UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2002
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
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (707) 573-4800
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par
value.
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X
The aggregate market value of the Registrant's common stock held by
non-affiliates on June 28, 2002 (based on the closing sale price of the Common
Stock) was $42,551,296.
As of March 5, 2003 there were 3,373,523 shares outstanding of the
Registrant's common stock.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated by reference in this Form
10-K:
DOCUMENT FORM 10-K REFERENCE
Redwood's Definitive Proxy Statement Part III
For the 2003 Annual Meeting of Shareholders
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TABLE OF CONTENTS
Page
PART I
Forward-Looking Information............................................................................................. 4
Item 1. Business.............................................................................................. 5
Item 2. Properties........................................................................................... 20
Item 3. Legal Proceedings.................................................................................... 20
Item 4. Submission of Matters to a Vote of Security Holders.................................................. 21
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............................ 21
Item 6. Selected Financial Data.............................................................................. 22
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................................ 23
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........................................... 49
Item 8. Financial Statements and Supplementary Data.......................................................... 53
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure........................................................................................... 88
PART III
Item 10. Directors and Executive Officers of the Registrant................................................... 88
Item 11. Executive Compensation................................................................................88
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters........89
Item 13. Certain Relationships and Related Transactions........................................................90
Item 14. Controls and Procedures...............................................................................90
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................... 90
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PART I
Forward-Looking Information
This Annual Report on Form 10-K includes forward-looking information, which
is subject to the "safe harbor" created by Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. These forward-looking statements (which involve, among other things,
the Company's plans, beliefs and goals, refer to estimates or use similar terms)
involve certain risks and uncertainties that could cause actual results to
differ materially from those in the forward-looking statements. Such risks and
uncertainties include, but are not limited to, the following factors:
o Competitive pressure in the banking industry and changes in banking or
other laws and regulations or governmental fiscal or monetary policies.
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 Uncertainty regarding the economic outlook resulting from the continuing
war on terrorism, as well as actions taken or to be taken by the U.S. or
other governments as a result of further acts or threats of terrorism or as
a result of possible military action in Iraq.
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 merchant or card holder fraud or merchant business failure and the
ability of the Company to comply with the rules and regulations of the
major credit card associations, such as Visa and Mastercard, 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, including the
long-term impact of the California energy crisis and the decline in the
technology sector.
o Certain operational risks involving data processing systems or fraud.
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o The proposal or adoption of changes in accounting standards by the
Financial Accounting Standards Board, the Securities and Exchange
Commission or other standard setting bodies.
The Company undertakes no obligation to update these forward-looking
statements to reflect facts, circumstances, assumptions or events that occur
after the date the forward-looking statements are made. For additional
information concerning risks and uncertainties related to the Company and its
operations please refer to "Certain Important Considerations for Investors" in
Item 1, "Management's Discussion and Analysis of Financial Condition and Results
of Operations" in Item 7 and other information in this Report.
Item 1. Business
Redwood Empire Bancorp ("Redwood," and with its subsidiaries, the
"Company") is a bank holding company headquartered in Santa Rosa, California,
and operating in Northern California with two wholly-owned subsidiaries,
National Bank of the Redwoods, a national bank ("NBR" or the "Bank") and Redwood
Statutory Trust I, a Connecticut statutory trust. A previously owned subsidiary
of the Company, Allied Bank, F.S.B., a federal savings bank ("Allied"), merged
with its sister subsidiary, NBR, in March 1997.
(a) General Development of Business.
Redwood is a California corporation, headquartered in Santa Rosa,
California. One of its wholly-owned subsidiaries is NBR, a national bank which
was chartered in 1985. In addition, NBR has three wholly-owned California
chartered subsidiaries, Valley Mortgage Corporation, Allied Diversified Credit,
and Redwood Merchant Services, Inc., all of which are currently inactive.
Redwood was created by NBR in August 1988, in order to become a bank holding
company through the acquisition of all of NBR's outstanding shares. That
transaction was consummated in January 1989. Redwood acquired Allied in
September 1990, through a tax-free reorganization in which Redwood exchanged
shares of its stock for all of the outstanding shares of Allied. The acquisition
of Allied was accounted for as a pooling of interests for financial reporting
purposes.
On October 31, 1992, Lake Savings and Loan Association, a one-branch
California chartered savings and loan based in Lakeport, California ("Lake"),
was purchased for approximately $2,300,000 in cash, and merged into Allied. At
the time of its acquisition, Lake had total assets of approximately $41 million.
The acquisition was accounted for as a purchase.
On November 4, 1994, Codding Bank, a multiple-branch California chartered
bank based in Rohnert Park, California ("Codding"), with total assets of
approximately $42,048,000, was purchased for $7,028,000 in cash, including
merger related expenses, and merged into NBR.
On March 24, 1997, Allied was merged into NBR.
In September 1999, the Company divested its sub prime mortgage brokerage
and mortgage banking units, Valley Financial and Allied Diversified Credit. The
divestiture took the form of an
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asset sale and employee transfer to Valley Financial Funding, Inc., whose
shareholders included senior management of Valley Financial and Allied
Diversified Credit. The Company disclosed the operations of these units as well
as the after tax loss on disposition as discontinued operations. Accordingly,
historical financial information has been recast to present the operating
results of Valley Financial and Allied Diversified Credit as discontinued
operations.
On February 22, 2001, Redwood Statutory Trust I ("RSTI"), a wholly owned
subsidiary of the Company, closed a pooled offering of 10,000 Capital Securities
with a liquidation amount of $1,000 per security. The proceeds of the offering
were loaned to the Company in exchange for junior subordinated debentures with
terms similar to the Capital Securities. The sole assets of RSTI are the junior
subordinated debentures of the Company and payments thereunder. The junior
subordinated debentures and the back-up obligations, in the aggregate,
constitute a full and unconditional guarantee by the Company of the obligations
of RSTI under the Capital Securities. Distributions on the Capital Securities
are payable semi-annually at the annual rate of 10.2% and are included in
interest expense in the consolidated financial statements. These securities are
considered Tier 1 capital (with certain limitations applicable) under current
regulatory guidelines. As of December 31, 2002, the outstanding principal
balance of the Capital Securities was $10,000,000. The principal balance of the
Capital Securities constitute the trust preferred securities in the financial
statements.
The junior subordinated debentures are subject to mandatory redemption, in
whole or in part, upon repayment of the Capital Securities at maturity or their
earlier redemption at the liquidation amount. Subject to the Company having
received prior approval of the Federal Reserve, if then required, the Capital
Securities are redeemable prior to the maturity date of February 22, 2031, at
the option of the Company; on or after February 22, 2021 at par; or on or after
February 22, 2011 at a premium, or upon the occurrence of specific events set
forth in the trust indenture. The Company has the option to defer distributions
on the Capital Securities from time to time for a period not to exceed 10
consecutive semi-annual periods.
On January 15, 2002, NBR formed NBR Real Estate Investment Trust, a
Maryland Real Estate Investment Trust. The entity was formed to hold NBR's real
estate secured loans and to better organize NBR's marketing and origination of
real estate secured loans.
(b) Financial Information About Industry Segments.
The Company operates in two principal industry segments: core community
banking and merchant card services. The Company's core community banking
industry segment includes commercial, commercial real estate, construction, and
permanent residential lending along with all depository activities. The
Company's merchant card services industry group provides credit card settlement
services for approximately 39,000 merchants located throughout the United
States.
(c) Narrative Description of Business.
The Company's business strategy involves two principal business activities
which are conducted through NBR: community banking and merchant card services.
NBR provides its core community banking services through five retail
branches located in Sonoma County, California, one retail branch located in
Mendocino County, California, and one retail branch located in Lake County,
California. NBR generally extends commercial loans to
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professionals and businesses with annual revenues of less than $20 million.
These commercial loans are primarily for working capital and asset acquisitions.
NBR emphasizes the origination of commercial real estate loans within its
primary market area. Such loans are either owner-occupied or investor owned and
are usually supported by long-term leases. Properties which secure loans within
the Company's commercial real estate portfolio include office buildings, retail
centers and industrial buildings. NBR also originates commercial and residential
construction loans for its portfolio along with permanent single family and
multi-family residential loans. NBR's primary targeted lending market area
includes the California counties north of San Francisco.
The primary sources of funds for NBR's commercial and residential lending
programs are local deposits, proceeds from loan sales, loan payments, and other
borrowings. NBR attracts deposits primarily from local businesses, professionals
and retail customers. NBR's primary deposit market areas include the counties of
Sonoma, Mendocino and Lake. Sonoma, Mendocino and Lake Counties have benefited
from the migration of population and businesses into the area, as well as growth
in established firms and industries. These counties have generally exceeded the
growth in population and economic activity of California as a whole. NBR
generally does not purchase deposits through deposit brokers and had no brokered
deposits at December 31, 2002. In addition to deposits, NBR may obtain other
borrowed funds through its membership in the Federal Home Loan Bank of San
Francisco (the "FHLB") and its retention of treasury, tax and loan funds at the
Federal Reserve Bank of San Francisco.
The Company provides Visa and Mastercard credit card processing and
settlement services for approximately 39,000 merchants located throughout the
United States. In 2002, the Company's processing volume exceeded $1.7 billion.
The Company's merchant card services customer base is made up of merchants
located in its primary market area and merchants who have been acquired by the
Company through the use of independent sales agents and independent sales
organizations (individually an "ISO" and collectively "ISO's").
The Company is regulated by various government agencies, with the primary
regulators being the Board of Governors of the Federal Reserve System (the
"FRB"), the Office of the Comptroller of the Currency (the "OCC") and the
Federal Deposit Insurance Corporation (the "FDIC").
The Company and its subsidiaries had 151 full-time-equivalent employees at
December 31, 2002. Redwood's headquarters are located at 111 Santa Rosa Avenue,
Santa Rosa, California 95404-4905, and its telephone number is (707) 573-4800.
Regulation and Supervision
The Effect of Government Policy on Banking
The earnings and growth of the Company are affected not only by local
market area factors and general economic conditions, but also by government
monetary and fiscal policies. For example, the FRB influences the supply of
money through its open market operations in U.S. Government securities and
adjustments to the discount rates applicable to borrowings by depository
institutions and others. Such actions influence the growth of loans, investments
and deposits and also affect interest rates charged on loans and paid on
deposits. The nature and impact of future
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changes in such policies on the business and earnings of the Company cannot be
predicted. Additionally, state and federal tax policies can impact banking
organizations.
As a consequence of the extensive regulation of commercial banking
activities in the United States, the business of the Company is particularly
susceptible to being affected by the enactment of federal and state legislation
which may have the effect of increasing or decreasing the cost of doing
business, modifying permissible activities or enhancing the competitive position
of other financial institutions. Any change in applicable laws or regulations
may have a material adverse effect on the business and prospects of the Company.
Regulation and Supervision of Bank Holding Companies
The Company is a bank holding company subject to the Bank Holding Company
Act of 1956, as amended ("BHCA"). The Company reports to, registers with, and is
examined by the FRB. The FRB also has the authority to examine the Company's
subsidiaries.
The FRB has significant supervisory and regulatory authority over the
Company and its affiliates. The FRB requires the Company to maintain certain
levels of capital. See "Capital Standards." The FRB also has the authority to
take enforcement action against any bank holding company that commits any unsafe
or unsound practice, or violates certain laws, regulations or conditions imposed
in writing by the FRB. According to FRB policy, bank holding companies are
expected to act as a source of financial strength to subsidiary banks, and to
commit resources to support subsidiary banks. This support may be required at
times when a bank holding company may not be able to provide such support.
Under the BHCA, a company generally must obtain the prior approval of the
FRB before it exercises a controlling influence over a bank, or acquires
directly or indirectly, more than 5% of the voting shares or substantially all
of the assets of any bank or bank holding company. Thus, the Company is required
to obtain the prior approval of the FRB before it acquires, merges or
consolidates with any bank or bank holding company; any company seeking to
acquire, merge or consolidate with the Company also would be required to obtain
the prior approval of the FRB.
The Company is generally prohibited under the BHCA from acquiring ownership
or control of more than 5% of the voting shares of any company that is not a
bank or bank holding company and from engaging directly or indirectly in
activities other than banking, managing banks or providing services to
affiliates of the holding company. However, a bank holding company, with the
approval of the FRB, may engage in, or acquire the voting shares of companies
engaged in, activities that the FRB has determined to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto. A
bank holding company must demonstrate that the benefits to the public of the
proposed activity will outweigh the possible adverse effects associated with
such activity.
The Gramm-Leach-Bliley Act of 1999 (GLBA) eliminated many of the
restrictions placed on the activities of bank holding companies that become
financial holding companies. Among other things, GLBA repealed certain
Glass-Steagall Act restrictions on affiliations between banks and securities
firms, and amended the BHCA to permit bank holding companies that are financial
holding companies to engage in activities, and acquire companies engaged in
activities, that are:
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financial in nature (including insurance underwriting, insurance company
portfolio investment, financial advisory, securities underwriting, dealing and
market-making, and merchant banking activities); incidental to financial
activities; or complementary to financial activities if the FRB determines that
they pose no substantial risk to the safety or soundness of depository
institutions or the financial system in general. The Company has not become a
financial holding company. GLBA also permits national banks, such as NBR, to
engage in activities considered financial in nature through a financial
subsidiary, subject to certain conditions and limitations and with the approval
of the OCC.
A bank holding company may acquire banks in states other than its home
state without regard to the permissibility of such acquisitions under state law,
but subject to any state requirement that the acquired bank has been organized
and operating for the minimum period of time and providing that the bank holding
company, prior to or following the proposed acquisition, controls no more than
10% of the total amount of deposits of insured depository institutions in the
United States and no more than 30% of such deposits in that state (or such
lesser or greater amount set by state law). Banks may also merge across state
lines, creating interstate branches. Furthermore, a bank may open new branches
in a state in which it does not already have banking operations, if the laws of
such state permit such de novo branching.
Under California law, (a) out-of-state banks that wish to establish a
California branch office to conduct core banking business must first acquire by
merger or purchase a California bank or industrial loan company which is not
less than five years old; (b) California state-chartered banks are empowered to
conduct various authorized branch-like activities on an agency basis through
affiliated and unaffiliated insured depository institutions in California and
other states; and (c) the California Commissioner of Financial Institutions is
authorized to approve an interstate acquisition or merger which would result in
a deposit concentration exceeding 30% if the Commissioner finds that the
transaction is consistent with public convenience and advantage. However, a
state bank chartered in a state other than California may not enter California
by purchasing a California branch office of a California bank or industrial loan
company without purchasing the entire entity or by establishing a de novo
California bank.
The FRB generally prohibits a bank holding company from declaring or paying
a cash dividend which would impose undue pressure on the capital of subsidiary
banks or would be funded only through borrowing or other arrangements that might
adversely affect a bank holding company's financial position. The FRB's policy
is that a bank holding company should not continue its existing rate of cash
dividends on its common stock unless its net income is sufficient to fully fund
each dividend and its prospective rate of earnings retention appears consistent
with its capital needs, asset quality and overall financial condition. See the
section entitled "Restrictions on Dividends and Other Distributions" for
information regarding additional restrictions on the ability of the Company and
NBR to pay dividends.
Transactions between the Company and NBR are subject to a number of other
restrictions. FRB policies forbid the payment by bank subsidiaries of management
fees which are unreasonable in amount or exceed the fair market value of the
services rendered (or, if no market exists, actual costs plus a reasonable
profit). Subject to certain limitations, depository institution subsidiaries of
bank holding companies may extend credit to, invest in the securities of,
purchase assets from, or issue a guarantee, acceptance, or letter of credit on
behalf of, an affiliate, provided that the aggregate of such transactions with a
single affiliate may not exceed 10% of the capital stock and surplus of
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the institution, and the aggregate of such transactions with all affiliates may
not exceed 20% of the capital stock and surplus of such institution. The Company
may only borrow from depository institution subsidiaries if the loan is secured
by marketable obligations with a value of a designated amount in excess of the
loan. Further, the Company may not sell a low-quality asset to a depository
institution subsidiary.
Bank Regulation and Supervision
As a national bank, NBR is regulated, supervised and regularly examined by
the OCC. Deposit accounts at NBR are insured by the Bank Insurance Fund ("BIF")
and the Savings Institution Insurance Fund ("SAIF"), as administered by the
FDIC, to the maximum amount permitted by law. The Bank is also subject to
applicable provisions of California law, insofar as such provisions are not in
conflict with or preempted by federal banking law. The Bank is a member of the
Federal Reserve System, and is also subject to certain regulations of the FRB
dealing primarily with check clearing activities, establishment of banking
reserves, Truth-in-Lending (Regulation Z), Truth-in-Savings (Regulation DD), and
Equal Credit Opportunity (Regulation B).
The OCC may approve, on a case-by-case basis, the entry of bank operating
subsidiaries into a business incidental to banking, including activities in
which the parent bank is not permitted to engage. A national bank is permitted
to engage in activities approved for a bank holding company through a bank
operating subsidiary, such as acting as an investment or financial advisor,
leasing personal property and providing financial advice to customers. In
general, these activities are permitted only for well-capitalized or adequately
capitalized national banks.
The USA Patriot Act
Title III of the United and Strengthening America by Providing Appropriate
Tools Required to Intercept and Obstruct Terrorism Act of 2001, ("USA Patriot
Act") includes numerous provisions for fighting international money laundering
and blocking terrorist access to the U.S. financial system. The provisions of
Title III of the USA Patriot Act which affect banking organizations, including
NBR, relate principally to U.S. banking organizations' relationships with
foreign banks and with persons who are resident outside the United States. The
USA Patriot Act does not immediately impose any new filing or reporting
obligations for banking organizations, but does require certain additional due
diligence and record keeping practices. Some requirements take effect without
the issuance of regulations. Other provisions are to be implemented through
regulations that will be promulgated by the U.S. Department of the Treasury (the
"Treasury"), in consultation with the FRB and other federal financial
institutions regulators. The federal banking agencies have begun proposing and
implementing regulations interpreting the USA Patriot Act.
Part of the USA Patriot Act is the International Money Laundering Abatement
and Financial Anti-Terrorism Act of 2001 (IMLAFATA). Among its provisions,
IMLAFATA requires each financial institution to: (i) establish an anti-money
laundering program; (ii) establish due diligence policies, procedures and
controls with respect to its private banking accounts and correspondent banking
accounts involving foreign individuals and certain foreign banks; and (iii)
avoid establishing, maintaining, administering, or managing correspondent
accounts in the United States for, or on behalf of, a foreign bank that does not
have a physical presence in any country. In addition, IMLAFATA contains a
provision encouraging cooperation among financial institutions, regulatory
authorities and law enforcement authorities with respect to individuals,
entities and
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organizations engaged in, or reasonably suspected of engaging in, terrorist acts
or money laundering activities. IMLAFATA expands the circumstances under which
funds in a bank account may be forfeited and requires covered financial
institutions to respond under certain circumstances to requests for information
from federal banking agencies within 120 hours. IMLAFATA also amends the BHCA
and the Bank Merger Act to require the federal banking agencies to consider the
effectiveness of a financial institution's anti-money laundering activities when
reviewing an application under these acts.
Pursuant to IMLAFATA, the Secretary of the Treasury, in consultation with
the heads of other government agencies, has adopted and proposed special
measures applicable to banks, bank holding companies, and/or other financial
institutions. These measures include enhanced record keeping and reporting
requirements for certain financial transactions that are of primary money
laundering concern, due diligence requirements concerning the beneficial
ownership of certain types of accounts, and restrictions or prohibitions on
certain types of accounts with foreign financial institutions.
Privacy Restrictions
The GLBA, in addition to the previously described changes in permissible
non-banking activities permitted to banks, bank holding companies and financial
holding companies, also required the federal banking agencies, among others
federal regulatory agencies, to adopt regulations governing the privacy of
consumer financial information. The OCC adopted such regulations with an
effective date of November 13, 2000, and a date of full compliance with the
regulations of July 1, 2001. The Bank is subject to the OCC's regulations.
The regulations impose three main requirements established by the GLBA.
First, a banking organization must provide initial notices to customers about
their privacy policies, describing the conditions under which they may disclose
nonpublic personal information to nonaffiliated third parties and affiliates.
Second, banking organizations must provide annual notices of their privacy
policies to their customers. Third, banking organizations must provide a
reasonable method for customers to "opt-out" of disclosures to nonaffiliated
third parties.
In connection with the regulations governing the privacy of consumer
financial information, the federal banking agencies, including the OCC, adopted
guidelines for safeguarding confidential customer information, effective on July
1, 2001. The guidelines require banking organizations to establish an
information security program to: (1) identify and assess the risks that may
threaten customer information; (2) develop a written plan containing policies
and procedures to manage and control these risks; (3) implement and test the
plan; and (4) adjust the plan on a continuing basis to account for changes in
technology, the sensitivity of customer information, and internal or external
threats. The guidelines also outline the responsibilities of directors of
banking organizations in overseeing the protection of customer information.
The Company complies with all provisions of the GLBA and all implementing
regulations, and NBR has developed appropriate policies and procedures to meet
its responsibilities in connection with the privacy provisions of GLBA.
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Capital Standards
The federal banking agencies have risk-based capital adequacy guidelines
intended to provide a measure of capital adequacy that reflects the degree of
risk associated with a banking organization's operations for both transactions
reported on the balance sheet as assets and transactions, such as letters of
credit and recourse arrangements, which are recorded as off balance sheet items.
Under these guidelines, nominal dollar amounts of assets and credit equivalent
amounts of off balance sheet items are multiplied by one of several risk
adjustment percentages, which range from 0% for assets with low credit risk,
such as certain U.S. government securities, to 100% for assets with relatively
higher credit risk, such as certain loans.
In determining the capital level the Company and NBR are required to
maintain, the federal banking agencies do not, in all respects, follow
accounting principles generally accepted in the United States of America
("GAAP") and have special rules which have the effect of reducing the amount of
capital they will recognize for purposes of determining the capital adequacy of
NBR.
A banking organization's risk-based capital ratios are obtained by dividing
its qualifying capital by its total risk-adjusted assets and off balance sheet
items. The regulators measure risk-adjusted assets and off balance sheet items
against both total qualifying capital (the sum of Tier 1 capital and limited
amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists of common
stock, retained earnings, noncumulative perpetual preferred stock, trust
preferred securities (for up to 25% of total tier 1 capital), other types of
qualifying preferred stock and minority interests in certain subsidiaries, less
most other intangible assets and other adjustments. Net unrealized losses on
available-for-sale equity securities with readily determinable fair value must
be deducted in determining Tier 1 capital. For Tier 1 capital purposes, deferred
tax assets that can only be realized if an institution earns sufficient taxable
income in the future are limited to the amount that the institution is expected
to realize within one year, or 10% of Tier 1 capital, whichever is less. Tier 2
capital may consist of a limited amount of the allowance for possible loan and
lease losses, term preferred stock and other types of preferred stock and trust
preferred securities not qualifying as Tier 1 capital, term subordinated debt
and certain other instruments with some characteristics of equity. The inclusion
of elements of Tier 2 capital are subject to certain other requirements and
limitations of the federal banking agencies. The federal banking agencies
require a minimum ratio of qualifying total capital to risk-adjusted assets and
off-balance-sheet items of 8%, and a minimum ratio of Tier 1 capital to adjusted
average risk-adjusted assets and off balance sheet items of 4%.
Under OCC regulations, there are also two rules governing minimum capital
levels that OCC-supervised banks must maintain against the risks to which they
are exposed. The first rule makes risk-based capital standards consistent for
two types of credit enhancements (i.e., recourse arrangements and direct credit
substitutes) and requires different amounts of capital for different risk
positions in asset securitization transactions. The second rule permits limited
amounts of unrealized gains on debt and equity securities to be recognized for
risk-based capital purposes as of September 1, 1998. The OCC rules also provide
that a qualifying institution that sells small business loans and leases with
recourse must hold capital only against the amount of recourse retained. In
general, a qualifying institution is one that is well-capitalized under the
OCC's prompt corrective action rules. The amount of recourse that can receive
the preferential capital treatment cannot exceed 15% of the institution's total
risk-based capital.
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Effective January 1, 2002, the federal banking agencies, including the OCC,
adopted new regulations to change their regulatory capital standards to address
the treatment of recourse obligations, residual interests and direct credit
substitutes in asset securitizations that expose banks primarily to credit risk.
Capital requirements for positions in securitization transactions are varied
according to their relative risk exposures, while limited use is permitted of
credit ratings from rating agencies, a banking organization's qualifying
internal risk rating system or qualifying software. The regulation requires a
bank to deduct from Tier 1 capital, and from assets, all credit-enhancing
interest only-strips, whether retained or purchased, that exceed 25% of Tier 1
capital. Additionally, a bank must maintain dollar-for-dollar risk-based capital
for any remaining credit-enhancing interest-only strips and any residual
interests that do not qualify for a ratings-based approach. The regulation
specifically reserves the right to modify any risk-weight, credit conversion
factor or credit equivalent amount, on a case-by-case basis, to take into
account any novel transactions that do not fit well into the currently defined
categories.
In addition to the risked-based guidelines, the federal banking agencies
require banking organizations to maintain a minimum amount of Tier 1 capital to
adjusted average total assets, referred to as the leverage capital ratio. For a
banking organization rated in the highest of the five categories used to rate
banking organizations, the minimum leverage ratio of Tier 1 capital to total
assets must be 3%. It is improbable, however, that an institution with a 3%
leverage ratio would receive the highest rating since a strong capital position
is a significant part of the regulators' rating. Bank holding companies not
rated in the highest category must have a minimum leverage ratio of 4%. For all
banks not rated in the highest category, the minimum leverage ratio must be at
least 100 to 200 basis points above the 3% minimum. Thus, the effective minimum
leverage ratio, for all practical purposes, must be at least 4% or 5% for banks.
In addition to these uniform risk-based capital guidelines and leverage ratios
that apply across the industry, the regulators have the discretion to set
individual minimum capital requirements for specific institutions at rates
significantly above the minimum guidelines and ratios.
As of December 31, 2002, NBR's capital ratios exceeded applicable
regulatory requirements. The following tables present the capital ratios for the
Company and NBR, compared to the standards for well-capitalized bank holding
companies and depository institutions, as of December 31, 2002 (amounts in
thousands except percentage amounts).
The Company
---------------------------------------------------------------------
Actual Well Minimum
------------------------ Capitalized Capital
Capital Ratio Ratio Requirement
------- ----- ----------- -----------
Leverage..................................... $35,604 6.96% 5.00% 4.00%
Tier 1 Risk-Based............................ 35,604 9.18 6.00 4.00
Total Risk-Based............................. 41,585 10.72 10.00 8.00
The Bank
---------------------------------------------------------------------
Actual Well Minimum
------------------------ Capitalized Capital
Capital Ratio Ratio Requirement
------- ----- ----------- -----------
Leverage..................................... $37,500 7.35% 5.00% 4.00%
Tier 1 Risk-Based............................ 37,500 9.68 6.00 4.00
Total Risk-Based............................. 42,372 10.94 10.00 8.00
13
The federal banking agencies must take into consideration concentrations of
credit risk and risks from non-traditional activities, as well as an
institution's ability to manage those risks, when determining the adequacy of an
institution's capital. This evaluation will be made as a part of the
institution's regular safety and soundness examination. The federal banking
agencies must also consider interest rate risk (when the interest rate
sensitivity of an institution's assets does not match the sensitivity of its
liabilities or its off-balance-sheet position) in evaluation of a bank's capital
adequacy.
Prompt Corrective Action and Other Enforcement Mechanisms
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") requires each federal banking agency to take prompt corrective action
to resolve the problems of insured depository institutions, including but not
limited to those that fall below one or more prescribed minimum capital ratios.
The law required each federal banking agency to promulgate regulations defining
the following five categories in which an insured depository institution will be
placed, based on the level of its capital ratios: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized.
Under the prompt corrective action provisions of FDICIA, an insured
depository institution generally will be classified in the following categories
based on the capital measures indicated below:
"Well capitalized" "Adequately capitalized"
------------------ ------------------------
Total risk-based capital of 10%; Total risk-based capital of 8%;
Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and
Leverage ratio of 5%. Leverage ratio of 4%.
"Undercapitalized" "Significantly undercapitalized"
------------------ --------------------------------
Total risk-based capital less than 8%; Total risk-based capital less than 6%;
Tier 1 risk-based capital less than Tier 1 risk-based capital less than 3%;
4%; or or
Leverage ratio less than 4%. Leverage ratio less than 3%.
"Critically undercapitalized"
-----------------------------
Tangible equity to total assets equal
to or less than 2%.
An institution that, based upon its capital levels, is classified as "well
capitalized," "adequately capitalized" or "undercapitalized" may be treated as
though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition or an unsafe or unsound practice warrants such
treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions.
In addition to measures taken under the prompt corrective action
provisions, commercial banking organizations may be subject to potential
enforcement actions by the federal banking
14
agencies for unsafe or unsound practices in conducting their businesses or for
violations of any law, rule, regulation or any condition imposed in writing by
the agency or any written agreement with the agency. Enforcement actions may
include the imposition of a conservator or receiver, the issuance of a
cease-and-desist order that can be judicially enforced, the termination of
insurance of deposits (in the case of a depository institution), the imposition
of civil money penalties, the issuance of directives to increase capital, the
issuance of formal and informal agreements, the issuance of removal and
prohibition orders against institution-affiliated parties and the enforcement of
such actions through injunctions or restraining orders based upon a judicial
determination that the agency would be harmed if such equitable relief was not
granted. Additionally, a holding company's inability to serve as a source of
strength to its subsidiary banking organizations could serve as an additional
basis for a regulatory action against the holding company.
Safety and Soundness Standards
FDICIA also implemented certain specific restrictions on transactions and
required federal banking regulators to adopt overall safety and soundness
standards for depository institutions related to internal control, loan
underwriting and documentation and asset growth. Among other things, FDICIA
limits the interest rates paid on deposits by undercapitalized institutions,
restricts the use of brokered deposits, limits the aggregate extensions of
credit by a depository institution to an executive officer, director, principal
shareholder or related interest, and reduces deposit insurance coverage for
deposits offered by undercapitalized institutions for deposits by certain
employee benefits accounts.
The federal banking agencies may require an institution to submit to an
acceptable compliance plan as well as have the flexibility to pursue other more
appropriate or effective courses of action given the specific circumstances and
severity of an institution's noncompliance with one or more standards.
Restrictions on Dividends and Other Distributions
The power of the board of directors of an insured depository institution to
declare a cash dividend or other distribution with respect to capital is subject
to statutory and regulatory restrictions which limit the amount available for
such distribution depending upon the earnings, financial condition and cash
needs of the institution, as well as general business conditions. FDICIA
prohibits insured depository institutions from paying management fees to any
controlling persons or, with certain limited exceptions, making capital
distributions, including dividends, if, after such transaction, the institution
would be undercapitalized.
The payment of dividends by a national bank is further restricted by
additional provisions of federal law, which prohibit a national bank from
declaring a dividend on its shares of common stock unless its surplus fund
exceeds the amount of its common capital (total outstanding common shares times
the par value per share). Additionally, if losses have at any time been
sustained equal to or exceeding a bank's undivided profits then on hand, no
dividend may be paid. Moreover, even if a bank's surplus exceeded its common
capital and its undivided profits exceed its losses, the approval of the OCC is
required for the payment of dividends if the total of all dividends declared by
a national bank in any calendar year would exceed the total of its net profits
of that year combined
15
with its retained net profits of the two preceding years, less any required
transfers to surplus or a fund for the retirement of any preferred stock. A
national bank must consider other business factors in determining the payment of
dividends. The payment of dividends by NBR is governed by NBR's ability to
maintain minimum required capital levels and an adequate allowance for loan
losses.
Regulators also have authority to prohibit a depository institution from
engaging in business practices which are considered to be unsafe or unsound,
possibly including payment of dividends or other payments under certain
circumstances even if such payment are not expressly prohibited by statute.
In January 2003, NBR received approval for its 2003 dividend plan from the
OCC. In 2001, 2001 and 2000 NBR declared dividends payable to Redwood of
$6,600,000, $5,900,000 and $12,129,000.
Premiums for Deposit Insurance and Assessments for Examinations
FDICIA established several mechanisms to increase funds to protect deposits
insured by the BIF and SAIF administered by the FDIC. The FDIC is authorized to
borrow up to $30 billion from the United States Treasury; up to 90% of the fair
market value of assets of institutions acquired by the FDIC as receiver from the
Federal Financing Bank; and from depository institutions that are members of the
BIF and SAIF. Any borrowings not repaid by asset sales are to be repaid through
insurance premiums assessed to member institutions. Such premiums must be
sufficient to repay any borrowed funds within 15 years and provide insurance
fund reserves of $1.25 for each $100 of insured deposits. FDICIA also provides
authority for special assessments against insured deposits. No assurance can be
given at this time as to what the future level of premiums will be.
Community Reinvestment Act and Fair Lending
The Bank is subject to certain fair lending requirements and reporting
obligations involving home mortgage lending operations and Community
Reinvestment Act ("CRA") activities. The CRA generally requires the federal
banking agencies to evaluate the record of a financial institution in meeting
the credit needs of their local communities, including low and moderate income
neighborhoods. In addition to substantive penalties and corrective measures that
may be required for a violation of certain fair lending laws, the federal
banking agencies may take compliance with such laws and CRA into account when
regulating and supervising other activities.
Recently Enacted Legislation, Regulations and Accounting Guidance
On July 30, 2002, President Bush signed into law The Sarbanes-Oxley Act of
2002. This new legislation addresses accounting oversight and corporate
governance matters, including:
o the creation of a five-member oversight board that will set standards
for accountants and have investigative and disciplinary powers;
o the prohibition of accounting firms from providing various types of
consulting services to public clients and requiring accounting firms
to rotate partners among public client assignments every five years;
o increased penalties for financial crimes;
16
o expanded disclosure of corporate operations and internal controls and
certification of financial statements;
o enhanced controls on, and reporting of, insider trading; and
o prohibition on lending to officers and directors of public companies,
although NBR may still make these loans within the constraints of
existing banking relations.
The Nasdaq National Market has proposed additional corporate governance
rules that have been presented to the Securities and Exchange Commission for
review and approval. The proposed changes are intended to allow shareholders to
more easily and effectively monitor the performance of companies and directors.
The Company has implemented procedures to comply with the requirements for
expanded disclosure of internal controls and the certification of the financial
statements. A significant portion of the remaining items in the new legislation
will become effective during 2003. The Company is currently evaluating what
impact the new legislation and its implementing regulations will have upon our
operations, including a likely increase in certain outside professional costs.
Pending Legislation and Regulations and Accounting Guidance
Additional proposals to change the laws and regulations governing the
banking and financial services industry are frequently introduced in Congress,
in the state legislatures and before the various bank regulatory agencies. The
likelihood and timing of any such changes and the impact such changes might have
on the Company cannot be determined at this time.
Competition
In the past, an independent bank's principal competitors for deposits and
loans have been other banks (particularly major banks), savings and loan
associations and credit unions. To a lesser extent, competition was also
provided by thrift and loans, mortgage brokerage companies and insurance
companies. Other institutions, such as brokerage houses, mutual fund companies,
credit card companies, and even retail establishments have offered new
investment vehicles, which also compete with banks for deposit business. The
direction of federal legislation in recent years, especially the GLBA, favors
competition among different types of financial institutions. Using the financial
holding company structure, insurance companies and securities firms may compete
more directly with banks and bank holding companies.
Certain Important Considerations for Investors
Merchant Credit Card Processing. The Company's profitability can be
negatively impacted should one of the Company's merchant credit card customers
be unable to pay on charge-backs from cardholders. Due to contractual
obligations 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,
17
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 ISOs 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 affected 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 September
30, 2002 (the most recent period available from VISA) the Company's overall
fraud ratio was .24% 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 December 31,
2002 (the most recent information available from VISA), the Company's total VISA
transactions within these certain high-risk categories were 1.39% of its 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 December 31, 2002 (the most recent
information available from VISA), the Company's weekly VISA volume was 54% of
the Company's tangible equity capital, and aggregate charge-backs for the
previous six months were 5.29% of tangible equity capital and the aggregate
charge-backs for the quarter were .37% of the of the interchange count and .31%
of the interchange amount. Merchant bankcard participants, such as the Company,
must comply with these VISA rules by filing a compliance plan with VISA. At
December 31, 2002, the Company is in compliance with all rule changes that went
into effect on March 31, 2001, based on VISA's acceptance of the Company's
compliance plan. Should the Company be unable to comply with these rules, VISA
will require collateral of one to four times the short fall.
Concentration of Lending Activities. Concentration of the Company's lending
activities in the real estate sector, including construction loans, could have
the effect of intensifying the impact on the Company of adverse changes in the
real estate market in the Company's lending areas. At December 31, 2002,
approximately 79% of the Company's loans were secured by real estate, of which
55% were secured by commercial real estate, including small office buildings,
owner-user office/warehouses, mixed use residential and commercial properties
and retail properties. Substantially all of the properties that secure the
Company's present loans are located within Northern and Central California. The
ability of the Company to continue to originate mortgage, construction and other
loans may be impaired by adverse changes in local or regional economic
conditions, adverse changes in the real estate market, increasing interest
rates, or acts of nature (including earthquakes or floods, which may cause
uninsured damage and other loss of value to real estate that secures the
Company's loans). In addition, the long-term impact of the California energy
crisis may cause adverse changes in the Company's local economy. Due to the
concentration of the Company's real estate collateral in California, such events
could have a significant adverse impact on the value of such collateral or the
Company's earnings.
18
War on Terrorism. The terrorist attacks on the World Trade Center and the
Pentagon on September 11, 2001, ongoing acts or threats of terrorism and actions
taken by the U.S. or other governments as a result of such acts or threats, have
contributed to the continuing downturn in U.S. economic conditions and have
resulted in increased uncertainty regarding the economic outlook. Past
experience suggests that shocks to American society of far less severity have
resulted in a temporary loss of consumer and business confidence and a reduction
in the rate of economic growth. Continual deterioration in either the U.S. or
the California economy could adversely affect the Company's financial condition
and results of operations.
California Energy Crisis. Due to problems associated with the deregulation
of the electrical power industry in California, California utilities and other
energy industry participants have experienced difficulties with the supply and
price of electricity and natural gas. The California energy situation continues
to be fluid and subject to many uncertainties and a number of lawsuits and
regulatory proceedings have been commenced concerning various aspects of the
current energy situation. The long-term impact of the energy crisis in
California on the Company's markets and business cannot be predicted, but could
result in a sustained period of economic difficulties. 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, as a result, on the Company's financial condition and results of
operations.
Government Regulation. Redwood and its subsidiaries are subject to
extensive federal and state governmental supervision, regulation and control,
and future legislation and government policy could adversely affect the
financial industry. Although the full impact of such legislation and regulation
cannot be predicted, future changes may alter the structure of and competitive
relationship among financial institutions. See "Regulation and Supervision,"
above.
Competition from Other Financial Institutions. NBR 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, mutual funds and other
lending institutions. With respect to deposits, additional significant
competition arises from corporate and governmental debt securities, as well as
money market mutual funds. 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 NBR conducts operations. Banks, securities firms and
insurance companies can also now combine in a new type of financial services
firm, called a "financial holding company". Financial holding companies can
offer virtually any type of financial service, including banking, securities
underwriting, insurance (both agency and underwriting), and merchant banking.
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, such large financial
institutions may have greater access to capital at a lower cost than NBR, which
may adversely affect NBR's ability to compete effectively.
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.
19
Critical Accounting Policies. The Company's financial statements are
presented in accordance with accounting principles generally accepted in the
United States of America (US GAAP). The financial information contained within
our financial statements is, to a significant extent, financial information that
is based on approximate measures of the financial effects of transactions and
events that have already occurred. A variety of factors could affect the
ultimate value that is obtained either when earning income, recognizing an
expense, recovering an asset or relieving a liability. Along with other factors,
we use historical loss factors to determine the inherent loss that may be
present in our loan and lease portfolio. Actual loses could differ significantly
from the historical loss factors that we use. Other estimates that we use are
fair value of our securities and expected useful lives of our depreciable
assets. We have not entered into derivative contracts for our customers or for
ourselves, which relate to interest rate, credit, equity, commodity, energy, or
weather-related indices. US GAAP itself may change from one previously
acceptable method to another method. Although the economics of our transactions
would be the same, the timing of events that would impact our transactions could
change. Accounting standards and interpretations currently affecting the Company
and its subsidiaries may change at any time, and the Company's financial
condition and results of operations may be adversely affected.
Our most significant estimates are approved by our Management team, which
is comprised of our most senior officers. At each financial reporting period, a
review of these estimates is then presented to our Board of Directors.
As of December 31, 2002, other than disclosed on pages 45 and 46, we have
not created any special purpose entities to securitize assets or to obtain
off-balance sheet funding. Although we have sold a number of loans in the past
two years, those loans have been sold to third parties without recourse, subject
to customary representations and warranties. Please see our disclosure regarding
contractual obligations and commitments on page 46.
Item 2. Properties
The Company owns two depository branches and leases six other locations
used in the normal course of business. In addition, the Company leases certain
equipment. There are no contingent rental payments and the Company has five
sublease arrangements. Total rental expenses under all leases, including
premises, totaled $1,326,000, $1,282,000 and $1,202,000, in 2002, 2001 and 2000.
The expiration dates of the leases vary, with the first such lease expiring
during 2003 and the last such lease expiring during 2009. The Company maintains
insurance coverage on its premises, leaseholds and equipment, including business
interruption and record reconstruction coverage.
Item 3. Legal Proceedings
Certain lawsuits and claims arising in the ordinary course of business have
been filed or are pending against the Company or its subsidiaries. Based upon
information available to the Company, its review of such lawsuits and claims and
consultation with its counsel, the Company believes the liability relating to
these actions, if any, would not have a material adverse effect on its
consolidated financial statements.
20
Item 4. Submission of Matters to a Vote of Securities Holders
No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 2002.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company's Common Stock is publicly traded on the NASDAQ National Market
under the symbol "REBC". On September 20, 2001, the Company announced a
three-for-two stock split of its outstanding shares of common stock. All common
stock prices and dividends per share have been restated for the stock split. As
of December 31, 2002, the Company believes, based upon information it has
obtained from its transfer agent, there are 945 shareholders of record of its
Common Stock.
There are regulatory limitations on cash dividends that may be paid by the
Company as well as regulatory limitations on cash dividends that may be paid by
NBR to Redwood which could limit the Company's ability to pay dividends. Federal
regulatory agencies also have the authority to prohibit the payment of dividends
by NBR if a finding is made that such payment would constitute an unsafe or
unsound practice, or if NBR became critically undercapitalized. See "Regulation
and Supervision" in Item 1 and Note N to the Company's Consolidated Financial
Statements.
Redwood Empire Bancorp
Common Stock Prices
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4
2001 2001 2001 2001 2002 2002 2002 2002
----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------
High $19.00 $21.47 $25.57 $26.01 $28.80 $32.75 $28.00 $29.32
Low 13.50 17.07 18.60 22.37 24.40 26.16 25.20 25.75
Close 17.17 19.73 25.50 24.50 28.25 27.40 27.00 26.59
Dividends
Declared per share .100 .133 .133 N/A .200 .200 .200 .200
21
Item 6. Selected Financial Data
Summary of Consolidated Financial Data and Performance Ratios
At or for the Year ended December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands, except per share data)
Statements of Operations:
Total interest income $30,536 $33,555 $35,163 $30,633 $30,557
Net interest income 20,866 20,104 20,844 19,687 18,058
Provision for loan losses --- --- 150 750 2,040
Noninterest income 7,615 6,599 6,106 5,197 5,625
Income from continuing operations before extraordinary item 7,961 7,307 6,466 4,875 2,904
Income (loss) from discontinued operations --- --- --- (437) 2,187
Extraordinary loss, net of tax --- --- --- (276) ---
Net income 7,961 7,307 6,466 4,162 5,091
Net income available to common stock shareholders 7,961 7,307 6,466 4,162 4,979
Balance Sheets:
Total assets $513,181 $448,742 $453,439 $423,046 $422,299
Total loans 365,076 351,649 315,101 314,445 269,316
Mortgage loans held for sale (Discontinued operations) --- --- --- --- 32,620
Allowance for loan losses 7,400 7,580 7,674 7,931 8,041
Total deposits 453,093 397,412 405,333 369,509 364,720
Shareholders' equity 28,807 26,687 35,459 37,444 38,640
Performance and Financial Ratios:
Return on average assets from continuing operations 1.62% 1.63% 1.47% 1.20% 0.73%
Return on average common equity from continuing operations 28.98% 26.41% 17.75% 12.40% 8.09%
Common dividend payout ratio 35.08% 18.09% 25.29% 19.51% 8.09%
Average equity to average assets from continuing operations 5.58% 6.17% 8.30% 9.66% 9.09%
Leverage ratio 6.96% 7.46% 7.72% 8.66% 8.84%
Tier 1 risk-based capital ratio 9.18% 9.52% 9.99% 11.74% 11.84%
Total risk-based capital ratio 10.72% 11.16% 11.25% 13.01% 16.94%
Net interest margin from continuing operations 4.49% 4.78% 5.08% 5.30% 5.11%
Noninterest expense from continuing operations to net
interest income and other noninterest income from
continuing operations 56.20% 54.12% 59.18% 64.97% 71.26%
Average earning assets to average total assets from
continuing operations 94.34% 93.72% 93.50% 91.20% 89.40%
Nonperforming assets to total assets 0.54% 0.71% 0.43% 1.52% 2.11%
Net loan charge-offs to average loans 0.05% 0.03% 0.12% 0.29% 0.62%
Allowance for loan losses to total loans 2.03% 2.16% 2.44% 2.52% 2.99%
Allowance for loan losses to nonperforming loans 264.85% 238.66% 637.91% 194.34% 121.82%
Share Data (1):
Common shares outstanding (000) 3,405 3,530 4,287 4,844 5,054
Book value per common share $8.46 $7.56 $8.27 $7.73 $7.65
Basic earnings per common share:
Income from continuing operations before extraordinary item $2.29 $1.97 $1.41 $.97 $.59
Income (loss) from discontinued operations --- --- --- (.09) .46
Income before extraordinary item 2.29 1.97 1.41 .88 1.05
Net income available for common stock shareholders 2.29 1.97 1.41 .82 1.05
Weighted average shares outstanding (000) 3,474 3,703 4,577 5,046 4,755
Diluted earnings per common share:
Income from continuing operations before extraordinary item $2.21 $1.91 $1.39 $.94 $.54
Income (loss) from discontinued operations --- --- --- (.08) .42
Income before extraordinary item 2.21 1.91 1.39 .86 .96
Net income available for common stock shareholders 2.21 1.91 1.39 .80 .96
Weighted average shares outstanding (000) 3,600 3,825 4,664 5,184 5,197
Cash dividends per common share $.80 $.37 $.37 $.16 $.08
(1) Restated for 2001 3 for 2 stock split.
22
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Forward-Looking Information
This Annual Report on Form 10-K includes forward-looking information, which
is subject to the "safe harbor" created by Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. These forward-looking statements (which involve, among other things,
the Company's plans, beliefs and goals, refer to estimates or use similar terms)
involve certain risks and uncertainties that could cause actual results to
differ materially from those in the forward-looking statements. Such risks and
uncertainties include, but are not limited to, the following factors:
o Competitive pressure in the banking industry and changes in banking or
other laws and regulations or governmental fiscal or monetary
policies.
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 Uncertainty regarding the economic outlook resulting from the
continuing war on terrorism, as well as actions taken or to be taken
by the U.S. or other governments as a result of further acts or
threats of terrorism or as a result of possible military action in
Iraq.
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 and Mastercard, 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.
23
o A decline in the health of the Northern California economy, including
the long-term impact of the California energy crisis and the decline
in the technology sector.
o Certain operational risks involving data processing systems or fraud.
o The proposal or adoption of changes in accounting standards by the
Financial Accounting Standards Board, the Securities and Exchange
Commission or other standard setting bodies.
The Company undertakes no obligation to update forward-looking statements
to reflect facts, circumstances, assumptions or events that occur after the date
the forward-looking statements are made. For additional information concerning
risks and uncertainties related to the Company and its operations, please refer
to "Certain Important Considerations for Investors" in Item 1 and other
information in this Report.
General
The Company derives its income from two principal sources: (1) net interest
income, which is the difference between the interest income it receives on
interest-earning assets and the interest expense it pays on interest-bearing
liabilities; and (2) non interest income or fee income which includes, fees
earned on deposit services, fees earned from servicing loans for investors, fees
from processing services, electronic-based cash management services and merchant
credit card processing.
The following analysis of the Company's financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements of Redwood Empire Bancorp and related notes thereto included in this
Annual Report on Form 10-K. Average balances, including such balances used in
calculating financial and performance ratios, are generally daily averages for
NBR, which management believes are representative of the operations of the
Company.
Results of Operations
In 2002, the Company reported net income of $7,961,000, or $2.21 diluted
per share, as compared to 2001 and 2000 net income of $7,307,000, or $1.91
diluted per share, and $6,466,000, or $1.39 diluted per share.
Return on average assets for the year ended December 31, 2002 was 1.62% as
compared to 1.63% and 1.47% for the years ended December 31, 2001 and 2000.
Return on average common equity was 28.98% for the year ended December 31, 2002,
as compared to 26.41% and 17.75% for the years ended December 31, 2001 and 2000.
The Company's results in 2002 improved from 2001. Improvement was shown in
noninterest income, which increased $1,016,000 to $7,615,000 in 2002 as compared
to $6,599,000 in 2001 and net interest income, which increased $762,000 to
$20,866,000 in 2002 as compared to $20,104,000 in 2001. In addition, net income
increased due to a decline in the Company's effective tax rate from 40.4% in
2001 to 36.2% in 2002. For further information, see "Income Taxes" in this
section.
24
The Company's results in 2001 improved from 2000. Improvement was shown in
noninterest expense, which decreased $1,497,000 to $14,451,000 in 2001 as
compared to $15,948,000 in 2000. Other noninterest income increased $493,000 to
$6,599,000 in 2001 as compared to $6,106,000 in 2000. Improvement was also shown
in the provision for loan losses, which declined by $150,000 in 2001 as compared
to 2000.
Net Interest Income. For 2002, the Company's net interest income amounted
to $20,866,000 as compared to $20,104,000 in 2001 and $20,844,000 in 2000. This
represents an increase of $762,000 or 4% in 2002, a decrease of $740,000 or 4%
in 2001 and an increase of $1,157,000 or 6% in 2000, in each case as compared to
prior year. The increase in 2002 as compared to 2001 is due to an increase in
average earning assets of $44,273,000 from $420,340,000 in 2001 to $464,613,000
in 2002, offset by a decline in the net interest margin from 4.78% in 2001 to
4.49% in 2002. Such decline in the net interest margin is primarily due to the
lower interest rate environment and the Company carrying $29,948,000 in lower
yielding overnight investments during 2002 as compared to $17,552,000 in 2001.
The decrease in 2001 as compared to 2000 is due to a negative impact of $882,000
associated with the trust preferred debt financing. Without the impact of such
long term financing, net interest income would have increased in 2001 by
$142,000 as a result of growth in average earning assets of $9,799,000.
25
The following table presents for the years indicated the distribution of
consolidated average assets, liabilities and shareholders' equity, as well as
the total dollar amounts of interest income from average earning assets and the
resultant yields, and the dollar amounts of interest expense and average
interest-bearing liabilities, expressed both in dollars and in rates. Nonaccrual
loans are included in the calculation of the average balances of loans, and
interest not accrued is excluded.
2002 2001 2000
---------------------------- ------------------------------ ------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
---------------------------- ------------------------------ ------------------------------
(dollars in thousands)
Assets:
Portfolio loans $356,953 $25,678 7.19% $327,913 $27,904 8.51% $329,799 $29,769 9.03%
Mortgage loans held for sale 307 24 7.82 --- --- --- --- --- ---
Investment securities (1) 77,405 4,335 5.60 74,875 4,879 6.52 74,880 5,035 6.72
Federal funds sold 29,948 499 1.67 17,552 772 4.40 5,862 359 6.12
----------------- ------------------ -----------------
Total earning assets 464,613 30,536 6.57 420,340 33,555 7.98 410,541 35,163 8.57
------ ------ ------
Other non-earning assets 35,396 35,841 36,541
Allowance for loan losses (7,543) (7,673) (7,997)
--------- --------- ---------
Total average assets $492,466 $448,508 $439,085
========= ========= =========
Liabilities and Shareholders' Equity:
Interest bearing transaction accounts $123,068 1,618 1.31 $123,537 2,762 2.24 $125,626 3,675 2.93
Time deposits 217,332 6,961 3.20 186,011 9,668 5.20 180,130 10,294 5.71
Trust preferred securities 10,000 1,003 10.03 8,700 882 10.14 --- --- ---
Other borrowings 4,169 88 2.11 3,360 139 4.14 5,333 350 6.56
----------------- ------------------ -----------------
Total interest bearing liabilities 354,569 9,670 2.73 321,608 13,451 4.18 311,089 14,319 4.60
-------------- --------------- ---------------
Non-interest bearing demand deposits 99,148 88,909 80,923
Other non-interest bearing liabilities 11,274 10,322 10,635
Shareholders' equity 27,475 27,669 36,438
--------- --------- ---------
Total average liabilities and
shareholders' equity $492,466 $448,508 $439,085
========= ========= =========
Net interest spread 3.84 3.80 3.97
====== ====== ======
Net interest income and
net interest margin $20,866 4.49% $20,104 4.78% $20,844 5.08%
=============== ================ ================
(1) Investment securities are shown with the fair value adjustment included.
The Company's average earning assets for 2002 increased approximately 11%,
or $44,273,000, to $464,613,000, as compared to $420,340,000 for 2001. Average
earning assets increased approximately 2%, or $9,799,000, in 2001 as compared to
2000. During 2002, the increase in average earning assets was driven by strong
deposit growth. The increase in earning assets resulted primarily from an
increase of $33,347,000 in average outstanding commercial real estate loans. In
December 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 funds received from the loan sale have been used to fund growth in higher
yielding relationship-based commercial and commercial real estate loans.
Adjusting for the impact of the 2000 single-family residential loan sale and
securitization, average portfolio loans increased $37,268,000 during 2001.
26
With the increase in average earning assets in 2002 discussed above, the
Company's funding levels also increased. The average balance of higher cost time
deposits increased $31,321,000 in 2002 compared to an increase of $5,881,000 in
2001. The growth in time deposits in 2002 was a result of the successful
introduction of the Company's liquid CD product. Additionally, average interest
bearing transaction accounts decreased $469,000 in 2002 as compared to a
decrease of $2,089,000 in 2001. Average other borrowings increased $2,419,000 in
2002 and $6,727,000 in 2001, primarily due to the impact of the Company's pooled
trust preferred debt financing.
The following table sets forth changes in interest income and interest
expense for each major category of average earning asset and average
interest-bearing liability, and the amount of change attributable to volume and
rate changes for the years indicated. Changes not solely attributable to rate or
volume have been allocated proportionately to the change due to volume and the
change due to rate.
2002 over 2001 2001 over 2000
------------------------------ ------------------------------
Volume Rate Total Volume Rate Total
------------------------------ ------------------------------
(in thousands)
Increase (decrease) in interest income:
Portfolio loans (1), (2) $2,332 ($4,558) ($2,226) ($169) ($1,696) ($1,865)
Mortgage loans held for sale 24 --- 24 --- --- ---
Investment securities 160 (704) (544) --- (156) (156)
Federal funds sold 365 (638) (273) 539 (126) 413
------------------------------ ------------------------------
Total increase (decrease) 2,881 (5,900) (3,019) 370 (1,978) (1,608)
------------------------------ ------------------------------
Increase (decrease) in interest expense:
Interest bearing transaction accounts (10) (1,134) (1,144) (60) (853) (913)
Time deposits 1,437 (4,144) (2,707) 328 (954) (626)
Trust preferred 130 (9) 121 882 --- 882
Other borrowings 28 (79) (51) (106) (105) (211)
------------------------------ ------------------------------
Total increase (decrease) 1,585 (5,366) (3,781) 1,044 (1,912) (868)
------------------------------ ------------------------------
Increase (decrease) in net interest income $1,296 ($534) $762 ($674) ($66) ($740)
============================== ==============================
(1) Does not include interest income which would have been earned on nonaccrual
loans had such loans performed in accordance with their terms.
(2) Amortized loan fees of $377,000, $584,000 and $966,000 are included in
interest income for 2002, 2001 and 2000.
The net interest margin decreased to 4.49% for the year ended December 31,
2002, as compared to 4.78% and 5.08% for the years ended December 31, 2001 and
2000. During 2002 and 2001, the Company's net interest margin was negatively
impacted by sluggish loan growth and the decline in the general interest rate
environment. In addition, the pooled trust preferred debt financing which funded
two stock purchase plans had a negative impact on the net interest margin of 19
basis points in 2002 and 21 basis points in 2001. The yield on average earning
assets decreased to 6.57% in 2002 compared to 7.98% in 2001 and 8.57% in 2000.
The effective rates on average interest-bearing liabilities decreased to
2.72% for 2002 as compared to 4.18% for 2001 and 4.60% for 2000. The decrease in
2002 and 2001 is attributable to a lower interest rate environment, as discussed
above, offset by the impact of the Company's pooled trust preferred debt
financing.
27
Provision for Loan Losses. Annual fluctuations in the provision for loan
losses result from management's regular assessment of the adequacy of the
allowance for loan losses. There was no provision for loan losses for the years
ended December 31, 2002 and 2001. In 2001, the provision for loan losses
decreased from $150,000 in 2000. This decrease in the provision for loan losses
in 2002 and 2001 when compared to 2000 was due to the minimal level of loan
charge-offs and management's assessment of the level of risk in the portfolio.
Noninterest Income. Noninterest income from continuing operations increased
15%, or $1,016,000, to $7,615,000 as compared to $6,599,000, for 2001. The
Company's noninterest income from continuing operations for 2001 increased by
$493,000 or 8% from the $6,106,000 it received during 2000. The following table
sets forth the sources of noninterest income from continuing operations for the
years ended December 31, 2002, 2001 and 2000.
Year Ended December 31,
2002 2001 2000
-----------------------------------
(in thousands)
Service charges on deposit accounts $1,188 $1,116 $1,077
Merchant draft processing, net 5,009 4,240 4,856
Loan servicing income 268 295 272
Net realized gains (losses) on
securities available for sale 294 112 (171)
Gain (loss) on sale of loans 13 --- (584)
Other income 843 836 656
--------- --------- ---------
$7,615 $6,599 $6,106
========= ========= =========
Merchant draft processing net revenue amounted to $5,009,000 in 2002 as
compared to $4,240,000 in 2001 and $4,856,000 in 2000. The increase of $769,000
during 2002 when compared to 2001 is a result of the Company achieving success
in building its overall merchant draft processing business through direct
marketing efforts and new independent sales organization (ISO) business. The
decrease of $616,000 during 2001 when compared to 2000 is due to the expiration
of a large merchant draft processing contract with an ISO. In 2000, the Company
benefited from the amortization of a lump sum payment of $2,600,000 received in
December 1998. Such payment was a result of a renegotiated merchant card
services contract with an ISO. As of December 31, 2000, the payment had been
fully amortized. For the year ended December 31, 2000 the Company recorded
$1,440,000 as revenue associated with the payment. In addition, under the terms
of the renegotiated contract the Company received a contract, completion bonus
in the amount of $528,000 during 2000.
28
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 $1,261,000 and
$1,212,000 as of December 31, 2002 and 2001, was estimated based upon industry
loss data as a percentage of transaction volume throughout each year, the
historical losses incurred by NBR and management's assumptions regarding
merchant and ISO risk. For additional information, please refer to "Certain
Important Considerations for Investors" in Item I in this Report.
Loan servicing revenues decreased to $268,000 for the year ended December
31, 2002, compared to $295,000 in 2001, and $272,000 in 2000. The decrease in
2002 was due to a decrease in the Company's servicing portfolio, as compared to
an increase in the servicing portfolio during 2001. Future loan servicing income
will be dependent, in part, on prepayments of loans held in the Company's
servicing portfolio.
During 2002, the Company sold $9,025,000 in investment securities available
for sale, and recorded a gain on such sales of $294,000. See Note D of Notes to
Consolidated Financial Statements. During 2001, the Company sold $5,806,000 in
investment securities available for sale, and recorded a gain on such sales of
$112,000.
Noninterest Expense. Noninterest expense amounted to $16,005,000 in 2002,
$14,451,000 in 2001 and $15,948,000 in 2000. This represents an increase of
$1,554,000 or 11% in 2002 and a decrease of 1,497,000 or 9% in 2001 when
compared to 2000.
Salaries and employee benefits expense for 2002 increased $631,000, or 8%,
to $8,967,000, as compared to $8,336,000 for 2001. This compared with a 4%
decrease during 2001 over the 2000 salaries and employee benefits expense of
$8,640,000. The increase in 2002 is a result of an increase in the average
number of full-time-equivalent staff employed by the Company. The decrease in
2001 is a result of the Company's emphasis on improving efficiency through
process improvement and job function consolidation. The Company's
full-time-equivalent staff levels were 151, 148, and 150 at December 31, 2002,
2001, and 2000.
Occupancy and equipment expense was $2,126,000 in 2002, $2,026,000 in 2001,
and $2,040,000 in 2000. In 2002 occupancy and equipment expense increased
$100,000 due to normal operating cost increases. In 2001 the decrease of $14,000
as compared to 2000 was attributable to the Company's decreased space
requirements as a result of the relocation of operating personnel.
29
The following table describes the components of other noninterest expense
for the years ended December 31, 2002, 2001 and 2000.
Year Ended December 31,
2002 2001 2000
---------------------------------------
(in thousands)
Professional fees $1,119 $360 $950
Regulatory expense and insurance 420 396 453
Postage and office supplies 531 529 463
Shareholder expenses and director fees 379 377 412
Advertising 400 484 420
Telephone 395 389 351
Electronic data processing 1,113 944 1,274
Other 555 610 945
---------------------------------------
$4,912 $4,089 $5,268
=======================================
Other noninterest expenses were $4,912,000 during 2002, an increase of
$823,000, or 20%, when compared to 2001 expenses of $4,089,000. Other
noninterest expense decreased $1,179,000 or 22% in 2001 when compared to 2000.
The increase during 2002 is in part due to legal and consulting fees of $415,000
associated with certain corporate activities, including exploring strategic
options for the Company and its Merchant Card Services segment and $163,000 in
expenses incurred in association with the formation of NBR Real Estate
Investment Trust. The decline in 2001 was the result of an efficiency
improvement initiative, which began in December 2000. One aspect of such
initiative was to focus on vendor expense control.
Income Taxes. The Company's effective tax rate varies with changes in the
relative amounts of its non-taxable income and nondeductible expenses. The
Company's effective tax rate on continuing operations was 36.2% in 2002 and
40.4% in 2001 and 2000. The primary reason for the reduction in the Company's
effective tax rate in 2002 was the January 15, 2002 formation of the NBR Real
Estate Investment Trust, a Maryland Real Estate Investment Trust. This entity
was formed as a subsidiary of NBR to hold NBR's real estate secured loans and to
better organize NBR's marketing and origination of real estate secured lending.
As a result of the formation and funding of this entity, along with the one-time
benefit associated with the current year recapture of only 50% of the Company's
California state bad debt reserve, and the allowed permanent deduction of the
other 50% of the Company's California state bad debt reserve, the Company's
effective tax rate was reduced to 36.2%.
Business Segments
The Company operates in two principal industry segments: core community
banking and merchant credit card services. The Company's core community banking
industry segment includes commercial, commercial real estate, construction, and
permanent residential lending along with
30
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 industry segment follows:
For the Year Ended,
December 31,
-----------------------------------------------
2002 2001 2000
-----------------------------------------------
(in thousands)
Community Banking:
Revenue $22,876 $21,421 $20,960
Expenses 13,327 12,222 14,089
-----------------------------------------------
Income before income tax $9,549 $9,199 $6,871
===============================================
Average assets $465,678 $422,134 $414,181
===============================================
Merchant Credit Card Services:
Revenue $5,605 $5,282 $5,990
Expenses 2,678 2,229 2,009
-----------------------------------------------
Income before income tax $2,927 $3,053 $3,981
===============================================
Average assets $26,788 $26,374 $24,904
===============================================
Total Company:
Revenue $28,481 $26,703 $26,950
Expenses 16,005 14,451 16,098
-----------------------------------------------
Income before income tax $12,476 $12,252 $10,852
===============================================
Average assets $492,466 $448,508 $439,085
===============================================
Community Banking
The Community Banking segment's income before income taxes amounted to
$9,549,000 in 2002 as compared to $9,199,000 in 2001 and $6,871,000 in 2000. The
Community Banking segment's revenues increased in 2002 over 2001 as a result of
an increase in net interest income. Net interest income increased due to an
increase in earning assets, offset by a decline in the general interest rate
environment and the issuance of pooled trust preferred debt securities, which
have been fully allocated to the Community Banking segment. The increase during
2001 over 2000 is the result of increased service charges on deposit accounts,
loan servicing income and the absence of any loss on sale of loans and
investment securities. Additionally, during 2002 and 2001, the Company increased
its loan portfolio through marketing efforts. Total average portfolio loans were
$356,953,000 in 2002 up from $327,913,000 in 2001.
Merchant Card Services
The Merchant Card Services segment provides Visa and Mastercard credit card
processing and settlement services for approximately 39,000 merchants located
throughout the United States. In 2002, processing volume exceeded $1.7 billion.
The Company's merchant card services
31
customer base is made up of merchants located in its primary market area and
merchants who have been acquired by the Company through the use of ISOs.
During 2002, the Merchant Card Services segment net income decreased due to
an increase in salary and benefits expenses. The increase in the unit's salary
and benefits expense is due to a build-up in sales development personnel. The
increase in expenses was partially offset by an increase in processing revenue
brought about by the Company's efforts to build its overall merchant card
services business through direct marketing efforts, new ISO relationships and an
increase in the realization in deferred processing revenue associated with
certain merchants. During 2001, the Merchant Card Services segment's net income
declined 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. In 2000 and 1999, the segment had experienced two
successive years of revenue and earnings growth due to an increase in the number
of merchants it services and an increase of ISOs to market its services. In
December 1998, the Company renegotiated the terms of a processing contract with
an ISO who represented $1,736,000 or 66% of the Company's merchant draft net
processing revenue, $1,412,000 or 45%, $1,979,000 or 41% and $114,000 or 3% of
such revenue in 1999, 2000 and 2001. As a result of the renegotiation the ISO
brought down its processing rate in consideration for a payment of $2,600,000 to
the Company. The Company amortized the payment over the life of the renegotiated
contract. During 2000, 1999 and 1998, $1,440,000, $910,000 and $250,000 of this
payment was recognized as revenue. At December 31, 2000 such processing revenue
had been fully amortized.
Under the terms of the renegotiated contract, the Company received a
contract completion bonus in the amount of $528,000 during 2000. Since April
1999, in an effort to offset the anticipated decline in future merchant bankcard
processing revenues from the completion of the contract discussed above, the
Company has been building its overall merchant card services business through
additional direct marketing efforts, hiring of additional personnel and
developing new ISO relationships. Costs associated with this build up account
for the increase in the unit's expenses in 2002, which amounted to $2,678,000 as
compared to $2,229,000 in 2001 and $2,009,000 in 2000.
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 $1,261,000 and
$1,212,000 as of December 31, 2002 and 2001, was estimated based upon industry
loss data as a percentage of transaction volume throughout each year, historical
losses incurred by NBR, and management's assumptions regarding merchant and ISO
risk. The provision for charge-back losses, which is included in the financial
statements as a reduction in merchant draft processing income, was $246,000,
$138,000 and $713,000 in 2002, 2001 and 2000. The relatively higher level of the
provision during 2000 reflects the growth in proprietary merchant account
volume, increased exposure to internet merchants, and a new ISO relationship in
which the Company assumed fraud risk directly rather than looking first to the
ISO. For additional information, please refer to "Certain Important
Considerations for Investors" in Item I in this Report.
32
The following table summarizes the Company's merchant card allowance
for charge-back losses for the periods indicated:
For the Year Ended
December 31,
2002 2001 2000
--------------------------------------
(in thousands)
Beginning allowance $1,212 $1,277 $908
Provision for losses 246 138 713
Recoveries 37 105 ---
Charge-offs (234) (308) (344)
--------------------------------------
Ending allowance $1,261 $1,212 $1,277
======================================
Investment Portfolio
The Company classifies its investment securities as held to maturity or
available for sale. The Company's intent is to hold all securities held to
maturity until maturity and management believes that the Company has the ability
to do so. Securities available for sale may be sold to implement the Company's
asset/liability management strategies and in response to changes in interest
rates, prepayment rates and similar factors. The following table summarizes the
maturities of the Company's debt securities at their carrying value and their
weighted average yields at December 31, 2002. In the following table, yields on
tax-exempt securities have been presented on a tax-equivalent basis.
Debt Securities
Available for Sale
After Five
After One Through Through After
Within One Year Five Years Ten Years Ten Years Total
------------------------------------------------------------------------------------------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------------------------------------------------------------------------------------------------
(dollars in thousands)
U.S. Government
obligations $3,029 2.95 % $6,343 5.28 % $ --- --- $ --- --- $9,372 4.53 %
Mortgage-backed --- --- --- --- --- 71,183 5.26% 71,183 5.26
Other securities --- --- --- --- --- --- --- --- --- ---
----------- ----------- ----------- ----------- ------------
Total $3,029 2.95 % $6,343 5.28 % $ --- --- $71,183 5.26 % $80,555 5.17 %
=========== =========== =========== =========== ============
Held to Maturity
After Five
After One Through Through After
Within One Year Five Years Ten Years Ten Years Total
------------------------------------------------------------------------------------------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------------------------------------------------------------------------------------------------
(dollars in thousands)
U.S. Government
obligations $ --- --- $ --- --- $ --- --- $ --- --- $ --- ---
Mortgage-backed --- --- --- --- --- --- 8,611 8.17 % 8,611 8.17 %
Other securities --- --- 1,190 4.36 % 1,887 4.53 % 5,076 4.33 8,153 2.71
----------- ----------- ----------- ----------- -----------
Total $ --- --- $1,190 4.36 % $1,887 4.53 % $13,687 6.74 % $16,764 5.82 %
=========== =========== =========== =========== ===========
33
The following table summarizes the book value of the Company's investment
securities held on the dates indicated:
Available for Sale
December 31,
2002 2001 2000
-----------------------------------------------------
(in thousands)
U.S. Government obligations $9,372 $10,360 $28,001
Mortgage-backed securities 71,183 25,390 18,664
Other securities --- 9,308 5,967
FHLB and FRB Stock 2,602 2,515 2,777
-----------------------------------------------------
Total $83,157 $47,573 $55,409
=====================================================
Held to Maturity
December 31,
2002 2001 2000
-----------------------------------------------------
(in thousands)
U.S. Government obligations $ --- $2,000 $12,991
Mortgage-backed securities 8,611 9,066 11,953
Other securities 8,153 6,336 4,857
-----------------------------------------------------
Total $16,764 $17,402 $29,801
=====================================================
Loan Portfolio
The Company concentrates its lending activities in three principal areas:
real estate mortgage loans (residential and commercial loans), real estate
construction loans and commercial loans. At December 31, 2002, these three
categories accounted for approximately 67%, 12% and 17% of the Company's loan
portfolio. The interest rates charged for the loans made by the Company vary
with the degree of risk, the size and maturity of the loans, the borrowers'
depository relationships with the Company and prevailing money market rates
indicative of the Company's cost of funds.
Concentration of the Company's lending activities in the real estate sector
could have the effect of intensifying the impact on the Company of adverse
changes in the real estate market in the Company's lending areas. The ability of
the Company to continue to originate mortgage, construction and other loans may
be impaired by adverse changes in local or regional economic conditions, adverse
changes in the real estate market, increasing interest rates, or acts of nature
(including earthquakes or floods, which may cause uninsured damage and other
loss of value to real estate that secures the Company's loans). In addition, the
long-term impact of the California energy crisis may cause adverse changes in
the Company's local economy. Due to the concentration of the Company's real
estate collateral in California, such events could have a significant adverse
impact on the value of such collateral or the Company's earnings.
The following table sets forth the amounts of loans outstanding by category
as of the dates indicated. There were no concentrations of loans exceeding 10%
of total loans which are not otherwise disclosed as a category of loans in the
table below.
34
December 31,
---------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
---------------------------------------------------------------------------------------
(in thousands)
Residential real estate mortgage $87,764 $101,175 $98,914 $130,504 $97,194
Commercial real estate mortgage 158,018 121,456 93,091 79,476 59,257
Commercial 62,958 70,438 66,645 61,165 63,260
Real estate construction 42,749 46,501 49,460 40,059 46,905
Installment and other 14,260 12,567 7,900 4,624 5,095
Net deferred fees (673) (488) (909) (1,383) (2,395)
---------------------------------------------------------------------------------------
Total loans 365,076 351,649 315,101 314,445 269,316
Allowance for loan losses (7,400) (7,580) (7,674) (7,931) (8,041)
---------------------------------------------------------------------------------------
Net loans $357,676 $344,069 $307,427 $306,514 $261,275
=======================================================================================
Real Estate Mortgage Loans. As of December 31, 2002, the Company's
residential mortgage loans totaled $87,764,000, or 24%, of its total loans.
These loans were predominantly originated in Sonoma and Mendocino Counties.
Total residential loans decreased $13,411,000 during 2002 as compared to an
increase of $2,261,000 in 2001. The decrease during 2002 was the result of
substantial paydown activity, as compared to the increase during 2001, which was
the result of normal loan origination activity. During 2000, total residential
loans decreased due to the Company's sale of $21,205,000 in single family
residential loans and the securitization of another $17,949,000 as part of an
asset repositioning strategy. The funds received from the loan sale were used to
fund growth in higher yielding relationship-based commercial and commercial real
estate loans.
At December 31, 2002, $32,448,000, or 37%, of the Company's residential
real estate mortgage loans were fixed-rate mortgage loans having original terms
ranging from one to thirty years. Another $17,540,000, or 20%, were held as
adjustable-rate mortgages. The balance of these loans, $37,776,000, or 43%,
consisted of multifamily loans and loans on improved single-family lots. The
majority of the Company's residential mortgage loans have been underwritten for
the Company's portfolio and do not necessarily meet standard underwriting
criteria for sale in the secondary market. Approximately 48% of the total amount
outstanding had principal balances that were less than $300,000. The Company's
residential real estate mortgage loans predominately have loan-to-value ratios
of 80% or less, using current loan balances and appraised values as of the time
of origination. The Company's general policy is not to exceed an 80%
loan-to-value ratio on residential mortgage loans without mortgage insurance.
35
As of December 31, 2002, the Company had outstanding $158,018,000 in
commercial mortgage loans, which constituted 43% of total loans. Of these loans,
45% were secured by owner-occupied commercial properties and have 5- to 15-year
maturities based upon 25- to 30-year amortization periods. The ratio of the loan
principal amount to appraised values is generally 75% or less, using appraised
values at the time of loan origination, and the loans are for owner-occupied
small office buildings or office/warehouses. The Company originates commercial
mortgage loans that are guaranteed by the SBA up to 70% to 90% of the balance.
The SBA guaranteed portion of such loans can be sold into the secondary market
with the unguaranteed principal balance retained. The aggregate retained
unguaranteed principal balance of such loans was $8 million at December 31,
2002. Approximately 30% of the total amount outstanding of commercial mortgage
loans had principal balances that were less than $250,000.
Real Estate Construction Loans. The Company's primary market focus
emphasizes individual borrowers and small residential and commercial projects.
The economic viability of the project and the borrower's past development record
and creditworthiness are primary considerations in the loan underwriting
decision. The Company had $42,749,000 in construction loans outstanding at
December 31, 2002, comprising 12% of its total loans. These loans were
principally located in Northern California. This represents a decrease of
$3,752,000 or 8% from 2001. During 2001, construction loans decreased $2,959,000
or 6% from 2000. In 2000 construction loans increased $9,401,000 or 23%. As of
December 31, 2002, approximately $5 million of these loans consisted of 23
single-family individual-borrower construction loans, and the remaining loans
included 24 subdivision projects, 16 land development projects and 8 commercial
projects. At December 31, 2002, the largest single-family construction loan
commitment was $1,240,000, and the average commitment was less than $494,000.
The largest commitment for a subdivision project was $6,276,000 and the average
subdivision commitment was less than $1,117,000. The average commitment for a
commercial project was approximately $1,387,000.
Construction loans are funded on a line-item, percentage of completion
basis. As the builder completes various line items (foundation, framing,
electrical, etc.) of the project, or portions of those line items, the work is
reviewed by one of several independent inspectors hired by the Company. Upon
approval from the inspector, the Company funds the draw request according to the
percentage completion of the line items that have been approved. Actual funding
checks must be signed by an officer of the Company, and that officer must also
initial the line-item worksheet used to support the draw request. In addition,
Company personnel or agents routinely inspect the various construction projects,
all of which are located in the Company's lending area.
Commercial real estate mortgage and construction lending contains potential
risks which are not inherent in other types of portfolio loans. These potential
risks include declines in market values of underlying real property collateral
and, with respect to construction lending, delays or cost overruns, which could
expose the Company to loss. In addition, risks in commercial real estate lending
include declines in commercial real estate values, general economic conditions
surrounding the commercial real estate properties and vacancy rates. A decline
in general economic conditions or real estate values within the Company's market
area could have a negative impact on the performance of the loan portfolio or
value of the collateral. Because the Company lends primarily within its market
area, the real property collateral for its loans is similarly concentrated,
rather than diversified over a broader geographic area. The Company could
therefore be adversely affected by a decline in real estate values in its
primary market area even if real estate values elsewhere in California remain
stable or increase.
36
Commercial Loans. Commercial loans consist primarily of short-term
financing for businesses and professionals located in Sonoma and Mendocino
Counties. At December 31, 2002, these loans totaled $62,958,000, or 17%, of the
Company's total loans. This represents a decrease of $7,480,000 or 11% as
compared to an increase of $3,793,000 or 6% from 2001 and 2000. The decline in
commercial loans during 2002 is due to normal loan payoffs and the competitive
banking environment. The increase during 2001 was due to the Company's marketing
efforts and a general expansion of businesses within the Company's market area.
The commercial loans are diversified as to industries and types of businesses,
with no significant industry concentrations. Commercial loan borrowers generally
have deposit relationships with the Company. The commercial loans can be
unsecured or secured by various assets, including equipment, receivables,
deposits and other assets. Commercial loans may be secured by commercial or
residential property; however, they are not classified as mortgage loans since
these loans are not typically taken out for the purpose of acquiring real estate
and the loans are short-term. In these cases, the mortgage collateral is often
taken as additional collateral. As of December 31, 2002, the size of individual
commercial loans varied widely, with 93% having principal balances less than
$350,000. At December 31, 2002, the Company had 10 commercial borrowers whose
aggregate individual liability exceeded $2,000,000.
Loan Commitments. In the normal course of business, there are various
commitments outstanding to extend credit that are not reflected in the financial
statements. Annual review of the commercial credit lines and ongoing monitoring
of outstanding balances reduces the risk of loss associated with these
commitments. There were $75,958,000 in undisbursed loan commitments and $307,000
in standby letters of credit.
Maturity Distribution. The following table shows the maturity distribution
of the Company's commercial and real estate construction loans outstanding as of
December 31, 2002, which, based on remaining scheduled repayments of principal,
were due within the periods indicated.
After One
Within Through After Five
One Year Five Years Years Total
-------------------------------------------------
(in thousands)
Commercial $19,433 $17,403 $26,122 $62,958
Real estate construction 33,816 8,807 126 42,749
-------------------------------------------------
Total $53,249 $26,210 $26,248 $105,707
=================================================
Loans with fixed interest rates $5,681 $3,828 $839 $10,348
Loans with variable interest rates 47,568 22,382 25,409 95,359
-------------------------------------------------
Total $53,249 $26,210 $26,248 $105,707
=================================================
37
Deposit Structure
The Company's time deposits of $100,000 or more had the following schedule
of maturities at December 31, 2002 (in thousands):
Remaining Maturity:
Three months or less $30,400
Over three months to six months 13,248
Over six months to 12 months 21,997
Over 12 months 3,355
-------------------
Total $69,000
===================
Time deposits of $100,000 or more are generally from the Company's local
business and professional customer base. The Company primarily attracts deposits
from local businesses and professionals, as well as through retail certificates
of deposits, savings and checking accounts. In addition to the Company's local
depository offices, it attracts certificates of deposit, primarily from
financial institutions throughout the nation, by publishing rates in national
publications. These certificates of deposit have often been set at interest
rates at local market retail deposit rates to attract deposits. The national
deposit market is utilized to supplement the Company's liquidity needs. There
can be no assurance that this funding practice will continue to provide deposits
at attractive rates or that applicable federal regulations will not limit the
Company's ability to attract deposits in this manner. The amount of such
deposits was $399,000 and $11,052,000 as of December 31, 2002 and 2001. The
Company generally does not purchase brokered deposits and had no brokered
deposits at December 31, 2002. The Company also accepts certificates of deposit
from the State of California. Such certificates of deposit amounted to
$10,000,000 and $15,045,000 as of December 31, 2002 and 2001. In order to accept
deposits from the State of California, the Company is required to pledge
investment securities. The carrying amount of such securities amounted to
$13,016,000 and $16,786,000 as of December 31, 2002 and 2001.
38
The following table sets forth the distribution of the Company's average
daily deposits for the periods indicated.
Year Ended December 31,
------------------------------------------------------------------
2002 2001 2000
--------------------- -------------------- --------------------
Amount Rate Amount Rate Amount Rate
--------------------- -------------------- --------------------
(dollars in thousands)
Transaction accounts:
Savings & Money Market $93,166 1.56% $95,773 2.59% $98,576 3.40 %
NOW 29,902 0.55 27,764 1.00 27,050 1.19
Noninterest bearing 99,148 --- 88,909 --- 80,923 ---
Time deposits $100,000 and over 91,705 3.27 102,185 5.28 81,215 5.86
Other time deposits 125,627 3.16 83,826 5.09 98,915 5.60
The potential impact on the Company's liquidity from the withdrawal of
these deposits is considered in the Company's asset and liability management
policies, which attempt to anticipate adequate liquidity needs through its
management of investments, federal funds sold, or by generating additional
deposits.
Other Borrowings
NBR has a short term borrowing agreement with the Federal Home Loan Bank of
San Francisco (FHLB). This agreement is collateralized by approximately
$42,000,000 in residential mortgage loans. Available credit under this line at
December 31, 2002 was $37,000,000. Advances can be made on a long-term and
short-term basis with a rolling maturity date. On occasion, a borrowing is made
on a fixed maturity basis. In such instances, maturities do not extend beyond
one year. As of December 31, 2002, there was an outstanding balance of
$5,000,000 under this line. Redwood also maintains a $2,500,000 unsecured line
of credit with a major financial institution. As of December 31, 2002, there was
an outstanding balance of $1,150,000 under this line. In addition, the Company
enters into various short-term borrowing agreements, which include Treasury, Tax
and Loan borrowings. These borrowings have maturities of one day and are
collateralized by investments or loans.
The following table summarizes the balances outstanding at year end, the
highest amount of borrowings outstanding for a month-end during the year, the
average balance of borrowings and the weighted average rate for the years ended
December 31, 2002, 2001 and 2000 (in thousands).
2002 2001 2000
-------------------------------------------
Balance, December 31 $12,356 $3,870 $3,528
Average balance during the year 4,169 3,360 5,333
Weighted average interest rate during the year 2.11% 4.14% 6.56%
Maximum month-end balance during year $12,356 $6,000 $11,350
Date of maximum month-end balance December September November
39
Trust Preferred Securities
On February 22, 2001, Redwood Statutory Trust I ("RSTI"), a wholly owned
subsidiary of the Company, closed a pooled offering of 10,000 Capital Securities
with a liquidation amount of $1,000 per security. The net proceeds of the
offering were loaned to the Company in exchange for junior subordinated
debentures with terms similar to the Capital Securities. The sole assets of RSTI
are the junior subordinated debentures of the Company and payments thereunder.
The junior subordinated debentures and the back-up obligations, in the
aggregate, constitute a full and unconditional guarantee by the Company of the
obligations of RSTI under the Capital Securities. Distributions on the Capital
Securities are payable semi-annually at the annual rate of 10.2% and are
included in interest expense in the consolidated financial statements. These
securities are considered Tier 1 capital (with certain limitations applicable)
under current bank regulatory guidelines. As of December 31, 2002, the
outstanding principal balance of the Capital Securities was $10,000,000. The
principal balance of the Capital Securities constitute the trust preferred
securities in the financial statements.
The junior subordinated debentures are subject to mandatory redemption, in
whole or in part, upon repayment of the Capital Securities at maturity or their
earlier redemption at the liquidation amount. Subject to the Company having
received prior approval of the Federal Reserve, if then required, the Capital
Securities are redeemable prior to the maturity date of February 22, 2031, at
the option of the Company; on or after February 22, 2021 at par; or on or after
February 22, 2011 at a premium, or upon the occurrence of specific events set
forth in the trust indenture. The Company has the option to defer distributions
on the Capital Securities from time to time for a period not to exceed 10
consecutive semi-annual periods.
Asset Quality
The Company attempts to minimize credit risk through its underwriting and
credit review policies. The Company conducts its own internal credit review
processes and, in addition, contracts with an independent loan reviewer who
performs semi-annual reviews of new loans and potential problem loans that fall
within predetermined parameters. The Board of Directors of NBR has an internal
asset review committee which reviews the asset quality of new and problem loans
on a quarterly basis and reports the findings to the full Board. In management's
opinion, this loan review system facilitates the early identification of
potential problem loans.
The performance of the Company's loan portfolio is evaluated regularly by
management. The Company places a loan on nonaccrual status when one of the
following events occurs: (1) any installment of principal or interest is 90 days
or more past due (unless, in management's opinion, the loan is well secured and
in the process of collection); (2) management determines the ultimate collection
of principal of or interest on a loan to be unlikely; or (3) the terms of a loan
have been renegotiated to less than market rates due to a serious weakening of
the borrower's financial condition.
40
With respect to the Company's policy of placing loans 90 days or more past
due on nonaccrual status unless the loan is well secured and in the process of
collection, a loan is considered to be in the process of collection if, based on
a probable specific event, it is expected that the loan will be repaid or
brought current. Generally, this collection period would not exceed 30 days.
When a loan is placed on nonaccrual status, the Company's general policy is to
reverse and charge against current income previously accrued but unpaid
interest. Interest income on such loans is subsequently recognized only to the
extent that cash is received and future collection of principal is deemed by
management to be probable. Where the collectability of principal or interest on
a loan is considered to be doubtful by management, it is placed on nonaccrual
status prior to becoming 90 days delinquent.
Interest income is recognized on impaired loans in a manner similar to that
of all loans. It is the Company's policy to place loans that are delinquent 90
days or more as to principal or interest on nonaccrual status unless well
secured and in the process of collection, and to reverse from current income
accrued but uncollected interest. Cash payments subsequently received on
nonaccrual loans are recognized as income only when the future collection of
principal is considered by management to be probable.
At December 31, 2002 and 2001, the Company's total recorded investment in
impaired loans was $2,794,000 and $3,176,000 of which $2,493,000 and $2,892,000
related to the recorded investment for which there is a related allowance for
credit losses of $670,000 and $318,000. The amount of that recorded investment
for which there is no related allowance for credit losses was $301,000 and
$284,000 at December 31, 2002 and 2001. At December 31, 2002, substantially all
of the impaired loan balance was measured based on the fair value of the
collateral, with the remainder measured by the estimated present value of cash
flows.
The average recorded investment in impaired loans during the years ended
December 31, 2002, 2001 and 2000 was $1,866,000, $2,973,000 and $1,424,000. The
related amount of interest income recognized during the period that such loans
were impaired during such year was $65,000, $49,000 and $65,000.
As of December 31, 2002 and 2002, there were $2,516,000 and $2,892,000 of
loans on which the accrual of interest had been discontinued. Interest due but
excluded from interest income on loans placed on nonaccrual status was $66,000,
$88,000 and $72,000 for the years ended December 31, 2002, 2001 and 2000.
Interest income received on nonaccrual loans was $0, $1,000 and $14,000 for the
years ended December 31, 2002, 2001 and 2000.
41
The following table sets forth the amount of the Company's nonperforming assets
as of the dates indicated.
December 31,
---------------------------------------------------------
2002 2001 2000 1999 1998
---------------------------------------------------------
(dollars in thousands)
Nonaccrual loans $2,516 $2,892 $908 $3,063 $5,556
Accruing loans past due 90 days or more 6 --- --- --- ---
Restructured loans (in compliance with modified terms) 272 284 295 1,018 1,045
---------------------------------------------------------
Total nonperforming loans 2,794 3,176 1,203 4,081 6,601
Other real estate owned --- --- 757 2,363 2,181
Other assets owned --- --- --- --- 129
---------------------------------------------------------
Total nonperforming assets $2,794 $3,176 $1,960 $6,444 $8,911
=========================================================
Nonperforming loans to total loans 0.77% 0.90% 0.38% 1.30% 2.45%
Nonperforming assets to total assets 0.54 0.71 0.43 1.52 2.11
Allowance for loan losses to nonperforming assets 264.85 238.66 391.53 123.08 90.24
Allowance for loan losses to nonperforming loans 264.85 238.66 637.91 194.34 121.82
Nonperforming loans totaled $2,794,000 at December 31, 2002, consisting of
$476,000 that were secured by residential real estate with the remaining
$2,318,000 either unsecured or collateralized by various business assets other
than real estate.
At December 31, 2002, the Company did not carry any assets classified as
other real estate owned.
In addition to the above mentioned assets, as of December 31, 2002
management of the Company has identified eight lending relationships which in
aggregate amount to approximately $1,244,000 in potential nonperforming loans,
as to which it has serious doubts as to the ability of the borrowers to comply
with the present repayment terms and which may become nonperforming assets,
based on known information about possible credit problems of the borrower. Two
of these loans are secured by real estate and the others are secured by business
assets.
42
The following table provides certain information for the years
indicated with respect to the Company's allowance for loan losses as well as
charge-off and recovery activity.
Year Ended December 31,
-----------------------------------------------------------------
2002 2001 2000 1999 1998
-----------------------------------------------------------------
(dollars in thousands)
Balance at beginning of period $7,580 $7,674 $7,931 $8,041 $7,645
-----------------------------------------------------------------
Charge-offs:
Residential real estate mortgage --- --- 111 21 617
Commercial real estate mortgage --- --- --- 612 355
Commercial 264 177 461 769 794
Real estate construction 22 --- 90 100 179
Installment and other 12 8 39 13 55
-----------------------------------------------------------------
Total charge-offs 298 185 701 1,515 2,000
-----------------------------------------------------------------
Recoveries:
Residential real estate mortgage --- 4 69 42 31
Commercial real estate mortgage --- --- 22 45 10
Commercial 99 75 169 498 279
Real estate construction 2 --- 3 53 3
Installment and other 17 12 31 17 33
-----------------------------------------------------------------
Total recoveries 118 91 294 655 356
-----------------------------------------------------------------
Net charge-offs 180 94 407 860 1,644
-----------------------------------------------------------------
Provision for loan losses --- --- 150 750 2,040
-----------------------------------------------------------------
Balance at end of period $7,400 $7,580 $7,674 $7,931 $8,041
=================================================================
Net charge-offs during the period
to average loans 0.05% 0.03% 0.12% 0.29% 0.62%
Allowance for loan losses to total loans 2.03 2.16 2.44 2.52 2.99
Allowance for loan losses
to nonperforming loans 264.85 238.66 637.91 194.34 121.82
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.
43
The adequacy of the Company's allowance for loan losses is based on
specific and formula allocations to the Company's loan portfolio. Specific
allocations of the allowance for loan losses are made to identified problem
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 and
general economic conditions and other qualitative factors.
It is the policy of management to make additions to the allowance for loan
losses so that it remains adequate to cover probable incurred losses, and
management believes that the allowance at December 31, 2002 was adequate.
However, the determination of the amount of the allowance is judgmental and
subject to economic conditions which cannot be predicted with certainty.
Accordingly, the Company cannot predict whether charge-offs of loans in excess
of the allowance may be required in future periods.
The table below sets forth the allocation of the allowance for loan losses
by loan type as of the dates specified. The allocation of individual categories
of loans includes amounts applicable to specifically identified as well as
estimated losses inherent in that segment of the loan portfolio and will
necessarily change whenever management determines that the risk characteristics
of the loan portfolio have changed.
Management believes that any breakdown or allocation of the allowance for
loan losses into loan categories lends an appearance of exactness, which does
not exist, in that the allowance is utilized as a single amount available for
all loans. The allocation below should not be interpreted as an indication of
the specific amounts or loan categories in which future charge-offs will occur.
44
December 31,
-----------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-----------------------------------------------------------------------------------------------------
Allowance % of Allowance % of Allowance % of Allowance % of Allowance % of
for Losses Loans for Losses Loans for Losses Loans for Losses Loans for Losses Loans
-----------------------------------------------------------------------------------------------------
(dollars in thousands)
Residential real
estate mortgage $1,322 24% $1,283 29% $1,194 32% $2,258 42% $1,725 36%
Commercial real
estate mortgage 2,386 43 1,839 34 1,549 29 947 25 1,260 22
Commercial 2,341 17 2,198 20 2,187 21 2,088 19 2,514 23
Real estate
construction 871 12 1,433 13 1,416 16 1,064 13 1,691 17
Installment and
other 447 4 427 4 257 2 130 1 207 2
Unallocated 33 --- 400 --- 1,071 --- 1,444 --- 644 ---
--------------- ----------------- ---------------- ----------------- -----------------
Total $7,400 100% $7,580 100% $7,674 100% $7,931 100% $8,041 100%
=============== ================= ================ ================= =================
Mortgage Repurchase Commitments
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. The Company expects
that it may be required to repurchase loans in the future. During 2002 the
Company was required to repurchase one mortgage loan for $72,000, as compared to
2001, during which the Company was not required to repurchase any mortgage
loans. In 2000, the Company was required, by various mortgage loan investors, to
repurchase 2 nonperforming residential mortgage loans totaling $120,000.
Investment in REMIC
In 1995, Allied, formally a wholly owned subsidiary of Redwood which was
merged into NBR in 1997, sold a COFI ARM mortgage pool whose carrying value was
approximately $73.9 million as part of a transaction that resulted in creating a
Real Estate Mortgage Investment Conduit ("REMIC"). The REMIC issued three
classes of mortgage pass-through mortgage certificates, A, B and C. The sale
transaction took place as a result of Allied selling 100% interest in the COFI
indexed ARM mortgage pool in exchange for cash of $71.5 million and a Class "B"
certificate which represented the first loss position with respect to any
ultimate losses realized upon the liquidation of defaulted mortgage loans in the
pool. As part of the sale transaction, Allied retained the servicing of the
pool. The Class "A" and Class "B" certificates have sequential rights to
principal payments, such that the Class "B" certificate shall only receive
principal payments after all Class "A" certificates are retired.
45
The composition of the original certificate balances along with their
respective December 31, 2002 balances is as follows:
Original December 31, 2002
Certificate Certificate
Face Value Face Value
-------------------- --------------------
Class A $73,199,448 $2,598,893
Class B 3,249,067 3,196,477
Class C 100 100
-------------------- --------------------
$76,448,615 $5,795,470
==================== ====================
Since inception the pool has realized losses of $52,590 which reduced the
original face value of the Class "B" certificate.
Contractual Obligations and Commitments
The following table presents our longer term, non-deposit related,
contractual obligations and our commitments to extend credit to our borrowers,
in aggregate and by payment due dates:
December 31, 2002
------------------------------------------------------------------
Less Than One Through Four To After Five
One Year Three Years Five Years Years Total
------------------------------------------------------------------
(in thousands)
Trust preferred securities $ --- $ --- $ --- $10,000 $10,000
Operating leases (premises) 1,455 1,850 1,248 556 5,109
------------------------------------------------------------------
Total long-term debt
and operating leases $1,455 $1,850 $1,248 $10,556 $15,109
=========================================================
Commitments to extend credit 75,959
Standby letters of credit 307
----------
Total contractual obligations and commitments $91,375
==========
46
Liquidity
Redwood's primary source of liquidity is dividends from NBR. Redwood's
primary uses of liquidity are associated with common stock repurchases, dividend
payments made to the shareholders, interest payments relating to Redwood's trust
preferred debt and operating expenses. It is the Company's policy to maintain
liquidity levels at the parent company which management believes to be
consistent with the safety and soundness of the Company as a whole. As of
December 31, 2002, Redwood held $46,000 in deposits at NBR. In addition, Redwood
has a $2,500,000 unsecured line of credit with a major financial institution,
which bears an interest rate equal to the federal funds rate plus 1.50%. As of
December 31, 2002, there was an outstanding balance of $1,150,000 under this
line of credit.
Payment of dividends by Redwood 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 be
undercapitalized as a result. If NBR is restricted from paying dividends,
Redwood might be unable to pay the above obligations. No assurance can be given
as to the ability of NBR to pay dividends to Redwood. At December 31, 2002, NBR
could not pay additional dividends to Redwood without prior regulatory approval.
The approval of the OCC is required for the payment of dividends if the total of
all dividends declared by a national bank in any calendar year would exceed the
total of its net profits of that year combined with its retained net profits of
the two preceding years, less any required transfers to surplus or a fund for
the retirement of any preferred stock. In January 2003, NBR received approval
for its 2003 dividend plan from the OCC. In 2002, 2001 and 2000 NBR declared
dividends payable to Redwood of $6,600,000, $5,900,000 and $12,129,000. For
additional information, please see "Regulation and Supervision" in Item I of
this report and Note N to the Consolidated Financial Statements included in this
Report.
Although each entity within the consolidated group manages its own
liquidity, the Company's consolidated cash flows can be divided into three
distinct areas; operating, investing and financing. For the year ended December
31, 2002, the Company received $5,261,000 and $57,687,000 in cash flows from
operations and financing activities while using $47,860,000 in investing
activities.
The principal source of asset liquidity is federal funds sold. Secondary
sources of liquidity are loan repayments, investment securities available for
sale, maturing investment securities held to maturity, and loans and investments
that can be used as collateral for other borrowings. At December 31, 2002, the
Company had $17,500,000 in federal funds sold. Total investment securities were
$99,921,000, of which $34,402,000 were pledged.
47
Liability-based liquidity includes interest-bearing and noninterest bearing
retail deposits, which are a relatively stable source of funds, time deposits
from financial institutions throughout the United States, federal funds
purchased, and other short-term and long-term borrowings, some of which are
collateralized. As required by the Federal Home Loan Bank, NBR collateralizes
its advances from the FHLB with residential mortgage loans. Management uses FHLB
advances as part of its funding strategy because the rates paid for those
advances are generally in line with the rates paid on time deposits. At December
31, 2002, approximately $42,000,000 of residential mortgage loans were pledged
to secure any funds the Company may borrow from the FHLB in the future. NBR's
FHLB borrowing limitation at December 31, 2002 was $37,000,000. At December 31,
2002, NBR had outstanding FHLB advances of $5,000,000. At December 31, 2001 and
2000 NBR had paid off all FHLB advances. Management believes that at December
31, 2002 the Company's liquidity position was adequate for the operations of
Redwood and its subsidiaries for the foreseeable future.
Capital
A strong capital base is essential to the Company's continued ability to
service the needs of its customers. Capital protects depositors and the deposit
insurance fund from potential losses and is a source of funds for the
substantial investments necessary for the Company to remain competitive. In
addition, adequate capital and earnings enable the Company to gain access to the
capital markets to supplement its internal growth of capital. Capital is
generated internally primarily through earnings retention.
The Company and NBR are each required to maintain minimum capital ratios
defined by various federal government regulatory agencies. The FRB and the OCC
have each established capital guidelines, which include minimum capital
requirements. The regulations impose two sets of standards: "risk-based" and
"leverage".
Under the risk-based capital standard, assets reported on an institution's
balance sheet and certain off-balance-sheet items are assigned to risk
categories, each of which is assigned a risk weight. This standard characterizes
an institution's capital as being "Tier 1" capital (defined as principally
comprising shareholders' equity, trust preferred securities, for up to 25% of
total tier 1 capital, and noncumulative preferred stock) and "Tier 2" capital
(defined as principally comprising the allowance for loan losses and
subordinated debt). At December 31, 2002, 2001 and 2000, the Company and its
subsidiaries were required to maintain a total risk-based capital ratio of 8%
and a Tier 1 capital ratio of at least 4%.
Under the leverage capital standard, an institution must maintain a
specified minimum ratio of Tier 1 capital to total assets, with the minimum
ratio ranging from 4% to 6% for other than the highest rated institutions. The
minimum leverage ratio for the Company and NBR is based on average assets for
the quarter.
NBR maintains insurance on its customer deposits with the Federal Deposit
Insurance Corporation ("FDIC"). The FDIC manages the Bank Insurance Fund
("BIF"), which insures deposits of commercial banks such as NBR, and the Savings
Association Insurance Fund ("SAIF"), which insures deposits of savings
associations. FDICIA mandated that the two funds maintain reserves at 1.25% of
their respective federally insured deposits.
48
The table below shows the capital ratios for the Company and NBR at
December 31, 2002.
Company NBR
------------------------------
Total capital to risk weighted assets 10.72% 10.94%
Tier 1 capital to risk weighted assets 9.18 9.68
Leverage ratio 6.96 7.35
Under the most stringent capital requirement, the Company has approximately
$10,542,000 in capital above the level at which it would become
under-capitalized. Similarly, NBR has $11,395,000 in capital in excess of that
level.
Common Stock Repurchase
During the years ended December 31, 2002, 2001 and 2000, the Company
repurchased common stock of the Company. The number of shares and the average
cost per share of such repurchases is as follows:
2002 2001 2000
--------------------------------
Common shares repurchased 137,328 866,308 643,313
Average price paid $27.55 $18.92 $12.88
The above table reflects the three-for-two common stock split, which was
effective on October 19, 2001.
As of the date of this filing, the Company has a current common stock
repurchase authorization outstanding of 355,500 shares, of which 237,003 have
been purchased at an average cost of $26.81.
Certifications Under Section 906 of the Sarbanes-Oxley Act of 2002
The certification by the Company's chief executive officer and chief
financial officer of this report on Form 10-K, as required by section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350), has been submitted to the
Securities and Exchange Commission as additional correspondence accompanying
this report.
Item 7A. 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
49
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" in Item 7.
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. NBR'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. NBR, 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. NBR 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.
NBR 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. NBR has adopted formal policies and practices to
monitor and manage interest rate risk exposure. As part of this effort, NBR
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.
50
The following table sets forth, as of December 31, 2002, 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 Within After Five
Months Months One year Five Years Years Total
--------------------------------------------------------------------------
(dollars in thousands)
Earning assets:
Federal funds sold $17,500 $ --- $ --- $ --- $ --- $17,500
Investment securities 7,165 7,240 16,887 49,140 19,489 99,921
Loans 99,763 56,893 31,916 138,534 37,970 365,076
--------------------------------------------------------------------------
Total earning assets 124,428 64,133 48,803 187,674 57,459 482,497
--------------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing transaction accounts 128,292 --- --- --- --- 128,292
Time deposits 66,289 61,861 84,344 8,823 --- 221,317
Other borrowings 12,356 --- --- --- --- 12,356
Trust preferred securities --- --- --- --- 10,000 10,000
--------------------------------------------------------------------------
Total interest-bearing liabilities 206,937 61,861 84,344 8,823 10,000 371,965
--------------------------------------------------------------------------
Interest rate sensitivity gap ($82,509) $2,272 ($35,541) $178,851 $47,459 $110,532
==========================================================================
Cumulative interest rate sensitivity gap ($82,509) ($80,237) ($115,778) $63,073 $110,532
===============================================================
Interest rate sensitivity gap ratio 0.60% 1.04% 0.58% 21.27% 5.75%
Cumulative interest rate sensitivity gap ratio 0.60% 0.70% 0.67% 1.17% 1.30%
The Company's gap position is substantially dependent upon the volume of
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 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.
Even though the Company's gap position is liability sensitive within the
one year time horizon, management expects that, in a declining rate environment,
the Company's net interest margin would be expected to decline, and, in an
increasing rate environment, the Company's net interest margin would tend to
increase. The Company has experienced greater mortgage lending activity through
mortgage refinancing 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.
51
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 200 basis points up and 200 basis points down. All changes are
measured in dollars and are compared to projected net interest income and the
current theoretical market value of the Bank's equity. This theoretical market
value of the Bank's equity is calculated by discounting cash flows associated
with the Company's assets and liabilities. The following is a December 31, 2002
and 2001 summary of interest rate risk exposure as measured on a net interest
income basis and a market value of equity basis, given a change in general
interest rates of 200 basis points up and 200 basis points down.
Change in Annual Change in
Change in Interest Rate Net Interest Income Market Value of Equity
2002
----
+200 $546,000 ($10,255,000)
+100 412,000 (4,324,000)
-100 (1,541,000) 1,363,000
-200 (3,371,000) 3,807,000
2001
----
+200 $307,000 ($8,154,000)
+100 173,000 (4,180,000)
-100 (328,000) 1,690,000
-200 (2,240,000) 2,289,000
The Company's interest rate risk exposure to a rising rate environment
remained relatively stable in 2002 compared to 2001, while exposure to a falling
interest rate environment increased in 2002 compared to 2001. This increase was
principally due to the current low rate environment which limits the Company
from lowering its funding costs at a rate consistent with potential 100 or 200
basis point declines in yields on earning assets.
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 of 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
the current market rate. Actual results could differ significantly from those
estimates which would result in significant differences in the calculated
projected change.
52
Item 8. Financial Statements and Supplementary Data
Financial Statements
The following consolidated financial statements of Redwood and its
subsidiaries and the report of independent auditors are included in this
section:
Page
Report of Independent Auditors.......................................................................54
Consolidated Financial Statements of Redwood Empire Bancorp and Subsidiaries
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000..............................................................55
Consolidated Balance Sheets as of December 31, 2002 and 2001.......................................56
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2002, 2001 and 2000..............................................................57
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000..............................................................58
Notes to Consolidated Financial Statements.........................................................60
53
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
Redwood Empire Bancorp
Santa Rosa, California
We have audited the accompanying consolidated balance sheets of Redwood
Empire Bancorp and subsidiaries (Company) as of December 31, 2002 and 2001 and
the related consolidated statements of operations, shareholders' equity and cash
flows for the years ended December 31, 2002, 2001 and 2000. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Redwood
Empire Bancorp and subsidiaries as of December 31, 2002 and 2001 and the results
of their operations and their cash flows for the years ended December 31, 2002,
2001 and 2000 in conformity with accounting principles generally accepted in the
United States of America.
Crowe, Chizek and Company LLP
South Bend, Indiana
January 9, 2003
54
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except share and per share data)
Year Ended December 31,
------------------------------------------------
2002 2001 2000
------------------------------------------------
Interest income:
Interest and fees on loans $25,702 $27,904 $29,769
Interest on investment securities 4,335 4,879 5,035
Interest on federal funds sold 499 772 359
------------------------------------------------
Total interest income 30,536 33,555 35,163
Interest expense:
Interest on deposits 8,579 12,430 13,969
Interest on other borrowings 88 139 350
Interest on trust preferred securities 1,003 882 ---
------------------------------------------------
Total interest expense 9,670 13,451 14,319
------------------------------------------------
Net interest income 20,866 20,104 20,844
Provision for loan losses --- --- 150
------------------------------------------------
Net interest income after provision for loan losses 20,866 20,104 20,694
------------------------------------------------
Noninterest income:
Service charges on deposit accounts 1,188 1,116 1,077
Merchant draft processing, net 5,009 4,240 4,856
Loan servicing income 268 295 272
Net realized gains (losses) on securities
available for sale 294 112 (171)
Gain/(loss) on sale of loans 13 --- (584)
Other income 843 836 656
------------------------------------------------
Total noninterest income 7,615 6,599 6,106
------------------------------------------------
Noninterest expense:
Salaries and employee benefits 8,967 8,336 8,640
Occupancy and equipment expense 2,126 2,026 2,040
Other 4,912 4,089 5,268
------------------------------------------------
Total noninterest expense 16,005 14,451 15,948
------------------------------------------------
Income before income taxes 12,476 12,252 10,852
Provision for income taxes 4,515 4,945 4,386
------------------------------------------------
Net income $7,961 $7,307 $6,466
================================================
Basic earnings per common share:
Net income $2.29 $1.97 $1.41
Weighted average shares 3,474,000 3,703,000 4,577,000
Diluted earnings per common share:
Net income $2.21 $1.91 $1.39
Weighted average shares 3,600,000 3,825,000 4,664,000
See Notes to Consolidated Financial Statements.
55
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share data)
December 31, December 31,
2002 2001
-------------------------------
Assets:
Cash and due from banks $21,837 $19,596
Federal funds sold 17,500 4,653
-------------------------------
Cash and cash equivalents 39,337 24,249
Investment securities:
Held to maturity, at cost (fair value: 2002 - $17,268; 2001 - $17,635) 16,764 17,402
Available for sale, at fair value (amortized cost: 2002 - $81,092; 2001 -$46,433) 83,157 47,573
-------------------------------
Total investment securities 99,921 64,975
Loans:
Portfolio loans 365,076 351,649
Allowance for loan losses (7,400) (7,580)
-------------------------------
Net loans 357,676 344,069
Premises and equipment, net 2,760 2,636
Cash surrender value of life insurance 3,620 3,443
Other assets and interest receivable 9,867 9,370
-------------------------------
Total Assets $513,181 $448,742
===============================
Liabilities and Shareholders' Equity:
Deposits:
Noninterest bearing demand deposits $103,484 $86,969
Interest bearing transaction accounts 128,292 121,457
Time deposits one hundred thousand and over 69,000 112,638
Other time deposits 152,317 76,348
-------------------------------
Total deposits 453,093 397,412
Other borrowings 12,356 3,870
Trust preferred securities 10,000 10,000
Other liabilities and interest payable 8,925 10,773
-------------------------------
Total Liabilities 484,374 422,055
-------------------------------
Shareholders' Equity:
Preferred stock, no par value; authorized 2,000,000 shares;
issued and outstanding: no shares --- ---
Common stock, no par value; authorized 10,000,000 shares; issued
and outstanding: 2002 - 3,404,890 shares, 2001 - 3,530,135 shares 10,853 12,373
Retained earnings 16,654 13,653
Accumulated other comprehensive income, net of tax 1,300 661
-------------------------------
Total Shareholders' Equity 28,807 26,687
-------------------------------
Total Liabilities and Shareholders' Equity $513,181 $448,742
===============================
See Notes to Consolidated Financial Statements.
56
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Years ended December 31, 2002, 2001 and 2000
(in thousands, except per share data)
Accumulated
Other
Comprehensive Common Retained Comprehensive
Income Shares Stock Earnings Income (loss), Net Total
- ---------------------------------------------------------------------------------------------------------------------------------
Balances, January 1, 2000 3,229 $22,033 $15,950 ($539) $37,444
Comprehensive income:
Net income $6,466 6,466 6,466
Other comprehensive income:
Unrealized holding gains arising
during period, net of tax of $377 514
Add: reclassification adjustment
net of tax of $69 102
---------------
Other comprehensive income 616 616 616
---------------
Comprehensive income $7,082
===============
Common stock repurchased (430) (8,283) (8,283)
Stock options exercised, net of tax effect 59 851 851
Cash dividends declared - common ($0.37 per share) (1,635) (1,635)
---------------------------------------------------------
Balances, December 31, 2000 2,858 14,601 20,781 77 35,459
Comprehensive income:
Net income $7,307 7,307 7,307
Other comprehensive income:
Unrealized holding gains arising
during period, net of tax of $468 651
Less: reclassification adjustment
net of tax of ($45) (67)
---------------
Other comprehensive income 584 584 584
---------------
Comprehensive income $7,891
===============
Common stock repurchased (595) (3,278) (13,113) (16,391)
Stock split - 3 for 2 1,193
Stock options exercised, net of tax effect and shares
redeemed 74 1,050 1,050
Cash dividends declared - common ($0.37 per share) (1,322) (1,322)
---------------------------------------------------------
Balances, December 31, 2001 3,530 12,373 13,653 661 26,687
Comprehensive income:
Net income $7,961 7,961 7,961
Other comprehensive income:
Unrealized holding gains arising
during period, net of tax of $395 824
Less: reclassification adjustment
net of tax of ($109) (185)
---------------
Other comprehensive income 639 639 639
---------------
Comprehensive income $8,600
===============
Common stock repurchased (137) (1,616) (2,167) (3,783)
Stock options exercised, net of tax effect 12 96 96
Cash dividends declared - common ($0.80 per share) (2,793) (2,793)
---------------------------------------------------------
Balances, December 31, 2002 3,405 $10,853 $16,654 $1,300 $28,807
=========================================================
See Notes to Consolidated Financial Statements.
57
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
Year ended December 31,
2002 2001 2000
----------------------------------------------
Cash flows from operating activities:
Net income $7,961 $7,307 $6,466
----------------------------------------------
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization, net 456 130 (72)
Net realized (gains) losses on securities available for sale (294) (112) 171
Loans originated for sale (1,807) --- ---
Proceeds from sale of loans held for sale 1,820 --- ---
Gain on sale of loans and loan servicing (13) --- ---
Loss on sale of portfolio loans --- --- 584
Provision for loan losses --- --- 150
Change in cash surrender value of life insurance (177) (168) (88)
Change in other assets and interest receivable (837) 706 26
Change in other liabilities and interest payable (1,848) 2,084 (2,279)
Other, net --- --- ---
----------------------------------------------
Total adjustments (2,700) 2,640 (1,508)
----------------------------------------------
Net cash from operating activities 5,261 9,947 4,958
----------------------------------------------
Cash flows from investing activities:
Net change in loans (13,230) (36,058) (40,072)
Proceeds from sale of loans in portfolio --- --- 20,621
Purchases of investment securities available for sale (64,436) (24,832) (3,941)
Purchases of investment securities held to maturity (4,840) (1,326) (906)
Sales of investment securities available for sale 9,319 5,918 10,890
Maturities of investment securities available for sale 20,569 27,883 3,011
Maturities of investment securities held to maturity 5,623 13,866 1,430
Purchase of premises and equipment, net of retirements (865) (884) (351)
Proceeds from sale of other real estate owned --- 757 2,427
----------------------------------------------
Net cash from investing activities (47,860) (14,676) (6,891)
----------------------------------------------
Cash flows from financing activities:
Net change in noninterest bearing transaction accounts 16,515 (4,758) 13,974
Net change in interest bearing transaction accounts 6,835 (5,884) 2,984
Net change in time deposits 32,331 2,721 18,866
Net change in other borrowings 8,486 342 (1,167)
Issuance of trust preferred securities --- 10,000 ---
Repurchases of common stock (3,783) (16,391) (8,283)
Issuance of common stock 96 773 566
Cash dividends paid (2,793) (1,752) (1,635)
----------------------------------------------
Net cash from financing activities 57,687 (14,949) 25,305
----------------------------------------------
Net change in cash and cash equivalents 15,088 (19,678) 23,372
Cash and cash equivalents at beginning of year 24,249 43,927 20,555
----------------------------------------------
Cash and cash equivalents at end of year $39,337 $24,249 $43,927
==============================================
(Continued)
58
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
(in thousands)
(Continued)
Year ended December 31,
2002 2001 2000
------------- ---------------------------
Supplemental Disclosures:
Cash paid during the year for:
Income taxes $5,193 $5,155 $4,354
Interest 9,311 13,618 13,989
Noncash investing and financing activities:
Transfer from loans to other real estate owned --- --- $821
Securitization of residential real estate loans, net --- --- 17,949
(Concluded)
See Notes to Consolidated Financial Statements.
59
103
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - DESCRIPTION OF BUSINESS
Redwood Empire Bancorp ("Redwood," and with its subsidiaries, the
"Company") is a financial institution holding company headquartered in Santa
Rosa, California, and operating in Northern California with two wholly-owned
subsidiaries, National Bank of the Redwoods, a national bank chartered in 1985
and Redwood Statutory Trust I (RST1), a Connecticut statutory Trust. In 2002
National Bank of the Redwoods (and with its subsidiary, "NBR") formed NBR Real
Estate Investment Trust, a Maryland Real Estate Investment Trust. The entity was
formed to hold NBR's real estate secured loans and to better organize NBR's
marketing and origination of real estate secured lending. The Company's business
strategy involves two principal business activities, core community banking
services and merchant card services, which are conducted through NBR.
NBR provides its core community banking services through five retail
branches located in Sonoma County, California, one retail branch located in
Mendocino County, California, and one retail branch located in Lake County,
California. Loan services at NBR are generally extended to professionals and to
businesses with annual revenues of less than $20 million. Commercial loans are
primarily for working capital, asset acquisition and commercial real estate.
NBR's targeted commercial banking market area includes the California counties
north of San Francisco. NBR generates noninterest income through merchant draft
processing by virtue of its status as a Principal Member of Visa/MasterCard. In
addition, NBR originates both commercial and residential construction loans for
its portfolio.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States of America and
general practices within the banking industry. The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. The estimates of allowance for
loan losses, allowance for merchant card charge-back losses and fair values of
securities and other financial instruments are particularly subject to change. A
summary of the more significant policies follows:
Basis of Presentation
The consolidated financial statements include the accounts of Redwood
Empire Bancorp and its wholly-owned subsidiaries, National Bank of the Redwoods
(NBR) and RST1. All material intercompany transactions and accounts have been
eliminated.
60
For the purpose of the statements of cash flows, cash and cash equivalents
have been defined as cash on hand, demand deposits with correspondent banks,
cash items in transit and federal funds sold.
Investment Securities
Securities held to maturity are carried at cost adjusted by the accretion
of discounts and amortization of premiums. The Company has the ability and
intent to hold these investment securities to maturity. Securities available for
sale may be sold to implement the Company's asset/liability management
strategies and in response to changes in interest rates, prepayment rates and
similar factors. Available for sale securities are recorded at market value and
unrealized gains or losses, net of income taxes, are included in accumulated
other comprehensive income or loss, as a separate component of shareholders'
equity. Federal Reserve Bank (FRB) stock and Federal Home Loan Bank (FHLB) stock
are restricted equity securities and are carried at cost. Gain or loss on sale
of investment securities is based on the specific identification method.
Interest income includes amortization of purchased premium or discount.
Securities are written down to fair value when a decline in fair value is not
temporary.
Loans and the Allowance for Loan Losses
Loans are stated at the principal balance outstanding net of the allowance
for loan losses and net deferred loan fees or costs. Loan fees net of certain
related direct costs to originate loans are deferred and amortized over the
contractual life of the loan using a method approximating the interest method.
Loan fees and direct costs related to the origination of loans held for sale are
recognized as a component of gain or loss on sale of mortgage loans when the
related loans are sold.
The allowance for loan losses is maintained at a level considered adequate
for probable incurred credit losses that can be reasonably anticipated and is
based on management's quarterly evaluation of the economic climate and other
factors related to the collectability of loan balances.
The factors considered by management include growth and composition of the
loan portfolio, overall portfolio quality, review of specific problem loans,
historical loss rates, regulatory reviews, trends and concentrations in
delinquencies and current economic conditions that may affect the borrower's
ability to pay. The actual results could differ significantly from management's
estimates. The allowance for loan losses is increased by provisions charged to
operations and reduced by loan charge-offs net of recoveries. A loan charge-off
is recorded when a loan has been determined by management to be uncollectable.
A loan is impaired when, based upon current information and events, it is
probable that NBR will be unable to collect all amounts due according to the
contractual terms of the loan agreement. This standard is applicable to all
loans, uncollateralized as well as collateralized, except loans that are
measured at the lower of cost or fair value. Impairment is measured based on the
present value of expected future cash flows discounted at the loan's effective
interest rate, the loan's observable market price, or the fair value of the
collateral if the loan is collateral dependent.
61
Interest income is recognized on impaired loans in a manner similar to that
of all loans. It is the Company's policy to place loans that are delinquent 90
days or more as to principal or interest on nonaccrual status unless well
secured and in the process of collection, and to reverse from current income
accrued but uncollected interest. Cash payments subsequently received on
nonaccrual loans are recognized as income only where the future collection of
all principal is considered by management to be probable.
The Company originates loans to customers under a SBA program that
generally provides for SBA guarantees of 70% to 85% of each loan. The Company
may sell the guaranteed portion of each loan to a third party and retain the
unguaranteed portion in its own portfolio. A gain is recognized on these loans
through collection on sale of a premium over the adjusted carrying value,
through retention of an ongoing rate differential less a normal service fee
(excess servicing fee) between the rate paid by the borrower to the Company and
the rate paid by the Company to the purchaser, or both.
To calculate the gain or loss on the sale, the Company's investment in a
SBA loan is allocated among the retained portion of the loan, excess servicing
retained and the sold portion of the loan, based on the relative fair market
value of each portion. The gain on the sold portion of the loan is recognized
currently. The excess servicing fees are reflected as an asset which is
amortized over an estimated life using a method approximating the interest
method; in the event future prepayments are significant and future expected cash
flows are inadequate to cover the unamortized excess servicing asset, additional
amortization would be recognized.
Other Real Estate Owned
Property acquired by the Company through foreclosure is recorded at the
lower of estimated fair value less estimated selling costs (fair value) or the
carrying value of the related loan at the date of foreclosure. At the time the
property is acquired, if the fair value is less than the loan amounts
outstanding, any difference is charged against the allowance for loan losses.
After acquisition, valuations are periodically performed and, if the carrying
value of the property exceeds the fair value, a valuation allowance is
established by a charge to operations. Subsequent increases in the fair value
may reduce or eliminate this allowance.
Operating costs on foreclosed real estate are expensed as incurred. Costs
incurred for physical improvements to foreclosed real estate are capitalized if
the value is recoverable through future sale.
Company Owned Life Insurance
The Company has purchased life insurance policies on certain key
executives. Company owned life insurance is recorded at its cash surrender
value, or the amount that can be realized.
62
Mortgage Banking and Hedging Activities
Mortgage loans held for sale are carried at the lower of cost or market
value as determined by outstanding commitments from investors, indicators of
value obtained by management from independent third parties, current investor
yield requirements calculated on an aggregate loan basis and the market value of
its hedging instruments. Valuation adjustments are charged against the gain or
loss on sale of mortgage loans.
Off-Balance-Sheet Risk
The Company is party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments include commitments to extend credit and standby letters
of credit. Those instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet. The
contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments.
Loan commitments are typically contingent upon the borrower meeting certain
financial and other covenants, and such commitments typically have fixed
expiration dates and require payment of a fee. As many of these commitments are
expected to expire without being drawn upon, the total commitments do not
necessarily represent future cash requirements. The Company evaluates each
potential borrower and the necessary collateral on an individual basis.
Collateral varies, but may include real property, bank deposits, debt
securities, equity securities, or business assets.
Standby letters of credit are conditional commitments written by the
Company to guarantee the performance of a customer to a third party. These
guarantees relate primarily to inventory purchases by the Company's commercial
customers, and such guarantees are typically short-term. Credit risk is similar
to that involved in extending loan commitments to customers and the Company
accordingly uses evaluation and collateral requirements similar to those of loan
commitments. Virtually all such commitments are collateralized.
Premises and Equipment
Premises and equipment consist of building, leasehold improvements,
furniture and equipment and are stated at cost, less accumulated depreciation
and amortization. Depreciation is computed using the straight-line method over
the estimated useful lives for financial reporting purposes, and an accelerated
method for income tax reporting. The estimated useful life of furniture and
equipment is between five and ten years. Leasehold improvements are amortized
over the terms of the lease or their estimated useful lives, whichever is
shorter.
63
Income Taxes
The Company accounts for income taxes using an asset and liability
approach, which requires the recognition of deferred tax assets and liabilities.
Future tax benefits attributable to temporary differences are recognized
currently to the extent that realization of such benefits is more likely than
not. These future tax benefits are measured by applying currently enacted tax
rates. A valuation allowance, if needed, reduces deferred tax assets to the
amount expected to be realized.
Earnings per Common Share
Basic earnings per common 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 common share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
entity.
On September 20, 2001, the Company announced a three-for-two stock split of
its outstanding shares of common stock. Earnings per share information for all
periods presented give effect to the stock split.
The following table reconciles the numerator and denominator used in
computing both basic earnings per common share and diluted earnings per common
share for the periods indicated. The weighted average shares outstanding have
been restated to give effect for the 2001 3 for 2 stock split.
Twelve Months Ended
December 31,
---------------------------------------------------------------------
2002 2001 2000
--------------------- --------------------- ---------------------
Basic Diluted Basic Diluted Basic Diluted
(2) (2) (2)
--------- ----------- --------------------- ---------------------
(in thousands except per share data)
Earnings per common share:
Net income $7,961 $7,961 $7,307 $7,307 $6,466 $6,466
Net income per share $2.29 $2.21 $1.97 $1.91 $1.41 $1.39
Weighted average common shares
outstanding 3,474 3,600(1) 3,703 3,825(1) 4,577 4,664(1)
Notes to earnings per common share table:
(1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 126, 122 and 87 for 2002, 2001 and 2000.
(2) Stock options of 18, 0 and 90 shares of common stock were not considered in
computing earnings per common share for 2002, 2001 or 2000 because they
were not diultive.
64
Stock-Based Compensation
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in net
income, as all options granted had an exercise price equal to or greater than
the market price of the underlying common stock at date of grant. The following
table illustrates the effect on net income using earnings per share if expense
was measured using fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation.
2002 2001 2000
-----------------------------------------------
(dollars in thousands, except per share data)
Net income as reported $7,961 $7,307 $6,466
Deduct: Stock-based compensation expense
determined under fair value based method (166) (166) (194)
-----------------------------------------------
Pro forma net income $7,795 $7,141 $6,272
===============================================
Basic earnings per share as reported $2.29 $1.97 $1.41
Pro forma basic earnings per share 2.24 1.93 1.37
Diluted earnings per share as reported $2.21 $1.91 $1.39
Pro forma diluted earnings per share 2.17 1.87 1.34
Pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
2002 2001 2000
-----------------------------------------------
Risk-free interest rate 4.06% 4.88% 6.41%
Expected option life in years 10 10 10
Expected stock price volatility 32.44% 33.25% 32.36%
Dividend yield 3.7% 2.9% 1.9%
Business Segments
Internal financial information is primarily reported and aggregated in two
lines of business, community banking and bankcard services.
Comprehensive Income
Comprehensive income includes net income and other comprehensive income or
loss. The Company's only source of other comprehensive income or loss is derived
from unrealized gains and
65
losses on investment securities available-for-sale. Reclassification adjustments
result from gains or losses on investment securities available-for-sale that
were realized and included in net income of the current period that also had
been included in other comprehensive income or loss as unrealized holding gains
or losses in the period in which they arose. They are excluded from other
comprehensive income or loss of the current period to avoid double counting.
Recently Issued But Not Yet Effective Accounting Pronouncements
New accounting standards for asset retirement obligations, restructuring
activities and exit costs, operating leases, and early extinguishment of debt
were issued in 2002. Management has determined that when the new accounting
standards are adopted in 2003 they will not have a material impact on the
Company's financial condition or results of operations.
NOTE C - CASH AND DUE FROM BANKS
NBR is required to maintain average reserve and clearing balances including
cash on hand or on deposit with the Federal Reserve Bank. The required reserve
balance included in cash and due from banks was approximately $1,200,000 and
$3,247,000 at December 31, 2002 and 2001. These balances do not earn interest.
NOTE D - INVESTMENT SECURITIES
An analysis of the investment securities portfolio follows:
Gross Gross
Fair Unrealized Unrealized
Value Gains Losses
------------------------------------------------
(in thousands)
December 31, 2002:
Available for sale:
U.S. Government obligations $9,372 $371 $ ---
Mortgage-backed 71,183 1,694 ---
Other securities --- --- ---
------------------------------------------------
Total debt securities 80,555 2,065 ---
FRB and FHLB stock 2,602 --- ---
------------------------------------------------
Total available for sale $83,157 $2,065 $ ---
================================================
66
Gross Gross
Carrying Unrecognized Unrecognized Fair
Amount Gains Losses Value
------------------------------------------------------------
(in thousands)
Held to maturity:
Mortgage-backed $8,611 $274 $ --- $8,885
Other securities 8,153 239 (9) 8,383
------------------------------------------------------------
Total held to maturity $16,764 $513 ($9) $17,268
============================================================
Gross Gross
Fair Unrealized Unrealized
Value Gains Losses
------------------------------------------------
(in thousands)
December 31, 2001:
Available for sale:
U.S. Government obligations $10,360 $339 $---
Mortgage-backed 25,390 528 (16)
Other securities 9,308 312 (23)
------------------------------------------------
Total debt securities 45,058 1,179 (39)
FRB and FHLB stock 2,515 --- ---
------------------------------------------------
Total available for sale $47,573 $1,179 ($39)
================================================
Gross Gross
Carrying Unrecognized Unrecognized Fair
Amount Gains Losses Value
------------------------------------------------------------
(in thousands)
Held to maturity:
U.S. Government obligations $2,000 $72 $ --- $2,072
Mortgage-backed 9,066 118 --- 9,184
Other securities 6,336 66 (23) 6,379
------------------------------------------------------------
Total held to maturity $17,402 $256 ($23) $17,635
============================================================
67
Debt securities by contractual maturity at December 31, 2002 were due as
follows. Securities not due at single maturity date, primarily mortgage-backed
securities, are shown separately.
Fair
Value
-------------------
(in thousands)
Available for sale:
One year or less $3,029
After one year through five years 6,343
After five years through ten years ---
After ten years 2,602
Mortgage-backed 71,183
-------------------
$83,157
===================
Carrying Fair
Amount Value
------------------- ------------------
(in thousands)
Held to maturity:
One year or less $ --- $ ---
After one year through five years 1,190 1,242
After five years through ten years 1,887 1,985
After ten years 5,076 5,156
Mortgage-backed 8,611 8,885
------------------- ------------------
$16,764 $17,268
=================== ==================
Proceeds from sales of available for sale investments in debt securities
during 2002, 2001 and 2000 were $9,319,000, $5,918,000, and $10,890,000. These
sales resulted in the realization of gross gains of $294,000 and $112,000 for
2002 and 2001, and gross losses of $171,000 for 2000.
Securities carried at approximately $34,402,000 and $34,910,000 at December
31, 2002 and 2001 were pledged to secure public deposits, bankruptcy deposits,
and treasury tax and loan borrowings.
68
NOTE E - MORTGAGE LOAN SERVICING
The Company services mortgage loans and participating interests in mortgage
loans owned by investors. The unpaid principal balances of mortgage loans
serviced for others are as follows:
December 31,
2002 2001
--------------------------------------
(in thousands)
Mortgage loan portfolios serviced for:
Freddie Mac $347 $1,005
Fannie Mae 610 1,555
Other investors 7,421 12,481
----------------- --------------------
$8,378 $15,041
================= ====================
NOTE F - LOANS AND THE ALLOWANCE FOR LOAN LOSSES
The Company primarily makes permanent and construction residential real
estate loans in California, and loans to individuals and small businesses
primarily in Sonoma and Mendocino Counties, California. There are no major
industry segments in the loan portfolio. Outstanding loans by type were:
December 31,
2002 2001
-----------------------------------
(in thousands)
Residential real estate mortgage $87,764 $101,175
Commercial real estate mortgage 158,018 121,456
Commercial 62,958 70,438
Real estate construction 42,749 46,501
Installment and other 14,260 12,567
Less net deferred fees (673) (488)
----------------- -----------------
Total loans 365,076 351,649
Less allowance for loan losses (7,400) (7,580)
----------------- -----------------
Net loans $357,676 $344,069
================= =================
69
Activity in the allowance for loan losses is summarized as follows:
2002 2001 2000
---------------------------------------
(in thousands)
Balance, beginning of year $7,580 $7,674 $7,931
Provision for loan losses --- --- 150
Loans charged off (298) (185) (701)
Recoveries 118 91 294
----------- ----------- -----------
Balance, end of year $7,400 $7,580 $7,674
=========== =========== ===========
At December 31, 2002 and 2001 the Company's total recorded investment in
impaired loans was $2,794,000 and $3,176,000 of which $2,493,000 and $2,892,000
relates to the recorded investment for which there is a related allowance for
loan losses of $670,000 and $318,000, and $301,000 and $284,000 relates to the
amount of that recorded investment for which there is no related allowance for
loan losses. At December 31, 2002 and 2001, substantially all of the impaired
loan balance was measured based on the fair value of the collateral, with the
remainder measured by estimated cash flow.
The average recorded investment in impaired loans during the years ended
December 31, 2002, 2001 and 2000 was $1,866,000, $2,973,000 and $1,424,000. The
related amount of interest income recognized on an accrual and cash basis during
the periods that such loans were impaired was $65,000, $49,000 and $65,000.
As of December 31, 2002 and 2001 there were $2,516,000 and $2,892,000 of
loans on nonaccrual. Interest due but excluded from interest income on these
nonaccrual loans was $66,000, $88,000, and $72,000 for the years ended December
31, 2002, 2001 and 2000. Interest income recorded on nonaccrual loans was $0,
$1,000 and $14,000 for the years ended December 31, 2002, 2001 and 2000.
At December 31, 2002 and 2001 there was $6,000 and $0 in loans past due 90
days or more as to interest or principal and still accruing interest
The Company originates SBA loans for sale to investors. A summary of the
activity in SBA loans is as follows:
December 31,
2002 2001 2000
----------------------------------------
(in thousands)
SBA guaranteed portion of loans serviced for others $4,389 $8,389 $10,926
SBA loans, net of sold portion 7,938 8,163 7,402
70
From time to time the Company may extend credit to executive officers,
directors and related parties. There were no such balances outstanding at
December 31, 2002 and 2001.
NOTE G - PREMISES, EQUIPMENT AND LEASES
A summary of premises and equipment is as follows:
December 31,
2002 2001
---------------------------
(in thousands)
Land $187 $187
Building and leasehold improvements 3,352 3,349
Furniture and equipment 9,258 9,608
---------------------------
Total premises and equipment 12,797 13,144
Less accumulated depreciation and amortization (10,037) (10,508)
---------------------------
Premises and equipment, net $2,760 $2,636
===========================
Depreciation expense for the years ended December 31, 2002, 2001, and 2000
was $741,000, $736,000, and $1,050,000.
The Company leases certain premises and equipment used in the normal course
of business. There are no contingent rental payments and the Company has five
subleased properties. Total rental expense under all leases, including premises,
totaled $1,326,000, $1,282,000, and $1,202,000 in 2002, 2001 and 2000. Minimum
future lease commitments total $5,109,000. Lease commitments are as follows:
2003 - $1,455,000; 2004 - $1,217,000; 2005 - $633,000, 2006 - $616,000, 2007 -
$632,000 and thereafter - $556,000. Minimum future sublease receivables are as
follows: 2003 - $162,000; 2004 - $112,000; 2005 - $37,000; 2006 - $22,000; and
2007 - $19,000. All subleases expire by 2007.
NOTE H - DEPOSITS
Interest expense on time certificates of deposit of $100,000 or more was
$2,996,000, $5,398,000, and $4,756,000 during 2002, 2001 and 2000.
71
At December 31, 2002 the scheduled maturities for all time deposits are as
follows:
Year ending
December 31, (in thousands)
- --------------------- --------------------
2003 $212,490
2004 5,765
2005 1,575
2006 307
2007 1,180
--------------------
$221,317
====================
NOTE I - INCOME TAXES
The provision (benefit) for income taxes consists of the following:
Year Ended December 31,
2002 2001 2000
----------------------------------------
(in thousands)
Current:
Federal $4,402 $4,268 $3,999
State 257 1,080 1,057
------------- --------------------------
4,659 5,348 5,056
------------- --------------------------
Deferred:
Federal 139 (300) (513)
State (283) (103) (157)
------------- --------------------------
(144) (403) (670)
------------- --------------------------
$4,515 $4,945 $4,386
============= ==========================
A reconciliation of the statutory income tax rate to the effective
income tax rate attributable to continuing operations of the Company is as
follows:
2002 2001 2000
------------------------------------
Income tax at federal statutory rate 35.0% 35.0% 35.0%
State franchise tax, net of federal benefit (.1) 5.2 5.4
Other 1.3 .2 ---
----------- ---------- ---------
36.2% 40.4% 40.4%
=========== ========== =========
72
Deferred income taxes, included in other assets and interest receivable,
reflect the tax effect of temporary differences existing between the financial
statement basis and tax basis of the Company's assets and liabilities. Deferred
tax benefits attributable to temporary differences are recognized to the extent
that realization of such benefits is more likely than not. The Company believes
it is more likely than not that the net deferred tax assets at December 31, 2002
and 2001 will be utilized to reduce future taxable income. Accordingly, there
was no valuation allowance associated with deferred tax assets at December 31,
2002 and 2001. The tax effect of the principal temporary items creating the
Company's net deferred tax asset included in other assets and interest
receivable are:
December 31,
2002 2001
-------------------------
(in thousands)
Deferred tax assets:
Allowance for loan losses $3,392 $3,252
Restructuring costs --- 43
Accrued expenses not yet deductible 746 707
Depreciation 482 507
Securities marked to market for
tax purposes 765 479
Other 261 100
------------ ------------
Total deferred tax assets 5,646 5,088
------------ ------------
Deferred tax liabilities:
Unrealized gain on securities
available for sale (765) (479)
FHLB stock dividends (361) (322)
State taxes (420) (45)
------------ ------------
Total deferred tax liabilities (1,546) (846)
------------ ------------
Net deferred tax asset $4,100 $4,242
============ ============
73
NOTE J - OTHER BORROWINGS
Other borrowings consist of the following:
December 31,
2002 2001
------------------------
(in thousands)
Treasury, tax and loan note $3,870 $3,870
Advances from the FHLB 5,000 ---
Advance from Wells Fargo 1,150 ---
Security repurchase agreement 2,336 ---
----------- ----------
$12,356 $3,870
=========== ==========
Treasury, Tax and Loan Note
The Company enters into various short-term borrowing agreements, which
include Treasury, Tax and Loan borrowings. These borrowings have maturities of
one day and are collateralized by investments or loans.
Advances from the FHLB
The Company has a short-term borrowing agreement with the Federal Home Loan
Bank of San Francisco (FHLB). These borrowings have maturities of one day.
During 2002 and 2001, the highest month-end balance during the year was
$5,000,000 and $6,000,000. At December 31, 2002 there was an outstanding balance
of $5,000,000 as compared to the line of credit being fully paid off at December
31, 2001. All borrowings from the FHLB must be collateralized, and the Company
has pledged approximately $42,000,000 of residential mortgage loans as of
December 31, 2002, to the FHLB to secure any funds it may borrow. The available
credit under this agreement at December 31, 2002 was $37,000,000.
Advances from UBOC
During 1999, Redwood entered into an agreement with Union Bank of
California (UBOC) to obtain a $3,000,000 unsecured line of credit for short-term
borrowing purposes. At December 31, 2002 and 2001 the line had been paid off.
The average balance of UBOC advances was $35,000 for 2001 at an average interest
rate of 9.02%. The highest month-end balance during 2001 was $1,278,500. During
2002, there were no advances under this line of credit.
74
Advances from Wells Fargo
During 2001, Redwood entered into an agreement with Wells Fargo Bank to
obtain a $2,500,000 unsecured line of credit for short-term borrowing purposes.
At December 31, 2002 there was an outstanding balance of $1,150,000 as compared
to the line having been paid off as of December 31, 2001. The available credit
under this line at December 31, 2002 was $1,350,000. The average balance of
advances was $298,000 and $523,000 for 2002 and 2001 at an average interest rate
of 3.41% and 5.12%. The highest month-end balance during 2002 and 2001 was
$1,150,000 and $1,500,000. This agreement has a maturity date of October 15,
2003.
NOTE K - NONINTEREST EXPENSE - OTHER
The major components of noninterest expense - other are as follows:
Year Ended December 31,
2002 2001 2000
--------------------------------------
(in thousands)
Professional fees $1,119 $360 $950
Regulatory expense and insurance 420 396 453
Postage and office supplies 531 529 463
Shareholder expenses and director fees 379 377 412
Advertising 400 484 420
Telephone 395 389 351
Electronic data processing 1,113 944 1,274
Other 555 610 945
----------- ---------- -----------
$4,912 $4,089 $5,268
=========== ========== ===========
NOTE L - STOCK OPTIONS AND BENEFIT PLANS
The Company's 1991 stock option plan, which was amended in 1992, provides
for the granting of both incentive stock options and nonqualified stock options
to directors and key employees. Generally, options outstanding under the stock
option plan are granted at prices equal to the market value of the stock at the
date of grant, vest ratably over a four year service period and expire ten years
subsequent to the award. During 2001, all shares remaining in this plan were
granted.
During 2001, the Company's 2001 stock option plan was adopted. Similar to
the 1991 stock option plan, incentive stock options and nonqualified stock
options may be granted to key employees and directors. Options outstanding under
the stock option plan are granted at prices equal to the market value of the
stock at the date of grant, vest ratably over a four year service period and
expire ten years subsequent to the award.
75
Outstanding common stock options at December 31, 2002, are exercisable at
various dates through 2012. The following table summarizes option activity. The
following information has been restated to give effect of the September 20, 2001
3 for 2 stock split.
Weighted Average
Number Option Price
of Shares per Share
----------------------------------
(in thousands)
Balance at January 1, 2000 412 $8.35
Options exercised (88) 6.49
Options cancelled (2) 13.67
----------------------------------
Balance at December 31, 2000 322 8.81
Options granted 60 18.17
Options exercised, net of shares redeemed (119) 7.95
Options cancelled (3) 13.67
----------------------------------
Balance at December 31, 2001 260 11.34
Options granted 19 30.04
Options exercised (12) 7.40
----------------------------------
Balance at December 31, 2002 267 $12.84
==================
At December 31, 2002, 184,000 shares were available for future grants under
the 2001 plan.
Additional information regarding options outstanding as of December 31,
2002 is as follows:
Options Outstanding Options Exercisable
-------------------------------------------------------------------
Weighted Avg.
Range of Remaining
Exercise Number Contractual Weighted Avg. Number Weighted Avg.
Prices Outstanding Life (yrs) Exercise Price Exercisable Exercise Price
- -----------------------------------------------------------------------------------------------------
(in thousands) (in thousands)
$4.00 - $5.99 30 2 $5.62 30 $5.62
6.00 - 7.99 60 3 6.69 60 6.69
8.00 - 9.99 23 3 8.69 23 8.69
10.00 - 11.99 9 6 11.42 9 11.42
12.00 - 13.99 66 5 13.67 66 13.67
16.00 - 17.99 38 8 17.17 9 17.17
18.00 - 19.99 22 8 19.84 6 19.84
30.00 - 31.99 19 9 30.04 --- ---
----------------- -----------------
267 12.84 203 10.09
================= =================
76
In 1991 the Company established a 401(K) savings plan for employees over
age 21 who have at least 90 days of continuous service. The Company's matching
contributions are based on a sliding scale for a maximum contribution per
employee of $2,000 for 2000. The maximum contribution per employee was increased
to $4,000 in 2001 and remained the same during 2002. Company contributions
totaled $221,000, $228,000, and $146,000 in 2002, 2001 and 2000.
In December 1993 the Company established a supplemental benefit plan (Plan)
to provide death benefits and supplemental income payments during retirement for
selected officers. The Plan is a nonqualified defined benefit plan and is
unsecured. Benefits under the Plan are fixed for each participant and are
payable over a specific period following the participant's retirement or at such
earlier date as termination or death occurs. Participants vest in the plan based
on their years of service subsequent to being covered by the Plan. As of
December 31, 2002, 2001 and 2000, there is only one participant in the plan. The
Company has purchased insurance policies to provide for its obligations under
the Plan in the event a participant dies prior to retirement. The cash surrender
value of such policies was $3,620,000 at December 31, 2002 and $3,443,000 at
December 31, 2001. Under this Plan, the Company recognized expense of $81,000,
$70,000, and $64,000 in 2002, 2001 and 2000. The aggregate liability of the Plan
was approximately $324,000 and $275,000 at December 31, 2002 and 2001.
NOTE M - TRUST PREFERRED SECURITIES
On February 22, 2001, Redwood Statutory Trust I ("RSTI"), a wholly owned
subsidiary of the Company, closed a pooled offering of 10,000 Capital Securities
with a liquidation amount of $1,000 per security. The proceeds of the offering
were loaned to the Company in exchange for junior subordinated debentures with
terms similar to the Capital Securities. The sole assets of RSTI are the junior
subordinated debentures of the Company and payments thereunder. The junior
subordinated debentures and the back-up obligations, in the aggregate,
constitute a full and unconditional guarantee by the Corporation of the
obligations of RSTI under the Capital Securities. Distributions on the Capital
Securities are payable semi-annually at the annual rate of 10.2% and are
included in interest expense in the consolidated financial statements. These
securities are considered Tier 1 capital (with certain limitations applicable)
under current regulatory guidelines. As of December 31, 2002 and 2001 the
outstanding principal balance of the Capital Securities was $10,000,000. The
principal balance of the Capital Securities constitute the trust preferred
securities in the financial statements.
The junior subordinated debentures are subject to mandatory redemption, in
whole or in part, upon repayment of the Capital Securities at maturity or their
earlier redemption at the liquidation amount. Subject to the Company having
received prior approval of the Federal Reserve, if then required, the Capital
Securities are redeemable prior to the maturity date of February 22, 2031, at
the option of the Company; on or after February 22, 2021 at par; or on or after
February 22, 2011 at a premium, or upon occurrence of specific events defined
within the trust indenture. The Company has the option to defer distributions on
the Capital Securities from time to time for a period not to exceed 10
consecutive semi-annual periods.
77
NOTE N - REGULATORY MATTERS
One of the principal sources of cash for Redwood is dividends from NBR.
Total dividends which may be declared by subsidiary financial institutions
depend on the regulations which govern them. In addition, regulatory agencies
can place dividend restrictions on the subsidiaries based on their evaluation of
the financial condition of the subsidiaries. No restrictions are currently
imposed by regulatory agencies on the subsidiaries other than the limitations
found in the regulations which govern the respective subsidiaries. The approval
of the OCC is required for the payment of dividends if the total of all
dividends declared by a national bank in any calendar year would exceed the
total of its net profits of that year combined with its retained net profits of
the two preceding years, less any required transfers to surplus or a fund for
the retirement of any preferred stock. At December 31, 2002, NBR could not pay
additional dividends to Redwood without prior regulatory approval.
NBR is subject to certain restrictions under the Federal Reserve Act,
including restrictions on the extension of credit to affiliates. In particular,
it is prohibited from lending to an affiliated company unless the loans are
secured by specific types of collateral. Such secured loans and other advances
from the subsidiaries are limited to 10 percent of the subsidiary's equity. No
such loans or advances were outstanding during 2002 or 2001.
Redwood and NBR are subject to various regulatory capital requirements
administered by the federal banking agencies. In addition to these capital
guidelines, the Federal Deposit Insurance Corporation Improvement Act of 1991
(FDICIA) required each federal banking agency to implement a regulatory
framework for prompt corrective actions for insured depository institutions that
are not adequately capitalized. The FRB, FDIC, OCC and OTS have adopted such a
system which became effective on December 19, 1992. Failure to meet minimum
capital requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. The regulations require
the Company to meet specific capital adequacy guidelines that involve
quantitative measures of the Company's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
NBR's capital classification is also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain a minimum leverage ratio of Tier 1 capital (as
defined in the regulations) to adjusted assets (as defined), and minimum ratios
of Tier 1 and total capital (as defined) to risk-weighted assets (as defined).
As of December 31, 2002 and 2001, the most recent notification from the OCC
categorized NBR as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, NBR must maintain
minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set
forth in the table. There are no conditions or events since that notification
that management believes have changed NBR's category. The Company is also
considered to be well capitalized as of December 31, 2002 and 2001.
78
To Be Categorized as
For Capital Well-Capitalized Under
Actual Adequacy Purposes Prompt Corrective Action
------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
------------------------------------------------------------------------------
(in thousands (in thousands) (in thousands)
At December 31, 2002:
Company
Leverage Capital (to Average Assets) $35,604 6.96% $20,456 4.00% $25,570 5.00%
Tier 1 Capital (to Risk-weighted Assets) 35,604 9.18% 15,522 4.00% 23,283 6.00%
Total Capital (to Risk-weighted Assets) 41,585 10.72% 31,043 8.00% 38,804 10.00%
NBR
Leverage Capital (to Average Assets) 37,500 7.35% 20,411 4.00% $25,514 5.00%
Tier 1 Capital (to Risk-weighted Assets) 37,500 9.68% 15,489 4.00% 23,233 6.00%
Total Capital (to Risk-weighted Assets) 42,372 10.94% 30,977 8.00% 38,722 10.00%
At December 31, 2001:
Company
Leverage Capital (to Average Assets) $33,844 7.46% $18,156 4.00% $22,695 5.00%
Tier 1 Capital (to Risk-weighted Assets) 33,844 9.52% 14,217 4.00% 21,325 6.00%
Total Capital (to Risk-weighted Assets) 39,650 11.16% 28,434 8.00% 35,542 10.00%
NBR
Leverage Capital (to Average Assets) $34,835 7.69% $18,113 4.00% $22,641 5.00%
Tier 1 Capital (to Risk-weighted Assets) 34,835 9.82% 14,189 4.00% 21,283 6.00%
Total Capital (to Risk-weighted Assets) 39,308 11.08% 28,378 8.00% 35,472 10.00%
Management believes that as of December 31, 2002, the Company and NBR meet
all capital requirements to which they are subject. Under the most stringent
capital requirement, NBR has approximately $11,395,000 in excess capital before
it becomes "undercapitalized" under the regulatory framework for prompt
corrective action.
The prompt corrective action regulations impose restrictions upon all
financial institutions to refrain from certain actions which would cause an
institution to be classified as "undercapitalized", such as the declaration of
dividends or other capital distributions or payment of management fees, if
following the distribution or payment the institution would be classified as
"undercapitalized". In addition, financial institutions which are classified as
"undercapitalized" are subject to certain mandatory and discretionary
supervisory actions.
79
NOTE O - BUSINESS SEGMENTS
The Company operates in two principal industry segments: core community
banking, and merchant card services. The Company's core community banking
industry segment includes commercial, commercial real estate, construction, and
permanent residential lending along with all depository activities. The
Company's merchant card services industry group provides credit card settlement
services for 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 includes indirect costs, such as overhead and operations
and technology expense, which 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.
80
For the year ended December 31, 2002
(in thousands)
------------------------------------------
Community Total
Banking Bankcard Company
------------------------------------------
Total interest income $30,536 $ --- $30,536
Total interest expense 9,641 29 9,670
Interest income (expense) allocation (625) 625 ---
------------------------------------------
Net interest income 20,270 596 20,866
Provision for loan losses --- --- ---
Total other operating income 2,606 5,009 7,615
Total other operating expense 13,327 2,678 16,005
------------------------------------------
Income before income taxes 9,549 2,927 12,476
Provision for income taxes 3,469 1,046 4,515
------------------------------------------
Net income $6,080 $1,881 $7,961
==========================================
Total Average Assets $465,678 $26,788 $492,466
==========================================
For the year ended December 31, 2001
(in thousands)
------------------------------------------
Community Total
Banking Bankcard Company
------------------------------------------
Total interest income $33,555 $ --- $33,555
Total interest expense 13,441 10 13,451
Interest income (expense) allocation (1,052) 1,052 ---
------------------------------------------
Net interest income 19,062 1,042 20,104
Provision for loan losses --- --- ---
Total other operating income 2,359 4,240 6,599
Total other operating expense 12,222 2,229 14,451
------------------------------------------
Income before income taxes 9,199 3,053 12,252
Provision for income taxes 3,714 1,231 4,945
------------------------------------------
Net income $5,485 $1,822 $7,307
==========================================
Total Average Assets $422,134 $26,374 $448,508
==========================================
81
For the year ended December 31, 2000
(in thousands)
------------------------------------------
Community Total
Banking Bankcard Company
------------------------------------------
Total interest income $35,163 $ --- $35,163
Total interest expense 14,298 21 14,319
Interest income (expense) allocation (1,155) 1,155 ---
------------------------------------------
Net interest income 19,710 1,134 20,844
Provision for loan losses 150 --- 150
Total other operating income 1,250 4,856 6,106
Total other operating expense 13,939 2,009 15,948
------------------------------------------
Income before income taxes 6,871 3,981 10,852
Provision for income taxes 2,776 1,610 4,386
-----------------------------------------
Net income $4,095 $2,371 $6,466
=========================================
Total Average Assets $414,181 $24,904 $439,085
==========================================
NOTE P - FAIR VALUES OF FINANCIAL INSTRUMENTS
The Company discloses the fair values of financial instruments for which it
is practicable to estimate their value. Although management uses its best
judgment in assessing fair values, there are inherent weaknesses in any
estimating technique that may be reflected in the fair values disclosed. The
fair value estimates are made at a discrete point in time based on relevant
market data, information about the financial instruments, and other factors.
Estimates of fair value of financial instruments without quoted market prices
are subjective in nature and involve various assumptions and estimates that are
matters of judgment. Changes in the assumptions used could significantly affect
these estimates. The fair values have not been adjusted to reflect changes in
market conditions for the period subsequent to the valuation dates of December
31, 2002 and 2001, and therefore, estimates presented herein are not necessarily
indicative of amounts which could be realized in a current transaction.
The following estimates and assumptions were used on December 31, 2002 and
2001 to estimate the fair value of each class of financial instruments for which
it is practicable to estimate that value.
(a) Cash and Cash Equivalents
For cash and cash equivalents, the carrying amount is a reasonable estimate
of fair value.
82
(b) Investment Securities
Fair value equals quoted market price, if available. If a quoted market
price is not available, fair value is estimated using quoted market prices for
similar securities. For investments in unregistered mortgage-backed securities
with recourse, fair value was estimated based on the expected future cash flows
to be received adjusted for prepayments, foreclosures, losses and other
significant factors impacting fair value. U.S. Government agency stock has no
trading market but is required as part of membership, and therefore it is
carried at cost.
(c) Loans, net
To estimate fair value of loans held for investment, including commercial
loans, mortgages, construction and other loans, each loan category is segmented
by fixed and adjustable rate interest terms, by estimated credit risk, by
maturity, and by performing and nonperforming categories.
The fair value of performing loans is estimated by discounting contractual
cash flows using the current interest rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining maturities.
Assumptions regarding credit risk, cash flow, and discount rates are
judgmentally determined using available market information.
The fair value of nonperforming loans and loans delinquent more than 30
days is estimated by discounting estimated future cash flows using current
interest rates with an additional risk adjustment reflecting the individual
characteristics of the loans.
(d) Interest Receivable and Payable
For interest receivable and payable, the carrying amount is a reasonable
estimate of fair value.
(e) Deposits
The fair value of deposits with no stated maturity, such as noninterest
bearing demand deposits, savings and money market accounts, is equal to the
amount payable on demand on December 31, 2002 and 2001. The fair value of time
deposits is based on the discounted value of contractual cash flows. The
discount rate is based on rates currently offered for deposits of similar size
and remaining maturities.
(f) Other Borrowings and Trust Preferred Securities
The discounted value of contractual cash flows at market interest rates for
debt with similar terms and remaining maturities are used to estimate the fair
value of existing debt.
83
(g) Cash Surrender Value of Life Insurance
For cash surrender value of life insurance, the carrying amount is a
reasonable estimate of fair value.
(h) Commitments to Fund Other Loans
The fair value of commitments to fund other loans represents fees currently
charged to enter into similar agreements with similar remaining maturities.
The estimated fair values of the Company's financial instruments are as
follows:
December 31,
2002 2001
----------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------------------------------------------------
(in thousands)
Assets:
Cash and cash equivalents $39,337 $39,337 $24,249 $24,249
Investment securities 99,921 100,425 64,975 65,208
Loans, net 357,676 359,533 344,069 341,467
Cash surrender value of life insurance 3,620 3,620 3,443 3,443
Interest receivable 2,325 2,325 2,545 2,545
Liabilities:
Deposits (453,093) (455,169) (397,412) (399,546)
Other borrowings (12,356) (12,358) (3,870) (3,866)
Trust preferred securities (10,000) (10,678) (10,000) (10,000)
Interest payable (1,797) (1,797) (1,438) (1,438)
NOTE Q - COMMITMENTS AND CONTINGENCIES
Certain lawsuits and claims arising in the ordinary course of business have
been filed or are pending against the Company or its subsidiaries. Based upon
information available to the Company, its review of such lawsuits and claims and
consultation with its counsel, the Company believes the liability relating to
these actions, if any, would not have a material adverse effect on its
consolidated financial statements.
84
A listing of financial instruments whose contract amounts represent
credit risk is as follows:
December 31, 2002 December 31, 2001
Fixed Rate Variable Rate Fixed Rate Variable Rate
------------------------------ ------------------------------
(in thousands)
Commitments to extend credit $13,746 $62,213 $8,772 $58,714
Standby letters of credit 307 --- 233 ---
Commitments to make loans are generally made for periods of 60 days or
less. The fixed rate loan commitments have interest rates ranging from 4.5% to
9.25% and maturities ranging from one month to 198 months.
NOTE R - CONDENSED FINANCIAL INFORMATION OF
REDWOOD EMPIRE BANCORP (PARENT ONLY)
CONDENSED BALANCE SHEETS
December 31,
2002 2001
--------------------------
(in thousands)
Assets
Cash and cash equivalents $46 $202
Investment in NBR 39,604 36,353
Investment in RST1 310 310
Other assets 816 691
------------- ------------
Total assets $40,776 $37,556
============= ============
Liabilities and Shareholders' Equity
Trust preferred securities $10,000 $10,000
Short term borrowings 1,150 ---
Borrowings from RST1 310 310
Other liabilities 509 559
Shareholders' equity 28,807 26,687
------------- ------------
Total liabilities and shareholders' equity $40,776 $37,556
============= ============
85
CONDENSED STATEMENTS OF OPERATIONS
Year Ended December 31,
2002 2001 2000
----------------------------------
(in thousands)
Dividends from NBR $6,600 $5,900 $12,129
Interest expense 1,013 910 81
Operating expenses 979 585 828
----------------------------------
Income before equity in undistributed income of NBR 4,608 4,405 11,220
----------------------------------
Equity in undistributed (excess distributed) income of NBR 2,612 2,299 (5,106)
----------------------------------
Income before income taxes 7,220 6,704 6,114
Income tax benefit (741) (603) (352)
----------------------------------
Net income $7,961 $7,307 $6,466
==================================
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31,
2002 2001 2000
-------------------------------------
(in thousands)
Cash flows from operating activities:
Net income $7,961 $7,307 $6,466
------------ ------------------------
Adjustments:
Amortization and depreciation --- --- 1
Equity in (undistributed) excess distributed income of NBR (2,612) (2,299) 5,106
Change in other assets (125) 642 (64)
Change in other liabilities (50) 274 197
------------ ------------------------
Total adjustments (2,787) (1,383) 5,240
------------ ------------------------
Net cash from operating activities 5,174 5,924 11,706
------------ ------------------------
Cash flows from investing activities:
Capital investment into RST1 --- (310) ---
------------ ------------------------
Net cash from investing activities --- (310) ---
------------ ------------------------
Cash flows from financing activities:
Net change in other borrowings 1,150 --- (825)
Issuance of common stock 96 773 566
Issuance of trust preferred securities --- 10,000 ---
Net proceeds from borrowings from RST1 --- 310 ---
Repurchases of common stock (3,783) (16,391) (8,283)
Cash dividends paid (2,793) (1,752) (1,635)
------------ ------------------------
Net cash from financing activities (5,330) (7,060) (10,177)
-------------------------------------
Net change in cash and cash equivalents (156) (1,446) 1,529
Cash and cash equivalents at beginning of year 202 1,648 119
------------ ------------------------
Cash and cash equivalents at end of year $46 $202 $1,648
============ ========================
86
NOTE S- QUARTERLY RESULTS (UNAUDITED)
The following table summarizes the Company's quarterly results. All
earnings per share data and common stock prices have been restated to give
effect of the Company's September 20, 2001 3 for 2 stock split.
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
2001 2001 2001 2001 2002 2002 2002 2002
------------------------------------- -------------------------------------
Interest income $9,053 $8,442 $8,317 $7,743 $7,409 $7,734 $7,806 $7,587
Net interest income 5,301 4,826 4,991 4,986 4,989 5,323 5,271 5,283
Provision for loan losses --- --- --- --- --- --- --- ---
Other operating income 1,365 1,552 1,694 1,988 1,818 1,793 2,155 1,849
Other operating expenses 3,650 3,432 3,629 3,740 3,738 3,904 4,303 4,060
------------------------------------- -------------------------------------
Income before income taxes 3,016 2,946 3,056 3,234 3,069 3,212 3,123 3,072
Provision for income taxes 1,229 1,178 1,224 1,314 1,122 1,187 1,165 1,041
------------------------------------- -------------------------------------
Net income $1,787 $1,768 $1,832 $1,920 $1,947 $2,025 $1,958 $2,031
===================================== =====================================
Earnings per common share:
Basic earnings per common share: .44 .49 .51 .54 .56 .58 .56 .59
Diluted earnings per common share: .43 .47 .50 .52 .54 .56 .54 .57
Common Stock Prices:
High $19.00 $21.47 $25.57 $26.01 $28.80 $32.75 $28.00 $29.32
Low 13.50 17.07 18.60 22.37 24.40 26.16 25.20 25.75
Close 17.17 19.73 25.50 24.50 28.25 27.40 27.00 26.59
87
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Reference is made to the information contained in the Sections entitled
"Nominees", "Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" of Redwood's Proxy Statement for the May 20, 2003 Annual
Meeting of Shareholders, to be filed pursuant to Regulation 14A under the
Securities Exchange Act of 1934, as amended, and by this reference incorporated
herein.
Item 11. Executive Compensation
Reference is made to the information contained in the Sections entitled
"Performance Graph", "Board Compensation Committee Report on Executive
Compensation", "Compensation of Directors", "Executive Compensation" and
"Supplemental Benefit Plans" of Redwood's Proxy Statement for the May 20, 2003
Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A under the
Securities Exchange Act of 1934, as amended, and by this reference incorporated
herein.
88
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Information concerning ownership of the equity stock of Redwood by certain
beneficial owners and management is contained in the Sections entitled "Security
Ownership of Certain Beneficial Owners" and "Security Ownership of Management"
of Redwood's Proxy Statement for the May 20, 2003 Annual Meeting of
Shareholders, to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934, as amended, and is by this reference incorporated herein.
The following table provides information relating to the Company's equity
compensation plans as of December 31, 2002:
(a) (c)
Number of Number of securities
securities to remaining available for
be issued upon (b) future issuance under
exercise of Weighted-average equity compensation
outstanding exercise price of plans (excluding
options outstanding options securities reflected in
column (a))
-------------------- ------------------------ ---------------------------
Plan Category:
Equity compensation plans
approved by shareholders 267,000 $12.84 184,000
Equity compensation plans not
approved by shareholders --- --- ---
-------------------- ---------------------------
Total 267,000 $12.84 184,000
==================== ===========================
All equity compensation plans have been approved by the shareholders. At
December 31, 2002, there were 184,000 shares of common stock available for
future issuance under the Company's 2001 stock option plan. For additional
information concerning the Company's equity compensation plans, see Note L to
our Consolidated Financial Statements included in this Report.
89
Item 13. Certain Relationships and Related Transactions
Reference is made to the information contained in the Section entitled
"Certain Transactions" of Redwood's Proxy Statement for the May 20, 2003 Annual
Meeting of Shareholders to be filed pursuant to Regulation 14A under the
Securities Exchange Act of 1934, as amended, and by this reference incorporated
herein.
Item 14. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
Based on their evaluation as of December 31, 2002, the Company's principal
executive officer and principal financial officer have concluded that the
Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and
15d-14(c) under the Securities Exchange Act of 1934 (the "Exchange Act")) are
effective to ensure that information required to be disclosed by the Company in
reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms.
(b) Changes in Internal Controls.
Such officers have also concluded that there were no significant changes in
the Company's internal controls or in other factors that could significantly
affect these controls subsequent to the date of the most recent evaluation and
that there were no significant deficiencies or material weaknesses, and
therefore no corrective actions needed to be taken.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) 1. Financial Statements.
The following consolidated financial statements of Redwood and its
subsidiaries and independent auditors' report are included in Part III
(Item 8) of this Form 10-K:
Page
Report of Independent Auditors...........................................54
Consolidated Financial Statements of Redwood Empire Bancorp
and Subsidiaries
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000.......................................55
Consolidated Balance Sheets as of December 31, 2002 and 2001.............56
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2002, 2001 and 2000.......................................57
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000.......................................58
Notes to Consolidated Financial Statements...............................60
90
2. Financial Statement Schedules.
All financial statement schedules have been omitted, as inapplicable.
3. Exhibits.
The following documents are filed herewith or incorporated by
reference in this Annual Report on Form 10-K.
91
Exhibit
Number Description
3.1 Amended Articles of Incorporation of Redwood.
3.2 Amended and Restated By-Laws of Redwood dated May 18, 1999 filed as
Exhibit 3.2 to our Annual Report on Form 10-K for the year ended
December 31, 2001 and by this reference incorporated herein.
4. Indenture, dated February 22, 2001, between Redwood and State Street
Bank and Trust Company of Connecticut, National Association, filed as
Exhibit 4 to our Annual Report on Form 10-K for the year ended
December 31, 2000 and by this reference incorporated herein.
4.1 Amended and Restated Declaration of Trust, dated February 22, 2001, by
and among State Street Bank and Trust Company of Connecticut, National
Association, Redwood and the Administrators named therein filed as
Exhibit 4.1 to our Annual Report on Form 10-K for the year ended
December 31, 2000 and by this reference incorporated herein.
4.2 Certificate of Amendment of Certificate of Determination of Rights,
Preferences, Privileges and Restrictions of the Registrant's 7.80%
Noncumulative Convertible Perpetual Preferred Stock, Series A dated
August 11, 1998 filed as Exhibit 4.2 to our Annual Report on Form 10-K
for the year ended December 31, 2001 and by this reference
incorporated herein.
10. Executive Salary Continuation Agreement between Patrick W. Kilkenny
and Redwood dated November 1, 1993, Amendment 1 dated April 25, 1996,
Amendment 2 dated November 16, 1999, and Amendment 3 dated March 21,
2001, filed as Exhibit 10 to our Annual Report on Form 10-K for the
year ended December 31, 2001 and by this reference incorporated
herein. *
10.1 Executive Severance Agreement between Patrick W. Kilkenny and Redwood,
filed as Exhibit 10.1 to our Annual Report on Form 10-K for the year
ended December 31, 1999 and by this reference incorporated herein. *
10.2 Executive Salary Continuation Agreement between James E. Beckwith and
Redwood dated November 9, 2001 filed as Exhibit 10.2 to our Annual
Report on Form 10-K for the year ended December 31, 2001 and by this
reference incorporated herein. *
10.3 Executive Severance Agreement between James E. Beckwith and Redwood,
filed as Exhibit 10.3 to our Annual Report on Form 10-K for the year
ended December 31, 1999 and by this reference incorporated herein. *
92
10.4 Redwood's 401(k) Profit Sharing Plan, filed as Exhibit 28.1 to our
Registration Statement on Form S-8 dated June 12, 1990 (Registration
No. 33-35377), and by this reference incorporated herein. *
10.5 Redwood's Amended and Restated 1991 Stock Option Plan, filed as
Exhibit 4.1 to our Registration Statement on Form S-8 filed on July 8,
1992 (Registration No. 33-49372), and by this reference incorporated
herein. *
10.6 Redwood's 2001 Stock Option Plan, filed as Appendix A to our
Definitive Proxy Statement on Form 14A filed with the SEC on April 13,
2001, and by this reference incorporated herein. *
10.7 Redwood's Executive Salary Continuation Plan, filed as Exhibit 10.9 to
our Registration Statement on Form S-2 dated December 13, 1993
(Registration No. 33-71324), and by this reference incorporated
herein. *
10.8 Redwood's Dividend Reinvestment and Stock Purchase Plan filed as
Exhibit 4.1 to our Registration Statement on Form S-3 dated April 28,
1993 (Registration No. 33-61750), and by this reference incorporated
herein.
10.9 Lease, dated June 1, 1999, between National Bank of the Redwoods and
Advanced Development & Investments, filed as Exhibit 10.8 to our
Annual Report on Form 10-K for the year ended December 31, 1999 and by
this reference incorporated herein.
10.10 Placement Agreement, dated February 9, 2001, between Redwood, First
Tennessee Capital Markets and Keefe, Bruyette & Woods, Inc., filed as
Exhibit 10.9 to our Annual Report on Form 10-K for the year ended
December 31, 2000 and by this reference incorporated herein.
10.11 Subscription Agreement, dated February 22, 2001, between Redwood
Statutory Trust I, Redwood and Preferred Term Securities II, Ltd filed
as Exhibit 10.10 to our Annual Report on Form 10-K for the year ended
December 31, 2000 and by this reference incorporated herein.
10.12 Guarantee Agreement, dated February 22, 2001, by and between Redwood
and State Street Bank and Trust Company of Connecticut, National
Association filed as Exhibit 10.11 to our Annual Report on Form 10-K
for the year ended December 31, 2000 and by this reference
incorporated herein.
93
10.13 NBR REIT Declaration of Trust, dated February 5, 2002 filed as
Exhibit 10.13 to our Annual Report on Form 10-K for the year ended
December 31, 2001 and by this reference incorporated herein.
10.14 NBR REIT Bylaws dated February 5, 2002 filed as Exhibit 10.14 to our
Annual Report on Form 10-K for the year ended December 31, 2001 and by
this reference incorporated herein.
10.15 Lease, dated August 22, 2002, between National Bank of the Redwoods
and Santa Rosa Northpoint Associates.
11. Statement re Computation of Per Share Earnings.
21. Subsidiaries of the Registrant.
23.1 Consent of Crowe, Chizek and Company LLP.
* Management contract or compensatory plan, contract or arrangement.
(b) Reports on Form 8-K.
A report on Form 8-K was filed on October 7, 2002 to report under Item 5
the approval of a quarterly cash dividend and containing unaudited
financial statements.
A report on Form 8-K was filed on October 16, 2002 to report under Item 5
the press release of earnings for the third quarter of 2002.
(c) Exhibits Required by Item 601 of Regulation S-K
Reference is made to the exhibits under Item 15(a)(3) of this report.
(d) Additional Financial Statements
Not applicable.
94
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
REDWOOD EMPIRE BANCORP
By: /S/ PATRICK W. KILKENNY Dated: March 21, 2003
-----------------------------
Patrick W. Kilkenny
President, Chief Executive Officer and Director
(Principal Executive Officer)
And By: /S/ JAMES E. BECKWITH Dated: March 21, 2003
------------------------------------------
James E. Beckwith
Executive Vice President
Chief Operating Officer
Chief Financial Officer
(Principal Financial Officer
and Principal Accounting Officer)
95
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
/S/ JOHN H. BRENENGEN Dated: March 21, 2003
- --------------------------------------------
John H. Brenengen, Director
/S/ DANA R. JOHNSON Dated: March 21, 2003
- --------------------------------------------
Dana R. Johnson, Director
Chairman of the Board
/S/ PATRICK W. KILKENNY Dated: March 21, 2003
- --------------------------------------------
Patrick W. Kilkenny, Director
/S/ GREGORY J. SMITH Dated: March 21, 2003
- --------------------------------------------
Gregory J. Smith, Director
/S/ MARK H. RODEBAUGH Dated: March 21, 2003
- --------------------------------------------
Mark H. Rodebaugh, Director
96