================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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
Incorporation 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. November 1, 2000: 2,858,154
This page is page 1 of 34 pages.
<PAGE>
REDWOOD EMPIRE BANCORP
AND
SUBSIDIARIES
Index
Page
PART I. Financial Information
Item 1. Financial Statements
Consolidated Statements of Operations
Three and Nine Months ended September 30, 2000 and 1999...........3
Consolidated Balance Sheets
September 30, 2000 and December 31, 1999..........................5
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2000 and 1999.....................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 6. Exhibits and Reports on Item 8-K.................................33
SIGNATURES ..................................................................34
This page is page 2 of 34 pages.
<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 Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
----------------------------------- ---------------------------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $7,766 $6,601 $21,964 $19,025
Interest on investment securities 1,213 1,048 3,753 3,011
Interest on federal funds sold 48 37 271 293
----------------------------------- ---------------------------
Total interest income 9,027 7,686 25,988 22,329
Interest expense:
Interest on deposits 3,622 2,623 10,236 7,271
Interest on subordinated notes --- --- --- 142
Interest on other borrowings 128 90 261 297
----------------------------------- ---------------------------
Total interest expense 3,750 2,713 10,497 7,710
----------------------------------- ---------------------------
Net interest income 5,277 4,973 15,491 14,619
Provision for loan losses --- 200 150 700
----------------------------------- ---------------------------
Net interest income after loan loss provision 5,277 4,773 15,341 13,919
Noninterest income:
Service charges on deposit accounts 264 253 792 776
Merchant draft processing, net 1,116 733 3,088 2,375
Loan servicing income 67 14 187 79
Net realized (losses)/gains on sale of
investment securities available for sale (86) --- (124) 14
Other income 137 193 492 653
----------------------------------- --------------------------
Total noninterest income 1,498 1,193 4,435 3,897
Noninterest expense:
Salaries and employee benefits 2,133 2,187 6,375 6,652
Occupancy and equipment expense 498 598 1,508 1,713
Other 1,297 1,415 3,908 3,790
----------------------------------- --------------------------
Total noninterest expense 3,928 4,200 11,791 12,155
----------------------------------- --------------------------
Income from continuing operations before income taxes
and extraordinary item 2,847 1,766 7,985 5,661
Provision for income taxes 1,149 714 3,238 2,187
----------------------------------- --------------------------
Income from continuing operations before extraordinary
item 1,698 1,052 4,747 3,474
Discontinued Operations:
Loss from discontinued operations
(less applicable income taxes of ($356) and ($439)) --- (519) --- (429)
Loss on disposal of discontinued operations,
net of tax of ($113) --- (167) --- (167)
----------------------------------- ---------------------------
Loss from discontinued operations --- (686) --- (596)
----------------------------------- ---------------------------
Income before extraordinary item 1,698 366 4,747 2,878
Extraordinary item --- --- --- (459)
Income tax benefit --- --- --- 183
----------------------------------- ---------------------------
Total extraordinary item, net of tax --- --- --- (276)
----------------------------------- ---------------------------
Net income $1,698 $366 $4,747 $2,602
=================================== ===========================
Total comprehensive income $2,010 $346 $4,968 $2,031
=================================== ===========================
</TABLE>
(Continued)
This page is page 3 of 34 pages.
<PAGE>
<TABLE>
<CAPTION>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
(Continued)
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
------------------------ ------------------------
<S> <C> <C> <C> <C>
Basic earnings per common share:
Income from continuing operations before extraordinary item $0.58 $0.31 $1.52 $1.03
Loss from discontinued operations --- (0.20) --- (0.18)
Income before extraordinary item 0.58 0.11 1.52 0.85
Net income 0.58 0.11 1.52 0.77
Weighted average shares - basic 2,940,000 3,390,000 3,117,000 3,385,000
Diluted earnings per common share and common equivalent share:
Income from continuing operations before extraordinary item $0.56 $0.30 $1.50 $1.00
Loss from discontinued operations --- (0.20) --- (0.17)
Income before extraordinary item 0.56 0.11 1.50 0.83
Net income 0.56 0.11 1.50 0.75
Weighted average shares - diluted 3,009,000 3,458,000 3,173,000 3,472,000
See Notes to Consolidated Financial Statements.
</TABLE>
(Concluded)
This page is page 4 of 34 pages.
<PAGE>
<TABLE>
<CAPTION>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands)
September 30, December 31,
2000 1999
------------------ -------------------
(unaudited)
<S> <C> <C>
Assets:
Cash and due from banks $18,833 $19,058
Federal funds sold and repurchase agreements 97 1,497
------------------ -------------------
Cash and cash equivalents 18,930 20,555
Investment securities:
Held to maturity (fair value of $32,197 and $31,923) 32,910 32,967
Available for sale, at fair value (amortized cost of $39,402 and $44,667) 38,853 43,738
------------------ -------------------
Total investment securities 71,763 76,705
Loans:
Residential real estate mortgage 136,827 130,504
Commercial real estate mortgage 84,903 79,476
Commercial 64,958 61,165
Real estate construction 46,185 40,059
Installment and other 5,701 4,624
Less deferred loan fees (1,138) (1,383)
------------------ -------------------
Total portfolio loans 337,436 314,445
Less allowance for loan losses (8,064) (7,931)
------------------ -------------------
Net loans 329,372 306,514
Premises and equipment, net 2,604 3,045
Mortgage servicing rights, net 27 32
Other real estate owned 925 2,363
Cash surrender value of life insurance 3,305 3,187
Other assets and interest receivable 9,842 10,645
------------------ -------------------
Total assets $436,768 $423,046
================== ===================
Liabilities and Shareholders' equity:
Deposits:
Noninterest bearing demand deposits $81,103 $77,753
Interest-bearing transaction accounts 122,314 124,357
Time deposits $100,000 and over 89,365 69,294
Other time deposits 97,797 98,105
------------------ -------------------
Total deposits 390,579 369,509
Other short-term borrowings 3,844 4,695
Other liabilities and interest payable 8,633 11,398
------------------ -------------------
Total liabilities 403,056 385,602
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: 2,854,654 and 3,228,771 shares 14,551 22,033
Retained earnings 19,479 15,950
Accumulated other comprehensive loss, net (318) (539)
------------------ -------------------
Total shareholders' equity 33,712 37,444
------------------ -------------------
Total liabilities and shareholders' equity $436,768 $423,046
================== ===================
See Notes to Consolidated Financial Statements.
</TABLE>
This page is page 5 of 34 pages.
<PAGE>
<TABLE>
<CAPTION>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Nine Months Ended
September 30,
2000 1999
------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income $4,747 $2,602
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization, net 851 1,183
Net realized loss (gains) on securities available for sale 124 (14)
Loans originated for sale --- (250,853)
Proceeds from sale of loans held for sale --- 258,396
Gain on sale of loans and loan servicing --- (1,307)
Provision for loan losses 150 700
Change in other assets and interest receivable (55) 2,776
Change in other liabilities and interest payable (2,878) 9,807
Other, net --- 215
------------- --------------
Total adjustments (1,808) 20,903
------------- --------------
Net cash provided by operating activities 2,939 23,505
Cash flows from investing activities:
Net change in loans (23,068) (31,846)
Purchases of investment securities available for sale (3,943) (19,698)
Purchases of investment securities held to maturity (874) (6,192)
Proceeds from sales of investment securities available for sale 8,918 ---
Maturities of investment securities available for sale 162 5,987
Maturities or calls of investment securities held to maturity 1,029 3,189
Purchases of premises and equipment, net (410) (225)
Purchase of mortgage servicing rights 71
Proceeds from sale of other real estate owned 2,259 1,888
------------- --------------
Net cash used in investing activities (15,927) (46,826)
Cash flows from financing activities:
Change in noninterest bearing transaction accounts 3,350 (5,343)
Change in interest bearing transaction accounts (2,043) (9,729)
Repaymentof subordinated debt --- (12,000)
Change in time deposits 19,763 18,280
Change in other short-term borrowings (851) 16,414
Issuance/(repurchase) of common stock (7,752) (969)
Dividends paid (1,104) (273)
------------- --------------
Net cash provided by financing activities 11,363 6,380
------------- --------------
Net change in cash and cash equivalents (1,625) (16,941)
Cash and cash equivalents at beginning of period 20,555 42,187
------------- --------------
Cash and cash equivalents at end of period $18,930 $25,246
============= ==============
</TABLE>
(Continued)
This page is page 6 of 34 pages.
<PAGE>
<TABLE>
<CAPTION>
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
(Continued)
Nine Months Ended
September 30,
2000 1999
-------------- -------------
<S> <C> <C>
Supplemental Disclosures:
Cash paid during the period for:
Interest expense $11,514 $8,626
Income taxes 3,279 959
Noncash investing and financing activities:
Transfers from loans to other real estate owned 821 2,303
Dividends declared 440 202
Transfers from mortgage loans held for sale to portfolio loans --- 8,607
See notes to Consolidated Financial Statements.
</TABLE>
(Concluded)
This page is page 7 of 34 pages.
<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", together with Redwood, the
"Company"). 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 nine
months ended September 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 were issued 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 Redwood.
This page is page 8 of 34 pages.
<PAGE>
The Company's pertinent earnings per share data is as follows (in
thousands, except share and per share data):
<TABLE>
<CAPTION>
Three Months Ended
September 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 $1,698 $1,698 $1,052 $1,052
Earnings per share from income from continuing operations
before extraordinary item $0.58 $0.56 $0.31 $0.30
Loss from discontinued operations $--- $--- ($686) ($686)
Loss per share from loss from discontinued operations $0.00 $0.00 ($0.20) ($0.20)
Income before extraordinary item $1,698 $1,698 $366 $366
Earnings per share from income before extraordinary item $0.58 $0.56 $0.11 $0.11
Net income $1,698 $1,698 $366 $366
Net income per share $0.58 $0.56 $0.11 $0.11
Weighted average common shares outstanding 2,940,000 3,009,000 (1) 3,390,000 3,458,000 (1)
</TABLE>
(1)The weighted average common shares outstanding include the dilutive effects
of common stock options of 69 and 68.
<TABLE>
<CAPTION>
Nine Months Ended
September 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 $4,747 $4,747 $3,474 $3,474
Earnings per share from income from continuing operations
before extraordinary item $1.52 $1.50 $1.03 $1.00
Loss from discontinued operations $--- $--- ($596) ($596)
Loss per share from loss from of discontinued operations $--- $--- ($0.18) ($0.17)
Income before extraordinary item $4,747 $4,747 $2,878 $2,878
Earnings per share from income before extraordinary item $1.52 $1.50 $0.85 $0.83
Net income $4,747 $4,747 $2,602 $2,602
Net income per share $1.52 $1.50 $0.77 $0.75
Weighted average common shares outstanding 3,117,000 3,173,000 (1) 3,385,000 3,472,000 (1)
</TABLE>
(1)The weighted average common shares outstanding include the dilutive effects
of common stock options of 56 and 87.
This page is page 9 of 34 pages.
<PAGE>
3. Comprehensive Income
The Company's total comprehensive earnings presentation is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
-------------- -------------- ------------- --------------
(In thousands) (In thousands)
<S> <C> <C> <C> <C>
Net income as reported $1,698 $366 $4,747 $2,602
Other comprehensive income (net of tax):
Change in unrealized holding gain (losses)
on available for sale securities 262 (20) 149 (563)
Reclassification adjustment 50 - 72 (8)
-------------- -------------- ------------- --------------
Total comprehensive income $2,010 $346 $4,968 $2,031
============== ============== ============= ==============
</TABLE>
4. Common Stock Cash Dividend
On August 15, 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 October 16, 2000 to shareholders of record on September 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 $575,000 and $4,319,000 for the three and nine
months ended September 30, 1999. There was no such revenue recognized in 2000.
This page is page 10 of 34 pages.
<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 45,000 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.
This page is page 11 of 34 pages.
<PAGE>
Summary financial data by industry segment follows:
<TABLE>
<CAPTION>
For the quarter ended September 30,
2000
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total interest income $9,027 $ --- $9,027
Total interest expense 3,643 107 3,750
Interest income/(expense) allocation (327) 327 ---
---------------------------------------
Net interest income 5,057 220 5,277
Provision for loan losses --- --- ---
Total other operating income 382 1,116 1,498
Total other operating expense 3,398 530 3,928
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 2,041 806 2,847
Provision for income taxes 823 326 1,149
---------------------------------------
Income from continuing operations before extraordinary item $1,218 $480 $1,698
=======================================
Total Average Assets $412,459 $24,976 $437,435
=======================================
</TABLE>
<TABLE>
<CAPTION>
For the quarter ended September 30,
1999
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total interest income $7,686 $ --- $7,686
Total interest expense 2,713 --- 2,713
Interest income/(expense) allocation (140) 140 ---
---------------------------------------
Net interest income 4,833 140 4,973
Provision for loan losses 200 --- 200
Total other operating income 460 733 1,193
Total other operating expense 3,846 354 4,200
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 1,247 519 1,766
Provision for income taxes 504 210 714
---------------------------------------
Income from continuing operations before extraordinary item $743 $309 $1,052
=======================================
Total Average Assets $399,072 $10,003 $409,075
=======================================
</TABLE>
This page is page 12 of 34 pages.
<PAGE>
<TABLE>
<CAPTION>
For the nine months ended September 30,
2000
----------------------------------------
Community Total
Banking Bankcard Company
----------------------------------------
(in thousands)
<S> <C> <C> <C>
Total interest income $25,988 $ --- $25,988
Total interest expense 10,390 107 10,497
Interest income/(expense) allocation (909) 909 ---
----------------------------------------
Net interest income 14,689 802 15,491
Provision for loan losses 150 --- 150
Total other operating income 1,347 3,088 4,435
Total other operating expense 10,334 1,457 11,791
----------------------------------------
Income from continuing operations before income taxes
and extraordinary item 5,552 2,433 7,985
Provision for income taxes 2,250 988 3,238
----------------------------------------
Income from continuing operations before extraordinary item $3,302 $1,445 $4,747
========================================
Total Average Assets $411,540 $24,996 $436,536
========================================
</TABLE>
<TABLE>
<CAPTION>
For the nine months ended September 30,
1999
----------------------------------------
Community Total
Banking Bankcard Company
----------------------------------------
(in thousands)
<S> <C> <C> <C>
Total interest income $22,329 $ --- $22,329
Total interest expense 7,707 3 7,710
Interest income/(expense) allocation (415) 415 ---
----------------------------------------
Net interest income 14,207 412 14,619
Provision for loan losses 700 --- 700
Total other operating income 1,522 2,375 3,897
Total other operating expense 11,130 1,025 12,155
----------------------------------------
Income from continuing operations before income taxes
and extraordinary item 3,899 1,762 5,661
Provision for income taxes 1,515 672 2,187
----------------------------------------
Income from continuing operations before extraordinary item $2,384 $1,090 $3,474
========================================
Total Average Assets $390,300 $10,127 $400,427
========================================
</TABLE>
This page is page 13 of 34 pages.
<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 A decline 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.
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 September 30, 2000. Significant changes and trends in the
Company's results of operations for the three and nine months ended September
30, 2000, compared to the same period in 1999 are also discussed.
This page is page 14 of 34 pages.
<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 $575,000 and $4,319,000 for the three and nine
months ended September 30, 1999. There was no such revenue recognized for the
three and nine months ended September 30, 2000.
The Company reported income from continuing operations of $1,698,000
($.56 per diluted share) for the three months ended September 30, 2000 and
$1,052,000 ($.30 per diluted share) for the same period in 1999. This equates to
a 61% increase in income from continuing operations. This increase is due to an
increase of $304,000 in net interest income, an increase of $305,000 in
noninterest income, a decrease in the provision for loan losses of $200,000 and
a decrease of $272,000 in noninterest expense. The Company did not recognize any
income or loss associated with its discontinued operations during the three and
nine month period ended September 30, 2000, as compared to a loss of $686,000
(($.20) per diluted share) and $596,000 (($.17 per diluted share) for the same
period in 1999. Net income was $1,698,000 ($.56 per diluted share) for the
quarter ended September 30, 2000 and $366,000 ($.11 per diluted share) for the
same period in 1999. Income from continuing operations for the first nine months
of 2000 increased $1,273,000, or 37%, to $4,747,000 ($1.50 per diluted share)
from $3,474,000 ($1.00 per diluted share) as compared to the same period in
1999. Net income for the nine months ended September 30, 2000 was $4,747,000
($1.50 per diluted share) as compared to $2,602,000 ($.75 per diluted share), an
increase of $2,145,000 or 82%. This increase is due to an increase of $872,000
in net interest income, an increase of $538,000 in noninterest income, a
decrease in the provision for loan losses of $550,000 and a decrease of $364,000
in noninterest expense.
Net Interest Income
Net interest income from continuing operations increased from
$4,973,000 for the third quarter of 1999 to $5,277,000 for the third quarter of
2000, which represents an increase of $304,000 or 6%. While the Company's net
interest margin decreased to 5.15% for the three months ended September 30, 2000
from 5.32% for the three months ended September 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 $35,814,000 or 10% from
$373,806,000 for the quarter ended September 30, 1999 to $409,620,000 for the
quarter ended September 30, 2000.
This page is page 15 of 34 pages.
<PAGE>
Net interest income from continuing operations of $15,491,000 increased
$872,000 or 6% for the nine months ended September 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 $44,926,000 or 12% to $408,197,000 from $363,271,000. The Company's net
interest margin declined to 5.07% for the nine months ended September 30, 2000
from 5.37% for the nine months ended September 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 nine months of 2000, the yield on earning assets from
continuing operations, which excludes mortgage loans held for sale, increased
from 8.20% to 8.50%. This increase is primarily due to an increase in general
interest rates as evidenced by an increase in the prime rate from 8.25% at
September 30, 1999 to 9.5% at September 30, 2000. Yield paid on interest bearing
liabilities increased to 4.53% for the nine months ended September 30, 2000 as
compared to 3.92% for the same period in 1999.
Average earning assets from continuing operations, which excludes
mortgage loans held for sale, increased during the first nine months of 2000 to
$408,197,000 as compared to $363,271,000 for the nine months ended September 30,
1999. The increase in average earning assets of $44,926,000 during the first
nine months of 2000 when compared to 1999 is primarily due to an increase in
average portfolio loans of $36,551,000 and investment securities of $10,293,000,
partially offset by a decrease in federal funds sold of $1,918,000.
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 $262,160,000 during the first nine months of 1999 to
$309,352,000 for the same period in 2000, an increase of $47,192,000 or 18%.
This increase was coupled with a decrease in average noninterest bearing
transaction accounts of $9,021,000. 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
September 30, 2000 September 30, 1999
---------------------------------------- ----------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
---------------------------------------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Earning assets (1) $409,620 $9,027 8.81% $373,806 $7,686 8.22%
Interest-bearing liabilities 312,222 3,750 4.80 270,357 2,713 4.01
------------- --------------
Net interest income $5,277 $4,973
============= ==============
Net interest income to
earning assets 5.15% 5.32%
</TABLE>
This page is page 16 of 34 pages.
<PAGE>
<TABLE>
<CAPTION>
Nine months ended Nine months ended
September 30, 2000 September 30, 1999
---------------------------------------- ----------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
---------------------------------------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Earning assets (1) $408,197 $25,988 8.50% $363,271 $22,329 8.20%
Interest-bearing liabilities 309,352 10,497 4.53 262,160 7,710 3.92
------------- -------------
Net interest income $15,491 $14,619
============= =============
Net interest income to
earning assets 5.07% 5.37%
</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 nine months ended September 30, 2000 and 1999. Changes not solely
attributable to rate or volume have been allocated proportionately to the change
due to volume and the change due to rate.
<TABLE>
<CAPTION>
Three months ended September 30, 2000 compared
to the three months ended September 30, 1999
--------------------------------------------------
Volume Rate Total
--------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Increase (decrease) in interest income:
Portfolio loans $2,804 ($1,639) $1,165
Investment securities 324 (159) 165
Federal funds sold (9) 20 11
--------------------------------------------------
Total increase (decrease) 3,119 (1,778) 1,341
--------------------------------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts (242) 239 (3)
Time deposits 2,840 (1,838) 1,002
Other borrowings 1 37 38
--------------------------------------------------
Total increase (decrease) 2,600 (1,563) 1,037
--------------------------------------------------
Increase (decrease) in net interest income $519 ($215) $304
==================================================
</TABLE>
This page is page 17 of 34 pages.
<PAGE>
<TABLE>
<CAPTION>
Nine months ended September 30, 2000 compared
to the nine months ended September 30, 1999
Volume Rate Total
---------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Increase (decrease) in interest income:
Portfolio loans $3,269 ($330) $2,939
Investment securities 661 81 742
Federal funds sold (105) 83 (22)
---------------------------------------------------
Total increase (decrease) 3,825 (166) 3,659
---------------------------------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts (240) 213 (27)
Time deposits 3,308 (316) 2,992
Other borrowings (312) 134 (178)
---------------------------------------------------
Total increase 2,756 31 2,787
---------------------------------------------------
Increase (decrease) in net interest income $1,069 ($197) $872
===================================================
</TABLE>
Provision for Loan Losses
There was no provision for loan losses for the quarter ended September
30, 2000 as compared to $200,000 in the same quarter in the previous year. For
the nine months ended September 30, 2000 the provision decreased $550,000 from
$700,000 in 1999 to $150,000 in 2000. For further discussion see Allowance for
Loan Losses and Nonperforming Assets.
Noninterest Income and Expense
Noninterest Income
The following tables set forth the components of the Company's
noninterest income from continuing operations for the three and nine months
ended September 30, 2000, as compared to the same period in 1999.
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-------------------------- $ %
2000 1999 Change Change
----------- ----------- -----------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Service charges on deposit accounts $264 $253 $11 4%
Merchant draft processing, net 1,116 733 383 52
Loan servicing income 67 14 53 379
Gain (loss) on sale of securities (86) --- (86) ---
Other income 137 193 (56) (29)
----------- ----------- ------------
Total noninterest income $1,498 $1,193 $305 26%
=========== =========== ============
</TABLE>
This page is page 18 of 34 pages.
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------- $ %
2000 1999 Change Change
----------- ----------- -----------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Service charges on deposit accounts $792 $776 $16 2%
Merchant draft processing, net 3,088 2,375 713 30
Loan servicing income 187 79 108 137
Gain (loss) on sale of securities (124) 14 (138) (986)
Other income 492 653 (161) (25)
----------- ----------- ------------
Total noninterest income $4,435 $3,897 $538 14%
=========== =========== ============
</TABLE>
Noninterest income from continuing operations increased $305,000 or 26%
to $1,498,000 for the third quarter of 2000 when compared to $1,193,000 for the
same period in 1999. Such increase is primarily due to an increase in merchant
card net revenue of $383,000 and an increase in loan servicing income of
$53,000. These increases were partially offset by an increase of $86,000 in loss
on securities and decline of $56,000 in other income.
Noninterest income from continuing operations increased $538,000 or 14%
to $4,435,000 for the nine months ended September 30, 2000 when compared to
$3,897,000 for the same period in 1999. The increase of $538,000 is primarily
attributable to an increase of $713,000 in merchant draft processing income and
an increase of $108,000 in loan servicing income. The increase in noninterest
income from continuing operations of $305,000 and $538,000 for the three and
nine months ended September 30, 2000 as compared to the same periods one year
ago is primarily due to an increase in merchant card net revenue of $383,000 and
$713,000. This revenue growth is a result of an increase in the number of
merchants the Company services.
Noninterest Expense
The following tables set forth the components of the Company's
noninterest expense during the three and nine months ended September 30, 2000,
as compared to the same period in 1999.
<TABLE>
<CAPTION>
Three Months Ended
September 30,
----------------------------- $ %
2000 1999 Change Change
------------- ------------- ----------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Salaries and employee benefits $2,133 $2,187 ($54) (2%)
Occupancy and equipment expense 498 598 (100) (17)
Other 1,297 1,415 (118) (8)
------------- ------------- -----------
Total noninterest expense $3,928 $4,200 ($272) (6%)
============= ============= ===========
</TABLE>
This page is page 19 of 34 pages.
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------- $ %
2000 1999 Change Change
------------- ------------- ----------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Salaries and employee benefits $6,375 $6,652 ($277) (4%)
Occupancy and equipment expense 1,508 1,713 (205) (12)
Other 3,908 3,790 118 3
------------- ------------- -----------
Total noninterest expense $11,791 $12,155 ($364) (3%)
============= ============= ===========
</TABLE>
Noninterest expense from continuing operations decreased by $272,000
or 6% to $3,928,000 during the third quarter of 2000 compared to $4,200,000 for
the third quarter of 1999. For the nine months ended September 30, 2000,
noninterest expense from continuing operations decreased $364,000 from
$11,791,000 to $12,155000. The decrease in noninterest expense for the three and
nine month periods ending September 30, 2000 as compared to the same periods
ending September 30, 1999 is attributable to a decrease in salaries and employee
benefits and occupancy expense. Such decrease is a direct result of the decline
in the number of people employed by the Company as well as a reduction in space
and equipment requirements. At September 30, 2000 the Company had 150 full time
equivalent employees compared to 166 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 40.4% and 40.6% for the three and nine months ended September 30, 2000,
compared to 40.4% and 38.6% 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 45,000 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.
This page is page 20 of 34 pages.
<PAGE>
Summary financial data by industry segment are as follows:
<TABLE>
<CAPTION>
For the quarter ended September 30, 2000
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total interest income $9,027 $ --- $9,027
Total interest expense 3,643 107 3,750
Interest income/(expense) allocation (327) 327 ---
---------------------------------------
Net interest income 5,057 220 5,277
Provision for loan losses --- --- ---
Total other operating income 382 1,116 1,498
Total other operating expense 3,398 530 3,928
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 2,041 806 2,847
Provision for income taxes 823 326 1,149
---------------------------------------
Income from continuing operations before extraordinary item $1,218 $480 $1,698
=======================================
Total Average Assets $412,459 $24,976 $437,435
=======================================
</TABLE>
<TABLE>
<CAPTION>
For the quarter ended September 30, 1999
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
<S> <C> <C> <C>
Total interest income $7,686 $ --- $7,686
Total interest expense 2,713 --- 2,713
Interest income/(expense) allocation (140) 140 ---
---------------------------------------
Net interest income 4,833 140 4,973
Provision for loan losses 200 --- 200
Total other operating income 460 733 1,193
Total other operating expense 3,846 354 4,200
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 1,247 519 1,766
Provision for income taxes 504 210 714
---------------------------------------
Income from continuing operations before extraordinary item $743 $309 $1,052
=======================================
Total Average Assets $399,072 $10,003 $409,075
=======================================
</TABLE>
This page is page 21 of 34 pages.
<PAGE>
<TABLE>
<CAPTION>
For the nine months ended September 30,
2000
----------------------------------------
Community Total
Banking Bankcard Company
----------------------------------------
(in thousands)
<S> <C> <C> <C>
Total interest income $25,988 $ --- $25,988
Total interest expense 10,390 107 10,497
Interest income/(expense) allocation (909) 909 ---
----------------------------------------
Net interest income 14,689 802 15,491
Provision for loan losses 150 --- 150
Total other operating income 1,347 3,088 4,435
Total other operating expense 10,334 1,457 11,791
----------------------------------------
Income from continuing operations before income taxes
and extraordinary item 5,552 2,433 7,985
Provision for income taxes 2,250 988 3,238
----------------------------------------
Income from continuing operations before extraordinary item $3,302 $1,445 $4,747
========================================
Total Average Assets $411,540 $24,996 $436,536
========================================
</TABLE>
<TABLE>
<CAPTION>
For the nine months ended September 30,
1999
----------------------------------------
Community Total
Banking Bankcard Company
----------------------------------------
(in thousands)
<S> <C> <C> <C>
Total interest income $22,329 $ --- $22,329
Total interest expense 7,707 3 7,710
Interest income/(expense) allocation (415) 415 ---
----------------------------------------
Net interest income 14,207 412 14,619
Provision for loan losses 700 --- 700
Total other operating income 1,522 2,375 3,897
Total other operating expense 11,130 1,025 12,155
----------------------------------------
Income from continuing operations before income taxes
and extraordinary item 3,899 1,762 5,661
Provision for income taxes 1,515 672 2,187
----------------------------------------
Income from continuing operations before extraordinary item $2,384 $1,090 $3,474
========================================
Total Average Assets $390,300 $10,127 $400,427
========================================
</TABLE>
This page is page 22 of 34 pages.
<PAGE>
Community Banking
The Community Banking segment's income from continuing operations
before income tax and extraordinary item increased for the quarter and nine
months ended September 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 nine months ended September
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
$334,068,000 in the third quarter of 2000 up from $303,137,000 in the third
quarter of 1999, a 10% increase. Average portfolio loans for the nine months
ended September 30, 2000 was $326,120,000 as compared to $289,569,000 in 1999, a
13% increase.
Bankcard
The Merchant Card segment provides Visa and Mastercard credit card
processing and settlement services for roughly 45,000 merchants located
throughout the United States. Yearly processing volume is in excess of $1.4
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 $1,205,000 or 39% of such revenue for the nine months ended
September 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 nine months ended September 30, 2000,
$360,000 and $1,212,000 of this payment was recognized as revenue compared to
$180,000 and $781,000 for the same periods in 1999. The amount of unearned
processing revenue was $240,000 as of September 30, 2000, which will be
amortized into income in the fourth quarter of 2000.
This page is page 23 of 34 pages.
<PAGE>
The Company was informed in July, 2000 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
fourth quarter 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 an allowance to provide
for losses associated with charge-back losses. Such allowance 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 is included in the financial statements as a reduction in merchant draft
processing income. While charge offs were $296,000 for the three and nine months
ended September 30 2000, the increase in the allowance 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".
The following table summarizes the Company's merchant card allowance
for charge-back losses:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
2000 1999 2000 1999
----------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C>
Beginning allowance $1,145 $693 $908 $458
Provision for losses 417 101 654 336
Charge-offs (296) --- (296) ---
------------------------- -------------------------
Ending allowance $1,266 $794 $1,266 $794
========================= =========================
</TABLE>
Investment Securities
Total investment securities declined to $71,763,000 as of September 30,
2000 compared to $76,705,000 as of December 31, 1999. This decrease was
attributable to Management selling $9,042,000 in low yielding securities, and
the redeployment of the proceeds from such sale into portfolio loans.
This page is page 24 of 34 pages.
<PAGE>
Loans
Total loans increased $22,991,000 or 7% to $337,436,000 at September
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 $6,126,000 to $46,185,000 at September 30,
2000 as compared to $40,059,000 at December 31, 1999. Commercial loans increased
$3,793,000 to $64,958,000 at September 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 $20,014,000 from $884,000 as of December 31, 1999 to
$520,898,000 at September 30, 2000. In addition, commercial real estate has
grown $5,427,000 to $84,903,000 compared to $79,476,000 at December 31, 1999.
The following table summarizes the composition of the loan portfolio at
September 30, 2000 and December 31, 1999.
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------------------------ ------------------------------------
Amount % Amount %
------------------------------------ ------------------------------------
(dollars in thousands) (dollars in thousands)
<S> <C> <C> <C> <C>
Residential real estate mortgage $136,827 40% $130,504 42%
Commercial real estate mortgage 84,903 25 79,476 25
Commercial 64,958 19 61,165 19
Real estate construction 46,185 14 40,059 13
Installment and other 5,701 2 4,624 1
Less deferred loan fees (1,138) 0 (1,383) 0
------------------------------------ ------------------------------------
Total portfolio loans 337,436 100% 314,445 100%
================== ==================
Less allowance for loan losses (8,064) (7,931)
------------------ ------------------
Net loans $329,372 $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.
This page is page 25 of 34 pages.
<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 Nine months ended
September 30, September 30,
--------------------------- ---------------------------
2000 1999 2000 1999
------------ ------------ ------------ -----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Beginning allowance for loan losses $8,099 $8,001 $7,931 $8,041
Provision for loan losses 0 200 150 700
Charge-offs (118) (399) (265) (1,312)
Recoveries 83 161 248 534
------------ ------------ ------------ -----------
Ending allowance for loan losses $8,064 $7,963 $8,064 $7,963
============ ============ ============ ===========
Net charge-offs to average
loans (annualized) 0.04% 0.31% 0.01% 0.36%
</TABLE>
The allowance for loan losses as a percentage of portfolio loans
decreased from 2.52% at December 31, 1999 to 2.39% at September 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 allowance for loan losses methodology, such loans generally receive a
lower loan loss allowance allocation as compared to commercial or construction
loans.
This page is page 26 of 34 pages.
<PAGE>
Nonperforming Assets
The following table summarizes the Company's nonperforming assets.
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
-------------- --------------
(dollars in thousands)
<S> <C> <C>
Nonaccrual loans $1,136 $3,063
Restructured loans 300 1,018
-------------- --------------
Total nonperforming loans 1,436 4,081
Other real estate owned 925 2,363
-------------- --------------
Total nonperforming assets $2,361 $6,444
============== ==============
Nonperforming assets to total assets 0.54% 1.52%
</TABLE>
Nonperforming assets have decreased from $6,444,000 as of December 31,
1999 to $2,361,000 as of September 30, 2000. The decrease is attributable to a
decrease in restructured loans of $718,000, a decrease in nonaccrual loans of
$1,927,000 and a decline in other real estate owned of $1,438,000.
Nonperforming loans as of September 30, 2000 consist of loans to 23
borrowers, 6 of which have balances in excess of $100,000. The two largest loans
have recorded balances of $305,000 and $180,000. Both loans are secured by real
estate. Based on information currently available, management believes that
adequate allocations are included in the allowance for loan losses to cover any
loss exposure that may result from these loans.
Other real estate owned as of September 30, 2000 consists of four
properties. Two properties are residential, one is a commercial buildings and
the remaining is a motel. Based on information currently available, management
believes that no allowance for losses is required as property values mitigate
any loss exposure.
Although the volume of future nonperforming assets will depend in part
on the future economic environment, there are six additional loan relationships
which total approximately $701,000 about which management has serious doubts as
to the ability of the borrower to comply with the present repayment terms. These
loans may become nonperforming assets based on the information presently known
about possible credit problems of the borrowers.
At September 30, 2000, the Company's total recorded investment in
impaired loans (as defined by SFAS 114 and 118) was $1,613,000 of which
$1,313000 relates to the recorded investment for which there is a related
allowance for loan losses of $328,000. The remaining $300,000 did not require a
valuation allowance.
This page is page 27 of 34 pages.
<PAGE>
The average recorded investment in the impaired loans during the nine
months ended September 30, 2000 and 1999 was $1,653,000 and $5,218,000. The
decline in the average recorded investment of impaired loans of $3,565,000 for
the nine months ended September 30, 2000 compared to September 30, 1999 is
primarily a result of the Company's decline in nonperforming loans of
$2,645,000. The related amount of interest income recognized during the periods
that such loans were impaired was $13,000 and $49,000 for the three and nine
month periods ended September 30, 2000 and $65,000 and $217,000 for the three
and nine months ended September 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 nine months of 2000 the Company was required to
repurchase two such loans. The Company maintains an allowance for its estimate
of potential losses associated with the repurchase of previously sold mortgage
loans. Such allowance amounted to $96,000 as of September 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 nine months ended September 30, 2000
the Company made payments of $164,000 to reimburse investors for losses incurred
on the liquidation of collateral supporting a loan sold by the Company to such
investor. Such payment was charged against the allowance. There we no such
payments made during the third quarter ended September 30, 2000.
Liquidity
Redwood's primary source of liquidity is dividends from its financial
institution subsidiary. Redwood's primary uses of liquidity have 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 a level which
management believes to be consistent with the safety and soundness of the
Company as a whole. As of September 30, 2000, Redwood held $2,165,000 in
deposits at NBR.
In the second quarter of 1998, Redwood reinstated a cash dividend to
its common stock holders at a quarterly rate of $.04 per share. In the third
quarter of 1999 Redwood increased this dividend by 50% to $.06 per share. In the
fourth quarter of 1999, the dividend was increased to $.10 per share. Further,
in the second quarter 2000 the 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 redeemed early in the first quarter of 1999. 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.
This page is page 28 of 34 pages.
<PAGE>
During the first nine months of 2000, NBR declared a dividend of
$12,129,000 to Redwood. Management believes that as of September 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 nine months ended
September 30, 2000 the Company received cash of $2,939,000 from operating
activities and $11,363,000 in financing activities while using $15,927,000 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 limited to 1.25% of risk-weighted assets and subordinated debt subject to
certain limitations).
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.
This page is page 29 of 34 pages.
<PAGE>
The following table summarizes the consolidated capital ratios and the
capital ratios of the principal subsidiary at September 30, 2000 and December
31, 1999.
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
----------------------------------------------- -------------------------------------
Well- Minimum Well- Minimum
Actual Capitalized Requirement Actual Capitalized Requirement
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Company
Leverage 7.57% 5.00% 4.00% 8.66% 5.00% 4.00%
Tier 1 risk-based 9.79 6.00 4.00 11.74 6.00 4.00
Total risk-based 11.05 10.00 8.00 13.01 10.00 8.00
NBR
Leverage 7.00% 5.00% 4.00% 8.86% 5.00% 4.00%
Tier 1 risk-based 9.06 6.00 4.00 11.94 6.00 4.00
Total risk-based 10.33 10.00 8.00 13.20 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 636,875 shares at an average cost of $20.04. In the third quarter of
2000, the Company repurchased 158,700 shares at an average cost of $22.25. Under
the repurchase program the Company repurchased shares from time to time on the
open market or through privately negotiated transactions. On September 25, 2000,
the Company announced its Board of Directors did not approve a new share
repurchase authorization. In making its decision the Company's Board of
Directors cited capital retention to support future earning asset growth as its
principal reason to terminate the program.
Certain Important Considerations for Investors
Merchant Credit Card Processing. The Company's profitability can be
negatively impacted should any 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.
This page is page 30 of 34 pages.
<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 June 30, 2000 (the most recent information available
from VISA) the Company's total VISA transactions within these certain high-risk
categories were 10.3% 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 June 30, 2000, (the most recent information
available from VISA) the Company's weekly VISA volume was 31.4% of tangible
equity capital, and aggregate charge-backs for the previous six months were
13.2% 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, VISA will require collateral of one to four times the
short fall amount.
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 September
30, 2000, approximately 79% of the Company's loans were secured by real estate,
of which 32% 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.
This page is page 31 of 34 pages.
<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 or savings and loan
associations, credit unions, mortgage companies, insurance companies, mutual
funds 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.
Recent Accounting Pronouncements. SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended by SFAS No. 138,
requires derivative instruments be carried at fair value on the balance sheet.
The statement continues to allow derivative instruments to be used to hedge
various risks and sets forth specific criteria to be used to determine when
hedge accounting can be used. The statement also provides for offsetting changes
in fair value or cash flows of both the derivative and the hedged asset or
liability to be recognized in earnings in the same period; however, any changes
in fair value or cash flow that represent the ineffective portion of a hedge are
required to be recognized in earnings and cannot be deferred. For derivative
instruments not accounted for as hedges, changes in fair value are required to
be recognized in earnings. The adoption of this statement on January 1, 2001 is
not expected to have a material effect on the consolidated financial statements.
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 September 30, 2000.
This page is page 32 of 34 pages.
<PAGE>
PART II. - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) 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
September 30, 2000.
(b) Reports on Form 8-K
1. Form 8-K filing dated September 29, 2000 announcing the termination of
the appointment of Deloitte & Touche LLP and the engagement of Crowe,
Chizek and Company LLP as the Company's principal accountants.
2. Form 8-K filing dated September 27, 2000 announcing no new share
repurchase authorization and the successful launch of the Company's
internet banking product.
3. Form 8-K filing dated September 5, 2000 announcing completion of the
Company's 10% share repurchase program.
This page is page 33 of 34 pages.
<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.
REDWOOD EMPIRE BANCORP
DATE: 11/8/00 BY: /s/ James E. Beckwith
------- ----------------------------
James E. Beckwith
Executive Vice President,
Chief Operating Officer,
Principal Financial Officer, and
Principal Accounting Officer
This page is page 34 of 34 pages.
