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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
[REDDING BANCORP LOGO]
Commission file number 0-25135
REDDING BANCORP
(Exact name of Registrant as specified in its charter)
California 94-2823865
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1951 Churn Creek Road
Redding, California 96002
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (530) 224-3333
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 per share
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
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 to Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $39,298,646 as of December 31, 2001 which was
calculated based on the last reported sale of the Company's Common Stock prior
to December 31, 2001. This calculation does not reflect a determination that
certain persons are affiliates of the Registrant for any other purpose.
As of December 31, 2001, there were 2,703,457 shares of the Registrant's common
stock outstanding.
1
Documents Incorporated By Reference
Items numbered 10 (as to directors), 11 and 12 of Part III incorporate
by reference information from the Registrant's Proxy Statement to be filed with
the Securities and Exchange Commission in connection with the solicitation of
proxies for the Registrant's 2002 Annual Meeting of Shareholders.
PART I
ITEM 1. BUSINESS.
This report includes forward-looking statements within the meaning of the
Securities Exchange Act of 1934 (the "Exchange Act"). These statements are based
on management's beliefs and assumptions, and on information available to
management as of the date of this document. Forward-looking statements include
the information concerning possible or assumed future results of operations of
the Company set forth under the heading "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Forward-looking statements also
include statements in which words such as "expect," "anticipate," "intend,"
"plan," "believe," "estimate," "consider" or similar expressions are used.
Forward-looking statements are not guarantees of future performance. They
involve risks, uncertainties and assumptions, including the risks discussed
under the heading "Risk Factors That May Affect Results" and elsewhere in this
report. The Company's actual future results and shareholder values may differ
materially from those anticipated and expressed in these forward-looking
statements. Many of the factors that will determine these results and values,
including those discussed under the heading "Risk Factors That May Affect
Results," are beyond the Company's ability to control or predict. Investors are
cautioned not to put undue reliance on any forward-looking statements. In
addition, the Company does not have any intention or and assumes no obligation
to update forward-looking statements after the date of the filing of this
report, even if new information, future events or other circumstances have made
such statements incorrect or misleading. Except as specifically noted herein all
referenced to the "Company" refer to Redding Bancorp, a California corporation,
and its consolidated subsidiaries.
General
Redding Bancorp (the "Company") is a financial services holding
company ("FHC") registered under the Bank Holding Company Act of 1956, as
amended, and was incorporated in California on January 21, 1982, for the purpose
of organizing, as a wholly owned subsidiary, Redding Bank of Commerce (the
"Bank"). The Company elected to change to a FHC in 2000. As a financial services
holding company, the Company is subject to the Financial Holding Company Act and
to supervision by the Board of Governors of the Federal Reserve System ("FRB").
The Company's principal business is to serve as a holding company for the Bank
and Redding Service Corporation, a California corporation formed in 1993 for the
purpose of processing trust deeds, and for other banking or banking-related
subsidiaries which the Company may establish or acquire. The Company's principal
source of income is dividends from its subsidiaries. The Company conducts its
corporate business operations at the offices of the Bank located at 1951 Churn
Creek Road, Redding, California 96002. The Company conducts its business
operations in two geographic market areas, Redding and Roseville, California and
within two industry segments, general banking and credit card processing.
The Bank was incorporated as a California banking corporation on
November 25, 1981, and received its certificate of authority to begin banking
operations on October 22, 1982. The Bank operates three full service branches
and one focused-service deposit facility. The Company established its first full
service branch at 1177 Placer Street, Redding, California, and opened for
business on October 22, 1982. On November 1, 1988, the Bank received a
certificate of authority to establish and maintain a loan production office in
Citrus Heights, California. On September 1, 1998, the Company relocated the loan
production office to 2400 Professional Drive in Roseville, California. On March
1, 1994, the Bank received a certificate of authority to open a second
full-service branch at 1951 Churn Creek Road in Redding, California. On June 30,
2000, the Bank received a certificate of authority to convert the loan
production office in Roseville to a full service banking facility under the name
Roseville Banking Center, a division of Redding Banking of Commerce. On June 15,
2001 the Bank acquired the deposit liabilities of FirstPlus Bank at Citrus
Heights, California and has renamed the facility Roseville Banking Center at
Sunrise, a division of Redding Bank of Commerce. On February 22, 2002, the
Eureka office will locate to its permanent location at 1504 Eureka Road, Suite
100, Roseville, California. At this time the office will be renamed Roseville
Bank of Commerce. The Bank is principally supervised and regulated by the
California Department of Financial Institutions ("DFI") and the Federal Deposit
Insurance Corporation ("FDIC"), and conducts a general commercial banking
business in the counties of El Dorado, Placer, Shasta, and Sacramento,
California. The Company considers Upstate California to be the major market area
of the Bank.
2
The services offered by the Bank include those traditionally offered
by commercial banks of similar size and character in California, such as
checking, interest-bearing checking ("NOW") and savings accounts, money market
deposit accounts, commercial, real estate, construction, personal, home
improvement, automobile and other installment and term loans, travelers checks,
safe deposit boxes, collection services and telephone transfers. The primary
focus of the Bank is to provide services to the business and professional
community of its major market area, including Small Business Administration
loans, and payroll and accounting packages. The Bank does not offer trust
services or international banking services and does not plan to do so in the
near future.
Most of the Bank's customers are small to medium sized businesses,
professionals and other individuals with medium to high net worth, and most of
the Bank's deposits are obtained from such customers. The Bank emphasizes
servicing the needs of local businesses and professionals and individuals
requiring specialized services. The primary business strategy of the Bank is to
focus on its lending activities. The Bank's principal lines of lending are (i)
commercial, (ii) real estate construction and (iii) commercial and residential
real estate. The majority of the loans of the Bank are direct loans made to
individuals and small businesses in the major market area of the Bank and are
secured by real estate. See "-Risk Factors That May Affect Results-Dependence on
Real Estate." A relatively small portion of the loan portfolio of the Bank
consists of loans to individuals for personal, family or household purposes. The
Bank accepts real estate, listed and unlisted securities, savings and time
deposits, automobiles, machinery and equipment as collateral for loans.
The commercial loan portfolio of the Bank consists of a mix of
revolving credit facilities and intermediate term loans. The loans are generally
made for working capital, asset acquisition and business expansion purposes and
are generally secured by a lien on the borrowers' assets. The Bank also makes
unsecured loans to borrowers who meet the Bank's underwriting criteria for such
loans. The Bank manages its commercial loan portfolio by monitoring its
borrowers' payment performance and their respective financial condition and
makes periodic and appropriate adjustments, if necessary, to the risk grade
assigned to each loan in the portfolio. The primary sources of repayment of the
commercial loans of the Bank are the borrower's conversion of short-term assets
to cash and operating cash flow. The net assets of the borrower or guarantor are
usually identified as a secondary source of repayment.
The principal factors affecting the Bank's risk of loss from
commercial lending include each borrower's ability to manage its business
affairs and cash flows, local and general economic conditions and real estate
values in the Bank's service area. The Bank manages risk through its
underwriting criteria, which includes strategies to match the borrower's cash
flow to loan repayment terms, and periodic evaluations of the borrower's
operations. The Bank's evaluations of its borrowers are facilitated by
management's knowledge of local market conditions and periodic reviews by a
consultant of the credit administration policies of the Bank.
The real estate construction loan portfolio of the Bank consists of
a mix of commercial and residential construction loans, which are principally
secured by the underlying project. The real estate construction loans of the
Bank are predominately made for projects, which are intended to be owner
occupied. The Bank also makes real estate construction loans for speculative
projects. The principal sources of repayment of the Bank's construction loans
are sale of the underlying collateral or permanent financing provided by the
Bank or another lending source. The principal risks associated with real estate
construction lending include project cost overruns that absorb the borrower's
equity in the project and deterioration of real estate values as a result of
various factors, including competitive pressures and economic downturns. See
"-Risk Factors That May Affect Results-Lending Risks Associated with Commercial
Banking and Construction Activities." The Bank manages its credit risk
associated with real estate construction lending by establishing maximum
loan-to-value ratios on projects on an as-completed basis, inspecting project
status in advance of controlled disbursements and matching maturities with
expected completion dates. Generally, the Bank requires a loan-to-value ratio of
no more than 80% on single-family residential construction loans.
The commercial and residential real estate mortgage loan portfolio
of the Bank consists of loans secured by a variety of commercial and residential
real property. The Bank makes real estate mortgage loans for both owner-occupied
properties and investor properties. The Bank's underwriting criteria for loans
to investors is generally more conservative and such loans constitute a smaller
percentage of the Bank's commercial and residential real estate loan portfolio.
The principal source of repayment of the real estate loans of the Bank is the
Borrower's operating cash flow.
3
Similar to commercial loans, the principal factors affecting the
Bank's risk of loss in real estate mortgage lending include the borrower's
ability to manage its business affairs and cash flows, local and general
economic conditions and real estate values in the Bank's service area. The Bank
manages its credit risk associated with real estate mortgage lending primarily
by establishing maximum loan-to-value ratios and using strategies to match the
borrower's cash flow to loan repayment terms. Approximately 90% of the
residential real estate mortgage loans originated at the Bank are sold in the
secondary market.
The specific underwriting standards of the Bank and methods for each
of its principal lines of lending include industry-accepted analysis and
modeling and certain proprietary techniques. The Bank's underwriting criteria is
designed to comply with applicable regulatory guidelines, including required
loan-to-value ratios. The credit administration policies of the Bank contain
mandatory lien position and debt service coverage requirements, and the Bank
generally requires a guarantee from 20% or more owners of its corporate
borrowers.
In April 1993, the Bank entered into an agreement (the "Merchant
Services Agreement") with Cardservice International, Inc. ("CSI"), an
independent sales organization ("ISO") and nonbank merchant credit card
processor, pursuant to which the Bank has agreed to provide credit and debit
card processing services for merchants solicited by CSI who accept credit and
debit cards as payment for goods and services. Pursuant to the Merchant Services
Agreement, the Bank acts as a clearing bank for CSI and processes credit or
debit card transactions into the Visa(R) or MasterCard(R) system for presentment
to the card issuer. As a result of the Merchant Services Agreement, the Bank has
acquired electronic credit and debit card processing relationships with
merchants in various industries on a nationwide basis. The Merchant Services
Agreement with CSI was renewed in April 2001 for a period of four years.
Effective April 1, 2001, pricing of the contract renewal is .002 percent of
transaction processing and one-half of the earnings on the deposit relationship.
The contract renewal represents a significant decline in revenues from merchant
credit card processing. The Company has been successful in pursuing various
strategies to offset the decline in revenues, including expansion of the
Roseville Bank of Commerce at Eureka, acquisition of the Sunrise location and
projecting aggressive growth in the loan markets.
Merchant bankcard processing services are highly regulated by credit
card associations such as Visa. In order to participate in the credit card
program, Redding Bank of Commerce must comply with the credit card association's
rules and regulations that may change from time to time. During November 1999,
Visa adopted several rule changes to reduce the risk profile in high-risk
acquiring programs and these rule changes affect the Bank's Merchant Services
business segment. These changes include a requirement that an acquiring
processor's reported fraud ratios be no greater than three times the national
average.
Redding Bank of Commerce's overall fraud ratio met and complied
with the Visa requirement. Other Visa changes announced included the requirement
that total processing volume in certain high-risk categories (as defined by
Visa) is less than 20% of total processing volume.
4
Supervision and Regulation
Regulation and Supervision of Bank Holding Companies
The Company is financial services holding company subject to the
Financial Holding Company Act ("FHCA"). The Company reports to, registers with,
and may be examined by, the FRB. The FRB also has the authority to examine the
Company's subsidiaries. The costs of any examination by the FRB are payable by
the Company.
The Company is a bank holding company within the meaning of Section
3700 of the California Financial Code. As such, the Company and the Bank are
subject to examination by, and may be required to file reports with, the
California Commissioner of Financial Institutions (the "Commissioner"). The FRB
has significant supervisory and regulatory authority over the Company and its
affiliates. The FRB requires the Company to maintain certain levels of capital.
See "Capital Standards." The FRB also has the authority to take enforcement
action against any bank holding company that commits any unsafe or unsound
practice, or violates certain laws, regulations or conditions imposed in writing
by the FRB. See "Prompt Corrective Action and Other Enforcement Mechanisms."
Under the FHCA, a company generally must obtain the prior approval
of the FRB before it exercises a controlling influence over a bank, or acquires
directly or indirectly, more than 5% of the voting shares or substantially all
of the assets of any bank or bank holding company. Thus, the Company is required
to obtain the prior approval of the FRB before it acquires, merges or
consolidates with any bank or financial services holding company. Any company
seeking to acquire, merge or consolidate with the Company also would be required
to obtain the prior approval of the FRB.
A financial services holding company may acquire banks in states
other than its home state without regard to the permissibility of such
acquisitions under state law, but subject to any state requirement that the bank
has been organized and operating for a minimum period of time, not to exceed
five years, and the requirement that the bank holding company, prior to or
following the proposed acquisition, controls no more than 10% of the total
amount of deposits of insured depository institutions in the United States and
no more than 30% of such deposits in that state (or such lesser or greater
amount set by state law). Banks may also merge across state lines, therefore
creating interstate branches. Furthermore, a bank is now able to open new
branches in a state in which it does not already have banking operations if the
laws of such state permit such de novo branching.
Under California law, (a) out-of-state banks that wish to establish
a California branch office to conduct core banking business must first acquire
an existing five year old California bank or industrial loan company by merger
or purchase; (b) California state-chartered banks are empowered to conduct
various authorized branch-like activities on an agency basis through affiliated
and unaffiliated insured depository institutions in California and other states
and (c) the Commissioner is authorized to approve an interstate acquisition or
merger which would result in a deposit concentration exceeding 30% if the
Commissioner finds that the transaction is consistent with public convenience
and advantage. However, a state bank chartered in a state other than California
may not enter California by purchasing a California branch office of a
California bank or industrial loan company without purchasing the entire entity
or by establishing a de novo California bank.
The FRB generally prohibits a financial services holding company
from declaring or paying a cash dividend which would impose undue pressure on
the capital of subsidiary banks or would be funded only through borrowing or
other arrangements that might adversely affect a bank holding company's
financial position.
The FRB's policy is that a bank holding company should not continue
its existing rate of cash dividends on its common stock unless its net income is
sufficient to fully fund each dividend and its prospective rate of earnings
retention appears consistent with its capital needs, asset quality and overall
financial condition. See "-Restrictions on Dividends and Other Distributions"
for additional restrictions on the ability on the Company and the Bank to pay
dividends.
Transactions between the Company and the Bank are subject to a
number of other restrictions. FRB policies forbid the payment by bank
subsidiaries of management fees, which are unreasonable in amount or exceed the
fair market value of the services rendered (or, if no market exists, actual
costs plus a reasonable profit).
5
Subject to certain limitations, depository institution subsidiaries
of financial services holding companies may extend credit to, invest in the
securities of, purchase assets from, or issue a guarantee, acceptance, or letter
of credit on behalf of, an affiliate, provided that the aggregate of such
transactions with affiliates may not exceed 10% of the capital stock and surplus
of the institution, and the aggregate of such transactions with all affiliates
may not exceed 20% of the capital stock and surplus of such institution. The
Company may only borrow from depository institution subsidiaries if the loan is
secured by marketable obligations with a value of a designated amount more than
the loan. Further, the Company may not sell a low-quality asset to a depository
institution subsidiary.
Comprehensive amendments to Regulation Y became effective in 1997,
and are intended to improve the competitiveness of financial services holding
companies by, among other things: (i) expanding the list of permissible
nonbanking activities in which well-run bank holding companies may engage
without prior FRB approval, (ii) streamlining the procedures for well-run bank
holding companies to obtain approval to engage in other nonbanking activities
and (iii) eliminating most of the anti-tying restrictions imposed upon bank
holding companies and their nonbank subsidiaries. Amended Regulation Y also
provides for a streamlined and expedited review process for bank acquisition
proposals submitted by well-run bank holding companies and eliminates certain
duplicative reporting requirements when there has been a further change in bank
control or in bank directors or officers after an earlier approved change. These
changes to Regulation Y are subject to numerous qualifications, limitations and
restrictions. In order for a financial services holding company to qualify as
"well-run," both it and the insured depository institutions that it controls
must meet the "well-capitalized" and "well-managed" criteria set forth in
Regulation Y.
To qualify as "well-capitalized," the bank must, on a consolidated
basis: (i) maintain a total risk-based capital ratio of 10% or greater, (ii)
maintain a Tier 1 risk-based capital ratio of 6% or greater and (iii) not be
subject to any order by the FRB to meet a specified capital level. Its lead
insured depository institution must be well-capitalized (as that term is defined
in the capital adequacy regulations of the applicable bank regulator), 80% of
the total risk-weighted assets held by its insured depository institutions must
be held by institutions that are well-capitalized, and none of its insured
depository institutions may be undercapitalized.
To qualify as "well-managed": (i) each of its lead depository
institutions and its depository institutions holding 80% of the total
risk-weighted assets of all its depository institutions at their most recent
examination or review must have received a composite rating, rating for
management and rating for compliance which were at least satisfactory, (ii) none
of the bank holding company's depository institutions may have received one of
the two lowest composite ratings and (iii) neither the bank holding company nor
any of its depository institutions during the previous 12 months may have been
subject to a formal enforcement order or action.
Bank Regulation and Supervision
The Bank is a California chartered bank insured by the Federal
Deposit Insurance Corporation (the "FDIC"), and as such is subject to
regulation, supervision and regular examination by the California Department of
Financial Institutions ("DFI") and the FDIC. As a non-member of the Federal
Reserve System, the primary federal regulator of the Bank is the FRB. The
regulations of these agencies affect most aspects of the Bank's business and
prescribe permissible types of loans and investments, the amount of required
reserves, requirements for branch offices, the permissible scope of the Bank's
activities and various other requirements.
The Bank is also subject to applicable provisions of California law,
insofar as such provisions are not in conflict with or preempted by federal
banking law. In addition, the Bank is subject to certain regulations of the FRB
dealing primarily with check-clearing activities, establishment of banking
reserves, Truth-in-Lending (Regulation Z), Truth-in-Savings (Regulation DD), and
Equal Credit Opportunity (Regulation B).
Under California law, a state chartered bank is subject to various
restrictions on, and requirements regarding, its operations and administration
including the maintenance of branch offices and automated teller machines,
capital and reserve requirements, deposits and borrowings, shareholder rights
and duties, and investment and lending activities. Whenever it appears that the
contributed capital of a California bank is impaired, the Commissioner is
required to order the bank to correct such impairment. If a bank is unable to
correct the impairment, the bank is required to levy and collect an assessment
upon its common shares. If such assessment becomes delinquent, the common shares
are to be sold by the bank.
6
California law permits a state chartered bank to invest in the stock
and securities of other corporations, subject to a state chartered bank
receiving either general authorization or, depending on the amount of the
proposed investment, specific authorization from the Commissioner. The Federal
Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), however,
imposes limitations on the activities and equity investments of state chartered,
federally insured banks. FDICIA also prohibits a state bank from engaging as a
principal in any activity that is not permissible for a national bank, unless
the bank is adequately capitalized and the FDIC approves the activity after
determining that such activity does not pose a significant risk to the bank
deposit insurance fund.
The FDIC rules on activities generally permit subsidiaries of banks,
without prior specific FDIC authorization, to engage in those that have been
approved by the FRB for bank holding companies because such activities are so
closely related to banking to be a proper incident thereto. Other activities
generally require specific FDIC prior approval and the FDIC may impose
additional restrictions on such activities on a case-by-case basis in approving
applications to engage in otherwise impermissible activities.
Capital Standards
The federal banking agencies have risk-based capital adequacy
guidelines intended to provide a measure of capital adequacy that reflects the
degree of risk associated with a banking organization's operations for both
transactions reported on the balance sheet as assets and transactions, such as
letters of credit and recourse arrangements, which are recorded as off balance
sheet items. Under these guidelines, nominal dollar amounts of assets and credit
equivalent amounts of off balance sheet items are multiplied by one of several
risk adjustment percentages, which range from 0% for assets with low credit
risk, such as certain U.S. government securities, to 100% for assets with
relatively higher credit risk, such as certain loans.
In determining the capital level a bank is required to maintain, the
federal banking agencies do not, in all respects, follow accounting principles
generally accepted in the United States of America ("GAAP") and have special
rules which have the effect of reducing the amount of capital that will be
recognized for purposes of determining the capital adequacy of a bank.
A banking organization's risk-based capital ratios are obtained by
dividing its qualifying capital by its total risk-adjusted assets and off
balance sheet items. The regulators measure risk-adjusted assets and off balance
sheet items against both total qualifying capital (the sum of Tier 1 capital and
limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists
of common stock, retained earnings, non-cumulative perpetual preferred stock,
other types of qualifying preferred stock and minority interests in certain
subsidiaries, less most other intangible assets and other adjustments. Net
unrealized losses on available-for-sale equity securities with readily
determinable fair value must be deducted in determining Tier 1 capital. For Tier
1 capital purposes, deferred tax assets that can only be realized if an
institution earns sufficient taxable income in the future are limited to the
amount that the institution is expected to realize within one year, or ten
percent of Tier 1 capital, whichever is less. Tier 2 capital may consist of a
limited amount of the allowance for possible loan and lease losses, term
preferred stock and other types of preferred stock not qualifying as Tier 1
capital, term subordinated debt and certain other instruments with some
characteristics of equity. The inclusion of elements of Tier 2 capital are
subject to certain other requirements and limitations of the federal banking
agencies. The federal banking agencies require a minimum ratio of qualifying
total capital to risk-adjusted assets and off balance sheet items of 8%, and a
minimum ratio of Tier 1 capital to adjusted average risk-adjusted assets and off
balance sheet items of 4%. The Company exceeds the minimum requirements.
On October 1, 1998, the FDIC adopted two rules governing minimum
capital levels that FDIC-supervised banks must maintain against the risks to
which they are exposed. The first rule makes risk-based capital standards
consistent for two types of credit enhancements (i.e., recourse arrangements and
direct credit substitutes) and requires different amounts of capital for
different risk positions in asset securitization transactions. The second rule
permits limited amounts of unrealized gains on debt and equity securities to be
recognized for risk-based capital purposes as of September 1, 1998.
The FDIC rules also provide that a qualifying institution that sells
small business loans and leases with recourse must hold capital only against the
amount of recourse retained.
7
In general, a qualifying institution is one that is well
capitalized under the FDIC's prompt corrective action rules. The amount of
recourse that can receive the preferential capital treatment cannot exceed 15%
of the institution's total risk-based capital.
In addition to the risked-based guidelines, federal banking
regulators require banking organizations to maintain a minimum amount of Tier 1
capital to adjusted average total assets, referred to as the leverage capital
ratio. For a banking organization rated in the highest of the five categories
used by regulators to rate banking organizations, the minimum leverage ratio of
Tier 1 capital to total assets must be 3%. It is improbable; however, that an
institution with a 3% leverage ratio would receive the highest rating by the
regulators since a strong capital position is a significant part of the
regulators' rating. For all banking organizations not rated in the highest
category, the minimum leverage ratio must be at least 100 to 200 basis points
above the 3% minimum. Thus, the effective minimum leverage ratio, for all
practical purposes, must be at least 4% or 5%. In addition to the uniform
risk-based capital guidelines and leverage ratios that apply across the
industry, the regulators have the discretion to set individual minimum capital
requirements for specific institutions at rates significantly above the minimum
guidelines and ratios.
As of December 31, 2001, the Company's and the Bank's capital ratios
exceeded applicable regulatory requirements. The following tables present the
capital ratios for the Company and the Bank, compared to the standards for
well-capitalized depository institutions, as of December 31, 2001.
The Company
---------------------------------------------------------
Actual Minimum Capital Requirement
-------------------------- ----------------------------
Leverage ............. $27,247,887 9.38% 4.0%
Tier 1 Risk-Based .... 27,247,887 11.08 4.0
Total Risk-Based ..... 30,323,015 12.33 8.0
Redding Bank of Commerce
--------------------------------------------------------------
Actual Well Minimum
------------------------- Capitalized Capital
Capital Ratio Requirement Requirement
----------- ----- ----------- -----------
Leverage ............. $26,883,167 9.38% 5.0% 4.0%
Tier 1 Risk-Based .... 26,883,167 10.93 6.0 4.0
Total Risk-Based ..... 29,958,295 12.18 10.0 8.0
Banking agencies must take into consideration concentrations of
credit risk and risks from non-traditional activities, as well as an
institution's ability to manage those risks, when determining the adequacy of an
institution's capital. This evaluation is a part of the institution's regular
safety and soundness examination. Banking agencies must also consider interest
rate risk (when the interest rate sensitivity of an institution's assets does
not match the sensitivity of its liabilities or its off-balance-sheet position)
in evaluation of a banks capital adequacy.
Dividends and Other Distributions
The power of the board of directors of an insured depository
institution to declare a cash dividend or other distribution with respect to
capital is subject to statutory and regulatory restrictions which limit the
amount available for such distribution depending upon the earnings, financial
condition and cash needs of the institution, as well as general business
conditions. FDICIA prohibits insured depository institutions from paying
management fees to any controlling persons or, with certain limited exceptions,
making capital distributions, including dividends, if, after such transaction,
the institution would be undercapitalized.
In addition to the restrictions imposed under federal law, banks
chartered under California law generally may only pay cash dividends to the
extent such payments do not exceed the lesser of retained earnings of the bank
or the bank's net income for its last three fiscal years (less any distributions
to shareholders during such period).
8
In the event a bank desires to pay cash dividends in excess of such
amount, the bank may pay a cash dividend with the prior approval of the
Commissioner in an amount not exceeding the greatest of the bank's retained
earnings, the bank's net income for its last fiscal year, or the bank's net
income for its current fiscal year.
Regulators also have authority to prohibit a depository institution
from engaging in business practices which are considered to be unsafe or
unsound, possibly including payment of dividends or other payments under certain
circumstances even if such payments are not expressly prohibited by statute.
Prompt Corrective Action and Other Enforcement Mechanisms
FDICIA requires each federal banking agency to take prompt
corrective action to resolve the problems of insured depository institutions,
including but not limited to those that fall below one or more prescribed
minimum capital ratios. The law required each federal banking agency to
promulgate regulations defining the following five categories in which an
insured depository institution will be placed, based on the level of its capital
ratios: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized.
Under the prompt corrective action provisions of FDICIA, an insured
depository institution generally will be classified in the following categories
based on the capital measures indicated below:
"Well capitalized" - Bank only "Adequately capitalized"
Total risk-based capital of 10%; Total risk-based capital of 8%;
Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and
Leverage ratio of 5%. Leverage ratio of 4%.
"Undercapitalized" "Significantly undercapitalized"
Total risk-based capital less than 8%; Total risk-based capital less than 6%;
Tier 1 risk-based capital less than 4%; or Tier 1 risk-based capital less than 3%; or
Leverage ratio less than 4%. Leverage ratio less than 3%.
"Critically undercapitalized"
Tangible equity to total assets less than 2%.
An institution that, based upon its capital levels, is classified as
"well capitalized," "adequately capitalized" or "undercapitalized" may be
treated as though it were in the next lower capital category if the appropriate
federal banking agency, after notice and opportunity for hearing, determines
that an unsafe or unsound condition or an unsafe or unsound practice warrants
such treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions. The federal banking agencies,
however, may not treat an institution as "critically undercapitalized" unless
its capital ratio actually warrants such treatment.
If an insured depository institution is undercapitalized, it will be
closely monitored by the appropriate federal banking agency. Undercapitalized
institutions must submit an acceptable capital restoration plan with a guarantee
of performance issued by the holding company. Further restrictions and sanctions
are required to be imposed on insured depository institutions that are
critically undercapitalized. The most important additional measure is that the
appropriate federal banking agency is required to either appoint a receiver for
the institution within 90 days, or obtain the concurrence of the FDIC in another
form of action.
In addition to measures taken under the prompt corrective action
provisions, commercial banking organizations may be subject to potential
enforcement actions by the federal regulators for unsafe or unsound practices in
conducting their businesses or for violations of any law, rule, regulation or
any condition imposed in writing by the agency or any written agreement with the
agency. Enforcement actions may include the imposition of a conservator or
receiver, the issuance of a cease-and-desist order that can be judicially
enforced, the termination of insurance of deposits (in the case of a depository
institution), the imposition of civil money penalties, the issuance of
directives to increase capital, the issuance of formal and informal agreements,
the issuance of removal and prohibition orders against institution-affiliated
parties and the enforcement of such actions through injunctions or restraining
orders based upon a judicial determination that the agency would be harmed if
such equitable relief was not granted. Additionally, a holding company's
inability to serve as a source of strength to its subsidiary banking
organizations could serve as an additional basis for a regulatory action against
the holding company.
9
Safety and Soundness Standards
FDICIA also implemented certain specific restrictions on
transactions and required federal banking regulators to adopt overall safety and
soundness standards for depository institutions related to internal control,
loan underwriting, documentation, and asset growth. Among other things, FDICIA
limits the interest rates paid on deposits by undercapitalized institutions,
restricts the use of brokered deposits, limits the aggregate extensions of
credit by a depository institution to an executive officer, director, principal
shareholder or related interest, and reduces deposit insurance coverage for
deposits offered by undercapitalized institutions for deposits by certain
employee benefits accounts.
The federal banking agencies may require an institution to submit to
an acceptable compliance plan as well as have the flexibility to pursue other
more appropriate or effective courses of action given the specific circumstances
and severity of an institution's noncompliance with one or more standards.
Premiums for Deposit Insurance and Assessments for Examinations
The Bank has its deposits insured by the Bank Insurance Fund ("BIF")
administered by the FDIC. The FDIC is authorized to borrow up to $30 billion
from the United States Treasury; up to 90% of the fair market value of assets of
institutions acquired by the FDIC as receiver from the Federal Financing Bank;
and from depository institutions that are members of the BIF. Any borrowings not
repaid by asset sales are to be repaid through insurance premiums assessed to
member institutions. Such premiums must be sufficient to repay any borrowed
funds within 15 years and provide insurance fund reserves of $1.25 for each $100
of insured deposits. FDICIA also provides authority for special assessments
against insured deposits. No assurance can be given at this time as to what the
future level of premiums will be.
Community Reinvestment Act and Fair Lending Developments
The Bank is subject to certain fair lending requirements and
reporting obligations involving home mortgage lending operations and Community
Reinvestment Act ("CRA") activities. The CRA generally requires the federal
banking agencies to evaluate the record of a financial institution in meeting
the credit needs of their local communities, including low and moderate-income
neighborhoods. In addition to substantive penalties and corrective measures that
may be required for a violation of certain fair lending laws, the federal
banking agencies may take compliance with such laws and CRA into account when
regulating and supervising other activities.
Recently Enacted Legislation
On November 12, 1999, former President Clinton signed into law the
Gramm-Leach-Bliley Act of 1999 (the "Financial Services Modernization Act"). The
Financial Services Modernization Act repeals the affiliation provisions of the
Glass-Steagall Act: Section 20, that restricted the affiliation of Federal
Reserve Member Banks with firms "engaged principally" in specified securities
activities; and Section 32, that restricts officer, director or employee
interlocks between a member bank and any company or person "primarily engaged"
in specified securities activities. In addition, The Financial Services
Modernization Act also contains provisions that expressly preempt any state law
restricting the establishment of financial affiliations, primarily related to
insurance. The general effect of the law is to establish a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms, and other financial service providers by revising and
expanding the BHCA framework to permit a holding company system to engage in a
full range of financial activities through a new entity known as a Financial
Services Holding Company.
10
The law also:
- - broadens the activities that may be conducted by national banks, banking
subsidiaries of bank holding companies and their financial subsidiaries;
- - provides an enhanced framework for protecting the privacy of the
consumer information;
- - adopts a number of provisions related to the capitalization, membership,
corporate governance, and other measures designed to modernize the
Federal Home Loan Bank system;
- - modifies the laws governing the implementation of the Community
Reinvestment Act; and
- - addresses a variety of other legal and regulatory issues affecting both
day-to-day operations and long-term activities of financial
institutions.
The Company does not expect the Financial Services Modernization Act
to have a material effect on operations. To the extent that it permits banks,
securities firms and insurance companies to affiliate, the financial services
industry may experience even further consolidation. The Financial Services
Modernization Act is intended to grant community banks certain powers as a
matter of right that larger institutions have accumulated on an ad hoc basis.
This act may have the results of increasing the amount of competition from
larger institutions and other types of companies offering financial products.
The Company filed for and was approved as a Financial Services
Holding Company in April 2000. Financial Services Holding Companies may
affiliate with securities firms and insurance companies and engage in other
activities that are financial in nature or are complementary to activities that
are financial in nature. "Financial in nature" activities include: securities
underwriting; dealing and market making; sponsoring mutual funds and investment
companies; insurance underwriting and agencies; merchant banking; and activities
that the Federal Reserve, in consultation with the Secretary of the Treasury,
determines from time to time to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto.
Privacy
Under the Financial Services Modernization Act, federal banking
regulators are required to adopt rules that will limit the ability of banks and
other financial institutions to disclose non-public information about consumers
to nonaffiliated third parties. These limitations will require disclosure of
privacy policies to consumers and, in some circumstances, will allow consumers
to prevent disclosure of certain personal information to a nonaffiliated third
party.
Federal banking regulators issued final rules on May 10, 2000. Pursuant to the
rules, financial institutions must provide:
- - initial notices to customers about their privacy policies, describing
the conditions under which they may disclose nonpublic personal
information to nonaffiliated third parties and affiliates;
- - annual notices of their privacy policies to current customers; and
- - a reasonable method for customers to "opt-out" of disclosures to
nonaffiliated third parties.
The rules wee effective November 13, 2000, but compliance was
optional until July 1, 2001. These privacy provisions will affect how consumer
information is transmitted through diversified financial companies and conveyed
to outside vendors. There has been no material impact on the Company's financial
condition or results of operations as a result of compliance with the privacy
provisions.
Pending Legislation and Regulations
Certain pending legislative proposals include bills to let banks pay
interest on business checking accounts, to cap consumer liability for stolen
debit cards, and to give judges the authority to force high-income borrowers to
repay their debts rather than cancel them through bankruptcy.
11
Competition
In the past, an independent bank's principal competitors for
deposits and loans have been other banks (particularly major banks), savings and
loan associations and credit unions. To a lesser extent, competition was also
provided by thrift and loans, mortgage brokerage companies and insurance
companies.
Other institutions, such as brokerage houses, mutual fund
companies, credit card companies, and even retail establishments have offered
new investment vehicles, which also compete with banks for deposit business. The
direction of federal legislation in recent years seems to favor competition
between different types of financial institutions and to foster new entrants
into the financial services market, and it is anticipated that this trend will
continue.
Among the competitive advantages, that major banks have is their
ability to finance wide ranging advertising campaigns and to allocate their
investment assets into investments of higher yield and demand. Such institutions
offer certain services such as trust services and international banking services
that are not offered directly by the Bank (but are offered indirectly through
correspondent relationships). Because of their greater total capitalization,
major banks have substantially higher legal lending limits than the Bank.
In order to compete with major banks and other competitors in its
primary service areas, the Bank relies upon the experience of its executive and
senior officers in serving business clients, and upon its specialized services,
local promotional activities and the personal contacts made by its officers,
directors and employees. For customers whose loan demand exceeds the Bank's
legal lending limit, the Bank may arrange for such loans on a participation
basis with correspondent banks.
The recent enactment of Federal and California interstate banking
legislation will likely increase competition within California. Regulatory
reform, as well as other changes in federal and California law will also affect
competition. While the impact of these changes, and of other proposed changes,
cannot be predicted with certainty, it is clear that the business of banking in
California will remain highly competitive.
Competitive pressures in the banking industry significantly increase
changes in the interest rate environment, reducing net interest margins, and
less than favorable economic conditions can result in a deterioration of credit
quality and an increase in the provisions for loan losses.
With respect to its credit card processing services, the Bank
competes with other banks, independent sales organizations ("ISOs") and other
nonbank processors. Many of these competitors are substantially larger than the
Bank. The bank competes on the basis of price, the availability of products and
services, the quality of customer service, support, and transaction processing
speed. The majority of the Bank's contracts with merchants are cancelable at
will or on short notice or provide for renewal at frequent periodic intervals
and, accordingly, the Bank regularly rebids such contracts. This competition may
influence the prices that can be charged by the Bank and require aggressive cost
control or increase transaction volume in order to maintain acceptable profit
margins. Further, because of tightening margins, there has been a trend toward
consolidation in the merchant processing industry.
Consolidation will enable certain of the Company's competitors to
have access to significant capital, management, marketing and technological
resources that are equal to or greater than those of the Company.
Employees
As of December 31, 2001, the Company employed 103 persons. None of
the Company's employees are represented by a labor union and the Company
considers its employee relations to be good.
12
Risk Factors That May Affect Results
This report includes forward-looking statements within the meaning
of the Securities Exchange Act of 1934 (the "Exchange Act"). These statements
are based on management's beliefs and assumptions, and on information available
to management as of the date of this document. Forward-looking statements
include the information concerning possible or assumed future results of
operations of the Company set forth under the heading "Management's Discussion
and Analysis of Financial Condition and Results of Operations." Forward-looking
statements also include statements in which words such as "expect,"
"anticipate," "intend," "plan," "believe," "estimate," "consider" or similar
expressions are used. Forward-looking statements are not guarantees of future
performance. They involve risks, uncertainties and assumptions, including the
risks discussed under the heading "Risk Factors That May Affect Results" and
elsewhere in this report. The Company's actual future results and shareholder
values may differ materially from those anticipated and expressed in these
forward-looking statements. Many of the factors that will determine these
results and values, including those discussed under the heading "Risk Factors
That May Affect Results," are beyond the Company's ability to control or
predict. Investors are cautioned not to put undue reliance on any
forward-looking statements. In addition, the Company does not have any intention
or and assumes no obligation to update forward-looking statements after the date
of the filing of this report, even if new information, future events or other
circumstances have made such statements incorrect or misleading. Except as
specifically noted herein all referenced to the "Company" refer to Redding
Bancorp, a California corporation, and its consolidated subsidiaries.
Lending Risks Associated with Commercial Banking and Construction
Activities
The business strategy of the Bank is to focus on commercial and
multi-family real estate loans, construction loans and commercial business
loans. Loans secured by commercial real estate are generally larger and involve
a greater degree of credit and transaction risk than residential mortgage
(one-to-four family) loans. Because payments on loans secured by commercial and
multi-family real estate properties are often dependent on successful operation
or management of the underlying properties, repayment of such loans may be
subject to a greater extent to the then prevailing conditions in the real estate
market or the economy. Moreover, real estate construction financing is generally
considered to involve a higher degree of credit risk than long-term financing on
improved, owner-occupied real estate. Risk of loss on a construction loan is
dependent largely upon the accuracy of the initial estimate of the property's
value at completion of construction or development compared to the estimated
cost (including interest) of construction. If the estimate of value proves to be
inaccurate, the Bank may be confronted with a project which, when completed, has
a value which is insufficient to assure full repayment of the construction loan.
Although the Bank manages lending risks through its underwriting and
credit administration policies, no assurance can be given that such risks would
not materialize, in which event the Company's financial condition, results of
operations, cash flows and business prospects could be materially adversely
affected.
Dependence on Real Estate
At December 31, 2001, approximately 80% of the loans of the Bank
were secured by real estate. The value of the Bank's real estate collateral has
been, and could in the future continue to be, adversely affected by any economic
recession and any resulting adverse impact on the real estate market in Upstate
California such as that experienced during the early years of this decade. See
"-Economic Conditions and Geographic Concentration."
The Bank's primary lending focus has historically been commercial
real estate, construction and, to a lesser extent, commercial lending. At
December 31, 2001, commercial real estate and construction loans comprised
approximately 44% and 21%, respectively, of the total loans in the portfolio of
the Bank. At December 31, 2001, all of the Bank's real estate mortgage and
construction loans, and approximately 40% of its commercial loans, were secured
fully or in part by deeds of trust on underlying real estate. The Bank's
dependence on real estate increases the risk of loss in the loan portfolio of
the Bank and its holdings of other real estate owned if economic conditions in
Upstate California deteriorate in the future. Deterioration of the real estate
market in Upstate California would have a material adverse effect on the
Company's business, financial condition and results of operations. See
"-Economic Conditions and Geographic Concentration."
13
California Energy Crisis
The recent California energy crisis has resulted in higher energy
costs to consumers, who have also seen disruptions in service and face
uncertainty about the future availability and cost of power. Various
legislative, regulatory and legal remedies to the California crisis are being
pursued, but their outcome is uncertain and far reaching and the solution is not
likely to be immediate. Continued deterioration of the California energy
resources in California could have a material adverse effect on the Company's
customers, resulting in material adverse effects on the Company's business,
financial condition and results of operations.
Interest Rate Risk
The income of the Bank depends to a great extent on "interest rate
differentials" and the resulting net interest margins (i.e., the difference
between the interest rates earned on the Bank's interest-earning assets such as
loans and investment securities, and the interest rates paid on the Bank's
interest-bearing liabilities such as deposits and borrowings). These rates are
highly sensitive to many factors, which are beyond the Company's control,
including general economic conditions and the policies of various governmental
and regulatory agencies, in particular, the FRB. Because of the Bank's capital
position and non-interest-bearing demand deposit accounts, the Bank is asset
sensitive. As a result, the Company is generally adversely affected by declining
interest rates. In addition, changes in monetary policy, including changes in
interest rates, influence the origination of loans, the purchase of investments
and the generation of deposits and affect the rates received on loans and
investment securities and paid on deposits, which could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Quantitative and Qualitative Disclosure about Market Risk."
Merchant Credit Card Processing Services
The Bank's fee income from merchant processing services represented
approximately 4.1%, 8.2% and 9.4% of the Company's consolidated revenues in
2001, 2000 and 1999, respectively. In addition, contract deposit relationships
with the merchants in the portfolio of the Bank and CSI represented
approximately 3.3% of the Bank's total deposits as of December 31, 2001.
In April 1993, the Bank entered into an agreement (the "Merchant
Services Agreement") with Cardservice International, Inc. ("CSI"), an
independent sales organization ("ISO") and nonbank merchant credit card
processor, pursuant to which the Bank has agreed to provide credit and debit
card processing services for merchants solicited by CSI who accept credit and
debit cards as payment for goods and services. Pursuant to the Merchant Services
Agreement, the Bank acts as a clearing bank for CSI and processes credit or
debit card transactions into the Visa(R) or MasterCard(R) system for presentment
to the card issuer. As a result of the Merchant Services Agreement, the Bank has
acquired electronic credit and debit card processing relationships with
merchants in various industries on a nationwide basis. The Merchant Services
Agreement with CSI was on April 1, 2001. Effective April 1, 2001, pricing of the
contract renewal is .002 percent of transaction processing and one-half of the
earnings on the deposit relationship. The contract renewal represents a
significant decline in revenues from merchant credit card processing.
The Company has been successful in pursuing various strategies to
offset the decline in revenues, including expansion of the Roseville Bank of
Commerce, acquisition of the Citrus Heights office, and projecting aggressive
growth in the loan markets.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Noninterest Income-Merchant Processing Services Income."
14
Chargebacks and Payment Risks Associated with Merchant Processing
Services
The Bank is subject to the Card Association Rules in processing
credit and debit card transactions. In the event of certain types of billing
disputes between a cardholder and a merchant, the processor of the transaction
assists the merchant in investigating and resolving the dispute. If the dispute
is not resolved in favor of the merchant, the transaction is "charged back" to
the merchant and that amount is credited or otherwise refunded to the
cardholder. If the processor is unable to collect such amounts from the
merchant's account, and if the merchant refuses or is unable due to bankruptcy
or other reasons to reimburse the processor for the chargeback, the processor
bears the loss for the amount of the refund paid to the cardholder. Pursuant to
the Merchant Services Agreement, CSI has agreed to indemnify the Bank against
losses incurred in connection with credit card transactions generated by
merchants in CSI's portfolio. In addition, pursuant to the Merchant Services
Agreement, CSI is required to maintain a general account with the Bank and has
granted the Bank a security interest in such account to secure CSI's obligations
under the Merchant Services Agreement.
The balances required to be maintained by CSI in general account
constitute a small percentage of the dollar volume of transactions processed by
the Bank each month. In the event that the funds in accounts maintained by CSI
are not sufficient to cover chargebacks and refund payments to cardholders and
CSI is unable to reimburse the Bank for such deficiencies, the Bank would bear
the loss which could have a material adverse effect on the Company's financial
condition, results of operations and cash flows. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Noninterest
Income-Merchant Processing Services Income."
Chargeback exposure can also result from fraudulent credit card
transactions initiated by merchant customers. Examples of merchant fraud include
logging fictitious sales transactions and falsification of transaction amounts
on actual sales. The Bank conducts a background review of its merchant customers
at the time the relationship is established with the merchant. The Bank also can
withhold or delay a merchant's daily settlement if fraudulent activity is
suspected, thereby mitigating exposure to loss. However, there can be no
assurance that the Bank will not experience significant amounts of merchant
fraud, which could have a material adverse effect on the Company's business,
financial condition and results of operations. The degree of exposure to
chargebacks may also be adversely affected by the development of new transaction
delivery channels, such as the Internet, which have yet to be fully evaluated.
The Company is not exposed to card issuer credit losses unassociated
with a dispute between the cardholder and the merchant.
Potential Volatility of Deposits
At December 31, 2001, time certificates of deposit in excess of
$100,000 represented approximately 25% of the dollar value of the total deposits
of the Bank. As such, these deposits are considered volatile and could be
subject to withdrawal. Withdrawal of a material amount of such deposits would
adversely affect the liquidity of the Bank, profitability, business prospects,
results of operations and cash flows.
Dividends
Because the Company conducts no other significant activity than the
management of its investment in the Bank, the Company is dependent on the Bank
for income. The ability of the Bank to pay cash dividends in the future depends
on the profitability, growth and capital needs of the Bank. In addition, the
California Financial Code restricts the ability of the Bank to pay dividends. No
assurance can be given that the Company or the Bank will pay any dividends in
the future or, if paid, such dividends will not be discontinued.
See "-Supervision and Regulation-Supervision and Regulation of Bank Holding
Companies" and "-Supervision and Regulation-Restrictions on Dividends and Other
Distributions."
15
Competition
In California generally, and in the Company's primary market area
specifically, major banks and brokerage firms dominate the financial services
industry. By virtue of their larger capital bases, such institutions have
substantially greater lending limits than those of the Bank do. In obtaining
deposits and making loans, the Bank competes with these larger commercial banks
and other financial institutions, such as savings and loan associations and
credit unions, which offer many services, which traditionally, were offered only
by banks. In addition, the Bank competes with other institutions such as money
market funds, brokerage firms, and even retail stores seeking to penetrate the
financial services market. During periods of declining interest rates,
competitors with lower costs of capital may solicit the Bank's customers to
refinance their loans. Furthermore, during periods of economic slowdown or
recession, the borrowers of the Bank may face financial difficulties and be more
receptive to offers from the Bank's competitors to refinance their loans. No
assurance can be given that the Bank will be able to compete with these lenders.
See "-Competition" page 12
Competition in the merchant processing industry is intense. The Bank
competes with other banks, ISOs and other nonbank processors. Many of these
competitors are substantially larger than the Bank. The Bank competes on the
basis of price, the availability of products and services, the quality of
customer service and support and transaction processing speed. The majority of
the Bank's contracts with merchants are cancelable at will or on short notice or
provides for renewal at frequent periodic intervals and, therefore, the Bank
regularly rebids such contracts.
This competition may influence the prices that can be charged by the
Bank and require aggressive cost control or increased transaction volume in
order to maintain acceptable profit margins. If the Bank is not able to maintain
acceptable profit margins, it could be forced to discontinue merchant processing
services, which would have a material adverse effect on the Company's results of
operations and cash flows. Further, because of tightening margins, there has
been a trend toward consolidation in the merchant processing industry.
Consolidation will enable certain of the Bank's competitors to have access to
significant capital, management, marketing and technological resources that are
equal to or greater than those of the Bank. No assurance can be given that the
Bank or any ISO for which the Bank performs clearing bank services will be able
to compete successfully for merchant processing business in the future. See
"-Competition"- page 12
Government Regulation and Legislation
The Company and the Bank are subject to extensive state and federal
regulation, supervision and legislation, which govern almost all aspects of the
operations of the Company and the Bank. The business of the Company is
particularly susceptible to being affected by the enactment of federal and state
legislation which may have the effect of increasing or decreasing the cost of
doing business, modifying permissible activities or enhancing the competitive
position of other financial institutions. Such laws are subject to change from
time to time and are primarily intended for the protection of consumers,
depositors and the deposit insurance funds and not for the protection of
shareholders of the Company. The Company cannot predict what effect any
presently contemplated or future changes in the laws or regulations or their
interpretations would have on the business and prospects of the Company, but it
could be material and adverse. See "-Supervision and Regulation."
Economic Conditions and Geographic Concentration
The Company's operations are located and concentrated primarily in
Upstate California, particularly the counties of Butte, El Dorado, Placer,
Shasta and Sacramento, and are likely to remain so for the foreseeable future.
At December 31, 2001, approximately 80% of the Bank's loan portfolio consisted
of real estate related loans, all of which were related to collateral located in
Upstate California. A change in California economic and business conditions may
adversely affect the performance of these loans. Deterioration in economic
conditions could have a material adverse effect on the quality of the loan
portfolio of the Bank and the demand for its products and services. In addition,
during periods of economic slowdown or recession, the Bank may experience a
decline in collateral values and an increase in delinquencies and defaults. A
decline in collateral values and an increase in delinquencies and defaults
increase the possibility and severity of losses. California real estate is also
subject to certain natural disasters, such as earthquakes, floods and mudslides,
which are typically not covered by the standard hazard insurance policies
maintained by borrowers.
16
Uninsured disasters may make it difficult or impossible for
borrowers to repay loans made by the Bank.
The recent California energy crisis has resulted in higher energy
costs to consumers, who have also seen disruptions in service and face
uncertainty about the future availability and cost of power. Various
legislative, regulatory and legal remedies to the California crisis are being
pursued, but their outcome is uncertain and far reaching and the solution is not
likely to be immediate. Continued deterioration of the California energy
resources in California could have a material adverse effect on the Company's
customers, resulting in material adverse effects on the Company's business,
financial condition and results of operations.
Reliance on Key Employees and Others
As of December 31, 2001, the Company and its subsidiaries employed
in the aggregate 103 employees. The Company considers employee relations to be
excellent. A collective bargaining group represents none of the employees of the
Company or its subsidiaries. Failure of the Company to attract and retain
qualified personnel could have an adverse effect on the Company's business,
financial condition and results of operations. The Company does maintain life
insurance with respect to two of its officers with regard to a salary
continuation plan.
Adequacy of Allowance for Loan and Other Real Estate Losses
The Bank's allowance for estimated losses on loans was approximately
$3.2 million, or 1.5% of total loans, and 10.97% of total nonperforming loans at
December 31, 2001. Material future additions to the allowance for estimated
losses on loans might be necessary if material adverse changes in economic
conditions occur and the performance of the loan portfolio of the Bank
deteriorates.
In addition, future additions to the Bank's allowance for losses on
other real estate owned may also be required in order to reflect changes in the
markets for real estate in which the Bank's other real estate owned is located
and other factors which may result in adjustments which are necessary to ensure
that the Bank's foreclosed assets are carried at the lower of cost or fair
value, less estimated costs to dispose of the properties. Moreover, the FDIC and
the DFI, as an integral part of their examination process, periodically review
the Bank's allowance for estimated losses on loans and the carrying value of its
assets. The Bank was most recently examined by the FDIC and the DFI in this
regard during the second quarter of 2001. Increases in the provisions for
estimated losses on loans and foreclosed assets would adversely affect the
Bank's financial condition and results of operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations-Asset
Quality" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Allowance for Loan Losses (ALL)."
Certain Ownership Restrictions under California and Federal Law
Federal law prohibits a person or group of persons "acting in
concert" from acquiring "control" of a bank holding company unless the FRB has
been given 60 days prior written notice of such proposed acquisition and within
that time period the FRB has not issued a notice disapproving the proposed
acquisition or extending for up to another 30 days, the period during which such
a disapproval may be issued. An acquisition may be made before the expiration of
the disapproval period if the FRB issues written notice of its intent not to
disapprove the action. Under a rebuttal presumption established by the FRB, the
acquisition of more than 10% of a class of voting stock of a bank with a class
of securities registered under Section 12 of the Exchange Act (such as the
Common Stock), would, under the circumstances set forth in the presumption,
constitute the acquisition of control. In addition, any "company" would be
required to obtain the approval of the FRB under the BHCA, before acquiring 25%
(5% in the case of an acquiror that is, or is deemed to be, a bank holding
company) or more of the outstanding shares of the Company's Common Stock, or
such lesser number of shares as constitute control. See "-Supervision and
Regulation-Regulation and Supervision of Bank Holding Companies."
Under the California Financial Code, no person shall, directly or
indirectly, acquire control of a California licensed bank or a bank holding
company unless the Commissioner has approved such acquisition of control. A
person would be deemed to have acquired control of the Company and the Bank
under this state law if such person, directly or indirectly, has the power (i)
to vote 25% or more of the voting power of the Company or (ii) to direct or
cause the direction of the management and policies of the Company. For purposes
of this law, a person who directly or indirectly owns or controls 10% or more of
the Common Stock would be presumed to direct or cause the direction of the
management and policies of the Company and thereby control the Company.
17
Shares Eligible for Future Sale
As of December 31, 2001, the Company had 2,703,457 shares of Common
Stock outstanding, of which 1,827,844 shares are eligible for sale in the public
market without restriction. 875,613 shares are eligible for sale in the public
market pursuant to Rule 144 under the Securities Act of 1933, as amended (the
"Securities Act"). Future sales of substantial amounts of the Company's Common
Stock, or the perception that such sales could occur, could have a material
adverse effect on the market price of the Common Stock. In addition, options to
acquire up to 427,850 shares of the outstanding shares of Common Stock at
exercise prices ranging from $8.25 to $20.00 have been issued to directors and
certain employees of the Company under the Company's 1998 Stock Option Plan, and
options to acquire up to an additional five percent, approximately 135,000
shares of the outstanding shares at an exercise price of not less than 85% of
the market value of the Company's Common Stock on the date of grant are reserved
for issuance under the plan. No prediction can be made as to the effect, if any,
that future sales of shares, or the availability of shares for future sale, will
have on the market price of the Company's Common Stock.
Technology and Computer Systems
Advances and changes in technology can significantly impact the
business and operations of the Company. The Bank faces many challenges including
the increased demand for providing computer access to bank accounts and the
systems to perform banking transactions electronically. The Company's ability to
compete depends on its ability to continue to adapt its technology on a timely
and cost-effective basis to meet these requirements. In addition, the Bank's
business and operations are susceptible to negative impacts from computer system
failures, communication and energy disruption and unethical individuals with the
technological ability to cause disruptions or failures of the Bank's data
processing systems.
Environmental Risks
The Bank, in its ordinary course of business, acquires real property
securing loans that are in default, and there is a risk that hazardous substance
or waste, contaminants or pollutants could exist on such properties. The Bank
may be required to remove or remediate such substances from the affected
properties at its expense, and the cost of such removal or remediation may
substantially exceed the value of the affected properties or the loans secured
by such properties. Furthermore, the Bank may not have adequate remedies against
the prior owners or other responsible parties to recover its costs. Finally, the
Bank may find it difficult or impossible to sell the affected properties either
before or following any such removal.
In addition, the Bank may be considered liable for environmental
liabilities concerning its borrowers' properties, if, among other things, it
participates in the management of its borrowers' operations. The occurrence of
such an event could have a material adverse effect on the Company's business,
financial condition, results of operations and cash flows.
Dilution
The Company has issued options to purchase shares of the Company's
Common Stock at prices equal to 85% of the fair market value of the Company's
Common Stock on the date of grant. As of December 31, 2001, the Company had
outstanding options to purchase an aggregate of 427,850 shares of Common Stock
at exercise prices ranging from $8.25 to $20.00 per share, or a weighted average
exercise price per share of $9.87. To the extent such options are exercised,
shareholders of the Company will experience dilution. The Company established a
Treasury Repurchase program to mitigate the effects of dilution. The program
authorizes a systematic approach to repurchasing shares over a seven-year ramp.
18
ITEM 2. PROPERTIES.
The Company's principal offices and the Bank's main office are
housed in a two-story building with approximately 21,000 square feet of space
located at 1951 Churn Creek Road, Redding, California, 96002. The Bank owns the
building and the 1.25 acres of land on which the building is situated. The Bank
also owns the land and building located at 1177 Placer Street, Redding,
California, 96002, in which the Bank uses approximately 11,650 square feet of
space for its banking operations.
The Company's Roseville Bank of Commerce office is located on the
first floor of a three-story building with approximately 4,656 square feet of
space located at 1548 Eureka Road, Roseville, California. The Company leases the
space pursuant to a triple net lease expiring in November 30, 2005. The
Company's Roseville Banking Center at Sunrise office is a free standing building
with approximately 4,982 square feet of space located at 6950 Sunrise Boulevard,
Citrus Heights. The Company subleases the space from Wells Fargo Bank expiring
on March 5, 2009.
ITEM 3. LEGAL PROCEEDINGS.
The Company and its subsidiaries are involved in various legal
actions arising in the ordinary course of business. The Company believes that
the ultimate disposition of all currently pending matters will not have a
material adverse effect on the Company's financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
19
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
Trades in the Company's common stock are made through Hoefer &
Arnett located at 353 Sacramento Street, 10th Floor, San Francisco, California
94111. The Company's common stock is traded on the OTC Bulletin Board under the
symbol, "RDDB".
The following table, which summarizes trading activity during the
Company's last two fiscal years, is based on information obtained from the OTC
Bulletin Board. The quotations reflect the price that would be received by the
seller without retail mark-up, mark-down or commissions and may not have
represented actual transactions.
Sales Price Per Share
------------------------------------
Quarter Ended: High Low Volume
------ ------ --------
March 31, 2001 $17.00 $14.00 13,401
June 30, 2001 $17.25 $15.50 161,942
September 30, 2001 $21.15 $18.00 304,585
December 30, 2001 $24.50 $21.00 121,066
March 31, 2000 $17.45 $14.87 54,890
June 30, 2000 $13.85 $13.23 6,930
September 30, 2000 $14.36 $13.23 40,480
December 30, 2000 $15.70 $13.00 30,451
As of December 31, 2001, there were approximately 350 shareholders
of record of the Company's Common Stock and the market price on that date was
$21.50 per share.
The Company's ability to pay dividends is subject to certain
regulatory requirements. The Federal Reserve Board ("FRB") generally prohibits a
financial services holding company from declaring or paying a cash dividend
which would impose undue pressure on the capital of subsidiary banks or would be
funded only through borrowing or other arrangements that might adversely affect
a financial services holding company's financial position. The FRB's policy is
that a financial services holding company should not continue its existing rate
of cash dividends on its common stock unless its net income is sufficient to
fully fund each dividend and its prospective rate of earnings retention appears
consistent with its capital needs, asset quality and overall financial
condition. The power of the board of directors of an insured depository
institution to declare a cash dividend or other distribution with respect to
capital is subject to statutory and regulatory restrictions which limit the
amount available for such distribution depending upon the earnings, financial
condition and cash needs of the institution, as well as general business
conditions.
On October 22, 2001, a cash dividend of $0.65 per share was paid to
shareholders of record as of October 1, 2001.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") prohibits insured depository institutions from paying management fees
to any controlling persons or, with certain limited exceptions, making capital
distributions, including dividends, if, after such transaction, the institution
would be undercapitalized.
In addition to the restrictions imposed under federal law, banks
chartered under California law generally may only pay cash dividends to the
extent such payments do not exceed the lesser of retained earnings of the bank
or the bank's net income for its last three fiscal years (less any distributions
to shareholders during such period). In the event a bank desires to pay cash
dividends in excess of such amount, the bank may pay a cash dividend with the
prior approval of the Commissioner of Financial Institutions in an amount not
exceeding the greatest of the bank's retained earnings, the bank's net income
for its last fiscal year, or the bank's net income for its current fiscal
20
year.
Regulators also have authority to prohibit a depository institution
from engaging in business practices which are considered to be unsafe or
unsound, possibly including payment of dividends or other payments under certain
circumstances even if such payments are not expressly prohibited by statute.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below for the
five years ended December 31, 2001, have been derived from the Company's audited
consolidated financial statements and should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's audited financial statements and notes thereto,
included elsewhere in this report.
As of and for the years ended December 31,
-----------------------------------------------------------------------
In Thousands (Except Per Share Data) 2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -----------
Statements of Income
Total Interest Income $ 20,216 $ 20,177 $ 17,270 $ 16,322 $ 15,764
Net Interest Income $ 11,190 $ 11,455 $ 10,835 $ 10,436 $ 9,430
Provision for Loan Losses $ 255 $ 142 $ 120 $ 500 $ 1,024
Total Non-interest Income $ 2,823 $ 2,807 $ 2,790 $ 2,539 $ 2,364
Total Non-interest Expense $ 7,143 $ 6,458 $ 6,434 $ 5,975 $ 4,983
Total Revenues $ 23,039 $ 22,984 $ 20,060 $ 18,861 $ 18,128
Net Income $ 4,274 $ 4,812 $ 4,370 $ 4,054 $ 3,658
Balance Sheets
Total Assets $ 318,686 $ 255,107 $ 232,008 $ 216,085 $ 204,820
Total Loans $ 219,876 $ 194,295 $ 172,817 $ 148,202 $ 113,410
Allowance for Loan Losses $ 3,180 $ 2,974 $ 2,972 $ 3,235 $ 2,819
Total Deposits $ 281,436 $ 218,036 $ 198,323 $ 188,621 $ 180,673
Stockholders Equity $ 27,240 $ 28,754 $ 26,059 $ 24,654 $ 21,824
Performance Ratios
Return on Average Assets 1.49% 1.98% 1.91% 1.98% 1.83%
Return on Average Equity 15.43% 17.95% 17.60% 18.04% 18.27%
Dividend Payout 41.94% 35.31% 21.75% 33.18% 24.62%
Average Equity to Average Assets 9.67% 11.02% 10.86% 10.97% 10.03%
Tier 1 Risk-Based Capital-Bank 10.93% 12.86% 13.59% 14.33% 14.91%
Total Risk-Based Capital-Bank 12.18% 14.11% 14.85% 15.58% 16.16%
Net Interest Margin 4.24% 5.16% 5.15% 5.57% 5.20%
Earning Assets to Total Assets 92.15% 91.34% 92.10% 91.48% 90.90%
Nonperforming Assets to Total Assets .11% .31% .28% .53% .52%
Annualized Net Charge-offs to Total Loans .02% .08% .24% .06% .44%
ALL to Total Loans 1.45% 1.53% 1.72% 2.18% 2.49%
Nonperforming Loans to ALL 10.97% 26.94% 20.19% 33.69% 25.40%
Share Data
Common Shares Outstanding - basic 2,703 2,884 2,907 2,959 2,952
Common Shares Outstanding - diluted 2,856 3,035 3,144 2,858 2,850
Book Value Per Common Share $ 10.08 $ 9.97 $ 8.97 $ 8.34 $ 7.40
Basic Earnings Per Common Share $ 1.52 $ 1.67 $ 1.49 $ 1.37 $ 1.23
Diluted Earnings Per Common Share $ 1.44 $ 1.59 $ 1.38 $ 1.30 $ 1.23
Cash Dividends Per Common Share $ 0.65 $ 0.59 $ 0.55 $ 0.45 $ 0.33
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements of the Company and related notes thereto
appearing elsewhere in this report. All statements other than statements of
historical fact included in the following discussion are forward-looking
statements within the meaning of the Exchange Act. These statements are based on
management's beliefs and assumptions, and on information currently available to
management. Forward-looking statements include the information concerning
possible or assumed future results of operations of the Company and also include
statements in which words such as "expect," "anticipate," "intend," "plan,"
"believe," "estimate," "consider" or similar expressions are used.
Forward-looking statements are not guarantees of future performance. They
involve risks, uncertainties and assumptions, including the risks discussed
under the heading "Risk Factors That May Affect Results" and elsewhere in this
report. The Company's future results and shareholder values may differ
materially from those expressed in these forward-looking statements. Many of the
factors that will determine these results and values, including those discussed
under the heading "Risk Factors That May Affect Results," are beyond the
Company's ability to control or predict. Investors are cautioned not to put
undue reliance on any forward-looking statements. In addition, the Company does
not have any intention or obligation to update forward-looking statements after
the filing of this report, even if new information, future events or other
circumstances have made them incorrect or misleading.
I. Critical Accounting Policies
A. General
Redding Bancorp's financial statements are prepared in accordance
with accounting principles generally accepted in the United States of America
(GAAP). The financial information contained within our statements is, to a
significant extent, financial information that is based on measures of the
financial effects of transactions and events that have already occurred. We use
historical loss factors to determine the inherent loss that may be present in
our loan portfolio. Actual losses could differ significantly from the historical
factors that we use. Other estimates that we use are expected useful lives of
our depreciable assets. In addition GAAP itself may change from one previously
acceptable method to another method. Although the economics of our transactions
would be the same, the timing of events that would impact our transactions could
change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may
be sustained in our loan and lease portfolio. The allowance is based on two
basic principles of accounting. (1) Statement of Financial Accountings Standards
(SFAS) No. 5 "Accounting for Contingencies", which requires that losses be
accrued when they are probable of occurring and estimable and (2) SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan", which requires that losses
be accrued based on the differences between that value of collateral, present
value of future cash flows or values that are observable in the secondary market
and the loan balance.
Our allowance for loan losses has three basic components: the
formula allowance, the specific allowance and the unallocated allowance. Each of
these components is determined based upon estimates that can and do change when
the actual events occur. The formula allowance uses an historical loss view as
an indicator of future losses and as a result could differ from the loss
incurred in the future. However, since this history is updated with the most
recent loss information, the errors that might otherwise occur are mitigated.
The specific allowance uses various techniques to arrive at an estimate of loss.
Historical loss information, and fair market value of collateral are used to
estimate those losses. The use of these values is inherently subjective and our
actual losses could be greater or less than the estimates. The unallocated
allowance captures losses that are attributable to various economic events,
industry or geographic sectors whose impact on the portfolio have occurred but
have yet to be recognized in either the formula or specific allowances. For
further information regarding our allowance for credit losses, see page 30.
22
THE COMPANY
Redding Bancorp ("the Company") is a financial service holding
company ("FHC") with its principal offices in Redding, California. A financial
service holding company may engage in commercial banking, insurance and
securities business and offer other financial products to customers. The Company
currently engages in a general commercial banking business in Redding and
Roseville and the counties of Butte, El Dorado, Placer, Shasta, and Sacramento,
California.
The Company considers Upstate California to be the Company's major
market area. The Company conducts its business through the Redding Bank of
Commerce ("The Bank"), its principal subsidiary and Roseville Bank of Commerce,
a division of the Bank. The services offered by the Company include those
traditionally offered by commercial banks of similar size and character in
California, such as checking, interest-bearing checking ("NOW") and savings
accounts, money market deposit accounts, commercial, construction, real estate,
personal, home improvement, automobile and other installment and term loans,
travelers checks, safe deposit boxes, collection services, telephone and
Internet banking.
The primary focus of the Company is to provide financial services to
the business and professional community of its major market area including Small
Business Administration ("SBA") loans, commercial building financing, payroll
and benefit accounting packages and merchant credit card acquisition. The
Company does not offer trust services or international banking services and does
not plan to do so in the near future.
The Company derives its income from two principal sources: (i) Net
interest income, which is the difference between the interest income it receives
on interest-earning assets and the interest expense it pays on interest-bearing
liabilities, and (ii) fee income, which includes fees earned on deposit
services, income from SBA lending, electronic-based cash management services and
merchant credit card processing services.
Management considers the business of the Company to be divided into
two segments: (i) commercial banking and (ii) credit card services. Credit card
services are limited to those revenues, net of related data processing costs,
associated with the Merchant Services Agreement and the Bank's agreement to
provide credit and debit card processing services for merchants solicited by the
Bank who accept credit and debit cards as payment for goods and services.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
The Company reported net income of $4.3 million for the year ended
December 31, 2001, representing a decrease of approximately $500,000 or 10.4%,
over net income of $4.8 million for the year ended December 31, 2000. Factors
contributing to the decrease in net income include a significant decrease in net
interest income resulting from multiple interest rate reductions partially
offset by increased loan volume and repricing of deposit liabilities. The
provision for loan loss was increased by $113,000 over the prior year reflecting
the Company's growth in the loan portfolio, ongoing efforts to increase the
effectiveness of its collection efforts, as well as, a reduction in classified
assets.
Return on average assets (ROA) was 1.49% and return on average
common equity (ROE) was 15.43% in 2000 compared with 1.98% and 17.95%
respectively in 2000. Diluted earnings per share for 2001 and 2000 were $1.44
and $1.59, respectively, a decrease of 9.4% in 2001 over 2000. The Company's
average total assets increased to $286.6 million in 2001 or 17.8% from $243.3
million in 2000. As a result of the expansion of the Company's Roseville Bank of
Commerce at Eureka and continued loan demand in the Redding market area, net
loans, at December 31, 2001 increased to $216.7 million over $191.3 million in
2000, an increase of $25.4 million or 13.3%.
23
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
The Company reported net income of $4.8 million for the year ended
December 31, 2000, representing an increase of $442,000, or 10%, over net income
of $4.4 million for the year ended December 31, 1999. Factors contributing to
the increase in net income include an increase in net interest income resulting
from increased loan volume, partially offset by the higher costs of funding. The
provision for loan loss was increased by $22,000 over the prior year reflecting
the Company's increased loan portfolio, ongoing efforts to increase the
effectiveness of its collection efforts, as well as, a reduction in classified
assets.
Return on average assets (ROA) was 1.98% and return on average
common equity (ROE) was 17.95% in 2000 compared with 1.91% and 17.60%
respectively in 1999. Diluted earnings per share for 2000 and 1999 were $1.59
and $1.38, respectively, an increase of 15% in 2000 over 1999. The Company's
average total assets increased to $243.3 million in 2000 or 6.5% from $228.5
million in 1999. As a result of the expansion of the Company's Roseville Bank of
Commerce in Roseville, California and continued loan demand in the Redding
market area, net loans, at December 31, 2000 increased to $191.3 million over
$169.8 million in 1999, an increase of $21.5 million or 12.7%.
NET INTEREST INCOME
The primary source of income for the Bank is derived from net
interest income. Net interest income represents the excess of interest and fees
earned on assets (loans, securities and federal funds sold) over the interest
paid on deposits and borrowed funds. Net interest margin is net interest income
expressed as a percentage of average earning assets.
Net interest income decreased to $11.2 million in 2001 versus $11.5
million in 2000 and $10.8 million in 1999, representing a 2.6% decrease in 2001
over 2000, and a 6.5% increase in 2000 over 1999. The average balance of total
earning assets increased to $264.1 million or 18.9% over 2000. Average loan
balances outstanding increased $26.4 million or 14.8% in 2001, while average
balances of investments and federal funds sold decreased $15.6 million or 35.6%
in 2001. The average yields on loans decreased by 135 basis points and
investment income decreased by 120 basis points. The resulting yield on interest
earning assets decreased to 7.65% for 2001 compared with 9.08% for 2000. The
decrease in net interest margin from a year ago is attributed to a 4.75% drop in
the prime lending rate. The Federal Reserve has cut rates to 40-year lows in an
effort to fend off a recession. The Company's financial models indicate that in
periods of falling interest rates its net interest margin is expected to
decrease. This decrease of net interest margin is magnified by the fact that the
Company's assets reprice at a more rapid rate than liabilities.
Total interest expense increased to $9.0 million in 2001, from $8.7
million in 2000 and $6.4 million in 1999, representing a 3.5% increase for 2001
over 2000, and a 35.5% increase in 2000 over 1999. Average balances of
interest-bearing liabilities increased to $221.3 million over $176.9 million for
the year ended December 31, 2001, or 25.1%. Yields on deposits dropped 85 basis
points, from 4.93% to 4.08% in 2001, partially offset by the volumes attributed
to the acquisition of the Sunrise office. Included in the deposit yields are
$4.7 million in brokered deposits at an average yield of 6.75% maturing in March
2002. These deposits were purchased with the specific intent to raise liquidity
to support the growth in the Roseville Bank of Commerce, and the Company has
sufficient liquidity to repay the deposits without further borrowings.
The Company's net interest margin was 4.24% in 2001 and 5.16% in
2000. The combined effect of the increase in volume of earning assets and
liabilities coupled with a substantial decrease in yields, resulted in an
decrease of $265,000 (2.3%) in net interest income for the year ended December
31, 2001 over 2000.
24
The following table sets forth the Company's daily average balance
sheet, related interest income or expense and yield or rate paid for the periods
indicated. The yield on tax-exempt securities has not been adjusted to a
tax-equivalent yield basis.
AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND YIELDS/RATES PAID
YEARS ENDED DECEMBER 31,
(Dollars in thousands) 2001 2000 1999
---------------------------- -------------------------------- --------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------- -------- ------ -------- -------- --------- -------- -------- ---------
EARNING ASSETS
Portfolio Loans $204,861 $17,459 8.52% $178,486 $17,622 9.87% $159,855 $14,605 9.14%
Tax Exempt Securities 4,428 200 4.52% 3,129 138 4.41% 5,601 240 4.28%
US Government Securities 30,960 1,645 5.31% 23,052 1,305 5.66% 30,273 1,714 5.66%
Federal Funds Sold and
Securities purchased
under agreements to
resell 23,170 833 3.60% 16,861 1,050 6.23% 11,868 551 4.64%
Other Securities 683 79 11.57% 639 62 9.70% 2,889 160 5.54%
-------- ------- ---- -------- ------- ---- -------- ------- ----
Average Earning Assets $264,102 $20,216 7.65% $222,167 $20,177 9.08% $210,486 $17,270 8.20%
------- ------- -------
Cash & Due From Banks 12,346 10,783 10,824
Bank Premises 5,276 5,397 5,591
Other Assets 4,887 4,992 1,648
------- ------- -------
Average Total Assets $286,611 $ 243,339 $228,549
======== ========= ========
INTEREST BEARING LIABILITIES
Interest Bearing Demand $ 57,288 $ 909 1.59% $ 43,569 $ 1,122 2.58% $ 41,442 $ 717 1.73%
Savings Deposits 14,925 340 2.28% 13,426 428 3.19% 12,874 352 2.73%
Certificates of Deposit 142,651 7,584 5.32% 115,640 6,881 5.95% 101,289 5,240 5.17%
Other Borrowings 6,461 193 2.99% 4,237 291 6.87% 1,710 126 7.37%
-------- ------- ---- -------- ------- ---- -------- ------- ----
221,325 9,026 4.08% 176,872 8,722 4.93% 157,315 6,435 4.09%
------- ------- -------
Non-interest Bearing Demand 34,259 36,579 43,548
Other Liabilities 3,321 3,084 2,857
Shareholder Equity 27,706 26,804 24,829
-------- -------- ------
Average Liabilities and
Shareholders Equity $286,611 $243,339 $228,549
======== ======== ========
Net Interest Income and
Net Interest Margin $11,190 4.24% $11,455 5.16% $10,835 5.15%
------- ------- -------
Interest income on loans includes fee income of $285,000, $369,000
and $492,000 for the years ended December 31, 2001, 2000, and 1999 respectively.
The Company's average total assets increased to $286.6 million in
2001 to $243.3 in 2000 and $228.5 in 1999, representing a 17.8% increase 2001
over 2000, and 6.5% increase in 2000 over 1999. Portfolio loans increased to
$204.8 million in 2001 and $178.5 million in 2000, representing an increase of
14.7% and 11.7%, respectively.
The following tables set forth changes in interest income and
expense for each major category of earning assets and interest-bearing
liabilities, and the amount of change attributable to volume and rate changes
for the periods indicated. Changes not solely attributable to rate or volume has
been allocated to volume. The yield on tax-exempt securities has not been
adjusted to a tax-equivalent yield basis.
25
Analysis of Changes in Net Interest Income
Years ended December 31,
(Dollars in thousands) 2001 OVER 2000 2000 OVER 1999
-------------------------------- ---------------------------------
Volume Rate Total Volume Rate Total
------- ------- ------- ------- ------- -------
Increase (Decrease)
In Interest Income:
Portfolio Loans $ 1,645 $(1,808) $ (163) $ 1,839 $ 1,178 $ 3,017
Tax-exempt securities 60 2 62 (109) 7 (102)
US Government securities 400 (60) 340 (409) (0) (409)
Federal Funds sold 116 (333) (217) 311 188 499
Other investment securities 8 9 17 (218) 120 (98)
------- ------- ------- ------- ------- -------
Total Increase (Decrease) $ 2,229 $(2,190) $ 39 $ 1,414 $ 1,493 $ 2,907
======= ======= ======= ======= ======= =======
Increase (Decrease)
In Interest Expense:
Interest-bearing Demand 110 (323) (213) 55 350 405
Savings Deposits 4 (92) (88) 18 58 76
Certificates of Deposit 1,253 (550) 703 854 787 1,641
Other Borrowings 25 (123) (98) 174 (9) 165
------- ------- ------- ------- ------- -------
Total Increase (Decrease) $ 1,392 $(1,088) $ 304 $ 1,101 $ 1,186 $ 2,287
------- ------- ------- ------- ------- -------
Net Increase (Decrease) $ 837 $(1,102) $ (265) $ 313 $ 307 $ 620
======= ======= ======= ======= ======= =======
NON-INTEREST INCOME
The Company's non-interest income consists primarily of processing
fees for merchants who accept credit card payments for goods and services,
service charges on deposit accounts, and other service fees. Non-interest income
also includes ATM fees earned at various locations. For the year ended December
31, 2001, non-interest income represented 12.3% of the Company's revenues
(interest income plus non-interest income) versus 12.2% in 2000 and 13.9% in
1999. Historically, the Company's service charges on deposit accounts have
lagged peer levels for similar services. This is consistent with the Company's
philosophy of allowing customers to pay for services through an analysis of
compensating balances and the emphasis on certificates of deposit as a
significant funding source.
Total noninterest income in 2001 was $2.8 million, unchanged from
$2.8 million in 2000 and in 1999. The decrease of $935,000 in merchant credit
card processing was offset primarily by a $616,000 increase in gains taken on
sales of investment securities, and $326,000 in other fee income.
Securities were sold to shorten and reposition the duration of the
investment portfolio and the proceeds from the sales were immediately reinvested
in similar securities with shorter maturities. With investment rates at a
40-year low, as announced by the Federal Reserve Board, management felt
repositioning in the fourth quarter would better poise the Company to take
advantage of rising rates in the following year.
26
The following table sets forth a summary of non-interest income for
the periods indicated.
Years Ended December 31,
--------------------------------
(Dollars in thousands) 2001 2000 1999
------- ------- -------
Non-interest Income:
Service Charges on deposit accounts $ 222 $ 214 $ 251
Other Income 1,104 778 715
Net realized (Loss) Gain on Sale of
Securities available-for-sale 557 (59) (58)
Credit Card service income, net 940 1,875 1,882
------- ------- -------
Total Non-interest Income $ 2,823 $ 2,808 $ 2,790
======= ======= =======
Merchant Services Processing Income
Pursuant to the Merchant Services Agreement, the Bank acts as a
clearing bank for an Independent Sales Organization (ISO), a nonbank merchant
credit card processor. The Bank processes credit or debit card transactions into
the Visa(R) or MasterCard(R) system for presentment to the card issuer.
As a result of the Merchant Services Agreement, the Bank has
acquired electronic credit and debit card processing relationships with
merchants in various industries on a nationwide basis. As of December 31, 2001
and 2000, the ISO portfolio consisted of approximately 35,000 and 36,000
merchants, respectively.
The Merchant Services Agreement was renewed on April 1, 2001.
Effective April 1, 2001, pricing of the contract is .002% of transaction
processing and one-half of the earnings on the deposit relationship. The Company
was successful in pursuing various strategies to offset the decline in revenues,
including expansion of the Roseville Banking Center, acquisition of the Citrus
Heights office and projecting aggressive growth in the loan markets.
The Merchant Services Agreement provides for indemnification of the
Bank by the ISO against losses incurred by the Bank in connection with either
the processing of credit/debit card transactions for covered merchants or any
alleged violations by the ISO of the Card Association Rules. The Bank has been
granted a security interest in the deposit accounts to secure the ISO's
obligations under the agreement.
Merchant bankcard processing services are highly regulated by credit
card associations such as Visa(R). In order to participate in the credit card
program, Redding Bank of Commerce must comply with the credit card association's
rules and regulations, which may change from time to time. During November 1999,
Visa adopted several rule changes to reduce the risk profile in high-risk
acquiring programs and these rule changes affect the Bank's Merchant Services
business segment. These changes include a requirement that an acquiring
processor's reported high-risk volume chargeback ratios be no greater than three
times the national average of 5% of equity capital.
Redding Bank of Commerce's high-risk chargeback ratio was met and is
in compliance with the Visa requirement at 3% as of December 31, 2001. Other
Visa changes included the requirement that total processing volume in certain
high-risk categories (as defined by Visa) is less than 20% of total processing
volume. At December 31, 2001 the Bank's total Visa transactions within these
certain high-risk categories were 14% of Visa total processing volume.
Although these merchants are categorized high-risk, precautions have
been taken to mitigate these risks, including requiring higher deposit reserves,
daily monitoring and aggressive fraud control, indemnification of the ISO, and
to date the Company has not seen significant losses in these categories. The
Company's ISO has set the industry standards for fraud control and electronic
detection, reporting significantly lower than industry standard losses. By
contract, the ISO indemnifies the Company from losses associated with fraudulent
activities.
Merchant services processing is one of the Bank's two reportable
segments. See additional information in Note 18 to the consolidated financial
statements (page 59-60).
27
Non-interest Expense
Non-interest expense consists of salaries and related employee
benefits, occupancy and equipment expenses, data processing fees, professional
fees, directors' fees and other operating expenses. Non-interest expense for
2001 increased to $7.1 million compared to $6.4 million for 2000 and $6.4
million in 1999, representing an increase of $685,000 or 10.6% in 2001.
Occupancy expenses reflect the acquisition of the Sunrise office as well as
relocation and expansion of the Roseville office at Eureka Road. Professional
fees reflect one time charges associated with the acquisition of the Sunrise
office. Salaries and benefits increased $195,000 or 5.2% reflecting staff
additions in the Roseville market.
The following table sets forth a summary o