ITEM 1. BUSINESS
GENERAL
Northern California Bancorp, Inc. was incorporated on August 29, 1995, as a for-profit corporation under California corporate laws for the principal purpose of engaging in banking and non-banking activities as allowed for a bank holding company. At December 31, 2009, on a consolidated basis the Corporation had total assets of $273,295,000, total loans of $166,742,000 and total deposits of $202,422,000. The Corporation owns 100% of the stock of Monterey County Bank (the “Bank”). The Corporation’s sources of revenues at this time are dividends on investments, gains on securities transactions and potential dividends, management fees and tax equalization payments, if any, from the Bank.
The Corporation, as a bank holding company, engages in commercial banking through the Bank. The Corporation may also engage in certain non-banking activities closely related to banking and own certain other business companies that are not banks, subject to applicable laws and regulations, although it has no current plans to do so.
BANK SUBSIDIARY
Monterey County Bank, an independent, California chartered commercial banking corporation, was chartered by the State of California on July 30, 1976. The Bank’s customer base includes individuals, small and medium-sized businesses and a variety of government agencies with residences, offices or other relationships located in or about the city and county of Monterey, California, including the cities of Carmel by the Sea, Pacific Grove and Salinas. The Bank offers its
customers a wide variety of the normal personal, consumer and commercial services expected of a locally owned, independently operated bank. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”), and, as such, the Bank is subject to regulations by that federal agency and to periodic audits of its operations and documentary compliance by FDIC personnel. As a state chartered bank, which is not a member of the Federal Reserve System, it is also regulated and periodically examined by the California Department of Financial Institutions (DFI).
The Bank’s activities are conducted at its principal branch offices, 601 Munras Ave., Monterey, California and at its four branch offices in Carmel-By-The-Sea, Carmel Valley, Pacific Grove and Salinas, California and a loan production office in Monterey, California. At December 31, 2009, the Bank had total assets, loans and deposits of approximately $272,154,000, $166,742,000 and $202,671,000, respectively.
The Bank provides a range of competitive retail and commercial banking services. The deposit services offered include various types of personal and business checking accounts, savings accounts, money market investment accounts, certificates of deposit, and retirement accounts. Lending services include consumer loans, various types of mortgage loans for residential and commercial real estate, personal lines of credit, home equity loans, real estate construction, accounts receivable financing and commercial loans to small and medium-sized businesses and professionals. The Bank also provides drive-through facilities, at its Monterey and Carmel offices, and night depository facilities for customer convenience. The Bank offers safe deposit box facilities, cashiers’ checks, travelers’ checks, U.S. Savings Bonds, and wire transfers. The Bank does not provide trust services.
While the Bank has the authority to engage in a wide range of banking activities, and offers most of the types of banking services of a commercial bank, over the past three years it has derived much of its profitability and differentiated itself from its competitors through (i) commercial and real estate loans guaranteed by the Small Business Administration (“SBA”), (ii) sponsorship of credit card and debit card programs and (iii) credit card depository services for merchants.
The primary issue that affected the Corporation in 2009 was the depressed economic conditions and related stress in real estate markets. The Corporation focused much of its efforts on managing the deterioration of asset quality resulting from the effect that deteriorating economic conditions had on loans made primarily to residential real estate development projects. The increase in the Corporation’s provision for loan losses ($3,368,000 in 2009 compared to $1,132,000 in 2008) was largely due to asset quality issues related to this market segment.
Management’s efforts focused on identifying potentially weak credits as early as possible, which enabled a proactive and aggressive approach to managing these credits and the development of workout strategies as appropriate. Nonetheless, loans 30 days past due increased from $6,925,000 (4.1% of total loans) at December 31, 2008 to $8,190,000 (4.9% of total loans) at December 31, 2009. Past due loans increased during this period by $1,265,000 or 18.3%. During the same period, non-performing loans (non-accrual loans and troubled debt restructurings) increased from $7,091,000 (4.8% of total loans) to $8,884,000 (5.3% of total loans) at December 31, 2009. Of the non-performing loans outstanding at December 31, 2009, $5,137,000 or 57.8% were secured by real estate (net of any charge-offs previously taken). Total past due loans and non-performing loans are net of the guaranteed portion of SBA loans totaling $1,636,000 and $1,421,000, respectively. Management believes the presence of real estate collateral mitigates the level of expected loss though the level of mitigation is uncertain due to the difficulty ascertaining
real estate values at this time.
Management utilized a pricing discipline and other strategies to offset pressure on the Corporation’s net yield on earning assets created by declining interest rates and an increase in non-performing loans. To combat this and other adverse factors, Management’s efforts to improve its net yield on earning assets included the development of a loan pricing model, establishing floors on variable rate loan products, increased investment in tax free municipal securities, increased efforts to attract lower cost checking accounts and increased use of competitively priced out-of-area deposits and Federal Reserve Bank borrowings. The Corporation’s tax-equivalent net yield on earning assets increased to 3.1% for 2009 compared to 2.9% for 2008. The tax-equivalent net yield on earning assets was affected in 2008 by the increase in loans being placed on non-accrual during the year. Non-accrual loans totaled $8,884,000 at year-end 2009 compared to $7,091,000 at year-end 2008, an increase of $1,793,000 or 25.3%. The increase in non-accrual loans resulted from slowing economic activity and a depressed real estate market.
The Bank has provided sponsorship of third party credit card and debit card programs since August 2002. The Bank gave notice in June 2008 to the third-party card vendors that it will reduce its sponsorship of credit card and stored value card programs, terminating sponsorship agreements on all programs except a drug manufactures’ rebate card program. The characteristics of the drug manufactures’ rebate card program significantly reduces the level of required monitoring. The Bank decided to continue its sponsorship of a debit card program which issues payroll cards. The Bank decided to continue its sponsorship of one credit card program in order to preserve the third party’s indemnification of the Bank against potential expenses and/or liabilities. The Bank also decided to grant extensions of its sponsorship of one credit card program to allow time for the final resolution of issues raised by the FDIC as further discussed under “Regulatory Enforcement Powers”. Extension of the program sponsorship is considered quarterly with the third party paying an extension fee each time an extension is granted. The Bank’s sponsorship of the terminated programs ended in 2009. The Bank has been named as a defendant in a lawsuit brought by one of the third-party credit card companies, seeking to compel the Bank to continue its sponsorship for a period of time. (See “Item 3. Legal Proceedings” for further discussion.)
The Bank’s revenues, consisting of a monthly fee per card or a minimum monthly fee, from the credit card programs were $1,075,000, $514,000 and $684,000 in 2009, 2008 and 2007, respectively. The 2007 revenues included $204,000 in transfer fees received as a result of a card portfolio being transferred to another financial institution. The Bank’s revenues from the credit card programs in 2009 increased due to the collection of quarterly extension fees paid by one of the programs. The Bank’s revenues, consisting of a monthly fee per card or a minimum monthly fee, from the debit card programs were $81,000, $155,000 and $293,000 in 2009, 2008 and 2007, respectively.
Northern California Bancorp, Inc. Trust I
On March 27, 2003, Northern California Bancorp, Inc. Trust I, a Delaware statutory business trust and a wholly owned subsidiary of the Corporation (“Trust I”), issued an aggregate of $3.0 million of principal amount of Floating Rate TRUPSâ (Capital Trust Pass-through Securities of the Trust) (the “Trust Preferred Securities”). The securities issued by Trust I are fully guaranteed by the Corporation with respect to distributions and amounts payable upon liquidation, redemption or repayment. The entire proceeds to Trust I from the sale of the Trust Preferred Securities were used by Trust I in order to purchase $3.0 million in principal amount of the Floating Rate Junior Subordinated Deferrable Interest Debentures due 2033 issued by the Corporation (the
“Subordinated Debt Securities”).
Pursuant to Financial Accounting Standards Board (FASB) issued ASC 810-10 (formerly interpretation FIN 46(R)) entitled “Consolidation of Variable Interest Entities,” Trust I is not reflected on a consolidated basis in our consolidated financial statements.
The Subordinated Debt Securities bear a variable interest rate equal to the three-month London Interbank Offered Rate (“LIBOR”) plus 3.25%. The effective rate at December 31, 2009 was 3.53%. Total broker and legal costs associated with the issuance of $115,000 are being amortized over a 30 year period.
The Corporation exercised its rights in accordance with Section 2.11 Extension of Interest Payment Period of the Indentures dated March 27, 2003 for Northern California Bancorp, Inc. Trust I to defer interest payments for an undetermined period of time, not to exceed twenty (20) consecutive quarterly payments. The deferral of interest payments on Northern California Bancorp, Inc. Trust I was effective with the October 7, 2009 interest payment. At December 31, 2009 accrued and unpaid interest totaled $60,000.
Northern California Bancorp, Inc. Trust II
On November 13, 2003, Northern California Bancorp, Inc. Trust II, a Delaware statutory business trust and a wholly owned subsidiary of the Corporation (“Trust II”), issued an aggregate of $5.0 million of principal amount of Floating Rate TRUPSâ (the “Trust Preferred Securities-II”). The securities issued by Trust II are fully guaranteed by the Corporation with respect to distributions and amounts payable upon liquidation, redemption or repayment. The entire proceeds to Trust II from the sale of the Trust Preferred Securities were used by Trust II in order to purchase $5.0 million in principal amount of the Floating Rate Junior Subordinated Deferrable Interest Debentures due 2033 issued by the Corporation (the “Subordinated Debt Securities-II”).
Pursuant to Financial Accounting Standards Board (FASB) issued ASC 810-10 (formerly interpretation FIN 46(R)) entitled “Consolidation of Variable Interest Entities,” Trust II is not reflected on a consolidated basis in our consolidated financial statements.
The Subordinated Debt Securities-II bear a variable interest rate equal to the three-month LIBOR plus 2.85%. The effective rate at December 31, 2009 was 3.13%. Total broker and legal costs associated with the issuance of $54,000 are being amortized over a 30 year period.
The Corporation has exercised its rights in accordance with Section 2.11 Extension of Interest Payment Period of the Indentures dated November 13, 2003 for Northern California Bancorp, Inc. Trust II to defer interest payments for an undetermined period of time, not to exceed twenty (20) consecutive quarterly payments. The deferral of interest payments on Northern California Bancorp, Inc. Trust II was effective with the November 8, 2009 interest payment. At December 31, 2009 accrued and unpaid interest totaled $65,000.
EMPLOYEES
At December 31, 2009, the Corporation and the Bank employed a total of 56 full-time equivalent persons. Our employees are not represented by any union or other collective bargaining agreement and we consider our relations with our employees to be excellent.
COMPETITION
All phases of the Bank’s business have been, since inception, and will continue to be subject to significant competitive forces. Although the Bank has increasing recognition in its primary service area of Monterey County as a whole, it nevertheless has to compete with other independent local banking institutions, including commercial banks and savings and loan associations, as well as branch offices of regional and national commercial banks, which have assets, capital and lending limits substantially larger than the Bank, as well as wider geographic markets, more support services and larger media advertising capabilities. The Bank competes with respect to its lending activities, as well as in attracting demand deposits, with savings banks, savings and loan associations, insurance companies, regulated small loan companies and credit unions, as well as securities brokerage offices which can issue commercial paper and other securities (such as shares in money market funds).
Among the advantages such institutions have over the Bank are their ability to finance wide ranging advertising campaigns and to allocate their investment assets to regions of highest yields and demand. Many institutions offer certain services, such as trust services and international banking, which the Bank does not currently offer or plan to offer. By virtue of their greater total capital, such institutions have substantially higher lending limits than the Bank (legal lending limits to an individual customer being limited to a percentage of a bank’s total capital accounts). These competitors may intensify their advertising and marketing activities to counter any efforts by the Bank to further attract new business as a commercial bank. In addition, as a result of legislation enacted earlier in the decade, there is increased competition between banks, savings and loan associations and credit unions for the deposit and loan business of individuals. These activities may hinder the Bank’s ability to capture a significant market share.
To compete with the financial institutions in its primary service area, the Bank intends to use the flexibility which its independent status permits. Its activities in this regard include an ability and intention to respond quickly to changes in the interest rates paid on time and savings deposits and charged on loans, and to charges imposed on depository accounts, so as to remain competitive in the market place. It also will continue to emphasize specialized services for the small business person and professional and personal contacts by the Bank’s officers, directors and employees. If there are customers whose loan demands exceed the Bank’s lending limits, the Bank has the ability to arrange for such loans on a participation basis with other financial institutions. No assurance can be given, however, that the Bank’s efforts to compete with other financial institutions in its primary service area will be successful.
The Bank’s earnings depend largely on rate differentials. In general, the difference between the interest rate paid by the Bank on its deposits and its other borrowings, and the interest rate received by the Bank on loans extended to its customers and securities held in the Bank’s portfolio, comprise the major portion of the Bank’s earnings. These rates are highly sensitive to many factors that are beyond the control of the Bank. Accordingly, the earnings and growth of the Bank are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment.
Monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve Board, also impact on the Bank’s business. The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in U.S. Government securities, by adjusting the required level of reserves for financial intermediaries subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the
Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted.
SUPERVISION AND REGULATION
The Corporation
On December 29, 1995, after receipt of appropriate approvals, the Corporation acquired the Bank through a reverse triangular merger (the “Merger”). As a result, by operation of law, each outstanding share of common stock of the Bank prior to the Merger was converted into a share of common stock of the Corporation, while the Corporation became the sole owner of the newly issued shares of common stock of the Bank.
The Bank Holding Company Act of 1956, as amended, places the Corporation under the supervision of the Board of Governors of the Federal Reserve System (the “FRB”). The Corporation must generally obtain the approval of the FRB before acquiring all or substantially all of the assets of any bank, or ownership or control of any voting securities of any bank if, after giving effect to such acquisition, the Corporation would own or control more than 5% of the voting shares of such bank.
A bank holding company is generally prohibited from engaging in, or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in non-banking activities unless the FRB, by order or regulation, has found such activities to be so closely related to banking, managing or controlling banks as to be a proper incident thereto. In making such determinations, the FRB considers whether the performance of such activities by a bank holding company would offer advantages to the public, which outweigh possible adverse effects.
The FRB’s Regulation “Y” sets out the non-banking activities that are permissible for bank holding companies under the law, subject to the FRB’s approval in individual cases. Most of these activities are now permitted for California banks that are well-capitalized. The Corporation and its subsidiaries are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities. The Gramm-Leach-Bliley Act did three fundamental things: 1) it repealed key provisions of the Glass Steagal Act to permit commercial banks to affiliate with investment banks, 2) it substantially modified the Bank Holding Company Act of 1956 to permit companies that own commercial banks to engage in any type of financial activity, and 3) it allowed subsidiaries of banks to engage in a broad range of financial activities that are not permitted by banks. Management believes the Act has resulted in increased competition for financial services.
The Corporation is required to file reports with the FRB and provide such additional information as the FRB may require. The FRB also has the authority to examine the Corporation and each of its subsidiaries with the cost thereof borne by the Corporation. Under California banking law, the Corporation and its subsidiaries are also subject to examination by, and may be required to file reports with, the Commissioner of the Department of Financial Institutions.
The Corporation and any subsidiaries which it may acquire or organize will be deemed affiliates of the Bank within the meaning of the Federal Reserve Act. Pursuant thereto, loans by the Bank to affiliates, investments by the Bank in affiliates’ stock, and taking affiliates’ stock by the Bank as collateral for loans to any borrower is limited to 10% of the Bank’s capital, in the case of
any one affiliate, and is limited to 20% of the Bank’s capital, in the case of all affiliates. Federal and State law place other limitations on transactions between the Bank and its affiliates designed to ensure that the Bank receives treatment in such transactions comparable to that available from unaffiliated third parties.
The Corporation and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, the Bank may not condition an extension of credit on a customer’s obtaining other services provided by it, the Corporation or any other subsidiary, or on a promise from its customer not to obtain other services from a competitor.
Future offers or sales of the stock of the Corporation will be subject to the registration requirements of the Securities Act of 1933, and qualification under the California Corporate Securities Act of 1968, and possibly other state Blue Sky laws (unless an exemption is available).
Recent Regulatory Developments
In light of current conditions in the global financial markets and the global economy, legislators and banking regulators have increased their focus on the financial services industry. Proposals for legislation that could substantially intensify the regulation of the financial services industry are expected to be introduced in the U.S. Congress and in state legislatures. The agencies regulating the financial services industry also adopt changes to their regulations. Substantial regulatory and legislative initiatives, including a comprehensive overhaul of the regulatory system in the U.S., are possible in the months or years ahead. Any such action could have a materially adverse effect on our business, financial condition and results of operations.
Recent months have already seen an unprecedented number of government initiatives designed to respond to the stresses experienced in financial markets. In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law on October 3, 2008. Pursuant to EESA, the U.S. Treasury was given the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Pursuant to EESA, the U.S. Treasury established the Troubled Asset Relief Program (“TARP”) and has since injected capital into many financial institutions under the TARP Capital Purchase Program (“TARP CPP”). Neither the Corporation nor the Bank has participated in TARP CPP.
On February 10, 2009, the U.S. Treasury announced the Financial Stability Plan (“FSP”) which, among other things, established a new Capital Assistance Program (“CAP”) through which eligible banking institutions will have access to U.S. Treasury capital as a bridge to private capital until market conditions normalize, and extended the Debt Guarantee Program of the FDIC’s Temporary Liquidity Guarantee Program (“TLGP”) to October 31, 2009 pursuant to which the FDIC fully guaranteed certain newly issued senior unsecured debt and provided full FDIC deposit insurance coverage for certain accounts, including noninterest-bearing transaction deposit accounts. The FSP also extended the Transaction Account Guarantee Program of the TLGP to June 30, 2010. As a complement to CAP, a new Public-Private Investment Fund on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion, was announced to catalyze the removal of legacy assets from the balance sheets of financial institutions. This proposed fund will combine public and private capital with government financing to help free up capital to support new lending. In addition, the existing Term Asset-Backed Securities Lending Facility (“TALF”) would be
expanded (up to $1 trillion) in order to reduce credit spreads and restart the securitized credit markets that in recent years supported a substantial portion of lending to households, students, small businesses, and others. Furthermore, the FSP proposed a new framework of governance and oversight to help ensure that banks receiving funds are held responsible for appropriate use of those funds through stronger conditions on lending, dividends and executive compensation along with enhanced reporting to the public. The Bank participates in the Transaction Account Guarantee Program under the TLGP.
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law. ARRA is intended to provide tax breaks for individuals and businesses, direct aid to distressed states and individuals, and provide infrastructure spending. In addition, ARRA imposes new executive compensation and expenditure limits on all previous and future TARP CPP recipients and expands the class of employees to whom the limits and restrictions apply. ARRA also provides the opportunity for additional repayment flexibility for existing TARP CPP recipients. Among other things, ARRA prohibits the payment of bonuses, other incentive compensation and severance to certain highly paid employees (except in the form of restricted stock subject to specified limitations and conditions), and requires each TARP CPP recipient to comply with certain other executive compensation related requirements. These provisions modify the executive compensation provisions that were included in EESA, and in most instances apply retroactively for so long as any obligation arising from financial assistance provided to the recipient under TARP remains outstanding. On June 10, 2009, the U.S. Treasury issued final regulations that implement and clarify the provisions of ARRA relating to corporate governance and executive compensation limitations.
In addition, ARRA directs the Secretary of the U.S. Treasury to review previously-paid bonuses, retention awards and other compensation paid to the senior executive officers and certain other highly-compensated employees of each TARP CPP recipient to determine whether any such payments were excessive, inconsistent with the purposes of ARRA or the TARP, or otherwise contrary to the public interest. If the Secretary determines that any such payments have been made by a TARP CPP recipient, the Secretary will seek to negotiate with the TARP CPP recipient and the subject employee for appropriate reimbursements to the U.S. government (not the TARP CPP recipient) with respect to any such compensation or bonuses. ARRA also permits the Secretary, subject to consultation with the appropriate federal banking agency, to allow a TARP CPP recipient to repay any assistance previously provided to such TARP CPP recipient under the TARP, without regard to whether the TARP CPP recipient has replaced such funds from any source, and without regard to any waiting period. Any TARP CPP recipient that repays its TARP assistance pursuant to this provision would no longer be subject to the executive compensation provisions under ARRA.
On February 18, 2009, the U.S. Treasury announced the Homeowner Affordability and Stability Plan (“HASP”), which proposes to provide refinancing for certain homeowners, to support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac, and to establish a Homeowner Stability Initiative to reach at-risk homeowners. Among other things, the Homeowner Stability Initiative would offer monetary incentive to mortgage servicers and mortgage holders for certain modifications of at-risk loans, and would establish an insurance fund designed to reduce foreclosures.
It is not clear at this time what impact EESA, the CPP, the TLGP, the FSP, ARRA, HASP, or other liquidity and funding initiatives will have on the financial markets and the other difficulties described above, including the high levels of volatility and limited credit availability currently being experienced, or on the U.S. banking and financial industries and the broader U.S. and global economies. Failure of these programs to address the issues noted above could have an adverse effect
on the Bank and its business.
Moreover, in light of current conditions in the global financial markets and the global economy, legislators and banking regulators have increased their focus on the financial services industry. Proposals for legislation that could substantially intensify the regulation of the financial services industry are expected to be introduced in the U.S. Congress and in state legislatures. The agencies regulating the financial services industry also adopt changes to their regulations. Substantial regulatory and legislative initiatives, including a comprehensive overhaul of the regulatory system in the U.S., are possible in the months or years ahead. Any such action could have a materially adverse effect on the business, financial condition and results of operations of the Bank.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) was enacted to increase corporate responsibility, provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and protect investors by improving the accuracy and reliability of disclosures pursuant to the securities laws. Sarbanes-Oxley includes important new requirements for public companies in the areas of financial disclosure, corporate governance, and the independence, composition and responsibilities of audit committees. Among other things, Sarbanes-Oxley mandates chief executive and chief financial officer certifications of periodic financial reports, additional financial disclosures concerning off-balance sheet items, and speedier transaction reporting requirements for executive officers, directors and 10% shareholders. In addition, penalties for non-compliance with the Exchange Act were heightened. SEC rules promulgated pursuant to Sarbanes-Oxley impose obligations and restrictions on auditors and audit committees intended to enhance their independence from management, and include extensive additional disclosure, corporate governance and other related rules. Sarbanes-Oxley represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a Board of Directors and management and between a Board of Directors and its committees.
The Corporation has not experienced any significant difficulties in complying with Sarbanes-Oxley. However, the Corporation has incurred and expects to continue to incur significant costs in the future in connection with compliance with Section 404 of Sarbanes-Oxley, which starting with the year ended December 31, 2007, requires management to undertake an assessment of the adequacy and effectiveness of our internal controls over financial reporting and will require our auditors to attest to, and report on, management’s assessment and the operating effectiveness of these controls. The SEC has extended the compliance date for the auditor attestation requirements so that the Corporation will not be required to comply until its fiscal year ending December 31, 2010.
Monterey County Bank
Both federal and state laws provide extensive regulation of the banking business. State and federal statutes and regulations apply to many aspects of the Bank’s operations, including minimum capital requirements, reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices. The DFI and the FDIC provide primary supervision, periodic examination and regulation of the Bank.
The FDIC, through its Deposit Insurance Fund (the “DIF”), insures the Bank’s deposits. Previously, the maximum deposit insurance coverage was $100,000 per depositor, except that individual retirement accounts were insured up to a maximum of $250,000 per depositor. Effective
November 21, 2008 and until December 31, 2013, the FDIC expanded deposit insurance limits under the FDIC’s TLGP to $250,000 per depositor for certain accounts and unlimited coverage for noninterest-bearing transaction accounts held at financial institutions which have not opted out of the Program. On January 1, 2014, these increased limits on deposit insurance coverage will return to $100,000 for all deposit categories except individual retirement accounts and certain other retirement accounts, which will continue to be insured up to $250,000 per depositor. For this protection, the Bank, like all insured banks, pays a quarterly statutory assessment and is subject to the rules and regulations of the FDIC. Although the Bank is not a member of the Federal Reserve System, certain regulations of the Federal Reserve Board also apply to its operations.
California law restricts the amount available for cash dividends by state-chartered banks to the lesser of retained earnings or the bank’s net income for its last three fiscal years (less any distributions to shareholders made during such period). Cash dividends may also be paid in an amount not exceeding the net income for such bank’s last preceding fiscal year after obtaining the prior approval of the Commissioner. The FDIC also has authority to prohibit the Bank from engaging in unsafe or unsound practices. The FDIC can use this power, under certain circumstances, to restrict or prohibit a bank from paying dividends.
Federal law imposes restrictions on banks with regard to transactions with affiliates, including any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, its affiliates, as well as the purchase of or investments in stock or other securities thereof, or the taking of such securities as collateral for loans, and the purchase of assets from affiliates. These restrictions have the effect of preventing affiliates (such as the Corporation) from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Secured loans and investments by the Bank are limited to 10% of the Bank’s capital and surplus (as defined by federal regulations) in the case of any one affiliate, and 20% thereof in the case of all affiliates. California law also imposes certain restrictions with respect to transactions involving other controlling persons of the Bank.
From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial intermediaries. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial intermediaries are frequently made in Congress, in the California legislature and before various bank regulatory and other professional agencies. The Bank cannot predict what, if any legislation or regulations will be enacted, or the impact thereof on its business and profitability.
Capital Adequacy Standards
Government agencies have traditionally regulated bank capital through explicit and implicit guidelines and rules. State law requires “adequate” capital, without objective definition. Federal law and regulations require minimum levels of risk-based and so-called “Leverage” capital.
FDIC guidelines implement the risk-based capital requirements. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles (using the rough measures set forth therein) among banking organizations, take certain off-balance sheet items into account in assessing capital adequacy and minimize disincentives to holding liquid, low-risk assets. Under these guidelines, assets and credit equivalent amounts of off-balance sheet items, such as letters of credit and outstanding loan
commitments, are assigned to one of several risk categories, which range from 0% for risk-free assets, such as cash and certain U.S. government securities, to 100% for relatively high-risk assets, such as loans and investments in fixed assets, premises and other real estate owned. The aggregate dollar amount of each category is then multiplied by the risk-weight associated with that category. The resulting weighted values from each of the risk categories are then added together to determine the total risk-weighted assets.
A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets, including dollar equivalents for certain off-balance sheet assets.
The guidelines require a minimum ratio of qualifying total capital to risk-weighted assets of 8%, of which at least 4% must consist of Tier I capital. Higher risk-based ratios are required to be considered “well capitalized” under prompt corrective action provisions.
A banking organization’s qualifying total capital consists of two components: Tier 1 capital (core capital) and Tier 2 capital (supplementary capital). Tier 1 capital consists primarily of common stock, related surplus and retained earnings, qualifying noncumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries. Trust preferred securities qualify as Tier 1 capital up to a maximum of 25% of capital for holding companies only. Any additional portion will qualify as Tier 2 capital for holding companies only. Intangibles, such as goodwill, are generally deducted from Tier 1 capital; however, purchased mortgage servicing rights and purchased credit card relationships may be included, subject to certain limitations. At least 50% of the banking organization’s total regulatory capital must consist of Tier 1 capital.
Tier 2 capital may consist of (i) the allowance for loan and lease losses in an amount up to 1.25% of risk-weighted assets; (ii) cumulative perpetual preferred stock and long-term preferred stock and related surplus; (iii) hybrid capital instruments (instruments with characteristics of both debt and equity), perpetual debt and mandatory convertible debt securities; and (iv) eligible term subordinated debt and intermediate-term preferred stock with an original maturity of five years or more, including related surplus, in an amount up to 50% of Tier 1 capital. The inclusion of the foregoing elements of Tier 2 capital is subject to certain requirements and limitations of the federal banking agencies.
The FDIC imposes a minimum leverage ratio of Tier I capital to average total assets of 3% for the highest rated banks, and 4% for all other banks. Institutions experiencing or anticipating significant growth or those with other than minimum risk profiles are expected to maintain capital at least 100-200 basis points above the minimum level.
In addition, the FRB and the FDIC have issued or proposed rules to take account of interest rate risk, concentration of credit risk and the risks of nontraditional activities in calculating risk-based capital.
For capital adequacy purposes, deferred tax assets that can be realized from taxes paid in prior carry-back years, and from the future reversal of temporary differences, are generally unlimited. However, deferred tax assets that can only be realized through future taxable earnings, including the implementation of a tax planning strategy, count toward regulatory capital purposes only up to the lesser of (i) the amount that can be realized within one year of the quarter-end report date or (ii) 10% of Tier I capital. The amount of deferred taxes in excess of this limit, if any, would be deducted from Tier I capital and total assets in regulatory capital calculations.
Effective January 17, 1995, the federal banking agencies issued a final rule relating to capital standards and the risks arising from the concentration of credit and nontraditional activities. Institutions which have significant amounts of their assets concentrated in high risk loans or nontraditional banking activities and who fail to adequately manage these risks, will be required to set aside capital in excess of the regulatory minimums. The federal banking agencies have not imposed any quantitative assessment for determining when these risks are significant, but have identified these issues as important factors they will review in assessing an individual bank’s capital adequacy. Management of the Corporation does not believe that the Bank’s assets and activities, as currently structured, would lead the FDIC to require additional capital under this rule.
Future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends.
Prompt Corrective Action and Other Enforcement Mechanisms
Under Section 38 of the Federal Deposit Insurance Act (“FDIA”), as added by the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action. Under the regulations, an institution shall generally be deemed to be: (i) “well capitalized” if it has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of “well capitalized;” (iii) “undercapitalized” if it has a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under certain circumstances); (iv) “significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is less than 3.0%; and (v) “critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.
Section 38 of the FDIA and the implementing regulations also provide that a federal banking agency may, after notice and an opportunity for a hearing, reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category if the institution is in an unsafe or unsound condition or engaging in an unsafe or unsound practice. (The FDIC may not, however, reclassify a significantly undercapitalized institution as critically undercapitalized.)
An institution generally must file a written capital restoration plan which meets specified requirements, as well as a performance guaranty by each company that controls the institution, with the appropriate federal banking agency within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. Immediately upon becoming undercapitalized, an institution shall become subject to the provisions of Section 38 of the FDIA, which sets forth various mandatory and discretionary restrictions on its operations.
At December 31, 2009, the Bank met the tests to be categorized as “well capitalized” under the prompt corrective action regulations of the FDIC.
Safety and Soundness Standards
Federal law requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; and (vi) compensation, fees and benefits. The federal banking agencies recently adopted final regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness (the “Guidelines”) to implement safety and soundness standards required by the FDIA. The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The agencies also proposed asset quality and earnings standards which, if adopted in final, would be added to the Guidelines. Under the final regulations, if the FDIC determines that the Bank fails to meet any standard prescribed by the Guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDIA. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.
FDIC Insurance and Insurance Assessments
Banks and thrifts have historically paid varying amounts of premiums on deposits for federal deposit insurance depending upon a risk-based system which evaluated the institution’s regulatory and capital adequacy ratings. The FDIC operated two separate insurance funds, the Bank Insurance Fund (“BIF”) and the Savings Association Insurance Fund (“SAIF”).
As a result of the Federal Deposit Insurance Reform Act of 2006 and regulations adopted by the FDIC effective as of November 2, 2007: (i) the BIF and the SAIF have been merged into the Deposit Insurance Fund (the “DIF”); (ii) the $100,000 insurance level has been indexed to reflect inflation (the first adjustment for inflation will be effective January 1, 2011 and thereafter adjustments will occur every 5 years); (iii) deposit insurance coverage for retirement accounts has been increased to $250,000, and will also be subject to adjustment every five years; (iv) banks that historically have capitalized the BIF are entitled to a one-time credit which can be used to off-set premiums otherwise due (this addresses the fact that institutions that have grown rapidly have not had to pay deposit premiums); (v) a cap on the level of the DIF has been imposed and dividends will be paid when the DIF grows beyond a specified threshold; and (vi) the previous risk-based system for assessing premiums has been revised.
Effective January 1, 2007, the FDIC utilized a risk-based assessment system to set semi-annual insurance premium assessments which categorizes banks into four risk categories based on capital levels and supervisory “CAMELS” ratings and named them Risk Categories I, II, III and IV. The “CAMELS” rating system is based upon an evaluation of the five critical elements of an institution’s operations: Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to risk. This rating system is designed to take into account and reflect all significant financial and operational factors financial institution examiners assess in their evaluation of an institution’s performance. The following table sets forth these four Risk Categories:
Within Risk Category I, the assessment system combines supervisory ratings with other risk measures to differentiate risk. For most institutions, the assessment system combines CAMELS component ratings with financial ratios to determine an institution’s assessment rate. For large institutions that have long-term debt issuer ratings, the new assessment system differentiates risk by combining CAMELS component ratings with those ratings. For large institutions within Risk Category I, initial assessment rate determinations may be modified within limits upon review of additional relevant information. The new assessment system assess those within Risk Category I that pose the least risk a minimum assessment rate and those that pose the greatest risk a maximum assessment rate that is two basis points higher. An institution that poses an intermediate risk within Risk Category I will be charged a rate between the minimum and maximum that will vary incrementally by institution.
On February 27, 2009, the FDIC adopted final rules modifying the risk-based assessment system and setting initial base assessment rates that began on April 1, 2009. Under these new rules, risk assessments for small Risk Category I institutions and large Risk Category I institutions with no long-term debt rating will include a consideration of such institution’s adjusted brokered deposit ratio. The adjusted brokered deposit ratio affects institutions whose brokered deposits are more than 10% of domestic deposits and whose total assets are more than 40% greater than they were four years previously. The adjusted brokered deposit ratio excludes certain reciprocal deposits for institutions in Risk Category I. Brokered deposits that consist of balances swept into an insured institution are included in the adjusted brokered deposit ratio for all institutions.
Further, the new rules revised the method for calculating the assessment rate for a large Risk Category I institution with a long-term debt issuer rating so that it equally weights the institution’s weighted average CAMELS component ratings, its long-term debt issuer ratings and the financial ratios method assessment rate. The final rule updates the uniform amount and the pricing multipliers for the weighted average CAMELS component ratings and financial ratios method. It also increases the maximum possible large bank adjustment from 0.5 basis point to 1.0 basis point.
These new rules set forth three possible adjustments to an institution’s initial base assessment rate: (i) a decrease of up to five basis points for long-term unsecured debt, including senior unsecured debt (other than debt guaranteed under the Temporary Liquidity Guarantee Program) and subordinated debt and, for small institutions, a portion of Tier 1 capital; (ii) an increase not to exceed 50% of an institution’s assessment rate before the increase for secured liabilities in excess of 25% of domestic deposits; and (ii) for non-Risk Category I institutions, an increase not to exceed 10 basis points for brokered deposits in excess of 10% of domestic deposits.
Under these new rules, the FDIC adopted new initial base assessment rates as of April 1, 2009, as follows, expressed in terms of cents per $100 in insured deposits:
Initial Base Assessment Rates
*Initial base rates that were not the minimum or maximum rate will vary between these rates.
After applying all possible adjustments, minimum and maximum total base assessment rates for each Risk Category are as follows:
Total Base Assessment Rates
* All amounts for all risk categories are in basis points annually. Total base rates that are not the minimum or maximum rate will vary between these rates.
In addition, on February 27, 2009, the FDIC adopted an interim rule that imposed a 20 basis point emergency special assessment on all insured depository institutions on June 30, 2009. The special assessment was collected on September 30, 2009, at the same time that the risk-based assessments for the second quarter of 2009 were collected. The interim rule also permits the FDIC to impose an emergency special assessment of up to 10 basis points on all insured depository institutions whenever, after June 30, 2009, the FDIC estimates that the DIF reserve ratio will fall to a level that the FDIC believes would adversely affect public confidence or to a level close to zero or negative at the end of a calendar quarter.
Effective November 21, 2008 and until December 31, 2009, the FDIC expanded deposit insurance limits for certain accounts under the FDIC’s TLGP. Provided an institution has not opted out of the Temporary Liquidity Guarantee Program, the FDIC may (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008 and before June 30, 2009 and (ii) provide full FDIC deposit insurance coverage for noninterest-bearing transaction deposit accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts (IOLTAs) held at participating FDIC-insured institutions through December 31, 2009. On May 20, 2009, the Helping Families Save Their Homes Act extended the temporary increase in the standard maximum deposit insurance amount to $250,000 per depositor through December 31, 2013. The standard maximum deposit insurance amount will return to $100,000 on January 1, 2014. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding $250,000. On February 10, 2009, the U.S. Treasury extended the TLGP to October 31, 2009 pursuant to the Financial Stability Plan - Capital Assistance Program. On August 26, 2009, the FDIC extended the TAGP portion of the TLGP for an additional six months, through June 30, 2010. The Bank has not opted out of the TLGP.
Effective November 17, 2009 the FDIC amended its regulations requiring insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012. The prepaid assessment for these periods were collected on December 30, 2009, along with each institution’s regular quarterly risk-based deposit insurance assessment for the third quarter of 2009. For purposes of estimating an institution’s assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, and calculating the amount that an institution will prepay on December 30, 2009, the institution’s assessment rate was its total base assessment rate in effect on September 30, 2009. On September 29, 2009, the FDIC increased annual assessment rates uniformly by 3 basis points beginning in 2011. As a result, an institution’s total base assessment rate for purposes of estimating an institution’s assessment for 2011 and 2012 will be increased by an annualized 3 basis points beginning in 2011. Again for purposes of calculating the amount that an institution prepaid on December 30, 2009, an institution’s third quarter 2009 assessment base was increased quarterly at a 5% annual growth rate through the end of 2012. The FDIC will begin to draw down an institution’s prepaid assessments on March 30, 2010, representing payment for the regular quarterly risk-based assessment for the fourth quarter of 2009. The Bank’s prepaid assessment totaled $1,816,000 and was paid on December 31, 2009.
The FDIC may terminate its insurance of deposits if it finds that the Bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
The Financing Corporation (“FICO”), established by the Competitive Equality Banking Act of 1987, is a mixed-ownership government corporation whose sole purpose was to function as the financing vehicle for the Federal Savings and Loan Insurance Corporation. Effective December 12, 1991, as provided by the Resolution Trust Corporation Refinancing, Restructuring and Improvement Act of 1991, FICO’s ability to issue new debt was terminated. Outstanding FICO bonds, which are 30-year non-callable bonds with a principal amount of approximately $8.1 billion, mature in 2017 through 2019.
FICO has assessment authority, separate from the FDIC’s authority to assess risk-based premiums for deposit insurance, to collect funds from FDIC-insured institutions sufficient to pay interest on FICO bonds. The FDIC acts as collection agent for FICO. The FICO assessment rate is adjusted quarterly to reflect changes in the assessment basis of the respective funds based on the quarterly Call Report and the Thrift Financial Report submissions. The FICO rates are expressed as basis points per $100 of deposits. The FICO quarterly rates for 2009 were 0.285, 0.26, 0.26 and 0.255. The FICO quarterly rate for the first and second quarters of 2010 is 0.265 and 0.26, respectively.
Interstate Banking and Branching
On September 29, 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Act”) was signed into law. Under the Interstate Act, beginning one year after the date of enactment, a bank holding company that is adequately capitalized and managed may obtain regulatory approval to acquire an existing bank located in another state without regard to state law. A bank holding company would not be permitted to make such an acquisition if, upon consummation, it would control (a) more than 10% of the total amount of deposits of insured depository institutions in the United States or (b) 30% or more of the deposits in the state in which the bank is located. A state may limit the percentage of total deposits that may be held in that state by any one bank or bank holding company if application of such limitation does not discriminate against out-of-state banks. An out-of-state bank holding company may not acquire a state bank in
existence for less than a minimum length of time that may be prescribed by state law except that a state may not impose more than a five year existence requirement.
The Interstate Act also permitted, effective June 1, 1997, mergers of insured banks located in different states and conversion of the branches of the acquired bank into branches of the resulting bank. Each state may adopt legislation to prohibit interstate mergers after June 1, 1997 in that state or in other states by that state’s banks. The same concentration limits discussed in the preceding paragraph apply. The Interstate Act also permits a national or state bank to establish branches in a state other than its home state if permitted by the laws of that state, subject to the same requirement and conditions as for a merger transaction.
The Interstate Act has increased competition in the Bank’s market areas, especially from larger financial institutions and their holding companies.
On October 2, 1995, the “California Interstate Banking and Branching Act of 1995” (the “1995 Act”) became effective. The 1995 Act generally allows out-of-state banks to enter California by merging with, or purchasing, a California bank or industrial loan company which is at least five years old.
Community Reinvestment Act and Fair Lending Developments
The Bank is subject to certain fair lending requirements, reporting obligations involving home mortgage lending operations and Community Reinvestment Act (the “CRA”). The CRA generally requires the federal banking agencies to evaluate the record of financial institutions in meeting the credit needs of their local community, including low and moderate income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities.
In May, 1995, the federal banking agencies issued final regulations which change the manner in which they measure a bank’s compliance with its CRA obligations. The final regulations adopt a performance-based evaluation system which bases CRA ratings on an institution’s actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. In March 1994, the Federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in lending. The policy statement describes the three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment and evidence of disparate impact. Following the Bank’s most recent CRA examination, the Bank’s rating was “needs to improve.” The rating is due primarily to issues related to the Bank’s third party vendor programs.
Other Regulations and Policies
The federal regulatory agencies have adopted regulations that implement Section 304 of FDICIA which requires federal banking agencies to adopt uniform regulations prescribing standards for real estate lending. Each insured depository institution must adopt and maintain a comprehensive written real estate lending policy, developed in conformance with prescribed guidelines, and each agency has specified loan-to-value limits in guidelines concerning various categories of real estate loans.
Section 24 of the FDIA, as amended by the FDICIA, generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. Under regulations dealing with equity investments, an insured state bank generally may not directly or indirectly acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. An insured state bank is not prohibited from, among other things, (i) acquiring or retaining a majority interest in a subsidiary, (ii) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank’s total assets, (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors’, trustees’ and officers’ liability insurance coverage or bankers’ blanket bond group insurance coverage for insured depository institutions, and (iv) acquiring or retaining the voting shares of a depository institution if certain requirements are met.
FDIC regulations implementing Section 24 of the FDIA provide that an insured state-chartered bank may not, directly, or indirectly through a subsidiary, engage as “principal” in any activity that is not permissible for a national bank unless the FDIC has determined that such activities would pose no risk to the insurance fund of which it is a member and the bank is in compliance with applicable regulatory capital requirements. Any insured state-chartered bank directly or indirectly engaged in any activity that is not permitted for a national bank must cease the impermissible activity.
Effect of Governmental Monetary Policies
The Corporation’s earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through the Federal Reserve’s statutory power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The Federal Reserve, through its monetary and fiscal policies, affects the levels of the Bank’s loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
The actions of the FRB in these areas influence the growth of bank loans, investments, and deposits and also affect market interest rates. From January 2001 to June 2003, the FRB decreased interest rates numerous times, reducing the overnight “Federal Funds” rate from 6.50% to 1.00%, the lowest level in four decades. From June 2004 to June 2006, the FRB reversed direction and increased rates 17 times to 5.25%. From September 2007 through December 2008, the FRB reduced rates ten times to their current level of 0.00%. The nature and timing of any future changes in such policies and their impact on the Corporation cannot be predicted. However, depending on the degree to which the Bank’s interest-earning assets and interest-bearing liabilities are rate sensitive, increases in rates would have a temporary effect of increasing the Bank’s net interest margin, while decreases in interest rates would have the opposite effect. In addition, adverse economic conditions, including a downturn in the local or regional economy and rising energy prices, have made a higher provision for loan losses a prudent course and have caused higher loan charge-offs, thus adversely affecting the Corporation’s net income or other operating costs.
Financial Modernization Act
Effective March 11, 2000, the Gramm-Leach-Bliley Act eliminated most barriers to affiliations among banks and securities firms, insurance companies, and other financial service providers, and enabled full affiliations to occur between such entities. This legislation permits bank holding companies to become “financial holding companies” and thereby acquire securities firms and insurance companies and engage in other activities that are financial in nature. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized under the prompt corrective action provisions discussed above, is well managed, and has at least a satisfactory rating under the CRA by filing a declaration that the bank holding company wishes to become a financial holding company. No regulatory approval will be required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the FRB. The Corporation has no current intention of becoming a financial holding company, does not currently qualify to do so, but may do so at some point in the future if deemed appropriate in view of opportunities or circumstances at the time.
The Gramm-Leach-Bliley Act defines “financial in nature” to include securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agencies; merchant banking activities; and activities that the FRB has determined to be closely related to banking. A national bank (and therefore, a state bank as well) may also engage, subject to limitations on investment, in activities that are financial in nature, other than insurance underwriting, insurance company portfolio investment, real estate development and real estate investment, through a financial subsidiary of the bank, if the bank is well capitalized, well managed and has at least a satisfactory CRA rating. Subsidiary banks of a financial holding company or national banks with financial subsidiaries must continue to be well capitalized and well managed in order to continue to engage in activities that are financial in nature without regulatory actions or restrictions, which could include divestiture of the financial in nature subsidiary or subsidiaries. In addition, a financial holding company or a bank may not acquire a company that is engaged in activities that are financial in nature unless each of the subsidiary banks of the financial holding company or the bank has a CRA rating of satisfactory or better.
The Gramm-Leach-Bliley Act also imposed significant new requirements on financial institutions with respect to the privacy of customer information, and modified other laws, including those related to community reinvestment.
USA Patriot Act of 2001
The USA Patriot Act of 2001, enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. on September 11, 2001, is intended to strengthen U.S. law enforcement’s and the intelligence communities’ ability to work cohesively to combat terrorism on a variety of fronts. The impact of the USA Patriot Act on financial institutions of all kinds has been significant and wide ranging. The USA Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations applicable to financial institutions, including:
· due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons;
· standards for verifying customer identification at account opening; and
· rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.
The Bank implemented the requirements under the USA Patriot Act during 2001 and 2002. Compliance with such requirements has all been accomplished with existing staff, so the financial impact on the Bank has been negligible.
Regulatory Enforcement Powers
Commercial banking organizations, such as the Bank, may be subject to enforcement actions by the FDIC and the DFI for engaging in unsafe or unsound practices in the conduct of their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits, the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the imposition of restrictions and sanctions under the prompt corrective action provisions of the FDICIA.
The FDIC requested the Bank consent to a regulatory order resulting from its 2008 Consumer Compliance Examination, which was completed in 2009. The Bank disputes various provisions in the proposed order and is consulting with legal counsel regarding the issues at dispute. As a result of the Bank’s refusal to sign the order in accord with the FDIC’s time frame, the FDIC has indicated to the Bank that it will proceed with the Administrative Hearing process to issue the order. The FDIC is asserting that three credit and debit card programs operated by third-party vendors violated certain provisions of Federal law, which the Bank disputes, and the FDIC is demanding that the Bank make restitution to affected customers and be subjected to a civil money penalty as a result of the alleged violations. The Bank also believes that restitution and civil money penalty are inappropriate under the circumstances. The FDIC is presently investigating the Bank’s involvement in the subject card programs utilizing its subpoena powers pursuant to statutory authority. The financial and non-financial impact of this matter is not known as of the balance sheet date and as of the issuance date of this report.
California and Federal Change in Bank Control Laws
The Federal Change in Bank Control Act of 1978 prohibits a person or group of persons “acting in concert” from acquiring “control” of a bank or holding company unless the appropriate federal regulatory agency has been given 60 days’ prior written notice of such proposed acquisition and, within that time period, has not issued a notice disapproving the proposed acquisition or extending for up to another 30 days the period during which such a disapproval may be issued. An acquisition may be made prior to the expiration of the disapproval period if the agency issues written notice of its intent not to disapprove the action. The acquisition of more than 10% of a class of voting stock of a bank (or holding company) with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (such as the Common stock), is generally presumed, subject to rebuttal, to constitute the acquisition of control.
Under the California Financial Code, no person shall, directly or indirectly, acquire control of a California licensed bank or a bank holding company unless the DFI has approved such acquisition of control. A person would be deemed to have acquired control of the Corporation
under this state law if such person, directly or indirectly, has the power (i) to vote 25% or more of the voting power of the Corporation or (ii) to direct or cause the direction of the management and policies of the Corporation. For purposes of this law, a person who directly or indirectly owns or controls 10% or more of the Common stock would be presumed to control the Corporation, subject to rebuttal.
In addition, any “company” would be required to obtain the approval of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), before acquiring 25% (5% in the case of an acquirer that is, or is deemed to be, a bank holding company) or more of the outstanding Common stock of, or such lesser number of shares as constitute control over, the Bank or the Corporation.
RESEARCH
Neither the Corporation nor the Bank makes any material expenditures for research and development.
DEPENDENCE UPON A SINGLE CUSTOMER
Neither the Corporation nor the Bank is dependent upon a single customer or very few customers. The Bank’s business is concentrated in, and largely dependent upon the strength of the local economy in, the Monterey Peninsula area of Northern California. The local economy is affected by both national trends and by local factors. Tourism and the activities at the former Fort Ord military base are among the major contributors to the local economy.
ITEM 1A.
ITEM 1A. RISK FACTORS
DIFFICULT CONDITIONS IN THE CAPITAL MARKETS AND THE ECONOMY GENERALLY MAY MATERIALLY ADVERSELY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS.
Our results of operations are materially affected by conditions in the capital markets and the economy generally. The capital and credit markets have been experiencing extreme volatility and disruption for more than twelve months at unprecedented levels. In many cases, these markets have produced downward pressure on stock prices of, and credit availability to, certain companies without regard to those companies’ underlying financial strength.
Recently, concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining U.S. real estate market have contributed to increased volatility and diminished expectations for the economy and the capital and credit markets going forward. These factors, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown and national recession. In addition, the fixed-income markets are experiencing a period of extreme volatility which has negatively impacted market liquidity conditions. Initially, the concerns on the part of market participants were focused on the subprime segment of the mortgage-backed securities market. However, these concerns have since expanded to include a broad range of mortgage-and asset-backed and other fixed income securities, including those rated investment grade, the U.S. and international credit and interbank money markets generally, and a wide range of financial institutions and markets, asset classes and sectors.
Factors such as consumer spending, business investment, government spending, the volatility and strength of the capital markets, and inflation all affect the business and economic environment and, ultimately, the amount and profitability of our business. In an economic downturn characterized by higher unemployment, lower family income, lower corporate earnings, lower business investment and lower consumer spending, the demand for our financial products could be adversely affected. Adverse changes in the economy could affect earnings negatively and could have a material adverse effect on our business, results of operations and financial condition. The current mortgage crisis and economic slowdown has also raised the possibility of future legislative and regulatory actions in addition to the enactment of EESA that could further impact our business. We cannot predict whether or when such actions may occur, or what impact, if any; such actions could have on our business, results of operations and financial condition.
THERE CAN BE NO ASSURANCE THAT ACTIONS OF THE U.S. GOVERNMENT, FEDERAL RESERVE AND OTHER GOVERNMENTAL AND REGULATORY BODIES FOR THE PURPOSE OF STABILIZING THE FINANCIAL MARKETS WILL ACHIEVE THE INTENDED EFFECT.
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, President Bush signed EESA into law. Pursuant to EESA, the U.S. Treasury has the authority to utilize up to $700 billion to purchase distressed assets from financial institutions or infuse capital into financial institutions for the purpose of stabilizing the financial markets. The U.S. Treasury announced the Capital Purchase Program under EESA pursuant to which it has purchased and will continue to purchase senior preferred stock in participating financial institutions such as the Corporation. There can be no assurance, however, as to the actual impact that EESA, including the Capital Purchase Program and the Treasury’s Troubled Asset Repurchase Program, will have on the financial markets or on us. The failure of these programs to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.
The federal government, Federal Reserve and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis. There can be no assurance as to what impact such actions will have on the financial markets, including the extreme levels of volatility currently being experienced. Such continued volatility could materially and adversely affect our business, financial condition and results of operations, or the trading price of our common stock.
WE WILL BE REQUIRED TO PAY SIGNIFICANTLY HIGHER FEDERAL DEPOSIT INSURANCE CORPORATION PREMIUMS IN THE FUTURE.
Recent insured institution failures, as well as deterioration in banking and economic conditions, have significantly increased FDIC loss provisions, resulting in a decline in the designated reserve ratio to historical lows. The FDIC expects a higher rate of insured institution failures in the next few years compared to recent years; thus, the reserve ratio may continue to decline. In addition, EESA temporarily increased the limit on FDIC coverage to $250,000 through December 31, 2013. These developments have caused the premiums assessed to us by the FDIC to increase.
On December 16, 2008, the FDIC Board of Directors determined deposit insurance assessment rates for the first quarter of 2009 at 12 to 14 basis points per $100 of deposits. Beginning April 1, 2009, the rates increased to 12 to 16 basis points per $100 of deposits. Additionally, on February 27, 2009, the FDIC announced an interim rule imposing a 20 basis point special emergency assessment on June 30, 2009, payable September 30, 2009. The special assessment for the Bank was $134,000. The interim rule also allows the FDIC to impose a special emergency assessment after June 30, 2009, of up to 10 basis points if necessary to maintain public confidence in FDIC insurance. These higher FDIC assessment rates and special assessments could have an adverse impact on our results of operations.
RECENT NEGATIVE DEVELOPMENTS IN THE FINANCIAL INDUSTRY AND THE CREDIT MARKETS MAY SUBJECT US TO ADDITIONAL REGULATION.
As a result of the recent global financial crisis, the potential exists for new federal or state laws and regulations regarding lending and funding practices and liquidity standards to be promulgated, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders. Negative developments in the financial industry and the domestic and international credit markets, and the impact of new legislation in response to those developments, may negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and may adversely impact our financial performance.
THE GEOGRAPHIC CONCENTRATION OF OUR MARKETS MAKES OUR BUSINESS HIGHLY SUSCEPTIBLE TO LOCAL ECONOMIC CONDITIONS.
Unlike larger banking organizations that are more geographically diversified, our operations are currently concentrated in the Monterey Peninsula and Salinas, California markets. As a result of this geographic concentration, our financial results depend largely upon economic conditions in these market areas. Deterioration in economic conditions in one or all of these markets could result in an increase in loan delinquencies, an increase in problem assets and foreclosures, a decrease in the demand for our products and services or a decrease in the value of collateral for loans, especially real estate, in turn reducing customers’ borrowing power, the value of assets associated with problem loans and collateral coverage.
FUTURE GROWTH OR OPERATING RESULTS MAY REQUIRE THE CORPORATION TO RAISE ADDITIONAL CAPITAL BUT THAT CAPITAL MAY NOT BE AVAILABLE OR IT MAY BE DILUTIVE.
The Corporation is required by federal and state regulatory authorities to maintain adequate levels of capital to support its operations. To the extent the Corporation’s future operating results erode capital or the Corporation elects to expand through loan growth or acquisition it may be required to raise capital. The Corporation’s ability to raise capital will depend on conditions in the capital markets, which are outside of its control, and on the Corporation’s financial performance. Accordingly, the Corporation cannot be assured of its ability to raise capital when needed or on favorable terms. If the Corporation cannot raise additional capital when needed, it will be subject to increased regulatory supervision and the imposition of restrictions on its growth and business. These could negatively impact the Corporation’s ability to operate or further expand its operations through acquisitions or the establishment of additional branches and may result in increases in operating expenses and reductions in revenues that could have a material adverse effect on its financial condition and results of operations.
THE CORPORATION’S ALLOWANCE FOR POSSIBLE LOAN LOSSES MAY BE INSUFFICIENT.
The Corporation maintains an allowance for possible loan losses, which is a reserve established through a provision for possible loan losses charged to expense that represents management’s best estimate of probable losses within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for possible loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes. In addition, bank regulatory agencies periodically review the Corporation’s allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. If charge-offs in future periods exceed the allowance for possible loan losses, the Corporation will need additional provisions to increase the allowance for possible loan losses. Any increases in the allowance for possible loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Corporation’s financial condition and results of operations.
THE CORPORATION IS SUBJECT TO INTEREST RATE RISK.
The Corporation’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Corporation’s control, including general economic conditions and policies of various governmental and regulatory agencies. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Corporation receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect the Corporation’s ability to originate loans and obtain deposits and the fair value of the Corporation’s financial assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Corporation’s net interest income, and earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
THE CORPORATION IS SUBJECT TO ENVIRONMENTAL LIABILITY RISK ASSOCIATED WITH LENDING ACTIVITIES.
A significant portion of the Corporation’s loan portfolio is secured by real property. During the ordinary course of business, the Corporation may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Corporation may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Corporation to incur substantial expenses and may materially reduce the affected property’s value or limit the Corporation’s ability to use or sell the affected property. In addition,
future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase the Corporation’s exposure to environmental liability. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Corporation’s financial condition and results of operations.
THE CORPORATION IS SUBJECT TO EXTENSIVE GOVERNMENT REGULATION AND SUPERVISION.
The Corporation, primarily through the Bank, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect the Corporation’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Corporation in substantial and unpredictable ways. Such changes could subject the Corporation to additional costs, limit the types of financial services and products the Corporation may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Corporation’s business, financial condition and results of operations.
THE CORPORATION’S CONTROLS AND PROCEDURES MAY FAIL OR BE CIRCUMVENTED.
Management regularly reviews and updates the Corporation’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Corporation’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Corporation’s business, results of operations and financial condition.
THE CORPORATION’S INFORMATION SYSTEMS MAY EXPERIENCE AN INTERRUPTION OR BREACH IN SECURITY.
The Corporation relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Corporation’s customer relationship management, general ledger, deposit, loan and other systems. While the Corporation has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of the Corporation’s information systems could damage the Corporation’s reputation, result in a loss of customer business, subject the Corporation to additional regulatory scrutiny, or expose the Corporation to civil litigation and possible financial liability, any of which could have a material adverse effect on the Corporation’s financial condition and results of operations.
CHANGES IN TECHNOLOGY COULD BE COSTLY.
The banking industry is undergoing technological innovation. In order to maintain its competitive position, the Corporation must react to these innovations and evaluate the technologies to enable it to compete on a cost-effective basis. The cost of such technology, including personnel, may be high in both absolute and relative terms. There can be no assurance, given the fast pace of change and innovation, that the Corporation’s technology will meet or continue to meet its needs.
THE TRADING VOLUME IN THE CORPORATION’S COMMON STOCK IS LESS THAN THAT OF OTHER LARGER FINANCIAL SERVICES COMPANIES.
Although the Corporation’s common stock is listed for trading on the Over The Counter Bulletin Board (OTCBB), the trading volume in its common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of the Corporation’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which the Corporation has no control. Given the lower trading volume of the Corporation’s common stock, significant sales of the Corporation’s common stock, or the expectation of these sales, could cause the Corporation’s stock price to fall.
WE MAY NOT BE ABLE TO PAY DIVIDENDS IN THE FUTURE IN ACCORDANCE WITH PAST PRACTICES.
The Corporation may not be able to pay dividends in accordance with past practice. The Corporation traditionally pays an annual dividend to shareholders. The payment of dividends is subject to legal and regulatory restrictions and, therefore, any payment of dividends in the future will depend in large part on the Corporation’s earnings, capital requirements, financial conditions, liquid resources (including the ability to receive dividends from the Bank), and other factors considered relevant by the Corporation’s Board of Directors.
The Corporation has deferred interest payments on its subordinated debt securities, therefore it may not pay any dividends or distribution on its capital stock until the total deferred interest is paid. Additionally the Corporation, prior to paying any dividend or distribution, must request the prior approval of the Federal Reserve Bank.
The Bank must request the prior approval of the FDIC and the DFI before paying any dividends to the Corporation.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2.
ITEM 2. PROPERTIES
The main branch office of the Bank, which also serves as the principal office of the Corporation, is located at 601 Munras Ave., Monterey, California 93940. This facility contains a lobby, executive and customer service offices, teller stations, safe deposit boxes and related non-vault area, vault, operations area, lounge and miscellaneous areas. A drive-through facility and adequate paved parking are also on the premises. Both the land and all improvements thereto are
owned by the Bank.
The Bank also owns a building located at 556 Abrego St., Monterey, California 93940, which houses a loan production office and additional office space. The Bank currently operates four branch offices in Carmel-By-The-Sea, Carmel Valley, Pacific Grove and Salinas, California, all within approximately 20 miles from the Bank’s main office. The land and improvements dedicated to the Carmel-By-The-Sea, Carmel Valley, Pacific Grove and Salinas branch offices are leased. See Footnote 13 to the Corporation’s financial statements included herewith.
Generally, neither the Bank nor the Corporation may invest in equity interests in real estate, except for the direct use of the Bank or the Corporation in their business. The Bank makes and/or purchases loans secured by real estate, subject to normal banking practices, its own policies and the restrictions described above under Item 1.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
For a discussion of legal proceedings see Note 13, “Commitments and Contingencies” in the Consolidated Financial Statements.
Although the amount of any ultimate liability with respect to such proceedings cannot be determined, in the opinion of management, any such liability will not have a material effect on the consolidated financial position of the Corporation or the Bank.
ITEM 4.
ITEM 4.
REMOVED AND RESERVED.
PART II
ITEM 5.
ITEM 5.
MARKET FOR THE COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER OF PURCHASES OF EQUITY SECURITIES
The Corporation’s stock is traded on the OTCBB) a quotation service for securities not listed or traded on NASDAQ or a national securities exchange, under the stock symbol “NRLB.” The Corporation also has knowledge of a limited number of transactions conducted between individual shareholders.
The Corporation currently has one company which makes a market for its common stock, Howe Barnes Hoeffer & Arnett.
At December 31, 2009, there were 530 record holders of common stock of the Corporation. This does not reflect the number of persons or entities who hold their stock in nominee or street name through various brokerage firms.
The Corporation repurchased 20,678 and 46,010 shares of common stock in 2009 and 2008, respectively, at an average price of $4.10 and $7.41 per share in 2009 and 2008, respectively; no shares were repurchased in 2007.
The information in the following table indicates the high and low bid information and volume of trading for our Common Stock for each quarterly period since January 1, 2007, and is based upon information provided by the OTCBB. The information does not include transactions for which no public records are available. The OTCBB market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions.
The principal source of cash flow of the Corporation, including cash flow to pay dividends on its stock or principal and interest on debt, is from interest and dividends on investments and tax benefit payments and dividends from the Bank. There are statutory and regulatory limitations on the payment of dividends by the Bank to the Corporation, as well as by the Corporation to its shareholders.
If in the opinion of the applicable federal and/or state regulatory authority, a depository institution or holding company is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the depository institution or holding company, could include the payment of dividends), such authority may require, after notice and hearing (except in the case of an emergency proceeding where there is in no notice or hearing), that such institution or holding company cease and desist from such practice. Moreover, the Federal Reserve and the FDIC have issued policy statements which provide that bank holding companies and insured depository institutions generally should only pay dividends out of current operating earnings.
Under the FDICIA, an FDIC insured depository institution may not pay any dividend if payment would cause it to become undercapitalized or once it is undercapitalized.
The Bank’s payment of dividends, as a California chartered commercial banking corporation, is also regulated by the California Financial Code. Under the California Financial Code, funds available for cash dividend payments by the Bank are restricted to the lessor of: (i) retained earnings; or (ii) the Bank’s net income for its last three fiscal years (less any distributions
to the shareholders made during such period). As of December 31, 2009 the Bank had $16,347,000 in retained earnings. The Bank’s net income for the last three fiscal years less distributions to shareholders was $6,577,000.
The Corporation did not pay a cash dividend in 2009. In December 2008 and 2007 the Corporation paid cash dividends of $0.25 per share. The Bank paid cash dividends totaling $500,000 and $800,000 to the Corporation during 2009 and 2007, respectively; no dividends were paid by the Bank in 2008.
The Corporation has deferred interest payments on its subordinated debt securities, therefore it may not pay any dividends or distribution on its capital stock until the total deferred interest is paid. Additionally the Corporation, prior to paying any dividend or distribution, must request the prior approval of the Federal Reserve Bank.
The Bank must request the prior approval of the Federal Deposit Insurance Corporation and the California Department of Financial Institutions before paying any dividends to the Corporation.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
(1) Basic earnings per share amounts were computed on the basis of the weighted average number of shares of common stock during the year. The weighted average number of shares used for this computation was 1,791,218
for 2009, 1,823,965 for 2008, 1,785,812 for 2007, 1,658,675 for 2006 and 1,614,196 for 2005.
(2) Fully diluted earnings per share amounts were computed on the basis of the weighted average number of shares of common stock and common stock equivalents outstanding during the year. Common stock equivalents include employee stock options. The weighted average number of shares used for this computation was 1,795,764, 1,848,173, 1,881,004, 1,831,892 and 1,923,532 in 2009, 2008, 2007, 2006 and 2005, respectively.
(3) Weighted average common shares.
(4) Includes loans being held for sale.
(5) Averages are of daily balances.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
OVERVIEW
General
The following discussion reviews and analyzes the operating results and financial condition of the Corporation, focusing on the Bank. It should be read in conjunction with the consolidated financial statements and the other financial data presented elsewhere herein.
Net income for each of the last three years was $1,611,000 in 2009, $1,462,000 in 2008, and $1,929,000 in 2007. The net income per share for each of the last three years was $0.90, $0.80, and $1.08 respectively. The diluted net income per share for the same time periods was $.90, $0.79 and $1.03, respectively. Return on average shareholders’ equity was 9.98%, 10.67%, and 14.09% in 2009, 2008 and 2007, respectively. Return on average assets was 0.55%, 0.54%, and 0.91% in 2009, 2008 and 2007, respectively.
The increase in earnings in 2009 compared to 2008 was due to an increase in noninterest income of $5,089,000 and a decrease of $940,000 in income tax expense, partially offset by a decrease of $1,804,000 in net interest income after provision for loan losses and an increase of $4,077,000 in noninterest expense.
The decrease in earnings in 2008 compared to 2007 was due to a decrease of $2,455,000 in net interest income after provision for loan losses, partially offset by an increase in noninterest income of $695,000, and decreases of $98,000 in noninterest expense and $1,195,000 in income tax expense.
Critical Accounting Policies
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the Corporation’s financial statements and accompanying notes. Management believes that the judgments, estimates and assumptions used in preparation of the Corporation’s financial statements are appropriate given the factual circumstances as of December 31, 2009.
Various elements of the Corporation’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Critical accounting policies are those that involve the most complex and subjective decisions and
assessments and have the greatest potential impact of the Corporation’s results of operations. In particular, management has identified one accounting policy that, due to judgments, estimates and assumptions inherent in this policy, and the sensitivity of the Corporation’s consolidated financial statements to those judgments, estimates and assumptions, are critical to an understanding of the Corporation’s consolidated financial statements. This policy relates to the methodology that determines the allowance for loan and lease losses. Management has discussed the development and selection of this critical accounting policy with the Audit Committee of the Board of Directors. Although Management believes the level of the allowance at December 31, 2009 is adequate to absorb losses inherent in the loan portfolio, a decline in the regional economy may result in increasing losses that cannot reasonably be predicted at this time. For further information regarding the allowance for loan losses see “Provision and Allowance for Loan and Lease Losses,” and Note 6 to the Corporation’s audited consolidated financial statements included elsewhere herein.
Recently Issued Accounting Standards
Refer to Note 1 to the Financial Statements - “Summary of Significant Accounting Policies” for discussion of the recently issued accounting standards.
NET INTEREST INCOME
Net interest income, the difference between (a) interest and fees earned on interest-earning assets and (b) interest paid on interest-bearing liabilities, is the most significant component of the Bank’s earnings. Changes in net interest income from period to period result from increases or decreases in the average balances of interest-earning assets portfolio, the availability of particular sources of funds and changes in prevailing interest rates.
The following table summarizes the Corporation’s net interest income.
Net interest income increased $433,000 or 6.40% from 2008 to 2009. Average interest-earning assets increased 6.75%, while the average rate earned decreased 66 basis points, resulting in a decrease of $1,238,000 in total interest income. Interest expense decreased $1,670,000, the result of a 7.04% increase in average interest-bearing liabilities, while the average rate paid decreased 98 basis points.
Net interest income decreased $2,188,000 or 24.5% from 2007 to 2008. Average interest-earning assets increased 28.19%, while the average rate earned decreased 202 basis points, resulting in a decrease of $441,000 in total interest income. Interest expense increased $1,747,000, the result of a 33.04% increase in average interest-bearing liabilities, while the average rate paid decreased 40 basis points.
Average Balances, Interest Income and Expense, Rates and Yields
The following table shows the components of net interest income, setting forth, for each of the three years ended December 31, 2009, 2008 and 2007 (i) average assets, liabilities and investments, (ii) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (iii) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (iv) the net interest spread (i.e., the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities) and (v) the net interest yield on average interest-earning assets (i.e., net interest income divided by average interest-earning assets). Yields are computed on a tax-equivalent basis, resulting in adjustments to interest earned on non-taxable securities of $1,026,000, $378,000 and $148,000 in 2009, 2008 and 2007, respectively. Non-accrual loans and overdrafts are included in average loan balances. Average loans are presented net of unearned income.
Rate and Volume Analysis
The following tables show the increase or decrease in interest income, interest expense and net interest income, resulting from changes in rates and volumes, for the year ended December 31, 2009 compared with the same period in 2008 and for the year ended December 31, 2008 compared with the same period in 2007:
PROVISION AND ALLOWANCE FOR LOAN AND LEASE LOSSES
The Corporation maintains a detailed, systematic analysis and procedural discipline to determine the amount of the allowance for loan losses (“ALLL”). The ALLL is based on estimates and is intended to be adequate to provide for probable losses inherent in the loan portfolio. This process involves deriving probable loss estimates that are based on individual loan loss estimation, historical loss rates and management’s judgment.
The Corporation employs several methodologies for estimating probable losses. Methodologies are determined based on a number of factors, including type of asset, risk rating, concentrations, and collateral value.
The Corporation calculates the required ALLL on a quarterly basis and makes adjusting entries as needed. The review of the adequacy of the allowance takes into consideration such factors as concentrations of credit, changes in the growth, size and composition of the loan portfolio, overall and individual portfolio quality, review of specific problem loans, collateral, guarantees and economic conditions that may affect the borrowers’ ability to pay and/or the value of the underlying collateral. Additional factors considered include: geographic location of borrowers, changes in the Corporation’s product-specific credit policy and lending staff experience. These estimates depend on subjective factors and, therefore, contain inherent uncertainties.
The Corporation’s ALLL is maintained at a level believed adequate by management to absorb known and inherent probable losses on existing loans. A provision for loan losses is charged to expense. The allowance is charged for losses when management believes that full recovery on the loan is unlikely. Generally, the Corporation charges off any loan classified as a “loss”; portions of loans which are deemed to be uncollectible; overdrafts which have been outstanding for more than 90 days; and, all other unsecured loans past due 120 or more days. Subsequent recoveries, if any, are credited to the ALLL.
Although no assurance can be given that actual losses will not exceed the amount provided for in the allowance, Management believes that the allowance is adequate to provide for all estimated credit losses in light of all known relevant factors. At the end of 2009, 2008 and 2007, the Bank’s allowance stood at 2.12%, 1.42%, and 1.19% of gross loans, respectively. Provisions were made to the allowance for loan and lease losses in 2009, 2008 and 2007 of $3,368,000, $1,132,000, and $865,000, respectively. Loans charged off in 2009, 2008 and 2007 totaled $2,329,000, $750,000 and $250,000, respectively. Recoveries for these same periods were $77,000, $3,000, and $4,000, respectively.
The Bank’s non-performing (delinquent 90 days or more and on non-accrual) loans as a percentage of total loans were 5.33% 4.18% and 1.98% as of the end of 2009, 2008 and 2007, respectively. The significant increase in non-accrual loans is primarily attributable to the continued economic slowdown and the softening of the real estate market.
NON-INTEREST INCOME
The following table presents a summary of the noninterest income:
Total noninterest income increased $5,089,000 or 101.15% in 2009 when compared with 2008. The increase resulted from increases in gain on sales of investment securities of $2,740,000, other income of $2,410,000, and income from sales and servicing of Small Business Administration loans of $71,000, while service charges on deposit accounts decreased $133,000. The increase in other income was due to increases in merchant discount fees of $1,764,000, fee income from credit card programs of $561,000 and a reduction of $829,000 in losses on trading assets ($138,000 of losses in 2009 compared with a loss of $967,000 in 2008); partially offset by fee income from stored value card programs decreasing $74,000 and the gain of $694,000 on the mandatory repurchase of Visa, Inc. in conjunction with Visa, Inc.’s initial public offering reported in 2008.
Total noninterest income increased $695,000 or 16.03% in 2008 when compared with 2007. The increase resulted from increases in service charges on deposit accounts of $126,000 and other income of $720,000; while income from sales and servicing of Small Business Administration loans decreased $151,000. The increase in other income was due primarily to a gain of $694,000 on the mandatory repurchase of Visa, Inc. in conjunction with Visa, Inc.’s initial public offering, increases in gains on security sales of $233,000 and merchant discount fees of $308,000; partially offset by $944,000 in losses on trading assets compared with a loss of $686,000 in 2007, and decreases of $170,000 in fee income from credit card programs and $138,000 in stored value card programs.
The sale of Small Business Administration (SBA) guaranteed loans is a contributor to the Bank’s income. SBA guaranteed loans yield up to 3.75% over the New York prime rate, and the guaranteed portions can be sold at premiums which vary with market conditions. SBA loans are guaranteed by the full faith of the United States Government up to 85% of the principal amount. The guaranteed portion has risks comparable for an investor in a U.S. Government security and can usually be sold in the secondary financial market, either at a premium or at a yield which allows the Bank to maintain a significant spread for itself.
There can be no assurance that the gains on sale of SBA loans will continue at, or above, the levels realized in the past three years. The Small Business Administration has recently increased the guarantee fees borrowers must pay. Increasing competition among lenders for qualified SBA borrowers makes it difficult for the Bank to continually expand its program in this area, and may limit the level of premium that can be earned with regard thereto.
The following table presents a summary of activity in SBA loans for the years ended December 31:
The following table presents a summary of income from sales and servicing of SBA loans for the years ended December 31:
NON-INTEREST EXPENSES
The following table presents a summary of other noninterest expenses:
Salary and benefits expense decreased $573,000 in 2009 due primarily to the Bank limiting merit increases, not paying incentive bonuses and suspending the 401K contribution match and a $184,000 adjustment which reduced the deferred compensation accrual. Salary and benefits expense decreased $385,000 in 2008 due primarily to the Bank not paying incentive bonuses, partially offset by an accrual of $110,000 for post retirement benefits associated with a split-dollar insurance program and an increase of $47,000 in health care insurance premiums.
Occupancy and equipment expenses increased $63,000 in 2009, primarily due to increases of $26,000 in premises rent, $26,000 in depreciation expense and $22,000 in maintenance expense. Occupancy and equipment expenses increased $101,000 in 2008, primarily due to increases of $66,000 in premises rent, $18,000 in depreciation expense, $15,000 in utilities expense, and a
reduction of $24,000 in sublease rental income; while merchant terminal expense decreased $24,000.
Professional fees for 2009 increased $870,000 due primarily to an increase of $677,000 in legal fees and an increase of $170,000 in audit fees. The increase in legal fees was a result of increased collection expense on loans and cost associated with legal proceedings. The increase in acudit fees related to third party reviews deferred in 2008 to 2009 and additional reviews of compliance related matter. Professional fees for 2008 were primarily unchanged when compared to 2007.
Data processing expense for 2009 decreased $68,000 due primarily to negotiation of a new data processing contract. Data processing expense for 2008 was primarily unchanged when compared to 2007.
Other general and administrative expense for 2009 totaled $5,247,000 compared with $3,640,000 for 2008, an increase of $1,607,000. Significant changes occurred in the following categories with increases in merchant processing expense of $1,370,000, FDIC and state assessments of $398,000, loan expenses of $105,000 and stored value card program expense of $65,000; while decreases occurred in ATM expense of $79,000, business development of $55,000, operational losses of $164,000 and stationary/supplies expense of $46,000.
Other general and administrative expense for 2008 totaled $3,640,000 compared with $3,564,000 for 2007, an increase of $76,000. Significant changes occurred in the following categories with increases in merchant processing expense of $246,000, FDIC and state assessments of $88,000, ATM expense of $39,000, loan expenses of $29,000 and miscellaneous expense of $22,000; while decreases occurred in advertising of $61,000, business development of $56,000, operational losses of $25,000, director fees of $24,000 and entertainment and meals of $23,000.
INCOME TAXES
In 2009, the provision for federal and state income taxes was a benefit of $(659,000), while the provision was $281,000 and $1,476,000 for 2008 and 2007, respectively. This represents (69.17%) of income before taxes (benefit) in 2009, 16.12% in 2008 and 43.35% in 2007. The decrease in the effective tax rate for 2009 is a direct result of the Bank’s investing in tax-exempt securities, increased taxable deductions for provisions to the allowance for loan and lease losses and recognition of a tax benefit for losses on trading assets.
The amount of the tax provision is determined by applying the statutory income tax rates to pre-tax book income, adjusted for permanent differences between pre-tax book income and actual taxable income. Such permanent differences include but are not limited to tax-exempt interest income, increases in the cash surrender value of life insurance, and certain other expenses that are not allowed as tax deductions.
LOANS
Loans, the largest component of earning assets, represented 64.07% of average earning assets, and 57.56% of average total assets during 2009, compared with 67.23% and 61.48%, respectively during 2008. In 2009, average loans increased 1.74% from $166,960,000 in 2008 to $169,853,000. Average real estate loans increased $6,837,000 or 5.09%, average commercial loans increased $3,617,000 or 11.62% and average installment loans increased $1,071,000 or 120.60%;
while average construction loans decreased $8,632,000 or 41.41%.
Loans represented 67.23% of average earning assets, and 61.80% of average total assets during 2008, compared with 75.85% and 69.11%, respectively during 2007. In 2008, average loans increased 13.62% from $146,944,000 in 2007 to $166,960,000. Average real estate loans increased $17,314,000 or 17.89%, average commercial loans increased $2,799,000 or 9.88% and average installment loans increased $193,000 or 27.82%; while average construction loans decreased $290,000 or 1.37%.
Loans represented 75.85% of average earning assets, and 69.11% of average total assets during 2007, compared with 75.79% and 69.17%, respectively during 2006. In 2007, average loans increased 23.80% from $118,699,000 in 2006 to $146,944,000. Average real estate loans increased $16,590,000 or 20.69%, average construction loans increased $9,117,000 or 75.89%, average commercial loans increased $2,687,000 or 10.48%; while average installment loans decreased $149,000 or 17.68%.
The Bank’s commercial and industrial loans are generally made for the purpose of providing working capital, financing the purchase of equipment or inventory, and other business purposes. Such loans generally have maturities ranging from one year to several years. Short-term business loans are generally intended to finance current transactions and typically provide for monthly interest payments with principal being payable at maturity or at 90-day intervals. Term loans (usually for a term of two to five years) normally provide for monthly installments of principal and interest. The Bank from time to time utilizes accounts receivable and inventory as security for loans.
The Bank is the recognized leader for SBA lending in Monterey County, and holds SBA’s coveted Preferred Lender Status. Generally, SBA loans are guaranteed by the SBA for up to 85% of their principal amount, which can be retained in portfolio or sold to investors. Such loans are made at floating interest rates, but generally for longer terms (up to 25 years) than are available on a conventional basis to small businesses. The unguaranteed portion of the loans, although generally supported by collateral, is considered to be more risky than conventional commercial loans because they may be based upon credit standards the Bank would not otherwise apply, such as lower cash flow coverage, or longer repayment terms.
The Bank’s real estate loan portfolio consists both of real estate construction loans and real estate mortgage loans. The Bank has initiated a program to generate more commercial and industrial real estate loans, which generally yield higher returns than normal commercial loans. The Bank has also developed a broker program for generating residential real estate loans. The Bank does not make real estate development loans. Real estate construction loans are made for a much shorter term, and often at higher interest rates, than conventional single-family residential real estate loans. The cost of administering such loans is often higher than for other real estate loans, as principal is drawn on periodically as construction progresses.
The Bank also makes real estate loans secured by a first deed of trust on single family residential properties and commercial and industrial real estate. California commercial banks are permitted, depending on the type and maturity of the loan, to lend up to 90% of the fair market value of real property (or more if the loan is insured either by private mortgage insurers or governmental agencies). In certain instances, the appraised value may exceed the actual amount which could be realized on foreclosure, or declines in market value subsequent to making the loan can impair the Bank’s security.
Consumer loans are made for the purpose of financing the purchase of various types of consumer goods, home improvement loans, auto loans and other personal loans. Consumer installment loans generally provide for monthly payments of principal and interest, at a fixed rate. Most of the Bank’s consumer installment loans are generally secured by the personal property being purchased. The Bank generally makes consumer loans to those customers with a prior banking relationship with the Bank.
The following table presents the composition of the loan portfolio, including loans held for sale, at December 31 for the last five years:
The following table shows the maturity distribution and repricing intervals of the Bank’s outstanding loans, excluding non-accrual loans, at December 31, 2009. Balances of fixed rate loans are displayed in the column representative of the loan’s stated maturity date. Balances for variable rate loans are displayed in the column representative of the loan’s next interest rate change.
Loan Concentrations
The Corporation has concentration in real estate secured loans. At December 31, 2009, loans secured by real estate totaled $121,887,000, or 73.00% of the total loan portfolio, compared to $122,951,000, or 72.38%, at December 31, 2008. While there is a concentration in real estate secured loans, the risk associated with that concentration is mitigated by the diversity of types of real estate held as collateral and the variety of businesses that are borrowers. The Corporation’s lending is concentrated in its primary lending area of Monterey County, California with $139,334,000, or 83.56%, located in this area at December 31, 2009 compared to $125,650,000, or 73.97%, at December 31, 2008.
Concentration of loans for specific industries and their percentage of total loans at December 31, 2009 and 2008 are as follows:
Non-performing and Non-accrual Loans
The Bank’s present policy is to cease accruing interest on loans which are past due as to principal or interest 90 days or more, except for loans which are well secured or when collection of interest and principal is deemed likely. When a loan is placed on non-accrual, previously accrued and unpaid interest is generally reversed out of income unless adequate collateral from which to collect the principal of and interest on the loan appears to be available.
The following table presents information with respect to loans which, as of the dates indicated, were past due 90 days or more or were placed on non-accrual status (referred to collectively as “non-performing loans”) and other real estate owned (“OREO”), which are foreclosed properties:
Interest income of $103,000 and $218,000 for the years ended December 31, 2009 and 2008, was recognized on the non-accruing and restructured loans listed in the table above; whereas, interest income of $578,000 and $602,000 would have been recognized under their original terms.
Potential Problem Loans
In addition to loans classified for regulatory purposes, management also designates certain loans for internal monitoring purposes in a “watch” category. Loans may be placed on management’s watch list as a result of delinquent status, concern about the borrower’s financial condition or the value of the collateral securing the loan, substandard classification during regulatory examinations, or simply as a result of management’s desire to monitor more closely a borrower’s financial condition and performance. “Watch” category loans may include loans with loss potential that are still performing and accruing interest and may be current under the terms of the loan agreements; however, management may have a significant degree of concern about the borrowers’ ability to continue to perform according to the terms of the loans. Loss exposure on these loans is typically evaluated based primarily upon adequacy of the cash flow repaying the loan or the estimated liquidation value of the collateral securing these loans. Also, “watch” category loans may include credits which, although adequately secured and performing, have past delinquency problems or where unfavorable financial trends are exhibited by borrowers.
All watch list loans are subject to additional scrutiny and monitoring on a monthly or quarterly basis. The Company’s philosophy encourages loan officers to identify borrowers that should be monitored in this fashion and believes this process ultimately results in the identification of problem loans in a more timely fashion.
Management has identified $4,893,000 and $7,901,000 of loans on its watch list, which were not included in impaired or non-performing loans at December 31, 2009 and 2008, respectively.
The Bank does not have any foreign loans or loans for highly leveraged transactions.
Summary of Loan Loss Experience
The following table reflects the activity in the Corporation’s allowance for loan and lease losses for the years ended December 31, 2009, 2008, 2007, 2006 and 2005:
The following table summarizes the allocation of the allowance for loan and lease losses by loan type based on the Bank’s methodology for evaluating its allowance, and the percent of loans and leases in each category to total loans at the dates indicated. The allocation of individual categories of loans includes amounts applicable to specifically identified as well as unidentified losses inherent in that segment of the loan portfolio and will necessarily change whenever management determines that the risk characteristics of the loan portfolio have changed. Management believes that any breakdown or allocation of the allowance for loan losses into loan categories lends an appearance of exactness which does not exist, in that the allowance is utilized as a single allowance available for all loans. The allocation below should not be interpreted as an indication of the specific amounts of or loan categories in which future charge-offs may occur:
FUNDING SOURCES
Average deposits increased 13.85% to $207,073,000 in 2009 from $184,017,000 in 2008. In 2009 average certificates of deposit increased 15.32% and average demand deposits increased 10.96% while average interest checking, money market savings accounts as a group decreased 2.06%. Average certificates of deposit represented 74.21% of average deposits in 2009 compared with 72.42% in 2008. Average interest checking, money market and savings accounts as a group were 10.62% of average deposits in 2009 compared with 12.20% in 2008. Average demand deposits represented 15.17% of average deposits in 2009 compared with 15.38% in 2008.
The following table summarizes the distribution of average daily deposits and the average daily rates paid for the years ended December 31, 2009, 2008, 2007, respectively.
The following table sets forth the scheduled maturities of time deposits in denominations of $100,000 or greater, which amounted to $58,701,000 at December 31, 2009:
Maturities of Time Deposits of $100,000 or more
At December 31, 2009
($ in thousands)
The Corporation has a line of credit with M & I Marshall & Ilsley Bank in the amount of $3,000,000, at a fixed interest rate of 6.50% and a maturity date of April 30, 2010. At December 31, 2009, $2,850,000 was advanced on the line.
The Bank has lines of credit from the FHLB of San Francisco, and the Federal Reserve Bank with remaining available borrowing capacity on December 31, 2009 of $1,337,000 and $2,707,000, respectively. The Federal Home Loan Bank line of credit has a maximum borrowing capacity of 20% of the Bank’s total assets, adjusted quarterly. The FHLB line of credit is secured by a portion of the Bank’s real estate secured loans and securities at December 31, 2009. At December 31, 2009, the total principal balance of pledged loans and securities was $43,869,000 and $8,470,000, respectively. At December 31, 2008, the total principal balance of pledged loans and securities was $38,597,000 and $43,044,000, respectively.
The Federal Reserve Bank discount window line is secured by a portion the Bank’s securities. At December 31, 2009 and 2008 the total market value of securities pledged was $24,245,000 and $21,448,000, respectively. At December 31, 2009 and 2008 the remaining available credit on the line was $2,707,000 and $7,165,000, respectively.
The following table provides information on FHLB advances outstanding at December 31, 2009.
The Bank had a loan from the FRB in the amount of $10,000,000 with an interest rate of 0.50% and a maturity date of January 11, 2010. At maturity, the loan was paid off with cash funds and funding from a new loan in the amount of $5,000,000 with the same terms and a maturity date of February 8, 2010. The loan was paid off at maturity on February 8, 2010.
The Bank has two letters of credit issued by FHLB of San Francisco. One letter of credit in the amount of $330,000, expiring April 20, 2011, is used to secure local agency deposits. The beneficiary of the letter of credit is the Administrator of Local Agency Security, DFI. The other letter of credit, in the amount of $1,300,000, expiring February 17, 2019, has MasterCard International Inc. as the beneficiary.
CAPITAL RESOURCES
The Corporation and the Bank maintain capital to comply with legal requirements, to provide a margin of safety for depositors and shareholders, and to provide for future growth and the ability to pay dividends. At December 31, 2009, the Corporation’s shareholders’ equity was $16,150,000 versus $14,352,000 at December 31, 2008. The Corporation paid no cash dividends in 2009, whereas cash dividends of $0.25 per share were paid in 2008 and 2007. The Bank paid cash dividends totaling $500,000, $0 and $800,000 to the Corporation in 2009, 2008 and 2007, respectively.
The FDIC and FRB have adopted capital adequacy guidelines for use in their examination and regulation of banks and bank holding companies. If the capital of a bank or bank holding company falls below the minimum levels established by these guidelines, it may be denied approval to acquire or establish additional banks or non-bank businesses, or the FDIC or Federal Reserve Board may take other administrative actions. The guidelines employ two measures of capital: (1) risk-based capital and (2) leverage capital.
In general, the risk-based capital guidelines provide detailed definitions of which obligations will be treated as capital, and assign different weights to various assets and off-balance sheet items, depending upon the perceived degree of credit risk associated with each asset. Each asset is assigned to one of four risk-weighted categories. For example, 0% for cash and unconditionally guaranteed government securities; 20% for deposits with other banks and fed funds; 50% for state
bonds and certain residential real estate loans; and 100% for commercial loans and other assets. Capital is categorized as either Tier 1 capital, consisting of common shareholders equity, qualifying perpetual preferred stock to certain limits, minority interests in equity accounts of consolidated subsidiary and trust preferred securities to certain limits, less goodwill and other intangibles, or Tier 2 capital, which consists of supplementary capital including allowance for possible credit losses to certain limits, certain preferred stock, eligible subordinated debt, and other qualifying instruments). The guidelines also define and set minimum capital requirements (risk-based capital ratios). All banks are required to maintain Tier 1 capital of at least 4% and total capital of 8.0% of risk-adjusted assets. The Bank had a Tier 1 capital to total risk-adjusted assets capital ratio of 13.27% and 11.93% at December 31, 2009 and 2008, respectively. The Bank’s Tier 1 capital exceeds the minimum regulatory requirement by $18,141,000. The Bank had a Total Risk-Based capital to risk-adjusted assets ratio of 14.53% and 13.13% at December 31, 2009 and 2008, respectively. The Bank’s Total Risk-Based capital exceeds the minimum regulatory requirement by $12,754,000.
The Tier 1 leverage capital ratio guidelines require a minimum leverage capital ratio of 4% of Tier 1 capital to total assets less goodwill. The Bank had a leverage capital ratio of 9.63% and 8.48% at December 31, 2009 and 2008, respectively. The Bank’s Tier 1 leverage capital exceeds the minimum regulatory requirement by $15,182,000.
As of the end of 2009, the Bank was considered to be “well capitalized” by regulatory standards. We do not foresee any circumstances that would cause either the Corporation or the Bank to be less than “well capitalized”, although no assurance can be given that this will not occur.
On March 27, 2003, the Corporation’s wholly owned special-purpose trust subsidiary, Northern California Bancorp, Inc. Trust I (“Trust I”) issued $3 million in cumulative Trust Preferred Securities. The securities bear a floating rate of interest of 3.25% over the three month LIBOR rate, payable quarterly. The effective rate at December 31, 2009 and 2008 was 3.53% and 8.07%, respectively. Concurrent with the issuance of the Trust Preferred Securities, Trust I used the proceeds from the Trust Preferred Securities offering to purchase a like amount of Junior Subordinated Debentures of the Corporation. The Subordinated Debentures are the sole assets of Trust I and are eliminated, along with the related income statement effects, in the consolidated financial statements. The Corporation pays interest on the Junior Subordinated Debentures to Trust I, which represents the sole revenue and sole source of dividend distributions to the holders of the Trust Preferred Securities. The Corporation has the right, assuming no default has occurred, to defer payments of interest on the Junior Subordinated Debentures at any time for a period not to exceed 20 consecutive quarters. The Trust Preferred Securities will mature on April 7, 2033, but can be redeemed, in whole or in part, on any January 7, April 7, July 7 or October 7 on or after April 7, 2008 at par. The Corporation fully and unconditionally guarantees the obligations of Trust I, on a subordinated basis.
The Corporation received $2.91 million from Trust I upon issuance of the Junior Subordinated Debentures, of which $1 million was contributed by the Corporation to the Bank to increase its capital, $1.14 million was used to retire existing Corporation debt and the remainder held as working capital.
On November 13, 2003, the Corporation’s wholly owned special-purpose trust subsidiary, Northern California Bancorp, Inc. Trust II (“Trust II”) issued $5 million in cumulative Trust Preferred Securities. The securities bear a floating rate of interest of 2.85% over the three month LIBOR rate, payable quarterly. The effective rate at December 31, 2009 and 2008 was 3.13% and 6.04%, respectively. Concurrent with the issuance of the Trust Preferred Securities, Trust II used
the proceeds from the Trust Preferred Securities offering to purchase a like amount of Junior Subordinated Debentures of the Corporation. The Subordinated Debentures are the sole assets of Trust II and are eliminated, along with the related income statement effects, in the consolidated financial statements. The Corporation pays interest on the Junior Subordinated Debentures to Trust II, which represents the sole revenue and sole source of dividend distributions to the holders of the Trust Preferred Securities. The Corporation has the right, assuming no default has occurred, to defer payments of interest on the Junior Subordinated Debentures at any time for a period not to exceed 20 consecutive quarters. The Trust Preferred Securities will mature on August 8, 2033, but can be redeemed, in whole or in part, on any February 8, May 8, August 8 or November 8 on or after August 8, 2008 at par. The Corporation fully and unconditionally guarantees the obligations of Trust II, on a subordinated basis.
The Corporation received $4.96 million from Trust II upon issuance of the Junior Subordinated Debentures, of which $2.5 million was contributed by the Corporation to the Bank to increase its capital and the remainder held as working capital.
Under current applicable regulatory guidelines for bank holding companies, a portion of the Trust Preferred Securities qualifies as Tier I Capital, and the remainder as Tier II Capital. No assurance can be given that the Trust Preferred Securities will continue to be treated as Tier I Capital in the future.
The Corporation has exercised its rights in accordance with Section 2.11 Extension of interest Payment Period of the Indentures for both Northern California Bancorp, Inc. Trust I and Trust II to defer interest payments for period not to exceed twenty (20) consecutive quarters.
LIQUIDITY
Liquidity represents the ability to provide sufficient cash flows or cash resources in a manner that enables an entity to meet its obligations in a timely fashion and adequately provide for anticipated future cash needs.
For the Bank, liquidity considerations involve the capacity to meet expected and potential requirements of depositors seeking access to balances and to provide for the credit demands of borrowing customers. In the ordinary course of the Bank’s business, funds are generated from the repayment of loans, maturities within the investment securities portfolio and the acquisition of deposit balances and short-term borrowings. The Bank has lines of credit from the FHLB of San Francisco, and the Federal Reserve Bank with remaining available borrowing capacity on December 31, 2009 of $1,337,000 and $2,707,000, respectively. The FHLB line of credit has a maximum borrowing capacity of 20% of the Bank’s total assets, adjusted quarterly. The Federal Home Loan Bank line of credit is secured by a portion of the Bank’s real estate secured loans and securities. At December 31, 2009, the total principal balance of pledged loans and securities was $43,869,000 and $8,470,000, respectively. At December 31, 2008, the total principal balance of pledged loans and securities was $38,597,000 and $43,044,000, respectively.
The FRB discount window line is secured by a portion the Bank’s securities, at December 31, 2009 and 2008 the total market value of securities pledged was $24,245,000 and $21,448,000. At December 31, 2009 and 2008 the remaining available credit on the line was $2,707,000 and $7,165,000, respectively.
As a matter of policy, the Bank seeks to maintain a level of liquid assets, including marketable investment securities, equal to a least 15% of total assets (“primary liquidity”), while maintaining sources of secondary liquidity (borrowing lines from other institutions) equal to at least
an additional 10% of assets. In addition, it seeks to generally limit loans to not more than 110% of deposits. Within these ratios, the Bank generally has excess funds available to sell as federal funds on a daily basis, and is able to fund its own liquidity needs without the need of short-term borrowing. The Bank’s total liquidity at December 31, 2009, 2008 and 2007 was 27.94%, 35.49%, and 24.31%, respectively, while its average loan to deposit ratio for such years was 82.37%, 89.48% and 100.85%, respectively.
Brokered deposits are deposit instruments, such as certificates of deposit, deposit notes, bank investment contracts and certain municipal investment contracts that are issued through brokers and dealers who then offer and/or sell these deposit instruments to one or more investors. Additionally, deposits on which a financial institution pays an interest rate significantly higher than prevailing rates are considered to be brokered deposits. Federal law and regulation restricts banks from soliciting or accepting brokered deposits, unless the bank is well capitalized under Federal guidelines. The Bank had brokered deposits totaling $11,026,000 and $1,996,000 at December 31, 2009 and 2008, this represented 5.44% and 1.05% of total deposits, respectively, and no brokered deposits at December 31, 2007. None of the Bank’s brokered deposits paid an interest rate significantly higher than prevailing rates.
The Corporation’s sources of revenues and liquidity are the dividends, tax equalization payments or management fees from the Bank and gains on securities held in a trading account and other investments. The ability of the Bank to pay such items to the Corporation is subject to limitations under state and Federal law.
INTEREST RATE RISK
Management of interest rate sensitivity (asset/liability management) involves matching and repricing rates of interest-earning assets with interest-bearing liabilities in a manner designed to optimize net interest income within the constraints imposed by regulatory authorities, liquidity determinations and capital considerations.
The purpose for asset/liability management is to provide stable net interest income growth by protecting the Bank’s earnings from undue interest rate risk. The Bank expects to generate earnings from increasing loan volume, appropriate loan pricing and expense control and not from trying to accurately forecast interest rates. Another important function of asset/liability management is managing the risk/return relationships between interest rate risk, liquidity, market risk and capital adequacy. The Bank gives priority to liquidity concerns followed by capital adequacy, then interest rate risk and market risk in the investment portfolio. The policy of the Bank will be to control the exposure of the Bank’s earnings to changing interest rates by generally maintaining a position within a narrow range around an “earnings neutral position.” An earnings neutral position is defined as the mix of assets and liabilities that generate a net interest margin that is not affected by interest rate changes. However, Management does not believe that the Bank can maintain a totally earnings neutral position. Further, the actual timing of repricing of assets and liabilities does not always correspond to the timing assumed by the Bank for analytical purposes. Therefore, changes in market rates of interest will generally impact the Bank’s net interest income and net interest margin for long or short periods of time.
The Bank monitors its interest rate risk on a quarterly basis through the use of a model which calculates the effect on earnings of changes in the fed funds rate. The model converts a fed funds rate change into rate changes for each major class of asset and liability, then simulates the bank’s net interest margin based on the bank’s actual repricing over a one year period, assuming
that maturities are reinvested in instruments identical to those maturing during the period. The following table shows the affect on net interest income of 100, 200 and a 300 basis point rate shocks and a negative 25 basis point rate shock at December 31, 2009. The table only includes projections for decrease 25 basis points since the Federal Funds target rate is currently between 0% and 0.25%.
INVESTMENT SECURITIES
The Corporation maintains a trading account, at fair value, consisting of marketable securities. At December 31, 2009 and 2008 the account value was $153,000 and $361,000, respectively. In addition the Corporation has investments in Northern California Bancorp Trust I of $93,000 and Northern California Bancorp Trust II of $155,000. These are special-purpose trust subsidiaries which were formed to facilitate the issuance of trust preferred securities.
The following table sets forth the book and market value of investment securities as of December 31, 2009, 2008 and 2007:
INVESTMENT PORTFOLIO MIX
(Dollars in thousands)
The contractual maturities of investment securities as well as yields based on amortized cost of those securities at December 31, 2009 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.
INFLATION
The impact of inflation on a financial institution can differ significantly from that exerted on other companies. Banks, as financial intermediaries, have many assets and liabilities which may move in concert with inflation, both as to interest rates and value. However, financial institutions are affected by inflation’s impact on noninterest expenses, such as salaries and occupancy expenses.
From 2004 through mid-2006, the Bank experienced an increasing rate environment due to the actions of the Federal Reserve, which began increasing rates in mid-2004. Beginning in September 2007 the Federal Reserve began reducing rates and through the date of this Annual Report on Form 10-K, the Federal Reserve has reduced rates 10 times for an overall rate reduction of 525 basis points. Because of the Bank’s ratio of rate sensitive assets to rate sensitive liabilities, the Bank benefits in the short term from an increasing interest rate market and suffers in a decreasing interest rate market. As such, the management of the money supply by the Federal Reserve to control the rate of inflation has an impact on the earnings of the Bank. The changes in interest rates may have a corresponding impact on the ability of borrowers to repay loans with the Bank.
OFF-BALANCE SHEET ARRANGEMENTS
The Bank has various “off-balance sheet” arrangements that might have an impact on its financial condition, liquidity, or results of operations. The Bank’s primary source of funds for its lending is its deposits.
As of December 31, 2009 the Bank had commitments to extend credit in the amount of $14,839,000. 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. Since many of the commitments are expected to expire without being drawn upon, the total amount does not necessarily represent future cash requirements.
CONTRACTUAL OBLIGATIONS
The following table presents, as of December 31, 2009, the Corporation’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts, or other similar carrying value adjustments
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
Not Applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements included in the Consolidated Financial Report issued by Hutchinson and Bloodgood LLP, Certified Public Accountants at the pages indicated
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Cash Flows
5-6
Notes to Consolidated Financial Statements
7-55
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
Not Applicable.
ITEM 9A(T).
ITEM 9A(T). CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain “disclosure controls and procedures,” as such phrase is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed in our Exchange Act reports are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure. We conducted an evaluation under the supervision and with the participation of our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures (“Disclosure Controls”) as of the end of the period covered by this report pursuant to Rule 13a-15(e) of the Exchange Act. Based on this evaluation, our CEO and CFO concluded that our disclosure controls were effective as of the end of the period covered by this report.
Changes in Internal Controls
Our management has evaluated, with the participation of our CEO and our CFO, any changes in our internal control over financial reporting that has occurred during the fourth quarter of our fiscal year ended December 31, 2009, as required by Rule 13a-15(d) of the Exchange Act. Based on this evaluation, we have determined that there has been no change in our internal controls over
financial reporting that has occurred in the fourth quarter of our fiscal year ended December 31, 2009 that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.
Limitations on the Effectiveness of Controls
Our management, including our CEO and CFO, does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, 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. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Corporation have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management or board override of the control.
The design of any system of controls also is based in part upon 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; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
CEO and CFO Certifications
Appearing immediately following the Signatures section of this report there are Certifications of the CEO and the CFO. The Certifications are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section 302 Certifications”). This Item 9A(T) of this report is the information concerning the evaluation referred to in the Section 302 Certifications and this information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. The Corporation’s internal control over financial reporting is a process designed by or under the supervision of our CEO and CFO and effected by our 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.
The Corporation’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Corporation; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of management and directors of the Corporation; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Corporation’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. 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.
Our management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2009. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on this assessment, our management believes that, as of December 31, 2009, the Corporation’s internal control over financial reporting was effective.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not Applicable
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The information required by this Item is incorporated from the Proxy Statement for the Corporation’s 2010 Annual Meeting of Shareholders to be filed by no later than April 30, 2010, or will be provided by amendment to this Annual Report on Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated from the Proxy Statement for the Corporation’s 2010 Annual Meeting of Shareholders to be filed by no later than April 30, 2010, or will be provided by amendment to this Annual Report on Form 10-K.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND RELATED STOCKHOLDER MATTERS
The information required by this Item relating to securities authorized for issuance under equity compensation plans is incorporated by reference to the information set forth above under “ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES - Securities Authorized for Issuance Under Equity Compensation Plans.”
Except for information incorporated by reference to information provided under other items of this Annual Report on Form 10-K, the information required by this Item is incorporated from the Proxy Statement for the Corporation’s 2010 Annual Meeting of Shareholders to be filed by no later than April 30, 2010, or will be provided by amendment to this Annual Report on Form 10-K.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated from the Proxy Statement for the Corporation’s 2010 Annual Meeting of Shareholders to be filed by no later than April 30, 2010, or will be provided by amendment to this Annual Report on Form 10-K.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated from the Proxy Statement for the Corporation’s 2010 Annual Meeting of Shareholders to be filed by no later than April 30, 2010, or will be provided by amendment to this Annual Report on Form 10-K.
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
A. EXHIBITS
23.1
Consent of Hutchinson and Bloodgood, LLP
31.1
Certification of the Chief Executive Officer of Northern California Bancorp, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of the Chief Financial Officer of Northern California Bancorp, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of the Chief Executive Officer of Northern California Bancorp, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of the Chief Financial Officer of Northern California Bancorp, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
1) Filed as an exhibit to Form 10-KSB dated December 31, 1995.
2) Filed as an exhibit to Form 10-KSB dated December 31, 1999.
3) Filed as an exhibit to Form 10-KSB dated December 31, 2001.
4) Filed as an exhibit to Form 10-KSB dated December 31, 2002.
5) Filed as an exhibit to Form 10-KSB dated December 31, 2004.
6) Filed as an exhibit to Form 10-KSB dated December 31, 2006.
7) Filed as an Exhibit to DEF 14A filed April 26, 2007.
8) Filed as an exhibit to Form 10-QSB dated March 31, 2008.
9 ) Filed as an exhibit to Form 10-KSB dated December 31, 2008.
B. REPORTS
None
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
In accordance with the Exchange Act, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name
Position
Date
/s/ Charles T. Chrietzberg, Jr.
March 29,
Charles T. Chrietzberg, Jr.
Director
/s/ Sandra G. Chrietzberg
March 29,
Sandra G. Chrietzberg
Director
Peter J. Coniglio
Director
/s/ Carla S. Hudson
March 29,
Carla S. Hudson
Director
/s/ John M. Lotz
March 29,
John M. Lotz
Director
/s/ Mark A. Briant
March 29,
Mark A. Briant
Director
/s/ Stephanie G. Chrietzberg
March 29,
Stephanie G. Chrietzberg
Director
NORTHERN CALIFORNIA BANCORP, INC.
AND SUBSIDIARY
CONSOLIDATED FINANCIAL REPORT
December 31,
Page
Report of Independent Registered Public Accounting Firm
FINANCIAL STATEMENTS
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Cash Flows
5-6
Notes to Consolidated Financial Statements
7-55
Report of Independent Registered Public Accounting Firm
To the Board of Directors
Northern California Bancorp, Inc. and Subsidiary
Monterey, California
We have audited the accompanying consolidated balance sheets of Northern California Bancorp, Inc. and its wholly owned subsidiary, Monterey County Bank (collectively the Corporation), as of December 31, 2009 and 2008 and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2009. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Northern California Bancorp, Inc. and its wholly owned subsidiary, Monterey County Bank, as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America.
/s/ Hutchinson and Bloodgood LLP
Glendale, California
March 29, 2010
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2009 and 2008
(Dollars in Thousands, Except Share Data)
The notes to consolidated financial statements are an integral part of these statements.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2009, 2008, and 2007
(Dollars in Thousands, Except Per Share Data)
The notes to consolidated financial statements are an integral part of these statements.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years Ended December 31, 2009, 2008, and 2007
(Dollars in Thousands, Except Share Data)
The notes to consolidated financial statements are an integral part of these statements.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2009, 2008, and 2007
(Dollars in Thousands)
The notes to consolidated financial statements are an integral part of these statements.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2009, 2008, and 2007
(Dollars in Thousands)
The notes to consolidated financial statements are an integral part of these statements.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Northern California Bancorp, Inc., (the Corporation) provides a variety of financial services through Monterey County Bank, (the Bank) to individuals and small businesses through its five offices in Monterey County. Its primary deposit products are demand and term certificate accounts. Its primary lending products are real estate, commercial, construction, and Small Business Administration (SBA) loans.
Basis of Presentation and Consolidation
The consolidated financial statements include the accounts of Northern California Bancorp, Inc. and its wholly owned subsidiary, Monterey County Bank. All significant inter-company balances and transactions have been eliminated in consolidation.
In consolidating, the Corporation determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity under accounting principles generally accepted in the United States of America. Voting interest entities are entities in which the total equity investment at risk is sufficient to enable the entity to finance itself independently and provides the equity holders with the obligation to absorb losses, the right to receive residual returns and the right to make decisions about the entity’s activities. The Corporation consolidates voting interest entities in which it has all, or at least a majority of, the voting interest. As defined in applicable accounting standards, variable interest entities (VIEs) are entities that lack one or more of the characteristics of a voting interest entity. A controlling financial interest in an entity is present when an enterprise has a variable interest, or a combination of variable interests, that will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE. The Corporation’s wholly owned subsidiaries, Northern California Bancorp, Inc. Trust I and Northern California Bancorp, Inc. Trust II, are VIEs for which the Corporation is not the primary beneficiary. Accordingly, the accounts of these entities are not included in the Corporation’s consolidated financial statements.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Use of Estimates
In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of deferred tax assets.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash, amounts due from banks and Federal funds sold on a daily basis, all of which mature within ninety days.
Time Deposits with Other Financial Institutions
Interest-bearing deposits in banks mature within one year and are carried at cost.
Trading Activities
The Corporation engages in trading activities consisting of securities that are held principally for resale in the near term. The securities are recorded in the trading assets account at fair value with changes in fair value recorded in earnings. Interest and dividends are included in net interest income.
Quoted market prices, when available, are used to determine the fair value of trading instruments. If quoted market prices are not available, then the fair values are estimated using pricing models, quoted prices of instruments with similar characteristics, or discounted cash flows.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Investment Securities
Investments in debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and reflected at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income. Other marketable securities are classified as “available for sale” and are reflected at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the Bank does not have the intent to sell the security; and it is more likely than not it will not have to sell the security before recovery of its cost basis.
Gains and losses on disposition are generally recognized on the trade date, based on the net proceeds and the adjusted carrying amount of the securities sold using the specific identification method.
Restricted Stock Investments
Federal Home Loan Bank (FHLB) stock is carried at cost, and is evaluated for impairment based on an estimate of the ultimate recoverability of par value.
Sales and Servicing of SBA Loans
The Bank originates loans to customers under the SBA program that generally provides for SBA guarantees of 70% to 90% of each loan. The Bank generally sells the guaranteed portion of each loan to a third party and retains only the non-guaranteed portion in its own portfolio. A gain is recognized on these loans through collection on sale of a premium over the adjusted carrying value, or through retention of an ongoing rate differential, less a normal service fee between the rate paid by the borrower to the Bank and the rate paid by the Bank to the purchaser (excess servicing fee). In calculating the gain, the Bank assumes that the loans sold will be outstanding for one-half of their contractual lives.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Sales and Servicing of SBA Loans (Continued)
The Bank’s investment in an SBA loan is allocated among the retained portion of the loan, excess servicing retained, and the sold portion of the loan, based on the relative fair market value of each portion at the time of loan origination, adjusted for payments and other activities. Since the portion retained does not carry an SBA guarantee, part of the gain recognized on the sold portion of the loan is deferred and amortized as a yield enhancement on the retained portion of the loan. Excess servicing fees are reflected as an asset which is amortized over an expected half life; in the event future prepayments are significant and future expected cash flows are inadequate to cover the unamortized excess servicing asset, additional amortization is recognized.
Loans Held for Sale
Loans held for sale consist of the portion of loans that are guaranteed by the SBA and are carried at the lower of cost or market. Market value for loans guaranteed by the SBA is generally determined based on the price at which the loans were committed to be sold on the trade date. Direct loan origination costs are recorded at settlement as an adjustment to gain or loss on sale.
Loans and Loan Fees
The Bank grants residential mortgage, commercial, construction, and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans on the Monterey Peninsula. The ability of the Bank’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in the area.
Loans, as reported, have been reduced by undisbursed loan funds, net deferred loan fees, and the allowance for loan losses.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or cost on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loans and Loan Fees (Continued)
The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Credit card loans and other personal loans are typically charged off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Loan origination fees and costs are deferred and amortized as an adjustment of the loan’s yield over the life of the loan using the interest method, which results in a constant rate of return or the straight-line method for lines of credit.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to earnings and is maintained at a level considered adequate to provide for reasonably foreseeable loan losses.
The provision and the level of the allowance are evaluated on a regular basis by management and are based upon management’s periodic review of the collectibility of the loans in light of historical experience, known and inherent risks in the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for losses on loans and other real estate owned. Such agencies may require the Bank to recognize additions to the allowance based on their judgment of information available to them at the time of their examination. Ultimately, losses may vary from current estimates and future additions to the allowance may be necessary.
Loan losses are charged against the allowance when management believes the collectibility of the loan balance is unlikely. Subsequent recoveries, if any, are credited to the allowance.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan Losses (Continued)
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than that of the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Substantially, all of the Bank’s loans that have been identified as impaired have been measured by the fair value of existing collateral.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer loans for impairment disclosures.
Loan Servicing
Rights to service loans for others are capitalized as separate assets, whether acquired through purchase or origination, if such loans are sold or securitized with servicing rights retained. Accordingly, the total cost of the loan is allocated to the related servicing right and to the loan based on the relative fair values if it is practicable to estimate those fair values.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loan Servicing (Continued)
The Bank estimates fair value based on the present value of estimated expected future cash flows using prepayment speeds and discount rates commensurate with the risks involved, and servicing costs determined on an incremental cost basis.
Capitalized mortgage servicing rights are reported in other assets and amortized to servicing revenue in proportion to, and over the period of, estimated future net servicing revenues of the underlying assets. Impairment of mortgage servicing rights is assessed based on the fair value of those rights. For purposes of measuring impairment, the rights are stratified based on the following predominant risk characteristics of the underlying loans: loan type, size, note rate, date of origination, term, and geographic location. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum.
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated cost to sell. Any write-down to fair value at the time of transfer to foreclosed assets is charged to the allowance for loan losses. Property is evaluated regularly to ensure that the recorded amount is supported by its current fair value and that valuation allowances to reduce the carrying amount to fair value less estimated costs to dispose are recorded as necessary. Revenue and expenses from operations of foreclosed assets and changes in the valuation allowance are included in net expenses from foreclosed assets.
Premises and Equipment
The Banks premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives. Leasehold improvements are amortized over the term of the lease or the service lives of the improvements, whichever is shorter. The straight-line method of depreciation is followed for financial reporting purposes, while both accelerated and straight-line methods are followed for income tax purposes.
It is general practice to charge the cost of maintenance and repairs to earnings when incurred; major expenditures for betterments are capitalized and depreciated.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Company Owned Life Insurance
The Company has purchased life insurance policies on certain key executives. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
On September 7, 2006, the Emerging Issues Task Force reached a consensus on the issue, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements, and on March 15, 2007, on the issue, Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements. The scope of these two issues relates to the recognition of a liability and related compensation costs for endorsement split-dollar life insurance arrangements and for collateral assignment split-dollar life insurance arrangements, respectively. Both issues became effective for fiscal years beginning after December 15, 2007, although early adoption was permitted. The Corporation adopted the standards for both issues effective as of January 1, 2008 as a change in accounting principle through a $362,000 cumulative-effect adjustment to retained earnings. The amount expensed to recognize the liability for future benefits for the year ended December 31, 2008 was $110,000.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commitments under credit card advancements, and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable. The credit risk associated with these commitments is considered by management and is reserved for at a level deemed adequate to provide for known and inherent losses.
Income Taxes
Deferred income taxes are recognized for estimated future tax effects attributable to income tax carry forwards as well as temporary differences between income tax and financial reporting purposes. A valuation allowance is established when necessary to reduce the deferred tax asset to the amount expected to be realized. 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. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted accordingly through the provision for income taxes.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes (continued)
The Corporation uses a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions are recognized in the consolidated financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold are recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when 1) the assets have been isolated from the Bank, 2) the transferee (buyer) obtains the right to pledge or exchange the transferred assets, free of conditions that would constrain it from taking advantage of that right, and 3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Stock-Based Compensation Plans
The cost relating to stock-based compensation is measured at the grant-date fair value of the equity instruments issued. Cost is recognized over the required service period, generally defined as the vesting period. The Bank uses the Black-Scholes option pricing model to estimate the fair value of stock options.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings per share
Basic earnings per share represent income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options, and are determined using the treasury stock method. The weighted average number of shares outstanding for basic earnings per share amounted to 1,791,218 for 2009, 1,823,965 for 2008, and 1,785,812 for 2007. The weighted average number of shares outstanding for dilutive earnings per share amounted to 1,795,764 for 2009, 1,848,173 for 2008, and 1,881,004 for 2007. The Corporation paid no cash dividends in 2009, and cash dividends of $.25, per share in 2008 and 2007.
Recent Accounting Pronouncements
In August 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2009-05, Fair Value Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value. This ASU provides amendments for fair value measurements of liabilities. It provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more techniques. ASU 2009-05 also clarifies that when estimating a fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. ASU 2009-05 is effective for the periods beginning after October 1, 2009. Management is assessing the impact of ASU 2009-05 on the consolidated financial condition, results of operations, and disclosures.
In June 2009, the FASB issued ASU No. 2009-01 (formerly Statement No. 168), Topic 105 - Generally Accepted Accounting Principles - FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. The Codification is the single source of authoritative nongovernmental U.S. generally accepted accounting principles (GAAP). The Codification does not change current GAAP, but is intended to simplify user access to all authoritative GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents are superseded and all other accounting literature not included in the Codification is considered non-authoritative. The Codification is effective for interim or annual reporting periods ending after September 15, 2009. Management has made the appropriate changes to GAAP references in the consolidated financial statements.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recent Accounting Pronouncements (continued)
In June 2009, the FASB issued Statement No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140 (SFAS No. 166). SFAS No. 166 amends the de-recognition accounting and disclosure guidance relating to SFAS 140. SFAS No. 166 eliminates the exemption from consolidation for qualifying special purpose entities (QSPEs). It also amends the accounting rules relating to the sale of loans, including the sale of SBA-guaranteed loans. SFAS No. 166 is effective as of the beginning of the first annual reporting period that begins after November 15, 2009. Management is assessing the impact of SFAS No. 166 on the Corporation’s consolidated financial condition, results of operations, and disclosures.
In June 2009, the FASB issued SFAS No. 167, Amendments to Interpretation No. 46(R), which amends guidance for consolidation of variable interest entities by replacing the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has (1) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of the entity or the right to receive benefits from the entity. Additional disclosures about an enterprise’s involvement in variable interest entities are also required. This guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Early adoption is prohibited. Management is assessing the impact of SFAS 167 on the Corporation’s consolidated financial condition, results of operations, and disclosures.
In April 2009, the FASB issued ASC 320 (formerly Staff Position FAS 115-2, FAS 124-2 and EITF 99-20-2), Recognition and Presentation of Other-Than-Temporary-Impairment. ASC 320 (i) changes existing guidance for determining whether an impairment of debt securities is other than temporary and (ii) replaces the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis. Under ASC 320, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of impairment related to other factors is recognized in other comprehensive income. ASC 320 is effective for interim and annual periods ending after June 15, 2009. The adoption of ASC 320 in the second quarter of 2009 did not have an impact on Corporation’s consolidated financial statements. However, the disclosures have been modified to conform to ASC 320, as presented in Note 4.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recent Accounting Pronouncements (continued)
In April 2009, the FASB issued ASC 820 (formerly FSP FAS 157-4), Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. ASC 820 affirms the objective of fair value when a market is not active, clarifies and includes additional factors for determining whether there has been a significant decrease in market activity, eliminates the presumption that all transactions are distressed unless proven otherwise, and requires an entity to disclose a change in valuation technique. ASC 820 is effective for interim and annual periods ending after June 15, 2009. The Corporation adopted the provisions of ASC 820 on April 1, 2009. The provisions of ASC 820 did not have a material impact on Corporation’s consolidated financial condition and results of operations.
Comprehensive Income (Loss)
Accounting principles generally accepted in the United States require that recognized revenue, expenses, gains, and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
The components of other comprehensive income (loss) and related tax effects for the years ended December 31, are as follows:
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Comprehensive Income (Loss) (continued)
The components of accumulated other comprehensive income (loss) and related tax effects as of December 31 are as follows:
Advertising Costs
Advertising costs are charged to operations when incurred. The amount expensed for advertising for the years ended December 31, 2009, 2008, and 2007 was $80,000, $103,000, and $164,000, respectively.
Reclassification
Certain amounts have been reclassified in the 2008 and 2007 financial statements to conform to the 2009 presentation with no changes to previously reported income.
Note 2. CASH AND DUE FROM BANKS
The Corporation is required to maintain aggregate reserves (in the form of cash and deposits with the Federal Reserve Bank) to satisfy federal regulatory requirements. At December 2009 and 2008, the Bank met these requirements by maintaining reserve balances of $1,890,000 and $942,000, respectively.
Note 3. TRADING ASSETS
At December 31, 2009 and 2008, the Corporation’s trading assets consisted of marketable equity securities in the amount of $153,000 and $361,000, respectively.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 4. INVESTMENT SECURITIES AND OTHER INVESTMENTS
The following is a comparison of amortized cost and approximate fair value of investment securities at December 31:
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 4. INVESTMENT SECURITIES AND OTHER INVESTMENTS (Continued)
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 4. INVESTMENT SECURITIES AND OTHER INVESTMENTS (Continued)
On April 1, 2008 State/Local Agency Securities with total amortized cost of $7,869,000 and total fair value of $8,112,000 were transferred from a held to maturity classification to an available for sale classification. Subsequent to the transfer to available for sale, securities with total amortized cost of $4,290,000 and market value of $4,510,000 were sold with a realized gain of $220,000. The change in classification was made in order to provide greater flexibility in managing the security portfolio and increase liquidity.
The amortized cost and fair value of debt securities by contractual maturity date at December 31, 2009 follows:
Proceeds from maturity and sales of investment securities for the years ended December 31, 2009, 2008, and 2007 were $130,659,000, $55,022,000, and $24,217,000, respectively. Realized gains for the years ended December 31, 2009, 2008, and 2007 were $3,189,000, $449,000, and $216,000, respectively.
As a member of the Federal Home Loan Bank (FHLB) system, the Bank is required to maintain an investment in FHLB stock in an amount equal to the greater of 1% of its outstanding mortgage loans or 5% of advances from the FHLB. As of December 31, 2009 and 2008, the Bank had advances from the FHLB totaling $29,000,000 and $66,500,000, respectively. No ready market exists for FHLB stock, and it has no quoted market value. FHLB stock is evaluated for impairment based on an estimate of the ultimate recoverability of par value.
At December 31, 2009 and 2008, U.S. Government and Mortgage Backed obligations with a carrying value of $8,761,000 and $43,044,000, respectively, were pledged to secure advances from the FHLB.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 4. INVESTMENT SECURITIES AND OTHER INVESTMENTS (Continued)
At December 31, 2009 and 2008 State/Local Agency obligations with a carrying value of $20,462,000 and $23,144,000, respectively, were pledged to secure loans from the Federal Reserve Bank.
In December 2008, the Bank purchased three debt securities totaling $3,050,000 that had settlement dates in January 2009. The Bank had recorded the investment securities purchased as of the trade date and had recorded the corresponding payable for investment securities purchased of $3,050,000 at December 31, 2008.
Information pertaining to securities with gross unrealized losses at December 31, 2009, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 4. INVESTMENT SECURITIES AND OTHER INVESTMENTS (Continued)
Information pertaining to securities with gross unrealized losses at December 31, 2008, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the Bank does not have the intent to sell the security; and it is more likely than not it will not have to sell the security before recovery of its cost basis.
On December 31, 2009, forty securities had an unrealized loss with aggregate depreciation of 5.62% from the Bank’s amortized cost basis. On December 31, 2008, fifty five securities had an unrealized loss with aggregate depreciation of 1.20% from the Bank’s amortized cost basis. The unrealized losses relate to a mortgage backed security issued by federally sponsored agencies, which are fully secured by conforming residential loans, securities issued by agencies of the United States and securities issued by local government agencies. Since the Bank has the ability to hold these securities until estimated maturity, no decline is deemed to be other than temporary.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 5. SALES AND SERVICING OF SBA LOANS
A summary of the activity of SBA loans for the years ended December 31 follows:
A summary of income from SBA loans sold for the years ended December 31 is as follows:
Note 6. LOANS AND ALLOWANCE FOR LOAN LOSSES
A summary of loan balances at December 31 follows:
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 6. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
An analysis of the allowance for loan losses for the years ended December 31 follows:
The following table summarizes the Bank’s investment in loans for which impairment has been recognized as of and for the years ended December 31. Impaired loans consist of the loans on non-accrual status.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 6. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
No funds are committed to be advanced in connection with impaired loans.
As of December 31, 2009 and 2008, there were no loans past due ninety days or more and still accruing interest.
Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balance of loans serviced for others was $30,746,000 and $112,849,000 at December 31, 2009 and 2008, respectively.
Note 7. FORECLOSED ASSETS
As of December 31, 2009 and 2008, foreclosed assets totaled $15,343,000 and $7,364,000, respectively. Based on property values, a valuation allowance of $1,010,000 was deemed necessary at December 31, 2009. No valuation allowance was deemed necessary at December 31, 2008.
Subsequent to December 31, 2009, properties valued $8,582,000 were transferred to foreclosed assets. Based on property values, a valuation allowance of $212,000 was deemed necessary for these properties. One property was sold for $225,000, with a gain on sale of $23,000.
Operating expenses for foreclosed assets totaled $326,000 and $112,000 for the years ended December 31, 2009 and 2008, respectively. A net loss of $65,000 was recognized on the sale of foreclosed assets for the year ended December 31, 2009. There were no sales of foreclosed assets during the year ended December 31, 2008.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 8. PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of banking premises and equipment and their estimated useful lives at December 31 follows:
Depreciation and amortization expense for the years ended December 31, 2009, 2008, and 2007 amounted to $332,000, $312,000, and $293,000, respectively.
Note 9. DEPOSITS
At December 31, 2009, the scheduled maturities of time deposits are as follows:
(Dollars in thousands)
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 10. JUNIOR SUBORDINATED DEBT SECURITIES
On March 27, 2003, the Corporation’s wholly owned special-purpose trust subsidiary, Northern California Bancorp, Inc. Trust I (“Trust I”) issued $3 million in cumulative Trust Preferred Securities. The securities bear a floating rate of interest of 3.25% over the three month LIBOR rate, payable quarterly. The effective rate at December 31, 2009 and 2008 was 3.53% and 8.07%, respectively. Concurrent with the issuance of the Trust Preferred Securities, Trust I used the proceeds from the Trust Preferred Securities offering to purchase a like amount of Junior Subordinated Debentures of the Corporation. The Corporation will pay interest on the Junior Subordinated Debentures to Trust I, which represents the sole revenue and sole source of dividend distributions to the holders of the Trust Preferred Securities. The Corporation has the right, assuming no default has occurred, to defer payments of interest on the Junior Subordinated Debentures at any time for a period not to exceed 20 consecutive quarters. The Trust Preferred Securities will mature on April 7, 2033, but can be redeemed, in whole or in part, on any January 7, April 7, July 7 or October 7 occurring after April 7, 2008 at par. The Corporation fully and unconditionally guarantees the obligations of Trust I, on a subordinated basis.
The Corporation received $2.91 million from Trust I upon issuance of the Junior Subordinated Debentures, of which $1 million was contributed by the Corporation to the Bank to increase its capital, $1.14 million was used to retire existing Corporation debt and the remainder was held as working capital. Under applicable regulatory guidelines, a portion of the Trust Preferred Securities will qualify as Tier I Capital and the remainder as Tier II Capital.
On November 13, 2003, the Corporation’s wholly owned special-purpose trust subsidiary, Northern California Bancorp, Inc. Trust II (“Trust II”) issued $5 million in cumulative Trust Preferred Securities. The securities bear a floating rate of interest of 2.85% over the three month LIBOR rate, payable quarterly. The effective rate at December 31, 2009 and 2008 was 3.13% and 6.04%, respectively. Concurrent with the issuance of the Trust Preferred Securities, Trust II used the proceeds from the Trust Preferred Securities offering to purchase a like amount of Junior Subordinated Debentures of the Corporation. The Corporation will pay interest on the Junior Subordinated Debentures to Trust II, which represents the sole revenue and sole source of dividend distributions to the holders of the Trust Preferred Securities. The Corporation has the right, assuming no default has occurred, to defer payments of interest on the Junior Subordinated Debentures at any time for a period not to exceed 20 consecutive quarters. The Trust Preferred Securities will mature on November 8, 2033, but can be redeemed, in whole or in part, on any February 8, May 8, August 8 or November 8 occurring after November 8, 2008 at par. The Corporation fully and unconditionally guarantees the obligations of Trust II on a subordinated basis.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 10. JUNIOR SUBORDINATED DEBT SECURITIES (Continued)
The Corporation received $4.96 million from Trust II upon issuance of the Junior Subordinated Debentures, of which $2.5 million was contributed by the Corporation to the Bank to increase its capital and the remainder was held as working capital.
Issuance costs of $116,000 and $54,000 related to Trust I and Trust II, respectively have been capitalized and are being amortized over the 30-year life of the securities.
During the years ended December 31, 2009, 2008 and 2007 interest expense on Junior Subordinated Debentures totaled $328,000, $534,000, and $696,000, respectively. The amortization of the issuance cost totaled $6,000 for each year ended December 31, 2009, 2008 and 2007, respectively.
The Corporation exercised its rights in accordance with Section 2.11 Extension of Interest Payment Period of the Indentures dated March 27, 2003 and November 13, 2003, for Northern California Bancorp, Inc. Trust I and Trust II, respectively, to defer interest payments for an undetermined period of time, not to exceed twenty (20) consecutive quarterly payments. The deferral of interest payments on Northern California Bancorp, Inc. Trust I was effective with the October 7, 2009 interest payment. At December 31, 2009 accrued and unpaid interest totaled $60,000. The deferral of interest payments on Northern California Bancorp, Inc. Trust II was effective with the November 8, 2009 interest payment. At December 31, 2009 accrued and unpaid interest totaled $65,000.
Note 11. FUNDING SOURCES
The Corporation has a line of credit with M & I Marshall & Ilsley Bank in the amount of $3,000,000, a fixed interest rate of 6.50% and a maturity date of April 30, 2010. At December 31, 2009, $2,850,000 was advanced on the line.
The Bank has lines of credit from the Federal Home Loan Bank (FHLB) of San Francisco, and the Federal Reserve Bank with remaining available borrowing capacity on December 31, 2009 of $1,337,000, $2,707,000, respectively. The Federal Home Loan Bank line of credit has a maximum borrowing capacity of 20% of the Bank’s total assets, adjusted quarterly. The FHLB line of credit is secured by a portion of the Bank’s real estate secured loans and securities at December 31, 2009. At December 31, 2009, the total principal balance of pledged loans and securities was $43,869,000 and $8,470,000, respectively. At December 31, 2008, the total principal balance of pledged loans and securities was $38,597,000 and $43,044,000, respectively.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 11. FUNDING SOURCES (Continued)
The Federal Reserve Bank discount window line is secured by a portion the Bank’s securities, at December 31, 2009 and 2008 the total market value of securities pledged was $24,245,000 and $21,448,000. At December 31, 2009 and 2008 the remaining available credit on the line was $2,707,000 and $7,165,000, respectively. No advances were outstanding on line at December 31, 2009 and 2008.
The following table provides information on ten FHLB advances outstanding at December 31, 2009.
The Bank has a loan from the Federal Reserve Bank in the amount of $10,000,000 with an interest rate of 0.50% and a maturity date of January 11, 2010. At maturity, the loan was paid off with cash funds and funding from a new loan in the amount of $5,000,000 with the same terms and a maturity date of February 8, 2010. The loan was paid off at maturity on February 8, 2010.
The Bank has two letters of credit issued by FHLB of San Francisco. One letter of credit in the amount of $330,000, expiring April 20, 2011, is used to secure local agency deposits. The beneficiary of the letter of credit is the Administrator of Local Agency Security, Department of Financial Institutions. The other letter of credit in the amount of $1,300,000, expiring February 17, 2019 has MasterCard International Inc. as the beneficiary.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 12. INCOME TAXES
Allocation of federal and California income taxes between current and deferred portions for the year ended December 31 is as follows:
The differences between the statutory federal income tax rates and the effective tax rates for the years ended December 31 are summarized as follows:
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 12. INCOME TAXES (Continued)
The components of the net deferred tax asset, included in other assets at December 31, are as follows:
The tax effects of each type of income and expense item that give rise to deferred taxes at December 31 are as follows:
The Bank establishes a valuation allowance if, based on the weight of evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 12. INCOME TAXES (Continued)
The Corporation adopted the provisions of ASC 740, formerly FIN 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. The Corporation had no unrecognized tax benefits which would have required an adjustment to the January 1, 2007 beginning balance of retained earnings. The Corporation has no unrecognized tax benefits at December 31, 2009 and 2008. The Corporation recognizes, when applicable interest accrued and penalties related to unrecognized tax benefits in tax expense. During the years ended December 31, 2009 and 2008 the Corporation recognized no interest and penalties.
Note 13. COMMITMENTS AND CONTINGENCIES
In the normal course of business, there are outstanding commitments that are not reflected in the consolidated financial statements.
Operating lease commitments
The Bank leases its branch offices in Carmel By-The-Sea, Carmel Valley, Pacific Grove and a Salinas branch office which opened during the second quarter of 2008. The Carmel By-The-Sea office has a five and one half year lease with four, five year options and commenced in April 2002. The Carmel Valley building had a twenty-five year lease which commenced in March 1981 and an addendum to the lease executed in 2005 provides for two options to renew the lease for an additional 10 years each, and may be adjusted annually for changes in the Consumer Price Index. The Pacific Grove building has a five-year lease with five, five-year options and commenced in April 1997. The Salinas building has a five-year lease with four, five-year options and commenced in November 2007. The Bank leases approximately 1,000 square feet of office space at 321 Webster Street, Monterey, CA, which had a term of three years commencing September 2000, with a three-year option. An addendum to the lease was executed in 2004 and provided for two, five year options to extend the lease, which commenced in September 2006. The Bank also leases certain equipment used in the normal course of business.
Rent expense for operating leases is included in occupancy and equipment expense and amounted to approximately $378,000, $352,000, and $286,000 for the years ended December 31, 2009, 2008, and 2007, respectively.
Effective November 1, 2009, the Bank entered into a one year sublease agreement to rent one of the units in the Carmel-By-The-Sea branch for a monthly rent of $2,000.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 13. COMMITMENTS AND CONTINGENCIES (Continued)
Operating lease commitments (Continued)
Future minimum lease commitments for all non-cancelable operating leases are as follows:
Loan commitments
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. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Bank’s exposure to credit loss is represented by the contractual amount of these commitments. The Bank uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
At December 31, 2009 and 2008, such commitments to extend credit were $14,839,000 and $13,941,000, respectively, of undisbursed lines of credit, undisbursed loans in process, and commitment letters.
Contingencies
The Corporation, its principal subsidiary Monterey County Bank and its Chief Executive Officer were named as defendants in a lawsuit filed by Golden State Bank on November 3, 2008 in the Monterey County Court-Civil Division. The lawsuit involved claims related to loan participations and seeks to compel arbitration of the issues, rescission of the participation agreements, payment of all principal and interest, damages, attorney fees and costs.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 13. COMMITMENTS AND CONTINGENCIES (Continued)
Contingencies (Continued)
This action was settled in December 2009. Under the terms of the settlement Golden State Bank dismissed its claims without receiving any payment or other consideration from the Corporation, Monterey County Bank or its officers.
The Bank, Chief Executive Officer and Chief Credit Officer were named as defendants in a lawsuit filed July 27, 2009 in the Monterey County Superior Court’s Civil Division, by Bank of the Orient. The lawsuit involves claims related to loan participations purchased by Bank of the Orient from Monterey County Bank. The lawsuit seeks rescission of the participation agreements, payment of all principal and interest, damages, attorneys’ fees and costs.
While the action was originally filed in the Superior Court under the terms of the participation agreements the matter has been submitted to arbitration through the American Arbitration Association.
Monterey County Bank was named as defendant in a lawsuit filed February 26, 2009 in Monterey County Superior Court-Civil Division by Tighorn Financial Services, LLC (“Tighorn”). The lawsuit seeks to compel Monterey County Bank to continue its credit card sponsorship and the servicing of a credit card portfolio under a card sponsorship agreement with the third party. Pursuant to termination provisions contained in the parties’ Agreement Monterey County Bank gave the third party written notice of termination of the agreement in June 2008.
Settlement discussions are pending between the Bank and Tighorn that could result in third Tighorn’s agreement to dismiss the action and to turn over its interest in the receivables realized from the accounts.
The Bank, Chief Executive Officer and Chief Credit Officer were named as defendants in a lawsuit filed April 29, 2009 in the Monterey County Superior Court’s Civil Division, by First Foundation Bank. The lawsuit involves claims related to two loan participations purchased by First Foundation Bank from Monterey County Bank. The lawsuit seeks to rescind the participation agreements, payment of all principal and interest, damages, attorneys’ fees and costs.
Monterey County Bank was named as defendant in two separate actions filed June 17, 2008 and June 26, 2008 to foreclose mechanic’s liens on site improvements performed in the amounts of $1.5 million and $6.0 million, respectively. The actions assert that the mechanic’s liens have priority over the Bank’s Deeds of Trust against various lots in the subdivision that were benefited by the site improvements. In the legal counsel’s opinion the Bank does not have any exposure in these matters because the priority of its trust deeds are insured by policies of title insurance.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 13. COMMITMENTS AND CONTINGENCIES (Continued)
Contingencies (Continued)
While the action was originally filed in the Superior Court under the terms of the participation agreements the matter has been submitted to arbitration through the American Arbitration Association.
Although the amount of any ultimate liability with respect to the above proceedings cannot be determined, in the opinion of management, any such liability will not have a material effect on the consolidated financial position of the Corporation and its subsidiary.
Note 14. CONCENTRATION OF RISK
The Bank grants commercial, construction, real estate and installment loans to businesses and individuals primarily in the Monterey Peninsula area of Northern California. Most loans are secured by business assets, and commercial and residential real estate. Real estate and construction loans held for investment represented 79% and 83% of total loans held for investment at December 31, 2009 and 2008, respectively. The Bank has no concentration of loans with any one customer.
Concentration of loans for specific industries and their percentage of total loans at December 31, 2009 and 2008 are as follows:
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 15. OTHER INCOME AND OTHER GENERAL AND ADMINISTRATIVE EXPENSES
Other income for the years ended December 31, 2009, 2008, and 2007 totaled $5,904,000, $3,493,000, and $3,006,000, respectively. Significant categories comprising other income were as follows:
Other general and administrative expenses for the years ended December 31, 2009, 2008, and 2007 totaled $5,247,000, $3,640,000, and $3,564,000, respectively. Significant categories comprising other general and administrative expenses were as follows:
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 16. MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Corporation (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s and Bank’s financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Under applicable regulatory guidelines, a portion of the Trust Preferred Securities qualify as Tier I Capital, and the remainder as Tier II Capital. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2009 and 2008, that the Corporation and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2009, the most recent notification from the Federal Deposit Insurance Corporation (FDIC) categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the Bank’s category. The Corporation’s and the Bank’s actual capital amounts and ratios as of December 31, 2009 and 2008 are also presented in the tables.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 16. MINIMUM REGULATORY CAPITAL REQUIREMENTS (Continued)
December 31, 2009
December 31,
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 17. OTHER REGULATORY MATTERS
The Corporation is subject to regulation by the Board of Governors of the Federal Reserve System under the Bank Holding Corporation Act. The Bank is subject to regulation, supervision, and regular examination by the California Department of Financial Institutions (DFI) and the FDIC. The regulations of these agencies affect most aspects of the Corporation’s business and prescribe permissible types of loans and investments, the amount of required reserves, requirements for branch offices, the permissible scope of the Corporation’s activities, and various other requirements. The Corporation is also subject to certain regulations of the Federal Reserve Bank dealing primarily with check clearing activities, establishment of banking reserves, Truth-in-Lending (Regulation Z), and Equal Credit Opportunity (Regulation B).
The Bank is currently in discussions with the FDIC regarding a draft regulatory order, resulting from its 2008 Consumer Compliance Examination, which was completed in 2009. The FDIC alleged certain violations existed per their examination which the Bank denies committing such alleged violations. The Bank anticipates entering negotiations with the FDIC in the near future to determine if a mutually agreeable resolution can be reached. The financial and non-financial impact of this matter is not known as of the balance sheet date and as of the issuance date of this report.
Note 18. STOCK-BASED COMPENSATION
Under the Corporation’s 1998 Stock Option Plan, the Corporation may grant incentive stock options and non-qualified stock options to directors, officers, and employees of the Corporation and its subsidiary, so long as the Corporation owns a majority of the equity interest of such subsidiary. Incentive stock options are granted at fair value of the common stock on the date of grant. However, an incentive stock option granted to an individual owning 10% or more of the Corporation’s stock after such grant must have an exercise price of at least 110% of such fair market value and an exercise period of not more than five years. Non-qualified stock options may be granted at prices not lower than 85% of the fair market value of the common stock on the date of grant. The Board of Directors (Board) is authorized to determine when options become exercisable within a period not exceeding 10 years from the date of grant. Under the Plan, 26,161 shares of common stock have been reserved for the granting of these options. At December 31, 2009, all 26,161 options were outstanding. During 2009, no options were granted or exercised by officers, employees, and Board members. As of December 31, 2009, all options have been vested.
No further Options may be granted under the 1998 Stock Option Plan. The plan provided that options could be granted for a period of ten years from the date the Plan was adopted by the Board. The Board adopted the Plan on April 16, 1998. The Plan remains in effect until all Options granted under the Plan have been satisfied or expired.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 18. STOCK-BASED COMPENSATION (Continued)
Under the Corporation’s 2007 Stock Option Plan, the Corporation may grant incentive stock options and non-qualified stock options to directors, officers, and employees of the Corporation and its subsidiary, so long as the Corporation owns a majority of the equity interest of such subsidiary. Incentive stock options are granted at fair value of the common stock on the date of grant. However, an incentive stock option granted to an individual owning 10% or more of the Corporation’s stock after such grant must have an exercise price of at least 110% of such fair market value and an exercise period of not more than five years. The Board is authorized to determine when options become exercisable within a period not exceeding 10 years from the date of grant. Under the Plan, 300,000 shares of common stock have been reserved for the granting of these options. Through December 31, 2009, no options have been granted under the 2007 stock option plan.
At December 31, 2009, options for the purchase of 26,161 shares of the Corporation’s common stock were outstanding and exercisable at prices ranging from $2.25 - $ 4.00. The status of all stock options is as follows:
The weighted average exercise price was $3.10, $3.00, and $3.56 for the years ending December 31, 2009, 2008, and 2007, respectively. No options were granted in 2009, 2008 and 2007. All options are vested and exercisable as of December 31, 2009 and 2008.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 18. STOCK-BASED COMPENSATION (Continued)
There was $10,000 of intrinsic value attributable to options outstanding and exercisable at December 31, 2009. The aggregate intrinsic value represents the total pretax intrinsic value based on stock options with an exercise price less than the Corporation’s closing stock price of $3.55 as of December 31, 2009, which would have been received by the option holders had those option holders exercised those options as of that date.
Note 19. RELATED PARTY TRANSACTIONS
The Corporation has and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal shareholders, and their associates. These transactions, including loans and deposits, are granted on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with others and do not involve more than the normal risk of collectibility or present other unfavorable features.
Aggregate loan transactions with related parties are approximately as follows:
Related party deposits totaled $836,000 and $611,000 at December 31, 2009 and 2008, respectively.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 20. EMPLOYEE BENEFIT PLANS
During 1995, the Corporation established an employee stock ownership plan (ESOP) to invest in the Corporation’s common stock for the benefit of eligible employees. The Board determines the Corporation’s contribution to the plan. Shares in the plan generally vest after seven years. The Corporation did not contribute to the ESOP trust in 2009, 2008, or 2007. There were no shares in the plan as of December 31, 2009.
The Bank has a salary reduction plan under Section 401(k) of the Internal Revenue Code. The plan covers substantially all full-time employees who have completed one year of service with the Bank. Employees are allowed to defer up to 15% of their compensation subject to certain limits based on federal tax laws. Under the provisions of the plan, the Bank’s contribution policy is discretionary. The Bank initiated a matching contribution in 2001 of 100% of each employee’s contribution up to 6% of the employee’s compensation. There were no matching contributions made for the year ended December 31, 2009. The Bank’s matching contributions in 2008, and 2007 totaled $139,000, and $114,000, respectively.
Note 21. RESTRICTION ON DIVIDENDS, LOANS AND ADVANCES
Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Corporation. The total amount of dividends which may be paid by the Bank to the Corporation at any date is generally limited to the lesser of: (i) retained earnings; or (ii) the Bank’s net income for its last three fiscal years (less any distributions to the stockholders made during such period). Loans or advances are limited to 25% of the Bank’s primary capital plus the allowance for loan losses on a secured basis and 15% on an unsecured basis.
The Corporation deferred payment of interest (see Note 10), for an undetermined period of time which cannot exceed twenty consecutive quarters, on its subordinated debt securities effective with the October 7, 2009 payment on Northern California Bancorp, Inc. Trust I and with the November 8, 2009 payment on Northern California Bancorp, Inc. Trust I. Additionally the Bank currently is prohibited from paying dividends to the Corporation without the prior consent of the FDIC and the DFI.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 22. SALARY CONTINUATION PLANS
The Corporation has established salary continuation plans, which provide for payments to a certain officer at retirement. Included in other liabilities is $671,000 and $855,000 of deferred compensation related to the continuation plans at both December 31, 2009 and 2008, respectively. Also included in other liabilities is $471,000 in accrued post retirement benefits under split-dollar insurance policies. The plans are funded through life insurance policies that generate value to fund the future benefits.
Note 23. NON-CASH TRANSACTION
During the year ended December 31, 2009, the Bank had non-cash transactions relating to the transfer of $10,958,000 in loans to other real estate owned.
During the year ended December 31, 2008, the Bank had non-cash transactions relating to the purchase of three debt securities totaling $3,050,000, transfers of $7,869,000 in securities from held to maturity to available for sale, a transfer of $6,348,000 in loans to other real estate owned, and a $362,000 increase in other payables due to the cumulative effect of applying a new accounting standard.
The Bank had non-cash transactions relating to the purchase of three debt securities totaling $5,225,000 for the year ended December 31, 2007.
Note 24. STOCK REPURCHASE PROGRAM AND STOCK AUTHORIZATION
In 2008, the Board approved a stock repurchase program pursuant to which the Corporation, from time to time and at management’s discretion, may repurchase up to $500,000 in value of the Corporation’s outstanding shares. The Corporation repurchased 20,678 and 46,010 shares of common stock at an average cost of $4.10 and $7.41 per share in open market transactions during the years ended December 31, 2009 and 2008, respectively.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 24. STOCK REPURCHASE PROGRAM AND STOCK AUTHORIZATION (Continued)
In October 2008, the Board and the holders of more than a majority of our issued and outstanding common stock approved by written consent, an amendment to the Corporation’s articles of incorporation (the “Amendment”). The Amendment authorizes the Corporation to issue up to 10,000,000 shares of preferred stock, which may be issued from time to time in one or more series as determined by the Board. The Board is authorized to designate all rights, preferences, privileges and restrictions attendant to each series as well as the number of shares authorized for issuance in each series of the preferred stock, which matters shall be expressed in resolutions adopted by the Board and filed with the Secretary of State of the state of California. Additionally, the Amendment authorizes the Corporation to issue an additional 7,500,000 shares of common stock for a total of 10,000,000 shares of common stock authorized for issuance after the Amendment. The Amendment became effective January 23, 2009.
Note 25. FAIR VALUE OF FINANCIAL INSTRUMENTS
Effective January 1, 2008, the Corporation adopted ASC 820, formerly FAS 157, Fair Value Measurements. This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. ASC 820 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, ASC 820 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows:
Level 1: Valuation for assets and liabilities traded in active exchange markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2: Valuation for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities.
Level 3: Valuation for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models, and similar techniques, and not based on market exchange, dealer, or broker traded transactions. These valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 25. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
The application of ASC 820 in situations where the market for a financial asset is not active was clarified in October 2008 by the issuance of ASC 820-10-35, formerly FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. This clarification was effective for financial statements issued as of September 30, 2008 and thereafter and did not have a material impact on the methods by which the Corporation determines the fair values of its financial assets. ASC 820 was also clarified in April 2009 effective for the second quarter 2009 by ASC-10-65, formerly FSP No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. This section clarifies factors that determine whether transactions are orderly or not in evaluating the reliability of market transactions for fair value estimates. ASC 820-10-15, formerly FSP FAS 157-2, deferred the application of ASC 820 for nonfinancial assets and nonfinancial liabilities that are measured at fair value on a nonrecurring basis to fiscal years beginning after November 15, 2008. The Corporation adopted the provisions of this standard with respect to nonfinancial assets and nonfinancial liabilities beginning on January 1, 2009.
Fair Value Measured on a Recurring Basis
The following tables present the balance of assets whose fair values are measured on a recurring basis:
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 25. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
The fair values of the Corporation’s securities available for sale are determined using Level 2 inputs, which are derived from readily available pricing sources and third-party pricing services for identical or comparable instruments, respectively.
Fair Value Measured on a Nonrecurring Basis
Certain assets are measured at fair value on a nonrecurring basis; that is, the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following tables present such assets carried on the balance sheet by caption and by level within the valuation hierarchy:
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 25. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Impaired Loans
Collateral-dependent impaired loans are carried at the fair value of the collateral less estimated costs to sell. The fair value of collateral is determined based on appraisals. In some cases, adjustments were made to the appraised values for various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. When significant adjustments were based on unobservable inputs, the resulting fair value measurement has been categorized as a Level 3 measurement. Otherwise, collateral-dependent impaired loans are categorized under Level 2.
Impaired loans that are not collateral dependent are carried at the present value of expected future cash flows discounted at the loan’s effective interest rate. Troubled debt restructurings are also carried at the present value of expected future cash flows. However, expected cash flows for troubled debt restructurings are discounted using the loan’s original effective interest rate rather than the modified interest rate. Since fair value of these loans is based on management’s own projection of future cash flows, the fair value measurements are categorized as Level 3 measurements.
Loans Held for Sale
Loans held for sale are required to be measured at the lower of cost or fair value. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions, which are a level 2 inputs. Premiums received or to be received on the quotes or bids are indicative of the fact that cost is lower than fair value. At December 31, 2008, the fair value of loans held for sale was greater than cost; therefore, the entire balance of loans held for sale was recorded at cost. There were no loans held for sale at December 31, 2009.
Foreclosed Assets
Assets acquired through foreclosure or other proceedings are initially recorded at fair value at the date of foreclosure less estimated costs of disposal, which establishes a new cost. After foreclosure, valuations are periodically performed, and foreclosed assets held for sale are carried at the lower of cost or fair value, less estimated costs of disposal. All foreclosed assets are real properties. The fair values of real properties initially are determined based on appraisals. In some cases, adjustments were made to the appraised values for various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market or in the collateral. Subsequent valuations of the real properties are based on management estimates or on updated appraisals. Foreclosed assets are categorized under Level 3 when significant adjustments are made by management to appraised values based on unobservable inputs. Otherwise, foreclosed assets are categorized under Level 2 if their values are based solely on appraisals.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 25. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
The Corporation in estimating fair value disclosures for financial instruments used the following methods and assumptions:
Cash and cash equivalents: The carrying amounts of cash and short-term instruments approximate fair values.
Investment securities: Fair values for investment securities, excluding Federal Home Loan Bank stock and Pacific Coast Banker’s Bank stock, are based on quoted market prices. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.
Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value of performing fixed-rate loans is estimated by discounting future cash flows using the Corporation’s current offering rate for loans with similar characteristics. The fair value of performing adjustable-rate loans is considered the same as book value. The fair value of non-performing loans is estimated at the fair value of the related collateral or, when in management’s opinion foreclosure upon the collateral is unlikely, by discounting future cash flows using rates which take into account management’s estimate of credit risk.
Commitments to Extend Credit and Standby Letters of Credit: The Corporation does not generally enter into long-term fixed rate commitments or letters of credit. These commitments are generally priced at current prevailing rates. These rates are generally variable and, therefore, there is no interest rate exposure. Accordingly, the fair market value of these instruments is equal to the carrying value amount of their net deferred fees. The net deferred fees associated with these instruments are not material. The Corporation has no unusual credit risk associated with these instruments.
Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Accrued interest: The carrying amounts of accrued interest approximate fair value.
Cash Surrender Value of Life Insurance: The carrying amount of life insurance approximate fair value.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 25. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Short-term borrowing: The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values. Fair values of other borrowings are estimated using discounted cash flow analyses based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements.
Long-term borrowing: The fair values of the Corporation’s long-term borrowings are estimated using discounted cash flow analyses based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements.
The estimated fair values, and related carrying amounts, of the Corporation’s financial instruments as of December 31 are as follows:
Management uses judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates presented herein are not necessarily indicative of the amounts the Corporation’s could have realized in a sales transaction at December 31, 2009 and 2008.
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 26. NORTHERN CALIFORNIA BANCORP, INC. (PARENT CORPORATION ONLY)
The following are the financial statements of Northern California Bancorp, Inc. (Parent Corporation only):
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 26. NORTHERN CALIFORNIA BANCORP, INC. (PARENT CORPORATION ONLY) (Continued)
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 26. NORTHERN CALIFORNIA BANCORP, INC. (PARENT CORPORATION ONLY) (Continued)
NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009 and 2008
Note 26. NORTHERN CALIFORNIA BANCORP, INC. (PARENT CORPORATION ONLY) (Continued)