We reportedIn 2008, the Federal Reserve lowered its Federal funds rate (the rate at which banks may borrow from each other) by two hundred basis points resulting in lower deposit rates being offered by the Bank, which has a positive, effect on the interest margin. However, with the decline in the Prime Rate, the variable rate loans adjusted downward with the decline in the Prime Rate subject to any contract floor rates. The net incomeeffect of $557,886these changes was a decline in the net interest margin for the first threenine months ending September 30, 2009 as compared to the same period in the prior year. Also contributing to this decline is the increase in nonperforming assets, which decreased the yield of 2009 compared with $1,027,289the loan portfolio for this period.
The Company recorded a net loss of $19,812,330 for the first threenine months ended September 30, 2009. This represents a decline of $22.7 million from earnings of $2,889,989 during the period ended September 30, 2008. The $469,403 decreasedecline in net income is largely attributableearnings relates to a $410,000$28.5 million increase in the provision for loan losses. The significant increase in the provision for loan losses in 2009 reflects deterioration in regional economic conditions, decline in regional real estate values, updated assessments of the financial condition of borrowers and regulatory review of our portfolio. Non interest income showed a $129,000decline of 7.1% or $115,000 and non interest expense showed an increase of 8.5% or $612,000. The reason for the increase in loan losses is fu rther described on Page 18 under “Provision for Loan Losses”.
Net income (loss) available to common shareholders declined from net income of $2,889,989 during the accrual for FDIC assessment duenine months ended September 30, 2008 to increases in the premium and in anticipationa net loss of a special assessment. On a$20,146,843 or $(8.75) per share basis, net income equaled $.22 compared with $.46for the nine months ended September 30, 2009. This represents a decline of $20.1 million from earnings of $2,889,989 or $1.26 per diluted share during the same period ended September 30, 2008. Included in the current year loss was the net income statement loss described above of $19,812,330 plus $334,513 which represents dividends accrued and discount amortized on preferred stock.
On February 20, 2009 the Company entered into a Letter Agreement with the United States Department of the Treasury, pursuant to which the Company issued and sold (i) 8,653 shares of the Company’s Preferred Stock, Series A and (ii) a warrant to purchase 433 shares of the Company’s Preferred Stock, Series B for an aggregate purchase price of $8,653,000 in cash. Of the $8,653,000, $6,000,000 was transferred to the Bank as a capital infusion. The remainder has been temporarily invested in excess reserves at the Federal Reserve Bank.
Total assets at September 30, 2009 were $335.6 million, an increase of $13.7 million from the $321.9 million at December 31, 2008. Cash and due from banks increased by $8.1 million from $18.2 million at December 31, 2008 to $26.4 million at September 30, 2009 and investment securities increased by $3.52 million to $23.95 million at September 30, 2009. Loans net of unearned fees increased $3.5 million. Deposits increased by $35.11 million from $253.95 million at December 31, 2008 to $289.06 million at September 30, 2009. All categories of deposits showed increases with CD’s greater than $100,000 growing 56% or $28.4 million from $50.69 million in December 2008 to $79.08 million as of September 30, 2009. This is a result of customers placing deposits with the CDARS program for which we receive reciprocal deposits. Total shareholders’ equity decreased by $11.7 million from $30.9 million at December 31, 2008 to $19.2 million at September 30, 2009. This decline is a result of the 9 months loss of $19.8 million as described above.
Return (loss) on average total assets on an annualized basis for the three-monthnine month period was 0.70%(7.94%) in 2009 and 1.39%1.30% in 2008.2008 based on net loss of $20,146,843 as of September 30, 2009. The decline in the return on assets is the result of a 45.7% or $469,403the $23.0 million decline in net income combined with a 8.8% increasegrowth of $42.7 million or 14.4% in average assets from $298.0$296.6 million as of March 31,September 30, 2008 to $324.3$339.3 million as of March 31,September 30, 2009. Return (loss) on average shareholders' equity on an annualized basis at the end of the firstthird quarter 2009 and 2008 was 6.57%(73.60%) and 14.25%12.99%, respectively. The lowerdecline in return (loss) on equity is the result of $469,403the decline in net income combined with the 18.9% or $5.5 million increase in average equity from $29.0$2.9 million in 2008 to $34.5 million asa loss of March 31, 2009.
At March 31, 2009, total assets were $331.8 million, a 3.06% increase over $321.9 million as of December 31, 2008 and an 11.33% increase over $298.0 million as of March 31, 2008. We showed loans of $279.7 million at March 31, 2009 compared with $267.4 million and $251.9 million as of December 31, 2008 and March 31, 2008, increases of 4.60% and 11.02%, respectively. Deposits increased 4.0% or $10.1 million from $253.9 million as of December 31, 2008 and increased 9.8% or $23.6 million from $240.5 as of March 31, 2008 to $264.0 million as of March 31, 2009. The increase in deposits is a result of $8.2 million growth in CD’s greater than $100,000 in response to various promotions offered by the Bank and an increase of $3.6$20.1 million in savings deposit. The loan-to-deposit ratio increased slightly to 105.9% at March 31, 2009 from 105.3% at December 31, 2008 and 104.8% at March 31, 2008.2009.
Total shareholders equity increased by $8,708,522 or 28.2% during the quarter. At March 31, 2009, we reported net income of $557,886. In March, we paid out $694,147 for cash dividends declared in February 2009. In July 2006, 26,000 restricted stock options were granted to senior employees with a fifth of the shares vesting each year over a five-year period and 3,000 shares of restricted stock were granted to a senior employee with a third of the shares vesting over a three-year period. In 2009, equity was increased by $40,687 year to date to reflect the expense for this restricted stock. In June 2007, 10,000 unqualified stock options were granted to a director with a fifth of the options vesting each year over a five year period. Additionally, in December, 2007, 7,410 unqualified stock options were granted to two directors with one third vesting immediately and two thirds vesting over a two year period. In 2009, equity has been increased by $5,012 and $4,191, respectively, for these 2007 grants. In January 2008, 10,000 incentive stock options were awarded to a senior employee with a fifth of the options vesting each year over a five year period. In 2009, equity increased by $3,487 year to date. In April 2008, 10,000 unqualified stock options were granted to a director with a fifth of the options vesting each year over a five year period. In 2009, equity increased $4,083 year to date for these options. The net income figure of $557,866 reflects an expense for the incentive stock options of $3,487, restricted stock options of $40,687, and the unqualified stock options of $13,285; therefore, the net effect of the stock option transactions relative to equity was zero. Directors exercised 23,164 options which added $184,524 to the capital accounts. The tax benefit of these options was $29,019, which also increased equity. In February, 2009, we issued 8,653 shares of Series A Senior Preferred and 433 shares of Series B Warrant Preferred to the U.S. Treasury for an aggregate purchase price of $8,653,000. The net effect of this activity results in capital of $39,568,618 as of March 31, 2009, compared to capital of $30,860,096 as of December 31, 2008.
Section 404 of Sarbanes-Oxley Act of 2002 (“Section 404”) requires the Securities and Exchange Commission (“SEC”) to prescribe rules requiring the establishment, maintenance and evaluation of an issuer’s internal control of financial reporting. We certified compliance for the year ended December 31, 2008. Our external independent auditors are required to attest to and report on management's assessment of internal control over financial reporting beginning December 31, 2009. Our management and staff have worked diligently evaluating and documenting the internal control systems in order to allow our management to report on our internal control over financial reporting.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the difference between total interest income and total interest expense. Net interest income, adjusted to a fully taxable equivalent basis, as shown on the table- Average Balances, Balances/Yields and Rates Paid, on page 1117, is higher than net interest income on the statement of income because it reflects adjustments applicable to tax-exempt income from certain securities and loans ($83,926249,849 in 2009 and $85,384$251,756 in 2008, based on a 34% federal income tax rate).
The slight declineincrease in net interest income for the threenine months ended March 31,September 30, 2009 (stated on a fully taxabletax equivalent basis) is a result of the net effect of a $530,614an $1,076,286 decrease in interest income offset by a slightly smallerlarger decrease in interest expense of $516,912,$1,162,589, showing a net increase of $13,702. The decline in both interest income and interest expense is a result$86,303. As of September 30, 2008 the 200 plus basis point decline in the Fed Fundsfederal funds rate and Wall Street Journal prime rate since March 31, 2008. The Fed Fundswere 2% and 5%, respectively. Since December, 2008 rates have declined 175 basis points. At September 30, 2009 the federal funds rate decreased from 2.25% at the end of March 2008 to .25% at the end of March 2009was 0.00% - 0.25% and the prime lending rate decreased from 5.25% towas 3.25%.
SONOMA VALLEY BANCORP
AVERAGE BALANCES/YIELDS AND RATES PAID
For the nine months ended September 30, 2009 (As Restated) and 2008
| | | 2009 | | | 2008 | |
| ASSETS | | Average Balance (As Restated) | | | Income/ Expense (As Restated) | | | Yield/ Rate | | | Average Balance | | | Income/ Expense | | | Yield/ Rate | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Loans(2): | | | | | | | | | | | | | | | | | | |
| Commercial | | $ | 193,074,487 | | | $ | 9,226,106 | | | | 6.39 | % | | $ | 176,487,467 | | | $ | 9,856,967 | | | | 7.47 | % |
| Consumer | | | 37,687,842 | | | | 1,779,258 | | | | 6.31 | % | | | 31,149,537 | | | | 1,696,535 | | | | 7.28 | % |
| Real estate construction | | | 26,685,185 | | | | 1,098,542 | | | | 5.50 | % | | | 26,852,216 | | | | 1,612,353 | | | | 8.03 | % |
| Real estate mortgage | | | 21,533,527 | | | | 1,108,178 | | | | 6.88 | % | | | 19,430,397 | | | | 1,078,099 | | | | 7.42 | % |
| Tax exempt loans (1) | | | 2,084,563 | | | | 128,461 | | | | 8.24 | % | | | 2,195,780 | | | | 135,664 | | | | 8.26 | % |
| Leases | | | 11,560 | | | | 0 | | | | 0.00 | % | | | 19,673 | | | | 1,617 | | | | 10.99 | % |
| Unearned loan fees | | | (240,864 | ) | | | | | | | | | | | (328,825 | ) | | | | | | | | |
| Total loans | | | 280,836,300 | | | | 13,340,545 | | | | 6.35 | % | | | 255,806,245 | | | | 14,381,235 | | | | 7.52 | % |
| Investment securities | | | | | | | | | | | | | | | | | | | | | | | | |
| Available for sale: | | | | | | | | | | | | | | | | | | | | | | | | |
| Taxable | | | 6,909,964 | | | | 127,594 | | | | 2.47 | % | | | 3,402,856 | | | | 83,917 | | | | 3.30 | % |
| Hold to maturity: | | | | | | | | | | | | | | | | | | | | | | | | |
| Tax exempt (1) | | | 13,660,263 | | | | 606,392 | | | | 5.94 | % | | | 14,006,800 | | | | 604,795 | | | | 5.77 | % |
| Total investment securities | | | 20,570,227 | | | | 733,986 | | | | 4.77 | % | | | 17,409,656 | | | | 688,712 | | | | 5.29 | % |
| CA Warrants | | | 30,823 | | | | 837 | | | | 3.63 | % | | | 0 | | | | 0 | | | | 0.00 | % |
| Federal funds sold | | | 0 | | | | 0 | | | | 0.00 | % | | | 64,672 | | | | 1,284 | | | | 2.65 | % |
| FHLB stock | | | 1,592,385 | | | | 0 | | | | 0.00 | % | | | 1,658,850 | | | | 73,747 | | | | 5.94 | % |
| Total due from banks/interest-bearing | | | 17,567,293 | | | | 30,510 | | | | 0.23 | % | | | 2,266,925 | | | | 37,186 | | | | 2.19 | % |
Total interest-earning assets | | | 320,597,028 | | | $ | 14,105,878 | | | | 5.88 | % | | | 277,206,348 | | | $ | 15,182,164 | | | | 7.32 | % |
| Noninterest-bearing assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Reserve for loan losses | | | (7,434,435 | ) | | | | | | | | | | | (3,898,303 | ) | | | | | | | | |
| Cash and due from banks | | | 5,086,751 | | | | | | | | | | | | 5,579,748 | | | | | | | | | |
| Premises and equipment | | | 683,916 | | | | | | | | | | | | 804,965 | | | | | | | | | |
| Other real estate owned | | | 275,042 | | | | | | | | | | | | 228,366 | | | | | | | | | |
| Other assets | | | 20,107,957 | | | | | | | | | | | | 16,650,308 | | | | | | | | | |
| Total assets | | $ | 339,316,259 | | | | | | | | | | | $ | 296,571,432 | | | | | | | | | |
| LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest- bearing deposits | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing transaction | | $ | 31,144,230 | | | $ | 31,061 | | | | 0.13 | % | | $ | 30,176,377 | | | $ | 37,592 | | | | 0.17 | % |
| Savings deposits | | | 90,803,579 | | | | 649,318 | | | | 0.96 | % | | | 77,548,456 | | | | 1,112,540 | | | | 1.92 | % |
| Time deposits over $100,000 | | | 60,603,767 | | | | 1,151,891 | | | | 2.54 | % | | | 51,073,637 | | | | 1,546,942 | | | | 4.05 | % |
| Other time deposits | | | 36,781,942 | | | | 611,447 | | | | 2.22 | % | | | 31,230,447 | | | | 886,185 | | | | 3.79 | % |
| Total interest-bearing deposits | | | 219,333,518 | | | | 2,443,717 | | | | 1.49 | % | | | 190,028,917 | | | | 3,583,259 | | | | 2.52 | % |
| Federal funds purchased | | | | | | | | | | | | | | | 156,934 | | | | 2,578 | | | | 2.20 | % |
| Other borrowings | | | 26,835,897 | | | | 600,669 | | | | 2.99 | % | | | 20,617,153 | | | | 621,138 | | | | 4.03 | % |
| Total interest-bearing liabilities | | | 246,169,415 | | | $ | 3,044,386 | | | | 1.65 | % | | | 210,803,004 | | | $ | 4,206,975 | | | | 2.67 | % |
| Non-interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-interest-bearing demand deposits | | | 49,012,034 | | | | | | | | | | | | 49,487,970 | | | | | | | | | |
| Other liabilities | | | 7,538,196 | | | | | | | | | | | | 6,559,041 | | | | | | | | | |
| Shareholders' equity | | | 36,596,614 | | | | | | | | | | | | 29,721,417 | | | | | | | | | |
| Total liabilities and shareholders' equity | | $ | 339,316,259 | | | | | | | | | | | $ | 296,571,432 | | | | | | | | | |
| Interest rate spread | | | | | | | | | | | 4.23 | % | | | | | | | | | | | 4.65 | % |
| Interest income | | | | | | $ | 14,105,878 | | | | 5.88 | % | | | | | | $ | 15,182,164 | | | | 7.32 | % |
| Interest expense | | | | | | | 3,044,386 | | | | 1.27 | % | | | | | | | 4,206,975 | | | | 2.03 | % |
| Net interest income/margin | | | | | | $ | 11,061,492 | | | | 4.61 | % | | | | | | $ | 10,975,189 | | | | 5.29 | % |
| (1) | Fully tax equivalent adjustments are based on a federal income tax rate of 34% in 2009 and 2008. |
| (2) | Non accrual loans have been included in loans for the purposes of the above presentation. Loan fees of approximately $194,649 and $291,943 for the nine months ended September 30, 2009 and 2008, respectively, were amortized to the appropriate interest income categories. |
Net interest income (stated on a fully taxable equivalent basis) expressed as a percentage of average earning assets, is referred to as net interest margin. InFor the first nine months of 2009, our net interest margin decreased forty-threedeclined 68 basis points to 4.84%4.61%, from 5.27%5.29% for the same period in 2008. ThisThe decline in the net interest margin is a result of asset yields repricing downward more than the strong growthyields on earning liabilities. Additionally, with the increase in time deposits greater than $100,000, which receivesnon- accrual loans, we have experienced the highest interest rates paid on deposits. The yield on interest earning assets declined by 130 basis points while the yield on interest bearing liabilities declined by only 113 basis points.loss of earnings from those loans.
Interest Income
As previously stated, interest income (stated on a fully taxable equivalent basis) decreaseddeclined by $531,000$1.1 million to $4.7$14.1 million in the first threenine months of 2009, a 10.1%7.09% decrease from the $5.2$15.2 million realized during the same period in 2008.
The $531,000$1.1 million decrease in interest income is awas the result of the net effect of the $26.3 million (9.4%) growth in earning assets from $278.8 million for the first quarter of 2008 to $305.1 million for the first quarter of 2009; offset by a 130144 basis point declinedecrease in the yield on earning assets to 5.88% for the nine months ended September 30, 2009 from 7.58%7.32% for the same period in 2008. Average balances of interest-bearing assets increased $43.4 million or 15.65% from $277.2 million as of September 30, 2008 to 6.28% in$320.6 million as of September 30, 2009.
The gain in volume of average earning assets was responsible for a $293,000$1,272,580 increase in interest income, offset by aand the decrease in interest rates which was responsible for a $824,000 decrease in interest income,contributed $2,348,866, for a net decrease in interest income of $531,000.
Interest Expense
Total interest expense for the first threenine months of 2009 decreased by $517,000$1,162,589 to $1.1$3.044 million from $1.6$4.207 million for the same period ofin 2008. The average rate paid on all interest-bearing liabilities decreased from 3.00%2.67% in the first nine months of 2008 to 1.87%1.65% in the same period in 2009, a decrease of 113102 basis points. Average balances of interest-bearing liabilities increased from $214.3$210.8 million to $234.7$246.2 million, a 9.5% gain$35.4 million or 16.8% increase in interest-bearing liabilities.
The gain in volume of average balances was responsible for a $74,000$508,369 increase in interest expense offset byand the lower interest rates paid which waswere responsible for a $591,000$1,670,957 decrease in interest expense for a net decrease of $517,000.$1,162,589.
Individual components of interest income and interest expense are provided in the table-Average Balances, table “Average Balances/Yields and Rates PaidPaid” on page 1117.
Provision for Loan Losses
The provision for loan losses charged to operations as of March 31,September 30, 2009 was $630,000$29.3 million compared to $220,000$830,000 in 2008. The provision for loan losses is based on our monthly evaluation of the loan portfolio and the adequacy of the allowance for loan losses in relation to total loans outstanding. We have experienced strongmodest loan growth duringin 2009. Like many community banks, the first quarterBank does have a significant concentration in commercial real estate loans. In 2009, due to severe economic recession, overly inflated real estate values, and the lack of 2009available financing options, local commercial real estate values declined considerably. This severely impacted the Bank’s commercial real estate portfolio causing addi tional provisions for loan losses. The Bank has been proactive in obtaining current appraisals on loans secured by commercial real estate. Per regulatory and we anticipateaccounting guidelines, the Bank is required to write-down collateral-dependant loans to the fair market value of the collateral and set a reserve for potential selling costs. As these loans are charged off against the loan growth will continue,loss reserve, the reserve was reduced to a level that did not take into consideration the inherent risk in the remaining portfolio, and thus needed to be replenished. Additionally, due to increased risk associated with a faltering economy and an increase in the Bank’s loss history, the Bank increased reserves on all non-classified loans. Although the economy has shown some signs of stabilization, conditions in the commercial real estate market are anticipated to worsen further which will requirelikely result in additional provisions for loan losses. Additionally, there are regulatory concerns about concentrations of commercial real estate loans and loans to developers, and about the decline in collateral values across our lending area. We have a concentration of commercial real estate loans and we determined that it is prudent to continue making a provision for loan losses. In addition to the above, in recent months the economy has demonstrated growing weakness and real estate values have declined further. We are monitoring our loan portfolio in order to be aware of any concerns which may develop.loss.
At the quarter ending March 31, 2009 theThe non-performing assets to totalratio (non-performing assets divided by loans ratioplus OREO) was 2.18%12.7% as of September 30, 2009 compared to 0.27% for the same period of3.4% in 2008. Non accrual loans were $5.9$26.6 million as of March 31,September 30, 2009 compared to $339,000$1.9 million as of March 31,September 30, 2008, an increase of $5.5 million.1300.0%. Loans charged-off were $672,000$21.6 million and recoveries were $51,000$63,000 as of March 31,September 30, 2009 compared with $144,000$416,000 in charge-offs and $8,000$21,000 in recoveries for the same period in 2008. The increase in charge offscharge-offs in 2009 is a result of multiple issuescauses including an increase in total loans, a significant and growing recession continuing induring 2009 which caused more business failures and borrowers to become delinquent and unable to payback their loans, and a material drop in real estate values a nd the application of regulatory and accounting guidance which required certain assets to be written down to fair market value, in some cases as much as 60%. Refer to page 24 for the Bank’s lending area. See pages 19 and 20 for a discussion of theon allowance for loan and lease losses.
Non-interest Income
Non-interest income for the first nine months of $479,164$1.5 million decreased 14.0%7.1% or $77,770$115,339 over the $556,934$1.6 million recorded in the comparable period in 2008. A decline in service charges on deposit accounts represents 49.3%Other fee income has shown the largest decrease of the overall decline in non-interest income. Service charges on deposit accounts declined $38,328 or 10.99%$47,440 from $348,801$276,769 as of March 31,September 30, 2008 to $310,473$229,329 as of March 31, 2009. Most categoriesSeptember 30, 2009, a decline of service charges showed small increases however, the charges on checks written against insufficient funds declined by $30,439.17.1%.
Other fee income represents 39.2% of the $77,770 decline in non-interest income. Other fee income declined $30,512 or 31.8% as of March 31, 2009 from $95,962 as of March 31, 2008 to $65,450 in 2009. The decrease in income is a result of a $15,661 decrease in income the Bank earns from loan referrals, which decreased from $17,761 as of March 31, 2008 to $2,100 for the same period of 2009. Also contributing to the decrease in other fee income was a decrease of $9,584 in merchant credit card income from $37,271 in 2008 to $27,687 in 2009. Additionally, there was a decline of $2,937 in money transfer fees for funds sent to Mexico from $3,989 as of March 31, 2008 to $1,052 as of March 31, 2009.
All other non-interest income showed a 7.96%an 11.2%, or $37,954, decrease or $8,930, from $112,171$338,209 in for the first nine months of 2008 to $103,241$300,255 in the same period of 2009. This is a result of a decrease in the income generated by bank owned life insurance policies. Income on the policies was $106,012$319,000 as of March 31,September 30, 2008 compared to $96,748$281,000 as of March 31, 2009.September 30, 2009, a decrease of $38,000. The decline in earnings on thesethe policies is a result ofhave declined due to the currentconsistently low market interest rates and a declineat this time.
Income from service charges on deposit accounts has declined 3.0%, or $29,945, from $1,002,293 in for the first nine months of 2008 to $972,348 in the valuesame period of the investment portfolios of the life insurance companies.2009. We experienced a $54,439 decrease related to fee income charged for overdrafts and checks drawn against insufficient funds.
Non-interestNon-Interest Expense
Total non-interest expense increased $263,578grew $612,000, or 11.07%8.5%, to $2.65$7.8 million for the first threenine months of 2009 compared to $2.38from $7.2 million in the comparable period ofin 2008. Non-interest expense on an annualized basis represented 3.31%3.06% of average total assets in 2009 compared with 3.21%3.24% in the comparable period in 2008. The expense/asset ratio is a standard industry measurement of a bank’s ability to control its overhead or non-interest costs.
Salaries and benefits decreased $71,076 in 2009 and was $1.36$413,000, or 9.8%, from $4.2 million for the first threenine months of 2009 comparedended September 30, 2008 to $1.43$3.8 million for the first threenine months of 2008. Total full time equivalent employees as of March 31, 2009 were 53 compared to 51 full time equivalent in 2008. As of March 31, 2009, assets per employee were $6.3 million compared with $5.8 million as of March 31, 2008.ended September 30, 2009. Management tries to utilize efficiencies to stabilize the growth in full-time equivalent employees. At September 30, 2009, total full time equivalent employees although we have added employeeswere 54 compared to better manage our loan operations and tighten standards.55 as of September 30, 2008. As of September 30, 2009, assets per employee were $6.6 million compared with $5.8 million as of September 30, 2008.
ExpenseExpenses related to premises and equipment increased 6.6%5.7% to $243,734$738,000 in 2009 from $228,705$699,000 for the same period in 2008. The $39,000 increase in expense in 2009 is the result of increases in software expense of $24,068 or 51.8% from $46,000 to $70,500 as of September 30, 2008 and 2009, respectively. This expense is related to enhancements in our on-line consumer banking product and software to allow greater efficiency in performing our work. Miscellaneous equipment expense showed an increase of $7,000 from $7,000 as of September 30, 2008 to $14,000 as of September 30, 2009 Lease expense increased for the first nine months of 2009 to $300,000 from $294,000 for the same period of 2008, an increase of $15,029. The increase in expense in 2009 is the result of a $7,288 increase in software expense due to upgrades in our on line banking product, $3,648 increase in lease expense and smaller increases in other categories of premises and equipment.2.0% or $6,000.
Other operating expensesexpense increased 44.1%43.8% to $3.2 million in 2009 to $1,044,402 from $724,777$2.3 million in 2008, an increase of $319,625.$986,000. The increase is a result of a $129,000$494,000 increase in insurance expense from $193,000 as of September 30, 2008 to $687,000 for the period ending September 30, 2009. Of the $494,000 increase $491,000 was related to the accrual for the FDIC assessment due to increases in premiums from $36,000 for the three months ended March 31, 2008 to $165,000 as of March 31, 2009. Additionally the FDIC will need to doand a special assessment from $114,000 for the nine months ended September 30, 2008 to maintain an appropriate level in$605,000 for the fund which should cause additionalsame period ending September 30, 2009. Other categories of insurance showed increases throughout theof $4,000 over prior year. Loan expense has increased $114,135 during the first quarter of 2009. This is due to a $42,055 write down on foreclosed property and an accrual of $64,346 for a provision on unfunded loan commitments. There was also an $86,868a $351,256 increase in professional fees from $254,755$823,000 as of March 31,September 30, 2008 to $341,623.$1.2 million as of September 30, 2009. This is a resultresul t of increases in legal fees-corporate matters and legal fees-loan collection expense of $58,537$94,000 and $22,387,$83,000, respectively. Other areas of professional fees showing increases are other professional fees which included expenses relative to personnel salary and benefit consultant, outside marketing assistance and information technology consultant expense, increase in Director fees and retirement expenses, increase in accounting and tax expense and an increase in other exam fees. Loan expense increased $177,000 from $29,000 as of September 30, 2008 to $206,000 as September 30, 2009. We established a provision for unfunded loan commitments, which created an expense for the first nine months of 2009 of $60,000, where in the past this amount was included in the provision for loan losses. Other loan expenses that have increased are expenses on foreclosed property, which reflects costs associated with that property, as well as a write down to reflect the market value of the property, higher appraisal expe nse due to the need to re-evaluate non-accrual loans secured by real estate and increases in loan collection expense.
Provision (Benefit) for Income Taxes
As of September 30, 2009 we recorded an income tax benefit of $5.0 million or 20% of pre-tax loss in 2009. This compares to income tax expenses of $1.4 million, or 33.2% of pre-tax income as of September 30, 2008. The percentage for the first nine months of 2009 is less than the statutory rate due to the creation of a partial valuation allowance against the deferred tax asset, after management determined that it is “more likely than not” that we will be able to fully recognize all of our deferred tax assets based on the cumulative pre-tax losses exceeding four years. This increased expense is partially offset by federal tax credits on California Affordable Housing Investments and tax exempt income such as earning s on Bank owned life insurance and municipal loan and investment income, which are in addition to the tax benefit generated as a result of the net loss.
Provision for Income Taxes
The provision for income taxes decreased to an effective tax rate of 26.85% for the three months of 2009 compared with 32.69% for the three months of 2008. The lower effective tax rate is a reflection of tax benefits received for options exercised and tax credits resulting from the Bank’s investment in California affordable housing. Income taxes reported in the financial statements include deferred taxes resulting from timing differences in the recognition of items for tax and financial reporting purposes.
BALANCE SHEET ANALYSIS
Investments
Investment securities were $20.4$24.0 million at March 31,September 30, 2009, a .30% decrease17.2% increase from the $20.4 million at December 31, 2008 and a 16.42%55.4% increase from $17.5$15.4 million at March 31,September 30, 2008. The declineincrease in the portfolio is a result of strong loan demandUS Treasury and agency purchases to pledge at the need to utilize maturing and called investments to fund loans.Federal Reserve Bank for discount window borrowings, a contingent liquidity source for the Company. We will usually maintain an investment portfolio of securities rated A“A” or higher by Standard and Poor's and or Moody's Investors Service. Local tax-exempt bonds are occasionally purchased without an A“A” rating. In this uncertain time, with the downgrades of the credit rating agencies, some purchased bonds now have an underlying rat ing of less than an “A” rating, although all except two have an Investment Grade bond rating.
Securities are classified as held to maturity (HTM) if we have both the intent and the ability to hold these securities to maturity. As of March 31,September 30, 2009, we had securities totaling $13.8$13.4 million with a market value of $14.2$13.8 million categorized as HTM. Decisions to acquire municipal securities, which are generally placed in this category, are based on tax planning needs and pledge requirements.
Securities are classified as available for sale (AFS) if we intend to hold these debt securities for an indefinite period of time, but not necessarily to maturity. Investment securities which are categorized as AFS are acquired as part of the overall asset and liability management function and serve as a primary source of liquidity. Decisions to acquire or dispose of different investments are based on an assessment of various economic and financial factors, including, but not limited to, interest rate risk, liquidity and capital adequacy. Securities held in the AFS category are recorded at market value, which was $6.53$10.6 million compared to an amortized cost of $6.52$10.5 million as of March 31, 2008.September 30, 2009.
There were sixteenfifteen equity securities of $13,000totaling $14,752 in the AFS portfolio and fivetwo securities of $1.5 milliontotaling $394,404 in the HTM portfolio that are temporarily impaired as of March 31,September 30, 2009. Unrealized losses totaled $35,000$32,688 on equity securities and $80,000$3,229 on municipal securities. Of the above, 15fourteen equity securities or $12,000$11,617 in the AFS portfolio and oneboth municipal security of $51,000securities in the HTM portfolio that have been in a continuous loss position for 12 months or more as of March 31,September 30, 2009. The primary cause of the impairment of these securities is interest rate volatility due to market volatility and downgrades of municipal insurers causing municipal securities to rely on the underlying rating of the municipality which is typically lower than AAA rated. 0; It is our intention to carry the securities to maturity date, at which time we will receivehave received face value for the securities at no loss. The equity securities are minimal shares of local and peer group banks which we hold so that we may better review their financial and compensation information.
Although the quoted market values fluctuate, investment securities are generally held to maturity, and accordingly, gains and losses to the income statement are recognized upon sale, or at such time as management determines that a permanent decline in value exists. In our opinion, there was no investment in securities at March 31,September 30, 2009 that constituted a material credit risk to the Company. The lower market value to amortized costs was a result of the increase in market interest rates and not an indication of lower credit quality. At the present time there is some uncertainty in the market relative to the companies insuring the municipal securities that we hold. We are monitoring this situation very closely and believe that the municipalitiesmun icipalities will be able to fulfill their obligations and there will be no need to rely on the insurance companies for payment. If the insurance companies are down gradeddown-graded it could lower the rating on the securities and therefore effectaffect the fair value.
Loans
OurLoan balances, net of deferred loan fees, grew $3.5 million or 1.3% from $267.4 million as of September 30, 2008 to $270.9 million as of September 30, 2009. The following table sets forth components of loans outstanding by category:
| | | September 30, | | | Percentage | | | September 30, | | | Percentage | |
| | | 2009 | | | of Total | | | 2008 | | | of Total | |
| | | | | | | | | | | | | |
| One to four family residential | | $ | 62,329,294 | | | | 23.0 | % | | $ | 55,799,862 | | | | 21.1 | % |
| Multifamily residential | | | 21,081,633 | | | | 7.8 | % | | | 19,105,223 | | | | 7.2 | % |
| Farmland | | | 8,904,884 | | | | 3.3 | % | | | 7,140,993 | | | | 2.7 | % |
| Commercial real estate | | | 108,205,901 | | | | 39.9 | % | | | 108,456,774 | | | | 41.1 | % |
| Construction/Land Development 1-4 family | | | 26,883,826 | | | | 9.9 | % | | | 23,174,666 | | | | 8.8 | % |
| Other construction/land development | | | 19,652,681 | | | | 7.2 | % | | | 26,840,182 | | | | 10.2 | % |
| Consumer loans | | | 2,703,531 | | | | 1.0 | % | | | 3,170,297 | | | | 1.2 | % |
| Other loans to farmers | | | 3,652,179 | | | | 1.3 | % | | | 3,614,057 | | | | 1.4 | % |
| Commercial, non real estate | | | 15,773,036 | | | | 5.8 | % | | | 14,539,890 | | | | 5.5 | % |
| Municipalities | | | 1,982,833 | | | | 0.8 | % | | | 2,099,035 | | | | 0.8 | % |
| Lease financing receivables | | | 0 | | | | 0.0 | % | | | 17,868 | | | | 0.0 | % |
| Total gross loans | | | 271,169,798 | | | | 100.0 | % | | | 263,958,847 | | | | 100.0 | % |
| Deferred loan fees | | | (249,748 | ) | | | | | | | (285,242 | ) | | | | |
| Loans net of deferred loan fees | | $ | 270,920,050 | | | | | | | $ | 263,700,605 | | | | | |
As indicated above, the majority of the Company’s loan portfolio was $279.7 million at March 31,is secured by real estate. As of September 30, 2009 or 105.9%and September 30, 2008, approximately 91.2% and 89.8% respectively, of total deposits. This compares with $267.4 million, or 105.3%the Bank’s loans were secured by real estate. As of total deposits, at December 31, 2008 and $251.9 million, or 104.8%September 30, 2009, commercial real estate properties were identified as a concentration of total deposits, at March 31, 2008. A comparative schedulecredit as it represented 39.9% of averagethe loan balancesportfolio. Another significant concentration is presentedloans secured by one to four family residential properties, which represented 23.0% of the loan portfolio.
The substantial decline in the table on page 11; period-endeconomy in general and year-end balances are presentedthe decline in residential and commercial real estate values in the following table.Company’s primary market area in particular have had an adverse impact on the collectability of certain of these loans and have required increases in the provision for loan losses. The Bank monitors the effects of current and expected market conditions as well as other factors on the collectability of real estate loans. Management believes that the adverse impact on the collectability of certain of these loans will continue in 2010, as the combined effects of declining commercial real estate values and deteriorating economic conditions will place continued stress on the Bank’s small business and commerci al real estate investor borrowers.
As of September 30, 2009, there was $108.2 million in commercial real estate loans representing 39.9% of the loan portfolio. Commercial real estate loans have been identified as a higher risk concentration based on the impact of the economic conditions and supported by the rise in delinquencies and requests for payment deferments. Many of these loans have been assigned to a special asset manager for enhanced monitoring. Updated financial data is being obtained from borrowers. The allowance for loan losses may be increased in the coming quarters if there is further deterioration in the credit quality of the commercial real estate loan portfolio, or if collateral values continue to drop.
Construction loans are primarily interim loans to finance the construction of commercial and single family residential property. These loans are typically short-term. Maturities on real estate loans other than construction loans are generally restricted to five years (on an amortization of thirty years with a balloon payment due in five years). Any loans extended for greater than five years generally have re-pricing provisions that adjust the interest rate to market rates at times prior to maturity.
Commercial loans and lines of credit are made for the purpose of providing working capital, covering fluctuations in cash flows, financing the purchase of equipment, or for other business purposes. Such loans and lines of credit include loans with maturities ranging from one to five years.
Consumer loans and lines of credit are made for the purpose of financing various types of consumer goods and other personal purposes. Consumer loans and lines of credit generally provide for the monthly payment of principal and interest or interest only payments with periodic principal payments.
| | | March 31, 2009 | | | Percentage of Total | | | December 31, 2008 | | | Percentage of Total | | | March 31, 2008 | | | Percentage of Total | |
| | | | | | | | | | | | | | | | | | | |
| Commercial | | $ | 191,388,415 | | | | 68.4 | % | | $ | 182,975,920 | | | | 68.4 | % | | $ | 177,950,151 | | | | 70.5 | % |
| Consumer | | | 38,154,607 | | | | 13.6 | % | | | 36,549,623 | | | | 13.7 | % | | | 29,784,989 | | | | 11.8 | % |
| Real estate construction | | | 30,092,429 | | | | 10.7 | % | | | 27,918,414 | | | | 10.4 | % | | | 25,594,481 | | | | 10.2 | % |
| Real estate mortgage | | | 20,302,172 | | | | 7.3 | % | | | 20,163,163 | | | | 7.5 | % | | | 18,930,063 | | | | 7.5 | % |
| Leases | | | 17,634 | | | | 0.0 | % | | | 17,634 | | | | 0.0 | % | | | 19,884 | | | | 0.0 | % |
| | | | 279,955,257 | | | | 100.0 | % | | | 267,624,754 | | | | 100.0 | % | | | 252,279,568 | | | | 100.0 | % |
| Deferred loan fees and costs, net | | | (250,931 | ) | | | | | | | (215,470 | ) | | | | | | | (345,779 | ) | | | | |
| Allowance for loan and lease losses | | | (5,042,344 | ) | | | | | | | (5,032,500 | ) | | | | | | | (3,806,794 | ) | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | $ | 274,661,982 | | | | | | | $ | 262,376,784 | | | | | | | $ | 248,126,995 | | | | | |
In extending credit and commitments to borrowers, the Bank generally requires collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrowers. The Bank’s requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management’s evaluation of the creditworthiness of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property. The Bank protects its collateral interests by perfecting its security interest in business assets, obtaining deeds of trust, or outright possession among other means.
Risk Elements
The majority of our loan activity is with customers located within Sonoma County. Approximately 91.7%91.2% of the total loan portfolio is secured by real estate located in our service area. Significant concentrations of credit risk may exist if a number of loan customers are engaged in similar activities and have similar economic characteristics. We believe we have policies
As of September 30, 2009, the Company had nine borrowing relationships that exceeded 25% of risk-based capital. Additionally, the Company identified three
geographic concentrations in place to identify problem loansdevelopments located in Santa Rosa, Petaluma and to monitor concentrations of credits.Windsor.
Based on its risk management review and a review of its loan portfolio, management believes that its allowance for loan losses for the quarter ending March 31,as of September 30, 2009, is sufficient to absorb losses inherent in the loan portfolio. This assessment is based upon the best available information and does involve uncertainty and matters of judgment. Accordingly, the adequacy of the loan loss reserve cannot be determined with precision, but is subject to periodic review, and could be susceptible to significant change in future periods.
Loan Commitments and Letters of Credit
Loan commitments are written agreements to lend to customers at agreed upon terms, provided there are no violations of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Loan commitments may have variable interest rates and terms that reflect current market conditions at the date of commitment. Because many of the commitments are expected to expire without being drawn upon, the amount of total commitments does not necessarily represent our anticipated future funding requirements. Unfunded loan commitments were $40.2 million at September 30, 2009 and $46.6 million at September 30, 2008.
Standby letters of credit commit us to make payments on behalf of customers when certain specified events occur. Standby letters of credit are primarily issued to support customers' financing requirements of twelve months or less and must meet our normal policies and collateral requirements. Standby letters of credit outstanding were $123,000 at September 30, 2009 and $118,000 at September 30, 2008.
Non-Performing Assets
Non-performing assets consistThe Bank manages credit losses by enforcing administration procedures and aggressively pursuing collection efforts with troubled debtors. The Bank closely monitors the market in which it conducts its lending operations and continues its strategy to control exposure to loans with high credit risk and to increase diversification of earning assets. Internal and external loan reviews are performed periodically using grading standards and criteria similar to those employed by bank regulatory agencies. Management has evaluated loans that it considers to carry additional risk above the normal risk of collectability, and by taking actions where possible to reduce credit risk exposure by methods that include, but are not limited to, seeking liquidation of the loan by the borrower, seeking additional tangible collateral or other repayment support, converting the property through judicial or non-judicial foreclosure proceedings, selling loans and other collection techniques.
The Bank has a process to review all nonperforming loans on a quarterly basis. The Bank considers a loan to be impaired when, based on current information and events, it is probable that it will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Impaired loans as of September 30, 2009 were $33.3 million as compared to $10.8 million as of September 30, 2008. The evaluation of impaired loans will continue in the coming quarters as the Bank receives updated appraisals, financial information, and economic trends relevant to individual non-accrual loans.
We had loans of $26.6 million in non-accrual status delinquentat September 30, 2009 and $1.9 million at September 30, 2008. There were $5.7 million in loans 90 days or more past due greater thatat September 30, 2009 and $1.5 million at September 30, 2008. We have more loans in non-accrual status than are 90 days and other real estate owned (“OREO”). past due because management determined the continued collection of principal or interest is unlikely, given the information available today. This is further discussed in the guidelines in the paragraph below.
Management classifies all loans as non-accrual loans when they become more than 90 days past due as to principal or interest, or when the timely collection of interest or principal becomes uncertain, if earlier, unless they are adequately secured and in the process of collection.
A In addition, some loans secured by real estate with temporarily impaired values and commercial loans to borrowers experiencing financial difficulties are placed on non accrual status even though the borrowers continue to repay the loans as scheduled. Such loans are classified by management as “performing nonaccrual” and are included in total non accrual loans. Any interest accrued, but unpaid, is reversed against current income. Interest received on non-accrual loans is applied to principal until the loan has been repaid in full or the loan is brought current and potential for future payments appears reasonably certain, at which time the interest received is credited to income. Generally, a loan remains in a non-accrual status until both principal and interest have been current for six months and it meets cash flow or collateral criteria, or when the loan is determined to be uncollectible and is charged off against the allowance for loan losses, or in the case of real estate loans, is transferred to other real estate owned.owned upon foreclosure.
A loan is classified as a restructured loan when the interest rate is reduced, when the term is extended beyond the original maturity date, or other concessions are made by us, because of the inability of the borrower to repay the loan under the original terms. We had $7.3 million in renegotiated loans as of September 30, 2009 and $6.9 million as of September 30, 2008.
The following table provides information with respect to the components of nonperforming assets at the dates indicated:
| | | September 30, 2009 | | | September 30, 2008 | |
| Non-accrual loans | | $ | 26,586,588 | | | $ | 1,916,867 | |
| Other real estate owned | | | 478,610 | | | | 320,416 | |
| Restructured loans | | | 7,317,831 | | | | 325,163 | |
Total non performing assets | | $ | 34,383,029 | | | $ | 2,562,446 | |
| | | | | | | | | |
| Nonperforming assets as a percent of loans, net of unearned fees, plus OREO | | | 12.67 | % | | | .96 | % |
| Nonperforming assets as a percent of total assets | | | 10.24 | % | | | .76 | % |
When appropriate or necessary to protect the Bank’s interest, real estate taken as collateral on a loan may be taken by the Company through foreclosure or a deed in lieu of foreclosure. Real property acquired in this manner is known as other real estate owned (OREO). OREO is carried on the books as an asset at the lower of the loan balance or the fair value less estimated costs to sell. OREO represents assets held through loan foreclosure or recovery activities. Asan additional category of March 31, 2009 we“nonperforming assets.” The Company had $243,610 classified as OREO compared to $285,665two OREO’s as of December 31, 2008September 30, 2009 for $479,000 and $320,416one OREO for $320,000 as of March 31, 2008.
There were $5.9 million non-accrual loans and no loans 90 days or more past due and still accruing at March 31, 2009 up from $351,000 non-accrual loans and no loans 90 days or more past due and still accruing at March 31, 2008. There were $2.6 million in non-accrual loans 90 days or more past due at March 31, 2009 and $118,000 loans in non-accrual status and 90 days or more past due as of March 31, 2008. Occasionally, we will have more loans in non-accrual status than are 90 days past due following the guidelines in the above paragraph or if management determines the collection of principal or interest is unlikely.September 30, 2008
Allowance for Loan Losses
The Bank maintains an allowance for loan losses is maintained at a level considered adequate to provide for potential losses that can be reasonably anticipated. Thein the loan portfolio. Additions to the allowance is increasedare made by provisions chargedcharges to operating expense in the form of a provision for loan losses. All loans that are judged to be uncollectible are charged against the allowance while any recoveries are credited to the allowance. Management has instituted loan policies which include using grading standards and reducedcriteria similar to those employed by charge-offs, netbank regulatory agencies to adequately evaluate and assess the analysis of recoveries.risk factors associated with its loan portfolio. These policies and standards enable management to assess such risk factors associated with its loan portfolio prior to granting new loans and t o assess the sufficiency of the allowance. The allowance is based on estimates and ultimateactual loan losses may varycould differ materially from management’s estimate if actual loss factors and conditions differ significantly from the current estimates. These estimates are reviewed monthly and, as adjustments become necessary, they are reported in earnings in the periods in which they become known.assumptions utilized.
The review process is intended to identify loan customers who may be experiencing financial difficulties. In these circumstances, a specific reserve allocation or charge-off may be recommended. Other factors considered by management in evaluating the adequacyManagement conducts an evaluation of the allowance include: loan volume, historical netportfolio quarterly. This evaluation is an assessment of a number of factors including the results of the internal loan review, external loan review by outside consultants, any regulatory examination, loan loss experience, estimated potential loss exposure on each credit, concentrations of credit, value of collateral, and any known impairment in the conditionborrower’s ability to repay and present economic conditions as the Bank is obtaining updated appraisals, current financial statements, current credit report, and verifying current net worth and liquidity positions of industriesselected borrowers. Loans receiving lesser grades fall under the “classified” category, which includes all nonpe rforming and geographic areas experiencing or expectedpotential problem loans, and receive an elevated level of attention to experience economic adversities, credit evaluationsensure collection.
Each month the Bank reviews the allowance and current economic conditions. Theincreases the allowance as needed. As of September 30, 2009 and September 30, 2008, the allowance for loan losses was 4.72% and 1.58%, respectively, of loans net of unearned. No assurance can be given that the increase in the allowance is not a precise amount, butadequate to reflect the increase in the loan portfolio balance, non-accrual loans and the overall economic downturn, which may adversely affect small businesses and borrowers in the Bank’s market area as of September 30, 2009. The Bank is working diligently with all borrowers to proactively identify and address difficulties as they arise. As of September 30, 2009 and September 30, 2008, loan charge-offs totaled $21.6 million and $416,000, respectively, and recoveries on previously charged-off loans totaled $63,000 and $21,000, respectively.
As of September 30, 2009, the allowance for loan losses was $12.8 million, or 4.72% of period-end loans, compared with $4.2 million, or 1.58%, at September 30, 2008. In accordance with FASB ASC 310 accounting standards, the Bank recognizes estimated losses based on appraised values on collateral dependent loans. The Bank’s year end net charge-offs of $21.6 million is largely due to the factors above, represents management's best estimateBank’s recognition of estimated losses that may be ultimately realized fromcaused by deterioration of real estate collateral values in the currentBank’s lending area.
An analysis of the changes in the allowance for loan portfolio.losses, including charge-offs and recoveries by loan categories, is presented below.
| | | September 30, 2009 | | | September 30, 2008 | |
| | | | | | | |
| Beginning balance | | $ | 5,032,500 | | | $ | 3,723,217 | |
| Provision for loan and lease losses | | | 29,330,000 | | | | 830,000 | |
| Loans charged off: | | | | | | | | |
Commercial | | | (17,961,610 | ) | | | (120,120 | ) |
Consumer | | | (798,711 | ) | | | (236,932 | ) |
Real Estate Construction | | | (2,368,456 | ) | | | 0 | |
Real Estate Loans | | | (383,513 | ) | | | (28,400 | ) |
Leases | | | (17,635 | ) | | | 0 | |
Overdrafts | | | (88,212 | ) | | | (30,802 | ) |
| Total charge-offs | | | (21,618,137 | ) | | | (416,254 | ) |
| Recoveries: | | | | | | | | |
Commercial | | | 56,329 | | | | 13,444 | |
Consumer | | | 5,219 | | | | 1,508 | |
Leases | | | 0 | | | | 0 | |
Overdrafts | | | 1,014 | | | | 5,556 | |
| Total recoveries | | | 62,562 | | | | 20,508 | |
| Net recoveries (charge-offs) | | | (21,555,575 | ) | | | (395,746 | ) |
| Ending balance | | $ | 12,806,925 | | | $ | 4,157,471 | |
Net charge-offs to average loans increased when compared with the prior year. We recorded net losses of $21.6 million or 10.26% of average loans in 2009 compared to net losses of $396,000 in 2008 or .21% of average loans.
Worsening conditions in the general economy and real estate markets will likely continue to adversely affect the loan portfolio, which could necessitate materially larger provisions for loan losses than in prior periods. The drastic changes in the availability of credit during 2008 and continuing into 2009 hashave negatively impacted most asset values which serve as collateral to the majority of the Bank’s loans. However, as of March 31,September 30, 2009, we believe the overall allowance for loan losses is adequate based on our analysis of conditions at that time.
timeAt March 31, 2009, the allowance for loan losses was $5.0 million, or 1.80% of period-end loans, compared with $5.0 million, or 1.88% at December 31, 2008 and $3.8 million, or 1.51% at March 31, 2008. The increase in the allowance is a result of the loan growth and our review and analysis of the portfolio, which includes the deterioration in real estate values and extraordinarily poor economic conditions..
Net charge-offs to average loans increased when compared with the prior year. We recorded net charge-offs of $620,000 or .92% of average loans as of March 31, 2009 compared to March 31, 2008 which showed charge offs of $136,000 or .22% of average loans. The increase in charge offs is a direct result of the economic downturn, falling asset values and increased risk associated with borrowers of all types.
An analysis of the changes in the allowance for loan losses, including charge-offs and recoveries by loan categories, is presented below.
| | | For the Three Months Ended 3/31/09 | | | For the Year Ended 12/31/08 | | | For the Three Months Ended 3/31/08 | |
| Balance beginning of year | | $ | 5,032,500 | | | $ | 3,723,217 | | | $ | 3,723,217 | |
| Charge-offs: | | | | | | | | | | | | |
| Commercial | | | (438,253 | ) | | | (519,318 | ) | | | (91,308 | ) |
| Consumer | | | (233,058 | ) | | | (508,758 | ) | | | (52,773 | ) |
| Total charge-offs | | | (671,311 | ) | | | (1,028,076 | ) | | | (144,081 | ) |
| Recoveries: | | | | | | | | | | | | |
| Commercial | | | 48,800 | | | | 218,812 | | | | 4,223 | |
| Consumer | | | 2,355 | | | | 8,547 | | | | 3,435 | |
| Total recoveries | | | 51,155 | | | | 227,359 | | | | 7,658 | |
| | | | | | | | | | | | | |
| Net recoveries (charge-offs) | | | (620,156 | ) | | | (800,717 | ) | | | (136,423 | ) |
| Provision charged to operations | | | 630,000 | | | | 2,110,000 | | | | 220,000 | |
| Balance end of period | | $ | 5,042,344 | | | $ | 5,032,500 | | | $ | 3,806,794 | |
| Ratio of net charge-offs annualized to average loans | | | 0.92 | % | | | 0.31 | % | | | 0.22 | % |
| Balance in allowance as a percentage of loans outstanding at period end | | | 1.80 | % | | | 1.88 | % | | | 1.51 | % |
Deposits
A comparative schedule of average deposit balances is presented in the table on page 1117;. period-endPeriod-end and year-end deposit balances are presented in the following table.
| | | March 31, 2009 | | | Percentage of Total | | | December 31, 2008 | | | Percentage of Total | | | March 31, 2008 | | | Percentage of Total | | | September 30, 2009 | | | Percentage of Total | | | December 31, 2008 | | | Percentage of Total | | | September 30, 2008 | | | Percentage of Total | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing transaction deposits | | $ | 29,109,747 | | | | 11.0 | % | | $ | 31,062,597 | | | | 12.2 | % | | $ | 32,523,931 | | | | 13.5 | % | | $ | 32,471,725 | | | | 11.2 | % | | $ | 31,062,597 | | | | 12.2 | % | | $ | 28,306,822 | | | | 11.5 | % |
| Savings deposits | | | 91,953,928 | | | | 34.8 | % | | | 88,317,397 | | | | 34.8 | % | | | 75,938,300 | | | | 31.6 | % | | | 90,202,813 | | | | 31.2 | % | | | 88,317,397 | | | | 34.8 | % | | | 81,724,337 | | | | 33.0 | % |
| Time deposits, $100,000 and over | | | 58,919,208 | | | | 22.3 | % | | | 50,694,468 | | | | 20.0 | % | | | 50,915,989 | | | | 21.2 | % | | | 79,077,355 | | | | 27.4 | % | | | 50,694,468 | | | | 20.0 | % | | | 51,394,535 | | | | 20.8 | % |
| Other time deposits | | | 35,253,932 | | | | 13.4 | % | | | 35,591,280 | | | | 14.0 | % | | | 31,570,905 | | | | 13.1 | % | | | 36,365,253 | | | | 12.6 | % | | | 35,591,280 | | | | 14.0 | % | | | 31,767,944 | | | | 12.8 | % |
| Total interest-bearing deposits | | | 215,236,815 | | | | 81.5 | % | | | 205,665,742 | | | | 81.0 | % | | | 190,949,125 | | | | 79.4 | % | | | 238,117,146 | | | | 82.4 | % | | | 205,665,742 | | | | 81.0 | % | | | 193,193,638 | | | | 78.1 | % |
| Demand deposits | | | 48,800,308 | | | | 18.5 | % | | | 48,279,759 | | | | 19.0 | % | | | 49,534,037 | | | | 20.6 | % | | | 50,941,938 | | | | 17.6 | % | | | 48,279,759 | | | | 19.0 | % | | | 54,162,469 | | | | 21,9 | % |
| Total deposits | | $ | 264,037,123 | | | | 100.0 | % | | $ | 253,945,501 | | | | 100.0 | % | | $ | 240,483,162 | | | | 100.0 | % | | $ | 289,059,084 | | | | 100.0 | % | | $ | 253,945,501 | | | | 100.0 | % | | $ | 247,356,107 | | | | 100.0 | % |
Total deposits increased by $10.1$35.1 million, (3.97%)or 13.8%, during the 3nine months of 2009 to $264.0$289.1 million from $253.9 million at December 31, 2008, and increased by 9.80%16.9% from $240.5$247.4 million as of March 31,September 30, 2008. TimeAll categories of deposits greater than $100,000, savings deposits and non-interest bearing demand showed increases over year end 2008. Timegrowth with time deposits greater that $100,000 showed strongshowing the most significant growth of 16.2%56.0% or $8.2$28.4 million and were $58.9 million as of March 31, 2009 compared tofrom $50.7 million at year end 2008. Savings deposits of $92.0 million increased $3.6 million or 4.1% from $88.3 million at December 31, 2008. Non-interest bearing demand grew $521,000 (1.1%) from $48.3 million as of December 31, 2008 to $48.8$79.1 million at March 31,September 30, 2009. This growth is largely through reciprocal CDARS deposits where our depositors spread deposits among other financial institutions through the CDARS programs in order to realize FDIC coverage of their deposits and we in turn accept deposits equal to the amount sent to CDARS. Additionally, many of our depositors are t aking advantage of the higher $250,000 FDIC coverage now offered.
Interest-bearing checkingNon interest bearing demand also showed a declinedeposit growth of $2.0$2.6 million or 6.3%(5.5%) to $50.9 million as of September 30, 2009 from $31.1$48.3 at December 31, 2008 to $29.1 as of March 31, 2009. Other2008. Savings, interest bearing checking and other time deposits declined slightly from $35.6also showed growth of $1.9 million, at December 31, 2008$1.4 million and $776,000 to $35.3$90.2 million, as of March 31, 2009 a decline of $337,348 or 0.9%.$32.5 million and $36.4 million, respectively.
Capital
Our subsidiary, Sonoma ValleyThe Bank (the “Bank”) is subject to FDIC regulations governing capital adequacy. The FDIC has adopted risk-based capital guidelines which establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures. Under the current guidelines, as of March 31,September 30, 2009, the Bank was required to have minimum Tier 1I and total risk-based capital ratios of 4% and 8%, respectively. To be well capitalized under Prompt Corrective Action Provisions requires minimum Tier 1I and total risk-based capital ratios to be 6% and 10%, respectively. We participated in the U.S. Treasury Troubled Asset Relief Program-Capital Purchase Program in the first quarter and issued $8,653,000 of Series A preferred stock and related warrants for Series B preferred stock. The new capital qualifies as Tier 1 capital and increases our Tier 1 and total capital ratios as further described below.
The FDIC has also adopted minimum leverage ratio guidelines for compliance by banking organizations. The guidelines require a minimum leverage ratio of 4% of Tier 1 capital to total average assets. Banks experiencing high growth rates are expected to maintain capital positions well above the minimum levels. The leverage ratio, in conjunction with the risk-based capital ratio, constitutes the basis for determining the capital adequacy of banking organizations.
Based on the FDIC's guidelines, the Sonoma Valley Bank's total risk-based capital ratio at March 31,September 30, 2009 was 11.29%6.40% and its Tier 1 risk-based capital ratio was 10.03%5.11%. The Bank's leverage ratio was 9.30%4.16%. All the ratios exceed the minimum guidelines of 8.00%, 4.00% and 4.00%, respectively.
The Company’s total risk basedrisk-based capital, Tier 1 risk based capital and leverage ratios for the Company at March 31,September 30, 2009, were 14.31%6.51%, 13.05%5.22% and 12.11%4.25%, respectively. The capital ratios for the Company at September 30, 2008, were 11.45%, 10.20% and 9.86%, respectively. On February 1, 2010, the FDIC notified the Bank by letter that it was “undercapitalized” within the meaning of the Federal Deposit Insurance Act (“FDI Act”) prompt corrective action (“PCA”) capital requirements (12 U.S.C. § 1831o), and directed the Bank to submit, as required by laws and regulations, a Capital Restoration Plan (“CRP”) to the FDIC by March 17, 2010. The Bank is subject to Section 38 of the FDI Act with respect t o undercapitalized institutions requiring that the FDIC monitor the condition of the Bank; requiring submission of a CRP; restricting the growth of the Bank’s assets; and acquiring prior approval for acquisitions, branching and new lines of business. In addition, the Bank must cease paying dividends, is prohibited from paying management fees to a controlling person and is prohibited from accepting or renewing any brokered deposits. The Company submitted a CRP to the FDIC on March 17, 2010.
In November 2008, the Company applied for funds through the U.S. Treasury’s Capital Purchase Program. On February 11, 2009 shareholder approval was received and the Articles of Incorporation were amended allowing us to issue preferred shares. On February 20, 2009, we completed the issuance of $8,653,000 of Series A preferred stock and related warrant for Series B preferred stock underCompany entered into a Letter Agreement with the U.S.United States Department of Treasury’sthe Treasury pursuant to the Troubled Asset Relief Program Capital Purchase Program. WeUnder the terms of the Letter Agreement, the Company issued to the Treasury, 8,653 shares of Series Asenior preferred stock and a warrant to acquire 433up to 433.00433 shares of Series B preferreda separate series of senior preferr ed stock, which has been exercised, for thean aggregate purchase price (collectively the “Preferred Stock”). The Series A preferred stock has a cumulative dividend of 5% per annum for five years and, unless redeemed, 9% thereafter. The liquidation amount is $1,000 per share. The Series B preferred stock pays a dividend of 9%. The Preferred Stock has no maturity date and ranks senior the Common Stock with respect$8,653,000, pursuant to the paymentstandard Capital Purchase Program terms and conditions for non-public companies. Since the Bank is currently not allowed to pay cash dividends as a result of being undercapitalized, the Company suspended the payments of quarterly dividends and distributions and amounts payable upon liquidation, dissolution and winding upto the US Treasury of the Company. $117,905 as of February 15, 2010.
The Preferred Stock is generally non-voting, other than class voting on certain matters that could adversely affect the Preferred Stock.
TheLetter Agreement contains limitations on certain actions of the Company, including, but not limited to, payment of dividends, redemptions and acquisitions of Company equity securities, and compensation of senior executive officers.
In February 2001, we approved a program to repurchase Sonoma Valley Bancorp stock up to $1.0 million and in August 2002 we approved the repurchase of an additional $1.0 million ofretire Sonoma Valley Bancorp stock. As of December 31, 2005, $1,580,162 had been repurchased and retired, net of options which were exercised and then subsequently repurchased and retired. In February 2006 we approved the repurchase of 60,000 shares of Sonoma Valley Bancorp stock, in October 2006 we approved an additional 60,000 shares of Sonoma Valley Bancorp stock and in July, 2007 we approved an additional 60,000 shares of Sonoma Valley Bancorp stock. During the twelve months ended December 31, 2006, 55,028 shares were repurchased and retired of which 15,035 shares or $364,729 were a part of the amount approved August 2002. As of December 31, 2007, 100,415 shares had been repurchased and retired. As of December 31, 2008, 1,190 shares had been repurchased and retired. As of March 31, 2009, no shares have been repurchased and retired. Effective February 20, 2009, the repurchase program has beenwas suspended pending the repayment of the Preferred Stock.
We believeIn September 2009, the shareholders were notified that the Bank's current capital position, which exceeds guidelines established by industry regulators, is adequateBoard of Directors had made a strategic decision to support our business.suspend its cash dividend program until further notice.
Off BalanceOff-Balance Sheet Commitments
Our off balanceoff-balance sheet commitments consist of commitments to extend credit and standby letters of credit. These commitments are extended to customers in the normal course of business. Unfunded loan commitments were $42.8$40.2 million at March 31,September 30, 2009 and $48.8$46.6 million at March 31,September 30, 2008. Standby letters of credit outstanding were $123,000 at September 30, 2009 and $118,000 at March 31, 2009 and $158,000 at March 31,September 30, 2008. We also have contractual obligations consisting of operating leases for various facilities and payments to participants under our supplemental executive retirement plan and deferred compensation plan. We believe our available liquidity is sufficient to accommodate existing contingent obligations listed above.
Liquidity Management
Our liquidity is determined by the level of assets (such as cash, federal funds sold and available-for-sale securities) that are readily convertible to cash to meet customer withdrawal and borrowing needs. Deposit growth also contributes to our liquidity. We review our liquidity position on a regular basis to verify that it is adequate to meet projected loan funding and potential withdrawal of deposits. We have a comprehensive Asset and Liability Policy which we use to monitor and determine adequate levels of liquidity. As of March 31,September 30, 2009, our primary liquidity ratio (adjusted liquid assets to deposits and short term liabilities) was 6.76%10.44% of assets compared to 5.56%7.67% as of March 31,September 30, 2008. Available liquidity, which includes the ability to borrow at the Federal Home Loan Bank, was 28.48%27.3% of assets as of March 31,September 30, 2009 and 31.65%37.9% as of March 31,September 30, 2008. Management expects that liquidity will remain adequate throughout 2009, as deposit growth keeps pace with loan growth slows.growth. Any excess funds will be invested in quality liquid assets, such as excess reserves with the Federal Reserve Bank or U.S. Treasury and Agencyagency securities. Management believes that the Company has adequate liquidity and capital resources to meet its short termshort-term and long termlong-term commitments.
Market Risk Management
Overview. Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises primarily from interest rate risk inherent in our loan and deposit functions. The goal for managing the assets and liabilities is to maximize shareholder value and earnings while maintaining a high quality balance sheet without exposing us to undue interest rate risk. Our Board has overall responsibility for the interest rate risk management policies. The Bank has an Asset and Liability Management Committee (ALCO) that establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates.
Asset/Liability Management. Activities involved in asset/liability management include but are not limited to lending, accepting and placing deposits and investing in securities. Interest rate risk is the primary market risk associated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities. To mitigate interest rate risk, the structure of the balance sheet is managed with the goal that movements of interest rates on assets and liabilities are correlated and contribute to earnings even in periods of volatilevolat ile interest rates. When interest rates increase, the market value of securities held in the investment portfolio declines. Generally, this decline is offset by an increase in earnings. When interest rates decline, the market value of securities increases while earnings decrease due to the Bank's asset sensitivity caused by the variable rate loans. Usually we are able to mitigate risks from changes in interest rates with this balance sheet structure. The asset/liability management policy sets limits on the acceptable amount of variance in net interest margin and market value of equity under changing interest environments. The Bank uses simulation models to forecast earnings, net interest margin and market value of equity.
Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Using computer-modeling techniques, we are able to estimate the potential impact of changing interest rates on earnings. A balance sheet forecast is prepared quarterly using inputs of actual loans, securities and interest bearing liabilities (i.e. deposits/borrowings) positions as the beginning base. The forecast balance sheet is processed against fourfive interest rate scenarios. The scenarios include a flat rate forecast, 100, 200 and 300 basis point rising rate forecasts and a flat25 basis point declining rate forecast which take place within a one year time frame. Normally we forecast a 100, 200, and 200300 basis point fallingdeclining rate forecast, but since the target Fed Funds is currently 0 – 25 basis points we feel we cannot forecast a lowerdeclining rate scenario.scenario of more than 25 basis points. The net interest income is measured during the year assuming a gradual change in rates over the twelve-month horizon. Our 2009 net interest income, as forecast below, was modeled utilizing a forecast balance sheet projected from March 31,September 30, 2009 balances. The following table summarizes the effect on net interest income (NII) of 100, 200 and 300 basis point changes in interest rates as measured against a constant rate (no change) scenario.
Interest Rate Risk Simulation of Net Interest Income as of March 31,September 30, 2009
(dollars in thousands)
Variation from a constant rate scenario | | $ Change in NII |
+300bp | | $ 1,633 |
+200bp | | $ 930 |
+100bp | | $ 385 |
| Variation from a constant rate scenario | | | $ Change in NII | |
| | +300 | bp | | $ | 1,000 | |
| | +200 | bp | | $ | 533 | |
| | +100 | bp | | $ | 187 | |
| | -25 | bp | | $ | (24 | ) |
The simulations of earnings do not incorporate any management actions. Therefore, they do not reflect likely actual results, but serve as conservative estimates of interest rate risk.
Since the primary tool used by management to measure and manage interest rate exposure is a simulation model, use of the model to perform simulations reflecting changes in interest rates over a twelve month horizon enables management to develop and initiate strategies for managing exposure to interest rate risks. Management believes that both individually and in the aggregate its modeling assumptions are reasonable, but the complexity of the simulation modeling process results in a sophisticated estimate, not an absolutely precise calculation of exposure.
Interest Rate Sensitivity Analysis. Interest rate sensitivity is a function of the repricing characteristics of the portfolio of assets and liabilities. These repricing characteristics are the time frames within which the interest-bearing assets and liabilities are subject to change in interest rates either at replacement, repricing or maturity. Interest rate sensitivity management focuses on the maturity of assets and liabilities and their repricing during periods of change in market interest rates. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in the current portfolio that are subject to repricing at various time horizons. The differences are known as interest sensitivity gaps.
A positive cumulative gap may be equated to an asset sensitive position. An asset sensitive position in a rising interest rate environment will cause a bank=sbank’s interest rate margin to expand. This results as floating or variable rate loans reprice more rapidly than fixed rate certificates of deposit that reprice as they mature over time. Conversely, a declining interest rate environment will cause the opposite effect. A negative cumulative gap may be equated to a liability sensitive position. A liability sensitive position in a rising interest rate environment will cause a bank=s interest rate margin to contract, while a declining interesti nterest rate environment will have the opposite effect.
The following table sets forth the dollar amounts of maturing and/or repricing assets and liabilities for various periods. This does not include the impact of prepayments or other forms of convexity caused by changing interest rates. Historically, this has been immaterial and estimates for them are not included.
We have more liabilities than assets repricing during the next year. Usually because our asset rates change more than deposit rates, our interest income will change more than the cost of funds when rates change. However, because the Company=sCompany’s asset rates change more than deposit rates, the Company=sCompany’s interest income will change more than the cost of funds when rates change. Its net interest margin should therefore increase somewhat when rates increase and shrink somewhat when rates fall. The table below indicates that we are liability sensitive for the first six months. During the seven to twelve month period, we show more assets than liabilities repriceable in the seven to twelve month category. Still at the end of the twelvetwel ve month cycle, the rate sensitive gap shows $57.4$100.2 million more in liabilities than assets repricing.
We control long term interest rate risk by keeping long term fixed rate assets (longer than 5 years) less than long term fixed rate funding, primarily demand deposit accounts and capital. The following table sets forth cumulative maturity distributions as of March 31,September 30, 2009 for our interest-bearing assets and interest-bearing liabilities, and our interest rate sensitivity gap as a percentage of total interest-earning assets. Of the $142.7$175.6 million in fixed rate assets over 12 months, shown in the table below, $36.2$15.3 million are long term assets over five years. This $36.2$15.3 million compares favorably to the $88.4$89.0 million in demand and core deposits and equity.
SEPTEMBER 30, 2009 (dollars in thousands) | | Immediate Reprice | | | Up to 3 Months | | | 4 to 6 Months | | | 7 to 12 Months | | | Over 12 Months | | | Total | |
| FFS + overnight IBB | | $ | 21,762 | | | | | | | | | | | | | | | $ | 21,762 | |
| Securities + Other IBB | | | 0 | | | $ | 985 | | | $ | 421 | | | $ | 843 | | | $ | 21,709 | | | | 23,958 | |
| Loans | | | 41,924 | | | | 10,723 | | | | 17,330 | | | | 32,183 | | | | 155,953 | | | | 258,113 | |
| Total RSA | | $ | 63,686 | | | $ | 11,708 | | | $ | 17,751 | | | $ | 33,026 | | | $ | 177,662 | | | $ | 303,833 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| MMDA/NOW/SAV | | $ | 122,674 | | | | | | | | | | | | | | | | | | | $ | 122,674 | |
| CD’s <$100k | | | 0 | | | $ | 10,298 | | | $ | 10,465 | | | $ | 10,465 | | | $ | 5,138 | | | | 36,366 | |
| CD’s >$100k | | | 0 | | | | 23,944 | | | | 34,856 | | | | 8,714 | | | | 11,564 | | | | 79,078 | |
| Borrowings | | | 0 | | | | 0 | | | | 0 | | | | 5,000 | | | | 15,000 | | | | 20,000 | |
| Total RSL | | $ | 122,674 | | | $ | 34,242 | | | $ | 45,321 | | | $ | 24,179 | | | $ | 31,702 | | | $ | 257,118 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| GAP | | $ | (58,988 | ) | | $ | (22,534 | ) | | $ | (27,570 | ) | | $ | 8,847 | | | $ | 145,960 | | | $ | 46,134 | |
| Cumulative | | $ | (58,988 | ) | | $ | (81,522 | ) | | $ | (109,092 | ) | | $ | (100,245 | ) | | $ | 45,715 | | | | | |
| % Assets | | | -17.6 | % | | | -24.3 | % | | | -32.6 | % | | | -29.9 | % | | | 13.6 | % | | | | |
MARCH 31, 2009 (dollars in thousands) | | Immediate Reprice | | | Up to 3 Months | | | 4 to 6 Months | | | 7 to 12 Months | | | Over 12 Months | | | Total | |
| FFS + overnight IBB | | $ | 9,626 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 9,626 | |
| Securities + Other IBB | | | 0 | | | | 5,769 | | | | 692 | | | | 1,383 | | | | 12,537 | | | | 20,381 | |
| Loans | | | 71,771 | | | | 11,543 | | | | 21,425 | | | | 39,788 | | | | 130,135 | | | | 274,662 | |
| Total RSA | | $ | 81,397 | | | $ | 17,312 | | | $ | 22,117 | | | $ | 41,171 | | | $ | 142,672 | | | $ | 304,669 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| MMDA/NOW/SAV | | $ | 121,064 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 121,064 | |
| CD’s <$100k | | | 0 | | | | 13,127 | | | | 8,729 | | | | 8,729 | | | | 4,470 | | | | 35,055 | |
| CD’s >$100k | | | 0 | | | | 19,824 | | | | 25,388 | | | | 6,347 | | | | 7,560 | | | | 59,119 | |
| Borrowings | | | 0 | | | | 1,199 | | | | 15,000 | | | | 0 | | | | 5,001 | | | | 21,200 | |
| Total RSL | | $ | 121,064 | | | $ | 34,150 | | | $ | 49,117 | | | $ | 15,076 | | | $ | 17,031 | | | $ | 236,438 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| GAP | | $ | (39,667 | ) | | $ | (16,838 | ) | | $ | (27,000 | ) | | $ | 26,095 | | | $ | 125,641 | | | $ | 68,231 | |
| Cumulative | | $ | (39,667 | ) | | $ | (56,505 | ) | | $ | (83,505 | ) | | $ | (57,410 | ) | | $ | 68,231 | | | | | |
| % Assets | | | -12.0 | % | | | -17.0 | % | | | -25.2 | % | | | -17.3 | % | | | 20.6 | % | | | | |
Market risk in securities. Market risk in securities shows the amount of gain or loss (before tax) in the securities portfolio. Portfolio volume, sector distribution, duration, and quality all affect market valuation. The adjusted equity ratio is tier 1 capital adjusted for the market gain or loss less and any applicable tax effect divided by average total assets for leverage capital purposes for the most recent quarter. The ratiorati o is designed to show tier 1 capital if the securities portfolio had to be liquidated and all gains and losses recognized. If the ratio remains strong after a +2% or +3% rate shock, market risk is reasonable in relation to the level of capital. A bank has flexibility and strength when the securities portfolio can be liquidated for liquidity purposes without affecting capital adequacy.
The Bank has only moderate market risk in investments because the average maturity in the portfolio is not very long, except for municipals, which are held to maturity (see page 1722 for discussion of investments). The portfolio should decline in value only about 0.2% or $322,000$478,000 for a 1% increase in rates. The current gain in the portfolio is $488,000 which means for each 1% interest rate shock the gain would be $10,000. The gain in value if rates fall would be somewhat less, because there are some callable bonds. Marking-to-market available for sale securities when rates change would add only modest volatility to a strong level of equity. This market risk acts to offset the interest rate risk (i.e. if rates decline and NIM is squeezed, there would be a concurrent gain in the value of securities).
SONOMA VALLEY BANCORP
AVERAGE BALANCES/YIELDS AND RATES PAID
For the three months ended September 30, 2009 (As Restated) and 2008
| | | 2009 | | | 2008 | |
| ASSETS | | Average Balance (As Restated) | | | Income/ Expense (As Restated) | | | Yield/ Rate | | | Average Balance | | | Income/ Expense | | | Yield/ Rate | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Loans(2): | | | | | | | | | | | | | | | | | | |
| Commercial | | $ | 198,569,474 | | | $ | 3,071,735 | | | | 6.14 | % | | $ | 175,215,278 | | | $ | 3,134,791 | | | | 7.10 | % |
| Consumer | | | 36,505,309 | | | | 580,864 | | | | 6.31 | % | | | 32,782,080 | | | | 578,947 | | | | 7.01 | % |
| Real estate construction | | | 24,787,167 | | | | 310,094 | | | | 4.96 | % | | | 29,788,071 | | | | 569,324 | | | | 7.58 | % |
| Real estate mortgage | | | 23,670,818 | | | | 421,179 | | | | 7.06 | % | | | 19,796,888 | | | | 348,622 | | | | 6.99 | % |
| Tax exempt loans (1) | | | 2,055,303 | | | | 42,714 | | | | 8.25 | % | | | 2,168,815 | | | | 45,018 | | | | 8.24 | % |
| Leases | | | 0 | | | | 0 | | | | 0.00 | % | | | 18,459 | | | | 539 | | | | 11.58 | % |
| Unearned loan fees | | | (253,498 | ) | | | | | | | | | | | (276,328 | ) | | | | | | | | |
| Total loans | | | 285,334,573 | | | | 4,426,586 | | | | 6.15 | % | | | 259,493,263 | | | | 4,677,241 | | | | 7.15 | % |
| Investment securities | | | | | | | | | | | | | | | | | | | | | | | | |
| Available for sale: | | | | | | | | | | | | | | | | | | | | | | | | |
| Taxable | | | 8,672,875 | | | | 46,019 | | | | 2.11 | % | | | 2,040,040 | | | | 14,553 | | | | 2.83 | % |
| Hold to maturity: | | | | | | | | | | | | | | | | | | | | | | | | |
| Tax exempt (1) | | | 13,461,701 | | | | 199,884 | | | | 5.89 | % | | | 13,651,033 | | | | 196,700 | | | | 5.72 | % |
| Total investment securities | | | 22,134,578 | | | | 245,903 | | | | 4.41 | % | | | 15,691,073 | | | | 211,253 | | | | 5.34 | % |
| CA Warrants | | | 91,706 | | | | 837 | | | | 3.62 | % | | | 0 | | | | 0 | | | | 0.00 | % |
| Federal funds sold | | | 0 | | | | 0 | | | | 0.00 | % | | | 23,555 | | | | 76 | | | | 1.28 | % |
| FHLB stock | | | 1,645,000 | | | | 0 | | | | 0.00 | % | | | 1,477,089 | | | | 24,298 | | | | 6.53 | % |
| Total due from banks/interest-bearing | | | 31,791,398 | | | | 17,346 | | | | 0.22 | % | | | 3,055,401 | | | | 5,953 | | | | .77 | % |
| Total interest-earning assets | | | 340,997,253 | | | $ | 4,690,672 | | | | 5.46 | % | | | 279,740,381 | | | $ | 4,918,821 | | | | 6.98 | % |
| Noninterest-bearing assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Reserve for loan losses | | | (8,615,790 | ) | | | | | | | | | | | (4,087,362 | ) | | | | | | | | |
| Cash and due from banks | | | 5,090,475 | | | | | | | | | | | | 5,510,959 | | | | | | | | | |
| Premises and equipment | | | 646,315 | | | | | | | | | | | | 792,107 | | | | | | | | | |
| Other real estate owned | | | 297,832 | | | | | | | | | | | | 320,416 | | | | | | | | | |
| Other assets | | | 20,113,662 | | | | | | | | | | | | 17,010,745 | | | | | | | | | |
| Total assets | | $ | 358,529,747 | | | | | | | | | | | $ | 299,287,246 | | | | | | | | | |
| LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest- bearing deposits | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing transaction | | $ | 33,855,559 | | | $ | 13,631 | | | | 0.16 | % | | $ | 29,773,852 | | | $ | 12,457 | | | | 0.17 | % |
| Savings deposits | | | 93,034,074 | | | | 199,734 | | | | 0.85 | % | | | 79,737,471 | | | | 348,426 | | | | 1.73 | % |
| Time deposits over $100,000 | | | 70,166,186 | | | | 395,921 | | | | 2.24 | % | | | 51,496,000 | | | | 442,232 | | | | 3.41 | % |
| Other time deposits | | | 39,354,763 | | | | 183,456 | | | | 1.85 | % | | | 31,748,081 | | | | 252,826 | | | | 3.16 | % |
| Total interest-bearing deposits | | | 236,410,582 | | | | 792,742 | | | | 1.33 | % | | | 192,755,404 | | | | 1,055,941 | | | | 2.17 | % |
| Federal funds purchased | | | | | | | | | | | | | | | 539,674 | | | | 2,578 | | | | 1.90 | % |
| Other borrowings | | | 29,428,315 | | | | 187,324 | | | | 2.53 | % | | | 17,524,412 | | | | 177,344 | | | | 4.01 | % |
| Total interest-bearing liabilities | | | 265,838,897 | | | $ | 980,066 | | | | 1.46 | % | | | 210,819,490 | | | $ | 1,235,863 | | | | 2.33 | % |
| Non-interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-interest-bearing demand deposits | | | 50,148,413 | | | | | | | | | | | | 51,086,420 | | | | | | | | | |
| Other liabilities | | | 7,588,031 | | | | | | | | | | | | 6,960,284 | | | | | | | | | |
| Shareholders' equity | | | 34,954,405 | | | | | | | | | | | | 30,421,052 | | | | | | | | | |
| Total liabilities and shareholders' equity | | $ | 358,529,746 | | | | | | | | | | | $ | 299,287,246 | | | | | | | | | |
| Interest rate spread | | | | | | | | | | | 3.99 | % | | | | | | | | | | | 4.65 | % |
| Interest income | | | | | | $ | 4,690,672 | | | | 5.46 | % | | | | | | $ | 4,918,821 | | | | 6.98 | % |
| Interest expense | | | | | | | 980,066 | | | | 1.14 | % | | | | | | | 1,235,863 | | | | 1.75 | % |
| Net interest income/margin | | | | | | $ | 3,710,606 | | | | 4.32 | % | | | | | | $ | 3,682,958 | | | | 5.23 | % |
| (1) | Fully tax equivalent adjustments are based on a federal income tax rate of 34% in 2009 and 2008. |
| (2) | Non accrual loans have been included in loans for the purposes of the above presentation. Loan fees of approximately $58,683 and $73,855 for the three months ended September 30, 2009 and 2008, respectively, were amortized to the appropriate interest income categories. |
| | For the Three Month Periods |
Ended September 30, 2009 and 2008
Overview
Net Loss for the three months ended September 30, 2009 was $18.9 million. This represents a decline of $19.8 million from earnings of $916,075 during the same period ended September 30, 2008. The decline in earnings is a result of a $24.2 million increase in the provision for loan losses. The reason for the increase in loan losses is further described on page 31 under “Provision for Loan Losses.
Net income (loss) available to common shareholders declined from net income of $916,075 during the three months ended September 30, 2008 to a net loss of $19.0 million during the same period 2009. Included in the current year loss was $136,935, which represents dividends accrued and discount amortized on preferred stock. On a per share basis, net loss for the three months ended September 30, 2009 equaled ($8.27) per diluted share compared with net income of $0.40 per diluted share during the same period in 2008. See page 5 for the comparative detail.
Return (loss) on average total assets on an annualized basis for the three months ended September 30, 2009 and 2008 was (21.23%)and 1.22%, respectively. Return (loss) on average shareholders' equity on an annualized basis for the three months ended September 30, 2009 and 2008 was (217.76%) and 12.05%, respectively. The decrease in the return on equity is a result of the decline in earnings and the increase in average equity when comparing the third quarter of 2009 to 2008.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income, adjusted to a fully taxable equivalent basis, increased by $28,000 to $3.71 million for the three months ended September 30, 2009, from $3.7 million during the comparable period of 2008. Net interest income on a fully taxable equivalent basis, as shown on the table “Average Balances/Yields and Rates Paid” on page 30, is higher than net interest income on the statements of income because it reflects adjustments applicable to tax-exempt income from certain securities and loans ($82,482 in 2009 and $82,184 in 2008, based on a 34% federal income tax rate).
Net interest income (stated on a fully taxable equivalent basis) expressed as a percentage of average earning assets, is referred to as net interest margin. Our net interest margin for the third quarter of 2009 decreased 91 basis points to 4.32% from 5.23% for the quarter ended September 30, 2008. The decrease in net interest margin is the result of the yield on earning assets declining faster than the yield on earning liabilities. For the three months ended September 30, 2009, the yield on average earning assets has decreased 152 basis points, while the yield on interest-bearing liabilities decreased 87 basis points from 2.33% for the three months of 2008 to 1.46% for the three month period ended September 30, 2009. &# 160; As of September 30, 2009 the federal funds rate was 0.00% - 0.25% and the prime rate was 3.25% compared to the fed funds rate of 2.00% and prime lending rate of 5.00% as of September 30, 2008.
Interest Income
Interest income, adjusted to a fully taxable equivalent basis, for the three months ended September 30, 2009 decreased by $228,000 to $4.7 million, a 4.69% decrease over the $4.9 million realized during the same period in 2008. The gain in volume of average balances was responsible for a $473,000 increase in interest income and a $701,000 decrease in income was related to lower interest rates, resulting in a net decline in interest income of $228,000.
Interest Expense
Total interest expense for the three months ended September 30, 2009 decreased by $256,000 to $980,000 compared with $1.2 million in the same period of 2008. The average rate paid on all interest-bearing liabilities for the third quarter of 2009 decreased 87 basis points to 1.46% from 2.33% in the third quarter of 2008. Average interest-earning liabilities for the third quarter of 2009 increased to $265.8 million from $210.8 million in the same period of 2008, a 26.1% gain.
The gain in volume of average balances accounted for a $247,000 increase in interest expense while a decline of $503,000 was related to lower interest rates paid, resulting in a $256,000 decrease in interest expense for the third quarter of 2009.
Individual components of interest income and interest expense are provided in the table “Average Balances/Yields and Rates Paid” on page 30.
Provision for Loan Losses
The provision for loan losses charged to operations was $24.5 million during the third quarter of 2009 compared to the $300,000 provision for the third quarter of 2008. The provision for loan losses is based on our evaluation of the loan portfolio and the adequacy of the allowance for loan losses in relation to total loans outstanding. Like many community banks, the Bank does have a significant concentration in commercial real estate loans. During 2009, due to severe economic recession, overly inflated real estate values, and the lack of available financing options, local commercial real estate values declined considerably. This severely impacted the Bank’s commercial real estate portfolio causing addi tional provisions for loan losses. The Bank has been proactive in obtaining current appraisals on loans secured by commercial real estate. Per regulatory and accounting guidelines, the Bank is required to write-down collateral-dependent loans to the fair market value of the collateral and set a reserve for potential selling costs. As these loans were charged off against the loan loss reserve, the reserve was reduced to a level that did not take into consideration the inherent risk in the remaining portfolio, and thus needed to be replenished. Additionally, due to increased risk associated with a faltering economy and an increase in the Bank’s loss history, the Bank increased reserves on all non-classified loans. Although the economy has shown some signs of stabilization, conditions in the commercial real estate market are anticipated to worsen further which will likely result in additional provisions for loan loss in 2009.
Non-interest Income
Non-interest income of $520,000 for the third quarter of 2009 represented a decrease of $9,000, or 1.62%, from the $529,000 for the comparable period in 2008. Contributing to this variance was a decline in income generated by bank-owned life insurance policies. Income on the policies was $96,000 for the quarter ending September 30, 2009 compared to $107,000 for the same period in 2008.
Non-interest Expense
For the third quarter of 2009, non-interest expense was $2.58 million compared with $2.45 million for the same period in 2008, representing an increase of $127,000, or 5.2%.The largest increase was in the area of other non-interest expense which increased $303,000 (37.6%) from $805,000 as of September 30, 2008 to $1.1 million as of September 30, 2009. The largest increase in other non-interest expense was in the accrual for FDIC insurance and a special assessment from $42,000 for the three months ended September 30, 2008 to $180,000 for the same period ended September 30, 2009, an increase of $138,000. Professional fee expense increased $110,000, or 33.8% from $324,000 for the three months ended September 30, 2008 to $434,000 for the same period in 2009. This is a result of increases in consulting fees and legal fees for loan collections of $42,000 and $35,000, respectively.
Salaries and benefits expense decreased $186,000, or 13.2% for the three months ended September 30, 2009 from $1.41 million to $1.23 million. At September 30, 2009 and September 2008, total full-time equivalent employees were 54 and 55, respectively.
The expenses for premises and equipment increased 4.2% from $234,000 for the third quarter of 2008 to $244,000 in 2009. The $10,000 increase in expense in 2009 is a result of increased building lease expense and additional software costs.
Provision (Benefit) for Income Taxes
The Company recorded an income tax benefit of $4.0 million, or 17.4% of pre-tax loss for the quarter ended September 30, 2009. This compares to income tax expense of $459,843, or 33.4% of pre-tax income for the comparable quarter of 2008. The percentage for 2009 is less than the statutory rate due to the creation of a partial valuation allowance against the deferred tax asset, after management determined that it is “more likely than not” that we will be able to fully recognize all of our deferred tax assets based on the cumulative pre-tax losses exceeding four years. This increased expense is partially offset by federal tax credits on California Affordable Housing Investments and tax exempt income such as earnings on Bank owned life i nsurance and municipal loan and investment income, which are in addition to the tax benefit generated as a result of the net loss.
Information regarding Quantitative and Qualitative Disclosures about Market Risk appears on page 2227 through 2529 under the caption “Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations - Market“Market Risk Management” in Item 2, and is incorporated herein by reference.
Disclosure Controls and Procedures
Disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in reports filed by the Company under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Evaluation of Disclosure Controls and Procedures
The Company carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, about the effectiveness of the Company’s disclosure controls and procedures pursuant to(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act Rule 13a-15(e)of 1934, as amended (“Exchange Act”). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, the disclosure controls and procedures, as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s disclosure controls and procedures were effective.
Inherent Limitations on Effectiveness of Controls
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision - -making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are effectivesubject to risks. Over time, controls may become inadequate because of changes in alerting them to material information required to be includedconditions or deterioration in this Form 10-Q.the degree of compliance with policies or procedures.
Changes in Internal Control over Financial Reporting
During the quarter ended March 31,September 30, 2009, there have been no changes in our internal control over financial reporting or to our knowledge, in other factors, that have materially affected, or are reasonably likely to materially affect, our internal controlscontrol over financial reporting.
Management Consideration of Restatement
Background
In connection with filing the Company’s Form 10-Q for the quarterly period ended September 30, 2009 (“Original Report”), management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of September 30, 2009. In this original evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of the Company’s disclosure controls and procedures were effective.
Commencing after the date of the filing of the Company’s Original Report, bank examiners began their normal and periodic on-site examination of the Bank. At the conclusion of the on-site work by the examiners, the examiners advised the Bank that certain impaired loans that the Bank had restructured should be valued using collateral values which had declined due to market conditions, rather than the discounted cash flow method, which management believes was appropriate at the time, resulting in additional loan charge-offs and provisions for loan losses related to the reclassified loans. These additional specific charge offs changed the Company’s loan loss history statistics, which then required additional general provisions for potential fut ure losses on the entire portfolio. In addition, the examiners advised the Company that certain restructured loans should be placed in non-accrual status and directed that the Company reverse interest income previously recognized on these loans. The bank examiners directed the Bank to amend its call report for the quarter ended September 30, 2009, to reflect these adjustments. After discussing the requested adjustments with its outside independent accountants and the Company’s Audit Committee, management determined that the Company should record additional loss reserves, charge offs, and a reversal of interest income in the quarter ended September 30, 2009, and reflect the additional non-accrual and impaired loans in its financial statements as of September 30, 2009.
Reevaluation
In connection with the revision to the financial statements as described in this Amended Report, management reevaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of September 30, 2009. In connection therewith, management determined there were no material weaknesses in the Company’s internal control over financial reporting (ICFR) as of September 30, 2009 and that the Company’s disclosure controls and procedures were effective as of September 30, 2009. In making this determination, management determined, among other things, that:
| · | The design of the Company’s disclosure controls and procedures was effective. In making this determination management concluded that (i) the Company had qualified individuals administering, analyzing and managing the Company’s accounting decisions and the information disclosed in reports filed with the SEC, (ii) the Company maintained policies and procedures necessary to allow the Company to make proper accounting determinations, (iii) the Company designed and followed policies and procedures that allowed information and analysis about the Company’s loans to be communicated fully and frequently to management and the loan committee and (iv) the Company maintained effective policies and procedures that allowed management, the Company’s loan committee and an independent third party loan review specialist to r eview, analyze and oversee the Company’s loan portfolio and the accounting decisions relating thereto. |
| · | The Company’s disclosure controls and procedures operated properly. Management concluded that the Company followed all of its policies and procedures as well as the applicable accounting standards and regulatory guidelines in existence at September 30, 2009. |
| · | The Company did not have a material weakness in its ICFR as of September 30, 2009. The bank regulators made different accounting conclusions regarding the Company’s loans than the Company made in the Original Report, which differing conclusions led to the filing of an amended call report for the quarter ended September 30, 2009 and this Amended Report. These conclusions are based upon differences in interpretation and judgment of subjective factors, which, given the regulatory environment and deteriorating real estate conditions in general, the Company does not believe constitute a material weakness in ICFR. |
Part II
From time to time we are involved in litigation incidental to the conduct of our business. While the outcome of lawsuits and other proceedings against us cannot be predicted with certainty, in the opinion of management, individually, or in the aggregate, no such lawsuits are expected to have a material effect on our financial position or results of operations.
Item 1A. RISK FACTORS
The risks identified in the Annual Report on Form 10-K for the year ended December 31, 2008, have not changed in any material respect, except that additional risk factors are added at the end of the list of risk factors under Item 1A to read in its entirety as follows:
If Economic Conditions Deteriorate, Our Results of Operations and Financial Condition could be Adversely Impacted.
Our financial results may be adversely affected by changes in prevailing economic conditions, including decreases in real estate values, changes in interest rates which may cause a party to legal proceedings arisingdecrease in interest rate spreads, adverse employment conditions, the monetary and fiscal policies of the federal government and other significant external events, including credit availability from correspondent banks. Adverse changes in the ordinary courseeconomy may also have a negative effect of business. Wethe ability of borrowers to make timely repayments of their loans, which could have an adverse impact on earnings.
Our Securities Portfolio may be Negatively Impacted by Fluctuations in Market Value.
Our securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other comprehensive income and/or earnings. Fluctuations in market value may be caused by decreases in interest rates, lower market prices for securities and lower investor demand. Our securities portfolio is evaluated for other-than-temporary impairment on at least a quarterly basis. If this evaluation shows an impairment to cash flow connected with one or more securities, a potential loss to earnings may occur.
Current levels of market volatility are unprecedented.
The market for certain investment securities has become highly volatile or inactive, and may not currentlystabilize or resume in the near term. This volatility can result in significant fluctuations in the prices of those securities, which may affect the Company’s results of operations.
Our business has been and may continue to be adversely affected by current conditions in the financial markets and economic conditions generally.
The global and U.S. economies are experiencing significantly reduced business activity and consumer spending as a partyresult of, among other factors, disruptions in the capital and credit markets during the past year. Dramatic declines in the housing market during the past year, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks.
A sustained weakness or weakening in business and economic conditions generally or specifically in the principal markets in which we do business could have one or more of the following adverse effects on our business:
a decrease in the demand for loans or other products and services offered by us;
a decrease in the value of our loans or other assets secured by consumer or commercial real estate;
a decrease to nor isdeposit balances due to overall reductions in the accounts of customers;
an impairment of certain intangible assets or investment securities;
an increase in the number of borrowers who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to us. An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming assets, net charge-offs and provision for credit losses.
Additional requirements under our regulatory framework, especially those imposed under the American Recovery and Reinvestment Act of 2009 ("ARRA"), the Emergency Economic Stabilization Act of 2008 ("EESA") or other legislation intended to strengthen the U.S. financial system, could adversely affect us.
Recent government efforts to strengthen the U.S. financial system, including the implementation of ARRA, EESA, the FDIC’s Temporary Liquidity Guaranty Program (“TLGP”) and special assessments imposed by the FDIC, subject participants to additional regulatory fees and requirements, including corporate governance requirements, executive compensation restrictions, restrictions on declaring or paying dividends, restrictions on share repurchases, limits on executive compensation tax deductions and prohibitions against golden parachute payments. These requirements, and any other requirements that may be subsequently imposed, may have a material and adverse affect on our business, financial condition, and results of its propertiesoperations.
If we are unable to redeem the subjectSeries A Preferred Stock within five years, the cost of anythis capital to us will increase substantially.
If we are unable to redeem the Series A Preferred Stock prior to February 20, 2014, the cost of the Series A Preferred Stock will increase substantially on that date, from 5.0% per annum to 9.0% per annum. Depending on our financial condition at the time, this increase in the annual dividend rate on the Series A Preferred Stock could have a material pending legal proceedings.negative effect on our liquidity.
Certain restrictions will affect our ability to declare or pay dividends and repurchase our shares as a result of our decision to participate in the Treasury’s Capital Purchase program (the “CPP”).
As a result of our participation in the CPP, our ability to declare or pay dividends on any of our common stock has been limited. Specifically, we are not able to declare dividend payments on our common, junior preferred or pari passu preferred stock if we are in arrears on the dividends on our Preferred Stock.
Further, we are not permitted to increase dividends on our common stock without the Treasury’s approval until the third anniversary of the investment unless the Preferred Stock has been redeemed or transferred. In addition, our ability to repurchase our shares has been restricted. The Treasury’s consent generally will be required for us to make any stock repurchases until the tenth anniversary of the investment by the Treasury unless the Preferred Stock has been redeemed or transferred.