<S> <C> <C> <C> <C>
(dollars in thousands, except per share data)
Interest income:
Loans $8,855 $6,820 $17,194 $13,193
Federal funds sold and
investment securities 543 306 1,056 692
------ ------ ------- -------
Total interest income 9,398 7,126 18,250 13,885
Interest expense 4,476 2,946 8,709 5,817
------ ------ ------- -------
Net interest income before
provision for loan losses 4,922 4,180 9,541 8,068
Provision for loan losses 240 200 480 320
------ ------ ------- -------
Net interest income after
provision for loan losses 4,682 3,980 9,061 7,748
------ ------ ------- -------
Other income:
Service charges on deposits 83 116 175 235
Gain on sale of loans 66 184 253 320
Other 222 176 370 351
------ ------ ------- -------
Total other income 371 476 798 906
------ ------ ------- -------
Other expenses:
Salaries and employee benefits 1,316 1,114 2,591 2,277
Occupancy 209 195 414 383
Equipment 140 133 263 246
Advertising and business development 142 108 244 193
Outside customer services 105 89 206 174
Director and shareholder expenses 67 79 143 150
Deposit and other insurance 75 53 131 105
Professional fees 78 41 124 65
Other 214 232 451 427
------ ------ ------- -------
Total other expenses 2,346 2,044 4,567 4,020
------ ------ ------- -------
Income before income taxes 2,707 2,412 5,292 4,634
Provision for income taxes 1,121 976 2,159 1,870
------ ------ ------- -------
Net income $1,586 $1,436 $3,133 $2,764
====== ====== ======= =======
Earnings per common share $ 0.42 $ 0.39 $ 0.83 $ 0.75
====== ====== ======= =======
Earnings per common share
assuming dilution $ 0.42 $ 0.38 $ 0.82 $ 0.74
====== ====== ======= =======
</TABLE>
See notes to Consolidated Financial Statements
NORTHERN EMPIRE BANCSHARES AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30, 2000 and 1999
(Unaudited)
(dollars in thousands) 2000 1999
Cash flows from operating activities:
Net income $ 3,133 $ 2,764
Adjustments to reconcile net income
to net cash provided by operating activities:
Provision for loan losses and OREO losses 480 320
Depreciation, amortization and accretion 189 178
FHLB stock dividends (40) (38)
Net increase in deferred loan fees
and discounts 3 385
Change in deferred income taxes 700 (97)
Tax benefit from stock options exercised 96 -
Increase in interest receivable and
other assets (910) (306)
Increase (decrease) in accrued interest
payable and other liabilities 590 (170)
-------- --------
Net cash provided by in operating activities 4,241 3,074
-------- --------
Cash flows from investing activities:
Purchase of restricted securities (38) (43)
Maturities of available for sale securities - 4,010
Redemption of restricted securities 666 512
Net increase in loans receivable (36,148) (36,607)
Purchase of leasehold improvements
and equipment, net (254) (94)
-------- --------
Net cash used in investing activities (35,774) (32,222)
-------- --------
Cash flows from financing activities:
Net increase in deposits 53,394 22,762
Net decrease FHLB advances (7,211) -
Payment of cash dividends (2) (4)
Stock options exercised 69 253
-------- --------
Net cash provided by financing activities 46,250 23,011
-------- --------
Net increase (decrease) in cash and
cash equivalents 14,717 (6,137)
Cash and cash equivalents at beginning of year 28,059 39,333
-------- --------
Cash and cash equivalents at end of period $ 42,776 $ 33,196
======== ========
Supplemental cash flow information:
Interest paid $ 8,734 $ 5,834
======== ========
Income taxes paid $ 1,383 $ 2,042
======== ========
Additions to other real estate owned $ 940 $ 238
======== ========
See notes to Consolidated Financial Statements
Northern Empire Bancshares and Subsidiary
Notes to Consolidated Financial Statements
June 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 June
30, 2000 and the results of operations for the three and six 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 six months ended June 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:
<TABLE>
<CAPTION>
For the three months ended For the three months ended
June 30, 2000 June 30, 1999
Per Per
Income/ Shares/ Share Income/ Shares/ Share
Numerator Denominator Amount Numerator Denominator Amount
------------------------------- -----------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Income $1,584,000 $1,436,000
========== ==========
EPS - Income available
to common stockholders $1,584,000 3,765,462 $0.42 $1,436,000 3,720,868 $0.39
========== ===== ========== =====
Effect of Dilutive
Securities-Stock
Options 26,906 53,222
--------- --------
EPS assuming dilution -
Income available to
common stockholders
plus assumed
conversion $1,584,000 3,792,368 $0.42 $1,436,000 3,760,722 $0.38
========== ========= ===== ========== ========= =====
</TABLE>
<TABLE>
<CAPTION>
For the six months ended For the six months ended
June 30, 2000 June 30, 1999
Per Per
Income/ Shares/ Share Income/ Shares/ Share
Numerator Denominator Amount Numerator Denominator Amount
------------------------------- -----------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Income $3,133,000 $2,764,000
========== ==========
EPS - Income available
to common stockholders $3,133,000 3,754,343 $0.83 $2,764,000 3,678,461 $0.75
========== ===== ========== =====
Effect of Dilutive
Securities - Stock
Options 46,343 53,222
--------- ---------
EPS assuming dilution -
Income available to
common stockholders
plus assumed
conversion $3,133,000 3,800,686 $0.82 $2,764,000 3,734,344 $0.74
========== ========= ===== ========== ========= =====
</TABLE>
Note 3 - Comprehensive Income
The Corporation's total comprehensive earnings presentation is as
follows:
For the three For the six
months ended months ended
June 30, June 30,
2000 1999 2000 1999
---- ---- ---- -----
(In thousands)
Net Income $1,586 $1,436 $3,133 $2,764
Other Comprehensive income (loss):
Change in unrealized holding
gain (losses) arising during
the period 9 (12) 12 (15)
Reclassification adjustment for
gains included in net income - - - (4)
Income tax benefit (expense) 4 (5) 4 (8)
------ ------ ------ ------
5 (7) 8 (11)
------ ------ ------ ------
Comprehensive income $1,591 $1,429 $3,142 $2,753
====== ====== ====== ======
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Northern Empire Bancshares 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 $448,003,000 at June 30, 2000 compared
to $397,928,000 at December 31, 1999. Cash and cash equivalents
decreased $14.7 million since year end. Net loans increased $35.7
million since year end with $29.0 million occurring in the second
quarter.
Net income after tax for the first six months of 2000 equaled $3,133,000
compared to $2,764,000 for the comparable period last year, an increase
of 13.3%. The second quarter's net income of $1,586,000 increased 10.4%
over the second quarter of 1999 when net income equaled $1,436,000. 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 $4,922,000
for the second quarter of 2000 increased 17.8% from $4,180,000 for the
comparable period last year. This increase in net interest income
resulted from volume increases of $91.8 million in average earning
assets for the second quarter of 2000 compared to the second quarter of
1999. Average loans outstanding increased $82.5 million over the second
quarter of 1999 while investments and fed funds sold increased $9.3
million. Average interest bearing deposits for the second quarter
increased $80.3 million over the same period last year.
The net interest margin equaled 4.77% during the second quarter of 2000
compared to an average margin of 5.03% for the full year of 1999. The
yield on average loans equaled 9.37% in the second 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 5.20%
during the second quarter of 2000 which also results from increasing
deposit rates during the past year.
Several factors impact the Bank's interest margin. The mix of loans
influences the overall yield on loans. During the second quarter of
2000, there was significant growth 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 relatively unchanged. 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 96.9% during the second quarter
of 1999 to 97.6% for the same period this year, this increase has a
positive impact on net interest margin.
The Bank is considered asset sensitive and benefits from rate increases,
since more of its assets reprice at a faster rate than deposits. The
Prime lending rate was 9.5% on June 30, 2000 compared to 7.75% at June
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. 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 $399.8 million at June 30, 2000, $309.5 million or
77.4% of the loans are adjustable rate loans which have not reached a
floor or ceiling rate. Approximately $136.9 million are prime-based
loans, of which $42.3 million reprice immediately and $94.6 million
reprice on a quarterly basis. Approximately $167.1 million of the
Bank's loan portfolio is periodically adjustable (generally every six
months) based upon the Eleventh District's Cost of Funds Index (COFI) in
effect 45 days before the change date. This repricing index in effect
at June 30, 1999 was 4.49% compared to 5.08% at June 30, 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 had a negative impact on the net interest margin.
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 June 30, 1999 the Bank had $24,000 classified as non-accrual loans
compared to $1,474,000 at the end of this quarter. This increase has
negatively impacted net interest margin. Management continually monitors
the loan portfolio for potential problem loans and expects to have
non-accrual loans with a loan portfolios 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".
Interest expense increased from $2,946,000 in the second quarter of 1999
to $4,476,000 in 2000. The major factor was the increase of $82.9
million in average interest bearing liabilities when comparing the
second quarter of 1999 to 2000. The average cost of interest bearing
liabilities increased from 4.50% to 5.21% when comparing the second
quarter of last year to the second 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 which approximates 27% of total deposits. The rate on this account
increased from an average of 3.89% in the second quarter of 1999 to
4.99% this quarter which was a major factor in the increase of 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.
The following is an analysis of the net interest margin:
<TABLE>
<CAPTION>
Three months ended Three months ended
June 30, 2000 June 30, 1999
Average Average
Balance Interest Yield Balance Interest Yield
-------- -------- ----- -------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
Earning assets(1) $415,237 $9,398 9.10% $323,588 $7,126 8.83%
Interest bearing liabilities 345,527 4,476 5.21% 262,589 2,946 4.50%
------ ------
Net interest income $4,922 $4,180
====== ======
Net Interest income to
earning assets 4.77% 5.18%
===== =====
<FN>
(1) Non-accrual loans are included in the calculation of average
balance of earning assets, and interest not accrued is excluded.
</TABLE>
<TABLE>
<CAPTION>
Six months ended Six months ended
June 30, 2000 June 30, 1999
Average Average
Balance Interest Yield Balance Interest Yield
-------- -------- ----- -------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
Earning assets (1) $408,784 $18,253 8.98% $315,148 $13,885 8.88%
Interest bearing liabilities 341,176 8,712 5.14% 257,234 5,817 4.56%
------- -------
Net interest income $9,541 $8,068
======= =======
Net Interest income to
earning assets 4.69% 5.16%
===== =====
<FN>
(1) Non-accrual loans are included in the calculation of average
balance of earning assets, and interest not accrued is excluded.
</TABLE>
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 six months ended June 30, 2000
and 1999. Changes not solely attributable to rate or volume have been
allocated to rate.
For the three months ended June 30, 2000
over June 30, 1999
Volume Yield/Rate Total
(dollars in thousands) ------ ---------- ------
Increase (decrease) in interest income:
Portfolio loans $1,902 $133 $2,035
Other earning assets 110 127 237
------ ------ ------
Total increase (decrease) 2,012 260 2,272
------ ------ ------
Increase in interest expense
Interest-bearing transaction accounts 212 302 514
Time deposits 723 256 979
Other borrowings 34 3 37
------ ------ ------
Total increase 969 561 1,530
------ ------ ------
Increase (decrease) in net interest income $1,043 $(301) $742
====== ====== ======
For the six months ended June 30, 2000
over June 30, 1999
Volume Yield/Rate Total
(dollars in thousands) ------ ---------- ------
Increase (decrease) in interest income:
Portfolio loans $4,025 ($24) $4,001
Other earning assets 184 180 364
------ ------ ------
Total increase (decrease) 4,209 156 4,365
------ ------ ------
Increase in interest expense
Interest-bearing transaction accounts 395 588 983
Time deposits 1,506 289 1,795
Other borrowings 104 10 114
------ ------ ------
Total increase 2,005 887 2,892
------ ------ ------
Increase (decrease) in net interest income $2,204 ($731) $1,473
====== ====== ======
Provision for Loan Losses
The provision for loan losses equaled $240,000 for the three months
ended June 30, 2000 and $480,000 for the first six months of 2000
compared to $200,000 and $320,000 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 $371,000 for
the second quarter of this year compared to $476,000 for the same period
last year.
Service charges on deposit accounts decreased from $116,000 during the
second quarter of 1999 to $83,000 during the second quarter of 2000. A
portion of this fluctuation is partially 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, have 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 second quarter of 2000, the Bank sold the guaranteed portion of
SBA loans totaling $1.6 million and recognized gains on those sales of
$66,000. During the second quarter of 1999, the Bank sold the
guaranteed portion of SBA loans totaling $3.8 million and the Bank
recognized gains on those sales of $184,000. 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 $69,000 during the second quarter of
2000, was slightly below last year's level of $70,000 for the same
period. The serviced portfolio equaled $26.7 million at June 30, 1999
compared to $30.4 million at the end of the second quarter of 2000.
The Bank sold other real estate owned (OREO) during this quarter
resulting in a gain of $39,000. The Bank had no properties classified
as OREO at the end of this quarter. In 1999 there were no OREO gains or
losses during the second quarter and the Bank held $283,000 as OREO at
the end of the second quarter.
Non-Interest Expenses
The Bank's non-interest expenses increased from $2,044,000 in the second
quarter of last year to $2,346,000 for the second 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 18.1% from $1,114,000 to $1,316,000. The Bank added a new
branch in Sebastopol and a loan production office in Walnut Creek which
added six new staff positions since June of last year. The record level
of loan and deposit growth has resulted in higher incentive payments
during this quarter. Personnel costs were also affected by annual salary
increases and changes in benefit costs.
Occupancy expenses increased 7.2%, mainly due to the new branch and loan
production office. Equipment costs increased 5.3% over the comparable
quarter last year due to growth. The Bank continues to upgrade computer
equipment and operations. The use of personal computers continues to
expand since the network was installed two years ago. The Bank
installed a new teller system during this quarter.
Deposit and other insurance of $75,000 includes an increase of $22,000
over the second 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 increased due to Bank growth and
additions to the Bank's insurance coverage which resulted in higher
premiums.
Professional fees increased by $37,000 from the second quarter of 1999
to $78,000 in the second quarter of 2000. Legal expenses increased this
quarter due to services provided on the sale of OREO property and other
problem loans. The Bank has experience an increase in problem loans;
however, these still remain at a low level when compared to the Bank's
peer group. See "Allowance for Loan Losses."
Advertising and business development costs increased to $142,000 from
$108,000 in the second quarter of 1999. This expense category can vary
significantly based on activity during the period and the need to
promote loan and deposit products. Outside customer services increased
due to new customers using the Bank's analysis system which added
expense charges. Other expenses, which includes stationery & supplies,
telephone, postage, loan expenses, dues and subscriptions and automobile
costs, have increased due to Bank growth.
Total non-interest expenses for the SBA lending department for the
second quarter was approximately $483,000 (including $267,000 in
personnel costs, $67,000 in occupancy and equipment expenses, $42,000 in
marketing/business development) compared to $412,000 for the second
quarter of 1999. The SBA department's expenses vary depending upon loan
activity. In addition, there has been an increase in staff levels. At
June 30, 2000, the SBA loan portfolio (serviced portion and Bank's
portion) equaled $124.4 million, of which $30.4 million has been sold
and is being serviced.
Income Taxes
The effective tax rate was 41.4% for the second quarter of 2000. The
provision for the second quarter of 2000 was $1,121,000 versus $976,000
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 $42.8 million or
9.5% of total assets at June 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 June 30, 2000 the Bank
held $62.1million in SBA guaranteed loans which could be sold if
additional liquidity was needed.
At June 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 under FHLB's blanket lien agreement,
secured by a pool of real estate loans, the Bank has $9.6 million
available to borrow. 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 June 30, 2000, the Corporation had non-interest and interest bearing
cash balances of $221,000, 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 second quarter of 2000 total deposits increased by $13.2
million to $411.3 million at June 30, 2000.
Money market rate deposits equaled $121.1 million at June 30, 2000.
This is a limited transaction account which pays a floating rate equal
to 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 $216.3 million as of June 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 June 30, 2000, non-interest bearing deposits equaled $53.6 million
compared to $40.4 million at December 31, 1999 and $48.7 million on June
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 $392.9 million at June 30,
2000 compared to $357.2 million at December 31, 1999, increasing 10.0%
over year end and 29.8% over the June 30,1999 balance of $302.6. The
following is an analysis of the loan portfolio.
Type of Loan
(in thousands)
June 30, 2000 December 31, 1999
------------- -----------------
Commercial $128,745 $130,924
Real Estate Construction 34,266 39,523
Real Estate Other 235,144 191,472
Installment Loans to Individuals 1,665 1,783
-------- --------
399,820 363,702
Deferred loan fees and discount (2,693) (2,690)
Allowance for loan losses (4,237) (3,787)
-------- --------
TOTAL $392,890 $357,225
======== ========
The SBA loan program continued to be a popular program; however,
competition continues to be strong in our market area. At June 30, 2000,
SBA loans equaled $93.9 million, net of $30.4 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 $57.9 million to $62.1 million when
comparing June 30, 1999 to June 30, 2000.
The Bank continues to emphasize commercial and real estate lending. At
June 30, 2000, 32.2% of the loans held for investment were commercial
loans and 67.4% 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 $17.8 million at June 30, 1998 to $26.3 million at June
30, 1999 to its June 30, 2000 balance of $34.3 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 0.4% of
the total loan portfolio at June 30, 2000 and 0.5% at December 31, 1999.
Allowance for Loan Losses
The allowance for loan losses equaled $4.2 million at June 30, 2000,
compared to $3.8 million at December 31, 1999. At June 30, 2000, the
allowance for loan losses equaled 1.3% of loans, net of the guaranteed
portion of SBA loans . The allowance for loan losses is reviewed on a
monthly basis, based upon an allocation for each loan category, plus an
allocation for any outstanding loans which have been classified by
regulators or internally for the "Watch List". Each loan that has been
classified is individually analyzed for the risk involved with a
specific reserve allocation assigned according to the risk assessment.
At June 30, 2000, there were six loans on non-accrual totaling
$1,474,000 all were collateralized by real estate and $966,000 of which
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
$2,046,000 of which $1,556,000 was collateralized by real estate and
$17,000 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 second quarter of 2000 there were $30,000 in loan charge offs
which constitutes total charge offs for the year-to-date. During the
first six months of 1999 there was $19,000 in charge offs and no
recoveries. 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 Six months ended
June 30, 2000 June 30, 2000
------------- ----------------
Balance - Beginning of period $4,027 $3,787
Provision for loan losses 240 480
Charge offs 30 30
Recoveries 0 0
------ ------
Balance - End of period $4,237 $4,237
====== ======
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 June 30,
2000, the Bank was considered "well capitalized." The total risk-based
capital ratios were 10.6% for the Bank and 10.7% 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 and sustained increases and decreases in market
interest rates of 100 basis points. 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 $19,070 $528
+100 18,954 416
Base Scenario 18,542 -
-100 18,365 (177)
-200 18,166 (376)
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 interest rate sensitivity profile as
of June 30, 2000 of assets, liabilities and shareholders' equity
classified by earliest possible repricing opportunity or maturity date.
<TABLE>
<CAPTION>
Over 3 Over Non-rate
months 1 Year Sensitive
(in thousands) Through 3 Through Through or Over 5
months 1 year 5 Years Years Total
<S> <C> <C> <C> <C> <C>
Assets
Fed funds sold & certificates
of deposit $28,861 $693 $29,554
Investment securities 2,982 $700 3,682
Loans (net of discounts) 151,005 183,038 $53,317 9,767 397,127
Non-interest-earning assets
(net of allowance for loan losses) 17,640 17,640
-------- -------- -------- -------- --------
$179,866 $186,713 $53,317 $28,107 $448,003
======== ======== ======== ======== ========
Liabilities & Shareholders' Equity
Time Deposits $100,000 and over $15,915 $44,341 $9,201 $69,457
All other interest-bearing
liabilities 164,276 94,340 23,747 $7,799 290,162
Non-interest bearing liabilities 53,481 53,481
Other Liabilities &
Shareholders' Equity 34,903 34,903
-------- -------- -------- -------- --------
$180,191 $138,681 $32,948 $96,183 $448,003
======== ======== ======== ======== ========
Interest Rate Sensitivity (1) ($325) $48,032 $20,369 ($68,076)
Cumulative Interest
Rate Sensitivity ($325) $47,707 $68,076 -
</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
The Annual Meeting of Shareholders of the Corporation was held on
May 16, 2000. The following candidates received the votes indicated.
Withheld/Abstained/
For Broker Non-Votes
Clement C. Carinalli 3,064,930 21,140
Patrick R. Gallaher 3,064,930 21,140
William P. Gallaher 3,063,595 22,475
William E. Geary 3,064,930 21,140
James B. Keegan, Jr. 3,064,930 21,140
Dennis R. Hunter 3,064,930 21,140
Robert V. Pauley 3,061,443 24,627
All candidates were re-elected.
No other matters were voted on at the meeting.
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: August 10, 2000
---------------------
/s/ Dennis R. Hunter /s/ Patrick R. Gallaher
----------------------- ---------------------------
Dennis R. Hunter Patrick R. Gallaher
Chairman of the Board Chief Accounting Officer
<PAGE>
Exhibit (27)(a) Financial Data Schedule
