SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
/X/ Annual report under Section 13 or 15(d) of the Securities Exchange Act of
1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1996 or
/ / Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
(NO FEE REQUIRED)
Commission file number: 0-19231
REDWOOD EMPIRE BANCORP
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(Exact number of Registrant as specified in its charter)
California 68-0166366
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
111 Santa Rosa Avenue, Santa Rosa, California 95404-4905
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(Address of principal executive officers) (Zip Code)
Registrant's telephone number, including area code: (707) 545-9611
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
- ------------------------ ------------------------
Common Stock American Stock Exchange
7.80% Noncumulative Convertible American Stock Exchange
Perpetual Preferred Stock, Series A
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed under 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 the
filing requirements for the past 90 days. Yes /X/ No / /
The aggregate market value of the Registrant's common stock held by
non-affiliates on March 1, 1997 (based on the closing sale price of the Common
Stock on the American Stock Exchange on such date) was $24,208,712.
As of March 1, 1997 there were outstanding 2,756,187 shares of the
Registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
1. Definitive Proxy Statement (see Part III, Items 10, 11, and 12).
1
TABLE OF CONTENTS
Page
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PART I
Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . 25
Item 4. Submission of Matters to A Vote of Securities Holders . . . . . . . 25
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . 27
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations. . . . . . . . . . . . . . . . . . . . . 28
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . 57
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure. . . . . . . . . . . . . . . 99
PART III
Item 10. Directors and Executive Officers of the Registrant. . . . . . . . .100
Item 11. Executive Compensation. . . . . . . . . . . . . . . . . . . . . . .100
Item 12. Security Ownership of Certain Beneficial Owners and Management. . 100
Item 13. Certain Relationships and Related Transactions. . . . . . . . . . 100
PART IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K. 101
2
PART I
ITEM 1. BUSINESS
Redwood Empire Bancorp ("Redwood," and with its subsidiaries, the
"Company") is a financial institution holding company headquartered in Santa
Rosa, California, and operating in Northern and Central California through two
principal subsidiaries: National Bank of the Redwoods, a national bank ("NBR"),
and Allied Bank, F.S.B., a federal savings bank ("Allied").
(a) GENERAL DEVELOPMENT OF BUSINESS.
Redwood is a California corporation, headquartered in Santa Rosa,
California. Its wholly-owned subsidiaries are NBR, a national bank which was
chartered in 1985, and Allied, a federal savings bank which was chartered in
1986. In addition, NBR has two wholly-owned subsidiaries, NBR Mortgage Company,
Inc. and Redwood Empire Datacorp. Redwood was created by NBR in August 1988, in
order to become a bank holding company through the acquisition of all of NBR's
outstanding shares. That transaction was consummated in January 1989. Redwood
acquired Allied in September 1990, through a tax-free reorganization in which
Redwood exchanged shares of its stock for all of the outstanding shares of
Allied. The acquisition of Allied was accounted for as a pooling of interests
for financial reporting purposes.
On October 31, 1992, Lake Savings and Loan Association, a one-branch
California chartered savings and loan based in Lakeport, California ("Lake"),
was purchased for approximately $2,300,000 in cash, and merged into Allied. At
the time of its acquisition Lake had total assets of approximately $41 million.
The acquisition was accounted for as a purchase.
On November 4, 1994, Codding Bank, a multiple-branch California chartered
bank based in Rohnert Park, California ("Codding"), was purchased for $7,028,000
in cash, including merger related expenses, and merged into NBR. At the merger
date, the fair value of the assets acquired totalled approximately $42 million.
(See Item 8 "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA--NOTE C OF NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS OF REDWOOD EMPIRE BANCORP.") The
acquisition was accounted for as a purchase.
In November, 1996 the Board of Directors of the Company voted to merge
Allied into NBR. The proposed combination of the two wholly-owned subsidiaries
of Redwood will be structured as a merger transaction wherein Allied will be
merged into NBR with NBR as the survivor. As a result of the merger NBR will
assume all of Allied's rights and obligations. Allied will cease to exist as a
federally chartered savings institution upon the merger. On February 3, 1997,
NBR received approval from the Office of the Comptroller of the Currency to
merge Allied into NBR. The merger is expected to be consummated by the end of
the first quarter of 1997.
3
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
During the year ended December 31, 1996, the Company operated in two
principal industry segments: commercial banking and mortgage banking. The
Company's mortgage banking activities relate principally to the origination for
sale, servicing of loans sold to investors, and sale and purchase of mortgage
loans and servicing rights. Commercial banking activities include all other
services provided by the Company, including portfolio lending, the origination
for sale and servicing of Small Business Administration loans, various deposit
programs and numerous fee-based services.
In 1996, the Company's mortgage banking operations generated revenues of
$19,382,000 as compared to $16,089,000 in 1995 and $16,269,000 in 1994. In 1996
the Company's mortgage operations generated an operating loss of $1,109,000
compared to an operating profit of $138,000 in 1995 and an operating loss of
$9,821,000 in 1994. During 1996, the Company's commercial banking operations
generated revenues of approximately $45,972,000 and operating profits of
approximately $1,304,000, as compared to operating revenues and profits of
approximately $47,860,000 and $7,639,000 in 1995 and $32,621,000 and $6,881,000
in 1994. (See Item 7 "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" and Item 8 "FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA - NOTE Q OF NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
REDWOOD EMPIRE BANCORP".)
In the fourth quarter of 1996 the Company significantly curtailed its
wholesale mortgage loan originations operations associated with the wholesale
generation of mortgage loans which predominantly conform to the underwriting
standards set by Fannie Mae, Freddie Mac, or other institution investors. This
type of activity is commonly referred to as "A paper" wholesale mortgage
banking. This decision was taken due to concerns over declining profit margins
and interest rate risk. "A paper" wholesale lending volume amounted to $1.4
billion, $877 million, and $1.1 billion for the years ended December 31, 1996,
1995 and 1994 respectively. As a result of this action, the Company's future
mortgage banking operations will focus on its subprime mortgage business along
with retail generation of "A paper" mortgage loans through its brokerage
operations. Accordingly, revenues and expenses associated with this segment
will be significantly reduced from historic levels.
(c) NARRATIVE DESCRIPTION OF BUSINESS.
Redwood Empire Bancorp ("Redwood," and with its subsidiaries, the
"Company") is a financial institution holding company headquartered in Santa
Rosa, California, and operating in California, Oregon and Washington. Its
wholly-owned subsidiaries are National Bank of the Redwoods("NBR"), a national
bank chartered in 1985 and Allied Bank, F.S.B., ("Allied"), a federal savings
bank chartered in 1986. The Company's business strategy involves two principal
business activities, commercial banking and mortgage lending which are conducted
through NBR and Allied, respectively.
4
NBR provides its commercial banking services through five retail branches
located in Sonoma County, California and one retail branch located in Mendocino
County, California. NBR generally extends commercial loans to professionals and
to businesses with annual revenues of less than $10 million. Commercial loans
are primarily for working capital, asset acquisition and commercial real estate.
NBR's targeted commercial banking market area includes the California counties
north of San Francisco. NBR generates noninterest income through merchant
draft processing by virtue of its status as a Principal Bank of Visa/MasterCard.
As a Preferred Lender under the Small Business Administration ("SBA") Loan
Guarantee Program, NBR generates noninterest income through premiums received on
the sale of the guaranteed portions of SBA loans and the resulting on-going
servicing income on its SBA portfolio.
The Company's residential mortgage lending business is conducted primarily
through Allied. Allied originates one-to-four family residential mortgage loans
which predominantly conform to the underwriting standards set by Fannie Mae,
Freddie Mac or other institutional mortgage conduits. These loans are commonly
referred to as "A paper" loans and are acquired by Allied on a wholesale basis,
through mortgage brokers, or retail basis through Allied's own retail loan
officers. Allied also provides mortgage loan brokerage services to retail
customers through its Valley Financial division. In addition Allied originates
mortgage loans through its Allied Diversified Credit ("ADC") division that do
not comply with all standards established by Fannie Mae or Freddie Mac. These
loans are commonly referred to as "Sub Prime" loans and are acquired by ADC on a
wholesale and retail basis. Substantially all mortgage loan originations are
packaged and sold into the secondary market. Allied sells substantially all the
servicing rights on the mortgage loans it sells and from time to time may
purchase mortgage loan servicing rights from other companies, thereby generating
ongoing servicing fees. In addition, Allied originates construction loans for
its portfolio.
As previously stated, the Company has significantly curtailed its "A paper"
wholesale mortgage banking operations with an aim to eliminate this product. As
a result of this action the company's future mortgage loan production revenue
and expenses will be significantly reduced from historic levels. Future
mortgage banking operations will focus on the Company's sub prime mortgage
business along with mortgage loan brokerage services.
Allied's principal targeted mortgage banking territory includes Northern
and Central California. These areas are served by two loan production offices
located in Santa Rosa and San Jose, both of which provide retail and wholesale
sub-prime mortgage lending and three retail mortgage loan brokerage offices
located in the East San Francisco bay area. To fund its lending activities
Allied maintains depository branches in Santa Rosa, Ukiah and Lakeport,
California.
5
In addition to its lending activities, the Company has purchased mortgage
loan servicing rights from other institutions to augment and diversify its
income sources. Based on market conditions, the Company either retains or sells
the servicing on mortgage loans sold to institutional investors. In the third
and fourth quarters of 1996 the Company sold servicing rights for $839,945,000
in loans whose carrying value amounted to $4,150,000 resulting in net revenue of
$2,153,000. At December 31, 1996 the Company's mortgage loan servicing
portfolio aggregated approximately $124 million, a decrease of approximately 88%
from the size of the portfolio as of December 31, 1995 due to such servicing
sales. The Company is also approved to offer various other specialized
products. It is an approved Fannie Mae/Freddie Mac lender/servicer, a Principal
Bank for VISA/Mastercard, and an approved lender of the Federal Housing,
Veterans and Farmers Home Administrations.
The primary sources of funds for the Company's lending programs are local
deposits, proceeds from loan sales, loan payments, and other borrowings by its
subsidiaries. The Company attracts deposits primarily from local businesses,
professionals and retail customers. These deposits are periodically
supplemented through insured certificates of deposit obtained directly by the
Company from other financial institutions located throughout the United States.
The Company generally does not purchase deposits through deposit brokers and had
no brokered deposits at December 31, 1996. In addition to deposits, the Company
obtains other borrowed funds through its membership in the Federal Home Loan
Bank of San Francisco (the "FHLB") and its retention of treasury, tax and loan
funds at the Federal Reserve Bank of San Francisco.
The Company is regulated by various government agencies, with the primary
regulators being the Board of Governors of the Federal Reserve System (the
"FRB"), the Office of Thrift Supervision (the "OTS"), the Office of the
Comptroller of the Currency (the "OCC"), and the Federal Deposit Insurance
Corporation (the "FDIC").
The Company and its subsidiaries had 321 full-time-equivalent employees at
December 31, 1996. Redwood's headquarters are located at 111 Santa Rosa Avenue,
Santa Rosa, California 95404-4905, and its telephone number is (707) 545-9611.
PRIMARY MARKET AREA
The Company's deposit market area is Sonoma, Mendocino and Lake Counties,
California. Sonoma, Mendocino and Lake Counties have benefited from migration
of population and businesses into the area, as well as growth in established
firms and industries. These counties have generally exceeded the growth in
population and economic activity of California as a whole.
6
INVESTMENT PORTFOLIO
The Company classifies its investment securities as held to maturity or
available for sale. The Company's intent is to hold all securities held to
maturity until maturity and management believes that the Company has the
ability to do so. Securities available for sale may be sold to implement the
Company's asset/liability management strategies and in response to changes in
interest rates, prepayment rates and similar factors. The following table
summarizes the maturities of the Company's debt securities at their carrying
value and their weighted average yields at December 31, 1996. Yields on
tax-exempt securities have been computed on a tax-equivalent basis. At December
31, 1996, the total market value of the securities described below was
$49,605,000.
After One Through After Five
Within One Year Five Years Years Total
--------------------- --------------------- --------------------- ---------------------
Amount Yield Amount Yield Amount Yield Amount Yield
--------------------- --------------------- --------------------- ---------------------
(dollars in thousands)
U.S. Government and agencies $4,003 5.50 % $20,844 5.74 % $21,741 6.45 % $46,588 6.05 %
Other bonds 26 4.05 --- n/a 2,675 7.58 2,701 4.05
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Total $4,029 5.49 % $20,844 5.74 % $24,416 6.57 % $49,289 5.94 %
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The following table summarizes the book value of the Company's investment
securities held on the dates indicated:
December 31,
1996 1995 1994
------------------------------
(in thousands)
U.S. Government and agencies $46,588 $37,436 $31,910
Other bonds and mortgage-backed securities 2,701 2,638 2,093
FHLB and FRB Stock 3,344 3,890 8,063
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Total $52,633 $43,964 $42,066
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DEPOSIT STRUCTURE
The Company primarily attracts deposits from local businesses and
professionals, as well as through retail certificates of deposits, savings and
checking accounts. In addition to the Company's local depository offices, it
attracts certificates of deposit, primarily from financial institutions
throughout the nation, by publishing rates in national publications. These
certificates of deposit have often been attracted at interest rates at or above
local market retail deposit rates. The national deposit market is utilized to
supplement funding for the Company's mortgage banking activities and other
liquidity needs. There can be no assurance that this funding practice will
continue to provide deposits at attractive rates, or that applicable federal
regulations will not limit the Company's ability to attract deposits in this
manner. The Company generally does not purchase brokered deposits and had no
brokered deposits at December 31, 1996.
7
The following chart sets forth the distribution of the Company's average
daily deposits for the periods indicated.
Year Ended December 31,
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1996 1995 1994
---------------------------- ---------------------------- ----------------------------
Amount Rate Amount Rate Amount Rate
---------------------------- ---------------------------- ----------------------------
(dollars in thousands)
Transaction accounts:
Savings & Money Market $129,405 4.02% $93,480 4.12 % $92,200 3.49 %
NOW 21,245 1.64 22,836 2.28 22,066 2.27
Noninterest bearing 65,082 --- 51,946 --- 44,283 ---
Time deposits $100,000
and over 95,258 5.35 120,499 6.29 72,980 5.98
Other time deposits 143,770 6.09 183,897 5.86 160,916 4.27
The Company's time deposits of $100,000 or more had the following schedule
of maturities at December 31, 1996:
Amount
------------------
(in thousands)
Remaining Maturity:
Three months or less $32,524
Over three months to six months 14,558
Over six months to 12 months 20,134
Over 12 months 8,195
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Total $75,411
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------------------
Time deposits of $100,000 or more are generally from the Company's
institutional and business and professional customer base. The potential impact
on the Company's liquidity from the withdrawal of these deposits is considered
in the Company's asset and liability management policies, which attempt to
anticipate adequate liquidity needs through its management of investments,
federal funds sold, loan sales, or by generating additional deposits.
OTHER BORROWINGS
At December 31, 1996, the Company had FHLB short-term borrowings of
$4,000,000 with a weighted average interest rate of 5.57%, collateralized by
$63,155,000 in residential mortgage loans. Remaining available credit at
December 31, 1996 was $41,000,000. Advances are made on a short-term basis with
a rolling maturity date and are typically repaid within a 30-day period. On
occasion, a borrowing is made on a fixed maturity basis. In such instances,
maturities do not extend beyond one year. The following table summarizes the
highest amount of FHLB borrowings outstanding for a month-end during the year,
the average balance of borrowings from the FHLB and the weighted average rate
for the three years ended December 31, 1996.
8
December 31,
1996 1995 1994
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(in thousands)
Average balance during the year $21,834 $46,600 $83,034
Average interest rate during the year 5.94% 6.56% 5.18%
Maximum month-end balance during the year $39,000 $112,150 $143,200
Date of maximum month-end balance 4/30/96 1/31/95 9/30/94
REGULATION AND SUPERVISION
FEDERAL SECURITIES LAWS. Redwood is subject to various federal securities
laws, including the Securities Act of 1933 (the "1933 Act") and the Securities
Exchange Act of 1934 (the "1934 Act"). The 1933 Act regulates the distribution
or public offering of securities, while the 1934 Act regulates trading in
securities that are already issued and outstanding. Both Acts provide civil and
criminal penalties for misrepresentations and omissions in connection with the
sale of securities, and the 1934 Act also prohibits market manipulation and
insider trading.
Redwood files annual, quarterly, and current reports with the Securities
and Exchange Commission (the "SEC"). In addition, Redwood's directors,
executive officers, and 5% or greater shareholders, and certain of the senior
officers of Redwood's subsidiaries are subject to further reporting requirements
under the 1934 Act, including obligations to submit to the SEC reports of
beneficial ownership of Redwood's securities.
THE EFFECT OF GOVERNMENTAL POLICIES AND REGULATIONS ON THE COMPANY. The
Company's overall earnings and growth, as well as that of NBR and Allied
individually, are affected not only by local market area factors and general
economic conditions, but also by government monetary and fiscal policies. For
example, the Board of Governors of the Federal Reserve System (the "FRB")
influences the supply of money through its open market operations in U.S.
Government securities, as well as by adjustments to the discount rates
applicable to borrowings by depository institutions and others. Such actions
influence the growth of loans, investments and deposits and also affect interest
rates charged on loans and paid on deposits. The nature and impact of future
changes in such policies on the Company's business and earnings cannot be
predicted.
9
Beginning with the enactment of the Financial Institutions Reform, Recovery
and Enforcement Act of 1989 (the "FIRREA"), and following with Federal Deposit
Insurance Corporation Improvement Act of 1991 (the "FDICIA"), numerous
regulatory requirements have been placed on the banking and thrift industries in
the recent past, and additional changes have been and are being proposed. As a
consequence of the extensive regulation of commercial and mortgage banking and
thrift activities in the United States, the business of the Company is
particularly susceptible to being affected by enactment of federal and state
legislation which may have the effect of increasing or decreasing the cost of
doing business, modifying permissible activities, or enhancing the competitive
position of other financial institutions. Any change in applicable laws or
regulations could have a material adverse effect on the business and prospects
of the Company.
BANK HOLDING COMPANY REGULATION. Because of its ownership of NBR, Redwood
is a bank holding company subject to the Bank Holding Company Act of 1956, as
amended (the "BHCA"). Redwood reports to, registers with, and may be examined
by, the FRB, which also has the authority to examine Redwood's subsidiaries.
The FRB, which has significant supervisory and regulatory authority over
Redwood and its affiliates, requires Redwood to maintain certain levels of
capital. See "CAPITAL STANDARDS," below. The FRB also has the authority to
take enforcement action against any bank holding company that commits any unsafe
or unsound practice, or violates certain laws, regulations, or conditions
imposed in writing by the FRB.
Under the BHCA, a company generally must obtain the prior approval of the
FRB before it exercises a controlling influence over, or acquires directly or
indirectly, more than 25% of the voting shares or substantially all of the
assets of any bank or bank holding company. Thus, Redwood may be required to
obtain the prior approval of the FRB before it or its subsidiaries may acquire,
merge or consolidate with any bank or bank holding company; any company seeking
to acquire or merge with Redwood also would be required to obtain the FRB's
approval.
Redwood is generally prohibited under the BHCA from acquiring ownership or
control of more than 5% of the voting shares of any company that is not a bank
or bank holding company and from engaging directly or indirectly in activities
other than banking, managing banks, or providing services to affiliates of the
holding company. A bank holding company, with the approval of the FRB, may
engage, or acquire the voting shares of companies engaged, in activities that
the FRB has determined to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. A bank holding company
must demonstrate that the benefits to the public of the proposed activity will
outweigh the possible adverse effects associated with such activity.
The FRB generally prohibits a bank holding company from declaring or paying
a cash dividend which would impose undue pressure on the capital of subsidiary
banks or would be funded only through borrowing or other arrangements that might
adversely affect a bank holding company's financial position. The FRB's policy
is that a bank holding company is expected to act as a source of financial
strength to its financial institution subsidiaries, and to commit resources to
support such subsidiaries even at the expense of any of its non-bank
subsidiaries, if necessary.
10
Transactions between Redwood and its subsidiaries are subject to a number
of other restrictions. FRB policies forbid the payment by bank subsidiaries of
management fees which are unreasonable in amount or exceed the fair market value
of the services rendered (or, if no market exists, actual costs plus a
reasonable profit). Additionally, a bank holding company and its subsidiaries
are prohibited from engaging in certain tie-in arrangements in connection with
the extension of credit, sale or lease of property, or furnishing of services.
Subject to certain limitations, depository institution subsidiaries of bank
holding companies may extend credit to, invest in the securities of, purchase
assets from, or issue a guarantee, acceptance, or letter of credit on behalf of,
an affiliate, provided that the aggregate of such transactions with affiliates
may not exceed 10% of the capital stock and surplus of the institution, and the
aggregate of such transactions with all affiliates may not exceed 20% of the
capital stock and surplus of such institution. Redwood may only borrow from
depository institution subsidiaries if the loan is secured by marketable
obligations with a value of a designated amount in excess of the loan. Further,
Redwood may not sell a low-quality asset to a depository institution subsidiary.
BANK REGULATION AND SUPERVISION. As a national bank, NBR is regulated,
supervised and regularly examined by the Office of the Comptroller of the
Currency (the "OCC"). Deposit accounts at NBR are insured by the Bank Insurance
Fund (the "BIF"), as administered by the Federal Deposit Insurance Corporation
(the "FDIC"), to the maximum amount permitted by law. NBR is also subject to
applicable provisions of California law, insofar as such provisions are not in
conflict with or preempted by federal banking law.
The OCC or the FDIC regulate or monitor virtually all areas of NBR's
operations, including security devices and procedures, adequacy of
capitalization and loss reserves, loans, investments, borrowings, deposits,
mergers, payment of dividends, establishment of branches, interest rates
chargeable on loans or payable on deposits, establishment of branches, mergers,
reorganizations, and the like. NBR is required by the OCC to prepare quarterly
reports on its financial condition and to conduct an annual audit of its affairs
in compliance with minimum standards and procedures prescribed by the OCC.
Under FDICIA, all insured institutions must undergo regular on-site
examination by their appropriate federal banking agency, which in the case of
NBR is the OCC. The cost of these examinations may be assessed against the
institution. Insured institutions are also required to submit annual reports to
the FDIC and their principal regulatory agency. FDICIA also requires the
federal regulatory agencies to prescribe, by regulation, standards for all
insured depository institutions and their holding companies relating, among
other things, to (a) internal controls, including internal information and audit
systems, (b) loan documentation, (c) credit underwriting, (d) interest rate risk
exposure, and (e) asset quality.
National banks and their holding companies which have undergone a change in
control within two years, or which are deemed by the FRB or the OCC to be
troubled institutions must give the FRB or the OCC, respectively, thirty days'
prior notice of the appointment of any senior executive officer or director.
Within the thirty days the FRB or the OCC, as the case may be, may approve or
disapprove any such appointment.
11
THRIFT HOLDING COMPANY REGULATION. Because it controls Allied, which is a
federal savings bank, Redwood is also a savings and loan holding company within
the meaning of the Home Owners' Loan Act (the "HOLA"). As such, Redwood reports
to and is regulated, examined and supervised by the Office of Thrift Supervision
(the "OTS"). As a savings and loan holding company, Redwood is required to file
with the OTS an annual report and such additional information as the OTS may
require pursuant to the HOLA. The OTS may also conduct examinations of Redwood
and its subsidiaries.
Under the HOLA, Redwood is required to obtain the prior approval of the OTS
before it can acquire direct or indirect control over the business or
substantially all of the assets of another savings and loan or savings and loan
holding company; however acquisition of 5% or less of such an institution's
voting shares does not require the approval of the OTS. In considering such a
transaction, the OTS will consider not only the financial and managerial
resources of the prospective acquiror, but also the insurance risk posed by such
a transaction to the Savings Association Insurance Fund.
THRIFT REGULATION AND SUPERVISION. As a federal savings bank, Allied is
federally-chartered and subject to regulation, examination and general
supervision of its operations by the OTS. Savings institutions and their
directors, officers or employees failing to conform to OTS regulations,
policies, and directives may be sanctioned for noncompliance. The OTS requires
an annual audit of all savings institutions by independent accountants and, in
connection with its own periodic examinations, may revalue assets, based upon
appraisals, and require establishment of specific reserves based upon such
revaluation. Deposit accounts with Allied are insured by the Savings
Association Insurance Fund ("SAIF") as administered by the FDIC to the maximum
amount permitted by law. As a member of the Federal Home Loan Bank System,
Allied may obtain collateralized advances from the FHLB for certain purposes at
favorable rates.
In 1993 the OTS amended its qualified thrift lender ("QTL") regulations to
require that at least 65% of the association's portfolio assets consist of
certain types of housing related investments for at least nine out of every
twelve consecutive months. Associations which fail the QTL test lose their
right to long-term Federal Home Loan Bank ("FHLB") advances and must either
limit their new activities and new branches to those permitted to a national
bank or convert to a bank charter. In addition, the OTS may limit or restrict
activities of a savings and loan holding company which it determines create a
serious risk for subsidiary savings associations. As of December 31, 1996,
Allied qualified as a QTL, substantially exceeding the QTL test.
CAPITAL STANDARDS. The FRB, the OCC, the OTS, and other federal banking
agencies have risk based capital adequacy guidelines intended to provide a
measure of capital adequacy that reflects the degree of risk associated with a
banking organization's operations for both transactions reported on the balance
sheet as assets and transactions, such as letters of credit and recourse
arrangements, which are reported as off balance sheet items. Under these
guidelines, nominal dollar amounts of assets and credit equivalent amounts of
off balance sheet items are multiplied by one of several risk adjustment
percentages, which range from 0% for assets with low credit risk, such as
certain U.S. government securities, to 100% for assets with relatively higher
credit risk, such as business loans.
12
A banking organization's risk based capital ratios are obtained by dividing
its qualifying capital by its total risk-adjusted assets and off balance sheet
items. The regulators measure risk-adjusted assets and off balance sheet items
against both total qualifying capital (the sum of Tier 1 capital and limited
amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists of
common stock, retained earnings, noncumulative perpetual preferred stock and
minority interests in certain subsidiaries, less most other intangible assets.
Tier 2 capital may consist of a limited amount of the allowance for possible
loan and lease losses and certain other instruments with some characteristics of
equity. The inclusion of elements of Tier 2 capital is subject to certain other
requirements and limitations imposed by the federal banking agencies. Since
December 31, 1992, the federal banking agencies have required a minimum ratio of
qualifying total capital to risk- adjusted assets and off balance sheet items of
8%, and a minimum ratio of Tier 1 capital to risk-adjusted assets and off
balance sheet items of 4%.
In addition to the risk-based guidelines, federal banking regulators
require banking organizations to maintain a minimum amount of Tier 1 capital to
average total assets, referred to as the leverage ratio. For a banking
organization rated in the highest of the five categories used by regulators to
rate banking organizations, the minimum leverage ratio of Tier 1 capital to
average total assets is 3%. It is improbable, however, that an institution with
a 3% leverage ratio would receive the highest rating by the regulators since a
strong capital position is a significant part of the regulators' rating. For
all banking organizations not rated in the highest category, the minimum
leverage ratio is at least 100 to 200 basis points above the 3% minimum. Thus,
the effective minimum leverage ratio, for all practical purposes, is at least 4%
or 5%. In addition to these uniform risk-based capital guidelines and leverage
ratios that apply across the industry, the regulators have the discretion to set
individual minimum capital requirements for specific institutions at rates
significantly above the minimum guidelines and ratios.
Savings associations (such as Allied) are also required to maintain minimum
tangible capital (generally the same as Tier 1 capital) of 1.5% of adjusted
total assets. Allied also has a minimum core capital ratio of 4% where core
capital is defined as Tier 1 capital to total assets. Allied had tangible and
core capital ratios of 7.06% as of December 31, 1996. During 1994, the OTS
issued a final rule regarding the types and amounts of intangible assets that
may be included in a savings association's capital for purposes of complying
with the minimum capital ratios. Under this rule, purchased mortgage servicing
rights ("PMSR's") and purchased credit card relationships ("PCCR's") may be
included in a savings association's regulatory capital but may not exceed, in
the aggregate, 50% of core capital, while PCCR's alone may not exceed 25% of
core capital. Savings associations may include in tangible capital the same
dollar amounts of PMSR's that they include in core capital.
13
As required by FDICIA, the OTS has added an interest rate risk component to
its risk-based capital rules. Under the new regulation, for which no effective
date has been set, any thrift institution regulated by the OTS deemed to have an
"above-normal" level of interest rate exposure will be required to deduct an
interest rate risk ("IRR") component from its total capital when determining its
compliance with the risk based capital requirements. An "above normal" level of
interest rate risk exposure is a projected decline in the association's net
portfolio value of assets and liabilities that is greater than 2% of assets
resulting from a projected two percentage point swing in interest rates. The
IRR component will equal one-half of the difference between the institution's
measured interest rate exposure and the level of exposure deemed "normal."
Financial institutions subject to these regulations, including Allied but not
NBR or Redwood, are required to file IRR-related data with the OTS, which the
OTS will use to calculate, on a quarterly basis, the institution's interest rate
risk and IRR components.
A final rule regarding a market risk component of risk-based capital was
issued on September 6, 1996. The rule was issued jointly by the OCC, the Board
of Governors of the Federal Reserve System, and the FDIC. The final rule amends
the risk-based capital guidelines to incorporate a measure for market risk. A
bank subject to this rule must measure the market risk of the debt and equity
positions located in its trading account and of the foreign exchange and
commodity positions throughout the bank. The rule is consistent with the
amendment to the Capital Accord adopted by the Basle Committee on Banking
Supervision. If a bank is subject to this rule, its trading account debt and
equity positions and its commodity positions will no longer be included in the
capital calculation for credit risk. The existing counterparty credit
risk-based capital requirements for off-balance sheet transactions will,
however, continue to apply to all banks.
The OCC intends to apply the rule to a limited group of national banks with
significant trading activity. Specifically, the rule will apply to banks that
meet one of the following two criteria:
- the sum of the bank's trading assets and liabilities is at least 10
percent of total assets, or
- the sum of the bank's trading assets and liabilities exceeds $1
billion.
Additionally, the final rule provides the agencies with flexibility to
exempt from the rule banks that meet either of these two criteria. It also
allows the agencies to apply the rule on a case-by-case basis to any bank with
significant market risk exposure but which is not captured by the above
criteria. NBR does not meet any of the above criteria.
PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS. FDICIA requires
each federal banking agency to take prompt corrective action to resolve the
problems of insured depository institutions, including but not limited to those
that fall below one or more prescribed minimum capital ratios. The law required
each federal banking agency to promulgate regulations defining the following
five categories in which an insured depository institution will be placed, based
on the level of its capital ratios: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized.
14
In September 1992, the federal banking agencies issued uniform final
regulations implementing the prompt corrective action provisions of FDICIA. An
insured depository institution generally will be classified in the following
categories based on capital measures indicated below:
"WELL-CAPITALIZED"
Total risk-based capital of 10% or more;
Tier 1 risk-based ratio capital of 6% or more; and
Leverage ratio of 5% or more.
"ADEQUATELY CAPITALIZED"
Total risk-based capital of at least 8%;
Tier 1 risk-based capital of at least 4%; and
Leverage ratio of at least 4%.
"UNDERCAPITALIZED"
Total risk-based capital less than 8%;
Tier 1 risk-based capital less than 4%; or
Leverage ratio less than 4%.
"SIGNIFICANTLY UNDERCAPITALIZED"
Total risk-based capital less than 6%;
Tier 1 risk-based capital less than 3%; or
Leverage ratio less than 3%.
"CRITICALLY UNDERCAPITALIZED"
Tangible equity to total assets less than 2%.
An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized or undercapitalized may be treated as though
it were in the next lower capital category if the appropriate federal banking
agency, after notice and opportunity for hearing, determines that an unsafe or
unsound condition or an unsafe or unsound practice warrants such treatment. At
each successive lower capital category, an insured depository institution is
subject to more restrictions. The federal banking agencies, however, may not
treat an institution as "critically undercapitalized" unless its capital ratio
actually warrants such treatment.
15
The following tables present the capital ratios for NBR and Allied compared
to the standards for well-capitalized depository institutions, as of December
31, 1996.
Well- Minimum
Actual Capitlaized Requirement
---------------------------------------------
NBR
Leverage 6.87 5.00 4.00
Tier 1 risk-based 9.40 6.00 4.00
Total risk-based 12.28 10.00 8.00
ALLIED
Core 7.05 5.00 4.00
Tier 1 risk-based 9.42 6.00 4.00
Total risk-based 10.68 10.00 8.00
If an insured depository institution is undercapitalized, it will be
closely monitored by the appropriate federal banking agency. Undercapitalized
institutions must submit an acceptable capital restoration plan with a guarantee
of performance issued by the holding company. An undercapitalized depository
institution generally will not be able to acquire other banks or thrifts,
establish additional branches, or engage in any new lines of business unless
consistent with its capital plan. A "significantly undercapitalized"
institution will be subject to additional restrictions on its affiliate
transactions, the interest rates paid by the institution on its deposits, asset
growth, the compensation of its senior executive officers, and other activities
deemed to pose excessive risk to the institution. Regulators may also order a
significantly undercapitalized institution to hold elections for new directors,
terminate any director or senior executive officer employed for more than 180
days prior to the time the institution became significantly undercapitalized, or
hire qualified senior executive officers approved by the regulators. Further
restrictions and sanctions are required to be imposed on insured depository
institutions that are "critically undercapitalized." The most important
additional measure is that the appropriate federal banking agency is required to
either appoint a receiver for the institution within 90 days or obtain the
concurrence of the FDIC in another form of action.
16
In addition to measures taken under the prompt corrective action
provisions, commercial banking organizations may be subject to potential
enforcement actions by the federal regulators for unsafe or unsound practices in
conducting their businesses or for violations of any law, rule, regulation or
any condition imposed in writing by the agency or any written agreement with the
agency. Enforcement actions may include the imposition of a conservator or
receiver, the issuance of a cease-and-desist order that can be judicially
enforced, the termination of insurance of deposits (in the case of a depository
institution), the imposition of civil money penalties, the issuance of
directives to increase capital, the issuance of formal and informal agreements,
the issuance of removal and prohibition orders against institution-affiliated
parties and the enforcement of such actions through injunctions or restraining
orders based upon a prima facie showing by the agency that such relief is
appropriate. Additionally, a holding company's inability to serve as a source
of strength to its subsidiary banking organizations could serve as an additional
basis for a regulatory action against the holding company.
SAFETY AND SOUNDNESS STANDARDS. FDICIA also implemented certain specific
restrictions on transactions and required the regulators to adopt overall safety
and soundness standards for depository institutions related to internal control,
loan underwriting and documentation, and asset growth. Among other things,
FDICIA limits the interest rates paid on deposits by undercapitalized
institutions, the use of brokered deposits and the aggregate extensions of
credit by a depository institution to an executive officer, director, principal
stockholder or related interest, and reduces deposit insurance coverage for
deposits offered by undercapitalized institutions for deposits by certain
employee benefits accounts.
In addition to the statutory limitations, FDICIA requires the federal
banking agencies to prescribe, by regulation, standards for all insured
depository institutions for such things as classified loans and asset growth.
In July 1992, the federal banking agencies issued a joint advance notice of
proposed rule making requesting public comment on the safety and soundness
standards. Although final regulations are required by law to be issued by
August 1, 1993 and to become effective no later than December 1, 1993, final
regulations have not yet been issued.
In December 1992, the federal banking agencies issued final regulations
prescribing uniform guidelines for real estate lending. The regulations, which
became effective on March 19, 1993, require insured depository institutions to
adopt written policies establishing standards, consistent with such guidelines,
for extensions of credit secured by real estate. The policies must address loan
portfolio management, underwriting standards and loan to value limits that do
not exceed the supervisory limits prescribed by the regulations.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS. The power of the board
of directors of an insured depository institution to declare a cash dividend or
other distribution with respect to capital is subject to statutory and
regulatory restrictions which limit the amount available for such distribution
depending upon the earnings, financial condition and cash needs of the
institution, as well as general business conditions. FDICIA prohibits insured
depository institutions from paying management fees to any controlling persons
or, with certain limited exceptions, making capital distributions, including
dividends, if, after such transaction, the institution would be
undercapitalized.
17
The payment of dividends by a national bank is further restricted by
additional provisions of federal law, which prohibit a national bank from
declaring a dividend on its shares of common stock unless its surplus fund
exceeds the amount of its common capital (total outstanding common shares times
the par value per share). Additionally, if losses have at any time been
sustained equal to or exceeding a bank's undivided profits then on hand, no
dividend shall be paid. Moreover, even if a bank's surplus exceeded its common
capital and its undivided profits exceed its losses, the approval of the OCC is
required for the payment of dividends if the total of all dividends declared by
a national bank in any calendar year would exceed the total of its net profits
of that year combined with its retained net profits of the two preceding years,
less any required transfers to surplus or a fund for the retirement of any
preferred stock. A national bank must consider other business factors in
determining the payment of dividends. The payment of dividends by NBR is
governed by NBR's ability to maintain minimum required capital levels and an
adequate allowance for loan losses. Regulators also have the authority to
prohibit a depository institution from engaging in business practices which are
considered to be unsafe or unsound, possibly including payment of dividends or
other payments under certain circumstances even if such payments are not
expressly prohibited by statute. As of December 31, 1996, NBR had the ability
to dividend $3,758,000 to Redwood without prior regulatory approval.
Federal savings banks, such as Allied, which meet the minimum capital
requirements described above (see "CAPITAL STANDARDS," above) may distribute as
dividends up to 100% of their current net income plus an amount that would
reduce by one-half its surplus capital ratio at the beginning of the calendar
year. A federal savings bank which equals or exceeds current minimum capital
requirements may distribute up to 75% of its net income for the most recent four
quarters, depending upon its level of compliance with its risk-based capital
requirements. A federal savings bank not meeting minimum capital requirements
may not make any capital distribution without the prior written approval of the
OTS. In any event, the OTS must be given 30-days' advance written notice of all
proposed capital distributions by federal savings banks. Upon application, the
OTS may, in its discretion, allow capital distributions in excess of those
permitted by its regulations. In addition to the foregoing restrictions, in
1990 Redwood entered into a Capital Maintenance/Dividend Agreement (the "Capital
Maintenance Agreement") with the OTS as a condition to its acquisition of
Allied. Under the terms of the Capital Maintenance Agreement, Redwood may not
accept from Allied, or cause Allied to pay, any dividend (1) without the prior
written approval of the OTS if, and as long as, Allied's capital falls or
remains below the applicable minimum capital requirements of the OTS, (2) if
Allied's capital is below the current capital requirements of the OTS, or (3) if
payment of the dividend would cause Allied's capital to fall below the current
capital requirements of the OTS. In addition, the Capital Maintenance Agreement
prohibits Allied from paying dividends in excess of its cumulative net income
for the prior eight quarters, less cumulative dividends paid during that period,
without prior OTS approval, even when Allied's capital exceeds its capital
requirements. As of December 31, 1996, Allied had the ability to dividend
$1,205,000 to Redwood.
18
PREMIUMS FOR DEPOSIT INSURANCE AND ASSESSMENTS FOR EXAMINATIONS. FDICIA
established several mechanisms to increase funds to protect deposits insured by
the BIF administered by the FDIC. The FDIC is authorized to borrow up to $30
billion from the U.S. Treasury; borrow from the Federal Financing Bank up to 90%
of the fair market value of assets of institutions acquired by the FDIC as
receiver; and borrow from depository institutions that are members of the BIF.
Any borrowings not repaid by asset sales are to be repaid through insurance
premiums assessed to member institutions. Such premiums must be sufficient to
repay any borrowed funds within 15 years and provide insurance fund reserves of
$1.25 for each $100 of insured deposits. The result of these provisions is that
the assessment rate on deposits of BIF members could increase in the future.
FDICIA also provides authority for special assessments against insured deposits.
No assurance can be given at this time as to what the future level of premiums
will be.
As required by FDICIA, the FDIC adopted a transitional risk-based
assessment system for deposit insurance premiums which became effective
January 1, 1993. Under this system, depository institutions are charged
anywhere from 23 cents to 31 cents for every $100 in insured domestic deposits,
based on such institutions' capital levels and supervisory subgroup assignment.
The FDIC has adopted a permanent risk-based assessment system, which
incorporates the same basic rate structure. The limited changes adopted by the
FDIC are those it proposed in December 1992. These amendments clarify the basis
on which supervisory subgroup assignments are made by the FDIC, eliminate from
the assessment classification review procedure the specific reference to an
"informal hearing," provide for the assignment of new institutions to the "well
capitalized" assessment group, clarify that an institution is to make timely
adjustments as appropriate, clarify the basis, and report data, on which capital
group assignments are made for insured branches of foreign banks, and expressly
address the treatment of certain lifeline accounts for which special assessment
treatment is given. FDICIA prohibits assessment rates from falling below the
current annual assessment rate of 23 cents per $100 of eligible deposits if the
FDIC has outstanding borrowings from the United States Treasury Department or
the 1.25% designated reserve ratio has not been met.
During 1995, the FDIC announced that the BIF had reached its mandated
reserve level, reducing insurance premiums on BIF-insured deposits, and
accordingly deposit insurance premiums on BIF-insured deposits were reduced. On
September 30, 1996 Congress passed a bill which addressed the deposit insurance
premium differential between BIF and SAIF insured deposits. As a result, a
one-time insurance premium charge was assessed on SAIF-insured deposits to bring
the SAIF reserves to the mandated level. Calculated at .675% of Allied's
deposits at March 31, 1995, the resulting charge to the Company was $2,192,000.
Such charge was recorded in the third quarter of 1996.
19
The FDIC finalized a rule on November 26, 1996 amending its regulation
regarding Oakar institutions. Oakar institutions are those insured institutions
that maintain both BIF and SAIF insured deposits. Upon consummation of the
merger with Allied, NBR will be an "Oakar institution". Pursuant to the final
rule, at merger date the adjusted attributable deposit amount ("AADA") will be
calculated. For NBR, the AADA represents the assessable deposits attributable
to the secondary insurance fund (SAIF). The AADA at merger date equals the
amount of deposits maintained by Allied at the merger date. Subsequent
increases or decreases of the AADA occur at the same rate of NBR's overall
deposit base due to ordinary business operations. Deposit growth through
acquisition will not affect the AADA attributable to the Allied merger. When an
Oakar institution sells deposits, it sells deposits insured by its primary fund,
which for NBR is the BIF.
FDICIA requires all insured depository institutions to undergo a
full-scope, on-site examination by their primary federal banking regulator at
least once every 12 months. The cost of examinations of insured depository
institutions and any affiliates may be assessed by the appropriate federal
banking agency against each institution or affiliate as it deems necessary or
appropriate.
RECENTLY ENACTED AND PROPOSED LEGISLATION. The United States Department of
the Treasury has issued a proposal to consolidate the federal bank regulatory
agencies. Under this proposal, the supervisory and regulatory oversight
authority of the FDIC, the FRB, the OCC, and the OTS would be transferred to a
new independent federal banking agency, although the FRB would continue to carry
out monetary and fiscal policy, discount window operations, and payments system
functions and the FDIC would continue to have oversight over the deposit
insurance funds. At the present time, due to the preliminary nature of the
proposals the Company cannot determine what, if any, effect such a consolidation
of regulatory agencies would have on its operations.
In September of 1994 the Riegle Community Development and Regulatory
Improvement Act (the "Riegle Act") and the Riegle-Neal Interstate Banking and
Branching Efficiency Act (the "Riegle-Neal Act") became law. The Riegle Act is
intended to reduce much of the federal red tape with which financial
institutions have had to contend, providing about fifty different kinds of
specific relief. Among other things, the Riegle Act requires the federal
regulatory agencies to set up regulatory appeals systems and an ombudsman
system, streamlines the examination process, simplifies the audit requirements
for CAMEL 1 or 2 rated institutions with less than $5 billion in assets,
requires the regulatory agencies to take into account the size and activities of
financial institutions in issuing certain risk-related capital rules,
streamlines the application process for bank holding company activities, and
simplifies certain Truth-in-Lending rules. The Riegle Act also provides for new
consumer protections with respect to certain high cost home mortgages, amends
securities, banking, pension, and tax laws to encourage securitization of small
business loans and the development of a secondary market for pools of such
loans, and permits lenders to participate in capital access programs designed to
encourage lenders to make loans to small and medium sized businesses.
20
The Riegle-Neal Act allows adequately capitalized and managed bank holding
companies, with the approval of the FRB, to acquire control of, or to acquire
all or substantially all of the assets of, banks in any State, commencing in
September of 1995. States are permitted, however, to pass legislation either
providing for earlier approval of such mergers or prohibiting interstate mergers
entirely. California had already adopted legislation permitting interstate
mergers. Additionally, the Riegle-Neal Act permits the federal bank regulatory
agencies to approve merger transactions between insured banks having different
home states, without regard to the laws of either of the States involved, unless
between September 1994 and June 1, 1997 one of the involved States has enacted a
law prohibiting expressly prohibiting merger transactions involving out-of-state
banks.
The Economic Growth and Regulatory Paperwork Reduction Act (the "1996 Act")
as part of the Omnibus Appropriations Bill was enacted on September 30, 1996 and
includes many banking related provisions. The most important banking provisions
is the recapitalization of the SAIF. The 1996 Act provides for a one-time
assessment of approximately 65 basis point per $100 of deposits of SAIR insured
deposits including Oakar deposits payable on November 30, 1996. For the years
1997 through 1999 the banking industry will assist in the payment of interest on
FICO bonds that were issued to help pay for the clean-up of the savings and loan
industry. Banks will pay approximately 1.3 cents per $100 of deposits for this
special assessment, and after the year 2000, banks will pay approximately 2.4
cents per $100 of deposits until the FICO bonds mature in 2017. There is a
three year moratorium on conversions of SAIF deposits to BIF deposits. The 1996
Act also has certain regulatory relief provisions for the banking industry.
Lender liability under the Superfund is eliminated for lenders who foreclose on
property that is contaminated provided that the lenders were not involved with
the management of the entity that contributed to the contamination. There is a
five year sunset provision for the elimination of civil liability under the
Truth in Savings Act. The FRB and the Department of Housing and Urban
Development are to develop a single format for Real Estate Settlement Procedures
Act and Truth in Lending Act ("TILA") disclosures. TILA disclosures for
adjustable mortgage loans are to be simplified. Significant revisions are made
to the Fair Credit Reporting Act ("FCRA") including requiring that entities
which provide information to credit bureaus conduct an investigation if a
consumer claims the information to be in error. Regulatory agencies may not
examine for FCRA compliance unless there is a consumer complaint investigation
that reveals a violation or where the agency otherwise finds a violation. In
the area of the Equal Credit Opportunity Act, banks that self-test for
compliance with fair lending laws will be protected from the results of the test
provided that appropriate corrective action is taken when violations are found.
Bills are regularly introduced in the United States Congress which contain
wide-ranging proposals for altering the structures, regulations, and competitive
relationships of the nation's financial institutions. It cannot be predicted
whether or in what form any proposed legislation will be adopted, or the extent
to which the business of the Company may be affected by such legislation.
21
COMPETITION
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. Among the advantages of the
larger of these institutions are their ability to make larger loans, finance
extensive advertising campaigns, access international money markets and to
generally allocate their investment assets to regions of highest yield and
demand. Major commercial banks, savings and loans in California, and certain
national mortgage companies operating in the Company's primary market area
dominate the commercial banking and mortgage banking industries with large
branch systems and loan production offices operating over a wide geographical
area.
In order to compete with the other financial institutions in its primary
market area, the Company relies principally upon local directors and employees,
extended hours and quick turnaround on loan requests. The Company's promotional
activities emphasize the advantages of dealing with a locally-owned and
headquartered institution attuned to the particular needs of the community. For
customers whose loan demands exceed the Company's lending limit, the Company
attempts to arrange for such loans on a participation basis with its
correspondent banks.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
SALES.
Not applicable.
CERTAIN IMPORTANT CONSIDERATIONS FOR INVESTORS
MORTGAGE BANKING 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. The following is a table of mortgage banking revenues
and operating profits for the last three years.
Year Ended December 31,
1996 1995 1994
------------------------------------------
(in thousands)
Revenue $19,382 $16,089 $16,269
Operating (loss) profit (1,109) 138 (9,821)
22
The Company seeks to minimize its interest rate risk by monitoring its
exposure to potential losses from shifts in interest rates on a daily basis and
hedging that exposure through the use of various financial instruments,
including derivatives. These investments include purchased put options and
forward commitments to sell mortgage loans and mortgage-backed securities to
investors. The Company uses software developed by an independent party to
evaluate its daily hedging position and the potential impact of various changes
in interest rates. Interest rate fluctuations, however, can leave the Company
unable to adjust its hedging position in a timely manner, and could have a
material adverse effect on the Company's results of operations. 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
historic levels.
INTEREST RATE RISK. The Company's profitability may be adversely affected
by rapid changes in interest rates. The Company is substantially dependent on
mortgage banking activity, which can fluctuate significantly with interest rate
movements. The Company's ability to manage its net interest margin depends on
the volume of commercial loans compared to residential mortgage loans.
Additionally, the volume of adjustable rate mortgage loans ("ARMs") compared to
fixed rate mortgage loans can impact the net interest margin. ARMs can be
originated with initial rates at or below the cost of funding the loans and
reduce the net interest margin while the loans are held until the loans reprice.
A decline in net interest margin can result from fixed rate loans in a rising
rate environment as the Company's cost of funding loans rises. In a declining
rate environment, refinancing of fixed rate loans can inhibit an increase in the
net interest margin.
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
elimination of all merchants in the travel business and the discontinuance of
other high-risk accounts.
CONCENTRATION OF LENDING ACTIVITIES. Concentration of the Company's
lending activities in the real estate sector, including construction loans could
have the effect of intensifying the impact on the Company of adverse changes in
the real estate market in the Company's lending areas. At December 31, 1996,
approximately 84% of the Company's loans were secured by real estate, of which
27% 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 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.
23
DIVIDENDS. Beginning with the fourth quarter of 1992, Redwood paid a
quarterly dividend on its Common Stock each quarter until the fourth quarter of
1994, when the payment of Common Stock dividends was suspended indefinitely by
the Board of Directors. There can be no assurance that such dividend payments
will be resumed in the future. Federal regulatory agencies have the authority
to prohibit the payment of dividends by NBR and Allied to Redwood if a finding
is made that such payment would constitute an unsafe or unsound practice, or if
NBR or Allied became undercapitalized. If NBR or Allied are restricted from
paying dividends, Redwood could be unable to pay dividends on either its Common
or its Preferred Stock. In addition, the payment of dividends by Redwood is
limited by California law and subject to the discretion of the Board of
Directors of Redwood. No assurance can be given as to the ability of the
Company's subsidiaries to pay dividends to Redwood, the ability of Redwood to
continue or resume paying dividends in accordance with prior practice or at all,
or the determination by the Board of Directors that payment of any such dividend
will be appropriate under the circumstances. Under applicable law and
regulations, at December 31, 1996, Allied and NBR were able to pay up to
$1,205,000 and $3,758,000 in additional dividends to Redwood. See "REGULATION
AND SUPERVISION--RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS," above.
GOVERNMENT REGULATION. Redwood and its subsidiaries are subject to
extensive federal and state governmental supervision, regulation and control,
and future legislation and government policy could adversely affect the
financial industry. Although the full impact of such legislation and regulation
cannot be predicted, future changes may alter the structure of and competitive
relationship among financial institutions. See "REGULATION AND SUPERVISION,"
above.
COMPETITION FROM OTHER FINANCIAL INSTITUTIONS. 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. See "COMPETITION," above.
24
ITEM 2. PROPERTIES
The Company owns two depository branches and leases seventeen other
locations and equipment used in the normal course of business. There are no
contingent rental payments and the Company has three sublease arrangements.
Total rental expenses under all leases, including premises, totaled $2,258,000,
$2,172,000 and $2,336,000, in 1996, 1995 and 1994. The expiration dates of the
leases vary, with the last such lease expiring during 2009.
The Company enters into leases for premises and equipment as the Company
expands its business. The Company maintains insurance coverage on its premises,
leaseholds and equipment, including business interruption and record
reconstruction coverage. Management believes that there are no premises
occupied that could not be relocated with minimal impact.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending against the Company to
which the Company is a party or to which any of its properties is subject,
except ordinary routine litigation incidental to the businesses of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 1996.
25
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Redwood's Common Stock is publicly traded on the American Stock Exchange.
Market information for Redwood's Common Stock for the two most recent fiscal
years can be found under the heading "Quarterly Results" of the 1996 Annual
Report to Shareholders, and is by this reference incorporated herein. As of
December 31, 1996 there were 610 shareholders of record of Redwood's Common
Stock.
Redwood declared quarterly cash dividends on its Common Stock at the rate
of $.03 per share for the fourth quarter of 1992 and the first three quarters of
1993. In the fourth quarter of 1993, the Common Stock dividend was increased to
$.035 per share, and it remained at that level through the first three quarters
of 1994. The Common Stock dividend was suspended during the fourth quarter of
1994. See Item 8 "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA--NOTE P OF
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OF REDWOOD EMPIRE BANCORP," below.
Dividends from NBR and Allied are a primary source of cash for Redwood.
There are regulatory limitations on cash dividends that may be paid by NBR and
Allied to Redwood which could limit Redwood's ability to pay dividends. Federal
regulatory agencies have the authority to prohibit the payment of dividends by
NBR and Allied if a finding is made that such payment would constitute an unsafe
or unsound practice, or if NBR or Allied became critically undercapitalized.
Redwood is not subject to any prohibitions or limitations imposed on its ability
to pay dividends by any regulatory agency, although it has entered into a
Capital Maintenance/Dividend Agreement with the OTS with respect to the payment
of dividends by Allied. See Item 1(c) "NARRATIVE DESCRIPTION OF BUSINESS--
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS," above.
26
ITEM 6. SELECTED FINANCIAL DATA
SUMMARY OF CONSOLIDATED FINANCIAL DATA AND PERFORMANCE RATIOS
At or for the Year ended December 31,
------------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENTS OF OPERATIONS:
Total interest income $45,784 $47,374 $38,005 $27,465 $21,459
Net interest income 23,141 19,703 17,339 14,980 11,087
Provision for loan losses 6,262 1,590 1,095 1,679 2,272
Other operating income 19,570 16,575 10,885 19,177 12,327
Net (loss) income (1,486) 3,313 (3,035) 4,564 2,609
Net (loss) income available to common equity (1,935) 2,977 (3,483) 4,132 2,609
BALANCE SHEETS:
Total assets $499,466 $557,910 $630,652 $471,674 $326,730
Total loans 347,414 368,224 384,569 210,257 185,366
Mortgage loans held for sale 29,487 62,620 138,003 168,619 68,186
Allowance for loan losses 7,040 5,037 5,787 5,209 4,320
Total deposits 436,450 458,393 469,008 351,775 295,100
Shareholders' equity 29,732 31,585 28,194 31,576 22,251
PERFORMANCE RATIOS:
Return on average assets (.28%) .57% (.56%) 1.21% .97%
Return on average common equity (7.43) 12.37 (13.17) 17.39 13.80
Common dividend payout ratio N/A N/A N/A 7.70 2.76
Average equity to average assets 5.96 5.14 5.90 7.56 7.01
Leverage ratio 5.45 5.14 4.08 6.99 6.88
Tier 1 risk-based capital ratio 7.63 7.24 6.55 10.72 10.50
Total risk-based capital ratio 12.11 11.68 10.75 16.04 11.76
Net interest margin 4.64 3.63 3.40 4.20 4.48
Other operating expense to net interest
income and other operating income 91.19 79.98 113.46 72.06 70.51
Average earning assets to average
total assets 93.46 93.50 93.39 94.32 91.93
Nonperforming assets to total assets 2.64 1.28 1.34 1.72 1.94
Net loan charge-offs to average loans 1.22 .60 .40 .40 .53
Allowance for loan losses to total loans 2.03 1.37 1.50 2.48 2.33
Allowance for loan losses to nonperforming loans 67.82 101.88 104.97 122.65 104.15
SHARE DATA:
Common shares outstanding (000) 2,749 2,679 2,663 2,598 2,470
Book value per common share $8.72 $9.64 $8.43 $9.94 $9.01
Primary (loss) earnings per share (.71) 1.11 (1.31) 1.54 1.11
Fully diluted (loss) earnings per share (.71) 1.04 (1.31) 1.44 1.10
Cash dividend per common share --- --- .105 .125 .03
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Redwood Empire Bancorp ("Redwood" and with its subsidiaries, the "Company")
is a financial institution holding company headquartered in Santa Rosa,
California.
The Company's business strategy involves two principal business activities,
commercial banking and mortgage banking which are conducted through its two
principal subsidiaries, National Bank of the Redwoods, a national bank ("NBR"),
and Allied Bank, F.S.B., a federal savings bank ("Allied"). Commercial banking
activities include portfolio lending, including construction loans, the
origination for sale and servicing of Small Business Administration ("SBA")
loans, various deposit programs and numerous fee-based services. Mortgage
banking activities relate principally to the origination of mortgage loans for
sale, servicing of mortgage loans sold to investors, and sale and purchase of
mortgage loans and servicing rights.
The Company derives its income from three principal sources: (1) net
interest income, which is the difference between the interest income it receives
on interest-earning assets and the interest expense it pays on interest-bearing
liabilities; (2) mortgage banking operations, which involve the origination for
sale and sale of real estate secured loans, the sale of mortgage loan servicing
rights, and mortgage loan servicing fee income on loans serviced; and (3) fee
income, which includes fees earned on deposit services, income from SBA lending,
electronic-based cash management services and merchant credit card processing.
In November 1996, the Board of Directors voted to merge Allied into NBR.
The proposed combination of the two wholly-owned subsidiaries of Redwood will be
structured as a merger wherein Allied will be merged into NBR with NBR being the
surviving bank. As a result of the merger NBR will assume all of Allied's
rights and obligations. On February 3, 1997 NBR received approval from the
Office of the Comptroller of the Currency for the merger. Such merger is
expected to be completed by the end of the first quarter of 1997.
In the fourth quarter of 1996 the Company began a process to significantly
curtail its A paper wholesale mortgage loan production. As a result of this
process it is expected the Company will eliminate A paper wholesale mortgage
banking as a product line. As a result of this action the Company's future
mortgage loan production revenue and expenses will be significantly reduced from
historic levels.
Associated with the elimination of A paper wholesale mortgage banking and
the merger of Allied and NBR, the Company recorded restructuring charges of
$2,357,000 in the fourth quarter of 1996. For further discussion see "Financial
Statements and Supplementary Data - Note S of Notes to Consolidated Financial
Statements Redwood Empire Bancorp."
28
The following analysis of the Company's financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements of Redwood Empire Bancorp, related notes thereto. Average balances,
including such balances used in calculating financial and performance ratios,
are generally a blend of daily averages for NBR and for Allied, which management
believes are representative of the operations of the Company.
ACQUISITIONS
On November 4, 1994, NBR acquired Codding Bank, a California-chartered bank
headquartered in Rohnert Park, California ("Codding"). The purchase price of
Codding totalled $7,028,000 in cash, including merger related expenses. At the
merger date, the fair value of Codding's assets totalled approximately
$42,048,000, including loans of approximately $28,294,000 and investment
securities of approximately $7,935,000 and the fair value of liabilities assumed
was approximately $43,224,000, including deposits of $42,817,000. The Company
recorded goodwill of $1,176,000 which is being amortized over 15 years on a
straight-line basis. The Company's consolidated financial statements include
the results of Codding beginning October 31, 1994.
RESULTS OF OPERATIONS
The Company reported a net loss of $1,486,000, or $.71 per fully-diluted
common share for 1996. In 1995, the Company reported net income of $3,313,000,
or $1.04 per fully-diluted share. The Company's net loss in 1994 was $3,035,000
($1.31 per fully-diluted share).
Return on average assets for the year ended December 31, 1996 was a
negative .28%, as compared to .57% and a negative .56% for the years ended
December 31, 1995 and 1994. Return on average common equity was a negative
7.43% for the year ended December 31, 1996, as compared to 12.39% and a negative
13.22% for the years ended December 31, 1995 and 1994.
Several significant matters adversely impacted the Company in 1996. These
events include a provision for loan losses of $6,262,000, a pre-tax
restructuring charge of $2,357,000 associated with the merging of Allied into
NBR and the reduction of A paper wholesale mortgage banking, a pre tax charge of
$2,192,000 associated with SAIF deposit insurance fund recapitalization, and a
$1,200,000 charge to operations relating to the Company's obligation following
the bankruptcy of one of its merchant credit card customers.
29
In 1996, the Company's mortgage banking segment lost $1,109,000 on a
pre-tax basis as compared to a pre-tax operating profit in 1995 of $138,000 and
a pre-tax loss of $9,821,000 in 1994. Due to concerns regarding the future
profitability and risk of the "A paper" wholesale mortgage banking business, the
Company has decided to eliminate this line of business. As a result, future
operations of the Company's mortgage banking business will be comprised of its
sub-prime mortgage unit, Allied Diversified Credit, and retail "A paper"
mortgage brokerage. Accordingly, the Company's future mortgage loan production
revenue and expenses will be significantly reduced from historic levels. See
Note Q to the Consolidated Financial Statements for a description of operating
income and for additional information relating to the Company's two principal
business segments.
NET INTEREST INCOME. For 1996, the Company's net interest income
amounted to $23,141,000 as compared to $19,703,000 in 1995 and $17,339,000 in
1994. This represents an increase of $3,438,000 or 17% in 1996 and $2,364,000
or 14% in 1995. The increase in 1996 when compared to 1995 is due to an
increase in net interest margin from 3.63% in 1995 to 4.64% in 1996 partially
offset by a decline in earning assets from $542,408,000 in 1995 to $498,882,000
in 1996. The increase in 1995 when compared to 1994 is primarily attributable
to increasing earning assets from $509,912,000 in 1994 to $542,408,000 coupled
with a slight increase in net interest margin from 3.40% in 1994 to 3.63% in
1995.
30
The following table presents for the years indicated the distribution of
consolidated average assets, liabilities and shareholders' equity, as well as
the total dollar amounts of interest income from average earning assets and the
resultant yields, and the dollar amounts of interest expense and average
interest-bearing liabilities, expressed both in dollars and in rates.
Nonaccrual loans are included in the calculation of the average balances of
loans, and interest not accrued is excluded.
1996 1995
------------------------------------- -------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------------------------------------- -------------------------------------
(dollars in thousands)
ASSETS:
Portfolio loans $349,859 $35,919 10.27% $390,664 $38,052 9.74%
Mortgage loans held for sale 78,030 5,550 7.11 71,395 4,417 6.19
Investment securities 47,414 3,120 6.58 49,105 3,187 6.49
Federal funds sold 19,685 1,028 5.22 27,777 1,581 5.69
Interest-bearing deposits due
from financial institutions 3,894 167 4.29 3,467 137 3.95
--------------------- --------------------
Total earning assets 498,882 45,784 9.18 542,408 47,374 8.73
------- -------
Other assets 41,363 43,738
Less allowance for loan losses (6,473) (6,023)
-------- --------
Total average assets $533,772 $580,123
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Savings $150,650 6,076 4.03 $116,316 4,367 3.75
Other time deposits 239,028 13,851 5.79 304,396 18,363 6.03
Other borrowings 41,083 2,716 6.61 71,593 4,941 6.90
--------------------- ---------------------
Total interest-bearing liabilities 430,761 22,643 5.26 492,305 27,671 5.62
------ ------
Demand deposits 65,082 51,946
Other liabilities 6,136 6,054
Shareholders' equity 31,793 29,818
-------- --------
Total average liabilities and
shareholders' equity $533,772 $580,123
-------- --------
-------- --------
Net interest spread 3.92 3.11
Net interest income and
net interest margin $23,141 4.64 $19,703 3.63
-------- -------
-------- -------
1994
-------------------------------------
Average Yield/
Balance Interest Rate
-------------------------------------
ASSETS:
Portfolio loans $287,257 $26,057 9.07%
Mortgage loans held for sale 163,495 9,397 5.75
Investment securities 30,359 1,381 4.55
Federal funds sold 25,140 1,006 4.00
Interest-bearing deposits due
from financial institutions 3,661 164 4.48
---------------------
Total earning assets 509,912 38,005 7.45
------
Other assets 41,431
Less allowance for loan losses (5,353)
--------
Total average assets $545,990
--------
--------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Savings $114,266 3,679 3.22
Other time deposits 233,896 11,239 4.81
Other borrowings 105,009 5,748 5.47
---------------------
Total interest-bearing liabilities 453,171 20,666 4.56
------
Demand deposits 44,283
Other liabilities 16,339
Shareholders' equity 32,197
--------
Total average liabilities and
shareholders' equity $545,990
--------
--------
Net interest spread 2.89
Net interest income and
net interest margin $17,339 3.40
-------
-------
The Company's average earning assets for 1996 decreased approximately 8%,
or $43,526,000, to $498,882,000, as compared to $542,408,000 for 1995. Average
earning assets increased approximately 6% in 1995 as compared to 1994. The
decrease in average earning assets for 1996 is attributable to a 10% decline in
portfolio loans while the growth in average earning assets for 1995 and 1994 was
also derived from portfolio loans, principally construction loans, which
increased 36% for 1995 and 45% for 1994. Portfolio loans are the Company's
highest yielding category of earning assets.
In addition, the average balance of investment securities decreased
approximately 3% to $47,414,000 in 1996 as compared to $49,105,000 in 1995.
31
The following table sets forth changes in interest income and interest
expense for each major category of earning asset and interest-bearing liability,
and the amount of change attributable to volume and rate changes for the years
indicated. Changes not solely attributable to rate or volume have been
allocated to rate.
1996 over 1995 1995 over 1994
--------------------------------------------------------------
Volume Rate Total Volume Rate Total
--------------------------- ---------------------------
(in thousands)
Increase (decrease) in interest income:
Portfolio loans (1), (2) ($3,974) $1,841 ($2,133) $9,379 $2,616 $11,995
Mortgage loans held for sale 411 722 1,133 (5,296) 316 (4,980)
Investment securities (110) 43 (67) 853 953 1,806
Federal funds sold (460) (93) (553) 105 470 575
Interest-earning deposits with other institutions 17 13 30 (9) (18) (27)
--------------------------- --------------------------
Total increase (decrease) (4,116) 2,526 (1,590) 5,032 4,337 9,369
--------------------------- --------------------------
Increase (decrease) in interest expense:
Interest-bearing transaction accounts 1,288 421 1,709 66 622 688
Time deposits (3,942) (570) (4,512) 3,391 3,733 7,124
Other borrowings (2,106) (119) (2,225) (1,829) 1,022 (807)
--------------------------- --------------------------
Total increase (decrease) (4,760) (268) (5,028) 1,628 5,377 7,005
--------------------------- --------------------------
Increase (decrease) in net interest income $644 $2,794 $3,438 $3,404 ($1,040) $2,364
--------------------------- --------------------------
--------------------------- --------------------------
(1) Does not include interest income which would have been earned on nonaccrual
loans had such loans performed in accordance with their terms.
(2) Loan fees of $2,805,000, $2,112,000, and $1,611,000 are included in
interest income for 1996, 1995 and 1994.
(3) The average balance of securities classified as available for sale are
presented at historical amortized cost without the effects of the fair
value adjustments.
The net interest margin increased to 4.64% for the year ended December 31,
1996, as compared to 3.63% and 3.40% for the years ended December 31, 1995 and
1994. The increase in net interest margin in 1996 was primarily due to
increased yield on earning assets and decreased liability costs. The yield on
earning assets increased to 9.18% in 1996 compared to 8.73% in 1995 and 7.45% in
1994. In 1996, the Company increased its high-yielding construction loan
portfolio from an average of $49.0 million in 1995 to $78.2 million in 1996.
See "Loan Portfolio and Mortgage Banking". The increase in 1995 was due to the
seasoning of adjustable-rate mortgage loans in the portfolio as many of these
loans were originated in 1994 with "teaser" rates which reset to market in 1995.
32
The effective rates on interest-bearing liabilities decreased to 5.26% for
1996, as compared to 5.62% for 1995 and 4.56% for 1994. The decrease in 1996
was due to a 53% decline in high cost FHLB advances and a 21% decline in time
deposits . The increase in 1995 when compared to 1994 was due primarily to an
increase in high-cost time deposits and FHLB advances to fund mortgage loan
growth.
PROVISION FOR LOAN LOSSES. Annual fluctuations in the provision for loan
losses result from management's regular assessment of the adequacy of the
allowance for loan losses. The provision for loan losses was $6,262,000 for the
year ended December 31, 1996, which represents an increase of $4,672,000 or 294%
from 1995. The increase in the provision for loan losses in 1996 when compared
to 1995 relates to the deterioration of several major commercial loans, net loan
charge-offs of $4,259,000, and an increase in non performing construction loans.
In 1995, the provision for loan losses of $1,590,000 represented a 45% increase
from $1,095,000 in 1994. This increase was primarily due to net loan charge-
offs of $2,340,000.
Outstanding construction loans at December 31, 1996 represent 24% of total
portfolio loans. Construction lending generally bears a higher degree of risk
than other major portfolio lending programs the Company maintains. Factors
that could affect the quality of the construction loan portfolio include
regional economic conditions, adverse changes in the real estate market,
increasing interest rates or acts of nature such as earthquakes. Such events
could have an adverse impact on the level of future provisions for loan losses
and the Company's earnings. See further discussion in "Asset Quality".
OTHER OPERATING INCOME. Other operating income increased 18%, or
$2,995,000, to $19,570,000, for 1996, as compared to $16,575,000 for 1995. The
Company's other operating income for 1995 represented an increase of $5,690,000
or 52% from the $10,885,000 it received during 1994. The following table sets
forth the sources of other operating income for the years ended December 31,
1996, 1995 and 1994.
Year Ended December 31,
1996 1995 1994
---------------------------
(in thousands)
Service charges on deposit accounts $1,224 $1,148 $1,009
Merchant draft processing, net 1,849 1,505 1,168
Loan servicing income 1,619 1,625 1,943
Net realized gains (losses) on sale of
investment securities available for sale (3) 386 (24)
Gain on sale of loans and loan servicing 12,328 10,195 5,448
Other income 2,553 1,716 1,341
------- ------- -------
$19,570 $16,575 $10,885
------- ------- -------
------- ------- -------
33
The primary cause of the increase in the Company's other operating income
was the increased gain on sale of loans and loan servicing of $2,133,000 in 1996
over 1995. In the third and fourth quarter of 1996 the Company sold mortgage
loan servicing rights which resulted in a gain of $2,153,000. In 1995 gain on
sale of loans and loan service amounted to $10,195,000 as compared to $5,448,000
in 1994. As a result of an improved interest rate environment and higher
demand, in the first half of 1995 the Company was able to sell its $110 million
of COFI-based mortgage loans held for sale whose carrying amount had been
adjusted at December 31, 1994 by a $5,534,000 valuation allowance. As a result,
the Company recorded a gain of approximately $2,300,000 in 1995 associated with
the disposition of these loans. For further discussion see "Mortgage Banking".
Loan servicing revenues slightly decreased to $1,619,000 for the year ended
December 31, 1996, compared to $1,625,000 and $1,943,000 in 1995 and 1994. Due
to the loan servicing sale discussed above, future loan servicing income will be
significantly less than what was recorded in 1996 and 1995. In addition, future
loan servicing income will be dependent on prepayments of loans held in the
Company's servicing portfolio, the volume of additional loans added to this
portfolio and any future bulk servicing sales. See "Mortgage Banking" and Note
B of Notes to Consolidated Financial Statements.
Other income amounted to $2,553,000 in 1996, $1,716,000 in 1995 and
$1,341,000 in 1994. In 1995, the Company sold securities available for sale as
part of its ongoing asset liability management strategies for a gain of $386,000
compared to losses of $24,000 recorded in 1994. See Note E of Notes to
Consolidated Financial Statements.
OTHER OPERATING EXPENSE. Other operating expense amounted to $38,946,000
in 1996, $29,016,000 in 1995 and $32,023,000 in 1994. This represents an
increase of $9,930,000 or 34% in 1996 and a decrease of $3,007,000 or 9% in
1995. The 1996 increase was a direct result of $2,357,000 in expenses
associated with the Company's restructuring plan, $2,192,000 resulting from a
one time insurance premium assessment attributable to SAIF-insured deposits, an
increase in salary and benefits of $2,783,000 and a $1,200,000 charge associated
with the bankruptcy of one of its merchant card customers. In 1995 the decrease
in other expense of $3,007,000 or 9% when compared to 1994 related primarily to
the Company's cost cutting measures enacted in the last half of 1994 and the
first half of 1995.
Salary and employee benefits expense and occupancy and equipment increased
each period. Salary and employee benefits expense for 1996 increased $2,783,000,
or 19%, to $17,151,000, as compared to $14,368,000 for 1995. This compared with
a 2% increase during 1995 over the 1994 salary and employee benefits expense of
$14,147,000. The increase in 1996 was attributable to a 53% increase in
commissions paid for mortgage loan production. The increases during 1995 and
1994 were due to the salaries and benefits resulting from higher
full-time-equivalent staff levels and general salary and benefit increases. The
Company's full-time-equivalent staff levels were 321, 353 and 336 at
December 31, 1996, 1995 and 1994, respectively.
34
Occupancy and equipment expense was $5,604,000 in 1996, $5,544,000 in 1995
and $5,025,000 in 1994. This represents an increase of 1%, or $60,000, over
1995 occupancy and equipment expense. This increase was primarily attributable
to annual lease payment increases. 1995 increases over 1994 amounted to
$519,000 which was due to the addition of three branch offices of NBR in late
1994 and annual lease payment increases.
In November, 1996 the Company's Board of Directors approved a plan to merge
its two wholly owned subsidiaries, National Bank of the Redwoods and Allied Bank
F.S.B. As a result of the merger, the surviving bank, National Bank of the
Redwoods, will assume all of Allied's rights and obligations. In connection
with the merger, and as a result of the Company's decision to significantly
curtail its wholesale mortgage banking production capacity, the Company recorded
a restructuring charge of $2,357,000 in the fourth quarter of 1996. The
restructuring of the Company, which includes both the merger of Allied into
National Bank of the Redwoods and the reduction in "A" paper wholesale lending,
includes the closing of the Portland and Sacramento mortgage loan production
offices, the partial write-off of Allied's administrative headquarters,
termination of employees, and write-off of duplicative or unnecessary fixed
assets. The total charge to operations associated with these matters consisted
of:
Severance for 70 employees $651,000
Accrual of discontinued leases 772,000
Writeoff of leasehold improvements,
furniture and fixtures 934,000
----------
$2,357,000
----------
----------
During the third and fourth quarters of 1994, the Company implemented major
cost reduction programs in response to declining origination volumes in the
Company's mortgage banking business and recorded a restructuring charge of
$815,000 in the third quarter and $1,594,000 in the fourth quarter. The
restructuring entailed closing wholesale mortgage production offices in Fresno,
San Diego, San Ramon and Windsor, California, Phoenix, Arizona and Seattle,
Washington. The charge also includes the effects of consolidation of leased
space in the Sacramento and Santa Rosa, California offices and termination of
related employees. The 1994 restructuring charge consisted of:
Severance for 125 employees $374,000
Accrual of discontinued leases 1,683,000
Writeoff of leasehold improvements,
furniture and fixtures 352,000
----------
$2,409,000
----------
----------
35
In 1995, the Company was able to sublease three properties allowing a
recovery of $456,000 related to leases discontinued in 1994.
At December 31, 1996, $1,808,000 of the restructuring charge remained in
other liabilities, substantially all of which is related to the future minimum
lease payments associated with the closed facilities. The Company is continuing
to seek sublease tenants for many of these closed facilities and an additional
portion of the restructuring charge may be reversed in future periods if the
Company is successful in entering into such arrangements. For further
discussion, see "Mortgage Banking."
The following table describes the components of other operating expense for
the years ended December 31, 1996, 1995 and 1994.
Year Ended December 31,
1996 1995 1994
---------------------------
(in thousands)
Professional fees $1,942 $2,187 $2,065
Regulatory expense and insurance 3,401 1,716 1,345
Postage and office supplies 1,715 1,224 1,013
Shareholder expenses and Director fees 406 486 950
Advertising 581 481 919
Telephone 758 778 782
Electronic data processing 1,216 1,022 775
Net costs of other real estate owned 451 163 609
Other 3,364 1,503 1,984
------- ------ -------
$13,834 $9,560 $10,442
------- ------ -------
------- ------ -------
Other expenses were $13,834,000 during 1996, an increase of $4,274,000, or
45%, over 1995 expenses of $9,560,000. This increase is primarily attributable
to a one time insurance premium charge assessed by Congress to SAIF-insured
deposits of $2,192,000, a $1,200,000 charge to other expenses relating to the
Company's obligation following the bankruptcy of one of its merchant credit card
customers and an increase in postage and office supplies of $491,000 due to an
increase in mortgage banking activity. The decrease during 1995 compared to
1994 was due to decreased mortgage banking related advertising and telephone
costs and decreased OREO expenses partially offset by higher regulatory and
insurance expenses.
INCOME TAXES. The Company's effective tax rate was a benefit of 40.5% in
1996, a provision of 41.6% in 1995 and a benefit of 38.0% in 1994. The benefit
recorded in 1994 was limited due to the absence of carrybacks and limitation on
carryforwards for California tax purposes.
36
LOAN PORTFOLIO
The Company concentrates its lending activities in three principal areas:
real estate mortgage loans (residential and commercial loans), real estate
construction loans and commercial loans. At December 31, 1996, these three
categories accounted for approximately 60%, 24% and 15%, respectively, of the
Company's loan portfolio. The interest rates charged for the loans made by the
Company vary with the degree of risk, the size and maturity of the loans, the
borrowers' depository relationships with the Company and prevailing money market
rates indicative of the Company's cost of funds.
Concentration of the Company's lending activities in the real estate sector
could have the effect of intensifying the impact on the Company of adverse
changes in the real estate market in the Company's lending areas. The ability
of the Company to continue to originate mortgage 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.
The following table sets forth the amounts of loans outstanding by category
as of the dates indicated. There were no concentrations of loans exceeding 10%
of total loans which are not otherwise disclosed as a category of loans in the
table below.
December 31,
--------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------------------------------------------------------------
(in thousands)
Residential real estate mortgage $128,025 $168,022 $222,822 $102,254 $83,273
Commercial real estate mortgage 80,366 65,655 61,347 35,909 25,051
Commercial 53,573 63,975 64,807 49,556 48,147
Real estate construction 84,517 69,504 33,348 21,476 20,598
Installment and other 3,730 4,103 5,063 3,033 9,804
Less deferred fees (2,797) (3,035) (2,818) (1,971) (1,507)
--------------------------------------------------------------------
Total loans 347,414 368,224 384,569 210,257 185,366
Less allowance for loan losses (7,040) (5,037) (5,787) (5,209) (4,320)
--------------------------------------------------------------------
Net loans $340,374 $363,187 $378,782 $205,048 $181,046
--------------------------------------------------------------------
--------------------------------------------------------------------
37
REAL ESTATE MORTGAGE LOANS. As of December 31, 1996, the Company's
residential mortgage loans totaled $128,025,000, or 37%, of its total loans.
These loans were predominantly originated in Sonoma and Mendocino Counties.
Total residential loans declined $39,997,000 during the year as a result of
normal prepayments and a continuing restructuring of Allied's balance sheet.
This 1996 restructuring was accomplished by a $34,000,000 loan sale in the
second quarter of 1996. The Company does not anticipate any further
restructuring of the Company's balance sheet through loan sales. In 1995, total
residential mortgage loans decreased $54,800,000. The decrease in residential
real estate loans is due primarily to loan sales of $35.9 million during the
second quarter of 1995. The sale was executed to restructure Allied's balance
sheet and consequently improve Allied's capital ratios and reduce its interest
rate risk. In addition, in the third quarter of 1995, the Company swapped $22.1
million of adjustable rate loans with Fannie Mae for a mortgage-backed security
which had a coupon rate of 7.295% and was scheduled to mature in 2025; this
security, which was classified as available for sale, was sold prior to
December 31, 1995, with settlement due from broker in January 1996.
The increase in residential mortgage loans in 1994 was directly
attributable to Allied's desire to increase its earning asset base. As a result
of the Company's acquisition of Lake on October 31, 1992, the Company's
residential real estate mortgage loan portfolio increased by approximately
$25 million during the fourth quarter of 1992. These loans were originated by
Lake, prior to its acquisition, throughout the greater San Francisco Bay Area.
The remaining increase in the Company's residential real estate mortgage loan
portfolio resulted from loans originated by the Company.
At December 31, 1996, $38 million, or 30%, of the Company's residential
real estate mortgage loans were fixed-rate mortgage loans having original terms
ranging from one to 30 years, with the majority having terms of five years or
less. Another $78 million, or 61%, were held as adjustable-rate mortgages,
substantially all of which adjust semi-annually, based on the Eleventh District
Cost-of-Funds Index published monthly by the FHLB. The balance of these loans,
$12 million, or 9%, consisted of multifamily loans, second mortgage loans and
loans on improved single-family lots. The majority of the Company's residential
mortgage loans have been underwritten for the Company's portfolio and do not
necessarily meet standard underwriting criteria for sale in the secondary
market. Approximately 66% of the total amount outstanding had principal balances
that were less than $300,000. The Company's residential real estate mortgage
loans predominately have loan-to-value ratios of 80% or less, using current loan
balances and appraised values as of the time of origination. The Company's
general policy is not to exceed an 80% loan-to-value ratio on residential
mortgage loans without mortgage insurance. The Company generally does not make
portfolio loans on a negative amortization basis.
38
As of December 31, 1996, the Company had outstanding $80,366,000 in
commercial mortgage loans, which constituted 23% of total loans. These loans
were primarily secured by owner-occupied commercial properties and have 5- to
15-year maturities based upon 25- to 30-year amortization periods. The ratio of
the loan principal amount to appraised values are generally 75% or less, using
appraised values at the time of loan origination, and the loans are
predominantly for owner-occupied small office buildings or office/warehouses.
The Company originates commercial mortgage loans that are guaranteed by the SBA
up to 70% to 90% of the balance. The SBA guaranteed portion of such loans are
sold into the secondary market with the unguaranteed principal balance retained.
The aggregate retained unguaranteed principal balance of such loans was $13.2
million at December 31, 1996. Approximately 27% of the total amount outstanding
of commercial mortgage loans had principal balances that were less than
$250,000.
The Company also originates residential mortgage loans for sale. See
"Mortgage Banking."
REAL ESTATE CONSTRUCTION LOANS. Real estate construction loans are
primarily for residential housing. The primary market focus is toward
individual borrowers and small residential and commercial projects. The
economic viability of the project and the borrower's past development record and
creditworthiness are primary considerations in the loan underwriting decision.
The Company had $84,517,000 in construction loans outstanding at December 31,
1996, comprising 24% of its total loans. These loans were principally located
in Northern California. This represents an increase of $15,013,000 or 22% from
1995. In 1995 construction loans increased $36,156,000 or 108% from 1994.
Approximately $49 million of these loans consisted of 286 single-family
individual-borrower construction loans, and the remaining loans included 135
subdivision projects, 21 land development projects and two commercial projects.
At December 31, 1996, the largest single-family construction loan commitment was
$932,000, and the average commitment was less than $245,000. The largest
commitment for a subdivision project was $1.5 million, and the average
subdivision commitment was less than $480,000. The average commercial project
involved a loan of approximately $340,000.
Construction loans are funded on a line-item, percentage of completion
basis. As the builder completes various line items (foundation, framing,
electrical, etc.) of the project, or portions of those line items, the work is
reviewed by one of several independent inspectors hired by the Company. Upon
approval from the inspector, the Company funds the draw request according to the
percentage completion of the line items that have been approved. The Company
rotates inspectors during construction to insure independent review. Actual
funding checks must be signed by an officer of the Company, and that officer
must also initial the line-item worksheet used to support the draw request. In
addition, senior management routinely inspects the various construction
projects, all of which are located in the Company's lending area.
39
Commercial real estate mortgage and construction lending contains potential
risks which are not inherent in other types of commercial loans. These
potential risks include declines in market values of underlying real property
collateral and, with respect to construction lending, delays or cost overruns
which could expose the Company to loss. In addition, risks in commercial real
estate lending include declines in commercial real estate values, general
economic conditions surrounding the commercial real estate properties, and
vacancy rates. A decline in the general economic conditions or real estate
values within the Company's market area could have a negative impact on the
performance of the loan portfolio or value of the collateral. Because the
Company lends primarily within its market area, the real property collateral for
its loans is similarly concentrated, rather than diversified over a broader
geographic area. The Company could therefore be adversely affected by a decline
in real estate values in its primary market area even if real estate values
elsewhere in California remained stable or increased.
COMMERCIAL LOANS. Commercial loans consist primarily of short-term
financing for businesses and professionals located in Sonoma and Mendocino
Counties. At December 31, 1996, these loans totaled $53,573,000, or 15%, of the
Company's total loans. This represents a decrease of $10,402,000 or 16% from
1995. In 1995 commercial loans decreased $832,000 or 1% from 1994. The
commercial loans are diversified as to industries and types of businesses, with
no material industry concentrations. Commercial loan borrowers generally have
deposit relationships with the Company. The commercial loans can be unsecured or
secured by various assets, including equipment, receivables, deposits and other
assets. Commercial loans may be secured by commercial or residential property;
however they are not classified as mortgage loans since these loans are not
typically taken out for the purpose of acquiring real estate and the loans are
short-term. In these cases, the mortgage collateral is often taken as
additional collateral. As of December 31, 1996, the size of individual
commercial loans varied widely, with 99% having principal balances less than
$350,000. At December 31, 1996, the Company had 36 commercial borrowers whose
aggregate individual liability exceeded $1,000,000.
LOAN COMMITMENTS. In the normal course of business, there are various
commitments outstanding to extend credit that are not reflected in the financial
statements. Annual review of the commercial credit lines and ongoing monitoring
of outstanding balances reduces the risk of loss associated with these
commitments. As of December 31, 1996, the Company had outstanding $32,169,000
in unfunded mortgage loan commitments, $76,010,000 in undisbursed loan
commitments and $2,462,000 in standby letters of credit. The Company's
undisbursed commercial loan commitments represented primarily business lines of
credit. The undisbursed construction commitments represented undisbursed
funding on construction projects in process. The mortgage loan commitments
represented approved but unfunded mortgage loans with the Company's mortgage
banking business.
40
MORTGAGE BANKING
The Company's results of operations has been substantially effected by
mortgage banking activity, which can fluctuate significantly, in both volume and
profitability, with changes in interest rates. For 1996, mortgage banking loan
originations totaled $1.373 billion, or $534 million more than the $839 million
originated in 1995. 1995 mortgage loan originations were $234 million less than
the $1.073 billion originated in 1994. The mix of these originations in 1996
was approximately 88% fixed rate loans vs. 12% adjustable rate loans compared to
84% fixed, 16% variable for 1995, and 67% fixed rate loans vs. 33% adjustable
rate loans for 1994.
The following table represents the Company's residential mortgage banking
origination and sale activity for the years indicated.
Year Ended December 31,
----------------------------
1996 1995 1994
----------------------------
(in millions)
Mortgage banking loan originations $1,373 $839 $1,073
Increase (decrease) from prior period 64% (22%) (45%)
Mortgage banking loan sales $1,481 $878 $1,048
Increase (decrease) from prior period 69% (16%) (44%)
Mortgage banking revenue $19 $16 $16
Operating (loss) profit ($1,109) $138 ($9,821)
All of the Company's mortgage loans held for sale meet certain investor
underwriting criteria regarding loan-to-value ratios, maturities, yields and
related documentation. The majority of the loans sold by the Company have been
sold to either Fannie Mae, Freddie Mac or other institutional mortgage conduits.
These loans must conform to established Freddie Mac/Fannie Mae underwriting
criteria, including a maximum dollar limit, maturities that vary from five to 30
years, loan-to-value ratios of 80% or less (90% or less with mortgage
insurance), adequate borrower liquidity, and the ability of the borrower to
service the mortgage debt (and all other debt) out of income. Loans sold to
other investors, such as savings and loans, insurance companies and other
conduits, usually are for dollar amounts in excess of the Freddie Mac/Fannie Mae
limit, but otherwise generally meet standard Freddie Mac/Fannie Mae underwriting
criteria.
As part of its mortgage banking activities, the Company enters into forward
commitments to sell mortgage loans, either in the form of mortgage-backed
securities ("MBS") or as whole loans. These commitments may be optional or
mandatory. Under optional commitments, a commitment fee is paid and the Company
carries no risk in excess of the loss of such fee in the event that the Company
is unable to deliver sufficient mortgage loans to fulfill the commitment.
Mandatory commitments may entail possible financial risk to the Company if it is
unable to deliver mortgage loans in sufficient quantity or at sufficient rates
to meet the terms of the commitments.
41
In order to minimize the risk that a change in interest rates will result
in a decrease in the value of the Company's current mortgage loan inventory or
its commitments to purchase or originate mortgage loans ("committed pipeline"),
the Company enters into hedging transactions. The Company's hedging policies
generally require that its inventory of mortgage loans held for sale and the
maximum portion of its committed pipeline that may close be hedged with forward
sales of MBS or options to buy or sell mortgage-backed or U.S. Treasury
securities. As such, the Company is not exposed to significant risk nor will it
derive any significant benefit from changes in interest rates on the price of
the mortgage loan inventory net of gains or losses of associated hedge
positions. The correlation between the price performance of the hedge
instruments and the inventory being hedged is very high due to the similarity of
the asset and the related hedge instrument. The Company is exposed to interest-
rate risk to the extent that the portion of loans from the committed pipeline
that actually closes at the committed price is less than the portion expected to
close in the event of a decline in rates, and in the event such decline in
closings is not covered by forward contracts and options to purchase MBS needed
to replace the loans in process that do not close at their committed price. The
Company determines the portion of its committed pipeline that it will hedge
based on numerous factors, including the composition of the Company's committed
pipeline, the portion of such committed pipeline likely to close, the timing of
such closings and the current interest rate environment.
The following lists the notional amounts of the various hedging instruments
outstanding at December 31, 1996 and the date through which exercise dates
extend:
Exercise Dates
Notional Amount Extend Through
----------------------------------
(in thousands)
Forward contracts to sell MBS $27,063 March 1997
Purchased put options:
U.S. Treasury 15,000 March 1997
Purchased call options - U.S. Treasury 7,500 March 1997
MORTGAGE LOAN SERVICING. Mortgage loan servicing includes the collection
and remittance of loan payments, accounting for principal and interest, holding
escrow (impound) funds for payment of taxes and insurance, making inspections of
the mortgage premises when required, collection of past due amounts from
delinquent mortgagors, supervision of foreclosures in the event of unremedied
defaults, and general administration of the loans, either for the Company or for
the investors to whom the loans have been sold. The amounts of impound payments
held by the Company for others totaled $1,651,000, $2,809,000, and $2,407,000 on
December 31, 1996, 1995 and 1994, respectively. Servicers of loans sold to
Freddie Mac or Fannie Mae generally receive a loan servicing fee of at least
.25% per annum on the declining principal balance of the loans being serviced,
but the actual fee can be higher depending upon the coupon rate of the loans
being serviced and the actual pass-through rate paid to the investor. Servicing
fees for other investors can vary according to market conditions at the time the
loan is sold.
42
In general, the value of the Company's loan servicing portfolio may be
adversely affected by declining mortgage interest rates and increasing loan
prepayments. Income generated from the portfolio may also decline in such an
environment. In a low interest rate environment, the rate at which mortgage
loans are prepaid tends to increase as borrowers refinance their loans. A high
level of prepayments for an extended period of time could have an adverse effect
on the value of the Company's PMSR pools, the level of the Company's outstanding
loan portfolio, and the size of its mortgage loan servicing portfolio.
Additionally, the Company's decision to sell servicing rights, and the timing of
such sales, may affect the Company's earnings on a quarter-to-quarter basis.
Certain factors, including demand and prepayment, delinquency and foreclosure
rates, could have an adverse effect on the Company's ability to sell servicing
rights and the value of those rights. In a rising interest rate environment,
prepayments of loans decrease and the value of the Company's loan servicing
portfolio will decline at a slower rate.
The following table sets forth the dollar amounts of the Company's mortgage
loan servicing portfolio at the dates indicated, the portion of the Company's
loan servicing portfolio resulting from loan originations and purchases and the
carrying value as a percentage of loans serviced.
December 31,
-------------------------------
1996 1995 1994
-------------------------------
(in thousands)
Loans originated by the Company and sold $123,988 $266,712 $92,230
Loans underlying purchased mortgage
servicing rights --- 772,626 863,426
-------------------------------
Total $123,988 $1,039,338 $955,656
-------------------------------
-------------------------------
Purchased and originated mortgage
servicing rights $582 $5,970 $6,270
Purchased and originated mortgage
servicing rights as a percentage of
loans serviced .47% .57% .66%
43
Management may from time to time determine to sell the Company's mortgage
loans on a servicing released basis based on market conditions. The Company
sells loan servicing rights to offset the cost of originating mortgage loans.
The amount of loan servicing rights sold annually by the Company may vary
because of market fluctuations in the pricing of loan servicing rights, and the
amount of gain upon sale of servicing rights may vary significantly from period
to period. In 1996, 1995 and 1994, the Company sold a portion of its originated
servicing rights on a bulk basis for gains of $2,153,000, $149,000 and
$10,150,000. The Company also purchases mortgage servicing rights ("PMSR") in
order to better utilize its servicing capabilities and to take advantage of
market prices which management believed to be favorable. The amounts the
Company pays for the rights to service loans are carried on the Company's
statement of financial condition as intangible assets and are amortized in
proportion to, and over the estimated life of, the related pools of mortgage
loans using a method approximating the interest method. The Company's carrying
values of purchased mortgage servicing rights, and the amortization thereon, are
evaluated quarterly, by portfolios, and such carrying values are adjusted for
indicated impairments based on management's best estimate of the remaining cash
flows. Such estimates may vary from the actual remaining cash flows due to
unanticipated prepayments of the underlying mortgage loans and increases in
servicing costs. The Company's carrying values of purchased mortgage servicing
rights do not purport to represent the amount that would be realizable by a sale
of these assets in the open market. The prepayment rates of the Company's PMSR
pools ranged between 7% and 33% during 1995. The Company's OMSR and PMSR
amortization, including valuation adjustments, totaled $2,021,000 for 1996,
$2,140,000 for 1995, and $1,024,000 for 1994. The amortized values of the
Company's PMSR pools were $4,494,000, and $6,270,000 at December 31, 1995 and
1994, respectively with no amortized value remaining at December 31, 1996.
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards ("SFAS") No. 122 "Accounting for Mortgage
Servicing Rights," an amendment of SFAS No. 65 in May 1995. SFAS No. 122
requires a mortgage banking enterprise that purchases or originates mortgage
loans with a definitive plan to sell or securitize those loans and retain the
mortgage servicing rights to allocate the cost of the mortgage loans based on
the relative fair values of the mortgage loans and mortgage servicing rights at
the date of purchase or origination. Prior to SFAS No. 122, originated mortgage
servicing rights were not recognized for financial statement purposes with the
entire cost of the mortgage loan being allocated to the loan.
The Company adopted SFAS No. 122 on January 1, 1995. The effect of
adoption on the 1995 statement of operations was to increase gain on sale of
loans by $1,830,000 and net income by $857,000 ($.27 per fully-diluted share).
SFAS No. 122 prohibited the restatement of results for prior years. Originated
mortgage servicing rights of $1,476,000 arising in 1995 are included in mortgage
servicing rights on the balance sheet at December 31, 1995.
44
ASSET QUALITY
The Company attempts to minimize credit risk through its underwriting and
credit review policies. The Company conducts its own internal credit review
processes and, in addition, contracts with an independent loan reviewer who
performs monthly reviews of new loans and potential problem loans that meet
predetermined parameters. The Boards of Directors of both Allied and NBR have
internal asset review committees which review the asset quality of new and
problem loans on a monthly basis and report their findings to their full Boards.
In management's opinion, this loan review system facilitates the early
identification of potential problem loans.
The performance of the Company's loan portfolio is evaluated regularly by
management. The Company places a loan on nonaccrual status when one of the
following events occurs: any installment of principal or interest is 90 days or
more past due (unless, in management's opinion, the loan is well secured and in
the process of collection); management determines the ultimate collection of
principal of or interest on a loan to be unlikely; or the terms of a loan have
been renegotiated to less than market rates due to a serious weakening of the
borrower's financial condition.
With respect to the Company's policy of placing loans 90 days or more past
due on nonaccrual status unless the loan is well secured and in the process of
collection, a loan is considered to be in the process of collection if, based on
a probable specific event, it is expected that the loan will be repaid or
brought current. Generally, this collection period would not exceed 30 days.
When a loan is placed on nonaccrual status, the Company's general policy is to
reverse and charge against current income previously accrued but unpaid
interest. Interest income on such loans is subsequently recognized only to the
extent that cash is received and future collection of principal is deemed by
management to be probable. Where the collectibility of the principal of or
interest on a loan is considered to be doubtful by management, it is placed on
nonaccrual status prior to becoming 90 days delinquent.
On January 1, 1995, the Company adopted SFAS No. 114 "Accounting by
Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors
for Impairment of a Loan - Income Recognition and Disclosure." These statements
address the accounting and reporting by creditors for impairment of certain
loans. In general, a loan is impaired when, based upon current information and
events, it is probable that a creditor will be unable to collect all amounts due
according to the contractual terms of the loan agreement. These statements are
applicable to all loans, uncollateralized as well as collateralized, except
loans that are measured at the lower of cost or fair value. Impairment is
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate, except that as a practical expedient, the
Company measures impairment based on a loan's observable market price or the
fair value of the collateral if the loan is collateral dependent. Loans are
measured for impairment as part of the Company's normal internal asset review
process. The effect of adopting SFAS 114 has not been material to the Company's
balance sheet or statement of operations.
45
Interest income is recognized on impaired loans in a manner similar to that
of all loans. It is the Company's policy to place loans that are delinquent 90
days or more as to principal or interest on nonaccrual status unless secured and
in the process of collection, and to reverse from current income accrued but
uncollected interest. Cash payments subsequently received on nonaccrual loans
are recognized as income only where the future collection of principal is
considered by management to be probable.
At December 31, 1996 and 1995 the Company's total recorded investment in
impaired loans was $10,409,000 and $5,202,000 of which $708,000 and $3,515,000
relates to the recorded investment for which there is a related allowance for
credit losses of $275,000 and $425,000 determined in accordance with these
statements and $9,700,000 and $1,687,000 relates to the amount of that recorded
investment for which there is no related allowance for credit losses determined
in accordance with these statements. At December 31, 1996, more than one half
of the impaired loan balance was measured based on the fair value of the
collateral, with the remainder measured by estimated cash flow.
The average recorded investment in impaired loans during the year ended
December 31, 1996 and 1995 was $10,662,000 and $5,196,000. The related amount
of interest income recognized during the period that such loans were impaired
was $218,000 and $187,000. No interest income was recognized using a cash-basis
method of accounting during the period that the loans were impaired.
As of December 31, 1996 and 1995 there were $9,878,000 and $4,201,000 of
loans on which the accrual of interest had been discontinued. Interest due but
excluded from interest income on loans placed on nonaccrual status was $499,000,
$485,000 and $236,000 for the years ended December 31, 1996, 1995 and 1994.
Interest income received on nonaccrual loans was $438,000, $554,000 and $166,000
for the years ended December 31, 1996, 1995 and 1994.
The following table sets forth the amount of the Company's nonperforming
assets as of the dates indicated.
December 31,
-------------------------------------------------------------------
1996 1995 1994 1993 1992
-------------------------------------------------------------------
(dollars in thousands)
Nonaccrual loans $8,246 $4,201 $2,314 $3,964 $4,133
Accruing loans past due 90 days or more 1,536 92 2,767 131 15
Restructured loans (in compliance with modified terms) 599 651 432 152 ---
-------------------------------------------------------------------
Total nonperforming loans 10,381 4,944 5,513 4,247 4,148
Other real estate owned 2,132 963 1,814 3,633 2,184
Other assets owned 668 1,249 1,133 250 ---
-------------------------------------------------------------------
Total nonperforming assets $13,181 $7,156 $8,460 $8,130 $6,332
-------------------------------------------------------------------
-------------------------------------------------------------------
Nonperforming loans to total loans 2.99% 1.34% 1.43% 2.02% 2.24%
Nonperforming assets to total assets 2.64 1.28 1.34 1.72 1.94
Allowance for loan losses to nonperforming assets 53.41 70.39 68.40 64.07 68.22
Allowance for loan losses to nonperforming loans 67.82 101.88 104.97 122.65 104.15
46
Nonperforming assets were $13,181,000, or 2.64% of total assets, as of
December 31, 1996, compared to $7,156,000, or 1.28% of total assets, as of
December 31, 1995.
Nonperforming loans totaled $10,381,000 at December 31, 1996, consisting of
$3,667,000 that were secured by residential real estate, $659,000 secured by
commercial real estate and the remaining $6,055,000 were either unsecured or
collateralized by various business assets, other than real estate.
Other real estate owned totaled $2,132,000 at December 31, 1996, consisting
of $1,010,000 in commercial real estate properties and $1,122,000 in residential
properties. Other assets owned were contract receivable rights and repossessed
personal property valued at $668,000.
In addition to the above mentioned assets, management of the Company has
identified approximately $4.6 million in potential nonperforming loans, as to
which it has serious doubts as to the ability of the borrowers to comply with
the present repayment terms and which may become nonperforming assets, based on
known information about possible credit problems of the borrower.
The following table provides certain information for the years indicated
with respect to the Company's allowance for loan losses as well as charge-off
and recovery activity.
47
Year Ended December 31,
------------------------------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
(in thousands)
Balance at beginning of period $5,037 $5,787 $5,209 $4,320 $2,441
------------------------------------------------------------------
Charge-offs:
Residential real estate mortgage: 741 304 434 334 324
Commercial real estate mortgage 244 14 57 55 34
Commercial 2,517 1,985 593 347 473
Real estate construction 725 --- 32 --- 51
Installment and other 337 147 86 91 79
------------------------------------------------------------------
Total charge-offs 4,564 2,450 1,202 827 961
------------------------------------------------------------------
Recoveries:
Residential real estate mortgage 2 25 39 12 ---
Commercial real estate mortgage 5 --- 3 25 ---
Commercial 252 84 8 --- 101
Installment and other 46 1 1 --- 3
------------------------------------------------------------------
Total recoveries 305 110 51 37 104
------------------------------------------------------------------
Net charge-offs 4,259 2,340 1,151 790 857
Reserves acquired from Lake --- --- --- --- 464
Reserves acquired from Codding --- --- 634 --- ---
Provision for loan losses 6,262 1,590 1,095 1,679 2,272
------------------------------------------------------------------
Balance at end of period $7,040 $5,037 $5,787 $5,209 $4,320
------------------------------------------------------------------
------------------------------------------------------------------
Net charge-offs during the year to average loans 1.22% .60% .40% .40% .53%
Allowance for loan losses to total loans 2.03 1.37 1.50 2.48 2.33
Allowance for loan losses to nonperforming loans 67.82 101.88 104.97 122.65 104.15
Net charge-offs increased by $1,919,000 to $4,259,000 in 1996 primarily due
to $1,407,000 in charge-offs related primarily to three separate borrowers.
48
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, which is applied against the general portfolio segments.
It is the policy of management to make additions to the allowance for loan
losses so that it remains adequate to cover anticipated charge-offs, and
management believes that the allowance at December 31, 1996 is adequate.
However, the determination of the amount of the allowance is judgmental and
subject to economic conditions which cannot be predicted with certainty.
Accordingly, the Company cannot predict whether charge-offs of loans in excess
of the allowance may be required in future periods.
The provision for loan losses reflects an accrual sufficient to cover
projected probable charge-offs and the maintenance of the allowance at a level
deemed adequate to absorb potential future losses.
The table below sets forth the allocation of the allowance for loan losses
by loan type as of the dates specified. The allocation of individual categories
of loans includes amounts applicable to specifically identified as well as
unidentified losses inherent in that segment of the loan portfolio and will
necessarily change whenever management determines that the risk characteristics
of the loan portfolio have changed.
Management believes that any breakdown or allocation of the allowance for
loan losses into loan categories lends an appearance of exactness which does not
exist, in that the allowance is utilized as a single unallocated allowance
available for all loans and undisbursed commitments. The allocation below
should not be interpreted as an indication of the specific amounts or loan
categories in which future charge-offs may occur.
49
December 31,
--------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------------------------------------------------------------------------------------------
Allowance % of Allowance % of Allowance % of Allowance % of Allowance % of
for Losses Loans for Losses Loans for Losses Loans for Losses Loans for Losses Loans
--------------------------------------------------------------------------------------------------
(dollars in thousands)
Residential real
estate mortgage $1,522 37% $1,922 45% $2,231 57% $1,770 49% $1,346 45%
Commercial real
estate mortgage 809 23 664 18 728 16 455 17 318 13
Commercial 1,753 15 1,082 17 1,441 17 1,488 23 1,294 26
Real estate construction 2,076 24 1,210 19 723 9 702 10 504 11
Installment and other 231 1 118 1 336 1 119 1 227 5
Unallocated 649 --- 41 --- 328 --- 675 --- 631 ---
--------------------------------------------------------------------------------------------------
Total $7,040 100% $5,037 100% $5,787 100% $5,209 100% $4,320 100%
--------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------
ASSET/LIABILITY MANAGEMENT
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 principal sources of asset liquidity are
federal funds sold and loans held for sale. Secondary sources of liquidity are
loan repayments, investments available for sale, maturing investments, and
investments that can be used as collateral for other borrowings. At
December 31, 1996, the Company had $25,212,000 in federal funds sold and
$29,487,000 in loans held for sale. Total investments were $52,633,000, of
which $15,750,000 were pledged.
50
Liability-based liquidity includes interest-bearing and noninterest bearing
retail deposits, which are a relatively stable source of funds, time deposits
from financial institutions throughout the United States, federal funds
purchased, and other short-term and long-term borrowings, some of which are
collateralized. The Company obtains collateralized FHLB advances solely through
Allied. Management uses FHLB advances as part of its funding strategy because
the rates paid for those advances are generally lower than the rates paid on
deposits. FHLB advances must be collateralized by the pledging of qualified
mortgage loans of Allied. Allied's FHLB borrowing limitation at December 31,
1996 was $45 million compared to $80 million at December 31, 1995. At December
31, 1996, Allied had $4,000,000 in FHLB advances outstanding, as compared to
$23,000,000 at December 31, 1995. As an integral part of its funding strategy,
the Company will consider alternatives to FHLB advances while seeking to
increase its maximum borrowing limits from the FHLB as Allied's total assets
increase from time to time. There is no assurance, however, that the Company
will be able to continue to obtain additional increases in its FHLB borrowing
authority, or that the rates paid on such advances will be advantageous in the
future. If additional increases are not obtained, the Company's cost of funds
could increase, as the Company may be required to raise interest rates offered
on deposit programs in order to retain deposits in both the retail and wholesale
markets to fund its mortgage banking operations.
Time deposits from other financial institutions totaled $16.1 million, or
4% of total deposits, at December 31, 1996, a decrease of $31.8 million from
the $47.9 million recorded at December 31, 1995, which amounted to 10% of total
deposits at that time. These deposits are used to supplement liquidity when the
Company determines that deposits from local sources would be more expensive. The
Company is able to retain such deposits at favorable rates when desired. The
volume of these deposits are dependent on anticipated mortgage origination
volumes.
The following table sets forth, as of December 31, 1996, 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.
51
After Three After Six After One
Within Months But Months But Year But
Three Within Six Within Within After Five
Months Months One year Five Years Years Total
-----------------------------------------------------------------------------------
(dollars in thousands)
EARNING ASSETS:
Federal funds sold $25,212 $ --- $ --- $ --- $ --- $25,212
Investment securities and other 2,312 --- 2,032 20,887 27,717 52,948
Mortgage loans held for sale 29,487 --- --- --- --- 29,487
Loans 146,926 64,654 42,036 29,300 64,498 347,414
-----------------------------------------------------------------------------------
Total earning assets 203,937 64,654 44,068 50,187 92,215 455,061
-----------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Interest-bearing transaction accounts 156,453 --- --- --- --- 156,453
Time deposits 83,136 47,696 53,361 23,990 --- 208,183
Other borrowings 10,167 83 57 --- --- 10,307
Subordinated notes --- --- --- --- 12,000 12,000
-----------------------------------------------------------------------------------
Total interest-bearing liabilities 249,756 47,779 53,418 23,990 12,000 386,943
-----------------------------------------------------------------------------------
Interest rate sensitivity gap ($45,819) $16,875 ($9,350) $26,197 $80,215 $68,118
-----------------------------------------------------------------------------------
-----------------------------------------------------------------------------------
Cumulative interest rate sensitivity
gap ($45,819) ($28,944) ($38,294) ($12,097) $68,118
--------------------------------------------------------------------
--------------------------------------------------------------------
Interest rate sensitivity gap ratio .82 1.35 .82 2.09 7.68
Cumulative interest rate sensitivity
gap ratio .82 .90 .89 .97 1.18
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.
52
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. In 1994, the net interest margin
decreased due to higher funding costs associated with mortgage originations.
This was coupled with teaser rates on new fundings, the flattened yield curve
and the increase in funding from FHLB advances rather than deposits, all of
which caused the net interest margin to decline.
The following table shows the maturity distribution of the Company's
commercial and real estate construction loans outstanding as of December 31,
1996, which, based on remaining scheduled repayments of principal, were due
within the periods indicated.
After One
Within Through After Five
One Year Five Years Years Total
----------------------------------------
(in thousands)
Commercial $25,980 $21,265 $6,328 $53,573
Real estate construction 80,307 3,892 318 84,517
----------------------------------------
Total $106,287 $25,157 $6,646 $138,090
----------------------------------------
----------------------------------------
Loans with fixed interest rates $75,829 $11,839 $2,204 $89,872
Loans with variable interest rates 30,458 13,318 4,442 48,218
----------------------------------------
Total $106,287 $25,157 $6,646 $138,090
----------------------------------------
----------------------------------------
53
LIQUIDITY
Redwood's primary source of liquidity is dividends from its financial
institution subsidiaries. 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. It is the Company's
general policy to retain liquidity at the parent at a level which management
believes to be consistent with the safety and soundness of the Company as a
whole. As of December 31, 1996, Redwood held $2,178,000 in deposits at its
subsidiaries and a $3,000,000 subordinated note issued by NBR.
Beginning with the fourth quarter of 1992, Redwood paid a quarterly
dividend of $.03 per share of Common Stock. In the fourth quarter of 1993, this
dividend was increased to $.035 per share. In the fourth quarter of 1994 the
dividend was suspended. In addition, Redwood pays quarterly dividends of 7.8%
on $5,750,000 of its preferred stock and interest at 8.5% on $12,000,000 of
subordinated debentures issued in 1993. Payment of these obligations is
dependent on dividends from NBR and Allied. Federal regulatory agencies have
the authority to prohibit the payment of dividends by NBR and Allied to Redwood
if a finding is made that such payment would constitute an unsafe or unsound
practice, or if NBR or Allied became undercapitalized. If NBR or Allied are
restricted from paying dividends, Redwood could be unable to pay the above
obligations. No assurance can be given as to the ability of Redwood's
subsidiaries to pay dividends to Redwood.
In the fourth quarter of 1994, Redwood received a dividend of $200,000 from
NBR and $400,000 from Allied. During 1995, NBR and Allied declared dividends of
$860,000 and $227,000 respectively. During 1996, NBR and Allied declared
dividends of $215,000 and $2,227,000 respectively. Management believes that at
December 31, 1996 the Company's liquidity position was adequate for the
operations of Redwood and its subsidiaries for the foreseeable future.
Although each entity within the consolidated group manages its own
liquidity, the Company's consolidated cash flows can be divided into three
distinct areas; operating, investing and financing. For the year ended December
31, 1996 the Company received $105,240,000 in cash flows from operations while
using $55,457,000 and $59,450,000 in investment and financing activities,
respectively. Although the Company experienced a decline in cash and cash
equivalents of $9,667,000 for the year ended December 31, 1996, such balance was
unusually high at December 31, 1995 due to proceeds of $20.9 million from a
security sale not being received prior to 1995 year end but treated as a cash
equivalent due to short term settlement date.
54
CAPITAL
A strong capital base is essential to the Company's continued ability to
service the needs of its customers. Capital protects depositors and the deposit
insurance fund from potential losses and is a source of funds for the
substantial investments necessary for the Company to remain competitive. In
addition, adequate capital and earnings enable the Company to gain access to the
capital markets to supplement its internal growth of capital. Capital is
generated internally primarily through earnings retention.
The Company and each of its principal subsidiaries are required to maintain
minimum capital ratios defined by various federal government regulatory
agencies. The FRB, the OCC and the OTS 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). At December 31, 1994, 1995 and 1996, the Company
and its subsidiaries were required to maintain a total risk-based capital ratio
of 8%, including a Tier 1 capital ratio of at least 4%.
Under the leverage capital standard, an institution must maintain a
specified minimum ratio of Tier 1 capital to total assets, with the minimum
ratio ranging from 4% to 6%. The minimum core ratio for Allied is 3% and is
based on period end assets while the leverage ratio for the Company and NBR is
based on average assets for the quarter. Allied is subject to a minimum
tangible capital ratio of 1.5% of adjusted total assets.
NBR and Allied maintain insurance on its customer deposits with the Federal
Deposit Insurance Corporation ("FDIC"). The FDIC manages the Bank Insurance
Fund ("BIF"), which insures deposits of commercial banks such as NBR, and the
Savings Association Insurance Fund ("SAIF"), which insures deposits of savings
associations such as Allied. FDICIA mandated that the two funds maintain
reserves at 1.25% of their respective federally insured deposits.
The table below shows the capital ratios for the Company and its
subsidiaries at December 31, 1996.
Company NBR Allied
--------------------------------
Total capital to risk based assets 12.11% 12.28% 10.68%
Tier 1 capital to risk based assets 7.63 9.40 9.42
Leverage ratio 5.45 6.87 N/A
Tangible and core ratio N/A N/A 7.05
55
In addition to these capital guidelines, the Federal Deposit Insurance Act
of 1991 required each federal banking agency to implement a regulatory framework
for prompt corrective actions for insured depository institutions that are not
adequately capitalized. The FDIC, OCC and OTS have adopted regulations which
became effective on December 19, 1992, implementing a system of prompt
corrective action pursuant to Section 38 of the Federal Deposit Insurance Act
and Section 131 of the FDIC Improvement Act of 1991. The regulations establish
five capital categories with the following characteristics:
Total Tier 1
risk- risk-
based based Leverage
capital capital ratio
ratio ratio
--------------------------------------
"WELL CAPITALIZED" - the institution at least 10% at least 6% at least 5%
is not subject to an order,
written agreement, capital
directive or prompt corrective
action directive
"ADEQUATELY CAPITALIZED" - the at least 8% at least 4% at least 4%
institution does not meet the
definition of a well-capitalized
institution
"UNDERCAPITALIZED"- the less than 8% less than 4% less than 4%
institution's capital level fails
to meet the minimum levels
"SIGNIFICANTLY UNDERCAPITALIZED" - less than 6% less than 3% less than 3%
the institution's capital level is
significantly below the minimum
levels
"CRITICALLY UNDERCAPITALIZED" -
the institution has a ratio of
tangible equity to total assets of
2% or less
56
The regulations established procedures for classification of financial
institutions within the capital categories, filing and reviewing capital
restoration plans required under the regulations and procedures for issuance of
directives by the appropriate regulatory agency, among other matters. The
regulations impose restrictions upon all institutions to refrain from certain
actions which would cause an institution to be classified within any of the
three "undercapitalized" categories, such as the declaration of the dividends or
other capital distributions or payment of management fees, if following the
distribution or payment the institution would be classified within one of the
"undercapitalized" categories. In addition, institutions which are classified
in one of the three "undercapitalized" categories are subject to certain
mandatory and discretionary supervisory actions. Mandatory supervisory actions
include: (1) increased monitoring and review by the appropriate federal banking
agency; (2) implementation of a capital restoration plan; (3) total asset growth
restrictions; and (4) limitation upon acquisitions, branch expansion, and new
business activities without prior approval of the appropriate federal banking
agency. Discretionary supervisory actions may include: (1) requirements to
segment capital; (2) restriction upon affiliate transactions; (3) restrictions
upon deposit-gathering activities and interest rates paid; (4) replacement of
senior executive officers and directors; (5) restrictions upon activities of the
institution and its affiliates; (6) requiring divestiture or sale of the
institution; and (7) any other supervisory action that the appropriate federal
banking agency determines is necessary to further the purpose of the
regulations.
Under the most stringent capital requirement, the Company has approximately
$7,570,000 in excess capital before it becomes under-capitalized. Similarly,
Allied has approximately $4,121,000 and NBR has $7,904,000 in excess capital.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL STATEMENTS
The following consolidated financial statements of Redwood and its
subsidiaries, and independent auditors' report included in the Annual Report of
Redwood to its shareholders for the years ended December 31, 1996, 1995 and
1994.
Page
Independent Auditors' Report 58
Consolidated Financial Statements of Redwood Empire Bancorp
Consolidated Statements of Operations for the years ended
December 31, 1996, 1995 and 1994 59
Consolidated Balance Sheets December 31, 1996 and 1995 60
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1996, 1995 and 1994 61
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994 62
Notes to Consolidated Financial Statements 64
57
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Redwood Empire Bancorp
Santa Rosa, California
We have audited the accompanying consolidated balance sheets of Redwood Empire
Bancorp and subsidiaries (Company) as of December 31, 1996 and 1995 and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Redwood Empire Bancorp and
subsidiaries at December 31, 1996 and 1995, and the results of their operations
and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
As discussed in Note B to the consolidated financial statements, the Company
changed its method of accounting for originated mortgage servicing rights
effective January 1, 1995 to conform with Statement of Financial Accounting
Standards No. 122.
Deloitte & Touche LLP
Sacramento, California
February 3, 1997
58
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except per share data)
Year Ended December 31,
-----------------------------------------------
1996 1995 1994
------- ------- -------
Interest income:
Interest and fees on loans $41,469 $42,469 $35,454
Interest on investment securities 3,120 3,187 1,381
Interest on federal funds sold 1,028 1,581 1,006
Interest on time deposits due from financial institutions 167 137 164
------- ------- -------
Total interest income 45,784 47,374 38,005
Interest expense:
Interest on deposits 19,927 22,730 14,918
Interest on other borrowings 1,601 3,841 4,617
Interest on subordinated notes 1,115 1,100 1,131
------- ------- -------
Total interest expense 22,643 27,671 20,666
------- ------- -------
Net interest income 23,141 19,703 17,339
Provision for loan losses 6,262 1,590 1,095
------- ------- -------
Net interest income after provision for loan losses 16,879 18,113 16,244
------- ------- -------
Other operating income:
Service charges on deposit accounts 1,224 1,148 1,009
Merchant draft processing, net 1,849 1,505 1,168
Loan servicing income 1,619 1,625 1,943
Net realized gains (losses) on sale of investment
securities available for sale (3) 386 (24)
Gain on sale of loans and loan servicing 12,328 10,195 5,448
Other income 2,553 1,716 1,341
------- ------- -------
Total other operating income 19,570 16,575 10,885
------- ------- -------
Other operating expense:
Salaries and employee benefits 17,151 14,368 14,147
Occupancy and equipment expense 5,604 5,544 5,025
Restructuring charge 2,357 (456) 2,409
Other 13,834 9,560 10,442
------- ------- -------
Total other operating expense 38,946 29,016 32,023
------- ------- -------
(Loss) income before income taxes (2,497) 5,672 (4,894)
(Benefit) provision for income taxes (1,011) 2,359 (1,859)
------- ------- -------
Net (loss) income (1,486) 3,313 (3,035)
Dividends on preferred stock 449 336 448
------- ------- -------
Net (loss) income available for common stockholders ($1,935) $2,977 ($3,483)
------- ------- -------
------- ------- -------
Earnings per common and common equivalent share:
Primary net (loss) income per share ($.71) $1.11 ($1.31)
Fully diluted net (loss) income per share (.71) 1.04 (1.31)
Dividends per common share --- --- .105
See Notes to Consolidated Financial Statements.
59
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share data)
December 31, December 31,
1996 1995
------------ ------------
Assets:
Cash and due from banks $20,261 $24,312
Federal funds sold 25,212 9,969
Due from broker --- 20,859
-------- --------
Cash and cash equivalents 45,473 55,140
Interest bearing deposits due from financial institutions 315 417
Investment securities:
Held to maturity, at cost (market value: 1996 - $19,097, 1995 - $6,528) 18,781 6,528
Available for sale, at market (cost: 1996 - $33,935, 1995 - $37,195) 33,852 37,436
-------- --------
Total investment securities 52,633 43,964
Mortgage loans held for sale 29,487 62,620
Loans:
Portfolio loans 347,414 368,224
Less allowance for loan losses (7,040) (5,037)
-------- --------
Net loans 340,374 363,187
Premises and equipment, net 4,049 6,561
Mortgage servicing rights, net 582 5,970
Other real estate owned 2,132 963
Cash surrender value of life insurance 2,814 4,363
Other assets and interest receivable 21,607 14,725
-------- --------
Total Assets $499,466 $557,910
-------- --------
-------- --------
Liabilities and Shareholders' Equity:
Deposits:
Noninterest bearing demand deposits $71,814 $65,602
Interest bearing transaction accounts 156,453 129,436
Time deposits $100,000 and over 75,411 139,979
Other time deposits 132,772 123,376
-------- --------
Total deposits 436,450 458,393
Other borrowings 10,307 47,871
Other liabilities and interest payable 10,977 8,061
Subordinated notes 12,000 12,000
-------- --------
Total Liabilities 469,734 526,325
-------- --------
Shareholders' Equity:
Preferred stock, no par value; authorized 2,000,000 shares;
issued and outstanding 575,000 shares; liquidation
preference of $10.00 per share 5,750 5,750
Common stock, no par value; authorized 10,000,000 shares; issued
and outstanding: 1996 - 2,748,652 shares, 1995 - 2,679,227 shares 19,281 18,728
Retained earnings 5,032 6,967
Unrealized gain (loss) on investment securities carried as, or
transfered from, available for sale, net of income
taxes (1996 - ($240); 1995 - $101) (331) 140
-------- --------
Total Shareholders' Equity 29,732 31,585
-------- --------
Total Liabilities and Shareholders' Equity $499,466 $557,910
-------- --------
-------- --------
See Notes to Consolidated Financial Statements.
60
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Years ended December 31, 1996, 1995 and 1994
(in thousands)
Unrealized
gain (loss) on
investment
securities
Preferred Common Retained available
Stock Stock Earnings for sale Total
- -----------------------------------------------------------------------------------------------------------------------------
Balances, January 1, 1994 $5,750 $18,119 $7,746 ($39) $31,576
Stock options exercised 490 490
Cash dividends declared - preferred (448) (448)
Cash dividends declared - common (273) (273)
Unrealized loss on investment
securities available for sale, net of
income taxes (116) (116)
Net loss (3,035) (3,035)
---------------------------------------------------------------------
Balances, December 31, 1994 5,750 18,609 3,990 (155) 28,194
Stock options exercised 119 119
Cash dividends declared - preferred (336) (336)
Unrealized gain on investment
securities available for sale, net of
income taxes 295 295
Net income 3,313 3,313
---------------------------------------------------------------------
Balances, December 31, 1995 5,750 18,728 6,967 140 31,585
Stock options exercised 553 553
Cash dividends declared - preferred (449) (449)
Unrealized loss on investment
securities carried as, or transfered from,
available for sale, net of income taxes (471) (471)
Net loss (1,486) (1,486)
---------------------------------------------------------------------
Balances, December 31, 1996 $5,750 $19,281 $5,032 ($331) $29,732
---------------------------------------------------------------------
---------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
61
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
Year ended December 31,
1996 1995 1994
---------- ---------- ----------
Cash flows from operating activities:
Net (loss) income ($1,486) $3,313 ($3,035)
---------- ---------- ----------
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation and amortization, net 2,500 2,559 268
Deferred taxes (2,334) (709) 664
Net realized losses (gains) on securities available for sale 3 (386) 24
Loans originated for sale (1,381,133) (848,236) (1,089,567)
Proceeds from sale of loans held for sale 1,492,795 887,249 1,080,249
Gain on sale of loans and loan servicing (12,328) (10,195) (5,448)
Provision for loan losses 6,262 1,590 1,095
Change in cash surrender value of life insurance (2,071) (169) 513
Change in other assets and interest receivable 3,520 2,658 (4,238)
Change in other liabilities and interest payable (916) (829) 1,517
Noncash restructuring charge 2,260 (456) 2,035
Other, net (1,832) (1,936) 359
---------- ---------- ----------
Total adjustments 106,726 31,140 (12,529)
---------- ---------- ----------
Net cash provided by (used in) operating activities 105,240 34,453 (15,564)
---------- ---------- ----------
Cash flows from investing activities:
Acquisitions, net of cash acquired --- --- 5,318
Net increase in loans (55,729) (30,602) (108,401)
Proceeds from sale of loans in portfolio 4,168 91,229 6,467
Purchases of investment securities available for sale (31,235) (51,438) (16,712)
Purchases of investment securities held to maturity (207) (20,215) (9,286)
Sales of investment securities available for sale 4,918 31,481 4,177
Maturities of investment securities available for sale 13,500 21,000 9,100
Maturities of investment securities held to maturity 4,012 18,811 5,122
Premises and equipment, net (884) (1,096) (4,654)
Sale (purchase) of mortgage servicing rights 3,281 (101) (5,817)
Change in interest bearing deposits due from financial institutions 102 95 4,502
Proceeds from sale of other real estate owned 2,617 3,328 2,372
---------- ---------- ----------
Net cash provided by (used in) investing activities (55,457) 62,492 (107,812)
---------- ---------- ----------
Cash flows from financing activities:
Change in noninterest bearing transaction accounts 6,743 17,181 (4,483)
Change in interest bearing transaction accounts 26,487 8,580 (5,879)
Change in time deposits (55,173) (36,376) 84,778
Change in other borrowings (37,564) (64,204) 41,739
Issuance of stock 506 108 425
Dividends paid (449) (448) (810)
---------- ---------- ----------
Net cash used in financing activities (59,450) (75,159) 115,770
---------- ---------- ----------
Net change in cash and cash equivalents (9,667) 21,786 (7,606)
Cash and cash equivalents at beginning of period 55,140 33,354 40,960
---------- ---------- ----------
Cash and cash equivalents at end of period $45,473 $55,140 $33,354
---------- ---------- ----------
---------- ---------- ----------
(Continued)
62
REDWOOD EMPIRE BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Continued)
Year ended December 31,
1996 1995 1994
---------- ---------- ----------
Supplemental Disclosures:
Cash paid during the period for:
Income taxes $2,730 $2,661 $582
Interest expense 23,166 27,547 20,086
Noncash investing and financing activities:
Transfer from loans to other real estate owned 4,263 2,434 1,853
Transfer from loans to other assets owned --- --- 1,344
Loans to facilitate sale of other real estate owned 350 485 910
Transfer from mortgage loans held for sale to loans 59,000 15,000 45,443
Transfer of investment securities from held to maturity
to available for sale --- 20,709 ---
Transfer of investment securities from available for sale
to held to maturity 17,193 --- ---
Components of cash acquired in acquisitions:
Fair value of assets, net of cash acquired --- --- 37,906
Liabilities assumed --- --- 43,224
Acquisitions, net of cash acquired --- --- 5,318
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - DESCRIPTION OF BUSINESS
Redwood Empire Bancorp ("Redwood," and with its subsidiaries, the "Company") is
a financial institution holding company headquartered in Santa Rosa, California,
and operating in California, Oregon and Washington. Its wholly-owned
subsidiaries are National Bank of the Redwoods("NBR"), a national bank chartered
in 1985 and Allied Bank, F.S.B., ("Allied"), a federal savings bank chartered in
1986. The Company's business strategy involves two principal business
activities, commercial banking and mortgage lending which are conducted through
NBR and Allied, respectively.
NBR provides its commercial banking services through five retail branches
located in Sonoma County, California and one retail branch located in Mendocino
County, California. Loan services at NBR are generally extended to
professionals and to businesses with annual revenues of less than $10 million.
Commercial loans are primarily for working capital, asset acquisition and
commercial real estate. NBR's targeted commercial banking market area includes
the California counties north of San Francisco. NBR generates noninterest
income through merchant draft processing by virtue of its status as a Principal
Bank of Visa/MasterCard. As a Preferred Lender under the Small Business
Administration ("SBA") Loan Guarantee Program, NBR generates noninterest income
through premiums received on the sale of the guaranteed portions of SBA loans
and the resulting on-going servicing income on its SBA portfolio. In November
1994, NBR acquired Codding Bank, a California-chartered bank headquartered in
Sonoma County, California. In connection with the acquisition, NBR added two
branches and approximately $42 million in assets. In October, 1994 NBR also
opened a new branch in Mendocino County, California.
The Company's residential mortgage lending business has been conducted primarily
through Allied. Allied originates one-to-four family residential mortgage loans
which predominantly conform to the underwriting standards set by Fannie Mae,
Freddie Mac or other institutional mortgage conduits. These loans are commonly
referred to as "A paper" loans and are acquired by Allied on a wholesale basis,
through mortgage brokers, or retail basis through Allied's own retail loan
officers. Allied also originates mortgage loans through its Allied Diversified
Credit ("ADC") division that do not comply with all standards established by
Fannie Mae or Freddie Mac. These loans are commonly referred to as "Sub Prime"
loans and are acquired by ADC on a wholesale and retail basis. Substantially
all mortgage loan originations are packaged and sold into the secondary market.
Allied sells substantially all the servicing rights on the mortgage loans it
sells and from time to time may purchase mortgage loan servicing rights from
other companies, thereby generating ongoing servicing fees. In addition, Allied
originates construction loans for its portfolio.
64
Allied's principal targeted mortgage banking territory includes Northern and
Central California and Oregon and Washington State. These areas are served by
four loan production offices located in Santa Rosa and San Jose, California. To
fund its lending activities Allied maintains depository branches in Santa Rosa,
Ukiah and Lakeport, California. In the fourth quarter of 1996 Allied
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 historic levels.
In November 1996 the Board of Directors voted to merge Allied into NBR. The
proposed combination of the two wholly-owned subsidiaries of Redwood Empire
Bancorp will be structured as a merger transaction wherein Allied will be merged
into NBR with NBR as the surviving bank. As a result of the merger, the
surviving bank, NBR, will assume all of Allied's rights and obligations. Allied
will cease to exist as a federally chartered savings institution upon the merger
of Allied and National Bank of the Redwoods. On February 3, 1997 NBR received
approval for the merger from the Office of the Comptroller of the Currency. The
merger is expected to be consummated by the end of first quarter in 1997. In
connection with this matter and the reduction in A paper wholesale lending, the
Company has recorded a restructuring charge of $2,357,000. See Note S.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of the Company conform with generally
accepted accounting principles and general practice within the banking industry.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. A summary of the more
significant policies follows:
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Redwood Empire
Bancorp and its wholly-owned subsidiaries, National Bank of the Redwoods and
Allied Bank, F.S.B. All material intercompany transactions and accounts have
been eliminated.
Certain reclassifications to the 1995 and 1994 financial statements were made to
conform to the 1996 presentation.
For the purpose of the statements of cash flows, cash and cash equivalents have
been defined as cash, demand deposits with correspondent banks, cash items in
transit, federal funds sold and amounts due from broker, (which in 1995
represents a mortgage-backed security traded but not settled), with original
maturities of 90 days or less at date of acquisition.
INVESTMENT SECURITIES
65
Securities held to maturity are carried at cost adjusted by the accretion of
discounts and amortization of premiums. The Company has the ability and intent
to hold these investment securities to maturity. Securities available for sale
may be sold to implement the Company's asset/liability management strategies and
in response to changes in interest rates, prepayment rates and similar factors.
Available for sale securities are recorded at market value and unrealized gains
or losses, net of income taxes, are included in shareholders' equity. Gain or
loss on sale of investment securities is based on the specific identification
method.
LOANS AND THE ALLOWANCE FOR LOAN LOSSES
Loans are stated at the principal balance outstanding net of allowance for loan
losses and deferred loan fees. Loan fees net of certain related direct costs to
originate loans are deferred and amortized over the contractual life of the loan
using a method approximating the interest method. Loan fees and direct costs
related to the origination of loans held for sale are recognized as a component
of gain or loss on sale of mortgage loans when the related loans are sold.
The allowance for loan losses is maintained at a level considered adequate to
provide for losses that can be reasonably anticipated and is based on
management's continual evaluation of the economic climate and other factors
related to the collectability of loan balances. The factors considered by
management include growth and composition of the loan portfolio, overall
portfolio quality, review of specific problem loans, historical loss rates and
current economic conditions that may affect the borrower's ability to pay. The
actual results could differ significantly from management's estimates. The
allowance for loan losses is increased by provisions charged to operations and
reduced by loan charge-offs net of recoveries. A loan charge-off is recorded
when a loan has been determined by management to be uncollectable.
On January 1, 1995, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan"
and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosure." These statements address the accounting and
reporting by creditors for impairment of certain loans. In general, a loan is
impaired when, based upon current information and events, it is probable that a
creditor will be unable to collect all amounts due according to the contractual
terms of the loan agreement. These statements are applicable to all loans,
uncollateralized as well as collateralized, except loans that are measured at
the lower of cost or fair value. Impairment is measured based on the present
value of expected future cash flows discounted at the loan's effective interest
rate, except that as a practical expedient, the Company measures impairment
based on a loan's observable market price or the fair value of the collateral if
the loan is collateral dependent. Management measures all loans individually
for impairment as part of the Company's normal internal asset review process.
The effect of adopting SFAS 114 was not material to the Company's financial
position or results of operations.
Interest income is recognized on impaired loans in a manner similar to that of
all loans. It is the Company's policy to place loans that are delinquent 90
days or more as to principal or interest on nonaccrual status unless secured and
in the process of collection, and to reverse from current income accrued but
uncollected interest. Cash payments subsequently received on nonaccrual loans
are
66
recognized as income only where the future collection of principal is considered
by management to be probable.
The Company originates loans to customers under a Small Business Administration
(SBA) program that generally provides for SBA guarantees of 70% to 85% of each
loan. The Company generally sells the guaranteed portion of each loan to a
third party and retains the unguaranteed portion in its own portfolio. A gain
is recognized on these loans through collection on sale of a premium over the
adjusted carrying value, through retention of an ongoing rate differential less
a normal service fee (excess servicing fee) between the rate paid by the
borrower to the Company and the rate paid by the Company to the purchaser, or
both.
To calculate the gain or loss on the sale, the Company's investment in an SBA
loan is allocated among the retained portion of the loan, excess servicing
retained and the sold portion of the loan, based on the relative fair market
value of each portion. The gain on the sold portion of the loan is recognized
currently. The excess servicing fees are reflected as an asset which is
amortized over an estimated life using a method approximating the interest
method; in the event future prepayments are significant and future expected cash
flows are inadequate to cover the unamortized excess servicing asset, additional
amortization would be recognized. SBA loans held for sale are carried at the
lower of cost or estimated market value, determined on an aggregate basis.
OTHER REAL ESTATE OWNED
Property acquired by the Company through foreclosure is recorded at the lower of
estimated fair value less estimated selling costs (fair value) or the carrying
value of the related loan at the date of foreclosure. At the time the property
is acquired, if the fair value is less than the loan amounts outstanding, any
difference is charged against the allowance for loan losses. After acquisition,
valuations are periodically performed and, if the carrying value of the property
exceeds the fair value, a valuation allowance is established by a charge to
operations. Subsequent increases in the fair value may reduce or eliminate the
allowance.
Operating costs on foreclosed real estate are expensed as incurred. Costs
incurred for physical improvements to foreclosed real estate are capitalized if
the value is recoverable through future sale.
67
MORTGAGE BANKING ACTIVITIES
The Company sells residential mortgage loans to a variety of secondary market
investors, including Freddie Mac and Fannie Mae. Gains or losses on the sale
of mortgage loans are recognized based on the difference between the selling
price and the carrying value of the related mortgage loans sold.
Mortgage loans held for sale are carried at the lower of cost or market value as
determined by outstanding commitments from investors, indicators of value
obtained by management from independent third parties, current investor yield
requirements calculated on an aggregate loan basis and the market value of its
hedging instruments. Valuation adjustments are charged against the gain or loss
on sale of mortgage loans.
In order to minimize the risk that a change in interest rates will result in a
decrease in the value of the Company's current mortgage loan inventory or its
commitments to purchase or originate mortgage loans ("committed pipeline"), the
Company utilizes various financial instruments, including derivatives. These
instruments involve, to varying degrees, elements of credit and interest-rate
risk. All of the Company's derivative financial instruments are held or issued
for purposes other than trading.
These instruments include forward sales of mortgage-backed securities ("MBS")
and options to sell or buy mortgage-backed or U.S. treasury securities.
Unrealized gains and losses resulting from changes in the market value of
uncommitted mortgage loans and interest rate locks and open hedge positions are
netted. Any net unrealized gain that results is deferred; any net unrealized
loss that results is recognized currently. Hedging gains and losses realized
before the hedged loans are sold are deferred. Unrealized or realized hedging
losses are recognized currently if deferring such losses would result in
mortgage loans held for sale and the interest rate locks being valued in excess
of their estimated net realizable value.
Option premiums paid for purchased put or call options are amortized on a
straight-line basis over the life of the option. Premiums paid are included in
the carrying values of the related hedged items for purposes of determining
lower of cost or market.
The Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards No. 122 "Accounting for Mortgage Servicing Rights," an
amendment of SFAS No. 65 in May 1995. SFAS No. 122 requires a mortgage banking
enterprise that purchases or originates mortgage loans with a definitive plan to
sell or securitize those loans and retain the mortgage servicing rights to
allocate the cost of the mortgage loans based on the relative fair values of the
mortgage loans and mortgage servicing rights at the date of purchase or
origination. Prior to the adoption of SFAS No. 122, originated mortgage
servicing rights were not recognized for financial statement purposes with the
entire cost of the mortgage loan being allocated to the loan.
The Company early adopted SFAS No. 122 on January 1, 1995 as permitted. The
effect of adoption on the 1995 statement of operations was to increase gain on
sale of loans by $1,830,000 and net income by $857,000 ($.27 per fully-diluted
share). SFAS No. 122 prohibited the restatement of results for prior years.
68
Mortgage servicing rights are amortized in proportion to and over the period of
estimated net servicing income. The Company evaluates impairment of its
mortgage servicing rights quarterly. Impairment is measured on a disaggregated
basis using the state of origination as the predominant risk characteristic with
respect to originated mortgage servicing rights. Impairment of purchased
mortgage servicing rights is measured based on discrete acquisitions. Any
impairment is calculated as the difference between fair value and amortized cost
by stratum. Fair value is estimated on a loan by loan basis using market prices
under comparable servicing sale contracts, when available or, using a cash flow
model with current assumptions with respect to prepayments, servicing costs and
other significant factors. Impairment is recognized through a valuation
allowance by stratum. Such estimates may vary from the actual remaining cash
flows due to unanticipated prepayments of the underlying mortgage loans and
increases in servicing costs. The Company's carrying values of purchased
mortgage servicing rights do not purport to represent the amount that would be
realizable by a sale of these assets in the open market.
OFF BALANCE SHEET RISK
The Company is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers and to
reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit, standby letters of credit,
forward contracts to sell mortgage-backed securities and written options. Those
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the statement of financial position.
The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. The Company manages credit risk with respect to MBS, and
options to sell or buy mortgage-backed or U.S. treasury securities by entering
into agreements with entities approved by senior management and the Board of
Directors. These entities include Wall Street firms having primary dealer
status. The Company uses the same credit policies in making commitments and
conditional obligations as it does for on-balance sheet instruments. For
forward contracts to sell mortgage-backed securities and written options, the
contract or notional amounts do not represent exposure to credit loss. The
Company controls the credit risk of its forward contracts through credit
approvals, limits and monitoring procedures.
69
A listing of financial instruments whose contract amounts represent credit risk
and financial instruments whose contract amounts exceed the amount of credit
risk is as follows:
Contract or notional amount
1996 1995
------------ ------------
Financial instruments whose contract amounts
represent credit risk:
Commitments to extend credit $108,179,000 $152,011,000
Standby letters of credit 2,462,000 1,372,000
Financial instruments whose contract amounts
exceed the amount of credit risk:
Forward contracts 27,063,000 12,770,000
Written Options --- 100,000,000
Loan commitments are typically contingent upon the borrower meeting certain
financial and other covenants, and such commitments typically have fixed
expiration dates and require payment of a fee. As many of these commitments are
expected to expire without being drawn upon, the total commitments do not
necessarily represent future cash requirements. The Company evaluates each
potential borrower and the necessary collateral on an individual basis.
Collateral varies, but may include real property, bank deposits, debt
securities, equity securities, or business assets.
Standby letters of credit are conditional commitments written by the Company to
guarantee the performance of a customer to a third party. These guarantees
relate primarily to inventory purchases by the Company's commercial customers,
and such guarantees are typically short-term. Credit risk is similar to that
involved in extending loan commitments to customers and the Company accordingly
uses evaluation and collateral requirements similar to those of loan
commitments. Virtually all such commitments are collateralized.
Forward contracts are contracts for delayed delivery of mortgage-backed
securities in which the Company agrees to make delivery at a specified future
date of a specified instrument, at a specified yield. Risks arise from the
possible inability of counterparties to meet those terms of their contracts and
from movements in interest rates. The Company's exposure to risk in the event
of default by the counterparty is the difference between the contract price and
the current market price.
PREMISES AND EQUIPMENT
Premises and equipment consist of building, leasehold improvements, furniture
and equipment and are stated at cost, less accumulated depreciation and
amortization. Depreciation is computed using the straight-line method over the
estimated useful lives for financial reporting purposes and an accelerated
method for income tax reporting. Leasehold improvements are amortized over the
terms of the lease or their estimated useful lives whichever is shorter.
INCOME TAXES
70
The Company accounts for income taxes using an asset and liability approach,
which requires the recognition of deferred tax assets and liabilities at tax
rates in effect when these balances are utilized. Future tax benefits
attributable to temporary differences are recognized currently to the extent
that realization of such benefits is more likely than not. These future tax
benefits are measured by applying currently enacted tax rates.
EARNINGS PER COMMON SHARE
Earnings per common and common equivalent shares are computed by dividing net
income applicable to common stock by the total of the average number of common
shares outstanding and the additional dilutive effect of stock options
outstanding during the respective period. The dilutive effect of stock options
is computed using the average market price of the common stock for the period
for primary earnings per share.
Earnings per common share, assuming full dilution, are computed by dividing net
income by the average number of common shares outstanding during the period, the
dilutive effect of the Convertible Preferred Stock assuming conversion at the
time it was issued, and the additional dilutive effect of stock options
outstanding during the period. The dilutive effect of outstanding stock options
is computed using the greater of the closing market price or the average market
price of the common stock for the period. The effect of the Convertible
Preferred Stock is excluded from the computation in loss years due to its
antidilutive effect.
Earnings per common share have been computed based on the following:
Year Ended December 31,
1996 1995 1994
----------------------------
(in thousands)
Net (loss) income ($1,486) $3,313 ($3,035)
Dividends on preferred stock 449 336 448
------- ------ -------
Net (loss) income applicable to common stock ($1,935) $2,977 ($3,483)
------- ------ -------
------- ------ -------
Average number of common shares outstanding 2,721 2,671 2,649
Average number of common and common equivalent
shares outstanding 2,721 2,680 2,649
Average number of common shares outstanding -
assuming full dilution 2,721 3,179 2,649
71
NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
SFAS No. 121 establishes standards for accounting for the impairment of long-
lived assets, certain identifiable intangibles and goodwill. It does not apply
to financial instruments, long-term customer relationships of a financial
institution (e.g., core deposit intangibles), mortgage and other servicing
rights, or deferred tax assets. The effect of adoption of this standard was not
material.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." The new standard defines a fair value method of accounting for
stock options and other equity instruments, such as stock purchase plans.
Under this method, compensation cost is measured based on the fair value of the
stock award when granted and is recognized as an expense over the service
period, which is usually the vesting period. The standard was effective for the
Company beginning in 1996, and requires measurement of awards made beginning in
1995.
As permitted under SFAS No. 123, the Company has elected to continue to account
for equity transactions with employees under existing accounting rules, and
provide required disclosure in a note to the financial statements of the pro
forma net income and earnings per share as if the Company had applied the new
method of accounting.
The Company is required to adopt SFAS No. 125 "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" in 1997. The
statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities. These
standards are based on consistent application of a financial-component approach
that focuses on control. Under this approach, after a transfer of financial
assets, an entity recognizes the financial and servicing assets it controls and
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. Management
believes that adoption of SFAS 125 will not have a material effect on the
financial condition or results of operations of the Company.
NOTE C - ACQUISITION
On November 4, 1994, NBR acquired Codding Bank, a California-chartered bank
headquartered in Rohnert Park, California ("Codding"). The amended acquisition
agreement (the "Agreement") provided for a two-step merger transaction in which
a wholly-owned non-bank subsidiary of NBR would first be merged into Codding,
followed immediately thereafter by the merger of Codding into NBR, with NBR
being the surviving entity. The transaction was structured as a cash-for-stock
merger, in which shareholders of Codding received $12.12 per share of Codding
stock outstanding at the time of the acquisition. Holders of outstanding
options to purchase shares of Codding stock received $12.12 per share covered by
such options less the option exercise price per share. The transaction was
accounted for as a purchase in accordance with Accounting Principles Board
Opinion No. 16, "Business Combinations". Under this method of accounting, the
purchase price is allocated to the respective assets acquired and liabilities
assumed based on their estimated fair values, net of applicable income tax
effects. The purchase price of Codding totalled $7,028,000 in cash, including
merger related expenses. At the merger date, the fair value of the assets
acquired totalled approximately $42,048,000, including loans of approximately
$28,294,000 and investment securities of approximately $7,935,000 and the fair
value of liabilities assumed was approximately $43,224,000, including deposits
of $42,817,000. The Company recorded goodwill of $1,176,000 which is being
amortized over 15 years on a straight-line basis. The Company's consolidated
financial statements include the results of Codding beginning October 31, 1994.
The following Unaudited Pro Forma Combined Summary of Operations presents a pro
forma combined summary of operations of the Company and Codding for the year
ended December 31, 1994 and it is presented as if the merger had been effective
on January 1, 1994. This pro forma combined historical summary of operations was
adjusted for the amortization of purchase accounting adjustments.
72
The Unaudited Pro Forma Combined Summary of Operations data is intended for
informational purposes only and is not necessarily indicative of the future
results of operations of the Company, or the results of operations that would
have actually occurred had the Codding merger been in effect for the periods
presented.
Unaudited Pro Forma Combined Summary of Operations
Year Ended
December 31, 1994
-----------------
(in thousands,
except per share data)
Interest income $41,243
Interest expense 21,682
-------
Net interest income 19,561
Provision for loan losses 1,296
-------
Net interest income after provision for loan losses 18,265
Other operating income 11,036
Other operating expense 34,015
-------
Income (loss) before income taxes and accounting change (4,714)
Provision (benefit) for income taxes (1,780)
-------
Income (loss) before accounting change (2,934)
Change in accounting for income taxes ---
-------
Net income (loss) (2,934)
Dividends on preferred stock 448
-------
Net income (loss) available for common stock ($3,382)
-------
-------
Primary earnings (loss) per share ($1.28)
Fully diluted earnings (loss) per share (1.28)
Weighted average shares outstanding:
Primary 2,649
Fully diluted 2,649
73
NOTE D - CASH AND DUE FROM BANKS
The Company's subsidiaries are required to maintain average reserve balances
with the Federal Reserve Bank. The required reserve balance included in cash
and due from banks was approximately $4,515,000 and $3,307,000 at December 31,
1996 and 1995.
NOTE E - INVESTMENT SECURITIES
An analysis of the investment securities portfolio follows:
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------------------------------------
(in thousands)
December 31, 1996:
Held to maturity:
U.S. Government obligations $12,736 $382 $5 $13,113
Mortgage-backed and other securities 2,701 1 62 2,640
--------------------------------------
Total debt securities 15,437 383 67 15,753
FRB and FHLB stock 3,344 --- --- 3,344
--------------------------------------
Total held to maturity $18,781 $383 $67 $19,097
--------------------------------------
--------------------------------------
Available for sale:
U.S. Government obligations $33,935 $93 $176 $33,852
--------------------------------------
--------------------------------------
December 31, 1995:
Held to maturity:
Mortgage-backed and other securities $2,638 --- --- $2,638
--------------------------------------
Total debt securities 2,638 --- --- 2,638
FRB and FHLB stock 3,890 --- --- 3,890
--------------------------------------
Total held to maturity $6,528 $ --- $ --- $6,528
--------------------------------------
--------------------------------------
Available for sale:
U.S. Government obligations $37,195 $267 $26 $37,436
--------------------------------------
--------------------------------------
74
Debt securities by contractual maturity at December 31, 1996, were due as
follows:
Amortized Market
Cost Value
--------- ------
(in thousands)
Held to maturity:
One year or less $26 $26
After one year through five years 2,866 2,914
After five years 12,545 12,813
------- -------
$15,437 $15,753
------- -------
------- -------
Available for sale:
One year or less $3,997 $4,003
After one year through five years 17,929 17,978
After five years 12,009 11,871
------- -------
$33,935 $33,852
------- -------
------- -------
Proceeds from sales of investments in debt securities during 1996, 1995 and 1994
were $4,918,000, $31,481,000 and $4,177,000. These sales resulted in the
realization of gross gains of $5,000 and gross losses of $8,000 for 1996, gross
gains of $386,000 for 1995 and gross losses of $24,000 for 1994.
During 1995, the FASB issued a Special Report, "A Guide to Implementation of
Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities". The Special Report provided the Company a one-time opportunity to
reassess the appropriateness of its designations of securities subject to the
accounting and reporting requirements of Statement 115, without calling into
question the intent to hold other debt securities to maturity in the future. In
accordance with the Special Report, in December 1995, the Company transferred
$20,709,000 in U.S. Government obligations with an unrealized gain of $145,000
from held to maturity to available for sale.
During 1996 the Company transferred $17,193,000 in investment securities
carried as available for sale into the held to maturity category. This action
was taken for asset liability management purposes.
Securities carried at approximately $15,750,000 and $11,607,000 at December 31,
1996 and 1995 were pledged to secure public deposits, bankruptcy deposits, and
treasury tax and loan borrowings.
75
NOTE F - MORTGAGE BANKING ACTIVITIES
As part of its mortgage banking activities, the Company enters into forward
commitments to sell mortgage loans, either in the form of mortgage-backed
securities or as whole loans. These commitments may be optional or mandatory.
Under optional commitments, a commitment fee is paid and the Company carries no
risk in excess of the loss of such fee in the event that the Company is unable
to deliver sufficient mortgage loans to fulfill the commitment. Mandatory
commitments may entail possible financial risk to the Company if it is unable to
deliver mortgage loans in sufficient quantity or at sufficient rates to meet the
terms of the commitments.
In order to minimize the risk that a change in interest rates will result in a
decrease in the value of the Company's current mortgage loan inventory or its
commitments to purchase or originate mortgage loans ("committed pipeline"), the
Company enters into hedging transactions. The Company's hedging policies
generally require that its inventory of mortgage loans held for sale and the
maximum portion of its committed pipeline that may close be hedged with forward
sales of MBS or options to buy or sell mortgage-backed or U.S. Treasury
securities. As such, to the extent the Company hedges its committed pipeline,
the Company is not exposed to significant interest rate risk nor will it derive
any significant benefit from changes in interest rates on the price of the
mortgage loan inventory net of gains or losses of associated hedge positions.
The correlation between the price performance of the hedge instruments and the
inventory being hedged is very high due to the similarity of the asset and the
related hedge instrument. The Company is exposed to interest-rate risk to the
extent that the portion of loans from the committed pipeline that actually
closes at the committed price is less than the portion expected to close, in the
event of a decline in rates and in the event such decline in closings is not
covered by options to purchase MBS needed to replace the loans in process that
do not close at their committed price. The Company determines the portion of its
committed pipeline that it will hedge based on numerous factors, including the
composition of the Company's committed pipeline, the portion of such committed
pipeline likely to close, the timing of such closings and the current interest
rate environment.
The following lists the notional amounts of the various hedging instruments
outstanding at December 31, 1996 and 1995 and the date through which exercise
dates extend:
1996 1995
Notional Exercise Dates Notional Exercise Dates
Amount Extend Through Amount Extend Through
---------------------------------------------------------------------------
(in thousands) (in thousands)
Forward contracts to sell MBS $27,063 March 1997 $12,770 February 1996
Purchased put options:
MBS --- 30,000 April 1996
U.S. Treasury 15,000 March 1997 80,000 March 1996
Purchased call options - U.S. Treasury 7,500 March 1997 25,000 March 1996
Written call options - MBS --- 80,000 February 1996
Written put options - U.S. Treasury --- 20,000 March 1996
The Company services mortgage loans and participating interests in mortgage
loans owned by investors. The unpaid principal balances of mortgage loans
serviced for others are as follows:
76
December 31,
1996 1995
-------- ----------
(in thousands)
Mortgage loan portfolios serviced for:
Freddie Mac $5,702 $468,555
Fannie Mae 5,026 411,707
Other investors 113,260 159,076
-------- ----------
$123,988 $1,039,338
-------- ----------
-------- ----------
During the third and fourth quarters of 1996 the Company sold mortgage loan
servicing rights associated with $839,945,000 mortgage loans whose carrying
amount was $4,150,000. In connection with these sales the Company recorded net
revenue of $2,153,000, which has been included in gain on sale of loans and
servicing.
At December 31, 1996 and 1995, the Company also serviced $670,856,000 and
$19,900,000 in loans and participating interests in loans owned by investors,
under subservicing agreements.
Escrow funds held in trust for loans serviced for others were $1,651,000 and
$2,809,000 at December 31, 1996 and 1995.
The following table provides a summary of the Company's purchased ("PMSR") and
originated ("OMSR") mortgage servicing rights portfolio:
OMSR
-----------------------------
States
-------------------
PMSR California Other Total
------ ---------- ----- -----
(in thousands)
Balance, January 1, 1994 $1,439 $ --- $ --- $ ---
Purchases 5,855 ---
Amortization (980) ---
Valuation adjustments (44) ---
------ ------ ------ ------
Balance, December 31, 1994 6,270 --- --- ---
Purchases 11 ---
Originations 1,616 213 1,829
Amortization (1,787) (290) (38) (328)
Valuation adjustments --- (22) (3) (25)
------ ------ ------ ------
Balance, December 31, 1995 4,494 1,304 172 1,476
77
Originations --- 744 39 783
Sales (3,033) (1,061) (56) (1,117)
Amortization (1,461) (456) (129) (585)
Valuation adjustments --- 22 3 25
------ ------ ------ ------
Balance, December 31, 1996 $ --- $553 $29 $582
------ ------ ------ ------
------ ------ ------ ------
Prior to 1995 OMSR's could not be capitalized under generally accepted
accounting principles until the adoption of SFAS No. 122.
NOTE G - LOANS AND THE ALLOWANCE FOR LOAN LOSSES
The Company primarily makes permanent and construction residential real estate
loans in California, and loans to individuals and small businesses primarily in
Sonoma and Mendocino Counties, California. There are no major industry segments
in the loan portfolio. Outstanding loans by type were:
December 31,
1996 1995
--------------------------
(in thousands)
Residential real estate mortgage $128,025 $168,022
Commercial real estate mortgage 80,366 65,655
Commercial 53,573 63,975
Real estate construction 84,517 69,504
Installment and other 3,730 4,103
Less deferred fees (2,797) (3,035)
-------- --------
Total loans 347,414 368,224
Less allowance for loan losses (7,040) (5,037)
-------- --------
Net loans $340,374 $363,187
-------- --------
-------- --------
78
A summary of the transactions in the allowance for loan losses follows:
1996 1995 1994
--------------------------
(in thousands)
Balance, beginning of year $5,037 $5,787 $5,209
Allowance obtained through acquisition --- --- 634
Provision for loan losses 6,262 1,590 1,095
Loans charged off (4,564) (2,450) (1,202)
Recoveries 305 110 51
------ ------ ------
Balance, end of year $7,040 $5,037 $5,787
------ ------ ------
------ ------ ------
At December 31, 1996 and 1995 the Company's total recorded investment in
impaired loans (as defined by SFAS 114 and 118; see Note B) was $10,409,000 and
$5,202,000 of which $708,000 and $3,515,000 relates to the recorded investment
for which there is a related allowance for loan losses of $275,000 and $425,000
determined in accordance with these statements and $9,700,000 and $1,687,000
relates to the amount of that recorded investment for which there is no related
allowance for loan losses determined in accordance with these statements. At
December 31, 1996, approximately 80% of the impaired loan balance was measured
based on the fair value of the collateral, with the remainder measured by
estimated cash flow.
The average recorded investment in impaired loans during the year ended
December 31, 1996 and 1995 was $10,662,000 and $5,196,000. The related amount
of interest income recognized during the periods that such loans were impaired
was $218,000 and $187,000.
As of December 31, 1996 and 1995 there were $9,878,000 and $4,201,000 of loans
on which the accrual of interest had been discontinued. Interest due but
excluded from interest income on these nonaccrual loans was $499,000, $485,000
and $236,000 for the years ended December 31, 1996, 1995 and 1994. Interest
income received on nonaccrual loans was $438,000, $554,000 and $166,000 for the
years ended December 31, 1996, 1995 and 1994.
At December 31, 1996 and 1995, the Company had $1,536,000 and $92,000 in loans
past due 90 days or more in interest or principal and still accruing interest.
These loans were collateralized and in the process of collection.
79
The Company originates SBA loans for sale to investors. A summary of the
activity in SBA loans is as follows:
December 31,
1996 1995 1994
--------------------------
(in thousands)
SBA guaranteed portion of loans originated $7,730 $8,509 $9,448
SBA loans sold 7,930 8,992 8,097
Premium received at sale 620 700 689
SBA guaranteed portion of loans serviced
for others 36,325 36,203 31,833
From time to time the Company extends credit to executive officers, directors
and related parties. No preference is given to these individuals as these
transactions are made in the ordinary course of business at the Company's normal
credit terms, including interest rates and collateralization. There were no
such balances outstanding at December 31, 1996 and 1995.
NOTE H - PREMISES, EQUIPMENT AND LEASES
A summary of premises and equipment is as follows:
December 31,
1996 1995
--------------------------
(in thousands)
Land $187 $307
Building and leasehold improvements 2,491 2,556
Furniture and equipment 10,685 10,917
------ ------
Total premises and equipment 13,363 13,780
Less accumulated depreciation and amortization 9,314 7,219
------ ------
Premises and equipment, net $4,049 $6,561
------ ------
------ ------
Depreciation expense for the years ended December 31, 1996, 1995 and 1994 was
$2,528,000, $2,647,000 and $2,022,000.
The Company leases certain premises and equipment used in the normal course of
business. There are no contingent rental payments and the Company has three
subleased properties. Total rental expense under all leases, including
premises, totalled $2,258,000, $2,172,000 and $2,336,000 in 1996, 1995 and 1994.
Minimum future lease commitments are as follows: 1997 - $3,023,000; 1998 -
$2,305,000; 1999 - $1,271,000; 2000 - $434,000; 2001 - $360,000 and
thereafter - $1,252,000. Minimum future sublease receivables are as follows:
1997 - $215,000; 1998 - $192,000; and 1999 - $158,000.
80
NBR leases 34,000 square feet of office space for its main office from a
partnership that includes one director of a subsidiary as a minority partner.
The lease calls for payments of $71,954 per month plus operating cost
adjustments through September, 1999. Total lease payments for the years ended
December 31, 1996, 1995 and 1994 were $863,000, $863,000 and $648,000.
NOTE I - INCOME TAXES
The provision (benefit) for income taxes consists of the following:
Year Ended December 31,
1996 1995 1994
--------------------------
(in thousands)
Current:
Federal $1,106 $2,897 ($2,424)
State 217 171 (99)
------- ------ -------
1,323 3,068 (2,523)
------- ------ -------
Deferred:
Federal (1,875) (1,191) 833
State (459) 482 (169)
------- ------ -------
(2,334) (709) 664
------- ------ -------
($1,011) $2,359 ($1,859)
------- ------ -------
------- ------ -------
A reconciliation of the statutory income tax rate to the effective income tax
rate of the Company is as follows:
1996 1995 1994
------------------------
Income tax at federal statutory rate 35.0% 35.0% 35.0%
State franchise tax, net of federal benefit 6.3 7.5 3.6
Other (.8) (.9) (.6)
---- ---- ----
40.5% 41.6% 38.0%
---- ---- ----
---- ---- ----
Deferred income taxes reflect the tax effect of temporary differences existing
between the financial statement basis and tax basis of the Company's assets and
liabilities. Deferred tax benefits attributable to temporary differences are
recognized to the extent that realization of such benefits is more likely than
not. The Company believes it is more likely than not that the net deferred tax
asset at December 31, 1996 will be utilized to reduce future taxable income.
Accordingly, there is no valuation allowance associated with deferred tax assets
at December 31, 1996. The tax effect of the principal temporary items creating
the Company's net deferred tax asset included in other assets and interest
receivable are:
81
December 31,
1996 1995
------ ------
(in thousands)
Deferred tax assets:
Allowance for loan losses $1,886 $1,300
Mortgage servicing rights 654 597
Interest foregone on nonaccrual loans 538 336
Restructuring costs 1,060 280
Accrued expenses not yet deductible 401 276
Unrealized (gain) loss on securities
available for sale 240 (101)
Other real estate owned 298 (5)
Depreciation 399 201
------ ------
Total deferred tax assets 5,476 2,884
------ ------
Deferred tax liabilities:
Deferred loan fees 1,001 935
FHLB stock dividends 201 326
Securities and loans marked to
market for tax purposes 61 152
Premium on loan sales 12 125
State taxes 133 19
Other, net 113 53
------ ------
Total deferred tax liabilities 1,521 1,610
------ ------
Net deferred tax asset $3,955 $1,274
------ ------
------ ------
NOTE J - OTHER BORROWINGS
Other borrowings consist of the following:
December 31,
1996 1995
------------------------
(in thousands)
Advances from FHLB $4,000 $23,000
Treasury, tax and loan note 4,330 1,463
Securities and loans sold under agreements to
repurchase 900 21,355
Federal funds purchased 746 1,445
Capital leases 223 608
OREO Mortgages 109 ---
------- -------
$10,308 $47,871
------- -------
------- -------
82
(a) ADVANCES FROM THE FHLB
The Company has a line of credit for short-term purposes with the Federal Home
Loan Bank (FHLB). There were $4,000,000 in advances drawn under this line of
credit at December 31, 1996 at 5.57% with an overnight maturity.
The average balance of FHLB advances was $21,834,000 for 1996 at an average
interest rate of 5.94%. The highest month-end balance during the year was
$39,000,000.
All borrowings from the FHLB must be collateralized, and the Company has pledged
approximately $63,155,000 of residential mortgage loans as of December 31, 1996,
to the FHLB to secure any funds it may borrow.
(b) FEDERAL FUNDS PURCHASED, SECURITIES AND LOANS SOLD UNDER AGREEMENTS TO
REPURCHASE AND TREASURY, TAX AND LOAN NOTE
The Company enters into various short-term borrowing agreements which include
Treasury, Tax and Loan borrowings. These borrowings have maturities of one day
and are collateralized by investments or loans. Federal Funds purchased had
maturities of one day. Securities sold under agreements to repurchase have
maturities ranging from January to March 1997. Loans sold under agreements to
repurchase had maturities of one day.
The average balance of securities and loans sold under agreements to repurchase
was $2,552,000 for 1996 at an average interest rate of 5.01%. The highest
month-end balance during the year was $6,572,000.
(c) CAPITAL LEASES
The Company has $223,000 in capital leases at fixed rates from 2.73% to 4.90%.
The leases mature through August, 1997, and are collateralized by specific fixed
assets with a net carrying value of $17,000 at December 31, 1996.
83
NOTE K - GAINS ON SALE OF LOANS AND LOAN SERVICING
The components of gains on sale of loans and loan servicing are as follows:
Year Ended December 31,
1996 1995 1994
---------------------------
(in thousands)
Gain (loss) on sale of mortgage loans $9,197 $9,091 ($5,391)
Gains on sale of SBA loans 978 955 689
Gains on bulk servicing sales 2,153 149 10,150
------- ------- -------
$12,328 $10,195 $5,448
------- ------- -------
------- ------- -------
NOTE L - OTHER EXPENSES
The major components of other expense are as follows:
Year Ended December 31,
1996 1995 1994
---------------------------
(in thousands)
Professional fees $1,942 $2,187 $2,065
Regulatory expense and insurance 3,401 1,716 1,345
Postage and office supplies 1,715 1,224 1,013
Shareholder expenses and Director fees 406 486 950
Advertising 581 481 919
Telephone 758 778 782
Electronic data processing 1,216 1,022 775
Net costs of other real estate owned 451 163 609
Other 3,364 1,503 1,984
------- ------- -------
$13,834 $9,560 $10,442
------- ------- -------
------- ------- -------
NBR and Allied maintain insurance on their customer deposits with the Federal
Deposit Insurance Corporation ("FDIC"). The FDIC manages the Bank Insurance
Fund ("BIF"), which insures deposits of commercial banks such as NBR, and the
Savings Association Insurance Fund ("SAIF"), which insures deposits of savings
associations such as Allied. FDICIA mandated that the two funds maintain
reserves at 1.25% of their respective federally insured deposits.
84
During 1995, the FDIC announced that the BIF had reached its mandated reserve
level, reducing insurance premiums on BIF-insured deposits, and accordingly
deposit insurance premiums on BIF-insured deposits were reduced. On September
30, 1996 Congress passed a bill which addressed the deposit insurance premium
differential between BIF and SAIF insured deposits. As a result, a one-time
insurance premium charge was assessed on SAIF-insured deposits to bring the SAIF
reserves to the mandated level. Calculated at .675% of Allied's deposits at
March 31, 1995, the resulting charge to the Company was $2,192,000. Such charge
was recorded in the third quarter of 1996.
NOTE M - STOCK OPTIONS AND BENEFIT PLANS
The Company's 1991 stock option plan, which was amended in 1992, provides for
the granting of both incentive stock options and nonqualified stock options to
Directors and key employees. Generally, options outstanding under the stock
option plan are granted at prices equal to the market value of the stock at the
date of grant, vest ratably over a four year service period and expire ten years
subsequent to the award. There are 539,000 shares authorized and available for
options under the plans, with 431,500 shares granted but unexercised at December
31, 1996.
Outstanding common stock options at December 31, 1996, are exercisable at
various dates through 2005. The following table summarizes option activity:
Weighted Average
Option Price
Number of Shares per Share
-------------------------------------
Balance at December 31, 1993 509,000 $7.99
Options granted 55,000 12.88
Options exercised (75,000) 7.58
Options cancelled (24,000) 12.81
-------
Balance at December 31, 1994 465,000 8.70
Options granted 50,000 8.25
Options exercised (16,000) 7.55
Options cancelled (99,000) 8.43
-------
Balance at December 31, 1995 400,000 8.80
Options granted 108,500 10.16
Options exercised (72,000) 7.39
Options cancelled (5,000) 12.88
-------
Balance at December 31, 1996 431,500 $9.33
-------
-------
At December 31, 1996 107,500 shares were available for future grants under the
plans.
Additional information regarding options outstanding as of December 31, 1996 is
as follows:
85
Options Outstanding Options Exercisable
-------------------------------- ------------------------------------
Weighted Avg.
Range of Remaining
Exercise Number Contractual Weighted Avg. Number Weighted Avg.
Prices Outstanding Life (yrs) Exercise Price Exercisable Exercise Price
- -----------------------------------------------------------------------------------------------------------------------------
$ 6.00 - $ 7.99 41,000 5 $7.49 41,000 $7.49
8.00 - 9.99 314,000 6 9.00 195,000 8.76
10.00 - 11.99 41,000 7 10.67 11,000 10.44
12.00 - 13.99 35,500 7 12.90 18,000 12.90
------- -------
431,500 265,000
------- -------
------- -------
The Company applies APB opinion 25 and related interpretations in accounting for
its stock option plan. Under the intrinsic value method no compensation cost
has been recognized for its stock option grants. Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
123) requires disclosure of pro forma net income and earnings per share had the
Company adopted the fair value method as of the beginning of 1995. Had
compensation cost for the grants been determined based upon the fair value
method, the Company's net income and earnings per share would have been reduced
to the pro forma amounts indicated below.
1996 1995
----------------------
Net (loss) income
As reported ($1,486) $3,313
Pro forma (1,583) 3,286
Primary earnings per share
As reported (.71) 1.11
Pro forma (.75) 1.10
Fully diluted earnings
As reported (.71) 1.04
Pro forma (.75) 1.04
The fair value of the options granted during 1996 and 1995 is estimated as
$604,073 and $238,000 on the date of grant using the Black-Scholes option-
pricing model with the following assumptions: no dividend, volatility of 29.0%
and 31.2%, risk-free interest rate of 6.04% and 6.50%, assumed forfeiture rate
of zero, and an expected life of 10 years. The weighted average per share fair
value of the 1996 and 1995 awards was $5.56 and $4.76 , respectively. The
impact of outstanding non-vested stock options granted prior to 1995 has been
excluded from the proforma calculations; acccordingly the 1995 and 1996 proforma
adjustments are not indicative of future proforma adjustments when the
calculation will apply to all applicable stock options.
In 1991 the Company established a 401(K) savings plan for employees who have at
least one year of continuous service. The Company's contributions are based on a
sliding scale where it matches 100% of the first $300 contributed by the
employee, 75% of the next $400, 50% of the next $800 and 25% of
86
the next $4,000 for a maximum contribution per employee of $2,000. Company
contributions totalled $257,000, $151,000 and $186,000 in 1996, 1995 and 1994.
In December 1993 the Company established a supplemental benefit plan (Plan) to
provide death benefits and supplemental income payments during retirement for
selected officers. The Plan is a nonqualified defined benefit plan and is
unsecured and unfunded. Benefits under the Plan are fixed for each participant
and are payable over a specific period following the participant's retirement or
at such earlier date as termination or death occurs. Participants vest in the
plan based on their years of service subsequent to being covered by the Plan.
The Company has purchased insurance policies to provide for its obligations
under the Plan in the event a participant dies prior to retirement. The cash
surrender value of such policies was $2,814,000 at December 31, 1996. Under
this plan, the Company recognized expense of $167,000, $221,000 and $210,000 in
1996, 1995 and 1994. The aggregate projected benefit obligation of the Plan was
approximately $267,000 and $308,000 at December 31, 1996 and 1995. A discount
rate of 8.5% was used to determine the aggregate projected benefit obligation
for both years. The aggregate vested present value benefit obligation was
$141,000 at December 31, 1996.
NOTE N - SUBORDINATED DEBT AND PREFERRED STOCK
In 1993, the Company issued $12,000,000 of 8.5% subordinated notes. The notes
are due February 15, 2004 and qualify as capital for bank regulatory purposes
(total capital). The notes are callable at par after January 15, 1997.
Issuance costs of $640,000 are carried as a deferred asset and are amortized
over the life of the notes as an adjustment to interest expense.
In 1993, the Company issued 575,000 shares of 7.80% Noncumulative Convertible
Perpetual Preferred Stock, Series A. The preferred stock is convertible, at the
option of the holder, into .8674 shares of common stock for each share of
preferred stock. The preferred stock may be redeemed after February 15, 1996,
at the option of the Company, at redemption prices which range from $10.55 at
February 15, 1996 to $10.00 after February 14, 2003. The preferred stock has a
liquidation preference of $10.00.
87
NOTE O - REGULATORY MATTERS
One of the principal sources of cash for Redwood are dividends from its
subsidiary financial institutions. Total dividends which may be declared by the
subsidiary financial institutions depend on the regulations which govern them.
In addition, regulatory agencies can place dividend restrictions on the
subsidiaries based on their evaluation of the financial condition of the
subsidiaries. No restrictions are currently imposed by regulatory agencies on
the subsidiaries other than the limitations found in the regulations which
govern the respective subsidiaries. At December 31, 1996, NBR could pay
additional dividends to Redwood of approximately $3,758,000 without prior
regulatory approval and Allied could pay additional dividends of approximately
$1,205,000.
The subsidiary financial institutions are subject to certain restrictions under
the Federal Reserve Act, including restrictions on the extension of credit to
affiliates. In particular, the subsidiaries are prohibited from lending to an
affiliated company unless the loans are secured by specific types of collateral.
Such secured loans and other advances from the subsidiaries are limited to 10
percent of the subsidiary's equity. No such loans or advances were outstanding
during 1996 or 1995.
Redwood and its subsidiaries are subject to various regulatory capital
requirements administered by the federal banking agencies. In addition to these
capital guidelines, the Federal Deposit Insurance Corporation Improvement Act of
1991 (FDICIA) required each federal banking agency to implement a regulatory
framework for prompt corrective actions for insured depository institutions that
are not adequately capitalized. The Board of Governors of the Federal Reserve
System, FDIC, OCC and OTS have adopted such a system which became effective on
December 19, 1992. Failure to meet minimum capital requirements can initiate
certain mandatory, and possibly additional discretionary, actions by regulators
that, if undertaken, could have a direct material effect on the Company's
financial statements. The regulations require the Company to meet specific
capital adequacy guidelines that involve quantitative measures of the Company's
assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. NBR's and Allied's capital classification is
also subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain a minimum leverage ratio of Tier 1 capital (as
defined in the regulations) to adjusted assets (as defined), and minimum ratios
of Tier 1 and total capital (as defined) to risk-weighted assets (as defined).
As of December 31, 1996, the most recent notification from the Office of the
Comptroller of the Currency and the Office of Thrift Supervision categorized NBR
and Allied as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Company and it's
operating subsidiaries must maintain minimum total risk-based, Tier I risk-
based, and Tier I leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institutions' category.
88
To Be Categorized
as Well Capitalized
For Capital Under Prompt
Actual Adequacy Purposes Corrective Action
---------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
---------------------------------------------------------
(dollars in thousands)
At December 31, 1996:
COMPANY
Leverage Capital (to Average Assets) $28,378 5.46% $20,808 4.00% n/a n/a
Tier 1 Capital (to Risk-weighted Assets) 28,378 7.63 14,875 4.00 n/a n/a
Total Capital (to Risk-weighted Assets) 45,056 12.12 29,749 8.00 n/a n/a
NBR
Leverage Capital (to Average Assets) 17,352 6.87 10,110 4.00 $12,637 5.00%
Tier 1 Capital (to Risk-weighted Assets) 17,352 9.40 7,384 4.00 11,075 6.00
Total Capital (to Risk-weighted Assets) 22,671 12.28 14,767 8.00 18,459 10.00
ALLIED
Core Capital (to Total Assets) 17,064 7.06 7,251 3.00 12,085 5.00
Tier 1 Capital (to Risk-weighted Assets) 14,402 9.43 n/a n/a 9,167 6.00
Total Capital (to Risk-weighted Assets) 16,335 10.69 12,222 8.00 15,278 10.00
Tangible Capital (to Total Assets) 17,064 7.06 3,626 1.50 n/a n/a
At December 31, 1995:
COMPANY
Leverage Capital (to Average Assets) $29,723 5.14% $23,134 4.00% n/a n/a
Tier 1 Capital (to Risk-weighted Assets) 27,123 7.24 14,991 4.00 n/a n/a
Total Capital (to Risk-weighted Assets) 43,780 11.68 29,981 8.00 n/a n/a
NBR
Leverage Capital (to Average Assets) 17,283 7.47 9,258 4.00 $11,572 5.00%
Tier 1 Capital (to Risk-weighted Assets) 17,283 9.41 7,349 4.00 11,023 6.00
Total Capital (to Risk-weighted Assets) 22,395 12.19 14,698 8.00 18,372 10.00
ALLIED
Core Capital (to Total Assets) 19,955 6.26 9,564 3.00 15,940 5.00
Tier 1 Capital (to Risk-weighted Assets) 17,355 9.22 n/a n/a 11,292 6.00
Total Capital (to Risk-weighted Assets) 19,713 10.47 15,056 8.00 18,820 10.00
Tangible Capital (to Total Assets) 19,955 6.26 4,782 1.50 n/a n/a
Management believes that as of December 31, 1996, the Company and its
subsidiaries meet all capital requirements to which they are subject. Under the
most stringent capital requirement, the Company has approximately $7,570,000 in
excess capital before it becomes "undercapitalized" under the regulatory
framework for prompt corrective action. Similarly, Allied has approximately
$4,121,000 and NBR has $7,904,000 in excess capital.
89
The prompt corrective action regulations impose restrictions upon all
institutions to refrain from certain actions which would cause an institution to
be classified as "undercapitalized", such as the declaration of the dividends or
other capital distributions or payment of management fees, if following the
distribution or payment the institution would be classified as
"undercapitalized". In addition, institutions which are classified as
"undercapitalized" are subject to certain mandatory and discretionary
supervisory actions.
NOTE P - DIVIDENDS
The cash dividend was $.035 per share for the first three quarters of 1994. In
December, 1994, the Company suspended its quarterly cash dividend on common
shares.
The Company declared cash dividends of $449,000, $336,000 and $448,000 on its
preferred stock for the years ended December 31, 1996, 1995 and 1994.
NOTE Q - INDUSTRY SEGMENT DATA
During the years ended December 31, 1996, 1995 and 1994, the Company operated in
two principal industry segments: mortgage banking and commercial banking. The
Company's mortgage banking activities relate to the origination for sale,
servicing of sold mortgages and sale of residential mortgage loans. Commercial
banking activities relate to the origination of commercial, real estate
(including construction) and installment loans for the Company's portfolio and
origination and sale of SBA loans. Commercial banking also includes other fee
services.
Revenue from mortgage banking activities is defined as interest income on
mortgage loans held for sale and investments used to hedge or provide liquidity,
gains on sale of loans and loan servicing and income from mortgage loan
servicing activities. Revenue for commercial banking activities include
interest income on loans and investments and service fee income. Operating
profit for both segments excludes holding company expenses and income taxes.
Identifiable assets are those assets that are used in the Company's operations
in each industry segment. Corporate assets primarily consist of investments in
subsidiaries. Substantially all mortgage loan sales are made to Freddie Mac and
Fannie Mae. Capital expenditures and depreciation and amortization expenses are
not material for the industry segments.
90
Year Ended December 31,
1996 1995 1994
---------------------------
(in thousands)
REVENUE
Mortgage banking $19,382 $16,089 $16,269
Commercial banking 45,972 47,860 32,621
-------- -------- --------
Total $65,354 $63,949 $48,890
-------- -------- --------
-------- -------- --------
OPERATING (LOSS) PROFIT
Mortgage banking ($1,109) $138 ($9,821)
Commercial banking 1,304 7,639 6,881
-------- -------- --------
Total operating (loss) profit 195 7,777 (2,940)
Corporate (2,692) (2,105) (1,954)
Inter-segment eliminations --- --- ---
-------- -------- --------
(Loss) income before income taxes ($2,497) $5,672 ($4,894)
-------- -------- --------
-------- -------- --------
IDENTIFIABLE ASSETS
Mortgage banking $98,436 $105,580 $168,461
Commercial banking 397,866 450,486 459,444
Corporate 3,164 1,844 2,747
-------- -------- --------
Total $499,466 $557,910 $630,652
-------- -------- --------
-------- -------- --------
As mentioned in Note A, it is anticipated that revenue, operations and assets
attributable to mortgage banking operations will decline in future periods as a
result of curtailed A paper wholesale mortgage loan production.
NOTE R - FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures About Fair
Value of Financial Instruments" (SFAS No. 107) requires that the Company
disclose the fair value of financial instruments for which it is practicable to
estimate that value. Although management uses its best judgment in assessing
fair value, there are inherent weaknesses in any estimating technique that may
be reflected in the fair values disclosed. The fair value estimates are made at
a discrete point in time based on relevant market data, information about the
financial instruments, and other factors. Estimates of fair value of
instruments without quoted market prices are subjective in nature and involve
various assumptions and estimates that are matters of judgment. Changes in the
assumptions used could significantly affect these estimates. Fair value has not
been adjusted to reflect changes in market conditions for the period subsequent
to the valuation dates of December 31, 1996 and 1995 and therefore estimates
presented herein are not necessarily indicative of amounts which could be
realized in a current transaction.
The following estimates and assumptions were used on December 31, 1996 and 1995
to estimate the fair value of each class of financial instruments for which it
is practicable to estimate that value.
91
(a) CASH AND CASH EQUIVALENTS
For cash and cash equivalents, the carrying amount is a reasonable estimate of
fair value.
(b) INTEREST-BEARING DEPOSITS DUE FROM FINANCIAL INSTITUTIONS
The fair value of interest-bearing deposits held by the Company is based on the
discounted cash flows through the date of maturity at market interest rates for
similar maturities as of the valuation date.
(c) INVESTMENTS
Fair value equals quoted market price, if available. If a quoted market price
is not available, fair value is estimated using quoted market prices for similar
securities. For investments in unregistered mortgage-backed securities with
recourse, fair value was estimated based on the expected future cash flows to be
received adjusted for prepayments, foreclosures, losses and other significant
factors impacting fair value. U.S. Government agency stock has no trading
market but is required as part of membership, and therefore it is carried at
cost.
(d) LOANS HELD FOR SALE
For uncommitted residential mortgages held for sale, fair value is estimated
using indications of value obtained by management from independent third parties
or quoted market prices for securities backed by similar loans, adjusted for
differences in loan characteristics. Committed residential mortgage loans held
for sale are valued based on actual commitment prices. Fair value of certain
loans held for sale include the value of premiums associated with the sale of
the related servicing rights in the instance that a commitment exists for the
sale of such servicing at a predetermined rate.
(e) LOANS RECEIVABLE
To estimate fair value of loans held for investment, including commercial loans,
mortgages and construction loans, each loan category is segmented by fixed and
adjustable rate interest terms, by estimated credit risk, by maturity, and by
performing and nonperforming categories.
The fair value of performing loans is estimated by discounting contractual cash
flows using the current interest rates at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining maturities.
Assumptions regarding credit risk, cash flow, and discount rates are
judgmentally determined using available market information.
The fair value of nonperforming loans and loans delinquent more than 30 days is
estimated by discounting estimated future cash flows using current interest
rates with an additional risk adjustment reflecting the individual
characteristics of the loans.
(f) INTEREST RECEIVABLE
For interest receivable, the carrying amount is a reasonable estimate of fair
value.
92
(g) MORTGAGE SERVICING RIGHTS
The fair value of mortgage servicing rights is estimated on a loan by loan basis
using market prices under comparable servicing sale contracts, when available
or, using a cash flow model with current assumptions with respect to
prepayments, servicing costs and other significant factors.
(h) DEPOSIT LIABILITIES
Under SFAS No. 107, the fair value of deposits with no stated maturity, such as
noninterest bearing demand deposits, savings and money market accounts, is equal
to the amount payable on demand on December 31, 1996 and 1995. The fair value
of time deposits, is based on the discounted value of contractual cash flows.
The discount rate is based on rates currently offered for deposits of similar
size and remaining maturities.
(i) OTHER BORROWINGS AND SUBORDINATED NOTES
The discounted value of contractual cash flows at market interest rates for debt
with similar terms and remaining maturities are used to estimate the fair value
of existing debt.
(j) COMMITMENTS TO FUND MORTGAGE LOANS
The fair value of commitments to fund fixed-rate mortgage loans represents the
estimated gain (loss) to the Company of fully funding its commitments at current
interest rates and selling the underlying loans in the secondary market.
(k) COMMITMENTS TO FUND OTHER LOANS
The fair value of commitments to fund other loans represents fees currently
charged to enter into similar agreements with similar remaining maturities.
(l) FORWARD CONTRACTS TO SELL MBS
The fair value of forward contracts to sell MBS represents the difference
between current rates for similar quantities and delivery dates of mortgage-
backed securities as compared to the contractual rates.
(m) PURCHASED AND WRITTEN OPTIONS
Carrying value represents premiums paid or received. Fair values were obtained
from third party dealers of such options.
93
The estimated fair values of the Company's financial instruments are as follows:
December 31,
1996 1995
--------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------- -------- -------
(in thousands)
ASSETS:
Cash and cash equivalents $45,473 $45,473 $55,140 $55,140
Interest-bearing deposits 315 318 417 417
Investments 52,633 52,949 43,964 43,964
Loans held for sale 29,487 29,763 62,620 64,251
Portfolio loans, net 340,374 350,249 363,187 366,046
Interest receivable 3,399 3,399 3,825 3,825
Mortgage servicing rights 582 628 5,970 7,446
LIABILITIES:
Deposits 436,450 436,724 458,393 458,070
Other borrowings 10,307 10,307 47,871 45,438
Subordinated notes 12,000 12,120 12,000 12,300
UNRECOGNIZED FINANCIAL INSTRUMENTS:
Commitments to fund mortgage loans (26) 76
Commitments to fund other loans 362 3 49
Forward contracts to sell MBS --- 73 --- (64)
Purchased put options:
MBS --- ) --- 217 )84
U.S. Treasury 250 163 340 197
Purchased call options - U.S. Treasury 205 79 308 320
Written call options - MBS --- --- 261 464
Written put options - U.S. Treasury --- --- 204 170
NOTE S - RESTRUCTURING CHARGES
In November, 1996 the Company's Board of Directors approved a plan to merge its
two wholly owned subsidiaries, National Bank of the Redwoods and Allied Bank
F.S.B. As a result of the merger, the surviving bank, National Bank of the
Redwoods, will assume all of Allied's rights and obligations. In connection
with the merger, and as a result of the Company's decision to significantly
curtail its wholesale mortgage banking production capacity, the Company recorded
a restructuring charge of $2,357,000 in the fourth quarter of 1996. The
restructuring of the Company, which includes both the merger of Allied into
National Bank of the Redwoods and the reduction in "A" paper wholesale lending,
includes the closing of the Portland and Sacramento mortgage loan production
offices, the partial write-off of Allied's administrative headquarters lease,
termination of employees, and write-off of duplicative or unnecessary fixed
assets. The total charge to operations associated with these matters
consisted of:
94
Severance for 70 employees $651,000
Accrual of discontinued leases 772,000
Write-off of leasehold improvements,
furniture and fixtures 934,000
----------
$2,357,000
----------
----------
During the third and fourth quarters of 1994, the Company implemented major cost
reduction programs in response to declining origination volumes in the Company's
mortgage banking business and recorded restructuring charges of $815,000 in the
third quarter and $1,594,000 in the fourth quarter. During 1995, the Company
was able to sublease some of the properties noted below and recorded a recovery
of $456,000. The 1994 restructuring charge consisted of:
Severance for 125 employees $374,000
Accrual of discontinued leases 1,683,000
Writeoff of leasehold improvements,
furniture and fixtures 352,000
----------
$2,409,000
----------
----------
At December 31, 1996, $1,808,000 of the restructuring charges remained in other
liabilities, substantially all of which is related to the future minimum lease
payments associated with the closed facilities or future employee severance
payments. The Company is actively seeking sublease tenants for many of these
closed facilities and a portion of the restructuring charge may be reversed in
future periods if the Company is successful in entering into such arrangements.
The following table presents a summary of activity with respect to the
restructuring accrual.
1996 1995 1994
------------------------------------
(dollars in thousands)
Balance, beginning of year $619 $1,757 $ ---
Provision charged against income 2,357 (456) 2,409
Cash outlays (234) (682) (300)
Noncash writedowns (934) (352)
------------------------------------
Balance, end of year $1,808 $619 $1,757
------------------------------------
------------------------------------
95
NOTE T - COMMITMENTS AND CONTINGENCIES
Certain lawsuits and claims arising in the ordinary course of business have been
filed or are pending against the Company or its subsidiaries. Based upon
information available to the company, its review of such lawsuits and claims and
consultation with its counsel, the Company believes the liability relating to
these actions, if any, would not have a material adverse effect on its financial
position.
NOTE U - CONDENSED FINANCIAL INFORMATION OF REDWOOD EMPIRE BANCORP (PARENT ONLY)
BALANCE SHEETS
December 31,
1996 1995
------- -------
(in thousands)
ASSETS
Cash $2,178 $1,623
Investment in subsidiaries 39,016 39,100
Capitalized issuance costs 640 735
Other assets 346 2,486
------- -------
Total assets $42,180 $43,944
------- -------
------- -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable $448 $359
Subordinated notes 12,000 12,000
------- -------
Total liabilities 12,448 12,359
------- -------
Shareholders' equity:
Preferred stock, authorized 2,000,000 shares;
issued and outstanding 575,000 shares 5,750 5,750
Common stock, no par value: authorized
10,000,000 shares; issued and outstanding:
1996 - 2,748,652 shares; 1995 - 2,679,227 shares 19,281 18,728
Retained earnings 5,032 6,967
Unrealized gain (loss) on investment securities
available for sale, net of taxes (331) 140
------- -------
Total shareholders' equity 29,732 31,585
------- -------
Total liabilities and shareholders' equity $42,180 $43,944
------- -------
------- -------
96
STATEMENTS OF OPERATIONS
Year Ended December 31,
1996 1995 1994
---------------------------
(in thousands)
Operating income:
Management service fees $736 $403 $61
Dividends from subsidiaries 2,442 1,087 600
Interest income from subsidiaries 297 292 311
Other income --- --- 13
------- ------ -------
Total operating income 3,475 1,782 985
------- ------ -------
Expenses:
Interest expense 1,115 1,100 1,131
Operating expenses 1,876 1,700 1,208
------- ------ -------
Total expenses 2,991 2,800 2,339
------- ------ -------
(Loss) income before undistributed income of
subsidiaries 484 (1,018) (1,354)
Equity in undistributed (loss) income of
subsidiaries (2,613) 3,447 (1,900)
------- ------ -------
(Loss) income before income taxes (2,129) 2,429 (3,254)
Income tax benefit (643) (884) (219)
------- ------ -------
Net (loss) income ($1,486) $3,313 ($3,035)
------- ------ -------
------- ------ -------
97
STATEMENTS OF CASH FLOWS
Year Ended December 31,
1996 1995 1994
-----------------------------------------------
(in thousands)
Cash flows from operating activities:
Net (loss) income ($1,486) $3,313 ($3,035)
------- ------- -------
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Amortization and depreciation 23 10 5
Equity in undistributed net (income) loss of subsidiaries 2,613 (3,447) 1,900
Change in other assets (741) 1,275 (300)
Change in other liabilities 89 186 225
------- ------- -------
Total adjustments 1,984 (1,976) 1,830
------- ------- -------
Net cash provided by (used in) operating activities 498 1,337 (1,205)
------- ------- -------
Cash flows from investing activities:
Investment in subsidiaries --- --- (6,000)
------- ------- -------
Net cash used in investing activities --- --- (6,000)
------- ------- -------
Cash flows from financing activities:
Notes issued --- --- ---
Note repayments --- --- ---
Stock issuance 506 108 425
Cash dividends (449) (448) (810)
------- ------- -------
Net cash provided by (used in) financing activities 57 (340) (385)
Increase (decrease) in cash 555 997 (7,590)
------- ------- -------
Cash at beginning of year 1,623 626 8,216
------- ------- -------
------- ------- -------
Cash at end of year $2,178 $1,623 $626
------- ------- -------
------- ------- -------
98
QUARTERLY RESULTS
UNAUDITED QUARTERLY STATEMENTS OF OPERATIONS DATA
(dollars in thousands)
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
1995 1995 1995 1995 1996 1996 1996 1996
------------------------------------ ------------------------------------
Net interest income $4,612 $4,692 $4,823 $5,576 $5,499 $6,082 $5,898 $5,662
Provision for credit losses 300 370 385 535 1,515 1,315 545 2,887
Other operating income 4,433 4,121 3,525 4,496 5,585 4,411 3,929 5,645
Other operating expense 7,197 7,077 6,957 7,785 8,091 9,067 10,681 11,107
------------------------------------ ------------------------------------
Income (loss) before income taxes 1,548 1,366 1,006 1,752 1,478 111 (1,399) (2,687)
Provision (benefit) for
income taxes 637 604 391 727 592 73 (595) (1,081)
------------------------------------ ------------------------------------
Net income (loss) $911 $762 $615 $1,025 $886 $38 ($804) ($1,606)
------------------------------------ ------------------------------------
------------------------------------ ------------------------------------
Net income (loss) available
for common stock $799 $650 $503 $1,025 $774 ($74) ($916) ($1,718)
------------------------------------ ------------------------------------
------------------------------------ ------------------------------------
Per share:
Primary earnings (loss) $ .30 $ .24 $ .19 $.38 $ .29 ($ .03) ($ .33) ($ .63)
Fully-diluted earnings (loss) .29 .24 .19 .32 .27 (.03) (.33) (.63)
Common dividend --- --- --- --- --- --- --- ---
Common Stock Prices:
High $7.25 $9.25 $10.13 $9.38 $7.25 $9.25 $10.13 $11.50
Low 5.75 6.38 7.25 7.50 5.75 6.38 7.25 10.38
Close 6.75 8.50 8.88 8.00 6.75 8.50 8.88 11.50
Net income in the fourth quarter of 1996 decreased $2,631,000 compared to
the same quarter in 1995 primarily due to the provision for loan losses of
$2,887,000 as compared to $535,000 in the same period one year ago.
The results for the first quarter of 1995 were restated to reflect the
adoption of SFAS No. 122 as of January 1, 1995, accounting for an additional
$167,000 ($.05 per fully-diluted share) in the first quarter.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
99
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item can be found in Redwood's definitive
Proxy Statement pursuant to Regulation 14A under the Securities Exchange Act of
1934, and is by this reference incorporated herein.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item can be found in Redwood's definitive
Proxy Statement pursuant to Regulation 14A under the Securities Exchange Act of
1934, and is by this reference incorporated herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item can be found in Redwood's definitive
Proxy Statement pursuant to Regulation 14A under the Securities Exchange Act of
1934, and is by this reference incorporated herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
(a) TRANSACTIONS WITH MANAGEMENT AND OTHERS.
NBR leases 34,000 square feet of office space for its main office from 137
Group, a partnership that includes as a minority partner NBR director Richard
Colombini. The lease calls for payments of $71,954 per month plus annual rental
increases through September 1999. Total lease payments in 1996, 1995, and 1994
for this location were $863,000, $863,000 and $648,000, respectively.
(b) CERTAIN BUSINESS RELATIONSHIPS.
Except as disclosed elsewhere in this Item, management is not aware of any
business relationships required to be disclosed hereunder.
100
(c) INDEBTEDNESS OF MANAGEMENT.
Some of the Company's directors and executive officers and their immediate
families, as well as the companies with which they are associated, are customers
of or have had banking transactions with the Company in the ordinary course of
the Company's business, and the Company expects to have banking transactions
with such persons in the future. In management's opinion, all such loans and
commitments to lend were made in the ordinary course of business, in compliance
with applicable laws, on substantially the same terms, including interest rates
and collateral, as those prevailing for comparable transactions with other
persons of similar credit worthiness and, in the opinion of management, did not
involve more than a normal risk of collectibility or present other unfavorable
features. The Company has a strong policy regarding review of the adequacy and
fairness to the Company of loans to its directors and officers. At December 31,
1996, there were no outstanding balances under extensions of credit to directors
and executive officers of the Company and companies with which directors are
associated.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K.
1. The following consolidated financial statements of Redwood and its
subsidiaries, and independent auditors' report included for the years ended
December 31, 1996, 1995 and 1994 are included in Item 8.
Independent Auditors' Report
Consolidated Financial Statements of Redwood Empire Bancorp
Consolidated Statements of Operations
Consolidated Balance Sheets
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES.
All financial statement schedules have been omitted, as inapplicable.
101
3. EXHIBITS.
The following documents are included or incorporated by reference in this
Annual Report on Form 10-K. Exhibits marked with an asterisk (*) represent
management contracts or compensatory plans or arrangements.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1 Acquisition and Merger Agreement between National Bank of the
Redwoods and Codding Bank, dated June 21, 1994, including
Exhibits A and B thereto, filed as Exhibit 2.1 to the
Registrant's Current Report on Form 8-K dated June 21, 1994, and
by this reference incorporated herein.
2.2 Amendment No. 1 to Acquisition and Merger Agreement between
National Bank of the Redwoods and Codding Bank, dated September
21, 1994, filed as Exhibit 2.1 to the Registrant's Current Report
on Form 8-K dated September 21, 1994, and by this reference
incorporated herein.
3. 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.
4.1 Form of Indenture (including form of Notes) between the
Registrant and the Bank of New York, as Trustee, relating to the
issuance of 8.50% Subordinated Notes due 2004, filed as Exhibit
4.1 to the Registrant's Registration Statement on Form S-2 dated
December 13, 1993 (Registration No. 33-71324), and by this
reference incorporated herein.
4.2 Certificate of Determination of the Rights, Preferences,
Privileges and Restrictions of the Registrant's 7.80%
Noncumulative Convertible Perpetual Preferred Stock, Series A,
filed as Exhibit 4.1 to the Registrant's Registration Statement
on Form S-2 dated February 16, 1993 (Registration No. 33-56962),
and by this reference incorporated herein.
10.1* Severance Compensation Agreement between Allied Savings Bank,
F.S.B. and Terance O'Mahoney, filed as Exhibit 10.1 to the
Registrant's 1990 Annual Report on Form 10-K and by this
reference incorporated herein.
10.2* Amendment No. 1 to Severance Compensation Agreement between
Allied Savings Bank, F.S.B. and Terance O'Mahoney dated as of
January 1, 1993, filed as Exhibit 10.2 to the Registrant's 1992
Annual Report on Form 10-K and by this reference incorporated
herein.
102
10.3* Employment Agreement between Allied Savings Bank, F.S.B. and
Martin B. McCormick, dated as of July 1, 1990, filed as Exhibit
10.5 to the Registrant's 1992 Annual Report on Form 10-K and by
this reference incorporated herein.
10.4* Amendment No. 1 to Employment Agreement between Allied Savings
Bank, F.S.B. and Martin B. McCormick, dated as of January 1,
1993, filed as Exhibit 10.6 to the Registrant's 1992 Annual
Report on Form 10-K and by this reference incorporated herein.
10.5* 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.
10.6 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.
10.7 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.
10.8* 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.
10.9* The Allied Savings Bank, F.S.B. 1986 Stock Option Plan, filed as
Exhibit 28.1 to the Registrant's Registration Statement on Form
S-8 dated June 28, 1991 (Registration No. 33-41503), and by this
reference incorporated herein.
10.10* 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.
10.11* 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.
10.12* The Registrant's Performance Incentive Bonus Plan, filed as
Exhibit 10.13 to the Registrant's 1992 Annual Report on Form 10-
K, and by this reference incorporated herein.
10.13 The Registrant's Dividend Reinvestment and Stock Purchase Plan,
filed as Exhibit 10.14 to the Registrant's 1992 Annual Report on
Form 10-K, and by this reference incorporated herein.
103
10.14* The Registrant's Phantom Stock Plan, filed as Exhibit 10.16 to
the Registrant's 1993 Annual Report on Form 10-K, and by this
reference incorporated herein.
10.15* Phantom Stock Agreement between the Registrant and John H.
Downey, Jr., dated as of January 1, 1994, filed as Exhibit 10.17
to the Registrant's 1993 Annual Report on Form 10-K, and by this
reference incorporated herein.
10.16* 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.
10.17* 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.
10.18* 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.
10.19* Lease, dated December 23, 1993 between Allied Bank, F.S.B. and
Santa Rosa Corporate Center Associates II, filed as Exhibit 10.21
to the Registrant's 1994 Annual Report on Form 10-K, and by this
reference incorporated herein.
10.20* Compensation Agreement between Patrick W. Kilkenny and Redwood
Empire Bancorp.
10.21* Executive Severance Agreement between Patrick W. Kilkenny and
Redwood Empire Bancorp.
10.22* Salary Continuation Agreement between James E. Beckwith and
Redwood Empire Bancorp.
11. Statement re Computation of Per Share Earnings.
12.1 Statement re Computation of Ratio of Earnings to Fixed Charges.
12.2 Statement re Computation of Ratio of Earnings to Fixed Charges
and Preferred Dividends.
21. Subsidiaries of the Registrant.
24. Consent of Deloitte & Touche LLP.
104
(b) REPORTS ON FORM 8-K.
The Company filed the following Current Reports on Form 8-K during the last
quarter of 1996:
1. On October 24, 1996 reporting the declaration of a quarterly dividend
of 19.5 cents per share on the Registrant's 7.80% Noncumulative
Convertible Perpetual Preferred Stock and the earnings for the quarter
ended September 30, 1996.
2. On November 21, 1996 reporting the Board approval of the combination
of Allied Bank and National Bank of the Redwoods.
(c) EXHIBITS.
See Item 14(a)3 and the Index to Exhibits.
(d) EXCLUDED FINANCIAL STATEMENTS
Not applicable.
105
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
REDWOOD EMPIRE BANCORP
By: /S/ TOM D. WHITAKER Dated: March 18, 1997
-----------------------------------
Tom D. Whitaker
Chairman of the Board
And By: /S/ PATRICK W. KILKENNY Dated: March 18, 1997
--------------------------------
Patrick W. Kilkenny
President and Chief Executive Officer
(Principal Executive Officer)
And By: /S/ JAMES E. BECKWITH Dated: March 18, 1997
--------------------------------
James E. Beckwith
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
106
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
/S/ ORLANDO J. ANTONINI Dated: March 18, 1997
- --------------------------------
Orlando J. Antonini, Director
/S/ HASKELL E. BOYETT Dated: March 18, 1997
- --------------------------------
Haskell E. Boyett, Director
/S/ ROBERT D. COOK Dated: March 18, 1997
- --------------------------------
Robert D. Cook, Director
/S/ PATRICK W. KILKENNY Dated: March 18, 1997
- --------------------------------
Patrick W. Kilkenny, Director
/S/ JOHN R. OLSEN Dated: March 18, 1997
- --------------------------------
John R. Olsen, Director
/S/ WILLIAM B. STEVENSON Dated: March 18, 1997
- --------------------------------
William B. Stevenson, Director
/S/ TOM D. WHITAKER Dated: March 18, 1997
- --------------------------------
Tom D. Whitaker, Director
and Chairman of the Board
107
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.20 Compensation Agreement between Patrick W. Kilkenny and Redwood
Empire Bancorp.
10.21 Executive Severance Agreement between Patrick W. Kilkenny and
Redwood Empire Bancorp.
10.22 Salary Continuation Agreement between James E. Beckwith and
Redwood Empire Bancorp.
11. Statement re Computation of Per Share Earnings.
12.1 Statement re Computation of Ratio of Earnings to Fixed Charges.
12.2 Statement re Computation of Ratio of Earnings to Fixed Charges
and Preferred Dividends.
21. Subsidiaries of the Registrant.
24. Consent of Deloitte & Touche LLP.
108