SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________________ TO __________________ Commission file number 000-33063 --------- SIERRA BANCORP (Exact name of Registrant as specified in its charter) California 33-0937517 (State of Incorporation) (IRS Employer Identification No) 86 North Main Street, Porterville, California 93257 (Address of principal executive offices) (Zip Code) (559) 782-4900 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES X NO _____ --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common stock, no par value, 9,212,280 shares outstanding as of October 31, 2001 1
FORM 10-Q Table of Contents ----------------- <TABLE> <CAPTION> Page ---- <S> <C> Part I - Financial Information 3 Item 1. Financial Statements 3 Consolidated Balance Sheets 3 Consolidated Statements of Income & Comprehensive Income 4 Consolidated Statements of Cash Flows 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion & Analysis of Financial Condition & Results of Operations 8 Summary of Financial Data 8 Earnings Performance 9 Net Interest Income 9 Non-interest Income/Expense 14 Balance Sheet Analysis 15 Earning Assets 15 Loan Portfolio 15 Non-accrual and Restructured Loans and Other Assets 16 Allowance for Loan Losses 18 Interest Bearing Liabilities 20 Deposits 20 Fed Funds Purchased & Securities Sold Under Agreements to Repurchase 20 Other Borrowed Money 20 Non-Interest Bearing Liabilities 20 Interest Rate Risk Management 21 Liquidity 23 Capital Resources 23 Item 3. Qualitative & Quantitative Disclosures About Market Risk 25 Market Risk Management 25 Forward-Looking Statements 26 Part II - Other Information 27 Item 1. - Legal Proceedings 27 Item 2. - Changes in Securities 27 Item 3. - Defaults upon Senior Securities 27 Item 4. - Submission of Matters to a vote of Security Holders 27 Item 5. - Other Information 27 Item 6. - Exhibits and Reports on Form 8-K 27 Signatures 28 </TABLE> 2
<TABLE> <CAPTION> ======================================================================================================================= PART I - FINANCIAL INFORMATION Item 1 ======================================================================================================================= SIERRA BANCORP CONSOLIDATED BALANCE SHEETS (dollars in thousands, unaudited) ======================================================================================================================= ASSETS September 30, 2001 December 31, 2000 September 30, 2000 ------------------- ------------------ ------------------ <S> <C> <C> <C> Total cash and cash equivalents $ 34,342 $ 44,910 $ 43,872 ------------------- ----------------- ------------------ Securities: Held to maturity - - 76,758 Available for sale 98,634 109,925 39,474 ------------------- ----------------- ------------------ Total Securities 98,634 109,925 116,232 Loans: Gross loans 432,000 421,696 420,831 Allowance for loan losses (5,370) (5,362) (5,210) Deferred loan fees (309) 58 97 ------------------- ----------------- ------------------ Net Loans 426,321 416,392 415,718 Other equity securities 1,774 2,591 - Premises and equipment, net 14,240 14,477 14,423 Other real estate owned 774 1,530 1,449 Accrued interest receivable 4,000 4,902 4,745 Other assets 11,986 11,999 10,375 ------------------- ----------------- ------------------ TOTAL ASSETS 592,071 606,726 606,814 =================== ================= ================== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits: Demand $ 129,800 $ 130,592 $ 125,955 Interest bearing demand 45,645 45,815 46,041 Savings 30,094 31,195 32,431 MMDA's 90,566 44,239 47,147 TDOA's, IRA's & KEOGH'S 21,812 19,197 19,210 Time deposits * $100,000 116,222 130,884 132,689 Time deposits ** $100,000 87,299 125,854 119,892 ------------------- ----------------- ------------------ Total Deposits 521,438 527,776 523,365 Federal funds purchased and repurchase agreements 16,273 13,584 13,434 Other borrowed funds 5,050 20,700 28,000 Accrued interest payable 591 1,087 1,029 Other liabilities 3,409 2,797 2,007 ------------------- ----------------- ------------------ TOTAL LIABILITIES 546,761 565,944 567,835 ------------------- ----------------- ------------------ STOCKHOLDERS' EQUITY Common stock, no par value 2,285 2,285 2,285 Retained earnings 40,855 37,430 36,371 Accumulated other comprehensive income 2,170 1,067 323 ------------------- ----------------- ------------------ Total stockholders' equity 45,310 40,782 38,979 ------------------- ----------------- ------------------ TOTAL LIABILITIES AND $ 592,071 $ 606,726 $ 606,814 =================== ================= ================== STOCKHOLDERS' EQUITY ======================================================================================================================= </TABLE> * less than ** more than 3
<TABLE> <CAPTION> ========================================================================================================================= SIERRA BANCORP CONSOLIDATED STATEMENTS OF INCOME & COMPREHENSIVE INCOME (dollars in thousands, except per share data, unaudited) ========================================================================================================================= For the Quarter For the Nine-Month Period Ended Sept 30, Ended Sept 30, INTEREST INCOME: 2001 2000 2001 2000 ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Interest on federal funds sold and interest bearing deposits $ 128 $ 199 $ 392 $ 218 US Treasury securities 15 299 253 981 US Gov't agencies & corporations 523 804 1,928 1,826 State and political subdivsions 493 518 1,522 1,496 Mortgage-backed securities 370 - 712 - Other domestic debt - 264 - 264 Equities 13 24 76 75 Interest and fees on loans 8,978 10,595 28,071 28,123 ----------- ----------- ----------- ----------- Total interest income 10,520 12,703 32,954 32,983 INTEREST EXPENSE: Interest on deposits 3,512 4,978 12,790 12,387 Interest on borrowed funds 111 211 419 933 ----------- ----------- ----------- ----------- Total Interest Expense 3,623 5,189 13,209 13,320 Net Interest Income 6,897 7,514 19,745 19,663 Provision for loan losses 100 690 700 2,070 ----------- ----------- ----------- ----------- Net Interest Income after Provision for Loan Losses 6,797 6,824 19,045 17,593 OTHER OPERATING INCOME: Service charges on deposit accounts 1,230 1,136 3,532 2,954 Gains on sales of securities 420 - 748 - Gains on sales of loans 316 123 755 297 Other 548 462 2,416 1,324 ----------- ----------- ----------- ----------- Total other operating income 2,514 1,721 7,451 4,575 OTHER OPERATING EXPENSES: Salaries and employee benefits 2,522 2,676 8,504 7,312 Occupancy expense 1,035 1,044 3,113 2,560 Other 2,590 2,671 7,488 6,355 ----------- ----------- ----------- ----------- Total other operating expenses 6,147 6,391 19,105 16,227 ----------- ----------- ----------- ----------- INCOME BEFORE PROVISION FOR INCOME TAXES 3,164 2,154 7,391 5,941 Provision for income taxes 1,155 713 2,677 2,073 ----------- ----------- ----------- ----------- NET INCOME $ 2,009 $ 1,441 $ 4,714 $ 3,868 Other comprehensive income, unrealized gain (loss) on securities, net of income taxes $ 709 $ 80 $ 1,103 $ (23) ----------- ----------- ----------- ----------- COMPREHENSIVE INCOME $ 2,718 $ 1,521 $ 5,817 $ 3,845 =========== =========== =========== =========== PER SHARE DATA Earnings per share basic $ 0.22 $ 0.16 $ 0.51 $ 0.42 Average shares outstanding, basic and diluted 9,212,280 9,212,280 9,212,280 9,212,280 Book value $ 4.92 $ 4.23 $ 4.92 $ 4.23 Cash dividends $ 0.04 $ 0.06 $ 0.14 $ 0.17 ======================================================================================================================== </TABLE> 4
<TABLE> <CAPTION> ======================================================================================================================== SIERRA BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands, unaudited) ======================================================================================================================== Nine Months Ended Sept 30, Cash Flows from Operating Activities 2001 2000 -------- -------- <S> <C> <C> Net income $ 4,714 $ 3,868 Adjustments to reconcile net income to net cash provided by (used in) operating activities: (Gain) Loss from sale of other real estate owned, net of write-downs (154) 485 (Gain) on sales of loans (755) - Loss on sale of premises and equipment - - Provision for loan losses 700 2,070 Depreciation 1,465 1,251 Net accretion on securities (89) (41) (Gain) on sale of securities (748) - Loss on write-off of fixed assets 4 - Amortization of intangibles 252 132 Increase (Decrease) in unearned net loan fees 368 (191) (Decrease) Increase in deferred taxes (435) 30 Proceeds from sales of loans held for sale 46,370 20,131 Originations of loans held for sale (46,057) (11,801) (Increase) Decrease in interest receivable and other assets (154) (1,705) Increase (Decrease) in other liabilities 268 (1,041) -------- -------- Net cash provided by (used in) operating activities 5,749 13,188 -------- -------- Cash Flows from Investing Activities Maturities of securities held to maturity - 2,448 Maturities of securities available for sale 7,746 11,036 Proceeds from calls of securities held to maturity - 386 Proceeds from sales/calls of securities available for sale 32,804 2,042 Purchases of securities held to maturity - (14,668) Purchases of securities available for sale (31,550) (12,578) Principal paydowns on securities available for sale 5,917 - Decrease in federal funds sold 246 - Increase in loans receivable (10,341) (58,132) Purchases of premises and equipment (1,277) (1,299) Proceeds from sales of other real estate owned 1,771 2,052 Purchase of Sierra National Bank, net of cash and cash equivalents acquired - 2,926 Other (895) 1,768 -------- -------- Net cash provided by (used in) investing activities 4,421 (64,019) -------- -------- Cash Flows from Financing Activities (Decrease) Increase in deposits (6,338) 55,860 (Decrease) Increase in borrowed funds (15,800) 4,200 Increase in repurchase agreements 2,689 4,796 Cash dividends paid (1,289) (1,566) -------- -------- Net cash (used in) provided by financing activities (20,738) 63,290 -------- -------- Increase (decrease) in cash equivalents (10,568) 12,459 Cash and Cash Equivalents Beginning of period 44,910 31,413 -------- -------- End of period $ 34,342 $ 43,872 ======== ======== ===================================================================================================================== </TABLE> 5
SIERRA BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2001 Sierra Bancorp - -------------- On November 16, 2000, Sierra Bancorp was incorporated as a bank holding company, for the purpose of acquiring Bank of the Sierra (the "Bank") in a one bank holding company reorganization. The new corporate structure is intended to give Sierra Bancorp and the Bank greater flexibility in terms of operation, expansion and diversification. Shortly after the incorporation, Sierra Bancorp filed a registration statement on form S-4 with the Securities and Exchange Commission in order to register its common stock which was issued pursuant to the terms of a Plan of Reorganization and Agreement of Merger dated December 14, 2000. The Plan of Reorganization and Agreement of Merger provided for the exchange of shares of the Bank for shares of Sierra Bancorp on a share-for-share basis (the "Reorganization"). The registration statement was declared effective on April 27, 2001. The Reorganization was approved by the Company's shareholders on May 23, 2001, and all required regulatory approvals or non-disapprovals with respect to the Reorganization were obtained. The Reorganization was consummated on August 10, 2001, subsequent to which the Bank continued its operations as previously conducted but as a wholly-owned subsidiary of Sierra Bancorp. Sierra Bancorp, the Bank, and the subsidiary of the Bank are collectively referred to herein as the "Company". Basis of Presentation - --------------------- The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The information furnished in these interim statements reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results for such period. Such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter, or for the full year. Certain amounts reported for 2000 have been reclassified to be consistent with the reporting for 2001. The interim financial information should be read in conjunction with the Bank's Annual Report on Form 10-K as filed with the Securities and Exchange Commission. Current Accounting Developments - ------------------------------- In September 2000, the FASB issued Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Liabilities." This Statement replaces FASB Statement No. 125. It revises the standards for securitizations and other transfers of financial assets and collateral after March 2001 and requires certain additional disclosures, but it carries over most of Statement No. 125's provisions without reconsideration. Management does not believe there will be a material effect on the Company's consolidated financial statements upon the adoption of Statement No. 140. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No. 141, Business Combinations, and SFAS No.142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible 6
assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will rather be tested at least annually for impairment. The Company will adopt SFAS No. 142 for its fiscal year beginning January 1, 2002. In October 2001, the FASB issued Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, that replaces FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The accounting model for long-lived assets to be disposed of by sale applies to all long-lived assets, including discontinued operations, and replaces the provisions of APB Opinion No. 30, Reporting Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, for the disposal of segments of a business. Statement 144 requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. Therefore, discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet occurred. Statement 144 also broadens the reporting of discontinued operations to include all components of an entity with operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. The provisions of Statement 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001 and, generally, are to be applied prospectively. In management's opinion, the adoption of this statement will not have a material impact on the Company's current financial position or results of operations. Supplemental Disclosure of Cash Flow Information - ------------------------------------------------ During the three months ended September 30, 2001 and 2000, cash paid for interest expense on interest bearing liabilities was $3.7 million and $5.2 million, respectively, while cash paid for income taxes during the three months ended September 30, 2001 and 2000 was $1.2 million and $700,000, respectively. There was $272,000 in other real estate acquired in the settlement of loans for the quarter ended September 30, 2001, and $795,000 acquired for the quarter ended September 30, 2000. There were no loans made to finance the sale of other real estate for the quarters ended September 30, 2001 or September 30, 2000. Earnings Per Share - ------------------ Earnings per share for all periods presented in the Consolidated Statements of Income are computed based on the weighted average number of shares outstanding during each year retroactively restated for stock splits and dividends. Diluted earnings per share include the effect of the potential issuance of common shares. For the Company, these include only shares issuable on the exercise of outstanding stock options. For the three-month and nine-month periods ended September 30, 2001 and 2000, the effect of the exercise of stock options was not dilutive. 7
PART I - FINANCIAL INFORMATION ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW OF THE RESULTS OF OPERATION AND FINANCIAL CONDITION SUMMARY OF FINANCIAL DATA RESULTS OF OPERATIONS SUMMARY - ----------------------------- Net income in the third quarter ended September 30, 2001 was $2.0 million compared with the $1.4 million for the quarter ended September 30, 2000. Basic earnings per share were $0.22 for the third quarter of 2001 compared to $0.16 for the third quarter of 2000. The Company's annualized return on average equity was 18.01%, and the Company's annualized return on average assets was 1.34% for the quarter ended September 30, 2001. This compares favorably when compared with 14.76% and .94%, respectively, for the quarter ended September 30, 2000. As a result, year-to-date September 30, 2001 results reflected earnings of $4.7 million as compared to $3.9 million for the first nine months of 2000. This increase of $800,000 in earnings for year-to-date September 30, 2001 over the same period of 2000 represents a positive variance of almost 21%. For the nine-month period ended September 30, 2001, the Company's annualized return on average assets was 1.06% and its annualized return on average equity was 14.85%, as compared to .92% and 13.71%, respectively, for the nine months ended September 30, 2000. The Company's net interest income for the quarter ended September 30, 2001 was $6.9 million, an 8% reduction from the $7.5 million reported for the third quarter of 2000. This decrease is after a 37% decrease in the Bank's prime lending rate between December 31, 2000 and September 30, 2001. As one can see from the average balances and rates table for the quarter ended September 30, 2001, when compared to the same quarter of the previous year, average earning assets declined by approximately 1%, while interest bearing liabilities decreased by about 3%. The decrease in net interest income is primarily rate related, as one may deduce from the prime rate reduction previously noted, and the minimal change in interest earning assets and interest bearing liabilities volumes. Average earning assets for the quarter ended September 30, 2001 were $539 million, a reduction of $6 million or about 1% from the average earning asset base at September 30, 2000 (see discussion below). Correspondingly, average interest bearing liabilities declined by 3% to $419 million for the quarter ended September 30, 2001, from $434 million for the same period of 2000. With similar average volumes for the third quarter of 2001 as compared with the same period of 2000, and a substantially lower prime rate and money market conditions, the Bank's net interest margin before the provision for loan losses was also reduced. For the quarter ended September 30, 2001, the Bank's net interest margin was 5.07%, a reduction of 41 basis points, or about 7% from the net interest margin of 5.48% for the three-month period ended September 30, 2000. 8
For the nine months ended September 30, 2001, a similar analysis can be made. While earning assets grew about $54 million or 11% over the averages for the nine months ended September 30, 2000, interest-bearing liabilities increased about 3% during the same period. Funding needs also declined due to a reduction in non-earning assets. The Bank's net interest margin for the nine months ended September 30, 2001 was 4.90% before the provision for loan losses, a reduction of 52 basis points or about 10% from the net interest margin reported for the nine months ended September 30, 2000. At September 30, 2001, the Company's allowance for possible loan losses stood at 1.24% of gross loans, while at the same date in 2000 the Company's allowance was also 1.24% of gross loans. The growth of the allowance through September 30, 2001 essentially mirrored the growth of the portfolio over the same period. FINANCIAL CONDITION SUMMARY - --------------------------- The Company's total assets decreased slightly in size between December 31, 2000 and September 30, 2001. The volume decline was about $15 million, while the percentage of change was approximately 2%. Since December 30, 2000, there has been a reduction of approximately $6 million in deposits and an increase of about $3 million in borrowed funds. The asset shrinkage was focused in cash and investment balances, which declined by a combined $22 million, while loan balances actually increased by about $10 million over the period. This shift into relatively higher yielding loans should contribute to a higher net interest margin as the Bank goes forward into 2002. Since September 30, 2000, the most notable changes in deposits have been due to reductions of about $49 million in certificates of deposits, offset by an increase in money market accounts of about $46 million. With the substantial reduction in the Bank's lending rates over the past nine months, the Bank has attempted to shorten the duration of its interest bearing liabilities by advertising and deposit promotions for its money market account. The higher rates paid on initial deposits have allowed the reduction of longer term certificate accounts while increasing the volume of money market accounts by approximately $36 million, or about 61% on average, since the quarter ended September 30, 2000. The net reduction in Bank size, when combined with earnings retained from operations, has allowed the Company to post stronger capital ratios than were evident at the third quarter ended September 30, 2000. At September 30, 2001, the Company was considered "adequately capitalized" under the "Prompt Corrective Action" guidelines of the FDIC. EARNINGS PERFORMANCE NET INTEREST INCOME As previously noted and reflected on the Consolidated Balance Sheet and the Consolidated Statements of Income, during the quarter ended September 30, 2001 the Company generated net income of $2.0 million as compared to $1.4 million for the same period in 2000, on a slightly smaller asset base. The Company earns income from two primary sources: Net interest income brought about by the successful employment of earning assets less the costs of interest-bearing deposits, and net non-interest income, which is generated by service charges and fees charged for services provided, less the operating costs of providing a full range of banking services to the Bank's customers. 9
The Company's net interest margin is heavily reliant on the mix and volumes of earning assets as compared to the costs of various funding sources. The Average Balances and Rates table reflects the Company's average volumes of assets, liabilities, and stockholders' equity; the amount of interest income or interest expense; net interest income; the average rate or yield for each category of interest bearing asset or liability; and the net interest margin for the periods noted. Net interest income before the provision for loan losses for the third quarter of 2001 was $6.9 million, as compared to $7.5 million for the third quarter of 2000. This represents a decrease of $600,000, or about 8%. As previously noted, net interest income is the difference between the interest income and fees earned on loans and investments, and the interest expense paid on deposits and other borrowings. The amount by which interest income exceeds interest expense depends on two factors: the volume and mix of earning assets as compared to that of interest bearing deposits and borrowings, and the interest rates earned versus the interest rates paid on each of the balance sheet portfolios. The Company's net interest margin is the net interest income expressed as a percentage of average earning assets. The margin for the third quarter of 2001 and the third quarter of 2000 are reflected in the Average Balances and Rates tables and reflect the changes in the rates earned and rates paid on loans, investments, deposits, and borrowed funds held by the Company during the third quarter 2001 as compared to the same period during 2000. The overall decrease in the rate earned on the Company's loan portfolio was partially offset by lower rates paid on deposit accounts, due to the generally lower level of market rates in existence during the year 2001, coupled with very competitive money market account rates and a higher average utilization of borrowed funds to support the loan growth. As a result, while the Company's earning asset yield decreased from 9.26% in September 2000 to 7.74% for the quarter ended September 30, 2001, a reduction of about 152 basis points, the rates paid on interest bearing liabilities also decreased from 4.75% for the quarter ended September 30, 2000, to 3.43% for the same period of 2001, a reduction of about 132 basis points. These changing rates, combined with a $3 million reduction in average demand deposit balances, resulted in a decrease in the Company's net interest margin for the quarter ended September 30, 2001 to 5.07% before the provision for loan losses, as compared to 5.48% for the same period in 2000. As one can see from the Average Balances and Rates table, yields on the Company's investment portfolio decreased to 5.15% during the quarter ended September 30, 2001, from 6.50% for the third quarter of 2000, on an 8% lower average volume. The decrease in the rate earned on the Company's investment portfolio was 135 basis points, or about 21%. The rate earned on the Company's loan portfolio during the quarter ended September 30, 2001 was 8.47%, while the Company earned 10.12% on average loans outstanding for the third quarter of 2000. The decrease of interest earned was 165 basis points, a decrease of about 16% between the Company's third quarter of 2001 and 2000. This decrease was primarily due to a year-to-date 350 basis point reduction in the prime rate through September 30, 2001, coupled with a relatively unchanged average volume of loans for the three months ended September 30, 2001 as compared to September 30, 2000. During this period between the quarter ended September 30, 2001, and September 30, 2000, the Company's average loans outstanding increased by only $4 million, or approximately 1%, and coupled with the magnitude of the change in rates earned, the result was a substantial change in interest earned on loans. 10
The results of lower yields on both the loan portfolio and the investment portfolio reduced the Company's rate earned on average earning assets for the nine months ended September 30, 2001 as compared to the same period ended September 30, 2000. At September 30, 2001, interest income as a percentage of earning assets was 8.18%, as compared to a rate of 9.09% for the same period in 2000. This was a reduction of 91 basis points, or about 10% between the periods reported. During the same period, the rates paid on average interest-bearing liabilities decreased to 4.17% for the nine months ended September 30, 2001 from 4.34% for the nine months ended September 30, 2000. This decrease of 17 basis points equaled an average decrease in interest bearing liabilities costs of about 4%. Rates paid on deposit accounts increased primarily in the shorter-term money market accounts, while rates paid on longer maturity deposits decreased at a lesser rate. However, the volume of average interest bearing liabilities increased by about $14 million, or about 3%, which increase was less than the decrease in rate. As a result, for the nine months ended September 30, 2001, the Bank's net interest margin before the provision for loan losses decreased to 4.90% from 5.42% for the corresponding period of 2000. This was a reduction of 52 basis points, or about 10%. For the year ending December 31, 2001, the Company expects no substantial increases in deposit or loan volumes, and it is anticipated that the Company will end the year 2001 with approximately the same volume of deposits and loans as it currently holds. However, there can be no absolute assurance that this, in fact, will occur. 11
<TABLE> <CAPTION> =================================================================================================================================== Average Balances and Rates For the Quarter For the Quarter (dollars in thousands, except per share data) Ended September 30, 2001(a) Ended September 30, 2000(a) ------------------------------------- ------------------------------------- Average Income/ Average Average Income/ Average Assets Balance Expense Rate/Yield(4) Balance Expense Rate/Yield(4) <S> <C> <C> <C> <C> <C> <C> Investments: - ----------- Federal funds sold & due from time $ 13,769 $ 128 3.69% $ 12,526 $ 199 6.32% Taxable 61,378 908 5.87% 73,074 1,367 7.44% Non-taxable/(1)/ 41,618 494 4.71% 40,989 518 5.03% Equity 2,035 13 2.53% 2,398 24 3.98% ---------------------- ------------------------- Total Investments 118,800 1,543 5.15% 128,987 2,108 6.50% ---------------------- ------------------------- Loans:/(2)/ - ------ Agricultural 10,238 221 8.56% 16,844 475 11.22% Commercial 81,698 1,860 9.03% 66,658 1,549 9.24% Real estate 273,397 5,515 8.00% 289,125 7,337 10.10% Consumer 37,241 1,019 10.85% 32,411 876 10.75% Credit cards 11,803 363 12.21% 10,991 358 12.96% Other 6,235 - 0.00% 609 - 0.00% ---------------------- ------------------------- Total Loans 420,612 8,978 8.47% 416,638 10,595 10.12% ---------------------- ------------------------- Total Earning Assets 539,412 10,520 7.74% 545,625 12,703 9.26% ------------ ------------ Non-Earning Assets $ 57,426 $ 61,853 ---------- ------------- Total Assets $596,838 $607,478 ========== ============= Liabilities and Stockholders' Equity Interest Bearing Deposits: - ------------------------- NOW $ 45,909 $ 27 0.24% $ 46,712 $ 113 0.96% Savings accounts 29,642 60 0.80% 31,959 186 2.32% Money market 95,870 782 3.24% 59,697 472 3.15% TDOA's, IRA & KEOGH's 21,082 235 4.42% 20,424 259 5.04% Certificates of Deposit*$100,000 117,063 1,382 4.68% 140,374 2,117 6.00% Certificates of Deposit**$100,000 93,689 1,027 4.35% 117,327 1,831 6.21% ---------------------- ------------------------- Total Interest Bearing Deposits 403,255 3,512 3.46% 416,493 4,978 4.75% Borrowed Funds: - -------------- Federal funds purchased - - - 53 1 7.51% Repurchase agreements 16,242 111 2.71% 14,146 158 4.44% Other borrowings - - - 3,767 52 5.49% ---------------------- ------------------------- Total Borrowed Funds 16,242 111 2.71% 17,966 211 4.67% ---------------------- ------------------------- Total Interest Bearing Liabilities 419,497 3,623 3.43% 434,459 5,189 4.75% Demand deposits 125,738 129,053 Other liabilities 7,344 5,122 Stockholders' equity 44,259 38,844 ---------- ------------- Total Liabilities and Stockholders' Equity $596,838 $607,478 ========== ============= Interest income/earning assets 7.74% 9.26% Interest expense/earning assets 2.66% 3.78% -------------- ---------------- Net Income Interest Margin/(3)/ $ 6,897 5.07% $ 7,514 5.48% Provision for loan losses charged to operations/earning assets $ 100 0.07% $ 690 0.50% -------------------------- ---------------------------- Net interest margin after provision for loan losses $ 6,797 5.00% $ 6,824 4.98% ============== ================ Net Interest Income $ 6,797 $ 6,824 ============ ============ </TABLE> * means less than ** means greater than (a) Average balances are obtained from the best available daily or monthly data (1) Yields on tax exempt income have not been computed on a tax equivalent basis (2) Loan fees have been included in the calculation of interest income. Loan fees were approximately $504 thousand and $158 thousand for the quarters ended September 30, 2001 and 2000 respectively. Loans are gross of the allowance for possible loan losses, deferred fees and related direct costs. (3) Represents net interest income as a percentage of average interest-earning assets. (4) Annualized =============================================================================== 12
<TABLE> <CAPTION> =================================================================================================================================== Average Balances and Rates Nine Months Ended Nine Months Ended (dollars in thousands, except per share data) September 30, 2001(a) September 30, 2000(a) ------------------------------------ ---------------------------------- Average Income/ Average Average Income/ Average Assets Balance Expense Rate/Yield(4) Balance Expense Rate/Yield(4) <S> <C> <C> <C> <C> <C> <C> Investments: Federal funds sold & due from time $ 12,412 $ 392 4.22% $ 4,716 $ 218 6.17% Taxable 62,409 2,893 6.20% 65,169 3,071 6.29% Non-taxable/(1)/ 41,973 1,522 4.85% 39,730 1,496 5.03% Equity 2,154 76 4.72% 2,651 75 3.78% --------------------- ----------------------- Total Investments 118,947 4,883 5.49% 112,266 4,860 5.78% --------------------- ----------------------- Loans:/(2)/ Agricultural 11,828 699 7.90% 15,991 1,310 10.94% Commercial 73,822 4,910 8.89% 58,773 4,303 9.78% Real estate 280,448 18,637 8.88% 256,287 19,136 9.97% Consumer 36,194 2,685 9.92% 29,805 2,331 10.45% Credit cards 11,910 1,140 12.80% 10,956 1,043 12.72% Other 5,554 - 0.00% 596 - 0.00% --------------------- ----------------------- Total Loans 419,757 28,071 8.94% 372,408 28,123 10.09% --------------------- ----------------------- Total Earning Assets 538,704 32,954 8.18% 484,674 32,983 9.09% ----------- ---------- Non-Earning Assets $ 57,654 $ 77,613 ---------- ------------- Total Assets $596,358 $562,287 ========== ============= Liabilities and Stockholders' Equity Interest Bearing Deposits: NOW 45,206 204 0.60% 48,011 297 0.83% Savings accounts 29,832 323 1.45% 26,218 438 2.23% Money market 80,495 2,356 3.91% 56,170 1,206 2.87% TDOA's, IRA & KEOGH's 20,105 725 4.82% 20,149 638 4.23% Certificates of Deposit * less than $100,000 123,543 4,881 5.28% 135,255 5,480 5.41% Certificates of Deposit ** more than $100,000 108,807 4,300 5.28% 99,913 4,328 5.79% --------------------- ----------------------- Total Interest Bearing Deposits 407,988 12,790 4.19% 385,716 12,387 4.29% Borrowed Funds: Federal funds purchased 2 - 0.00% 450 28 6.22% Repurchase agreements 14,307 365 3.41% 13,411 451 4.49% Other borrowings 1,036 54 6.97% 10,083 454 4.50% --------------------- ----------------------- Total Borrowed Funds 15,346 419 3.65% 23,944 933 5.20% --------------------- ----------------------- Total Interest Bearing Liabilities 423,334 13,209 4.17% 409,660 13,320 4.34% Demand deposits 124,056 109,926 Other liabilities 6,385 4,968 Stockholders' equity 42,583 37,733 ---------- ------------- Total Liabilities and Stockholders' Equity $596,358 $562,287 ========== ============= Interest income/earning assets 8.18% 9.09% Interest expense/earning assets 3.28% 3.67% ---------------- -------------- Net Interest Income Margin /(3)/ $19,745 4.90% $19,663 5.42% Provision for loan losses charged to operations/earning assets $ 700 0.17% $ 2,070 0.57% --------------------------- ------------------------ Net interest margin after provision for loan losses $19,045 4.73% $17,593 4.85% ================ ============== Net Interest Income $19,045 $17,593 =========== ========== </TABLE> * less than ** more than (a) Average balances are obtained from the best available daily or monthly data (1) Yields on tax exempt income have not been computed on a tax equivalent basis (2) Loan fees have been included in the calculation of interest income. Loan fees were approximately $-209 thousand and $481 thousand for the nine months ended September 30, 2001 and 2000, respectively. Loans are gross of the allowance for possible loan losses, deffered fees and related direct costs. (3) Represents net interest income as a percentage of average interest-earning assets. (4) Annualized - ------------------------------------------------------------------------------- 13
NON-INTEREST INCOME/EXPENSE The Company's results reflected a higher level of non-interest income in the quarter ended September 30, 2001 than that ended September 30, 2000. The increase was primarily gains on sales of loans and the sale of the Company's residential loan servicing portfolio, as well as gains on sales of investments. For the three months ended September 30, 2001, the gain on the sale of the servicing portfolio was $78,000, while the gains on sales of investments were $420,000 and the gains on sales of loans totaled $316,000. The only comparable category showing a gain for the like period in 2000 was gain on sales of loans, which totaled $123,000. The overall ratio of annualized non-interest income to average assets increased to 1.67% from 1.12% for the quarter ended September 30, 2001 as compared to September 30, 2000. As a result of loan servicing sales over the past year, the portfolio of serviced loans is comprised of only agriculturally related loans. It is likely that no further loan servicing sales will occur. Some additional investments may be sold, however, to realize gains and partially mitigate the negative impact of declining rates on the Bank's profitability. In an effort to control overhead expenses and enhance profitability, staff levels were reduced to 284.8 full-time equivalents (FTE's) at September 30, 2001 as compared to 313.5 FTE's at September 30, 2000. Other operating costs during the period remained relatively constant, while annualized salaries and benefit costs dropped to 1.68% from 1.75% of average assets when comparing the quarter ended September 30, 2001 to that of 2000. As a result of the foregoing, total annualized non-interest expenses were 4.09% of average assets for the three months ended September 30, 2001, as compared to 4.17% for the same period of 2000. For the nine months ended September 30, 2001, total annualized non-interest income equaled 1.67% of average assets, while for the same period of 2000 the rate was only 1.08%. This 63% increase in non-interest income was due primarily to loan servicing portfolio sales of $856,000, gains on sales of investments of $748,000, and loan sales of $755,000 during the nine months ended September 30, 2001. There were gains on loan sales of $297,000 and no gains on sales of investments or loan servicing during the nine months ended September 30, 2000. For the nine months ended September 30, 2001, annualized non-interest expense was 4.28% of average assets, while for the nine months ended September 30, 2000 such costs were 3.84% of average assets. Primary differences are in salary costs, occupancy costs, item processing costs, and other areas associated with the increased staffing and volume levels brought about by the addition of four branches during mid-2000, from the acquisition of Sierra National Bank. Despite recent reductions in salary costs, year-to-date costs increased because all months of 2001 include impact of the May, 2000 acquisition of Sierra National Bank. Management expects that non-interest expenses will continue to decline relative to assets over the rest of the year 2001 as most areas of the Company's cost structure are examined for further reductions. However, no assurance can be given that this, in fact, will occur. 14
BALANCE SHEET ANALYSIS EARNING ASSETS -------------- Loan Portfolio - -------------- A comparative schedule of the distribution of the Company's loans at September 30, 2001 and 2000 is presented in the Loan Distribution table. The amounts shown in the table are before deferred or unamortized loan origination, extension, or commitment fees and origination costs for loans in that category. Further, the figures noted for each category are presented as percentages, for ease of reviewer analysis. <TABLE> <CAPTION> ================================================================================ Loan Distribution (dollars in thousands, unaudited) September 30 September 30 2001 2000 ----------- ----------- <S> <C> <C> Agricultural $ 15,369 $ 17,061 Commercial and industrial 71,544 56,704 Small Business Association loans 14,299 11,212 Real estate: Secured by commercial/professional office Properties including const. & devel 171,326 163,970 Secured by residential properties 91,165 107,174 Secured by farmland 17,103 18,166 Held for sale 2,092 2,627 ----------- ----------- Total Real Estate 281,686 291,937 Consumer loans 37,189 32,751 Credit cards 11,362 10,642 Other 552 524 ----------- ----------- Total Gross Loans $ 432,000 $ 420,831 =========== =========== Percentage of Total Loans Agricultural 3.56% 4.05% Commercial and industrial 16.56% 13.47% Small Business Association loans 3.31% 2.66% Real Estate: Secured by commercial/professional office Properties including const. and devel 39.66% 38.96% Secured by residential properties 21.10% 25.47% Secured by farmland 3.96% 4.32% Held for sale 0.48% 0.62% ----------- ----------- Total Real Estate 65.20% 69.37% Consumer loans 8.61% 7.78% Credit cards 2.63% 2.53% Other 0.13% 0.12% ----------- ----------- Total 100.00% 100.00% =========== =========== =============================================================================== </TABLE> 15
The balance for total gross loans has increased by about $11 million, or less than 3% between the periods ended September 30, 2001 and September 30, 2000. As one can see in the Loan Distribution table, the most significant change between September 30, 2001 and September 30, 2000 has been the increase of the Company's commercial and industrial loan portfolio. This volume increased by about $15 million during the intervening period, increasing to about 17% of all loans, from 13% of all loans at September 30, 2000. Generally speaking, there are no substantial changes in the Company's loans held in the categories noted, over the periods under review. Another portion of the Company's lending business which is not readily determinable from the loan volumes presented, are the residential loans previously generated by the real estate mortgage loan department and then sold in the secondary market to government sponsored agencies or other long term lenders. Further, the Company originates and sells agricultural mortgage loans to certain other investors. During the second and third quarters of 2001, the Company's mortgage loan servicing portfolio was sold, and the Bank now only provides servicing for a small number of SBA loans, and a certain number of agricultural mortgage loans. Loans currently serviced total $62 million, as compared to $181 million serviced at September 30, 2000. In the usual course of business, the Company makes commitments to extend credit as long as there are no violations of any conditions established in the outstanding contractual arrangement. Total commitments to extend credit were $151 million at September 30, 2001 as compared to $144 million at September 30, 2000. These commitments represented 35% and 34% of outstanding gross loans at each of the periods noted, respectively. Of total commitments, credit card commitments represented $42 million and $35 million at September 30, 2001 and 2000, respectively. These amounts approximated 28% and 24%, respectively, of total commitments at that time. The Company's stand-by letters of credit totaled $7 million at September 30, 2001 and $7 million at September 30, 2000. These totals represented about 5% of total commitments outstanding at each of the reported periods. NONACCRUAL AND RESTRUCTURED - --------------------------- LOANS AND OTHER ASSETS - ---------------------- The Non-performing Assets table presents comparative data for non-accrual and restructured loans and other assets. Management's classification of a loan as non-accrual or restructured is an indication that there is reasonable doubt as to the collectivity of principal or interest on the loan. At that point, the Company stops recognizing income from the interest on the loan and reverses any uncollected interest that had been accrued but unpaid. These loans may or may not be collateralized, but collection efforts are continuously pursued. 16
<TABLE> <CAPTION> ============================================================================================ Non-performing Assets (dollars in thousands, unaudited) September September 30 NON-ACCRUAL LOANS: 2001 2000 ------ ------ <S> <C> <C> Agricultural $ 76 $ - Commercial and industrial 866 - Real Estate Secured by commercial/professional office Properties including construction and development - - Secured by residential properties 16 - Secured by farmland 4,764 - Held for sale - - Consumer loans 41 37 Credit cards 44 95 -------- --------- TOTAL $ 5,807 $ 132 ======== ========= LOANS 90 DAYS OR MORE PAST DUE & STILL ACCRUING: (as to principal OR interest) Agricultural - 72 Commercial and industrial 1,066 275 Real Estate Secured by commercial/professional office Properties including construction and development - - Secured by residential properties 485 428 Secured by farmland 685 127 Held for sale - - Consumer loans 80 52 Credit cards 28 25 -------- --------- TOTAL $ 2,344 $ 979 ======== ========= Restructured loans N/A N/A Other real estate owned $ 774 $ 1,449 Total non-performing assets $ 8,925 $ 2,560 Non-performing loans as percentage of total gross loans 1.89% 0.26% Non-performing assets as a percentage of total gross loans 2.07% 0.61% and other real estate owned ============================================================================================ </TABLE> Non-performing assets increased to $8.9 million at September 30, 2001 from $2.6 million at September 30, 2000, an increase of over 350%. This increase was due largely to the transfer of a total of $4.5 million in loans to a single borrower to non-accrual status during the quarter ended March 31, 2001. Management considers these loans to be adequately reserved. Loans 90 days or more past due and still accruing increased over the period by $1.4 million, due mainly to the addition of several commercial and industrial loans to this category. As a result of the increase in non-accrual loans, non-performing assets increased to 2.07% of total gross loans and OREO at September 30, 2001 from .61% at September 30, 2000. The Company anticipates normal influxes of non-accrual loans as it further increases its lending activities, and expects some level of other real estate owned to occur as more aggressive collection activities are undertaken to resolve problem and non-accrual credits. The performance of any individual loan can be impacted by factors beyond the Company's control, such as the interest rate environment or factors particular to a borrower, such as their suppliers or personal circumstances. 17
ALLOWANCE FOR LOAN LOSSES - ------------------------- Credit risk is inherent in the business of extending credit to individuals, partnerships, and corporations, and the Company sets aside an allowance for loan losses through charges to earnings. The charges are reflected in the income statement as the provision for loan losses. The specifically identifiable and quantifiable losses are immediately charged off against the allowance. The Company conducts a quarterly comprehensive analysis to assess the adequacy of the allowance for loan losses. An important step in this assessment and managing credit risk is to periodically grade all of the larger loans and other loans where there may be a question of repayment. A portion of the allowance for loan losses is then allocated to the delinquent or otherwise questionable loans in an amount sufficient to cover the Company's estimate of the loss potential that might exist in each of these identified credits. A portion of the allowance is also allocated to the remainder of the loans based on their portfolio category and the extent of collateralization inherent. The Company's determination of the level of the allowance and corresponding provision for loan losses rests on various judgments and assumptions, including general economic conditions, loan portfolio composition, prior loan loss experience and the Company's ongoing internal examination process and that of its regulators. The Company considers the allowance for loan losses of $5.4 million at September 30, 2001, adequate to cover losses inherent in loans, commitments to extend credit, and standby letters of credit. However, no assurance can be given that the Company will not sustain losses in any given period which could be substantial in relation to the size of the allowance. An analysis of the changes in the allowance for loan losses, including charge-offs and recoveries by category, is presented in the Allowance for Possible Loan Losses table. 18
<TABLE> <CAPTION> ============================================================================================================================= Allowance for Possible Loan Losses (dollars in thousands, unaudited) For the Quarter For the Nine Month Period Ended September 30, Ended September 30, Balances: 2001 2000 2001 2000 --------- --------- --------- ----------- <S> <C> <C> <C> <C> Average gross loans outstanding during period $ 420,612 $ 416,638 $ 419,757 $ 372,408 Gross loans outstanding at end of period $ 432,000 $ 420,831 $ 432,000 $ 420,831 Allowance for Possible Loan Losses: Balance at beginning of period $ 5,406 $ 4,729 $ 5,362 $ 3,319 Provision charged to expense 100 690 700 2,070 Loan charge-offs Agricultural - - 67 50 Commercial & industrial loans 50 86 236 602 Real estate loans - - - - Consumer loans 67 60 228 163 Credit card loans 112 89 460 480 --------- --------- --------- ----------- Total 229 235 990 1,295 --------- --------- --------- ----------- Recoveries Agricultural 25 - 26 12 Commercial & industrial loans 22 4 170 19 Real estate loans - - - - Consumer loans 9 5 32 26 Credit card loans 37 17 71 40 --------- --------- --------- ----------- Total 93 26 298 97 --------- --------- --------- ----------- Net loan (charge offs) recoveries (136) (209) (692) (1,198) Acquired reserve - - - 1,019 --------- --------- --------- ----------- Balance $ 5,370 $ 5,210 $ 5,370 $ 5,210 ========= ========= ========= =========== RATIOS Net charge-offs to average loans 0.03% 0.05% 0.16% 0.32% Net charge-offs to loans at end of period 0.03% 0.05% 0.16% 0.28% Allowance for possible loan losses to Gross loans at end of period 1.24% 1.24% 1.24% 1.24% Allowance for possible loan losses to Net loans at end of period 1.26% 1.25% 1.26% 1.25% Net loan charge-offs to Allowance for possible loan losses 2.53% 4.01% 12.89% 22.99% Net loan charge-offs to Provision charged to operating expense 136.00% 30.29% 98.90% 57.87% ============================================================================================================================= </TABLE> As shown at September 30, 2001, the allowance for loan losses was $5.4 million or 1.24% of gross loans, as compared to $5.2 million or 1.24% at September 30, 2000. The provision for loan losses was $100,000 in the third quarter of 2001 as compared to $690,000 for the same period of 2000. On a year-to-date basis through September 30th, the provision for loan losses was $700,000 for 2001 and $2,070,000 for 2000. 19
INTEREST BEARING LIABILITIES ---------------------------- DEPOSITS - -------- An important component in analyzing net interest margin is the composition and cost of the Company's deposit base. Net interest margin is improved to the extent that growth in deposits can be focused in the less volatile and somewhat more traditional core deposits, which are non-interest bearing demand, NOW accounts, savings accounts and money market deposit accounts. As illustrated in the Average Balances and Rates table, the average rate paid on interest bearing deposits decreased to 3.46% during the quarter ended September 30, 2001 from 4.75% for the quarter ended September 30, 2000. Average interest bearing deposit volumes decreased by about $13 million, or approximately 3% for the third quarter of 2001 when compared to the quarter ended September 30, 2000. As previously noted, the primary difference between deposit volumes at September 30, 2001, when compared to September 30, 2000, is the growth of money market accounts and the simultaneous decline in time certificates of deposit. This change was due to promotional rates and terms within money market advertisements during the first and third quarters of the year. FED FUNDS PURCHASED & SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - -------------------------------------------------------------------- In addition to deposit accounts at September 30, 2001, repurchase agreements totaled approximately $16 million; these represent "sweep accounts", non-deposit investment accounts secured by pledged assets held segregated from the Company's own securities portfolio. The commercial account customer base of the Company has requested more intensive cash management facilities than those previously available in the local market, and the Company's "sweep" product is meant to meet this need. The extent of utilization has grown over the past year, and as reflected in the Average Balances and Rates table for the period ended September 30, 2001, "sweep" funds represented about 4% of total interest bearing liabilities, as compared to approximately 3% for the quarter ended September 30, 2000. OTHER BORROWED MONEY - -------------------- As noted in the Average Balances and Rates table, the Company also has had occasion to make use of "other borrowings". These funds represent temporary overnight advances from the Federal Home Loan Bank of San Francisco which are intended to support temporary reductions in liquidity due to seasonal deposit flows, high temporary loan demands, or other short-term needs. This source was not utilized during the quarter ended September 30, 2001, and represented about 1% of total interest bearing liabilities during the quarter ended September 30, 2000. NON-INTEREST BEARING LIABILITIES -------------------------------- DEPOSITS - -------- Non-interest bearing deposit liabilities are an integral part of a financial institution's funds portfolio. Generally speaking, they provide a stable source of non-interest bearing funds which require cash, personnel, and data systems to support. Conversely, they provide fee income and investable funds. Non-interest bearing demand deposits averaged about 24% of total average deposits for the third quarters of both 2001 and 2000. 20
OTHER - ----- Other liabilities are primarily comprised of interest payable, expenses accrued but unpaid, and certain clearing amounts. Generally speaking, this other liability balance represents a very small percentage of overall liabilities, and is inconsequential to the discussion of bank funding sources. INTEREST RATE RISK MANAGEMENT ----------------------------- The Company derives its income from two sources. As previously discussed: one is net interest income brought about by the successful employment of earning assets less the costs of interest bearing liabilities; the other is net non-interest income which is service charges and fees, less the other operating costs borne by the Company. The net interest margin is a calculation which reflects variable and fixed rate interest on investments and loans, less variable and fixed rate interest expense on deposits and other interest bearing liabilities. A majority of the rates of interest that the Company earns on its assets and pays on its liabilities, are established contractually for a specified period of time. Unfortunately, market interest rates change over time and if a financial institution cannot quickly adapt to market interest rate changes, then as a result it may be exposed to lower profit margins or even losses. For instance, if the Company was to fund long-term assets with short-term deposits, and interest rates rise over the term of the asset, the short-term deposits would rise in cost, decreasing or perhaps eliminating the prior amount of net interest income. Similar risks exist when rate sensitive assets (for example, prime based loans) are funded by longer-term fixed rate liabilities in a falling rate environment. Several techniques are used by the Company to manage this interest rate risk. The Company continually analyzes assets and liabilities based on their payment streams and interest rates, the timing of their maturities, and their sensitivity to potential changes in market interest rates. Such activities fall within the broad definition of asset/liability management. One technique used is measurement of the Company's asset/liability gap - the difference between cash flow amounts of interest sensitive assets and liabilities that will be repriced over a specified period, as illustrated in the Interest Rate Sensitivity Gap table. For example, if the total asset amount to be repriced within a certain period exceeds the corresponding total liability amount for the same period, then the institution is said to be asset sensitive. In this example, if market interest rates rose, net interest income would increase. If the opposite were true and rates fell, net interest income would also fall. The gap analysis used by the Company may not accurately reflect the effect on the Company as a result of changing interest rates since the gap analysis 1) assumes that assets and liabilities will be repriced only when they mature; and 2) assumes the same amount of change will be felt in both asset and liability portfolios. The following Interest Rate Sensitivity Gap table sets forth the interest rate sensitivity of the Company's interest earning assets and interest bearing liabilities as of September 30, 2001; the interest rate sensitivity gap, (interest rate sensitive assets minus interest rate sensitive liabilities) the cumulative interest rate sensitivity gap and the interest rate sensitivity gap ratio (interest rate sensitive assets divided by interest rate sensitive liabilities): 21
<TABLE> <CAPTION> =================================================================================================================================== Interest Rate DNC Gap September 30, 2001 (dollars in thousands, unaudited) After Three After One Within Months but Year but Three Within One Within Five After Five Months Year Years Years Total --------- --------- --------- --------- --------- <S> <C> <C> <C> <C> <C> Interest Earning Assets: Interest earning deposits $ 285 $ 95 $ 95 $ - $ 475 Federal funds sold - - - - - Investment securities 3,027 9,413 40,002 46,192 98,634 Loans (net of deferred fees) 188,153 26,339 58,846 158,353 431,691 --------- --------- --------- --------- --------- TOTAL $ 191,465 $ 35,847 $ 98,943 $ 204,545 $ 530,800 Interest Bearing Liabilities: Interest bearing demand deposits $ 45,645 $ - $ - $ - $ 45,645 Savings deposits 30,094 - - - 30,094 MMDA's 90,566 - - - 90,566 Time deposits less than $100,000 72,554 52,808 7,683 - 133,045 Time deposits of $100,000 or more 63,932 25,649 2,707 - 92,288 Borrowed funds 21,323 - - - 21,323 --------- --------- --------- --------- --------- TOTAL $ 324,114 $ 78,457 $ 10,390 $ - $ 412,961 Interest rate sensivity gap $(132,649) $ (42,610) $ 88,553 $ 204,545 $ 117,839 --------- --------- --------- --------- --------- Cumulative interest rate sensitivity gap $(132,649) $(175,259) $ (86,706) $ 117,839 --------- --------- --------- --------- Cumulative interest rate Sensitivity gap ratio 59.07% 56.47% 79.00% 128.54% --------- --------- --------- --------- =================================================================================================================================== </TABLE> The interest rate gap reported in Interest Rate Sensitivity Gap table for the first time frame, within three months, is $132 million, or almost 59%. This reports that the Company is liability sensitive, or likely to exhibit decreased earnings in a rising interest rate environment. Over the periods reported, the Company becomes more liability sensitive within one year, but becomes more asset sensitive as the longer-term consumer loans and tax free bond portfolio maturities appear, such longer-term assets which are unmatched in customer originated deposit maturities. Generally speaking, however, although the Company appears liability sensitive, shorter-term repriceable deposits such as NOW accounts, savings deposits and Money Market Deposit Accounts have very little immediate rate movement in an increasing rate environment. If this were the case, the Company would actually appear to be somewhat asset sensitive, with an asset sensitivity of about $44 million in the current period. No such assurance can be given, however, that this would be the case in a rising rate environment. Within the short-term, however, based on current economic conditions it does not appear that a rising rate environment is likely. 22
Another technique adds to gap analysis by considering the average life of the sum of cash flows for the asset or liability. This "duration" is measured by weighting cash flow amounts based on their timing, which takes into effect a consideration not made in gap analysis. The Company uses a more sophisticated technique called simulation modeling. The Company's simulation modeling system analyzes data from each of the Company's current asset and liability portfolios which has been downloaded from the Company's loan and deposit applications, and then projects various scenarios over future periods. The estimated cash flows for each of three market interest rate scenarios (most likely, rising and falling) are separately calculated for each likelihood. The resulting three ranges of probable risk exposures then reflect current and expected interest rate risk based on current loan and deposit structures. One can also vary the mix of asset and liability portfolios and pricing strategies, and arrive at the most desirable interest income alternative. This is the method by which the Company governs its extent of interest rate risk. See Part I, Item 3 - Qualitative and Quantitative Disclosures about Market Risk. LIQUIDITY --------- Liquidity refers to the Company's ability to maintain a cash flow that is adequate to fund operations, meet obligations and other commitments in a timely and cost-effective fashion. The Company needs sources of funds to meet short-term cash requirements which may be brought about by loan growth or deposit outflows, or other asset purchases or liability repayments. These funds are traditionally made available by drawing down correspondent Company deposit accounts reducing the volume of Fed funds sold, selling securities, selling other assets, or borrowing funds from other institutions. This funds availability is called liquidity. There were no Fed funds sold at September 30, 2001. In addition, the Company generally has a portfolio of available for sale investments, which could be sold should the need arise for immediate cash. As of September 30, 2001, this category comprised all of the Company's investment portfolio, as compared to $77 million and about 66% of the investment portfolio at September 30, 2000. In addition to on-balance-sheet liquidity, the Company has available off-balance-sheet liquidity in the form of lines of credit available in the approximate amount of $65 million at September 30, 2001. The Company manages its liquidity in such a fashion as to always be able to meet any unexpected sudden change in levels of assets held or deposit liabilities assumed. CAPITAL RESOURCES ----------------- The Company uses a variety of measures to evaluate the Company's capital adequacy. Management reviews the various capital measurements on a monthly basis and takes appropriate action to ensure that they are within established internal and external guidelines. The Company's current capital position exceeds current guidelines established by industry regulators. By the current regulatory definitions, the Company is adequately capitalized, the second highest rating of the categories defined under Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991. The Federal Deposit Insurance Corporation (FDIC) has promulgated risk-based capital guidelines for all state non-member companies such as the Company. These guidelines 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 guidelines, Tier 1 Capital includes common stockholders' equity less goodwill and certain other deductions, notably the unrealized net gains or losses (after tax adjustments) on available for sale investment securities carried at fair market value. Tier 2 Capital includes preferred stock and certain types of debt equity, which the Company does not hold, as well as the allowance for loan losses, subject to certain limitations. 23
Under the guidelines, the Company was defined as "adequately capitalized" as of September 30, 2001 and December 2000. The following table sets forth the Company's regulatory capital ratios as of the dates indicated: <TABLE> <CAPTION> ======================================================================================================================= Risk Based Ratios (dollars in thousands, unaudited) September 30, December 31, Minimum for 2001 2000 Capital Adequacy Purposes ----------------- ------------------ ---------------------------- <S> <C> <C> <C> Total capital to total risk-weighted assets 9.56% 9.00% 8.00% Tier 1 capital to total risk-weighted assets 8.35% 7.80% 4.00% Tangible equity ratio 6.29% 5.60% 4.00% ======================================================================================================================= </TABLE> As a result of the acquisition of Sierra National Bank during May 2000, the Company's capital ratios declined compared to previous years when the Company was "well capitalized". Between December 31, 2000 and September 30, 2001, these ratios improved as the Company retained additional earnings and declined slightly in total assets. It is expected that the Company's capital ratios will continue to improve in the fourth quarter of this year through additional retained earnings and limited growth, although no assurance can be given that this, in fact, will occur. It is also expected that the Company's capital will be supplemented by additional debt equity during the fourth quarter of 2001, although no absolute assurance can be given that this in fact will occur. At the current time, there are no commitments that would engender the use of material amounts of the Company's capital. 24
PART I - FINANCIAL INFORMATION Item 3 QUALITATIVE & QUANTITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK MANAGEMENT - ---------------------- Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices. The Company does not engage in trading of financial instruments. The Company has risk management policies to monitor and limit exposure to market risk arising due to changes in interest rates, and performs an earnings simulation analysis and a market value of portfolio equity calculation to identify more dynamic interest rate risk exposure. The Company's policy is to limit the change in the Company's net interest income to plus or minus 5% based on a 200 basis point (bp) shock in interest rates. As of September 30, 2001, the Company had the following estimated net interest income sensitivity profile: ------------------------------------------------------------------ Immediate Change In Rate ------------------------ +200 bp -200 bp ------- ------- Net Interest Income Change 119,000 271,000 -------------------------- ------------------------------------------------------------------- The above profile illustrates that if there were an immediate increase of 2% in the prime rate over the next year, the Company's net interest income would be increased by $271,000, or approximately .81%. By the same token, if there were an immediate downward adjustment of 200 bp or 2% in the prime rate, the Company's net interest income would also be increased by $119,000 over the next year, or approximately .36%. This seemingly contradictory circumstance, to make more money under both an increasing and decreasing net interest scenario, is due to the particular level of current interest rates and the floors and ceilings built into the model's assumptions for both loan and deposit accounts. In addition, the Company calculates changes in the economic value of its investment, loan and deposit portfolios based on various rate scenarios. The amount of change of economic value is based on the profiles of each portfolio and its inherent structure, which includes: the rate, whether its rate is fixed or floating, the likelihood of prepayment or repayment, the maturity of the instrument and the particular circumstances of the customer. The quantification of the change in economic value can somewhat be noted by the FAS 107 Fair Value of Financial Instruments in the Consolidated Financial Statements in the Annual Report on Form 10-K. However, such values change over time based on certain assumptions about interest rates and likely changes in the yield curve. See also Part I, Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Risk Management. 25
FORWARD-LOOKING STATEMENTS - -------------------------- This Form 10-Q includes forward-looking statements that involve inherent risks and uncertainties. The Company cautions readers that a number of important factors could cause actual results to differ materially from those in the forward-looking statements. Those factors include fluctuations in interest rates, inflation, government regulations, and economic conditions and competition in the geographic and business areas in which the Company conducts its operations. Words such as "expects", "anticipates", "believes", and "estimates", or variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed, forecasted in, or implied by, such forward-looking statements. 26
PART II - OTHER INFORMATION ITEM 1 : LEGAL PROCEEDINGS - -------------------------- In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the Company's financial condition or results of operation. ITEM 2 : CHANGES IN SECURITIES - ------------------------------ Not applicable ITEM 3 : DEFAULTS UPON SENIOR SECURITIES - ---------------------------------------- Not applicable ITEM 4 : SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------ None ITEM 5 : OTHER INFORMATION - -------------------------- Not applicable ITEM 6 : EXHIBITS AND REPORTS ON FORM 8-K - ----------------------------------------- None 27
SIGNATURES - ---------- Pursuant to the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 9, 2001. 11/13/01 /s/ James C. Holly - ------------------ ------------------------------------------ Date SIERRA BANCORP James C. Holly President & Chief Executive Officer 11/13/01 /s/ Kenneth R. Taylor - ------------------ -------------------------------------------- Date SIERRA BANCORP Kenneth R. Taylor Senior Vice President & Chief Financial Officer 28