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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________________
Commission File Number : 0-12499
First Financial Bancorp
(Exact name of registrant as specified in its charter)
California 94-28222858
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
701 South Ham Lane, Lodi, California 95242
(Address of principal executive offices) (Zip Code)
(209)-367-2000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
Preferred Share Purchase Rights
(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 period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
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 this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the Common Stock held by non-affiliates of the
registrant was approximately $18,998,387 (based on the $11.75 average of bid and
ask prices per share on June 28, 2002).
As of March 3, 2003, there were 1,623,257 shares of Common Stock, no
par value, outstanding.
Documents Incorporated by Reference Part of Form 10-K into which Incorporated
- ----------------------------------- -----------------------------------------
Proxy Statement for the Annual
Meeting of Shareholders to be
held on April 22, 2003. Part III, Items 10, 11, 12, 13
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FIRST FINANCIAL BANCORP
2002 FORM 10-K
TABLE OF CONTENTS
PART 1
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ITEM 1. BUSINESS .................................................................. 4
General ................................................................ 4
The Bank ............................................................... 4
Bank Services .......................................................... 4
Sources of Business .................................................... 5
Competition ............................................................ 5
Officers ............................................................... 6
Employees .............................................................. 6
Supervision and Regulation ............................................. 7
The Company ................................................... 7
The Bank....................................................... 7
Recent Legislation and Regulations Affecting Banking .......... 8
ITEM 2. PROPERTIES ................................................................ 14
ITEM 3. LEGAL PROCEEDINGS ......................................................... 14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ....................... 14
Part II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS .................................................... 15
ITEM 6. SELECTED FINANCIAL DATA ................................................... 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS .............................................. 17
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................. 38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ............................... 38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE .................................... 38
PART III
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ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ........................ 38
ITEM 11. EXECUTIVE COMPENSATION .................................................... 38
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ............ 38
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ............................ 38
ITEM 14. CONTROLS AND PROCEDURES ................................................... 38
PART IV
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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ........... 39
Signatures ............................................................................ 67
Certifications under Section 906 of the Sarbanes-Oxley Act of 2002..................... 68
Index to Exhibits...................................................................... 70
2
PART I
Certain statements in this Annual Report on Form 10-K include forward-looking
information within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and
are subject to the "safe harbor" created by those sections. These
forward-looking statements involve certain risks and uncertainties that could
cause actual results to differ materially from those in the forward-looking
statements. Forward-looking statements, which are based on certain assumptions
and describe future plans, strategies, and expectations, are generally
identifiable by the use of words such as "believe", "expect", "intend",
"anticipate", "estimate", "project", "assume," "plan," "predict," "forecast" or
similar expressions. These forward-looking statements relate to, among other
things, expectations of the business environment in which the Company operates,
projections of future performance, potential future performance, potential
future credit experience, perceived opportunities in the market, and statements
regarding the Company's mission and vision.
The Company's actual results, performance, and achievements may differ
materially from the results, performance, and achievements expressed or implied
in such forward-looking statements due to a wide range of risks and
uncertainties. Such risks and uncertainties include, but are not limited to, the
following factors: competitive pressure in the banking industry; changes in the
interest rate environment; general economic conditions, either nationally or
regionally becoming less favorable than expected and resulting in, among other
things, a deterioration in credit quality and an increase in the provision for
possible loan losses; changes in the regulatory environment; monetary and fiscal
policies of the U.S. Government; changes in real estate valuations; changes in
business conditions; volatility of rate sensitive deposits; operational risks,
including data processing system failures or fraud; asset/liability matching
risks and liquidity risks; civil disturbances or terrorist threats or acts; or
apprehension about the possible future occurrences of acts of this type; the
outbreak or escalation of hostilities involving the United States; and changes
in the securities markets. Also, all of the Company's operations and most of its
customers are located in California. During recent times, the availability of a
sufficient supply of electrical power in California has been unreliable at
times. In addition, other events, including those of September 11, 2001, have
increased the uncertainty related to the national and California economic
outlook and could have an effect on the future operations of the Company or its
customers, including borrowers.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
3
ITEM 1. BUSINESS
General:
First Financial Bancorp (the "Company") was incorporated under the laws of the
State of California on May 13, 1982, and operates principally as a bank holding
company for its wholly owned subsidiary, Bank of Lodi, N.A. (the "Bank"). The
Company is registered under the Bank Holding Company Act of 1956, as amended.
The Bank is the principal source of income for the Company. The Company also
holds all of the capital stock of its other subsidiaries, Western Auxiliary
Corporation and First Financial (CA) Statutory Trust I. Western Auxiliary
Corporation (WAC), a California Corporation, functions as trustee on deeds of
trust securing mortgage loans originated by the Bank. First Financial (CA)
Statutory Trust I is a Delaware business trust formed in 2001 for the exclusive
purpose of issuing Company obligated manditorily redeemable cumulative trust
preferred securities of Subsidiary Grantor Trust holding solely junior
subordinated debentures. All references herein to the "Company" include the Bank
and all other subsidiaries, unless the context otherwise requires.
Information on the Company's financial results and its products and services is
available on the Internet at http://www.bankoflodi.com. Copies of the Company's
Annual Report on Form 10-K, Quarterly Reports on 10-Q and Current Reports on
Form 8-K filed with the Securities and Exchange Commission will be furnished to
any shareholder, free of charge, upon request. These reports also are available
over the Internet at http://www.sec.gov.
The Bank:
The Bank was organized on May 13, 1982 as a national banking association. The
application to organize the Bank was accepted for filing by the Comptroller of
the Currency (the "OCC") on September 8, 1981, and preliminary approval to
organize was granted on March 27, 1982. On July 18, 1983 the Bank received from
the OCC a Certificate of Authority to Commence the Business of Banking.
Subsequently, the Bank opened branch offices in Woodbridge and Lockeford,
California. Effective February 22, 1997, the Bank acquired the Galt, Plymouth
and San Andreas offices of Wells Fargo Bank. A loan production office in Folsom,
California was opened in January 1998, and was approved to operate as a
full-service branch in July 1999. In July 2001 the Bank relocated the Folsom
branch. A full-service branch was opened in Elk Grove, California in August
1998. In March 2001, the Bank established a Small Business Administration loan
production office in Folsom, California.
The Bank's headquarters is located at 701 South Ham Lane, Lodi, California. The
Bank's primary service area, from which the Bank attracts 50% of its business,
is the city of Lodi and the surrounding area. This area is estimated to have a
population approaching 60,000 persons, with a median annual family income of
approximately $42,000. The area includes residential developments, neighborhood
shopping centers, business and professional offices and manufacturing and
agricultural concerns.
Bank Services:
The Bank offers a wide range of commercial banking services to individuals and
business concerns located in and around its primary service area. These services
include personal and business checking and savings accounts (including
interest-bearing negotiable order of withdrawal ("NOW") accounts and/or accounts
combining checking and savings accounts with automatic transfers), and time
certificates of deposit. The Bank also offers extended banking hours at its
drive-through window, night depository and bank-by-mail services, and travelers'
checks (issued by an independent entity). Each branch location has a 24-hour ATM
machine, and the Bank has 24 hour telephone banking and bill paying services.
The Bank issues debit cards, MasterCard credit cards and acts as a merchant
depository for cardholder drafts under both VISA and MasterCard. In addition, it
provides direct deposit of social security and other government checks. The Bank
also offers Internet banking and bill payment services, which are located at
http://www.bankoflodi.com.
During 1998, the Bank entered into an agreement with Investment Centers of
America to offer stocks, bonds, mutual funds, annuities and insurance products
through offices located on-site at Bank branches. The first Investment Centers
of America office was established at the Lodi branch location, and additional
offices are planned for Elk Grove and Folsom.
The Bank engages in a full complement of lending activities, including
commercial, Small Business Administration (SBA), residential mortgage,
consumer/installment, and short-term real estate loans, with particular emphasis
on short and medium-term obligations. Commercial lending activities are directed
principally toward businesses whose demand for funds falls within the Bank's
lending limit, such as small to medium-sized professional firms, retail and
wholesale outlets and manufacturing and agricultural concerns. Consumer lending
is oriented primarily to the needs of the Bank's customers, with an emphasis on
automobile financing and leasing. Consumer loans also include loans for boats,
home improvements, debt consolidation, and other personal needs. Real estate
loans include short-term "swing" loans and construction loans. Residential
mortgages are generally sold into the secondary market for these loans. SBA
loans are made available to small to medium-sized businesses. The Bank generates
noninterest income through premiums received on the sale of the guaranteed
portions of SBA loans and the resulting on-going servicing income on its SBA
portfolio.
4
Sources of Business:
Management seeks to obtain sufficient market penetration through the full range
of services described above and through the personal solicitation of the Bank's
officers, directors and shareholders. All officers are responsible for making
regular calls on potential customers to solicit business and on existing
customers to obtain referrals. Promotional efforts are directed toward
individuals and small to medium-sized businesses. The Bank's customers are able
in their dealings with the Bank to be served by bankers who have commercial loan
experience, lending authority, and the time to serve their banking needs quickly
and competently. Bankers are assigned to customers and not transferred from
office to office as in many major chain or regional banks. In order to expedite
decisions on lending transactions, the Bank's loan committee meets on a regular
basis and is available where immediate authorization is important to the
customer.
The risk of non-payment (or deferred payment) of loans is inherent in commercial
banking. Furthermore, the Bank's marketing focus on small to medium-sized
businesses may involve certain lending risks not inherent in loans to larger
companies. Smaller companies generally have shorter operating histories, less
sophisticated internal record keeping and financial planning capabilities, and
greater debt-to-equity ratios. Management of the Bank carefully evaluates all
loan applicants and attempts to minimize its credit risk through the use of
thorough loan application and approval procedures.
Consistent with the need to maintain liquidity, management of the Bank seeks to
invest the largest portion of the Bank's assets in loans of the types described
above. Loans are generally limited to less than 80% of deposits and capital
funds. The Bank's surplus funds are invested in the investment portfolio, made
up of both taxable and non-taxable debt securities of the U.S. government, U.S.
government agencies, states, and municipalities. On a day-to-day basis, surplus
funds are invested in federal funds sold, securities purchased under resale
agreements and other short-term money market instruments.
Competition:
The banking business in California generally, and in the northern portion of
central California where the Bank is located, is highly competitive with respect
to both loans and deposits and is dominated by a relatively small number of
major banks with branch office networks and other operating affiliations
throughout the State. The Bank competes for deposits and loans with these banks,
as well as with savings and loan associations, thrift and loan associations,
credit unions, mortgage companies, insurance companies and other lending
institutions. Among the advantages certain of these institutions have over the
Bank are their ability (i) to finance extensive advertising campaigns, (ii) to
allocate a substantial portion of their investment assets in securities with
higher yields (not available to the Bank if its investments are to be
diversified) and (iii) to make funds available for loans in geographic regions
with the greatest demand. In competing for deposits, the Bank is subject to the
same regulations with respect to interest rate limitations on time deposits as
other depository institutions. See "Supervision and Regulation" below.
Many of the major commercial banks operating in the Bank's service area offer
certain services, such as international banking and trust services, which are
not offered directly by the Bank, and such banks, by virtue of their greater
capitalization, have substantially higher lending limits than the Bank. In
addition, other entities, both public and private, seeking to raise capital
through the issuance and sale of debt and equity securities compete with the
Bank for the acquisition of funds for deposit.
In order to compete with other financial institutions in its primary service
area, the Bank relies principally on local promotional activities, personal
contacts by its officers, directors, employees and shareholders, extended hours
and specialized services. The Bank's promotional activities emphasize the
advantages of dealing with a locally-owned and headquartered institution
sensitive to the particular needs of the community. The Bank also assists
customers in obtaining loans in excess of the Bank's lending limit or services
not offered by the Bank by arranging such loans or services in participation
with or through its correspondent banks.
The State Bank Parity Act, effective January 1, 1996, eliminated certain
existing disparities between California state chartered banks and national
banking associations, such as the Bank, by authorizing the California
Commissioner of Financial Institutions (the "Commissioner") to address such
disparities through a streamlined rule-making process.
5
Officers:
Leon Zimmerman, age 59, is President and Chief Executive Officer of the Bank and
of the Company; Robert H. Daneke, age 49 is Executive Vice President and Chief
Credit Officer of the Bank and of the Company, and; Allen R. Christenson, age 45
is Senior Vice-President, Chief Financial Officer and Secretary of the Bank and
of the Company.
Mr. Zimmerman joined the Company in April 1990. He was promoted from Executive
Vice President and Chief Credit Officer of Bank of Lodi to President and CEO in
August of 1994. Mr. Zimmerman became President and CEO of the Company effective
August 1995. He lives in Lodi with his wife and has resided and worked in the
San Joaquin-Sacramento Valley since 1960, serving in various banking capacities
since 1962. Mr. Zimmerman serves on many community boards and committees,
including the Lodi Police Chaplaincy Association, San Joaquin County Education
Foundation, Chamber of Commerce - Agribusiness Committee, and LEED - Sacramento
Steering Committee. He is a member of Lodi Rotary Club, Sutter Club -
Sacramento, World Trade Club - San Francisco, Independent Order of Odd Fellows,
Lodi Grape Festival and Harvest Fair and several other community groups.
Mr. Daneke joined the Company in December 1999 bringing on board 23 years of
banking experience. Prior to joining the Company, Mr. Daneke was employed at
Clovis Community Bank for eight years and was promoted to Senior Vice
President/Senior Credit Officer in 1997. In addition, his career has included:
seven years with the Correspondent Bank Division of Community Bank in Redwood
City and seven years with Bank of America Corporate Banking Group. Mr. Daneke
holds a B.B.A. Degree in Finance from the University of Iowa. He is also a
graduate of Pacific Coast Banking School at the University of Washington, the
California Intermediate Banking School at the University of San Diego and the
Lodi Chamber of Commerce Leadership Lodi Program. He currently is a member of
the Lodi Chapter of Independent Order of Odd Fellows and serves on Lodi Unified
School District's Budget Advisory Committee. Mr. Daneke resides in Lodi with his
wife and two children.
Mr. Christenson joined the Company in August 1999. Prior to joining the Company,
Mr. Christenson was Senior Vice President and Chief Financial Officer of River
City Bank, located in Sacramento, California (1994-1999). Prior to joining River
City Bank, Mr. Christenson was Senior Vice President and Chief Financial Officer
of CapitolBank Sacramento, which was acquired by another bank (1993-1994). Prior
to joining CapitolBank Sacramento, Mr. Christenson was in public accounting for
over eight years, specializing in financial audits and consulting within the
financial services industry. Mr. Christenson is a Certified Public Accountant
and has a Bachelors degree from California State University, Sacramento. He
resides in South Sacramento with his wife and five children. He is a life-long
resident of the greater Sacramento area and continues to serve in various
community and civic organizations.
Employees:
As of December 31, 2002, the Company employed 129 full-time equivalent
employees, including three executive officers. Management believes that the
Company's relationship with its employees is good.
6
Supervision and Regulation
The Company:
The common stock of the Company is subject to the registration requirements of
the Securities Act of 1933, as amended, and the qualification requirements of
the California Corporate Securities Law of 1968, as amended. The Company is also
subject to the periodic reporting requirements of Section 13(d) of the
Securities Exchange Act of 1934, as amended, which include, but are not limited
to, annual, quarterly and other current reports with the Securities and Exchange
Commission.
The Company is a bank holding company registered under the Bank Holding Company
Act of 1956 (the "Act") and is subject to supervision by the Board of Governors
of the Federal Reserve System (the "Board"). As a bank holding company, the
Company must file with the Board quarterly reports, annual reports, and such
other additional information as the Board may require pursuant to the Act. The
Board also examines the Company and its subsidiaries on a regular basis.
The Act requires prior approval of the Board for, among other things, the
acquisition by a bank holding company of direct or indirect ownership or control
of more than 5% of the voting shares, or substantially all the assets, of any
bank, or for a merger or consolidation by a bank holding company with any other
bank holding company. The Act also prohibits the acquisition by a bank holding
company or any of its subsidiaries of voting shares, or substantially all the
assets, of any bank located in a state other than the state in which the
operations of the bank holding company's banking subsidiaries are principally
conducted, unless the statutes of the state in which the bank to be acquired is
located expressly authorize the acquisition.
With certain limited exceptions, a bank holding company is prohibited from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company that is not a bank or bank holding company and from
engaging directly or indirectly in any activity other than banking or managing
or controlling banks or furnishing services to, or performing services for, its
authorized subsidiaries. A bank holding company may, however, engage in or
acquire an interest in a company that engages in activities that the Board has
determined to be so closely related to banking or to managing or controlling
banks as to be properly incident thereto. In making this determination, the
Board is required to consider whether the performance of an activity reasonably
can be expected to produce benefits to the public, such as greater convenience,
increased competition, or gains in efficiency, which outweigh possible adverse
effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interest or unsound banking practices. The Board is
also empowered to differentiate between activities commenced de novo and
activities commenced by the acquisition, in whole or in part, of a going
concern.
Additional statutory provisions prohibit a bank holding company and any
subsidiary banks from engaging in certain tie-in arrangements in connection with
the extension of credit, sale or lease of property or furnishing of services.
Thus, a subsidiary bank may not extend credit, lease or sell property, or
furnish any services, or fix or vary the consideration for any of the foregoing
on the condition that: (i) a customer obtain or provide some additional credit,
property or service from or to the bank other than a loan, discount, deposit or
trust service; or (ii) the customer obtain or provide some additional credit,
property or service from or to the company or any other subsidiary of the
company; or (iii) the customer not obtain some other credit, property or service
from competitors, except reasonable requirements to assure soundness of the
credit extended. These anti-tying restrictions also apply to bank holding
companies and their non-bank subsidiaries as if they were banks.
The Company's ability to pay cash dividends is subject to restrictions set forth
in the California General Corporation Law. The Bank is a legal entity separate
and distinct from the Company, and is subject to various statutory and
regulatory restrictions on its ability to pay dividends to the Company. See Note
13(c) to the consolidated financial statements for further information regarding
the payment of cash dividends by the Company and the Bank.
The Company is a bank holding company within the meaning of Section 3700 of the
California Financial Code. As such, the Company and its subsidiaries are subject
to examination by, and may be required to file reports with, the Commissioner.
Regulations have not yet been proposed or adopted to implement the
Commissioner's powers under this statute.
The Bank:
The Bank, is a national banking association whose deposit accounts are insured
by the Federal Deposit Insurance Corporation (the "FDIC") up to the maximum
legal limits. The Bank is subject to regulation, supervision, and regular
examination by the OCC. The Bank is a member of the Federal Reserve System, and,
as such, is subject to certain provisions of the Federal Reserve Act and
regulations issued by the Board. The Bank is also subject to applicable
provisions of California law, insofar as they are not in conflict with, or
preempted by, federal law. The regulations of these various agencies govern most
aspects of the Bank's business, including reserves against deposits, interest
rates payable on deposits, loans, investments, mergers and acquisitions,
borrowings, dividends and location of branch offices.
7
Recent Legislation and Regulations Affecting Banking:
From time to time, new laws are enacted which increase the cost of doing
business, limit permissible activities, or affect the competitive balance
between banks and other financial institutions. Proposals to change the laws and
regulations governing the operations and taxation of bank holding companies,
banks and other financial institutions are frequently made in Congress, in the
California legislature and before various bank holding company and bank
regulatory agencies. The likelihood of any major changes and the impact such
changes might have are impossible to predict. Certain significant recently
proposed or enacted laws and regulations are discussed below.
Interstate Banking. Beginning in 1986, California permitted California banks and
bank holding companies to be acquired by banking organizations based in other
states on a "reciprocal" basis (i.e., provided the other state's laws permit
California banking organizations to acquire banking organizations in that state
on substantially the same terms and conditions applicable to local banking
organizations). Since October 2, 1995, California law implementing certain
provisions of prior federal law have (1) permitted interstate merger
transactions; (2) prohibited interstate branching through the acquisition of a
branch business unit located in California without acquisition of the whole unit
of the California bank; and (3) prohibited interstate branching through de novo
establishment of California branch offices. Initial entry into California by an
out-of-state institution must be accomplished by acquisition of or merger with
an existing whole bank which has been in existence for at least five years.
Capital Requirements. Federal regulation imposes upon all FDIC-insured financial
institutions a variable system of risk-based capital guidelines designed to make
financial institution capital requirements sensitive to differences in risk
profiles among banking organizations, to take into account off-balance sheet
exposures and to aid in making the definition of bank capital uniform
internationally. Under the risk-based capital guidelines, the Bank is required
to maintain capital equal to at least 8 percent of its assets, weighted by risk.
Assets and off-balance sheet items are categorized by the guidelines according
to risk, and certain assets considered to present less risk than others permit
maintenance of capital below the 8 percent level. The guidelines established two
categories of qualifying capital: Tier 1 capital comprising core capital
elements, and Tier 2 comprising supplementary capital requirements. At least
one-half of the required capital must be maintained in the form of Tier 1
capital. For the Bank, Tier 1 capital includes only common stockholders' equity
and retained earnings, but qualifying perpetual preferred stock would also be
included without limit if the Bank were to issue such stock. Tier 2 capital
includes, among other items, limited life and cumulative preferred stock,
mandatory convertible securities, subordinated debt, and a limited amount of the
institution's allowance for loan and lease losses.
The risk-based capital guidelines also require insured institutions to maintain
a minimum leverage ratio of 3 percent Tier 1 capital to total assets (the
"leverage ratio"). The OCC emphasizes that the leverage ratio constitutes a
minimum requirement for the most well run banking organizations. All other
banking organizations are required to maintain a minimum leverage ratio ranging
generally from 4 to 5 percent. The Bank's required minimum leverage ratio is 4
percent.
In 1996, the federal banking agencies issued a joint agency policy statement
regarding the management of interest-rate risk exposure . Interest rate risk is
the risk that changes in market interest rates might adversely affect a bank's
financial condition. The goal of the policy is to ensure that institutions with
high levels of interest-rate risk have sufficient capital to cover their
exposures to risk. The policy statement reflected the agencies' decision at that
time not to promulgate a standardized measure and explicit capital charge for
interest rate risk, in the expectation that industry techniques for measurement
of such risk will evolve.
Also in 1996, the Federal Financial Institutions Examination Council ("FFIEC")
approved an updated Uniform Financial Rating System ("UFIRS"). The UFIRS
utilizes the "CAMELS" rating system, which classifies and evaluates the
soundness of financial institutions based upon an evaluation of capital
adequacy, asset quality, management, earnings, liquidity and sensitivity to
market risk, which is intended to reflect the degree to which changes in
interest rates, foreign exchange rates, commodity prices or equity prices may
adversely affect an institution's earnings and capital.
As of December 31, 2002, the Bank's total risk-based capital ratio was
approximately 11.16 percent and its leverage ratio was approximately 8.22
percent. The Bank does not presently expect that compliance with the risk-based
capital guidelines, minimum leverage sensitivity to market risk requirements
will have a materially adverse effect on its business in the reasonably
foreseeable future.
During 2002 the Holding Company contributed $2 million into the bank as
contributed capital which is included in Tier 1 capital for regulatory capital
adequacy determination purposes. The funds were made available as a result of a
$5 million trust preferred securities offering. The securities offering is
discussed in Note 17 to the consolidated financial statements.
8
Deposit Insurance Assessments. In 1995 the FDIC reduced bank deposit insurance
assessment rates to a range from $0 to $.27 per $100 of deposits, with the
assessment amount charged to a particular financial institution based upon the
risk the institution is perceived to present to the deposit insurance fund. The
FDIC has continued these reduced assessment rates through 2002. Based upon the
above risk-based assessment rate schedule, the Bank's current capital ratios,
the Bank's current level of deposits, and assuming no further change in the
assessment rate applicable to the Bank during 2003, the Bank estimates that its
annual noninterest expense attributed to the regular assessment schedule will
not increase during 2003.
Prompt Corrective Action. The Prompt Corrective Action Regulations (the "PCA
Regulations") of the federal bank regulatory agencies establish the following
five capital categories in descending order: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. Assignment to a capital category depends upon an 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. The Bank has been classified
as a well-capitalized bank since adoption of the PCA Regulations.
Community Reinvestment Act. Community Reinvestment Act ("CRA") regulations
evaluate banks' lending to low and moderate income individuals and businesses
across a four-point scale from "outstanding" to "substantial noncompliance," and
are a factor in regulatory review of applications to merge, establish new
branches or form bank holding companies. In addition, any bank rated in
"substantial noncompliance" with the CRA regulations may be subject to
enforcement proceedings. The Bank has a current rating of "satisfactory" CRA
compliance.
Safety and Soundness Standards. Federal bank regulatory agency safety and
soundness standards for insured financial institutions establish standards for
(1) internal controls, information systems and internal audit systems; (2) loan
documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset
growth; and (6) compensation, fees and benefits. In addition, the standards
prohibit the payment of compensation which is excessive or which could lead to
material financial loss. 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. Agencies may elect to initiate enforcement action
in certain cases where failure to meet one or more of the standards could
threaten the safe and sound operation of the institution. The Bank has not been
and does not expect to be required to submit a safety and soundness compliance
plan because of a failure to meet any of the safety and soundness standards.
Permitted Activities. In recent years, the Federal banking agencies, especially
the OCC and the Board, have taken steps to increase the types of activities in
which national banks and bank holding companies can engage, and to make it
easier to engage in such activities. In particular, the OCC has issued
regulations permitting national banks to engage in a wide range of activities
through subsidiaries. "Eligible institutions" (national banks that are well
capitalized, have a high overall rating and a satisfactory CRA rating, and are
not subject to an enforcement order) may engage in activities related to banking
through operating subsidiaries after going through an expedited application
process. In addition, the regulations include a provision whereby a national
bank may apply to the OCC to engage in an activity through a subsidiary in which
the bank itself may not engage.
Monetary Policies. Banking is a business in which profitability depends on rate
differentials. In general, the differences between the interest rate received by
a bank on loans extended to its customers and securities held in that bank's
investment portfolio and the interest rate paid on its deposits and its other
borrowings constitute the major portion of the bank's earnings. To the extent
that a bank is not able to compensate for increases in the cost of deposits and
other borrowings with greater income from loans, securities and fees, the net
earnings of that bank will be reduced. The interest rates paid and received by
any bank are highly sensitive to many factors that are beyond the control of
that bank, including the influence of domestic and foreign economic conditions.
See Item 7 herein, Management's Discussion and Analysis of Financial Condition
and Results of Operations.
The earnings and growth of a bank are also affected by the monetary and fiscal
policy of the United States Government and its agencies, particularly the Board.
These agencies can and do implement national monetary policy, which is used in
part to curb inflation and combat recession. Among the instruments of monetary
policy used by these agencies are open market transactions in United States
Government securities, changes in the discount rates of member bank borrowings,
and changes in reserve requirements. The actions of the Board have had a
significant effect on banks' lending, investments and deposits, and such actions
are expected to continue to have a substantial effect in the future. However,
the nature and timing of any further changes in such policies and their impact
on banks cannot be predicted.
9
Financial Services Modernization Legislation. The Gramm-Leach-Bliley Act of 1999
(the "Modernization Act") repealed two affiliation provisions of the
Glass-Steagall Act: Section 20, which restricted the affiliation of Federal
Reserve member banks with firms "engaged principally" in specified securities
activities; and Section 32, which restricted officer, director, or employee
interlocks between a member bank and any company or person "primarily engaged"
in specified securities activities. In addition, the Modernization Act also
expressly preempts any state law restricting the establishment of financial
affiliations, primarily related to insurance. The law establishes a
comprehensive framework to permit affiliations among commercial banks, insurance
companies, securities firms, and other financial service providers by revising
and expanding the BHC Act framework to permit a holding company system to engage
in a full range of financial activities through a new entity known as a
Financial Holding Company. "Financial activities" is broadly defined to include
not only banking, insurance, and securities activities, but also merchant
banking and additional financial activities or complementary activities that do
not pose a substantial risk to the safety and soundness of depository
institutions or the financial system generally.
In order for the Company to take advantage of the ability provided by the
Modernization Act to affiliate with other financial service providers, it must
become a "Financial Holding Company." To do so, the Company would file a
declaration with the Federal Reserve electing to engage in activities
permissible for Financial Holding companies and certifying that it is eligible
to do so because its insured depository institution subsidiary (the Bank) is
well-capitalized and well-managed. In addition, the Federal Reserve must also
determine that an insured depository institution subsidiary has at least a
"satisfactory" rating under the Community Reinvestment Act. The Company
currently meets the requirements for Financial Holding Company status. The
Company will continue to monitor its strategic business plan to determine
whether, based on market conditions and other factors, the Company wishes to
utilize any of its expanded powers provided in the Modernization Act.
Under the Modernization Act, securities firms and insurance companies that elect
to become Financial Holding Companies may acquire banks and other financial
institutions. The Company does not believe that the Modernization Act will have
a material adverse effect on its operations in the near-term. However, to the
extent that it permits banks, securities firms, and insurance companies to
affiliate, the financial services industry may experience further consolidation.
The Modernization Act is intended to grant to community banks certain powers as
a matter of right that larger institutions have accumulated on an ad hoc basis.
Nevertheless, the Act may have the result of increasing the amount of
competition that the Company and the Bank face from larger institutions and
other types of companies offering financial products, many of which may have
substantially more financial resources than the Company and the Bank.
Privacy Provisions of the Modernization Act. The Modernization Act required
federal banking regulators to adopt rules limiting the ability of banks and
other financial institutions to disclose nonpublic information about consumers
to nonaffiliated third parties. The rules require disclosure of privacy policies
to consumers and, in some circumstances, allow consumers to prevent disclosure
of certain personal information to nonaffiliated third parties. The privacy
provisions of the Modernization Act also affect how consumer information may be
transmitted through diversified financial services companies and conveyed to
outside vendors.
Regulation W. On December 12, 2002, the Federal Reserve adopted Regulation W,
the rule that comprehensively implements sections 23A and 23B of the Federal
Reserve Act. The rule is effective April 1, 2003.
Sections 23A and 23B and Regulation W limit the risks to a bank from
transactions between the bank and its affiliates and limit the ability of a bank
to transfer to its affiliates the benefits arising from the bank's access to
insured deposits, the payment system and the discount window and other benefits
of the Federal Reserve system. The statute and rule impose quantitative and
qualitative limits on the ability of a bank to extend credit to, or engage in
certain other transactions with, an affiliate (and a nonaffiliate if an
affiliate benefits from the transaction). However, certain transactions that
generally do not expose a bank to undue risk or abuse the safety net are
exempted from coverage under Regulation W.
Historically, a subsidiary of a bank was not considered an affiliate for
purposes of Sections 23A and 23B, since their activities were limited to
activities permissible for the bank itself. The GLB Act authorized "financial
subsidiaries" that may engage in activities not permissible for a bank. These
financial subsidiaries are now considered affiliates. Certain transactions
between a financial subsidiary and another affiliate of a bank are also covered
by sections 23A and 23B under Regulation W.
10
Regulation W has certain exemptions, including:
o For state-chartered banks, an exemption for subsidiaries
lawfully conducting nonbank activities before issuance of the
final rule.
o An exemption for extensions of credit by a bank under a
general purpose credit card where the borrower uses the credit
to purchase goods or services from an affiliate of the bank,
so long as less than 25 percent of the aggregate amount of
purchases with the card are purchases from an affiliate of the
bank (a bank that does not have nonfinancial affiliates is
exempt from the 25 percent test).
o An exemption for loans by a bank to a third party secured by
securities issued by a mutual fund affiliate of the bank
(subject to a number of conditions).
o An exemption that would permit a banking organization to
engage more expeditiously in internal reorganization
transactions involving a bank's purchase of assets from an
affiliate (subject to a number of conditions.
The final rule contains new valuation rules for a bank's investments in, and
acquisitions of, affiliates.
The Federal Reserve expects examiners and other supervisory staff to review
intercompany transactions closely for compliance with the statutes and
Regulation W and to resolve any violations or potential violations quickly.
Sarbanes-Oxley Act. The Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley")
implemented legislative reforms intended to address corporate and accounting
fraud. In addition to the establishment of a new accounting oversight board that
will enforce auditing, quality control and independence standards and will be
funded by fees from all publicly traded companies, Sarbanes-Oxley places certain
restrictions on the scope of services that may be provided by accounting firms
to their public company audit clients. Any non-audit services being provided to
a public company audit client will require preapproval by the company's audit
committee. In addition, Sarbanes-Oxley makes certain changes to the requirements
for accounting firm partner rotation after a period of time. Sarbanes-Oxley
requires chief executive officers and chief financial officers, or their
equivalent, to certify to the accuracy of periodic reports filed with the SEC,
subject to civil and criminal penalties if they knowingly or willingly violate
the certification requirement. In addition, under Sarbanes-Oxley, counsel are
required to report evidence of a material violation of the securities laws or a
breach of fiduciary duty by a company to its chief executive officer or its
chief legal officer, and, if such officer does not appropriately respond, to
report such evidence to the audit committee or other similar committee of the
board of directors or to the board itself.
Under Sarbanes-Oxley, longer prison terms will apply to corporate executives who
violate federal securities laws; the period during which certain types of suits
can be brought against a company or its officers is extended; and bonuses issued
to top executives prior to restatement of a company's financial statements are
subject to disgorgement if the restatement was due to corporate misconduct.
Executives are also prohibited from insider trading during retirement plan
"blackout" periods, and loans to company executives (other than loans by
financial institutions permitted by federal rules and regulations) are
restricted. In addition, a provision directs that civil penalties levied by the
SEC as a result of any judicial or administrative action under Sarbanes-Oxley be
deposited to a fund for the benefit of harmed investors. The legislation
accelerates the time frame for disclosures by public companies, as they must
immediately disclose any material changes in their financial condition or
operations. Directors and executive officers must also provide information for
most changes in ownership in a company's securities generally within two
business days of the change.
Sarbanes-Oxley also increases responsibilities and codifies certain requirements
relating to audit committees of public companies and how they interact with the
company's "registered public accounting firm." Audit Committee members must be
independent and are absolutely barred from accepting consulting, advisory or
other compensatory fees from the issuer. In addition, companies must disclose
whether at least one member of the committee is a "financial expert" (as defined
by the SEC) and if not, why not. A company's public accounting firm is
prohibited from performing audit services for the company if the company's chief
executive officer, chief financial officer, comptroller, chief accounting
officer or any person serving in equivalent positions had been employed by the
auditor and participated in the company's audit during the year preceding the
audit initiation date. Sarbanes-Oxley also prohibits any officer or director of
a company or any other person acting under their direction from taking any
action to fraudulently influence, coerce, manipulate or mislead any independent
accountant engaged in the audit of the company's financial statements for the
purpose of rendering the financial statements materially misleading.
Sarbanes-Oxley requires the SEC to prescribe rules requiring inclusion of any
internal control report and assessment by management in the annual report to
shareholders. Sarbanes-Oxley also requires the public accounting firm that
issues a company's audit report to attest to and report on management's
assessment of the company's internal controls.
11
Although the Company anticipates that it will incur additional expense in
complying with the provisions of Sarbanes-Oxley, management does not expect that
compliance will have a material impact on the Company's financial condition or
results of operations.
Source of Strength Policy. According to FRB policy, bank holding companies are
expected to act as a source of financial strength to each subsidiary bank and to
commit resources to support each such subsidiary.
USA PATRIOT Act. The terrorist attacks in September, 2001 impacted the financial
services industry and led to the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the
"USA PATRIOT Act"). Part of the USA Patriot Act is the International Money
Laundering Abatement and Financial Anti-Terrorism Act of 2001 ("IMLAFATA").
IMLAFATA authorizes the Secretary of the Treasury, in consultation with the
heads of other government agencies, to adopt special measures applicable to
banks, bank holding companies, and/or other financial institutions. These
measures may include enhanced recordkeeping and reporting requirements for
certain financial transactions that are of primary money laundering concern, due
diligence requirements concerning the beneficial ownership of certain types of
accounts, and restrictions or prohibitions on certain types of accounts with
foreign financial institutions.
Among its other provisions, IMLAFATA requires each financial institution to: (i)
establish an anti-money laundering program; (ii) establish due diligence
policies, procedures and controls with respect to its private banking accounts
and correspondent banking accounts involving foreign individuals and certain
foreign banks; and (iii) avoid establishing, maintaining, administering, or
managing correspondent accounts in the United States for, or on behalf of, a
foreign bank that does not have a physical presence in any country. In addition,
IMLAFATA contains a provision encouraging cooperation among financial
institutions, regulatory authorities and law enforcement authorities with
respect to individuals, entities and organizations engaged in, or reasonably
suspected of engaging in, terrorist acts or money laundering activities.
IMLAFATA expands the circumstances under which funds in a bank account may be
forfeited and requires covered financial institutions to respond under certain
circumstances to requests for information from federal banking agencies within
120 hours. IMLAFATA also amends the Bank Holding Company Act and the Bank Merger
Act to require the federal banking agencies to consider the effectiveness of a
financial institution's anti-money laundering activities when reviewing an
application under these acts.
Treasury regulations implementing the due diligence requirements must be issued
no later than April 24, 2002. Whether or not regulations are adopted, IMLAFATA
becomes effective July 23, 2002. Additional regulations are to be adopted during
2002 to implement minimum standards to verify customer identity, to encourage
cooperation among financial institutions, federal banking agencies, and law
enforcement authorities regarding possible money laundering or terrorist
activities, to prohibit the anonymous use of "concentration accounts," and to
require all covered financial institutions to have in place a Bank Secrecy Act
compliance program.
The Company is establishing policies and procedures to ensure compliance with
the IMLAFATA. As of the date of this filing, the Company has not determined the
impact that IMLAFATA will have on the Company's operations.
Cross-Institution Assessments. Any insured depository institution owned by the
Company can be assessed for losses incurred by the FDIC in connection with
assistance provided to, or the failure of, any other depository institution
owned by the Company.
Audit Requirements. The Bank is required to have an annual independent audit and
to prepare all financial statements in accordance with generally accepted
accounting principles. The Bank is also required to have an independent audit
committee comprised entirely of outside directors. Under National Association of
Securities Dealers (NASD) on-time certifications, the Company has certified that
the audit committee has adopted a formal written charter and meets the requisite
number of directors, independence and qualification standards.
Other Consumer Protection Laws and Regulations. The bank regulatory agencies
closely monitor an institution's compliance with consumer protection laws and
regulations. The examination and enforcement activities conducted by these
agencies are intense, and banks have been advised to focus on compliance with
consumer protection laws and their implementing regulations. The federal
Interagency Task Force on Fair Lending has issued a policy statement on
discrimination in home mortgage lending which describes three methods that
federal agencies will use to prove discrimination: overt evidence of
discrimination, evidence of disparate treatment, and evidence of disparate
impact. In addition to CRA and fair lending requirements, the Bank is subject to
numerous other federal consumer protection statutes and regulations. Due to
heightened regulatory concern related to compliance with consumer protection
laws and regulations generally, the Bank may incur additional compliance costs
or be required to expend additional funds for investments in the local
communities it serves.
Proposed Legislation and Regulation. Certain legislative and regulatory
proposals that could affect the Bank and the banking business in general are
pending or may be introduced before the United States Congress, the California
State Legislature and Federal and state government agencies. The United States
Congress regularly considers bills designed to substantially reform
12
banking laws. It is not known whether any of these legislative proposals will be
enacted and what effect such legislation would have on the structure, regulation
and competitive relationships of financial institutions. It is likely, however,
that many of these proposals would subject the Bank to increased regulation,
disclosure and reporting requirements and would increase competition to the Bank
and its cost of doing business.
In addition to pending legislative changes, the various banking regulatory
agencies frequently propose rules and regulations to implement and enforce
already existing legislation. It cannot be predicted whether or in what form any
such rules or regulations will be enacted or the effect that such rules and
regulations may have on the Bank's business.
The above description of the business of the Bank should be read in conjunction
with Item 7 herein, Management's Discussion and Analysis of Financial Condition
and Results of Operations.
13
ITEM 2. PROPERTIES
The Bank owns a 0.861 acre lot located at the corner of Ham Lane and Tokay
Street, Lodi, California. A 34,000 square foot, tri-level commercial building
for the main branch and administrative offices of the Company and the Bank was
constructed on the lot. The Company and the Bank use approximately 75% of the
leasable space in the building and the remaining area is either leased or
available for lease as office space to other tenants. The construction of this
building in 1991 has enabled the Bank to better serve its customers with more
teller windows, four drive-through lanes and expanded safe deposit box capacity.
The Company owns a 10,000 square foot lot located on Lower Sacramento Road in
the unincorporated San Joaquin County community of Woodbridge, California. The
entire parcel has been leased to the Bank on a long-term basis at market rates.
The Bank has constructed, furnished and equipped a 1,437 square foot branch
office on the parcel and commenced operations of the Woodbridge Branch at that
location on December 15, 1986.
The Bank assumed a long-term ground lease on 1.7 acres of land at 19000 North
Highway 88, Lockeford, California. The building previously occupying the Lodi
site at 701 South Ham Lane was moved to Lockeford, California, and has become
the permanent branch office of the Bank at that location. A temporary 1,000
square foot office had been used by the Bank at the Lockeford location. The
permanent office was opened on April 1, 1991. The temporary office, along with a
portion of the permanent building, is leased by the Bank to two tenants.
On February 22, 1997, the Bank acquired the Galt, Plymouth and San Andreas
branches of Wells Fargo Bank. The transaction included the assumption of the
6,000 square foot branch building lease in Galt with a remaining term of two
years, and the purchase of the branch building and land for the Plymouth and San
Andreas offices. The Plymouth and San Andreas offices are approximately 1,200
and 5,500 square feet, respectively. In November 1998, upon expiration of the
Galt lease, the Galt branch was relocated to a new 3,000 square foot leased
facility one block west of the old location. The new Galt location is leased
under a five-year lease with three successive five-year renewal options.
In January 1998, the Bank opened a 1,220 square foot loan production office in
Folsom, California. The office was leased for one year with a one-year renewal
option that has been exercised by the Bank. In July 1999, the Bank received
approval to operate the Folsom office as a full-service branch. In December
1999, the lease was extended for one year to allow the Bank time to identify a
permanent location in the Folsom community. In December 2000, the Landlord
agreed to extend the lease on a month-to-month basis while the Bank completed
the process of moving into a new full-service branch location. In January 2001,
the Bank entered into a 10-year lease for a 2,426 square foot full-service
branch location in the Folsom area. In July 2001, the new Folsom branch became
fully operational and the former branch was subsequently closed.
In August 1998, the Bank opened a 4,830 square foot full service branch in Elk
Grove, California. The office is leased under a three-year lease with two
successive three-year renewal options. In January 2001, the Bank entered into a
three-year lease for a 1,557 square foot Small Business Administration loan
production office in the Folsom area.
ITEM 3. LEGAL PROCEEDINGS
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public trading market for the common stock of the
Company. The Company's common stock is traded in the over-the-counter market on
the Over-the-Counter Bulletin Board (OTCBB) under the symbol "FLLC" and is not
presently listed on a national exchange or reported by the NASDAQ Stock Market.
Trading of the stock has been limited and has been principally contained within
the Company's general service area. As of March 3, 2003, there were 1,203
shareholders of record of the Company's common stock. Set forth below is the
range of high and low bid prices for the common stock during 2002 and 2001 and
is based on information obtained from the OTCBB.
2002 2001
Bid Price of Common Shares High Low High Low
First Quarter $ 11.35 10.40 10.13 9.00
Second Quarter 12.50 11.00 9.87 9.12
Third Quarter 11.88 11.65 10.42 9.00
Fourth Quarter 12.65 11.71 11.15 9.90
The foregoing prices are based on trades of which Company is aware and reflect
inter-dealer prices, without retail mark-up, mark-down or commissions, and may
not necessarily represent actual transactions.
The Company has not declared or paid any cash dividends on its common stock in
its two most recent fiscal years. The Company's principal source of funds for
dividend payments is dividends received from the Bank. Future dividend payments
by the Bank, if any, will be subject to regulatory limitations, earnings,
general economic conditions, financial condition, capital requirements, and
other factors as may be appropriate in determining dividend policy. The OCC has
authority to prohibit a bank from engaging in business practices that are
considered to be unsafe or unsound. Depending upon the financial condition of a
bank and upon other factors, the OCC could assert that payments of dividends or
other payments by a bank might be such an unsafe or unsound practice. Also,
under applicable Federal laws a national bank must seek permission from the OCC
to pay a dividend if the total dividend payment in any calendar year exceeds the
net profits of that year, as defined, combined with net profits for the two
preceding years. For legal and regulatory restrictions on the payment of
dividends see "Item I. Business - The Company" and "Supervision and Regulation."
For the amount available for dividends at December 31, 2002, see Note 13 to the
notes to consolidated financial statements filed with this report. No assurance
can be given that the Bank will pay dividends at any time.
15
ITEM 6. SELECTED FINANCIAL DATA
(in thousands except per share amounts)
Consolidated Statement of Income 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Income $ 13,677 13,858 13,496 12,526 11,508
Interest Expense 3,459 4,644 4,613 3,699 4,028
Net Interest Income 10,218 9,214 8,883 8,827 7,480
Provision for Loan Losses 625 391 135 1,051 250
Noninterest Income 4,703 3,828 2,690 2,461 1,878
Noninterest Expense 12,486 11,226 9,855 8,803 7,712
Net Income $ 1,355 1,207 1,283 1,159 1,052
Per Share Data
- ------------------------------------------------------------------------------------------------------------------------------------
Basic Earnings $ .82 .75 .81 .75 .69
Diluted Earnings .79 .73 .79 .72 .65
Cash Dividends Declared $ -- -- .05 .20 .20
Consolidated Balance Sheet Data
- ------------------------------------------------------------------------------------------------------------------------------------
Federal Funds Sold and Securities
Purchased Under Resale Agreements $ 19,634 6,129 10,115 100 4,800
Investment Securities 33,125 41,015 29,560 36,096 45,647
Loans held for sale 7,578 3,876 1,292 647 2,619
Loans, net of loss reserve and
deferred fees 154,090 135,430 110,793 108,947 88,459
Total Assets 255,246 226,175 185,064 176,334 164,400
Total Deposits 210,679 201,571 162,261 156,161 149,544
Other Borrowings 19,885 4,000 4,588 4,300 --
Total Stockholders' Equity $ 19,270 17,863 16,454 14,521 13,857
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Prospective Accounting Pronouncements
The Financial Accounting Standards Board (FASB) issued Statement No. 143,
Accounting for Asset Retirement Obligations in August 2001. This Statement
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. As a result, FASB Statement No. 143 applies to all entities that have
legal obligations associated with the retirement of long-lived tangible assets
that result from the acquisition, construction, development or normal use of the
asset. As used in this Statement, a legal obligation results from existing law,
statute, ordinance, written or oral contract, or by legal construction of a
contract under the doctrine of promissory estoppels. Statement No. 143 requires
an enterprise to record the fair value of an asset retirement obligation as a
liability in the period in which it incurs a legal obligation associated with
the retirement of a tangible long-lived asset. Since the requirement is to
recognize the obligation when incurred, approaches that have been used in the
past to accrue the asset retirement obligation over the life of the asset are no
longer acceptable. Statement No. 143 also requires the enterprise to record the
contra to the initial obligation as an increase to the carrying amount of the
related long-lived asset (i.e., the associated asset retirement costs) and to
depreciate that cost over the remaining useful life of the asset. The liability
is changed at the end of each period to reflect the passage of time (i.e.,
accretion expense) and changes in the estimated future cash flows underlying the
initial fair value measurement. Enterprises are required to adopt Statement No.
143 for fiscal years beginning after June 15, 2002. Early adoption is
encouraged. The Company does not expect adoption of Statement No. 143 to have a
material impact to the consolidated financial statements of the Company.
In April 2002, FASB issued Statement Financial Accounting Standards (SFAS) No.
145. Statement No. 145 rescinds SFAS No. 4, which requires all gains and losses
from extinguishment of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. As a result, the criteria
in Opinion No. 30 will now be used to classify those gains and losses. SFAS No.
64 amended SFAS No. 4, and is no longer necessary because SFAS No. 4 has been
rescinded. The accounting, disclosure and financial statements provision of SFAS
No. 145 are effective for financial statements in fiscal years beginning after
May 15, 2002. Any gain or loss on extinguishment of debt that was classified as
an extraordinary item in prior periods presented that does not meet the criteria
in Opinion No. 30 for classification as an extraordinary item shall be
reclassified. The implementation of Statement No. 145 is not expected to have a
material impact to the consolidated financial statements of the Company.
The Financial Accounting Standards Board issued FASB Statement No. 146,
Accounting for Costs Associated with Exit or Disposal Activities in June 2002.
Statement No. 146 requires the Company to recognize costs associated with exit
or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. SFAS 146 replaces Emerging Issues Task
Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The provisions of SFAS 146 are to be
applied prospectively to exit or disposal activities initiated after December
31, 2002.
In October 2002, the FASB issued SFAS 147, which removes certain acquisitions of
financial institutions (other than transactions between two or more mutual
enterprises) from the scope of SFAS 72, Accounting for Certain Acquisitions of
Banking or Thrift Institutions and FASB Interpretation 9, Applying APB Opinions
16 and 17 When a Savings and Loan or a Similar Institution Is Acquired in a
Business Combination Accounted for by the Purchase Method. These types of
transactions are now accounted for under SFAS 141 and 142. In addition, this
Statement amends SFAS 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, to include in its scope long-term customer relationship
intangible assets of financial institutions. The provisions of this Statement
were effective October 1, 2002, with earlier adoption permitted. The
implementation of Statement No. 147 is not expected to have a material impact to
the consolidated financial statements of the Company.
In December 2002, the FASB issued SFAS 148, which provides alternative methods
of transition for a voluntary change to the fair value based method of
accounting for stock-based compensation. In addition, this Statement amends the
disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. Finally, this Statement amends APB Opinion 28, Interim Financial
Reporting, to require disclosure about those effects in interim financial
information. This Statement is effective for fiscal and interim periods ending
after December 15, 2002. Management does not expect this Statement to have a
material impact to the consolidated financial statements. See Note 1(n) to the
consolidated financial statements for stock based compensation disclosures.
17
In November 2002, the FASB issued FIN 45, which elaborates on the disclosures to
be made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of the guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and initial measurement provisions of this
Interpretation are applied prospectively to guarantees issued or modified after
December 31, 2002. The adoption of these recognition provisions will result in
recording liabilities associated with certain guarantees provided by the
Company. These currently include standby letters of credit and first-loss
guarantees on securitizations. The disclosure requirements of this
Interpretation are effective for financial statements of interim or annual
periods ending after December 15, 2002. Management does not expect this
Interpretation to have a material impact to the consolidated financial
statements.
In January 2003, the FASB issued FIN 46, which clarifies the application of
Accounting Research Bulletin ("ARB") 51, consolidated financial statements, to
certain entities (called variable interest entities) in which equity investors
do not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. The disclosure
requirements of this Interpretation are effective for all financial statements
issued after January 31, 2003. The consolidation requirements apply to all
variable interest entities created after January 31, 2003. In addition, public
companies must apply the consolidation requirements to variable interest
entities that existed prior to February 1, 2003 and remain in existence as of
the beginning of annual or interim periods beginning after June 15, 2003.
Management is currently assessing the impact of FIN 46, and does not expect this
Interpretation to have a material impact to the consolidated financial
statements.
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. The preparation of these financial statements requires the
Company to make estimates and judgments that affect the reported amounts of
assets, liabilities, income and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, the Company evaluates its
estimates, including those related to the allowance for loan losses, other real
estate owned, investments and income taxes. 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 believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements. The Company maintains allowances for loan losses resulting
from the customer's inability to make required loan payments. If the financial
conditions of the Company's customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required. The Company invests in debt and equity securities. If the Company
believes these securities have experienced a decline in value that is other than
temporary, an investment impairment charge is recorded. Future adverse changes
in market conditions or poor operating results of underlying investments could
result in losses or an inability to recover the carrying value of the
investments that may not be reflected in an investment's carrying value, thereby
requiring an impairment charge in the future. For a more complete discussion of
the Company's accounting policies, see Note 1 to the consolidated financial
statements.
The following discussion addresses information pertaining to the financial
condition and results of operations of the Company that may not be otherwise
apparent from a review of the consolidated financial statements and related
footnotes. It should be read in conjunction with those statements and notes
found on pages 41 through 66, as well as other information presented throughout
this report.
18
Summary of Earnings Performance
- -------------------------------------------------------------------------------
For the Year Ended December 31:
-------------------------------------------
2002 2001 2000
Earnings (in thousands) $ 1,355 1,207 1,283
- -------------------------------------------------------------------------------
Basic earnings per share $ .82 .75 .81
Diluted earnings per share $ .79 .73 .79
Return on average assets 0.57% 0.59% 0.71%
Return on average equity 7.30% 7.03% 8.74%
Dividend payout ratio -- -- 5.88%
- -------------------------------------------------------------------------------
Average equity to average assets 7.74% 8.34% 8.10%
- -------------------------------------------------------------------------------
Net income totaled $1,355 thousand for the year ended December 31, 2002,
resulting in an increase of $148 thousand, or 12.3%, over the prior year. Basic
earnings per share in 2002 were $.82, compared to $.75 and $.81 in 2001 and
2000, respectively. During 2002, the Company experienced increases in both
earning assets and deposits. As a result of interest income and interest expense
decreasing $181 thousand and $1,185 thousand, respectively, the Company realized
an increase in net interest income to $10,218 thousand as compared to $9,214
thousand in 2001. This represents an increase of $1,004 thousand or 10.9%. As a
result of increases in loans during 2002, the Company increased the provision
for loan losses by $234 thousand as compared to 2001. In addition, the Company
experienced an $875 thousand increase in noninterest income which was offset by
an increase of $1,260 thousand in noninterest expense. Furthermore, the
Company's provision for income taxes increased $237 thousand in 2002 as compared
to 2001.
During 2002, the Company's total gross loans (total portfolio loans plus loans
held for sale) increased 16.0%. While the Company experienced significant growth
in loans during the year, the lower interest rate environment during 2002, when
compared to 2001 reduced the overall earnings potential generated by the
increase in the Company's primary earning asset. As a further benefit to
interest income, the Company was successful in collecting interest totaling $242
thousand and $423 thousand on loans that had previously been on nonaccrual
during 2002 and 2001, respectively. Interest forgone on nonaccrual loans
amounted to $364 thousand during 2002 compared to $310 thousand during 2001.
The lower interest rate environment during 2002, as compared to 2001, also
resulted in a decrease in the Company's total interest expense. The reduction in
interest expense occurred primarily as a result of a decrease in the overall
interest rate paid for deposits combined with a $14.3 million reduction in
Certificates of Deposit. The reduction in Certificates of Deposit resulted from
the Bank focusing its deposit development efforts on core deposit relationships.
Accordingly, excluding certificates of deposit, total deposits increased $23.5
million, or 17.8% during 2002 when compared to 2001.
The Provision for Loan Losses for the year ending December 31, 2002 was $625
thousand, an increase of $234 thousand over 2001's provision of $391 thousand.
The increase in the provision was primarily related to the growth in the
Company's loans.
Noninterest income totaled $4,703 thousand for the year ending December 31, 2002
representing an increase of $875 thousand, or 22.9% over the prior year. The
increase resulted primarily from gains on the sale of investment securities and
loans, increased service charge revenue, which resulted from the increase in
total deposits, increased mortgage lending activity and an increase in the cash
surrender value of life insurance. Total noninterest expense increased $1,260
thousand, or 11.2% during the year primarily as a result of additions to
personnel and the upgrading of existing positions in addition to general overall
increases in the cost of operations incurred with strategic expansion projects.
19
Branch Expansion and Acquisitions
In January 2001, the Bank entered into a three-year lease for a 1,557 square
foot Small Business Administration loan production office in the Folsom area.
During 2001, the Bank was approved as a Certified Lender by the Small Business
Administration (SBA) thereby allowing the department to provide quicker
responses to customer's requests for SBA loans.
In August 1998, the Bank opened a full-service branch in the Elk Grove,
California market. The Elk Grove office is approximately 30 miles north of the
Bank's corporate headquarters in Lodi, California and it effectively expands the
Bank's trade area into South Sacramento County. In January 1998, the Bank opened
a loan production office in the growing market of Folsom, California. The
location was converted to a full-service branch in July 1999 and in July 2001
was relocated to a new site in Folsom. The Folsom office is approximately 45
miles northeast of the Bank's corporate headquarters in Lodi, California and
effectively expanded the Bank's trade area into the greater Sacramento area.
On February 22, 1997, the Bank completed the acquisition of the Galt, Plymouth,
and San Andreas, California, branches of Wells Fargo Bank. The Bank purchased
the premises and equipment of the Plymouth and San Andreas branches and assumed
the building lease for the Galt branch. The Bank also purchased the furniture
and equipment of all three branches and paid a premium for the deposits of each
branch. The total cost of acquiring the branches, including payments to Wells
Fargo Bank as well as other direct costs associated with the purchase, was $2.86
million. The transaction was accounted for using the purchase method of
accounting. Accordingly, the purchase price was allocated first to identifiable
tangible assets based upon those assets' fair value and then to identifiable
intangible assets based upon the assets' fair value. The excess of the purchase
price over identifiable tangible and intangible assets was allocated to
goodwill. Allocations to identifiable tangible assets, identifiable intangible
assets, and goodwill were $856 thousand, $1.98 million, and $24 thousand,
respectively. Deposits totaling $34 million were acquired in the transaction.
20
Net Interest Income
The following table provides a detailed analysis of average earning assets and
liabilities, net interest spread and net interest margin for the years ended
December 31, 2002, 2001, and 2000, respectively:
- ------------------------------------------------------------------------------------------------------------------------------------
For the Year Ended For the Year Ended For the Year Ended
December 31, 2002 December 31, 2001 December 31, 2000
(Dollar amounts in thousands) (Dollar amounts in thousands) (Dollar amounts in thousands)
-------------------------------------------------------------------------------------------------
Average Income/ Average Income/ Average Income/
Balance Expenses Yield Balance Expenses Yield Balance Expense Yield
------- -------- ----- ------- -------- ----- ------- ------- -----
Earning Assets:
Investment securities (1) $ 34,076 1,602 4.70% 35,260 2,073 5.88% 34,690 2,214 6.38%
Federal funds sold and
securities purchased under
resale agreements $ 9,464 158 1.67% 11,360 481 4.23% 5,090 329 6.46%
Loans (2) $ 155,986 11,917 7.64% 123,600 11,304 9.15% 114,690 10,953 9.55%
------- ------ ----- ------- ------ ----- ------- ------ -----
Total Earning Assets $ 199,526 13,677 6.85% 170,220 13,858 8.14% 154,470 13,496 8.74%
======= ====== ===== ======= ====== ===== ======= ====== =====
Liabilities:
Noninterest bearing deposits $ 33,529 -- -- 25,350 -- -- 21,240 -- --
Savings, money market, & NOW
deposits 112,727 1,296 1.15% 91,600 1,297 1.42% 83,970 1,350 1.61%
Time deposits 62,026 1,880 3.03% 66,630 3,342 5.02% 53,020 2,801 5.28%
Other borrowings 8,288 283 3.41% 120 5 4.17% 7,000 462 6.60%
------- ------ ----- ------- ------ ----- ------- ------ -----
Total Liabilities $ 216,570 3,459 1.60% 183,700 4,644 2.53% 165,230 4,613 2.79%
======= ====== ===== ======= ====== ===== ======= ====== =====
Net Spread 5.25% 5.61% 5.95%
===== ===== =====
- ----------------------------------------------------------------------------------------------------------------------------------
Earning Income Earning Income Earning Income
Assets (Expense) Yield Assets (Expense) Yield Assets (Expense) Yield
------ --------- ----- ------ --------- ----- ------ --------- -----
Yield on average earning assets $ 199,526 13,677 6.85% 170,220 13,858 8.14% 154,470 13,496 8.74%
Cost of funds for average
earning assets 199,526 (3,459) (1.73%) 170,220 (4,644) (2.73%) 154,470 (4,613) (2.99%
------ ----- ----- ----- ----- -----
Net Interest Margin 199,526 10,218 5.12% 170,220 9,214 5.41% 154,470 8,883 5.75%
====== ===== ===== ===== ===== =====
- ----------------------------------------------------------------------------------------------------------------------------------
(1) Income on tax-exempt securities has not been adjusted to a tax equivalent
basis.
(2) Loans held for sale and nonaccrual loans are included in the loan totals for
each year.
Net interest income increased $1,004 thousand, or 11% in 2002 after increasing
4% in 2001. While the yield on average earning assets declined to 6.85% in 2002
as compared to 8.14% in 2001, the cost of funds for average earning assets also
decreased to 1.73% in 2002 from 2.73% in 2001. The increase in net interest
income in 2002 is attributable to an increase of 17% in average earning assets
combined with a 14% increase in average deposits, which offset the decline in
net interest margin from 5.41% to 5.12% from 2001 to 2002.
During 2002, average loans, increased $32,386 thousand, or 26%, while investment
securities and federal funds sold and securities purchased under resale
agreements decreased $1,184 thousand and $1,896 thousand, or 3% and 17%,
respectively, compared to 2001. Average deposits increased $24,702 thousand, or
13% during 2002 and other borrowings increased $8,168 thousand, primarily as a
result of a $5 million floating rate pooled trust preferred securities offering
which closed March 26, 2002.
Net interest margin decreased 29 basis points in 2002 after decreasing by 34
basis points in 2001. This decrease in 2002 was the result of several key items:
- - Interest forgone on nonaccrual loans during 2002 totaled $364 thousand.
This reduced the yield on loans by 23 basis points and the net interest
margin by 18 basis points.
o Interest collected on loans that had previously been on
nonaccrual status totaled $242 thousand. This increased the yield
on loans by 16 basis points and the net interest margin by 12
basis points.
21
- - Changes in the mix of the investment portfolio during 2002 resulted in a
decrease of 118 basis points in the average yield earned on investments
securities.
- - The general decrease in interest rates during 2002 resulted in a decrease
of 256 basis points in the average yield earned on federal funds sold and
securities purchased under resale agreements.
- - The general decrease in interest rates during 2002 resulted in a decrease
of 199 basis points in the cost of average certificates of deposit.
Net interest income increased $331 thousand, or 4% in 2001 after increasing 1%
in 2000. The increase in 2001 is attributable to an increase of 10% in average
earning assets combined with a 16% increase in average deposits. In addition,
during 2001, the Company's base lending rate decreased 475 basis points. The
decrease in the base lending rate was consistent with the national decrease in
the prime lending rate during 2001 from 9.50% at December 31, 2000 to 4.75% at
December 31, 2001. The decline in the prime lending rate resulted from the
eleven interest rate reductions by the Federal Reserve during 2001. Furthermore,
while the Company recorded $423 thousand in interest income on nonaccrual loans
during the year, interest forgone on nonaccrual loans totaled $310 thousand.
The mix of earning assets at December 31, 2001 changed as compared to December
31, 2000 as a result of year-over-year loan growth of 24% in 2001 as compared to
2% in 2000. During 2001, average loans, investment securities and federal funds
sold and securities purchased under resale agreements increased $8,910 thousand,
$570 thousand and $6,270 thousand, or 8%, 2% and 123%, respectively, compared to
2000. Average earnings assets increased as a result of a $25,350 thousand, or
16%, increase in average deposits during 2001. As average deposit growth
outpaced average loan growth during the year, the average loan to deposit ratio
decreased to 67% for 2001 as compared to 73% in 2000.
Net interest margin decreased 34 basis points in 2001 after decreasing by 28
basis points in 2000. This decrease in 2001 was the result of several key items:
- - Interest forgone on nonaccrual loans during 2001 totaled $310 thousand.
This reduced the yield on loans by 25 basis points and the net interest
margin by 19 basis points.
o Interest collected on loans that had previously been on
nonaccrual status totaled $423 thousand. This increased the yield
on loans by 35 basis points and the net interest margin by 25
basis points.
Changes in the mix of the investment portfolio during 2001 resulted in a
decrease of 50 basis points in the average yield earned on investments
securities.
- - The general decrease in interest rates during 2001 resulted in a decrease
of 223 basis points in the average yield earned on federal funds sold and
securities purchased under resale agreements.
- - The general decrease in interest rates during 2001 resulted in a decrease
of 26 basis points in the cost of average certificates of deposit.
22
The following table presents the monetary impact of the aforementioned changes
in earning asset and deposit volumes and yields for the two years ended December
31, 2002 and 2001.
- ------------------------------------------------------------------------------------------------------
2002 compared to 2001 2001 compared to 2000
(in thousands) (in thousands)
Change due to: Change due to:
Interest Income: Volume Rate Total Volume Rate Total
-----------------------------------------------------------------------------
Investment securities $ (70) (401) (471) 36 (177) (141)
Federal funds sold and
securities purchased
under resale agreements (80) (243) (323) 405 (253) 152
Loans 2,962 (2,349) 613 851 (500) 351
-------- ------- --- ----- --- ---
Total interest income $ 2,812 (2,993) (181) 1,292 (930) 362
======== ======= ======= ===== === ===
Interest Expense:
Savings, money market, &
NOW accounts $ 384 (385) (1) 111 (164) (53)
Time deposits (231) (1,231) (1,462) 719 (178) 541
Other borrowings 340 (62) 278 (454) (3) (457)
--- -- --- ===== --- ---
Total interest expense $ 493 (1,678) (1,185) 376 (345) 31
======== ======= ======= ===== === ===
Net interest income $ 2,319 (1,315) 1,004 916 (585) 331
======== ======= ======= ===== === ===
- ------------------------------------------------------------------------------------------------------
The volume variances for total interest income in 2002 compared to 2001 indicate
that the increase in average loans of 26% together with decreases in average
investment securities and federal funds sold and securities purchased under
resale agreements of 3% and 17%, respectively, combined for a net increase to
interest income of $2,812 thousand. However, the continued decline of the
interest rate environment during 2002 reduced interest income $2,993 thousand,
as compared to the prior year, with $2,349 thousand of the decrease resulting
from a 151 basis point decline in the yield earned on loans, $401 thousand
decrease resulting from a 118 basis points decline in the yield earned on
investment securities and a $243 thousand decrease resulting from a 256 basis
points decline in the yield earned on federal funds sold and securities
purchased under resale agreements. While average interest bearing liabilities
increased 14% during 2002, the average rate paid on interest bearing liabilities
declined 100 basis points resulting in a net decrease in total interest expense
of $1,462 thousand. In addition, during 2002, other borrowings (which includes
the proceeds from the trust preferred securities) increased $8.2 million
resulting in an increase in total interest expense of $278 thousand.
The total interest income volume variances for 2001 compared to 2000 indicate
that increases in average loans, investment securities and federal funds sold
and securities purchased under resale agreements of 8%, 2% and 123%,
respectively combined to increase interest income by $1,292 thousand. However,
the declining interest rate environment during 2001 reduced interest income $930
thousand, as compared to the prior year, with $500 thousand of the decrease
resulting from a 40 basis point decline in the yield earned on loans, $177
thousand decrease resulting from a 50 basis point decline in the yield earned on
investment securities and a $113 thousand decrease resulting from a 223 basis
points decrease in the yield earned on federal funds sold and securities
purchased under resale agreements. Additionally, while average interest bearing
liabilities increased 11% during 2001, the average rate paid on interest bearing
liabilities decreased 9% resulting in a net increase in total interest expense.
23
Allowance for Loan Losses
The following table reconciles the beginning and ending allowance for loan
losses for the previous five years. Reconciling activity is broken down into the
three principal items that impact the reserve: (1) reductions from charge-offs;
(2) increases from recoveries; and (3) increases or decreases from positive or
negative provisions for loan losses.
- -------------------------------------------------------------------------------------------------------------
(in thousands) 2002 2001 2000 1999 1998
Balance at beginning of period $ 2,668 $ 2,499 $ 2,580 $ 1,564 $ 1,313
Charge-offs:
Commercial 178 226 201 90 67
Real estate 62 -- -- -- 25
Consumer 30 57 45 20 40
------- ------- ------- ------- -------
Total Charge-offs 270 283 246 110 132
Recoveries:
Commercial 26 21 15 68 112
Real estate -- -- -- -- --
Consumer 8 40 15 7 21
------- ------- ------- ------- -------
Total Recoveries 34 61 30 75 133
------- ------- ------- ------- -------
Net charge-offs (236) (222) (216) (35) (1)
Additions charged to operations 625 391 135 1,051 250
------- ------- ------- ------- -------
Balance at end of period 3,057 2,668 2,499 2,580 1,564
======= ======= ======= ======= =======
Ratio of net charge-offs to average loans outstanding
(0.14%) (0.16%) (0.19%) (0.03%) (0.001%)
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------
Note 1(f) to the consolidated financial statement discusses the factors used in
determining the provision for loan losses and the adequacy of the allowance for
loan losses.
Net charge-offs during 2002 totaled $236 thousand and represents an increase of
$14 thousand, or 6%, over 2001. This activity was comprised of $270 thousand in
gross charge-offs combined with $34 thousand in recoveries representing a
decrease of 5% in gross charge-offs and a decrease of 44% in recoveries compared
to 2001. The decrease in both charge-offs and recoveries during 2002 is related
to the reduction of nonaccrual loans. The Bank has not modified or significantly
compromised its underwriting standards despite growing competition within the
industry.
The loan loss provision for 2002 totaled $625 thousand and represents an
increase of $234 thousand, or 60%, over 2001. The provision increased primarily
in response to the increases in loan growth and the potential for declines in
the economy. During 2002, average loans and gross loans (including loans held
for sale) increased 26% and 16%, respectively compared to 2001. Management
remained concerned throughout 2002 about declines in the national economy and
the potential for declines in the credit quality of its borrowers as a result.
During 2002, the Company continued to eliminate nonperforming loans without
incurring substantial charge-offs.
Net charge-offs during 2001 totaled $222 thousand and represents an increase of
$6 thousand, or 3%, over 2000. This activity was comprised of $283 thousand in
gross charge-offs combined with $61 thousand in recoveries representing an
increase of 15% in gross charge-offs and an increase of 103% in recoveries
compared to 2000. The increase in charge-offs during 2001 is related to measures
taken by the Company to reduce the level of nonaccrual loans.
At December 31, 2001, the loan provision totaled $391 thousand and represents an
increase of $256 thousand, or 190%, when compared to December 31, 2000. The
increase in the provision resulted primarily from three events; increases in
loan growth and the potential for declines in the economy combined with the
resolution of several nonperforming loans. While average loans increased 8%
during 2001 as compared to 2000, gross loans (including loans held for sale) at
December 31, 2001 increased 24% as compared to December 31, 2000. In addition,
during 2000, management became increasingly concerned over the potential for
possible declines in the credit quality of its borrowers resulting from declines
in the national economy. Furthermore, the Company eliminated several
nonperforming loans during the year without sustaining substantial charge-offs.
24
Noninterest Income
Noninterest income increased 23% and 42% in 2002 and 2001, respectively. The
primary components of noninterest income consist of: service charges, SBA and
mortgage income, and other noninterest income. The following table summarizes
the significant elements of service charge, SBA, mortgage and Farmer Mac revenue
for the three years ending 2002, 2001, and 2000:
- ------------------------------------------------------------------------------------------------------
(in thousands) 2002 2001 2000
- ------------------------------------------------------------------------------------------------------
Periodic deposit account charges $ 483 492 477
Returned item charges 849 624 561
Ancillary services charges 97 95 99
Other service charges 169 203 124
-------------------------------------------------
Total service charge revenue 1,598 1,414 1,261
=================================================
Gain on sale of SBA loans 331 95 114
SBA loan servicing revenue 206 223 224
-------------------------------------------------
Total SBA revenue 537 318 338
Gain on sale of mortgage loans 640 458 132
Mortgage loan servicing revenue 221 127 123
-------------------------------------------------
Total mortgage revenue 861 585 255
Farmer Mac origination, sale and servicing 34 29 31
-------------------------------------------------
Total loan origination, sale and
servicing revenue 1,432 932 624
- ------------------------------------------------------------------------------------------------------
Service charge revenue increased 13% in 2002 compared to 2001 and 12% in 2001
compared to 2000. These increases are primarily the result of continued growth
in demand deposits. While average total deposits increased 14% in 2002 and 16%
in 2001, average noninterest-bearing demand deposits increased 32% and 19% and
money market accounts increased 78% and 6%, during 2002 and 2001 as compared to
2001 and 2000, respectively.
During 2002, SBA revenue increased 69% after declining 6% and 12% during 2001
and 2000. The increase in 2002 was the result of the sale of $6,904 thousand SBA
7a loans. The declines in 2001 and 2000 SBA revenue resulted primarily from a
decrease in the production of SBA 7a and an increase in the level of SBA 504
loans. The Company typically sells the SBA 7a loans to the secondary market
whereas the SBA 504 loans are typically held in the Company's loan portfolio.
The Company experienced increased mortgage lending activity for both new loans
and refinancing of existing loans due to the continued decline in mortgage
lending rates during 2002. The increased lending activity resulted in an
increase in the Company's mortgage revenue totaling $276 thousand, or 47% from
2002 to 2001 and $330 thousand, or 129% in 2001 as compared to 2000. Farmer Mac
revenue increased 17% in 2002 as compared to 2001 after declining 7% during 2001
as compared to 2000.
The Company realized gains on the sale of investment securities totaling $603
thousand, $267 thousand and $149 thousand in 2002, 2001 and 2000, respectively.
The Company purchased single-premium life insurance policies written on the
lives of certain officers and directors of the Company and the Bank. The
increase in the cash surrender value of these policies is included in other
noninterest income and totaled $649 thousand, $658 thousand and $458 thousand
during 2002, 2001 and 2000, respectively.
25
Noninterest Expenses
Noninterest expenses increased 11% in 2002 compared to 2001 and 14% in 2001
compared to 2000. The increase in noninterest expense during 2002 was primarily
a result of increases in the number of full-time equivalent employees, the cost
of employee benefits, marketing and occupancy expenditures. During 2001, the
Company experienced increases in salaries and employee benefits as a result of
increases in the number of full time equivalent employees combined with
increases in the salaries of a few officer positions within the Company
resulting from upgrades to certain officers titles, duties and responsibilities.
During 2000, the company incurred expenses associated with the resolution of
non-performing loans.
Noninterest expense is broken down into four primary categories each of which is
discussed in this section.
Salaries and Employee Benefits
The following table provides the detail for each major segment of salaries and
employee benefits together with relevant statistical data:
- --------------------------------------------------------------------------------------------------
(in thousands except full time equivalents) 2002 2001 2000
- --------------------------------------------------------------------------------------------------
Regular payroll, contract labor, and overtime $ 4,423 4,054 3,338
Incentive compensation and profit sharing 743 449 233
Payroll taxes and employment benefits 1,146 1,177 935
------------------------------------
Total Salaries and Employee Benefits $ 6,312 5,680 4,506
====================================
Average number of full-time equivalent employees 121 117 109
------------------------------------
Regular payroll per full-time equivalent employee 36.55 34.58 31.02
------------------------------------
Incentive compensation to regular payroll 16.8% 11.1% 5.6%
------------------------------------
Payroll taxes and benefits per full-time equivalent employee 9.47 10.04 8.58
- --------------------------------------------------------------------------------------------------
The number of full-time equivalent employees increased 3% in 2002 compared to
2001 and 7% in 2001 compared to 2000. Regular payroll, contract labor and
overtime increased 9% in 2002 compared to 2001 and 21% in 2001 compared to 2000.
Total salaries and benefits expense increased 11% in 2002 compared to 2001 and
26% in 2001 compared to 2000. The average regular payroll per full-time
equivalent employee increased 6% in 2002 compared to 2001 and increased 11.5% in
2001 compared to 2000.
Incentive compensation includes compensation to bonus awards to employees under
the Incentive Compensation Plan, contributions to the Employee Stock Ownership
Plan and matching contributions to the 401(k) Stock Ownership Plan. The
Incentive Compensation Plan pays incentive compensation to officers based upon
the achievement of specific performance goals within their area of
responsibility combined with the achievement of company-wide performance goals.
Contributions to the Employee Stock Ownership Plan are made at the discretion of
the board of directors based upon profitability. Matching contributions to the
401(k) Stock Ownership Plan are made at the rate of 50% of the first 4% of
compensation contributed by employees.
Payroll taxes and employee benefits per full-time equivalent decreased 6% in
2002 as compared to 2001 and increased 17% in 2001 as compared to 2000. The
decrease in 2002 as compared to 2001 is primarily the result of a $162 thousand
reduction in the supplemental compensation accrual (see Note 9 to the
consolidated financial statements for further information relating to the
Company's supplemental compensation program). Of that amount, $121,000 is
attributable to the forfeiture of an unvested post employment/retirement benefit
by a former executive officer of the Company. The increase from 2001 as compared
to 2000 is related primarily to a $132 thousand and $293 thousand increase
during 2001 and 2000, respectively, in the supplemental compensation accrual,
combined with increases in the Company's contribution to the Employee Stock
Ownership Plan, general increases in the cost of medical and other related
insurance benefits and education and training expenses.
26
Occupancy Expense
The following table provides the detail for each major segment of occupancy
expense:
- -------------------------------------------------------------------------------------------------
(in thousands except square footage and cost per sq. ft.) 2002 2001 2000
- -------------------------------------------------------------------------------------------------
Depreciation 405