10-K405 1 p15180_10-k405.txt FORM 10-K405 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 Commission File Number : 0-12499 First Financial Bancorp (Exact name of registrant as specified in its charter) California 94-28222858 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 701 South Ham Lane, Lodi, California 95242 (Address of principal executive offices) (Zip Code) (209)-367-2000 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value (Title of Class) Preferred Share Purchase Rights (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [ X ] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] As of March 1, 2002, there were 1,624,419 shares of Common Stock, no par value, outstanding. The aggregate market value of the Common Stock held by non-affiliates of the registrant was approximately $18,031,051 (based on the $11.10 average of bid and ask prices per share on March 1, 2002). Documents Incorporated by Reference Part of Form 10-K into which Incorporated ----------------------------------- ----------------------------------------- Proxy Statement for the Annual Meeting of Shareholders to be held on April 23, 2002. Part III, Items 10, 11, 12, 13 ================================================================================ 1 FIRST FINANCIAL BANCORP 2001 FORM 10-K TABLE OF CONTENTS PART 1 ITEM 1. BUSINESS ......................................................... 3 General .......................................................... 3 The Bank ......................................................... 3 Bank Services .................................................... 3 Sources of Business .............................................. 4 Competition ...................................................... 4 Employees ........................................................ 4 Supervision and Regulation ....................................... 5 The Company ............................................... 5 The Bank .................................................. 5 Officers .................................................. 6 Recent Legislation and Regulations Affecting Banking ...... 6 ITEM 2. PROPERTIES .......................................................10 ITEM 3. LEGAL PROCEEDINGS ................................................10 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ..............10 Part II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ..............................................11 ITEM 6. SELECTED FINANCIAL DATA ..........................................11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ........................................12 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ......................31 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ..............................31 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ...............32 ITEM 11. EXECUTIVE COMPENSATION ...........................................32 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ...32 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ...................32 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ..32 Signatures ..................................................................60 Index to Exhibits............................................................61 2 PART I ITEM 1. BUSINESS General: First Financial Bancorp (the "Company") was incorporated under the laws of the State of California on May 13, 1982, and operates principally as a bank holding company for its wholly owned subsidiary, Bank of Lodi, N.A. (the "Bank"). The Company is registered under the Bank Holding Company Act of 1956, as amended. The Bank is the principal source of income for the Company. The Bank owns the office building where the Bank's Lodi Branch and administrative offices are located, and the Company owns the land upon which the Bank's Woodbridge Branch is located. The Company receives income from the Bank under the lease associated with the Woodbridge property. The Company also holds all of the capital stock of Western Auxiliary Corporation (WAC), a California Corporation which functions as trustee on deeds of trust securing mortgage loans originated by the Bank. All references herein to the "Company" include the Bank and WAC, unless the context otherwise requires. The Bank: The Bank was organized on May 13, 1982 as a national banking association. The application to organize the Bank was accepted for filing by the Comptroller of the Currency (the "OCC") on September 8, 1981, and preliminary approval to organize was granted on March 27, 1982. On July 18, 1983 the Bank received from the OCC a Certificate of Authority to Commence the Business of Banking. Subsequently, the Bank opened branch offices in Woodbridge and Lockeford, California. Effective February 22, 1997, the Bank acquired the Galt, Plymouth and San Andreas offices of Wells Fargo Bank. A loan production office in Folsom, California was opened in January 1998, and was approved to operate as a full-service branch in July 1999. In July 2001 the Bank relocated the Folsom branch. A full-service branch was opened in Elk Grove, California in August 1998. In March 2001, the Bank established a Small Business Administration loan production office in Folsom, California. The Bank's headquarters is located at 701 South Ham Lane, Lodi, California. The Bank's primary service area, from which the Bank attracts 50% of its business, is the city of Lodi and the surrounding area. This area is estimated to have a population approaching 60,000 persons, with a median annual family income of approximately $40,000. The area includes residential developments, neighborhood shopping centers, business and professional offices and manufacturing and agricultural concerns. Bank Services: The Bank offers a wide range of commercial banking services to individuals and business concerns located in and around its primary service area. These services include personal and business checking and savings accounts (including interest-bearing negotiable order of withdrawal ("NOW") accounts and/or accounts combining checking and savings accounts with automatic transfers), and time certificates of deposit. The Bank also offers extended banking hours at its drive-through window, night depository and bank-by-mail services, and travelers' checks (issued by an independent entity). Each branch location has a 24-hour ATM machine, and the Bank has 24 hour telephone banking and bill paying services. The Bank issues MasterCard credit cards and acts as a merchant depository for cardholder drafts under both VISA and MasterCard. In addition, it provides note and collection services and direct deposit of social security and other government checks. During 2000, the Bank introduced Internet banking and bill payment services, which are located at www.bankoflodi.com. During 1998, the Bank entered into an agreement with Investment Centers of America to offer stocks, bonds, mutual funds, annuities and insurance products through offices located on-site at Bank branches. The first Investment Centers of America office was established at the Lodi branch location, and additional offices are planned for Elk Grove and Folsom. The Bank engages in a full complement of lending activities, including commercial, Small Business Administration (SBA), residential mortgage, consumer/installment, and short-term real estate loans, with particular emphasis on short and medium-term obligations. Commercial lending activities are directed principally toward businesses whose demand for funds falls within the Bank's lending limit, such as small to medium-sized professional firms, retail and wholesale outlets and manufacturing and agricultural concerns. Consumer lending is oriented primarily to the needs of the Bank's customers, with an emphasis on automobile financing and leasing. Consumer loans also include loans for boats, home improvements, debt consolidation, and other personal needs. Real estate loans include short-term "swing" loans and construction loans. Residential mortgages are generally sold into the secondary market for these loans. SBA loans are made available to small to medium-sized businesses. The Bank generates noninterest income through premiums received on the sale of the guaranteed portions of SBA loans and the resulting on-going servicing income on its SBA portfolio. 3 Sources of Business: Management seeks to obtain sufficient market penetration through the full range of services described above and through the personal solicitation of the Bank's officers, directors and shareholders. All officers are responsible for making regular calls on potential customers to solicit business and on existing customers to obtain referrals. Promotional efforts are directed toward individuals and small to medium-sized businesses. The Bank's customers are able in their dealings with the Bank to be served by bankers who have commercial loan experience, lending authority, and the time to serve their banking needs quickly and competently. Bankers are assigned to customers and not transferred from office to office as in many major chain or regional banks. In order to expedite decisions on lending transactions, the Bank's loan committee meets on a regular basis and is available where immediate authorization is important to the customer. The risk of non-payment (or deferred payment) of loans is inherent in commercial banking. Furthermore, the Bank's marketing focus on small to medium-sized businesses may involve certain lending risks not inherent in loans to larger companies. Smaller companies generally have shorter operating histories, less sophisticated internal record keeping and financial planning capabilities, and greater debt-to-equity ratios. Management of the Bank carefully evaluates all loan applicants and attempts to minimize its credit risk through the use of thorough loan application and approval procedures. Consistent with the need to maintain liquidity, management of the Bank seeks to invest the largest portion of the Bank's assets in loans of the types described above. Loans are generally limited to less than 80% of deposits and capital funds. The Bank's surplus funds are invested in the investment portfolio, made up of both taxable and non-taxable debt securities of the U.S. government, U.S. government agencies, states, and municipalities. On a day-to-day basis, surplus funds are invested in federal funds and other short-term money market instruments. Competition: The banking business in California generally, and in the northern portion of central California where the Bank is located, is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major banks with branch office networks and other operating affiliations throughout the State. The Bank competes for deposits and loans with these banks, as well as with savings and loan associations, thrift and loan associations, credit unions, mortgage companies, insurance companies and other lending institutions. Among the advantages certain of these institutions have over the Bank are their ability (i) to finance extensive advertising campaigns, (ii) to allocate a substantial portion of their investment assets in securities with higher yields (not available to the Bank if its investments are to be diversified) and (iii) to make funds available for loans in geographic regions with the greatest demand. In competing for deposits, the Bank is subject to the same regulations with respect to interest rate limitations on time deposits as other depository institutions. See "Supervision and Regulation" below. Many of the major commercial banks operating in the Bank's service area offer certain services, such as international banking and trust services, which are not offered directly by the Bank, and such banks, by virtue of their greater capitalization, have substantially higher lending limits than the Bank. In addition, other entities, both public and private, seeking to raise capital through the issuance and sale of debt and equity securities compete with the Bank for the acquisition of funds for deposit. In order to compete with other financial institutions in its primary service area, the Bank relies principally on local promotional activities, personal contacts by its officers, directors, employees and shareholders, extended hours and specialized services. The Bank's promotional activities emphasize the advantages of dealing with a locally-owned and headquartered institution sensitive to the particular needs of the community. The Bank also assists customers in obtaining loans in excess of the Bank's lending limit or services not offered by the Bank by arranging such loans or services in participation with or through its correspondent banks. The State Bank Parity Act, effective January 1, 1996, eliminated certain existing disparities between California state chartered banks and national banking associations, such as the Bank, by authorizing the California Commissioner of Financial Institutions (the "Commissioner") to address such disparities through a streamlined rule-making process. Employees: As of December 31, 2001, the Company employed 120 full-time equivalent employees, including four executive officers. Management believes that the Company's relationship with its employees is good. 4 Supervision and Regulation The Company: The common stock of the Company is subject to the registration requirements of the Securities Act of 1933, as amended, and the qualification requirements of the California Corporate Securities Law of 1968, as amended. The Company is also subject to the periodic reporting requirements of Section 13(d) of the Securities Exchange Act of 1934, as amended, which include, but are not limited to, annual, quarterly and other current reports with the Securities and Exchange Commission. The Company is a bank holding company registered under the Bank Holding Company Act of 1956 (the "Act") and is subject to supervision by the Board of Governors of the Federal Reserve System (the "Board"). As a bank holding company, the Company must file with the Board quarterly reports, annual reports, and such other additional information as the Board may require pursuant to the Act. The Board may also make examinations of the Company and its subsidiaries. The Act requires prior approval of the Board for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares, or substantially all the assets, of any bank, or for a merger or consolidation by a bank holding company with any other bank holding company. The Act also prohibits the acquisition by a bank holding company or any of its subsidiaries of voting shares, or substantially all the assets, of any bank located in a state other than the state in which the operations of the bank holding company's banking subsidiaries are principally conducted, unless the statutes of the state in which the bank to be acquired is located expressly authorize such acquisition. With certain limited exceptions, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or furnishing services to, or performing services for, its authorized subsidiaries. A bank holding company may, however, engage in or acquire an interest in a company that engages in activities that the Board has determined to be so closely related to banking or to managing or controlling banks as to be properly incident thereto. In making such a determination, the Board is required to consider whether the performance of such activities reasonably can be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, which outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Board is also empowered to differentiate between activities commenced de novo and activities commenced by the acquisition, in whole or in part, of a going concern. Additional statutory provisions prohibit a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit, sale or lease of property or furnishing of services. Thus, a subsidiary bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer must obtain or provide some additional credit, property or service from or to such bank other than a loan, discount, deposit or trust service; or (ii) the customer must obtain or provide some additional credit, property or service from or to the company or any other subsidiary of the company; or (iii) the customer may not obtain some other credit, property to service from competitors, except reasonable requirements to assure soundness of the credit extended. These anti-tying restrictions also apply to bank holding companies and their non-bank subsidiaries as if they were banks. The Company's ability to pay cash dividends is subject to restrictions set forth in the California General Corporation Law. The Bank is a legal entity separate and distinct from the Company, and is subject to various statutory and regulatory restrictions on its ability to pay dividends to the Company. See Note 14(c) to the consolidated financial statements for further information regarding the payment of cash dividends by the Company and the Bank. The Company is a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the Commissioner. Regulations have not yet been proposed or adopted to implement the Commissioner's powers under this statute. The Bank: The Bank, is a national banking association whose deposit accounts are insured by the Federal Deposit Insurance Corporation (the "FDIC") up to the maximum legal limits and the Bank is subject to regulation, supervision, and regular examination by the OCC. The Bank is a member of the Federal Reserve System, and, as such, is subject to certain provisions of the Federal Reserve Act and regulations issued by the Board. The Bank is also subject to applicable provisions of California law, insofar as they are not in conflict with, or preempted by, federal law. The regulations of these various agencies govern most aspects of the Bank's business, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends and location of branch offices. 5 Officers: Leon Zimmerman, age 59, is President and Chief Executive Officer of the Bank and of the Company; Robert H. Daneke, age 48 is Executive Vice President and Chief Credit Officer of the Bank and of the Company; Allen R. Christenson, age 44 is Senior Vice-President, Chief Financial Officer and Secretary of the Bank and of the Company and; Lance Gallagher, age 57 is Senior Vice President and Operations Administrator of the Bank and the Company. Mr. Zimmerman joined the Company in April 1990. He was promoted from Executive Vice President and Chief Credit Officer of Bank of Lodi to President and CEO in August of 1994. Mr. Zimmerman became President and CEO of the Company effective August 1995. He lives in Lodi with his wife and has resided and worked in the San Joaquin-Sacramento Valley since 1960, serving in various banking capacities since 1962. Mr. Zimmerman serves on many community boards and committees, including the Lodi Police Chaplaincy Association, San Joaquin County Education Foundation, Chamber of Commerce - Agribusiness Committee, and LEED - Sacramento Steering Committee. He is a member of Lodi Rotary Club, Sutter Club - Sacramento, World Trade Club - San Francisco, Independent Order of Odd Fellows, Lodi Grape Festival and Harvest Fair and several other community groups. Mr. Daneke joined the Company in December 1999 bringing on board 23 years of banking experience. Prior to joining the Company, Mr. Daneke was employed at Clovis Community Bank for eight years and was promoted to Senior Vice President/Senior Credit Officer in 1997. In addition, his career has included: seven years with the Correspondent Bank Division of Community Bank in Redwood City and seven years with Bank of America Corporate Banking Group. Mr. Daneke holds a B.B.A. Degree in Finance from the University of Iowa. He is also a graduate of Pacific Coast Banking School at the University of Washington, the California Intermediate Banking School at the University of San Diego and the Lodi Chamber of Commerce Leadership Lodi Program. He currently is a member of the Lodi Chapter of Independent Order of Odd Fellows and serves on Lodi Unified School District's Budget Advisory Committee. Mr. Daneke resides in Lodi with his wife and two children. Mr. Christenson joined the Company in August 1999. Prior to joining the Company, Mr. Christenson was Senior Vice President and Chief Financial Officer of River City Bank, located in Sacramento, California (1994-1999). Prior to joining River City Bank, Mr. Christenson was Senior Vice President and Chief Financial Officer of CapitolBank Sacramento, which was acquired by another bank (1993-1994). Prior to joining CapitolBank Sacramento, Mr. Christenson was in public accounting for over eight years, specializing in financial audits and consulting within the financial services industry. Mr. Christenson is a Certified Public Accountant and has a Bachelors degree from California State University, Sacramento. He resides in South Sacramento with his wife and five children. He is a life-long resident of the greater Sacramento area and continues to serve in various community and civic organizations. Mr. Gallagher joined the Bank in February 1991. He was promoted from Vice President of Compliance to Senior Vice President and Operations Administrator in January 1997. As a graduate of the American Bankers Associations Graduate School of Compliance, he is responsible for the Bank's regulatory compliance program in addition to Bank operations and item processing. Prior to joining the Company, Mr. Gallagher was with Wells Fargo Bank for 22 years in various customer service, operations, and human resource capacities of increasing responsibility. He lives in San Joaquin County with his wife and has four boys and a grandson. Mr. Gallagher is a banking instructor for The American Institute of Banking and Delta Community College, serves as a member of the Colleges Banking Advisory Board, a member of the HEALD College Employer Advisory Committee, and is the Initiation Coaching Program Director with U. S. Hockey Pacific District. Recent Legislation and Regulations Affecting Banking: From time to time, new laws are enacted which increase the cost of doing business, limit permissible activities, or affect the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of bank holding companies, banks and other financial institutions are frequently made in Congress, in the California legislature and before various bank holding company and bank regulatory agencies. The likelihood of any major changes and the impact such changes might have are impossible to predict. Certain significant recently proposed or enacted laws and regulations are discussed below. Interstate Banking. Since 1986, California has permitted California banks and bank holding companies to be acquired by banking organizations based in other states on a "reciprocal" basis (i.e., provided the other state's laws permit California banking organizations to acquire banking organizations in that state on substantially the same terms and conditions applicable to local banking organizations). Since October 2, 1995, California law implementing certain provisions of prior federal law have (1) permitted interstate merger transactions; (2) prohibited interstate branching through the acquisition of a branch business unit located in California without acquisition of the whole unit of the California bank; and (3) prohibited interstate branching through de novo establishment of California branch offices. Initial entry into California by an out-of-state institution must be accomplished by acquisition of or merger with an existing whole bank, which has been in existence for at least five years. 6 Capital Requirements. Federal regulation imposes upon all FDIC-insured financial institutions a variable system of risk-based capital guidelines designed to make capital requirements sensitive to differences in risk profiles among banking organizations, to take into account off-balance sheet exposures and to aid in making the definition of bank capital uniform internationally. Under the OCC's risk-based capital guidelines, the Bank is required to maintain capital equal to at least 8 percent of its assets, weighted by risk. Assets and off-balance sheet items are categorized by the guidelines according to risk, and certain assets considered to present less risk than others permit maintenance of capital below the 8 percent level. The guidelines established two categories of qualifying capital: Tier 1 capital comprising core capital elements, and Tier 2 comprising supplementary capital requirements. At least one-half of the required capital must be maintained in the form of Tier 1 capital. For the Bank, Tier 1 capital includes only common stockholders' equity and retained earnings, but qualifying perpetual preferred stock would also be included without limit if the Bank were to issue such stock. Tier 2 capital includes, among other items, limited life (and in the case of banks, cumulative) preferred stock, mandatory convertible securities, subordinated debt and a limited amount of the allowance for loan and lease losses. The guidelines also require all insured institutions to maintain a minimum leverage ratio of 3 percent Tier 1 capital to total assets (the "leverage ratio"). The OCC emphasizes that the leverage ratio constitutes a minimum requirement for the most well run banking organizations. All other banking organizations are required to maintain a minimum leverage ratio ranging generally from 4 to 5 percent. The Bank's required minimum leverage ratio is 4 percent. The federal banking agencies during 1996 issued a joint agency policy statement regarding the management of interest-rate risk exposure (interest rate risk is the risk that changes in market interest rates might adversely affect a bank's financial condition) with the goal of ensuring that institutions with high levels of interest-rate risk have sufficient capital to cover their exposures. This policy statement reflected the agencies' decision at that time not to promulgate a standardized measure and explicit capital charge for interest rate risk, in the expectation that industry techniques for measurement of such risk will evolve. However, the Federal Financial Institutions Examination Council ("FFIEC") on December 13, 1996, approved an updated Uniform Financial Rating System ("UFIRS"). In addition to the five components traditionally included in the so-called "CAMEL" rating system which has been used by bank examiners for a number of years to classify and evaluate the soundness of financial institutions (including capital adequacy, asset quality, management, earnings and liquidity), UFIRS includes for all bank regulatory examinations conducted on or after January 1, 1997, a new rating for a sixth category identified as sensitivity to market risk. Ratings in this category are intended to reflect the degree to which changes in interest rates, foreign exchange rates, commodity prices or equity prices may adversely affect an institution's earnings and capital. The rating system henceforth will be identified as the "CAMELS" system. As of December 31, 2001, the Bank's total risk-based capital ratio was approximately 10.24 percent and its leverage ratio was approximately 7.45 percent. The Bank does not presently expect that compliance with the risk-based capital guidelines or minimum leverage requirements will have a materially adverse effect on its business in the reasonably foreseeable future. Nor does the Bank expect that its sensitivity to market risk will adversely affect its overall CAMELS rating as compared with its previous CAMELS ratings by bank examiners. Deposit Insurance Assessments. In 1995, the FDIC, pursuant to Congressional mandate, reduced bank deposit insurance assessment rates to a range from $0 to $.27 per $100 of deposits, dependent upon a bank's risk. The FDIC has continued these reduced assessment rates through 2001. Based upon the above risk-based assessment rate schedule, the Bank's current capital ratios, the Bank's current level of deposits, and assuming no further change in the assessment rate applicable to the Bank during 2002, the Bank estimates that its annual noninterest expense attributed to the regular assessment schedule will not increase during 2002. 7 Prompt Corrective Action. Prompt Corrective Action Regulations (the "PCA Regulations") of the federal bank regulatory agencies established five capital categories in descending order (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized), assignment to which depends upon the institution's total risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage ratio. Institutions classified in one of the three undercapitalized categories are subject to certain mandatory and discretionary supervisory actions, which include increased monitoring and review, implementation of capital restoration plans, asset growth restrictions, limitations upon expansion and new business activities, requirements to augment capital, restrictions upon deposit gathering and interest rates, replacement of senior executive officers and directors, and requiring divestiture or sale of the institution. The Bank has been classified as a well-capitalized bank since adoption of the PCA Regulations. Community Reinvestment Act. Community Reinvestment Act ("CRA") regulations effective as of July 1, 1995 evaluate banks' lending to low and moderate income individuals and businesses across a four-point scale from "outstanding" to "substantial noncompliance," and are a factor in regulatory review of applications to merge, establish new branches or form bank holding companies. In addition, any bank rated in "substantial noncompliance" with the CRA regulations may be subject to enforcement proceedings. The Bank has a current rating of "satisfactory" CRA compliance. Safety and Soundness Standards. Federal bank regulatory agency safety and soundness standards for insured financial institutions establish standards for (1) internal controls, information systems and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset growth; and (6) compensation, fees and benefits. In addition, the standards prohibit the payment of compensation which is excessive or which could lead to material financial loss. If an agency determines that an institution fails to meet any standard established by the guidelines, the agency may require the financial institution to submit to the agency an acceptable plan to achieve compliance with the standard. Agencies may elect to initiate enforcement action in certain cases where failure to meet one or more of the standards could threaten the safe and sound operation of the institution. The Bank has not been and does not expect to be required to submit a safety and soundness compliance plan because of a failure to meet any of the safety and soundness standards. Permitted Activities. In recent years, the Federal banking agencies, especially the OCC and the Board, have taken steps to increase the types of activities in which national banks and bank holding companies can engage, and to make it easier to engage in such activities. On November 20, 1996, the OCC issued final regulations permitting national banks to engage in a wider range of activities through subsidiaries. "Eligible institutions" (those national banks that are well capitalized, have a high overall rating and a satisfactory CRA rating, and are not subject to an enforcement order) may engage in activities related to banking through operating subsidiaries after going through a new expedited application process. In addition, the new regulations include a provision whereby a national bank may apply to the OCC to engage in an activity through a subsidiary in which the bank itself may not engage. Although the Bank is not currently intending to enter into any new type of business, this OCC regulation could be advantageous to the Bank if the Bank determines to expand its operations in the future, depending on the extent to which the OCC permits national banks to engage in new lines of business and whether the Bank qualifies as an "eligible institution" at the time of making application. Monetary Policies. Banking is a business in which profitability depends on rate differentials. In general, the differences between the interest rate received by a bank on loans extended to its customers and securities held in that bank's investment portfolio and the interest rate paid on its deposits and its other borrowings constitute the major portion of the bank's earnings. To the extent that a bank is not able to compensate for increases in the cost of deposits and other borrowings with greater income from loans, securities and fees, the net earnings of that bank will be reduced. The interest rates paid and received by any bank are highly sensitive to many factors that are beyond the control of that bank, including the influence of domestic and foreign economic conditions. See Item 7 herein, Management's Discussion and Analysis of Financial Condition and Results of Operations. The earnings and growth of a bank are also affected by the monetary and fiscal policy of the United States Government and its agencies, particularly the Board. These agencies can and do implement national monetary policy, which is used in part to curb inflation and combat recession. Among the instruments of monetary policy used by these agencies are open market transactions in United States Government securities, changes in the discount rates of member bank borrowings, and changes in reserve requirements. The actions of the Board have had a significant effect on banks' lending, investments and deposits, and such actions are expected to continue to have a substantial effect in the future. However, the nature and timing of any further changes in such policies and their impact on banks cannot be predicted. 8 Financial Services Modernization Legislation. On November 12, 1999 President Clinton signed into law the Gramm-Leach-Bliley Act of 1999 (the "Modernization Act"). The Modernization Act repeals the two affiliation provisions of the Glass-Steagall Act: Section 20, which restricts the affiliation of Federal Reserve member banks with firms "engaged principally" in specified securities activities; and Section 32, which restricts officer, director, or employee interlocks between a member bank and any company or person "primarily engaged" in specified securities activities. In addition, the Modernization Act also expressly preempts any state law restricting the establishment of financial affiliations, primarily related to insurance. The law establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHC Act framework to permit a holding company system to engage in a full range of financial activities through a new entity known as a Financial Holding Company. "Financial activities" is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. In order for the Company to take advantage of the ability provided by the modernization Act to affiliate with other financial service providers, it must become a "Financial Holding Company." To do so, the Company would file a declaration with the Federal Reserve, electing to engage in activities permissible for Financial Holding companies and certifying that it is eligible to do so because its insured depository institution subsidiary (the Bank) is well-capitalized and well-managed. In addition, the Federal Reserve must also determine that an insured depository institution subsidiary has at least a "satisfactory" rating under the Community Reinvestment Act. [The Company currently meets the requirements for Financial Holding Company status]. The Company will continue to monitor its strategic business plan to determine whether, based on market conditions and other factors, the Company wishes to utilize any of its expanded powers provided in the Modernization Act. Under the Modernization Act, securities firms and insurance companies that elect to become Financial Holding Companies may acquire banks and other financial institutions. The Company does not believe that the Modernization Act will have a material adverse effect on its operations in the near-term. However, to the extent that it permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. The Modernization Act is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the amount of competition that the Company and the Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company and the Bank. Proposed Legislation and Regulation. Certain legislative and regulatory proposals that could affect the Bank and the banking business in general are pending or may be introduced before the United States Congress, the California State Legislature and Federal and state government agencies. The United States Congress is considering numerous bills that could reform banking laws substantially. It is not known whether any of these current legislative proposals will be enacted and what effect such legislation would have on the structure, regulation and competitive relationships of financial institutions. It is likely, however, that many of these proposals would subject the Bank to increased regulation, disclosure and reporting requirements and would increase competition to the Bank and its cost of doing business. In addition to pending legislative changes, the various banking regulatory agencies frequently propose rules and regulations to implement and enforce already existing legislation. It cannot be predicted whether or in what form any such rules or regulations will be enacted or the effect that such rules and regulations may have on the Bank's business. The above description of the business of the Bank should be read in conjunction with Item 7 herein, Management's Discussion and Analysis of Financial Condition and Results of Operations. 9 ITEM 2. PROPERTIES The Bank owns a 0.861 acre lot located at the corner of Ham Lane and Tokay Street, Lodi, California. A 34,000 square foot, tri-level commercial building for the main branch and administrative offices of the Company and the Bank was constructed on the lot. The Company and the Bank use approximately 75% of the leasable space in the building and the remaining area is either leased or available for lease as office space to other tenants. The construction of this building in 1991 has enabled the Bank to better serve its customers with more teller windows, four drive-through lanes and expanded safe deposit box capacity. The Company owns a 10,000 square foot lot located on Lower Sacramento Road in the unincorporated San Joaquin County community of Woodbridge, California. The entire parcel has been leased to the Bank on a long-term basis at market rates. The Bank has constructed, furnished and equipped a 1,437 square foot branch office on the parcel and commenced operations of the Woodbridge Branch on December 15, 1986. The Bank assumed a long-term ground lease on 1.7 acres of land at 19000 North Highway 88, Lockeford, California. The building previously occupying the Lodi site at 701 South Ham Lane was moved to Lockeford, California, and has become the permanent branch office of the Bank at that location. A temporary 1,000 square foot office had been used by the Bank at the Lockeford location. The permanent office was opened on April 1, 1991. The temporary office, along with a portion of the permanent building, is leased by the Bank to two tenants. On February 22, 1997, the Bank acquired the Galt, Plymouth and San Andreas branches of Wells Fargo Bank. The transaction included the assumption of the 6,000 square foot branch building lease in Galt with a remaining term of two years, and the purchase of the branch building and land for the Plymouth and San Andreas offices. The Plymouth and San Andreas offices are approximately 1,200 and 5,500 square feet, respectively. In November 1998, upon expiration of the Galt lease, the Galt branch was relocated to a new 3,000 square foot leased facility one block west of the old location. The new Galt location is leased under a five-year lease with three successive five-year renewal options. In January 1998, the Bank opened a 1,220 square foot loan production office in Folsom, California. The office was leased for one year with a one-year renewal option that has been exercised by the Bank. In July 1999, the Bank received approval to operate the Folsom office as a full-service branch. In December 1999, the lease was extended for one year to allow the Bank time to identify a permanent location in the Folsom community. In December 2000, the Landlord agreed to extend the lease on a month-to-month basis while the Bank completed the process of moving into a new full-service branch location. In January 2001, the Bank entered into a 10-year lease for a 2,426 square foot full-service branch location in the Folsom area. In July 2001, the new Folsom branch became fully operational and the former branch was subsequently closed. In August 1998, the Bank opened a 4,830 square foot full service branch in Elk Grove, California. The office is leased under a three-year lease with two successive three-year renewal options. In January 2001, the Bank entered into a three-year lease for a 1,557 square foot Small Business Administration loan production office in the Folsom area. ITEM 3. LEGAL PROCEEDINGS Not Applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable 10 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS There is no established public trading market for the common stock of the Company. The Company's common stock is traded in the over-the-counter market and is not presently listed on a national exchange or reported by the NASDAQ Stock Market. Trading of the stock has been limited and has been principally contained within the Company's general service area. As of March 1, 2002, there were 1,048 shareholders of record of the Company's common stock. Set forth below is the range of high and low bid prices for the common stock during 2001 and 2000. 2001 2000 Bid Price of Common Shares High Low High Low First Quarter $ 10.13 9.00 12.00 9.50 Second Quarter 9.87 9.12 10.75 8.00 Third Quarter 10.42 9.00 10.38 8.50 Fourth Quarter 11.15 9.90 10.88 9.75 The foregoing prices are based on trades of which Company is aware and reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions. ITEM 6. SELECTED FINANCIAL DATA
------------------------------------------------------------------------------------------------------------------- (in thousands except per share amounts) Consolidated Statement of Income 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------- Interest Income $ 13,858 13,496 12,526 11,508 10,592 Interest Expense 4,644 4,613 3,699 4,028 3,785 Net Interest Income 9,214 8,883 8,827 7,480 6,807 Provision for Loan Losses 391 135 1,051 250 (60) Noninterest Income 3,828 2,690 2,461 1,878 1,423 Noninterest Expense 11,226 9,855 8,803 7,712 6,796 Net Income $ 1,207 1,283 1,159 1,052 1,015 Per Share Data ------------------------------------------------------------------------------------------------------------------- Basic Earnings $ .75 .81 .75 .69 .67 Diluted Earnings .73 .79 .72 .65 .64 Cash Dividends Declared $ - .05 .20 .20 .20 Consolidated Balance Sheet Data ------------------------------------------------------------------------------------------------------------------- Federal Funds Sold $ 6,129 10,115 100 4,800 4,900 Investment Securities 41,015 29,560 36,096 45,647 61,917 Loans held for sale 3,876 1,292 647 2,619 1,807 Loans, net of loss reserve and deferred fees 135,430 110,793 108,947 88,459 60,421 Total Assets 226,175 185,064 176,334 164,400 147,850 Total Deposits 201,571 162,261 156,161 149,544 133,891 Other Borrowings 4,000 4,588 4,300 - - Total Stockholders' Equity $ 17,863 16,454 14,521 13,857 12,861
11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements in this Annual Report on Form 10-K include forward-looking information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the "safe harbor" created by those sections. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors: competitive pressure in the banking industry; changes in the interest rate environment; general economic conditions, either nationally or regionally becoming less favorable than expected and resulting in, among other things, a deterioration in credit quality and an increase in the provision for possible loan losses; changes in the regulatory environment; changes in business conditions; volatility of rate sensitive deposits; operational risks, including data processing system failures or fraud; asset/liability matching risks and liquidity risks; and changes in the securities markets. Prospective Accounting Pronouncements In July 2001, the Financial Accounting Standards Board (FASB) issued Statement No. 142, Goodwill and Other Intangible Assets. Statement No. 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement No. 142. Statement No. 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The Company is required to adopt Statement No. 142 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001, but prior to the effective date of Statement No. 142, will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-statement No. 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of Statement No. 142. The only exception to Statement No. 142 is the amortization of goodwill and intangible assets acquired under the provisions of Statement No. 72, Accounting of Certain Acquisitions of Banking or Thrift Institutions. The Company will continue to amortize goodwill and intangible assets acquired under this statement. The FASB recently issued Statement No. 143, Accounting for Asset Retirement Obligations, in August 2001. This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. As a result, FASB Statement No. 143 applies to all entities that have legal obligations associated with the retirement of long-lived tangible assets that result from the acquisition, construction, development or normal use of the asset. As used in this Statement, a legal obligation results from existing law, statute, ordinance, written or oral contract, or by legal construction of a contract under the doctrine of promissory estoppels. Statement No. 143 requires an enterprise to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of a tangible long-lived asset. Since the requirement is to recognize the obligation when incurred, approaches that have been used in the past to accrue the asset retirement obligation over the life of the asset are no longer acceptable. Statement No. 143 also requires the enterprise to record the contra to the initial obligation as an increase to the carrying amount of the related long-lived asset (i.e., the associated asset retirement costs) and to depreciate that cost over the remaining useful life of the asset. The liability is changed at the end of each period to reflect the passage of time (i.e., accretion expense) and changes in the estimated future cash flows underlying the initial fair value measurement. Enterprises are required to adopt Statement No. 143 for fiscal years beginning after June 15, 2002. Early adoption is encouraged. On October 3, 2001,the Financial Accounting Standards Board issued FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While Statement No. 144 supersedes FASB Statement No.121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of that Statement. Statement No.144 also supersedes the accounting and reporting provisions of APB Opinion No.30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the Disposal of a Segment of a Business. However, it retains the requirement in Opinion 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. By broadening the presentation of discontinued operations to include more disposal transactions, the FASB has enhanced management's ability 12 to provide information that helps financial statement users to assess the effects of a disposal transaction on the ongoing operations of an entity. The statement is required to be adopted for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. Early adoption is encouraged. The Company does not expect adoption of Statements No. 142, 143 or 144 to have a material impact on the financial condition or operating results of the Company. Critical Accounting Policies and Estimates The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, income and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to the allowance for loan losses, other real estate owned, investments and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. The Company maintains allowances for loan losses resulting from the inability to make required loan payments. If the financial conditions of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company invests in debt and equity securities. If the Company believes these securities have experienced a decline in value that is other than temporary, an investment impairment charge is recorded. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment's carrying value, thereby requiring an impairment charge in the future. The following discussion addresses information pertaining to the financial condition and results of operations of the Company that may not be otherwise apparent from a review of the consolidated financial statements and related footnotes. It should be read in conjunction with those statements and notes found on pages 35 through 59, as well as other information presented throughout this report. Summary of Earnings Performance
--------------------------------------------------------------------------------------------------------- For the Year Ended December 31: ------------------------------------------------------------------ 2001 2000 1999 Earnings (in thousands) $ 1,207 1,283 1,159 --------------------------------------------------------------------------------------------------------- Basic earnings per share $ .75 .81 .75 Diluted earnings per share $ .73 .79 .72 Return on average assets 0.59% 0.71% 0.69% Return on average equity 7.03% 8.74% 8.19% Dividend payout ratio - 5.88% 24.19% --------------------------------------------------------------------------------------------------------- Average equity to average assets 8.34% 8.10% 8.40% ---------------------------------------------------------------------------------------------------------
Net income totaled $1,207 thousand for the year ended December 31, 2001, resulting in a decrease of $76 thousand, or 5.9%, over the prior year. The Company experienced growth in earning assets and deposits during 2001 resulting in a $331 thousand increase in net interest income. Net interest income was negatively impacted during 2001 as a result of an overall decline in interest rates. As a result of increases in loans during 2001, the Company increased the provision for loan losses by $256 thousand as compared to 2000. In addition, the Company experienced a $1,138 thousand increase in noninterest income which was offset by an increase of $1,371 thousand in noninterest expense. Furthermore, the Company's provision for income taxes declined $82 thousand in 2001 as compared to 2000. 13 Basic earnings per share in 2001 were $.75, compared to $.81 and $.75 in 2000 and 1999, respectively. For the year ended December 31, 2001, interest income increased $362 thousand and interest expense increased $31 thousand resulting in an increase in net interest income totaling $331 thousand as compared to the prior year. During 2001, the Company experienced growth rates of 23.9% in gross loans (total portfolio loans plus loans held for sale) and 24.2% in deposits. In addition, during 2001 the Company experienced a significant decline in its prime lending rate as a result of eleven interest rate reductions by the Federal Reserve. While the Company experienced significant growth in loans and deposits during the year, the reductions in the prime lending rate reduced the overall earnings potential generated by the increases in the Company's earning assets. Furthermore, the Company was successful in collecting interest totaling $423 thousand and $224 thousand on loans that had previously been on nonaccrual during 2001 and 2000, respectively. Interest forgone on nonaccrual loans amounted to $310 thousand during 2001 compared to $542 thousand during 2000. The Provision for Loan Losses for the year ending December 31, 2001 was $391 thousand, an increase of $256 thousand over 2000's provision of $135 thousand. The increase in the provision was primarily related to the growth in the Company's loans. Noninterest income totaled $3,828 thousand for the year ending December 31, 2001 resulting in an increase of $1,138, or 42.3%, over the prior year. The increase resulted primarily from four areas; gains on the sale of investment securities, loans and other real estate, increased service charge revenue which resulted from the increase in total deposits, increased mortgage lending activity and an increase in the cash surrender value of life insurance. Total noninterest expense increased $1,371 thousand, or 13.9% during the year primarily as a result of additions to personnel and the upgrading of existing positions in addition to general overall increases in the cost of operations incurred with strategic expansion projects. During 2000, the Company experienced growth rates of 2.1% in gross loans and 3.9% in deposits resulting in an increase in net interest income. In addition, the Provision for Loan Losses for the year ending December 31, 2000 was $135 thousand, a decrease of $916 thousand over 1999's provision of $1,051 thousand. Furthermore, noninterest income increased 9.3% during 2000, primarily as a result of changes in the pricing of some of the Bank's deposit products (which were implemented during the third quarter of 1999) and a $149 thousand gain on the sale of investment securities. Additionally, the Company experienced a 12.0% increase in noninterest expense during the year. The increase in noninterest expense is attributable to general overall increases in the cost of operations combined with expenses incurred with strategic expansion projects and expenses associated with the resolution of non-performing loans. Additionally, interest forgone on nonaccrual loans amounted to $542 thousand during 2000 compared to $76 thousand during 1999. Branch Expansion and Acquisitions In January 2001, the Bank entered into a three-year lease for a 1,557 square foot Small Business Administration loan production office in the Folsom area. During 2001, the Bank was approved as a Certified Lender by the Small Business Administration (SBA) thereby allowing the department to provide quicker responses to customer's requests for SBA loans. In August 1998, the Bank opened a full-service branch in the Elk Grove, California market. The Elk Grove office is approximately 30 miles north of the Bank's corporate headquarters in Lodi, California and it effectively expands the Bank's trade area into South Sacramento County. In January 1998, the Bank opened a loan production office in the growing market of Folsom, California. The location was converted to a full-service branch in July 1999 and in July 2001 was relocated to a new site in Folsom. The Folsom office is approximately 45 miles northeast of the Bank's corporate headquarters in Lodi, California and effectively expanded the Bank's trade area into the greater Sacramento area. On February 22, 1997, the Bank completed the acquisition of the Galt, Plymouth, and San Andreas, California, branches of Wells Fargo Bank. The Bank purchased the premises and equipment of the Plymouth and San Andreas branches and assumed the building lease for the Galt branch. The Bank also purchased the furniture and equipment of all three branches and paid a premium for the deposits of each branch. The total cost of acquiring the branches, including payments to Wells Fargo Bank as well as other direct costs associated with the purchase, was $2.86 million. The transaction was accounted for using the purchase method of accounting. Accordingly, the purchase price was allocated first to identifiable tangible assets based upon those assets' fair value and then to identifiable intangible assets based upon the assets' fair value. The excess of the purchase price over identifiable tangible and intangible assets was allocated to goodwill. Allocations to identifiable tangible assets, identifiable intangible assets, and goodwill were $856 thousand, $1.98 million, and $24 thousand, respectively. Deposits totaling $34 million were acquired in the transaction. 14 Net Interest Income The following table provides a detailed analysis of net interest spread and net interest margin for the years ended December 31, 2001, 2000, and 1999, respectively:
---------------------------------------------------------------------------------------------------------------------------- For the Year Ended For the Year Ended For the Year Ended December 31, 2001 December 31, 2000 December 31, 1999 (Dollar amounts in thousands) (Dollar amounts in thousands) (Dollar amounts in thousands) -------------------------------------------------------------------------------------------------- Average Income/ Average Income/ Average Income/ Balance Expenses Yield Balance Expenses Yield Balance Expense Yield ------- -------- ----- ------- -------- ----- ------- ------- ----- Earning Assets: Investment securities (1) $ 35,260 2,073 5.88% 34,690 2,214 6.38% 41,050 2,413 5.88% Federal funds sold 11,360 481 4.23% 5,090 329 6.46% 4,150 202 4.86% Loans (2) 123,600 11,304 9.15% 114,690 10,953 9.55% 101,120 9,911 9.80% ------- ------ ----- ------- ------ ----- ------- ----- ----- $ 170,220 13,858 8.14% 154,470 13,496 8.74% 146,320 12,526 8.56% ======= ====== ===== ======= ====== ===== ======= ====== ===== Liabilities: Noninterest bearing deposits $ 25,350 - - 21,240 - - 19,830 - - Savings, money market, & NOW deposits 91,600 1,297 1.42% 83,970 1,350 1.61% 82,110 1,358 1.65% Time deposits 66,630 3,342 5.02% 53,020 2,801 5.28% 50,690 2,330 4.60% Other borrowings 120 5 4.17% 7,000 462 6.60% 170 11 6.25% ------- ------ ----- ------- ------ ----- ------- ----- ----- Total Liabilities $ 183,700 4,644 2.53% 165,230 4,613 2.79% 152,800 3,699 2.42% ======= ===== ===== ======= ===== ===== ======= ===== ===== Net Spread 5.61% 5.95% 5.73% ===== ===== ===== ---------------------------------------------------------------------------------------------------------------------------- Earning Income Earning Income Earning Income Assets (Expense) Yield Assets (Expense) Yield Assets (Expense) Yield ------ --------- ----- ------ --------- ----- ------ --------- ----- Yield on average earning assets $ 170,220 13,858 8.14% 154,470 13,496 8.74% 146,320 12,526 8.56% Cost of funds for average earning assets 170,220 (4,644) (2.73%) 154,470 (4,613) (2.99%) 146,320 (3,699) (2.53%) ----- ------- ------ ----- ----- ------- Net Interest Margin 170,220 9,214 5.41% 154,470 8,883 5.75% 146,320 8,827 6.03% ===== ===== ===== ===== ===== ===== ----------------------------------------------------------------------------------------------------------------------------
(1) Income on tax-exempt securities has not been adjusted to a tax equivalent basis. (2) Loans held for sale and nonaccrual loans are included in the loan totals for each year. Net interest income increased $331 thousand, or 4% in 2001 after increasing 1% in 2000. The increase in 2001 is attributable to an increase of 10% in average earning assets combined with a 16% increase in average deposits. In addition, during 2001, the Company's base lending rate decreased 475 basis points. The decrease in the base lending rate was consistent with the national decrease in the prime lending rate during 2001 from 9.50% at December 31, 2000 to 4.75% at December 31, 2001. The decline in the prime lending rate resulted from the eleven interest rate reductions by the Federal Reserve during 2001. Furthermore, while the Company recorded $423 thousand in interest income on nonaccrual loans during the year, interest forgone on nonaccrual loans totaled $310 thousand. 15 The mix of earning assets at December 31, 2001 changed as compared to December 31, 2000 as a result of year-over-year loan growth of 24% in 2001 as compared to 2% in 2000. During 2001, average loans, investment securities and federal funds sold increased $8,910 thousand, $570 thousand and $6,270 thousand, or 8%, 2% and 123%, respectively, compared to 2000. Average earnings assets increased as a result of a $25,350 thousand, or 16%, increase in average deposits during 2001. As average deposit growth outpaced average loan growth during the year, the average loan to deposit ratio decreased to 67% for 2001 as compared to 73% in 2000. Average investment securities decreased $6,360, or 16%, in 2000 as compared to 1999 as a result of the $13,570 thousand, or 13.4%, growth in average loans outpacing a $5,600, or 4%, growth in average deposits in 2000 as compared to 1999. Net interest margin decreased 34 basis points in 2001 after decreasing by 28 basis points in 2000. This decrease in 2001 was the result of several key items: - Interest forgone on nonaccrual loans during 2001 totaled $310 thousand. This reduced the yield on loans by 25 basis points and the net interest margin by 19 basis points. o Interest collected on loans that had previously been on nonaccrual status totaled $423 thousand. This increased the yield on loans by 35 basis points and the net interest margin by 25 basis points. - Changes in the mix of the investment portfolio during 2001 resulted in a decrease of 50 basis points in the average yield earned on investments securities. - The general decrease in interest rates during 2001 resulted in a decrease of 223 basis points in the average yield earned on federal funds sold. - The general decrease in interest rates during 2001 resulted in a decrease of 26 basis points in the cost of average certificates of deposit. Net interest income increased $56 thousand, or 1%, in 2000. The increase in 2000 is attributable to an increase of 6% in average earning assets combined with a 4% increase in average deposits. In addition, during 2000, the Company's base lending rate increased 100 basis points. The increase in the base lending rate was consistent with the national increase in Bank's prime lending rates during 2000 from 8.5% at December 31, 1999 to 9.5% at December 31, 2000. Furthermore, while the Company recorded $224 thousand in interest income on nonaccrual loans during the year, interest forgone on nonaccrual loans totaled $542 thousand. The mix of earning assets in 2000 changed as a result of year-over-year loan growth of 2% compared to 21% in 1999. Average loans in 2000 increased 13% compared to 1999. The increase in loans absorbed the liquidity created by the growth in deposits during 2000 and the proceeds from maturities and sales of investment securities. The loan growth also increased the average loan to deposit ratio to 73% in 2000 compared to 66% in 1999. Average investments decreased 16% in 2000 as compared to 1999 as a result of the increase in loans. Net interest margin decreased 28 basis points in 2000 after increasing by 44 basis points in 1999. This decrease in 2000 was the result of several key items: - Interest forgone on nonaccrual loans during 2000 totaled $542 thousand. This reduced the yield on loans by 47 basis points and the net interest margin by 35 basis points. - Changes in the mix of the investment portfolio during 2000 resulted in an increase of 50 basis points in the average yield earned on investments securities. - The general increase in interest rates resulted in an increase of 160 basis points in the average yield earned on federal funds sold. - The general increase in interest rates resulted in an increase of 68 basis points in the cost of average certificates of deposit. 16 The following table presents the monetary impact of the aforementioned changes in earning asset and deposit volumes, yields and mix for the two years ended December 31, 2001 and 2000.
---------------------------------------------------------------------------------------------------------------------------- 2001 compared to 2000 2000 compared to 1999 (in thousands) (in thousands) Change due to: Change due to: Interest Income: Volume Rate Mix Total Volume Rate Mix Total ------ ---- --- ----- ------ ---- --- ----- ----------------------------------------------------------------------------------------------------- Investment securities $ 36 (175) (2) (141) (341) 165 (23) (199) Federal funds sold 405 (113) (140) 152 46 66 15 127 Loans 851 (464) (36) 351 1,149 (96) (11) 1,042 --- --- --- --- ----- -- -- ----- Total interest income $ 1,292 (752) (178) 362 854 135 (19) 970 ===== === === === === === === === Interest Expense: Savings, money market, & NOW accounts $ 111 (151) (13) (53) 36 (42) (2) (8) Time deposits 719 (142) (36) 541 107 348 16 471 Other borrowings (454) (170) 167 (457) - 12 439 451 ----- ---- --- --- ----- -- --- --- Total interest expense $ 376 (463) 118 31 143 318 453 914 === === === == ==== === === === Net interest income $ 916 (289) (296) 331 711 (183) (472) 56 === === ===== === === === === == ----------------------------------------------------------------------------------------------------------------------------
The volume variances for total interest income in 2001 compared to 2000 indicate that increases in average loans, investment securities and federal funds sold of 8%, 2% and 123%, respectively combined to increase interest income by $1,292 thousand. However, the declining interest rate environment during 2001 reduced interest income $752 thousand, as compared to the prior year, with $464 thousand of the decrease resulting from a 40 basis point decline in the yield earned on loans, $175 thousand decrease resulting from a 50 basis points decline in the yield earned on investment securities and a $113 thousand decrease resulting from a 223 basis points decrease in the yield earned on federal funds sold. Additionally, while average interest bearing liabilities increased 11% during 2001, the average rate paid on interest bearing liabilities decreased 9% resulting in a net increase in total interest expense. The volume, rate, and mix variances for net interest income in 2000 compared to 1999 indicate that the 13% increase in average loans, the 50 basis point increase in the yield of the investment portfolio and the 160 basis point increase in the rate earned on federal funds sold was offset by the $542 thousand interest forgone on nonaccrual loans combined with a 68 basis point increase in the average cost of funding certificates of deposit. During 2000, average earning assets increased 6%. Average loans, the primary component of earning assets, comprised 74% and 69% of total earning assets during 2000 and 1999, respectively. While average federal funds sold increased 23% during 2000, average investment securities decreased 16%. Additionally, average interest bearing liabilities increased 8% during 2000 and the average rate paid on those liabilities increased 15% resulting in an increase in total interest expense. 17 Allowance for Loan Losses The following table reconciles the beginning and ending allowance for loan losses for the previous five years. Reconciling activity is broken down into the three principal items that impact the reserve: (1) reductions from charge-offs; (2) increases from recoveries; and (3) increases or decreases from positive or negative provisions for loan losses.
---------------------------------------------------------------------------------------------------------------------------- (in thousands) 2001 2000 1999 1998 1997 Balance at beginning of period $ 2,499 2,580 1,564 1,313 1,207 Charge-offs: Commercial 226 201 90 67 249 Real estate - - 25 - Consumer 57 45 20 40 41 ------ ------- ------- ------- ------- Total Charge-offs 283 246 110 132 290 Recoveries: Commercial 21 15 68 112 434 Real estate - - - - - Consumer 40 15 7 21 22 ------ ------- ------- ------- ------- Total Recoveries 61 30 75 133 456 ------ ------- ------- ------- ------- Net charge-offs (222) (216) (35) (1) (166) Additions charged to operations 391 135 1,091 250 (60) ------ ------- ------- ------- ------- Balance at end of period $ 2,668 2,499 2,580 1,564 1,313 ====== ====== ======= ======= ======= Ratio of net charge-offs to average loans outstanding 0.16% (0.19%) (0.03%) (0.001%) (0.28%) ====== ====== ======= ======= ======= ----------------------------------------------------------------------------------------------------------------------------
Footnote 1(g) to the consolidated financial statement discusses the factors used in determining the provision for loan losses and the adequacy of the allowance for loan losses. Net charge-offs during 2001 totaled $222 thousand and represents an increase of $6 thousand, or 3%, over 2000. This activity was comprised of $283 thousand in gross charge-offs combined with $61 thousand in recoveries representing an increase of 15% in gross charge-offs and an increase of 103% in recoveries compared to 2000, respectively. The increase in charge-offs during 2001 is related to measures taken by the Company to reduce the level of nonaccrual loans. The Bank has not modified or significantly compromised its underwriting standards despite growing competition within the industry. The loan loss provision for 2001 totaled $391 thousand and represents an increase of $256 thousand, or 190%, over 2000. The increase in the provision resulted primarily from three events; increases in loan growth and the potential for declines in the economy combined with the resolution of several nonperforming loans. While average loans increased 8% during 2001 as compared to 2000, gross loans (including loans held for sale) at December 31, 2001 increased 24% as compared to December 31, 2000. In addition, during 2001, management became increasingly concerned over the potential for possible declines in the credit quality of its borrowers resulting from declines in the national economy. Furthermore, the Company eliminated several nonperforming loans during the year without sustaining substantial charge-offs. Net charge-offs totaling $216 thousand during 2000 represents an increase of $181 thousand, or 517%, over 1999. This activity was comprised of $246 thousand in gross charge-offs combined with $30 thousand in recoveries representing an increase of 124% in gross charge-offs and a decrease of 60% in recoveries compared to 1999, respectively. The increase in charge-offs during 2000 is related to measures taken by the Company to reduce the level of nonaccrual loans. The Bank has not modified or significantly compromised its underwriting standards despite growing competition within the industry. The loan loss provision for 2000 totaled $135 thousand and represents a decrease of $916 thousand, or 87%, over 1999. The reason for the decrease is attributable primarily to three factors. First, during 1999, the Company identified certain loans which had deteriorating conditions in their credit quality and, in 1999, established specific loan loss reserves for those loans. During 2000, management continued to actively monitor the non-performing loans and determined that reserves previously established in 1999 continued to be adequate at December 31, 2000. Secondly, while nonaccrual loans increased $3,352 thousand during 2000, the majority of these loans were identified as problem loans during 1999; at which time, the specific 18 reserves for potential loan losses were established. In addition, the majority of the nonaccrual loans are secured by collateral that, in the opinion of management, possess adequate value to minimize any potential losses, in excess of the specific loss reserves previously established by the Company. Third, while average loans increased 13% during 2000, as compared to 1999, balances as of December 31, 2000 increased only 2% compared to December 31, 1999. Noninterest Income Noninterest income increased 42% and 9% in 2001 and 2000, respectively. The primary components of noninterest income consist of: service charges, SBA and mortgage income, and other noninterest income. The following table summarizes the significant elements of service charge, SBA, mortgage and Farmer Mac revenue for the three years ending 2001, 2000, and 1999:
---------------------------------------------------------------------------------------------------------------- (in thousands) 2001 2000 1999 ---------------------------------------------------------------------------------------------------------------- Periodic deposit account charges $ 492 477 407 Returned item charges 624 561 463 Ancillary services charges 95 99 98 Other service charges 203 124 110 ---------------- ----------------- ----------------- Total service charge revenue 1,414 1,261 1,078 ================ ================= ================= Gain on sale of SBA loans 95 114 177 SBA loan servicing revenue 223 224 207 ---------------- ----------------- ----------------- Total SBA revenue 318 338 384 Gain on sale of mortgage loans 458 132 133 Mortgage loan servicing revenue 127 123 122 ---------------- ----------------- ----------------- Total mortgage revenue 585 255 255 Farmer Mac origination, sale and servicing 29 31 42 ---------------- ----------------- ----------------- Total loan origination, sale and servicing revenue $ 932 624 681 ----------------------------------------------------------------------------------------------------------------
Service charge revenue increased 12% in 2001 compared to 2000 and 17% in 2000 compared to 1999. The growth in service charge income during 2001 and 2000 was driven by deposit growth combined with changes to the fee structure of certain deposit products implemented during the third quarter of 2000. While average deposits grew 16% in 2001 and 4% in 2000, average noninterest-bearing demand deposits increased 19% and 7% and NOW accounts increased 15% and 9%, during 2001 and 2000 as compared to 2000 and 1999, respectively. SBA revenue declined 6% and 12% during 2001 and 2000. The declines in SBA revenue resulted primarily from a decrease in the production of SBA 7a and an increase in the level of SBA 504 loans. The Company typically sells the SBA 7a loans to the secondary market whereas the SBA 504 loans are typically held in the Company's loan portfolio. As a result of declines in mortgage lending rates during 2001, the Company experienced increased mortgage lending activity for both new loans and refinancing of existing loans. The increased lending activity resulted in an increase in the Company's mortgage revenue totaling $330 thousand, or 129% in 2001 as compared to 2000 after being unchanged from 2000 to 1999. Farmer Mac revenue declined 7% in 2001 as compared to 2000 and declined 26% during 2000 as compared to 1999. The Company purchased single-premium life insurance policies written on the lives of certain officers and directors of the Company and the Bank. The increase in the cash surrender value of these policies is included in other noninterest income and totaled $658 thousand, $458 thousand and $206 thousand during 2001, 2000 and 1999, respectively. During 1999, one of the insurance companies converted from a mutual to a stock based company, which process is referred to as "demutualization." As a result of the demutualization, policyholders of the insurance company received shares of common stock of the insurance company. The number of shares of stock received by policyholders was based upon the cash surrender value of the individual policies. The Company received and subsequently sold the stock in December 1999. The gain recognized upon the receipt of the stock totaled $287 thousand. 19 Noninterest Expenses Noninterest expenses increased 14% in 2001 compared to 2000 and 12% in 2000 compared to 1999. Several events had a significant impact on year-to-year comparability. During 2001 the Company experienced increases in salaries and employee benefits as a result of increases in the number of full time equivalent employees combined with increases in the salaries of a few officer positions within the Company resulting from upgrades to certain officers titles, duties and responsibilities. During 2000, the company incurred expenses associated with the resolution of non-performing loans. Noninterest expense is broken down into four primary categories each of which is discussed in this section. Salaries and Employee Benefits The following table provides the detail for each major segment of salaries and employee benefits together with relevant statistical data:
----------------------------------------------------------------------------------------------------------------------- (in thousands except full time equivalents) 2001 2000 1999 ----------------------------------------------------------------------------------------------------------------------- Regular payroll, contract labor, and overtime $ 4,038 3,325 2,970 Incentive compensation and profit sharing 465 246 407 Payroll taxes and employment benefits 1,177 935 655 ---------------------------------------------------- Total Salaries and Employee Benefits $ 5,680 4,506 4,032 ==================================================== Number of full-time equivalent employees 117 109 104 ---------------------------------------------------- Regular payroll per full-time equivalent employee 34.51 30.50 28.56 ---------------------------------------------------- Incentive compensation to regular payroll 11.5% 7.4% 13.7% ---------------------------------------------------- Payroll taxes and benefits per full-time equivalent employee 10.04 8.70 6.28 -----------------------------------------------------------------------------------------------------------------------
The number of full-time equivalent employees increased 7% in 2001 compared to 2000 and 5% in 2000 compared to 1999. Regular payroll, contract labor and overtime increased 21% in 2001 compared to 2000 and 12% in 2000 compared to 1999. Total salaries and benefits expense increased 26% in 2001 compared to 2000 and 12% in 2000 compared to 1999. The average regular payroll per full-time equivalent employee increased 13% in 2001 compared to 2000 and increased 7% in 2000 compared to 1999. Incentive compensation includes compensation to commissioned employees, bonus awards to employees under the Incentive Compensation Plan, contributions to the Employee Stock Ownership Plan and matching contributions to the 401(k) Stock Ownership Plan. The Incentive Compensation Plan pays bonuses to officers based upon the actual results of departmental and Bank-wide performance in comparison to predetermined targets. Contributions to the Employee Stock Ownership Plan are made at the discretion of the board of directors based upon profitability. Matching contributions to the 401(k) Stock Ownership Plan are made at the rate of 50% of the first 4% of compensation contributed by employees. Payroll taxes and employee benefits per full-time equivalent increased 15% in 2001 as compared to 2000 and 39% in 2000 as compared to 1999. The increases are related primarily to a $132 thousand and $293 thousand increase during 2001 and 2000, respectively, in the supplemental compensation accruals made pursuant to the agreements summarized in Footnote 9 to the 2001 Consolidated Financial Statements, combined with increases in the Company's contribution to the Employee Stock Ownership Plan, general increases in the cost of medical and other related insurance benefits and education and training expenses. The accruals for the supplemental compensation agreements were initiated in April 1999. 20 Occupancy Expense The following table provides the detail for each major segment of occupancy expense:
---------------------------------------------------------------------------------------------------------------- (in thousands except square footage and cost per sq. ft.) 2001 2000 1999 ---------------------------------------------------------------------------------------------------------------- Depreciation $ 347 335 366 Property taxes, insurance, and utilities 245 213 230 Property maintenance 181 184 124 Net rental expense (income) 177 93 90 ---------------------------------------------------- Total Occupancy $ 950 825 810 ==================================================== Square footage of occupied and unoccupied space 45,708 42,945 42,945 ---------------------------------------------------- Occupancy cost per square foot $ 20.78 19.21 18.86 ---------------------------------------------------- Locations 9 8 8 ----------------------------------------------------------------------------------------------------------------
Occupancy expenses increased 15% in 2001 compared to 2000 and 2% in 2000 compared to 1999. The primary reason for the increases in 2001 and 2000 are the expansion into new offices combined with general increases in the maintenance of the existing locations. In January 2001 the Company entered into a long term lease to relocate its existing Folsom branch to a permanent site. In July 2001 the new branch opened for service and in August 2001, the former Folsom site was closed. In addition, in January 2001 the Company established a Small Business Administration loan production office in Folsom, California. Equipment Expense The following table provides the detail for each major segment of equipment expense:
---------------------------------------------------------------------------------------------------------------- (in thousands) 2001 2000 1999 ---------------------------------------------------------------------------------------------------------------- Depreciation $ 684 506 488 Maintenance 237 259 188 Rental expense 8 16 11 ---------------------------------------------------- Total Equipment $ 929 781 687 ----------------------------------------------------------------------------------------------------------------
Equipment expense increased 19% in 2001 compared to 2000 and increased 14% in 2000 compared to 1999. The increases in 2001 and 2000 are primarily attributable to investments made in the Company's computer hardware and software systems. In addition, as noted above, during 2001 the Company opened an SBA loan production office in Folsom, California and relocated its Folsom branch to a larger full service facility. 21 Other Noninterest Expense Other noninterest expense decreased 2% in 2001 as compared to 2000 and increased 14% in 2000 compared to 1999. The following table provides the detail for each major segment of other noninterest expense:
---------------------------------------------------------------------------------------------------------------- (in thousands) 2001 2000 1999 ---------------------------------------------------------------------------------------------------------------- Third party data processing $ 877 869 821 Professional fees 403 771 554 Marketing 413 422 23 Nonperforming loan costs 77 246 25 Telephone and postage 296 232 271 Intangible amortization 171 215 282 Director fees and retirement 385 193 158 Office supplies 247 189 193 Printing 121 105 109 Other real estate owned losses and holding costs 83 94 (8) Regulatory assessments 91 87 85 Business development 90 82 78 Year 2000 date change - 4 152 Other 413 234 231 ---------------------------------------------------- Total Other Noninterest Expense $ 3,667 3,743 3,274 ----------------------------------------------------------------------------------------------------------------
Professional fees increased during 2000 as a result of the Company increasing its use of third parties in the development and implementation of specific strategic initiatives. The two primary initiatives included enhancing the Company's use of technology and opportunities to increase noninterest income. The amortization of the core deposit and goodwill intangible assets purchased in the acquisition of the Wells Fargo Branches in 1997 declined 20% in 2001 as compared to 2000 and 24% in 2000 as compared to 1999. The Bank is using an accelerated method of amortization for these assets over an eight year period. Accordingly, the amortization expense is expected to continue to decline over the remaining amortization period. During 2000 the Company expensed $246 thousand in costs associated with the resolution of non-performing loans. Included in these costs are amounts paid for legal representation, past due rent of borrowers, security and other property maintenance expenses. The past due rent, security and other property maintenance expenses were incurred by the Company in order to protect and preserve the quality of assets pledged as collateral for the non-performing loans. During 2001 the Company expensed $385 thousand for director fees and retirement expense which represented an increase of $192 thousand, or 99%, as compared to 2000. The increase is primarily attributable to three events; a one time increase in the accrual for retirement benefits of certain emeritus directors, payment of insurance premiums for long term care insurance paid on behalf of certain directors and an increase in director fees associated with an increase in the total number of outside directors. Income Taxes The provision for income taxes as a percentage of pretax income for 2001, 2000, and 1999 was 15%, 19%, and 19%, respectively. The effective rate is lower than the combined marginal rate for state and federal taxes due primarily to the level of tax exempt income relative to total pre-tax income. The two primary components of tax exempt income are income from tax exempt investment securities and increases in the cash surrender value of life insurance. Total tax exempt income decreased in 2001 as compared to 2000 and increased during 2000 as compared to 1999. Interest income on tax exempt investment securities decreased $287 thousand in 2001 as compared to 2000 as a result of a $4,989 thousand decrease in average tax exempt securities. Interest income on tax exempt investment securities increased $260 thousand in 2000 as compared to 1999 as a result of a $5,440 thousand increase in average tax exempt securities. Tax exempt income increased $200 thousand in 2001 and $57 thousand in 2000 as compared to 2000 and 1999, respectively, as a result of an investment of $12,690 thousand and $10,032 thousand, respectively, in the cash surrender value of life insurance as discussed below under Balance Sheet Review. Footnote 13 to the Consolidated Financial Statements contains a detailed presentation of the income tax provision and the related current and deferred tax assets and liabilities. 22 Balance Sheet Review The following table presents average balance sheets for the years ended December 31, 2001, 2000 and 1999.
---------------------------------------------------------------------------------------------------------------------------- For the Year Ended For the Year Ended For the Year Ended December 31, 2001 December 31, 2000 December 31, 1999 (in thousands) (in thousands) (in thousands) ----------------------------------------------------------------------------- Amount Percent Amount Percent Amount Percent ---------------------------------------------------------------------------------------------------------------------------- Assets: Cash & Due from banks $ 11,310 5.59% 8,150 4.50% 7,488 4.45% Federal funds sold 11,360 5.61% 5,090 2.81% 4,150 2.47% Investment securities 35,260 17.42% 34,690 19.16% 41,050 24.39% Loans held for sale 3,130 1.55% 1,144 0.63% 564 0.34% Loans (net of allowance for loan losses and deferred income) 117,320 57.95% 111,490 60.93% 98,196 58.35% Premises and equipment, net 6,800 3.35% 6,860 3.79% 6,863 4.08% Other assets 17,260 8.53% 14,810 8.18% 9,969 5.92% ------ ----- ------ ----- ----- ----- Total Assets $ 202,440 100.00% 181,090 100.00% 168,280 100.00% ======= ======= ======= ======= ======= ======= Liabilities & Stockholders' Equity: Deposits $ 183,580 90.68% 158,230 87.37% 152,630 90.70% Short term borrowings 120 .06% 7,000 3.87% - - Other liabilities 1,730 .85% 1,190 0.66% 1,507 0.90% Stockholders' equity 17,010 8.40% 14,670 8.10% 14,143 8.40% ------ ----- ------ ----- ------ ----- Total Liabilities & Stockholders' Equity $ 202,440 100.00% 181,090 100.00% 168,280 100.00% ======= ======= ======= ======= ======= ======= ----------------------------------------------------------------------------------------------------------------------------
Average total assets increased 12% in 2001 compared to 2000 and 8% in 2000 compared to 1999. Year-end asset totals at December 31, 2001 reached $226,175 thousand and represented an increase of 22% over December 31, 2000. The increase in 2001 and 2000 is a function of deposit growth throughout the Bank's branch network, as average deposits increased 16% and 4%, respectively. During 2001 average gross loans increased 8%. This increase was funded by the growth in deposits. During 2000 average gross loans increased 13%, which was funded by the growth in deposits combined with a 12% reduction in fed funds sold and investment securities. Other assets at December 31, 2001 and 2000 increased 17% and 49% as compared to December 31, 2000 and 1999, respectively. The increases are primarily attributable to an increase in the cash surrender value of life insurance which averaged $11,831 thousand and $9,652 during 2001 and 2000, respectively. The cash surrender value of life insurance consists primarily of the Bank's contractual rights under single-premium life insurance policies written on the lives of certain officers and the directors of the Company and the Bank. The policies were purchased in order to indirectly offset anticipated costs of certain benefits payable upon the retirement, and the death or disability of the directors and officers pursuant to deferred compensation agreements. The cash surrender value accumulates tax-free based upon each policy's crediting rate which is adjusted by the insurance company on an annual basis. 23 Investment Securities The following table presents the investment portfolio at December 31, 2001, 2000 and 1999 by security type, maturity, and yield:
-------------------------------------------------------------------------------------------------------------------------------- Book Value at December 31 (dollars in thousands): 2001 2000 1999 ---- ---- ---- Amount Yield(a) Amount Yield(a) Amount Yield(a) ------ -------- ------ -------- ------ -------- -------------------------------------------------------------------------------------------------------------------------------- U.S. Agency Securities: Within 1 year $ 3,501 6.46% 3,520 6.34% 1,044 6.67% After 1 year, within 5 years 8,099 5.66% 8,018 6.26% 12,622 6.40% After 5 years, within 10 years - - 932 7.71% 1,500 7.18% After 10 years - - 1,500 6.85% 1,500 6.85% ------------------------------------------------------------------- Total U.S. Agency $ 11,600 5.90% 13,970 6.46% 16,666 6.53% Collateralized Mortgage Obligations: Within 1 year $ 1,192 4.27% 4,121 6.09% 57 3.37% After 1 year, within 5 years 21,741 4.76% 1,975 7.09% 5,477 6.52% After 5 years, within 10 years - - - - 961 6.87% After 10 years 131 3.42% 131 8.31% 132 8.17% ------------------------------------------------------------------- Total Collateralized Mortgage Obligations $ 23,064 4.72% 6,227 6.46% 6,627 6.58% Municipal Securities: Within 1 year $ 100 10.24% 1,048 5.28% 1,053 6.66% After 1 year, within 5 years 2,133 6.86% 1,630 7.42% 2,445 7.17% After 5 years, within 10 years 476 7.44% 1,564 7.40% 2,444 6.08% After 10 years 2,309 8.20% 3,750 8.42% 6,245 5.69% ------------------------------------------------------------------- Total Municipal Securities $ 5,018 7.60% 7,992 7.60% 12,187 6.15% Other Debt Securities: Within 1 year $ 202 7.41% 116 14.24% 10 7.57% After 1 year, within 5 years 194 6.33% 338 9.41% 938 7.32% After 5 years, within 10 years 274 4.48% 300 - - - After 10 years - - - - - - ------------------------------------------------------------------- Total Other Debt Securities $ 670 5.90% 754 8.15% 948 7.32% Money Market Mutual Fund - - - - - - Federal Agency Stock 126 6.00% 126 6.00% 126 6.00% Unrealized Holding (Loss) / Gain 537 - 491 - (458) - ------------------------------------------------------------------- Total $ 41,015 6.66% 29,560 6.66% $ 36,096 6.43% --------------------------------------------------------------------------------------------------------------------------------
(a) The yields on tax-exempt obligations have not been computed on a tax-equivalent basis. The investment portfolio increased $11,455, or 39%, at December 31, 2001 as compared to December 31, 2000 and declined $6,536 thousand, or 18%, at December 31, 2000 as compared to December 31, 1999. The increase in the investment portfolio during 2001 occurred as a result of deposit growth outpacing loan growth. The decline in the portfolio during 2000 funded increases in loan volume. During 2001 and 2000, investment securities totaling $18,381 thousand and $4,375 matured or were called prior to maturity during the year, respectively. During 2001, proceeds from the sale of investment securities totaled $3,578 thousand and resulted in gains totaling $267 thousand. During 2000, proceeds from the sale of investment securities totaled $4,391 thousand and resulted in gains totaling $149 thousand. 24 Loans The following table summarizes gross loans and the components thereof as of December 31, for each of the last five years (includes loans held for sale):
---------------------------------------------------------------------------------------------------------------------------- Outstanding at December 31 (in thousands): 2001 2000 1999 1998 1997 ---------------------------------------------------------------------------------------------------------------------------- Commercial and other real estate $ 125,274 99,377 95,509 77,956 53,684 Real estate construction 13,703 12,124 13,919 11,743 6,900 Installment and other 3,674 3,605 3,301 3,463 3,525 ----- ----- ----- ----- ----- Total Gross Loans $ 142,651 115,106 112,729 93,162 64,109 ======= ======= ======= ====== ====== ----------------------------------------------------------------------------------------------------------------------------
Gross loans outstanding as of December 31, 2001 and 2000 exceeded the comparable prior year-end totals by 24% and 2%, respectively. Improving economic conditions combined with increased business development efforts were the foundation for the growth in both years. With the acquisition of the Wells Fargo Branches in 1997 combined with the entry into the Folsom and Elk Grove areas in 1998, the Company entered into new market areas that substantially enhanced its marketing capabilities. The most significant segment of the loan portfolio is commercial loans, which represented 88% and 86% of the total portfolio at December 31, 2001 and 2000, respectively. Commercial loans include agricultural loans, working capital loans to businesses in a number of industries, and loans to finance commercial real estate. Agricultural loans represented approximately 17% and 17% of the commercial loan portfolio at December 31, 2001 and 2000, respectively. Agricultural loans are diversified throughout a number of agricultural business segments, including dairy, orchards, row crops, vineyards, cattle and contract harvesting. Agricultural lending risks are generally related to the potential for volatility of agricultural commodity prices. Commodity prices are affected by government programs to subsidize certain commodities, weather, and overall supply and demand in wholesale and consumer markets. Excluding agricultural loans, the remaining portfolio is principally dependent upon the health of the local economy and the related real estate market. The maturity and repricing characteristics of the loan portfolio at December 31, 2001 are as follows:
---------------------------------------------------------------------------------------------------------------------------- Due: (in thousands) (1) Fixed Rate Floating Rate Total ---------- ------------- ----- In 1 year or less $ 16,765 23,862 40,627 After 1 year through 5 years 15,873 9,751 25,624 After 5 years 8,106 68,294 76,400 ------ ------ ------ Total Loans $ 40,744 101,907 142,651 ======= ======= ======= ----------------------------------------------------------------------------------------------------------------------------
(1) Scheduled repayments are reported in the maturity category in which the payment is due. Approximately 29% of the loan portfolio carries a fixed rate of interest as of December 31, 2001, while approximately 46% of the portfolio matures within five years. 25 Deposits The following table summarizes average deposit balances and rates for the years ended December 31, 2001, 2000, and 1999:
---------------------------------------------------------------------------------------------------------------------------- For the Year Ended For the Year Ended For the Year Ended (in thousands) December 31, 2001 December 31, 2000 December 31, 1999 Type Average Average Average Average Average Average Amount Rate Amount Rate Amount Rate ---------------------------------------------------------------------------------------------------------------------------- Demand - non-interest bearing $ 25,350 N/A 21,240 N/A 19,830 N/A NOW accounts 47,600 1.01% 41,267 1.13% 37,985 1.14% Money market accounts 15,050 1.98% 14,194 2.25% 17,028 2.23% Savings 28,950 1.78% 28,509 1.97% 27,097 2.06% Time deposits 66,630 5.02% 53,020 5.28% 50,690 4.60% ------ ----- ------ ----- ------ ----- Total Deposits $ 183,580 2.53% 158,230 2.62% 152,630 2.42% ======= ===== ======= ===== ======= ===== ----------------------------------------------------------------------------------------------------------------------------
Average deposits increased approximately 16% and 4% in 2001 and 2000, respectively. Due to a decreasing rate environment during 2001, the average rate decreased 9 basis points when comparing 2001 to 2000. Due to an increasing rate environment during 2000, the average rate increased 20 basis points when comparing 2000 to 1999. The deposit growth in 2001 and 2000 came from account growth at all branches throughout the Company's network. The growth was the result of business development efforts in the lending area as well as a continued influx of bank customers seeking a higher level of customer service than that experienced at major financial institutions. In addition, during 2001, with the anticipated growth in the Company's loan portfolio, management elected to increase the ratio of total certificates of deposit to total deposits. The growth in certificates of deposit during 2001 was consistent with the budget established by management and the ratio of certificates of deposit to total deposits as compared to the Bank's peer group. Certificates of deposit contain regular and individual retirement account balances. There are no brokered certificates of deposit in the portfolio. Certificates of $100,000 or more represent approximately 36% and 29% of the certificate of deposit portfolio at December 31, 2001 and 2000, respectively. The following table summarizes the maturities of those certificates of $100,000 or more: -------------------------------------------------------------------------------- (in thousands) 2001 ---- Three months or less $ 7,694 Four months to six months 9,484 Seven months to twelve months 5,981 Over twelve months 2,304 ----- Total time deposits of $100,000 or more $25,463 ====== -------------------------------------------------------------------------------- Short Term Borrowings The Bank has two lines of credit with correspondent banks totaling $4 million at December 31, 2001. At December 31, 2000, the Bank had two lines of credit with correspondent banks totaling $7 million. The lines of credit are unsecured and renew annually. At December 31, 2001 and 2000 the Bank had outstanding borrowings under these lines totaling $4 million and $0, respectively. The maximum amount outstanding was $4 million and $7 million, the average balance outstanding was $50 thousand and $485 thousand and the weighted average interest rate was 3.02% and 5.57% for the years ending December 31, 2001 and 2000, respectively. At December 31, 2001 and 2000 securities sold under agreements to repurchase totaled $0 and $4,588 thousand, respectively. The maximum amount outstanding was $4,588 thousand and $9,835 thousand, the average balance outstanding was $70 thousand and $6,523 thousand and the weighted average interest rate was 6.79% and 6.62% for the years ending December 31, 2001 and 2000, respectively. These agreements generally mature within 30 days. These short term borrowings are used as temporary resources in managing the Bank's overall liquidity. The Bank's liquidity management is discussed in the Liquidity section below. 26 Asset Quality The following table contains asset quality information with respect to the loan portfolio and other real estate owned:
---------------------------------------------------------------------------------------------------------------------------- Asset Quality Statistics at December 31 (in thousands except multiples and percentages) 2001 2000 1999 1998 1997 ---------------------------------------------------------------------------------------------------------------------------- Nonaccrual loans $ 3,246 5,655 2,303 248 340 Accruing loans past due more than 90 days - - 374 191 65 ----- ----- --- --- -- Total non-performing loans $ 3,246 5,655 2,677 439 405 ===== ===== ===== === === Allowance for loan losses $ 2,668 2,499 2,580 1,564 1,313 Allowance for loan losses to non-performing loans 82% 44% 96% 356% 324% Total loan portfolio delinquency 3.30% 5.14% 3.32% 1.40% 1.09% Allowance for loan losses to total gross loans 1.87% 2.17% 2.29% 1.69% 2.05% Other real estate owned $ 809 405 129 129 159 ----------------------------------------------------------------------------------------------------------------------------
The Company's nonaccrual policy is discussed in note 1(c) to the consolidated financial statements. Interest income recorded on these nonaccrual loans was approximately $423 thousand, $224 thousand, $76 thousand, $2 thousand, and $8 thousand in 2001, 2000, 1999, 1998, and 1997, respectively. Interest income foregone or reversed on these loans was approximately $310 thousand, $542 thousand, $76 thousand, $43 thousand, and $45 thousand in 2001, 2000, 1999, 1998, and 1997, respectively. At December 31, 2001, there were no individually material or a material amount of loans in the aggregate for which management had serious doubts as to the borrower's ability to comply with present loan repayment terms and which may result in the subsequent reporting of such loans as nonaccrual. Non-performing loans decreased $2,409 thousand, or 43%, in 2001 while increasing $2,978 thousand, $2,238 thousand and $34 thousand in 2000, 1999 and 1998, respectively. Portfolio delinquency also decreased to 3.30% in 2001 after increasing to 5.14%, 3.32% and 1.40% in 2000, 1999 and 1998, respectively. The dollar amount of the allowance for loan losses increased $169 thousand during 2001 and decreased $81 thousand during 2000 after having increased in each of the prior three years. The reasons for the increase in the allowance for loan losses in 2001 as compared to 2000 is explained in the "Allowance for Loan Losses" section above. The following table summarizes the allocation of the allowance for loan losses at December 31, for each of the last five years:
---------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) December 31, 2001 December 31, 2000 December 31, 1999 December 31, 1998 December 31, 1997 ----------------- ----------------- ----------------- ----------------- ----------------- % % % % % Loan Category Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- Commercial and other real estate $ 2,122 87.82% 1,752 86.46% 1,943 84.72% 1,174 83.68% 986 83.74% Real estate construction 466 9.61% 666 10.41% 560 12.35% 342 12.60% 287 10.76% Installment and other 80 2.57% 81 3.13% 77 2.93% 48 3.72% 40 5.50% -- ----- -- ----- -- ----- -- ----- -- ----- $ 2,668 100.00% 2,499 100.00% 2,580 100.00% 1,564 100.00% 1,313 100.00% ===== ======= ===== ======= ===== ======= ===== ======= ===== ======= ----------------------------------------------------------------------------------------------------------------------------
Please also see "Allowance for Loan Losses." 27 Market Risk Market risk is the risk to a company's financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. The Company has no exposure to foreign currency exchange risk or any specific exposure to commodity price risk. The Company's major area of market risk exposure is interest rate risk ("IRR"). The Company's exposure to IRR can be explained as the potential for change in its reported earnings and/or the market value of the Company's net worth. Variations in interest rates affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. Interest rate changes also affect the underlying economic value of the Company's assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with the interest rates. The effects of the changes in these present values reflect the change in the Company's underlying economic value and provide a basis for the expected change in future earnings related to the interest rate. IRR is inherent in the role of banks as financial intermediaries, however a bank with a high IRR level may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, the Company and bank must carefully evaluate IRR to promote safety and soundness in their activities. The responsibility for the Company's market risk sensitivity management has been delegated to the Asset/Liability Committee ("ALCO"). Specifically, ALCO utilizes computerized modeling techniques to monitor and attempt to control the influence that market changes have on rate sensitive assets ("RSA") and rate sensitive liabilities ("RSL"). Market risk continues to be a major focal point of regulatory emphasis. In accordance with regulation, each Company is required to develop its own IRR management program depending on its structure, including certain fundamental components which are mandatory to ensure sound IRR management. These elements include appropriate board and management oversight as well as a comprehensive risk management process that effectively identifies, measures, monitors and controls risk. Should a company have material weaknesses in its risk management process or high exposure relative to its capital, the regulatory agencies will take action to remedy these shortcomings. Moreover, the level of a company's IRR exposure and the quality of its risk management process is a determining factor when evaluating a company's capital adequacy. The Company utilizes the tabular presentation alternative in complying with quantitative and qualitative disclosure rules. The following tables summarize the expected maturities, principal repayment and fair values of other financial instruments that are sensitive to changes in interest rates at December 31, 2001 and 2000. As of December 31, 2001:
-------------------------------------------------------------------------------------------------------------------------------- Expected Maturity / Principal Repayment Total Fair (in thousands) 2002 2003 2004 2005 2006 Thereafter Balance Value -------------------------------------------------------------------------------------------------------------------------------- Interest-Sensitive Assets: Federal funds sold $ 6,129 -- -- -- -- -- 6,129 6,129 Fixed rate investments (1) 10,908 8,342 6,476 4,339 4,214 6,128 40,407 40,407 Floating rate investments (1) 90 76 63 51 40 288 608 608 Fixed rate loans (2) 16,765 4,715 2,940 4,842 3,376 8,106 40,744 41,375 Floating rate loans (2) 23,862 3,028 2,495 903 3,325 68,294 101,907 99,663 Interest-Sensitive Liabilities: NOW account deposits (3) 19,571 3,259 3,259 3,259 3,259 16,321 48,928 48,928 Money market deposits (3) 8,448 1,407 1,407 1,407 1,407 7,043 21,119 21,119 Savings deposits (3) 12,717 2,117 2,117 2,117 2,117 10,608 31,793 31,793 Certificates of deposit 63,788 4,538 626 559 462 -- 69,973 70,906 Short term borrowings 4,000 -- -- -- -- -- 4,000 4,000 Interest-Sensitive Off-Balance Sheet Items: Commitments to lend -- -- -- -- -- -- 41,822 418 Standby letters of credit -- -- -- -- -- -- 920 1 --------------------------------------------------------------------------------------------------------------------------------
28 As of December 31, 2000:
-------------------------------------------------------------------------------------------------------------------------------- Expected Maturity / Principal Repayment Total Fair (in thousands) 2001 2002 2003 2004 2005 Thereafter Balance Value -------------------------------------------------------------------------------------------------------------------------------- Interest-Sensitive Assets: Federal funds sold $ 10,115 - - - - - 10,115 10,115 Fixed rate investments (1) 8,227 6,074 4,423 992 1,048 8,008 28,772 28,772 Floating rate investments (1) 120 99 83 68 55 363 788 788 Fixed rate loans (2) 1,489 12,446 5,681 5,769 2,447 15,091 42,923 44,929 Floating rate loans (2) 2,581 14,302 2,674 4,527 2,694 45,405 72,183 70,208 Interest-Sensitive Liabilities: NOW account deposits (3) 17,726 2,954 2,954 2,954 2,954 14,774 44,316 44,316 Money market deposits (3) 6,144 1,024 1,024 1,024 1,024 5,121 15,361 15,361 Savings deposits (3) 10,656 1,776 1,776 1,776 1,776 8,880 26,640 26,640 Certificates of deposit 46,313 4,517 528 111 252 - 51,721 52,491 Short term borrowings 4,588 - - - - - 4,588 4,588 Interest-Sensitive Off-Balance Sheet Items: Commitments to lend - - - - - - 25,306 253 Standby letters of credit - - - - - - 1,034 1 --------------------------------------------------------------------------------------------------------------------------------
(1) Expected maturities for investment securities are based upon anticipated prepayments as evidenced by historical prepayment patterns. (2) Expected maturities for loans are based upon contractual maturity dates. Amounts reported include loans held for sale. (3) NOW, money market and savings deposits do not carry contractual maturity dates; therefore the expected maturities reflect estimates applied in evaluating the Company's interest rate risk. The actual maturities of NOW, money market, and savings deposits could vary substantially if future prepayments differ from the Company's historical experience. At December 31, 2001, federal funds sold of $6,129 thousand with a yield of 1.46% and investment securities totaling $10,854 thousand with a weighted-average, tax-equivalent yield of 4.89% were scheduled to mature within one year. In addition, gross loans totaling $40,627 thousand with a weighted-average yield of 6.88% were scheduled to mature within the same time frame. Overall, interest-earning assets scheduled to mature within one year totaled $57,610 thousand with a weighted-average, tax-equivalent yield of 5.93% at December 31, 2001. With respect to interest-bearing liabilities, based on historical withdrawal patterns, NOW accounts, money market and savings deposits of $40,736 thousand with a weighted-average cost of 1.34% were scheduled to mature within one year. Certificates of deposit totaling $63,788 thousand with a weighted-average cost of 4.06% were scheduled to mature in the same time frame. In addition, short term borrowings totaling $4,000 with a weighted-average cost of 1.96% were scheduled to mature within one year. Total interest-bearing liabilities scheduled to mature within one year totaled $108,524 thousand with a weighted-average rate of 2.96%. Historical withdrawal patterns with respect to interest-bearing and noninterest-bearing transaction accounts are not necessarily indicative of future performance as the volume of cash flows may increase or decrease. Loan information is presented based on payment due dates, which may materially differ from actual results due to prepayments caused by changes in interest rates, sociological conditions, demographics, and the economic climate. Models that consider repricing frequencies of RSA and RSL in addition to maturity distributions are also used to monitor IRR. One such technique utilizes a static gap report, which attempts to measure the Company's interest rate exposure by calculating the net amount of RSA and RSL that reprice within specific time intervals. 29 The Company's interest rate sensitivity gap position, illustrating RSA and RSL at their related carrying values, is summarized in the table below. The distributions in the table are based on a combination of maturities, call provisions, repricing frequencies and prepayment patterns. Adjustable-rate assets are distributed based on the repricing frequency of the instrument. As of December 31, 2001:
---------------------------------------------------------------------------------------------------------------------------- By Repricing Interval ---------------------------------------------------------------------------------------------------------------------------- (in thousands) Within After three After six After one After five Noninterest Total three months, months, year, years bearing funds months within six within one within five months year years ---------------------------------------------------------------------------------------------------------------------------- Assets Federal funds sold $ 6,129 -- -- -- -- -- 6,129 Investment securities 5,520 1,874 3,460 23,290 6,871 -- 41,015 Loans (including loans held for sale) 46,357 20,534 10,371 59,036 6,353 -- 142,651 Noninterest earning assets and allowance for loan losses -- -- -- -- -- 37,057 37,057 ------------------------------------------------------------------------------------------------- Total Assets $ 58,006 22,408 13,831 82,326 13,224 37,057 226,175 ================================================================================================= Liabilities and Stockholders' Equity Savings, money market & NOW deposits $ 101,840 -- -- -- -- -- 101,840 Time deposits 21,126 22,635 20,027 6,185 -- -- 69,973 Short term borrowings 4,000 -- -- -- -- -- 4,000 Other liabilities and stockholders' equity -- -- -- -- -- 50,362 50,362 ------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 126,966 22,635 20,027 6,185 -- (13,305) 226,175 ================================================================================================= Interest Rate Sensitivity Gap $ (68,960) (227) (6,196) 76,141 11,870 (677) -- ================================================================================================= Cumulative Interest Rate Sensitivity Gap $ (68,960) (69,187) (75,383) 758 13,982 -- -- ================================================================================================= ----------------------------------------------------------------------------------------------------------------------------
The interest rate gaps reported in the table arise when assets are funded with liabilities having different repricing intervals. Since these gaps are actively managed and change daily as adjustments are made in interest rate forecasts and market outlook, positions at the end of any period may not be reflective of the Company's interest rate sensitivity in subsequent periods. Active management dictates that longer-term economic views are balanced against prospects for short-term interest rate changes in all repricing intervals. For purposes of the above analysis, repricing of fixed-rate instruments is based upon the contractual maturity of the applicable instruments. In addition, repricing of assets and liabilities is assumed in the first available repricing period. Actual payment patterns may differ from contractual payment patterns, and it has been management's experience that repricing does not always correlate directly with market changes in the yield curve. Fluctuations in interest rates can also impact the market value of assets and liabilities either favorably or adversely depending upon the nature of the rate fluctuations as well as the maturity and repricing structure of the underlying financial instruments. To the extent that financial instruments are held to contractual maturity, market value fluctuations related to interest rate changes are realized only to the extent that future net interest margin is either higher or lower than comparable market rates for the period. To the extent that liquidity management dictates the need to liquidate certain assets prior to contractual maturity, changes in market value from fluctuating interest rates will be realized in income to the extent of any gain or loss incurred upon the liquidation of the related assets. 30 Liquidity The Company's primary source of liquidity is dividends from the Bank. It is the Company's general policy to maintain liquidity levels at the parent which management believes to be consistent with the safety and soundness of the Company as a whole. Federal regulatory agencies have the authority to prohibit the payment of dividends by the Bank to the Company if a finding is made that such payment would constitute an unsafe or unsound practice or if the Bank would be undercapitalized as a result. The Company's primary uses of liquidity are associated with dividend payments made to the shareholders, and operating expenses. The Bank's liquidity is managed on a daily basis by maintaining cash, federal funds sold, and short-term investments at levels commensurate with the estimated requirements for loan demand and fluctuations in deposits. Loan demand and deposit fluctuations are affected by a number of factors, including economic conditions, seasonality of the borrowing and deposit bases, and the general level of interest rates. The Bank maintains two lines of credit with correspondent banks as a supplemental source of short-term liquidity in the event that saleable investment securities and loans or available new deposits are not adequate to meet liquidity needs. The Bank has also established reverse repurchase agreements with two brokerage firms, which allow for short-term borrowings that are secured by the Bank's investment securities. Furthermore, the Bank may also borrow on a short-term basis from the Federal Reserve in the event that other liquidity sources are not adequate. At December 31, 2001 liquidity was considered adequate, and funds available in the local deposit market and scheduled maturities of investments are considered sufficient to meet long-term liquidity needs and commitments (see Notes 8 and 10 to the consolidated financial statements for further information). Compared to 2000 liquidity decreased in 2001 as a result of the growth in loans, investment securities and cash surrender value of life insurance exceeding the growth in deposits. Capital Resources Consolidated capital increased $1,409 thousand, or 8.6%, during 2001. The increase was due primarily to net income of $1,207 thousand. Capital was further increased by $70 thousand as a result of an increase in the net unrealized holding gain on available-for-sale securities and $136 thousand as a result of stock options exercised. The consolidated capital to assets ratio decreased 99 basis points, or 11.1%, to 7.90% from 8.89%. This decrease is primarily due to the effect of asset growth exceeding the growth in capital. During 2001, total assets increased 22.2% while capital increased 8.6%. The Bank's total risk-based and leverage capital ratios were 10.24% and 7.45%, respectively, at December 31, 2001 compared to 11.27% and 7.99%, respectively, at December 31, 2000. The decrease in the total risk-based ratio resulted as the growth in total assets outpaced the growth in capital. The total risk-based and leverage capital ratios at December 31, 2001, are in excess of the required regulatory minimums of 10% and 5%, respectively, for well-capitalized institutions. At the February 28, 2002 regular Board of Directors Meeting, the Board approved a $5 million participation in a floating rate pooled trust preferred securities offering. The Company anticipates receiving the proceeds from the sale of the trust preferred securities on March 26, 2002. The Company intends to use the proceeds to increase the Bank's capital levels and for other corporate purposes. Under applicable regulatory guidelines, the Company expects that a portion of the trust preferred securities will qualify as Tier I Capital, and the remainder as Tier II Capital. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Item 14(a) herein. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable 31 PART III ITEMS 10, 11, 12 and 13 The information required by these items is contained in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 23, 2002, and is incorporated herein by reference. The definitive Proxy Statement will be filed with the Commission within 120 days after the close of the Company's fiscal year pursuant to Regulation 14A of the Securities Exchange Act of 1934. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Financial Statements and Schedules Page Reference Independent Auditors' Report 35 Consolidated Balance Sheets as of December 31, 2001 and 2000 36 Consolidated Statements of Income Years Ended 2001, 2000, and 1999 37 Consolidated Statements of Stockholders' Equity and Comprehensive Income Years Ended 2001, 2000, and 1999 38 Consolidated Statements of Cash Flows Years Ended 2001, 2000, and 1999 39 Notes to Consolidated Financial Statements 40 (b) Reports on Form 8-K None (c) Exhibits Exhibit No. Description ----------- ----------- 3(a) Articles of Incorporation, as amended, filed as Exhibit 3.1 to the Company's General Form for Registration of Securities on Form 10, filed on September 21, 1983, is hereby incorporated by reference. 3(b) Bylaws, as amended, filed as Exhibit 3(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1998, is hereby incorporated by reference. 4(a) Specimen Common Stock Certificate, filed as Exhibit 4.1 to the Company's General Form for Registration of Securities on Form 10, filed on September 21, 1983, is hereby incorporated by reference. 4(b) Rights Agreement between First Financial Bancorp and Mellon Investor Services LLC, dated as of June 15, 2001, including Form of Right Certificate, filed as Exhibit 4 to the Company's Form 8-K filed on June 28, 2001, is hereby incorporated by reference. 10(a)* First Financial Bancorp 1991 Director Stock Option Plan and form of Non-statutory Stock Option Agreement, filed as Exhibit 4.1 to the Company's Form S-8 Registration Statement (Registration No. 33-40954), filed on May 31, 1991, is hereby incorporated by reference. 10(b)* Amendment to First Financial Bancorp 1991 Director Stock Option Plan, filed as Exhibit 4.3 to the Company's Post-Effective Amendment No. 1 to Form S-8 Registration Statement 32 (Registration No. 33-40954), filed as Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1995, is hereby incorporated by reference. 10(c)* First Financial Bancorp 1991 Employee Stock Option Plan and forms of Incentive Stock Option Agreement and Non-statutory Stock Option Agreement, filed as Exhibit 4.2 to the Company's Form S-8 Registration Statement (Registration No. 33-40954), filed on May 31, 1991, is hereby incorporated by reference. 10(d)* Bank of Lodi Employee Stock Ownership Plan, filed as Exhibit 10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, is hereby incorporated by reference. 10(e)* First Financial Bancorp 1997 Stock Option Plan, filed as Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997, is hereby incorporated by reference. 10(f)* Bank of Lodi Incentive Compensation Plan, filed as Exhibit 10(f) to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, is hereby incorporated by reference. 10(g) First Financial Bancorp 401(k) Profit Sharing Plan, filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, is hereby incorporated by reference. 10(h)* Employment Agreement dated as of September 30, 1998, between First Financial Bancorp and Leon J. Zimmerman., filed as Exhibit 10(h) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, is hereby incorporated by reference. 10(i)* Executive Supplemental Compensation Agreement effective as of April 3, 1998, between Bank of Lodi, N.A. and Leon J. Zimmerman, filed as Exhibit 10(j) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, is hereby incorporated by reference. 10(j)* Life Insurance Endorsement Method Split Dollar Plan Agreement effective as of April 3, 1998, between Bank of Lodi, N.A. and Leon J. Zimmerman, filed as Exhibit 10(l) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, is hereby incorporated by reference. 10(k)* Form of Director Supplemental Compensation Agreement, effective as of April 3, 1998, as executed between Bank of Lodi, N.A. and each of Benjamin R. Goehring, Michael D. Ramsey, Weldon D. Schumacher and Dennis R. Swanson, filed as Exhibit 10(n) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, is hereby incorporated by reference. 10(l)* Form of Life Insurance Endorsement Method Split Dollar Plan Agreement, effective as of April 3, 1998, as executed between Bank of Lodi, N.A. and each of Benjamin R. Goehring, Michael D. Ramsey, Weldon D. Schumacher and Dennis R. Swanson, filed as Exhibit 10(o) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, is hereby incorporated by reference. 10(m)* Form of Director Supplemental Compensation Agreement, effective as of April 3, 1998, as executed between Bank of Lodi, N.A. and each of Angelo J. Anagnos, Raymond H. Coldani, Bozant Katzakian and Frank M. Sasaki, filed as Exhibit 10(p) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, is hereby incorporated by reference. 10(n)* Form of Life Insurance Endorsement Method Split Dollar Plan Agreement, effective as of April 3, 1998, as executed between Bank of Lodi, N.A. and each of Angelo J. Anagnos, Raymond H. Coldani, Bozant Katzakian and Frank M. Sasaki, filed as Exhibit 10(q) to the 33 Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, is hereby incorporated by reference. 10(o)* Form of Long Term Care Agreement by and between Bank of Lodi, N.A. and certain directors and executive officers filed as Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001, is hereby incorporated by reference. 11 Statement re computation of earnings per share is incorporated herein by reference to Footnotes 1(j) and 14 to the consolidated financial statements included in this report. 21 Subsidiaries of the Company: The Company owns 100 percent of the capital stock of Bank of Lodi, National Association, a national banking association, and 100 percent of the capital stock of Western Auxiliary Corporation. 23 Consent of KPMG LLP, independent auditors (d) Financial Statement Schedules No financial statement schedules are included in this report on the basis that they are either inapplicable or the information required to be set forth therein is contained in the financial statements included in this report. --------------------- * Management contract or compensatory plan or arrangement 34 Independent Auditors' Report The Board of Directors First Financial Bancorp: We have audited the accompanying consolidated balance sheets of First Financial Bancorp and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, stockholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Financial Bancorp and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP Sacramento, California February 28, 2002 35 FIRST FINANCIAL BANCORP AND SUBSIDIARIES Consolidated Balance Sheets (in thousands, except share amounts) December 31, 2001 and 2000
Assets 2001 2000 ------------------------------------------------------------------------------------------------------------------- Cash and due from banks $ 13,328 10,909 Federal funds sold 6,129 10,115 Investment securities available-for-sale, at fair value (includes securities pledged to creditors with the right to sell or pledge of $0 and $4,588, respectively) 41,015 29,560 Loans held for sale 3,876 1,292 Loans, net of deferred loan fees and allowance for loan losses of $3,345 and $3,021 in 2001 and 2000, respectively 135,430 110,793 Premises and equipment, net 7,185 7,002 Accrued interest receivable 1,265 1,447 Other Assets 17,947 13,946 ------------------------------------------------------------------------------------------------------------------- $ 226,175 185,064 =================================================================================================================== Liabilities and Stockholders' Equity ------------------------------------------------------------------------------------------------------------------- Liabilities: Deposits: Noninterest bearing $ 29,758 24,223 Interest bearing 171,813 138,038 ------------------------------------------------------------------------------------------------------------------- Total deposits 201,571 162,261 Accrued interest payable 307 316 Short term borrowings 4,000 4,588 Other liabilities 2,434 1,445 ------------------------------------------------------------------------------------------------------------------- Total liabilities 208,312 168,610 Stockholders' equity: Preferred stock - no par value; authorized 1,000,000 shares; no shares issued and outstanding - - Common stock - no par value; authorized 9,000,000 shares; issued and outstanding in 2001, 1,622,300 shares; in 2000, 1,526,063 shares 10,191 9,338 Retained earnings 7,317 6,831 Accumulated other comprehensive income, net 355 285 ------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 17,863 16,454 ------------------------------------------------------------------------------------------------------------------- Commitments and contingencies $ 226,175 185,064 ===================================================================================================================
See accompanying notes to consolidated financial statements. 36 FIRST FINANCIAL BANCORP AND SUBSIDIARIES Consolidated Statements of Income (in thousands except per share amounts) Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999 ------------------------------------------------------------------------------------------------------------------- Interest income: Loans, including fees $ 11,304 10,953 9,911 Interest on investment securities available for sale: Taxable 1,832 1,686 2,145 Exempt from Federal taxes 241 528 268 Federal funds sold 481 329 202 ------------------------------------------------------------------------------------------------------------------- Total interest income 13,858 13,496 12,526 Interest expense: Deposit accounts 4,639 4,151 3,688 Other borrowings 5 462 11 ------------------------------------------------------------------------------------------------------------------- Total interest expense 4,644 4,613 3,699 Net interest income 9,214 8,883 8,827 Provision for loan losses 391 135 1,051 ------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 8,823 8,748 7,776 Noninterest income: Service charges 1,414 1,261 1,078 Gain on sale of investment securities available-for-sale 267 149 - Gain on sale of other real estate owned 255 - - Gain on stock issued in insurance company demutualization - - 287 Gain on sale of loans 553 246 310 Premiums and fees from SBA and mortgage operations 379 378 371 Increase in cash surrender value of life insurance 658 458 206 Other 302 198 209 ------------------------------------------------------------------------------------------------------------------- Total noninterest income 3,828 2,690 2,461 Noninterest expense: Salaries and employee benefits 5,680 4,506 4,032 Occupancy 950 825 810 Equipment 929 781 687 Other 3,667 3,743 3,274 ------------------------------------------------------------------------------------------------------------------- Total noninterest expense 11,226 9,855 8,803 ------------------------------------------------------------------------------------------------------------------- Income before provision for income taxes 1,425 1,583 1,434 Provision for income taxes 218 300 275 ------------------------------------------------------------------------------------------------------------------- Net income $ 1,207 1,283 1,159 =================================================================================================================== Earnings per share: ------------------------------------------------------------------------------------------------------------------- Basic $ .75 .81 .75 =================================================================================================================== Diluted $ .73 .79 .72 =================================================================================================================== Dividends per share $ - .05 .20 ===================================================================================================================
See accompanying notes to consolidated financial statements. 37 FIRST FINANCIAL BANCORP AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity and Comprehensive Income (in thousands except share amounts) Years Ended December 31, 2001, 2000 and 1999
Accumulated Common Common Other Stock Stock Comprehensive Retained Comprehensive Description Shares Amounts Income Earnings Income (Loss), net Total -------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1998 1,349,292 $ 7,584 5,971 302 13,857 Comprehensive income: Net income $ 1,159 1,159 1,159 ----------- Other comprehensive loss: Unrealized holding loss arising during the current period, net of tax benefit of $410 (568) ------------ Total other comprehensive lo ss (568) (568) (568) ----------- Comprehensive income $ 591 =========== Options exercised 43,582 359 359 Stock dividend 40,860 490 (490) Cash issued in lieu of stock dividend (7) (7) Cash dividend (279) (279) ------------------------ -------------------------------------- Balance at December 31,1999 1,433,734 8,433 6,354 (266) 14,521 Comprehensive income: Net income $ 1,283 1,283 1,283 ----------- Other comprehensive income: Unrealized holding gain arising during the current period, net of tax effect of $459 639 Reclassification adjustment due to gains realized, net of tax effect of $61 (88) Total other comprehensive income, net of ----------- tax effect of $398 551 551 551 ----------- Comprehensive income $ 1,834 =========== Options exercised 20,565 173 173 Stock dividend 71,764 732 (732) Cash dividend (74) (74) ------------------------ -------------------------------------- Balance at December 31, 2000 1,526,063 9,338 6,831 285 16,454 Comprehensive income: Net income $ 1,207 1,207 1,207 ----------- Other comprehensive income: Unrealized holding gain arising during the current period, net of tax effect of $133 228 Reclassification adjustment due to gains realized, net of tax effect of $109 (158) Total other comprehensive income, net of ----------- tax effect of $24 70 70 70 ----------- Comprehensive income $ 1,277 =========== Options exercised 20,392 136 136 Stock dividend 75,845 717 (717) Cash in lieu of stock dividend (4) (4) ------------------------ -------------------------------------- Balance at December 31, 2001 1,622,300 $ 10,191 7,317 355 17,863 ======================== ======================================
See accompanying notes to consolidated financial statements. 38 FIRST FINANCIAL BANCORP AND SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands) Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999 ------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 1,207 1,283 1,159 Adjustments to reconcile net income to net cash flows (used in) provided by operating activities: Loans held for sale: Loans originated (33,950) (13,896) (15,918) Proceeds from sale 31,919 13,821 17,630 Gain on sale of loans (553) (246) (310) Increase (decrease) in deferred loan income 155 (34) 36 Depreciation and amortization 1,366 826 1,126 Provision for loan losses 391 135 1,051 Gain on sale of available-for-sale securities (267) (149) - Gain on sale of other real estate owned (255) - - Provision for deferred taxes (401) (46) (673) Decrease (increase) in accrued interest receivable 182 40 (134) (Decrease) increase in accrued interest payable (9) 12 (85) Increase in cash surrender value of life insurance (658) (458) (206) Increase in other assets (685) (258) (519) Increase in other liabilities 989 397 438 ------------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by operating activities (569) 1,427 3,595 Cash flows from investing activities: Investment securities available-for-sale: Purchases (33,269) (906) (43,666) Proceeds from prepayments 8,833 821 909 Proceeds from maturity 9,548 3,554 8,271 Proceeds from sale 3,578 4,391 43,054 Increase in loans made to customers (26,269) (2,676) (21,006) Proceeds from the sale of other real estate 937 160 11 Purchases of bank premises, equipment and intangible assets (1,210) (743) (684) Purchase of cash surrender value life insurance (2,000) (900) (4,194) ------------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by investing activities (39,852) 3,701 (17,305) Cash flows from financing activities: Net increase in deposits 39,310 6,100 6,617 (Decrease) increase in short term borrowings (588) 288 4,300 Proceeds received upon exercise of stock options 136 173 359 Dividends paid (4) (74) (286) ------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 38,854 6,487 10,990 ------------------------------------------------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (1,567) 11,615 (2,720) Cash and cash equivalents at beginning of year 21,024 9,409 12,129 ------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 19,457 21,024 9,409 =================================================================================================================== Supplemental Disclosures of Cash Flow Information: Cash paid during the year for: Interest $ 4,653 4,601 3,784 Income taxes 372 586 663 Loans transferred to other real estate owned 1,086 405 - Stock dividend 717 732 490
See accompanying notes to consolidated financial statements. 39 FIRST FINANCIAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000 and 1999 (1) Summary of Significant Accounting Policies The accounting and reporting policies of First Financial Bancorp (the Company) and its subsidiaries, Bank of Lodi, N.A., (the Bank) and Western Auxiliary Corporation (WAC) conform with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenue and expense for the period. Actual results could differ from those estimates applied in the preparation of the consolidated financial statements. The most significant accounting estimate for the Company is the allowance for loan losses. The following are descriptions of the significant accounting and reporting policies: (a) Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries for all periods presented. All material inter-company accounts and transactions have been eliminated in consolidation. (b) Investment Securities The Company designates a security as held-to-maturity or available-for-sale when a security is purchased. The selected designation is based upon investment objectives, operational needs, intent and ability to hold. The Company does not engage in trading activity. Held-to-maturity securities are carried at cost, adjusted for accretion of discounts and amortization of premiums. Available-for-sale securities are recorded at fair value with unrealized holding gains and losses, net of the related tax effect reported as a separate component of stockholders' equity until realized. To the extent that the fair value of a security is below cost and the decline is other than temporary, a new cost basis is established using the current market value, and the resulting loss is charged to earnings. Premiums and discounts are amortized or accreted over the life of the related held-to-maturity or available-for-sale security as an adjustment to yield using the effective interest method. Gains and losses realized upon disposition of securities are recorded as a component of noninterest income on the trade date, based upon the net proceeds and the adjusted carrying value of the securities using the specific identification method. (c) Loans Loans are stated at principal balances outstanding, net of deferred origination fees, costs and loan sale premiums. A loan is considered impaired when based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the "contractual terms" of the loan agreement, including scheduled interest payments. For a loan that has been restructured, the contractual terms of the loan agreement refer to the contractual terms specified by the original loan agreement, not the contractual terms specified by the restructuring agreement. An impaired loan is measured based upon the present value of future cash flows discounted at the loan's effective rate, the loan's observable market price, or the fair value of collateral if the loan is collateral dependent. Interest on impaired loans is recognized on a cash basis. Large groups of small balance, homogenous loans are collectively evaluated for impairment. If the measurement of the impaired loan is less than the recorded investment in the loan, an impairment is recognized by increasing the allowance for loan losses. Loans held for sale are carried at the lower of aggregate cost or market. Interest on loans is accrued daily. Nonaccrual loans are loans on which the accrual of interest ceases when the collection of principal or interest is determined to be doubtful by management. It is the general policy of the Company to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more unless the loan is well secured and in the process of collection. When a loan is placed on non-accrual status, accrued and unpaid interest is reversed against current period interest income. Interest accruals are resumed when such loans are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest. 40 (d) Loan Origination Fees and Costs Loan origination fees, net of certain direct origination costs, are deferred and amortized as a yield adjustment over the life of the related loans using the interest method, which results in a constant rate of return. Loan commitment fees are also deferred. Commitment fees are recognized over the life of the resulting loans if the commitments are funded or at the expiration of the commitments if the commitments expire unexercised. Origination fees and costs related to loans held for sale are deferred and recognized as a component of gain or loss when the related loans are sold. (e) Gain or Loss on Sale of Loans and Servicing Rights Transfers and servicing of financial assets and extinguishments of liabilities are accounted for and reported based on consistent application of a financial-components approach that focuses on control. Transfers of financial assets that are sales are distinguished from transfers that are secured borrowings. Retained interests in loans sold are measured by allocating the previous carrying amount of the transferred assets between the loans sold and retained interests, if any, based on their relative fair value at the date of transfer. Fair values are estimated using discounted cash flows based on a current market interest rate. The Company recognizes a gain and a related asset for the fair value of the rights to service loans for others when loans are sold. The Company measures the impairment of the servicing asset based on the difference between the carrying amount of the servicing asset and its current fair value. The servicing asset totaled $79 thousand and $37 thousand at December 31, 2001 and 2000, respectively. As of December 31, 2001 and 2000, there was no impairment in servicing asset. A sale is recognized when the transaction closes and the proceeds are other than beneficial interests in the assets sold. A gain or loss is recognized to the extent that the sales proceeds and the fair value of the servicing asset exceed or are less than the book value of the loan. Additionally, the fair value of servicing rights is considered in the determination of the gain or loss. When servicing rights are sold, a gain or loss is recognized at the closing date to the extent that the sales proceeds, less costs to complete the sale, exceed or are less than the carrying value of the servicing rights held. (f) Allowance for Loan Losses The allowance for loan losses is established through a provision charged to expense. Loans are charged off against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. Recoveries of amounts previously charged off are added back to the allowance. The allowance is an amount that management believes will be adequate to absorb losses inherent in existing loans and overdrafts based on evaluations of collectibility and prior loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, commitments, and current and anticipated economic conditions that may affect the borrowers' ability to pay. While management uses these evaluations to recognize the provision for loan losses, future provisions may be necessary based on changes in the factors used in the evaluations. The allowance for loan losses is also subject to review by the Comptroller of the Currency, the Bank's principal regulator. (g) Premises and Equipment Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization is calculated using the straight-line method over the estimated useful lives of the related assets. Estimated useful lives are as follows: Building 35 years Improvements, furniture, and equipment 3 to 10 years Expenditures for repairs and maintenance are charged to operations as incurred; significant betterments are capitalized. Interest expense attributable to construction-in-progress is capitalized. 41 (h) Intangible Assets Goodwill, representing the excess of purchase price over the fair value of net assets acquired, results from branch acquisitions made by the Company. Goodwill is being amortized on an accelerated basis over eight years. Core deposit intangibles are amortized on an accelerated basis over eight years. Intangible assets are reviewed on a periodic basis for other than temporary impairment. If such impairment is indicated, recoverability of the asset is assessed based upon expected undiscounted net cash flows. Intangible assets totaled $514 thousand and $685 thousand at December 31, 2001 and 2000, respectively, and are included in Other Assets. (i) Other Real Estate Owned (OREO) Other real estate is comprised of property acquired through foreclosure proceedings or acceptance of deeds-in-lieu of foreclosure. Losses recognized at the time of acquiring property in full or partial satisfaction of debt are charged against the allowance for loan losses. Other real estate is recorded at the lower of the related loan balance or fair value, less estimated disposition costs. Fair value of other real estate is generally based on an independent appraisal of the property. Any subsequent costs or losses are recognized as noninterest expense when incurred. Subsequent operating expenses or income, changes in carrying value, and gains or losses on disposition of OREO are reflected in other noninterest expense. Revenue recognition on the disposition of OREO is dependent upon the transaction meeting certain criteria relating to the nature of the property sold and the terms of the sale. Under certain circumstances, revenue recognition may be deferred until these criteria are met. (j) Earnings Per Share Basic earnings per share (EPS) includes no dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings of an entity. On May 8, 2001, the Company effected a five percent stock dividend payable to stockholders of record as of May 22, 2001. All share, per share, Common Stock and stock option amounts herein have been restated to reflect the effects of the stock dividend. (k) Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Income tax expense is allocated to each entity of the Company based upon analyses of the tax consequences of each company on a stand-alone basis. (l) Statements of Cash Flows For purposes of the statements of cash flows, cash, short term (90 days or less) deposits in other banks, and federal funds sold, which generally have maturities of one day, are considered to be cash equivalents. (m) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. 42 (n) Stock Based Compensation The Company accounts for its stock option plan using the intrinsic value method. Compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price of the stock options. (o) Impact Of Recently Issued Accounting Standards Effective April 1, 2001, the Company adopted FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125, which supersedes the guidance in FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Statement No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of the provisions of Statement No. 125 without reconsideration. Statement No. 140 is effective for transfers of financial assets occurring after March 31, 2001; it is applied prospectively. The adoption of Statement No. 140 did not have a material impact on the financial condition or operating results of the Company as of and for the year ending December 31, 2001. In July 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement No. 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. Statement No. 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement No. 142. Statement No. 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The Company adopted the provisions of Statement No. 141 in July 2001 and is required to adopt Statement No. 142 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001, but prior to the effective date of Statement No. 142, will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-Statement No. 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of Statement No. 142. The adoption of Statement No. 141 did not have a material impact on the financial condition or operating results of the Company as of and for the year ending December 31, 2001. The adoption of Statement No. 142 will not have a material impact on the financial condition or operating results of the Company. The only exception to Statement No. 142 is the amortization of goodwill and intangible assets acquired under the provisions of Statement No. 72, Accounting of Certain Acquisitions of Banking or Thrift Institutions. The Company will continue to amortize goodwill and intangible assets acquired under this statement. (p) Reclassifications Certain amounts in prior years' presentations have been reclassified to conform with the current presentation. These reclassifications have no effect on previously reported income. (2) Restricted Cash Balances The Bank is required to maintain certain daily reserve balances in accordance with Federal Reserve Board requirements. Aggregate reserves of $3,819 thousand and $2,956 thousand were necessary to satisfy these requirements at December 31, 2001 and 2000, respectively. 43 (3) Investment Securities Investment securities at December 31, 2001 and 2000 consisted of the following:
December 31, 2001 Estimated Gross Gross Amortized Unrealized Unrealized Market (in thousands) Cost Gains Losses Value -------------------------------------------------------------------------------------------------------- Available for Sale U.S. Agency securities $11,600 144 -- 11,744 Municipal securities 5,018 256 -- 5,274 Collateralized mortgage obligations 23,064 143 4 23,203 Other debt securities 670 1 3 668 Investment in Federal Agency stock 126 -- -- 126 -------------------------------------------------------------------------------------------------------- Total $40,478 544 7 41,015 ======================================================================================================== December 31, 2000 Estimated Gross Gross Amortized Unrealized Unrealized Market (in thousands) Cost Gains Losses Value -------------------------------------------------------------------------------------------------------- Available for Sale U.S. Agency securities $13,970 46 59 13,957 Municipal securities 7,992 450 -- 8,442 Collateralized mortgage obligations 6,227 48 4 6,271 Other debt securities 754 10 -- 764 Investment in Federal Agency stock 126 -- -- 126 -------------------------------------------------------------------------------------------------------- Total $29,069 554 63 29,560 ========================================================================================================
Investment securities totaling $13,806 thousand and $7,719 thousand were pledged as collateral to secure Local Agency Deposits as well as treasury, tax and loan accounts with the Federal Reserve at December 31, 2001 and 2000, respectively. Proceeds from the sale of Available for Sale securities during 2001, 2000 and 1999 were $3,578 thousand, $4,391 thousand and $43,054 thousand. The Company realized gross gains totaling $267 thousand and $149 on the sale of Available for Sale securities during the year ended December 31, 2001 and 2000, respectively. Federal Agency dividends paid to the Company were $7 thousand in 2001, 2000 and 1999. The amortized cost and estimated fair value of debt securities at December 31, 2001, by contractual maturity, or expected maturity where applicable, are shown below. Expected maturities will differ from contractual maturities because certain securities provide the issuer with the right to call or prepay obligations with or without call or prepayment penalties. December 31, 2001 Amortized Market (in thousands) Cost Value -------------------------------------------------------------------------------- Due in one year or less $ 4,995 5,011 Due after one year through five years 32,167 32,542 Due after five years through 10 years 750 772 Due after 10 years 2,440 2,564 -------------------------------------------------------------------------------- $40,352 40,889 ================================================================================ 44 (4) Loans The Bank grants commercial, installment, real estate construction and other real estate loans to customers primarily in the trade areas served by its branches. Commercial loans include agricultural loans, working capital loans to businesses in a number of industries, and loans to finance commercial real estate. Generally, the loans are secured by real estate or other assets. Although the Bank has a diversified loan portfolio, a significant portion of its debtors' ability to honor their contracts is dependent upon the condition of the local real estate markets in which the loans are made. Outstanding loans consisted of the following at December 31: (in thousands) 2001 2000 ------------------------------------------------------------------------------- Commercial $ 115,402 91,994 Real estate construction 13,703 12,124 Other real estate 5,996 6,091 Installment and other 3,674 3,605 ------------------------------------------------------------------------------- 138,775 113,814 Deferred loan fees and loan sale premiums (677) (522) Allowance for loan losses (2,668) (2,499) ------------------------------------------------------------------------------- $ 135,430 110,793 =============================================================================== SBA and mortgage loans serviced by the Bank totaled $83,252 thousand, $73,607 thousand and $73,154 thousand at December 31, 2001, 2000 and 1999, respectively. Changes in the allowance for loan losses were as follows: (in thousands) 2001 2000 1999 ------------------------------------------------------------------------------ Balance, beginning of year $ 2,499 2,580 1,564 Loans charged off (283) (246) (110) Recoveries 61 30 75 Provision charged to operations 391 135 1,051 ------------------------------------------------------------------------------ Balance, end of year $ 2,668 2,499 2,580 ============================================================================== Nonaccrual loans totaled $3,246 thousand, $5,655 thousand and $2,303 thousand at December 31, 2001, 2000 and 1999, respectively. Interest income, which would have been recorded on nonaccrual loans, was $310 thousand, $542 thousand and $76 thousand, in 2001, 2000, and 1999, respectively. Impaired loans are loans for which it is probable that the Bank will not be able to collect all amounts due. At December 31, 2001 and 2000, the Bank had outstanding balances of $3,246 thousand and $5,655 thousand in impaired loans which had valuation allowances of $464 thousand in 2001 and $744 thousand in 2000. The average outstanding balances of impaired loans for the years ended December 31, 2001, 2000 and 1999 were $4,871 thousand, $5,847 thousand and $805 thousand respectively, on which $423 thousand, $224 thousand and $76 thousand, respectively, was recognized as interest income. At December 31, 2001 and 2000, the collateral value method was used to measure impairment for all loans classified as impaired. Impaired loans at December 31, 2001 and 2000 consisted solely of commercial loans. (5) Premises and Equipment Premises and equipment consisted of the following at December 31: (in thousands) 2001 2000 -------------------------------------------------------------------------------- Land $ 874 874 Building 5,725 5,725 Leasehold improvements 1,952 1,874 Furniture and equipment 5,198 4,089 -------------------------------------------------------------------------------- 13,749 12,562 -------------------------------------------------------------------------------- Accumulated depreciation and amortization (6,564) (5,560) -------------------------------------------------------------------------------- $ 7,185 7,002 ================================================================================ 45 The Bank leases a portion of its building to unrelated parties under operating leases which expire in various years. The minimum future rentals to be received on non-cancelable leases as of December 31, 2001 are summarized as follows: (in thousands) Year Ending December 31, -------------------------------------------------------------------------------- 2002 $ 68 2003 39 2004 23 2005 19 2006 7 -------------------------------------------------------------------------------- Total minimum future rentals $ 156 ================================================================================ (6) Other Assets Other assets includes the cash surrender value of life insurance totaling $12,690 thousand and $10,032 thousand at December 31, 2001 and 2000 respectively. The cash surrender value of life insurance consists primarily of the Bank's contractual rights under single-premium life insurance policies written on the lives of certain officers and the directors of the Company and the Bank. The policies, for which the Bank is the beneficiary, were purchased in order to indirectly offset anticipated costs of certain benefits payable upon the retirement, and the death or disability of the directors and officers pursuant to deferred compensation agreements. The cash surrender value accumulates tax-free based upon each policy's crediting rate, which is adjusted by the insurance company on an annual basis. Other real estate owned is also included in other assets and was $809 thousand and $405 thousand at December 31, 2001 and 2000, respectively. Other real estate owned of $1,086 thousand and $405 thousand was acquired through foreclosure as settlement for loans during 2001 and 2000, respectively. These amounts represent non-cash transactions, and accordingly, have been excluded from the Consolidated Statements of Cash Flows. (7) Deposits The following is a summary of deposits at December 31: (in thousands) 2001 2000 -------------------------------------------------------------------------------- Demand $ 29,758 24,223 -------------------------------------------------------------------------------- NOW and Super NOW Accounts 48,928 44,316 Money Market 21,119 15,361 Savings 31,793 26,640 Time, $100,000 and over 25,463 14,783 Other Time 44,510 36,938 -------------------------------------------------------------------------------- $201,571 162,261 ================================================================================ Interest paid on time deposits in denominations of $100 thousand or more was $1,069 thousand, $943 thousand and $765 thousand in 2001, 2000 and 1999, respectively. At December 31, 2001, the aggregate maturities for time deposits is as follows: (in thousands) -------------------------------------------------------------------------------- 2002 $ 63,924 2003 4,538 2004 626 2005 559 2006 326 -------------------------------------------------------------------------------- Total $ 69,973 ================================================================================ 46 (8) Operating Leases The Bank has non-cancelable operating leases with unrelated parties for office space and equipment. The lease payments for future years are as follows: Year Ending December 31, (in thousands) Lease Payments -------------------------------------------------------------------------------- 2002 $ 223 2003 198 2004 107 2005 84 2006 86 -------------------------------------------------------------------------------- $ 698 ================================================================================ Total rental expense for operating leases was $254 thousand, $158 thousand and $101 thousand in 2001, 2000 and 1999 respectively. (9) Supplemental Compensation Agreements Effective April 3, 1999 the Company and the Bank entered into nonqualified supplemental compensation agreements with all of the directors and certain executive officers for the provision of death, disability and post-employment/retirement benefits. The agreement with directors includes elective provisions for service as a director emeritus following termination of service as a member of the Bank's Board of Directors. Directors who elect to serve as a director emeritus receive certain benefits during such period of service in addition to benefits applicable to all directors which commence upon expiration of the three year emeritus period. The Company accrues for the compensation based on anticipated years of service and the vesting schedule provided in the agreements. During 2000, the Company converted its existing nonqualified supplemental compensation agreements from a defined contribution retirement and death benefit plan to a defined benefit plan (Plan). The Plan is unsecured and unfunded and there are no Plan assets. The Company has purchased insurance on the lives of the directors and executive officers in the Plan and intends to use the cash values of these policies as a funding source to pay the supplemental compensation obligations. (See Note 6 for information regarding the cash values of the life insurance). The accrued pension obligation was $948 thousand and $456 thousand as of December 31, 2001 and 2000, respectively. The Company did not recognize any additional expense as a result of the conversion. The Company recognized expense related to the Plan during 2001 and 2000 totaling $493 thousand and $286 thousand, respectively. The net periodic benefits cost of $456 thousand was all related to service cost. The net periodic cost was determined using a discount rate of 7.50%. (10) Financial Instruments with Off-Balance Sheet Risk In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. At December 31, 2001 and 2000, financial instruments whose contract amounts represent credit risk are as follows: (in thousands) 2001 2000 -------------------------------------------------------------------------------- Commitments to extend credit $ 41,822 25,306 ================================================================================ Standby letters of credit $ 920 1,034 ================================================================================ 47 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates, other termination clauses and may require payment of a fee. Many of the commitments are expected to expire without being drawn upon and accordingly, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. Upon extension of credit, the amount of collateral obtained, if any, is based on management's credit evaluation of the counter-party. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing or other real estate. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral obtained, if any, is varied. (11) Non-interest Income During 1998, the Company purchased single-premium life insurance policies written on the lives of certain officers and the directors of the Company and the Bank. During 1999, one of the insurance companies converted from a mutual to a stock based company, which process is referred to as "demutualization." As a result of the demutualization, policyholders of the insurance company received shares of common stock of the insurance company. The number of shares of stock received by policyholders was based upon the cash surrender value of the individual policies. The Company received and subsequently sold the shares in December 1999. The gain recognized upon the receipt of the stock totaled $287 thousand. (12) Other Non-interest Expense Other noninterest expense for the years 2001, 2000 and 1999 included the following significant items: (in thousands) 2001 2000 1999 -------------------------------------------------------------------------------- Third party data processing expense $ 877 869 821 Professional fees 403 771 554 Marketing 413 422 323 Non-performing loan costs 77 246 25 Telephone and postage 296 232 271 Intangible amortization 171 215 282 Directors' fees and retirement 385 193 158 Supplies 247 189 193 Printing 121 105 109 Other 677 501 538 -------------------------------------------------------------------------------- Total $3,667 3,743 3,274 ================================================================================ 48 (13) Income Taxes The provision for income taxes for the years 2001, 2000 and 1999 consisted of the following: 2001 (in thousands) Federal State Total -------------------------------------------------------------------------------- Current $ 487 132 619 Deferred, net (358) (43) (401) -------------------------------------------------------------------------------- Income tax expense $ 129 89 218 ================================================================================ 2000 (in thousands) Federal State Total -------------------------------------------------------------------------------- Current $ 204 142 346 Deferred, net (29) (17) (46) -------------------------------------------------------------------------------- Income tax expense $ 175 125 300 ================================================================================ ================================================================================ 1999 (in thousands) Federal State Total -------------------------------------------------------------------------------- Current $ 716 232 948 Deferred, net (608) (65) (673) -------------------------------------------------------------------------------- Income tax expense $ 108 167 275 ================================================================================ Income taxes receivable of $12 thousand and $251 thousand are included in other assets at December 31, 2001 and 2000, respectively. The provision for income taxes differs from amounts computed by applying the statutory Federal income tax rate to operating income before income taxes. The reasons for these differences are as follows:
2001 2000 1999 (dollars in thousands) Amount Rate Amount Rate Amount Rate -------------------------------------------------------------------------------------------------------------------------- Federal income tax expense, at statutory income tax rates $ 485 34% 538 34% 488 34% State franchise tax expense, net of federal income tax benefits 75 7% 98 7% 103 7% Tax-free interest income (299) (21%) (319) (20%) (157) (11%) Change in the beginning of the year deferred tax asset valuation allowance -- -- -- -- (85) (6%) Other (43) (5%) (17) (2%) (74) (5%) -------------------------------------------------------------------------------------------------------------------------- $ 218 15% 300 19% 275 19% ==========================================================================================================================
49 The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2001 and 2000 are presented below. (dollars in thousands) 2001 2000 -------------------------------------------------------------------------------- Deferred tax assets: Allowance for loan losses $ 912 853 Interest on nonaccrual loans 115 115 Deferred loan income 121 162 Accumulated depreciation 107 -- Accumulated Amortization 377 361 Deferred compensation 448 225 Other 95 77 -------------------------------------------------------------------------------- Total gross deferred tax assets 2,175 1,793 Less valuation allowance (35) (35) -------------------------------------------------------------------------------- Deferred tax assets, net of allowance 2,140 1,758 -------------------------------------------------------------------------------- Deferred tax liabilities: Accumulated depreciation -- (9) Deferred loan origination costs (247) (272) Unrealized gain on available-for-sale securities, net (182) (206) Other (136) (121) -------------------------------------------------------------------------------- Total gross deferred tax liabilities (565) (608) -------------------------------------------------------------------------------- Net deferred tax asset $ 1,575 1,150 ================================================================================ In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods for which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 2001 and 2000. 50 (14) Stockholders' Equity (a) Stock Options In February 1997, the Board of Directors adopted the First Financial Bancorp 1997 Stock Option Plan. The maximum number of shares issuable under the Plan is 446,516 less any shares reserved for issuance pursuant to the 1991 Plans. Options are granted at an exercise price of at least 100% and 85% of the fair market value of the stock on the date of grant for employee stock options and director stock options, respectively. The options issued in 2001, 2000 and 1999 were not issued at less than 100% of market value. The per share weighted-average fair value of stock options granted during 2001, 2000 and 1999 was $2.53, $2.12 and $3.12, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Sholes option-pricing model with the following weighted-average assumptions used for grants as of December 31, 2001, 2000 and 1999, respectively: dividend yield of 0.00%, 0.00% and 0.00%; expected volatility of 18.4% and 18.4%; risk-free interest rate of 4.46%, 5.17% and 6.19%; and an expected life of five years in each of the years. Stock option plan activities are summarized as follows: Weighted Average Options Exercise Price ------- -------------- Balance, December 31, 1998 207,355 $ 6.98 Options granted 37,375 10.78 Options exercised (49,130) 6.00 Options expired (26,475) 10.24 -------------------------------------------------------------------------------- Balance, December 31, 1999 169,125 7.35 Options granted 68,775 8.96 Options exercised (22,187) 6.03 Options expired (13,774) 10.82 -------------------------------------------------------------------------------- Balance, December 31, 2000 201,939 7.82 Options granted 66,100 9.50 Options exercised (20,425) 5.95 Options expired (10,448) 6.84 -------------------------------------------------------------------------------- Balance, December 31, 2001 237,166 8.69 ================================================================================ At December 31, 2001, the range of exercise prices for all outstanding options ranged from $5.06 to $10.88. The following table provides certain information with respect to stock options outstanding at December 31, 2001: Weighted Weighted Stock Average Average Range of Options Exercise Remaining Exercise Prices Outstanding Price Contractual Life -------------------------------------------------------------------------------- Under $6.00 22,070 $ 5.64 2.12 $6.00 to $8.99 122,350 8.42 7.45 $9.00 to $9.50 73,555 9.48 9.31 Over $9.50 19,191 10.88 7.57 -------------------------------------------------------------------------------- 237,166 $ 8.69 7.70 ================================================================================ At December 31, 2001 and 2000, the weighted-average remaining contractual life of all outstanding options was 7.70 years and 5.50 years, respectively. The number of options exercisable was 140,992, 122,928 and 117,424 and the weighted-average exercise price of those options was $8.12, $7.64 and $7.11 at December 31, 2001, 2000 and 1999, respectively. 51 The following table provides certain information with respect to stock options exercisable at December 31, 2001: Weighted Stock Average Range of Options Exercise Exercise Prices Exercisable Price -------------------------------------------------------------------------------- Under $6.00 21,736 $ 5.65 $6.00 to $8.99 91,539 8.11 $9.00 to $9.50 16,202 9.47 Over $9.50 11,515 10.88 -------------------------------------------------------------------------------- 140,992 $ 8.12 ================================================================================ No compensation cost has been recognized for stock options in the accompanying consolidated financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options, the Company's net income would have been reduced to the pro forma amounts indicated below for the period ended December 31: 2001 2000 1999 -------------------------------------------------------------------------------- Net Income (in thousands) As reported $ 1,207 1,283 1,159 Pro forma 1,157 1,258 1,138 Basic Net Income Per Share As reported 0.75 0.81 0.75 Pro forma 0.72 0.79 0.73 Diluted Net Income Per Share As reported 0.73 0.79 0.72 Pro forma 0.70 0.77 0.71 Pro forma net income reflects only options granted after 1994. Therefore, the full impact of calculating compensation cost for stock options using the fair value method is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' vesting period of five years and compensation cost for options granted prior to January 1, 1995 is not considered. (b) Employee Stock Ownership Plan Effective January 1, 1992, the Bank established the Bank of Lodi Employee Stock Ownership Plan. The plan covers all employees, age 21 or older, beginning with the first plan year in which the employee completes at least 1,000 hours of service. The Bank's annual contributions to the plan are made in cash and are at the discretion of the Board of Directors based upon a review of the Bank's profitability. Contributions for 2001, 2000 and 1999 totaled approximately $171 thousand, $156 thousand and $149 thousand, respectively. Contributions to the plan are invested primarily in the Common Stock of First Financial Bancorp and are allocated to participants on the basis of salary in the year of allocation. Benefits become 20% vested after the third year of credited service, with an additional 20% vesting each year thereafter until 100% vested after seven years. As of December 31, 2001, the plan owned 164,187 shares of Company Common Stock. Of that amount, 113,032 shares were unallocated to participants at December 31, 2001. (c) Dividends and Dividend Restrictions The Company's principal source of funds for dividend payments is dividends received from the Bank. Under applicable Federal laws, permission to pay a dividend must be granted to a bank by the Comptroller of the Currency if the total dividend payment of any national banking association in any calendar year exceeds the net profits of that year, as defined, combined with net profits for the two preceding years. At December 31, 2001, there were Bank retained earnings of $3,706 thousand free of this condition. 52 (d) Weighted Average Shares Outstanding Basic and diluted earnings per share for the years ended December 31, 2001, 2000, and 1999 were computed as follows:
Income Shares Per-Share (numerator) (denominator) Amount 2001 (in thousands) -------------------------------------------------------------------------------- Basic earnings per share $ 1,207 1,609,236 $0.75 Effect of dilutive stock options -- 44,965 -- ------------------------ Diluted earnings per share $ 1,207 1,654,201 $0.73 ======================== Income Shares Per-Share (numerator) (denominator) Amount 2000 (in thousands) -------------------------------------------------------------------------------- Basic earnings per share $ 1,283 1,591,357 $0.81 Effect of dilutive stock options -- 39,206 -- ------------------------ Diluted earnings per share $ 1,283 1,630,563 $0.79 ======================== Income Shares Per-Share (numerator) (denominator) Amount 2000 (in thousands) -------------------------------------------------------------------------------- Basic earnings per share $ 1,159 1,545,342 $0.75 Effect of dilutive stock options -- 55,932 -- ------------------------ Diluted earnings per share $ 1,159 1,601,274 $0.72 ========================
(e) Preferred Stock Rights Plan On May 31, 2001, the Company's Board of Directors adopted a Shareholder Rights Plan (the "Rights Plan") pursuant to which preferred stock purchase rights ("Rights") were granted as a dividend to shareholders of record at the rate of one Right for each outstanding share of common stock held of record as of the close of business on July 6, 2001. The Rights will also be attached to certain future issuances of common stock. Subject to certain exceptions, each Right, when exercisable, will entitle the registered holder to buy one one-hundredth of a share of a Series A Junior Participating Preferred Stock of the Company (the "Series A Junior Preferred Stock") at an exercise price of $47.50 per Right, subject to adjustment. The Rights will become exercisable upon the occurrence of certain specified events, including an announcement that a person or group of affiliated or associated persons ("Acquiring Person") has acquired beneficial ownership of 10% or more of the outstanding common stock. In such event, each holder of a Right (other than Rights beneficially owned by the Acquiring Person) will thereafter have the right to purchase, at the then-current exercise price, a number of shares of common stock of the Company having a market value equal to twice the exercise price of the Right. For purposes of the Rights Plan, the Company's Board of Directors has designated 1,000,000 shares of Series A Junior Preferred Stock, which amount may be increased or decreased by the Board of Directors. All Rights expire on May 31, 2011, unless the Rights are earlier redeemed or exchanged by the Company in accordance with the Rights Plan or expire earlier upon the consummation of certain transactions as set forth in the Rights Plan. (15) Related Party Transactions During the normal course of business, the Bank enters into transactions with related parties, including directors, officers, and affiliates. These transactions include borrowings from the Bank with substantially the same terms, including rates and collateral, as loans to unrelated parties. At December 31, 2001 and 2000, respectively, such borrowings totaled $1,403 thousand and $1,366 thousand, respectively. Deposits of related parties held by the Bank totaled $463 thousand and $324 thousand at December 31, 2001 and 2000, respectively. 53 The following is an analysis of activity with respect to the aggregate dollar amount of loans made by the Bank to directors, officers and affiliates for the years ended December 31: (in thousands) 2001 2000 -------------------------------------------------------------------------------- Balance, beginning of year $ 1,366 1,177 Loans funded 475 550 Principal repayments (438) (361) -------------------------------------------------------------------------------- Balance, end of year $ 1,403 1,366 ================================================================================ (16) Parent Company Financial Information This information should be read in conjunction with the other notes to the consolidated financial statements. The following presents summary balance sheets as of December 31, 2001 and 2000, and statements of income, and cash flows information for the years ended December 31, 2001, 2000, and 1999.
Balance Sheets: (in thousands) -------------------------------------------------------------------------------------- Assets 2001 2000 -------------------------------------------------------------------------------------- Cash in bank $ 128 206 Investment securities available-for-sale, at fair value 6 6 Premises and equipment, net 60 60 Investment in wholly-owned subsidiaries 17,300 15,923 Other assets 369 259 -------------------------------------------------------------------------------------- $ 17,863 16,454 ====================================================================================== Liabilities and Stockholders' Equity -------------------------------------------------------------------------------------- Stockholders' equity Common stock $ 10,191 9,338 Retained earnings 7,317 6,831 Accumulated other comprehensive income, net 355 285 -------------------------------------------------------------------------------------- Total stockholders' equity 17,863 16,454 -------------------------------------------------------------------------------------- $ 17,863 16,454 ====================================================================================== Statements of Income: (in thousands) 2001 2000 1999 ------------------------------------------------------------------------------------------------------ Rent from subsidiary $ 6 6 6 Other expenses (213) (150) (218) Equity in income of subsidiaries 1,292 1,360 1,252 Income tax benefit 122 67 119 ------------------------------------------------------------------------------------------------------ Net income $ 1,207 1,283 1,159 ====================================================================================================== Statements of Cash Flows: (in thousands) 2001 2000 1999 ------------------------------------------------------------------------------------------------------ Net Income $ 1,207 1,283 1,159 Adjustments to reconcile net income to net cash flows (used in) provided by operating activities: Depreciation and amortization -- 3 1 Provision for deferred taxes (21) (10) (29) (Increase) decrease in other assets (89) 122 (196) Increase in equity of subsidiaries (1,307) (1,367) (1,052) ------------------------------------------------------------------------------------------------------ Net cash (used in) provided by operating activit (210) 31 (117) Cash flows from investing activities: Purchases of available-for-sale securities -- -- (1) ------------------------------------------------------------------------------------------------------ Net cash used in investing activities -- -- (1) Cash flows from financing activities: Proceeds received upon exercise of stock options 136 173 359 Dividends paid (4) (74) (286) ------------------------------------------------------------------------------------------------------ Net cash provided by financing activities 132 99 73 ------------------------------------------------------------------------------------------------------ Net (decrease) increase in cash (78) 130 (45) ------------------------------------------------------------------------------------------------------ Cash at beginning of year 206 76 121 ------------------------------------------------------------------------------------------------------ Cash at end of year $ 128 206 76 ======================================================================================================
54 (17) Short Term Borrowings The Bank has two lines of credit with correspondent banks totaling $4 million at December 31, 2001. At December 31, 2000, the Bank had two lines of credit with correspondent banks totaling $7 million. The lines of credit are unsecured and renew annually. At December 31, 2001 and 2000 the Bank had outstanding borrowings under these lines totaling $4 million and $0, respectively. The maximum amount outstanding was $4 million and $7 million, the average balance outstanding was $50 thousand and $485 thousand and the weighted average interest rate was 3.02% and 5.57% for the years ending December 31, 2001 and 2000, respectively. At December 31, 2001 and 2000 securities sold under agreements to repurchase totaled $0 and $4,588 thousand, respectively. The fair value and carrying value of securities sold under agreements to repurchase totaled $4,600 at December 31, 2000. The maximum amount outstanding was $4,588 thousand and $9,835 thousand, the average balance outstanding was $70 thousand and $6,523 thousand and the weighted average interest rate was 6.79% and 6.62% for the years ending December 31, 2001 and 2000, respectively. These agreements generally mature within 30 days. (18) Regulatory Matters The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measure of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below). First, a bank must meet a minimum Total Risk-Based Capital to risk-weighted assets ratio of 8%. Risk-based capital and asset guidelines vary from Tier I capital guidelines by redefining the components of capital, categorizing assets into different classes, and including certain off-balance sheet items in the calculation of the capital ratio. The effect of the risk-based capital guidelines is that banks with high exposure will be required to raise additional capital while institutions with low risk exposure could, with the concurrency of regulatory authorities, be permitted to operate with lower capital ratios. In addition, a bank must meet minimum Tier I Capital to average assets ratio. Management believes, as of December 31, 2001, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 2001, the most recent notification, the Federal Deposit Insurance Corporation (FDIC) categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized, the Bank must meet the minimum ratios as set forth below. There are no conditions or events since that notification that management believes have changed the Bank's category. 55 The Bank's actual capital amounts and ratios as of December 31, 2001 are as follows:
To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio -------------------------------------------------------------------------------------------------------------------------------- Total Risk-based Capital (to Risk Weighted Assets) $18,461 10.24% 14,425 >8.0% 18,031 >10.0% Tier I Capital (to Risk Weighted Assets) $16,202 8.99% 7,212 >4.0% 10,819 >6.0% Tier I Capital (to Average Assets) $16,202 7.45% 8,703 >4.0% 10,878 >5.0%
The Bank's actual capital amounts and ratios as of December 31, 2000 are as follows:
To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio -------------------------------------------------------------------------------------------------------------------------------- Total Risk-based Capital (to Risk Weighted Assets) $16,560 11.27% 11,698 >8.0% 14,622 >10.0% Tier I Capital (to Risk Weighted Assets) $14,724 10.02% 5,849 >4.0% 8,773 >6.0% Tier I Capital (to Average Assets) $14,724 7.99% 7,374 >4.0% 9,218 >5.0%
(19) Fair Values of Financial Instruments The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and due from banks and federal funds sold are a reasonable estimate of fair value. Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. (See Note 3). Loans: For variable-rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for fixed-rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Commitments to extend credit and standby letters of credit: The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreement and the present creditworthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based upon fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligation with the counter parties at the reporting date. Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for fixed-rate time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on time deposits to a schedule of aggregated expected monthly maturities on time deposits. 56 Short-term borrowings: The discounted value of contractual cash flows at market interest rates for short term borrowings with similar terms and remaining maturities are used to estimate the fair value of existing short-term borrowings. Limitations: Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on and off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets or liabilities include deferred tax assets, premises, and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in many of the estimates. The estimated fair values of the Company's financial instruments at December 31, 2001 are approximately as follows: 2001 Carrying Fair (in thousands) Amount Value -------------------------------------------------------------------------------- Financial assets: Cash and due from banks and federal funds sold $ 19,457 19,457 Investment securities 41,015 41,015 Loans held for sale 3,876 3,900 Loans, net 135,430 137,138 Financial liabilities: Deposits: Demand 29,758 29,758 Now and Super Now accounts 48,928 48,928 Money Market 21,119 21,119 Savings 31,793 31,793 Time 69,973 70,906 ------------------------------------------------------------------------ Total deposits 201,571 202,504 Short term borrowings 4,000 4,000 Contract Carrying Fair (in thousands) Amount Amount Value -------------------------------------------------------------------------------- Unrecognized financial instruments: Commitments to extend credit $41,822 -- 418 Standby letters of credit 920 -- 1 57 2000 Carrying Fair (in thousands) Amount Value -------------------------------------------------------------------------------- Financial assets: Cash and due from banks and federal funds sold $ 21,024 21,024 Investment securities 29,560 29,560 Loans held for sale 1,292 1,300 Loans, net 110,793 113,837 Financial liabilities: Deposits: Demand 24,223 24,223 Now and Super Now accounts 44,316 44,316 Money Market 15,361 15,361 Savings 26,640 26,640 Time 51,721 52,491 ------------------------------------------------------------------------ Total deposits 162,261 163,031 Short term borrowings 4,588 4,601 Contract Carrying Fair (in thousands) Amount Amount Value -------------------------------------------------------------------------------- Unrecognized financial instruments: Commitments to extend credit $25,306 -- 253 Standby letters of credit 1,034 -- 1 (20) Legal Proceedings The bank is involved in various legal actions arising in the ordinary course of business. In the opinion of management, after consulting with legal counsel, the ultimate disposition of these matters will not have a material effect on the Bank's financial condition, results of operations, or liquidity. (21) Derivative Financial Instruments As of December 31, 2001 and 2000, the Company has no off-balance sheet derivatives. The Company held $23,203 thousand and $6,271 thousand in collateralized mortgage obligations as of December 31, 2001 and 2000, respectively. These investments are held in the available for sale portfolio. 58 (22) Quarterly Financial Information (Unaudited)
------------------------------------------------------------------------------------------------------------------------------------ (in thousands, except per share data and price range of common stock) March 31, June 30, September 30, December 31, ------------------------------------------------------------------------------------------------------------------------------------ 2001 Interest income $ 3,310 3,383 3,563 3,602 Net interest income 2,204 2,153 2,377 2,480 Provision for loan losses 190 -- 55 146 Noninterest income 953 758 1,030 1,087 Noninterest expense 2,665 2,782 2,933 2,846 Income before taxes 302 129 419 575 Net income 255 153 322 477 Basic earnings per share .15 .10 .20 .30 Diluted earnings per share .15 .09 .19 .30 Dividends paid per share - - - - Price range, common stock 10.13 - 9.00 9.87 - 9.12 10.42 - 9.00 11.15 - 9.90 ------------------------------------------------------------------------------------------------------------------------------------ 2000 Interest income $ 3,196 3,278 3,370 3,652 Net interest income 2,161 2,123 2,145 2,454 Provision for loan losses 35 65 35 - Noninterest income 662 629 638 761 Noninterest expense 2,339 2,519 2,471 2,526 Income before taxes 449 168 277 689 Net income 346 196 247 494 Basic earnings per share .22 .12 .15 .32 Diluted earnings per share .21 .12 .15 .31 Dividends paid per share .05 -- -- -- Price range, common stock 12.00 - 9.50 10.75 - 8.00 10.38 - 8.50 10.88 - 9.75 ------------------------------------------------------------------------------------------------------------------------------------
(23) Subsequent Event At the February 28, 2002 regular Board of Directors Meeting, the Board approved a $5 million participation in a floating rate pooled trust preferred securities offering. The Company anticipates receiving the proceeds from the sale of the trust preferred securities on March 26, 2002. The Company intends to use the proceeds to increase the Bank's capital levels and for other corporate purposes. 59 SIGNATURES Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 20th day of March 2002. FIRST FINANCIAL BANCORP /s/ LEON J. ZIMMERMAN ----------------------------------- Leon J. Zimmerman President and Chief Executive Officer Pursuant to the requirements of the Securities and Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report.
Capacity Date -------- ---- /s/ BENJAMIN R. GOEHRING Director and Chairman of the Board March 20, 2002 ----------------------------- Benjamin R. Goehring /s/ WELDON D. SCHUMACHER Director and Vice Chairman of the Board March 20, 2002 ----------------------------- Weldon D. Schumacher /s/ ANGELO J. ANAGNOS Director March 20, 2002 ----------------------------- Angelo J. Anagnos /s/ STEVE M. COLDANI Director March 20, 2002 ----------------------------- Steve M. Coldani /s/ DAVID M. PHILIPP Director March 20, 2002 ----------------------------- David M. Philipp /s/ ROBERT H. MILLER, III Director March 20, 2002 ----------------------------- Robert H. Miller, III /s/ KEVIN VAN STEENBERGE Director March 20, 2002 ----------------------------- Kevin Van Steenberge /s/ LEON J. ZIMMERMAN Director, President and March 20, 2002 ----------------------------- Chief Executive Officer Leon J. Zimmerman (Principal Executice Officer) /s/ ROBERT H. DANEKE Director, Executive Vice President and March 20, 2002 ----------------------------- Chief Credit Officer Robert H. Daneke /s/ ALLEN R. CHRISTENSON Senior Vice President, March 20, 2002 ----------------------------- Chief Financial Officer and Secretary Allen R. Christenson (Principal Financial and Accounting Officer)
60 INDEX TO EXHIBITS Exhibit Page ------- ---- 23 Consent of Independent Auditors 62 61