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 September 30, 1998
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: 0-11771
SJNB FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
California 77-0058227
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE NORTH MARKET STREET, SAN JOSE, CALIFORNIA 95113
(Address of principal executive offices)
(Zip Code)
(408) 947-7562
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed, since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 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: 2,460,771 shares of common
stock outstanding as of November 3, 1998.
PART I - FINANCIAL INFORMATION
- - ------------------------------
Page
Item 1. - FINANCIAL STATEMENTS
- - ------
SJNB FINANCIAL CORP. AND SUBSIDIARY
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Shareholders' Equity 5
Condensed Consolidated Statements of Cash Flows 6
Notes to Unaudited Condensed Consolidated Financial Statements 8
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- - ------
CONDITION AND RESULTS OF OPERATIONS 9
Item 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
- - ------
MARKET RISK 27
PART II - OTHER INFORMATION
- - ---------------------------
Item 1. LEGAL PROCEEDINGS
- - ------ 29
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 29
- - ------
Item 3. DEFAULTS UPON SENIOR SECURITIES 29
- - ------
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 29
- - ------
Item 5. OTHER INFORMATION 29
- - ------
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 29
- - ------
SIGNATURES 32
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
SJNB FINANCIAL CORP. AND SUBSIDIARY
Condensed Consolidated Balance Sheets
(in thousands)
(Unaudited)
September 30, December 31,
Assets 1998 1997
- - ----------------------------------------------------------------------------------------------------------------------------
Cash and due from banks $19,552 $22,825
Money market investments 8,796 2,700
Investment securities:
Available for sale 46,863 48,305
Held to maturity (Fair value: $11,687 at September 30, 1998
and $13,843 at December 31, 1997) 11,492 13,737
- - ----------------------------------------------------------------------------------------------------------------------------
Total investment securities 58,355 62,042
- - ----------------------------------------------------------------------------------------------------------------------------
Loans 246,653 228,972
Allowance for possible loan losses (4,702) (4,493)
- - ----------------------------------------------------------------------------------------------------------------------------
Loans, net 241,951 224,479
- - ----------------------------------------------------------------------------------------------------------------------------
Premises and equipment, net 3,864 3,916
Accrued interest receivable and other assets 6,247 5,202
Intangibles, net of accumulated amortization of $2,044 at
September 30, 1998 and $1,707 at December 31, 1997 4,188 3,755
- - ----------------------------------------------------------------------------------------------------------------------------
Total $342,953 $324,919
============================================================================================================================
Liabilities and Shareholders' Equity
- - ----------------------------------------------------------------------------------------------------------------------------
Deposits:
Noninterest-bearing $78,042 $78,437
Interest-bearing 224,121 191,908
- - ----------------------------------------------------------------------------------------------------------------------------
Total deposits 302,163 270,345
- - ----------------------------------------------------------------------------------------------------------------------------
Other short-term borrowings ---- 16,000
Accrued interest payable and other liabilities 6,238 5,415
- - ----------------------------------------------------------------------------------------------------------------------------
Total liabilities 308,401 291,760
- - ----------------------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock, no par value; authorized, 20,000 shares; issued and outstanding,
2,460 shares at September 30, 1998
and 2,493 shares at December 31, 1997 16,688 18,800
Retained earnings 17,450 14,254
Accumulated other comprehensive income 414 105
- - ----------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 34,552 33,159
- - ----------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies ---- ----
- - ----------------------------------------------------------------------------------------------------------------------------
Total $342,953 $324,919
============================================================================================================================
<FN>
See accompanying Notes to Unaudited Consolidated Financial Statements.
</FN>
SJNB FINANCIAL CORP. AND SUBSIDIARY
Condensed Consolidated Statement of Operations
(in thousands, except per share amounts)
(Unaudited)
Quarter ended Nine months ended
September 30, September 30,
----------------------------------------------------------
1998 1997 1998 1997
- - ----------------------------------------------------------------------------------------------------------------------------
Interest income:
Interest and fees on loans $6,249 $5,776 $18,404 $16,571
Interest on money market investments 428 82 823 475
Interest and dividends on investment securities available for 658 758 2,172 2,233
sale
Interest on investment securities held to maturity 171 232 551 720
Other interest and investment income (2) (2) (7) (7)
- - ----------------------------------------------------------------------------------------------------------------------------
Total interest income 7,504 6,846 21,943 19,992
- - ----------------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest expense on interest-bearing deposits:
Certificates of deposit over $100 863 759 2,364 2,231
Other 1,522 1,412 4,475 4,243
- - ----------------------------------------------------------------------------------------------------------------------------
Total interest expense 2,385 2,171 6,839 6,474
- - ----------------------------------------------------------------------------------------------------------------------------
Net interest income 5,119 4,675 15,104 13,518
- - ----------------------------------------------------------------------------------------------------------------------------
Provision for possible loan losses 150 215 150 395
- - ----------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for
possible loan losses 4,969 4,460 14,954 13,123
- - ----------------------------------------------------------------------------------------------------------------------------
Other income:
Service charges on deposits 149 156 461 437
Other operating income 101 91 324 340
Net loss on securities available for sale ---- ---- (8) (41)
- - ----------------------------------------------------------------------------------------------------------------------------
Total other income 250 247 777 736
- - ----------------------------------------------------------------------------------------------------------------------------
Other expenses:
Salaries and benefits 1,679 1,438 5,009 4,337
Occupancy 215 194 564 519
Other 1,040 831 2,871 2,520
- - ----------------------------------------------------------------------------------------------------------------------------
Total other expenses 2,934 2,463 8,444 7,376
- - ----------------------------------------------------------------------------------------------------------------------------
Income before income taxes 2,285 2,244 7,287 6,483
Income taxes 960 948 3,046 2,740
- - ----------------------------------------------------------------------------------------------------------------------------
Net income $1,325 $1,296 $4,241 $3,743
============================================================================================================================
Net income per share - basic $0.54 $0.52 $1.70 $1.49
============================================================================================================================
Net income per share - diluted $0.51 $0.50 $1.61 $1.42
============================================================================================================================
<FN>
See accompanying Notes to Unaudited Consolidated Financial Statements.
</FN>
SJNB FINANCIAL CORP. AND SUBSIDIARY
Condensed Consolidated Statements of Shareholders' Equity
(in thousands)
(Unaudited)
Net
Unrealized
Gain (Loss)
on Total
Securities Share-
Common Retained Available holders'
Nine months ended September 30, 1997 Shares Stock Earnings for Sale Equity
- - ----------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 1996 2,571 $20,880 $10,263 $62 $31,205
--------------
Net income 3,743 3,743
Other comprehensive income - Unrealized loss
on securities held for sale, net 22 22
--------------
Comprehensive income 3,765
--------------
Common stock repurchased (102) (2,496) (2,496)
Stock options exercised 19 129 129
Cash dividends (527) (527)
- - ----------------------------------------------------------------------------------------------------------------------------
Balances, September 30, 1997 2,488 $18,513 $13,479 $84 $32,076
============================================================================================================================
Nine months ended September 30, 1998
- - ----------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 1997 2,493 $18,800 $14,254 $105 $33,159
--------------
Net income 4,241 4,241
Other comprehensive income - Unrealized gains
on securities held for sale, net 309 309
--------------
Comprehensive income 4,550
--------------
Common stock repurchased (77) (3,119) (3,119)
Issuance of common stock for purchase of Epic Funding, Corp. 12 501
Stock options exercised 32 506 506
Cash dividends (1,045) (1,045)
- - ----------------------------------------------------------------------------------------------------------------------------
Balances, September 30, 1998 2,460 $16,688 $17,450 $414 $34,051
============================================================================================================================
<FN>
See accompanying Notes to Unaudited Consolidated Financial Statements.
</FN>
SJNB FINANCIAL CORP. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
(dollars in thousands)
(Unaudited)
Nine months ended
September 30,
-------------------------------------------
1998 1997
- - ----------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $4,241 $3,743
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for possible loan losses 150 395
Depreciation and amortization 417 394
Amortization on intangibles 337 355
Net loss on securities available for sale 8 41
Net gain on sale of other real estate owned ---- (37)
Amortization of premium on investment securities, net (49) (32)
Increase in deferred tax benefit ---- (1,535)
Increase in intangibles assets (91) ----
Increase in accrued interest receivable and other assets (947) (444)
Increase in accrued interest payable and other liabilities 386 1,858
- - ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 4,452 4,738
- - ----------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sale of securities available for sale 21,009 10,057
Maturities of securities held to maturity 3,991 1,250
Purchase of securities available for sale (19,008) (10,699)
Purchase of securities held to maturity (1,749) (753)
Proceeds from the sale of other real estae owned ---- 491
Loans, net (17,473) (24,186)
Capital expenditures (354) (505)
Cash used to acquire Epic Funding, Corp. (206) ----
- - ----------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (13,790) (24,345)
- - ----------------------------------------------------------------------------------------------------------------------------
Cash flow from financing activities:
Deposits, net 31,819 25,145
Other short-term borrowings (16,000) (17,688)
Cash dividends (1,045) (526)
Stock buyback (3,119) (2,496)
Proceeds from stock options exercised 506 129
- - ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 12,161 4,564
- - ----------------------------------------------------------------------------------------------------------------------------
Net increase in cash and equivalents 2,823 (15,043)
Cash and equivalents at beginning of year 25,525 40,008
- - ----------------------------------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $28,348 $24,965
============================================================================================================================
Other cash flow information:
Interest paid $7,058 $6,336
===========================================
Income taxes paid $2,625 $2,365
============================================================================================================================
Noncash transactions:
Unrealized gain (loss) on securities available for sale, net of tax $309 $22
============================================================================================================================
Purchase of Epic Funding Corp.:
Leases $149 ----
Other assets 789 ----
- - ----------------------------------------------------------------------------------------------------------------------------
Total assets acquired 938 ----
Cash paid and expenses incurred (206) ----
Liabilities assumed:
Other liabilities 231 ----
- - ----------------------------------------------------------------------------------------------------------------------------
Total liabilities assumed 231 ----
- - ----------------------------------------------------------------------------------------------------------------------------
Common stock issued, net of registration costs $501 ----
============================================================================================================================
<FN>
See accompanying Notes to Unaudited Consolidated Financial Statements.
</FN>
SJNB FINANCIAL CORP. AND SUBSIDIARY
Notes to Unaudited Condensed Consolidated Financial Statements
Note A Unaudited Condensed Consolidated Financial Statements
The unaudited consolidated financial statements of SJNB Financial
Corp. (the "Company") and its subsidiary, San Jose National Bank and
its subsidiary Epic Funding Corp.(which was acquired on May 22,
1998), are prepared in accordance with generally accepted accounting
principles for interim financial information and the instructions to
Form 10-Q. In the opinion of management, all adjustments necessary
for a fair presentation of the financial position, results of
operations and cash flows for the periods have been included and are
normal and recurring. The results of operations and cash flows are
not necessarily indicative of those expected for the full fiscal
year.
Certain information and footnote disclosures normally included in
consolidated financial statements prepared in accordance with
generally accepted accounting principles have been condensed or
omitted. These condensed consolidated financial statements should be
read in conjunction with the consolidated financial statements and
notes thereto included in the Company's Annual Report to Shareholders
for the year ended December 31, 1997.
Note B Net Income Per Share of Common Stock
The reconciliation of the numerators and denominators of the basic
and diluted earnings per share (EPS) computations are as follows (in
thousands, except per share amounts):
Quarter ended Quarter ended
September 30, 1998 September 30, 1997
-------------------------------------------------------------------------------------------------------------------
Net Per Share Net Per Share
Income Shares Amounts Income Shares Amounts
----------------------------------------------------------------------------------------------------------------
Net income and basic EPS $1,325 2,466 $0.54 $1,296 2,487 $0.52
============ ===========
Effect of stock option dilutive shares 139 129
------------------------- -------------------------
Diluted earnings per share $1,325 2,605 $0.51 $1,296 2,616 $0.50
=========================================================================
Nine months ended Nine months ended
September 30, 1998 September 30, 1997
----------------------------------------------------------------------------------------------------------------
Net Per Share Net Per Share
Income Shares Amounts Income Shares Amounts
----------------------------------------------------------------------------------------------------------------
Net income and basic EPS $4,241 2,492 $1.70 $3,743 2,513 $1.49
============ ===========
Effect of stock option dilutive shares 147 118
------------------------- ------------------------
Diluted earnings per share $4,241 2,639 $1.61 $3,743 2,631 $1.42
=========================================================================
Note C Other Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information. The Statement establishes standards for the way public
business enterprises are to report information about operating
segments in annual financial statements and requires those
enterprises to report selected information about operating segments
in interim financial reports issued to shareholders. The Statement is
effective for fiscal years ending after December 31, 1998; the
Company is still evaluating the Statement's impact upon adoption.
In February 1998, the FASB issued SFAS No.132, Employers' Disclosures
about Pensions and Other Postretirement Benefits. SFAS No. 132
changes disclosure only on applicable defined benefit pension or
postretirement plans, of which the Company has none. The Company does
not believe SFAS No. 132 will have any impact on its consolidated
financial statements.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This Statement requires that an
entity recognize all derivatives as either assets or liabilities in
the statement of financial position and measure those instruments at
fair value. The Statement is effective for fiscal quarters of fiscal
years beginning after June 15, 1999. The Company expects to adopt
this Statement on January 1, 2000. The Company will begin evaluating
the impact of its adoption on the Company's consolidated financial
statements. Currently, management believes the Statement would not
have a significant effect on the Company's consolidated financial
position or its consolidated statement of operations.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SJNB Financial Corp. (the "Company") is the holding company for San Jose
National Bank and subsidiary ("SJNB" and the "Bank"), San Jose, California. This
discussion focuses primarily on the results of operations of the Company on a
consolidated basis for the three and nine months ended September 30, 1998 and
1997 and the liquidity and financial condition of the Company and SJNB as of
September 30, 1998 and December 31, 1997.
All dollar amounts in the text in Item 2 are in thousands, except per share
amounts or as otherwise indicated.
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 Exchange Act of 1934. These forward-looking statements (which involve
the Company's plans, beliefs and goals, refer to estimates or use similar terms)
involve certain risks and uncertainties that could cause actual results to
differ materially from those in the forward-looking statements. Such risks and
uncertainties include, but are not limited to, the following factors:
competitive pressure in the banking industry; changes in the interest rate
environment; the health of the economy declines, either nationally or
regionally; credit quality deteriorates, which could cause an increase in the
provision for possible loan losses; changes in the regulatory environment;
changes in business conditions, particularly in Santa Clara County and high tech
industries; certain operational risks involving data processing systems or
fraud; volatility of rate sensitive deposits; asset/liability matching risks and
liquidity risks; risks associated with the Year 2000 which could cause
disruptions in the Company's operations; and 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, 1997.
Current Developments
During the second quarter of 1998, the Company announced that the Board of
Directors approved the repurchase of up to $3.5 million of the Company's common
stock. Through September 30, 1998, the Company had repurchased 77,300 shares for
a total of $3.1 million.
Year 2000 Project
The Company's business is dependent on technology and data processing. As a
result, it has created a Year 2000 team whose members are familiar with the
Company's business and operations. The "Year 2000 issue" relates to the fact
that many computer programs and other technology utilizing microprocessors only
use two digits to represent a year, such as "98" to represent "1998," which
means that in the year 2000 such programs/processors could incorrectly treat the
year 2000 as the year 1900. This issue has grown in importance as the use of
computers and microprocessors has become more pervasive throughout the economy,
and interdependencies between systems has multiplied. The issue must be
recognized as a business problem, rather than simply a computer problem, because
of the way its effects could ripple through the economy. The Company could be
affected either directly or indirectly by the Year 2000 issue. This could happen
if any of its critical computer systems or equipment containing embedded logic
fail, if the local infrastructure (electric power, communications, or water
system) fails, if its significant vendors are adversely impacted, or if its
borrowers or depositors are significantly impacted by their internal systems or
their customers or suppliers.
The Company does not rely on its own data processing software for its
mission-critical applications needs. Rather, it uses outside vendors to license
software and/or data processing services for its critical applications such as
data and item processing and customer statements. The Company also is dependent
on an IBM AS 400 computer and OS 400 operating system, as well as personal
computers connected on a local area network. The foregoing systems are
classified by the Company as mission critical information technology ("IT")
systems.
The Company's business also involves non-IT products and services, some of which
have embedded technology which might not be Year 2000 ready. Some non-IT
products and services involve various infrastructure issues such as power,
communications and water, as well as elevators, ventilation and air conditioning
equipment. The Company classifies power and communications as non-IT
mission-critical systems.
The Company's application software, data processing vendors, computer operating
systems, local area network and the power and communication infrastructure
provide critical support to substantially all of its business and operations.
Failure to successfully complete renovation, validation and implementation of
its mission critical IT systems could have a material adverse effect on the
operations and financial performance of the Company. Moreover, Year 2000
problems experienced by significant vendors or customers of the Company could
negatively impact the business and operations of the Company even if its own
critical IT systems function satisfactorily. Due to the numerous issues and
problems which might arise and the lack of information on Year 2000 readiness
from non-IT service providers such as power and communication systems vendors,
the Company cannot quantify the potential cost of problems if the Company's
renovation and implementation efforts or the efforts of significant vendors or
customers are not successful.
State of Readiness
The Company has conducted a comprehensive review of its IT systems to identify
systems that present Year 2000 issues. The Company has developed a plan which it
believes should satisfactorily resolve Year 2000 problems related to its
mission-critical IT systems. The Company's Y2K team is also using external
resources provided by its outside vendors and a consultant hired to assist the
Company. Management anticipates that initial renovation and validation (testing)
of its critical IT systems should be completed by December 31, 1998.
The Company converted to a new core processing system (which handles accounting
for loans, deposit accounts and general ledger) in November 1997. The Conversion
to this system was not based on Year 2000 issues, however, the vendor of this
system represented to the Company that the system was Y2K compliant. Vendors of
the Company's other critical IT systems have also informed the Company that
their products/systems are Y2K compliant. If initial testing for critical IT
systems are not satisfactory the Company plans to take corrective action and
complete secondary testing by June 30, 1999.
The Company ran tests on its core processing system at a remote disaster
recovery site during October 1998 with technical assistance from the vendor and
an outside consultant. Actual data from a prior period was used to conduct
future date tests. The Company had not completed an assessment of the test
results as of the date of this Report. The Company is also monitoring the Y2K
readiness of its outside item processing and operating system vendors. At the
date of this report the Company believes it remains on schedule to complete
initial testing of all mission-critical IT applications systems by December 31,
1998.
By September 30, 1998 the Company had also tested 57% of its critical network
applications and 36% of its non-critical network applications. The Company's
target for completion of non-critical IT application testing is March 31, 1999.
The Company cannot test for Y2K readiness of its power and telecommunication
vendors, although the Company is monitoring their readiness. Additionally, at
the date of this report the Company had not identified any serious problems with
any of its systems.
Costs
The Company is expensing all period costs associated with the Year 2000 problem.
Through September 30, 1998, the amount of such expense has been approximately
$73. Management estimates that the Bank will incur approximately an additional
$130 in Year 2000 related expenses for the identification, correction and
reprogramming, and testing of systems for Year 2000 compliance during the last
three months of 1998 and in fiscal 1999. There can be no assurance that these
expenses will not increase as further testing and assessment of vendor and
customer readiness for the Year 2000 continues. The above cost estimates include
costs for consultants, running tests and technical assistance from vendors.
These costs exclude the cost of the Company's internal staff time and systems or
products which were not replaced due to the Y2K problem.
Risks
It is inherently difficult to predict the future outcome of most events and the
Y2K issue is no exception due to the complexity of technology, the numerous
variables and the inability to assess the impact of the Year 2000 problem on the
local, national and international economy. Management has identified a
long-range most reasonably likely worst case scenario. This scenario suggests
that the Y2K problem might negatively impact some significant customers and
non-IT vendors/products through the failure of the customer/vendor to be
prepared or the impact on them of their own vendors and customers. Management
believes that this scenario could occur in conjunction with an economic
recession, arising from the Y2K problem and, if it did, its asset quality and
earnings could be adversely impacted. It is not possible to predict the effect
of this scenario on the economic viability of its customers and the related
adverse impact it may have on SJNB's financial position and results of
operations, including the level of the Bank's provision for possible loan losses
in future periods.
The Company presently believes that, with modifications to existing software
which is Year 2000 compliant and assuming representations of Year 2000 readiness
from significant vendors and customers are accurate, the Year 2000 issue should
not pose significant operational risks for the Company's IT systems as so
modified. However, other significant risks relating to the Year 2000 problem are
that of the unknown impact of this problem on the operations of the Bank's
customers and vendors, the impact of catastrophic infrastructure issues such as
power, communications and water on the economy and future actions which banking
or securities regulators may take.
The Company is making efforts to ensure that its customer base is aware of the
Year 2000 problem. In addition to seminars for and mailings to its customer
base, the Bank has amended its credit policy and credit authorization
documentation to include consideration regarding the Year 2000 problem.
Significant customer relationships have been identified, and such customers are
being contacted by the Bank's account officers to determine whether they are
aware of Year 2000 risks and whether they are taking preparatory actions. An
initial assessment of these customers was substantially complete as of September
30, 1998. The Bank intends to take follow-up action based on the results of this
assessment.
The Company has also attempted to contact major vendors and suppliers of
non-software products and services including those where products utilize
embedded technology, to determine the Year 2000 readiness of such organizations
and/or the products and services which the Company purchases from such
organizations. The Company is monitoring reports provided by such vendors
regarding their preparations for Year 2000. This is an ongoing process, and the
company intends to continue to monitor the progress of such vendors through the
century date change.
Federal banking regulators have responsibility for supervision and examination
of banks to determine whether each institution has an effective plan for
identifying, renovating, testing and implementing solutions for Year 2000
processing and coordinating Year 2000 processing capabilities with its
customers, vendors and payment system partners. Examiners are also required to
assess the soundness of an institution's internal controls and to identify
whether further corrective action may be necessary to assure an appropriate
level of attention to Year 2000 processing capabilities. Management believes it
is currently in compliance with the federal bank regulatory guidelines and
timetables.
Contingency Plans
The Company has developed contingency plans for its software systems, should
they not successfully pass the Company's Year 2000 testing. Generally this
involves the identification of an alternate vendor or expected actions the
Company could take, as well as the establishment of a trigger date to implement
the contingency plan. The Company intends to develop, in accordance with
regulatory guidelines, further contingency plans to address potential business
disruptions resulting from Year 2000 issues, however, this process is not
expected to be completed until December 31, 1998.
Selected Financial Data
The following presents selected financial data and ratios as of and for the
three and nine months ended September 30, 1998 and 1997:
SELECTED FINANCIAL DATA AND RATIOS
- - ----------------------------------------------------------------------------------------------------------------------------
For the quarters For the nine months
ended September 30, ended September 30,
---------------------------------------------------------------------
SELECTED ANNUALIZED OPERATING RATIOS: 1998 1997 1998 1997
- - ----------------------------------------------------------------------------------------------------------------------------
Return on average equity 15.56% 16.43% 16.72% 16.28%
Return on average tangible equity 19.39 20.67 20.41 20.70
Return on average assets 1.51 1.64 1.69 1.61
Net chargeoffs (recoveries) to average loans (.02) (.04) (.03) .06
Average equity to average assets 9.71 9.98 10.12 9.91
Average tangible equity to average tangible assets 8.60 8.77 9.05 8.66
PER SHARE DATA:
Net income per share - basic $.54 $.52 $1.70 $1.49
Net income per share - diluted .51 .50 1.61 1.42
Net income per share - (core) - diluted (1) .55 .54 1.74 1.56
Dividends per share (2) .14 ---- .42 .21
============================================================================================================================
At September 30, At September 30, At December 31,
SHAREHOLDERS' EQUITY 1998 1997 1997
- - ----------------------------------------------------------------------------------------------------------------------------
Shareholders' equity per share $14.04 $12.89 $13.30
Tangible equity per share 12.34 11.24 11.80
SELECTED FINANCIAL POSITION RATIOS:
- - ----------------------------------------------------------------------------------------------------------------------------
Leverage capital ratio 8.80% 8.97% 9.06%
Nonperforming loans to total loans .18 1.07 .19
Nonperforming assets to total assets .13 .74 .13
Allowance for possible loan losses to total loans 1.91 1.94 1.96
Allowance for possible loan losses
to nonperforming loans 1,081.00 181.00 1,060.00
Allowance for possible loan losses
to nonperforming assets 1,081.00 181.00 1,060.00
============================================================================================================================
<FN>
(1) Excludes after-tax effect of goodwill and core deposit intangible
amortization.
(2) Effective with the first quarter of 1998, the Company commenced a policy of
paying quarterly cash dividends to its shareholders; previously semi-annual
dividends were paid.
</FN>
Summary of Financial Results
The Company reported net income of $1,325 or $.51 per share - diluted for the
quarter ended September 30, 1998, compared with net income of $1,296 or $.50 per
share - diluted for the third quarter of 1997. The improvement in earnings is
due primarily to an increase in net interest income due to growth in volume.
For the nine months ended September 30, 1998, net income was $4,241 or $1.61 per
share - diluted compared with net income of $3,743 or $1.42 per share - diluted
in 1997. The improvement is due primarily to an increase in net interest income
due to the growth in volume offset by an increase in third quarter 1998 expenses
which were primarily related to the new employees of Epic Funding and the
start-up of the East Bay Regional Office.
Net Interest Income
Net interest income for the quarter ended September 30, 1998 increased $448 as
compared to the same quarter a year ago. The Bank's average earning assets for
the same period increased by $39 million, primarily as the result of growth in
the Bank's loan portfolio and other short-term investments.
Net interest margin for the third quarter of 1998 was 6.28% as compared to 6.52%
for the same quarter in 1997. This decrease was primarily related to the
decrease in the yield on earning assets; in particular the yield on loans, which
account for 73% of earning assets, declined from 10.58% to 10.41%.
In contrast, the net interest margin for the nine months of 1998 was 6.51% as
compared to 6.42% for the same period in 1997. This increase was primarily
related to a decline in the cost of funds from 4.11% in 1997 to 4.0% in 1998 and
collection of a $107 prepayment fee in March 1998 relating to a fixed rate loan
which was repaid prior to its contractual maturity.
Economic conditions in Northern California have remained relatively strong in
the first nine months of 1998, although, there are indications that this
economic strength could be threatened by the problems in Asia and Latin America,
slow-down in demand for semi-conductors and other technology products, the
tightening of a skilled labor force and the potential for the real estate market
to slowdown. In addition, the competitive environment within the Bank's
marketplace continues to be aggressive and the competition between banks for
additional loans and deposits has caused more competitive pricing.
Due to the nature of the Company's target market in which loans are generally
tied to the prime rate, management believes modest increases in interest rates
should positively affect the Bank's net interest margin. Conversely, management
believes stable or declining rates will tend to have an adverse impact on net
interest margin. The Bank utilizes various methods to hedge some of its interest
rate risk. See "Loans" and "Asset/Liability Management." On September 30, 1998,
the Federal Open Market Committee decreased its target rate for interbank
borrowings to 5 1/4%. As a result, most domestic banks decreased their prime
lending rate to 8 1/4%, which was matched by SJNB. In management's view, the
future effect of this rate decrease is not precisely determinable due to the
many factors influencing the Bank's net interest margin, although the Bank's
margin will likely be negatively impacted.
The following tables shows the composition of average earning assets and average
funding sources, average yields and rates and the net interest margin, on an
annualized basis, for the three and nine months ended September 30, 1998 and
1997.
AVERAGE BALANCES, RATES AND YIELDS
Fully Taxable Equivalent
(dollars in thousands)
Quarter ended September 30,
------------------------------------------------------------------------------------
1998 1997
- - ----------------------------------------------------------------------------------------------------------------------------
Average Average Average Average
Assets Balance Interest Yield (1) Balance Interest Yield (1)
- - ----------------------------------------------------------------------------------------------------------------------------
Interest earning assets:
Loans, net (2) $238,197 $6,249 10.41% $216,630 $5,776 10.58%
Securities available for sale (3) 44,265 658 5.90 48,793 758 6.16
Securities held to maturity:
Taxable (4) 8,348 127 6.04 11,485 194 6.70
Nontaxable (5) 3,946 73 7.37 3,116 63 8.02
Money market investments 30,305 428 5.60 6,040 82 5.39
Interest rate hedging instruments ---- (2) ---- ---- (2) ----
- - -------------------------------------------------------------------- ----------------------------
Total interest-earning assets 325,061 7,533 9.19 286,064 6,871 9.53
- - -------------------------------------------------------------------- ----------------------------
Allowance for possible loan losses (4,545) (4,135)
Cash and due from banks 13,691 19,029
Other assets 9,526 8,517
Core deposit intangibles and
goodwill, net 4,231 4,155
- - ------------------------------------------------------ --------------
Total $347,964 $313,630
====================================================== ==============
Liabilities and Shareholders' equity Interest-bearing liabilities:
Deposits:
Interest-bearing demand $54,787 369 2.67 $47,509 304 2.54
Money market and savings 107,645 966 3.56 85,083 745 3.47
Certificates of deposit:
Less than $100 12,986 166 5.07 14,368 203 5.61
$100 or more 63,184 862 5.41 55,300 759 5.45
- - -------------------------------------------------------------------- ----------------------------
Total certificates of deposits 76,170 1,028 5.35 69,668 962 5.48
- - -------------------------------------------------------------------- ----------------------------
Other borrowings 981 22 8.90 10,347 160 6.13
- - -------------------------------------------------------------------- ----------------------------
Total interest-bearing 239,583 2,385 3.95 212,607 2,171 4.05
liabilities
- - -------------------------------------------------------------------- ----------------------------
Noninterest-bearing demand 68,973 63,267
Accrued interest payable and
other liabilities 5,633 6,459
- - ------------------------------------------------------ --------------
Total liabilities 314,189 282,333
- - ------------------------------------------------------ --------------
Shareholders' equity 33,775 31,297
- - ------------------------------------------------------ --------------
Total $347,964 $313,630
======================================================-------------- ==============--------------
Net interest income and margin (6) $5,148 6.28% $4,700 6.52%
======================================== ============================ ============================
<FN>
(1) Rates are presented on an annualized basis.
(2) Includes loan fees of $301 for 1998, and $248 for 1997. Nonperforming
loans have been included in average loan balances.
(3) Includes dividend income of $34 and $54 received in 1998 and 1997.
(4) Includes dividend income of $8 received in 1998and 1997.
(5) Adjusted to a fully taxable equivalent basis using the federal statutory
rate ($29 in 1998 and $25 in 1997).
(6) The net interest margin represents the fully taxable equivalent net
interest income as a percentage
</FN>
AVERAGE BALANCES, RATES AND YIELDS
Fully Taxable Equivalent
(dollars in thousands)
Nine months ended September 30,
------------------------------------------------------------------------------------
1998 1997
- - ----------------------------------------------------------------------------------------------------------------------------
Average Average Average Average
Assets Balance Interest Yield (1) Balance Interest Yield (1)
- - ----------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Loans, net (2) $231,296 $18,404 10.64% $208,160 $16,571 10.64%
Securities available for sale (3) 47,779 2,172 6.08 48,108 2,233 6.21
Securities held to maturity:
Taxable (4) 9,169 423 6.17 12,114 617 6.81
Nontaxable (5) 3,728 213 7.65 2,840 172 8.10
Money market investments 19,777 823 5.56 11,807 475 5.38
Interest rate hedging instruments ---- (7) ---- ---- (7) ----
- - -------------------------------------------------------------------- ----------------------------
Total interest-earning assets 311,749 22,028 9.45 283,029 20,061 9.48
- - -------------------------------------------------------------------- ----------------------------
Allowance for possible loan losses (4,565) (4,090)
Cash and due from banks 14,602 18,890
Other assets 9,411 7,998
Core deposit intangibles and
goodwill, net 3,931 4,275
- - ------------------------------------------------------ --------------
Total $335,128 $310,102
====================================================== ==============
Liabilities and Shareholders' equity Interest-bearing liabilities:
Deposits:
Interest-bearing demand $50,941 997 2.62 $45,051 866 2.57
Money market and savings 100,640 2,706 3.59 84,746 2,257 3.56
Certificates of deposit:
Less than $100 13,713 527 5.14 15,120 607 5.37
$100 or more 57,989 2,364 5.45 54,113 2,231 5.51
- - -------------------------------------------------------------------- ----------------------------
Total certificates of deposits 71,702 2,891 5.39 69,233 2,838 5.48
- - -------------------------------------------------------------------- ----------------------------
Other borrowings 5,218 245 6.28 11,462 514 6.00
- - -------------------------------------------------------------------- ----------------------------
Total interest-bearing liabilities 228,501 6,839 4.00 210,492 6,475 4.11
- - -------------------------------------------------------------------- ----------------------------
Noninterest-bearing demand 67,365 63,847
Accrued interest payable and
other liabilities 5,347 5,018
- - ------------------------------------------------------ --------------
Total liabilities 301,213 279,357
- - ------------------------------------------------------ --------------
Shareholders' equity 33,915 30,745
- - ------------------------------------------------------ --------------
Total $335,128 $310,102
======================================================-------------- ==============--------------
Net interest income and margin (6) $15,189 6.51% $13,586 6.42%
======================================== ============================ ============================
<FN>
(1) Rates are presented on an annualized basis.
(2) Includes loan fees of $928 for 1998, and $740 for 1997. Nonperforming
loans have been included in average loan balances.
(3) Includes dividend income of $113 and $166 received in 1998 and 1997.
(4) Includes dividend income of $23 received in 1998and 1997.
(5) Adjusted to a fully taxable equivalent basis using the federal statutory
rate ($85 in 1998 and $69 in 1997).
(6) The net interest margin represents the fully taxable equivalent net
interest income as a percentage of average earning assets.
</FN>
Provision for Possible Loan Losses
The level of the allowance for possible loan losses and the related provision,
if any, reflect management's judgment as to the inherent risk of loss associated
with the loan and lease portfolios as of September 30, 1998 and 1997 based on
information available to management as of said dates. Based on management's
evaluation of such risks, an addition of $150 was made to the allowance for
possible loan losses for the three and nine months ended September 30, 1998 and
additions of $215 and $395 were made in the three and nine months ended
September 30, 1997, respectively. See "Loan Portfolio."
Other Income
The following table sets forth the components of other income and the percentage
distribution of such income for the three and nine month periods ended September
30, 1998 and 1997:
OTHER INCOME
(dollars in thousands)
Quarter ended September 30, Nine months ended September 30,
------------------------------------------------------------------------------------
1998 1997 1998 1997
Amount Percent Amount Percent Amount Percent Amount Percent
- - ----------------------------------------------------------------------------------------------------------------------------
Depositor service charges $149 59.60% $156 63.16% $461 59.33% $437 59.38%
Other operating income 101 40.40 91 36.84 324 41.70 340 46.19
Net loss on securities available for sale ----- ----- ----- ----- (8) (1.03) (41) (5.57)
- - ----------------------------------------------------------------------------------------------------------------------------
Total $250 100.00% $247 100.00% $777 100.00% $736 100.00%
============================================================================================================================
Other Expenses
The following schedule summarizes the major categories of expense as a
percentage of average assets on an annualized basis:
OTHER EXPENSES AS A PERCENT OF AVERAGE ASSETS
(dollars in thousands)
Quarter ended September 30, Nine months ended September 30,
--------------------------------------------------------------------------------------------
1998 1997 1998 1997
Amount Percent * Amount Percent * Amount Percent * Amount Percent *
- - ----------------------------------------------------------------------------------------------------------------------------
Salaries and benefits $1,679 1.93% $1,438 1.83% $5,009 1.99% $4,337 1.86%
Data processing 172 .20 102 .13 497 .20 310 .13
Amortization of core deposit
intangibles and goodwill 119 .14 118 .15 337 .13 355 .15
Client services paid by bank 129 .15 80 .10 315 .13 243 .10
Furniture and equipment 113 .13 97 .12 301 .12 277 .12
Occupancy 102 .12 97 .12 263 .10 242 .10
Business promotion 79 .09 86 .11 248 .10 250 .11
Legal and professional fees 80 .09 90 .11 224 .09 190 .08
Directors' & shareholders' 70 .08 80 .10 193 .08 255 .11
Stationery and supplies 58 .07 31 .04 149 .06 124 .05
Advertising & marketing 47 .05 24 .03 138 .05 84 .04
Loan and collection 44 .05 31 .04 96 .04 77 .03
Regulators assessments 30 .03 28 .04 86 .03 81 .03
Net cost of foreclosed property 2 ----- 4 ----- 3 .01 (45) (.02)
Sundry losses ----- ----- ----- ----- (29) (.01) 124 .05
Other 210 .24 157 .20 614 .24 472 .20
- - ----------------------------------------------------------------------------------------------------------------------------
Total $2,934 3.37% $2,463 3.14% $8,444 3.36% $7,376 3.17%
============================================================================================================================
<FN>
(1) The percentages are calculated by annualizing the expenses and comparing
that amount to the average assets for the respective three and nine month
periods ended September 30, 1998 and 1997.
(2) Certain amounts have been reclassified in 1997 to conform to the 1998
classifications.
</FN>
Total other expenses for the third quarter of 1998 increased $471 from the same
period a year ago, primarily as a result of increases in salaries and benefits
(relating to the acquisition of Epic Funding Corp. during the second quarter and
the opening of the East Bay Regional Office in July 1998), an increase in data
processing expenses (relating to greater technology costs, impact of a
conversion of the Bank's core data processing system in November 1997 and
attention to the year 2000 issue), an increase in furniture and equipment,
occupancy, advertising and promotion and stationery and supplies also due to the
addition of Epic and the new East Bay Regional Office, an increase in client
services paid by the Bank representing an increase in costs associated with
several significant customers and an increase in other expense due to employment
fees.
Total other expenses for the nine months ended September 30, 1998 increased
$1,068 from the same period a year ago, primarily as a result of the same items
discussed above for the third quarter.
Income Tax Provision
The effective tax rate of 42% for the three months ended September 30, 1998 is
affected by several items. The most significant are the amortization of
intangibles, tax exempt income and the California Franchise Tax Enterprise Tax
Zone Credit. The effective tax rate for the year ended December 31, 1997 was
42%.
Financial Condition and Earning Assets
Consolidated assets increased to $343 million at September 30, 1998 compared to
$325 million at December 31, 1997. The increase related primarily to an increase
in loans and money market investments and was funded principally by an increase
in the Bank's core interest-bearing money market deposits and a growth in
certificates of deposits of greater than $100. See "Funding."
Money Market Investments
Money market investments, which include federal funds sold, were $8.8 million at
September 30, 1998 as compared to $2.7 million at December 31, 1997. This
increase is related to the increase in the Bank's core interest-bearing money
market deposits and a growth in certificates of deposits of greater than $100.
Securities
The following table shows the composition of the securities portfolio at
September 30, 1998 and December 31, 1997. There were no issuers of securities
(except U.S. Government Securities) for which the book value of securities of
any issuer held by the Bank exceeded 10% of the Company's shareholders' equity.
SECURITIES PORTFOLIO
(dollars in thousands)
September 30, 1998 December 31, 1997
- - --------------------------------------------------------------------------------------------------------------------------
Amortized Unrealized Market Amortized Unrealized Market
Cost Gain (Loss) Value Cost Gain (Loss) Value
- - ----------------------------------------------------------------------------------------------------------------------------
Securities available for sale:
U. S. Treasury $5,005 $93 $5,098 $5,001 $40 $5,041
U. S. Government Agencies 34,201 624 34,825 34,148 179 34,327
Mortgage backed 4,212 102 4,314 5,097 74 5,171
Mutual funds 2,767 (141) 2,626 3,898 (132) 3,766
- - ----------------------------------------------------------------------------------------------------------------------------
Total available for sale 46,185 678 46,863 48,144 161 48,305
- - ----------------------------------------------------------------------------------------------------------------------------
Securities held to maturity:
U. S. Treasury 1,000 11 1,011 1,992 16 2,008
U. S. Government Agencies 3,494 53 3,547 5,485 27 5,512
State and municipal (nontaxable) 4,221 97 4,318 3,224 34 3,258
Mortgage backed 2,259 34 2,293 2,518 29 2,547
- - ----------------------------------------------------------------------------------------------------------------------------
Total held to maturity 10,974 195 11,169 13,219 106 13,325
Federal Reserve Bank Stock 518 ---- 518 518 ---- 518
- - ----------------------------------------------------------------------------------------------------------------------------
Total 11,492 195 11,687 13,737 106 13,843
- - ----------------------------------------------------------------------------------------------------------------------------
Total investment securities portfolio 57,677 873 58,550 61,881 267 62,148
============================================================================================================================
<FN>
Unrealized gains generally result from the impact of current market rates being
less than those rates in effect at the time the Bank purchased the securities.
The unrealized gain on securities available for sale as of September 30, 1998
was $678 as compared to an unrealized gain of $161 as of December 31, 1997. The
Bank's weighted average maturity of the available for sale portfolio was
approximately 1.71 years as of September 30, 1998. It is estimated by management
that for each 1% change in interest rates the value of the Company's available
for sale securities will change by 1.37%.
</FN>
The unrealized gain on securities held to maturity was $195 as of September 30,
1998 as compared to an unrealized gain of $106 as of December 31, 1997. The
Bank's weighted average maturity of the held to maturity investment portfolio
was approximately 4.03 years as of September 30, 1998. It is estimated by
management that for each 1% change in interest rates, the value of the Company's
securities held to maturity will change by approximately 2.54%. The increase in
the maturity and duration are due to a 1997 change in Company policy relating to
the purchase and treatment of several securities. Since that time, management
has classified all new purchases of securities as "available for sale" except
for the state and municipal securities, which are classified as "held to
maturity."
The maturities and yields of the investment portfolio at September 30, 1998 are
shown below:
MATURITY AND YIELDS OF INVESTMENT SECURITIES
- - -----------------------------------------------------------------------------------------------------------------------------
At September 30, 1998
(dollars in thousands)
Available for Sale Held to Maturity
---------------------------------------------------------------------------------------------
FTE FTE
Amortized Estimated Average Amortized Estimated Average
Cost Fair Value Yield Cost Fair Value Yield
----------------------------------------------------------------------------------------------
U. S. Treasury:
Within 1 year $2,999 $3,015 6.03% $1,000 $1,011 6.38%
After 1 year within 5 years 2,006 2,083 6.11 ----- ----- -----
----------------------------------------------------------------------------------------------
Totals 5,005 5,098 6.06 1,000 1,011 6.38
----------------------------------------------------------------------------------------------
U.S. Government Agencies:
Within 1 year 14,982 15,056 5.76 1,995 2,011 6.42
After 1 year within 5 years 19,219 19,769 6.01 1,499 1,536 6.41
----------------------------------------------------------------------------------------------
Totals 34,201 34,825 5.90 3,494 3,547 6.42
----------------------------------------------------------------------------------------------
State and municipal:
Within 1 year ----- ----- ----- 645 648 6.90
After 1 year within 5 years ----- ----- ----- 1,199 1,220 6.11
After 10 years ----- ----- ----- 2,377 2,450 6.84
-----------------------------------------------
Totals ----- ----- ----- 4,221 4,318 6.64
-----------------------------------------------
Mortgage backed
After 1 year within 5 years 3,233 3,304 6.77 ----- ----- -----
After 5 years within 10 years 979 1,010 6.71 2,259 2,293 7.90
----------------------------------------------------------------------------------------------
Totals 4,212 4,314 6.76 2,259 2,293 7.90
----------------------------------------------------------------------------------------------
Mutual funds:
-----------------------------------------------
Within 1 year 2,767 2,626 5.05 ----- ----- -----
-----------------------------------------------
Other
-----------------------------------------------
After 10 years ----- ----- ----- 518 518 6.00
----------------------------------------------------------------------------------------------
Total investment securities 46,185 $46,863 5.95% $11,492 $11,687 6.77%
==============================================================================
Net unrealized gain on
securities available for sale 678
----------------
Total investment securities,
net carrying value $46,863
================
(1) Fully taxable equivalent.
Loan Portfolio
The following table provides a breakdown of the Company's consolidated loans by
type of loan or borrower:
LOAN PORTFOLIO
(dollars in thousands)
September 30, 1998 December 31, 1997
- - --------------------------------------------------------------------------------------------------------------------------
Percentage Percentage
Total of Total Total of Total
Amount Loans Amount Loans
- - --------------------------------------------------------------------------------------------------------------------------
Commercial $90,331 36.6% $92,693 40.5%
Real estate construction 32,683 13.2 17,818 7.8
Real estate-other 97,148 39.4 90,495 39.5
Consumer 9,338 3.8 9,042 3.9
Other 17,919 7.3 19,568 8.6
Unearned fee income (766) (0.3) (644) (0.3)
- - --------------------------------------------------------------------------------------------------------------------------
Total loans $246,653 100.0% $228,972 100.0%
==========================================================================================================================
Consolidated loans increased to $247 million at September 30, 1998 from $229
million at December 31, 1997. The decline in commercial loans related to the
sale of several of the Bank's commercial business customers and the competitive
market place. The growth in real estate construction loans is due to the impact
of the strong current demand in the local real estate market. The increase is
primarily related to growth in construction of single family residences.
Additionally the Bank has elected not to aggressively seek or renew loans where
in management's opinion the Bank's underwriting criteria is not satisfied; this
has caused a slow down in loan production and an increase in payoffs when the
Bank has not met competitive pressures.
Approximately 58% of the loan portfolio is directly related to real estate or
real estate interests, including real estate construction loans, real
estate-other, mortgage warehouse lines (1%, included in the Commercial
category), real estate equity lines (2%, included in the Consumer category), and
loans to real estate developers for short-term investment purposes (1%) and
loans for real estate investment purposes made to non-developers (1%). The
latter two types are included in the Other category. Approximately 38% of the
loan portfolio is made up of commercial loans; however, in management's view, no
particular industry represents a significant portion of such loans.
The following table shows the maturity and interest rate sensitivity of
commercial, real estate-other and real estate construction loans at September
30, 1998. Approximately 82% of the commercial and real estate loan portfolio
have floating interest rates which in management's opinion generally limits the
exposure to interest rate risk on long-term loans but can have a negative impact
when rates decline.
COMMERCIAL AND REAL ESTATE LOAN MATURITY AND INTEREST RATE
SENSISTIVITY
(dollars in thousands) Balances maturing Interest Rate Sensitivity
----------------------------------------------------------------------------------
Predeter-
Balances at One year mined Floating
September 30, One year to five Over five interest interest
1998 or less years years rates rates
- - ----------------------------------------------------------------------------------------------------------------------------
Commercial $90,331 $58,077 $27,268 $4,986 $2,974 $87,357
============================================================================================================================
Real estate construction $32,683 $31,251 $1,432 ----- $2,261 $30,422
============================================================================================================================
Real estate-other $97,148 $13,769 $25,716 $57,663 $33,770 $63,378
============================================================================================================================
The Company utilizes a method of assigning a minimum and maximum loss ratio to
each grade of loan within each category of loans (commercial, real estate-other,
real estate construction, etc.). Loans are graded on a ranking system based on
management's assessment of the loan's credit quality. The assigned loss ratio is
based upon, among other things, the Company's prior experience, industry
experience, delinquency trends and the level of nonaccrual loans. Loans secured
by real estate are evaluated on the basis of their underlying collateral in
addition to using the assigned loss ratios. The methodology also considers (and
assigns a risk factor for) current economic conditions, off-balance sheet risk
(including SBA guarantees and servicing and letters of credit) and
concentrations of credit. In addition, each loan is evaluated on the basis of
whether or not it is impaired. For impaired loans, the expected cash flow is
discounted on the basis of the loan's interest rate. The methodology provides a
systematic approach believed by management to measure the risk of possible
future loan losses. Management and the Board of Directors evaluate the allowance
and determine the desired level of the allowance considering objective and
subjective measures, such as knowledge of the borrowers' business, valuation of
collateral and exposure to potential losses. The allowance for possible loan
losses was approximately $4.7 million at September 30, 1998, or 1.91% of total
loans outstanding. Based on information available as of the date of this report,
management believes the allowance for possible loan losses, determined as
described above, is adequate for potential losses foreseeable at September 30,
1998.
The allowance for possible loan losses is a general reserve available against
the total loan portfolio and off-balance sheet credit exposure. While management
uses available information to recognize losses on loans, future additions to the
allowance may be necessary based on changes in economic conditions or other
factors. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for possible loan
losses. Such agencies may require the Bank to provide additions to the allowance
based on their judgment of information available to them at the time of their
examination.
The following schedule provides an analysis of the allowance for possible loan
losses:
ALLOWANCE FOR POSSIBLE LOAN LOSSES
(dollars in thousands)
Quarter ended Nine months ended Year ended
September 30, September 30, December 31,
-------------------------------------------------------------------
1998 1997 1998 1997 1997
- - ------------------------------------------------------------------------------------------------------------------------------
Balance, beginning of the period $4,540 $4,076 $4,493 $4,005 $4,005
Charge-offs by loan category:
Commercial ---- ---- 125 115 242
Real estate-construction ---- ---- ---- 33 ----
Real estate-other ---- ---- ---- ---- 33
Consumer ---- ---- ---- ---- 13
- - ------------------------------------------------------------------------------------------------------------------------------
Total charge-offs ---- ---- 125 148 288
- - ------------------------------------------------------------------------------------------------------------------------------
Recoveries by loan category:
Commercial 12 20 84 55 67
Real estate-other ---- ---- 33 4 4
Consumer ---- ---- 67 ---- ----
- - ------------------------------------------------------------------------------------------------------------------------------
Total recoveries 12 20 184 59 71
- - ------------------------------------------------------------------------------------------------------------------------------
Net charge-offs (recoveries) (12 ) (20 ) (59) 89 217
- - ------------------------------------------------------------------------------------------------------------------------------
Provision charged to expense 150 215 150 395 705
- - ------------------------------------------------------------------------------------------------------------------------------
Balance, end of the period $4,702 $4,311 $4,702 $4,311 $4,493
==============================================================================================================================
Ratios:
Net charge-offs (recoveries) to average loans, annualized (.02%) (.04%) (.03%) .06% .10%
Allowance to total loans at the end of the period 1.91 1.94 1.91 1.94 1.96
Allowance to nonperforming loans at end of the period 1,081.00 181.00 1,081.00 181.00 1,060.00
==============================================================================================================================
During the three months ended September 30, 1998 and 1997, there were no
charge-offs. During the nine months ended September 30, 1998 and 1997, there
were charge-offs of $125 and $148. Management does not believe there were any
trends indicated by the detail of the aggregate charge-offs for any of the
periods discussed. The allowance for possible loan losses was 1,081% of
nonperforming loans at September 30, 1998 compared to 1,060% at December 31,
1997.
Nonperforming Loans
Nonperforming loans consist of loans for which the accrual of interest has been
suspended, restructured loans and other loans with principal or interest
contractually past due 90 days or more and still accruing. The following table
provides information about such loans:
NONPERFORMING LOANS
(dollars in thousands)
September 30, December 31,
1998 1997
- - ----------------------------------------------------------------------------------------------------------------------------
Loans accounted for on a non-accrual basis $388 $360
Loans restructured and in compliance with modified terms 47 $63
Other loans with principal or interest contractually past
due 90 days or more 1
- - ----------------------------------------------------------------------------------------------------------------------------
Total $435 $424
============================================================================================================================
As of September 30, 1998, nonperforming loans consisted of six loans, none of
which were individually significant.
Management conducts an ongoing evaluation and review of the loan portfolio in
order to identify potential nonperforming loans. Management considers loans
which are classified for regulatory purposes, loans which are graded as
classified by the Bank's outside loan review consultant and internal personnel,
as to whether they (i) represent or result from trends or uncertainties which
management reasonably expects will materially impact future operating results,
liquidity, or capital resources, or (ii) represent material credits about which
management is aware of any information which causes management to have serious
doubts as to the ability of such borrowers to comply with the loan repayment
terms. Based on such reviews as of September 30, 1998, management has not
identified any loans not included within the Nonperforming Loan table above with
respect to which known information causes management to have serious doubts
about the borrowers' abilities to comply with present repayment terms, such that
the loans might subsequently be classified as nonperforming. Changes in world,
national or local economic conditions or specific industry segments (including
declining exports), rising interest rates, declines in real estate values, year
2000 problems, declines in securities markets and acts of nature could have an
adverse effect on the ability of borrowers to repay outstanding loans and the
value of real estate and other collateral securing such loans.
Funding
The following table provides a breakdown of deposits by category as of the dates
indicated:
DEPOSIT CATEGORIES
(dollars in thousands)
September 30, 1998 December 31, 1997
- - ----------------------------------------------------------------------------------------------------------------------------
Percentage Percentage
Total of Total Total of Total
Amount Deposits Amount Deposits
- - ----------------------------------------------------------------------------------------------------------------------------
Noninterest-bearing demand $78,041 25.8% $78,437 29.0%
Interest-bearing demand 49,543 16.4 45,655 16.9
Money market and savings 100,970 33.5 82,619 30.6
Certificates of deposit:
Less than $100 12,442 4.1 15,207 5.6
$100 or more 61,167 20.2 48,427 17.9
- - ----------------------------------------------------------------------------------------------------------------------------
Total $302,163 100.0% $270,345 100.0%
============================================================================================================================
Deposits as of September 30, 1998 were $302 million compared to $270 million at
December 31, 1997. The most significant growth in deposits has occurred in the
area of interest-bearing core deposits which increased approximately $22
million. Management believes this growth in interest-bearing core deposits has
been due to unusual activity by several of the Bank's customers and to the
business development efforts of the Bank's business development officers.
Because of this high level of unusual activity, the Bank has maintained
significant short-term liquidity. The growth in the certificates of deposit
greater than $100 was due to activity of several significant customers. While
the amount of noninterest-bearing demand deposits was essentially unchanged the
percentage of such deposits declined 3.2%. Management believes this trend could
continue due, in part, to competitive pressures and changes in the deposit
products being utilized by some of the Bank's customers, which has caused a
shift to interest-bearing products. In addition, the Bank has been notified that
a large customer with money market deposit accounts is consolidating accounts in
the Midwest and approximately $18 million of such deposits will be transferred
out of the Bank over the next six to nine months, commencing in the fourth
quarter of 1998. See "Liquidity."
Asset/Liability Management
The Company's balance sheet position is asset-sensitive (based upon the
significant amount of variable rate loans and the repricing characteristics of
its deposit accounts). This balance sheet position generally provides a hedge
against rising interest rates, but has a detrimental effect during times of
interest rate decreases. Net interest revenues are negatively impacted by a
decline in interest rates. The recent cuts, and any further cuts, in interest
rates by the Federal Reserve System could negatively impact the Company's net
interest revenues in future periods. Management notes, however, that these cuts
and any further interest rate cuts might stimulate demand for loans in the
future which could offset some of the decline in the Company's interest income.
To counter a portion of its asset sensitive interest rate position, the Bank
entered into an interest rate "floor" in the amount of $10 million which expires
in May 1999. The Bank paid a fixed premium of $47 for which it will receive the
amount of interest on $10 million based on the difference of 7% and prime when
prime is less than 7%. This protects the Bank against decreases in its net
income when the prime decreases to less than 7%. Settlement, if any, is done
quarterly and the Bank records the impact of this hedge on an accrual basis.
Capital and Liquidity
Capital
The Federal Reserve Board's risk-based capital guidelines require that total
capital be in excess of 8% of total assets on a risk-weighted basis. Under the
guidelines for a bank holding company, capital requirements are based upon the
composition of the Company's asset base and the risk factors assigned to those
assets. The guidelines characterize an institution's capital as being "Tier 1"
capital (defined to be principally shareholders' equity less intangible assets)
and "Tier 2" capital (defined to be principally the allowance for loan losses,
limited to one and one-fourth percent of gross risk weighted assets). The
guidelines require the Company to maintain a risk-based capital target ratio of
8%, one-half or more of which should be in the form of Tier 1 capital.
The Comptroller of the Currency also requires SJNB to maintain adequate capital.
The Comptroller's current regulations require national banks to maintain Tier 1
leverage capital ratio equal to at least 3% to 5% of total assets, depending on
the Comptroller's evaluation of the Bank. The Comptroller also has adopted
risk-based capital requirements. Similar to the Federal Reserve's guidelines,
the amount of capital the Comptroller requires a bank to maintain is based upon
the composition of its asset base and risk factors assigned to those assets. The
guidelines require the Bank to maintain a risk-based capital target ratio of 8%,
one-half or more of which should be in the form of Tier 1 capital. The capital
ratios of the Bank are similar to the capital ratios of the Company.
The table below summarizes the various capital ratios of the Company at
September 30, 1998 and December 31, 1997.
Risk-based and Leverage Capital Ratios
(dollars in thousands)
Company September 30, 1998 December 31, 1997
- - ------- ----------------------------------------------------------------------
Risk-based
- - ---------- Amount Ratio Amount Ratio
----------------------------------------------------------------------
Tier 1 capital $29,809 10.58% $29,167 11.28%
Tier 1 capital minimum requirement 11,267 4.00 10,344 4.00
----------------------------------------------------------------------
Excess $18,542 6.58% $18,823 7.28%
======================================================================
Total capital $33,344 11.84% $32,415 12.53%
Total capital minimum requirement 22,534 8.00 20,689 8.00
----------------------------------------------------------------------
Excess $10,810 3.84% $11,726 4.53%
======================================================================
Risk-adjusted assets $281,677 $258,608
================== ==================
Leverage
- - --------
Tier 1 capital $29,809 8.80% $29,167 9.07%
Minimum leverage ratio requirement 13,545 4.00 12,870 4.00
----------------------------------------------------------------------
Excess $16,264 4.80% $16,297 5.07%
======================================================================
Average total assets $338,623 $321,747
================== ==================
Bank
- - ----
Risk-based
- - ----------
Tier 1 capital $29,237 10.38% $28,879 11.17%
Tier 1 capital minimum requirement 11,264 4.00 10,341 4.00
----------------------------------------------------------------------
Excess $17,973 6.38% $18,538 7.17%
----------------------------------------------------------------------
Total capital $32,771 11.64% $32,126 12.43%
Total capital minimum requirement 22,528 8.00 20,683 8.00
----------------------------------------------------------------------
Excess $10,243 3.64% $11,443 4.43%
======================================================================
Risk-adjusted assets $281,602 $258,533
================== ==================
Leverage
- - --------
Tier 1 capital $29,237 8.50% $28,879 8.97%
Minimum leverage ratio requirement 13,757 4.00 12,881 4.00
----------------------------------------------------------------------
Excess $15,480 4.50% $15,998 4.97%
======================================================================
Average total assets $343,914 $322,014
================== ==================
To allow for the effective management of capital, the Board of Directors has
approved the repurchase from time-to-time of up to $3.5 million of its common
stock through open market or privately negotiated transactions. Through
September 30, 1998, the Company had repurchased 77,300 shares for a total price
of $3.1 million.
Liquidity
Management strives to maintain a level of liquidity sufficient to meet customer
requirements for loan funding and deposit withdrawals in an economically
feasible manner. Liquidity requirements are evaluated by taking into
consideration factors such as deposit concentrations, seasonality and
maturities, loan demand, capital expenditures, and prevailing and anticipated
economic conditions. SJNB's business is generated primarily through customer
referrals and employee business development efforts; however the Bank could
utilize purchased deposits to satisfy temporary liquidity needs.
The Bank's source of liquidity consists of its deposits with other banks,
overnight funds sold to correspondent banks, short-term securities held to
maturity, and securities available for sale less short-term borrowings. At
September 30, 1998, consolidated net liquid assets totaled $87 million or 25% of
consolidated total assets as compared to $62 million or 19% of consolidated
total assets at December 31, 1997. The increase in the liquid assets is due to
the growth of the deposits. See "Funding." In addition to the liquid asset
portfolio, SJNB also has available $17 million in lines of credit with five
major commercial banks, a collateralized repurchase agreement with a maximum
limit of $30 million (of which none has been utilized at September 30, 1998),
the guaranteed portion of the SBA loan portfolio of approximately $16 million,
and a credit facility with the Federal Reserve Bank based on loans secured by
real estate for approximately $4 million.
SJNB is primarily a business and professional bank and, as such, its deposit
base may be more susceptible to economic fluctuations than other potential
competitors. Accordingly, management strives to maintain a balanced position of
liquid assets to volatile and cyclical deposits. Commercial clients in their
normal course of business maintain balances in large certificates of deposit,
the stability of which hinge upon, among other factors, market conditions,
interest rates and business' seasonality. Large certificates of deposit amounted
to 20% of total deposits on September 30, 1998 and 18% at December 31, 1997.
Recently one of the Bank's significant depositors was acquired by a large
multi-national corporation. In this connection the parent of the Bank's customer
consolidated domestic operations in the Midwest. The impact of this move will be
the withdrawal of approximately $18 million included in money market savings
accounts over a six to nine month period commencing during the fourth quarter of
1998. Management believes it has adequate liquidity and additional sources of
funds to replenish the loss of these accounts.
Liquidity is also affected by portfolio maturities and the effect of interest
rate fluctuations on the marketability of both assets and liabilities. The loan
portfolio consists primarily of floating rate, short-term loans. On September
30, 1998, approximately 41% of total consolidated assets had maturities under
one year and 82% of total consolidated loans had floating rates tied to the
prime rate or similar indexes. The short-term nature of the loan portfolio, and
loan agreements which generally require monthly interest payments, provide the
Company with a secondary source of liquidity. There are no material commitments
for capital expenditures in 1998.
Effects of Inflation
The most direct effect of inflation on the Company is higher interest rates.
Because a significant portion of the Bank's deposits are represented by
non-interest-bearing demand accounts, changes in interest rates have a direct
impact on the financial results of the Bank. See "Asset/Liability Management."
Another effect of inflation is the upward pressure on the Company's operating
expenses. Inflation did not have a material effect on the Bank's operations in
1997 or the first nine months of 1998.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company defines interest rate sensitivity as the measurement of the mismatch
in repricing characteristics of assets, liabilities and off balance sheet
instruments at a specified point in time. This mismatch (known as interest rate
sensitivity gap) represents the potential mismatch in the change in the rate of
interest income and interest expense that would result from a change in interest
rates. Mismatches in interest rate repricing among assets and liabilities arise
primarily from the interaction of various customer businesses (i.e., types of
loans versus the types of deposits maintained) and from management's
discretionary investment and funds gathering activities. The Company attempts to
manage its exposure to interest rate sensitivity. However, due to its size and
direct competition from the major banks, the Company must offer products which
are competitive in the market place, even if less than optimum with respect to
its interest rate exposure.
The Company's balance sheet position at September 30, 1998 was asset-sensitive,
based upon the significant amount of variable rate loans and the repricing
characteristics of its deposit accounts. This position provides a hedge against
rising interest rates, but has a detrimental effect during times of interest
rate decreases. Net interest revenues are negatively impacted by a decline in
interest rates. The interest rate gap is a measure of interest rate exposure and
is based upon the known repricing dates of certain assets and liabilities and
assumed repricing dates of others. Management believes there has been no
significant change in the Bank's market risk exposures disclosed in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997. See
"Summary of Financial Results - Net Interest Income."
On September 30, 1998, the Federal Open Market Committee ("FOMC") decreased its
target rate for interbank borrowings to 5 1/4%. As a result, most domestic banks
decreased their prime lending rate to 8 1/4%, which was matched by SJNB.
Additionally, on October 21, 1998 the FOMC decreased its target rate for
interbank borrowings to 5% and reduced its discount rate to 4 3/4%. In
management's view, the future effect of there rate decreases is not precisely
determinable due to the many factors influencing the Bank's net interest margin,
including the repricing of deposits, a change in mix of the loan and deposit
portfolios, changes in relative volume, the speed in which fixed rate loans are
repriced, discretionary investment activities and other factors, although the
Bank's margin will likely be negatively impacted.
In evaluating the Company's exposure to interest rate risk, certain shortcomings
inherent in the method of analysis must be considered. For example, although
certain assets and liabilities may have similar maturities or periods to
reprice, they may react in different degrees to changes in market interest
rates. Additionally, the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market interest rates.
Further, certain earning assets have features which restrict changes in interest
rates on a short-term basis and over the life of the asset. The Company
considers the anticipated effects of these various factors when implementing its
interest rate risk management activities, including the utilization of certain
interest rate hedges. Considering the above it is estimated that the annual
impact of the 25 basis point decrease in the Bank's prime rate on a pre-tax
basis would be a decrease in income of approximately $270 or $162 after tax.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
- - --------------------------
Neither the Company nor the Bank is a party to any material pending legal
proceedings other than as previously disclosed. Material legal proceedings and
changes were reported in the Company's Form 10-K for the year ended December 31,
1997 and the Company's Form 10-Q for the six months ended June 30, 1998; and,
subsequent thereto, there have been no material changes in said proceedings.
Item 2. Changes in Securities
- - ------------------------------
Not applicable.
Item 3. Defaults Upon Senior Securities
- - ----------------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
- - ------------------------------------------------------------
Not applicable.
Item 5. Other Information
- - --------------------------
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
- - -----------------------------------------
(a) Exhibits
The following exhibits are filed as part of this report:
(3) a. The Registrant's restated Articles of Incorporation.
(3) b. The Registrant's restated bylaws as of July 23, 1998.
*(10) a. The Registrant's 1992 Employee Stock Option Plan
is hereby incorporated by reference from Exhibit
4.1 of the Registrant's Registration Statement on
Form S-8, as filed on September 4, 1992, under
Registration No. 33-51740.
*(10) b. Amendment No. 1 to the 1992 Employee Stock Option
Plan is hereby incorporated by reference to Exhibit
(10)f. of the Registrant's Quarterly Report on Form
10-QSB for the quarterly period ended June 30,1995.
*(10) c. The form of Incentive Stock Option Agreement
being utilized under the 1992 Employee Stock Option
Plan is hereby incorporated by reference from
Exhibit 4.2 of the Registrant's Registration
Statement on Form S-8, as filed on September 4,
1992, under Registration No. 33-51740.
*(10) d. The form of Stock Option Agreement being utilized
under the 1992 Employee Stock Option Plan is hereby
incorporated by reference from Exhibit 4.3 of the
Registrant's Registration Statement on Form S-8,
as filed on September 4, 1992, under Registration
No. 33-51740.
*(10) e. The Registrant's 1992 Director Stock Option Plan
is hereby incorporated by reference from Exhibit
(10) i. of the Registrant's Annual Report on Form
10-KSB for the fiscal year ended December 31, 1992.
*(10) f. Amendment No. 1 to the 1992 Director Stock Option
Plan is hereby incorporated by reference to Exhibit
(10)i. of the Registrant's Quarterly Report on Form
10-QSB for the quarterly period ended June 30,1995.
*(10) g. The form of Stock Option Agreement being utilized
under the 1992 Director Stock Option Plan is hereby
incorporated by reference from Exhibit (10) j. of
the Registrant's Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1992.
*(10) h. The Registrant's Amended 1996 Stock Option Plan is
incorporated by reference to exhibit 99.1 of the
Registrant's Form S-8 filed July 1, 1998.
*(10) i. Agreement between James R. Kenny and SJNB Financial
Corp. and San Jose National Bank dated March 27,
1996 is hereby incorporated by reference to Exhibit
(10) m. of the Registrant's Quarterly Form 10-QSB
for the quarterly period ended June 30, 1996.
*(10) j. Agreement between Eugene E. Blakeslee and SJNB
Financial Corp. and San Jose National Bank dated
March 27, 1996 is hereby incorporated by reference
to Exhibit (10) n. of the Registrant's Quarterly
Form 10-QSB for the quarterly period ended June 30,
1996.
(10) k. Sublease dated April 5, 1982, for premises at 95
South Market Street, San Jose, CA is hereby
incorporated by reference to Exhibit (10) n. of the
Registrant's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1994.
(10) l. Sublease by and between McWhorter's Stationary
and San Jose National Bank, dated July 6, 1995, and
as amended August 11, 1995 and September 21, 1995,
for premises at 95 South Market Street, San Jose CA
is hereby incorporated by reference to Exhibit (10)
o. of the Registrant's Quarterly Report on Form
10-QSB for the quarterly period ended September 30,
1995.
(10) m. Sublease by and between Greater Unified Management
Businesses, Inc. (d.b.a. as Logistics) and SJNB
Financial Corp., dated January 15, 1996, and as
amended March 19, 1996, for premises at 95 South
Market Street, San Jose CA is hereby incorporated
by reference to Exhibit (10) s. of the Registrant's
Quarterly Form 10-QSB for the quarterly period
ended June 30, 1996.
(27) Financial Data Schedule.
* Indicates management contract or compensation plan or arrangement.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the first quarter.
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.
SJNB FINANCIAL CORP.
(Registrant)
Date: November 10, 1998 /S/ J. Kenny
-------------------------------
James R. Kenny
President and
Chief Executive Officer
Date: November 10, 1998 /S/ E. Blakeslee
-------------------------------
Eugene E. Blakeslee
Executive Vice President and
Chief Financial Officer (Chief
Accounting Officer)