UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

 

WESTERN SIERRA BANCORP

(Exact name of Registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (530) 677-5600

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value per share

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý  No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes  ý  No  o

 

As of May 7, 2004 there were approximately 7,547,000 shares outstanding of the Registrant’s common stock.

 

 

WESTERN SIERRA BANCORP & SUBSIDIARIES

 

Index to Form 10-Q

 

PART I. Financial Information
	Item 1. Consolidated Financial Statements (unaudited)
		Consolidated Balance Sheet  March 31, 2004 and December 31, 2003
		Consolidated Statement of Income  Three months ended March 31, 2004 and 2003
		Consolidated Statement of Cash Flows  Three months ended March 31, 2004 and 2003
		Notes to Consolidated Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosure about Market Risk  Item 4. Controls and Procedures
	Item 4. Controls and Procedures
PART II. Other Information
	Item 1. Legal proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 3. Defaults Upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits and Report on Form 8-K
SIGNATURES

 

2

 

PART I. FINANCIAL INFORMATION

 

Western Sierra Bancorp and Subsidiaries

Unaudited Consolidated Balance Sheet

(dollars in thousands, except number of shares)

 

		March 31, 2004			December 31, 2003
ASSETS:
Cash and due from banks		$	36,453		$	38,584
Federal funds sold		43,295			17,380
Cash and cash equivalents		79,748			55,964
Interest-bearing deposits		4,000			4,198
Loans held for sale		1,729			940
Investment securities:
Trading, at estimated market value		31			28
Available for sale (amortized cost $75,650 in 2004 and $78,156 in 2003)		77,695			79,502
Held to maturity (market value of $3,989 in 2004 and $4,219 in 2003)		3,811			4,058
Total investments		81,537			83,588
Portfolio loans and leases:
Real estate mortgage		544,422			495,948
Real estate construction		180,633			195,889
Commercial		114,813			109,685
Agricultural		11,509			12,185
Installment		5,178			5,795
Lease financing		1,983			2,016
Total gross loans and leases		858,538			821,518
Deferred loan and lease fees, net		(2,490		)	(2,729		)
Allowance for loan and lease losses		(12,165		)	(11,529		)
Net portfolio loans and leases		843,883			807,260
Premises and equipment, net		19,543			19,591
Goodwill and other intangible assets		34,551			34,731
Other assets		29,971			29,439
Total assets		$	1,094,962		$	1,035,711
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Non-interest bearing deposits		$	238,523		$	221,898
Interest bearing deposits:
NOW, money market and savings		336,424			340,922
Time, over $100,000		174,583			145,608
Other time		168,769			164,710
Total deposits		918,299			873,138
Borrowed funds		32,750			20,650
Subordinated debentures		36,496			36,496
Other liabilities		9,867			11,990
Total liabilities		997,412			942,274
Commitments and contingencies (Note 6)
Shareholders’ equity:
Preferred stock— no par value; 15,000,000 shares authorized; none issued (1)		—			—
Common stock— no par value; 15,000,000 shares authorized; 7,463,299 shares issued in 2004 and 7,439,029 shares in 2003 (1)		66,649			66,459
Retained earnings		29,562			26,097
Accumulated other comprehensive income		1,339			881
Total shareholders’ equity		97,550			93,438
Total liabilities and shareholders’ equity		$	1,094,962		$	1,035,711

 

(1) As adjusted for the May 7, 2004 three for two stock split.

 

See notes to the unaudited consolidated financial statements.

 

3

 

Western Sierra Bancorp and Subsidiaries

Unaudited Consolidated Statement of Income

(dollars in thousands, except per share data)

 

		Three Months Ended
		March 31, 2004			March 31, 2003
Interest income:
Interest and fees on loans		$	14,036		$	9,752
Interest on investment securities:
Taxable		369			401
Exempt from Federal income taxes		387			359
Interest on Federal funds sold		53			42
Total interest income		14,844			10,555
Interest expense:
Interest on deposits		2,004			1,999
Interest on borrowed funds and subordinated debentures		557			272
Total interest expense		2,562			2,271
Net interest income		12,282			8,284
Provision for loan and lease losses		710			525
Net interest income after provision for loan and lease losses		11,572			7,759
Non-interest income:
Service charges and fees		1,195			819
Investment service fee income		291			16
Net gain on sale and packaging of residential mortgage and government-guaranteed commercial loans		855			1,104
Other income		227			117
Total non-interest income		2,568			2,055
Other expenses:
Salaries and benefits		4,887			3,416
Occupancy and equipment		1,352			1,052
Other expenses		2,309			1,645
Amortization of core deposits and other intangibles		180			62
Total other expenses		8,728			6,175
Income before income taxes		5,412			3,639
Income taxes		1,947			1,352
Net income		$	3,465		$	2,287
Basic earnings per share (1)		$	0.46		$	0.36
Fully diluted earnings per share (1)		$	0.44		$	0.35

 

(1) As adjusted for the May 7, 2004 three for two stock split.

 

See notes to the unaudited consolidated financial statements.

 

4

 

Western Sierra Bancorp and Subsidiaries

Unaudited Consolidated Statement of Cash Flows

(dollars in thousands)

 

		Three Months Ended
		March 31, 2004			March 31, 2003
Cash flows from operating activities:
Net income		$	3,465		$	2,287
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses		710			525
Depreciation and amortization		762			544
Deferred loan and lease origination fees, net		(239		)	(116		)
Amortization of investment security premiums, net of accretion of discount		241			110
Increase in trading securities		(3		)	—
Increase in cash surrender value of life insurance policies		(165		)	(50		)
(Increase) decrease in loans held for sale		(789		)	581
Increase in other assets		(550		)	(1,667		)
(Decrease) increase in other liabilities		(2,167		)	1,950
(Increase) decrease in deferred taxes		(20		)	—
Net cash provided by operating activities		1,245			4,164
Cash flows from investing activities:
Proceeds from sale and call of available-for-sale investment securities		4			—
Proceeds from called held-to-maturity investment securities		—			1,000
Proceeds from matured available-for-sale investment securities		—			500
Purchases of available-for-sale investment securities		(385		)	(488		)
Principal repayments received from available-for-sale SBA pools and  mortgage-backed securities		2,649			2,256
Principal repayments received from held-to-maturity mortgage-backed securities		243			178
Net decrease in interest-bearing deposits in banks		198			396
Net increase in loans and leases		(37,050		)	(29,029		)
Purchases of premises and equipment		(534		)	(236		)
Net cash used in investing activities		(34,875		)	(25,423		)
Cash flows from financing activities:
Net increase (decrease) in demand, interest-bearing and savings deposits		$	12,127		$	(4,177	)
Net increase in time deposits		33,034			51,933
Net increase (decrease) in borrowings		12,100			(7,000		)
Proceeds from the exercise of stock options		153			127
Net cash provided by financing activities		57,414			40,883
Increase in cash and cash equivalents		23,784			19,624
Cash and cash equivalents at beginning of year		55,964			36,964
Cash and cash equivalents at end of period		$	79,748		$	56,588
Non-cash investing activities:
Net change in unrealized gain on available-for-sale investment securities		$	698		$	407

 

See notes to the unaudited consolidated financial statements.

 

5

 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of Western Sierra Bancorp and subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of Management, all adjustments (which consist solely of normal recurring accruals) considered necessary for a fair presentation of the results for the interim periods presented have been included. These interim condensed consolidated financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s 2003 Annual Report to Shareholders.

 

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Western Sierra National Bank (WSNB) and its subsidiary WSNB Investment Trust (a Real Estate Investment Trust (“REIT”), Lake Community Bank (LCB), Central California Bank (CCB), Auburn Community Bank (ACB) and Western Sierra Statutory Trusts I, II, III, and IV.  All significant inter-company balances and transactions have been eliminated.  Western Sierra Statutory Trusts I, II, III, and IV are unconsolidated subsidiaries formed solely for the purpose of issuing trust preferred securities.  Operating results for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. Certain amounts in the consolidated financial statements for the year ended December 31, 2003 and the three-month period ended March 31, 2003 may have been reclassified to conform to the presentation of the consolidated financial statements in 2004.

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires Management to make estimates and assumptions.  These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from these estimates.

 

2.  Stock-based Compensation

 

At March 31, 2004, the Company has four stock-based compensation plans.  The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations.  No stock-based compensation cost is reflected in net income, as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant.  In accordance with Financial Accounting Standards Board (“FASB”) No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of FASB No. 12, the following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation.

 

Pro forma adjustments to the Company’s consolidated net earnings and earnings per share are disclosed during the years in which the options become vested (dollars in thousands, except per share data).

 

		Three Months Ended March 31,
		2004			2003
Net earnings as reported		$	3,465		$	2,287
Deduct:  Total stock-based compensation expense  determined under the fair value based method for all awards,net of related tax effects		(287		)	(195		)
Pro forma net income		$	3,178		$	2,092
Basic earnings per share - as reported		$	0.46		$	0.36
Basic earnings per share - pro forma		$	0.43		$	0.33
Diluted earnings per share - as reported		$	0.44		$	0.35
Diluted earnings per share - pro forma		$	0.41		$	0.33

 

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3. Earnings per Share

 

Basic earnings per share (EPS), which excludes dilution, is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options, result in the issuance of common stock, which shares in the earnings of the Company. Earnings per share is retroactively adjusted for stock dividends for all periods presented. A reconciliation of the numerators and denominators of the basic and diluted EPS computations is as follows (dollars in thousands, except for per share data).

 

		Three Months Ended
		March 31, 2004			March 31, 2003
Basic EPS Computation:
Numerator-net income		$	3,465		$	2,287
Denominator— weighted average number of shares outstanding		7,457,544			6,288,334
Basic earnings per share		$	0.46		$	0.36
Diluted EPS Computation:
Numerator-net income		$	3,465		$	2,287
Denominator— weighted average number of shares outstanding		7,457,544			6,288,334
Effect of dilutive stock options		406,798			274,884
		7,864,342			6,563,218
Diluted earnings per share		$	0.44		$	0.35

 

4. Stock Repurchase Plan

 

On January 16, 2004 the Company announced that the Board of Directors approved a plan to utilize up to $2 million (or approximately 1% of the total outstanding shares) to repurchase the Company’s common stock.  As of March 31, 2004, the Company did not repurchase any shares under this plan, but did repurchase 2,000 shares in April 2004.

 

On May 29, 2002, the Company announced that the Board of Directors approved a plan to repurchase up to 5% (or approximately 200,000 shares) of the Company’s common stock. The Company has purchased 5,000 shares at an average price of approximately $21.00 under the plan through March 31, 2004.

 

5. Acquisitions

 

During 2003, the Company acquired Auburn Community Bank (ACB) and Central Sierra Bank (CSB).  ACB became a wholly-owned subsidiary of the Company and CSB was merged into CCB.  These acquisitions were completed because management believes that their combined performance exceeds what each entity could accomplish independently and furthers the Company’s expansion throughout Northern California.  Total consideration paid to each entity acquired was determined through extensive negotiation supported by internal modeling, which management believes will result in earnings per share accretion to the Company’s shareholders within twelve months of each acquisition date.  The funds required to pay the cash portion of the consideration for these mergers was generally obtained through the issuance of subordinated debentures (see Note 11 of the Company’s 2003 audited financial statements).

 

7

 

The following table summarizes the terms of each acquisition (dollars in thousands):

 

		ACB			CSB
Date of acquisition		December 13, 2003			July 11, 2003
Common stock issued		349,976			404,173
Value of common stock issued		$	15,900		$	12,700
Cash paid		$	6,500		$	10,700
Total consideration		$	22,400		$	23,400
Goodwill recorded		$	14,500		$	11,600
Core deposit intangible recorded		$	1,800		$	2,900

 

6.              Commitments and Contingencies

 

Leases

 

The Company leases certain of its branch offices under non-cancelable operating leases.  These leases expire on various dates through 2019 and have various renewal options ranging from five to ten years.  Rental payments include minimum rentals, plus adjustments for changing price indexes.  The Company has subleased various office spaces to other companies under non-cancelable agreements that expire in 2007 and 2008.  Future minimum lease payments and sublease rental income are as follows (dollars in thousands):

 

Year Ending December 31,		Minimum Lease Payments			Minimum Sublease Rental Income
2004		$	1,541		$	96
2005		1,582			96
2006		1,451			96
2007		1,208			95
2008		943			64
Thereafter		4,378			—
		$	11,103		$	447

 

Rental expense included in occupancy expense totaled $1,072,000, $675,000 and $519,000 for the years ended December 31, 2003, 2002 and 2001, respectively.  Sublease income included in occupancy expense totaled $97,000, $68,000 and $66,000 for the years ended 2003, 2002 and 2001, respectively.

 

Financial Instruments With Off-Balance-Sheet Risk

 

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business in order to meet the financing needs of its customers and to reduce its exposure to fluctuations in interest rates.  These financial instruments include commitments to extend credit, letters of credit and commitments to sell loans.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the consolidated balance sheet.

 

The Company’s exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments.  The Company uses the same credit policies in making commitments and letters of credit as they do for loans and leases included on the consolidated balance sheet.

 

8

 

The following financial instruments represent off-balance-sheet credit risk (dollars in thousands):

 

		March 31, 2004			December 31, 2003
Commitments to extend credit:
Revolving lines of credit secured by 1-4 family residences		$	24,960		$	21,691
Commercial real estate, construction and land development  commitments secured by real estate		159,811			161,107
Other commercial commitments not secured by real estate		566			1,023
Agricultural commitments		1,688			4,237
		51,087			49,949
		$	238,112		$	238,007
Letters of credit		$	18,614		$	18,752

 

Real estate commitments are generally secured by property with loan-to-value ratios not to exceed 80%.  In addition, the majority of the Company’s commitments have variable interest rates.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  Each customer’s creditworthiness is evaluated on a case-by-case basis.  The amount of collateral obtained, if deemed necessary upon extension of credit, is based on Management’s credit evaluation of the borrower.  Collateral held varies, but may include deposits, accounts receivable, inventory, equipment, income-producing commercial properties and residential real estate.

 

Letters of credit are conditional commitments to guarantee the performance or financial obligation of a customer to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

 

Commitments to sell loans are agreements to sell to another party loans originated by the Company.  The Company only sells loans to third parties without recourse.  The Company is not exposed to credit loss if the borrower fails to perform according to the promissory note as long as the Company has fulfilled its obligations stated in the sales commitment.

 

7.              Comprehensive Income

 

Comprehensive income includes net income and other comprehensive income.  The Company’s only source of other comprehensive income is derived from unrealized gains and losses on investment securities available-for-sale.  Reclassification adjustments resulting from gains or losses on investment securities that were realized and included in net income of the current period that also had been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose are excluded from comprehensive income of the current period.  The Company’s total comprehensive income was as follows:

 

		Three Months Ended March 31,
(In thousands)		2004			2003
Net income		$	3,465		$	2,287
Other comprehensive income:
Holding gains arising during period, net of tax		458			266
Re-classification adjustment, net of tax		—			—
Total other comprehensive income		458			266
Total comprehensive income		$	3,923		$	2,553

 

8.              Subsequent Events

 

On April 22, 2004, the Company announced a three-for-two stock split effective May 7, 2004.  All shares and per share amounts have been retroactively restated to give effect for the stock split as if it had been declared at the beginning of the earliest period presented.

 

9

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION.

 

Private securities litigation reform act safe harbor statement

 

This quarterly report on Form 10-Q includes forward-looking information, which is subject to the “safe harbor” created by the Securities Act of 1933 and Securities Act of 1934. These forward-looking statements (which involve the Company’s plans, beliefs and goals) involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors:

 

1.               Competitive pressure in the banking industry and changes in the regulatory environment.

 

2.               Changes in the interest rate environment and volatility of rate sensitive deposits.

 

3.               Decline in the health of the economy nationally or regionally which could reduce the demand for loans or reduce the value of real estate collateral securing most of the Company’s loans.

 

4.               Credit quality deterioration that could cause an increase in the provision for loan losses.

 

5.               The Company’s exposure to real estate values in the markets that it serves, as over 80% of the Company’s loans are secured by real estate.

 

6.               Asset/Liability matching risks and liquidity risks.

 

7.               Volatility and devaluation in the securities markets.

 

For additional information concerning risks and uncertainties related to the Company and its operations, please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 under the heading “Forward-Looking Information”.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

The following sections discuss significant changes and trends in financial condition, capital resources and liquidity of the Company from December 31, 2003 to March 31, 2004. Also discussed are significant trends and changes in the Company’s results of operations for the three months ended March 31, 2004 compared to the same periods in 2003. The consolidated financial statements and related notes appearing elsewhere in this report are condensed and unaudited.

 

10

 

General

 

Western Sierra Bancorp (the “Company”) was incorporated under the laws of the State of California on July 11, 1996. The Company was organized pursuant to a plan of reorganization for the purpose of becoming the parent corporation of Western Sierra National Bank, and on December 31, 1996, the reorganization was effected and shares of the Company’s common stock were issued to the shareholders of Western Sierra National Bank for the common shares held by Western Sierra National Bank’s shareholders.

 

In April 1999, the Company acquired Roseville 1st National Bank and Lake Community Bank in a stock for stock exchange. In May of 2000, the Company acquired Sentinel Community Bank in a stock for stock exchange. All of these mergers were accounted for as poolings of interests and, accordingly, all prior period financial information has been restated to reflect the combined operations of the Company, Roseville 1st National Bank, Lake Community Bank and Sentinel Community Bank. Sentinel Community Bank was immediately merged into Western Sierra National Bank. In May of 2000, Roseville 1st National Bank was also merged into Western Sierra National Bank.

 

In April 2002, the Company acquired Central California Bank for $3.7 million in cash and 252,181 shares of the Company’s stock.  This transaction was accounted for under purchase accounting, which resulted in a purchase price allocation resulting in intangible assets totaling $2.3 million in goodwill and $1.9 million in core deposit premium. As required under purchase accounting, no prior period financial statements have been restated to reflect the combined operations of Central California Bank.  In July of 2002, certain assets and liabilities of the Sentinel Community Bank branches were transferred from Western Sierra National Bank to Central California Bank.

 

In July 2003, the Company acquired Central Sierra Bank for $10.7 million in cash and 404,173 shares of the Company’s stock.  This transaction was accounted for under purchase accounting, which resulted in a preliminary purchase price allocation  resulting in intangible assets totaling $11.6 million in goodwill and $2.9 million in core deposit premium. As required under purchase accounting, no prior period financial statements have been restated to reflect the combined operations of Central California Bank.

 

In December 2003, the Company acquired Auburn Community Bank for $6.5 million in cash and 349,976 shares of the Company’s stock.  This transaction was accounted for under purchase accounting, which resulted in a preliminary purchase price allocation resulting in intangible assets totaling $14.5 million in goodwill and $1.8 million in core deposit premium. As required under purchase accounting, no prior period financial statements have been restated to reflect the combined operations of Auburn Community Bank.

 

The Company is a registered bank holding company under the Bank Holding Company Act. The Company conducts its operations at 4080 Plaza Goldorado Circle, Cameron Park, California 95682.

 

Western Sierra National Bank was organized under national banking laws and commenced operations as a national bank on January 4, 1984. Western Sierra National Bank is a member of the Federal Reserve System and the FDIC insures its deposits to the maximum amount permitted by law. Western Sierra National Bank’s head office is located at 4080 Plaza Goldorado Circle, Cameron Park, and its branch offices are located at 4011 Plaza Goldorado Circle, Cameron Park, 2661 Sanders Drive, Pollock Pines, 3970 J Missouri Flat Road, Placerville, 1450 Broadway, Placerville, 3880 El Dorado Hills Blvd., El Dorado Hills, 571 5th Street, Lincoln, 1545 River Park Dr. #101 & #200, Sacramento, 1801 Douglas Blvd., Roseville, 6951 Douglas Blvd., Granite Bay, 9050 Fairway Drive, Roseville, and 2779 East Bidwell, Folsom, CA.    In March 2002, Western Sierra National Bank formed WSNB Investment Trust, a Real Estate Investment Trust (“REIT”), to potentially generate additional capital at Western Sierra National Bank and reduce the Company’s overall effective tax rate. Western Sierra National Bank does not have any other affiliates other than Sentinel Associates, Inc., an inactive entity formed by Sentinel Bank in 1983 to develop single-family residential real estate.

 

Lake Community Bank was incorporated as a banking corporation under the laws of the State of California on March 9, 1984 and commenced operations as a California state-chartered bank on November 15, 1984. Lake Community Bank is an insured bank under the Federal Deposit Insurance Act and became a member of the Federal Reserve System in June 2003. Lake Community Bank engages in the general commercial banking business in Lake County in the State of California from its headquarters banking office located at 805 Eleventh Street, Lakeport, California, and its branch located at 4280 Main Street, Kelseyville, California. Lake Community Bank does not have any affiliates or subsidiaries.

 

Central California Bank was incorporated under the laws of the State of California on January 13, 1997, and commenced operations on April 24, 1998. Central California Bank is an insured bank under the Federal Deposit Insurance Act and became a  member of the Federal Reserve System in January 2003. Central California Bank engages in the general commercial banking business in Tuolumne and Stanislaus counties in the state of California from its headquarters banking office located at 13753-A

 

11

 

Mono Way, Sonora, CA, and its branches located at 400 E. Olive Ave, Turlock, CA, 3700 Lone Tree Way, Antioch, CA, 229 South Washington Street, Sonora, CA, 18711 Tiffeni Drive, Twain Harte, CA, 22712 Main Street, Columbia, CA and loan production offices located at 3400 Tully Rd., #B, Modesto, CA, 1111 Dunbar Road, Arnold, CA,  373 West St. Charles Street, San Andreas, CA, 1239 South Main Street, Angels Camp, CA, 18281 Main Street, Jamestown, CA, 89 Lakewood Mall, Lodi, CA, 11 Ridge Road, Sutter Creek, CA, 87 Highway 26, Valley Springs, CA, and 3505 Spangler Lane, Suite 300, Copperopolis, CA.  Central California Bank does not have any affiliates or subsidiaries.  In July 2003, Central Sierra Bank merged into Central California Bank and its branches are located at 373 West St. Charles Street, San Andreas, CA, 1239 South Main Street, Angels Camp, CA, 18281 Main Street, Jamestown, CA, 89 Lakewood Mall, Lodi, CA, 11 Ridge Road, Sutter Creek, CA, 87 Highway 26, Valley Springs, CA, and 3505 Spangler Lane, Suite 300, Copperopolis, CA.

 

In July 2001, December 2001 and September 30, 2003, respectively, four trusts, Western Sierra Statutory Trust I, Western Sierra Statutory Trust II and Western Sierra Statutory Trust III /IV, were established as wholly-owned subsidiaries of the Company for the purpose of issuing and holding Trust Preferred Securities.

 

Auburn Community Bank, a state non-member bank, was originally operating under the name of Auburn National Bank which was incorporated under the laws of the State of California on July 28, 1997, and commenced operations on February 2, 1998.              On  July 29, 1999, Auburn National Bank converted from national bank to a state non-member bank and was renamed Auburn Community Bank.  Auburn Community Bank is an insured bank under the Federal Deposit Insurance Act and operates its headquarters banking office located at 412 Auburn-Folsom Road, Auburn, CA and its branch located at 11795 Atwood Road, Auburn, CA.  Auburn Community Bank does not have any affiliates or subsidiaries.

 

Banking Services.  The Company is a locally owned and operated bank holding company, and its primary service area is the Northern California communities of Cameron Park, Pollock Pines, Placerville, El Dorado Hills, Folsom, Lincoln, Sacramento, Roseville, Granite Bay, Sonora, Twain Harte, Columbia, Turlock, Lakeport, Antioch, Rocklin, Sand Andreas, Angels Camp, Jamestown, Lodi, Sutter Creek, Valley Springs, Copperopolis, Auburn and the surrounding communities. The Company’s primary business is serving the banking needs of these communities and its marketing strategy stresses its local ownership and commitment to serve the banking needs of individuals living and working in the Company’s primary service areas and local businesses, including retail, professional and real estate-related activities, in those service areas.

 

The Company offers a broad range of services to individuals and businesses in its primary service areas with an emphasis upon efficiency and personalized attention. The Company provides a full line of consumer services and also offers specialized services, such as courier services to small businesses, middle market companies and professional firms. Each of the Company’s subsidiary banks offers personal and business checking and savings accounts (including individual interest-bearing negotiable orders of withdrawal (“NOW”), money market accounts and/or accounts combining checking and savings accounts with automatic transfer), IRA accounts, time certificates of deposit and direct deposit of social security, pension and payroll checks, computer cash management and internet banking including bill payment. The Company’s subsidiary banks also make available commercial, construction, accounts receivable, inventory, automobile, home improvement, real estate, commercial real estate, single family mortgage, agricultural, Small Business Administration, office equipment, leasehold improvement, installment and credit card loans (as well as overdraft protection lines of credit), issue drafts and standby letters of credit, sell travelers’ checks (issued by an independent entity), offer ATMs tied in with major statewide and national networks, extend special considerations to senior citizens and offer other customary commercial banking services.

 

Most of the Company’s deposits are obtained from commercial businesses, professionals and individuals. At March 31, 2004 there was a title company customer with $6.9 million or 6.6% of total deposits at Lake Community Bank and another title company customer with $5.5 million or 7.2% of total deposits at Auburn Community Bank.  There were no other customers with 5% or more of any of the subsidiary banks’ deposits.

 

Other special services and products include both personal and business economy checking products, business cash management products, financial services through Western Sierra Bank’s Financial Services Division and mortgage products and services.

 

Employees.  At March 31, 2004, the Company and its subsidiaries employed 344 persons on a full-time equivalent basis. The Company believes its employee relations are satisfactory.

 

Financial Condition

 

The Company increased total assets from $1.04 billion at December 31, 2003 to $1.09 billion at March 31, 2004, an increase of $59 million or 5.7%. The two primary components of asset growth were portfolio loans, which grew $37 million, and cash and equivalents, which increased $24 million.  Asset growth was primarily funded by growth in deposits of $45 million.

 

12

 

During the first three months of 2004, non-interest bearing deposits increased from $222 million at year-end 2003 to $239 million at March 31, 2004.  Included in non-interest deposits are local title company deposits, which have increased $22 million from $27 million at December 31, 2003 to $49 million at March 31, 2004.  These funds do not receive interest but do result in an assessment of service fees by the title company’s service bureau to the Company.  During the first three months of 2004, the  service fees on title company deposits incurred by the Company were less than 1% of the average title company deposits outstanding.

 

Results of Operations

 

Note:      All references to shares and per share amounts are have been adjusted for the three-for-two stock split effective May 7, 2004.  The Company’s earnings press release for the quarter ended March 31, 2004 reported fully diluted earnings per share of $0.66,  but is reported herein as $0.44 as adjusted for the subsequent three-for-two stock split.

 

The Central Sierra Bank (“CSB”) acquisition was effective July 11, 2003 and was accounted for under purchase accounting.  The Auburn Community Bank (“ACB”) acquisition was effective December 13, 2003 and was also accounted for under purchase accounting.  Pursuant to purchase accounting rules, the operating results of the Company for the three-month period ended March 31, 2003 does not include the operational results of CSB and ACB.

 

The Company reported net income of $3.47 million for the three months ended March 31, 2004 (or $0.44 per share, diluted) compared to $2.29 million (or $0.35 per share, diluted) for the same period in 2003. The quarterly earnings represent an increase of $1.18 million or a 52% increase in net income and a 26% increase in diluted earnings per share.

 

The primary factors contributing to the increase in operating results during the three-month period ended March 31, 2004 as compared to the same period in 2003 include:

 

1.               An increase in net interest income of $4.0 million or 48% in the first quarter over the same period in 2003.  The net increase is due to an overall increase in average earning assets (partially due to the acquisition of $133 million in earning assets from the CSB transaction completed in July 2003, and $84 million in earning assets from the ACB transaction completed in December 2003)

 

2.               An increase in non-interest income, primarily service fees on deposit accounts and investment service fee income.  Non-interest income increased $513,000 or 25% over the first quarter in the previous year.

 

3.               An effective tax rate of 36.0% as compared to 37.2% in the first quarter of the previous year.

 

The above factors were offset in part by:

 

1.               An increase in loan and lease loss provisions of $185,000 for the first quarter ended March 31, 2004 as compared to the same period in 2003. Additional provisions were recorded as a result of growth in loans outstanding.  The percentage of loan and lease loss reserves to gross loans and leases increased to 1.42% at March 31, 2004 as compared to 1.40% at December 31, 2003 and 1.35% at March 31, 2003.

 

2.               Total other expenses increased $2.55 million or 41% over the first quarter in the previous year.          Total other expenses increased significantly as a result of the addition of CSB and ACB’s operating costs, which totaled approximately $1.81 million (71% of the total increase)  in the first quarter of 2004, that were not included in the 2003 first quarter results as the acquisitions, accounted for under purchase accounting, did not close until July and December of 2003.

 

13

 

Return on Average Assets and Average Equity

 

Return on average assets (“ROA”) was 1.32% for the first quarter of 2004 as compared to 1.34% for the first quarter of 2003.  Return on equity (“ROE”) was 14.74% for the first of 2004 as compared to 16.84% for the first quarter of 2003.  The compression of ROE was largely due to growth in equity which exceeded the Company’s income growth rate.  Equity grew significantly as a result of the acquisition of two bank subsidiaries since June 30, 2003.

 

Net Interest Income (Tax Equivalent Yield Basis)

 

Net interest income is the primary source of income for the Company and represents the excess of interest and fees earned on interest-earning assets (loans, investments and Federal funds sold) over the interest paid on deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets.

 

For the three months ended March 31, 2004, interest income on a tax equivalent basis increased by $4.3 million to $15.1 million or 40% over the same period in 2003. Interest expense on deposit accounts and borrowings increased $291,000 or 13% over the same three-month period ended March 31, 2003. Average earning assets yielded (on a fully tax equivalent basis) 6.41% versus 6.80% a year ago, the effect of which was partially offset by a decrease in the cost of funds where the average cost of funds decreased to 1.41% from 1.87% a year ago. Net interest income (on a tax equivalent basis) increased $4.0 million or 47% to $12.5 million. The net interest margin decreased 4 basis points to 5.32% from 5.36% for the same three-month period a year ago.

 

Overall, yields trended down from the prior year as a result of market interest rates.  The most material decrease was realized in taxable investment securities, which decreased to 3.06% for the first quarter of 2004 as compared to 4.27% in the same period of 2003 as a result of declining interest rates over the last few years in the bond market, accelerated prepayments on mortgage-backed securities and a lower yield on new investments than the effective yield of the existing portfolio.

 

14

 

The following tables present, for the periods indicated, the distribution of consolidated average assets, liabilities and shareholders’ equity, as well as the total dollar amounts of interest income from average earning assets and the resultant yields and the dollar amounts of interest expense and average interest-bearing liabilities, expressed both in dollars and in rates. Non-accrual loans, which are not considered material, are included in the calculation of the average balances of loans.  Savings deposits include NOW and money market accounts. To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pre-tax equivalents based on the marginal corporate federal tax rate of 35 percent for the three months ending March 31, 2004 and 34 percent for the three months ended March 31, 2003 (dollars in thousands).

 

Average Balances, Interest Income/Expense and Yields/Rates Paid

 

 

		Three Months Ended
		March 31, 2004								March 31, 2003
		Average Balance			Interest			Yield/ Rate		Average Balance			Interest			Yield/ Rate
Earning assets:
Portfolio loans		$	837,635		$	14,049		6.75%		$	559,085		$	9,775		7.09%
Tax exempt investment securities		34,063			595			7.02%		30,858			545			7.16%
Taxable investment securities		47,158			359			3.06%		36,715			387			4.27%
Federal funds sold		21,730			53			0.98%		13,596			42			1.27%
Interest bearing deposits in banks		3,948			10			0.99%		1,656			14			3.42%
Average earning assets		944,534			15,066			6.41%		641,911			10,763			6.80%
Other assets		119,325								59,772
Less ALLL		(11,856		)						(7,377		)
Average total assets		$	1,052,003							$	694,306
Interest bearing liabilities:
Savings deposits		$	335,767		$	544		0.65%		$	185,174		$	376		0.82%
Time deposits		328,601			1,461			1.79%		278,104			1,623			2.37%
Other borrowings (1)		66,832			557			3.35%		29,200			272			3.78%
Average interest bearing liabilities		731,200			2,562			1.41%		492,478			2,271			1.87%
Non-interest bearing liabilities		214,849								140,825
Other liabilities		11,371								5,927
Shareholders’ equity		94,582								55,076
Average total liabilities and shareholders’ equity		$	1,052,003							$	694,306
Net interest income and net interest margin					$	12,504		5.32%					$	8,492		5.36%

 

(1) For the purpose of this schedule the Company’s subordinated debentures are included in other borrowings.

(2) Net interest margin is calculated by dividing net interest income by average earning assets.

 

15

 

The following tables set forth changes in interest income and expense for each major category of earning assets and interest-bearing liabilities, and the amount of change attributable to volume and rate changes for the periods indicated. Changes attributable to rate/volume have been allocated to rate changes (dollars in thousands).

 

Analysis of Changes in Net Interest Income

 

		Three Months Ended March 31, 2004 over 2003
		Volume			Rate			Total
Increase (decrease) in interest income:
Portfolio loans		$	4,911		$	(636	)	$	4,274
Investment securities, tax exempt		57			(6		)	51
Investment securities		111			(139		)	(28		)
Federal funds sold		26			(16		)	10
Interest bearing deposits		20			(24		)	(4		)
Net increase (decrease)		5,124			(821		)	4,302
Increase (decrease) in interest expense:
Interest bearing accounts		308			(140		)	168
Time deposits		297			(459		)	(162		)
Other borrowings (1)		353			(68		)	285
Net increase (decrease)		959			(667		)	292
Total net increase (decrease)		$	4,165		$	(154	)	$	4,011

 

(1) For the purpose of this schedule the interest on the Company’s subordinated debentures is included in other borrowings.

 

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Non-interest Income

 

The Company’s non-interest income consists primarily of service charges on deposit accounts, investment service fee income, other service fees, and mortgage loan origination and processing fees.

 

For the three months ended March 31, 2004, total non-interest income increased $513,000 or 25% over the same period in 2003.

 

Service charge income rose $376,000 or 46% over the same three-month period of 2003. Approximately $336,000 or 89% of the increase relates to CSB and ACB’s service charges in the first quarter of 2004, which were not included in the first quarter 2003 results.

 

In addition, income from mortgage loan origination and packaging fees decreased $249,000 or 23% over the same three-month period of 2003. The decrease can be primarily attributed to an increase in mortgage interest rates which has had a negative effect on refinance activity.  The decline in mortgage revenues were completely offset by an increase of $275,000 in investment service fee income as Western Sierra Bank’s Investment Services Division was not in operation in the first quarter of 2003.

 

Non-interest Expense

 

Non-interest expenses consist of salaries and related employee benefits, occupancy and equipment expenses, data processing fees, professional fees, directors’ fees, and other operating expenses. Non-interest expense increased $2.55 million or 41% over the same three-month period of 2003. Approximately $1.81 million or 71% of the increase relates to CSB and ACB’s non-interest expenses in the first quarter of 2004, which were not included in the first quarter 2003 results.

 

Salaries and benefits increased $1.47 million or 43% over the same three-month period of last year. This increase was due primarily to the integration of the CSB and ACB employees after their respective mergers both of which occurred after the second quarter of 2003.

 

The following tables set forth a summary of non-interest expense for the periods indicated (dollars in thousands, percentages are annualized):

 

		Three Months Ended March 31,
		2004					2003
		Expense			% of Avg Earning Assets		Expense			% of Avg Earning Assets
Salaries and benefits		$	4,887		2.07%		$	3,416		2.16%
Occupancy & equipment		1,352			0.57%		1,052			0.66%
Other expenses		2,309			0.98%		1,645			1.04%
Amortization of core deposit and other intangibles		180			0.08%		62			0.04%
Total non-interest expense		$	8,728		3.72%		$	6,175		3.90%

 

17

 

Efficiency Ratio

 

The Company uses a widely used banking operating ratio as a measure of its progress in increasing operating efficiency.  The efficiency ratio is derived by dividing total other (i.e. operating) expenses by the sum of tax adjusted net interest income and non-interest income.  Simply put, this ratio describes the funds necessary to generate $1 in tax equivalent total revenue.  The Company’s efficiency ratio has continued to improve in 2004.

 

The following table sets forth the Company’s tax adjusted efficiency ratio for the periods indicated (dollars in thousands):

 

		Three Months Ended March 31,
		2004			2003
Non-interest expense		$	8,728		$	6,175
Amortization of core deposit and other intangibles		(180		)	(62		)
Investment in limited partnership		(56		)	—
Net non-interest expense		$	8,492		$	6,113
Fully tax equivalent income:
Net interest income		$	12,282		$	8,284
Non-interest income		2,568			2,055
Tax benefit adjustment for tax-exempt income		313			236
Total fully tax equivalent Income		$	15,163		$	10,575
Efficiency Ratio		56.0		%	57.8		%

 

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Income Taxes

 

The following table reflects the Company’s tax provision and the related effective tax rate for the periods indicated (dollars in thousands):

 

		Three Months Ended March 31,
		2004			2003
Tax provision		$	1,947		$	1,352
Effective tax rate		36.0		%	37.2		%

 

The Company’s effective tax rate varies with changes in the relative amounts of its non-taxable income and non-deductible expenses. The increase in the Company’s tax provision is attributable to increases in the Company’s net income and the relative amount of tax-exempt income.

 

As previously disclosed, the Company abandoned its Real Estate Investment Trust (REIT) tax strategy in the fourth quarter of 2003.  While the Company took no book tax benefit for the REIT during 2003, a charge of $940,000 was taken in the fourth quarter of 2003 for the 2002 tax benefits and related penalties.  The Company has retained its right of appeal relative to the REIT transaction and will continue to evaluate its alternatives in the future.

 

During the first quarter of 2004, the Company filed amended 2002 tax returns with the Franchise Tax Board and reviewed its quarterly tax liability for 2003.  The Company remitted $1.51 million to the Franchise Tax Board during the first quarter of 2004, which the Company believes represents full payment of its historical tax liability.  The Company will realize a federal tax benefit for this payment for 2004.  The Company has retained its right of appeal relative to the REIT transaction and will continue

 

Asset Quality

 

The Company concentrates its lending activities primarily within areas directly serviced by its branches as previously discussed.

 

The Company manages its credit risk through diversification of its loan portfolio, the application of underwriting policies and procedures and credit monitoring practices. Although the Company has a diversified loan portfolio, a significant portion of its borrowers’ ability to repay their loans is dependent upon the professional services and residential real estate development industry sectors. Generally, loans are secured by real estate or other assets and are expected to be repaid from the cash flows of the borrower or proceeds from the sale of collateral.

 

The following table sets forth the amounts of loans outstanding by category as of the dates indicated (dollars in thousands):

 

		March 31, 2004			% of Total		December 31, 2003			% of Total
Commercial and residential real estate mortgage		$	544,422		63.41%		$	495,948		60.37%
Commercial and residential real estate construction		180,633			21.04%		195,889			23.84%
Commercial		114,813			13.37%		109,685			13.35%
Agricultural		11,509			1.34%		12,185			1.48%
Installment and other		5,178			0.60%		5,795			0.71%
Lease financing		1,983			0.23%		2,016			0.25%
Total		858,539			100.00%		821,518			100.00%
Deferred loan fees and costs, net		(2,490		)	—0.29%		(2,729		)	—0.33%
Less allowance for loan and lease losses		(12,165		)	—1.42%		(11,529		)	—1.40%
Total net loans and leases		$	843,883				$	807,260

 

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The following table sets forth a summary of the Company’s non-performing assets as of the dates indicated (dollars in thousands):

 

		March 31, 2004			December 31, 2003
Non-accrual loans		$	1,854		$	1,554
Non-performing assets as a% of total assets		0.17		%	0.15		%
Non-accrual loans as a% of gross loans		0.22		%	0.19		%
Ratio of allowance for loan and lease losses to non-accrual loans		6.56			7.42

 

The Company’s non-accrual loans increased from $1,554,000 to $1,854,000 in the first three months of 2004. The Company’s “coverage ratio” or the ratio of allowance for loan and lease losses to non-accrual loans decreased from 7.42 to 6.56 during the first three months of 2004.  The Company carried no other real estate as of March 31, 2004.

 

Allowance for Loan and Lease Losses

 

The allowance for loan and lease losses is established through charges to earnings in the form of the provision for loan and lease losses. Loan and lease losses are charged to, and recoveries are credited to, the allowance for loan and lease losses. The provision for loan and lease losses is determined after considering various factors such as loan and lease loss experience, current economic conditions, maturity of the portfolio, size of the portfolio, industry concentrations, borrower credit history, the existing allowance for loan and lease losses, independent loan reviews, current charges to and recoveries within the allowance for loan and lease losses and the overall quality of the portfolio as determined by management, regulatory agencies, and independent credit review consultants retained by the Company.

 

The adequacy of the Company’s allowance for loan and lease losses is based on specific and formula allocations to the Company’s loan and lease portfolio. Specific allocations are made for impaired loans and leases. The specific allocations are increased or decreased through management’s reevaluation of the status of the particular problem loans and leases. Loans and leases which do not receive a specific allocation receive an allowance allocation based on a formula represented by a percentage factor based on underlying collateral, type of loan and lease, historical charge-offs and general economic conditions which is applied against the general portfolio segments.

 

It is the policy of management to make additions to the allowance for loan and lease losses so that it remains adequate to cover anticipated charge-offs and management believes that the allowance at December 31, 2003 is adequate. However, the determination of the amount of the allowance is judgmental and subject to economic conditions which cannot be predicted with certainty. Accordingly, the Company cannot predict whether charge-offs of loans and leases in excess of the allowance may be required in future periods. The provision for loan and lease losses reflects an accrual sufficient to cover projected potential charge-offs.  The table below sets forth the allocation of the allowance for loan and lease losses by loan type as of the dates specified. The allocation of individual categories of loans includes amounts applicable to specifically identified, as well as unidentified, losses inherent in that segment of the loan and lease portfolio and will necessarily change whenever management determines that the risk characteristics of the loan portfolio have changed.

 

Management believes that any breakdown or allocation of the allowance for loan and lease losses into loan categories lends an appearance of exactness which does not exist, in that the allowance is utilized as a single unallocated allowance available for all loans and undisbursed commitments.

 

The allowance for loan and lease losses percentage to portfolio loans increased in the first quarter of 2004 because CSB and ACB had a greater percentage of land and development loans that required a higher reserve percentage.

 

20

 

The following table summarizes the activity in the allowance for loan and lease losses for the periods indicated (dollars in thousands):

 

		Three Months Ended March 31,
		2004			2003
Beginning balance for allowance for loan and lease losses		$	11,529		$	7,113
Provision for loan and lease losses		710			525
Charge offs:
Commercial		25			—
Real estate		—			—
Agricultural		—			—
Other		19			—
Total charge offs		44			—
Recoveries:
Commercial		13			7
Real estate		—			—
Agricultural		—			14
Other		1			2
Total recoveries		14			23
Net (charge offs) recoveries		(30		)	23
Undisbursed amount transferred out		(44		)	—
Ending balance		$	12,165		$	7,661
allowance for loan and lease losses to total loans		1.42		%	1.35		%
Annualized net (charge offs) recoveries to average loans		-0.01		%	0.02		%

 

Liquidity

 

A Funds Management Policy has been developed by the Company’s Management and approved by the Company’s Board of Directors that establishes guidelines for the investments and liquidity of the Company. The goals of this policy are to provide liquidity to meet the financial requirements of the Company’s customers, maintain adequate reserves as required by regulatory agencies and maximize earnings of the Company. The Company’s liquidity ratio at March 31, 2004 was 11.5% and was 9.6% at December 31, 2003.  The increased liquidity ratio at March 31, 2004 is due to an increase in Federal Funds Sold of $26 million.  Liquidity is computed by dividing liquid assets (consisting of cash and due from banks, available-for-sale investments not pledged, federal funds sold and loans available-for-sale) by total liabilities. The Company’s Management believes it maintains adequate liquidity levels.

 

21

 

Capital Adequacy

 

Overall capital adequacy is monitored on a day-to-day basis by the Company’s Management and reported to the Company’s Board of Directors on a monthly basis. The Company’s and subsidiary banks’ regulators measure capital adequacy by using a risk-based capital framework and by monitoring compliance with minimum risk-based and leverage ratio guidelines. Under the risk-based capital standards, assets reported on the Company’s balance sheet and certain off-balance sheet items are assigned to risk categories, each of which is assigned a risk weight.

 

This standard characterizes an institution’s capital as being “Tier 1” capital (defined as principally comprising shareholders’ equity and qualifying subordinated debentures) and “Tier 2” capital (defined as principally comprising the qualifying portion of the allowance for loan and lease losses and any remaining subordinated debentures).

 

The minimum ratio of total risk-based capital to risk-weighted assets, including certain off-balance sheet items, is 8% (10% to be considered well-capitalized).  The minimum ratio of Tier 1 capital to average assets (leverage ratio) is 4.0% (5.0% to be considered well-capitalized).  The minimum ratio of Tier 1 capital to risk-weighted assets is 4.0% (6.0% to be considered well-capitalized).  At least one-half (4%) of the total risk-based capital (Tier 1) is to be comprised of common equity; the balance may consist of debt securities and a limited portion of the allowance for loan and lease losses.  Subordinated debentures in the amount of  $32.1 million and $30.9 million are included in the Company’s Tier 1 capital as of March 31, 2004 and December 31, 2003, respectively, as allowed by Federal Reserve regulations, in the consolidated totals below.   The remaining $3.9 million and $5.1 million, respectively, in subordinated debentures are included in Tier 2.

 

The following table sets forth the Company’s and its banking subsidiaries’ capital ratios as of the dates indicated.

 

		March 31, 2004										December 31, 2003
		ACB		CCB		LCB		WSNB		Company		ACB		CCB		LCB		WSNB		Company
Total risk-based capital to risk-weighted assets		11.9	%	11.3	%	11.5	%	10.5	%	12.1	%	11.0	%	11.0	%	11.0	%	10.3	%	12.1	%
Tier 1 capital to risk-weighted assets		10.6	%	10.0	%	10.2	%	9.3	%	10.4	%	9.7	%	9.8	%	9.7	%	9.0	%	10.3	%
Tier 1 capital to average assets (leverage ratio)		7.5	%	7.8	%	9.6	%	8.4	%	8.8	%	7.1	%	7.8	%	9.2	%	8.3	%	8.8	%

 

The Company and its bank subsidiaries continue to meet all regulatory capital requirements at March 31, 2004.

 

22

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

As a financial institution, the Company’s primary component of market risk is interest rate volatility. Fluctuation in interest rates will ultimately impact both the level of income and expense recorded on a large portion of the Company’s assets and liabilities, and the market value of all interest earning assets and interest bearing liabilities, other than those which possess a short term to maturity. Virtually all of the Company’s interest earning assets and interest bearing liabilities are located at the banking subsidiary level. Thus, virtually all of the Company’s interest rate risk exposure lies at the banking subsidiary level. As a result, all significant interest rate risk Management procedures are performed at the banking subsidiary level. The subsidiary banks’ real estate loan portfolios, concentrated primarily within Northern California, are subject to risks associated with their local economies.

 

The fundamental objective of the Company’s management of its assets and liabilities is to maximize the Company’s economic value while maintaining adequate liquidity and an exposure to interest rate risk deemed by Management to be acceptable. Management believes an acceptable degree of exposure to interest rate risk results from the management of assets and liabilities through maturities, pricing and mix to attempt to neutralize the potential impact of changes in market interest rates. The Company’s profitability is dependent to a large extent upon its net interest income, which is the difference between its interest income on interest-earning assets, such as loans and investments, and its interest expense on interest-bearing liabilities, such as deposits and borrowings. The Company is subject to interest rate risk to the degree that its interest-earning assets reprice differently than its interest-bearing liabilities. The Company manages its mix of assets and liabilities with the goals of limiting its exposure to interest rate risk, ensuring adequate liquidity, and coordinating its sources and uses of funds.

 

The Company seeks to control interest rate risk exposure in a manner that will allow for adequate levels of earnings and capital over a range of possible interest rate environments. The Company has adopted formal policies and practices to monitor and manage interest rate risk exposure.  Management believes historically it has effectively managed the effect of changes in interest rates on its operating results.  Management believes that it can continue to manage the short-term effect of interest rate changes under various interest rate scenarios.

 

23

 

The following table sets forth, as of March 31, 2004, the distribution of re-pricing opportunities for the Company’s earning assets and interest-bearing liabilities, the interest rate sensitivity gap, the cumulative interest rate sensitivity gap, the interest rate sensitivity gap ratio (i.e. earning assets divided by interest-bearing liabilities) and the cumulative interest rate sensitivity gap ratio.

 

Earning assets:		Within 3 Months			After 3 Months But Within One Year			After One Year But Within Five Years			After Five Years			Total
Federal funds sold		$	43,295		$	—		$	—		$	—		$	43,295
Investment securities and other		9,195			11,143			36,411			28,473			85,222
Loans		258,624			149,948			223,978			223,498			856,048
Total earning assets		311,114			161,091			260,389			251,971			984,565
Interest-bearing liabilities:
Savings		50,985			25,492			—			—			76,477
Interest-bearing transaction accounts		218,498			41,449			—			—			259,947
Time deposits		123,595			152,129			67,628			—			343,352
Subordinated debentures		36,496			—			—			—			36,496
Other borrowings		—			22,600			10,150			—			32,750
Total interest-bearing liabilities		429,574			241,671			77,778			—			749,022
Interest rate sensitivity gap		(118,460		)	(80,579		)	182,611			251,971			235,543
Cumulative interest rate sensitivity gap		$	(118,460	)	$	(199,039	)	$	(16,428	)	$	235,543		$	—
Interest rate sensitivity gap to total earning assets		-12.03		%	-8.18		%	18.55		%	25.59		%	23.92		%
Cumulative interest rate sensitivity gap to total earning assets		-12.03		%	-20.22		%	-1.67		%	23.92		%
Ratio of rate sensitive assets to rate sensitive liabilities		0.72			0.67			3.35			N/A			1.31
Cumulative ratio		0.72			0.70			0.98			1.31			1.31

 

The opportunity to reprice assets in the same dollar amounts and at the same time as liabilities would minimize interest rate risk in any interest rate environment. The difference between the amounts of assets and liabilities repriced at the same time, or “gap”, represents the risk, or opportunity, in repricing. In general, if more assets than liabilities are repriced at a given time in a rising rate environment, net interest income would improve while in a declining rate environment, net interest income would decline. If more liabilities than assets were repriced under the same conditions the opposite would result. The Company appears liability sensitive in the immediate to one-year period, and turns asset sensitive in the longer term. This can be and is influenced by the fact that the majority of interest-bearing transaction accounts which consist of money market, NOW and savings deposit accounts are classified as repricing within three months when in fact these deposits may be immediately repriced at Management’s option, thus assisting in the further management of interest rate risk.

 

Because of the inherent limitations of the static GAP model described above, management deployed a new interest rate sensitivity measurement tool in April 2003 that more accurately measures the Company’s exposure to future changes in interest rates.  This model measures the expected cash flows and repricing of each financial asset/liability separately in measuring the Company’s and each bank’s interest sensitivity. Management and the Board’s Investment/ALCO Committee have carefully reviewed the initial reports that indicate that the Company as a whole is “asset sensitive”.  This means the Company expects (all other things being equal) to expand its net interest income if rates rise and expects it conversely to contract if rates fall.  The level of potential or expected contraction is considered manageable at this time.  Management will continue to perform this analysis each quarter to further validate the expected results against actual data.

 

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The following tables, in management’s opinion, reflect estimates of the Company’s future net interest income under different interest rate scenarios.  The net interest income estimates are one-year projections based on the earning assets and interest- bearing liabilities as of March 31, 2004.  The estimates are derived from an asset/liability management model deployed in 2003.  There are numerous underlying assumptions that management believes are accurate, but if they are inaccurate could have an impact to the results of operations.  Under the shock scenarios, the changes to interest rates are assumed to occur immediately (on April 1, 2004).  Under the ramp scenarios the changes to interest rates gradually ramp up or down over the course of one year (dollars in thousands).

 

		Shock Scenario
Change in Interest Rates		Estimated Net Interest Income			Dollar Change from Base			Percentage Change from Base
300 basis point rise		$	55,750		$	6,721		13.71%
200 basis point rise		53,331			4,303			8.78%
100 basis point rise		50,962			1,934			3.94%
50 basis point rise		49,876			847			1.73%
Base scenario		49,029			0			0.00%
50 basis point decline		47,660			(1,368		)	-2.79%
100 basis point decline		46,188			(2,841		)	-5.79%

 

		Ramp Scenario
Change in Interest Rates		Estimated Net Interest Income			Dollar Change from Base			Percentage Change from Base
300 basis point rise		$	51,114		$	2,085		4.25%
200 basis point rise		50,341			1,312			2.68%
100 basis point rise		49,618			590			1.20%
50 basis point rise		49,299			271			0.55%
Base scenario		49,029			0			0.00%
50 basis point decline		48,441			(588		)	-1.20%
100 basis point decline		47,804			(1,225		)	-2.50%

 

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ITEM 4.    Controls and Procedures.

 

The Company’s Chief Executive Officer and Chief Financial Officer, based on their evaluation as of the date of this report of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a—15(e), have concluded that the Company’s disclosure controls and procedures are adequate and effective for purposes of Rule 13a—15(e) in timely alerting them to material information relating to the Company required to be included in the Company’s filings with the SEC under the Securities Exchange Act of 1934.

 

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.

 

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PART II. Other Information

 

Item #1. Legal proceedings

 

The Company and its subsidiaries are involved in various routine legal actions arising in the ordinary course of business. The Company believes that the ultimate disposition of all currently pending matters will not have a material adverse effect on the Company’s financial condition or results of operations.

 

Item #2. Changes in securities and use of proceeds

 

N/A

 

Item #3. Defaults upon Senior Securities

 

N/A

 

Item #4.    Submission of Matters to a Vote of Security Holders

 

N/A

 

Item #5. Other Information

 

N/A

 

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Item #6A. Exhibits

 

Exhibit No.		Description of Exhibit
3.1		Articles of Incorporation are contained in the Registrant’s Registration Statement on Form S-4, file #333-66675, as Exhibit 3.1 and are incorporated herein by this reference.
3.2		Bylaws are contained in the Registrant’s Registration Statement on Form S-4, file #333-66675, as Exhibit 3.2 and are incorporated herein by this reference.
3.3		Amendments to Bylaws are contained in the Registrant’s Registration Statement on Form S-4, file #333-76678, as Exhibit 3.2 and are incorporated herein by this reference.
10.1		Severance Compensation Agreement dated December 4, 1997 between Mr. Kirk Dowdell and Western Sierra National Bank is contained in the Registrant’s Registration Statement on Form S-4, file #333-33256, as Exhibit 10.1 and is incorporated herein by this reference.
10.2		Stock Option Agreement dated September 22, 1997 between Mr. Kirk Dowdell and Western is contained in the Registrant’s Registration Statement on Form S-4, file # 333-33256, as Exhibit 10.2 and is incorporated herein by this reference.
10.3		Stock Option Agreement dated May 19, 1999 between Mr. Kirk Dowdell and Western is contained in the Registrant’s Registration Statement on Form S-4, file # 333-33256, as Exhibit 10.3 and is incorporated herein by this reference.
10.4		Stock Option Agreement dated May 19, 1999 between Mr. Gary D. Gall and Western is contained in the Registrant’s Registration Statement on Form S-4 file, # 333-33256, as Exhibit 10.3 and is incorporated herein by this reference.
10.5		Executive Salary Continuation Agreement dated August 22, 2002, between Mr. Gary D. Gall and Western Sierra National Bank. (1)
10.6		Stock Option Agreement dated April 11, 1995 between Mr. Gary D. Gall and Western Sierra National Bank is contained in the Registrant’s Registration Statement on Form S-4, file #333-66675, as Exhibit 10.5 and is incorporated herein by this reference.
10.7		Stock Option Agreement dated November 14, 1996 between Mr. Gary D. Gall and Western Sierra National Bank is contained in the Registrant’s Registration Statement on Form S-4, file #333-66675, as Exhibit 10.6 and is incorporated herein by this reference.
10.8		Stock Option Agreement dated May 20, 1997 between Mr. Gary D. Gall and Western is contained in the Registrant’s Registration Statement on Form S-4, file #333-66675, as Exhibit 10.7 and is incorporated herein by this reference.
10.9		Western Sierra Bancorp 1999 Stock Option Plan and form of stock option agreements are contained in the Registrant’s Registration Statement on Form S-8, file #333-86653, as Exhibit 99.3 and are incorporated herein by this reference.
10.10		Western Sierra National Bank 1989 Stock Option Plan, form of incentive stock option and form of nonqualified stock option agreements are contained in the Registrant’s Registration Statement on Form S-4, file #333-66675, as Exhibit 10.10 and are incorporated herein by this reference.
10.11		Western Sierra Bancorp 1997 Stock Option Plan, form of incentive stock option and form of nonqualified stock option agreements are contained in the Registrant’s Registration Statement on Form S-4 ,file #333-66675, as Exhibit 10.11 and are incorporated herein by this reference.
10.12		Indemnification Agreement between Mr. Gary D. Gall and Western Sierra National Bank is contained in the Registrant’s Registration Statement on Form S-4, file #333-66675, as Exhibit 10.13 and is incorporated herein by this reference.
10.13		Indemnification Agreement between Mr. Kirk Dowdell and Western is contained in the Registrant’s Registration Statement on Form S-4, file #333-86653, as Exhibit 10.14 and is incorporated herein by this reference.

 

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10.14		Form of Indemnification Agreement for the directors of Western Sierra National Bank is contained in the Registrant’s Registration Statement on Form  S-4 file, #333-66675, as Exhibit 10.15 and is incorporated herein by this reference.
10.15		Placerville Branch lease is contained in the Registrant’s Registration Statement on Form S-4, file #333-66675, as Exhibit 10.1 and is incorporated herein by this reference.
10.16		Executive Salary Continuation Agreement dated February 1, 2002, between Mr. Kirk N. Dowdell. (1)
10.17		Severance Benefits Agreement dated December 4, 1997 between Mr. Gary D. Gall and Western Sierra National Bank is contained in the Registrant’s Registration Statement on Form S-4, file #333-66675, as Exhibit 10.2 and is incorporated herein by this reference.
10.18		Western Sierra National Bank Incentive Compensation Plan for Senior Management is contained in the Registrant’s Registration Statement on Form S-4, file # 333-66675, as Exhibit 10.12 and is incorporated herein by this reference.
10.19		Stock Option Agreement dated April 11, 2000 between Mr. Kirk Dowdell and Western is contained in the Registrant’s Registration Statement on Form S-4, file # 333-76678, as Exhibit 10.19 and is incorporated herein by this reference.
10.20		Stock Option Agreement dated April 11, 2000 between Mr. Gary D. Gall and Western is contained in the Registrant’s Registration Statement on Form S-4, file # 333-76678, as Exhibit 10.20 and is incorporated herein by this reference.
10.21		Stock Option Agreement dated April 10, 2001 between Mr. Kirk Dowdell and Western is contained in the Registrant’s Registration Statement on Form S-4, file # 333-76678, as Exhibit 10.21 and is incorporated herein by this reference.
10.22		Stock Option Agreement dated April 10, 2001 between Mr. Gary D. Gall and Western is contained in the Registrant’s Registration Statement on Form S-4, file # 333-76678, as Exhibit 10.22 and is incorporated herein by this reference.
10.23		Stock Option Agreement dated December 11, 2001 between Mr. Kirk Dowdell and Western is contained in the Registrant’s Registration Statement on Form S-4, file # 333-76678, as Exhibit 10.23 and is incorporated herein by this reference.
10.24		Folsom Western Sierra National Bank branch lease and lease amendment. (1)
10.25		Agreement and Plan of Reorganization by and between the Western and Central Sierra Bank dated as of March 12, 2003 is attached as Appendix A to the proxy statement-prospectus contained in the S-4 Registration Statement file #333-104817 and is incorporated herein by this reference.
10.26		Wells Fargo Note Contract dated April 10, 2003. (1)
10.27		Stock Option Agreement dated December 11, 2001 between Mr. Phillip Wood and Western Sierra Bancorp. (1)
10.28		Stock Option Agreement dated December 11, 2001 between Mr. Doug Nordell and Western Sierra Bancorp. (1)
10.29		Stock Option Agreement dated April 25, 2002 between Mr. Doug Nordell and Western Sierra Bancorp. (1)
10.30		Stock Option Agreement dated April 25, 2002  between Mr. Fred Rowden and Western Sierra Bancorp. (1)
10.31		Stock Option Agreement dated April 25, 2002 between Mr. Kirk Dowdell and Western Sierra Bancorp. (1)
10.32		Stock Option Agreement dated June 27, 2002 between Mr. Gary Gall and Western Sierra Bancorp. (1)
10.33		Stock Option Agreement dated June 27, 2002 between Mr. Anthony Gould and Western Sierra Bancorp. (1)
10.34		Stock Option Agreement dated March 30, 2003 between Mr. Phillip Wood and Western Sierra Bancorp. (1)
10.35		Stock Option Agreement dated March 30, 2003 between Mr. Gary Gall and Western Sierra Bancorp. (1)
10.36		Stock Option Agreement dated March 30, 2003 between Mr. Kirk Dowdell and Western Sierra Bancorp. (1)

 

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10.37		Stock Option Agreement dated March 30, 2003 between Mr. Anthony Gould and Western Sierra Bancorp. (1)
10.38		Stock Option Agreement dated March 30, 2003 between Mr. Doug Nordell and Western Sierra Bancorp. (1)
10.39		Stock Option Agreement dated March 30, 2003 between Mr. Fred Rowden and Western Sierra Bancorp. (1)
10.40		Stock Option Agreement dated January 1, 2002 between Mr. Charles Bacchi and Western Sierra Bancorp. (1)
10.41		Stock Option Agreement dated January 1, 2002 between Mrs. Barbara Cook and Western Sierra Bancorp. (1)
10.42		Stock Option Agreement dated January 1, 2002 between Mr. William Fisher and Western Sierra Bancorp. (1)
10.43		Stock Option Agreement dated January 1, 2002 between Mr. Howard Jahn and Western Sierra Bancorp. (1)
10.44		Stock Option Agreement dated January 1, 2002 between Mr. Alan Kleinert and Western Sierra Bancorp. (1)
10.45		Stock Option Agreement dated January 1, 2002 between Mr. Thomas Manz and Western Sierra Bancorp. (1)
10.46		Stock Option Agreement dated January 1, 2002 between Mr. Harold Prescott and Western Sierra Bancorp. (1)
10.47		Stock Option Agreement dated January 1, 2002 between Mr. Lary Davis and Western Sierra Bancorp. (1)
10.48		Stock Option Agreement dated December 31, 2002 between Mr. Charles Bacchi and Western Sierra Bancorp. (1)
10.49		Stock Option Agreement dated December 31, 2002 between Ms. Barbara Cook and Western Sierra Bancorp. (1)
10.50		Stock Option Agreement dated December 31, 2002 between Mr. William Fisher and Western Sierra Bancorp. (1)
10.51		Stock Option Agreement dated December 31, 2002 between Mr. Howard Jahn and Western Sierra Bancorp. (1)
10.52		Stock Option Agreement dated December 31, 2002 between Mr. Alan Kleinert and Western Sierra Bancorp. (1)
10.53		Stock Option Agreement dated December 31, 2002 between Mr. Thomas Manz and Western Sierra Bancorp. (1)
10.54		Stock Option Agreement dated December 31, 2002 between Mr. Harold Prescott and Western Sierra Bancorp. (1)
10.55		Stock Option Agreement dated December 31, 2002 between Mr. Matthew Bruno Sr. and Western Sierra Bancorp. (1)
10.56		Stock Option Agreement dated December 31, 2002 between Mr. Lary Davis and Western Sierra Bancorp. (1)
10.57		Stock Option Agreement dated December 31, 2002 between Mr. William Eames and Western Sierra Bancorp. (1)
10.58		Executive Salary Continuation Agreement dated June 22, 2002, between Mr. Fred Rowden and Central California Bank. (1)
10.59		Executive Salary Continuation Agreement dated June 1, 2002, between Mr. Phillip Wood and Western Sierra National Bank. (1)
10.60		Executive Salary Continuation Agreement dated June 25, 2002, between Mr. Doug Nordell and Roseville 1st National Bank. (1)
10.61		Stock Option Agreement dated July 1, 2003 between Mr. Charles Bacchi and Western Sierra Bancorp. (2)
10.62		Stock Option Agreement dated July 1, 2003 between Mr. Matthew Bruno Sr. and Western Sierra Bancorp. (2)
10.63		Stock Option Agreement dated July 1, 2003 between Mr. Lary Davis and Western Sierra Bancorp. (2)
10.64		Stock Option Agreement dated July 1, 2003 between Mr. William Fisher and Western Sierra Bancorp. (2)
10.65		Stock Option Agreement dated December 31, 2002 between Mr. William Fisher and Western Sierra Bancorp. (2)

 

30

 

10.66		Stock Option Agreement dated July 1, 2003 between Mr. Howard Jahn and Western Sierra Bancorp. (2)
10.67		Stock Option Agreement dated July 1, 2003 between Mr. Alan Kleinert and Western Sierra Bancorp. (2)
10.68		Stock Option Agreement dated July 1, 2003 between Mr. Thomas Manz and Western Sierra Bancorp. (2)
10.69		Stock Option Agreement dated July 1, 2003 between Mr. Harold Prescott and Western Sierra Bancorp. (2)
10.70		Stock Option Agreement dated July 15, 2003 between Mr. Kirk Dowdell and Western Sierra Bancorp. (2)
10.71		Agreement and Plan of Reorganization by and between the Western and Auburn Community Bank dated as of August 20, 2003 is attached as Appendix A to the proxy statement-prospectus contained in the S-4 Registration Statement file #333-109833 and is incorporated herein by this reference. (2)
10.72		Contract between Woodbury Financial Services, Inc. and Western Sierra National Bank dated July 22, 2003. (2)
10.73		Summary of financial terms for Western Sierra Statutory Trusts III, and IV. (2)
10.74		Stock Option Agreement dated January 1, 2004 between Mr. Howard Jahn and Western Sierra Bancorp.
10.75		Stock Option Agreement dated January 1, 2004 between Mr. Charles Bacchi and Western Sierra Bancorp.
10.76		Stock Option Agreement dated January 1, 2004 between Ms. Barbara Cook and Western Sierra Bancorp.
10.77		Stock Option Agreement dated January 1, 2004 between Mr. William Fisher and Western Sierra Bancorp.
10.78		Stock Option Agreement dated January 1, 2004 between Mr. Thomas Manz and Western Sierra Bancorp.
10.79		Stock Option Agreements dated January 1, 2004 between Mr. Matthew Bruno Sr. and Western Sierra Bancorp (two identical agreements both represented by exhibit 10.79).
10.80		Stock Option Agreement dated January 1, 2004 between Mr. Lary Davis and Western Sierra Bancorp.
10.81		Stock Option Agreement dated January 1, 2004 between Mr. Lary Davis and Western Sierra Bancorp.
10.82		Stock Option Agreements dated January 1, 2004 between Mr. William Eames and Western Sierra Bancorp (two identical agreements both represented by exhibit 10.82).
10.83		Stock Option Agreement dated January 1, 2004 between Ms. Lori Warden and Western Sierra Bancorp.
10.84		Stock Option Agreement dated January 1, 2004 between Mr. Alan Kleinert and Western Sierra Bancorp.
10.85		Stock Option Agreement dated January 1, 2004 between Mr. Harold Prescott and Western Sierra Bancorp.
10.86		Severance Benefits Agreement dated January 16, 2004 between Mr. Kirk Dowdell and Western Sierra Bancorp.
10.87		Severance Benefits Agreement dated February 10, 2004 between Mr. Anthony Gould and Western Sierra Bancorp.
11.1		Statement re: Computation of earnings per share is included in Note 3 to the financial statements.
31.1		Section 302 Certification by Anthony J. Gould
31.2		Section 302 Certification by Gary D. Gall
32.1		Section 906 Certification by Anthony J. Gould.
32.2		Section 906 Certification by Gary D. Gall.
(1) included as an exhibit to the Registrant’s 10-Q for March 31, 2003, which is incorporated by this reference herein.
(2) included as an exhibit to the Registrant’s 10-Q for September 30, 2003, which is incorporated by this reference herein.

 

Item #6B. Reports on Form 8-K

 

January 21, 2004:		Press Release results for the 4th quarter of 2003
March 10, 2004:		Slide presentation for Sandler O’Neill West Coast Financial Services conference

 

31

 

SIGNATURES

 

Following the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

WESTERN SIERRA BANCORP
(Registrant)
Date: May 10, 2004
		/s/  GARY D. GALL    Gary D. Gall
		President/Chief Executive Officer
		/s/  ANTHONY J. GOULD    Anthony J. Gould
		Executive Vice President/Chief Financial and Accounting Officer

 

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