UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark one) (x) Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 1996, or: ( ) Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission file number: 0-11090 NAPA NATIONAL BANCORP (Exact name of registrant as specified in its charter) California 94-2780134 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 901 Main Street, Napa, California 94559 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code:(707) 257-2440 Not Applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No As of May 10, 1996, the number of shares outstanding of the registrant's Common Stock, without par value, was 754,500. Fully diluted shares outstanding at this date were 882,300. PART I FINANCIAL INFORMATION Item 1. Financial Statements The following interim consolidated financial statements are unaudited. However, they reflect all adjustments (which included only normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of financial position, results of operations, and cash flows for the interim periods presented. Results for the quarter as presented are not necessarily indicative of results to be expected of the year as a whole. 2 NAPA NATIONAL BANCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In 000s) March 31, December 31, 1996 1995 (Unaudited) ASSETS Cash and due from banks $ 5,781 $ 7,106 Federal funds sold 8,040 14,780 Time deposits with other financial institutions 4,356 4,356 Investment securities: Held to maturity 1,724 1,235 Federal Reserve Stock 215 197 Loans, less allowance for loan losses of $1,343 and $1,325 at March 31, 1996 and December 31, 1995 73,639 73,374 Premises, furniture, fixtures and equipment, net 2,488 2,489 Accrued interest receivable 720 666 Other assets 655 648 TOTAL ASSETS $97,618 $104,851 LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Non-interest-bearing demand $15,819 $ 19,068 Interest-bearing: Savings 12,646 12,305 Transaction 25,697 28,060 Time certificates 35,511 37,319 Total deposits 89,673 96,752 Accrued interest payable and other liabilities 340 652 TOTAL LIABILITIES 90,013 97,404 SHAREHOLDERS' EQUITY Preferred stock, no par value, 1,000,000 shares authorized; no shares outstanding 0 0 Common stock, no par value, 20,000,000 shares authorized; 754,500 shares issued and outstanding at March 31, 1996 and December 31, 1995 6,915 6,915 Retained Earnings 690 532 TOTAL SHAREHOLDERS' EQUITY 7,605 7,447 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $97,618 $104,851 3 NAPA NATIONAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In 000s, except earnings per share data) Quarter Ended March 31, 1996 1995 Interest income: Interest and fees on loans $ 2,008 $ 1,696 Interest on federal funds sold 154 102 Interest on time deposits with other financial institutions 61 59 Interest on investment securities 25 20 Total interest income 2,248 1,877 Interest expense: Interest on deposits 735 498 Total interest expense 735 498 Net interest income 1,513 1,379 Provision for loan losses 72 49 Net interest income after provision for loan losses 1,441 1,330 Non-interest income: Service charges on deposit accounts 131 110 Other customer fees and charges 63 71 Mortgage loan origination 3 2 Total non-interest income 197 183 Non-interest expense: Salaries and employee benefits, net 660 513 Occupancy 109 91 Furniture, fixtures and equipment 109 110 Marketing and business development 25 25 Other 308 273 Total non-interest expense 1,211 1,012 Income before income taxes 427 501 Income taxes 175 207 Net income $ 252 $ 294 Net income per share $ 0.29 $ 0.39 Dividends paid per share $ 0.125 $ 0.000 Weighted average common shares outstanding used to compute net income per share 882,300 754,500 4 NAPA NATIONAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In 000s) Quarter Ended March 31, 1996 1995 Cash flows from operating activities: Net income $ 252 $ 294 Reconciliation of net incomes to net cash provided by operating activities: Depreciation on premises and equipment 113 67 Amortization of deferred loan fees and discounts/premiums on investment securities (294) (272) Provision for loan losses 72 49 (Increase) in accrued interest receivable (54) (74) (Increase) in other assets, net (7) (141) (Decrease) in accrued interest payable and other liabilities (312) (373) NET CASH (USED) BY OPERATING ACTIVITIES (230) (450) Cash flows from investing activities: Loan originations net of collections (43) (807) Net decrease in time deposits with other financial institutions 0 1 Activity in securities held to maturity Purchases (1,724) 0 Maturities 1,237 0 Capital expenditures (114) (357) Purchase of Federal Reserve Stock (18) (16) NET CASH (USED) IN INVESTING ACTIVITIES (662) (1,179) Cash flows from financing activities: Net (decrease) increase in deposits (7,079) 5,342 Cash Dividend paid to shareholders (94) 0 NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES (7,173) 5,342 (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (8,065) 3,713 Cash and cash equivalents at beginning of period 21,886 16,219 Cash and cash equivalents at end of period $13,821 $19,932 (Continued on following page) 5 NAPA NATIONAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In 000s) Quarter Ended March 31, 1996 1995 CASH AND CASH EQUIVALENTS AT MARCH 31 CONSIST OF: Cash and due from banks $ 5,781 $ 7,106 Federal funds sold 8,040 14,780 $13,821 $21,886 SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid for interest $ 999 $ 442 Cash paid for income taxes $ 110 $ 735 (Concluded) 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation The following should be read in conjunction with the unaudited consolidated financial statements presented elsewhere in this Form 10-Q. Since Napa National Bancorp (the Company) is a holding company whose principal asset is, and is expected to be, the capital stock of Napa National Bank (the Bank), the following relates principally to the financial condition and results of operations of the Bank. All dollar amounts are rounded and expressed in thousands except earnings per share data. Summary of Financial Results The Company recorded net income of $252, or $0.29 per share, for the first quarter of 1996, compared to net income of $294, or $0.39 per share, during the first quarter of 1995. The Company's year-to-date 1996 operating results were $42 below the results for the same period in 1995 for the following reasons. Net interest income for the first quarter of 1996 was $134 above the results for the similar period in 1995. Provision for loan losses for the first three months of 1996 was $23 above the same period in 1995. Non-interest income in 1996 was $14 above the results for 1995 due to increases in various service charges and product enhancements. Non-interest expenses were $199 higher in the first quarter of 1996 over the similar period of 1995. Net Interest Income The Company's primary source of income is the difference between interest income and fees derived from earning assets and interest paid on liabilities incurred for the funding of those assets. This difference is referred to as "net interest income". Net interest income expressed as a percentage of average total earning assets is referred to as the "net interest margin" or "margin". For the first quarter of 1996, net interest income was $134, or 10%, higher than the same quarter of 1995. Net interest income increased over 1995, primarily due to an increase in earning assets (see below) and slight increases on rates earned on loans and investments during the latter half of 1995. For the first three months of 1996, the loan-to-deposit ratio averaged 81%, while in the same period of 1995, the ratio averaged 84%. For the first quarter of 1996, total average earning assets were approximately $93,713, an increase of $15,998, or 21%, over total average earning assets of $77,715 for the same period in 1995. This increase in average assets in the first quarter of 1996 over that of 1995, contributed significantly to the increase of $371, or 20%, in total interest income between the two periods. First quarter 1996 total interest expense increased substantially over the same period of 1995 ($735 and $498, respectively). This increase 7 is primarily attributed to a limited time, one year 7% certificate of deposit product offered by the Bank late in the first quarter of 1995 (See "Deposits" herein). Average interest bearing deposits for the first quarter of 1996 were $76,651, an increase of $13,803, or 22%, over 1995's total of $62,848. This growth in interest bearing deposits, coupled with general increases on rates paid on deposits, and the 7% certificate of deposit product discussed above, resulted in the growth in total interest expense of $237, or 48%, between the two periods. Provision for Loan Losses The provision for loan losses is based upon management's assessment of the amount that is necessary to maintain the allowance for loan losses at an adequate level. As further described in "Allowance for Loan Losses" herein, management takes many factors into consideration when determining the provision. In addition to the factors described in the "Allowance for Loan Losses" section, management also considers loan portfolio growth in establishing the provision. The provision for loan losses was $72, or $23 higher in the first quarter of 1996 over the same period of 1995, an increase of 47%. Gross loans totaled $74,982 as of March 31, 1996, an increase of $10,752, or 17%, over the March 31, 1995 total of $64,230. The provision for loan losses increased in the first quarter of 1996 over the 1995 figure primarily due to an increase in outstanding loan balances, projected loan growth in the second quarter and management's assessment of the adequacy of the allowance for loan losses (See "Loans and Nonaccrual Loans" herein). Non-Interest Income Non-interest income consists primarily of service charges on deposit accounts and fees charged for other banking services. Non-interest income increased in the first quarter of 1996 by $14, or 8%, compared to the same period in 1995. The growth experienced in 1996 can be attributed to the continued increase in number of deposit accounts subject to service charges during the period under review. Additionally, the Bank's merchant card processing program has shown strong gains throughout 1995 and into 1996, contributing to the growth in non-interest income during the first quarter of 1996. Non-Interest Expense Total non-interest expenses for the first three months of 1996 were $1,211, representing an increase of $199, or 20%, over 1995's total of $1,012. Salaries and employee benefits increased by $147, or 29%, for the first three months of 1996 over the same period in 1995. This increase is attributed to the addition of approximately seven full time equivalent employees during the previous twelve months. This staff increase was a strategic move by management in order to take advantage of unique marketing opportunities taking place in the Company's service area and the overall growth in the Bank in general. 8 Occupancy and furniture, fixtures and equipment expenses increased a combined total of $17, or 8%, during the first quarter of 1996 over the same period of 1995. During 1995, the Bank closed and relocated a branch, relocated its head quarters, moved the bulk of its lending and loan administrative staff, remodeled its North Napa office and relocated the EDP and Customer Service Departments. The bulk of these moves and costs were incurred during the second and third quarters of 1995. These moves increased the Company's total occupied rental space by approximately 7,500 square feet. This increase in square footage and associated costs, contributed materially to the increase in 1996 verse 1995 totals. The Company's marketing and business development costs remained flat between the first three months of 1996 over the same period of 1995. The Bank's marketing efforts remained consistent during the first three months of both 1996 and 1995. Other non-interest expenses increased by $35, or 13%, during 1996 over the first quarter of 1995. A significant portion of this increase is attributable to the fact that the Company has grown 6% in total assets during the previous twelve months. Additionally, the Company enhanced its director compensation plan effective January 1, 1996. Director and other professional fees attributed significantly to the increase in expenses during the prior twelve months. In addition to these costs, the Bank began an extensive training program for a significant number of employees early in the first quarter of 1996. Income Taxes Income tax expense was approximately 41% of pre-tax income for the three months ending March 31, 1996 and 1995. 9 Loans and Nonaccrual Loans Loans totaled $74,982 at March 31, 1996, an increase of $283, or .4%, over December 31, 1995's balance of $74,699, and an increase of $10,752, or 17%, over March 31, 1995's balance of $64,230. The increase in the Company's loan portfolio over the last twelve months, in management's opinion, resulted from new loan generation by the Bank's loan officers, a concentrated marketing plan, and current changes in the Company's service area. As of March 31, 1996,nonperforming loans were $2,105, as compared to $1,447, at December 31, 1995. Nonperforming loans at March 31, 1995 were $1,005. Accruing loans past due 90 days or more were $0 at both March 31, 1996 and December 31, 1995. 10 On January 1, 1995, the Company adopted SFAS No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure." These statements address the accounting and reporting by creditors for impairment of certain loans. A loan is impaired when, based upon current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. These statements are applicable to all loans, uncollateralized as well as collateralized, except large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment such as credit cards, residential mortgage and consumer installment loans, loans that are measured at fair value or at the lower of cost or fair value and leases. Impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, the Company measures impairment based on a loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Loans are measured for impairment as part of the Company's normal internal asset review process. Interest income is recognized on impaired loans in a manner similar to that of all loans. It is the Company's policy to place loans that are delinquent 90 days or more as to principal or interest on a nonaccrual of interest basis unless secured and in the process of collection, and to reverse from current income accrued but uncollected interest. Cash payments subsequently received on nonaccrual loans are recognized as income only where the future collection of principal is considered by management to be probable. At March 31, 1996, the Company had approximately $2,105 in loans considered to be impaired. These loans were evaluated for impairment based on fair value of the underlying collateral and required an allowance for credit losses measured in accordance with SFAS No. 114 of $242. The average recorded investment in the impaired loans during the three months ended March 31, 1996, was $1,310: the related amount of interest income recognized during the period that such loans were impaired was $7, and the amount of interest income recognized under the cash-basis method of accounting during the time within the period that the loans were impaired was $7. Allowance for Loan Losses Inherent in the lending function is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made and the credit-worthiness of the borrower over the term of the loan. The Company maintains an allowance for possible loan losses at a level estimated to be adequate to provide for losses that can be reasonably anticipated based upon specific loan conditions as determined by management, and based upon management's assessment of historical loan loss experience, prevailing economic conditions and other factors. While these factors are essentially judgmental and may not be reduced to a mathematical formula, it is management's view that the $1,343 allowance at March 31, 1996, approximately 1.79% of total loans, was adequate as an allowance against probable losses in the portfolio. At March 31, 1995, the $1,099 allowance amounted to approximately 1.71% of total loans. There can be no assurance that in any given period the Bank may not 11 sustain charge-offs which are substantial in relation to the size of the allowance. The allowance is increased by charges to the provision for loan loss and reduced by net charge-offs. The activity in the allowance for loan losses was as follows: 1996 1995 (in 000's) Balance at January 1 $1,050 $1,050 Provision for loan losses 72 49 Recoveries 0 0 Charge-offs 54 0 Balance at March 31 $1,343 $1,099 Investments The Bank's classification of its investment in debt securities according to the provisions of SFAS 115 are as follows: March 31, 1996 - Investment Securities Classified According to the Provisions of SFAS No. 115 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Held-to-Maturity Securities U.S. Treasury $1,724 $2 $0 $1,726 Federal Reserve Stock $ 215 $0 $0 $ 215 Deposits Deposits totaled $89,673 at March 31, 1996, a decrease of $7,079, or 7%, below December 31, 1995's balance of $96,752. During the last twelve months, deposits have grown however, $4,953, or 6%, over March 31, 1995's total of $84,720. The decrease in the first quarter of 1996 was primarily concentrated in non-interest bearing demand and interest bearing transaction accounts. Late in March 1996, the special 7% one year certificates of deposits offered a year ago, matured. The Bank conducted a special marketing promotion for these customers through an employee telephone campaign. These customers were offered certificate of deposits with maturities ranging from 12 to 24 months. Interest rates offered on these certificate of deposits were tiered dependent on the certificate of deposit's term and ranged 100 to 200 basis points below the previous 7% rate. The rates offered were similar to rates offered for similar products at other financial institutions in the Bank's service area. The Bank's program was successful in maintaining the bulk of these maturities at a substantially lower cost of funds, as evidenced in only a $1,808, or 5%, drop in certificate of deposits from $37,319 at December 31, 1995 to $35,511 at March 31, 1996. 12 Management attributes the 6% growth over the last twelve months to changes in the Company's current service market, and an advertisement plan focused on deposit growth, primarily time certificates. Non-interest-bearing demand deposits were 18% of total deposits at March 31, 1996 and March 31, 1995. Time certificates of deposit were 40% of total deposits at quarter end, as compared to 38% at March 31, 1995. New Accounting Pronouncements The Company was required to adopt SFAS No. 123, Accounting for Stock-Based Compensation, on January 31, 1996. SFAS No. 123 establishes accounting and disclosure requirements using a fair value-based method of accounting for stock- based employee compensation plans. Under SFAS No. 123, the Company may either adopt the new fair value-based accounting method or continue the intrinsic value-based method and provide pro forma disclosures of net income and earnings per share as if the accounting provisions of SFAS No. 123 had been adopted. The Company has adopted only the disclosure requirements of SFAS No. 123. There were no stock options granted to employees or directors during the first quarter of 1996. In March 1995, the Financial Accounting Standards Board issued SFAS No. 121, Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 121 is effective for fiscal years beginning after December 15, 1995. This Statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The financial statement impact of adopting SFAS No. 121 is not expected to be material. Liquidity and Capital Resources Liquidity refers to the Company's ability to maintain a cash flow adequate to fund operations and meet obligations and other commitments on a timely basis. As shown in the Consolidated Statements of Cash Flows ("Statement") for the three months ended March 31, 1996, cash and cash equivalents decreased $8,068. This was primarily due to the large drop in deposits (See "Deposits" herein). For the same period of 1995, the Company's primary sources of funds were customer deposits and loan principal repayments. The significant drop in cash and cash equivalents during the first quarter of 1996 is not indicative of a trend and is not expected to continue. The usual sources of customer deposits is expected to provide significant amounts of funds in the future. However, the mix of deposits, as well as other sources of funds, will depend on future economic and other market conditions. The maturity and repricing profile of the Company's asset-liability mix is currently in an asset sensitive position. This means that when there exists a declining interest rate environment, the returns on the Company's earning assets drops more quickly than the Company's cost of funds. This causes a narrowing of the net interest spread and a possible reduction to the overall earnings of the Company. As rates increase, the opposite effect occurs. The Company's management monitors the asset- 13 liability position of the Company on a monthly basis and is continually assessing both the asset-liability mix and the products being offered to its customers. If the Bank's loan portfolio grows substantially, it might be necessary to raise deposits to support the growth. The Bank monitors its loan-to-deposit ratio (84% at March 31, 1996 and 77% at December 31, 1995) on a daily basis. If the loan-to-deposit ratio indicates that a liquidity squeeze is possible, the Bank can raise rates on deposits to attract more funds. In addition, the Bank has $5,500 in short-term lines of credit available to it from its correspondent banks. Liquidity is measured by various ratios, the most common being the liquidity ratio of cash less reserve requirements, time deposits in other financial institutions, federal funds sold, securities held for sale and unpledged investment securities compared to total deposits. At March 31, 1996 and December 31, 1995, this ratio was 20% and 26%, respectively. The Company's primary source of income is interest income earned on its liquid investments. The amounts invested by the Company in the Bank at March 31, 1996 were approximately $184. The Company's yearly investment income is expected to exceed operating expenses by approximately $10 during 1996. During the first quarter of 1996, the Company declared and paid a cash dividend of twelve and a half cents ($.125) per share of outstanding stock. This dividend was based on 1995 earnings and amount to $94. During the beginning of the second quarter of 1996, the Company declared another cash dividend of twelve and a half cents ($.125) per share. The record date of this dividend is May 10, 1996 and will be paid out to shareholders on June 1, 1996. This second cash dividend was based on the first quarter earnings and will also be $94. If the Company continues with this cash pay out, the Bank will need to pay dividends to the Company by the end of the third quarter of 1996. Capital Adequacy The FRB and the Comptroller of the Currency have specified guidelines for the purpose of evaluating the capital adequacy of holding companies and banks. The table below summarizes the current requirements for 1996, and the Company's and the Bank's compliance therewith. The requirements for the ratio of regulatory capital to risk-weighted assets for an "adequately capitalized" institution is 8.00%. Capital as a Minimum Tier 1 % of Risk- Leverage Capital Weighted Assets Ratio Ratio Regulatory Requirements for 1996 8.00% 4.00% 4.00% Consolidated Company Ratio at March 31, 11.69% 7.50 9.93% Bank Ratio at March 31, 10.93% 7.30% 9.68% 14 The capital levels of both the Bank and the Company currently exceed all minimum regulatory requirements. Management anticipates that both companies will continue to exceed the regulatory minimums in the foreseeable future. Therefore, the Company and the Bank have adequate capital in order to expand in the future, either through loan generation or other means of expansion. Effects of Inflation The impact of inflation on a financial institution differs significantly from that exerted on an industrial concern, primarily because its assets and liabilities consist largely of monetary items. The most direct effect of inflation is higher interest rates. However, the Bank's earnings are affected by the spread between the yield on earning assets and rates paid on interest- bearing liabilities rather than the absolute level of interest rates. Additionally, there may be some upward pressure on the Company's operating expenses, such as adjustments in staff expense and occupancy expense, based upon consumer price indices. In the opinion of management, inflation has not had a material effect on the consolidated results of operations. 15 INDEX TO EXHIBITS Exhibit No. Description 27 Financial Data Schedule 16 PART II OTHER INFORMATION Item 1. Not applicable Item 2. Not applicable Item 3. Not applicable Item 4. Not applicable Item 5. Not applicable Item 6. Exhibits and Reports on Form 8-K. No reports filed in 1996. 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NAPA NATIONAL BANCORP Date May 13, 1996 By:_______________________ Brian J. Kelly President & COO By:_______________________ Joan E. Heinitz Treasurer 18