ITEM 1. BUSINESS
The Company
The Bank Holdings
The Bank Holdings is a bank holding company incorporated in Nevada on January 17, 2003 and registered under the Bank Holding Company Act of 1956, as amended. We conduct banking operations through our principal subsidiary, Nevada Security Bank, a Nevada state-chartered commercial bank which also operates in northern California under the name Silverado Bank. We and Nevada Security Bank are both headquartered in Reno, Nevada at 9990 Double R Boulevard. We acquired all of the outstanding shares of Nevada Security Bank on August 29, 2003. On November 6, 2006, the Company acquired through merger NNB Holdings, Inc. in Reno, Nevada and its subsidiary bank Northern Nevada Bank whose branches became part of Nevada Security Bank.
During the first quarter of 2006, the Company acquired two qualified intermediary (the “QI”) companies, Rocky Mountain Exchange (formerly known as Big Sky Property Exchange) and 75% of Granite Exchange, Inc., which facilitate tax-deferred real estate transactions under Section 1031 of the Internal Revenue Code. In January 2007 the Company acquired an additional 5% of Granite Exchange, Inc. at a predetermined cost of $260,000 from one of its minority shareholders. This transaction increased the Company’s ownership to 80% and allowed the Company to include Granite Exchange in its consolidated tax returns. Effective February 1, 2008 the Company acquired the remaining 20% of Granite Exchange, at a predetermined cost of approximately $1.0 million, and is now the sole owner. Rocky Mountain Exchange is located in Bozeman Montana, and Granite Exchange is headquartered in Roseville, California. Qualified intermediaries select the financial institution to hold depositor accounts created as part of the exchange transactions. The exchange balances deposited into the Bank should increase the Bank’s core deposits, decrease the Bank’s loan to deposit ratio, and support future loan growth. These subsidiaries have been consolidated on the Company’s books.
The Company’s other direct subsidiaries are The Bank Holdings Statutory Trust I, a Connecticut statutory trust which was formed in November, 2005 solely to facilitate the issuance of variable rate capital trust pass through securities and NNB Holdings Statutory Trust I which was formed in June 2005 as a subsidiary of NNB Holdings, Inc., and was acquired by the Company in the merger with NNB Holdings, Inc. NNB Holdings Statutory Trust I is a Delaware Statutory Trust also formed to facilitate the issuance of capital trust pass through securities. The additional regulatory capital generated through the securities has enabled the Company to follow previously established expansion plans without an impairment of risk-based capital ratios. Pursuant to FASB Interpretation No. 46 Consolidation of Variable Interest Entities (FIN 46), The Bank Holdings Statutory Trust I and NNB Holdings Statutory Trust I are not reflected on a consolidated basis in the financial statements of the Company.
The Bank Holdings and its QI subsidiaries have nine full and part-time employees who are not also employees of Nevada Security Bank. The Company exists primarily for the purpose of holding the stock of the Bank and of other such subsidiaries it may acquire or establish. References herein to the “Company” include the Company and its consolidated subsidiaries, unless the context indicates otherwise.
The Company’s stock is traded on the NASDAQ Stock Market under the symbol TBHS, and as such the Company is subject to NASDAQ rules and regulations including those related to corporate governance. The Company is also subject to the periodic reporting requirements of Section 13 of the Securities Exchange Act of 1934 (the “Exchange Act”) which requires the Company to file annual, quarterly and other current reports with the Securities and Exchange Commission (the “SEC”). The Company is subject to additional regulations including, but not limited to, the proxy and tender offer rules promulgated by the SEC under Sections 13 and 14 of the Exchange Act; the reporting requirements of directors, executive officers and principal shareholders regarding transactions in the Company’s common stock and short-swing profits rules promulgated by the SEC under Section 14 of the Exchange Act; and certain additional reporting requirements by principal shareholders of the Company promulgated by the SEC under Section 13 of the Exchange Act.
The Company’s strategy has been to profitably grow its business through internal growth and selective acquisitions. We continue to look for profitable expansion opportunities in existing and contiguous markets. At December 31, 2007, the Company had consolidated assets of $626.6 million, gross loans of $474.8 million, deposits of $451.3 million and shareholder’s equity of $74.8 million.
The Company’s principal sources of income are from interest earning assets held in portfolio, as well as dividends from the Bank, which are currently restricted, and the income from the qualified intermediary companies. The Company intends to explore supplemental sources of income in the future. The Company’s website is www.thebankholdings.com.
Copies of the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 are available free of charge through the Company’s website (www.thebankholdings.com) as soon as reasonably practicable after the Company has filed the material with, or furnished it to, the Securities and Exchange Commission. This information is also available at www.sec.gov, Bank Holdings CIK#000-1234383.
The 1031 Division
During March 2006, the Federal Reserve Board approved the Company’s acquisition of Rocky Mountain Exchange (formerly Big Sky Property Exchange) of Bozeman, Montana and Granite Exchange Inc., of
Roseville, California. These companies are qualified intermediaries under Section 1031 of the Internal Revenue Code. The websites for these companies are: www.rockymountainexchange.com for Rocky Mountain Exchange and www.ges1031.com for Granite Exchange. These companies have seven full time equivalent employees.
A qualified intermediary (“QI”) is the professional provider of the mandatory mechanics of a 1031 exchange. The use of a qualified intermediary, as an independent party to facilitate a tax-deferred exchange, is a safe harbor established by Treasury Regulations. These qualified intermediaries are frequently referred to as accommodators or exchange facilitators. When the taxpayer engages the services of “QI” pursuant to an exchange agreement, the IRS does not consider the taxpayer to be in receipt of any funds from the transaction. The sales proceeds go directly to the QI, which holds them until they are needed to acquire any replacement property. The QI then delivers the funds directly to the closing agent who completes, generally with a title company, the deeding of the property directly to the taxpayer. Without a QI, and pursuant to an exchange agreement, the IRS may not define a transaction as an exchange, thereby making it ineligible for tax deferment status.
The theory behind Section 1031 is that when a property owner has reinvested the sales proceeds into another property, the economic gain has not been realized in a way that generates funds to pay any tax. This means that the taxpayers investment is still the same, only the form has changed (e.g. from a rental house to a rented six-unit apartment building). Therefore, it would be unfair to force the taxpayer to pay tax on a “form, not substance”, transfer. These like-kind exchanges under Section 1031 are tax deferred, not tax-free. When the replacement property is ultimately sold, (not as part of another exchange) the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.
The Company, through its 1031 Division, places funds that may be generated from such transactions in the subsidiary bank, or in other financial institutions where at least a portion of such funds are guaranteed by FDIC insurance. Such funds are of a short term (less than 180 days until maturity) nature, and are traditionally characterized as savings or money market deposits.
The address of the Company’s 1031 QI’s are as follows:
Rocky Mountain Exchange:
Stoneridge Drive Suite 3
Bozeman, Montana 59718
(866) 554-1031
Purchased: March 24, 2006
Granite Exchange:
Rocky Ridge Drive, Suite 280
Roseville, California 95661
(877) 937-1031
Purchased: March 28, 2006
The Bank
Nevada Security Bank
Nevada Security Bank was incorporated under the laws of the State of Nevada on February 26, 2001, and was licensed by the Nevada Commissioner of Financial Institutions and commenced operations as a Nevada state-chartered bank on December 27, 2001. The Bank’s website is: www.nevadasecuritybank.com.
Nevada Security Bank (NSB) operates from its head office in Reno, Nevada. Additional Reno branches are Moana and MaeAnne. The Bank also has branch offices in Carson City, Sparks, and Incline Village, Nevada as well as Roseville and Rancho Cordova, California. Incline Village is located on the north shore of Lake Tahoe, Nevada, approximately 25 miles south of Reno, Nevada. Roseville and Rancho Cordova are located in the Sacramento, California environs, about 124 miles southwest of Reno, Nevada. These California branches are separately branded as Silverado Bank, a division of NSB. Silverado Bank also focuses on government guaranteed loans through the Small Business Administration, or SBA. The addresses of our locations are as follows:
Northern Nevada
Main
Double R Boulevard
Office:
Reno, Nevada 98521
(775) 853-8600
Date of opening: 12/27/01
MaeAnne
Robb Drive
Reno:
Reno, Nevada 89523
(775) 746-9800
Date of opening: 10/11/04
Moana
So. Virginia St.
Reno:
Reno, Nevada 89502
(775) 689-6555
Date of Opening: 10/23/00
Operations
Riggins Court #5
Center
Reno, Nevada
Reno:
(775) 689-6575
Date of Opening: 8/11/00
Northern California
Roseville:
Douglas Blvd., Ste 220
Roseville, California 95661-4239
(916) 787-1900
Date of opening: 3/18/05
Rancho
Sunrise Blvd. Ste 100
Cordova:
Rancho Cordova, CA 95742
(916) 288-1500
Date of opening: 6/4/07
Incline Village:
Tahoe Boulevard, Suite 101
Incline Village, Nevada 89451
(775) 832-8100
Date of opening: 3/6/02
Sparks:
Isidor Court #203
Sparks, NV 89431
Phone: (775) 424-1500
Date of Opening: 3/27/06
Carson City:
Highway 50 East #1
Carson City, NV 89701
(775) 687-2323
Date of Opening: 5/9/05
As an independent community oriented commercial bank, Nevada Security Bank offers a full range of consumer and commercial banking services primarily to the business and professional community and individuals located in two primary areas; Washoe, Douglas and Carson City counties, in Nevada and Placer and Sacramento Counties, in California. Nevada Security Bank has a full complement of lending activities, including commercial and industrial, real estate construction, real estate mortgage, as well as agricultural and consumer loans, with particular emphasis on short and medium-term obligations. Nevada Security Bank’s loan portfolio is not concentrated in any one industry, although approximately 80% of Nevada Security
Bank’s loans are secured by real estate. A loan may be secured (in whole or in part) by real estate even though the purpose of the loan is not to facilitate the purchase or development of real estate.
As of December 31, 2006, the principal areas in which we directed our lending activities, and the percentage of our total loan portfolio for which each of those areas was responsible, were as follows: (i) loans secured by real estate 79.7%; (ii) commercial and industrial (including USDA) loans, 18.6%, and (iii) consumer loans 1.7%. See Appendix 6 for further information.
Nevada Security Bank offers a wide range of deposit instruments including personal and business checking accounts and savings accounts, interest-bearing negotiable order of withdrawal accounts, money market accounts and time certificates of deposit. Most of Nevada Security Bank’s deposits are attracted from individuals and from small and medium-sized business-related sources. Its deposits are insured under the Federal Deposit Insurance Act up to applicable limits, and subject to regulations by that federal agency. The Bank is subject to periodic examinations of its operations and verification of compliance with applicable laws and regulations issued by the FDIC and the Nevada Financial Institutions Division.
As of December 31, 2007 the Bank had 7,512 deposit accounts with balances totaling approximately $451.3 million and as of December 31, 2006 there were reported, 9,512 deposit accounts with balances totaling approximately $447.0 million, compared to 4,196 deposit accounts with balances totaling approximately $338.2 million at December 31, 2005. After the data conversion in December, 2006 to accommodate the purchase of Northern Nevada Bank, the Company purged closed and zero balance accounts which lead to a reduction of 3,807 deposit accounts that were reported open as of December 31, 2006. We attract deposits through our customer oriented product mix, competitive pricing, and convenient locations where all are provided with the highest level of customer service. Further, we offer shared ATM and point-of-sale (POS) networks to allow customer access to national and international funds transfer networks, as well as remote capture devises to speed a customer’s deposit funding efficiency.
In addition to the loan and deposit services Nevada Security Bank also offers a wide range of specialized services designed to attract and meet the needs of commercial customers and personal account holders. These services include cashiers’ checks, travelers’ checks and foreign drafts. Nevada Security Bank does not operate a trust department; however, it has made an arrangement with a private trust company to offer trust services to its customers on request. Most of Nevada Security Bank’s business originates from within Washoe and Douglas Counties, Nevada; however, Placer County, California is a substantial source of additional business through Silverado Bank, a division of Nevada Security Bank. Neither Nevada Security Bank’s business nor liquidity is seasonal, and there have been no material effects upon Nevada Security Bank’s capital expenditures, earnings or competitive position as a result of federal, state or local environmental regulation, except as regards the implementation costs of the Sarbanes-Oxley Act, Section 404.
The Company
The Company has not engaged in any material research activities relating to the development of new products or services during the last two fiscal years, however, a substantial investment of time and intellectual capital has been directed to the improvement of existing Bank services during the last twenty-four months. Specifically, during June 2007 we opened the Bank’s ninth branch in Rancho Cordova, California. Further, the officers and employees of the Bank are continually engaged in marketing activities, including the evaluation and development of new products and services, among which are “free checking” and more comprehensive electronic banking capabilities to enable the Bank to retain and improve its competitive position in its service areas. For example, during 2007 the Bank implemented remote deposit capture. Other alternatives for future electronic banking delivery systems are currently being evaluated in an effort to keep pace with evolving technology, and to continue to provide superior service to our various individual customers and entities.
We hold no patents or licenses (other than licenses required by appropriate bank regulatory agencies or cities in which we conduct business), franchises or concessions. We are not dependent on a single customer or group of related customers for a material portion of our deposits, nor is a material portion of our loans concentrated within a single industry or group of related industries, except as noted in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The amounts expended in compliance with new government and regulatory initiatives related to anti-terrorism, corporate responsibility, and customer privacy have substantially increased over the past few years, and the amount specifically related to Sarbanes-Oxley Section 404 compliance is anticipated to moderate during 2008 and subsequent years.
Our mission is to be an organization of excellence by:
· Providing quality banking products and services, offered personally and professionally;
· Committing our resources, energy and leadership to our communities;
· Creating value for our shareholders;
· Conducting our business with integrity and respect for all; and
· Fulfilling potential opportunities for growth and development.
Our business strategy is to increase shareholder and franchise value by continuing to expand our geographic footprint through new branches, regional and/or loan production offices, and/or strategic acquisitions as they may become available. We expect to achieve these goals with our core group of experienced bankers, meeting the needs of our constituent shareholder, customer, and employee groups. This will be accomplished by understanding our customers’ needs and expectations and addressing each of them in a focused and responsive fashion, on a timely basis.
Further, we expect to constantly refine and redefine our asset and liability portfolios through growth and product line diversification, increase our base of higher yielding assets as the economic cycle changes, and improve our efficiency ratio as we leverage our talents and capital.
Safety and Soundness Standards
The federal banking agencies have adopted guidelines establishing safety and soundness standards for all insured depository institutions. Those guidelines relate to internal controls, information systems, internal audit systems, loan underwriting and documentation, compensation and interest rate exposure. In general, the standards are designed to assist the federal banking agencies in identifying and addressing problems at insured depository institutions before capital becomes impaired. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan and may institute enforcement proceedings if an acceptable compliance plan is not submitted.
Competition
There are a large number of depository institutions including savings banks, commercial banks, and credit unions in northern Nevada and the northern California counties in which the Company has offices. The Bank, like other depository institutions, is operating in a rapidly changing environment. Non-depository financial service institutions primarily in the securities and insurance industries have become competitors for retail savings and investment funds. Mortgage banking/brokerage firms are actively competing for residential mortgage business. In addition to offering competitive interest rates, the principal methods used by banking institutions to attract deposits include the offering of a variety of services and convenient office locations and business hours. The primary factors in competing for loans are interest rates and rate adjustment provisions, loan maturities, loan fees, and the quality of service to borrowers and brokers.
Nevada Security Bank competes for loans and deposits with other commercial banks, savings and loan associations, finance companies, money market funds, credit unions and other financial institutions, including a number that are much larger than Nevada Security Bank. As of June 30, 2007, the most recent date for which data is available from the FDIC, there were 89 banking offices, including 50 offices of three
major chain banks (Bank of America, US Bank and Wells Fargo), operating within Nevada Security Bank’s primary market areas in Washoe County. These three major chain banks were reported to have held 20.5% of the deposits in Washoe County at June 30, 2007. Further, the single Charles Schwab Bank NA office alone holds an additional 62.6% or $11.7 billion of the county’s reported total deposits. Nevada Security Bank’s share of such market at that date was reported to be 2.34% of the county’s $18.7 billion deposit base (6.24% exclusive of Schwab), as compared to 1.78% of the county’s $15.2 billion deposit base on June 30, 2006 (4.06% exclusive of Schwab), and compared to 1.73% of the county’s $11.2 billion deposit base at June 30, 2005. At June 30, 2007 the Bank was the largest independent bank headquartered in northern Nevada. Of the $3.5 billion change in the county’s deposit base between June 30, 2006 and 2007, $3.2 billion or 91% was represented by the Schwab office. There has been increased competition for deposit and loan business over the last several years as a result of deregulation. Many of the major commercial banks operating in Nevada Security Bank’s market areas offer certain services, such as trust and international banking services, which Nevada Security Bank does not offer directly. Additionally, banks with larger capitalization have larger lending limits and are thereby able to serve larger customers. At December 31, 2007, the legal lending limit for Nevada Security Bank was approximately $20 million.
To a great extent, the super-regional state banks and multi-state chain banks also have the advantage of geographically diffused name recognition and may actively pursue wide-ranging advertising campaigns and branding tactics which are not available to a local community institution, due to economies of scale.
Further, other competitors have entered banking markets with focused products targeted at specific highly profitable customer segments. Many competitors are able to compete across geographic boundaries that are blocked to us and provide customers with alternatives to traditional banking services and nearly all significant products. These competitive trends are likely to continue.
In addition to competition from insured depository institutions, principal competitors for deposits and loans have been mortgage companies, insurance companies, investment brokerage houses, credit card companies and even retail establishments offering investment vehicles such as mutual funds, annuities and money market funds, as well as traditional bank-like services such as check access to money market funds, or cash advances on credit card accounts. Further, the advent of prepaid credit, gift, and loyalty cards, as well as re-loadable prepaid cards with which a consumer may delay purchase, have come into active use and have drained deposits from the banking system.
In order to compete with the other financial institutions in its principal marketing areas, Nevada Security Bank relies principally upon local promotional activities, personal contacts by its officers, directors and employees, and close connections with its communities.
The Bank primarily targets its general commercial banking services to businesses, professional concerns, developers and individuals residing in or doing business in the greater Reno, Sparks, Carson City and Incline Village communities in northern Nevada, and the Roseville and Rancho Cordova communities in northern California. As an independent community bank, management emphasizes quality service, efficiency and personal attention to the needs of its customers. The Bank’s wide range of deposit accounts is designed to attract businesses, professionals and individuals as depositors. Management has hired competent and professional banking staff in its branches to focus on the financial needs of its customers, and various promotional opportunities have been made available to customers through newspaper advertising and flyers, brochures, and other media.
The Bank’s full complement of lending products includes commercial lines of credit and term loans, credit lines to individuals, checking overdraft credit lines, commercial loans, SBA loans, equipment loans, accounts receivable financing and real estate and construction loans. The Bank offers attractive and competitive programs for lot loans, owner-builders of personal residences, and commercial term real estate loan financing. Consumer loans offered include auto loans, home improvement loans, and home equity lines of credit. To accommodate borrowers with loan requests which exceed the Bank’s legal lending limit, the Bank has established participation arrangements with correspondent banks to facilitate approval and funding. Management has hired a professional and competent lending staff comprised of numerous commercial and
real estate lenders with substantial years of knowledge, experience and expertise in the northern Nevada and northern California markets.
These individuals have expertise in consumer, real estate and commercial lending, in addition to current knowledge of government lending programs, and all areas of deposit management facilities. When competing one-on-one with the chain banks, we feel our strength lies in our capabilities at the individual level.
The Bank offers other services including an internet banking alternative, cash management, remote deposit capture, credit cards, wire transfers, ATM networks, night depository facilities, safe deposit boxes, etc. All services stress convenient, personal attention and efficient, timely presentation for the Bank’s clientele base.
In certain instances, we have been unable to compete for deposit acquisition business due solely to our lack of extensive and well known operating history. In these situations, there are few alternatives available to us. However, we may have other specialized services to overcome some objections to our relatively short six full years of operating history, such as those available from correspondent banks, the highly technological alternative delivery channels available through our website, and the ever-present capabilities of our well-seasoned and capable staff.
The Bank’s Board of Directors, management and staff are active in local civic, charitable and community organizations and events, soliciting business referrals and generating profitable business opportunities for the Bank. The Bank relies on its independent status, flexibility and timely response to provide greater personal service to customers. The Bank emphasizes personal contacts with potential customers by management, the Board of Directors and staff to develop local promotional activities and to develop specialized or streamlined services. The Bank prides itself on being a local bank for local people and businesses.
Subsequent Events
The Company acquired the remaining 20% minority interest of Granite Exchange, Inc. on February 1, 2008 and pursuant to the original purchase agreement, at a cost of approximately $1.0 million.
Employees
As of December 31, 2007, the Company had 124 employees. Of these, Nevada Security Bank has 115 employees, the 1031 division has seven and the parent has one full time and one part time employee. On a full-time equivalent basis, the Company’s staff level was 118.1 at December 31, 2007, as compared to 115.7 at December 31, 2006 and 57.2 at December 31, 2005. Staff was added during 2006 primarily due to the Company’s purchase of the 1031 companies, acquisition of NNB Holdings, Inc, and the addition of other professional staff at other locations. None of our employees is represented by a union or covered by a collective bargaining agreement. Management of the Company believes its employee relations are satisfactory.
Recent Accounting Pronouncements
FASB
In February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115. SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. The fair value option may be applied instrument by instrument with certain exceptions and is applied generally on an irrevocable basis to the entire instrument. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Early adoption is permitted under certain circumstances. Management adopted this Statement effective as of January 1, 2007. For the year 2007 the Company recorded unrealized losses of $77,000 on the financial instruments management choose to record at fair value. The Company also recorded a $464,000 charge to beginning retained earnings.
FASB
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. The statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The statement emphasizes that fair value is a market-based measurement, not an entity-specific measurement and establishes a fair value hierarchy. This statement also clarifies how the assumptions of risk and the effect of restrictions on sales or use of an asset effect the valuation. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption was permitted. Management adopted this statement effective as of January 1, 2007.
EITF 06-04
In September 2006, the Emerging Issues Task Force (“EITF”) of the FASB ratified EITF Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements, and EITF Issue No. 06-5, Accounting for Purchases of Life Insurance - Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance. EITF 06-4 provides that an employer should recognize a liability for future benefits based on the substantive agreement with the employee. The Issue should be applied to fiscal years beginning after December 15, 2007, with earlier application permitted. EITF 06-5 provides that in determining the amount recognized as an asset, a policyholder should consider the cash surrender value as well as any additional amounts included in the contractual terms of the policy that will be paid upon surrender. The amount that could be realized should be calculated at the individual policy level and consider any probable contractual limitations, including the exclusion of any additional amounts paid for the surrender of an entire group of policies. The Issue is effective for fiscal years beginning after December 15, 2007. The banking subsidiary of the Company has life insurance arrangements. The Company has evaluated the impact of adoption of this rule on the Company’s financial statements and results of operations and it has been determined by outside benefits administrators that $1.0 million will be adjusted to retained earnings pursuant to this accounting pronouncement, effective January 1, 2008.
SAB 110
In December 2007 the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) 110, which expresses the staffs view regarding the use of a “simplified” method, as discussed in SAB 107, in developing an estimate of expected term of “plain vanilla” share options in accordance with FASB 123R. Due to the perceived lack of widely available detailed information about employee exercise behavior the staff will continue to accept, under certain circumstances, the use of the simplified method beyond December 31, 2007. The Company has evaluated the requirements of SAB 107, and we have determined that the adoption of these issues will not have a material impact on the Company’s financial statements or results of operations.
SEC RELEASE NOS. 33-8810; 34-55929; 33-8829 AND 34-56203
The Securities and Exchange Commission issued these releases during June and September 2007 dealing with guidance over Management’s Report on Internal Control Over Financial Reporting under Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The June releases provide interpretive guidance to management regarding its evaluation and assessment of internal control and sets forth an approach by which management can conduct a top down, risk based evaluation of internal control over financial reporting. The September release provided a definition of the term “significant deficiency” for purpose of the rules implementing Section 302 and 404 of the Sarbanes-Oxley Act of 2002. A “significant deficiency” is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness; yet important enough to merit attention by those responsible for oversight of a registrant’s financial reporting. The Company has evaluated the requirements of these releases, and we have determined that the adoption of these issues will not have a material impact on the Company’s financial statements or results of operations.
FASB FIN 48-1
In May 2007, FASB amended No. 48, Accounting for Uncertainty in Income Taxes, to provide guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. This guidance is applied upon the initial adoption of FIN 48. The Company has evaluated the requirements of this position, and we have determined that the adoption of this issue will not have a material impact on the Company’s financial statements or results of operations.
FDIC FIL-100-2007
The FDIC, along with other federal regulatory agencies has issued a final rule and guidelines on identity theft “red flags” and discrepancies. The rule requires that financial institutions implement a written identity theft prevention program, in which card issuers assess the validity of change of address requests and that users of credit reports reasonably verify the identity of the subject of a consumer report in the event of a notice of address discrepancy. This final regulation became effective November 2007. The Company has evaluated the requirements of this position, and we have determined that the adoption of this issue will not have a material impact on the Company’s financial statements or results of operations.
The list of recent accounting and regulatory pronouncements noted above, while not an exhaustive list, includes those which we believe will, or may, have the greatest likelihood of application to the Company’s consolidated balance sheets and/or consolidated statements of operations. We believe that adoption of these standards will not have a material impact on our financial condition, results of operations, earnings per share or cash flow, unless otherwise noted, however, no absolute assurance can be given that this in fact will occur.
Regulation and Supervision
The following discussion sets forth certain of the material elements of the significant regulatory framework provided by federal and state regulatory agencies applicable to bank holding companies and their subsidiaries and provides certain specific information relevant to the Company. The regulatory framework is intended primarily for the protection of depositors and the insurance funds administered by the FDIC and not for the protection of security holders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. A change in applicable status, regulations or regulatory policy may have a material effect on our business. The following discussion of statutes and regulations is only a brief summary and does not purport to be complete. This discussion is qualified in its entirety by reference to such statutes and regulations. No assurance can be given that such statues or regulations will not change in the future.
The Company
The Company is subject to the periodic reporting requirements of Section 13 of the Securities Exchange Act of 1934 (the “Exchange Act”) which require the Company to file annual, quarterly and other current reports with the Securities and Exchange Commission (the “SEC”). The Company is also subject to additional regulations including, but not limited to, the proxy and tender offer rules promulgated by the SEC under Sections 13 and 14 of the Exchange Act; the reporting requirements of directors, executive officers and principle shareholders regarding transactions in the Company’s Common Stock and short-swing profits rules promulgated by the SEC under Section 16 of the Exchange Act; and certain additional reporting requirements by principal shareholders of the Company promulgated by the SEC under Section 13 of the Exchange Act.
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (“BHCA”) and is registered as such with the Federal Reserve Board. A bank holding company is required to file with the Federal Reserve Board annual reports and other information regarding its business operations and those of its subsidiaries. It is also subject to examination by the Federal Reserve Board and is required to obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or control of any voting shares of any bank if, after such acquisition, it would directly or indirectly own or control more than 5% of the voting stock of that bank, unless its already owns a majority of the voting stock of that bank.
The Federal Reserve Board has by regulation determined certain activities through which a bank holding company may or may not conduct business. A bank holding company must engage, with certain exceptions, in the business of banking or managing or controlling banks or furnishing services to or performing services for its subsidiary banks. The permissible activities and affiliations of certain bank holding companies have recently been expanded. (See “Financial Modernization Act” below.)
The Company, its qualified intermediary exchange companies and Bank are deemed to be affiliates of each other within the meaning set forth in the Federal Reserve Act and are subject to Sections 23A and 23B of the Federal Reserve Act. This means, for example, that there are limitations on loans by the Bank to affiliates, and that all affiliate transactions must satisfy certain limitations and otherwise be on terms and conditions at least as favorable to the Bank as would be available for non-affiliates.
The Federal Reserve Board has a policy that bank holding companies must serve as a source of financial and managerial strength to their subsidiary banks. It is the Federal Reserve Bank’s position that bank holding companies should stand ready to use their available resources to provide adequate capital to their subsidiary banks during periods of financial stress or adversity. Bank holding companies should also maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting their subsidiary banks.
The Federal Reserve Board also has the authority to regulate bank holding company debt, including the authority to impose interest rate ceilings and reserve requirements on such debt. Under certain circumstances, the Federal Reserve Board may require the Company to file written notice and obtain its approval prior to purchasing or redeeming the Company’s equity securities.
The Bank
As a Nevada state-chartered bank whose accounts are insured by the FDIC up to a maximum of $100,000 per depositor, the Bank is subject to regulation, supervision and regular examination by the Nevada Financial Institutions Division (the “FID”) and the FDIC. In addition, while the Bank is not a member of the Federal Reserve System, it is subject to certain regulations of the Federal Reserve Board. The regulations of these agencies govern most aspects of the Bank’s business, including the making of periodic reports by the Bank and the Bank’s activities relating to dividends, investments, loans, borrowings, capital requirements, certain check-clearing activities, branching, mergers and acquisitions, reserves against deposits and numerous other areas. Supervision, legal action and examination of the Bank by the FID and FDIC is generally intended to protect depositors and is not intended for the protection of shareholders.
The earnings and growth of the Bank are largely dependent on its ability to maintain a favorable differential or “spread” between the yield on its interest-earning assets and the rates paid on its deposits and other interest-bearing liabilities. As a result, the Bank’s performance is influenced by general economic conditions, both domestic and foreign, the monetary and fiscal policies of the federal government, and the policies of the regulatory agencies, particularly the Federal Reserve Board. The Federal Reserve Board implements national monetary policies (such as seeking to curb inflation and combat recession) by its open market operations in United States Government securities, by adjusting the required level of reserves for
financial institutions subject to its reserve requirements and by varying the discount rate applicable to borrowings by banks that are members of the Federal Reserve System. The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and interest rates paid on deposits. The nature and impact of any future changes in monetary policies cannot be reasonably predicted.
Capital Adequacy Requirements
The Company and the Bank are subject to the regulations of the Federal Reserve Board and the FDIC, respectively, governing capital adequacy. The Bank and the Company currently exceed all regulatory minimums. Those regulations incorporate both risk-based and leverage capital requirements. Each of the federal regulators has established risk-based and leverage capital guidelines for the banks or bank holding companies they regulate, which set total capital requirements and define capital in terms of “core capital elements,” or Tier 1 capital; and “supplemental capital elements,” or Tier 2 capital. Tier 1 capital is generally defined as the sum of the core capital elements less goodwill and certain other deductions, notably the unrealized net gains or losses (after tax adjustments) on available for sale investment securities carried at fair market value. The following items are defined as core capital elements: (i) common shareholders’ equity; (ii) qualifying non-cumulative perpetual preferred stock and related surplus (not to exceed 25% of tier 1 capital); and (iii) minority interest in the equity of consolidated subsidiaries. Supplementary capital elements include: (i) allowance for loan and lease losses (but not more than 1.25% of an institution’s risk-weighted assets); (ii) perpetual preferred stock and related surplus not qualifying as core capital; (iii) hybrid capital instruments, perpetual debt and mandatory convertible debt instruments; and (iv) term subordinated debt and intermediate-term preferred stock and related surplus. The maximum amount of supplemental capital elements which qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of goodwill.
The minimum required ratio of qualifying capital to total risk-weighted assets is 8.0% (“Total Risk-Based Capital Ratio”), at least one-half of which must be in the form of Tier 1 capital, and the minimum required ratio of Tier 1 capital to total risk-weighted assets is 4.0% (“Tier 1 Risk-Based Capital Ratio”). Risk-based capital ratios are calculated to provide a measure of capital 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 the risk-based capital guidelines, the 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. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans. As of December 31, 2007 and 2006, the Bank’s Total Risk-Based Capital ratios were 10.97% and 10.74%, respectively, and its Tier 1 Risk-Based Capital Ratios were 9.71% and 9.57%, respectively.
The risk-based capital requirements also take into account concentrations of credit (i.e., relatively large proportions of loans involving one borrower, industry, location, collateral or loan type) and the risks of “non-traditional” activities (those that have not customarily been part of the banking business). The regulations require institutions with high or inordinate levels of risk to operate with higher minimum capital standards, and authorize the regulators to review an institution’s management of such risks in assessing an institution’s capital adequacy. Additionally, the risk-based capital regulations also include exposure to interest rate risk as a factor that the regulators will consider in evaluating a bank’s capital adequacy. Interest rate risk is the exposure of a bank’s current and future earnings and equity capital arising from adverse movements in interest rates. While interest rate risk is inherent in a bank’s role as financial intermediary, it introduces volatility to earnings and to the economic value of the bank.
The FDIC and the Federal Reserve Board also require the maintenance of a leverage capital ratio designed to supplement risk-based capital guidelines. Banks and bank holding companies that have received the highest
rating of the five categories used by regulators to rate banks and are not anticipating or experiencing any significant growth must maintain a ratio of Tier 1 capital (net of all intangibles) to adjusted total assets (“Leverage Capital Ratio”) of at least 3%. All other institutions are required to maintain a leverage ratio of at least 100 to 200 basis points above the 3% minimum, for a minimum of 4% to 5%. Pursuant to federal regulations, banks must maintain capital levels commensurate with the level of risk to which they are exposed, including the volume and severity of problem loans; federal regulators may, however, set higher capital requirements when a bank’s particular circumstances warrant. The Bank’s Tier 1 Capital to Average Assets (Leverage Capital Ratio) was 8.60% and 8.04% on December 31, 2007 and 2006 respectively. As of December 31, 2007, the Company’s leverage capital ratio was 10.39%, as compared to 9.85% at December 31, 2006. Both of these ratios exceeded regulatory minimums, and since the most recent balance sheet date, management does not believe conditions or events have changed the institution’s category.
For more information on the Company’s capital, see Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation-Capital Resources. Risk-based capital ratio requirements are discussed in greater detail in the following section.
Prompt Corrective Action Provisions
Federal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured financial institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The federal banking agencies have by regulation defined the following five capital categories: “well-capitalized” (Total Risk-Based Capital Ratio of 10%; Tier 1 Risk-Based Capital Ratio of 6%; and Leverage Ratio of 5%); “adequately capitalized” (Total Risk-Based Capital Ratio of 8%; Tier 1 Risk-Based Capital Ratio of 4%; and Leverage Ratio of 4%) (or 3% if the institution receives the highest rating from its primary regulator); “undercapitalized” (Total Risk-Based Capital Ratio of less than 8%; Tier 1 Risk-Based Capital Ratio of less than 4%; and Leverage Ratio of less than 4%) (or 3% if the institution receives the highest rating from its primary regulator); “significantly undercapitalized” (Total Risk-Based Capital Ratio of less than 6%; Tier 1 Risk-Based Capital Ratio of less than 3%; and Leverage Ratio of less than 3%); and “critically undercapitalized” (tangible equity to total assets less than 2%). A bank may be treated as though it were in the next lower capital category if after notice and the opportunity for a hearing, the appropriate federal agency finds an unsafe or unsound condition or practice so warrants, but no bank may be treated as “critically undercapitalized” unless its actual capital ratio warrants such treatment.
At each successively lower capital category, an insured bank is subject to increased restrictions on its operations. For example, a bank is generally prohibited from paying management fees to any controlling persons or from making capital distributions if to do so would make the bank “undercapitalized.” Asset growth and branching restrictions apply to undercapitalized banks, which are required to submit written capital restoration plans meeting specified requirements (including a guarantee by the parent holding company, if any). “Significantly undercapitalized” banks are subject to broad regulatory authority, including among other things, capital directives, forced mergers, restrictions on the rates of interest they may pay on deposits, restrictions on asset growth and activities, and prohibitions on paying bonuses or increasing compensation to senior executive officers without FDIC approval. Even more severe restrictions apply to critically undercapitalized banks. Most importantly, except under limited circumstances, not later than 90 days after an insured bank becomes critically undercapitalized the appropriate federal banking agency is required to appoint a conservator or receiver for the bank.
In addition to measures taken under the prompt corrective action provisions, insured banks may be subject to potential 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 issuance of cease and desist orders, termination of insurance of deposits (in the case of a bank), the imposition of civil money penalties, the
issuance of directives to increase capital, formal and informal agreements, or removal and prohibition orders against “institution-affiliated” parties.
Safety and Soundness Standards
The federal banking agencies have also adopted guidelines establishing safety and soundness standards for all insured depository institutions. Those guidelines relate to internal controls, information systems, internal audit systems, loan underwriting and documentation, compensation and interest rate exposure. In general, the standards are designed to assist the federal banking agencies in identifying and addressing problems at insured depository institutions before capital becomes impaired. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan and may institute enforcement proceedings if an acceptable compliance plan is not submitted.
Premiums for Deposit Insurance
The FDIC regulations also implement a risk-based premium system, whereby insured depository institutions are required to pay insurance premiums depending on their risk classification. Under this system, insured banks are categorized into one of three capital categories (well capitalized, adequately capitalized, and undercapitalized) and each institution is also assigned to one of three supervisor groups based on the consideration of supervisory evaluations provided by the institutions primary federal regulator. The supervisory evaluations include the results of examination findings by the primary regulator, as well as other information the primary regulator determines to be relevant. In addition, the FDIC will take into consideration such other information (such as state examination findings, if appropriate) as it determines to be relevant to the institution’s financial condition and the risk posed to the Deposit Insurance Fund. The three supervisory categories are: 1) financially sound with only a few minor weaknesses which generally corresponds to the primary federal regulator’s composite rate of “1” or “2” (Group A), 2) demonstrated weaknesses that could result in significant deterioration, which generally corresponds to the regulator’s composite rate of “3” (Group B), and 3) poses a substantial probability of loss, which generally corresponds to the regulator composite rate of “4” or “5” (Group C). The current base assessment rates (expressed as cents per $100 of deposits) are summarized as follows:
* Rates for institutions that do not pay the minimum or maximum rate will vary between these rates.
In general, while the FDIC’s Deposit Insurance Fund maintains a reserve ratio of 1.25% or greater, no deposit insurance premiums are required. In February 2006, the FDIC Reform Act of 2005 was signed into law. Included in this legislation were provisions to merge the BIF and the Savings Association Insurance Fund into one fund (the “Deposit Insurance Fund”), increase insurance coverage for retirement accounts to $250,000 and index deposit insurance levels for inflation.
In addition, banks must pay an amount toward the retirement of the Financing Corporation bonds issued in the 1980’s to assist in the recovery of the savings and loan industry. This amount fluctuates but for the first quarter of 2008 was 1.14 cents per $100 of insured deposits.
Community Reinvestment Act
The Bank is subject to certain requirements and reporting obligations involving 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 its local communities, including low and moderate income neighborhoods. The CRA further requires the agencies to take into account a financial institution’s record of meeting its community credit needs when evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions, or holding company formations. In measuring a bank’s compliance with its CRA obligations, the regulators utilize a performance-based evaluation system which bases CRA ratings on the bank’s actual lending service and investment performance, rather than on the extent to which the institution conducts needs assessments, documents community outreach activities or complies with other procedural requirements. In connection with its assessment of CRA performance, the FDIC assigns a rating of “outstanding,” “satisfactory,” or “substantial noncompliance.”
The Bank was last examined for CRA compliance in November 2003 when it received an “Outstanding” CRA Assessment rating.
Other Consumer Protection Laws and Regulations
The bank regulatory agencies are increasingly focusing attention on compliance with consumer protection laws and regulations. Examination and enforcement has become intense, and banks have been advised to carefully monitor compliance with various consumer protection laws and regulations. The federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in home mortgage lending describing three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment, and evidence of disparate impact. In addition to CRA and fair lending requirements, the Bank is subject to numerous other federal consumer protection statutes and regulations. Due to heightened regulatory concern related to compliance with consumer protection laws and regulations generally, the Bank may incur additional compliance costs or be required to expend additional funds for investments in the local communities it serves.
Interstate Banking and Branching
The Riegle - Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Banking Act”) regulates the interstate activities of banks and bank holding companies and establishes a framework for nationwide interstate banking and branching. Since June 1, 1997, a bank in one state has generally been permitted to merge with a bank in another state without the need for explicit state law authorization. However, states were given the ability to prohibit interstate mergers with banks in their own state by “opting-out” (enacting state legislation applying equality to all out-of-state banks prohibiting such mergers) prior to June 1, 1997.
Since 1995, adequately capitalized and managed bank holding companies have been permitted to acquire banks located in any state, subject to two exceptions: first, any state may still prohibit bank holding companies from acquiring a bank which is less than five years old; and second, no interstate acquisition can be consummated by a bank holding company if the acquirer would control more than 10% of the deposits held by insured depository institutions nationwide or 30% or more of the deposits held by insured depository institutions in any state in which the target bank has branches.
A bank may establish and operate de novo branches in any state in which the bank does not maintain a branch if that state has enacted legislation to expressly permit all out-of-state banks to establish branches in that state.
The changes effected by the Interstate Banking Act have increased competition in the environment in which the Bank operates to the extent that out-of-state financial institutions directly or indirectly enter the Bank’s
market areas. In addition, it appears that the Interstate Banking Act has contributed to the accelerated consolidation of the banking industry. While many large out-of-state banks have already entered the Nevada market as a result of this legislation, it is not possible to predict the precise impact of this legislation on the Bank and the Company and the competitive environment in which they operate.
Financial Modernization Act
In November 1999, the Gramm-Leach-Bliley Act, or the GLB Act, became law, significantly changing the regulatory structure and oversight of the financial services industry. Effective March 11, 2000, the GLB Act repealed the provisions of the Glass-Steagall Act that restricted banks and securities firms from affiliating. It also revised the BHCA to permit a “qualifying” bank holding company, called a financial holding company, to engage in a full range of financial activities, including banking, insurance, securities, and merchant banking activities. It also permits qualifying bank holding companies to acquire many types of financial firms without the FRB’s prior approval.
The GLB Act thus provides expanded financial affiliation opportunities for existing bank holding companies and permits other financial services providers to acquire banks and become bank holding companies without ceasing any existing financial activities. Previously, a bank holding company could only engage in activities that were “closely related to banking.” This limitation no longer applies to bank holding companies that qualify to be treated as financial holding companies. To qualify as a financial holding company, a bank holding company’s subsidiary depository institutions must be well-capitalized, well-managed and have at least a “satisfactory” Community Reinvestment Act examination rating. “Non-qualifying” bank holding companies are limited to activities that were permissible under the BHCA as of November 11, 1999.
Also effective on March 11, 2000, the GLB Act changed the powers of national banks and their subsidiaries, and made similar changes in the powers of state banks and their subsidiaries. National banks may now underwrite, deal in and purchase state and local revenue bonds. A subsidiary of a national bank may now engage in financial activities that the bank cannot itself engage in, except for general insurance underwriting and real estate development and investment. In order for a subsidiary of a national bank to engage in these new financial activities, the national bank and its depository institution affiliates must be “well capitalized,” have at least “satisfactory” general, managerial and Community Reinvestment Act examination ratings, and meet other qualification requirements relating to total assets, subordinated debt, capital, risk management, and affiliate transactions. Subsidiaries of state banks can exercise the same powers as national bank subsidiaries if they satisfy the same qualifying rules that apply to national banks, except that state-chartered banks do not have to satisfy the statutory managerial and debt rating-requirements of national banks.
The GLB Act also reformed the overall regulatory framework of the financial services industry. In order to implement its underlying purposes, the GLB Act preempted state laws that would restrict the types of financial affiliations that are authorized or permitted under the GLB Act, subject to specified exceptions for state insurance laws and regulations. With regard to securities laws, effective May 12, 2001, the GLB Act removed the blanket exemption for banks from being considered brokers or dealers under the Securities Exchange Act of 1934 and replaced it with a number of more limited exemptions. Thus, previously exempted banks may become subject to the broker-dealer registration and supervision requirements of the Securities Exchange Act of 1934. The exemption that prevented bank holding companies and banks that advise mutual funds from being considered investment advisers under the Investment Advisers Act of 1940 was also eliminated.
Separately, the GLB Act imposes customer privacy requirements on any company engaged in financial activities. Under these requirements, a financial company is required to protect the security and confidentiality of customer nonpublic personal information. Also, for customers who obtain a financial product such as a loan for personal, family or household purposes, a financial company is required to
disclose its privacy policy to the customer at the time the relationship is established and annually thereafter, including its policies concerning the sharing of the customer’s nonpublic personal information with affiliates and third parties. If an exemption is not available, a financial company must provide consumers with a notice of its information sharing practices that allows the consumer to reject the disclosure of its nonpublic personal information to third parties. Third parties that receive such information are subject to the same restrictions as the financial company on the reuse of the information. Finally, a financial company is prohibited from disclosing an account number or similar item to a third party for use in telemarketing, direct mail marketing or other marketing through electronic mail.
Sarbanes-Oxley Act
During July 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The purpose of the Sarbanes-Oxley Act is to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes.
The Sarbanes-Oxley Act amends the Securities Exchange Act of 1934 to prohibit a registered public accounting firm from performing specified nonaudit services contemporaneously with a mandatory audit. The Sarbanes-Oxley Act also vests the audit committee of an issuer with responsibility for the appointment, compensation, and oversight of any registered public accounting firm employed to perform audit services. It requires each committee member to be a member of the board of directors of the issuer, and to be otherwise independent. The Sarbanes-Oxley Act further requires the chief executive officer and chief financial officer of an issuer to make certain certifications as to each annual or quarterly report.
In addition, the Sarbanes-Oxley Act requires officers to forfeit specific bonuses and profits under certain circumstances. Specifically, if an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer as a result of misconduct with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall be required to reimburse the issuer for (1) any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the SEC of the financial document embodying such financial reporting requirement; and (2) any profits realized from the sale of securities of the issuer during that 12-month period.
The Sarbanes-Oxley Act also instructs the SEC to require by rule:
· disclosure of all material off-balance sheet transactions and relationships that may have a material effect upon the financial status of an issuer; and
· the presentation of pro forma financial information in a manner that is not misleading, and which is reconcilable with the financial condition of the issuer under generally accepted accounting principles.
The Sarbanes-Oxley Act also prohibits insider transactions in the company’s stock held within its pension plans during lock out periods, and any profits on such insider transactions are to be disgorged. In addition, there is a prohibition of company loans to its executives, except in certain circumstances. The Sarbanes-Oxley Act also provides for a mandated internal control report and assessment with the annual report and an attestation and a report on such report by the company’s auditor. The SEC also requires the company to issue a code of ethics for senior financial officers of the company. Further, the Sarbanes-Oxley Act adds a criminal penalty of fines and imprisonment of up to 10 years for securities fraud.
Regulation W
The Federal Reserve Board (“FRB”) on October 31, 2002 approved a final Regulation W that comprehensively implements sections 23A and 23B of the Federal Reserve Act. Sections 23A and 23B and Regulation W restrict loans by a depository institution to its affiliates, asset purchases by a depository institution from its affiliates, and other transactions between a depository institution and its affiliates. Regulation W unifies in one public document the FRB’s interpretations of sections 23A and 23B. Regulation W had an effective date of April 1, 2003.
Regulatory Capital Treatment of Equity Investments
In December of 2001 and January of 2002, the OCC, the FRB and the FDIC adopted final rules governing the regulatory capital treatment of equity investments in non-financial companies held by banks, bank holding companies and financial holding companies. The final rules became effective on April 1, 2002. The new capital requirements apply symmetrically to equity investments made by banks and their holding companies in non-financial companies under the legal authorities specified in the final rules. Among others, these include the merchant banking authority granted by the Gramm-Leach-Bliley Act and the authority to invest in small business investment companies (“SBICs”) granted by the Small Business Investment Act. Covered equity investments will be subject to a series of marginal Tier 1 capital charges, with the size of the charge increasing as the organization’s level of concentration in equity investments increases. The highest marginal charge specified in the final rules requires a 25 percent deduction from Tier 1 capital for covered investments that aggregate more than 25 percent of an organization’s Tier 1 capital. Equity investments through SBICs will be exempt from the new charges to the extent such investments in the aggregate do not exceed 15 percent of the banking organization’s Tier 1 capital. The new charges would not apply to individual investments made by banking organizations prior to March 13, 2000. Grandfathered investments made by state banks under section 24(f) of the Federal Deposit Insurance Act also are exempted from coverage.
USA Patriot Act
The terrorist attacks in September 2001, have impacted the financial services industry and led to federal legislation that attempts to address certain issues involving financial institutions. On October 26, 2001, President Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”).
Part of the USA Patriot Act is the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLA”). IMLA authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to banks, bank holding companies, and/or other financial institutions. These measures may include enhanced recordkeeping 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.
Among its other provisions, IMLA requires each financial institution to: (i) establish an anti-money laundering program; (ii) establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks; and (iii) avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, IMLA 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. IMLA 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. IMLA 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. IMLA became effective July 23, 2002.
Merchant Banking Investments
The FRB and the Secretary of the Treasury in January 2001 jointly adopted a final rule governing merchant banking investments made by financial holding companies. The rule implements provisions of the Gramm-Leach-Bliley Act discussed below that permit financial holding companies to make investments as part of a bona fide securities underwriting or merchant or investment banking activity. The rule provides that a financial holding company may not, without FRB approval, directly or indirectly acquire any additional shares, assets or ownership interests or make any additional capital contribution to any company the shares, assets or ownership interests of which are held by the financial holding company subject to the rule if the aggregate carrying value of all merchant banking investments held by the financial holding company exceeds:
· 30 percent of the Tier 1 capital of the financial holding company, or
· after excluding interests in private equity funds, 20 percent of the Tier 1 capital of the financial holding company.
A separate final rule will establish the capital charge of merchant banking investments for the financial holding company.
Amendments to Regulation H and Y for Trust Preferred Securities.
The Federal Reserve Board issued a final rule on March 1, 2005 that amends Regulation H and Regulation Y to limit restricted core capital elements (including trust preferred securities) which count as Tier 1 capital to 25 percent of all core capital elements, net of goodwill less any associated deferred tax liability. Internationally active bank holding companies, defined as those with consolidated assets greater than $250 billion or on-balance-sheet foreign exposure greater than $10 billion, will be subject to a 15 percent limit, but they may include qualifying mandatory convertible preferred securities up to the generally applicable 25 percent limit. Amounts of restricted core capital elements in excess of these limits generally may be included in Tier 2 capital. The final rule provides a five-year transition period, ending March 31, 2009, for application of the quantitative limits.
On November 3, 2005 the Company and its newly formed Connecticut statutory trust subsidiary, The Bank Holdings Statutory Trust I (the “Trust”) entered into a purchase agreement pursuant to which it was agreed that the Trust would issue $15 million of floating interest rate trust preferred securities (the “Trust Preferred Securities”) to Merrill Lynch International. The Trust Preferred Securities were issued and sold in a private placement exempt from registration under the Securities Exchange Act of 1933, as amended.
The Trust Preferred Securities will be redeemable at the Company’s option on or after December 15, 2010. In addition, the Trust Preferred Securities require quarterly distributions of interest by the Trust to the Holders of the Trust Preferred Securities at a floating rate equal to the three month London Inter-bank Offered Rate (“LIBOR”) plus 1.42%, which rate thereafter will be reset until maturity.
The Trust used the proceeds of the sale of the Trust Preferred Securities to purchase $15 million of the Company’s floating rate junior subordinated debentures (the “Debentures”). Like the Trust Preferred Securities, the Debentures bear interest at a floating rate equal to the three month LIBOR plus 1.42%.
The Debentures will mature on December 15, 2035, but may be redeemed by the Company at its option at any time on or after December 15, 2010.
As a result of the purchase of and agreement with NNB Holdings, Inc. the Company acquired NNB Holdings Statutory Trust I which was formed in June 2005 to issue $5,155,000 of fixed/floating rate Cumulative Trust Preferred Securities, which are classified as junior subordinated debt. The fixed rate of 5.95% began on the date of issuance and will end on (but not including) the interest payment date in June 2010, at which time the interest rate switches to a floating interest rate equal to the three month LIBOR plus 1.85%. The acquired debentures will mature in 2035, but may be redeemed by the Company at its option at any time on or after June 15, 2010 with a payment of a premium as outlined in the indenture agreement.
Financial Services Regulatory Relief Act of 2006
In October 2006, the President signed the Financial Services Regulatory Relief Act of 2006 into law (the “Relief Act”). The Relief Act amends several existing banking laws and regulations, eliminates some unnecessary and overly burdensome regulations of depository institutions and clarifies several existing regulations. The Relief Act, among other things, (i) authorizes the Federal Reserve Board to set reserve ratios; (ii) amends national banks regulations relating to shareholder voting and granting of dividends; (iii) amends several provisions relating to such issues as loans to insiders, regulatory applications, privacy notices, and golden parachute payments; and (iv) expands and clarifies the enforcement authority of federal banking regulators. We do not expect that our business, expenses, or operations will be significantly impacted.
FDIC Reform Act
On February 8, 2006, the President signed The Federal Deposit Insurance Reform Act of 2005 (the Reform Act) into law. The Federal Deposit Insurance Reform Conforming Amendments Act of 2005, which the President signed into law on February 15, 2006, contains necessary technical and conforming changes to implement deposit insurance reform, as well as a number of study and survey requirements. The Reform Act provides for the following changes:
·
Merging the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) into a new fund, the Deposit Insurance Fund (DIF). This change was made effective March 31, 2006.
·
Increasing the coverage limit for retirement accounts to $250,000 and indexing the coverage limit for retirement accounts to inflation as with the general deposit insurance coverage limit. This change was made effective April 1, 2006.
·
Establishing a range of 1.15 percent to 1.50 percent within which the FDIC Board of Directors may set the Designated Reserve Ratio (DRR).
·
Allowing the FDIC to manage the pace at which the reserve ratio varies within this range.
1.
If the reserve ratio falls below 1.15 percent-or is expected to within 6 months-the FDIC must adopt a restoration plan that provides that the DIF will return to 1.15 percent generally within 5 years.
2.
If the reserve ratio exceeds 1.35 percent, the FDIC must generally dividend to DIF members half of the amount above the amount necessary to maintain the DIF at 1.35 percent, unless the FDIC Board, considering statutory factors, suspends the dividends.
3.
If the reserve ratio exceeds 1.5 percent, the FDIC must generally dividend to DIF members all amounts above the amount necessary to maintain the DIF at 1.5 percent.
·
Eliminating the restrictions on premium rates based on the DRR and granting the FDIC Board the discretion to price deposit insurance according to risk for all insured institutions regardless of the level of the reserve ratio.
·
Granting a one-time initial assessment credit (of approximately $4.7 billion) to recognize institutions’ past contributions to the fund.
The Federal Reserve Board in February 2006 approved a final rule that expands the definition of a small bank holding company under its Small Bank Holding Company Policy Statement and the Board’s risk-based and leverage capital guidelines for bank holding companies. The policy statement facilitates the transfer of ownership of small community banks by permitting debt levels at small bank holding companies that are higher than what would typically be permitted for larger small bank holding companies. In its revisions to the Policy Statement, the Federal Reserve Board has raised the small bank holding company asset size threshold from $150 million to $500 million and amended the related qualitative criteria for determining eligibility as a small bank holding company for the purposes of the policy statement and the capital guidelines.
The FDIC finalized its interim final rule, with changes, that amended its deposit insurance regulations to implement applicable revisions to the Federal Deposit Insurance Act made by the Federal Deposit Insurance Reform Act of 2005 and the Federal Deposit Insurance Reform Conforming Amendments Act of 2005. The final rule provides for consideration of inflation adjustments to increase the current standard maximum deposit insurance amount of $100,000 on a five-year cycle beginning in 2010; increases the deposit insurance limit for certain retirement accounts from $100,000 to $250,000, also subject to inflation adjustments; and provides per-participant insurance coverage to employee benefit plan accounts, even if the depository institution at which the deposits are placed is not authorized to accept employee benefit plan deposits. The final rule was effective on October 12, 2006.
The Board of Governors of the Federal Reserve System amended Regulation E, which implements the Electronic Fund Transfer Act, and the official staff commentary to the regulation, which interprets the requirements of Regulation E to become effective on July 1, 2006. The final rule provides that Regulation E covers payroll card accounts that are established directly or indirectly through an employer, and to which transfers of the consumer’s salary, wages, or other employee compensation are made on a recurring basis. The final rule also provides financial institutions with an alternative to providing periodic statements for payroll card accounts if they make account information available to consumers by specified means.
The federal financial regulatory agencies in September 2006 issued final guidance to address the risks posed by nontraditional residential mortgage products that allow borrowers to defer repayment of principal and sometimes interest, including “interest-only” mortgages and “payment option” adjustable-rate mortgages. These products allow borrowers to exchange lower payments during an initial period for higher payments later. The lack of principal amortization and the potential for negative amortization and features that compound risks (such as no document loans and simultaneous second mortgages) elevate the concern of the federal banking agencies for nontraditional mortgage products. The guidelines require depository institutions to ensure that loan terms and underwriting standards are consistent with prudent lending practices, including consideration of a borrower’s repayment capacity, to recognize that many nontraditional mortgage loans, particularly when they have risk-layering features, are untested in a stressed environment. The guidelines also express the need for depository institutions to have strong risk management standards, capital levels commensurate with the risk, an allowance for loan and lease losses that reflects the collectibility of the portfolio, and the need to make sure that consumers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice.
The federal financial regulatory agencies in December 2006 issued a new interagency policy statement on the allowance for loan and lease losses (ALLL) along with supplemental frequently asked questions. The policy statement revises and replaces a 1993 policy statement on the ALLL. The agencies issued the revised policy statement in view of today’s uncertain economic environment and the presence of concentrations in untested loan products in the loan portfolios of insured depository institutions. The policy statement has also been revised to conform to generally accepted accounting principles (GAAP) and post-1993 supervisory guidance. The 1993 policy statement described the responsibilities of the boards of directors, management, and banking examiners regarding the ALLL; factors to be considered in the estimation of the ALLL; and the objectives and elements of an effective loan review system, including a sound credit grading system. The policy statement reiterates that each institution has a responsibility for developing, maintaining and documenting a comprehensive, systematic, and consistently applied process appropriate to its size and the nature, scope, and risk of its lending activities for determining the amounts of the ALLL and the provision for loan and lease losses and states that each institution should ensure controls are in place to consistently determine the ALLL in accordance with GAAP, the institution’s stated policies and procedures, management’s best judgment and relevant supervisory guidance.
The policy statement also restates that insured depository institutions must maintain an ALLL at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the remainder of the loan and lease portfolio, and that estimates of credit losses should reflect consideration of all significant factors that affect the collectibility of the portfolio as of the evaluation date. The policy statement states that prudent, conservative, but not excessive, loan loss allowances that represent management’s best estimate from within an acceptable range of estimated losses are appropriate.
The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation in December 2006 issued final guidance on sound risk management practices for concentrations in commercial real estate lending. The agencies observed that the commercial real estate is an area in which some banks are becoming increasingly concentrated, especially with small- to medium- sized banks that face strong competition in their other business lines. The agencies support banks serving a vital role in their communities by supplying credit for business and real estate development. However, the agencies are concerned that rising commercial real estate loan concentrations may expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in commercial real estate markets. The guidance provides supervisory criteria, including numerical indicators to assist in identifying institutions with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny, but such criteria are not limits on commercial real estate lending.
Other Pending and Proposed Legislation
Other legislative and regulatory initiatives which could affect the Company, the Bank, our qualified intermediary companies and the banking industry in general are pending, and additional initiatives may be proposed or introduced before the United States Congress, the Nevada legislature, the California and Montana legislatures and other governmental bodies in the future. Such proposals, if enacted, may further alter the structure, regulation, and competitive relationship among financial institutions, and may subject the Company to increased regulation, disclosure, and reporting requirements. In addition, the various banking regulatory agencies often adopt new rules and regulations to implement and enforce existing legislation. It cannot be predicted whether, or in what form, any such legislation or regulations may be enacted or the extent to which the business of the Company or the Bank would be affected thereby.
Other Information Concerning the Company
The Company holds no material patents, trademarks, licenses, franchises or concessions. No expenditures were made by the Company since inception on material research activities relating to the development of services or the improvement of existing services. Based upon present business activities, it is believed that compliance with federal, state and local provisions regulating discharge of materials into the environment will have no material effects upon the capital expenditures, earnings or competitive position of the company.
We are subject to certain of the informational requirements of the Securities Exchange Act of 1934, as amended, referred to as the Exchange Act. In accordance with the Exchange Act, we file annual and quarterly reports and other information with the Securities and Exchange Commission, or SEC. Copies may be obtained at the prescribed rates from the public reference room maintained by the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549 and be inspected without charge and copied at the prescribed rates at the SEC’s regional office at Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. The public may also obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. An electronic version of our filings may be viewed at the SEC’s website: www.sec.gov, CIK #1234383. Additionally, this site also provides access to any other report or other information we file with the SEC.
Accounting for Goodwill
Goodwill arises from business acquisitions and represents the value attributable to the unidentifiable intangible elements in our acquired businesses. Goodwill is initially recorded at fair value and is subsequently evaluated at least annually for impairment in accordance with SFAS No. 142. The Company performs this annual test generally as of November 30 of each year. Evaluations are also performed on a more frequent basis if events or circumstances indicate an impairment could have taken place. Such events could include, among others, a significant adverse change in the business climate, an adverse action by a regulator, an unanticipated change in the competitive environment and a decision to change the operations or dispose of a reporting unit.
The first step in this evaluation process is to determine if a potential impairment exists in any of the Company’s reporting units and, if required from the results of this step, a second step measures the amount of any impairment loss. The computations required by steps 1 and 2 call for us to make a number of estimates and assumptions. In completing step 1, we determine the fair value of the reporting unit that is being evaluated. In determining the fair value, we generally calculate value using a combination of up to three separate methods: comparable publicly traded financial service companies in the Western states; comparable acquisitions of financial services companies in the Western states; and, the discounted present value of management’s estimates of future cash or income flows. Critical assumptions that are used as part of these calculations include:
· selection of comparable publicly traded companies, based on location, size and business composition;
· selection of comparable acquisition transactions, based on location, size, business composition and date of transaction;
· the discount rate applied to future earnings, based on an estimate of the cost of capital;
· the potential future earnings of the reporting unit;
· the relative weight given to the valuations derived by the three methods described.
If step 1 indicates a potential impairment of a reporting unit, step 2 requires us to estimate the “implied fair value” of the reporting unit. This process estimates the fair value of the unit’s individual assets and liabilities in the same manner as if a purchase of the reporting unit were taking place. To do this we must determine the fair value of the assts, liabilities and identifiable intangible assets of the reporting unit based upon the best available information. If the value of goodwill calculated in step 2 is less than the carrying amount of goodwill for the reporting unit, an impairment is indicated and the carrying value of goodwill is written down to the calculated value.
Since estimates are an integral part of the impairment computations, changes in these estimates could have a significant impact on any calculated impairment amount. Factors that may significantly affect the estimates include, among other, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, changes in discount rate, changes in stock and mergers and acquisitions market values and changes in industry or market sector conditions.
During the fourth quarter of 2007, an outside consulting firm performed our annual goodwill impairment evaluation for the entire organization effective November 30, 2007. This same firm performed the annual goodwill impairment evaluation for the period ended December 31, 2006. Step 1 was performed by using both market value and transaction value approaches for all reporting units and, in certain cases; the discounted cash flow approach was also used. In the market value approach, the consultants identified a group of publicly traded banks that are similar in size and location to our subsidiary banks and then used valuation multiples developed from the group to apply to our subsidiary companies. In the transaction value approach, the consultants reviewed the purchase price paid in recent mergers and acquisitions of bank similar in size to our subsidiary companies. From these purchase prices they developed a set of valuation multiples, which were applied to our subsidiary companies. In instances where the discounted cash flow approach was used, they discounted projected cash flows to their present value to arrive at our estimate of fair value.
Upon completion of step 1 of the evaluation process, they concluded that no potential impairment existed for any of the Company’s reporting units. In reaching this conclusion, they determined that the fair values of goodwill exceeded the recorded values of goodwill. Since this evaluation process required them to make estimates and assumptions with regard to the fair value of the Company’s reporting unites, actual values may differ significantly from these estimates. Such differences could result in future impairment of goodwill that would, in turn, negatively impact the Company’s results of operations and the business segments where the goodwill is recorded. However, had the estimated fair values been 10% lower, there would still have been no indication of impairment for any of our reporting units.
ITEM 1A.
ITEM 1A. RISK FACTORS
This Annual Report on Form 10-K includes forward-looking statements and information and is subject to the “safe harbor” provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements (which involve The Bank Holdings’ (the “Company’s”) plans, beliefs and goals, refer to estimates or use similar terms) involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements.
In addition, our business exposes us to certain risks. 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.
Our Northern Nevada and Northern California business focus and economic conditions in Nevada and California could adversely affect our operations. Our operations are located primarily in northern Nevada and northern California. As a result of this geographic concentration, our results depend largely upon economic conditions in these areas. A deterioration in economic conditions or a natural or manmade disaster in our market area could have a material adverse impact on the quality of our loan portfolio, the demand for our products and services, and our financial condition and results of operations.
Changes in market interest rates could adversely affect our earnings. Our earnings depend largely on the relationship between the cost of funds, primarily deposits and borrowings, and the yield on earning assets, such as loans and investment securities. This relationship, known as the interest rate spread, is subject to fluctuation and is affected by the monetary policies of the Federal Reserve Board, the international interest rate environment, as well as by economic, regulatory and competitive factors which influence interest rates, the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of nonperforming assets. Many of these factors are beyond our control. Fluctuations in interest rates affect the demand of customers for our products and services. We are subject to interest rate risk to the degree that our interest-bearing liabilities reprice or mature more slowly or more rapidly or on a different basis than our interest-earning assets. Given our current volume and mix of interest-bearing liabilities and interest-earning assets, our interest rate spread could be expected to increase during times of rising interest rates and, conversely, to decline during times of falling interest rates. Therefore, significant fluctuations in interest rates may have an adverse or a positive effect on our results of operations.
We are subject to government regulations that could limit or restrict our activities, which in turn could adversely impact our operations. The financial services industry is subject to extensive federal and state supervision and regulation. Significant new laws or changes in existing laws, or repeals of existing laws may cause our results to differ materially. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for us and a material change in these conditions could have a material adverse impact on our financial condition and results of operations.
Failure to manage growth may adversely affect our performance. Our financial performance and profitability depends on our ability to manage our recent growth and possible future growth. In addition, any future acquisitions and our continued growth may present operating and other problems that could have an adverse effect on our financial condition and results of operations.
Competition may adversely affect our performance. The banking and financial services businesses in our market areas are highly competitive. We face competition in attracting deposits and in making loans. The increasingly competitive environment is a result of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial service providers. Our results in the future may differ depending on the nature or level of competition.
If a significant number of borrowers, guarantors and related parties fail to perform as required by the terms of their loans, we will sustain losses. A significant source of risk arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans and guarantees. We have adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance, and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could have a material adverse effect on our results of operations.
We have a high concentration of loans secured by real estate and a downturn in the real estate market, for any reason, could hurt our business and prospects. Our real estate-secured loans are concentrated in the northern Nevada and greater Sacramento, California areas. A downturn in those local economies could have a material adverse effect on a borrower’s ability to repay these loans due to either loss of borrower’s employment or a reduction in borrower’s business. Further, such reduction in those local economies could severely impair the value of the real property held as collateral. As a result, the value of real estate collateral securing our loans could be reduced. Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and it would be more likely to suffer losses on defaulted loans.
Our growth could be hindered unless we are able to recruit additional, qualified employees which, if difficult, may divert resources and limit its ability to successfully expand operations. If we are unable to hire and retain qualified employees in the near term, we may be unable to successfully execute our business strategy and/or be unable to successfully manage our growth. We believe that we have built our management team and personnel, and established an infrastructure, to support our current size. Our future success will depend on the ability of our executives and employees to continue to implement and improve our operational, financial and management controls and processes, reporting systems and procedures, and to manage a growing number of client relationships. We may not be able to successfully implement improvements to its management information and control systems and control procedures and processes in an efficient or timely manner. We cannot assure you that our growth strategy will not place a strain on our administrative and operational infrastructure. If we are unable to locate additional personnel and to manage future expansion in our operations, we may experience compliance and operational issues, have to slow the pace of growth, or have to incur additional expenditures beyond current projections to support such growth, any one of which could adversely affect our business.
Our business would be harmed if we lost the services of any of our executive management team. We believe that our prospects for success in the future are substantially dependent on our senior management team, which includes Chief Executive Officer, Hal Giomi, President, Joe Bourdeau, Chief Financial Officer, Jack Buchold, and Chief Credit Officer, John Donovan. The loss of the services of any of these persons could have an adverse effect on our business.
As a public reporting company, Bank Holdings is subject to significant laws and regulations that will increase its compliance costs and may strain management resources. We are a public company and, reporting requirements of the Securities Exchange Act of 1934, as amended and the Sarbanes-Oxley Act of 2002, or SOX, and related regulations are applicable to our operations. Our expenses related to services rendered by accountants, legal counsel and consultants will increase in order to ensure compliance with these laws and regulations that it is subject to as a public company.
Our allowance for loan losses may not be adequate to cover actual losses. A significant source of risk arises from the possibility that losses could be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The underwriting and credit monitoring policies that we have adopted to address this risk may not prevent unexpected losses that could have a material adverse affect on our business. Like all financial institutions, we maintain an allowance for loan losses to provide for loan defaults and non-performance. The allowance for loan losses may not be adequate to cover actual loan losses, and future provisions for loan losses could materially and adversely affect our business. Our allowance for loan losses is based on prior experience and peer bank experience, as well as an evaluation of the known risks in the current portfolio, composition and growth of the loan portfolio and economic factors. The determination of the appropriate level of loan loss allowance is an inherently difficult process and is based on numerous assumptions. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond our control and these losses may exceed current estimates. We cannot assure you that we will not increase the allowance for loan losses further or that regulators will not require us to increase this allowance. Either of these occurrences could adversely affect business and prospects.
We are exposed to risk of environmental liabilities with respect to properties to which we takes title. A large portion of our outstanding loan portfolio is secured by real estate. In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial, adversely affecting our business, profitability and prospects.
You should not place undue reliance on any forward-looking statements. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update them in light of new information or future events except to the extent required by federal securities laws.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
There are no comments received from Securities and Exchange Commission staff regarding our periodic or current reports that are unresolved.
ITEM 2.
ITEM 2. PROPERTIES
The Company currently operates from eleven locations, the principal location being 9990 Double R Boulevard, Reno, Nevada, 89521 where the administrative functions and regular branch activities of the Bank occur. The Bank Holdings is also located at this address. Company facilities are of various ages and correspondingly require different levels of maintenance. All are suitable and adequate for their intended use.
Nevada Security Bank leases the first floor of this free-standing facility under an agreement dated October 2, 2001, which notes the use of approximately 9,300 square feet for a ten-year term beginning at the issuance of a certificate of occupancy. Nevada Security Bank took possession on December 6, 2002 and may extend the lease for four, five-year periods if not in default under the terms of the agreement at each renewal period. The lease payment under this agreement is approximately $9,600 per month with annual escalations for each of the first four years; beginning in year five there is a fixed annual escalation of 2.5%.
Nevada Security Bank also leases part of the second floor of this free-standing facility under an agreement dated May 1, 2005, which notes the use of approximately 1,686 square feet for a seven-year six month term the expiration of which is coterminous with the lease on the first floor. Nevada Security Bank took possession on May 1, 2005 and the lease terms are the same as the lease for the first floor. The lease payment under this agreement is approximately $2,765 per month with annual escalations for each of the first four years; beginning in year five there is a fixed annual escalation of 2.5%.
The Bank Holdings leases part of the second floor of the same facility under an agreement dated November 17, 2003, which notes the use of approximately 4,028 square feet for an eight year eight month term which is also coterminous with the Bank’s leases. The Bank Holdings took possession on April 9, 2004 and may extend the lease for four, five-year periods if not in default under the terms of the agreement at each renewal period. The lease payment under this agreement is approximately $5,720 per month with annual escalations for each of the first three years; beginning in year four there is a fixed annual escalation of 2.5%.
Nevada Security Bank’s Incline Village branch office operates in approximately 4,200 square feet in an office at the northeast end of the Raley’s Shopping Center located at 910 Tahoe Boulevard, Incline Village, Nevada, 89451. Nevada Security Bank renovated this property and took possession on March 6, 2003 under
a five-year lease dated February 26, 2001 that contained two renewal periods of five years each if the bank is not in default under the terms of the lease at each renewal period. The bank and the lessors of the property have agreed to both extensions of the lease, under the renewal terms as were previously documented. The lease payment under this agreement is approximately $7,056 per month with annual consumer price index (CPI) adjustments.
Nevada Security Bank’s MaeAnne office in Northwest Reno operates in approximately 3,500 square feet in a newly constructed free standing building in the McQueen’s Crossings shopping center development. Nevada Security Bank occupies this facility under a lease agreement dated October 7, 2003 within a land area of about 46,000 square feet. The location consists of a building, three drive-up lanes, one of which houses an ATM, and one bypass lane. The term of the lease is twenty years, commencing October 11, 2004, with two ten year extensions available if the tenant is not in default under the terms of the lease. The lease payment under this agreement is approximately $11,250 per month for the first five years, with escalations thereafter.
The Bank also occupies the former head office location of Northern Nevada Bank, acquired on November 6, 2006. This property is owned by the Bank and includes a 10,784 square foot two story building on a site area of .99 acres at 3490 S. Virginia Street, Reno, NV 89505. This property was originally one story of 5,064 square feet, but was improved during 2004 to add a 5,720 square foot two story addition. The property was appraised in December 2006 at $2.6 million and is used as a retail banking facility.
The second branch acquired during November, 2006 is the Carson office, located at 3120 Highway 50 East #1, Carson City, NV 89706. This facility is 2,552 square feet operating under a five year triple net lease which was signed on June 14, 2004 and commenced on May 1, 2005. The lease has two five year extension provisions, and common area operating costs are based on a 16% factor. The rent was established at $4,721.20 per month with a $0.10 per square foot increase on the 25th month of the term, and another such increase on the 49th month of the term.
The third location acquired is the Information Technology and Operations Center, located at 5450 Riggins Court, Suite 5, Reno, NV 89515. The facility is 5,138 rentable square feet with approximately 3,500 square feet used for operations and 1,600 square feet used as warehouse storage. The lease is dated August 11, 2000 and extends for ten years with a base rate of $0.65 per square foot. The property has an annual CPI adjustment commencing September 1 of each year, based on the San Francisco - Oakland California regional area index as published by the BLS. There are two five year options to renew within the body of the agreement, which is a triple net lease with a CAM charge base of 16.6%.
Additionally in the acquisition, the Bank became the owner of a 2.41 acre vacant lot located in Sparks, NV. This parcel is located adjacent east of Queens Way Lane with approximately 534 feet of frontage on Pyramid Highway, north of McCarran Blvd. The property is zoned PO - professional office and is considered to be an infill site, as most of the surrounding land has been developed. During December 2006 the property was appraised for $1.6 million.
The Spanish Springs branch office in Sparks, Nevada opened late in the first quarter of 2006, in a temporary location. The permanent location was delayed due to site completion activities. This temporary lease site is for one year, is dated February 1, 2006 for 1,471 rentable square feet with six months at $2,353.60 per month base rent and months 7 - 18 on a month to month at the same rate. The Bank has exceeded the original month-to-month term, and the current lease payment is approximately $3,530.42 per month. This temporary facility will be discontinued from use on March 31, 2008.
In addition, Nevada Security Bank opened a branch office at 2270 Douglas Blvd., Suite 220 Roseville, California under the name Silverado Bank, a division of Nevada Security Bank. The Roseville facility is newly renovated and operates under a lease dated October 6, 2004 with premises of approximately 5,968
square feet. The term of the lease is five years, commencing with occupancy in March 2005, with one five year extension available if the tenant is not in default under the terms of the lease. The lease payment under this agreement is approximately $12,533 per month for the first year, with escalations thereafter.
A further branch of Silverado Bank was opened at 2865 Sunrise Blvd, Suite 100, Rancho Cordova, CA. The property has 7,695 rentable square feet in a two story building under a five year term which lease is dated May 5, 2006, however, which commenced in June, 2007, due to permitting and remodeling delays. The base rent is established at $1.40 per square foot, with an annual $0.05 per foot escalation and a tenant pro rata CAM base of 16.66%. The agreement has two five year option periods, subject to the tenant not being in default under any lease provisions.
Nevada Security Bank’s total occupancy expense for the years ended December 31, 2007 and 2006 was approximately $2.4 million and $1.6 million respectively. Management believes that existing facilities are adequately covered by insurance and sufficient for our present purposes and anticipated growth in the foreseeable future.
The Company’s Qualified Intermediaries (the “QI’s”) 1031 offices are operated as Rocky Mountain Exchange at 1087 Stoneridge Drive, Bozeman, Montana and Granite Exchange, Inc. at 1400 Rocky Ridge Drive, Suite 280, Roseville, CA.
The Bozeman, Montana property is newly constructed and operates under a three year lease dated October 11, 2006 for 954 rentable square feet. Occupancy started in November 2006 under a triple net lease with an ability to extend for a five year period if tenant is not in default. The lease payment under this agreement is $13.00 per square foot per year with no escalation, and pro-rata common area maintenance charges.
The Granite Exchange location is in a new two story building constructed during 2005, commonly called the Rocky Ridge Corporate Center. The property is 2,776 rentable square feet available under a five year lease dated April 12, 2005 with occupancy started August 2005. The monthly rent per square foot is $2.35 with annual escalations of $0.05 per year, and monthly payments of pro-rata operating expenses. The agreement has two available three year options to extend, provided tenant is not in default under any terms or conditions of occupancy.
The Company’s 1031 division occupancy expense for the year ended December 31, 2007 was approximately $172,000. Management believes that such facilities as currently house these two subsidiary 1031 QI entities are adequately covered by insurance and sufficient for the present activities of the two operating units and their anticipated growth during the foreseeable future.
The Company maintains insurance coverage on all premises described above, and there are no known likely trends or uncertainties in future rent or amortization expense that could materially affect the Company’s cash flows.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the Company’s financial condition or results of operation.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No substantive matters were submitted to a vote of the security holders during the fourth quarter of the period covered by this report.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
(a) Market Information
Between December 27, 2001 the date the Bank opened for business, and March 22, 2004, there were no trades in the Bank’s stock of which management is aware, and there appeared to be no active trading market.
The Company’s Common Stock was listed on the NASDAQ Small Cap Market on March 23, 2004. Prior to that, Nevada Security Bank’s Common Stock was listed on the Over-The-Counter Bulletin Board (OTCBB). Our Common Stock trades on the NASDAQ Stock Market® under the symbol TBHS and the CUSIP number of such common stock is 88331E104.
(1) Trading commenced March 23, 2004.
THE BANK HOLDINGS
Source: SNL Financial LC, Charlottesville, VA
(434) 977-1600
© 2008
www.snl.com
Management is aware of the following securities dealers who make a market in the Company’s stock: D.A. Davidson & Co., Two Centerpointe Dr., Suite 400, Lake Oswego, OR 97035, phone number 800-249-2610 attn: Cindy Burg; Howe Barnes Investments Inc., 135 South LaSalle Street, Chicago, IL 60603, phone number 312-655-3000; attn: Glenn Harris, and Mitchell Securities Corporation of Oregon, 121 S.W. Morrison St., Suite 1060, Portland, OR 97204, phone number 800-224-2226 attn: Mitch Almy, (the “Securities Dealers”).
The Company has not made any repurchases of its stock during the fourth quarter of the period covered by this report, nor has it had any recent sales of unregistered securities.
(b) Holders
On March 3, 2008 total shareholders of record were 1,165. There were 585 individual shareholders while street name holders totaled about 580.
(c) Dividends
As a bank holding company which currently has no significant assets other than our 100% ownership of Nevada Security Bank and our 100% ownership of Rocky Mountain Exchange as well as our 80% ownership of Granite Exchange (subsequently 100% as of February 1, 2008), our ability to pay cash dividends depends upon the dividends we receive from our subsidiaries. The dividend practice of Nevada Security Bank and our QI’s, like our dividend practice, will depend upon earnings, financial condition and other relevant factors, including applicable regulatory orders and restrictions with respect to dividends.
Nevada Security Bank’s ability to pay cash dividends to us is also subject to certain legal limitations. Under Nevada law, a bank cannot declare a cash dividend or make a distribution of its net profits until (a) the bank’s surplus fund equals its initial stockholders’ equity (excluding the amount of the initial surplus fund) and (b) ten percent of the previous year’s net profits have been carried to the surplus fund. Additionally, no distribution may be made if it would result in the bank’s stockholders’ equity (including the reserve for loan losses) being less than 6% of the bank’s average total daily deposit liabilities for the preceding 60 days or if it would reduce the stockholders’ equity below the initial stockholders’ equity or below minimum applicable regulatory capital requirements under federal law. Also, under Nevada law applicable to Nevada Security Bank, and to Nevada corporations generally, no distribution may be made if, after giving effect to it, the corporation would be unable to pay its debts as they become due in the usual course of business or the sum of the corporation’s assets would be less than the sum of its liabilities plus the amount (if any) that would be needed to satisfy the rights of holders of any preferred stock of the corporation, assuming the corporation were to be dissolved at the time of the distribution.
Stock dividends are not subject to the Nevada law restrictions or distributions, as described above, because a corporation’s assets, liabilities and total stockholders’ equity do not change as a result of the stock dividend.
During the first quarter of 2007, the Company declared a five percent (5%) stock dividend payable to shareholders as of February 15, 2007. The Company previously declared a five percent (5%) stock dividend during 2006 payable to shareholders as of December 8, 2005.
Shareholders are entitled to receive dividends only when and if declared by our board of directors, and we have no intention to pay cash dividends in the foreseeable future. Instead, any earnings which may be generated will be retained for the purpose of increasing our capital and reserves in order to facilitate growth.
During any period in which the Company has deferred payment of interest otherwise due and payable on its subordinated debt securities, it may not make any dividends or distributions with respect to its capital stock (see “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources”).
(d) Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information as of December 31, 2007, with respect to options outstanding and available under our Stock Option Plan, which is our only equity compensation plan other than an employee benefit plan meeting the qualification requirements of Section 401(a) of the Internal Revenue Code:
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
*
Adjusted for Stock Dividends of February 15, 2007 and December 28, 2005
(1)
The Company removed the valuation allowance on deferred tax assets, and incurred franchise taxes on its allocated California income.
(2)
Non-performing assets consists of loans 90 days or more delinquent and still accruing interest, investments or loans placed on non-accrual status, and other real estate owned.
(3)
Net interest income divided by average interest earning assets.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following provides Management’s comments on the financial condition and results of operations of The Bank Holdings and its subsidiaries. Unless otherwise stated, “the Company” refers to this consolidated entity and “we” refers to the Company’s Management. You should read this discussion in conjunction with the Company’s Consolidated Financial Statements and the notes to the Consolidated Financial Statements.
The “summary consolidated selected financial data” that precedes is derived from the audited Consolidated Financial Statements of the Company and from our internal accounting system. The selected financial data should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This discussion presents management’s analysis of the financial condition and result of operations of The Bank Holdings, Nevada Security Bank, and the Company’s 1031 QI division, for each of the periods ended December 31, 2007, 2006, and 2005 and includes the statistical disclosures required by SEC Guide 3 (“Statistical Disclosure by Bank Holding Companies”). The discussion should be read in conjunction with the financial statements of The Bank Holdings, Nevada Security Bank, and the 1031 division, and the notes related thereto which appear elsewhere in this document.
Critical Accounting Policies
The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The financial information contained within these statements is, to a significant extent, based on approximate measures of the financial effects of transactions and events that have already occurred. Critical accounting policies are those that involve the most complex and subjective decisions and assessments, and have the greatest potential impact on the Company’s stated results of operations. In Management’s opinion, the Company’s critical accounting policies deal with the following five areas: the establishment of the Company’s allowance for loan losses, as explained in detail in the “Provision for Loan Losses” and “Allowance for Loan Losses” sections of this discussion and analysis; loan origination costs, which are estimated and aggregated by loan type based on a regular evaluation of expenses (primarily salaries and benefits) associated with successful loan originations and are allocated to individual loans as they are booked, but can actually vary significantly for individual loans depending on the characteristics of such loans; income taxes, especially with regard to the ability of the Company to recover deferred tax assets, as discussed in the “provision for income taxes” and “other assets” sections of this discussion and analysis; goodwill, which is evaluated annually for impairment based on changes in the market value of subsidiary organizations; and equity-based compensation, which is discussed in greater detail in Footnote 1 “Basis of Presentation” to the financial statements contained herein, under the caption “Stock Compensation Plan”. Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate the most recent expectations with regard to these areas.
Allowance for Loan Losses
Our allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan loss that management believes is appropriate at each reporting date. Quantitative factors include our historical loss experience, peer bank loss experience, delinquency and charge-off trends, collateral values, changes in nonperforming loans, loan concentrations and other factors. Qualitative factors include the general economic conditions in our multi-state locations, and in particular, the state of certain industries in northern Nevada and northern California. Size and complexity of individual credits in relation to loan structure, existing loan policies and pace of portfolio
growth are other qualitative factors that are considered in the methodology. As we add new products and increase the complexity of our loan portfolio, we enhance our methodology accordingly. Management may report a materially different amount for the provision for loan losses in the statement of operations to change the balance of the allowance for loan losses if its assessment of the above factors were different. This discussion and analysis should be read in conjunction with our financial statements and the accompanying notes presented elsewhere herein as well as the portion of this Management’s Discussion and Analysis section entitled “Provision for Loan Losses” and “Allowance for Loan Losses”. Although management believes the levels of the allowance as of December 31, 2007 and 2006 were adequate to absorb probable losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.
Loan Origination Costs
Loan origination costs are those costs borne by the Company to originate, record and service a new loan. Such costs are deferred from current expense and amortized over the life of the loan. Such costs are estimated based on a bi-annual evaluation of expenses (primarily salaries) associated with successful loan originations and are allocated to individual loans based on their type as they are booked. Such costs may actually vary substantially, based on the individual characteristics of any given loan. Deferred costs and associated loan fees are disclosed in NOTE 5. Deferred costs are adjustments to salary expense, while deferred fees are adjustments to loan yields.
Deferred Tax Assets
The Company’s deferred tax assets are explained in NOTE 9. The Company uses an estimate of future earnings to support its position that the benefit of its deferred tax assets will be realized. If future income should prove non-existent or not sufficient to recover the amount of the deferred tax assets within the tax years to which they may be applied, the assets may not be realized and the Company’s net income could be reduced.
The Company’s pretax income for 2007 was $2.4 million, somewhat less than the net deferred tax asset of $3.1 million. Consequently, the Company considers it more likely than not that the Company will be able to utilize the deferred tax assets in the normal course of business.
Business Combinations
Assets and liabilities acquired in business combinations are recorded at fair value. The Company uses a variety of methodologies to estimate these fair values. In general the methodologies are the same as those used in determining the fair value of assets and liabilities as are described in NOTE 16. The fair value of most financial assets and liabilities are determined by discounting the anticipated cash flows from or for the instrument using current market rates applicable to each category of instrument. Where market quotes may be available as in the case of securities, these are used in reference to estimates determined by discounting cash flows. Because the excess of consideration paid in the business combination over the fair value of the net assets is recorded as goodwill, errors in the estimation process of the fair value of acquired assets and liabilities will result in an overstatement or understatement of income and expenses and, in the case of an overstatement of goodwill, could make the Company more subject to an impairment charge when the overstatement is discovered in its annual assessment for impairment.
Goodwill and other intangible assets
The Company has recorded approximately $31 million in goodwill and other intangible assets arising from business combinations. The Company must assess goodwill and other intangible assets each year for impairment. This assessment involves estimating cash flows for future periods, preparing analysis of market multiples for similar operations and estimating the fair value of the reporting unit to which the goodwill is allocated. If the future cash flows were materially less than the estimates, the Company would be required to take a charge against earnings to write down the asset to the lower fair value. Goodwill and other intangible assets were not impaired as of December 31, 2007 or 2006.
Equity Based Compensation
Equity based compensation is a significant accounting policy and this is discussed in detail in NOTE 14 to the financial statements contained herein, under the caption “Stock Compensation Plan.”
Estimates of the fair value of assets
Certain assets of the Company are recorded at fair value, or the lower of cost or fair value. In some cases, the fair value used is an estimate. Included among these assets are securities that are classified as available-for-sale, goodwill and other intangible assets, and other real estate owned and impaired loans. These estimates may change from period to period as they are impacted by changes in interest rates and other market conditions. Losses not anticipated or greater than anticipated could result if the Company were forced to sell these assets and discovered that its estimate of fair value had been too high. Gains not anticipated or greater than anticipated could result if the Company were to sell any of these assets and discover that its estimate of fair value had been too low.
OVERVIEW
The Company earns income from two primary sources; net interest income generated by the successful employment of earning assets less the costs of interest-bearing liabilities, and net non-interest income, which is generated by service charges and fees charged for services provided, less the operating costs of providing the full range of banking and other financial services to our customers. Income on bank owned life insurance and 1031 exchange fees, gains on sale of securities and unrealized gains or losses on the Company’s trading account and fair value loans comprise primary areas of non-interest income.
SUMMARY: RESULTS OF OPERATIONS
2007 Over 2006
As previously noted and also as reflected in the Consolidated Statements of Operations, for the year ended December 31, 2007, the Company generated after tax net income of $1.7 million and for the years ended December 31, 2006 and 2005, the Company generated net income of $2.1 million, and $1.4 million, respectively. Basic and diluted earnings per share for the year ended December 31, 2007 was $0.30 and $0.29 compared with basic and diluted earnings per share of $0.51 and $0.49 for the year ended December 31, 2006. The Company’s annual return on average equity was 2.31% and annual return on average assets was 0.27% for the year ended December 31, 2007, compared to 5.05% and 0.46% respectively, for the same period of 2006 and 5.03% and 0.48% for 2005. There were a number of monetary and non-monetary events that occurred during 2007 that had an impact on the reported performance of the Company. The monetary events that resulted in significant changes in the Company’s reported performance include the growth of assets under management and the interest rate margin compression resulting from the large changes in short term interest rates. The significant non-monetary events include expanding our branch network with a new branch office in Rancho Cordova, CA, increasing our product lines with the addition of customer available remote deposit capture, the third and fourth quarter downturn in the national, state, and regional economies and the deteriorating economy faced by our customers; especially those affected by the real estate markets downturn.
The primary drivers behind the variance in net income for the year of 2007 relative to 2006 are as follows:
· The additional assets, liabilities, income and expense attributed to the full year addition of NNB Holdings, Inc. during 2007 when compared with 2006.
· The additional professional expenses reflective of the Congressional adoption of the Sarbanes-Oxley Act.
· Interest income increased $14.1 million to $45.2 million or 45.6% for 2007 compared to 2006.
· Net interest income before provision for loan losses increased by $6.3 million or 39.3%.
· Net interest margin increased five basis points to 3.79%.
· The provision for loan losses increased by $2.2 million or 301.8% for the year end 2007.
· Non-interest income was $1.4 million, for 2007 a decrease of $260,000 or 15.5%.
· Non-interest expense increased $4.7 million or 34.8%.
· Salaries and benefits increased $1.9 million or 25.6%.
· Occupancy increased $788,000 or 41.0%.
· Accounting, legal and other professional costs increased $928,000 or 162.8%.
· Deposit service costs were $1.1 million, an increase of 139.5% over the same period in 2006.
· All other expenses increased $419,000 or 13.9%.
· Average earning assets increased $160.0 million or 37.5%.
· Average interest bearing liabilities were $495.8 million, an increase of 38.6%.
· The Company’s weighted average prime rates for the years 2007, 2006 and 2005 were 8.05%, 7.96%, and 6.19%, respectively.
Focusing on 2008, the following strategic initiatives are expected to drive profitability and growth in earnings per share:
· Focus on leveraging our 1031 QI footprint and the expanded product set made possible by these acquisitions. This may included the possible additions of smaller “mom and pop” 1031 QI operations within our markets or contiguous markets.
· A renewed effort on gathering deposits through electronic remote deposit capture channels and restructuring of incentive plans to reward deposit gathering in a fashion similar to that of new loan growth.
· A continued reduction of non-interest expense as the Company is committed to the delivery of products and services in the most efficient manner possible, re-engineering processes to capture efficiencies while maintaining Sox 404 procedural separation requirements.
· A commitment to invest in revenue generating strategic initiatives to be funded through operational efficiencies.
· Strengthening of our balance sheet through specific strategies intended to reduce our funding costs without losing sight of liquidity and customer maintenance responsibilities.
2006 Over 2005
For the year ended December 31, 2006, the Company generated after tax net income of $2.1 million. Basic and diluted earnings per share for the year ended December 31, 2006 was $0.51 and $0.49. The Company’s annual return on average equity was 5.05% and annual return on average assets was 0.46% for the year ended December 31, 2006. There were a number of monetary and non-monetary events that occurred during 2006 that had an impact on the reported performance of the Company. The monetary events that resulted in significant changes in the Company’s reported performance include the substantial growth of assets under management, the increase in short term funding costs during the year, being in a fully taxable position as compared to the removal of a valuation allowance against deferred tax assets during 2005 and the addition of $42.9 million in new capital for the Company. The significant non-monetary events included the acquisition of the 1031 financial intermediaries during the first quarter of 2006 and the purchase and merger with NNB Holdings and Northern Nevada Bank in November of 2006. In addition, we opened a new branch office in Sparks, Nevada, and had an approved but unopened office in Rancho Cordova, CA. The Company in
conjunction with the purchase and merger of NNB Holdings and Northern Nevada Bank also converted its data processing structure from a service bureau to an in-house processing system.
The primary drivers behind the variance in net income for the year of 2006 relative to 2005 were as follows:
· Net interest income after provision for loan losses increased by $6.4 million or 73.5%.
· The Company recorded $448,000 in exchange fee income and there was no similar item in 2005.
· Unrealized gains on trading equities amounted to $443,000 for 2006.
· Salaries and benefits increased $3.4 million or 80.4%.
· Occupancy expenses increased $389,000 or 25.4%.
· Data processing costs increased $227,000 or 31.0%.
· All other expenses increased $748,000 or 32.0%.
· The Company’s weighted average prime rates for the years 2006, 2005 and 2004 were 7.96%, 6.19%, and 4.34%, respectively.
2005 over 2004
The strong improvement in results of operations for the year ended December 31, 2005 when compared to the results of the comparable 2004 period, were primarily due to increases in volumes held of interest earning assets and interest bearing liabilities. Total assets increased $137.8 million or 55.8% when comparing December 31, 2005 to 2004, and average total assets increased about $60.1 million or 25.8% over the same period.
The Company’s income from operations was $1.4 million for the year ended December 31, 2005 as compared to $281,000 for the comparable period in 2004. This was a change of approximately $1.1 million from the previous period. The income per basic share was $0.45 for 2005, as compared to $0.10 for 2004. The Company’s return on averages assets (ROAA) was 0.48% and the return on average equity (ROAE) was 5.03%, as compared to 0.12% and 1.22% respectively, for 2004.
There were a number of monetary and non-monetary events that occurred during the year 2005 that had an impact on the reported performance of the Company. The monetary events that prompted significant changes in the Company’s reported performance include the substantial growth of assets under management, the actions of the FOMC and the concomitant increases in short-term funding costs over the year, the elimination of the allowance for deferred tax assets, and the addition of $15.5 million in trust preferred securities at the holding company level. Significant non-monetary events include the opening of the Silverado Bank division in Roseville, California, the addition of executive compensation plans in the form of Bank Owned Life Insurance (“BOLI”) and the continued growth of personnel over the intervening year. In addition, the Bank’s defense against the DOT1web allegations diverted management’s attention and added to professional expenses over 2005; such litigation expense did not continue beyond the first quarter of 2006.
RESULTS OF OPERATIONS
2007 over 2006
The primary factor in the Company’s reduced earnings in 2007 when compared to 2006 was a $2.2 million increase in the provision for loan losses. This was brought about by deteriorating real estate market conditions which appeared in the third quarter, and which are expected to continue through much of 2008. Increasing management attention to credit quality, increases in non-performing assets and concern about real estate values led the Company to substantially increase the provision for 2007. While management believes the allowance adequately covers the inherent losses in the loan portfolio, no assurance can be given that
further substantial additions will not be required. The provision is determined pursuant to a quarterly comprehensive analysis of the allowance for loan losses. The allowance is described in more detail in the Allowance for Loan Losses discussion section (see Appendix 8 & 9) herein.
Also contributing to the Company’s reduction in earnings for 2007 was the $4.7 million increase or 34.8% in non-interest expense when compared to 2006. This increase was primarily brought about by an increase in FTE, the increase in the number of Company locations, and the costs associated with providing deposit documents for more customers, as well as the substantial increase in professional expenses to comply with accounting pronouncements, regulatory mandated internal audit services, and SOX 404 requirements. Personnel, occupancy and deposit service costs increases primarily relate to the full year costs borne in 2007 having to do with the acquisition of Northern Nevada Bank during November 2006.
Other factors of lesser import include a decrease of $260,000 or 15.5% in non-interest income. This decrease is mostly due to the decreases in unrealized gains on trading equities which decreased $325,000 over 2006 and exchange fee income with a decrease of $285,000 over 2006. These decreases in non-interest income were mitigated by increases in service charges on deposit accounts and other fees and charges which increased $355,000 over 2006.
One very positive factor during the year was net interest income before provision for loan losses, which amounted to $22.2 million, an increase of 39.3% over 2006. This change brought about an increase in the Company’s net interest margin, from 3.74% in 2006 to 3.79% for 2007. A negative factor concerning the Company’s net interest income is the $400,000 of interest income foregone as a result of loans placed on non-accrual during 2007. In addition, the Company has reported a provision for income taxes of $625,000 for the year ended 2007 as compared to $1.1 million for the year of 2006.
2006 over 2005
A primary contribution to the Company’s improvement in earnings in 2006 when compared to 2005 was a $6.2 million increase in net interest income. This was brought about by average earning assets being approximately 48.8% greater during 2006 over 2005, and the Company’s net interest margin increase of 25 basis points to 3.74% compared to 3.49% for the year of 2005. The increase in the net interest margin was almost solely due to continuing increased volumes, as rate and rate/volume changes nearly offset one another.
Another factor which contributed to the Company’s earning improvement in earnings during 2006 compared with 2005 is an increase of $910,000 or 118% in non-interest income. This increase was mostly due to the substantial increase in unearned income on trading equities which increased $396,000 over 2005 and exchange fee income of $448,000 for 2006 with no corresponding income category for 2005. A reduction in the provision for loan losses of $298,000 or 27.9% when comparing 2006 to 2005 was also a factor in the yearly earnings improvement for the period ending December 31, 2006. The provision is determined pursuant to a quarterly comprehensive analysis of the allowance for loan losses. The allowance is described in more detail in the Allowance for Loan Losses discussion section (see Appendix 8 & 9) herein.
Several factors mitigated the improved earnings discussed above. These factors include the increase in non-interest expenses due to the continued internal growth of the Company and the acquisitions made during the year. Non-interest expense for the year ending December 31, 2006 was $13.6 million, an increase of $4.8 million or 54.6%. In addition, the Company reported a provision for income taxes of $1.1 million for the year ended 2006 as compared to a tax benefit of ($710,000) for the year of 2005.
2005 over 2004
The Company’s net income for the year ended December 31, 2005 was $1.4 million as compared to $281,000 for the year ended December 31, 2004. The Company’s basic income per share for the twelve months ended December 31, 2005 was $.45 as compared to $.10 per share for the prior year ended December 31, 2004, while the Company’s return on average equity was 5.03% and 1.22% for the same periods, and return on average assets was 0.48% and 0.12%, respectively for 2005 and 2004.
The primary contribution to the Company’s earnings improvement in 2005 when compared to 2004 was a $3.0 million increase in net interest income. This was brought about by average earning assets approximately 28% greater than the prior period, and the Company’s net interest margin increase of 37 basis points to 3.49% for 2005, from 3.12% for the year ended December 31, 2004. The increase in the net interest margin was due more to continuing increased volumes and a redistribution of assets held, rather than any marked increase in interest earned on investment or loan portfolio assets. The second most notable area of change in the Company’s reported results when one compares 2005 to 2004 was the removal of the valuation reserve in the Company’s deferred tax asset. The Company’s prior tax-loss carry-forwards were substantially decreased by the results of 2005 operations. However, the lack of historical loan losses impaired the Company’s ability to recognize the tax effect of the provisions for loan losses, and as a result a substantial deferred tax asset remained on the books and records of both the Bank and the Company.
Other changes included a $305,000 increase in the Company’s provision for loan losses, for the year ended December 31, 2005, when compared to the same period of 2004. The provision for loan losses was $1.1 million for 2005 and $764,000 for 2004, an increase of 40%. The provision is determined pursuant to a periodic comprehensive analysis of the allowance for loan losses. The allowance is described in more detail in the Allowance for Loan Losses discussion section (see Appendix 8 & 9) herein.
Non-interest income for the year ended December 31, 2005 was $772,000 as compared to $420,000 in 2004 an increase of $352,000 or 84%. A substantial portion of the increase in 2005 was due to the BOLI increase in cash surrender value. This favorable increase in non-interest income was more than off-set by an increase of $2.6 million in non-interest expenses which negatively affected the Company’s net non-interest margin.
While the Company had a tax loss carry forward on a consolidated basis, the valuation allowance was removed from the Company’s deferred tax assets and net tax benefits in the amount of ($710,000) were recorded for the year of 2005.
Net Interest Income and Net Interest Margin
The Company’s net interest margin depends on the yields, volumes, and mix of its earning asset components as compared to the rates, volume and mix of various funding sources. The Company’s net interest margin is its net interest income expressed as a percentage of average earning assets. The Average Balances and Rates Table, (see Appendix 1), reflects the Company’s average balance sheet volumes of assets, liabilities, and stockholders equity; the amount of associated interest income or interest expense; net interest income; the average rate or yield for each category of interest earning asset or interest bearing liability; and the net interest margin for the periods noted.
Rate/Volume Analysis
Net interest income can be evaluated from the perspective of relative dollars of change in each period. Interest income and interest expense, which are the components of net interest income are shown in Appendix 2 on the basis of the amount of any increases (or decreases) attributable to changes in the dollar levels of the Company’s interest-earning assets and interest-bearing liabilities (“Volume”) and the yields
earned and rates paid on such assets and liabilities (“Rate”). The change in interest income and interest expense attributable to changes in both volume and rate has been allocated proportionately to the change due to volume and the change due to rate.
2007 Over 2006
Net interest income before the provision for loan losses for the year ended December 31, 2007 was $22.2 million, as compared to $16.0 million for the same period in 2006. This represents an increase of $6.2 million or about 39%. As previously noted, net interest income is the difference between the interest income and fees earned on loans and investments, and the interest expense paid on deposits and other borrowings. The amount by which interest income exceeds interest expense depends on two factors: the volume and mix of earning assets as compared to that of interest bearing liability portfolios. The Company’s net interest margin is the net interest income expressed as a percentage of earning assets. The margins for 2007, 2006, and 2005, are reflected in Appendix 1 which reflects the changes in interest rates earned on loans and investments, and rates paid on deposits and interest bearing liabilities held by the Company during the periods under review.
For the majority of the past three years the Company’s net interest margin has been impacted by three over-riding conditions. The first is the continued rising interest rate environment of the previous two years or so brought about the actions of the Federal Open Market Committee, the second has been the continued improving general economic conditions of the local and regional markets in the prior periods with an increasing deterioration in these markets during the latter half of 2007, and the third is the continuing extremely competitive loan and deposit pricing of the major banks in the Company’s markets. As a result, the Company’s net interest margin was 3.79%, and its interest rate spread was 3.06% for the year ended December 31, 2007, compared with 3.74% and 3.05%, respectively, for 2006.
The Company’s 4.36% earnings rate on its investment portfolio for the year ended December 31, 2007 as compared to 4.30% and 3.37% for the same periods in 2006 and 2005, respectively, was an increase of six basis points over 2006 or 1.4%. This earning rate was favorably impacted by the increasing rate environment coupled with current period purchases, and heavy refinancing in the mortgage backed portfolio.
The Company uses an effective tax rate of 37% when calculating the tax equivalent yield of its state, county, and municipal investment portfolio. This is the same factor that was used in 2006; however, 34% was used for calculations during the year of 2005. Approximately $21.4 million of the investment portfolio is comprised of tax exempt investments which is an increase of $6.8 million from the prior year.
The Company’s rates earned on its loan portfolio during 2007 increased four basis points to 8.46% or an increase less than 1%. The significant increase in average loans outstanding was the primary contributor to the increase in loan interest income during 2007. While the prime rate decreased three times from 8.25% to 7.25% during 2007, the weighted average prime rate increased nine basis points during 2007 when compared to 2006. This resulted in the overall earning rate of 8.46% for the year ended December 31, 2007 a four basis point improvement from the 8.42% rate earned for the year ended December 31, 2006 and a one hundred and twenty seven basis point increase from the 7.19% earnings rate for the year ended December 31, 2005.
As a result of the foregoing, the Company’s gross interest earnings asset rate for the year ended December 31, 2007 was 7.70%, as compared to 7.27% for the same period of 2006, and 6.10% for 2005.
Interest expense for 2007, 2006 and 2005 was impacted by the escalating short-term interest rate environment previously noted, and competitive pressures in our local markets. This caused the Company’s interest paid rate on all interest bearing liabilities to be 4.63% for the year ended December 31, 2007 as
compared to 4.22% for the same period in 2006, and 3.23% for 2005. The Company’s overall net interest margin increased to 3.79% for the year ended December 31, 2007 as compared to 3.74% for the same period in 2006, and 3.49% for 2005.
Actual earning rates increased on the Company’s investments and loan portfolios over the year ended December 31, 2007 when compared to the same period in 2006; the change in asset mix combined with significant volume increases on total earning assets resulted in the most impact on interest income. As a result, the Company’s yield on total earning assets increased by 43 basis points during the year ended December 31, 2007 when compared to the same period of 2006, and 117 basis points during the year ended December 31, 2006 when compared to the same period in 2005. In contrast, interest bearing liabilities also had significant volume increases combined with liability mix changes which had an impact on net interest income. The cost of interest bearing liabilities increased by 41 basis points during the year ended December 31, 2007 when compared to 2006, and 99 basis points during the year ended December 31, 2006, when compared with 2005.
The Changes in Net Interest Income Table (see Appendix 2) presents information regarding interest income and interest expense for each major category of interest-earning assets and interest-bearing liabilities. The table sets forth changes in interest income and expense attributable to changes in average balances (volume) or changes in average interest rates (rates). The calculation is as follows: (i) changes in rate (changes in rate multiplied by prior year volume), (ii) change in volume (change in volume multiplied by prior year rate) and (iii) changes in both rate and volume (change in rate multiplied by change in volume). Changes in interest income and expense that are not due solely to volume or rate changes are combined with the rate/volume change category.
Rate and rate/volume changes combined are shown to have brought about a decline of $1.2 million in net interest income for the year ended December 31, 2007 as compared to the same period of 2006 which had an approximately neutral position. While the rate and rate/volume effect is negative, this was more than six times completely offset by increases in net interest income due to volume changes. Total interest income on a volume basis substantially overshadowed the rate and rate/volume effects and accordingly net interest income rose by $6.3 million over the period due to positive variances in loan portfolio volumes.
The Company’s net interest margin is also impacted by changes in the mix of interest earning assets and interest bearing liabilities, as well as by changes in the relative level of non - earning assets (including cash and due from banks). The relative percentage of interest earning assets to interest bearing liabilities remained essentially unchanged in 2007 as compared to 2006. For the years ended December 31, 2007 and 2006 net interest income increases were related solely to volume increases.
For the twelve months ended December 31, 2007 the average yield on the investment portfolio was 4.36%, while the average yield on the loan portfolio was 8.46% for a combined weighted yield of 7.70% on $587 million of average earning assets.
For the same period, the interest costs on deposit liabilities was 4.42% and 6.05% on other interest bearing liabilities, for a combined weighted average cost of 4.63% on $496 million of total average interest bearing liabilities.
2006 over 2005
Net interest income before the provision for loan losses for the year ended December 31, 2006 was $16.0 million, as compared to $9.8 million for the same period in 2005. This represents an increase of $6.2 million or about 63%. The amount by which interest income exceeds interest expense depends on two factors: the
volume and mix of earning assets as compared to that of interest portfolios. The Company’s net interest margin is the net interest income expressed as a percentage of earning assts.
The Company’s net interest margin was impacted by three over-riding conditions. The first was the continued rising interest rate environment of the last year or so brought about the actions of the Federal Open Market Committee, the second was the continued improving general economic conditions of the local and regional markets, and the third was the continuing extremely competitive loan and deposit pricing of the major banks in the Company’s market. As a result, the Company’s net interest margin was 3.74%, and its interest rate spread was 3.05% for the year ended December 31, 2006.
The Company’s 4.30% earnings rate on its investment portfolio for the year ended December 31, 2006 as compared to 3.37% and 3.09% for the same periods in 2005 and 2004, respectively, was an increase of 93 basis points over 2005 or 27.6%. This earning rate was favorably impacted by the increasing rate environment coupled with current period purchases, heavy refinancing in the mortgage backed portfolio, and the rising interest rates on liquid overnight funds sold on a daily basis.
The Company uses an effective tax rate of 37% in calculating the tax equivalent yield of its state, county, and municipal investment portfolio. Approximately $14.6 million of the investment portfolio is comprised of tax exempt investments which is an increase of $13.2 million from the prior year.
The Company’s rates earned on its loan portfolio over the same periods increased 123 basis points to 8.42% or an increase of about 17%. The significant increase in loans outstanding and the change in asset mix contributed to the increase in loan interest income over the periods under review. While the prime rate rose five times from 7.0% to 8.25% during 2005, the overall earnings rate of 8.42% for the year ended December 31, 2006 was noticeably improved from the 7.19% rate earned for the year ended December 31, 2005.
As a result of the foregoing, the Company’s gross interest earning assets rate for the year ended December 31, 2006 was 7.27%, as compared to 6.10% for the same period of 2005, and 4.79% for 2004.
Interest expense for 2006 and 2005 was impacted by the escalating short-term interest rate environment previously noted, and the Company’s interest paid rate on all interest bearing liabilities was 4.22% for the year ended December 31, 2006 as compared to 3.23% for the same period in 2005, and 2.06% for 2004. The Company’s overall net interest margin increased to 3.74% for the year ended December 31, 2006 as compared to 3.49% for the same period in 2005, and 3.12% for 2004.
Although actual earning rates increased on the Company’s investments and loan portfolios over the year ended December 31, 2006 when compared to the same period in 2005, the change in asset mix combined with significant volume increases on total earning assets resulted in the greatest change in interest income. As a result, the Company’s net interest margin increased by 25 basis points during the year ended December 31, 2006 when compared to the same period of 2005, and 37 basis points over the year ended December 31, 2005 when compared to the same period in 2004.
Rate/volume changes are shown to have brought about the decline of $1.2 million in net interest income for the year ended December 31, 2006 relative to the same period of 2005. While the rate/volume effect is negative, this was substantially offset by increases in net interest income due to rate changes. Total interest income on a volume basis was five times the magnitude of the rate and rate/volume effects and accordingly net interest income rose by $6.1 million over the period due to positive variances in loan and investment portfolio volumes.
The Company’s net interest margin was also impacted by changes in the mix of interest earning assets and interest bearing liabilities, as well as by changes in the relative level of non - earning assets (including cash
and due from banks). The relative mix of interest earning assets to interest bearing liabilities remained essentially unchanged in 2006 as compared to 2005. Changes in the volume mix and rising rates had a positive impact on the weighted average yield on net interest spread.
For the twelve months ended December 31, 2006 the average yield on the investment portfolio was 4.30%, while the average yield on the loan portfolio was 8.42% for a combined weighted yield of 7.27% on $427 million of average earning assets.
For the same period, the interest costs on deposit liabilities was 4.08% and 5.21% on other interest bearing liabilities, for a combined weighted average cost of 4.22% on $358 million of total average interest bearing liabilities.
2005 over 2004
Net interest income before the provision for loan losses for the year ended December 31, 2005 was $9.8 million, as compared to $6.9 million for the same period in 2004. This represented an increase of about $3.0 million or about 43%.
The Company’s net interest margin was impacted by three over-riding conditions. The first was the continued rising interest rate environment of the last year or so brought about the actions of the Federal Open Market Committee, the second was the continued improving general economic conditions of the local and regional markets, and the third was the continuing extremely competitive loan and deposit pricing of the major banks in the Company’s market. As a result, the Company’s net interest margin was 3.49%, and its interest rate spread was 2.87% for the year ended December 31, 2005.
The Company’s 3.37% earnings rate on its investment portfolio for the year ended December 31, 2005 as compared to 3.09% for the same periods in 2004 and 2003 was an increase of 28 basis points or 9.06%. This earning rate was favorably impacted by the increasing rate environment coupled with current period purchases, heavy refinancing in the mortgage backed portfolio, and the rising interest rates on liquid overnight funds sold on a daily basis.
The Company uses an effective tax rate of 34% in calculating the tax equivalent yield of its state, county, and municipal investment portfolio. Approximately $1.4 million of the investment portfolio was comprised of tax exempt investments which was an increase of $1.3 million from the prior year.
The Company’s rates earned on its loan portfolio over the same periods increased 105 basis points to 7.19% or an increase of about 17%. The significant increase in loans outstanding and the change in mix contributed to the increase in loan interest income over the periods under review. While the prime rate rose eight times from 5.0% to 7.0% during 2005, the overall earnings rate of 7.19% for the year ended December 31, 2005 was noticeably improved from the 6.14% rate earned for the year ended December 31, 2004.
As a result of the foregoing, the Company’s gross interest earnings asset rate for the year ended December 31, 2005 was 6.10%, as compared to 4.79% for the same period of 2004, and 4.55% for 2003.
Interest expense for 2005 was impacted by the rapidly escalating short-term interest rate environment previously noted, and the Company’s interest paid rate on all interest bearing liabilities was 3.23% for the year ended December 31, 2005 as compared to 2.06% for the same period in 2004, and 2.01% for 2003. Although the Company’s overall net interest margin increased to 3.49% for the year ended December 31, 2005 as compared to 3.12% for the same period in 2004, and 2.91% for 2003, prior to the fourth quarter of 2005, the Company’s net interest margin had not been as adversely affected by rising short-term interest rates on the liability side of the balance sheet.
Although actual earning rates increased in the Company’s investment and loan portfolios over the year ended December 31, 2005 when compared to the same period in 2004, the change in asset mix combined with significant volume increases in total earning assets resulted in the most impact on interest income. As a result, the Company’s net interest margin increased by 37 basis points during the year ended December 31, 2005 when compared to the same period of 2004, and 21 basis points over the year ended December 31, 2003 when compared to the same period in 2002.
Interest bearing liability rate changes are shown to have brought about the decline of $525,000 in net interest income for the year ended December 31, 2005 relative to the same period of 2004. While the rate effect is negative, total interest income on a volume basis was substantially overshadowed this negative effect and net interest income rose by $3.0 million over the period due to positive variances in loan portfolio volumes.
The Company’s net interest margin is also impacted by changes in the mix of interest earning assets and interest bearing liabilities, as well as by changes in the relative level of non - earning assets (including cash and due from banks). On the asset side of the balance sheet, the relative increase in loan volumes as compared to investment volumes as a portion of average earnings assets, as well as the change in the loan to deposit ratio, had a greater impact on the weighted average yield on earning assets.
For the twelve months ended December 31, 2005 the average yield on the investment portfolio was 3.37%, while the average yield on the loan portfolio was 7.19% for a combined weighted yield of 6.10% on $281 million of average earning assets.
For the same period, the interest costs on deposit liabilities was 3.17% and 3.87% on other interest bearing liabilities, for a combined weighted average cost of 3.23% on $228 million of total average interest bearing liabilities.
Non-Interest Income and Non-Interest Expense
2007 Over 2006
Non-Interest Income Overview:
The Company’s results reflected a lower level of non-interest income in the year ended December 31, 2007 than that ended December 31, 2006. Please refer to Non-Interest Income and Non-Interest Expense Table Appendix 3 for additional specific information. The overall ratio of non-interest income to average earning assets decreased to 0.24% from 0.39% for the year ended December 31, 2007 as compared to 2006, and 0.27% for 2005.
Non-Interest Expense Overview:
Total non-interest expenses increased to $18.3 million in the year ended December 31, 2007 from $13.6 million in the period ended December 31, 2006, and $8.8 million for the year ended December 31, 2005. As a percentage of average earning assets, total non-interest expenses were 3.12% and 3.18% for the years ended December 31, 2007 and 2006, respectively, and 3.14% for 2005. The dollar increase of approximately 35% for the year 2007 as compared to 2006, and the 55% increase for 2006 over 2005 reflect the continued additions to staff, offices, and data processing capabilities over time, as the Bank has continued its expansion in both northern Nevada and northern California over the periods under review. Both geographic centers are anticipated to continue to grow more slowly over the foreseeable future, as the Company refines its marketing plans and growth strategies.
The Company’s efficiency ratio is mixed for the periods under review due to the Company’s substantial growth, as well as the variability in non-interest income. The efficiency ratio represents total non-interest expense divided by the sum of net interest income and total non-interest income. Neither the provision for loan losses nor realized securities gains or losses is factored into the equation. The Company’s efficiency ratio was 77.5% for the twelve months ended December 31, 2007 versus 77.2% for the same period of 2006, and 83.4% for 2005. Generally, while management was able to maintain a relatively constant non-interest expense to average earning assets ratio, it was unable to stem the reductions in non-interest income in the short run due to adverse money market conditions. Generally speaking, a company’s efficiency ratio rises prior to growth spurts as increases are felt in staffing levels, geographic dispersion of operating units, and volumes of business activity. Certainly, that has been the history of our Company prior to 2007. Further, it is expected that this ratio falls as such additions are put to full and effective use - this is always our goal. At the current time our ratio (although high) reflects the continuing growth of the Company.
Non-interest income:
Included in non-interest income is $436,000 in service charges on deposit accounts for the year ended December 31, 2007 which represented 30.7% of consolidated non-interest income, while the amount for the twelve months ended December 31, 2006 was $261,000 or 15.5%, respectively and $253,000 or 32.8%, respectively, for 2005. Other service charges, commissions and fees are primarily comprised of safe deposit, referral income and other miscellaneous fees, for all periods under review. These fees increased $33,000 to $52,000 for the twelve months ended December 31, 2007 versus $19,000 for the same period in 2006, and $23,000 for 2005.
Loan documentation fees and other loan charges increased to $292,000 for the year ended December 31, 2007 as compared to $162,000 and $95,000 for the same periods in 2006 and 2005, respectively. With the slowing economy, these fees and other loan charges may decline during 2008.
Pre-underwriting fees are a result of agreements with third parties whereby the Company performs certain pre-underwriting activities on SBA loans which are funded by the third party. These activities are primarily conducted in the Roseville, California office. This activity may contribute some additional loan volumes to the Company, and provide additional sources of income based on sales of government guaranteed loans to financial intermediaries. No absolute assurance can be given, however, that this will in fact, occur. Pre-underwriting fees for the periods under review were $26,000 and $9,000 for the periods ending December 31, 2007 and 2006, respectively, and $25,000 for 2005.
Increases in the cash surrender value of bank owned life insurance amounted to $393,000 for the year ended December 31, 2007, compared to $307,000 for the same period in 2006 and $313,000 for 2005.
Exchange fee income is the result of agreements with investors whereby the qualified intermediaries perform activities pursuant to IRS code 1031 which allows investors to defer taxes on the exchange of investment property. The Company earned $163,000 in exchange fee income for the year ending December 31, 2007 a decrease of $285,000 and such income represented 11.5% of consolidated non-interest income, compared with $448,000 income representing 26.6% of non-interest income for 2006. There was no such income in prior years. The decrease for 2007 primarily relates to the downturn in real estate related activity in all markets, which declined precipitously in the third quarter of the year.
The Company has a small equity portfolio which is held as a trading account. Unrealized gains and losses are recorded in non-interest income. The amount of net trading income was $118,000 for the year ending December 31, 2007, and represented 8.3% of consolidated non-interest income as compared to $443,000 or 26.3% for the same period in 2006 and $47,000 or 6.1% for 2005. Management in late 2007 began to restructure the trading portfolio to produce more stable income streams from this portfolio, although no absolute assurances can be given that this will in fact occur.
As of January 1, 2007 the Company adopted FAS 159 Fair Value Option for Financial Assets and Financial Liabilities and FAS 157 Fair Value Measurements. The Company applied FAS 159 to certain USDA/SBA loans that were acquired in late 2003 and early 2004. Unrealized gains and losses on these fair value loans are recorded in non-interest income. For the year ending December 31, 2007, the Company had $77,000 of unrealized losses on its fair value USDA/SBA loan portfolio. In addition, the Company also recorded $5,000 of gains on the sale of such loans for the year ending December 31, 2007. There was so such activity in any of the prior periods.
The total amount of non-interest income for the year ended December 31, 2007 included sales transactions of securities and other assets. Net gains on the sale of securities amounted to $3,000 for the year ended December 31, 2007 as compared to net gains of $31,000 for the same period in 2006 and net gains of $12,000 for 2005. In addition, the Company had a net gain on the sale of fixed assets of $11,000 for the year ending December 31, 2007 as compared to $2,000 and $4,000 for the years ending 2006 and 2005, respectively.
Non-interest expense
The largest increase for any specific category of expenses was in salaries and employee benefits, which were $1.9 million or 25.6% higher in the year ended December 31, 2007 when compared to the same period of 2006, and $3.4 million or 80.4% higher in 2006 than 2005. Personnel costs approximated 52% of total non-interest expense and 1.6% of average earning assets during 2007 as compared to 56% and 1.8%, respectively, for 2006, and 48% and 1.5% respectively, for 2005. This primarily reflects the Company’s addition of three office locations with the addition of Northern Nevada Bank in November 2006, and the new Rancho Cordova office during 2007.
The second greatest increase in non-interest expenses is in occupancy costs for the Company. Occupancy costs amounted to $2.7 million as of December 31, 2007 as compared with $1.9 million at December 31, 2006 and $1.5 million for 2005. This was due to four additional locations being added for the year, and normal increases in lease costs. Total occupancy costs increased approximately $788,000 or 41.0% and represented 14.8% of total non-interest expense and 0.46% of average earning assets as of December 31, 2007. This compares with the increase of 2006 over 2005 in the amount of $389,000 or 25.4% and costs which represented 14.1% of total non-interest expense and 0.45% of average earnings assets as of December 31, 2006. In consideration of the delays in obtaining a permanent location for the Bank’s Spanish Springs (Sparks) branch and the downturn in the economy, the Company has decided to close the temporary Spanish Springs (Sparks) branch effective March 31, 2008.
The third largest increase in non-interest expenses was in deposit servicing costs which increased $641,000 or 139.7% to $1.1 million for the year ending December 31, 2007 as compared with $459,000 outstanding for the same period in 2006. The 2007 increase includes core and non-core deposit intangible amortization of $480,000. Deposit service costs were 6.0% and 0.19% of non-interest expenses and average earning assets, respectively for the year ended December 31, 2007. The same costs were 3.4% and 0.11% for the year ended in 2006. These increases were largely due to the increase in offices at the acquisition of Northern Nevada Bank.
The fourth largest increase in non-interest expense was in accounting, legal and other professional services. These expenses combined increased a total of $928,000 to $1.5 million for the year ended December 31, 2007. These costs were 8.2% of non-interest expense and 0.26% of average assets for the year ending in 2007. This compares to $570,000 for the year ending in 2006 which was 4.2% of non-interest expense for the same period. Internal, external auditing and tax expenses were $713,000, legal costs were $258,000 and other professional service costs were $527,000 for the year ended December 31, 2007 as compared with $251,000, $120,000 and $199,000, respectively, for the same period ending December 31, 2006. The
increases in these costs are directly related to the growth of the Company, regulatory mandates for increased internal audit reviews, and the implementation of SOX 404 requirements. While some of these expenditures specifically included implementation costs, there is no guarantee that these costs will decline in the future.
The remaining non-interest expenses increased $419,000 for the year ended December 31, 2007 to $3.4 million as compared to $3.0 million for the same period in 2006. These remaining expenses represented 0.59% of average assets for the year ended December 31, 2007 as compared to 0.70% for the same period in 2006.
In Appendix 3, each of certain other non-interest expense categories are shown with their related percentage of overall non-interest expense, so that one may view their contribution to the overall cost structure of the company. Further, the Company’s efficiency ratio is noted, as was explained above.
Management expects that non-interest expense will moderate as a percentage of average earning assets as the Company continues to further refine most areas of the Company’s cost structure, however, no assurance can be given that this, in fact, will occur.
2006 over 2005
Non-Interest Income Overview:
The Company’s results reflected a higher level of non-interest income in the year ended December 31, 2006 than that ended December 31, 2005. The overall ratio of non-interest income to average earning assets increased to 0.39% from 0.27% for the year ended December 31, 2006 as compared to 2005, and 0.19% for 2004. The “1031” company acquisitions contributed $448,000 or 27% of non-interest income which was unavailable in previous periods.
Non-Interest Expense Overview:
Total non-interest expenses increased to $13.6 million in the year ended December 31, 2006 from $8.8 million in the period ended December 31, 2005, and $6.2 million for the year ended December 31, 2004. As a percentage of average earning assets, total non-interest expenses were 3.18% and 3.14% for the years ended December 31, 2006 and 2005, respectively, and 2.84% for 2004. The increase of approximately 54% for the year 2006 as compared to 2005, and the 42% increase for 2005 over 2004 reflect the substantial additions to staff, offices, and data processing capabilities over time, as the Bank continued its expansion in both northern Nevada and northern California over the periods under review. Both geographic centers continue to grow as the Company solidifies its position in these two markets.
The Company’s efficiency ratio for all the periods under review declined due to the Company’s substantial growth, with the increase in non-interest income. The Company’s efficiency ratio was 77.2% for the twelve months ended December 31, 2006 versus 83.4% for the same period of 2005, and 84.3% for 2004. Generally speaking, a company’s efficiency ratio rises prior to growth spurts as increases are felt in staffing levels, geographic dispersion of operating units, and volumes of business activity. Certainly, that has been the history of our Company. Further, it is expected that this ratio falls as such additions are put to full and effective use - this is always our goal. At the current time our ratio (although high) reflects the continuing unabated growth of the Company.
Non-interest income:
Included in the increase in non-interest income is $261,000 in service charges on deposit accounts for the year ended December 31, 2006 which represented 15.5% of consolidated non-interest income, while the amount for the twelve months ended December 31, 2005 was $253,000 or 32.8%, respectively and $193,000
or 50.0%, respectively, for 2004. The 2006 increase was impacted by a reduction in wire transfer fees of $24,000 compared to the year ending 2005. Other service charges, commissions and fees are primarily comprised of safe deposit, referral income and other miscellaneous fees, for all periods under review. These fees decreased $4,000 to $19,000 for the twelve months ended December 31, 2006 versus $23,000 for the same period in 2005, and $20,000 for 2004.
Loan documentation fees and other loan charges increased to $162,000 for the year ended December 31, 2006 compared to $95,000 and $62,000 for the same periods in 2005 and 2004, respectively.
Pre-underwriting fees are a result of agreements with third parties whereby the Company performs certain pre-underwriting activities on SBA loans which are funded by the third party. These activities are primarily conducted in the Roseville, California office. This activity may contribute some additional loan volumes to the Company, and provide additional sources of income based on sales of government guaranteed loans to financial intermediaries. No absolute assurance can be given, however, that this will in fact, occur. Pre-underwriting fees for the periods under review decreased to $9,000 from $25,000 for the periods ending December 31, 2006 and 2005, respectively, and $154,000 for 2004.
Increases in the cash surrender value of bank owned life insurance amounted to $307,000 for the year ended December 31, 2006, compared to $313,000 for the same period in 2005. There was no increase in cash surrender value of bank owned life insurance for the year ending 2004.
Exchange fee income is the result of agreements with investors whereby the qualified intermediaries perform activities pursuant to the IRS code 1031 which allows investors to defer taxes on the exchange of investment property. The Company earned $448,000 in exchange fee income for the year ending December 31, 2006 and such income represented 26.6% of consolidated non-interest income; no such income was recorded in prior years.
The Company has an equity portfolio which is held as a trading account. Unrealized gains and losses are recorded in non-interest income. The amount of net trading income was $443,000 for the year ending December 31, 2006, and represented 26.3% of consolidated non-interest income as compared to $47,000 and 6.1% for the same period in 2005 and $110,000 and 26.2% for 2004.
The total amount of non-interest income for the year ended December 31, 2006 was somewhat impacted by the transactions taken on sale of securities. Net gains on the sale of securities amounted to $31,000 for the year ended December 31, 2006 as compared to net gains of $12,000 for the same period in 2005 and net losses of $128,000 for 2004. In addition the Company had a net gain on the sale of fixed assets of $2,000 for the year ending December 31, 2006 as compared to $4,000 and $9,000 for the years ending 2005 and 2004, respectively.
Non-interest expense
The largest increase for any specific category of expenses was in salaries and employee benefits, which were $3.4 million or 80.4% higher in the year ended December 31, 2006 than for the same period of 2005, and $1.5 million or 53.9% higher in 2005 than 2004. Personnel costs approximated 56% of total non-interest expense and 1.8% of average earning assets during 2006 as compared to 48% and 1.5%, respectively, for 2005, and 44% and 1.3% respectively, for 2004. This reflects the Company’s addition of experienced professional staff during all three periods as it aligned its staffing levels to business plan requirements.
The second greatest increase in non-interest expenses was occupancy costs for the Company. Occupancy costs amounted to $1.9 million as of December 31, 2006 as compared with $1.5 million at December 31, 2005 and $1.3 million for 2004. This was due to increased branch locations, and normal cost of living increases in lease costs. Total occupancy costs increased approximately $389,000 or 25.4% and represented
14.1% of total non-interest expense and 0.45% of average earning assets as of December 31, 2006. This compares with the increase of 2005 over 2004 in the amount of $202,000 or 15.2% and costs which represented 17.4% of total non-interest expense and 0.54% of average earnings assets as of December 31, 2005.
The third greatest increase in non-interest expenses was data processing costs for the Company. Data processing costs amounted to $960,000 as of December 31, 2006 as compared with $733,000 at December 31, 2005 and $369,000 for 2004. This was due to increased branch locations, upgrades to the Company’s IT infrastructure and web-sites as well as third party processing system upgrades. Total data processing costs increased approximately $227,000 or 31.0% and represented 7.1% of total non-interest expense and 0.23% of average earning assets as of December 31, 2006. This compares with the increase of 2005 over 2004 in the amount of $364,000 or 98.6% and costs which represented 8.3% of total non-interest expense and 0.26% of average earnings assets as of December 31, 2005. As a result of the Company’s orientation towards being an integrated data provider, telephone and data communication costs have been higher than one might anticipate in a local community institution. With eight offices in Nevada, two in California and one in Montana all inter-connected to our data center which provides on-line capabilities, the Company’s communication costs have not been unexpected. Based on the technology supported focus of the Company, it is expected that this higher cost area is likely to continue into the future.
The fourth largest increase in non-interest expenses was in deposit service costs which increased $200,000 or 77.2% to $459,000 for the year ending December 31, 2006 as compared with $259,000 outstanding for the same period in 2005. Deposit service costs were 3.4% and 0.11% of non-interest expenses and average earning assets, respectively for the year ended December 31, 2006. The same costs were 2.9% and 0.09% for the year ended in 2005. These increases were largely necessitated by the increase in offices and growth of customer accounts in the Company.
2005 over 2004
The Company’s results reflected a higher level of non-interest income in the year ended December 31, 2005 than that ended December 31, 2004. The overall ratio of non-interest income to average earning assets increased to 0.27% from 0.19% for the year ended December 31, 2005 as compared to December 31, 2004, and 0.77% for 2003. The Company’s non-interest income, exclusive of BOLI and securities items, as a percentage of average earning assets, was 0.14% for the year ended December 31, 2005, as compared to 0.20% for 2004 and 0.34% for 2003. The primary difference between the reported results was the previous extent of SBA loan pre-underwriting fees that declined over the past three years as that area has had lesser staff available for such endeavors.
Total non-interest expenses increased to $8.8 million in the year ended December 31, 2005 from $6.2 million in the period ended December 31, 2004, and $4.2 million for the year ended December 31, 2003. As a percentage of average earning assets, total non-interest expenses were 3.14% and 2.84% for the years ended December 31, 2005 and 2004, respectively, and 3.65% for 2003. The increase of approximately 42% for the year 2005 as compared to 2004, and the 48% increase for 2004 over 2003 reflect the continued substantial additions to staff, offices, and data processing capabilities over time, as the Bank has continued its expansion in both northern Nevada and northern California over the periods under review.
The Company’s efficiency ratio for all the periods under review declined due to the Company’s substantial growth. The Company’s efficiency ratio was 83.4% for the twelve months ended December 31, 2005 versus 84.3% for the same period of 2004, and 112.3% for 2003. Generally speaking, a company’s efficiency ratio rises prior to growth spurts as increases are felt in staffing levels, geographic dispersion of operating units, and volumes of business activity.
Included in the increase in non-interest income is $206,000 in service charges on deposit accounts for the year ended December 31, 2005 while the amount for the twelve months ended December 31, 2004 was $136,000 and $75,000 for 2003. The 2005 increase was based on the more consistent collection of monthly service charges and non-sufficient funds charges paid on higher deposit account volumes. Other service charges, commissions and fees are primarily comprised of wire transfer and loan documentation fees, for all periods under review. These fees increased $26,000 to $165,000 for the twelve months ended December 31, 2005 versus $139,000 for the same period in 2004, and $97,000 for 2003.
Pre-underwriting fees are a result of agreements with third parties whereby the Company performs certain pre-underwriting activities on SBA loans which are funded by the third party. These activities are primarily conducted in the Roseville, California office. This activity contributed some additional loan volumes to the Company, and provided additional sources of income based on sales of government guaranteed loans to financial intermediaries. Pre-underwriting fees for the periods under review decreased to $25,000 from $154,000 for the periods ending December 31, 2005 and 2004, and $224,000 for 2003, respectively.
Increases in the cash surrender value of bank owned life insurance amounted to $313,000 for the year ended December 31, 2005. There were no such earnings reported for the prior periods under review.
The total amount of non-interest income for the year ended December 31, 2005 was somewhat impacted by the transactions taken on sale of securities. Gross losses on the sale of securities amounted to $14,000 which was offset by gains on the sale of trading equities in the amount of $26,000. These activities amount to net gains on sales of $12,000 as compared to losses of $119,000 taken during the preceding year ended December 31, 2004. In addition the Company had a net gain on the sale of fixed assets of $4,000.
The Company has an equity portfolio which is held as a trading account. Unrealized gains and losses are recorded in non-interest income. The amount of unrealized net trading income was $47,000 for the period ending December 31, 2005, and represented 6.1% of consolidated non-interest income as compared to $110,000 and 26.2% for the same period in 2004. The Company did not have a trading account for the year ending 2003.
The largest increase for any specific category of expenses was salaries and employee benefits, which were $1.5 million or 53.9% higher in the year ended December 31, 2005 than for the same period of 2004, and $719,000 higher in 2004 than 2003. Personnel costs approximated 48% of total non-interest expense and 1.5% of average earning assets during 2005 as compared to 44% of total non interest expenses, and 1.3% of average earning assets for the same period in 2004, and 48% of total non-interest expenses and 1.8% of average-earning assets for 2003. This reflects the Company’s addition of experienced professional staff during all three periods as it aligned its staffing levels to business plan requirements. In addition to the growth of the Company, approximately $520,000 or 35% of the 2005 increase in salaries and benefits came as a result of premium expenses on the bank owned life insurance program.
The second greatest increase in non-interest expenses was data processing costs for the Company. Data processing costs amounted to $733,000 as of December 31, 2005 as compared with $369,000 at December 31, 2004 and $200,000 for 2003. This was due to increased branch locations, upgrades to the Company’s IT infrastructure and web-sites as well as third party processing system upgrades. Total data processing costs increased approximately $364,000 or 98.6% and represented 8.3% of total non-interest expense and 0.3% of average earning assets as of December 31, 2005. This compares with the increase of 2004 over 2003 in the amount of $169,000 or 84.5% and costs which represented 5.9% of total non-interest expense and 0.2% of average earnings assets as of December 31, 2004.
As a result of the Company’s orientation towards being an integrated data provider, telephone and data communication costs have been higher than one might anticipate in a local community institution. However,
with three offices in Nevada and one in California inter-connected out of state locations which provide on-line capabilities, the Company’s communication costs have been high.
The third largest increase in non-interest expenses was in other professional services which increased $211,000 or 82.1% to $468,000 for the year ending December 31, 2005 as compared with $257,000 outstanding for the same period in 2004. Other professional services were 5.3% and 0.2% of non-interest expenses and average earning assets, respectively for the year ended December 31, 2005. The same costs were 4.1% and 0.1% for the year ended in 2004. These increases were largely necessitated by the increasing role of external professional staff evaluation of certain risk evaluated areas, as well as by compliance with Sarbanes-Oxley, and heightened asset liability and risk management practices.
The fourth largest increase in non-interest expenses was in the occupancy costs for the Company. This was due to two primary factors; 1) the new California branch added during the first quarter of 2005, and 2) the additional premises, equipment, and data processing costs initiated by additional lending and administrative people in the main office. Total occupancy costs approximated 17% of total non-interest expense and 0.54% of average earning assets during the year ended December 31, 2005, 21% and 0.60% for 2004, and 21% and 0.78% respectively for 2003.
The next largest area of non-interest expense was legal and accounting costs. These costs amounted to $515,000 or 5.8% of total non-interest expense and 0.2% of average earnings assets for the year ended December 31, 2005. Legal and accounting costs were approximately $519,000 or 8.31% of total non-interest expenses and 0.2% of average earning assets during 2004 and 3.87% of total non-interest expenses, as well as .14% of average earning assets for the same period in 2003. Reported legal and accounting costs have been high primarily as a result of the Company’s continuing response to a lawsuit previously filed, and the additional legal support required in the purchases of two “1031” companies, such acquisitions which were completed in the first quarter of 2006. Accounting costs themselves did not significantly change over the year 2004.
Provision for Loan Losses
Credit risk is inherent in the business of making loans. The Company sets aside an allowance for probable loan losses through periodic charges to earnings, which are reflected in the income statement as the provision for loan losses. Specifically, the provision for loan losses represents the amount charged against current period earnings to achieve an allowance for loan losses that in management’s judgment is adequate to absorb losses inherent in the Bank’s loan portfolio. The loan and lease loss provision is determined by conducting a regular evaluation of the adequacy of the company’s allowance for loan and lease losses, and charging the difference, if any, to the current month’s expense. This has the effect of creating volatility in the amount of charges to the Company’s earnings, based on loan growth, the particular types of loan growth, collateral values, debt service coverage, and various other factors. See Appendices 8 & 9 for information regarding the activity in the Allowance for Loan Losses. The provision is determined pursuant to a periodic comprehensive analysis of the Company’s loan portfolio and its allowance for loan losses, as previously described.
2007 over 2006 and 2005
For the year ended December 31, 2007 the Company’s provision for probable loan losses was $3.0 million, which was $2.2 million more than the $771,000, provided during the twelve months ended December 31, 2006, and $1.9 million more than the $1.1 million provided in 2005. The procedures for monitoring the adequacy of the allowance, and detailed information on the allowance, are included below in “Allowance for Loan Losses”.
For the year ending December 31, 2007 there were no substantive changes in loan concentrations, credit underwriting or credit terms, however, the year reflected a deterioration in loan quality which resulted in management’s decision to substantially increase the loan loss provision. For the periods December 31, 2006, and 2005, there were as well, no substantive changes in loan concentrations, loan quality, or loan terms, and as a result, the change in the provision for loan losses was primarily related to loan portfolio growth. See Appendix 6 regarding composition of the loan portfolio and Appendix 7 regarding the contractual maturities of the loan portfolio.
During 2007, however, we continued to refine and further evaluate certain assumptions and estimation methods related to each primary loan category including peer group and the Company’s loan loss histories. The Company had previously sustained a very low level of loan charge-offs and, 2007 losses combined with a declining economic environment, substantially altered our view of certain assumptions made during better times. To the current date, there have been no reallocations of the allowance for loan losses among different parts of the portfolio.
The Company also provides an allowance for undisbursed loan commitments, such allowance which is reported in other liabilities. At December 31, 2007, this allowance totaled $199,000 and represented 0.04% of total gross loans. At December 31, 2006 this allowance was $334,000 and represented 0.07% of total gross loans, as compared to $225,000 and 0.09% of the total gross loans reported at December 31, 2005. The volume of this provision very closely follows the changes in the amount of loan commitments as a percentage of outstanding loans. This percentage is currently 13.3%, as compared to 23.2% at December 31, 2006.
Provision for Income Taxes
The Company and its subsidiaries, with the exception of the two statutory trusts, file consolidated tax returns. For financial reporting purposes, income tax effects of transactions are recognized in the year in which they enter into the determination of recorded income, regardless of when they are recognized for income tax purposes.
Income tax expense is the sum of two components: the current tax expense or provision and the deferred tax expense or provision. Current tax expense is the result of applying the current tax rate to taxable income.
The deferred tax provision is intended to account for the fact that income on which the Company pays taxes in its returns differs from pre-tax income in the accompanying Consolidated Statements of Income. Some items of income and expense are recognized in different years for income tax purposes than in the financial statements. For example, the Company is only permitted to deduct from Federal taxable income, actual net loan charge-offs, irrespective of the amount of provision for credit losses (bad credit expense) recognized in its financial statements. This causes what is termed a temporary difference. Eventually, as loans are charged-off, the Company will be able to deduct for tax purposes what has already been recognized as an expense in the financial statements. Another example is the accretion of discount on certain securities. Accretion is the recognition as interest income of the excess of the par value of a security over its cost at the time of purchase. For its financial statements, the Company recognizes income as the discount related to these securities is accreted. For its tax return, however, the Company can defer the recognition of that income until the value is received at the maturity of the security. The first example causes a deferred tax asset to be created because the Company has recognized as an expense for its current financial statements an item that it will be able to deduct from its taxable income in a future year’s tax return. The second example causes a deferred tax liability, because the Company has been able to delay until a subsequent year the paying of tax on an item of current year financial statement income.
There are some items of income and expense that create permanent differences. Examples of permanent differences would include:
· tax-exempt income from municipal securities that is recognized as interest income for the financial statements but never included in taxable income; and
· a portion of meal and entertainment expense that is recognized as an expense for the financial statements, but never deductible in computing taxable income.
The significant items of income and expense that create permanent differences are disclosed in the second table of NOTE 9 as amounts that cause a difference between the statutory Federal tax rate of 34% and the effective tax rate. The effective tax rate is the amount of the combined current and deferred tax expense divided by the Company’s income before taxes as reported in the Consolidated Statements of Income.
The amounts of the deferred tax assets and liabilities are calculated by multiplying the temporary differences by the current tax rate. The Company measures all of its deferred tax assets and liabilities at the end of each year. The difference between the net asset or liability at the beginning of the year and the end of the year is the deferred tax provision for the year.
Most of the Company’s temporary differences involve recognizing substantially more expenses in its financial statements than it has been allowed to deduct for taxes in the return for the year. This results in a net deferred tax asset. Deferred tax assets are dependent for realization on past taxes paid, against which they may be carried back, or on future taxable income, against which they may be offset. If there were a question about the Company’s ability to realize the benefit from the asset, then it would have to record a valuation allowance against the asset to reflect the uncertainty. Given the amount and nature of the Company’s deferred assets, the past taxes paid, and the likelihood of future taxable income, management believes realization is assured for the full amount of the net deferred tax asset and no valuation allowance is needed.
The amounts of the current expense and deferred benefit, the amounts of the various deferred tax assets and liabilities, and the tax effect of the principal temporary differences between taxable income and pre-tax financial statement income are shown in NOTE 9.
Included in the reconciliation table is an item for state taxes. In addition to the 34% Federal income tax included in tax expense, the Company pays a California franchise tax and Montana taxes, as well as Nevada taxes and fees. These taxes and fees are equivalent to a tax on the Company’s income. While the California franchise tax rate is almost 11%, the Company may deduct its state franchise tax from its Federal taxable income. This reduces the effective tax rate for the state tax by 35%. Montana financial institutions are subject to a corporation tax, which incorporates or is substantially similar to applicable provisions of the Internal Revenue Code. The corporation tax is imposed on federal taxable income, subject to certain adjustments. State taxes are incurred at the rate of 6.75% in Montana. Nevada imposes no income tax, however, the Bank pays a 2% employment tax on salaries and benefits and pays an annual branch location fee of $7,000 per location.
At December 31, 2007 the Company has no operating loss carry-forward for federal income tax purposes as compared to December 31, 2006 and 2005, respectively, when the Company had approximately $217,000 and $1.2 million of operating loss carry-forwards for federal income tax purposes. The Company recorded $625,000 of tax provision for the year ending December 31, 2007 as compared to a recorded $1.1 million tax provision for the year ending December 31, 2006 and compared to 2005 when the Company removed its deferred tax asset valuation allowance and accordingly reported a net tax expense credit of $710,000. Refer to NOTE 9 of the financial statements for further discussion and analysis of the deferred tax assets.
Financial Condition
As a result of the failing national, state and regional economies, the Company has redefined its growth plans as evidenced by the decrease in total assets to $626.6 million at December 31, 2007 from $651.5 million at December 31, 2006 a reduction of about $24.9 million since year end 2006, and previous growth of about $267 million between December 31, 2006 and December 31, 2005. Of the $267 million growth in 2006, approximately $150 million was due to the acquisition of NNB Holdings, Inc., and approximately $117 million of the growth was internal organic growth. Between December 31, 2006 and December 31, 2007, total deposits decreased $47 million or approximately 9.2%, investment securities (not including the trading account) decreased over $12.6 million, or 13.6%, and gross loans grew by over $10.9 million, an increase of approximately 2.3%.
Historically the Company’s primary deposit growth has come from its branches and a specialized program of tax free real estate exchange deposits. At December 31, 2007, these exchange deposits totaled approximately $31 million and accounted for about 7% of the subsidiary bank’s deposits as compared with $70 million and 14%, respectively for 2006. Management has intentionally allowed some of these deposits to depart the Bank and has replaced them with lower cost funding sources.
BALANCE SHEET ANALYSIS
INTEREST EARNING ASSETS
Investment Portfolio
The major components of the earning asset base for the Company are its investment securities and loan portfolios. The detailed composition and growth characteristics of both of these portfolios are very significant to any analysis of the financial condition as well as the results of operations of the Company. The Company’s investments are analyzed in this section, while the loan portfolio is discussed in a later section of this Form 10-K.
See Appendix 4 for a detailed schedule or securities available for sale and held to maturity and Appendix 5 for information regarding the contractual maturities of our debt securities. Actual maturities will differ from contracted scheduled maturities because obligors may have the right to call for redemption or prepay obligations with or without call or prepayment penalties.
Pursuant to SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” issued on December 31, 1993, the Company has classified its investments into three primary portfolios; “available for sale”, “held to maturity”, and “trading”.
The investment portfolio serves several purposes: 1) it provides liquidity to mitigate uneven cash flows from the loan and deposit activities of customers; 2) it provides a source of pledged assets for securing public deposits and borrowed funds; 3) it is a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of the Company; 4) it is an alternative interest-earning use of funds when loan demand is light; and 5) it may provide partially tax exempt income. During the Company’s growth since its inception six years ago, deposit acquisition activities outpaced loan growth until the latter half of 2004. As a result, the Company’s investment portfolio was the primary placement of interest earning funds over the first two and one half years of the Company’s existence. Since that time, loan volumes have replaced investment volumes as the primary interest earning asset base.
The Company’s investment portfolio is primarily composed of six subsets: (1) liquid funds, which includes “Fed Funds Sold”, temporary sales of excess funds to correspondent banks, and money market funds with maturities of less than 30 days. These items are not detailed as an element within the Company’s reported longer-term securities portfolio; (2) US Treasury and Agency issues for liquidity; (3) state, county and municipal obligations which may provide limited tax free income and pledging potential; (4) mortgage-backed securities for cash flow and enhanced earnings; (5) corporate bonds; and (6) other equity investments, some of which are readily marketable and carried in investments, and some of which are not readily marketable and are carried in other assets. These latter items include equity in the Federal Home Loan Bank of San Francisco, Pacific Coast Bankers’ Bancshares and a passive investment in Carson River Community Bank, (“CRCB”), all of which are currently considered not to have readily determinable fair market values. Other non-marketable investments include purchase fund costs in the Company’s 1031 subsidiaries and some shares of the Bank’s mutual workman’s compensation insurance carrier that went public. At December 31, 2007, the amount of FHLB stock and Pacific Coast Bankers’ Bancshares (“PCBB”) equity shares was $4.6 million and $398,000 respectively, while the CRCB investment is $500,000 and the insurance shares are $138,000. The amount of FHLB stock purchased is related to the Company’s extent of funds borrowed from the FHLB as of each reporting period. These restricted investments are carried at cost and the FHLB stock value is determined by ultimate recoverability of par value. The value of PCBB stock will be ultimately determined by earnings, marketing considerations, and the number and health of banks within PCBB’s customer base. For discussion purposes, when we refer to the securities portfolio, we mean investment portfolio subsets 2-5, which are listed as our available-for-sale securities and our held-to-maturity securities on our reports of condition. The relative distribution of these groups within the overall portfolio has varied over the periods noted, especially as regards the extent of agency, mortgage-backed, state, county and municipal obligations, other equity and corporate investments held. They may vary in volume based on investment rates paid, perceived value in a rising or falling interest rate environment, and various other factors having to do with current FOMC activities and money market conditions. The trading portfolio consists of equity investments in listed stocks on the national exchanges. In some instances covered call options were written against issues carried in this portfolio.
Total investment securities were approximately $80 million at December 31, 2007, exclusive of temporary overnight placements of about $313,000 held in liquid money market funds. This compares to $93 million of investment securities and about $1.8 million in overnight placements and liquid money market funds at December 31, 2006. The securities portfolio decreased approximately $13 million or 14% at December 31, 2007 as compared with the same period in 2006. The majority of the decrease was represented by agency and mortgage-backed investments which declined during 2007.
Total investments averaged approximately $108 million for the year ended December 31, 2007, a 8% decrease from the approximately $118 million average reported at December 31, 2006. The most noticeable difference in the portfolio was the addition of a greater volume of municipal securities and preferred securities as compared to the previous period. This growth was offset by the reduction in agencies and mortgage-backed investments noted previously. The Company has been successful in modifying its balance sheet allocation activities to achieve greater earnings through loans than was possible in prior periods. The investment portfolio for the years ended December 31, 2007, 2006 and 2005 comprised 18%, 28% and 28%, respectively, of average earning assets.
Concentrations of investments or securities held exceeding 10% of stockholders’ equity are as follows: the current book value of held to maturity pass through securities issued by FNMA and FHLMC at December 31, 2007 was $18.5 million, with a market value of $18.3 million, while at December 31, 2006 this amount was $21.7 million with a market value of $21.2 million. For the date of December 31, 2007 the amount of mortgage backed pass through securities guaranteed by GNMA was $1.4 million with a market value of $1.4 million, while at December 31, 2006 this was $1.9 million with a market value of $1.8 million. Other held to maturity mortgage backed CMO’s issued or guaranteed by FNMA, FHLMC or GNMA at December 31,
2007 were $7.5 million with a market value of $7.5 million, while at December 31, 2006 this amount was $10.6 million with a market value of $10.4 million. The current book value of available for sale pass through securities and preferred securities issued by FNMA and FHLMC at December 31, 2007 was $11.0 million with a market value of $10.9 million. For the year 2006 no such concentration existed.
Effective duration is a measure of duration which considers changes in cash flows and is based on the expected price volatility of a security. Generally the greater the duration of the security or portfolio, the greater will be its percentage price volatility. The effective duration is presented in years and is equal to the approximate percentage change in price per 100 basis point change in rate. The effective duration of the Company’s investment portfolio at December 31, 2007 is 2.62, as compared with 2.53 and 2.38 as of the same date in 2006 and 2005, respectively. This slight increase in duration during the year was the result of changes in market rates of interest as well as the additions of generally longer term to maturity municipal securities purchased during the year as a portion of the overall investment portfolio.
Loan Portfolio
The major component of interest earning assets is the Company’s loan portfolio. A detailed review of the composition and characteristics of this portfolio is important to any analysis of the financial condition and results of operations of the Company.
A comparative schedule of the distribution of the Company’s loans at December 31, 2007, 2006 and 2005 is presented in Appendix 6, Composition of The Loan Portfolio. The amounts shown in the table are before deferred or unamortized loan origination, extension, or commitment fees and origination costs for loans in that particular category. Further, the figures noted for each category are presented as percentages, for ease of reviewer analysis. For each period reported, there are no loans being serviced by the institution for the benefit of others, except participation loans sold during the normal course of business. Further, no loans, other than the USDA/SBA fair value loans, are considered held for sale.
Gross loans including USDA loans at fair value have increased by about $11 million, or over 2% to almost $475 million during the twelve months ended December 31, 2007. As one can see in Appendix 6, the largest volume change between December 31, 2007 and December 31, 2006 has been the increase of the Company’s term real estate secured loan portfolio, followed by the commercial portfolio. These portfolios increased by about $17 million and $13 million respectively, and comprised almost all loan growth during the twelve months ended December 31, 2007. This growth was offset by the reduction of $8 million in the real estate construction portfolio and $12 million in the fair value USDA/SBA portfolios. Internal growth has been accomplished primarily in the increased activity levels of the Company’s Roseville, and Rancho Cordova, California offices. This growth may portend well for the diversification of risk within the Company’s large and growing loan portfolio. While the types of credits granted in this market are not extremely dissimilar from those granted in the northern Nevada market, the fact that these areas are separated by a mountain range and are in different states subject to differing regional economies and governmental regulations reflects the added benefit of geographic risk dispersion within the Company’s overall loan portfolio.
Real Estate Lending
The Banks’ lending activities consist of the origination of both construction and permanent loans on residential and commercial real estate. The Bank would only rarely make a residential mortgage loan. The Bank actively solicits real estate loan applications from real estate brokers, contractors, existing customers, customer referrals, and walk-ins to their offices. The Bank’s lending policies generally establish loan to value guidelines that are less than regulatory limits. The Bank does not originate either conventional or sub-prime 30 year residential mortgages. The Bank also provides interim construction financing for single-family dwellings. The Bank also makes lot acquisition loans to borrowers who intend to construct their
primary residence on the respective lot. These loans are generally for a term of three to five years and are secured by the developed lot.
Land Acquisition and Development Loans
Where real estate market conditions warrant, the Bank makes land acquisition and development loans on properties intended for residential and commercial use. These loans are generally made for a term of 18 months to two years and secured by the developed property with a loan to value not to exceed 80% of cost or 70% of market value, whichever is less. The loans are made to borrowers with real estate development experience and appropriate financial strength. Generally it is required a certain percentage of the development be pre-sold or that construction has been pre-qualified for a term take-out by the Company.
Commercial Real Estate Loans
Loans are made to purchase, construct and finance commercial real estate properties. These loans are generally made to borrowers who own and will occupy the property. Loans to finance investment or income properties are made, but require additional equity and a higher debt service coverage margin commensurate with the specific property and projected income.
Consumer Lending
The majority of all consumer loans are secured by real estate, automobiles, or other assets. The Bank intends to continue adding such loans due to their short-term generally fixed rate nature, generally between three months and five years, with an average term of approximately two years. Moreover, interest rates on consumer loans are generally higher than on other types of loans. The Bank also originates second mortgage and home equity loans, especially to its existing customers in instances where the first and second mortgage loans are less than 80% of the current appraised value of the property.
Credit Risk Management
The Company’s credit risk management includes appropriate credit policies, individual loan approval limits and committee approval of larger loan requests. Management practices also include regular internal and external credit examinations, management review and quarterly monitoring of loans experiencing deterioration of credit quality.
Loan Approval Limits
Nevada Security Bank’s Board of Directors has voted to allow a Directors Loan Committee (“Committee”) to approve up to 90% of the Bank’s legal lending limit in regard to loans secured by real estate and listed stocks and bonds. In addition, the Committee is able to approve all other loans up to 50% of the bank’s legal lending limit. All higher limits must be approved by the Board of Directors. Cash secured loans are excluded from these limits.
The Committee has established individual loan limits for senior lenders and a threshold of loan limits for approval by a combination of senior lenders. The Committee approves loans above these thresholds after the recommendation of the Chief Credit Officer.
Loan Origination and Other Fees
In addition to interest earned on loans, the Bank receives loan origination fees for originating loans. Loan fees generally are a percentage of the principal amount of the loan, are charged to the borrower, and are
normally deducted from the proceeds of the loan. Loan origination fees are generally 1.0% to 1.5% on real estate loans and .5% to 1.5% on commercial loans. Consumer loans require a flat fee as well as a minimum interest amount. The Bank also receives other fees and charges relating to existing loans, which include charges and fees collected in connection with loan modifications and tax service fees.
Loan Maturities
Appendix 7, the Scheduled Contractual Maturities of the Loan Portfolio presents the contracted maturity distribution for each major category of our loan portfolio and the sensitivity of such loans to changes in interest rates at December 31, 2007.
Off - Balance Sheet Arrangements
In the usual course of business, the Company makes commitments to extend credit as long as there are no violations of any conditions established in the outstanding contractual arrangement. Commitments to extend credit were $62.9 million at December 31, 2007 as compared to $107.5 million and $71.2 million at December 31, 2006 and 2005, respectively. These commitments represented about 13%, 23% and 29% of outstanding gross loans at each of the periods noted, respectively. The Company’s stand-by letters of credit totaled $714,000, $545,000 and $293,000 at December 31, 2007, 2006 and 2005, respectively. This total represented an insignificant portion of total commitments outstanding at each noted date.
The importance to and effect on the Company’s revenues, expenses, cash flows, liquidity, capital resources and market risk from the unused portion of the commitments to provide credit cannot be reasonably predicted since there is no guarantee that the lines of credit will ever be used. For more information regarding the Company’s off-balance sheet arrangements, please refer to NOTE 11 to the financial statements.
Non-Performing Assets
We manage asset quality and control credit risk through the application of policies, practices and procedures designed to promote sound underwriting and loan monitoring, and the diversification of the loan portfolio. The loan administration function is charged with monitoring asset quality and establishing credit policies, practices and procedures which are thorough and consistently enforced. The Company has ten non-accrual loans totaling $5.6 million as of December 31, 2007. At December 31, 2006 the Company had two loans on non-accrual which totaled $549,000.
For 2007 all non-performing SBA loans have been written down to the SBA guaranteed portion. Non-performing construction, acquisition and development loans have been evaluated and management believes that collateral values are sufficient to mitigate any loss potential except as noted. The OREO property was written down to estimated fair market value as it was placed in the Company’s OREO portfolio. Management believes that the property has sufficient value to mitigate any loss potential, however, no assurance can be given that further loss will not in fact occur. For 2006 both loans were collateralized and had partial SBA guarantees which mitigated any loss potential. At all prior periods under review, we had no non-performing assets.
The evaluation of these factors of risk is performed by independent third party review firms that employ credit professionals to determine our adherence to previously established internal guidelines. These evaluations include many factors, such as loan growth, changes in the composition of the loan portfolio, delinquencies, general economic conditions that could impact the value of collateral, management’s general assessment of loan portfolio quality, and other trends and conditions. Further, such independent external reviews include evaluating the financial strength of the borrowers, the value of applicable collateral, any prior loan loss experiences, the growth in the loan portfolio, and other conditions. During the twelve months ended December 31, 2007, four such evaluations were conducted, as was an evaluation of the adequacy of our loan loss allowance and the methodology employed in its adequacy testing. In addition, bank regulatory authorities, as part of their periodic examinations of the Bank, review loan quality and the adequacy of the allowance for loan losses. There most recent review was conducted in January, 2008.
Non-performing assets are comprised of the following: loans for which the Company is no longer accruing interest; loans 90 days or more past due and still accruing interest (although loans are generally placed on non-accrual when they become 90 days past due); loans restructured where the terms of repayment have been renegotiated resulting in a deferral of interest or principal; and other real estate owned (“OREO”). Management’s classification of a loan as non-accrual or restructured is an indication that there is reasonable doubt as to the Company’s ability to collect principal and/or interest on the loan. At that point, the Company stops accruing income from the interest on the loan, reverses any uncollected interest that had been accrued but unpaid, and recognizes interest income only as cash interest payments are received and as long as the collection of all outstanding principal is not in doubt. These loans may or may not be collateralized, but in all cases collection efforts are continuously pursued.
Allowance for Loan Losses
The allowance for loan losses (ALL) is established through a provision for loan losses based on management’s evaluation of known and inherent risks in the Company’s loan portfolio. The allowance is increased by provisions charged against current earnings, and reduced by net charge-offs. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when cash payments are received subsequent to the charge off.
We employ a systematic methodology for determining the allowance for loan losses that includes a monthly review process and quarterly adjustment of the allowance. Our process includes a periodic review of individual loans that have been specifically identified as problem loans or have characteristics that could lead to impairment, as well as a detailed review of other loans (either individually or in pools). While this methodology utilizes historical and other objective information, the establishment of the allowance for loan losses and the classification of loans are also to some extent, based on management’s judgment and experience.
Peer data for all institutions reported in the Uniform Bank Performance Report for the State of Nevada reflects an allowance for loan losses of 1.12% of total loans at December 31, 2007. This compares to the
National Peer Group 3 (all insured commercial banks having assets between $300 million and $1 billion) ratio of 1.20% as of the same date. For the National Peer Group, loan losses were reported at .18% of average total loans outstanding, on an annualized basis for the period ended December 31, 2007, while it was reported at .11%, for the period ended December 31, 2006 and .08% for the year ended December 31, 2005.
As reported in appendix 8 the Company’s allowance for loan losses as a percent of gross loans including fair value loans was 1.53% as of December 31, 2007. The Company had net loan losses of $1.2 million for the year ended December 31, 2007. At December 31, 2006 the Company’s allowance for loan losses as a percentage of gross loans was 1.17% and the Company had no loan losses for the year.
Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan losses that management believes is appropriate at each reporting date. Quantitative factors include national peer and state peer historical loss experience, our historical loss experience, delinquency and charge-off trends, collateral values, changes in non-performing loans, and other factors. Other factors include the strength of the borrower, collateral (if any), the loan-to-value ratio and other specific criteria.
Qualitative factors include the general economic environment nationwide and in our specific geographic markets and indications of economic activity in key industries in the northern Nevada and northern California markets. The way a particular loan might be structured, the extent and nature of conditional waivers of existing loan policies, the results of bank regulatory examination, model imprecision, and the rate of portfolio growth are additional qualitative factors that are considered.
Appendix 8 summarizes the activity in the Allowance for Loan Losses for the periods indicated.
Appendix 9 provides information regarding the allocation of the Allowance for Loan Losses.
Management believes that the ALL at December 31, 2007 is sufficient to absorb losses inherent in the loan portfolio. This amount is based on the best available information and does involve uncertainty and matters of judgment. Accordingly, the adequacy of the loan loss reserve cannot be determined with precision and could be susceptible to significant change in future periods. In addition, however, we carry an allowance for undisbursed loan commitments which is reported as an “other liability.” At December 31, 2007, 2006 and 2005, such allowance totaled $199,000, $334,000 and $225,000, respectively, and represented 0.32%, 0.32% and 0.32% of loan commitments outstanding, respectively, and 0.04%, 0.07% and 0.09% of total gross loans, respectively.
NON-INTEREST EARNING ASSETS
Non-earning assets are those assets that by their characteristics do not generate interest income for the Company. Generally speaking, a financial institution would prefer to minimize such assets, which are primarily composed of cash and due from balances, premises and equipment, bank owned life insurance, intangibles and “other” assets. At December 31, 2007, 2006 and December 31, 2005 such assets totaled about $64 million, $72 million and $19 million, and represented approximately 10%, 11% and 5% of total assets, respectively. At December 31, 2007 this total is comprised of $31 million goodwill, $9 million non-interest bearing cash and due from banks, $10 million bank owned life insurance, $7 million in property and equipment, $3 million in accrued interest receivable and $4 million in other assets.
Cash and Due From Banks
Cash on hand and balances due from correspondent banks amounted to $14 million as of December 31, 2007 of which nearly $5 million is interest bearing mostly related to activities of the 1031 qualified intermediaries.
The remainder represents a major portion of the Company’s non-earning assets. At December 31, 2007, non-interest bearing cash and due from banks totaled $9 million, and comprised about 1% of total assets and about 14% of total non-earning assets, as compared to about 2% and 20%, respectively, of total assets and non-earning assets at December 31, 2006.
Bank Owned Life Insurance
At December 31, 2007, the Company had $9.5 million in Bank Owned Life Insurance (“BOLI”) classified as a non-earning asset, as compared to $11.9 million for the same period in 2006. Approximately $3.5 million was acquired in the purchase and merger of NNB Holdings, and Northern Nevada Bank. The $3.5 million of BOLI acquired in the merger of NNB Holdings was pre-refunded during 2007. BOLI is an insurance policy with a single premium paid at policy commencement. Its initial net cash surrender value is equivalent to the premium paid, and it adds income through non-taxable increases in its cash surrender value, net of the cost of insurance, plus any death benefits ultimately received by the Company. The costs of certain benefit plans added by the Company in 2005 are “funded” with BOLI income, projected to have a tax-equivalent return of about 5%. No assurance can be given that this return will be fully realized, however.
Premises and Equipment
Fixed assets totaled $7.5 million of non-earnings assets at December 31, 2007, representing about 12% of such total at December 31, 2007 as compared to $7.9 million or 11% at December 31, 2006. The Company acquired about $4.5 million in land, buildings and fixed assets during the acquisition of NNB Holdings Inc., and Northern Nevada Bank during November of 2006.
The net book value of the Company’s premises and equipment decreased by $345,000, or 4%, in 2007. The Company’s net premises and equipment were approximately 1% of total assets at December 31, 2007, and 2006. At December 31, 2007 there were no material commitments for capital expenditures, nor were there any fixed or long lived assets held for sale or impaired in value.
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is charged to income over the estimated useful lives of the assets and leasehold improvements are amortized over the terms of the related lease, or the estimated useful lives of the improvements, whichever is shorter. Depreciation and amortization were approximately $1.0 million for the year ended December 31, 2007 as compared to $650,000 during 2006. Appendix 10, Premises and Equipment reflects the balances by major category of fixed assets.
Intangible Assets
Intangible assets represented the largest single component of non-earning assets with a total of $31.0 million as of December 31, 2007 and 2006. Intangible assets consist of several identified intangible assets like “Core Deposit Intangible”, which are amortized over their useful lives and a general intangible of goodwill which is subject to an annual impairment test. The Company had identifiable intangibles of $1.1 million and $2.4 million as of December 31, 2007 and 2006, respectively, related to the acquisition of NNB Holdings, and Northern Nevada Bank. The general intangible goodwill is comprised of three components which are: the acquisition of NNB for approximately $24 million, Granite Exchange for $5 million and CNA Trust for $500,000.
Other Assets
Other assets are primarily composed of accrued interest receivable on investments and loans, certain prepaid accounts, deferred tax assets, and items in process of review and determination as to their ultimate
disposition. These amounts were $7.3 million, $8.0 million and $3.3 million as of December 31, 2007, 2006 and 2005, respectively. Of the total “other assets”, accrued interest receivable represented 40%, 42% and 51% at December 31, 2007, 2006 and 2005, respectively.
Deferred tax assets amounted to approximately $3.1 million and represent nearly 42% of the “other assets” category, for the year ended December 31, 2007, as compared to approximately $1.7 million and 22% for 2006. Most of the Company’s temporary differences between book and taxable income and expenses involve recognizing more expenses in its financial statements that it has been allowed to deduct for taxes; therefore, the Company’s deferred tax asserts typically exceed its deferred tax liabilities. The net deferred tax asset is primarily due to temporary book/tax differences in the reported allowance for loan losses plus deferred compensation and securities depreciation, net of deferred liabilities comprised mainly of fixed asset depreciation differences and deferred loan origination costs. Management has evaluated all deferred tax assets, and has no reason to believe that either the quality of the tax deferred tax assets or the Company’s future taxable income potential would preclude the full realization of all amounts in future years.
Deposits
Deposits are the most important source of the Companies’ funds for lending and other business purposes. In addition, the Bank derives funds from loan repayments, advances from the FHLB of San Francisco, repurchase agreements, treasury term borrowings, and loan sales. Loan repayments can be a relatively stable source of funds, while interest bearing deposit inflows and outflows are significantly influenced by general interest rate levels and money market conditions. Borrowings and advances may be used on a short-term basis to compensate for reductions in normal sources of funds such as deposit inflows at less than projected levels. They also may be used on a long-term basis to support expanded activities and to match maturities of longer-term assets. Deposits obtained through the subsidiary Bank have traditionally been the principal source of funds for use in lending and other business purposes. Currently, the Bank has a number of different deposit programs designed to attract both short-term and long-term deposits from the general public by providing a wide selection of accounts and rates. These programs include regular statement savings, interest-bearing checking, money market deposit accounts, and fixed rate certificates of deposit with maturities ranging from three months to five years, negotiated-rate jumbo certificates, non-interest demand accounts, 1031 QI accounts, and individual retirement accounts. Deposits are obtained primarily from individual and business residents of the Company’s northern Nevada and northern California market areas.
An important balance sheet component impacting the Company’s net interest margin is the composition and cost of the Company’s deposit and other interest bearing liability base. Net interest margin is improved to the extent that growth in deposits can be focused in the less volatile and somewhat more traditional core deposits, which are non-interest bearing demand, NOW accounts, savings accounts, money market deposit accounts (MMDA’s) and time deposits under $100,000.
The Company’s growth of deposit accounts in the demand, NOW, and Certificate areas has been patterned along traditional means of acquisition: new customers coming into a branch facility; returning customers well known to staff or management bringing their relationships over to the bank, or as the result of calls made by staff, officers, or directors on certain prospective or potential customers. Further, it is the Company’s goal to have established both deposit and loan relationships with all of the Company’s customers.
In addition to these sources, however, the Company has a deposit acquisition officer assigned to real estate related companies, who is responsible for developing growth in this deposit class. As a result of such activities, the Company has generated $31 million of savings deposits related to that source of endeavor at December 31, 2007, which represented about 7% of total deposit accounts. At December 31, 2006 this type of savings deposit approximated $70 million and represented about 14% of deposit accounts.
An additional source of deposit growth for the Company during 2007 was the acquisition of time certificates of deposits under $100,000 from deposit broker sources. These bulk deposits issued in denominations of less than $100,000 amounted to $153.8 million, and $135.5 million as of December 31, 2007, and 2006, respectively. The average maturity of these deposits is about one year. These funds were acquired as part of the Company’s asset liability management process and are covering a portfolio of term loans that have a next re-pricing date on average of approximately one and a half times the same period.
As illustrated in the Average Balances Sheet (see Appendix 1), the average rate paid on interest bearing deposits increased to 4.42% during the year ended December 31, 2007 from 4.08% and 3.17% for the years ended December 31, 2006, and 2005, respectively. Average interest bearing deposit volumes increased by about $116 million, or approximately 37% for the year ended December 31, 2007 over the year ended December 31, 2006.
One of the primary differences between deposit volumes at December 31, 2007, when compared to December 31, 2006, is the growth of $20 million in certificates of deposit under $100,000. The major portion of this growth was in the bulk deposit sourcing discussed above which carried market rates of interest slightly higher at inception than deposit rates in the local market. As local deposit rates increased over much of 2007, however, such rates were below advertised rates for time deposits with similar terms to maturity. As money market conditions weakened over late 2007 and into 2008, however, brokered funds have again become a lower cost source of funds when compared to local competitive rates for deposits are published in northern Nevada and northern California markets. As a result, funding sources became quite fluid in the last few months of 2007 and the first two months of 2008.
NOW deposits decreased approximately $1.5 million to $9.4 million or 13.6% at December 31, 2007 as compared with $10.9 million outstanding as of December 31, 2006. Average NOW accounts represented 2.6% of average interest bearing liabilities as of December 31, 2007 as compared to 2.5% for the same period in 2006. Savings accounts decreased $38.4 million to $39.4 million for year ended December 31, 2007 versus $77.8 million for the year ended 2006. The majority of this decrease is due to reduced rates paid on certain non-affiliated 1031 exchange accounts which encouraged those deposits to leave the Bank. Average savings accounts were 16.9% and 25.6% of average interest bearing deposits for the years ended December 31, 2007 and 2006, respectively.
MMDA accounts declined $9.1 million to $98.0 million at December 31, 2007. Average MMDA accounts represented 25.3% and 35.9% of average interest bearing deposits as of December 31, 2007 and 2006, respectively.
Time certificates of deposit under $100,000 (including all IRA’s), increased $19.4 million to $179.7 million or 12%, at December 31, 2007 as compared to $160.3 million as of December 31, 2006. Average time certificates of deposits under $100,000 (including all IRA’s) amounted to 40.4% of average interest bearing deposits as of December 31, 2007 as compared to 22.5% for the year ended December 31, 2006.
Potentially, the most volatile deposits in a financial institution are the large certificates of deposits, those generally over $100,000. Because these deposits, when considered with other customer specific deposits, may exceed the maximum amount of FDIC insurance for an account, depositors may select shorter maturities to offset perceived risk elements associated with deposits over $100,000. The Company may find such certificates to be more volatile than those generated within its branches from traditional sources; however, as branches generate additional deposit growth, this effect is somewhat mitigated. Refer to Appendix 11, Maturity Schedule of Time Certificates of Deposit for more information.
Non-Interest Bearing Liabilities
Non-interest bearing deposit liabilities are an integral part of a financial institution’s funds portfolio. These consumer and business checking accounts provide a relatively stable source of investable funds which are considered among a financial institution’s core deposits. Non-interest bearing demand deposits totaled $65.4, $73.7 and $49.4 million, respectively, and comprised about 14.5%, 14.8% and 14.6%, of total deposits at December 31, 2007, 2006 and 2005 respectively, and averaged about 12%, 12% and 14% of total average deposits for each of the twelve months ended December 31, 2007, 2006 and 2005, respectively.
Accrued expenses and other liabilities totaled $3.9 million and $6.1 million respectively at December 31, 2007 and 2006, and are primarily represented by amounts calculated for interest payable and other expenses accrued but unpaid, minority shareholder interests, and certain clearing amounts. Accrued interest payable amounted to $1.0 million during the twelve months ended December 31, 2007 and $1.5 million for 2006. Reserve for taxes payable amounted to a negative $0.9 million as of December 31, 2007 and was $0.8 million as of December 31, 2006. Accounts payable and other accrued expenses amounted to $3.9 million and $3.8 million for the years ended December 31, 2007 and 2006, respectively. Minority shareholder interest amounted to $1.1 million at December 31, 2007 and $1.4 million as of 2006. The majority of the reduction occurred with the acquisition of 5% additional ownership during the first quarter of 2007.
Other Borrowings and Subordinated Debt
We may occasionally use Fed funds purchased and short-term Federal Home Loan Bank (“FHLB”) borrowings to support liquidity needs created by seasonal deposit flows, to temporarily satisfy funding needs from increased loan demand, and for other short-term purposes. Uncommitted lines are available from several correspondent banks, however, the borrowing line at FHLB is dependent on the level of pledged collateral and the extent of FHLB equity held. There was a total of $100 million available from this source at December 31, 2007 and $56 million at December 31, 2006, less funds drawn, as noted below. Such funds were made available on an overnight, index based rate at both December 31, 2007 and 2006.
These lines of credit available to us under various agreements with the Federal Home Loan Bank of San Francisco, Pacific Coast Bankers’ Bank, and Zions National Bank are generally available under specified conditions. The extent of pledged collateral available, the amount of the line and the period over which funds can be drawn may be subject to terms and conditions set forth in an underlying letter of understanding. At the current time, management is not aware of any known events, demands, trends or uncertainties that would likely result in the termination or material reduction in availability of our off-balance sheet borrowing arrangements. Should such availabilities be substantially reduced, management would look to other internal and external sources of liquidity to support any reduced availability from current lines, although no absolute assurance can be given that this, in fact, would occur. As of December 31, 2007 the Company had $70.5 million in advances outstanding from the FHLB as compared to December 31, 2006, when $31.0 million had been drawn. Included in the total advances the Company holds $8 million in term advances from the FHLB as a result of the merger with NNB Holdings, and Northern Nevada Bank. As of December 31, 2007 the Company had drawn $110,000 on one of its overnight fed fund lines of credit. There were no such advances as of December 31, 2006.
With the acquisition of the 1031 qualified intermediaries the Company acquired debt of $187,000 to another financial institution and the Company also issued two notes payable of $265,000 each, due in one and two years. These notes were carried at prime and interest was payable at maturity. All of these notes payable and acquired debt were paid in full as of December 31, 2007.
Since growth in core deposits may be at intervals different from loan demand, we may follow a pattern of funding irregular growth in assets with overnight borrowings, which are then replaced with core deposits.
This temporary funding is likely to be utilized for generally short-term periods, although no assurance can absolutely be given that this will, in fact, occur. Refer to Appendix 12, Other Borrowed Funds, which notes the extent of utilization of various funding sources over represented periods.
During the fourth quarter of 2005 the Company and its Connecticut statutory trust subsidiary, “The Bank Holdings Statutory Trust I”, (the “Trust”) entered into a purchase agreement pursuant to which it was agreed that the trust would issue approximately $15.5 million of floating interest rate trust preferred securities (the “Trust Preferred Securities”). The Trust Preferred Securities were issued and sold in a private placement exempt from registration under the Securities Exchange Act of 1933, as amended. The Company acquired an additional $5.2 million in Trust Preferred Securities in the purchase of NNB Holdings, Inc. The Trust Preferred Securities issued by the Company require quarterly distributions of interest at a floating rate equal to the three month LIBOR plus 1.42%. The securities acquired from the purchase currently have a fixed rate of 5.95% and will adjust to LIBOR plus 1.85% beginning June 15, 2010.
Economic Value of Equity
The changes in net interest income under rising and declining rate scenarios are typically expected to bear a linear relationship. The exposure to declining rates is disproportionate in these simulations, however, because some of the Company’s variable deposit rates may be close to a perceived floor. As rates on interest-bearing liabilities hit this floor the Company’s yields on earning assets continue to fall, creating significant compression in the Company’s net interest margin. This effect is exacerbated by the fact that prepayments on fixed-rate loans tend to increase as rates decline.
The economic (or “fair”) value of financial instruments on the Company’s balance sheet will also vary under the interest rate scenarios previously discussed. Economic values for financial instruments are estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while the fair value of non-financial accounts is assumed to equal book value and does not vary with interest rate fluctuations. An economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change substantially over time as the characteristics of the Company’s balance sheet evolve and as interest rate and yield curve assumptions are updated.
The amount of change in economic value under different interest rate scenarios is dependent upon the characteristics of each class of financial instrument, including the stated interest rate or spread relative to current market rates or spreads, the likelihood of prepayment, whether the rate is fixed or floating, and the maturity date of the instrument. As a general rule, fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline, while fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios. The longer the maturity of the financial instrument, the greater the impact a given rate change will have on its value. In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are also projected based on management’s best estimates. We have found that model results are highly sensitive to changes in the assumed decay rate for non-maturity deposits, in particular.
The economic value of equity (EVE) is calculated by subtracting the estimated fair value of liabilities from the estimated fair value of assets.
Capital Resources
At December 31, 2007, the Company had total shareholders’ equity of $74.8 million, comprised of $73.8 million in common stock and surplus, $2.1 million in retained earnings, and $1.1 million in accumulated other comprehensive loss. Total shareholders’ equity at the end of 2006 was $73.6 million. The Company’s
wholly owned subsidiary, Nevada Security Bank, was required by the FDIC to maintain an 8% capital ratio during its first three years of operation. Due to the Bank’s substantial growth, the Company contributed additional capital to the Bank in 2006 to assure that the mandated ratio was not breached and none was needed in 2007.
Regulatory Capital Guidelines
Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are “risk-based,” meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies.
Tier I and Tier II Capital
Under the guidelines, an institution’s capital is divided into two broad categories, Tier I capital and Tier II capital. Tier I capital generally consists of common shareholders’ equity, surplus and undivided profits. Tier II capital generally consists of the allowance for loan losses, hybrid capital instruments, and subordinated debt. The sum of Tier I capital and Tier II capital represents an institution’s total capital. The guidelines require that at least 50% of an institution’s total capital consist of Tier I capital.
Risk-based Capital Ratios
The adequacy of an institution’s capital is gauged primarily with reference to the institution’s risk-weighted assets. The guidelines assign risk weightings to an institution’s assets in an effort to quantify the relative risk of each asset and to determine the minimum capital required to support that risk. An institution’s risk-weighted assets are then compared with its Tier I capital and total capital to arrive at a Tier I risk-based ratio and a total risk-based ratio, respectively. The guidelines provide that an institution must have a minimum Tier I risk-based ratio of 4% and a minimum total risk-based ratio of 8%.
Leverage Ratio
The guidelines also employ a leverage ratio, which is Tier I capital as a percentage of total assets, less intangibles. The principal objective of the leverage ratio is to constrain the maximum degree to which a bank holding company may leverage its equity capital base. The minimum leverage rate is 3%; however, for all but the most highly rated bank hold companies and for bank holding companies seeking to expand, regulators expect and additional cushion of at least 1% to 2%.
Prompt Corrective Action
Under the guidelines, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. The categories range from “well capitalized” to “critically under capitalized.” Institutions that are “under capitalized” or lower are subject to certain mandatory supervisory corrective actions.
The Company uses a variety of measures to evaluate its capital adequacy, with risk-based capital ratios calculated separately for the Bank and the Company. Management reviews these capital measurements on a quarterly basis and takes appropriate action to ensure that they are within established internal and external guidelines. Based on current regulatory definitions, the Bank is well capitalized, which is the highest rating of the categories defined under Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991. The Company’s current capital position exceeds minimum thresholds established by industry regulators.
The Federal Deposit Insurance Corporation (“FDIC”) has promulgated risk-based capital guidelines for all state non-member banks such as Nevada Security Bank. These guidelines establish a risk-adjusted ratio relating capital to different categories of assets and off balance sheet exposures. There are two categories of capital under the guidelines, Tier 1 Capital includes common stockholders’ equity and qualifying minority interests in consolidated subsidiaries, less goodwill and certain other deductions, notably the unrealized net gains or losses (after tax adjustments) on available for sale investment securities carried at fair market value.
Tier 2 Capital includes preferred stock, certain types of debt equity, and the allowance for loan losses, subject to certain limitations. At December 31, 2007 Nevada Security Bank’s total risk based assets were $520.4 million. At December 31, 2006, 2005 and 2004, the Company’s total risk based assets were $543.7 million, $516.1 million and $279.3 million, respectively. This roughly indicates the intensity of capital usage when compared to total reported assets as noted elsewhere in the body of this report.
Appendix 15 sets forth the Bank’s and the Company’s regulatory capital ratios as of the dates indicated.
Impact of Inflation
A financial institution’s asset and liability structure is substantially different from that of an industrial firm in that primarily all assets and liabilities of a bank are monetary in nature, with relatively little investment in fixed assets or inventories. Inflation can have an impact on the growth of total assets and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to asset ratio. Inflation has been minimal for the past several years and as such has had little or no impact on the financial condition and results of operations of the Company during the periods discussed herein.
Liquidity and Market Risk Management
The Company must address on a daily basis the various and sundry factors which impact its continuing operations. Three of these factors have been previously discussed: The economic climate which encompasses our business environment, the regulatory framework that governs our practices and procedures, and credit risk. This section will address liquidity risk and market risk, two additional risks specific to the operation of a financial institution that also require active management.
Liquidity
The liquidity of the Company is comprised of three primary classifications: Cash flows from or used in operating activities, cash flows used in investing activities, and cash flows provided by financing activities. Net cash provided by or used in operating activities consists primarily of net income or loss adjusted for certain non-cash income and expense items such as the loan loss provision, investment and other amortizations and depreciation. For the twelve months ended December 31, 2007 net cash used in operating activities was about $7.4 million, compared to operating activities which provided $11.5 million for the same period of 2006. The deterioration for the twelve months ended December 31, 2007 over the same period of 2006 was primarily as a result of the reduction in the exchange activity and increases in the provision for loan losses caused by the difficulties in the real estate markets in the latter part of 2007.
Net cash used in investing activities, consists primarily the of activities of securities and loans, was approximately $2.6 million for the twelve months ended December 31, 2007 as compared to $99 million for the twelve months ended December 31, 2006. The change in investing activities for 2007 was primarily due to the lower loan origination activities and the shrinkage of the investment portfolio as a result of economic factors in local markets felt by the Company during 2007.
Net cash provided by financing activities for prior periods overwhelmingly reflects the deposit growth of the organization. For the twelve months ending December 31, 2007, however, the net cash used in financing activities was $14.6 million, as compared to cash provided by financing of $79 million for the same period of 2006. This change from 2006 acknowledges balance sheet management which reflected reduced activity in deposit origination and retention of high cost deposits.
Liquidity refers to our ability to maintain a cash flow that is adequate to fund operations and meet obligations and other commitments in a timely and cost-effective fashion. We require sources of funds to meet short-term
cash needs that may result from loan growth or deposit outflows, or other asset purchases or liability repayments. These funds are traditionally made available by drawing down from our correspondent bank deposit accounts, reducing the volume of fed funds sold, or liquid money market funds, selling securities, liquidating other assets, or borrowing funds from other institutions.
The extent to which these funds are available to meet our cash needs determines our liquidity. In addition, should the need arise for immediate cash, we could sell either permanently or under agreement to repurchase, those investments in our portfolio which are not pledged as collateral to support various borrowings or the collateralization of public deposits.
As of December 31, 2007, non-pledged securities comprised about $34.6 million or 43% of our securities portfolio. Other forms of balance sheet liquidity on that date include vault cash and balances due from banks which totaled $14 million. In addition to the liquidity inherent in our balance sheet, we have off-balance-sheet liquidity in the form of lines of credit from two correspondent banks. Availability on these lines totaled approximately $11.4 million at December 31, 2007. We manage our liquidity in such a fashion as to be able to meet any unexpected sudden change in levels of assets or liabilities. At December 31, 2006 all non-pledged investments were approximately 31% of our securities portfolio.
On a long term basis, the Bank’s liquidity may be met by changing the relative distribution of its asset portfolios, i.e., reducing investment or loan volumes, or selling or encumbering assets. Further, it may increase liquidity by soliciting higher levels of deposit accounts through promotional activities, the use of deposit brokers, or borrowing from correspondents through drawing on its lines of credit. At the current time, the long-term liquidity needs of the Bank primarily relate to funds required to support loan commitments, lease obligations, certificate of deposit maturities and debt repayment. All of these needs can currently be met by cash flows from investment payments and maturities, and investment sales if needs be.
The Bank Holdings is a company separate and apart from Nevada Security Bank. It must provide for its own liquidity. The private placement which closed August 6, 2006 provided equity with which it may expand its activities, support the continued growth of Nevada Security Bank, and the 1031 qualified intermediaries, and pay for its obligations incurred during the normal course of business.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk Management
Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices. The Bank’s market risk exposure is primarily that of interest rate risk, and it has established policies and procedures to monitor and limit earnings and balance sheet exposure to changes in interest rates. The Bank does not engage in trading of financial instruments, nor does the Bank have any exposure to exchange rates.
The principal objective of interest rate risk management (often referred to as “asset/liability management”) is to manage the financial components of the Company in a manner that will optimize the risk/reward equation for earnings and capital in relation to changing interest rates. To identify areas of potential exposure to rate changes, the Bank uses modeling software to perform an earnings simulation analysis and a market value of portfolio equity calculation on a quarterly basis. This identifies more dynamic interest rate risk exposures than those apparent in standard re-pricing gap analyses.
BancWare modeling software is used for asset/liability management in order to simulate the effects of potential interest rate changes on the Company’s primary subsidiary, Nevada Security Bank and its net interest margin. These simulations can also provide both static and dynamic information on the projected fair market values of the Bank’s financial instruments under different interest rate scenarios. The simulation
program utilizes Bank specific loan, deposit and investment data, and incorporates assumptions on the re-pricing characteristics of embedded options to determine the effects of a given interest rate change on the subsidiary bank’s interest income and interest expense. Rate scenarios consisting of key rate and yield curve projections are run against the Bank’s investment, loan, deposit and borrowed funds portfolios. These rate projections can be shocked (an immediate and sustained change in rates, up or down), ramped (an incremental increase or decrease in rates over a specified time period), economic (based on current trends and econometric models) or stable (unchanged from current actual levels). The Bank typically uses seven standard interest rate scenarios in conducting its simulations, four of which are provided in Appendix 13.
The Bank’s policy is to target the change in the Bank’s net interest income for the next 12 months to plus or minus 7% based on a 100 basis point (b.p.) shock, plus or minus 14% based on a 200 b.p. shock, and plus or minus 21% based on a 300 b.p. shock in interest rates.
See Appendix 13 for information on the Bank’s estimated net interest income sensitivity profile as of December 31, 2007. The table illustrates that if there were an immediate downward adjustment of 100 basis points in interest rates and the Bank did nothing further with regard to the active management of its assets or liabilities, net interest income would likely decrease by around $44,000, or approximately 0.01%, over the next twelve months. By the same token, if there were an immediate increase of 100 basis points in interest rates, the Bank’s net interest income would decrease by $281,000 or 0.05% over the next year. Management expects current rates to fall further over the next twelve months. While the simulations as of December 31, 2007 show declines in net interest income in all scenarios, the impact in earnings is negligible. The Company’s balance sheet is fairly well insulated to interest rate risk and management is proactive in addressing the maintenance of the Company’s net interest margin. However, the preceding interest rate simulation model discussion does not represent a financial forecast and should not be relied upon as being indicative of future results.
One lesser utilized method of reviewing an institution’s likely changes in net interest income is to analyze its “gap” position. That is, to look at the dollar volume of assets and liabilities whose interest rates earned and paid, will be repricing in various base periods. This repricing information is also used in the liquidity management. These repricing characteristics are the time frames within which the interest bearing assets and liabilities are currently subject to change in interest rates, either at replacement, repricing or maturity during the life of the instruments. Interest rate sensitivity management focuses on the repricing characteristics and the maturity structure of assets and liabilities during periods of changes in market interest rates. Effective interest rate sensitivity management seeks to examine how and when assets and liabilities respond to changes in interest rates, and quantify the impact of interest rate changes on net interest income. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in our current portfolios that are subject to repricing at various time horizons: immediate; within three months; over three to twelve months; one to five years; over five years, and on a cumulative basis. The differences are known as interest rate sensitivity gaps.
As shown in Appendix 14, Interest Rate Sensitivity Gap, during the first three months of 2008, approximately 64% of interest bearing liabilities could reprice, compared with 46% of all interest earning assets. This would be characterized as a negative gap, that is, more liabilities reprice in this period than assets. A positive gap implies that more assets than liabilities reprice in a given time frame, and the intuitive reaction would be that in a falling rate environment, it would be more beneficial to be negatively gapped; that is, interest bearing liabilities drop in price faster than interest earning assets, and in a rising interest rate environment it would be better to have interest earning assets reprice quicker than interest bearing liabilities, thereby creating additional short-term income.
A short term positive net interest income effect would occur in either instance, based on the positive gap in a falling rate environment, or a negative gap in a rising interest rate environment, at least until all interest
bearing liabilities or assets are repriced in respect to their maturities, and the enhanced net interest margin is reduced. However, loan and deposit portfolio repricing periods do not bring automatic short-term increases or decreases in the net interest margin, because rates may not be adjusted concurrently with market condition changes, and may be “sticky” in either direction.
Further changes in the mix of earning assets or interest bearing liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing for both the asset and the liability remains the same, thereby impacting net interest income. This characteristic is referred to as basis risk and in general relates to the possibility that the repricing characteristics of short-term assets tied to various indices are different from those of funding sources. Varying interest rate environments can create unexpected changes in prepayment volumes of assets, and pre-maturity demands for liabilities that are not reflected in the interest rate sensitivity analysis. These customer originated prepayments or pre-maturities may have a significant impact on our net interest margin. Because of these factors, an interest rate sensitivity gap analysis may not provide an accurate assessment of our exposure to changes in interest rates and we use modeling software to more accurately reflect interest rate risk.
The economic (or “fair”) value of financial instruments on the Company’s balance sheet will also vary under the interest rate scenarios previously discussed. Economic values for financial instruments are estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while the fair value of non-financial accounts is assumed to equal book value and does not vary with interest rate fluctuations. An economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change substantially over time as the characteristics of the Company’s balance sheet evolve and as interest rate and yield curve assumptions are updated. At the current time, the Company determines the economic value of equity (“EVE”) on a quarterly basis, and has established guidelines for such variances based on historical economic and Company trends.
Federal Taxation
The Company files a consolidated federal tax return for all entities, using the accrual method of accounting. All required tax returns have been filed when due. Financial institutions are subject to the provisions of the Internal Revenue Code of 1986, as amended in the same general manner as other corporations. See NOTE 9 to the Consolidated Financial Statements for additional information.
State Taxation
Under Nevada law, financial institutions are subject to employment and branch location taxes but not income taxes. The employment tax is calculated 2.0% of total salaries and wages, while the branch location fee is $7,000 per branch location, per year. Montana and California impose state income taxes. In these states the Company files a tax return based on allocated income that is calculated pursuant to income allocation criteria. These criteria are:
· Property Factor. Real and personal property, rent or lease expense and loan and credit card receivables sourced on the location;
· Revenue Factor. Interest, fees and penalties secured by real property sourced to the state where the property is located; and
· Payroll Factor. Payroll consists of salaries, wages and other compensation by state tied to Federal 940 reports or state unemployment reports.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements and independent auditors’ reports listed below are included herein:
Page
I a.
Report on Management’s Assessment of Internal Control Over Financial Reporting
I b.
Report of Independent Registered Public Accounting Firm
II.
Consolidated Balance Sheets - December 31, 2007, and 2006
III.
Consolidated Statements of Operations - (Years Ended December 31, 2007, 2006 and 2005)
IV.
Consolidated Statements of Stockholders’ Equity - Years Ended December 31, 2007, 2006 and 2005)
V.
Consolidated Statements of Cash Flows - (Years Ended December 31, 2007, 2006, and 2005)
VI.
Notes to the Consolidated Statements
REPORT ON MANAGEMENT’S ASSESSMENT OF
INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of The Bank Holdings and subsidiaries (“the Company”) is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined by Exchange Act Rules 13a - 15 and 15d - 15. The Company’s management has used the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) to evaluate the effectiveness of the Company’s internal control over financial reporting.
The Company’s management has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007 and has concluded that such internal control over financial reporting is effective. There are no material weaknesses in the Company’s internal control over financial reporting that have been identified by the Company’s management.
Moss-Adams, LLP the Company’s independent registered public accounting firm, has audited the consolidated financial statements of the Company for the year ended December 31, 2007, and has also issued an attestation report, which is included herein, on internal control over financial reporting pursuant to Auditing Standard No. 5 of the Public Company Accounting Oversight Board (“PCAOB”).
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
The Bank Holdings
We have audited the accompanying consolidated balance sheets of The Bank Holdings and Subsidiaries (Company) as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three year period ended December 31, 2007. We also have audited The Bank Holdings and Subsidiaries internal control over financial reporting as of December 31, 2007, based on criteria established in the 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 and for 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 and an opinion on the Company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with auditing 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 and whether effective internal control over financial reporting was maintained in all material respects. 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, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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 the 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 only 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 its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of 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 the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Bank Holdings and Subsidiaries as of December 31, 2007 and 2006, and the results of their operations and cash flows for each of the years in the three year period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, The Bank Holdings and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As discussed in Note 1 and Note 14 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 Standards (SFAS) No. 123(R), Share-Based Payment. As discussed in Note 1 and Note 3 to the consolidated financial statements, effective January 1, 2007, the Company adopted the provisions of SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, and SFAS No. 157, Fair Value Measurements.
/s/ Moss Adams LLP
Stockton, California
April 1, 2008
THE BANK HOLDINGS AND SUBSIDIARIES
Consolidated Balance Sheet
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
THE BANK HOLDINGS AND SUBSIDIARIES
Consolidated Statements of Operations
(Dollars in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
THE BANK HOLDINGS AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
For the Years Ended December 31, 2007, 2006 and 2005
The accompanying notes are an integral part of these consolidated financial statements.
THE BANK HOLDINGS AND SUBSIDIARIES
Consolidated Statement of Cash Flows
(Dollars in thousands)
Non-Cash Items:
For year end December 31, 2007 the Company adopted FAS 159 and recorded a non-cash decrease to certain USDA and SBA loans of $736,000, a decrease to retained earnings of $464,000 and an increase of deferred taxes of $272,000.
The accompanying notes are an integral part of these consolidated financial statements.
THE BANK HOLDINGS
Notes to Consolidated Financial Statements
December 31, 2007
NOTE 1 - BASIS OF PRESENTATION AND NATURE OF OEPRATIONS
Principles of Consolidation and Basis of Presentation
On July 9, 2003, the stockholders of Nevada Security Bank approved the exchange of their common stock in Nevada Security Bank for common stock in the newly formed holding company, The Bank Holdings. This transaction was consummated on August 29, 2003 and was accounted for at historical cost. The consolidated financial statements include the accounts of The Bank Holdings, its wholly-owned subsidiary, Nevada Security Bank, its wholly owned subsidiary Rocky Mountain Exchange, and its 80% owned subsidiary Granite Exchange which was subsequently increased to wholly owned as of February 1, 2008. Nevada Security Bank was organized on February 26, 2001 and opened for business on December 27, 2001. Rocky Mountain Exchange (formerly Big Sky Property Exchange) and Granite Exchange were both purchased in March 2006. All significant inter-company balances and transactions have been eliminated in consolidation.
In accordance with provisions of Financial Accounting Statements Board (“FASB”) interpretation No. 46 Consolidation of Variable Interest Entities, the Company’s investment in The Bank Holdings Statutory Trust I, and NNB Holdings Statutory Trust I, are not consolidated and they are accounted for under the equity method and included in other assets on the consolidated balance sheet. The subordinated debentures issued and guaranteed by the Company and held by the Trusts are reflected on the Company’s consolidated balance sheet.
Nature of Banking Activities
The Bank Holdings is a bank holding company incorporated in Nevada on January 17, 2003 and registered under the Bank Holding Company Act of 1956, as amended. We conduct bank operations through our principal subsidiary, Nevada Security Bank, a Nevada state-chartered commercial bank. We and Nevada Security Bank are both headquartered in Reno, Nevada at 9990 Double R Boulevard. We acquired all of the outstanding shares of Nevada Security Bank on August 29, 2003. On November 6, 2006, the Company acquired NNB Holdings, Inc. in Reno, Nevada and its subsidiary bank Northern Nevada Bank whose branches became part of Nevada Security Bank.
During the first quarter of 2006, the Company acquired two qualified intermediary (the “QI”) companies, Rocky Mountain Exchange (formerly known as Big Sky Property Exchange) and Granite Exchange, Inc. which facilitate tax-deferred real estate transactions under Section 1031 of the Internal Revenue Code. Rocky Mountain Exchange is located in Bozeman, Montana, and Granite Exchange is headquartered in Roseville, California. Qualified intermediaries select the financial institution to hold depositor accounts created as part of the exchange transactions. The exchange balances deposited into the Bank should increase the Bank’s core deposits, decrease the Bank’s loan to deposit ratio, and support future loan growth. These subsidiaries have been consolidated on the Company’s books.
The Company’s other direct subsidiaries are The Bank Holdings Statutory Trust I, a Connecticut statutory trust which was formed in November, 2005 solely to facilitate the issuance of variable rate capital trust pass through securities and NNB Holdings Statutory Trust I which was formed in June 2005, and was acquired by the Company in the merger with NNB Holdings, Inc. This additional regulatory capital has enabled the Company to follow previously established expansion plans without an impairment of risk-based capital ratios. Pursuant to FASB Interpretation No. 46 Consolidation of Variable Interest Entities (FIN 46R), The Bank Holdings Statutory Trust I and NNB Holdings Statutory Trust I are not reflected on a consolidated basis in the financial statements of the Company.
These entities are collectively referred to herein as the Company. Segment information is presented in NOTE 17. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the banking industry.
Use of Estimates
In preparing consolidated financial statements in conformity with generally accepted accounting principles in the United States of America and general practices within the banking industry, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, material estimates that are susceptible to substantial change over the longer term related to the determination of loan origination costs, equity-based compensation, goodwill and income taxes.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, demand amounts due from banks (including cash items in the process of clearing), liquid money market funds and federal funds sold. Cash flows from loans, deposits, and proceeds from issuance of common stock are reported net. The Company maintains amounts on account with other institutions which, at times, may exceed federally insured limits. A significant concentration exists with relation to deposits held at Pacific Coast Bankers’ Bank, Nevada Security Bank’s primary correspondent bank. A significant concentration exists with relation to deposits held at Nevada Security Bank, Umpqua Bank and Countrywide Bank, depositories for the Company’s 1031 QI’s. The Company has not experienced any losses on any such accounts.
Securities
Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity including equity securities with readily determinable fair values, are classified as “available for sale” and are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Management determines the appropriate classification of its investments at the time of purchase and may only change the classification under certain limited circumstances. Any transfers between categories would be accounted for at fair value. There were no transfers during any periods under review.
Purchase premiums and discounts are recognized in interest income using the interest method over the estimated life of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Trading Account & Derivative Financial Instruments
The Company’s “trading account” consists of specific equity investments that are carried at market value and separately reported in NOTE 4, “Securities”. Unrealized gains and losses are included in earnings as non-interest income. Gains and losses on the sale of equities are recorded on the trade date and are determined using the specific identification method.
The Company has a policy that provides for the use of derivative financial instruments held or issued for “trading account” purposes. These instruments are utilized for risk management purposes, and are measured at market value with gains or losses represented in earnings. Equity investments comprise the major portion of “trading account” assets. “Derivative financial instruments” are exchange traded covered call options written on some, but not all, of such equity investments. These options are carried at market value and are recorded in other liabilities.
Loans
The Company grants real estate, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by real estate loans throughout northern Nevada and northern California. The ability of the Company’s borrowers to honor their contracts is dependent upon the real estate and general economic conditions in these areas.
Loans are reported at their outstanding unpaid principal balances reduced by the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance.
Loan origination fees, net of certain deferred origination costs and purchase premiums and discounts are recognized as an adjustment to yield of the related loans over the contractual life of the loan using both the effective interest and straight line method, based on the loan type.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to expense. Loan losses are charged against the allowance when management believes the collection of a loan balance is unlikely. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical peer bank experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that may be susceptible to significant revision as more information becomes available.
The allowance consists of specific and general components. The specific component relates to loans that are impaired which are also classified as doubtful or substandard. For such loans an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on Company historical, other Nevada banks, and Uniform Bank Performance Report peer bank loss experience adjusted for qualitative factors.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall
in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.
Interest and fees on loans
Interest on loans is recognized over the terms of the loans and is calculated under the effective interest method. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to make payments as they become due.
The Company determines a loan to be delinquent when payments have not been made according to contractual terms, typically evidenced by nonpayment of a monthly installment by the due date. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Personal loans are typically charged off no later than 180 days delinquent.
All interest accrued but not collected for loans that are placed on non-accrual is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment to the related loan’s yield. The Bank is generally amortizing these amounts over the contractual life of the loan. Commitment fees, based upon a percentage of a customer’s unused line of credit, and fees related to standby letters of credit are recognized over the commitment period.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement that both entities and obligates the Company to repurchase them before their maturity.
Premises and Equipment
Premises and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the following estimated lives of the assets.
Amortization of leasehold improvements is computed principally by the straight line method over the term of the lease or the estimated useful life of the assets, whichever is shorter. Amortization expense on assets acquired under capital leases, which are being amortized over the lease terms, is included with depreciation expense on owned assets.
Non-Marketable Securities
Non-marketable securities are included in other equity securities on the balance sheet. These securities include debt and equity investments acquired for various regulatory, investment and other purposes. These securities are recorded at cost as we believe that the cost of these investments is initially the best indication of estimated fair value unless there have been significant subsequent negative developments that justify an adjustment. The Bank is a member of the Federal Home Loan Bank (FHLB) system and is required to maintain an investment in capital stock of the FHLB in an amount equal to the greater of 1% of its outstanding home loans or 5% of advances from the FHLB. The recorded amount of the FHLB stock equals its fair value because the shares can only be redeemed by the FHLB at the $100 per share par value. The Bank also has an investment in Pacific Coast Bankers’ Bancshares (PCBB) its correspondent bank, to facilitate transactions between the two companies. The Bank has a small investment in an insurance company that provides workman’s compensation insurance to the bank. The Company has made some additional equity investments in its qualified intermediaries and has a small investment in Carson River Community Bank which was opened during 2006.
Pre-underwriting fees
The Company has agreements with third parties under which the Company performs certain pre-underwriting activities on SBA loans which are funded by the third party. These activities are conducted in the Silverado Bank division. The Company would be required to refund any fee paid, in the event of delinquency, default, or early payoff during the first six months of the loan term. Management records a liability equal to 100% of the fee at the date the fee is received, less any commissions, fees or incentives paid to individuals involved in the transaction. This liability is reduced ratably over the six month contingency period.
Goodwill and Intangible Assets
In connection with its acquisition of the QI’s and NNB Holdings, the Company recorded the excess of the purchase price over the estimated fair value of the assets received and liabilities assumed as goodwill. The goodwill resulting from these transactions represents that amount by which the purchase price exceeded the fair value of the net assets acquired. Intangible assets are generally acquired in an acquisition. Intangible assets are subject to amortization over their useful lives. Among these intangible assets are core deposit intangibles and non-core deposit and loan intangibles which the Company will amortize over their estimated useful lives.
Goodwill is evaluated periodically, at least annually for impairment. There was no impairment recognized for the years ended December 31, 2007, 2006, or 2005 on the Company’s goodwill.
Income Taxes
The Company files its income taxes on a consolidated basis. The allocation of income tax expense represents each entity’s proportionate share of the consolidated provision for taxes. Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Therefore, deferred taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between tax financial statement carrying amounts and the basis of existing assets and liabilities. The effect on deferred taxes of a change in tax rates would be recognized in income in the period that includes the enactment date. Prior to 2005 deferred tax assets were reduced by a valuation allowance and that valuation allowance was removed in 2005.
Salary Continuation Plan
The Company has initiated action to provide certain key executives, or their designated beneficiaries, with annual benefits after retirement, until death. These benefits would be substantially equivalent to those
available under split-dollar life insurance policies purchased by the Company on the lives of such key executives. The Company has completed the final plan and agreements, and has accrued for these future benefits from the date of the plan. At the consolidated balance sheet date, the amount of accrued benefits equals the then present value of the benefits expected to be provided to the key executives or their beneficiaries, in exchange for the executives’ services to that date.
In 2005, the Company entered into salary continuation agreements with certain executive officers. The plans provide for annual lifetime benefits. The Plan, which is treated as a defined benefit plan, gave rise to Prior Service Costs and an attendant intangible asset of $1.2 million as of January 1, 2005, which is being amortized on a straight line basis over an estimated average service life of eleven years. As of December 31, 2007 the total unrecognized Prior Service Costs were $828,000 which is now subject to treatment under FAS No. 158 as Other Comprehensive Expense under FAS No. 158.
The benefit obligation under the plan totaled $2.0 million for the year ended December 31, 2006 and $1.5 million for the same period in 2005.
In connection with these plans, the Company holds single premium life insurance policies (BOLI) with cash surrender values totaling $9.5 million and $11.9 million at December 31, 2007 and 2006, respectively. On the consolidated balance sheet, the cash surrender values are included in other assets.
During 2007 the Company liquidated $3.4 million of bank owned life insurance that had been acquired in the merger with Northern Nevada Bank.
Officer and Director Deferred Compensation Plan
The Company has established a deferred compensation plan for certain members of the management group and deferred fee plan for directors for the purpose of providing the opportunity for participants to defer compensation. The Company bears the costs for the plan’s administration and the interest earned on participant deferrals. The related expense was not material for the years ended December 31, 2007, 2006, and 2005. In connection with this plan, life insurance policies were purchased with cash surrender values totaling $584,000, $468,000 and $320,000 at December 31, 2007, 2006 and 2005, respectively, which are included on the consolidated balance sheet in other assets.
401(k) Savings Plan
The 401(k) savings plan (the “Plan”) allows participants to defer, on a pre-tax basis, up to 100% of their salary (subject to Internal Revenue Service limitations) and accumulate tax-deferred earnings as a retirement fund. The Bank may make a discretionary contribution to match a specified percentage or dollar amount of the of the participants’ annual contributions. The matching contribution is discretionary; it vests over a period of one year from the participants’ hire date and is subject to the approval of the Board of Directors. For 2007 the matching contribution was $1,200, while for 2008 the contribution remains $1,200 per participant.
Stock Compensation Plan
At December 31, 2007, the Company had a stock-based employee compensation plan, which is more fully described in NOTE 14. On January 1, 2006 the Company adopted the FASB Statement No 123(R), Accounting for Share Based Payments. FAS 123(R) requires all share-based payments to employees, including grants of employee stock options to be recognized in the financial statements based on the grant-date fair value of the award. The fair value is amortized over the requisite service period (generally the vesting period). The Company previously accounted for the plan using the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations.
The Company adopted FAS 123(R) using the modified-prospective-transition method, compensation cost recognized in the year ending December 31, 2006 includes: a) compensation cost for all share-based awards granted prior to, but not yet vested as of January 1, 2006, and b) compensation cost for all share-based awards granted subsequent to January 1, 2006. The results of prior periods have not been restated.
On December 28, 2005, the Directors of The Bank Holdings approved the acceleration of non-qualified stock options granted under The Bank Holdings Stock Option Plan of 2002 as amended. Non-qualified options previously granted under this Plan were to be vested over a five year term.
The Company determines the fair value of each option grant on the grant date using the Black-Scholes pricing model (1) that takes into account the stock price at the grant date, the exercise price, the expected life of the option, the volatility of the underlying stock and the expected dividend yield and the risk-free interest rate over the expected life of the option
(1) The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected life of the stock based award and stock price volatility. The assumptions listed above represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if other assumptions had been used, the Company’s recorded compensation expense could have been materially different from that depicted in here. In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If the Company’s actual forfeiture rate is materially different from the estimate, the share-based compensation expense could be materially different. The dividend yield is based on the lack of historical cash dividends paid during the life of the company, while the projected stock price volatility is based on historical factors. The Company uses the seven year zero coupon treasury rate as the risk-free interest rate. The expected life of options (in years) is based on limited historical data, since very few options have been exercised and employees’ and directors’ exercise of awards have been based primarily on four separations, and three deaths. The vesting period has been noted above.
Income Per Common Share
Income per share for all periods presented in the Consolidated Statements of Operations is computed based on the weighted average number of shares outstanding during each period. Options outstanding as of December 31, 2007 were 731,310. The computation of basic and diluted earnings per weighted average share outstanding is as follows:
(1) Reflects the 5% Stock Dividend declared on February 15, 2007.
Off-Balance Sheet Instruments
In the ordinary course of business, the Company has entered into off-balance sheet instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains 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. Comprehensive income includes net income or loss and other comprehensive income or loss. The Company’s sources of other comprehensive income are derived from unrealized gains and losses on investment securities available for sale and amortization of prior service costs for the defined benefit plan. Reclassification adjustments, resulting from gains or losses on investment securities that were realized and included in the net income of the current period that also had been included in other comprehensive income or loss as unrealized holding gains or losses in the period in which they arose, are excluded from comprehensive income of the current period. The reconciliation of transactions affecting Accumulated Other Comprehensive Income is included in the Consolidated Statement of Shareholders’ Equity for the periods indicated.
Recent Accounting Pronouncements
FASB
In February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115. SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. The fair value option may be applied instrument by instrument with certain exceptions and is applied generally on an irrevocable basis to the entire instrument. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Early adoption is permitted under certain circumstances. Management adopted this Statement effective as of January 1, 2007. For the year 2007 the Company recorded unrealized losses of $77,000 on the financial instruments management choose to record at fair value. The Company also recorded a $464,000 charge to beginning retained earnings.
FASB
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. The statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The statement emphasizes that fair value is a market-based measurement, not an entity-specific measurement and establishes a fair value hierarchy. This statement also clarifies how the assumptions of risk and the effect of restrictions on sales or use of an asset effect the valuation. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption was permitted. Management adopted this statement effective as of January 1, 2007.
EITF 06-04
In September 2006, the Emerging Issues Task Force (“EITF”) of the FASB ratified EITF Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements, and EITF Issue No. 06-5, Accounting for Purchases of Life Insurance - Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance. EITF 06-4 provides that an employer should recognize a liability for future benefits based on the substantive agreement with the employee. The Issue should be
applied to fiscal years beginning after December 15, 2007, with earlier application permitted. EITF 06-5 provides that in determining the amount recognized as an asset, a policyholder should consider the cash surrender value as well as any additional amounts included in the contractual terms of the policy that will be paid upon surrender. The amount that could be realized should be calculated at the individual policy level and consider any probable contractual limitations, including the exclusion of any additional amounts paid for the surrender of an entire group of policies. The Issue is effective for fiscal years beginning after December 15, 2007. The banking subsidiary of the Company has life insurance arrangements. The Company has evaluated the impact of adoption of this rule on the Company’s financial statements and results of operations and it has been determined, by outside benefits administrators, that $1.0 million will be adjusted to retained earnings pursuant to this accounting pronouncement, effective January 1, 2008.
SAB 110
In December 2007 the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) 110, which expresses the staffs view regarding the use of a “simplified” method, as discussed in SAB 107, in developing an estimate of expected term of “plain vanilla” share options in accordance with FASB 123R. Due to the perceived lack of widely available detailed information about employee exercise behavior the staff will continue to accept, under certain circumstances, the use of the simplified method beyond December 31, 2007. The Company has evaluated the requirements of SAB 107, and we have determined that the adoption of these issues will not have a material impact on the Company’s financial statements or results of operations.
SEC RELEASE NOS. 33-8810; 34-55929; 33-8829 AND 34-56203
The Securities and Exchange Commission issued these releases during June and September 2007 dealing with guidance over Management’s Report on Internal Control Over Financial Reporting under Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The June releases provide interpretive guidance to management regarding its evaluation and assessment of internal control and sets forth an approach by which management can conduct a top down, risk based evaluation of internal control over financial reporting. The September release provided a definition of the term “significant deficiency” for purpose of the rules implementing Section 302 and 404 of the Sarbanes-Oxley Act of 2002. A “significant deficiency” is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness; yet important enough to merit attention by those responsible for oversight of a registrant’s financial reporting. The Company has evaluated the requirements of these releases, and we have determined that the adoption of these issues will not have a material impact on the Company’s financial statements or results of operations.
FASB FIN 48-1
In May 2007, FASB amended No. 48, Accounting for Uncertainty in Income Taxes, to provide guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. This guidance is applied upon the initial adoption of FIN 48. The Company has evaluated the requirements of this position, and we have determined that the adoption of this issue will not have a material impact on the Company’s financial statements or results of operations.
The list of recent accounting and regulatory pronouncements noted above, while not an exhaustive list, includes those which we believe will, or may, have the greatest likelihood of application to the Company’s consolidated balance sheets and/or consolidated statements of operations. We believe that adoption of these standards will not have a material impact on our financial condition, results of operations, earnings per share or cash flow, unless otherwise noted, however, no absolute assurance can be given that this in fact will occur.
Reclassification
Various reclassifications have been made to the consolidated balance sheet at December 31, 2007 and the consolidated statements of operations for the periods ended December 31, 2007 and 2006, in order to be
consistent with the presentation as of December 31, 2007. Further, certain captions have had revisions to more accurately reflect activities of the Company. There were no changes to previously reported stockholders’ equity or net income.
NOTE 2 - RESTRICTIONS ON CASH AND AMOUNT DUE FROM BANKS
The Company is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2007 and 2006, these reserve balances required amounted to approximately $2.9 million and $1.4 million, respectively.
NOTE 3 - FAIR VALUE MEASUREMENT
Effective January 1, 2007, the Company adopted FAS 157 “Fair Value Measurements,” concurrent with its early adoption of FAS 159 “The Fair Value Option for Financial Assets and Financial Liabilities.” FAS 157 clarifies the definition of fair value and describes methods available to appropriately measure fair value in accordance with generally accepted accounting principles. This statement applies whenever other accounting pronouncements require or permit fair value measurements. FAS 159 allows entities to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities that are not otherwise required to be measured at fair value, with changes in fair value recognized in earnings as they occur. FAS 159 also requires entities to report those financial assets and liabilities that are measured at fair value in a manner that separates those reported fair values from the carrying amounts of similar assets and liabilities measured using another measurement attribute on the face of the statement of financial condition. FAS 159 establishes presentation and disclosure requirements designed to improve comparability between entities that elect different measurement attributes for similar assets and liabilities. The Company has elected early adoption of FAS 159 effective January 1, 2007 for USDA/SBA loans purchased during late 2003 and early 2004.
The Company believes its adoption of FAS 159 will have a positive impact on its ability to better manage the balance sheet and interest rate risks which were associated with this group of specifically acquired assets while potentially benefiting the net interest margin, net interest income, net income and earning per common share during future periods. These loan purchases were initiated when the Company’s sole subsidiary Nevada Security Bank was just two years old and suffered from a lack of substantive loan growth. Further, interest rates were at a very low ebb and these loans were purchased at a yield of approximately 5%. While this yield was approximately 150 basis points greater than the Bank’s investment portfolio yield, current loan portfolio yields for internally generated loans are in the range of 7.5%. As a result, purchased loans were available in the market at narrower spreads and higher interest rates. With a lower than market coupon rate, and substantial premiums paid at acquisition, the Company’s cost basis of these purchased loans recorded on the statement of condition did not properly reflect the true opportunity costs to the Company.
FAS 157 requires the fair value of the assets or liabilities to be determined based on the assumptions that market participants use in pricing the financial instrument. In developing those assumptions, the Company identified characteristics that distinguish market participants generally, and considered factors specific to (a) the asset type, (b) the principal (or most advantageous) market for the asset group, and (c) market participants with whom the reporting entity would transact in that market. These loans may be sold in a secondary market with a limited number of active market participants. An active market quote to determine pricing and the current market value of these loans in the secondary market was completed as of December 31, 2007 and obtained from a recognized investment brokerage house. These factors met the definition of the most advantageous market and form the basis of the determination of a precise method for determining the value of these loans.
The Company performs fair-market valuations on certain assets as the result of the application of accounting guidelines that were in effect prior to the adoption of FAS 157. Some fair value measurements, such as available for sale securities are performed on a monthly recurring basis, while others, such as impairment of loans and USDA loans, are performed on a quarterly basis, unless significant information comes to the attention of management which suggests a more frequent evaluation should be undertaken.
The following table summarizes the Company’s financial instruments that were measured at fair value as of December 31, 2007.
Securities that are available for sale are valued based upon open market quotes obtained from reputable third-party brokers. Market pricing is based upon specific CUSIP identification for each individual security. Changes in fair value are recorded in other comprehensive income. Trading securities are valued based on open market quotes obtained from reputable third party brokers and pricing is based upon specific identification for each individual security. Changes in fair value are recorded in the statement of operations.
The fair value measurements for impaired loans are performed pursuant to FAS 114 and are based upon either collateral values supported by appraisals, or discounted cash-flow assumptions. All but two of the impaired loans at December 31, 2007 have collateral to support their fair values. Adjustments for fair value of impaired loans are a component in determining the overall adequacy of the loan loss reserve. Consequently, adjustments to the estimated fair value of impaired loans may result in increases or decreases to the provision for loan losses recorded in current earnings.
Fair value measurements for Other Real Estate Owned (“OREO”) are based upon collateral values supported by appraisals. Changes in the estimated fair value of OREO are recorded in the statement of operations.
The fair value measurements for USDA loans are based on upon market quotes obtain from reputable third-party brokers. Prices for similar assets in the market place and other inputs are used to provide a reasonable basis for the fair value determination. Adjustments to the fair value estimates of the USDA loans are recorded in current earnings.
The following table presents a reconciliation of retained earnings at the initial adoption of FAS 159 for the Company’s USDA/SBA loan portfolio.
During 2007, a pre-tax net unrealized loss of $77,000 was recorded in earnings, representing the change in fair value of these loans from the fair value election date of January 1, 2007. The fair value at December 31, 2007 was calculated using fair value hierarchy level two and in the same manner as the valuation at January 1, 2007.
NOTE 4 - SECURITIES
The amortized cost and fair value of securities with gross unrealized gains and losses are as follows:
At December 31, 2007 and 2006, securities in the investment portfolio with a carrying value of $45.5 million and $64.0 million, respectively, were pledged as collateral or for other purposes as required or permitted by law. Of the amounts pledged, $35.8 million was pledged for FHLB borrowing as of December 31, 2007.
The amortized cost and fair value of debt securities by contractual maturity at December 31, 2007 is shown below. Over certain interest rate environments, some, or all of these securities may be called for redemption by their issuers prior to the scheduled maturities. Further, maturities within the mortgage-backed securities portfolio may differ from scheduled and contractual maturities because the mortgages underlying the securities may be called for redemption or repaid without penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary.
For the year ended December 31, 2007 realized gains and losses from sales of securities available for sale were approximately $4,000 in gains and $3,000 in losses as compared to $11,000 in gains and $3,000 in losses for the same period in 2006 and gains of $8,000 for the same period in 2005. Realized gains and losses in the trading account were $18,000 in gains and $16,000 in losses for the period ending 2007 as compared to $29,000 in gains and $6,000 in losses for 2006. The results of these activities resulted in net realized gains of $3,000 for the year ended 2007 and net realized gains of $31,000 for 2006. The trading account had net unrealized gains of approximately $198,000 for the year of 2007, as compared to $443,000 for 2006 and $47,000 for 2005.
Information pertaining to securities with gross unrealized losses at December 31, 2007 and 2006, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to; 1) the length of time and the extent to which the fair value has been less than cost, 2) the financial condition and near-term prospects of the issuer, and 3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
At December 31, 2007, debt securities had an aggregate depreciation of less than 1.4% from the Company’s amortized cost basis. In the available-for-sale portfolio, twenty-six securities have an unrealized loss. In twelve of those securities the unrealized loss has exceeded one year. There are ninety-five securities in the held-to-maturity portfolio that have an unrealized loss. In sixty-five of those securities the losses have exceeded one year. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and industry analysts’ reports. As management has the ability and intent to hold debt securities until maturity, or for the foreseeable future if classified as available-for-sale, no declines are deemed to be other than temporary, and there are no declines in value that are not related to the current interest rate environment.
At December 31, 2006, debt securities had an aggregate depreciation of less than 1.2% from the Company’s amortized cost basis. None of these unrealized losses was deemed to be other than temporary. Those unrealized losses related primarily to fluctuations in the interest rate environment at that time.
NOTE 5 - LOANS
A summary of the balances of loans is as follows:
An analysis of the allowance for loan losses is as follows:
The Company also carries an allowance for undisbursed loan commitments which is reported as an “other liability”. At December 31, 2007 and 2006 such allowance was $199,000, and $334,000, respectively.
The Company had no loans which were classified as troubled restructured debt as of December 31, 2007 or 2006. The Company had ten loans on non-accrual ($5.6 million) as of December 31, 2007, two loans on non-accrual ($549,000) as of December 31, 2006 and none as of 2005, as well as no loans past due greater than 90 days and still accruing as of December 31, 2007, 2006 or 2005.
The following table summarizes the Company’s investment in loans for which impairment has been recognized as of December 31, 2007. No loans had been recorded as impaired as of December 31, 2006.
NOTE 6 - PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of premises and equipment is as follows:
Pursuant to the terms of non-cancelable lease agreements in effect at December 31, 2007, pertaining to Company premises, future minimum rent commitments (in thousands) under various operating leases are as follows:
The leases contain options to extend for periods of time from one to a maximum of fifteen years. Total rent expense for the periods ended December 2007, 2006 and 2005, amounted to approximately $1.0 million, $836,000 and $648,000, respectively. At December 31, 2007 there were no leasing transactions with related parties, nor were there any capital leases.
NOTE 7 - DEPOSITS
At December 31, 2007, the scheduled maturities of time deposits, including IRA accounts are as follows:
At December 31, 2007 and, 2006, the Bank’s specialized program of tax free exchange deposits aggregated $31 million and $70 million, respectively. At December 31, 2007 and 2006 the Bank had brokered deposits in the amount of $154 million and $135 million, respectively.
NOTE 8 - OTHER BORROWED FUNDS
The Company has entered into two agreements with correspondent banks under which it can purchase federal funds up to $11.5 million. Subsequent to year end we received notice that an increase was granted to the Company effective December 17, 2007 causing the limit to increase to $19.5 million. The interest charged on borrowings is determined by the lending institution at the time of the borrowing. These lines of credit are for short-term use, are unsecured and are renewed on an annual basis. There was $110,000 outstanding as of December 31, 2007 and there were no balances outstanding under these agreements at December 31, 2006, or 2005.
The Company also has an agreement with the Federal Home Loan Bank of San Francisco (FHLB) to borrow funds. Advances are collateralized by qualifying assets pursuant to collateral agreements with FHLB. There was $39.0 million outstanding as of December 31, 2006 and $70.5 million outstanding as of December 31, 2007. Of the amount outstanding at December 31, 2007 and 2006, $8.0 million were term advances acquired in the merger with NNB Holdings, and Northern Nevada Bank, with $1.0 million maturing in 2008, $2.0 million maturing in 2009 and $5.0 maturing in 2010.
As part of the acquisition of the two exchange intermediaries, the Company issued two notes payable in the amount of approximately $265,000 each with one and two year maturities payable at prime. The one year note was paid in full in 2006 and the remaining note was paid off in the first quarter of 2007.
Other subordinated debt as of December 31, 2006 includes $15.5 million in subordinated debentures issued by the Company and $5.1 million acquired in the merger with NNB Holdings, Inc. Of the debentures issued by the Company, $4.2 million of such funds were invested in the Bank in 2005 to maintain adequate capital levels.
NOTE 9 - INCOME TAXES
The cumulative tax effects of the primary temporary differences which created deferred tax assets and liabilities at December 31, 2007 and 2006 are as follows:
The components of income tax expense (benefit) for the years presented were as follows:
The following were the significant components of deferred tax assets and liabilities:
At December 31, 2007 and 2006 the Company had approximately $0 thousand and $640 thousand, respectively, of operating loss carryforwards for federal income tax purposes that expire beginning in 2021.
The income tax provision differs from the amount of income tax determined by applying the US federal income tax rate to pretax income for the years ended December 31, 2007, 2006 and 2005 due to the following:
NOTE 10 - SUBORDINATED DEBENTURES
The Bank Holdings Statutory Trust I, a Connecticut statutory trust (the “Trust”) was formed by the Company for the sole purpose of issuing trust preferred securities fully and unconditionally guaranteed by the Company. For financial reporting purposes, the Trust is not consolidated and the Floating Rate Subordinated Deferrable Interest Debentures (the “Subordinated Debentures”) held by the Trust, issued and guaranteed by the Company are reflected in the Company’s consolidated balance sheet in accordance with provisions of FIN 46R. Under applicable regulatory guidance, the amount of trust preferred securities eligible for inclusion in Tier 1 capital is limited to twenty-five percent (25%) of the Company’s Tier 1 capital on a pro-forma basis. At December 31, 2006, $20.0 million of trust preferred securities qualified as Tier 1 capital.
During the fourth quarter of 2005, the Trust issued $15 million Floating Rate Capital Trust Pass-through Securities (“TRUPS”) with a liquidation value of $1,000 per security for gross proceeds of $15 million. The entire proceeds of the issuance were invested by the Trust in $15,464,000 of subordinated Debentures issued by the Company, with identical maturity, repricing and payment terms as the TRUPS. These Subordinated Debentures represent the sole assets of the Trust. The Subordinated Debentures issued by the Trust mature on December 15, 2035, bear a current interest rate of 90 day LIBOR plus 1.42% with repricing and payments due quarterly. These Subordinated Debentures are redeemable by the Company, subject to receipt by the Company of prior approval from the Federal Reserve Bank, on any December 15 on or after December 15, 2010. The redemption price is par plus accrued and unpaid interest, except in the case of redemption under a special event which is defined in the debenture. The TRUPS are subject to mandatory redemption to the extent of any early redemption of the related Subordinated Debentures and upon maturity of those Subordinated Debentures on December 15, 2035.
Holders of the TRUPS are entitled to a cumulative cash distribution on the liquidation amount of $1,000 per security at an interest rate at December 31, 2007 of 6.41%. For each successive three month period beginning on December 15 of each year, the rate will be adjusted to equal the 3 month LIBOR plus 1.42%, provided, however, that such annual rate does not exceed 11%. The Trust has the option to defer payment of the distributions for a period of up to five years, as long as the Company is not in default on the payment of interest on the Subordinated Debentures. The TRUPS issued in the offering were sold in private transactions pursuant to an exemption from registration under the Securities Act of 1933, as amended. The Company has guaranteed, on a subordinated basis, distributions and other payments due on the TRUPS.
As a result of the purchase and merger agreement with NNB Holdings, Inc. the Company acquired NNB Holdings Statutory Trust I which was formed in June 2005 to issue $5,155,000 of fixed/floating rate Cumulative Trust Preferred Securities, which are classified as junior subordinated debt. The fixed rate of 5.95% began on the date of issuance and will end on (but not including) the interest payment date in June 2010, at which time the interest rate switches to a floating interest rate equal to the three month LIBOR plus 1.85%. The acquired debentures will mature in 2035, but may be redeemed by the Company at its option at any time on or after June 15, 2010 with a payment of a premium as outlined in the indenture agreement.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
Financial Instruments with Off-balance Sheet Risk
The Company is 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 may include commitments to extend credit and standby letters of credit. Such commitments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss, in the event of nonperformance by the other parties to the financial instrument, is represented by the contractual amount of these instruments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments. A summary of the contract amount of the company’s exposure to off-balance sheet risk as of December 31, 2007 and 2006 is as follows:
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 ever being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate and income producing commercial properties.
Unfunded commitments under commercial lines-of-credit, revolving credit lines and overdraft protection agreements are commitments for possible extension of credit to existing customers. These lines-of-credit may be uncollateralized, may not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.
Standby letters-of-credit are conditional lending commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters-of-credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit have expiration dates within one year.
As of December 31, 2007 there were commitment fee obligations of less than $1 thousand, for the $714,000 Standby Letters of Credit. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending facilities to customers, and management believes that no undue credit or service fee income exposure exists as a result of such transaction.
In connection with standby letters of credit, the Bank recognizes the related commitment fee received from the third party as a liability at the inception of the guarantee pursuant to FASB Interpretation 45 (FIN 45)
Initial Recognition and Measurement of the Liability for a Guarantor’s Obligations. Commitment fees where the likelihood of exercise of the commitment is remote are generally recognized as service fee income over the commitment period.
Concentrations
The Company makes commercial, commercial real estate, and residential real estate loans in northern Nevada and northern California. The Company makes consumer loans to customers primarily in northern Nevada. At December 31, 2007 and 2006, real estate loans accounted for approximately 80% and 80%, respectively, of total loans. Substantially all of these loans are secured by first liens with an initial loan to value ratio of generally not more than 75%. The Company’s policy for requiring collateral is to obtain collateral whenever it is available or desirable; depending upon the degree of risk the Company is willing to take. In addition, approximately 7% of total loans are unsecured. The Company’s loans are expected to be repaid from cash flow or from proceeds from the sale of selected assets of the borrowers.
A substantial portion of the Company’s customers’ ability to honor their contracts is dependent on the economy in the areas the Company serves. The Company’s goal is to maintain a diversified loan portfolio which requires the loans to be well collateralized and supported by cash flows.
Legal Contingencies
In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the Company’s financial condition or results of operation.
Executive Agreements
The Company has entered into agreement with five executives, which state that in the event the Company terminates the employment of these officers without cause, or upon change in control of the Company, the Company may be liable for the officers’ salaries as outlined in the agreements.
NOTE 12 - REGULATORY CAPITAL REQUIREMENTS
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet certain specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Additionally, State of Nevada bank regulations restrict distribution of the net assets of the Bank due to the fact that such regulations require the sum of the Bank’s stockholders’ equity and allowance for loan losses to be at least 6% of the average of the Bank’s total daily deposit liabilities for the preceding 60 days. As a result of these regulations, approximately $27.5 million and $29.3 million of the Bank’s stockholders’ equity was restricted at December 31, 2007 and 2006 respectively.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2007 and 2006, that the Company and Bank exceeded all minimum capital adequacy requirements to which they were subject.
As of December 31, 2007, the most recent notification from the Federal Deposit Insurance Company categorized the Bank as well capitalized under the regulatory framework for prompt correct action. To be categorized as well capitalized, an institution must maintain certain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios.
The Company’s and the Bank’s capital amounts and ratios as of December 31, 2007 and 2006, as well as regulatory minimums, are presented in the table below:
NOTE 13 - EMPLOYEE BENEFIT PLANS
The Company has a qualified 401(k) benefit plan for all eligible employees. Participants are able to defer up to 100% of their compensation subject to certain limits based on federal tax laws. The plan also provides a profit sharing component where the Company can make discretionary contributions to the plan, which is allocated based on the compensation of eligible employees. A contribution up to a maximum of $1,200 was made per participant by the Company which amounted to approximately $112,000 and $30,000 for the years ended December 31, 2007 and 2006 respectively, whereas no contribution was made during the year ended December 31, 2005.
NOTE 14 - STOCK COMPENSATION PLAN
Stock Compensation Plan
The Company has adopted the 2002 Stock Option Plan (the “Plan”) under which options to acquire common
stock of the Company may be granted to employees, officers, directors and others at the discretion of the Board of Directors. The Plan allows for the granting of incentive and non-qualifying stock options as those terms are defined in the Internal Revenue Code. The Plan, as amended at the shareholder’s 2004 Annual Meeting, authorizes up to 1,162,357 shares of common stock to be provided by shares authorized but not outstanding. Under the terms of the plan authorized shares approximate 20% of outstanding shares of the Company. The Plan provides for the exercise price and term of each option to be determined by the Board at the date of grant, provided that no options shall have a term greater than 10 years. All stock options granted under the plan expire ten years after the date of grant.
A summary of stock option activity for the year ended December 31, 2007 is as follows:
For the years ended December 31, 2007 and 2006 the Company recognized $421,000 and $416,000, respectively, for stock option compensation expense. The tax benefit of the compensation expense is $109,000 for 2007 and $108,000 for 2006. As of December 31, 2007 there was $651,000 in unrecognized compensation expense related to non-vested stock options. This unrecognized compensation cost has a weighted average life of about 3 years.
All options granted under the plan, except for founder’s options (9,000 non-qualified options) and options to two individuals which were carried over from the NNB Holdings, Inc. plan (18,899) which were immediately exercisable, have been granted with a five year vesting period. Twenty percent of such options are immediately exercisable, with the remaining 80% exercisable at 20% per year, over each of the next four anniversary dates of the grant.
On December 28, 2005, the Directors of The Bank Holdings approved the acceleration of non-qualified stock options granted under The Bank Holdings Stock Option Plan of 2002 as amended. Non-qualified options previously granted under this Plan were to be vested over a five year term.
As stated previously, the Company has adopted FAS 123(R) using the modified-prospective-transition method; as such, the results for prior periods have not been restated. The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of
FAS 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FAS 123.
NOTE 15 - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company has had, and may be expected to have in the future, banking transactions with directors, significant stockholders, principal officers, their immediate families and affiliated companies in which they are principal stockholders (commonly referred to as related parties). In management’s opinion, these loan and deposit transactions were on the same terms as those for comparable loan and deposit transactions with non-related parties.
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial Accounting Standards Board (FASB) Statement No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheets, for which it is practicable to estimate that value.
Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial
instruments, the fair value estimates presented herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction at December 31, 2007 or 2006. The estimated fair value amounts have been measured as of year end, and have not been reevaluated or updated for purposes of these financial statements subsequent to these dates. As such, the estimated fair values of these financial instruments subsequent to the reporting dates may be different than the amounts reported at year-end.
The information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only required for a limited portion of the Company’s assets, and due to the wide range of valuation techniques and the degree of subjectivity used in making the estimate, comparisons between the Company’s disclosures and those of other companies or banks may not be meaningful. The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments.
Cash and cash equivalents
The carrying amounts of cash, due from banks, liquid money market funds, and federal funds sold approximate fair value.
Securities held to maturity and available for sale
Fair values for 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.
Trading Securities
Fair values for trading equity securities are based on quoted market prices.
Non-marketable Securities
The reported amount of Federal Home Loan Bank (FHLB) stock equals its fair value due to the fact that the shares can only be redeemed by the FHLB at the $100 per share value. No ready market exists for the Pacific Coast Bankers’ Bancshares stock and it has no quoted market value. The Company’s other debt and equity investments including Carson River Community Bank are reported at book value which equals its fair value due to the fact that these items have no quoted market value.
Loans
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 all other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.
Deposit liabilities
The fair values disclosed for deposits with no defined maturities are equal to their carrying amounts which represent the amount payable on demand. The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair value at the reporting date. 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.
Other borrowed funds
The carrying amount of FHLB advances and Federal Funds purchased approximate fair value due to the next day maturity. The FHLB term advances are estimated using discounted cash flow analyses, using interest rate currently being offered for advances with similar terms to borrowers with similar credit quality.
Junior Subordinated Debt
The carrying amount of the variable junior subordinated debt approximates fair value due to the fact that interest rates reprice on $15 million quarterly. The fair value on the $5 million fixed rate junior subordinated debt is estimated using discounted cash flow analyses, using interest rates currently being offered with similar terms to companies with similar credit quality.
Accrued interest receivable and payable
The carrying amounts of accrued interest receivable and payable approximate fair value.
Off-balance sheet instruments
Fair values for the Company’s off-balance sheet lending commitments (commitments to extend credit) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. As of December 31, 2007 and 2006, loan commitments on which the committed fixed interest rate is less than the current market rate are insignificant.
The estimated fair values, and related carrying amounts, of the Company’s financial instruments are as follows:
NOTE 17 - SEGMENT INFORMATION
SFAS No. 131, Financial Reporting for Segments of a Business Enterprise, requires that a public business enterprise report financial and descriptive information about is reportable operating segments. According to the statement, operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance.
The Company evaluates segment performance internally based on the bank charter, the 1031 QI operating division, and “other”. The operating segment defined as “other” includes the Parent company, and eliminations of transactions between segments.
The accounting policies of the individual operating segments are the same as those of the Company, as described in NOTE 1. Transactions between operating segments are conducted at fair value, resulting in profits that are eliminated for reporting consolidated results of operations.
There is no segment reporting for 2005, since there only existed the Bank and Parent at December 31, 2005 and there was no separately evaluated information concerning allocation of resources or assessment of performance.
NOTE 18 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Financial Information Pertaining only to The Bank Holdings is as follows:
Statement of Condition
Statement of Operations:
Statement of Cash Flows:
NOTE 19 - QUARTERLY DATA (UNADUDITED)
NOTE 20 - SUBSEQUENT EVENT
In February 2008, pursuant to certain purchase agreements, the Company acquired the remaining 20% of Granite Exchange in the amount of $1.0 million from its minority shareholders. Granite exchange is now a wholly owned subsidiary of the Bank Holdings.
The Company intends to close the temporary Sparks, Nevada branch effective March 31, 2008 due to environmental and local permitting issues which will not allow the Company to open the permanent branch in its intended location and no suitable locations have been identified.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and its Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) as of the end of the period covered by this report have concluded that, the Company’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company and its consolidated subsidiary would be made known to them by others within those entities, particularly during the period in which this annual report was being prepared.
To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at ensuring that Company policies and procedures are understood throughout the organization. In establishing internal controls, management weighs the costs of such systems against the benefits it believes such systems will provide.
It should be noted that in designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. The Company has designed its disclosure controls and procedures to reach a level of reasonable assurance of achieving desired control objectives and, based on the evaluation described above, the Company’s Chief Executive Officer and Chief Financial Officer (Principal Accounting Officer) concluded that the Company’s disclosure controls and procedures were effective at reaching that level of reasonable assurance.
Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Controls
There were no substantive changes in the Company’s internal controls or in other factors that could significantly affect the Company’s internal controls subsequent to the end of the period covered by this report.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item can be found in the Company’s Definitive Proxy Statement pursuant to Regulation 14A under the Securities Exchange Act of 1934 and by this reference are incorporated herein.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information required by this item can be found in the Company’s Definitive Proxy Statement pursuant to Regulation 14A under the Securities Exchange Act of 1934 and by this reference are incorporated herein.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information in response to Item 201(d) of Regulation S-B can be found in Item 5 hereof and is incorporated herein by this reference. The remaining information required by this item can be found in the Company’s Definitive Proxy Statement pursuant to Regulation 14A under the Securities Exchange Act of 1934 and by this reference are incorporated herein.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this item can be found in the Company’s Definitive Proxy Statement pursuant to Regulation 14A under the Securities Exchange Act of 1934 and by this reference are incorporated herein.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Pre-Approval Policy for Services of Independent Auditors
As part of its duties, the Audit Committee is required to pre-approve audit and non-audit services performed by the independent auditors in order to assure that the provision of such services does not impair the auditors’ independence. On an annual basis, the Audit Committee will review and provide pre-approval for certain types of services that may be provided by the independent auditors without obtaining specific pre-approval from the Audit Committee. If a type of service to be provided by the independent auditors has not received pre-approval during this annual process, it will require specific pre-approval by the Audit Committee. The Audit Committee does not delegate to management its responsibilities to pre-approve services performed by the independent auditors.
Fees for Services Provided by Independent Auditors
Fees for all services provided by Moss-Adams, LLP the Company’s independent auditors for fiscal years 2007 and 2006, are as follows:
Audit Fees
Principal Accountant Fees and Services
(1)
Audit fees consist of fees for professional services rendered for the audit of The Bank Holdings consolidated financial statements for 2007 and 2006. Audit fees for 2007 and 2006 also include fees and costs associated with SAS 100 reviews associated with Form 10-Q filings.
(2)
All other fees consist of due diligence review work for the Company’s 1031 exchange acquisition and the acquisition of NNB Holdings, Inc.
PART IV
ITEM 15.
ITEM 15. EXHIBITS
(a) Exhibits
The following documents are included or incorporated by reference in this Annual Report on Form 10-K:
Exhibit No.
Description
3.1
Articles of Incorporation of The Bank Holdings (1)
3.2
Amendment to Articles of Incorporation of The Bank Holdings (1)
3.3
By-laws of The Bank Holdings (1)
4.1
Share Certificate (3)
10.1
2002 Stock Option Plan (2)
10.2
Amendment to the 2002 Stock Option Plan (4)
10.3
Form of Incentive Stock Option Agreement (2)
10.4
Form of Non-qualified Stock Option Agreement (2)
10.5
Form of Amendment to Non-qualified Stock Option Agreement (9)
10.6
Employment Agreement of Harold G. Giomi (5)
10.7
2nd Amended and Restated Split Dollar Agreement for Harold G. Giomi (10)
10.8
Executive Supplemental Compensation Agreement for Harold G. Giomi (5)
10.9
First Amendment to Executive Supplemental Compensation Agreement for Harold G. Giomi (10)
10.10
Employment Agreement of David A. Funk (2)
10.11
2nd Amended and Restated Split Dollar Agreement for David A. Funk (10)
10.12
Executive Supplemental Compensation Agreement for David A. Funk (5)
10.13
First Amendment to Executive Supplemental Compensation Agreement for David A. Funk (10)
10.14
Employment Agreement Addendum for David A. Funk (11)
10.15
Employment Agreement of Joe P. Bourdeau (8)
10.16
2nd Amended and Restated Split Dollar Agreement for Joe P. Bourdeau (10)
10.17
Executive Supplemental Compensation Agreement for Joe P. Bourdeau (5)
10.18
First Amendment to Executive Supplemental Compensation Agreement for Joe P. Bourdeau (10)
10.19
Employment Agreement of Jack B. Buchold (5)
10.20
2nd Amended and Restated Split Dollar Agreement for Jack B. Buchold (10)
10.21
Executive Supplemental Compensation Agreement for Jack B. Buchold (5)
10.22
Employment Agreement Addendum for Jack B. Buchold (8)
10.23
First Amendment to Executive Supplemental Compensation Agreement for Jack B. Buchold (10)
10.24
Employment Agreement of John N. Donovan (11)
10.25
2nd Amended and Restated Split Dollar Agreement for John N. Donovan (10)
10.26
Executive Supplemental Compensation Agreement for John N. Donovan (5)
10.27
First Amendment to Executive Supplemental Compensation Agreement for John N. Donovan (10)
10.28
Lease Agreement for Incline Village Office (2)
10.29
Lease Agreement for Reno Office (2)
10.30
Lease Agreement for Roseville Office (4)
10.31
Lease Agreement for Robb and Mae Ann Office (2)
10.32
Deferred Compensation Plan (2)
10.33
Directors Supplemental Insurance Plan Agreement (5)
10.34
Indenture (7)
Statement re: Computation of Per Share Earnings (4)
Registrant’s principal subsidiary is Nevada Security Bank, a Nevada corporation, which also does business under the name Silverado Funding and Silverado Bank
23.1
Consent of Moss-Adams, LLP
31.1
Section 302 Certification by Hal Giomi
31.2
Section 302 Certification by Jack Buchold
32.1
Section 706 Certification by Hal Giomi
32.2
Section 706 Certification by Jack Buchold
(1) This exhibit was previously filed as part of, and is hereby incorporated by reference to, our registration Statement on Form S-4 filed with the Commission on May 21, 2003.
(2) This exhibit was previously filed as part of, and is herby incorporated by reference to, our Form 10Q-SB, filed with the Commission on November 14, 2003
(3) This exhibit was previously filed as part of, and is hereby incorporated by reference to our Form SB-2 filed with the Commission on December 17, 2003.
(4) Computation of earnings per share is incorporated herein by reference to Note 1 of the Financial Statements.
(5) This exhibit was previously filed as part of, and is hereby incorporated by reference from, Form 8-K filed with the Commission on June 14, 2005.
(6) This exhibit was previously filed as part of, and is hereby incorporated by reference from, Form 8-K filed with the Commission on September 21, 2005.
(7) This exhibit was previously filed as part of, and is hereby incorporated by reference from, Form 8-K filed with the Commission on November 14, 2005.
(8) This exhibit was previously filed as part of, and is hereby incorporated by reference from, Form 8-K filed with the Commission on November 15, 2005.
(9) This exhibit was previously filed as part of, and is hereby incorporated by reference from, Form 8-K filed with the Commission on January 4, 2006.
(10) This exhibit was previously filed as part of, and is hereby incorporated by reference from, Form 8-K filed with the Commission on October 11, 2007.
(11) This exhibit was previously filed as part of, and is hereby incorporated by reference from, Form 8-K filed with the Commission on June 25, 2007.
FINANCIAL TABLES
Appendix 1 - Average Balances and Rates
The following table sets forth, for the periods indicated, information regarding (i) the total dollar amount of interest income on interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average cost; (iii) net interest income; (iv) interest rate spread; and (v) net interest margin.
(a)
Average balances are obtained from the best available daily or monthly data.
(b)
Yields are not reflected on a tax equivalent basis.
(c)
Loans are gross of the allowance for possible loan losses, deferred fees and related direct costs.
(d)
Represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities.
(e)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
Appendix 2 - Changes in Net Interest Income
The following table presents certain information regarding changes in our interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume) and (iii) changes in rate/volume (Change in rate multiplied by change in volume).
(1)
Includes changes in interest income and expense not due solely to volume or rate changes.
Appendix 3 - Non-Interest Income and Non-Interest Expense
The following table sets forth the various components of the Company’s non-interest income and expense for the periods indicated.
(a) Represents non-interest expenses as a percentage of net interest income and non-interest income excluding securities gains and losses.
Appendix 4 - Securities Available for Sale, Held to Maturity and Trading
The following table sets forth our investment securities as of the dates indicated.
Appendix 5 - Maturities of Securities
The following table sets forth the contractual maturities and weighted average yields of our debt securities as of December 31, 2007. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Appendix 6 - Composition of Loan Portfolio
The following table sets forth the composition of our loan portfolio at the dates indicated.
(1) Company adopted FAS 159 on January 1, 2007, amount outstanding represents fair value
Appendix 7- Scheduled Contractual Maturities of the Loan Portfolio
The following table sets forth the scheduled contractual amortization of our loan portfolio at December 31, 2007
as well as the amount of loans which are scheduled to mature after one year which have fixed or adjustable interest rates.
Appendix 8 - Table of Activity in the Allowance for Loan Losses
The following table sets forth information concerning the activity in our allowance for loan losses during the periods indicated.
Appendix 9 - Allocation of the Allowance for Loan Losses
The following table sets forth information concerning the allocation of our allowance for loan losses by loan categories at the dates indicated.
The allowance for loan losses is available for offsetting credit losses in connection with any loan, but is internally allocated to various loan categories as part of our process for evaluating the adequacy of the allowance for loan losses.
(1) Represents percentage of loans in category to total loans.
Appendix 10 - Premises and Equipment
The following table sets forth the cost and net book value of our fixed assets as of the dates indicated.
Appendix 11 - Maturity Schedule of Time Certificates of Deposit
At December 31, 2007, the scheduled maturities of time deposits including IRA’s (in thousands) are as follows:
Appendix 12 - Other Borrowed Funds
The following table sets forth the FHLB advances and other borrowing
* Acquired in merger on 11/06/06
+ $5.2 million acquired in merger on 11/06/06
Appendix 13- Estimated Net Interest Income Sensitivity Profile
The following table sets forth the estimated effects on the Bank’s net interest income over a 12 month period following December 31, 2007 in the event of an immediate change up or down in the indicated market interest rates.
Appendix 14 - Interest Rate Sensitivity Gap
The following table sets forth the Company’s interest rate sensitivity as of December 31, 2007. Interest rate sensitivity
difference between the volumes of assets and liabilities subject to repricing at various time periods.
Appendix 15 - Capital Adequacy - Risk-based Ratios
SIGNATURES
Pursuant to the requirements of Section 13 or 1516(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Pursuant to the requirements of the Securities and 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.
Signature
Title
Date
/s/ Edward Allison
Director
April 1,
Edward Allison
/s/ Marybel Batjer
Director
April 1,
Marybel Batjer
/s/ Joseph Bourdeau
President and Director
April 1,
Joseph Bourdeau
/s/ Edward Coppin
Director
April 1,
Edward Coppin
/s/ David A. Funk
Director
April 1,
David A. Funk
/s/ Jesse Haw
Director
April 1,
Jesse Haw
/s/ Kelvin Moss
Director
April 1,
Kelvin Moss
/s/ James Pfrommer
Director
April 1,
James Pfrommer
/s/ Hal Giomi
Chairman and Chief Executive Officer
April 1,
Hal Giomi
/s/ Jack B. Buchold
Chief Financial Officer
April 1,
Jack B. Buchold