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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Under Section 13 or 15 (d) of the SECURITIES
Exchange Act of 1934
For the quarterly period ended June 30,1999
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
Incorporated or organization) Identification No.)
111 Santa Rosa Avenue, Santa Rosa, California 95404-4905
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (707) 573-4800
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. July 31, 1999: 3,409,807
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, 1999 and 1998...............3
Consolidated Balance Sheets
June 30, 1999 and December 31, 1998.............................4
Consolidated Statements of Cash Flows
Six Months Ended June 30, 1999 and 1998.........................5
Notes to Consolidated Financial Statements......................7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations...............11
Item 3. Quantitative and Qualitative Disclosure
about Market Risk..............................................30
PART II. Other Information
Item 4. Submission of Matters to a Vote of Securities Holders..........33
Item 6. Exhibits and Reports on Item 8-K...............................34
SIGNATURES ...............................................................36
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,
1999 1998 1999 1998
--------------------------- ---------------------------
Interest income:
Interest and fees on loans $6,913 $6,814 $13,522 $13,668
Interest on investment securities 1,007 1,099 1,963 2,225
Interest on federal funds sold 78 310 256 636
--------------------------- ---------------------------
Total interest income 7,998 8,223 15,741 16,529
Interest expense:
Interest on deposits 2,755 3,257 5,476 6,638
Interest on subordinated notes --- 277 142 554
Interest on other borrowings 154 75 207 149
--------------------------- ---------------------------
Total interest expense 2,909 3,609 5,825 7,341
--------------------------- ---------------------------
Net interest income 5,089 4,614 9,916 9,188
Provision for loan losses 200 510 500 1,020
--------------------------- ---------------------------
Net interest income after loan loss provision 4,889 4,104 9,416 8,168
Noninterest income:
Service charges on deposit accounts 268 267 523 541
Merchant draft processing, net 863 605 1,642 1,046
Loan servicing income 103 105 169 284
Net realized gain on sale of
investment securities available for sale --- --- 14 105
Gain on sale of loans and loan servicing 536 1,655 1,240 2,602
Mortgage loan brokerage revenue, net 828 1,084 2,030 1,905
Other income 193 409 559 969
--------------------------- ---------------------------
Total noninterest income 2,791 4,125 6,177 7,452
Noninterest expense:
Salaries and employee benefits 3,254 3,388 6,674 6,391
Occupancy and equipment expense 826 841 1,629 1,650
Other 1,688 2,079 3,275 3,916
--------------------------- ---------------------------
Total noninterest expense 5,768 6,308 11,578 11,957
--------------------------- ---------------------------
Income before income taxes and extraordinary item 1,912 1,921 4,015 3,663
Provision for income taxes 694 710 1,503 1,345
--------------------------- ---------------------------
Income before extraordinary item 1,218 1,211 2,512 2,318
Extraordinary item --- --- 459 ---
Income tax benefit --- --- (183) ---
--------------------------- ---------------------------
Total extraordinary item, net of tax --- --- 276 ---
--------------------------- ---------------------------
Net income 1,218 1,211 2,236 2,318
Dividends on preferred stock --- --- --- 112
--------------------------- ---------------------------
Net income available for common stock shareholders $1,218 $1,211 $2,236 $2,206
=========================== ===========================
Earnings per common share and common equivalent share:
Basic earnings per share before extraordinary item $.36 $.39 $.74 $.74
Basic earnings per share .36 .39 .66 .74
Diluted earnings per share before extraordinary item .35 .35 .72 .67
Dilute earnings per share .35 .35 .64 .67
See Notes to Consolidated Financial Statements.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands)
(unaudited)
June 30, December 31,
1999 1998
------------------ ------------------
Assets:
Cash and due from banks $28,409 $15,982
Federal funds sold and repurchase agreements 2,276 26,205
------------------ ------------------
Cash and cash equivalents 30,685 42,187
Investment securities:
Held to maturity (market value of $32,405 and $30,014) 33,252 29,872
Available for sale, at market (amortized cost of $32,134 and $30,127 31,597 30,538
------------------ ------------------
Total investment securities 64,849 60,410
Mortgage loans held for sale 28,266 32,620
Loans:
Residential real estate mortgage 113,091 97,194
Commercial real estate mortgage 76,742 59,257
Commercial 58,312 63,260
Real estate construction 45,211 46,905
Installment and other 4,620 5,095
Less deferred loan fees (1,380) (2,395)
------------------ ------------------
Total portfolio loans 296,596 269,316
Less allowance for loan losses (8,001) (8,041)
------------------ ------------------
Net loans 288,595 261,275
Premises and equipment, net 3,849 4,082
Mortgage servicing rights 192 305
Other real estate owned 2,486 2,181
Cash surrender value of life insurance 3,111 3,033
Other assets and interest receivable 9,833 16,206
------------------ ------------------
Total assets $431,866 $422,299
================== ==================
Liabilities and Shareholders' equity:
Deposits:
Noninterest bearing demand deposits $90,197 $82,448
Interest-bearing transaction accounts 128,362 141,316
Time deposits $100,000 and over 65,502 62,600
Other time deposits 82,501 78,356
------------------ ------------------
Total deposits 366,562 364,720
Other borrowings 13,870 1,371
Subordinated notes --- 12,000
Other liabilities and interest payable 11,168 5,568
------------------ ------------------
Total liabilities 391,600 383,659
Shareholders' equity:
Common stock, no par value; authorized 10,000,000 shares;
issued and outstanding 3,409,807 and 3,363,565 shares 26,015 25,801
Retained earnings 14,563 12,600
Accumulated other comprehensive income, net (312) 239
------------------ ------------------
Total shareholders' equity 40,266 38,640
------------------ ------------------
Total liabilities and shareholders' equity $431,866 $422,299
================== ==================
See Notes to Consolidated Financial Statements.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Six Months Ended
June 30,
1999 1998
-------------- --------------
Cash flows from operating activities:
Net income $2,236 $2,318
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization, net 749 526
Net realized gains on securities available for sale (14) (105)
Loans originated for sale (192,313) (220,571)
Proceeds from sale of loans held for sale 190,865 208,900
Gain on sale of loans and loan servicing (1,240) (2,602)
Provision for loan losses 500 1,020
Change in other assets and interest receivable 3,073 1,522
Change in other liabilities and interest payable 8,953 (4,207)
Other, net 102 430
-------------- --------------
Total adjustments 10,675 (15,087)
-------------- --------------
Net cash provided by (used in) operating activities 12,911 (12,769)
-------------- --------------
Cash flows from investing activities:
Net change in loans (22,411) 19,980
Proceeds from sales of loans in portfolio --- 288
Purchases of investment securities available for sale (7,016) (14,079)
Purchases of investment securities held to maturity (6,160) (11,131)
Sales of investment securities available for sale --- 2,955
Maturities of investment securities available for sale 5,000 14,900
Maturities of investment securities held to maturity 2,774 11,382
Premises and equipment, net (516) (1,020)
Purchase of mortgage servicing rights --- (11)
Proceeds from sale of other real estate owned 1,637 3,034
-------------- --------------
Net cash provided by (used in) investment activities (26,692) 26,298
-------------- --------------
Cash flows from financing activities:
Change in noninterest bearing transaction accounts 7,749 (1,865)
Change in interest bearing transaction accounts (12,954) (11,693)
Change in subordinated debt (12,000) ---
Change in time deposits 7,047 (4,294)
Change in borrowings 12,499 4,000
Issuance of stock 214 219
Dividends paid (273) (245)
-------------- --------------
Net cash provided by (used in) financing activities 2,282 (13,878)
-------------- --------------
Net change in cash and cash equivalents (11,499) (349)
Cash and cash equivalents at beginning of period 42,187 56,058
-------------- --------------
Cash and cash equivalents at end of period $30,688 $55,709
============== ==============
(Continued)
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Continued)
Six Months Ended
June 30,
1999 1998
-------------- -------------
Supplemental Disclosures:
Cash paid during the period for:
Interest expense 5,798 5,261
Income taxes 410 820
Noncash investing and financing activities:
Transfers from loans to other real estate owned 2,044 2,534
Transfer from mortgage loans held for sale to loans 1,547 5,564
Dividend declared 273 245
Conversion of Preferred Stock into Common Stock 5,739
See notes to Consolidated Financial Statements
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements should be
read in conjunction with the financial statements and related notes contained in
Redwood Empire Bancorp's 1998 Annual Report to Shareholders. The statements
include the accounts of Redwood Empire Bancorp ("Redwood"), and its wholly owned
subsidiary, National Bank of the Redwoods ("NBR"). All significant inter-company
balances and transactions have been eliminated. The financial information
contained in this report reflects all adjustments which, in the opinion of
management, are necessary for a fair presentation of the results of the interim
periods. All such adjustments are of a normal recurring nature. The results of
operations and cash flows for the six months ended June 30, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999.
Certain reclassifications were made to prior period financial
statements to conform to current period presentations.
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, federal funds sold and repurchase
agreements. 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 entity.
The Company's pertinent earnings per share data is as follows:
Three Months Ended
June 30,
1999 1998
---------------------- -----------------------
Basic Diluted Basic Diluted
---------- ---------- ---------- ----------
Earnings per share before extraordinary item:
Income before extraordinary item $1,218 $1,218 $1,211 $1,211
========== ========== ========== ==========
Weighted average common shares outstanding 3,395 3,509 3,141 3,463
========== ========== ========== ==========
Earnings per share before extraordinary item $0.36 $0.35 $0.39 $0.35
========== ========== ========== ==========
Earnings per share:
Net income $1,218 $1,218 $1,211 $1,211
========== ========== ========== ==========
Weighted average common shares outstanding 3,395 3,509 3,141 3,463
========== ========== ========== ==========
Earnings per share $0.36 $0.35 $0.39 $0.35
========== ========== ========== ==========
Six Months Ended
June 30,
1999 1998
---------------------- -----------------------
Basic Diluted Basic Diluted
---------- ---------- ---------- ----------
Earnings per share before extraordinary item:
Income before extraordinary item $2,512 $2,512 $2,318 $2,206
Less: Preferred stock dividend --- --- 112 112
---------- --------- --------- ---------
Income before extraordinary item available to
common stock shareholders $2,512 $2,512 $2,206 $2,318
========== ========== ========== ==========
Weighted average common shares outstanding 3,383 3,485 2,967 3,454
========== ========== ========== ==========
Earnings per share before extraordinary item $0.74 $0.72 $0.74 $0.67
========== ========== ========== ==========
Earnings per share:
Net income $2,236 $2,236 $2,318 $2,206
Less: Preferred stock dividend --- --- 112 112
--------- --------- --------- ---------
Net income available to common stock shareholders $2,236 $2,236 $2,206 $2,318
========== ========== ========== ==========
Weighted average common shares outstanding 3,383 3,485 2,967 3,454
========== ========== ========== ==========
Earnings per share $0.66 $0.64 $0.74 $0.67
========== ========== ========== ==========
3. Comprehensive Income
The Company's total comprehensive earnings presentation is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- --------------------------
1999 1998 1999 1998
-------------- -------------- ----------- -----------
(In thousands) (In thousands)
Net income as reported $1,218 $1,211 $2,236 $2,318
Other comprehensive income (net of tax):
Change in unrealized holding gain (losses)
on available for sale securities
(361) 132 (543) 151
Reclassification adjustment - - - - (8) (25)
-------------- -------------- ----------- -----------
Total comprehensive income $857 $1,343 $1,685 $2,444
============== ============== =========== ===========
4. Common Stock Dividend
On May 18, 1999 the Board of Directors declared a quarterly cash
dividend of 4 cents per share on the Company's Common Stock. The dividend is
payable on July 15, 1999 to shareholders of record on June 30, 1999.
5. Extraordinary Item
In the first quarter of 1999 the Company recorded an extraordinary
charge of $276,000, net of tax. Such charge is comprised of the unamortized debt
issuance costs associated with the Company's $12,000,000 subordinated debt which
was early redeemed in the first quarter of 1999. In the first quarter of 1999
Redwood obtained funding for the early redemption through an $8.0 million
dividend from NBR and the redemption of a $3.0 million note from NBR.
6. Business Segments
During the three and six months ended June 30, 1999 and 1998, the
Company operated in four principal product and service lines: core community
banking, merchant card services, sub prime lending, and residential mortgage
banking and brokerage. The Company's core community banking industry segment
includes commercial, commercial real estate, construction, and permanent
residential lending along with all depository activities. The Company's merchant
card services industry group provides credit card settlement services for 30,000
merchants throughout the United States. The Company's sub prime lending unit,
known as Allied Diversified Credit, provides sub prime residential loans for
homeowners located principally in Northern California. The Company's residential
mortgage banking and brokerage arm, known as Valley Financial, includes the
origination and brokerage of "A paper" loans, and servicing of loans for
investors.
The condensed income statements and average assets of the individual
segments are set forth in the table below. The information in this table is
derived from the internal management reporting system used by management to
measure the performance of the segments and the Company. The management
reporting system assigns balance sheet and income statement items to each
segment based on internal management accounting policies. Net interest income is
determined by the Company's internal funds transfer pricing system, which
assigns a cost of funds or credit for funds to assets or liabilities based on
their type, maturity or repricing characteristics. Noninterest income and
expense directly attributable to a segment are assigned to that business. Total
other operating expense including indirect costs, such as overhead, operations
and technology expense are allocated to the segments based on an evaluation of
costs for product or data processing. All amounts other than allocations of
interest and indirect costs are derived from third parties. The provision for
credit losses is allocated based on the required reserves and the net
charge-offs for each respective segment.
For the quarter ended June 30, 1999
------------------------------------------------------------
Mortgage
Community Banking and Total
Banking Sub Prime Bankcard Brokerage Company
------------------------------------------------------------
(in thousands)
Total Interest Income $7,415 $102 $0 $481 $7,998
Total Interest Expense 2,909 0 0 0 2,909
Interest income/(expense) allocation 323 (74) 138 (387) 0
------------------------------------------------------------
Net Interest Income 4,829 28 138 94 5,089
Provision for Loan Losses 196 4 0 0 200
Total other Operating Income 516 63 863 1,349 2,791
Total other Operating Expense 3,359 283 347 1,779 5,768
------------------------------------------------------------
Income before income taxes 1,790 (196) 654 (336) 1,912
Provision for income taxes 659 (72) 236 (129) 694
------------------------------------------------------------
Income before extraordinary item $1,131 ($124) $418 ($207) $1,218
============================================================
Total Average Assets $394,990 $3,948 $10,233 $24,715 $433,886
============================================================
For the quarter ended June 30, 1998
------------------------------------------------------------
Mortgage
Community Banking and Total
Banking Sub Prime Bankcard Brokerage Company
------------------------------------------------------------
(in thousands)
Total Interest Income $7,614 $147 $0 $462 $8,223
Total Interest Expense 3,585 8 8 8 3,609
Interest income/(expense) allocation 286 (78) 134 (342) 0
------------------------------------------------------------
Net Interest Income 4,315 61 126 112 4,614
Provision for Loan Losses 504 6 0 0 510
Total other Operating Income 632 667 605 2,221 4,125
Total other Operating Expense 3,595 556 253 1,904 6,308
------------------------------------------------------------
Income before income taxes 848 166 478 429 1,921
Provision for income taxes 314 60 177 159 710
------------------------------------------------------------
Income before extraordinary item $534 $106 $301 $270 $1,211
============================================================
Total Average Assets $383,664 $5,881 $9,450 $23,512 $422,507
============================================================
For the six months ended June 30, 1999
------------------------------------------------------------------
Mortgage
Community Banking and Total
Banking Sub Prime Bankcard Brokerage Company
-----------------------------------------------------------------
(in thousands)
Total Interest Income $14,643 $223 $0 $875 $15,741
Total Interest Expense 5,811 5 3 6 5,825
Interest income/(expense) allocation 762 (205) 275 (832) 0
-----------------------------------------------------------------
Net Interest Income 9,594 13 272 37 9,916
Provision for Loan Losses 490 10 0 0 500
Total other Operating Income 1,063 163 1,642 3,309 6,177
Total other Operating Expense 6,399 612 670 3,897 11,578
-----------------------------------------------------------------
Income before income taxes 3,768 (446) 1,244 (551) 4,015
Provision for income taxes 1,426 (171) 462 (214) 1,503
-----------------------------------------------------------------
Income before extraordinary item $2,342 ($275) $782 ($337) $2,512
=================================================================
Total Average Assets $386,072 $5,655 $10,190 $26,542 $428,459
=================================================================
For the six months ended June 30, 1998
------------------------------------------------------------------
Mortgage
Community Banking and Total
Banking Sub Prime Bankcard Brokerage Company
-----------------------------------------------------------------
(in thousands)
Total Interest Income $15,359 $277 $0 $893 $16,529
Total Interest Expense 7,296 15 15 15 7,341
Interest income/(expense) allocation 549 (151) 267 (665) 0
-----------------------------------------------------------------
Net Interest Income 8,612 111 252 213 9,188
Provision for Loan Losses 1,008 12 0 0 1,020
Total other Operating Income 1,538 958 1,046 3,910 7,452
Total other Operating Expense 7,053 1,144 498 3,262 11,957
-----------------------------------------------------------------
Income before income taxes 2,089 (87) 800 861 3,663
Provision for income taxes 766 (33) 294 318 1,345
-----------------------------------------------------------------
Income before extraordinary item $1,323 ($54) $506 $543 $2,318
=================================================================
Total Average Assets $387,913 $5,699 $9,404 $22,887 $425,903
=================================================================
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Forward-Looking Information
This Quarterly Report on Form 10-Q includes forward-looking information
which is subject to the "safe harbor" created by the Securities Act of 1933 and
Securities Act of 1934. These forward-looking statements (which involve the
Company's plans, beliefs and goals, refer to estimates or use similar terms)
involve certain risks and uncertainties that could cause actual results to
differ materially from those in the forward-looking statements. Such risks and
uncertainties include, but are not limited to, the following factors:
o Competitive pressure in the banking and mortgage industry and
changes in the regulatory environment.
o Changes in the interest rate environment and volatility of rate
sensitive deposits.
o The health of the economy declines nationally or regionally which could
reduce the demand for loans or reduce the value of real estate
collateral securing most of the Company's loans.
o Credit quality deteriorates which could cause an increase in the
provision for loan losses.
o Risks associated with the Year 2000 which could cause disruptions in
the Company's operations or increase expenses.
o Losses in the Company's merchant credit card processing business.
o Asset/liability matching risks and liquidity risks.
o Changes in the securities markets.
The Company undertakes no obligation to revise or publicly release the
results of any revision to these forward-looking statements. For additional
information concerning risks and uncertainties related to the Company and its
operations please refer to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998 and Certain Important Considerations for Investors.
The following sections discuss significant changes and trends in
financial condition, capital resources and liquidity of the Company from
December 31, 1998 to June 30, 1999, and significant changes and trends in the
Company's results of operations for the three and six months ended June 30,
1999, compared to the same period in 1998.
Summary of Financial Results
The Company reported net income of $1,218,000 ($.35 per diluted share)
for the three months ended June 30, 1999, as compared to $1,211,000 ($.35 per
diluted share) for the same period in 1998. Net income before extraordinary item
was $2,512,000 ($.72 per diluted share) and net income of $2,236,000 ($.64 per
diluted share) for the six months ended June 30, 1999, as compared to $2,318,000
($.67 per diluted share) for the same period in 1998. The extraordinary item
relates to the unamortized debt issuance costs, net of tax, associated with the
Company's $12,000,000 subordinated debt. Such debt was redeemed in the first
quarter of 1999.
The slight increase in net income for the second quarter in 1999 when
compared to the same period one year ago is due to an increase of $475,000 in
net interest income, a decrease of $1,334,000 in non interest income, a decrease
in the provision for loan losses of $310,000 and a decrease of $540,000 in non
interest expense. The increase in income before extraordinary item during the
first six months of 1999 when compared to the same period in 1998 is due to a
decrease of $1,275,000 in non interest income, a decrease in the provision for
loan losses of $520,000, a decrease of $379,000 in non interest expense and an
increase of $728,000 in net interest income.
Net Interest Income
Net interest income increased from $4,614,000 during the second quarter
of 1998 to $5,089,000 in the second quarter of 1999, which represents an
increase of $475,000 or 9%. Such increase is due to an increase in the
Company's net interest margin from 4.90% to 5.15% and an increase in average
earning assets of $18,465,000 from $376,513,000 for the quarter ended June 30,
1998 to $394,978,000 for the quarter ended June 30, 1999.
Net interest income of $9,916,000 increased $728,000 or 8% for the six
months ended June 30, 1999 when compared to the same period one year ago. The
increase is primarily due to an increase of $8,795,000 or 2% in average earning
assets and a decrease of $13,307,000 or 4% in interest bearing liabilities. Net
interest margin for the first six months of 1999 was 5.08% as compared to 4.81%
for the same period one year ago.
Yield on earning assets decreased from 8.66% to 8.06% primarily due to
a decrease in general interest rates as evidenced by a decline in the prime rate
from 8.50% in 1998 to 7.75% in 1999. Yield paid on interest bearing liabilities
also declined as such yield was 4.83% for the six months ended June 30, 1998 as
compared to 4.01% in the same period in 1999. This decline is attributable to a
decline in the general interest rate environment and the Company's downward
repricing of the rates paid on money market accounts in mid 1998.
Average earning assets increased in the second quarter of 1999 when
compared to the same period one year ago. Average earning assets were
$390,602,000 during the six month period ended June 30, 1999 as compared to
$381,807,000 in 1998. The increase in average earning assets during the first
six months of 1999 when compared to 1998 is primarily due to an increase in
average portfolio loans and average mortgage loans held for sale, partially
offset by a decline in federal funds sold.
Further contributing to the improvement in the Company's net interest
margin was a change in the Company's funding mix. Total average interest bearing
liabilities declined from $303,984,000 in the second quarter of 1998 to
$290,677,000 for the same period in 1999 which represents a decrease of
$13,307,000. This decrease was partially offset by an increase in average
noninterest bearing transaction accounts of $7,248,000.
The following is an analysis of the net interest margin:
Three months ended Three months ended
June 30, 1999 June 30, 1998
---------------------------------------- ----------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield Balance Interest Yield
---------------------------------------- ----------------------------------------
Earning assets (1) $394,978 $7,998 8.10 $376,513 $8,223 8.74
Interest-bearing liabilities 294,466 2,909 3.95 304,101 3,609 4.75
------------- --------------
Net interest income $5,089 $4,614
============= ==============
Net interest income to
earning assets 5.15 4.90
Six months ended Six months ended
June 30, 1999 June 30, 1998
---------------------------------------- ---------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield Balance Interest Yield
---------------------------------------- ---------------------------------------
Earning assets (1) $390,602 $15,741 8.06 $381,807 $16,529 8.66
Interest-bearing liabilities 290,677 5,825 4.01 303,984 7,342 4.83
------------- -------------
Net interest income $9,916 $9,187
============= =============
Net interest income to
earning assets 5.08 4.81
(1) Nonaccrual loans are included in the calculation of the average balance
of earning assets, and interest not accrued is excluded.
The following table sets forth changes in interest income and interest
expense for each major category of interest-earning asset and interest-bearing
liability, and the amount of change attributable to volume and rate changes for
the three and six months ended June 30, 1999 and 1998. Changes not solely
attributable to rate or volume have been allocated to rate.
Three months ended June 30, 1999
over June 30, 1998
--------------------------------------------------
Volume Rate Total
--------------------------------------------------
(in thousands)
Increase (decrease) in interest income:
Portfolio loans $453 ($328) $125
Mortgage loans held for sale (206) 180 (26)
Investment securities (911) 819 (92)
Federal funds sold (498) 266 (232)
--------------------------------------------------
Total increase (decrease) (1,162) 937 (225)
--------------------------------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts (77) (352) (429)
Time deposits 892 (965) (73)
Other borrowings (282) 84 (198)
--------------------------------------------------
Total increase (decrease) 533 (1,233) (700)
--------------------------------------------------
Increase in net interest income ($1,695) $2,170 $475
==================================================
Year to date June 30, 1999
over June 30, 1998
---------------------------------------------------
Volume Rate Total
---------------------------------------------------
(in thousands)
Increase (decrease) in interest income:
Portfolio loans $906 ($979) ($73)
Mortgage loans held for sale 164 (237) (73)
Investment securities (100) (162) (262)
Federal funds sold (330) (50) (380)
---------------------------------------------------
Total increase (decrease) 640 (1,428) (788)
---------------------------------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts (232) (722) (954)
Time deposits 132 (340) (208)
Other borrowings (240) (114) (354)
---------------------------------------------------
Total increase (decrease) (340) (1,176) (1,516)
---------------------------------------------------
Increase in net interest income $980 ($252) $728
===================================================
Provision for Loan Losses
The provision for loan losses for the three months ended June 30, 1999
amounted to $200,000 as compared to $510,000 in the same quarter in the previous
year. For the six months ended June 30, 1999 the provision decreased $520,000
from $1,020,000 in 1998 to $500,000 in 1999. For further discussion see
Allowance for Loan Losses.
Other Operating Income and Expense and Income Taxes
Other Operating Income
The following table sets forth the components of the Company's other
operating income for the three and six months ended June 30, 1999, as compared
to the same period in 1998.
Three Months Ended Six Months Ended
June 30, % June 30, %
----------------------- ------------------------
(dollars in thousands) 1999 1998 Change 1999 1998 Change
----------- ---------- ----------- ----------- ----------- ------------
Service charges on deposit accounts 268 267 0 523 541 (3)
Merchant draft processing, net 863 605 43 1,642 1,046 57
Loan servicing income 103 105 (2) 169 284 (40)
Gain (loss) on securities --- --- --- 14 105 (87)
Gain on sale of loans and servicing 536 1,655 (68) 1,240 2,602 (52)
Mortgage brokerage revenue, net 828 1,084 (24) 2,030 1,905 7
Other income 193 409 (53) 559 969 (42)
----------- ---------- ----------- ----------
Total other operating income $2,791 $4,125 (32) $6,177 $7,452 (17)
=========== ========== =========== ===========
Other operating income decreased $1,334,000 or 32% to $2,791,000 for
the second quarter of 1999 when compared to $4,125,000 for the same period in
1998. Such decrease is primarily due to a decrease of $256,000 in net mortgage
loan brokerage revenue, an increase of $258,000 in merchant card net revenue and
a decrease of $1,119,000 in gain on sale of loans and servicing. Gain on sale
revenue is derived from the sale of both sub prime mortgage loans the Company
originates and "A" paper mortgage loans originated within the Company's mortgage
loan division, Valley Financial. The decrease in the second quarter of 1999 when
compared to the second quarter of 1998 relates to a slight decrease in loan
origination volume, a lower margin and an increasing mortgage loan interest rate
environment. Net revenue from the mortgage loan brokerage operation amounted to
$828,000 in the second quarter of 1999 as compared to $1,084,000 in 1998 and
$2,030,000 for the six month period ending June 30, 1999 when compared to
$1,905,000 for the six month period ending June 30, 1998.
Other operating income amounted to $6,177,000 for the six months ended
June 30, 1999 as compared to $7,452,000 for the same period in 1998. The
decrease of $1,275,000 or $17% is primarily attributable to a decrease in gain
on sale of loans and loan servicing due to decreased mortgage loan origination
volume and lower margins.
Other Operating Expense
Other operating expense decreased by $540,000 or 9% to $5,768,000
during the second quarter of 1999 compared to $6,308,000 for the second quarter
of 1998, primarily due to the Company's cost control efforts. Other operating
expense decreased 379,000 or 3% to $11,578,000 for the six month period ended
June 30, 1999 compared to $11,957,000 for the same period one year ago.
The following table sets forth the components of the Company's other
operating expense during the three and six months ended June 30, 1999, as
compared to the same period in 1998.
Three Months Ended Six Months Ended
June 30, % June 30, %
--------------------------- ------------------------
(dollars in thousands) 1999 1998 Change 1999 1998 Change
------------- ------------ ---------- ----------- ----------- -----------
Salaries and employee benefits $3,254 $3,388 (4) $6,674 $6,391 4
Occupancy and equipment expense 826 841 (2) 1,629 1,650 (1)
Other 1,688 2,079 (19) 3,275 3,916 (16)
------------- ------------ ----------- -----------
Total other operating expense $5,768 $6,308 (9) $11,578 $11,957 (3)
============= ============ =========== ===========
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 rate
was 36.3% and 37.4% for the three and six months ended June 30, 1999, compared
to 37.0% and 36.7% for the same periods in 1998.
Business Segments
Summary financial data by industry segment as follows:
For the Three Months For the Six Months
Ended Ended
June 30, June 30,
(in thousands) (in thousands)
1999 1998 1999 1998
----------- ---------- ----------- ----------
Community Banking:
Revenue 5,345 4,947 10,657 10,150
Expenses 3,555 4,099 6,889 8,061
----------- ---------- ----------- -----------
Income (loss) before income tax 1,790 848 3,768 2,089
=========== ========== =========== ===========
Sub Prime:
Revenue 91 728 176 1,069
Expenses 287 562 622 1,156
----------- ---------- ----------- -----------
Income (loss) before income tax (196) 166 (446) (87)
=========== ========== =========== ===========
Bankcard:
Revenue 1,001 731 1,914 1,298
Expenses 347 253 670 498
----------- ---------- ----------- -----------
Income (loss) before income tax 654 478 1,244 800
=========== ========== =========== ===========
Mortgage Banking and Brokerage:
Revenue 1,443 2,333 3,346 4,123
Expenses 1,779 1,904 3,897 3,262
----------- ---------- ----------- -----------
Income (loss) before income tax (336) 429 (551) 861
=========== ========== =========== ===========
Total Company:
Revenue 7,880 8,739 16,093 16,640
Expenses 5,968 6,818 12,078 12,977
----------- ---------- ----------- -----------
Income (loss) before income tax 1,912 1,921 4,015 3,663
=========== ========== =========== ===========
Community Banking
The Community Banking segment income before income tax increased for
the quarter ended June 30, 1999 as well as the six months ended June 30, 1999
when compared to the same periods in the prior year. The increase is due to an
improvement in the net interest margin and reduced overhead, principally OREO
disposition costs and administrative expenses. Additionally, the Company
moderately increased all categories of permanent loans within the group through
renewed marketing efforts and development of new distribution channels. Total
average portfolio loans amounted to $293,321,000 and $257,094,000 in the second
quarter of 1999 and 1998, which reflects a 14% increase. For the full six months
such amounts are $282,698,000 and $263,574,000 which reflects a 7% increase.
Sub Prime Lending
In the second quarter of 1999 the Company's sub prime lending segment
which is known as Allied Diversified Credit, or "ADC" recorded an operating loss
of $196,000 compared to operating income of $166,000 in 1998. For the six months
ended June 30, 1999 the segment recorded an operating loss of $446,000 compared
to a loss of $87,000 for the same period one year ago. The sub prime mortgage
banking business has undergone substantial changes in the last two years as
increased competition, narrowing margins, and deterioration of the secondary
marketing environment has caused several well publicized bankruptcies of major
sub prime conduits. In response to these conditions the Company significantly
downsized its sub prime operations in the fourth quarter of 1998. The Company is
currently evaluating all aspects of this business line.
Bankcard
The Merchant Card processing segment has experienced three successive
years of revenue and earnings growth due to an increase in the number of
merchants it services and an increased reliance on independent sales
organizations (ISO's) to market its services. Second quarter of 1999 revenue was
up $270,000 or 37% over the same period in 1998. For the six months ended June
30, 1999, revenue was up $616,000 or 47% to $1,914,000 from $1,298,000 one year
ago. In December 1998 the Company renegotiated the terms of a processing
contract with an ISO who represented $1,736,000 or 66% of the Company's 1998
merchant draft net processing revenue. In summary, as a result of the
renegotiation the ISO bought down its processing rate in consideration for a
payment of $2,600,000 to the Company. The term of the renegotiated contract is
for two years and requires the Company to continue to process merchant card
transaction volume from this ISO's customers. The Company will amortize such
payment over the life of the renegotiated contract into income. The Company
expects to build its overall merchant card processing business in an effort to
offset any potential decline in future revenues that may result in periods
following the term of the buydown.
Mortgage Banking and Brokerage
The Residential Mortgage Banking and Brokerage segment of the company
has operated under the name "Valley Financial" since the beginning of 1997. The
segment performance in the first six months of 1999 when compared to the same
period in 1998 was hindered by a rise in mortgage loan interest rates. This
segment is highly sensitive to changes in mortgage interest rates and local
economic conditions. In response to these conditions the Company is currently
evaluating its strategic options with respect to this unit.
Investment Securities
Total investment securities increased $4,439,000 or 7% to $64,849,000
as of June 30, 1999 when compared to $60,410,000 as of December 31, 1998. Such
increase is due to an effort to increase the overall yield in earning assets of
the Company by decreasing it's overnight fed fund investment position and
redeploying such amounts into the higher yielding investment portfolio. The
Company's average federal fund position amounted to $10,480,000 for the first
six months of 1999 as compared to $21,794,000 in 1998.
Loans
Total loans increased $27,280,000 or 10% to $296,596,000 at June 30,
1999 compared to $269,316,000 at December 31, 1998. The increase in portfolio
loans is primarily attributable to the Company's marketing efforts and a general
expansion of businesses within the Company's market area. In addition, the
Company has emphasized the funding of permanent residential real estate loans
and commercial real estate loans in the first six months of 1999.
The following table summarizes the composition of the loan portfolio at
June 30, 1999 and December 31, 1998
June 30, 1999 December 31, 1998
------------------------------------ ------------------------------------
(dollars in thousands) Amount % Amount %
------------------------------------ ------------------------------------
Residential real estate mortgage $113,091 37% $97,194 36%
Commercial real estate mortgage 76,742 26 59,257 22
Commercial 58,312 20 63,260 23
Real estate construction 45,211 15 46,905 18
Installment and other 4,620 2 5,095 2
Less deferred loan fees (1,380) 0 (2,395) (1)
------------------------------------ ------------------------------------
Total portfolio loans 296,596 100% 269,316 100%
================== ==================
Less allowance for loan losses (8,001) (8,041)
------------------ ------------------
Net loans $288,595 $261,275
================== ==================
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 adequacy of the Company's allowance for loan losses is based on
specific and formula allocations to the Company's loan portfolio. Specific
allocations of the allowance for loan losses are made to identified problem or
potential problem loans. The specific allocations are increased or decreased
through management's reevaluation of the status of the particular problem loans.
Loans which do not receive a specific allocation receive an allowance allocation
based on a formula, represented by a percentage factor based on underlying
collateral, type of loan, historical charge-offs and general economic conditions
and other qualitative factors.
The following table summarizes the Company's allowance for loan losses:
Three months ended Six months ended
June 30, June 30,
--------------------------- --------------------------
(dollars in thousands) 1999 1998 1999 1998
----------- ------------- ----------- -----------
Beginning allowance for loan losses $8,242 $7,649 $8,041 $7,645
Provision for loan losses 200 510 500 1,020
Charge-offs (656) (334) (913) (871)
Recoveries 215 105 373 136
----------- ------------- ----------- -----------
Ending allowance for loan losses $8,001 $7,930 $8,001 $7,930
=========== ============= =========== ===========
Net charge-offs to average
loans (annualized) .55% .32% .38% .56%
The allowance for loan losses as a percentage of portfolio loans
decreased from 2.99% at December 31, 1998 to 2.70% at June 30, 1999. The slight
decrease in this percentage is due to a $27,280,000 increase in the Company's
total loan portfolio.
Nonperforming Assets
The following table summarizes the Company's nonperforming assets.
June 30, December 31,
(dollars in thousands) 1999 1998
-------------- ---------------
Nonaccrual loans $3,944 $5,556
Accruing loans past due 90 days or more 1,664 ---
Restructured loans 1,029 1,045
-------------- ---------------
Total nonperforming loans 6,637 6,601
Other real estate owned 2,486 2,181
Other assets owned 67 129
-------------- ---------------
Total nonperforming assets $9,190 $8,911
============== ===============
Nonperforming assets to total assets 2.13% 2.11%
Nonperforming assets have increased from $8,911,000 as of December 31,
1998 to $9,190,000 as of June 30, 1999. The principal reasons for this increase
relates an increase in accruing loans past due 90 days or more of $1,664,000,
all of which paid off subsequent to June 30, 1999, an increase in other real
estate owned of $305,000 offset by a decline in nonaccrual loans of
$1,612,000.
Nonperforming loans consist of loans to 36 borrowers, 20 of which have
balances in excess of $100,000. The two largest have recorded balances of
$1,405,000 and $716,000, both secured by real estate. Based on information
currently available, management believes that adequate reserves are included in
the allowance for loan losses to cover any loss exposure that may result from
these loans.
Other real estate owned consists of eight properties. Four properties
are residential, two are commercial buildings and the remaining are undeveloped
acres and a motel. Other assets owned included contract receivable rights and
repossessed personal property carried at $67,000.
Although the volume of nonperforming assets will depend in part on the
future economic environment, there is one loan relationship which totals
approximately $221,000 about which management has serious doubts as to the
ability of the borrower to comply with the present repayment terms and which
may become a nonperforming asset based on the information presently known about
possible credit problems of the borrower.
In the first six months of 1999 the Company was required by a mortgage
loan investor to repurchase two residential mortgage loans in the amount of
$205,000. From time to time the Company may be required to repurchase mortgage
loans from investors depending upon representations and warranties of the
purchase agreement between the investor and the Company. Such representations
and warranties include valid appraisal, status of borrower, first payment
default or fraud. Primarily these repurchases involve loans which are in
default. The Company expects that it may be required to repurchase loans in the
future. The Company maintains a reserve for its estimate of potential losses
associated with the repurchase of previously sold mortgage loans. Such reserve
amounts to $152,000 as of June 30, 1999 and $172,000 as of December 31, 1998.
At June 30, 1999 the Company's total recorded investment in impaired
loans (as defined by SFAS 114 and 118) was $7,402,000 of which $6,923,000
relates to the recorded investment for which there is a related allowance for
credit losses of $1,136,000 determined in accordance with these statements and
$478,000 relates to the amount of that recorded investment for which there is no
related allowance for credit losses determined in accordance with these
standards.
The average recorded investment in the impaired loans during the six
months ended June 30, 1999 and 1998 was $7,660,000 and $11,888,000. The related
amount of interest income recognized during the periods that such loans were
impaired was $91,000 and $213,000 for the three and six month periods ended June
30, 1999 and $200,000 and $317,000 for the same period in 1998. No interest
income was recognized using a cash-basis method of accounting during the period
that the loans were impaired.
Liquidity
Redwood's primary source of liquidity is dividends from its financial
institution subsidiary. Redwood's primary uses of liquidity are associated with
cash payments made to the subordinated debt holders, dividend payments made to
the preferred stock holders, and operating expenses of the parent. It is
Redwood's general policy to retain liquidity at Redwood at a level which
management believes to be consistent with the safety and soundness of the
Company as a whole. As of June 30, 1999, Redwood held $1,363,000 in deposits at
NBR.
Prior to April 30, 1998 Redwood paid quarterly dividends of 7.8% on its
preferred stock of $5,750,000. On April 30, 1998 Redwood converted its preferred
stock into common, thus eliminating the preferred dividend. On May 19, 1998
Redwood reinstated its quarterly common dividend at a rate of $.04 per share.
Prior to March 1999 Redwood was required to make monthly payments of interest at
8.5% on $12,000,000 of subordinated debentures issued in 1993. The subordinated
debentures issue was early redeemed in the first quarter of 1999. Payment of
these obligations was dependent on dividends from NBR. Federal regulatory
agencies have the authority to prohibit the payment of dividends by NBR to
Redwood if a finding is made that such payment would constitute an unsafe or
unsound practice, or if NBR became undercapitalized. If NBR is restricted from
paying dividends, Redwood could be unable to pay dividends to its shareholders.
No assurance can be given as to the ability of NBR to pay dividends to Redwood.
During the first six months of 1999, NBR declared dividends of
$8,600,000, of which $8,000,000 was used to fund the early redemption of the
$12,000,000 subordinated debt. Management believes that at June 30, 1999, the
Company's liquidity position was adequate for the operations of Redwood and its
subsidiary for the foreseeable future.
Although each entity within the consolidated Company manages its own
liquidity, the Company's consolidated cash flow can be divided into three
distinct areas; operating, investing and financing. For the six months ended
June 30, 1999 the Company received cash of $12,911,000 from operating activities
and $2,282,000 in financing activities while using $26,692,000 in investing
activities.
Capital Resources
A strong capital base is essential to the Company's continued ability
to service the needs of its customers. Capital protects depositors and the
deposit insurance fund from potential losses and is a source of funds for the
substantial investments necessary for the Company to remain competitive. In
addition, adequate capital and earnings enable the Company to gain access to the
capital markets to supplement its internal growth of capital. Capital is
generated internally primarily through earnings retention.
The Company and NBR are required to maintain minimum capital ratios
defined by various federal government regulatory agencies. The FRB and the OCC
have each established capital guidelines, which include minimum capital
requirements. The regulations impose three sets of standards: a "risk-based",
"leverage" and "tangible" capital standard.
Under the risk-based capital standard, assets reported on an
institution's balance sheet and certain off-balance sheet items are assigned to
risk categories, each of which is assigned a risk weight. This standard
characterizes an institution's capital as being "Tier 1" capital (defined as
principally comprising shareholders' equity and noncumulative preferred stock)
and "Tier 2" capital (defined as principally comprising the allowance for loan
losses and subordinated debt).
Under the leverage capital standard, an institution must maintain a
specified minimum ratio of Tier 1 capital to total assets, with the minimum
ratio ranging from 4% to 6%. The leverage ratio for the Company and NBR is based
on average assets for the quarter.
The following table summarizes the consolidated capital ratios and
the capital ratios of the principal subsidiaries at June 30, 1999 and December
31, 1998.
Company NBR
-------------- -------------
June 30, 1999
Total capital to risk based assets 13.05% 12.50%
Tier 1 capital to risk based assets 11.79 11.24
Leverage ratio 9.31 8.67
December 31, 1998
Total capital to risk based assets 16.94 15.98
Tier 1 capital to risk based assets 11.84 13.75
Leverage ratio 8.84 10.31
NBR's capital ratios declined in the first quarter of 1999 due to an
$8.0 million dividend to Redwood and the early payoff of a $3.0 million note due
Redwood. Such payments were necessary to provide funding of Redwood's early
redemption of its $12.0 million subordinated debt.
Year 2000
The "Year 2000 Problem" relates to the fact that many computer programs
and equipment utilizing microprocessors only use two digits to represent a year,
such as "99" to represent "1999," which means that in the year 2000 such
programs/processors could incorrectly treat the year 2000 as the year 1900. The
Company's business is highly dependent on technology and data processing. As a
result, Bank management and the Board of Directors have made Year 2000
compliance a high priority. The issue must be recognized as a business issue,
rather than simply a computer issue, because of the way its effects could ripple
through the economy. The Company could be affected either directly or indirectly
by the Year 2000 issue. This could happen if any of its critical computer
systems or equipment containing embedded logic fail, if the local infrastructure
(power, communication system, or water system) fails, if its significant vendors
or third-party processors are adversely impacted, or if its borrowers or
depositors are significantly impacted by their internal systems or their
customers or suppliers.
The Company principally relies on third-party software and processing
for its mission-critical applications needs. It licenses software and/or data
processing services from outside vendors for its critical functions such as
mortgage lending, merchant credit card program, ATM, item processing and
customer statements. The Company also is dependent on personal computers and a
local area network which is supported by a Microsoft operating environment. The
foregoing systems are classified by the Company as mission critical information
technology ("IT") systems.
The Company's business also involves non-IT products and services, some
of which have embedded technology which might not be Year 2000 ready. Some
non-IT products and services involve infrastructure issues such as power,
communications and water, as well as elevators, ventilation and air conditioning
equipment. The Company classifies power and communications as non-IT mission
critical systems.
The Company's third-party application software, data processing
vendors, local area network and operating systems and the power and
communication infrastructure provide critical support to substantially all of
its business and operations. Failure to successfully complete renovation,
validation and implementation of mission critical IT systems could have a
material adverse effect on the operations and financial performance of the
Company. Moreover, Year 2000 issues experienced by significant vendors or
third-party processors or customers of the Company could negatively impact the
business and operations of the Company even if its critical IT systems function
satisfactorily. Due to the many variables related to the Year 2000 issue and the
lack of information on Year 2000 readiness from non-IT service providers such as
power and phone systems vendors, the Company cannot quantify the potential cost
of problems if the Company's renovation and implementation efforts or the
efforts of significant vendors or customers are not successful.
State of Readiness
The Company has formed a Year 2000 team comprised of senior level
employees and officers who are familiar with the business and operations of the
Company. The Year 2000 team has conducted a comprehensive review of the
Company's IT systems to identify systems that present Year 2000 issues. The
Company has developed a plan which it believes should satisfactorily resolve
Year 2000 problems related to its mission-critical IT systems. The Company's
Year 2000 team is also using external resources provided by outside vendors and
a consultant hired to assist the Company.
Many vendors and third-party processors of the Company's critical IT
systems have informed the Company that their products/systems are Year 2000
compliant. The Company's merchant credit card program is dependent on a
third-party processor. The Company has been informed that this processor's
testing for Year 2000 compliance is onging, and that such testing is
satisfactory. No alternate vendor is readily available. In the event this
vendor cannot satisfactorily process credit card changes for merchants in the
Bank's program, the Bank's results of operations could be adversely
impacted.
The Company has run tests on selected components of its core processing
system during 1998 with technical assistance from the vendor and an outside
consultant. At the date of this report the Company believes it remains on
schedule to complete initial testing of all mission-critical IT systems by June
30, 1999.
Costs
The Company is expensing all period costs associated with the Year 2000
issue. Management estimates that the Bank will incur approximately an additional
$150,000 in Year 2000 related expenses for the identification, correction and
reprogramming, and testing of systems for Year 2000 compliance in fiscal 1999.
There can be no assurance that these expenses will not increase as further
testing and assessment of vendor and customer readiness for the Year 2000
continues. The above cost estimates include costs for consultants, running
tests, technical assistance from vendors and costs for products replaced for
Year 2000 compliance. These costs exclude the cost of the Company's internal
staff time.
Risks
Management believes it will be difficult to predict the outcome of the
Year 2000 issue due to the complexity of technology and the inability to assess
the impact of the Year 2000 problem on third-party processors, non-IT mission
critical systems and the local, national and international economy. Management
has attempted, however, to identify a most reasonably likely worst case
scenario. This scenario suggests that the Year 2000 problem might negatively
impact some of the Company's significant IT vendors and processors and non-IT
vendors/products through the failure of the party to be prepared or the impact
on them of their own vendors and customers including possible short-term power
failures. Management believes that if this scenario occurs its ability to
process mortgages and/or credit card charges could be temporarily delayed and
earnings could be materially adversely impacted especially if a recession
results. It is not possible to predict the effect of this scenario on the
economic viability of its customers and the related adverse impact it may have
on the Company's financial position and results of operations, including the
level of the Bank's provision for possible loan losses in future periods.
Further, there can be no assurance that other possible adverse scenarios will
not occur.
The Company presently believes that, with modifications to existing
software within its control which needs to be made Year 2000 compliant and
assuming representations of Year 2000 readiness from significant IT vendors,
processors and customers are accurate, the Year 2000 issue should not pose
significant operational risks for the Company's IT systems as so modified.
However, other significant risks relating to the Year 2000 problem are that of
the unknown impact of this problem on the operations of the Bank's customers,
processors and vendors, the impact of catastrophic infrastructure failures such
as power, communications and water on the Company's systems, the economy and
future actions which banking or securities regulators may take.
The Company is making efforts to ensure that its customer base is aware
of the Year 2000 problem. Year 2000 correspondence has been sent to both deposit
and loan customers. The Bank has amended its credit authorization documentation
to include consideration regarding the Year 2000 problem. Significant customer
relationships have been identified, and such customers are being contacted by
the Bank's employees to determine whether they are aware of Year 2000 risks and
whether they are taking preparatory actions.
The Company has also attempted to contact major vendors and suppliers
of non-software products and services including those where products utilize
embedded technology, to determine the Year 2000 readiness of such organizations
and/or the products and services which the Company purchases from such
organizations. The Company is monitoring reports provided by such vendors
regarding their preparations for Year 2000. This is an ongoing process, and the
company intends to continue to monitor the progress of such vendors through the
century date change.
Federal banking regulators have responsibility for supervision and
examination of banks to determine whether each institution has an effective plan
for identifying, renovating, testing and implementing solutions for Year 2000
processing and coordinating Year 2000 processing capabilities with its
customers, vendors and payment system partners. Examiners are also required to
assess the soundness of an institution's internal controls and to identify
whether further corrective action may be necessary to assure an appropriate
level of attention to Year 2000 processing capabilities. Management believes it
is currently in compliance with the federal bank regulatory guidelines and
timetables.
Contingency Plans
The Company has developed contingency plans for software systems
utilized by the Company, should they not successfully pass the Company's Year
2000 testing. Generally this involves the identification of an alternate vendor
or expected actions the Company could take, as well as the establishment of a
trigger date to implement the contingency plan. The Company is also considering
the purchase of a backup generator to provide power for certain critical
functions in the event of a power failure and additional cash will be on hand
for potential liquidity needs. Company personnel are being trained to manually
perform certain critical functions if computers fail. The Company has developed,
in accordance with regulatory guidelines, further contingency plans to address
potential business disruptions resulting from Year 2000 issues. The Company's
contingency plans will be subject to change throughout 1999.
Certain Important Considerations for Investors
Mortgage Banking and Brokerage Activity. The Company's historic results
of operations has been significantly influenced by mortgage banking activity,
which can fluctuate significantly, in both volume and profitability, with
changes in interest rate movements. In the fourth quarter of 1996, the Company
significantly curtailed its "A paper" wholesale mortgage loan production. As a
result of this action, the Company's future mortgage loan production revenue and
expenses will be significantly reduced from pre-1997 levels. The Company's
current mortgage banking operations include both the origination and brokering
of retail oriented mortgage loan production. Such mortgage loan lending activity
primarily is centered in northern California. The Company is currently
evaluating its strategic options with respect to this business activity.
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 a contractual
obligation between the Company and Visa and Mastercard, NBR stands in the place
of the merchant in the event that a merchant is unable to pay on charge-backs
from cardholders. Management has taken certain actions to decrease the risk of
merchant bankruptcy with its merchant bankcard business. These steps include the
discontinuance of high-risk accounts. The Company utilizes ISO's to acquire
merchant credit card customers. The Company's ability to maintain and grow net
revenue from its merchant credit card processing operation is dependent upon
maintaining and adding to these ISO relationships.
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,
1999, approximately 79% of the Company's loans were secured by real estate, of
which 33% were secured by commercial real estate, including small office
buildings, owner-user office/warehouses, mixed use residential and commercial
properties and retail properties. Substantially all of the properties that
secure the Company's present loans are located within Northern and Central
California. The ability of the Company to continue to originate mortgage or
construction loans may be impaired by adverse changes in local or regional
economic conditions, adverse changes in the real estate market, increasing
interest rates, or acts of nature (including earthquakes, which may cause
uninsured damage and other loss of value to real estate that secures the
Company's loans). Due to the concentration of the Company's real estate
collateral, such events could have a significant adverse impact on the value of
such collateral or the Company's earnings.
Government Regulation. Redwood and its subsidiaries are subject to
extensive federal and state governmental supervision, regulation and control,
and future legislation and government policy could adversely affect the
financial industry. Although the full impact of such legislation and regulation
cannot be predicted, future changes may alter the structure of and competitive
relationship among financial institutions.
Competition from Other Financial Institutions. The Company competes for
deposits and loans principally with major commercial banks, other independent
banks, savings and loan associations, savings banks, thrift and loan
associations, credit unions, mortgage companies, insurance companies and other
lending institutions. With respect to deposits, additional significant
competition arises from corporate and governmental debt securities, as well as
money market mutual funds. The Company also depends for its origination of
mortgage loans on independent mortgage brokers who are not contractually
obligated to do business with the Company and are regularly solicited by the
Company's competitors. Aggressive policies of such competitors have in the past
resulted, and may in the future result, in a decrease in the Company's volume of
mortgage loan originations and/or a decrease in the profitability of such
originations, especially during periods of declining mortgage loan origination
volumes. Several of the nation's largest savings and loan associations and
commercial banks have a significant number of branch offices in the areas in
which the Company conducts operations. Among the advantages possessed by the
larger of these institutions are their ability to make larger loans, finance
extensive advertising campaigns, access international money markets and
generally allocate their investment assets to regions of highest yield and
demand.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
As a financial institution, the Company's primary component of market
risk is interest rate volatility. Fluctuation in interest rates will ultimately
impact both the level of income and expense recorded on a large portion of the
Bank's assets and liabilities, and the market value of all interest earning
assets and interest bearing liabilities, other than those which possess a short
term to maturity. Since virtually all of the Company's interest bearing
liabilities and all of the Company's interest earning assets are located at the
Bank, virtually all of the Company's interest rate risk exposure lies at the
Bank level. As a result, all significant interest rate risk management
procedures are performed at the Bank level. Based upon the nature of its
operations, the Bank is not subject to foreign currency exchange or commodity
price risk. The Bank's real estate loan portfolio, concentrated primarily within
northern California, is subject to risks associated with the local economy. The
Company does not own any trading assets. See "Asset Quality".
The fundamental objective of the Company's management of its assets and
liabilities is to maximize the economic value of the Company while maintaining
adequate liquidity and an exposure to interest rate risk deemed by management to
be acceptable. Management believes an acceptable degree of exposure to interest
rate risk results from the management of assets and liabilities through
maturities, pricing and mix to attempt to neutralize the potential impact of
changes in market interest rates. The Bank's profitability is dependent to a
large extent upon its net interest income, which is the difference between its
interest income on interest-earning assets, such as loans and securities, and
its interest expense on interest-bearing liabilities, such as deposits and
borrowings. The Bank, like other financial institutions, is subject to interest
rate risk to the degree that its interest-earning assets reprice differently
than its interest-bearing liabilities. The Bank manages its mix of assets and
liabilities with the goals of limiting its exposure to interest rate risk,
ensuring adequate liquidity, and coordinating its sources and uses of funds.
The Bank seeks to control its interest rate risk exposure in a manner
that will allow for adequate levels of earnings and capital over a range of
possible interest rate environments. The Bank has adopted formal policies and
practices to monitor and manage interest rate risk exposure. As part of this
effort, the Bank measures risk in three ways: repricing of earning assets and
interest bearing liabilities; changes in net interest income for interest rate
shocks up and down 200 basis points; and changes in the market value of equity
for interest rate shocks up and down 200 basis points.
The following table sets forth, as of June 30, 1999, the distribution
of repricing opportunities for the Company's earning assets and interest-bearing
liabilities, the interest rate sensitivity gap, the cumulative interest rate
sensitivity gap, the interest rate sensitivity gap ratio (i.e., earning assets
divided by interest-bearing liabilities) and the cumulative interest rate
sensitivity gap ratio.
After Three After Six After One
Within Months but Months but Year But
Three Within Six Within One Within After Five
Months Months Year Five Years Years Total
---------------------------------------------------------------------------
(Dollars in thousands)
Interest earning assets:
Federal funds sold $2,276 $ --- $ --- $ --- $ --- $2,276
Investment securities and other 1,307 4,989 11,789 27,402 19,368 64,855
Mortgage loans held for sale 28,266 --- --- --- --- 28,266
Loans 110,220 33,382 19,566 68,634 64,794 296,596
---------------------------------------------------------------------------
Total interest-earning assets 142,069 38,371 31,355 96,036 84,162 391,993
---------------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing transaction
accounts 128,362 --- --- --- --- 128,362
Time deposits 49,334 28,968 55,734 13,967 --- 148,003
Short-term borrowings 13,870 --- --- --- --- 13,870
---------------------------------------------------------------------------
Total interest-bearing
liabilities 191,566 28,968 55,734 13,967 --- 290,235
---------------------------------------------------------------------------
Interest rate sensitivity gap ($49,497) $9,403 ($24,379) $82,069 $84,162
===============================================================
Cumulative interest rate
sensitivity gap (49,497) (40,094) (64,473) 17,596 101,758
===============================================================
Interest rate sensitivity gap 0.74 1.32 0.56 6.88 ---
ratio
Cumulative interest rate 0.74 0.82 0.77 1.06 1.35
sensitivity gap ratio
The Company's gap position is substantially dependent upon the volume
of mortgage loans held for sale and held in the portfolio. These loans generally
have maturities greater than five years; however, mortgage loans held for sale
are generally sold within 5 to 60 days of funding and therefore are classified
in the above table as repricing within three months. The Company enters into
commitments to sell such loans on a forward basis, usually within 30 to 60 days.
The amount of loans held for sale and the amount of forward commitments can
fluctuate significantly from period to period. Additionally, interest-bearing
transaction accounts, which consist of money market, demand and savings deposit
accounts, are classified as repricing within three months. Some of these
deposits may be repriced at management's option, and therefore a decision not to
reprice such deposits could significantly alter the Company's net interest
margin.
Management expects that, in a declining rate environment, the Company's
net interest margin would be expected to decline, and, in an increasing rate
environment, the Company's net interest margin would tend to increase. The
Company has experienced greater mortgage lending activity through mortgage
refinancings and financing new home purchases as rates declined, and may
increase its net interest margins in an increasing rate environment if more
traditional commercial bank lending becomes a higher percentage of the overall
earning assets mix. There can be no assurance, however, that under such
circumstances the Company will experience the described relationships to
declining or increasing interest rates.
On a monthly basis, NBR management prepares an analysis of interest
rate risk exposure. Such analysis calculates the change in net interest income
and the theoretical market value of the Bank's equity given a change in general
interest rates of 100 basis points up and 100 basis points down. All changes are
measured in dollars and are compared to projected net interest income and the
current theoretical market value of the Bank's equity. This theoretical market
value of the Bank's equity is calculated by discounting cash flows associated
with the Company's assets and liabilities. The following is a June 30, 1999
summary of interest rate risk exposure as measured on a net interest income
basis and a market value of equity basis, given a change in general interest
rates of 100 basis points up and 100 basis points down.
June 30, 1999
Change in Annual Change in
Change in Interest Rate Net Interest Income Market Value of Equity
+100 573,000 (1,406,000)
-100 (694,000) 106,000
The model utilized by management to create the report presented above
makes various estimates at each level of interest rate change regarding cash
flows from principal repayments on loans and mortgage-backed securities and/or
call activity on investment securities. In addition, repricing these earning
assets and matured liabilities can occur in one of three ways: (1) the rate of
interest to be paid on an asset or liability may adjust periodically based on an
index; (2) an asset, such as a mortgage loan, may amortize, permitting
reinvestment of cash flows at the then-prevailing interest rates; or (3) an
asset or liability may mature, at which time the proceeds can be reinvested at
current market rate. Actual results could differ significantly from those
estimates, which would result in significant differences in the calculated
projected change.
PART II. - OTHER INFORMATION
Item 4. Submission of Matters to a vote of Security Holders
(a) The Company held its Annual Meeting of Shareholders on
May 18, 1999.
(b) Proxies for the Annual Meeting were solicited pursuant to
Regulation 14 under the Securities Exchange Act of 1934.
There was no solicitation in opposition to management's
nominees for directors as listed in the Company's proxy
statement for the Annual Meeting, and all such nominees
were elected.
(c) The vote for the nominated directors was as follows:
Nominee For Withheld
Richard I. Colombini 2,986,519 5,526
Robert D. Cook 2,984,692 7,353
Patrick W. Kilkenny 2,985,664 6,381
William B. Stevenson 2,985,766 6,279
Tom D. Whitaker 2,985,433 6,612
The vote for ratifying the appointment of Deloitte & Touche
LLP as the Company's independent auditors was as follows:
For 2,982,056
Against 3,049
Abstain 6,940
Broker Non-Vote -0-
The vote to amend Section 2 of Article III of the Company's
Bylaws was as follows:
For 1,853,779
Against 94,792
Abstain 7,131
Broker Non-Vote 1,036,343
Item 6. Exhibits and Reports on Form 8-K.
1. Exhibits.
The following documents are included or incorporated by reference in
Form 10-Q.
Exhibit Number Description
-------------- -----------
3.1 Articles of Incorporation
3.2 Amended and restated By-Laws of the Registrant, filed
as Exhibit 3 to the Registrant's 1994 Annual Report
on Form 10-K and by this reference incorporated
herein.
10.1 Employment Agreement between National Bank of the
Redwoods and Patrick W. Kilkenny, dated as of
January 1, 1994, filed as Exhibit 10.7 to the
Registrant's 1993 Annual Report on Form 10-K and by
this reference incorporated herein.
10.2 Lease, dated August 30, 1988, between National Bank
of the Redwoods and 137 Group, a general partnership,
filed as Exhibit 10.1 to the Registrant's 1989
Annual Report on Form 10-K, and by this reference
incorporated herein.
10.3 Lease, dated April 18, 1990, between Allied Savings
Bank, F.S.B and Stony Point West, General
Partnership, filed as Exhibit 10.2 to the
Registrant's 1990 Annual Report on Form 10-K,
and by this reference incorporated herein.
10.4 The Registrant's 401 (k) Profit Sharing Plan, filed
as Exhibit 28.1 to the Registrant's Registration
Statement on Form S-8 dated June 12, 1990
(Registration No. 33-35377), and by this reference
incorporated herein.
10.5 The National Bank of the Redwoods Stock Option Plan,
filed as Exhibit 28.1 to the Registrant's
Post-Effective Amendment No. 1 to Registration
Statement on Form S-4 dated March 27, 1989
(Registration No. 33-24642), and by this reference
incorporated herein.
10.6 The Registrant's Amended and Restated 1991 Stock
Option Plan, filed as Exhibit 4.1 to the Registrant's
Registration Statemen on Form S-8 filed on July 8,
1992 (Registration No. 33-49372), and by this
reference incorporated herein.
10.7 The Registrant's Executive Salary Continuation Plan,
filed as Exhibit 10.9 to the Registrant's
Registration Statement on Form S-2 dated December 13,
1993 (Registration No. 33-71324), and by this
reference incorporated herein.
10.8 Director Retirement Plan, filed as Exhibit 10.10 to
the Registrant's Registration Statement on Form S-2
dated December 13, 1993 (Registration No. 33-71324),
and by this reference incorporated herein.
10.9 Chairman Retirement Agreement, dated November 30,
1993, between the Registrant and John H. Downey, Jr.,
filed as Exhibit 10.11 to the Registrant's
Registration Statement on Form S-2 dated December 13,
1993 (Registration No. 33-71324), and by this
reference incorporated herein.
10.10 Compensation Agreement between Patrick W. Kilkenny
and Redwood Empire Bancorp filed as Exhibit 10.20
to the Registrant's 1996 Annual Report on Form 10K.
10.11 Executive Severance Agreement between Patrick W.
Kilkenny and Redwood Empire Bancorp filed as
Exhibit 10.21 to the Registrant's 1996 Annual Report
on Form 10K.
10.12 Salary Continuation Agreement between James E.
Beckwith and Redwood Empire Bancorp filed as
Exhibit 10.22 to the Registrant's 1996 Annual Report
on Form 10K.
10.13 Dividend Reinvestment and Stock Purchase Plan on
Form S-3 dated April 28, 1993 (Registration No.
3361750), and by this reference incorporated herein.
27. Financial Data Schedule for the period ended June 30,
1999.
2. Reports on Form 8-K
Form 8-K dated May 25, 1999 announcing quarterly cash dividend on
common stock under Item 5 "Other Events".
Form 8-K dated April 28, 1999 announcing first quarter 1999 financial
results.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized and in the capacity indicated.
REDWOOD EMPIRE BANCORP
(Registrant)
DATE: 8/12/99 BY: /s/ James E. Beckwith
------- -----------------------------
James E. Beckwith
Executive Vice President,
Chief Operating Officer,
Principal Financial Officer, and
Principal Accounting Officer