Exhibit 13
SELECTED CONSOLIDATED FINANCIAL DATA
Financial Condition As of June 30
----------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
(Dollars In Thousands)
Assets $391,058 $364,713 $311,349 $295,094 $263,768
Loans receivable, net 343,852 324,711 267,497 239,052 207,315
Loans held for sale - - 10,209 9,731 15,997
Mortgage-backed securities held to maturity 1,672 1,778 5,130 7,304 1,130
Mortgage-backed securities available for sale 8,441 6,165 1,733 2,767 2,992
Investments 1 17,795 14,776 11,390 21,712 22,492
Savings accounts 283,909 276,900 255,075 255,338 225,865
Advances from FHLB 60,036 47,695 19,217 3,247 5,816
Other borrowings 9,332 3,118 3,055 4,895 3,788
Stockholders' equity 34,578 33,684 31,233 28,076 24,984
Operations For the Year Ended June 30
--------------------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
(In Thousands Except Per Share Amounts)
Interest income $ 26,154 $ 22,914 $ 24,254 $ 26,478 $ 26,398
Interest expense 14,463 9,225 9,615 13,373 15,378
------ ----- ----- ------ ------
Net interest income 11,691 13,689 14,639 13,105 11,020
Provision for loan losses 412 725 722 529 214
--- --- --- --- ---
Net interest income after provision for
loan losses 11,279 12,964 13,917 12,576 10,806
Noninterest income 950 1,286 1,335 1,022 996
Noninterest expense 9,170 9,125 8,656 7,235 6,910
----- ----- ----- ----- -----
Income before tax 3,059 5,125 6,596 6,363 4,892
Income tax expense (1,127) (2,067) (2,859) (2,876) (2,060)
Cumulative effect of change in accounting
principle for income taxes 2 - 220 - - -
- --- - - -
Net income $ 1,932 $ 3,278 $ 3,737 $ 3,487 $ 2,832
-------- -------- -------- -------- --------
Earnings per share 3
Primary $ .67 $ 1.36 $ 1.55 $ 1.45 $ 1.19
Fully diluted $ .67 $ 1.35 $ 1.55 $ 1.44 $ 1.18
===== ====== ====== ====== ======
Dividends declared per share $ .44 $ .41 $ .32 $ .28 $ 0
===== ===== ===== ===== ===
Other Selected Data As of or for the Year Ended June 30
------------------------------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
Net interest rate spread 2.88% 4.14% 4.87% 4.60% 4.15%
Net yield on average interest-earning assets 3.14% 4.36% 5.11% 4.98% 4.57%
Return on average assets 0.50% 1.00% 1.24% 1.26% 1.12%
Return on average equity 5.64% 9.95% 12.47% 13.05% 11.94%
Average equity to average assets ratio 8.82% 10.03% 9.98% 9.69% 9.35%
Dividend payout ratio' 57.23% 25.63% 14.90% 9.80%
Average interest-earning assets to
average interest-bearing liabilities 106.52% 107.37% 107.25% 107.55% 106.70%
Ratio of total operating expenses to
total average assets 2.36% 2.78% 2.88% 2.62% 2.72%
Ratio of nonperforming assets to average assets 0.74% 1.37% 0.92% 0.44% 0.32%
Branch office 8 8 7 7 6
1 Includes certificates of deposit, overnight federal funds, income funds, U.S.
Government securities and interest-bearing cash balances.
2 See note 1 of Notes to Consolidated Financial Statements.
3 See note 11 of Notes to Consolidated Financial Statements.
4 Aggregate cash dividends paid during the fiscal year divided by net income
NORTHBAY FINANCIAL CORPORATION AND SUBSIDIARY
Management's Discussion and Analysis of
Financial Condition and Results of Operations
General
Northbay Financial Corporation (the "Company") is the holding company
for Northbay Savings Bank, F.S.B. (The "Bank"), its wholly owned subsidiary.
Virtually all financial activity of the Company is conducted through the Bank,
which is the sole asset of the Company.
The operations of the Bank, which consist primarily of managing
financial assets and liabilities are dictated to a large extent by the changing
nature of the financial markets in general, and the changing interest rate
environment in particular. The Bank's primary source of acquiring financial
assets and liabilities is its access to the retail market, attracting deposits
from the general public through its branch network and utilizing those funds to
provide financing for local housing in the form of mortgage, construction, and
commercial real estate loans.
The Bank's profitability depends primarily on its net interest income,
which is the difference between the interest income it receives from the Bank's
investment and loan portfolios and its cost of funds, consisting primarily of
the interest paid on deposits and borrowings. Net interest income is affected by
the volume of interest-earning assets, interest-bearing liabilities, yields on
interest-earning assets and rates paid on interest-bearing liabilities (see
Rate/Volume Analysis). When interest-earning assets approximate or exceed
interest-bearing liabilities, any positive interest rate spread will generate
net interest income.
During a year of extreme volatility in interest rates, the Bank has
been challenged to maintain its historically high interest rate spread. After a
year of generally rising interest rates which ended March 31,1995, a period
viewed by many as carrying a high degree of inflationary risk as evidenced by
the actions of the Federal Reserve Board (FRB) which increased the Federal Funds
Rate on seven separate occasions, we began to experience a significant decline
in interest rates. The FRB, implemented the final of seven increases of the
Federal Funds Rates, moving the rate up from 5.50% to 6.00% on February 2, 1995.
This upward movement, combined with more economic data supporting an apparent
slowing in the economy, led to the market decline in interest rates on
maturities beyond six months. For example, while the rate on the one year
treasury had increased from 3.35% at its low point in October of 1993 to 7.17%
at its peak in December of 1994 (an increase of 3.82%) during the six months
ended June 30, 1995, this same rate declined to 5.72%. On July 2, 1995 the FRB
signaled a change in its outlook for inflation, implementing the first drop in
the Federal Funds rate in more than 2 years. Despite the welcome relief in terms
of generally lower interest rates, the impact of this positive event in the
financial markets is not readily apparent in the operating results of the Bank
during the six months ended June 30, 1995, and as with all rate changes in such
a large portfolio of financial assets and liabilities, will take time to work
through the portfolios. The lingering effects of a year of rising interest rates
continue to be reflected through a lower level of net interest income for the
year ended June 30, 1995. During a period of a flattening yield curve in which
short-term rates are rising more rapidly than long-term rates, such as we
experienced, the Bank will feel the negative effect of a shrinking net interest
rate spread. The Bank suffered a negative impact as a result of the continued
increase in interest rates on its shorter-term retail deposits and borrowings
that could not be matched by the adjustment taking place on the adjustable rate
loan portfolio.
During a period of stable to falling interest rates, the Bank should
now begin to experience the benefits of the lagging nature of the 11th District
Cost of Funds Index (COFI) to which such a large volume of the Bank's financial
assets are tied. While the Bank's large portfolio of adjustable rate loans
indexed to the COFI continues to reprice upward due to the lagging nature of the
index, the Bank's cost of funding these assets with short-term liabilities
should diminish. Despite erosion of the net interest rate spread from 3.04% for
the quarter ended December 31, 1994 to 2.45% for the quarter ended March 31,
1995, it is significant to note that after seven consecutive quarters of decline
the margin hit a low of 2.45% in January, stabilizing at that spread for the
remainder of the quarter before increasing to 2.55% for the quarter ended June
30, 1995.
To a lesser extent, the Bank's profitability is also affected by the
level of noninterest income and expense. Noninterest income consists primarily
of service fee income relating to both loans and transaction accounts. During
the few years preceding the fiscal year ending June 30, 1995, the Bank had
relied more heavily on loan sales in the secondary markets as a means of
generating funds to originate new loans and to transfer the interest risk
associated with carrying longer-term fixed rate loans. This increased volume of
loan sales in previous years was reflected in noninterest income under the
category of gains on sale of loans and mortgage-backed securities. With the
sharp increase in interest rates which occurred between October of 1993 and
December of 1994, the consumer demand for fixed rate loans, which are typically
sold in the secondary markets, has been extremely limited. With such a small
volume of fixed rate product being originated the Bank's ability to continue to
generate noninterest income from this source of business has and will continue
to be hampered. Noninterest expense consists of compensation and benefits,
occupancy related expenses, deposit insurance premiums and other operating
expenses.
The Financial Institutions Reform, Recovery, and Enforcement Act of
1989 (FIRREA), which became effective on August 8, 1989 has had a significant
impact on the thrift industry. The Bank, like the rest of the thrift industry,
has been affected by FIRREA through more stringent capital requirements. The
requirements include a leverage ratio of core capital to adjusted total assets
of 3%, a tangible capital ratio of 1.5% and a risk-based capital standard
currently set at 8% of risk-weighted assets. The Bank exceeds all of the
regulatory capital standards with ratios of core, tangible, and risk-based
capital to assets of 8.60%, 8.58% and 14.56%, respectively.
Under FIRREA, the capital standards for savings associations must be
no less stringent than the capital standards applicable to national banks. On
September 17, 1990, the Office of the Comptroller of the Currency (OCC)
announced the adoption, effective December 31,1990, of regulations implementing
more stringent core capital requirements for national banks. The OCC regulations
establish a new minimum core capital ratio of 3% for the most highly rated
banks, with an additional 100 to 200 basis point "cushion" amount of additional
capital required on a case-by-case basis, considering the quality of risk
management systems and the overall risk in individual banks. On April 22, 1991,
the Office of Thrift Supervision (OTS) proposed to amend its core capital
requirement to reflect the OCC's amendments to the core capital requirement for
national banks. The OTS proposal would establish a 3% core capital ratio for
savings institutions in the strongest financial and managerial condition. For
all other savings institutions, the minimum core capital ratio would be 3% plus
at least an additional 100 to 200 basis points. In determining the amount of
additional capital, the OTS would assess both the quality of risk management
systems and the level of overall risk in each individual savings institution
through the supervisory process on a case-by-case basis. At June 30, 1995 the
Bank had core capital of approximately $33.6 million, or 8.60% of adjusted total
assets. Management, therefore, does not expect the proposed amendment to cause
the Bank to fall below its regulatory capital requirements.
The OTS published a final regulation incorporating the interest rate
risk component in the risk-based capital rule on August 31,1993. The rule took
effect January 1, 1994 and requires savings institutions with more than a
"normal" level of interest rate risk to maintain additional total capital. A
savings institution's interest rate risk will be measured in terms of the
sensitivity of its "net portfolio value" to changes in interest rates. Net
portfolio value is defined, generally, as the present value of expected cash
inflows from existing assets and off-balance-sheet contracts less the present
value of expected cash outflows from existing liabilities. A savings institution
is considered to have a "normal" level of interest rate risk if the decline in
the market value of its portfolio equity after an immediate 200 basis point
increase or decrease in market interest rates (whichever leads to the greater
decline) is less than two percent of the current estimated market value of its
assets. A savings institution with a greater than normal interest rate risk will
be required to deduct from total capital, for purposes of calculating its risk-
based capital requirement, an amount (the interest rate risk component "IRR")
equal to one half the difference between the institutions measured interest rate
risk and the normal level of interest rate risk, multiplied by the economic
value of its total assets.
The OTS will calculate the sensitivity of a savings institution's net
portfolio value based on data submitted by the institution in a schedule
included in its quarterly Thrift Financial Report and using the interest rate
risk measurement model adopted by the OTS. The amount of the IRR component, if
any, to be deducted from a savings institution's risk-based capital. The IRR
component is to be computed quarterly, and the capital requirement for the IRR
will have an effective lag of two calendar quarters. The first quarter to be
measured has once again been postponed indefinitely until questions regarding a
review procedure for institutions challenging the results of the OTS model have
been resolved. Institutions that do not have sufficient capital to comply with
the IRR component will be required to submit a capital plan to achieve
compliance. Based upon the Bank's current level of adjustable rate, shorter-term
assets and regulatory capital, management does not expect the Bank's interest
rate risk component to have a material impact on the Bank's regulatory capital
level or its compliance with the regulatory capital requirements.
Components of the Bank's regulatory capital at June 30, 1995 are summarized as
follows:
Tangible Core Risk Based % of
Capital % of Capital % of Capital Risk Based
Requirement Assets' Requirement Assets' Requirement Assets'
------------ ---------- ------------- --------- ------------ ------------
(Unaudited) (Dollars In Thousands)
Equity $33,876 8.67% $33,876 8.67% $33,876 13.82%
ESOP loan (188) (.05%) (188) (05%) (188) (.08%)
General loan loss reserves -- -- -- -- 2,051 .84%
Core deposit premium (74) (.02%)
Unrealized loss on debt securities available for sale (57) (.02%) (57) (.02%) (57) (.02%)
------- ---- ------- ---- ------- -----
$33,557 8.58% $33,631 8.60% $35,682 14.56%
======= ==== ======= ==== ======= =====
Minimum capital required $ 5,865 1.50% $11,730 3.00% $19,602 8.00%
======= ==== ======= ==== ======= =====
Excess regulatory capital $27,692 7.08% $21,901 5.60% $16,080 6.56%
======= ==== ======= ==== ======= =====
1 Adjusted total assets are a savings association's total assets as determined
under generally accepted accounting principles.
2 Total risk-based assets as calculated for OTS requirements were $245 million
at June 30, 1995.
3 Premium paid on the purchase of core deposits of $74 thousand at June 30, 1995
is excluded from tangible capital.
The Bank's assessment for deposit insurance premiums (expressed in
terms of percentage of total savings accounts) is 23 basis points. The minimum
rate may be decreased to not less than 18 basis points for the period ending
December 31,1997, declining further to 15 basis points thereafter. However, the
Federal Deposit Insurance Corporation (FDIC) may increase the assessment rate to
32.5 basis points if certain reserve fund ratios are not met. Although the FDIC
insures both commercial banks as well as savings and loans, the reserve funds
have been segregated to the Bank Insurance Fund (BIF) and the Savings
Association Insurance Fund (SAIF). The FDIC voted on August 8, 1995 to reduce
the premiums for most BIF members while keeping existing assessment rates intact
for savings associations. While the SAIF members will continue paying premiums
on a risk-related basis ranging from 23 cents to 31 cents per $100 of domestic
deposits, the assessment rate charged to BIF-insured members will be reduced to
an average of 4.4 cents for every $100 down from 23 cents. SAIF-insured
institutions will pay a higher rate than BIF-insured institutions because the
SAIF remains seriously undercapitalized. As of March 31, 1995, the SAIF had a
balance of $2.2 billion or only .31 percent of insured deposits. At the current
pace, the SAIF is unlikely to reach the minimum reserve ratio of 1.25% until the
year 2002.
The BIF on the other hand achieved a reserve ratio of 1.22% of BIF-
insured deposits, or approximately $23.2 billion as of March 31, 1995. It is
believed that the reserve ratio of 1.25% was achieved during the quarter ended
June 30, 1995. A primary reason the SAIF is undercapitalized is that SAIF
premiums have been diverted to uses other than rebuilding the fund. As described
in a recent report by the General Accounting Office, since 1989 $7.4 billion,
approximately three-quarters of SAIF assessments have been used to pay off
obligations arising from the governments' efforts to resolve the thrift failures
of the 1980's. SAIF assessments were diverted to fund the Resolution Funding
Corporation, the Federal Savings and Loan Insurance Corporation Resolution Fund
and FICO. FICO was established by congress in 1987 in an attempt to recapitalize
the Federal Savings and Loan Insurance Fund (FSLIC). From 1987 to 1989 the FICO
issued approximately $8.2 billion in bonds, proceeds of which were channeled to
the FSLIC. Approximately $4.3 billion of SAIF assessments have been utilized to
service the debt on these FICO obligations. Currently approximately 45% of all
SAIF assessments are utilized to pay interest on the FICO debt rather than to
replenish the fund. Without these diversions it has been estimated that the SAIF
would have reached its designated reserve ratio of 1.25% at some point in 1994.
There is currently a proposal within congress to eliminate duplicate
charters which separate BIF-insured members from SAIF-insured members. The
single charter would be part of comprehensive legislation designed to resolve
the looming disparity between deposit insurance premiums paid by BIF and SAIF
members. The Wall Street Journal reported that as the proposal is being
developed, SAIF members would be required to pay a one-time assessment of
approximately 85 basis points of total retail savings liabilities to replenish
the fund and reduce future deposit premiums to 5 basis points. After the
replenishment of the SAIF fund the two funds, SAIF and BIF, would be merged and
the FICO debt obligation would be shared by all members.
Effective January 1, 1993, a transitional risk-based methodology was
implemented. Under the transitional risk-based system, the assessment rate for
an insured depository institution depends on the assessment risk classification
assigned to the institution by the FDIC based upon the institution's level of
capitalization and the FDIC's judgement of the risk posed by the institution.
Each institution is assigned to one of three groups ("well-capitalized,"
"adequately-capitalized" or "under-capitalized") based on its capital ratios. A
well-capitalized institution is one that has at least a 10% total risk-based
capital ratio, and a 6% core capital to risk-based assets. An adequately-
capitalized institution is one that has an 8% total risk-based capital ratio, a
4% core capital to risk-based assets ratio and a 4% leverage capital ratio. An
under-capitalized institution is one that does not meet either of the above
definitions. The FDIC also assigns each institution to one of three subgroups
based upon reviews by the institution's primary federal or state supervisory
agency, statistical analysis of financial statements and other information
relevant to gauging the risk posed by the institution. The assessment for well-
capitalized, healthy institutions is three basis points less than the average
assessment rate for insured depository institutions. Well-capitalized
institutions
that present supervisory concern pay the average assessment rate. All other
institutions pay an assessment rate of two basis points over the average
assessment rate. The assessment rate for insured depository institutions ranges
from 23 basis points to 31 basis points.
Asset/Liability Management
The Bank's exposure to interest rate risk results from the differences
in maturities and repricing of its interest-earning assets and interest-bearing
liabilities. The goal of the Bank's asset,'liability policy is to manage
interest rate risk so as to maximize net interest income over time in changing
interest rate environments.
In order to achieve this goal, over the years the Bank has
concentrated on shortening the loan portfolio's average maturity and increasing
its sensitivity to changes in interest rates. This has been accomplished by
originating adjustable rate mortgage loans to include in the Bank's portfolio
and by emphasizing the origination of short-term construction, land, and
commercial real estate loans. The balance of construction, land and commercial
real estate loans (gross) at June 30, 1995 was approximately $75 million, or 21%
of the Bank's total gross loan portfolio. The Bank's portfolio of adjustable
rate mortgage secured by residential housing has increased from approximately
$136 million or 45% of the gross loan portfolio at June 30, 1993 to
approximately $258 million or 72% of the gross loan portfolio at June 30, 1995.
For the purpose of transferring the interest rate risk associated with holding
to maturity 30-year fixed rate mortgage loans, over the course of many years the
Bank has elected to sell the majority of such loans in the secondary markets. As
a result of the Bank's general trend of divesting itself of such noninterest
rate sensitive assets, the Bank's exposure to such 30-year fixed rate loans is
approximately $14 million or 3.9% of the total loan portfolio. The Bank
originates relatively small commercial loans, (average principal balance of
under $250 thousand per loan at June 30, 1995), and at the same time has
enhanced its asset/liability position by adding higher-margined adjustable rate
loans. Many of the commercial loans as of June 30, 1995 were initiated as short-
term construction loans and borrowers subsequently elected permanent financing
with the Bank.
The Bank's asset/liability management strategies have helped to
decrease the exposure of its earnings to future interest rate increases. This
significant volume of shorter-term and adjustable rate loans have also allowed
the Bank to fund those assets with shorter-term lower rate paying retail
deposits. The Bank's portfolio of passbook, money market and transaction
accounts, all of which are assumed to reprice within a 0-6 month time frame,
totaled $99.6 million or 35% of total retail savings liabilities at June 30,
1995. Unlike many financial institutions, which for repricing purposes assume
that passbook, money market and transaction accounts are a non-rate sensitive
liability, the Bank believes that a more accurate depiction of theses
liabilities as the Bank's experience would support, is one of a rate sensitive
instrument. These liabilities will reprice frequently to match the current rate
environment. For this reason, the Bank does not follow a straight erosion theory
in its analysis of the interest rate risk.
The Bank's cumulative one-year Gap (i.e., interest-earning assets
which reprice or mature in one year or less minus interest-bearing liabilities
which reprice or mature in one year or less) was approximately +2% of total
assets at June 30, 1995, compared to approximately +5% of total assets at June
30, 1994. Despite the fact that the Gap report would indicate the volumes of
assets repricing over a one year horizon out-paces the liabilities repricing
over a similar time frame, the Gap report fails to provide a description as to
the level of repricing.
Gap Analysis
The following table sets forth the amounts of interest-earning assets
and interest-bearing liabilities outstanding at June 30,1995, which are expected
to reprice or mature in each of the future time periods shown.
Except as stated below, the amount of assets or liabilities which reprice or
mature during a particular period were determined in accordance with contractual
terms of the asset or liability. Fixed rate loans and mortgage-backed securities
are assumed to prepay at speeds ranging from approximately 9% to 24% annually
according to the underlying coupon. Passbook, money market and NOW accounts are
assumed to be interest sensitive and will reprice immediately in step with
market rates. Adjustable rate loans are assumed to reprice at contractual
repricing intervals.
Remaining Term to Maturity or Repricing Period
----------------------------------------------
6 Months 6 Months 1 to 3 3 to 5 5 to 10 10 to 20 Over 20 or Less
to 1 Year Years Years Years Years Years Total -------
--------- -------- ------ ------ ------- -------- -------
Interest-earning assets: (In Thousands)
Mortgage loans
Adjustable rate first
mortgage loans $198,890 $ 2,105 $ - $ - $ - $ - $ - $200,995
Fixed rate: 1 to 4
family residential
first 5,894 5,130 14,526 7,397 6,895 1,578 - 41,420
construction and land 16,346 3,251 - - 19,597
Other residential and
all nonresidential
adjustable rate 57,706 - - - - - - 57,706
Other residential and all
nonresidential fixed
rate 444 391 1,176 724 546 - - 3,281
Other residential and
all nonresidential fixed
rate construction and land 1,988 723 - - - - - 2,711
Adjustable rate second
mortgage loans 1,172 - - - - - - 1,172
Nonmortgage loans'
Nonmortgage consumer
loans 16,161 452 1,557 422 - - - 18,592
Commercial 1,642 - - - - - - 1,642
Mortgage-backed
securities 2 3,724 927 2,781 1,339 1,231 21 - 10,023
Investment securities 2 13,613 2,626 3,079 1,306 - - - 20,624
Total rate sensitive assets $317,580 $15,605 $23,119 $11,188 $ 8,672 $ 1,599 $ 0 $377,763
-------- ------- ------- ------- ------- -------- -------- --------
Interest-bearing
liabilities:
Fixed maturity deposits 120,919 40,648 22,713 - - - - 184,280
NOW, Super NOW and other
transaction accounts 32,624 - - - - - - 32,624
Money market deposit
accounts 25,686 - - - - - - 25,686
Passbook accounts 35,589 - - - - - - 35,589
Noninterest-bearing
deposits 5,730 - - - - - - 5,730
FHLB and other borrowings 46,470 16,330 2,100 1,251 2,461 757 - 69,369
Total rate sensitive
liabilities $267,018 $56,978 $24,813 $ 1,251 $ 2,461 $ 757 $ 0 $353,278
-------- ------- ------- ------- ------- -------- -------- --------
Cumulative interest
sensitivity Gap $ 50,562 $ 9,189 $ 7,495 $17,432 $23,643 $24,485 $24,485 $ 24,485
Ratio of
interest-rate-sensitive
assets to
interest-rate-sensitive
liabilities 118.94% 27.39% 93.17% 894.32% 352.38% - - -
Ratio of cumulative gap to
total assets 12.93% 2.35% 1.92% 4.46% 6.05% 6.26% 6.26% -
l Does not include reductions for loan loss allowances and unearned fees.
2 Does not include adjustments for unrealized gain or losses under FAS 115.
This table does not necessarily indicate the impact of general
interest rate movements on the Bank's net interest yield because the repricing
of various categories of assets and liabilities is discretionary is subject to
competitive and other pressures. As a result, various assets and liabilities
indicated as repricing within the same period and may in fact reprice at
different times and at different rate levels.
Because the Gap analysis fails to provide an adequate measure of the
interest rate sensitivity of assets and liabilities repricing, during recent
years the Bank has relied upon a market value approach to manage the
relationship between interest rates and the effect on the Bank's Net Portfolio
Value (NPV). Under a methodology similar to that incorporated by the OTS to
arrive at the additional capital the Bank must hold as the interest rate risk
component of risk-based capital, the Bank calculates the difference between the
present value of expected cash flows from assets and the present value of
expected cash flows from liabilities as well as cash flows from off-balance
sheet contracts. Management of the Bank's assets and liabilities is done in the
context of the marketplace, but also within limits established by the Board of
Directors on the amount of change in NPV which is acceptable given interest rate
changes.
Presented below, as of June 30, 1995, is an analysis of the Bank's
interest rate risk as measured by changes in NPV for instantaneous and sustained
parallel shifts in the yield curve, in 100 basis point (100 basis points equals
1%) increments up and down 400 basis points and compared to policy limits set by
the Board of Directors and in accordance with OTS regulations. Such limits have
been established with consideration of the dollar impact of various rate changes
and the Bank's capital position.
In the above table the first column on the left presents the basis
point increments of yield curve shifts. The second column presents the board
policy limits of each 100 basis point increment for the Bank's percent change in
NPV. For example, the Board's policy limit for a 100 basis point upward shift in
the yield curve indicates that NPV should not decrease by more than 15%. The
remaining columns present the Bank's actual position in dollar change and
percent change in NPV at each basis point increment at the date indicated.
Based on the June 30, 1995 interest rate risk exposure report, the
Bank's required deduction from total risk-based capital available would have
been $211 thousand. If the Bank would have been subject to the IRR capital
component at June 30, 1995, as described previously, the Bank's total risk-based
capital ratio would have declined from 14.56% to 14.48%.
As with any method of measuring interest rate risk, certain short
comings are inherent in the method of analysis presented in the foregoing table.
For example, although certain assets and liabilities may have similar maturities
or period to repricing, they may react in different degrees to changes in market
interest rates. Also, the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest on other types may lag behind changes in market rates. Additionally,
certain assets, such as ARM loans have features which restrict changes in
interest rates on a short-term basis and over the life of the asset. Further, in
the event of a change in interest rates, expected rates of prepayments on loans
and early withdrawals from certificates could likely deviate significantly from
those assumed in calculating the table.
The ability to reprice assets to the same level as liabilities is
especially relevant to the Bank because of the volume of adjustable rate
products that are tied to the 11th District COFI. Because this is a lagging
index and does not rise as rapidly as current indices such as those based on U.
S. Treasury rates, the Bank's net interest income is vulnerable over a time
frame that allows the COFI to move up to current interest rate ranges. For
example, while other rates, such as the yield on a one year treasury, increased
from 3.61% at January 1, 1993 to 7.17% at December 31, 1994 an increase of 356
basis points, the COFI increased much more slowly from 3.82% at January 1,1993
to 4.37% at December 31, 1994. Adding further to this issue of level of
repricing, has been the Bank's reliance on short-term advances and reverse
repurchase agreements from the FHLB of San Francisco. As of June 30, 1995, the
Bank held $61.4 million in fixed rate FHLB advances and reverse repurchase
agreements which are scheduled to mature in one year or less. Because all fixed
rate FHLB advances are tied to current treasury rates this source of funding has
and will continue to reprice more quickly than the COFI. Despite the level of
repricing mismatch that the Bank will experience over the next year, the Bank's
decision to hold in portfolio a significant volume of adjustable rate loans will
help protect the Bank from rising interest )rates over the longer term.
During the period of October 1, 1993 through March 31, 1995, a period
of substantial rise in interest rates in which we witnessed seven increases by
the Federal Reserve Bank, raising the Federal Funds rate from 3% to 6%, the
Banks's net interest rate spread declined from 4.22% to 2.88%. It has become
evident that COFI indexed assets alone have not and will not provide an adequate
level of protection to the Bank's net interest margin during these periods of
rapidly increasing interest rates. The reality of an extremely volatile interest
rate environment has caused the Bank to re-evaluate its strategies aimed at
controlling interest rate risk. Under this new phase of interest rate risk
management the Bank will focus on another restructuring of the balance sheet to
diversify indexes upon which assets will reprice to achieve a portfolio of
assets which in aggregate will more closely correlate to the rate sensitivity of
the liabilities funding those assets. The Bank has, on an incremental basis,
been carrying out such strategies aimed at limiting exposure to rising rates
over the shorter term. As a result, the Bank has on its books as of June 30,
1995, approximately $17.6 million of assets which reprice to "current" indices
such as prime and the one-year treasury rate. Further, the Bank has over the
years been attempting to build a portfolio of more rate sensitive COFI based
products such as those that adjust on monthly, rather than semiannual basis. As
a result of this strategy the Bank held in portfolio approximately $18 million
of such loans and investments. Finally, the Bank has followed a strategy of
enhancing the profitability of the Bank's originated COFI products by
systematically increasing the margins, life-time caps and initial discount rates
on such products.
Change in At June 30, 1995
Interest Rate Board Limit -----------------
(Basis Points) % Change $ Change % Change
- ---------------- ------------ ----------------- ---------
+400 -75% $(21,081) (52)%
+300 -55 (14,350) (36)
+200 -35 (8,373) (21)
+100 -15 (3,585) (9)
0
-100 -5 2,901 7
-200 -10 5,510 14
-300 -15 8,503 21
-400 -20 12,267 30
RESULTS OF OPERATIONS
Net Interest Income
The earnings of Northbay Savings Bank depend primarily upon the level
of net interest income generated from the difference between interest earned on
its interest-earning assets, such as loans and investments, and the interest
paid on interest-bearing liabilities. Net interest income is a function of the
interest rate spread, which is the difference between the weighted average yield
earned on interest-earning assets and the weighted average rate paid on
interest-bearing liabilities, as well as the average balance of interest-earning
assets as compared to interest-bearing liabilities. The following table sets
forth certain information relating to the Bank's average balance sheet and
reflects the average yield on assets and average cost of liabilities for the
periods indicated. Such yields and costs are derived by dividing income or
expense by the average balance of assets or liabilities, respectively, for the
periods presented. Average balances are derived from month-end balances.
Management does not believe that the use of month-end balances instead of daily
average balances has caused any material difference in the information
presented. For purposes of this analysis, nonaccrual loans have been included in
the average loan balance of interest-earning assets. The lack of interest income
generated from these assets is reflected in a lower interest income which
translates to a lower average yield earned on the related assets.
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
Year Ended June 30
--------------------
1995 1994 1993
-------- -------- --------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
-------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars In Thousands)
Interest-earning assets:
Loan portfolio $342,815 $24,366 7.11% $292,610 $21,775 7.44% $262,101 $22,874 8.73%
Investment securities 14,478 837 5.78% 9,066 426 4.69% 7,357 386 5.25%
Overnight federal funds 287 17 5.82% 812 27 3.34% 1,271 51 4.01%
FHLB of San Francisco stock 3,674 180 4.91% 2,138 91 4.28% 1,911 26 1.37%
Mortgage-backed securities 8,485 593 6.99% 5,917 388 6.55% 8,413 615 7.31%
Short-term investments and
other interest-earning assets 3,103 161 5.20% 3,761 207 5.50% 5,172 303 5.86%
-------- ------- -------- ------- -------- -------
Total interest-earning assets $372,842 $26,154 7.01% $314,304 $22,914 7.29% $286,225 $24,255 8.47%
-------- ------- -------- ------- -------- -------
Noninterest-earning assets 15,043 14,080 14,061
-------- -------- --------
Total assets $387,885 $328,384 $300,286
======== ======== ========
Interest-bearing liabilities:
Deposits 277,011 10,356 3.74% $263,281 8,183 3.11% $250,843 9,061 3.61%
Borrowings 72,998 4,107 5.63% 29,450 1,042 3.54% 16,028 554 3.46%
-------- ------- -------- ------- -------- -------
Total interest-bearing liabilities $350,009 $14,463 4.13% $292,731 $ 9,225 3.15% $266,871 $ 9,615 3.60%
-------- ------- -------- ------- -------- -------
Noninterest-bearing liabilities 3,667 2,701 3,439
-------- -------- --------
Total liabilities 353,676 295,432 270,310
Stockholders' equity 34,078 32,952 29,976
-------- -------- --------
Total liabilities and
Stockholders' equity $387,754 $328,384 $300,286
======== ======== ========
Net interest income $11,691 $13,689 $14,640
======= ======= ========
Interest rate spread 2.88% 4.14% 4.87%
====== ====== ======
Net yield on
interest-earning assets 3.14% 4.36% 5.11%
====== ====== ======
Ratio of average interest-earning
assets to average interest-bearing
liabilities 106.52% 107.37% 107.25%
====== ======= ======
Rate/Volume Analysis
The following table sets forth certain information regarding changes
in interest income and interest expense of the Bank for the periods indicated.
For each category of interest-earning asset and interest- bearing liability,
information is provided on changes attributable to (i) changes in volume
(changes in volume multiplied by old rate); (ii) changes in rates (change in
rate multiplied by old volume); and (iii) changes in rate-volume (changes in
rate multiplied by the change in volume).
Year Ended June 30
1994 vs 1995 1993 vs 1994
Increase (Decrease) Due to Increase (Decrease) Due to
---------------------------- -----------------------------
Rate/ Rate/
Volume Rate Vol. Total Volume Rate Vol. Total
-------- -------- -------- ------- --------- --------- ------- -------
Interest income: (In Thousands)
Loan portfolio $3,736 (977) (168) 2,591 $2,662 (3,369) (392) (1,099)
Mortgage-backed securities 168 26 11 205 (182) (64) 19 (227)
Investments 224 118 59 401 27 12 l 40
Other interest-earning assets 44 (1) - 43 (30) (27) - (55)
------ ------ ------ ------ ------ ------ ----- ------
Total interest-earning assets $4,172 (834) (98) 3,240 $2,477 (3,448) (370) (1,341)
====== ====== ====== ====== ====== ====== ===== ======
Interest expense:
Deposits $ 427 1,659 87 2,173 $ 449 (1,264) (62) (877)
Borrowings and FHLB advances 1,540 615 910 3,065 464 13 10 487
Total interest-bearing liabilities $1,967 2,274 997 5,238 $ 913 (1,251) (52) (390)
------ ------ ------ ------ ------ ------ ----- ------
Net interest income $2,205 (3,108) (1,095) (1,998) $1,564 (2,197) (318) (951)
====== ====== ====== ====== ====== ====== ===== ======
Comparison of Year Ended June 30, 1995
to the Year Ended June 30, 1994
General. For the year ended June 30,1995, the Bank had net income of
$1.9 million which represented a .50% return on average assets and a 5.6% return
on average equity. For the year ended June 30, 1994, the Bank had net income of
$3.3 million which represented a 1.00% return on average assets or a 9.95%
return on average equity. The following table is a summary of unaudited
selected quarterly results of operations for the years ended June 30, 1995 and
1994:
Cumulative
Effect of
Adopting a
Change in
Accounting
Gross Interest Net Interest Provision For Income Principle Net Earnings
Income Income Loan Loss Before Tax (Note 1) Income Per Share
--------------- ------------ ------------- ---------- ----------- ------- ---------
1995: (In Thousands)
First quarter $ 6,323 $ 3,394 $127 $1,159 $ - $ 712 $ .25
Second quarter 6,454 3,055 95 1,001 - 622 .21
Third quarter 6,458 2,562 60 464 - 309 .11
Fourth quarter 6,920 2,680 130 435 - 289 .10
------- ------- ---- ------ ---- ------ -----
$26,155 $11,691 $412 $3,059 $ 0 $1,932 $ .67
======= ======= ==== ====== ==== ====== =====
1994:
First quarter $ 5,759 $ 3,450 $153 $1,507 $220 $1,085 $ .37
Second quarter 5,747 3,424 202 1,391 - 864 .30
Third quarter 5,593 3,354 200 1,016 - 624 .21
Fourth quarter 5,815 3,461 170 1,211 - 705 .24
------- ------- ---- ------ ---- ------ -----
$22,914 $13,689 $725 $5,125 $220 $3,278 $1.12
======= ======= ==== ====== ==== ====== =====
Severe volatility in interest rates was the key factor to the Bank's
decline in profitability. During the first six months of the year ended June
30,1995, the Bank continued to witness a flattening of the yield curve (the
differential between short-term rates and longer-term rates narrowed as a result
of further increases in the short-term rates without corresponding increases in
longer-term rates). While the offering rate on the 30-year fixed rate loans
increased from 7.2% at December 31, 1993, to 9.125% at December 31,1994, an
increase of 193 basis points, the rate on one year treasury notes increased from
3.68% at December 31, 1993, to 7.17% at December 31, 1994, an increase of 349
basis points. The Bank's inability to match the upward repricing, which occurred
in its large volume of shorter-term retail deposits and Federal Home Loan Bank
(FHLB) advances with similar increases in its loan and investment portfolios,
resulted in a reduced interest rate spread.
During the next six month period ended June 30, 1995, inflationary
pressures seemed to ease as a result of the previous interest rate increases,
creating a significant downward shift in the entire yield curve. While the one-
year treasury rate decreased from 7.17% at December 31, 1994 to 5.72% at June
30, 1995, the Bank's offering rate on the 30-year fixed rate loan decreased from
9.125% to 7.625% over the similar time frame. The net effect of this near 150
basis point parallel decline in the yield curve over this six month period was a
stabilization and finally gradual improvement in the Bank's net interest rate
spread. The resulting net interest rate spread decreased from 4.14% for the year
ended June 30, 1994, to 2.88% for the year ended June 30, 1995.
The Bank's rather slow growth of retail deposits is a function of two factors.
First, the Bank continued its policy of conservative pricing on savings rates.
The strategy aimed at achieving a flow of funds from the most efficient source
of retail savings funds versus wholesale funds in the form of Advances and
Reverse Repurchase Agreements from
the FHLB of San Francisco. The result of such a strategy has been to maintain an
overall cost of funds considerably below the 11th District Cost of Funds thus
enhancing the net interest rate spread. The moderate growth in retail deposits
as well as the net growth of $24.5 million in the loan and investment portfolios
for the year ended June 30, 1995, was supported by increases in FHLB of San
Francisco advances and reverse repurchase agreements of approximately $20.1
million.
The last quarter ended June 30, 1994, and the remainder of the fiscal
year ended June 30, 1995, marked a reversal of a generally declining interest
rate environment in which the volume of loans being refinanced to lower paying
fixed rate loans was tremendous. Principal payments received on longer term
loans, which consist primarily of loans being refinanced, decreased from
approximately $107 million in 1994 to approximately $82 million in 1995. This
volume of refinancing had contributed to the Bank's yield on interest earning
assets through the recognition of net deferred loan origination fees. These loan
origination fees are normally deferred at the time of origination and amortized
as a yield adjustment over the life of the associated loans. Loan fees
recognized into income as a yield adjustment remained in a relatively high range
between the years of heavy refinance from 1992 through 1994. Deferred fees of
approximately $1.46 million were recorded during the year ended June 30, 1994,
compared to $1.17 million for the year ended June 30, 1995, a year that was
absent of a significant volume of loans being refinanced.
The reduction in fees as a result of declining refinance activity is
masked somewhat by the increased volumes of discount adjustable rate loans
originated late in fiscal year 1994 and early in 1995. When adjustable rate
loans are booked at a discount the Bank follows a policy of recognizing loan
fees is a level yield based upon the fully indexed note rate. Under this
methodology deferred fees on such discounted loans are usually recognized into
income over a period of a few months rather than the life of the loan. As the
Bank's volume of new origination discounted ARM loans slowed the yield
adjustment from this source quickly disappeared. The Bank estimates that
approximately $285 thousand of such loan fees were recognized during the first
six months of the fiscal year ended June 30, 1995.
Despite the decline in the Bank's net interest margin for the fiscal
year ended June 30,1995, to 2.88% from 4.14% for 1994, after experiencing seven
consecutive quarters of decline in its net interest margin, that decline
stabilized during the third quarter of 1995 and the margin widened during the
fourth quarter of fiscal 1995. There were a number of factors contributing to
the decline in the net interest spread during the fiscal year ended 1995 and a
number of reasons why management believes the current trend of a widening spread
will continue into 1996. First, exacerbating the lagging nature of the COFI
index was the fact that the Bank was quite aggressive in its pricing of the COFI
ARM product, offering discounted start rates of up to 200 basis points below the
fully indexed rate. Deep discounted loans with a six month reset period and a 1%
six month rate cap created an asset that continues to fall behind current market
rates in a rapidly rising interest rate environment. From January 1, 1994
through September 30,1994 the Bank originated approximately $80 million in loans
at a discounted rate with a weighted average estimated at 4.5%. As of June 30,
1995 this pool of discounted COFI ARMS had a weighted average rate of
approximately 5.90%, fully indexed these loans would be yielding approximately
7.70%. Should rates remain completely static from this point forward over the
next twelve month period this portfolio of discounted loans would still reprice
upward by approximately 180 basis points based upon the COFI index of 5.14% at
June 30, 1995.
Although the discounted ARMS negatively affected the Bank's interest
rate spread, the Bank was successful in achieving three of its strategic goals
in generating this volume of discounted ARMS. First, the Bank was successful in
further leveraging its capital, reducing equity as a percentage of assets from
9.24% at June 30,1994 to 8.82% at June 30,1995. Equity, while still far in
excess of regulatory requirements, has now been put to work generating a greater
volume of interest earning assets which are now beginning to achieve positive
returns for the Bank. Second, the Bank was successful in leveraging its
operations. The Bank was able to decrease operating expenses as a percentage of
average assets for the year ended June 30, 1995 to 2.36% from 2.78% in 1994. The
Bank achieved this leverage in operating expense by growth in terms of assets of
approximately 7% while holding down growth in operating expenses at less than
1%. Third and finally, the Bank took advantage of an opportunity to meet a
consumer demand for adjustable rate mortgage financing while at the same time
adding a high quality interest earning asset that met the requirements of the
Bank as a portfolio lender. The structure of the Bank's loan portfolio remains
heavily weighted with adjustable rate loans. At June 30, 1995, the Bank held in
portfolio approximately $283 million or 82% of the total portfolio in adjustable
rate loans. Despite the fact that the majority of such adjustable rate loans
adjust in six month intervals and are indexed to the FHLB 11th District COFI, an
index which lags more current indices, these loans will continue to gradually
reprice upward even after other indices remain static. While the one year
treasury rate declined from 7.17% at December 31,1994 to 5.72% at June 30, 1995,
the COFI has continued to increase during this same period of time from 4.37% to
5.14%.
Interest Income. Net interest income before provision for loan losses
was approximately $11.7 million for the year ended June 30,1995, a decrease of
$2 million or 14.6%, from $13.7 million recorded in 1994. The decline in net
interest income can be attributed in large part to a year of volatile shifts in
the direction of interest rates. First, during a period of generally rapidly
rising interest rates, the Bank was unable to match the upward repricing of its
short-term liabilities with similar increases in its loan and investment
portfolios. This inability to reprice assets to the degree of liabilities
relates to two specific characteristics of the adjustable rate loan portfolios.
First, as has already been documented, interest rate increases were inhibited
due to the lagging nature of the COFI to which the majority of the Bank's assets
are tied. Second, the small increases that were taking place in the ARM
portfolio were inhibited by both six-month adjustment periods, and periodic caps
of 1%. With a 1% periodic cap, assuming COFI matched treasury increases (which
it did not), while the one-year treasury note increased 350 basis points over a
one year period, the Bank's ARM portfolio inhibited by the periodic rate caps
would have increased by only 200 basis points or less than 60% of the current
market rate change.
The result of the rising interest rate environment and the inability
of the Bank's assets to reprice in concert with other "current" market rates was
a decline in the net interest rate spread from 4.14% during the fiscal year
ended June 30, 1994 to 2.88% for the fiscal year ended June 30, 1995. The
average rate on interest bearing liabilities for the year ended June 30, 1995
increased almost 100 basis points from 3.15% to 4.13% for the year ended June
30, 1995, while the average yield on interest-earning assets declined from 7.29%
in 1994 to 7.01% in 1995. The increase in total interest income for the year
ended June 30, 1995 of approximately $3.2 million, can be attributed to the
large volumes of discounted adjustable rate single family loans originated in
late fiscal 1993 and early fiscal 1994. The increase in the average volume of
the loan portfolio of $50 million over 1994 was at substantially reduced rates
which failed to keep pace with the rising market interest rates paid on
liabilities to support those assets. While total interest income increased by
$3.2 million total, the corresponding increase in interest expense generated
from liabilities to support these assets increased by $5.2 million.
Although the Bank's overall cost of interest bearing liabilities
increased at a much greater rate than the interest earning assets, the Bank's
cost of retail deposits as anticipated did in fact move in concert with the 11th
District COFI. While the 11th District COFI increased from 3.73% at June 30,
1994 to 5.14% at June 30, 1995, an increase of 141 basis points, the Bank's cost
of retail deposits increased from 3.10% to 4.40% or 130 basis points during this
same period of time. However there was a definite cost associated with the
ability to maintain a low cost of retail savings funds. The cost of maintaining
a low cost retail deposit base was realized in the form of higher interest
expense and greater exposure to rising interest rates that resulted by
supplementing lack of growth in retail savings with short-term borrowings which
repriced with current treasury rates. The average volume of borrowed funds which
consisted of advances and reverse repurchase agreements with the FHLB of San
Francisco increased from $29.5 million with a weighted average rate of 3.54%
during the year ended June 30, 1994. to an average volume of $73 million with a
weighted average rate of 5.63% during the similar year ended June 30, 1995.
Provision for Losses on Loans. During the year ended June 30,1995, the
Bank recognized $412 thousand in provision for possible loan losses, compared
with $725 thousand in 1994. The decrease in provision for loan loss reserves can
be attributed to two factors which positively impacted the assessment of the
Bank's credit risk on its loan portfolio. First, the Bank experienced a
significant decline in nonperforming assets from approximately $4.5 million or
1.23% of total assets at June 30, 1994, to $2.9 million or .74% of total assets
as of June 30,1995. Second, the Bank experienced a decline in the portfolio of
more risk-oriented construction, commercial, and concentration of loans to a
single borrower. For example, total gross construction, land and commercial real
estate loans declined from $103.3 million at June 30, 1994 to $74.8 million at
June 30, 1995, a decline of $28.5 million or 28%. The charge-offs of $266
thousand during the fiscal year ended June 30,1995 are reflective of the Bank's
policy of analyzing all troubled assets and recording a write down to the value
of those assets to the estimated fair value at the time the Bank becomes aware
of any
deterioration in the value. The Bank adheres to a stringent internal modeling
policy that dictates the level of general valuation allowances. Among several of
the portfolio criteria that are evaluated are, concentration of risk weighted
portfolio assets, concentration of credit to a single borrower, and level of
adversely internally classified assets. The provision of $412 thousand for the
year ended June 30, 1995 is reflective of a decline in concentration of risk
weighted assets, and concentration to a single borrower. Virtually all of the
growth within the Bank's loan portfolio during the year ended June 30, 1995, was
in the less risk oriented category of mortgage loans secured by the borrowers'
primary residence.
Management believes that the current level of loan loss reserves,
which stands at $2.2 million or .64% of the total loan portfolio, provides the
Bank with a pool of reserves to adequately reflect the unforeseen credit losses
within the portfolio. While management uses available information to recognize
losses on loans and real estate owned, future additions to the allowances may be
necessary based on changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for losses on loans and real estate
owned. Such agencies may require the Bank to recognize additions to the
allowance based on their judgement or information available to them at the time
of their examination.
Noninterest income. Despite a decline in noninterest income of $337
thousand or 26%, from $1.29 million for the year ended June 30, 1994 to $949
thousand for the same period in 1995, the decline is concentrated in the
categories of nonrecurring income such as gains or loss on the sales of loans,
investment securities, and association premises. Due to a year of generally
rising interest rates and the corresponding lack of consumer demand for fixed
rate mortgage financing, the Bank's ability to generate and sell such long-term
fixed rate loans in the secondary market has been eliminated. As a result, the
Bank completed no sales of such loans or mortgage-backed securities in the
secondary markets during the year ended June 30, 1995, compared to sales of
approximately $25 million and corresponding gains of $161 thousand in 1994. The
decline of $251 thousand in gains on sales of investment securities relates
primarily to the sale of stock of the Federal Home Loan Mortgage Corporation
(FHLMC). The Bank sold 9,000 shares of FHLMC, recognizing gains of $403 thousand
during the year ended June 30, 1994, compared to the sale of the final block of
stock being held by the Bank of 3,000 shares in 1995, upon which the Bank
recognized a gain of $116 thousand. Finally, during the fiscal year ended June
30, 1995, the Bank recorded a loss of $51 thousand on the disposal of a property
located in downtown Santa Rosa which the Bank had acquired previously with the
intention of constructing a Bank Branch thereon.
Conversely, noninterest income from recurring core business operations
under the categories of service charges and "other" income increased in
aggregate from $924 thousand in 1994 to $1.02 million for 1995, an increase of
$98 thousand or 10.6%. A decline in service fees associated with loan servicing
of $36 thousand as a result of less problem loans was more than offset by an
increase of $63 thousand in fees relating to deposit account services. The
increase in service fees on retail savings represents the initial results of an
increased pricing policy implemented late in fiscal 1995 to more accurately
reflect the cost of services provided. An increase of $71 thousand in the
category of "other" income represents increased fees from a third party vendor
in compensation for sale of official check products. This category was further
enhanced by rental income generated from the rent of foreclosure properties
which the Bank owns. The final significant enhancement to this line item is the
increased volume of sales of alternative investment products. Through its
contractual agreement with Primevest Financial Services, an independent broker-
dealer the Bank offers full-service brokerage capabilities at each of its branch
offices.
Adding positively to noninterest income, is the decline in the write
down of deferred servicing premiums of $27 thousand for the fiscal year ended
June 30, 1995 compared to 1994. This write down decreased from $31 thousand for
the year ended June 30, 1994 to $4 thousand for the year ended June 30, 1995.
When loans are sold and the right to service those loans is retained, the gain
or loss recognized is based upon the net present value of expected cash flows to
be received resulting from the difference between the contractual interest rates
received from the borrower and the rates paid to the buyer. The related
deferred charge (deferred premium on loans sold) is amortized to operations over
the estimated remaining life of the loan as a yield adjustment. The decline in
the write down of this asset in 1995 can be attributed to the fact that more
severe write downs had been taken in the previous periods when interest rates
were declining and the underlying loans were prepaying at a more rapid rate. In
the current market of rising interest rates, the assumption as to the estimated
life of the loans sold is adjusted, on a quarterly basis, to reflect the most
recent market expectation of the life and value of the expected cash flows to be
received from this asset. At June 30, 1995, the remaining value of the asset is
only $51 thousand.
The Bank recognized net losses of $134 thousand for the year ended
June 30, 1995 compared to a net loss of $137 thousand for the year ended June
30, 1994, on the resolution of properties acquired through foreclosure. During
the year ended June 30, 1995, the Bank completed the disposal of five properties
acquired as a result of foreclosure on which losses upon liquidation totaled $61
thousand. The Bank additionally recorded permanent valuation write downs on
five properties being held to reflect the fair market value of those properties
in a market in which real estate sales remain slow.
Noninterest Expense. The Bank's attention to the control of operating
expenses is evident in the nominal increase in noninterest expense of $46
thousand or .5% over the similar year ended June 30, 1994. Compensation and
employee benefits, the largest component of non- interest expense, increased to
$4.30 million for the year ended June 30, 1995 from $4.28 million for the
comparable year ended June 30, 1994, an increase of .5%. Contributing to the
control of compensation and benefits has been the elimination of officer bonus
incentives which are based upon the Bank's ability to achieve various levels of
operating results, as well as reductions in the loan origination area as a
result of reduced loan origination volumes.
The increase in data processing expense from $546 thousand for the
year ended June 30, 1994 to $591 thousand for the similar year ended June 30,
1995, can be attributed to an increase volume of data being processed as well as
scheduled increases in the cost of data services provided by an independent
service bureau.
The decrease in advertising and supplies of $103 thousand or 25% can
be attributed equally to cutbacks in stationary, printing and supplies, and
advertising expense. These declines are reflective of the Bank's efforts
throughout the year to be more selective in targeting its advertising efforts.
Other operating expense which includes such expenditures as other
insurance premiums, legal, accounting, telephone, postage, and miscellaneous
loan origination expense, increased from $1.66 million for the year ended June
30, 1993 to $1.68 million for the similar year ended June 30, 1995. Declines in
other operating expenses spread over a broad range of expenditures as including
telephone, postage, employee expenses were more than offset by increased
consultant and legal expenses relating to strategic planning and new regulatory
issues.
Income Taxes. On February 10, 1992, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standards 109, entitled
Accounting for Income Taxes. This statement which supersedes SFAS 96 and changed
the criteria for recognition and measurement of deferred tax assets and various
other requirements of SFAS 96 and reduces its complexity. Under SFAS 109
deferred tax liabilities are recognized on all taxable temporary differences,
and deferred tax assets are recognized on all deductible temporary differences,
operating loss and tax credit carry-forwards. Valuation allowances are
recognized to reduce deferred tax assets if it is determined to be "more likely
than not" that all or some portion of the potential deferred tax assets will not
be realized. Other significant changes made by SFAS 109 include: (1) the
comprehensive scheduling of temporary differences required by SFAS 96 will not
be required; (2) a deferred tax asset may be recognized for the financial
statement general valuation allowance for loans and real estate owned, while a
deferred tax liability must be recognized for the portion of the tax bad debt
reserve exceeding the "base year" reserves; (3) tax-planning strategies must be
prudent and feasible, and; (4) tax benefits recognized as a result of all tax
planning strategies should be net of any expense or losses.
The cumulative effect to July 1, 1993 of adopting SFAS 109, which
resulted in a cumulative tax benefit of $220 thousand to the Company, has been
shown as a separate item in the accompanying statement of operations for the
year ended June 30, 1994. The adoption of this accounting method did not have a
material impact on
income tax expense and net income before the cumulative effect of adopting SFAS
109 for 1994 over the amount that would have been recorded under SFAS 96.
The Bank provided $1.13 million for income taxes for the year ended
June 30, 1995, compared to $2.07 million for the year ended June 30, 1994. The
effective tax rate decreased to 36.8% in 1995, from 40.3% in 1994. The decreased
effective tax rate in 1995 can be attributed primarily to an increased tax
benefits derived from investments in low income housing tax credits in relation
to a smaller pre-taxable income base.
Comparison of Year Ended June 30, 1994
to the Year Ended June 30, 1993
General. For the year ended June 30, 1994, the Bank had net income of
$3.3 million which represented a 1.00% return on average assets and a 9.95%
return on average equity. For the year ended June 30, 1993, the Bank had net
income of $3.7 million which represented a 1.24% return on average assets or a
12.46% return on average equity.
Severe volatility in the direction of interest rates was the key
factor to the Bank's decline in profitability. During the first six months of
the year ended June 30, 1994, the Bank witnessed a flattening of the yield curve
(the differential between short-term rates and longer- term rates narrowed as a
result of further declines in the long-term rates without corresponding declines
in shorter-term rates). While the interest rate on the 30-year fixed rate loans
declined from 8.10% at December 31, 1992 to 7.2% at December 31, 1993, a decline
of 90 basis points, the weighted average rate earned on overnight Federal funds
sold actually increased marginally from 2.42% for the month ended December 31,
1992 to 2.53% for the month ended December 31, 1993. The Bank's inability to
match the downward repricing which occurred in its loan and investment
portfolios with a similar downward repricing on its large volume of shorter-term
retail deposits resulted in a reduced interest rate spread.
During the next six-month period ended June 30, 1994, inflationary
fears created a strong upward shift in the entire yield curve. While the two-
year treasury rate increased from 4% in January 1994 to approximately 6% by June
30, 1994, the Bank's interest rate on the 30-year fixed rate loan increased from
7.2% to 8.75% over the similar time frame. The net effect of this near 200 basis
point parallel rise in the yield curve over that six-month period was a further
decline in the net interest margin due to the Bank's inability to match the
upward repricing of liabilities with assets. The resulting net interest rate
spread decreased from 4.87% for the year ended June 30, 1993 to 4.14% for the
year ended June 30, 1994. It is noteworthy that in 1994, a year of generally low
interest rates in which the thrift and banking industry in general had been
shrinking in terms of volume of retail deposits, the Bank was successful in
increasing its retail savings deposit base by approximately $21.8 million or
8.5% over the deposit base at June 30, 1993. Further, in an effort to enhance
the retail branch network, and continue to provide quality banking services and
affordable home financing within its market area, the Bank opened a new full-
service branch office in downtown Santa Rosa. The Bank believed the benefits of
expanding the branch network in the Santa Rosa market outweighed the costs of
opening a new branch on a de novo basis.
The Bank continued to follow a strategy of protecting its interest
margins as opposed to pursuing growth with higher rate paying retail deposits.
This strategy had contributed to the Bank's ability to maintain a low cost of
funds. The moderate growth in retail deposits as well as the net growth of $47
million in the net loan portfolio for the year ended June 30, 1994, was
supported by increases in FHLB of San Francisco advances of approximately $28.5
million.
During the first nine months of the fiscal year ended June 30,1994,
the Bank continued to experience a tremendous volume of loans being refinanced.
This trend was a continuation of the previous two years of generally declining
interest rates. This volume of refinancing had contributed to the Bank's yield
on interest-earning assets through the recognition of net deferred loan
origination fees. Principal payments received on longer-term loans which consist
primarily of loans being refinanced remained at a very high level increasing
from $103 million in 1993, to $107 million in 1994. With the upward movement in
interest rates experienced near the end of the quarter ended March 31, 1994, we
began to see a significant decline in the volume of loans being refinanced.
The Bank's net interest margin for the fiscal year ended June 30, 1994
had declined to 4.14% from 4.87% for 1993. The pressure on interest margins was
coming from two sources. First, the Bank had previously repriced down its short-
term retail deposits and had no latitude for further downward adjustments even
though longer-term rates continued down. Second, the Bank continued to
experience refinancing of its higher rate fixed rate loans as well as downward
adjustments on its adjustable rate portfolio.
The Bank made significant progress towards achieving goals of
leveraging both capital and operations. Despite the addition of a new full-
service retail savings branch office, a facility to consolidate and house loan
administration and origination functions, and a full fiscal year's operation in
a new administration facility, the Bank was able to decrease operating expenses
as a percentage of average assets for the year ended June 30, 1994 to 2.78% from
2.88% in 1993. The Bank was successful in leveraging operating expenses by
growth in terms of assets by 17% while only expanding operating expenses by
5.4%. Similarly, the Bank was successful in leveraging capital through growth of
financial assets and liabilities at a positive spread, earning incremental
revenues for the shareholders. Equity, while in excess of regulatory
requirements was reduced as a percentage of assets at June 30, 1994, to 9.24%,
compared to 10.03% at June 30, 1993.
During yet another period of slow economic growth in which
unemployment levels had remained high and consumer confidence low, the Bank
resolved to increase its commitment to the community to help provide affordable
housing. During the year ended June 30,1994, the Bank committed approximately $5
million in loans with favorable rates to finance low-income housing projects in
its market area.
Interest Income. Net interest income before provision for loan losses
was approximately $13.7 million for the year ended June 30 1994, a decrease of
$950 thousand or 6.5%, from $14.6 million recorded in 1993. The decline in net
interest income was attributed in large part to a year of volatile shifts in the
direction of interest rates. During this period of generally declining interest
rates and a period of historically low interest rates, the Bank was unable to
price downward short-term liabilities to match the further declines in the rates
earned on longer-term interest-earning assets. The average rate on interest-
bearing liabilities for the year ended June 30, 1994 declined to 3.15% from
3.60% for the year ended June 30, 1993, while the average yield on interest-
earning assets due to refinancing and downward adjustments on adjustable rate
products declined more rapidly from 8.47% in 1993 to 7.29% in 1994. Further
exacerbating the decline in yield on interest-earning assets was the volume of
lower rate adjustable rate loans originated in the quarter ended June 30,1994.
With the increase in interest rates late in the quarter ended March 31, 1994,
there was an abrupt change in consumer demand from fixed rate loans to lower
rate adjustable loans indexed to the 11th District COFI. The Bank added
approximately $36 million in such adjustable rate loans with a weighted average
yield of approximately 6.20%. Total interest income for the year ended June 30,
1994 had declined by approximately $1. 3 million or 5.5% to $22.9 million. The
increase of $28.1 million, or 9.8%, in the average balance of interest-earning
assets for the year ended June 30,1994, as compared to the year ended June 30,
1993, was offset somewhat by the decline in yield of 118 basis points to 7.29%.
The significant decrease in interest expense on retail savings of $878
thousand due to the decline in yield of 50 basis points below the similar yield
in 1993, was offset in large part by the Bank's use of FHLB advances to fund
loan growth. The average balance of other borrowing, which consisted mainly of
FHLB advances, grew from $16 million during the year ended June 30, 1993 to
$29.5 million for the similar year ended June 30, 1994. Due to the fact that
most of those short-term borrowings are indexed to current treasury yields, when
rates shifted upward, a source of funding repriced fully to current market
conditions. While the yield on retail savings had declined by 50 basis points
for the year ended June 30, 1994 the average yield on other borrowing increased
by 8 basis points.
Provision for Losses on Loans. During the year ended June 30,1994, the
Bank recognized $725 thousand in provision for possible loan losses, compared
with
$722 thousand in 1993. The similar provision for loan loss reserves represented
the Bank's calculation of the credit risk of the loan portfolio as well as
charge-offs of approximately $475 thousand in specific problem assets. The
provision of $725 thousand as well as charge-offs of $475 thousand during the
fiscal year ended June 30 1994, were representative of a real estate market
which had remained somewhat soft during the first nine months of the fiscal year
ended June 30 1994. The local real estate market seemed to have bottomed out in
1993 and was reflected in the ratio of nonperforming assets to total assets of
1.71% at March 31,1994. In the quarter ended June 30, 1994, the Bank made
significant progress in reducing the volume of troubled assets and the ratio of
nonperforming assets to total assets declined to 1.23%. The charge-offs of $475
thousand during the fiscal year ended June 30, 1994 was reflective of the Bank's
policy of analyzing all troubled assets and recording a write down to the value
of those assets to the estimated fair value at the time the Bank becomes aware
of any deterioration in the value. In establishing the level of reserves,
several criteria are reviewed. Among the portfolio criteria that are evaluated
are: concentration of risk-weighted portfolio assets, concentration of credit to
a single borrower, and level of adversely internally classified assets. Despite
an increase in troubled assets, the provision of $725 thousand for the year
ended June 30 1994, was reflective of a decline in concentration of risk-
weighted assets, and concentration to a single borrower. Virtually all of the
growth within the Bank's loan portfolio during the year ended June 30, 1994 was
in the less risk oriented category of mortgage loans secured by the borrower's
primary residence.
Management believes that the level of loan loss reserves, which stood
at $2.1 million or .65% of the total loan portfolio, provided the Bank with a
pool of reserves to adequately address the inherent credit losses within the
portfolio. While management used available information to recognize losses on
loans and real estate owned, additions to the allowances may be necessary based
on changes in economic conditions. In addition, various regulatory agencies, as
an integral part of their examination process, periodically review the Bank's
allowance for losses on loans and real estate owned. Such agencies may require
the Bank to recognize additions to the allowance based on their judgement of
information available to them at the time of their examination.
Noninterest income. Despite the relatively small change in noninterest
income which had decreased by $49 thousand or just 3.7%, from $1.34 million for
the year ended June 30, 1993 to $1.29 million for the same period in 1994, the
sources of that noninterest income had changed significantly.
First, the Bank had taken advantage of historically high valuations
with the equity markets, electing to realize a gain in the price of its stock
held for sale in the Federal Home Loan Mortgage Corporation (FHLMC). The Bank
sold 8,000 shares of FHLMC stock, recognizing gains of $403 thousand. That gain
was offset somewhat by a loss of $8 thousand recorded on the sale of a fixed
income mutual fund held for sale and write downs to record various mutual funds
held in the Bank's investment portfolio as held for sale and accounted for at
fair market value of $33 thousand. That compared to a $77 thousand gain recorded
on the sale of an intermediate term bond fund recognized during the year ended
June 30, 1993.
Second, the Bank's recognition of gains on the sale of loans and
mortgage-backed securities had declined from $427 thousand for the year ended
June 30,1993 to $161 thousand for the similar year ended June 30, 1994. Although
the volume of loans sold during 1994 was down to $25 million from $34.6 million
in 1993, the gains recognized from sales combined with recognition of deferred
fees on those loans was consistent at $464 thousand in 1994 and $427 thousand in
1993. However, the gains of $464 thousand recorded in 1994 were offset by write
downs of $303 thousand to record loans held for sale at the lower of cost or
market value. The majority of this market valuation adjustment occurred during
the quarter ended March 31, 1994. That adjustment was due to a dramatic increase
in long-term interest rates which had caused some loans originated and held for
sale at lower interest rates to decline in market value at March 31,1994. During
the quarter ended June 30, 1994, the Bank had elected to reclassify all
permanent loans held for sale, totaling $6 million, to be held for investment.
At the same time the Bank altered its policy regarding the classification of
current production of all mortgage loan products. The current and revised policy
states that current production of all permanent mortgage loans will be held to
maturity. The Bank may at some future period determine that the economic
benefits of originating such loans for sale in the secondary markets will
benefit shareholder value, therefore this policy remains subject to change. The
Bank had taken this action for the following reasons: (1) having written down
the value of those assets to the lower of cost or market at March 31, 1994,
during a period of rapidly rising rates, the Bank believed there was a greater
economic value in holding those loans to maturity rather than selling the assets
at a substantial discount into a market that may be overreacting to inflationary
threats; and (2) upon review of the Bank's concentration of assets and a
favorable exposure to a long-term rising interest rate environment, the addition
of those predominantly fixed rate loans provided an acceptable diversification
to the volume of adjustable rate loans within the portfolio. Gains on sales of
loans and mortgage-backed securities may not be available to the Bank as a
source of revenue under the current policy.
Third, a significant variation in noninterest income appeared in the
write down of deferred servicing premiums. The write down decreased from $178
thousand for the year ended June 30, 1993 to $31 thousand for the year ended
June 30, 1994, a decrease of $147 thousand. When loans are sold and the right to
service those loans is retained, the gain or loss recognized is based upon the
then difference between the contractual interest rates received from the
borrower and the rates aid to the buyer. The related deferred charge (deferred
premium on loans sold) is amortized to operations over the estimated remaining
life of the loan as a yield adjustment. The decline in the write down of this
asset in 1994 can be attributed to the fact when interest rates were declining
more rapidly. In a market of rising interest rates the assumption as to the
estimated life of the loans sold is adjusted on a quarterly basis to reflect the
most recent market expectation of the life and value of the expected cash flows
to be received from this asset. At June 30,1994 the remaining value of the asset
was only $58 thousand.
Fourth, the Bank recognized net losses of $137 thousand for the year
ended June 30, 1994, compared to a net gain of $2 thousand for the year ended
June 30, 1993, on the disposition of properties acquired through foreclosure.
During the year ended June 30, 1994, the Bank completed the disposal of three
properties acquired as a result of foreclosure. The majority of that loss was
concentrated within one subdivision land loan which experienced the greatest
effect of the declining value of land in a soft real estate environment.
Fifth, and finally, the gain on sale of premises had dropped from $117
thousand for the year ended June 30,1993 to $0 during the similar year ended
June 30,1994. As a result of the Bank's consolidation of administration
functions into a newly leased facility in the year ended June 30,1993, the Bank
elected to sell a facility previously utilized to house various administrative
divisions. The sale of this facility resulted in a nonrecurring gain during the
year ended June 30, 1993. Noninterest Expense. Noninterest expense had increased
by approximately $470 thousand or 5.4%, to $9.1 million for the year ended June
30, 1994, compared to $8.7 million in 1993. Compensation and employee benefits,
the largest component of noninterest expense, increased to $4.3 million for the
year ended June 30, 1994 from $3.9 million for the comparable year ended June
30, 1993, an increase of 8.4%. The Bank had experienced a similar increase in
occupancy related expenses, which increased by $92 thousand or 8.4% during the
year ended June 30, 1994, compared with the similar period in 1993. The
increases in compensation and other employee benefits as well as occupancy and
depreciation, were due in part to the addition of the new retail savings branch
in the city of Santa Rosa, California, added in February of 1994, a full year's
operation of a new branch administration facility opened in December of 1992,
and the opening of a new loan administration office in Santa Rosa, California,
in September 1993. Further increases in compensation and other employee benefits
were due to the additional staffing of experienced personnel to strengthen the
Bank's loan divisions. Additional increases in depreciation which had increased
from $376 thousand for the year ended June 30,1993 to $454 thousand for the
similar year ended June 30, 1994, were attributed to the Bank's capital
expenditures undertaken during the previous fiscal year to position the Bank for
growth in future periods. Those capital expenditures included leasehold
improvements on the newly acquired facilities as well as depreciation of
furniture and fixture necessary to carry out operations in those facilities.
The increase in data processing expense from $515 thousand for the
year ended June 30, 1993 to $546 thousand for the similar year ended June 30,
1994, was attributed to an increased volume of data being processed as well as
scheduled increases in the cost of data services provided by an independent
service bureau. Other operating expense which includes such items as other
insurance premiums, legal, accounting, telephone, postage, and miscellaneous
loan origination expense, declined from $1.75 million for the year ended June
30, 1993 to $1.66 million for the similar year ended June 30, 1994. The decline
in other operating expense was spread over a broad range of expenditures as
indicated above and relates to some more favorable contracts negotiated with
vendors as well as the orchestrated effort at cutting operating expense.
Income Taxes. The Bank provided $2.07 million for income taxes for the
year ended June 30, 1994, compared to $2.86 million for the year ended June
30,1993. The effective tax rate had decreased to 40.3% in 1994, from 43.3% in
1993. The decrease in 1994 was attributed in part to the tax benefits derived
from investments in low income housing tax credits in relation to a smaller
pretaxable income base. Further reductions in the provision for income tax was
attributed to the implementation of SFAS 109, which allowed recognition of
deferred tax assets for financial statement general valuation allowance.
Liquidity and Capital Resources Under current OTS regulations, the
Bank is required to maintain liquid assets at 5% or more of its net withdrawable
deposits plus short-term borrowings. The Bank has at all times maintained
liquidity levels in excess of that required by regulation. At June 30, 1995, the
Bank's liquidity ratio was 6.41%. The principal sources of liquidity are
deposit accounts, short-term borrowings, principal and interest payments on
loans, proceeds from the sale of loans and mortgage-backed securities, and
interest and dividends on investments. The Bank uses its capital resources
principally to fund real estate and consumer loans, purchases of mortgage-backed
and investment securities, repay maturing borrowings, fund maturing savings
certificates and to provide for maintenance of its liquidity.
Deposits were approximately $283.9 million at June 30, 1995, a net
increase of approximately $7 million from 1994. The Bank's net (decrease)
increase in deposits (including interest credited) for the years ended June 30,
1993, 1994 and 1995 was approximately, ($263) thousand, $9.9 million, and $7
million respectively. The liquidity ratio over the past two fiscal years has
been maintained at a relatively low level, decreasing slightly from 6.85% at
June 30, 1994 to 6.41% at June 30, 1995. Principal payments on loans and
mortgage- backed securities decreased to $82.9 million for the year ended June
30, 1995 from $111 million for the year ended June 30, 1994, and $106 million
for the year ended June 30, 1993.
Net loans receivable increased to $343.9 million at June 30, 1995 from
$324.7 million at June 30, 1994, and $277.7 million at June 30, 1993. The Bank
originated $101.6 million in loans for the year ended June 30,1995, compared to
$166.6 million in loans for the year ended June 30, 1994, and $160.7 million for
the year ended June 30, 1993.
As of June 30, 1995, the Bank had commitments to originate and
purchase loans totaling approximately $29.9 million.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been
prepared in accordance with generally accepted accounting principles which
require the measurement of financial position and operating results in terms of
historical dollars, without considering changes in the relative purchasing power
of money over time due to inflation.
Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the price
of goods and services, since such prices are affected by inflation. In the
current interest rate environment, liquidity and the maturity structure of the
bank's assets and liabilities are critical to the maintenance of acceptable
performance levels.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders Northbay Financial Corporation:
We have audited the accompanying consolidated statements of financial
condition of Northbay Financial Corporation (the "Company") and Subsidiary as of
June 30, 1995 and 1994, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the years in the three-year
period ended June 30, 1995. These consolidated financial statements are the
responsibility of the Company 's management. Our responsibility is to express an
opinion on these consolidated 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, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Northbay Financial Corporation and Subsidiary as of June 30, 1995 and 1994, and
the results of their operations and their cash flows for each of the years in
the three-year period ended June 30, 1995, in conformity with generally accepted
accounting principles.
As discussed in Notes 1 and 10 to the Consolidated Financial
Statement, the Company adopted the provisions of the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," in 1994.
/s/KPMG Peat Marwick LLP
San Francisco, California
September 1, 1995
NORTHBAY FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Financial Condition
June 30,1995 and 1994
Assets 1995 1994
------------- -------------
Cash, including noninterest-bearing deposits of
$7,302,588 and $6,563,911 $ 7,815,778 $ 7,254,910
Overnight federal funds 425,000
Certificates of deposit 1,444,100 1,744,730
Investment securities held to maturity (note 2) 12,525,738 9,518,101
Investment securities available for sale, at
market value (note 2) 2,887,261 2,822,436
Mortgage-backed securities held to maturity (note
3) 1,672,373 1,778,350
Mortgage-backed securities available for sale, at
market value (note 3) 8,441,233 6,164,962
Loans receivable, net (notes 4 and 8) 343,852,434 324,711,259
Interest receivable:
Loans 2,066,605 1,810,384
Mortgage-backed securities 56,420 48,484
Investments 280,969 164,495
Office property, equipment and leasehold
improvements, net (note 5) 2,473,926 3,099,742
Real estate held for sale (note 6) 1,555,759 1,636,909
Stock of Federal Home Loan Bank of San Francisco,
at cost (note lc) 3,291,400 2,315,400
Deferred premiums on loans sold (note 4) 51,048 58,553
Prepaid expenses and other assets (note 14) 2,218,038 1,583,987
------------ ------------
$391,058,082 $364,712,702
============ ============
Liabilities and Stockholders' Equity
Savings accounts (note 7) 283,909,075 276,900,055
Advances from the Federal Home Loan Bank (note 8) 60,036,173 47,694,752
Other borrowings (note 9) 9,331,986 3,118,130
Other liabilities and accrued expenses 1,988,702 1,783,109
Deferred income taxes (note 10) 653,193 938,064
Deferred gain on sale of buildings (note 12) 560,652 594,663
------- -------
356,479,781 331,028,773
Stockholders' equity (notes 10, 13, 14 and 16):
Common stock (par value $ .10 per share,
4,000,000 shares authorized and issued;
2,750,522
and 2,741,123 shares outstanding at June 30,
1995 and June 30, 1994, respectively) 275,081 228,427
Additional paid-in capital 20,849,324 20,802,673
Retained earnings substantially restricted 13,618,628 12,894,804
Debt incurred by ESOP (187,500) (237,500)
Net unrealized gain (loss) on securities
available for sale 22,768 (4,475)
------ -------
34,578,301 33,683,929
---------- ----------
Commitments and contingencies (notes 13, 14 and
15)
$391,058,082 $364,712,702
============ ============
See accompanying notes to consolidated financial statements.
NORTHBAY FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Operations
Years ended June 30, 1995, 1994 and 1993
1995 1994 1993
------------- ------------- -------------
Interest income:
Loans $24,366,204 $21,775,136 $22,873,714
Mortgage-backed securities 592,759 387,711 614,785
Interest and dividends on
investments 1,195,712 751,130 766,015
----------- ----------- -----------
26,154,675 22,913,977 24,254,514
----------- ----------- -----------
Interest expense:
Savings accounts (note 7) 10,355,883 8,183,390 9,060,708
Advances and other borrowings 4,107,446 1,041,977 554,623
----------- ----------- -----------
14,463,329 9,225,367 9,615,331
----------- ----------- -----------
Net interest income 11,691,346 13,688,610 14,639,183
Provision for loan losses (note 4) 412,000 725,000 722,433
----------- ----------- -----------
Net interest income after
provision for loan losses 11,279,346 12,963,610 13,916,750
----------- ----------- -----------
Noninterest income:
Service charges 759,589 733,122 729,688
Gain on sale of loans and
mortgage-backed securities,
net (note 4) - 161,365 427,276
Write down deferred servicing
premiums (note 4) (3,610) (31,134) (177,954)
(Loss) gain from real estate
acquired in
settlement of loans (note 6) (134,278) (136,541) 2,275
Gain on sale of investments held
for sale 116,727 368,058 77,599
(Loss) gain on sale of premises
(note 12) (50,866) - 116,519
Other 261,921 191,271 160,088
----------- ----------- -----------
949,483 1,286,141 1,335,491
----------- ----------- -----------
Noninterest expense:
Compensation and benefits 4,297,106 4,277,628 3,947,960
Occupancy 1,229,611 1,186,926 1,094,703
Depreciation 442,673 454,279 376,187
Data processing 591,112 545,813 514,884
Advertising and supplies 310,833 413,780 398,389
Federal deposit insurance
premiums 619,575 583,420 570,732
Other 1,679,261 1,662,635 1,753,478
----------- ----------- -----------
9,170,171 9,124,481 8,656,333
----------- ----------- -----------
Income before income taxes and
cumulative effect
of change in accounting
principle 3,058,658 5,125,270 6,595,908
Income taxes (note 10) 1,126,808 2,067,251 2,858,900
----------- ----------- -----------
Income before cumulative effect
of change in
accounting principle $ 1,931,850 $ 3,058,019 $ 3,737,008
----------- ----------- -----------
Cumulative effect of change in
accounting
principle for income taxes
(note 1) - 220,000 -
----------- ----------- -----------
Net income $ 1,931,850 $ 3,278,019 $ 3,737,008
----------- ----------- -----------
Earnings per share (note 11)
Primary earnings per share
before cumulative
effect of accounting change $0.67 $1.05 $1.29
Cumulative effect of accounting
change - .08 -
----- ----- -----
Net Income $0.67 $1.13 $1.29
===== ===== =====
Fully diluted $0.67 $1.12 $1.29
===== ===== =====
See accompanying notes to consolidated financial statements.
NORTHBAY FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
Years ended June 30, 1995, 1994 and 1993
Retained Unrealized
Earnings - Loss on
Substantially Debt Securities Total
Common Additional Restricted Incurred Available Stock
Stock Paid*In (Notes 10 by ESOP for Sale Holders
Amount Capital 13 and 16) (Note 14) (Note 2 and 3) Equity
-------------- ----------- ------------ ------------ -------------- ------------
Balances, June 30, 1992 $188,703 $13,875,911 $14,349,768 $ (337,500) $(1,322) $28,075,560
Issuance of nonincentive stock options
issued at below market value - 18,800 - - - 18,800
15% stock dividend paid July 31, 1992
10% stock dividend paid Jan. 29, 1993 18,866 3,282,857 (3,301,655)
Cash dividends declared and paid
($ .22 per share) - - (430,135) - - (430,135)
Cash dividend declared ($ .10 per share) - - (207,500) - - (207,500)
Cash dividend paid in lieu of fractional
shares relating to stock dividend (68) 68 (11,970) - - (11,970)
Reduction of debt incurred by ESOP - - - 50,000 - 50,000
Recovery of unrealized loss on
marketable equity securities - - - - 1,322 1,322
Net income - - 3,737,008 - - 3,737,008
------------- ----------- ----------- ----------- ------------- -----------
Balances, June 30, 1993 207,501 17,177,568 14,135,516 (287,500) 0 31,233,085
------------- ----------- ----------- ----------- ------------- -----------
10% stock dividend paid June 24, 1994 20,771 3,614,172 (3,634.943)
Cash dividends declared and paid
($ .30 per share) - - (622,788) - - (622,788)
Cash dividend declared ($ .11 per share) - - (251,263) - - (251,263)
Cash dividend paid in lieu of fractional
shares relating to stock dividend (55) 55 (9,737) - - (9,737)
Reduction of debt incurred by ESOP - - - 50,000 - 50,000
Issuance of common stock (Employee
stock options exercised) 210 10,878 - - - 11,088
Unrealized loss on securities
available for sale - - - - (4,475) (4,475)
Net income - - 3,278,019 - - 3,278,019
------------- ----------- ----------- ----------- ------------- -----------
Balances, June 30, 1994 228,427 20,802,673 12,894,804 (237,500) (4,475) 33,683,929
------------- ----------- ----------- ----------- ------------- -----------
20% stock split/dividend declared
Sept 30, 1994 45,694 - (45,694)
Cash dividends paid ($ .11 per share) - - (854,403) - - (854,403)
Cash dividends declared ($ .11 per share) - - (302,557) - - (302,557)
Cash dividend paid in lieu of fractional
shares relating to stock dividend - - (5,372) - - (5,372)
Reduction of debt incurred by ESOP - - - 50,000 - 50,000
Issuance of common stock (Employee
stock options exercised) 960 46,651 - - - 47,611
Recovery of unrealized loss on
marketable equity securities - - - - 27,243 27,243
Net income - - 1,931,850 - - 1,931,850
------------- ----------- ----------- ----------- ------------- -----------
Balances, June 30, 1995 $275,081 $20,849,324 $13,618,628 $ (187,500) $22,768 $34,578,301
------------- ----------- ----------- ----------- ------------- -----------
See accompanying notes to consolidated financial statements.
NORTHBAY FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended June 30, 1995, 1994 and 1993
1995 1994 1993
-------------- -------------- --------------
Cash flows from operating
activities:
Net income $ 1,931,850 $ 3,278,019 $ 3,737,008
Adjustments to reconcile net
income to net cash (used in)
provided by operating activities
Depreciation and amortization 442,673 454,279 376,187
Amortization of:
Deferred premiums 3,895 31,007 106,690
Deferred loan fees (1,164,378) (1,467,636) (1,548,369)
Deferred gain on
sale/leaseback of buildings (34,012) (34,012) (34,012)
Other (1,382) 49,702 65,264
Provision for loan losses 412,000 725,000 722,433
Gain on sale of loans and
mortgage-backed securities - (161,365) (427,276)
Loss (gain) from real estate
activities 134,278 136,541 (2,275)
Loss (gain) from sale of
property, plant and equipment 50,893 - (116,519)
Gain on sale of investment
securities held for sale (116,727) (368,058) (77,599)
Decrease in income taxes
payable and deferred (128,349) (64,749) (104,217)
(Increase) decrease in accrued
interest receivable (380,630) (44,322) 315,022
Increase (decrease) in other
liabilities and accrued
expenses 33,045 645,928 (632,108)
(Increase) decrease in prepaid
and other assets (634,051) (75,535) 306,197
Write down deferred servicing
premiums 3,610 31,134 177,954
Long-term loans originated and
purchased as held for sale (649,123) (15,623,968) (34,984,822)
Proceeds from sales of loans
held for sale 649,123 25,007,576 34,614,391
Investment securities
purchased as held for sale (1,205,760) (600,000) (1,076,451)
Proceeds from sales of
investment securities held
for sale 1,119,039 912,119 4,918,867
Mortgage-backed securities
purchased as held for sale (3,030,639) (3,537,245) -
FHLB stock dividend (170,400) (79,900) (27,300)
Cumulative effect of adopting
a change in accounting
principle - (220,000) -
Other - (672) (7,010)
------------- ------------- -------------
Net cash (used in) provided by
operating activities (2,735,045) 8,993,843 6,302,055
------------- ------------- -------------
Cash flows from investing
activities:
Principal payments on loans 81,883,032 107,430,728 103,120,838
Long-term loans originated to be
held to maturity (100,915,876) (150,978,107) (125,708,896)
Long-term loans purchased to be
held to maturity (421,559) (14,026,568) (5,692,396)
Net decrease in short-term loans 111,948 164,697 59,137
Maturities of investment
securities held to maturity 2,073,000 2,570,000 2,453,111
Purchases of investment
securities held to maturity (4,749,169) (7,188,284) (1,792,651)
Purchases of property, equipment
and leasehold improvements (145,476) (586,409) (1,354,041)
Purchases of mortgage-backed
securities held to maturity - (1,007,188) -
Principal payments on
mortgage-backed securities 977,654 3,445,595 3,182,981
Purchase of FHLB stock (1,705,600) (219,800) (160,400)
Proceeds from sale of FHLB stock 900,000 - -
Proceeds from sale of fixed
assets 279,835 3,309 603,275
Proceeds from sale of real
estate received in settlement
of loans 934,477 627,028 523,209
------------- ------------- -------------
Net cash used in investing
activities (20,777,734) (59,764,999) (24,765,833)
------------- ------------- -------------
Cash flows from financing
activities:
Dividends paid on common stock (1,111,171) (840,026) (544,998)
Net increase (decrease) in
savings accounts 7,009,019 21,824,750 (262,303)
Net increase in short-term
borrowings 18,555,276 28,541,217 14,129,905
Common stock issued as a result
of stock options exercised 47,613 - -
------------- ------------- -------------
Net cash from financing activities 24,500,737 49,525,941 13,322,604
------------- ------------- -------------
Increase (decrease) in cash and
cash equivalents 987,958 (1,245,215) (5,141,174)
Cash and cash equivalents at
beginning of year 7,254,910 8,500,125 13,641,299
------------- ------------- -------------
Cash and cash equivalents at end
of year $ 8,242,868 $ 7,254,910 $ 8,500,125
============= ============= =============
Supplemental disclosures of cash
flow information:
Noncash investing and financing
activities:
Real estate acquired in
settlement of loans $ 979,666 $ 2,248,895 $ 951,490
Additions to loans resulting
from sale of real estate owned $ 63,900 $ 242,250 $
Transfers from mortgage-backed
securities held to maturity to
mortgage-backed securities
available for sale $ - $ 2,080,087 $
Cash paid during the year for:
Income taxes $ 1,214,000 $ 1,912,000 $ 2,393,000
Interest on deposits $ 10,416,227 $ 8,212,853 $ 9,083,614
See accompanying notes to consolidated financial statements.
NORTHBAY FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended June 30, 1995, 1994 and 1993
(1) Summary of Significant Accounting Policies
The following items set forth the significant accounting policies not
disclosed elsewhere in the notes to the consolidated financial statements,
which Northbay Financial Corporation and Subsidiary (the "Company") follow
in preparing and presenting its consolidated financial statements.
(a) Basis of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary, Northbay Savings Bank, F.S.B.
(the "Bank"). All intercompany transactions and balances have been
eliminated in consolidation. The consolidated financial statements have
been prepared in conformity with generally accepted accounting principles.
(b) Investment Securities, Mortgage-Backed Securities
and Investments in Liquid Assets
In accordance with the Office of Thrift Supervision (OTS) regulations, the
Company maintains an amount at least equal to a specified percentage of
average daily withdrawable savings accounts plus short-term borrowing in
U.S. Government and other approved securities that are readily convertible
to cash.
In May 1993, Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) 115, "Accounting for Certain Investments
in Debt and Equity Securities." Under SFAS 115, institutions are required to
classify investments in debt securities and equity securities as "held to
maturity," "trading," or "available-for-sale." SFAS 115 modifies the current
accounting treatment for debt and equity securities by replacing the "held-for-
sale" categorization (with lower-of-cost or market accounting treatment) with an
"available-for-sale" categorization (with fair value accounting treatment).
Further, it imposes strict criteria over securities accounted for as "held-to-
maturity." The Bank elected to adopt SFAS 115 on June 30, 1994. Upon the
adoption of SFAS 115, debt securities that may not be held until maturity and
marketable equity securities are considered available-for-sale and as such are
classified as securities carried at fair value, with unrealized gains and
losses, net of applicable taxes, reported in a separate component of
stockholders' equity. Declines in the value of debt securities and marketable
equity securities that are considered other than temporary are recorded in
noninterest income as loss on investment securities. he market value of
securities were determined by quotes from primary securities dealers, whenever
available, or by other estimates.
Prior to June 30,1994, securities were classified as held-for-sale or held-for-
investment, based upon management's intent and ability at the time of purchase.
Assets held for investment purposes, other than marketable equity securities
were accounted for at cost, net of any unamortized premiums or discounts.
Marketable equity securities were carried at the lower of cost or market.
Securities that did not meet the reporting criteria for investment were
designated as held-for-sale and are accounted for at the lower of cost or
market.
Interest and dividends on investment securities includes interest earned on
investment securities, related amortization of premiums and discounts, and
dividends earned on stock of the Federal Home Loan Bank of San Francisco and
stock of the Federal Home Loan Mortgage Corporation. Gains or losses on sales of
securities are recognized at the time of sale using the specific identification
method.
(c) Interest on Loans
Interest on loans is credited to income when earned. Interest is reserved
on loans that are 90 days or more delinquent, or considered to be
uncollectible or are in the process of foreclosure.
(d) Office Property, Equipment and Leasehold
Improvements
Depreciation and amortization of office property, equipment, and leasehold
improvements are computed using the straight-line method over the estimated
useful lives of the various classes of assets or lease life, whichever is
shorter. Maintenance and repairs are charged to expense and improvements
are capitalized. Gains and losses on dispositions are credited or charged
to operations.
(e) Investment in Federal Home Loan Bank Stock
The Bank is a member of the Federal Home Loan Bank of San Francisco and, as
required, owned 32,914 shares and 23,154 shares at June 30, 1995 and 1994,
respectively, of its $100 par value capital stock. The Bank is required to
own capital stock in the FHLB of San Francisco in an amount at least equal
to the greater of 1% of the aggregate principal amount of its unpaid single
family mortgage loans and similar obligations at the end of each calendar
year or 5% of its advances (borrowings) from the FHLB of San Francisco. The
Bank was in compliance with this requirement at June 30, 1995.
(f) Income Taxes
The Bank changed its method of accounting for income taxes in 1994 to the
asset and liability method to conform with SFAS 109, "Accounting for Income
Taxes." The objective of the asset and liability method is to establish
deferred tax assets and liabilities for the temporary differences between
the financial reporting bases and the tax bases of assets and liabilities
at enacted tax rates expected to be in effect when such amounts are
realized or settled. Under SFAS 109, deferred tax assets are recognized for
deductible temporary differences and operating loss and tax credit carry
forwards, and then a valuation allowance is established to reduce that
deferred tax asset if it is "more likely than not" that the related tax
benefits will not be realized.
(g) Loan Origination Fees
The Company recognizes loan origination fees as an adjustment of the loan's
yield over the life of the loan using a method which approximates the
interest method, which results in a constant rate of return. Certain direct
costs of originating the loan are deferred and recognized over the life of
the loan as a reduction of the yield.
(h) Valuation of Loans and Real Estate Owned (REO)
Provisions for estimated losses on loans and real estate owned are charged
to operations when, in the opinion of management, such losses are expected
to be incurred. Management evaluates the carrying value of such assets
regularly and the allowances are adjusted accordingly. The Bank currently
utilizes a modeling technique that analyzes several factors identified as
posing additional credit risk to the Bank's loan portfolio. Such factors
include concentration of risk-weighted assets in the portfolio, historical
loss experience, concentration of loans to a single borrower, and assets
with an adverse internal classification.
Management believes that the allowance for losses on loans and REO are
adequate. While management uses available information to recognize losses
on loans and real estate owned, future additions to the allowance may be
necessary based on changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for losses on loans and real
estate owned. Such agencies may require the Bank to recognize additions to
the allowance based on their examination.
Real estate owned is comprised of properties acquired through settlement of
loans. At time of foreclosure, real estate owned is accounted for at the
lower of the recorded investment or fair market value. Subsequent to
foreclosure, real estate owned is accounted for at the lower of the new
cost basis or fair market value less estimated selling costs. Costs
relating to maintenance of the properties are expensed as incurred.
Valuations are performed periodically by management and losses are
established by a charge to operations if the carrying value exceeds its
estimated disposition value.
(i) Sales of Loan Participations and Mortgage-Backed Securities
Gains or losses resulting from sales of mortgage-backed securities and
loans or interests in loans are recorded at the time of sale and are
determined by the difference between the net sales proceeds and the
carrying value of the assets sold. When the right to service the loans is
retained, the gain or loss recognized is based upon the net present value
of expected amounts to be received or paid resulting from the difference
between the contractual interest rates received from the borrowers and the
rate paid to the buyer plus a normal servicing fee. The related deferred
charge (i.e., premium on loans sold) or credit is amortized to operations
over the estimated remaining life of the loan using a method that
approximates the interest method. Loans originated and intended for sale in
the secondary market are carried at the lower of cost or estimated market
value in the aggregate. Net unrealized losses are recognized in a valuation
allowance by charges to income.
(j) Statement of Cash Flows
For purposes of the statement of cash flows, the Company considers cash on
hand, cash in banks, interest-earning deposits and Federal funds sold (with
original maturities of three months or less) as cash and cash equivalents.
(k) Reclassifications
Certain of the 1994 and 1993 financial statement amount have been
reclassified to conform to the 1995 presentations
(l) Impact of New Accounting Standards
Accounting for impaired loans. In June 1993, the Financial Accounting
Standards Board (FASB) issued SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan." SFAS 114 required that expected loss of interest
income on nonperforming loans be taken into account when calculating loan
loss reserves. SFAS 114 required that specified impaired loans be measured
based on the present value of expected future cash flows discounted at the
loan's effective interest rate. SFAS 114 did not apply to large groups of
small balance, homogeneous loans that are collectively evaluated for
impairment. SFAS 114 was amended during 1994 by SFAS 118, "Accounting by
Creditors for Impairment of a Loan-Income Recognition and Disclosures."
SFAS 118 amends Statement 114 to allow a creditor to use existing methods
for recognizing interest income on impaired loans. SFAS 118 also amended
the disclosure requirements in Statement 114 to require information about
the recorded investment in certain impaired loans and about how a creditor
recognizes interest income related to those impaired loans. Both SFAS 114
and 118 are effective for financial statements for fiscal years beginning
after December 15, 1994 and the two statements are not expected to have a
material effect on the Bank's financial condition or results of operation.
In October of 1994 the FASB issued Statement of Financial Accounting
Standards No. 119, "Disclosure about Derivative Financial Instruments and
Fair Value of Financial Instruments." SFAS 119 requires disclosures about
derivative financial instruments such as futures, option contracts and
other financial instruments with similar characteristics. SFAS 119 also
amends SFAS 105, "Disclosure of Information about Financial Instruments
with Off-Balance-Sheet Risk and Financial Instruments with Concentrations
of Credit Risk," and SFAS 107, "Disclosures about Fair Value of Financial
Instruments." This statement is effective for fiscal years ending after
December 15, 1994 and is not expected to have a material impact on the
financial condition or operating results of the Bank.
In May of 1995, the FASB issued Statement of Financial Accounting Standard
No. 122, "Accounting for Mortgage Servicing Rights." SFAS 122 amends SFAS
65, "Accounting for Certain Mortgage Banking Activities," to require that
an institution recognize, as separate assets, rights to service mortgage
loans for others. An institution that acquires mortgage servicing rights
through purchase or origination of mortgage loans and sells those loans
with servicing rights retained, should allocate the total cost of the
mortgage loans to the mortgage servicing rights and loans based on their
relative fair values. SFAS 122 requires the institution to assess its
capitalized mortgage servicing rights for impairment based on the fair
value of those rights with the impairment recognized through a valuation
allowance. SFAS 122 is effective for fiscal years beginning after December
15, 1995 and applies prospectively to retained servicing rights, including
purchases prior to the adoption of the statement. SFAS 122 is not expected
to have a material impact on the financial condition or operating results
of the Bank.
(2) Investment Securities
The Company adopted Statement of Financial Accounting Standards No. 115
(SFAS 115), Accounting for Certain Investments in Debt and Equity
Securities, on June 30, 1994. SFAS 115 addresses the accounting and
reporting for certain investments in debt and marketable equity securities.
SFAS 115 establishes three classifications of securities, each of which
receives different accounting treatment. Held-to-maturity investment
securities are reported at cost. Available-for-sale investment securities
are reported at fair value, with unrealized gains and losses, after
applicable taxes, reported as a separate component of stockholders' equity.
Trading securities are reported at fair value, with unrealized gains and
losses included in earnings. The estimated fair value of investments is
determined based on current quotations, where available. Where current
quotations are not available, the estimated fair value is determined based
primarily on the present value of future cash flows, adjusted for the
quality rating of the securities, pre-payment assumptions and other
factors. The Company had no trading securities in 1995 or 1994.
Investment securities at June 30, 1995 are summarized as follows:
Gross Gross Estimated
Unrealized Unrealized Market
Cost Gains Losses Value
------------ ------------ ----------- ------------
Held-to-maturity securities at cost:
U.S. Government and Federal Agency securities $12,525,738 $ 85,974 $(185,183) $12,426,530
----------- ----------- --------- ------------
$12,525,738 $ 85,974 $(185,183) $12,426,530
=========== =========== ========= ============
Available-for-sale securities at fair value:
Income funds short-term $ 156,696 $ - $ - $ 156,696
Income funds variable rate government fund 983,000 - (57,553) 925,447
U.S. Government and Federal Agency securities 1,799,002 12,716 (6,600) 1,805,118
----------- ----------- --------- ------------
$ 2,938,698 $ 12,716 $ (64,153) $ 2,887,261
=========== =========== ========= ============
Investment securities at June 30. 1994 are summarized as follows:
Held-to-maturity securities at cost:
U.S. Government and Federal Agency securities $ 9,518,101 $ 2,300 $(362,713) $ 9,157,688
----------- ----------- --------- ------------
$ 9,518,101 $ 2,300 $(362,713) $ 9,157,688
=========== =========== ========= ============
Available-for-sale securities at fair value:
Income funds short-term $ 149,902 $ - $ - $ 149,902
Income funds adjustable rate mortgage fund 994,001 - (10,010) 983,991
Income funds variable rate government fund 983,101 - (24,851) 958,250
FHLMC preferred stock 8,878 128,215 - 137,093
U.S. Government and Federal Agency securities 600,000 - (6,800) 593,200
----------- ----------- --------- ------------
$ 2,735,882 $ 128,215 $ (41,661) $ 2,822,436
=========== =========== ========= ============
The following table sets forth the scheduled maturities, carrying values,
and market values for the Bank's investment debt securities at June 30, Estimated
1995: Market
Cost Value
---- -----
Available-for-sale securities at fair value:
Equity investment security funds (no stated maturity) $ 1,139,696 $ 1,082,144
U.S. Government and Federal Agency securities:
Due in one year or less
Due over one year to five years 200,000 200,000
Due over five years to ten years 1,599,002 1,605,118
----------- -----------
$ 2,938,698 $ 2,887,262
----------- -----------
Held-to-maturity securities at cost:
U.S. Government and Federal Agency securities:
Due in one year or less $ - $
Due over one year to five years 12,325,738 12,222,530
Due over five years to ten years 200,000 204,000
----------- -----------
$12,525,738 $12,426,530
=========== ===========
(3) Mortgage Backed Securities
Mortgage-backed securities are categorized as debt securities under the
definition of SFAS 115, and are therefore classified into one of the three
categories subject to the same accounting treatment as investment
securities. (Please refer to Note 2, Investment Securities.)
Mortgage-backed securities at June 30, 1995 are summarized as follows:
Gross Gross Estimated
Unrealized Unrealized Market
Cost Gains Losses Value
----------- ----------- ----------- -----------
Held-to-maturity
securities at cost:
FHLMC $ 1,451,687 $ 5,465 $ (25,816) $1,431,336
FHLMC REMIC 220,686 - (4,932) 215,754
---------- ---------- --------- -----------
$ 1,672,373 $ 5,465 $ (30,748) $1,647,090
----------- ---------- --------- -----------
Available-for-sale
securities at fair value:
FHLMC $ 4,550,835 $ 64,701 $ - $4,615,536
FHLMC REMIC 710,458 1,833 - 712,291
FNMA 1,820,136 24,151 (9,552) 1,834,735
FNMA REMIC 1,269,574 9,097 $ - 1,278,671
---------- ---------- --------- -----------
$ 8,351,003 $ 99,782 $ (9,552) $8,441,233
----------- ---------- --------- -----------
Mortgage-backed securities
at June 30, 1994 are
summarized as follows:
Held-to-maturity
securities at cost:
FHLMC $ 1,547,422 $ - $ (52,565) $1,494,857
FHLMC REMIC 230,928 - (5,887) 225,041
---------- ---------- --------- -----------
$ 1,778,350 $ 0 $ (58,452) $1,719,898
----------- ---------- --------- -----------
Available-for-sale
securities at fair value:
FHLMC $ 4,671,101 $ 7,752 $(105,092) $4,573,761
FNMA 1,584,890 25,835 (19,524) 1,591,201
---------- ---------- --------- -----------
$ 6,255,991 $ 33,587 $(124,616) $6,164,962
=========== ========== ========= ===========
The following table sets forth the scheduled maturities, cost, and market
values for the Bank's mortgage-backed securities at June 30, 1995:
Estimated
Market
Cost Value
---- -----
Held-to-maturity
securities at cost:
Mortgage-Backed Securities:
Due in one year or less $ - $ -
Due over one year to five
years 1,672,373 1,647,090
Due over five years to
ten years - -
Due over ten years to
twenty years - -
Due over twenty years - -
---------- ----------
$ 1,672,373 $1,647,090
=========== ==========
Available-for-sale
securities at estimated
market value:
Mortgage-Backed Securities:
Due in one year or less $ 157,567 $ 160,419
Due over one year to five
years 269,409 276,480
Due over five years to
ten years 1,567,757 1,570,578
Due over ten years to
twenty years 3,178,745 3,243,166
Due over twenty years 3,177,525 3,190,590
---------- ----------
$ 8,351,003 $8,441,233
=========== ==========
(4) Loans Receivable
Loans receivable at June 30, are summarized as follows:
1995 1994
---- ----
Loans secured by first deeds of
trust:
Dwellings, not more than
four units $242,414,741 $203,746,052
Dwellings, over four units 18,934,985 16,502,692
Commercial properties 41,481,567 44,614,898
Construction and land loans 33,302,857 58,675,351
------------ ------------
336,134,150 323,538,993
------------ ------------
Equity loan 1,741,538 2,516,698
Loans on savings accounts 1,403,484 1,497,915
Consumer loans 17,188,785 13,286,387
Commercial - other 1,642,093 1,323,538
------------ ------------
21,975,900 18,624,538
------------ ------------
Less:
Loans in process
nonconstruction loans (84,065) (277,765)
Loans in process
construction loans (10,910,594) (13,749,546)
Allowance for losses (2,232,819) (2,067,408)
Unearned loan origination
fees (1,030,138) (1,357,553)
------------ ------------
Total loans $343,852,434 $324,711,259
------------ ------------
Less:
Loans held for sale - -
------------ ------------
Loans receivable, net $343,852,434 $324,711,259
------------ ------------
Weighted average interest
rate at the dates indicated 7.19% 6.53%
===== =====
Changes in the allowance for losses for the years ended June 30, are summarized
as follows:
1995 1994 1993
---- ---- ----
Beginning balance $2,067,408 $1,808,813 $1,150,350
Provision charged to operations 412,000 725,000 722,433
Charge-offs (266,048) (474,909) (71,781)
Recoveries 19,459 8,504 7,811
---------- ---------- ----------
Ending balance $2,232,819 $2,067,408 $1,808,813
========== ========== ==========
At June 30, 1995 and 1994, nonaccrual loans were $1.35 and $2.80 million,
respectively. Approximately $53 thousand and $256 thousand, respectively, of
accrued interest on nonaccrual loans had been reserved for as a reduction of
interest receivable. The majority of this nonperforming loan portfolio are loans
secured by single family residential properties within the Bank's market area.
The following table represents a breakdown of the Bank's allocation of loan loss
reserves for the years ended June 30, 1995, 1994
and 1993, respectively.
Allocation of loan loss reserves at June 30, are summarized as follows:
1995 1994 1993
---- ---- ----
Loans secured by first deeds of trust:
Dwellings, not more than four units $ 840,260 $ 532,970 $ 534,010
Dwellings, over four units 126,440 17,860 13,140
Commercial properties 300,810 184,640 128,810
Construction and land loans 661,640 921,390 619,070
---------- ---------- ----------
$1,929,150 $1,656,860 $1,295,030
Equity loans 7,150 18,875 58,158
Loans on savings accounts
Consumer loans 104,040 54,293 41,460
Commercial - other 192,479 337,380 414,165
---------- ---------- ----------
$ 303,669 $ 410,548 $ 513,783
---------- ---------- ----------
Total loan loss reserves $2,232,819 $2,067,408 $1,808,813
========== ========== ==========
The Bank serviced approximately $55 million, $61.1 million and $63.5
million of loans, sold to third parties, at June 30,1995,1994 and 1993,
respectively.
The Bank is party to financial instruments with off-balance-sheet
risk. Such instruments are entered into in the normal course of business to meet
the financing needs of its customers and/or to facilitate the sale of loans. The
Bank uses the same credit policies in entering into off-balance-sheet financial
instruments as it does for on-balance-sheet items.
Loans receivable include mortgage loans due from officers and
directors. Activity related to these loans, which bear interest at rates ranging
from 3.68% to 5.56%, is summarized as follows:
Total as of June 30, 1993 $2,033,000
Additions 135,000
Loan repayments (65,000)
----------
Total as of June 30, 1994 $2,103,000
Additions 200,000
Loan repayments (47,000)
----------
Total as of June 30, 1995 $2,256,000
==========
Following are the components of gains on sale of loans and mortgage-backed
securities and an analysis of the deferred premium, resulting from such sales
for the years ended June 30:
1995 1994 1993
---- ---- ----
Deferred servicing premiums $ - $ 19,757 $ 7,769
Recognition of deferred loan fees - 242,119 323,338
Cash gain on sale of loans and
mortgage-backed securities - 202,489 96,169
Adjustment in carrying value of loans held
for sale to the lower of cost or market - (303,000) -
------ --------- ---------
$ 0 $ 161,365 $ 427,276
====== ========= =========
Deferred servicing premiums:
Balance at beginning of period 58,553 105,587 382,462
Additions - 19,757 7,769
Amortization and adjustments to reflect
market prepayment assumptions (7,505) (66,791) (284,644)
------ --------- ---------
Balance at end of period $51,048 $ 58,553 $ 105,587
======= ========= =========
(5) Office Property, Equipment and Leasehold Improvements
Office property, equipment and leasehold improvements at June 30, are
summarized as follows:
Estimated
1995 1994 useful lives
---- ---- ------------
Land $ 35,587 $ 363,073
Buildings 1,193,881 1,193,881 30 years
Leasehold improvements 1,165,634 1,103,019 10-25 years
Office furniture, fixtures and equipment 3,480,060 3,401,401 1-10 years
Automobiles 67,025 67,025 5 years
---------- ----------
Total, at cost 5,942,187 6,128,399
Less accumulated depreciation and
amortization 3,468,261 3,028,657
---------- ----------
$2,473,926 $3,099,742
========== ==========
(6) Real Estate Held For Sale
Real estate held for sale by the Company at June 30, is summarized as
follows:
1995 1994
---- ----
Real estate acquired in settlement of loans, net of
write downs $1,555,759 $1,636,909
Less allowance for estimated losses - -
---------- -----------
$1,555,759 $1,636,909
========== ===========
Changes in the allowance for losses on real estate owned for the years ended
June 30, are summarized as follows:
1995 1994 1993
---- ---- ----
Beginning balance $ - $ - $ -
Provision charged to operations 94,000 135,000 -
Charge-offs (94,000) (135,000) -
Recoveries - - -
-------- --------- -----
$ 0 $ 0 $ 0
======== ========= =====
(7) Savings Accounts
Comparative details of savings accounts by stated interest rate is as
follows:
1995 1994
---- ----
1.10% to 2.47% NOW accounts $ 35,868,745 $ 37,552,882
1.75% to 2.30% passbook accounts 35,589,258 45,421,817
0.00% to 3.00% money market deposit accounts 25,685,892 38,949,539
Commercial checking 2,485,184 2,330,401
------------ ------------
99,629,079 124,254,639
------------ ------------
Certificate accounts:
Less than 3.00% 1,059,223 5,857,370
3.00% to 3.50% 3,269,800 40,156,558
3.51% to 4.00% 13,648,210 46,400,187
4.01% to 4.50% 7,700,581 17,436,855
4.51% to 5.00% 10,105,277 6,879,845
5.01% to 5.50% 40,028,197 35,270,462
5.51% to 6.00% 48,371,297 373,024
6.01% to 6.50% 35,416,845 240,889
6.51% to 7.00% 24,464,506 -
7.01% to 7.50% 200,000 -
7.51% to 8.00% 16,060 30,226
Greater than 8.01% -- --
------------ ------------
184,279,996 152,645,416
------------ ------------
$ 283,909,075 $276,900,055
------------ ------------
Aggregate Weighted Average Interest Rate (WAIR) at the dates indicated
above 4.40% 3.09%
============ ============
The savings accounts summarized by type are as follows at June 30:
1995 1994
---- ----
WAIR Amount WAIR Amount
---- ----
Passbook accounts $ 35,589,258 2.91% $ 45,421,817 2.25%
NOW and money market deposit accounts 64,039,821 2.03% 78,832,822 1.77%
Certificate accounts 184,279,996 4.96% 152,645,416 4.03%
------------ ------------
$283,909,075 $276,900,055
============ ============
A summary of certificate accounts by maturity as of June 30, is
summarized as follows:
1995 1994
---- ----
Maturing within one year $ 160,086,916 $122,222,538
Maturing within two years 16,368,489 25,668,513
Maturing within three years 6,765,531 3,811,480
Maturing within four years 1,059,060 942,885
------------ ------------
$ 184,279,996 $152,645,416
============ ============
Interest expense on savings accounts for the years ended June 30, is
summarized as follows:
1995 1994 1993
---- ---- ----
Passbook accounts $ 1,014,330 $ 1,232,970 $ 1,707,349
NOW and money market deposit accounts 1,306,150 1,664,190 2,260,181
Certificate accounts 8,035,403 5,286,230 5,093,178
------------ ------------ ------------
$ 10,355,883 $ 8,183,390 $ 9,060,708
------------ ------------ ------------
Accrued interest on deposits at June 30, 1995 and 1994, was $113 thousand and
$49 thousand, respectively.
Included in deposits above are certain accounts in excess of $100 thousand which
totaled approximately $32.2 million and $30.7 million at June 30, 1995 and 1994,
respectively.
(8) Advances from Federal Home Loan Bank
The advances from Federal Home Loan Bank at June 30, 1995 and 1994 consisted of
the following:
1995 1994
Average Average
Maturity Interest Principal Interest Principal
Rates Rates
1994 -- $ -- 4.66% $42,100,000
1995 6.54% 37,300,000 4.21% 2,000,000
1996 6.73% 17,385,000 4.39% 1,000,000
1998 6.10% 1,000,000 - -
1999 6.30% 1,000,000 - -
2000 9.20% 357,500 9.19% 357,500
2001 8.61% 669,500 8.66% 669,500
2002 7.99% 93,252 7.32% 93,252
2003 6.33% 87,500 6.33% 87,500
2004 7.60% 1,387,000 7.60% $ 1,387,000
2009 7.77% 650,000 - -
2014 7.90% 106,421 - -
---- ----------- ------- -----------
$60,036,173 $47,694,752
=========== ===========
Weighted average interest
rate at the dates
indicated above 6.66% 4.81%
===== =====
The advances are collateralized by the pledge of loans receivable and
securities of approximately $126 million as of June 30, 1995 (note 3).
The Bank recognized $3.97 million, $1 million and $548 thousand of interest
expense on FHLB advances for the years ended June 30, 1995, 1994 and 1993,
respectively.
(9) Other Borrowings
The Bank recognized $137 thousand and $42 thousand of interest expense on
other borrowings for the years ended June 30, 1995 and 1994, respectively.
Other borrowings at June 30,are summarized as follows:
1995 1994
---- ----
Short-term banking disbursement overdraft arrangement $ 741,890 $2,138,297
Debt incurred by ESOP (note 14) 187,500 237,500
Securities sold under agreement to repurchase' 7,800,000
Other2 602,596 742,333
---------- ----------
$9,331,986 $3,118,130
========== ==========
1 The Bank enters into sales of U.S. Government securities and mortgage-backed
securities under agreements to repurchase (reverse repurchase agreements).
Reverse repurchase agreements are treated as financings, and the obligations
to repurchase securities sold are reflected as a liability in the consolidated
statements of financial condition. The dollar amount of securities underlying
the agree-ments remains in the asset accounts. The carrying amount of
securities sold with an agreement to repurchase was $9 million with a market
value of $9.2 million and accrued interest of $51 thousand at June 30, 1995.
2 Other consists of retail repurchase agreements which are secured by FHLMC and
FNMA mortgage-backed securities held to maturity of approximately $1 million
as of June 30, 1995. (note 3)
The following is a summary of securities sold under agreements to repurchase
at June 30, 1995:
1995
----
Balance at June 30 $7,800,000
Market Value at June 30, 1995 7,800,000
Average balance during year 1,825,000
Maximum balance at any month-end 7,800,000
Weighted average interest rate at June 30 6.38%
Weighted average interest rate
during year 6.39%
Securities sold under agreements to repurchase had the following maturities at
June 30, 1995:
1995
Average
Maturity Interest Rates Principal
- -------- -------------- ---------
0-90 days 6.17% $1,500,000
91-180 days 6.35% 3,800,000
181-270 days 6.55% 2,500,000
---- ----------
$7,800,000
==========
Weighted average interest
rate at the dated
indicated above 6.38%
=====
(10) Taxes on Income
The provision (benefit) for income taxes in the consolidated statements of
operations for the years ended June 30, is comprised of the
following components:
1995 1994 1993
---- ---- ----
Current:
Federal income tax $ 975,305 $1,414,532 $2,005,000
California franchise tax 436,374 521,673 770,100
---------- ---------- ----------
1,411,679 1,936,205 2,775,100
---------- ---------- ----------
Deferred:
Federal income tax (202,007) 80,530 120,800
California franchise tax (82,864) 50,516 (37,000)
---------- ---------- ----------
(284,871) 131,046 83,800
---------- ---------- ----------
Total:
Federal income tax 773,298 1,495,062 2,125,800
California franchise tax 353,510 572,189 733,100
---------- ---------- ----------
$1,126,808 $2,067,251 $2,858,900
========== ========== ==========
Under the Internal Revenue Code, the Company is allowed a Federal bad debt
deduction based on the greater of amounts computed on the percentage of taxable
income method or the percentage of eligible loans method. The percentage of
taxable income method has been used for financial statement purposes for all
periods presented. An alternative minimum tax is applicable to corporations to
the extent that the alternative minimum tax exceeds the corporate tax. For the
years ended June 30, 1995, 1994, and 1993, the Company's corporate tax exceeded
the alternative minimum tax. Savings and Loan associations that meet certain
definitions and other conditions prescribed by the Internal Revenue Code are
allowed to deduct, within limitations, earnings appropriated to tax bad debt
reserves in arriving at Federal taxable income. Approximately $2.4 million of
the Company's retained income at June 30, 1995 rep-resents current or future
appropriations to tax bad debt reserves of earnings for which no provision for
Federal income taxes has been made. If in the future, these amounts are used for
any purpose other than to absorb losses from bad debts, Federal income taxes
will be imposed at the then-applicable rates.
The differences between the Federal statutory income tax rate and the effective
rate of the Company's tax provision are as follows:
Years ended June 30
-------------------
1995 1994 1993
---- ---- ----
Statutory Federal tax rate 34.0% 34.0% 34.0%
California franchise tax, net of Federal income
tax benefit 7.6% 7.4% 7.3%
Book provision for loan losses - - 3.7%
Low Income Housing Tax Credits (4.2%) (1.6%) (1.2%)
Other (0.6%) .5% (.5%)
---- ---- ----
36.8% 40.3% 43.3%
==== ==== ====
Under SFAS 109:
Temporary differences between the financial statement carrying amounts
and tax bases of assets and liabilities that gave rise to significant portions
of the deferred tax liability at June 30, 1995 and June 30, 1994 relate to the
following:
1995 1994
---- ----
Deferred tax assets:
Book allowance for loan losses in excess of tax $ 433,635 $ 338,730
Gain on sale of building 231,868 247,107
Deferred compensation 93,594 73,855
California Franchise tax 112,335 177,367
Other 5,032 10,065
---------- ----------
Deferred tax assets 876,464 847,124
Less valuation allowance -- --
---------- ----------
Net deferred tax assets 876,464 847,124
Deferred tax liabilities:
Loan fees deferred for tax purposes $1,032,181 $1,383,958
FHLB dividends 251,350 180,877
Tax depreciation in excess of book 166,362 164,294
Other 79,764 56,059
---------- ----------
Net deferred tax liabilities 1,529,657 1,785,188
---------- ----------
Net deferred tax liability $ 653,193 $ 938,064
========== ==========
(11) Earnings per share
Primary and fully diluted earnings per share are calculated by dividing
earnings by the weighted average number of common shares and common stock
equivalents outstanding for the year. Stock options are regarded as common
stock equivalents and are therefore con-sidered in both primary and fully
diluted earnings per share calculations. Common stock equivalents are
computed using the treasury stock method. Shares outstanding and the common
stock equivalents of stock options have been adjusted in all periods to
reflect all stock dividends. Following are average shares outstanding at
June 30, for computation of earnings per share:
1995 1994 1993
---- ---- ----
Primary:
Weighted average number of shares outstanding 2,742,820 2,739,833 2,738,598
Common stock equivalents of stock options 160,291 171,230 170,299
--------- --------- ---------
Total weighted average common stock and stock
equivalents 2,903,111 2,911,063 2,908,897
========= ========= =========
Fully diluted:
Weighted average number of shares outstanding 2,742,820 2,739,833 2,738,598
Common stock equivalents of stock options 160,291 181,557 170,299
--------- --------- ---------
Total weighted average common stock and stock
equivalents 2,903,111 2,921,390 2,908,897
========= ========= =========
(12) Related Party Transactions
In December 1985, the Company sold its Headquarters building and two other
branches to certain members of the Company's Board of Directors and entered
into agreements to lease the buildings. Sales proceeds amounted to
$3,050,271. The combined book value of the buildings at the time of sale
was $2,166,504, resulting in a gain on sale of $883,767. The balance of the
remaining deferred gain was $560,651 and $594,663 at June 30, 1995 and June
30, 1994, respectively. As required under generally accepted accounting
principles, the gain has been deferred for financial statement purposes and
is being amortized over the terms of the leases. The Company has long-term
lease commitments related to these buildings (note 14). The Company
utilizes brokerage services of a member of the Board of Directors to
purchase its insurance coverage. The net amount of commission is
insignificant to the Company. In December 1992, the Company sold its
administrative office building located at 101 4th Street, Petaluma,
California, to a member of the Board of Directors. The sales price was at
fair market value and the financing was provided by a third party financial
institution. Sales proceeds were $600,000. The book value of the building
at the time of sale was $483,482 resulting in a gain of $116,519.
(13) Retained Earnings and Regulatory Matters
The Bank is subject to the regulations of the Office of Thrift Supervision
(OTS) and the Savings Association Insurance Fund (SAIF), which is
administered by the Federal Deposit Insurance Corporation (FDIC). Under the
current laws, the Bank is subject to minimum capital requirements. The OTS
requirements include a leverage ratio of core capital to adjusted total
assets of 3 %, a tangible capital standard expressed as 1.5% of total
adjusted assets and a risk-based capital standard of 8% of risk-weighted
assets. The risk-based capital standard requires the Bank to classify its
assets into one of four levels of perceived risk. Based upon the perceived
risk of those assets, the Bank is required to maintain capital on ranges of
0 to 100% of those assets at a rate of 8%. The OTS published a revision to
its capital regulations requiring savings institutions to maintain
additional capital based on the amount of their exposure to losses from
changes in market interest rates (the "interest rate risk component"). The
amount of such capital will equal 50% of the estimated decline in the
market value of the institution's portfolio equity after an immediate 200
basis point increase or decrease (whichever yields the larger decline) in
market interest rates. The market value of portfolio equity is equal the
net present value of the cash flows from an institution's assets,
liabilities and off-balance sheet items. Under the regulation, the Interest
Rate Risk (IRR) component is computed quarterly by the OTS based upon data
provided by the Bank in its quarterly Thrift Financial Report. The capital
requirement for IRR will have an effective lag of two calendar quarters.
The first quarter to be measured has once again been postponed indefinitely
until questions regarding a review procedure for institutions challenging
the results of the OTS model have been resolved. Based upon the Bank's
current capital levels, current interest rate risk exposure and upon
analysis of a similar cash flow methodology, management does not expect the
Bank's interest rate risk component to have a material effect on the Bank's
regulatory capital requirements.
(14) Employee Benefit Plans
The Company has a noncontributory Profit Sharing Plan (the "Plan") covering
substantially all employees. The Plan is administered by the Company
through a committee of trustees, for the benefit of eligible employees. The
aggregate amount of the contribution to the Plan to be allocated to
employees is determined annually by the Board of Directors and is based
upon current profits of the Company. Profit Sharing Plan expense recorded
by the Company for the years ended June 30,1995,1994, and 1993 amounted to
$25,476, $25,121, and $20,361, respectively. The Incentive Compensation
Plan for officers provides for incentive compensation based on attainment
of a targeted level of performance by the Company. The target bonuses are
calculated by applying various percentages to eligible employees' salaries
as of July 1 of the current fiscal year. Incentive compensation bonuses for
the years ended June 30, 1995, 1994, and 1993 amounted to $0, $60,136, and
$116,620, respectively.
The Company established an Employee Stock Ownership Plan (ESOP) for the
benefit of participating employees. The ESOP borrowed $500,000 from a third
party lender to purchase 104,362 shares of the Company's common stock. The
loan is secured by the common stock purchased and will be repaid by the
ESOP with funds from the Company's contributions and earnings on ESOP
assets. Accordingly, the unpaid balance of the loan has been reflected in
other borrowing in the Company's consolidated balance sheet, and an equal
amount has been recorded as a deduction from stockholders' equity. The
Company's contributions to the ESOP are charged to expense. Such
contributions amounted to $68,930, $66,077 and $70,540 for the years ended
June 30, 1995, 1994 and 1993, respectively.
In June 1986, the Company established a deferred compensation program for
its Chief Executive Officer. The program provides for payments to be made
to the Chief Executive Officer for ten years beginning in the first year of
his retirement. The payments will be made in exchange for consulting
services. The program has been funded through the purchase of a key-man
universal life insurance policy pertaining to the Chief Executive Officer,
which names the Company as beneficiary and currently provides coverage of
approximately $1.1 million. Other assets as of June 30, 1995 includes
$718,241 representing the net cash surrender value of the insurance policy.
The estimated present value amount of anticipated future payments to the
Chief Executive Officer is included in other liabilities and accrued
expenses.
In connection with the Conversion (note 16), the Company adopted the 1988
Stock Option and Incentive Plan (the "Option Plan") which provides for the
issuance of options to directors, officers and key employees of the Company
and its subsidiary. Additionally, the Option Plan provides for the granting
of Stock Appreciation Rights and Restricted Stock. The Option Plan
Committee of the Board of Directors selects the options and determines the
number of shares to be granted. A total of 273,638 shares of common stock
(adjusted for a three-for-two stock split, 15%, two 10%, and 20% stock
dividends) had been reserved for issuance under the Option Plan. The option
price may not be less than 100% of the fair market value of the shares on
the date of the grant and options generally shall not be exercisable after
the expiration of ten years from the date granted. In the case of an
employee who owns more than 10% of the
outstanding Common Stock at the date of the grant, the option price may not
be less than 110% of the fair market value of the shares on the date of the
grant and the option shall not be exercisable after the expiration of five
years from the date it is granted. Options may be exercised by payment in
cash, shares of Common Stock, or a combination of both. As of June 30, 1995
employees have exercised options to purchase 13,220 shares of common stock.
Number of Shares
-----------------
Outstanding options as of June 30, 1992 216,096
Granted (price $11.55) 25,588
Exercised --
-------
Outstanding options as of June 30, 1993 241,684
Granted (price $12.41) 7,892
Exercised (2,777)
-------
Outstanding options as of June 30, 1994 246,799
Granted --
Exercised (9,616)
-------
Outstanding options as of June 30, 1995 237,183
=======
Shares available for future grants 20,237
=======
As of June 30,1995 there are 205,309 options outstanding at $3.99 per share
,24,700 outstanding at $ 11.55 per share and 7,174 options at $12.41 per share.
Options and shares have been adjusted in all periods to reflect the three-for-
two stock split effective November 18, 1991, a 15% stock dividend effective July
31, 1992, a 10% stock dividend effective January 29, 1993, a 10% stock dividend
effective June 24, 1994 and a 20% stock dividend on October 28, 1994.
(15) Commitments and Contingencies
As of June 30, 1995 the Bank had commitments to originate loans totaling
approximately $29.9 million. Of this total, approximately $10.1 million
pertained to one year fixed rate construction and land loans; $16.5 million
adjustable rate construction and land loans; $2.1 million to longer-term
fixed rate mortgage loans; the remaining $1.2 million pertained to long-
term variable rate loans. Interest rates pertaining to fixed rate loan
origination commitments at June 30,1995 ranged from 6.65 % to 9.0% . As of
June 30, 1995, the Bank had commitments to purchase construction loans
totaling approximately $779 thousand.
At June 30,1995, the minimum rental commitments under operating leases with
initial or remaining terms of more than one year were as follows:
Years ending June 30:
1996................................................... $ 805,751
1997................................................... 805,751
1998................................................... 784,463
1999................................................... 721,067
2000................................................... 653,459
Thereafter through 2014................................ 5,878,783
Rental expense for operating leases totaled approximately $761,889,
$724,114 and $620,025, for the years ended June 30, 1995, 1994 and 1993,
respectively.
(16) Conversion and Sale of Common Stock
Northbay Financial Corporation (the "Corporation") was incorporated under
the laws of the State of Delaware on October 5,1988 for the purpose of
becoming a savings and loan holding company. On April 10, 1989, the
Corporation acquired all of the outstanding stock of Northbay Savings and
Loan Association (the "Association") issued in connection with its
conversion from a California chartered mutual to a California chartered
stock institution. At the time of conversion, the Bank established a
liquidation account in an amount equal to the Bank's retained earnings of
$8,680,644. The liquidation account is maintained for the benefit of
eligible account holders who continue to maintain their deposits in the
Bank after the conversion. In the unlikely event of a liquidation of the
Bank (and only in such an event), each eligible depositor will be entitled
to receive a liquidation distribution from the liquidation account, in the
proportionate amount of the then current adjusted balance for deposits
reflected in such account, before any liquidation distribution may be made
with respect to the stockholders. Except for the payment of dividends by
the Bank, the existence of the liquidation account will not restrict the
use or application of such retained earnings. The Bank is able to pay
dividends of up to 100% of cumulative net income, less dividends paid for
the previous eight quarters if the Bank meets its "fully phased-in capital
requirement." If the Bank does not meet its fully phased-in capital
requirements, its dividends to the Company would be limited to 50% of net
income, less dividends paid for the previous eight quarters. Under the
regulations of the OTS, the Bank will not be permitted to pay dividends on
its capital stock if its regulatory capital would thereby be reduced below
the applicable regulatory capital requirement or the amount required for
the liquidation account.
(17) Parent Company Financial Information
The Company and its subsidiary file a consolidated Federal income tax
return in which the taxable income or loss of the Company is combined with
that of its subsidiary. The Company's share of income tax expense is based
on the amount which would be payable if separate returns were filed.
Accordingly, the Company's equity in net income of its subsidiary is
excluded from the computation of the provision for income taxes for
financial statement purposes.
Statements of Financial Condition as of
June 30, 1995 and 1994
1995 1994
---- ----
Assets:
Receivable from subsidiary, net $ 889,979 $ 1,046,673
Investment in subsidiary 33,688,322 32,637,256
----------- -----------
$34,578,301 $33,683,929
=========== ===========
Liabilities and stockholders' equity:
Stockholders' equity $34,578,301 $33,683,929
=========== ===========
Statements of Operations
Years ended June 30, 1995, 1994 and 1993
1995 1994 1993
---- ---- ----
Income:
Net income of subsidiary $2,126,211 $3,413,619 $3,737,008
Operating expense 194,361 135,600 --
---------- ---------- ----------
Net income $1,931,850 $3,278,019 $3,737,008
========== ========== ==========
Statements of Cash Flows
Years ended June 30, 1995, 1994 and 1993
1995 1994 1993
---- ---- ----
Cash flows from operations:
Net income $ 1,931,850 $ 3,278,019 $ 3,737,008
Adjustments to reconcile net income
to net cash provided by operations:
Net income of subsidiary (2,088,544) (3,087,670) (2,976,612)
Change in receivable from subsidiary 156,694 (190,349) (760,396)
----------- ----------- -----------
Net cash used by operations - - -
Cash flows from investing activities:
Investing in subsidiary - - -
Cash flows from financing activities:
Dividend received from subsidiary 1,111,171 840,024 544,998
Cash dividend paid (1,111,171) (840,024) (544,998)
Net increase in cash - - -
Cash at beginning of year - - -
----------- ----------- -----------
Cash at end of year $ 0 $ 0 $ 0
=========== =========== ===========
(18) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107 (SFAS No. 107),
"Disclosures About Fair Value of Financial Instruments," requires
disclosure of estimated fair values for financial instruments. Such
estimates are subjective in nature and significant judge-ment is needed
regarding the risk characteristics of various financial instruments at a
discrete point in time. Therefore, such estimates could vary significantly
if assumptions regarding uncertain factors were to change. Major
assumptions, methods, and fair value estimates for the company's financial
instruments are set forth below.
(a) Cash and Short-Term Investments
The carrying amount is a reasonable estimate of fair value.
(b) Investments and Mortgage-Backed Securities
The fair value of mutual funds, U.S. Government and Federal Agency
securities, and investment in preferred stock of the Federal Home Loan
Mortgage Corporation, have been estimated based upon quotes from primary
securities dealers. The fair value of certificates of deposit invested with
other financial institutions is estimated by discounting future cash flows
at current market rates for similar instruments with similar remaining
maturities.
(c) Loans Receivable
Fair values for loans are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as single
family mortgage, multi-family mortgage, commercial, and consumer. Each loan
category is further segmented into fixed and adjustable rate categories. The
fair values for the segmented loan portfolio is calculated by discounting
the scheduled cash flows through the estimated maturity using estimated
market discount rates that reflect the credit and interest rate risk
inherent in the loan. The estimate of maturity is based upon current dealer
published projected prepayment speeds on mortgage securities with similar
characteristics whenever available. The prepayment speeds utilized on other
loans where dealer projected speeds are not applicable are based upon the
Company's historical experience modified by current market conditions.
(d) Federal Home Loan Bank Stock
The fair value of Federal Home Loan Bank stock is estimated to approximate
its face value $3,291,400 and $2,315,400 at June 30, 1995 and June 30, 1994,
respectively. The amount of dividend payments to be received is uncertain
and no free market exists for this asset which is required to be held by the
Bank in order to have access to service provided by the Federal Home Loan
Bank.
(e) Other Financial Instrument Assets
Other financial assets at June 30, 1995 are comprised of the net cash
surrender value of $718,241, representing a key-man universal life insurance
policy pertaining to the Chief Executive Officer and accrued interest receivable
of $2,403,994, and $51,048 representing the value of the retained servicing
spread on loans sold. The carrying amount is a reasonable estimate of fair value
for these assets.
Other financial assets at June 30, 1994 were comprised of the net cash
surrender value of $681,767, representing a key-man universal life insurance
policy pertaining to the Chief Executive Officer and accrued interest receivable
of $2,023,363, and $58,553 representing the value of the retained servicing
spread on loans sold. The carrying amount was a reasonable estimate of fair
value for these assets.
(f) Deposit Liabilities
Deposits with no stated maturity date are included at the amount
payable on demand. The fair value of time deposits (certificates of deposit) is
estimated by discounting future cash flows at current yields of similar maturity
U.S. treasury notes less estimated cost of approximately 40 basis points
representing the incremental cost of servicing those retail liabilities.
(g) Federal Home Loan Bank Advances
The fair value of Federal Home Loan Bank Advances is estimated by
discounting the future cash flows of these instruments at a rate which
approximates the current offering rate of an FHLB advance with a similar
remaining average life as the current weighted average life of the current
portfolio at June 30, 1995 and 1994.
(h) Other Borrowings
Other borrowings at June 30, 1995 consist of $741,890 in a short-term
banking disbursement overdraft arrangement, a ten year adjustable rate loan
incurred by the Employee Stock Ownership Plan ($187,500), and $602,596
representing retail repurchase arrangements secured by FHLMC and FNMA mortgage-
backed securities. Due to the fact that each of these liabilities reprice
immediately to current market rates, the carrying amount is a reasonable
estimate of fair value for these liabilities. The final component of other
borrowings is $7,800,000 representing securities sold under agreements to
repurchase identical securities at a specified future date is estimated by
discounting the future cash flows from the instruments at a rate which
approximates the current offering rate of similar borrowings with a similar
remaining term to maturity.
Other borrowings at June 30, 1994 consisted of $2,138,297 in a short-
term banking disbursement overdraft arrangement, a ten year adjustable rate loan
incurred by the Employee Stock Ownership Plan ($237,500), and $742,333
representing retail repurchase arrangements secured by FHLMC and FNMA mortgage-
backed securities. Due to the fact that each of those liabilities repriced
immediately to current market rates, the carrying amount was a reasonable
estimate of fair value for those liabilities.
(i) Other Financial Instrument Liabilities
Consists of accrued interest payable. The carrying amount is a reasonable
estimate of fair value for this liability.
(j) Commitments to Extend Credit
Commitments to extend credit relate primarily to the purchase or
construction of residential mortgage loans. The fair value of such commitments
is estimated using current market rates for loans with similar characteristics
versus committed rates.
Estimated fair values of financial instruments at June 30, 1995 and 1994, are as
follows:
1995 1994
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
Financial Assets: (In Thousands)
Investment securities:
Cash and short-term investments $ 8,241 $ 8,241 $ 7,255 $ 7,255
Investments and mortgage-backed
securities 26,932 26,846 22,029 21,661
Loans receivable, net 343,852 342,963 324,711 320,689
Other financial assets 3,173 3,173 2,763 2,763
Financial liabilities:
Demand deposits 99,629 99,629 124,254 124,254
Certificates of deposit 184,279 184,410 152,645 151,676
Federal Home Loan Bank Advances 60,036 60,420 47,695 47,996
Other borrowings 9,332 9,341 3,118 3,118
Off-balance-sheet financial
instruments:
Commitments to extend credit - (13) - (623)
STOCK MARKET INFORMATION
Northbay Financial Corporation common stock is listed on the American Stock
Exchange (AMEX). Ticker Symbol is NBF.
The number of record holders of common stock of Northbay Financial
Corporation as of the record date, August 23, 1995, was approximately 832
including those shares registered in names of various investment brokers held in
account for their customers.
The common stock initially began trading on April 11, 1989. The
following table sets forth the range of closing common stock prices as reported
by AMEX, adjusted for a 10% stock dividend on June 24, 1994 and a 20% stock
dividend on October 28,1994, for each quarter during the last two fiscal years
ended June 30, 1995 and 1994, as follows:
1995 1994
High Low High Low
---- ---- ---- ---
First Quarter 16 14 1/2 12 7/8 11 3/8
Second Quarter 16 3/8 13 3/4 13 12 1/4
Third Quarter 14 1/2 12 5/8 13 12
Fourth Quarter 14 5/8 13 15 7/8 11 1/2
Cash dividends have been paid as follows: $ .10 per share on July 30,
1993; $ .10 per share on October 29, 1993; $. 10 per share on January 29, 1994;
$. 10 per share on April 29, 1994; $ .11 per share on July 20, 1994; $ .11 per
share on October 19, 1994; $ .11 per share on January 18, 1995; and $ .11 per
share on April 19, 1995. On June 21, 1995, the Board of Directors declared an $
.11 per share cash dividend to shareholders of record as of July 5, 1995, to be
paid July 19, 1995.