================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 0-19231
REDWOOD EMPIRE BANCORP
(Exact name of registrant as specified in its charter)
California 68-0166366
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
111 Santa Rosa Avenue, Santa Rosa, California 95404-4905
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (707) 573-4800
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _
At August 8, 2001, there were 2,371,928 shares of the Registrant's common stock
outstanding.
REDWOOD EMPIRE BANCORP
AND
SUBSIDIARIES
Index
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Operations
Three and Six Months Ended June 30, 2001 and 2000............3
Consolidated Balance Sheets
June 30, 2001 and December 31, 2000..........................5
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2001 and 2000......................6
Notes to Consolidated Financial Statements...................8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations............12
Item 3. Quantitative and Qualitative Disclosures
About Market Risk...........................................33
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds...................35
Item 4. Submission of Matters to a Vote of Security Holders.........36
Item 6. Exhibits and Reports on Form 8-K............................37
SIGNATURES....................................................................38
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
------------------- -------------------
Interest income:
Interest and fees on loans $6,967 $7,432 $14,356 $14,198
Interest on investment securities 1,212 1,290 2,599 2,540
Interest on federal funds sold 263 80 540 223
-------- -------- -------- --------
Total interest income 8,442 8,802 17,495 16,961
Interest expense:
Interest on deposits 3,333 3,443 6,933 6,614
Interest on other borrowings 283 84 435 133
-------- -------- -------- --------
Total interest expense 3,616 3,527 7,368 6,747
-------- -------- -------- --------
Net interest income 4,826 5,275 10,127 10,214
Provision for loan losses -- 50 -- 150
-------- -------- -------- --------
Net interest income after loan loss provision 4,826 5,225 10,127 10,064
Noninterest income:
Service charges on deposit accounts 266 251 535 528
Merchant draft processing, net 1,019 1,075 1,832 1,972
Loan servicing income 80 80 157 120
Net realized (losses)/gains on sale of
investment securities available for sale -- (37) -- (38)
Other income 187 157 393 355
-------- -------- -------- --------
Total noninterest income 1,552 1,526 2,917 2,937
Noninterest expense:
Salaries and employee benefits 1,989 2,092 4,221 4,242
Occupancy and equipment expense 503 509 992 1,010
Other 940 1,404 1,869 2,611
-------- -------- -------- --------
Total noninterest expense 3,432 4,005 7,082 7,863
-------- -------- -------- --------
Income before income taxes 2,946 2,746 5,962 5,138
Provision for income taxes 1,178 1,117 2,407 2,089
-------- -------- -------- --------
Net income $1,768 $1,629 $3,555 $3,049
======== ======== ======== ========
Total comprehensive income $1,754 $1,646 $4,009 $2,958
======== ======== ======== ========
(Continued)
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
(Continued)
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
------------------------- -------------------------
Basic earnings per common share:
Net income $.73 $.52 $1.39 $.95
Weighted average shares - basic 2,414,000 3,157,000 2,567,000 3,205,000
Diluted earnings per common share and common equivalent share:
Net income $.71 $.51 $1.34 $.94
Weighted average shares - diluted 2,489,000 3,213,000 2,645,000 3,239,000
See Notes to Consolidated Financial Statements.
(Concluded)
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands)
June 30, December 31,
2001 2000
--------- ---------
(unaudited)
Assets:
Cash and due from banks $20,037 $21,599
Federal funds sold and repurchase agreements 17,171 22,328
--------- ---------
Cash and cash equivalents 37,208 43,927
Investment securities:
Held to maturity (fair value of $19,934 and $29,657) 19,934 29,801
Available for sale, at fair value (amortized cost of $54,115 and $55,276) 55,030 55,409
--------- ---------
Total investment securities 74,964 85,210
Loans:
Residential real estate mortgage 91,806 98,914
Commercial real estate mortgage 105,812 93,091
Commercial 76,497 66,645
Real estate construction 43,479 49,460
Installment and other 8,958 7,900
Less deferred loan fees (770) (909)
--------- ---------
Total portfolio loans 325,782 315,101
Less allowance for loan losses (7,704) (7,674)
--------- ---------
Net loans 318,078 307,427
Premises and equipment, net 2,395 2,489
Mortgage servicing rights, net 16 25
Other real estate owned -- 757
Cash surrender value of life insurance 3,357 3,275
Other assets and interest receivable 10,372 10,329
--------- ---------
Total assets $446,390 $453,439
========= =========
Liabilities and Shareholders' equity:
Deposits:
Noninterest bearing demand deposits $88,806 $91,727
Interest-bearing transaction accounts 122,746 127,341
Time deposits $100,000 and over 100,305 93,040
Other time deposits 84,943 93,225
--------- ---------
Total deposits 396,800 405,333
Other short-term borrowings 5,370 3,528
Trust Preferred 10,000 --
Other liabilities and interest payable 9,988 9,119
--------- ---------
Total liabilities 422,158 417,980
Shareholders' equity:
Preferred stock, no par value; authorized 2,000,000 shares;
None outstanding -- --
Common stock, no par value; authorized 10,000,000 shares;
Issued and outstanding: 2,369,835 and 2,858,154 shares 12,323 14,601
Retained earnings 11,378 20,781
Accumulated other comprehensive income, net 531 77
--------- ---------
Total shareholders' equity 24,232 35,459
--------- ---------
Total liabilities and shareholders' equity $446,390 $453,439
========= =========
See Notes to Consolidated Financial Statements.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Six Months Ended
June 30,
2001 2000
-------- --------
Cash flows from operating activities:
Net income $3,555 $3,049
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization, net 33 650
Net realized loss (gains) on securities available for sale -- 38
Provision for loan losses -- 150
Change in other assets and interest receivable (467) (690)
Change in other liabilities and interest payable 395 (1,415)
Other, net 30 14
-------- --------
Total adjustments (9) (1,253)
-------- --------
Net cash from operating activities 3,546 1,796
Cash flows from investing activities:
Net change in loans (10,134) (20,983)
Purchases of investment securities available for sale (18,758) (3,943)
Purchases of investment securities held to maturity (1,326) (840)
Proceeds from sales of investment securities available for sale -- 3,968
Maturities of investment securities available for sale 19,965 149
Maturities or calls of investment securities held to maturity 11,256 607
Purchases of premises and equipment, net (267) (358)
Proceeds from sale of other real estate owned 512 1,737
-------- --------
Net cash provided by/(used in) investing activities 1,248 (19,663)
Cash flows from financing activities:
Change in noninterest bearing transaction accounts (2,921) 7,608
Change in interest bearing transaction accounts (4,595) (1,353)
Change in time deposits (1,017) 16,270
Change in other short-term borrowings 1,842 315
Trust preferred issuance 10,000 --
Issuance/(repurchase) of common stock (14,451) (4,319)
Dividends paid (371) (664)
-------- --------
Net cash (used in)/provided by financing activities (11,513) 17,857
-------- --------
Net change in cash and cash equivalents (6,719) (10)
Cash and cash equivalents at beginning of period 43,927 20,555
-------- --------
Cash and cash equivalents at end of period $37,208 $20,545
======== ========
(Continued)
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
(Continued)
Six Months Ended
June 30,
2001 2000
--------------- --------------
Supplemental Disclosures:
Cash paid during the period for:
Interest expense $6,965 $7,864
Income taxes 2,535 2,224
Noncash investing and financing activities:
Transfers from loans to other real estate owned --- 670
Dividends declared 474 451
See Notes to Consolidated Financial Statements.
(Concluded)
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements should be
read in conjunction with the financial statements and related notes contained in
Redwood Empire Bancorp's 2000 Annual Report to Shareholders. The statements
include the accounts of Redwood Empire Bancorp ("Redwood"), and its wholly owned
subsidiary, National Bank of the Redwoods ("NBR", together with Redwood, the
"Company"). All significant inter-company balances and transactions have been
eliminated. The financial information contained in this report reflects all
adjustments which, in the opinion of management, are necessary for a fair
presentation of the results of the interim periods. All such adjustments are of
a normal recurring nature. The results of operations and cash flows for the six
months ended June 30, 2001 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2001.
Certain reclassifications were made to prior period financial
statements to conform to current period presentations.
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, federal funds sold and repurchase
agreements with original maturities of 90 days or less. Federal funds sold and
repurchase agreements are generally for one day periods.
2. Earnings per Share
Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the Company.
The Company's pertinent earnings per share data is as follows (in
thousands, except per share data):
Three Months Ended
June 30,
2001 2000
--------------------------- ----------------------------
Basic Diluted Basic Diluted
------------ ------------ ------------- ------------
Earnings per common share:
Net Income $1,768 $1,768 $1,629 $1,629
Earnings per share .73 .71 .52 .51
Weighted average common shares outstanding 2,414,000 2,489,000 (1) 3,157,000 3,213,000 (1)
1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 75,000 and 56,000 for the three months ended
June 30, 2001 and June 30, 2000.
Six Months Ended
June 30,
2001 2000
--------------------------- ----------------------------
Basic Diluted Basic Diluted
------------ ------------ ------------- ------------
Earnings per common share:
Net Income $3,555 $3,555 $3,049 $3,049
Earnings per share 1.39 1.34 .95 .94
Weighted average common shares outstanding 2,567,000 2,645,000 (1) 3,205,000 3,239,000 (1)
1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 78,000 and 34,000 for the six months ended June
30, 2001 and June 30, 2000.
3. Comprehensive Income
The Company's total comprehensive earnings presentation is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
(In thousands)
Net income as reported $1,768 $1,629 $3,555 $3,049
Other comprehensive income (net of tax):
Change in unrealized holding gain (losses)
on available for sale securities (14) 39 454 (68)
Reclassification adjustment - (22) - (23)
----------- ----------- ----------- -----------
Total comprehensive income $1,754 $1,646 $4,009 $2,958
=========== =========== =========== ===========
4. Common Stock Dividend
On May 15, 2001 the Board of Directors declared a quarterly cash
dividend of 20 cents per share on the Company's Common Stock. The dividend was
paid on July 16, 2001 to shareholders of record on June 29, 2001.
5.Business Segments
The Company operates in two principal business segments: core community
banking and merchant card services. The Company's core community banking segment
includes commercial, commercial real estate, construction and permanent
residential lending along with all depository activities. The Company's merchant
card services industry group provides credit card settlement services for
approximately 39,000 merchants throughout the United States.
The condensed income statements and average assets of the individual
segments are set forth in the table below. The information in this table is
derived from the internal management reporting system used by management to
measure the performance of the segments and the Company. The management
reporting system assigns balance sheet and income statement items to each
segment based on internal management accounting policies. Net interest income is
determined by the Company's internal funds transfer pricing system, which
assigns a cost of funds or credit for funds to assets or liabilities based on
their type, maturity or repricing characteristics. Noninterest income and
expense directly attributable to a segment are assigned to that business. Total
other operating expense, including indirect costs, such as overhead, operations
and technology expense, are allocated to the segments based on an evaluation of
costs for product or data processing. All amounts other than allocations of
interest and indirect costs are derived from third parties. The provision for
credit losses is allocated based on the required reserves and the net
charge-offs for each respective segment. The Company allocates depreciation
expense without allocating the related depreciable asset to that segment.
Summary financial data by business segment follows:
For the quarter ended June 30, 2001
---------------------------------------
Merchant
Community Card Total
Banking Services Company
---------------------------------------
(in thousands)
Total interest income $8,442 $ --- $8,442
Total interest expense 3,614 2 3,616
Interest income/(expense) allocation (263) 263 ---
---------------------------------------
Net interest income 4,565 261 4,826
Provision for loan losses --- --- ---
Total other operating income 533 1,019 1,552
Total other operating expense 2,896 536 3,432
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 2,202 744 2,946
Provision for income taxes 880 298 1,178
---------------------------------------
Income from continuing operations before extraordinary item $1,322 $446 $1,768
=======================================
Total Average Assets $418,208 $25,653 $443,861
=======================================
For the quarter ended June 30, 2000
---------------------------------------
Merchant
Community Card Total
Banking Services Company
---------------------------------------
(in thousands)
Total interest income $8,802 $ --- $8,802
Total interest expense 3,527 --- 3,527
Interest income/(expense) allocation (287) 287 ---
---------------------------------------
Net interest income 4,988 287 5,275
Provision for loan losses 50 --- 50
Total other operating income 451 1,075 1,526
Total other operating expense 3,526 479 4,005
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 1,863 883 2,746
Provision for income taxes 757 360 1,117
---------------------------------------
Income from continuing operations before extraordinary item $1,106 $523 $1,629
=======================================
Total Average Assets $416,243 $26,083 $442,326
=======================================
For the six months ended June 30, 2001
----------------------------------------
Merchant
Community Card Total
Banking Services Company
----------------------------------------
(in thousands)
Total interest income $17,495 $ --- $17,495
Total interest expense 7,363 5 7,368
Interest income/(expense) allocation (574) 574 ---
----------------------------------------
Net interest income 9,558 569 10,127
Provision for loan losses --- --- ---
Total other operating income 1,085 1,832 2,917
Total other operating expense 5,999 1,083 7,082
----------------------------------------
Income from continuing operations before income taxes
and extraordinary item 4,644 1,318 5,962
Provision for income taxes 1,875 532 2,407
----------------------------------------
Income from continuing operations before extraordinary item $2,769 $786 $3,555
========================================
Total Average Assets $418,849 $25,125 $443,974
========================================
For the six months ended June 30, 2000
----------------------------------------
Merchant
Community Card Total
Banking Services Company
----------------------------------------
(in thousands)
Total interest income $16,961 $ --- $16,961
Total interest expense 6,747 --- 6,747
Interest income/(expense) allocation (582) 582 ---
----------------------------------------
Net interest income 9,632 582 10,214
Provision for loan losses 150 --- 150
Total other operating income 965 1,972 2,937
Total other operating expense 6,935 928 7,863
----------------------------------------
Income from continuing operations before income taxes
and extraordinary item 3,512 1,626 5,138
Provision for income taxes 1,427 662 2,089
----------------------------------------
Income from continuing operations before extraordinary item $2,085 $964 $3,049
========================================
Total Average Assets $410,605 $25,007 $435,612
========================================
6.Common Stock Repurchases and Trust Preferred Issuance
In January and February 2001, the Board of Directors authorized
separate share repurchases of up to 10% of the Company's total shares
outstanding or 285,000 and 257,000 shares. All shares have been repurchased
under these two authorizations. The repurchased shares were funded, in part,
with proceeds received from a $10,000,000 pooled trust preferred securities
offering which concluded on February 22, 2001. The financing, which qualifies
for tier 1 capital treatment, bears an interest rate of 10.2% and is due in 30
years. Debt issuance costs amounted to approximately $300,000 and will be
amortized over the life of the trust preferred securities.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Forward-Looking Information
This Quarterly Report on Form 10-Q includes forward-looking information
which is subject to the "safe harbor" created by Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as
amended. These forward-looking statements (which involve the Company's plans,
beliefs and goals, refer to estimates, projections or expectations 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
(many of which are beyond our ability to control):
o Competitive pressure in the banking industry and changes in the
regulatory and legislative environment.
o Changes in the interest rate environment (including possible further
declines in interest rates) and volatility of rate sensitive loans and
deposits.
o A decline in the health of the economy nationally or regionally which
could reduce the demand for loans or reduce the value of real estate
collateral securing most of the Company's loans or reduce the volume of
the Company's merchant credit card processing business.
o Credit quality deterioration which could cause an increase in the
provision for loan losses.
o Dividend restrictions.
o Regulatory discretion.
o Material losses in the Company's merchant credit card processing
business from card holder fraud or merchant business failure and the
ability of the Company to comply with the regulations and rules of the
major credit card associations, such as Visa, as described under
"Certain Important Considerations for Investors" in this report.
o Asset/liability repricing risks and liquidity risks.
o Changes in the securities markets.
o A decline in the health of the Northern California economy as a result
of shortages of electrical power or increases in energy costs
o Certain operational risks involving data processing systems or fraud.
Any forward-looking statements made by the Company are intended to
provide investors with additional information with which they may assess the
Company's future potential. All forward-looking statements are based on
assumptions about an uncertain future and are based on information available at
the date such statements are issued. 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, 2000 and "Certain Important
Considerations for Investors" herein.
The following sections discuss significant changes and trends in
financial condition, capital resources and liquidity of the Company from
December 31, 2000 to June 30, 2001. Significant changes and trends in the
Company's results of operations for the three and six months ended June 30,
2001, compared to the same period in 2000 are also discussed.
Summary of Financial Results
The Company reported net income of $1,768,000 ($.71 per diluted share)
for the three months ended June 30, 2001 as compared to $1,629,000 ($.51 per
diluted share) for the same period in 2000, an increase of $139,000 or 9%. This
increase is due to a decrease of $573,000 in noninterest expense, a decrease of
$50,000 in the provision for loan losses, an increase of $26,000 in noninterest
income, all partially offset by a decrease of $449,000 in net interest income.
Net income for the six months ended June 30, 2001 was $3,555,000 ($1.34
per diluted share) as compared to $3,049,000 ($.94 per diluted share) for the
same period in 2000, an increase of $506,000 or 17%. This increase is due to a
decrease of $781,000 in noninterest expense, a decrease of $150,000 in the
provision for loan losses, partially offset by a decrease of $87,000 in net
interest income and a decrease of $20,000 in noninterest income.
Net Interest Income
Net interest income decreased from $5,275,000 in the second quarter of
2000 to $4,826,000 in the second quarter of 2001, which represents a decrease of
$449,000 or 9%. The decline in net interest income was driven by a decrease in
net interest margin as earning assets increased only $1,389,000. The Company's
net interest margin decreased to 4.66% for the three months ended June 30, 2001
from 5.12% for the three months ended June 30, 2000. The decline in net interest
margin is due in part to the interest expense of the Company's pooled trust
preferred debt financing which amounted to $251,000 for the three months ended
June 30, 2001. Such debt had a negative impact on net interest margin of 24
basis points during this period.
Net interest income for the six months ended June 30, 2001 was
$10,127,000, which represents a decrease of $87,000 when compared to the same
period one year ago. The Company's net interest margin decreased from 5.04% at
June 30, 2000 to 4.91% at June 30, 2001. The decline in net interest margin is
due in part to the interest expense of the Company's pooled trust preferred debt
financing which amounted to $357,000 for the six months ended June 30, 2001.
Such debt had a negative impact on net interest margin of 17 basis points during
this period.
For the three months ended June 30, 2001, yield on earning assets
decreased to 8.15% from 8.55% for the same period one year ago. The decrease is
due to a decline in the general interest rate environment. During the first six
months of 2001, the Federal Reserve lowered it's discount rate 2.75%. To counter
the impact of a lower interest rate environment, the Company has embarked on an
asset repositioning strategy. In December 2000, the Company sold $21,205,000 in
single family residential loans and securitized another $17,949,000 as part of
this asset repositioning strategy. Funds received from the loan sale have been
used to fund growth in higher yielding, relationship-based commercial and
commercial real estate loans. As of June 30, 2001, average residential loans
have declined $44,825,000 or 32% while average commercial loans increased by
$13,372,000 or 22% and average commercial real estate loans increased
$18,077,000 or 22%, all when compared to June 30, 2000. At June 30, 2001,
overall average portfolio loans decreased $11,955,000 from June 30, 2000.
However, when considering the impact of the single family residential loan sale
and securitization, average total portfolio loans grew $27,199,000 or 9% as of
June 30, 2001 when compared to June 30, 2000.
For the first six months of 2001, the yield on earning assets increased
to 8.48% from 8.37% for the same period one year ago. This increase is primarily
due to growth of $17,169,000 or 21% in average commercial real estate loans and
$11,490,000 or 11% in average commercial loans and a decline in lower yielding
average residential loans of $36,962,000 or 28% during this period. Overall
average portfolio loans decreased $3,372,000 during this period when compared to
the same period one year ago. However, when considering the impact of the single
family residential loan sale and securitization, average total portfolio loans
grew $35,782,000 or 13% for the first six months of 2001 when compared to the
same period one year ago.
Yield paid on interest bearing liabilities decreased to 4.51% for the
three months ended June 30, 2001 as compared to 4.53% for the same period one
year ago. This slight decline is attributable to a lower interest rate
environment as discussed above, offset by the impact of the Company's pooled
trust preferred debt financing.
Yield paid on interest bearing liabilities increased to 4.65% for the
six months ended June 30, 2001, as compared to 4.41% for the same period in
2000, primarily as a result of the Company's pooled trust preferred debt
financing.
With the increase in average earning assets in the first six months of
2001, the Company's funding levels also increased as average interest bearing
liabilities increased $11,949,000 or 4% during this period. The average balance
of higher cost time deposits increased $9,977,000 during the first six months of
2001 as compared to the same period one year ago. The growth in time deposits in
2001 is a result of the Company's efforts to fund earning asset growth.
The following is an analysis of the Company's net interest margin for
the indicated periods:
Three months ended Three months ended
June 30, 2001 June 30, 2000
------------------------------------- --------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
------------------------------------- --------------------------------------
Commercial loans $73,152 $1,664 9.12% $59,780 $1,626 10.94%
Real estate-mortgage loans 93,736 1,923 8.23 138,561 2,654 7.70
Real estate-commercial loans 102,117 2,263 8.89 84,040 1,860 8.90
Construction loans 40,294 934 9.30 44,417 1,189 10.77
Installment and other 10,371 183 7.08 5,256 103 7.88
Deferred loan fees (856) --- --- (1,285) --- ---
-------------------------- --------------------------
Portfolio loans 318,814 6,967 8.77 330,769 7,432 9.04
Investments 74,546 1,212 6.52 78,100 1,290 6.64
Federal funds sold 22,285 263 4.73 5,387 80 5.97
-------------------------- -------------------------
Total earning assets (1) 415,645 8,442 8.15 414,256 8,802 8.55
Interest bearing transaction accounts 123,727 782 2.54 127,596 935 2.95
Time deposits 184,540 2,551 5.54 180,608 2,508 5.59
Other borrowings 13,211 283 8.59 5,175 84 6.53
-------------------------- --------------------------
Total interest-bearing liabilities $321,478 $3,616 4.51% $313,379 $3,527 4.53%
Net interest income $4,826 $5,275
============ ============
Net interest income to
earning assets 4.66% 5.12%
Six months ended Six months ended
June 30, 2001 June 30, 2000
------------------------------------- --------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
------------------------------------- --------------------------------------
Commercial loans $70,773 $3,409 9.71% $59,283 $3,133 10.63%
Real estate-mortgage loans 95,820 3,932 8.28 132,782 5,036 7.63
Real estate-commercial loans 100,285 4,452 8.95 83,116 3,604 8.72
Construction loans 43,300 2,202 10.26 42,692 2,231 10.51
Installment and other 9,442 361 7.71 5,556 194 7.02
Deferred loan fees (896) --- --- (1,333) --- ---
-------------------------- --------------------------
Portfolio loans 318,724 14,356 9.08 322,096 14,198 8.86
Investments 76,235 2,599 6.87 77,701 2,540 6.57
Federal funds sold 21,107 540 5.16 7,685 223 5.84
-------------------------- --------------------------
Total earning assets (1) 416,066 17,495 8.48 407,482 16,961 8.37
Interest bearing transaction accounts 123,907 1,630 2.65 127,493 1,852 2.92
Time deposits 186,048 5,303 5.75 176,071 4,762 5.44
Other borrowings 9,899 435 8.86 4,341 133 6.16
-------------------------- --------------------------
Total interest-bearing liabilities $319,854 $7,368 4.65% $307,905 $6,747 4.41%
Net interest income $10,127 $10,214
============ ============
Net interest income to
earning assets 4.91% 5.04%
(1) Nonaccrual loans are included in the calculation of the average balance
of earning assets (interest not accrued is excluded).
The following table sets forth changes in interest income and interest
expense for each major category of interest-earning asset and interest-bearing
liability, and the amount of change attributable to volume and rate changes for
the three and six months ended June 30, 2001 and 2000. Changes not solely
attributable to rate or volume have been allocated proportionately to the change
due to volume and the change due to rate.
Three months ended June 30, 2001 compared
to the three months ended June 30, 2000
Volume Rate Total
---------------------------------------
(in thousands)
Increase (decrease) in interest income:
Commercial loans $1,317 ($1,279) $38
Real estate-mortgage loans (3,634) 2,903 (731)
Real estate-commercial loans 1,602 (1,199) 403
Construction loans (417) 162 (255)
Installment and other 365 (285) 80
Investments (232) 154 (78)
Federal funds sold 810 (627) 183
---------------------------------------
Total increase (decrease) (189) (171) (360)
---------------------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts (111) (42) (153)
Time deposits 218 (175) 43
Other borrowings 660 (461) 199
---------------------------------------
Total increase (decrease) 767 (678) 89
---------------------------------------
Increase (decrease) in net interest income ($956) $507 ($449)
=======================================
Six months ended June 30, 2001 compared
to the six months ended June 30, 2000
Volume Rate Total
---------------------------------------
(in thousands)
Increase (decrease) in interest income:
Commercial loans $1,141 ($865) $276
Real estate-mortgage loans (2,981) 1,877 (1,104)
Real estate-commercial loans 1,521 (673) 848
Construction loans 63 (92) (29)
Installment and other 294 (127) 167
Investments (97) 156 59
Federal funds sold 693 (376) 317
---------------------------------------
Total increase (decrease) 634 (100) 534
---------------------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts (102) (120) (222)
Time deposits 555 (14) 541
Other borrowings 451 (149) 302
---------------------------------------
Total increase (decrease) 904 (283) 621
---------------------------------------
Increase (decrease) in net interest income ($270) $183 ($87)
=======================================
Provision for Loan Losses
Due to the improved asset quality of the Company, there was no
provision for loan losses for the quarter and six months ended June 30, 2001 as
compared to $50,000 and $150,000 for the same periods in the previous year. For
further information, see "Allowance for Loan Losses" and "Nonperforming Assets"
in this section.
Noninterest Income and Expense and Income Taxes
Noninterest Income
The following tables set forth the components of the Company's
noninterest income for the three and six months ended June 30, 2001, as compared
to the same period in 2000.
Three Months Ended
June 30,
-------------------------- $ %
2001 2000 Change Change
----------- ----------- -----------------------
(dollars in thousands)
Service charges on deposit accounts $266 $251 $15 6%
Merchant draft processing, net 1,019 1,075 (56) (5)
Loan servicing income 80 80 --- ---
Gain (loss) on sale of securities --- (37) 37 (100)
Other income 187 157 30 19
----------- ----------- ------------
Total noninterest income $1,552 $1,526 $26 2%
=========== =========== ============
Six Months Ended
June 30,
-------------------------- $ %
2001 2000 Change Change
----------- ----------- -----------------------
(dollars in thousands)
Service charges on deposit accounts $535 $528 $7 1%
Merchant draft processing, net 1,832 1,972 (140) (7)
Loan servicing income 157 120 37 31
Gain (loss) on sale of securities --- (38) 38 (100)
Other income 393 355 38 11
----------- ----------- ------------
Total noninterest income $2,917 $2,937 ($20) (1%)
=========== =========== ============
Noninterest income increased $26,000, or 2%, to $1,552,000 for the
second quarter of 2001 when compared to $1,526,000 for the same period in 2000.
During this period, such increase is primarily due to a decrease in merchant
card net revenue of $56,000, a decrease of $37,000 in losses associated with
investment securities available for sale partially offset by an increase of
$30,000 in other income during this period.
Noninterest income decreased $20,000, or 1%, to $2,917,000 for the
second quarter of 2001 when compared to $2,937,000 one year ago. During this
period, the decrease is due to a decline in merchant card net revenue of
$140,000 during this period. In the fourth quarter of 2000, a large merchant
card processing contract with an independent sales organization ("ISO", or
collectively, "ISO's") expired. To help offset the decline in merchant credit
card processing revenue brought about by the expiration of this contract, the
Company has been seeking to build its overall merchant credit card processing
business through direct marketing efforts and new ISO business. Excluding net
revenue from merchant credit card processing, noninterest income grew $120,000,
or 12%, for the first six months of 2001 when compared to the same period one
year ago.
Noninterest Expense
The following tables set forth the components of the Company's
noninterest expense during the three and six months ended June 30, 2001, as
compared to the same period in 2000.
Three Months Ended
June 30,
------------------------------ $ %
2001 2000 Change Change
-------------- -------------- ----------------------
(dollars in thousands)
Salaries and employee benefits $1,989 $2,092 ($103) (5%)
Occupancy and equipment expense 503 509 (6) (1)
Other 940 1,404 (464) (33)
-------------- -------------- ----------
Total noninterest expense $3,432 $4,005 ($573) (14%)
============== ============== ==========
Six Months Ended
June 30,
------------------------------ $ %
2001 2000 Change Change
-------------- -------------- ---------------------
(dollars in thousands)
Salaries and employee benefits $4,221 $4,242 ($21) ---
Occupancy and equipment expense 992 1,010 (18) (2)
Other 1,869 2,611 (742) (28)
-------------- -------------- ----------
Total noninterest expense $7,082 $7,863 ($781) (10%)
============== ============== ==========
Noninterest expense decreased by $573,000, or 14%, to $3,432,000 during
the second quarter of 2001 as compared to $4,005,000 for the second quarter of
2000. The decrease in noninterest expense for the three-month period ended June
30, 2001, as compared to the same period ended June 30, 2000, is attributable to
a decline in salaries and employee benefits of $103,000, occupancy and equipment
expense of $6,000 and other expense of $464,000. During the fourth quarter of
2000, the Company embarked on an efficiency improvement initiative, which seeks
to lower to Company's efficiency ratio to less than 50%. Such initiative is
primarily comprised of process improvement, job function consolidation and
vendor expense control. For the quarter ended June 30, 2001 the Company's
efficiency ratio was 53.81% as compared to 58.89% for the same period one year
ago.
Noninterest expense decreased by $781,000, or 10%, to $7,082,000 during
the six months ended June 30, 2001 as compared to $7,863,000 during the same
period one year ago. The decline in noninterest expense is directly attributable
to the Company's focus on improving efficiency as referred to above. The
Company's efficiency ratio for the first six months of 2001 amounted to 54.29%
as compared to 59.79% for the same period one year ago.
Income Taxes
The Company's effective tax rate varies with changes in the relative
amounts of its non-taxable income and nondeductible expenses. The effective tax
rate was 39.99% and 40.37% for the three and six months ended June 30, 2001, as
compared to 40.68% and 40.66% for the same periods in 2000.
Business Segments
The Company operates in two principal product and service lines: core
community banking and merchant credit card services. The Company's core
community banking segment includes commercial, commercial real estate,
construction and permanent residential lending along with treasury and
depository activities. The Company's merchant card services industry group
provides credit card settlement services for approximately 39,000 merchants
throughout the United States.
Summary financial data by business segment for the indicated periods is
as follows:
For the quarter ended June 30, 2001
---------------------------------------
Merchant
Community Card Total
Banking Services Company
---------------------------------------
(in thousands)
Total interest income $8,442 $ --- $8,442
Total interest expense 3,614 2 3,616
Interest income/(expense) allocation (263) 263 ---
---------------------------------------
Net interest income 4,565 261 4,826
Provision for loan losses --- --- ---
Total other operating income 533 1,019 1,552
Total other operating expense 2,896 536 3,432
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 2,202 744 2,946
Provision for income taxes 880 298 1,178
---------------------------------------
Income from continuing operations before extraordinary item $1,322 $446 $1,768
=======================================
Total Average Assets $418,208 $25,653 $443,861
=======================================
For the quarter ended June 30, 2000
---------------------------------------
Merchant
Community Card Total
Banking Services Company
---------------------------------------
(in thousands)
Total interest income $8,802 $ --- $8,802
Total interest expense 3,527 --- 3,527
Interest income/(expense) allocation (287) 287 ---
---------------------------------------
Net interest income 4,988 287 5,275
Provision for loan losses 50 --- 50
Total other operating income 451 1,075 1,526
Total other operating expense 3,526 479 4,005
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 1,863 883 2,746
Provision for income taxes 757 360 1,117
---------------------------------------
Income from continuing operations before extraordinary item $1,106 $523 $1,629
=======================================
Total Average Assets $416,243 $26,083 $442,326
=======================================
For the six months ended June 30, 2001
----------------------------------------
Merchant
Community Card Total
Banking Services Company
----------------------------------------
(in thousands)
Total interest income $17,495 $ --- $17,495
Total interest expense 7,363 5 7,368
Interest income/(expense) allocation (574) 574 ---
----------------------------------------
Net interest income 9,558 569 10,127
Provision for loan losses --- --- ---
Total other operating income 1,085 1,832 2,917
Total other operating expense 5,999 1,083 7,082
----------------------------------------
Income from continuing operations before income taxes
and extraordinary item 4,644 1,318 5,962
Provision for income taxes 1,875 532 2,407
----------------------------------------
Income from continuing operations before extraordinary item $2,769 $786 $3,555
========================================
Total Average Assets $418,849 $25,125 $443,974
========================================
For the six months ended June 30, 2000
----------------------------------------
Merchant
Community Card Total
Banking Services Company
----------------------------------------
(in thousands)
Total interest income $16,961 $ --- $16,961
Total interest expense 6,747 --- 6,747
Interest income/(expense) allocation (582) 582 ---
----------------------------------------
Net interest income 9,632 582 10,214
Provision for loan losses 150 --- 150
Total other operating income 965 1,972 2,937
Total other operating expense 6,935 928 7,863
----------------------------------------
Income from continuing operations before income taxes
and extraordinary item 3,512 1,626 5,138
Provision for income taxes 1,427 662 2,089
----------------------------------------
Income from continuing operations before extraordinary item $2,085 $964 $3,049
========================================
Total Average Assets $410,605 $25,007 $435,612
========================================
Community Banking
The Community Banking segment's income before income tax increased for
the three and six months ended June 30, 2001 when compared to the same periods
in 2000. The increase is due to reduced operating expenses, and no provision for
loan losses. For the three and six months ended June 30, 2001, segment expenses
declined $630,000 or 22% and $936,000 or 13%, primarily due to reduced overhead
and administrative expenses. This reduction in expenses offset the decline in
net interest income. Net interest income declined $423,000 and $74,000 for the
three and six months ended June 30, 2001, principally due to the issuance of
pooled trust preferred debt financing which has been fully allocated to the
Community Banking segment. The Company increased its loan portfolio during the
first six months of 2001 through renewed marketing efforts. At June 30, 2001,
total average portfolio loans were $318,724,000, up 13% from $282,942,000 at
June 30, 2000, after consideration of the impact of the single family
residential loan sale and securitization in the fourth quarter of 2000.
Merchant Card Services
The Company's credit card segment earned $446,000 and $786,000 in the
three and six months ended June 30, 2001 compared to $523,000 and $964,000 for
the same periods in 2000. The decline in the unit's net income is due to a
decline in processing revenue, which is directly attributable to the expiration
of a large merchant credit card processing contract in the fourth quarter of
2000. The merchant credit card segment's net income comprised 25% and 22% of the
Company's consolidated net income for the three and six months ended June 30,
2001.
The Company bears certain risks associated with its merchant credit
card processing business. Due to a contractual obligation between NBR and Visa
and MasterCard, NBR stands in the place of the merchant in the event that a
merchant is unable to pay charge-backs from cardholders. As a result of this
obligation, NBR may incur losses associated with its merchant credit card
processing business. Accordingly, NBR has established a reserve to provide for
losses associated with charge-back losses. Such reserve, which totaled
$1,240,000 and $1,146,000 as of June 30, 2001 and 2000, was estimated based upon
industry loss data as a percentage of transaction volume throughout each year,
historical losses incurred by the Company and management's assumptions regarding
merchant and Independent Sales Organization (ISO) risk. The Company utilizes the
services of ISOs to acquire merchants as customers. The provision for
charge-back losses, which is included in the financial statements as a reduction
in merchant draft processing income, was $54,000 and $74,000 for the three and
six months ended June 30, 2001, as compared to $102,000 and $238,000 for the
three and six months ended June 30, 2000. Charge offs were $113,000 and $189,000
for the three and six months ended June 30, 2001. There were no charge-offs in
the three and six months ended June 30, 2000. For further discussion see
"Certain Important Considerations for Investors" in this section.
The following table summarizes the Company's merchant card allowance
for charge-back losses for the periods indicated:
Three months ended Six months ended
June 30, June 30,
2001 2000 2001 2000
-----------------------------------------------------
(in thousands)
Beginning allowance $1,266 $1,044 $1,276 $908
Provision for losses 54 102 74 238
Recoveries 33 --- 79 ---
Charge-offs (113) --- (189) ---
------------------------- --------------------------
Ending allowance $1,240 $1,146 $1,240 $1,146
========================= ==========================
Investment Securities
Total investment securities declined to $74,964,000, as of June 30,
2001, compared to $85,210,000 as of December 31, 2000. This decrease is
primarily due to $26,000,000 in investment securities being called by their
issuer during the first six months of 2001. The Company's average federal funds
sold position was $21,107,000 for the first six months of 2001 as compared to
$7,685,000 for the same period in 2000. This was primarily due to the single
family residential loan sale in the fourth quarter of 2000 and the called
investment securities referred to above. As proceeds from these transactions are
redeployed into the loan portfolio, the Company anticipates that its average
federal funds sold position will decline in the future.
Loans
Total loans increased $10,681,000, or 3%, to $325,782,000 at June 30,
2001 compared to $315,101,000 at December 31, 2000. The increase in portfolio
loans during this period is primarily attributable to the Company's marketing
efforts and a general expansion of businesses within the Company's market area.
Commercial real estate loans increased $12,721,000 to $105,812,000, at June 30,
2001, compared to $93,091,000 at December 31, 2000. Commercial loans increased
$9,852,000 to $76,497,000, at June 30, 2001, compared to $66,645,000 at December
31, 2000. During the fourth quarter of 2000, the Company sold $21,205,000 in
single family residential loans and securitized another $17,949,000 as part of
an asset repositioning strategy. The Company anticipates that the funds received
from the loan sale will be used to fund growth in higher yielding,
relationship-based commercial and commercial real estate loans.
The following table summarizes the composition of the loan portfolio at
June 30, 2001 and December 31, 2000:
June 30, 2001 December 31, 2000
-------------------------------- --------------------------------
Amount % Amount %
-------------------------------- --------------------------------
(dollars in thousands) (dollars in thousands)
Residential real estate mortgage $91,806 29% $98,914 31%
Commercial real estate mortgage 105,812 32 93,091 29
Commercial 76,497 23 66,645 21
Real estate construction 43,479 13 49,460 16
Installment and other 8,958 3 7,900 3
Less deferred loan fees (770) 0 (909) 0
-------------------------------- --------------------------------
Total portfolio loans 325,782 100% 315,101 100%
============= =============
Less allowance for loan losses (7,704) (7,674)
------------------- -------------------
Net loans $318,078 $307,427
=================== ===================
Allowance for Loan Losses
The allowance for loan losses is established through charges to
earnings in the form of the provision for loan losses. Loan losses are charged
to, and recoveries are credited to, the allowance for loan losses. The provision
for loan losses is determined after considering various factors such as loan
loss experience, current economic conditions, maturity of the portfolio, size of
the portfolio, industry concentrations, borrower credit history, the existing
allowance for loan losses, independent loan reviews, current charges and
recoveries to the allowance for loan losses and the overall quality of the
portfolio, as determined by management, regulatory agencies and independent
credit review consultants retained by the Company.
The Company's allowance for loan losses is based on specific and
formula allocations to the Company's loan portfolio. Specific allocations of the
allowance for loan losses are made to identified problem loans where management
has identified significant conditions or circumstances related to a given loan,
which management believes indicates the probability that a loss may occur. The
specific allocations are increased or decreased through management's
reevaluation on a quarterly basis of the status of the particular problem loans.
Loans which do not receive a specific allocation receive an allowance allocation
based on a formula, represented by a percentage factor based on underlying
collateral, type of loan, historical charge-offs, general economic conditions
and other qualitative factors.
The following table summarizes changes in the Company's allowance for
loan losses for the indicated periods:
Three months ended Six months ended
June 30 June 30
--------------------------- --------------------------
2001 2000 2001 2000
----------- ------------ ----------- ------------
(dollars in thousands)
Beginning allowance for loan losses $7,696 $7,980 $7,674 $7,931
Provision for loan losses --- 50 --- 150
Charge-offs (2) (80) (2) (147)
Recoveries 10 149 32 165
----------- ------------ ----------- ------------
Ending allowance for loan losses $7,704 $8,099 $7,704 $8,099
=========== ============ =========== ============
Net charge-offs to average
loans (annualized) (0.01%) (0.08%) (0.02%) (0.01%)
The allowance for loan losses as a percentage of portfolio loans
decreased from 2.44%, at December 31, 2000, to 2.36% at June 30, 2001. This
decrease is due to several factors which include an improvement in the overall
credit quality of the Company's loan portfolio, reflected in a reduction in loan
charge-offs and growth in the Company's loan portfolio. The growth in the
Company's loan portfolio is primarily comprised of commercial real estate loans
that generally bear a lower credit risk than construction or commercial loans.
Accordingly, under the Company's loan loss reserve methodology, such loans
generally receive a lower loan loss reserve allocation as compared to commercial
or construction loans.
Nonperforming Assets
The following table summarizes the Company's nonperforming assets at
the dates indicated:
June 30, December 31,
2001 2000
---------------- ---------------
(dollars in thousands)
Nonaccrual loans $1,553 $908
Accruing loans past due 90 days or more --- ---
Restructured loans 293 295
---------------- ---------------
Total nonperforming loans 1,846 1,203
Other real estate owned --- 757
---------------- ---------------
Total nonperforming assets $1,846 $1,960
================ ===============
Nonperforming assets to total assets 0.41% 0.43%
Nonperforming assets have decreased from $1,960,000, as of December 31,
2000, to $1,846,000 as of June 30, 2001. The decrease is attributable to a
decrease in other real estate owned of $757,000 during this period.
Nonperforming loans consist of loans to 12 borrowers, six of which have
balances in excess of $100,000. The two largest have recorded balances of
$632,000 and $222,000. One property is secured by real estate, the other by
commercial property. Based on information currently available, management
believes that adequate reserves are included in the allowance for loan losses to
cover any loss exposure that may result from these loans.
At June 30, 2001, the Company did not have any loans classified as
other real estate owned.
Although the volume of nonperforming assets will depend in part on the
future economic environment, there are four additional loan relationships which
total approximately $2,669,000 about which management has serious doubts as to
the ability of the borrowers to comply with the present repayment terms. These
loans may become nonperforming assets based on the information presently known
about possible credit problems of the borrowers.
At June 30, 2001, the Company's total recorded investment in impaired
loans (as defined by SFAS 114 and 118) was $1,846,000 of which $1,551,000
relates to the recorded investment for which there is a related allowance for
loan losses of $782,000. The remaining $295,000 in impaired loans did not
require a valuation allowance.
The Company's average recorded investment in impaired loans during the
six months ended June 30, 2001 and 2000 was $1,358,000 and $1,762,000. The
decline of $404,000 in the average recorded investment of impaired loans at June
30, 2001 compared to the same period one year ago is a direct result of the
Company's efforts in reducing nonperforming assets. The related amount of
interest income recognized during the periods that such loans were impaired was
$15,000 and $44,000 for the three and six months ended June 30, 2001, and
$12,000 and $27,000 for the three and six months ended June 30, 2000.
As of June 30, 2001 there was $1,553,000 of loans on which the accrual
of interest had been discontinued as compared to $908,000 at December 31, 2000.
During the first three and six months of 2001 interest due but excluded from
interest income on loans placed on nonaccrual status was $23,000 and $41,000,
and interest income received on nonaccrual loans was $2,000 and $5,000.
From time to time the Company may be required to repurchase mortgage
loans from mortgage loan investors as a result of breaches of representations
and warranties in the purchase agreement between the investor and the Company.
The Company may also be required to reimburse a mortgage loan investor for
losses incurred as a result of liquidating collateral which had secured a
mortgage loan sold by the Company. Such representations and warranties include
the existence of a valid appraisal, status of borrower, or fraud. In the first
six months of 2001 the Company was not required to repurchase any such loans.
The Company maintains a reserve for its estimate of potential losses associated
with the repurchase of previously sold mortgage loans. Such reserve amounted to
$93,000 as of June 30, 2001 and $93,000 as of December 31, 2000. The Company
expects that it may be required to repurchase loans in the future.
Liquidity
Redwood's primary source of liquidity is dividends from NBR. Redwood's
primary uses of liquidity have historically been associated with cash payments
made to subordinated debt holders, dividend payments made to preferred stock
holders and operating expenses. It is Redwood's general policy to retain
liquidity at the parent level which management believes to be consistent with
the safety and soundness of the Company as a whole. As of June 30, 2001, Redwood
held $11,000 in deposits at NBR.
Prior to June 30, 2001, Redwood paid a cash dividend to its common
stockholders at a quarterly rate of $.15 per share. Such quarterly dividend rate
was increased to $.20 in May 2001. Further, Redwood is required to make
semi-annual payments of interest at 10.2% on $10,000,000 of trust preferred
securities issued in 2001. Payment of these obligations is ultimately dependent
on dividends from NBR to Redwood. Federal regulatory agencies have the authority
to prohibit the payment of dividends by NBR to Redwood if a finding is made that
such payment would constitute an unsafe or unsound practice or if NBR would
become undercapitalized as a result. If NBR is restricted from paying dividends,
Redwood could be unable to pay dividends to its common shareholders. No
assurance can be given as to the ability of NBR to pay dividends to Redwood in
the future.
During the first six months of 2001, NBR declared a dividend of
$2,600,000. Management believes that as of June 30, 2001, the Company's
liquidity position was adequate for the operations of Redwood and NBR for the
foreseeable future.
Although each entity within the consolidated Company manages its own
liquidity, the Company's consolidated cash flow can be divided into three
distinct areas: operating, investing and financing. For the six months ended
June 30, 2001, the Company received cash of $1,248,000 from investing
activities, while using $9,000 in operating activities and $11,513,000 in
financing activities.
Capital Resources
A strong capital base is essential to the Company's continued ability
to service the needs of its customers. Capital protects depositors and the
deposit insurance fund from potential losses and is a source of funds for the
substantial investments necessary for the Company to remain competitive. In
addition, adequate capital and earnings enable the Company to gain access to the
capital markets to supplement its internal growth of capital. Capital is
generated internally primarily through earnings retention.
The Company and NBR are required to maintain minimum capital ratios
defined by various federal government regulatory agencies. The Board of
Governors of the Federal Reserve System and the Office of the Comptroller of
Currency have each established capital guidelines which include minimum capital
requirements. These regulations impose three sets of standards: "risk-based",
"leverage" and "tangible" capital.
Under the risk-based capital standard, assets reported on an
institution's balance sheet and certain off-balance sheet items are assigned to
risk categories, each of which is assigned a risk weight. This standard
characterizes an institution's capital as being "Tier 1" capital (defined as
principally comprising shareholders' equity and noncumulative preferred stock)
and "Tier 2" capital (defined as principally comprising the allowance for loan
losses and subordinated debt).
Under the leverage capital standard, an institution must maintain a
specified minimum ratio of Tier 1 capital to total assets, with the minimum
ratio ranging from 4% to 6%. The leverage ratio for the Company and NBR is based
on average assets for the quarter.
The following table summarizes the consolidated capital ratios and the
capital ratios of the principal subsidiaries at June 30, 2001 and December 31,
2000.
June 30, 2001 December 31, 2000
--------------------------------------- -------------------------------------
Well- Minimum Well- Minimum
Actual Capitalized Requirement Actual Capitalized Requirement
--------------------------------------- -------------------------------------
Company
Leverage 7.00% 5.00% 4.00% 7.72% 5.00% 4.00%
Tier 1 risk-based 8.78 6.00 4.00 9.99 6.00 4.00
Total risk-based 10.55 10.00 8.00 11.25 10.00 8.00
NBR
Leverage 7.68% 5.00% 4.00% 7.29% 5.00% 4.00%
Tier 1 risk-based 9.62 6.00 4.00 9.44 6.00 4.00
Total risk-based 10.88 10.00 8.00 10.70 10.00 8.00
In January and February 2001, the Board of Directors authorized
separate share repurchases of up to 10% of the Company's total shares
outstanding or 285,000 and 257,000 shares. As of June 30, 2001, all shares have
been repurchased under these two authorizations. Under the repurchase programs,
the Company repurchased shares on the open market or through privately
negotiated transactions. The repurchased shares were funded in part with
proceeds received from a $10,000,000 pooled trust preferred securities offering
which concluded on February 22, 2001. The Company accounted for this repurchase
program by reducing common stock by $3,028,000, or 20% of the repurchase cost,
with the remaining 80% of the repurchase cost, or $12,112,000, reducing retained
earnings.
Trust Preferred Securities
In February 2001 the Company completed its $10,000,000 participation in
a pooled trust preferred securities offering. The financing, which qualifies for
tier 1 capital treatment, bears an interest rate of 10.2% and is due in 30
years. Debt issuance costs amounted to approximately $300,000 and will be
amortized over the life of the securities. The funds have been, and will
continue to be, used for stock repurchases and other general corporate purposes.
Cash required to service this debt on a semi-annual basis is approximately
$510,000.
Certain Important Considerations for Investors
Merchant Credit Card Processing. The Company's profitability can be
negatively impacted should any of the Company's merchant credit card customers
be unable to pay on charge-backs from cardholders. Due to a contractual
obligation between the Company and Visa and Mastercard, NBR stands in the place
of the merchant in the event that a merchant refuses, or is unable due to
bankruptcy or other reasons to pay on charge-backs from cardholders. Management
has taken certain actions to decrease the risk of merchant bankruptcy associated
with its merchant credit card business. These steps include the discontinuance
of high-risk accounts. Chargeback exposure can also result from fraudulent
credit card transactions initiated by merchant customers. To mitigate merchant
fraud risk, the Company employs certain underwriting standards when accepting a
new merchant. Further, the Company monitors merchant activity for unusual
transactions. In addition, the Company bears the risk of merchant nonpayment
of applicable interchange, assessment and other fees. Failure by the merchants
to pay such fees may adversely affect the Company's revenues. The Company
utilizes ISO's to acquire merchant credit card customers. The Company's ability
to maintain and grow net revenue from its merchant credit card processing
operation is dependent upon maintaining and adding to these ISO relationships.
Merchant credit card processing services are highly regulated by credit
card associations such as VISA. In order to participate in the credit card
programs, the Company must comply with the credit card association's rules and
regulations that may change from time to time. If the Company fails to comply
with these credit card association standards, the Company's status as a member
service provider and as a certified processor could be suspended or terminated.
During November 1999, VISA adopted several rule changes to reduce risks in
high-risk merchant credit card programs and these rule changes affect the
Company's merchant credit card business. The rule changes went into effect on
March 31, 2001. These changes included a requirement that a processor's reported
fraud ratios be no greater than three times the national average. At February
28, 2001 (the most recent period available from VISA), the Company's overall
fraud ratio was equal to the VISA requirement. Other VISA changes included the
requirement that total processing volume in certain high-risk categories (as
defined by VISA) be less than 20% of total processing volume. At June 30, 2001,
the Company's total VISA transactions within these certain high-risk categories
were 15% of total VISA processing volume. Other changes VISA announced included
a requirement that weekly VISA volumes be less than 60% of an institution's
tangible equity capital, as well as a requirement that aggregate charge-backs
for the previous six months be less than 5% of the institution's tangible equity
capital or the aggregate charge-backs for the quarter be less than .59% of the
interchange count and .95% of the interchange amount. At June 30, 2001 the
Company's weekly VISA volume was 34.8% of the Company's tangible equity capital,
and aggregate charge-backs for the previous six months were 6.2% of tangible
equity capital and the aggregate charge-backs for the quarter were .56% of the
interchange count and .68% of the interchange amount. Merchant credit card
participants, such as the Company, must comply with these new VISA rules by
filing a compliance plan with VISA. Such plan has been filed by the Company and
accepted by VISA. At June 30, 2001, the Company is in compliance with all rule
changes that went into effect on March 31, 2001. Should the Company be unable to
comply with these rule changes, VISA will require collateral of one to four
times the shortfall.
Concentration of Lending Activities. Concentration of the Company's
lending activities in the real estate sector, including construction loans,
could have the effect of intensifying the impact on the Company of adverse
changes in the real estate market in the Company's lending areas. At June 30,
2001, approximately 74% of the Company's loans were secured by real estate, of
which 44% were secured by commercial real estate, including small office
buildings, owner-user office/warehouses, mixed use residential and commercial
properties and retail properties. Substantially all of the properties that
secure the Company's present loans are located in Northern and Central
California. The ability of the Company to continue to originate mortgage or
construction loans may be impaired by adverse changes in local or regional
economic conditions, adverse changes in the real estate market, increasing
interest rates, or acts of nature (including earthquakes, which may cause
uninsured damage and other loss of value to real estate that secures the
Company's loans). In addition, prolonged electrical power shortages or increases
in energy costs in Northern California may cause adverse changes in the
Company's local economy. Due to the concentration of the Company's real estate
collateral, such events could have a significant adverse impact on the value of
such collateral and the Company's earnings.
Government Regulation. The Company and its subsidiaries are subject to
extensive federal and state governmental supervision, regulation and control.
Future legislation and government policy could adversely affect the financial
industry. Although the full impact of such legislation and regulation cannot be
predicted, future changes may alter the structure of, and competitive
relationship among, financial institutions.
Competition from Other Financial Institutions. The Company competes for
deposits and loans principally with major commercial banks, other independent
banks, savings and loan associations, savings banks, thrift and loan
associations, credit unions, mortgage companies, insurance companies and other
lending institutions. With respect to deposits, additional significant
competition arises from corporate and governmental debt securities, as well as
money market mutual funds. The Company also depends for its origination of
mortgage loans on independent mortgage brokers who are not contractually
obligated to do business with the Company and are regularly solicited by the
Company's competitors. Aggressive policies of such competitors have in the past
resulted, and may in the future result, in a decrease in the Company's volume of
mortgage loan originations and/or a decrease in the profitability of such
originations, especially during periods of declining mortgage loan origination
volumes. Several of the nation's largest savings and loan associations and
commercial banks have a significant number of branch offices in the areas in
which the Company conducts operations. Among the advantages possessed by the
larger of these institutions are their ability to make larger loans, finance
extensive advertising campaigns, access international money markets and
generally allocate their investment assets to regions of highest yield and
demand.
In addition, the market in which the Company competes for merchant
credit card processing is intensely competitive and, in recent years, has been
characterized by increased consolidation. This consolidation has enabled certain
of the Company's competitors to have access to significant capital, management,
marketing and technological resources that are equal to or greater than those of
the Company, and there can be no assurance that the Company will be able to
continue to compete successfully with such other processors.
Risks Arising from the California Energy Crisis. Due to problems
associated with the deregulation of the electrical power industry in California,
two California utilities have publicly announced that their financial situation
is grave. One of these utilities filed for bankruptcy protection in April 2001.
In addition, customers of these utilities have been faced with increased gas and
electric prices, power shortages and, in some cases, rolling blackouts. The
long-term impact of the energy crisis in California on the markets and
businesses served by the Company cannot be predicted but could result in an
economic slowdown. This could have an adverse effect on the demand for new
loans, the ability of borrowers to repay outstanding loans, the value of real
estate and other collateral securing loans, and the demand for merchant
processing services, and as a result, on the financial condition and results of
operations of the Company and the market value of its common stock.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
As a financial institution, the Company's primary component of market
risk is interest rate volatility. Fluctuation in interest rates will ultimately
impact both the level of income and expense recorded on a large portion of the
Bank's assets and liabilities, and the market value of all interest earning
assets and interest bearing liabilities, other than those which possess a short
term to maturity. Since virtually all of the Company's interest bearing
liabilities and all of the Company's interest earning assets are located at the
Bank, virtually all of the Company's interest rate risk exposure lies at the
Bank level. As a result, all significant interest rate risk management
procedures are performed at the Bank level. Based upon the nature of its
operations, the Bank is not subject to foreign currency exchange or commodity
price risk. The Bank's real estate loan portfolio, concentrated primarily within
Northern California, is subject to risks associated with the local economy. The
Company does not own any trading assets. See "Asset Quality".
The fundamental objective of the Company's management of its assets and
liabilities is to maximize the economic value of the Company while maintaining
adequate liquidity and an exposure to interest rate risk deemed by management to
be acceptable. Management believes an acceptable degree of exposure to interest
rate risk results from the management of assets and liabilities through
maturities, pricing and mix to attempt to neutralize the potential impact of
changes in market interest rates. The Bank's profitability is dependent to a
large extent upon its net interest income, which is the difference between its
interest income on interest-earning assets, such as loans and securities, and
its interest expense on interest-bearing liabilities, such as deposits and
borrowings. The Bank, like other financial institutions, is subject to interest
rate risk to the degree that its interest-earning assets reprice differently
than its interest-bearing liabilities. The Bank manages its mix of assets and
liabilities with the goals of limiting its exposure to interest rate risk,
ensuring adequate liquidity, and coordinating its sources and uses of funds.
The Bank seeks to control its interest rate risk exposure in a manner
that will allow for adequate levels of earnings and capital over a range of
possible interest rate environments. The Bank has adopted formal policies and
practices to monitor and manage interest rate risk exposure. As part of this
effort, the Bank measures risk in three ways: repricing of earning assets and
interest bearing liabilities; changes in net interest income for interest rate
shocks up and down 200 basis points; and changes in the market value of equity
for interest rate shocks up and down 200 basis points.
The following table sets forth, as of June 30, 2001, the distribution
of repricing opportunities for the Company's earning assets and interest-bearing
liabilities, the interest rate sensitivity gap, the cumulative interest rate
sensitivity gap, the interest rate sensitivity gap ratio (i.e., earning assets
divided by interest-bearing liabilities) and the cumulative interest rate
sensitivity gap ratio.
After Three After Six After One
Within Months but Months but Year But
Three Within Six Within One Within After Five
Months Months Year Five Years Years Total
----------------------------------------------------------------------------
(Dollars in thousands)
Interest earning assets:
Federal funds sold $17,171 $ --- $ --- $ --- $ --- $17,171
Investment securities and other --- 1,010 7,471 18,691 47,792 74,964
Mortgage loans held for sale --- --- --- --- --- ---
Loans 162,623 42,694 17,983 52,152 50,330 325,782
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Total interest-earning assets 179,794 43,704 25,454 70,843 98,122 417,917
----------------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing transaction accounts 20,458 20,458 20,458 61,373 --- 122,746
Time deposits 73,455 61,990 39,928 9,874 1 185,248
Trust preferred --- --- --- --- 10,000 10,000
Short-term borrowings 5,370 --- --- --- --- 5,370
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Total interest-bearing liabilities 99,283 82,448 60,386 71,247 10,001 323,364
----------------------------------------------------------------------------
Interest rate sensitivity gap $80,511 ($38,744) ($34,931) ($404) $88,121
================================================================
Cumulative interest rate sensitivity gap 80,511 41,768 6,836 6,433 94,553
Interest rate sensitivity gap ratio 1.81 0.53 0.42 0.99 9.81
Cumulative interest rate sensitivity gap ratio 1.81 1.23 1.03 1.02 1.29
The Company's gap position is substantially dependent upon the volume
of mortgage loans held in the portfolio. These loans generally have maturities
greater than five years; however, these loans have a repricing frequency of at
least quarterly and therefore are classified in the above table as repricing
within three months. Additionally, interest-bearing transaction accounts, which
consist of money market, demand and savings deposit accounts, are classified as
repricing within three months. Some of these deposits may be repriced at
management's option, and therefore a decision not to reprice such deposits could
significantly alter the Company's net interest margin.
Management expects that, in a declining interest rate environment, the
Company's net interest margin would be expected to decline, and, in an
increasing rate environment, the Company's net interest margin would tend to
increase. The Company has experienced greater mortgage lending activity through
mortgage refinancings and financing new home purchases as rates declined, and
may increase its net interest margins in an increasing rate environment if more
traditional commercial bank lending becomes a higher percentage of the overall
earning assets mix. There can be no assurance, however, that under such
circumstances the Company will experience the described relationships to
declining or increasing interest rates.
On a quarterly basis, NBR management prepares an analysis of interest
rate risk exposure. Such analysis calculates the change in net interest income
and the theoretical market value of the Bank's equity given a change in general
interest rates of 100 basis points up and 100 basis points down. All changes are
measured in dollars and are compared to projected net interest income and the
current theoretical market value of the Bank's equity. This theoretical market
value of the Bank's equity is calculated by discounting cash flows associated
with the Company's assets and liabilities. The following is a summary of
interest rate risk exposure as of June 30, 2001 as measured on a net interest
income basis and a market value of equity basis, given a change in general
interest rates of up to 200 basis points up and 200 basis points down.
June 30, 2001
-------------
Change in Annual Change in
Change in Interest Rate Net Interest Income Market Value of Equity
+200 $236,000 ($9,787,000)
+100 $146,000 ($5,082,000)
-100 ($378,000) $1,918,000
-200 ($994,000) $2,982,000
The model utilized by management to create the report presented above
makes various estimates at each level of interest rate change regarding cash
flows from principal repayments on loans and mortgage-backed securities and/or
call activity on investment securities. In addition, repricing these earning
assets and matured liabilities can occur in one of three ways: (1) the rate of
interest to be paid on an asset or liability may adjust periodically based on an
index; (2) an asset, such as a mortgage loan, may amortize, permitting
reinvestment of cash flows at the then-prevailing interest rates; or (3) an
asset or liability may mature, at which time the proceeds can be reinvested at
current market rate. Actual results could differ significantly from those
estimates, which would result in significant differences in the calculated
projected change.
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
On February 22, 2001, the Company completed its $10,000,000
participation in a pooled trust preferred securities offering. Issuance costs
amounted to approximately $300,000 and are being amortized over the 30-year life
of the securities. The Company, relying on Section 4(2),
Rule 506 and Rule 903 of the Securities Act of 1933, as amended, sold the
securities directly to Preferred Term Securities, Ltd. II, a Cayman Islands
corporation. The proceeds have been, and will continue to be, used for share
repurchases and general corporate purposes.
Item 4. Submission of Matters to a Vote of Security Holders
a) The Company held its Annual Meeting of Shareholders on May 15, 2001.
b) Proxies for the Annual Meeting were solicited pursuant to Regulation 14
under the Securities Exchange Act of 1934. There was no solicitation in
opposition to management's nominees for directors as listed in the
Company's proxy statement for the Annual Meeting.
c) The vote for the nominated directors was as follows:
Nominee For Withheld
Robert D. Cook 2,322,257 2,573
Dana R. Johnson 2,323,283 1,547
Patrick W. Kilkenny 2,238,650 86,180
Gregory J. Smith 2,323,110 1,720
William B. Stevenson 2,322,257 2,573
The vote for approval of adoption of the Redwood Empire Bancorp 2001
Stock Option Plan was as follows:
For 1,660,744
Against 174,290
Abstain 11,817
Broker Non-Vote 477,979
The vote for ratifying the appointment of Crowe Chizek and Company LLP
as the Company's independent auditors was as follows:
For 2,303,211
Against 13,992
Abstain 7,627
Broker Non-Vote -0-
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits.
None.
b) Reports on Form 8-K
1. Form 8-K filing dated May 17, 2001 announcing completion of
the Company's share repurchase program and an increase in its
quarterly cash dividend to $0.20 per common share.
2. Form 8-K filing dated April 18, 2001 announcing first quarter
2001 results.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized and in the capacity indicated.
REDWOOD EMPIRE BANCORP
(Registrant)
Date: 8/10/01 By: /s/ James E. Beckwith
------- -------------------------------------------
James E. Beckwith
Executive Vice President,
Chief Financial Officer and
Chief Operating Officer,
Principal Financial Officer, and
Duly Authorized Officer