================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 0-19231
REDWOOD EMPIRE BANCORP
(Exact name of registrant as specified in its charter)
California 68-0166366
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
111 Santa Rosa Avenue, Santa Rosa, California 95404-4905
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (707) 573-4800
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _ Indicate by check mark whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act). Yes No X
At August 5, 2003, there were 3,303,016 shares of the Registrant's common stock
outstanding.
This page is page 1 of 43 pages.
REDWOOD EMPIRE BANCORP
AND
SUBSIDIARIES
Index
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Operations
Three and Six Months Ended June 30, 2003 and 2002.............................3
Consolidated Balance Sheets
June 30, 2003 and December 31, 2002...........................................5
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2003 and 2002.......................................6
Notes to Consolidated Financial Statements....................................8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations.............................14
Item 3. Quantitative and Qualitative Disclosures
About Market Risk............................................................37
Item 4. Controls and Procedures......................................................40
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Vote of Security Holders..................41
Item 6. Exhibits and Reports on Form 8-K.............................................41
SIGNATURES.....................................................................................43
This page is page 2 of 43 pages.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
--------------------------------------------------
Interest income:
Interest and fees on loans $6,730 $6,486 $13,136 $12,703
Interest on investment securities 868 1,128 1,991 2,216
Interest on federal funds sold 10 120 23 224
--------------------------------------------------
Total interest income 7,608 7,734 15,150 15,143
Interest expense:
Interest on deposits 1,637 2,132 3,381 4,294
Interest on other borrowings 293 279 561 537
--------------------------------------------------
Total interest expense 1,930 2,411 3,942 4,831
--------------------------------------------------
Net interest income 5,678 5,323 11,208 10,312
Provision for loan losses --- --- --- ---
--------------------------------------------------
Net interest income after provision for loan losses 5,678 5,323 11,208 10,312
Noninterest income:
Service charges on deposit accounts 254 308 522 622
Merchant draft processing, net 1,088 1,197 2,217 2,376
Loan servicing income 43 81 78 135
Net realized gains on
investment securities available for sale 86 --- 86 35
Other income 178 207 375 443
--------------------------------------------------
Total noninterest income 1,649 1,793 3,278 3,611
Noninterest expense:
Salaries and employee benefits 2,258 2,302 4,542 4,348
Occupancy and equipment expense 478 533 1,092 1,057
Other 1,165 1,069 2,353 2,237
--------------------------------------------------
Total noninterest expense 3,901 3,904 7,987 7,642
--------------------------------------------------
Income before income taxes 3,426 3,212 6,499 6,281
Provision for income taxes 1,245 1,187 2,302 2,309
--------------------------------------------------
Net income $2,181 $2,025 $4,197 $3,972
==================================================
Total comprehensive income $2,037 $2,697 $3,945 $4,409
==================================================
(Continued)
This page is page 3 of 43 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
(Continued)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
--------------------------------------------------------
Basic earnings per common share:
Net income $.43 $.39 $.83 $.76
Weighted average shares - basic 5,084,000 5,237,000 5,081,000 5,243,000
Diluted earnings per common share:
Net income $.42 $.37 $.80 $.73
Weighted average shares - diluted 5,216,000 5,426,000 5,239,000 5,436,000
See Notes to Consolidated Financial Statements.
(Concluded)
This page is page 4 of 43 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands)
June 30, December 31,
2003 2002
---------------------------------
(unaudited)
Assets:
Cash and due from banks $23,139 $21,837
Federal funds sold 4,600 17,500
---------------------------------
Cash and cash equivalents 27,739 39,337
Investment securities:
Held to maturity (fair value of $17,048 and $17,268) 16,269 16,764
Available for sale, at fair value (amortized cost of $55,345 and
$81,092) 57,151 83,157
---------------------------------
Total investment securities 73,420 99,921
Mortgage loans held for sale 653 ---
Loans:
Residential real estate mortgage 119,619 87,764
Commercial real estate mortgage 173,757 158,018
Commercial 60,960 62,958
Real estate construction 47,756 42,749
Installment and other 13,178 14,260
Less net deferred loan fees (207) (673)
---------------------------------
Total portfolio loans 415,063 365,076
Less allowance for loan losses (7,492) (7,400)
---------------------------------
Net loans 407,571 357,676
Premises and equipment, net 2,876 2,760
Cash surrender value of life insurance 3,703 3,620
Other assets and interest receivable 9,912 9,867
---------------------------------
Total assets $525,874 $513,181
=================================
Liabilities and Shareholders' equity:
Deposits:
Noninterest bearing demand deposits $98,853 $103,484
Interest-bearing transaction accounts 158,426 128,292
Time deposits one hundred thousand and over 75,217 69,000
Other time deposits 134,139 152,317
---------------------------------
Total deposits 466,635 453,093
Short-term borrowings 4,463 12,356
Trust preferred securities 10,000 10,000
Other liabilities and interest payable 14,500 8,925
---------------------------------
Total liabilities 495,598 484,374
Shareholders' equity:
Preferred stock, no par value; authorized 2,000,000 shares;
none issued and outstanding --- ---
Common stock, no par value; authorized 10,000,000 shares;
issued and outstanding: 3,410,166 and 3,404,890 shares 11,130 10,853
Retained earnings 18,098 16,654
Accumulated other comprehensive income, net of tax 1,048 1,300
---------------------------------
Total shareholders' equity 30,276 28,807
---------------------------------
Total liabilities and shareholders' equity $525,874 $513,181
=================================
See Notes to Consolidated Financial Statements.
This page is page 5 of 43 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Six Months Ended
June 30,
2003 2002
-------------------------
Cash flows from operating activities:
Net income $4,197 $3,972
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization, net 299 45
Loans originated for sale (2,138) (608)
Proceeds from sale of loans held for sale 1,480 300
Net realized gains on securities available for sale (86) (35)
Net realized (gain) loss on sale of loans held for sale 5 (5)
Change in other assets and interest receivable (129) (1,240)
Change in other liabilities and interest payable 5,575 265
-------------------------
Total adjustments 5,006 (1,278)
-------------------------
Net cash from operating activities 9,203 2,694
Cash flows from investing activities:
Net change in loans (49,620) (5,952)
Purchases of investment securities available for sale (3,080) (24,255)
Purchases of investment securities held to maturity (1,684) (358)
Proceeds from sales of investment securities available for sale 9,812 5,079
Maturities of investment securities available for sale 18,956 8,101
Maturities or calls of investment securities held to maturity 2,124 1,561
Purchases of premises and equipment, net (482) (685)
-------------------------
Net cash from investing activities (23,974) (16,509)
Cash flows from financing activities:
Net change in noninterest bearing demand deposits (4,631) 19,609
Net change in interest bearing transaction accounts 30,134 (1,437)
Net change in time deposits (11,961) 29,567
Net change in short-term borrowings (7,893) 1,953
Repurchases of common stock (1,322) (1,146)
Issuance of common stock 541 ---
Cash dividends paid (1,695) (1,403)
-------------------------
Net cash from financing activities 3,173 47,143
-------------------------
Net change in cash and cash equivalents (11,598) 33,328
Cash and cash equivalents at beginning of period 39,337 24,249
-------------------------
Cash and cash equivalents at end of period $27,739 $57,577
=========================
(Continued)
This page is page 6 of 43 pages.
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
(Continued)
Six Months Ended
June 30,
2003 2002
------------------------
Supplemental Disclosures:
Cash paid during the period for:
Interest expense $3,893 $4,701
Income taxes 1,790 2,393
See Notes to Consolidated Financial Statements.
(Concluded)
This page is page 7 of 43 pages.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements should be
read in conjunction with the consolidated financial statements and related notes
contained in Redwood Empire Bancorp's 2002 Annual Report to Shareholders. The
statements include the accounts of Redwood Empire Bancorp ("Redwood," and with
its subsidiaries, the "Company"), and its wholly owned subsidiaries, National
Bank of the Redwoods and Redwood Statutory Trust I ("RSTI"). 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. All significant inter-company
balances and transactions have been eliminated. The financial information
contained in this report reflects all adjustments, which, in the opinion of
management, are necessary for a fair presentation of the results of the interim
periods. All such adjustments are of a normal recurring nature. The results of
operations for the three and six months ended June 30, 2003 and cash flows for
the six months ended June 30, 2003 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2003.
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, federal funds sold and repurchase
agreements with original maturities of 90 days or less. Federal funds sold and
repurchase agreements are generally for one day periods.
2. Earnings per Share
Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the Company.
On July 16, 2003, the Company announced a three-for-two stock split of
its outstanding shares of common stock payable on August 13, 2003 to common
shareholders of record on July 28, 2003. Earnings per share information for all
periods presented give effect to the stock split.
This page is page 8 of 43 pages.
3. 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 the fair value recognition provisions of FASB Statement No.
123, Accounting for Stock-Based Compensation.
Three months ended Six months ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------------------------------ ------------------------------------
(dollars in thousands, except per share data)
Net income as reported $2,181 $2,025 $4,197 $3,972
Deduct: Stock-based compensation expense
determined under fair value based method (20) (39) (39) (76)
------------------------------------ ------------------------------------
Pro forma net income $2,161 $1,986 $4,158 $3,896
==================================== ====================================
Basic earnings per share as reported $.43 $.39 $.83 $.76
Pro forma basic earnings per share .43 .38 .82 .74
Diluted earnings per share as reported $.42 $.37 $.80 $.73
Pro forma diluted earnings per share .41 .37 .79 .72
Pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
Three months ended Six months ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------------------------------ ------------------------------------
Risk-free interest rate 3.53% 5.41% 3.53% 5.41%
Expected option life in years 10 10 10 10
Expected stock price volatility 31.71% 33.12% 31.81% 33.12%
Dividend yield 3.5% 2.8% 3.2% 2.1%
This page is page 9 of 43 pages.
The following table reflects the Company's earnings per share data.
Three Months Ended
June 30,
2003 2002
---------------------------- ----------------------------
Basic Diluted Basic Diluted
---------------------------- ----------------------------
(in thousands, except per share data)
Earnings per common share:
Net income $2,181 $2,181 $2,025 $2,025
Earnings per share .43 .42 .39 .37
Weighted average common shares outstanding 5,084,000 5,216,000(1) 5,237,000 5,426,000(1)
1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 132,000 and 189,000 for the three months ended
June 30, 2003 and June 30, 2002, as adjusted for the three-for-two stock
split announced July 16, 2003.
Six Months Ended
June 30,
2003 2002
---------------------------- ----------------------------
Basic Diluted Basic Diluted
---------------------------- ----------------------------
(in thousands, except per share data)
Earnings per common share:
Net income $4,197 $4,197 $3,972 $3,972
Earnings per share .83 .80 .76 .73
Weighted average common shares outstanding 5,081,000 5,239,000(1) 5,243,000 5,436,000(1)
1) The weighted average common shares outstanding include the dilutive effects
of common stock options of 158,000 and 193,000 for the six months ended
June 30, 2003 and June 30, 2002, as adjusted for the three-for-two stock
split announced July 16, 2003.
4. Comprehensive Income
The Company's total comprehensive earnings presentation is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------------------------ ------------------------
(in thousands)
Net income as reported $2,181 $2,025 $4,197 $3,972
Other comprehensive income (net of
tax):
Change in unrealized holding gain
on available for sale securities (94) 672 (202) 459
Reclassification adjustment (50) --- (50) (22)
------------------------ ------------------------
Total comprehensive income $2,037 $2,697 $3,945 $4,409
======================== ========================
This page is page 10 of 43 pages.
5. Subsequent Events - Common Stock Cash Dividend, Three-for-Two Common
Stock Split, Trust Preferred Financing and Share Repurchase
Authorization
On July 2, 2003, the Board of Directors declared a quarterly cash
dividend of 25 cents per share on the Company's Common Stock. The dividend was
paid on July 28, 2003 to shareholders of record on July 14, 2003.
On July 16, 2003, the Company announced the declaration of a
three-for-two stock split of its outstanding shares of common stock. The stock
split is in the form of a stock dividend and entitles each stockholder of record
at the close of business on July 28, 2003 three shares for every two shares of
Redwood Empire Bancorp common stock held on that date. The Company will pay cash
in lieu of fractional shares. The stock dividend will be paid on August 13,
2003.
On July 24, 2003, the Company announced the completion of an additional
$10,000,000 trust preferred securities financing. The financing, which is due in
30 years, currently qualifies for Tier II regulatory capital treatment, bears an
interest rate of 6.35% for five years and then resets to the three month LIBOR
plus 3.1% for the next 25 years. Debt issuance costs amounted to approximately
$215,000 and will be amortized over the life of the offering. The funds will be
used for stock repurchases and other corporate purposes.
On August 1, 2003, the Company announced the authorization to
repurchase an additional 331,000 common shares, as adjusted for the
three-for-two stock split announced July 16, 2003, which represented
approximately 10% of the shares outstanding at that time. The repurchases will
be made by the Company from time to time in the open market, as conditions
allow.
6. Business Segments
The Company operates in two principal business segments: core community
banking and merchant card services. The Company's core community banking segment
includes commercial, commercial real estate, construction and permanent
residential lending along with all treasury and depository activities. The
Company's merchant card services industry group provides credit card settlement
services for approximately 35,000 merchants throughout the United States.
The condensed income statements and average assets of the individual
segments are set forth in the table below. The information in this table is
derived from the internal management reporting system used by management to
measure the performance of the segments and the Company. The management
reporting system assigns balance sheet and income statement items to each
segment based on internal management accounting policies. Net interest income is
determined by the Company's internal funds transfer pricing system, which
assigns a cost of funds or credit for funds to assets or liabilities based on
their type, maturity or repricing characteristics. Noninterest income and
expense directly attributable to a segment are assigned to that business. Total
other operating expense, including indirect costs, such as overhead, operations
and technology expense, are allocated to the segments based on an evaluation of
costs for product or data processing. All amounts other than allocations of
interest and indirect costs are derived from
This page is page 11 of 43 pages.
third parties. The provision for credit losses is allocated based on the
required reserves and the net charge-offs for each respective segment. The
Company allocates depreciation expense without allocating the related
depreciable asset to that segment.
Summary financial data by business segment for the indicated periods is as
follows:
For the quarter ended June 30, 2003
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $7,608 $ --- $7,608
Total interest expense 1,913 17 1,930
Interest income/(expense) allocation (245) 245 ---
-----------------------------------------------
Net interest income 5,450 228 5,678
Provision for loan losses --- --- ---
Total other operating income 561 1,088 1,649
Total other operating expense 3,190 711 3,901
-----------------------------------------------
Income before income taxes 2,821 605 3,426
Provision for income taxes 1,026 219 1,245
-----------------------------------------------
Net income $1,795 $386 $2,181
===============================================
Total Average Assets $485,739 $37,032 $522,771
===============================================
For the quarter ended June 30, 2002
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $7,734 $ --- $7,734
Total interest expense 2,395 16 2,411
Interest income/(expense) allocation (176) 176 ---
-----------------------------------------------
Net interest income 5,163 160 5,323
Provision for loan losses --- --- ---
Total other operating income 596 1,197 1,793
Total other operating expense 3,261 643 3,904
-----------------------------------------------
Income before income taxes 2,498 714 3,212
Provision for income taxes 923 264 1,187
-----------------------------------------------
Net income $1,575 $450 $2,025
===============================================
Total Average Assets $455,964 $27,906 $483,870
===============================================
For the six months ended June 30, 2003
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $15,150 $ --- $15,150
Total interest expense 3,920 22 3,942
Interest income/(expense) allocation (415) 415 ---
-----------------------------------------------
Net interest income 10,815 393 11,208
Provision for loan losses --- --- ---
Total other operating income 1,061 2,217 3,278
Total other operating expense 6,585 1,402 7,987
-----------------------------------------------
Income before income taxes 5,291 1,208 6,499
Provision for income taxes 1,876 426 2,302
-----------------------------------------------
Net income $3,415 $782 $4,197
===============================================
Total Average Assets $485,315 $31,416 $516,731
===============================================
This page is page 12 of 43 pages.
For the six months ended June 30, 2002
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $15,143 $ --- $15,143
Total interest expense 4,813 18 4,831
Interest income/(expense) allocation (332) 332 ---
-----------------------------------------------
Net interest income 9,998 314 10,312
Provision for loan losses --- --- ---
Total other operating income 1,235 2,376 3,611
Total other operating expense 6,349 1,293 7,642
-----------------------------------------------
Income before income taxes 4,884 1,397 6,281
Provision for income taxes 1,797 512 2,309
-----------------------------------------------
Net income $3,087 $885 $3,972
===============================================
Total Average Assets $449,566 $27,310 $476,876
===============================================
7. Common Stock Repurchases
The Company has announced authorizations to repurchase up to 533,250
common shares, as adjusted for the three-for-two stock splits announced
September 20, 2001 and July 16, 2003. To date, 355,505 shares have been
repurchased, as adjusted for the three-for-two stock splits announced September
20, 2001 and July 16, 2003. In the quarter ended June 30, 2003, the Company did
not purchase any shares under the program. For the six months ended June 30,
2003, the Company has purchased 69,551 shares at a cost of $19.01, as adjusted
for the three-for-two stock split announced July 16, 2003. Under the repurchase
program, the Company plans to purchase shares from time to time on the open
market and/or in privately negotiated transactions.
8. New Accounting Pronouncements
The Financial Accounting Standards Board ("FASB") recently issued two
new accounting standards, Statement of Financial Accounting Standards ("SFAS")
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities", and SFAS No. 150, "Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity", both of which generally
become effective in the quarter beginning July 1, 2003. Management has
determined that the adoption of these standards will not have a material impact
on the Company's operating results or financial condition. However, the Federal
Reserve is reviewing the regulatory capital implications of the requirements to
report trust preferred securities with liabilities.
This page is page 13 of 43 pages.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Information
This Quarterly Report on Form 10-Q includes forward-looking information
which is subject to the "safe harbor" created by Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities 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, projections or
expectations or use similar terms) involve certain risks and uncertainties that
could cause actual results to differ materially from those in the
forward-looking statements. Such risks and uncertainties include, but are not
limited to, the following factors (many of which are beyond the Company's
ability to control):
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.
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 continuing decline in the health of the Northern California economy,
including the
This page is page 14 of 43 pages.
long-term impact of the California energy crisis, the decline in the
technology sector and any negative effect of the State of California
substantial budget deficit.
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.
Any forward-looking statements made by the Company are intended to
provide investors with additional information with which they may assess the
Company's future potential. All forward-looking statements are based on
assumptions about an uncertain future and are based on information available at
the date such statements are issued. The Company undertakes no obligation to
update these forward-looking statements to reflect facts, circumstances,
assumptions or events that occur after the date the forward-looking statements
are made or to publicly release the results of any revision to these
forward-looking statements. For additional information concerning risks and
uncertainties related to the Company and its operations, please refer to the
Company's Annual Report on Form 10-K for the year ended December 31, 2002 and
"Certain Important Considerations for Investors" herein.
The following sections discuss significant changes and trends in
financial condition, capital resources and liquidity of the Company from
December 31, 2002 to June 30, 2003. Significant changes and trends in the
Company's results of operations for the three and six months ended June 30,
2003, compared to the same period in 2002, are also discussed.
Summary of Financial Results
The Company reported net income of $2,181,000 ($.42 per diluted share)
for the three months ended June 30, 2003 as compared to $2,025,000 ($.37 per
diluted share) for the same period in 2002, an increase of $156,000 in net
income or 8%. This increase is due to an increase of $355,000 in net interest
income, partially offset by a decrease of $144,000 in other noninterest income.
Net income for the six months ended June 30, 2003 was $4,197,000 ($.80
per diluted share), as compared to $3,972,000 ($.73 per diluted share) for the
same period in 2002, and increase of $225,000 or 6%. This increase is due to an
increase of $896,000 in net interest income, partially offset by a decrease of
$333,000 in noninterest income and an increase of $345,000 in noninterest
expense.
On July 16, 2003, the Company announced a three-for-two stock split of
its outstanding shares of common stock payable on August 13, 2003 to common
shareholders of record on July 28, 2003. Earnings per share information for all
periods presented give effect to the stock split.
Net Interest Income
Net interest income increased from $5,323,000 in the second quarter of
2002 to
This page is page 15 of 43 pages.
$5,678,000 in the second quarter of 2003, which represents an increase
of $355,000 or 7%. The increase in net interest income was driven by a
significant increase in average earning assets of $39,422,000 from $453,927,000
for the quarter ended June 30, 2002 to $493,349,000 for the quarter ended June
30, 2003. The largest component of the increase in earning assets was growth in
the Company's loan portfolio. Average portfolio loans increased $56,474,000 or
16%, when compared to the same quarter in 2002. The Company continues to focus
on growth in the overall loan portfolio, and in particular the commercial real
estate portfolio, through marketing efforts and a general expansion of
businesses within the Company's market area. Average commercial real estate
loans increased $34,314,000 or 26%, average real estate mortgage loans increased
$22,978,000 or 25% and average installment and other loans increased $1,439,000
or 10%, offset by a decline of $10,192,000, or 14% in average commercial loans
for the three months ended June 30, 2003 as compared to the three months ended
June 30, 2002.
Net interest income for the six months ended June 30, 2003 was
$11,208,000, which represents an increase of $896,000 when compared to the same
period one year ago. The increase in net interest income was driven by an
increase in average earning assets of $41,469,000 from $447,790,000 at June 30,
2002 to $489,259,000 at June 30, 2003. For the six months ended June 30, 2003,
average portfolio loans increased $44,664,000 or 13%, when compared to the same
period in 2002.
For the three months ended June 30, 2003, net interest margin decreased
to 4.62% from 4.70% for the same period one year ago. For the six months ended
June 30, 2003, net interest margin decreased slightly to 4.62% from 4.64% one
year ago. Yield on earning assets decreased to 6.19% for the three months ended
June 30, 2003 from 6.83% for the same period one year ago. For the six months
ended June 30, 2003, yield on earning assets decreased to 6.24% from 6.82% for
the same period one year ago. The decrease in the yield on earning assets for
the three and six month periods during 2003 is due to a decline in the general
interest rate environment. Yield paid on interest bearing liabilities decreased
to 2.02% for the three month period ended June 30, 2003 from 2.78% for the same
period one year ago. For the six month period ended June 30, 2003, yield paid on
interest bearing liabilities decreased to 2.05% from 2.82% for the three months
ending June 30, 2002.
This page is page 16 of 43 pages.
The following is an analysis of the Company's net interest margin for
the indicated periods:
Three months ended Three months ended
June 30, 2003 June 30, 2002
------------------------------------- -----------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
------------------------------------- -----------------------------------
Real estate-mortgage loans $116,085 $1,811 6.26% $93,107 $1,673 7.21%
Real estate-commercial loans 165,627 2,934 7.11 131,313 2,542 7.76
Commercial loans 60,128 919 6.13 70,320 1,204 6.87
Real estate construction loans 51,064 901 7.08 43,499 902 8.32
Installment and other 15,182 163 4.31 13,743 163 4.76
Deferred loan fees (289) --- --- (659) --- ---
----------------------- ----------------------
Portfolio loans 407,797 6,728 6.62 351,323 6,484 7.40
Mortgage loans held for sale 296 3 4.07 147 2 5.46
Investments 82,136 867 4.23 76,050 1,128 5.95
Federal funds sold 3,120 10 1.29 26,407 120 1.82
----------------------- ----------------------
Total earning assets (1) $493,349 7,608 6.19 $453,927 7,734 6.83
============= ============
Interest bearing transaction
accounts $152,770 358 0.94 $122,311 446 1.46
Time deposits 211,463 1,279 2.43 211,333 1,686 3.20
Other borrowings 18,540 293 6.34 13,960 279 8.02
----------------------- ----------------------
Total interest-bearing liabilities $382,773 1,930 2.02% $347,604 2,411 2.78%
============= ============
----------- -----------
Net interest income $5,678 $5,323
=========== ===========
Net interest income to
earning assets 4.62% 4.70%
This page is page 17 of 43 pages.
Six months ended Six months ended
June 30, 2003 June 30, 2002
------------------------------------- -------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
------------------------------------- -------------------------------------
Real estate-mortgage loans $107,177 $3,430 6.45% $95,087 $3,382 7.17%
Real estate-commercial loans 162,779 5,790 7.17 127,225 4,835 7.66
Commercial loans 61,132 1,875 6.19 69,838 2,402 6.94
Real estate construction loans 47,853 1,708 7.20 44,547 1,765 7.99
Installment and other 15,928 326 4.13 13,683 316 4.66
Deferred loan fees (416) --- --- (591) --- ---
---------------------- ------------------------
Portfolio loans 394,453 13,129 6.71 349,789 12,700 7.32
Mortgage loans held for sale 258 7 5.47 91 3 6.65
Investments 90,890 1,991 4.42 72,523 2,216 6.16
Federal funds sold 3,658 23 1.27 25,387 224 1.78
---------------------- ------------------------
Total earning assets (1) $489,259 15,150 6.24 $447,790 15,143 6.82
============= ===============
Interest bearing transaction
accounts $145,292 662 0.92 $123,343 868 1.42
Time deposits 214,268 2,719 2.56 207,837 3,426 3.32
Other borrowings 18,075 561 6.26 14,064 537 7.70
---------------------- ------------------------
Total interest-bearing
liabilities $377,635 3,942 2.11% $345,244 4,831 2.82%
============= ===============
---------- ----------
Net interest income $11,208 $10,312
========== ==========
Net interest income to
earning assets 4.62% 4.64%
(1) Nonaccrual loans are included in the calculation of the average balance
of earning assets (interest not accrued is excluded).
This page is page 18 of 43 pages.
The following table sets forth changes in interest income and interest
expense for each major category of interest-earning asset and interest-bearing
liability, and the amount of change attributable to volume and rate changes for
the three and six months ended June 30, 2003 and 2002. Changes not solely
attributable to rate or volume have been allocated proportionately to the change
due to volume and the change due to rate.
Three months ended
June 30, 2003 compared to the
three months ended June 30, 2002
------------------------------------------
Volume Rate Total
------------------------------------------
(in thousands)
Increase/(decrease) in interest income:
Real estate-mortgage loans $377 ($239) $138
Real estate-commercial loans 622 (230) 392
Commercial loans (164) (121) (285)
Real estate construction loans 144 (145) (1)
Installment and other 16 (16) ---
Mortgage loans held for sale 2 (1) 1
Investments 85 (346) (261)
Federal funds sold (82) (28) (110)
------------------------------------------
Total increase/(decrease) 1,000 (1,126) (126)
------------------------------------------
Increase/(decrease) in interest expense:
Interest-bearing transaction accounts 95 (183) (88)
Time deposits 1 (408) (407)
Other borrowings 80 (66) 14
------------------------------------------
Total increase/(decrease) 176 (657) (481)
------------------------------------------
Increase/(decrease) in net interest income $824 ($469) $355
==========================================
Six months ended
June 30, 2003 compared to the
six months ended June 30, 2002
-----------------------------------------
Volume Rate Total
-----------------------------------------
(in thousands)
Increase/(decrease) in interest income:
Real estate-mortgage loans $406 ($358) $48
Real estate-commercial loans 1,281 (326) 955
Commercial loans (282) (245) (527)
Real estate construction loans 125 (182) (57)
Installment and other 48 (38) 10
Mortgage loans held for sale 5 (1) 4
Investments 486 (711) (225)
Federal funds sold (150) (51) (201)
-----------------------------------------
Total increase/(decrease) 1,919 (1,912) 7
-----------------------------------------
Increase/ (decrease) in interest expense:
Interest-bearing transaction accounts 136 (342) (206)
Time deposits 103 (810) (707)
Other borrowings 136 (112) 24
-----------------------------------------
Total increase/ (decrease) 375 (1,264) (889)
-----------------------------------------
Increase/(decrease) in net interest income $1,544 ($648) $896
=========================================
This page is page 19 of 43 pages.
Provision for Loan Losses
Due to the absence of significant net loan charge-offs, little change
in loan portfolio asset quality and the balance in the allowance for loan
losses, there was no provision for loan losses for the three and six months
ended June 30, 2003 and 2002. For further information, see "Allowance for Loan
Losses" and "Nonperforming Assets" in this section.
Noninterest Income and Expense
Noninterest Income
The following table sets forth the components of the Company's
noninterest income for the three and six months ended June 30, 2003, as compared
to the same period in 2002.
Three Months Ended
June 30, $ %
---------------------------
2003 2002 Change Change
--------------------------- ----------------------
(dollars in thousands)
Service charges on deposit accounts $254 $308 ($54) (18)%
Merchant draft processing, net 1,088 1,197 (109) (9)
Loan servicing income 43 81 (38) (47)
Net realized gains on investment securities available
for sale 86 --- 86 ---
Other income 178 207 (29) (14)
----------------------------------------
Total noninterest income $1,649 $1,793 ($144) (8)%
=========================== ============
Noninterest income decreased $144,000, or 8%, to $1,649,000 for the
three months ended June 30, 2003 when compared to $1,793,000 for the same period
in 2002. During this period, such decrease was primarily due to a decrease of
$109,000 in merchant card net revenue, a $54,000 decrease in service charges on
deposit accounts and a decrease in loan servicing income of $38,000, all
partially offset by an increase in net realized gains on investment securities
available for sale of $86,000. The decrease in merchant card net revenue is due
to a decrease in processing revenue and the decrease in loan servicing income is
due to a decline in loans serviced by the Company. The decrease in service
charges on deposit accounts is due to a decline in the fees charged customers
for certain products and services. The net realized gains on investment
securities available for sale increased due to the sale of $9,812,000 in
mortgage-backed securities in the second quarter. Such securities were sold to
facilitate liquidity needs.
This page is page 20 of 43 pages.
Six Months Ended
June 30, $ %
---------------------------
2003 2002 Change Change
------------------------------------------------
(dollars in thousands)
Service charges on deposit accounts $522 $622 ($100) (16)%
Merchant draft processing, net 2,217 2,376 (159) (7)
Loan servicing income 78 135 (57) (42)
Net realized gains on investment securities available
for sale 86 35 51 146
Other income 375 443 (68) (15)
--------------------------------------
Total noninterest income $3,278 $3,611 ($333) (9)%
======================================
Noninterest income decreased $333,000 or 9% to $3,278,000 for the six
months ended June 30, 2003 when compared to $3,611,000 for the same period in
2002. During this period, such decrease was primarily due to a decrease of
$159,000 in merchant card net revenue, a decrease in service charges on deposit
accounts of $100,000, a decrease in loan servicing income of $57,000 and an
increase of $51,000 in net realized gains on investment securities available for
sale, as discussed above.
Noninterest Expense
The following table sets forth the components of the Company's
noninterest expense during the three and six months ended June 30, 2003, as
compared to the same period in 2002.
Three Months Ended
June 30, $ %
---------------------------
2003 2002 Change Change
------------- --------------------------------------
(dollars in thousands)
Salaries and employee benefits $2,258 $2,302 ($44) (2)%
Occupancy and equipment expense 478 533 (55) (10)
Other 1,165 1,069 96 9
--------------------------------------
Total noninterest expense $3,901 $3,904 ($3) (0)%
============= ========================
Noninterest expense decreased by $3,000, or .08%, to $3,901,000 during
the second quarter of 2003 as compared to $3,904,000 for the second quarter of
2002. The decrease in noninterest expense for the three-month period ended June
30, 2003, as compared to the same period ended June 30, 2002, is primarily
attributable to a decrease in salaries and employee benefits of $44,000 and a
decrease in occupancy and equipment expense of $55,000, offset by an increase in
other expense of $96,000. The decrease in salaries and employee benefits was
primarily due to a decrease of $24,000 in commission expense. The decrease in
occupancy and equipment expense was due to the February 2003 move of the
Company's operations center. Such move resulted in a decrease in the Company's
monthly rent expense by approximately $11,000. The increase in other expense is
primarily due to an increase in consulting related expenses.
This page is page 21 of 43 pages.
Six Months Ended
June 30, $ %
------------------------
2003 2002 Change Change
------------------------ ---------------------
(dollars in thousands)
Salaries and employee benefits $4,542 $4,348 $194 4%
Occupancy and equipment expense 1,092 1,057 35 3
Other 2,353 2,237 116 5
------------- ---------- -----------
Total noninterest expense $7,987 $7,642 $345 5%
============= ========== ===========
Noninterest expense increased by $345,000 or 5%, to $7,987,000 during
the six months ended June 30, 2003 as compared to $7,642,000 for the same period
one year ago. The increase in noninterest expense was due to an increase in
salaries and employee benefits of $194,000, an increase in occupancy and
equipment expense of $35,000 and an increase in other expense of $116,000. The
increase in salaries and employee benefits is due to a build-up in sales
development personnel. Occupancy and equipment expense increased during 2003 as
a result of the one-time costs associated with the move of the Company's
operations center. Other expense increased due to normal corporate activities.
Income Taxes
The Company's effective tax rate varies with changes in the relative
amounts of its non-taxable income and nondeductible expenses. The effective tax
rate was 36.3% and 35.4% for the three and six months ended June 30, 2003, as
compared to 37.0% and 36.8% for the same periods in 2002. The primary reason for
the Company's effective tax rate being significantly lower than the statutory
rate of 41% is due to the January 15, 2002 formation of 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.
Business Segments
The Company operates in two principal product and service lines: core
community banking and merchant credit card services. The Company's core
community banking segment includes commercial, commercial real estate,
construction and permanent residential lending along with treasury and
depository activities. The Company's merchant card services industry group
provides credit card settlement services for approximately 35,000 merchants
throughout the United States.
This page is page 22 of 43 pages.
Summary financial data by business segment for the indicated periods is
as follows:
For the quarter ended June 30, 2003
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $7,608 $ --- $7,608
Total interest expense 1,913 17 1,930
Interest income/(expense) allocation (245) 245 ---
-----------------------------------------------
Net interest income 5,450 228 5,678
Provision for loan losses --- --- ---
Total other operating income 561 1,088 1,649
Total other operating expense 3,190 711 3,901
-----------------------------------------------
Income before income taxes 2,821 605 3,426
Provision for income taxes 1,026 219 1,245
-----------------------------------------------
Net income $1,795 $386 $2,181
===============================================
Total Average Assets $485,739 $37,032 $522,771
===============================================
For the quarter ended June 30, 2002
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $7,734 $ --- $7,734
Total interest expense 2,395 16 2,411
Interest income/(expense) allocation (176) 176 ---
-----------------------------------------------
Net interest income 5,163 160 5,323
Provision for loan losses --- --- ---
Total other operating income 596 1,197 1,793
Total other operating expense 3,261 643 3,904
-----------------------------------------------
Income before income taxes 2,498 714 3,212
Provision for income taxes 923 264 1,187
-----------------------------------------------
Net income $1,575 $450 $2,025
===============================================
Total Average Assets $455,964 $27,906 $483,870
===============================================
For the six months ended June 30, 2003
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $15,150 $ --- $15,150
Total interest expense 3,920 22 3,942
Interest income/(expense) allocation (415) 415 ---
-----------------------------------------------
Net interest income 10,815 393 11,208
Provision for loan losses --- --- ---
Total other operating income 1,061 2,217 3,278
Total other operating expense 6,585 1,402 7,987
-----------------------------------------------
Income before income taxes 5,291 1,208 6,499
Provision for income taxes 1,876 426 2,302
-----------------------------------------------
Net income $3,415 $782 $4,197
===============================================
Total Average Assets $485,315 $31,416 $516,731
===============================================
This page is page 23 of 43 pages.
For the six months ended June 30, 2002
-----------------------------------------------
Merchant
Community Card Total
Banking Services Company
-----------------------------------------------
(in thousands)
Total interest income $15,143 $ --- $15,143
Total interest expense 4,813 18 4,831
Interest income/(expense) allocation (332) 332 ---
-----------------------------------------------
Net interest income 9,998 314 10,312
Provision for loan losses --- --- ---
Total other operating income 1,235 2,376 3,611
Total other operating expense 6,349 1,293 7,642
-----------------------------------------------
Income before income taxes 4,884 1,397 6,281
Provision for income taxes 1,797 512 2,309
-----------------------------------------------
Net income $3,087 $885 $3,972
===============================================
Total Average Assets $449,566 $27,310 $476,876
===============================================
Community Banking
The Community Banking segment's income before income tax increased for
the three and six months ended June 30, 2003 when compared to the same periods
in 2002. The increase was primarily due to an increase in net interest income.
Net interest income increased $287,000 and $817,000 for the three and six months
ended June 30, 2003, principally due to an increase in earning assets. The
Company increased its loan portfolio during the first six months of 2003 through
marketing efforts. For the six months ended June 30, 2003, total average
portfolio loans were $394,453,000, up 13% from $349,789,000 for the six months
ended June 30, 2002.
Merchant Card Services
The Company's merchant credit card segment earned $386,000 and $782,000
for the three and six months ended June 30, 2003 compared to $450,000 and
$885,000 for the same period in 2002. The decrease in the unit's net income for
the three and six months ended June 30, 2003 is primarily due to a decrease in
merchant processing revenue and an increase in salaries and benefits expenses.
The increase in the unit's salaries and employee benefits expense is due to a
build-up in sales development personnel. The merchant credit card segment's net
income comprised approximately 18% and 19% of the Company's consolidated net
income for the three and six months ended June 30, 2003 as compared to 22% for
the same periods one year ago.
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 refuses or is unable to pay on charge-backs from cardholders.
Charge-back exposure can also result from fraudulent credit card transactions
initiated by merchant customers. As a result, 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-backs. Such
reserve, which totaled $1,314,000 and $1,251,000 as of June 30, 2003 and 2002,
was estimated based upon industry loss data as a percentage of transaction
volume throughout each year, historical losses incurred by the Company and
management's evaluation regarding merchant and ISO (Independent Sales
Organization) risk. The Company utilizes the services of ISOs to acquire
merchants as
This page is page 24 of 43 pages.
customers. The provision for charge-back losses, which is included in the
financial statements as a reduction in merchant draft processing income, was
$103,000 and $148,000 for the three and six months ended June 30, 2003, as
compared to $49,000 and $108,000 for the three and six months ended June 30,
2002. For further discussion, see "Certain Important Considerations for
Investors" in this section.
The following table summarizes the Company's merchant card allowance
for charge-back losses for the periods indicated:
Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
---------------------------------------------------
(in thousands)
Beginning allowance $1,263 $1,233 $1,261 $1,212
Provision for losses 103 49 148 108
Recoveries 0 3 3 11
Charge-offs (52) (34) (98) (80)
------------------------- -------------------------
Ending allowance $1,314 $1,251 $1,314 $1,251
========================= =========================
Investment Securities
Total investment securities decreased to $73,420,000, as of June 30,
2003, compared to $99,921,000 as of December 31, 2002. The decrease in the
investment securities portfolio from December 31, 2002 was primarily due to
prepayments of the Company's mortgage backed securities portfolio and the second
quarter sale of mortgage backed securities of $9,812,000. Such mortgage-backed
securities portfolio amounted to $79,794,000 as of December 31, 2002 as compared
to $55,652,000 as of June 30, 2003. The average federal funds sold balance for
the six months ended June 30, 2003 of $3,658,000 was substantially lower than
$25,387,000 for the six months ended June 30, 2002. This decrease was due to the
Company's increased focus on greater growth in the Company's loan portfolio.
Loans
Total loans increased to $415,716,000 at June 30, 2003 compared to
$365,076,000 at December 31, 2002. The Company continues to focus on growth in
the overall loan portfolio through marketing efforts and a general expansion of
businesses within the Company's market area. Commercial real estate loans
increased $15,739,000 to $173,757,000, at June 30, 2003, compared to
$158,018,000 at December 31, 2002. Residential real estate mortgage loans also
increased $31,855,000 to $119,619,000 at June 30, 2003, compared to $87,764,000
at December 31, 2002.
This page is page 25 of 43 pages.
The following table summarizes the composition of the loan portfolio at
June 30, 2003 and December 31, 2002:
June 30, 2003 December 31, 2002
---------------------------- ----------------------------
Amount % Amount %
---------------------------- ----------------------------
(dollars in thousands)
Residential real estate
mortgage $119,619 29% $87,764 24%
Commercial real estate
mortgage 173,757 41 158,018 43
Commercial 60,960 15 62,958 17
Real estate construction 47,756 12 42,749 12
Installment and other 13,178 3 14,260 4
Less net deferred loan fees (207) --- (673) ---
---------------------------- ----------------------------
Total portfolio loans 415,063 100% 365,076 100%
=========== ============
Less allowance for loan
losses (7,492) (7,400)
----------------- -----------------
Net loans $407,571 $357,676
================= =================
Allowance for Loan Losses
The allowance for loan losses is established through charges to
earnings in the form of the provision for loan losses. Loan losses are charged
to, and recoveries are credited to, the allowance for loan losses. The provision
for loan losses is determined after considering various factors such as loan
loss experience, current economic conditions, maturity of the portfolio, size of
the portfolio, industry concentrations, borrower credit history, the existing
allowance for loan losses, independent loan reviews, current charges and
recoveries to the allowance for loan losses and the overall quality of the
portfolio, as determined by management, regulatory agencies and independent
credit review consultants retained by the Company.
The Company's allowance for loan losses is based on specific and
formula allocations to the Company's loan portfolio. Specific allocations of the
allowance for loan losses are made to identified problem loans where management
has identified significant conditions or circumstances related to a given loan,
which management believes indicate the probability that a loss may occur. The
specific allocations are increased or decreased through management's
reevaluation on a quarterly basis of the status of the particular problem loans.
Loans which do not receive a specific allocation receive an allowance allocation
based on a formula, represented by a percentage factor based on underlying
collateral, type of loan, historical charge-offs, general economic conditions
and other qualitative factors.
This page is page 26 of 43 pages.
The following table summarizes changes in the Company's allowance for
loan losses for the indicated periods:
Three months ended Six months ended
June 30, June 30
-------------------------------- ------------------------------
2003 2002 2003 2002
-------------------------------- ------------------------------
(dollars in thousands)
Beginning allowance for loan losses $7,355 $7,549 $7,400 $7,580
Provision for loan losses --- --- --- ---
Charge-offs --- --- (79) (45)
Recoveries 137 37 171 51
-------------------------------- ------------------------------
Ending allowance for loan losses $7,492 $7,586 $7,492 $7,586
================================ ==============================
Net recoveries to average
loans (annualized) 0.13% 0.04% 0.05% 0.01%
The allowance for loan losses as a percentage of total loans decreased
from 2.03%, at December 31, 2002, to 1.81% at June 30, 2003. The growth in the
Company's loan portfolio resulted primarily from commercial real estate loans
and residential real estate loans that generally bear a lower credit risk than
construction or commercial loans. Accordingly, under the Company's loan loss
reserve methodology, such loans generally receive a lower loan loss reserve
allocation as compared to commercial or construction loans.
Nonperforming Assets
The following table summarizes the Company's nonperforming assets at
the dates indicated:
June 30, December 31,
2003 2002
---------------- ---------------
(dollars in thousands)
Nonaccrual loans $2,839 $2,516
Accruing loans past due 90 days or more --- 6
Restructured loans 269 272
---------------- ---------------
Total nonperforming loans 3,108 2,794
Other real estate owned --- ---
---------------- ---------------
Total nonperforming assets $3,108 $2,794
================ ===============
Nonperforming assets to total assets 0.59% 0.54%
This page is page 27 of 43 pages.
Nonperforming assets have increased from $2,794,000 or .54% of total
assets, as of December 31, 2002, to $3,108,000 or .59% of total assets as of
June 30, 2003. The increase was primarily attributable to an increase of
$323,000 in nonaccrual loans during this period.
At June 30, 2003, nonperforming loans consisted of loans to 13
borrowers, 9 of which have balances in excess of $100,000. The two largest have
recorded balances of $1,283,000 and $360,000. Both loans are secured by
industrial equipment or various other business assets. Based on information
currently available, management believes that adequate allocations are included
in the allowance for loan losses to cover the estimated loss exposure that may
result from these loans.
At June 30, 2003, the Company did not have any properties classified as
other real estate owned.
Although the volume of nonperforming assets will depend in part on the
future economic environment, there are four loan relationships which total
approximately $4,200,000 as of June 30, 2003, compared to eight loan
relationships totaling approximately $1,244,000 at December 31, 2002, about
which management has serious doubts as to the ability of the borrowers to comply
with the present repayment terms. These loans may become nonperforming assets
based on the information presently known about possible credit problems of the
borrower.
At June 30, 2003, the Company's total recorded investment in impaired
loans (as defined by SFAS No. 114 and No. 118) was $3,108,000, of which
$2,839,000 relates to the recorded investment in loans for which there is a
related allowance for loan losses allocation of $1,097,000. The remaining
$269,000 in impaired loans did not require a specific allowance for loan losses
allocation.
The Company's average recorded investment in impaired loans during the
six months ended June 30, 2003 and 2002 was $3,295,000 and $2,056,000. The
increase of $1,239,000 in the average recorded investment in impaired loans
during the six months ending June 30, 2003 compared to the same period one year
ago was primarily due to the increase in nonperforming loans. There was $0 and
$22,000 interest income recognized during the periods that such loans were
impaired for the three and six months ended June 30, 2003 as compared to $0 and
$32,000 for the same periods one year ago.
As of June 30, 2003, there was $2,839,000 of loans on which the accrual
of interest had been discontinued as compared to $2,516,000 at December 31,
2002. During the three and six months ended June 30, 2003, interest due but
excluded from interest income on loans placed on nonaccrual status was $66,000
and $135,000, as compared to $11,000 and $47,000 for the same periods one year
ago. There was no interest income received on nonaccrual loans during the three
and six months ended June 30, 2003 and 2002.
This page is page 28 of 43 pages.
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, legal status of borrower, nature of the
collateral and other matters. The Company expects that it may be required to
repurchase loans in the future. In the first three and six months of 2003, the
Company was not required to repurchase any such loans. During the first quarter
of 2002, the Company paid $33,000 for a settlement related to disputed title
issues.
Investment in REMIC
In 1995, Allied Savings Bank ("Allied"), formerly a wholly owned
subsidiary of the Company which merged into NBR in 1997, sold a COFI ARM
mortgage pool whose carrying value was approximately $73,900,000 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 certificates:
A, B and C. The sale transaction took place as a result of Allied selling its
100% interest in the COFI indexed ARM mortgage pool in exchange for cash of
$71,500,000 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 Class B certificates shall only receive
principal payments after all Class A certificates are retired.
The composition of the original certificate balances along with their
respective June 30, 2003 balances are as follows:
Original June 30, 2003
Certificate Certificate
Face Value Face Value
-----------------------------------
Class A $73,199,448 $2,216,941
Class B 3,249,067 3,196,478
Class C 100 100
-----------------------------------
Total pool $76,448,615 $5,413,519
===================================
Since inception the pool has realized losses of $52,590, which reduced
the original face value of the Class B certificate.
This page is pae 29 of 43 pages.
Contractual Obligations and Commitments
The following table presents the Company's longer term, non-deposit
related, contractual obligations and commitments to extend credit to our
borrowers, in aggregate and by payment due dates.
June 30, 2003
-------------------------------------------------------------------------
Less Than One Through Four Through After Five
One Year Three Years Five Years Years Total
-------------------------------------------------------------------------
(in thousands)
Trust preferred securities $ --- $ --- $ --- $10,000 $10,000
Operating leases (premises) 1,362 1,487 1,158 399 4,406
-------------------------------------------------------------------------
Total long-term debt
and operating leases $1,362 $1,487 $1,158 $10,399 $14,406
============================================================
Commitments to extend credit 67,617
Standby letters of credit 5,290
Total contractual obligations
and commitments --------------
$87,313
==============
Liquidity
Redwood's primary source of liquidity is dividends from NBR. Redwood's
primary uses of liquidity have historically been common stock repurchases,
dividend payments made to common shareholders, interest payments relating to
Redwood's trust preferred securities and operating expenses. It is Redwood's
general policy to maintain liquidity at the parent level which management
believes to be consistent with the safety and soundness of the Company as a
whole. As of June 30, 2003, Redwood held $146,000 in deposits at NBR. In
addition, the Company 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 June 30, 2003, there was $1,220,000 outstanding under
this line of credit.
This page is page 30 of 43 pages.
Redwood's current cash dividend to its common shareholders is $.25 per
common share per quarter. Further, Redwood is required to make semi-annual
payments of interest at the rate of 10.2% per annum on $10,000,000 of trust
preferred securities issued in 2001 and quarterly payments of interest at the
rate of 6.35% for the first five years then at the three month LIBOR plus 3.1%
per annum on $10,000,000 of trust preferred financing issued in July 2003.
Payment of these obligations is ultimately dependent on dividends from NBR to
Redwood. Federal regulatory agencies have the authority to prohibit the payment
of dividends by NBR to Redwood if a finding is made that such payment would
constitute an unsafe or unsound practice or if NBR would become undercapitalized
as a result. If NBR is restricted from paying dividends, Redwood might be unable
to pay dividends to its common shareholders. No assurance can be given as to the
ability of NBR to pay dividends to Redwood in the future. The approval of the
Office of the Comptroller of the Currency ("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. Due to
this requirement, NBR obtained such approval for its 2003 dividend plan from the
OCC in January 2003.
During the first six months of 2003, NBR declared a dividend payable to
Redwood of $3,300,000. Management believes that as of June 30, 2003, the
Company's liquidity position was adequate for the operations of Redwood and NBR.
Although each entity within the consolidated Company manages its own
liquidity, the Company's consolidated cash flow can be divided into three
distinct areas: operating, investing and financing. For the six months ended
June 30, 2003, the Company received cash of $9,203,000 from operating activities
and $3,173,000 from financing activities, while using $23,974,000 in investing
activities.
Capital Resources
A strong capital base is essential to the Company's continued ability
to service the needs of its customers. Capital protects depositors and the FDIC
deposit insurance fund from potential losses and is a source of funds for the
substantial investments necessary for the Company to remain competitive. In
addition, adequate capital and earnings enable the Company to gain access to the
capital markets to supplement its internal growth of capital. Capital is
generated internally primarily through earnings retention.
The Company and NBR are required to maintain minimum capital ratios
defined by various federal government regulatory agencies. The Board of
Governors of the Federal Reserve System (the "FRB") and the OCC have each
established capital guidelines, which include minimum capital requirements.
These regulations impose three sets of standards: "risk-based", "leverage" and
"tangible" capital.
This page is page 31 of 43 pages.
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).
Under the leverage capital standard, an institution must maintain a
specified minimum ratio of Tier 1 capital to total assets, with the minimum
ratio ranging from 4% to 6%. The leverage ratio for the Company and NBR is based
on average assets for the quarter.
The following table summarizes the consolidated capital ratios of the
Company and the capital ratios of NBR at June 30, 2003 and December 31, 2002.
June 30, 2003 December 31, 2002
------------------------------------- -------------------------------------
Well- Minimum Well- Minimum
Actual Capitalized Requirement Actual Capitalized Requirement
------------------------------------- -------------------------------------
Company
Leverage 7.26% 5.00% 4.00% 6.96% 5.00% 4.00%
Tier 1 risk-based 9.13 6.00 4.00 9.18 6.00 4.00
Total risk-based 10.51 10.00 8.00 10.72 10.00 8.00
NBR
Leverage 7.47% 5.00% 4.00% 7.35% 5.00% 4.00%
Tier 1 risk-based 9.39 6.00 4.00 9.68 6.00 4.00
Total risk-based 10.65 10.00 8.00 10.94 10.00 8.00
The Company has announced authorizations to repurchase up to 533,250 of
common shares, as adjusted for the three-for-two stock splits announced
September 20, 2001 and July 16, 2003. To date, 355,505 shares have been
repurchased, as adjusted for the three-for-two stock splits announced September
20, 2001 and July 16, 2003. In the quarter ended June 30, 2003, the Company did
not purchase any shares under the program. For the six months ended June 30,
2003, the Company has purchased 69,551 shares at a cost of $19.01, as adjusted
for the three-for-two stock split announced July 16, 2003. Under the repurchase
program, the Company plans to purchase shares from time to time on the open
market and/or in privately negotiated transactions.
This page is page 32 of 43 pages.
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 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 June 30, 2003, the outstanding
principal balance of the Capital Securities was $10,000,000. The principal
balance of the Capital Securities constitutes the trust preferred securities in
the Company's 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 FRB, 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.
On July 22, 2003, Redwood Statutory Trust II ("RSTII"), a wholly owned
subsidiary of the Company, closed a financing of 10,000 Capital Securities with
a liquidation amount of $1,000 per security. The proceeds of the financing were
loaned to the Company in exchange for junior subordinated debentures with terms
similar to the Capital Securities. The sole assets of RSTII 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 RSTII under the Capital Securities. Distributions on the Capital Securities,
which are payable quarterly at the annual rate of 6.35% for the first five years
and then reset to the three month LIBOR plus 3.1%, will be included in interest
expense in the consolidated financial statements. These securities can be
considered Tier I capital (with certain limitations applicable) under current
regulatory guidelines, resulting in a current qualification as only Tier II
regulatory capital.
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 FRB, if then required, the Capital
Securities are redeemable prior to the maturity date of July 22, 2033, at the
option of the Company; on or after July 22, 2008 at par; 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.
This page is page 33 of 43 pages.
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. Charge-back exposure can also result from fraudulent
credit card transactions initiated by merchant customers. To mitigate merchant
fraud risk, the Company employs certain underwriting standards when accepting a
new merchant. Further, the Company monitors merchant activity for unusual
transactions. In addition, the Company bears the risk of merchant nonpayment of
applicable interchange, assessment and other fees. Failure by the merchants to
pay such fees may adversely affect the Company's revenues. The Company utilizes
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 growing proprietary accounts.
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 June 30,
2003 (the most recent period available from Visa), the Company's overall fraud
ratio was less than the Visa requirement. Other Visa changes included the
requirement that total processing volume in certain high-risk categories (as
defined by Visa) be less than 20% of total processing volume. At June 30, 2003,
the Company's total Visa transactions within these certain high-risk categories
were 1.68% 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 that aggregate charge-backs for the quarter be less
than .59% of the interchange count and .95% of the interchange amount. At June
30, 2003, the Company's weekly Visa volume was 55% of the Company's tangible
equity capital, and aggregate charge-backs for the previous six months were
6.36% of tangible equity capital and the aggregate charge-backs for the quarter
were .26% of the interchange count and .30% 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 June 30, 2003, 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 shortfall.
This page is page 34 of 43 pages.
Concentration of Lending Activities. Concentration of the Company's
lending activities in the real estate sector, including construction loans,
could have the effect of intensifying the impact on the Company of adverse
changes in the real estate market in the Company's lending areas. At June 30,
2003, approximately 82% of the dollar value of the Company's loans were secured
by real estate, of which 49% were secured by commercial real estate, including
small office buildings, owner-user office/warehouses, mixed use residential and
commercial properties and retail properties. Substantially all of the properties
that secure the Company's present loans are located in Northern and Central
California. The ability of the Company to continue to originate mortgage,
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 and the decline in the technology sector in Northern
California 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.
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. Continued 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.
This page is page 35 of 43 pages.
Government Regulation. The Company and its subsidiaries are subject to
extensive federal and state governmental supervision, regulation and control.
Future legislation and government policy could adversely affect the financial
industry. Although the full impact of such legislation and regulation cannot be
predicted, future changes may alter the structure of, and competitive
relationship among, financial institutions. The Company's business may be
adversely affected by any future changes in laws, regulations, policies or
interpretations, including legislative and regulatory reactions to the terrorist
attack on September 11, 2001, and future acts of terrorism, and the Enron
Corporation and WorldCom Inc. bankruptcies and recent reports of accounting
irregularities at public companies, including various large and seemingly
well-regarded companies. Additionally, the Company's business is affected
significantly by the fiscal and monetary policies of the federal government and
its agencies, particularly the FRB, which regulates the supply of money and
credit in the U.S. Among the instruments of monetary policy available to the FRB
are (a) conducting open market operations in U.S. government securities, (b)
changing the discount rates of borrowings of depository institutions, and (c)
imposing or changing reserve requirements against certain borrowings by banks
and their affiliates. These methods are used in varying degrees and combinations
to directly affect the availability of bank loans and deposits, as well as the
interest rates charged on loans and paid on deposits. The policies of the FRB
may have a material effect on our business, financial condition and results of
operations.
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. Banks, securities firms and insurance
companies can also now combine as 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. Several of the nation's largest savings and loan associations
and commercial banks have a significant number of branch offices in the areas in
which the Company conducts operations. Among the advantages possessed by the
larger of these institutions are their ability to make larger loans, finance
extensive advertising campaigns, access international money markets and
generally allocate their investment assets to regions of highest yield and
demand. In addition, 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.
This page is page 36 of 43 pages.
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 losses 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 June 30, 2003, other than NBR Real Estate Investment Trust and
the REMIC, (discussed elsewhere in this report), 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As a financial institution, the Company's primary component of market
risk is interest rate volatility. Fluctuation in interest rates will ultimately
impact both the level of income and expense recorded on a large portion of the
Bank's assets and liabilities, and the market value of all interest earning
assets and interest bearing liabilities, other than those which possess a short
term to maturity. Since virtually all of the Company's interest bearing
liabilities and all of the Company's interest earning assets are located at the
Bank (or in its wholly owned subsidiary), 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 and Central California, is subject to risks associated
with the local economy. The Company does not own any trading assets.
This page is page 37 of 43 pages.
The fundamental objective of the Company's management of its assets and
liabilities is to maximize the economic value of the Company while maintaining
adequate liquidity and an exposure to interest rate risk deemed by management to
be acceptable. Management believes an acceptable degree of exposure to interest
rate risk results from the management of assets and liabilities through
maturities, pricing and mix to attempt to neutralize the potential impact of
changes in market interest rates. The Bank's profitability is dependent to a
large extent upon its net interest income, which is the difference between its
interest income on interest-earning assets, such as loans and securities, and
its interest expense on interest-bearing liabilities, such as deposits and
borrowings. The Bank, like other financial institutions, is subject to interest
rate risk to the degree that its interest-earning assets reprice differently
than its interest-bearing liabilities. The Bank manages its mix of assets and
liabilities with the goals of limiting its exposure to interest rate risk,
ensuring adequate liquidity, and coordinating its sources and uses of funds.
The Bank seeks to control its interest rate risk exposure in a manner
that will allow for adequate levels of earnings and capital over a range of
possible interest rate environments. The Bank has adopted formal policies and
practices to monitor and manage interest rate risk exposure. As part of this
effort, the Bank measures risk in three ways: repricing of earning assets and
interest bearing liabilities; changes in net interest income for interest rate
shocks up and down 200 basis points; and changes in the market value of equity
for interest rate shocks up and down 200 basis points.
This page is page 38 of 43 pages.
The following table sets forth, as of June 30, 2003, the distribution of
repricing opportunities for the Bank's earning assets and interest-bearing
liabilities, the interest rate sensitivity gap, the cumulative interest rate
sensitivity gap, the interest rate sensitivity gap ratio (i.e., earning assets
divided by interest-bearing liabilities) and the cumulative interest rate
sensitivity gap ratio.
After Three After Six After One
Within Months but Months but Year But
Three Within Six Within One Within After Five
Months Months Year Five Years Years Total
-----------------------------------------------------------------------
(Dollars in thousands)
Interest earning assets:
Federal funds sold $4,600 $ --- $ --- $ --- $ --- $4,600
Investment securities and other 5,843 4,506 16,218 33,237 13,616 73,420
Mortgage loans held for sale 653 --- --- --- --- 653
Loans 108,178 48,809 51,514 168,790 37,772 415,063
-----------------------------------------------------------------------
Total interest-earning assets 119,274 53,315 67,732 202,027 51,388 493,736
-----------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing transaction accounts 158,426 --- --- --- --- 158,426
Time deposits 89,819 47,205 61,484 10,848 --- 209,356
Trust preferred securities --- --- --- --- 10,000 10,000
Short-term borrowings 4,463 --- --- --- --- 4,463
-----------------------------------------------------------------------
Total interest-bearing liabilities 252,708 47,205 61,484 10,848 10,000 382,245
-----------------------------------------------------------------------
Interest rate sensitivity gap ($133,434) $6,110 $6,248 $191,179 $41,388
===========================================================
Cumulative interest rate sensitivity gap (133,434) (127,324) (121,076) 70,103 111,491
Interest rate sensitivity gap ratio 0.47 1.13 1.10 18.62 5.14
Cumulative interest rate sensitivity gap ratio 0.47 0.58 0.66 1.19 1.29
The Bank's gap position is substantially dependent upon the volume of
mortgage loans held in the portfolio. These loans generally have maturities
greater than five years; however, these loans have a repricing frequency of at
least quarterly and therefore are classified in the above table as repricing
within three months. Additionally, interest-bearing transaction accounts, which
consist of money market 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 Bank's net interest margin.
Management expects that, in a declining interest rate environment, the
Bank's net interest margin would be expected to decline, and, in an increasing
interest rate environment, the Bank's net interest margin would tend to
increase. The Bank has experienced greater mortgage lending activity through
mortgage refinancings and financing new home purchases as rates declined, and
may increase its net interest margins in an increasing rate environment if more
traditional commercial bank lending becomes a higher percentage of the overall
earning assets mix. There can be no assurance, however, that under such
circumstances the Bank will experience the described relationships to declining
or increasing interest rates.
This page is page 39 of 43 pages.
On a quarterly basis, the Bank's 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 Bank's assets and liabilities. The following is a
summary of interest rate risk exposure as of June 30, 2003 as measured on a net
interest income basis and a market value of equity basis, given a change in
general interest rates of up to 200 basis points up and 200 basis points down.
June 30, 2003
-------------
Change in Annual Change in
Change in Interest Rate Net Interest Income Market Value of Equity
----------------------- ------------------- ----------------------
+200 $190,000 ($11,661,000)
+100 $186,000 ($5,106,000)
-100 ($1,310,000) $2,210,000
-200 ($3,171,000) $5,669,000
The model utilized by management to create the report presented above
makes various estimates at each level of interest rate change regarding cash
flows from principal repayments on loans and mortgage-backed securities and/or
call activity on investment securities. In addition, repricing these earning
assets and matured liabilities can occur in one of three ways: (1) the rate of
interest to be paid on an asset or liability may adjust periodically based on an
index; (2) an asset, such as a mortgage loan, may amortize, permitting
reinvestment of cash flows at the then-prevailing interest rates; or (3) an
asset or liability may mature, at which time the proceeds can be reinvested at
current market rate. Actual results could differ significantly from those
estimates, which would result in significant differences in the calculated
projected change.
Item 4. Controls and Procedures
a) Evaluation of Disclosure Controls and Procedures. Based on their
evaluation as of June 30, 2003, 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-15(e) and 15d-15(e) 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
over financial reporting during the fiscal quarter to which this report
relates that have materially affected, or are reasonably likely to
materially affect the Company's internal control over financial
reporting.
This page is page 40 of 43 pages.
PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
a) The Company held its Annual Meeting of Shareholders on May 20, 2003.
b) Proxies for the Annual Meeting were solicited pursuant to Regulation
14 under the Securities and Exchange Act of 1934. There was no
solicitation in opposition to management's nominees for directors as
listed in the Company's proxy statement for the Annual Meeting and all
such nominees were relected.
c) The vote for the nominated directors was as follows:
Nominee For Withheld
John H. Brenengen 3,119,109 1,477
Dana R. Johnson 3,119,148 1,438
Patrick W. Kilkenny 3,079,250 41,336
Mark H. Rodebaugh 3,082,087 38,499
Gregory J. Smith 3,082,129 38,457
William B. Stevenson 3,081,955 38,631
The vote for ratifying the appointment of Crowe Chizek and Company LLP
as the Company's independent auditors was as follows:
For 3,071,495
Against 46,462
Abstain 2,529
Broker Non Vote -0-
Item 6. Exhibits and Reports on Form 8-K.
d) Exhibits.
31.1 Certification of the Chief Executive Officer Under Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer Under Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Financial Officer Under Section 906 of the
Sarbanes-Oxley Act of 2002.
This page is page 41 of 43 pages.
32.2 Certification of the Chief Executive Officer Under Section 906 of the
Sarbanes-Oxley Act of 2002.
e) Reports on Form 8-K
1. Form 8-K filing dated April 17, 2003 reporting under Item 7 and 9
thereof, first quarter 2003 results and related press release dated
April 16, 2003.
2. Form 8-K filing dated April 7, 2003 reporting under Item 5 thereof,
announcing declaration of quarterly dividend.
This page is page 42 of 43 pages.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
REDWOOD EMPIRE BANCORP
(Registrant)
Date: 8/12/2003 By: /s/ James E. Beckwith
--------- ---------------------------------
James E. Beckwith
Executive Vice President,
Chief Financial Officer and
Chief Operating Officer
(Principal Financial Officer and
Duly Authorized Officer)
This page is page 43 of 43 pages.