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UNITED STATES
SECURITIES AND EXCHANGE COMISSION
Washington, D.C. 20006
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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, 2001
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SIERRA BANCORP
(Exact name of registrant as specified in its charter)
California 94-2431437
State of incorporation I.R.S. Employer Identification Number
86 North Main Street 93257
Porterville, California Zip Code
Address of principal executive offices
(559) 782-4900
Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
No Par Value
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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Check if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of
Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this form 10-K.______
As of February 15, 2002, the aggregate market value of the voting stock
held by non-affiliates of the Registrant was approximately $49.4 million, based
on the closing price reported to the Registrant on that date of $9.90 per share.
Shares of Common Stock held by each officer and director and each person
owning more than five percent of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This
determination of the affiliate status is not necessarily a conclusive
determination for other purposes.
The number of shares of Common Stock of the registrant outstanding as of
February 15, 2002 was 9,212,280.
Documents Incorporated by Reference: Portions of the definitive proxy
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statement for the 2002 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission pursuant to SEC Regulation 14A are
incorporated by reference in Part III, Items 10-13.
This Form 10-K consists of a total of 285 pages. The Exhibit Index
appears on page 92.
TABLE OF CONTENTS
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ITEM PAGE
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PARTI................................................................................... 3
Item 1. Business.................................................................. 3
Item 2. Properties................................................................ 20
Item 3. Legal Proceedings......................................................... 22
Item 4. Submission of Matters to a Vote of Security Holders....................... 22
PART II................................................................................. 23
Item 5. Market for Common Equity and Related Shareholder Matters.................. 23
Item 6. Selected Financial Data................................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................ 27
Item 7A. Quantitative and Qualitative Disclosures about Market Risk................ 52
Item 8. Consolidated Financial Statements and Supplementary Data.................. 52
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...................................... 52
PART III................................................................................ 54
Item 10. Directors and Executive Officers of the Registrant........................ 54
Item 11. Executive Compensation.................................................... 54
Item 12. Security Ownership of Certain Beneficial
Owners and Management..................................................... 54
Item 13. Certain Relationships and Related Transactions............................ 54
PART IV................................................................................. 55
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K................................................... 55
SIGNATURES.............................................................................. 91
2
PART I
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ITEM 1. BUSINESS
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GENERAL
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THE COMPANY
Sierra Bancorp (the "Company") is a California corporation registered as a bank
holding company under the Bank Holding Company Act of 1956, as amended (the "BHC
Act"), and is headquartered in Porterville, California. The Company was
incorporated in November, 2000 and acquired all of the outstanding shares of
Bank of the Sierra (the "Bank") in August, 2001. The Company's principal
subsidiary is the Bank. The Company's only other subsidiary is Sierra Capital
Trust I, which was formed in November, 2001 solely to facilitate the issuance of
capital trust pass-through securities. The Company exists primarily for the
purpose of holding the stock of the Bank and of such other subsidiaries as it
may acquire or establish.
The Company's principal source of income is currently dividends from the Bank,
but the Company intends to explore supplemental sources of income in the future.
The expenditures of the Company, including (but not limited to) the payment of
dividends to shareholders, if and when declared by the Board of Directors, and
the cost of servicing debt, will generally be paid from such payments made to
the Company by the Bank.
At December 31, 2001, the Company had consolidated assets of $650.4 million,
deposits of $521.3 million and shareholders' equity of $46.1 million. The
Company's liabilities include $15 million in capital trust pass-through
securities issued by Sierra Capital Trust I (see "Recent Developments" for
further details).
The Company's Administrative Offices are located at 86 North Main Street,
Porterville, California and its telephone number is (559) 782-4900. References
herein to the "Company" include the Company and the Bank, unless the context
indicates otherwise.
THE BANK
Bank of the Sierra was incorporated under the laws of the State of California on
September 14, 1977, and commenced operations as a California state-chartered
commercial bank on January 19, 1978. The Bank's Administrative Office is located
at 86 North Main Street, Porterville, California. The Bank is an insured bank
under the Federal Deposit Insurance Act up to the maximum limits thereof. The
Bank is not a member of the Federal Reserve System. At December 31, 2001, the
Bank had approximately $649.0 million in assets, $486.1 million in loans and
$521.3 million in deposits.
We operate nine full-service branch offices in seven Tulare County communities,
five full-service branch offices in Kern County, and one full-service branch
office each in Kings County and Fresno County. We offer a full range of banking
services to individuals and various-size businesses in the communities we serve.
The locations of those offices are:
Porterville: Main Office Bakersfield: Bakersfield California Office
90 North Main Street 5060 California Avenue
Administrative Headquarters Bakersfield Ming Office
86 North Main Street 1621 Mill Rock Way
West Olive Branch
1498 West Olive Avenue
Lindsay: Lindsay Office Tulare: Tulare Office
142 South Mirage Avenue 246 East Tulare Avenue
Exeter: Exeter Office Hanford: Hanford Office
1103 West Visalia Road 427 West Lacey Boulevard
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Visalia: Visalia Mooney Office Tehachapi: Tehachapi Downtown Office
2515 South Mooney Boulevard 224 West "F" Street
Visalia Downtown Office Tehachapi Old Town Office
128 East Main Street 21000 Mission Street
Three Rivers: Three Rivers Office Fresno: Fresno Office
40884 Sierra Drive 636 East Shaw Avenue
Dinuba: Dinuba Office California City: California City Office
401 East Tulare Street 8031 California City
In addition, our Bank Card Center is located at 80 North Main Street,
Porterville, California. We also have specialized credit centers for
agricultural lending and construction and real estate lending within a number of
these branch offices. These facilities are located in the cities of Porterville
and Visalia in Tulare County, the city of Fresno in Fresno County, the city of
Bakersfield in Kern County, and the city of Hanford in Kings County.
Prior to 1997, Bank of the Sierra had grown exclusively by establishing de novo
full-service branch offices and credit centers in various locations in
California's South Central San Joaquin Valley. In February 1997 we made our
first branch purchase of the Dinuba Office of Wells Fargo Bank. Between February
1997 and September, 1999 we opened three additional de novo offices, in Tulare,
Hanford, and Fresno. In May 2000 we added four new branches by the acquisition
of Sierra National Bank ("SNB"). These branches stretch from California City, in
the high desert, westerly to Bakersfield along the Highway 58 corridor, a
distance of approximately 81 miles.
With a predominant focus on personal service, Bank of the Sierra has positioned
itself as a multi-community independent bank serving the financial needs of
individuals and businesses, including agricultural and real estate customers in
Tulare and other surrounding counties. We are currently the largest independent
bank headquartered in Tulare County. Our principal retail lending services
include home equity and consumer loans. In addition, we have three other
significant dimensions which surround this core of retail community banking:
agricultural lending, credit card loans, and real estate financing (both
construction and long term).
The Agricultural Credit Centers located in Fresno, Porterville, and Bakersfield
provide a complete line of credit services in support of the agricultural
activities which are key to the continued economic development of the
communities we serve. "Ag lending" clients include a full range of individual
farming customers, small business farming organizations and major corporate
farming units.
The Bank Card Center, headquartered in Porterville, provides a range of credit,
debit and ATM card services, which are made available to each of the customers
served by the branch banking offices. In addition, we staff our Fresno, Visalia,
Porterville, and Bakersfield offices with real estate lending specialists. These
officers are responsible for a complete line of land acquisition and development
loans, construction loans for residential and commercial development, and
multifamily credit facilities. Secondary market services are provided though the
Bank's affiliations with Freddie Mac, Fannie Mae and various non-governmental
programs. Until recently, the Bank also had a group dedicated to originating
residential mortgage loans. However, in an effort to improve customer service
and reduce overhead expense, the real estate lending area was restructured and
this group's focus was shifted to other products. In early 2002 the Bank entered
into an agreement with Moneyline Lending Services, Inc. ("Moneyline"), whereby
Moneyline underwrites single family mortgage loans for qualifying Bank customers
referred to them via Bank-branded delivery channels (i.e., Bank branches, the
Bank's internet site, and a dedicated telephone line).
We also engage in Small Business Administration lending and have been designated
as a Preferred Lender since 1999. The Bank's SBA program generated approximately
$13 million in loans during the past year. It is anticipated that loans under
this program will be an increasing segment of our loan portfolio over the next
few years.
4
As of December 31, 2001, the principal areas in which we directed our lending
activities, and the percentage of our total loan portfolio for which each of
these areas was responsible, were as follows: (i) agricultural loans (2.97%);
(ii) commercial and industrial (including SBA) loans (18.25%); (iii) real estate
loans (66.02%); (iv) consumer loans (10.42%); and (v) credit cards (2.33%).
In addition to the lending activities noted above, we offer a wide range of
deposit products for the retail banking market including checking, interest
bearing transaction, savings, time certificates of deposit and retirement
accounts, as well as telephone banking and internet banking with bill pay
options. As of December 31, 2001, we had 47,661 deposit accounts with balances
totaling approximately $521.3 million, compared to 47,262 deposit accounts with
balances totaling approximately $527.8 million at December 31, 2000. Bank of the
Sierra attracts deposits through its customer-oriented product mix, competitive
pricing, convenient locations, extended hours and drive-up banking, all provided
with the highest level of customer service.
Most of the Bank's deposits are attracted from individuals, business-related
sources and smaller municipal entities. This results in a relatively modest
average deposit balance of approximately $11,000 at December 31, 2001, but makes
the Bank less subject to adverse effects from the loss of a substantial
depositor who may be seeking higher yields in other markets or who may have need
of money otherwise on deposit with the Bank, especially during periods of
inflation or conservative monetary policies.
We also offer other products and services to our customers, which complement the
lending and deposit services previously reviewed. These include installment note
collection, cashier's checks, traveler's checks, bank-by-mail, ATM, night
depository, safe deposit boxes, direct deposit, automated payroll services and
other customary banking services. Shared ATM and Point of Sale (POS) networks
allow customers access to the national and international funds transfer
networks. In 1997, as part of our continuing efforts to meet the needs of our
various communities, we added a Spanish language option to our network of ATMs
throughout our service area. During the past three years we have substantially
enhanced our ATM locations to include off-site areas not previously served by
cash or deposit facilities. We now have a total of nine such remote ATM's at
eight different locations, including a hospital, county offices, a college
campus, a grocery store, and a restaurant parking lot. These locations
facilitate cash advances and deposits which would not otherwise be available to
consumers at non-branch locations, thereby increasing consumer convenience. We
also have a mobile ATM unit which is transportable and is used at fairs,
exhibitions, and various other community functions within our market area. In
addition to such specifically oriented customer applications, we provide safe
deposit, wire transfer capabilities and a convenient customer service group to
answer questions and assure a high level of customer satisfaction with the level
of services and products we provide.
For non-deposit services, we have a strategic alliance with Investment Centers
of America, Inc. of Bismarck, North Dakota ("ICA"). Through this arrangement,
registered and licensed representatives of ICA provide Bank customers with
convenient access to annuities, insurance products, mutual funds, and a full
range of investment products. They conduct business from offices located in our
Porterville, Visalia, Tulare and Tehachapi branches.
We do not believe there is a significant demand for additional trust services in
our service areas, and we do not operate or have any present intention to seek
authority to operate a Trust Department. We believe that the cost of
establishing and operating such a department would not be justified by the
potential income to be gained therefrom. However, we occasionally make
arrangements with correspondent institutions to offer trust services to our
customers upon request.
The Bank currently has one wholly-owned subsidiary, Sierra Phoenix, Inc., whose
sole function is to hold certain investments which the Bank is not permitted to
hold directly but which can now be held directly by the Company. This subsidiary
currently holds two investments, one of which is stock in Sphinx International,
Inc. ("Sphinx"). Sphinx was formerly known as Phoenix International Ltd., Inc.,
a computer software company which specialized in the production and marketing of
client user software for financial institutions. In 2001,
5
Sphinx sold substantially all of its assets (including all of its operating
business) and certain of its liabilities to London Bridge Phoenix Software,
Inc., and a partial distribution of the sale proceeds has been remitted to
Sphinx shareholders. The remainder of the cash will be distributed subsequent
to the resolution of the remaining contingent liabilities, at which time Sphinx
will conclude operations. The other investment held by Sierra Phoenix is an
equity position in California Banker's Insurance Agency ("CBIA"), an entity
which was formed to facilitate insurance product sales after enabling
legislation under the Gramm-Leach-Bliley Financial Services Modernization Act
was passed. Bank of the Sierra is currently a passive investor, through Sierra
Phoenix, Inc., in CBIA. It is expected that during 2002 the Bank's investment
in Sierra Phoenix will be transferred via a dividend to Sierra Bancorp, at
which time the aforementioned investments would be placed under the direct
ownership of Sierra Bancorp and Sierra Phoenix would be dissolved. This would
not have a material impact on the operations of the Bank or Company.
During the year ended December 31, 2001, one class of products or services
accounted for more than 15% of the Bank's consolidated revenues. Our real estate
lending, loan sales, and loan servicing activities (including gains from the
sale of loan servicing) generated approximately 17.62% of consolidated revenue
for 2001. During 2000, this area accounted for 16.66% of the Bank's consolidated
revenues. Real estate lending activities are generated by real estate loan
officers who are not responsible for branch deposit gathering activities but who
are solely dedicated to the Bank's real property secured lending activities.
This class of services includes a complete line of land acquisition and
development loans, construction loans for residential and commercial
development, and multifamily credit facilities. In addition, secondary market
services are provided though this group and its affiliations with Freddie Mac,
Fannie Mae and various non-governmental programs. Real estate lending and
related activities generated total revenue of $9.3 million and $8.7 million for
2001 and 2000, respectively.
We have not engaged in any material research activities relating to the
development of new products or services or the improvement of existing banking
services during the last two fiscal years. However, the officers and employees
of the Bank are continually engaged in marketing activities, including the
evaluation and development of new products and services, which enable the Bank
to retain and improve its competitive position in its service area. Our decision
to introduce "Sierra Access" internet banking in October of 1999 was the result
of such evaluation. This product includes electronic bill paying capabilities
for enhanced customer value, and Sierra Access has been actively marketed for
the last two years. Another example is "Sierra Loan Access", a consumer loan
application process made available through the Bank's internet site during the
year 2001. This function allows a consumer to gain an answer within fifteen to
thirty minutes on a request for any number of consumer loans, including auto,
personal revolving lines, credit card, or home equity/home improvement loans.
The initiation of our partnership with Moneyline has enabled similar
improvements in the consumer mortgage lending process. We also rolled out
"Sierra Web Cash Manager" in 2001, a commercial checking account cash management
system which functions through the Bank's internet web site. During 2001, the
Bank further expanded its off-site ATM locations by installing an ATM at the
Town & Country market in Porterville. This facility is an in-store ATM, and has
substantially enhanced convenience for Bank customers who patronize that market.
All of these developments are meant to increase public convenience in the Bank's
service area and enhance public access to the electronic payments system. The
cost to the Bank for these development, implementation, and marketing activities
cannot expressly be calculated with any degree of certainty.
The Bank holds no patents or licenses (other than licenses required by
appropriate bank regulatory agencies), franchises, or concessions. The Bank's
business has a modest seasonal component due to the heavy agricultural
orientation of the Central Valley. As our branches in more metropolitan areas
such as Fresno and Bakersfield have expanded, however, the agriculturally
related economic base has become less important. The Bank is not dependent on a
single customer or group of related customers for a material portion of its
deposits, nor is a material portion of the Bank's loans concentrated within a
single industry or group of related industries. There has been no material
effect upon the Bank's capital expenditures, earnings, or competitive position
as a result of Federal, state, or local environmental regulation.
6
RECENT DEVELOPMENTS
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On November 16, 2000, Sierra Bancorp was incorporated as a bank holding company,
for the purpose of acquiring the Bank in a one bank holding company
reorganization. Shortly after the incorporation, Sierra Bancorp filed a
registration statement on Form S-4 with the Securities and Exchange Commission
in order to register its common stock which was issued pursuant to the terms of
a Plan of Reorganization and Agreement of Merger dated December 14, 2000. The
Plan of Reorganization and Agreement of Merger provided for the exchange of
shares of the Bank for shares of Sierra Bancorp on a share-for-share basis (the
"Reorganization"). The registration statement was declared effective on April
27, 2001. The Reorganization was approved by the Company's shareholders on May
23, 2001, and all required regulatory approvals or non-disapprovals with respect
to the Reorganization were obtained. The Reorganization was consummated on
August 10, 2001, subsequent to which the Bank continued its operations as
previously conducted but as a wholly-owned subsidiary of Sierra Bancorp. The new
corporate structure is intended to give Sierra Bancorp and the Bank greater
flexibility in terms of operation, expansion and diversification.
On November 28, 2001, Sierra Capital Trust I, a newly formed Delaware statutory
business trust and a wholly-owned subsidiary of the Company (the "Trust"),
issued an aggregate of $15,000,000 of principal amount of Floating Rate TRUPS(R)
(Capital Trust Pass-through Securities of the Trust) (the "Trust Preferred
Securities"). Salomon Smith Barney, Inc. acted as placement agent in connection
with the offering of the trust securities. The securities issued by the Trust
are fully guaranteed by the Company with respect to distributions and amounts
payable upon liquidation, redemption or repayment. The entire proceeds to the
Trust from the sale of the Trust Preferred Securities were used by the Trust in
order to purchase $15,000,000 in principal amount of the Fixed Rate Junior
Subordinated Deferrable Interest Debentures due 2031 issued by the Company (the
"Subordinated Debt Securities"). Subject to a maximum of 25% of Tier 1 capital
for all cumulative preferred stock, the Trust Preferred Securities are included
as Tier 1 capital for purposes of calculating the Company's regulatory capital
ratios under the Prompt Corrective Action guidelines issued by the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"). The
Company used $10 million of the proceeds it ultimately received to increase its
equity investment in the Bank. A portion of the proceeds was also used to retire
debt incurred during 2001 to pay for the formation of the holding company, and
the remainder has been placed in a demand deposit account at the Bank. On a
consolidated basis, the Company should be able to leverage its increased
regulatory capital to generate additional loan growth, although there can be no
guarantee that this expected loan growth will indeed occur.
RECENT ACCOUNTING PRONOUNCEMENTS
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In September 2000, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 140, Accounting for
Transfers and Servicing of Financial Assets and Liabilities. This Statement
replaces SFAS No. 125. It revised the standards for securitizations and other
transfers of financial assets and collateral after March 2001 and requires
certain additional disclosures, but it carries over most of SFAS No. 125's
provisions without reconsideration. Management does not believe there was a
material effect on the Bank's consolidated financial statements upon the
adoption of SFAS No. 140.
In June 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS
No.142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all
business combinations initiated after June 30, 2001 be accounted for under the
purchase method and addresses the initial recognition and measurement of
goodwill and other intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement of intangible assets
acquired outside of a business combination and the accounting for goodwill and
other intangible assets subsequent to their acquisition. SFAS No. 142 provides
that intangible assets with finite useful lives be amortized and that goodwill
and intangible assets with indefinite lives will not be amortized, but will
rather be tested at least annually for impairment. The Company has adopted SFAS
No. 142 for its fiscal year beginning January 1, 2002. At December 31, 2001, the
Company had approximately $5.5
7
million in goodwill which has an indefinite life that management will now
evaluate periodically for impairment. Previously, the Company reflected charges
of $332,000 and $214,000 in its income statement for the years ended 2001 and
2000, respectively, as amortization relating to that goodwill.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, that replaces FASB Statement No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of. The accounting model for long-lived assets to be disposed of by sale applies
to all long-lived assets, including discontinued operations, and replaces the
provisions of APB Opinion No. 30, Reporting Results of Operations-Reporting the
Effects of Disposal of a Segment of a Business, for the disposal of segments of
a business. SFAS No. 144 requires that those long-lived assets be measured at
the lower of carrying amount or fair value less cost to sell, whether reported
in continuing operations or in discontinued operations. Therefore, discontinued
operations will no longer be measured at net realizable value or include amounts
for operating losses that have not yet occurred.
SFAS No. 144 also broadens the reporting of discontinued operations to include
all components of an entity with operations that can be distinguished from the
rest of the entity and that will be eliminated from the ongoing operations of
the entity in a disposal transaction. The provisions of SFAS No. 144 are
effective for financial statements issued for fiscal years beginning after
December 15, 2001 and, generally, are to be applied prospectively. In
management's opinion, the adoption of this statement will not have a material
impact on the Company's current financial position or results of operations.
COMPETITION
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The banking business in California generally, and specifically in our market
areas, is highly competitive with respect to virtually all products and services
and has become increasingly more so in recent years. The industry continues to
consolidate and strong, unregulated competitors have entered banking markets
with focused products targeted at highly profitable customer segments. Many
largely unregulated competitors are able to compete across geographic boundaries
and provide customers increasing access to meaningful alternatives to banking
services in nearly all significant products. These competitive trends are likely
to continue.
With respect to commercial bank competitors, the business is largely dominated
by a relatively small number of major banks with many offices operating over a
wide geographical area, which banks have, among other advantages, the ability to
finance wide-ranging and effective advertising campaigns and to allocate their
investment resources to regions of highest yield and demand. Many of the major
banks operating in the area offer certain services which we do not offer
directly but may offer indirectly through correspondent institutions. By virtue
of their greater total capitalization, such banks also have substantially higher
lending limits than we do.
In addition to other banks, competitors include savings institutions, credit
unions, and numerous non-banking institutions such as finance companies, leasing
companies, insurance companies, brokerage firms, and investment banking firms.
In recent years, increased competition has also developed from specialized
finance and non-finance companies that offer wholesale finance, credit card, and
other consumer finance services, including on-line banking services and personal
finance software. Strong competition for deposit and loan products affects the
rates of those products as well as the terms on which they are offered to
customers. Mergers between financial institutions have placed additional
pressure on banks within the industry to streamline their operations, reduce
expenses, and increase revenues to remain competitive. Competition has also
intensified due to federal and state interstate banking laws enacted in the
mid-1990's, which permit banking organizations to expand into other states, and
the California market has been particularly attractive to out-of-state
institutions. The recently enacted Financial Modernization Act, which, effective
March 11, 2000, has made it possible for full affiliations to occur between
banks and securities firms, insurance companies, and other financial companies,
is also expected to intensify competitive conditions.
8
Technological innovation has also resulted in increased competition in financial
services markets. Such innovation has, for example, made it possible for
non-depository institutions to offer customers automated transfer payment
services that previously have been considered traditional banking products. In
addition, many customers now expect a choice of several delivery systems and
channels, including telephone, mail, home computer, ATMs, self-service branches,
and/or in-store branches. In addition to other banks, the sources of competition
for such products include savings associations, credit unions, brokerage firms,
money market and other mutual funds, asset management groups, finance and
insurance companies, internet-only financial intermediaries, and mortgage
banking firms.
For many years, we have countered this increasing competition by providing our
own style of community-oriented, personalized service. We rely upon local
promotional activity, personal contacts by our officers, directors, employees,
and shareholders, automated 24-hour banking, and the individualized service
which we can provide through our flexible policies. This appears to be
well-received by the populace of the San Joaquin Valley, who appreciate a more
personal and customer-oriented environment in which to conduct their financial
transactions. In addition, however, to meet the needs of customers with
electronic access requirements, the Company has embraced the electronic age and
installed telephone banking and personal computer and internet banking with bill
payment capabilities. This high tech and high touch approach allows the
individual to customize the Bank's contact methodologies to their particular
preference. Moreover, for customers whose loan demands exceed our legal lending
limit, we attempt to arrange for such loans on a participation basis with
correspondent banks. We also assist our customers in obtaining from our
correspondent banks other services that the Bank may not offer.
Our credit card business is subject to an even higher level of competitive
pressure than our general banking business. There are a number of major banks
and credit card issuers that are able to finance often highly successful
advertising campaigns with which community banks generally do not have the
resources to compete. As a result, our credit card outstandings are much more
likely to increase at a slower rate than that which might be seen in nationwide
issuers' year-end statistics. Additional competition comes from many
non-financial institutions, such as providers of various retail products, which
offer many types of credit cards.
EMPLOYEES
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As of December 31, 2001 the Company had 217 full-time and 88 part-time
employees. On a full time equivalent basis, the Company's staff level was 287 at
December 31, 2001, as compared to 323 at December 31, 2000. None of our
employees is concurrently represented by a union or covered by a collective
bargaining agreement. Management of the Company believes its employee relations
are satisfactory.
REGULATION AND SUPERVISION
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The Company and the Bank are subject to significant regulation by federal and
state regulatory agencies. The following discussion of statutes and regulations
is only a brief summary and does not purport to be complete. This discussion is
qualified in its entirety by reference to such statutes and regulations. No
assurance can be given that such statutes or regulations will not change in the
future.
THE COMPANY
The Company is subject to the periodic reporting requirements of Section 13 of
the Securities Exchange Act of 1934 (the "Exchange Act") which requires the
Company to file annual, quarterly and other current reports with the Securities
and Exchange Commission (the "SEC"). The Company is also subject to additional
regulations including, but not limited to, the proxy and tender offer rules
promulgated by the SEC under Sections 13 and 14 of the Exchange Act; the
reporting requirements of directors, executive officers and principal
shareholders regarding transactions in the Company's Common Stock and
short-swing profits rules promulgated by the SEC under Section 16 of the
Exchange Act; and certain additional reporting requirements by principal
shareholders of
9
the Company promulgated by the SEC under Section 13 of the Exchange Act.
The Company is a bank holding company within the meaning of the Bank Holding
Company Act of 1956 and is registered as such with the Federal Reserve Board. A
bank holding company is required to file with the Federal Reserve Board annual
reports and other information regarding its business operations and those of its
subsidiaries. It is also subject to examination by the Federal Reserve Board and
is required to obtain Federal Reserve Board approval before acquiring, directly
or indirectly, ownership or control of any voting shares of any bank if, after
such acquisition, it would directly or indirectly own or control more than 5% of
the voting stock of that bank, unless it already owns a majority of the voting
stock of that bank.
The Federal Reserve Board has by regulation determined certain activities in
which a bank holding company may or may not conduct business. A bank holding
company must engage, with certain exceptions, in the business of banking or
managing or controlling banks or furnishing services to or performing services
for its subsidiary banks. The permissible activities and affiliations of certain
bank holding companies have recently been expanded. (See "Financial
Modernization Act" below.)
The Company and the Bank are deemed to be affiliates of each other within the
meaning set forth in the Federal Reserve Act and are subject to Sections 23A and
23B of the Federal Reserve Act . This means, for example, that there are
limitations on loans by the Bank to affiliates, and that all affiliate
transactions must satisfy certain limitations and otherwise be on terms and
conditions at least as favorable to the Bank as would be available for
non-affiliates.
The Federal Reserve Board has a policy that bank holding companies must serve as
a source of financial and managerial strength to their subsidiary banks. It is
the Federal Reserve Bank's position that bank holding companies should stand
ready to use their available resources to provide adequate capital to their
subsidiary banks during periods of financial stress or adversity. Bank holding
companies should also maintain the financial flexibility and capital-raising
capacity to obtain additional resources for assisting their subsidiary banks.
The Federal Reserve Board also has the authority to regulate bank holding
company debt, including the authority to impose interest rate ceilings and
reserve requirements on such debt. Under certain circumstances, the Federal
Reserve Board may require The Company to file written notice and obtain its
approval prior to purchasing or redeeming The Company's equity securities.
THE BANK
As a California state-chartered bank whose accounts are insured by the FDIC up
to a maximum of $100,000 per depositor, the Bank is subject to regulation,
supervision and regular examination by the Department of Financial Institutions
(the "DFI") and the FDIC. In addition, while the Bank is not a member of the
Federal Reserve System, it is subject to certain regulations of the Federal
Reserve Board. The regulations of these agencies govern most aspects of the
Bank's business, including the making of periodic reports by the Bank, and the
Bank's activities relating to dividends, investments, loans, borrowings, capital
requirements, certain check-clearing activities, branching, mergers and
acquisitions, reserves against deposits and numerous other areas. Supervision,
legal action and examination of the Bank by the FDIC is generally intended to
protect depositors and is not intended for the protection of shareholders.
The earnings and growth of the Bank are largely dependent on its ability to
maintain a favorable differential or "spread" between the yield on its
interest-earning assets and the rate paid on its deposits and other
interest-bearing liabilities. As a result, the Bank's performance is influenced
by general economic conditions, both domestic and foreign, the monetary and
fiscal policies of the federal government, and the policies of the regulatory
agencies, particularly the Federal Reserve Board. The Federal Reserve Board
implements national monetary policies (such as seeking to curb inflation and
combat recession) by its open-market operations in United States Government
securities, by adjusting the required level of reserves for financial
institutions subject
10
to its reserve requirements and by varying the discount rate applicable to
borrowings by banks which are members of the Federal Reserve System. The actions
of the Federal Reserve Board in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates charged on loans and
deposits. The nature and impact of any future changes in monetary policies
cannot be predicted.
CAPITAL ADEQUACY REQUIREMENTS
The Company and the Bank are subject to the regulations of the Federal Reserve
Board and the FDIC, respectively, governing capital adequacy. Those regulations
incorporate both risk-based and leverage capital requirements. Each of the
federal regulators has established risk-based and leverage capital guidelines
for the banks or bank holding companies it regulates, which set total capital
requirements and define capital in terms of "core capital elements," or Tier 1
capital; and "supplemental capital elements," or Tier 2 capital. Tier 1 capital
is generally defined as the sum of the core capital elements less goodwill and
certain other deductions, notably the unrealized net gains or losses (after tax
adjustments) on available for sale investment securities carried at fair market
value. The following items are defined as core capital elements: (i) common
shareholders' equity; (ii) qualifying non-cumulative perpetual preferred stock
and related surplus (not to exceed 25% of tier 1 capital); and (iii) minority
interests in the equity accounts of consolidated subsidiaries. Supplementary
capital elements include: (i) allowance for loan and lease losses (but not more
than 1.25% of an institution's risk-weighted assets); (ii) perpetual preferred
stock and related surplus not qualifying as core capital; (iii) hybrid capital
instruments, perpetual debt and mandatory convertible debt instruments; and (iv)
term subordinated debt and intermediate-term preferred stock and related
surplus. The maximum amount of supplemental capital elements which qualifies as
Tier 2 capital is limited to 100% of Tier 1 capital, net of goodwill.
The minimum required ratio of qualifying total capital to total risk-weighted
assets is 8.0% ("Total Risk-Based Capital Ratio"), at least one-half of which
must be in the form of Tier 1 capital, and the minimum required ratio of Tier 1
capital to total risk-weighted assets is 4.0% ("Tier 1 Risk-Based Capital
Ratio"). Risk-based capital ratios are calculated to provide a measure of
capital that reflects the degree of risk associated with a banking
organization's operations for both transactions reported on the balance sheet as
assets, and transactions, such as letters of credit and recourse arrangements,
which are recorded as off-balance sheet items. Under the risk-based capital
guidelines, the nominal dollar amounts of assets and credit-equivalent amounts
of off-balance sheet items are multiplied by one of several risk adjustment
percentages, which range from 0% for assets with low credit risk, such as
certain U. S. Treasury securities, to 100% for assets with relatively high
credit risk, such as business loans. As of December 31, 2001 and 2000, the
Bank's Total Risk-Based Capital Ratios were 11.17% and 9.00%, respectively and
its Tier 1 Risk-Based Capital Ratios were 10.01% and 7.76%, respectively. As of
December 31, 2001, the Company's Total Risk-Based Capital was 12.18% and its
Tier 1 Risk-Based Capital Ratio was 11.03%.
The risk-based capital requirements also take into account concentrations of
credit (i.e., relatively large proportions of loans involving one borrower,
industry, location, collateral or loan type) and the risks of "non-traditional"
activities (those that have not customarily been part of the banking business).
The regulations require institutions with high or inordinate levels of risk to
operate with higher minimum capital standards, and authorize the regulators to
review an institution's management of such risks in assessing an institution's
capital adequacy.
The risk-based capital regulations also include exposure to interest rate risk
as a factor that the regulators will consider in evaluating a bank's capital
adequacy. Interest rate risk is the exposure of a bank's current and future
earnings and equity capital arising from adverse movements in interest rates.
While interest risk is inherent in a bank's role as financial intermediary, it
introduces volatility to earnings and to the economic value of the bank.
The FDIC and the Federal Reserve Board also require the maintenance of a
leverage capital ratio designed to supplement the risk-based capital guidelines.
Banks and bank holding companies that have received the highest rating of the
five categories used by regulators to rate banks and are not anticipating or
experiencing any
11
significant growth must maintain a ratio of Tier 1 capital (net of all
intangibles) to adjusted total assets ("Leverage Capital Ratio") of at
least 3%. All other institutions are required to maintain a leverage ratio of at
least 100 to 200 basis points above the 3% minimum, for a minimum of 4% to 5%.
Pursuant to federal regulations, banks must maintain capital levels commensurate
with the level of risk to which they are exposed, including the volume and
severity of problem loans, and federal regulators may, however, set higher
capital requirements when a bank's particular circumstances warrant. As of
December 31, 2001 and 2000, the Bank's Leverage Capital Ratios were 8.17% and
5.64%, respectively. As of December 31, 2001, the Company's leverage capital
ratio was 9.02%, exceeding regulatory minimums. See Part II, Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operation - Capital Resources.
PROMPT CORRECTIVE ACTION PROVISIONS
Federal law requires each federal banking agency to take prompt corrective
action to resolve the problems of insured financial institutions, including but
not limited to those that fall below one or more prescribed minimum capital
ratios. The federal banking agencies have by regulation defined the following
five capital categories: "well capitalized" (Total Risk-Based Capital Ratio of
10%; Tier 1 Risk-Based Capital Ratio of 6%; and Leverage Ratio of 5%);
"adequately capitalized" (Total Risk-Based Capital Ratio of 8%; Tier 1
Risk-Based Capital Ratio of 4%; and Leverage Ratio of 4%) (or 3% if the
institution receives the highest rating from its primary regulator);
"undercapitalized" (Total Risk-Based Capital Ratio of less than 8%; Tier 1
Risk-Based Capital Ratio of less than 4%; or Leverage Ratio of less than 4%) (or
3% if the institution receives the highest rating from its primary regulator);
"significantly undercapitalized" (Total Risk-Based Capital Ratio of less than
6%; Tier 1 Risk-Based Capital Ratio of less than 3%; or Leverage Ratio less than
3%); and "critically undercapitalized" (tangible equity to total assets less
than 2%). A bank may be treated as though it were in the next lower capital
category if after notice and the opportunity for a hearing, the appropriate
federal agency finds an unsafe or unsound condition or practice so warrants, but
no bank may be treated as "critically undercapitalized" unless its actual
capital ratio warrants such treatment.
At each successively lower capital category, an insured bank is subject to
increased restrictions on its operations. For example, a bank is generally
prohibited from paying management fees to any controlling persons or from making
capital distributions if to do so would make the bank "undercapitalized." Asset
growth and branching restrictions apply to undercapitalized banks, which are
required to submit written capital restoration plans meeting specified
requirements (including a guarantee by the parent holding company, if any).
"Significantly undercapitalized" banks are subject to broad regulatory
authority, including among other things, capital directives, forced mergers,
restrictions on the rates of interest they may pay on deposits, restrictions on
asset growth and activities, and prohibitions on paying certain bonuses without
FDIC approval. Even more severe restrictions apply to critically
undercapitalized banks. Most importantly, except under limited circumstances,
not later than 90 days after an insured bank becomes critically
undercapitalized, the appropriate federal banking agency is required to appoint
a conservator or receiver for the bank.
In addition to measures taken under the prompt corrective action provisions,
insured banks may be subject to potential actions by the federal regulators for
unsafe or unsound practices in conducting their businesses or for violations of
any law, rule, regulation or any condition imposed in writing by the agency or
any written agreement with the agency. Enforcement actions may include the
issuance of cease and desist orders, termination of insurance of deposits (in
the case of a bank), the imposition of civil money penalties, the issuance of
directives to increase capital, formal and informal agreements, or removal and
prohibition orders against "institution-affiliated" parties.
12
SAFETY AND SOUNDNESS STANDARDS
The federal banking agencies have also adopted guidelines establishing safety
and soundness standards for all insured depository institutions. Those
guidelines relate to internal controls, information systems, internal audit
systems, loan underwriting and documentation, compensation and interest rate
exposure. In general, the standards are designed to assist the federal banking
agencies in identifying and addressing problems at insured depository
institutions before capital becomes impaired. If an institution fails to meet
these standards, the appropriate federal banking agency may require the
institution to submit a compliance plan and institute enforcement proceedings if
an acceptable compliance plan is not submitted.
PREMIUMS FOR DEPOSIT INSURANCE
The FDIC regulations also implement a risk-based premium system, whereby insured
depository institutions are required to pay insurance premiums depending on
their risk classification. Under this system, institutions such as the Bank
which are insured by the Bank Insurance Fund ("BIF"), are categorized into one
of three capital categories (well capitalized, adequately capitalized, and
undercapitalized) and one of three supervisory categories based on federal
regulatory evaluations. The three supervisory categories are: financially sound
with only a few minor weaknesses (Group A), demonstrates weaknesses that could
result in significant deterioration (Group B), and poses a substantial
probability of loss (Group C). The capital ratios used by the FDIC to define
well capitalized, adequately capitalized and undercapitalized are the same in
the FDIC's prompt corrective action regulations. The current BIF base assessment
rates (expressed as cents per $100 of deposits) are summarized as follows:
Group A Group B Group C
------- ------- -------
Well Capitalized.................. 0 3 17
Adequately Capitalized............ 3 10 24
Undercapitalized.................. 10 24 27
In addition, BIF member banks (such as the Bank) must pay an amount toward the
retirement of the Financing Corporation bonds issued in the 1980's to assist in
the recovery of the savings and loan industry. This amount fluctuates but for
the first quarter of 2002 is 1.82 basis points (cents per $100 of insured
deposits).
COMMUNITY REINVESTMENT ACT
The Bank is subject to certain requirements and reporting obligations involving
Community Reinvestment Act ("CRA") activities. The CRA generally requires the
federal banking agencies to evaluate the record of a financial institution in
meeting the credit needs of its local communities, including low and moderate
income neighborhoods. The CRA further requires the agencies to take a financial
institution's record of meeting its community credit needs into account when
evaluating applications for, among other things, domestic branches, consummating
mergers or acquisitions, or holding company formations. In measuring a bank's
compliance with its CRA obligations, the regulators utilize a performance-based
evaluation system which bases CRA ratings on the bank's actual lending service
and investment performance, rather than on the extent to which the institution
conducts needs assessments, documents community outreach activities or complies
with other procedural requirements. In connection with its assessment of CRA
performance, the FDIC assigns a rating of "outstanding," "satisfactory," "needs
to improve" or "substantial noncompliance." The Bank was last examined for CRA
compliance in June, 2001 and received a "satisfactory" CRA Assessment Rating.
13
OTHER CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are increasingly focusing attention on compliance
with consumer protection laws and regulations. Examination and enforcement has
become intense, and banks have been advised to carefully monitor compliance with
various consumer protection laws and their implementing regulations. The federal
Interagency Task Force on Fair Lending issued a policy statement on
discrimination in home mortgage lending describing three methods that federal
agencies will use to prove discrimination: overt evidence of discrimination,
evidence of disparate treatment, and evidence of disparate impact. In addition
to CRA and fair lending requirements, the Bank is subject to numerous other
federal consumer protection statutes and regulations. Due to heightened
regulatory concern related to compliance with consumer protection laws and
regulations generally, the Bank may incur additional compliance costs or be
required to expend additional funds for investments in the local communities it
serves.
INTERSTATE BANKING AND BRANCHING
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Interstate Banking Act") regulates the interstate activities of banks and bank
holding companies and establishes a framework for nationwide interstate banking
and branching. Since June 1, 1997, a bank in one state has generally been
permitted to merge with a bank in another state without the need for explicit
state law authorization. However, states were given the ability to prohibit
interstate mergers with banks in their own state by "opting-out" (enacting state
legislation applying equality to all out-of-state banks prohibiting such mergers
) prior to June 1, 1997.
Since 1995, adequately capitalized and managed bank holding companies have been
permitted to acquire banks located in any state, subject to two exceptions:
first, any state may still prohibit bank holding companies from acquiring a bank
which is less than five years old; and second, no interstate acquisition can be
consummated by a bank holding company if the acquiror would control more than
10% of the deposits held by insured depository institutions nationwide or 30%
percent or more of the deposits held by insured depository institutions in any
state in which the target bank has branches.
A bank may establish and operate de novo branches in any state in which the bank
does not maintain a branch if that state has enacted legislation to expressly
permit all out-of-state banks to establish branches in that state.
In 1995 California enacted legislation to implement important provisions of the
Interstate Banking Act discussed above and to repeal California's previous
interstate banking laws, which were largely preempted by the Interstate Banking
Act.
The changes effected by Interstate Banking Act and California laws have
increased competition in the environment in which the Bank operates to the
extent that out-of-state financial institutions directly or indirectly enter the
Bank's market areas. It appears that the Interstate Banking Act has contributed
to the accelerated consolidation of the banking industry. While many large
out-of-state banks have already entered the California market as a result of
this legislation, it is not possible to predict the precise impact of this
legislation on the Bank and the Company and the competitive environment in which
they operate.
FINANCIAL MODERNIZATION ACT
Effective March 11, 2000 the Gramm-Leach-Bliley Act eliminated most barriers to
affiliations among banks and securities firms, insurance companies, and other
financial service providers, and enabled full affiliations to occur between such
entities. This legislation permits bank holding companies to become "financial
holding companies" and thereby acquire securities firms and insurance companies
and engage in other activities that are financial in nature. A bank holding
company may become a financial holding company if each of its subsidiary banks
is well capitalized under the FDICIA prompt corrective action provisions, is
well managed, and has at least a satisfactory rating under the CRA by filing a
declaration that the bank holding company wishes to
14
become a financial holding company. No regulatory approval will be required
for a financial holding company to acquire a company, other than a bank or
savings association, engaged in activities that are financial in nature or
incidental to activities that are financial in nature, as determined by the
Federal Reserve Board. The Company has no current intention of becoming a
financial holding company, but may do at some point in the future if deemed
appropriate in view of opportunities or circumstances at the time.
The Gramm-Leach-Bliley Act defines "financial in nature" to include securities
underwriting, dealing and market making; sponsoring mutual funds and investment
companies; insurance underwriting and agency; merchant banking activities; and
activities that the Board has determined to be closely related to banking. A
national bank (and therefore, a state bank as well) may also engage, subject to
limitations on investment, in activities that are financial in nature, other
than insurance underwriting, insurance company portfolio investment, real estate
development and real estate investment, through a financial subsidiary of the
bank, if the bank is well capitalized, well managed and has at least a
satisfactory CRA rating. Subsidiary banks of a financial holding company or
national banks with financial subsidiaries must continue to be well capitalized
and well managed in order to continue to engage in activities that are financial
in nature without regulatory actions or restrictions, which could include
divestiture of the financial in nature subsidiary or subsidiaries. In addition,
a financial holding company or a bank may not acquire a company that is engaged
in activities that are financial in nature unless each of the subsidiary banks
of the financial holding company or the bank has a CRA rating of satisfactory or
better.
The Gramm-Leach-Bliley Act also imposes significant new requirements on
financial institutions with respect to the privacy of customer information, and
modifies other existing laws, including those related to community reinvestment.
USA PATRIOT ACT OF 2001
On October 26, 2001, President Bush signed the USA Patriot Act of 2001 (the
"Patriot Act"). Enacted in response to the terrorist attacks in New York,
Pennsylvania and Washington, D.C. on September 11, 2001, the Patriot Act is
intended to strengthen U.S. law enforcement's and the intelligence communities'
ability to work cohesively to combat terrorism on a variety of fronts. The
potential impact of the Act on financial institutions of all kinds is
significant and wide ranging. The Act contains sweeping anti-money laundering
and financial transparency laws and requires various regulations, including:
. due diligence requirements for financial institutions that
administer, maintain, or manage private bank accounts or correspondent
accounts for non-U.S. persons;
. standards for verifying customer identification at account opening;
. rules to promote cooperation among financial institutions, regulators,
and law enforcement entities in identifying parties that may be
involved in terrorism or money laundering;
. reports by nonfinancial trades and business filed with the Treasury
Department's Financial Crimes Enforcement Network for transactions
exceeding $10,000 and;
. filing of suspicious activities reports securities by brokers and
dealers if they believe a customer may be violating U.S. laws and
regulations.
The Company is not able to predict the impact of such law on its financial
condition or results of operations at this time.
15
OTHER PENDING AND PROPOSED LEGISLATION
Other legislative and regulatory initiatives which could affect the Company, the
Bank and the banking industry in general are pending, and additional initiatives
may be proposed or introduced before the United States Congress, the California
legislature and other governmental bodies in the future. Such proposals, if
enacted, may further alter the structure, regulation and competitive
relationship among financial institutions, and may subject the Bank to increased
regulation, disclosure and reporting requirements. In addition, the various
banking regulatory agencies often adopt new rules and regulations to implement
and enforce existing legislation. It cannot be predicted whether, or in what
form, any such legislation or regulations may be enacted or the extent to which
the business of the Company or the Bank would be affected thereby.
RISK FACTORS
Statements and financial discussion and analysis by management contained
throughout this report that are not historical facts are forward-looking
statements made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements involve a number of
risks and uncertainties. The important factors that could cause actual results
to differ materially from the forward-looking statements herein include, without
limitation, the factors set forth below.
Poor Economic Conditions May Cause Us to Incur Losses. A substantial majority of
- ------------------------------------------------------
our assets and deposits are generated in the San Joaquin Valley in central
California. As a result, poor economic conditions in the San Joaquin Valley may
cause us to incur losses associated with higher default rates and decreased
collateral values in our loan portfolio. The San Joaquin Valley has not
experienced the same type of growth that has occurred in other areas of
California, especially those where high-tech industries have taken hold.
Unemployment levels remain relatively high, especially in Tulare County, which
is our geographic center and the base of our agriculturally oriented
communities. The United States entered into an economic recession in 2001, and
California's Silicon Valley and other high-tech areas have been particularly
impacted. While the current National recession has not necessarily worsened
economic conditions in the San Joaquin Valley, the Company's level of
non-performing assets increased in 2001 anyway due mainly to lingering
agricultural difficulties. Because of increased global competition and other
factors, excess supply and low prices characterize the markets for many
agricultural products. If current recessionary conditions continue or
deteriorate, we expect that our level of non-performing assets could increase
further.
Poor Economic Conditions Affecting Particular Industries Could Have an Adverse
- ------------------------------------------------------------------------------
Effect on Our Customers and Their Ability to Make Payments to Us. We are also
- -----------------------------------------------------------------
affected by certain industry-specific economic factors. For example, a
significant portion of our total loan portfolio is related to real estate
obligations, particularly commercial real estate loans. A downturn in the
commercial real estate industry in California could have an adverse effect on
our operations. Similarly, a sizable portion of our total loan portfolio is to
borrowers either directly or indirectly involved in the agricultural industry.
While a great number of our borrowers may not be individually involved in
agriculture, many of the jobs in the San Joaquin Valley are ancillary to the
regular production, processing, marketing and sales of agricultural commodities.
The ripple effect of lower commodity prices for milk, olives, grapes, tree fruit
and oranges has a tendency to spread to lower land prices, lower borrower
income, and lower collateral values. In addition, weather patterns are of
critical importance to row crop, tree fruit, and orange production. A
degenerative cycle of weather and commodity prices can impact consumer
purchasing power, which has the potential to create further unemployment
throughout the San Joaquin Valley. Such conditions have affected and may
continue to adversely affect our borrower base and negatively impact our
business.
The California Energy Crisis May Adversely Impact Our Customers. California
- ----------------------------------------------------------------
experienced severe energy shortages in 2001, which resulted in rolling blackouts
in certain instances in portions of the state. Poor economic conditions as a
result of energy shortages in the areas where our customers are located could
adversely
16
affect our borrower base, and consequently, may negatively impact our
business. The issue of energy shortages has been resolved, to some extent, but
the prices paid by consumers and businesses for energy have increased
significantly in many cases. While the full impact has not yet been determined,
these price increases could cause customers of the Bank to experience losses or
go out of business, which could result in delinquencies and losses on loans made
to our borrowers and in turn have a material adverse effect on our business.
We May Incur Risks As a Result of Our Growth. Our Company's/1/ total assets
- ---------------------------------------------
increased from $607 million at December 31, 2000, to $650 million at December
31, 2001, with most of the growth occurring in the fourth quarter of the year.
Management's intention is to leverage the Company's current infrastructure to
sustain the momentum achieved in latter part of 2001, although no assurance can
be provided that this strategy will result in significant growth.
Our ability to manage growth will depend primarily on our ability to:
. monitor operations;
. control funding costs and operating expenses;
. maintain positive customer relations; and
. attract, assimilate and retain qualified personnel.
If we fail to achieve those objectives in an efficient and timely manner we may
experience disruptions in our business plans, and our financial condition and
results of operations could be adversely affected.
Changing Interest Rates May Reduce Our Net Interest Income. Banking companies'
- -----------------------------------------------------------
earnings depend largely on the relationship between the cost of funds, primarily
deposits and borrowings, and the yield on earning assets such as loans and
investment securities. This relationship, known as the interest rate spread, is
subject to fluctuation and is affected by economic, regulatory and competitive
factors which influence interest rates, the volume and mix of interest-earning
assets and interest-bearing liabilities, and the level of nonperforming assets.
Many of these factors are beyond our control. Fluctuations in interest rates
affect the demand of customers for our products and services. The Bank is
subject to interest rate risk to the degree that our interest-bearing
liabilities reprice or mature more slowly or more rapidly or on a different
basis than our interest-earning assets. Given our current volume and mix of
interest-bearing liabilities and interest-earning assets, our interest rate
spread could be expected to decline during times of falling interest rates, but
could also be adversely impacted if interest rates increase. Therefore,
significant fluctuations in interest rates may have a negative effect on our
results of operations.
Intense Competition Exists for Loans and Deposits. The banking and financial
- --------------------------------------------------
services business in California generally, and in our market area specifically,
is highly competitive. The increasingly competitive environment is a result
primarily of changes in regulation, changes in technology and product delivery
systems and the accelerating pace of consolidation among financial service
providers. We compete for loan, deposit, and financial services customers with
other commercial banks, savings and loan associations, securities and brokerage
companies, mortgage companies, insurance companies, finance companies, money
market funds, credit unions and other non-bank financial service providers. Many
of these competitors are much larger in total assets and capitalization, have
greater access to capital markets and offer a broader array of financial
services than we do, which creates certain competitive disadvantages for the
Company.
You May Have Difficulty Selling Your Shares in the Future If a More Active
- --------------------------------------------------------------------------
Trading Market for Our Stock Does Not Develop. Although Sierra Bancorp's Common
- ----------------------------------------------
Stock has been listed on the Nasdaq National Market since August 10, 2001 (the
effective date of the holding company reorganization) and Bank of the Sierra's
Common Stock was previously listed on the Nasdaq National Market since June 10,
1999, trading in our stock has not been extensive and cannot be characterized as
amounting to an active trading market.
- -------------------------
/1/ Inasmuch as the Company did not acquire the outstanding shares of the Bank
until August, 2001, the financial information contained throughout this Annual
Report for 2000 and earlier is for the Bank only. Information for 2001 is for
the Company on a consolidated basis unless otherwise stated.
17
Because the Price of Our Common Stock May Vary Widely, When You Decide to Sell
- ------------------------------------------------------------------------------
It, You May Encounter a Delay or Have to Accept a Reduced Price. The price of
- ----------------------------------------------------------------
our common stock may fluctuate widely, depending on many factors. Some of these
factors have little to do with our operating results or the intrinsic worth of
our Company. For example, the market value of our common stock may be affected
by the trading volume of the shares, announcements of expanded services by us
or our competitors, operating results of our competitors, general trends in the
banking industry, general price and volume fluctuations in the stock market,
acquisition of related companies, or variations in quarterly operating results.
Also, if the trading market for our common stock remains limited, that may
exaggerate changes in market value, leading to more price volatility than would
occur in a more active trading market. As a result, if you want to sell your
common stock, you may encounter a delay or have to accept a reduced price.
Adverse Effects of Banking Regulations or Changes in Banking Regulations Could
- ------------------------------------------------------------------------------
Adversely Affect Our Business. We are governed by significant federal and state
- ------------------------------
regulation and supervision, which is primarily for the benefit and protection
of our customers and not for the benefit of our investors. In the past, our
business has been materially affected by these regulations, and our business
may be adversely affected by any future changes in laws, regulations, policies
or interpretations. Laws, regulations or policies currently affecting us and
our subsidiaries may change at any time, and regulatory authorities may also
change their interpretation of these statutes and regulations.
The Allowance for Loan Losses May Not Cover Actual Loan Losses. We try to limit
- ---------------------------------------------------------------
the risk that borrowers will fail to repay loans by carefully underwriting the
loans, nevertheless losses can and do occur. We create an allowance for
estimated loan losses in our accounting records, based on estimates of the
following:
. industry standards;
. historical experience with our loans;
. evaluation of economic conditions;
. regular reviews of the quality mix and size of the overall loan portfolio;
. regular reviews of delinquencies; and
. the quality of the collateral underlying our loans.
We maintain an allowance for loan losses at a level which we believe is
adequate to absorb any specifically identified losses as well as any other
losses inherent in our loan portfolio. However, changes in economic, operating
and other conditions, including changes in interest rates, that are beyond our
control, may cause our actual loan losses to exceed our current allowance
estimates. If the actual loan losses exceed the amount reserved, it will hurt
our business. In addition, the FDIC and the Department of Financial
Institutions, as part of their supervisory functions, periodically review our
allowance for loan losses. Such agencies may require us to increase our
provision for loan losses or to recognize further loan losses, based on their
judgments, which may be different from those of our management. Any increase in
the allowance required by the FDIC or the Department of Financial Institutions
could also hurt our business.
Our Directors and Executive Officers Control Almost a Majority of Our Stock,
- ----------------------------------------------------------------------------
and Your Interests May Not Always be the Same as Those of the Board and
- -----------------------------------------------------------------------
Management. As of December 31, 2001, our directors and executive officers
- ----------
together with their affiliates, beneficially owned approximately_45.9% of the
Bank's outstanding voting stock (not including vested option shares). As a
result, if all of these shareholders were to take a common position, they could
most likely control the outcome of most corporate actions, such as:
. approval of mergers or other business combinations;
. sales of all or substantially all of our assets;
. any matters submitted to a vote of our shareholders;
. issuance of any additional common stock or other equity securities;
18
. incurrence of debt other than in the ordinary course of business;
. the selection and tenure of our Chief Executive Officer; and
. payment of dividends on common stock or other equity securities.
In some situations, the interests of our directors and executive officers may
be different from yours. However, our Board of Directors and executive officers
have a fiduciary duty to act in the best interests of the shareholders, rather
than in their own best interests, when considering a proposed business
combination or any of these types of matters.
Provisions in Our Articles of Incorporation Will Delay or Prevent Changes in
- ----------------------------------------------------------------------------
Control of Our Corporation or Our Management. These provisions make it more
- ---------------------------------------------
difficult for another company to acquire us, which could reduce the market
price of our common stock and the price that you receive if you sell your
shares in the future. These provisions include the following:
. a requirement that certain business combinations not approved by our Board of
Directors receive the approval of two-thirds of the outstanding shares;
. staggered terms of office for members of the board of directors;
. the elimination of cumulative voting in the election of directors; and
. a requirement that our Board of Directors consider the potential social and
economic effects on the our employees, depositors, customers and the
communities we serve as well as certain other factors, when evaluating a
possible tender offer, merger or other acquisition of the Company.
19
ITEM 2. PROPERTIES
- -------------------
The following properties (real properties and/or improvements thereon) are
owned by the Company/(1)/ and are unencumbered. In the opinion of Management,
all properties are adequately covered by insurance.
Square Feet of Land and
Location Use of Facilities Office Space Building Cost
- -------- ----------------- ------------ -------------
90 North Main Street Main Office 8,500 $324,560
Porterville, California
(Opened January 1978)
1498 West Olive Avenue Branch Office 5,000 $803,380
Porterville, California
(Opened January 1980)
142 South Mirage Branch Office 5,500 $816,366
Lindsay, California
(Opened December 1980)
1103 West Visalia Street Branch Office 4,500 $609,337
Exeter, California
(Opened November 18, 1988)
40884 Sierra Drive Branch Office 2,500 $496,251
Three Rivers, California
(Opened March 4, 1994)
401 East Tulare Street Branch Office 2,300 $500,793
Dinuba, California
(Opened February 14, 1997)
246 East Tulare Avenue Branch Office 7,800 $1,189,607
Tulare, California
(Opened May 2, 1998)
427 West Lacey Boulevard Branch Office 4,500 $1,271,189
Hanford, California
(Opened January 16, 1999)
636 E. Shaw Avenue Branch Office 12,000 $1,498,445
Fresno, California
(Opened September 27, 1999)
224 West "F" Street Branch Office 7,749 $330,000
Tehachapi, California
(Opened May 22, 2000)
- -----------------------
/1/ As used throughout this Annual Report, the term "Company" includes, where
appropriate, both Sierra Bancorp and its consolidated subsidiary, Bank of the
Sierra.
20
Square feet of Land and
Location Use of Facilities Office Space Building Cost
- -------- ----------------- ------------ -------------
21000 Mission Street Branch Office 1,479 $250,000
Tehachapi, California
(Opened May 22, 2000)
8031 California City Boulevard Branch Office 2,182 $285,000
California City, California
(Opened May 22, 2000)
1621 Mill Rock Way Branch Office 3,920 $1,160,000
Bakersfield, California
(Opened May 22, 2000)
The following facilities are leased by the Bank:
Square Feet of Monthly Rent Term of
Location Use of Facilities Office Space as of 12/31/01 Lease
- -------- ----------------- ------------ -------------- -----
80-86 North Main Street Administrative 37,000 $10,225 4/26/14/1/
Porterville, California Headquarters Office
128 East Main Street Branch Office 8,000 $7,650 6/30/05/2/
Visalia, California
(Opened September 5, 1995)
2515 South Mooney Blvd. Branch Office 3,300 $4,705 6/18/06
Visalia, California
(Opened June, 1991)
5060 California Avenue Branch Office 7,410 $11,292 7/31/08
Bakersfield, California
(Opened May, 2, 1997)
Additionally, the Bank has eight remote ATM locations. The amount of monthly
rent at these locations is minimal.
Management believes that the Company's existing facilities are adequate to
accommodate the Company's operations for the immediately foreseeable future.
- -----------------------
/1/ This is the termination date of the original 20-year lease; the Company has
the right, however, to terminate the lease with 90 days advance notice on the
10th and 15th anniversary dates of the lease commencement.
/2/ This is the termination date of the original lease; the Company also has
three renewal options for five years each under this lease agreement.
21
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
From time to time, the Company is a party to claims and legal proceedings
arising in the ordinary course of business. After taking into consideration
information furnished by counsel to the Company as to the current status of
these claims or proceedings to which the Company is a party, management is of
the opinion that the ultimate aggregate liability represented thereby, if any,
will not have a material adverse affect on the financial condition of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
Not applicable.
22
PART II
-------
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
- -----------------------------------------------------------------
(a) Market Information
Sierra Bancorp's Common Stock has been listed on the Nasdaq National Market
since August 10, 2001 (the effective date of the holding company
reorganization), and Bank of the Sierra's Common Stock was previously listed on
the Nasdaq National Market since June 10, 1999. Our Common Stock trades on the
Nasdaq Stock Market(R) under the symbol BSRR and the CUSIP number for such
common stock is #064860109. Trading in the Common Stock of the Company has not
been extensive and such trades cannot be characterized as amounting to an
active trading market. Management is aware of the following securities dealers
who make a market in the Company's stock: Hoefer & Arnett, San Francisco,
California; J. Alexander Securities, Inc., Los Angeles, California; Morgan
Stanley Dean Witter, Bakersfield, California Sutro & Co., Los Angeles,
California, and Wedbush Morgan Securities, Portland, Oregon (the "Securities
Dealers").
The following table summarizes trades of the Company's /1/ Common Stock, setting
forth the approximate high and low sales prices and volume of trading for the
periods indicated, based upon information provided by public sources. The
information in the following table does not include trading activity between
dealers.
Calendar Sale Price of the Company's /1/ Approximate
Quarter Ended Common Stock Trading Volume
High Low Shares
---- --- ------
March 31, 2000.......... 9.50 7.50 183,200
June 30, 2000........... 8.25 7.13 94,800
September 30, 2000...... 8.00 5.68 89,200
December 31, 2000....... 7.50 5.75 137,700
March 31, 2001.......... 8.13 6.25 96,100
June 30, 2001........... 7.30 6.00 126,400
September 30, 2001...... 7.25 6.00 122,000
December 31, 2001....... 7.30 6.00 167,300
(b) Holders
On February 15, 2002 there were approximately 739 shareholders of record of the
Company's Common Stock.
(c) Dividends
As a bank holding company which currently has no significant assets other than
its equity interest in the Bank, the Company's ability to declare dividends
depends primarily upon dividends it receives from the Bank. The Bank's dividend
practices in turn depend upon the Bank's earnings, financial position, current
and anticipated cash requirements and other factors deemed relevant by the
Bank's Board of Directors at that time.
The Company paid quarterly cash dividends totaling $1.66 million or $0.18 per
share in 2001 and $2.12 million or $0.23 per share in 2000, representing 24%
and 38%, respectively of the prior year's earnings. (As the holding company
reorganization became effective on August 10, 2001, all of the dividends paid
prior to that date were paid by the Bank, rather than the Company.) Since 1999,
the Bank (or the Company, as applicable) has
- -----------------------
/1/ Inasmuch as the Company did not acquire the outstanding shares of the Bank
until August, 2001, the information contained herein for 2000 and part of 2001
is for the Bank's stock. As of the effective date of the holding company
reorganization (August 10, 2001), each outstanding share of common stock of the
Bank was converted into one outstanding share of common stock of the Company.
23
generally adhered to a policy of paying quarterly cash dividends totaling about
35% of the prior year's net earnings to the extent consistent with general
considerations of safety and soundness, provided that such payments do not
adversely affect the Bank's or the Company's financial condition and are not
overly restrictive to its growth capacity. However, the Bank experienced
significant growth in 2000, due mainly to its acquisition of Sierra National
Bank in May of that year, and also had a slight contraction in earnings in the
2000 calendar year. In light of these events, the Board of Directors declared
dividends in 2001 totaling only approximately 24% of the prior year earnings.
The Company anticipates paying dividends in the future consistent with the
general dividend policy as described above. However, no assurance can be given
that the Bank's and the Company's future earnings and/or growth expectations in
any given year will justify the payment of such a dividend.
The power of the Bank's Board of Directors to declare cash dividends is also
limited by statutory and regulatory restrictions which restrict the amount
available for cash dividends depending upon the earnings, financial condition
and cash needs of the Bank, as well as general business conditions. Under
California banking law, the Bank may declare dividends in an amount not
exceeding the lesser of its retained earnings or its net income for the last
three years (reduced by dividends paid during such period) or, with the prior
approval of the California Commissioner of Financial Institutions, in an amount
not exceeding the greatest of (i) the retained earnings of the Bank, (ii) the
net income of the Bank for its last fiscal year, or (iii) the net income of the
Bank for its current fiscal year. The payment of any cash dividends by the Bank
will depend not only upon the Bank's earnings during a specified period, but
also on the Bank meeting certain regulatory capital requirements.
The Company's ability to pay dividends is also limited by state corporation
law. The California General Corporation Law prohibits the Company from paying
dividends on the Common Stock unless: (i) its retained earnings, immediately
prior to the dividend payment, equals or exceeds the amount of the dividend or
(ii) immediately after giving effect to the dividend the sum of the Company's
assets (exclusive of goodwill and deferred charges) would be at least equal to
125% of its liabilities (not including deferred taxes, deferred income and
other deferred liabilities) and the current assets of the Company would be at
least equal to its current liabilities, or, if the average of its earnings
before taxes on income and before interest expense for the two preceding fiscal
years was less than the average of its interest expense for the two preceding
fiscal years, at least equal to 125% of its current liabilities.
(d) Recent Sales of Unregistered Securities
On November 28, 2001, the Company issued an aggregate of $15,000,000 in
principal amount of its Floating Rate Junior Subordinated Deferrable Interest
Debentures due 2031 (the "Subordinated Debt Securities"). All of the
Subordinated Debt Securities were issued to Sierra Capital Trust I, a Delaware
statutory business trust and a wholly-owned subsidiary of the Company (the
"Trust"). The Subordinated Debt Securities were not registered under the
Securities Act in reliance on the exemption set forth in Section 4(2) thereof.
The Subordinated Debt Securities were issued to the Trust in consideration for
the receipt of the net proceeds (approximately $14.5 million) raised by the
Trust from the sale of $15,000,000 in principal amount of the Trust's Floating
Rate Capital Trust Pass-through Securities (the "Trust Preferred Securities").
Salomon Smith Barney, Inc. ("SSB") acted as the placement agent in connection
with the offering of the Trust Preferred Securities for aggregate commissions
of $450,000 payable by the Trust. The sale of the Trust Preferred Securities
was part of a larger transaction arranged by SSB pursuant to which the Trust
Preferred Securities were deposited into a special purpose vehicle along with
similar securities issued by a number of other banks and the special purpose
vehicle then issued its securities to the public (the "Pooled TRUPS"). The
Pooled TRUPS were sold by SSB only (i) to those entities SSB reasonably
believed were qualified institutional buyers (as defined in Rule 144A under the
Securities Act), (ii) to "accredited investors" (as defined in Rule 501(a)(1),
(2), (3) or (7) or Regulation D promulgated under the Securities Act) or (iii)
in offshore transactions in compliance with Rule 903 of Regulation S under the
Securities Act. The Trust Preferred Securities were not registered under the
Securities Act in reliance on exemptions set forth in Rule 144A, Regulation D
and Regulation S, as applicable.
24
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
The "selected financial data" for 2001 which follows is derived from the
audited Consolidated Financial Statements of the Company and other data from
our internal accounting system. The selected financial data should be read in
conjunction with the audited Consolidated Financial Statements and Notes
thereto, and Management's Discussion and Analysis of Financial Condition and
Results of Operations in Item 7 below. Statistical information below is
generally based on average daily amounts.
25
Selected Financial Data
As of December 31,
(Dollars in thousands, except per share data)
Income Statement Summary 2001 2000/1/ 1999 1998 1997
------------- ------------- ------------- ------------- ------------
Interest income $ 43,338 $ 45,528 $ 33,864 $ 33,652 $ 30,011
Interest expense $ 15,892 $ 18,677 $ 11,721 $ 12,378 $ 9,846
Net interest income before provision for
loan losses $ 27,446 $ 26,851 $ 22,143 $ 21,274 $ 20,165
Provision for loan losses $ 1,300 $ 2,760 $ 2,118 $ 2,800 $ 2,013
Non interest income $ 9,663 $ 6,436 $ 5,346 $ 6,076 $ 4,389
Non-interest expense $ 25,309 $ 22,304 $ 16,984 $ 16,383 $ 15,463
Income before provision for income taxes $ 10,500 $ 8,223 $ 8,387 $ 8,167 $ 7,078
Provision for income taxes $ 3,622 $ 2,742 $ 2,775 $ 2,943 $ 2,536
Net Income $ 6,878 $ 5,481 $ 5,612 $ 5,224 $ 4,542
Balance Sheet Summary
Total loans, net $ 480,393 $ 416,392 $ 314,474 $ 270,920 $ 258,142
Allowance for loan losses $ (5,675) $ (5,362) $ (3,319) $ (4,394) $ (3,034)
Securities held to maturity $ - $ - $ 64,886 $ 53,096 $ 37,033
Securities available for sale $ 92,689 $ 110,752 $ 26,528 $ 30,656 $ 23,082
Cash and due from banks $ 39,835 $ 43,433 $ 31,413 $ 24,545 $ 26,774
Federal funds sold $ - $ 246 $ - $ 9,800 $ 5,300
Other real estate owned $ 769 $ 1,530 $ 2,553 $ 1,273 $ 2,285
Premises and equipment, net $ 14,304 $ 14,477 $ 11,597 $ 9,491 $ 7,540
Total Interest-Earning assets $ 579,480 $ 535,689 $ 408,924 $ 369,216 $ 327,264
Total Assets $ 650,410 $ 606,726 $ 458,384 $ 404,064 $ 365,333
Total Interest-Bearing liabilities $ 454,216 $ 431,468 $ 327,835 $ 283,464 $ 260,373
Total Deposits $ 521,317 $ 527,776 $ 385,818 $ 355,881 $ 321,113
Total Liabilities $ 604,269 $ 565,944 $ 421,685 $ 369,046 $ 334,882
Total Shareholders' Equity $ 46,141 $ 40,782 $ 36,699 $ 35,018 $ 30,451
Per Share Data /(2)/
Net Income $ 0.75 $ 0.60 $ 0.61 $ 0.57 $ 0.49
Book Value $ 5.01 $ 4.43 $ 3.98 $ 3.80 $ 3.31
Cash Dividends $ 0.18 $ 0.23 $ 0.22 $ 0.15 $ 0.05
Weighted Average Common Shares Outstanding, Basic 9,212,280 9,212,280 9,212,280 9,212,280 9,212,280
Weighted Average Common Shares Outstanding, Diluted 9,221,480 9,212,280 9,252,193 9,212,280 9,212,280
Key Operating Ratios:
Performance Ratios:
Return on Average Equity /(3)/ 15.94% 14.30% 16.24% 15.81% 15.74%
Return on Average Assets /(4)/ 1.15% 0.96% 1.33% 1.33% 1.37%
Net Interest Spread /(5)/ 4.25% 4.60% 5.10% 4.97% 5.68%
Net Interest Margin 5.07% 5.48% 5.97% 5.92% 6.68%
Dividend Payout Ratio /(6)/ 24.11% 38.33% 36.07% 26.32% 10.20%
Equity to Assets Ratio /(7)/ 7.21% 6.69% 8.22% 8.42% 8.71%
Net Loans to Total Deposits at Period End 92.15% 78.90% 81.51% 76.13% 80.39%
Asset Quality Ratios:
Non Performing Loans to Total Loans 2.01% 0.73% 0.29% 1.43% 0.55%
Nonperforming Assets to Total Loans and
Other Real Estate Owned 2.17% 1.05% 1.08% 1.88% 1.41%
Net Charge-offs (recoveries) to Average Loans 0.23% 0.43% 1.11% 0.55% 0.78%
Allowance for Loan Losses to
Net Loans at Period End 1.18% 1.29% 1.06% 1.62% 1.18%
Allowance for Loan Losses to Non-Performing Loans 58.00% 173.87% 363.13% 111.58% 211.13%
Capital Ratios:
Tier 1 Capital to Adjusted Total Assets 9.02% 5.64% 8.13% 8.16% 8.10%
Tier 1 Capital to Total Risk-weighted Assets 11.03% 7.76% 10.30% 11.54% 10.50%
Total Capital to Total Risk-weighted Assets 12.18% 9.00% 11.32% 12.79% 11.61%
/(1)/ On May 19, 2000, Bank of the Sierra acquired the net assets of Sierra
National Bank. The transaction was accounted for using the purchase method of
accounting. Bank of the Sierra paid $9,563,000 in cash (including
acquisition-related costs of $463,000) for net assets of $3,694,000. The
resulting purchase price in excess of net assets acquired (intangibles) is
$5,869,000. The allocation of the purchase price is preliminary as not all
estimations have been finalized.
/(2)/ All per share data and the average number of shares outstanding have been
retroactively restated on a split adjusted basis.
/(3)/ Net income divided by average shareholders' equity.
/(4)/ Net income divided by average total assets.
/(5)/ Represents the average rate earned on interest-earning assets less the
average rate paid on interest-bearing liabilities.
/(6)/ Dividends declared per share divided by net income per share.
/(7)/ Average equity divided by average total assets.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
-------------
This discussion presents Management's analysis of the financial condition and
results of operations of the Company as of and for each of the years in the
three-year period ended December 31, 2001./(1)/ The Company also wholly owns
Sierra Capital Trust I, a Delaware statutory business trust (see "Part II, Item
5 -- Market for Common Equity and Related Shareholder Matters -- Recent Sales
of Unregistered Securities"). The discussion should be read in conjunction with
the Consolidated Financial Statements of the Company and the Notes related
thereto presented elsewhere in this Form 10-K Annual Report (see Item 8 below).
Statements contained in this report that are not purely historical are forward
looking statements within the meaning of Section 21E of the Securities Exchange
Act of 1934 as amended, including the Company's expectations, intentions,
beliefs, or strategies regarding the future. All forward-looking statements
concerning economic conditions, rates of growth, rates of income or values as
may be included in this document are based on information available to the
Company on the date noted, and the Company assumes no obligation to update any
such forward-looking statements. It is important to note that the Company's
actual results could materially differ from those in such forward-looking
statements. Factors that could cause actual results to differ materially from
those in such forward-looking statements are fluctuations in interest rates,
inflation, government regulations, economic conditions, customer
disintermediation and competitive product and pricing pressures in the
geographic and business areas in which the Company conducts its operations.
SUMMARY OF PERFORMANCE
- ----------------------
After a slight dip in earnings in 2000, the Company regained its footing in
2001 and increased net earnings by more than 25% despite only a 4.7% increase
in average earning assets and a slight decline in the Company's net interest
margin. Net income in 2000 declined primarily due to increased operating costs
associated with the May 2000 acquisition of Sierra National Bank ("SNB"), a
Tehachapi-based, four branch financial institution with approximately $87
million in total assets. The purchase of SNB was a strategic decision meant to
improve the Company's long-term potential. Gains on the sale of investment
securities were responsible for approximately half of the increase in net
income in 2001. The increase in net earnings in 2001 was also achieved through
increased net interest income, gains from the sale of loans and loan servicing,
a reduction in the loan loss provision (which occurred in spite of an increase
in the level of non-performing loans - see "Non-performing Assets"), and the
implementation of expense controls during the course of the year. For 2001, net
income was $6.88 million, compared to the $5.48 million earned in 2000 and net
income of $5.61 million in 1999. Net income per share was $0.75 for 2001, as
compared to $0.60 during 2000 and $0.61 in 1999. The Company's Return on
Average Assets ("ROA") was 1.15% and Return on Average Equity ("ROE") was
15.94% in 2001, as compared to .96% and 14.30%, respectively in 2000, and 1.33%
and 16.24%, respectively for 1999.
Perhaps the most significant single factor impacting the Company's performance
in 2001 was the Federal Reserve Board's record reduction in the target
overnight fed funds rate and discount rate, although this negative factor was
more than offset by the combination of positive factors discussed elsewhere in
this section. The Federal Reserve Board's rate reductions injected liquidity
into the banking system, which forced other market interest rates to decline in
response. As is typical in many other community banks, the Company's net
interest margin was negatively impacted as market rates fell. The rate-related
decline in net interest income, however, was mitigated by the increased income
generated by a higher level of average earning assets and favorable changes in
the Company's deposit mix, and net interest income increased by $595,000 from
2000 to 2001. Moreover, the decline in market rates boosted the Company's
volume of mortgage loans, some of which we were able to sell at a substantial
gain, and increased the value of the Bank's investment portfolio, a portion of
which was also sold with realized gains.
- -----------------------
/1/ As the holding company reorganization pursuant to which the Company became
the sole shareholder of the Bank was effective in August, 2001, all financial
information as of and for the years ended December 31, 2000 and any earlier
years or periods relates to the Bank rather than the Company. Information as of
and for the year ended December 31, 2001 is provided for the Bank and the
Company on a consolidated basis.
27
The Company's lower loan loss provision is, on the surface, inconsistent with
the increase in non-performing assets and higher aggregate loan balances, and
the Company's allowance for loan losses fell as a percentage of loans and as a
percentage of non-performing loans. Actual loan losses, however, declined in
2001, and management's detailed analysis of the adequacy of the allowance
provides justification for the amounts added to the allowance by means of the
loan loss provision during the year.
Due in part to an increase in operating expenses associated with the SNB
acquisition, the Company undertook a thorough review of its major expenses in
early 2001. As a result of this effort, certain cost-cutting measures were
implemented during the year, including a staff reduction program. The Company
also decided to sell its mortgage servicing to reduce associated expenses and
realize non-recurring gains. It is anticipated that these expense controls will
continue to enhance the Company's profitability in subsequent years, although no
absolute assurance can be given that this, in fact, will occur.
On November 28, 2001, Sierra Capital Trust I, a newly formed Delaware statutory
business trust and a wholly-owned subsidiary of the Company (the "Trust"),
issued an aggregate of $15,000,000 of principal amount of Floating Rate
TRUPS(R) (Capital Trust Pass-through Securities of the Trust) , which in turn
were used to purchase the same amount of Subordinated Debt Securities issued by
the Company. These Trust Preferred Securities currently qualify as Tier 1
capital when calculating regulatory risk-based capital ratios. The issuance of
the Trust Preferred Securities in the fourth quarter of 2001, coupled with
relatively slow asset growth during most of 2001, resulted in substantial
improvement in the Company's capital ratios. Proceeds from the issuance of Trust
Preferred Securities were used to increase the capital of the Bank and for
general corporate purposes. The Bank is now considered to be "well capitalized"
pursuant to the FDIC's prompt corrective action guidelines. We anticipate that
this increase in capital will provide a springboard for future asset growth,
while allowing the Bank to maintain its well capitalized position. There can be
no absolute assurance given that this in fact will occur, however, as numerous
local market, general economic and regulatory changes could impact capital
ratios going forward.
RESULTS OF OPERATIONS
- ---------------------
NET INTEREST INCOME AND NET INTEREST MARGIN
- -------------------------------------------
During 2001 the Company generated net income of $6.88 million as compared to
$5.48 million in 2000 and $5.61 million in 1999. The Company earns income from
two primary sources. The first is net interest income brought about by income
from the successful deployment of earning assets less the costs of
interest-bearing liabilities. The second is non-interest income, which generally
comes from customer service charges and fees, but can also result from
non-customer sources such as gains on loan sales and gains on sales from the
Company's investment portfolio. The majority of the Company's expenses are
operating costs which relate to providing a full range of banking services to
our customers.
Net interest income, which is simply total interest income (including fees) less
total interest expense, was $27.45 million in 2001 compared to $26.85 million
and $22.14 million in 2000 and 1999, respectively. This represents an increase
of 2.2% in 2001 over 2000 and an increase of 21.3% in 2000 over 1999. Going
forward, the $15 million in Trust Preferred Securities, which currently bear an
interest rate of 6.007%, are expected to add approximately $900,000 per year to
the Company's interest expense, although the rate adjusts every six months and
this amount will likely vary somewhat. The Company will be able to maintain a
positive interest spread on these funds, however, by leveraging this additional
regulatory capital to increase loan balances.
The amount by which total interest income exceeds total interest expense depends
on several factors. Among those factors are yields on earning assets, the cost
of interest-bearing liabilities, the relative volume of total earning assets and
total interest-bearing liabilities, and the mix of products which comprise the
Company's earning assets, deposits, and other interest-bearing liabilities.
Change in the amount and mix of interest-earning
28
assets and interest-bearing liabilities is referred to as "volume change."
Change in interest rates earned on assets and rates paid on deposits and other
borrowed funds is referred to as "rate change."
The Volume and Rate Variances table which follows sets forth the dollar amount
of changes in interest earned and paid for each major category of
interest-earning assets and interest-bearing liabilities and the amount of
change attributable to changes in average balances (volume) or changes in
average interest rates. The calculation is as follows: the change due to
increase or decrease in volume is equal to the increase or decrease in the
average balance times the prior period's rate. The change due to an increase or
decrease in the rate is equal to the increase or decrease in the average rate
times the current period's balance. The variances attributable to both the
volume and rate changes have been allocated to the change in rate.
===========================================================================================================
Volume & Rate Variances Years Ended December 31,
- -----------------------
(dollars in thousands) 2001 over 2000 2000 over 1999
----------------------------- -------------------------------
Increase(decrease) due to Increase(decrease) due to
Assets: Volume Rate Net Volume Rate Net
----------------------------- -------------------------------
Investments:
- -----------
Federal funds sold / Due from time $ 334 $ (180) $ 154 $ 105 $ (103) $ 2
Taxable $ (447) $ (207) $ (654) $ 809 $ 609 $ 1,418
Non-taxable/(1)/ $ 111 $ (133) $ (22) $ 284 $ (74) $ 210
Equity $ (7) $ 67 $ 60 $ (19) $ 30 $ 11
----------------------------- -------------------------------
Total Investments $ (9) $ (453) $ (462) $ 1,179 $ 462 $ 1,641
----------------------------- -------------------------------
Loans:
- -----
Agricultural $ (490) $ (331) $ (821) $ 7 $ 251 $ 258
Commercial $ 1,456 $ (1,137) $ 319 $ 1,824 $ (412) $ 1,412
Real Estate $ 101 $ (1,680) $(1,579) $ 8,881 $(1,078) $ 7,803
Consumer $ 694 $ (439) $ 255 $ 566 $ 58 $ 624
Credit Cards $ 101 $ (3) $ 98 $ 15 $ (89) $ (74)
----------------------------- -------------------------------
Total Loans $ 1,862 $ (3,590) $(1,728) $ 11,293 $(1,270) $10,023
----------------------------- -------------------------------
Total Earning Assets $ 1,853 $ (4,043) $(2,190) $ 12,472 $ (808) $11,664
----------------------------- -------------------------------
Liabilities
Interest Bearing Deposits:
- -------------------------
NOW $ (16) $ (180) $ (196) $ 115 $ (41) $ 74
Savings Accounts $ 51 $ (255) $ (204) $ 156 $ 61 $ 217
Money Market $ 862 $ 510 $ 1,372 $ 334 $ 34 $ 368
TDOA's & IRA's $ 27 $ 4 $ 31 $ 266 $ (12) $ 254
Certificates of Deposit * $100,000 $ (767) $ (884) $(1,651) $ 1,863 $ 741 $ 2,604
Certificates of Deposit ** $100,000 $ (240) $ (1,062) $(1,302) $ 1,491 $ 1,040 $ 2,531
----------------------------- -------------------------------
Total Interest Bearing Deposits $ (83) $ (1,867) $(1,950) $ 4,225 $ 1,823 $ 6,048
----------------------------- -------------------------------
Borrowed Funds:
- --------------
Federal Funds Purchased $ 189 $ (103) $ 86 $ 2 $ 23 $ 25
Repurchase Agreements $ 95 $ (264) $ (169) $ 116 $ 117 $ 233
Other Borrowings $ (840) $ 3 $ (837) $ 531 $ 119 $ 650
TRUPS $ 85 $ - $ 85 $ - $ - $ -
----------------------------- -------------------------------
Total Borrowed Funds $ (471) $ (364) $ (835) $ 649 $ 259 $ 908
----------------------------- -------------------------------
Total Interest Bearing Liabilities $ (554) $ (2,231) $(2,785) $ 4,874 $ 2,082 $ 6,956
----------------------------- -------------------------------
Net Interest Margin/Income $ 2,407 $ (1,812) $ 595 $ 7,598 $(2,890) $ 4,708
============================= ===============================
/(1)/ Yields on tax exempt income have not been computed on a tax equivalent basis.
===========================================================================================================
The Company's net interest margin is its net interest income expressed as a
percentage of average earning assets. The Company's net interest margin for 2001
was 5.07%, a decline of 12 basis points from the 5.19% reported for 2000. For
the year 1999, this margin was 5.80%. The following Distribution, Rate and Yield
table shows, for each of the past three years, the rates earned on each
component of the Company's investment and loan portfolio, the rates paid on each
segment of the Company's interest bearing liabilities, and the Company's net
interest margin. That same table also shows the Company's average daily balances
for each principal category of assets, liabilities and shareholders' equity, the
amount of interest income or interest expense, and the average
29
yield or rate for each category of interest-earning asset and interest-bearing
liability along with the net interest margin for each of the reported periods.
Distribution, Rate & Yield Year Ended December 31,
(dollars in thousands)
2001(a) 2000(a)
------------------------------ ------------------------------
Average Income/ Average Average Income/ Average
Assets Balance Expense Rate Balance Expense Rate
Investments:
Federal Funds Sold/Due from Time $ 9,395 $ 398 4.24% $ 3,959 $ 243 6.14%
Taxable $ 60,057 $ 3,662 6.10% $ 66,993 $ 4,316 6.44%
Non-taxable/(1)/ $ 42,427 $ 2,000 4.71% $ 40,211 $ 2,022 5.03%
Equity $ 2,391 $ 94 3.93% $ 2,680 $ 34 1.27%
------------------ --------------------
Total Investments $114,270 $ 6,154 5.39% $ 113,843 $ 6,615 5.81%
------------------ --------------------
Loans:/(2)/
- -----
Agricultural $ 11,344 $ 885 7.80% $ 15,921 $ 1,706 10.72%
Commercial $ 76,341 $ 6,525 8.55% $ 61,830 $ 6,206 10.04%
Real Estate $284,239 $24,715 8.70% $ 283,147 $26,294 9.29%
Consumer $ 37,264 $ 3,561 9.56% $ 30,795 $ 3,306 10.74%
Credit Cards $ 11,781 $ 1,499 12.72% $ 10,987 $ 1,401 12.75%
Other $ 5,999 $ - 0.00% $ 610 $ - 0.00%
------------------ --------------------
Total Loans $426,968 $37,185 8.71% $ 403,290 $38,913 9.65%
------------------ --------------------
Total Earning Assets/(4)/ $541,238 $43,339 8.01% $ 517,133 $45,528 8.80%
------- -------
Non-Earning Assets $ 57,318 $ 56,093
-------- ----------
Total Assets $598,556 $ 573,226
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