ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion
presents Managements analysis of the financial condition of the Company as of December 31, 2007 and December 31, 2006, and the results of operations for each of the years in the three-year period ended December 31, 2007. 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 or incorporated by reference 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 Companys expectations, intentions, beliefs, or strategies regarding the future. All forward-looking statements concerning economic conditions, growth rates, income, expenses, or
other 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
Companys actual results could materially differ from those in such forward-looking statements. Risk factors that could cause actual results to differ materially from those in forward-looking statements include but are not limited to those
outlined previously in Item 1A.
Critical Accounting Policies
The Companys financial statements are prepared in accordance with accounting principles generally accepted in the United States. The financial information and disclosures contained within those statements are
significantly impacted by Managements estimates and judgments, which are based on historical experience and various other assumptions that are believed to be reasonable under current circumstances. Actual results may differ from those
estimates under different conditions.
Critical accounting policies are those that involve the most complex and subjective decisions and assessments, and
have the greatest potential impact on the Companys stated results of operations. In Managements opinion, the Companys critical accounting policies deal with the following areas: the establishment of the Companys allowance for
loan losses, as explained in detail in the Provision for Loan Losses and Allowance for Loan Losses sections of this discussion and analysis; deferred loan origination costs, which are estimated pursuant to an annual
evaluation of expenses (primarily salaries) associated with successful loan originations and are allocated in like amount to each new loan based on loan type, but can actually vary significantly for individual loans depending on the characteristics
of such loans (deferred amounts are disclosed below in conjunction with salaries expense, under Non-interest Revenue and Operating Expense); income taxes, especially with regard to the ability of the Company to recover deferred tax
assets, as discussed in the Provision for Income Taxes and Other Assets sections of this discussion and analysis; goodwill, which is evaluated annually based on changes in the market capitalization of the Company and for
which management has determined that no impairment exists; and equity-based compensation, which is discussed in greater detail in footnote 2 (Significant Accounting Policies) to the financial statements contained herein, under the caption
Stock-Based Compensation. Critical accounting areas are evaluated on an ongoing basis to ensure that the Companys financial statements incorporate the most recent expectations with regard to these areas.
Summary of Performance
The Company has increased net income
in 24 of the last 25 years. Net income in 2007 was $21.0 million, an increase of $1.8 million, or 10%, over the $19.2 million in net earnings achieved in 2006. Net income in 2006 was $3.0 million higher than 2005 net earnings of $16.2 million. Net
income per basic share was $2.17 for 2007, as compared to $1.96 in 2006 and $1.66 in 2005. The Companys Return on Average Assets was 1.74% and Return on Average Equity was 22.28% in 2007, as compared to 1.70% and 22.75%, respectively for 2006,
and 1.59% and 21.47%, respectively in 2005.
24
The following are major factors impacting the Companys results of operations in recent years:
|
|
While the increase in net interest income was minimal in 2007, solid growth in net interest income made a major contribution to higher net income in 2006.
Average interest-earning assets were 7% higher in 2007 than in 2006, but the lift in net interest income that was created by higher earning assets was almost completely offset by net interest margin compression, thus net interest income increased by
less than 1%. Our net interest margin was 33 basis points lower in 2007 than in 2006, primarily because average non-interest bearing deposits were $21 million lower, and because our cost of interest-bearing liabilities was negatively impacted by
market interest rate fluctuations, a shift to higher-cost deposits, and a more competitive market for deposits. In contrast to the relatively weak growth in 2007, net interest income grew by $4.8 million, or 10%, in 2006 relative to 2005. That
increase was largely driven by growth in average interest-earning assets, which increased by $103 million, or 11%, in 2006 compared to 2005. The favorable effect of this growth on net interest income in 2006 was offset in part by the impact of
interest rate changes and relatively lackluster core deposit growth.
|
|
|
Our provision for loan losses was $599,000 lower in 2007 than in 2006, a decline of 16%, but was $701,000 higher in 2006 than in 2005, representing an increase
of 22%.
A significant increase in non-performing assets and a higher level of charge-offs are factors that might lead to expectations of a higher loan loss provision in 2007. The provision actually declined in 2007, however, due to the sale of
our credit card portfolio and release of the associated loan loss allowance, significantly slower growth in loans, and a higher level of recoveries in 2007. The increase in 2006 was the result of the $147 million increase in gross outstanding loan
balances during 2006, as well as an increased allocation for certain classified loans.
|
|
|
Non-interest income increased by $3.7 million, or 33%, in 2007 relative to 2006, and by $2.0 million, or 21%, in 2006 compared to 2005.
The most significant
factor in the Companys profit improvement in 2007 is service charges on deposits, which increased by $1.7 million, or 29%, relative to 2006. The increase is primarily attributable to 19% net growth in the number of transaction accounts during
2007. A one-time gain on the sale of our credit card portfolio in the second quarter of 2007 also had a major impact on the Companys financial results, causing loan sale income to increase by over $1.5 million in 2007 relative to 2006. The
increase in non-interest income in 2006 relative to 2005 is due in part to the impact of non-recurring items, but comes mainly from strong increases in service charges on deposits, check card interchange fees, and operating lease income.
|
|
|
Operating expense increased by $2.1 million, or 6%, in 2007 in comparison to 2006, and by $1.2 million, or 4%, in 2006 over 2005.
Salaries and benefits
accounted for more than half of the 2007 increase in operating expense, rising by $1.1 million, or 7%, mainly because of normal annual salary adjustments and staffing costs associated with our new Delano branch. Occupancy expense actually dropped
slightly for 2007 due to lower depreciation expense on furniture, fixtures and equipment, and a reduction in property taxes stemming from one-time refunds received in 2007. Non-interest expenses comprising the Other line item under
Other operating expense on our consolidated statements of income were a combined $1.1 million higher in 2007 than in 2006, an increase of 10%. Much of that increase was in marketing expense, which was up by over 68% due to
deposit-focused initiatives put in place at the beginning of 2007. Several non-recurring items totaling over $600,000 also affected the Other category, as explained below in detail under Non-interest Revenue and Operating
Expense. For 2006, the increase in salaries and benefits comprises almost the entire increase in total operating expense relative to 2005. The $1.1 million, or 7%, increase in salaries and benefits in 2006 includes $314,000 in stock option
expense for which recognition was not required in previous years.
|
The following summarizes additional key information relating to our
current financial condition:
|
|
Total assets increased by only $19 million, or 2%, during 2007.
Gross loans and leases increased by $37 million for the year, an increase of 4% due primarily
to organic growth in real-estate loans and commercial loans and leases. Loan growth for the year was negatively impacted by the sale of our credit card portfolio in June 2007. Prior to the sale, we had close to $3 million in business credit card
balances that were included in commercial loans and over $8 million in consumer credit card balances. The net increase in loans was partially offset by a drop of $9 million, or 16%, in cash and due from banks; a drop of $5 million, or 3%, in
investment securities; and a decline of over $6 million in fed funds sold, which fell to zero. The lower balance of cash
|
25
|
and due from banks is the result of a reduction in cash items in process of collection, while the drop in investment securities is due to prepayments and
maturing balances.
|
|
|
Non-performing assets increased by almost $9 million during 2007, ending the year at $9.6 million.
Foreclosed assets represent $556,000 of the balance at
December 31, 2007. The remaining $9.1 million of the year-end 2007 non-performing balance is in the form of non-accruing loans, with $7.6 million of that balance secured by real estate and $895,000 guaranteed by the U.S. Government. Specific
reserves have been allocated for all non-accruing loans based on a detailed analysis of expected cash flows for each loan, and all non-performing and substandard assets are being actively managed.
|
|
|
Total deposits declined by $18 million, or 2%, in 2007, inclusive of a $25 million drop in wholesale-sourced brokered deposits.
We experienced a difficult
year for deposits in 2007, with branch-generated deposits increasing by only $7 million and lower-cost deposits migrating into higher-cost deposits. Core deposits actually declined by $6 million over the course of the year. A positive development
during 2007 was a net increase of close to 7,000 transaction accounts, which contributed to the rise in non-interest income.
|
|
|
Total non-deposit borrowings grew by $28 million in 2007, increasing to 24% of total liabilities at the end of 2007 from 21% at the end of 2006.
Federal Home
Loan Bank (FHLB) borrowings were used to replace maturing brokered deposits in the fourth quarter of 2007 because of a change in pricing dynamics, and were also used to fund that portion of annual asset growth not covered by the increase in branch
deposits. Our net loans to total deposits ratio rose to 107% at the end of 2007 from 101% at the end of 2006 due to the runoff of brokered deposits and the increase in wholesale funding. Despite this development, we feel that we still have ample
sources of liquidity to fund expected loan growth even if anticipated retail deposit increases dont materialize.
|
Results of
Operations
The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning
assets less interest expense on interest-bearing liabilities. The second is non-interest income, which primarily consists of customer service charges and fees but also comes from non-customer sources such as bank-owned life insurance. The majority
of the Companys non-interest expense consists of operating costs that relate to providing a full range of banking services to our customers.
Net Interest Income and Net Interest Margin
Net interest income was $56.1 million in 2007, compared to $55.6 million in 2006 and
$50.8 million in 2005. This represents an increase of 1% in 2007 over 2006, and an increase of 10% in 2006 over 2005. The level of net interest income depends on several factors in combination, including growth in earning assets, yields on earning
assets, the cost of interest-bearing liabilities, the relative volumes of earning assets and interest-bearing liabilities, and the mix of products which comprise the Companys earning assets, deposits, and other interest-bearing liabilities.
The following Distribution, Rate and Yield table shows, for each of the past three years, the annual average balance for each principal balance sheet
category, and the amount of interest income or interest expense associated with that category. This table also shows the yields earned on each component of the Companys investment and loan portfolio, the average rates paid on each segment of
the Companys interest bearing liabilities, and the Companys net interest margin.
26
Distribution, Rate & Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2007(a)
|
|
|
2006(a)
|
|
|
2005(a)
|
|
(dollars in thousands)
|
|
Average
Balance
|
|
Income/
Expense
|
|
Average
Rate
(b)
|
|
|
Average
Balance
|
|
Income/
Expense
|
|
Average
Rate
(b)
|
|
|
Average
Balance
|
|
Income/
Expense
|
|
Average
Rate
(b)
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal Funds Sold/Due from Time
|
|
$
|
1,032
|
|
$
|
51
|
|
4.94
|
%
|
|
$
|
765
|
|
$
|
34
|
|
4.44
|
%
|
|
$
|
4,314
|
|
$
|
136
|
|
3.15
|
%
|
Taxable
|
|
$
|
131,888
|
|
$
|
6,072
|
|
4.60
|
%
|
|
$
|
141,747
|
|
$
|
6,294
|
|
4.44
|
%
|
|
$
|
164,490
|
|
$
|
6,526
|
|
3.97
|
%
|
Non-taxable
|
|
$
|
55,305
|
|
$
|
2,230
|
|
6.20
|
%
|
|
$
|
50,941
|
|
$
|
2,040
|
|
6.16
|
%
|
|
$
|
37,526
|
|
$
|
1,507
|
|
6.08
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investments
|
|
$
|
188,225
|
|
$
|
8,353
|
|
5.08
|
%
|
|
$
|
193,453
|
|
$
|
8,368
|
|
4.89
|
%
|
|
$
|
206,330
|
|
$
|
8,169
|
|
4.34
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans and Leases
:
(c)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
|
|
$
|
11,339
|
|
$
|
929
|
|
8.19
|
%
|
|
$
|
10,950
|
|
$
|
932
|
|
8.51
|
%
|
|
$
|
11,257
|
|
$
|
1,471
|
|
13.07
|
%
|
Commercial
|
|
$
|
138,193
|
|
$
|
12,875
|
|
9.32
|
%
|
|
$
|
136,946
|
|
$
|
12,886
|
|
9.41
|
%
|
|
$
|
123,351
|
|
$
|
9,646
|
|
7.82
|
%
|
Real Estate
|
|
$
|
674,793
|
|
$
|
58,166
|
|
8.62
|
%
|
|
$
|
600,047
|
|
$
|
51,839
|
|
8.64
|
%
|
|
$
|
506,991
|
|
$
|
39,514
|
|
7.79
|
%
|
Consumer
|
|
$
|
55,935
|
|
$
|
5,719
|
|
10.22
|
%
|
|
$
|
53,790
|
|
$
|
5,115
|
|
9.51
|
%
|
|
$
|
50,506
|
|
$
|
4,144
|
|
8.20
|
%
|
Consumer Credit Cards
|
|
$
|
3,511
|
|
$
|
384
|
|
10.94
|
%
|
|
$
|
8,819
|
|
$
|
829
|
|
9.40
|
%
|
|
$
|
8,414
|
|
$
|
851
|
|
10.11
|
%
|
Direct Financing Leases
|
|
$
|
17,883
|
|
$
|
1,125
|
|
6.29
|
%
|
|
$
|
13,110
|
|
$
|
809
|
|
6.17
|
%
|
|
$
|
5,020
|
|
$
|
340
|
|
6.77
|
%
|
Other
|
|
$
|
1,392
|
|
$
|
|
|
0.00
|
%
|
|
$
|
379
|
|
$
|
|
|
0.00
|
%
|
|
$
|
2,463
|
|
$
|
|
|
0.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Loans and Leases
|
|
$
|
903,046
|
|
$
|
79,198
|
|
8.77
|
%
|
|
$
|
824,041
|
|
$
|
72,410
|
|
8.79
|
%
|
|
$
|
708,002
|
|
$
|
55,966
|
|
7.90
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Interest-Earning Assets
(e)
|
|
$
|
1,091,271
|
|
$
|
87,551
|
|
8.13
|
%
|
|
$
|
1,017,494
|
|
$
|
80,778
|
|
8.05
|
%
|
|
$
|
914,332
|
|
$
|
64,135
|
|
7.10
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Earning Assests
|
|
$
|
8,432
|
|
|
|
|
|
|
|
$
|
7,823
|
|
|
|
|
|
|
|
$
|
6,188
|
|
|
|
|
|
|
Non-Earning Assets
|
|
$
|
111,399
|
|
|
|
|
|
|
|
$
|
105,979
|
|
|
|
|
|
|
|
$
|
98,213
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
1,211,102
|
|
|
|
|
|
|
|
$
|
1,131,296
|
|
|
|
|
|
|
|
$
|
1,018,733
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholders Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-Bearing Deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW
|
|
$
|
77,880
|
|
$
|
302
|
|
0.39
|
%
|
|
$
|
65,234
|
|
$
|
69
|
|
0.11
|
%
|
|
$
|
68,502
|
|
$
|
63
|
|
0.09
|
%
|
Savings
|
|
$
|
56,840
|
|
$
|
298
|
|
0.52
|
%
|
|
$
|
68,133
|
|
$
|
358
|
|
0.53
|
%
|
|
$
|
72,903
|
|
$
|
383
|
|
0.53
|
%
|
Money Market
|
|
$
|
136,609
|
|
$
|
4,078
|
|
2.99
|
%
|
|
$
|
125,344
|
|
$
|
2,947
|
|
2.35
|
%
|
|
$
|
114,171
|
|
$
|
821
|
|
0.72
|
%
|
TDOAs, and IRAs
|
|
$
|
24,123
|
|
$
|
913
|
|
3.78
|
%
|
|
$
|
23,399
|
|
$
|
780
|
|
3.33
|
%
|
|
$
|
22,267
|
|
$
|
481
|
|
2.16
|
%
|
Certificates of Deposit < $100,000
|
|
$
|
120,540
|
|
$
|
5,343
|
|
4.43
|
%
|
|
$
|
96,050
|
|
$
|
3,595
|
|
3.74
|
%
|
|
$
|
86,734
|
|
$
|
2,155
|
|
2.48
|
%
|
Certificates of Deposit
>
$100,000
|
|
$
|
222,483
|
|
$
|
10,795
|
|
4.85
|
%
|
|
$
|
182,380
|
|
$
|
8,059
|
|
4.42
|
%
|
|
$
|
159,579
|
|
$
|
4,781
|
|
3.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Int.-Bearing Deposits
|
|
$
|
638,475
|
|
$
|
21,729
|
|
3.40
|
%
|
|
$
|
560,540
|
|
$
|
15,808
|
|
2.82
|
%
|
|
$
|
524,156
|
|
$
|
8,684
|
|
1.66
|
%
|
Borrowed Funds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal Funds Purchased
|
|
$
|
19,211
|
|
$
|
1,019
|
|
5.30
|
%
|
|
$
|
13,235
|
|
$
|
675
|
|
5.10
|
%
|
|
$
|
690
|
|
$
|
28
|
|
4.06
|
%
|
Repurchase Agreements
|
|
$
|
24,070
|
|
$
|
169
|
|
0.70
|
%
|
|
$
|
24,281
|
|
$
|
161
|
|
0.66
|
%
|
|
$
|
28,772
|
|
$
|
110
|
|
0.38
|
%
|
Short Term Borrowings
|
|
$
|
127,115
|
|
$
|
5,888
|
|
4.63
|
%
|
|
$
|
92,106
|
|
$
|
4,307
|
|
4.68
|
%
|
|
$
|
25,357
|
|
$
|
824
|
|
3.25
|
%
|
Long Term Borrowings
|
|
$
|
10,907
|
|
$
|
350
|
|
3.21
|
%
|
|
$
|
32,674
|
|
$
|
975
|
|
2.98
|
%
|
|
$
|
60,564
|
|
$
|
1,501
|
|
2.48
|
%
|
TRUPS
|
|
$
|
30,928
|
|
$
|
2,280
|
|
7.37
|
%
|
|
$
|
38,385
|
|
$
|
3,205
|
|
8.35
|
%
|
|
$
|
31,013
|
|
$
|
2,185
|
|
7.05
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Borrowed Funds
|
|
$
|
212,231
|
|
$
|
9,706
|
|
4.57
|
%
|
|
$
|
200,681
|
|
$
|
9,323
|
|
4.65
|
%
|
|
$
|
146,396
|
|
$
|
4,648
|
|
3.17
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Int.-Bearing Liabilities
|
|
$
|
850,706
|
|
$
|
31,435
|
|
3.70
|
%
|
|
$
|
761,221
|
|
$
|
25,131
|
|
3.30
|
%
|
|
$
|
670,552
|
|
$
|
13,332
|
|
1.99
|
%
|
Demand Deposits
|
|
$
|
249,103
|
|
|
|
|
|
|
|
$
|
270,183
|
|
|
|
|
|
|
|
$
|
260,661
|
|
|
|
|
|
|
Other Liabilities
|
|
$
|
16,954
|
|
|
|
|
|
|
|
$
|
15,530
|
|
|
|
|
|
|
|
$
|
12,089
|
|
|
|
|
|
|
Shareholders Equity
|
|
$
|
94,339
|
|
|
|
|
|
|
|
$
|
84,362
|
|
|
|
|
|
|
|
$
|
75,431
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Liab. and Shareholders Equity
|
|
$
|
1,211,102
|
|
|
|
|
|
|
|
$
|
1,131,296
|
|
|
|
|
|
|
|
$
|
1,018,733
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Income/Earning Assets
|
|
|
|
|
|
|
|
8.13
|
%
|
|
|
|
|
|
|
|
8.05
|
%
|
|
|
|
|
|
|
|
7.10
|
%
|
Interest Expense/Earning Assets
|
|
|
|
|
|
|
|
2.88
|
%
|
|
|
|
|
|
|
|
2.47
|
%
|
|
|
|
|
|
|
|
1.46
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest Margin
(d)
|
|
|
|
|
$
|
56,116
|
|
5.25
|
%
|
|
|
|
|
$
|
55,647
|
|
5.58
|
%
|
|
|
|
|
$
|
50,803
|
|
5.64
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.
|
(b)
|
Yields and net interest margin have been computed on a tax equivalent basis.
|
(c)
|
Loan fees have been included in the calculation of interest income. Loan Fees were $1,633,356, $2,395,610, and $2,171,360 for the years ended December 31, 2007, 2006, and 2005
respectively. Loans are gross of the allowance for possible loan losses.
|
(d)
|
Represents net interest income as a percentage of average interest-earning assets (tax-equivalent).
|
(e)
|
Non-accrual loans have been included in total loans for purposes of total interest earning assets.
|
The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the
amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in the average balance multiplied by the prior period rate, and rate variances
are equal to the increase or decrease in the average rate times the prior period average balance. Variances attributable to both rate and volume changes are equal to the change in rate times the change in average balance.
27
Volume & Rate Variances
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007 over 2006
|
|
|
2006 over 2005
|
|
|
|
Increase (decrease) due to
|
|
|
Increase (decrease) due to
|
|
(dollars in thousands)
|
|
Volume
|
|
|
Rate
|
|
|
Rate/Vol
|
|
|
Net
|
|
|
Volume
|
|
|
Rate
|
|
|
Rate/Vol
|
|
|
Net
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal funds sold / Due from time
|
|
$
|
12
|
|
|
|
4
|
|
|
|
1
|
|
|
$
|
17
|
|
|
$
|
(112
|
)
|
|
|
56
|
|
|
|
(46
|
)
|
|
$
|
(102
|
)
|
Taxable
|
|
$
|
(438
|
)
|
|
|
232
|
|
|
|
(16
|
)
|
|
$
|
(222
|
)
|
|
$
|
(902
|
)
|
|
|
778
|
|
|
|
(108
|
)
|
|
$
|
(232
|
)
|
Non-taxable
(1)
|
|
$
|
175
|
|
|
|
14
|
|
|
|
1
|
|
|
$
|
190
|
|
|
$
|
539
|
|
|
|
(4
|
)
|
|
|
(2
|
)
|
|
$
|
533
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investments
|
|
$
|
(251
|
)
|
|
$
|
250
|
|
|
$
|
(14
|
)
|
|
$
|
(15
|
)
|
|
$
|
(475
|
)
|
|
$
|
830
|
|
|
$
|
(156
|
)
|
|
$
|
199
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
|
|
$
|
33
|
|
|
|
(35
|
)
|
|
|
(1
|
)
|
|
$
|
(3
|
)
|
|
$
|
(40
|
)
|
|
|
(513
|
)
|
|
|
14
|
|
|
$
|
(539
|
)
|
Commercial
|
|
$
|
117
|
|
|
|
(127
|
)
|
|
|
(1
|
)
|
|
$
|
(11
|
)
|
|
$
|
1,063
|
|
|
|
1,961
|
|
|
|
216
|
|
|
$
|
3,240
|
|
Real Estate
|
|
$
|
6,457
|
|
|
|
(116
|
)
|
|
|
(14
|
)
|
|
$
|
6,327
|
|
|
$
|
7,253
|
|
|
|
4,286
|
|
|
|
786
|
|
|
$
|
12,325
|
|
Consumer
|
|
$
|
204
|
|
|
|
385
|
|
|
|
15
|
|
|
$
|
604
|
|
|
$
|
269
|
|
|
|
659
|
|
|
|
43
|
|
|
$
|
971
|
|
Credit Cards
|
|
$
|
(499
|
)
|
|
|
136
|
|
|
|
(82
|
)
|
|
$
|
(445
|
)
|
|
$
|
41
|
|
|
|
(60
|
)
|
|
|
(3
|
)
|
|
$
|
(22
|
)
|
Direct Financing Leases
|
|
$
|
294
|
|
|
|
16
|
|
|
|
6
|
|
|
$
|
316
|
|
|
$
|
548
|
|
|
|
(30
|
)
|
|
|
(49
|
)
|
|
$
|
469
|
|
Other
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Loans and Leases
|
|
$
|
6,606
|
|
|
$
|
259
|
|
|
$
|
(77
|
)
|
|
$
|
6,788
|
|
|
$
|
9,134
|
|
|
$
|
6,303
|
|
|
$
|
1,007
|
|
|
$
|
16,444
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Interest Earning Assets
|
|
$
|
6,355
|
|
|
$
|
509
|
|
|
$
|
(91
|
)
|
|
$
|
6,773
|
|
|
$
|
8,659
|
|
|
$
|
7,133
|
|
|
$
|
851
|
|
|
$
|
16,643
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW
|
|
$
|
13
|
|
|
|
184
|
|
|
|
36
|
|
|
$
|
233
|
|
|
$
|
(3
|
)
|
|
|
9
|
|
|
|
|
|
|
$
|
6
|
|
Savings Accounts
|
|
$
|
(59
|
)
|
|
|
(1
|
)
|
|
|
|
|
|
$
|
(60
|
)
|
|
$
|
(25
|
)
|
|
|
|
|
|
|
|
|
|
$
|
(25
|
)
|
Money Market
|
|
$
|
265
|
|
|
|
795
|
|
|
|
71
|
|
|
$
|
1,131
|
|
|
$
|
81
|
|
|
|
1,863
|
|
|
|
182
|
|
|
$
|
2,126
|
|
TDOAs & IRAs
|
|
$
|
24
|
|
|
|
106
|
|
|
|
3
|
|
|
$
|
133
|
|
|
$
|
25
|
|
|
|
261
|
|
|
|
13
|
|
|
$
|
299
|
|
Certificates of Deposit < $100,000
|
|
$
|
917
|
|
|
|
662
|
|
|
|
169
|
|
|
$
|
1,748
|
|
|
$
|
232
|
|
|
|
1,091
|
|
|
|
117
|
|
|
$
|
1,440
|
|
Certificates of Deposit
>
$100,000
|
|
$
|
1,772
|
|
|
|
790
|
|
|
|
174
|
|
|
$
|
2,736
|
|
|
$
|
683
|
|
|
|
2,271
|
|
|
|
324
|
|
|
$
|
3,278
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Int. Bearing Deposits
|
|
$
|
2,932
|
|
|
$
|
2,536
|
|
|
$
|
453
|
|
|
$
|
5,921
|
|
|
$
|
993
|
|
|
$
|
5,495
|
|
|
$
|
636
|
|
|
$
|
7,124
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Borrowed Funds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal Funds Purchased
|
|
$
|
305
|
|
|
|
27
|
|
|
|
12
|
|
|
$
|
344
|
|
|
$
|
509
|
|
|
|
7
|
|
|
|
131
|
|
|
$
|
647
|
|
Repurchase Agreements
|
|
$
|
(1
|
)
|
|
|
9
|
|
|
|
|
|
|
$
|
8
|
|
|
$
|
(17
|
)
|
|
|
81
|
|
|
|
(13
|
)
|
|
$
|
51
|
|
Short Term Borrowings
|
|
$
|
1,637
|
|
|
|
(41
|
)
|
|
|
(15
|
)
|
|
$
|
1,581
|
|
|
$
|
2,169
|
|
|
|
362
|
|
|
|
952
|
|
|
$
|
3,483
|
|
Long Term Borrowings
|
|
$
|
(650
|
)
|
|
|
74
|
|
|
|
(49
|
)
|
|
$
|
(625
|
)
|
|
$
|
(691
|
)
|
|
|
306
|
|
|
|
(141
|
)
|
|
$
|
(526
|
)
|
TRUPS
|
|
$
|
(623
|
)
|
|
|
(375
|
)
|
|
|
73
|
|
|
$
|
(925
|
)
|
|
$
|
519
|
|
|
|
404
|
|
|
|
97
|
|
|
$
|
1,020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Borrowed Funds
|
|
$
|
668
|
|
|
$
|
(306
|
)
|
|
$
|
21
|
|
|
$
|
383
|
|
|
$
|
2,489
|
|
|
$
|
1,160
|
|
|
$
|
1,026
|
|
|
$
|
4,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Int. Bearing Liabilities
|
|
$
|
3,600
|
|
|
$
|
2,230
|
|
|
$
|
474
|
|
|
$
|
6,304
|
|
|
$
|
3,482
|
|
|
$
|
6,655
|
|
|
$
|
1,662
|
|
|
$
|
11,799
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest Income
|
|
$
|
2,755
|
|
|
$
|
(1,721
|
)
|
|
$
|
(565
|
)
|
|
$
|
469
|
|
|
$
|
5,177
|
|
|
$
|
478
|
|
|
$
|
(811
|
)
|
|
$
|
4,844
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Yields on tax exempt income have not been computed on a tax equivalent basis.
|
As shown above, pure volume variances contributed $2.8 million to net interest income in 2007 relative to 2006. The positive volume variance is mainly due to growth in average earning assets, as shown in the Average Balances and Rates
table. Average interest-earning assets were $74 million higher in 2007 than in 2006, an increase of 7% resulting from growth of $79 million, or 10%, in average loan balances which was partially offset by a decline of $5 million, or 3%, in average
investment balances. Average non-earning assets remained at 9% of total assets in 2007 relative to 2006, but average demand deposits declined to 21% of average assets in 2007 from 24% in 2006 with a corresponding increase in the proportion of
interest-bearing liabilities. The volume variance was also negatively impacted by a shift on the liability side from lower-cost non-maturity deposits to higher-cost time deposits. The average balance of total interest-bearing deposits increased by
$78 million, or 14%, in 2007 relative to 2006, with most of the increase coming in higher-cost deposit categories. Lower-cost NOW, savings, and money market deposits declined to 42% of average interest-bearing deposits in 2007 from 46% in 2006.
28
The rate variance for 2007 relative to 2006 was negative $1.7 million, because our weighted average yield on loans
experienced a slight dip while most of our deposit categories display fairly significant rate increases. Part of the negative variance results from the reversal of $295,000 in accrued but unpaid interest for loans placed on non-accrual status in
late 2007. Without this reversal, the weighted average yield on loans in 2007 would have been a basis point higher than the average yield for 2006. The most significant factors contributing to the unfavorable rate variance, however, have been the
negative impact of market interest rate changes and competitive forces on our cost of interest-bearing liabilities, as described more thoroughly in the next paragraph. The result is a cost of interest-bearing deposits that is 58 basis points higher
in 2007 than in 2006. This caused a 40 basis point increase in our weighted average cost of interest-bearing liabilities, relative to an 8 basis point increase in our yield on earning assets in 2007. The unfavorable rate variance would have been
even greater if not for the Companys large net interest position, which is the difference between interest-earning assets and interest-bearing liabilities. The Companys net interest position averaged $256 million in 2006, the base period
for the rate variance calculations, thus the yield increase for earning assets was applied to a substantially larger volume than the rate increase for interest-bearing liabilities.
The Companys net interest margin, which is tax-equivalent net interest income expressed as a percentage of average interest-earning assets, is affected by many of the same factors discussed relative to rate and
volume variances. Our net interest margin was 5.25% in 2007 as compared to 5.58% in 2006, a drop of 33 basis points. Our interest rate risk profile is currently relatively neutral in declining rate scenarios and displays slight exposure to rising
rates, but the Companys balance sheet was asset-sensitive for most of the last two years. An asset-sensitive balance sheet means that all else being equal, the Companys net interest margin was negatively impacted when short-term interest
rates were falling and favorably affected when rates were rising. In reality, short-term rates were rising for a period of about two years prior to the third quarter of 2006, and remained relatively stable thereafter until the Federal Reserve Board
approved a decrease in the fed funds rate in September 2007. After rates stopped increasing in 2006, deposit rates, which typically lag when market interest rates are increasing, began to catch up to the increases experienced in earning asset yields
when rates were rising and created compression in our net interest margin. Short-term market interest rates have been falling for the past several months, and our interest rate risk model currently shows that we should not be negatively impacted by
declining rates. However, due to competitive pressures, deposit rates have been slow to follow the drop in market interest rates. Also contributing to pressure on our net interest margin has been a drop in average non-interest bearing deposits and
relatively slow growth in lower-cost core deposits, which has necessitated the use of higher-cost funding options and caused relatively low-margin growth since mid-2006.
In 2006 relative to 2005, volume variances contributed $5.2 million to net interest income. The positive volume variance is mainly due to growth in average interest-earning assets, which were $103 million higher in
2006 than in 2005, an increase of 11%. The volume variance in 2006 was negatively impacted by a shift on the liability side from lower-cost deposits to higher-cost borrowed funds. The average balance of borrowed funds was $54 million higher in 2006
than in 2005, an increase of 37%, while average interest-bearing deposits increased by only $36 million, or 7%, for the same time periods. The addition of higher-cost short-term borrowings also impacted the rate variance, as evidenced by the 148
basis point increase in the cost of borrowed funds relative to only a 116 basis point increase in the cost of interest-bearing deposits for 2006 relative to 2005. Overall, the weighted average cost of interest-bearing liabilities increased by 131
basis points while the weighted average yield on interest-earning assets increased by only 95 basis points. This would have led to an unfavorable rate variance in 2006 relative to 2005 if not for the large net interest position, which again means
that the increase in the weighted average rate on interest-bearing liabilities was applied to a much lower base than the increased yield on earning assets. There was, then, actually a favorable rate variance of $478,000 in 2006 over 2005. Our net
interest margin was 5.58% in 2006 as compared to 5.64% in 2005, a drop of 6 basis points.
Provision for Loan and Lease Losses
Credit risk is inherent in the business of making loans. The Company sets aside an allowance or reserve for loan and lease losses through charges to earnings, which are
shown in the income statement as the provision for loan and lease losses. Specifically identifiable and quantifiable losses are immediately charged off against the allowance. The loan and lease loss provision is
29
determined by conducting a periodic evaluation of the adequacy of the Companys allowance for loan and lease losses, and charging the shortfall, if any,
to current period expense. This has the effect of creating variability in the amount and frequency of charges to the Companys earnings. The procedures for monitoring the adequacy of the allowance, as well as detailed information concerning the
allowance itself, are included below under Allowance for Loan and Lease Losses.
The Companys provision for loan and lease losses was
$3.3 million in 2007, $3.9 million in 2006, and $3.2 million in 2005. Despite increased reserves for non-performing assets and a $1.2 million increase in gross loan balances charged off, our loan loss provision was $599,000 lower in 2007 than in
2006 for the following reasons: Outstanding loan balances increased by only $37 million in 2007 but grew by $147 million in 2006, and the associated reserve for inherent losses was increased accordingly; the sale of the Companys credit card
portfolio in 2007 enabled the release of about $500,000 of the loan loss allowance that was allocated to those loans; and, principal recovered on previously charged-off balances, which is added back to the loan loss allowance, was $292,000 higher in
2007 than in 2006. The provision was higher in 2006 than in 2005 because of robust growth in loans and a higher degree of uncertainty (and corresponding loan loss allowance increase) with regard to certain classified loans. Furthermore, recoveries
on previously charged off balances in 2005 exceeded recoveries in 2006 by $481,000.
Because the provision exceeded net charge-offs in 2007, the allowance
for loan losses increased by $697,000 during the year, rising slightly to 1.33% of total gross loans and leases at the end of 2007 from 1.30% at the end of 2006. Subsequent to a thorough review of the allowance relative to the current size,
composition and quality of the Companys loan and lease portfolio, it has been judged by management to be adequate to absorb currently identified potential losses as well as any likely future losses.
Non-interest Revenue and Operating Expense
The following
table sets forth the major components of the Companys non-interest revenue and other operating expense, along with relevant ratios, for the years indicated:
30
Non Interest Revenue/Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands, unaudited)
|
|
2007
|
|
|
% of Total
|
|
|
2006
|
|
|
% of Total
|
|
|
2005
|
|
|
% of Total
|
|
NON INTEREST REVENUE:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service charges on deposit accounts
|
|
$
|
7,794
|
|
|
52.31
|
%
|
|
$
|
6,049
|
|
|
53.95
|
%
|
|
$
|
5,575
|
|
|
60.22
|
%
|
Credit card fees
|
|
$
|
687
|
|
|
4.61
|
%
|
|
$
|
968
|
|
|
8.63
|
%
|
|
$
|
817
|
|
|
8.83
|
%
|
Checkcard fees
|
|
$
|
1,256
|
|
|
8.43
|
%
|
|
$
|
922
|
|
|
8.22
|
%
|
|
$
|
696
|
|
|
7.52
|
%
|
Other service charges & fees
|
|
$
|
2,842
|
|
|
19.07
|
%
|
|
$
|
2,756
|
|
|
24.58
|
%
|
|
$
|
2,283
|
|
|
24.66
|
%
|
BOLI Income
|
|
$
|
1,234
|
|
|
8.28
|
%
|
|
$
|
774
|
|
|
6.90
|
%
|
|
$
|
792
|
|
|
8.55
|
%
|
Gains on sales of loans
|
|
$
|
1,601
|
|
|
10.75
|
%
|
|
$
|
79
|
|
|
0.71
|
%
|
|
$
|
523
|
|
|
5.65
|
%
|
(Loss) Gains on sale of investment securities
|
|
$
|
14
|
|
|
0.09
|
%
|
|
$
|
9
|
|
|
0.08
|
%
|
|
$
|
(394
|
)
|
|
-4.26
|
%
|
(Loss) on tax credit investment
|
|
$
|
(985
|
)
|
|
-6.61
|
%
|
|
$
|
(940
|
)
|
|
-8.38
|
%
|
|
$
|
(1,092
|
)
|
|
-11.80
|
%
|
Other
|
|
$
|
457
|
|
|
3.07
|
%
|
|
$
|
595
|
|
|
5.31
|
%
|
|
$
|
58
|
|
|
0.63
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-interest revenue
|
|
$
|
14,900
|
|
|
100.00
|
%
|
|
$
|
11,212
|
|
|
100.00
|
%
|
|
$
|
9,258
|
|
|
100.00
|
%
|
As a % of average interest-earning assets
|
|
|
|
|
|
1.37
|
%
|
|
|
|
|
|
1.10
|
%
|
|
|
|
|
|
1.01
|
%
|
|
|
|
|
|
|
|
OTHER OPERATING EXPENSES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries and employee benefits
|
|
$
|
17,861
|
|
|
49.64
|
%
|
|
$
|
16,770
|
|
|
49.55
|
%
|
|
$
|
15,648
|
|
|
47.95
|
%
|
Occupancy costs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Furniture & Equipment
|
|
$
|
3,009
|
|
|
8.36
|
%
|
|
$
|
3,228
|
|
|
9.54
|
%
|
|
$
|
3,192
|
|
|
9.78
|
%
|
Premises
|
|
$
|
3,466
|
|
|
9.63
|
%
|
|
$
|
3,277
|
|
|
9.68
|
%
|
|
$
|
2,964
|
|
|
9.08
|
%
|
Advertising and Marketing Costs
|
|
$
|
1,722
|
|
|
4.79
|
%
|
|
$
|
1,022
|
|
|
3.02
|
%
|
|
$
|
1,524
|
|
|
4.67
|
%
|
Data Processing Costs
|
|
$
|
1,147
|
|
|
3.19
|
%
|
|
$
|
1,427
|
|
|
4.22
|
%
|
|
$
|
1,194
|
|
|
3.66
|
%
|
Deposit Services Costs
|
|
$
|
2,094
|
|
|
5.82
|
%
|
|
$
|
1,811
|
|
|
5.35
|
%
|
|
$
|
1,303
|
|
|
3.99
|
%
|
Loan Services Costs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan Processing
|
|
$
|
209
|
|
|
0.58
|
%
|
|
$
|
297
|
|
|
0.88
|
%
|
|
$
|
281
|
|
|
0.86
|
%
|
ORE Owned
|
|
$
|
9
|
|
|
0.03
|
%
|
|
$
|
80
|
|
|
0.24
|
%
|
|
$
|
617
|
|
|
1.89
|
%
|
Credit Card
|
|
$
|
598
|
|
|
1.66
|
%
|
|
$
|
700
|
|
|
2.07
|
%
|
|
$
|
613
|
|
|
1.88
|
%
|
Other loan services
|
|
$
|
|
|
|
0.00
|
%
|
|
$
|
|
|
|
0.00
|
%
|
|
$
|
8
|
|
|
0.02
|
%
|
Other Operating Costs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Telephone & data communications
|
|
$
|
915
|
|
|
2.54
|
%
|
|
$
|
825
|
|
|
2.44
|
%
|
|
$
|
846
|
|
|
2.59
|
%
|
Postage & mail
|
|
$
|
559
|
|
|
1.55
|
%
|
|
$
|
380
|
|
|
1.12
|
%
|
|
$
|
315
|
|
|
0.98
|
%
|
Other
|
|
$
|
1,192
|
|
|
3.31
|
%
|
|
$
|
1,076
|
|
|
3.18
|
%
|
|
$
|
827
|
|
|
2.54
|
%
|
Professional Services Costs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Legal & Accounting
|
|
$
|
1,009
|
|
|
2.80
|
%
|
|
$
|
1,121
|
|
|
3.31
|
%
|
|
$
|
1,296
|
|
|
3.97
|
%
|
Other professional service
|
|
$
|
1,384
|
|
|
3.85
|
%
|
|
$
|
1,083
|
|
|
3.20
|
%
|
|
$
|
1,215
|
|
|
3.72
|
%
|
Stationery & Supply Costs
|
|
$
|
528
|
|
|
1.47
|
%
|
|
$
|
598
|
|
|
1.77
|
%
|
|
$
|
683
|
|
|
2.09
|
%
|
Sundry & Tellers
|
|
$
|
279
|
|
|
0.78
|
%
|
|
$
|
146
|
|
|
0.43
|
%
|
|
$
|
108
|
|
|
0.33
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other operating expense
|
|
$
|
35,981
|
|
|
100.00
|
%
|
|
$
|
33,841
|
|
|
100.00
|
%
|
|
$
|
32,634
|
|
|
100.00
|
%
|
As a % of average interest-earning assets
|
|
|
|
|
|
3.30
|
%
|
|
|
|
|
|
3.32
|
%
|
|
|
|
|
|
3.57
|
%
|
Net non-interest income as a % of avg. interest-earning assets
|
|
|
|
|
|
-1.93
|
%
|
|
|
|
|
|
-2.22
|
%
|
|
|
|
|
|
-2.56
|
%
|
Efficiency Ratio (tax-equivalent)
|
|
|
|
|
|
49.36
|
%
|
|
|
|
|
|
49.63
|
%
|
|
|
|
|
|
52.64
|
%
|
Because of a strong increase in non-interest revenue, the Companys tax-equivalent overhead efficiency ratio
declined to 49.4% for 2007, relative to 49.6% for 2006 and 52.6% in 2005. The overhead efficiency ratio represents total operating expense divided by the sum of fully tax-equivalent net interest plus non-interest income, with the provision for loan
losses and investment gains and losses excluded from the equation.
Non-interest income increased by $3.7 million, or 33%, in 2007 relative to 2006,
including a $1.7 million increase in service charges on deposit accounts and a $1.5 million increase in gains from the sale of loans. The Companys 2006 results reflect an overall increase of $2.0 million in non-interest income, due in part to
the impact of non-recurring items but mainly from strong increases in service charges on deposits, check card interchange fees, and operating lease income. Non-interest income increased to 1.37% of average interest-earning assets in 2007, from 1.10%
in 2006 and 1.01% in 2005.
31
The categories itemized in the table above are indicative of the primary sources of non-interest operating revenue for
the Company, including some non-recurring items. The $1.6 million gain from the sale of our credit cards was the only significant non-recurring income item in 2007. Items of a non-recurring nature that impacted non-interest income in 2006 include a
$100,000 gain upon the outsourcing of merchant services to First Data and an $88,000 gain on a life insurance policy, both of which are included in Other non-interest revenue in the table above. Non-recurring items in 2005 include a
$523,000 gain on the bulk sale of $21 million in residential mortgage loans, a $406,000 loss on the sale of investment securities resulting from a year-end repositioning of the portfolio, gains on the sale of OREO totaling $127,000 that are
reflected in the Other category, and write-downs of our investment in Diversified Holdings, Inc. totaling $570,000 that are also included in Other. Mainly because of non-recurring items, the Other category dropped
by $138,000, or 23%, in 2007, and increased by $537,000, or 926%, in 2006.
As noted above, service charges on deposit accounts, the largest component of
other operating income, increased by $1.7 million, or 29%, in 2007 relative to 2006. The main reason for this increase was the net addition of almost 7,000 new transaction accounts during 2007, representing a 19% increase, along with adjustments to
our schedule of fees and charges and the enhancement of deposit scoring and overdraft management capabilities. Service charges increased by $474,000, or 9% in 2006 primarily because of higher returned item and overdraft charges resulting from higher
levels of activity. The Companys ratio of service charge income to average transaction account balances (demand and interest-bearing NOW accounts) was 2.4% in 2007, 1.8% in 2006, and 1.7% in 2005. Despite this increase in service charges per
transaction account balances, service charges declined as a percentage of total non-interest revenue in both 2007 and 2006 because of the impact of non-recurring items on total non-interest revenue.
Other service charges and fees constitute the second largest portion of non-interest income, with the principal components consisting of operating lease income,
dividends received on restricted stock (primarily our equity investment in FHLB stock), currency order fees, late charge income, and ATM fees. Other service charges and fees totaled $2.8 million in both 2007 and 2006, up from $2.3 million in 2005.
In 2007, the overall change relative to the prior year was minimal. In 2006, the largest year-over-year changes within this category were higher operating lease income and higher dividends received on FHLB stock. Other service charges and fees were
19% of total non-interest revenue in 2007, down from 25% in 2006 and 2005 because of the impact of non-recurring items on the total.
Credit card fees
include credit card interchange fees and credit card annual fees as primary components. Credit card fees were $281,000 lower in 2007 than in 2006, a drop of 29% because of the sale of the credit card portfolio in June 2007. Despite the sale of all
our credit card balances, we still receive a portion of the interchange and interest from credit cards issued in our name and thus credit card income is not expected to completely evaporate. These fees were only 5% of total non-interest income in
2007, down from 9% in 2006 and 2005.
Check card fees, consisting mainly of point of sale (POS) interchange fees, increased by $334,000 in 2007, due to
increased usage and an increase in the number of cards outstanding associated with new transaction accounts. These fees increased $226,000, or 32%, in 2006, again due to an increase in the number of cards and higher usage per card. Check card fees
have been increasing as a percentage of total non-interest revenue, and the increasing popularity of POS transactions leads us to believe that this access channel will continue to grow in importance. The number of active Sierra Check Cards now in
use by retail account holders is 26,000, up from 22,000 at the end of 2006.
BOLI income increased by $460,000, or 59%, in 2007 relative to 2006, but
declined by $18,000, or 2%, in 2006 compared to 2005. At December 31, 2007 the Company had $26.0 million invested in single-premium general account BOLI, with an interest credit rate that does not change frequently and is floored at
no less than 3%. Income from this BOLI is used to fund expenses associated with executive salary continuation plans and director retirement plans. In addition, as of the same date the Company had $2.0 million invested in separate account
BOLI, the earnings on which help offset deferred compensation accruals for certain directors and senior officers. These deferred compensation BOLI accounts have returns pegged to participant-directed investment allocations which can include equity,
bond, or real estate indices, and are thus subject to gains or losses. Much of the increase in BOLI income for 2007 is due to income from an additional $6 million investment in general account BOLI made in December 2006, but separate account BOLI
income was also $145,000 higher. The decline in BOLI income in 2006 is the result of fluctuations in separate account BOLI income.
32
Income from loan sales was $1.6 million in 2007, $79,000 in 2006, and $523,000 in 2005. The $1.5 million increase in 2007
compared to 2006 is due to the sale of our credit card portfolio, as previously discussed. The 85% decline in 2006 relative to 2005 is due mainly to the gain on the first quarter 2005 sale of $21 million in residential mortgage loans. The Company
still originates a limited number of residential mortgage loans (primarily those associated with its all-in-one construction through permanent financing product), but we have been holding most newly originated residential mortgage loans
in our loan portfolio rather than selling them.
While there were negligible gains from the sale of investment securities in 2007 and 2006, the sale of
approximately $13 million in underperforming investment securities in December 2005 resulted in a loss of $406,000, although this was partially offset by earlier gains on called securities and the net loss for 2005 was $394,000. In addition to
non-recurring losses generated by investment portfolio activities, losses on our tax credit investments are also netted out of non-interest revenue and are shown as a separate line item in the table above because of their relative size. The losses
represent our limited partnership allocation of net losses generated by the operations of low-income housing tax credit funds, and are an expected component of tax credit fund investments which is factored into our initial assessment of projected
returns. The losses, which reduce the balance of tax credit fund investments shown in other assets, increased by $45,000 in 2007 relative to 2006 due in part to losses on additional investments in newly formed tax credit funds, although those losses
were partially offset by favorable developments in the operations of properties comprising some of the other funds we have invested in. Losses declined by $152,000 in 2006 relative to 2005.
We turn now to a discussion of operating expense, which increased by $2.1 million, or 6%, in 2007 as compared to 2006. Total operating expense declined to 3.30% of
average interest-earning assets in 2007, from 3.32% in 2006 and 3.57% in 2005. In 2006, total operating expense was up by only $1.2 million, or 4%, relative to 2005, primarily because a $502,000 drop in advertising and marketing expenses helped
offset increases in other areas but also because non-recurring expenses had a slightly smaller impact in 2006.
The largest component of total operating
expense, salaries and employee benefits, experienced year-over-year growth of $1.1 million in 2007 and $1.1 million in 2006, an increase of 7% for both years. In 2007, almost all of the increase was in salaries. Total employee benefits were up only
negligibly in 2007, because increases in cross-sell incentive payments to employees, the Companys 401(k) matching contribution to employees retirement accounts, accruals for earnings on deferred compensation balances, and group health
insurance premiums were nearly offset by a $129,000 reduction in workers compensation insurance premiums and a $128,000 decline in salary continuation plan accruals. Salaries alone increased by over 8% in 2007 due to in large part to regular annual
salary increases and staffing costs for the new Delano branch. The increase in salaries in 2007 also includes a $241,000 reduction in salaries attributable to successful loan originations, which are deferred from current expense and amortized as an
adjustment to loan yields pursuant to FAS 91. FAS 91 deferrals increased in the latter part of the year because of a revision in our estimate of the personnel costs involved in each successfully-originated loan, pursuant to an annual review of such
costs in August 2007, but that increase was not enough to offset the drop resulting from lower loan origination activity throughout the year. Salaries deferred pursuant to FAS 91 totaled $3.4 million in 2007, $3.7 million in 2006, and $3.4 million
in 2005.
In analyzing the 2006 over 2005 change in salaries and benefits, salaries increased by $1.3 million, or 12%, due to regular annual pay increases,
staff for new branches, the commencement of accruals for stock option expense, salaries for additional administrative support staff, and the impact of revised incentive compensation plans, all of which were partially offset by a $246,000 increase in
FAS 91 deferrals. The cost of employee benefits fell by $186,000, or 4%, in 2006, due to a reduction in workers compensation premiums and declining salary continuation plan accruals.
Salaries and employee benefits were 50% of total operating expense in 2007 and 2006, compared to 48% in 2005. The number of full-time equivalent employees was 371 at the end of 2007, relative to 361 at the end of 2006
and 351 at the end of 2005.
Total rent and occupancy costs, including furniture and equipment expenses, declined by $30,000 in 2007 compared to 2006. We
experienced typical inflationary increases in rent and other occupancy costs in 2007, along with costs associated with our Delano branch which opened in March 2007. However, these increases were offset by lower furniture and equipment depreciation,
which
33
was down by $406,000 because of some equipment and large fixtures which became fully depreciated during 2007. The year-to-date decline also includes a
$105,000 drop in property taxes which resulted from one-time property tax refunds received in the first quarter of 2007 pursuant to re-assessments. The increase in 2006 was $349,000, or 6%, relative to 2005. Rent and occupancy costs were 18% of
total operating expense in 2007, down from 19% in 2006 and 2005.
Advertising and marketing costs increased by $700,000, or 68%, in 2007, because of costs
associated with our high-performance checking initiative targeting consumer deposits (as explained above, in Recent Developments under Part I Item 1), which was implemented at the beginning of 2007. A similar high-performance
checking initiative was instituted for business accounts during the fourth quarter of 2007. Marketing expense declined by $502,000, or 33%, in 2006, in large part because of the discontinuation of a direct-mail marketing campaign run during 2005.
Data processing costs declined by $280,000 in 2007 relative to 2006, mainly because 2006 expenses include a non-recurring $358,000 early termination fee
paid to Digital Insight in connection with our internet banking platform conversion. Data processing costs increased by $233,000, or 20%, in 2006 relative to 2005, again primarily because of the aforementioned early termination fee. Data processing
costs would have increased even more in 2006 if not for the fact that Federal Reserve Bank processing charges were included in this category in 2005, but were moved to deposit services costs in 2006.
Deposit services costs were $283,000 higher in 2007 than in 2006, an increase of 16% resulting in part from a $125,000 increase in bulk filing losses attributable almost
entirely to check fraud losses on a single business deposit account. This category also includes card re-issuance costs stemming from our debit card conversion in mid-November 2007, which caused debit card costs to increase by $105,000. Deposit
costs increased by $508,000, or 39%, in 2006 relative to 2005, in large part because Federal Reserve Bank processing charges are in deposit services costs in 2006 but are reflected in data processing costs for 2005. These charges totaled $334,000 in
2006.
Loan services costs, including credit card expenses, costs associated with repossessed assets, and other loan processing costs, were down by
$261,000, or 24%, in 2007. Part of this was a reduction in credit card expenses, which fell by $102,000 even though 2007 expenses include a $249,000 de-conversion fee associated with the credit card portfolio sale. Lower loan origination activity in
2007 also contributed to lower loan services costs. Non-recurring items in 2006, including $133,000 in OREO write-downs net of a $72,000 expense recovery, added to the decline in total loan services costs in 2007 relative to 2006. Loan services
costs fell by $442,000, or 29% in 2006 relative to 2005, mainly because of $550,000 in OREO write-downs included in 2005 expenses.
The other
operating costs category, which includes telecommunications, postage, and other miscellaneous costs, totaled $2.7 million in 2007, $2.3 million in 2006, and $2.0 million in 2005. Telecommunications expense increased by $90,000, or 11%, in
2007, due to the addition of equipment for the new branch and the enhancement of equipment and circuit redundancy for the entire Company. That category fell slightly in 2006 as the result of a more efficient telecommunications configuration. Postage
and mailing costs increased by $179,000, or 47%, in 2007, due to additional mailings associated with compliance disclosures and our debit and credit card conversions. The $65,000 increase in postage in 2006 offsets a decline of similar magnitude in
2005, due primarily to the timing of payments. Other miscellaneous operating expenses increased by $116,000, or 11%, in 2007, and by $249,000, or 30% in 2006. The increase in 2007 was driven by higher costs related to education and training. The
increase in 2006 was mainly due to higher depreciation on operating leases, resulting from an increasingly larger volume of leasing business.
Legal and
accounting costs fell by $112,000 in 2007, following on the heels of an even larger decline of $175,000 in 2006. The reduction in 2007 stems mainly from fewer audit hours spent reviewing and testing SOX 404 internal controls. The reduction in 2006
is due in part to a non-recurring legal recovery of $76,000. The cost of other professional services increased by $301,000, or 28%, in 2007, but fell by $132,000, or 11% in 2006. The increase in 2007 is mainly the result of $249,000 in consulting
costs related to our debit card and EFT processing conversion, but also includes an increase in accruals for directors retirement plans and for earnings on directors deferred fee plans. The drop in 2006 was due to lower accruals for
directors retirement plans.
34
Income Taxes
The Companys provision for federal and state income taxes was $10.8 million in 2007, $10.0 million in 2006, and $8.1 million in 2005. This represents 34% of income before taxes in 2007 and 2006, and 33% in 2005. The accrual rate
increased slightly in 2006 largely because stock option expense, which wasnt recognized in operating results in prior years, is not allowed as a tax deduction.
The Company sets aside its provision for income taxes on a monthly basis. As indicated in Note 9 in the Notes to the Consolidated Financial Statements, the amount of such provision is determined by applying the
Companys statutory income tax rates to pre-tax book income as adjusted for permanent differences between pre-tax book income and actual taxable income. These permanent differences include but are not limited to tax-exempt interest income,
increases in the cash surrender value of BOLI, California Enterprise Zone deductions, certain expenses that are not allowed as tax deductions, and tax credits. Tax-exempt interest income is generated primarily by the Companys investments in
state, county and municipal bonds, which provided $2.2 million in federal tax-exempt income in 2007, $2.0 million 2006, and $1.5 million in 2005. Although not reflected in the investment portfolio, the company also has total investments of $13.8
million in low-income housing tax credit funds as of December 31, 2007, including a $3 million investment commitment made in August 2007. These investments have generated substantial tax credits for the past few years, with about $1.5 million
in credits available for the 2007 tax year and $1.3 million in tax credits realized in 2006. The investments are expected to generate an additional $12.4 million in aggregate tax credits from 2008 through 2019; however, the credits are dependent
upon the occupancy level of the housing projects and income of the tenants and cannot be projected with complete certainty.
Some items of income and
expense are recognized in different years for tax purposes than when applying generally accepted accounting principles, leading to timing differences between the Companys actual tax liability and the amount accrued for this liability based on
book income. These temporary differences comprise the deferred portion of the Companys tax expense, which is accumulated on the Companys books as a deferred tax asset or deferred tax liability until such time as it reverses.
At the end of 2007, the Company had a net deferred tax asset of $3.3 million.
Financial Condition
A comparison between the summary year-end balance sheets for 2003 through 2007 was presented in the table of Selected Financial Data (see Item 6 above). As indicated
in that table, the Companys total assets, loans, and shareholders equity have grown each year for the past four years. Total assets grew by only $19 million, or 2%, during 2007 for the following reasons: Growth in loans totaled only $37
million, or 4%, due to the sale of $11 million in credit card balances and declining loan origination activity; cash and due from banks fell by $9 million; fed funds sold declined by $6 million; and investment securities were down by $5 million.
Asset growth in 2006 was quite robust, with total assets increasing by $162 million, or 15%, due to growth in loans. The Company experienced its most pronounced growth in assets during 2004, with total assets increasing by $196 million, or 24%, due
to a $100 million leverage strategy implemented by the Company that year and strong organic loan growth. Assets increased by only $55 million, or 6%, in 2005, because of the sale of $21 million in mortgage loans and the prepayment of an $8 million
loan participation.
Deposit growth has generally lagged behind asset growth in recent years. Nevertheless, deposits increased by varying amounts from 2004
through 2006, but declined by $18 million in 2007 due to the runoff of $25 million in wholesale-sourced brokered deposits. Growth in branch-generated deposits was about $7 million in 2007. Branch deposits increased at an almost identical rate in
2006, since $45 million of the $53 million increase in aggregate deposits in 2006 came from an increase in wholesale-sourced brokered deposits. In 2005, deposits grew at a strong 10% pace, increasing by $73 million relative to the $55 million
increase in assets that year.
Significant changes in the relative size of balance sheet components in 2007 include net loans and leases, which increased
to 74% of total assets at the end of 2007 from 72% at the end of 2006. On the liability side, deposits declined to 75% of total liabilities at December 31, 2007 from 77% at December 31, 2006, with an offsetting increase in other borrowed
money, which increased to 24% of total liabilities at the end of 2007 from 21% at the end of 2006. Within deposits, non-interest bearing deposits declined to 29% of total deposits at the end of 2007 from 32% at the end of 2006. The major components
of the Companys balance sheet are individually analyzed below, along with off-balance sheet information.
35
Loan and Lease Portfolio
The Companys loan and lease portfolio represents the single largest portion of invested assets, substantially greater than the investment portfolio or any other asset category, and the quality and
diversification of the loan and lease portfolio are important considerations when reviewing the Companys financial condition. The Company is not involved with chemicals or toxins that might have an adverse effect on the environment, thus its
primary exposure to environmental legislation is through its lending activities. The Companys lending procedures include steps to identify and monitor this exposure in an effort to avoid any related loss or liability.
As noted above, loan and lease balances grew at a faster pace than total assets during 2007, and thus increased as a percentage of the total. Since loans also grew at a
faster rate than deposits, the ratio of net loans and leases to deposits increased to 107% at the end of 2007 from 101% at the end of 2006. Presumably because of the weakening economy, demand for loans has softened somewhat in many of our market
areas. Competition has thus intensified, and to help ensure that we remain competitive, we make every effort to be flexible and creative in our approach to structuring loans without compromising credit quality.
The Selected Financial Data table in Item 6 above reflects the amount of loans and leases outstanding at
December 31
st
for each year from 2003 through 2007, net of deferred fees and origination costs and the allowance for loan and lease losses. The
Loan and Lease Distribution table that follows sets forth the Companys gross loans and leases outstanding and the percentage distribution in each category at the dates indicated. The amounts shown in the table do not reflect any deferred loan
fees or deferred origination costs, nor is the allowance deducted.
36
Loan and Lease Distribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
(dollars in thousands)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
Agricultural
|
|
$
|
13,103
|
|
|
$
|
13,193
|
|
|
$
|
9,898
|
|
|
$
|
13,146
|
|
|
$
|
13,693
|
|
Commercial and Industrial
|
|
$
|
117,183
|
|
|
$
|
113,644
|
|
|
$
|
100,545
|
|
|
$
|
100,042
|
|
|
$
|
93,287
|
|
Real Estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured by Commercial/Professional Office Properties including Const. and Development
|
|
$
|
457,236
|
|
|
$
|
420,973
|
|
|
$
|
363,094
|
|
|
$
|
336,065
|
|
|
$
|
306,635
|
|
Secured by Residential Properties
|
|
$
|
187,267
|
|
|
$
|
177,448
|
|
|
$
|
128,735
|
|
|
$
|
126,241
|
|
|
$
|
98,891
|
|
Secured by Farmland
|
|
$
|
51,607
|
|
|
$
|
53,668
|
|
|
$
|
45,353
|
|
|
$
|
37,648
|
|
|
$
|
25,281
|
|
Held for Sale
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
440
|
|
|
$
|
513
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Real Estate
|
|
$
|
696,110
|
|
|
$
|
652,089
|
|
|
$
|
537,182
|
|
|
$
|
500,394
|
|
|
$
|
431,320
|
|
Small Business Administration loans
|
|
$
|
20,366
|
|
|
$
|
25,946
|
|
|
$
|
24,190
|
|
|
$
|
21,547
|
|
|
$
|
21,964
|
|
Consumer Loans
|
|
$
|
54,731
|
|
|
$
|
54,568
|
|
|
$
|
51,006
|
|
|
$
|
48,992
|
|
|
$
|
41,106
|
|
Direct Financing Leases
|
|
$
|
23,140
|
|
|
$
|
20,150
|
|
|
$
|
10,138
|
|
|
$
|
3,490
|
|
|
$
|
792
|
|
Consumer Credit Cards
|
|
$
|
|
|
|
$
|
8,418
|
|
|
$
|
8,401
|
|
|
$
|
8,665
|
|
|
$
|
8,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Loans and Leases
|
|
$
|
924,633
|
|
|
$
|
888,008
|
|
|
$
|
741,360
|
|
|
$
|
696,276
|
|
|
$
|
610,681
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of Total Loans and Leases
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
|
|
|
1.42
|
%
|
|
|
1.49
|
%
|
|
|
1.34
|
%
|
|
|
1.89
|
%
|
|
|
2.24
|
%
|
Commercial and Industrial
|
|
|
12.67
|
%
|
|
|
12.80
|
%
|
|
|
13.56
|
%
|
|
|
14.37
|
%
|
|
|
15.27
|
%
|
Real Estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured by Commercial/Professional Office Properties including Const. and Development
|
|
|
49.45
|
%
|
|
|
47.41
|
%
|
|
|
48.98
|
%
|
|
|
48.27
|
%
|
|
|
50.21
|
%
|
Secured by Residential Properties
|
|
|
20.26
|
%
|
|
|
19.98
|
%
|
|
|
17.36
|
%
|
|
|
18.13
|
%
|
|
|
16.20
|
%
|
Secured by Farmland
|
|
|
5.58
|
%
|
|
|
6.04
|
%
|
|
|
6.12
|
%
|
|
|
5.41
|
%
|
|
|
4.14
|
%
|
Held for Sale
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
0.06
|
%
|
|
|
0.08
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Real Estate
|
|
|
75.29
|
%
|
|
|
73.43
|
%
|
|
|
72.46
|
%
|
|
|
71.87
|
%
|
|
|
70.63
|
%
|
Small Business Administration loans
|
|
|
2.20
|
%
|
|
|
2.92
|
%
|
|
|
3.26
|
%
|
|
|
3.09
|
%
|
|
|
3.60
|
%
|
Consumer Loans
|
|
|
5.92
|
%
|
|
|
6.14
|
%
|
|
|
6.88
|
%
|
|
|
7.04
|
%
|
|
|
6.73
|
%
|
Direct Financing Leases
|
|
|
2.50
|
%
|
|
|
2.27
|
%
|
|
|
1.37
|
%
|
|
|
0.50
|
%
|
|
|
0.13
|
%
|
Consumer Credit Cards
|
|
|
0.00
|
%
|
|
|
0.95
|
%
|
|
|
1.13
|
%
|
|
|
1.24
|
%
|
|
|
1.40
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As displayed in the table, aggregate loan and lease balances increased by $314 million, or 51%, from the end of
2003 to the end of 2007. The Companys branches and other business units generated the bulk of that growth. Overall, loan demand in the Companys immediate market has been weighted toward loans secured by real estate. Real estate loans
secured by commercial and professional buildings increased by $36 million, or 9%, in 2007, while loans secured by residential properties increased by $10 million, or 6%. Within loans secured by residential properties, home equity loans and lines
actually declined by about $7 million, while permanent mortgage loans increased by $17 million. Loans secured by commercial properties was the only category within real estate loans to change significantly as a percentage of total loans in 2007,
increasing to 49% of total loans at the end of 2007 from 47% at the end of 2006.
Agricultural production loan balances fluctuated during the year due to
varying seasonal needs, but ended 2007 with about the same balance as at the end of 2006. Even though the balance didnt change much, ag production loans have been trending downward as a percentage of total loans. The Company has, to some
extent, withdrawn from financing production lines, where year-to-year cash flow variations can impede the ability of borrowers to meet contractual repayment terms. With uncertain commodity prices some of our borrowers have experienced declining
equity in farming operations, and many are selling farm land for alternate uses such as housing and commercial development. The Company also originates and sells agricultural mortgage loans to certain investors, and the volume of agricultural
mortgage loans serviced totaled $7 million as of December 31, 2007. Total loans serviced for others numbered 31 with an aggregate balance of $12 million as of the end of 2007, as compared to 44 loans with an aggregate balance of $17 million at
the end of 2006.
37
Commercial and industrial loans, including SBA loans, fell by a combined $2 million, or 1%, in 2007, due primarily to the
sale of approximately $3 million in commercial credit card balances and $6 million runoff in our SBA portfolio. The SBA runoff was the result of a relatively high level of prepayments and lower SBA loan origination activity, which slowed during the
latter part of 2007 due to the challenging economic environment. The Company has increased its emphasis on SBA loans and we anticipate stronger growth in this area in 2008, although no assurance can be provided in that regard. The growth rate for
commercial and industrial loans, in general, has lagged growth in the aggregate loan portfolio, as evidenced by the drop in commercial loans to 15% of total loans at the end of 2007 from 19% at the end of 2003. The Companys commercial loans
are centered in locally-oriented commercial activities in markets where the Company has a physical presence, and this segment of the portfolio has struggled for growth as the local market has become increasingly competitive. Potential business has
been passed over in some instances, and in others the Company has taken real estate collateral as an abundance of caution, which causes the loans to be classified as commercial real estate. Direct finance leases are also a form of secured commercial
credit, and are an increasingly popular option for our business customers. Part of the reason for relatively slow growth in commercial loans is because of growth in direct finance leases, which increased by $3 million, or 15%, in 2007 and are now 3%
of total loans and leases.
The consumer loans category represented 6% of total loans and leases outstanding at the end of both 2007 and 2006. These
balances, which consist primarily of automobile loans and unsecured lines of credit, grew by less than 1% in 2007. As discussed earlier, credit card loans were sold during the year, with consumer credit card balances dropping to zero at the end of
2007 from over $8 million at the end of 2006.
Loan and Lease Maturities
The following table shows the maturity distribution for total loans and leases outstanding as of December 31, 2007, including non-accruing loans. The maturity distribution is grouped by remaining scheduled
principal payments that are due within three months, after three months but less than one year, after one but within five years, or after five years. The principal balance of loans due after one year is indicated by both fixed and floating rate
categories.
Loan and Lease Maturity Distribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007
|
(dollars in thousands)
|
|
Three months
or less
|
|
Three months
to twelve
months
|
|
One to five
years
|
|
Over five
years
|
|
Total
|
|
Floating rate:
due after one
year
|
|
Fixed rate:
due after
one year
|
Agricultural
|
|
$
|
2,276
|
|
$
|
9,764
|
|
$
|
1,063
|
|
$
|
|
|
$
|
13,103
|
|
$
|
616
|
|
$
|
447
|
Comml and Industrial
(1)
|
|
$
|
9,632
|
|
$
|
42,052
|
|
$
|
61,703
|
|
$
|
24,162
|
|
$
|
137,549
|
|
$
|
38,716
|
|
$
|
47,149
|
Real Estate
|
|
$
|
65,528
|
|
$
|
55,724
|
|
$
|
118,818
|
|
$
|
456,040
|
|
$
|
696,110
|
|
$
|
219,685
|
|
$
|
355,173
|
Consumer Loans
|
|
$
|
3,177
|
|
$
|
5,072
|
|
$
|
21,610
|
|
$
|
24,872
|
|
$
|
54,731
|
|
$
|
21,090
|
|
$
|
25,392
|
Direct Financing Leases
|
|
$
|
|
|
$
|
200
|
|
$
|
17,165
|
|
$
|
5,775
|
|
$
|
23,140
|
|
$
|
|
|
$
|
22,940
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL
|
|
$
|
80,613
|
|
$
|
112,812
|
|
$
|
220,359
|
|
$
|
510,849
|
|
$
|
924,633
|
|
$
|
280,107
|
|
$
|
451,101
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes Small Business Administration Loans
|
For a comprehensive discussion of the Companys liquidity position, re-pricing characteristics of the balance sheet, and sensitivity to changes in interest rates,
see the Liquidity and Market Risk section.
Off-Balance Sheet Arrangements
In the normal course of business, the Company makes commitments to extend credit to its customers as long as there are no violations of any conditions established in
contractual arrangements. These commitments are obligations that represent a potential credit risk to the Company, and a $160,000 reserve for unfunded commitments is reflected as a liability in the Companys consolidated balance
38
sheet at December 31, 2007. Total unused commitments to extend credit were $208 million at December 31, 2007, as compared to $301 million at
December 31, 2006. Net of credit card lines available, which were eliminated with the sale of the credit card portfolio in 2007 but stood at $40 million at December 31, 2006, unused commitments represented 23% and 29% of outstanding gross
loans and leases at December 31, 2007 and 2006, respectively. The Companys stand-by letters of credit totaled $22 million at December 31, 2007 and $29 million at December 31, 2006.
The effect on the Companys revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably
predicted, because there is no certainty that the lines of credit will ever be fully utilized. For more information regarding the Companys off-balance sheet arrangements, see Note 11 to the financial statements in Item 8 herein.
Contractual Obligations
At the end of 2007,
the Company had contractual obligations for the following payments, by type and period due:
Contractual Obligations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
Total
|
|
Less than
1 Year
|
|
1-3 Years
|
|
3-5 Years
|
|
More than
5 Years
|
Long-term debt obligations
|
|
$
|
30,928,000
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
30,928,000
|
Operating lease obligations
|
|
$
|
7,042,000
|
|
$
|
962,000
|
|
$
|
1,668,000
|
|
$
|
1,399,000
|
|
$
|
3,013,000
|
Other long-term obligations
|
|
$
|
3,981,000
|
|
$
|
2,918,000
|
|
$
|
340,000
|
|
$
|
47,000
|
|
$
|
676,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
41,951,000
|
|
$
|
3,880,000
|
|
$
|
2,008,000
|
|
$
|
1,446,000
|
|
$
|
34,617,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-performing Assets
Financial institutions generally have a certain level of exposure to asset quality risk, and could potentially receive less than a full return of principal and interest if a debtor becomes unable or unwilling to
repay. Since loans are the most significant assets of the Company and generate the largest portion of its revenues, the Companys management of risk related to asset quality is focused primarily on loan quality. Banks have generally experienced
their most severe earnings declines as a result of customers inability to generate sufficient cash flow to service their debts, or as a result of the downturns in national and regional economies which have brought about declines in overall
property values. In addition, certain debt securities that the Company may purchase have the potential of declining in value if the obligors financial capacity to repay deteriorates.
To help minimize credit quality concerns, we have established a sound approach to credit that includes well-defined goals and objectives and well-documented credit
policies and procedures. The policies and procedures identify market segments, set goals for portfolio growth or contraction, and establish limits on industry and geographic credit concentrations. In addition, these policies establish the
Companys underwriting standards and the methods of monitoring ongoing credit quality. The Companys internal credit risk controls are centered in underwriting practices, credit granting procedures, training, risk management techniques,
and familiarity with loan and lease customers as well as the relative diversity and geographic concentration of our loan and lease portfolio.
As a
multi-community independent bank serving a specific geographic area, the Company must contend with unpredictable changes in the California and San Joaquin Valley markets, including the current real estate slump. Our credit risk is affected by
external factors such as the level of interest rates, unemployment, general economic conditions, real estate values, and trends in particular industries or geographic markets. At times we have been affected by national and regional economic
recessions, consumer bankruptcies, weather-related agricultural losses, and depressed prices for agricultural goods. Nevertheless, the San Joaquin Valley remains an ideal central location for distribution facilities serving most of California, and
we have comparatively low-cost housing. These favorable factors have the potential to stimulate growth and mitigate some of the effects of the current slowdown, although our market areas are still being negatively impacted and our asset quality has
suffered.
39
Non-performing assets are comprised of the following: Loans and leases for which the Company is no longer accruing
interest; loans and leases 90 days or more past due and still accruing interest (although they are generally placed on non-accrual when they become 90 days past due); loans and leases restructured where the terms of repayment have been renegotiated,
resulting in a deferral of interest or principal; and foreclosed assets, including other real estate owned (OREO). Managements classification of a loan or lease as non-accrual is an indication that there is reasonable
doubt as to the full recovery of principal or interest on the loan or lease. At that point, the Company stops accruing interest income, reverses any uncollected interest that had been accrued as income, and begins recognizing interest income only as
cash interest payments are received and as long as the collection of all outstanding principal is not in doubt. The loans may or may not be collateralized, and collection efforts are continuously pursued. Loans or leases may be restructured by
management when a borrower has experienced some change in financial status causing an inability to meet the original repayment terms and where the Company believes the borrower will eventually overcome those circumstances and make full restitution.
OREO consists of properties acquired by foreclosure or similar means that management is offering or will offer for sale. The following table provides information with respect to components of the Companys non-performing assets at the dates
indicated:
40
Non-performing Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
(dollars in thousands)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
Nonaccrual Loans and Leases:
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
725
|
|
Commercial and Industrial
|
|
$
|
75
|
|
|
$
|
370
|
|
|
$
|
|
|
|
$
|
393
|
|
|
$
|
2,370
|
|
Real Estate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured by Commercial/Professional Office Properties including construction and development
|
|
$
|
6,976
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
116
|
|
Secured by Residential Properties
|
|
$
|
666
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
260
|
|
Secured by Farmland
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
1,313
|
|
|
$
|
1,920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL REAL ESTATE
|
|
$
|
7,642
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
1,313
|
|
|
$
|
2,296
|
|
Small Business Administration loans
|
|
$
|
1,174
|
|
|
$
|
262
|
|
|
$
|
288
|
|
|
$
|
255
|
|
|
$
|
787
|
|
Consumer Loans
|
|
$
|
161
|
|
|
$
|
57
|
|
|
$
|
21
|
|
|
$
|
168
|
|
|
$
|
284
|
|
Credit Cards
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
19
|
|
|
$
|
15
|
|
Direct Financing Leases
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SUBTOTAL
|
|
$
|
9,052
|
|
|
$
|
689
|
|
|
$
|
309
|
|
|
$
|
2,148
|
|
|
$
|
6,477
|
|
|
|
|
|
|
|
Loans and leases 90 days or more past due & still accruing:
(as to principal or interest)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Commercial and Industrial
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Real Estate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured by Commercial/Professional Office Properties including construction and development
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Secured by Residential Properties
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Secured by Farmland
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL REAL ESTATE
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Small Business Administration loans
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
280
|
|
|
$
|
206
|
|
Consumer Loans
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
20
|
|
|
$
|
|
|
Credit Cards
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Direct Financing Leases
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SUBTOTAL
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
300
|
|
|
$
|
206
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL NON-PERFORMING LOANS AND LEASES
|
|
$
|
9,052
|
|
|
$
|
689
|
|
|
$
|
309
|
|
|
$
|
2,448
|
|
|
$
|
6,683
|
|
|
|
|
|
|
|
Other Real Estate Owned
|
|
$
|
556
|
|
|
$
|
|
|
|
$
|
533
|
|
|
$
|
2,524
|
|
|
$
|
2,784
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total nonperforming assets
|
|
$
|
9,608
|
|
|
$
|
689
|
|
|
$
|
842
|
|
|
$
|
4,972
|
|
|
$
|
9,467
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructured loans and leases
(2)
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
Nonperforming loans and leases as % of total gross loans and leases
|
|
|
0.98
|
%
|
|
|
0.08
|
%
|
|
|
0.04
|
%
|
|
|
0.35
|
%
|
|
|
1.09
|
%
|
Nonperforming assets as a % of total gross loans and leases and other real estate owned
|
|
|
1.04
|
%
|
|
|
0.08
|
%
|
|
|
0.11
|
%
|
|
|
0.71
|
%
|
|
|
1.54
|
%
|
(1)
|
Additional interest income of approximately $391,525 would have been recorded for the year ended December 31, 2007 if these loans had been paid in accordance with their
original terms and had been outstanding throughout the applicable period then ended or, if not outstanding throughout the applicable period then ended, since origination.
|
(2)
|
A restructured loan or lease is one where the terms were renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the
financial position of the borrower.
|
41
Total non-performing assets increased by $8.9 million during 2007 and ended the year at $9.6 million, with most of the
increase coming in the fourth quarter. The aggregate balance of non-performing assets at the end of 2006 represents a drop of $153,000, or 18%, from year-end 2005 levels due to the sale of the Companys last remaining OREO early in 2006. In
2005, non-performing assets fell $4.1 million, or 83%, from year-end 2004 levels. The main changes during 2005 were in loans secured by farmland, which were reduced by $1.3 million due to the sale of a non-accruing note, and OREO, which was reduced
by $2.0 million. As might be expected by the large increase in non-performing balances in 2007, the ratio of non-performing assets to total gross loans plus OREO also rose, reaching 1.04% at the end of 2007 relative to 0.08% at the end of 2006 and
0.11% at the end of 2005. From a historical perspective, it should be noted that the ratio is still not as high as the 1.54% level reached at the end of 2003.
Foreclosed assets represent $556,000 of the non-performing asset balance at December 31, 2007, although an OREO property included in that total with a book value of $196,000 was sold during January 2008. The non-accruing loan balance
of $9.1 million is comprised of $236,000 in unsecured commercial and consumer loans, $1.2 million in SBA loans which carry a 75% government guarantee, and $7.6 million in loans secured by real estate. The real estate loans include a $1.9 million
acquisition and development loan, a $1.2 million commercial real estate loan, $3.6 million in construction loans, and loans secured by residential properties totaling $666,000. A large portion of the construction loans on non-accrual are also
secured by properties that are ultimately slated for residential use. Specific reserves have been allocated for all non-accruing loans, based on a detailed analysis of expected cash flows for each loan. The reserve for SBA loans on non-accrual
status does not include the guaranteed portion of the loans, since a loss is not probable for those balances.
An action plan is in place for each of our
non-performing and foreclosed assets and they are all being actively managed, although we cannot provide assurance that all will be resolved in a timely manner or that non-performing balances will not increase further. Significant changes in
non-performing assets subsequent to year-end include the sale of the $1.2 million non-performing commercial real estate loan referenced in the previous paragraph, with full recovery of principal. There are also four real estate loans totaling
$432,000 for which the borrowers are being fully cooperative in restructuring efforts, due to relatively low loan to value ratios. If restructuring efforts are successful, delinquent principal and interest payments for those loans will be brought
current. And, five loans totaling $1.7 million which were included in non-accruing loans at year-end have subsequently been acquired into OREO. The largest of those, a property on our books at $1.1 million, is currently in escrow.
While we had no subprime loans and only $14 million in so-called stated income loans on our books at December 31, 2007, we recognize that an increase in
the dollar amount of non-accrual loans and leases is possible in the normal course of business as we expand our lending activities and as the credit climate changes. We also expect additional foreclosures as a last resort in the resolution of some
problem credits.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses is established through a provision for loan and lease losses based on managements evaluation of known and inherent risks in the Companys loan portfolio. At December 31, 2007, the
allowance for loan and lease losses was $12.3 million, or 1.33% of gross loans, as compared to the $11.6 million allowance at December 31, 2006 which was 1.30% of gross loans. An allowance for potential losses inherent in unused commitments is
included in other liabilities, and totaled $160,000 at December 31, 2007.
We employ a systematic methodology for determining the appropriate level of
the allowance for loan and lease losses and adjusting it on at least a quarterly basis. Our process includes a periodic review of individual loans that have been specifically identified as problem loans or have characteristics that could lead to
impairment, as well as detailed reviews of other loans either individually or in pools. While this methodology utilizes historical data, projected cash flows and other objective information, the classification of loans and the establishment of the
allowance for loan and lease losses are both to some extent based on managements judgment and experience.
Our methodology incorporates a variety of
risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that management believes is appropriate at each reporting date. Quantitative factors include our historical loss experience, delinquency
and charge-off trends, collateral values, the anticipated timing of collection of principal for nonperforming
42
loans, fluctuations in loan balances, the rate of loan portfolio growth, and other factors. Quantitative factors also incorporate other known information
about individual loans, including a borrowers sensitivity to interest rate movements or other quantifiable external factors such as commodity prices or acts of nature (freezes, earthquakes, fires, etc.).
Qualitative factors include the general economic environment in our markets and, in particular, the state of the agricultural industry and other key industries in the
Central San Joaquin Valley. The way a particular loan might be structured, the extent and nature of waivers of existing loan policies, the results of bank regulatory examinations, and model imprecision are additional factors that are considered.
The table that follows summarizes the activity in the allowance for loan and lease losses for the periods indicated:
43
Allowance For Loan Losses and Leases
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of and for the years ended December 31,
|
|
(dollars in thousands)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
Balances:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average gross loans and leases outstanding during period
|
|
$
|
903,046
|
|
|
$
|
824,041
|
|
|
$
|
708,002
|
|
|
$
|
636,598
|
|
|
$
|
550,744
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross loans and leases outstanding at end of period
|
|
$
|
924,633
|
|
|
$
|
888,008
|
|
|
$
|
741,360
|
|
|
$
|
696,276
|
|
|
$
|
610,681
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for Loan and Lease Losses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
11,579
|
|
|
$
|
9,330
|
|
|
$
|
8,842
|
|
|
$
|
6,701
|
|
|
$
|
5,939
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision Charged to Expense
|
|
$
|
3,252
|
|
|
$
|
3,851
|
|
|
$
|
3,150
|
|
|
$
|
3,473
|
|
|
$
|
3,105
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Charge-offs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
|
|
$
|
15
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
60
|
|
|
$
|
|
|
Commercial & Industrial Loans
(1)
|
|
$
|
666
|
|
|
$
|
1,301
|
|
|
$
|
2,864
|
|
|
$
|
459
|
|
|
$
|
1,491
|
|
Real Estate loans
|
|
$
|
724
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Consumer Loans
|
|
$
|
1,636
|
|
|
$
|
571
|
|
|
$
|
494
|
|
|
$
|
596
|
|
|
$
|
542
|
|
Direct Financing Leases
|
|
$
|
|
|
|
$
|
4
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Credit Card Loans
|
|
$
|
139
|
|
|
$
|
344
|
|
|
$
|
400
|
|
|
$
|
402
|
|
|
$
|
561
|
|
Overdrafts
|
|
$
|
498
|
|
|
$
|
213
|
|
|
$
|
216
|
|
|
$
|
254
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
3,678
|
|
|
$
|
2,433
|
|
|
$
|
3,974
|
|
|
$
|
1,771
|
|
|
$
|
2,594
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recoveries
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
|
|
$
|
|
|
|
$
|
5
|
|
|
$
|
747
|
|
|
$
|
143
|
|
|
$
|
34
|
|
Commercial & Industrial Loans
(1)
|
|
$
|
862
|
|
|
$
|
439
|
|
|
$
|
325
|
|
|
$
|
95
|
|
|
$
|
68
|
|
Real Estate loans
|
|
$
|
77
|
|
|
$
|
|
|
|
$
|
2
|
|
|
$
|
|
|
|
$
|
|
|
Consumer Loans
|
|
$
|
77
|
|
|
$
|
253
|
|
|
$
|
95
|
|
|
$
|
120
|
|
|
$
|
73
|
|
Direct Financing Leases
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Credit Card Loans
|
|
$
|
50
|
|
|
$
|
86
|
|
|
$
|
88
|
|
|
$
|
71
|
|
|
$
|
76
|
|
Overdrafts
|
|
$
|
57
|
|
|
$
|
48
|
|
|
$
|
55
|
|
|
$
|
10
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,123
|
|
|
$
|
831
|
|
|
$
|
1,312
|
|
|
$
|
439
|
|
|
$
|
251
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Loan and Lease Charge-offs
|
|
$
|
2,555
|
|
|
$
|
1,602
|
|
|
$
|
2,662
|
|
|
$
|
1,332
|
|
|
$
|
2,343
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
12,276
|
|
|
$
|
11,579
|
|
|
$
|
9,330
|
|
|
$
|
8,842
|
|
|
$
|
6,701
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Loan and Lease Charge-offs to Average Loans and Leases
|
|
|
0.28
|
%
|
|
|
0.19
|
%
|
|
|
0.38
|
%
|
|
|
0.21
|
%
|
|
|
0.43
|
%
|
Allowance for Loan and Lease Losses to Gross Loans and Leases at End of Period
|
|
|
1.33
|
%
|
|
|
1.30
|
%
|
|
|
1.26
|
%
|
|
|
1.27
|
%
|
|
|
1.10
|
%
|
Allowance for Loan and Lease Losses to Non-Performing Loans and Leases
|
|
|
135.62
|
%
|
|
|
1680.55
|
%
|
|
|
3019.42
|
%
|
|
|
361.19
|
%
|
|
|
100.27
|
%
|
Net Loan and Lease Charge-offs to Allowance for Loan and Lease Losses at End of Period
|
|
|
20.81
|
%
|
|
|
13.84
|
%
|
|
|
28.53
|
%
|
|
|
15.06
|
%
|
|
|
34.96
|
%
|
Net Loan and Lease Charge-offs to Provision for Loan and Lease Losses
|
|
|
78.57
|
%
|
|
|
41.60
|
%
|
|
|
84.51
|
%
|
|
|
38.35
|
%
|
|
|
75.46
|
%
|
(1)
|
Includes Small Business Administration Loans.
|
44
The allowance is increased by a provision for possible loan and lease losses charged against current earnings, and by the
recovery of previously charged-off balances. It is reduced by loan charge-offs. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when cash payments are
received subsequent to the charge off. Despite increased specific reserves for non-performing loans and increased general reserves for equity lines and unsecured credit lines, the Companys provision for loan and lease losses was reduced by
$599,000 in 2007 relative to 2006. As noted previously, the provision was lower because of the sale of the credit card portfolio, a higher level of recoveries and slower loan growth.
The level of net charge-offs to average loans and leases increased to 0.28% for 2007 in comparison to 0.19% for 2006. Gross loans charged off during 2007 increased by $1.2 million mainly because of a $1.1 million
increase in unsecured consumer loans charged off. That number has escalated as economic growth has decelerated. Real estate loan charge-offs also increased by $724,000, mostly due to charged-off equity lines, and overdraft losses were $285,000
higher due to a higher level of overdraft activity. Partially offsetting those increases were a $205,000 drop in credit card charge-offs subsequent to the sale of the credit card portfolio, and a $635,000 decline in commercial loan charge-offs
because prior-year commercial charge-offs include a single $443,000 loan. Net charge-offs were $953,000 higher in 2007 than in 2006, which is lower than the increase in gross charge-offs because loan recoveries were $292,000 higher in 2007. Most of
the increase in loan recoveries is due to the recoupment of previously charged-off principal on a single commercial loan.
While evolving somewhat to
incorporate a greater level of detail and sophistication in the past few years, our methodology for determining the adequacy of the Companys allowance for loan and lease losses has, for the most part, been consistently followed. As we add new
products and expand our geographic coverage, we expect to continue to enhance our methodology to keep pace with the size and complexity of the loan and lease portfolio. We engage outside firms on a regular basis to independently assess our
methodology and perform independent credit reviews of our loan and lease portfolio. In addition, the Companys external auditors, the FDIC, and the California Department of Financial Institutions review the allowance for loan and lease losses
as an integral part of their audit and examination processes. Management believes that the current methodology is appropriate given our size and level of complexity. Further, management believes that the allowance for loan and lease losses at
December 31, 2007 was adequate to cover known and inherent risks in the portfolio. Fluctuations in credit quality, changes in economic conditions, or other factors could induce us to augment the allowance, however, and no assurance can be given
that such factors will not result in increased losses in the loan and lease portfolio in the future.
The following table provides a summary of the
allocation of the allowance for loan and lease losses for specific categories at the dates indicated. The allocation presented should not be interpreted as an indication that charges to the allowance for loan and lease losses will be incurred in
these amounts or proportions, or that the portion of the allowance allocated to each category represents the total amounts available for charge-offs that may occur within these categories.
Allocation of Loan and Lease Loss Allowance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
(dollars in thousands)
|
|
Amount
|
|
% Total
(1)
Loans
|
|
|
Amount
|
|
% Total
(1)
Loans
|
|
|
Amount
|
|
% Total
(1)
Loans
|
|
|
Amount
|
|
% Total
(1)
Loans
|
|
|
Amount
|
|
% Total
(1)
Loans
|
|
Agricultural
|
|
$
|
911
|
|
1.42
|
%
|
|
$
|
1,496
|
|
1.49
|
%
|
|
$
|
64
|
|
1.34
|
%
|
|
$
|
442
|
|
1.89
|
%
|
|
$
|
351
|
|
2.24
|
%
|
Comml and Industrial
(2)
|
|
$
|
1,808
|
|
14.87
|
%
|
|
$
|
1,470
|
|
15.72
|
%
|
|
$
|
2,295
|
|
16.82
|
%
|
|
$
|
4,421
|
|
17.46
|
%
|
|
$
|
2,728
|
|
18.87
|
%
|
Real Estate
|
|
$
|
8,294
|
|
75.29
|
%
|
|
$
|
6,866
|
|
73.43
|
%
|
|
$
|
5,918
|
|
72.46
|
%
|
|
$
|
2,211
|
|
71.87
|
%
|
|
$
|
2,721
|
|
70.63
|
%
|
Consumer Loans
|
|
$
|
1,018
|
|
5.92
|
%
|
|
$
|
1,077
|
|
6.14
|
%
|
|
$
|
467
|
|
6.88
|
%
|
|
$
|
884
|
|
7.04
|
%
|
|
$
|
719
|
|
6.73
|
%
|
Direct Financing Leases
|
|
$
|
245
|
|
2.50
|
%
|
|
$
|
212
|
|
2.27
|
%
|
|
$
|
71
|
|
1.37
|
%
|
|
$
|
177
|
|
0.50
|
%
|
|
$
|
|
|
0.13
|
%
|
Consumer Credit Cards
|
|
$
|
|
|
0.00
|
%
|
|
$
|
458
|
|
0.95
|
%
|
|
$
|
515
|
|
1.13
|
%
|
|
$
|
707
|
|
1.24
|
%
|
|
$
|
182
|
|
1.40
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL
|
|
$
|
12,276
|
|
100.00
|
%
|
|
$
|
11,579
|
|
100.00
|
%
|
|
$
|
9,330
|
|
100.00
|
%
|
|
$
|
8,842
|
|
100.00
|
%
|
|
$
|
6,701
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Represents percentage of loans in category to total loans.
|
(2)
|
Includes Small Business Administration loans.
|
45
Investments
The Companys investments consist of debt and marketable equity securities (together, the investment portfolio), investments in the time deposits of other banks, and overnight fed funds sold. Fed funds sold represent the
investment of temporary excess liquidity with one or more correspondent banks. There were no fed funds sold as of December 31, 2007, but fed funds sold totaled $6 million at the end of 2006.
With a book value of $185 million at December 31, 2007, the investment portfolio is the second largest component of the Companys interest earning assets, and
the structure and composition of this portfolio is important to any analysis of the financial condition of the Company. The investment portfolio serves the following purposes: 1) it can be readily reduced in size to provide liquidity for loan
balance increases or deposit balance decreases; 2) it provides a source of pledged assets for securing certain deposits and borrowed funds, as may be required by law or by specific agreement with a depositor or lender; 3) it can be used as an
interest rate risk management tool, since it provides a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding
sources of the Company; 4) it is an alternative interest-earning use of funds when loan demand is weak or when deposits grow more rapidly than loans; and 5) it can enhance the Companys tax position by providing partially tax exempt income.
The Company uses two portfolio classifications for its investment portfolio: held-to-maturity, and available-for-sale. Accounting
rules also allow a trading portfolio classification, but the Company has no investments that would be classified as such. The held-to-maturity portfolio can consist only of investments that the Company has both the intent and ability to hold until
maturity, to be sold only in the event of concerns with an issuers credit worthiness, a change in tax law that eliminates their tax exempt status, or other infrequent situations as permitted by generally accepted accounting principles. Since
the Company does not have a trading portfolio, the available-for-sale portfolio is comprised of all securities not included as held-to-maturity. Even though management currently has the intent and the ability to hold the Companys
marketable investments to maturity, they are all currently classified as available-for-sale to allow maximum flexibility with regard to the active management of the Companys investment portfolio. SFAS 115 requires available-for-sale securities
to be marked to market on a periodic basis with an offset to accumulated other comprehensive income, a component of equity. Monthly adjustments are made to that account to reflect changes in the market value of the Companys available-for-sale
securities.
The Companys investment portfolio is currently composed of: (1) U.S. Treasury and Agency issues for liquidity and pledging;
(2) mortgage-backed securities, which in many instances can also be used for pledging, and which generally enhance the yield of the portfolio; (3) state, county and municipal obligations, which provide limited tax free income and pledging
potential; and (4) other equity investments. The fourth category includes an equity investment in Farmer Mac stock, which is a required element to allow the Company to sell certain agricultural loans to this quasi-governmental agency. The
Companys Board also recently approved an allocation of funds to be used to invest in the equity securities of other community banks, although no purchases had been consummated as of the end of 2007 and this is not expected to become a material
component of the Companys business in the near future. Securities pledged as collateral for repurchase agreements, public deposits and for other purposes as required or permitted by law were $162 million and $167 million at December 31,
2007 and 2006, respectively.
Approximately $48 million of the investment portfolio at December 31, 2007 represents remaining balances from the $100
million leverage strategy implemented in April 2004. The leverage balances are funded in part by $27 million in fixed-rate FHLB borrowings obtained at the commencement of the leverage strategy, of which $5 million is currently classified as long
term and $22 million represents balances that mature in April 2008. Short-term FHLB borrowings that are rolled over every 30 to 60 days make up the difference.
Total investment portfolio balances declined $5 million during 2007, with a $10 million drop in mortgage-backed securities partially offset by a $4 million increase in municipal securities and a $1 million increase in Agency securities.
Investment portfolio balances also fell $3 million in 2006, with a $13 million drop in mortgage-backed securities partially offset by a $9 million increase in municipal securities and a $1 million increase in Agency securities. The decline in
mortgage-backed securities over the past two years is due to prepayments on our leverage strategy bonds. Mortgage-backed securities have fallen to 58% of total investment securities at December 31, 2007, from 62% at the end of 2006 and 68% at
the end of 2005. Longer-duration municipal bonds have increased in
46
weighting over the last two years, to 31% of the total portfolio at the end of 2007 from 28% at the end of 2006 and 23% at the end of 2005, as a defensive
measure to protect against falling bond rates. At December 31, 2007, the investment portfolio was 15% of total assets, as compared to 16% at the end of 2006 and 18% at the end of 2005.
As can be seen on the Distribution, Rate & Yield table presented in a previous section, the average tax-equivalent yield earned on total investments increased
to 5.08% in 2007 from 4.89% in 2006. The following Investment Portfolio table reflects the amortized cost and fair market values for the total portfolio for each of the categories of investments for the past three years.
Investment Portfolio - Available For Sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
(dollars in thousands)
|
|
Amortized
Cost
|
|
Fair Market
Value
|
|
Amortized
Cost
|
|
Fair Market
Value
|
|
Amortized
Cost
|
|
Fair Market
Value
|
US Treasury securities
|
|
$
|
698
|
|
$
|
706
|
|
$
|
501
|
|
$
|
496
|
|
$
|
504
|
|
$
|
495
|
US Government agencies
|
|
|
18,613
|
|
|
18,831
|
|
|
18,035
|
|
|
17,879
|
|
|
17,360
|
|
|
17,143
|
Mortgage-backed securities
|
|
|
108,729
|
|
|
107,684
|
|
|
121,204
|
|
|
118,175
|
|
|
134,455
|
|
|
131,050
|
State & political subdivisions
|
|
|
57,242
|
|
|
57,688
|
|
|
53,387
|
|
|
53,713
|
|
|
44,477
|
|
|
44,977
|
Equity securities
|
|
|
6
|
|
|
8
|
|
|
6
|
|
|
9
|
|
|
6
|
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investment Securities
|
|
$
|
185,288
|
|
$
|
184,917
|
|
$
|
193,133
|
|
$
|
190,272
|
|
$
|
196,802
|
|
$
|
193,676
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The investment maturities table below summarizes contractual maturities for the Companys investment
securities and their weighted average yields at December 31, 2007. The actual timing of principal payments may differ from remaining contractual maturities, because obligors may have the right to repay certain obligations with or without
penalties.
Investment Maturities - Available For Sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007
|
|
|
|
Within One
Year
|
|
|
After One But
Within Five Years
|
|
|
After Five Years But
Within Ten Years
|
|
|
After Ten
Years
|
|
|
Total
|
|
(dollars in thousands)
|
|
Amount
|
|
Yield
|
|
|
Amount
|
|
Yield
|
|
|
Amount
|
|
Yield
|
|
|
Amount
|
|
Yield
|
|
|
Amount
|
|
Yield
|
|
US Treasury securities
|
|
$
|
199
|
|
3.02
|
%
|
|
$
|
507
|
|
4.70
|
%
|
|
$
|
|
|
|
|
|
$
|
|
|
|
|
|
$
|
706
|
|
4.22
|
%
|
US Government agencies
|
|
|
2,992
|
|
4.11
|
%
|
|
|
13,242
|
|
4.66
|
%
|
|
|
2,597
|
|
5.51
|
%
|
|
|
|
|
|
|
|
|
18,831
|
|
4.69
|
%
|
Mortgage-backed securities
|
|
|
1,121
|
|
4.43
|
%
|
|
|
102,271
|
|
4.60
|
%
|
|
|
4,292
|
|
5.65
|
%
|
|
|
|
|
|
|
|
|
107,684
|
|
4.64
|
%
|
State & political subdivisions
(1)
|
|
|
3,688
|
|
5.99
|
%
|
|
|
17,533
|
|
5.88
|
%
|
|
|
25,133
|
|
5.86
|
%
|
|
|
11,334
|
|
6.08
|
%
|
|
|
57,688
|
|
5.92
|
%
|
Equity securities
(2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8
|
|
4.63
|
%
|
|
|
8
|
|
4.63
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment securities
|
|
$
|
8,000
|
|
|
|
|
$
|
133,553
|
|
|
|
|
$
|
32,022
|
|
|
|
|
$
|
11,342
|
|
|
|
|
$
|
184,917
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Yields are not adjusted for the tax benefits of non taxable income
|
(2)
|
Equity securities have no stated maturity but have been added to the after ten years, for ease of review.
|
Cash and Due from Banks
Cash on hand and non-interest bearing
balances due from correspondent banks totaled $44 million at the end of 2007 and $53 million at the end of 2006. Cash and due from banks comprised 4% of total assets at December 31, 2007 and December 31, 2006. These balances fluctuate
frequently and by large amounts depending on the status of cash items in process of collection and cash on hand, thus period-end balances are not optimal indicators of trends in cash and due from banks. Annual average balances provide a much more
appropriate gauge. The average balance for 2007 was $38 million, down from $40 million in 2006 due to our conversion to electronic image presentment for checks sent for collection and the subsequent reduction in negative float. This balance is
expected to increase further as we add more branches in the future.
47
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is charged to income over the estimated useful lives of the assets and leasehold improvements are amortized over the terms of the
related lease, or the estimated useful lives of the improvements, whichever is shorter. Depreciation and amortization included in occupancy and equipment expense was $2.8 million for the year ended December 31, 2007 as compared to $3.1 million
during 2006. Depreciation on equipment leased to others is reflected in other operating costs. The following premises and equipment table reflects the balances by major category of fixed assets:
Premises & Equipment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
(dollars in thousands)
|
|
Cost
|
|
Accumulated
Depr. and
Amortization
|
|
Net Book
Value
|
|
Cost
|
|
Accumulated
Depr. and
Amortization
|
|
Net Book
Value
|
|
Cost
|
|
Accumulated
Depr. and
Amortization
|
|
Net Book
Value
|
Land
|
|
$
|
2,329
|
|
$
|
|
|
$
|
2,329
|
|
$
|
2,054
|
|
$
|
|
|
$
|
2,054
|
|
$
|
2,054
|
|
$
|
|
|
$
|
2,054
|
Buildings
|
|
$
|
11,358
|
|
$
|
4,311
|
|
$
|
7,047
|
|
$
|
11,189
|
|
$
|
3,929
|
|
$
|
7,260
|
|
$
|
10,287
|
|
$
|
3,543
|
|
$
|
6,744
|
Leasehold Improvements
|
|
$
|
6,564
|
|
$
|
1,935
|
|
$
|
4,629
|
|
$
|
5,336
|
|
$
|
1,591
|
|
$
|
3,745
|
|
$
|
4,847
|
|
$
|
1,568
|
|
$
|
3,279
|
Construction in progress
|
|
$
|
72
|
|
$
|
|
|
$
|
72
|
|
$
|
443
|
|
$
|
|
|
$
|
443
|
|
$
|
416
|
|
$
|
|
|
$
|
416
|
Furniture and Equipment
|
|
$
|
20,075
|
|
$
|
15,897
|
|
$
|
4,178
|
|
$
|
19,312
|
|
$
|
14,836
|
|
$
|
4,476
|
|
$
|
18,949
|
|
$
|
13,387
|
|
$
|
5,562
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
40,398
|
|
$
|
22,143
|
|
$
|
18,255
|
|
$
|
38,334
|
|
$
|
20,356
|
|
$
|
17,978
|
|
$
|
36,553
|
|
$
|
18,498
|
|
$
|
18,055
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The net book value of the Companys premises and equipment increased by $277,000 in 2007, due to an increase
in leasehold improvements associated with our new Delano branch. The net book value declined by $77,000 in 2006, since the net increase in accumulated depreciation more than offset capitalized costs associated with building and outfitting the new
Bakersfield Riverlakes branch. The net book value of the Companys aggregate premises and equipment was 1.5% of total assets at December 31, 2007 and December 31, 2006, and 1.7% at December 31, 2005.
Other Assets
Other assets increased by $2.3 million, or 3%,
during 2007, and were about 6% of total assets at the end 2007 relative to 5% at the end of 2006. Significant changes in 2007 in the categories comprising other assets include the following: our investment in tax credit funds increased by $2.0
million, due to an additional $3.0 million commitment less pass-through losses recognized during the year; the net cash surrender value of BOLI increased by $1.5 million, due to $1.2 million in earnings for the year plus an increased investment in
the separate account BOLI associated with deferred compensation plans; our net deferred tax asset declined by $1.7 million; our restricted stock balance increased $395,000; and accrued interest receivable was up by $171,000.
As noted above, the Company holds certain equity investments that are not readily marketable securities and thus are classified as other assets on the
Companys balance sheet. These include investments in Pacific Coast Bankers Bancshares, California Economic Development Lending Initiative, and the FHLB. At December 31, 2007, the largest of the referenced investments is the Companys
$10.2 million investment in FHLB stock. This investment fluctuates from time to time based on the Companys borrowing activity at the Federal Home Loan Bank, and as noted earlier increased in 2007 due to an increase in short-term borrowings.
The other assets category also includes low-income housing tax credit funds, which lower the Companys tax liability through direct tax credits as
well as partnership operating losses. Pass-through partnership losses from tax credit funds are charged against the Companys investment in such funds, thus the investment has been written down from an aggregate original total of $18.4 million
to $13.8 million at December 31, 2007. Even taking losses into consideration and assuming no gain upon disposition, the estimated tax-equivalent return on most of these investments over their expected 15-year life is around 11%, although no
guarantee can be provided that this level of return will ultimately be realized.
Another item included in other assets is an aggregate $28.0 million
investment in bank-owned life insurance at December 31, 2007. BOLI is an insurance policy with a single premium paid at policy commencement. Its initial net cash surrender value is equivalent to the premium paid, and it adds income through
non-taxable increases in its cash surrender value, net of the cost of insurance, plus any death benefits ultimately received by the Company. The expenses of certain benefit plans are offset by BOLI income.
48
At December 31, 2007, a $3.3 million net deferred tax asset is also an element of other assets. Most of the
Companys temporary differences between book and taxable income and expenses involve recognizing more expense in its financial statements than it has been allowed to deduct for current-period taxes; therefore, the Companys deferred tax
assets typically exceeds its deferred tax liabilities. The net deferred tax asset is primarily due to temporary book/tax differences in the reported allowance for loan losses plus deferred compensation, net of deferred liabilities comprised mainly
of fixed asset depreciation differences and deferred loan origination costs. Management has evaluated all deferred tax assets, and has no reason to believe that either the quality of the deferred tax assets or the Companys future taxable
income potential would preclude full realization of all amounts in future years.
Deposits
Another key balance sheet component impacting the Companys net interest margin is our deposit base. Deposits provide liquidity to fund growth in earning assets, and
the Companys net interest margin is improved to the extent that growth in deposits is concentrated in less volatile and typically less costly core deposits, which include demand deposit accounts, interest-bearing demand accounts (NOW
accounts), savings accounts, money market demand accounts (MMDAs), and time deposits under $100,000. Information concerning the average balance and average rates paid on deposits by deposit type for the past three fiscal years is contained in
the Distribution, Rate, and Yield table located in the previous section on Results of OperationsNet Interest Income and Net Interest Margin.
A comparative schedule of the distribution of the Companys deposits at December 31
st
for each year from 2003 through 2007, by outstanding balance as well as by percentage of total deposits, is presented in the following Deposit Distribution
table:
Deposit Distribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
(dollars in thousands)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
Demand
|
|
$
|
243,764
|
|
|
$
|
281,024
|
|
|
$
|
282,451
|
|
|
$
|
235,732
|
|
|
$
|
196,392
|
|
NOW
|
|
|
86,936
|
|
|
|
64,599
|
|
|
|
69,088
|
|
|
|
62,887
|
|
|
|
55,047
|
|
Savings
|
|
|
51,442
|
|
|
|
62,922
|
|
|
|
71,901
|
|
|
|
68,192
|
|
|
|
50,643
|
|
Money Market
|
|
|
126,347
|
|
|
|
115,266
|
|
|
|
107,045
|
|
|
|
137,545
|
|
|
|
130,804
|
|
TDOAs & IRAs
|
|
|
23,715
|
|
|
|
23,321
|
|
|
|
22,480
|
|
|
|
22,195
|
|
|
|
22,358
|
|
Time deposit < $100,000
|
|
|
118,799
|
|
|
|
110,233
|
|
|
|
90,639
|
|
|
|
84,576
|
|
|
|
100,128
|
|
Time deposits
>
$100,000
|
|
|
199,144
|
|
|
|
211,080
|
|
|
|
172,067
|
|
|
|
131,576
|
|
|
|
129,105
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Deposits
|
|
$
|
850,147
|
|
|
$
|
868,445
|
|
|
$
|
815,671
|
|
|
$
|
742,703
|
|
|
$
|
684,477
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of Total Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand
|
|
|
28.67
|
%
|
|
|
32.36
|
%
|
|
|
34.63
|
%
|
|
|
31.74
|
%
|
|
|
28.69
|
%
|
NOW
|
|
|
10.23
|
%
|
|
|
7.44
|
%
|
|
|
8.47
|
%
|
|
|
8.47
|
%
|
|
|
8.04
|
%
|
Savings
|
|
|
6.05
|
%
|
|
|
7.25
|
%
|
|
|
8.81
|
%
|
|
|
9.18
|
%
|
|
|
7.40
|
%
|
Money Market
|
|
|
14.86
|
%
|
|
|
13.27
|
%
|
|
|
13.12
|
%
|
|
|
18.52
|
%
|
|
|
19.11
|
%
|
TDOAs & IRAs
|
|
|
2.79
|
%
|
|
|
2.68
|
%
|
|
|
2.76
|
%
|
|
|
2.99
|
%
|
|
|
3.27
|
%
|
Time deposit < $100,000
|
|
|
13.97
|
%
|
|
|
12.69
|
%
|
|
|
11.11
|
%
|
|
|
11.39
|
%
|
|
|
14.63
|
%
|
Time deposits
>
$100,000
|
|
|
23.43
|
%
|
|
|
24.31
|
%
|
|
|
21.10
|
%
|
|
|
17.71
|
%
|
|
|
18.86
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Despite current deposit-oriented marketing initiatives, we experienced a challenging deposit environment in 2007,
with relatively subdued growth in branch deposits and migration from non-interest demand deposits and low-cost savings accounts into higher-cost NOW accounts, money market accounts and time deposits. The Companys total deposits declined by $18
million, or 2%, in 2007, due primarily to the replacement of $25 million in wholesale-sourced brokered time deposits with FHLB borrowings.
49
Branch-generated deposits thus increased by $7 million, although that net increase was due to growth in relatively costly time deposits over $100,000 (jumbo
CDs). Aggregate core deposit balances actually fell by $6 million, or 1%, in 2007, despite net growth of over 8,300, or 14%, in the absolute number of those accounts in response to our marketing initiatives. Our core deposit accounts increased
in number to about 68,300 at the end of 2007 from around 60,000 at the end of 2006, but the average balance per core deposit account declined to about $9,500 at the end of 2007 from $10,900 at the end of 2006. Because of the drop in brokered
deposits during 2007, core deposit balances increased slightly to 76% of total deposits at the end of 2007 from 75% at the end of 2006, although that ratio has been trending down over the past several years.
Among core deposit categories, non-interest bearing demand deposits dropped by $37 million, or 13%, falling to 29% of total deposits at the end of 2007 from 32% at the
end of 2006. Furthermore, relatively low-cost savings account balances fell by $11 million, or 18%. NOW accounts, however, increased by $22 million, or 35%, and money market accounts increased by $11 million, or 10%. Time deposits under $100,000
also increased by $9 million, or 8%. Part of the increase in NOW accounts represents migration from non-interest bearing personal demand deposits, pursuant to aggressive marketing initiatives that increased awareness among current customers of our
new account line-up and higher rates on NOW accounts. In addition, much of the increase in money market accounts represents dollars transferred from non-interest bearing business demand deposits, as the result of our money market sweep account for
businesses that pays relatively aggressive rates.
Our deposit-focused marketing initiatives and the implementation of the money market sweep account had
the primary goal of attracting new deposit accounts and balances to the Company, but they also represent defensive moves to retain current customers and some of the aforementioned cannibalization was expected. Furthermore, banks in general are
experiencing the movement of lower-cost non-maturity deposit balances into higher-cost time deposits, and in many cases out of the banking system into brokerage accounts and online accounts, as customers have become increasingly aware of
higher-yield alternatives. The migration of balances into higher-yielding deposits and systemic disintermediation have intensified local competition for deposits, which has in turn increased our cost of funds.
Non-core deposit changes include a $13 million increase in other jumbo time deposits and the previously noted decline in brokered deposits. The Company had a total of
$55 million in wholesale brokered deposits on its books at December 31, 2007 and $80 million at year-end 2006. Maturities of these deposits are staggered over the next five months, and it is our intention to replace them with
internally-generated branch deposits when possible.
The shift from lower-cost to higher-cost deposit balances and the overall stagnation in deposit growth
experienced by the Company during 2007 appear to be typical for many financial institutions around the country, based on FDIC banking industry reports and other institution-specific data. Management recognizes that maintaining a high level of core
deposits is one of the keys to sustaining a strong net interest margin, but we also understand that merely growing at the same rate as the market is no longer sufficient. We will continue to focus on attracting deposits from other institutions and
garnering a higher deposit market share through our ongoing High-Performance Checking initiatives. We also plan to utilize other aggressive sales efforts focused on our strong array of deposit products and services, including deposit sales
specialists for each of our major markets. Furthermore, core deposit growth is a key component of our branch managers incentive goals. No assurance can be provided that these efforts will have the desired impact on core deposit growth,
however.
50
The scheduled maturity distribution of the Companys time deposits as of December 31, 2007 was as follows:
Deposit Maturity Distribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007
|
(dollars in thousands)
|
|
Three
months
or less
|
|
Three
to six
months
|
|
Six
to twelve
months
|
|
One
to three
years
|
|
Over
three
Years
|
|
Total
|
Time Certificates of Deposits < $100,000
|
|
$
|
71,493
|
|
$
|
42,295
|
|
$
|
17,940
|
|
$
|
5,343
|
|
$
|
1,021
|
|
$
|
138,092
|
Other Time Deposits
>
$100,000
|
|
$
|
95,932
|
|
$
|
88,265
|
|
$
|
16,853
|
|
$
|
1,822
|
|
$
|
694
|
|
$
|
203,566
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL
|
|
$
|
167,425
|
|
$
|
130,560
|
|
$
|
34,793
|
|
$
|
7,165
|
|
$
|
1,715
|
|
$
|
341,658
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In addition to deposit liabilities obtained in local markets, the Company provides a cash management product to
its commercial business customers. This product group is categorized as a non-deposit sweep account. Due to their overnight nature and because they are collateralized, the cost of these sweep accounts has generally been significantly
lower than the Companys interest rates for longer-term non-collateralized funds. At December 31, 2007, the Companys balance sheet includes $22 million in repurchase agreements in short-term borrowings (see next section), secured by
pledged investments held segregated from the Companys securities portfolio, that represent such sweep accounts. At December 31, 2006, the Companys financial statements reflected approximately $26 million in repurchase agreements.
Migration from this category into the money market sweep account has occurred to some extent for companies that do not require collateralization of their deposits.
Other Borrowings
The Company utilizes other short-term borrowings to temporarily fund loan growth when customer deposit growth has
not kept pace with increases in outstanding loan balances. In addition, short-term borrowings may be used to purchase additional investments, or when additional liquidity is required to support higher customer cash utilization. Short-term borrowings
principally include overnight fed funds purchased, advances from the Federal Home Loan Bank of San Francisco (FHLB), and securities sold under repurchase agreements which were described more fully in the previous section. The details of these
borrowings for the years 2007, 2006, and 2005 are presented below:
Short-term Borrowings
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Repurchase Agreements
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31st
|
|
$
|
22,082
|
|
|
$
|
26,003
|
|
|
$
|
26,791
|
|
Average amount outstanding
|
|
$
|
24,070
|
|
|
$
|
24,281
|
|
|
$
|
28,772
|
|
Maximum amount outstanding at any month end
|
|
$
|
27,492
|
|
|
$
|
29,541
|
|
|
$
|
31,038
|
|
|
|
|
|
Average interest rate for the year
|
|
|
0.70
|
%
|
|
|
0.66
|
%
|
|
|
0.38
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fed funds purchased
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31st
|
|
$
|
17,000
|
|
|
$
|
25,000
|
|
|
$
|
|
|
Average amount outstanding
|
|
$
|
19,211
|
|
|
$
|
13,235
|
|
|
$
|
690
|
|
Maximum amount outstanding at any month end
|
|
$
|
78,789
|
|
|
$
|
25,000
|
|
|
$
|
10,600
|
|
|
|
|
|
Average interest rate for the year
|
|
|
5.30
|
%
|
|
|
5.10
|
%
|
|
|
4.06
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FHLB advances
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31st
|
|
$
|
193,000
|
|
|
$
|
131,400
|
|
|
$
|
41,070
|
|
Average amount outstanding
|
|
$
|
127,115
|
|
|
$
|
92,106
|
|
|
$
|
25,357
|
|
Maximum amount outstanding at any month end
|
|
$
|
197,000
|
|
|
$
|
171,300
|
|
|
$
|
56,900
|
|
|
|
|
|
Average interest rate for the year
|
|
|
4.63
|
%
|
|
|
4.68
|
%
|
|
|
3.25
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51
In addition to short-term borrowings, the Company had $5 million in long-term borrowings on its balance sheet at
December 31, 2007, down from $27 million at December 31, 2006. The decline is due to $22 million that had a remaining maturity of more than one year at December 31, 2006, but which now matures within a year and has thus been
reclassified as short-term. The long-term borrowings represent secured advances from the FHLB pursuant to the leverage strategy, and original maturities on these borrowings ranged from one year up to five years.
Capital Resources
At December 31, 2007, the Company had
total shareholders equity of $99.5 million, comprised of $19.6 million in common stock, $80.1 million in retained earnings, and a $215,000 accumulated other comprehensive loss. Total shareholders equity at the end of 2006 was $90.4
million. The $9.1 million increase in shareholders equity is comprised of the following: a $3.5 million increase in common stock due primarily to additional capital relating to stock option exercises; a $4.2 million increase in retained
earnings representing net income of $21.0 million, less $6.0 million in dividends paid and less the allocation to retained earnings of much of the cost of stock repurchases executed during the year; and a $1.4 million increase in accumulated other
comprehensive income, representing the change in the unrealized loss on our investment securities, net of the tax impact, pursuant to rising market values. While the retention of earnings has been the Companys main source of capital since
1982, the Company currently has a total of $30 million in trust preferred securities outstanding, issued through its unconsolidated wholly-owned subsidiaries, Sierra Statutory Trust II and Sierra Capital Trust III. Trust preferred proceeds are
generally considered to be Tier 1 or Tier 2 capital for regulatory purposes, but long-term debt for financial statement purposes in accordance with generally accepted accounting principles. However, no assurance can be given that trust preferred
securities will continue to be treated as Tier 1 capital in the future.
The Company paid cash dividends totaling $6.0 million, or $0.62 per share in 2007,
and $5.3 million, or $0.54 per share in 2006, representing 31% of the prior years earnings for 2007 and 33% for 2006. The Company anticipates paying future dividends of around 30% to 35% of the prior years net earnings, which is within
the range of typical peer payout ratios. However, no assurance can be given that earnings and/or growth expectations in any given year will justify the payment of such a dividend.
The Company uses a variety of measures to evaluate capital adequacy. Management reviews various capital measurements on a regular basis and takes appropriate action to ensure that such measurements are within
established internal and external guidelines. The external guidelines, which are issued by the Federal Reserve Board and the FDIC, establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures.
There are two categories of capital under the Federal Reserve Board and FDIC guidelines: Tier 1 and Tier 2 Capital. By definition, Tier 1 Capital currently includes common shareholders equity and the proceeds from the issuance of trust
preferred securities (trust preferred securities are counted only up to a maximum of 25% of Tier 1 capital), less goodwill and certain other deductions, notably the unrealized net gains or losses (after tax adjustments) on securities available for
sale, which are carried at fair market value. Tier 2 Capital includes preferred stock, the amount of trust preferred securities not includible in Tier 1 Capital, and the allowance for loan losses, subject to certain limitations. (For more details,
see Item 1, Business-Supervision and Regulation Capital Adequacy Requirements herein.)
At December 31, 2007, the Company had a
total capital to risk-weighted assets ratio of 13.33%, a Tier 1 risk based capital ratio of 12.11%, and a leverage ratio of 10.22%. Because of relatively mild growth in risk-adjusted assets, these ratios increased relative to previous year-end
ratios of 12.98% for total capital to risk-weighted assets, 11.77% for Tier 1 to risk-weighted assets, and 9.92% for leverage. Note 13 of the Notes to the Consolidated Financial Statements provides more detailed information concerning the
Companys capital amounts and ratios. At December 31, 2007, on a stand-alone basis, the Bank had a total risk-based capital ratio of 13.28%, a Tier 1 risk-based capital ratio of 12.06%, and a leverage capital ratio of 10.17%. As of the end
of 2007, both the Company and the Bank were considered to be well capitalized by regulatory standards. We do not foresee any circumstances that would cause the Company or the Bank to be less than well capitalized, although no
assurance can be given that this will not occur.
52
Liquidity and Market Risk Management
Liquidity
Liquidity refers to the Companys ability to maintain cash flows sufficient to fund
operations, and to meet obligations and other commitments in a timely and cost-effective fashion. At various times the Company requires funds to meet short-term cash requirements brought about by loan growth or deposit outflows, the purchase of
assets, or liability repayments. To manage liquidity needs properly, cash inflows must be timed to coincide with anticipated outflows, or sufficient liquidity resources must be available to meet varying demands. The Company manages liquidity in such
a fashion as to be able to meet unexpected sudden changes in levels of its assets or deposit liabilities without maintaining excessive amounts of on-balance sheet liquidity. Over-abundant balance sheet liquidity can negatively impact the net
interest margin.
An integral part of the Companys ability to manage its liquidity position appropriately is the Companys large base of core
deposits, which are generated by offering traditional banking services in the communities in its service area and which have, historically, been a stable source of funds. In addition to core deposits, the Company has the ability to raise deposits
through various deposit brokers if required for liquidity purposes. The Companys net loan to deposit ratio increased significantly to 107% at the end of 2007 from 101% at the end of 2006, due to the fact that we experienced net growth in loans
but our total deposits declined in 2007.
We also monitor the Companys liquidity position with a liquidity ratio defined as net cash,
non-pledged investment securities, and other marketable assets, divided by total deposits and short-term liabilities minus liabilities secured by investments or other marketable assets. This ratio was 16.8% at the end of December 2007 and 17.2% at
the end of December 2006, well within the policy guideline of over 10%. Other liquidity measures are also monitored and reported to the Board on a monthly basis, including average loans to total assets, a net non-core funding dependence
ratio, and a reliance on wholesale funding ratio. As of December 31, 2007, all of these ratios were within policy guidelines.
The unpledged portion
of the Companys investment portfolio is an integral component of liquidity management due to the relative ease with which many bonds can be sold. There were $23 million in unpledged marketable investments, and $27 million more in pledged
securities in excess of actual needs, at the end of 2007 that could be sold for liquidity purposes if necessary. Management is of the opinion that its investments and other potentially liquid assets, along with other standby funding sources it has
arranged, are more than sufficient to meet the Companys current and anticipated short-term liquidity needs. In addition to available investment balances, other sources of balance sheet liquidity include $40 million in cash and due from banks
and $16 million in the guaranteed portion of SBA loans. Standby funding sources include a formal secured borrowing line with the Federal Home Loan Bank that has availability of $26 million based on the current level of pledged real estate assets,
informal unsecured short-term liquidity lines for overnight fed funds with certain correspondent banks totaling $113 million, and a $2 million secured line at the Federal Reserve Discount Window.
Interest Rate Risk Management
Market risk arises from changes
in interest rates, exchange rates, commodity prices and equity prices. The Companys market risk exposure is primarily that of interest rate risk, and it has established policies and procedures to monitor and limit earnings and balance sheet
exposure to changes in interest rates. The Company does not engage in the trading of financial instruments, nor does it have exposure to currency exchange rates.
The principal objective of interest rate risk management (often referred to as asset/liability management) is to manage the financial components of the Companys balance sheet in a manner that will optimize the risk/reward
equation for earnings and capital in relation to changing interest rates. To identify areas of potential exposure to rate changes, the Company performs an earnings simulation analysis and a market value of portfolio equity calculation on a monthly
basis.
53
The Company utilizes Sendero modeling software for asset/liability management in order to simulate the effects of
potential interest rate changes on the Companys net interest margin, and to calculate the estimated fair values of the Companys financial instruments under different interest rate scenarios. The program imports current balances, interest
rates, maturity dates and repricing information for individual financial instruments, and incorporates assumptions on the characteristics of embedded options along with pricing and duration for new volumes to project the effects of a given interest
rate change on the Companys interest income and interest expense. Rate scenarios consisting of key rate and yield curve projections are run against the Companys investment, loan, deposit and borrowed funds portfolios. These rate
projections can be shocked (an immediate and parallel change in all base rates, up or down), ramped (an incremental increase or decrease in rates over a specified time period), economic (based on current trends and econometric models) or stable
(unchanged from current actual levels).
The Company uses seven standard interest rate scenarios in conducting its simulations: stable, upward
shocks of 100, 200 and 300 basis points, and downward shocks of 100, 200, and 300 basis points. Our policy is to limit any projected decline in net interest income relative to the stable rate scenario for the next 12 months to less than 5% for a 100
basis point (b.p.) shock, 10% for a 200 b.p. shock, and 15% for a 300 b.p. shock in interest rates. As of December 31, 2007, the Company had the following estimated net interest income sensitivity profile:
Immediate Change in Rate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-300 b.p.
|
|
|
-200 b.p.
|
|
|
-100 b.p.
|
|
|
+100 b.p.
|
|
|
+200 b.p.
|
|
|
+300 b.p.
|
|
Change in Net Int. Inc. (in $000s)
|
|
$
|
729
|
|
|
$
|
957
|
|
|
$
|
703
|
|
|
-$
|
1,031
|
|
|
-$
|
2,154
|
|
|
-$
|
3,504
|
|
% Change
|
|
|
+1.29
|
%
|
|
|
+1.69
|
%
|
|
|
+1.24
|
%
|
|
|
-1.82
|
%
|
|
|
-3.81
|
%
|
|
|
-6.20
|
%
|
The above profile illustrates that if there were an immediate increase of 100 basis points in interest rates, the
Companys net interest income would likely be about $1 million, or 1.82%, lower than net interest income in a flat rate scenario. The negative variance becomes more pronounced the greater the increase in interest rates. On the other hand, if
there were an immediate and sustained downward adjustment of 100 basis points in interest rates, all else being equal, net interest income over the next twelve months would likely be $703,000, or 1.24%, higher than net interest income under a stable
rate scenario. The variance does not change significantly in magnitude as the rate decline steepens.
In the past, the Company has generally been asset
sensitive over a one-year time frame, meaning that interest-earning assets will re-price more quickly than interest-bearing liabilities and, all else being equal, the Companys net interest margin will be lower when short-term rates are falling
and higher when short-term rates are rising. Over the past year, however, our interest rate risk profile has changed because we have added more long-term fixed-rate loans to our loan mix, experienced runoff in non-interest DDAs and
disproportionate growth in rate-sensitive deposits, and shortened the duration of other borrowings. With the exception of the competitive pressures on deposit rates we have seen recently, our exposure to declining rates has been eliminated, but the
gain in net interest income that we previously would have realized in rising rate scenarios has turned negative. This has made us effectively interest-rate neutral in declining rate scenarios, and slightly liability-sensitive in rising rate
scenarios. We would be liability-sensitive in declining rate scenarios, as well, and would thus gain net interest income, if not for the fact that some of the Companys variable deposit rates (on NOW accounts and savings accounts, for example)
are relatively close to a natural floor of zero. If rates were to move down to a significant degree certain deposit rates would hit this floor, but earning asset yields would continue to fall and our net interest margin would likely experience
significant compression. This effect is exacerbated by the fact that prepayments on fixed-rate loans tend to increase as rates decline. Another characteristic inherent in our interest rate risk profile was experienced in 2006, when rates leveled off
after a period of increasing rates. Margin compression occurred after that, since the cost of rate-sensitive liabilities continued to rise even after yields on rate-sensitive earning assets stopped increasing.
The economic (or fair) value of financial instruments on the Companys balance sheet will also vary under the interest rate scenarios previously
discussed. Economic values for financial instruments are estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while the fair value of non-financial accounts is assumed to equal
book value and does not vary with interest rate fluctuations. An economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change substantially over time as the characteristics of the
Companys balance sheet evolve and as interest rate and yield curve assumptions are updated.
54
The amount of change in economic value under different interest rate scenarios is dependent upon the characteristics of
each class of financial instrument, including the stated interest rate or spread relative to current market rates or spreads, the likelihood of prepayment, whether the rate is fixed or floating, and the maturity date of the instrument. As a general
rule, fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain value as interest rates rise and lose value as interest rates decline. The
longer the maturity of the financial instrument, the greater the impact a given rate change will have on its value. In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and
decay rates for non-maturity deposits are also projected based on managements best estimates. We have found that model results are highly sensitive to changes in the assumed decay rate for non-maturity deposits, in particular.
The economic value of equity (EVE) is calculated by subtracting the estimated fair value of liabilities from the estimated fair value of assets. The table below shows
estimated changes in the Companys EVE as of December 31, 2007, under different interest rate scenarios relative to a base case of current interest rates:
Immediate Change in Rate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-300 b.p.
|
|
|
-200 b.p.
|
|
|
-100 b.p.
|
|
|
+100 b.p.
|
|
+200 b.p.
|
|
|
+300 b.p.
|
|
Change in EVE (in $000s)
|
|
$
|
23,912
|
|
|
$
|
20,190
|
|
|
$
|
10,623
|
|
|
-$
|
13,219
|
|
-$
|
26,506
|
|
|
-$
|
42,016
|
|
% Change
|
|
|
+11.04
|
%
|
|
|
+9.32
|
%
|
|
|
+4.91
|
%
|
|
|
-6.11
|
|
|
-12.24
|
%
|
|
|
-19.40
|
%
|
The slope of EVE under varying interest rate scenarios is substantially steeper than the slope for the
Companys net interest income simulations, due primarily to the fact that $508 million in non-maturity deposits are assumed to run off at the rate of 10% per year. In contrast, our net interest income simulations incorporate growth rather
than run-off for aggregate non-maturity deposits. If a higher deposit decay rate is used for EVE simulations the decline becomes more severe, while the slope conforms more closely to that of our net interest income simulations if non-maturity
deposits do not run off. Under declining rates, a floor of zero (or slightly above zero) for the discount rate on variable rate deposits and other liabilities, and increased principal prepayments and calls on investment securities and fixed rate
loans, partially offset the increase in the value of fixed-rate loans. During the past year, the addition of fixed-rate loans and the shift into more rate-sensitive funding has caused the negative slope in rising rate scenarios to become steeper and
the slope in declining rate scenarios to move from negative to positive.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information concerning quantitative and
qualitative disclosures of market risk called for by Item 305 of Regulation S-K is included as part of Item 7 above. See Managements Discussion and Analysis of Financial Condition and Results of Operations Liquidity and
Market Risk Management.
55