ITEM 1. BUSINESS
Forward-Looking Statements: Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K including, but not limited to, matters described in “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. Such forward-looking statements may contain words related to future projections including, but not limited to, words such as “believe,” “expect,” “anticipate,” “intend,” “may,” “will,” “should,” “could,” “would,” and variations of those words and similar words that are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected. Factors that could cause or contribute to such differences include, but are not limited to, the following: (1) variances in the actual versus projected growth in assets; (2) return on assets; (3) loan and lease losses; (4) expenses; (5) changes in the interest rate environment including interest rates charged on loans, earned on securities investments and paid on deposits; (6) competition effects; (7) fee and other noninterest income earned; (8) general economic conditions nationally, regionally, and in the operating market areas of the Company and its subsidiary; (9) changes in the regulatory environment; (10) changes in business conditions and inflation; (11) changes in securities markets; (12) data processing problems; (13) a decline in real estate values in the Company’s operating market areas; (14) the effects of terrorism, the threat of terrorism or the impact of the current military conflict in Iraq and Afghanistan, and the conduct of the war on terrorism by the United States and its allies, as well as other factors. The factors set forth under “Item 1A
ITEM 1A. RISK FACTORS
In addition to the risks associated with the business of banking generally, as described above under Item 1 (Description of Business), the Company’s business, financial condition, operating results, future prospects and stock price can be adversely impacted by certain risk factors, as set forth below, any of which could cause the Company’s actual results to vary materially from recent results or from the Company’s anticipated future results.
Extensive Regulation of Banking. The Company’s operations are subject to extensive regulation by Federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of its operations. The Company believes that it is in substantial compliance in all material respects with laws, rules and regulations applicable to the conduct of its business. Because the Company’s business is highly regulated, the laws, rules and regulations applicable to it are subject to regular modification and change. There can be no assurance that these laws, rules and regulations, or any other laws, rules or regulations, will not be adopted in the future, which could make compliance much more difficult or expensive, restrict the Company’s ability to originate, broker or sell loans, further limit or restrict the amount of commissions, interest or other charges earned on loans originated or sold by the Company, or otherwise adversely affect the Company’s results of operations, financial condition, or future prospects.
Governmental Fiscal and Monetary Policies. The business of banking is affected significantly by the fiscal and monetary policies of the federal government and its agencies. Such policies are beyond the control of the Company. The Company is particularly affected by the policies established by the Board of Governors in relation to the supply of money and credit in the United States, and the target federal funds rate. The instruments of monetary policy available to the Board of Governors can be used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits, and this can and does have a material effect on the Company’s business, results of operations and financial condition. Federal monetary policy may also affect the longer-term inflation rate which directly affects the national and local economy.
The Effects of Legislation in Response to Current Credit Conditions. Legislation passed at the federal level and/or by the State of California in response to current conditions affecting credit markets could cause the Company to experience higher credit losses if such legislation reduces the amount that borrowers are otherwise contractually required to pay under existing loan contracts with First National Bank. Such legislation could also result in the imposition of limitations upon First National Bank’s ability to foreclose on property or other collateral or make foreclosure less economically feasible. Such events could result in increased loan losses and require a material increase in the allowance for loan losses and thereby adversely affect the Company’s results of operations, financial condition, future prospects, profitability and stock price.
Geographic Concentration. All of the business of the Company is located in the State of California and the banking offices of the Company are located in the Northern California Counties of San Mateo and San Francisco. The Company and the Bank conduct business primarily in the San Francisco Bay area. As a result, our financial condition, results of operations and cash flows are subject to changes in the economic conditions in this area. Our success depends upon the business activity, population, income levels, deposits and real estate activity in these markets, and adverse economic conditions could reduce our growth rate, or affect the ability of our customers to repay their loans, and generally impact our financial condition and results of operations. Economic conditions in the State of California are subject to various uncertainties at this time, including the budgetary and fiscal difficulties facing the State Government. The Company can provide no assurance that conditions in the California economy will not deteriorate further or that such deterioration will not adversely affect the Company.
Competition. Increased competition in the market of First National Bank of Northern California (the “Bank”) may result in reduced loans and deposits. Ultimately, the Bank may not be able to compete successfully against current and future bank and non bank competitors. Many competitors offer the banking services that are offered by the Bank in its service area. These competitors include national and super-regional banks, finance companies, investment banking and brokerage firms, credit unions, government-assisted farm credit programs, other community banks and technology-oriented financial institutions offering online services. In particular, the Bank’s competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits, and range and quality of products and services provided, including new technology-driven products and services. Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances, such as Internet-based banking services that cross traditional geographic bounds, enable more companies to provide financial services. If First National Bank is unable to attract and retain banking customers, it may be unable to continue its loan growth and level of deposits, which may adversely affect its and the Company’s results of operations, financial condition and future prospects.
The Effects of Changes to FDIC Insurance Coverage Limits and Assessments. These changes are uncertain and increased premiums may adversely affect the Company. The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund. Current economic conditions have increased expectations for bank failures. In such event, the FDIC would take control of failed banks and guarantee payment of deposits up to applicable insured limits from the Deposit Insurance Fund. Insurance premium assessments to insured financial institutions may increase as necessary to maintain adequate funding of the Deposit Insurance Fund.
The Emergency Economic Stabilization Act of 2008 included a provision for an increase in the amount of deposits insured by the FDIC to $250,000. On October 24, 2008, the FDIC announced the Temporary Liquidity Guarantee Program that provides unlimited deposit insurance on funds in noninterest-bearing transaction deposit accounts not otherwise covered by the existing deposit insurance limit of $250,000. All eligible institutions will be covered under the program for the first 30 days without incurring any costs. After the initial period, participating institutions will be assessed a 10 basis point surcharge on the additional insured deposits through the scheduled end of the program, currently December 31, 2009. Increased premiums will impact the Company’s earnings.
It is not clear how depositors may respond regarding the increase in insurance coverage. Despite the increase, some depositors may reduce the amount of deposits held at First National Bank if concerns regarding bank failures persist, which could affect the level and composition of the Bank’s deposit portfolio and thereby directly impact the Bank’s funding costs and net interest margin. First National Bank’s funding costs may also be adversely affected in the event that activities of the Federal Reserve Board and the U.S. Treasury to provide liquidity for the banking system and improvement in capital markets are curtailed or are unsuccessful. Such events could reduce liquidity in the markets, thereby increasing funding costs to First National Bank or reducing the availability of funds to First National Bank to finance its existing operations and thereby adversely affect the Company’s results of operations, financial condition, future prospects, profitability and stock price.
Dependence on Key Officers and Employees. We are dependent on the successful recruitment and retention of highly qualified personnel. Our ability to implement our business strategies is closely tied to the strengths of our executive officers who have extensive experience in the banking industry but who are not easily replaced. In addition, business banking, one of the Company’s principal lines of business, is dependent on relationship banking, in which First National Bank personnel develop professional relationships with small business owners and officers of larger business customers who are responsible for the financial management of the companies they represent. If these employees were to leave First National Bank and become employed by a local competing bank, we could potentially lose business customers. In addition, we rely on our customer service staff to effectively serve the needs of our consumer customers. We actively recruit for all open positions and management believes that its relations with employees are good.
Growth strategy. We have pursued and continue to pursue a growth strategy which depends primarily on generating an increasing level of loans and deposits at acceptable risk levels. We may not be able to sustain this growth strategy without establishing new branches or new products. Therefore, we may expand in our current market by opening or acquiring branch offices or other financial institutions or branch offices. This expansion may require significant investments in equipment, technology, personnel and site locations. The Company and the Bank may also attempt to grow through mergers and acquisitions. There can be no assurance that a successful merger or acquisition can be successfully completed. We cannot assure you of our success in implementing our growth strategy either through expansion of our existing branch system or through mergers and acquisitions, and there may be significant increases in our noninterest expenses, without any corresponding balance sheet growth.
Commercial loans. As of December 31, 2008, approximately 16.5% of our loan portfolio consisted of commercial business loans, which have a higher degree of risk than other types of loans. Commercial lending is dependent on borrowers making payments on their loans and lines of credit in accordance with the terms of their notes. Our current economic recession has made it difficult for many commercial borrowers to make their required loan payments. This credit risk is increased when there is a concentration of principal in a limited number of loans and borrowers, the mobility of collateral, the effect of general economic conditions and the increased difficulty of evaluating and monitoring these types of loans. The availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself and the general economic environment. If the cash flow from business operations is reduced, the borrower’s ability to repay the loan may be impaired. In addition, unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. If the Bank is required to repossess equipment or pursue collection efforts under personal guarantees, there could be a substantial decrease in value of collateral, if any, increased legal costs, and an increased risk of loss on the amount outstanding.
Real Estate Values. A large portion of the loan portfolio of the Company is dependent on the performance of our real estate portfolio. At December 31, 2008, real estate (including construction loans) served as the principal source of collateral with respect to approximately 82.9% of the Company’s loan portfolio. The current substantial decline in the economy in general, coupled with a continued decline in real estate values in the Company’s primary operating market areas could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, and the value of real estate and other collateral securing loans. Real estate values have declined, due in part to reduced construction lending, tighter underwriting requirements, and reduced borrower ability to make payments. Real estate loans may pose collection problems, resulting in increased collection expenses, and delays in the ultimate collection of these loans. In addition, acts of nature, including fires, earthquakes and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact the Company’s financial condition.
Allowance for Loan and Lease Losses. The Company maintains an allowance for loan losses to provide for loan defaults and non-performance, but its allowance for loan losses may not be adequate to cover actual loan and lease losses. In addition, future provisions for loan and lease losses could materially and adversely affect the Company and therefore the Company’s operating results. The Company’s allowance for loan and lease losses is based on prior experience, as well as an evaluation of the risks in the current portfolio. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond the Company’s control, and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review the Company’s loans and allowance for loan and lease losses. Although we believe that the Company’s allowance for loan and lease losses is adequate to cover current losses, we cannot assure you that it will not further increase the allowance for loan and lease losses or that the regulators will not require it to increase this allowance. Either of these occurrences could materially and adversely affect the Company’s earnings.
Environmental Liabilities. 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 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 investigations or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we could become subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business prospects, financial condition, liquidity, results of operations and stock price could be materially and adversely affected.
Dilution of Common Stock. Shares of the Company’s common stock eligible for future sale could have a dilutive effect on the market for common stock and could adversely affect the market price.
The Articles of Incorporation of the Company authorize the issuance of 10,000,000 shares of common stock, of which 3,030,000 were outstanding at December 31, 2008. Pursuant to its 1997, 2002 and 2008 Stock Option Plans, at December 31, 2008, the Company had outstanding options to purchase 347,792 shares of common stock. As of December 31, 2008, 337,386 shares of common stock remained available for grants under the 2008 Stock Option Plan as well as an additional 27,866 shares under the 2002 Stock Option Plan. The issuance of substantial amounts of the Company’s newly issued common stock in the public market could adversely affect the market price of the Company’s common stock. The market for the Company’s common stock is limited. The ability to raise funds in the future through a stock offering could be difficult.
Operating Losses. The Company is subject to certain operations risks, including, but not limited to, data processing system failures and errors and customer or employee fraud. The Company maintains a system of internal controls to mitigate against such occurrences and maintains insurance coverage for such risks, but should such an event occur that is not prevented or detected by the Company’s internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on the Company’s business, financial condition or results of operations. Additionally, the Company is dependent on network and computer systems. If these systems and their back-up systems were to fail or were breached, the Company could be adversely affected.
Business Confidence Uncertainty. Terrorist activities in the future and the actions taken by the United States and its allies in combating terrorism on a worldwide basis could adversely impact the Company and the extent of such impact is uncertain. Even more so, the problems in the mortgage and credit markets, the government conservatorship of Fannie Mae and Freddie Mac, the failure of investment firms such as of Bear, Stearns, and Lehman Brothers, as well as large write-offs at some major financial institutions have had a ripple effect on the entire financial services industry, and may continue to do so for some time. Such events have had and may continue to have an adverse effect on the economy in the Company’s market areas. Such continued economic deterioration could adversely affect the Company’s future results of operations by, among other matters, reducing the demand for loans and the amounts required to be reserved for loan losses, reducing the value of collateral held as security for the Company’s loans, and causing a decline in the Company’s stock price.
Restrictions in Purchase Agreement with U.S. Treasury. The Purchase Agreement between the Company and the U.S. Treasury dated February 27, 2009, pursuant to which the Company sold $12 million of the Company’s Series A Preferred Stock and issued 600 share of the Company’s Series B Preferred Stock (upon exercise of the Warrant issued to the U.S. Treasury), provides that prior to the earlier of (1) February 27, 2012 and (2) the date on which all of the shares of the U.S. Treasury Preferred Stock have been redeemed by the Company or transferred by the U.S. Treasury to third parties, the Company may not, without the consent of the Treasury, (a) declare or pay any dividend or make any distribution on capital stock or other equity securities of any kind of the Company other than (i) regular quarterly cash dividends of not more than the amount of the last quarterly cash dividend per share declared, or (ii) dividends payable solely in shares of common stock, or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of the Company’s common stock or preferred stock other than the U.S. Treasury Preferred Stock. In addition, the Company is unable to pay any dividends on the Company’s common stock unless the Company is current in the Company’s dividend payments on the U.S. Treasury Preferred Stock. These restrictions could have a negative effect on the value of the Company’s common stock. Dividends paid by the Company on the shares of U.S. Treasury Preferred Stock will reduce the net income available to the holders of Company common stock and the Company’s earnings per common share. The holders of the Company’s common stock are entitled to receive dividends only when, as and if declared by the Company’s Board of Directors. Although the Company has historically paid stock and cash dividends on the Company’s common stock, the Company is not required to do so and the Company’s Board of Directors could reduce or eliminate these common stock dividends in the future, depending on the circumstances. The U.S. Treasury Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of the Company.
Restrictions on Executive Compensation. Pursuant to the terms of the Purchase Agreement, the Company adopted certain standards for executive compensation and corporate governance. These standards generally apply to the Company’s Chief Executive Officer, the Chief Financial Officer and the three next most highly compensated senior executive officers. The standards (1) ensure that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) require “clawback” of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibit making golden parachute payments to senior executives; and (4) confirm agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. Pursuant to the American Recovery and Reinvestment Act of 2009, further compensation restrictions, including significant limitations on incentive compensation and “golden parachute” payments, have been imposed on the Company’s most highly compensated employees, which could, in the future, make it more difficult for the Company to retain and recruit qualified personnel.
Federal Home Loan Bank Risk. The failure of the Federal Reserve Bank (“FHLB”) of San Francisco or the national Federal Home Loan Bank System may have a material negative impact on our earnings and liquidity.
Recently, the FHLB of San Francisco announced that it was suspending dividend payments and suspending capital repurchases due to the deterioration in the market value of their mortgage-backed securities portfolio. While the FHLB of San Francisco has announced it does not anticipate that additional capital is immediately necessary, nor does it believe that its capital level is inadequate to support realized losses in the future, the FHLB of San Francisco could require its members, including the Bank, to contribute additional capital in order to return the FHLB of San Francisco to compliance with capital guidelines.
At December 31, 2008, we held $4.4 million of common stock in the FHLB of San Francisco. Should the FHLB of San Francisco fail, we anticipate that our investment in the FHLB’s common stock would be “other than temporarily” impaired and may have no value.
At December 31, 2008, we maintained a line of credit with the FHLB of San Francisco equal to 30% of total assets to the extent the Bank provides qualifying collateral and holds sufficient FHLB stock. At December 31, 2008, we were in compliance with collateral requirements. We are highly dependent on the FHLB of San Francisco to provide the primary source of wholesale funding for immediate liquidity and borrowing needs. The failure of the FHLB of San Francisco or the FHLB System in general, may materially impair our ability to meet our growth plans or to meet short and long term liquidity demands.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
FNB Bancorp does not own any real property. Since its incorporation on February 28, 2001, FNB Bancorp has conducted its operations at the administrative offices of First National Bank, located at 975 El Camino Real, South San Francisco, California 94080.
First National Bank owns the land and building at 975 El Camino Real, South San Francisco, California 94080. The premises consist of a modern, three-story building of approximately 15,000 square feet and off-street parking for employees and customers of approximately 45 vehicles. The Buri Buri Branch Office of First National Bank is located on the ground floor of this three-story building and administrative offices, including the offices of senior management, occupy the second and third floors.
First National Bank owns the land and two-story building occupied by the Daly City Branch Office (6600 Mission Street, Daly City, CA 94014); the land and two-story building occupied by the Colma Branch Office (1300 El Camino Real, Colma, CA 94014); the land and two-story building occupied by the South San Francisco Branch Office (211 Airport Boulevard, South San Francisco, CA 94080); the land and two-story building occupied by the Redwood City Branch Office (700 El Camino Real, Redwood City, CA 94063); the land and two-story building occupied by the Millbrae Branch Office (1551 El Camino Real, Millbrae, CA 94030); the land and single-story building occupied by the Half Moon Bay Branch Office (756 Main Street, Half Moon Bay, CA 94019); and the land and two-story building occupied by the Pescadero Branch Office (239 Stage Road, Pescadero, CA 94060). All properties include adequate vehicle parking for customers and employees.
First National Bank leases premises at 1450 Linda Mar Shopping Center, Pacifica, California 94044, for its Linda Mar Branch Office. This ground floor space of approximately 4,100 square feet is leased from Fifty Associates and Demartini/Linda Mar, LLC. The lease term is 10 years and expires on September 1, 2009.
First National Bank leases premises at 210 Eureka Square, Pacifica, California 94044, for its Eureka Square Branch Office. This ground floor space of approximately 3,000 square feet is leased from Joseph A. Sorci and Eldiva Sorci. The lease term is for 5 years, commencing January 1, 1995, with two 5-year options to extend the lease term, the second of which has been exercised and expires on December 31, 2009.
First National Bank leases premises at 65 Post Street, San Francisco, CA 94104, for its Financial District Office. The current lease term expires April 30, 2013, with one 5-year option to extend the lease remaining. The location consists of approximately 2,826 square feet of street level, 1,322 square feet of basement, and 1,077 square feet of mezzanine space.
First National Bank leases premises at 6599 Portola Drive, San Francisco, CA 94127, for its Portola Office. The current lease expires June 30, 2009, and has a remaining 5-year option to extend the lease. The location consists of approximately 1,325 square feet of street level space.
First National Bank leases premises at 150 East Third Avenue, San Mateo, CA 94401, for its San Mateo Branch Office. The current lease term, expires July 31, 2013. It has one remaining five-year option to extend the lease. The location consists of approximately 4,000 square feet of ground floor usable commercial space.
First National Bank leases a warehouse facility at 450 Cabot Road, South San Francisco, CA 94080. The lease term is for 5 years and one half month, and will expire February 28, 2011. The facility consists of approximately 7,600 square feet of office/warehouse space.
The foregoing summary descriptions of leased premises are qualified in their entirety by reference to the full text of the lease agreements listed as exhibits to this report.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings adverse to the Company or First National Bank to which any director, officer, affiliate of the Company, or 5% shareholder of the Company, or any associate of any such director, officer, affiliate or 5% shareholder of the Company are a party, and none of the foregoing persons has a material interest adverse to the Company or First National Bank.
From time to time, the Company and/or First National Bank are a party to claims and legal proceedings arising in the ordinary course of business. The Company’s management is not aware of any material pending legal proceedings to which either it or First National Bank may be a party or has recently been a party, which will have a material adverse effect on the financial condition or results of operations of the Company and First National Bank, taken as a whole.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None in the fourth quarter.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Since March 18, 2002, the common stock of the Company has been quoted on the OTC Bulletin Board under the trading symbol, “FNBG.OB.” There has been limited trading in the shares of common stock of the Company. On February 28, 2009, the Company had approximately 700 shareholders of common stock of record.
The following table summarizes sales of the Common Stock of FNB Bancorp during the periods indicated of which management of the Bank has knowledge, including the approximate high and low bid prices during such periods and the per share cash dividends declared for the periods indicated. All information has been adjusted to reflect 5% stock dividends effected on December 14, 2007 and on December 15, 2008. The prices indicated below reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
(1)
See Item 1, “Limitations on Dividends,” above, for a description of the limitations applicable to the payment of dividends by FNB Bancorp.
STOCK PERFORMANCE GRAPH
Set forth below is a line graph comparing the annual percentage change in the cumulative total return on FNB Bancorp Common Stock with the cumulative total return of the SNL Securities Index of Pink Banks (asset size of over $500 million) and the Russell 2000 Index as of the end of each of the last five fiscal years.
The graph assumes that $100.00 was invested on December 31, 2003 in FNB Bancorp Common Stock and each index, and that all dividends were reinvested. Returns have been adjusted for any stock dividends and stock splits declared by FNB Bancorp. Shareholder returns over the indicated period should not be considered indicative of future shareholder returns.
ISSUER PURCHASES OF EQUITY SECURITIES
On August 24, 2007, the Board of Directors of the Company authorized a stock repurchase program which calls for the repurchase of up to five percent (5%) of the Company’s then outstanding 2,863,635 shares of Common Stock, or 143,182 shares. There were no repurchases during the quarter ended December 31, 2008. There were 10,457 shares remaining that may be purchased under this Plan as of December 31, 2008. Effective February 27, 2009, based on the Purchase Agreement with the U. S. Treasury, the Company may not repurchase Company common stock so long as the Treasury’s Preferred Stock investment is outstanding.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The following table presents a summary of selected financial information that should be read in conjunction with the Company’s consolidated financial statements and notes thereto included under item 8 - “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.”
(1) per share data has been adjusted for stock dividends.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF FNB BANCORP AND SUBSIDIARY
Critical Accounting Policies And Estimates
Management’s discussion and analysis of its financial condition and results of operations are based upon the Company’s financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to its loans and allowance for loan losses. The Company bases its estimates on current market conditions, historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. All adjustments that, in the opinion of management, are necessary for a fair presentation for the periods presented have been reflected as required by Regulation S-X, Rule 10-01. The Company believes the following critical accounting policy requires significant judgments and estimates used in the preparation of the consolidated financial statements.
Allowance for Loan Losses
The allowance for loan losses is periodically evaluated for adequacy by management. Factors considered include the Company’s loan loss experience, known and inherent risks in the portfolio, current economic conditions, known adverse situations that may affect the borrower’s ability to repay, regulatory policies, and the estimated value of underlying collateral. The evaluation of the adequacy of the allowance is based on the above factors along with prevailing and anticipated economic conditions that may impact borrowers’ ability to repay loans. Determination of the allowance is part objective and part a subjective judgment by management given the information it currently has in its possession. Adverse changes in any of these factors or the discovery of new adverse information could result in higher charge-offs and loan loss provisions.
Goodwill
Goodwill arises from the Company’s purchase price exceeding the fair value of the net assets of an acquired business. Goodwill represents the value attributable to intangible elements acquired. The value of goodwill is supported ultimately by profit from the acquired business. A decline in earnings could lead to impairment, which would be recorded as a write-down in the Company’s consolidated statements of income. Events that may indicate goodwill impairment include significant or adverse changes in results of operations of the acquired business or asset, economic or political climate; an adverse action or assessment by a regulator; unanticipated competition; and a more-likely-than-not expectation that a reporting unit will be sold or disposed of at a loss.
Other Than Temporary Impairment
The decline in the fair value of any security in the Company’s investment portfolio that is considered other than temporarily impaired is written down with a charge to noninterest income in the period in which the impairment occurs in an amount that equals the book value less the fair value of the security. There are many factors that are considered before an other than temporary impairment is recorded. These factors include the length of time and the extent to which market value has been less than cost, reasons for decline in market price - whether an industry issue or issuer specific, changes in the general market condition of the area or issuer’s industry, the issuer’s financial condition, capital strength, ability to make timely future payments and any changes in agencies ratings that drop the security’s rating below investment grade and any potential legal actions.
Provision for Income Taxes
The Company is subject to income tax laws of the United States, its states, and municipalities in which it operates. The Company considers its income tax provision methodology to be critical, as the determination of current and deferred taxes based on complex analyses of many factors including interpretation of federal and state laws, the difference between tax and financial reporting bases of assets and liabilities (temporary differences), estimates of amounts due or owed, the timing of reversals of temporary differences and current financial standards. Actual results could differ significantly from the estimates due to tax law interpretations used in determining the current and deferred income tax liabilities. Additionally, there can be no assurances that estimates and interpretations used in determining income tax liabilities may not be challenged by federal and state taxing authorities.
Recent Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board (“FASB”) announced that it had revised Statement 141, Business Combinations, with 141(R). The revised Statement No. 141 was written to improve the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. This Statement establishes principles and requirements for how the acquirer:
a.
Recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree
b.
Recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase
c.
Determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination
This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company does not expect this Standard to have a material effect on the Company’s financial statements.
In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement No. 160, “Noncontrolling Interest in Consolidated Financial Statements - an amendment of ARB No. 51.” Statement No. 160 clarifies reporting and disclosure requirements related to noncontrolling interest included in an entity’s consolidated financial statements. This Statement clarifies that noncontrolling interests are to be reported in the noncontrolling section of the balance sheet and requires net income to include amounts from both the parent and the noncontrolling interest. This Statement also requires the parent company to recognize a gain or loss in net income when a subsidiary is deconsolidated. This Statement is effective for fiscal years (and interim periods within those years), beginning on or after December 15, 2008. The Company will apply this Statement prospectively and does not expect the Statement to have a material impact on the Company’s financial statements.
In March, 2008, the Financial Accounting Standards Board (“FASB”) issued Statement No. 161 “Disclosures About Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133.” Statement No. 161 changes the disclosure requirements for derivative instruments and hedging activities by requiring enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. This statement is effective for fiscal years and interim periods beginning after November 15, 2008. The Company does not expect this Standard to have a material impact on the Company’s financial statements.
In May, 2008 the Financial Accounting Standards Board (“FASB”) issued Statement No. 162 “The Hierarchy of Generally Accepted Accounting Principles.” This new standard is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U. S. generally accepted accounting principles (GAAP) for nongovernmental entities. This Statement becomes effective 60 days following the SEC’s approval of the Public Company Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The Company does not expect this Standard to have a material impact on the Company’s financial statements.
Earnings Analysis
Net earnings in 2008 were $3,963,000, a $2,716,000 or a 40.7% decrease from 2007 earnings of $6,679,000. Earnings for the year 2007 decreased $903,000 or 11.9% from year 2006 earnings of $7,582,000. The principal source of earnings is interest income on loans. The Federal Open Market Committee made a series of significant reductions in the intended federal funds rate in 2008, with a 4.25% rate on January 1, 2008, ending with a target rate of 0% to 0.25% on December 16, 2008.
Basic earnings per share were $1.29 in 2008, $2.13 in 2007 and $2.42 in 2006. Diluted earnings per share were $1.28 in 2008; $2.10 in 2007; and $2.37 in 2006.
Net interest income for 2008 was $27,920,000, a decrease of $713,000 or 2.5% from 2007. In 2007 it was $28,633,000, an increase of $1,258,000 or 4.6% from 2006. Interest income was $39,531,000 in 2008, a decrease of $2,759,000 or 6.5% from 2007. Interest income was $42,290,000 in 2007, an increase of $5,094,000 or 13.7% over 2006. The decrease in net interest income was caused by a decrease in the interest rate on earning assets which exceed the decrease in the interest rate on interest bearing liabilities, reflecting the actions of the Federal Open Market Committee, mentioned above. Most of the interest earning assets are tied to the prime lending rate, which adjusts immediately, whereas most of the interest-bearing liabilities adjust on a lagged basis, particularly in the case of time deposits, which change only at maturity. An increase in the volume of loans in nonaccrual status of $2,637,000 during 2008 also contributed to the decline. Average interest earnings assets in 2008 were $598,399,000, an increase of $31,154,000 or 5.5% over 2007. Average interest earning assets in 2007 were $567,245,000, an increase of $46,315,000 or 8.9% over 2006. The yield on interest earning assets decreased 79 basis points in 2008 compared to 2007. The yield on interest earning assets increased 32 basis points in 2007 compared to 2006. The principal earning assets were loans, and average loans outstanding increased $30,100,000 in 2008 versus 2007, and $80,269,000 in 2007 versus 2006, while their yield decreased 100 basis points in 2008 versus 2007, and decreased 10 basis points in 2007 versus 2006.
Interest expense for 2008 was $11,507,000 compared to $13,657,000 for 2007, a decrease of $2,150,000 or 15.7%. It increased by $3,836,000 in 2007 over 2006, or 39.1%. The decrease in interest expense during 2008 and 2007 was caused by rate decreases on deposits, as rates followed the declines in prevailing short term market interest rates. The Federal Open Market Committee intended federal funds rate was 4.25% on December 31, 2007. By December 31, 2008, that rate had been reduced to a target of 0% to 0.25%. No new branches or significant product lines were added during 2008. Average interest bearing liabilities were $463,546,000 in 2008, $426,354,000 in 2007 and $386,254,000 in 2006. This represented an increase of $37,192,000 in 2008 over 2007, or 8.7%, and an increase of $40,100,000 or 10.4% in 2007 compared to 2006. The cost of these liabilities decreased 72 basis points in 2008 compared to 2007, and increased 66 basis points in 2007 compared to 2006. The principal cost was in time deposits, which decreased 113 basis points in 2008 compared to 2007, and increased 78 basis points in 2007 compared to 2006.
Net Interest Income
Net interest income is the difference between interest yield generated by earning assets and the interest expense associated with the funding of those assets. Net interest income is affected by the interest rate earned or paid and by volume changes in loans, investment securities, deposits and borrowed funds.
TABLE 1
(1) Interest on non-accrual loans is recognized into income on a cash received basis.
(2) Amounts of interest earned included loan fees of $1,425,000, $1,593,000 and $1,445,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
(3) Tax equivalent adjustments recorded at the statutory rate of 34% that are included in the nontaxable securities portfolio are $481,000, $608,000 and $625,000 for the years ended December 31, 2008, 2007 and 2006, respectively, and were derived from nontaxable municipal interest income. Tax equivalent adjustments recorded at the statutory rate of 34% that are included in taxable securities portfolio were created by a dividends received deduction of $5,000, $0 and $19,000 in the years ended December 31, 2008, 2007 and 2006, respectively.
(4) Net interest margin is computed by dividing net interest income by total average interest earning assets.
The following table analyzes the dollar amount of change in interest income and expense and the changes in dollar amounts attributable to (a) changes in volume (changes in volume at the current year rate), (b) changes in rate (changes in rate times the prior year’s volume) and (c) changes in rate/volume (changes in rate times changes in volume). In this table, the dollar change in rate/volume is prorated to volume and rate proportionately.
TABLE 2
In 2008, net interest income represented 84.70% of net revenue (net interest income plus noninterest income) compared to 86.94% in 2007 and 81.39% in 2006. The net interest margin on average earning assets was 4.75% in 2008 compared to 5.05% in 2007 and 5.26% in 2006. The average rate earned on interest earning assets was 6.67% in 2008, up from 7.46% in 2007, and 7.14% in 2006. The average cost for interest-bearing liabilities was 2.48% in 2008 compared to 3.20% in 2007 and 2.54% in 2006.
As mentioned above under the heading “Earnings Analysis”, there were increases in the prime lending rate during 2006, followed by decreases from 8.25% at the end of 2006 to 7.25% at the end of 2007, and 3.25% at the end of 2008, as a result of action by the Federal Open Market Committee of the Federal Reserve, which affected interest-bearing assets and interest-bearing liabilities.
Yield on average loans was 7.14% in 2008, 8.14% in 2007 and 8.24% in 2006. Interest on average taxable securities was 4.22% in 2008, 5.05% in 2007, and 4.13% in 2006. Interest on average nontaxable securities was 4.77% in 2008, 3.63% in 2007 and 3.54% in 2006. Interest on average federal funds sold was 2.24% in 2008, 5.18% in 2007 and 4.94% in 2006. Interest on average total interest earning assets was 6.67% in 2008, 7.46% in 2007 and 7.14% in 2006. On the expense side, interest on average interest bearing demand deposits was 0.55% in 2008, 0.70% in 2007 and 0.54% in 2006. Interest on average money market accounts was 2.32% in 2008, 3.41% in 2007 and 2.86% in 2006. Interest on average savings accounts was 0.27% in 2008, 0.51% in 2007 and 0.49% in 2006. Interest on average time deposits was 3.28% in 2008, 4.41% in 2007 and 3.63% in 2006. Interest on average Federal Home Loan Bank advances was 4.18% in 2008, 5.24% in 2007 and 5.55% in 2006. Interest on federal funds purchased was 3.58% in 2008, 5.08% in 2007 and 5.77% in 2006. Interest on average total interest bearing liabilities was 2.48% in 2008, 3.20% in 2007 and 2.54% in 2006.
Allowance For Loan Losses
The Bank has the responsibility of assessing the overall risks in its loan portfolio, assessing the specific loss expectancy, and determining the adequacy of the loan loss reserve. The level of reserves is determined by internally generating credit quality ratings, reviewing economic conditions in the Bank’s market area, and considering the Bank’s historical loan loss experience. The Bank is committed to maintaining adequate reserves, identifying credit weaknesses by consistent review of loans, and maintaining the risk ratings and changing those risk ratings in a timely manner as circumstances change.
During 2006, the Bank transferred a portion of the allowance for loan losses to establish a reserve for unfunded loan commitments in a separate account in Other Liabilities. The Allowance for Loan Losses in Table 3 has been reclassified for prior years to agree with the current year presentation.
Real estate loans outstanding increased by $961,000 in 2008 compared to 2007. They increased by $33,395,000 in 2007 compared to 2006. The proportion of the Allowance for Loan Losses attributable to real estate loans was $4,712,000 in 2008 compared to $3,669,000 in 2007, and $3,864,000 in 2006. Real estate loans in 2008 remained nearly the same as in 2007, reflecting tighter underwriting standards that were imposed during 2008 coupled with the fact that there were fewer loans available that met those standards. We priced our loans competitively, but did not discount our loans in order to attract new business. The real estate loan growth in 2007 and 2006 was primarily the result of increased market penetration within our existing market area. The perceived risk in the Real Estate loan portfolio had decreased slightly in 2006 and 2007. The reserve allocated to these loans was increased in 2008, to mitigate the risk involved in the current markets. We experienced increased loan charge-offs and non accrual loans during 2008. The credit quality of our underlying collateral also deteriorated during 2008, necessitating an increased provision for loan losses.
The allowance for loan losses totaled $7,075,000, $5,638,000 and $5,002,000 at December 31, 2008, 2007, and 2006, respectively. This represented 1.40%, 1.14% and 1.18% of total loans outstanding on those dates. These balances reflect amounts that, in management’s judgment, are adequate to provide for probable loan losses based on the considerations listed above. During 2008, the provision for loan losses was $3,045,000, and the charge-offs were $1,788,000. During 2007, the provision for loan losses was $690,000, and the charge-offs were $80,000. In 2006, the provision for loan losses was $683,000, while charge-offs were $59,000.
TABLE 3
Table 4 summarizes transactions in the allowance for loan losses and details the charge-offs, recoveries and net loan losses by loan category for each of the last five fiscal years ended December 31, 2008. The amount added to the provision and charged to operating expenses for each period is based on the risk profile of the loan portfolio.
TABLE 4
The increase in charge-offs during 2008 is primarily related to problems related to specific borrowers rather than problems with a specific segment of the loan portfolio. In particular, borrowers who had exposure to real estate projects outside of San Mateo and San Francisco counties were identified as having a relatively higher risk profile than those operating solely in these two counties. If real estate values continue to decline in the future, an increase in our allowance for loan losses may be warranted.
Non-performing Assets.
Non-performing assets consist of nonaccrual loans, foreclosed assets, and loans that are 90 days or more past due but are still accruing interest. The accrual of interest on non-accrual loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. For the years ended December 31, 2008, 2007 and 2006, had non-accrual loans performed as agreed, approximately $692,000, $547,000, and $70,000, respectively, would have accrued in additional interest.
Table 5 provides a summary of contractually past due loans for the most recent five years. Nonperforming loans were 1.8% of total loans at December 31, 2008 compared to 2.4% of total loans at December 31, 2007. Nonperforming loans were 2.4% of total loans at December 31, 2007 compared to 0.6% of total loans at December 31, 2006. Management believes the current list of past due loans are collectible and does not anticipate significant losses. Nonperforming loans at December 31, 2008 include five Real Estate loans compared to four Real Estate loans at December 31, 2007. The one nonperforming Real Estate loan at the end of 2006 has since paid off.
TABLE 5
There was no commitment to lend additional funds to any customer whose loan was classified as nonperforming at December 31, 2008, 2007 or 2006.
Nonaccrual loans at December 31, 2008 consist of several single family residence loans and commercial loans as well as some commercial real estate loans. The Bank is working with our borrowers to develop strategies that can give the borrowers time to work through their financial difficulties. The other real estate owned consists of two single family residences and a land development parcel. The Bank is actively marketing these properties. However, given current market conditions, there can be no assurance that these properties can be sold in the near future.
Noninterest Income
The following table sets forth the principal components of noninterest income:
TABLE 6
Total noninterest income consists mainly of service charges on deposits. The increase in service charges on deposits in 2008 over 2007 is primarily attributable to an increase in non-sufficient-funds fees and ATM surcharge fees. The increased non-sufficient-funds fees are the result of increased liquidity problems that some of our deposit customers are facing, stemming from the current economic downturn. The increase in ATM surcharge fees is a function of increased demand for cash from our ATM machines by those who do not have a deposit relationship with the Bank. Noninterest income in 2008 included proceeds from a life insurance contract related to death benefits received from a policy that was placed on the life of an executive who is no longer working at the Bank. Noninterest income in 2006 included a gain on sale of other equity securities of $1,352,000 related to the sale of Pacific Coast Banker’s Bank stock and a gain of $756,000 on sale of other real estate owned in 2006. The principal source of Other Income was policy dividends on Officers’ Life Insurance, which was $404,000, $364,000, and $304,000 in the years 2008, 2007 and 2006, respectively, which reflected an increased investment in these policies.
Noninterest Expenses
The following table sets forth the various components of noninterest expense:
TABLE 7
Total noninterest expenses for the year ended December 31, 2008 were $25,344,000 compared to $23,182,000 and $21,760,000 for the years ended December 31, 2007 and 2006. Salaries and employee benefits were $14,335,000 in 2008, $12,778,000 in 2007, and $12,300,000 in 2006. Salaries and employee benefits represent over 50% of noninterest expense. They increased by 12.2% in 2008 over 2007 and 3.9% in 2007 over 2006. During the third quarter of 2008, a Call Center was established; there were also support staff increases in the loan area during 2008. In an effort to stem the increasing salaries and employee benefits costs, the company instituted a downsizing program, whereby eight staff positions were eliminated in the fourth quarter. In a further effort to reduce expenses, advertising expense decreased by $256,000 in 2008 compared to 2007. Within this category, efficiencies were achieved by decreasing advertising in the media, community and through advertising agencies, which decreased $185,000. Surety insurance increased $340,000 in 2008 over 2007. The principal item in this expense is FDIC insurance, which increased by $378,000, while the remaining items (Office of the Comptroller of the Currency assessment, Local Agency assessment and regular insurance) declined $38,000 net in the same period. Other expense, which includes numerous smaller accounts, increased $281,000 in 2008 over 2007. The principal increase was an Other Real Estate Owned write-down of $218,000. which is primarily related to a single family residence in San Jose, while the remaining thirty-seven expense categories increased a net $63,000. Other expense increased $611,000 in 2007 over 2006, due primarily to Low Income Housing investment expenses of $219,000. The remaining thirty-seven expense categories increased a net $392,000.
Balance Sheet Analysis
Total assets of the Company were $660,957,000, an increase of 2.6% over 2007. Total assets were $644,465,000 at December 31, 2007, an increase of 10.9% over 2006. Assets averaged $658.1 million in 2008, compared to $623.4 million in 2007 and $575.1 million in 2006. Average earning assets increased from $520.9 million in 2006 to $567.2 in 2007 and $598.4 million in 2008. Average earning assets represented 90.6% of total average assets in 2006, 91.0% in 2007 and 90.9% in 2008. Average interest-bearing liabilities were $386.3 million in 2006, $426.4 million in 2007 and $463.5 million in 2008.
Loans
The loan portfolio is the principal earning asset of the Bank. Loans outstanding at December 31, 2008 increased by $9.8 million or 2.0% over December 31, 2007. December 31, 2007 increased by $70.8 million or 16.7% over December 31, 2006.
Real estate loans increased by $1.0 million or 0.3% in 2008 compared to 2007, and they increased by $33.4 million or 10.5% in 2007 compared to 2006. Construction loans increased by $8.3 million or 14.4% in 2008 compared to 2007, and they increased by $20.3 million or 54.6% in 2007 compared to 2006. This increase occurred despite a tightening in our underwriting standards. Commercial loans increased by $1.2 million in 2008 or 1.5% compared to 2007, and increased by $16.1 million in 2007 or 24.3% compared to 2006. Consumer loans represent a nominal portion of total loans. They decreased by $0.5 million in 2008 or 13.6% compared to 2007, and they increased $0.4 million in 2007 or 10.9% compared to 2006.
Table 8 presents a detailed analysis of loans outstanding at December 31, 2004 through December 31, 2008.
TABLE 8
The following table shows the Bank’s loan maturities and sensitivities to changes in interest rates as of December 31, 2008.
TABLE 9
Investment Portfolio
Investments at December 31, 2008 were $99,221,000, an increase of $4,789,000 or 5.1% over December 31, 2007. At December 31, 2007, they were $94,432,000, a decrease of $513,000 or 0.5% from 2006.
Available funds are first used to fund Loans, purchase investments, pay down borrowings, or sold as Federal Funds. The Company’s primary source of funds is the deposit base. If more funds are needed, investment maturities, calls and sales from the Investment Portfolio may be used, which accounts for the volume variances in Investments year over year. The Bank’s investment portfolio is concentrated in debt securities of U. S. Government Agencies and in obligations of States and their political subdivisions. The Bank believes this provides for an appropriate liquidity level.
The following table sets forth the maturity distribution and interest rate sensitivity of investment securities at December 31, 2008:
TABLE 10
The following table shows the securities portfolio mix at December 31, 2008, 2007 and 2006.
Deposits
The increase in average earning assets in 2008 was funded by increases in average deposits and from increased Federal Home Loan Bank advances. During 2008, average deposits were $508,023,000, a decrease of $1,473,000, or 0.3% over 2007. During 2007, average deposits were $509,496,000, an increase of $18,916,000, or 3.9% over 2006. In 2008, average interest-bearing deposits were $389,239,000, an increase of $3,509,000, or 0.9% over 2007. In 2007, average interest-bearing deposits were $385,730,000, an increase of $17,107,000, or 4.6% over 2006. The prime lending rate rose from 5.25% at the beginning of 2005 to 7.25% at the end of 2005 and 8.25% at the end of 2006. The rate did not change again until September 18, 2007, when it dropped to 7.75%, followed by a decrease to 7.50% on October 31, 2007 and 7.25% on December 11, 2007. Time deposits lagged the prime rate changes because their rates changed only as certificates matured or new certificates were issued. Thus, interest-bearing demand costs averaged 0.3% in 2005, 0.5% in 2006 and 0.7% in 2007. Money market deposit costs averaged 2.9% in 2006, 3.4% in 2007 and 2.3% in 2008. Savings rates averaged 0.5% in 2006 and 2007 and 0.3% in 2008. Finally, average interest on time certificates of deposit of $100,000 or more was 4.0% in 2006, 4.9% in 2007 and 3.6% in 2008. On certificates under $100,000, average rates were 3.1% in 2006, 3.7% in 2007 and 2.8% in 2008.
The following table summarizes the distribution of average deposits and the average rates paid for them in the periods indicated:
TABLE 12
The following table indicates the maturity schedule of time deposits of $100,000 or more:
TABLE 13
Capital
At December 31, 2008, shareholders’ equity of the Company was $68,149,000 an increase of $1,604,000 or 2.4% over 2007; at December 31, 2007, shareholders’ equity of the Company was $66,545,000, an increase of $4,482,000 or 7.2% over 2006. The increases were primarily attributable to retention of net income after payment of cash dividends of $1,772,000 in 2008, $1,720,000 in 2007 and, $1,633,000 in 2006.
In 1989, the Federal Deposit Insurance Corporation (FDIC) established risk-based capital guidelines requiring banks to maintain certain ratios of “qualifying capital” to “risk-weighted assets”. Under the guidelines, qualifying capital is classified into two tiers, referred to as Tier 1 (core) and Tier 2 (supplementary) capital. Currently, the Company’s Tier 1 capital consists of common shareholders’ equity, though other instruments such as certain types of preferred stock can also be included in Tier 1 capital. Tier 2 capital consists of eligible reserves for possible loan losses and qualifying subordinated notes and debentures. Total capital is the sum of Tier 1 plus Tier 2 capital. Risk-weighted assets are calculated by applying risk percentages specified by the FDIC to categories of both balance sheet assets and off-balance sheet obligations. At year-end 1990, the FDIC also adopted a leverage ratio requirement. This ratio supplements the risk-based capital ratios and is defined as Tier 1 capital divided by quarterly average assets during the reporting period. This requirement established a minimum leverage ratio of 3.0% for the highest rated banks and ratios of 100 to 200 basis points higher for most other banks. Furthermore, in 1993, the FDIC began assessing risk-based deposit insurance assessments based on financial institutions’ capital resources and “management strength”, as mandated by the FDIC Improvement Act of 1991. To qualify for the lowest insurance premiums as indicated in the following table, “well-capitalized” financial institutions must maintain risk-based Tier 1 and total capital ratios of at least 6.0% and 10.0% respectively. “Well-capitalized” financial institutions must also maintain a leverage ratio equal to or exceeding 5.0%.
The following table shows the risk-based capital ratios and the leverage ratios at December 31, 2008, 2007 and 2006 for the Bank.
TABLE 14
Subsequent to December 31, 2008, the Company accepted a $12 million dollar investment in Preferred Shares issue to the U. S. Department of the Treasury. The funds were subsequently contributed to the Bank. If this capital investment had been received on December 31, 2008, the Bank’s risk-based capital ratios would have been as follows:
Liquidity
The Company’s primary source of liquidity on a stand-alone basis is dividends from the Bank. The payment of dividends by the Bank is subject to regulatory restrictions. Liquidity is a measure of the Company’s ability to convert assets into cash. Liquidity consists of cash and due from other banks accounts, including time deposits, federal funds sold, and Securities Available-for-Sale. The Company’s policy is to maintain a liquidity ratio of 5% or greater of total assets. As of December 31, 2008, the Company’s primary liquidity was 17.26%, compared to 17.10% in 2007 and 20.98% in 2006. Total Liquid Assets were $114,086,000 in 2008, $110,182,000 in 2007 and $121,967,000 in 2006. The objective of liquidity management is to ensure that the Company has funds available to meet all present and future financial obligations and to take advantage of business opportunities as they occur. Financial obligations arise from withdrawals of deposits, repayment on maturity of purchased funds, extension of loans or other forms of credit, payment of operating expenses and payments of dividends.
Core deposits, which consist of all deposits other than time deposits, have provided the Company with a sizable source of relatively stable low-cost funds. The Company’s average core deposits represented 61.8% of average total liabilities of $590,620,000 for the year ended December 31, 2008, 65.9% of average total liabilities of $559,097,000 for the year ended December 31, 2007 and 69.4% of average total liabilities of $516,155,000 for the year ended December 31, 2006.
As of December 31, 2008, the Company had contractual obligations and other commercial commitments totaling approximately $205,553,000. The following table sets forth the Company’s contractual obligations and other commercial commitments as of December 31, 2008. These obligations and commitments will be funded primarily by loan repayments and the Company’s liquidity sources, such as cash and due from other banks, federal funds sold, securities available for sale, as well as time deposits.
TABLE 15
The largest component of the Company’s earnings is net interest income, which can fluctuate widely when significant interest rate movements occur. The prime lending rate rose from 5.25% at the beginning of 2005 to 7.25% at the end of 2005 and 8.25% at the end of 2006. The rate decreased to 7.25% at the end of 2007, and to 3.25% at the end of 2008. The Company’s management is responsible for minimizing the Bank’s exposure to interest rate risk and assuring an adequate level of liquidity. This is accomplished by developing objectives, goals and strategies designed to enhance profitability and performance.
Ongoing management of the Company’s interest rate sensitivity in order to keep interest rate risk levels within acceptable limits. Management can adjust the Bank’s interest rate by controlling the mix and maturity of assets and liabilities. Management regularly reviews the Company’s position and evaluates alternative sources and uses of funds as well as changes in external factors. Various methods are used to achieve and maintain the desired rate sensitivity position including the sale or purchase of assets and product pricing.
In order to ensure that sufficient funds are available for loan growth and deposit withdrawals, as well as to provide for general needs, the Company must maintain an adequate level of liquidity. Asset liquidity comes from the Company’s ability to convert short-term investments into cash and from the maturity and repayment of loans and investment securities. Liability liquidity is provided by the Company’s ability to attract deposits and obtain short term credit through established borrowing lines. The primary source of liability liquidity is the Bank’s customer base, which provides core deposit growth. The overall liquidity position of the Company is closely monitored and evaluated regularly. The Company has federal fund borrowing facilities for a total of $40,000,000, a Federal Home Loan Bank line of credit of up to 30% of total assets, and a Federal Reserve Bank borrowing facility. Management believes the Company’s liquidity sources at December 31, 2008 are adequate to meet its operating needs in 2009 and into the foreseeable future. Subsequent to December 31, 2008, the Company received a $12,000,000 investment in Company Preferred Stock from the U. S. Department of the Treasury. This investment was then contributed to the Bank as an additional capital contribution. These funds are intended to fund loan workout programs and to bolster lending activity of the Bank.
Effect of Changing Prices
The results of operations and financial conditions presented in this report are based on historical cost information and are not adjusted for the effects of inflation.
Since the assets and liabilities of banks are primarily monetary in nature (payable in fixed, determinable amounts), the performance of the Company is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same.
The effect of inflation on banks is normally not as significant as its influence on those businesses that have large investments in plant and inventories. During periods of high inflation, there are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans and deposits. Also, increases in the price of goods and services will result in increased operating expenses.
The following table includes key ratios, including returns on average assets and equity.
TABLE 16
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Closely related to the concept of liquidity is the concept of interest rate sensitivity (i. e., the extent to which assets and liabilities are sensitive to changes in interest rates). Management uses an asset/liability model that considers the relative sensitivities of the balance sheet, including the effect of interest rate caps on adjustable rate mortgages and the relatively stable aspects of core deposits. As such, management can model a net interest income simulation that is designed to address the probability of interest rate changes and behavioral response of the balance sheet to those changes. Market value of portfolio equity represents the fair value of the net present value of assets, liabilities and off-balance sheet items. The starting point (or “base case”) for the following table is the Company’s net portfolio at December 31, 2008, using current discount rates, and an estimate of net interest income for 2009 assuming that both interest rates and the Company’s interest-sensitive assets and liabilities remain at December 31, 2008 levels. The “rate shock” information in the table shows estimates of net portfolio value at December 31, 2008 and net interest income for 2009 assuming fluctuations or “rate shocks” of minus 100 and 200 basis points and plus 100 and 200 basis points. Rate shocks assume that current interest rates change immediately. The information set forth in the following table is based on significant estimates and assumptions, and constitutes a forward-looking statement within the meaning of that term set forth in Rule 175 under the Securities Act of 1933 and Rule 3b-6(c) of the Securities Exchange Act of 1934.
TABLE 17
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets, December 31, 2008 and
Consolidated Statements of Earnings for the years ended December 31, 2008, 2007 and 2006
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2008, 2007 and 2006
Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
FNB Bancorp and Subsidiary
We have audited the accompanying consolidated balance sheets of FNB Bancorp and subsidiary, (the Company) as of December 31, 2008 and 2007 and the related statements of earnings, changes in stockholders’ equity and comprehensive income and cash flows for each of the years in the three year period ended December 31, 2008. We have also audited FNB Bancorp’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). FNB Bancorp’s management is responsible for these financial statements, 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 effectiveness of the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits 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, 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 opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made 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 the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of FNB Bancorp and subsidiary as of December 31, 2008 and 2007 and the results of its operations and cash flows for each of the three years in the three year period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion FNB Bancorp maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the COSO.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2008, the Company adopted Statement of Financial Accounting Standard No. 157, “Fair Value Measurements.”
/s/ Moss Adams, LLP
Stockton, California
March 13, 2009
FNB BANCORP AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 2008 and 2007
See accompanying notes to consolidated financial statements.
FNB BANCORP AND SUBSIDIARY
Consolidated Statements of Earnings
Years ended December 31, 2008, 2007 and 2006
See accompanying notes to consolidated financial statements.
FNB BANCORP AND SUBSIDIARY
Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Income
Years ended December 31, 2008, 2007 and 2006
See accompanying notes to consolidated financial statements.
FNB BANCORP AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 2008, 2007 and 2006
See accompanying notes to consolidated financial statements.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(1)
The Company and Summary of Significant Accounting Policies
FNB Bancorp (the “Company”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was incorporated under the laws of the State of California on February 28, 2001. The consolidated financial statements include the accounts of FNB Bancorp and its wholly owned subsidiary, First National Bank of Northern California (the Bank). The Bank provides traditional banking services in San Mateo and San Francisco counties.
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenue and expenses during the reporting period. Actual results could differ from those estimates. For the Bank, the significant accounting estimate is the allowance for loan losses (note 1f). A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows.
(a)
Basis of Presentation
The accounting and reporting policies of the Company and its wholly owned subsidiary are in accordance with accounting principles generally accepted in the United States of America. All intercompany balances and transactions have been eliminated.
(b)
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are sold for one-day periods. The cash equivalents are readily convertible to known amounts of cash and present insignificant risk of changes in value due to original maturity dates of 90 days or less. Included in cash and cash equivalents are amounts restricted for the Federal Reserve requirement of approximately $3,046,000 and $791,000 at December 31, 2008 and 2007, respectively.
(c)
Investment Securities
Investment securities consist of U.S. Treasury securities, U.S. agency securities, obligations of states and political subdivisions, obligations of U.S. corporations, mortgage-backed securities and other securities. At the time of purchase of a security, the Company designates the security as held-to-maturity or available-for-sale, based on its investment objectives, operational needs, and intent to hold. The Company does not purchase securities with the intent to engage in trading activity. Held to maturity securities are recorded at amortized cost, adjusted for amortization of premiums or accretion of discounts. The Company did not have any investments in the held-to-maturity portfolio at December 31, 2008 or 2007. Securities available-for-sale are recorded at fair value with unrealized holding gains or losses, net of the related tax effect, reported as a separate component of stockholders’ equity until realized. A decline in the market value of any security available-for-sale or held-to-maturity below cost that is deemed other than temporary results in a charge to earnings and the corresponding establishment of a new cost basis for the security. Amortization of premiums and accretion of discounts on debt securities are included in interest income over the life of the related security held-to-maturity or available-for-sale using the effective interest method. Dividend and interest income are recognized when earned. Realized gains and losses for securities classified as available-for-sale and held-to-maturity are included in earnings and are derived using the specific identification method for determining the cost of securities sold.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(d)
Derivatives
All derivatives contracts are recognized as either assets or liabilities in the balance sheet and measured at fair value. The Company did not hold any derivative contracts at December 31, 2008 and 2007.
(e)
Loans
Loans are reported at the principal amount outstanding, net of deferred loan fees and the allowance for loan losses. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. For a loan that has been restructured, the contractual terms of the loan agreement refer to the contractual terms specified by the original loan agreement, not the contractual terms specified by the restructuring agreement. An impaired loan is measured based upon the present value of future cash flows discounted at the loan’s effective rate, the loan’s observable market price, or the fair value of collateral if the loan is collateral dependent. Interest on impaired loans is recognized on a cash basis. If the measurement of the impaired loan is less than the recorded investment in the loan, an impairment is recognized by a charge to the allowance for loan losses. An unearned discount on installment loans is recognized as income over the terms of the loans by the interest method. Interest on other loans is calculated by using the simple interest method on the daily balance of the principal amount outstanding.
Loan fees net of certain direct costs of origination, which represent an adjustment to interest yield, are deferred and amortized over the contractual term of the loan using the interest method.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Accrual of interest on loans is discontinued either when reasonable doubt exists as to the full and timely collection of interest or principal when a loan becomes contractually past due by 90 days or more with respect to interest or principal. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest. Restructured loans are loans on which concessions in terms have been granted because of the borrowers’ financial difficulties. Interest is generally accrued on such loans in accordance with the new terms. Net interest written off in 2008 was $692,000 (see Allowance for Loan Losses discussed in the Management Discussion and Analysis section).
(f)
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged off against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb probable losses inherent in existing loans, standby letters of credit, overdrafts, and commitments to extend credit based on evaluations of collectibility and prior loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, loan concentrations, specific problem loans and current and anticipated economic conditions that may affect the borrowers’ ability to pay. While management uses these evaluations to determine the level of the allowance for loan losses, future provisions may be necessary based on changes in the factors used in the evaluations. Material estimates relating to the determination of the allowance for loan losses are particularly susceptible to significant change in the near term. Management believes that the allowance for loan losses is adequate as of December 31, 2008. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, and our borrowers ability to pay. In addition, the banking regulators, as an integral part of its examination process, periodically review the Bank’s allowance for loan losses. The banking regulators may require the Bank to recognize additions to the allowance based on their judgment about information available to them at the time of their examination.
(g)
Premises and Equipment
Premises and equipment are reported at cost less accumulated depreciation using the straight-line method over the estimated service lives of related assets ranging from 3 to 50 years original life. Leasehold improvements are amortized over the estimated lives of the respective leases or the service lives of the improvements, whichever is shorter.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(h)
Cash Dividends
The Company’s ability to pay cash dividends is subject to restrictions set forth in the California General Corporation Law. Funds for payment of any cash dividends by the Company would be obtained from its investments as well as dividends and/or management fees from First National Bank. First National Bank’s ability to pay cash dividends is subject to restrictions imposed under the National Bank Act and regulations promulgated by the Office of the Comptroller of the Currency.
(i)
Stock Dividend
On October 24, 2008, the Company announced that its Board of Directors had declared a five percent (5%) stock dividend resulting in approximately 145,310 shares, payable at the rate of one share of Common Stock for every twenty (20) shares of Common Stock owned. The stock dividend was paid on December 15, 2008, to shareholders of record on November 28, 2008. The earnings per share data for all periods presented has been adjusted for this stock dividend.
(j)
Income Taxes
Deferred income taxes are determined using the assets and liabilities method. Under this method, the net deferred tax asset or liability is recognized for tax consequences of temporary differences by applying current tax rates to differences between the financial reporting and the tax basis of existing assets and liabilities. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. A valuation allowance is established through the provision for income taxes for any deferred tax assets where the collectibility of the asset is in doubt. During 2008, the Company recorded a tax valuation of $368,000. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Accounting for Income Tax Uncertainties
The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. The Company had no unrecognized tax benefits which would require adjustment to the January 1, 2007 beginning balance of retained earnings. The Company had unrecognized tax benefits of $37,500 at December 31, 2008.
The Company recognizes interest accrued and penalties related to unrecognized tax benefits in tax expense. During the years ended December 31, 2008 and 2007 the Company believes that any penalties and interest penalties that may exist are not material and have not been accrued for.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(k)
Earnings per Share
Basic earnings per share is computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share reflects potential dilution from outstanding stock options, using the treasury stock method. There were 305,258 and 44,290 antidilutive shares in the years ended December 31, 2008 and 2007, respectively. There were no antidilutive shares in the year ended December 31, 2006.
For each of the years presented, net income is the same for basic and diluted earnings per share. Reconciliation of weighted average shares used in computing basic and diluted earnings per share is as follows:
(l)
Stock Option Plans
Effective January 1, 2006, the Company adopted SFAS No. 123(R) “Share-Based Payment”. Measurement of the cost of stock options granted is based on the grant-date fair value of each stock option granted using the Black-Scholes valuation model. The cost is then amortized to expense on a straight-line basis over each option’s vesting period. The amortized expense of the stock option’s fair value has been included in salaries and employee benefits expense for the three years ended December 31, 2008, 2007 and 2006. The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U. S. Treasury yield curve in effect at the time of the grant. FNB Bancorp stock has limited liquidity and limited trading activity. Volatility was calculated using historical price changes on a monthly basis over the expected life of the option.
(m)
Fair Values of Financial Instruments
Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements,” which requires enhanced disclosures about financial instruments carried at fair value. SFAS No. 157 establishes a disclosure framework that quantifies fair value estimates by the level of pricing precision. The degree of judgment utilized in measuring the fair value of assets generally correlates to the level of pricing precision. Financial instruments rarely traded or not quoted will generally have a higher degree of judgment utilized in measuring fair value. Pricing precision is impacted by a number of factors including the type of asset, the availability of the asset, the market demand for the asset, and other conditions that were considered at the time of the valuation. See “Fair Value Measurements” for additional information about the level of pricing transparency associated with the financial instruments carried at fair value.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
Fair Value Measurement. The following tables present information about the Company’s assets and liabilities measured at fair value as of December 31, 2008, and indicates the fair value techniques used by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
The following table presents the recorded amounts of assets measured at fair value on a recurring basis:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
The following methods were used to estimate the fair value of each class of financial instrument above:
Available-for-sale-Securities. Fair values established for available-for-sale investment securities are based on estimates of fair values quoted for similar types of securities with similar maturities, risk and yield characteristics.
The following table presents the recorded amount of assets measured at fair value on a non-recurring basis:
Impaired Loans. The Bank does not record loans at fair value. However, from time to time, if a loan is considered impaired, and a specific allowance for loan losses is established, loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement, are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” In accordance with SFAS No. 157, impaired loans where a specific allowance is established based on the fair value of collateral require classification in the fair value hierarchy. If the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loans as nonrecurring Level 2. When an appraised value is not available, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank records the impaired loans as nonrecurring Level 3. Specific reserves of $678,000 have been established for impaired loans as of December 31, 2008.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(n)
Income Tax Credits
At December 31, 2008, the Bank had a $2,529,000 equity investment in three partnerships, which own low-income affordable housing projects that generate tax benefits in the form of federal and state housing tax credits. As a limited partner investor in these partnerships, the Company receives tax benefits in the form of tax deductions from partnership operating losses and federal and state income tax credits. The federal and state income tax credits are earned over a 10-year period as a result of the investment properties meeting certain criteria and are subject to recapture for noncompliance with such criteria over a 15-year period. The expected benefit resulting from the low-income housing tax credits is recognized in the period for which the tax benefit is recognized in the Company’s consolidated tax returns. These investments are accounted for using the effective yield method and are recorded in other assets on the balance sheet. Under the effective yield method, the Company recognizes tax credits as they are allocated and amortizes the initial cost of the investments to provide a constant effective yield over the period that tax credits are allocated to the Company. The effective yield is the internal rate of return on the investment, based on the cost of the investment and the tax credits allocated to the Company. The expected residual value of the investment is zero and therefore was excluded from the effective yield calculation. Cash received from operations of the limited partnership or sale of the properties, if any, will be included in earnings when realized.
(o)
Reclassifications
Certain prior year information has been reclassified to conform to current year presentation. The reclassifications had no impact on net income or retained earnings.
(p)
Bank Owned Life Insurance
The Company purchased insurance on the lives of certain executives. The policies accumulate asset values to meet future liabilities including the payment of employee benefits such as the deferred compensation plan. Increases in the cash surrender value are recorded as other noninterest income in the consolidated statements of income. The cash surrender value of bank owned life insurance is reflected in other assets on the consolidated balance sheets in the amount of $10,781,000 and $9,617,000 at December 31, 2008 and 2007, respectively. During 2008, the Company realized $760,000 in death benefits from a life insurance contract covering a former executive of the Company.
(q)
Federal Home Loan Bank Borrowings
The Bank maintains a collateralized line of credit with the Federal Home Loan Bank (“FHLB”) of San Francisco. Under this line, the Bank may borrow on a short term or a long term (over one year) basis. FHLB advances are recorded and carried at their historical cost. FHLB advances are not transferable and may contain prepayment penalties. In addition to the collateral pledged, the Company is required to hold prescribed amounts of FHLB stock that vary with the usage of FHLB credits.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(r)
Recently Issued Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement No. 159 The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115. Statement No. 159 establishes a fair value option that allows an entity to designate individual financial assets and liabilities as fair value option instruments. Under the fair value option, the change in unrealized gains and losses created by the change in fair value of financial instruments shall be reported in an entity’s earnings for each reporting period. Additional disclosures regarding fair value for financial assets and liabilities accounting for under the fair value option are also required. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company did not elect the fair value option for any of its financial assets or liabilities and therefore the adoption did not have a material effect.
In December 2007, the Financial Accounting Standards Board (“FASB”) announced that it had revised Statement 141, Business Combinations, with 141(R). The revised Statement No. 141 was written to improve the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. This Statement establishes principles and requirements for how the acquirer:
a)
Recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree
b)
Recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase
c)
Determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination
This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company does not expect this Standard to have a material effect on the Company’s financial statements.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement No. 160, “Noncontrolling Interest in Consolidated Financial Statements - an amendment of ARB No. 51.” Statement No. 160 clarifies reporting and disclosure requirements related to noncontrolling interest included in an entity’s consolidated financial statements. This Statement clarifies that noncontrolling interests are to be reported in the noncontrolling section of the balance sheet and requires net income to include amounts from both the parent and the noncontrolling interest. This Statement also requires the parent company to recognize a gain or loss in net income when a subsidiary is deconsolidated. This Statement is effective for fiscal years (and interim periods within those years), beginning on or after December 15, 2008. The Company will apply this Statement prospectively and does not expect the Statement to have a material impact on the Company’s financial statements.
(2)
Restricted Cash Balance
Cash and due from banks includes balances with the Federal Reserve Bank (the FRB). The Bank is required to maintain specified minimum average balances with the FRB, based primarily upon the Bank’s deposit balances. As of December 31, 2008 and 2007, the Bank maintained deposits in excess of the FRB reserve requirement.
(3)
Securities Available-for-Sale
The amortized cost and carrying values of securities available-for-sale are as follows:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
An analysis of gross unrealized losses of the available for sale investment securities portfolio as of December 31, 2008 and December 31, 2007 follows.
At December 31, 2008, there were no securities in an unrealized loss position for greater than 12 consecutive months. Management periodically evaluates each security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary. Management has determined that no investment security is other-than-temporarily impaired at December 31, 2008. The unrealized losses are due solely to interest rate changes and the Company has the ability and intent to hold all investment securities with identified impairments resulting from interest rate changes to the earliest of forecasted recovery or the maturity of the underlying investment security.
The amortized cost and carrying value of debt securities as of December 31, 2008, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
For the years ended December 31, 2008, 2007 and 2006, gross realized gains amounted to $205,000, $4,000 and $185,000, respectively. For the years ended December 31, 2008, 2007 and 2006, gross realized losses amounted to $495,000, $0 and $196,000, respectively.
At December 31, 2008 and 2007, securities with an amortized cost of $91,456,000 and $83,874,000, and fair value of $93,635,000 and $84,505,000, respectively, were pledged as collateral for public deposits and for other purposes required by law.
As of December 31, 2008 and 2007, the Bank had investments in Federal Reserve Bank stock classified as other assets in the accompanying balance sheets of $702,000. These investments in Federal Reserve Bank stock are carried at cost, and evaluated periodically for impairment.
(4)
Loans, Net
Loans are summarized as follows at December 31:
The Bank had total impaired loans of $14,118,000 and $12,158,000 at December 31, 2008 and 2007, respectively. The allowance for loan losses related to the impaired loans was $678,000 and $707,000 as of December 31, 2008 and 2007, respectively. The amount of the recorded investment in impaired loans for which there is no related allowance is $2,558,000 and $11,451,000 as of December 31, 2007 and 2006. The average recorded investment in impaired loans during 2008, 2007 and 2006 was $12,193,000, $6,036,000 and $610,000, respectively. Interest income on impaired loans of $64,000, $69,000 and $3,000 was recognized for cash payments received in 2008, 2007, and 2006, respectively. The amount of interest on impaired loans not collected in 2008, 2007 and 2006, was $692,000, $547,000 and $70,000, respectively. The cumulative amount of unpaid interest on impaired loans was $1,022,000, $547,000 and $70,000 at December 31, 2008, 2007 and 2006, respectively.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(5)
Allowance for Loan Losses
Changes in the allowance for loan losses are summarized as follows for the years ended December 31:
(6)
Related Party Transactions
In the ordinary course of business, the Bank made loans and advances under lines of credit to directors, officers, and their related interests. The Bank’s policies require that all such loans be made at substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties and do not involve more than normal risk or unfavorable features. The following summarizes activities of loans to such parties in 2008 and 2007:
(7)
Bank Premises, Equipment, and Leasehold Improvements
Bank premises, equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization, and are summarized as follows at December 31:
Depreciation expense for the years ended December 31, 2008, 2007, and 2006 was $1,597,000, $1,270,000, and $1,183,000, respectively.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(8)
Deposits
The aggregate amount of jumbo time certificates, each with a minimum denomination of $100,000 or more, was $90,176,000 and $81,169,000 at December 31, 2008 and 2007, respectively.
At December 31, 2008, the scheduled maturities of all time certificates of deposit are as follows:
(9)
Federal Home Loan Bank Advances
As of December 31, 2008, Federal Home Loan Bank (“FHLB”) advances consisted of $81,100,000 in short-term advances due in one year or less, and $5,000,000 in long-term advances due in two years. The interest rate on total advances ranged from 0.05% to 5.57% at year end December 31, 2008. As of December 31, 2007, the short-term advances consisted of $36,000,000 due in one year or less, and in $30,000,000 in long-term advances due in over one to three years. The interest rate on total advances ranged from 3.82% to 5.57% at year end December 31, 2007. Average FHLB advances were $73,777,000 and $39,482,000 in 2008 and 2007, respectively. Weighted average rates were 4.18% and 5.24% in 2008 and 2007, respectively. The maximum amount borrowed during 2008 and 2007 was $93,200,000 and $66,000,000, respectively. At December 31, 2008, the Bank had a maximum borrowing capacity under Federal Home Loan Bank advances of $134,112,000, of which $48,012,000 was available. The Federal Home Loan Bank advances are secured by a blanket collateral agreement by a pledge of FHLB stock and certain other qualifying collateral, such as commercial and mortgage loans.
(10)
Commitments and Contingencies
The Bank leases a portion of its facilities and equipment under noncancelable operating leases expiring at various dates through 2013. Some of these leases provide that the Bank pay taxes, maintenance, insurance, and other occupancy expenses applicable to leased premises. Generally, the leases provide for renewal for various periods at stipulated rates.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
The minimum rental commitments under the operating leases as of December 31, 2008 are as follows:
Total rent expense for operating leases was $630,000, $591,000 and $554,000, in 2008, 2007, and 2006, respectively.
The Bank is engaged in various lawsuits either as plaintiff or defendant in the ordinary course of business and, in the opinion of management, based upon the advice of counsel, the ultimate outcome of these lawsuits will not have a material effect on the Bank’s financial statements.
(11)
Bank Savings Plan
The Bank maintains a salary deferral 401(k) plan covering substantially all employees, known as the First National Bank Savings Plan (the “Plan”). The Plan allows employees to make contributions to the Plan up to a maximum allowed by law and the Bank’s contribution is discretionary. Beginning in 2008, the Board approved a safe harbor election related to the Plan which requires the Company to contribute 3% of qualifying employees wages as a profit sharing contribution. The Bank’s contribution to the Plan for the years ended December 31, 2008, 2007, and 2006 was $400,000, $600,000 and $602,000, respectively.
(12)
Salary Continuation and Deferred Compensation Plans
The Bank maintains a Salary Continuation Plan for certain Bank officers. Officers participating in the Salary Continuation Plan are entitled to receive a monthly payment for a period of fifteen to twenty years upon retirement. The Company accrues such post-retirement benefits over the individual’s employment period. The Salary Continuation Plan expense for the years ended December 31, 2008, 2007, and 2006 was $238,000, $181,000 and $239,000, respectively. Accrued compensation payable under the salary continuation plan totaled $1,833,000 and $2,010,000 at December 31, 2008 and 2007, respectively.
The Deferred Compensation Plan allows eligible officers to defer annually their compensation up to a maximum 80% of their base salary and 100% of their cash bonus. The officer will be entitled to receive distribution upon reaching a specified age, passage of at least five years or termination of employment. As of December 31, 2008 and 2007, the related liability included in accrued expenses and other liabilities was $848,000 and $1,715,000, respectively. The decrease in 2008 was due to withdrawals by employees in the Plan.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(13)
Income Taxes
The provision for income taxes for the years ended December 31, consists of the following:
The reason for the differences between the statutory federal income tax rate and the effective tax rates for the years ending December 31, are summarized as follows:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
The tax effect of temporary differences giving rise to the Bank’s net deferred tax asset is as follows:
As of December 31, 2008, the Bank had no state tax credit carryforwards for income tax purposes as these were all used during 2005. Accordingly, there is no valuation allowance related to these credits as of December 31, 2008 or 2007. Additionally, management believes that it is more likely than not that the deferred tax assets will be realized through recovery of taxes previously paid and/or future taxable income, with the exception of a portion of low income housing credit carryforwards. The Bank has federal net operating loss carryforwards resulting from the acquisition of Sequoia National Bank which expire from December 31, 2011 through December 31, 2020, for a total balance of $2,609,000 as of December 31, 2008. These losses are limited to approximately $469,000 per year under IRS regulations.
In assessing the Company’s ability to realize the tax benefits of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the recorded benefits of these deductible differences, with the possible exception of our low income housing tax credit carryforwards. In the opinion of management, a valuation allowance of $368,000 was necessary as of December 31, 2008. This valuation allowance only became necessary during 2008, and is equivalent to 100% of the low income housing credit carryforwards that existed as of December 31, 2008. There was no tax valuation allowance in 2007 or 2006.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(14)
Financial Instruments
The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the balance sheet.
The Bank’s exposure to credit loss is represented by the contractual amount of those instruments and is usually limited to amounts funded or drawn. The contract or notional amounts of these agreements, which are not included in the balance sheets, are an indicator of the Bank’s credit exposure. Commitments to extend credit generally carry variable interest rates and are subject to the same credit standards used in the lending process for on-balance-sheet instruments. Additionally, the Bank periodically reassesses the customer’s creditworthiness through ongoing credit reviews. The Bank generally requires collateral or other security to support commitments to extend credit. The following table provides summary information on financial institutions whose contract amounts represent credit risk as of December 31:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial and residential properties.
Equity reserve and unused credit card lines are additional commitments to extend credit. Many of these customers are not expected to draw down their total lines of credit, and therefore, the total contract amount of these lines does not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank issues both financial and performance standby letters of credit. The financial standby letters of credit are primarily to guarantee payment to third parties. As of December 31, 2008, there were $1,841,000 issued in financial standby letters of credit. The performance standby letters of credit are typically issued to municipalities as specific performance bonds. As of December 31, 2008 there were $902,000 issued in performance standby letters of credit. The terms of the guarantees will expire in 2009.
The Bank has experienced no draws on these letters of credit, and does not expect to in the future; however, should a triggering event occur, the Bank either has collateral in excess of the letters of credit or embedded agreements of recourse from the customer.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
The following table provides summary information on the estimated fair value of financial instruments at December 31, 2008:
The following table provides summary information on the estimated fair value of financial instruments at December 31, 2007:
The carrying amounts of loans include $14,118,000 and $11,465,000 of nonaccrual loans (loans that are not accruing interest) at December 31, 2008 and 2007, respectively. Management has determined that primarily because of the uncertainty of predicting an observable market interest rate, excessive amounts of time and money would be incurred to estimate the fair values of nonperforming loans. As such, these loans are recorded at their carrying amount in the estimated fair value columns.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
The following aggregate information is provided at December 31, about the contractual provisions of these loans:
(15)
Significant Group Concentrations of Credit Risk
Most of the Bank’s business activity is with customers located within San Mateo and San Francisco counties. Generally, the loans are secured by assets of the borrowers. The loans are expected to be repaid from cash flows or proceeds from the sale of selected assets of the borrowers. The Bank does not have significant concentrations of loans to any one industry.
The distribution of commitments to extend credit approximates the distribution of loans outstanding. Commercial and standby letters of credit were granted primarily to commercial borrowers. The contractual amounts of credit-related financial instruments such as commitments to extend credit, credit-card arrangements, and letters of credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer default, and the value of any existing collateral become worthless.
(16)
Regulatory matters
The Company, as a bank holding company, is subject to regulation by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended. The Bank is 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 financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities and certain off balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) 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, 2008, that the Company and the Bank have met all regulatory capital requirements.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
As of December 31, 2008, the most recent notification from the regulatory agencies categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s categories.
The consolidated actual capital amounts and ratios of FNB Bancorp and Subsidiary are also presented in the following table:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(17)
Stock Option Plans
In 1997, the Company adopted an incentive employee stock option plan, known as the 1997 FNB Bancorp Plan. In 2002, the Company adopted an incentive employee option plan known as the 2002 FNB Bancorp Plan. In 2008, the Company adopted an incentive employee stock option plan known as the 2008 FNB Bancorp Stock Option Plan. The Plans allow the Company as of December 31, 2008 to grant options to employees covering 378,600 shares. Incentive stock options currently outstanding become exercisable in one to five years from the grant date, based on a vesting schedule of 20% per year and expire 10 years after the grant date. Nonqualified options to directors become vested on the date of grant. The options exercise price is the fair value of the per share price of the underlying stock options at the grant date.
The amount of compensation expense for options recorded in the years ended December 31, 2008, December 31, 2007, and December 31 2006 was $171,000, $68,000 and $39,000, respectively. The income tax benefit related to stock option exercises was $14,000 for 2008, under $3,000 for 2007 and under $1,000 for 2006.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
There were no options exercised during the year ended December 31, 2008 under the 2008 Stock Option Plan. The intrinsic value of options exercised during 2008 was $37,000 under the 1997 Plan.
The total intrinsic value of options exercised during the year ended December 31, 2007 was $158,000 which includes $62,000 under the 2002 Plan and $96,000 under the 1997 Plan.
The total intrinsic value of options exercised during the year ended December 31, 2006 was $263,000 which includes $60,000 under the 2002 Plan and $203,000 under the 1997 Plan.
The amount of total unrecognized compensation expense related to non-vested options at December 31, 2008 was $420,000, and the weighted average period it will be amortized over is 2.5 years.
The fair value of each option granted is estimated on the date of grant using the fair value method with the following weighted average assumptions used for grants in 2008; dividend yield of 4.86% for the year; risk-free interest rate of 3.51%; expected volatility of 50.92%; expected life of 8.8 years; and weighted average fair value of $4.22 per share. The assumptions for grants in 2007; dividend yield of 1.97% for the year; risk-free interest rate of 5.11%; expected volatility of 11.32%; expected life of 6.4 years; and weighted average fair value of $5.82 per share. The assumptions for grants in 2006; dividend yield of 6.66% for the year; risk-free interest rate of 5.19%; expected volatility of 10%; expected life of 6.5 years; and weighted average fair value of $1.50 per share.
A summary of option activity under the 2008 FNB Bancorp Plan as of December 31, 2008 and changes during the year then ended is presented below.
FNB Bancorp Plan
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
A summary of option activity under the 2002 FNB Bancorp Plan as of December 31, 2008 and changes during the year then ended is presented below.
FNB Bancorp Plan
The following supplemental information applies to the three years ended December 31:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
A summary of option activity under the 1997 FNB Bancorp Plan as of December 31, 2008, and changes during the year then ended is presented below.
First National Bank Plan
The following supplemental information applies to the three years ended December 31:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(18)
Quarterly Data (Unaudited)
There may be rounding differences between the sum of the four quarters presented and the annual amounts used throughout the annual report.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(19)
Condensed Financial Information of Parent Company
The parent company-only condensed balance sheets, condensed statements of income, and condensed statements of cash flows information are presented as of and for the year ended December 31, as follows:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2008, 2007 and 2006
(20)
Subsequent Event
The Company decided to participate in the U. S. Treasury Department Capital Purchase Program. The additional funds will be used to increase the Company’s lending capability in the midst of the current recessionary environment. It will also act as a cushion for future capital adequacy, should the economy continue to deteriorate and adversely affect its borrowers ability to repay their loans.
The Company completed a $12,000,000 capital transaction with the U. S. Department of the Treasury through their Capital Purchase Program. The transaction was completed on Friday, February 27, 2009. As a condition of the transaction, the Company issued the Treasury Department 12,000 shares of senior preferred stock with a 5% stated coupon for 5 years, which would become 9% if not repaid in five years. The shares have a liquidation value of $1,000 per share and must be redeemed after ten years. In addition, the Company issued a warrant to purchase 600 shares of warrant preferred stock with a 9% stated coupon with a liquidation value of $1,000 per share, and a purchase price of $0.01 per share. The Treasury purchased these shares immediately as part of the transaction.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. Disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in reports filed by the Company under the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Evaluation of Disclosure Controls and Procedures and Internal Control over Financial Reporting. The Company’s management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2008. Based on this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 2008 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting. Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Rule 13a-15(f) under the Exchange Act, internal control over financial reporting is a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board of directors, management and other personnel, 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. It includes those policies and procedures that:
a)
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of a company;
b)
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 a company are being made only in accordance with authorizations of management and the board of directors of the company, and
c)
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of a company’s assets that could have a material effect on its financial statements.
Because of the 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.
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. Management has selected the COSO framework for its evaluation as it is a control framework recognized by the SEC and the Public Company Accounting Oversight Board, that is free from bias, permits reasonably consistent qualitative and quantitative measurement of the Company’s internal controls, is sufficiently complete so that relevant controls are not omitted and is relevant to an evaluation of internal controls over financial reporting.
Based on our assessment, management has concluded that our internal control over financial reporting, based on criteria established in “Internal Control-Integrated Framework” issued by COSO was effective as of December 31, 2008.
Moss Adams LLP, the registered public accounting firm that audited the consolidated financial statements included in this Annual Report under Item 8, “Financial Statements and Supplementary Data,” has issued a report with respect to the effectiveness of the Company’s internal control over financial reporting. This report appears as part of the Report of Independent Registered Public Accounting Firm under said Item 8 of this Annual Report and is incorporated here by reference.
Date: March 13, 2009
/s/ Thomas C. Mc Graw
/s/ David A. Curtis
Thomas C. Mc Graw
David A. Curtis
Chief Executive Officer
Chief Financial Officer
Inherent Limitations on Effectiveness of Controls
The Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 of Form 10-K is incorporated by reference to the applicable information contained in the Company’s Proxy Statement for the 2009 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by reference to the applicable information contained in the Company’s Proxy Statement for the 2009 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information required by Item 12 of Form 10-K is incorporated by reference to the applicable information contained in the Company’s Proxy Statement for the 2009 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 13 of Form 10-K is incorporated by reference to the applicable information contained in the Company’s Proxy Statement for the 2009 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 14 of Form 10-K is incorporated by reference to the applicable information contained in the Company’s Proxy Statement for the 2009 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES
(a)(1)
Financial Statements. Listed and included in Part II, Item 8.
(2)
Financial Statement Schedules. All schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Financial Statements or notes thereto.
(3)
Exhibits.
Exhibit
Number
Document Description
**2.1
(deleted)
2.2
Acquisition Agreement dated November 5, 2004, signed among First National Bank of Northern California, Sequoia National Bank and Hemisphere National Bank (incorporated by reference from Exhibit 2.2 to the Company’s Current Report on Form 8-K filed with the Commission on November 9, 2004).
2.3
First Addendum to Acquisition Agreement, dated December 13, 2004, signed among First National Bank of Northern California, Sequoia National Bank, Hemisphere National Bank and Privee Financial, Inc. (incorporated by reference from Exhibit 2.5 to the Company’s Current Report on Form 8-K filed with the Commission on December 17, 2004)
2.4
Second Addendum to Acquisition Agreement. Dated as of April 15, 2005, signed among First National Bank Of Northern California, Sequoia National Bank, Hemisphere National Bank and Privee Financial, Inc. (incorporated by reference from Exhibit 2.4 to the Company’s Current Report on Form 8-K filed with the Commission on May 2, 2005)
**3.1
Articles of Incorporation of FNB Bancorp
3.2
Certificate of Determination of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), of FNB Bancorp (incorporated by reference from Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
3.3
Certificate of Determination of Fixed Rate Cumulative Perpetual Preferred Stock, Series B (“Series B Preferred Stock”), of FNB Bancorp (incorporated by reference from Exhibit 3.2 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
3.4
Bylaws of FNB Bancorp (as amended through February 27, 2009).
**4.1
Specimen of the Registrant’s common stock certificate.
4.2
Form of Certificate for the Series A Preferred Stock (incorporated by reference from Exhibit 4.1 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
4.3
Warrant for Purchase of Shares of Series B Preferred Stock (“Warrant”) (incorporated by reference from Exhibit 4.2 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
4.4
Form of Certificate for the Series B Preferred Stock (incorporated by reference from Exhibit 4.3 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
**10.1
Lease agreement dated April 24, 1995, as amended, for Eureka Square Branch Office of First National Bank of Northern California at Eureka Square Shopping Center, Pacifica, California
Exhibit
Number
Document Description
**10.2
Lease agreement dated June 8, 1999, as amended, for Linda Mar Branch Office of First National Bank of Northern California at Linda Mar Shopping Center, Pacifica, California.
10.3
(deleted)
10.4
(deleted)
10.5
(deleted)
10.6
(deleted)
10.7
(deleted)
10.8(a)
(deleted)
10.8(b)
(deleted)
**10.9
First National Bank Profit Sharing and 401(k) Plan dated August 26, 1969.*
**10.10
First National Bank Deferred compensation Plan dated November 1, 1997.*
**10.11
Salary Continuation Agreement between First National Bank of Northern California and Michael R. Wyman, dated December 20, 1996.*
**10.12
Salary Continuation Agreement between First National Bank of Northern California and Paul B. Hogan dated December 20, 1996.*
**10.13
Salary Continuation Agreement between First National Bank of Northern California and James B. Ramsey, dated December 23, 1999.*
**10.14
Form of Management Continuity Agreement signed on July 20, 2000, between First National Bank of Northern California and Jim D. Black, Charles R. Key and Anthony J. Clifford.*
10.15
(deleted)
**10.16
Communications Site Lease Agreement as amended dated March 30, 1999, between First National Bank of Northern California, as Lessor and Nextel of California, Inc., as Lessee, with respect to Redwood City Branch Office.
10.17
(deleted)
**10.18
Separation Agreement between First National Bank of Northern California and Paul B. Hogan, dated December 5, 2001.*
***10.19
First Amendment to Separation Agreement between First National Bank of Northern California and Paul B. Hogan, dated March 22, 2002.*
****10.20
FNB Bancorp Stock Option Plan (effective March 15, 2002).*
****10.21
FNB Bancorp Stock Option Plan, Form of Incentive Stock Option Agreement.*
****10.22
FNB Bancorp Stock Option Plan, Form of Nonstatutory Stock Option Agreement.*
*****10.23
FNB Bancorp 2002 Stock option Plan (adopted June 28, 2002).*
*****10.24
FNB Bancorp 2002 Stock Option Plan, Form of Incentive Stock Option Agreement.*
*****10.25
FNB Bancorp 2002 Stock Option Plan, Form of Nonstatutory Stock option Agreement.*
Exhibit
Number
Document Description
******10.26
Lease Agreement dated August 13, 2003, for San Mateo Branch Office of First National Bank of Northern California, located at 150 East Third Avenue, San Mateo, California.
10.27
Salary Continuation Agreement and Split-Dollar Agreement for Jim D. Black (incorporated by reference from Exhibit 10.27 to the Company’s Current Report on Form 8-K filed with the Commission on September 10, 2004).*
10.28
Salary Continuation Agreement and Split-Dollar Agreement for Anthony J. Clifford (incorporated by reference from Exhibit 10.28 to the Company’s Current Report on Form 8-K filed with the Commission on September 10, 2004).*
10.29
Amended and Restated Salary Continuation and Split-Dollar Agreement for James B. Ramsey (incorporated by reference from Exhibit 10.29 o the company’s current Report on Form 8-K filed with the Commission on September 10, 2004).*
*******10.30
Lease Agreement dated May 1, 2003 as amended by Assignment, Assumption and Consent Agreement for the Financial District Branch of First National Bank of Northern California located at 65 Post Street, San Francisco, California.
*******10.31
Lease Agreement dated July 1, 1999, as amended by Assignment, Assumption and Consent for the Portola Branch Office of First National Bank of Northern California located at 699 Portola Drive, San Francisco, California.
10.32
Amendment to Salary Continuation Agreement for Jim D. Black (incorporated by reference from Exhibit 99.37 to the Company’s Current Report on Form 8-K filed with the Commission on July 26, 2006).*
10.33
Amendment to Salary Continuation Agreement for Anthony J. Clifford (incorporated by reference from Exhibit 99.38 to the Company’s Current Report on Form 8-K filed with the Commission on July 26, 2006).*
10.34
Amendment to Amended and Restated Salary Continuation Agreement for James B. Ramsey (incorporated by reference from Exhibit 99.39 to the Company’s Current report on Form 8-K filed with the Commission on July 26, 2006).*
10.35
Lease Agreement dated February 3, 2006, for warehouse facility of First National Bank of Northern California (incorporated by reference from Exhibit 10.35 to the company’s Annual Report on Form 10-K filed with the Commission on March 13, 2008).
10.36
First National Bank Deferred Compensation Plan dated December 1, 2007 (incorporated by reference from Exhibit 10.36 to the Company’s Annual Report on Form 10-K filed with the Commission on March 13, 2008).*
10.37
Amendment No. 5 to the First National Bank Profit Sharing and 401(k) Plan dated December 1, 2007 (incorporated by reference from Exhibit 10.37 to the Company’s Annual Report on Form 10-K filed with the Commission on March 13, 2008).*
10.38
Executive Supplemental Compensation Agreement between First National Bank of Northern California and David A. Curtis dated March 3, 2008 (incorporated by reference from Exhibit 10.38 to the Company’s Current Report on Form 8-K filed with the Commission on March 6, 2008).*
10.39
Split-Dollar Life Insurance Agreement between First National Bank of Northern California and David A. Curtis dated March 3, 2008 (incorporated by reference from Exhibit 10.39 to the Company’s Current Report on Form 8-K filed with the Commission on March 6, 2008).*
********10.40
FNB Bancorp 2008 Stock option Plan (adopted February 22, 2008).*
10.41
Second 409A Amendment to the Salary Continuation Agreement for Jim D. Black (incorporated by reference from Exhibit 99.66 to the Company’s Current Report on Form 8-K filed with the Commission on December 22, 2008).*
10.42
Second 409A Amendment to the Salary Continuation Agreement for Anthony J. Clifford (incorporated by reference from Exhibit 99.67 to the Company’s Current Report on Form 8-K filed with the Commission on December 22, 2008).*
Exhibit
Number
Document Description
10.43
Amendment to the Executive Supplemental Compensation Agreement for David A. Curtis (incorporated by reference from Exhibit 99.68 to the Company’s Current Report on Form 8-K filed with the Commission on December 22, 2008).*
10.44
Letter Agreement dated February 27, 2009, between FNB Bancorp and United States Department of the Treasury pertaining to the election of directors by the holder(s) of the Series A and Series B Preferred Stock (incorporated by reference from Exhibit 4.4 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
10.45
Letter Agreement, including Schedule A and Securities Purchase Agreement Standard Terms, dated February 27, 2009, between FNB Bancorp and United States Department of the Treasury, with respect to the issuance and sale of the Series A and Series B Preferred Stock and the Warrant (incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
10.46
Letter Agreement dated February 27, 2009, between FNB Bancorp and United States Department of the Treasury pertaining to the American Recovery and Reinvestment Act of 2009 (incorporated by reference from Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
10.47
Letter Agreement dated February 27, 2009, between FNB Bancorp and United States Department of the Treasury amending certain sections of the Securities Purchase Agreement Standard Terms (incorporated by reference from Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
10.48
Form of Compensation Modification Agreement and Waiver, dated February 27, 2009, executed by each of:
Thomas C. McGraw
Chief Executive Officer
FNB Bancorp and First National Bank of Northern California
Jim D. Black, President
FNB Bancorp and First National Bank of Northern California
Anthony J. Clifford
Executive Vice President and Chief Operating Officer
FNB Bancorp and First National Bank of Northern California
David A. Curtis
Senior Vice President and Chief Financial Officer
FNB Bancorp and First National Bank of Northern California
Randy R. Brugioni
Senior Vice President and Senior Loan Officer
FNB Bancorp and First National Bank of Northern California
(incorporated by reference from Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009).
******14.0
Code of Ethics
21.1
The Registrant has one subsidiary, First National Bank of Northern California.
23.1
Consent of Moss Adams LLP
31.1
Rule 13a-14(a)/15d-14(a) Certification (principal executive officer)
31.2
Rule 13a-14(a)/15d-14(a) Certification (principal financial officer)
32.0
Section 1350 Certifications
*
Denotes management contracts, compensatory plans or arrangements.
**
Incorporated by reference to registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 15, 2002.
***
Incorporated by reference to registrant’s Annual Report on Form 10-K filed with the Commission on March 31, 2002.
****
Incorporated by reference to registrant’s Statement on Form S-8 (No. 333-91596) filed with the Commission on July 1, 2002.
*****
Incorporated by reference to the registrant’s Registration Statement on Form S-8 (No. 333-98293) filed with the Commission on August 16, 2002.
******
Incorporated by reference to registrant’s Annual Report on Form 10-K filed with the Commission on March 30, 2003.
*******
Incorporated by reference to registrant’s Annual Report on Form 10-K filed with the Commission on March 29, 2006.
********
Incorporated by reference from Appendix A to the Registrant’s Definitive Proxy Statement for its 2008 Annual Meeting of Shareholders, filed with the Commission on April 21, 2008.
An Annual Report for the fiscal year ended December 31, 2008, and Notice of Annual Meeting and Proxy Statement for the Company’s 2009 Annual Meeting will be mailed to security holders subsequent to the date of filing this report. Copies of said materials will be furnished to the Commission in accordance with the Commission’s Rules and Regulations.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(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.
FNB BANCORP
Dated: March 13, 2009
By:
/s/ Thomas C. McGraw
Thomas C. McGraw
Chief Executive Officer
(Principal Executive Officer)
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 in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Michael R. Wyman
Chairman of the Board of Directors
March 13,
Michael R. Wyman
/s/ Thomas C. McGraw
Director, Chief Executive Officer and Secretary
March 13,
Thomas C. McGraw
/s/ David A. Curtis
Senior Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)
March 13,
David A. Curtis
Signature
Title
Date
/s/ Merrie Turner Lightner
Director
March 13,
Merrie Turner Lightner
/s/ Michael Pacelli
Director
March 13,
Michael Pacelli
/s/ Edward J. Watson
Director
March 13,
Edward J. Watson
/s/ Lisa Angelot
Director
March 13,
Lisa Angelot
/s/ Anthony J. Clifford
Director and Executive Vice President and Chief Operating Officer
March 13,
Anthony J. Clifford