FIRST NORTHERN COMMUNITY BANCORP - Annual Report: 2006 (Form 10-K)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
———————————
FORM
10-K
x ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the Fiscal Year Ended December 31, 2006
OR
o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the transition period from _________ to __________.
Commission
File Number 000-30707
First
Northern Community Bancorp
(Exact
name of Registrant as specified in its charter)
|
California
|
68-0450397
|
|
(State
or other jurisdiction of incorporation or organization)
|
(I.R.S.
Employer Identification Number)
|
|
195
N. First St., Dixon, CA
|
95620
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
707-678-3041
(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)
|
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act.
Yes
o No
x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act.
Yes
o No
x
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements
for
the past 90 days.
Yes
x No
o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act.
|
Large
accelerated filer o
|
Accelerated
filer x
|
Non-accelerated
filer o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes
o No
x
The
aggregate market value of the Common Stock held by non-affiliates of the
registrant on June 30, 2006 (based upon the last reported sales price of such
stock on the OTC Bulletin Board on June 30, 2006) was $209,686,313.
The
number of shares of Common Stock outstanding as of March 13, 2007 was 7,958,805.
DOCUMENTS
INCORPORATED BY REFERENCE
Items
10,
11, 12 (as to security ownership of certain beneficial owners and management),
13 and 14 of Part III incorporate by reference information from the
registrant’s proxy statement to be filed with the Securities and Exchange
Commission in connection with the solicitation of proxies for the registrant’s
2007 Annual Meeting of Shareholders.
TABLE
OF CONTENTS
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PART
I
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Page
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3
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14
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19
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19
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19
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19
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PART
II
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19
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21
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22
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41
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43
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79
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79
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80
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PART
III
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80
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80
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81
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81
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81
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PART
IV
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82
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84
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This Annual Report on Form 10-K contains forward-looking statements 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, which are subject to the “safe harbor” created by those sections. Forward-looking statements include the information concerning possible or assumed future results of operations of the Company set forth under the heading “Management's Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements can be identified by the fact that they do no relate strictly to historical or current facts. Often they include words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” estimate,” “consider,” or words of similar meaning, or future or conditional verbs such as “will”, “would”, “should”, “could”, “might”, or “may. 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 risks discussed in Item 1A under the caption “Risk Factors” and other risk factors discussed elsewhere in this Report. All of these forward-looking statements are based on assumptions about an uncertain future and are based on information available to us at the date of these statements. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.
PART
I
ITEM
1 - BUSINESS
Unless
otherwise indicated, all information herein has been adjusted to give effect
to
our two-for-one stock split in 2005 and stock dividends.
First
Northern Bank of Dixon (“First Northern” or the “Bank”) was established in 1910
under a California state charter as Northern Solano Bank, and opened for
business on February 1st of that year. On January 2, 1912, the First National
Bank of Dixon was established under a federal charter, and until 1955, the
two
entities operated side by side under the same roof and with the same management.
In an effort to increase efficiency of operation, reduce operating expense,
and
improve lending capacity, the two banks were consolidated on April 8, 1955,
with
the First National Bank of Dixon as the surviving entity.
On
January 1, 1980, the Bank’s federal charter was relinquished in favor of a
California state charter, and the Bank’s name was changed to First Northern Bank
of Dixon.
In
April
of 2000, the shareholders of First Northern approved a corporate reorganization,
which provided for the creation of a bank holding company, First Northern
Community Bancorp (the “Company”). The objective of this reorganization, which
was effected May 19, 2000, was to enable the Bank to better compete and grow
in
its competitive and rapidly changing marketplace. As a result of the
reorganization, the Bank is a wholly owned and principal operating subsidiary
of
the Company.
First
Northern engages in the general commercial banking business in the Solano,
Yolo,
Placer and Sacramento Counties of California.
The
Company’s and the Bank’s Administrative Offices are located in Dixon,
California. Also located in Dixon are the back office functions of the
Information Services/Central Operations Department and the Central Loan
Department.
The
Bank
has eleven full service branches. Four are located in the Solano County cities
of Dixon, Fairfield, and Vacaville (2). Four branches are located in the Yolo
County cities of Winters, Davis, West Sacramento and Woodland. Two branches
are
located in Sacramento County, one in Downtown Sacramento and the other in the
city of Folsom, and one branch is located in the city of Roseville in Placer
County. The Bank also has two satellite-banking offices inside retirement
communities in the city of Davis. In addition, the Bank has real estate loan
offices in Davis, Woodland, Vacaville, Folsom and Roseville that originate
residential mortgages and construction loans. The Bank also has a Small Business
Administration (the “SBA”) Loan Department and an Asset Management & Trust
Department in Downtown Sacramento that serve the Bank’s entire market
area.
First
Northern is in the commercial banking business, which includes accepting demand,
interest bearing transaction, savings, and time deposits, and making commercial,
consumer, and real estate related loans. It also offers installment note
collection, issues cashier’s checks and money orders, sells travelers’ checks,
rents safe deposit boxes, and provides other customary banking services. The
Bank is a member of the Federal Deposit Insurance Corporation (“FDIC”) and each
depositor’s account is insured up to $100,000.
First
Northern also offers a broad range of alternative investment products and
services. The Bank offers these services through an arrangement with Raymond
James Financial Services, Inc., an independent broker/dealer and a member of
NASD and SIPC. All investments and/or financial services offered by
representatives of Raymond James Financial Services, Inc. are not insured by
the
FDIC.
The
Bank
offers equipment leasing and limited international banking services through
third parties.
The
operating policy of the Bank since its inception has emphasized serving the
banking needs of individuals and small-to medium-sized businesses. In Dixon,
this has included businesses involved in crop and livestock production.
Historically, the economy of the Dixon area has been primarily dependent upon
agricultural related sources of income and most employment opportunities have
also been related to agriculture. Since 2000, Dixon has been growing and
becoming more diverse with noticeable expansion in the areas of industrial,
commercial, retail and residential housing projects.
Agriculture
continued to be a significant factor in the Bank’s business after the opening of
the first branch office in Winters in 1970. A significant step was taken in
1976
to reduce the Company’s dependence on agriculture with the opening of the Davis
Branch.
The
Davis
economy is supported significantly by the University of California, Davis.
In
1981, a branch was opened in South Davis, and was consolidated into the main
Davis Branch in 1986.
In
1983,
the West Sacramento Branch was opened. The West Sacramento economy is built
primarily around transportation and distribution related business. This addition
to the Bank’s market area further reduced the Company’s dependence on
agriculture.
In
order
to accommodate the demand of the Bank’s customers for long-term residential real
estate loans, a Real Estate Loan Office was opened in 1983. This office is
centrally located in Davis, and has enabled the Bank to access the secondary
real estate market.
The
Vacaville Branch was opened in 1985. Vacaville is a rapidly growing community
with a diverse economic base including a California state prison, food
processing, distribution, shopping centers (Factory Outlet Stores), medical,
biotech and other varied industries.
In
1994,
the Fairfield Branch was opened. Fairfield has also been a rapidly growing
community bounded by Vacaville on the east. Its diverse economic base includes
military (Travis AFB), food processing (an Anheuser-Busch plant), retail (Solano
Mall), manufacturing, medical, agriculture, and other varied industries.
Fairfield is the county seat of Solano County.
A
real
estate loan production office was opened in El Dorado Hills, in April 1996,
to
serve the growing mortgage loan demand in the foothills area east of Sacramento.
This office was moved to Folsom in 2006, a more central location for serving
Folsom, Rancho Cordova, and the eastern slope of El Dorado County.
The
SBA
Loan Department was opened in April 1997 in Sacramento to serve the small
business and industrial loan demand throughout the Bank’s entire market
area.
In
June
of 1997, the Bank’s seventh branch was opened in Woodland, the county seat of
Yolo County. Woodland is an expanding and diversified city with an economy
dominated by agribusiness, retail services, and a healthy industrial
sector.
The
Bank’s eighth branch, the Downtown Financial Center, opened in July of 2000 in
Vacaville to serve the business and individual financial needs on the west
side
of Interstate-80. Also in July of 2000, in an adjacent office, the Bank opened
its third real estate loan production office.
Two
satellite banking offices of the Bank’s Davis Branch were opened in 2001 in the
Davis senior living communities of Covell Gardens and the University Retirement
Community.
In
December of 2001, Roseville became the site of the Bank’s fourth real estate
loan production office. This office serves the residential mortgage loan needs
throughout Placer County.
In
March
of 2002 the Bank opened its ninth branch in a new class-A commercial building
located on the harbor in Suisun City. Suisun’s Downtown waterfront area is part
of an ongoing community revitalization project put into place with the goal
of
attracting new small businesses and merchants. After five years in operation
and
slower than anticipated city growth, the Bank decided to close its Suisun City
Branch and serve the Branch’s customers out of its Fairfield Branch. The
Fairfield Branch is undergoing an expansion and remodel to accommodate the
additional customers.
In
October of 2002, the Bank opened its tenth branch on a prominent corner in
Downtown Sacramento to serve Sacramento Metro’s business center and its
employees. The Bank’s Asset Management & Trust Department, located on the
mezzanine of the Downtown Sacramento Branch, was opened in 2002 to serve the
trust and fiduciary needs of the Bank’s entire market area. Fiduciary services
are offered to individuals, businesses, governments and charitable organizations
in the Solano, Yolo, Sacramento, Placer and El Dorado County
regions.
In
August
of 2003, a fifth full service real estate loan production office was opened
in
Woodland. This loan office is located within the same commercial office complex
as the Bank’s Woodland Branch. The Bank’s history of servicing the Woodland
community, coupled with the continued growth of the Woodland housing market,
prompted this decision to expand the Bank’s real estate loan services for the
community.
The
Bank
expanded its presence in Placer County in January 2005 by opening a full service
branch on a prominent corner in the rapidly growing business district of
Roseville.
In
the
fourth quarter of 2006, the Bank opened its Folsom Financial Center which houses
a full service branch, a real estate loan production office, and an investment
& brokerage services office. Folsom is one of the fastest growing cities in
Sacramento County and its central proximity to Rancho Cordova and El Dorado
Hills makes it ideal for building market share in the eastern part of the
County.
Through
this period of change and diversification, the Bank’s strategic focus, which
emphasizes serving the banking needs of individuals and small to medium-sized
businesses, has not changed. The Bank takes real estate, crop proceeds,
securities, savings and time deposits, automobiles, and equipment as collateral
for loans.
Most
of
the Bank’s deposits are attracted from the market of northern and central Solano
County and southern and central Yolo County. The Company believes that the
Bank’s deposit base does not involve any undue concentration levels from one or
a few major depositors.
As
of
December 31, 2006, the Company and the Bank employed 242 full-time equivalent
staff. The Company and the Bank consider their relationship with their employees
to be good and have not experienced any interruptions of operations due to
labor
disagreements.
First
Northern has historically experienced seasonal swings in both deposit and loan
volumes due primarily to general economic factors and specific economic factors
affecting our customers. Deposits have typically hit lows in February or March
and have peaked in November or December. Loans typically peak in the late spring
and hit lows in the fall as crops are harvested and sold. Since the real estate
and agricultural economies generally follow the same seasonal cycle, they
experience the same deposit and loan fluctuations.
Available
Information
The
Company’s internet address is www.thatsmybank.com,
and the
Company makes available free of charge on this website its Annual Reports on
Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and
amendments to those reports, as soon as reasonably practicable after the Company
electronically files such material with, or furnishes it to, the SEC. These
filings are also accessible on the SEC's website at www.sec.gov.
The
information found on the Company’s website shall not be deemed incorporated by
reference by any general statement incorporating by reference this report into
any filing under the Securities Act of 1933 or under the Securities Exchange
Act
of 1934, except to the extent the Company specifically incorporates the
information found on the Company’s website by reference, and shall not otherwise
be deemed filed under such Acts.
The
Effect of Government Policy on Banking
The
earnings and growth of the Bank are affected not only by local market area
factors and general economic conditions, but also by government monetary and
fiscal policies. For example, the Board of Governors of the Federal Reserve
System (the “FRB”) influences the supply of money through its open market
operations in U.S. Government securities, adjustments to the discount rates
applicable to borrowings by depository institutions and others and establishment
of reserve requirements against both members and non-members financial
institutions’ deposits. Such actions significantly affect the overall growth and
distribution of loans, investments and deposits and also affect interest rates
charged on loans and paid on deposits. The nature and impact of future changes
in such policies on the business and earnings of the Company cannot be
predicted. Additionally, state and federal tax policies can impact banking
organizations.
As
a
consequence of the extensive regulation of commercial banking activities in
the
United States, the business of the Company is particularly susceptible to being
affected by the enactment of federal and state legislation which may have the
effect of increasing or decreasing the cost of doing business, modifying
permissible activities or enhancing the competitive position of other financial
institutions. Any change in applicable laws or regulations may have a material
adverse effect on the business and prospects of the Company.
Regulation
and Supervision of Bank Holding Companies
The
Company is a bank holding company subject to the Bank Holding Company Act of
1956, as amended (the “BHCA”). The Company reports to, registers with, and may
be examined by, the FRB. The FRB also has the authority to examine the Company’s
subsidiaries. The costs of any examination by the FRB are payable by the
Company.
The
Company is a bank holding company within the meaning of Section 3700 of the
California Financial Code. As such, the Company and the Bank are subject to
examination by, and may be required to file reports with, the California
Commissioner of Financial Institutions (the “Commissioner”).
The
FRB
has significant supervisory and regulatory authority over the Company and its
affiliates. The FRB requires the Company to maintain certain levels of capital.
See“Capital
Standards” below for more information. The FRB also has the authority to take
enforcement action against any bank holding company that commits any unsafe
or
unsound practice, or violates certain laws, regulations or conditions imposed
in
writing by the FRB. See“Prompt
Corrective Action and Other Enforcement Mechanisms” below for more information.
According to FRB policy, bank holding companies are expected to act as a source
of financial strength to subsidiary banks, and to commit resources to support
subsidiary banks. This support may be required at times when a bank holding
company may not be able to provide such support.
Under
the
BHCA, a company generally must obtain the prior approval of the FRB before
it
exercises a controlling influence over a bank, or acquires directly or
indirectly, more than 5% of the voting shares or substantially all of the assets
of any bank or bank holding company. Thus, the Company is required to obtain
the
prior approval of the FRB before it acquires, merges or consolidates with any
bank or bank holding company. Any company seeking to acquire, merge or
consolidate with the Company also would be required to obtain the prior approval
of the FRB.
The
Company is generally prohibited under the BHCA from acquiring 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 activities
other than banking, managing banks, or providing services to affiliates of
the
holding company. However, a bank holding company, with the approval of the
FRB,
may engage, or acquire the voting shares of companies engaged, in activities
that the FRB has determined to be so closely related to banking or managing
or
controlling banks as to be a proper incident thereto. A bank holding company
must demonstrate that the benefits to the public of the proposed activity will
outweigh the possible adverse effects associated with such
activity.
The
Gramm-Leach-Bliley Act of 1999 (“GLBA”) eliminated many of the restrictions
placed on the activities of bank holding companies that become financial holding
companies. Among other things, GLBA repealed certain Glass-Steagall Act
restrictions on affiliations between banks and securities firms, and amended
the
BHCA to permit bank holding companies that are financial holding companies
to
engage in activities, and acquire companies engaged in activities, that are:
financial in nature (including insurance underwriting, insurance company
portfolio investment, financial advisor, securities underwriting, dealing and
market-making, and merchant banking activities); incidental to financial
activities; or complementary to financial activities if the FRB determines
that
they pose no substantial risk to the safety or soundness of depository
institutions or the financial system in general. The Company has not become
a
financial holding company. GLBA also permits national banks to engage in
activities considered financial in nature through a financial subsidiary,
subject to certain conditions and limitations and with the approval of the
Comptroller of the Currency.
A
bank
holding company may acquire banks in states other than its home state without
regard to the permissibility of such acquisitions under state law, but subject
to any state requirement that the bank has been organized and operating for
a
minimum period of time, not to exceed five years, and the requirement that
the
bank holding company, prior to or following the proposed acquisition, controls
no more than 10% of the total amount of deposits of insured depository
institutions in the United States and no more than 30% of such deposits in
that
state (or such lesser or greater amount set by state law). Banks may also merge
across state lines, thereby creating interstate branches. Furthermore, a bank
is
able to open new branches in a state in which it does not already have banking
operations, if the laws of such state permit such de novo
branching.
Under
California law, (a) out-of-state banks that wish to establish a California
branch office to conduct core banking business must first acquire an existing
California bank or industrial bank, which has existed for at least five years,
by merger or purchase, (b) California state-chartered banks are empowered to
conduct various authorized branch-like activities on an agency basis through
affiliated and unaffiliated insured depository institutions in California and
other states, and (c) the Commissioner of Financial Institutions is authorized
to approve an interstate acquisition or merger which would result in a deposit
concentration in California exceeding 30% if the Commissioner finds that the
transaction is consistent with public convenience and advantage. However, a
state bank chartered in a state other than California may not enter California
by purchasing a California branch office of a California bank or industrial
bank
without purchasing the entire entity or by establishing a de novo California
bank.
The
FRB
generally prohibits a bank holding company from declaring or paying a cash
dividend which would impose undue pressure on the capital of subsidiary banks
or
would be funded only through borrowing or other arrangements that might
adversely affect a bank holding company's financial position. The FRB's policy
is that a bank holding company should not continue its existing rate of cash
dividends on its common stock unless its net income is sufficient to fully
fund
each dividend and its prospective rate of earnings retention appears consistent
with its capital needs, asset quality and overall financial condition. The
Company is also subject to restrictions relating to the payment of dividends
under California corporate law. See “Restrictions on Dividends and Other
Distributions” below for additional restrictions on the ability of the Company
and the Bank to pay dividends.
Transactions
between the Company and the Bank are subject to a number of other restrictions.
FRB policies forbid the payment by bank subsidiaries of management fees, which
are unreasonable in amount or exceed the fair market value of the services
rendered (or, if no market exists, actual costs plus a reasonable profit).
Subject to certain limitations, depository institution subsidiaries of bank
holding companies may extend credit to, invest in the securities of, purchase
assets from, or issue a guarantee, acceptance, or letter of credit on behalf
of,
an affiliate, provided that the aggregate of such transactions with affiliates
may not exceed 10% of the capital stock and surplus of the institution, and
the
aggregate of such transactions with all affiliates may not exceed 20% of the
capital stock and surplus of such institution. The Company may only borrow
from
depository institution subsidiaries of the Company if the loan is secured by
marketable obligations with a value of a designated amount in excess of the
loan. Further, the Company may not sell a low-quality asset to the
Bank.
Bank
Regulation and Supervision
The
Bank
is subject to regulation, supervision and regular examination by the California
Department of Financial Institutions (“DFI”) and the FDIC and the Company by the
FRB. The regulations of these agencies affect most aspects of the Company’s
business and prescribe permissible types of loans and investments, the amount
of
required reserves, requirements for branch offices, the permissible scope of
the
Company’s activities and various other requirements. While the Bank is not a
member of the FRB, it is also directly subject to certain regulations of the
FRB
dealing primarily with check clearing activities, establishment of banking
reserves, Truth-in-Lending (Regulation Z), Truth-in-Savings (Regulation DD),
and
Equal Credit Opportunity (Regulation B). In addition, the banking industry
is
subject to significantly increased regulatory scrutiny and enforcement regarding
Bank Secrecy Act and anti-money laundering matters. In recent years, a number
of
banks and bank holding companies announced the imposition of regulatory
sanctions, including regulatory agreements and cease and desist orders and,
in
some cases, fines and penalties by the bank regulators due to failures to comply
with the Bank Secrecy Act and other anti-money laundering legislation. In a
number of these cases, the fines and penalties have been
significant.
Under
California law, the Bank is subject to various restrictions on, and requirements
regarding, its operations and administration including the maintenance of branch
offices and automated teller machines, capital and reserve requirements,
deposits and borrowings, stockholder rights and duties, and investment and
lending activities.
California
law permits a state chartered bank to invest in the stock and securities of
other corporations, subject to a state chartered bank receiving either general
authorization or, depending on the amount of the proposed investment, specific
authorization from the Commissioner. Federal banking laws, however, impose
limitations on the activities and equity investments of state chartered,
federally insured banks. The FDIC rules on investments prohibit a state bank
from acquiring an equity investment of a type, or in an amount, not permissible
for a national bank. Non-permissible investments must have been divested by
state banks no later than December 19, 1996. FDIC rules also prohibit a state
bank from engaging as a principal in any activity that is not permissible for
a
national bank, unless the bank is adequately capitalized and the FDIC approves
the activity after determining that such activity does not pose a significant
risk to the deposit insurance fund. The FDIC rules on activities generally
permit subsidiaries of banks, without prior specific FDIC authorization, to
engage in those activities that have been approved by the FRB for bank holding
companies because such activities are so closely related to banking to be a
proper incident thereto. Other activities generally require specific FDIC prior
approval and the FDIC may impose additional restrictions on such activities
on a
case-by-case basis in approving applications to engage in otherwise
impermissible activities.
The
USA Patriot Act
Title
III
of the United and Strengthening America by Providing Appropriate Tools Required
to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”) includes
numerous provisions for fighting international money laundering and blocking
terrorism access to the U.S. financial system. The USA Patriot Act requires
certain additional due diligence and record keeping practices, including, but
not limited to, new customers, correspondent and private banking accounts.
In
March
2006, President Bush signed into law a renewal of the USA Patriot
Act.
Part
of
the USA Patriot Act is the International Money Laundering Abatement and
Financial Anti-Terrorism Act of 2001 (“IMLAFATA”). Among its provisions,
IMLAFATA requires each financial institution to: (i) establish an anti-money
laundering program; (ii) establish appropriate anti-money laundering policies,
procedures and controls; (iii) appoint a Bank Secrecy Act officer responsible
for day-to-day compliance; and (iv) conduct independent audits. In addition,
IMLAFATA contains a provision encouraging cooperation among financial
institutions, regulatory authorities and law enforcement authorities with
respect to individuals, entities and organizations engaged in, or reasonably
suspected of engaging in, terrorist acts or money laundering activities.
IMLAFATA expands the circumstances under which funds in a bank account may
be
forfeited and requires covered financial institutions to respond under certain
circumstances to requests for information from federal banking agencies within
120 hours. IMLAFATA also amends the BHCA and the Bank Merger Act to require
the
federal banking agencies to consider the effectiveness of a financial
institution's anti-money laundering activities when reviewing an application
under these Acts.
Pursuant
to IMLAFATA, the Secretary of the Treasury, in consultation with the heads
of
other government agencies, has adopted and proposed special measures applicable
to banks, bank holding companies, and/or other financial institutions. These
measures include enhanced record keeping and reporting requirements for certain
financial transactions that are of primary money laundering concern, due
diligence requirements concerning the beneficial ownership of certain types
of
accounts, and restrictions or prohibitions on certain types of accounts with
foreign financial institutions.
Privacy
Restrictions
GLBA,
in
addition to the previous described changes in permissible non-banking activities
permitted to banks, bank holding companies and financial holding companies,
also
requires financial institutions in the U.S. to provide certain privacy
disclosures to customers and consumers, to comply with certain restrictions
on
the sharing and usage of personally identifiable information, and to implement
and maintain commercially reasonable customer information safeguarding
standards.
The
Company believes that it complies with all provisions of GLBA and all
implementing regulations, and the Bank has developed appropriate policies and
procedures to meet its responsibilities in connection with the privacy
provisions of GLBA.
California
and other state legislatures have adopted privacy laws, including laws
prohibiting sharing of customer information without the customer’s prior
permission. These laws may make it more difficult for the Company to share
information with its marketing partners, reduce the effectiveness of marketing
programs, and increase the cost of marketing programs.
Capital
Standards
The
federal banking agencies have risk-based capital adequacy guidelines intended
to
provide a measure of capital adequacy that reflects the degree of risk
associated with a banking organization's operations for both transactions
reported on the balance sheet as assets and transactions, such as letters of
credit and recourse arrangements, which are recorded as off-balance-sheet items.
Under these guidelines, nominal dollar amounts of assets and credit equivalent
amounts of off-balance-sheet items are multiplied by one of several risk
adjustment percentages, which range from 0% for assets with low credit risk,
such as certain U.S. government securities, to 100% for assets with relatively
higher credit risk, such as certain loans.
In
determining the capital level the Bank is required to maintain, the federal
banking agencies do not, in all respects, follow generally accepted accounting
principles (“GAAP”) and have special rules which have the effect of reducing the
amount of capital that will be recognized for purposes of determining the
capital adequacy of the Bank.
A
banking
organization's risk-based capital ratios are obtained by dividing its qualifying
capital by its total risk-adjusted assets and off-balance-sheet items. The
regulators measure risk-adjusted assets and off balance sheet items against
both
total qualifying capital (the sum of Tier 1 capital and limited amounts of
Tier
2 capital) and Tier 1 capital. Tier 1 capital consists of common stock, retained
earnings, non-cumulative perpetual preferred stock, trust preferred securities
(for up to 25% of total tier 1 capital), other types of qualifying preferred
stock and minority interests in certain subsidiaries, less most other intangible
assets and other adjustments. Net unrealized losses on available-for-sale equity
securities with readily determinable fair value must be deducted in determining
Tier 1 capital. For Tier 1 capital purposes, deferred tax assets that can only
be realized if an institution earns sufficient taxable income in the future
are
limited to the amount that the institution is expected to realize within one
year, or 10% of Tier 1 capital, whichever is less. Tier 2 capital may consist
of
a limited amount of the allowance for possible loan and lease losses, term
preferred stock and other types of preferred stock and trust preferred
securities not qualifying as Tier 1 capital, term subordinated debt and certain
other instruments with some characteristics of equity. The inclusion of elements
of Tier 2 capital are subject to certain other requirements and limitations
of
the federal banking agencies. The federal banking agencies require a minimum
ratio of qualifying total capital to risk-adjusted assets and off-balance-sheet
items of 8%, and a minimum ratio of Tier 1 capital to adjusted average
risk-adjusted assets and off-balance-sheet items of 4%.
Under
FDIC regulations, there are also two rules governing minimum capital levels
that
FDIC-supervised banks must maintain against the risks to which they are exposed.
The first rule makes risk-based capital standards consistent for two types
of
credit enhancements (i.e., recourse arrangements and direct credit substitutes)
and requires different amounts of capital for different risk positions in asset
securitization transactions. The second rule permits limited amounts of
unrealized gains on debt and equity securities to be recognized for risk-based
capital purposes as of September 1, 1998. The FDIC rules also provide that
a
qualifying institution that sells small business loans and leases with recourse
must hold capital only against the amount of recourse retained. In general,
a
qualifying institution is one that is well capitalized under the FDIC's prompt
corrective action rules. The amount of recourse that can receive the
preferential capital treatment cannot exceed 15% of the institution's total
risk-based capital.
Effective
January 1, 2002, the federal banking agencies, including the FDIC, adopted
new
regulations to change their regulatory capital standards to address the
treatment of recourse obligations, residual interests and direct credit
substitutes in asset securitizations that expose banks primarily to credit
risk.
Capital requirements for positions in securitization transactions are varied
according to their relative risk exposures, while limited use is permitted
of
credit ratings from rating agencies, a banking organization’s qualifying
internal risk rating system or qualifying software. The regulation requires
a
bank to deduct from Tier 1 capital, and from assets, all credit-enhancing
interest only-strips, whether retained or purchased that exceed 25% of Tier
1
capital. Additionally, a bank must maintain dollar-for-dollar risk-based capital
for any remaining credit-enhancing interest-only strips and any residual
interests that do not qualify for a ratings-based approach. The regulation
specifically reserves the right to modify any risk-weight, credit conversion
factor or credit equivalent amount, on a case-by-case basis, to take into
account any novel transactions that do not fit well into the currently defined
categories.
In
addition to the risk-based guidelines, federal banking regulators require
banking organizations to maintain a minimum amount of Tier 1 capital to adjusted
average total assets, referred to as the leverage capital ratio. For a banking
organization rated in the highest of the five categories used by regulators
to
rate banking organizations, the minimum lever-age ratio of Tier 1 capital to
total assets must be 3%. It is improbable; however, that an institution with
a
3% leverage ratio would receive the highest rating by the regulators since
a
strong capital position is a significant part of the regulators' rating. For
all
banking organizations not rated in the highest category, the minimum leverage
ratio must be at least 100 to 200 basis points above the 3% minimum. Thus,
the
effective minimum leverage ratio, for all practical purposes, must be at least
4% or 5%. In addition to these uniform risk-based capital guidelines and
leverage ratios that apply across the industry, the regulators have the
discretion to set individual minimum capital requirements for specific
institutions at rates significantly above the minimum guidelines and
ratios.
As
of
December 31, 2006, the Company’s and the Bank’s capital ratios exceeded
applicable regulatory requirements.
The
following tables present the capital ratios for the Company and the Bank,
compared to the standards for well-capitalized bank holding companies and
depository institutions, as of December 31, 2006 (amounts in thousands
except percentage amounts).
|
The
Company
|
|||||||||||||
|
Well
|
Minimum
|
||||||||||||
|
Actual
|
Capitalized
|
Capital
|
|||||||||||
|
Capital
|
Ratio
|
Ratio
|
Requirement
|
||||||||||
|
Leverage
|
$
|
62,400
|
9.1
|
%
|
5.0
|
%
|
4.0
|
%
|
|||||
|
Tier 1
Risk-Based
|
62,400
|
11.1
|
%
|
6.0
|
%
|
4.0
|
%
|
||||||
|
Total
Risk-Based
|
69,078
|
12.3
|
%
|
10.0
|
%
|
8.0
|
%
|
||||||
|
The
Bank
|
|||||||||||||
|
Well
|
Minimum
|
||||||||||||
|
Actual
|
Capitalized
|
Capital
|
|||||||||||
|
Capital
|
Ratio
|
Ratio
|
Requirement
|
||||||||||
|
Leverage
|
$
|
61,719
|
9.0
|
%
|
5.0
|
%
|
4.0
|
%
|
|||||
|
Tier 1
Risk-Based
|
61,719
|
11.0
|
%
|
6.0
|
%
|
4.0
|
%
|
||||||
|
Total
Risk-Based
|
68,397
|
12.2
|
%
|
10.0
|
%
|
8.0
|
%
|
||||||
The
federal banking agencies must take into consideration concentrations of credit
risk and risks from non-traditional activities, as well as an institution's
ability to manage those risks, when determining the adequacy of an institution's
capital. This evaluation will be made as a part of the institution's regular
safety and soundness examination. The federal banking agencies must also
consider interest rate risk (when the interest rate sensitivity of an
institution's assets does not match the sensitivity of its liabilities or its
off-balance-sheet position) in evaluating a Bank’s capital
adequacy.
Prompt
Corrective Action and Other Enforcement Mechanisms
The
Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”)
requires each federal banking agency to take prompt corrective action to resolve
the problems of insured depository institutions, including but not limited
to
those that fall below one or more prescribed minimum capital ratios. The law
required each federal banking agency to promulgate regulations defining the
following five categories in which an insured depository institution will be
placed, based on the level of its capital ratios: well capitalized, adequately
capitalized, under-capitalized, significantly undercapitalized and critically
undercapitalized.
Under
the
prompt corrective action provisions of FDICIA, an insured depository institution
generally will be classified in the following categories based on the capital
measures indicated below:
|
“Well
capitalized”
Total
risk-based capital of 10%;
Tier 1
risk-based capital of 6%; and
Leverage
ratio of 5%.
|
“Adequately
capitalized”
Total
risk-based capital of 8%;
Tier 1
risk-based capital of 4%; and
Leverage
ratio of 4%.
|
|
“Undercapitalized”
Total
risk-based capital less than 8%;
Tier 1
risk-based capital less than 4%; or
Leverage
ratio less than 4%.
|
“Significantly
undercapitalized”
Total
risk-based capital less than 6%;
Tier 1
risk-based capital less than 3%; or
Leverage
ratio less than 3%.
|
|
“Critically
undercapitalized”
Tangible
equity to total assets less than 2%.
|
An
institution that, based upon its capital levels, is classified as “well
capitalized,” “adequately capitalized” or “under-capitalized” may be treated as
though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that
an unsafe or unsound condition or an unsafe or unsound practice warrants such
treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions. Management believes that at
December 31, 2006, the Company and the Bank met the requirements for “well
capitalized institutions.”
In
addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by the federal regulators for unsafe or unsound practices in conducting their
businesses or for violations of any law, rule, regulation or any condition
imposed in writing by the agency or any written agreement with the agency.
Enforcement actions may include the imposition of a conservator or receiver,
the
issuance of a cease-and-desist order that can be judicially enforced, the
termination of insurance of deposits (in the case of a depository institution),
the imposition of civil money penalties, the issuance of directives to increase
capital, the issuance of formal and informal agreements, the issuance of removal
and prohibition orders against institution-affiliated parties and the
enforcement of such actions through injunctions or restraining orders based
upon
a judicial determination that the agency would be harmed if such equitable
relief was not granted. Additionally, a holding company’s inability to serve as
a source of strength to its subsidiary banking organizations could serve as
an
additional basis for a regulatory action against the holding
company.
Safety
and Soundness Standards
FDICIA
also implemented certain specific restrictions on transactions and required
federal banking regulators to adopt overall safety and soundness standards
for
depository institutions related to internal control, loan underwriting and
documentation and asset growth. Among other things, FDICIA limits the interest
rates paid on deposits by undercapitalized institutions, restricts the use
of
brokered deposits, limits the aggregate extensions of credit by a depository
institution to an executive officer, director, principal shareholder or related
interest, and reduces deposit insurance coverage for deposits offered by
undercapitalized institutions for deposits by certain employee benefits
accounts.
The
federal banking agencies may require an institution to submit to an acceptable
compliance plan as well as have the flexibility to pursue other more appropriate
or effective courses of action given the specific circumstances and severity
of
an institution's non-compliance with one or more standards.
Restrictions
on Dividends and Other Distributions
The
power
of the board of directors of an insured depository institution to declare a
cash
dividend or other distribution with respect to capital is subject to statutory
and regulatory restrictions which limit the amount available for such
distribution depending upon the earnings, financial condition and cash needs
of
the institution, as well as general business conditions. FDICIA prohibits
insured depository institutions from paying management fees to any controlling
persons or, with certain limited exceptions, making capital distributions,
including dividends, if, after such transaction, the institution would be
undercapitalized.
The
federal banking agencies also have authority to prohibit a depository
institution from engaging in business practices, which are considered to be
unsafe or unsound, possibly including payment of dividends or other payments
under certain circumstances even if such payments are not expressly prohibited
by statute.
In
addition to the restrictions imposed under federal law, banks chartered under
California law generally may only pay cash dividends to the extent such payments
do not exceed the lesser of retained earnings of the Bank’s net income for its
last three fiscal years (less any distributions to shareholders during such
period). In the event a bank desires to pay cash dividends in excess of such
amount, the bank may pay a cash dividend with the prior approval of the
Commissioner in an amount not exceeding the greatest of the Bank’s retained
earnings, the Bank’s net income for its last fiscal year, or the Bank’s net
income for its current fiscal year.
Premiums
for Deposit Insurance
The
Bank
is a member of the Deposit Insurance Fund (DIF) maintained by the FDIC. Through
the DIF, the FDIC insures the deposits of the Bank up to prescribed limits
for
each depositor. The DIF was formed March 31, 2006, upon the merger of the Bank
Insurance Fund and the Savings Insurance Fund in accordance with the Federal
Deposit Insurance Reform Act of 2005. To maintain the DIF, member institutions
are assessed an insurance premium based on their deposits and their
institutional risk category. The FDIC determines an institution’s risk category
by combining its supervisory ratings with its financial ratios and other risk
measures.
To
offset
assessments, a member institution may apply certain one time credits, based
on
the institution’s (or its successor’s) assessment base as of the end of 1996. An
institution may apply available credits up to 100% of assessments in 2007,
and
up to 90% of assessments in each of 2008, 2009 and 2010. Based on available
credits, we expect the increase in total deposit insurance expense in 2007
under
the new assessment schedule to be fully offset.
The
FDIC
may terminate a depository institution’s deposit insurance upon a finding that
the institution’s financial condition is unsafe or unsound or that the
institution has engaged in unsafe or unsound practices or has violated any
applicable rule, regulation, order or condition enacted or imposed by the
institution’s regulatory agency. The termination of deposit insurance for the
Bank would have a material adverse effect on our business and
prospects.
The
Deposit Insurance Funds Act of 1996 (the “Deposit Funds Act”) separated the
Financing Corporation (“FICO”) assessment to service the interest on FICO bond
obligations from the BIF and Savings Association Insurance Fund (“SAIF”)
assessments. The FICO annual assessment on individual depository institutions
is
in addition to the amount, if any, paid for deposit insurance according to
the
FDIC’s risk-based assessment rate schedules. FICO assessment rates may be
adjusted quarterly by the FDIC. The current FICO assessment rate is 1.32 cents
per $100 of deposits. In addition, the FDIC has authority to impose special
assessments from time to time, subject to certain limitations specified in
the
Deposit Funds Act.
Community
Reinvestment Act and Fair Lending
The
Bank
is subject to certain fair lending requirements and reporting obligations
involving home mortgage lending operations and Community Reinvestment Act
(“CRA”) activities. The CRA generally requires the federal banking agencies to
evaluate the record of a financial institution in meeting the credit needs
of
the bank’s local communities, including low and moderate-income neighborhoods.
In addition to substantive penalties and corrective measures that may be
required for a violation of certain fair lending laws, the federal banking
agencies may take compliance with such laws and CRA into account when regulating
and supervising other activities, particularly applications involving business
expansion.
Sarbanes
- Oxley Act
On
July
30, 2002, President Bush signed into law The Sarbanes-Oxley Act of 2002. This
legislation addressed accounting oversight and corporate governance matters
among public companies, including:
|
·
|
the
creation of a five-member oversight board that sets standards for
accountants and has investigative and disciplinary
powers;
|
|
·
|
the
prohibition of accounting firms from providing various types of consulting
services to public clients and requires accounting firms to rotate
partners among public client assignments every five
years;
|
|
·
|
increased
penalties for financial crimes;
|
|
·
|
expanded
disclosure of corporate operations and internal controls and certification
of financial statements;
|
|
·
|
enhanced
controls on, and reporting of, insider trading;
and
|
|
·
|
prohibition
on lending to officers and directors of public companies, although
the
Bank may continue to make these loans within the constraints of existing
banking regulations.
|
Among
other provisions, Section 302(a) of the Sarbanes-Oxley Act requires that our
Chief Executive Officer and Chief Financial Officer certify that our quarterly
and annual reports do not contain any untrue statement or omission of a material
fact. Specific requirements of the certifications include having these officers
confirm that they are responsible for establishing, maintaining and regularly
evaluating the effectiveness of our disclosure controls and procedures; they
have made certain disclosures to our auditors and Audit Committee about our
internal controls; and they have included information in our quarterly and
annual reports about their evaluation and whether there have been significant
changes in our internal controls or in other factors that could significantly
affect internal controls subsequent to their evaluation.
In
addition, Section 404 of the Sarbanes-Oxley Act and the SEC’s rules and
regulations thereunder require our management to evaluate, with the
participation of our principal executive and principal financial officers,
the
effectiveness, as of the end of each fiscal year, of our internal control over
financial reporting. Our management must then provide a report of management
on
our internal control over financial reporting that contains, among other things,
a statement of their responsibility for establishing and maintaining adequate
internal control over financial reporting, and a statement identifying the
framework they used to evaluate the effectiveness of our internal control over
financial reporting.
Pending
Legislation and Regulations
Proposals
to change the laws and regulations governing the banking and financial services
industry are frequently introduced in Congress, in the state legislatures and
before the various bank regulatory agencies. The likelihood and timing of any
such changes and the impact such changes might have on the Company cannot be
determined at this time.
Competition
In
the
past, an independent bank’s principal competitors for deposits and loans have
been other banks (particularly major banks), savings and loan associations
and
credit unions. For agricultural loans, the Bank also competes with constituent
entities with the Federal Farm Credit System. To a lesser extent, competition
was also provided by thrift and loans, mortgage brokerage companies and
insurance companies. Other institutions, such as brokerage houses, mutual fund
companies, credit card companies, and even retail establishments have offered
new investment vehicles, which also compete with banks for deposit business.
The
direction of federal legislation in recent years seems to favor competition
among different types of financial institutions and to foster new entrants
into
the financial services market.
The
enactment of GLBA is the latest evidence of this trend, and it is anticipated
that this trend will continue as financial services institutions combine to
take
advantage of the elimination of the barriers against such affiliations. The
enactment of the federal Interstate Banking and Branching Act in 1994 and the
California Interstate Banking and Branching Act of 1995 have increased
competition within California. Recent legislation has also made it easier for
out-of-state credit unions to conduct business in California and allows
industrial banks to offer consumers more lending products. Moreover, regulatory
reform, as well as other changes in federal and California law will also affect
competition. The availability of banking services over the Internet or
“e-banking” has continued to expand. While the impact of these changes, and of
other proposed changes, cannot be predicted with certainty, it is clear that
the
business of banking in California will remain highly competitive.
In
order
to compete with major financial institutions and other competitors in its
primary service areas, the Bank relies upon the experience of its executive
and
senior officers in serving business clients, and upon its specialized services,
local promotional activities and the personal contacts made by its officers,
directors and employees.
For
customers whose loan demand exceeds the Bank’s legal lending limit, the Bank may
arrange for such loans on a participation basis with correspondent banks. The
seasonal swings discussed earlier have, in the past, had some impact on the
Bank’s liquidity. The management of investment maturities, sale of loan
participations, federal fund borrowings, qualification for funds under the
Federal Reserve Bank’s seasonal credit program, and the ability to sell
mortgages in the secondary market has allowed the Bank to satisfactorily manage
its liquidity.
ITEM
1A - RISK FACTORS
In
addition to factors mentioned elsewhere in this Report, the factors contained
below, among others, could cause our financial condition and results of
operations to be materially and adversely affected. If this were to happen,
the
value of our common stock could decline, perhaps significantly, and you could
lose all or part of your investment.
The
Bank is Subject to Lending Risks of Loss and Repayment Associated with
Commercial Banking Activities
The
Bank’s business strategy is to focus on commercial business loans (which
includes agricultural loans), construction loans and commercial and multi-family
real estate loans. The principal factors affecting the Bank’s risk of loss in
connection with commercial business loans include the borrower's ability to
manage its business affairs and cash flows, general economic conditions and,
with respect to agricultural loans, weather and climate conditions. Loans
secured by commercial real estate are generally larger and involve a greater
degree of credit and transaction risk than residential mortgage (one to four
family) loans. Because payments on loans secured by commercial and multi-family
real estate properties are often dependent on successful operation or management
of the underlying properties, repayment of such loans may be dependent on
factors other than the prevailing conditions in the real estate market or the
economy. Real estate construction financing is generally considered to involve
a
higher degree of credit risk than long-term financing on improved,
owner-occupied real estate. Risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value at
completion of construction or development compared to the estimated cost
(including interest) of construction. If the estimate of value proves to be
inaccurate, the Bank may be confronted with a project which, when completed,
has
a value which is insufficient to assure full repayment of the construction
loan.
Although
the Bank manages lending risks through its underwriting and credit
administration policies, no assurance can be given that such risks will not
materialize, in which event, the Company’s financial condition, results of
operations, cash flows and business prospects could be materially adversely
affected.
The
Bank’s Dependence on Real Estate Lending Increases Our Risk of
Losses
At
December 31, 2006, approximately 70% of the Bank’s loans (excluding loans
held-for-sale) were secured by real estate. The value of the Bank’s real estate
collateral has been, and could in the future continue to be, adversely affected
by any economic recession and any resulting adverse impact on the real estate
market in Northern California such as that experienced during the early 1990’s.
See“Adverse
California Economic Conditions Could Adversely Affect the Bank’s Business”
below.
The
Bank’s primary lending focus has historically been commercial (including
agricultural), construction and real estate mortgage. At December 31, 2006,
real
estate mortgage (excluding loans held-for-sale) and construction loans comprised
approximately 48% and 22%, respectively, of the total loans in the Bank’s
portfolio. At December 31, 2006, all of the Bank’s real estate mortgage and
construction loans and approximately 49% of its commercial loans were secured
fully or in part by deeds of trust on underlying real estate. The Company’s
dependence on real estate increases the risk of loss in both the Bank’s loan
portfolio and its holdings of other real estate owned if economic conditions
in
Northern California deteriorate in the future. Deterioration of the real estate
market in Northern California would have a material adverse effect on the
Company’s business, financial condition and results of operations. See“Adverse
California Economic Conditions Could Adversely Affect the Bank’s Business”
below.
Adverse
California Economic Conditions Could Adversely Affect the Bank’s
Business
The
Bank’s operations and a substantial majority of the Bank’s assets and deposits
are generated and concentrated primarily in Northern California, particularly
the counties of Placer, Sacramento, Solano and Yolo, and are likely to remain
so
for the foreseeable future. At December 31, 2006, approximately 70% of the
Bank’s loan portfolio (excluding loans held-for-sale) consisted of real
estate-related loans, all of which were secured by collateral located in
Northern California. As a result, poor economic conditions in Northern
California may cause the Bank to incur losses associated with high default
rates
and decreased collateral values in its loan portfolio. In the early 1990’s, the
California economy experienced an economic recession that resulted in increases
in the level of delinquencies and losses for many of the state’s financial
institutions. Economic conditions in California are subject to various
uncertainties at this time, including the softening in the California real
estate market and housing industry. California’s state government has undergone
serious fiscal and budget difficulties in the recent past. If economic
conditions in California decline or if California were to experience another
recession, it is expected that the Bank’s level of problem assets would increase
accordingly. California real estate is also subject to certain natural
disasters, such as earthquakes, floods and mudslides, which are typically not
covered by the standard hazard insurance policies maintained by borrowers.
Uninsured disasters may make it difficult or impossible for borrowers to repay
loans made by the Bank. The occurrence of natural disasters in California could
have a material adverse effect on the Company’s financial condition, results of
operations, cash flows and business prospects.
The
Bank is Subject to Interest Rate Risk
The
income of the Bank depends to a great extent on “interest rate differentials”
and the resulting net interest margins (i.e., the difference between the
interest rates earned on the Bank’s interest-earning assets such as loans and
investment securities, and the interest rates paid on the Bank’s
interest-bearing liabilities such as deposits and borrowings). These rates
are
highly sensitive to many factors, which are beyond the Bank’s control,
including, but not limited to, general economic conditions and the policies
of
various governmental and regulatory agencies, in particular, the FRB. The Bank
is generally adversely affected by declining interest rates. Changes in the
relationship between short-term and long-term market interest rates or between
different interest rate indices, can also impact our interest rate differential,
possibly resulting in a decrease in our interest income relative to interest
expense. In addition, changes in monetary policy, including changes in interest
rates, influence the origination of loans, the purchase of investments and
the
generation of deposits and affect the rates received on loans and investment
securities and paid on deposits, which could have a material adverse effect
on
the Company’s business, financial condition and results of operations. See
“Quantitative and Qualitative Disclosures About Market Risk” below.
Potential
Volatility of Deposits May Increase Our Cost of Funds
At
December 31, 2006, 11% of the dollar value of the Company’s total deposits was
represented by time certificates of deposit in excess of $100,000. These
deposits are considered volatile and could be subject to withdrawal. Withdrawal
of a material amount of such deposits would adversely impact the Company’s
liquidity, profitability, business prospects, results of operations and cash
flows.
Our
Ability to Pay Dividends is Subject to Legal Restrictions
As
a bank
holding company, our cash flow typically comes from dividends of the Bank.
Various statutory and regulatory provisions restrict the amount of dividends
the
Bank can pay. The ability of the Company to pay cash dividends in the future
also depends on the Company’s profitability, growth and capital needs. In
addition, California law restricts the ability of the Company to pay dividends.
No assurance can be given that the Company will pay any dividends in the future
or, if paid, such dividends will not be discontinued. See“Business
- Restrictions on Dividends and Other Distributions” above.
Competition
Adversely Affects our Profitability
In
California generally, and in the Bank’s primary market area specifically, major
banks dominate the commercial banking industry. By virtue of their larger
capital bases, such institutions have substantially greater lending limits
than
those of the Bank. In obtaining deposits and making loans, the Bank competes
with these larger commercial banks and other financial institutions, such as
savings and loan associations, credit unions and member institutions of the
Farm
Credit System, which offer many services that traditionally were offered only
by
banks. Using the financial holding company structure, insurance companies and
securities firms may compete more directly with banks and bank holding
companies. In addition, the Bank competes with other institutions such as mutual
fund companies, brokerage firms, and even retail stores seeking to penetrate
the
financial services market. Also, technology and other changes increasingly
allow
parties to complete financial transactions electronically, and in many cases,
without banks. For example, consumers can pay bills and transfer funds over
the
internet and by telephone without banks. Non-bank financial service providers
may have lower overhead costs and are subject to fewer regulatory constraints.
If consumers do not use banks to complete their financial transactions, we
could
potentially lose fee income, deposits and income generated from those deposits.
During periods of declining interest rates, competitors with lower costs of
capital may solicit the Bank’s customers to refinance their loans. Furthermore,
during periods of economic slowdown or recession, the Bank’s borrowers may face
financial difficulties and be more receptive to offers from the Bank’s
competitors to refinance their loans. No assurance can be given that the Bank
will be able to compete with these lenders. See “Business - Competition”
above.
Government
Regulation and Legislation
The
Company and the Bank are subject to extensive state and federal regulation,
supervision and legislation, which govern almost all aspects of the operations
of the Company and the Bank. The business of the Bank is particularly
susceptible to being affected by the enactment of federal and state legislation,
which may have the effect of increasing the cost of doing business, modifying
permissible activities or enhancing the competitive position of other financial
institutions. Such laws are subject to change from time to time and are
primarily intended for the protection of consumers, depositors and the deposit
insurance funds and not for the protection of shareholders of the Company.
The
Company cannot predict what effect any presently contemplated or future changes
in the laws or regulations or their interpretations would have on the business
and prospects of the Company, but it could be material and adverse. See“Bank
Regulation and Supervision” above.
Our
Controls and Procedures May Fail or be Circumvented
The
Company maintains controls and procedures to mitigate against risks such as
processing system failures and errors, and customer or employee fraud, and
maintains insurance coverage for certain of these risks. Any system of controls
and procedures, however well designed and operated, is based in part on certain
assumptions and can provide only reasonable, not absolute, assurances that
the
objectives of the system are met. Events could occur which are not prevented
or
detected by the Company’s internal controls or are not insured against or are in
excess of the Company’s insurance limits. Any failure or circumvention of the
Company’s controls and procedures or failure to comply with regulations related
to controls and procedures could have a material adverse effect on the Company’s
business, results of operations and financial condition.
Recent
Changes in Deposit Insurance Premiums Could Adversely Affect Our
Business
In
2006,
the FDIC created a new assessment system designed to more closely tie what
banks
pay for deposit insurance to the risks they pose and adopted a new base schedule
of rates that the FDIC can adjust up or down, depending on the revenue needs
of
the insurance fund. This new assessment system is expected to result in
increased annual assessments on deposits of the Bank. Although an FDIC credit
for prior contributions is expected to fully offset the assessment for 2007,
increases in the insurance assessments will increase our costs once the credit
is exceeded.
Negative
Public Opinion could Damage Our Reputation and Adversely Affect Our
Earnings
Reputational
risk, or the risk to our earnings and capital from negative public opinion,
is
inherent in our business. Negative public opinion can result from the actual
or
perceived manner in which we conduct our business activities, management of
actual or potential conflicts of interest and ethical issues and our protection
of confidential client information. Negative public opinion can adversely affect
our ability to keep and attract customers and can expose us to litigation and
regulatory action. We take steps to minimize reputation risk in the way we
conduct our business activities and deal with our clients and
communities.
Reliance
on Key Employees and Others
The
Company’s future success depends to a significant extent on the efforts and
abilities of its executive officers. The loss of the services of certain of
these individuals, or the failure of the Company to attract and retain other
qualified personnel, could have a material adverse effect on the Company’s
business, financial condition and results of operations.
War
on Terrorism; Foreign Hostilities
Acts
or
threats of terrorism and actions taken by the U.S. or other governments as
a
result of such acts or threats and other international hostilities may result
in
a downturn in U.S. economic conditions and could adversely affect business
and
economic conditions in the U.S. generally and in our principal markets. The
war
in Iraq has also generated various political and economic uncertainties
affecting the global and U.S. economies.
Critical
Accounting Policies
The
Company’s financial statements are presented in accordance with accounting
principles generally accepted in the United States of America (“US GAAP”). The
financial information contained within our financial statements is, to a
significant extent, financial information that is based on approximate measures
of the financial effects of transactions and events that have already occurred.
A variety of factors could affect the ultimate value that is obtained either
when earning income, recognizing an expense, recovering an asset or relieving
a
liability. Along with other factors, we use historical loss factors to determine
the inherent loss that may be present in our loan portfolio. Actual losses
could
differ significantly from the historical loss factors that we use. Other
estimates that we use are fair value of our securities and expected useful
lives
of our depreciable assets. We have not entered into derivative contracts for
our
customers or for ourselves, which relate to interest rate, credit, equity,
commodity, energy, or weather-related indices. US GAAP itself may change from
one previously acceptable method to another method. Although the economics
of
our transactions would be the same, the timing of events that would impact
our
transactions could change. Accounting standards and interpretations currently
affecting the Company and its subsidiaries may change at any time, and the
Company’s financial condition and results of operations may be adversely
affected.
Adequacy
of Allowance for Loan and Other Real Estate Losses
The
Bank’s allowance for estimated losses on loans was approximately $8.4 million,
or 1.73% of total loans at December 31, 2006 compared to $7.9 million or 1.70%
of total loans at December 31, 2005 and 243% of total non-performing loans
at
December 31, 2006 compared to 352% at December 31, 2005. Material future
additions to the allowance for estimated losses on loans may be necessary if
material adverse changes in economic conditions occur and the performance of
the
Bank’s loan portfolio deteriorates. In addition an allowance for losses on other
real estate owned may also be required in order to reflect changes in the
markets for real estate in which the Bank’s other real estate owned is located
and other factors which may result in adjustments which are necessary to ensure
that the Bank’s foreclosed assets are carried at the lower of cost or fair
value, less estimated costs to dispose of the properties. Moreover, the FDIC
and
the DFI, as an integral part of their examination process, periodically review
the Bank’s allowance for estimated losses on loans and the carrying value of its
assets. Increases in the provisions for estimated losses on loans and foreclosed
assets would adversely affect the Bank’s financial condition and results of
operations. See“Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Summary of Loan Loss Experience” below.
Shares
Eligible for Future Sale
As
of
December 31, 2006, the Company had 7,980,952 shares of Common Stock outstanding,
all of which are eligible for sale in the public market without restriction.
Future sales of substantial amounts of the Company’s Common Stock, or the
perception that such sales could occur, could have a material adverse effect
on
the market price of the Common Stock. In addition, options to acquire up to
6%
of the unissued authorized shares of Common Stock at exercise prices ranging
from $4.27 to $27.75 have been issued to directors and employees of the Company,
over the past seven (7) years, under the Company’s 2000 Stock Option Plan and
Outside Directors 2000 Non-statutory Stock Option Plan, and options to acquire
up to an additional 10% of the unissued authorized shares of Common Stock are
reserved for issuance under such plans. No prediction can be made as to the
effect, if any, that future sales of shares, or the availability of shares
for
future sale, will have on the market price of the Company’s Common Stock.
See“Market
for the Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities” below.
Limited
Public Market; Volatility in Stock Price
The
Company’s common stock is not listed on any exchange, nor is it included on
NASDAQ. However, trades may be reported on the OTC Bulletin Board under the
symbol “FNRN”. The Company is aware that Howe Barnes Hoefer & Arnett, Stone
& Youngberg, Wedbush Morgan Securities and Monroe Securities, Inc., all
currently make a market in the Company’s common stock. Management is aware that
there are also private transactions in the Company’s common stock. However, the
limited trading market for the Company’s common stock may make it difficult for
shareholders to dispose of their shares. Also, the price of the Company’s common
stock may be affected by general market price movements as well as developments
specifically related to the financial services sector, including interest rate
movements, quarterly variations, or changes in financial estimates by securities
analysts and a significant reduction in the price of the stock of another
participant in the financial services industry, as well as the level of
repurchases of Company stock by the Company pursuant to its stock repurchase
program.
Technology
and Computer Systems
Advances
and changes in technology can significantly impact the business and operations
of the Company. The Company faces many challenges including the increased demand
for providing computer access to Company accounts and the systems to perform
banking transactions electronically. The Company’s merchant processing services
require the use of advanced computer hardware and software technology and
rapidly changing customer and regulatory requirements. The Company’s ability to
compete depends on its ability to continue to adapt its technology on a timely
and cost-effective basis to meet these requirements. In addition, the Company’s
business and operations are susceptible to negative impacts from computer system
failures, communication and energy disruption and unethical individuals with
the
technological ability to cause disruptions or failures of the Company’s data
processing systems.
Environmental
Risks
The
Company, in its ordinary course of business, acquires real property securing
loans that are in default, and there is a risk that hazardous substances or
waste, contaminants or pollutants could exist on such properties. The Company
may be required to remove or remediate such substances from the affected
properties at its expense, and the cost of such removal or remediation may
substantially exceed the value of the affected properties or the loans secured
by such properties. Furthermore, the Company may not have adequate remedies
against the prior owners or other responsible parties to recover its costs.
Finally, the Company may find it difficult or impossible to sell the affected
properties either prior to or following any such removal. In addition, the
Company may be considered liable for environmental liabilities in connection
with its borrowers' properties, if, among other things, it participates in
the
management of its borrowers' operations. The occurrence of such an event could
have a material adverse effect on the Company’s business, financial condition,
results of operations and cash flows.
Dilution
As
of
December 31, 2006, the Company had outstanding options to purchase an aggregate
of 517,953 shares of Common Stock at exercise prices ranging from $4.27 to
$27.75 per share, or a weighted average exercise price per share of $10.94.
To
the extent such options are exercised, shareholders of the Company will
experience dilution. See“Market
for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities” below.
ITEM
1B - UNRESOLVED STAFF COMMENTS
None.
ITEM
2 - PROPERTIES
The
Company and the Bank are engaged in the banking business through 19 offices
in
five counties in Northern California including six offices in Solano County,
eight in Yolo County, three in Sacramento County and two in Placer County.
In
addition, the Company owns two vacant lots, one in northern Solano County and
the other in eastern Sacramento County for possible future bank sites. The
Company and the Bank believe all of their offices are constructed and equipped
to meet prescribed security requirements.
The
Bank
owns three branch office locations and two administrative facilities and leases
13 facilities. Most of the leases contain multiple renewal options and
provisions for rental increases, principally for changes in the cost of living
index, property taxes and maintenance.
ITEM
3 - LEGAL PROCEEDINGS
Neither
the Company nor the Bank is a party to any material pending legal proceeding,
nor is any of their property the subject of any material pending legal
proceeding, except ordinary routine litigation arising in the ordinary course
of
the Bank's business and incidental to its business, none of which is expected
to
have a material adverse impact upon the Company's or the Bank's business,
financial position or results of operations.
ITEM
4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
No
matters were submitted to a vote of the Company’s shareholders during the fourth
quarter of the fiscal year covered by this report.
PART
II
ITEM
5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The
Company’s common stock is not listed on any exchange, nor is it included on
NASDAQ. However, trades may be reported on the OTC Bulletin Board under the
symbol “FNRN”. The Company is aware that Howe Barnes Hoefer & Arnett, Stone
& Youngberg, Wedbush Morgan Securities and Monroe Securities, Inc., all
currently make a market in the Company’s common stock. Management is aware that
there are also private transactions in the Company’s common stock and the data
set forth below may not reflect all such transactions.
The
following table summarizes the range of reported high and low bid quotations
of
the Company’s Common Stock for each quarter during the last two fiscal years and
is based on information provided by Stone & Youngberg. The quotations
reflect the price that would be received by the seller without retail mark-up,
mark-down or commissions and may not have represented actual
transactions:
|
QUARTER/YEAR
|
HIGH*
|
LOW*
|
||
|
4th
Quarter 2006
|
$25.53
|
$21.46
|
||
|
3rd
Quarter 2006
|
$25.46
|
$23.58
|
||
|
2nd
Quarter 2006
|
$27.36
|
$24.62
|
||
|
1st
Quarter 2006
|
$27.12
|
$22.47
|
||
|
4th
Quarter 2005
|
$22.34
|
$20.47
|
||
|
3rd
Quarter 2005
|
$22.25
|
$20.25
|
||
|
2nd
Quarter 2005
|
$23.04
|
$14.24
|
||
|
1st
Quarter 2005
|
$14.68
|
$11.75
|
|
*
|
Price
adjusted for dividends and splits.
|
As
of
December 31, 2006, there were approximately 1,148 holders of record of the
Company’s common stock, no par value, which is the only class of equity
securities authorized or issued.
In
the
last two fiscal years the Company has declared the following stock
dividends:
|
Shareholder
Record
Date
|
Dividend
Percentage
|
Date
Payable
|
||
|
February
28, 2007
|
6%
|
March
30, 2007
|
||
|
February
28, 2006
|
6%
|
March
31, 2006
|
||
|
February
28, 2005
|
6%
|
March
31, 2005
|
In
addition to the above, on April 21, 2005, the Board of Directors of the Company
declared a two-for-one stock split. The stock split doubled the outstanding
common stock recorded on the books of the Company as of the record date, May
10,
2005.
The
Company does not expect to pay a cash dividend in the foreseeable
future.
Purchases
of Equity Securities by the Issuer or Affiliated
Purchasers
On
April
20, 2006, the Company approved a stock repurchase program effective April 30,
2006 to replace the Company’s previous stock purchase plan that expired on April
30, 2006. The new stock repurchase program, which will remain in effect until
April 30, 2008, allows repurchases by the Company in an aggregate of up to
2.5%
of the Company’s outstanding shares of common stock over each rolling
twelve-month period. The Company repurchased 30,078 shares of the Company’s
outstanding common stock during the fourth quarter of 2006. The following table
details stock repurchase activity during this period:
|
|
(a)
|
(b)
|
(c)
|
(d)
|
|
Period
|
Total
number of shares purchased
|
Average
price paid per share
|
Total
Number of shares purchased as part of publicly announced plans
or
programs
|
Maximum
number of shares that may yet be purchased under the plans or
programs
|
|
October
1 - October 31, 2006
|
16,599
|
$25.24
|
16,599
|
138,380
|
|
November
1 - November 30, 2006
|
11,360
|
$24.86
|
11,360
|
127,020
|
|
December
1 - December 31, 2006
|
2,119
|
$23.16
|
2,119
|
124,901
|
|
Total
|
30,078
|
$24.95
|
30,078
|
124,901
|
The
selected consolidated financial data below have been derived from the Company’s
audited consolidated financial statements. The selected consolidated financial
data set forth below as of December 31, 2003, and 2002 have been derived from
the Company’s historical financial statements not included in this Report. The
financial information for 2006, 2005 and 2004 should be read in conjunction
with
“Management's Discussion and Analysis of Financial Condition and Results of
Operations,” which is in Part II (Item 7) of this Report and with the Company’s
audited consolidated financial statements and the notes thereto, which are
included in Part II (Item 8) of this Report.
Consolidated
Financial Data as of and for the years ended December
31,
(in
thousands, except share and per share amounts)
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Interest
Income and Loan Fees
|
$
|
48,070
|
$
|
40,902
|
$
|
31,619
|
$
|
30,326
|
$
|
28,941
|
||||||
|
Interest
Expense
|
(9,426
|
)
|
(5,729
|
)
|
(3,426
|
)
|
(3,109
|
)
|
(4,237
|
)
|
||||||
|
Net
Interest Income
|
38,644
|
35,173
|
28,193
|
27,217
|
24,704
|
|||||||||||
|
Provision
for Loan Losses
|
(735
|
)
|
(600
|
)
|
(207
|
)
|
(2,153
|
)
|
(676
|
)
|
||||||
|
Net
Interest Income after Provision for Loan Losses
|
37,909
|
34,573
|
27,986
|
25,064
|
24,028
|
|||||||||||
|
Other
Operating Income
|
5,289
|
5,720
|
5,214
|
7,160
|
4,972
|
|||||||||||
|
Other
Operating Expense
|
(29,219
|
)
|
(26,813
|
)
|
(22,943
|
)
|
(22,868
|
)
|
(20,411
|
)
|
||||||
|
Income
before Taxes
|
13,979
|
13,480
|
10,257
|
9,356
|
8,589
|
|||||||||||
|
Provision
for Taxes
|
(5,169
|
)
|
(4,792
|
)
|
(3,550
|
)
|
(3,245
|
)
|
(2,871
|
)
|
||||||
|
Net
Income
|
$
|
8,810
|
$
|
8,688
|
$
|
6,707
|
$
|
6,111
|
$
|
5,718
|
||||||
|
Basic
Income Per Share
|
$
|
1.04
|
$
|
1.02
|
$
|
.78
|
$
|
.71
|
$
|
.65
|
||||||
|
Diluted
Income Per Share
|
$
|
0.99
|
$
|
0.98
|
$
|
.76
|
$
|
.69
|
$
|
.64
|
||||||
|
Total
Assets
|
$
|
685,225
|
$
|
660,647
|
$
|
629,503
|
$
|
559,441
|
$
|
495,876
|
||||||
|
Total
Investments
|
$
|
76,273
|
$
|
48,788
|
$
|
55,154
|
$
|
50,235
|
$
|
69,958
|
||||||
|
Total
Loans, including loans held-for-sale, net
|
$
|
480,009
|
$
|
460,501
|
$
|
433,421
|
$
|
380,491
|
$
|
356,018
|
||||||
|
Total
Deposits
|
$
|
603,682
|
$
|
581,781
|
$
|
557,186
|
$
|
498,849
|
$
|
442,241
|
||||||
|
Total
Equity
|
$
|
61,990
|
$
|
56,802
|
$
|
51,901
|
$
|
46,972
|
$
|
43,442
|
||||||
|
Weighted
Average Shares of Common Stock outstanding used for Basic Income
Per Share
Computation 1
|
8,468,643
|
8,531,880
|
8,585,409
|
8,608,209
|
8,749,315
|
|||||||||||
|
Weighted
Average Shares of Common Stock outstanding used for Diluted Income
Per
Share Computation 1
|
8,882,925
|
8,881,596
|
8,809,916
|
8,799,158
|
8,999,552
|
|||||||||||
|
Return
on Average Total Assets
|
1.32
|
%
|
1.35
|
%
|
1.14
|
%
|
1.18
|
%
|
1.25
|
%
|
||||||
|
Net
Income/Average Equity
|
14.90
|
%
|
16.17
|
%
|
13.73
|
%
|
13.56
|
%
|
13.71
|
%
|
||||||
|
Net
Income/Average Deposits
|
1.49
|
%
|
1.52
|
%
|
1.28
|
%
|
1.32
|
%
|
1.40
|
%
|
||||||
|
Average
Loans/Average Deposits
|
81.20
|
%
|
79.44
|
%
|
75.81
|
%
|
79.25
|
%
|
73.99
|
%
|
||||||
|
Average
Equity to Average Total Assets
|
8.87
|
%
|
8.37
|
%
|
8.32
|
%
|
8.69
|
%
|
9.11
|
%
|
||||||
1.
All
years
have been restated to give retroactive effect for stock dividends issued and
stock splits.
ITEM
7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
This
report includes forward-looking statements, which include forecasts of our
financial results and condition, expectations for our operations and business,
and our assumptions for those forecasts and expectations. Do not rely unduly
on
forward-looking statements. Actual results might differ significantly from
our
forecasts and expectations. Please refer to Part I, Item 1A “Risk Factors” for a
discussion of some factors that may cause results to differ.
Introduction
This
overview of Management’s Discussion and Analysis highlights selected information
in this annual report and may not contain all of the information that is
important to you. For a more complete understanding of trends, events,
commitments, uncertainties, liquidity, capital resources and critical accounting
estimates, you should carefully read this entire annual report.
Our
subsidiary, First Northern Bank of Dixon, is a California state-chartered bank
that derives most of its revenues from lending and deposit taking in the
Sacramento Valley region of Northern California. Interest rates, business
conditions and customer confidence all affect our ability to generate revenues.
In addition, the regulatory environment and competition can challenge our
ability to generate those revenues.
The
Company experienced strong earnings performance in 2006 due to a combination
of
(1) growth in earning assets, (2) improvement in the mix of earning assets
as
reflected by an increase in loans as a percentage of average earning assets,
and
(3) the increase in low cost deposits which helped to support the increase
in
loans. Financial highlights for 2006 include:
|
·
|
Net
income for 2006 totaled $8.8 million, a 1.2% increase compared to
$8.7
million for 2005. Net income per common share for 2006 of $1.04 increased
2.0% compared to $1.02 for 2005, and net income per common share
on a
fully diluted basis was $0.99 for 2006, an increase of 1.0% compared
to
$0.98 for 2005.
|
|
·
|
Loans
(including loans held-for-sale) increased to $480.0 million at
December 31, 2006, a 4.2% increase from $460.5 million at
December 31, 2005. Commercial loans totaled $97.3 million at
December 31, 2006, up 11.7% from $87.1 million a year earlier;
agriculture loans were $38.6 million, up 17.7% from $32.8 million
at
December 31, 2005; real estate construction loans were $106.8 million,
up
3.3% from $103.4 million at December 31, 2005; and real estate
mortgage loans were $232.0 million, down 0.4% from $233.0 million
a year
earlier.
|
|
·
|
Average
deposits grew to $589.8 million during 2006, a $20.0 million or 3.5%
increase from 2005.
|
|
·
|
The
Company reported average total assets of $666.4 million at
December 31, 2006, up 3.7% from $642.5 million a year
earlier.
|
|
·
|
The
provision for loan losses in 2006 totaled $735,000, an increase of
22.5%
from $600,000 in 2005. Net charge-offs were $291,000 in 2006 compared
to
$128,000 in net charge-offs in 2005. The increase in the provision
for
loan losses and increase in net charge-offs can be primarily attributed
to
increased loan volume combined with charge-offs.
|
|
·
|
Net
interest income totaled $38.6 million for 2006, an increase of 9.7%
from
$35.2 million in 2005, primarily due to strong loan volumes and increased
rates.
|
|
·
|
Other
operating income totaled $5.3 million for the year ended December 31,
2006, a decrease of 7.0% from $5.7 million for the year ended
December 31, 2005. The decrease was due primarily to decreases in
gains on sales of loans and gains on other real estate
owned.
|
|
·
|
Other
operating expenses totaled $29.2 million for 2006, up 9.0% from $26.8
million in 2005. Contributing to the increase were increased salaries
and
employee benefits, increased rents and other expenses associated
with
opening new branches and offices, and advertising
expenses.
|
In
2007,
the Company intends to continue its long-term strategy of maintaining deposit
growth to fund growth in loans and other earning assets and intends to identify
opportunities for growing other operating income in areas such as Asset
Management and Trust and Investment and Brokerage Services, and deposit fee
income while remaining conscious of the need to maintain appropriate expense
levels. We expect gradual growth in commercial and real estate loan volumes
and
deposit growth, assuming that inflation remains in check throughout the year.
If
the current flat or inverted interest rate environment continues, the Company’s
net interest income and net interest margin may decrease due to an increase
in
the cost of deposits, unless accompanied by a disproportionate increase in
loan
volume.
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’s most significant estimates are approved by its senior management team.
At the end of each financial reporting period, a review of these estimates
is
presented to the Company’s Board of Directors.
The
Company believes the following critical accounting policy affects its more
significant judgments and estimates used in the preparation of its consolidated
financial statements. The Company believes the allowance for loan losses
accounting policy is critical because the loan portfolio represents the largest
asset type on the consolidated balance sheet. The Company maintains an allowance
for loan losses resulting from the inability of borrowers to make required
loan
payments. Loan losses are charged off against the allowance, while recoveries
of
amounts previously charged off are credited to the allowance. A provision for
loan losses is charged to operations based on the Company’s periodic evaluation
of the factors mentioned below, as well as other pertinent factors. The
allowance for loan losses consists of an allocated component and an unallocated
component. The components of the allowance for loan losses represent an
estimation done pursuant to either Statement of Financial Accounting Standards
No. (“SFAS”) 5, Accounting for Contingencies, or SFAS 114, Accounting by
Creditors for Impairment of a Loan. The allocated component of the allowance
for
loan losses reflects expected losses resulting from analyses developed through
specific credit allocations for individual loans and historical loss experience
for each loan category. The specific credit allocations are based on regular
analyses of all loans where the internal credit rating is at or below a
predetermined classification. These analyses involve a high degree of judgment
in estimating the amount of loss associated with specific loans, including
estimating the amount and timing of future cash flows and collateral values.
The
historical loan loss element is determined using analysis that examines loss
experience.
The
allocated component of the allowance for loan losses also includes consideration
of concentrations and changes in portfolio mix and volume. The unallocated
portion of the allowance reflects the Company’s estimate of probable inherent
but undetected losses within the portfolio due to uncertainties in economic
conditions, delays in obtaining information, including unfavorable information
about a borrower’s financial condition, the difficulty in identifying triggering
events that correlate perfectly to subsequent loss rates, and risk factors
that
have not yet manifested themselves in loss allocation factors. Uncertainty
surrounding the strength and timing of economic cycles also affects estimates
of
loss. There are many factors affecting the allowance for loan losses; some
are
quantitative while others require qualitative judgment. Although the Company
believes its process for determining the allowance adequately considers all
of
the potential factors that could potentially result in credit losses, the
process includes subjective elements and may be susceptible to significant
change. To the extent actual outcomes differ from Company estimates, additional
provision for credit losses could be required that could adversely affect
earnings or financial position in future periods.
Prospective
Accounting Pronouncements
In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments,” which amends the guidance in SFAS No. 133, “Accounting
for Derivative Instruments and Hedging Activities,” and SFAS No. 140,
“Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities.” SFAS No. 155 provides entities with relief from having to
separately determine the fair value of an embedded derivative that would
otherwise be required to be bifurcated from its host contract in accordance
with
SFAS No. 133. SFAS No. 155 allows an entity to make an irrevocable election
to
measure such a hybrid financial instrument at fair value in its entirety, with
changes in fair value recognized in earnings. SFAS No. 155 will be effective
for
the Company for financial instruments acquired, issued or subject to a
re-measurement event in the fiscal year beginning January 1, 2007. The Company
does not expect the adoption of SFAS No. 155 will have a material impact on
its
financial condition, results of operations or cash flows.
In
March
2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets,” which amends the guidance in SFAS No. 140. SFAS No. 156 requires that
an entity separately recognize a servicing asset or a servicing liability when
it undertakes an obligation to service a financial asset under a servicing
contract in certain situations. Such servicing assets or servicing liabilities
are required to be measured initially at fair value, if practicable. SFAS No.
156 also allows an entity to measure its servicing assets and servicing
liabilities subsequently using either the amortization method, which existed
under SFAS No. 140, or the fair value measurement method. SFAS No. 156 will
be
effective for the Company in the fiscal year beginning January 1, 2007. The
Company does not expect the adoption of SFAS No. 156 will have a material impact
on its financial condition, results of operations or cash flows.
In
July 2006,
the
FASB issued Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income
Taxes - An Interpretation of FASB Statement No. 109” and FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with FASB Statement No. 109, “Accounting for
Income Taxes”. FIN 48 establishes a “more-likely-than-not” recognition
threshold that must be met before a tax benefit can be recognized in the
financial statements. For tax positions that meet the
"more-likely-than-not" threshold, an enterprise should recognize the largest
amount of tax benefit that is greater than 50 percent likely of being realized
upon ultimate settlement with the taxing authority. The Interpretation was
effective January 1, 2007. The cumulative effect of applying the
provisions of the Interpretation would be recognized as an adjustment to the
beginning balance of retained earnings. Management is currently evaluating
the
impact of this Interpretation on the Company’s financial position and results of
operations.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS
No. 157 defines fair value, establishes a framework for measuring fair value
and
expands disclosures about fair value measurements. SFAS No. 157 establishes
a
fair value hierarchy about the assumptions used to measure fair value and
clarifies assumptions about risk and the effect of a restriction on the sale
or
use of an asset. The standard is effective for fiscal years beginning after
November 15, 2007. The Company has not completed its evaluation of the impact
of
the adoption of this standard.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities.” Under this standard, the Company
may elect to report financial instruments and certain other items at fair value
on a contract-by-contract basis with changes in value reported in earnings.
This
election is irrevocable. SFAS No. 159 provides an opportunity to mitigate
volatility in reported earnings that is caused by measuring hedged assets and
liabilities that were previously required to use a different accounting method
than the related hedging contracts when the complex provisions of SFAS No.
133
hedge accounting are not met.
SFAS
No.
159 is effective for years beginning after November 15, 2007. Early adoption
within 120 days of the beginning of the Company’s 2007 fiscal year is
permissible, provided the Company has not yet issued interim financial
statements for 2007 and has adopted SFAS No. 157. The Company has not completed
its evaluation of the impact of the adoption of this standard.
In
September 2006, the Emerging Issues Task Force issued EITF 06-4, “Accounting for
Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements.” This consensus concludes that for a
split-dollar life insurance arrangement within the scope of this Issue, an
employer should recognize a liability for future benefits in accordance with
FASB Statement No. 106 (if, in substance, a postretirement benefit plan exits)
or APB Opinion No. 12 (if the arrangement is, in substance, an individual
deferred compensation contract) based on the substantive agreement with the
employee. The consensus is effective for fiscal years beginning after December
15, 2007. The Company has not completed its evaluation of the impact of the
adoption of this standard.
In
September 2006, The Emerging Issues Task Force issued EITF 06-5, “Accounting for
Purchases of Life Insurance- Determining the Amount That Could Be Realized
in
Accordance with FASB
Technical Bulletin No. 85-4.”
This
consensus concludes that a policyholder should consider any additional amounts
included in the contractual terms of the insurance policy other than the cash
surrender value in determining the amount that could be realized under the
insurance contract. A consensus also was reached that a policyholder should
determine the amount that could be realized under the life insurance contract
assuming the surrender of an individual-life by individual-life policy (or
certificate by certificate in a group policy). The consensuses are effective
for
fiscal years beginning after December 15, 2006. The Company has not completed
its evaluation of the impact of the adoption of this standard.
STATISTICAL
INFORMATION AND DISCUSSION
The
following statistical information and discussion should be read in conjunction
with the Selected Financial Data included in Part II (Item 6) and the audited
consolidated financial statements and accompanying notes included in Part II
(Item 8) of this Annual Report on Form 10-K.
The
following tables present information regarding the consolidated average assets,
liabilities and stockholders’ equity, the amounts of interest income from
average earning assets and the resulting yields, and the amount of interest
expense paid on interest-bearing liabilities. Average loan balances include
non-performing loans. Interest income includes proceeds from loans on
non-accrual status only to the extent cash payments have been received and
applied as interest income. Tax-exempt income is not shown on a tax equivalent
basis.
Distribution
of Assets, Liabilities and Stockholders' Equity;
Interest
Rates and Interest Differential
|
2006
|
2005
|
2004
|
|||||||||||||||||
|
Average
Balance
|
Percent
|
Average
Balance
|
Percent
|
Average
Balance
|
Percent
|
||||||||||||||
|
ASSETS
|
|||||||||||||||||||
|
Cash
and Due From Banks
|
$
|
29,934
|
4.49
|
%
|
$
|
31,287
|
4.87
|
%
|
$
|
37,542
|
6.40
|
%
|
|||||||
|
Investment
Securities:
|
|||||||||||||||||||
|
U.S.
Government Securities
|
31,968
|
4.80
|
%
|
20,279
|
3.16
|
%
|
15,745
|
2.68
|
%
|
||||||||||
|
Obligations
of States & Political
|
|||||||||||||||||||
|
Subdivisions
|
23,688
|
3.56
|
%
|
27,045
|
4.21
|
%
|
32,899
|
5.60
|
%
|
||||||||||
|
Other
Securities
|
11,201
|
1.68
|
%
|
3,065
|
0.48
|
%
|
3,277
|
0.56
|
%
|
||||||||||
|
Federal
Funds Sold
|
61,904
|
9.29
|
%
|
81,948
|
12.75
|
%
|
77,169
|
13.15
|
%
|
||||||||||
|
Loans
1
|
478,908
|
71.87
|
%
|
452,646
|
70.45
|
%
|
395,883
|
67.43
|
%
|
||||||||||
|
Other
Assets
|
28,750
|
4.31
|
%
|
26,211
|
4.08
|
%
|
24,551
|
4.18
|
%
|
||||||||||
|
Total
Assets
|
$
|
666,353
|
100.00
|
%
|
$
|
642,481
|
100.00
|
%
|
$
|
587,066
|
100.00
|
%
|
|||||||
|
LIABILITIES
& STOCKHOLDERS' EQUITY
|
|||||||||||||||||||
|
Deposits:
|
|||||||||||||||||||
|
Demand
|
$
|
187,766
|
28.18
|
%
|
$
|
184,171
|
28.67
|
%
|
$
|
158,676
|
27.03
|
%
|
|||||||
|
Interest-Bearing
Transaction Deposits
|
95,180
|
14.28
|
%
|
73,990
|
11.52
|
%
|
63,619
|
10.84
|
%
|
||||||||||
|
Savings
& MMDAs
|
190,036
|
28.52
|
%
|
190,562
|
29.65
|
%
|
174,539
|
29.73
|
%
|
||||||||||
|
Time
Certificates
|
116,787
|
17.53
|
%
|
121,067
|
18.84
|
%
|
125,366
|
21.35
|
%
|
||||||||||
|
Borrowed
Funds
|
11,350
|
1.70
|
%
|
14,320
|
2.23
|
%
|
13,681
|
2.33
|
%
|
||||||||||
|
Other
Liabilities
|
6,113
|
0.92
|
%
|
4,627
|
0.72
|
%
|
2,332
|
0.40
|
%
|
||||||||||
|
Stockholders'
Equity
|
59,121
|
8.87
|
%
|
53,744
|
8.37
|
%
|
48,853
|
8.32
|
%
|
||||||||||
|
Total
Liabilities & Stockholders’ Equity
|
$
|
666,353
|
100.00
|
%
|
$
|
642,481
|
100.00
|
%
|
$
|
587,066
|
100.00
|
%
|
|||||||
|
1.
|
Average
Balances for Loans include non-accrual loans and are net of the allowance
for loan losses.
|
Net
Interest Earnings
Average
Balances, Yields and Rates
(Dollars
in thousands)
|
2006
|
2005
|
2004
|
||||||||||||||||||||||||||
|
Assets
|
Average
Balance
|
Interest
Income/
Expense
|
Yields
Earned/
Rates
Paid
|
Average
Balance
|
Interest
Income/
Expense
|
Yields
Earned/
Rates
Paid
|
Average
Balance
|
Interest
Income/
Expense
|
Yields
Earned/
Rates
Paid
|
|||||||||||||||||||
|
Securities:
|
||||||||||||||||||||||||||||
|
U.S.
Government
|
$
|
31,968
|
$
|
1,299
|
4.06
|
%
|
$
|
20,279
|
$
|
767
|
3.78
|
%
|
$
|
15,745
|
$
|
747
|
4.74
|
%
|
||||||||||
|
Obligations
of States And Political Subdivisions 1
|
23,688
|
1,311
|
5.53
|
%
|
27,045
|
1,577
|
5.83
|
%
|
32,899
|
1,892
|
5.75
|
%
|
||||||||||||||||
|
Other
Securities
|
11,201
|
580
|
5.18
|
%
|
3,065
|
133
|
4.34
|
%
|
3,277
|
135
|
4.12
|
%
|
||||||||||||||||
|
Total
Investment Securities
|
66,857
|
3,190
|
4.77
|
%
|
50,389
|
2,477
|
4.92
|
%
|
51,921
|
2,774
|
5.34
|
%
|
||||||||||||||||
|
Federal
Funds Sold
|
61,904
|
2,986
|
4.82
|
%
|
81,948
|
2,587
|
3.16
|
%
|
77,169
|
972
|
1.26
|
%
|
||||||||||||||||
|
Loans
2
|
478,908
|
39,082
|
8.16
|
%
|
452,646
|
32,808
|
7.25
|
%
|
395,883
|
25,331
|
6.40
|
%
|
||||||||||||||||
|
Loan
Fees
|
—
|
2,812
|
0.59
|
%
|
—
|
3,030
|
0.67
|
%
|
—
|
2,542
|
0.64
|
%
|
||||||||||||||||
|
Total
Loans, Including Loan Fees
|
478,908
|
41,894
|
8.75
|
%
|
452,646
|
35,838
|
7.92
|
%
|
395,883
|
27,873
|
7.04
|
%
|
||||||||||||||||
|
Total
Earning Assets
|
607,669
|
$
|
48,070
|
7.91
|
%
|
584,983
|
$
|
40,902
|
6.99
|
%
|
524,973
|
$
|
31,619
|
6.02
|
%
|
|||||||||||||
|
Cash
and Due from Banks
|
29,934
|
31,287
|
37,542
|
|||||||||||||||||||||||||
|
Premises
and Equipment
|
8,188
|
7,743
|
7,531
|
|||||||||||||||||||||||||
|
Interest
Receivable and Other Assets
|
20,562
|
18,468
|
17,020
|
|||||||||||||||||||||||||
|
Total
Assets
|
$
|
666,353
|
$
|
642,481
|
$
|
587,066
|
||||||||||||||||||||||
|
1.
|
Interest
income and yields on tax-exempt securities are not presented on a
tax
equivalent basis.
|
|
2.
|
Average
Balances for Loans include non-accrual loans and are net of the allowance
for loan losses, but non-accrued interest thereon is
excluded.
|
Continuation
of
Net
Interest Earnings
Average
Balances, Yields and Rates
(Dollars
in thousands)
|
2006
|
2005
|
2004
|
||||||||||||||||||||||||||
|
Liabilities
and Stockholders' Equity
|
Average
Balance
|
Interest
Income/
Expense
|
Yields
Earned/
Rates
Paid
|
Average
Balance
|
Interest
Income/
Expense
|
Yields
Earned/
Rates
Paid
|
Average
Balance
|
Interest
Income/
Expense
|
Yields
Earned/
Rates
Paid
|
|||||||||||||||||||
|
Interest-Bearing
Deposits:
|
||||||||||||||||||||||||||||
|
Interest-Bearing
Transaction Deposits
|
$
|
95,180
|
$
|
1,568
|
1.65
|
%
|
$
|
73,990
|
$
|
512
|
0.69
|
%
|
$
|
63,619
|
$
|
89
|
0.14
|
%
|
||||||||||
|
Savings
& MMDAs
|
190,036
|
3,813
|
2.01
|
%
|
190,562
|
2,279
|
1.20
|
%
|
174,539
|
893
|
0.51
|
%
|
||||||||||||||||
|
Time
Certificates
|
116,787
|
3,682
|
3.15
|
%
|
121,067
|
2,443
|
2.02
|
%
|
125,366
|
2,003
|
1.60
|
%
|
||||||||||||||||
|
Total
Interest-Bearing Deposits
|
402,003
|
9,063
|
2.25
|
%
|
385,619
|
5,234
|
1.36
|
%
|
363,524
|
2,985
|
0.82
|
%
|
||||||||||||||||
|
Borrowed
Funds
|
11,350
|
363
|
3.20
|
%
|
14,320
|
495
|
3.46
|
%
|
13,681
|
441
|
3.22
|
%
|
||||||||||||||||
|
Total
Interest-Bearing Deposits and Funds
|
413,353
|
9,426
|
2.28
|
%
|
399,939
|
5,729
|
1.43
|
%
|
377,205
|
3,426
|
0.91
|
%
|
||||||||||||||||
|
Demand
Deposits
|
187,766
|
—
|
—
|
184,171
|
—
|
—
|
158,676
|
—
|
—
|
|||||||||||||||||||
|
Total
Deposits and Borrowed Funds
|
601,119
|
$
|
9,426
|
1.57
|
%
|
584,110
|
$
|
5,729
|
0.98
|
%
|
535,881
|
$
|
3,426
|
0.64
|
%
|
|||||||||||||
|
Accrued
Interest and Other Liabilities
|
6,113
|
4,627
|
2,332
|
|||||||||||||||||||||||||
|
Stockholders'
Equity
|
59,121
|
53,744
|
48,853
|
|||||||||||||||||||||||||
|
Total
Liabilities and Stockholders' Equity
|
$
|
666,353
|
$
|
642,481
|
$
|
587,066
|
||||||||||||||||||||||
|
Net
Interest Income and Net Interest Margin 1
|
$
|
38,644
|
6.36
|
%
|
$
|
35,173
|
6.01
|
%
|
$
|
28,193
|
5.37
|
%
|
||||||||||||||||
|
Net
Interest Spread 2
|
5.63
|
%
|
5.56
|
%
|
5.11
|
%
|
||||||||||||||||||||||
|
1.
|
Net
interest margin is computed by dividing net interest income by total
average interest-earning assets.
|
|
2.
|
Net
interest spread represents the average yield earned on interest-earning
assets less the average rate paid on interest-bearing
liabilities.
|
Analysis
of Changes
in
Interest Income and Interest Expense
(Dollars
in thousands)
Following
is an analysis of changes in interest income and expense (dollars in thousands)
for 2006 over 2005 and 2005 over 2004. Changes not solely due to interest rate
or volume have been allocated proportionately to interest rate and
volume.
|
2006
Over 2005
|
2005
Over 2004
|
||||||||||||||||||
|
Volume
|
Interest
Rate
|
Change
|
Volume
|
Interest
Rate
|
Change
|
||||||||||||||
|
Increase
(Decrease) in Interest Income:
|
|||||||||||||||||||
|
Loans
& Banker’s Acceptance
|
$
|
1,983
|
$
|
4,291
|
$
|
6,274
|
$
|
3,882
|
$
|
3,595
|
$
|
7,477
|
|||||||
|
Investment
Securities
|
787
|
(74
|
)
|
713
|
(81
|
)
|
(216
|
)
|
(297
|
)
|
|||||||||
|
Federal
Funds Sold
|
(347
|
)
|
746
|
399
|
63
|
1,552
|
1,615
|
||||||||||||
|
Loan
Fees
|
(218
|
)
|
—
|
(218
|
)
|
488
|
—
|
488
|
|||||||||||
|
$
|
2,205
|
$
|
4,963
|
$
|
7,168
|
$
|
4,352
|
$
|
4,931
|
$
|
9,283
|
||||||||
|
Increase
(Decrease) in Interest Expense:
|
|||||||||||||||||||
|
Deposits:
|
|||||||||||||||||||
|
Interest-Bearing
Transaction Deposits
|
$
|
180
|
$
|
876
|
$
|
1,056
|
$
|
17
|
$
|
406
|
$
|
423
|
|||||||
|
Savings
& MMDAs
|
(6
|
)
|
1,540
|
1,534
|
88
|
1,298
|
1,386
|
||||||||||||
|
Time
Certificates
|
(83
|
)
|
1,322
|
1,239
|
(66
|
)
|
506
|
440
|
|||||||||||
|
Borrowed
Funds
|
(97
|
)
|
(35
|
)
|
(132
|
)
|
21
|
33
|
54
|
||||||||||
|
$
|
(6
|
)
|
$
|
3,703
|
$
|
3,697
|
$
|
60
|
$
|
2,243
|
$
|
2,303
|
|||||||
|
Increase
(Decrease) in Net Interest Income
|
$
|
2,211
|
$
|
1,260
|
$
|
3,471
|
$
|
4,292
|
$
|
2,688
|
$
|
6,980
|
|||||||
INVESTMENT
PORTFOLIO
Composition
of Investment Securities
The
mix
of investment securities held by the Company at December 31, for the previous
three fiscal years is as follows (dollars
in thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Investment
securities available for sale:
|
||||||||||
|
U.S.
Treasury Securities
|
$
|
253
|
$
|
250
|
$
|
256
|
||||
|
Securities
of U.S. Government Agencies and Corporations
|
31,703
|
21,556
|
21,063
|
|||||||
|
Obligations
of State & Political Subdivisions
|
30,193
|
23,047
|
30,747
|
|||||||
|
Mortgage
Backed Securities
|
12,031
|
1,803
|
1,260
|
|||||||
|
Other
Securities
|
2,093
|
2,132
|
1,828
|
|||||||
|
Total
Investments
|
$
|
76,273
|
$
|
48,788
|
$
|
55,154
|
||||
Maturities
of Investment Securities
The
following table is a summary of the relative maturities (dollars
in
thousands)
and
yields of the Company’s investment securities as of December 31, 2006. The
yields on tax-exempt securities are shown on a tax equivalent
basis.
Period
to Maturity
|
Within
One Year
|
After
One But
Within
Five Years
|
After
Five But
Within
Ten Years
|
|||||||||||||||||
|
Security
|
Amount
|
Yield
|
Amount
|
Yield
|
Amount
|
Yield
|
|||||||||||||
|
U.S.
Treasury Securities
|
$
|
—
|
—
|
$
|
253
|
5.00
|
%
|
$
|
—
|
—
|
|||||||||
|
Securities
of U.S. Government Agencies and Corporations
|
6.907
|
3.16
|
%
|
20,708
|
4.38
|
%
|
4,088
|
5.26
|
%
|
||||||||||
|
Obligations
of State & Political Subdivisions
|
5,356
|
7.12
|
%
|
8,534
|
7.37
|
%
|
5,712
|
6.72
|
%
|
||||||||||
|
Mortgage
Backed Securities
|
35
|
7.10
|
%
|
11,996
|
5.14
|
%
|
—
|
—
|
|||||||||||
|
TOTAL
|
$
|
12,298
|
4.90
|
%
|
$
|
41,491
|
5.22
|
%
|
$
|
9,800
|
6.11
|
%
|
|||||||
|
After
Ten Years
|
Other
|
Total
|
|||||||||||||||||
|
Security
|
Amount
|
Yield
|
Amount
|
Yield
|
Amount
|
Yield
|
|||||||||||||
|
U.S.
Treasury Securities
|
$
|
—
|
—
|
$
|
—
|
—
|
$
|
253
|
5.00
|
%
|
|||||||||
|
Securities
of U.S. Government Agencies and Corporations
|
—
|
—
|
—
|
—
|
31,703
|
4.23
|
%
|
||||||||||||
|
Obligations
of State & Political Subdivisions
|
10,591
|
6.27
|
%
|
—
|
—
|
30,193
|
6.82
|
%
|
|||||||||||
|
Mortgage
Backed Securities
|
—
|
—
|
—
|
—
|
12,031
|
5.15
|
%
|
||||||||||||
|
Other
Securities
|
—
|
—
|
2,093
|
5.13
|
%
|
2,093
|
5.13
|
%
|
|||||||||||
|
TOTAL
|
$
|
10,591
|
6.27
|
%
|
$
|
2,093
|
5.13
|
%
|
$
|
76,273
|
5.43
|
%
|
|||||||
LOAN
PORTFOLIO
Composition
of Loans
The
mix
of loans, net of deferred origination fees and allowance for loan losses and
excluding loans held-for-sale, at December 31, for the previous five fiscal
years is as follows (dollars
in
thousands):
|
December
31,
|
|||||||||||||||||||
|
2006
|
2005
|
2004
|
|||||||||||||||||
|
Balance
|
Percent
|
Balance
|
Percent
|
Balance
|
Percent
|
||||||||||||||
|
Commercial
|
$
|
97,268
|
20.5
|
%
|
87,091
|
19.1
|
%
|
$
|
89,721
|
20.9
|
%
|
||||||||
|
Agriculture
|
38,607
|
8.1
|
%
|
32,808
|
7.2
|
%
|
32,910
|
7.7
|
%
|
||||||||||
|
Real
Estate Mortgage
|
227,552
|
47.9
|
%
|
228,524
|
50.1
|
%
|
216,846
|
50.4
|
%
|
||||||||||
|
Real
Estate Construction
|
106,752
|
22.4
|
%
|
103,422
|
22.7
|
%
|
85,584
|
19.9
|
%
|
||||||||||
|
Installment
|
5,370
|
1.1
|
%
|
4,216
|
0.9
|
%
|
4,641
|
1.1
|
%
|
||||||||||
|
TOTAL
|
$
|
475,549
|
100.0
|
%
|
$
|
456,061
|
100.0
|
%
|
$
|
429,702
|
100.0
|
%
|
|||||||
|
2003
|
2002
|
||||||||||||
|
Balance
|
Percent
|
Balance
|
Percent
|
||||||||||
|
Commercial
|
$
|
88,949
|
24.1
|
%
|
$
|
76,887
|
24.6
|
%
|
|||||
|
Agriculture
|
32,766
|
8.9
|
%
|
31,926
|
10.2
|
%
|
|||||||
|
Real
Estate Mortgage
|
174,867
|
47.2
|
%
|
144,171
|
46.0
|
%
|
|||||||
|
Real
Estate Construction
|
68,370
|
18.5
|
%
|
54,094
|
17.3
|
%
|
|||||||
|
Installment
|
4,867
|
1.3
|
%
|
5,967
|
1.9
|
%
|
|||||||
|
TOTAL
|
$
|
369,819
|
100.0
|
%
|
$
|
313,045
|
100.0
|
%
|
|||||
Commercial
loans are primarily for financing the needs of a diverse group of businesses
located in the Bank’s market area. The Bank also makes loans to individuals for
investment purposes. Most of these loans are relatively short-term (an overall
average life of approximately two years) and secured by various types of
collateral. Real estate construction loans are generally for financing the
construction of single-family residential homes for well-qualified individuals
and builders. These loans are secured by real estate and have short
maturities.
As
shown
in the comparative figures for loan mix during 2006 and 2005, total loans
increased as a result of increases in commercial loans, agriculture loans,
real
estate construction loans and installment loans which were partially offset
by a
decrease in real estate mortgage loans.
Maturities
and Sensitivities of Loans to Changes in Interest
Rates
Loan
maturities of the loan portfolio at December 31,
2006 are as follows (dollars in thousands) (excludes
loans
held-for-sale):
|
Maturing
|
Fixed
Rate
|
Variable
Rate
|
Total
|
|||||||
|
Within
one year
|
$
|
52,221
|
$
|
174,338
|
$
|
226,559
|
||||
|
After
one year through five years
|
44,208
|
110,925
|
155,133
|
|||||||
|
After
five years
|
18,169
|
75,688
|
93,857
|
|||||||
|
Total
|
$
|
114,598
|
$
|
360,951
|
$
|
475,549
|
||||
Non-accrual,
Past Due and Restructured Loans
It
is the
Bank’s policy to recognize interest income on an accrual basis. Accrual of
interest is suspended when a loan has been in default as to principal or
interest for 90 days, unless well secured by collateral believed by management
to have a fair market value that at least equals the book value of the loan
plus
accrued interest receivable and in the process of collection. Real estate
acquired through foreclosure is written down to its estimated fair market value
at the time of acquisition and is carried as a non-earning asset until sold.
Any
write-down at the time of acquisition is charged against the allowance for
loan
losses; subsequent write-downs or gains or losses upon disposition are credited
or charged to non-interest income/expense. The Bank has made no foreign
loans.
The
following table shows the aggregate amounts of assets (dollars
in
thousands)
in each
category at December 31, for the years indicated:
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Non-accrual
Loans
|
$
|
3,399
|
$
|
2,073
|
$
|
4,907
|
$
|
3,877
|
$
|
552
|
||||||
|
90
Days Past Due But Still Accruing
|
37
|
178
|
55
|
4
|
8
|
|||||||||||
|
Total
Non-performing Loans
|
3,436
|
2,251
|
4,962
|
3,881
|
560
|
|||||||||||
|
Other
Real Estate Owned
|
375
|
268
|
—
|
—
|
—
|
|||||||||||
|
Total
Non-performing Assets
|
$
|
3,811
|
$
|
2,519
|
$
|
4,962
|
$
|
3,881
|
$
|
560
|
||||||
If
interest on non-accrual loans had been accrued, such interest income would
have
approximated $280,000, $101,000, and $280,000 during the years ended December
31, 2006, 2005 and 2004, respectively. Income actually recognized for these
loans approximated $113,000, $100,000 and $64,000 for the years ended December
31, 2006, 2005 and 2004, respectively.
There
was
a $1,292,000 increase in non-performing assets for 2006 over 2005. At December
31, 2006, non-performing assets included five non-accrual commercial loans
totaling $1,469,000, two non-accrual agricultural loans totaling $620,000,
one
non-accrual commercial real estate loan totaling $90,000 and one non-accrual
residential mortgage loan totaling $1,220,000. Additional non-performing assets
included two loans past due more than 90 days totaling $37,000. Other Real
Estate Owned (“OREO”) properties totaled $375,000 at December 31, 2006. The
Bank’s management believes that nearly $3,277,000 of the $3,399,000 in
non-accrual loans at December 31, 2006, are adequately collateralized or
guaranteed by a governmental entity, and the remaining $122,000 may have some
potential loss which management believes is sufficiently covered by the Bank’s
existing loan loss reserve (Allowance for Loan Losses).
Potential
Problem Loans
In
addition to the non-performing assets described above, the Bank's Branch
Managers each month submit to the Loan Committee of the Board of Directors
a
report detailing the status of those loans that are past due over sixty days
and
each quarter a report detailing the status of those loans that are classified
as
such. Also included in the report are those loans that are not necessarily
past
due, but the branch manager is aware of problems with these loans which may
result in a loss.
The
monthly Allowance for Loan Loss Analysis Report is prepared based upon the
Problem Loan Report, internal loan grading, regulatory classifications and
loan
review classification and is reviewed by the Management Loan Committee of the
Bank. The Management Loan Committee reviewed the Allowance for Loan Loss
Analysis Report, dated December 31, 2006, on January 9, 2007. This report
included all non-performing loans reported in the table on the previous page
and
all other potential problem loans. Excluding the non-performing loans cited
previously, loans totaling $10,744,000 were classified as potential problem
loans. The Bank’s management believes that of these loans, loans totaling
$10,434,000 are adequately collateralized or guaranteed, the remaining loans
totaling $310,000 may have some loss potential which management believes is
sufficiently covered by the Bank’s existing loan loss reserve (Allowance for
Loan Losses). The ratio of the Allowance for Loan Losses to total loans at
December 31, 2006 was 1.73%.
SUMMARY
OF LOAN LOSS EXPERIENCE
The
Allowance for Loan Losses is maintained at a level believed by management to
be
adequate to provide for losses that can be reasonably anticipated. The allowance
is increased by provisions charged to operating expense and reduced by net
charge-offs. The Bank makes credit reviews of the loan portfolio and considers
current economic conditions, loan loss experience, and other factors in
determining the adequacy of the allowance for loan losses. The allowance for
loan losses is based on estimates and actual losses may vary from current
estimates.
Analysis
of the Allowance for Loan Losses
(Dollars
in
thousands)
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Balance
at Beginning of Year
|
$
|
7,917
|
$
|
7,445
|
$
|
7,006
|
$
|
6,630
|
$
|
6,116
|
||||||
|
Provision
for (Recovery of) Loan Losses
|
735
|
600
|
207
|
2,153
|
676
|
|||||||||||
|
Loans
Charged-Off:
|
||||||||||||||||
|
Commercial
|
(572
|
)
|
(670
|
)
|
(122
|
)
|
(143
|
)
|
(51
|
)
|
||||||
|
Agriculture
|
(57
|
)
|
—
|
(214
|
)
|
(1,662
|
)
|
(191
|
)
|
|||||||
|
Installment
Loans to Individuals
|
(431
|
)
|
(185
|
)
|
(46
|
)
|
(104
|
)
|
(87
|
)
|
||||||
|
Total
Charged-Off
|
(1,060
|
)
|
(855
|
)
|
(382
|
)
|
(1,909
|
)
|
(329
|
)
|
||||||
|
Recoveries:
|
||||||||||||||||
|
Commercial
|
561
|
64
|
199
|
101
|
92
|
|||||||||||
|
Agriculture
|
—
|
663
|
399
|
11
|
33
|
|||||||||||
|
Real
Estate Mortgage
|
—
|
—
|
—
|
—
|
35
|
|||||||||||
|
Installment
Loans to Individuals
|
208
|
—
|
16
|
20
|
7
|
|||||||||||
|
Total
Recoveries
|
769
|
727
|
614
|
132
|
167
|
|||||||||||
|
Net
(Charge-Offs) Recoveries
|
(291
|
)
|
(128
|
)
|
232
|
(1,777
|
)
|
(162
|
)
|
|||||||
|
Balance
at End of Year
|
$
|
8,361
|
$
|
7,917
|
$
|
7,445
|
$
|
7,006
|
$
|
6,630
|
||||||
|
Ratio
of Net (Charge-Offs) Recoveries During the Year to Average Loans
Outstanding During the Year
|
(0.06
|
%)
|
(0.03
|
%)
|
0.06
|
%
|
(0.48
|
%)
|
(0.05
|
%)
|
||||||
Allocation
of the Allowance for Loan Losses
The
Allowance for Loan Losses has been established as a general reserve available
to
absorb probable inherent losses throughout the Loan Portfolio. The following
table is an allocation of the Allowance for Loan Losses balance on the dates
indicated (dollars
in
thousands):
|
December
31, 2006
|
December
31, 2005
|
December
31, 2004
|
|||||||||||||||||
|
Allocation
of
Allowance
for
Loan
Losses
Balance
|
Loans
as a
%
of Total
Loans
|
Allocation
of
Allowance
for
Loan
Losses
Balance
|
Loans
as a
%
of Total
Loans
|
Allocation
of
Allowance
for
Loan
Losses
Balance
|
Loans
as a
%
of Total
Loans
|
||||||||||||||
|
Loan
Type:
|
|||||||||||||||||||
|
Commercial
|
$
|
2,037
|
20.5
|
%
|
$
|
1,779
|
19.1
|
%
|
$
|
1,727
|
20.9
|
%
|
|||||||
|
Agriculture
|
1,133
|
8.1
|
%
|
1,518
|
7.2
|
%
|
1,484
|
7.7
|
%
|
||||||||||
|
Real
Estate Mortgage
|
3,016
|
47.9
|
%
|
3,003
|
50.1
|
%
|
2,767
|
50.4
|
%
|
||||||||||
|
Real
Estate Construction
|
1,535
|
22.4
|
%
|
1,001
|
22.7
|
%
|
668
|
19.9
|
%
|
||||||||||
|
Installment
|
640
|
1.1
|
%
|
616
|
0.9
|
%
|
801
|
1.1
|
%
|
||||||||||
|
Total
|
$
|
8,361
|
100.0
|
%
|
$
|
7,917
|
100.0
|
%
|
$
|
7,445
|
100.0
|
%
|
|||||||
|
December
31, 2003
|
December
31, 2002
|
||||||||||||
|
Allocation
of
Allowance
for
Loan
Losses
Balance
|
Loans
as a
%
of Total
Loans
|
Allocation
of
Allowance
for
Loan
Losses
Balance
|
Loans
as a
%
of Total
Loans
|
||||||||||
|
Loan
Type:
|
|||||||||||||
|
Commercial
|
$
|
1,881
|
24.1
|
%
|
$
|
2,377
|
24.6
|
%
|
|||||
|
Agriculture
|
1,746
|
8.9
|
%
|
974
|
10.2
|
%
|
|||||||
|
Real
Estate Mortgage
|
2,181
|
47.2
|
%
|
279
|
46.0
|
%
|
|||||||
|
Real
Estate Construction
|
621
|
18.5
|
%
|
2,472
|
17.3
|
%
|
|||||||
|
Installment
|
577
|
1.3
|
%
|
528
|
1.9
|
%
|
|||||||
|
Total
|
$
|
7,006
|
100.0
|
%
|
$
|
6,630
|
100.0
|
%
|
|||||
The
Bank
believes that any breakdown or allocation of the Reserve into loan categories
lends an appearance of exactness, which does not exist, because the Reserve
is
available for all loans. The Reserve breakdown shown above is computed taking
actual experience into consideration but should not be interpreted as an
indication of the specific amount and allocation of actual charge-offs that
may
ultimately occur.
Deposits
The
following table sets forth the average amount and the average rate paid on
each
of the listed deposit categories (dollars
in
thousands)
during
the periods specified:
|
2006
|
2005
|
2004
|
|||||||||||||||||
|
Average
Amount
|
Average
Rate
|
Average
Amount
|
Average
Rate
|
Average
Amount
|
Average
Rate
|
||||||||||||||
|
Deposit
Type:
|
|||||||||||||||||||
|
Non-interest-Bearing
Demand
|
$
|
187,766
|
—
|
$
|
184,171
|
—
|
$
|
158,676
|
—
|
||||||||||
|
Interest-Bearing
Demand (NOW)
|
$
|
95,180
|
1.65
|
%
|
$
|
73,990
|
0.69
|
%
|
$
|
63,619
|
0.14
|
%
|
|||||||
|
Savings
and MMDAs
|
$
|
190,036
|
2.01
|
%
|
$
|
190,562
|
1.20
|
%
|
$
|
174,539
|
0.51
|
%
|
|||||||
|
Time
|
$
|
116,787
|
3.15
|
%
|
$
|
121,067
|
2.02
|
%
|
$
|
125,366
|
1.60
|
%
|
|||||||
The
following table sets forth by time remaining to maturity the Bank’s time
deposits in the amount of $100,000 or more (dollars
in
thousands)
as of
December 31, 2006:
|
Three
months or less
|
$
|
28,729
|
||
|
Over
three months through twelve months
|
32,355
|
|||
|
Over
twelve months
|
5,215
|
|||
|
Total
|
$
|
66,299
|
Short-Term
Borrowings
Short-term
borrowings at December 31, 2006 and 2005 consisted of secured borrowings from
the U.S. Treasury in the amounts of $858,000 and $1,476,000, respectively.
The
funds are placed at the discretion of the U.S. Treasury and are callable on
demand by the U.S. Treasury.
Additional
short-term borrowings available to the Company consist of a line of credit
and
advances from the Federal Home Loan Bank (“FHLB”) secured under terms of a
blanket collateral agreement by a pledge of FHLB stock and certain other
qualifying collateral such as commercial and mortgage loans. At December 31,
2006, the Company had a current collateral borrowing capacity from the FHLB
of
$93,832,000. The Company also has unsecured formal lines of credit totaling
$25,700,000 with correspondent banks and borrowing capacity of $2,000,000 with
the Federal Reserve Bank (loans and discounts), which is fully collateralized,
with a pledge of U.S. Agency Notes.
Long-Term
Borrowings
Long-term
borrowings consisted of Federal Home Loan Bank advances, totaling $10,124,000
and $13,493,000, respectively, at December 31, 2006 and 2005. Such advances
ranged in maturity from 1.4 years to 2.3 years at a weighted average interest
rate of 2.91% at December 31, 2006. Maturity ranged from 0.3 years to 3.3 years
at a weighted average interest rate of 3.48% at December 31, 2005. Average
outstanding balances were $10,776,000 and $13,628,000, respectively, during
2006
and 2005. The weighted average interest rate paid was 3.15% in 2006 and 3.48%
in
2005.
Results
of Operations
Net
Income
Year
Ended December 31, 2006 Compared to Year Ended December 31,
2005
Net
income for the year ended December 31, 2006, was $8,810,000, representing an
increase of $122,000, or 1.4% over net income of $8,688,000 for the year ended
December 31, 2005. The increase in net income is principally attributable to
a
$3,471,000 increase in net interest income, which was partially offset by a
decrease of $431,000 in other operating income, a $1,539,000 increase in
salaries and employee benefits, an increase of $135,000 in the provision for
loan losses, a $437,000 increase in occupancy and equipment, an increase of
$175,000 in data processing, a $158,000 increase in advertising, and a $377,000
increase in the provision for income taxes.
Year
Ended December 31, 2005 Compared to Year Ended December 31,
2004
Net
income for the year ended December 31, 2005, was $8,688,000, representing an
increase of $1,981,000, or 30% over net income of $6,707,000 for the year ended
December 31, 2004. The increase in net income is principally attributable to
a
$6,980,000 increase in net interest income and an increase of $506,000 in other
operating income, which was partially offset by a $2,371,000 increase in
salaries and employee benefits, an increase of $393,000 in the provision for
loan losses, a $194,000 increase in occupancy and equipment, a $320,000 increase
in advertising, and a $1,242,000 increase in the provision for income
taxes.
Net
Interest Income
Net
interest income is the excess of interest and fees earned on the Bank’s loans,
investment securities, federal funds sold and banker's acceptances over the
interest expense paid on deposits, mortgage notes and other borrowed funds.
It
is primarily affected by the yields on the Bank’s interest-earning assets and
loan fees and interest-bearing liabilities outstanding during the period. The
$3,471,000 increase in the Bank’s net interest income in 2006 from 2005 was due
to the effects of a higher level of core deposits and strong commercial and
real
estate loan volumes, combined with higher funding costs. The $6,980,000 increase
in 2005 from 2004 was due to the effects of a higher level of core deposits
and
strong commercial and real estate loan volumes, combined with higher funding
costs. The “Analysis of Changes in Interest Income and Interest Expense” set
forth on page 28 of this Annual Report on Form 10-K identifies the effects
of
interest rates and loan/deposit volume. Another factor that affected the net
interest income was the average earning asset to average total asset ratio.
This
ratio was 91.2% in 2006, 91.1% in 2005 and 89.4% in 2004.
Interest
income on loans (including loan fees) was $41,894,000 for 2006, representing
an
increase of $6,056,000, or 16.9% from $35,838,000 for 2005. This compared to
an
increase in 2005 of $7,965,000 or 28.58% greater than loan interest income
earned in 2004. The increased interest income on loans in 2006 over 2005 was
the
result of a 5.8% increase in loan volume, combined with a 91 basis point
increase in loan interest rates, which was partially offset by a decrease of
approximately $218,000 in loan fees. Loan fee comparisons were impacted by
a net
decrease in deferred loan fees and costs of $355,000 in 2006, a net decrease
of
$373,000 in 2005, and a net increase of $326,000 in 2004.
Average
outstanding federal funds sold fluctuated during this period, ranging from
$61,904,000, in 2006 to $81,948,000 in 2005 and $77,169,000 in 2004. At December
31, 2006 federal funds sold were $62,470,000. Federal funds are used primarily
as a short-term investment to provide liquidity for funding of loan commitments
or to accommodate seasonal deposit fluctuations. Federal funds sold yields
were
4.82%, 3.16% and 1.26% for 2006, 2005 and 2004, respectively.
The
average total level of investment securities increased $16,468,000 in 2006
to
$66,857,000 from $50,389,000 in 2005 and decreased $1,532,000 in 2005 to
$50,389,000 from $51,921,000 in 2004. The level of securities interest income
attributable to investment securities increased to $3,190,000 in 2006 from
$2,477,000 in 2005 and $2,774,000 in 2004, due to the effects of interest rates
and volume. The Bank’s strategy for this period has emphasized the use of the
investment portfolio to maintain the Bank’s increasing loan demand. The Bank
continues to reinvest maturing securities to provide future liquidity while
attempting to reinvest the cash flows in short duration securities that provide
higher cash flow for reinvestment in a higher interest rate instrument.
Investment securities yields were 4.77%, 4.92% and 5.34% for 2006, 2005 and
2004, respectively.
Total
interest expense increased to $9,426,000 in 2006 from $5,729,000 in 2005, and
increased to $5,729,000 in 2005 from $3,426,000 in 2004, representing a 64.53%
increase in 2006 over 2005 and a 67.22% increase in 2005 over 2004. The increase
in total interest expense from 2006 to 2005 was due to increases in volume
combined with increases in interest rates paid on deposits. The increase in
total interest expense from 2005 to 2004 was due to increases in volume combined
with increases in interest rates paid on deposits.
The
mix
of deposits for the previous three years is as follows (dollars
in
thousands):
|
2006
|
2005
|
2004
|
|||||||||||||||||
|
Average
Balance
|
Percent
|
Average
Balance
|
Percent
|
Average
Balance
|
Percent
|
||||||||||||||
|
Non-interest-Bearing
Demand
|
$
|
187,766
|
31.9
|
%
|
$
|
184,171
|
32.3
|
%
|
$
|
158,676
|
30.4
|
%
|
|||||||
|
Interest-Bearing
Demand (NOW)
|
95,180
|
16.1
|
%
|
73,990
|
13.0
|
%
|
63,619
|
12.2
|
%
|
||||||||||
|
Savings
and MMDAs
|
190,036
|
32.2
|
%
|
190,562
|
33.4
|
%
|
174,539
|
33.4
|
%
|
||||||||||
|
Time
|
116,787
|
19.8
|
%
|
121,067
|
21.3
|
%
|
125,366
|
24.0
|
%
|
||||||||||
|
Total
|
$
|
589,769
|
100.0
|
%
|
$
|
569,790
|
100.0
|
%
|
$
|
522,200
|
100.0
|
%
|
|||||||
The
three
years ended December 31, 2006 have been characterized by fluctuating interest
rates. Loan rates and deposit rates both increased in 2006, 2005 and 2004.
The
net spread between the rate for total earning assets and the rate for total
deposits and borrowed funds increased 7 basis points in the period from 2006
to
2005 and increased 45 basis points in the period from 2005 to 2004.
The
Bank’s net interest margin (net interest income divided by average earning
assets) was 6.36% in 2006, 6.01% in 2005, and 5.37% in 2004. The net interest
margin benefited in 2006 from rising interest rates combined with increased
loan
volume and was partially offset by higher cost of funds, the continued
flattening of the yield curve, a slowdown in mortgage originations and
maturities and calls of higher yielding securities. Going forward into the
first
half of 2007, it is Bank managements belief that net interest income and net
interest margin will be flat because of anticipated stabilization of the Federal
Funds Rate.
Provision
for Loan Losses
The
provision for loan losses is established by charges to earnings based on
management's overall evaluation of the collectibility of the loan portfolio.
Based on this evaluation, the provision for loan losses increased to $735,000
in
2006 from $600,000 in 2005, primarily as a result of loan growth and loan
quality in the Bank’s loan portfolio. The amount of loans charged-off increased
in 2006 to $1,060,000 from $855,000 in 2005, and recoveries increased to
$769,000 in 2006 from $727,000 in 2005. The increase in charge-offs was due,
for
the most part, to an increase in charge-offs of installment loans to
individuals. The ratio of the Allowance for Loan Losses to total loans at
December 31, 2006 was 1.73% compared to 1.70% at December 31, 2005. The ratio
of
the Allowance for Loan Losses to total non-accrual loans and loans past due
90
days or more at December 31, 2006 was 243% compared to 352% at December 31,
2005.
The
provision for loan losses is established by charges to earnings based on
management's overall evaluation of the collectibility of the loan portfolio.
Based on this evaluation, the provision for loan losses increased to $600,000
in
2005 from $207,000 in 2004, primarily as a result of loan growth and loan
quality in the Bank’s loan portfolio. The amount of loans charged-off increased
in 2005 to $855,000 from $382,000 in 2004, and recoveries increased to $727,000
in 2005 from $614,000 in 2004. The increase in charge-offs was due, for the
most
part, to a charge-off of an unsecured commercial loan. The ratio of the
Allowance for Loan Losses to total loans at December 31, 2005 was 1.70% compared
to 1.70% at December 31, 2004. The ratio of the Allowance for Loan Losses to
total non-accrual loans and loans past due 90 days or more at December 31,
2005
was 352% compared to 150% at December 31, 2004.
Other
Operating Income and Expenses
Other
operating income consisted primarily of service charges on deposit accounts
and
other income, which was partially offset by a decrease in net realized gains
on
loans held for sale and a decrease in gains on other real estate owned. Service
charges on deposit accounts increased $420,000 in 2006 over 2005 and $197,000
in
2005 over 2004. The increase in 2006 was due, for the most part, to increased
service charges on regular and business checking accounts. Net realized gains
on
loans held-for-sale decreased $718,000 in 2006 over 2005 and increased $21,000
in 2005 over 2004. The decrease in 2006 was due, for the most part, to a
decrease in sold loans. Gains on other real estate owned decreased $317,000
in
2006 over 2005 and increased $291,000 in 2005 over 2004. The decrease in 2006
was due to the sale of a previously foreclosed commercial property. Other income
increased $199,000 in 2006 over 2005 and decreased $15,000 in 2005 over
2004.
The
Bank
realized net gains of $-0- on sale of investment securities in 2006, $15,000
in
2005 and $3,000 in 2004.
Other
operating expenses consisted primarily of salaries and employee benefits,
occupancy and equipment expense, data processing, advertising, and other
expenses. Other operating expenses increased to $29,219,000 in 2006 from
$26,813,000 in 2005, and increased to $26,813,000 in 2005 from $22,943,000
in
2004, representing an increase of $2,406,000, or 9.0% in 2006 over 2005, and
an
increase of $3,870,000, or 16.9% in 2005 over 2004.
Following
is an analysis of the increase or decrease in the components of other operating
expenses (dollars in thousands) during the periods specified:
|
2006
over 2005
|
2005
over 2004
|
||||||||||||
|
Amount
|
Percent
|
Amount
|
Percent
|
||||||||||
|
Salaries
and Employee Benefits
|
$
|
1,539
|
9.7
|
%
|
$
|
2,371
|
17.5
|
%
|
|||||
|
Occupancy
and Equipment
|
437
|
13.5
|
%
|
194
|
6.4
|
%
|
|||||||
|
Data
Processing
|
175
|
14.5
|
%
|
130
|
12.0
|
%
|
|||||||
|
Stationery
and Supplies
|
43
|
8.9
|
%
|
(5
|
)
|
(1.0
|
%)
|
||||||
|
Advertising
|
158
|
21.5
|
%
|
320
|
76.9
|
%
|
|||||||
|
Directors
Fees
|
34
|
26.6
|
%
|
1
|
0.8
|
%
|
|||||||
|
Other
Expense
|
20
|
0.4
|
%
|
859
|
20.2
|
%
|
|||||||
|
Total
|
$
|
2,406
|
9.0
|
%
|
$
|
3,870
|
16.9
|
%
|
|||||
In
2006,
salaries and employee benefits increased $1,539,000 to $17,455,000 from
$15,916,000 for 2005. This increase was due, for the most part, to an increase
in regular salaries, incentive compensation, profit sharing payments and group
insurance. Increases in occupancy and equipment were associated with increased
rents and equipment associated with opening new branches and offices. Increases
in the data processing area were attributed to continued emphasis on
Internet-related products and security services and network improvements.
Increases in stationary and supplies were attributed to an increase in the
usage
of office supplies. Increases in advertising were due to increased costs related
to promoting new deposit products. Increases in director fees were due to
increased fees.
In
2005,
salaries and employee benefits increased $2,371,000 to $15,916,000 from
$13,545,000 for 2004. This increase was due, for the most part, to an increase
in regular salaries, incentive compensation and profit sharing payments.
Increases in occupancy and equipment were associated with increased rents and
equipment associated with opening new branches and offices. Increases in the
data processing area were attributed to continued emphasis on Internet-related
products and security services and network improvements. Increases in
advertising were due to increased costs related to promoting new deposit
products. Other expenses increased, for the most part, due to increased
accounting, audit and consulting fees associated with Sarbanes-Oxley Act
compliance.
Income
Taxes
The
provision for income taxes is primarily affected by the tax rate, the level
of
earnings before taxes and the amount of lower taxes provided by non-taxable
earnings. In 2006, taxes increased $377,000 to $5,169,000 from $4,792,000 for
2005. In 2005, taxes increased $1,242,000 to $4,792,000 from $3,550,000 for
2004. The Bank’s effective tax rate was 37%, 36%, and 35%, for the years ended
December 31, 2006, 2005 and 2004, respectively. Non-taxable municipal bond
income was $636,000, $562,000, and $610,000 for the years ended December 31,
2006, 2005, and 2004, respectively.
Liquidity,
Contractual Obligations, Commitments, Off-Balance Sheet Arrangements and Capital
Resources
Liquidity
is defined as the ability to generate cash at a reasonable cost to fulfill
lending commitments and support asset growth, while satisfying the withdrawal
demands of customers and any borrowing requirements. The Bank’s principal
sources of liquidity are core deposits and loan and investment payments and
prepayments. Providing a secondary source of liquidity is the available-for-sale
investment portfolio. As a final source of liquidity, the Bank can exercise
existing credit arrangements.
The
Company’s primary source of liquidity on a stand-alone basis is dividends from
the Bank. As discussed in Part I (Item 1) of this Annual Report on Form 10-K,
dividends from the Bank are subject to regulatory restrictions.
As
discussed in Part I (Item 1) of this Annual Report on Form 10-K, the Bank
experiences seasonal swings in deposits, which impact liquidity. Management
has
adjusted to these seasonal swings by scheduling investment maturities and
developing seasonal credit arrangements with the Federal Reserve Bank and
Federal Funds lines of credit with correspondent banks. In addition, the ability
of the Bank’s real estate department to originate and sell loans into the
secondary market has provided another tool for the management of liquidity.
As
of
December 31, 2006, the Company has not created any special purpose entities
to
securitize assets or to obtain off-balance sheet funding.
The
liquidity position of the Bank is managed daily, thus enabling the Bank to
adapt
its position according to market fluctuations. Liquidity is measured by various
ratios, the most common of which is the ratio of net loans (including loans
held-for-sale) to deposits. This ratio was 79.6% on December 31, 2006, 79.2%
on
December 31, 2005, and 77.8% on December 31, 2004. At December 31, 2006 and
2005, the Bank’s ratio of core deposits to total assets was 78.5% and 78.1%,
respectively. Core deposits are important in maintaining a strong liquidity
position as they represent a stable and relatively low cost source of funds.
The
Bank’s liquidity position increased slightly in 2006; management believes that
it remains adequate. This is best illustrated by the change in the Bank’s net
non-core and net short-term non-core funding dependence ratio, which explain
the
degree of reliance on non-core liabilities to fund long-term assets. At December
31, 2006, the Bank’s net core funding dependence ratio, the difference between
non-core funds, time deposits $100,000 or more and brokered time deposits under
$100,000, and short-term investments to long-term assets, was 0.53%, compared
to
-3.54% in 2005. The Bank’s net short-term non-core funding dependence ratio,
non-core funds maturing within one year, including borrowed funds, less
short-term investments to long-term assets equaled -2.29% at the end of 2006,
compared to -6.32% at year-end 2005. These ratios indicated at December 31,
2006, the Bank had minimal reliance on non-core deposits and borrowings to
fund
the Bank’s long-term assets, namely loans and investments. The Bank believes
that by maintaining adequate volumes of short-term investments and implementing
competitive pricing strategies on deposits, it can ensure adequate liquidity
to
support future growth. The Bank also believes that its liquidity position
remains strong to meet both present and future financial obligations and
commitments, events or uncertainties that have resulted or are reasonably likely
to result in material changes with respect to the Bank’s liquidity.
The
Company has various financial obligations, including contractual obligations
and
commitments that may require future cash payments. The following table presents,
as of December 31, 2006, the Company’s significant fixed and determinable
contractual obligations to third parties by payment date:
|
Payments
due by period
|
||||||||||||||||
|
Contractual
Obligations
|
Total
|
Less
than
1
year
|
1-3
years
|
3-5
years
|
More
than
5
years
|
|||||||||||
|
Deposits
without a stated maturity (a)
|
$
|
490,246
|
490,246
|
—
|
—
|
—
|
||||||||||
|
Certificates
of Deposit (a)
|
113,436
|
104,675
|
5,534
|
3,227
|
—
|
|||||||||||
|
Short-Term
Borrowings (a)
|
858
|
858
|
—
|
—
|
—
|
|||||||||||
|
Long-Term
Borrowings (b)
|
10,654
|
511
|
10,143
|
—
|
—
|
|||||||||||
|
Operating
Leases
|
6,545
|
1,212
|
2,333
|
1,265
|
1,735
|
|||||||||||
|
Purchase
Obligations
|
1,454
|
1,454
|
—
|
—
|
—
|
|||||||||||
|
Total
|
$
|
623,193
|
598,956
|
18,010
|
4,492
|
1,735
|
||||||||||
|
(a)
|
Excludes
interest
|
|
(b)
|
Includes
interest on fixed rate obligations.
|
The
Company’s operating lease obligations represent short-term and long-term lease
and rental payments for facilities, certain software and data processing and
other equipment. Purchase obligations represent obligations under agreements
to
purchase goods or services that are enforceable and legally binding on the
Company and that specify all significant terms, including: fixed or minimum
quantities to be purchased; fixed, minimum or variable price provisions; and
the
approximate timing of the transaction. The purchase obligation amounts presented
above primarily relate to certain contractual payments for services provided
for
information technology, capital expenditures, and the outsourcing of certain
operational activities.
The
Company’s long-term borrowing consists of FHLB fixed-rate obligations. FHLB
advances are collateralized by qualifying residential real estate loans.
The
Company’s borrowed funds consist of secured borrowings from the U.S. Treasury.
These borrowings are collateralized by qualifying securities. The funds are
placed at the discretion of the U.S. Treasury and are callable on demand by
the
U.S. Treasury.
The
following table details the amounts and expected maturities of commitments
as of
December 31, 2006:
|
Maturities
by period
|
||||||||||||||||
|
Commitments
|
Total
|
Less
than
1
year
|
1-3
years
|
3-5
years
|
More
than
5
years
|
|||||||||||
|
Commitments
to extend credit
|
||||||||||||||||
|
Commercial
|
$
|
67,969
|
62,181
|
2,719
|
1,784
|
1,285
|
||||||||||
|
Agriculture
|
25,496
|
23,076
|
19
|
2,401
|
—
|
|||||||||||
|
Real
Estate Mortgage
|
58,220
|
3,983
|
5,608
|
24,018
|
24,611
|
|||||||||||
|
Real
Estate Construction
|
43,644
|
33,454
|
7,956
|
—
|
2,234
|
|||||||||||
|
Installment
|
2,871
|
1,503
|
1,338
|
30
|
—
|
|||||||||||
|
Standby
Letters of Credit
|
12,222
|
12,220
|
2
|
—
|
—
|
|||||||||||
|
Total
|
$
|
210,422
|
136,417
|
17,642
|
28,233
|
28,130
|
||||||||||
Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements.
The
Company is a party to financial instruments with off-balance sheet risk in
the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit in the form of loans
or through standby letters of credit. These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amounts
recognized in the balance sheet. The contract amounts of those instruments
reflect the extent of involvement the Company has in particular classes of
financial instruments. These loans have been sold to third parties without
recourse, subject to customary default, representations and warranties, recourse
for breaches of the terms of the sales contracts and payment default
recourse.
Financial
instruments, whose contract amounts represent credit risk at December 31 of
the indicated years, are as follows:
|
2006
|
2005
|
||||||
|
Undisbursed
loan commitments
|
$
|
198,200
|
$
|
203,101
|
|||
|
Standby
letters of credit
|
12,222
|
14,077
|
|||||
|
Commitments
to sell loans
|
700
|
—
|
|||||
|
$
|
211,122
|
$
|
217,178
|
||||
The Bank expects its liquidity position to remain strong in 2007 as the Bank expects to continue to grow into existing and new markets. The stock market has rebounded this past year and, while the Bank did not experience a significant outflow of deposits, the potential of additional outflows still exists as the stock market continues to improve. Regardless of the outcome, the Bank believes that it has the means to provide adequate liquidity for funding normal operations in 2007.
The
Bank
believes a strong capital position is essential to the Bank’s continued growth
and profitability. A solid capital base provides depositors and shareholders
with a margin of safety, while allowing the Bank to take advantage of profitable
opportunities, support future growth and provide protection against any
unforeseen losses.
At
December 31, 2006, stockholders’ equity totaled $62.0 million, an increase of
$5.2 million from $56.8 million at December 31, 2005. An important source of
capital is earnings retention. Net income of $8.8 million in 2006, offset by
stock repurchases of $4.2 million, was the primary factor contributing to the
increase. Also affecting capital in 2006 was paid in capital in the amount
of
$0.5 million resulting from a tax benefit on stock options exercised and a
decrease in other comprehensive income of $0.6 million, consisting of unrealized
losses on investment securities available-for-sale and directors’ and employees’
retirement plan equity adjustment. The Bank’s Tier 1 Leverage Capital ratio at
year-end 2006 was 9.0% and 8.3% for 2005.
On
April
24, 2006, the Company approved a stock repurchase program effective April 30,
2006 to replace the Company’s previous stock purchase plan that expired on April
30, 2006. The stock repurchase program, which will remain in effect until April
30, 2008, allows repurchases by the Company in an aggregate of up to 2.5% of
the
Company’s outstanding shares of common stock over each rolling twelve-month
period. The Company’s previous stock purchase plan had allowed repurchases by
the Company in an aggregate of up to 3% of the Company’s outstanding shares of
common stock over each rolling twelve-month period. During 2006, the Bank paid
$2.5 million in dividends to the Company to fund the repurchase of 155,678
shares of the Company’s outstanding common stock. During 2005, the Bank paid
$3.5 million in dividends to the Company to fund the repurchase of 174,979
shares of the Company’s outstanding common stock. The
purpose of the stock repurchase program is to give management the ability to
more effectively manage capital and create liquidity for shareholders who want
to sell their stock. Management believes that the stock repurchase program
has
been a prudent use of excess capital.
The
capital of the Bank historically has been maintained at a level that is in
excess of regulatory guidelines. The policy of annual stock dividends has,
over
time, allowed the Bank to match capital and asset growth through retained
earnings and a managed program of geographic growth.
ITEM
7A -
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market
risk is the risk to a bank’s financial position resulting from adverse changes
in market rates or prices, such as interest rates, foreign exchange rates or
equity prices. The Bank has no exposure to foreign currency exchange risk or
any
specific exposure to commodity price risk. The Bank’s major area of market risk
exposure is interest rate risk (“IRR”). The Bank’s exposure to IRR can be
explained as the potential for change in the Bank’s reported earnings and/or the
market value of its 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 Bank’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, changes with the interest rates. The effects of
the
changes in these present values reflect the change in the Bank’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, banks must carefully evaluate IRR to promote
safety and soundness in their activities.
The
responsibility for the Bank’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 and rate sensitive
liabilities.
Market
risk continues to be a major focal point of regulatory emphasis. In accordance
with regulation, each bank is required to develop an IRR management program
depending on its structure, including certain fundamental components, which
are
mandatory to ensure IRR management. These elements include appropriate board
and
management oversight, as well a comprehensive risk management process that
effectively identifies, measures, monitors and controls risk. Should a bank
have
material weaknesses in its risk management process or high exposure relative
to
its capital, the bank regulatory agencies will take action to remedy these
shortcomings. Moreover, the level of a bank’s IRR exposure and the quality of
its risk management process is a determining factor when evaluating a bank’s
capital adequacy.
The
Bank
utilizes the tabular presentation alternative in complying with quantitative
and
qualitative disclosure rules.
The
following tables summarize the expected maturity, principal repricing, principal
repayment and fair value of the financial instruments that are sensitive to
changes in interest rates.
Interest
Rate Sensitivity Analysis at December 31, 2006
|
Expected
Maturity/Repricing/Principal Payment
|
|||||||||||||||||||
|
In
Thousands
|
Within
1
Year
|
1
Year to
3
Years
|
3
Years to
5
Years
|
After
5
Years
|
Total
Balance
|
Fair
Value
|
|||||||||||||
|
Interest-Sensitive
Assets:
|
|||||||||||||||||||
|
Federal
funds sold
|
$
|
62,470
|
—
|
—
|
—
|
62,470
|
62,470
|
||||||||||||
|
Average
interest rate
|
5.31
|
%
|
—
|
—
|
—
|
5.31
|
%
|
—
|
|||||||||||
|
Fixed
rate investments
|
$
|
12,298
|
27,799
|
13,692
|
22,484
|
76,273
|
76,273
|
||||||||||||
|
Average
interest rate
|
4.90
|
%
|
5.22
|
%
|
5.22
|
%
|
6.09
|
%
|
5.43
|
%
|
—
|
||||||||
|
Fixed
rate loans (1)
|
$
|
52,221
|
23,571
|
20,637
|
18,169
|
114,598
|
114,665
|
||||||||||||
|
Average
interest rate
|
6.87
|
%
|
7.30
|
%
|
7.72
|
%
|
6.88
|
%
|
7.11
|
%
|
—
|
||||||||
|
Variable
rate loans (1)
|
$
|
174,338
|
63,695
|
47,230
|
75,688
|
360,951
|
361,283
|
||||||||||||
|
Average
interest rate
|
8.97
|
%
|
8.16
|
%
|
8.13
|
%
|
7.56
|
%
|
8.42
|
%
|
—
|
||||||||
|
Loans
held-for-sale
|
$
|
4,460
|
—
|
—
|
—
|
4,460
|
4,460
|
||||||||||||
|
Average
interest rate
|
6.35
|
%
|
—
|
—
|
—
|
6.35
|
%
|
—
|
|||||||||||
|
Interest-Sensitive
Liabilities:
|
|||||||||||||||||||
|
NOW
account deposits (2)
|
$
|
30,453
|
9,992
|
6,929
|
70,246
|
117,620
|
96,703
|
||||||||||||
|
Average
interest rate
|
1.10
|
%
|
1.10
|
%
|
1.10
|
%
|
1.10
|
%
|
1.10
|
%
|
—
|
||||||||
|
Money
market deposits (2)
|
$
|
37,513
|
6,431
|
5,359
|
57,875
|
107,178
|
90,573
|
||||||||||||
|
Average
interest rate
|
1.25
|
%
|
1.25
|
%
|
1.25
|
%
|
1.25
|
%
|
1.25
|
%
|
—
|
||||||||
|
Savings
deposits (2)
|
$
|
23,783
|
8,834
|
6,795
|
28,538
|
67,950
|
59,681
|
||||||||||||
|
Average
interest rate
|
1.65
|
%
|
1.65
|
%
|
1.65
|
%
|
1.65
|
%
|
1.65
|
%
|
—
|
||||||||
|
Certificates
of deposit
|
$
|
104,673
|
5,535
|
3,228
|
—
|
113,436
|
113,563
|
||||||||||||
|
Average
interest rate
|
3.60
|
%
|
3.65
|
%
|
4.25
|
%
|
—
|
3.62
|
%
|
—
|
|||||||||
|
Borrowed
funds (3)
|
$
|
858
|
10,123
|
—
|
—
|
10,981
|
10,528
|
||||||||||||
|
Average
interest rate
|
5.38
|
%
|
2.91
|
%
|
—
|
—
|
3.11
|
%
|
—
|
||||||||||
|
Interest-Sensitive
Off-Balance Sheet Items:
|
|||||||||||||||||||
|
Commitments
to lend
|
—
|
—
|
—
|
—
|
$
|
198,200
|
1,487
|
||||||||||||
|
Standby
letters of credit
|
—
|
—
|
—
|
—
|
$
|
12,222
|
122
|
||||||||||||
|
(1)
|
Based
upon contractual maturity dates and interest rate
repricing.
|
|
(2)
|
NOW,
money market and savings deposits do not carry contractual maturity
dates.
The actual maturities of NOW, money market and savings deposits could
vary
substantially if future withdrawals differ from the Company’s historical
experience.
|
|
(3)
|
Excludes
interest on fixed rate obligations.
|
At
December 31, 2006, federal funds sold of $62.5 million with a yield of 5.31%
and
investments of $12.3 million with a weighted-average, tax equivalent yield
of
4.90% were scheduled to mature within one year. In addition, net loans
(including loans held-for-sale) of $231.0 million with a weighted-average yield
of 8.45% were scheduled to mature or reprice within the same time-frame.
Overall, interest-earning assets scheduled to mature within one year totaled
$305.8 million with a weighted-average, tax-equivalent yield of 7.78%. With
respect to interest-bearing liabilities, based on historical withdrawal
patterns, NOW accounts, money market and savings deposits of $91.7 million
with
a weighted-average cost of 1.30% were scheduled to mature within one year.
Certificates of deposit totaling $104.7 million with a weighted-average cost
of
3.60% were scheduled to mature in the same time-frame. In addition, borrowed
funds totaling $0.9 million with a weighted-average cost of 5.38% were scheduled
to mature within one year. Total interest-bearing liabilities scheduled to
mature within one year equaled $197.3 million with a weighted-average cost
of
2.54%.
Historical
withdrawal patterns with respect to interest-bearing and non-interest-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 and repricing dates, which may differ materially
from
actual results due to prepayments.
The
Bank
seeks to control IRR by matching assets and liabilities. One tool used to ensure
market rate return is variable rate loans. Loans totaling $231.0 million or
48.1% of the total loan portfolio at December 31, 2006 (including loans
held-for-sale) are subject to repricing within one year. Loan maturities in
the
after five year category decreased to $93.9 million at December 31, 2006 from
$129.6 million at December 31, 2005.
The
Bank
is required by FASB 115 to mark to market the Available-for-Sale investments
at
the end of each quarter. Mark to market adjustments resulted in a reduction
of
$112,000 in other comprehensive income as reflected in the December 31, 2006
consolidated balance sheet. Mark to market adjustments during the year ended
December 31, 2005 resulted in a reduction of $914,000 in other comprehensive
income. These adjustments were the result of fluctuating interest
rates.
ITEM
8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA
In
response to this Item, the information set forth on pages 47 through 84 in
this
Annual Report is incorporated herein by reference.
Financial
Statements Filed:
|
Management’s
Report
|
Page
44
|
|
|
|
|
Reports
of Independent Registered Public Accounting Firms
|
Page
45
|
|
Consolidated
Balance Sheets as of December 31, 2006 and 2005
|
Page
47
|
|
Consolidated
Statements of Operations for Years ended December 31, 2006, 2005,
and
2004
|
Page
48
|
|
Consolidated
Statements of Stockholders' Equity and Comprehensive Income for Years
ended December 31, 2006, 2005, and 2004
|
Page
49
|
|
Consolidated
Statements of Cash Flows for Years ended December 31, 2006, 2005,
and
2004
|
Page
50
|
|
Notes
to Consolidated Financial Statements
|
Page
51
|
Management’s
Report
|
FIRST
NORTHERN COMMUNITY BANCORP AND SUBSIDIARY
MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL
REPORTING
|
Management
of First Northern Community Bancorp and subsidiary (the "Company") is
responsible for establishing and maintaining effective internal control over
financial reporting. Internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes
in
accordance with accounting principles generally accepted in the United States
of
America.
Under
the
supervision and with the participation of management, including the principal
executive officer and principal financial officer, the Company conducted an
evaluation of the effectiveness of internal control over financial reporting
based on the framework in Internal Control - Integrated Framework issued by
the
Committee of Sponsoring Organizations of the Treadway Commission. Based on
this
evaluation under the framework in Internal Control - Integrated Framework,
management of the Company has concluded the Company maintained effective
internal control over financial reporting, as such term is defined in Securities
Exchange Act of 1934 Rules 13a-15(f), as of December 31, 2006.
Internal
control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. Internal
control over financial reporting is a process that involves human diligence
and
compliance and is subject to lapses in judgment and breakdowns resulting from
human failures. Internal control over financial reporting can also be
circumvented by collusion or improper management override. Because of such
limitations, there is a risk that material misstatements may not be prevented
or
detected on a timely basis by internal control over financial reporting.
However, these inherent limitations are known features of the financial
reporting process. Therefore, it is possible to design into the process
safeguards to reduce, though not eliminate, this risk.
Management
is also responsible for the preparation and fair presentation of the
consolidated financial statements and other financial information contained
in
this report. The accompanying consolidated financial statements were prepared
in
conformity with accounting principles generally accepted in the United States
of
America and include, as necessary, best estimates and judgments by management.
MOSS ADAMS LLP, an independent registered public accounting firm, has audited
the Company’s consolidated financial statements as of and for the year ended
December 31, 2006, and the Company’s assertion as to the effectiveness of
internal control over financial reporting as of December 31, 2006, as stated
in
their reports, which are included herein.
|
/s/
Owen J. Onsum
|
|
|
Owen
J. Onsum
|
|
|
President/Chief
Executive Officer/Director
|
|
|
(Principal
Executive Officer)
|
|
|
/s/
Louise A. Walker
|
|
|
Louise
A. Walker
|
|
|
Senior
Executive Vice President/Chief Financial Officer
|
|
|
(Principal
Financial Officer)
|
March
15,
2007
Report
of Independent Registered Public Accounting Firm
To
The
Board of Directors and Stockholders
First
Northern Community Bancorp:
We
have
audited the accompanying consolidated balance sheet of First Northern Community
Bancorp and subsidiary (the Company) as of December 31, 2006 and the related
consolidated statements of operations, stockholders’ equity and comprehensive
income and cash flows for the year ended December 31, 2006. We have also audited
management’s assessment, included in the accompanying Management Report on
Internal Control over Financial Reporting, that the Company maintained effective
internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). The
Company’s management is responsible for these financial statements, maintaining
effective internal control over financial reporting, and for its assessment
of
the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on these financial statements, an
opinion on management’s assessment, and an opinion on the effectiveness of the
Company’s internal control over financial reporting based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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. An audit of internal control over financial
reporting includes obtaining an understanding of internal control over financial
reporting, evaluating management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing such other
procedures as we considered necessary in the circumstances. We believe that
our
audits provide a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made in accordance with authorizations of management and directors of
the
company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of the inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of the
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with policies or procedures may deteriorate.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of First Northern
Community Bancorp and subsidiary as of December 31, 2006 and the consolidated
results of their operations and cash flows for the year ended December 31,
2006
in conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion management’s assessment that First Northern
Community Bancorp and subsidiary maintained effective internal control over
financial reporting as of December 31, 2006, is fairly stated, in all material
respects, based on criteria established in Internal Control - Integrated
Framework issued by the COSO. Furthermore, in our opinion, First Northern
Community Bancorp and subsidiary maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal Control - Integrated Framework issued by the
COSO.
As
discussed in notes 1 and 12 to the consolidated financial statements, effective
January 1, 2006, the Company changed its method of accounting for share-based
payment arrangements to conform to Statement of Financial Accounting Standard
No. 123(R), “Share-Based Payment”.
/s/
MOSS
ADAMS LLP
Stockton, California
March 15,
2007
Report
of Independent Registered Public Accounting Firm
The
Board
of Directors and Stockholders
First
Northern Community Bancorp:
We
have
audited the accompanying consolidated balance sheet of First Northern Community
Bancorp and subsidiary as of December 31, 2005, and the related
consolidated statments of operations, stockholders’ equity and comprehensive
income, and cash flows for each of the years in the two-year period ended
December 31, 2005. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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 Northern Community
Bancorp and subsidiary as of December 31, 2005, and the results of their
operations and their cash flows for each of the years in the two-year period
ended December 31, 2005, in conformity with U.S. generally accepted accounting
principles.
/s/
KPMG
LLP
Sacramento, California
March 15,
2007
FIRST
NORTHERN COMMUNITY BANCORP
AND
SUBSIDIARY
Consolidated
Balance Sheets
December
31, 2006 and 2005
(in
thousands, except share amounts)
|
2006
|
2005
|
||||||
|
Assets
|
|||||||
|
Cash
and due from banks
|
$
|
35,531
|
$
|
35,507
|
|||
|
Federal
funds sold
|
62,470
|
87,185
|
|||||
|
Investment
securities - available-for-sale (includes securities pledged to creditors
with the right to sell or repledge of $3,935 and $3,963, respectively)
|
76,273
|
48,788
|
|||||
|
Loans,
net
|
475,549
|
456,061
|
|||||
|
Loans
held-for-sale
|
4,460
|
4,440
|
|||||
|
Premises
and equipment, net
|
8,060
|
8,311
|
|||||
|
Other
real estate owned
|
375
|
268
|
|||||
|
Other
assets
|
22,507
|
20,087
|
|||||
|
Total
assets
|
$
|
685,225
|
$
|
660,647
|
|||
|
Liabilities
and Stockholders' Equity
|
|||||||
|
Deposits:
|
|||||||
|
Demand
|
$
|
197,498
|
$
|
192,436
|
|||
|
Interest-bearing
transaction deposits
|
117,620
|
85,560
|
|||||
|
Savings
and MMDAs
|
175,128
|
185,878
|
|||||
|
Time,
under $100,000
|
47,137
|
51,921
|
|||||
|
Time,
$100,000 and over
|
66,299
|
65,986
|
|||||
|
Total
Deposits
|
603,682
|
581,781
|
|||||
|
FHLB
advances and other borrowings
|
10,981
|
14,969
|
|||||
|
Accrued
interest payable and other liabilities
|
8,572
|
7,095
|
|||||
|
Total
Liabilities
|
623,235
|
603,845
|
|||||
|
Stockholders'
Equity:
|
|||||||
|
Common
stock, no par value; 16,000,000 shares authorized; 7,980,952 and
7,558,759
shares issued and outstanding in 2006 and 2005,
respectively;
|
45,726
|
36,100
|
|||||
|
Additional
paid-in capital
|
977
|
977
|
|||||
|
Retained
earnings
|
15,792
|
19,606
|
|||||
|
Accumulated
other comprehensive (loss) income, net
|
(505
|
)
|
119
|
||||
|
Total
stockholders’ equity
|
61,990
|
56,802
|
|||||
|
Commitments
and contingencies
|
|||||||
|
Total
liabilities and stockholders’ equity
|
$
|
685,225
|
$
|
660,647
|
|||
See
accompanying notes to consolidated financial statements.
FIRST
NORTHERN COMMUNITY BANCORP
AND
SUBSIDIARY
Consolidated
Statements of Operations
Years
Ended December 31, 2006, 2005 and 2004
(in
thousands, except share amounts)
|
2006
|
2005
|
2004
|
||||||||
|
Interest
income:
|
||||||||||
|
Interest
and fees on loans
|
$
|
41,894
|
$
|
35,838
|
$
|
27,873
|
||||
|
Federal
funds sold
|
2,986
|
2,587
|
972
|
|||||||
|
Investment
securities:
|
||||||||||
|
Taxable
|
2,554
|
1,915
|
2,164
|
|||||||
|
Non-taxable
|
636
|
562
|
610
|
|||||||
|
Total
interest income
|
48,070
|
40,902
|
31,619
|
|||||||
|
Interest
expense:
|
||||||||||
|
Time
deposits $100,000 and over
|
2,315
|
1,452
|
1,122
|
|||||||
|
Other
deposits
|
6,748
|
3,782
|
1,863
|
|||||||
|
Other
borrowings
|
363
|
495
|
441
|
|||||||
|
Total
interest expense
|
9,426
|
5,729
|
3,426
|
|||||||
|
Net
interest income
|
38,644
|
35,173
|
28,193
|
|||||||
|
Provision
for loan losses
|
735
|
600
|
207
|
|||||||
|
Net
interest income after provision for loan losses
|
37,909
|
34,573
|
27,986
|
|||||||
|
Other
operating income:
|
||||||||||
|
Service
charges on deposit accounts
|
2,820
|
2,400
|
2,203
|
|||||||
|
Net
realized gains on available-for-sale securities
|
—
|
15
|
3
|
|||||||
|
Net
realized gains on loans held-for-sale
|
45
|
763
|
742
|
|||||||
|
Net
realized gains on other real estate owned
|
6
|
323
|
32
|
|||||||
|
Other
income
|
2,418
|
2,219
|
2,234
|
|||||||
|
Total
other operating income
|
5,289
|
5,720
|
5,214
|
|||||||
|
Other
operating expenses:
|
||||||||||
|
Salaries
and employee benefits
|
17,455
|
15,916
|
13,545
|
|||||||
|
Occupancy
and equipment
|
3,673
|
3,236
|
3,042
|
|||||||
|
Data
processing
|
1,384
|
1,209
|
1,079
|
|||||||
|
Stationery
and supplies
|
524
|
481
|
486
|
|||||||
|
Advertising
|
894
|
736
|
416
|
|||||||
|
Directors
fees
|
162
|
128
|
127
|
|||||||
|
Other
|
5,127
|
5,107
|
4,248
|
|||||||
|
Total
other operating expenses
|
29,219
|
26,813
|
22,943
|
|||||||
|
Income
before income tax expense
|
13,979
|
13,480
|
10,257
|
|||||||
|
Provision
for income tax expense
|
5,169
|
4,792
|
3,550
|
|||||||
|
Net
income
|
$
|
8,810
|
$
|
8,688
|
$
|
6,707
|
||||
|
Basic
income per share
|
$
|
1.04
|
$
|
1.02
|
$
|
0.78
|
||||
|
Diluted
income per share
|
$
|
0.99
|
$
|
0.98
|
$
|
0.76
|
||||
See
accompanying notes to consolidated financial statements.
FIRST
NORTHERN COMMUNITY BANCORP
AND
SUBSIDIARY
Consolidated
Statements of Stockholders' Equity and Comprehensive Income
Years
Ended December 31, 2006, 2005 and 2004
(in
thousands, except share amounts)
|
Accumulated
|
||||||||||||||||||||||
|
Additional
|
Other
|
|||||||||||||||||||||
|
Common
Stock
|
Comprehensive
|
Paid-in
|
Retained
|
Comprehensive
|
||||||||||||||||||
|
Description
|
Shares
|
Amounts
|
Income
|
Capital
|
Earnings
|
Income
|
Total
|
|||||||||||||||
|
Balance
at December 31, 2003
|
6,834,514
|
$
|
28,193
|
$
|
977
|
$
|
15,933
|
$
|
1,869
|
$
|
46,972
|
|||||||||||
|
Comprehensive
income:
|
||||||||||||||||||||||
|
Net
income
|
$
|
6,707
|
$
|
6,707
|
$
|
6,707
|
||||||||||||||||
|
Other
comprehensive loss:
|
||||||||||||||||||||||
|
Unrealized
holding losses arising during the current period, net of tax effect
of
$513
|
(770
|
)
|
||||||||||||||||||||
|
Reclassification
adjustment due to gains realized, net of tax effect of $1
|
2
|
|||||||||||||||||||||
|
Directors’
and officers’ retirement plan equity adjustments
|
(116
|
)
|
||||||||||||||||||||
|
Total
other comprehensive loss, net of tax effect of $512
|
2(884
|
)
|
(884
|
)
|
(884
|
)
|
||||||||||||||||
|
Comprehensive
income
|
$
|
5,823
|
||||||||||||||||||||
|
6%
stock dividend
|
410,214
|
5,537
|
(5,537
|
)
|
—
|
|||||||||||||||||
|
Cash
in lieu of fractional shares
|
(12
|
)
|
(12
|
)
|
||||||||||||||||||
|
Stock-based
compensation and related tax benefits
|
360
|
360
|
||||||||||||||||||||
|
Common
shares issued, including tax benefits
|
80,668
|
398
|
398
|
|||||||||||||||||||
|
Stock
repurchase and retirement
|
(123,062
|
)
|
(1,640
|
)
|
(1,640
|
)
|
||||||||||||||||
|
Balance
at December 31, 2004
|
7,202,334
|
32,848
|
977
|
17,091
|
985
|
51,901
|
||||||||||||||||
|
Comprehensive
income:
|
||||||||||||||||||||||
|
Net
income
|
$
|
8,688
|
8,688
|
8,688
|
||||||||||||||||||
|
Other
comprehensive loss:
|
||||||||||||||||||||||
|
Unrealized
holding losses arising during the current period, net of tax effect
of
$615
|
(923
|
)
|
||||||||||||||||||||
|
Reclassification
adjustment due to gains realized, net of tax effect of $6
|
9
|
|||||||||||||||||||||
|
Directors’
and officers’ retirement plan equity adjustments
|
48
|
|||||||||||||||||||||
|
Total
other comprehensive loss, net of tax effect of $609
|
(866
|
)
|
(866
|
)
|
(866
|
)
|
||||||||||||||||
|
Comprehensive
income
|
$
|
7,822
|
||||||||||||||||||||
|
6%
stock dividend
|
432,132
|
6,158
|
(6,158
|
)
|
—
|
|||||||||||||||||
|
Cash
in lieu of fractional shares
|
(15
|
)
|
(15
|
)
|
||||||||||||||||||
|
Stock-based
compensation and related tax benefits
|
554
|
554
|
||||||||||||||||||||
|
Common
shares issued, including tax benefits
|
99,262
|
394
|
394
|
|||||||||||||||||||
|
Stock
repurchase and retirement
|
(174,969
|
)
|
(3,854
|
)
|
(3,854
|
)
|
||||||||||||||||
|
Balance
at December 31, 2005
|
7,558,759
|
36,100
|
977
|
19,606
|
119
|
56,802
|
||||||||||||||||
|
Comprehensive
income:
|
||||||||||||||||||||||
|
Net
income
|
$
|
8,810
|
8,810
|
8,810
|
||||||||||||||||||
|
Other
comprehensive loss:
|
||||||||||||||||||||||
|
Unrealized
holding losses arising during the current period, net of tax effect
of
$75
|
(112
|
)
|
||||||||||||||||||||
|
Reclassification
adjustment due to gains realized, net of tax effect of
$-0-
|
—
|
|||||||||||||||||||||
|
Directors’
and officers’ retirement plan equity adjustments, net of tax effect of
$341
|
(512
|
)
|
||||||||||||||||||||
|
Total
other comprehensive loss, net of tax effect of $416
|
(624
|
)
|
(624
|
)
|
(624
|
)
|
||||||||||||||||
|
Comprehensive
income
|
$
|
8,186
|
||||||||||||||||||||
|
6%
stock dividend
|
455,472
|
12,525
|
(12,525
|
)
|
—
|
|||||||||||||||||
|
Cash
in lieu of fractional shares
|
(15
|
)
|
(15
|
)
|
||||||||||||||||||
|
Accrued
compensation
|
(84
|
)
|
(84
|
)
|
||||||||||||||||||
|
Stock-based
compensation and related tax benefits
|
817
|
817
|
||||||||||||||||||||
|
Common
shares issued, including tax benefits
|
122,399
|
472
|
472
|
|||||||||||||||||||
|
Stock
repurchase and retirement
|
(155,678
|
)
|
(4,188
|
)
|
(4,188
|
)
|
||||||||||||||||
|
Balance
at December 31, 2006
|
7,980,952
|
$
|
45,726
|
$
|
977
|
$
|
15,792
|
$
|
(505
|
)
|
$
|
61,990
|
||||||||||
See
accompanying notes to consolidated financial statements.
FIRST
NORTHERN COMMUNITY BANCORP
AND
SUBSIDIARY
Consolidated
Statements of Cash Flows
Years
Ended December 31, 2006, 2005 and 2004
(in
thousands, except share amounts)
|
2006
|
2005
|
2004
|
||||||||
|
Cash
flows from operating activities:
|
||||||||||
|
Net
income
|
$
|
8,810
|
$
|
8,688
|
$
|
6,707
|
||||
|
Adjustments
to reconcile net income to net cash provided by
operating activities:
|
||||||||||
|
Provision
for loan losses
|
735
|
600
|
207
|
|||||||
|
Stock
plan accruals
|
395
|
286
|
204
|
|||||||
|
Tax
benefit for stock options
|
422
|
268
|
156
|
|||||||
|
Depreciation
and amortization
|
1,041
|
1,016
|
1,283
|
|||||||
|
Accretion
and amortization, net
|
(96
|
)
|
25
|
60
|
||||||
|
Net
realized gains on available-for-sale securities
|
—
|
(15
|
)
|
(3
|
)
|
|||||
|
Net
realized gains on loans held-for-sale
|
(45
|
)
|
(763
|
)
|
(742
|
)
|
||||
|
Gain
on sale of OREO
|
(6
|
)
|
(323
|
)
|
(32
|
)
|
||||
|
Gain
on sale of bank premises and equipment
|
—
|
(5
|
)
|
—
|
||||||
|
Benefit
from deferred income taxes
|
(503
|
)
|
(666
|
)
|
(625
|
)
|
||||
|
Proceeds
from sales of loans held-for-sale
|
38,386
|
62,428
|
58,387
|
|||||||
|
Originations
of loans held-for-sale
|
(38,361
|
)
|
(62,386
|
)
|
(56,694
|
)
|
||||
|
(Decrease)
increase in deferred loan origination fees and costs, net
|
(355
|
)
|
(372
|
)
|
325
|
|||||
|
(Increase)
decrease in accrued interest receivable and other assets
|
(2,016
|
)
|
(1,707
|
)
|
422
|
|||||
|
Increase
in accrued interest payable and other liabilities
|
1,477
|
2,135
|
913
|
|||||||
|
Net
cash provided by operating activities
|
9,884
|
9,209
|
10,568
|
|||||||
|
Cash
flows from investing activities:
|
||||||||||
|
Proceeds
from maturities of available-for-sale securities
|
12,900
|
10,755
|
8,715
|
|||||||
|
Proceeds
from sales of available-for-sale securities
|
—
|
405
|
—
|
|||||||
|
Principal
repayments on available-for-sale securities
|
2,027
|
655
|
836
|
|||||||
|
Purchase
of available-for-sale securities
|
(42,503
|
)
|
(6,982
|
)
|
(15,807
|
)
|
||||
|
Net
increase in loans
|
(19,975
|
)
|
(26,855
|
)
|
(54,464
|
)
|
||||
|
Purchases
of bank premises and equipment
|
(790
|
)
|
(1,892
|
)
|
(745
|
)
|
||||
|
Proceeds
from bank premises and equipment
|
—
|
5
|
—
|
|||||||
|
Proceeds
from sale of other real estate owned
|
6
|
323
|
32
|
|||||||
|
Net
cash used in investing activities
|
(48,335
|
)
|
(23,586
|
)
|
(61,433
|
)
|
||||
|
Cash
flows from financing activities:
|
||||||||||
|
Net
increase in deposits
|
21,901
|
24,595
|
58,337
|
|||||||
|
Net
(decrease) increase in FHLB advances and other borrowings
|
(3,988
|
)
|
(487
|
)
|
5,883
|
|||||
|
Cash
dividends paid in lieu of fractional shares
|
(15
|
)
|
(15
|
)
|
(12
|
)
|
||||
|
Common
stock issued
|
472
|
394
|
398
|
|||||||
|
Tax
benefit for stock options
|
(422
|
)
|
(268
|
)
|
(156
|
)
|
||||
|
Repurchase
of common stock
|
(4,188
|
)
|
(3,854
|
)
|
(1,640
|
)
|
||||
|
Net
cash provided by financing activities
|
13,760
|
20,365
|
62,966
|
|||||||
|
Net
change in cash and cash equivalents
|
(24,691
|
)
|
5,988
|
11,945
|
||||||
|
Cash
and cash equivalents at beginning of year
|
122,692
|
116,704
|
104,759
|
|||||||
|
Cash
and cash equivalents at end of year
|
$
|
98,001
|
$
|
122,692
|
$
|
116,704
|
||||
See
accompanying notes to consolidated financial statements.
FIRST
NORTHERN COMMUNITY BANCORP
AND
SUBSIDIARY
Notes
to
Consolidated Financial Statements
Years
Ended December 31, 2006, 2005 and 2004
(in
thousands, except share amounts)
| (1) |
Summary
of Significant Accounting
Policies
|
First
Northern Community Bancorp (the “Company”) is a bank holding company whose only
subsidiary, First Northern Bank of Dixon (the “Bank”), a California state
chartered bank, conducts general banking activities, including collecting
deposits and originating loans, and serves Solano, Yolo, Sacramento, Placer
and
El Dorado Counties. All intercompany transactions between the Company and the
Bank have been eliminated in consolidation.
The
accounting and reporting policies of the Company conform with accounting
principles generally accepted in the United States of America. 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 revenues and expenses for the period. Actual
results could differ from those estimates applied in the preparation of the
accompanying consolidated financial statements. For the Bank the most
significant accounting estimate is the allowance for loan losses. See
footnote
(1)(e). A summary of the significant accounting policies applied in the
preparation of the accompanying consolidated financial statements
follows.
|
(a)
|
Cash
Equivalents
|
For
purposes of the consolidated statements of cash flows, the Company considers
due
from banks, federal funds sold for one-day periods and short-term bankers
acceptances to be cash equivalents.
|
(b)
|
Investment
Securities
|
Investment
securities consist of U.S. Treasury securities, U.S. Agency securities,
obligations of states and political subdivisions, obligations of U.S.
Corporations, mortgage backed securities and other securities. At the time
of
purchase of a security the Company designates the security as held-to-maturity
or available-for-sale, based on its investment objectives, operational needs
and
intent to hold. The Company does not purchase securities with the intent to
engage in trading activity.
Held-to-maturity
securities are recorded at amortized cost, adjusted for amortization or
accretion of premiums or discounts. 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.
A
decline
in the market value of any available-for-sale or held-to-maturity security
below
cost that is deemed other than temporary results in a charge to earnings and
the
corresponding establishment of a new cost basis for the security. 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. Dividend and interest income are recognized
when
earned. Realized gains and losses for securities classified as
available-for-sale and held-to-maturity are included in earnings and are derived
using the specific identification method for determining the cost of securities
sold.
Derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and hedging activities,
are
recognized as either assets or liabilities in the statement of financial
position and measured at fair value. The Company did not hold any derivatives
at
December 31, 2006 and 2005.
|
(c)
|
Loans
|
Loans
are
reported at the principal amount outstanding, net of deferred loan fees and
the
allowance for loan losses. 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. If the measurement of the impaired loan is less
than
the recorded investment in the loan, an impairment is recognized by a charge
to
the allowance for loan losses.
Unearned
discount on installment loans is recognized as income over the terms of the
loans by the interest method. Interest on other loans is calculated by using
the
simple interest method on the daily balance of the principal amount
outstanding.
Loan
fees
net of certain direct costs of origination, which represent an adjustment to
interest yield are deferred and amortized over the contractual term of the
loan
using the interest method.
Loans
on
which the accrual of interest has been discontinued are designated as
non-accrual loans. Accrual of interest on loans is discontinued either when
reasonable doubt exists as to the full and timely collection of interest or
principal or when a loan becomes contractually past due by ninety days or more
with respect to interest or principal. When a loan is placed on non-accrual
status, all interest previously accrued but not collected is reversed against
current period interest income. Interest accruals are resumed on such loans
only
when they 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. Restructured loans are loans
on
which concessions in terms have been granted because of the borrowers’ financial
difficulties. Interest is generally accrued on such loans in accordance with
the
new terms.
|
(d)
|
Loans
Held-for-Sale
|
Loans
originated and held-for-sale are carried at the lower of cost or estimated
market value in the aggregate. Net unrealized losses are recognized through
a
valuation allowance by charges to income.
|
(e)
|
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. The allowance
is
an amount that management believes will be adequate to absorb losses inherent
in
existing loans and overdrafts 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.
Material
estimates relating to the determination of the allowance for loan losses are
particularly susceptible to significant change in the near term. Management
believes that the allowance for loan losses is adequate. While management uses
available information to recognize losses on loans, future additions to the
allowance may be necessary based on changes in economic conditions. In addition,
the Federal Deposit Insurance Corporation (“FDIC”), as an integral part of its
examination process, periodically reviews the Bank’s allowance for loan losses.
The FDIC may require the Bank to recognize additions to the allowance based
on
their judgment about information available to them at the time of their
examination.
|
(f)
|
Premises
and Equipment
|
Premises
and equipment are stated at cost, less accumulated depreciation. Depreciation
is
computed substantially by the straight-line method over the estimated useful
lives of the related assets. Leasehold improvements are depreciated over the
estimated useful lives of the improvements or the terms of the related leases,
whichever is shorter. The useful lives used in computing deprecation are as
follows:
|
Buildings
and improvements
|
15
to 50 years
|
|
|
Furniture
and equipment
|
3
to 10 years
|
|
(g)
|
Other
Real Estate Owned
|
Other
real estate acquired by foreclosure, is carried at the lower of the recorded
investment in the property or its fair value less estimated selling costs.
Prior
to foreclosure, the value of the underlying loan is written down to the fair
value of the real estate to be acquired by a charge to the allowance for loan
losses, if necessary. Fair value of other real estate owned is generally
determined based on an appraisal of the property. Any subsequent operating
expenses or income, reduction in estimated values and gains or losses on
disposition of such properties are included in other operating
expenses.
Revenue
recognition on the disposition of real estate 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.
|
(h)
|
Impairment
of Long-Lived Assets and Long-Lived Assets to Be Disposed
Of
|
Long-lived
assets and certain identifiable intangibles 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 exceeds 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.
|
(i)
|
Gain
or Loss on Sale of Loans and Servicing
Rights
|
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.
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, a normal cost for
servicing the loan 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.
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 (mortgage servicing rights) in loans sold are
measured by allocating the previous carrying amount of the transferred assets
between the loans sold and retained interest, 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 sold substantially
all of its conforming long-term residential mortgage loans originated during
the
years ended December 31, 2006, 2005 and 2004 for cash proceeds equal to the
fair
value of the loans.
The
recorded value of mortgage servicing rights is included in other assets, and
is
amortized in proportion to, and over the period of, estimated net servicing
revenues. The Company assesses capitalized mortgage servicing rights for
impairment based upon the fair value of those rights at each reporting date.
For
purposes of measuring impairment, the rights are stratified based upon the
product type, term and interest rates. Fair value is determined by discounting
estimated net future cash flows from mortgage servicing activities using
discount rates that approximate current market rates and estimated prepayment
rates, among other assumptions. The amount of impairment recognized, if any,
is
the amount by which the capitalized mortgage servicing rights for a stratum
exceeds their fair value. Impairment, if any, is recognized through a valuation
allowance for each individual stratum.
The
Company had mortgage loans held-for-sale of $4,460 and $4,440 at December 31,
2006 and 2005, respectively. At December 31, 2006 and 2005, the Company serviced
real estate mortgage loans for others of $112,742 and $112,743, respectively.
Mortgage
servicing rights as of December 31, 2006 were $945. The balance as of December
31, 2005 was $973.
|
(j)
|
Income
Taxes
|
The
Company accounts for income taxes under the asset and liability method. Under
the asset and liability method, 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 carry forwards.
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.
On
July
15, 2002, the Bank made a $2,355 equity investment in a partnership, which
owns
low-income affordable housing projects that generate tax benefits in the form
of
federal and state housing tax credits. On December 31, 2004, the Bank
transferred the amortized cost of the equity investment to a similar equity
investment partnership which owns low income affordable housing projects that
generate tax benefits in the form of federal and state tax credits. As a limited
partner investor in this partnership, the Company receives tax benefits in
the
form of tax deductions from partnership operating losses and federal and state
income tax credits. The federal and state income tax credits are earned over
a
10-year period as a result of the investment property meeting certain criteria
and are subject to recapture for non-compliance with such criteria over a
15-year period. The expected benefit resulting from the low-income housing
tax
credits is recognized in the period for which the tax benefit is recognized
in
the Company’s consolidated tax returns. This investment is accounted for using
the effective yield method and is recorded in other assets on the balance sheet.
Under the effective yield method, the Company recognizes tax credits as they
are
allocated and amortizes the initial cost of the investment to provide a constant
effective yield over the period that tax credits are allocated to the Company.
The effective yield is the internal rate of return on the investment, based
on
the cost of the investment and the guaranteed tax credits allocated to the
Company. Any expected residual value of the investment was excluded from the
effective yield calculation. Cash received from operations of the limited
partnership or sale of the property, if any, will be included in earnings when
realized or realizable.
|
(k)
|
Stock
Option Plan
|
On
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
(“SFAS”) No. 123R, “Share-Based Payments,” which addresses the accounting for
stock-based payment transactions whereby an entity receives employee services
in
exchange for equity instruments, including stock options. SFAS No. 123R
eliminates the ability to account for stock-based compensation transactions
using the intrinsic value method under Accounting Principles Board Opinion
(“APB”) No. 25, “Accounting for Stock Issued to Employees,” and instead
generally requires that such transactions be accounted for using a fair-value
based method. The Company has elected the modified prospective transition method
as permitted under SFAS No. 123R, and accordingly prior periods have not been
restated to reflect the impact of SFAS No. 123R. The modified prospective
transition method requires that stock-based compensation expense be recorded
for
all new and unvested stock options that are ultimately expected to vest as
the
requisite service is rendered beginning on January 1, 2006. Stock-based
compensation for awards granted prior to January 1, 2006 is based upon the
grant-date fair value of such compensation as determined under the pro forma
provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” The
Company issues new shares of common stock upon the exercise of stock options.
See Note 12 of Notes to Consolidated Financial Statements (page
68).
|
(l)
|
Earnings
Per Share (EPS)
|
Basic
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. See
Note
9 of
Notes to Consolidated Financial Statements (page 67).
|
(m)
|
Comprehensive
Income
|
Accounting
principles generally accepted in the United States require that recognized
revenue, expenses, gains and losses be included in net income. Although certain
changes in assets and liabilities, such as unrealized gain and losses on
available-for-sale securities, are reported as a separate component of the
equity section of the balance sheet, such items, along with net income, are
components of comprehensive income.
|
(n)
|
Fiduciary
Powers
|
On
July
1, 2002, the Bank received trust powers from applicable regulatory agencies
and
on that date began to offer fiduciary services for individuals, businesses,
governments and charitable organizations in the Solano, Yolo, Sacramento, Placer
and El Dorado County areas. The Bank’s full-service asset management and trust
department, which offers and manages such fiduciary services, is located in
downtown Sacramento.
|
(o)
|
Impact
of Recently Issued Accounting
Standards
|
In
September 2006, the SEC released Staff Accounting Bulletin No. 108, Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements (“SAB 108”), which is effective for fiscal
years ending on or after November 15, 2006. SAB 108 provides guidance on how
the
effects of prior-year uncorrected financial statement misstatements should
be
considered in quantifying a current year misstatement. SAB 108 requires public
companies to quantify misstatements using both an income statement (rollover)
and balance sheet (iron curtain) approach and evaluate whether either approach
results in a misstatement that, when all relevant quantitative and qualitative
factors are considered, is material. If prior year errors that had been
previously considered immaterial now are considered material based on either
approach, no restatement is required so long as management properly applied
its
previous approach and all relevant facts and circumstances were considered.
Adjustments considered immaterial in prior years under the method previously
used, but now considered material under the dual approach required by SAB 108,
are to be recorded upon initial adoption of SAB 108. Management has completed
its review and adopted the new guidance effective January 1, 2006. The impact
of
the adoption was a decrease in beginning retained earnings of $84, related
to
accrued vacation pay and accrued hourly compensation.
In
September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements
No. 87, 88, 106 and 132(R)” (“SFAS 158”). SFAS 158 requires the Company to (a)
recognize in its statement of financial position an asset for a plan’s
overfunded status or a liability for a plan’s underfunded status, (b) measure a
plan’s assets and its obligations that determine its funded status as of the end
of the fiscal year, (c) recognize changes in the funded status of a defined
postretirement plan in the year in which the changes occur (reported in
comprehensive income) and (d) provide additional disclosure. The requirement
to
recognize the funded status of a benefit plan and the disclosure requirements
are effective as of the end of the fiscal year ending after December 15, 2006.
The requirement to measure the plan assets and benefit obligations as of the
date of the employer’s fiscal year-end statement of financial position is
effective for fiscal years ending after December 15, 2008.
As
of
December 31, 2006, the Company adopted SFAS No. 158. In accordance with this
standard, the Company recorded the funded status of each of its defined benefit
pension and postretirement plans as an asset or liability on its Consolidated
Balance Sheet with a corresponding offset, net of taxes, recorded in Accumulated
other comprehensive (loss) income within Stockholders’ Equity, resulting in an
after-tax decrease in equity of $549. See Note 7 of Notes to Consolidated
Financial Statements (page 60).
|
(p)
|
Reclassifications
|
Certain
reclassifications have been made to the prior years’ financial statements to
conform to the current year’s presentation.
|
(2)
|
Cash
and Due from Banks
|
The
Bank
is required to maintain reserves with the Federal Reserve Bank based on a
percentage of deposit liabilities. No aggregate reserves were required at
December 31, 2006 and 2005. The Bank has met its average reserve requirements
during 2006 and 2005 and the minimum required balance at December 31, 2006
and
2005.
|
(3)
|
Investment
Securities
|
The
amortized cost, unrealized gains and losses and estimated market values of
investments in debt and other securities at December 31, 2006 are summarized
as
follows:
|
Amortized
cost
|
Unrealized
gains
|
Unrealized
losses
|
Estimated
market
value
|
||||||||||
|
Investment
securities available for sale:
|
|||||||||||||
|
U.S.
Treasury securities
|
$
|
249
|
$
|
4
|
$
|
—
|
$
|
253
|
|||||
|
Securities
of U.S. government agencies and corporations
|
31,887
|
82
|
(266
|
)
|
31,703
|
||||||||
|
Obligations
of states and political subdivisions
|
29,836
|
382
|
(25
|
)
|
30,193
|
||||||||
|
Mortgage
backed securities
|
12,084
|
23
|
(76
|
)
|
12,031
|
||||||||
|
Total
debt securities
|
74,056
|
491
|
(367
|
)
|
74,180
|
||||||||
|
Other
securities
|
2,093
|
—
|
—
|
2,093
|
|||||||||
|
$
|
76,149
|
$
|
491
|
$
|
(367
|
)
|
$
|
76,273
|
|||||
The
amortized cost, unrealized gains and losses and estimated market values of
investments in debt and other securities at December 31, 2005 are
summarized as follows:
|
Amortized
cost
|
Unrealized
gains
|
Unrealized
losses
|
Estimated
market
value
|
||||||||||
|
Investment
securities available for sale:
|
|||||||||||||
|
U.S.
Treasury securities
|
$
|
250
|
$
|
—
|
$
|
—
|
$
|
250
|
|||||
|
Securities
of U.S. government agencies and corporations
|
21,924
|
16
|
(384
|
)
|
21,556
|
||||||||
|
Obligations
of states and political subdivisions
|
22,377
|
678
|
(8
|
)
|
23,047
|
||||||||
|
Mortgage
backed securities
|
1,795
|
8
|
—
|
1,803
|
|||||||||
|
Total
debt securities
|
46,346
|
702
|
(392
|
)
|
46,656
|
||||||||
|
Other
securities
|
2,132
|
—
|
—
|
2,132
|
|||||||||
|
$
|
48,478
|
$
|
702
|
$
|
(392
|
)
|
$
|
48,788
|
|||||
Gross
realized gains from sales of available-for-sales securities were $0, $15 and
$3
for the years ended December 31, 2006, 2005 and 2004, respectively. Gross
realized losses from sales of available-for-sale securities were $-0- for each
of the years ended December 31, 2006, 2005 and 2004.
The
amortized cost and estimated market value of debt and other securities at
December 31, 2006, by contractual maturity, are shown in the following table:
|
Amortized
cost
|
Estimated
market
value
|
||||||
|
Due
in one year or less
|
$
|
12,345
|
12,298
|
||||
|
Due
after one year through five years
|
41,556
|
41,491
|
|||||
|
Due
after five years through ten years
|
9,640
|
9,800
|
|||||
|
Due
after ten years
|
10,515
|
10,591
|
|||||
|
Other
|
2,093
|
2,093
|
|||||
|
$
|
76,149
|
76,273
|
|||||
Expected
maturities may differ from contractual maturities because borrowers may have
the
right to call or prepay obligations with or without call or prepayment
penalties. Securities
due after one year through five years included mortgage-backed securities
totaling $11,996. The maturities on these securities were based on the average
lives of the securities.
An
analysis of gross unrealized losses of the available-for-sale investment
securities portfolio as of December 31, 2006, follows:
|
Less
than 12 months
|
12
months or more
|
Total
|
|||||||||||||||||
|
Fair
Value
|
Unrealized
losses
|
Fair
Value
|
Unrealized
losses
|
Fair
Value
|
Unrealized
losses
|
||||||||||||||
|
Securities
of U.S. government agencies and corporations
|
$
|
8,867
|
$
|
(59
|
)
|
$
|
14,740
|
$
|
(207
|
)
|
$
|
23,607
|
$
|
(266
|
)
|
||||
|
Obligations
of states and political subdivisions
|
3,929
|
(20
|
)
|
225
|
(5
|
)
|
4,154
|
(25
|
)
|
||||||||||
|
Mortgage
backed securities
|
8,156
|
(76
|
)
|
—
|
—
|
8,156
|
(76
|
)
|
|||||||||||
|
Total
|
$
|
20,952
|
$
|
(155
|
)
|
$
|
14,965
|
$
|
(212
|
)
|
$
|
35,917
|
$
|
(367
|
)
|
||||
No
decline in value was considered “other than temporary” during 2006. The
unrealized losses on investments in U.S. government agency securities were
caused by market interest rate increases that occurred after these securities
were purchased. Thirty-one securities that had a fair market value of $20,952
and a total unrealized loss of $155 have been in an unrealized loss position
for
less than twelve months as of December 31, 2006. In addition, sixteen securities
with a fair market value of $14,965 and a total unrealized loss of $212 that
have been in an unrealized loss position for more than twelve months as of
December 31, 2006. Due to the fact the Company has the ability and intent to
hold these investments until a market price recovery or maturity, these
investments are not considered other-than-temporarily impaired.
Investment
securities carried at $26,675 and $22,042 at December 31, 2006 and 2005,
respectively, were pledged to secure public deposits or for other purposes
as
required or permitted by law.
The
Bank
is a member of the Federal Home Loan Bank (“FHLB”) and holds stock, which is
included in securities, carried at cost which approximates fair value of $1,983
and $2,022 at December 31, 2006 and 2005, respectively.
|
(4)
|
Loans
|
The
composition of the Bank’s loan portfolio at December 31, is as follows:
|
2006
|
2005
|
||||||
|
Commercial
|
$
|
99,138
|
88,816
|
||||
|
Agriculture
|
39,346
|
33,458
|
|||||
|
Real
estate:
|
|||||||
|
Mortgage
|
231,920
|
233,049
|
|||||
|
Commercial
and Construction
|
108,795
|
105,472
|
|||||
|
Installment
and other loans
|
5,470
|
4,297
|
|||||
|
484,669
|
465,092
|
||||||
|
Allowance
for loan losses
|
(8,361
|
)
|
(7,917
|
)
|
|||
|
Net
deferred origination fees and costs
|
(759
|
)
|
(1,114
|
)
|
|||
|
Loans,
net
|
$
|
475,549
|
456,061
|
||||
As
of
December 31, 2006, approximately 22% of the Bank’s loans are for real estate
construction. Additionally approximately 48% of the Bank’s loans are mortgage
type loans which are secured by residential real estate. Approximately 29%
of
the Bank’s loans are for general commercial uses including professional, retail,
agricultural and small businesses. Generally, real estate loans are secured
by
real property and other loans are secured by funds on deposit, business or
personal assets. Repayment is generally expected from the proceeds of the sales
of property for real estate construction loans, and from cash flows of the
borrower for other loans. The Bank’s access to this collateral is through
foreclosure and/or judicial procedures. The Bank’s exposure to credit loss if
the real estate or other security proved to be of no value is the outstanding
loan balance.
Loans
that were sold and were being serviced by the Bank totaled approximately
$112,742 and $112,743 at December 31, 2006 and 2005, respectively.
Non-accrual
loans totaled approximately $3,399 and $2,073 at December 31, 2006 and 2005,
respectively. If interest on these non-accrual loans had been accrued, such
income would have approximated $280 and $101 during the years ended December
31,
2006 and 2005, respectively.
Loans
90
days past due and still accruing totaled approximately $37 and $178 at December
31, 2006 and 2005, respectively.
The
Bank
did not restructure any loans in 2006 or 2005.
Impaired
loans are loans for which it is probable that the Bank will not be able to
collect all amounts due. Impaired loans totaled approximately $3,399 and $2,073
at December 31, 2006 and 2005, respectively, and had related valuation
allowances of approximately $122, and $201 at December 31, 2006 and 2005,
respectively. The average outstanding balance of impaired loans was
approximately $2,710, $3,221, and $2,108, on which $113, $100, and $64 of
interest income was recognized for the years ended December 31, 2006, 2005
and
2004, respectively.
Loans
in
the amount of $161,222 and $163,385 at December 31, 2006 and 2005, respectively,
were pledged under a blanket collateral lien to secure actual and potential
borrowings from the Federal Home Loan Bank.
Changes
in the allowance for loan losses for the following years ended December 31,
are
summarized as follows:
|
2006
|
2005
|
2004
|
||||||||
|
Balance,
beginning of year
|
$
|
7,917
|
7,445
|
7,006
|
||||||
|
Provision
for loan losses
|
735
|
600
|
207
|
|||||||
|
Loans
charged-off
|
(1,060
|
)
|
(855
|
)
|
(382
|
)
|
||||
|
Recoveries
of loans previously charged-off
|
769
|
727
|
614
|
|||||||
|
Balance,
end of year
|
$
|
8,361
|
7,917
|
7,445
|
||||||
|
(5)
|
Premises
and Equipment
|
Premises
and equipment consist of the following at December 31 of the indicated
years:
|
2006
|
2005
|
||||||
|
Land
|
$
|
2,718
|
$
|
2,718
|
|||
|
Buildings
|
4,484
|
4,454
|
|||||
|
Furniture
and equipment
|
10,325
|
9,639
|
|||||
|
Leasehold
improvements
|
1,539
|
1,465
|
|||||
|
19,066
|
18,276
|
||||||
|
Less
accumulated depreciation
|
11,006
|
9,965
|
|||||
|
$
|
8,060
|
$
|
8,311
|
||||
Depreciation
and amortization expense, included in occupancy and equipment expense, is
$1,041, $1,016 and $1,016 for the years ended December 31, 2006, 2005 and 2004,
respectively.
|
(6)
|
Other
Assets
|
Other
assets consisted of the following at December 31 of the indicated
years:
|
2006
|
2005
|
||||||
|
Accrued
interest
|
$
|
3,832
|
$
|
3,119
|
|||
|
Software,
net of amortization
|
346
|
421
|
|||||
|
Officer’s
Life Insurance
|
9,995
|
9,159
|
|||||
|
Prepaid
and other
|
2,900
|
2,872
|
|||||
|
Investment
in Limited Partnerships
|
1,747
|
1,875
|
|||||
|
Deferred
tax assets, net (see note 8)
|
3,687
|
2,641
|
|||||
|
$
|
22,507
|
$
|
20,087
|
||||
The
Company amortizes capitalized software costs on a straight-line basis using
a
useful life from three to five years.
Software
amortization expense, included in other operating expense, is $243, $248 and
$267 for the years ended December 31, 2006, 2005 and 2004,
respectively.
The
Bank
held other real estate owned (OREO) in the amount of $375 and $268 as of
December 31, 2006 and 2005, respectively. The Bank had no allowance for losses
on OREO recorded for these years.
|
(7)
|
Supplemental
Compensation Plans
|
EXECUTIVE
SALARY CONTINUATION PLAN
Pension
Benefit Plans
On
July
19, 2001, the Company and the Bank approved an unfunded non-contributory defined
benefit pension plan (“Salary Continuation Plan”) and related split dollar plan
for a select group of highly compensated employees. The plan provides defined
benefit levels between $50 and $125 depending on responsibilities at the Bank.
The retirement benefits are paid for 10 years following retirement at age 65.
Reduced retirement benefits are available after age 55 and 10 years of service.
Additionally,
the Company and the Bank adopted a new supplemental executive retirement plan
(“SERP”) in 2006. The new plan is intended to integrate the various forms of
retirement payments offered to executives. There are currently two participants
in the plan.
The
plan
benefit is calculated using 3-year average salary plus 7-year average bonus
(average compensation). For each year of service the benefit formula credits
2%
of average compensation (2.5% for the CEO) up to a maximum of 50%. Therefore,
for an executive serving 25 years (20 for the CEO), the target benefit is 50%
of
average compensation.
The
target benefit is reduced for other forms of retirement income provided by
the
bank. Reductions are made for 50% of the social security benefit expected at
age
65 and for the accumulated value of contributions the bank makes to the
executive’s profit sharing plan. For purposes of this reduction, contributions
to the profit sharing plan are accumulated each year at a 3-year average of
the
yields on 10-year treasury securities. Retirement benefits are paid monthly
for
120 months plus 6 months for each full year of service over 10 years, up to
a
maximum of 180 months.
Reduced
benefits are payable for retirement prior to age 65. Should retirement occur
prior to age 65, the benefit determined by the formula described above is
reduced 5% for each year payments commence prior to age 65. Therefore, the
new
SERP benefit is reduced 50% for retirement at age 55. No benefit is payable
for
voluntary terminations prior to age 55.
Eligibility
to participate in the Plan is limited to a select group of management or highly
compensated employees of the bank that are designated by the
Board.
The
Bank
uses a December 31 measurement date for these plans.
|
For
the Year Ended December 31,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Change
in benefit obligation
|
||||||||||
|
Benefit
obligation at beginning of year
|
$
|
1,079
|
$
|
885
|
$
|
596
|
||||
|
Service
cost
|
183
|
160
|
156
|
|||||||
|
Interest
cost
|
65
|
53
|
47
|
|||||||
|
Amendments
|
798
|
—
|
—
|
|||||||
|
Plan
loss (gain)
|
(40
|
)
|
(19
|
)
|
86
|
|||||
|
Benefits
Paid
|
(45
|
)
|
—
|
—
|
||||||
|
Benefit
obligation at end of year
|
$
|
2,040
|
$
|
1,079
|
$
|
885
|
||||
|
Change
in plan assets
|
||||||||||
|
Employer
Contribution
|
$
|
45
|
$
|
—
|
$
|
—
|
||||
|
Benefits
Paid
|
(45
|
)
|
—
|
—
|
||||||
|
Fair
value of plan assets at end of year
|
$
|
—
|
$
|
—
|
$
|
—
|
||||
|
Reconciliation
of funded status
|
||||||||||
|
Funded
status
|
$
|
(2,040
|
)
|
$
|
(1,079
|
)
|
$
|
(885
|
)
|
|
|
Unrecognized
net plan loss (gain)
|
(19
|
)
|
21
|
40
|
||||||
|
Unrecognized
prior service cost
|
933
|
148
|
161
|
|||||||
|
Net
amount recognized
|
$
|
(1,126
|
)
|
$
|
(910
|
)
|
$
|
(684
|
)
|
|
|
Amounts
recognized in the consolidated balance sheets consist
of:
|
||||||||||
|
Accrued
benefit liability
|
$
|
(2,040
|
)
|
$
|
(1,079
|
)
|
$
|
(885
|
)
|
|
|
Intangible
asset
|
—
|
148
|
161
|
|||||||
|
Accumulated
other comprehensive income
|
914
|
21
|
40
|
|||||||
|
Net
amount recognized
|
$
|
(1,126
|
)
|
$
|
(910
|
)
|
$
|
(684
|
)
|
|
|
For
the Year Ended December 31,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Components
of net periodic benefit cost
|
||||||||||
|
Service
cost
|
$
|
183
|
$
|
160
|
$
|
156
|
||||
|
Interest
cost
|
65
|
54
|
47
|
|||||||
|
Amortization
of prior service cost
|
13
|
13
|
13
|
|||||||
|
Net
periodic benefit cost
|
261
|
227
|
216
|
|||||||
|
Additional
amounts recognized
|
—
|
—
|
—
|
|||||||
|
Total
benefit cost
|
$
|
261
|
$
|
227
|
$
|
216
|
||||
|
Additional
Information
|
||||||||||
|
Minimum
benefit obligation at year end
|
$
|
2,040
|
$
|
1,079
|
$
|
885
|
||||
|
Increase
(decrease) in minimum liability included in other comprehensive
income
|
$
|
893
|
$
|
(19
|
)
|
$
|
40
|
|||
|
Assumptions
used to determine benefit obligations at December
31
|
2006
|
2005
|
2004
|
|||||||
|
Discount
rate used to determine net periodic benefit cost for years ended
December
31
|
5.30
|
%
|
5.10
|
%
|
6.25
|
%
|
||||
|
Discount
rate used to determine benefit obligations at December 31
|
5.40
|
%
|
5.30
|
%
|
5.10
|
%
|
||||
|
Future
salary increases
|
6.00
|
%
|
—
|
—
|
||||||
Plan
Assets
The
Bank
informally funds the liabilities of this plan through life insurance purchased
on the lives of plan participants. This informal funding does not meet the
definition of plan assets within the meaning of pension accounting standards.
Therefore, assets held for this purpose are not disclosed as part of the Salary
Continuation Plan.
Cash
Flows
Contributions
and Estimated Benefit Payments
For
unfunded plans, contributions to the plan are the benefit payments made to
participants. The Bank paid $45,120 benefit payments during fiscal 2006. The
following benefit payments, which reflect expected future service, are expected
to be paid in future fiscal years:
|
Year
ending December 31,
|
Pension
Benefits
|
|
2007
|
$54
|
|
2008
|
54
|
|
2009
|
54
|
|
2010
|
197
|
|
2011
|
197
|
|
2012-2016
|
1,151
|
Disclosure
of settlements and curtailments:
There
were no events during fiscal 2006 that would constitute a curtailment or
settlement within the meaning of SFAS No. 88.
Impact
of Adopting SFAS No. 158 at December 31, 2006:
|
Reconciliation
of funded status
|
||||||||||
|
Before
Adoption
|
Impact
|
After
Adoption
|
||||||||
|
Funded
Status
|
$
|
(2,040
|
)
|
$
|
—
|
$
|
(2,040
|
)
|
||
|
Unrecognized
net plan loss (gain)
|
(19
|
)
|
—
|
(19
|
)
|
|||||
|
Unrecognized
prior service cost
|
933
|
—
|
933
|
|||||||
|
Net
amount recognized
|
$
|
(1,126
|
)
|
$
|
—
|
$
|
(1,126
|
)
|
||
|
Amounts
recognized in the statement of financial position consist
of:
|
||||||||||
|
Accrued
benefit liability
|
$
|
(1,725
|
)
|
$
|
(315
|
)
|
$
|
(2,040
|
)
|
|
|
Intangible
asset
|
599
|
(599
|
)
|
—
|
||||||
|
Accumulated
other comprehensive income
|
—
|
914
|
914
|
|||||||
|
Fair
value of plan assets at end of year
|
$
|
(1,126
|
)
|
$
|
—
|
$
|
(1,126
|
)
|
||
DIRECTORS’
RETIREMENT PLAN
Pension
Benefit Plans
On
July
19, 2001, the Company and the Bank approved an unfunded non-contributory defined
benefit pension plan ("Directors’ Retirement Plan") and related split dollar
plan for the directors of the bank. The plan provides a retirement benefit
equal
to $1 per year of service as a director, up to a maximum benefit amount of
$15.
The retirement benefit is payable for 10 years following retirement at age
65.
Reduced retirement benefits are available after age 55 and 10 years of service.
The
Bank
uses a December 31 measurement date for this plan.
|
For
the Year Ended December 31,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Change
in benefit obligation
|
||||||||||
|
Benefit
obligation at beginning of year
|
$
|
402
|
$
|
347
|
$
|
244
|
||||
|
Service
cost
|
54
|
73
|
71
|
|||||||
|
Interest
cost
|
24
|
21
|
19
|
|||||||
|
Plan
loss (gain)
|
4
|
(23
|
)
|
28
|
||||||
|
Benefits
paid
|
(15
|
)
|
(15
|
)
|
(15
|
)
|
||||
|
Benefit
obligation at end of year
|
$
|
469
|
$
|
403
|
$
|
347
|
||||
|
Change
in plan assets
|
||||||||||
|
Employer
contribution
|
$
|
15
|
$
|
15
|
$
|
15
|
||||
|
Benefits
paid
|
(15
|
)
|
(15
|
)
|
(15
|
)
|
||||
|
Fair
value of plan assets at end of year
|
$
|
—
|
$
|
—
|
$
|
—
|
||||
|
Reconciliation
of funded status
|
||||||||||
|
Funded
status
|
$
|
(469
|
)
|
$
|
(403
|
)
|
$
|
(347
|
)
|
|
|
Unrecognized
net plan loss
|
50
|
47
|
76
|
|||||||
|
Net
amount recognized
|
$
|
(419
|
)
|
$
|
(356
|
)
|
$
|
(271
|
)
|
|
|
Amounts
recognized in the statement of financial position consist
of:
|
||||||||||
|
Accrued
benefit liability
|
$
|
(469
|
)
|
$
|
(403
|
)
|
$
|
(347
|
)
|
|
|
Accumulated
other comprehensive income
|
50
|
47
|
76
|
|||||||
|
Net
amount recognized
|
$
|
(419
|
)
|
$
|
(356
|
)
|
$
|
(271
|
)
|
|
|
For
the Year Ended December 31,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Components
of net periodic benefit cost
|
||||||||||
|
Service
cost
|
$
|
54
|
$
|
73
|
$
|
71
|
||||
|
Interest
cost
|
24
|
21
|
19
|
|||||||
|
Recognized
actuarial (gain)/loss
|
1
|
5
|
3
|
|||||||
|
Net
periodic benefit cost
|
79
|
99
|
93
|
|||||||
|
Additional
amounts recognized
|
—
|
—
|
—
|
|||||||
|
Total
benefit cost
|
$
|
79
|
$
|
99
|
$
|
93
|
||||
|
Additional
Information
|
||||||||||
|
Minimum
benefit obligation at year end
|
$
|
469
|
$
|
403
|
$
|
347
|
||||
|
Increase
(decrease) in minimum liability included in other comprehensive
loss
|
$
|
3
|
$
|
(
28
|
)
|
$
|
25
|
|||
|
Assumptions
used to determine benefit obligations at December
31
|
2006
|
2005
|
2004
|
|||||||
|
Discount
rate used to determine net periodic benefit cost for years ended
December
31
|
5.30
|
%
|
5.10
|
%
|
6.25
|
%
|
||||
|
Discount
rate used to determine benefit obligations at December 31
|
5.20
|
%
|
5.30
|
%
|
5.10
|
%
|
||||
Plan
Assets
The
Bank
informally funds the liabilities of this plan through life insurance purchased
on the lives of plan participants. This informal funding does not meet the
definition of plan assets within the meaning of pension accounting standards.
Therefore, assets held for this purpose are not disclosed as part of the
Director’s Retirement Plan.
Cash
Flows
Contributions
and Estimated Benefit Payments
For
unfunded plans, contributions to the plan are the benefit payments made to
participants. The Bank paid $15 in benefit payments during fiscal 2006. The
following benefit payments, which reflect expected future service, are expected
to be paid in future fiscal years:
|
Year
ending December 31,
|
Pension
Benefits
|
|
2007
|
$15
|
|
2008
|
21
|
|
2009
|
45
|
|
2010
|
59
|
|
2011
|
70
|
|
2012-2016
|
369
|
Disclosure
of settlements and curtailments:
There
were no events during fiscal 2006 that would constitute a curtailment or
settlement within the meaning of SFAS No. 88.
Impact
of Adopting SFAS No. 158 at December 31, 2006:
|
Reconciliation
of funded status
|
||||||||||
|
Before
Adoption
|
Impact
|
After
Adoption
|
||||||||
|
Funded
Status
|
$
|
(469
|
)
|
$
|
—
|
$
|
(469
|
)
|
||
|
Unrecognized
net plan loss
|
50
|
—
|
50
|
|||||||
|
Net
amount recognized
|
$
|
(419
|
)
|
$
|
—
|
$
|
(419
|
)
|
||
|
Amounts
recognized in the statement of financial position consist
of:
|
||||||||||
|
Accrued
benefit liability
|
$
|
(469
|
)
|
$
|
—
|
$
|
(469
|
)
|
||
|
Accumulated
other comprehensive income
|
50
|
—
|
50
|
|||||||
|
Fair
value of plan assets at end of year
|
$
|
(419
|
)
|
$
|
—
|
$
|
(419
|
)
|
||
EXECUTIVE
ELECTIVE DEFERRED COMPENSATION PLAN — 2001 EXECUTIVE DEFERRAL
PLAN.
On
July
19, 2001, the Bank approved a revised Executive Elective Deferred Compensation
Plan, — the 2001 Executive Deferral Plan previously called “1995 Executive
Deferral Plan”, for certain officers to provide them the ability to make
elective deferrals of compensation due to tax-law limitations on benefit levels
under qualified plans. Deferred amounts earn interest at an annual rate
determined by the Bank’s Board. The plan is a non-qualified plan funded with
bank owned life insurance policies taken on the life of the officer. During
the
year ended December 31, 2001, the Bank purchased insurance making a
single-premium payment aggregating $1,125, which is reported in other assets.
The Bank is the beneficiary and owner of the policies. The cash surrender value
of the related insurance policies as of December 31, 2006 and 2005 totaled
$1,758 and $1,699, respectively. The accrued liability for the plan as of
December 31, 2006 and 2005 totaled $252 and $91, respectively. The expenses
for
the plan for the years ended December 31, 2006, 2005 and 2004 totaled $43,
$30
and $30, respectively.
DIRECTOR
ELECTIVE DEFERRED FEE PLAN
— 2001 DIRECTOR
DEFERRAL PLAN.
On
July
19, 2001, the Bank approved a Director Elective Deferred Fee Plan, — the 2001
Director Deferral Plan for directors to provide them the ability to make
elective deferrals of fees. Deferred amounts earn interest at annual rate
determined by the Bank’s Board. The plan is a non-qualified plan funded with
bank owned life insurance policies taken on the life of the director. The Bank
is the beneficiary and owner of the policies. The cash surrender value of the
related insurance policies as of December 31, 2006 and 2005 totaled $93 and
$90,
respectively. The accrued liability for the plan as of December 31, 2006 and
2005 totaled $5 and $4, respectively. The expenses for the plan for the years
ended December 31, 2006, 2005 and 2004 totaled $1, $1 and $1,
respectively.
|
(8)
|
Income
Taxes
|
The
provision for income tax expense consists of the following for the years ended
December 31:
|
2006
|
2005
|
2004
|
||||||||
|
Current:
|
||||||||||
|
Federal
|
$
|
4,461
|
$
|
4,076
|
$
|
3,193
|
||||
|
State
|
1,211
|
1,382
|
982
|
|||||||
|
5,672
|
5,458
|
4,175
|
||||||||
|
Deferred:
|
||||||||||
|
Federal
|
(112
|
)
|
(488
|
)
|
(495
|
)
|
||||
|
State
|
(391
|
)
|
(178
|
)
|
(130
|
)
|
||||
|
(503
|
)
|
(666
|
)
|
(625
|
)
|
|||||
|
$
|
5,169
|
$
|
4,792
|
$
|
3,550
|
|||||
The
tax
effects of temporary differences that give rise to significant portions of
the
deferred tax assets and deferred tax liabilities at December 31, 2006 and 2005
consist of:
|
2006
|
2005
|
||||||
|
Deferred
tax assets:
|
|||||||
|
Allowance
for loan losses
|
$
|
3,844
|
$
|
3,326
|
|||
|
Deferred
compensation
|
336
|
230
|
|||||
|
Retirement
compensation
|
629
|
521
|
|||||
|
Stock
option compensation
|
439
|
276
|
|||||
|
Post
retirement benefits
|
386
|
276
|
|||||
|
Current
state franchise taxes
|
284
|
454
|
|||||
|
Non-accrual
interest
|
43
|
13
|
|||||
|
Other
|
6
|
—
|
|||||
|
Deferred
tax assets
|
5,967
|
4,820
|
|||||
|
Less
valuation allowance
|
—
|
(83
|
)
|
||||
|
Total
deferred tax assets
|
5,967
|
4,737
|
|||||
|
Deferred
tax liabilities:
|
|||||||
|
Fixed
assets
|
1,506
|
1,683
|
|||||
|
FHLB
dividends
|
170
|
141
|
|||||
|
Tax
credit - loss on passthrough
|
212
|
42
|
|||||
|
Deferred
loan costs
|
231
|
—
|
|||||
|
Other
|
111
|
106
|
|||||
|
Investment
securities unrealized gains
|
50
|
124
|
|||||
|
Total
deferred tax liabilities
|
2,280
|
2,096
|
|||||
|
Net
deferred tax assets (see note 6)
|
$
|
3,687
|
$
|
2,641
|
|||
Based
upon the level of historical taxable income and projections for future taxable
income over the periods during 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.
|
2006
|
2005
|
2004
|
||||||||
|
Income
tax expense at statutory rates
|
$
|
4,753
|
$
|
4,583
|
$
|
3,487
|
||||
|
Reduction
for tax exempt interest
|
(213
|
)
|
(205
|
)
|
(207
|
)
|
||||
|
State
franchise tax, net of federal income tax benefit
|
541
|
750
|
734
|
|||||||
|
CSV
of life insurance
|
(114
|
)
|
(90
|
)
|
(119
|
)
|
||||
|
Other
|
202
|
(246
|
)
|
(345
|
)
|
|||||
|
$
|
5,169
|
$
|
4,792
|
$
|
3,550
|
|||||
A
reconciliation of income taxes computed at the federal statutory rate of 34%
and
the provision for income taxes as follows:
|
(9)
|
Outstanding
Shares and Earnings Per
Share
|
On
January 25, 2007, the Board of Directors of the Company declared a 6% stock
dividend payable as of March 30, 2007 to shareholders of record as of
February 28, 2007. All income per share amounts have been adjusted to give
retroactive effect to stock dividends and stock splits.
Earnings
Per Share (“EPS”)
Basic
and
diluted earnings per share for the years ended December 31, were computed as
follows:
|
2006
|
2005
|
2004
|
||||||||
|
Basic
earnings per share:
|
||||||||||
|
Net
income
|
$
|
8,810
|
$
|
8,688
|
$
|
6,707
|
||||
|
Weighted
average common shares outstanding
|
8,468,643
|
8,531,880
|
8,585,409
|
|||||||
|
Basic
EPS
|
$
|
1.04
|
$
|
1.02
|
$
|
0.78
|
||||
|
Diluted
earnings per share:
|
||||||||||
|
Net
income
|
$
|
8,810
|
$
|
8,688
|
$
|
6,707
|
||||
|
Weighted
average common shares outstanding
|
8,468,643
|
8,531,880
|
8,585,409
|
|||||||
|
Effect
of dilutive options
|
414,282
|
349,716
|
224,507
|
|||||||
|
8,882,925
|
8,881,596
|
8,809,916
|
||||||||
|
Diluted
EPS
|
$
|
0.99
|
$
|
0.98
|
$
|
0.76
|
||||
|
(10)
|
Related
Party Transactions
|
The
Bank,
in the ordinary course of business, has loan and deposit transactions with
directors and executive officers. In management’s opinion, these transactions
were on substantially the same terms as comparable transactions with other
customers of the Bank. The amount of such deposits totaled approximately $2,338
and $2,339 at December 31, 2006 and 2005, respectively.
The
following is an analysis of the activity of loans to executive officers and
directors for the years ended December 31:
|
2006
|
2005
|
2004
|
||||||||
|
Outstanding
balance, beginning of year
|
$
|
304
|
$
|
217
|
$
|
1,187
|
||||
|
Credit
granted
|
58
|
626
|
578
|
|||||||
|
Repayments
|
(89
|
)
|
(539
|
)
|
(1,548
|
)
|
||||
|
Outstanding
balance, end of year
|
$
|
273
|
$
|
304
|
$
|
217
|
||||
|
(11)
|
Profit
Sharing Plan
|
The
Bank
maintains a profit sharing plan for the benefit of its employees. Employees
who
have completed 12 months and 1,000 hours of service are eligible. Under the
terms of this plan, a portion of the Bank’s profits, as determined by the Board
of Directors, will be set aside and maintained in a trust fund for the benefit
of qualified employees. Contributions to the plan, included in salaries and
employee benefits in the consolidated statements of operations, were $1,607,
$1,569 and $1,207 in 2006, 2005 and 2004, respectively.
|
(12)
|
Stock
Compensation Plans
|
On
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
(“SFAS”) No. 123R, “Share-Based Payments,” which addresses the accounting for
stock-based payment transactions whereby an entity receives employee services
in
exchange for equity instruments, including stock options. SFAS No. 123R
eliminates the ability to account for stock-based compensation transactions
using the intrinsic value method under Accounting Principles Board Opinion
(“APB”) No. 25, “Accounting for Stock Issued to Employees,” and instead
generally requires that such transactions be accounted for using a fair-value
based method. The Company has elected the modified prospective transition method
as permitted under SFAS No. 123R, and accordingly prior periods have not been
restated to reflect the impact of SFAS No. 123R. The modified prospective
transition method requires that stock-based compensation expense be recorded
for
all new and unvested stock options that are ultimately expected to vest as
the
requisite service is rendered beginning on January 1, 2006. Stock-based
compensation for awards granted prior to January 1, 2006 is based upon the
grant-date fair value of such compensation as determined under the pro forma
provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” The
Company issues new shares of common stock upon the exercise of stock options.
Prior
to
the adoption of SFAS No. 123R, the Company during the first quarter of fiscal
2003, adopted the fair value recognition provisions of Financial Accounting
Standards Board (“FASB”) Statement No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123, for stock-based employee compensation, effective as of the beginning of
the
fiscal year. Under the prospective method of adoption selected by the Company,
stock-based employee compensation recognized for all stock options granted
after
January 1, 2003 is based on the fair value recognition provisions of Statement
123. For stock options issued prior to January 1, 2003, the Company is using
the
intrinsic value method, under which compensation expense is recorded on the
date
of grant only if the current market price of the underlying stock exceeds the
exercise price. The following table illustrates the effect on net income and
earnings per share as if the fair value based method had been applied to all
outstanding and unvested awards in each period.
The
following table presents basic and diluted EPS for the years ended December
31,
2005 and 2004.
|
2005
|
2004
|
||||||
|
Net
income as reported
|
$
|
8,688
|
$
|
6,707
|
|||
|
Add:
Stock-based employee compensation included in reported net income,
net of
related tax effects
|
286
|
204
|
|||||
|
Deduct:
Total stock-based employee compensation expense determined under
fair
value based method for all awards, net of related tax
effects
|
(367
|
)
|
(363
|
)
|
|||
|
Net
income Pro forma under SFAS No. 123
|
$
|
8,607
|
$
|
6,548
|
|||
|
Basic
earnings per share:
|
|||||||
|
As
reported
|
$
|
1.02
|
$
|
0.78
|
|||
|
|
|||||||
|
Pro
forma under SFAS No. 123
|
$
|
1.01
|
$
|
0.76
|
|||
|
Diluted
earnings per share:
|
|||||||
|
As
reported
|
$
|
0.98
|
$
|
0.76
|
|||
|
Pro
forma under SFAS No. 123
|
$
|
0.97
|
$
|
0.74
|
|||
As
of
December 31, 2006, the Company has the following share-based compensation
plans:
The
Company has two fixed stock option plans. Under the 2000 Employee Stock Option
Plan, the Company may grant options to an employee for an amount up to 25,000
shares of common stock each year. There are 1,657,746 shares authorized under
the plan. The plan will terminate February 27, 2007. The Compensation Committee
of the Board of Directors is authorized to prescribe the terms and conditions
of
each option, including exercise price, vestings or duration of the option.
Generally, options vest at a rate of 25% per year after the first anniversary
of
the date of grant. Options are granted at the fair value of the related common
stock on the date of grant.
Under
the
2000 Outside Directors Non-statutory Stock Option Plan, the Company may grant
options to an outside director for an amount up to 19,881 shares of common
stock
during the director’s lifetime. There are 497,315 shares authorized under the
Plan. The Plan will terminate February 27, 2007. The exercise price of each
option equals the fair value of the Company’s stock on the date of grant, and an
option’s maximum term is five years. Options vest at the rate of 20% per year
beginning on the grant date. Other than a grant of 19,881 shares to a new
director, any future grants require stockholder approval.
Stock
option activity for the employee and outside director’s stock option plans
during the years indicated is as follows:
|
Employee
stock
option
plan
|
Outside
directors
stock
option plan
|
||||||||||||
|
Number
of
shares
|
Weighted
average
exercise
price
|
Number
of
shares
|
Weighted
average
exercise
price
|
||||||||||
|
Balance
at December 31, 2005
|
602,696
|
8.84
|
—
|
—
|
|||||||||
|
Granted
|
57,790
|
24.98
|
—
|
—
|
|||||||||
|
Exercised
|
(132,108
|
)
|
7.52
|
—
|
—
|
||||||||
|
Cancelled
|
(10,425
|
)
|
10.48
|
—
|
—
|
||||||||
|
Balance
at December 31, 2006
|
517,953
|
$
|
10.94
|
—
|
$
|
—
|
|||||||
The
2000
Employee Stock Option Plan permits stock-for-stock exercises of shares. During
2006, employees tendered 29,959 (adjusted for stock options exercised before
stock dividend) mature shares in stock-for-stock exercises. Matured shares
are
those held by employees longer than six months.
The
following table presents information on stock options for the year ended
December 31, 2006:
|
Number
of
Shares
|
Weighted
Average
Exercise
Price
|
Aggregate
Intrinsic
Value
|
Weighted
Average
Remaining
Contractual
Term
|
||||||||||
|
Options
exercised
|
132,108
|
$
|
7.52
|
$
|
2,427
|
||||||||
|
Stock
options fully vested and expected to vest:
|
517,953
|
$
|
10.94
|
$
|
6,246
|
5.90
|
|||||||
|
Stock
options vested and currently exercisable:
|
334,849
|
$
|
8.12
|
$
|
4,899
|
4.78
|
|||||||
The
weighted average fair value per share of options granted during the years ended
December 31 was $7.75 in 2006, $3.98 in 2005 and $3.33 in 2004.
At
December 31, 2006, the range of exercise prices for all outstanding options
ranged from $4.27 to $27.75.
The
following table provides certain information with respect to stock options
outstanding at December 31, 2006:
|
Range
of exercise prices
|
Stock
options
outstanding
|
Weighted
average
exercise
price
|
Weighted
average
remaining
contractual
life
|
|||
|
Under $ 11.10
|
373,972
|
$
8.19
|
4.90
|
|||
|
$
11.10 to $ 16.65
|
80,891
|
12.89
|
8.02
|
|||
|
$
16.65 to $ 24.97
|
54,590
|
24.30
|
9.04
|
|||
|
$
24.97 to $ 27.75
|
8,500
|
27.57
|
9.41
|
|||
|
517,953
|
$
10.94
|
5.90
|
The
following table provides certain information with respect to stock options
exercisable at December 31, 2006:
|
Range
of exercise prices
|
Stock
options
exercisable
|
Weighted
average
exercise
price
|
||
|
Under $ 11.10
|
313,298
|
$
8.19
|
||
|
$
11.10 to $ 16.65
|
20,226
|
12.89
|
||
|
$
16.65 to $ 24.97
|
1,325
|
22.17
|
||
|
334,849
|
$
8.12
|
As
of
December 31, 2006, there was $646 of total unrecognized compensation related
to
non-vested stock options. This cost is expected to be recognized over a weighted
average period of approximately 1.6 years.
The
Company determines fair value at grant date using the Black-Scholes-Merton
pricing model that takes into account the stock price at the grant date, the
exercise price, the risk free interest rate, the volatility of the underlying
stock and the expected life of the option.
The
weighted average assumptions used in the pricing model are noted in the
following table. The expected term of options granted is derived from historical
data on employee exercise and post-vesting employment termination behavior.
The
risk free rate for periods within the contractual life of the option is based
on
the U.S. Treasury yield curve in effect at the time of the grant. Expected
volatility is based on both the implied volatilities from the traded option
on
the Company’s stock and historical volatility on the Company’s
stock.
For
options granted prior to January 1, 2006, and valued in accordance with FAS
123,
the expected volatility used to estimate the fair value of the options was
based
solely on the historical volatility of First Northern Bank’s (the “Bank”) stock.
The Bank recognized option forfeitures as they occurred.
The
Bank
expenses the fair value of the option on a straight line basis over the vesting
period. The Bank estimates forfeitures and only recognizes expense for those
shares expected to vest. The Bank’s estimated forfeiture rate for 2006, based on
historical forfeiture experience, is approximately 0.0%.
The
following table shows our weighted average assumptions used in valuing stock
options granted for the years ended December 31:
|
2006
|
2005
|
2004
|
||||||||
|
Risk
Free Interest Rate
|
4.57
|
%
|
3.73
|
%
|
3.76
|
%
|
||||
|
Expected
Dividend Yield
|
0.00
|
%
|
0.00
|
%
|
0.00
|
%
|
||||
|
Expected
Life in Years
|
4.67
|
6.00
|
6.00
|
|||||||
|
Expected
Price Volatility
|
26.39
|
%
|
26.04
|
%
|
23.80
|
%
|
||||
Employee
Stock Purchase Plan
Under
the
First Northern Community Bancorp 2006 Amended Employee Stock Purchase Plan
(the
“Plan”), the Company is authorized to issue to an eligible employee shares of
common stock. There are 250,000 shares authorized under the Plan. The Plan
will
terminate March 15, 2016. The Plan is implemented by participation periods
of
not more than twenty-seven months each. The Board of Directors determines the
commencement date and duration of each participation period. An eligible
employee is one who has been continually employed for at least ninety (90)
days
prior to commencement of a participation period. Under the terms of the Plan,
employees can choose to have up to 10 percent of their compensation withheld
to
purchase the Company’s common stock each participation period. The purchase
price of the stock is 85 percent of the lower of the fair market value on the
last trading day before the Date of Participation or the fair market value
on
the last trading day during the participation period. Approximately 73 percent
of eligible employees are participating in the Plan in the current participation
period, which began November 24, 2006 and will end November 23,
2007.
The
First
Northern Community Bancorp 2006 Amended Employee Stock Purchase Plan replaced
the 2000 Employee Stock Purchase Plan. Under the 2000 Plan, at the annual stock
purchase date of November 23, 2006, there were $250 in contributions, and
22,784 shares were purchased at an average price of $10.95, totaling $249.
|
(13)
|
Short-Term
and Long-Term Borrowings
|
Short-term
borrowings at December 31, 2006 and 2005 consisted of secured borrowings from
the U.S. Treasury in the amounts of $858 and $1,476, respectively. The funds
are
placed at the discretion of the U.S. Treasury and are callable on demand by
the
U.S. Treasury.
Additional
short-term borrowings available to the Company consist of a line of credit
and
advances with the Federal Home Loan Bank (“FHLB”) secured under terms of a
blanket collateral agreement by a pledge of FHLB stock and certain other
qualifying collateral such as commercial and mortgage loans. At December 31,
2006, the Company had a current collateral borrowing capacity with the FHLB
of
$93,832. The Company also has unsecured formal lines of credit totaling $25,700
with correspondent banks and borrowing capacity of $2,000 with the Federal
Reserve Bank (loans and discounts), which is fully collateralized, with a pledge
of U.S. Agency Notes.
Long-term
borrowings consisted of Federal Home Loan Bank advances, totaling $10,124 and
$13,493, respectively, at December 31, 2006 and 2005. Such advances ranged
in
maturity from 1.4 years to 2.3 years at a weighted average interest rate of
2.91% at December 31, 2006. Maturity ranged from 0.3 years to 3.3 years at
a
weighted average interest rate of 3.48% at December 31, 2005. Average
outstanding balances were $10,776 and $13,628, respectively, during 2006 and
2005. The weighted average interest rate paid was 3.15% in 2006 and 3.48% in
2005.
|
(14)
|
Commitments
and Contingencies
|
The
Company is obligated for rental payments under certain operating lease
agreements, some of which contain renewal options. Total rental expense for
all
leases included in net occupancy and equipment expense amounted to approximately
$1,294, $1,058, and $921 for the years ended December 31, 2006, 2005 and 2004,
respectively. At December 31, 2006, the future minimum payments under
non-cancelable operating leases with initial or remaining terms in excess of
one
year are as follows:
|
Year
ending December 31:
|
||||
|
2007
|
$
|
1,212
|
||
|
2008
|
1,312
|
|||
|
2009
|
1,021
|
|||
|
2010
|
753
|
|||
|
2011
|
512
|
|||
|
Thereafter
|
1,735
|
|||
|
$
|
6,545
|
|||
At
December 31, 2006, the aggregate maturities for time deposits are as
follows:
|
Year
ending December 31:
|
||||
|
2007
|
$
|
104,675
|
||
|
2008
|
4,256
|
|||
|
2009
|
1,278
|
|||
|
2010
|
2,953
|
|||
|
2011
|
274
|
|||
|
Thereafter
|
—
|
|||
|
$
|
113,436
|
|||
The
Company is subject to various legal proceedings in the normal course of its
business. In the opinion of management, after having consulted with legal
counsel, the outcome of the legal proceedings should not have a material effect
on the consolidated financial condition or results of operations of the
Company.
|
(15)
|
Financial
Instruments with Off-Balance Sheet
Risk
|
The
Company is a party to financial instruments with off-balance sheet risk in
the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit in the form of loans
or through standby letters of credit. These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amounts
recognized in the balance sheet. The contract amounts of those instruments
reflect the extent of involvement the Company has in particular classes of
financial instruments.
The
Bank’s exposure to credit loss in the event of non-performance 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 Bank uses the same credit policies in making commitments and
conditional obligations as it does for on-balance sheet
instruments.
Financial
instruments, whose contract amounts represent credit risk at December 31 of
the indicated periods, are as follows:
|
2006
|
2005
|
||||||
|
Undisbursed
loan commitments
|
$
|
198,200
|
203,101
|
||||
|
Standby
letters of credit
|
12,222
|
14,077
|
|||||
|
$
|
210,422
|
217,178
|
|||||
Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since many of the commitments are expected to expire without being
drawn upon the total commitment amounts do not necessarily represent future
cash
requirements. The Bank evaluates each customer’s creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary
by
the Bank upon extension of credit, is based on management’s credit evaluation.
Collateral held varies but may include accounts receivable, inventory, property,
plant and equipment, and income-producing commercial properties.
The
Bank
issues both financial and performance standby letters of credit. The financial
standby letters of credit are primarily to guarantee payment to third parties.
At December 31, 2006 there were no financial standby letters of credit
outstanding. The performance standby letters of credit are typically issued
to
municipalities as specific performance bonds. At December 31, 2006, there was
$12,222 issued in performance standby letters of credit and the Bank carried
no
liability. The terms of the guarantees will expire primarily in 2007. The Bank
has experienced no draws on these letters of credit, and does not expect to
in
the future; however, should a triggering event occur, the Bank either has
collateral in excess of the letter of credit or imbedded agreements of recourse
from the customer. The Bank has set aside a reserve for unfunded commitments
in
the amount of $950, which is recorded in “accrued interest payable and other
liabilities.”
Standby
letters of credit are conditional commitments issued by the Bank to guarantee
the performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers.
Commitments
to extend credit and standby letters of credit bear similar credit risk
characteristics as outstanding loans. As of December 31, 2006, the Company
has
no off-balance sheet derivatives requiring additional disclosure.
|
(16)
|
Capital
Adequacy and Restriction on
Dividends
|
The
Company 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 Company’s
consolidated financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company must meet
specific capital guidelines that involve quantitative measures of the Company’s
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company’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 Tier I Capital ratio (as defined in the regulations)
ranging from 3% to 5% based upon the bank’s CAMELS (capital adequacy, asset
quality, management, earnings, liquidity and sensitivity to market risk)
rating.
Second,
a
bank must meet 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
risk
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 concurrence 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, 2006, that the Bank meets all capital adequacy
requirements to which it is subject. As of December 31, 2006, the most recent
notification from the Federal Deposit Insurance Corporation (“FDIC”) categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Bank must meet
the
minimum ratios as set forth above. There are no conditions or events since
that
notification that management believes have changed the institution’s
category.
The
Company and the Bank had Tier I, total capital and Tier I leverage above the
well capitalized levels at December 31, 2006 and 2005, respectively, as set
forth in the following tables:
|
The
Company
|
|||||||||||||
|
2006
|
2005
|
||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||
|
Total
Risk-Based Capital (to Risk Weighted Assets)
|
$
|
69,078
|
12.3
|
%
|
$
|
62,824
|
11.8
|
%
|
|||||
|
Tier
I Capital (to Risk Weighted Assets)
|
62,400
|
11.1
|
%
|
56,438
|
10.6
|
%
|
|||||||
|
Tier
I Leverage Capital (to Average Assets)
|
62,400
|
9.1
|
%
|
56,438
|
8.5
|
%
|
|||||||
|
The
Bank
|
|||||||||||||
|
2006
|
2005
|
||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||
|
Total
Risk-Based Capital (to Risk Weighted Assets)
|
$
|
68,397
|
12.2
|
%
|
$
|
61,672
|
11.6
|
%
|
|||||
|
Tier
I Capital (to Risk Weighted Assets)
|
61,719
|
11.0
|
%
|
55,287
|
10.4
|
%
|
|||||||
|
Tier
I Leverage Capital (to Average Assets)
|
61,719
|
9.0
|
%
|
55,287
|
8.3
|
%
|
|||||||
Cash
dividends declared by the Bank are restricted under California State banking
laws to the lesser of the Bank’s retained earnings or the Bank’s net income for
the latest three fiscal years, less dividends previously declared during that
period.
|
(17)
|
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 short-term
instruments 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.
Loans
Receivable
For
variable-rate loans that reprice frequently and with no significant change
in
credit risk, fair values are based on carrying values. The fair values for
other
loans (e.g., commercial real estate and rental property mortgage loans,
commercial and industrial loans, and agricultural 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. The carrying
amount of accrued interest receivable approximates its fair value.
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 agreements
and the present creditworthiness of the counterparties. 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 on fees currently charged for similar agreements or on the estimated
cost
to terminate them or otherwise settle the obligation with the counterparties
at
the reporting date.
Deposit
Liabilities
The
fair
values disclosed for demand deposits (e.g., interest and non-interest checking,
passbook 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 certificates of deposit are estimated using
a
discounted cash flow calculation that applies interest rates currently being
offered on certificates to a schedule of aggregated expected monthly maturities
on time deposits. The carrying amount of accrued interest payable approximates
its fair value.
FHLB
Advances and Other Borrowings
The
fair
values of borrowed funds were estimated by discounting future cash flows related
to these financial instruments using current market rates for financial
instruments with similar characteristics.
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 liabilities
and
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 for the years ended
December 31 are approximately as follows:
|
2006
|
2005
|
||||||||||||
|
Carrying
amount
|
Fair
value
|
Carrying
amount
|
Fair
value
|
||||||||||
|
Financial
assets:
|
|||||||||||||
|
Cash
and federal funds sold
|
$
|
98,001
|
$
|
98,001
|
$
|
122,692
|
$
|
122,692
|
|||||
|
Investment
securities
|
76,273
|
76,273
|
48,788
|
48,788
|
|||||||||
|
Loans:
|
|||||||||||||
|
Net
loans
|
475,549
|
475,948
|
456,061
|
457,858
|
|||||||||
|
Loans
held-for-sale
|
4,460
|
4,460
|
4,440
|
4,440
|
|||||||||
|
Financial
liabilities:
|
|||||||||||||
|
Deposits
|
603,682
|
507,688
|
581,781
|
496,881
|
|||||||||
|
FHLB
advances and other borrowings
|
10,981
|
10,528
|
14,969
|
14,416
|
|||||||||
|
2006
|
||||||||||
|
Contract
amount
|
Carrying
amount
|
Fair
value
|
||||||||
|
Unrecognized
financial instruments:
|
||||||||||
|
Commitments
to extend credit
|
$
|
198,200
|
$
|
951
|
$
|
1,487
|
||||
|
Standby
letters of credit
|
$
|
12,222
|
$
|
—
|
$
|
122
|
||||
|
2005
|
||||||||||
|
Contract
amount
|
Carrying
amount
|
Fair
value
|
||||||||
|
Unrecognized
financial instruments:
|
||||||||||
|
Commitments
to extend credit
|
$
|
203,101
|
$
|
975
|
$
|
1,523
|
||||
|
Standby
letters of credit
|
$
|
14,077
|
$
|
—
|
$
|
141
|
||||
|
(18)
|
Supplemental
Consolidated Statements of Cash Flows
Information
|
Supplemental
disclosures to the Consolidated Statements of Cash Flows for the years ended
December 31, are as follows:
|
2006
|
2005
|
2004
|
||||||||
|
Supplemental
disclosure of cash flow information:
|
||||||||||
|
Cash
paid during the year for:
|
||||||||||
|
Interest
|
$
|
9,243
|
$
|
5,641
|
$
|
3,417
|
||||
|
Income
taxes
|
$
|
6,165
|
$
|
6,946
|
$
|
3,931
|
||||
|
Supplemental
disclosure of non-cash investing and financing activities:
|
||||||||||
|
Accrued
compensation
|
$
|
(84
|
)
|
$
|
—
|
$
|
—
|
|||
|
Stock
dividend distributed
|
$
|
12,525
|
$
|
6,158
|
$
|
5,537
|
||||
|
Loans
held-for-sale transferred to loans
|
$
|
—
|
$
|
—
|
$
|
6,002
|
||||
|
Loans
held-for-investment transferred to other real estate owned
|
$
|
375
|
$
|
268
|
$
|
—
|
||||
|
(19)
|
Quarterly
Financial Information
(Unaudited)
|
|
March 31,
|
June 30,
|
September 30,
|
December 31,
|
||||||||||
|
2006:
|
|||||||||||||
|
Interest
income
|
$
|
11,331
|
$
|
11,896
|
$
|
12,408
|
$
|
12,435
|
|||||
|
Net
interest income
|
9,372
|
9,776
|
9,857
|
9,619
|
|||||||||
|
Provision
for loan losses
|
(575
|
)
|
350
|
810
|
150
|
||||||||
|
Other
operating income
|
1,209
|
1,363
|
1,446
|
1,271
|
|||||||||
|
Other
operating expense
|
7,327
|
7,141
|
7,250
|
7,501
|
|||||||||
|
Income
before taxes
|
3,849
|
3,648
|
3,243
|
3,239
|
|||||||||
|
Net
income
|
2,402
|
2,294
|
2,048
|
2,066
|
|||||||||
|
Basic
earnings per share
|
.28
|
.27
|
.25
|
.24
|
|||||||||
|
Diluted
earnings per share
|
.26
|
.26
|
.24
|
.23
|
|||||||||
|
2005:
|
|||||||||||||
|
Interest
income
|
$
|
9,154
|
$
|
10,022
|
$
|
10,590
|
$
|
11,136
|
|||||
|
Net
interest income
|
8,086
|
8,731
|
9,022
|
9,334
|
|||||||||
|
Provision
for loan losses
|
519
|
(450
|
)
|
(69
|
)
|
600
|
|||||||
|
Other
operating income
|
1,218
|
1,346
|
1,506
|
1,650
|
|||||||||
|
Other
operating expense
|
6,368
|
6,829
|
6,760
|
6,856
|
|||||||||
|
Income
before taxes
|
2,417
|
3,698
|
3,837
|
3,528
|
|||||||||
|
Net
income
|
1,692
|
2,323
|
2,418
|
2,255
|
|||||||||
|
Basic
earnings per share
|
.20
|
.27
|
.28
|
.27
|
|||||||||
|
Diluted
earnings per share
|
.19
|
.26
|
.27
|
.26
|
|||||||||
|
(20)
|
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
and summary statements of operations and cash flows information for the years
ended December 31:
|
Balance
Sheets
|
2006
|
2005
|
|||||
|
Assets
|
|||||||
|
Cash
|
$
|
681
|
$
|
1,151
|
|||
|
Investment
in wholly owned subsidiary
|
61,309
|
55,651
|
|||||
|
Other
assets
|
—
|
—
|
|||||
|
Total
assets
|
$
|
61,990
|
$
|
56,802
|
|||
|
Liabilities
and stockholders’ equity
|
|||||||
|
Stockholders’
equity
|
61,990
|
56,802
|
|||||
|
Total
liabilities and stockholders’ equity
|
$
|
61,990
|
$
|
56,802
|
|||
|
Statements
of Operations
|
2006
|
2005
|
2004
|
|||||||
|
Dividends
from subsidiary
|
$
|
2,500
|
$
|
3,500
|
$
|
1,000
|
||||
|
Other
operating expenses
|
(94
|
)
|
(97
|
)
|
(68
|
)
|
||||
|
Income
tax benefit
|
39
|
40
|
28
|
|||||||
|
Income
before undistributed earnings of subsidiary
|
2,445
|
3,443
|
960
|
|||||||
|
Equity
in undistributed earnings of subsidiary
|
6,365
|
5,245
|
5,747
|
|||||||
|
Net
income
|
$
|
8,810
|
$
|
8,688
|
$
|
6,707
|
||||
|
Statements
of Cash Flows
|
2006
|
2005
|
2004
|
|||||||
|
Net
income
|
$
|
8,810
|
$
|
8,688
|
$
|
6,707
|
||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities
|
||||||||||
|
Decrease
(increase) in other assets
|
—
|
11
|
(10
|
)
|
||||||
|
Equity
in undistributed earnings of subsidiary
|
(6,365
|
)
|
(5,245
|
)
|
(5,747
|
)
|
||||
|
Net
cash provided by operating activities
|
2,445
|
3,454
|
950
|
|||||||
|
Cash
flows from financing activities:
|
||||||||||
|
Common
stock issued
|
1,288
|
948
|
758
|
|||||||
|
Stock
repurchases
|
(4,188
|
)
|
(3,854
|
)
|
(1,640
|
)
|
||||
|
Cash
in lieu of fractional shares
|
(15
|
)
|
(15
|
)
|
(12
|
)
|
||||
|
Net
cash used in financing activities
|
(2,915
|
)
|
(2,921
|
)
|
(894
|
)
|
||||
|
Net
change in cash
|
(470
|
)
|
533
|
56
|
||||||
|
Cash
at beginning of year
|
1,151
|
618
|
562
|
|||||||
|
Cash
at end of year
|
$
|
681
|
$
|
1,151
|
$
|
618
|
||||
ITEM
9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
ITEM
9A - CONTROLS AND PROCEDURES
(a) Disclosure
controls and procedures
The
Company maintains “disclosure controls and procedures,” as such term is defined
in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934
(the “Exchange Act”), that are designed to ensure that information required to
be disclosed in reports that the Company files or submits under the Exchange
Act
is recorded, processed, summarized, and reported within the time periods
specified in Securities and Exchange Commission rules and forms, and that such
information is accumulated and communicated to management, including the
Company’s chief executive officer and chief financial officer, as appropriate,
to allow timely decisions regarding required disclosure. The Company’s
disclosure controls and procedures have been designed to meet and management
believes that they meet reasonable assurance standards. Based on their
evaluation as of the end of the period covered by this Annual Report on Form
10-K, the chief executive officer and chief financial officer have concluded
that the Company’s disclosure controls and procedures were effective to ensure
that material information relating to the Company, including its consolidated
subsidiary, is made known to them by others within those entities.
(b)
Internal controls over financial reporting
The
management of the Company is responsible for the preparation, integrity and
fair
presentation of its published financial statements and all other information
presented in the Company’s consolidated financial statements. The Company’s
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America (“US
GAAP”) and, as such, include amounts based on informed judgments and estimates
made by management.
Management
maintains a system of internal accounting controls to provide reasonable
assurance that assets are safeguarded and transactions are executed in
accordance with management’s authorization and recorded properly to permit the
preparation of consolidated financial statements in accordance with US GAAP.
Management recognizes that even a highly effective internal control system
has
inherent risks, including the possibility of human error and the circumvention
or overriding of controls, and that the effectiveness of an internal control
system can change with circumstances. Management has assessed the effectiveness
of the Company’s internal control over financial reporting as of December 31,
2006. In making this assessment, management used the following criteria:
criteria established in Internal Control - Integrated Framework issued by
Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based
on Management’s assessment, they believe that, as of December 31, 2006, the
Company’s internal control system over financial reporting is effective based on
those criteria. “Management’s Report on Internal Control over Financial
Reporting” is presented on page 44.
The
Audit
Committee of the Board of Directors is comprised entirely of directors who
are
independent of the Company’s Management. It includes an audit committee
technical expert and members with banking or related financial management
expertise and who are not large customers of the Bank. The Audit Committee
has
access to outside counsel. The Audit Committee is responsible for selecting
the
independent registered public accounting firm subject to ratification by the
shareholders. It meets periodically with management, the independent registered
public accounting firm, and the internal auditors to provide a reasonable basis
for concluding that the Audit Committee is carrying out its responsibilities.
The Audit Committee is also responsible for performing an oversight role by
reviewing and monitoring Management’s financial, accounting, and auditing
procedures in addition to reviewing Management’s financial reports. The
independent registered public accounting firm and internal auditors have full
and free access to the Audit Committee, with or without the presence of
management; to discuss the adequacy of internal controls for financial reporting
and any other matters which they believe should be brought to the attention
of
the Audit Committee.
The
Company’s assessment of the effectiveness of internal control over financial
reporting and the Company’s consolidated financial statements have been audited
by MOSS ADAMS LLP, an independent registered public accounting firm, which
was
given unrestricted access to all financial records and related data, including
minutes of all meetings of shareholders, the Board of Directors and committees
of the Board. Management believes that all representations made to the
independent registered public accounting firm during their audit were valid
and
appropriate. The independent registered public accounting firm’s report is
presented on page 45.
During
the quarter ended December 31, 2006, there were no changes in the Company's
internal controls over financial reporting that have materially affected, or
are
reasonably likely to materially affect, the Company’s internal controls over
financial reporting.
ITEM
9B - OTHER INFORMATION
None.
PART
III
ITEM
10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT AND
CORPORATE GOVERNANCE
The
information called for by this item with respect to director and executive
officer information is incorporated by reference herein from the sections of
the
Company’s proxy statement for the 2007 Annual Meeting of Shareholders entitled
“Executive Officers,” “Security Ownership of Certain Beneficial Owners and
Management,” “Executive Compensation” “Report of Audit Committee,” “Section
16(a) Beneficial Ownership Compliance” and “Nomination and Election of
Directors.”
The
Company has adopted a Code of Conduct, which complies with the Code of Ethics
requirements of the Securities and Exchange Commission. A copy of the Code
of
Conduct is posted on the “Investor Relations” page of the Company’s website, or
is available, without charge, upon the written request of any shareholder
directed to Lynn Campbell, Corporate Secretary, First Northern Community
Bancorp, 195 North First Street, Dixon, California 95620. The Company intends
to
disclose promptly any amendment to, or waiver from any provision of, the Code
of
Conduct applicable to senior financial officers, and any waiver from any
provision of the Code of Conduct applicable to directors, on the “Investor
Relations” page of its website.
The
Company’s website address is www.thatsmybank.com.
ITEM
11 - EXECUTIVE COMPENSATION
The
information called for by this item is incorporated by reference herein from
the
sections of the Company’s proxy statement for the 2007 Annual Meeting of
Shareholders entitled “Compensation Committee Interlocks and Insider
Participation,” “Nomination and Election of Directors,” “Compensation Discussion
and Analysis,” “Compensation Committee Report,” “Transactions with Related
Persons,” “Director Compensation,” and “Executive Compensation.”
ITEM
12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information
concerning ownership of the equity stock of the Company by certain beneficial
owners and management is incorporated herein by reference from the sections
of
the Company’s proxy statement for the 2007 Annual Meeting of Shareholders
entitled “Security Ownership of Management” and “Nomination and Election of
Directors.”
Stock
Purchase Equity Compensation Plan Information
The
following table shows the Company’s equity compensation plans approved by
security holders. The table also indicates the number of securities to be issued
upon exercise of outstanding options, weighted average exercise price of
outstanding options and the number of securities remaining available for future
issuance under the Company’s equity compensation plans as of December 31, 2006.
The plans included in this table are the Company’s 2000 Stock Option Plan, the
Company’s Outside Director 2000 Non-statutory Stock Option Plan and the
Company’s 2006 Amended Employee Stock Purchase Plan. See“Stock
Compensation Plans” Note 12 of Notes to Consolidated Financial Statements (page
68) included in this report.
|
Plan
category
|
Number
of securities to be issued upon exercise of outstanding options,
warrants
and rights (a)
|
Weighted-average
exercise price of outstanding options, warrants and rights
(b)
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column
(a))
|
|||
|
Equity
compensation plans approved by security holders
|
519,656
|
$10.97
|
1,012,452
|
|||
|
Equity
compensation plans not approved by security holders
|
—
|
—
|
—
|
|||
|
Total
|
519,656
|
$10.97
|
1,012,452
|
ITEM
13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
The
information called for by this item is incorporated herein by reference from
the
sections of the Company’s proxy statement for the 2007 Annual Meeting of
Shareholders entitled “Director Independence” and “Transactions with Related
Persons.”
ITEM
14 - PRINCIPAL
ACCOUNTANT FEES AND SERVICES
The
information called for by this item is incorporated herein by reference from
the
section of the Company’s proxy statement for the 2007 Annual Meeting of
Shareholders entitled “Audit and Non-Audit Fees.”
PART
IV
ITEM
15 - EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES
|
(a)(1)
|
Financial
Statements:
|
Reference
is made to the Index to Financial Statements under Item 8 in Part II of this
Form 10-K
|
(a)(2)
|
Financial
Statement Schedules:
|
All
schedules to the Company’s Consolidated Financial Statements are omitted because
of the absence of the conditions under which they are required or because the
required information is included in the Consolidated Financial Statements or
accompanying notes.
|
(a)(3)
|
Exhibits:
|
The
following is a list of all exhibits filed as part of this Annual Report on
Form
10-K
|
Exhibit
Number
|
Exhibit
|
|
|
Amended
Articles of Incorporation of the Company - provided
herewith
|
||
|
3.3
|
Amended
and Restated Bylaws of the Company - incorporated by reference to
Exhibit
3.1 of the Registrant’s Current Report on Form 8-K on September 15,
2005
|
|
|
10.1
|
First
Northern Community Bancorp 2000 Stock Option Plan - incorporated
herein by
reference to Exhibit 4.1 of Registrant’s Registration Statement on Form
S-8 on May 25, 2000 *
|
|
|
10.2
|
First
Northern Community Bancorp Outside Directors 2000 Non-statutory Stock
Option Plan - incorporated herein by reference to Exhibit 4.3 of
Registrant’s Registration Statement on Form S-8 on May 25, 2000
*
|
|
|
10.3
|
Amended
First Northern Community Bancorp Employee Stock Purchase Plan -
incorporated by reference to Appendix B of the Company’s Definitive Proxy
Statement on Schedule 14A for its 2006 Annual Meeting of Shareholders
|
|
|
10.4
|
First
Northern Community Bancorp 2000 Stock Option Plan Forms “Incentive Stock
Option Agreement” and “Notice of Exercise of Stock Option” - incorporated
herein by reference to Exhibit 4.2 of Registration Statement on Form
S-8
on May 25, 2000 *
|
|
|
10.5
|
First
Northern Community Bancorp 2000 Outside Directors 2000 Non-statutory
Stock
Option Plan Forms “Non-statutory Stock Option Agreement” and “Notice of
Exercise of Stock Option” - incorporated herein by reference to Exhibit
4.4 of Registrant’s Registration Statement on Form S-8 May 25, 2000
*
|
|
|
10.6
|
First
Northern Community Bancorp 2000 Employee Stock Purchase Plan Forms
“Participation Agreement” and “Notice of Withdrawal” - incorporated herein
by reference to Exhibit 4.6 of Registration Statement on Form S-8
on May
25, 2000 *
|
|
|
10.7
|
Amended
and Restated Employment Agreement entered into as of July 23, 2001
by and
between First Northern Bank of Dixon and Don Fish - incorporated
herein by
reference to Exhibit 10.1 to Quarterly Report on Form 10-Q for the
quarter
ended September 30, 2001 *
|
|
10.8
|
Employment
Agreement entered into as of July 23, 2001 by and between First Northern
Bank of Dixon and Owen J. Onsum - incorporated herein by reference
to
Exhibit 10.2 of Registrant’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2001 *
|
|
|
10.9
|
Employment
Agreement entered into as of July 23, 2001 by and between First Northern
Bank of Dixon and Louise Walker - incorporated herein by reference
to
Exhibit 10.3 of Registrant’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2001 *
|
|
|
10.10
|
Employment
Agreement entered into as of July 23, 2001 by and between First Northern
Bank of Dixon and Robert Walker - incorporated herein by reference
to
Exhibit 10.4 of Registrant’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2001 *
|
|
|
10.11
|
Form
of Director Retirement and Split Dollar Agreements between First
Northern
Bank of Dixon and Lori J. Aldrete, Frank J. Andrews Jr., John M.
Carbahal,
Gregory DuPratt, John F. Hamel, Diane P. Hamlyn, Foy S. McNaughton,
William Jones, Jr. and David Schulze - incorporated herein by reference
to
Exhibit 10.11 to Registrant’s Annual Report on Form 10-K for the year
ended December 31, 2001 *
|
|
|
10.12
|
Form
of Salary Continuation and Split Dollar Agreement between First Northern
Bank of Dixon and Owen J. Onsum, Louise A. Walker, Don Fish, and
Robert
Walker - incorporated herein by reference to Exhibit 10.12 to Registrant’s
Annual Report on Form 10-K for the year ended December 31, 2001
*
|
|
|
10.13
|
Amended
Form of Director Retirement and Split Dollar Agreements between First
Northern Bank of Dixon and Lori J. Aldrete, Frank J. Andrews Jr.,
John M.
Carbahal, Gregory DuPratt, John F. Hamel, Diane P. Hamlyn, Foy S.
McNaughton, William Jones, Jr. and David Schulze - by reference to
Exhibit
10.13 to Registrant’s Annual Report on Form 10-K for the year ended
December 31, 2005 *
|
|
|
10.14
|
Amended
Form of Salary Continuation and Split Dollar Agreement between First
Northern Bank of Dixon and Owen J. Onsum, Louise A. Walker, Don Fish,
and
Robert Walker - by reference to Exhibit 10.14 to Registrant’s Annual
Report on Form 10-K for the year ended December 31, 2005
*
|
|
|
Form
of Salary Continuation Agreement between Pat Day and First Northern
Bank
of Dixon - provided herewith*
|
||
|
Form
of Supplemental Executive Retirement Plan Agreement between First
Northern
Bank of Dixon and Owen J. Onsum and Louise A. Walker - provided
herewith*
|
||
|
10.17
|
First
Northern Bancorp 2006 Stock Incentive Plan - incorporated by reference
to
Appendix A of the Company’s Definitive Proxy Statement on Schedule 14A for
its 2006 Annual Meeting of Shareholders *
|
|
|
First
Northern Bank Annual Incentive Compensation Plan - provided
herewith
|
||
|
11
|
Statement
of Computation of Per Share Earnings (See
Page 55 of this Form 10-K)
|
|
|
Subsidiaries
of the Company - provided herewith
|
||
|
Consent
of independent registered public accounting firm - provided
herewith
|
||
|
Consent
of independent registered public accounting firm - provided
herewith
|
||
|
Rule
13(a) - 14(a) / 15(d) -14(a) Certification of the Company’s Chief
Executive Officer - provided herewith
|
||
|
Rule
13(a) - 14(a) / 15(d) -14(a) Certification of the Company’s Chief
Financial Officer - provided herewith
|
||
|
Section
1350 Certification of the Chief Executive Officer - provided
herewith
|
||
|
Section
1350 Certification of the Chief Financial Officer - provided
herewith
|
||
|
*
Management contract or compensatory plan or
arrangement.
|
||
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, the registrant has duly caused this report to be signed on
its
behalf by the undersigned, thereunto duly authorized, on March 15,
2007.
|
FIRST
NORTHERN COMMUNITY BANCORP
|
||
|
By:
|
/s/
Owen J. Onsum
|
|
|
Owen
J. Onsum
|
||
|
President/Chief
Executive Officer/Director
|
||
|
(Principal
Executive Officer)
|
||
|
By:
|
/s/
Louise A. Walker
|
|
|
Louise
A. Walker
|
||
|
Senior
Executive Vice President/Chief Financial Officer
|
||
|
(Principal
Financial Officer)
|
||
|
By:
|
/s/
Stanley R. Bean
|
|
|
Stanley
R. Bean
|
||
|
Senior
Vice President/Controller
|
||
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
|
Name
|
Title
|
Date
|
||
|
/s/
LORI J. ALDRETE
|
Director
|
March
15, 2007
|
||
|
Lori
J. Aldrete
|
||||
|
/s/
FRANK J. ANDREWS, JR.
|
Director
and Chairman of the Board
|
March
15, 2007
|
||
|
Frank
J. Andrews, Jr.
|
||||
|
/s/
JOHN M. CARBAHAL
|
Director
|
March
15, 2007
|
||
|
John
M. Carbahal
|
||||
|
/s/
GREGORY DUPRATT
|
Director
and Vice Chairman of the Board
|
March
15, 2007
|
||
|
Gregory
DuPratt
|
||||
|
/s/
JOHN F. HAMEL
|
Director
|
March
15, 2007
|
||
|
John
F. Hamel
|
||||
|
/s/
DIANE P. HAMLYN
|
Director
|
March
15, 2007
|
||
|
Diane
P. Hamlyn
|
||||
|
/s/
FOY S. MCNAUGHTON
|
Director
|
March
15, 2007
|
||
|
Foy
S. McNaughton
|
||||
|
/s/
DAVID W. SCHULZE
|
Director
|
March
15, 2007
|
84