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 period ended March 31, 2006.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Quarterly Transition Period From __________ to __________
Commission file number 0-10652
NORTH VALLEY BANCORP
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(Exact name of registrant as specified in its charter)
California 94-2751350
-------------------------------- ------------------------
(State or other jurisdiction (IRS Employer ID Number)
of incorporation or organization)
300 Park Marina Circle, Redding, CA 96001
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (530) 226-2900
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(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 Exchange Act of 1934 during the
preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definitions of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock - 7,558,154 shares as of May 9, 2006.
INDEX
NORTH VALLEY BANCORP AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets--
March 31, 2006 and December 31, 2005 3
Condensed Consolidated Statements of Income--
For the Three months ended March 31, 2006 and 2005 4
Condensed Consolidated Statements of Cash Flows--
For the Three months Ended March 31, 2006 and 2005 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 25
Item 4. Controls and Procedures 25
PART II. OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings 25
Item 1A. Risk Factors 25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 25
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits 26
SIGNATURES 27
- ----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands except share data)
March 31, December 31,
2006 2005
------------- -------------
ASSETS
Cash and cash equivalents:
Cash and due from banks $ 37,519 $ 48,294
Federal funds sold 12,128 7,800
------------- -------------
Total cash and cash equivalents 49,647 56,094
Investment securities available for sale, at fair value 156,757 164,258
Investment securities held to maturity, at amortized cost 88 91
Loans and leases 627,547 624,512
Less: Allowance for loan and lease losses (7,832) (7,864)
------------- -------------
Net loans and leases 619,715 616,648
Premises and equipment, net 14,997 14,946
Accrued interest receivable 3,396 3,834
Other real estate owned 898 902
FHLB and FRB stock and other securities 5,717 5,663
Company-owned life insurance policies 28,734 28,495
Core deposit intangibles, net 2,374 2,537
Goodwill 15,187 15,187
Other assets 8,094 9,760
------------- -------------
TOTAL ASSETS $ 905,604 $ 918,415
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing $ 192,125 $ 186,555
Interest-bearing 554,965 560,135
------------- -------------
Total deposits 747,090 746,690
Other borrowed funds 43,500 56,500
Accrued interest payable and other liabilities 9,669 11,463
Subordinated debentures 31,961 31,961
------------- -------------
Total liabilities 832,220 846,614
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Commitments and Contingencies (Note G)
STOCKHOLDERS' EQUITY:
Preferred stock, no par value: authorized 5,000,000 shares; none
outstanding -- --
Common stock, no par value: authorized 20,000,000 shares; outstanding
7,539,654 and 7,497,599 at March 31, 2006 and December 31, 2005 40,130 39,810
Retained earnings 35,815 34,437
Accumulated other comprehensive loss, net of tax (2,561) (2,446)
------------- -------------
Total stockholders' equity 73,384 71,801
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 905,604 $ 918,415
============= =============
The accompanying notes are an integral part of these condensed consolidated
financial statements (unaudited).
3
NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In thousands except per share data)
For the three months
ended March 31,
-----------------------------
2006 2005
------------ ------------
INTEREST INCOME:
Interest and fees on loans and leases $ 11,746 $ 9,457
Interest on investments:
Taxable interest income 1,502 1,688
Nontaxable interest income 274 311
Interest on Federal funds sold and repurchase agreements 105 171
------------ ------------
Total interest income 13,627 11,627
------------ ------------
INTEREST EXPENSE:
Deposits 2,010 1,252
Subordinated debentures 627 411
Other borrowings 597 366
------------ ------------
Total interest expense 3,234 2,029
------------ ------------
NET INTEREST INCOME 10,393 9,598
PROVISION FOR LOAN AND LEASE LOSSES -- 270
------------ ------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 10,393 9,328
------------ ------------
NONINTEREST INCOME:
Service charges on deposit accounts 1,477 1,133
Other fees and charges 702 568
Earnings on cash surrender value of life insurance policies 293 277
Gain on sale of loans 80 47
Gain on sales or calls of securites -- 93
Other 246 332
------------ ------------
Total noninterest income 2,798 2,450
------------ ------------
NONINTEREST EXPENSES:
Salaries and employee benefits 5,637 4,682
Occupancy expense 707 627
Furniture and equipment expense 533 561
Other 3,139 2,564
------------ ------------
Total noninterest expenses 10,016 8,434
------------ ------------
INCOME BEFORE PROVISION FOR INCOME TAXES 3,175 3,344
PROVISION FOR INCOME TAXES 1,046 1,085
------------ ------------
NET INCOME $ 2,129 $ 2,259
============ ============
Per Share Amounts
Basic Earnings Per Share $ 0.28 $ 0.31
============ ============
Diluted Earnings Per Share $ 0.27 $ 0.29
============ ============
Cash Dividends Per Common Share $ 0.10 $ 0.10
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements (unaudited).
4
NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
For the three months
ended March 31,
----------------------------
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 2,129 $ 2,259
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 572 530
Amortization of premium on securites 37 51
Amortization of core deposit intangible 129 163
Provision for loan and lease losses -- 270
Gain on sale or calls on securities -- (93)
Gain on sale of loans (80) (47)
Gain on sale of premises and equipment (14) --
Stock-based compensation expense 81 53
Effect of changes in:
Accrued interest receivable 438 600
Other assets 1,540 (1,451)
Accrued interest payable and other liabilities (1,795) (1,681)
------------ ------------
Net cash provided by operating activities 3,037 654
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of available for sale securities -- 20,033
Proceeds from maturities/calls of available for sale securities 7,273 7,826
Net change in FHLB and FRB stock and other securities (54) 43
Net change in interest bearing deposits in other financial institutions -- 500
Proceeds from sales of loans 6,252 --
Net increase in loans and leases (9,239) (20,151)
Proceeds from sales of premises and equipment 14 --
Purchases of premises and equipment (619) (1,772)
------------ ------------
Net cash provided by investing activities 3,627 6,479
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 400 33,342
Net change in other borrowed funds (13,000) (7,428)
Cash dividends paid (751) --
Tax benefit on stock-based compensation 175 357
Exercise of stock options 65 438
------------ ------------
Net cash (used in) provided by financing activities (13,111) 26,709
------------ ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (6,447) 33,842
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 56,094 24,215
----------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 49,647 $ 58,057
============================
Supplemental Disclosures of Cash Flow Information
Cash Paid During the Year for:
Interest $ 3,652 $ 1,469
Income taxes 2,313 1,313
The accompanying notes are an integral part of these condensed consolidated
financial statements (unaudited).
5
NORTH VALLEY BANCORP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
of North Valley Bancorp and subsidiaries (the "Company") have been prepared in
accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X
of the Securities and Exchange Commission. Accordingly, certain information and
notes required by accounting principles generally accepted in the United States
for annual financial statements are not included herein. In the opinion of
management, all adjustments (consisting solely of normal recurring accruals)
considered necessary for a fair presentation of the results for the interim
periods presented have been included. For further information, refer to the
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
Operating results for the three months ended March 31, 2006 are not necessarily
indicative of the results that may be expected for any subsequent period or for
the year ended December 31, 2006.
The condensed consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries North Valley Bank ("NVB"), NVB
Business Bank ("NVBBB"), North Valley Trading Company, which is inactive, and
Bank Processing, Inc. ("BPI"). Significant intercompany items and transactions
have been eliminated in consolidation. North Valley Capital Trust I, North
Valley Capital Trust II, North Valley Capital Trust III and North Valley Capital
Statutory Trust IV are unconsolidated subsidiaries formed solely for the purpose
of issuing trust preferred securities.
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions. These estimates and assumptions
affect the reported amounts of assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
6
NOTE B - INVESTMENT SECURITIES
At March 31, 2006 and December 31, 2005, the amortized cost of securities and
their approximate fair value were as follows (in thousands):
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------ ------------ ------------ ------------
Available for sale securities:
March 31, 2006
Securities of US government agencies and
corporations $ 14,020 $ -- $ (175) $ 13,845
Obligations of states and political subdivisions 23,500 602 (76) 24,026
Mortgage-backed securities 100,596 17 (3,928) 96,685
Corporate debt securities 7,995 43 (23) 8,015
Equity Securities 15,088 26 (928) 14,186
------------ ------------ ------------ ------------
$ 161,199 $ 688 $ (5,130) $ 156,757
============ ============ ============ ============
December 31, 2005
Securities of US government agencies and
corporations $ 16,015 $ -- $ (241) $ 15,774
Obligations of states and political subdivisions 23,473 541 (83) 23,931
Mortgage-backed securities 105,935 43 (3,499) 102,479
Corporate debt securities 7,994 23 (32) 7,985
Equity Securities 15,089 27 (1,027) 14,089
------------ ------------ ------------ ------------
$ 168,506 $ 634 $ (4,882) $ 164,258
============ ============ ============ ============
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------ ------------ ------------ ------------
Held to maturity securities:
March 31, 2006
Mortgage-backed securities $ 88 $ -- $ (2) $ 86
============ ============ ============ ============
December 31, 2005
Mortgage-backed securities $ 91 $ -- $ (3) $ 88
============ ============ ============ ============
There were no gross realized gains or losses on sales or calls of
available for sale securities for the three months ended March 31, 2006. Gross
realized gains on sales or calls of available for sale securities were $273,000
for the three months ended March 31, 2005. Gross realized losses on sales or
calls of available for sale securities for the three months ended March 31, 2005
were $180,000. There were no sales or transfers of held to maturity securities
for the three months ended March 31, 2006 and 2005.
At March 31, 2006 and December 31, 2005, securities having fair value
amounts of approximately $97,186,000 and $103,584,000 were pledged to secure
public deposits, short-term borrowings, treasury, tax and loan balances and for
other purposes required by law or contract.
Investment securities are evaluated for other-than-temporary impairment
on at least a quarterly basis and more frequently when economic or market
conditions warrant such an evaluation to determine whether a decline in their
value below amortized cost is other than temporary. Management utilizes criteria
such as the magnitude and duration of the decline and the intent and ability of
the Bank to retain its investment in the issues for a period of time sufficient
to allow for an anticipated recovery in fair value, in addition to the reasons
underlying the decline, to determine whether the loss in value is other than
temporary. The term "other than temporary" is not intended to indicate that the
decline is permanent, but indicates that the prospects for a near-term recovery
7
of value is not necessarily favorable, or that there is a lack of evidence to
support a realizable value equal to or greater than the carrying value of the
investment. Once a decline in value is determined to be other than temporary,
the value of the security is reduced and a corresponding charge to earnings is
recognized.
At March 31, 2006, the Company held $126,060,000 of available for sale
investment securities in an unrealized loss position of which $17,078,000 were
in a loss position for less than twelve months and $108,982,000 were in a loss
position and had been in a loss position for twelve months or more. Management
periodically evaluates each investment security for other than temporary
impairment, relying primarily on industry analyst reports, observation of market
conditions and interest rate fluctuations. Management believes it will be able
to collect all amounts due according to the contractual terms of the underlying
investment securities and that the noted decline in fair value is considered
temporary and due only to interest rate fluctuations.
Included in the above securities at March 31, 2006 are 100,000 shares
of FNMA, Series M perpetual preferred stock. The coupon rate is fixed at 4.75%
with a taxable-equivalent yield of 6.38%. The securities are owned at par, or
$50.00 per share, for a total investment of $5,000,000 and an unrealized loss of
$865,000 at March 31, 2006 as compared to $1,100,000 at December 31, 2005. The
securities are callable at par on June 1, 2008.
Management carefully evaluated the FNMA preferred stock to determine
whether the decline in fair value below book value of these securities is
other-than-temporary. Among other items, management reviewed relevant accounting
literature which included Statement of Financial Accounting Standards ("SFAS")
No. 115, Statement of Auditing Standard ("SAS") 92, and Staff Accounting
Bulletin ("SAB") No. 59. In conducting this assessment, management evaluated a
number of factors including, but not limited to:
o How far fair value has declined below book value
o How long the decline in fair value has existed
o The financial condition of the issuer
o Rating agency changes on the issuer
o Management's intent and ability to hold the security for a period of
time sufficient to allow for any anticipated recovery in fair value
Based on this evaluation, management concluded that these securities
were deemed to be temporarily impaired. Management's assessment weighed heavily
on the normal market fluctuations during the holding period, FNMA's response to
its weaker financial condition and analysis of FNMA by rating agencies and
investment bankers.
NOTE C - STOCK-BASED COMPENSATION
Stock Option Plans
At March 31, 2006, the Company has three stock-based compensation
plans: the North Valley Bancorp 1989 Director Stock Option Plan, the 1998
Employee Stock Incentive Plan and the 1999 Director Stock Option Plan. The
shares available for grant may be granted to anyone eligible to participate in
the plans. All options granted under the Employee plan had an exercise price
equal to the market value of the underlying common stock on the date of grant.
Prior to January 1, 2006, compensation expense was recognized in the financial
statements for the Director Plans for the difference between the fair market
value of the options at the date of the grant and the exercise price which
represented 85% of the fair market value. The options under the plans expire on
dates determined by the Board of Directors, but not later than ten years from
the date of grant. The vesting period is generally four or five years; however
the vesting period can be modified at the discretion of the Company's Board of
Directors. Outstanding options under the plans are exercisable until their
expiration. Total options of 2,502,353 were authorized under all plans at March
31, 2006. The Company issues new shares of common stock upon exercise of stock
options by all plan participants.
Adoption of FAS 123(R)
Prior to January 1, 2006, the Company accounted for the plans under the
recognition and measurement provisions of Accounting Principals Board ("APB")
Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations, as permitted by Financial Accounting Standards Board ("FASB")
Statement No. 123, Accounting for Stock-Based Compensation and FASB Statement
No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure.
Stock-based compensation cost of $53,000 was recognized in the Statement of
Income for options granted for the three months ended March 31, 2005, as
Director options granted under the plans had an exercise price equal to 85% of
the market value of the underlying common stock on the date of grant. Effective
8
January 1, 2006, the Company adopted the fair value recognition provisions of
FASB Statement No. 123(R), Share-Based Payment, using the modified prospective
transition method. Under the transition method, compensation cost recognized in
fiscal year 2006 includes: (a) compensation cost for all share-based payments
vesting during 2006 that were granted prior to, but not yet vested as of,
January 1, 2006 based on the grant-date fair value estimated in accordance with
the original provisions of Statement 123 and (b) compensation cost for all
share-based payments vesting during 2006 that were granted subsequent to January
1, 2006, based on the grant-date fair value estimated in accordance with the
provisions of Statement 123(R).
As a result of adopting Statement 123(R) on January 1, 2006, the
Company's income before provision for income taxes and net income for the three
months ended March 31, 2006, was $48,000 and $32,000 lower, respectively, than
if it had continued to account for share-based compensation under APB Opinion
No. 25. Diluted earnings per share for the three months ended March 31, 2006
would have remained unchanged if it had continued to account for share-based
compensation under APB Opinion No. 25.
Statement 123(R) requires the cash flows resulting from the tax
benefits from tax deductions in excess of the compensation cost recognized for
those options (excess tax benefits) to be classified as a cash flow from
financing activities in the statement of cash flows. The $175,000 excess tax
benefits classified as cash flows from financing activities would have been
classified as an operating cash inflow if the Company had not adopted Statement
123(R).
Determining Fair Value
The fair value of each option award is estimated on the date of grant
using a Black-Scholes based option valuation model that uses the assumptions
discussed below. This fair value is then amortized on a straight-line basis over
the requisite service periods of the awards, which is generally the vesting
period.
Expected Term - The Company's expected term represents the period that
the Company's stock-based awards are expected to be outstanding and was
determined based on the "simplified" method as outlined in Staff Accounting
Bulletin ("SAB") No. 107. Under this method the expected term is determined by
adding the vesting term to the original contractual term and dividing by 2.
Expected Volatility - The Company uses the trading history of the
common stock of the Company in determining an estimated volatility factor when
using the Black-Scholes option-pricing formula to determine the fair value of
options granted.
Expected Dividend - The Company estimates the expected dividend based
on its historical experience of dividends declared per year, giving
consideration to any anticipated changes and the estimated stock price over the
expected term based on historical experience when using the Black-Scholes
option-pricing formula to determine the fair value of options granted.
Risk-Free Interest Rate - The Company bases the risk-free interest rate
used in the Black-Scholes option-pricing formula on the implied yield currently
available on U.S. Treasury zero-coupon issues with the same or substantially
equivalent remaining term as the expected term of the options.
Estimated Forfeitures - When estimating forfeitures, the Company
considers voluntary and involuntary termination behavior as well as analysis of
actual option forfeitures.
Pro Forma
The following table illustrates the effect on net income and earnings
per share for the three months ended March 31, 2005 if the Company had applied
the fair value recognition provisions of Statement 123 to options granted under
the Company's stock option plans. For purposes of this pro forma disclosure, the
value of the options is estimated using a Black-Scholes option-pricing formula
and amortized to expense over the options' vesting periods:
9
Three months ended,
(in thousands except per share data) March 31, 2005
--------------
Net income, as reported $ 2,259
Add: total stock-based compensation expense
included in net income, net of tax 31
Deduct: total stock-based compensation expense
determined under the fair value based method
for all awards, net of tax (78)
--------------
Net income, pro forma $ 2,212
Basic earnings per common share:
As reported $ 0.31
Pro forma $ 0.30
Diluted earnings per common and equivalent share:
As reported $ 0.29
Pro forma $ 0.28
The fair value of the options granted during the three months ended
March 31, 2006 and 2005 are noted below and were calculated using the
Black-Scholes option-pricing formula with the following assumptions and prices:
Three months ended March 31,
-----------------------------
2006 2005
-------- --------
Dividend yield 2.24% 2.28%
Expected volatility 14.78% 15.29%
Risk-Free interest rate 3.58% 3.58%
Expected option life 7 years 7 years
Weighted average grant date fair value $3.01 $3.39
Stock Compensation Expense - Stock Options
At March 31, 2006, the total unrecognized compensation cost related to
stock-based awards granted to employees under the Company's stock option plans
was $313,000. This cost will be amortized on a straight-line basis over a
weighted average period of approximately 1.6 years and will be adjusted for
subsequent changes in estimated forfeitures. The total fair value of shares
vested during the quarter ended March 31, 2006 was $48,000.
Stock Option Activity
A summary of the activity in the Company's option plans is as follows:
-------------------------------------------------------------------------
Weighted
Weighted Average
Average Remaining Exercise Aggregate
Exercise Contractual Price Intrinsic
Shares Price Term Range Value ($000)
-------------------------------------------------------------------------
Outstanding at January 1 896,560 $ 9.51 4.2 years $5.36 - 19.86 $ 7,528
Granted 31,157 17.95 N/A $17.95 $ --
Exercised (42,055) 9.44 N/A $5.53 - 15.72 $ 356
Expired or Cancelled (66,221) 12.09 N/A $8.58 - 19.86 $ 389
-------------------------------------------------------------------------
Outstanding at March 31 819,441 $ 9.63 4.9 years $5.36 - 19.86 $ 6,887
-------------------------------------------------------------------------
Fully vested and excercisable
at March 31,2006 720,890 $ 8.68 4.4 years $5.36 - 17.95 $ 6,711
-------------------------------------------------------------------------
10
The total intrinsic value of options exercised for the three months
ended March 31, 2005 was $1,689,000.
Cash received from stock option exercises under the Company's option
plans for the three months ended March 31, 2006 and March 31, 2005 was $65,000
and $438,000, respectively. The actual tax benefit realized for the tax
deductions from stock option exercises under the stock option plans totaled
$175,000 and $357,000 for the three months ended March 31, 2006 and March 31,
2005, respectively.
NOTE D - COMPREHENSIVE INCOME
Comprehensive income includes net income and other comprehensive income
or loss. The Company's only sources of other comprehensive income (loss) are
unrealized gains and losses on available for sale investment securities and
adjustments to the minimum pension liability. Reclassification adjustments
resulting from gains or losses on investment securities that were realized and
included in net income of the current period that also had been included in
other comprehensive income (loss) as unrealized holding gains or losses in the
period in which they arose are excluded from comprehensive income of the current
period. The Company's total comprehensive income was as follows:
(in thousands) Three months ended March 31,
----------------------------
2006 2005
------------ ------------
Net income $ 2,129 $ 2,259
Other comprehensive loss, net of tax:
Holding loss arising during period (115) (1,337)
Reclassification adjustment -- (55)
------------ ------------
(115) (1,392)
------------ ------------
Total comprehensive income $ 2,014 $ 867
============ ============
NOTE E - EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income by the
weighted average common shares outstanding for the period. Diluted earnings per
share reflect the potential dilution that could occur if options or other
contracts to issue common stock were exercised and converted into common stock.
There was no difference in the numerator, net income, used in the
calculation of basic earnings per share and diluted earnings per share. The
denominator used in the calculation of basic earnings per share and diluted
earnings per share for the three month periods ended March 31, 2006 and 2005 is
reconciled as follows (in thousands, except per share amounts):
11
Three months ended March 31,
----------------------------
2006 2005
------------ ------------
Calculation of basic earnings per share:
Numerator - net income $ 2,129 $ 2,259
Denominator - weighted average common shares outstanding 7,507 7,339
------------ ------------
Basic earnings per share $ 0.28 $ 0.31
============ ============
Calculation of diluted earnings per share:
Numerator - net income $ 2,129 $ 2,259
Denominator:
Weighted average common shares outstanding 7,507 7,339
Dilutive effect of outstanding options 317 463
------------ ------------
Weighted average common shares outstanding
and common stock equivalents 7,824 7,802
------------ ------------
Diluted earnings per share $ 0.27 $ 0.29
============ ============
NOTE F - PENSION PLAN BENEFITS
The Company has a supplemental retirement plan for key executives and a
supplemental retirement plan for certain retired key executives and directors.
These plans are nonqualified defined benefit plans and are unsecured and
unfunded. Components of net periodic benefit cost for the Company's supplemental
nonqualified defined benefit plans for the three months ended March 31, 2006 and
2005 are presented in the following table (in thousands):
Three months ended March 31,
----------------------------
2006 2005
------------ ------------
Components of net periodic benefits cost:
Service cost $ 122 $ 66
Interest cost 67 48
Amortization of net obligation at transition -- 7
Prior service amortization 8 9
Recognized net actuarial loss 15 --
------------ ------------
Total components of net periodic cost $ 212 $ 130
============ ============
NOTE G - COMMITMENTS AND CONTINGENCIES
The Company is involved in legal actions arising from normal business
activities. Management, based upon the advice of legal counsel, believes that
the ultimate resolution of all pending legal actions will not have a material
effect on the Company's financial position or results of its operations or its
cash flows.
The Company was contingently liable under letters of credit issued on
behalf of its customers in the amount of $17,080,000 and $14,196,000 at March
31, 2006 and December 31, 2005. At March 31, 2006, commercial and consumer lines
of credit and real estate loans of approximately $66,029,000 and $141,361,000
were undisbursed. At December 31, 2005, commercial and consumer lines of credit
and real estate loans of approximately $78,602,000 and $127,608,000 were
undisbursed.
Loan commitments are typically contingent upon the borrower meeting
certain financial and other covenants and such commitments typically have fixed
expiration dates and require payment of a fee. As many of these commitments are
expected to expire without being drawn upon, the total commitments do not
necessarily represent future cash requirements. The Company evaluates each
potential borrower and the necessary collateral on an individual basis.
Collateral varies, but may include real property, bank deposits, debt
securities, equity securities or business or personal assets.
Standby letters of credit are conditional commitments written by the
Company to guarantee the performance of a customer to a third party. These
guarantees are issued primarily relating to inventory purchases by the Company's
commercial and technology division customers and such guarantees are typically
short term. Credit risk is similar to that involved in extending loan
commitments to customers and the Company, accordingly, uses evaluation and
12
collateral requirements similar to those for loan commitments. Virtually all of
such commitments are collateralized.
Loan commitments and standby letters of credit involve, to varying
degrees, elements of credit and market risk in excess of the amounts recognized
in the balance sheet and do not necessarily represent the actual amount subject
to credit loss. However, at March 31, 2006, no losses are anticipated as a
result of these commitments.
In management's opinion, a concentration exists in real estate-related
loans which represent approximately 84% and 77% of the Company's loan portfolio
at March 31, 2006 and December 31, 2005. Although management believes such
concentrations to have no more than the normal risk of collectibility, a
substantial decline in the economy in general, or a decline in real estate
values in the Company's primary market areas in particular, could have an
adverse impact on collectibility of these loans. However, personal and business
income represents the primary source of repayment for a majority of these loans.
NOTE H - NEW ACCOUNTING PRONOUNCEMENTS
Accounting for Servicing of Financial Assets
In March 2006, the Financial Accounting Standards Board (FASB) issued
Statement No. 156 (SFAS 156), Accounting for Servicing of Financial Assets - An
Amendment of FASB Statement No. 140. SFAS 156 requires that a servicing asset or
liability be recognized each time a contract to service a financial asset is
entered into, requires that all separately recognized servicing assets and
servicing liabilities be initially measured at fair value, if practicable, and
permits the subsequent measurement of servicing assets and servicing liabilities
based on the amortization method or the fair value measurement method. SFAS 156
also permits a one-time reclassification of available for sale securities to
trading securities provided that the available for sale securities are
identified in some manner as offsetting the entity's exposure to changes in the
fair value of servicing assets or servicing liabilities that are subsequently
measured at fair value. SFAS 156 will become effective as of the beginning of
the first fiscal year that begins after September 15, 2006. Earlier adoption is
permitted at the beginning of an entity's fiscal year provided the entity has
not yet issued financial statements, including interim financial statements, for
any period of that fiscal year.
The Company will apply the requirements for recognition and initial
measurement of servicing assets and servicing liabilities prospectively to all
transactions entered into on or after January 1, 2007. Management has not
completed its evaluation of the impact of SFAS 156 but believes that the effect
on the Company's financial position and results of operations will not be
material.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-----------------------------------------------------------------------
OF OPERATIONS.
-------------
Certain statements in this Form 10-Q (excluding statements of fact or
historical financial information) involve forward-looking information within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, and are subject to the
"safe harbor" created by those sections. These forward-looking statements
involve certain risks and uncertainties that could cause actual results to
differ materially from those in the forward-looking statements. Such risks and
uncertainties include, but are not limited to, the following factors:
competitive pressure in banking industry increases significantly; changes in the
interest rate environment reduce margins; general economic conditions, either
nationally or regionally, are less favorable than expected, resulting in, among
other things, a deterioration in credit quality and an increase in the provision
for possible loan losses; changes in the regulatory environment; changes in
business conditions, particularly in the Northern California region; volatility
of rate sensitive deposits; operational risks including data processing system
failures or fraud; asset/liability matching risks and liquidity risks; the
California power crises; the U.S. "war on terrorism" and military action by the
U.S. in the Middle East, and changes in the securities markets.
Critical Accounting Policies
- ----------------------------
General
North Valley Bancorp's financial statements are prepared in accordance
with accounting principles generally accepted in the United States of America
(GAAP). The financial information contained within our financial statements is,
to a significant extent, financial information that is based on measures of the
financial effects of transactions and events that have already occurred. A
13
variety of factors could affect the ultimate value that is obtained either when
earning income, recognizing an expense, recovering an asset or relieving a
liability. We use historical loss factors as one factor in determining the
inherent loss that may be present in our loan and lease portfolio. Actual losses
could differ significantly from the historical factors that we use. Another
estimate that we use is related to the expected useful lives of our depreciable
assets. In addition, GAAP itself may change from one previously acceptable
method to another method. Although the economics of our transactions would be
the same, the timing of events that would impact our transactions could change.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses is an estimate of the losses
that may be sustained in our loan and lease portfolio. The allowance is based on
two basic principles of accounting: (1) Statement of Financial Accountings
Standards (SFAS) No. 5 "Accounting for Contingencies," which requires that
losses be accrued when they are probable of occurring and estimable; and (2)
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," which requires
that losses be accrued on impaired loans (as defined) based on the differences
between the value of collateral, present value of future cash flows or values
that are observable in the secondary market and the loan balance.
The allowance for loan and lease losses is established through a
provision for loan and lease losses based on management's evaluation of the
risks inherent in the loan and lease portfolio. In determining levels of risk,
management considers a variety of factors, including, but not limited to, asset
classifications, economic trends, industry experience and trends, geographic
concentrations, estimated collateral values, historical loan and lease loss
experience, and the Company's underwriting policies. The allowance for loan and
lease losses is maintained at an amount management considers adequate to cover
losses in loans and leases receivable which are considered probable and
estimable. While management uses the best information available to make these
estimates, future adjustments to allowances may be necessary due to economic,
operating, regulatory, and other conditions that may be beyond the Company's
control. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan and
lease losses. Such agencies may require the Company to recognize additions to
the allowance based on judgments different from those of management.
Share Based Payment
At March 31, 2006, the Company had three stock-based compensation
plans: the North Valley Bancorp 1989 Director Stock Option Plan, the 1998
Employee Stock Incentive Plan and the 1999 Director Stock Option Plan, which are
described more fully in Note C to the Unaudited Condensed Consolidated Financial
Statements included herein in Item 1 - Financial Statements. On January 1, 2006,
the Company adopted Statement of Financial Accounting Standards No. 123 (revised
2004), Share-Based Payment (SFAS 123R), using the modified-prospective
transition method. Under this transition method, compensation cost recognized
during the quarter ended March 31, 2006 includes: (a) compensation cost for all
share-based awards granted prior to, but not yet vested as of, January 1, 2006,
based on the grant-date fair value and related service period estimates in
accordance with the original provisions of SFAS 123 and (b) compensation cost
for all share-based awards granted subsequent to January 1, 2006, based on the
grant-date fair value and related service periods estimated in accordance with
the provisions of SFAS 123R. Under the provisions of the modified-prospective
transition method, results for the three months ended March 31, 2005 have not
been restated.
Prior to the adoption of SFAS 123R, the Company used the intrinsic
value method to account for its stock option plans (in accordance with the
provisions of Accounting Principles Board Opinion No. 25). Intrinsic value is
the difference between share fair market value and option exercise price. Under
this method, compensation expense was recognized for awards of options to
purchase shares of common stock to employees under compensatory plans only if
the fair market value of the stock at the option grant date (or other
measurement date, if later) was greater than the amount the employee was
required to pay to acquire the stock. Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), permitted
companies to continue using the intrinsic value method or to adopt a fair value
based method to account for stock option plans. The fair value based method
would have resulted in the recognition, as expense over the vesting period, of
the fair value of all stock-based awards on the date of grant.
SFAS 123R clarifies and expands the guidance in SFAS 123 in several
areas, including measuring fair value and attributing compensation cost to
reporting periods. SFAS 123R includes a requirement to: (a) estimate forfeitures
of share-based awards at the date of grant, (b) expense share-based awards
granted to retirement eligible employees and those employees with
non-substantive non-compete agreements immediately, (c) attribute compensation
costs of share-based award grants to the stated future vesting period, (d)
recognize compensation cost of all share-based awards based upon the grant-date
fair value (including pre-2006 options).
14
Goodwill
Business combinations involving the Company's acquisition of the equity
interests or net assets of another enterprise may give rise to goodwill.
Goodwill represents the excess of the cost of an acquired entity over the net of
the amounts assigned to assets acquired and liabilities assumed in transactions
accounted for under the purchase method of accounting. Goodwill of $15,187,000
was recorded in the Company's acquisition of NVBBB. The value of goodwill is
ultimately derived from the Company's ability to generate net earnings. A
decline in net earnings could be indicative of a decline in the fair value of
goodwill and result in impairment. For that reason, goodwill will be assessed
for impairment at a reporting unit level at least annually. Management will
conduct its assessment of impairment during the fourth quarter of 2006.
Impairment of Investment Securities
Investment securities are evaluated for other-than-temporary impairment
on at least a quarterly basis and more frequently when economic or market
conditions warrant such an evaluation to determine whether a decline in their
value below amortized cost is other than temporary. Management utilizes criteria
such as the magnitude and duration of the decline, the financial condition of
the issuer, rating agency changes related to the issuer's securities and the
intent and ability of the Bank to retain its investment in the issues for a
period of time sufficient to allow for an anticipated recovery in fair value, in
addition to the reasons underlying the decline, to determine whether the loss in
value is other than temporary. The term "other than temporary" is not intended
to indicate that the decline is permanent, but indicates that the prospects for
a near-term recovery of value is not necessarily favorable, or that there is a
lack of evidence to support a realizable value equal to or greater than the
carrying value of the investment. Once a decline in value is determined to be
other than temporary, the value of the security is reduced and a corresponding
charge to earnings is recognized. See Note B to Unaudited Condensed Consolidated
Financial Statements in Item 1 - Financial Statements.
Overview
- --------
North Valley Bancorp (the "Company") is a bank holding company for
North Valley Bank ("NVB") and, since September 1, 2004, NVB Business Bank
("NVBBB"), both state-chartered banks. NVB operates out of its main office
located at 300 Park Marina Circle, Redding, CA 96001, with twenty-one branches,
including two supermarket branches, in Northern California. NVBBB, acquired in a
business combination more fully described in Note 2 to the financial statements
contained in the Company's Annual Report on Form 10-K for the year ended
December 31, 2005, operates out of its main office located at 630 Main Street in
Woodland, California with five branches. The Company's principal business
consists of attracting deposits from the general public and using the funds to
originate commercial, real estate and installment loans to customers, who are
predominately small and middle market businesses and middle income individuals.
The Company's primary source of revenues is interest income from its loan and
investment securities portfolios. The Company is not dependent on any single
customer for more than ten percent of its revenues. Management has submitted an
application to merge the Company's two subsidiary banks, NVB and NVBBB and is
waiting for regulatory approval. The Company anticipates completion of the
merger process by the end of the second quarter of 2006.
Earnings Summary
- ----------------
Three months ended March 31,
----------------------------
(in thousands except per share amounts) 2006 2005
------------ ------------
Net interest income $ 10,393 $ 9,598
Provision for loan and lease losses -- 270
Noninterest income 2,798 2,450
Noninterest expense 10,016 8,434
Provision for income taxes 1,046 1,085
------------ ------------
Net income $ 2,129 $ 2,259
============ ============
Earnings Per Share
Basic $ 0.28 $ 0.31
Diluted $ 0.27 $ 0.29
Annualized Return on Average Assets 0.96% 1.00%
Annualized Return on Average Equity 11.96% 13.74%
15
For the three months ended March 31, 2006, the Company did not
recognize any additional provision for loan and lease losses compared to a
$270,000 provision recorded in the same period in 2005. The process for
determining allowance adequacy includes a comprehensive analysis of the loan
portfolio. Factors in the analysis include size and mix of the loan portfolio,
nonperforming loan levels, charge-off/recovery activity and other qualitative
factors including economic activity. Management believes that the current level
of allowance for loan and lease losses as of March 31, 2006 of $7,832,000, or
1.25% of total loans and leases, is adequate at this time. The allowance for
loan and lease losses was $7,864,000, or 1.26% of total loans and leases, at
December 31, 2005. For further information regarding our allowance for loan and
lease losses, see "Allowance for Loan and Lease Losses" on page 20.
Net Interest Income
- -------------------
Net interest income is the principal source of the Company's operating
earnings and represents the difference between interest earned on loans and
leases and other investments and interest paid on deposits and other borrowings.
The amount of interest income and expense is affected by changes in the volume
and mix of earning assets and interest-bearing deposits and borrowings, along
with changes in interest rates.
The following table is a summary of the Company's net interest income,
presented on a fully taxable equivalent (FTE) basis for tax-exempt investments
included in earning assets, for the periods indicated:
16
======================================================================================================================
Average Daily Balance Sheets
(Dollars in thousands, except percentages)
March 31, 2006 March 31, 2005
-------------------------------------- --------------------------------------
Average Yield/ Interest Average Yield/ Interest
Balance Rate Amount Balance Rate Amount
---------- ---------- ---------- ---------- ---------- ----------
Assets
Earning assets:
Federal Funds Sold $ 8,768 4.86% $ 105 $ 37,293 1.86% $ 171
Investment securities:
Taxable 134,930 4.07% 1,355 168,306 3.75% 1,557
Non-taxable (1) 23,483 7.06% 409 26,440 7.12% 464
FNMA preferred stock (1) 12,039 6.67% 198 12,040 4.35% 129
Interest earning deposits -- -- -- 367 2.21% 2
---------- ---------- ---------- ---------- ---------- ----------
Total investments 170,452 4.67% 1,962 207,153 4.21% 2,152
Loans and leases (2) 624,879 7.62% 11,746 556,936 6.89% 9,457
---------- ---------- ---------- ---------- ---------- ----------
Total earning assets 804,099 6.97% 13,813 801,382 5.96% 11,780
Non earning assets 106,905 109,383
Allowance for loan and
lease losses (7,929) (7,189)
---------- ----------
Total non-earning assets 98,976 102,194
Total assets $ 903,075 $ 903,576
========== ==========
Liabilities and Shareholders' Equity
Interest bearing liabilities:
Transaction accounts $ 192,771 0.30% $ 143 $ 194,236 0.40% $ 193
Savings and money market 184,893 1.16% 527 207,598 0.68% 349
Time certificates 170,440 3.19% 1,340 156,240 1.84% 710
Other borrowed funds 91,573 5.42% 1,224 84,591 3.73% 777
---------- ---------- ---------- ---------- ---------- ----------
Total interest bearing
liabilities 639,677 2.05% 3,234 642,665 1.28% 2,029
Demand deposits 180,440 180,928
Other liabilities 10,743 14,209
---------- ----------
Total liabilities 830,860 837,802
---------- ----------
Shareholders' equity 72,215 65,774
---------- ----------
Total liabilities and
shareholders' equity $ 903,075 $ 903,576
========== ==========
Net interest income $ 10,579 $ 9,751
========== ==========
Net interest spread 4.92% 4.68%
========== ==========
Net interest margin 5.34% 4.93%
========== ==========
======================================================================================================================
(1) Tax-equivalent basis; non-taxable securities are exempt from federal
taxation.
(2) Loans on nonaccrual status have been included in the computations of
averages balances.
Net interest income has been adjusted to a fully taxable equivalent
basis (FTE) for tax-exempt investments included in earning assets. The increase
in net interest income (FTE) for the three-month period ended March 31, 2006
resulted primarily from a shift in earning asset composition to higher yielding
loans as well as increased yields resulting from the increasing rate
environment. Management is proactive in attempting to manage the Company's net
interest margin, that is, trying to maximize current net interest income without
placing an undue risk on future earnings. Currently the Company is selling all
fixed-rate 15-and 30-year residential mortgages in order to minimize the
Company's interest rate risk and to generate consistent mortgage fee income.
While average earning assets for the three months ended March 31, 2006
increased by $2,717,000 from the same period last year, yields on average
earning assets also increased 101 basis points from 5.96% to 6.97%. Yields in
the three months ended March 31, 2006 increased by 300 basis points on fed funds
sold and 73 basis points on loans compared to the same period in 2005, while
yields on investment securities increased by 46 basis points. Average interest
bearing liabilities decreased by $2,988,000 for the three months ended March 31,
2006 compared to the same period in 2005 while the average rate paid on those
liabilities increased by 77 basis points. The Company's net interest margin
(FTE) increased from 4.93% for the three months ended March 31, 2005 to 5.34%
for the same period in 2006.
17
Provision for Loan and Lease Losses
- -----------------------------------
The Company did not record a provision for loan and lease losses for
the three months ended March 31, 2006, while $270,000 was recorded for the same
period in 2005. Provisions for loan and lease losses are recorded based on
management's evaluation of the risks inherent in the loan and lease portfolio.
The allowance for loan and lease losses is maintained at an amount management
considers adequate to cover losses in loans and leases receivable which are
considered probable and estimable.
Noninterest Income
- ------------------
The following table is a summary of the Company's noninterest income
for the periods indicated:
Three months ended March 31,
---------------------------
(In thousands) 2006 2005
------------ ------------
Service charges on deposit accounts $ 1,477 $ 1,133
Other fees and charges 702 568
Earnings on cash surrender value of life insurance policies 293 277
Gain on sale of loans 80 47
Gain on sale or calls of securities -- 93
Other 246 332
------------ ------------
Total noninterest income $ 2,798 $ 2,450
============ ============
Noninterest income increased from $2,450,000 for the three months ended
March 31, 2005 to $2,798,000 for the same period in 2006. Service charges on
deposits increased $344,000 from the three months ended March 31, 2005 compared
to the same period in 2006. Other fees and charges increased from $568,000 for
the three months ended March 31, 2005 to $702,000 for the same period in 2006
due to organic growth. The increase in fees is directly attributable to the
increase in debit card activity, specifically, point-of-sale and foreign ATM
use. Earnings on cash surrender value of life insurance policies increased to
$293,000 for the three months ended March 31, 2006 compared to $277,000 for the
same period in 2005. The Company recorded $80,000 in gains on sales of mortgages
but had no gains on sales of securities for the three months ended March 31,
2006 compared to $47,000 in gains on sales of mortgages and $93,000 in gains on
sales of securities for the same period in 2005. Other income decreased to
$246,000 for the three months ended March 31, 2006 from $332,000 for the same
period in 2005. The decrease in other income was primarily due to a decrease in
fees earned associated with the Company's retail investment sales.
Noninterest Expense
- -------------------
The following table is a summary of the Company's noninterest expense
for the periods indicated:
Three months Ended March 31,
---------------------------
(In thousands) 2006 2005
------------ ------------
Salaries & employee benefits $ 5,637 $ 4,682
Equipment expense 533 561
Occupancy expense 707 627
Data processing expenses 503 319
Professional services 364 314
Marketing 255 198
ATM expense 203 202
Printing & supplies 195 160
Postage 153 111
Other 1,466 1,260
------------ ------------
Total noninterest expense $ 10,016 $ 8,434
============ ============
Noninterest expense totaled $10,016,000 for the three months ended
March 31, 2006, compared to $8,434,000 for the same period in 2005. This
represents an increase of $1,582,000, or 18.8%, from 2005 levels due primarily
to the Company's continued investment in higher growth markets, most notably
Sonoma and Placer Counties, as well as the execution of the Company's decision
to enhance its infrastructure for planned future growth. Salaries and benefits
increased by $955,000 or 20.4% to $5,637,000 for the three months ended March
18
31, 2006 compared to $4,682,000 for the same period in 2005. Data processing
expenses increased from $319,000 in 2005 to $503,000 in 2006 primarily driven by
the number of transactions processed. Most other expense categories for the
three months ended March 31, 2006 experienced relatively small decreases or
increases from the same respective periods in 2005. The Company's ratio of
noninterest expense to average assets was 4.44% for the three months ended March
31, 2006 compared to 3.73% for the same period in 2005. The increase in
noninterest expense to average assets ratio is a result of the increase in
expenses noted above compounded by minimal balance sheet growth.
Income Taxes
- ------------
The provision for income taxes for the three months ended March 31,
2006 was $1,046,000 as compared to $1,085,000 for the same period in 2005. The
effective income tax rate for state and federal income taxes was 32.9% for the
three months ended March 31, 2006 compared to 32.4% for the same period in 2005.
The increase in the effective tax rate is due to higher overall revenues in the
Company but the same or slightly lower level of revenues that are exempt from
federal taxes in the first quarter of 2006 compared to the same period in 2005.
The difference in the effective tax rate compared to the statutory tax rate
(approximately 42.05%) is primarily the result of the Company's investment in
municipal securities, FNMA Preferred Stock, and life insurance policies whose
income is exempt from Federal taxes. In addition, the Company receives special
tax benefits from the State of California Franchise Tax Board for operating and
providing loans in designated `Enterprise Zones'.
Impaired, Nonaccrual, Past Due and Restructured Loans and Leases and Other
Nonperforming Assets
- --------------------------------------------------------------------------
The Company considers a loan or lease impaired if, based on current
information and events, it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. The measurement of impaired loans
and leases is generally based on the present value of expected future cash flows
discounted at the historical effective interest rate, except that all
collateral-dependent loans and leases are measured for impairment based on the
fair value of the collateral.
At March 31, 2006, the recorded investment in loans and leases for
which impairment had been recognized was approximately $127,000 compared to
$1,088,000 at March 31, 2005. During the portion of the year that the loans and
leases were impaired, the Company recognized interest income of approximately
$1,600 for cash payments received in 2006.
At December 31, 2005, the recorded investment in loans and leases for
which impairment had been recognized was approximately $686,000. Of the 2005
balance, approximately $196,000 has a related valuation allowance of $98,000.
For the year ended December 31, 2005, the average recorded investment in loans
and leases for which impairment had been recognized was approximately $791,000.
During the portion of the year that the loans and leases were impaired, the
Company recognized interest income of approximately $6,000 for cash payments
received in 2005.
Loans on which the accrual of interest has been discontinued are
designated as nonaccrual loans. Accrual of interest on loans is discontinued
either when reasonable doubt exists as to the full and timely collection of
interest or principal, or when a loan becomes contractually past due by 90 days
or more with respect to interest or principal (except that when management
believes a loan is well secured and in the process of collection, interest
accruals are continued on loans deemed by management to be fully collectible).
When a loan is placed on nonaccrual status, all interest previously accrued but
not collected is reversed against current period interest income. Income on such
loans is then recognized only to the extent that cash is received and where the
future collection of principal is probable. Interest accruals are resumed on
such loans when, in the judgment of management, the loans are estimated to be
fully collectible as to both principal and interest.
19
Nonperforming assets at March 31, 2006, and December 31, 2005, are
summarized as follows:
March 31, December 31,
2006 2005
------------ ------------
Nonaccrual loans and leases $ 127 $ 686
Loans and leases past due 90 days and accruing interest 935 67
Other real estate owned 898 902
------------ ------------
Total nonperforming assets $ 1,960 $ 1,655
============ ============
Nonaccrual loans and leases to total gross loans and leases 0.02% 0.12%
Nonperforming loans and leases to total gross loans and leases 0.17% 0.14%
Total nonperforming assets to total assets 0.22% 0.19%
Allowance for Loan and Lease Losses
- -----------------------------------
A summary of the allowance for loan and lease losses at March 31, 2006
and March 31, 2005 is as follows:
Three months ended March 31,
----------------------------
2006 2005
------------ ------------
Balance beginning of period $ 7,864 $ 7,217
Provision for loan and lease losses -- 270
Net charge-offs 32 120
------------ ------------
Balance end of period $ 7,832 $ 7,367
============ ============
Allowance for loan and lease losses to total loans 1.25% 1.28%
Allowance for loan and lease losses to non performing loans 737.48% 507.02%
Allowance for loan and lease losses to non performing assets 396.16% 496.09%
The allowance for loan and lease losses is established through a
provision for loan and lease losses based on management's evaluation of the
risks inherent in the loan and lease portfolio. In determining levels of risk,
management considers a variety of factors, including, but not limited to, asset
classifications, economic trends, industry experience and trends, geographic
concentrations, estimated collateral values, historical loan and lease loss
experience, and the Company's underwriting policies. While management uses the
best information available to make these estimates, future adjustments to
allowances may be necessary due to economic, operating, regulatory, and other
conditions that may be beyond the Company's control. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the adequacy of the Company's allowance for loan and lease
losses. Such agencies may require the Company to recognize additions to the
allowance based on judgments different from those of management.
The allowance for loan and lease losses is comprised of two primary
types of allowances:
1. Formula Allowance
Formula allowances are based upon loan and lease loss factors
that reflect management's estimate of the inherent loss in
various segments of pools within the loan and lease portfolio.
The loss factor is multiplied by the portfolio segment (e.g.
multifamily permanent mortgages) balance to derive the formula
allowance amount. The loss factors are updated periodically by
the Company to reflect current information that has an effect
on the amount of loss inherent in each segment.
The formula allowance is adjusted for qualitative factors that
are based upon management's evaluation of conditions that are
not directly measured in the determination of the formula and
specific allowance. The evaluation of inherent loss with
respect to these conditions is subject to a higher degree of
uncertainty because they are not identified with specific
problem credits or historical performance of loan and lease
portfolio segments. The conditions evaluated to determine the
adjustment to the formula allowance at March 31, 2006 included
the following, which existed at the balance sheet date:
20
o General business and economic conditions effecting the
Company's key lending areas
o Real estate values and market trends in Northern
California
o Loan volumes and concentrations
o Seasoning of the loan portfolio, including trends in
past due and nonperforming loans
o Status of the current business cycle
o Specific industry or market conditions within portfolio
segments o Model imprecision
2. Specific Allowance
Specific allowances are established in cases where management
has identified significant conditions or circumstances related
to an individually impaired credit. In other words, these
allowances are specific to the loss inherent in a particular
loan. The amount for a specific allowance is calculated in
accordance with SFAS No. 114, "Accounting By Creditors For
Impairment Of A Loan."
The $7,832,000 in formula and specific allowances at March 31, 2006
reflects management's estimate of the inherent loss in various pools or segments
in the portfolio, and includes adjustments for general economic conditions,
trends in the portfolio and changes in the mix of the portfolio.
Management anticipates that as the Company continues to implement its strategic
plan the Company will:
o generate further growth in loans receivable held for investment
o emphasize the origination and purchase of income property real estate loans
o continue expansion of commercial business lending
As a result, future provisions will be required and the ratio of the
allowance for loan and lease losses to loans outstanding may increase.
Experience across the financial services industry indicates that commercial
business and income property loans may present greater risks than residential
real estate loans, and therefore should be accompanied by suitably higher levels
of reserves.
Liquidity
- ---------
The objective of liquidity management is to ensure the continuous
availability of funds to meet the demands of depositors and borrowers.
Collection of principal and interest on loans and leases, the liquidations and
maturities of investment securities, deposits with other banks, customer
deposits and short term borrowings, when needed, are primary sources of funds
that contribute to liquidity. Unused lines of credit from correspondent banks to
provide federal funds of $42,500,000 as of March 31, 2006 were also available to
provide liquidity. In addition, the Company has a revolving, unsecured line of
credit for $8,000,000 with a correspondent bank as of March 31, 2006 and NVB is
a member of the Federal Home Loan Bank ("FHLB") providing additional unused
borrowing capacity of $54,294,000 secured by certain loans and investment
securities as of March 31, 2006. The Company also has a line of credit with
Federal Reserve Bank of San Francisco ("FRB") of $3,138,000 secured by first
deeds of trust on eligible commercial real estate loans and leases. As of March
31, 2006, borrowings consisted of $6,000,000 in short term FHLB advances,
long-term borrowings of $37,500,000 were outstanding with the FHLB, and
$31,961,000 was outstanding in the form of subordinated debt issued by the
Company.
The Company manages both assets and liabilities by monitoring asset and
liability mixes, volumes, maturities, yields and rates in order to preserve
liquidity and earnings stability. Total liquid assets (cash and due from banks,
federal funds sold, and available for sale investment securities) totaled
$206,404,000 and $220,352,000 (or 22.8% and 24.0% of total assets) at March 31,
2006 and December 31, 2005, respectively.
21
Core deposits, defined as demand deposits, interest bearing demand
deposits, regular savings, money market deposit accounts and time deposits of
less than $100,000, continue to provide a relatively stable and low cost source
of funds. Core deposits totaled $687,009,000 and $686,608,000 at March 31, 2006
and December 31, 2005, respectively.
In assessing liquidity, historical information such as seasonal loan
demand, local economic cycles and the economy in general are considered along
with current ratios, management goals and unique characteristics of the Company.
Management believes the Company is in compliance with its policies relating to
liquidity.
Interest Rate Sensitivity
- -------------------------
The Company constantly monitors earning asset and deposit levels,
developments and trends in interest rates, liquidity, capital adequacy and
marketplace opportunities. Management responds to all of these to protect and
possibly enhance net interest income while managing risks within acceptable
levels as set forth in the Company's policies. In addition, alternative business
plans and contemplated transactions are also analyzed for their impact. This
process, known as asset/liability management, is carried out by changing the
maturities and relative proportions of the various types of loans, investments,
deposits and other borrowings in the ways prescribed above.
The tool used to manage and analyze the interest rate sensitivity of a
financial institution is known as a simulation model and is performed with
specialized software built for this specific purpose for financial institutions.
This model allows management to analyze three specific types of risks: market
risk, mismatch risk, and basis risk.
Market Risk
Market risk results from the fact that the market values of assets or
liabilities on which the interest rate is fixed will increase or decrease with
changes in market interest rates. If the Company invests in a fixed-rate, long
term security and then interest rates rise, the security is worth less than a
comparable security just issued because the older security pays less interest
than the newly issued security. If the security had to be sold before maturity,
then the Company would incur a loss on the sale. Conversely, if interest rates
fall after a fixed-rate security is purchased, its value increases, because it
is paying at a higher rate than newly issued securities. The fixed rate
liabilities of the Company, like certificates of deposit and fixed-rate
borrowings, also change in value with changes in interest rates. As rates drop,
they become more valuable to the depositor and hence more costly to the Company.
As rates rise, they become more valuable to the Company. Therefore, while the
value changes when rates move in either direction, the adverse impacts of market
risk to the Company's fixed-rate assets are due to rising rates and for the
Company's fixed-rate liabilities, they are due to falling rates. In general, the
change in market value due to changes in interest rates is greater in financial
instruments that have longer remaining maturities. Therefore, the exposure to
market risk of assets is lessened by managing the amount of fixed-rate assets
and by keeping maturities relatively short. These steps, however, must be
balanced against the need for adequate interest income because variable-rate and
shorter-term assets generally yield less interest than longer-term or fixed-rate
assets.
Mismatch Risk
The second interest-related risk, mismatch risk, arises from the fact
that when interest rates change, the changes do not occur equally in the rates
of interest earned and paid because of differences in the contractual terms of
the assets and liabilities held. A difference in the contractual terms, a
mismatch, can cause adverse impacts on net interest income.
The Company has a certain portion of its loan portfolio tied to the
national prime rate. If these rates are lowered because of general market
conditions, e.g., the prime rate decreases in response to a rate decrease by the
Federal Reserve Open Market Committee ("FOMC"), these loans will be repriced. If
the Company were at the same time to have a large proportion of its deposits in
long-term fixed-rate certificates, interest earned on loans would decline while
interest paid on the certificates would remain at higher levels for a period of
time until they mature. Therefore net interest income would decrease
immediately. A decrease in net interest income could also occur with rising
interest rates if the Company had a large portfolio of fixed-rate loans and
securities that was funded by deposit accounts on which the rate is steadily
rising.
This exposure to mismatch risk is managed by attempting to match the
maturities and repricing opportunities of assets and liabilities. This may be
done by varying the terms and conditions of the products that are offered to
depositors and borrowers. For example, if many depositors want shorter-term
certificates while most borrowers are requesting longer-term fixed rate loans,
the Company will adjust the interest rates on the certificates and loans to try
to match up demand for similar maturities. The Company can then partially fill
in mismatches by purchasing securities or borrowing funds from the FHLB with the
appropriate maturity or repricing characteristics.
22
Basis Risk
The third interest-related risk, basis risk, arises from the fact that
interest rates rarely change in a parallel or equal manner. The interest rates
associated with the various assets and liabilities differ in how often they
change, the extent to which they change, and whether they change sooner or later
than other interest rates. For example, while the repricing of a specific asset
and a specific liability may occur at roughly the same time, the interest rate
on the liability may rise one percent in response to rising market rates while
the asset increases only one-half percent. While the Company would appear to be
evenly matched with respect to mismatch risk, it would suffer a decrease in net
interest income. This exposure to basis risk is the type of interest risk least
able to be managed, but is also the least dramatic. Avoiding concentration in
only a few types of assets or liabilities is the best means of increasing the
chance that the average interest received and paid will move in tandem. The
wider diversification means that many different rates, each with their own
volatility characteristics, will come into play.
Net Interest Income and Net Economic Value Simulations
To quantify the extent of all of these risks both in its current
position and in transactions it might make in the future, the Company uses
computer modeling to simulate the impact of different interest rate scenarios on
net interest income and on net economic value. Net economic value or the market
value of portfolio equity is defined as the difference between the market value
of financial assets and liabilities. These hypothetical scenarios include both
sudden and gradual interest rate changes, and interest rate changes in both
directions. This modeling is the primary means the Company uses for interest
rate risk management decisions.
The hypothetical impact of sudden interest rate shocks applied to the
Company's asset and liability balances are modeled quarterly. The results of
this modeling indicate how much of the Company's net interest income and net
economic value are "at risk" (deviation from the base level) from various sudden
rate changes. This exercise is valuable in identifying risk exposures. The
results for the Company's most recent simulation analysis indicate that the
Company's net interest income at risk over a one-year period and net economic
value at risk from 2% shocks are within normal expectations for sudden changes
and do not materially differ from those of December 31, 2005.
For this simulation analysis, the Company has made certain assumptions
about the duration of its non-maturity deposits that are important to
determining net economic value at risk.
Financial Condition as of March 31, 2006 As Compared to December 31, 2005
- -------------------------------------------------------------------------
Total assets at March 31, 2006, were $905,604,000, compared to
$918,415,000 at December 31, 2005. Investment securities, interest-bearing
deposits in other financial institutions, and federal funds decreased to
$168,973,000 at March 31, 2006, compared to $172,149,000 at December 31, 2005.
Loans and leases, the Company's major component of earning assets,
increased during the first three months of 2006 to $627,547,000 at March 31,
2006 from $624,512,000 at December 31, 2005. The Company's average loan to
deposit ratio was 85.8% for the quarter ended March 31, 2006 compared to 75.4%
for the same period in 2005.
Total deposits increased to $747,090,000 at March 31, 2006 compared to
$746,690,000 at December 31, 2005. Noninterest-bearing demand deposits increased
$5,570,000 or 3.0% from December 31, 2005, interest-bearing demand deposits
increased $4,665,000 or 2.4%, and certificates of deposits increased $974,000 or
0.6% mostly offset by a decrease in savings and money market accounts of
$10,809,000 or 5.5%. This growth along with a slight decrease in savings and
money markets has continued to have a favorable effect on the Company's interest
expense.
The Company maintains capital to support future growth and dividend
payouts while trying to effectively manage the capital on hand. From the
depositor standpoint, a greater amount of capital on hand relative to total
assets is generally viewed as positive. At the same time, from the standpoint of
the shareholder, a greater amount of capital on hand may not be viewed as
positive because it limits the Company's ability to earn a high rate of return
on stockholders' equity (ROE). Stockholders' equity increased to $73,384,000 as
of March 31, 2006, as compared to $71,801,000 at December 31, 2005. The increase
was due to net income of $2,129,000 and stock option activity of $320,000,
partially offset by cash dividends paid out in the amount of $751,000 and an
increase in unrealized loss on available for sale securities of $115,000. Under
current regulations, management believes that the Company meets all capital
adequacy requirements and North Valley Bank and NVB Business Bank were
considered well capitalized at March 31, 2006 and December 31, 2005.
23
The Company's, North Valley Bank's and NVB Business Bank's capital
amounts and risk-based capital ratios are presented below.
To be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
-------------------------------------------------------------------------------
Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
-------------------------------------------------------------------------------
Company
As of March 31, 2006
Total capital (to risk weighted assets) $ 96,656 12.04% $ 64,223 8.00% N/A N/A
Tier 1 capital (to risk weighted assets) $ 82,982 10.34% $ 32,101 4.00% N/A N/A
Tier 1 capital (to average assets) $ 82,982 9.37% $ 35,425 4.00% N/A N/A
As of December 31, 2005
Total capital (to risk weighted assets) $ 94,473 11.92% $ 63,395 8.00% N/A N/A
Tier 1 capital (to risk weighted assets) $ 80,181 10.12% $ 31,698 4.00% N/A N/A
Tier 1 capital (to average assets) $ 80,181 8.87% $ 36,147 4.00% N/A N/A
North Valley Bank
As of March 31, 2006
Total capital (to risk weighted assets) $ 77,437 11.48% $ 53,949 8.00% $67,436 10.00%
Tier 1 capital (to risk weighted assets) $ 70,950 10.52% $ 26,974 4.00% $40,461 6.00%
Tier 1 capital (to average assets) $ 70,950 9.44% $ 30,061 4.00% $37,577 5.00%
As of December 31, 2005
Total capital (to risk weighted assets) $ 76,647 11.58% $ 52,940 8.00% $66,175 10.00%
Tier 1 capital (to risk weighted assets) $ 70,127 10.60% $ 26,470 4.00% $39,705 6.00%
Tier 1 capital (to average assets) $ 70,127 9.19% $ 30,522 4.00% $38,153 5.00%
NVB Business Bank
As of March 31, 2006
Total capital (to risk weighted assets) $ 15,380 12.01% $ 10,246 8.00% $12,808 10.00%
Tier 1 capital (to risk weighted assets) $ 14,035 10.96% $ 5,123 4.00% $ 7,685 6.00%
Tier 1 capital (to average assets) $ 14,035 10.08% $ 5,569 4.00% $ 6,962 5.00%
As of December 31, 2005
Total capital (to risk weighted assets) $ 15,354 11.02% $ 11,145 8.00% $13,931 10.00%
Tier 1 capital (to risk weighted assets) $ 14,010 10.06% $ 5,572 4.00% $ 8,359 6.00%
Tier 1 capital (to average assets) $ 14,010 9.89% $ 5,669 4.00% $ 7,086 5.00%
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
In management's opinion there has not been a material change in the
Company's market risk profile for the three months ended March 31, 2006 compared
to December 31, 2005. Please see discussion under the caption "Interest Rate
Sensitivity" on page 22.
ITEM 4. CONTROLS AND PROCEDURES
- -------------------------------
Disclosure Controls and Procedures. Disclosure controls and procedures
are designed with the objective of ensuring that information required to be
disclosed in reports filed by the Company under the Exchange Act, such as this
Quarterly Report, is recorded, processed, summarized and reported within the
time periods specified in the rules and forms of the Securities and Exchange
Commission. Disclosure controls and procedures are also designed with the
objective of ensuring that such information is accumulated and communicated to
management, including the Chief Executive Officer and the Chief Financial
Officer, as appropriate to allow timely decisions regarding required disclosure.
Evaluation of Disclosure Controls and Procedures and Internal Control
over Financial Reporting. The Company's management, including the Chief
Executive Officer and the Chief Financial Officer, evaluated the Company's
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Exchange Act) as of March 31, 2006. Based on this evaluation, the Chief
Executive Officer and the Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective. An evaluation of any changes
in the Company's internal control over financial reporting that occurred during
the Company's fiscal quarter ended March 31, 2006 was carried out under the
supervision and with the participation of the Company's Chief Executive Officer,
Chief Financial Officer and other members of the Company's senior management
group. The Company's Chief Executive Officer and Chief Financial Officer
concluded that no change identified in connection with such evaluation has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings
There are no material legal proceedings pending against the Company or
against any of its property. The Company, because of the nature of its business,
is generally subject to various legal actions, threatened or filed, which
involve ordinary, routine litigation incidental to its business. Some of the
pending cases seek punitive damages in addition to other relief. Although the
amount of the ultimate exposure, if any, cannot be determined at this time, the
Company does not expect that the final outcome of threatened or filed suits will
have a materially adverse effect on its consolidated financial position.
Item 1A. Risk Factors
There have been no material changes from risk factors as previously
disclosed by the Company in its response to Item 1A of Part 1 of Form 10-K for
the fiscal year ended December 31, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Period Total Average Price Number of Maximum number
------ Number of Paid per Share Shares of Shares that
Shares -------------- Purchased as May Yet Be
Purchased Part of Purchased
--------- Publicly Under the
Announced Plans Plans or
or Programs Programs
----------- --------
January 1 thru March 31, 2006 0 0 0 54
The above repurchase program was announced on July 28, 2003. The
program calls for the repurchase of up to 3.0% of the Company's outstanding
shares, or 199,154 shares. The repurchases will be made from time to time by the
Company in the open market as conditions allow. All such transactions will be
structured to comply with Securities and Exchange Commission Rule 10b-18 and all
25
shares repurchased under this program will be retired. The number, price and
timing of the repurchases shall be at the Company's sole discretion and the
program may be re-evaluated depending on market conditions, liquidity needs or
other factors. The Board of Directors, based on such re-evaluations, may
suspend, terminate, modify or cancel the program at any time without notice. No
shares were purchased during the quarter ended March 31, 2006. On May 2, 2006,
the Company announced the adoption of a stock purchase program and the press
release describing such program was attached to the Current Report on Form 8-K
filed with the Commission on May 3, 2006. This new program calls for the
repurchase of 4%, or approximately 300,000 shares, of common stock of the
Company, which includes the 54 shares remaining available for purchase under the
previous program (as indicated in the table above), as it has been terminated.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits
None
26
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.
NORTH VALLEY BANCORP
- --------------------
(Registrant)
Date May 9, 2006
-----------
By:
/s/ MICHAEL J. CUSHMAN
- -----------------------------------------------
Michael J. Cushman
President & Chief Executive Officer
(Principal Executive Officer)
/s/ KEVIN R. WATSON
- -----------------------------------------------
Kevin R. Watson
Executive Vice President & Chief Financial Officer
(Principal Financial Officer & Principal Accounting Officer)
27