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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 (FEE REQUIRED)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
Commission file number: 0-19231
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REDWOOD EMPIRE BANCORP
(Exact name of Registrant as specified in its charter)
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CALIFORNIA 68-0166366
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification
No.)
111 SANTA ROSA AVENUE, SANTA ROSA, 95404-4905
CALIFORNIA
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (707) 573-4800
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Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par
value.
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed under 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 the
filing requirements for the past 90 days. Yes _X_ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X]
The aggregate market value of the Registrant's common stock held by
non-affiliates on March 1, 1999 (based on the closing sale price of the Common
Stock) was $54,235,900.
As of March 1, 1999 there were 3,379,656 shares outstanding of the
Registrant's common stock.
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TABLE OF CONTENTS
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PART I
Forward-Looking Information................................................................................ 3
Item 1. Business..................................................................................... 3
Item 2. Properties................................................................................... 14
Item 3. Legal Proceedings............................................................................ 14
Item 4. Submission of Matters to A Vote of Securities Holders........................................ 14
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.................... 14
Item 6. Selected Financial Data...................................................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........ 16
Item 7a. Quantitative and Qualitative Disclosures about Market Risk................................... 40
Item 8. Financial Statements and Supplementary Data.................................................. 43
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure......... 78
PART III
Item 10. Directors and Executive Officers of the Registrant........................................... 79
Item 11. Executive Compensation....................................................................... 81
Item 12. Security Ownership of Certain Beneficial Owners and Management............................... 86
Item 13. Certain Relationships and Related Transactions............................................... 88
PART IV
Item 14. Exhibits, Financial Statements, Financial Statements Schedules and Reports on Form 8-K....... 89
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PART I
FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K includes forward-looking information which
is subject to the "safe harbor" created by the Securities Act of 1933 and
Securities Exchange Act of 1934. These forward-looking statements (which involve
the Company's plans, beliefs and goals, refer to estimates or use similar terms)
involve certain risks and uncertainties that could cause actual results to
differ materially from those in the forward-looking statements. Such risks and
uncertainties include, but are not limited to, the following factors:
- Competitive pressure in the banking and mortgage industry and changes in
the regulatory environment.
- Changes in the interest rate environment and volatility of rate sensitive
deposits.
- Declines in the health of the economy nationally or regionally which could
reduce the demand for loans or reduce the value of real estate collateral
securing most of the Company's loans.
- Credit quality deterioration which could cause an increase in the
provision for loan losses.
- Risks associated with the Year 2000 which could cause disruptions in the
Company's operations or increase expenses.
- Losses in the Company's merchant credit card processing business.
- Changes in the securities markets.
- Asset/Liability matching risks and liquidity risks.
The Company undertakes no obligation to revise or publicly release the
results of any revision to these forward-looking statements. For additional
information concerning risks and uncertainties related to the Company and its
operations please refer to Certain Important Considerations for Investors in
Item 1, Management's Discussion and Analysis of Financial Condition and Results
of Operations in Item 7 and other information in this Report.
ITEM 1. BUSINESS
Redwood Empire Bancorp ("Redwood," and with its subsidiaries, the "Company")
is a financial institution holding company headquartered in Santa Rosa,
California, and operating in Northern California through one principal
subsidiary, National Bank of the Redwoods, a national bank ("NBR" or the
"Bank"). A previously owned subsidiary of the Company, Allied Bank, F.S.B., a
federal savings bank ("Allied") merged with its sister subsidiary, NBR, in March
1997.
(a) GENERAL DEVELOPMENT OF BUSINESS.
Redwood is a California corporation, headquartered in Santa Rosa,
California. Its wholly-owned subsidiary is NBR, a national bank which was
chartered in 1985. In addition, NBR has three wholly-owned California chartered
subsidiaries, Valley Mortgage Corporation and Allied Diversified Credit, and
Redwood Empire Datacorp which are currently inactive. Redwood was created by NBR
in August 1988, in order to become a bank holding company through the
acquisition of all of NBR's outstanding shares. That transaction was consummated
in January 1989. Redwood acquired Allied in September 1990, through a tax-free
reorganization in which Redwood exchanged shares of its stock for all of the
outstanding shares of Allied. The acquisition of Allied was accounted for as a
pooling of interests for financial reporting purposes.
On October 31, 1992, Lake Savings and Loan Association, a one-branch
California chartered savings and loan based in Lakeport, California ("Lake"),
was purchased for approximately $2,300,000 in cash, and
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merged into Allied. At the time of its acquisition Lake had total assets of
approximately $41 million. The acquisition was accounted for as a purchase.
On November 4, 1994, Codding Bank, a multiple-branch California chartered
bank based in Rohnert Park, California ("Codding"), was purchased for $7,028,000
in cash, including merger related expenses, and merged into NBR. At the merger
date, the fair value of the assets acquired totalled approximately $42 million.
In November 1996, the Board of Directors of the Company voted to merge
Allied into NBR. On February 3, 1997, NBR received approval from the Office of
the Comptroller of the Currency to merge Allied into NBR. The merger was
consummated March 24, 1997. The combination of the two wholly-owned subsidiaries
of Redwood was structured as a merger transaction wherein Allied has merged into
NBR with NBR as the survivor. As a result of the merger NBR assumed all of
Allied's rights and obligations. Allied ceased to exist as a federally chartered
savings institution upon the merger.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
During the year ended December 31, 1998, the Company operated in four
principal industry segments: core community banking, merchant card services, sub
prime lending, and residential mortgage banking and brokerage. The Company's
core community banking industry segment includes commercial, commercial real
estate, construction, and permanent residential lending along with all
depository activities. The Company's merchant card services industry group
provides credit card settlement services for 30,000 merchants throughout the
United States. The Company's sub prime lending unit, known as Allied Diversified
Credit, provides sub prime residential loans for homeowners located principally
in Northern California. The Company's residential mortgage banking and brokerage
arm, known as Valley Financial, provides mortgage brokerage services, the
origination for sale of "A paper" loans, and the servicing of loans for
investors. For further discussion see "Management Discussion and Analysis of
Financial Condition and Results of Operations" in Item 7.
(c) NARRATIVE DESCRIPTION OF BUSINESS.
The Company's business strategy involves four principal business activities
which are conducted through NBR.
NBR provides its core community banking services through five retail
branches located in Sonoma County, California, one retail branch located in
Mendocino County, California, and one retail branch located in Lake County,
California. NBR generally extends commercial loans to professionals and to
businesses with annual revenues of less than $10 million. Commercial loans are
primarily for working capital, asset acquisition and commercial real estate.
NBR's targeted commercial banking market area includes the California counties
north of San Francisco. As a Preferred Lender under the Small Business
Administration ("SBA") Loan Guarantee Program, NBR generates noninterest income
through premiums received on the sale of the guaranteed portions of SBA loans
and the resulting on-going servicing income on its SBA portfolio. NBR also
originates commercial and residential construction loans for its portfolio.
The primary sources of funds for the Company's commercial and residential
lending programs are local deposits, proceeds from loan sales, loan payments,
and other borrowings. The Company attracts deposits primarily from local
businesses, professionals and retail customers. The Company generally does not
purchase deposits through deposit brokers and had no brokered deposits at
December 31, 1998. In addition to deposits, the Company may obtain other
borrowed funds through its membership in the Federal Home Loan Bank of San
Francisco (the "FHLB") and its retention of treasury, tax and loan funds at the
Federal Reserve Bank of San Francisco.
The Company provides Visa and Mastercard credit card processing and
settlement services for roughly 30,000 merchants located throughout the United
States. Yearly processing volume is in excess of $1 billion. The Company's
merchant card services customer base is made up of merchants located in its
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primary market area and merchants who have been acquired by the Company through
the use of independent sales organizations, or ISO's.
The Company's mortgage banking business consists of the origination of
one-to-four family residential mortgage loans which predominantly conform to the
underwriting standards set by Fannie Mae, Freddie Mac or other institutional
mortgage conduits. These loans are commonly referred to as "A paper" loans. The
Company acquires these mortgage loans predominantly on a retail basis. NBR also
provides mortgage loan brokerage services to retail customers through its Valley
Financial division. Substantially all mortgage loan originations are packaged
and sold into the secondary market. NBR sells substantially all the servicing
rights on the mortgage loans it sells and from time to time may purchase
mortgage loan servicing rights from other companies, thereby generating ongoing
servicing fees. In addition, Valley Financial provides mortgage loan brokerage
services for its customers. Valley Financial maintains brokerage relationships
with approximately 50 mortgage lenders in California.
Valley Financial's primary market area is the San Francisco Bay Area with an
emphasis on the East Bay Counties of Contra Costa and Alameda and the North Bay
Counties with an emphasis on Sonoma County. Valley Financial also provides
mortgage loan origination services to 38 credit unions located in California,
Washington, Maryland, Florida and Colorado.
The Company originates mortgage loans through its Allied Diversified Credit
("ADC") division that do not comply with all standards established by Fannie Mae
or Freddie Mac. These loans are commonly referred to as "Sub Prime" loans and
are acquired by ADC on a wholesale and retail basis.
The Company is regulated by various government agencies, with the primary
regulators being the Board of Governors of the Federal Reserve System (the
"FRB"), the Office of the Comptroller of the Currency (the "OCC") and the
Federal Deposit Insurance Corporation (the "FDIC").
The Company and its subsidiaries had 308 full-time-equivalent employees at
December 31, 1998. Redwood's headquarters are located at 111 Santa Rosa Avenue,
Santa Rosa, California 95404-4905, and its telephone number is (707) 573-4800.
PRIMARY MARKET AREA
The Company's deposit market area is Sonoma, Mendocino and Lake Counties,
California. Sonoma, Mendocino and Lake Counties have benefited from the
migration of population and businesses into the area, as well as growth in
established firms and industries. These counties have generally exceeded the
growth in population and economic activity of California as a whole.
REGULATION AND SUPERVISION
THE EFFECT OF GOVERNMENT POLICY ON BANKING
The earnings and growth of the Company are affected not only by local market
area factors and general economic conditions, but also by government monetary
and fiscal policies. For example, the FRB influences the supply of money through
its open market operations in U.S. Government securities and adjustments to the
discount rates applicable to borrowings by depository institutions and others.
Such actions influence the growth of loans, investments and deposits and also
affect interest rates charged on loans and paid on deposits. The nature and
impact of future changes in such policies on the business and earnings of the
Company cannot be predicted. Additionally, state and federal tax policies can
impact banking organizations.
As a consequence of the extensive regulation of commercial banking
activities in the United States, the business of the Company is particularly
susceptible to being affected by the enactment of federal and state legislation
which may have the effect of increasing or decreasing the cost of doing
business, modifying permissible activities or enhancing the competitive position
of other financial institutions. Any change in
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applicable laws or regulations may have a material adverse effect on the
business and prospects of the Company.
REGULATION AND SUPERVISION OF BANK HOLDING COMPANIES
The Company is a bank holding company subject to the Bank Holding Company
Act of 1956, as amended ("BHCA"). The Company reports to, registers with, and
may be examined by, the FRB. The FRB also has the authority to examine the
Company's subsidiaries. The costs of any examination by the FRB are payable by
the Company.
The FRB has significant supervisory and regulatory authority over the
Company and its affiliates. The FRB requires the Company to maintain certain
levels of capital. See "Capital Standards." The FRB also has the authority to
take enforcement action against any bank holding company that commits any unsafe
or unsound practice, or violates certain laws, regulations or conditions imposed
in writing by the FRB. See "Prompt Corrective Action and Other Enforcement
Mechanisms."
Under the BHCA, a company generally must obtain the prior approval of the
FRB before it exercises a controlling influence over a bank, or acquires
directly or indirectly, more than 5% of the voting shares or substantially all
of the assets of any bank or bank holding company. Thus, the Company is required
to obtain the prior approval of the FRB before it acquires, merges or
consolidates with any bank or bank holding company; any company seeking to
acquire, merge or consolidate with the Company also would be required to obtain
the prior approval of the FRB.
The Company is generally prohibited under the BHCA from acquiring ownership
or control of more than 5% of the voting shares of any company that is not a
bank or bank holding company and from engaging directly or indirectly in
activities other than banking, managing banks or providing services to
affiliates of the holding company. However, a bank holding company, with the
approval of the FRB, may engage, or acquire the voting shares of companies
engaged, in activities that the FRB has determined to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto. A
bank holding company must demonstrate that the benefits to the public of the
proposed activity will outweigh the possible adverse effects associated with
such activity.
A bank holding company may acquire banks in states other than its home state
without regard to the permissibility of such acquisitions under state law, but
subject to any state requirement that the acquired bank has been organized and
operating for the minimum period of time and providing that the bank holding
company, prior to or following the proposed acquisition, controls no more than
10% of the total amount of deposits of insured depository institutions in the
United States and no more than 30% of such deposits in that state (or such
lesser or greater amount set by state law). Banks may also merge across state
lines, creating interstate branches. Furthermore, a bank may open new branches
in a state in which it does not already have banking operations, if the laws of
such state permit such DE NOVO branching.
Under California law, (a) out-of-state banks that wish to establish a
California branch office to conduct core banking business must first acquire an
existing five year old California bank or industrial loan company by merger or
purchase; (b) California state-chartered banks are empowered to conduct various
authorized branch-like activities on an agency basis through affiliated and
unaffiliated insured depository institutions in California and other states and
(c) the Commissioner is authorized to approve an interstate acquisition or
merger which would result in a deposit concentration exceeding 30% if the
Commissioner finds that the transaction is consistent with public convenience
and advantage. However, a state bank chartered in a state other than California
may not enter California by purchasing a California branch office of a
California bank or industrial loan company without purchasing the entire entity
or by establishing a de novo California bank.
The FRB generally prohibits a bank holding company from declaring or paying
a cash dividend which would impose undue pressure on the capital of subsidiary
banks or would be funded only through
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borrowing or other arrangements that might adversely affect a bank holding
company's financial position. The FRB's policy is that a bank holding company
should not continue its existing rate of cash dividends on its common stock
unless its net income is sufficient to fully fund each dividend and its
prospective rate of earnings retention appears consistent with its capital
needs, asset quality and overall financial condition. See the section entitled
"Restrictions on Dividends and Other Distributions" for additional restrictions
on the ability on the Company and the Bank to pay dividends.
Transactions between the Company and the Bank are subject to a number of
other restrictions. FRB policies forbid the payment by bank subsidiaries of
management fees which are unreasonable in amount or exceed the fair market value
of the services rendered (or, if no market exists, actual costs plus a
reasonable profit). Subject to certain limitations, depository institution
subsidiaries of bank holding companies may extend credit to, invest in the
securities of, purchase assets from, or issue a guarantee, acceptance, or letter
of credit on behalf of, an affiliate, provided that the aggregate of such
transactions with affiliates may not exceed 10% of the capital stock and surplus
of the institution, and the aggregate of such transactions with all affiliates
may not exceed 20% of the capital stock and surplus of such institution. The
Company may only borrow from depository institution subsidiaries if the loan is
secured by marketable obligations with a value of a designated amount in excess
of the loan. Further, the Company may not sell a low-quality asset to a
depository institution subsidiary.
Comprehensive amendments to Regulation Y became effective in 1997, and are
intended to improve the competitiveness of bank holding companies by, among
other things: (i) expanding the list of permissible nonbanking activities in
which well-run bank holding companies may engage without prior FRB approval,
(ii) streamlining the procedures for well-run bank holding companies to obtain
approval to engage in other nonbanking activities and (iii) eliminating most of
the anti-tying restrictions imposed upon bank holding companies and their
nonbank subsidiaries. Amended Regulation Y also provides for a streamlined and
expedited review process for bank acquisition proposals submitted by well-run
bank holding companies and eliminates certain duplicative reporting requirements
when there has been a further change in bank control or in bank directors or
officers after an earlier approved change. These changes to Regulation Y are
subject to numerous qualifications, limitations and restrictions. In order for a
bank holding company to qualify as "well-run," both it and the insured
depository institutions that it controls must meet the "well-capitalized" and
"well-managed" criteria set forth in Regulation Y.
To qualify as "well-capitalized," the bank holding company must, on a
consolidated basis: (i) maintain a total risk-based capital ratio of 10% or
greater; (ii) maintain a Tier 1 risk-based capital ratio of 6% or greater; and
(iii) not be subject to any order by the FRB to meet a specified capital level.
Its lead insured depository institution must be well-capitalized as that term is
defined in the capital adequacy regulations of the applicable bank regulator,
80% of the total risk-weighted assets held by its insured depository
institutions must be held by institutions that are well-capitalized, and none of
its insured depository institutions may be undercapitalized.
To qualify as "well-managed": (i) each of the bank holding company, its lead
depository institution and its depository institutions holding 80% of the total
risk-weighted assets of all its depository institutions at their most recent
examination or review must have received a composite rating, rating for
management and rating for compliance which were at least satisfactory; (ii) none
of the bank holding company's depository institutions may have received one of
the two lowest composite ratings; and (iii) neither the bank holding company nor
any of its depository institutions during the previous 12 months may have been
subject to a formal enforcement order or action.
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BANK REGULATION AND SUPERVISION
As a national bank, the Bank is regulated, supervised and regularly examined
by the OCC. Deposit accounts at the Bank are insured by the Bank Insurance Fund
("BIF") and the Savings Institution Insurance Fund ("SAIF"), as administered by
the FDIC, to the maximum amount permitted by law. The Bank is also subject to
applicable provisions of California law, insofar as such provisions are not in
conflict with or preempted by federal banking law. The Bank is a member of the
Federal Reserve System, and is also subject to certain regulations of the FRB
dealing primarily with check clearing activities, establishment of banking
reserves, Truth-in-Lending (Regulation Z), Truth-in-Savings (Regulation DD), and
Equal Credit Opportunity (Regulation B).
The OCC may approve, on a case-by-case basis, the entry of bank operating
subsidiaries into a business incidental to banking, including activities in
which the parent bank is not permitted to engage. A national bank is permitted
to engage in activities approved for a bank holding company through a bank
operating subsidiary, such as acting as an investment or financial advisor,
leasing personal property and providing financial advice to customers. In
general, these activities are permitted only for well-capitalized or adequately
capitalized national banks.
CAPITAL STANDARDS
The federal banking agencies have risk-based capital adequacy guidelines
intended to provide a measure of capital adequacy that reflects the degree of
risk associated with a banking organization's operations for both transactions
reported on the balance sheet as assets and transactions, such as letters of
credit and recourse arrangements, which are recorded as off balance sheet items.
Under these guidelines, nominal dollar amounts of assets and credit equivalent
amounts of off balance sheet items are multiplied by one of several risk
adjustment percentages, which range from 0% for assets with low credit risk,
such as certain U.S. government securities, to 100% for assets with relatively
higher credit risk, such as certain loans.
In determining the capital level the Company and the Bank are required to
maintain, the federal banking agencies do not, in all respects, follow generally
accepted accounting principles ("GAAP") and have special rules which have the
effect of reducing the amount of capital they will recognize for purposes of
determining the capital adequacy of the Bank.
A banking organization's risk-based capital ratios are obtained by dividing
its qualifying capital by its total risk-adjusted assets and off balance sheet
items. The regulators measure risk-adjusted assets and off balance sheet items
against both total qualifying capital (the sum of Tier 1 capital and limited
amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists of common
stock, retained earnings, noncumulative perpetual preferred stock, other types
of qualifying preferred stock and minority interests in certain subsidiaries,
less most other intangible assets and other adjustments. Net unrealized losses
on available-for-sale equity securities with readily determinable fair value
must be deducted in determining Tier 1 capital. For Tier 1 capital purposes,
deferred tax assets that can only be realized if an institution earns sufficient
taxable income in the future are limited to the amount that the institution is
expected to realize within one year, or ten percent of Tier 1 capital, whichever
is less. Tier 2 capital may consist of a limited amount of the allowance for
possible loan and lease losses, term preferred stock and other types of
preferred stock not qualifying as Tier 1 capital, term subordinated debt and
certain other instruments with some characteristics of equity. The inclusion of
elements of Tier 2 capital are subject to certain other requirements and
limitations of the federal banking agencies. The federal banking agencies
require a minimum ratio of qualifying total capital to risk-adjusted assets and
off balance sheet items of 8%, and a minimum ratio of Tier 1 capital to adjusted
average risk-adjusted assets and off balance sheet items of 4%.
On October 1, 1998, the OCC adopted two rules governing minimum capital
levels that OCC-supervised banks must maintain against the risks to which they
are exposed. The first rule makes risk-based capital standards consistent for
two types of credit enhancements (i.e., recourse arrangements
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and direct credit substitutes) and requires different amounts of capital for
different risk positions in asset securitization transactions. The second rule
permits limited amounts of unrealized gains on debt and equity securities to be
recognized for risk-based capital purposes as of September 1, 1998. The OCC
rules also provide that a qualifying institution that sells small business loans
and leases with recourse must hold capital only against the amount of recourse
retained. In general, a qualifying institution is one that is well-capitalized
under the FDIC's prompt corrective action rules. The amount of recourse that can
receive the preferential capital treatment cannot exceed 15% of the
institution's total risk-based capital.
In addition to the risked-based guidelines, the federal banking agencies
require banking organizations to maintain a minimum amount of Tier 1 capital to
adjusted average total assets, referred to as the leverage capital ratio. For a
banking organization rated in the highest of the five categories used to rate
banking organizations, the minimum leverage ratio of Tier 1 capital to total
assets must be 3%. It is improbable, however, that an institution with a 3%
leverage ratio would receive the highest rating since a strong capital position
is a significant part of the regulators' rating. Bank holding companies not
rated in the highest category must have a minimum leverage ratio of 4%. For all
banks not rated in the highest category, the minimum leverage ratio must be at
least 100 to 200 basis points above the 3% minimum. Thus, the effective minimum
leverage ratio, for all practical purposes, must be at least 4% or 5% for banks.
In addition to these uniform risk-based capital guidelines and leverage ratios
that apply across the industry, the regulators have the discretion to set
individual minimum capital requirements for specific institutions at rates
significantly above the minimum guidelines and ratios.
The federal banking agencies recently amended their guidelines to clarify
the leverage ratio requirement for banks to conform to that of bank holding
companies. As of April 1, 1999, banks not rated in the highest category must
have a minimum leverage ratio of 4%. The ratio for banks in the highest category
will remain at 3%.
As of December 31, 1998, the Bank's capital ratios exceeded applicable
regulatory requirements. The following tables present the capital ratios for the
Company and the Bank, compared to the standards for well-capitalized bank
holding companies and depository institutions, as of December 31, 1998 (amounts
in thousands except percentage amounts).
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THE COMPANY
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ACTUAL MINIMUM
-------------------- CAPITAL
CAPITAL RATIO REQUIREMENT
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Leverage..................................................... $ 37,072 8.84% 4.0%
Tier 1 Risk-Based............................................ 37,072 11.84 4.0
Total Risk-Based............................................. 53,036 16.94 8.0
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THE BANK
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ACTUAL WELL MINIMUM
-------------------- CAPITALIZED CAPITAL
CAPITAL RATIO RATIO REQUIREMENT
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Leverage........................................ $ 48,110 10.31% 5.0% 4.0%
Tier 1 Risk-Based............................... 43,100 13.75 6.0 4.0
Total Risk-Based................................ 50,079 15.98 10.0 8.0
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The federal banking agencies must take into consideration concentrations of
credit risk and risks from non-traditional activities, as well as an
institution's ability to manage those risks, when determining the adequacy of an
institution's capital. This evaluation will be made as a part of the
institution's regular safety and soundness examination. The federal banking
agencies must also consider interest rate risk (when the interest rate
sensitivity of an institution's assets does not match the sensitivity of its
liabilities or its off-balance-sheet position) in evaluation of a bank's capital
adequacy.
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PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
requires each federal banking agency to take prompt corrective action to resolve
the problems of insured depository institutions, including but not limited to
those that fall below one or more prescribed minimum capital ratios. The law
required each federal banking agency to promulgate regulations defining the
following five categories in which an insured depository institution will be
placed, based on the level of its capital ratios: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized.
Under the prompt corrective action provisions of FDICIA, an insured
depository institution generally will be classified in the following categories
based on the capital measures indicated below:
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"WELL CAPITALIZED" "ADEQUATELY CAPITALIZED"
Total risk-based capital of 10%; Total risk-based capital of 8%;
Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and
Leverage ratio of 5%. Leverage ratio of 4%.
"UNDERCAPITALIZED" "SIGNIFICANTLY UNDERCAPITALIZED"
Total risk-based capital less than Total risk-based capital less than 6%;
8%;
Tier 1 risk-based capital less than Tier 1 risk-based capital less than 3%; or
4%; or
Leverage ratio less than 4%. Leverage ratio less than 3%.
"CRITICALLY UNDERCAPITALIZED"
Tangible equity to total assets equal
to or less than 2%.
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An institution that, based upon its capital levels, is classified as "well
capitalized," "adequately capitalized" or "undercapitalized" may be treated as
though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition or an unsafe or unsound practice warrants such
treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions.
In addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by the federal banking agencies for unsafe or unsound practices in conducting
their businesses or for violations of any law, rule, regulation or any condition
imposed in writing by the agency or any written agreement with the agency.
Enforcement actions may include the imposition of a conservator or receiver, the
issuance of a cease-and-desist order that can be judicially enforced, the
termination of insurance of deposits (in the case of a depository institution),
the imposition of civil money penalties, the issuance of directives to increase
capital, the issuance of formal and informal agreements, the issuance of removal
and prohibition orders against institution-affiliated parties and the
enforcement of such actions through injunctions or restraining orders based upon
a judicial determination that the agency would be harmed if such equitable
relief was not granted. Additionally, a holding company's inability to serve as
a source of strength to its subsidiary banking organizations could serve as an
additional basis for a regulatory action against the holding company.
SAFETY AND SOUNDNESS STANDARDS
FDICIA also implemented certain specific restrictions on transactions and
required federal banking regulators to adopt overall safety and soundness
standards for depository institutions related to internal control, loan
underwriting and documentation and asset growth. Among other things, FDICIA
limits the interest rates paid on deposits by undercapitalized institutions,
restricts the use of brokered deposits, limits the aggregate extensions of
credit by a depository institution to an executive officer, director, principal
10
<PAGE>
shareholder or related interest, and reduces deposit insurance coverage for
deposits offered by undercapitalized institutions for deposits by certain
employee benefits accounts.
The federal banking agencies may require an institution to submit to an
acceptable compliance plan as well as the flexibility to pursue other more
appropriate or effective courses of action given the specific circumstances and
severity of an institution's noncompliance with one or more standards.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS
The power of the board of directors of an insured depository institution to
declare a cash dividend or other distribution with respect to capital is subject
to statutory and regulatory restrictions which limit the amount available for
such distribution depending upon the earnings, financial condition and cash
needs of the institution, as well as general business conditions. FDICIA
prohibits insured depository institutions from paying management fees to any
controlling persons or, with certain limited exceptions, making capital
distributions, including dividends, if, after such transaction, the institution
would be undercapitalized.
The federal banking agencies also have authority to prohibit a depository
institution from engaging in business practices that are considered to be unsafe
or unsound, possibly including the payment of dividends or other payments under
certain circumstances even if such payments are not expressly prohibited by
statute.
The payment of dividends by a national bank is further restricted by
additional provisions of federal law, which prohibit a national bank from
declaring a dividend on its shares of common stock unless its surplus fund
exceeds the amount of its common capital (total outstanding common shares times
the par value per share). Additionally, if losses have at any time been
sustained equal to or exceeding a bank's undivided profits then on hand, no
dividend shall be paid. Moreover, even if a bank's surplus exceeded its common
capital and its undivided profits exceed its losses, the approval of the OCC is
required for the payment of dividends if the total of all dividends declared by
a national bank in any calendar year would exceed the total of its net profits
of that year combined with its retained net profits of the two preceding years,
less any required transfers to surplus or a fund for the retirement of any
preferred stock. A national bank must consider other business factors in
determining the payment of dividends. The payment of dividends by the Bank is
governed by the Bank's ability to maintain minimum required capital levels and
an adequate allowance for loan losses. Regulators also have authority to
prohibit a depository institution from engaging in business practices which are
considered to be unsafe or unsound, possibly including payment of dividends or
other payments under certain circumstances even if such payment are not
expressly prohibited by statute.
PREMIUMS FOR DEPOSIT INSURANCE AND ASSESSMENTS FOR EXAMINATIONS
FDICIA established several mechanisms to increase funds to protect deposits
insured by the BIF and SAIF administered by the FDIC. The FDIC is authorized to
borrow up to $30 billion from the United States Treasury; up to 90% of the fair
market value of assets of institutions acquired by the FDIC as receiver from the
Federal Financing Bank; and from depository institutions that are members of the
BIF and SAIF. Any borrowings not repaid by asset sales are to be repaid through
insurance premiums assessed to member institutions. Such premiums must be
sufficient to repay any borrowed funds within 15 years and provide insurance
fund reserves of $1.25 for each $100 of insured deposits. FDICIA also provides
authority for special assessments against insured deposits. No assurance can be
given at this time as to what the future level of premiums will be.
COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS
The Bank is subject to certain fair lending requirements and reporting
obligations involving home mortgage lending operations and Community
Reinvestment Act ("CRA") activities. The CRA generally requires the federal
banking agencies to evaluate the record of a financial institution in meeting
the credit
11
<PAGE>
needs of their local communities, including low and moderate income
neighborhoods. In addition to substantive penalties and corrective measures that
may be required for a violation of certain fair lending laws, the federal
banking agencies may take compliance with such laws and CRA into account when
regulating and supervising other activities.
RECENTLY ENACTED LEGISLATION
During 1996, new federal legislation amended the Comprehensive Environmental
Response, Compensation, and Liability Act ("CERCLA") and the underground storage
tank provisions of the Resource Conversation and Recovery Act to provide lenders
and fiduciaries with greater protections from environmental liability. In June
1997, the U.S. Environmental Protection Agency ("EPA") issued its official
policy with regard to the liability of lenders under CERCLA as a result of the
enactment of the Asset Conservation, Lender Liability and Deposit Insurance
Protection Act of 1996.
California law provides that, subject to numerous exceptions, a lender
acting in the capacity of a lender shall not be liable under any state or local
statute, regulation or ordinance, other than the California Hazardous Waste
Control Law, to undertake a cleanup, pay damages, penalties or fines, or forfeit
property as a result of the release of hazardous materials at or from the
property.
In 1997, California adopted the Environmental Responsibility Acceptance Act
(Cal. Civil Code SectionSection 850-855) to facilitate (i) the notification of
government agencies and potentially responsible parties (e.g., for cleanup) of
the existence of contamination and (ii) the cleanup or other remediation of
contamination by the potentially responsible parties. The Act requires, among
other things, that owners of sites who have actual awareness of a release of a
hazardous material that exceeds a specified notification threshold to take all
reasonable steps to identify the potentially responsible parties and to send a
notice of potential liability to the parties and the appropriate oversight
agency.
The Company cannot be certain of the effect of the foregoing recently
enacted legislation on its business.
PENDING LEGISLATION AND REGULATIONS
There are pending legislative proposals to modernize federal banking laws
and regulations, including to the reform Glass-Steagall Act, to allow
affiliations between banks and other firms engaged in "financial activities,"
including insurance companies and securities firms.
Certain other pending legislative proposals include bills to let banks pay
interest on business checking accounts, to institute "know your customer"
policies, to cap consumer liability for stolen debit cards and to give judges
the authority to force high-income borrowers to repay their debts rather than
cancel them through bankruptcy.
COMPETITION
In the past, an independent bank's principal competitors for deposits and
loans have been other banks (particularly major banks), savings and loan
associations and credit unions. To a lesser extent, competition was also
provided by thrift and loans, mortgage brokerage companies and insurance
companies. Other institutions, such as brokerage houses, mutual fund companies,
credit card companies, and even retail establishments have offered new
investment vehicles which also compete with banks for deposit business. The
direction of federal legislation in recent years seems to favor competition
between different types of financial institutions and to foster new entrants
into the financial services market, and it is anticipated that this trend will
continue.
The enactment of the Interstate Banking and Branching Act in 1994 and the
California Interstate Banking and Branching Act of 1995 have increased
competition within California. Regulatory reform, as well as other changes in
federal and California law will also affect competition. While the impact of
these
12
<PAGE>
changes, and of other proposed changes, cannot be predicted with certainty, it
is clear that the business of banking in California will remain highly
competitive.
CERTAIN IMPORTANT CONSIDERATIONS FOR INVESTORS
MORTGAGE BANKING AND BROKERAGE ACTIVITY. The Company's historic results of
operations has been significantly influenced by mortgage banking activity, which
can fluctuate significantly, in both volume and profitability, with changes in
interest rate movements. In the fourth quarter of 1996, the Company
significantly curtailed its "A paper" wholesale mortgage loan production. As a
result of this action, the Company's future mortgage loan production revenue and
expenses will be significantly reduced from pre-1997 levels. The Company's
current mortgage banking operations include both the origination and brokering
of retail oriented mortgage loan production. Such mortgage loan lending activity
primarily is centered in northern California. The Company's ability to maintain
and grow mortgage banking and brokerage revenue depends on a favorable interest
rate, economic, and real estate market conditions.
MERCHANT CREDIT CARD PROCESSING. The Company's profitability can be
negatively impacted should one of the Company's merchant credit card customers
be unable to pay on charge-backs from cardholders. Due to a contractual
obligation between the Company and Visa and Mastercard, NBR stands in the place
of the merchant in the event that a merchant is unable to pay on charge-backs
from cardholders. Management has taken certain actions to decrease the risk of
merchant bankruptcy with its merchant bankcard business. These steps include the
discontinuance of high-risk accounts. The Company utilizes ISO's to acquire
merchant credit card customers. The Company's ability to maintain and grow net
revenue from its merchant credit card processing operation is dependent upon
maintaining and adding to these ISO relationships.
CONCENTRATION OF LENDING ACTIVITIES. Concentration of the Company's lending
activities in the real estate sector, including construction loans, could have
the effect of intensifying the impact on the Company of adverse changes in the
real estate market in the Company's lending areas. At December 31, 1998,
approximately 76% of the Company's loans were secured by real estate, of which
29% were secured by commercial real estate, including small office buildings,
owner-user office/warehouses, mixed use residential and commercial properties
and retail properties. Substantially all of the properties that secure the
Company's present loans are located within Northern and Central California. The
ability of the Company to continue to originate mortgage or construction loans
may be impaired by adverse changes in local or regional economic conditions,
adverse changes in the real estate market, increasing interest rates, or acts of
nature (including earthquakes, which may cause uninsured damage and other loss
of value to real estate that secures the Company's loans). Due to the
concentration of the Company's real estate collateral, such events could have a
significant adverse impact on the value of such collateral or the Company's
earnings.
GOVERNMENT REGULATION. Redwood and its subsidiaries are subject to
extensive federal and state governmental supervision, regulation and control,
and future legislation and government policy could adversely affect the
financial industry. Although the full impact of such legislation and regulation
cannot be predicted, future changes may alter the structure of and competitive
relationship among financial institutions. See "Regulation and Supervision,"
above.
COMPETITION FROM OTHER FINANCIAL INSTITUTIONS. The Company competes for
deposits and loans principally with major commercial banks, other independent
banks, savings and loan associations, savings banks, thrift and loan
associations, credit unions, mortgage companies, insurance companies and other
lending institutions. With respect to deposits, additional significant
competition arises from corporate and governmental debt securities, as well as
money market mutual funds. The Company also depends for its origination of
mortgage loans on independent mortgage brokers who are not contractually
obligated to do business with the Company and are regularly solicited by the
Company's competitors. Aggressive policies of such competitors have in the past
resulted, and may in the future result, in a decrease in the Company's volume of
mortgage loan originations and/or a decrease in the profitability of such
originations, especially
13
<PAGE>
during periods of declining mortgage loan origination volumes. Several of the
nation's largest savings and loan associations and commercial banks have a
significant number of branch offices in the areas in which the Company conducts
operations. Among the advantages possessed by the larger of these institutions
are their ability to make larger loans, finance extensive advertising campaigns,
access international money markets and generally allocate their investment
assets to regions of highest yield and demand.
ITEM 2. PROPERTIES
The Company owns two depository branches and leases 14 other locations used
in the normal course of business. In addition, the Company leases certain
equipment. There are no contingent rental payments and the Company has two
sublease arrangements. Total rental expenses under all leases, including
premises, totaled $2,210,000, $2,095,000 and $2,258,000, in 1998, 1997 and 1996.
The expiration dates of the leases vary, with the last such lease expiring
during 2009.
The Company enters into leases for premises and equipment as the Company
expands its business. The Company maintains insurance coverage on its premises,
leaseholds and equipment, including business interruption and record
reconstruction coverage.
ITEM 3. LEGAL PROCEEDINGS
Certain lawsuits and claims arising in the ordinary course of business have
been filed or are pending against the Company or its subsidiaries. Based upon
information available to the Company, its review of such lawsuits and claims and
consultation with its counsel, the Company believes the liability relating to
these actions, if any, would not have a material adverse effect on its
consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted to a vote of the Company's shareholders during the
fourth quarter of 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
As of November 2, 1998, Redwood's Common Stock has been publicly traded on
the NASDAQ National Market under the symbol "REBC". Prior to November 2, 1998,
the Company Common Stock traded on the American Stock Exchange under the symbol
"REB". As of December 31, 1998, there were 478 shareholders of record of
Redwood's Common Stock.
In June of 1998 Redwood began quarterly cash dividends of $0.04 per
outstanding share. Redwood did not pay dividends during the two year period
ended December 31, 1997. There are regulatory limitations on cash dividends that
may be paid by Redwood as well as regulatory limitations on cash dividends that
may be paid by NBR to Redwood which could limit Redwood's ability to pay
dividends. Federal regulatory agencies have the authority to prohibit the
payment of dividends by NBR if a finding is made that such payment would
constitute an unsafe or unsound practice, or if NBR became critically
undercapitalized. See "Regulation and Supervision".
REDWOOD EMPIRE BANCORP
COMMON STOCK PRICES
<TABLE>
<CAPTION>
QTR 1 QTR 2 QTR 3 QTR 4 QTR 1 QTR 2 QTR 3 QTR 4
1998 1998 1998 1998 1997 1997 1997 1997
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
High................................... $ 20.50 $ 21.88 $ 21.25 $ 17.50 $ 14.13 $ 13.75 $ 17.25 $ 18.25
Low.................................... 16.63 17.75 14.13 13.00 11.00 12.50 13.00 14.87
Close.................................. 18.88 20.75 16.38 17.06 13.13 13.00 15.38 18.25
</TABLE>
14
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
SUMMARY OF CONSOLIDATED FINANCIAL DATA AND PERFORMANCE RATIOS
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- ----------- --------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS:
Total interest income............................. $ 33,059 $ 37,306 $ 45,784 $ 47,374 $ 38,005
Net interest income............................... 18,880 20,519 23,141 19,703 17,339
Provision for loan losses......................... 2,040 2,100 6,262 1,590 1,095
Other operating income............................ 15,666 10,143 19,570 16,575 10,885
Net income (loss)................................. 5,091 3,441 (1,486) 3,313 (3,035)
Net income (loss) available to common equity...... 4,979 2,992 (1,935) 2,977 (3,483)
BALANCE SHEETS:
Total assets...................................... $ 422,299 $ 446,719 $ 499,466 $ 557,910 $ 630,652
Total loans....................................... 269,316 282,396 347,414 368,223 384,570
Mortgage loans held for sale...................... 32,620 16,929 29,487 62,620 138,003
Allowance for loan losses......................... 8,041 7,645 7,040 5,037 5,787
Total deposits.................................... 364,720 391,421 436,450 458,393 469,008
Shareholders' equity.............................. 38,640 33,243 29,732 31,585 28,194
PERFORMANCE RATIOS:
Return on average assets.......................... 1.20% 0.75% (.28)% 0.57% (.56)%
Return on average common equity................... 14.78% 11.72% (7.43)% 12.37% (13.17)%
Common dividend payout ratio...................... 8.09% N/A N/A N/A (7.89)%
Average equity to average assets.................. 8.47% 6.83% 5.96% 5.14% 5.90%
Leverage ratio.................................... 8.84% 7.10% 5.45% 5.14% 4.08%
Tier 1 risk-based capital ratio................... 11.84% 9.72% 7.63% 7.24% 6.55%
Total risk-based capital ratio.................... 16.94% 14.64% 12.11% 11.68% 10.75%
Net interest margin............................... 4.94% 4.90% 4.64% 3.63% 3.40%
Other operating expense to net interest income and
other operating income.......................... 73.27% 74.54% 91.18% 79.98% 113.46%
Average earning assets to average total assets.... 90.12% 91.44% 93.46% 93.50% 93.39%
Nonperforming assets to total assets.............. 2.11% 3.72% 2.64% 1.28% 1.34%
Net loan charge-offs to average loans............. 0.62% 0.46% 1.22% 0.60% 0.40%
Allowance for loan losses to total loans.......... 2.99% 2.71% 2.03% 1.37% 1.50%
Allowance for loan losses to nonperforming
loans........................................... 121.82% 78.60% 67.82% 101.88% 104.97%
SHARE DATA:
Common shares outstanding (000)................... 3,369 2,785 2,749 2,679 2,663
Book value per common share....................... $ 9.76 $ 9.87 $ 8.72 $ 9.64 $ 8.43
Basic earnings (loss) per share................... 1.57 1.08 (.71) 1.11 (1.31)
Diluted earnings (loss) per share................. 1.47 1.02 (.71) 1.04 (1.31)
Cash dividend per common share.................... .120 -- -- -- .105
</TABLE>
15
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K includes forward-looking information which
is subject to the "safe harbor" created by the Securities Act of 1933 and
Securities Exchange Act of 1934. These forward-looking statements (which involve
the Company's plans, beliefs and goals, refer to estimates or use similar terms)
involve certain risks and uncertainties that could cause actual results to
differ materially from those in the forward-looking statements. Such risks and
uncertainties include, but are not limited to, the following factors:
- Competitive pressure in the banking and mortgage industry and changes in
the regulatory environment.
- Changes in the interest rate environment and volatility of rate sensitive
deposits.
- Declines in the health of the economy nationally or regionally which could
reduce the demand for loans or reduce the value of real estate collateral
securing most of the Company's loans.
- Credit quality deterioration that could cause an increase in the provision
for loan losses.
- Risks associated with the Year 2000 that could cause disruptions in the
Company's operations or increase expenses.
- Losses in the Company's merchant credit card processing business.
- Asset/liability matching risks and liquidity risks.
- Changes in the securities markets.
The Company undertakes no obligation to revise or publicly release the
results of any revision to these forward-looking statements. For additional
information concerning risks and uncertainties related to the Company and its
operations, please refer to Certain Important Considerations for Investors in
Item 1, Management's Discussion and Analysis of Financial Condition and Results
of Operations and other information in this Report.
GENERAL
The Company derives its income from two principal sources: (1) net interest
income, which is the difference between the interest income it receives on
interest-earning assets and the interest expense it pays on interest-bearing
liabilities; (2) non interest income or fee income which includes the
origination for sale and sale of real estate secured loans, the sale of mortgage
loan servicing rights, mortgage loan servicing fee income on loans serviced,
brokerage income from residential loans brokered to other lenders, fees earned
on deposit services, income from SBA lending, electronic-based cash management
services and merchant credit card processing.
The following analysis of the Company's financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements of Redwood Empire Bancorp and related notes thereto. Average
balances, including such balances used in calculating financial and performance
ratios, are generally a blend of daily averages for NBR and where applicable for
Allied, which management believes are representative of the operations of the
Company.
16
<PAGE>
RESULTS OF OPERATIONS
In 1998 the Company reported net income of $5,091,000, or $1.47 diluted per
share as compared to 1997 net income of $3,441,000, or $1.02 diluted per share
and a 1996 net loss of $1,486,000 or $.71 diluted per share.
Return on average assets for the year ended December 31, 1998 was 1.20% as
compared to a positive .75% and a negative .28% for the years ended December 31,
1997 and 1996. Return on average common equity was 14.18% for the year ended
December 31, 1998, as compared to positive 11.72% and a negative 7.43% for the
years ended December 31, 1997 and 1996.
The Company's results of operation in 1998 improved significantly from 1997.
Substantial improvement was shown in other operating income which totaled
$15,666,000 in 1998 as compared to $10,143,000 in 1997 which amounts to an
increase of $5,523,000. The improvement in other operating income offset an
increase in non interest expense of $2,458,000 and a decline in net interest
income $1,639,000. 1997 operations improved substantially from 1996. Non
interest expense decreased by $16,091,000 in 1997 which more than offset
declines of $2,622,000 in net interest income and other operating income of
$9,427,000.
Several significant matters adversely impacted the Company in 1996. These
events include a provision for loan losses of $6,262,000, a pre-tax
restructuring charge of $2,357,000 associated with the merging of Allied into
NBR and the reduction of "A" paper wholesale mortgage banking, a pre tax charge
of $2,192,000 associated with SAIF deposit insurance fund recapitalization, and
a $1,200,000 charge to operations relating to the Company's obligation following
the bankruptcy of one of its merchant credit card customers.
NET INTEREST INCOME. For 1998, the Company's net interest income amounted
to $18,880,000 as compared to $20,519,000 in 1997 and $23,141,000 in 1996. This
represents a decrease of $1,639,000 or 8% in 1998 and a decrease of $2,622,000
or 11.3% in 1997. The decrease in 1998 when compared to 1997 is due to a decline
in earning assets from $418,793,000 in 1997 to $382,102,000 in 1998 partially
offset by an improvement in net interest margin from 4.90% in 1997 to 4.94% in
1998. The decrease in 1997 when compared to 1996 is primarily attributable to an
increase in net interest margin from 4.64% in 1996 to 4.90% in 1997 offset by a
decline in earning assets from $498,882,000 in 1996 to $418,793,000 in 1997.
The following table presents for the years indicated the distribution of
consolidated average assets, liabilities and shareholders' equity, as well as
the total dollar amounts of interest income from average earning assets and the
resultant yields, and the dollar amounts of interest expense and average
interest-
17
<PAGE>
bearing liabilities, expressed both in dollars and in rates. Nonaccrual loans
are included in the calculation of the average balances of loans, and interest
not accrued is excluded.
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------- ----------------------------------- ---------
AVERAGE YIELD/ AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST YIELD/ RATE BALANCE
--------- --------- --------- --------- ----------- ----- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Portfolio loans........................ $ 266,716 $ 25,183 9.44% $ 322,122 $ 30,448 9.45% $ 349,859
Mortgage loans held for sale........... 28,788 2,502 8.69 19,937 1,835 9.20 78,030
Investment securities.................. 67,562 4,334 6.41 54,034 3,702 6.85 47,414
Federal funds sold..................... 19,030 1,040 5.47 22,541 1,314 5.83 19,685
Interest-bearing deposits due from
financial institutions............... 6 0 0.00 159 7 4.40 3,894
--------- --------- --------- ----------- ---------
Total earning assets................. 382,102 33,059 8.65 418,793 37,306 8.91 498,882
--------- -----------
Other assets........................... 49,903 45,901 41,363
Less allowance for loan losses......... (8,020) (6,690) (6,473)
--------- --------- ---------
Total average assets................. $ 423,985 $ 458,004 $ 533,772
--------- --------- ---------
--------- --------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Savings................................ $ 142,859 5,047 3.53 $ 152,803 6,080 3.98 $ 150,650
Time deposits.......................... 139,645 7,665 5.49 172,344 9,348 5.42 239,028
Other borrowings....................... 18,413 1,467 7.97 15,181 1,359 8.95 41,083
--------- --------- --------- ----------- ---------
Total interest-bearing liabilities... 300,917 14,179 4.71 340,328 16,787 4.93 430,761
--------- -----------
Demand deposits........................ 82,074 77,382 65,082
Other liabilities...................... 5,089 9,008 6,136
Shareholders' equity................... 35,905 31,286 31,793
--------- --------- ---------
Total average liabilities and
shareholders' equity............... $ 423,985 $ 458,004 $ 533,772
--------- --------- ---------
--------- --------- ---------
Net interest spread.................... 3.94 3.98
Net interest income and net interest
margin............................... $ 18,880 4.94 $ 20,519 4.90
--------- -----------
--------- -----------
<CAPTION>
INTEREST YIELD/ RATE
----------- -----
<S> <C> <C>
ASSETS:
Portfolio loans........................ $ 35,919 10.27%
Mortgage loans held for sale........... 5,550 7.11
Investment securities.................. 3,120 6.58
Federal funds sold..................... 1,028 5.22
Interest-bearing deposits due from
financial institutions............... 167 4.29
-----------
Total earning assets................. 45,784 9.18
-----------
Other assets...........................
Less allowance for loan losses.........
Total average assets.................
LIABILITIES AND SHAREHOLDERS' EQUITY:
Savings................................ 6,076 4.03
Time deposits.......................... 13,851 5.79
Other borrowings....................... 2,716 6.61
-----------
Total interest-bearing liabilities... 22,643 5.26
-----------
Demand deposits........................
Other liabilities......................
Shareholders' equity...................
Total average liabilities and
shareholders' equity...............
Net interest spread.................... 3.92
Net interest income and net interest
margin............................... $ 23,141 4.64
-----------
-----------
</TABLE>
The Company's average earning assets for 1998 decreased approximately 8.8%,
or $36,691,000, to $382,102,000, as compared to $418,793,000 for 1997. Average
earning assets decreased $80,089,000 or 16.1% in 1997 as compared to 1996. The
decrease in earning assets in 1998 is primarily attributable to a decline in
average portfolio loans of $55,406,000. Components of the decline include a
decline of $24,455,000 in average outstanding construction loans and $26,535,000
in average outstanding residential loans. During 1997 and 1998 the Company
reduced its concentration in construction and residential loans in an effort to
balance its entire loan portfolio.
The decrease in average earning assets for 1997 is primarily attributable to
the Company's decision to significantly curtail is "A" paper mortgage banking
operation in the fourth quarter of 1996. This decision directly impacted the
mortgage loans held for sale average balance which equaled $19,937,000 in 1997
and $78,030,000 in 1996. In addition average construction loans declined from
$78,200,000 in 1996 to $70,297,000 in 1997.
With the reduction in earning assets discussed above, the Company's funding
sources also declined. The average balance of high cost time deposits declined
$32,699,000 in 1998 and $66,684,000 in 1997. Conversely, average demand deposits
grew $4,692,000 in 1998 and $12,300,000 in 1997 as the Company was successful in
obtaining low cost transactional accounts. Average other borrowings, which
includes FHLB advances, increased $3,232,000 in 1998 and declined $25,902,000 in
1997.
The following table sets forth changes in interest income and interest
expense for each major category of earning asset and interest-bearing liability,
and the amount of change attributable to volume and rate
18
<PAGE>
changes for the years indicated. Changes not solely attributable to rate or
volume have been allocated to rate.
<TABLE>
<CAPTION>
1998 OVER 1997 1997 OVER 1996
------------------------------- -------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
--------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Increase (decrease) in interest income:
Portfolio loans (1), (2)............................. ($ 5,238) ($ 27) ($ 5,265) ($ 2,849) ($ 2,622) ($ 5,471)
Mortgage loans held for sale......................... 814 (147) 667 (4,130) 415 (3,715)
Investment securities (3)............................ 927 (295) 632 436 146 582
Federal funds sold................................... (205) (69) (274) 149 137 286
Interest-earning deposits with other institutions.... (7) 0 (7) (160) 0 (160)
--------- --- --------- --------- --------- ---------
Total increase (decrease).......................... (3,709) (538) (4,247) (6,554) (1,924) (8,478)
--------- --- --------- --------- --------- ---------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts................ (396) (637) (1,033) 87 (83) 4
Time deposits........................................ (1,772) 89 (1,683) (3,861) (642) (4,503)
Other borrowings..................................... 288 (180) 108 (1,712) 355 (1,357)
--------- --- --------- --------- --------- ---------
Total increase..................................... (1,880) (728) (2,608) (5,486) (370) (5,856)
--------- --- --------- --------- --------- ---------
Increase (decrease) in net interest income........... ($ 1,829) $ 190 ($ 1,639) ($ 1,068) ($ 1,554) ($ 2,622)
--------- --- --------- --------- --------- ---------
--------- --- --------- --------- --------- ---------
</TABLE>
- ------------------------
(1) Does not include interest income which would have been earned on nonaccrual
loans had such loans performed in accordance with their terms.
(2) Loan fees of $687,000, $928,000 and $2,805,000 are included in interest
income for 1998, 1997 and 1996.
(3) The average balance of securities classified as available for sale are
presented at historical amortized cost without the effects of the fair value
adjustments.
The net interest margin increased to 4.94% for the year ended December 31,
1998, as compared to 4.90% and 4.64% for the years ended December 31, 1997 and
1996. The increase in net interest margin in 1998 was primarily due to decreased
liability costs slightly offset by a decline in yield on earning assets. The
yield on earning assets decreased to 8.65% in 1998 compared to 8.91% in 1997 and
9.18% in 1996. The decline in earning asset yield in 1998 is primarily
attributable in an overall decline in interest rates while the decline in 1997
earning asset yield is directly attributable to a decline in the Company's high
yielding construction portfolio.
The effective rates on interest-bearing liabilities decreased to 4.71% for
1998 as compared to 4.93% for 1997 and 5.26% for 1996. The decrease in 1998 was
due to a substantial downward repricing of the Company's money market accounts
mid year. The decrease in 1997 when compared to 1996 was due primarily to a
decline in high-cost time deposits and FHLB advances.
PROVISION FOR LOAN LOSSES. Annual fluctuations in the provision for loan
losses result from management's regular assessment of the adequacy of the
allowance for loan losses. The provision for loan losses was $2,040,000 for the
year ended December 31, 1998 which represents a decrease of $60,000 or 2.9% from
1997. In 1997, the provision for loan losses of $2,100,000 represented a 66.5%
decrease from $6,262,000 in 1996. This decrease in the provision for loan losses
in 1997 when compared to 1996 was due to a decline in loan charge-offs and the
size of the loan portfolio.
Outstanding construction loans at December 31, 1998 represented 17% of total
portfolio loans. Construction lending generally bears a higher degree of risk
than other major portfolio lending programs the Company maintains. Factors that
could affect the quality of the construction loan portfolio include
19
<PAGE>
regional economic conditions, adverse changes in the real estate market,
increasing interest rates or acts of nature such as earthquakes. Such events
could have an adverse impact on the level of future provisions for loan losses
and the Company's earnings. See further discussion in "Asset Quality".
OTHER OPERATING INCOME. Other operating income increased 54%, or
$5,523,000, to $15,666,000 as compared to $10,143,000, for 1997. The Company's
other operating income for 1997 represented a decrease of $9,427,000 or 48% from
the $19,570,000 it received during 1996. The following table sets forth the
sources of other operating income for the years ended December 31, 1998, 1997
and 1996.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Service charges on deposit accounts.......................... $ 1,072 $ 1,146 $ 1,224
Merchant draft processing, net............................... 2,609 1,585 1,849
Loan servicing income........................................ 584 831 1,619
Net realized gains (losses) on sale of investment securities
available for sale......................................... 225 23 (3)
Gain on sale of loans and loan servicing..................... 5,095 3,601 12,328
Mortgage brokerage revenue, net.............................. 4,976 2,238 73
Other income................................................. 1,105 719 2,480
--------- --------- ---------
$ 15,666 $ 10,143 $ 19,570
--------- --------- ---------
--------- --------- ---------
</TABLE>
Merchant draft processing net revenue increased substantially in 1998 to
$2,609,000 as compared to $1,585,000 in 1997 and $1,849,000 in 1996. The two
primary reasons for the 1998 increase are due to an increase in processing
volume associated with existing customers and the addition of a new ISO whose
customer base is primarily internet merchant based.
In December 1998, the Company renegotiated the terms of a processing
contract with an independent sales organization who represented $1,736,000 or
66% of the Company's 1998 merchant draft net processing revenue. In summary, as
a result of the renegotiation, the ISO bought down its processing rate in
consideration for a payment of $2,400,000 to the Company. The term of the
renegotiated contract is for two years and requires the Company to continue to
process merchant card transaction volume from this ISO's customers. The Company
will amortize such payment over the life of the renegotiated contract into
income. The Company expects to build its overall merchant card processing
business in an effort to offset any potential decline in future revenues.
Loan servicing revenues decreased to $584,000 for the year ended December
31, 1998, compared to $831,000 and $1,619,000 in 1997 and 1996. The decline in
1997 was due to a 1996 loan, the loan servicing sale, and prepayments occurring
within the Company's SBA servicing portfolio. Future loan servicing income will
be dependent on prepayments of loans held in the Company's servicing portfolio,
the volume of additional loans added to this portfolio and any future bulk
servicing sales. See "Mortgage Banking and Mortgage Brokerage" and Note B of
Notes to Consolidated Financial Statements.
In 1998, $32,700,000 of callable bonds carried within the Company's
investment securities portfolio were called by their issuers. As several of
these bonds were purchased at a discount the Company recorded a gain on the
redemption of $199,000 in 1998. Securities sale and call activity was minimal in
1997 and 1996. See Note D of Notes to Consolidated Financial Statements.
OTHER OPERATING EXPENSE. Other operating expense amounted to $25,313,000 in
1998, $22,855,000 in 1997 and $38,946,000 in 1996. This represents an increase
of $2,458,000 or 11% in 1998 and a decrease of $16,091,000 or 41% in 1997 when
compared to 1996.
20
<PAGE>
Salary and employee benefits expense for 1998 increased $2,564,000, or 22%,
to $14,041,000, as compared to $11,477,000 for 1997. This compared with a 33%
decrease during 1997 over the 1996 salary and employee benefits expense of
$17,151,000. The increase in 1998 is due to an increase in staff to accommodate
mortgage loan origination. The decline in salary and benefit expense in 1997 is
due to the merger of Allied into NBR and the reduction in mortgage banking
operations. The Company's full-time equivalent staff levels were 308, 252 and
321 at December 31, 1998, 1997, and 1996, respectively.
Occupancy and equipment expense was $3,676,000 in 1998, $3,328,000 in 1997,
and $5,604,000 in 1996. In 1998 the increase of $348,000 was attributable to the
additional space requirement of the Company's mortgage brokerage operations. In
1997, this represents a decrease of 41%, or $2,276,000, over 1996 occupancy and
equipment expense. The reduction in occupancy and equipment expense in 1997 of
$2,276,000 is attributable to the merger of Allied into NBR and the reduction of
mortgage banking operations.
In November 1996 the Company's Board of Directors approved a plan to merge
its two wholly owned subsidiaries, National Bank of the Redwoods and Allied
Bank, F.S.B. As a result of the merger, the surviving bank, National Bank of the
Redwoods, assumed all of Allied's rights and obligations. In connection with the
merger, and as a result of the Company's decision to significantly curtail its
wholesale mortgage banking production capacity, the Company recorded a
restructuring charge of $2,357,000 in the fourth quarter of 1996. The
restructuring of the Company, which includes both the merger of Allied into
National Bank of the Redwoods and the reduction in "A" paper wholesale lending,
includes the closing of the Portland and Sacramento mortgage loan production
offices, the partial write-off of Allied's administrative headquarters,
termination of employees, and write-off of duplicative or unnecessary fixed
assets. The total charge to operations associated with these matters consisted
of:
<TABLE>
<S> <C>
Severance for 70 employees...................................... $ 651,000
Accrual for discontinued leases................................. 772,000
Writeoff of leasehold improvements, furniture and fixtures...... 934,000
---------
$2,357,000
---------
---------
</TABLE>
At December 31, 1998, $163,000 of the restructuring charge remained in other
liabilities, substantially all of which is related to the future minimum lease
payments associated with the closed facilities. The Company is continuing to
seek sublease tenants for many of these closed facilities and an additional
portion of the restructuring charge may be reversed in future periods if the
Company is successful in entering into such arrangements.
21
<PAGE>
The following table describes the components of other operating expense for
the years ended December 31, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Professional fees.................................. $ 1,138 $ 1,757 $ 1,942
Regulatory expense and insurance................... 676 563 1,209
Postage and office supplies........................ 1,055 1,297 1,715
Shareholder expenses and Director fees............. 339 381 406
Advertising........................................ 468 409 581
Telephone.......................................... 702 829 758
Electronic data processing......................... 1,612 1,417 1,216
Net costs of other real estate owned............... 956 568 451
Merchant card loss................................. -- -- 1,200
SAIF recapitalization charge....................... -- -- 2,192
Other.............................................. 650 1,115 2,164
--------- --------- ---------
$ 7,596 $ 8,336 $ 13,834
--------- --------- ---------
--------- --------- ---------
</TABLE>
Other expenses were $7,596,000 during 1998, a decrease of $740,000, or 9%,
when compared to 1997 expenses of $8,336,000. Other expense decreased $5,498,000
or 40% in 1997 when compared to 1996. The 1998 decline is a result of the
Company's cost control efforts. The decrease in 1997 is attributable to the
merger of Allied into NBR, curtailment of "A paper" wholesale mortgage banking,
and the 1996 SAIF deposit insurance premium charge of $2,192,000 and a
$1,200,000 charge related to the Company's obligation following the bankruptcy
of one of its merchant card customers.
INCOME TAXES. The Company's effective tax rate was a provision of 29.7% in
1998, a provision of 39.8% in 1997 and a benefit of 40.5% in 1996. The decrease
in the Company's effective tax rate in 1998 is a result of a change in estimate
associated with a deferred tax item. Prior to the fourth quarter in 1998, the
Company had maintained a deferred tax liability for deferred loan fees. During
the fourth quarter it was determined that such deferred liability was no longer
required.
22
<PAGE>
BUSINESS SEGMENTS
Summary financial data by industry segment as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Community Banking:
Revenue..................................... $ 20,595 $ 23,201 $ 28,754
Expenses.................................... 16,314 17,795 29,469
--------- --------- ---------
Income (loss) before income tax........... $ 4,281 $ 5,406 $ (715)
--------- --------- ---------
--------- --------- ---------
Sub Prime:
Revenue..................................... $ 1,741 $ 1,852 $ 4,843
Expenses.................................... 2,339 3,014 4,383
--------- --------- ---------
Income (loss) before income tax........... $ (598) $ (1,162) $ 460
--------- --------- ---------
--------- --------- ---------
Bankcard:
Revenue..................................... $ 3,120 $ 2,095 $ 2,264
Expenses.................................... 1,128 1,290 2,267
--------- --------- ---------
Income (loss) before income tax........... $ 1,992 $ 805 $ (3)
--------- --------- ---------
--------- --------- ---------
Mortgage Banking and Brokerage:
Revenue..................................... $ 9,090 $ 3,514 $ 6,850
Expenses.................................... 7,572 2,856 9,089
--------- --------- ---------
Income (loss) before income tax........... $ 1,518 $ 658 $ (2,239)
--------- --------- ---------
--------- --------- ---------
Total Company:
Revenue..................................... $ 34,546 $ 30,662 $ 42,711
Expenses.................................... 27,353 24,955 45,208
--------- --------- ---------
Income (loss) before income tax........... $ 7,193 $ 5,707 $ (2,497)
--------- --------- ---------
--------- --------- ---------
</TABLE>
COMMUNITY BANKING
The Community Banking segment revenues have declined for the last three
years principally as a result of decling earning assets. In an effort to balance
the Company's permanent loan portfolio, over the last two years management has
limited the origination of construction and residential loans. In addition, the
competitive nature of community banking has hindered the origination of both
commercial and commercial real estate loans. Prospectively the Company expects
to moderately increase all categories of permanent loans within the group
through renewed marketing efforts and development of new distribution channels.
SUB PRIME LENDING
In 1998 the Company's sub prime lending segment which is known as Allied
Diversified Credit, or "ADC" recorded an operating loss of $598,000 in 1998
compared to an operating loss of $1,162,000 in 1997 and operating income of
$460,000 in 1996. The sub prime mortgage banking business has undergone
substantial changes in the last two years as increased competition, narrowing
margins, and deterioration of the secondary marketing environment has caused
several well publicized bankruptcies of major sub prime conduits. In response to
these conditions the Company significantly downsized it's sub prime operations
in the fourth quarter of 1998. The Company is currently evaluating all aspects
of this business line.
23
<PAGE>
BANKCARD
The Merchant Card processing segment has experienced three successive years
of revenue and earnings growth due to an increase in the number of merchants it
services and an increase reliance on independent sales organizations (ISO's) to
market its services. In December 1998 the Company renegotiated the terms of a
processing contract with an ISO who represented $1,736,000 or 66% of the
Company's 1998 merchant draft net processing revenue. In summary, as a result of
the renegotiation the ISO bought down its processing rate in consideration for a
payment of $2,600,000 to the Company. The term of the renegotiated contract is
for two years and requires the Company to continue to process merchant card
transaction volume from this ISO's customers. The Company will amortize such
payment over the life of the renegotiated contract into income. The Company
expects to build its overall merchant card processing business in an effort to
offset any potential decline in future revenues that may result in periods
following the term of the buydown.
MORTGAGE BANKING AND BROKERAGE
The Residential Mortgage Banking and Brokerage segment of the company has
operated under the name "Valley Financial" since the beginning of 1997. This
segments performance dramatically improved in 1998 with substantial gains in
total revenue and operating income over 1997 and 1996. The principal reason for
the improvement relate to a favorable interest rate and economic environment.
This segment is highly sensitive to changes in mortgage interest rates and local
economical conditions.
In the fourth quarter of 1996 the Company significantly curtailed its
wholesale mortgage loan originations operations associated with the wholesale
generation of mortgage loans which predominantly conform to the underwriting
standards set by Fannie Mae, Freddie Mac, or other institutional investors. This
type of activity is commonly referred to as "A paper" wholesale mortgage
banking. This decision was taken due to concerns over declining profit margins
and interest rate risk. As a result of this action, the Company's mortgage
banking operations has focused on its sub prime mortgage business along with
retail generation of "A paper" mortgage loans through its brokerage operations.
Accordingly, revenues and expenses associated with this segment have been
significantly reduced from historic levels.
INVESTMENT PORTFOLIO
The Company classifies its investment securities as held to maturity or
available for sale. The Company's intent is to hold all securities held to
maturity until maturity and management believes that the Company has the ability
to do so. Securities available for sale may be sold to implement the Company's
asset/liability management strategies and in response to changes in interest
rates, prepayment rates and similar factors. The following table summarizes the
maturities of the Company's debt securities at their
24
<PAGE>
carrying value and their weighted average yields at December 31, 1998. Yields on
tax-exempt securities have been computed on a tax-equivalent basis.
<TABLE>
<CAPTION>
AVAILABLE FOR SALE
--------------------------------------------------------------------------------
AFTER ONE AFTER FIVE
WITHIN ONE THROUGH FIVE THROUGH TEN AFTER TEN
YEAR YEARS YEARS YEARS TOTAL
------------- -------------- ------------- -------------- --------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------ ----- ------- ----- ------ ----- ------ ----- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government and agencies............ $4,018 6.36% $19,372 5.72% $5,151 5.99% -- -- $28,541 5.86%
Other bonds and mortgaged backed
securities............................ -- -- 1,997 5.80% -- -- -- -- $1,997 5.80%
------ ------- ------ ------ -------
Total................................. $4,018 6.36% $21,369 5.72% $5,151 5.99% $ -- -- $30,538 5.85%
------ ------- ------ ------ -------
------ ------- ------ ------ -------
</TABLE>
<TABLE>
<CAPTION>
HELD TO MATURITY
--------------------------------------------------------------------------------
AFTER ONE AFTER FIVE
WITHIN ONE THROUGH FIVE THROUGH TEN AFTER TEN
YEAR YEARS YEARS YEARS TOTAL
-------------- ------------- ------------- -------------- --------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------ ----- ------ ----- ------ ----- ------- ----- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government and agencies............ $ -- -- $4,000 6.32% $6,986 6.58% -- -- $10,986 6.49%
Other bonds and mortgaged backed
securities............................ 41 3.60% 541 4.45% 338 4.50% 13,861 7.04% $14,781 6.84%
------ ------ ------ ------- -------
Total................................... $ 41 3.60% $4,541 6.10% $7,324 6.48% $13,861 7.04% $25,767 6.69%
------ ------ ------ ------- -------
------ ------ ------ ------- -------
</TABLE>
The following table summarizes the book value of the Company's investment
securities held on the dates indicated:
<TABLE>
<CAPTION>
AVAILABLE FOR SALE
---------------------------------
DECEMBER 31,
1998 1997 1996
--------- ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
U.S. Government and agencies.................. $ 28,542 $ 41,907 $ 33,852
Other bonds and mortgage-backed securities.... 1,996 -- --
--------- ----------- ---------
Total....................................... $ 30,538 $ 41,907 $ 33,852
--------- ----------- ---------
--------- ----------- ---------
</TABLE>
<TABLE>
<CAPTION>
HELD TO MATURITY
---------------------------------
DECEMBER 31,
1998 1997 1996
--------- ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
U.S. Government and agencies.................. $ 10,986 $ 18,360 $ 12,736
Other bonds and mortgage-backed securities.... 14,781 8,401 2,701
FHLB and FRB Stock............................ 4,105 3,897 3,344
--------- ----------- ---------
Total....................................... $ 29,872 $ 30,658 $ 18,781
--------- ----------- ---------
--------- ----------- ---------
</TABLE>
LOAN PORTFOLIO
The Company concentrates its lending activities in three principal areas:
real estate mortgage loans (residential and commercial loans), real estate
construction loans and commercial loans. At December 31, 1998, these three
categories accounted for approximately 58%, 17% and 23%, respectively, of the
Company's loan portfolio. The interest rates charged for the loans made by the
Company vary with the degree of risk, the size and maturity of the loans, the
borrowers' depository relationships with the Company and prevailing money market
rates indicative of the Company's cost of funds.
25
<PAGE>
Concentration of the Company's lending activities in the real estate sector
could have the effect of intensifying the impact on the Company of adverse
changes in the real estate market in the Company's lending areas. The ability of
the Company to continue to originate mortgage loans may be impaired by adverse
changes in local or regional economic conditions, adverse changes in the real
estate market, increasing interest rates, or acts of nature (including
earthquakes or floods, which may cause uninsured damage and other loss of value
to real estate that secures the Company's loans). Due to the concentration of
the Company's real estate collateral, such events could have a significant
adverse impact on the value of such collateral or the Company's earnings.
The following table sets forth the amounts of loans outstanding by category
as of the dates indicated. There were no concentrations of loans exceeding 10%
of total loans which are not otherwise disclosed as a category of loans in the
table below.
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Residential real estate
mortgage................ $ 97,194 $ 93,516 $ 115,631 $ 160,767 $ 220,764
Commercial real estate
mortgage................ 59,257 57,425 67,401 55,667 52,385
Commercial................ 63,260 69,097 73,987 79,723 72,728
Real estate
construction............ 46,905 55,031 84,908 62,432 31,086
Installment and other..... 5,095 9,200 8,284 12,669 10,425
Less deferred fees........ (2,395) (1,873) (2,797) (3,035) (2,818)
--------- --------- --------- --------- ---------
Total loans............... 269,316 282,396 347,414 368,223 384,570
Less allowance for loan
losses.................. (8,041) (7,645) (7,040) (5,037) (5,787)
--------- --------- --------- --------- ---------
Net loans................. $ 261,275 $ 274,751 $ 340,374 $ 363,186 $ 378,783
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
REAL ESTATE MORTGAGE LOANS. As of December 31, 1998, the Company's
residential mortgage loans totaled $97,194,000, or 36%, of its total loans.
These loans were predominantly originated in Sonoma and Mendocino Counties.
Total residential loans increased $3,678,000 during the year as a result of
normal origination activity. As of December 31, 1997, residential mortgage loans
totaled $93,516,000 or 33% of total loans. Such loans declined $22,115,000 due
to a curtailment of origination activity. As of December 31, 1996 residential
mortgage loans totaled $115,631,000. Such loans declined $34,509,000 during the
year due to prepayments and continuing restructuring of the Company's balance
sheet. This 1996 restructuring was accomplished by a $34,000,000 loan sale in
the second quarter of 1996. In 1995, total residential mortgage loans decreased
$54,800,000. The decrease in residential real estate loans is due primarily to
loan sales of $35.9 million during the second quarter of 1995. The sale was
executed to restructure the Company's balance sheet and consequently improve the
Company's capital ratios and reduce its interest rate risk. In addition, in the
third quarter of 1995, the Company swapped $22.1 million of adjustable rate
loans with Fannie Mae for a mortgage-backed security which had a coupon rate of
7.295% and was scheduled to mature in 2025; this security, which was classified
as available for sale, was sold prior to December 31, 1995, with settlement due
from broker in January 1996. The Company does not anticipate any further
restructuring of the Company's balance sheet through loan sales.
26
<PAGE>
At December 31, 1998, $31,994,000, or 33%, of the Company's residential real
estate mortgage loans were fixed-rate mortgage loans having original terms
ranging from one to thirty years. Another $59,187,000, or 61%, were held as
adjustable-rate mortgages, substantially all of which adjust semi-annually,
based on the Eleventh District Cost-of-Funds Index published monthly by the
FHLB. The Company no longer originates mortgages tied to this index. The balance
of these loans, $6,013,000, or 6%, consisted of multifamily loans, second
mortgage loans and loans on improved single-family lots. The majority of the
Company's residential mortgage loans have been underwritten for the Company's
portfolio and do not necessarily meet standard underwriting criteria for sale in
the secondary market. Approximately 59% of the total amount outstanding had
principal balances that were less than $300,000. The Company's residential real
estate mortgage loans predominately have loan-to-value ratios of 80% or less,
using current loan balances and appraised values as of the time of origination.
The Company's general policy is not to exceed an 80% loan-to-value ratio on
residential mortgage loans without mortgage insurance. The Company generally
does not make portfolio loans on a negative amortization basis.
As of December 31, 1998, the Company had outstanding $63,260,000 in
commercial mortgage loans, which constituted 23% of total loans. These loans
were primarily secured by owner-occupied commercial properties and have 5- to
15-year maturities based upon 25- to 30-year amortization periods. The ratio of
the loan principal amount to appraised values are generally 75% or less, using
appraised values at the time of loan origination, and the loans are
predominantly for owner-occupied small office buildings or office/ warehouses.
The Company originates commercial mortgage loans that are guaranteed by the SBA
up to 70% to 90% of the balance. The SBA guaranteed portion of such loans are
sold into the secondary market with the unguaranteed principal balance retained.
The aggregate retained unguaranteed principal balance of such loans was $9
million at December 31, 1998. Approximately 54% of the total amount outstanding
of commercial mortgage loans had principal balances that were less than
$250,000.
The Company also originates residential mortgage loans for sale. See
"Mortgage Banking and Mortgage Brokerage."
REAL ESTATE CONSTRUCTION LOANS. Real estate construction loans are
primarily for residential housing. The primary market focus is toward individual
borrowers and small residential and commercial projects. The economic viability
of the project and the borrower's past development record and creditworthiness
are primary considerations in the loan underwriting decision. The Company had
$46,905,000 in construction loans outstanding at December 31, 1998, comprising
17% of its total loans. These loans were principally located in Northern
California. This represents a decrease of $8,126,000 or 15% from 1997. In 1997
construction loans decreased $29,486,000 or 35% from 1996. Approximately $22
million of these loans consisted of 107 single-family individual-borrower
construction loans, and the remaining loans included 51 subdivision projects, 11
land development projects and 6 commercial projects. At December 31, 1998, the
largest single-family construction loan commitment was $3,000,000, and the
average commitment was less than $350,000. The largest commitment for a
subdivision project was $3,215,000 million, and the average subdivision
commitment was less than $850,000. The average commercial project involved a
loan of approximately $790,000.
Construction loans are funded on a line-item, percentage of completion
basis. As the builder completes various line items (foundation, framing,
electrical, etc.) of the project, or portions of those line items, the work is
reviewed by one of several independent inspectors hired by the Company. Upon
approval from the inspector, the Company funds the draw request according to the
percentage completion of the line items that have been approved. The Company
rotates inspectors during construction to ensure independent review. Actual
funding checks must be signed by an officer of the Company, and that officer
must also initial the line-item worksheet used to support the draw request. In
addition, Company personnel or agents routinely inspect the various construction
projects, all of which are located in the Company's lending area.
27
<PAGE>
Commercial real estate mortgage and construction lending contains potential
risks which are not inherent in other types of commercial loans. These potential
risks include declines in market values of underlying real property collateral
and, with respect to construction lending, delays or cost overruns which could
expose the Company to loss. In addition, risks in commercial real estate lending
include declines in commercial real estate values, general economic conditions
surrounding the commercial real estate properties and vacancy rates. A decline
in the general economic conditions or real estate values within the Company's
market area could have a negative impact on the performance of the loan
portfolio or value of the collateral. Because the Company lends primarily within
its market area, the real property collateral for its loans is similarly
concentrated, rather than diversified over a broader geographic area. The
Company could therefore be adversely affected by a decline in real estate values
in its primary market area even if real estate values elsewhere in California
remained stable or increased.
COMMERCIAL LOANS. Commercial loans consist primarily of short-term
financing for businesses and professionals located in Sonoma and Mendocino
Counties. At December 31, 1998, these loans totaled $63,260,000, or 23%, of the
Company's total loans. This represents a decrease of $5,837,000 or 8% from 1997
due to normal loan payoffs. In 1997 commercial loans increased $15,524,000 or
29% from 1996. The commercial loans are diversified as to industries and types
of businesses, with no material industry concentrations. Commercial loan
borrowers generally have deposit relationships with the Company. The commercial
loans can be unsecured or secured by various assets, including equipment,
receivables, deposits and other assets. Commercial loans may be secured by
commercial or residential property; however, they are not classified as mortgage
loans since these loans are not typically taken out for the purpose of acquiring
real estate and the loans are short-term. In these cases, the mortgage
collateral is often taken as additional collateral. As of December 31, 1998, the
size of individual commercial loans varied widely, with 97% having principal
balances less than $350,000. At December 31, 1998, the Company had 20 commercial
borrowers whose aggregate individual liability exceeded $2,000,000.
LOAN COMMITMENTS. In the normal course of business, there are various
commitments outstanding to extend credit that are not reflected in the financial
statements. Annual review of the commercial credit lines and ongoing monitoring
of outstanding balances reduces the risk of loss associated with these
commitments. As of December 31, 1998, the Company had outstanding $36,322,000 in
unfunded mortgage loan commitments, $27,298,000 in undisbursed loan commitments
and $557,000 in standby letters of credit. The Company's undisbursed commercial
loan commitments represent primarily business lines of credit. The undisbursed
construction commitments represented undisbursed funding on construction
projects in process. The mortgage loan commitments represented approved but
unfunded mortgage loans with the Company's mortgage banking business.
MATURITY DISTRIBUTION. The following table shows the maturity distribution
of the Company's commercial and real estate construction loans outstanding as of
December 31, 1998, which, based on remaining scheduled repayments of principal,
were due within the periods indicated.
<TABLE>
<CAPTION>
AFTER ONE
WITHIN THROUGH AFTER FIVE
ONE YEAR FIVE YEARS YEARS TOTAL
--------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
Commercial..................................... $ 22,802 $ 17,849 $ 22,609 $ 63,260
Real estate construction....................... 44,703 1,908 294 46,905
--------- ----------- ----------- ----------
Total........................................ $ 67,505 $ 19,757 $ 22,903 $ 110,165
--------- ----------- ----------- ----------
--------- ----------- ----------- ----------
Loans with fixed interest rates................ $ 41,697 $ 9,897 $ 1,972 $ 53,566
Loans with variable interest rates............. 25,808 9,860 20,931 56,599
--------- ----------- ----------- ----------
Total........................................ $ 67,505 $ 19,757 $ 22,903 $ 110,165
--------- ----------- ----------- ----------
--------- ----------- ----------- ----------
</TABLE>
28
<PAGE>
DEPOSIT STRUCTURE
The Company primarily attracts deposits from local businesses and
professionals, as well as through retail certificates of deposits, savings and
checking accounts. In addition to the Company's local depository offices, it
attracts certificates of deposit, primarily from financial institutions
throughout the nation, by publishing rates in national publications. These
certificates of deposit have often been attracted at interest rates at or above
local market retail deposit rates. The national deposit market is utilized to
supplement funding for the Company's mortgage banking activities and other
liquidity needs. There can be no assurance that this funding practice will
continue to provide deposits at attractive rates, or that applicable federal
regulations will not limit the Company's ability to attract deposits in this
manner. The Company generally does not purchase brokered deposits and had no
brokered deposits at December 31, 1998.
The following chart sets forth the distribution of the Company's average
daily deposits for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Transaction accounts:
Savings & Money Market.... $ 119,624 3.58% $ 130,999 3.94% $ 129,405 4.02%
NOW....................... 23,236 1.27 21,804 1.47 21,245 1.64
Noninterest bearing....... 82,074 -- 77,382 -- 65,082 --
Time deposits $100,000 and
over...................... 57,724 5.62 44,342 5.68 95,258 5.35
Other time deposits......... 81,920 5.39 128,002 5.33 143,770 6.09
</TABLE>
The Company's time deposits of $100,000 or more had the following schedule
of maturities at December 31, 1998:
<TABLE>
<CAPTION>
AMOUNT
-------------
(IN
THOUSANDS)
<S> <C>
Remaining Maturity:
Three months or less......................................................... $ 20,331
Over three months to six months.............................................. 13,912
Over six months to 12 months................................................. 19,690
Over 12 months............................................................... 8,667
-------------
Total...................................................................... $ 62,600
-------------
-------------
</TABLE>
Time deposits of $100,000 or more are generally from the Company's local
business and professional customer base. The potential impact on the Company's
liquidity from the withdrawal of these deposits is considered in the Company's
asset and liability management policies, which attempt to anticipate adequate
liquidity needs through its management of investments, federal funds sold, loan
sales, or by generating additional deposits.
OTHER BORROWINGS
At December 31, 1998, the Company had paid off all outstanding FHLB
short-term borrowings with a weighted average interest rate of 6.03%,
collateralized by approximately $54,183,000 in residential mortgage loans.
Remaining available credit at December 31, 1998 was $2,105,000. Advances are
made on a short-term basis with a rolling maturity date and are typically repaid
within a 30-day period. On occasion, a borrowing is made on a fixed maturity
basis. In such instances, maturities do not extend beyond one year. The
following table summarizes the highest amount of FHLB borrowings outstanding for
a month-end
29
<PAGE>
during the year, the average balance of borrowings from the FHLB and the
weighted average rate for the three years ended December 31, 1998.
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1998 1997 1966
--------- ------------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Average balance during the year......... $1,318 $566 $21,834
Average interest rate during the year... 6.03% 5.00% 5.94%
Maximum month-end balance during the
year.................................. $1,966 $1,819 $39,000
Date of maximum month-end balance....... March 31 December 31 April 30
</TABLE>
MORTGAGE BANKING AND MORTGAGE BROKERAGE
MORTGAGE BANKING.
The Company's results of operations have been substantially affected by
mortgage banking and mortgage brokerage activity, which can fluctuate
significantly, in both volume and profitability, with changes in interest rates.
For 1998, mortgage loans originated for sale volume totaled $479 million, or
$300 million more than the $179 million originated in 1997. In 1997, such
originations were $1.194 billion less than the $1.373 billion originated in
1996. The mix of these originations in 1998 was approximately 92% fixed rate
loans vs. 8% adjustable rate loans compared to 84% fixed, and 16% adjustable for
1997, and 88% fixed rate loans vs. 12% variable for 1996.
The following table represents the Company's residential lending origination
and sale activity for the years indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN MILLIONS)
<S> <C> <C> <C>
Mortgage banking loan originations.................. $ 479 $ 179 $ 1,373
Increase (decrease) from prior period............... 168% (87)% 64%
Mortgage banking loan sales......................... $ 480 $ 225 $ 1,481
Increase (decrease) from prior period............... 113% (85)% 69%
Mortgage banking revenue............................ $ 21 $ 15 $ 31
</TABLE>
All of the Company's mortgage loans held for sale meet certain investor
underwriting criteria regarding loan-to-value ratios, maturities, yields and
related documentation. The majority of the loans sold by the Company have been
sold to either Fannie Mae, Freddie Mac or other institutional mortgage conduits.
These loans must conform to established Freddie Mac/Fannie Mae underwriting
criteria, including a maximum dollar limit, maturities that vary from five to
thirty years, loan-to-value ratios of 80% or less (90% or less with mortgage
insurance), adequate borrower liquidity, and the ability of the borrower to
service the mortgage debt (and all other debt) out of income. Loans sold to
other investors, such as savings and loans, insurance companies and other
conduits, usually are for dollar amounts in excess of the Freddie Mac/Fannie Mae
limit, but otherwise generally meet standard Freddie Mac/Fannie Mae underwriting
criteria.
As part of its residential lending activities, the Company enters into
forward commitments to sell mortgage loans, either in the form of
mortgage-backed securities ("MBS") or as whole loans. These commitments may be
optional or mandatory. Under optional commitments, a commitment fee is paid and
the Company carries no risk in excess of the loss of such fee in the event that
the Company is unable to deliver sufficient mortgage loans to fulfill the
commitment. Mandatory commitments may entail possible financial risk to the
Company if it is unable to deliver mortgage loans in sufficient quantity or at
sufficient rates to meet the terms of the commitments.
30
<PAGE>
In order to minimize the risk that a change in interest rates will result in
a decrease in the value of the Company's current mortgage loan inventory or its
commitments to purchase or originate mortgage loans ("committed pipeline"), the
Company enters into hedging transactions. The Company's hedging policies
generally require that its inventory of mortgage loans held for sale and the
maximum portion of its committed pipeline that may close be hedged with forward
sales of MBS or options to buy or sell mortgage-backed or U.S. Treasury
securities. As such, the Company is not exposed to significant risk nor will it
derive any significant benefit from changes in interest rates on the price of
the mortgage loan inventory net of gains or losses of associated hedge
positions. The correlation between the price performance of the hedge
instruments and the inventory being hedged is very high due to the similarity of
the asset and the related hedge instrument. The Company is exposed to
interest-rate risk to the extent that the portion of loans from the committed
pipeline that actually closes at the committed price is less than the portion
expected to close in the event of a decline in rates, and in the event such
decline in closings is not covered by forward contracts and options to purchase
MBS needed to replace the loans in process that do not close at their committed
price. The Company determines the portion of its committed pipeline that it will
hedge based on numerous factors, including the composition of the Company's
committed pipeline, the portion of such committed pipeline likely to close, the
timing of such closings and the current interest rate environment.
The following lists the notional amounts of the various hedging instruments
outstanding at December 31, 1998 and the date through which exercise dates
extend:
<TABLE>
<CAPTION>
EXERCISE DATES
NOTIONAL AMOUNT EXTEND THROUGH
---------------- ----------------
<S> <C> <C>
Forward contracts to sell MBS............................. $ 11,000,000 February 1999
</TABLE>
MORTGAGE BROKERAGE.
Beginning in the later half of 1996 the Company commenced its mortgage loan
brokerage operation through Valley Financial, a division of National Bank of the
Redwoods. The Company's mortgage loan brokerage operates in six offices
throughout the San Francisco Bay Area. The Company maintains brokerage
relationships with approximately 100 mortgage lenders. Total volume of loans
brokered in 1998, 1997 and 1996 amounts to $893,224,000, $432,400,000, and
$67,750,000. Total revenue received from mortgage loan brokerage operations
amounted to $4,976,000, $2,238,000 and $73,000 in 1998, 1997 and 1996
respectively.
All of the Company's mortgage loans brokered to other lending institutions
meet certain investor underwriting criteria regarding loan-to-value ratios,
maturities, yields and related documentation. Generally speaking, these loans
must conform to established Freddie Mac/Fannie Mae underwriting criteria,
maturities that vary from five to thirty years, loan-to-value ratios of 80% or
less (90% or less with mortgage insurance), adequate borrowing liquidity, and
the ability of the borrower to service the mortgage debt (and all other debt)
out of income.
MORTGAGE LOAN SERVICING. Mortgage loan servicing includes the collection and
remittance of loan payments, accounting for principal and interest, holding
escrow (impound) funds for payment of taxes and insurance, making inspections of
the mortgage premises when required, collection of past due amounts from
delinquent mortgagors, supervision of foreclosures in the event of unremedied
defaults, and general administration of the loans, either for the Company or for
the investors to whom the loans have been sold. The amounts of impound payments
held by the Company for others totaled $507,000, $264,000 and $1,651,000 on
December 31, 1998, 1997 and 1996, respectively. Servicers of loans sold to
Freddie Mac or Fannie Mae generally receive a loan servicing fee of at least
.25% per annum on the declining principal balance of the loans being serviced,
but the actual fee can be higher depending upon the coupon rate of the loans
being serviced and the actual pass-through rate paid to the investor. Servicing
fees for other investors can vary according to market conditions at the time the
loan is sold.
31
<PAGE>
In general, the value of the Company's loan servicing portfolio may be
adversely affected by declining mortgage interest rates and increasing loan
prepayments. Income generated from the portfolio may also decline in such an
environment. In a low interest rate environment, the rate at which mortgage
loans are prepaid tends to increase as borrowers refinance their loans. A high
level of prepayments for an extended period of time could have an adverse effect
on the value of the Company's PMSR pools, the level of the Company's outstanding
loan portfolio, and the size of its mortgage loan servicing portfolio.
Additionally, the Company's decision to sell servicing rights, and the timing of
such sales, may affect the Company's earnings on a quarter-to-quarter basis.
Certain factors, including demand and prepayment, delinquency and foreclosure
rates, could have an adverse effect on the Company's ability to sell servicing
rights and the value of those rights. In a rising interest rate environment,
prepayments of loans decrease and the value of the Company's loan servicing
portfolio will decline at a slower rate.
The following table sets forth the dollar amounts of the Company's mortgage
loan servicing portfolio at the dates indicated, the portion of the Company's
loan servicing portfolio resulting from loan originations and purchases and the
carrying value as a percentage of loans serviced.
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Loans acquired or originated by the Company
and sold.................................... $ 122,525 $ 101,495 $ 123,988
Loans underlying purchased mortgage servicing
rights...................................... 9,200 23,867 --
--------- --------- ---------
Total......................................... $ 131,725 $ 125,362 $ 123,988
--------- --------- ---------
--------- --------- ---------
Purchased and originated mortgage servicing
rights...................................... $ 305 $ 620 $ 582
Purchased and originated mortgage servicing
rights as a percentage of loans serviced.... .23% .49% .47%
</TABLE>
Management may from time to time determine to sell the Company's mortgage
loans on a servicing released basis based on market conditions. The Company
sells loan servicing rights to offset the cost of originating mortgage loans.
The amount of loan servicing rights sold annually by the Company may vary
because of market fluctuations in the pricing of loan servicing rights, and the
amount of gain upon sale of servicing rights may vary significantly from period
to period. In 1996 the Company sold a portion of its originated servicing rights
on a bulk basis for gains of $2,153,000. No such gains or losses were realized
in 1998 and 1997. The Company also purchases mortgage servicing rights ("PMSR")
in order to better utilize its servicing capabilities and to take advantage of
market prices which management believed to be favorable. The amounts the Company
pays for the rights to service loans are carried on the Company's statement of
financial condition as intangible assets and are amortized in proportion to, and
over the estimated life of, the related pools of mortgage loans using a method
approximating the interest method. The Company's carrying values of purchased
mortgage servicing rights, and the amortization thereon, are evaluated
quarterly, by portfolios, and such carrying values are adjusted for indicated
impairments based on management's best estimate of the remaining cash flows.
Such estimates may vary from the actual remaining cash flows due to
unanticipated prepayments of the underlying mortgage loans and increases in
servicing costs. The Company's carrying values of purchased mortgage servicing
rights do not purport to represent the amount that would be realizable by a sale
of these assets in the open market. The Company's OMSR and PMSR amortization,
including valuation adjustments, totaled $327,000 for 1998, $293,000 for 1997,
and $2,021,000 for 1996. The amortized values of the Company's PMSR pools were
$97,000 and $145,000 at December 31, 1998 and 1997, respectively. There was no
amortized value at December 31, 1996.
32
<PAGE>
ASSET QUALITY
The Company attempts to minimize credit risk through its underwriting and
credit review policies. The Company conducts its own internal credit review
processes and, in addition, contracts with an independent loan reviewer who
performs monthly reviews of new loans and potential problem loans that meet
predetermined parameters. The Boards of Directors of NBR has an internal asset
review committee which reviews the asset quality of new and problem loans on a
monthly basis and reports the findings to the full Board. In management's
opinion, this loan review system facilitates the early identification of
potential problem loans.
The performance of the Company's loan portfolio is evaluated regularly by
management. The Company places a loan on nonaccrual status when one of the
following events occurs: any installment of principal or interest is 90 days or
more past due (unless, in management's opinion, the loan is well secured and in
the process of collection); management determines the ultimate collection of
principal of or interest on a loan to be unlikely; or the terms of a loan have
been renegotiated to less than market rates due to a serious weakening of the
borrower's financial condition.
With respect to the Company's policy of placing loans 90 days or more past
due on nonaccrual status unless the loan is well secured and in the process of
collection, a loan is considered to be in the process of collection if, based on
a probable specific event, it is expected that the loan will be repaid or
brought current. Generally, this collection period would not exceed 30 days.
When a loan is placed on nonaccrual status, the Company's general policy is to
reverse and charge against current income previously accrued but unpaid
interest. Interest income on such loans is subsequently recognized only to the
extent that cash is received and future collection of principal is deemed by
management to be probable. Where the collectibility of the principal of or
interest on a loan is considered to be doubtful by management, it is placed on
nonaccrual status prior to becoming 90 days delinquent.
On January 1, 1995, the Company adopted SFAS No. 114 "Accounting by
Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors
for Impairment of a Loan--Income Recognition and Disclosure." These statements
address the accounting and reporting by creditors for impairment of certain
loans. In general, a loan is impaired when, based upon current information and
events, it is probable that a creditor will be unable to collect all amounts due
according to the contractual terms of the loan agreement. These statements are
applicable to all loans, uncollateralized as well as collateralized, except
loans that are measured at the lower of cost or fair value. Impairment is
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate, except that as a practical expedient, the
Company measures impairment based on a loan's observable market price or the
fair value of the collateral if the loan is collateral dependent. Loans are
measured for impairment as part of the Company's normal internal asset review
process. The effect of adopting SFAS 114 has not been material to the Company's
balance sheet or statement of operations.
Interest income is recognized on impaired loans in a manner similar to that
of all loans. It is the Company's policy to place loans that are delinquent 90
days or more as to principal or interest on nonaccrual status unless secured and
in the process of collection, and to reverse from current income accrued but
uncollected interest. Cash payments subsequently received on nonaccrual loans
are recognized as income only where the future collection of principal is
considered by management to be probable.
At December 31, 1998 and 1997 the Company's total recorded investment in
impaired loans was $10,293,000 and $10,899,000 of which $8,573,000 and
$8,927,000 relates to the recorded investment for which there is a related
allowance for credit losses of $1,543,000 and $1,565,000 determined in
accordance with these statements. The amount of that recorded investment for
which there is no related allowance for credit losses determined in accordance
with these statements was $1,720,000 and $1,972,000 at December 31, 1998 and
1997. At December 31, 1998 approximately 80% of the impaired loan balance was
measured based on the fair value of the collateral, with the remainder measured
by estimated present value cash flow.
33
<PAGE>
The average recorded investment in impaired loans during the year ended
December 31, 1998 and 1997 was $10,377,000 and $10,949,000. The related amount
of interest income recognized during the period that such loans were impaired
was $578,000 and $558,000. No interest income was recognized using a cash-basis
method of accounting during the period that the loans were impaired.
As of December 31, 1998 and 1997 there were $5,556,000 and $7,883,000 of
loans on which the accrual of interest had been discontinued. Interest due but
excluded from interest income on loans placed on nonaccrual status was $341,000,
$469,000 and $499,000 for the years ended December 31, 1998, 1997 and 1996.
Interest income received on nonaccrual loans was $51,000, $84,000 and $12,000
for the years ended December 31, 1998, 1997 and 1996.
The following table sets forth the amount of the Company's nonperforming
assets as of the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Nonaccrual loans.................................. $ 5,556 $ 7,883 $ 8,246 $ 4,201 $ 2,314
Accruing loans past due 90 days or more........... -- 735 1,536 92 2,767
Restructured loans (in compliance with modified
terms).......................................... 1,045 1,109 599 651 432
--------- --------- --------- --------- ---------
Total nonperforming loans....................... 6,601 9,727 10,381 4,944 5,513
Other real estate owned........................... 2,181 6,352 2,132 963 1,814
Other assets owned................................ 129 542 668 1,249 1,133
--------- --------- --------- --------- ---------
Total nonperforming assets...................... $ 8,911 $ 16,621 $ 13,181 $ 7,156 $ 8,460
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Nonperforming loans to total loans................ 2.45% 3.44% 2.99% 1.34% 1.43%
Nonperforming assets to total assets.............. 2.11 3.72 2.64 1.28 1.34
Allowance for loan losses to nonperforming
assets.......................................... 90.24 46.00 53.41 70.39 68.40
Allowance for loan losses to nonperforming
loans........................................... 1.22 0.79 0.68 1.02 1.05
</TABLE>
Nonperforming loans totaled $6,601,000 at December 31, 1998, consisting of
$1,781,000 that were secured by residential real estate and $3,571,000 secured
by commercial real estate with the remaining $1,249,000 were either unsecured or
collateralized by various business assets other than real estate.
Other real estate owned totaled $2,181,000 at December 31, 1998, consisting
of $883,000 in construction and land development and $1,298,000 in residential
properties. Other assets owned were contract receivable rights and repossessed
personal property carried at $129,000.
In addition to the above mentioned assets, as of December 31, 1998
management of the Company has identified six lending relationships which in
aggregate amount to approximately $3,136,000 in potential nonperforming loans,
as to which it has serious doubts as to the ability of the borrowers to comply
with the present repayment terms and which may become nonperforming assets,
based on known information about possible credit problems of the borrower.
34
<PAGE>
The following table provides certain information for the years indicated
with respect to the Company's allowance for loan losses as well as charge-off
and recovery activity.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period...................... $ 7,645 $ 7,040 $ 5,037 $ 5,787 $ 5,209
--------- --------- --------- --------- ---------
Charge-offs:
Residential real estate mortgage.................. 617 408 741 304 434
Commercial real estate mortgage................... 355 124 244 14 57
Commercial........................................ 794 784 2,517 1,985 593
Real estate construction.......................... 179 456 725 -- 32
Installment and other............................. 55 148 337 147 86
--------- --------- --------- --------- ---------
Total charge-offs................................... 2,000 1,920 4,564 2,450 1,202
--------- --------- --------- --------- ---------
Recoveries:
Residential real estate mortgage.................. 31 15 2 25 39
Commercial real estate mortgage................... 10 -- 5 -- 3
Commercial........................................ 279 295 252 84 8
Real estate construction.......................... 3 -- -- -- --
Installment and other............................. 33 115 46 1 1
--------- --------- --------- --------- ---------
Total recoveries.................................... 356 425 305 110 51
--------- --------- --------- --------- ---------
Net charge-offs..................................... 1,644 1,495 4,259 2,340 1,151
--------- --------- --------- --------- ---------
Reserves acquired from Codding...................... -- -- -- -- 634
Provision for loan losses........................... 2,040 2,100 6,262 1,590 1,095
--------- --------- --------- --------- ---------
Balance at end of period............................ $ 8,041 $ 7,645 $ 7,040 $ 5,037 $ 5,787
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net charge-offs during the period to average
loans............................................. .62% .46% 1.22% .60% .40%
Allowance for loan losses to total loans............ 2.99 2.71 2.03 1.37 1.50
Allowance for loan losses to nonperforming loans.... 121.82 78.60 67.82 101.88 104.97
</TABLE>
The allowance for loan losses is established through charges to earnings in
the form of the provision for loan losses. Loan losses are charged to, and
recoveries are credited to, the allowance for loan losses. The provision for
loan losses is determined after considering various factors such as loan loss
experience, current economic conditions, maturity of the portfolio, size of the
portfolio, industry concentrations, borrower credit history, the existing
allowance for loan losses, independent loan reviews, current charges and
recoveries to the allowance for loan losses, and the overall quality of the
portfolio, as determined by management, regulatory agencies, and independent
credit review consultants retained by the Company.
The adequacy of the Company's allowance for loan losses is based on specific
and formula allocations to the Company's loan portfolio. Specific allocations of
the allowance for loan losses are made to identified problem or potential
problem loans. The specific allocations are increased or decreased through
management's reevaluation of the status of the particular problem loans. Loans
which do not receive a specific allocation receive an allowance allocation based
on a formula, represented by a percentage factor based on underlying collateral,
type of loan, historical charge-offs and general economic conditions, which is
applied against the general portfolio segments.
It is the policy of management to make additions to the allowance for loan
losses so that it remains adequate to cover anticipated charge-offs, and
management believes that the allowance at December 31, 1998 is adequate.
However, the determination of the amount of the allowance is judgmental and
subject to
35
<PAGE>
economic conditions which cannot be predicted with certainty. Accordingly, the
Company cannot predict whether charge-offs of loans in excess of the allowance
may be required in future periods.
The provision for loan losses reflects an accrual sufficient to cover
projected probable charge-offs and the maintenance of the allowance at a level
deemed adequate to absorb potential future losses.
The table below sets forth the allocation of the allowance for loan losses
by loan type as of the dates specified. The allocation of individual categories
of loans includes amounts applicable to specifically identified as well as
unidentified losses inherent in that segment of the loan portfolio and will
necessarily change whenever management determines that the risk characteristics
of the loan portfolio have changed.
Management believes that any breakdown or allocation of the allowance for
loan losses into loan categories lends an appearance of exactness which does not
exist, in that the allowance is utilized as a single unallocated allowance
available for all loans and undisbursed commitments. The allocation below should
not be interpreted as an indication of the specific amounts or loan categories
in which future charge-offs may occur:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------------------------------------------------------
1998 1997 1996 1995
------------------------ ------------------------ ------------------------ ------------------------
ALLOWANCE % OF ALLOWANCE % OF ALLOWANCE % OF ALLOWANCE % OF
FOR LOSSES LOANS FOR LOSSES LOANS FOR LOSSES LOANS FOR LOSSES LOANS
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Residential real estate
mortgage............... $ 1,725 36% $ 2,061 33% $ 1,522 34% $ 1,922 44%
Commercial real estate
mortgage............... 1,260 22 650 20 809 19 664 15
Commercial............... 2,514 23 1,640 24 1,753 21 1,082 21
Real estate
construction........... 1,691 17 1,821 20 2,076 24 1,210 17
Installment and other.... 207 2 194 3 231 2 118 3
Unallocated.............. 644 -- 1,279 -- 649 -- 41 --
----------- --- ----------- --- ----------- --- ----------- ---
Total.................... $ 8,041 100% $ 7,645 100% $ 7,040 100% $ 5,037 100%
----------- --- ----------- --- ----------- --- ----------- ---
----------- --- ----------- --- ----------- --- ----------- ---
<CAPTION>
1994
------------------------
ALLOWANCE % OF
FOR LOSSES LOANS
----------- -----------
<S> <C> <C>
Residential real estate
mortgage............... $ 2,231 56%
Commercial real estate
mortgage............... 728 14
Commercial............... 1,441 19
Real estate
construction........... 723 8
Installment and other.... 336 3
Unallocated.............. 328 --
----------- ---
Total.................... $ 5,787 100%
----------- ---
----------- ---
</TABLE>
In 1998 the Company was required by various mortgage loan investors to
repurchase 9 non performing residential mortgage loans or purchase foreclosed
real property. From time to time the Company may be required to repurchase
mortgage loans from investors depending upon representations and warranties of
the purchase agreement between the investor and the Company. Such
representations and warranties include valid appraisal, status of borrower,
first payment default or fraud. Primarily these repurchases involve loans which
are in default. The Company expects that it may be required to repurchase loans
in the future. The Company maintains a reserve for its estimate of potential
losses associated with the potential repurchase of previously sold mortgage
loans. Such reserve amounts to $172,000 as of December 31, 1998.
LIQUIDITY
Redwood's primary source of liquidity is dividends from NBR. Redwood's
primary uses of liquidity are associated with cash payments made to the
subordinated debt holders, dividend payments made to the preferred stock
holders, and operating expenses. It is the Company's general policy to retain
liquidity at the parent at a level which management believes to be consistent
with the safety and soundness of the Company as a whole. As of December 31,
1998, Redwood held $2,335,000 in deposits at NBR and a $3,000,000 subordinated
note issued by NBR.
In 1998, Redwood reinstated a cash dividend to its common stock holders at a
quarterly rate of $.04 per share. Payment of dividends by the Company is
ultimately dependent on dividends from NBR to Redwood. Federal regulatory
agencies have the authority to prohibit the payment of dividends by NBR to
Redwood if a finding is made that such payment would constitute an unsafe or
unsound practice, or if
36
<PAGE>
NBR became undercapitalized. If NBR is restricted from paying dividends, Redwood
could be unable to pay the above obligations. No assurance can be given as to
the ability of NBR to pay dividends to Redwood. In 1998, NBR declared dividends
of $1,200,000.
Although each entity within the consolidated group manages its own
liquidity, the Company's consolidated cash flows can be divided into three
distinct areas; operating, investing and financing. For the year ended December
31, 1998 the Company received $4,102,000 and $10,027,000 in cash flows from
operations and investment activities while using $28,006,000 in financing
activities, respectively.
The principal sources of asset liquidity are federal funds sold and loans
held for sale. Secondary sources of liquidity are loan repayments, investments
available for sale, maturing investments, and investments that can be used as
collateral for other borrowings. At December 31, 1998, the Company had
$26,205,000 in federal funds sold and $32,620,000 in loans held for sale. Total
investments were $60,410,000, of which $19,075,000 were pledged.
Time deposits from other financial institutions totaled $993,000 or .3% of
total deposits, at December 31, 1998, a decrease of $2,407,000 from the
$3,400,000 recorded at December 31, 1997, which amounted to .9% of total
deposits at that time. These deposits are used to supplement liquidity when the
Company determines that deposits from local sources would be more expensive. The
Company is able to retain such deposits at favorable rates when desired. The
volume of these deposits is dependent on anticipated mortgage origination
volumes.
Liability-based liquidity includes interest-bearing and noninterest bearing
retail deposits, which are a relatively stable source of funds, time deposits
from financial institutions throughout the United States, federal funds
purchased, and other short-term and long-term borrowings, some of which are
collateralized. The Company collateralized FHLB advances as NBR is a member of
the FHLB. Management uses FHLB advances as part of its funding strategy because
the rates paid for those advances are generally lower than the rates paid on
deposits. FHLB advances must be collateralized by the pledging of qualified
mortgage loans of NBR. NBR's FHLB borrowing limitation at December 31, 1998 and
December 31, 1997 was $2,105,000. At December 31, 1997, NBR had $1,800,000 in
FHLB advances outstanding, as compared to $4,000,000 at December 31, 1996.
Management believes that at December 31, 1998 the Company's liquidity position
was adequate for the operations of Redwood and its subsidiaries for the
foreseeable future.
CAPITAL
A strong capital base is essential to the Company's continued ability to
service the needs of its customers. Capital protects depositors and the deposit
insurance fund from potential losses and is a source of funds for the
substantial investments necessary for the Company to remain competitive. In
addition, adequate capital and earnings enable the Company to gain access to the
capital markets to supplement its internal growth of capital. Capital is
generated internally primarily through earnings retention.
The Company and NBR are each required to maintain minimum capital ratios
defined by various federal government regulatory agencies. The FRB and the OCC
have each established capital guidelines, which include minimum capital
requirements. The regulations impose two sets of standards: "risk-based" and
"leverage".
Under the risk-based capital standard, assets reported on an institution's
balance sheet and certain off-balance sheet items are assigned to risk
categories, each of which is assigned a risk weight. This standard characterizes
an institution's capital as being "Tier 1" capital (defined as principally
comprising shareholders' equity and noncumulative preferred stock) and "Tier 2"
capital (defined as principally comprising the allowance for loan losses and
subordinated debt). At December 31, 1998, 1997 and 1996, the Company and its
subsidiaries were required to maintain a total risk-based capital ratio of 8%,
including a Tier 1 capital ratio of at least 4%.
37
<PAGE>
Under the leverage capital standard, an institution must maintain a
specified minimum ratio of Tier 1 capital to total assets, with the minimum
ratio ranging from 4% to 6% for other than the highest rated institutions. The
minimum leverage ratio for the Company and NBR is based on average assets for
the quarter.
NBR maintains insurance on its customer deposits with the Federal Deposit
Insurance Corporation ("FDIC"). The FDIC manages the Bank Insurance Fund
("BIF"), which insures deposits of commercial banks such as NBR, and the Savings
Association Insurance Fund ("SAIF"), which insures deposits of savings
associations such as Allied. FDICIA mandated that the two funds maintain
reserves at 1.25% of their respective federally insured deposits.
The table below shows the capital ratios for the Company and NBR at December
31, 1998.
<TABLE>
<CAPTION>
COMPANY NBR
----------- ---------
<S> <C> <C>
Total capital to risk based assets......................................... 16.94% 15.98%
Tier 1 capital to risk based assets........................................ 11.84% 13.75%
Leverage ratio............................................................. 8.84% 10.31%
</TABLE>
Under the most stringent capital requirement, the Company has approximately
$27,992,000 in excess capital before it becomes under-capitalized. Similarly,
NBR has $25,002,000 in excess capital.
YEAR 2000 PROBLEM
The "Year 2000 Problem" relates to the fact that many computer programs and
equipment utilizing microprocessors only use two digits to represent a year,
such as "99" to represent "1999," which means that in the year 2000 such
programs/processors could incorrectly treat the year 2000 as the year 1900. The
Company's business is highly dependent on technology and data processing. As a
result, Bank management and the Board of Directors have made Year 2000
compliance a high priority. The issue must be recognized as a business issue,
rather than simply a computer issue, because of the way its effects could ripple
through the economy. The Company could be affected either directly or indirectly
by the Year 2000 issue. This could happen if any of its critical computer
systems or equipment containing embedded logic fail, if the local infrastructure
(power, communication system, or water system) fails, if its significant vendors
or third-party processors are adversely impacted, or if its borrowers or
depositors are significantly impacted by their internal systems or their
customers or suppliers.
The Company principally relies on third-party software and processing for
its mission-critical applications needs. It licenses software and/or data
processing services from outside vendors for its critical functions such as
mortgage lending, merchant credit card program, ATM, item processing and
customer statements. The Company also is dependent on personal computers and a
local area network which is supported by a Microsoft operating environment. The
foregoing systems are classified by the Company as mission critical information
technology ("IT") systems.
The Company's business also involves non-IT products and services, some of
which have embedded technology which might not be Year 2000 ready. Some non-IT
products and services involve infrastructure issues such as power,
communications and water, as well as elevators, ventilation and air conditioning
equipment. The Company classifies power and communications as non-IT mission
critical systems.
The Company's third-party application software, data processing vendors,
local area network and operating systems and the power and communication
infrastructure provide critical support to substantially all of its business and
operations. Failure to successfully complete renovation, validation and
implementation of mission critical IT systems could have a material adverse
effect on the operations and financial performance of the Company. Moreover,
Year 2000 issues experienced by significant vendors or third-party processors or
customers of the Company could negatively impact the business and operations of
the Company even if its critical IT systems function satisfactorily. Due to the
many variables related to the
38
<PAGE>
Year 2000 issue and the lack of information on Year 2000 readiness from non-IT
service providers such as power and phone systems vendors, the Company cannot
quantify the potential cost of problems if the Company's renovation and
implementation efforts or the efforts of significant vendors or customers are
not successful.
STATE OF READINESS
The Company has formed a Year 2000 team comprised of senior level employees
and officers who are familiar with the business and operations of the Company.
The Year 2000 team has conducted a comprehensive review of the Company's IT
systems to identify systems that present Year 2000 issues. The Company has
developed a plan which it believes should satisfactorily resolve Year 2000
problems related to its mission-critical IT systems. The Company's Year 2000
team is also using external resources provided by outside vendors and a
consultant hired to assist the Company.
Many vendors and third-party processors of the Company's critical IT systems
have informed the Company that their products/systems are Year 2000 compliant.
The Company's merchant credit card program is dependent on a third-party
processor. This processor's testing for Year 2000 compliance is ongoing. No
alternate vendor is readily available. In the event this vendor cannot
satisfactorily process credit card changes for merchants in the Bank's program,
the Bank's results of operations could be adversely impacted. If initial testing
for other critical IT systems is not satisfactory, the Company plans to commence
taking corrective action and complete secondary testing by on or about June 30,
1999.
The Company has run tests on selected components of its core processing
system during 1998 with technical assistance from the vendor and an outside
consultant. At the date of this report the Company believes it remains on
schedule to complete initial testing of all mission-critical IT systems by June
30, 1999.
COSTS
The Company is expensing all period costs associated with the Year 2000
issue. Through December 31, 1998, the amount of such expense has been
approximately $35,000. Management estimates that the Bank will incur
approximately an additional $150,000 in Year 2000 related expenses for the
identification, correction and reprogramming, and testing of systems for Year
2000 compliance in fiscal 1999. There can be no assurance that these expenses
will not increase as further testing and assessment of vendor and customer
readiness for the Year 2000 continues. The above cost estimates include costs
for consultants, running tests, technical assistance from vendors and costs for
products replaced for Year 2000 compliance. These costs exclude the cost of the
Company's internal staff time.
RISKS
Management believes it will be difficult to predict the outcome of the Year
2000 issue due to the complexity of technology and the inability to assess the
impact of the Year 2000 problem on third-party processors, non-IT mission
critical systems and the local, national and international economy. Management
has attempted, however, to identify a most reasonably likely worst case
scenario. This scenario suggests that the Year 2000 problem might negatively
impact some of the Company's significant IT vendors and processors and non-IT
vendors/products through the failure of the party to be prepared or the impact
on them of their own vendors and customers including possible short-term power
failures. Management believes that if this scenario occurs its ability to
process mortgages and/or credit card charges could be temporarily delayed and
earnings could be materially adversely impacted especially if a recession
results. It is not possible to predict the effect of this scenario on the
economic viability of its customers and the related adverse impact it may have
on the Company's financial position and results of operations, including the
level of the Bank's provision for possible loan losses in future periods.
Further, there can be no assurance that other possible adverse scenarios will
not occur.
39
<PAGE>
The Company presently believes that, with modifications to existing software
within its control which needs to be made Year 2000 compliant and assuming
representations of Year 2000 readiness from significant IT vendors, processors
and customers are accurate, the Year 2000 issue should not pose significant
operational risks for the Company's IT systems as so modified. However, other
significant risks relating to the Year 2000 problem are that of the unknown
impact of this problem on the operations of the Bank's customers, processors and
vendors, the impact of catastrophic infrastructure failures such as power,
communications and water on the Company's systems, the economy and future
actions which banking or securities regulators may take.
The Company is making efforts to ensure that its customer base is aware of
the Year 2000 problem. Year 2000 correspondence has been sent to both deposit
and loan customers. The Bank has amended its credit authorization documentation
to include consideration regarding the Year 2000 problem. Significant customer
relationships have been identified, and such customers are being contacted by
the Bank's employees to determine whether they are aware of Year 2000 risks and
whether they are taking preparatory actions.
The Company has also attempted to contact major vendors and suppliers of
non-software products and services including those where products utilize
embedded technology, to determine the Year 2000 readiness of such organizations
and/or the products and services which the Company purchases from such
organizations. The Company is monitoring reports provided by such vendors
regarding their preparations for Year 2000. This is an ongoing process, and the
company intends to continue to monitor the progress of such vendors through the
century date change.
Federal banking regulators have responsibility for supervision and
examination of banks to determine whether each institution has an effective plan
for identifying, renovating, testing and implementing solutions for Year 2000
processing and coordinating Year 2000 processing capabilities with its
customers, vendors and payment system partners. Examiners are also required to
assess the soundness of an institution's internal controls and to identify
whether further corrective action may be necessary to assure an appropriate
level of attention to Year 2000 processing capabilities. Management believes it
is currently in compliance with the federal bank regulatory guidelines and
timetables.
CONTINGENCY PLANS
The Company has developed contingency plans for software systems utilized by
the Company, should they not successfully pass the Company's Year 2000 testing.
Generally this involves the identification of an alternate vendor or expected
actions the Company could take, as well as the establishment of a trigger date
to implement the contingency plan. The Company is also considering the purchase
of a backup generator to provide power for certain critical functions in the
event of a power failure and additional cash will be on hand for potential
liquidity needs. Company personnel are being trained to manually perform certain
critical functions if computers fail. The Company intends to develop, in
accordance with regulatory guidelines, further contingency plans to address
potential business disruptions resulting from Year 2000 issues. However, this
process is not expected to be substantially completed until on or about June 30,
1999. The Company's contingency plans will be subject to change throughout 1999.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
As a financial institution, the Company's primary component of market risk
is interest rate volatility. Fluctuation in interest rates will ultimately
impact both the level of income and expense recorded on a large portion of the
Bank's assets and liabilities, and the market value of all interest earning
assets and interest bearing liabilities, other than those which possess a short
term to maturity. Since virtually all of the Company's interest bearing
liabilities and all of the Company's interest earning assets are located at the
Bank, virtually all of the Company's interest rate risk exposure lies at the
Bank level. As a result, all significant interest rate risk management
procedures are performed at the Bank level. Based upon the
40
<PAGE>
nature of its operations, the Bank is not subject to foreign currency exchange
or commodity price risk. The Bank's real estate loan portfolio, concentrated
primarily within northern California, is subject to risks associated with the
local economy. The Company does not own any trading assets. See "Asset Quality".
The fundamental objective of the Company's management of its assets and
liabilities is to maximize the economic value of the Company while maintaining
adequate liquidity and an exposure to interest rate risk deemed by management to
be acceptable. Management believes an acceptable degree of exposure to interest
rate risk results from the management of assets and liabilities through
maturities, pricing and mix to attempt to neutralize the potential impact of
changes in market interest rates. The Bank's profitability is dependent to a
large extent upon its net interest income, which is the difference between its
interest income on interest-earning assets, such as loans and securities, and
its interest expense on interest-bearing liabilities, such as deposits and
borrowings. The Bank, like other financial institutions, is subject to interest
rate risk to the degree that its interest-earning assets reprice differently
than its interest-bearing liabilities. The Bank manages its mix of assets and
liabilities with the goals of limiting its exposure to interest rate risk,
ensuring adequate liquidity, and coordinating its sources and uses of funds.
The Bank seeks to control its interest rate risk exposure in a manner that
will allow for adequate levels of earnings and capital over a range of possible
interest rate environments. The Bank has adopted formal policies and practices
to monitor and manage interest rate risk exposure. As part of this effort, the
Bank measures risk in three ways: repricing of earning assets and interest
bearing liabilities; changes in net interest income for interest rate shocks up
and down 200 basis points; and changes in the market value of equity for
interest rate shocks up and down 200 basis points.
The following table sets forth, as of December 31, 1998, the distribution of
repricing opportunities for the Company's earning assets and interest-bearing
liabilities, the interest rate sensitivity gap, the cumulative interest rate
sensitivity gap, the interest rate sensitivity gap ratio (i.e., earning assets
divided by interest-bearing liabilities) and the cumulative interest rate
sensitivity gap ratio.
<TABLE>
<CAPTION>
AFTER THREE AFTER SIX AFTER ONE
WITHIN MONTHS BUT MONTHS BUT YEAR BUT
THREE WITHIN SIX WITHIN WITHIN AFTER FIVE
MONTHS MONTHS ONE YEAR FIVE YEARS YEARS TOTAL
---------- ----------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
EARNING ASSETS:
Federal funds sold.............................. $ 26,205 $ -- $ -- $ -- $ -- $ 26,205
Investment securities and other................. 1,006 2,012 6,035 23,914 27,449 60,416
Mortgage loans held for sale.................... 32,620 -- -- -- -- 32,620
Loans........................................... 115,069 35,418 21,964 34,623 62,242 269,316
---------- ----------- ----------- ----------- ----------- ----------
Total earning assets............................ 174,900 37,430 27,999 58,537 89,691 388,557
---------- ----------- ----------- ----------- ----------- ----------
INTEREST-BEARING LIABILITIES:
Interest-bearing transaction accounts........... 141,316 -- -- -- -- 141,316
Time deposits................................... 45,593 33,717 42,720 18,758 168 140,956
Other borrowings................................ 1,371 -- -- -- -- 1,371
Subordinated notes.............................. 12,000 -- -- -- -- 12,000
---------- ----------- ----------- ----------- ----------- ----------
Total interest-bearing liabilities.............. 200,280 33,717 42,720 18,758 168 295,643
---------- ----------- ----------- ----------- ----------- ----------
Interest rate sensitivity gap................... $ (25,380) $ 3,713 $ (14,721) $ 39,779 $ 89,523 $ 92,914
---------- ----------- ----------- ----------- ----------- ----------
---------- ----------- ----------- ----------- ----------- ----------
Cumulative interest rate sensitivity gap........ $ (25,380) $ (21,667) $ (36,388) $ 3,391 $ 92,914
---------- ----------- ----------- ----------- -----------
---------- ----------- ----------- ----------- -----------
Interest rate sensitivity gap ratio............. .87 1.11 .66 3.12 533.87
Cumulative interest rate sensitivity gap
ratio......................................... .87 .91 .87 1.01 1.31
</TABLE>
41
<PAGE>
The Company's gap position is substantially dependent upon the volume of
mortgage loans held for sale and held in the portfolio. These loans generally
have maturities greater than five years; however, mortgage loans held for sale
are generally sold within 5 to 60 days of funding and therefore are classified
in the above table as repricing within three months. The Company enters into
commitments to sell such loans on a forward basis, usually within 30 to 60 days.
The amount of loans held for sale and the amount of forward commitments can
fluctuate significantly from period to period. Additionally, interest-bearing
transaction accounts, which consist of money market, demand and savings deposit
accounts, are classified as repricing within three months. Some of these
deposits may be repriced at management's option, and therefore a decision not to
reprice such deposits could significantly alter the Company's net interest
margin.
Management expects that, in a declining rate environment, the Company's net
interest margin would be expected to decline, and, in an increasing rate
environment, the Company's net interest margin would tend to increase. The
Company has experienced greater mortgage lending activity through mortgage
refinancings and financing new home purchases as rates declined, and may
increase its net interest margins in an increasing rate environment if more
traditional commercial bank lending becomes a higher percentage of the overall
earning assets mix. There can be no assurance, however, that under such
circumstances the Company will experience the described relationships to
declining or increasing interest rates.
On a monthly basis, NBR management prepares an analysis of interest rate
risk exposure. Such analysis calculates the change in net interest income and
the theoretical market value of the Bank's equity given a change in general
interest rates of 200 basis points up and 200 basis points down. All changes are
measured in dollars and are compared to projected net interest income and the
current theoretical market value of the Bank's equity. This theoretical market
value of the Bank's equity is calculated by discounting cash flows associated
with the Company's assets and liabilities. The following is a December 31, 1998
and 1997 summary of interest rate risk exposure as measured on a net interest
income basis and a market value of equity basis, given a change in general
interest rates of 200 basis points up and 200 basis points down.
<TABLE>
<CAPTION>
CHANGE IN ANNUAL CHANGE IN
NET INTEREST MARKET VALUE OF
CHANGE IN INTEREST RATE INCOME EQUITY
- -------------------------------------------------- ------------------ ---------------------
<S> <C> <C>
1998
+200.............................................. $ 557,000 $ (6,920,000)
+100.............................................. 270,000 (3,788,000)
- -100.............................................. (1,585,000) 3,563,000
- -200.............................................. (3,943,000) 6,455,000
1997
+200.............................................. $ 838,000 $ (4,938,000)
+100.............................................. 406,000 (2,862,000)
- -100.............................................. (704,000) 3,355,000
- -200.............................................. (1,479,000) 7,266,000
</TABLE>
The model utilized by management to create the report presented above makes
various estimates at each level of interest rate change regarding cash flows
from principal repayments on loans and mortgage-backed securities and/or call
activity on investment securities. In addition, repricing these earning assets
and matured liabilities can occur in one of three ways: (1) the rate of interest
to be paid on an asset or liability may adjust periodically based on an index;
(2) an asset, such as a mortgage loan, may amortize, permitting reinvestment of
cash flows at the then-prevailing interest rates; or (3) an asset or liability
may mature, at which time the proceeds can be reinvested at current market rate.
Actual results could differ significantly from those estimates which would
result in significant differences in the calculated projected change.
42
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL STATEMENTS
The following consolidated financial statements of Redwood and its
subsidiaries, and independent auditors' report included in the Annual Report of
Redwood to its shareholders for the years ended December 31, 1998, 1997 and
1996.
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Independent Auditors' Report.......................................................... 44
Consolidated Financial Statements of Redwood Empire Bancorp
Consolidated Statements of Operations for the years ended December 31, 1998, 1997
and 1996.......................................................................... 45
Consolidated Balance Sheets as of December 31, 1998 and 1997........................ 46
Consolidated Statements of Shareholders' Equity for the years ended December 31,
1998, 1997 and 1996............................................................... 47
Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997
and 1996.......................................................................... 48
Notes to Consolidated Financial Statements.......................................... 49
</TABLE>
43
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Redwood Empire Bancorp
Santa Rosa, California
We have audited the accompanying consolidated balance sheets of Redwood
Empire Bancorp and subsidiaries (Company) as of December 31, 1998 and 1997 and
the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Redwood Empire Bancorp and
subsidiaries at December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
San Francisco, California
January 26, 1999 (February 22, 1999, as to Note N)
44
<PAGE>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Interest income:
Interest and fees on loans..................................................... $ 27,685 $ 32,283 $ 41,469
Interest on investment securities.............................................. 4,334 3,702 3,120
Interest on federal funds sold................................................. 1,040 1,314 1,028
Interest on time deposits due from financial institutions...................... -- 7 167
--------- --------- ---------
Total interest income............................................................ 33,059 37,306 45,784
Interest expense:
Interest on deposits........................................................... 12,712 15,428 19,927
Interest on other borrowings................................................... 360 252 1,601
Interest on subordinated notes................................................. 1,107 1,107 1,115
--------- --------- ---------
Total interest expense........................................................... 14,179 16,787 22,643
--------- --------- ---------
Net interest income.............................................................. 18,880 20,519 23,141
Provision for loan losses........................................................ 2,040 2,100 6,262
--------- --------- ---------
Net interest income after provision for loan losses.............................. 16,840 18,419 16,879
--------- --------- ---------
Other operating income:
Service charges on deposit accounts............................................ 1,072 1,146 1,224
Merchant draft processing, net................................................. 2,609 1,585 1,849
Loan servicing income.......................................................... 584 831 1,619
Net realized gains (losses) on sale of investment securities held for sale and
redemption of investment securities.......................................... 225 23 (3)
Gain on sale of loans and loan servicing....................................... 5,095 3,601 12,328
Mortgage brokerage revenue, net................................................ 4,976 2,238 73
Other income................................................................... 1,105 719 2,480
--------- --------- ---------
Total other operating income..................................................... 15,666 10,143 19,570
--------- --------- ---------
Other operating expense:
Salaries and employee benefits................................................. 14,041 11,477 17,151
Occupancy and equipment expense................................................ 3,676 3,328 5,604
Restructuring (credit) charge.................................................. -- (286) 2,357
Other.......................................................................... 7,596 8,336 13,834
--------- --------- ---------
Total other operating expense.................................................... 25,313 22,855 38,946
--------- --------- ---------
Income (loss) before income taxes................................................ 7,193 5,707 (2,497)
Provision (benefit) for income taxes............................................. 2,102 2,266 (1,011)
--------- --------- ---------
Net income (loss)................................................................ 5,091 3,441 (1,486)
Dividends on preferred stock..................................................... 112 449 449
--------- --------- ---------
Net income (loss) available for common stock shareholders........................ $ 4,979 $ 2,992 $ (1,935)
--------- --------- ---------
--------- --------- ---------
Earnings (loss) per common and common equivalent share:
Basic earnings (loss) per share................................................ $ 1.57 $ 1.08 $ (0.71)
Diluted earnings (loss) per share.............................................. 1.47 1.02 (0.71)
</TABLE>
See Notes to Consolidated Financial Statements.
45
<PAGE>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
Assets:
Cash and due from banks.............................................................. $ 15,982 $ 21,511
Federal funds sold................................................................... 26,205 34,553
------------ ------------
Cash and cash equivalents.......................................................... 42,187 56,064
Investment securities:
Held to maturity, at cost (market value: 1998--$30,014; 1997--$31,273)............. 29,872 30,658
Available for sale, at market (cost: 1998--$30,127; 1997--$41,816)................. 30,538 41,907
------------ ------------
Total investment securities...................................................... 60,410 72,565
Mortgage loans held for sale......................................................... 32,620 16,929
Loans:
Portfolio loans.................................................................... 269,316 282,396
Less allowance for loan losses..................................................... (8,041) (7,645)
------------ ------------
Net loans........................................................................ 261,275 274,751
Premises and equipment, net.......................................................... 4,082 4,055
Mortgage servicing rights, net....................................................... 305 620
Other real estate owned.............................................................. 2,181 6,352
Cash surrender value of life insurance............................................... 3,033 2,929
Other assets and interest receivable................................................. 16,206 12,454
------------ ------------
Total Assets................................................................... $ 422,299 $ 446,719
------------ ------------
------------ ------------
Liabilities and Shareholders' Equity:
Deposits:
Noninterest bearing demand deposits................................................ $ 82,448 $ 98,915
Interest bearing transaction accounts.............................................. 141,316 149,939
Time deposits $100,000 and over.................................................... 62,600 53,878
Other time deposits................................................................ 78,356 88,689
------------ ------------
Total deposits................................................................... 364,720 391,421
Other borrowings..................................................................... 1,371 2,341
Other liabilities and interest payable............................................... 5,568 7,714
Subordinated notes................................................................... 12,000 12,000
------------ ------------
Total Liabilities.............................................................. 383,659 413,476
------------ ------------
Commitments and Contingencies........................................................ -- --
Shareholders' Equity:
Preferred stock, no par value; authorized 2,000,000 shares; issued and outstanding:
1988--no shares, 1997--575,000 shares; liquidation preference of $10.00 per share -- 5,750
Common stock, no par value; authorized 10,000,000 shares; issued and outstanding:
1998--3,363,565 shares, 1997--2,780,209 shares 25,801 19,656
Retained earnings.................................................................. 12,600 8,024
Accumulated other comprehensive income, net........................................ 239 (187)
------------ ------------
Total Shareholders' Equity..................................................... 38,640 33,243
------------ ------------
Total Liabilities and Shareholders' Equity................................. $ 422,299 $ 446,719
------------ ------------
------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements.
46
<PAGE>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
PREFERRED COMMON
COMPREHENSIVE ---------------------- ---------------------- RETAINED
INCOME SHARES STOCK SHARES STOCK EARNINGS
--------------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1996 575 $ 5,750 2,674 $ 18,728 $ 6,967
Comprehensive loss:
Net loss........................... $ (1,486) (1,486)
Other comprehensive loss:
Unrealized holding losses arising
during period, net of tax of
$137............................. (190)
Less: reclasssification adjustment
net of tax of $204............... (281)
-------
Other comprehensive loss......... (471)
-------
Comprehensive loss............... $ (1,957)
-------
-------
Stock options exercised.............. 70 553
Cash dividends declared--preferred... (449)
Cash dividends declared--common......
--- --------- ----------- --------- -----------
Balances, December 31, 1996 575 5,750 2,744 19,281 5,032
Comprehensive income:
Net income......................... $ 3,441 3,441
Other comprehensive income:
Unrealized holding gains arising
during period, net of tax of
$80.............................. 117
Less: reclasssification adjustment
net of tax of $17................ 27
-------
Other comprehensive income....... 144
-------
Comprehensive income............. $ 3,585
-------
-------
Stock options exercised.............. 36 375
Cash dividends declared--preferred... (449)
--- --------- ----------- --------- -----------
Balances, December 31, 1997 575 5,750 2,780 19,656 8,024
Comprehensive income:
Net income......................... $ 5,091 5,091
Other comprehensive income:
Unrealized holding gains arising
during period, net of tax of
$152............................. 208
Less: reclasssification adjustment
net of tax of $163............... 218
-------
Other comprehensive income....... 426
-------
Comprehensive income............. $ 5,517
-------
-------
Conversion of preferred stock to
common............................. (575) (5,750) 498 5,686
Common stock repurchased............. (17) (283)
Stock options exercised.............. 103 742
Cash dividends declared--preferred... (112)
Cash dividends declared--common...... (403)
--- --------- ----------- --------- -----------
Balances, December 31, 1998 -- -- 3,364 25,801 $ 12,600
--- --------- ----------- --------- -----------
--- --------- ----------- --------- -----------
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME, NET TOTAL
----------------- ---------
<S> <C> <C>
Balances, January 1, 1996 $ 140 $ 31,585
Comprehensive loss:
Net loss........................... (1,486)
Other comprehensive loss:
Unrealized holding losses arising
during period, net of tax of
$137.............................
Less: reclasssification adjustment
net of tax of $204...............
Other comprehensive loss......... (471) (471)
Comprehensive loss...............
Stock options exercised.............. 553
Cash dividends declared--preferred... (449)
Cash dividends declared--common...... --
----- ---------
Balances, December 31, 1996 (331) 29,732
Comprehensive income:
Net income......................... 3,441
Other comprehensive income:
Unrealized holding gains arising
during period, net of tax of
$80..............................
Less: reclasssification adjustment
net of tax of $17................
Other comprehensive income....... 144 144
Comprehensive income.............
Stock options exercised.............. 375
Cash dividends declared--preferred... (449)
----- ---------
Balances, December 31, 1997 (187) 33,243
Comprehensive income:
Net income......................... 5,091
Other comprehensive income:
Unrealized holding gains arising
during period, net of tax of
$152.............................
Less: reclasssification adjustment
net of tax of $163...............
Other comprehensive income....... 426 426
Comprehensive income.............
Conversion of preferred stock to
common............................. (64)
Common stock repurchased............. (283)
Stock options exercised.............. 742
Cash dividends declared--preferred... (112)
Cash dividends declared--common...... (403)
----- ---------
Balances, December 31, 1998 $ 239 $ 38,640
----- ---------
----- ---------
</TABLE>
See Notes to Consolidated Financial Statements.
47
<PAGE>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
--------- ---------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................................................. $ 5,091 $ 3,441 ($ 1,486)
--------- ---------- ----------
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation and amortization, net.......................................... 1,731 129 2,500
Deferred taxes.............................................................. (1,247) 1,382 (2,334)
Net realized (gains) losses on securities available for sale................ (225) (23) 3
Loans originated for sale................................................... (479,351) (182,096) (1,381,133)
Proceeds from sale of loans held for sale................................... 486,011 228,890 1,492,795
Gain on sale of loans and loan servicing.................................... (5,095) (3,601) (12,328)
Provision for loan losses................................................... 2,040 2,100 6,262
Change in cash surrender value of life insurance............................ (104) (628) (2,071)
Change in other assets and interest receivable.............................. (2,346) 8,436 3,520
Change in other liabilities and interest payable............................ (2,492) (3,334) (916)
Noncash restructuring (credit) charge....................................... -- (286) 2,260
Other, net.................................................................. 89 95 (1,832)
--------- ---------- ----------
Total adjustments........................................................... (989) 51,064 106,726
--------- ---------- ----------
Net cash provided by operating activities................................. 4,102 54,505 105,240
--------- ---------- ----------
Cash flows from investing activities:
Net increase in loans....................................................... (9,547) 26,073 (55,729)
Proceeds from sale of loans in portfolio.................................... 1,666 2,043 4,168
Purchases of investment securities available for sale....................... (22,146) (23,845) (31,235)
Purchases of investment securities held to maturity......................... (13,133) (17,056) (207)
Sales of investment securities available for sale........................... 1,995 7,031 4,918
Maturities of investment securities available for sale...................... 26,913 13,974 13,500
Maturities of investment securities held to maturity........................ 19,503 513 4,012
Purchase of premises and equipment, net of retirements...................... (1,611) (1,469) (884)
(Purchase) sale of mortgage servicing rights................................ (12) (330) 3,281
Change in interest bearing deposits due from financial institutions......... -- 315 102
Proceeds from sale of other real estate owned............................... 6,399 1,982 2,617
--------- ---------- ----------
Net cash provided by (used in) investing activities....................... 10,027 9,231 (55,457)
--------- ---------- ----------
Cash flows from financing activities:
Change in noninterest bearing transaction accounts.......................... (16,467) 27,101 6,743
Change in interest bearing transaction accounts............................. (8,623) (6,514) 26,487
Change in time deposits..................................................... (1,611) (65,616) (55,173)
Change in other borrowings.................................................. (970) (7,966) (37,564)
Issuance of stock........................................................... 180 299 506
Dividends paid.............................................................. (515) (449) (449)
--------- ---------- ----------
Net cash used in financing activities..................................... (28,006) (53,145) (59,450)
--------- ---------- ----------
Net change in cash and cash equivalents....................................... (13,877) 10,591 (9,667)
Cash and cash equivalents at beginning of period.............................. 56,064 45,473 55,140
--------- ---------- ----------
Cash and cash equivalents at end of period.................................... $ 42,187 $ 56,064 $ 45,473
--------- ---------- ----------
--------- ---------- ----------
Supplemental Disclosures:
Cash paid during the period for:
Income taxes................................................................ $ 2,709 $ 2,454 $ 2,730
Interest.................................................................... 14,047 18,571 23,166
Noncash investing and financing activities:
Transfer from loans to other real estate owned.............................. 2,900 6,436 4,263
Loans to facilitate sale of other real estate owned......................... -- -- 350
Transfer from mortgage loans held for sale to loans......................... 8,999 1,377 59,000
Transfer of investment securities from available for sale to held to
maturity.................................................................. -- -- 17,193
Conversion of preferred stock to common..................................... 5,686 -- --
</TABLE>
See Notes to Consolidated Financial Statements.
48
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A--DESCRIPTION OF BUSINESS
Redwood Empire Bancorp ("Redwood," and with its subsidiaries, the "Company")
is a financial institution holding company headquartered in Santa Rosa,
California, and operating in Northern California. Its wholly-owned subsidiary is
National Bank of the Redwoods("NBR"), a national bank chartered in 1985. A
previously wholly-owned subsidiary, Allied Bank, F.S.B., (Allied), a Federal
Savings Bank, was merged with its sister subsidiary, NBR, in March, 1997. The
Company's business strategy involves two principal business activities,
commercial banking and residential lending which are conducted through NBR.
NBR provides its commercial banking services through five retail branches
located in Sonoma County, California, one retail branch located in Mendocino
County, California, and one retail branch located in Lake County, California.
Loan services at NBR are generally extended to professionals and to businesses
with annual revenues of less than $10 million. Commercial loans are primarily
for working capital, asset acquisition and commercial real estate. NBR's
targeted commercial banking market area includes the California counties north
of San Francisco. NBR generates noninterest income through merchant draft
processing by virtue of its status as a Principal Member of Visa/MasterCard. As
a Preferred Lender under the Small Business Administration ("SBA") Loan
Guarantee Program, NBR generates noninterest income through premiums received on
the sale of the guaranteed portions of SBA loans and the resulting on-going
servicing income on its SBA portfolio. In addition, NBR originates both
commerical and residential construction loans for its portfolio.
The Company's residential mortgage lending business has been conducted
primarily through NBR. NBR originates one-to-four family residential mortgage
loans which predominantly conform to the underwriting standards set by Fannie
Mae, Freddie Mac or other institutional mortgage conduits. These loans are
commonly referred to as "A paper" loans and are primarily acquired by NBR on a
retail basis through NBR's own retail loan officers. NBR also originates
mortgage loans through its Allied Diversified Credit ("ADC") division that do
not comply with all standards established by Fannie Mae or Freddie Mac. These
loans are commonly referred to as "Sub Prime" loans and are acquired by ADC on a
wholesale and retail basis. Substantially all mortgage loan originations are
either brokered to other residential lenders or are packaged and sold into the
secondary market. NBR sells substantially all the servicing rights on the
mortgage loans it sells. From time to time NBR may purchase mortgage loan
servicing rights from other companies, thereby generating ongoing servicing
fees.
NBR's principal targeted residential lending territory includes Northern and
Central California. These areas are served by seven loan production offices
located in Santa Rosa, Alamo, Pleasanton, Richmond, Monterey, Tracy and
Berkeley, California.
In November 1996 the Board of Directors voted to merge Allied into NBR. The
combination of the two wholly-owned subsidiaries of Redwood Empire Bancorp was
structured as a merger transaction wherein Allied was merged into NBR with NBR
as the surviving bank. As a result of the merger, the surviving bank, NBR,
assumed all of Allied's rights and obligations. Allied ceased to exist as a
federally chartered savings institution upon the merger of Allied and National
Bank of the Redwoods. On February 3, 1997 NBR received approval for the merger
from the Office of the Comptroller of the Currency. The merger was consummated
on March 24, 1997. In connection with this matter and the reduction in A paper
wholesale lending, the Company recorded a restructuring charge of $2,357,000 in
1996. See Note R.
49
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of the Company conform with generally
accepted accounting principles and general practice within the banking industry.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. A summary of the more
significant policies follows:
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Redwood Empire
Bancorp and its wholly-owned subsidiary, National Bank of the Redwoods. All
material intercompany transactions and accounts have been eliminated.
Certain reclassifications to the 1997 and 1996 financial statements were
made to conform to the 1998 presentation.
For the purpose of the statements of cash flows, cash and cash equivalents
have been defined as cash, demand deposits with correspondent banks, cash items
in transit and federal funds sold.
INVESTMENT SECURITIES
Securities held to maturity are carried at cost adjusted by the accretion of
discounts and amortization of premiums. The Company has the ability and intent
to hold these investment securities to maturity. Securities available for sale
may be sold to implement the Company's asset/liability management strategies and
in response to changes in interest rates, prepayment rates and similar factors.
Available for sale securities are recorded at market value and unrealized gains
or losses, net of income taxes, are included in accumulated other comprehensive
income, a separate component of shareholders' equity. Gain or loss on sale of
investment securities is based on the specific identification method.
LOANS AND THE ALLOWANCE FOR LOAN LOSSES
Loans are stated at the principal balance outstanding net of allowance for
loan losses and deferred loan fees. Loan fees net of certain related direct
costs to originate loans are deferred and amortized over the contractual life of
the loan using a method approximating the interest method. Loan fees and direct
costs related to the origination of loans held for sale are recognized as a
component of gain or loss on sale of mortgage loans when the related loans are
sold.
The allowance for loan losses is maintained at a level considered adequate
to provide for losses that can be reasonably anticipated and is based on
management's quarterly evaluation of the economic climate and other factors
related to the collectability of loan balances. The factors considered by
management include growth and composition of the loan portfolio, overall
portfolio quality, review of specific problem loans, historical loss rates,
regulatory reviews, trends and concentrations in delinquencies and current
economic conditions that may affect the borrower's ability to pay. The actual
results could differ significantly from management's estimates. The allowance
for loan losses is increased by provisions charged to operations and reduced by
loan charge-offs net of recoveries. A loan charge-off is recorded when a loan
has been determined by management to be uncollectable.
A loan is impaired when, based upon current information and events, it is
probable that NBR will be unable to collect all amounts due according to the
contractual terms of the loan agreement. These
50
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
statements are applicable to all loans, uncollateralized as well as
collateralized, except loans that are measured at the lower of cost or fair
value. Impairment is measured based on the present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's observable
market price, or the fair value of the collateral if the loan is collateral
dependent. Management measures all loans individually for impairment as part of
the Company's normal internal asset review process.
Interest income is recognized on impaired loans in a manner similar to that
of all loans. It is the Company's policy to place loans that are delinquent 90
days or more as to principal or interest on nonaccrual status unless secured and
in the process of collection, and to reverse from current income accrued but
uncollected interest. Cash payments subsequently received on nonaccrual loans
are recognized as income only where the future collection of principal is
considered by management to be probable.
The Company originates loans to customers under a Small Business
Administration (SBA) program that generally provides for SBA guarantees of 70%
to 85% of each loan. The Company generally sells the guaranteed portion of each
loan to a third party and retains the unguaranteed portion in its own portfolio.
A gain is recognized on these loans through collection on sale of a premium over
the adjusted carrying value, through retention of an ongoing rate differential
less a normal service fee (excess servicing fee) between the rate paid by the
borrower to the Company and the rate paid by the Company to the purchaser, or
both.
To calculate the gain or loss on the sale, the Company's investment in an
SBA loan is allocated among the retained portion of the loan, excess servicing
retained and the sold portion of the loan, based on the relative fair market
value of each portion. The gain on the sold portion of the loan is recognized
currently. The excess servicing fees are reflected as an asset which is
amortized over an estimated life using a method approximating the interest
method; in the event future prepayments are significant and future expected cash
flows are inadequate to cover the unamortized excess servicing asset, additional
amortization would be recognized.
OTHER REAL ESTATE OWNED
Property acquired by the Company through foreclosure is recorded at the
lower of estimated fair value less estimated selling costs (fair value) or the
carrying value of the related loan at the date of foreclosure. At the time the
property is acquired, if the fair value is less than the loan amounts
outstanding, any difference is charged against the allowance for loan losses.
After acquisition, valuations are periodically performed and, if the carrying
value of the property exceeds the fair value, a valuation allowance is
established by a charge to operations. Subsequent increases in the fair value
may reduce or eliminate the allowance.
Operating costs on foreclosed real estate are expensed as incurred. Costs
incurred for physical improvements to foreclosed real estate are capitalized if
the value is recoverable through future sale.
MORTGAGE BANKING AND HEDGING ACTIVITIES
The Company sells residential mortgage loans to a variety of secondary
market investors, including Freddie Mac and Fannie Mae. Gains or losses on the
sale of mortgage loans are recognized based on the difference between the
selling price and the carrying value of the related mortgage loans sold.
Mortgage loans held for sale are carried at the lower of cost or market
value as determined by outstanding commitments from investors, indicators of
value obtained by management from independent third parties, current investor
yield requirements calculated on an aggregate loan basis and the market
51
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
value of its hedging instruments. Valuation adjustments are charged against the
gain or loss on sale of mortgage loans.
As part of its residential lending activities, the Company enters into
forward commitments to sell mortgage loans, either in the form of
mortgage-backed securities or as whole loans. These commitments may be optional
or mandatory. Under optional commitments, a commitment fee is paid and the
Company carries no risk in excess of the loss of such fee in the event that the
Company is unable to deliver sufficient mortgage loans to fulfill the
commitment. Mandatory commitments may entail possible financial risk to the
Company if it is unable to deliver mortgage loans in sufficient quantity or at
sufficient rates to meet the terms of the commitments.
In order to minimize the risk that a change in interest rates will result in
a decrease in the value of the Company's current mortgage loan inventory or its
commitments to purchase or originate mortgage loans ("committed pipeline"), the
Company enters into hedging transactions. The Company's hedging policies
generally require that its inventory of mortgage loans held for sale and the
maximum portion of its committed pipeline that may close be hedged with forward
sales of MBS or options to buy or sell mortgage-backed or U.S. Treasury
securities. As such, to the extent the Company hedges its committed pipeline,
the Company is not exposed to significant interest rate risk nor will it derive
any significant benefit from changes in interest rates on the price of the
mortgage loan inventory net of gains or losses of associated hedge positions.
The correlation between the price performance of the hedge instruments and the
inventory being hedged is very high due to the similarity of the asset and the
related hedge instrument. The Company is exposed to interest[cad 220]rate risk
to the extent that the portion of loans from the committed pipeline that
actually closes at the committed price is less than the portion expected to
close, in the event of a decline in rates and in the event such decline in
closings is not covered by options to purchase MBS needed to replace the loans
in process that do not close at their committed price. The Company determines
the portion of its committed pipeline that it will hedge based on numerous
factors, including the composition of the Company's committed pipeline, the
portion of such committed pipeline likely to close, the timing of such closings
and the current interest rate environment.
These hedging instruments include forward sales of mortgage-backed
securities ("MBS"). Unrealized gains and losses resulting from changes in the
market value of uncommitted mortgage loans and interest rate locks and open
hedge positions are netted. Any net unrealized gain that results is deferred;
any net unrealized loss that results is recognized currently. Hedging gains and
losses realized before the hedged loans are sold are deferred. Unrealized or
realized hedging losses are recognized currently if deferring such losses would
result in mortgage loans held for sale and the interest rate locks being valued
in excess of their estimated net realizable value.
Mortgage servicing rights are amortized in proportion to and over the period
of estimated net servicing income. The Company evaluates impairment of its
mortgage servicing rights periodically. Impairment is measured on a
disaggregated basis using the state of origination as the predominant risk
characteristic with respect to originated mortgage servicing rights. Impairment
of purchased mortgage servicing rights is measured based on discrete
acquisitions. Any impairment is calculated as the difference between fair value
and amortized cost by stratum. Fair value is estimated on a loan by loan basis
using market prices under comparable servicing sale contracts, when available
or, using a cash flow model with current assumptions with respect to
prepayments, servicing costs and other significant factors. Impairment is
recognized through a valuation allowance by stratum. Such estimates may vary
from the actual remaining cash flows due to unanticipated prepayments of the
underlying mortgage loans and increases in servicing
52
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
costs. The Company's carrying values of purchased mortgage servicing rights do
not purport to represent the amount that would be realizable by a sale of these
assets in the open market.
OFF BALANCE SHEET RISK
The Company is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit, standby letters of credit,
forward contracts to sell mortgage-backed securities (MBS) and written options.
Those instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the statement of financial
position. The contract or notional amounts of those instruments reflect the
extent of involvement the Company has in particular classes of financial
instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. The Company manages credit risk with respect to MBS by
entering into agreements with entities approved by senior management and the
Board of Directors. These entities include Wall Street firms having primary
dealer status. The Company uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments. For
forward contracts to sell mortgage-backed securities and written options, the
contract or notional amounts do not represent exposure to credit loss. The
Company controls the credit risk of its forward contracts through credit
approvals, limits and monitoring procedures.
A listing of financial instruments whose contract amounts represent credit
risk is as follows:
<TABLE>
<CAPTION>
CONTRACT OR NOTIONAL
AMOUNT
----------------------
DECEMBER 31,
----------------------
1998 1997
---------- ----------
<S> <C> <C>
Financial instruments whose contract amounts
represent credit risk:
Commitments to extend credit................... $63,620,000 $46,113,000
Standby letters of credit...................... 557,000 508,000
</TABLE>
Loan commitments are typically contingent upon the borrower meeting certain
financial and other covenants, and such commitments typically have fixed
expiration dates and require payment of a fee. As many of these commitments are
expected to expire without being drawn upon, the total commitments do not
necessarily represent future cash requirements. The Company evaluates each
potential borrower and the necessary collateral on an individual basis.
Collateral varies, but may include real property, bank deposits, debt
securities, equity securities, or business assets.
Standby letters of credit are conditional commitments written by the Company
to guarantee the performance of a customer to a third party. These guarantees
relate primarily to inventory purchases by the Company's commercial customers,
and such guarantees are typically short-term. Credit risk is similar to that
involved in extending loan commitments to customers and the Company accordingly
uses evaluation and collateral requirements similar to those of loan
commitments. Virtually all such commitments are collateralized.
53
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PREMISES AND EQUIPMENT
Premises and equipment consist of building, leasehold improvements,
furniture and equipment and are stated at cost, less accumulated depreciation
and amortization. Depreciation is computed using the straight-line method over
the estimated useful lives for financial reporting purposes and an accelerated
method for income tax reporting. Leasehold improvements are amortized over the
terms of the lease or their estimated useful lives whichever is shorter.
INCOME TAXES
The Company accounts for income taxes using an asset and liability approach,
which requires the recognition of deferred tax assets and liabilities at tax
rates in effect when these balances are utilized. Future tax benefits
attributable to temporary differences are recognized currently to the extent
that realization of such benefits is more likely than not. These future tax
benefits are measured by applying currently enacted tax rates.
EARNINGS PER COMMON SHARE
Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted-average number of common
shares outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity.
54
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table reconciles the numerator and denominator used in
computing both basic earnings (loss) per share and diluted earnings (loss) per
share for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
<S> <C> <C> <C>
1998 1997 1996
--------- --------- ---------
<CAPTION>
(IN THOUSANDS EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C>
BASIC EARNINGS (LOSS) PER SHARE:
Net income (loss)............................................... $ 5,091 $ 3,441 $ (1,486)
Less: Preferred stock dividend.................................. 112 449 449
--------- --------- ---------
Net income (loss) available to common stock shareholders........ $ 4,979 $ 2,992 $ (1,935)
--------- --------- ---------
--------- --------- ---------
Weighted average common shares outstanding...................... 3,170 2,776 2,721
--------- --------- ---------
--------- --------- ---------
Basic earnings (loss) per share................................. $ 1.57 $ 1.08 $ (0.71)
--------- --------- ---------
--------- --------- ---------
DILUTED EARNINGS (LOSS) PER SHARE:
Net income (loss) available to common stock shareholders........ $ 4,979 $ 2,992 $ (1,935)
Dilutive effect of Preferred Stock dividend..................... 112 449 --
--------- --------- ---------
$ 5,091 $ 3,441 $ (1,935)
--------- --------- ---------
--------- --------- ---------
Weighted average common shares outstanding...................... 3,170 2,776 2,721
Effect of outstanding stock options............................. 87 103 --
Effect of Convertible Preferred Stock........................... -- 499 --
--------- --------- ---------
3,257 3,378 2,721
--------- --------- ---------
--------- --------- ---------
Diluted earnings (loss) per share............................... $ 1.47 $ 1.02 $ (0.71)
--------- --------- ---------
--------- --------- ---------
</TABLE>
STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the intrinsic
value method in accordance with Accounting Principles Board (APB) No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Accordingly, no compensation cost has
been recognized on stock options granted. The Company presents the required pro
forma disclosures of the effect of stock-based compensation on net income and
earnings per share using the fair value method in accordance with SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION.
55
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS SEGMENTS
On January 1, 1998, the Company adopted FASB issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information", which
establishes annual and interim reporting standards for an enterprise's operating
segments and related disclosures about its products, services, geographic areas,
and major customers. The adoption of this statement at December 31, 1998 did not
impact the Company's consolidated financial position, results of operations or
cash flows, and any effect was limited to the form and content of its
disclosures.
COMPREHENSIVE INCOME
On January 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income. This statement requires that all items recognized under
accounting standards as components of comprehensive income be reported in an
annual financial statement that is displayed with the same prominence as other
annual financial statements. This statement also requires that an entity
classify items of other comprehensive income by their nature in an annual
financial statement. Comprehensive income includes net income and other
comprehensive income. The Company's only source of other comprehensive income is
derived from unrealized gains and losses on investment securities held-for-sale.
Reclassification adjustments result from gains or losses on investment
securities held-for-sale that were realized and included in net income of the
current period that also had been included in other comprehensive income as
unrealized holding gains or losses in the period in which they arose. They are
excluded from comprehensive income of the current period to avoid double
counting. Annual financial statements for all periods have been restated.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting For Derivative Instruments and Hedging Activities." The statement
establishes accounting and reporting standards for derivative instruments and
hedging activities. The statement is effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. The Company is in the process of
determining the impact of SFAS No. 133 on the Company's financial statements.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise". This Statement amends SFAS No.
65, "Accounting for Certain Mortgage Banking Activities", which established
accounting and reporting standards for certain activities of mortgage banking
and other similar enterprises. After securitization of mortgage loans held for
sale, SFAS No. 134 requires an entity to classify the resulting mortgage-backed
securities or other retained interests, based on its ability or intent to sell
or hold those investments. Management believes that the adoption of SFAS No. 134
will have no impact on the Company's financial position or results of
operations. This Statement is effective for fiscal years beginning after Decemer
15, 1998, with earlier application permitted.
NOTE C--CASH AND DUE FROM BANKS
The Company's subsidiaries are required to maintain average reserve balances
with the Federal Reserve Bank. The required reserve balance included in cash and
due from banks was approximately $3,183,000 and $5,489,000 at December 31, 1998
and 1997.
56
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE D--INVESTMENT SECURITIES
An analysis of the investment securities portfolio follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
----------- ------------- ------------- ---------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
December 31, 1998:
AVAILABLE FOR SALE:
U.S. Government obligations.......................... $30,127 $411 $-- $30,538
----------- ----- --- ---------
----------- ----- --- ---------
HELD TO MATURITY:
U.S. Government obligations.......................... $10,986 $ 63 $ 6 $11,043
Mortgage-backed and other securities................. 14,781 94 9 14,866
----------- ----- --- ---------
Total debt securities.............................. 25,767 157 15 25,909
FRB and FHLB stock................................... 4,105 -- -- 4,105
----------- ----- --- ---------
Total held to maturity............................. $29,872 $157 $15 $30,014
----------- ----- --- ---------
----------- ----- --- ---------
December 31, 1997:
AVAILABLE FOR SALE:
U.S. Government obligations.......................... $41,816 $126 $35 $41,907
----------- ----- --- ---------
----------- ----- --- ---------
HELD TO MATURITY:
U.S. Government obligations.......................... $18,360 $587 $12 $18,935
Mortgage-backed and other securities................. 8,401 40 -- 8,441
----------- ----- --- ---------
Total debt securities.............................. 26,761 627 12 27,376
FRB and FHLB stock................................... 3,897 -- -- 3,897
----------- ----- --- ---------
Total held to maturity............................. $30,658 $627 $12 $31,273
----------- ----- --- ---------
----------- ----- --- ---------
</TABLE>
Debt securities by contractual maturity at December 31, 1998, were due as
follows:
<TABLE>
<CAPTION>
AMORTIZED MARKET
COST VALUE
----------- ---------
<S> <C> <C>
(IN THOUSANDS)
Held to maturity:
One year or less..................................................... $ 41 $ 41
After one year through five years.................................... 4,541 4,581
After five years..................................................... 21,185 21,287
----------- ---------
$ 25,767 $ 25,909
----------- ---------
----------- ---------
Available for sale:
One year or less..................................................... $ 3,997 $ 4,018
After one year through five years.................................... 21,113 21,369
After five years..................................................... 5,017 5,151
----------- ---------
$ 30,127 $ 30,538
----------- ---------
----------- ---------
</TABLE>
Proceeds from sales of available held for sale investments in debt
securities during 1998, 1997 and 1996 were $1,995,000, $7,031,000, and
$4,918,000. This sale resulted in the realization of gross gains of
57
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE D--INVESTMENT SECURITIES (CONTINUED)
$40,000 for 1998, gross gains of $30,000 and gross losses of $12,000 for 1997,
gross gains of $5,000 and gross losses of $8,000 for 1996. Gains on redemption
by issuers of debt securities amounted to $185,000 and $5,000 in 1998 and 1997.
There were no redemptions made in 1996.
During 1996 the Company transferred $17,193,000 in investment securities
carried as available for sale into the held to maturity category. At the date of
transfer the unrealized holding loss of $300,000 continued to be reported as a
component of accumulated other comprehensive income, a separate component of
equity. Amortization or reduction through redemption of the securities by the
issuer of the unrealized loss and amortization of the equity component offset
each other with no effect on the results of operation. The balance of the
unrealized loss included in accumulated other comprehensive income was reduced
to zero as of December 31, 1998 as all transferred securities were redeemed. The
balance of such unrealized loss was $242,000 as of December 31, 1997.
Securities carried at approximately $19,545,000 and $17,994,000 at December
31, 1998 and 1997 were pledged to secure public deposits, bankruptcy deposits,
and treasury tax and loan borrowings.
NOTE E--MORTGAGE BANKING ACTIVITIES
The following lists the notional amounts of the various hedging instruments
outstanding at December 31, 1998 and 1997 and the date through which exercise
dates extend:
<TABLE>
<CAPTION>
1998 1997
------------------------------- -------------------------------
NOTIONAL EXERCISE DATES NOTIONAL EXERCISE DATES
AMOUNT EXTEND THROUGH AMOUNT EXTEND THROUGH
-------------- -------------- -------------- --------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C>
Forward contracts to sell MBS...... $11,000 February 1999 $10,836 January 1998
</TABLE>
The Company services mortgage loans and participating interests in mortgage
loans owned by investors. The unpaid principal balances of mortgage loans
serviced for others are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Mortgage loan portfolios serviced for:
Freddie Mac........................................... $ 3,919 $ 9,365
Fannie Mae............................................ 3,633 5,185
Other investors....................................... 124,173 110,812
--------- ---------
$ 131,725 $ 125,362
--------- ---------
--------- ---------
</TABLE>
During the third and fourth quarters of 1996 the Company sold mortgage loan
servicing rights associated with $839,945,000 mortgage loans whose carrying
amount was $4,150,000. In connection with these sales the Company recorded net
revenue of $2,153,000, which has been included in gain on sale of loans and loan
servicing.
58
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE E--MORTGAGE BANKING ACTIVITIES (CONTINUED)
The following table provides a summary of the Company's purchased ("PMSR")
and originated ("OMSR") mortgage servicing rights portfolio:
<TABLE>
<CAPTION>
OMSR
-----------------------------------
STATES
------------------------
PMSR CALIFORNIA OTHER TOTAL
--------- ------------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance, January 1, 1996............... $ 4,494 $ 1,304 $ 172 $ 1,476
Originations........................... 744 39 783
Sales.................................. (3,033) (1,061) (56) (1,117)
Amortization........................... (1,461) (456) (129) (585)
Valuation adjustments.................. 22 3 25
--------- ------------- --------- ---------
Balance, December 31, 1996............. -- 553 29 582
Originations........................... 163 150 18 168
Amortization........................... (18) (260) (15) (275)
--------- ------------- --------- ---------
Balance, December 31, 1997............. 145 443 32 475
Originations........................... 11 1 12
Amortization........................... (48) (265) (14) (279)
--------- ------------- --------- ---------
Balance, December 31, 1998............. $ 97 $ 189 $ 19 $ 208
--------- ------------- --------- ---------
--------- ------------- --------- ---------
</TABLE>
NOTE F--LOANS AND THE ALLOWANCE FOR LOAN LOSSES
The Company primarily makes permanent and construction residential real
estate loans in California, and loans to individuals and small businesses
primarily in Sonoma and Mendocino Counties, California. There are no major
industry segments in the loan portfolio. Outstanding loans by type were:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Residential real estate mortgage........................ $ 97,194 $ 93,516
Commercial real estate mortgage......................... 59,257 57,425
Commercial.............................................. 63,260 69,097
Real estate construction................................ 46,905 55,031
Installment and other................................... 5,095 9,200
Less deferred fees...................................... (2,395) (1,873)
--------- ---------
Total loans........................................... 269,316 282,396
Less allowance for loan losses.......................... (8,041) (7,645)
--------- ---------
Net loans............................................. $ 261,275 $ 274,751
--------- ---------
--------- ---------
</TABLE>
59
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE F--LOANS AND THE ALLOWANCE FOR LOAN LOSSES (CONTINUED)
A summary of the transactions in the allowance for loan losses follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
(IN THOUSANDS)
Balance, beginning of year.................................... $ 7,645 $ 7,040 $ 5,037
Provision for loan losses..................................... 2,040 2,100 6,262
Loans charged off............................................. (2,000) (1,920) (4,564)
Recoveries.................................................... 356 425 305
--------- --------- ---------
Balance, end of year.......................................... $ 8,041 $ 7,645 $ 7,040
--------- --------- ---------
--------- --------- ---------
</TABLE>
At December 31, 1998 and 1997 the Company's total recorded investment in
impaired loans was $10,293,000 and $10,899,000 of which $8,573,000 and
$8,927,000 relates to the recorded investment for which there is a related
allowance for loan losses of $1,543,000 and $1,565,000 determined in accordance
with these statements and $1,720,000 and $1,972,000 relates to the amount of
that recorded investment for which there is no related allowance for loan losses
determined in accordance with these statements. At December 31, 1998,
approximately 80% of the impaired loan balance was measured based on the fair
value of the collateral, with the remainder measured by estimated cash flow.
The average recorded investment in impaired loans during the year ended
December 31, 1998 and 1997 was $10,377,000 and $10,949,000. The related amount
of interest income recognized during the periods that such loans were impaired
was $578,000 and $558,000.
As of December 31, 1998 and 1997 there were $5,556,000 and $7,883,000 of
loans on which the accrual of interest had been discontinued. Interest due but
excluded from interest income on these nonaccrual loans was $341,000, $469,000,
and $499,000 for the years ended December 31, 1998, 1997 and 1996. Interest
income received on nonaccrual loans was $51,000, $84,000, and $12,000 for the
years ended December 31, 1998, 1997 and 1996.
At December 31, 1998, the Company did not have any loans past due 90 days or
more in interest or principal and still accruing interest, compared to $735,000
in 1997. These loans were collateralized and in the process of collection.
The Company originates SBA loans for sale to investors. A summary of the
activity in SBA loans is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
SBA guaranteed portion of loans originated......... $ -- $ 2,882 $ 7,730
SBA loans sold..................................... -- 2,579 7,930
Premium received at sale........................... -- 243 620
SBA guaranteed portion of loans serviced for
others........................................... 25,313 32,950 36,325
SBA Loans, net of sold portion..................... 10,330 12,960 14,175
</TABLE>
From time to time the Company extends credit to executive officers,
directors and related parties. No preference is given to these individuals as
these transactions are made in the ordinary course of business at the Company's
normal credit terms, including interest rates and collateralization. There were
no such balances outstanding at December 31, 1998 and 1997.
60
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G--PREMISES, EQUIPMENT AND LEASES
A summary of premises and equipment is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Land...................................................... $ 187 $ 187
Building and leasehold improvements....................... 3,219 2,912
Furniture and equipment................................... 12,478 11,176
--------- ---------
Total premises and equipment.............................. 15,884 14,275
Less accumulated depreciation and amortization............ 11,802 10,220
--------- ---------
Premises and equipment, net............................... $ 4,082 $ 4,055
--------- ---------
--------- ---------
</TABLE>
Depreciation expense for the years ended December 31, 1998, 1997, and 1996
was $1,731,000, $1,430,000, and $2,528,000.
The Company leases certain premises and equipment used in the normal course
of business. There are no contingent rental payments and the Company has five
subleased properties. Total rental expense under all leases, including premises,
totaled $2,210,000, $2,095,000, and $2,258,000 in 1998, 1997 and 1996. Minimum
future lease commitments are as follows: 1999--$2,052,000; 2000--$1,162,000;
2001-- $1,134,000; 2002--$870,000, 2003--$398,000 and thereafter--$780,000.
Minimum future sublease receivables are as follows: 1999--$184,000; 2000
- -$33,000; 2001--$33,000; and 2002--$22,000. All subleases expire in 2002.
NBR leases 34,000 square feet of an office building for its main office.
Prior to June 1997, a partnership, of which a director of the Company is a
minority partner, owned the office building. Total lease payments made to the
partnership for the years ended 1997 and 1996 were $440,000 and $863,000. There
were no payments made to the partnership in 1998.
NOTE H--DEPOSITS
Time certificates of deposit of $100,000 or more totaled $62,600,000 and
$53,878,000 at December 31, 1998 and 1997. Interest expense on such deposits was
$3,246,000, $2,520,000, and $5,068,000 during 1998, 1997 and 1996, respectively.
At December 31, 1998 the scheduled maturities for all time deposits are as
follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
- -----------------------------------
<S> <C>
1999............................... $ 122,034
2000............................... 12,743
2001............................... 294
2002............................... 4,023
2003............................... 1,862
----------
$ 140,956
----------
----------
</TABLE>
61
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I--INCOME TAXES
The provision (benefit) for income taxes consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal......................................... $ 2,482 $ 552 $ 1,106
State........................................... 867 332 217
--------- --------- ---------
3,349 884 1,323
--------- --------- ---------
Deferred:
Federal......................................... (975) 1,108 (1,875)
State........................................... (272) 274 (459)
--------- --------- ---------
(1,247) 1,382 (2,334)
--------- --------- ---------
$ 2,102 $ 2,266 ($ 1,011)
--------- --------- ---------
--------- --------- ---------
</TABLE>
A reconciliation of the statutory income tax rate to the effective income
tax rate of the Company is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Income tax at federal statutory rate................ 35.0% 35.0% 35.0%
State franchise tax, net of federal benefit......... 5.6 7.0 6.3
Change in estimate of deferred tax related to
deferred loan fees................................ (9.4) -- --
Other............................................... (1.5) (2.2) (.8)
--- --- ---
29.7% 39.8% 40.5%
--- --- ---
--- --- ---
</TABLE>
Items that cause a decrease in the Company's effective tax rate from the
federal statutory rate are state franchise taxes, net of Federal benefit and
certain other credits. In 1998 the federal statutory tax rate was substantially
reduced by a change in the estimate associated with a deferred tax item. Prior
to 1998 the Company had maintained a deferred tax liability for deferred loan
fees. During the fourth quarter of 1998 it was determined that such deferred tax
liability was no longer required.
Deferred income taxes reflect the tax effect of temporary differences
existing between the financial statement basis and tax basis of the Company's
assets and liabilities. Deferred tax benefits attributable to temporary
differences are recognized to the extent that realization of such benefits is
more likely than not. The Company believes it is more likely than not that the
net deferred tax asset at December 31, 1998 will be utilized to reduce future
taxable income. Accordingly, there is no valuation allowance associated with
62
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I--INCOME TAXES (CONTINUED)
deferred tax assets at December 31, 1998. The tax effect of the principal
temporary items creating the Company's net deferred tax asset included in other
assets and interest receivable are:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses................................. $ 3,239 $ 3,022
Restructuring costs....................................... 319 490
Accrued expenses not yet deductible....................... 400 376
Unrealized loss on securities available for sale.......... -- 137
Other real estate owned................................... 114 303
Depreciation.............................................. 38 3
Securities and loans marked to market for tax purposes.... 183 93
State taxes............................................... 69 38
--------- ---------
Total deferred tax assets............................... 4,362 4,462
--------- ---------
Deferred tax liabilities:
Deferred loan fees.......................................... 237 1,189
Unrealized gain on securities available for sale.......... 173 --
FHLB stock dividends...................................... 292 212
Premium on loan sales..................................... 13 --
Mortgage servicing rights................................. 75 208
Other, net................................................ 165 383
--------- ---------
Total deferred tax liabilities.......................... 955 1,992
--------- ---------
Net deferred tax asset...................................... $ 3,407 $ 2,470
--------- ---------
--------- ---------
</TABLE>
NOTE J--OTHER BORROWINGS
Other borrowings consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Advances from FHLB.......................................... $ -- $ 1,819
Treasury, tax and loan note................................. 1,371 --
Federal funds purchased..................................... -- 522
--------- ---------
$ 1,371 $ 2,341
--------- ---------
--------- ---------
</TABLE>
(A) ADVANCES FROM THE FHLB
The Company has a line of credit for short-term purposes with the Federal
Home Loan Bank (FHLB). At December 31, 1998 the line of credit had been fully
paid off compared to an outstanding balance of $1,819,000 at December 31, 1997.
The advances drawn in 1997 at 6.29% had various maturity dates through December
1998. The average balance of FHLB advances was $1,318,000 for 1998 at an average
interest rate of 6.03%. The highest month-end balance during the year was
$1,966,000. All borrowings from the FHLB must be collateralized, and the Company
has pledged approximately
63
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J--OTHER BORROWINGS (CONTINUED)
$54,183,000 of residential mortgage loans as of December 31, 1998, to the FHLB
to secure any funds it may borrow.
(B) FEDERAL FUNDS PURCHASED AND TREASURY, TAX AND LOAN NOTE
The Company enters into various short-term borrowing agreements which
include Treasury, Tax and Loan borrowings. These borrowings have maturities of
one day and are collateralized by investments or loans. Federal Funds purchased
had maturities of one day.
(C) LINE OF CREDIT
The Company has a $3,000,000 line of credit with a major lending
institution. No advances have been drawn on this credit facility.
NOTE K--GAINS ON SALE OF LOANS AND LOAN SERVICING
The components of gains on sale of loans and loan servicing are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Gain on sale of mortgage loans and servicing
rights........................................... $ 5,095 $ 3,322 $ 9,197
Gains on sale of SBA loans......................... -- 279 978
Gains on bulk servicing sales...................... -- -- 2,153
--------- --------- ---------
$ 5,095 $ 3,601 $ 12,328
--------- --------- ---------
--------- --------- ---------
</TABLE>
NOTE L--OTHER EXPENSES
The major components of other expense are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Professional fees.................................. $ 1,138 $ 1,757 $ 1,942
Regulatory expense and insurance................... 676 563 1,209
Postage and office supplies........................ 1,055 1,297 1,715
Shareholder expenses and Director fees............. 339 381 406
Advertising........................................ 468 409 581
Telephone.......................................... 702 829 758
Electronic data processing......................... 1,612 1,417 1,216
Net costs of other real estate owned............... 956 568 451
Merchant card loss................................. -- -- 1,200
SAIF recapitalization charge....................... -- -- 2,192
Other.............................................. 650 1,115 2,164
--------- --------- ---------
$ 7,596 $ 8,336 $ 13,834
--------- --------- ---------
--------- --------- ---------
</TABLE>
64
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M--STOCK OPTIONS AND BENEFIT PLANS
The Company's 1991 stock option plan, which was amended in 1992, provides
for the granting of both incentive stock options and nonqualified stock options
to Directors and key employees. Generally, options outstanding under the stock
option plan are granted at prices equal to the market value of the stock at the
date of grant, vest ratably over a four year service period and expire ten years
subsequent to the award.
Outstanding common stock options at December 31, 1998, are exercisable at
various dates through 2006. The following table summarizes option activity:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF OPTION PRICE
SHARES PER SHARE
----------- ---------------
<S> <C> <C>
Balance at December 31, 1995....................... 400,000 $ 8.80
Options granted.................................. 108,500 10.16
Options exercised................................ (72,000) 7.39
Options cancelled................................ (5,000) 12.88
-----------
Balance at December 31, 1996....................... 431,500 9.33
Options granted.................................. 30,000 13.13
Options exercised................................ (36,600) 8.14
Options cancelled................................ (10,900) 9.39
-----------
Balance at December 31, 1997....................... 414,000 9.71
Options granted.................................. 74,000 20.50
Options exercised................................ (124,000) 9.14
Options cancelled................................ (10,000) 9.94
-----------
Balance at December 31, 1998....................... 354,000 $ 12.16
-----------
-----------
</TABLE>
At December 31, 1998 16,600 shares were available for future grants under
the plan.
Additional information regarding options outstanding as of December 31, 1998
is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------ OPTIONS EXERCISABLE
WEIGHTED AVG. --------------------------
REMAINING WEIGHTED AVG. WEIGHTED AVG.
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE (YRS) PRICE EXERCISABLE PRICE
- ----------------------------- ----------- --------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
$ 6.00 - $ 7.99.............. 11,000 2.3 $ 7.54 11,000 $ 7.54
8.00 - 9.99.............. 178,000 4.9 8.96 136,000 8.76
10.00 - 11.99.............. 32,000 5.1 10.70 21,000 10.67
12.00 - 13.99.............. 59,000 5.9 13.01 40,000 12.96
14.00 - 20.99.............. 74,000 9.4 20.50 0 20.50
----------- -----------
354,000 208,000
----------- -----------
----------- -----------
</TABLE>
65
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M--STOCK OPTIONS AND BENEFIT PLANS (CONTINUED)
Had compensation cost for the grants been determined based upon the fair
value method, the Company's net income (loss) and earnings (loss) per share
would have been adjusted to the pro forma amounts indicated below.
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- -----------
<S> <C> <C> <C>
Net income (loss)
As reported......................... $5,091,000 $3,441,000 $(1,486,000)
Pro forma........................... 4,836,000 3,313,000 (1,587,000)
Basic earnings (loss) per share
As reported......................... 1.57 1.08 (.71)
Pro forma........................... 1.49 1.03 (.75)
Diluted earnings (loss) per share
As reported......................... 1.47 1.02 (.71)
Pro forma........................... 1.40 .98 (.75)
</TABLE>
The fair value of the options granted during 1998, 1997, and 1996, is
estimated as $727,000, $225,000, and $604,000, on the date of grant using the
Black-Scholes option-pricing model with the following assumptions: dividend at
the current rate, volatility of 30.32%, 29.5%, and 29.0% risk-free interest rate
of 5.53%, 6.65%, and 6.04%, assumed forfeiture rate of zero, and an expected
life of 10 years. The weighted average per share fair value of the 1998, 1997,
and 1996 awards was $9.82, $7.48, and $5.56, respectively. The impact of
outstanding non-vested stock options granted prior to 1995 has been excluded
from the proforma calculations; acccordingly the proforma adjustments are not
indicative of future proforma adjustments when the calculation will apply to all
applicable stock options.
In 1991 the Company established a 401(K) savings plan for employees who have
at least one year of continuous service. The Company's contributions are based
on a sliding scale where it matches 100% of the first $300 contributed by the
employee, 75% of the next $400, 50% of the next $800 and 25% of the next $4,000
for a maximum contribution per employee of $2,000. Company contributions
totalled $212,000, $179,000, and $257,000 in 1998, 1997 and 1996.
In December 1993 the Company established a supplemental benefit plan (Plan)
to provide death benefits and supplemental income payments during retirement for
selected officers. The Plan is a nonqualified defined benefit plan and is
unsecured. Benefits under the Plan are fixed for each participant and are
payable over a specific period following the participant's retirement or at such
earlier date as termination or death occurs. Participants vest in the plan based
on their years of service subsequent to being covered by the Plan. The Company
has purchased insurance policies to provide for its obligations under the Plan
in the event a participant dies prior to retirement. The cash surrender value of
such policies was $3,033,000 at December 31, 1998. Under this plan, the Company
recognized expense of $110,000, $142,000, and $167,000 in 1998, 1997 and 1996.
The aggregate projected benefit obligation of the Plan was approximately
$163,000 and $374,000 at December 31, 1998 and 1997. A discount rate of 8.5% was
used to determine the aggregate projected benefit obligation for both years. The
aggregate vested present value benefit obligation was $137,000 and $203,000 at
December 31, 1998 and 1997.
66
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N--SUBORDINATED DEBT AND PREFERRED STOCK
In 1993, the Company issued $12,000,000 of 8.5% subordinated notes. The
notes are due February 15, 2004 and qualify as capital for bank regulatory
purposes (total capital). The notes are callable at par after January 15, 1997.
Issuance costs of $473,000 are carried as a deferred asset and are amortized
over the life of the notes as an adjustment to interest expense.
On February 22, 1999, the Company redeemed the entire $12,000,000 of
outstanding subordinated notes. As a result of the redemption the Company will
record an extraordinary charge of $288,000 net of tax related to debt issuance
costs. Such charge will be recorded by the Company in the first quarter of 1999.
In 1993, the Company issued 575,000 shares of 7.80% Noncumulative
Convertible Perpetual Preferred Stock, Series A. The preferred stock was
convertible, at the option of the holder, into .8674 shares of common stock for
each share of preferred stock.
On April 30, 1998 the Company called all of its outstanding 7.80%
Noncumulative Convertible Preferred Stock at a redemption price of $10.39 per
share. As a result of this action, the Company issued 497,865 shares of the
Company's common stock in exchange for 573,290 shares of preferred stock. The
remaining shares were redeemed with cash.
NOTE O--REGULATORY MATTERS
One of the principal sources of cash for Redwood are dividends from NBR.
Total dividends which may be declared by the subsidiary financial institutions
depend on the regulations which govern them. In addition, regulatory agencies
can place dividend restrictions on the subsidiaries based on their evaluation of
the financial condition of the subsidiaries. No restrictions are currently
imposed by regulatory agencies on the subsidiaries other than the limitations
found in the regulations which govern the respective subsidiaries. At December
31, 1998, NBR could pay additional dividends to Redwood of approximately
$7,705,000 without prior regulatory approval.
NBR is subject to certain restrictions under the Federal Reserve Act,
including restrictions on the extension of credit to affiliates. In particular,
it is prohibited from lending to an affiliated company unless the loans are
secured by specific types of collateral. Such secured loans and other advances
from the subsidiaries are limited to 10 percent of the subsidiary's equity. No
such loans or advances were outstanding during 1998 or 1997.
Redwood, NBR, and previously Allied, are subject to various regulatory
capital requirements administered by the federal banking agencies. In addition
to these capital guidelines, the Federal Deposit Insurance Corporation
Improvement Act of 1991 (FDICIA) required each federal banking agency to
implement a regulatory framework for prompt corrective actions for insured
depository institutions that are not adequately capitalized. The Board of
Governors of the Federal Reserve System, FDIC, OCC and OTS have adopted such a
system which became effective on December 19, 1992. Failure to meet minimum
capital requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. The regulations require
the Company to meet specific capital adequacy guidelines that involve
quantitative measures of the Company's assets, liabilities and certain
off-balance sheet items as calculated under regulatory accounting practices.
NBR's and Allied's capital classification is also subject to qualitative
judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain a minimum leverage ratio of Tier 1 capital (as
defined in the regulations) to adjusted assets (as defined), and minimum ratios
of Tier 1 and total capital (as defined) to risk-weighted assets (as defined).
67
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE O--REGULATORY MATTERS (CONTINUED)
As of December 31, 1998 and 1997, the most recent notification from the Office
of the Comptroller of the Currency categorized NBR as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, NBR must maintain minimum total risk-based, Tier I risk-based, and
Tier I leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed NBR's
category.
<TABLE>
<CAPTION>
TO BE
CATEGORIZED
AS WELL
CAPITALIZED
FOR CAPITAL UNDER PROMPT
ADEQUACY CORRECTIVE
ACTUAL PURPOSES ACTION
-------------- -------------- -------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ------- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
At December 31, 1998:
COMPANY
Leverage Capital (to Average
Assets)........................ $37,072 8.84% $16,769 4.00% n/a n/a
Tier 1 Capital (to Risk-weighted
Assets)........................ 37,072 11.84 12,522 4.00 n/a n/a
Total Capital (to Risk-weighted
Assets)........................ 53,036 16.94 25,044 8.00 n/a n/a
NBR
Leverage Capital (to Average
Assets)........................ 43,110 10.31 16,726 4.00% 20,907 5.00%
Tier 1 Capital (to Risk-weighted
Assets)........................ 43,110 13.75 12,539 4.00 18,808 6.00
Total Capital (to Risk-weighted
Assets)........................ 50,079 15.98 25,077 8.00 31,347 10.00
At December 31, 1997:
COMPANY
Leverage Capital (to Average
Assets)........................ $31,892 7.10% $17,963 4.00% n/a n/a
Tier 1 Capital (to Risk-weighted
Assets)........................ 31,892 9.72 13,122 4.00 n/a n/a
Total Capital (to Risk-weighted
Assets)........................ 48,037 14.64 26,243 8.00 n/a n/a
NBR
Leverage Capital (to Average
Assets)........................ 38,184 8.58 17,792 4.00% 22,240 5.00%
Tier 1 Capital (to Risk-weighted
Assets)........................ 38,184 11.65 13,110 4.00 19,665 6.00
Total Capital (to Risk-weighted
Assets)........................ 45,325 13.83 26,220 8.00 32,775 10.00
</TABLE>
Management believes that as of December 31, 1998, the Company and NBR meet
all capital requirements to which they are subject. Under the most stringent
capital requirement, NBR has approximately $25,002,000 in excess capital before
it becomes "undercapitalized" under the regulatory framework for prompt
corrective action.
The prompt corrective action regulations impose restrictions upon all
financial institutions to refrain from certain actions which would cause an
institution to be classified as "undercapitalized", such as the declaration of
the dividends or other capital distributions or payment of management fees, if
following the distribution or payment the institution would be classified as
"undercapitalized". In addition, financial institutions which are classified as
"undercapitalized" are subject to certain mandatory and discretionary
supervisory actions.
68
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P--BUSINESS SEGMENTS
During the years ended December 31, 1998, 1997, and 1996, the Company
operated in four principal product and service lines: core community banking,
merchant card services, sub prime lending, and residential mortgage banking and
brokerage. The Company's core community banking industry segment includes
commercial, commercial real estate, construction, and permanent residential
lending along with all depository activities. The Company's merchant card
services industry group provides credit card settlement services for 30,000
merchants throughout the United States. The Company's sub prime lending unit,
known as Allied Diversified Credit, provides sub prime residential loans for
homeowners located principally in Northern California. The Company's residential
mortgage banking and brokerage arm, known as Valley Financial, includes the
origination and brokerage of "A paper" loans, and servicing of loans for
investors.
The condensed income statements and average assets of the individual
segments are set forth in the table below. The information in this table is
derived from the internal management reporting system used by management to
measure the performance of the segments and the Company. The management
reporting system assigns balance sheet and income statement items to each
segment based on internal management accounting policies. Net interest income is
determined by the Company's internal funds transfer pricing system, which
assigns a cost of funds or credit for funds to assets or liabilities based on
their type, maturity or repricing characteristics. Noninterest income and
expense directly attributable to a segment are assigned to that business. Total
other operating expense includes indirect costs, such as overhead, operations
and technology expense, are allocated to the segments based on an evaluation of
costs for product or data processing. All amounts other than allocations of
interest and indirect costs are derived from third parties. The provision for
credit losses is allocated based on the required reserves and the net
charge-offs for each respective segment. The Company allocates depreciation
expense without allocating the related depreciable asset to that segment.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1998
-----------------------------------------------------------------
MORTGAGE
COMMUNITY BANKING TOTAL
BANKING SUB PRIME BANKCARD AND BROKERAGE COMPANY
----------- ----------- ----------- --------------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Total interest income................ $ 30,557 $ 724 $ -- $ 1,778 $ 33,059
Total interest expense............... 14,083 32 32 32 14,179
Interest income/(expense)
allocation......................... 1,102 (367) 543 (1,278) 0
----------- ----------- ----------- ------- ---------
Net interest income.................. 17,576 325 511 468 18,880
Provision for loan losses............ 2,016 24 0 0 2,040
Total other operating income......... 3,019 1,416 2,609 8,622 15,666
Total depreciation expense........... 1,164 86 48 433 1,731
Total other operating expense........ 13,134 2,229 1,080 7,139 23,582
----------- ----------- ----------- ------- ---------
Income before income taxes........... 4,281 (598) 1,992 1,518 7,193
Provision for income taxes........... 1,018 (217) 737 564 2,102
----------- ----------- ----------- ------- ---------
Net income........................... $ 3,263 $ (381) $ 1,255 $ 954 $ 5,091
----------- ----------- ----------- ------- ---------
----------- ----------- ----------- ------- ---------
Total Average Assets................. $ 387,066 $ 5,403 $ 8,131 $ 23,385 $ 423,985
----------- ----------- ----------- ------- ---------
----------- ----------- ----------- ------- ---------
</TABLE>
69
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P--BUSINESS SEGMENTS (CONTINUED)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
-----------------------------------------------------------------
MORTGAGE
COMMUNITY BANKING TOTAL
BANKING SUB PRIME BANKCARD AND BROKERAGE COMPANY
----------- ----------- ----------- --------------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Total interest income................ $ 35,471 $ 262 $ -- $ 1,573 $ 37,306
Total interest expense............... 16,699 36 26 26 16,787
Interest income/(expense)
allocation......................... 374 (93) 536 (817) 0
----------- ----------- ----------- ------- ---------
Net interest income.................. 19,146 133 510 730 20,519
Provision for loan losses............ 1,995 105 0 0 2,100
Total other operating income......... 4,055 1,719 1,585 2,784 10,143
Total depreciation expense........... 1,101 66 21 242 1,430
Total other operating expense........ 14,699 2,843 1,269 2,614 21,425
----------- ----------- ----------- ------- ---------
Income before income taxes........... 5,406 (1,162) 805 658 5,707
Provision for income taxes........... 2,170 (464) 310 250 2,266
----------- ----------- ----------- ------- ---------
Net income........................... $ 3,236 $ (698) $ 495 $ 408 $ 3,441
----------- ----------- ----------- ------- ---------
----------- ----------- ----------- ------- ---------
Total average assets................. $ 430,048 $ 4,006 $ 8,019 $ 15,931 $ 458,004
----------- ----------- ----------- ------- ---------
----------- ----------- ----------- ------- ---------
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1996
-----------------------------------------------------------------
MORTGAGE
COMMUNITY BANKING TOTAL
BANKING SUB PRIME BANKCARD AND BROKERAGE COMPANY
----------- ----------- ----------- --------------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Total interest income................ $ 40,234 $ 960 -- $ 4,590 $ 45,784
Total interest expense............... 22,553 40 25 25 22,643
Interest income/(expense)
allocation......................... 3,435 (532) 440 (3,343) --
----------- ----------- ----------- ------- ---------
Net interest income.................. 21,116 388 415 1,222 23,141
Provision for loan losses............ 6,262 -- -- -- 6,262
Total other operating income......... 7,638 4,455 1,849 5,628 19,570
Total depreciation expense........... 1,732 163 4 629 2,528
Total other operating expense........ 21,475 4,220 2,263 8,460 36,418
----------- ----------- ----------- ------- ---------
Income before income taxes........... (715) 460 (3) (2,239) (2,497)
Provision for income taxes........... (260) 186 (1) (936) (1,011)
----------- ----------- ----------- ------- ---------
Net income........................... $ (455) $ 274 $ (2) $ (1,303) $ (1,486)
----------- ----------- ----------- ------- ---------
----------- ----------- ----------- ------- ---------
Total average assets................. $ 446,312 $ 6,936 $ 9,430 $ 71,094 $ 533,772
----------- ----------- ----------- ------- ---------
----------- ----------- ----------- ------- ---------
</TABLE>
NOTE Q--FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures About Fair
Value of Financial Instruments" (SFAS No. 107) requires that the Company
disclose the fair value of financial instruments for which it is practicable to
estimate that value. Although management uses its best judgment in assessing
fair value, there are inherent weaknesses in any estimating technique that may
be reflected in the fair values disclosed. The fair value estimates are made at
a discrete point in time based on relevant market data, information about the
financial instruments, and other factors. Estimates of fair value of instruments
without quoted market prices are subjective in nature and involve various
assumptions and estimates that are matters of judgment. Changes in the
assumptions used could significantly affect these estimates. Fair
70
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE Q--FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
value has not been adjusted to reflect changes in market conditions for the
period subsequent to the valuation dates of December 31, 1998 and 1997 and
therefore estimates presented herein are not necessarily indicative of amounts
which could be realized in a current transaction.
The following estimates and assumptions were used on December 31, 1998 and
1997 to estimate the fair value of each class of financial instruments for which
it is practicable to estimate that value.
(A) CASH AND CASH EQUIVALENTS
For cash and cash equivalents, the carrying amount is a reasonable estimate
of fair value.
(B) INTEREST-BEARING DEPOSITS DUE FROM FINANCIAL INSTITUTIONS
The fair value of interest-bearing deposits held by the Company is based on
the discounted cash flows through the date of maturity at market interest rates
for similar maturities as of the valuation date.
(C) INVESTMENTS
Fair value equals quoted market price, if available. If a quoted market
price is not available, fair value is estimated using quoted market prices for
similar securities. For investments in unregistered mortgage-backed securities
with recourse, fair value was estimated based on the expected future cash flows
to be received adjusted for prepayments, foreclosures, losses and other
significant factors impacting fair value. U.S. Government agency stock has no
trading market but is required as part of membership, and therefore it is
carried at cost.
(D) LOANS HELD FOR SALE
For uncommitted residential mortgages held for sale, fair value is estimated
using indications of value obtained by management from independent third parties
or quoted market prices for securities backed by similar loans, adjusted for
differences in loan characteristics. Committed residential mortgage loans held
for sale are valued based on actual commitment prices. Fair value of certain
loans held for sale include the value of premiums associated with the sale of
the related servicing rights in the instance that a commitment exists for the
sale of such servicing at a predetermined rate.
(E) LOANS RECEIVABLE
To estimate fair value of loans held for investment, including commercial
loans, mortgages and construction loans, each loan category is segmented by
fixed and adjustable rate interest terms, by estimated credit risk, by maturity,
and by performing and nonperforming categories.
The fair value of performing loans is estimated by discounting contractual
cash flows using the current interest rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining maturities.
Assumptions regarding credit risk, cash flow, and discount rates are
judgmentally determined using available market information.
The fair value of nonperforming loans and loans delinquent more than 30 days
is estimated by discounting estimated future cash flows using current interest
rates with an additional risk adjustment reflecting the individual
characteristics of the loans.
71
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE Q--FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
(F) INTEREST RECEIVABLE
For interest receivable, the carrying amount is a reasonable estimate of
fair value.
(G) MORTGAGE SERVICING RIGHTS
The fair value of mortgage servicing rights is estimated on a loan by loan
basis using market prices under comparable servicing sale contracts, when
available or, using a cash flow model with current assumptions with respect to
prepayments, servicing costs and other significant factors.
(H) DEPOSIT LIABILITIES
Under SFAS No. 107, the fair value of deposits with no stated maturity, such
as noninterest bearing demand deposits, savings and money market accounts, is
equal to the amount payable on demand on December 31, 1997 and 1996. The fair
value of time deposits, is based on the discounted value of contractual cash
flows. The discount rate is based on rates currently offered for deposits of
similar size and remaining maturities.
(I) OTHER BORROWINGS AND SUBORDINATED NOTES
The discounted value of contractual cash flows at market interest rates for
debt with similar terms and remaining maturities are used to estimate the fair
value of existing debt.
(J) COMMITMENTS TO FUND MORTGAGE LOANS
The fair value of commitments to fund fixed-rate mortgage loans represents
the estimated gain (loss) to the Company of fully funding its commitments at
current interest rates and selling the underlying loans in the secondary market.
(K) COMMITMENTS TO FUND OTHER LOANS
The fair value of commitments to fund other loans represents fees currently
charged to enter into similar agreements with similar remaining maturities.
(L) FORWARD CONTRACTS TO SELL MBS
The fair value of forward contracts to sell MBS represents the difference
between current rates for similar quantities and delivery dates of
mortgage-backed securities as compared to the contractual rates.
(M) PURCHASED AND WRITTEN OPTIONS
Carrying value represents premiums paid or received. Fair values were
obtained from third party dealers of such options.
72
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE Q--FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1998 1997
-------------------- --------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
ASSETS:
Cash and cash equivalents.......................... $ 42,187 $ 42,187 $ 56,058 $ 56,058
Interest-bearing deposits.......................... -- -- 6 6
Investments........................................ 60,410 60,552 72,565 73,180
Loans held for sale................................ 32,620 32,633 16,929 17,267
Portfolio loans, net............................... 261,275 271,730 274,751 275,879
Interest receivable................................ 2,996 2996 3,112 3,112
Mortgage servicing rights.......................... 305 1,351 620 1,191
LIABILITIES:
Deposits........................................... 364,720 351,625 391,421 391,550
Other borrowings................................... 1,371 1,429 2,341 2,341
Subordinated notes................................. 12,000 12,000 12,000 12,000
OFF BALANCE SHEET FINANCIAL INSTRUMENTS:
Commitments to fund mortgage loans................. 112 62
Commitments to fund other loans.................... 284 246
Forward contracts to sell MBS...................... (38) (8)
</TABLE>
NOTE R--RESTRUCTURING CHARGES
In November, 1996 the Company's Board of Directors approved a plan to merge
its two wholly owned subsidiaries, NBR and Allied. As a result of the merger,
the surviving bank, NBR, assumed all of Allied's rights and obligations. In
connection with the merger, and as a result of the Company's decision to
significantly curtail its wholesale mortgage banking production capacity, the
Company recorded a restructuring charge of $2,357,000 in the fourth quarter of
1996. The restructuring of the Company, which includes both the merger of Allied
into NBR and the reduction in "A" paper wholesale lending, includes the closing
of the Portland and Sacramento mortgage loan production offices, the partial
write-off of Allied's administrative headquarters lease, termination of
employees, and write-off of duplicative or unnecessary fixed assets. The total
charge to operations associated with these matters consisted of:
<TABLE>
<S> <C>
Severance for 70 employees........... $ 651,000
Accrual of discontinued leases....... 772,000
Write-off of leasehold improvements,
furniture and fixtures............. 934,000
-----------
$ 2,357,000
-----------
-----------
</TABLE>
At December 31, 1998, $163,000 of the previously recorded restructuring
charges remained in other liabilities, substantially all of which is related to
the future minimum lease payments associated with the closed facilities. The
Company is actively seeking sublease tenants for many of these closed facilities
and a
73
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE R--RESTRUCTURING CHARGES (CONTINUED)
portion of the restructuring charge may be reversed in future periods if the
Company is successful in entering into such arrangements.
The following table presents a summary of activity with respect to the
restructuring accrual.
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Balance, beginning of year.......................................................... $ 319 $ 1,808 $ 619
Provision (credited) charged (to) against income.................................... -- (286) 2,357
Cash outlays........................................................................ (156) (1,127) (234)
Noncash writedowns.................................................................. -- (76) (934)
--------- --------- ---------
Balance, end of year................................................................ $ 163 $ 319 $ 1,808
--------- --------- ---------
--------- --------- ---------
</TABLE>
NOTE S--COMMITMENTS AND CONTINGENCIES
Certain lawsuits and claims arising in the ordinary course of business have
been filed or are pending against the Company or its subsidiaries. Based upon
information available to the Company, its review of such lawsuits and claims and
consultation with its counsel, the Company believes the liability relating to
these actions, if any, would not have a material adverse effect on its
consolidated financial statements.
74
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE T-- CONDENSED FINANCIAL INFORMATION OF REDWOOD EMPIRE BANCORP
(PARENT ONLY)
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Cash...................................................................... $ 2,335 $ 2,645
Investment in subsidiaries................................................ 47,678 39,535
Capitalized debt issuance costs........................................... 473 560
Other assets.............................................................. 132 2,734
--------- ---------
Total assets............................................................ $ 50,618 $ 45,474
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable.......................................................... $ (22) $ 231
Subordinated notes........................................................ 12,000 12,000
--------- ---------
Total liabilities....................................................... 11,978 12,231
--------- ---------
Shareholders' equity:
Preferred stock, no par value; authorized 2,000,000 shares; issued and
outstanding: 1998--no shares, 1997--575,000 shares; liquidation
preference of $10.00 per share.......................................... -- 5,750
Common stock, no par value: authorized 10,000,000 shares; issued and
outstanding: 1998 3,363,565 shares; 1997--2,780,209 shares.............. 25,801 19,656
Retained earnings......................................................... 12,600 8,024
Accumulated other comprehensive income, net............................... 239 (187)
--------- ---------
Shareholders' equity.................................................... 38,640 33,243
--------- ---------
Total liabilities and shareholders' equity............................ $ 50,618 $ 45,474
--------- ---------
--------- ---------
</TABLE>
75
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE T-- CONDENSED FINANCIAL INFORMATION OF REDWOOD EMPIRE BANCORP
(PARENT ONLY) (CONTINUED)
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Operating income:
Management service fees.......................................... $ -- $ 186 $ 736
Dividends from subsidiaries...................................... 1,200 860 2,442
Interest income from subsidiaries................................ 274 274 297
--------- --------- ---------
Total operating income......................................... 1,474 1,320 3,475
--------- --------- ---------
Expenses:
Interest expense................................................. 1,107 1,107 1,115
Operating expenses............................................... 486 732 1,876
--------- --------- ---------
Total expenses................................................. 1,593 1,839 2,991
--------- --------- ---------
(Loss) income before undistributed income of subsidiaries.......... (119) (519) 484
Equity in undistributed income (loss) of subsidiaries.............. 4,713 3,378 (2,613)
--------- --------- ---------
Income (loss) income before income taxes........................... 4,594 2,859 (2,129)
Income tax benefit................................................. (497) (582) (643)
--------- --------- ---------
Net income (loss).................................................. $ 5,091 $ 3,441 $ (1,486)
--------- --------- ---------
--------- --------- ---------
</TABLE>
76
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE T-- CONDENSED FINANCIAL INFORMATION OF REDWOOD EMPIRE BANCORP
(PARENT ONLY) (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................................... $ 5,091 $ 3,441 $ (1,486)
--------- --------- ---------
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Amortization and depreciation................................. 17 26 23
Equity in undistributed net (income) loss of subsidiaries..... (4,713) (3,378) 2,613
Change in other assets........................................ (113) 745 (741)
Change in other liabilities................................... (257) (216) 89
--------- --------- ---------
Total adjustments........................................... (5,066) (2,823) 1,984
--------- --------- ---------
Net cash provided by operating activities................... 25 618 498
--------- --------- ---------
Cash flows from financing activities:
Stock issuance.................................................. 180 298 506
Cash dividends.................................................. (515) (449) (449)
--------- --------- ---------
Net cash provided by (used in) financing activities......... (335) (151) 57
--------- --------- ---------
Increase (decrease) in cash....................................... (310) 467 555
Cash at beginning of year......................................... 2,645 2,178 1,623
--------- --------- ---------
Cash at end of year............................................... $ 2,335 $ 2,645 $ 2,178
--------- --------- ---------
--------- --------- ---------
</TABLE>
77
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE T-- CONDENSED FINANCIAL INFORMATION OF REDWOOD EMPIRE BANCORP
(PARENT ONLY) (CONTINUED)
QUARTERLY RESULTS
UNAUDITED QUARTERLY STATEMENTS OF OPERATIONS DATA
(dollars in thousands)
<TABLE>
<CAPTION>
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
1997 1997 1997 1997 1998 1998 1998 1998
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net interest income.................... $ 5,089 $ 5,331 $ 5,139 $ 4,960 $ 4,574 $ 4,614 $ 4,918 $ 4,774
Provision for credit losses............ 585 585 465 465 510 510 510 510
Other operating income................. 3,009 2,335 2,092 2,707 3,327 4,125 4,024 4,190
Other operating expenses............... 6,513 5,554 5,240 5,548 5,649 6,308 6,333 7,023
--------- --------- --------- --------- --------- --------- --------- ---------
Income before income taxes............. 1,000 1,527 1,526 1,654 1,742 1,921 2,099 1,431
Provision (benefit) for income taxes... 420 643 601 602 635 710 764 (7)
--------- --------- --------- --------- --------- --------- --------- ---------
Net income............................. $ 580 $ 884 $ 925 $ 1,052 $ 1,107 $ 1,211 $ 1,335 $ 1,438
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
Net (loss) income available for common
stock shareholders................... $ 468 $ 772 $ 813 $ 939 $ 995 $ 1,211 $ 1,335 $ 1,438
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
Per share:
Basic earnings per share............. $ .16 $ .27 $ .28 $ .32 $ .36 $ .39 $ .40 $ .43
Diluted earnings per share........... .16 .26 .27 .31 .32 .35 .38 .41
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
78
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
<TABLE>
<CAPTION>
YEAR
FIRST
APPOINTED PRINCIPAL OCCUPATION
NAME AND TITLE AGE DIRECTOR DURING PAST FIVE YEARS
- ---------------------------------- --- ----------- ------------------------------------------------------------
<S> <C> <C> <C>
Haskell E. Boyett ................ 71 1991 Independent business consultant. Former Division Manager,
Director Pacific Gas and Electric Company, a San Francisco-based
public utility. Director of the Company since 1991.
Director of NBR since 1989. Director of Allied from 1995
to 1997.
Richard I. Colombini ............. 67 1997 President of Colombini Construction. Director of NBR since
Director 1984. Director of the Company since 1997.
Robert D. Cook ................... 68 1996 President and CEO of R. D. Cook Management Corporation, a
Director financial and business consulting firm. Director of the
Company since 1996. Director of NBR since 1996. Director
of Allied from 1996 to 1997.
Dennis E. Kelley ................. 44 1986 Executive Vice President and Chief Operations Officer of NBR
Director, Executive Vice since March 1997. Director of NBR since 1994. President of
President and Chief Operations NBR from 1994 to March 1997; Senior Vice President and
Officer Chief Financial Officer of Redwood from 1988 to 1994;
Senior Vice President and Chief Financial Officer of NBR
from 1986 to 1991.
Patrick W. Kilkenny .............. 52 1995 Director, Chief Executive Officer and President since 1995.
Director, Chief Executive Chairman of the Board of NBR from 1994 to 1997, CEO and
Officer and President Director of NBR since 1984. Director of the Company from
1988 to 1993 and reappointed in 1995. Director of Allied
from 1995 to 1997.
William B. Stevenson ............. 68 1995 Principal, Financial Institutions Analysts & Consultants, a
Director San Francisco financial institution consultancy, since
1992; President and CEO, Pan American Savings Bank, from
1984 to 1991. Director of the Company since 1995. Director
of NBR since 1995. Director of Allied from 1995 to 1997.
Tom D. Whitaker .................. 61 1992 President and CEO of Motion Analysis Corporation, Inc., a
Director and Chairman of the Northern California-based manufacturer of devices that
Board measure motion. Director of the Company since 1992.
Director of NBR since 1995. Director of Allied from 1995
to 1997.
</TABLE>
79
<PAGE>
No director was selected pursuant to any arrangement or understanding other
than with the directors and officers of Redwood acting within their capacities
as such. There are no family relationships between any of the directors and
executive officers of Redwood. No director or officer of Redwood serves as a
director of any company which has a class of securities registered under, or
which is subject to the periodic reporting requirements of, the Securities
Exchange Act of 1934, or of any company registered as an investment company
under the Investment Company Act of 1940.
The Company's directors serve a one-year term from one annual meeting to the
next.
EXECUTIVE OFFICERS
The following table sets forth certain information regarding the named
executive officers of the Company.
<TABLE>
<CAPTION>
YEAR FIRST
APPOINTED
EXECUTIVE POSITION & OFFICES WITH COMPANY AND PRINCIPAL
NAME AGE OFFICER OCCUPATION OR EMPLOYMENT FOR PAST FIVE YEARS
- ---------------------------------- --- ----------- ------------------------------------------------------------
<S> <C> <C> <C>
Patrick W. Kilkenny............... 52 1985 Chief Executive Officer, President and Director of Redwood
since 1995. Chairman of the Board of NBR from 1994 to
March 1997; Chief Executive Officer and Director of NBR
since 1985; Director of Redwood from 1988 to 1993.
Director and Chief Executive Officer of Allied from 1996
to March 1997.
James E. Beckwith................. 41 1995 Executive Vice President and Chief Financial Officer of
Redwood since January 1997. Executive Vice President and
Chief Financial Officer of NBR since March, 1997. Senior
Vice President and Chief Financial Officer of Redwood and
NBR from January 1995 to March 1997. Chief Financial
Officer of Allied from January 1995 to October 1996. Chief
Financial Officer of Sunrise Bancorp from 1991 to 1994.
Senior Manager with Deloitte & Touche from 1986 to 1991.
Dennis E. Kelley.................. 44 1986 Executive Vice President and Chief Operations Officer of NBR
since March 1997. Director of NBR since 1994. President of
NBR from 1994 to March 1997; Senior Vice President and
Chief Financial Officer of Redwood from 1988 to 1994;
Senior Vice President and Chief Financial Officer of NBR
from 1986 to 1991.
S. Deborah Kaufman................ 48 1996 Executive Vice President and Chief Credit Officer of NBR
since March 1997. Senior Vice President and Senior Loan
Officer of Redwood since December 1996. Examiner with the
Comptroller of the Currency in the Western United States
from 1993 to 1996. Vice President with Pacific Bank from
1992 to 1993. Vice President, Private Banking with Bank
America/Security Pacific Bank from 1988 to 1992.
</TABLE>
80
<PAGE>
Every Company officer serves at the pleasure of the Board of Directors.
There are no understandings or arrangements between any of such officers and any
other person pursuant to which they were or are to be selected as officers of
Redwood.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth all cash and non-cash compensation (including
bonuses and deferred compensation) paid or accrued to the named executive
officers as of December 31, 1998, for services rendered to the Company during
the periods indicated.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION
-------------------------------------------------- AWARDS
OTHER --------------------------------
NAME AND ANNUAL NUMBER OF ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(1) OPTIONS(2) COMPENSATION(3)
- --------------------------------- --------- ---------- --------- ---------------- ------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Patrick W. Kilkenny.............. 1998 $ 214,518 -- $ 27,785 9,000 $ 2,000
CEO and President, 1997 206,683 -- 25,107 -- 2,000
Redwood, President and 1996 205,202 -- 17,720 20,000 --
CEO of NBR
James E. Beckwith................ 1998 139,616 19,800 7,917 6,000 2,000
Executive Vice President 1997 131,648 15,000 6,620 -- 2,000
and Chief Financial 1996 126,046 20,000 6,520 15,000 2,000
Officer of Redwood and
NBR
Dennis E. Kelley(5).............. 1998 164,619 5,000 6,642 -- 2,000
Executive Vice President 1997 159,000 7,000 12,473 -- 2,000
and Chief Operating 1996 159,075 -- 8,107 15,000 2,000
Officer of NBR
S. Deborah Kaufman(4)............ 1998 140,755 15,000 4,922 6,000 2,000
Executive Vice President 1997 130,192 7,000 5,122 -- 2,000
and Chief Credit Officer
of NBR
</TABLE>
- ------------------------
(1) Includes directors' fees, auto allowances, personal use of company-owned
automobiles, insurance, the value of options exercised during the year, and
changes in the amounts vested for individuals under the Company's salary
continuation plan.
(2) Includes stock options issued under Redwood's stock option plan.
(3) Includes matching contributions to 401(K) plans.
(4) Ms. Kaufman was appointed to her position during 1997. Ms. Kaufman is no
longer employed by the Company as of March 25, 1999.
(5) Mr. Kelley resigned his position as Executive Vice President and Chief
Operating Officer of NBR in January, 1999.
81
<PAGE>
The following table sets forth information concerning the aggregate value of
all unexercised options held by each of the named executive officers as of
December 31, 1998.
AGGREGATED OPTION EXERCISES IN 1998 AND DECEMBER 31, 1998 OPTION VALUES
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS AT
SHARES VALUE OPTIONS AT DECEMBER DECEMBER 31, 1998 (2)
ACQUIRED REALIZED -------------------------- --------------------------
NAME ON EXERCISE (1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----------------------------------------- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Patrick W. Kilkenny -- $ -- 45,869 20,250 $ 364,450 $ 82,266
CEO and President, Redwood, CEO and
President of NBR
James E. Beckwith -- -- 11,250 14,750 86,485 64,453
Executive Vice President and Chief
Financial Officer of Redwood and NBR
Dennis E. Kelley 16,555 143,750 16,250 8,750 106,798 64,453
Executive Vice President and Chief
Operating Officer of NBR
S. Deborah Kaufman -- -- -- 6,000 -- --
Executive Vice President and Chief
Credit Officer of NBR
</TABLE>
- ------------------------
(1) The value realized is the difference between (a) the average of the high and
low prices of Redwood's Common Stock as reported by the NASDAQ National
Market System on the date of exercise and (b) the exercise price of the
option, multiplied by the number of shares exercised.
(2) All options were issued at the then-current market price on the grant date.
Total value of unexercised options is based on the closing price of the
Company's Common Stock as reported by the NASDAQ National Market System of
$17.06 as of December 31, 1998 less the exercise price of the option,
multiplied by the number of options outstanding.
The following table sets forth information concerning individual grants of
stock options by Redwood during 1998 to each of its executive officers named
below.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL
REALIZABLE VALUE AT
INDIVIDUAL GRANTS ASSUMED ANNUAL RATES
-------------------------------------------------------------- OF STOCK
% OF TOTAL APPRECIATION FOR
OPTIONS GRANTED EXERCISE OR OPTION TERM
OPTIONS TO EMPLOYEES IN BASE PRICE EXPIRATION ----------------------
NAME GRANTED (#) FISCAL YEAR ($ / SH) DATE 5% 10%
- ------------------------------------ ------------- ----------------- ----------- --------------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Patrick W. Kilkenny 9,000 20.93% $ 20.5000 June 01, 2008 $ 116,031 $ 294,045
President and CEO, Redwood
James E. Beckwith 6,000 13.95% $ 20.5000 June 01, 2008 $ 77,354 $ 196,030
Executive Vice President and CFO,
Redwood
S. Deborah Kaufman 6,000 13.95% $ 20.5000 June 01, 2008 $ 77,354 $ 196,030
Executive Vice President, NBR
</TABLE>
82
<PAGE>
SUPPLEMENTAL BENEFIT PLAN
Redwood has adopted an Executive Salary Continuation Policy which acts as a
supplemental benefit plan for senior management personnel. The Policy authorizes
Redwood and its subsidiaries to enter into individual agreements with selected
senior executive officers, providing them certain retirement benefits. The
Policy calls for Redwood's Board of Directors to approve all individual
agreements with executive officers, and to conduct a biennial review of all
scheduled benefits.
As authorized under the Policy, the Company has entered into an Executive
Salary Continuation Agreement with Mr. Kilkenny. This agreement, which provides
that upon retirement at age 65 the executive will receive, for a period of 15
years after the date of his retirement, a specified annual retirement payment,
payable in equal monthly installments. The annual retirement benefit payment to
which Mr. Kilkenny would be entitled upon his normal retirement age of 65 under
his agreement is currently $60,350. In the event that the executive dies after
his retirement, but before the end of the 15-year period, the Company will
continue to make such payments to the executive's designated beneficiary.
However, if the executive should die prior to his retirement as described above,
his designated beneficiary will receive, for a period of 15 years, the same
yearly benefit payable in equal monthly installments. The executive may take
early retirement at age 55 (if by that time he has completed 15 years of service
with the Company), but his annual retirement benefits will then be only about
25% of the amount he would have received if he had retired at age 65. If he
takes retirement between 55 and 65, his retirement benefits will continue to
vest incrementally, pursuant to a specified schedule, as his years of service
increase. The agreement provides that if the executive retires or is terminated
before age 55, or before he has completed his 15 years of service, he will be
entitled to receive a specified one-time payment, the amount of which increases
each year on a predetermined schedule. As of January 1, 1999, the amount of this
one-time payment for Mr. Kilkenny would be $80,865.
The agreement also provides that in the event of a change in control which
is defined by any person or company acquiring 25% or more of Redwood's
outstanding shares, through a tender offer, merger, or otherwise, and within two
years thereafter the executive's employment by the Company is terminated or his
salary or authority is materially reduced, the executive will be entitled to
receive an amount equal to one times his current annual salary. In addition, in
the event of a change in control, the executive, upon notice of such change of
control from the Company, may elect to terminate their employment with the
Company and receive an amount equal to one times annual salary.
The Company has also entered into a Salary Continuation Agreement with Mr.
Beckwith which provides that if any person or company acquires 25% or more of
Redwoods' outstanding shares, through a tender offer, merger, or otherwise, and
within two years thereafter Mr. Beckwith's employment by the Company is
terminated or his salary or authority is materially reduced, he is entitled to
receive an amount equal to one times annual salary. In addition, in the event of
a change of control and upon notice of such change in control from the Company,
Mr. Beckwith may give notice to terminate employment and receive an amount equal
to one times annual salary.
The Company has executed a one year Compensation Agreement with Mr. Kilkenny
which establishes an annual base salary of $213,200. The Company and Mr.
Kilkenny have also executed a one year Executive Severance Agreement which
generally provides that should Mr. Kilkenny be terminated for any reason other
than failure to perform his job duties, habitual neglect, illegal conduct, he
would be entitled to one times his current salary.
83
<PAGE>
OTHER INFORMATION
PERFORMANCE GRAPH.
Set forth below is a performance graph comparing the yearly cumulative total
shareholder returns on Redwood's Common Stock with the yearly cumulative total
shareholder return on (a) stocks included in the S&P 500 composite index, (b) an
index of peer group companies from SNL Securities, L.P., and (c) an index of
peer group companies (California independent banks) derived from the Montgomery
Securities WESTERN BANK MONITOR NORTHERN CALIFORNIA PROXY. The peer group
provided to the Company last year by Montgomery Securities was not made
available to the Company this year. Accordingly, the Company endeavored to
replicate such peer group for the performance graph with reference to the
WESTERN BANK MONITOR NORTHERN CALIFORNIA PROXY. Such peer group consists of the
following companies: TriCo Bancshares, Exchange Bank, Redwood Empire Bancorp,
Union Bank, Westamerica, Civic BanCorp, Silicon Valley Bancshares, Pacific
Capital Bancorp, SJNB Financial and Pacific Bank.
The total cumulative return on investment for each of the periods indicated
for Redwood, the peer group, and the S&P 500 is based on the stock price or
composite index at the end of 1993.
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
PERIOD ENDING
<S> <C> <C> <C> <C> <C> <C>
Index 12/31/1993 12/31/1994 12/31/1995 12/31/1996 12/31/1997 12/31/1998
Redwood Empire Bancorp 100.00 57.72 64.81 93.16 147.84 139.17
S&P 500 100.00 101.32 139.39 171.26 228.42 293.69
SNL Western Bank Index 100.00 99.01 166.03 236.05 347.97 356.54
Northern California Proxy 100.00 97.87 148.40 160.71 319.27 306.78
</TABLE>
84
<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION.
The members of the Compensation Committee include Haskell E. Boyett,
Chairman, Robert D. Cook and Tom D. Whitaker. The functions of the Compensation
Committee are to recommend compensation actions for executive officers, oversee
the compensation plan for the entire Company, and compensation for Directors.
The Compensation Committee met 4 times in 1998.
The Compensation Committee interfaces with the Board of Directors of REB and
NBR. The Committee reviews and makes recommendations regarding the salary and
bonus of the Company's Chief Executive Officer to these Boards. In addition, the
committee reviews recommendations from the Chief Executive Officer for salary
levels of other senior staff members. Members of the Compensation Committee
listed above are also members of the Board of Directors of NBR.
BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION.
The Compensation Committee of Redwood's Board of Directors provides
recommendations and oversight for Redwood's executive officers, subject to
review by the full Board of Directors. Compensation decisions relating to the
executive officers of Redwood's subsidiary, NBR, is made by the Board of
Directors of the subsidiary and neither the Compensation Committee nor Redwood's
Board of Directors participate in compensation awards to such individuals except
to the extent of stock option awards under Redwood's 1991 Stock Option Plan.
Option awards are also determined for the executive officers and directors of
Redwood and its subsidiaries (including the individuals named above under the
caption "Compensation Committee") by Redwood's full Board of Directors, except
where such individuals are also directors of Redwood, in which case their annual
option grants are determined under the terms of the 1991 Option Plan.
The following is a report submitted by the Compensation Committee,
addressing the compensation policies of the Company as they relate to employees
of Redwood.
EXECUTIVE COMPENSATION POLICY. The goal of the Compensation Committee is to
ensure that an appropriate relationship exists between executive compensation
and Redwood's overall performance, while at the same time retaining key
employees of Redwood and motivating them to perform at a superior level for the
benefit of the shareholders. To achieve this goal, Redwood integrates annual
base compensation with bonuses based on Redwood's performance and the
performance and initiative of its individual executive officers. Redwood
attempts to establish base salaries that are generally within the range of
salaries paid to people holding comparably responsible positions at other peer
group financial institutions in California, taking into account the individual's
past performance and potential future contributions. Bonus compensation is based
primarily on the performance of Redwood and specific individual performance.
Measurement of Company performance is based primarily on that of peer group
financial institutions and Company goals, including primarily its return on
equity. Except as limited by the Company's Stock Option Plan, stock options are
granted from time to time to officers of Redwood and its subsidiaries on the
basis of the recipient's potential for contribution to the Company's future
growth and profitability.
The Compensation Committee believes that linking executive compensation to
corporate performance results aligns executive compensation with Redwood's goals
and shareholder interests. As performance goals are met or exceeded, resulting
in increased shareholder value, Redwood's executives are commensurably rewarded.
1999 COMPENSATION GOALS. The committee relies principally on data gathered
through independent sources in determining the salary ranges for executive
positions. In addition, in 1996 an independent consultant was retained to review
the salary structure for substantially all positions within the Company. The
results of the survey provided the Company with a defined salary structure based
upon job function and relevant market data.
85
<PAGE>
EXECUTIVE BASE SALARY. The Committee reviews Mr. Kilkenny's salary on an
annual basis. Factors that are considered by the Committee include the annual
performance review performed by the Company's Executive Committee and peer group
compensation. Based on the Committee's review of these factors Mr. Kilkenny's
base salary is well within peer group levels.
BONUS COMPENSATION. The Company has adopted a bonus plan for its executive
officers. The purpose of the plan is to motivate each participant to perform in
an outstanding manner and to encourage teamwork at the executive level. The plan
is based upon exceeding the Company's annual budget. In summary, one ninth of
the amount of the Company's annual net income that exceeds plan net income is
reserved for executive bonuses. The maximum amount an executive may receive
under the plan is limited to 20% of base salary. No amounts were paid to any
executive under this plan in 1998.
In addition, executive officers below the rank of Chief Executive Officer
may also receive incentive compensation based upon achieving certain milestones,
or at the discretion of the Chief Executive Officer, in recognition of their
overall performance.
Haskell E. Boyett, Chairman
Robert D. Cook
Tom D. Whitaker
COMPENSATION OF DIRECTORS.
Directors of Redwood or its subsidiaries who are also employees of the
Company do not receive compensation for their service on such Boards of
Directors. For the twelve months of 1998, non-employee directors of Redwood
received a fee of $1,000 per Board meeting for attendance and participation
based upon 80% annual attendance. Members of Board Committees received $250 per
Committee meeting attended. Non-employee NBR subsidiary directors received
$1,000 per Board meeting for attendance and participation based upon 80% annual
attendance. Additionally, each non-employee director received $250 per
subsidiary Committee meeting attended.
In his position as Chairman Emeritus, Mr. Downey received the current
standard non-employee Director fee for attending Board meetings, but does not
receive a Chairman fee. Mr. Downey receives benefits due him under his
retirement agreement.
In his position as Chairman of Redwood, Mr. Whitaker receives an additional
$500 per month.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Management of the Company knows of no person who owns, beneficially or of
record, either individually or together with associates, more than five percent
of the outstanding shares of Redwood's Common Stock, except as set forth in the
following table. Unless otherwise indicated, the persons listed have sole voting
and investment power over the shares beneficially owned. Such information is
presented as of March 1, 1999.
<TABLE>
<CAPTION>
PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER AMOUNT OWNED OF CLASS
- ----------------------------------------------------------------- ---------------- ---------
<S> <C> <C>
Mr. B. John Barry ............................................... 562,334 shares 16.64%
1128 Red Mountain Road
Aspen, CO 81612
</TABLE>
- ------------------------
(1) Based on information reported by Mr. Barry in a Form 4 filed with the
Securities and Exchange Commission on or about May 7, 1998, reflecting
ownership data as of April 28, 1998.
86
<PAGE>
SECURITIES OWNERSHIP OF MANAGEMENT.
The following table sets forth, as of March 1, 1999, the number and
percentage of shares of Redwood's outstanding Common Stock which are
beneficially owned, directly or indirectly, by (a) each of Redwood's directors
and nominees for director, (b) the Chief Executive Officer of Redwood and each
of the Company's two most highly compensated executive officers other than the
Chief Executive Officer (the "named executive officers"), and (c) Redwood's
directors and the named executive officers as a group. The Company identifies as
its executive officers the Chief Executive Officer, President and Chief
Financial Officer of Redwood, and those key policy-making officers of Redwood's
subsidiaries who have a significant impact on the overall direction or financial
reporting of the Company. The shares "beneficially owned" are determined under
Securities and Exchange Commission Rules, and do not necessarily indicate
ownership for any other purpose. In general, beneficial ownership includes
shares over which the indicated person has sole or shared voting or investment
power and shares which he has the right to acquire within 60 days of March 1,
1999. Unless otherwise indicated, the persons listed have sole voting and
investment power over the shares beneficially owned. Management is not aware of
any arrangements which may, at a subsequent date, result in a change of control
of the Company.
<TABLE>
<CAPTION>
SHARES OF
COMMON STOCK PERCENT OF
HELD OPTIONS (1) TOTAL CLASS
-------------- ----------- --------- -------------
<S> <C> <C> <C> <C>
James E. Beckwith............................................. -- 15,000 15,000 *
Haskell E. Boyett (3)......................................... 37,725 17,650 55,375 1.63
Richard I. Colombini (4)...................................... 33,142 5,621 38,763 1.15
Robert D. Cook................................................ 1,000 3,750 4,750 *
S. Deborah Kaufman............................................ -- -- -- --
Dennis E. Kelley.............................................. 21,953 25,000 46,953 1.38
Patrick W. Kilkenny........................................... 9,001 50,869 59,979 1.75
William B. Stevenson.......................................... 500 7,500 8,000 *
Tom D. Whitaker............................................... 2,206 17,650 19,856 *
Directors, Nominees and Executive Officers as a Group (9 105,527 143,040 248,676 7.06
persons)....................................................
</TABLE>
- ------------------------
* Represents less then one percent of the outstanding shares.
(1) Includes shares acquirable by the exercise of stock options exercisable
within 60 days of March 1, 1999.
(2) The percentage for each individual (and for the group) is calculated by
dividing (i) the number of Redwood shares beneficially owned (including
shares that could be obtained through the exercise of options within 60 days
after March 1, 1999) by (ii) the number of Redwood shares outstanding on
March 1, 1999 plus, in each case, the number of shares which the individual
(or group) could obtain through the exercise of such an option.
(3) Mr. Boyett has shared voting and investment powers as to 10,129 shares.
(4) Mr. Colombini has shared voting and investment powers as to 484 shares.
87
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
(A) TRANSACTIONS WITH MANAGEMENT AND OTHERS.
During the year ended December 31, 1998, 1997, and 1996, the Company's
operating subsidiary, National Bank of the Redwoods, paid $174,577, $496,557,
and $20,909 pursuant to various construction contracts with Colombini
Construction in which Colombini Construction acted as a general contractor.
Richard Colombini, who is a director of the Company, is also the President and
majority owner of Colombini Construction. The amounts paid to Colombini
Construction included subcontractor costs. The construction contracts involved
leasehold improvements for one of the Bank's branches and two operations
centers. Substantially all of the contracts entered into with Colombini
Construction were granted based upon competitive bids.
NBR leases 34,000 square feet of an office building for its main office.
Prior to June 1997, a partnership of which Richard Colombini is a minority
partner, owned the building. Total lease payments made to the partnership for
the years ended December 31, 1997 and 1996 were $440,000, and $863,000.
(B) CERTAIN BUSINESS RELATIONSHIPS.
Except as disclosed elsewhere in this Item, management is not aware of any
business relationships required to be disclosed hereunder.
(C) INDEBTEDNESS OF MANAGEMENT.
Some of the Company's directors and executive officers and their immediate
families, as well as the companies with which they are associated, are customers
of or have had banking transactions with the Company in the ordinary course of
the Company's business, and the Company expects to have banking transactions
with such persons in the future. In management's opinion, all such loans and
commitments to lend were made in the ordinary course of business, in compliance
with applicable laws, on substantially the same terms, including interest rates
and collateral, as those prevailing for comparable transactions with other
persons of similar credit worthiness and, in the opinion of management, did not
involve more than a normal risk of collectibility or present other unfavorable
features. The Company has a strong policy regarding review of the adequacy and
fairness to the Company of loans to its directors and officers. At December 31,
1998, there were no outstanding balances under extensions of credit to directors
and executive officers of the Company and companies with which directors are
associated.
88
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K.
1. The following consolidated financial statements of Redwood and its
subsidiaries, and independent auditors' report included for the years ended
December 31, 1998, 1997 and 1996 are included in Item 8.
<TABLE>
<CAPTION>
<S> <C>
Independent Auditors' Report
Consolidated Financial Statements of Redwood Empire Bancorp
Consolidated Statements of Operations
Consolidated Balance Sheets
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
</TABLE>
2. FINANCIAL STATEMENT SCHEDULES.
All financial statement schedules have been omitted, as inapplicable.
3. EXHIBITS.
The following documents are included or incorporated by reference in this
Annual Report on Form 10-K.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------------- -----------------------------------------------------------------------------------------------------
<C> <S>
2.1 Acquisition and Merger Agreement between National Bank of the Redwoods and Codding Bank, dated June
21, 1994, including Exhibits A and B thereto, filed as Exhibit 2.1 to the Registrant's Current Report
on Form 8-K dated June 21, 1994, and by this reference incorporated herein.
2.2 Amendment No. 1 to Acquisition and Merger Agreement between National Bank of the Redwoods and Codding
Bank, dated September 21, 1994, filed as Exhibit 2.1 to the Registrant's Current Report on Form 8-K
dated September 21, 1994, and by this reference incorporated herein.
3. Amended and restated By-Laws of the Registrant, filed as Exhibit 3 to the Registrant's 1994 Annual
Report on Form 10-K and by this reference incorporated herein.
4.1 Form of Indenture (including form of Notes) between the Registrant and the Bank of New York, as
Trustee, relating to the issuance of 8.50% Subordinated Notes due 2004, filed as Exhibit 4.1 to the
Registrant's Registration Statement on Form S-2 dated December 13, 1993 (Registration No. 33-71324),
and by this reference incorporated herein.
4.2 Certificate of Determination of the Rights, Preferences, Privileges and Restrictions of the
Registrant's 7.80% Noncumulative Convertible Perpetual Preferred Stock, Series A, filed as Exhibit
4.1 to the Registrant's Registration Statement on Form S-2 dated February 16, 1993 (Registration No.
33-56962), and by this reference incorporated herein.
10.1 Employment Agreement between National Bank of the Redwoods and Patrick W. Kilkenny, dated as of
January 1, 1994, filed as Exhibit 10.7 to the Registrant's 1993 Annual Report on Form 10-K and by
this reference incorporated herein.
10.2 Lease, dated August 30, 1988, between National Bank of the Redwoods and 137 Group, a general
partnership, filed as Exhibit 10.1 to the Registrant's 1989 Annual Report on Form 10-K, and by this
reference incorporated herein.
10.3 Lease, dated April 18, 1990, between Allied Savings Bank, F.S.B. and Stony Point West, General
Partnership, filed as Exhibit 10.2 to the Registrant's 1990 Annual Report on Form 10-K, and by this
reference incorporated herein.
</TABLE>
89
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.4 The Registrant's 401 (k) Profit Sharing Plan, filed as Exhibit 28.1 to the Registrant's Registration
Statement on Form S-8 dated June 12, 1990 (Registration No. 33-35377), and by this reference
incorporated herein.
10.5 The National Bank of the Redwoods Stock Option Plan, filed as Exhibit 28.1 to the Registrant's
Post-Effective Amendment No. 1 to Registration Statement on Form S-4 dated March 27, 1989
(Registration No. 33-24642), and by this reference incorporated herein.
10.6 The Registrant's Amended and Restated 1991 Stock Option Plan, filed as Exhibit 4.1 to the
Registrant's Registration Statement on Form S-8 filed on July 8, 1992 (Registration No. 33-49372),
and by this reference incorporated herein.
10.7 The Registrant's Executive Salary Continuation Plan, filed as Exhibit 10.9 to the Registrant's
Registration Statement on Form S-2 dated December 13, 1993 (Registration No. 33-71324), and by this
reference incorporated herein.
10.8 Director Retirement Plan, filed as Exhibit 10.10 to the Registrant's Registration Statement on Form
S-2 dated December 13, 1993 (Registration No. 33-71324), and by this reference incorporated herein.
10.9 Chairman Retirement Agreement, dated November 30, 1993, between the Registrant and John H. Downey,
Jr., filed as Exhibit 10.11 to the Registrant's Registration Statement on Form S-2 dated December 13,
1993 (Registration No. 33-71324), and by this reference incorporated herein.
10.10 Compensation Agreement between Patrick W. Kilkenny and Redwood Empire Bancorp filed as Exhibit 10.20
to the Registrant's 1996 Annual Report on Form 10K.
10.11 Executive Severance Agreement between Patrick W. Kilkenny and Redwood Empire Bancorp filed as Exhibit
10.21 to the Registrant's 1996 Annual Report on Form 10K.
10.12 Salary Continuation Agreement between James E. Beckwith and Redwood Empire Bancorp filed as Exhibit
10.22 to the Registrant's 1996 Annual Report on Form 10K.
10.13 Dividend Reinvestment and Stock Purchase Plan on Form S-3 dated April 28, 1993 (Registration No.
3361750), and by this reference incorporated herein.
11. Statement re Computation of Per Share Earnings.
12.1 Statement re Computation of Ratio of Earnings to Fixed Charges.
12.2 Statement re Computation of Ratio of Earnings to Fixed Charges and Preferred Dividends.
21. Subsidiaries of the Registrant.
23. Consent of Deloitte & Touche LLP.
</TABLE>
(b) REPORTS ON FORM 8-K.
The Company filed the following Current Reports on Form 8-K during the last
quarter of 1998:
October 28, 1998 the Company reports third quarter 1998 financial results
and announces the Board's authorization to repurchase up to 5% of the
Company's outstanding shares of common stock.
November 25, 1998 the Company declares a dividend of 4 cents on the its
common stock.
December 29, 1998 the Company announces the redemption of the Company's
8 1/2% Subordinated Notes Due 2004.
(c) EXHIBITS.
See Item 14(a)3 and the Index to Exhibits.
(d) EXCLUDED FINANCIAL STATEMENTS
Not applicable.
90
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
<TABLE>
<S> <C> <C> <C>
REDWOOD EMPIRE BANCORP
BY: /S/ TOM D. WHITAKER
---------------------------------------- Dated: March 26, 1999
Tom D. Whitaker
CHAIRMAN OF THE BOARD
And By: /s/ PATRICK W. KILKENNY
---------------------------------------- Dated: March 26, 1999
Patrick W. Kilkenny
PRESIDENT AND CHIEF EXECUTIVE OFFICER (PRINCIPAL EXECUTIVE
OFFICER)
And By: /s/ JAMES E. BECKWITH
---------------------------------------- Dated: March 26, 1999
James E. Beckwith
EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING
OFFICER)
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
<TABLE>
<S> <C>
/s/ HASKELL E. BOYETT
- -------------------------------------------- Dated: March 26, 1999
Haskell E. Boyett, DIRECTOR
/s/ RICHARD I. COLOMBINI
- -------------------------------------------- Dated: March 26, 1999
Richard I. Colombini, DIRECTOR
/s/ ROBERT D. COOK
- -------------------------------------------- Dated: March 26, 1999
Robert D. Cook, DIRECTOR
/s/ DENNIS E. KELLEY
- -------------------------------------------- Dated: March 26, 1999
Dennis E. Kelley, DIRECTOR
/s/ PATRICK W. KILKENNY
- -------------------------------------------- Dated: March 26, 1999
Patrick W. Kilkenny, DIRECTOR
/s/ WILLIAM B. STEVENSON
- -------------------------------------------- Dated: March 26, 1999
William B. Stevenson, DIRECTOR
/s/ TOM D. WHITAKER Dated: March 26, 1999
- --------------------------------------------
Tom D. Whitaker, DIRECTOR AND
CHAIRMAN OF THE BOARD
</TABLE>
91
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
11. Statement re Computation of Per Share Earnings.
12.1 Statement re Computation of Ratio of Earnings to Fixed Charges.
12.2 Statement re Computation of Ratio of Earnings to Fixed Charges and Preferred Dividends.
21. Subsidiaries of the Registrant.
23. Consent of Deloitte & Touche LLP.
</TABLE>
92
<PAGE>
EXHIBIT 11
Redwood Empire Bancorp
EARNINGS PER COMMON SHARE
The Company adopted SFAS No. 128, EARNINGS PER SHARE. This statement replaces
previous standards for reporting earnings per share with basic and diluted
earnings per share. All earnings per share information has been restated to
give effect to the new standards. Basic earnings per share excludes dilution
and is computed by dividing income available to common shareholders by the
weighted-average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity.
The following table reconciles the numerator and denominator used in
computing both basic earnings (loss) per share and diluted earnings (loss)
per share for the periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
--------------------------------------------------
(in thousands except per share amounts)
<S> <C> <C> <C>
BASIC EARNINGS (LOSS) PER SHARE:
Net income (loss) $ 5,091 $ 3,441 ($1,486)
Less: Preferred stock dividend 112 449 449
------- ------- -------
Net income (loss) available to common stock shareholders $ 4,979 $ 2,992 ($1,935)
------- ------- -------
------- ------- -------
Weighted average common shares outstanding 3,170 2,776 2,721
------- ------- -------
------- ------- -------
Basic earnings (loss) per share $ 1.57 $ 1.08 ($ 0.71)
------- ------- -------
------- ------- -------
DILUTED EARNINGS (LOSS) PER SHARE:
Net income (loss) available to common stock shareholders $ 4,979 $ 2,992 ($1,935)
Dilutive effect of Preferred Stock dividend 112 449 --
------- ------- -------
$ 5,091 $ 3,441 ($1,935)
------- ------- -------
------- ------- -------
Weighted average common shares outstanding 3,170 2,776 2,721
Effect of outstanding stock options 87 103 --
Effect of Convertible Preferred Stock -- 499 --
------- ------- -------
3,257 3,378 2,721
------- ------- -------
------- ------- -------
Diluted earnings (loss) per share $ 1.47 $ 1.02 ($ 0.71)
------- ------- -------
------- ------- -------
</TABLE>
<PAGE>
Exhibit 12.1
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(in thousands, except ratios)
<TABLE>
<CAPTION>
Year Ended
December
1998
----------
<S> <C>
EXCLUDING INTEREST ON DEPOSITS
Net income $5,091
Taxes 2,102
Fixed charges:
Other interest expense 1,467
----------
Earnings before taxes and fixed charges $8,660
----------
----------
Ratio of earnings to fixed charges 5.90
----------
----------
INCLUDING INTEREST ON DEPOSITS
Fixed charges, per above $1,467
Interest on deposits 12,712
----------
Total fixed charges and interest on deposits $14,179
----------
----------
Earnings before taxes and fixed charges, per above $8,660
Interest on deposits 12,712
----------
Total earnings before taxes, fixed charges and
interest on deposits $21,372
----------
----------
Ratio of earnings to fixed charges 1.51
----------
----------
Surplus $7,193
----------
----------
</TABLE>
The 1998 earnings are adequate to cover fixed charges by the amount noted
above.
<PAGE>
Exhibit 12.2
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
AND PREFERRED STOCK DIVIDEND REQUIREMENT
(in thousands, except ratios)
<TABLE>
<CAPTION>
Year Ended
December
1998
----------
<S> <C>
EXCLUDING INTEREST ON DEPOSITS
Net income $5,091
Taxes 2,102
Other interest expense 1,467
----------
Earnings before taxes and fixed charges $8,660
----------
----------
Fixed charges per above $1,467
Preferred stock dividends 112
----------
Fixed charges including preferred stock dividends $1,579
----------
----------
Ratio of earnings to fixed charges and preferred stock
dividend requirements 5.48
----------
----------
INCLUDING INTEREST ON DEPOSITS
Fixed charges, including preferred stock dividends $1,579
Interest on deposits 12,712
----------
Total fixed charges and interest on deposits $14,291
----------
----------
Earnings before taxes and fixed charges, per above $8,660
Interest on deposits 12,712
----------
Total earnings before taxes, fixed charges and
interest on deposits $21,372
----------
----------
Ratio of earnings to fixed charges 1.50
----------
----------
Surplus $7,081
----------
----------
</TABLE>
The 1998 earnings are adequate to cover fixed charges by the amount noted
above.
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
December 31, 1998
REDWOOD EMPIRE BANCORP (REB)
Santa Rosa, California
a California corporation
|
|
|
|
NATIONAL BANK OF THE REDWOODS (NBR)
Santa Rosa, California
a national bank
Owned 100% by REB
|
|
|
|
----------------------------------------------------------
| | |
| | |
| | |
| | |
VALLEY MORTGAGE CORPORATION REDWOOD EMPIRE DATACORP ALLIED DIVERSIFIED CREDIT
Santa Rosa, California Santa Rosa, California Santa Rosa, California
a California corporation a California corporation a California corporation
Owned 100% by NBR Owned 100% by NBR Owned 100% by NBR
<PAGE>
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
33-49372 on Form S-8, Registration Statement No. 33-24642 on Form S-4 and
Registration Statement No. 33-61750 on Form S-3 of Redwood Empire Bancorp of
our report dated January 26, 1999 (February 22, 1999, as to Note N) appearing
in this Annual Report on Form 10-K of Redwood Empire Bancorp for the year
ended December 31, 1998.
Deloitte & Touche LLP
San Francisco, California
March 26, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERAIONS FOUND IN
THE COMPANY'S FORM 10-K FOR THE YEAR 1998 AND ITS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL INFORMATION.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 15,982
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 26,205
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 63,158
<INVESTMENTS-CARRYING> 29,872
<INVESTMENTS-MARKET> 30,014
<LOANS> 269,316
<ALLOWANCE> 8,041
<TOTAL-ASSETS> 422,299
<DEPOSITS> 364,720
<SHORT-TERM> 1,371
<LIABILITIES-OTHER> 5,568
<LONG-TERM> 12,000
0
0
<COMMON> 25,801
<OTHER-SE> 12,839<F1>
<TOTAL-LIABILITIES-AND-EQUITY> 422,299
<INTEREST-LOAN> 27,685
<INTEREST-INVEST> 4,334
<INTEREST-OTHER> 1,040
<INTEREST-TOTAL> 33,059
<INTEREST-DEPOSIT> 12,712
<INTEREST-EXPENSE> 14,179
<INTEREST-INCOME-NET> 18,880
<LOAN-LOSSES> 2,040
<SECURITIES-GAINS> 225
<EXPENSE-OTHER> 25,313
<INCOME-PRETAX> 7,193
<INCOME-PRE-EXTRAORDINARY> 5,091
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,091
<EPS-PRIMARY> 1.57
<EPS-DILUTED> 1.47
<YIELD-ACTUAL> 4.859
<LOANS-NON> 5,556
<LOANS-PAST> 0
<LOANS-TROUBLED> 1,045
<LOANS-PROBLEM> 3,136
<ALLOWANCE-OPEN> 7,645
<CHARGE-OFFS> 2,000
<RECOVERIES> 356
<ALLOWANCE-CLOSE> 8,041
<ALLOWANCE-DOMESTIC> 2,040
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 644
<FN>
<F1>INCLUDES $239 IN UNREALIZED LOSS ON AFS SECURITIES
</FN>
</TABLE>
