SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year Commission File Number 0-10661
ended December 31, 2003
TriCo Bancshares
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(Exact name of Registrant as specified in its charter)
California 94-2792841
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
63 Constitution Drive, Chico, California 95973
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:(530) 898-0300
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, without par value
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(Title of Class)
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 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
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Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
YES X NO
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The aggregate market value of the voting common stock held by non-affiliates of
the Registrant, as of February 24, 2004, was approximately $196,167,000. This
computation excludes a total of 2,135,085 shares that are beneficially owned by
the officers and directors of Registrant who may be deemed to be the affiliates
of Registrant under applicable rules of the Securities and Exchange Commission.
The number of shares outstanding of Registrant's common stock, as of February
24, 2004, was 7,780,175 shares of common stock, without par value.
The following documents are incorporated herein by reference into the parts of
Form 10-K indicated: Registrant's Proxy Statement for use in connection with its
2004 Annual Meeting of Shareholders, for Part III.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K.
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TABLE OF CONTENTS
Page Number
PART I
Item 1 Business 2
Item 2 Properties 10
Item 3 Legal Proceedings 10
Item 4 Submission of Matters to a Vote of Security Holders 10
PART II
Item 5 Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Equity Securities 11
Item 6 Selected Financial Data 12
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 7A Quantitative and Qualitative Disclosures About
Market Risk 35
Item 8 Financial Statements and Supplementary Data 36
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 69
Item 9A Controls and Procedures 69
PART III
Item 10 Directors and Executive Officers of the Registrant 70
Item 11 Executive Compensation 70
Item 12 Security Ownership of Certain Beneficial Owners
and Management, and Related Stockholder Matters 70
Item 13 Certain Relationships and Related Transactions 70
Item 14 Principal Accountant Fees and Services 70
PART IV
Item 15 Exhibits, Financial Statement Schedules and Reports
on Form 8-K 70
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements about TriCo
Bancshares (the "Company") for which it claims the protection of the safe harbor
provisions contained in the Private Securities Litigation Reform Act of 1995.
These forward-looking statements are based on Management's current knowledge and
belief and include information concerning the Company's possible or assumed
future financial condition and results of operations. When you see any of the
words "believes", "expects", "anticipates", "estimates", or similar expressions,
mean making forward-looking statements. A number of factors, some of which are
beyond the Company's ability to predict or control, could cause future results
to differ materially from those contemplated. These factors include but are not
limited to:
- a continued slowdown in the national and California economies;
- increased economic uncertainty created by the recent terrorist attacks
on the United States and the actions taken in response;
- the prospect of additional terrorist attacks in the United States and
the uncertain effect of these events on the national and regional
economies;
- changes in the interest rate environment;
- changes in the regulatory environment;
- significantly increasing competitive pressure in the banking industry;
- operational risks including data processing system failures or fraud;
- volatility of rate sensitive deposits; and
- asset/liability matching risks and liquidity risks.
PART I
ITEM 1. BUSINESS
Information About TriCo Bancshares' Business
TriCo Bancshares (the "Company") was incorporated in California on October 13,
1981. It was organized at the direction of the board of directors of Tri
Counties Bank (the "Bank") for the purpose of forming a bank holding company. On
September 7, 1982, the shareholders of Tri Counties Bank became the shareholders
of TriCo and Tri Counties Bank became a wholly owned subsidiary of TriCo. At
that time, TriCo became a bank holding company subject to the supervision of the
Federal Reserve under the Bank Holding Company Act of 1956, as amended. Tri
Counties Bank remains subject to the supervision of the California Department of
Financial Institutions and the FDIC. On July 31, 2003, the Company formed a
subsidiary business trust, TriCo Capital Trust I, to issue trust preferred
securities. Tri Counties Bank and TriCo Capital Trust I currently are the only
subsidiaries of TriCo and TriCo is not conducting any business operations
independent of Tri Counties Bank and TriCo Capital Trust I.
For financial reporting purposes, the financial statements of the Bank are
consolidated into the financial statements of the Company. Historically, issuer
trusts, such as TriCo Capital Trust, that issued trust preferred securities have
been consolidated by their parent companies and trust preferred securities have
been treated as eligible for Tier 1 capital treatment by bank holding companies
under Federal Reserve rules and regulations relating to minority interests in
equity accounts of consolidated subsidiaries. Applying the provisions of the
Financial Accounting Standards Board Revised Interpretation No. 46 (FIN 46R),
the Company is no longer permitted to consolidate the issuer trusts, beginning
on December 31, 2003. Although the Federal Reserve has stated in its July 2,
2003 Supervisory Letter that trust preferred securities will be treated as Tier
1 capital until notice is given to the contrary, the Supervisory Letter also
indicates that the Federal Reserve will review the regulatory implications of
any accounting treatment changes and will provide further guidance if necessary
or warranted.
On April 4, 2003, TriCo Bancshares acquired North State National Bank, a
national banking organization located in Chico, California, by the merger of
North State into its wholly owned subsidiary, Tri Counties Bank. The acquisition
and the related merger agreement dated October 3, 2002, was approved by the
California Department of Financial Institutions, the Federal Deposit Insurance
Corporation, and the shareholders of North State National Bank on March 4, March
7, and March 19, 2003, respectively. At the time of the acquisition, North State
had total assets of $140 million, investment securities of $41 million, loans of
$76 million, and deposits of $126 million. The acquisition was accounted for
using the purchase method of accounting. The amount of goodwill recorded as of
the merger date, which represented the excess of the total purchase price over
the estimated fair value of net assets acquired, was approximately $15.5
million. The Company recorded a core deposit intangible, which represents the
excess of the fair value of North State's deposits over their book value on the
acquisition date, of approximately $3.4 million. This core deposit intangible is
scheduled to be amortized over a seven-year average life.
Under the terms of the merger agreement, TriCo paid $13,090,057 in cash, issued
723,512 shares of TriCo common stock, and issued options to purchase 79,587
shares of TriCo common stock at an average exercise price of $6.22 per share in
exchange for all of the 1,234,375 common shares and options to purchase 79,937
common shares of North State National Bank outstanding as of April 4, 2003.
Additional information concerning the Company can be found on our website at
www.tcbk.com. Copies of our annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and amendments to these reports are
available free of charge through our website at Investor Information---"SEC
Filings" and "Annual Reports" as soon as reasonably practicable after the
Company files these reports to the Securities and Exchange Commission.
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Business of Tri Counties Bank
Tri Counties Bank was incorporated as a California banking corporation on June
26, 1974, and received its certificate of authority to begin banking operations
on March 11, 1975. Tri Counties Bank engages in the general commercial banking
business in the California counties of Butte, Contra Costa, Del Norte, Fresno,
Glenn, Kern, Lake, Lassen, Madera, Mendocino, Merced, Nevada, Placer,
Sacramento, Shasta, Siskiyou, Stanislaus, Sutter, Tehama, Tulare and Yuba. Tri
Counties Bank currently has 33 traditional branches and 12 in-store branches.
General Banking Services
The Bank conducts a commercial banking business including accepting demand,
savings and time deposits and making commercial, real estate, and consumer
loans. It also offers installment note collection, issues cashier's checks and
money orders, sells travelers checks and provides safe deposit boxes and other
customary banking services. Brokerage services are provided at the Bank's
offices by the Bank's association with Raymond James Financial Services, Inc.
The Bank does not offer trust services or international banking services.
The Bank has emphasized retail banking since it opened. Most of the Bank's
customers are retail customers and small to medium-sized businesses. The Bank
emphasizes serving the needs of local businesses, farmers and ranchers, retired
individuals and wage earners. The majority of the Bank's loans are direct loans
made to individuals and businesses in the regions of California where its
branches are located. At December 31, 2003, the total of the Bank's consumer
installment loans outstanding was $319,029,000 (32.5%), the total of commercial
loans outstanding was $142,252,000 (14.5%), and the total of real estate loans
including construction loans of $61,591,000 was $519,960,000 (53.0%). The Bank
takes real estate, listed and unlisted securities, savings and time deposits,
automobiles, machinery, equipment, inventory, accounts receivable and notes
receivable secured by property as collateral for loans.
Most of the Bank's deposits are attracted from individuals and business-related
sources. No single person or group of persons provides a material portion of the
Bank's deposits, the loss of any one or more of which would have a materially
adverse effect on the business of the Bank, nor is a material portion of the
Bank's loans concentrated within a single industry or group of related
industries.
In order to attract loan and deposit business from individuals and small to
medium-sized businesses, branches of the Bank set lobby hours to accommodate
local demands. In general, lobby hours are from 9:00 a.m. to 5:00 p.m. Monday
through Thursday, and from 9:00 a.m. to 6:00 p.m. on Friday. Certain branches
with less activity open later and close earlier. Some Bank offices also utilize
drive-up facilities operating from 9:00 a.m. to 7:00 p.m. The supermarket
branches are open from 9:00 a.m. to 7:00 p.m. Monday through Saturday and 11:00
a.m. to 5:00 p.m. on Sunday.
The Bank offers 24-hour ATMs at almost all branch locations. The ATMs are linked
to several national and regional networks such as CIRRUS and STAR. In addition,
banking by telephone on a 24-hour toll-free number is available to all
customers. This service allows a customer to obtain account balances and most
recent transactions, transfer moneys between accounts, make loan payments, and
obtain interest rate information.
In February 1998, the Bank became the first bank in the Northern Sacramento
Valley to offer banking services on the Internet. This banking service provides
customers one more tool for anywhere, anytime access to their accounts.
Other Activities
The Bank may in the future engage in other businesses either directly or
indirectly through subsidiaries acquired or formed by the Bank subject to
regulatory constraints. See "Regulation and Supervision."
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Employees
At December 31, 2003, the Company and the Bank employed 610 persons, including
five executive officers. Full time equivalent employees were 532. No employees
of the Company or the Bank are presently represented by a union or covered under
a collective bargaining agreement. Management believes that its employee
relations are excellent.
Competition
The banking business in California generally, and in the Bank's primary service
area of Northern and Central California specifically, is highly competitive with
respect to both loans and deposits. It is dominated by a relatively small number
of major banks with many offices operating over a wide geographic area. Among
the advantages such major banks have over the Bank is their ability to finance
wide ranging advertising campaigns and to allocate their investment assets to
regions of high yield and demand. By virtue of their greater total
capitalization such institutions have substantially higher lending limits than
does the Bank.
In addition to competing with savings institutions, commercial banks compete
with other financial markets for funds. Yields on corporate and government debt
securities and other commercial paper may be higher than on deposits, and
therefore affect the ability of commercial banks to attract and hold deposits.
Commercial banks also compete for available funds with money market instruments
and mutual funds. During past periods of high interest rates, money market funds
have provided substantial competition to banks for deposits and they may
continue to do so in the future. Mutual funds are also a major source of
competition for savings dollars.
The Bank relies substantially on local promotional activity, personal contacts
by its officers, directors, employees and shareholders, extended hours,
personalized service and its reputation in the communities it services to
compete effectively.
Regulation and Supervision
As a consequence of the extensive regulation of commercial banking activities in
California and the United States, the business of the Company and the Bank are
particularly susceptible to changes in state and federal legislation and
regulations, which may have the effect of increasing the cost of doing business,
limiting permissible activities or increasing competition. Following is a
summary of some of the laws and regulations which effect their business. This
summary should be read with the management's discussion and analysis of
financial condition and results of operation included at Item 7 of this report.
As a registered bank holding company under the Bank Holding Company Act of 1956
(the "BHC Act"), the Company is subject to the regulation and supervision of the
Board of Governors of the Federal Reserve System ("FRB"). The BHC Act requires
the Company to file reports with the FRB and provide additional information
requested by the FRB. The Company must receive the approval of the FRB before it
may acquire all or substantially all of the assets of any bank, or ownership or
control of the voting shares of any bank if, after giving effect to such
acquisition of shares, the Company would own or control more than 5 percent of
the voting shares of such bank.
The Company and any subsidiaries it may acquire or organize will be deemed to be
affiliates of the Bank within the Federal Reserve Act. That Act establishes
certain restrictions, which limit the extent to which the Bank can supply its
funds to the Company and other affiliates. The Company is also subject to
restrictions on the underwriting and the public sale and distribution of
securities. It is prohibited from engaging in certain tie-in arrangements in
connection with any extension of credit, sale or lease of property, or
furnishing of services.
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The Company is generally prohibited from engaging in, or acquiring direct or
indirect control of any company engaged in non-banking activities, unless the
FRB by order or regulation has found such activities to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
Notwithstanding this prohibition, under the Financial Services Modernization Act
of 1999, the Company may engage in any activity, and may acquire and retain the
shares of any company engaged in any activity, that the FRB, in coordination
with the Secretary of the Treasury, determines (by regulation or order) to be
financial in nature or incidental to such financial activities. Furthermore,
such law dictates several activities that are considered to be financial in
nature, and therefore are not subject to FRB approval.
The Bank, as a state-chartered bank, is subject to regulation, supervision and
regular examination by the California Department of Financial Institutions
("DFI") and is also subject to the regulations of the FDIC. Federal and
California statutes and regulations relate to many aspects of the Bank's
operations, some of which are described below. The DFI regulates the number and
location of branch offices and may permit a bank to maintain branches only to
the extent allowable under state law for state banks. California law presently
permits a bank to locate a branch in any locality in California.
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act was enacted in 1999 and became effective in 2000. The
act is a financial modernization law that is the result of a decade of debate in
the Congress regarding a fundamental reformation of the nation's financial
system. The law is subdivided into seven titles, by functional area. Title I
acts to facilitate affiliations among banks, insurance companies and securities
firms. Title II narrows the exemptions from the securities laws previously
enjoyed by banks, requires the Federal Reserve and the SEC to work together to
draft rules governing certain securities activities of banks and creates a new,
voluntary investment bank holding company. Title III restates the proposition
that the states are the functional regulators for all insurance activities,
including the insurance activities by depository institutions. The law
encourages the states to develop uniform or reciprocal rules for the licensing
of insurance agents. Title IV prohibits the creation of additional unitary
thrift holding companies. Title V imposes significant requirements on financial
institutions related to the transfer of nonpublic personal information. These
provisions require each institution to develop and distribute to accountholders
an information disclosure policy, and requires that the policy allow customers
to, and for the institution to honor a customer's request to, "opt-out" of the
proposed transfer of specified nonpublic information to third parties. Title VI
reforms the Federal Home Loan Bank system to allow broader access among
depository institutions to the systems advance programs, and to improve the
corporate governance and capital maintenance requirements for the system. Title
VII addresses a multitude of issues including disclosure of ATM surcharging
practices, disclosure of agreements among non-governmental entities and insured
depository institutions which donate to non-governmental entities regarding
donations made in connection with the Community Reinvestment Act and disclosure
by the recipient non-governmental entities of how such funds are used.
Additionally, the law extends the period of time between Community Reinvestment
Act examinations of community banks.
The Company has undertaken efforts to comply with all provisions of the
Gramm-Leach-Bliley Act and all implementing regulations, including the
development of appropriate policies and procedures to meet their
responsibilities in connection with the privacy provisions of Title V of that
act.
Safety and Soundness Standards
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
implemented certain specific restrictions on transactions and required the
regulators to adopt overall safety and soundness standards for depository
institutions related to internal control, loan underwriting and documentation,
and asset growth. Among other things, FDICIA limits the interest rates paid on
deposits by undercapitalized institutions, the use of brokered deposits and the
aggregate extension of credit by a depository institution to an executive
officer, director, principal stockholder or related interest, and reduces
deposit insurance coverage for deposits offered by undercapitalized institutions
for deposits by certain employee benefits accounts.
-5-
The federal financial institution agencies published a final rule effective on
August 9, 1995, implementing safety and soundness standards. The FDICIA added a
new Section 39 to the Federal Deposit Insurance Act which required the agencies
to establish safety and soundness standards for insured financial institutions
covering:
- internal controls, information systems and internal audit systems;
- loan documentation;
- credit underwriting;
- interest rate exposure;
- asset growth;
- compensation, fees and benefits;
- asset quality, earnings and stock valuation; and
- excessive compensation for executive officers, directors or principal
shareholders which could lead to material financial loss.
The agencies issued the final rule in the form of guidelines only for
operational, managerial and compensation standards and reissued for comment
proposed standards related to asset quality and earnings which are less
restrictive than the earlier proposal in November 1993. Unlike the earlier
proposal, the guidelines under the final rule do not apply to depository
institution holding companies and the stock valuation standard was eliminated.
If an agency determines that an institution fails to meet any standard
established by the guidelines, the agency may require the financial institution
to submit to the agency an acceptable plan to achieve compliance with the
standard. If the agency requires submission of a compliance plan and the
institution fails to timely submit an acceptable plan or to implement an
accepted plan, the agency must require the institution to correct the
deficiency. Under the final rule, an institution must file a compliance plan
within 30 days of a request to do so from the institution's primary federal
regulatory agency. The agencies may elect to initiate enforcement action in
certain cases rather than rely on an existing plan particularly where failure to
meet one or more of the standards could threaten the safe and sound operation of
the institution.
Restrictions on Dividends and Other Distributions
The power of the board of directors of an insured depository institution to
declare a cash dividend or other distribution with respect to capital is subject
to statutory and regulatory restrictions which limit the amount available for
such distribution depending upon the earnings, financial condition and cash
needs of the institution, as well as general business conditions. FDICIA
prohibits insured depository institutions from paying management fees to any
controlling persons or, with certain limited exceptions, making capital
distributions, including dividends, if, after such transaction, the institution
would be undercapitalized. Additionally, under FDICIA, a bank may not make any
capital distribution, including the payment of dividends, if after making such
distribution the bank would be in any of the "under-capitalized" categories
under the FDIC's Prompt Corrective Action regulations.
Under the Financial Institution's Supervisory Act, the FDIC also has the
authority to prohibit a bank from engaging in business practices that the FDIC
considers to be unsafe or unsound. It is possible, depending upon the financial
condition of a bank and other factors that the FDIC could assert that the
payment of dividends or other payments in some circumstances might be such an
unsafe or unsound practice and thereby prohibit such payment.
Under California law, dividends and other distributions by the Company are
subject to declaration by the board of directors at its discretion out of net
assets. Dividends cannot be declared and paid when such payment would make the
Company insolvent. Federal Reserve policy prohibits a bank holding company from
declaring or paying a cash dividend which would impose undue pressure on the
capital of subsidiary banks or would be funded only through borrowings or other
arrangements that might adversely affect the holding company's financial
position. The policy further declares that a bank holding company should not
continue its existing rate of cash dividends on its common stock unless its net
income is sufficient to fully fund each dividend and its prospective rate of
earnings retention appears consistent with its capital needs, asset quality and
overall financial condition. Other Federal Reserve policies forbid the payment
by bank subsidiaries to their parent companies of management fees, which are
unreasonable in amount or exceed a fair market value of the services rendered
(or, if no market exists, actual costs plus a reasonable profit).
In addition, the Federal Reserve has authority to prohibit banks that it
regulates from engaging in practices, which in the opinion of the Federal
Reserve are unsafe or unsound. Such practices may include the payment of
dividends under some circumstances. Moreover, the payment of dividends may be
inconsistent with capital adequacy guidelines. The Company may be subject to
assessment to restore the capital of the Bank should it become impaired.
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Consumer Protection Laws and Regulations
The bank regulatory agencies are focusing greater attention on compliance with
consumer protection laws and their implementing regulations. Examination and
enforcement have become more intense in nature, and insured institutions have
been advised to monitor carefully compliance with such laws and regulations. The
Company is subject to many federal consumer protection statues and regulations,
some of which are discussed below.
The Community Reinvestment Act is intended to encourage insured depository
institutions, while operating safely and soundly, to help meet the credit needs
of their communities. This act specifically directs the federal regulatory
agencies to assess a bank's record of helping meet the credit needs of its
entire community, including low- and moderate-income neighborhoods, consistent
with safe and sound practices. This act further requires the agencies to take a
financial institution's record of meeting its community credit needs into
account when evaluating applications for, among other things, domestic branches,
mergers or acquisitions, or holding company formations. The agencies use the
Community Reinvestment Act assessment factors in order to provide a rating to
the financial institution. The ratings range from a high of "outstanding" to a
low of "substantial noncompliance."
The Equal Credit Opportunity Act generally prohibits discrimination in any
credit transaction, whether for consumer or business purposes, on the basis of
race, color, religion, national origin, sex, marital status, age (except in
limited circumstances), receipt of income from public assistance programs, or
good faith exercise of any rights under the Consumer Credit Protection Act. The
Truth-in-Lending Act is designed to ensure that credit terms are disclosed in a
meaningful way so that consumers may compare credit terms more readily and
knowledgeably. As a result of the such act, all creditors must use the same
credit terminology to express rates and payments, including the annual
percentage rate, the finance charge, the amount financed, the total payments and
the payment schedule, among other things.
The Fair Housing Act regulates many practices, including making it unlawful for
any lender to discriminate in its housing-related lending activities against any
person because of race, color, religion, national origin, sex, handicap or
familial status. A number of lending practices have been found by the courts to
be, or may be considered, illegal under this Act, including some that are not
specifically mentioned in the Act itself. The Home Mortgage Disclosure Act grew
out of public concern over credit shortages in certain urban neighborhoods and
provides public information that will help show whether financial institutions
are serving the housing credit needs of the neighborhoods and communities in
which they are located. This act also includes a "fair lending" aspect that
requires the collection and disclosure of data about applicant and borrower
characteristics as a way of identifying possible discriminatory lending patterns
and enforcing anti-discrimination statutes.
Finally, the Real Estate Settlement Procedures Act requires lenders to provide
borrowers with disclosures regarding the nature and cost of real estate
settlements. Also, this act prohibits certain abusive practices, such as
kickbacks, and places limitations on the amount of escrow accounts.
Penalties under the above laws may include fines, reimbursements and other
penalties. Due to heightened regulatory concern related to compliance with these
acts generally, the Company may incur additional compliance costs or be required
to expend additional funds for investments in their local community.
-7-
USA Patriot Act of 2001
The USA Patriot Act was enacted in 2001 in response to the terrorist attacks in
New York, Pennsylvania and Washington, D.C. on September 11, 2001. The Patriot
Act is intended to strengthen U.S. law enforcement and the intelligence
communities' ability to work together to combat terrorism on a variety of
levels. The potential impact of the Patriot Act on financial institutions is
significant and wide ranging. The Patriot Act contains sweeping anti-money
laundering and financial transparency laws and requires various regulations,
including:
- Due diligence requirements for financial institutions that administer,
maintain, or manage private bank accounts or correspondent accounts for
non-U.S. persons;
- Standards for verifying customer identification at account opening;
- Rules to promote cooperation among financial institutions, regulators,
and law enforcement entities to assist in the identification of parties
that may be involved in terrorism or money laundering;
- Reports to be filed by non-financial trades and business with the
Treasury Department's Financial Crimes Enforcement Network for
transactions exceeding $10,000; and
- The filing of suspicious activities reports by securities brokers and
dealers if they believe a customer may be violating U.S. laws and
regulations.
Capital Requirements
Federal regulation imposes upon all financial institutions a variable system of
risk-based capital guidelines designed to make capital requirements sensitive to
differences in risk profiles among banking organizations, to take into account
off-balance sheet exposures and to promote uniformity in the definition of bank
capital uniform nationally.
The Bank and the Company are subject to the minimum capital requirements of the
FDIC, and the Federal Reserve, respectively. As a result of these requirements,
the growth in assets is limited by the amount of its capital accounts as defined
by the respective regulatory agency. Capital requirements may have an effect on
profitability and the payment of dividends on the common stock of the Bank and
the Company. If an entity is unable to increase its assets without violating the
minimum capital requirements or is forced to reduce assets, its ability to
generate earnings would be reduced.
The Federal Reserve, and the FDIC have adopted guidelines utilizing a risk-based
capital structure. Qualifying capital is divided into two tiers. Tier 1 capital
consists generally of common stockholders' equity, qualifying noncumulative
perpetual preferred stock, qualifying cumulative perpetual preferred stock (up
to 25% of total Tier 1 capital) and minority interests in the equity accounts of
consolidated subsidiaries, less goodwill and certain other intangible assets.
Tier 2 capital consists of, among other things, allowance for loan and lease
losses up to 1.25% of weighted risk assets, perpetual preferred stock, hybrid
capital instruments, perpetual debt, mandatory convertible debt securities,
subordinated debt and intermediate-term preferred stock. Tier 2 capital
qualifies as part of total capital up to a maximum of 100% of Tier 1 capital.
Amounts in excess of these limits may be issued but are not included in the
calculation of risk-based capital ratios. Under these risk-based capital
guidelines, the Bank and the Company are required to maintain capital equal to
at least 8% of its assets, of which at least 4% must be in the form of Tier 1
capital.
The guidelines also require the Company and the Bank to maintain a minimum
leverage ratio of 4% of Tier 1 capital to total assets (the "leverage ratio").
The leverage ratio is determined by dividing an institution's Tier 1 capital by
its quarterly average total assets, less goodwill and certain other intangible
assets. The leverage ratio constitutes a minimum requirement for the most
well-run banking organizations. See Note 21 in the financial statements at Item
8 of this report for a discussion about the Company's risk-based capital ratios.
Prompt Corrective Action
Prompt Corrective Action Regulations of the federal bank regulatory agencies
establish five capital categories in descending order (well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized and
critically undercapitalized), assignment to which depends upon the institution's
total risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage
ratio. Institutions classified in one of the three undercapitalized categories
are subject to certain mandatory and discretionary supervisory actions, which
include increased monitoring and review, implementation of capital restoration
plans, asset growth restrictions, limitations upon expansion and new business
activities, requirements to augment capital, restrictions upon deposit gathering
and interest rates, replacement of senior executive officers and directors, and
requiring divestiture or sale of the institution. Both the Company and the Bank
have been classified as a well-capitalized bank since adoption of these
regulations.
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Impact of Monetary Policies
Banking is a business that depends on interest rate differentials. In general,
the difference between the interest paid by a bank on its deposits and other
borrowings, and the interest rate earned by banks on loans, securities and other
interest-earning assets comprises the major source of banks' earnings. Thus, the
earnings and growth of banks are subject to the influence of economic conditions
generally, both domestic and foreign, and also to the monetary and fiscal
policies of the United States and its agencies, particularly the Federal
Reserve. The Federal Reserve implements national monetary policy, such as
seeking to curb inflation and combat recession, by its open-market dealings in
United States government securities, by adjusting the required level of reserves
for financial institutions subject to reserve requirements and through
adjustments to the discount rate applicable to borrowings by banks which are
members of the Federal Reserve. The actions of the Federal Reserve in these
areas influence the growth of bank loans, investments and deposits and also
affect interest rates. The nature and timing of any future changes in such
policies and their impact on the Company cannot be predicted. In addition,
adverse economic conditions could make a higher provision for loan losses a
prudent course and could cause higher loan loss charge-offs, thus adversely
affecting the Company's net earnings.
Insurance of Deposits
The Bank's deposit accounts are insured up to a maximum of $100,000 per
depositor by the FDIC. The FDIC issues regulations and generally supervises the
operations of its insured banks. This supervision and regulation is intended
primarily for the protection of depositors, not shareholders.
As of December 31, 2003, the deposit insurance premium rate was $0.0154 per
$100.00 in deposits. In November 1990, federal legislation was passed which
removed the cap on the amount of deposit insurance premiums that can be charged
by the FDIC. Under this legislation, the FDIC is able to increase deposit
insurance premiums as it sees fit. This could result in a significant increase
in the cost of doing business for the Bank in the future. The FDIC now has
authority to adjust deposit insurance premiums paid by insured banks every six
months.
Securities Laws
The Company is subject to the periodic reporting requirements of the Securities
and Exchange Act of 1934, as amended, which include filing annual, quarterly and
other current reports with the Securities and Exchange Commission.
The Sarbanes-Oxley Act was enacted in 2002 to protect investors by improving the
accuracy and reliability of corporate disclosures made pursuant to securities
laws. Among other things, this act:
- Prohibits a registered public accounting firm from performing specified
nonaudit services contemporaneously with a mandatory audit;
- Requires thechief executive officer and chief financial officer of an
issuer to certify each annual or quarterly report filed with the
Securities and Exchange Commission;
- Requires an issuer to disclose all material off-balance sheet
transactions that may have a material effect on an issuer's financial
status; and
- Prohibits insider transactions in an issuer's stock during lock-out
periods of an issuer's pension plans.
The Company is also required to comply with the rules and regulations of the
Nasdaq Stock Market, Inc.
-9-
ITEM 2. PROPERTIES
The Company is engaged in the banking business through 45 offices in 21 counties
in Northern and Central California including nine offices in Butte County, eight
in Shasta County, three each in Sacramento and Siskiyou Counties, two each in
Glenn, Sutter, Lassen, Yuba, and Stanislaus Counties, and one each in Madera,
Merced, Lake, Mendocino, Del Norte, Tehama, Nevada, Contra Costa, Kern, Tulare,
Placer and Fresno Counties. All offices are constructed and equipped to meet
prescribed security requirements.
The Company owns 17 branch office locations and one administrative building and
leases 28 branch office locations and 5 administrative facilities. Most of the
leases contain multiple renewal options and provisions for rental increases,
principally for changes in the cost of living index, property taxes and
maintenance.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor its subsidiaries, are party to any material pending
legal proceeding, nor is their property the subject of any material pending
legal proceeding, except routine legal proceedings arising in the ordinary
course of their business. None of these proceedings is expected to have a
material adverse impact upon the Company's business, financial position or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the shareholders during the fourth
quarter of 2003.
-10-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock is traded on the NASDAQ National Market System
("NASDAQ") under the symbol "TCBK." The following table shows the high and the
low prices for the common stock, for each quarter in the past two years, as
reported by NASDAQ:
2003: High Low
First quarter $26.77 $24.31
Second quarter $26.00 $24.10
Third quarter $29.87 $25.20
Fourth quarter $34.18 $29.81
2002:
First quarter $21.05 $18.05
Second quarter $27.40 $21.10
Third quarter $27.45 $21.60
Fourth quarter $25.25 $22.01
As of February 24, 2004 there were approximately 1,817 shareholders of record of
the Company's common stock.
Effective April 4, 2003, the Company (i) issued 723,512 shares of its common
stock pursuant to a registration statement on Form S-4, (ii) issued options to
purchase 79,587 shares of its common stock, and (iii) paid $13,090,057 in cash
to the former shareholders of North State National Bank. Additional information
concerning this acquisition is found under Item 1 of this report.
The Company has paid cash dividends on its common stock in every quarter since
March 1990, and it is currently the intention of the Board of Directors of the
Company to continue payment of cash dividends on a quarterly basis. There is no
assurance, however, that any dividends will be paid since they are dependent
upon earnings, financial condition and capital requirements of the Company and
the Bank. As of December 31, 2003, $23.9 million was available for payment of
dividends by the Company to its shareholders, under applicable laws and
regulations. The Company paid cash dividends of $0.20 per common share in each
of the quarters ended March 31, June 30, September 30, and December 31, 2003 and
2002.
As discussed in Note 10 to the consolidated financial statements included as
Item 8 of this report, in June 2001, the Company announced that its Board of
Directors adopted and entered into a Shareholder Rights Plan designed to protect
and maximize shareholder value and to assist the Board of Directors in ensuring
fair and equitable benefit to all shareholders in the event of a hostile bid to
acquire the Company.
The Company adopted a new stock repurchase plan on July 31, 2003 for the
repurchase of up to 250,000 shares of the Company's common stock from time to
time as market conditions allow. The 250,000 shares authorized for repurchase
under this plan represented approximately 3.2% of the Company's approximately
7,852,000 common shares outstanding as of July 31, 2003. This new plan has no
stated expiration date for the repurchases. As of December 31, 2003, the Company
had purchased 27,500 shares under this plan. The following table shows the
repurchases made by the Company under this plan during the fourth quarter of
2003:
Period (a) Total number (b) Average price (c) Total number of (d) Maximum number
of Shares purchased paid per share shares purchased as of shares that may yet
part of publicly be purchased under the
announced plans or plans or programs
programs
- -----------------------------------------------------------------------------------------------------
Oct. 1-31, 2003 - - - 241,900
Nov. 1-30, 2003 1,700 $32.00 1,700 240,200
Dec. 1-31, 2003 17,700 $32.22 17,700 222,500
-11-
ITEM 6. SELECTED FINANCIAL DATA
TRICO BANCSHARES
Financial Summary
(in thousands, except per share amounts)
=========================================================================================================
Year ended December 31, 2003 2002 2001 2000 1999
- ---------------------------------------------------------------------------------------------------------
Interest income $73,969 $64,696 $71,998 $76,327 $67,808
Interest expense 13,089 12,914 23,486 28,543 24,370
- ---------------------------------------------------------------------------------------------------------
Net interest income 60,880 51,782 48,512 47,784 43,438
Provision for loan losses 1,250 2,800 4,400 5,000 3,550
Noninterest income 22,909 19,180 16,238 14,922 12,775
Noninterest expense 55,527 45,971 40,607 37,846 34,726
- ---------------------------------------------------------------------------------------------------------
Income before income taxes 27,012 22,191 19,743 19,860 17,937
Provision for income taxes 10,124 8,122 7,324 7,237 6,534
- ---------------------------------------------------------------------------------------------------------
Net income $16,888 $14,069 $12,419 $12,623 $11,403
- ---------------------------------------------------------------------------------------------------------
Earnings per share:
Basic $2.21 $2.00 $1.76 $1.76 $1.60
Diluted 2.14 1.96 1.72 1.72 1.56
Per share:
Dividends paid $0.80 $0.80 $0.80 $0.79 $0.70
Book value at December 31 16.33 14.02 12.42 11.87 10.22
Tangible book value at December 31 13.58 13.45 11.69 11.11 9.32
Average common shares outstanding 7,641 7,019 7,073 7,192 7,130
Average diluted common shares outstanding 7,879 7,193 7,219 7,341 7,319
Shares outstanding at December 31 7,834 7,061 7,001 7,181 7,152
At December 31:
Loans, net $967,468 $673,145 $645,674 $628,721 $576,942
Total assets 1,468,755 1,144,574 1,005,447 972,071 924,796
Total deposits 1,236,823 1,005,237 880,393 837,832 794,110
Debt financing and notes payable 22,887 22,924 22,956 33,983 45,505
Junior subordinated debt 20,619 - - - -
Shareholders' equity 127,960 99,014 86,933 85,233 73,123
Financial Ratios:
For the year:
Return on assets 1.27% 1.35% 1.27% 1.35% 1.26%
Return on equity 14.24% 15.03% 14.19% 16.03% 15.59%
Net interest margin1 5.23% 5.61% 5.58% 5.70% 5.40%
Net loan losses to average loans 0.34% 0.22% 0.47% 0.70% 0.13%
Efficiency ratio1 65.39% 63.66% 61.62% 59.25% 60.53%
Average equity to average assets 8.91% 9.00% 8.94% 8.40% 8.09%
At December 31:
Equity to assets 8.71% 8.65% 8.65% 8.77% 7.91%
Total capital to risk-adjusted assets 11.56% 11.97% 11.68% 12.20% 11.77%
Allowance for loan losses to loans 1.40% 2.09% 1.98% 1.82% 1.88%
1 Fully taxable equivalent
-12-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company's discussion and analysis of its financial condition and results of
operations is intended to provide a better understanding of the significant
changes and trends relating to the Company's financial condition, results of
operations, liquidity and interest rate sensitivity. The following discussion is
based on the Company's consolidated financial statements which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. Please read the Company's audited consolidated
financial statements and the related notes included as Item 8 of this report.
Critical Accounting Policies and Estimates
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, the Company evaluates
its estimates, including those that materially affect the financial statements
and are related to the adequacy of the allowance for loan losses, investments,
mortgage servicing rights, and intangible assets. The Company bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. The Company's
policies related to estimates on the allowance for loan losses, other than
temporary impairment of investments and impairment of intangible assets can be
found in Note 1 to the Company's audited consolidated financial statements and
the related notes included as Item 8 of this report.
As the Company has not commenced any business operations independent of the
Bank, the following discussion pertains primarily to the Bank. Average balances,
including balances used in calculating certain financial ratios, are generally
comprised of average daily balances for the Company. Within Management's
Discussion and Analysis of Financial Condition and Results of Operations,
interest income and net interest income are generally presented on a fully
tax-equivalent (FTE) basis.
The following discussion and analysis is designed to provide a better
understanding of the significant changes and trends related to the Company and
the Bank's financial condition, operating results, asset and liability
management, liquidity and capital resources and should be read in conjunction
with the consolidated financial statements of the Company and the related notes
at Item 8 of this report.
-13-
Net Income
Following is a summary of the Company's net income for the past three years
(dollars in thousands, except per share amounts):
Components of Net Income
- -----------------------------------------------------------------------------
Year ended December 31, 2003 2002 2001
-------------------------------
Net interest income * $62,005 $53,029 $49,666
Provision for loan losses (1,250) (2,800) (4,400)
Noninterest income 22,909 19,180 16,238
Noninterest expense (55,527) (45,971) (40,607)
Taxes * (11,249) (9,369) (8,478)
-------------------------------
$16,888 $14,069 $12,419
===============================
Net income per average fully-diluted share $2.14 $1.96 $1.72
Net income as a percentage of average
shareholders' equity 14.24% 15.03% 14.19%
Net income as a percentage of average
total assets 1.27% 1.35% 1.27%
=============================================================================
* Fully tax-equivalent (FTE)
Earnings in 2003 increased $2.8 million (20.0%) from 2002. Net interest income
(FTE) grew $9.0 million (16.9%) due to a $239.1 million (25.3%) increase in
average earning assets that was partially offset by a net interest margin that
fell 38 basis points. The loan loss provision was reduced by $1.6 million in
2003 from 2002, and noninterest income increased $3.7 million (19.4%) while
noninterest expense also increased $9.6 million (20.8%).
The Company achieved earnings of $14.1 million in 2002, representing a 13.7%
increase from the $12.4 million earned in 2001, which was down 1.6% from 2000
earnings of $12.6 million. Net interest income on a fully tax-equivalent basis
for 2002 increased $3.4 million (6.8%) compared to 2001. Higher average balances
of interest earning assets added $4.4 million to net interest income on a fully
tax-equivalent basis, while changes in interest rates reduced net interest
income on a fully tax-equivalent basis by $1.0 million. The loan loss provision
was reduced by $1.6 million (36.4%), and noninterest income grew $2.9 million
(18.1%). Partially offsetting this higher revenue, noninterest expense expanded
$5.4 million (13.2%).
The Company's return on average total assets was 1.27% in 2003, compared to
1.35% and 1.27% in 2002 and 2001, respectively. Return on average equity in 2003
was 14.24%, compared to 15.03% in 2002 and 14.19% percent in 2001.
Net Interest Income
The Company's primary source of revenue is net interest income, which is the
difference between interest income on earning assets and interest expense on
interest-bearing liabilities. Net interest income (FTE) increased $9.0 million
(17.0%) to $62.0 million from 2002 to 2003. Net interest income (FTE) increased
$3.4 million (6.8%) from 2001 to $53.0 million in 2002.
Following is a summary of the Company's net interest income for the past three
years (dollars in thousands):
Components of Net Interest Income
-----------------------------------------------------------------
Year ended December 31, 2003 2002 2001
-------------------------------
Interest income $73,969 $64,696 $71,998
Interest expense (13,089) (12,914) (23,486)
FTE adjustment 1,125 1,247 1,154
-------------------------------
Net interest income (FTE) $62,005 $53,029 $49,666
=================================================================
Net interest margin (FTE) 5.23% 5.61% 5.58%
=================================================================
-14-
Interest income (FTE) increased $9.2 million (13.9%) from $65.9 million in 2002
to $75.1 million in 2003, due to increased volume of earning assets that was
partially offset by lower yields on earning assets. During 2003, the average
balance of loans and investment securities grew $167.0 million (25.3%) and $97.2
million (39.2%), respectively, while the average balance of federal funds sold
declined $25.1 million (68.5%). Yields on loans and investment securities fell
to 7.37% and 4.05%, respectively, in 2003 from 7.94% and 5.19%, respectively, in
2002. Overall, the yield on the Company's earning assets decreased from 6.98% in
2002 to 6.34% in 2003. The decrease in average yield on interest-earning assets
reduced interest income (FTE) by $8.7 million, while a net increase of $239.1
million (25.3%) in average balances of interest earning assets added $17.9
million to interest income (FTE) during 2003.
Interest expense increased $0.2 million (1.4%) in 2003 due to a $195.4 million
(26.2%) increase in average balance of interest-bearing liabilities that was
offset by a 34 basis point decrease in the average rate paid on interest-bearing
liabilities from 1.73% to 1.39%. Average balances of interest bearing demand,
savings, and time deposits were up $31.8 million (18.1%), $120.0 million
(45.4%), and $17.7 million (6.3%), respectively. The decrease in average yield
on interest-bearing liabilities reduced interest expense by $2.3 million, while
the increase in average balances of interest bearing liabilities added $2.5
million to interest expense during 2003.
Interest income (FTE) decreased $7.2 million (9.9%) from 2001 to 2002, the net
effect of lower earning-asset yields partially offset by higher average balances
of those assets. The total yield on earning assets dropped from 8.21% in 2001 to
6.98% in 2002, following the trend in overall interest markets in which federal
funds rates were reduced to historical lows ending 2002 at 1.25%. The average
yield on loans decreased 113 basis points to 7.94% during 2002. The decrease in
average yield on interest-earning assets reduced interest income (FTE) by $11.1
million, while a $54.8 million (6.2%) increase in average balances of
interest-earning assets added $3.9 million to interest income (FTE) during 2002.
Interest expense decreased $10.6 million (45.0%) in 2002 from $23.5 million in
2001, principally due to lower rates paid. The average rate paid on
interest-bearing liabilities was 1.73% in 2002, 155 basis points or 47% lower
than in 2001. The most pronounced declines included rates paid on savings
deposits (down from 2.11% to 1.02%) and time deposits (down from 5.07% to
2.99%). Rates paid on interest-bearing demand deposits decreased 68 basis points
to 0.27%. The decrease in the average rate paid on interest-bearing liabilities
decreased interest expense by $10.1 million, and changes in the mix of average
balances of interest-bearing liabilities decreased interest expense by $509,000
in 2002 despite an overall increase of $30.8 million (4.3%) in the average
balance of interest-bearing liabilities.
Net Interest Margin
Following is a summary of the Company's net interest margin for the past three
years:
Components of Net Interest Margin
--------------------------------------------------------------------------
Year ended December 31, 2003 2002 2001
-----------------------------
Yield on earning assets 6.34% 6.98% 8.21%
Rate paid on interest-bearing liabilities 1.39% 1.73% 3.28%
-----------------------------
Net interest spread 4.95% 5.24% 4.93%
Impact of all other net
noninterest-bearing funds 0.28% 0.35% 0.65%
-----------------------------
Net interest margin (FTE) 5.23% 5.61% 5.58%
==========================================================================
During 2002, the Company was able to maintain a relatively stable net interest
margin by aggressively reducing rates paid on interest-bearing liabilities as
yields on earning assets decreased along with market interest rates. During
2003, it became increasingly difficult to decrease rates on interest-bearing
liabilities as market interest rates continued to decrease. In addition, the
positive impact of all other net noninterest bearing funds on net interest
margin was reduced due to the lower market rates of interest at which they could
be invested.
-15-
Summary of Average Balances, Yields/Rates and Interest Differential
The following tables present, for the past three years, information regarding
the Company's consolidated average assets, liabilities and shareholders' equity,
the amounts of interest income from average earning assets and resulting yields,
and the amount of interest expense paid on interest bearing liabilities. Average
loan balances include nonperforming loans. Interest income includes proceeds
from loans on nonaccrual loans only to the extent cash payments have been
received and applied to interest income. Yields on securities and certain loans
have been adjusted upward to reflect the effect of income thereon exempt from
federal income taxation at the current statutory tax rate (dollars in
thousands):
Year ended December 31, 2003
-----------------------------------------------
Interest Rates
Average income/ earned/
balance expense paid
-----------------------------------------------
Assets
Loans $827,673 $60,997 7.37%
Investment securities - taxable 306,647 10,903 3.56%
Investment securities - nontaxable 38,562 3,065 7.95%
Federal funds sold 11,573 129 1.11%
---------- ----------
Total earning assets 1,184,455 75,094 6.34%
----------
Other assets 146,099
----------
Total assets $1,330,554
==========
Liabilities and shareholders' equity
Interest-bearing demand deposits $208,347 488 0.23%
Savings deposits 384,455 3,441 0.90%
Time deposits 299,799 7,328 2.44%
Federal funds purchased 17,645 189 1.07%
Other borrowings 22,903 1,288 5.62%
Junior subordinated debt 8,333 355 4.26%
---------- ----------
Total interest-bearing liabilities 941,482 13,089 1.39%
----------
Noninterest-bearing demand 245,538
Other liabilities 24,941
Shareholders' equity 118,593
----------
Total liabilities and shareholders' equity $1,330,554
==========
Net interest spread (1) 4.95%
Net interest income and interest margin (2) $62,005 5.23%
========== ========
(1) Net interest spread represents the average yield earned on interest earning
assets less the average rate paid on interest bearing liabilities.
(2) Net interest margin is computed by dividing net interest income by total
average earning assets.
-16-
Year ended December 31, 2002
-----------------------------------------------
Interest Rates
Average income/ earned/
balance expense paid
-----------------------------------------------
Assets
Loans $660,668 $52,472 7.94%
Investment securities - taxable 204,155 9,430 4.62%
Investment securities - nontaxable 43,871 3,435 7.83%
Federal funds sold 36,692 606 1.65%
---------- ----------
Total earning assets 945,386 65,943 6.98%
----------
Other assets 94,080
----------
Total assets $1,039,466
==========
Liabilities and shareholders' equity
Interest-bearing demand deposits $176,484 469 0.27%
Savings deposits 264,444 2,710 1.02%
Time deposits 282,084 8,441 2.99%
Federal funds purchased 116 2 1.47%
Other borrowings 22,939 1,292 5.63%
---------- ---------- -
Total interest-bearing liabilities 746,067 12,914 1.73%
----------
Noninterest-bearing demand 182,569
Other liabilities 17,250
Shareholders' equity 93,580
----------
Total liabilities and shareholders' equity $1,039,466
==========
Net interest spread (1) 5.24%
Net interest income and interest margin (2) $53,029 5.61%
========== ========
(1) Net interest spread represents the average yield earned on interest-earning
assets less the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by dividing net interest income by total
average earning assets.
Year ended December 31, 2001
-----------------------------------------------
Interest Rates
Average income/ earned/
balance expense paid
-----------------------------------------------
Assets
Loans $647,317 $58,730 9.07%
Investment securities - taxable 159,465 9,543 5.98%
Investment securities - nontaxable 44,615 3,373 7.56%
Federal funds sold 39,204 1,506 3.84%
---------- ----------
Total earning assets 890,601 73,152 8.21%
----------
Other assets 87,941
----------
Total assets $978,542
==========
Liabilities and shareholders' equity
Interest-bearing demand deposits $156,629 1,487 0.95%
Savings deposits 225,137 4,759 2.11%
Time deposits 301,023 15,261 5.07%
Federal funds purchased 289 7 2.42%
Long-term debt 32,133 1,972 6.14%
---------- ----------
Total interest-bearing liabilities 715,211 23,486 3.28%
----------
Noninterest-bearing demand 160,152
Other liabilities 15,660
Shareholders' equity 87,519
----------
Total liabilities and shareholders' equity $978,542
==========
Net interest spread (1) 4.93%
Net interest income and interest margin (2) $49,666 5.58%
========== ========
(1) Net interest spread represents the average yield earned on interest-earning
assets less the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by dividing net interest income by total
average earning assets.
-17-
Summary of Changes in Interest Income and Expense due to Changes in Average
Asset and Liability Balances and Yields Earned and Rates Paid
The following table sets forth a summary of the changes in the Company's
interest income and interest expense from changes in average asset and liability
balances (volume) and changes in average interest rates for the past three
years. The rate/volume variance has been included in the rate variance. Amounts
are calculated on a fully taxable equivalent basis (dollars in thousands):
2003 over 2002 2002 over 2001
-----------------------------------------------------------------------------
Yield/ Yield/
Volume Rate Total Volume Rate Total
-----------------------------------------------------------------------------
Increase (decrease) in (dollars in thousands)
interest income:
Loans $13,264 ($4,739) $8,525 $1,211 ($7,469) ($6,258)
Investment securities 5,041 (3,938) 1,103 2,781 (2,832) (51)
Federal funds sold (415) (62) (477) (96) (804) (900)
-----------------------------------------------------------------------------
Total 17,890 (8,739) 9,151 3,896 (11,105) (7,209)
-----------------------------------------------------------------------------
Increase (decrease) in
interest expense:
Demand deposits (interest-bearing) 85 (66) 19 188 (1,206) (1,018)
Savings deposits 1,230 (499) 731 831 (2,880) (2,049)
Time deposits 530 (1,643) (1,113) (960) (5,860) (6,820)
Federal funds purchased 257 (70) 187 (4) (1) (5)
Junior subordinated debt 355 - 355 - - -
Long-term borrowings (2) (2) (4) (564) (116) (680)
-----------------------------------------------------------------------------
Total 2,455 (2,280) 175 (509) (10,063) (10,572)
-----------------------------------------------------------------------------
Increase (decrease) in
net interest income $15,435 ($6,459) $8,976 $4,405 ($1,042) $3,363
=============================================================================
Provision for Loan Losses
In 2003, the Bank provided $1.25 million for loan losses compared to $2.8
million in 2002. Net loan charge-offs increased $1.3 million (87%) to $2.8
million during 2003. Included in the $2.8 million of net loan charge-offs during
2003 is a net charge-off of $1.6 million related to two commercial real estate
loans to a single entity that was collateralized by a single building. The
Company had previously established a specific allowance for the two commercial
real estate loans noted above in its allowance for loan losses. Collection of
the loan was realized on July 31, 2003 through receipt of net proceeds of $11.5
million from the sale of the building. The collection resulted in a recovery of
$0.3 million of the $1.9 million charged-off on these loans during the quarter
ended June 30, 2003. Net charge-offs of consumer installment loans increased
$191,000 (93%). Net charge-offs of commercial, financial and agricultural loans
increased $465,000 (99%) in 2003, while net charge-offs of real estate mortgage
loans increased $655,000 (81%). The 2003 charge-offs represented 0.34% of
average loans outstanding versus 0.22% in 2002. Nonperforming loans net of
government agency guarantees as a percentage of total loans were 0.45% and 1.19%
at December 31, 2003 and 2002, respectively. The ratio of allowance for loan
losses to nonperforming loans was 313% at the end of 2003 versus 176% at the end
of 2002.
In 2002, the Bank provided $2.8 million for loan losses compared to $4.4 million
in 2001. Net loan charge-offs decreased $1.5 million (51%) to $1.5 million
during 2002. Net charge-offs of commercial, financial and agricultural loans
decreased $2.3 million (83%) in 2002, while net charge-offs of real estate
mortgage and consumer installment loans increased $662,000 (463%) and $105,000
(205%), respectively. The 2002 net charge-offs represented 0.22% of average
loans outstanding versus 0.47% in 2001. Nonperforming loans net of government
agency guarantees were 1.19% of total loans at December 31, 2002 versus 0.92% at
December 31, 2001. The ratio of allowance for loan losses to nonperforming loans
was 176% at the end of 2002 versus 216% at the end of 2001.
-18-
Noninterest Income
The following table summarizes the Company's noninterest income for the past
three years (dollars in thousands):
Components of Noninterest Income
---------------------------------------------------------------------------
Year ended December 31, 2003 2002 2001
--------------------------------
Service charges on deposit accounts $12,495 $8,915 $5,875
ATM fees and interchange 2,220 1,823 1,423
Other service fees 1,782 1,261 1,133
Amortization of mortgage servicing rights,
net of mortgage servicing fees (1,356) (713) (336)
Provision for mortgage servicing
rights valuation allowance (600) - -
Gain on sale of loans 4,168 3,641 2,095
Commissions on sale of
nondeposit investment products 1,766 2,467 2,576
Gain on sale of investments 197 - 1,792
Increase in cash value of life insurance 1,296 606 476
Other noninterest income 941 1,180 1,204
--------------------------------
Total noninterest income $22,909 $19,180 $16,238
===========================================================================
Noninterest income increased $3.7 million (19.4%) to $22.9 million in 2003.
Service charges on deposit accounts was up $3.6 million (40.2%) due to 2003
being the first full year of the Company's overdraft privilege product that was
introduced in July 2002. ATM fees and interchange, and other service fees were
up $0.4 million (21.8%) and $0.5 million (41.3%) due to expansion of the
Company's ATM network and customer base through de-novo branch expansion and the
acquisition of North State National Bank. Overall, mortgage banking activities,
which includes amortization of mortgage servicing rights net of mortgage
servicing fees, provision for mortgage servicing valuation allowance, and gain
on sale of loans, accounted for $2.2 million of noninterest income in the 2003
compared to $2.9 million in 2002. The increase in the amortization of mortgage
servicing rights and the provision for mortgage servicing valuation allowance
taken in 2003 are the result of the recent peak in mortgage refinance activity.
While the Company benefits from increased gain on sale of loans during periods
of high levels of mortgage refinance activity, it may also experience increased
amortization and provisions for mortgage servicing valuations of mortgage
servicing rights. Commissions on sale of nondeposit investment products
decreased $0.7 million (28.4%) in 2003 due to lower demand for annuity products.
Income from increase in cash value of life insurance increased $0.7 million
(114%) due to an increase in life insurance owned by the Company from $15.2
million at December 31, 2002 to $39.0 million at December 31, 2003.
Noninterest income increased $2.9 million (18.1%) to $19.2 million in 2002. The
increase was mainly due to a $3.0 million (52%) increase in service charges on
deposit accounts to $8.9 million, and a $1.5 million (74%) increase in gain on
sale of loans to $3.6 million during 2002. Except for a $1.8 million gain from
sale of investments and insurance company stock in 2001, noninterest income
would have increased $4.7 million (29.2%). The increase in service charges on
deposit accounts was almost entirely due to the introduction of the Company's
overdraft privilege product in July 2002. The increase in gain on sale of loans
is due to continued and increased residential mortgage refinance activity during
2002.
Securities Transactions
During 2003 the Bank realized net gains of $0.2 million on the sale of
securities with market values of $22.3 million. In addition, during 2003, the
Bank received proceeds from maturities of securities totaling $205 million,
purchased $169.2 million of securities, and acquired $39.7 million of securities
through the acquisition of North State national Bank.
During 2002 the Bank had no sales of securities. Also during 2002, the Bank
received proceeds from maturities of securities totaling $131.6 million, and
used $241.8 million to purchase securities.
-19-
Noninterest Expense
The following table summarizes the Company's other noninterest expense for the
past three years:
Components of Noninterest Expense (dollars in thousands)
---------------------------------------------------------------------------
Year ended December 31, 2003 2002 2001
-------------------------------------
Salaries and benefits $29,714 $24,290 $21,199
Equipment and data processing 4,947 4,095 3,694
Occupancy 3,493 2,954 2,806
Professional fees 2,315 1,696 1,087
Telecommunications 1,539 1,422 1,253
Advertising 1,062 1,263 1,132
Intangible amortization 1,207 911 911
ATM network charges 1,043 847 913
Postage 855 801 639
Courier service 795 720 661
Operational losses 657 534 227
Assessments 268 233 223
Net other real estate owned expense 124 26 175
Other 7,508 6,179 5,687
-------------------------------------
Total noninterest expense $55,527 $45,971 $40,607
============================================================================
Average full time equivalent staff 505 435 403
Noninterest expense to revenue (FTE) 65.39% 63.66% 61.62%
Salary and benefit expenses increased $5.4 million (22.3%) in 2003 compared to
2002. Base salaries and benefits increased $3.3 million (20.9%) to $19.1 million
in 2003. The increase in base salaries was mainly due to a 16.1% increase in
average full time equivalent employees from 435 in 2002 to 505 in 2003, and
annual salary increases. Incentive and commission related salary expenses
increased $1.0 million (28.6%) to $4.5 million in 2003. The increase in
incentive and commission expenses was directly tied to significant loan,
deposit, and revenue growth during 2003. Benefits expense, including retirement,
medical and workers' compensation insurance, and taxes, increased $1.1 million
(21.6%) to $6.2 million during 2003.
Salary and benefit expenses increased $3.1 million (14.6%) to $24.3 million in
2002 compared to 2001. Base salaries increased $1.4 million (9.5%) to $15.7
million in 2002. The increase in base salaries was mainly due to an 8.2%
increase in average full time equivalent employees from 403 during 2001 to 435
during 2002, primarily due to the opening of four branches in 2002. Incentive
and commission related salary expenses increased $866,000 (33.5%) to $3.5
million in 2002. The increase in incentive and commission related salary expense
was mainly due to increased commissions paid on origination of residential
mortgage loans, and other functions that exhibited exceptional performance
during 2002. These results are consistent with the Bank's strategy of working
more efficiently with fewer employees who are compensated in part based on their
business unit's performance or on their ability to generate revenue. Benefits
expense, including retirement, medical and workers' compensation insurance, and
taxes, increased $855,000 (20.2%) to $5.1 million during 2002.
Other noninterest expense increased $4.1 million (18.9%) to $25.8 million in
2003. Increases in the areas of equipment and data processing, occupancy,
telecommunications, and ATM network charges were mainly due to the first full
year of operation of the Oroville, Brentwood, and Natomas branches, the opening
in 2003 of branches in Chico, Roseville and Folsom, the continued operation of
one branch added through the acquisition of North State National Bank in April
2003, and enhancements to data processing and ATM network equipment. One-time
merger expenses related to the North State acquisition were insignificant. All
expense reductions realized through the acquisition of North State were effected
immediately upon acquisition in April 2003. Increases in professional fees and
operational losses were related to the first full year operation of the
Company's overdraft privilege product introduced in July 2002, and were more
than offset by the large revenue that product is producing. The increase in
intangible amortization was due to the North State acquisition.
Other expenses increased $2.3 million (11.7%) to $21.7 million in 2002.
Increases in the areas of equipment and data processing, occupancy,
telecommunications, courier service, and other were mainly due to the opening of
four branches in 2002. Increases in professional fees and operational losses
were related to the overdraft privilege product introduced in July 2002, and
were more than offset by the large revenue that product is producing.
-20-
Provision for Taxes
The effective tax rate on income was 37.5%, 36.6%, and 37.1% in 2003, 2002, and
2001, respectively. The effective tax rate was greater than the federal
statutory tax rate due to state tax expense of $2.7 million, $2.0 million, and
$1.9 million, respectively, in these years. Tax-exempt income of $2.0 million,
$2.2 million, and $2.2 million, respectively, from investment securities in
these years helped to reduce the effective tax rate.
Financial Ratios
The following table shows the Company's key financial ratios for the past three
years:
Year ended December 31, 2003 2002 2001
--------------------------------
Return on average total assets 1.27% 1.35% 1.27%
Return on average shareholders' equity 14.24% 15.03% 14.19%
Shareholders' equity to total assets 8.71% 8.65% 8.65%
Common shareholders' dividend payout ratio 36.36% 39.95% 45.43%
==============================================================================
Loans
The Bank concentrates its lending activities in four principal areas: commercial
loans (including agricultural loans), consumer loans, real estate mortgage loans
(residential and commercial loans and mortgage loans originated for sale), and
real estate construction loans. At December 31, 2003, these four categories
accounted for approximately 14%, 33%, 47%, and 6% of the Bank's loan portfolio,
respectively, as compared to 18%, 29%, 47%, and 6%, at December 31, 2002. The
shift in the percentages was primarily due to the Bank's ability to increase its
consumer loan portfolio during 2003. The shift in percentages is reflected in
the Company's assessment of the adequacy of the allowance for loan losses. The
increase in consumer loans during 2003 was mainly due to increases in home
equity lines of credit and automobile loans. The interest rates charged for the
loans made by the Bank vary with the degree of risk, the size and maturity of
the loans, the borrower's relationship with the Bank and prevailing money market
rates indicative of the Bank's cost of funds.
The majority of the Bank's loans are direct loans made to individuals, farmers
and local businesses. The Bank relies substantially on local promotional
activity, personal contacts by bank officers, directors and employees to compete
with other financial institutions. The Bank makes loans to borrowers whose
applications include a sound purpose, a viable repayment source and a plan of
repayment established at inception and generally backed by a secondary source of
repayment.
At December 31, 2003 loans totaled $981 million and was a 43% ($294 million)
increase over the balances at the end of 2002. Contributing to the increase in
loans was $76 million of loans obtained through the acquisition of North State
National Bank on April 4, 2003. Demand for commercial and agriculture related
loans, commercial real estate mortgage loans, and real estate construction loans
improved in the Company's market areas in 2003. Demand for home equity and auto
loans remained strong throughout 2003. The average loan-to-deposit ratio in 2003
was 72.2% compared to 71.1% in 2002.
At December 31, 2002 loans totaled $687.5 million and was a 4.4% ($28.8 million)
increase over the balances at the end of 2001. Demand for home equity loans and
auto loans (both classified as consumer loans) were strong throughout 2002.
Residential mortgage loan activity was extremely strong in 2002, but the Company
generally sells all such loans. Commercial and agriculture related loan growth
continued to be relatively weak in 2002 as the economy continued to be weak, and
competition for such loans was high. The average loan-to-deposit ratio in 2002
was 71.1% compared to 76.8% in 2001.
-21-
Loan Portfolio Composite
The following table shows the Company's loan balances for the past five years:
December 31,
(dollars in thousands) 2003 2002 2001 2000 1999
--------------------------------------------------------------------------
Commercial, financial and agricultural $142,252 $125,982 $130,054 $148,135 $138,313
Consumer installment 319,029 201,858 155,046 120,247 79,273
Real estate mortgage 458,369 319,969 326,897 334,010 332,116
Real estate construction 61,591 39,713 46,735 37,999 38,277
--------------------------------------------------------------------------
Total loans $981,241 $687,522 $658,732 $640,391 $587,979
==========================================================================
Classified Assets
The Company closely monitors the markets in which it conducts its lending
operations and continues its strategy to control exposure to loans with high
credit risk. Asset reviews are performed using grading standards and criteria
similar to those employed by bank regulatory agencies. Assets receiving lesser
grades fall under the "classified assets" category, which includes all
nonperforming assets and potential problem loans, and receive an elevated level
of attention to ensure collection.
The following is a summary of classified assets on the dates indicated (dollars
in thousands):
At December 31, 2003 At December 31, 2002
------------------------- ------------------------
Gross Guaranteed Net Gross Guaranteed Net
-----------------------------------------------------
Classified loans $29,992 $18,783 $11,209 $52,264 $12,202 $40,062
Other classified assets 932 - 932 932 - 932
-----------------------------------------------------
Total classified assets $30,924 $18,783 $12,141 $53,196 $12,202 $40,994
=====================================================
Allowance for loan losses/
Classified loans 113.4% 35.1%
Classified assets, net of guarantees of the U.S. Government, including its
agencies and its government-sponsored agencies at December 31, 2003, decreased
$28.9 million (70%) to $12.1 million from $41.0 million at December 31, 2002.
Nonperforming Assets
Loans on which the accrual of interest has been discontinued are designated as
nonaccrual loans. Accrual of interest on loans is generally discontinued either
when reasonable doubt exists as to the full, 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. When loans are 90 days past due, but in
Management's judgment are well secured and in the process of collection, they
may not be classified as nonaccrual. When a loan is placed on nonaccrual status,
all interest previously accrued but not collected is reversed. 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 only when they are brought fully current with respect to interest and
principal and when, in the judgment of Management, the loans are estimated to be
fully collectible as to both principal and interest. The reclassification of
loans as nonaccrual does not necessarily reflect management's judgment as to
whether they are collectible.
Interest income on nonaccrual loans, which would have been recognized during the
year, ended December 31, 2003, if all such loans had been current in accordance
with their original terms, totaled $1.1 million. Interest income actually
recognized on these loans in 2003 was $372,000.
-22-
The Bank's policy is to place loans 90 days or more past due on nonaccrual
status. In some instances when a loan is 90 days past due management does not
place it on nonaccrual status because the loan is well secured and in the
process of collection. A loan is considered to be in the process of collection
if, based on a probable specific event, it is expected that the loan will be
repaid or brought current. Generally, this collection period would not exceed 30
days. Loans where the collateral has been repossessed are classified as other
real estate owned ("OREO") or, if the collateral is personal property, the loan
is classified as other assets on the Company's financial statements.
Management considers both the adequacy of the collateral and the other resources
of the borrower in determining the steps to be taken to collect nonaccrual
loans. Alternatives that are considered are foreclosure, collecting on
guarantees, restructuring the loan or collection lawsuits.
-23-
The following tables set forth the amount of the Bank's nonperforming assets net
of guarantees of the U.S. government, including its agencies and its
government-sponsored agencies, as of the dates indicated:
December 31, 2003 December 31, 2002
------------------------- -------------------------
(dollars in thousands): Gross Guaranteed Net Gross Guaranteed Net
------------------------------------------------------
Performing nonaccrual loans $10,997 $7,936 $3,061 $13,199 $8,432 $4,767
Nonperforming, nonaccrual loans 2,551 1,252 1,299 4,091 718 3,373
------------------------------------------------------
Total nonaccrual loans 13,548 9,188 4,360 17,290 9,150 8,140
Loans 90 days past due and still accruing 34 - 34 40 - 40
------------------------------------------------------
Total nonperforming loans 13,582 9,188 4,394 17,330 9,150 8,180
Other real estate owned 932 - 932 932 - 932
------------------------------------------------------
Total nonperforming loans and OREO $14,514 $9,188 $5,326 $18,262 $9,150 $9,112
======================================================
Nonperforming loans to total loans 0.45% 1.19%
Allowance for loan losses/nonperforming loans 313% 176%
Nonperforming assets to total assets 0.36% 0.80%
December 31, 2001 December 31, 2000
------------------------- -------------------------
(dollars in thousands): Gross Guaranteed Net Gross Guaranteed Net
------------------------------------------------------
Performing nonaccrual loans $2,733 - $2,733 $4,331 $142 $4,189
Nonperforming, nonaccrual loans 3,120 $387 2,733 8,161 88 8,073
------------------------------------------------------
Total nonaccrual loans 5,853 387 5,466 12,492 230 12,262
Loans 90 days past due and still accruing 584 - 584 965 - 965
------------------------------------------------------
Total nonperforming loans 6,437 387 6,050 13,457 230 13,227
Other real estate owned 71 - 71 1,441 - 1,441
------------------------------------------------------
Total nonperforming loans and OREO $6,508 387 $6,121 $14,898 $230 $14,668
======================================================
Nonperforming loans to total loans 0.92% 2.07%
Allowance for loan losses/nonperforming loans 216% 88%
Nonperforming assets to total assets 0.61% 1.51%
December 31, 1999
-------------------------
(dollars in thousands): Gross Guaranteed Net
-------------------------
Performing nonaccrual loans $666 $62 $604
Nonperforming, nonaccrual loans 1,662 508 1,154
-------------------------
Total nonaccrual loans 2,328 570 1,758
Loans 90 days past due and still accruing 923 - 923
-------------------------
Total nonperforming loans 3,251 570 2,681
Other real estate owned 760 - 760
-------------------------
Total nonperforming loans and OREO $4,011 $570 $3,441
=========================
Nonperforming loans to total loans 0.46%
Allowance for loan losses/nonperforming loans 412%
Nonperforming assets to total assets 0.37%
-24-
During 2003, nonperforming assets net of government guarantees decreased $3.8
million (42%) to $5.3 million. Nonperforming loans decreased $3.8 million (46%)
to $4.4 million. The ratio of nonperforming loans to total loans at December 31,
2003 was 0.45% versus 1.19% at the end of 2002. Classifications of nonperforming
loans as a percent of the total at the end of 2003 were as follows: secured by
real estate, 66%; loans to farmers, 19%; commercial loans, 10%; and consumer
loans, 5%.
During 2002, nonperforming assets net of government guarantees increased $3
million (49%) to a total of $9.1 million. Nonperforming loans net of government
guarantees increased $2.1 million (35%) to $8.2 million, and other real estate
owned (OREO) increased $861,000 to $932,000 during 2002. The ratio of
nonperforming loans to total loans at December 31, 2002 was 1.19% versus 0.92%
at the end of 2001. Classifications of nonperforming loans as a percent of total
loans at the end of 2002 were as follows: secured by real estate, 62%; loans to
farmers, 27%; commercial loans, 10%; and consumer loans, 1%.
Allowance for Loan Losses
Credit risk is inherent in the business of lending. As a result, the Company
maintains an allowance for loan losses to absorb losses inherent in the
Company's loan and lease portfolio. This is maintained through periodic charges
to earnings. These charges are shown in the consolidated income statements as
provision for loan losses. All specifically identifiable and quantifiable losses
are immediately charged off against the allowance. However, for a variety of
reasons, not all losses are immediately known to the Company and, of those that
are known, the full extent of the loss may not be quantifiable at that point in
time. The balance of the Company's allowance for loan losses is meant to be an
estimate of these unknown but probable losses inherent in the portfolio.
For the remainder of this discussion, "loans" shall include all loans and lease
contracts, which are a part of the Bank's portfolio.
Assessment of the Adequacy of the Allowance for Loan Losses
The Company formally assesses the adequacy of the allowance on a quarterly
basis. Determination of the adequacy is based on ongoing assessments of the
probable risk in the outstanding loan and lease portfolio, and to a lesser
extent the Company's loan and lease commitments. These assessments include the
periodic re-grading of credits based on changes in their individual credit
characteristics including delinquency, seasoning, recent financial performance
of the borrower, economic factors, changes in the interest rate environment,
growth of the portfolio as a whole or by segment, and other factors as
warranted. Loans are initially graded when originated. They are re-graded as
they are renewed, when there is a new loan to the same borrower, when identified
facts demonstrate heightened risk of nonpayment, or if they become delinquent.
Re-grading of larger problem loans occurs at least quarterly. Confirmation of
the quality of the grading process is obtained by independent credit reviews
conducted by consultants specifically hired for this purpose and by various bank
regulatory agencies.
The Company's method for assessing the appropriateness of the allowance includes
specific allowances for identified problem loans and leases, formula allowance
factors for pools of credits, and allowances for changing environmental factors
(e.g., interest rates, growth, economic conditions, etc.). Allowances for
identified problem loans are based on specific analysis of individual credits.
Allowance factors for loan pools are based on the previous 5 years historical
loss experience by product type. Allowances for changing environmental factors
are management's best estimate of the probable impact these changes have had on
the loan portfolio as a whole.
The Components of the Allowance for Loan Losses
As noted above, the overall allowance consists of a specific allowance, a
formula allowance, and an allowance for environmental factors. The first
component, the specific allowance, results from the analysis of identified
credits that meet management's criteria for specific evaluation. These loans are
reviewed individually to determine if such loans are considered impaired.
Impaired loans are those where management has concluded that it is probable that
the borrower will be unable to pay all amounts due under the contractual terms.
Loans specifically reviewed, including those considered impaired, are evaluated
individually by management for loss potential by evaluating sources of
repayment, including collateral as applicable, and a specified allowance for
loan losses is established where necessary.
-25-
The second component, the formula allowance, is an estimate of the probable
losses that have occurred across the major loan categories in the Company's loan
portfolio. This analysis is based on loan grades by pool and the loss history of
these pools. This analysis covers the Company's entire loan portfolio including
unused commitments but excludes any loans, which were analyzed individually and
assigned a specific allowance as discussed above. The total amount allocated for
this component is determined by applying loss estimation factors to outstanding
loans and loan commitments. The loss factors are based primarily on the
Company's historical loss experience tracked over a five-year period and
adjusted as appropriate for the input of current trends and events. Because
historical loss experience varies for the different categories of loans, the
loss factors applied to each category also differ. In addition, there is a
greater chance that the Company has suffered a loss from a loan that was graded
less than satisfactory than if the loan was last graded satisfactory. Therefore,
for any given category, a larger loss estimation factor is applied to less than
satisfactory loans than to those that the Company last graded as satisfactory.
The resulting formula allowance is the sum of the allocations determined in this
manner.
The third or "unallocated" component of the allowance for credit losses is a
component that is not allocated to specific loans or groups of loans, but rather
is intended to absorb losses that may not be provided for by the other
components.
There are several primary reasons that the other components discussed above
might not be sufficient to absorb the losses present in portfolios, and the
unallocated portion of the allowance is used to provide for the losses that have
occurred because of them.
The first reason is that there are limitations to any credit risk grading
process. The volume of loans makes it impractical to re-grade every loan every
quarter. Therefore, it is possible that some currently performing loans not
recently graded will not be as strong as their last grading and an insufficient
portion of the allowance will have been allocated to them. Grading and loan
review often must be done without knowing whether all relevant facts are at
hand. Troubled borrowers may deliberately or inadvertently omit important
information from reports or conversations with lending officers regarding their
financial condition and the diminished strength of repayment sources.
The second reason is that the loss estimation factors are based primarily on
historical loss totals. As such, the factors may not give sufficient weight to
such considerations as the current general economic and business conditions that
affect the Company's borrowers and specific industry conditions that affect
borrowers in that industry. The factors might also not give sufficient weight to
other environmental factors such as changing economic conditions and interest
rates, portfolio growth, entrance into new markets or products, and other
characteristics as may be determined by Management.
Specifically, in assessing how much unallocated allowance needed to be provided
at December 31, 2003, management considered the following:
- with respect to loans to the agriculture industry, management
considered the effects on borrowers of weather conditions and overseas
market conditions for exported products as well as commodity prices in
general;
- with respect to changes in the interest rate environment management
considered the recent changes in interest rates and the resultant
economic impact it may have had on borrowers with high leverage and/or
low profitability; and
- with respect to loans to borrowers in new markets and growth in
general, management considered the relatively short seasoning of such
loans and the lack of experience with such borrowers.
Each of these considerations was assigned a factor and applied to a
portion or all of the loan portfolio. Since these factors are not
derived from experience and are applied to large non-homogeneous
groups of loans, they are considered unallocated and are available for
use across the portfolio as a whole.
-26-
The following table sets forth the Bank's loan loss reserve as of the dates
indicated:
December 31,
-------------------------------------------------------------
2003 2002 2001 2000 1999
-------------------------------------------------------------
(dollars in thousands)
Specific allowance $1,003 $5,299 $5,672 $3,266 $600
Formula allowance 12,481 8,839 7,183 8,067 10,250
Unallocated allowance 289 239 203 337 187
-------------------------------------------------------------
Total allowance $13,773 $14,377 $13,058 $11,670 $11,037
=============================================================
The allowance for loan losses to total loans at December 31, 2003 was 1.40%
versus 2.09% at the end of 2002. At December 31, 2001, the allowance for loan
losses to total loans was 1.98%.
Based on the current conditions of the loan portfolio, management believes that
the $13.8 million allowance for loan losses at December 31, 2003 is adequate to
absorb probable losses inherent in the Bank's loan portfolio. No assurance can
be given, however, that adverse economic conditions or other circumstances will
not result in increased losses in the portfolio.
The following table summarizes, for the years indicated, the activity in the
allowance for loan losses:
December 31,
----------------------------------------------------------------
2003 2002 2001 2000 1999
----------------------------------------------------------------
(dollars in thousands)
Balance, beginning of year $14,377 $13,058 $11,670 $11,037 $8,206
Addition through merger 928 -- -- -- --
Provision charged to operations 1,250 2,800 4,400 5,000 3,550
Loans charged off:
Commercial, financial and
agricultural (1,142) (668) (2,861) (4,450) (865)