================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Under Section 13 or 15 (d) of the SECURITIES
Exchange Act of 1934
For the quarterly period ended June 30, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 0-19231
REDWOOD EMPIRE BANCORP
(Exact name of Registrant as specified in its charter)
California 68-0166366
(State or other jurisdiction of (IRS Employer
Incorporated or organization) Identification No.)
111 Santa Rosa Avenue, Santa Rosa, California 95404-4905
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (707) 573-4800
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. August 1, 2000: 3,005,715
<PAGE>
REDWOOD EMPIRE BANCORP
AND
SUBSIDIARIES
Index
Page
PART I. Financial Information
Item 1. Financial Statements
Consolidated Statements of Operations
Three and Six Months ended June 30, 2000....................... 3
Consolidated Balance Sheets
June 30, 2000 and December 31, 1999............................ 5
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2000................................. 6
Notes to Consolidated Financial Statements..................... 8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations............... 14
Item 3. Quantitative and Qualitative Disclosure
About Market Risk.............................................. 32
PART II. Other Information
Item 4. Submissions of Matters to a Vote of Security Holders........... 33
Item 6. Exhibits and Reports on Item 8-K............................... 34
SIGNATURES ............................................................... 35
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
----------------------------------- ---------------------------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $7,432 $6,330 $14,198 $12,424
Interest on investment securities 1,290 1,007 2,540 1,963
Interest on federal funds sold 80 78 223 256
----------------------------------- ---------------------------
Total interest income 8,802 7,415 16,961 14,643
Interest expense:
Interest on deposits 3,443 2,578 6,614 4,905
Interest on subordinated notes --- --- --- 142
Interest on other borrowings 84 --- 133 ---
----------------------------------- ---------------------------
Total interest expense 3,527 2,578 6,747 5,047
----------------------------------- ---------------------------
Net interest income 5,275 4,837 10,214 9,596
Provision for loan losses 50 200 150 500
----------------------------------- ---------------------------
Net interest income after loan loss provision 5,225 4,637 10,064 9,096
Noninterest income:
Service charges on deposit accounts 251 268 528 523
Merchant draft processing, net 1,075 863 1,972 1,642
Loan servicing income 80 48 120 64
Net realized (loss)/gain on sale of
investment securities available for sale (37) --- (38) 14
Other income 157 199 355 460
----------------------------------- ---------------------------
Total noninterest income 1,526 1,378 2,937 2,703
Noninterest expense:
Salaries and employee benefits 2,092 2,306 4,242 4,464
Occupancy and equipment expense 509 583 1,010 1,115
Other 1,404 1,262 2,611 2,377
----------------------------------- ---------------------------
Total noninterest expense 4,005 4,151 7,863 7,956
----------------------------------- ---------------------------
Income from continuing operations before income taxes
and extraordinary item 2,746 1,864 5,138 3,843
Provision for income taxes 1,117 684 2,089 1,452
----------------------------------- ---------------------------
Income from continuing operations before extraordinary
item 1,629 1,180 3,049 2,391
Discontinued Operations:
Income from discontinued operations
(less applicable income taxes of $10 and $51) 38 121
----------------------------------- ---------------------------
Income before extraordinary item 1,629 1,218 3,049 2,512
Extraordinary item --- --- --- 459
Income tax benefit --- --- --- (183)
----------------------------------- ---------------------------
Total extraordinary item, net of tax --- --- --- 276
----------------------------------- --------------------------
Net income $1,629 $1,218 $3,049 $2,236
=================================== ===========================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
(Continued)
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
------------------------- -------------------------
<S> <C> <C> <C> <C>
Basic earnings per common share:
Income from continuing operations before extraordinary item $0.52 $0.35 $0.95 $0.71
Income from discontinued operations --- 0.01 --- 0.04
Income before extraordinary item 0.52 0.36 0.95 0.74
Net income 0.52 0.36 0.95 0.66
Weighted average shares - basic 3,157,000 3,395,000 3,205,000 3,383,000
Diluted earnings per common share and common equivalent share:
Income from continuing operations before extraordinary item $0.51 $0.34 $0.94 $0.69
Income from discontinued operations --- 0.01 --- 0.03
Income before extraordinary item 0.51 0.35 0.94 0.72
Net income 0.51 0.35 0.94 0.64
Weighted average shares - diluted 3,213,000 3,503,000 3,239,000 3,483,000
See Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands)
June 30, December 31,
2000 1999
------------------ -------------------
(unaudited)
<S> <C> <C>
Assets:
Cash and due from banks $19,383 $19,058
Federal funds sold and repurchase agreements 1,162 1,497
------------------ -------------------
Cash and cash equivalents 20,545 20,555
Investment securities:
Held to maturity (fair value of $32,212 and $31,923) 33,272 32,967
Available for sale, at fair value (amortized cost of $44,452
and $44,667) 43,365 43,738
------------------ -------------------
Total investment securities 76,637 76,705
Loans:
Residential real estate mortgage 140,312 130,504
Commercial real estate mortgage 83,306 79,476
Commercial 64,116 61,165
Real estate construction 44,257 40,059
Installment and other 4,549 4,624
Less deferred loan fees (1,311) (1,383)
------------------ -------------------
Total portfolio loans 335,229 314,445
Less allowance for loan losses (8,099) (7,931)
------------------ -------------------
Net loans 327,130 306,514
Premises and equipment, net 2,753 3,045
Mortgage servicing rights 28 32
Other real estate owned 1,296 2,363
Cash surrender value of life insurance 3,265 3,187
Other assets and interest receivable 11,043 10,645
------------------ -------------------
Total assets $442,697 $423,046
================== ===================
Liabilities and Shareholders' equity:
Deposits:
Noninterest bearing demand deposits $85,361 $77,753
Interest-bearing transaction accounts 123,004 124,357
Time deposits $100,000 and over 83,791 69,294
Other time deposits 99,878 98,105
------------------ -------------------
Total deposits 392,034 369,509
Other borrowings 5,010 4,695
Other liabilities and interest payable 10,097 11,398
------------------ -------------------
Total liabilities 407,141 385,602
Shareholders' equity:
Preferred stock, no par value; authorized 2,000,000 shares;
none outstanding --- ---
Common stock, no par value; authorized 10,000,000 shares;
issued and outstanding: 3,005,715 and 3,228,771 shares 17,965 22,033
Retained earnings 18,221 15,950
Accumulated other comprehensive loss, net (630) (539)
------------------ -------------------
Total shareholders' equity 35,556 37,444
------------------ -------------------
Total liabilities and shareholders' equity $442,697 $423,046
================== ===================
See Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Six Months Ended
June 30,
2000 1999
------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income $3,049 $2,236
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization, net 650 749
Net realized loss (gains) on securities available for sale 38 (14)
Loans originated for sale --- (192,313)
Proceeds from sale of loans held for sale --- 190,865
Gain on sale of loans and loan servicing --- (1,240)
Provision for loan losses 150 500
Change in other assets and interest receivable (690) 3,073
Change in other liabilities and interest payable (1,415) 8,953
Other, net --- 102
------------- --------------
Total adjustments (1,267) 10,675
------------- --------------
Net cash provided by operating activities 1,782 12,911
------------- --------------
Cash flows from investing activities:
Net change in loans (20,983) (22,411)
Purchases of investment securities available for sale (3,943) (7,016)
Purchases of investment securities held to maturity (840) (6,160)
Proceeds from sales of investment securities available for sale 3,968 ---
Maturities of investment securities available for sale 149 5,000
Maturities or calls of investment securities held to maturity 607 2,774
Premises and equipment, net (358) (516)
Proceeds from sale of other real estate owned 1,737 1,637
------------- --------------
Net cash used in investing activities (19,663) (26,692)
------------- --------------
Cash flows from financing activities:
Change in noninterest bearing transaction accounts 7,608 7,749
Change in interest bearing transaction accounts (1,353) (12,954)
Change in subordinated debt --- (12,000)
Change in time deposits 16,270 7,047
Change in other borrowings 315 12,499
Issuance/(repurchase) of common stock (4,305) 214
Dividends paid (664) (273)
------------- --------------
Net cash provided by financing activities 17,871 2,282
------------- --------------
Net change in cash and cash equivalents (10) (11,499)
Cash and cash equivalents at beginning of period 20,555 42,187
------------- --------------
Cash and cash equivalents at end of period $20,545 $30,688
============= ==============
</TABLE>
(Continued)
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows
(in thousands)
(Continued)
Six Months Ended
June 30,
2000 1999
-------------- --------------
<S> <C> <C>
Supplemental Disclosures:
Cash paid during the period for:
Interest expense 7,864 5,798
Income taxes 2,224 410
Noncash investing and financing activities:
Transfers from loans to other real estate owned 670 2,044
Dividend declared 451 273
Transfers from mortgage loans held for sale to portfolio loans --- 1,547
See notes to Consolidated Financial Statements.
</TABLE>
(Concluded)
<PAGE>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements should be read
in conjunction with the financial statements and related notes contained in
Redwood Empire Bancorp's 1999 Annual Report to Shareholders. The statements
include the accounts of Redwood Empire Bancorp ("Redwood"), and its wholly owned
subsidiary, National Bank of the Redwoods ("NBR"). All significant inter-company
balances and transactions have been eliminated. The financial information
contained in this report reflects all adjustments which, in the opinion of
management, are necessary for a fair presentation of the results of the interim
periods. All such adjustments are of a normal recurring nature. The results of
operations and cash flows for the six months ended June 30, 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000.
In September 1999 the Company successfully completed the divestiture of its
mortgage brokerage and mortgage banking units, Valley Financial and Allied
Diversified Credit. The Company has disclosed the operations of these units as
well as the after tax loss on disposition as discontinued operations.
Accordingly, historical financial information has been recast to present the
operating results of Valley Financial and Allied Diversified Credit as
discontinued operations.
Certain reclassifications were made to prior period financial statements to
conform to current period presentations.
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, federal funds sold and repurchase
agreements with original maturities of 90 days or less. Federal funds sold and
repurchase agreements are generally for one day periods.
2. Earnings per 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.
<PAGE>
The Company's pertinent earnings per share data is as follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended
June 30,
2000 1999
------------------------ ------------------------
Basic Diluted Basic Diluted
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Earnings per common share:
Income from continuing operations before extraordinary item $1,629 $1,629 $1,180 $1,180
Earnings per share from income from continuing operations
before extraordinary item $0.52 $0.51 $0.35 $0.34
Income from discontinued operations, net of tax $--- $--- $38 $38
Earnings per share from income from discontinued operations $0.00 $0.00 $0.01 $0.01
Income before extraordinary item $1,629 $1,629 $1,218 $1,218
Earnings per share before extraordinary item $0.52 $0.51 $0.36 $0.35
Net income $1,629 $1,629 $1,218 $1,218
Net income per share $0.52 $0.51 $0.36 $0.35
Weighted average common shares outstanding 3,157 3,213 (1) 3,395 3,503 (1)
(1) The weighted average common shares outstanding include the dilutive effects of common stock options of 56 and 108.
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended
June 30,
2000 1999
----------------------- -----------------------
Basic Diluted Basic Diluted
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Earnings per common share:
Income from continuing operations before extraordinary item $3,049 $3,049 $2,391 $2,391
Earnings per share from continuing operations before
extraordinary item $0.95 $0.94 $0.71 $0.69
Income/(loss) from discontinued operations $--- $--- $121 $121
Earnings per share from income/(loss) of discontinued
operations $--- $--- $0.04 $0.03
Income before extraordinary item $3,049 $3,049 $2,512 $2,512
Earnings per share before extraordinary item $0.95 $0.94 $0.74 $0.72
Net income $3,049 $3,049 $2,236 $2,236
Net income per share $0.95 $0.94 $0.66 $0.64
Weighted average common shares outstanding 3,205 3,239 (1) 3,383 3,483 (1)
(1) The weighted average common shares outstanding include the dilutive effects of common stock options of 34 and 100.
</TABLE>
<PAGE>
3. Comprehensive Income
The Company's total comprehensive earnings presentation is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
-------------- -------------- ------------- --------------
(In thousands) (In thousands)
<S> <C> <C> <C> <C>
Net income as reported $1,629 $1,218 $3,049 $2,236
Other comprehensive income (net of tax):
Change in unrealized holding gain (losses)
on available for sale securities (361) (543)
39 (68)
Reclassification adjustment
(22) - (23) (8)
-------------- -------------- ------------- --------------
Total comprehensive income $1,646 $857 $2,958 $1,685
============== ============== ============= ==============
</TABLE>
4. Common Stock Dividend
On May 16, 2000 the Board of Directors declared a quarterly cash dividend
of 15 cents per share on the Company's Common Stock. The dividend was paid on
July 17, 2000 to shareholders of record on June 30, 2000.
5. Divestiture of Mortgage Banking and Mortgage Brokerage Units
On September 10, 1999 the Company divested itself of its subprime mortgage
brokerage and mortgage banking units, Allied Diversified Credit and Valley
Financial. The divestiture took the form of an asset sale and employee transfer
to Valley Financial Funding, Inc., whose shareholders include senior management
of Valley Financial and Allied Diversified Credit. As a result of the
divestiture, the Company lost ninety-five employees of which sixty-three were
transferred to Valley Financial Funding, Inc, while thirty-two were terminated
by the Company. As a result of its divestiture the Company recorded an after-tax
loss of $167,000 which is primarily comprised of termination benefits. The
Company has disclosed the operations of these units as well as the after tax
loss on disposition as discontinued operations. Accordingly, historical
financial information regarding changes due to overhead and interest allocation
for all segments has been recast to present the operating results of Valley
Financial and Allied Diversified Credit as discontinued operations. Revenue from
discontinued operations was $1,664,000 and $3,793,000 for the three and six
months ended June 30, 1999. There was no such revenue recognized in 2000.
<PAGE>
6. Extraordinary Item
In the first quarter of 1999 the Company recorded an extraordinary charge
of $276,000, net of tax. Such charge is comprised of the unamortized debt
issuance costs associated with the Company's $12,000,000 subordinated debt,
which was early redeemed in the first quarter of 1999. In the first quarter of
1999 Redwood obtained funding for the early redemption through an $8.0 million
dividend from NBR, the redemption of a $3.0 million note from NBR and $1.0
million from Redwood's general corporate funds.
7. Business Segments
Through September 10, 1999, 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
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 49,000
merchants throughout the United States. The Company's sub prime lending unit,
known as Allied Diversified Credit and the Company's residential mortgage
banking and brokerage arm, known as Valley Financial were divested on September
10, 1999. The divestiture took the form of an asset sale and employee transfer.
The Company has disclosed the operations of these units as well as the after tax
loss on disposition as discontinued operations. Accordingly, historical
financial information regarding segments has been restated to reflect only those
segments associated with continuing operations.
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 including 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.
Information related to the internal allocation of interest expense and
overhead to segments presented in previous periods has been restated to present
such amounts consistent with standards for accounting for discontinued
operations. These standards do not allow the allocation of general corporate
overhead to discontinued operations and generally require that the allocation of
interest to discontinued operations be based on the marginal interest expense
that would not have been incurred were it not for the discontinued operations.
Summary financial data by industry segment follows:
<PAGE>
<TABLE>
<CAPTION> For the quarter ended June 30, 2000
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total Interest Income $8,802 $ --- $8,802
Total Interest Expense 3,527 3,527
---
Interest income/(expense) allocation (287) 287 ---
---------------------------------------
Net Interest Income 4,988 287 5,275
Provision for Loan Losses 50 50
---
Total other Operating Income 451 1,075 1,526
Total other Operating Expense 3,526 479 4,005
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 1,863 883 2,746
Provision for income taxes 757 360 1,117
---------------------------------------
Income from continuing operations before extraordinary item $1,106 $523 $1,629
=======================================
Total Average Assets $416,243 $26,083 $442,326
=======================================
</TABLE>
<TABLE>
<CAPTION>
For the quarter ended June 30, 1999
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total Interest Income $7,415 $ --- $7,415
Total Interest Expense 2,578 2,578
---
Interest income/(expense) allocation (138) 138 ---
---------------------------------------
Net Interest Income 4,699 138 4,837
Provision for Loan Losses 200 200
---
Total other Operating Income 515 863 1,378
Total other Operating Expense 3,804 347 4,151
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 1,210 654 1,864
Provision for income taxes 448 236 684
---------------------------------------
Income from continuing operations before extraordinary $762 $418 $1,180
item
=======================================
Total Average Assets $383,142 $21,660 $404,802
=======================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
For the six months ended June 30, 2000
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total Interest Income $16,961 $ --- $16,961
Total Interest Expense 6,747 --- 6,747
Interest income/(expense) allocation (582) 582 ---
---------------------------------------
Net Interest Income 9,632 582 10,214
Provision for Loan Losses 150 --- 150
Total other Operating Income 965 1,972 2,937
Total other Operating Expense 6,935 928 7,863
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 3,512 1,626 5,138
Provision for income taxes 1,427 662 2,089
---------------------------------------
Income from continuing operations before extraordinary
item $2,085 $964 $3,049
=======================================
Total Average Assets $410,605 $25,007 $435,612
=======================================
</TABLE>
<TABLE>
<CAPTION>
For the six months ended June 30, 1999
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total Interest Income $14,643 $ --- $14,643
Total Interest Expense 5,044 3 5,047
Interest income/(expense) allocation (275) 275 ---
---------------------------------------
Net Interest Income 9,324 272 9,596
Provision for Loan Losses 500 --- 500
Total other Operating Income 1,061 1,642 2,703
Total other Operating Expense 7,286 670 7,956
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 2,599 1,244 3,843
Provision for income taxes 990 462 1,452
---------------------------------------
Income from continuing operations before extraordinary $1,609 $782 $2,391
item
=======================================
Total Average Assets $374,794 $21,019 $395,813
=======================================
</TABLE>
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Information
This Quarterly Report on Form 10-Q includes forward-looking information
which is subject to the "safe harbor" created by the Securities Act of 1933 and
Securities 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:
o Competitive pressure in the banking industry and changes in the
regulatory environment.
o Changes in the interest rate environment and volatility of rate
sensitive loans and deposits.
o The health of the economy declines 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.
o Credit quality deterioration which could cause an increase in the
provision for loan losses.
o Dividend restrictions.
o Regulatory discretion.
o Material losses in the Company's merchant credit card processing
business from card holder fraud or merchant business failure.
o Asset/liability repricing risks and liquidity risks.
o 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 the Company's Annual Report on Form 10-K for the year
ended December 31, 1999 and Certain Important Considerations for Investors.
The following sections discuss significant changes and trends in financial
condition, capital resources and liquidity of the Company from December 31, 1999
to June 30, 2000. Significant changes and trends in the Company's results of
operations for the three and six months ended June 30, 2000, compared to the
same period in 1999 are also discussed.
<PAGE>
Summary of Financial Results
On September 10, 1999 the Company divested itself of its mortgage brokerage
and mortgage banking units, Valley Financial and Allied Diversified Credit. The
divestiture took the form of an asset sale and employee transfer to Valley
Financial Funding, Inc., whose shareholders include senior management of Valley
Financial and Allied Diversified Credit. As a result of the divestiture, the
Company lost ninety-five employees of which sixty-three were transferred to
Valley Financial Funding, Inc, while thirty-two were terminated by the Company.
The Company has disclosed the operations of these units as well as the after tax
loss on disposition as discontinued operations. Accordingly, historical
financial information has been recast to present the operating results of Valley
Financial and Allied Diversified Credit as discontinued operations. Revenue from
discontinued operations was $1,664,000 and $3,793,000 for the three and six
months ended June 30, 1999. There was no such revenue recognized for the three
and six months ended June 30, 2000.
The Company reported income from continuing operations of $1,629,000 ($.51
per diluted share) for the three months ended June 30, 2000 and $1,180,000 ($.34
per diluted share) for the same period in 1999. The Company did not recognize
any income or loss associated with its discontinued operations during the three
and six month period ended June 30, 2000, as compared to income of $38,000 ($.01
per diluted share) and $121,000 ($.03 per diluted share) for the same period in
1999. Net income was $1,629,000 ($.51 per diluted share) for the quarter ended
June 30, 2000 and $1,218,000 ($.35 per diluted share) for the same period in
1999. Net income from continuing operations for the first six months of 2000
increased $658,000, or 28%, to $3,049,000 ($.94 per diluted share) from
$2,391,000 ($.69 per diluted share) as compared to the same period in 1999. Net
income for the six months ended June 30, 2000 was $3,049,000 ($.94 per diluted
share) as compared to $2,236,000 ($.64 per diluted share), an increase of
$813,000 or 36%. This increase is due to an increase of $618,000 in net interest
income, an increase of $234,000 in noninterest income, a decrease in the
provision for loan losses of $350,000 and a decrease of $93,000 in noninterest
expense.
Net Interest Income
Net interest income from continuing operations increased from $4,837,000
during the second quarter of 1999 to $5,275,000 in the second quarter of 2000,
which represents an increase of $438,000 or 9%. While the Company's net interest
margin decreased to 5.09% for the three months ended June 30, 2000 from 5.28%
for the three months ended June 30, 1999, the growth in earning assets more than
made up for the decline in margin resulting in an increase in net interest
income. Average earning assets from continuing operations, which excludes
mortgage loans held for sale, increased $48,092,000 or 13% from $366,164,000 for
the quarter ended June 30, 1999 to $414,256,000 for the quarter ended June 30,
2000.
<PAGE>
Net interest income from continuing operations of $10,214,000 increased
$618,000 or 6% for the six months ended June 30, 2000 when compared to the same
period one year ago. Such increase is due to an increase in average earning
assets from continuing operations, which excludes mortgage loans held for sale,
of $49,526,000 or 14% to $407,482,000 from $357,956,000. The Company's net
interest margin declined to 5.04% for the six months ended June 30, 2000 from
5.36% for the six months ended June 30, 1999. Factors that will affect the
Company's interest margin include the earning asset mix, competitive factors
affecting loan and deposit pricing and retention and the general interest rate
environment.
For the first six months of 2000, the yield on earning assets from
continuing operations, which excludes mortgage loans held for sale, increased
from 8.18% to 8.37%. This increase is primarily due to earning asset growth of
$49,526,000 or 14%, and an increase in general interest rates as evidenced by an
increase in the prime rate from 7.75% at June 30, 1999 to 9.5% at June 30, 2000.
Yield paid on interest bearing liabilities increased to 4.41% for the six months
ended June 30, 2000 as compared to 3.91% for the same period in 1999.
Average earning assets from continuing operations, which excludes mortgage
loans held for sale, increased during the first six months of 2000 to
$407,482,000 as compared to $357,956,000 for the six months ended June 30, 1999.
The increase in average earning assets of $49,526,000 during the first six
months of 2000 when compared to 1999 is primarily due to an increase in average
portfolio loans of $39,398,000 and investment securities of $12,923,000,
partially offset by a decrease in federal funds sold of $2,795,000.
Further contributing to the decrease in the Company's net interest margin
was a change in the Company's funding mix. Total average interest bearing
liabilities increased from $258,031,000 during the first six months of 1999 to
$307,905,000 for the same period in 2000, an increase of $49,874,000 or 19%.
This increase was coupled with a decrease in average noninterest bearing
transaction accounts of $10,682,000. This decrease in noninterest bearing
transaction accounts is a result of a decrease in balances deposited by one of
the Company's large customers.
The following is an analysis of the net interest margin:
<TABLE>
<CAPTION>
Three months ended Three months ended
June 30, 2000 June 30, 1999
---------------------------------------- ----------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield Balance Interest Yield
---------------------------------------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Earning assets (1) $414,256 $8,802 8.50 $366,164 $7,415 8.10
Interest-bearing liabilities 313,379 3,527 4.50 265,309 2,578 3.89
------------- --------------
Net interest income $5,275 $4,837
============= ==============
Net interest income to
earning assets 5.09 5.28
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Six months ended Six months ended
June 30, 2000 June 30, 1999
---------------------------------------- ----------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield Balance Interest Yield
---------------------------------------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Earning assets (1) $407,482 $16,961 8.37 $357,956 $14,643 8.18
Interest-bearing liabilities 307,905 6,747 4.41 258,031 $5,047 3.91
------------- -------------
Net interest income $10,214 $9,596
============= =============
Net interest income to
earning assets 5.04 5.36
</TABLE>
(1) Nonaccrual loans are included in the calculation of the average balance of
earning assets, and interest not accrued is excluded.
The following table sets forth changes in interest income and interest
expense for each major category of interest-earning asset and interest-bearing
liability, and the amount of change attributable to volume and rate changes for
the three and six months ended June 30, 2000 and 1999. Changes not solely
attributable to rate or volume have been allocated to rate.
<TABLE>
<CAPTION>
Three months ended June 30, 2000 compared
to the three months ended June 30, 1999
--------------------------------------------------
Volume Rate Total
--------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Increase (decrease) in interest income:
Portfolio loans $808 $294 $1,102
Investment securities 177 106 283
Federal funds sold (12) 14 2
--------------------------------------------------
Total increase 973 414 1,387
--------------------------------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts (57) 54 (3)
Time deposits 649 219 868
Other borrowings --- 84 84
--------------------------------------------------
Total increase 592 357 949
--------------------------------------------------
Increase in net interest income $381 $57 $438
==================================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Six months ended June 30, 2000 compared
to the six months ended June 30, 1999
Volume Rate Total
---------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Increase (decrease) in interest income:
Portfolio loans $1,731 $43 $1,774
Investment securities 391 186 577
Federal funds sold (68) 35 (33)
---------------------------------------------------
Total increase 2,054 264 2,318
---------------------------------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts (117) 92 (25)
Time deposits 1,439 295 1,734
Other borrowings 84 (93) (9)
---------------------------------------------------
Total increase 1,406 294 1,700
---------------------------------------------------
Increase (decrease) in net interest income $648 ($30) $618
===================================================
</TABLE>
Provision for Loan Losses
The provision for loan losses for the quarter ended June 30, 2000 was
$50,000 as compared to $200,000 in the same quarter in the previous year. For
the six months ended June 30, 2000 the provision decreased $350,000 from
$500,000 in 1999 to $150,000 in 2000. For further discussion see Allowance for
Loan Losses and Nonperforming Loans.
Noninterest Income and Expense and Income Taxes
Noninterest Income
The following tables set forth the components of the Company's noninterest
income from continuing operations for the three and six months ended June 30,
2000, as compared to the same period in 1999.
<TABLE>
<CAPTION>
Three Months Ended
June 30,
--------------------------
$ %
2000 1999 Change Change
----------- ---------- -----------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Service charges on deposit accounts $251 $268 ($17) (6)
Merchant draft processing, net 1,075 863 212 25
Loan servicing income 80 48 32 67
Gain (loss) on sale of securities (37) --- (37) ---
Other income 157 199 (42) (21)
----------- ---------- ------------
Total noninterest income $1,526 $1,378 $148 11
=========== ========== ============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------------
$ %
2000 1999 Change Change
----------- ---------- -----------------------
<S> <C> <C> <C> <C>
Service charges on deposit accounts 528 523 $5 1
Merchant draft processing, net 1,972 1,642 330 20
Loan servicing income 120 64 56 88
Gain (loss) on sale of securities (38) 14 (52) (371)
Other income 355 460 (105) (23)
----------- ---------- ------------
Total noninterest income $2,937 $2,703 $234 9
=========== ========== ============
</TABLE>
Noninterest income from continuing operations increased $148,000 or 11% to
$1,526,000 for the second quarter of 2000 when compared to $1,378,000 for the
same period in 1999. Such increase is primarily due to an increase in merchant
card net revenue of $212,000 and an increase in loan servicing income of
$32,000. These increases were partially offset by a decline of $37,000 in loss
on securities and $42,000 in other income.
Noninterest income from continuing operations increased $234,000 or 9% to
$2,937,000 for the six months ended June 30, 2000 when compared to $2,703,000
for the same period in 1999. The increase of $234,000 is primarily attributable
to an increase of $330,000 in merchant draft processing income and an increase
of $56,000 in loan servicing income.
Noninterest Expense
The following tables set forth the components of the Company's noninterest
expense during the three and six months ended June 30, 2000, as compared to the
same period in 1999.
<TABLE>
<CAPTION>
Three Months Ended
June 30,
-----------------------------
$ %
2000 1999 Change Change
------------- ------------- ----------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Salaries and employee benefits $2,092 $2,306 ($214) (9)
Occupancy and equipment expense 509 583 (74) (13)
Other 1,404 1,262 142 11
------------- ------------- -----------
Total noninterest expense $4,005 $4,151 ($146) (4)
============= ============= ===========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended
June 30, $ %
-----------------------------
2000 1999 Change Change
------------- ------------- ----------------------
<S> <C> <C> <C> <C>
Salaries and employee benefits $4,242 $4,464 ($222) (5)
Occupancy and equipment expense 1,010 1,115 (105) (9)
Other 2,611 2,377 234 10
------------- ------------- -----------
Total noninterest expense $7,863 $7,956 ($93) (1)
============= ============= ===========
</TABLE>
Noninterest expense from continuing operations decreased by $146,000 or 4%
to $4,005,000 during the second quarter of 2000 compared to $4,151,000 for the
second quarter of 1999. For the six months ended June 30, 2000, noninterest
expense from continuing operations decreased $93,000 from $7,956,000 to
$7,863,000. The decrease in noninterest expense for the three and six month
periods ending June 30, 2000 as compared to the same periods ending June 30,
1999 is attributable to a decrease in salaries and employee benefits. Such
decrease is a direct result of the decline in the number of people employed by
the Company. At June 30, 2000 the Company had 150 full time equivalent employees
compared to 179 one year ago.
Income Taxes
The Company's effective tax rate varies with changes in the relative
amounts of its non-taxable income and nondeductible expenses. The effective tax
rate was 40.7 for the three and six months ended June 30, 2000, compared to
36.7% and 37.7% for the same periods in 1999.
Business Segments
Through September 10, 1999, 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 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 49,000 merchants throughout the United States. The
Company's sub prime lending unit, known as Allied Diversified Credit and the
Company's residential mortgage banking and brokerage arm, known as Valley
Financial were divested on September 10, 1999. The divestiture took the form of
an asset sale and employee transfer. The Company has disclosed the operations of
these units as discontinued operations. Accordingly, historical financial
information regarding segments has been restated to reflect only those segments
associated with continuing operations.
<PAGE>
Summary financial data by industry segment as follows:
<TABLE>
<CAPTION>
For the quarter ended June 30, 2000
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total Interest Income $8,802 $ --- $8,802
Total Interest Expense 3,527 --- 3,527
Interest income/(expense) allocation (287) 287 ---
---------------------------------------
Net Interest Income 4,988 287 5,275
Provision for Loan Losses 50 --- 50
Total other Operating Income 451 1,075 1,526
Total other Operating Expense 3,526 479 4,005
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 1,863 883 2,746
Provision for income taxes 757 360 1,117
---------------------------------------
Income from continuing operations before extraordinary $1,106 $523 $1,629
item
=======================================
Total Average Assets $416,243 $26,083 $442,326
=======================================
</TABLE>
<TABLE>
<CAPTION>
For the quarter ended June 30, 1999
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total Interest Income $7,415 $ --- $7,415
Total Interest Expense 2,578 --- 2,578
Interest income/(expense) allocation (138) 138 ---
---------------------------------------
Net Interest Income 4,699 138 4,837
Provision for Loan Losses 200 --- 200
Total other Operating Income 515 863 1,378
Total other Operating Expense 3,804 347 4,151
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 1,210 654 1,864
Provision for income taxes 448 236 684
---------------------------------------
Income from continuing operations before extraordinary
item $762 $418 $1,180
=======================================
Total Average Assets $383,142 $21,660 $404,802
=======================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
For the six months ended June 30, 2000
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total Interest Income $16,961 $ --- $16,961
Total Interest Expense 6,747 --- 6,747
Interest income/(expense) allocation (582) 582 ---
---------------------------------------
Net Interest Income 9,632 582 10,214
Provision for Loan Losses 150 --- 150
Total other Operating Income 965 1,972 2,937
Total other Operating Expense 6,935 928 7,863
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 3,512 1,626 5,138
Provision for income taxes 1,427 662 2,089
---------------------------------------
Income from continuing operations before extraordinary
item $2,085 $964 $3,049
=======================================
Total Average Assets $410,605 $25,007 $435,612
=======================================
</TABLE>
<TABLE>
<CAPTION>
For the six months ended June 30, 1999
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total Interest Income $14,643 $ --- $14,643
Total Interest Expense 5,044 3 5,047
Interest income/(expense) allocation (275) 275 ---
---------------------------------------
Net Interest Income 9,324 272 9,596
Provision for Loan Losses 500 --- 500
Total other Operating Income 1,061 1,642 2,703
Total other Operating Expense 7,286 670 7,956
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 2,599 1,244 3,843
Provision for income taxes 990 462 1,452
---------------------------------------
Income from continuing operations before extraordinary
item $1,609 $782 $2,391
=======================================
Total Average Assets $374,794 $21,019 $395,813
=======================================
</TABLE>
<PAGE>
Community Banking
The Community Banking segment's income from continuing operations before
income tax and extraordinary item increased for the quarter and six months ended
June 30, 2000 when compared to the same periods in 1999. The increase is due to
reduced operating expenses, a lower provision for loan losses and growth in
earning assets. For the quarter and six months ended June 30,2000, segment
expenses declined primarily due to reduced overhead and administrative expenses.
Additionally, the Company increased its loan portfolio through renewed marketing
efforts. Total average portfolio loans were $330,769,000 in the second quarter
of 2000 up from $293,321,000 in the second quarter of 1999, a 13% increase.
Average portfolio loans for the six months ended June 30, 2000 was $334,622,000
as compared to $282,698,000 in 1999, an 18% increase.
Bankcard
The Merchant Card segment provides Visa and Mastercard credit card
processing and settlement services for roughly 49,000 merchants located
throughout the United States. Yearly processing volume is in excess of $1.3
billion. The Company's merchant card services customer base is made up of
merchants located in its primary market area and merchants who have been
acquired by the Company through the use of independent sales organizations, or
ISO's.
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 of 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, $1,412,000 or 45% of such
revenue in 1999 and $840,000 or 43% of such revenue for the six months ended
June 30, 2000. 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 has amortized such payment over the life of the renegotiated
contract into income. During the three and six months ended June 30, 2000,
$360,000 and $852,000 of this payment was recognized as revenue compared to
$191,000 and $601,000 for the same periods in 1999. The amount of unearned
processing revenue was $600,000 as of June 30, 2000, which will be amortized
into income in the third and fourth quarters of 2000.
<PAGE>
The Company was informed in July that the ISO discussed above was
transferring all of its remaining customers processed by the Company to a new
processor. The effective date of this transfer was July 24, 2000. Subsequent to
this transaction date, the Company will continue to process charge-back
transactions originating from merchant card sales activity occurring prior to
the final transfer date through the end of 2000. Under the terms of the
renegotiated contract the Company is to receive a contract completion bonus in
the amount of $500,000. Such bonus is expected to be recorded as revenue in the
second half of 2000. The remaining deferred revenue of $600,000 as of June 30,
2000 associated with the $2,600,000 payment will be recorded as revenue in the
third and fourth quarters of 2000. Since April 1999, in an effort to offset the
anticipated decline in future merchant bankcard processing revenues from the
completion of the contract discussed above, the Company has been building its
overall merchant card processing business through additional direct marketing
efforts and developing new ISO relationships.
The Company bears certain risks associated with its merchant credit card
processing business. Due to a contractual obligation between NBR and Visa and
MasterCard, NBR stands in the place of the merchant in the event that a merchant
is unable to pay charge-backs from cardholders. As a result of this obligation,
NBR may incur losses associated with its merchant credit card processing
business. Accordingly, NBR has established a reserve to provide for losses
associated with charge-back losses. Such reserve, which totaled $1,145,000 and
$694,000 as of June 30, 2000 and 1999, was estimated based upon industry loss
data as a percentage of transaction volume throughout each year, historical
losses incurred by the Company, and management's assumptions regarding merchant
and ISO risk. The provision for charge-back losses, which is included in the
financial statements as a reduction in merchant draft processing income, was
$102,000 and $88,000 for the quarters ended June 30, 2000 and 1999 and $237,000
and $235,000 for the six months ended June 30, 2000 and June 30, 1999,
respectively. While charge offs were minimal, the increase in the reserve
reflects the growth in proprietary merchant account volume, increased exposures
to internet merchants, and a new ISO relationship in which the Company assumes
fraud risk directly rather than looking first to the ISO. For further discussion
see "Certain Important Considerations for Investors".
Investment Securities
Total investment securities remained stable at $76,637,000 as of June 30,
2000 compared to $76,705,000 as of December 31, 1999. The Company's average
federal fund position was $7,685,000 for the first six months of 2000 as
compared to $10,480,000 in 1999.
<PAGE>
Loans
Total loans increased $20,784,000 or 7% to $335,229,000 at June 30, 2000
compared to $314,445,000 at December 31, 1999. The increase in portfolio loans
is primarily attributable to the Company's marketing efforts and a general
expansion of businesses within the Company's market area. Real estate
construction loans have increased $4,198,000 to $44,257,000 at June 30, 2000 as
compared to $40,059,000 at December 31, 1999. Commercial loans increased
$2,951,000 to $64,116,000 at June 30, 2000 as compared to $61,165,000 at
December 31, 1999. Within the residential real estate mortgage portfolio, the
Company has emphasized the funding of multi-family permanent residential real
estate loans in the first six months of 2000. Multi-family permanent residential
real estate loans increased $17,523,000 from $884,000 as of December 31, 1999 to
$18,407,000 at June 30, 2000. In addition, commercial real estate has grown
$3,830,000 to $83,306,000 compared to $79,476,000 at December 31, 1999.
The following table summarizes the composition of the loan portfolio at
June 30, 2000 and December 31, 1999.
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
------------------------------------ ------------------------------------
Amount % Amount %
------------------------------------ ------------------------------------
(dollars in thousands) (dollars in thousands)
<S> <C> <C> <C> <C>
Residential real estate mortgage $140,312 42 $130,504 42
Commercial real estate mortgage 83,306 25 79,476 25
Commercial 64,116 19 61,165 19
Real estate construction 44,257 13 40,059 13
Installment and other 4,549 1 4,624 1
Less deferred loan fees (1,311) 0 (1,383) 0
------------------------------------ ------------------------------------
Total portfolio loans 335,229 100 314,445 100
================== ==================
Less allowance for loan losses (8,099) (7,931)
------------------ ------------------
Net loans $327,130 $306,514
================== ==================
</TABLE>
Allowance for Loan Losses
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.
<PAGE>
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
and other qualitative factors.
The following table summarizes the Company's allowance for loan losses:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------------------------- ----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Beginning allowance for loan losses $7,980 $8,242 $7,931 $8,041
Provision for loan losses 50 200 150 500
Charge-offs (80) (656) (147) (913)
Recoveries 149 215 165 373
------------ ------------ ------------ ------------
Ending allowance for loan losses $8,099 $8,001 $8,099 $8,001
============ ============ ============ ============
Net (recoveries)/charge-offs to average
loans (annualized) (0.08%) 0.60% (0.01%) 0.38%
</TABLE>
The allowance for loan losses as a percentage of portfolio loans decreased
from 2.62% at December 31, 1999 to 2.42% at June 30, 2000. This decrease is due
to several factors which include an improvement in the overall credit quality of
the Company's loan portfolio, reflected in a reduction in loan charge-offs, the
reduction of nonperforming loans and growth in the Company's loan portfolio. The
growth in the Company's loan portfolio is primarily comprised of commercial and
residential real estate loans that generally bear a lower credit risk than
construction or commercial loans. Accordingly, under the Company's loan loss
reserve methodology, such loans generally receive a lower loan loss reserve
allocation as compared to commercial or construction loans.
<PAGE>
Nonperforming Assets
The following table summarizes the Company's nonperforming assets.
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------------- --------------
(dollars in thousands)
<S> <C> <C>
Nonaccrual loans $1,129 $3,063
Accruing loans past due 90 days or more --- ---
Restructured loans 305 1,018
-------------- --------------
Total nonperforming loans 1,434 4,081
Other real estate owned 1,296 2,363
-------------- --------------
Total nonperforming assets $2,730 $6,444
============== ==============
Nonperforming assets to total assets 0.62% 1.52%
</TABLE>
Nonperforming assets have decreased from $6,444,000 as of December 31, 1999
to $2,730,000 as of June 30, 2000. The decrease is attributable to a decrease in
restructured loans of $713,000, a decrease in nonaccrual loans of $1,934,000 and
a decline in other real estate owned of $1,067,000.
Nonperforming loans consist of loans to 24 borrowers, 5 of which have
balances in excess of $100,000. The two largest have recorded balances of
$305,000 and $185,000. Both properties are secured by real estate. Based on
information currently available, management believes that adequate reserves are
included in the allowance for loan losses to cover any loss exposure that may
result from these loans.
Other real estate owned consists of 5 properties. Two properties are
residential, two are commercial buildings and the remaining is a motel. Based on
information currently available, management believes that no reserves are
required as loan to values in this portfolio mitigate any loss exposure.
Although the volume of nonperforming assets will depend in part on the
future economic environment, there are five additional loan relationships which
totals approximately $1,140,000 about which management has serious doubts as to
the ability of the borrower to comply with the present repayment terms. This
loan may become a nonperforming asset based on the information presently known
about possible credit problems of the borrower.
At June 30, 2000, the Company's total recorded investment in impaired loans
(as defined by SFAS 114 and 118) was $1,611,000 of which $1,306,000 relates to
the recorded investment for which there is a related allowance for loan losses
of $412,000. The remaining $305,000 did not require a valuation allowance.
<PAGE>
The average recorded investment in the impaired loans during the six months
ended June 30, 2000 and 1999 was $1,762,000 and $7,660,000. The decline in the
average recorded investment of impaired loans of $5,898,000 at June 30, 2000
compared to June 30, 1999 is a direct result of the Company's decline in
nonperforming loans of $4,903,000. The related amount of interest income
recognized during the periods that such loans were impaired was $12,000 and
$27,000 for the three and six month periods ended June 30, 2000 and $91,000 and
$213,000 for the three and six months ended June 30, 1999.
From time to time the Company may be required to repurchase mortgage loans
from mortgage loan investors depending upon representations and warranties of
the purchase agreement between the investor and the Company. The Company may
also be required to reimburse a mortgage loan investor for losses incurred as a
result of liquidating collateral which had secured a mortgage loan sold by the
Company. Such representations and warranties include valid appraisal, status of
borrower or fraud. In the first six months of 2000 the Company was not required
to repurchase any such loans. The Company maintains a reserve for its estimate
of potential losses associated with the repurchase of previously sold mortgage
loans. Such reserve amounts to $50,000 as of June 30, 2000 and $142,000 as of
December 31, 1999. The Company expects that it may be required to repurchase
loans in the future. During the first quarter a payment of $92,000 was made to
reimburse an investor for a loss incurred on the liquidation of collateral
supporting a loan sold by the Company to such investor. Such payment was charged
against the reserve.
Liquidity
Redwood's primary source of liquidity is dividends from its financial
institution subsidiary. Redwood's primary uses of liquidity has historically
been associated with cash payments made to the subordinated debt holders,
dividend payments made to the preferred stock holders, and operating expenses of
the parent. It is Redwood's general policy to retain liquidity at Redwood at a
level which management believes to be consistent with the safety and soundness
of the Company as a whole. As of June 30, 2000, Redwood held $9,000 in deposits
at NBR.
In 1998, Redwood reinstated a cash dividend to its common stock holders at
a quarterly rate of $.04 per share. In 1999 Redwood increased this dividend 50%
to $.06 per share. In the fourth quarter of 1999, the dividend increased again
to $.10 per share. Further, in May 2000 such dividend was increased to $.15 per
share. Prior to March 1999 Redwood was required to make monthly payments of
interest at 8.5% on $12,000,000 of subordinated debentures issued in 1993. The
subordinated debentures were early redeemed in the first quarter of 1999.
Payment of these obligations 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 NBR became undercapitalized. If
NBR is restricted from paying dividends, Redwood could be unable to pay
dividends to its common shareholders. No assurance can be given as to the
ability of NBR to pay dividends to Redwood.
<PAGE>
During the first six months of 2000, NBR declared a dividend of $3,000,000.
Management believes that as of June 30, 2000, the Company's liquidity position
was adequate for the operations of Redwood and its subsidiary for the
foreseeable future.
Although each entity within the consolidated Company manages its own
liquidity, the Company's consolidated cash flow can be divided into three
distinct areas: operating, investing and financing. For the six months ended
June 30, 2000 the Company received cash of $1,896,000 from operating activities
and $17,757,000 in financing activities while using $19,663,000 in investing
activities.
Capital Resources
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 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 three sets of standards: a "risk-based", "leverage" and
"tangible" capital standard.
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).
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%. The leverage ratio for the Company and NBR is based
on average assets for the quarter.
<PAGE>
The following table summarizes the consolidated capital ratios and the
capital ratios of the principal subsidiaries at June
30, 2000 and December 31, 1999.
<TABLE>
<CAPTION>
Well- Minimum
Actual Capitalized Requirement
-----------------------------------------------
<S> <C> <C> <C>
Company
Leverage 7.97% n/a 4.00%
Tier 1 risk-based 10.42 n/a 4.00
Total risk-based 11.68 n/a 8.00
NBR
Leverage 8.57 5.00 4.00
Tier 1 risk-based 11.22 6.00 4.00
Total risk-based 12.48 10.00 8.00
</TABLE>
Since the fourth quarter of 1998 the Company has been an active acquirer of
its own common stock. Since inception and under three separate Board approved
common stock repurchase authorizations, the Company has repurchased 478,175
shares at an average cost of $19.31. In the second quarter of 2000, the Company
repurchased 270,175 shares at an average cost of $17.64. Under the repurchase
program the Company can repurchase shares from time to time on the open market
or through privately negotiated transactions.
Certain Important Considerations for Investors
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.
<PAGE>
Merchant bankcard processing services are highly regulated by credit card
associations such as VISA. In order to participate in the credit card programs,
the Company must comply with the credit card association's rules and regulations
that may change from time to time. During November 1999, VISA adopted several
rule changes to reduce risks in high-risk merchant bankcard programs and these
rule changes affect the Company's Merchant Bankcard business. The rule changes
go into effect on March 31, 2001. These changes include a requirement that a
processor's reported fraud ratios be no greater than three times the national
average. At December 31, 1999 (the most recent period available from VISA) the
Company's overall fraud ratio was below the VISA requirement. Other VISA changes
include the requirement that total processing volume in certain high-risk
categories (as defined by VISA) be less than 20% of total processing volume. At
December 31, 1999 (the most recent information available from VISA) the
Company's total VISA transactions within these certain high-risk categories were
10.4% of VISA total processing volume. Other changes VISA announced include a
requirement that weekly VISA volumes be less than 60% of an institution's
tangible equity capital, and a requirement that aggregate charge-backs for the
previous six months be less than 5% of the institution's tangible equity
capital. At December 31, 1999, (the most recent information available from VISA)
the Company's weekly VISA volume was 54.4% of tangible equity capital, and
aggregate charge-backs for the previous six months were 11.1% of tangible equity
capital. Merchant bankcard participants, such as the Company, must comply with
these new VISA rules by filing a compliance plan with VISA. Such plan has been
filed by the Company and accepted by VISA. At this time the Company believes
that it will be in compliance with all rule changes when they go into effect on
March 31, 2001. Should the Company be unable to comply with these rule changes,
the Company would seek a waiver from VISA. However, should VISA not grant the
Company a waiver, the Company would need to restructure the merchant bankcard
unit, which could adversely affect merchant bankcard revenue.
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 June 30, 2000,
approximately 80% of the Company's loans were secured by real estate, of which
31% 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.
<PAGE>
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 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 3. Quantitative and Qualitative Disclosure about Market Risk
There were no significant changes to the Company's market risk from
December 31, 1999 to June 30, 2000.
<PAGE>
PART II. - OTHER INFORMATION
Item 4. Submission of Matters to a vote of Security Holders
(a) The Company held its Annual Meeting of Shareholders on May 16, 2000.
(b) Proxies for the Annual Meeting were solicited pursuant to Regulation
14 under the Securities Exchange Act of 1934. There was no
solicitation in opposition to management's nominees for directors as
listed in the Company's proxy statement for the Annual Meeting. Tom D.
Whitaker resigned his directorship on May 15, 2000 and withdrew
acceptance of his nomination.
(c) The vote for the nominated directors was as follows:
Nominee For Withheld
Richard I. Colombini 2,687,082 309,106
Robert D. Cook 2,688,198 307,990
Margie L. Handley 2,686,935 309,253
Dana R. Johnson 2,685,412 310,776
Patrick W. Kilkenny 2,678,898 317,290
Patricia "Padi" Selwyn 2,687,198 308,990
Gregory J. Smith 2,685,265 310,923
William B. Stevenson 2,685,265 310,923
The vote for ratifying the appointment of Deloitte & Touche LLP as the
Company's independent auditors was as follows:
For 2,684,899
Against 5,159
Abstain 306,129
Broker Non-Vote -0-
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
1. Exhibits.
The following documents are included or incorporated by reference in Form
10-Q.
Exhibit Number Description
------------------- ---------------
27. Financial Data Schedule for the period
ended June 30, 2000.
2. Reports on Form 8-K
1. Form 8-K filing dated May 25, 2000 announcing quarterly cash dividend
increase to 15 cents on common stock, completion of Redwood's 5% share
repurchase announced on November 22, 1999 and authorization for the
repurchase of an additional 10% of the Company's total shares
outstanding or 316,000 shares, and announcement of changes in Holding
Company and Subsidiary Chairmanships.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized and in the capacity indicated.
REDWOOD EMPIRE BANCORP
(Registrant)
DATE: 8/11/00 BY: /s/ James E. Beckwith
James E. Beckwith
Executive Vice President,
Chief Operating Officer,
Principal Financial Officer, and
Principal Accounting Officer
