UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
Commission File Number: 000-31929
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SONOMA VALLEY BANCORP
(Name of registrant at as specific in its charter)
CALIFORNIA 68-0454068
(State of incorporation) (I.R.S. Employer Identification No.)
202 West Napa Street
Sonoma, California 95476
(707) 935-3200
(Address, including zip code, and telephone number,
including area code, of principal executive offices)
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Securities to be registered under section 12(b) of the Exchange Act: None
Securities to be registered under section 12(g) of the Exchange Act:
Name of each exchange
Title of each class on which registered
Common Stock, No Par Value None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (229.405 of this chapter) is contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment of this Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) [ ] Yes [ X ] No
Aggregate market value of Common Stock held by non-affiliates of Sonoma Valley
Bancorp as of March 16, 2004 based on the current market price of the stock:
$36,317,984
The number of shares of registrant's common stock outstanding as of March 15,
2004 was 1,484,823.
DOCUMENTS INCORPORATE BY REFERENCE
None.
With the exception of historical facts stated herein, the matters discussed
in this Form 10-K are "forward looking" statements that involve risks and
uncertainties that could cause actual results to differ materially from
projected results. Such "forward looking" statements include, but are not
necessarily limited to statements regarding anticipated levels of future
revenues and earnings from the operation of Sonoma Valley Bancorp's wholly owned
subsidiary, Sonoma Valley Bank, projected costs and expenses related to
operations of the bank's liquidity, capital resources, and the availability of
future equity capital on commercially reasonable terms. Factors that could cause
actual results to differ materially include, in addition to the other factors
identified in this Form 10-K, the following: (i) increased competition from
other banks, savings and loan associations, thrift and loan associations,
finance companies, credit unions, offerors of money market funds, and other
financial institutions; (ii) the risks and uncertainties relating to general
economic and political conditions, both domestically and internationally,
including, but not limited to, inflation, or natural disasters affecting the
primary service area of the Bank or its major industries; or (iii) changes in
the laws and regulations governing the Bank's activities at either the state or
federal level. Readers of this Form 10-K are cautioned not to put undue reliance
on "forward looking" statements which, by their nature, are uncertain as
reliable indicators of future performance. Sonoma Valley Bancorp disclaims any
obligation to publicly update these "forward looking" statements, whether as a
result of new information, future events, or otherwise.
PART I
ITEM 1. BUSINESS
General
Sonoma Valley Bancorp ("Company") was incorporated under California law on
March 9, 2000 at the direction of Sonoma Valley Bank for the purpose of forming
a single-bank holding company structure pursuant to a plan of reorganization.
The reorganization became effective November 1, 2000, after obtaining all
required regulatory approvals and permits, shares of the Company's common stock
were issued to shareholders of Sonoma Valley Bank in exchange for their Sonoma
Valley Bank stock. Previously, Sonoma Valley Bank filed its periodic reports and
current reports under the Securities Exchange Act of 1934 with the Federal
Deposit Insurance Corporation. Following the reorganization, periodic and
current reports are now filed with the Securities and Exchange Commission.
The business operations of the Company continue to be conducted through its
wholly-owned subsidiary, Sonoma Valley Bank ("Bank"), which began commercial
lending operations on June 3, 1988. In addition to its main branch located in
Sonoma, California, the Bank also operates a second branch office located in
Glen Ellen, California. In March 2004, the Bank opened a branch, Banco de
Sonoma, located in Boyes Hot Springs, California. The following discussion,
therefore, although presented on a consolidated basis, analyzes the financial
condition and results of operations of the Bank for the twelve month period
ended December 31, 2003.
Primary Services
The Bank emphasizes the banking needs of small to medium-sized commercial
businesses, professionals and upper middle to high income individuals and
families in its primary service area of Sonoma, California and the immediate
surrounding area.
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The Bank offers depository and lending services keyed to the needs of its
business and professional clientele. These services include a variety of demand
deposit, savings and time deposit account alternatives, all insured by the FDIC
up to its applicable limits. Special merchant and business services, such as
coin, night depository, courier, on line cash management and merchant teller are
available. The Bank offers bank by mail service, drive-up ATM service, extended
hours including Saturday banking, drive-up windows and telephone voice response.
In 2003, the bank began offering Internet Banking to its customer base. The
initial customers using the product were existing Cash Management Commercial
customers and by mid-year the bank offered Internet Banking to its entire
customer base with products for both commercial and individual customers. The
Bank's lending activities are directed primarily towards granting short and
medium-term commercial loans, augmented by customized lines of credit, for such
purposes as operating capital, business and professional start-ups, inventory,
equipment, accounts receivable, credit cards, and interim construction
financing, personal loans and loans secured by residential real estate.
With the opening of our third Branch office, Banco de Sonoma Office in
March 2004, the bank is offering additional services to the Latino community in
our market place. In 2003, the Bank installed a bilingual ATM machine, and has
bilingual officers and customer service employees. All of the employees at the
Banco de Sonoma Office are bilingual.
The business of the Bank is not seasonal. The Bank intends to continue with
the same basic commercial banking activities it has operated with since
beginning operations June 3, 1988. Retail deposit gathering activities at the
branches comprise the bulk of sources for lending. The bank has approved
borrowing levels at the Federal Home Bank for temporary funding needs.
Competition
In general, the banking business in California and in the market areas,
which the Bank serves, is highly competitive with respect to both loans and
deposits, and is dominated by a relatively small number of major banks, which
have many offices operating over a wide geographic area. The Bank competes for
loans and deposits with these and other regional banks, including several which
are much larger than the Bank, as well as savings and loan associations, thrift
and loan associations, finance companies, credit unions, offerors of money
market funds and other financial institutions.
The Bank's primary service area is currently served by branches of eight
other banks (including three major banks: Citigroup, Bank of America and Wells
Fargo Bank). In order to compete with the major financial institutions in its
primary service area, the Bank uses its flexibility as an independent bank. This
includes emphasis on specialized services and personalized attention.
In the event there are customers whose loan demands exceed the Bank's
lending limit, the Bank seeks to arrange for such loans on a participation basis
with other financial institutions and intermediaries. The Bank also is able to
assist those customers requiring other services not offered by the Bank by
obtaining those services through its correspondent banks.
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Concentration of Credit Risk
The majority of the Bank's loan activity is with customers located within
the county of Sonoma. While the Bank has a diversified loan portfolio,
approximately 84% of these loans are secured by real estate in its service area.
This concentration for the year ending December 31, 2003 is presented below:
(in thousands of dollars)
Secured by real estate:
Construction/land development $ 19,421
Farmland 3,784
1-4 family residences 15,919
Commercial/multi-family 63,691
Employees
As of December 31, 2003, the Company employed 49 full-time equivalent
employees. In anticipation of opening the Banco de Sonoma branch in 2004 the
bank began hiring additional employees in the 4th quarter of 2003.
Supervision and Regulation
The Company is a registered bank holding company under the Bank Holding
Company Act, regulated, supervised and examined by the Federal Reserve Bank. As
such, it must file with the Federal Reserve Bank an annual report and additional
reports as the Federal Reserve Board may require. The Company is also subject to
periodic examination by the Federal Reserve Board.
In addition, both the Company and the Bank are extensively regulated under
both federal and state laws and regulations. These laws and regulations are
primarily intended to protect depositors, not shareholders. To the extent that
the following information describes statutory or regulatory provisions, it is
qualified in its entirety by reference to the particular statutory and
regulatory provisions at issue.
As a California state-licensed bank, the Bank is subject to regulation,
supervision and periodic examination by the California Department of Financial
Institutions. The Bank is also subject to regulation, supervision, and periodic
examination by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank
is not a member of the Federal Reserve System, but is nevertheless subject to
certain regulations of the Board of Governors of the Federal Reserve System. As
a state bank, the Bank's deposits are insured by the FDIC to the maximum amount
permitted by law, which is currently $100,000 per depositor in most cases. For
this protection, the Bank pays a semi-annual assessment.
The regulations of these state and federal bank regulatory agencies govern
most aspects of the Company's and the Bank's business and operations, including
but not limited to, requiring the maintenance of non-interest bearing reserves
on deposits, limiting the nature and amount of investments and loans which may
be made, regulating the issuance of securities, restricting the payment of
dividends, regulating bank expansion and bank activities, including real estate
development activities. The Federal Reserve Board, the Federal Deposit Insurance
Corporation, and the California Department of Financial Institutions have broad
enforcement powers over depository institutions, including the power to prohibit
a bank from engaging in business practices which are considered to be unsafe or
unsound, to impose substantial fines and other civil and criminal penalties, to
terminate deposit insurance, and to appoint a conservator or receiver under a
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variety of circumstances. The Federal Reserve Board also has broad enforcement
powers over bank holding companies, including the power to impose substantial
fines and other civil and criminal penalties.
Regulation of Bank Holding Companies
As a bank holding company, the Company's activities are subject to
extensive regulation by the Federal Reserve Board. The Bank Holding Company Act
requires us to obtain the prior approval of the Federal Reserve Board before (i)
directly or indirectly acquiring ownership or control of any voting shares of
another bank or bank holding company if, after such acquisition, we would own or
control more than 5% of the shares of the other bank or bank holding company
(unless the acquiring company already owns or controls a majority of such
shares); (ii) acquiring all or substantially all of the assets of another bank
or bank holding company; or (iii) merging or consolidating with another bank
holding company. The Federal Reserve Board will not approve any acquisition,
merger or consolidation that would have a substantially anticompetitive result,
unless the anticompetitive effects of the proposed transaction are clearly
outweighed by a greater public interest in meeting the convenience and needs of
the community to be served. The Federal Reserve Board also considers capital
adequacy and other financial and managerial factors in its review of
acquisitions and mergers.
With certain exceptions, the Bank Holding Company Act also prohibits us
from acquiring or retaining direct or indirect ownership or control of more than
5% of the voting shares of any company that is not a bank or bank holding
company, or from engaging directly or indirectly in activities other than those
of banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
non-bank activities that, by statute or by Federal Reserve Board regulation or
order, have been determined to be activities closely related to the business of
banking or of managing or controlling banks.
Federal Deposit Insurance
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines that the institution has engaged or is
engaging in unsafe or unsound practices, is in an unsafe or unsound condition to
continue operations or has violated any applicable law, regulation, order or any
condition imposed in writing by, or pursuant to written agreement with, the
FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing
process for a permanent termination of insurance if the institution has no
tangible capital.
Impact of Economic Conditions and Monetary Policies
The earnings and growth of the Bank are and will be affected by general
economic conditions, both domestic and international, and by the monetary and
fiscal policies of the United States Government and its agencies, particularly
the Federal Reserve Bank (FRB). One function of the FRB is to regulate the money
supply and the national supply of bank credit in order to mitigate recessionary
and inflationary pressures. Among the instruments of monetary policy used to
implement these objects are open market transactions in United States Government
securities, changes in the discount rate on member bank borrowings, and changes
in reserve requirement held by depository institutions. The monetary policies of
the FRB have had a significant effect on the operating results of commercial
banks in the past and are expected to continue to do so in the future. However,
the effect of such policies on the future business and earnings of the Bank
cannot be accurately predicted.
5
Recent and Proposed Legislation
From time to time, legislation is enacted which has the effect of
increasing the cost of doing business, limiting or expanding permissible
activities, or affecting the competitive balance between banks and other
financial institutions. Proposals to change the laws and regulations governing
the operations and taxation of banks and other financial institutions are
frequently made in Congress, in the California legislature, and by various bank
regulatory agencies. No prediction can be made as to the likelihood of any major
changes or the impact such changes might have on the Bank. Certain changes of
potential significance to the Bank which have been enacted recently or others
which are currently under consideration by Congress or various regulatory or
professional agencies are discussed below.
The Financial Services Modernization Act of 1999 (also known as the
"Gramm-Leach-Bliley Act" after its Congressional sponsors) substantially
eliminates most of the separations between banks, brokerage firms, and insurers
enacted by the Glass-Steagall Act of 1933. The reform legislation permits
securities firms and insurers to buy banks, and banks to underwrite insurance
and securities. States retain regulatory authority over insurers. The Treasury
Department's Office of the Comptroller of the Currency has authority to regulate
bank subsidiaries that underwrite securities and the Federal Reserve has
authority over bank affiliates for activities such as insurance underwriting and
real-estate development.
In January 2001, the Basel Committee on Banking Supervision issued a
proposal for a "New Capital Accord." The New Capital Accord incorporates a
three-part framework of minimum capital requirements, supervisory review of an
institution's capital adequacy and internal assessment process, and market
discipline through effective disclosure to encourage safe and sound banking
practices. The New Capital Accord is scheduled for implementation by the end of
2006. The federal banking agencies are required to take "prompt corrective
action" in respect of depository institutions and their bank holding companies
that do not meet minimum capital requirements. FDIC established five capital
tiers: "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" and "critically undercapitalized." A depository
institution's capital tier, or that of its bank holding company, depends upon
where its capital levels are in relation to various relevant capital measures,
including a risk-based capital measure and a leverage ratio capital measure, and
certain other factors.
Under the implementing regulations adopted by the federal banking agencies,
a bank holding company or bank is considered "well capitalized" if it has (i) a
total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based
capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv)
is not subject to any order or written directive to meet and maintain a specific
capital level for any capital measure. An "adequately capitalized" bank holding
company or bank is defined as one that has (i) a total risk-based capital ratio
of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% or greater and
(iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank
with a composite CAMELS rating of 1). A bank holding company or bank is
considered (A) "undercapitalized" if it has (i) a total risk-based capital ratio
of less than 8%, (ii) a Tier 1 risk-based capital ratio of less than 4% or (iii)
a leverage ratio of less than 4% (or 3% in the case of a bank with a composite
CAMELS rating of 1); (B) "significantly undercapitalized" if the bank has (i) a
total risk-based capital ratio of less than 6%, or (ii) a Tier 1 risk-based
capital ratio of less than 3% or (iii) a leverage ratio of less than 3% and
(C)"critically undercapitalized" if the bank has a ratio of tangible equity to
total assets equal to or less than 2%. The Federal Reserve Board may reclassify
a "well capitalized" bank holding company or bank as "adequately capitalized" or
subject an "adequately capitalized" or "undercapitalized" institution to the
supervisory actions applicable to the next lower capital category if it
determines that the bank holding company or bank is in an unsafe or unsound
condition or deems the bank holding company or bank to be engaged in an unsafe
or unsound practice and not to have corrected the deficiency. The Company and
Bank currently meet the definition of "well capitalized" institutions.
6
"Undercapitalized" depository institutions, among other things, are subject to
growth limitations, are prohibited, with certain exceptions, from making capital
distributions, are limited in their ability to obtain funding from a Federal
Reserve Bank and are required to submit a capital restoration plan. The federal
banking agencies may not accept a capital plan without determining, among other
things, that the plan is based on realistic assumptions and is likely to succeed
in restoring the depository institution's capital. In addition, for a capital
restoration plan to be acceptable, the depository institution's parent holding
company must guarantee that the institution will comply with such capital
restoration plan and provide appropriate assurances of performance. If a
depository institution fails to submit an acceptable plan, including if the
holding company refuses or is unable to make the guarantee described in the
previous sentence, it is treated as if it is "significantly undercapitalized".
Failure to submit or implement an acceptable capital plan also is grounds for
the appointment of a conservator or a receiver. "Significantly undercapitalized"
depository institutions may be subject to a number of additional requirements
and restrictions, including orders to sell sufficient voting stock to become
"adequately capitalized," requirements to reduce total assets and cessation of
receipt of deposits from correspondent banks. Moreover, the parent holding
company of a "significantly undercapitalized" depository institution may be
ordered to divest itself of the institution or of nonbank subsidiaries of the
holding company. "Critically undercapitalized" institutions, among other things,
are prohibited from making any payments of principal and interest on
subordinated debt, and are subject to the appointment of a receiver or
conservator. Each federal banking agency prescribes standards for depository
institutions and depository institution holding companies relating to internal
controls, information systems, internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, compensation, a
maximum ratio of classified assets to capital, minimum earnings sufficient to
absorb losses, a minimum ratio of market value to book value for publicly traded
shares and other standards as they deem appropriate. The Federal Reserve Board
and OCC have adopted such standards. Depository institutions that are not "well
capitalized" or "adequately capitalized" and have not received a waiver from the
FDIC are prohibited from accepting or renewing brokered deposits. As of December
31, 2003, the Company and Bank had no brokered deposits.
The USA Patriot Act of 2001 ("USA Patriot Act") imposes additional
obligations on U.S. financial institutions, including banks and broker dealer
subsidiaries, to implement policies, procedures and controls which are
reasonably designed to detect and report instances of money laundering and the
financing of terrorism. In addition, provisions of the USA Patriot Act require
the federal financial institution regulatory agencies to consider the
effectiveness of a financial institution's anti-money laundering activities when
reviewing bank mergers and bank holding company acquisitions.
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") intended to address
corporate and accounting fraud. Sarbanes-Oxley applies to publicly reporting
companies. In addition to the establishment of a new accounting oversight board,
which will enforce auditing, quality control and independence standards and will
be funded by fees from all publicly traded companies, the bill restricts
provision of both auditing and consulting services by accounting firms. To
maintain auditor independence, any non-audit services being provided to an audit
client will require pre-approval by the Company's audit committee members. In
addition, the audit partners must be rotated.
Sarbanes-Oxley also requires chief executive officers and chief financial
officers to certify to the accuracy of periodic reports filed with the
Securities Exchange Commission (the "SEC"), subject to civil and criminal
penalties if they knowingly or willfully violate this certification requirement.
In addition, under Sarbanes-Oxley, legal counsel will be required to report
evidence of a material violation of the securities laws or a breach of fiduciary
duty by a company to its chief executive officer or its chief legal officer,
7
and, if such officer does not appropriately respond, to report such evidence to
the audit committee or other similar committee of the board of directors or the
board itself.
Longer prison terms and increased penalties will also be applied to
corporate executives who violate federal securities laws, the period during
which certain types of suits can be brought against a company or its officers
has been extended, and bonuses issued to top executives prior to restatement of
a company's financial statements are now subject to disgorgement if such
restatement was due to corporate misconduct. Executives are also prohibited from
insider trading during retirement plan "blackout" periods, and loans to company
executives are restricted. Sarbanes-Oxley accelerates the time frame for
disclosures by public companies, as they must immediately disclose any material
changes in their financial condition or operations. Directors and executive
officers must also provide information for most changes in ownership in a
company's securities within two business days of the change.
Sarbanes-Oxley also prohibits any officer or director of a company or any
other person acting under their direction from taking any action to fraudulently
influence, coerce, manipulate or mislead any independent public or certified
accountant engaged in the audit of the company's financial statements for the
purpose of rendering the financial statements materially misleading.
Sarbanes-Oxley also requires the SEC to prescribe rules requiring inclusion of
an internal control report and assessment by management in the annual report to
shareholders. In addition, the Sarbanes-Oxley requires that each financial
report required to be prepared in accordance with (or reconciled to) accounting
principles generally accepted in the United States of America and filed with the
SEC reflect all material correcting adjustments that are identified by a
"registered public accounting firm" in accordance with accounting principles
generally accepted in the United States of America and the rules and regulations
of the SEC.
Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". The Statement is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. This Statement had no impact on
the Company's financial condition or results of operations.
In May 2003, the Financial Accounting Standards Board issued SFAS No. 150,
"Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity". SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both a liability and equity. It requires that an issuer classify certain
financial instruments as a liability, although the financial instrument may
previously have been classified as equity. This Statement is effective for
financial instruments entered into or modified after May 31, 2003 and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. This Statement had no impact on the Company's financial condition or
results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"), which covers guarantees such
as standby letters of credit, performance guarantees, and direct or indirect
guarantees of the indebtedness of others, but not guarantees of funding. FIN 45
requires a guarantor to recognize, at the inception of a guarantee, a liability
8
in an amount equal to the fair value of the obligation undertaken in issuing the
guarantee, and requires disclosure about the maximum potential payments that
might be required, as well as the collateral or other recourse obtainable. The
recognition and measurement provisions of FIN 45 were effective on a prospective
basis after December 31, 2002, and its adoption by the Company on January 1,
2003 has not had a significant effect on the Company's consolidated financial
statements.
In December 2003, the FASB revised Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which explains identification of
variable interest entities and the assessment of whether to consolidate these
entities. FIN 46 requires existing unconsolidated variable interest entities to
be consolidated by their primary beneficiaries if the entities do not
effectively disperse risks among the involved parties. The provisions of FIN 46
are effective for all financial statements issued after January 1, 2003. The
Company has no variable interests in any entities which would require disclosure
or consolidation.
In December 2002, FASB issued SFAS No. 148, which provides three
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based compensation. In addition, this Statement
amends the disclosure requirements of SFAS No. 123 to require more prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the impact on reported
financial results. Finally, this Statement amends APB Opinion No. 28, Interim
Financial Reporting, to require disclosure about those effects in interim
financial information. This Statement is effective for fiscal and interim
periods ending after December 15, 2003. The Company has elected to adopt the
prospective transition method effective January 1, 2003 and, accordingly,
compensation expense was recognized for any stock options granted on or after
that date. The unvested portion of stock options granted prior to January 1,
2003 will continue to be accounted for under the provisions of APB Opinion No.
28. This Statement did not have an impact on the Company's financial condition
or results of operations in 2003 since no stock options were granted. Since the
method of determining the value of stock options prescribed under SFAS No. 123
is based on a valuation model that relies upon factors that are beyond the
Company's control, such as stock price volatility and market interest rates,
Management is not able to accurately predict the cost of options that may be
granted in the future and the resulting impact on the Company's financial
condition and results of operations. Additional information regarding stock
options is contained in Notes A and M of the Notes to the Consolidated Financial
Statements.
9
Statistical Data
The following information is required by the Industry Guide 3, "Statistical
Disclosure by Bank Holding Companies". The averages shown have been calculated
using the average daily balance.
Sequential Page
Number
I. Distribution of Assets, Liabilities and Share-
holders' Equity; Interest Rates and Differential
A. Average balance sheets 19
B. Analysis of net interest earnings 19
C. Rate/volume analysis 20
II. Investment Portfolio
A. Book value (Amortized Cost) of investments 42
B. Weighted average yield and maturity 19, 23, 28 and 43
C. Securities of issuer exceeding
ten percent of equity: None
III. Loan Portfolio
A. Types of loans 19 and 44
B. Maturities and sensitivities of loans
to change in interest rates 28 and 45
C. Risk elements
1. Non-accrual, past due,
and restructured loans 24 and 44
2. Potential problem loans: None
3. Foreign outstandings: None
4. Loan concentrations 23 and 44
D. Other Interest Bearing Assets: None
IV. Summary of Loan Loss Experience 21, 24 and 45
V. Deposits
A. Average balances and average rates paid 19
B. Other categories of deposits None
C. Foreign outstandings None
D. Maturity of time deposits greater than $100,000 28
E. Maturity of foreign time deposits
greater than 100,000 None
VI. Return on Equity and Assets 17
VII. Short-term Borrowings: None
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ITEM 2. PROPERTIES
The Company is headquartered in Sonoma, California. At the present time the
Company's Bank has two branch offices with a third branch opening first quarter
2004. In 1995 the Bank leased additional office space adjacent to the Sonoma
Branch and in September 1997 the Bank purchased property across the street from
the Sonoma Branch. The Sonoma Branch is located at 202 W. Napa Street, Sonoma.
The building contains approximately 6800 square feet and has been subleased on a
long-term basis (the initial term expires in 2009, with option to extend for two
additional five-year terms). The office is considered by management to be well
maintained and adequate for the purpose intended. Lease payments made in 2003
totaled $224,979 compared to the $216,326 paid in 2002. The lease provides for
future annual rents to be adjusted for changes in the Consumer Price Index
("CPI"), with a minimum annual increase of 4%, effective each March 1st.
In July, 1995, the Bank leased a building at 463 Second Street West. The
building contains approximately 2400 square feet and has been leased on a long
term basis to coincide with the Sonoma Branch lease. The initial term expired in
2000, with the first option exercised to expire in 2005, with an option to
extend for three additional five year terms and one additional four year term.
At present the Bank utilizes all of the units. Lease payments made in 2003
totaled $37,006 compared with the $36,376 paid in 2002. The lease provides for
future annual rents to be adjusted for changes in the Consumer Price Index
("CPI") effective each July 1st.
In September, 1997 the Bank purchased a building at 472 Second St. West.
The building contains approximately 1013 square feet. The Bank paid $246,943 for
the property. At present the Bank is utilizing the parking area for additional
parking for Bank employees and the Bank is renting out the building premises.
Rental income in 2003 was $17,406 compared to $16,521 in 2002.
The Glen Ellen Branch is located at 13751 Arnold Drive, Glen Ellen. The
facility is approximately 600 square feet. The facility is leased for a five
year term expiring in 2008 with the option to extend for two additional five
year terms. Lease payments made in 2003 totaled $12,889 compared to $12,172 in
2002. The lease provides for future annual rents to be adjusted for changes in
the CPI, with a minimum annual increase of 4% effective April 1st of each year.
The Banco de Sonoma Branch, opened in March 2004, is located at 18615
Sonoma Hwy #108, Boyes Hot Springs. The facility is approximately 1200 square
feet. The facility is leased for a five year term expiring in 2009 with an
option to extend for two additional five year terms. The lease provides for
future annual rents to be adjusted for changes in the CPI effective January 1st
of each year.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of operations, the Company and /or its Bank may have
disagreements or disputes with vendors, borrowers, or employees, which may or
may not result in litigation. These disputes are seen by the Company's
management as a normal part of business. There are no pending actions reported
and no threatened actions that management believes would have a significant
material impact on the Company's financial position, results of operations or
cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
The Company did not submit any matters to security holders during the
fourth quarter of its last fiscal year ended December 31, 2003.
11
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED
SECURITY HOLDER MATTERS
Following the reorganization the Company's common stock began trading on
the Over the Counter Bulletin Board ("OTC BB") under the symbol "SBNK", and the
Bank's stock ceased to be traded. The Company is not listed on any exchange or
on the National Association of Securities Dealers Automated Quotation System
("NASDAQ").
Several brokers act as facilitators in the trades of Sonoma Valley Bancorp
stock. They are:
A.G. Edwards Hoefer and Arnett
703 2nd Street, Suite 100 555 Market Street, 18th floor
Santa Rosa, CA 95409 San Francisco, CA 94105
Denise Gilseth Lisa Gallo
(800) 972-4800 (800) 346-5544
Paine Webber Monroe Securities
6570 Oakmont Drive 47 State Street
Santa Rosa, CA 95409 Rochester, NY 14614
John Rector Helen Rubeins
(707) 539-1500 (888)995-5560
Edward Jones Sutro & Co.
515 First Street East P.O. Box 2859
Sonoma, CA 95476 Big Bear Lake, CA 92315
Gary Scott Troy Norlander
(707) 935-1856 (800) 288-2811
Wedbush Morgan Securities
1300 S.W. Fifth Avenue, Suite 2000.
Portland, OR 97201-5667
Joey Warmenhoven
(503) 224-0480
12
The table below summarizes those trades of the common stock as reported by
OTC BB, setting forth the high and low prices for the periods shown. The stock
prices have been adjusted for stock dividends.
Quarter Ended: High Low
March 31, 2002 $ 21.32 $ 19.27
June 30, 2002 27.62 20.51
September 30, 2002 27.62 25.00
December 31, 2002 29.47 25.48
March 31, 2003 $ 29.52 $ 26.10
June 30, 2003 29.00 26.67
September 30, 2003 30.00 27.60
December 31, 2003 31.00 28.25
As of March 9, 2004, there were 1,661 holders of record of the Company's
common stock.
Payment of Dividends
Under state law, the Board of Directors of a California state-licensed bank
may declare a cash dividend, subject to the restriction that the amount
available for the payment of cash dividends shall be the lesser of retained
earnings of the bank or the bank's net income for its last three fiscal years
(less the amount of any distributions to shareholders made during such period).
However, under the Financial Institutions Supervisory Act, the FDIC has
broad authority to prohibit a bank from engaging in banking practices which it
considers to be unsafe or unsound. It is possible, depending upon the financial
condition of the bank in question and other factors, that the FDIC may assert
that the payment of dividends or other payments by a bank is considered an
unsafe and unsound banking practice and therefore, implement corrective action
to address such a practice.
The Bank paid cash dividends of $300,000 on December 29, 2000, $500,000 on
April 18, 2001, $500,000 on February 26, 2003 and $1,000,000 on June 18, 2003 to
the Company. Future dividend payments from the Bank to the Company will depend
on the Bank's future earnings and on the Bank's ability to meeting certain
capital requirements and having an adequate allowance for loan losses.
The Company paid a cash dividend of $0.25 cent per share to shareholders of
record as of March 1, 2004 with payment made on March 15, 2004. The Board of
Directors of the Company is currently reviewing our strategic plan to utilize
our capital assets in order to enhance shareholder value. One of the initiatives
includes review of the declaration of future cash dividends. No plan has yet
been finalized.
13
Historically, the Company and the Bank have declared ten stock dividends of
5% each, two stock dividends of 10% in May 1996 and June 1997, one 2 for 1 stock
split in March 1998 and a cash dividend in February 2004 as detailed below:
Dividends Paid by the Bank
--------------------------
Date Declared Record Date Date Paid
---------------------- ---------------------- ---------------------
May 13, 1992 May 31, 1992 June 15, 1992
June 26, 1993 July 15, 1993 July 31, 1993
July 20, 1994 August 1, 1994 August 15, 1994
January 18, 1995 February 5, 1995 February 20, 1995
August 16, 1995 September 11, 1995 September 29, 1995
May 22, 1996 June 14, 1996 June 28, 1996
June 18, 1997 July 15, 1997 August 1, 1997
March 18, 1998 April 15, 1998 April 30, 1998
July 21, 1999 August 16, 1999 August 31, 1999
August 16, 2000 September 8, 2000 September 25, 2000
Dividends Paid by the Company
-----------------------------
Date Declared Record Date Date Paid
---------------------- ---------------------- ---------------------
July 18, 2001 August 3, 2001 August 17, 2001
June 17, 2002 July 2, 2002 July 16, 2002
June 18, 2003 July 2, 2003 July 16, 2003
February 18, 2004 March 1, 2004 March 15, 2004
14
ITEM 6. SELECTED FINANCIAL DATA
SONOMA VALLEY BANCORP
Selected Consolidated Financial Data
dollars in thousands, except share
and per share data
For the years ended:
2003 2002 2001 2000 1999 1998
---- ---- ---- ---- ---- ----
RESULTS OF OPERATIONS:
Net interest income $ 8,906 $ 8,633 $ 8,236 $ 7,870 $ 6,699 $ 5,987
Provision for loan losses 20 393 342 335 240 335
Non-interest income 1,715 1,646 1,309 893 941 878
Non-interest expense 6,244 5,862 5,224 5,061 4614 4,100
Provision for income tax 1,446 1,275 1,379 1,160 976 843
-------- -------- -------- -------- -------- --------
$ 2,911 $ 2,744 $ 2,600 $ 2,207 $ 1,810 $ 1,587
======== ======== ======== ======== ======== ========
SELECTED AVERAGE BALANCES:
Assets $195,177 $164,200 $147,807 $135,924 $123,202 $107,202
Loans, net of unearned 123,044 116,867 100,605 86,547 73,222 70,838
Deposits 171,620 143,228 129,534 120,135 109,801 95,819
Shareholders' equity 20,232 17,964 15,121 12,984 11,490 9,976
PER SHARE DATA:
Basic net income $2.00 $1.87 $1.77 $1.49 $1.21 $1.06
Fully diluted net income $1.83 $1.72 $1.66 $1.45 $1.19 $1.05
Period end book value $14.73 $13.09 $11.36 $9.67 $8.10 $7.16
Weighted average shares
outstanding 1,457,431 1,464,344 1,473,151 1,478,573 1,497,447 1,502,803
FINANCIAL RATIOS:
Return on average assets 1.49% 1.67% 1.76% 1.62% 1.47% 1.48%
Return on average
shareholders' equity 14.39% 15.27% 17.19% 17.00% 15.75% 15.91%
Net yield on earning
assets 5.24% 6.06% 6.25% 6.49% 6.04% 6.22%
Cost Control ratio 56.95% 55.07% 52.72% 55.06% 58.52% 57.97%
Average shareholders'
equity to average assets 10.37% 10.94% 10.23% 9.55% 9.33% 9.31%
CAPITAL RATIOS:
Risk-based capital:
Tier I 12.81% 12.31% 11.81% 12.78% 12.36% 12.57%
Total 14.07% 13.57% 13.07% 14.04% 13.62% 13.83%
Leverage ratio 10.50% 10.62% 10.38% 10.11% 9.54% 9.55%
CREDIT QUALITY:
Net charge-offs to
average loans 0.14% 0.02% 0.05% -0.04% 0.04% 0.09%
Allowance for possible
loan losses to period
end loans 2.15% 2.17% 2.25% 2.29% 2.19% 2.12%
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Year Ended December 31, 2003 versus December 31, 2002
The business operations of the Company continue to be conducted through its
wholly-owned subsidiary, Sonoma Valley Bank ("Bank"), which began commercial
lending operations on June 3, 1988. Accordingly, the following discussion and
analysis of the financial condition and the results of operations should be read
in conjunction with the financial statements and notes included elsewhere in
this annual report. Per share amounts for prior years have been adjusted for the
Bank's prior 2 for 1 stock split declared March 18, 1998, 10% stock dividends
declared June 18, 1997 and May 22, 1996 and 5% stock dividends declared in June
2003, June 2002, July 2001, August 2000, July 1999, January and August, 1995,
July 1994, June 1993 and May, 1992. The continual growth and success of the
company is dependent upon a stable economy, an increasing deposit base in the
valley and economically viable technology to enhance customer service. Expansion
of services in the valley such as the opening of a new branch, the placement of
remote ATM in the local hospital, and the deployment of wire transfer services
through an international network are some of the strategies for our continual
successful performance. We continue to believe that community banking, through
providing useful services in niche markets will prosper in spite of the
consolidation taking place in the industry.
Critical Accounting Policies
The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States and general practices within
the financial services industry. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. A summary of the Company's most significant accounting policies is
contained in Note A to the consolidated financial statements. The Company
considers its most critical accounting policies to consist of the allowance for
loan and lease losses and the estimation of fair value, which are separately
discussed below.
Allowance for Loan and Lease Losses. The allowance for loan and lease
losses represents management's best estimate of inherent losses in the existing
loan portfolio. The allowance for loan and lease losses is increased by the
provision for losses on loans and leases charged to expense and reduced by loans
and leases charged off, net of recoveries. The provision for loan and lease
losses is determined based on management assessment of several factors: reviews
and evaluations of specific loans and leases, changes in the nature and volume
of the loan portfolio, current economic conditions and the related impact on
specific borrowers and industry groups, historical loan and lease loss
experience, the level of classified and nonperforming loans and the results of
regulatory examinations.
The Company's Audit Committee engage experienced independent loan portfolio
review professionals many of which are former bank examiners. The Audit
Committee determines the scope of such reviews and will provide the report of
findings to the Board's Loan Committee after they have accepted it. These
reviews are supplemented with periodic reviews by the Company's credit review
function, as well as periodic examination of both selected credits and the
credit review process by the applicable regulatory agencies. The information
from these reviews assists management in the timely identification of problems
and potential problems and provides a basis for deciding whether the credit
represents a probable loss or risk that should be recognized.
Changes in the financial condition of individual borrowers, in economic
conditions, in historical loss experience and in the conditions of the various
markets in which collateral may be sold may all affect the required level of the
16
allowance for loan and lease losses and the associated provision for loan and
lease losses.
Estimation of Fair Value. Accounting principles generally accepted in the
United States require that certain assets and liabilities be carried on the
Consolidated Balance Sheet at fair value or at the lower of cost or fair value.
Furthermore, the fair value of financial instruments is required to be disclosed
as a part of the notes to the consolidated financial statements for other assets
and liabilities. Fair values are volatile and may be influenced by a number of
factors, including market interest rates, prepayment speeds, discount rates, the
shape of yield curves and the credit worthiness of counterparties.
Fair values for the majority of the Company's available for sale investment
securities are based on quoted market prices. In instances where quoted market
prices are not available, fair values are based on the quoted prices of similar
instruments with adjustment for relevant distinctions. For trading account
assets, fair value is estimated giving consideration to the contractual interest
rates, weighted average maturities and anticipated prepayment speeds of the
underlying instruments and market interest rates.
Overview
Net income for 2003 was $2,911,007 compared with earnings of $2,744,333 in
2002. Basic earnings per share for 2003 was $2.00 compared with $1.87 in 2002.
Return on average shareholders' equity declined to 14.39% in 2003 compared to
15.27% in 2002. Return on average total assets for 2003, 2002 and 2001 were
1.49%, 1.67% and 1.76%, respectively.
While the bank continues to enjoy increased earnings over the last three
years, the banks growth in assets has exceeded the earnings growth. Earning
growth has been impacted by the decline in net interest margins, which is a
combination of increased rate competition for loans and the lower market rates
for investment securities. Retaining all of the banks earnings in its capital
accounts has resulted in the decline in the return on equity, as the capital
accounts increase at a faster growth rate than the increase in net income. The
capital planning strategy going forward will deploy both a repurchase of share
strategy with a cash dividend policy intended to better manage an adequate
capital level.
At December 31, 2003, total assets were $205.1 million, a 12.3% increase
over the $182.6 million at December 31, 2002. The Company showed loans of $122.5
million in 2003, compared with $128.1 million at year-end 2002, a decline of
4.4%. Deposits increased, growing 12.6%, from $160.0 million at year-end 2002 to
$180.1 million at year-end 2003. The loan-to-deposit ratio declined to 68.0% in
2003 from 80.0% in 2002. The decline in loans and the loan-to-deposit ratio is
reflective of management's attention to the risk associated with making long
term fixed rate loans at low interest rates and increased attention to loan
quality due to concern about the economy.
The company has acquired additional software to accommodate maintaining a
portfolio of adjustable rate residential loans, which was not an option
previously. Additionally, the bank has enhanced its ability to engage in
mortgage origination for the secondary market, and will be using the increased
liquidity for warehousing product available for sale. This activity is expected
to enhance earnings for the company.
Net Interest Income
Net interest income is the difference between total interest income and
total interest expense. Net interest income, adjusted to a fully taxable
equivalent basis, increased $250,000 to $9.3 million, up 2.8% from 2002 net
interest income of $9.0 million. Net interest income on a fully taxable
equivalent basis, as shown on the table - Average Balances, Yields and Rates
Paid (page 19), is higher than net interest income on the statements of
operations because it reflects adjustments applicable to tax-exempt income from
17
certain securities and loans ($343,000 in 2003 and $366,000 in 2002, based on a
34% federal income tax rate).
The increase in net interest income (stated on a fully taxable equivalent
basis) was the net effect of a small increase of $13,000 in interest income and
a $237,000 decrease in interest expense, which is a result of deposit rates
declining faster than loan rates. Declining rates influenced net interest income
in spite of the growth in earning assets. The decline in interest expense is
expected to plateau as the effective interest cost for the bank is not expected
to decline further. This combination of increased rate competition for loans and
investments with an inability to lower interest costs will likely result in a
flat earnings environment.
Net interest income (stated on a fully taxable equivalent basis) expressed
as a percentage of average earning assets, is referred to as net interest
margin. The Company's net interest margin declined 82 basis points to 5.24% in
2003 from 6.06% in 2002.
Interest Income
As previously stated, interest income (stated on a fully taxable equivalent
basis) increased by $13,000 to $11.0 million in 2003, a .12% increase over the
$10.9 million realized in 2002.
The $13,000 increase was the net effect of an 11.0% increase in average
earning assets to $176.6 million offset by a 117 basis point decline in average
yield for the year.
18
SONOMA VALLEY BANCORP
AVERAGE BALANCES/YIELDS AND RATES PAID
Rate/Volume
ASSETS Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield
Balance Expense Rate Balance Expense Rate Rate Expense Rate
- ------------------------- ------- ------- ------ -------- ------- ------ ------- ------- -----
Interest-earning assets:
Loans(2):
Commercial $85,965 $6,493 7.55% $75,696 $ 5,978 7.90% 61,888 $5,582 9.02%
Consumer 11,632 889 7.64% 13,186 1,098 8.33% 14,583 1,370 9.39%
Real estate construction 18,781 1,530 8.15% 19,040 1,689 8.87% 12,393 1,279 10.32%
Real estate mortgage 3,820 333 8.72% 5,732 481 8.39% 8,983 823 9.16%
Tax exempt loans (1) 3,147 263 8.36% 3,367 285 8.46% 2,566 220 8.57%
Leases 67 22 32.84% 164 27 16.46% 409 42 10.27%
Tax exempt leases (1) 47 10 21.28% 106 15 14.15% 165 15 9.09%
Unearned loan fees (416) (424) (382)
----- ----- -----
Total loans 123,043 9,540 7.75% 116,867 9,573 8.19% 100,605 9,331 9.27%
Investment securities
Available for sale:
Taxable 11,093 352 3.17% 6,029 365 6.05% 16,420 1,001 6.10%
Tax exempt(1) 0 0 0.00% 0 0 0.00% 0 0 0.00%
Hold to maturity:
Taxable 392 13 3.32% 201 13 6.47% 203 13 6.40%
Tax exempt (1) 11,270 736 6.53% 10,904 777 7.13% 11,779 837 7.11%
------ ----- ------ ----- ------ -----
Total investment 22,755 1,101 4.84% 17,134 1,155 6.74% 28,402 1,851 6.51%
securities
Federal funds sold 30,318 318 1.05% 14,053 216 1.54% 8,219 286 3.48%
FHLB Stock 288 13 4.51% 275 15 5.45% 261 15 5.75%
Total due from
banks/Interest bearing 202 1 0.50% 73 1 1.37% 11 0 2.73%
------- ------ ------- ------ ------- ------
Total interest earning 176,606 10,973 6.21% 148,402 10,960 7.39% 137,498 11,483 8.35%
assets ======= ====== ======= ====== ======= ======
Noninterest-bearing
assets:
Reserve for loan losses (2,772) (2,547) (2,263)
Cash and due from banks 9,090 7,600 6,620
Premises and equipment 1,120 705 620
Other assets 11,133 10,040 5,332
-------- -------- --------
Total assets $195,177 $164,200 $147,807
======== ======== ========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Interest bearing deposits
Interest bearing 29,819 $51 0.17% $23,794 $ 84 0.35% $21,940 $ 149 0.68%
transaction
Savings deposits 59,266 466 0.79% 48,052 656 1.37% 42,074 997 2.37%
Time deposits 19,794 477 2.41% 18,362 547 2.98% 16,739 845 5.05%
over $100,000
Other time deposits 25,209 730 2.90% 20,155 674 3.34% 18,913 885 4.68%
deposits ------ --- ------ --- ------ ---
Total interest bearing
Deposits 134,088 1,724 1.28% 110,363 1,961 1.78% 99,666 2,876 2.89%
Federal Funds purchased 0 0 0.00% 0 0 0.00% 0 0 0%
Other short term 3 0 0.00% 0 0 0.00% 174 7 4.02%
borrowings ------- ----- ------- ----- ------ -----
Total interest bearing
liabilities 134,091 1,724 1.28% 110,363 $ 1,961 1.78% 99,840 $ 2,883 2.89%
===== ======= =======
Non interest bearing
liabilities:
Non interest bearing 37,531 32,865 29,868
demand deposits
Other liabilities 3,323 3,008 2,978
Shareholders' equity 20,232 17,964 15,121
------- ------- ------
Total liabilities and
shareholders' equity 195,177 $164,200 $147,807
======= ======== ========
shareholders' equity
Interest rate spread 4.93% 5.61% 5.46%
Interest income $10,973 6.21% $10,960 7.39% $11,483 8.35%
Interest expense 1,724 0.98% 1,961 1.32% 2,883 2.10%
------- ------- -------
Net interest income/margin $9,249 5.24% $8,999 6.06% $8,600 6.25%
======= ======= =======
(1) Fully tax equivalent adjustments are based on a federal income tax
rate of 34% in 2003, 2002 and 2001.
(2) Non accrual loans have been included in loans for the purposes of the
above presentation. Loan fees of approximately $405,000, $343,000 and $334,000
for the twelve months ended December 31, 2003, 2002 and 2001, respectively,
were amortized to the appropriate interest income categories.
19
SONOMA VALLEY BANCORP
Rate/Volume Analysis
2003 over 2002 2002 over 2001
--------------- ---------------
Volume Rate Vol/Rate Total Volume Rate Vol/Rate Total
ASSETS
Interest-earning assets:
Loans:
Commercial 811 (261) (35) 515 1,245 (694) (155) 396
Consumer (129) (90) 11 (209) (131) (156) 15 (272)
Real estate (23) (138) 2 (159) 686 (180) (96) 410
construction
Real estate mortgage (160) 19 (6) (148) (298) (69) 25 (342)
Tax exempt loans (19) (4) 0 (22) 69 (3) (1) 65
Leases (16) 27 (16) (5) (25) 25 (15) (15)
Tax exempt leases (8) 8 (4) (5) (5) 8 (3) 0
Unearned fee income 0 0 0 0 0 0 0 0
---- ----- ---- ---- ----- ------- ----- ----
Total loans 456 (439) (48) (33) 1,541 (1,069) (230) 242
Investment securities:
Available for sale:
Taxable 307 (174) (146) (13) (633) (7) 4 (636)
Tax-exempt 0 0 0 0 0 0 0 0
Held to maturity:
Taxable 12 (6) (6) 0 0 0 0 0
Tax-exempt 26 (65) (2) (41) (62) 2 0 (60)
---- ----- ---- ---- ----- ------- ----- ----
Total investment
securities 345 (245) (154) (54) (695) (5) 4 (696)
Federal funds sold 250 (69) (79) 102 203 (160) (113) (70)
FHLB Stock 1 (3) (0) (2) 1 (1) 0 0
Due from banks-int bearing 2 (1) (1) 0 2 0 (1) 1
---- ----- ---- ---- ----- ------- ----- ----
Total interest-earning
assets 1,054 (757) (282) 13 1,052 (1,235) (340) (523)
===== ===== ===== ==== ===== ======= ===== =====
LIABILITIES
Interest-bearing liabilities:
Interest-bearing deposits:
Savings deposits 21 (44) (11) (34) 13 (72) (6) (65)
Interest-bearing demand
deposits 153 (277) (65) (189) 142 (423) (60) (341)
Time less than $100,000 43 (105) (8) (70) (26) (321) 9 (338)
Time $100,000 and over 169 (90) (23) 56 172 (285) (58) (171)
---- ----- ---- ---- ----- ------- ----- ----
Total interest-bearing
deposits 386 (516) (107) (237) 301 (1,101) (115) (915)
Federal funds purchased 0 0 0 0 0 0 0 0
Other borrowings 0 0 0 0 (7) (7) 7 (7)
---- ----- ---- ---- ----- ------- ----- ----
Total interest-bearing
liabilities 386 (516) (107) (237) 294 (1,108) (108) 922
Interest differential 668 (241) (175) 250 758 (127) (232) 399
===== ===== ===== ==== ===== ======= ===== =====
Volume/Rate variances were allocated in the following manner:
a. Changes affected by volume (change in volume times old rate)
b. Changes affected by rates (change in rates times old volume)
c. Changes affected by rate/volume (change in volume times change in rates)
The total for each category was arrived at by totaling the individual items
in their respective categories.
20
Interest Expense
Total interest expense declined by $237,000 to $1.7 million. The average
rate paid on all interest-bearing liabilities was 1.28%, compared to 1.78% in
2002. Average balances increased from $110.4 million to $134.1 million, a 21.5%
gain.
The gain in volume of average balances was responsible for a $279,000
increase in interest expense offset by a $516,000 decrease related to lower
interest rates paid for a net decrease of $237,000. The lower rates paid on
interest-bearing liabilities is a result of a declining interest rate
environment.
Individual components of interest income and interest expense are provided
in the table - Average Balances, Yields and Rates Paid on page 19.
Provision for Loan Losses
The provision for loan losses charged to operations is based on the Bank's
monthly evaluations of the loan portfolio and the adequacy of the allowance for
loan losses in relation to total loans outstanding. The provisions to the
allowance for loan losses amounted to $20,000 in 2003 and $393,000 in 2002. The
decrease in the provision is the result management's evaluation and assessment
of the loan portfolio and decline in the loan growth.
Loans charged-off, net of recoveries, resulted in losses totaling $167,000
in 2003 and $27,000 in 2002. The increase in charge offs reflects loan problems
related to the economic downturn. Refer to page 45, Note D for an analysis of
the changes in the allowance for loan and lease losses.
Non-interest Income
Non-interest income of $1.7 million increased 4.5% in comparison with the
$1.6 million recorded in 2002. The increase was primarily due to a $70,000
increase in service charges on deposit accounts.
Non-interest Expense
Total non-interest expense increased 6.5% to $6.2 million in 2003 from $5.9
million in 2002. Non-interest expense represented 3.2% of average total assets
in 2003 and 3.6% in 2001. The expense/asset ratio is a standard industry
measurement of a bank's ability to control its overhead or non-interest costs.
During 2004, the Company will continue to emphasize cost controls. Certain costs
are not controllable by management. Refer to Note I, page 49, for a detailed
description of Non-Interest Income and Other Non-Interest Expense.
Salaries and Benefits
Salaries and benefits increased 1.5% from $3.4 million in 2002 to $3.5
million in 2003. The 2003 increase reflects normal merit increases and employee
incentives paid as a result of the Company's earnings in 2003. Additionally,
there continues to be significant increases in workers compensation and employee
medical benefits. At December 31, 2003 and 2002 total full-time equivalent
employees were 49 and 44 respectively. Year-end assets per employee were $4.2
million in 2003 and 2002 compared to $3.3 million in 2001.
21
Premises and Equipment
Expenses related to premises and equipment increased by 24.4% to $769,000
in 2003 from $618,000 in 2002. Building lease expense on three locations and
storage units increased to $289,000 in 2003 from $278,000 in 2002. Lease income
for 2003 totaled $17,000 compared to lease income of $17,000 in 2002. The
increase in premises and equipment expense is the result renovation and
remodeling of the Operations Center and Sonoma Main Office facility.
Other Non-interest Expense
Other non-interest expense increased by 9.9% to $2.0 million in 2003 from
$1.8 million in 2002. The increase was the result of a 22.2% increase in
professional fees. Professional fees is the largest category of other
non-interest expense, primarily comprised of accounting, legal and other
professional fees. These services increased by $210,000 to $1,153,000 in 2003
from $944,000 in 2002. This increase is the result of the additional regulatory
requirements as a result of Sarbanes-Oxley and the U.S. Patriot Act. Increases
in other categories reflect the increased growth and volume of business in
general.
Provision for Income Taxes
The provision for income taxes increased to an effective tax rate of 33.2%
in 2003 compared with 31.7% in 2002.
Balance Sheet Analysis
Investment Securities
Securities are classified as held to maturity if the Company has both the
intent and the ability to hold these securities to maturity. As of December 31,
2003, the Company had securities totaling $16.6 million with a market value of
$17.0 million categorized as held to maturity. Decisions to acquire municipal
securities, which are generally placed in this category, are based on tax
planning needs and pledge requirements.
Securities are classified as available for sale if the Company intends to
hold these debt securities for an indefinite period of time, but not necessarily
to maturity. Investment securities which are categorized as available for sale
are acquired as part of the overall asset and liability management function and
serve as a primary source of liquidity. Decisions to acquire or dispose of
different investments are based on an assessment of various economic and
financial factors, including, but not limited to, interest rate risk, liquidity
and capital adequacy. Securities held in the available for sale category are
recorded at market value, which is $20.1 million compared to an amortized cost
of $20.1 million as of December 31, 2003.
At year end 2003 the overall portfolio had a market value of $37.2 million
compared with an amortized cost of $36.6 million. Investment securities
increased 166.8% to $36.7 million from $13.7 million in 2002. The Company
purchases securities rated A or higher by Standard and Poor's and/or Moody's
Investors Service. At year end the Company had two securities totaling $656,000
with ratings below A, both mature in 2004. Tax-exempt bonds are occasionally
purchased without an A rating. In the opinion of management, there was no
investment in securities at December 31, 2003 that would constitute a material
credit risk to the Company.
22
The table below shows the components of the investment portfolio and
average yields. For further information concerning the Company's total
securities portfolio, including market values and unrealized gains and losses,
refer to Note C of the Notes to Consolidated Financial Statements on pages 42
and 43.
Twelve months ended 12/31/03 Twelve months ended 12/31/02
Average Average Average Average
Balance Yield Balance Yield
------- ------- ------- -------
U.S. Treasury securities $ 780 1.8% $ 2,529 6.0%
U.S. federal agency issues 9,263 2.9% 1,596 6.1%
State, county and municipal issues 11,662 6.4% 11,105 7.1%
Corporate securities 1,050 6.4% 1,904 6.1%
-------- --------
Total investment securities $ 22,755 4.8% $ 17,134 6.7%
======== ========
Loans
A comparative schedule of average loan balances is presented in the table
on page 19; year-end balances are presented in Note D to the Consolidated
Financial Statements pages 44 and 45.
Loan balances, net of deferred loan fees at December 31, 2003, were $122.5
million, a decrease of 4.4% over 2002. Commercial loans, comprising 75.0% of the
portfolio, increased $2.7 million, or 3.0% over 2002. This increase represents
the only category of loans showing growth in 2003. Included in commercial loans
are loans made for commercial purposes and secured by real estate.
Real Estate Construction loans declined $2.8 million, or 14.7% over 2002
balances. Consumer loans, including home equity loans, decreased $1.6 million or
12.1% over 2002 balances while real estate mortgage loans declined $3.7 million
or 62.3%. In 1997 the Company began offering leasing opportunities to small
businesses. Lease financing receivables for year end 2003 decreased $94,000 or
54.0%.
Risk Elements
The majority of the Company's loan activity is with customers located
within Sonoma County. Approximately 84% of the total loan portfolio is secured
by real estate located in the Company's service area (see Note P, on page 57 of
the Consolidated Financial Statements, Concentration of Credit Risk).
Significant concentrations of credit risk may exist if a number of loan
customers are engaged in similar activities and have similar economic
characteristics. The Company believes that it has policies in place to identify
problem loans and to monitor concentration of credits of loan customers engaged
in similar activities.
Commitments and Letters of Credit
Loan commitments are written agreements to lend to customers at agreed upon
terms provided there are no violations of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses. Loan commitments may have variable interest rates and terms that
reflect current market conditions at the date of commitment. Because many of the
commitments are expected to expire without being drawn upon, the amount of total
commitments does not necessarily represent the Company's anticipated future
funding requirements. Unfunded loan commitments were $35.3 million at December
31, 2003 and $30.4 million at December 31, 2002.
23
Standby letters of credit commit the Company to make payments on behalf of
customers when certain specified events occur. Standby letters of credit are
primarily issued to support customers' financing requirements of twelve months
or less and must meet the Company's normal policies and collateral requirements.
Standby letters of credit outstanding were $725,000 at December 31, 2003 and
$589,000 at December 31, 2002.
Nonperforming Assets
Management classifies all loans as non-accrual loans when they become more
than 90 days past due as to principal or interest, or when the timely collection
of interest or principal becomes uncertain, if earlier, unless they are
adequately secured and in the process of collection.
A loan remains in a non-accrual status until both principal and interest
have been current for six months and meets cash flow or collateral criteria or
when the loan is determined to be uncollectible and is charged off against the
allowance for loan losses, or in the case of real estate loans, is transferred
to other real estate owned. A loan is classified as a restructured loan when the
interest rate is materially reduced, when the term is extended beyond the
original maturity date or other concessions are made by the Company because of
the inability of the borrower to repay the loan under the original terms.
The Company had $1.2 million in non-accrual status at December 31, 2003 and
$897,000 at December 31, 2002. There were $1.2 million in loans 90 days or more
past due at December 31, 2003 and $796,000 in loans 90 days or more past due at
December 31, 2002.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level considered adequate
to provide for losses that can be reasonably anticipated. The allowance is
increased by provisions charged to operating expense and reduced by charge-offs,
net of recoveries. The allowance is based on estimates, and ultimate losses may
vary from the current estimates. These estimates are reviewed monthly and, as
adjustments become necessary, they are reported in earnings in the periods in
which they become known.
The review process is intended to identify loan customers who may be
experiencing financial difficulties. In these circumstances, a specific reserve
allocation or charge-off may be recommended. Other factors considered by
management in evaluating the adequacy of the allowance include: loan volume,
historical net loan loss experience, the condition of industries and geographic
areas experiencing or expected to experience economic adversities, credit
evaluations, and current economic conditions. The allowance for loan losses is
not a precise amount, but based on the factors above, represents management's
best estimate of losses that may be ultimately realized from the current loan
portfolio.
Worsening conditions in certain economic sectors and geographic areas could
adversely affect the loan portfolio, necessitating larger provisions for loan
losses than currently estimated. However, as of December 31, 2003, the Company
believes its overall allowance for loan losses is adequate based on its analysis
of conditions at that time.
At December 31, 2003, the allowance for loan losses was $2.6 million, or
2.2% of year end loans, compared with $2.8 million or 2.2% of year end loans at
December 31, 2002. Net charge-offs to average loans increased when compared with
the prior year. The Company recorded net losses of $167,000 or .14% of average
loans in 2003 compared to $27,000 or .02% of average loans in 2002. The
continued low level of charge-offs in 2003 reflects the Company's attention and
effort in managing and collecting past due loans by encouraging the customer to
bring them to a current status or to pay them off.
24
Deposits
A comparative schedule of average deposit balances is presented in the
table on page 19; year-end deposit balances are presented in the table below.
Total deposits increased $20.1 million (12.6%) in 2003, to $180.1 million.
Demand deposits declined $813,000, or 2.1% in 2003. Savings deposits increased
by $11.9 million, or 22.9% and interest bearing checking increased $7.8 million
or 31.8% during 2003. Other time deposits of less than $100,000 decreased
$325,000, or 1.6% and time deposits over $100,000 increased $1.5 million, for an
increase of 6.2% over 2002 balances.
The composition of deposits for the years ending December 31, 2003 and 2002
are as follows:
December 31, Percentage December 31, Percentage
2003 of Total 2002 of Total
------------ ---------- ------------ ----------
Interest bearing transaction deposits $32,467,678 18.0% $24,627,589 15.4%
Savings deposits 63,680,697 35.4% 51,802,714 32.4%
Time deposits, $100,000 and over 26,565,347 14.7% 25,018,603 15.6%
Other time deposits 19,453,317 10.8% 19,778,540 12.4%
------------ ------------ ------
Total interest bearing deposits 142,167,039 78.9% 121,227,446 75.8%
Noninterest-bearing deposits 37,947,577 21.1% 38,760,806 24.2%
------------ ------------ ------
Total deposits $180,114,616 100.0% $159,988,252 100.0%
============ ============ ======
Capital
The Bank is subject to FDIC regulations governing capital adequacy. The
FDIC has adopted risk-based capital guidelines which establish a risk-adjusted
ratio relating capital to different categories of assets and off-balance sheet
exposures. Under the current guidelines, as of December 31, 2003, the Bank was
required to have minimum Tier I and total risk-based capital ratios of 4% and 8%
respectively. To be well capitalized under Prompt Corrective Action Provisions
requires minimum Tier I and total risk-based capital ratios should be 6% and 10%
respectively.
The FDIC has also adopted minimum leverage ratio guidelines for compliance
by banking organizations. The guidelines require a minimum leverage ratio of 4
percent of Tier 1 capital to total average assets. Banks experiencing high
growth rates are expected to maintain capital positions well above the minimum
levels. The leverage ratio in conjunction with the risk-based capital ratio
constitute the basis for determining the capital adequacy of banking
organizations.
Based on the FDIC's guidelines, the Bank's total risk-based capital ratio
at December 31, 2003 was 13.44% and its Tier 1 risk-based capital ratio was
12.18%. The Bank's leverage ratio was 10.00%. All the ratios exceed the minimum
guidelines of 8.00%, 4.00% and 4.00%, respectively. The ratios for the Holding
Company at December 31, 2002, were 13.57%, 12.31% and 10.62%, respectively. The
capital ratios for the Holding Company at December 31, 2003, were 14.07%, 12.81%
and 10.49%, respectively.
In February 2001, the Company approved a program to repurchase Sonoma
Valley Bancorp stock up to $1 million and in August 2002 the Company approved
the repurchase of an additional $1 million Sonoma Valley Bancorp stock. As of
December 31, 2003, $1,448,737 was repurchased and retired, net of options which
were exercised and then subsequently repurchased and retired. The Company is
continuing to repurchase Sonoma Valley Bancorp stock up to the authorized
amount.
25
Management believes that the Bank's current capital position, which exceeds
guidelines established by industry regulators, is adequate to support its
business.
Off Balance Sheet Commitments
The Company's off balance sheet commitments consist of commitments to
extend credit and standby letters of credit. These commitments are extended to
customers in the normal course of business and are described in Note O to the
Consolidated Financial Statements on page 55. The Company also has contractual
obligations consisting of operating leases for various facilities and payments
to participants under the Company's supplemental executive retirement plan and
deferred compensation plan, which are described in Note H.
The following table summarizes the Company's contractual obligations as of
December 31, 2003.
Payments due by period
Less than 1 More than 5
Contractual Obligations Total year 1-3 years 3-5 Years years
- ----------------------------------------------------------------------------------------------------
Operating Lease Obligations 1,623,625 302,802 582,837 594,949 143,037
Executive Officer Supplemental
Retirement 1,733,623 5,000 29,502 186,543 1,512,578
Deferred Compensation 989,788 12,819 16,844 106,504 853,621
Liquidity Management
The Company's liquidity is determined by the level of assets (such as cash,
federal funds sold and available-for-sale securities) that are readily
convertible to cash to meet customer withdrawal and borrowing needs. Deposit
growth also contributes to the Company's liquidity needs. The Company's
liquidity position is reviewed by management on a regular basis to verify that
it is adequate to meet projected loan funding and potential withdrawal of
deposits. The Company has a comprehensive Asset and Liability Policy which it
uses to monitor and determine adequate levels of liquidity. At year end 2003,
the Company's liquidity ratio (adjusted liquid assets to deposits and short term
liabilities) was 29.03% compared to 20.39% and 21.08% at year end 2002 and 2001,
respectively. Management expects that liquidity will remain adequate throughout
2004, as loans are not expected to grow significantly more than deposits, and
excess funds will continue to be invested in quality liquid assets.
Market Risk Management
Overview. Market risk is the risk of loss from adverse changes in market
prices and rates. The Company's market risk arises primarily from interest rate
risk inherent in its loan and deposit functions. The goal for managing the
assets and liabilities of the Company is to maximize shareholder value and
earnings while maintaining a high quality balance sheet without exposing the
Company to undue interest rate risk. The Board of Directors has overall
responsibility for the interest rate risk management policies. Sonoma Valley
Bank has an Asset and Liability Management Committee (ALCO) that establishes and
monitors guidelines to control the sensitivity of earnings to changes in
interest rates.
Asset/Liability Management. Activities involved in asset/liability
management include but are not limited to lending, accepting and placing
deposits and investing in securities. Interest rate risk is the primary market
risk associated with asset/liability management. Sensitivity of earnings to
interest rate changes arises when yields on assets change in a different time
period or in a different amount from that of interest costs on liabilities. To
26
mitigate interest rate risk, the structure of the balance sheet is managed with
the goal that movements of interest rates on assets and liabilities are
correlated and contribute to earnings even in periods of volatile interest
rates. The asset/liability management policy sets limits on the acceptable
amount of variance in net interest margin and market value of equity under
changing interest environments. The Company uses simulation models to forecast
earnings, net interest margin and market value of equity.
Simulation of earnings is the primary tool used to measure the sensitivity
of earnings to interest rate changes. Using computer-modeling techniques, the
Company is able to estimate the potential impact of changing interest rates on
earnings. A balance sheet forecast is prepared quarterly using inputs of actual
loans, securities and interest bearing liabilities (i.e. depositis/borrowings)
positions as the beginning base. The forecast balance sheet is processed against
four interest rate scenarios. The scenarios include a 100 and 200 basis point
rising rate forecasts, a flat rate forecast and a 100 basis point falling rate
forecast which take place within a one year time frame. The net interest income
is measured during the year assuming a gradual change in rates over the
twelve-month horizon. The Company's 2004 net interest income, as forecast below,
was modeled utilizing a forecast balance sheet projected from year-end 2002
balances. The following table summarizes the effect on net interest income (NII)
of a +/-100 and +200 basis point change in interest rates as measured against a
constant rate (no change) scenario.
Interest Rate Risk Simulation of Net Interest Income as of December 31, 2003
(In thousands)
Variation from a constant rate scenario Change in NII
+200bp $948
+100bp $434
-100bp ($328)
The simulations of earnings do not incorporate any management actions,
which might moderate the negative consequences of interest rate deviations.
Therefore, they do not reflect likely actual results, but serve as conservative
estimates of interest rate risk.
Interest Rate Sensitivity Analysis. Interest rate sensitivity is a function
of the repricing characteristics of the portfolio of assets and liabilities.
These repricing characteristics are the time frames within which the
interest-bearing assets and liabilities are subject to change in interest rates
either at replacement, repricing or maturity. Interest rate sensitivity
management focuses on the maturity of assets and liabilities and their repricing
during periods of changes in market interest rates. Interest rate sensitivity is
measured as the difference between the volumes of assets and liabilities in the
current portfolio that are subject to repricing at various time horizons. The
differences are known as interest sensitivity gaps.
A positive cumulative gap may be equated to an asset sensitive position. An
asset sensitive position in a rising interest rate environment will cause a
bank's interest rate margin to expand. This results as floating or variable rate
loans reprice more rapidly than fixed rate certificates of deposit that reprice
as they mature over time. Conversely, a declining interest rate environment will
cause the opposite effect. A negative cumulative gap may be equated to a
liability sensitive position. A liability sensitive position in a rising
interest rate environment will cause a bank's interest rate margin to contract,
while a declining interest rate environment will have the opposite effect.
The following table sets forth the dollar amounts of maturing and/or
repricing assets and liabilities for various periods. This does not include the
impact of prepayments or other forms of convexity caused by changing interest
rates. Historically, this has been immaterial and estimates for them are not
included.
27
The Company has more liabilities than assets repricing during the next
year. However, because the Company's asset rates change more than deposit rates,
the Company's interest income will change more than the cost of funds when rates
change. Its net interest margin should therefore increase somewhat when rates
increase and shrink somewhat when rates fall.
The Company controls its long term interest rate risk by keeping long term
fixed rate assets (longer than 5 years) less than its long term fixed rate
funding, primarily demand deposit accounts and capital. The following table sets
forth cumulative maturity distributions as of December 31, 2003 for the
Company's interest-bearing assets and interest-bearing liabilities, and the
Company's interest rate sensitivity gap as a percentage of total
interest-earning assets. The table shows $72.5 million in fixed rate loans over
5 years. Many variable rate credit lines reached floors in 2003, and were
reclassified to the fixed rate category. As soon as interest rates increase, the
loans will no longer be at floors and will be reclassified back to the floating
rate category.
(dollars in thousands)
December 31, 2003 3 months 12 months 3 years 5 years 15 years >15 years Totals
- -------------------------------------------------------------------------------------------------
ASSETS:
Fixed rate investments $300 $3,977 $11,268 $4,858 $15,298 $977 $36,678
Variable rate investments 295 295
Fixed rate loans 11,452 12,844 11,686 30,199 39,608 2,696 108,485
Variable rate loans 13,191 0 0 0 0 0 13,191
Interest-bearing balances 35 35
Fed funds sold 25,220 25,220
------ ------
Interest bearing assets 50,198 16,821 22,954 35,057 54,906 3,968 183,904
====== ====== ====== ====== ====== ===== =======
LIABILITIES:
Interest bearing 32,468 32,468
transaction deposits
Savings deposits 63,681 63,681
Time deposits
Fixed rate >100m 5,933 13,199 5,251 2,254 26,637
Fixed rate <100m 5,437 8,743 4,114 1,043 19,337
Floating rate >100m 0
Floating rate <100m 44 44
Borrowings 0 0
----- ------
Interest Bearing $107,563 $21,942 $9,365 $3,297 $ 0 $0 $142,167
Liabilities ======== ======= ====== ====== === ===== ========
Rate Sensitivity Gap (57,365) (5,121) 13,589 31,760 54,906 3,968
Cumulative Rate (57,365)(62,486) (48,897) (17,137) 37,769 41,737
Sensitivity Gap
Cumulative Position to (27.97%)(30.47%) (23.84%) (8.36%) 18.41% 20.34%
Total Assets
Inflation
Assets and liabilities of a financial institution are principally monetary
in nature. Accordingly, interest rates, which generally move with the rate of
inflation, have potentially the most significant effect on the Company's net
interest income. The Company attempts to limit inflation's impact on rates and
net income margins by minimizing its effect on these margins through continuing
asset/liability management programs.
28
Management's Discussion and Analysis
The Year Ended December 31, 2002 versus December 31, 2001
Summary
Net income for 2002 was $2.7 million compared with $2.6 million in 2001.
Basic earnings per share for 2002 were $1.87 compared with $1.77 in 2001. Return
on average assets was 1.67% in 2002 compared with 1.76% the previous year, while
return on average equity was 15.27% in 2002 and 17.19% for the previous year.
Total assets reached $182.6 million in 2002, an 16.0% increase over the
$157.4 million at December 31, 2001. Loans increased 19.2% to $128.1 million,
compared with $107.4 million at year-end 2001. Deposits also increased, growing
16.2% from $137.7 million at year-end 2001 to $160.0 million at year-end 2002.
The loan-to-deposit ratio increased from 78.1% to 80.0%.
Net Interest Income
Net interest income on a fully tax equivalent basis increased by $399,000
to $9.0 million in 2002, up 4.6% from 2001 net interest income of $8.6 million.
The net interest margin for 2002 decreased to 6.06% from 6.25% for the previous
year. Individual components of interest income and interest expense are provided
in the table - Average Balances, Yields and Rates Paid on page 19.
Interest Income
Interest income decreased by $523,000 to $11.0 million for a 4.6% decline
over the $11.5 million realized in 2001. The volume of earning assets increased
by 7.9% to $148.4 million from $137.5 million in 2001, while the yield on
average earning assets declined 97 basis points.
Interest Expense
Interest expense decreased by $922,000 to $2.0 million in 2002 from $2.9
million in 2001. The average rate paid on all interest-bearing liabilities
decreased from 2.89% in 2001 to 1.78% in 2002 while average balances increased
from $99.8 million to $110.4 million, a 10.5% gain over 2001. The gain in volume
of average balances was responsible for a $186,000 increase in interest expense
and higher interest rates paid resulted in a decrease of $1,108,000 for a total
decrease of $922,000. The higher rates paid on interest bearing liabilities is
the result of a raising rate environment.
Provision for Loan Losses
The provision for loan losses was $393,000 in 2002 and $342,000 in 2001.
The increase in the provision is primarily the result of loan growth and
management's evaluation and assessment of the loan portfolio. Loans charged off,
net of recoveries, resulted in losses totaling $27,000 in 2002 and losses of
$47,000 in 2001. The increase in charge-offs reflects current economic
conditions.
Non-interest Income
Non-interest income increased by 25.4% to $1.6 million from $1.3 million
the previous year. The increase was due to increases in all categories of non
interest income with a 189.0% increase in other non interest income, a 3.7%
increase in service charge on deposit accounts and a 24.3% increase in other fee
income.
29
Non-interest Expense
Non-interest expenses increased 12.2% to $5.9 million in 2002 from $5.2
million in 2001. Non-interest expense represented 3.6% of average total assets
at December 31, 2002 and 3.5% at December 31, 2001.
Salaries and benefits increased by 9.3% from $3.1 million in 2001 to $3.4
million in 2002. The 2002 increase reflects normal merit increases, incentives
and other increases in employee benefits. At December 31, 2002, total full-time
equivalent employees were 44 compared to 47 at December 31, 2001. Year end
assets per employee were $4.2 million in 2002 compared to $3.3 million in 2001.
Expenses related to premises and equipment increased by 5.5% to $618,000 in
2002, from $586,000 in 2001. Building lease expense on three locations and
storage units increased to $278,000 in 2002 from $268,000 in 2001.
Other non-interest expenses increased by 21.0% to $1.8 million in 2002 from
$1.5 million in 2001. The increase was primarily the result of a 66.2% increase
in professional fees. Professional fees is the largest category of other
non-interest expense, primarily comprised of accounting, legal and other
professional fees. These services increased by $190,000 to $478,000 in 2002 from
$288,000 in 2001. Advertising and business development show an increase of 90.2%
or $95,000 to $200,848 in 2002 from $105,614 in 2001. Advertising/business
development includes advertising, customer relations, shareholder relations,
public relations, donations and civic dues and is a result of the bank's
community involvement. Increases in other categories reflect the increased
growth and volume of business in general.
Provision for Income Taxes
The provision for income taxes decreased to an effective tax rate of 31.72%
in 2002 compared with 34.66% in 2001.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding Quantitative and Qualitative Disclosures about Market
Risk appears on page 26 through 28 under the caption "Management's Discussion
and Analysis of Consolidated Financial Condition and Results of Operations -
Market Risk Management" and is incorporated herein by reference.
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Richardson & Company 550 Howe Avenue, Suite 210
Sacramento, California 95825
Telephone: (916) 564-8727
FAX: (916) 564-8728
REPORT OF RICHARDSON & COMPANY
INDEPENDENT AUDITORS
Board of Directors and Shareholders
Sonoma Valley Bancorp and Subsidiary
Sonoma, California
We have audited the accompanying consolidated balance sheets of Sonoma Valley
Bancorp and Subsidiary as of December 31, 2003 and 2002, and the related
consolidated statements of operations, changes in the shareholders' equity and
cash flows for each of the three years in the period ended December 31, 2003.
These financial statements are the responsibility of the Bancorp's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Sonoma Valley
Bancorp and Subsidiary as of December 31, 2003 and 2002, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
January 29, 2004 /s/ Richardson & Company
31
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
ASSETS 2003 2002
----------- -----------
Cash and due from banks $ 9,803,272 $ 8,387,953
Federal funds sold 25,220,000 23,095,000
Interest-bearing due from banks 330,930 34,646
----------- -----------
Total cash and cash equivalents 35,354,202 31,517,599
Investment securities available-for-sale, at fair value 20,119,777 3,823,259
Investment securities held-to-maturity (fair value
of $17,042,186 and $10,440,453, respectively) 16,558,153 9,923,737
Loans and lease financing receivables, net 119,833,989 125,269,181
Premises and equipment, net 1,313,995 875,697
Accrued interest receivable 906,958 799,282
Cash surrender value of life insurance 7,730,600 7,387,712
Other assets 3,288,463 3,006,260
------------- -------------
Total assets $205,106,137 $182,602,727
============ ============
LIABILITIES
Noninterest-bearing demand deposits $ 37,947,577 $ 38,760,806
Interest-bearing transaction deposits 32,467,678 24,627,589
Savings and money market deposits 63,680,697 51,802,714
Time deposits, $100,000 and over 26,565,347 25,018,603
Other time deposits 19,453,317 19,778,540
------------ ------------
Total deposits 180,114,616 159,988,252
Accrued interest payable
and other liabilities 3,520,242 3,374,165
------------ ------------
Total liabilities 183,634,858 163,362,417
Commitments and contingencies ( see accompanying notes )
SHAREHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares
authorized; 1,457,594 shares in 2003 and 1,401,146 in
2002 issued and outstanding 15,061,636 12,936,225
Retained earnings 6,386,083 6,215,790
Accumulated other comprehensive income 23,560 88,295
------------ ------------
Total shareholders' equity 21,471,279 19,240,310
------------ ------------
Total liabilities and shareholders' equity $205,106,137 $182,602,727
============ ============
The accompanying notes are an integral part of these financial statements.
32
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001
---------------- --------------- ----------------
INTEREST INCOME
Loans and leases $ 9,446,841 $ 9,470,998 $ 9,251,314
Taxable securities 365,459 378,511 1,013,330
Tax-exempt securities 485,460 512,708 552,110
Federal funds sold and other 318,798 216,362 286,083
Dividends 13,269 15,227 15,812
----------- ----------- -----------
Total interest income 10,629,827 10,593,806 11,118,649
INTEREST EXPENSE
Interest-bearing transaction deposits 50,454 84,241 149,078
Savings and money market deposits 466,081 655,841 996,864
Time deposits, $100,000 and over 729,758 674,089 844,351
Other time deposits 477,061 546,543 885,322
Other
31 7,221
---------- ----------- -----------
Total interest expense 1,723,385 1,960,714 2,882,836
---------- ---------- -----------
NET INTEREST INCOME 8,906,442 8,633,092 8,235,813
Provision for loan and lease losses 20,000 393,000 342,000
---------- ---------- -----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN AND
LEASE LOSSES 8,886,442 8,240,092 7,893,813
NON-INTEREST INCOME 1,715,123 1,641,191 1,309,315
NON-INTEREST EXPENSE
Salaries and employee benefits 3,489,007 3,437,390 3,143,911
Premises and equipment 768,789 618,029 585,748
Other 1,986,365 1,806,954 1,494,285
---------- ---------- -----------
Total non-interest expense 6,244,161 5,862,373 5,223,944
Income before provision ---------- ---------- -----------
for income taxes 4,357,404 4,018,910 3,979,184
Provision for income taxes 1,446,397 1,274,577 1,378,940
---------- ---------- -----------
NET INCOME $2,911,007 $2,744,333 $ 2,600,244
========== ========== ===========
NET INCOME PER SHARE $ 2.00 $ 1.87 $ 1.77
NET INCOME PER SHARE ====== ====== ======
ASSUMING DILUTION $ 1.83 $ 1.72 $ 1.66
====== ====== ======
The accompanying notes are an integral part of these financial statements.
33
SONOMA VALLEY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQ