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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 September 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. October 29, 1999: 3,370,271
REDWOOD EMPIRE BANCORP
AND
SUBSIDIARIES
Index
Page
PART I. Financial Information
Item 1. Financial Statements
Consolidated Statements of Operations
Three and Nine Months ended September 30, 1999 and 1998...........3
Consolidated Balance Sheets
September 30, 1999 and December 31, 1998..........................5
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1999 and 1998.....................6
Notes to Consolidated Financial Statements........................8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations.................13
Item 3. Quantitative and Qualitative Disclosure
about Market Risk................................................32
PART II. Other Information
Item 6. Exhibits and Reports on Item 8-K.................................35
SIGNATURES .................................................................37
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 Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
--------------------------- ---------------------------
Interest income:
Interest and fees on loans $6,601 $6,489 $19,025 $18,987
Interest on investment securities 1,048 1,115 3,011 3,340
Interest on federal funds sold 37 207 293 843
--------------------------- ---------------------------
Total interest income 7,686 7,811 22,329 23,170
Interest expense:
Interest on deposits 2,623 2,680 7,271 8,544
Interest on subordinated notes --- 276 142 830
Interest on other borrowings 90 166 297 315
--------------------------- ---------------------------
Total interest expense 2,713 3,122 7,710 9,689
--------------------------- ---------------------------
Net interest income 4,973 4,689 14,619 13,481
Provision for loan losses 200 510 700 1,530
--------------------------- ---------------------------
Net interest income after loan loss provision 4,773 4,179 13,919 11,951
Noninterest income:
Service charges on deposit accounts 253 261 776 802
Merchant draft processing, net 733 686 2,375 1,732
Loan servicing income 14 201 79 485
Net realized gain on sale of
investment securities available for sale --- 22 14 127
Other income 193 226 653 835
--------------------------- ---------------------------
Total noninterest income 1,193 1,396 3,897 3,981
Noninterest expense:
Salaries and employee benefits 2,187 2,090 6,652 6,182
Occupancy and equipment expense 598 695 1,713 1,919
Other 1,415 1,259 3,790 4,134
--------------------------- ---------------------------
Total noninterest expense 4,200 4,044 12,155 12,235
--------------------------- ---------------------------
Income from continuing operations before income taxes
and extraordinary item 1,766 1,531 5,661 3,697
Provision for income taxes 714 554 2,187 1,349
--------------------------- ---------------------------
Income from continuing operations before extraordinary item 1,052 977 3,474 2,348
Discontinued Operations:
Income/(loss) from discontinued operations
(less applicable income taxes of ($356), $210, ($439) and $760) (519) 358 (429) 1,305
Loss on disposal of discontinued operations, net of tax of ($113) (167) --- (167) ---
--------------------------- ---------------------------
Income/(loss) from discontinued operations (686) 358 (596) 1,305
--------------------------- ---------------------------
Income before extraordinary item 366 1,335 2,878 3,653
Extraordinary item --- --- 459 ---
Income tax benefit --- --- (183) ---
--------------------------- ---------------------------
Total extraordinary item, net of tax --- --- 276 ---
--------------------------- ---------------------------
Net income 366 1,335 2,602 3,653
Dividends on preferred stock --- --- --- 112
--------------------------- ---------------------------
Net income available for common stock shareholders $366 $1,335 $2,602 $3,541
=========================== ===========================
(Continued)
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands except per share data)
(unaudited)
(Continued)
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---------------------------- ----------------------------
Basic earnings per common shares:
Income from continuing operations before extraordinary item $0.31 $0.29 $1.03 $0.72
Income/(loss) from discontinued operations (0.20) 0.11 (0.18) 0.38
Income before extraordinary item 0.11 0.40 0.85 1.14
Net income available for common stock shareholders 0.11 0.40 0.77 1.14
Weighted average shares 3,390,000 3,369,000 3,385,000 3,101,000
Diluted earnings per common share and common equivalent share:
Income from continuing operations before extraordinary item $0.30 $0.28 $1.00 $0.68
Income/(loss) from discontinued operations (0.20) 0.10 (0.17) 0.38
Income before extraordinary item 0.11 0.38 0.83 1.05
Net income available for common stock shareholders 0.11 0.38 0.75 1.05
Weighted average shares 3,458,000 3,486,000 3,472,000 3,465,000
See Notes to Consolidated Financial Statements.
(Concluded)
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands)
September 30, December 31,
1999 1998
------------------ ------------------
(unaudited)
Assets:
Cash and due from banks $23,451 $15,982
Federal funds sold and repurchase agreements 1,795 26,205
------------------ ------------------
Cash and cash equivalents 25,246 42,187
Investment securities:
Held to maturity (market value of $32,024 and $30,014) 32,861 29,872
Available for sale, at market (amortized cost of $43,807 and $30,127) 43,234 30,538
------------------ ------------------
Total investment securities 76,095 60,410
Mortgage loans held for sale 17,892 32,620
Loans:
Residential real estate mortgage 126,033 97,194
Commercial real estate mortgage 72,854 59,257
Commercial 62,228 63,260
Real estate construction 43,046 46,905
Installment and other 4,384 5,095
Less deferred loan fees (1,218) (2,395)
------------------ ------------------
Total portfolio loans 307,327 269,316
Less allowance for loan losses (7,963) (8,041)
------------------ ------------------
Net loans 299,364 261,275
Premises and equipment, net 3,124 4,082
Mortgage servicing rights 58 305
Other real estate owned 2,381 2,181
Cash surrender value of life insurance 3,149 3,033
Other assets and interest receivable 9,855 16,206
------------------ ------------------
Total assets $437,164 $422,299
================== ==================
Liabilities and Shareholders' equity:
Deposits:
Noninterest bearing demand deposits $77,105 $82,448
Interest-bearing transaction accounts 131,587 141,316
Time deposits $100,000 and over 66,905 62,600
Other time deposits 92,331 78,356
------------------ ------------------
Total deposits 367,928 364,720
Other borrowings 17,785 1,371
Subordinated notes --- 12,000
Other liabilities and interest payable 12,022 5,568
------------------ ------------------
Total liabilities 397,735 383,659
Shareholders' equity:
Preferred stock, no par value; authorized 2,000,000 shares; issued and
outstanding: no shares --- ---
Common stock, no par value; authorized 10,000,000 shares;
issued and outstanding: 3,370,271 and 3,363,565 shares 24,832 25,801
Retained earnings 14,929 12,600
Accumulated other comprehensive income/(loss), net (332) 239
------------------ ------------------
Total shareholders' equity 39,429 38,640
------------------ ------------------
Total liabilities and shareholders' equity $437,164 $422,299
================== ==================
See Notes to Consolidated Financial Statements.
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Nine Months Ended
September 30,
1999 1998
-------------- --------------
Cash flows from operating activities:
Net income $2,602 $3,653
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization, net 1,183 1,067
Net realized gains on securities available for sale (14) (127)
Loans originated for sale (250,853) (327,381)
Proceeds from sale of loans held for sale 258,396 338,288
Gain on sale of loans and loan servicing (1,307) (3,942)
Provision for loan losses 700 1,530
Change in other assets and interest receivable 2,776 774
Change in other liabilities and interest payable 9,807 907
Other, net 215 416
-------------- --------------
Total adjustments 20,903 11,532
-------------- --------------
Net cash provided by operating activities 23,505 15,185
-------------- --------------
Cash flows from investing activities:
Net change in loans (31,846) (752)
Proceeds from sales of loans in portfolio --- 946
Purchases of investment securities available for sale (19,698) (20,150)
Purchases of investment securities held to maturity (6,192) (11,594)
Sales of investment securities available for sale --- 2,987
Maturities of investment securities available for sale 5,987 17,900
Maturities of investment securities held to maturity 3,189 13,406
Premises and equipment, net (225) (1,383)
Purchase of mortgage servicing rights 71 (12)
Proceeds from sale of other real estate owned 1,888 5,205
-------------- --------------
Net cash provided by (used in) investment activities (46,826) 6,553
-------------- --------------
Cash flows from financing activities:
Change in noninterest bearing transaction accounts (5,343) (15,253)
Change in interest bearing transaction accounts (9,729) (17,260)
Change in subordinated debt (12,000) ---
Change in time deposits 18,280 (895)
Change in other borrowings 16,414 2,257
Issuance of stock (969) 463
Dividends paid (273) (381)
-------------- --------------
Net cash provided by (used in) financing activities 6,380 (31,069)
-------------- --------------
Net change in cash and cash equivalents (16,941) (9,331)
Cash and cash equivalents at beginning of period 42,187 56,058
-------------- --------------
Cash and cash equivalents at end of period $25,246 $46,727
============== ==============
(Continued)
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Continued)
Nine Months Ended
September 30,
1999 1998
-------------- -------------
Supplemental Disclosures:
Cash paid during the period for:
Interest expense 8,626 10,805
Income taxes 959 1,245
Noncash investing and financing activities:
Transfers from loans to other real estate owned 2,303 2,675
Transfer from mortgage loans held for sale to loans 8,607 8,999
Dividend declared 202 136
Conversion of Preferred Stock into Common Stock 5,739
See notes to Consolidated Financial Statements.
(Concluded)
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements should be read
in conjunction with the financial statements and related notes contained in
Redwood Empire Bancorp's 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 nine months ended September 30, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999.
During the third quarter of 1999 the Company successfully completed the
divestiture of its mortgage brokerage and mortgage banking units, Valley
Financial and Allied Diversified Credit. The Company has disclosed the
operations of these units as well as the after tax loss on disposition as
discontinued operations. Accordingly, historical financial information has been
recast to present the operating results of Valley Financial and Allied
Diversified Credit as discontinued operations.
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 (in
thousands, except per share data):
Three Months Ended
September 30,
1999 1998
------------------------ -----------------------
Basic Diluted Basic Diluted
---------- ---------- ---------- ----------
Earnings per common share:
Income from continuing operations before extraordinary item $1,052 $1,052 $977 $977
Earnings per share from continuing operations before extraordinary item $0.31 $0.30 $0.29 $0.28
Income/(loss) from discontinued operations, net of tax ($686) ($686) $358 $358
Earnings per share from income/(loss) of discontinued operations ($0.20) ($0.20) $0.11 $0.10
Net income $366 $366 $1,335 $1,335
Net income per share $0.11 $0.11 $0.40 $0.38
Weighted average common shares outstanding 3,390 3,458 1 3,369 3,486 1
========== ========== ========== ==========
Nine Months Ended
September 30,
1999 1998
------------------------ -----------------------
Basic Diluted Basic Diluted
---------- ---------- ---------- ----------
Earnings per common share:
Income from continuing operations before extraordinary item $3,474 $3,474 $2,236 3 $2,348
Earnings per share from continuing operations before extraordinary item $1.03 $1.00 $0.72 $0.68
Income/(loss) from discontinued operations ($596) ($596) $1,193 3 $1,305
Earnings per share from income/(loss) of discontinued operations ($0.18) ($0.17) $0.38 $0.38
Income before extraordinary item $2,878 $2,878 $3,541 3 $3,653
Earnings per share before extraordinary item $0.85 $0.83 $1.14 $1.05
Net income $2,602 $2,602 $3,541 3 $3,653
Net income per share $0.77 $0.75 $1.14 $1.05
Weighted average common shares outstanding 3,385 3,472 1 3,101 3,465 2
========== ========== ========== ==========
(1) The weighted average common shares outstanding include the dilutive
effects of common stock options.
(2) The weighted average common shares outstanding include the dilutive
effects of common stock options of 142 and convertible perpetual
preferred stock of 222.
(3) These earnings per share amounts are shown net of $112 of dividends on
preferred stock.
(Concluded)
3. Comprehensive Income
The Company's total comprehensive earnings presentation is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- --------------------------
1999 1998 1999 1998
-------------- -------------- ----------- -----------
(In thousands) (In thousands)
Net income as reported $366 $1,335 $2,236 $3,541
Other comprehensive income (net of tax):
Change in unrealized holding gain (losses)
on available for sale securities
(20) 418 (563) 594
Reclassification adjustment
- - (14) (8) (39)
-------------- -------------- ----------- -----------
Total comprehensive income $346 $1,739 $1,665 $4,096
============== ============== =========== ===========
4. Common Stock Dividend
On August 25, 1999 the Board of Directors declared a quarterly cash
dividend of 6 cents per share on the Company's Common Stock. This dividend
declaration represents an increase of 50% over the previous quarter dividend
payments. The dividend was paid on October 15, 1999 to shareholders of record on
September 30, 1999.
5. Divestiture of Mortgage Banking and Mortgage Brokerage Units
On September 10, 1999 the Company divested itself of its subprime mortgage
brokerage and mortgage banking units, Valley Financial and Allied Diversified
Credit. The divestiture took the form of an asset sale and employee transfer to
Valley Financial Funding, Inc., whose shareholders include senior management of
Valley Financial and Allied Diversified Credit. As a result of the divestiture,
the Company lost ninety-five employees of which sixty-three were transferred to
Valley Financial Funding, Inc, while thirty-two were terminated by the Company.
As a result of its divestiture the Company recorded an after-tax loss of
$167,000 which is primarily comprised of termination benefits. The Company has
disclosed the operations of these units as well as the after tax loss on
disposition as discontinued operations. Accordingly, historical financial
information has been recast to present the operating results of Valley Financial
and Allied Diversified Credit as discontinued operations. Revenue from
discontinued operations was $575,000 and $4,319,000 for the three and nine
months ended September 30, 1999 compared to revenue of $2,857,000 and $8,120,000
for the same periods in 1998. As of September 30, 1999 mortgage loans held for
sale, which represents previous production from discontinued operations was
$17,892,000. Results of operations from September 10, 1999 to September 30, 1999
for discontinued operations were not material.
6. 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, the redemption of a $3.0 million note from NBR and $1.0
million from Redwood's general corporate funds.
7. Business Segments
During the three and nine months ended September 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 and the Company's residential mortgage
banking and brokerage arm, known as Valley Financial were divested on September
10, 1999. The divestiture took the form of an asset sale and employee transfer.
The Company has disclosed the operations of these units as well as the after tax
loss on disposition as discontinued operations. Accordingly, historical
financial information regarding segments has been restated.
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 September 30, 1999
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
Total Interest Income $7,686 $0 $7,686
Total Interest Expense 2,713 0 2,713
Interest income/(expense) allocation (140) 140 0
---------------------------------------
Net Interest Income 4,833 140 4,973
Provision for Loan Losses 200 0 200
Total other Operating Income 460 733 1,193
Total other Operating Expense 3,978 222 4,200
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 1,115 651 1,766
Provision for income taxes 504 210 714
---------------------------------------
Income from continuing operations before extraordinary item $611 $441 $1,052
=======================================
Total Average Assets $399,072 $10,003 $409,075
=======================================
For the quarter ended September 30, 1998
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
Total Interest Income $7,811 $0 $7,811
Total Interest Expense 3,112 10 3,122
Interest income/(expense) allocation (139) 139 0
---------------------------------------
Net Interest Income 4,560 129 4,689
Provision for Loan Losses 510 0 510
Total other Operating Income 710 686 1,396
Total other Operating Expense 3,913 131 4,044
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 847 684 1,531
Provision for income taxes 362 192 554
---------------------------------------
Income from continuing operations before extraordinary item $485 $492 $977
======================================
Total Average Assets $386,713 $9,625 $396,338
======================================
For the nine months ended September
30, 1999
--------------------------------------
Community Total
Banking Bankcard Company
--------------------------------------
(in thousands)
Total Interest Income $22,329 $0 $22,329
Total Interest Expense 7,707 3 7,710
Interest income/(expense) allocation (415) 415 0
---------------------------------------
Net Interest Income 14,207 412 14,619
Provision for Loan Losses 700 0 700
Total other Operating Income 1,522 2,375 3,897
Total other Operating Expense 11,522 633 12,155
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 3,507 2,154 5,661
Provision for income taxes 1,515 672 2,187
---------------------------------------
Income from continuing operations before extraordinary item $1,992 $1,482 $3,474
=======================================
Total Average Assets $390,300 $10,127 $400,427
=======================================
PAGE>
For the nine months ended September
30, 1998
---------------------------------------
Community Total
Banking Bankcard Company
---------------------------------------
(in thousands)
Total Interest Income $23,170 $0 $23,170
Total Interest Expense 9,664 25 9,689
Interest income/(expense) allocation (406) 406 0
---------------------------------------
Net Interest Income 13,100 381 13,481
Provision for Loan Losses 1,530 0 1,530
Total other Operating Income 2,249 1,732 3,981
Total other Operating Expense 11,861 374 12,235
---------------------------------------
Income from continuing operations before income taxes
and extraordinary item 1,958 1,739 3,697
Provision for income taxes 863 486 1,349
---------------------------------------
Income from continuing operations before extraordinary item $1,095 1,253 $2,348
=======================================
Total Average Assets $386,944 $9,478 $396,422
=======================================
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:
- Competitive pressure in the banking and mortgage industry and changes
in the regulatory environment.
- Changes in the interest rate environment and volatility of rate
sensitive deposits.
- 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.
- Credit quality deteriorates which could cause an increase in the
provision for loan losses.
- Risks associated with the Year 2000 which could cause disruptions in
the Company's operations or increase expenses.
- Losses in the Company's merchant credit card processing business.
- Asset/liability matching risks and liquidity risks.
- 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 September 30, 1999, and significant changes and trends in the Company's
results of operations for the three and nine months ended September 30, 1999,
compared to the same period in 1998.
Summary of Financial Results
On September 10, 1999 the Company divested itself of its mortgage brokerage
and mortgage banking units, Valley Financial and Allied Diversified Credit. The
divestiture took the form of an asset sale and employee transfer to Valley
Financial Funding, Inc., whose shareholders include senior management of Valley
Financial and Allied Diversified Credit. As a result of the divestiture, the
Company lost ninety-five employees of which sixty-three were transferred to
Valley Financial Funding, Inc, while thirty-two were terminated by the Company.
As a result of its divestiture the Company recorded an after-tax loss of
$167,000 which is primarily comprised of termination benefits. The Company has
disclosed the operations of these units as well as the after tax loss on
disposition as discontinued operations. Accordingly, historical financial
information has been recast to present the operating results of Valley Financial
and Allied Diversified Credit as discontinued operations.
The Company reported income from continuing operations of $1,052,000 ($.30
per diluted share) for the three months ended September 30, 1999 and $977,000
($.28 per diluted share) for the same period in 1998. From discontinued
operations for the third quarter ended September 30, 1999, the Company had a
loss of $686,000 (($.20) per diluted share) and income of $358,000 ($.10 per
diluted share) for the same period one year ago. Net income was $366,000 ($.11
per diluted share) for the quarter ended September 30, 1999 as compared to
$1,335,000 ($.38 per diluted share) one year ago. The increase in net income
from continuing operations for the third quarter in 1999, when compared to the
same period one year ago, is due to an increase of $284,000 in net interest
income, a decrease of $203,000 in non interest income, a decrease in the
provision for loan losses of $310,000 and an increase of $156,000 in non
interest expense.
For the nine months ended September 30, 1999 income from continuing
operations was $3,474,000 ($1.00 per diluted share) as compared to $2,348,000
($.68 per diluted share) for the same period in 1998. From discontinued
operations for the first nine months of 1999, the Company had a loss of $596,000
(($.17) per diluted share) and income of $1,305,000 ($.38 per diluted share) for
the same period one year ago. Net income before extraordinary item was
$2,878,000 ($.83 per diluted share) and net income was $2,602,000 ($.75 per
diluted share) for the nine months ended September 30, 1999, as compared to
$3,541,000 ($1.05 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' $12,000,000 subordinated debt. Such debt was
redeemed in the first quarter of 1999.
The increase in income from continuing operations before an extraordinary
item during the first nine months of 1999 when compared to the same period in
1998 is due to an increase of $1,138,000 in net interest income, a decrease of
$84,000 in non interest income, a decrease in the provision for loan losses of
$830,000, a decrease of $80,000 in non interest expense.
Net Interest Income
Net interest income from continuing operations increased from $4,689,000
during the third quarter of 1998 to $4,973,000 in the third quarter of 1999,
which represents an increase of $284,000 or 6%. Such increase is due to an
increase in the Company's net interest margin from 5.30% to 5.32% and an
increase in average earning assets of $19,757,000 from $354,049,000 for the
quarter ended September 30, 1998 to $373,806,000 for the quarter ended September
30, 1999.
Net interest income from continuing operations of $14,619,000 increased
$1,138,000 or 8% for the nine months ended September 30, 1999 when compared to
the same period one year ago. The increase is primarily due to an increase of
$10,097,000 or 3% in average earning assets and a decrease of $11,820,000 or 4%
in interest bearing liabilities. Net interest margin for the first nine months
of 1999 was 5.37% as compared to 5.09% for the same period one year ago.
For the first nine months of 1999, the yield on earning assets decreased
from 8.75% to 8.20% 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 4.72%
for the nine months ended September 30, 1998 as compared to 3.92% 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 the third and fourth quarters of 1998.
Average earning assets increased in the third quarter of 1999 when compared
to the same period one year ago. Average earning assets were $363,271,000 during
the nine month period ended September 30, 1999 as compared to $353,174,000 in
1998. The increase in average earning assets during the first nine months of
1999 when compared to 1998 is primarily due to an increase in average portfolio
loans 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 $273,980,000 in the third quarter of 1998 to
$262,160,000 for the same period in 1999 which represents a decrease of
$11,820,000. This decrease was partially offset by an increase in average
noninterest bearing transaction accounts of $6,050,000.
The following is an analysis of the net interest margin:
Three months ended Three months ended
September 30, 1999 September 30, 1998
---------------------------------------- ----------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield Balance Interest Yield
---------------------------------------- ----------------------------------------
Earning assets (1) $373,806 $7,686 8.22 $354,049 $7,811 8.82
Interest-bearing liabilities 270,357 2,713 4.01 270,354 3,122 4.62
------------- --------------
Net interest income $4,973 $4,689
============= ==============
Net interest income to
earning assets 5.32 5.30
Nine months ended Nine months ended
September 30, 1999 September 30, 1998
---------------------------------------- ---------------------------------------
Average % Average %
(dollars in thousands) Balance Interest Yield Balance Interest Yield
---------------------------------------- ---------------------------------------
Earning assets (1) $363,271 $22,329 8.20 $353,174 $23,170 8.75
Interest-bearing liabilities 262,160 $7,710 3.92 273,980 $9,689 4.72
------------- -------------
Net interest income $14,619 $13,481
============= =============
Net interest income to
earning assets 5.37 5.09
(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 nine months ended September 30, 1999 and 1998. Changes not solely
attributable to rate or volume have been allocated to rate.
Three months ended September 30, 1999
over September 30, 1998
--------------------------------------------------
Volume Rate Total
--------------------------------------------------
(in thousands)
Increase (decrease) in interest income:
Portfolio loans $844 ($732) $112
Investment securities (42) (25) (67)
Federal funds sold (168) (2) (170)
--------------------------------------------------
Total increase (decrease) 2,035 (2,160) (125)
--------------------------------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts (46) (179) (225)
Time deposits 303 (135) 168
Other borrowings (314) (38) (352)
--------------------------------------------------
Total increase (decrease) (57) (352) (409)
--------------------------------------------------
Increase in net interest income $2,093 ($1,809) $284
==================================================
Year to date September 30, 1999
over September 30, 1998
---------------------------------------------------
Volume Rate Total
---------------------------------------------------
(in thousands)
Increase (decrease) in interest income:
Portfolio loans $1,772 ($1,734) $38
Investment securities (142) (187) (329)
Federal funds sold (503) (47) (550)
---------------------------------------------------
Total increase (decrease) 1,127 (1,968) (841)
---------------------------------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts (275) (904) (1,179)
Time deposits 315 (409) (94)
Other borrowings (561) (145) (706)
---------------------------------------------------
Total increase (decrease) (521) (1,458) (1,979)
---------------------------------------------------
Increase in net interest income $1,648 ($510) $1,138
===================================================
Provision for Loan Losses
The provision for loan losses for the three months ended September 30, 1999
was $200,000 as compared to $510,000 in the same quarter in the previous year.
For the nine months ended September 30, 1999 the provision decreased $830,000
from $1,530,000 in 1998 to $700,000 in 1999. A general decline in the provision
for the nine months ended September 30, 1999 is due to the decline of
nonperforming loans. For further discussion see Allowance for Loan Losses and
Nonperforming Loans.
Noninterest Income and Expense and Income Taxes
Noninterest Income
The following table sets forth the components of the Company's noninterest
income from continuing operations for the three and nine months ended September
30, 1999, as compared to the same period in 1998.
Three Months Ended Nine Months Ended
September 30, % September 30, %
------------------------ -------------------------
(dollars in thousands) 1999 1998 Change 1999 1998 Change
----------- ---------- ----------- ----------- ----------- ------------
Service charges on deposit accounts 253 261 (3) 776 802 (3)
Merchant draft processing, net 733 686 7 2,375 1,732 37
Loan servicing income 14 201 (93) 79 485 (84)
Gain (loss) on securities --- 22 (100) 14 127 (89)
Other income 193 226 (15) 653 835 (22)
=========== ========== =========== ===========
Total noninterest income $1,193 $1,396 (15) $3,897 $3,981 (2)
=========== ========== =========== ===========
Noninterest income from continuing operations decreased $203,000 or 15% to
$1,193,000 for the third quarter of 1999 when compared to $1,396,000 for the
same period in 1998. Such decrease is primarily due to a decrease in loan
servicing income of $187,000, a decrease in other income of $33,000 and an
increase of $47,000 in merchant card net revenue.
Noninterest income from continuing operations was $3,897,000 for the nine
months ended September 30, 1999 as compared to $3,981,000 for the same period in
1998. The decrease of $84,000 or 2% is primarily attributable to a decrease in
loan servicing income.
Noninterest Expense
Noninterest expense from continuing operations increased by $156,000 or 4%
to $4,200,000 during the third quarter of 1999 compared to $4,044,000 for the
third quarter of 1998. Noninterest expense decreased $80,000 or 1% to
$12,155,000 for the nine month period ended September 30, 1999 compared to
$12,235,000 for the same period one year ago.
The following table sets forth the components of the Company's noninterest
expense during the three and nine months ended
September 30, 1999, as compared to the same period in 1998.
Three Months Ended Nine Months Ended
September 30, % September 30, %
--------------------------- ------------------------
(dollars in thousands) 1999 1998 Change 1999 1998 Change
------------- ------------ ---------- ----------- ----------- -----------
Salaries and employee benefits $2,187 $2,090 5 $6,652 $6,182 8
Occupancy and equipment expense 598 695 (14) 1,713 1,919 (11)
Other 1,415 1,259 12 3,790 4,134 (8)
------------- ------------ ----------- -----------
Total noninterest expense $4,200 $4,044 4 $12,155 $12,235 (1)
============= ============ =========== ===========
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 40.4% and 38.6% for the three and nine months ended September 30, 1999,
compared to 36.2% and 36.5% for the same periods in 1998.
Business Segments
During the three and nine months ended September 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 and the Company's residential mortgage
banking and brokerage arm, known as Valley Financial were divested on September
10, 1999. The divestiture took the form of an asset sale and employee transfer.
The Company has disclosed the operations of these units as well as the after tax
loss on disposition as discontinued operations. Accordingly, historical
financial information regarding segments has been restated.
Summary financial data by industry segment as follows:
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
(in thousands) (in thousands)
------------------------------- -------------------------------
1999 1998 1999 1998
-------------- --------------- -------------- --------------
Community Banking:
Revenue $5,293 $5,270 $15,729 $15,349
Expenses 4,178 4,423 12,222 13,391
-------------- --------------- -------------- --------------
Income from continuing operations before
income tax and extraordinary item 1,115 847 3,507 1,958
============== =============== ============== ==============
Bankcard:
Revenue 873 815 2,787 2,113
Expenses 222 131 633 374
-------------- --------------- -------------- --------------
Income from continuing operations before 651 684 2,154 1,739
income tax and extraordinary item
============== =============== ============== ==============
Total Company:
Revenue 6,166 6,085 18,516 17,462
Expenses 4,400 4,554 12,855 13,765
-------------- --------------- -------------- --------------
Income from continuing operations before
income tax and extraordinary item $1,766 $1,531 $5,661 $3,697
============== =============== ============== ==============
Community Banking
The Community Banking segment income before income tax increased for the
quarter ended September 30, 1999 as well as the nine months ended September 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 $303,137,000 and $267,465,000 in the third
quarter of 1999 and 1998, which reflects a 13% increase. For the full nine
months such amounts were $289,569,000 and $264,861,000 which reflects a 9%
increase.
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. Third quarter of 1999 revenue was up $58,000 or 7% over the
same period in 1998. For the nine months ended September 30, 1999, revenue was
up $674,000 or 32% to $2,787,000 from $2,113,000 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 has amortized 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.
Investment Securities
Total investment securities increased $15,685,000 or 26% to $76,095,000 as
of September 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 federal fund investment position and
redeploying such amounts into the higher yielding investment portfolio. The
Company's average federal fund position was $7,927,000 for the first nine months
of 1999 as compared to $19,622,000 in 1998.
Loans
Total loans increased $38,011,000 or 14% to $307,327,000 at September 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 nine months of 1999.
The following table summarizes the composition of the loan portfolio at
September 30, 1999 and December 31, 1998.
September 30, 1999 December 31, 1998
------------------------------------ ------------------------------------
(dollars in thousands) Amount % Amount %
------------------------------------ ------------------------------------
Residential real estate mortgage $126,033 41% $97,194 36%
Commercial real estate mortgage 72,854 24 59,257 22
Commercial 62,228 20 63,260 23
Real estate construction 43,046 14 46,905 18
Installment and other 4,384 1 5,095 2
Less deferred loan fees (1,218) 0 (2,395) (1)
------------------------------------ ------------------------------------
Total portfolio loans 307,327 100% 269,316 100%
================== ==================
Less allowance for loan losses (7,963) (8,041)
------------------ -----------------
Net loans $299,364 $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 Nine months ended
September 30, September 30,
--------------------------- --------------------------
(dollars in thousands) 1999 1998 1999 1998
----------- ------------- ----------- -----------
Beginning allowance for loan losses $8,001 $7,930 $8,041 $7,645
Provision for loan losses 200 510 700 1,530
Charge-offs (399) (369) (1,312) (1,240)
Recoveries 161 150 534 286
=========== ============= =========== ===========
Ending allowance for loan losses $7,963 $8,221 $7,963 $8,221
=========== ============= =========== ===========
Net charge-offs to average
loans (annualized) .30% .31% .36% .48%
The allowance for loan losses as a percentage of portfolio loans decreased
from 2.99% at December 31, 1998 to 2.59% at September 30, 1999. The slight
decrease in this percentage is due to a $38,011,000 increase in the Company's
total loan portfolio and the general improvement of the Company's asset quality.
Nonperforming Assets
The following table summarizes the Company's nonperforming assets.
September 30, December 31,
(dollars in thousands) 1999 1998
-------------- ---------------
Nonaccrual loans $3,636 $5,556
Accruing loans past due 90 days or more 142 ---
Restructured loans 1,024 1,045
-------------- ---------------
Total nonperforming loans 4,802 6,601
Other real estate owned 2,381 2,181
Other assets owned 21 129
-------------- ---------------
Total nonperforming assets $7,204 $8,911
============== ===============
Nonperforming assets to total assets 1.65% 2.11%
Nonperforming assets have decreased from $8,911,000 as of December 31, 1998
to $7,204,000 as of September 30, 1999. The principal reasons for this decrease
relates a decrease in nonaccrual loans of $1,920,000, offset by an increase in
accruing loans past due 90 days or more of $142,000 and an increase in other
real estate owned of $200,000.
Nonperforming loans consist of loans to 29 borrowers, 14 of which have
balances in excess of $100,000. The two largest have recorded balances of
$745,000 and $713,000, 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 8 properties. Five properties are
residential, two are commercial buildings and the remaining is a motel. Other
assets owned included contract receivable rights and repossessed personal
property carried at $21,000.
Although the volume of nonperforming assets will depend in part on the
future economic environment, there is also one loan relationship which totals
approximately $711,000 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 nine months of 1999 the Company was required by a mortgage
loan investor to repurchase three residential mortgage loans in the amount of
$943,000. 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 or fraud. 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 $142,000
as of September 30, 1999 and $172,000 as of December 31, 1998.
At September 30, 1999 the Company's total recorded investment in impaired
loans (as defined by SFAS 114 and 118) was $5,277,000 of which $4,967,000
relates to the recorded investment for which there is a related allowance for
credit losses of $1,148,000 determined in accordance with these statements and
$310,000 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 nine
months ended September 30, 1999 and 1998 was $5,218,000 and $10,062,000. The
related amount of interest income recognized during the periods that such loans
were impaired was $4,000 and $217,000 for the three and nine month periods ended
September 30, 1999 and $92,000 and $409,000 for the same period in 1998.
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 September 30, 1999, Redwood held $624,000 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. On
August 25, 1999 the Company increased this dividend 50% to $.06 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 were 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 nine months of 1999, NBR declared dividends of $9,200,000,
of which $8,000,000 was used to fund the early redemption of the $12,000,000
subordinated debt. Management believes that at September 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 nine months ended
September 30, 1999 the Company received cash of $9,907,000 from operating
activities and $6,380,000 in financing activities while using $33,228,000 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 September 30, 1999 and December
31, 1998.
Company NBR
-------------- -------------
September 30, 1999
Total capital to risk based assets 13.05% 12.71%
Tier 1 capital to risk based assets 11.79 11.44
Leverage ratio 8.92 9.19
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 ongoing, 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 1999 with technical assistance from the vendor and an outside
consultant. At the date of this report the Company believes has completed
initial testing of all mission-critical IT systems.
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
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 September 30, 1999,
approximately 78% of the Company's loans were secured by real estate, of which
30% 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 September 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 $1,795 $ --- $ --- $ --- $ --- $1,795
Investment securities and other 4,989 8,871 9,924 26,992 25,319 76,095
Mortgage loans held for sale 17,892 --- --- --- --- 17,892
Loans 107,528 32,167 20,264 69,080 78,289 307,327
---------------------------------------------------------------------------
Total interest-earning assets 132,203 41,038 30,187 96,072 103,608 403,109
---------------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing transaction accounts 131,587 --- --- --- --- 131,587
Time deposits 36,414 33,599 76,600 12,623 --- 159,236
Short-term borrowings 17,785 --- --- --- --- 17,785
---------------------------------------------------------------------------
Total interest-bearing liabilities 185,786 33,599 76,600 12,623 --- 308,608
---------------------------------------------------------------------------
Interest rate sensitivity gap ($53,583) $7,439 ($46,412) $83,449 $103,608
===============================================================
Cumulative interest rate sensitivity gap (53,583) (46,144) (92,556) (9,108) 94,500
===============================================================
Interest rate sensitivity gap ratio 0.71 1.22 0.39 7.61 ---
Cumulative interest rate sensitivity gap ratio 0.71 0.79 0.69 0.97 1.31
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 September 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.
September 30, 1999
------------------ Change in Annual Change in
Change in Interest Rate Net Interest Income Market Value of Equity
+100 173,000 (4,711,000)
-100 (358,000) 3,784,000
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 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.
10.2 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 Statement
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 September 30, 1999.
2. Reports on Form 8-K
Form 8-K dated July 28, 1999 announcing second quarter 1999 financial
results and promotion announcement of James E. Beckwith to Chief Operating
Officer under Item 5 "Other Events".
Form 8-K dated August 25, 1999 announcing declaration of quarterly cash
dividned on its Common Stock under Item 5 "Other Events".
Form 8-K dated August 30, 1999 announcing divestiture of mortgage
brokerage and mortgage banking units under Item 5 "Other Events".
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: 11/12/99 BY: /s/ James E. Beckwith
James E. Beckwith
Executive Vice President,
Chief Operating Officer,
Principal Financial Officer, and
Principal Accounting Officer