UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year Commission File Number 0-10661
ended December 31, 2005
TriCo Bancshares
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(Exact name of Registrant as specified in its charter)
California 94-2792841
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
63 Constitution Drive, Chico, California 95973
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:(530) 898-0300
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, without par value
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(Title of Class)
Indicate by check mark whether the Registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Act.
YES NO X
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Indicate by check mark whether the Registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
YES NO X
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K.
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Act (check one).
Large accelerated filer Accelerated filer X Non-accelerated filer
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Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Act).
YES NO X
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The aggregate market value of the voting common stock held by non-affiliates of
the Registrant, as of March 7, 2006, was approximately $295,632,000 (based on
the closing sales price of the Registrants common stock on the date). This
computation excludes a total of 4,388,048 shares that are beneficially owned by
the officers and directors of Registrant who may be deemed to be the affiliates
of Registrant under applicable rules of the Securities and Exchange Commission.
The number of shares outstanding of Registrant's common stock, as of March 7,
2006, was 15,762,888 shares of common stock, without par value.
The following documents are incorporated herein by reference into the Part III
of this Form 10-K: Registrant's Proxy Statement for use in connection with its
2006 Annual Meeting of Shareholders. Except with respect to information
specifically incorporated by reference in the Form 10-K, the Proxy Statement is
not deemed to be filed as part hereof.
TABLE OF CONTENTS
Page Number
PART I
Item 1 Business 2
Item 1A Risk Factors 10
Item 1B Unresolved Staff Comments 17
Item 2 Properties 17
Item 3 Legal Proceedings 17
Item 4 Submission of Matters to a Vote of Security Holders 17
PART II
Item 5 Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Equity Securities 18
Item 6 Selected Financial Data 20
Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations 21
Item 7A Quantitative and Qualitative Disclosures About
Market Risk 41
Item 8 Financial Statements and Supplementary Data 42
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 77
Item 9A Controls and Procedures 77
Item 9B Other Information 77
PART III
Item 10 Directors and Executive Officers of the Registrant 78
Item 11 Executive Compensation 78
Item 12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 78
Item 13 Certain Relationships and Related Transactions 78
Item 14 Principal Accountant Fees and Services 78
PART IV
Item 15 Exhibits and Financial Statement Schedules 78
Signatures 82
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Annual Report on Form 10-K contains
forward-looking statements about TriCo Bancshares (the "Company") for which it
claims the protection of the safe harbor provisions contained in the Private
Securities Litigation Reform Act of 1995. These forward-looking statements are
based on Management's current knowledge and belief and include information
concerning the Company's possible or assumed future financial condition and
results of operations. When you see any of the words "believes", "expects",
"anticipates", "estimates", or similar expressions, these generally indicate
that we are making forward-looking statements. A number of factors, some of
which are beyond the Company's ability to predict or control, could cause future
results to differ materially from those contemplated. These factors include
those listed at Item 1A Risk Factors, in this report.
PART I
ITEM 1. BUSINESS
Information About TriCo Bancshares' Business
TriCo Bancshares (the "Company" or "TriCo") was incorporated in California on
October 13, 1981. It was organized at the direction of the board of directors of
Tri Counties Bank (the "Bank") for the purpose of forming a bank holding
company. On September 7, 1982, the shareholders of Tri Counties Bank became the
shareholders of TriCo and Tri Counties Bank became a wholly owned subsidiary of
TriCo. At that time, TriCo became a bank holding company subject to the
supervision of the Board of Governors of the Federal Reserve System ("FRB")
under the Bank Holding Company Act of 1956, as amended. Tri Counties Bank
remains subject to the supervision of the California Department of Financial
Institutions and the Federal Deposit Insurance Corporation ("FDIC"). On July 31,
2003, the Company formed a subsidiary business trust, TriCo Capital Trust I, to
issue trust preferred securities. On June 22, 2004, the Company formed a
subsidiary business trust, TriCo Capital Trust II, to issue trust preferred
securities. See Note 8 in the financial statements at Item 8 of this report for
a discussion about the Company's issuance of trust preferred securities. Tri
Counties Bank, TriCo Capital Trust I and TriCo Capital Trust II currently are
the only subsidiaries of TriCo and TriCo is not conducting any business
operations independent of Tri Counties Bank, TriCo Capital Trust I and TriCo
Capital Trust II.
For financial reporting purposes, the financial statements of the Bank are
consolidated into the financial statements of the Company. Historically, issuer
trusts, such as TriCo Capital Trust I and TriCo Capital Trust II, that issued
trust preferred securities have been consolidated by their parent companies and
trust preferred securities have been treated as eligible for Tier 1 capital
treatment by bank holding companies under FRB rules and regulations relating to
minority interests in equity accounts of consolidated subsidiaries. Applying the
provisions of the Financial Accounting Standards Board Revised Interpretation
No. 46 (FIN 46R), the Company is no longer permitted to consolidate such issuer
trusts beginning on December 31, 2003. Although the FRB has stated in its July
2, 2003 Supervisory Letter that trust preferred securities will be treated as
Tier 1 capital until notice is given to the contrary, the Supervisory Letter
also indicates that the FRB will review the regulatory implications of any
accounting treatment changes and will provide further guidance if necessary or
warranted.
On April 4, 2003, TriCo acquired North State National Bank, a national banking
organization located in Chico, California ("North State"), by the merger of
North State into the Bank. At the time of the acquisition, North State had total
assets of $140 million, investment securities of $41 million, loans of $76
million, and deposits of $126 million. The acquisition was accounted for using
the purchase method of accounting. The amount of goodwill recorded as of the
merger date, which represented the excess of the total purchase price over the
estimated fair value of net assets acquired, was approximately $15.5 million.
The Company recorded a core deposit intangible, which represents the excess of
the fair value of North State's deposits over their book value on the
acquisition date, of approximately $3.4 million. This core deposit intangible is
being amortized over a seven-year average life. TriCo paid $13,090,057 in cash,
issued 723,512 shares of TriCo common stock, and issued options to purchase
79,587 shares of TriCo common stock at an average exercise price of $6.22 per
share in exchange for all of the 1,234,375 common shares and options to purchase
79,937 common shares of North State outstanding as of April 4, 2003.
Additional information concerning the Company can be found on our website at
www.tcbk.com. Copies of our annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and amendments to these reports are
available free of charge through our website at Investor Information---"SEC
Filings" and "Annual Reports" as soon as reasonably practicable after the
Company files these reports to the Securities and Exchange Commission. The
information on our website is not incorporated into this annual report.
-2-
Business of Tri Counties Bank
Tri Counties Bank was incorporated as a California banking corporation on June
26, 1974, and received its certificate of authority to begin banking operations
on March 11, 1975. Tri Counties Bank engages in the general commercial banking
business in the California counties of Butte, Contra Costa, Del Norte, Fresno,
Glenn, Kern, Lake, Lassen, Madera, Mendocino, Merced, Nevada, Placer,
Sacramento, Shasta, Siskiyou, Stanislaus, Sutter, Tehama, Tulare, Yolo and Yuba.
Tri Counties Bank currently operates from 32 traditional branches and 17
in-store branches.
General Banking Services
The Bank conducts a commercial banking business including accepting demand,
savings and time deposits and making commercial, real estate, and consumer
loans. It also offers installment note collection, issues cashier's checks and
money orders, sells travelers checks and provides safe deposit boxes and other
customary banking services. Brokerage services are provided at the Bank's
offices by the Bank's association with Raymond James Financial Services, Inc.,
an independent financial services provider and broker-dealer. The Bank does not
offer trust services or international banking services.
The Bank has emphasized retail banking since it opened. Most of the Bank's
customers are retail customers and small to medium-sized businesses. The Bank
emphasizes serving the needs of local businesses, farmers and ranchers, retired
individuals and wage earners. The majority of the Bank's loans are direct loans
made to individuals and businesses in northern and central California where its
branches are located. At December 31, 2005, the total of the Bank's consumer
installment loans net of deferred fees outstanding was $508,233,000 (36.7%), the
total of commercial loans outstanding was $143,175,000 (10.3%), and the total of
real estate loans including construction loans of $110,116,000 was $733,627,000
(53.0%). The Bank takes real estate, listed and unlisted securities, savings and
time deposits, automobiles, machinery, equipment, inventory, accounts receivable
and notes receivable secured by property as collateral for loans.
Most of the Bank's deposits are attracted from individuals and business-related
sources. No single person or group of persons provides a material portion of the
Bank's deposits, the loss of any one or more of which, would have a materially
adverse effect on the business of the Bank, nor is a material portion of the
Bank's loans concentrated within a single industry or group of related
industries.
In order to attract loan and deposit business from individuals and small to
medium-sized businesses, branches of the Bank set lobby hours to accommodate
local demands. In general, lobby hours are from 9:00 a.m. to 5:00 p.m. Monday
through Thursday, and from 9:00 a.m. to 6:00 p.m. on Friday. Certain branches
with less activity open later and close earlier. Some Bank offices also utilize
drive-up facilities operating from 9:00 a.m. to 7:00 p.m. The supermarket
branches are open from 9:00 a.m. to 7:00 p.m. with some open until 8:00 p.m.
Monday through Saturday and 11:00 a.m. to 5:00 p.m. on Sunday.
The Bank offers 24-hour ATMs at almost all branch locations. The 56 ATMs are
linked to several national and regional networks such as CIRRUS and STAR. In
addition, banking by telephone on a 24-hour toll-free number is available to all
customers. This service allows a customer to obtain account balances and most
recent transactions, transfer moneys between accounts, make loan payments, and
obtain interest rate information.
In February 1998, the Bank became the first bank in the Northern Sacramento
Valley to offer banking services on the Internet. This banking service provides
customers one more tool for access to their accounts.
Other Activities
The Bank may in the future engage in other businesses either directly or
indirectly through subsidiaries acquired or formed by the Bank subject to
regulatory constraints. See "Regulation and Supervision."
-3-
Employees
At December 31, 2005, the Company and the Bank employed 670 persons, including
five executive officers. Full time equivalent employees were 604. No employees
of the Company or the Bank are presently represented by a union or covered under
a collective bargaining agreement. Management believes that its employee
relations are excellent.
Competition
The banking business in California generally, and in the Bank's primary service
area of Northern and Central California specifically, is highly competitive with
respect to both loans and deposits. It is dominated by a relatively small number
of national and regional banks with many offices operating over a wide
geographic area. Among the advantages such major banks have over the Bank is
their ability to finance wide ranging advertising campaigns and to allocate
their investment assets to regions of high yield and demand. By virtue of their
greater total capitalization such institutions have substantially higher lending
limits than does the Bank.
In addition to competing with savings institutions, commercial banks compete
with other financial markets for funds as a result of the deregulation of the
financial services industry. Yields on corporate and government debt securities
and other commercial paper may be higher than on deposits, and therefore affect
the ability of commercial banks to attract and hold deposits. Commercial banks
also compete for available funds with money market instruments and mutual funds.
During past periods of high interest rates, money market funds have provided
substantial competition to banks for deposits and they may continue to do so in
the future. Mutual funds are also a major source of competition for savings
dollars.
The Bank relies substantially on local promotional activity, personal contacts
by its officers, directors, employees and shareholders, extended hours,
personalized service and its reputation in the communities it services to
compete effectively.
Regulation and Supervision
As a consequence of the extensive regulation of commercial banking activities in
California and the United States, the business of the Company and the Bank are
particularly susceptible to changes in state and federal legislation and
regulations, which may have the effect of increasing the cost of doing business,
limiting permissible activities or increasing competition. Following is a
summary of some of the laws and regulations which effect the business. This
summary should be read with the management's discussion and analysis of
financial condition and results of operations included at Item 7 of this report.
As a registered bank holding company under the Bank Holding Company Act of 1956
(the "BHC Act"), the Company is subject to the regulation and supervision of the
FRB. The BHC Act requires the Company to file reports with the FRB and provide
additional information requested by the FRB. The Company must receive the
approval of the FRB before it may acquire all or substantially all of the assets
of any bank, or ownership or control of the voting shares of any bank if, after
giving effect to such acquisition of shares, the Company would own or control
more than 5 percent of the voting shares of such bank.
The Company and any subsidiaries it may acquire or organize will be deemed to be
affiliates of the Bank within the Federal Reserve Act. That Act establishes
certain restrictions, which limit the extent to which the Bank can supply its
funds to the Company and other affiliates. The Company is also subject to
restrictions on the underwriting and the public sale and distribution of
securities. It is prohibited from engaging in certain tie-in arrangements in
connection with any extension of credit, sale or lease of property, or
furnishing of services.
The Company is generally prohibited from engaging in, or acquiring direct or
indirect control of any company engaged in non-banking activities, unless the
FRB by order or regulation has found such activities to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
Notwithstanding this prohibition, under the Financial Services Modernization Act
of 1999, the Company may engage in any activity, and may acquire and retain the
shares of any company engaged in any activity, that the FRB, in coordination
with the Secretary of the Treasury, determines (by regulation or order) to be
financial in nature or incidental to such financial activities. Furthermore,
such law dictates several activities that are considered to be financial in
nature, and therefore are not subject to FRB approval.
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The Bank, as a state-chartered bank, is subject to regulation, supervision and
regular examination by the California Department of Financial Institutions
("DFI") and is also subject to the regulations of the FDIC. Federal and
California statutes and regulations relate to many aspects of the Bank's
operations, some of which are described below. The DFI regulates the number and
location of branch offices and may permit a bank to maintain branches only to
the extent allowable under state law for state banks. California law presently
permits a bank to locate a branch in any locality in California.
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act is subdivided into seven titles, by functional area.
Title I acts to facilitate affiliations among banks, insurance companies and
securities firms. Title II narrows the exemptions from the securities laws
previously enjoyed by banks, requires the FRB and the Securities and Exchange
Commission ("SEC") to work together to draft rules governing certain securities
activities of banks and creates a new, voluntary investment bank holding
company. Title III restates the proposition that the states are the functional
regulators for all insurance activities, including the insurance activities by
depository institutions. The law encourages the states to develop uniform or
reciprocal rules for the licensing of insurance agents. Title IV prohibits the
creation of additional unitary thrift holding companies. Title V imposes
significant requirements on financial institutions related to the transfer of
nonpublic personal information. These provisions require each institution to
develop and distribute to accountholders an information disclosure policy, and
requires that the policy allow customers to, and for the institution to honor a
customer's request to, "opt-out" of the proposed transfer of specified nonpublic
information to third parties. Title VI reforms the Federal Home Loan Bank system
to allow broader access among depository institutions to the systems advance
programs, and to improve the corporate governance and capital maintenance
requirements for the system. Title VII addresses a multitude of issues including
disclosure of ATM surcharging practices, disclosure of agreements among
non-governmental entities and insured depository institutions which donate to
non-governmental entities regarding donations made in connection with the
Community Reinvestment Act and disclosure by the recipient non-governmental
entities of how such funds are used. Additionally, the law extends the period of
time between Community Reinvestment Act examinations of community banks.
The Company has undertaken efforts to comply with all provisions of the
Gramm-Leach-Bliley Act and all implementing regulations, including the
development of appropriate policies and procedures to meet their
responsibilities in connection with the privacy provisions of Title V of that
act.
Safety and Soundness Standards
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
implemented certain specific restrictions on transactions and required the
regulators to adopt overall safety and soundness standards for depository
institutions related to internal control, loan underwriting and documentation,
and asset growth. Among other things, FDICIA limits the interest rates paid on
deposits by undercapitalized institutions, the use of brokered deposits and the
aggregate extension of credit by a depository institution to an executive
officer, director, principal stockholder or related interest, and reduces
deposit insurance coverage for deposits offered by undercapitalized institutions
for deposits by certain employee benefits accounts.
-5-
The FDICIA added a new Section 39 to the Federal Deposit Insurance Act which
required the agencies to establish safety and soundness standards for insured
financial institutions covering:
- internal controls, information systems and internal audit systems;
- loan documentation;
- credit underwriting;
- interest rate exposure;
- asset growth;
- compensation, fees and benefits;
- asset quality, earnings and stock valuation; and
- excessive compensation for executive officers, directors or principal
shareholders which could lead to material financial loss.
If an agency determines that an institution fails to meet any standard
established by the guidelines, the agency may require the financial institution
to submit to the agency an acceptable plan to achieve compliance with the
standard. If the agency requires submission of a compliance plan and the
institution fails to timely submit an acceptable plan or to implement an
accepted plan, the agency must require the institution to correct the
deficiency. An institution must file a compliance plan within 30 days of a
request to do so from the institution's primary federal regulatory agency. The
agencies may elect to initiate enforcement action in certain cases rather than
rely on an existing plan particularly where failure to meet one or more of the
standards could threaten the safe and sound operation of the institution.
Restrictions on Dividends and Other Distributions
The power of the board of directors of an insured depository institution, such
as the Bank, to declare a cash dividend or other distribution with respect to
capital is subject to statutory and regulatory restrictions which limit the
amount available for such distribution depending upon the earnings, financial
condition and cash needs of the institution, as well as general business
conditions. FDICIA prohibits insured depository institutions from paying
management fees to any controlling persons or, with certain limited exceptions,
making capital distributions, including dividends, if, after such transaction,
the institution would be undercapitalized. Additionally, under FDICIA, a bank
may not make any capital distribution, including the payment of dividends, if
after making such distribution the bank would be in any of the
"under-capitalized" categories under the FDIC's Prompt Corrective Action
regulations.
Under the Financial Institution's Supervisory Act, the FDIC also has the
authority to prohibit a bank from engaging in business practices that the FDIC
considers to be unsafe or unsound. It is possible, depending upon the financial
condition of a bank and other factors that the FDIC could assert that the
payment of dividends or other payments in some circumstances might be such an
unsafe or unsound practice and thereby prohibit such payment.
Under California law, dividends and other distributions by the Company are
subject to declaration by the board of directors at its discretion out of net
assets. Dividends cannot be declared and paid when such payment would make the
Company insolvent. FRB policy prohibits a bank holding company from declaring or
paying a cash dividend which would impose undue pressure on the capital of
subsidiary banks or would be funded only through borrowings or other
arrangements that might adversely affect the holding company's financial
position. The policy further declares that a bank holding company should not
continue its existing rate of cash dividends on its common stock unless its net
income is sufficient to fully fund each dividend and its prospective rate of
earnings retention appears consistent with its capital needs, asset quality and
overall financial condition. Other FRB policies forbid the payment by bank
subsidiaries to their parent companies of management fees, which are
unreasonable in amount or exceed a fair market value of the services rendered
(or, if no market exists, actual costs plus a reasonable profit).
In addition, the FRB has authority to prohibit banks that it regulates from
engaging in practices, which in the opinion of the FRB are unsafe or unsound.
Such practices may include the payment of dividends under some circumstances.
Moreover, the payment of dividends may be inconsistent with capital adequacy
guidelines. The Company may be subject to assessment to restore the capital of
the Bank should it become impaired.
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Consumer Protection Laws and Regulations
The bank regulatory agencies are focusing greater attention on compliance with
consumer protection laws and their implementing regulations. Examination and
enforcement have become more intense in nature, and insured institutions have
been advised to monitor carefully compliance with such laws and regulations. The
Company is subject to many federal consumer protection statues and regulations,
some of which are discussed below.
The Community Reinvestment Act of 1977 is intended to encourage insured
depository institutions, while operating safely and soundly, to help meet the
credit needs of their communities. This act specifically directs the federal
regulatory agencies to assess a bank's record of helping meet the credit needs
of its entire community, including low- and moderate-income neighborhoods,
consistent with safe and sound practices. This act further requires the agencies
to take a financial institution's record of meeting its community credit needs
into account when evaluating applications for, among other things, domestic
branches, mergers or acquisitions, or holding company formations. The agencies
use the Community Reinvestment Act assessment factors in order to provide a
rating to the financial institution. The ratings range from a high of
"outstanding" to a low of "substantial noncompliance."
The Equal Credit Opportunity Act generally prohibits discrimination in any
credit transaction, whether for consumer or business purposes, on the basis of
race, color, religion, national origin, sex, marital status, age (except in
limited circumstances), receipt of income from public assistance programs, or
good faith exercise of any rights under the Consumer Credit Protection Act. The
Truth-in-Lending Act is designed to ensure that credit terms are disclosed in a
meaningful way so that consumers may compare credit terms more readily and
knowledgeably. As a result of the such act, all creditors must use the same
credit terminology to express rates and payments, including the annual
percentage rate, the finance charge, the amount financed, the total payments and
the payment schedule, among other things.
The Fair Housing Act regulates many practices, including making it unlawful for
any lender to discriminate in its housing-related lending activities against any
person because of race, color, religion, national origin, sex, handicap or
familial status. A number of lending practices have been found by the courts to
be, or may be considered, illegal under this Act, including some that are not
specifically mentioned in the Act itself. The Home Mortgage Disclosure Act grew
out of public concern over credit shortages in certain urban neighborhoods and
provides public information that will help show whether financial institutions
are serving the housing credit needs of the neighborhoods and communities in
which they are located. This act also includes a "fair lending" aspect that
requires the collection and disclosure of data about applicant and borrower
characteristics as a way of identifying possible discriminatory lending patterns
and enforcing anti-discrimination statutes.
Finally, the Real Estate Settlement Procedures Act requires lenders to provide
borrowers with disclosures regarding the nature and cost of real estate
settlements. Also, this act prohibits certain abusive practices, such as
kickbacks, and places limitations on the amount of escrow accounts.
Penalties under the above laws may include fines, reimbursements and other
penalties. Due to heightened regulatory concern related to compliance with these
acts generally, the Company may incur additional compliance costs or be required
to expend additional funds for investments in their local community.
-7-
USA Patriot Act of 2001
The USA Patriot Act was enacted in 2001 to combat money laundering and terrorist
financing. The impact of the Patriot Act on financial institutions is
significant and wide ranging. The Patriot Act contains sweeping anti-money
laundering and financial transparency laws and requires various regulations,
including:
- due diligence requirements for financial institutions that administer,
maintain, or manage private bank accounts or correspondent accounts
for non-U.S. persons,
- standards for verifying customer identification at account opening,
- rules to promote cooperation among financial institutions, regulators,
and law enforcement entities to assist in the identification of
parties that may be involved in terrorism or money laundering,
- reports to be filed by non-financial trades and business with the
Treasury Department's Financial Crimes Enforcement Network for
transactions exceeding $10,000, and
- the filing of suspicious activities reports by securities brokers and
dealers if they believe a customer may be violating U.S. laws and
regulations.
Capital Requirements
Federal regulation imposes upon all financial institutions a variable system of
risk-based capital guidelines designed to make capital requirements sensitive to
differences in risk profiles among banking organizations, to take into account
off-balance sheet exposures and to promote uniformity in the definition of bank
capital uniform nationally.
The Bank and the Company are subject to the minimum capital requirements of the
FDIC and the FRB, respectively. As a result of these requirements, the growth in
assets is limited by the amount of its capital accounts as defined by the
respective regulatory agency. Capital requirements may have an effect on
profitability and the payment of dividends on the common stock of the Bank and
the Company. If an entity is unable to increase its assets without violating the
minimum capital requirements or is forced to reduce assets, its ability to
generate earnings would be reduced.
The FRB, and the FDIC have adopted guidelines utilizing a risk-based capital
structure. Qualifying capital is divided into two tiers. Tier 1 capital consists
generally of common stockholders' equity, qualifying noncumulative perpetual
preferred stock, qualifying cumulative perpetual preferred stock (up to 25% of
total Tier 1 capital) and minority interests in the equity accounts of
consolidated subsidiaries, less goodwill and certain other intangible assets.
Tier 2 capital consists of, among other things, allowance for loan and lease
losses up to 1.25% of weighted risk assets, perpetual preferred stock, hybrid
capital instruments, perpetual debt, mandatory convertible debt securities,
subordinated debt and intermediate-term preferred stock. Tier 2 capital
qualifies as part of total capital up to a maximum of 100% of Tier 1 capital.
Amounts in excess of these limits may be issued but are not included in the
calculation of risk-based capital ratios. Under these risk-based capital
guidelines, the Bank and the Company are required to maintain capital equal to
at least 8% of its assets, of which at least 4% must be in the form of Tier 1
capital.
The guidelines also require the Company and the Bank to maintain a minimum
leverage ratio of 4% of Tier 1 capital to total assets (the "leverage ratio").
The leverage ratio is determined by dividing an institution's Tier 1 capital by
its quarterly average total assets, less goodwill and certain other intangible
assets. The leverage ratio constitutes a minimum requirement for the most
well-run banking organizations. See Note 19 in the financial statements at Item
8 of this report for a discussion about the Company's risk-based capital ratios.
Prompt Corrective Action
Prompt Corrective Action Regulations of the federal bank regulatory agencies
establish five capital categories in descending order (well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized and
critically undercapitalized), assignment to which depends upon the institution's
total risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage
ratio. Institutions classified in one of the three undercapitalized categories
are subject to certain mandatory and discretionary supervisory actions, which
include increased monitoring and review, implementation of capital restoration
plans, asset growth restrictions, limitations upon expansion and new business
activities, requirements to augment capital, restrictions upon deposit gathering
and interest rates, replacement of senior executive officers and directors, and
requiring divestiture or sale of the institution. The Bank has been classified
as well-capitalized since adoption of these regulations.
-8-
Impact of Monetary Policies
Banking is a business that depends on interest rate differentials. In general,
the difference between the interest paid by a bank on its deposits and other
borrowings, and the interest rate earned by banks on loans, securities and other
interest-earning assets comprises the major source of banks' earnings. Thus, the
earnings and growth of banks are subject to the influence of economic conditions
generally, both domestic and foreign, and also to the monetary and fiscal
policies of the United States and its agencies, particularly the FRB. The FRB
implements national monetary policy, such as seeking to curb inflation and
combat recession, by its open-market dealings in United States government
securities, by adjusting the required level of reserves for financial
institutions subject to reserve requirements and through adjustments to the
discount rate applicable to borrowings by banks which are members of the FRB.
The actions of the FRB in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates. The nature and timing
of any future changes in such policies and their impact on the Company cannot be
predicted. In addition, adverse economic conditions could make a higher
provision for loan losses a prudent course and could cause higher loan loss
charge-offs, thus adversely affecting the Company's net earnings.
Insurance of Deposits
The Bank's deposit accounts are insured up to a maximum of $100,000 per
depositor by the FDIC. The FDIC issues regulations and generally supervises the
operations of its insured banks. This supervision and regulation is intended
primarily for the protection of depositors, not shareholders.
As of December 31, 2005, the deposit insurance premium rate was $0.0134 per
$100.00 in deposits. The FDIC is able to increase deposit insurance premiums as
it sees fit every six months. This could result in a significant increase in the
cost of doing business for the Bank in the future.
Securities Laws
The Company is subject to the periodic reporting requirements of the Securities
and Exchange Act of 1934, as amended, which include filing annual, quarterly and
other current reports with the Securities and Exchange Commission. The
Sarbanes-Oxley Act was enacted in 2002 to protect investors by improving the
accuracy and reliability of corporate disclosures made pursuant to securities
laws. Among other things, this act:
- prohibits a registered public accounting firm from performing
specified nonaudit services contemporaneously with a mandatory audit,
- requires the chief executive officer and chief financial officer of an
issuer to certify each annual or quarterly report filed with the
Securities and Exchange Commission,
- requires an issuer to disclose all material off-balance sheet
transactions that may have a material effect on an issuer's financial
status, and
- prohibits insider transactions in an issuer's stock during lock-out
periods of an issuer's pension plans.
The Company is also required to comply with the rules and regulations of the
Nasdaq Stock Market, Inc., on which its common stock is listed.
-9-
ITEM 1A. RISK FACTORS
In analyzing whether to make or continue an investment in the Company, investors
should consider, among other factors, the following:
The types of loans in our portfolio have a higher degree of credit risk and a
downturn in our real estate markets could hurt our business.
We generally invest a greater proportion of our assets in loans secured by
commercial real estate, commercial loans and consumer loans than savings
institutions that invest a greater proportion of their assets in loans secured
by single-family residences. Commercial real estate loans and commercial loans
generally involve a higher degree of credit risk than residential mortgage
lending due primarily to the large amounts loaned to individual borrowers.
Losses incurred on loans to a small number of borrowers could have a material
adverse impact on our income and financial condition. In addition, unlike
residential mortgage loans, commercial and commercial real estate loans depend
on the cash flow from the property or the business to service the debt. Cash
flow may be significantly affected by general economic conditions. Consumer
lending is riskier than residential mortgage lending because consumer loans are
either unsecured or secured by assets that depreciate in value. See Item 7 -
Loans of this report for information as to the percentage of loans invested in
commercial real estate, commercial and consumer loans.
In addition, a downturn in our real estate markets could hurt our business
because many of our loans are secured by real estate. Real estate values and
real estate markets are generally affected by changes in national, regional or
local economic conditions, fluctuations in interest rates and the availability
of loans to potential purchasers, changes in tax laws and other governmental
statutes, regulations and policies and acts of nature. If real estate prices
decline, the value of real estate collateral securing our loans could be
reduced. Our ability to recover on defaulted loans by foreclosing and selling
the real estate collateral would then be diminished and we would be more likely
to suffer losses on defaulted loans. As of December 31, 2005, approximately
79.7% of the book value of our loan portfolio consisted of loans collateralized
by various types of real estate. Substantially all of our real estate collateral
is located in California. If there is a significant decline in real estate
values, the collateral for our loans will provide less security. Real estate
values could also be affected by, among other things, earthquakes and national
disasters particular to California. Any such downturn could have a material
adverse effect on our business, financial condition, results of operations and
cash flows.
Decreasing interest rates could hurt our profits.
Our ability to earn a profit, like that of most financial institutions, depends
on our net interest income, which is the difference between the interest income
we earn on our interest-earning assets, such as mortgage loans and investments,
and the interest expense we pay on our interest-bearing liabilities, such as
deposits. Our profitability depends on our ability to manage our assets and
liabilities during periods of changing market interest rates. A sustained
decrease in market interest rates could adversely affect our earnings. When
interest rates decline, borrowers tend to refinance higher-rate, fixed-rate
loans at lower rates. Under those circumstances, we would not be able to
reinvest those prepayments in assets earning interest rates as high as the rates
on the prepaid loans on investment securities. In addition, our commercial real
estate and commercial loans, which carry interest rates that adjust in
accordance with changes in the prime rate, will adjust to lower rates.
An economic downturn in California could hurt our profits.
We conduct most of our business in northern and central California. As a result
of this geographic concentration, our results are effected by the economic
conditions in California. Deterioration in economic conditions could result in
the following consequences, any of which could have a material adverse effect on
our business, financial condition, results of operations and cash flows:
- problem assets and foreclosures may increase,
- demand for our products and services may decline,
- low cost or non-interest bearing deposits may decrease, and
- collateral for loans made by us, especially real estate, may decline
in value, in turn reducing customers' borrowing power, and reducing
the value of assets and collateral associated with our existing loans.
-10-
In view of the concentration of our operations and the collateral securing our
loan portfolio in both northern and central California, we may be particularly
susceptible to the adverse effects of any of these consequences, any of which
could have a material adverse effect on our business, financial condition,
results of operations and cash flows.
Strong competition in California could hurt our profits.
Competition in the banking and financial services industry is intense. Our
profitability depends upon our continued ability to successfully compete. We
compete exclusively in northern and central California for loans, deposits and
customers with commercial banks, savings and loan associations, credit unions,
finance companies, mutual funds, insurance companies, and brokerage and
investment banking firms. In particular, our competitors include several major
financial companies whose greater resources may afford them a marketplace
advantage by enabling them to maintain numerous locations and mount extensive
promotional and advertising campaigns. Additionally, banks and other financial
institutions with larger capitalization and financial intermediaries not subject
to bank regulatory restrictions may have larger lending limits which would allow
them to serve the credit needs of larger customers. Areas of competition include
interest rates for loans and deposits, efforts to obtain loan and deposit
customers and a range in quality of products and services provided, including
new technology-driven products and services. Technological innovation continues
to contribute to greater competition in domestic and international financial
services markets as technological advances enable more companies to provide
financial services. We also face competition from out-of-state financial
intermediaries that have opened loan production offices or that solicit deposits
in our market areas. If we are unable to attract and retain banking customers,
we may be unable to continue our loan growth and level of deposits and our
business, financial condition, results of operations and cash flows may be
adversely affected.
We operate in a highly regulated environment and we may be adversely affected by
changes in laws and regulations. Regulations may prevent or impair our ability
to pay dividends, engage in acquisitions or operate in other ways.
We are subject to extensive regulation, supervision and examination by the
California Department of Financial Institutions, or the DFI, the Federal Deposit
Insurance Corporation, and the Board of Governors of the Federal Reserve System.
See Item 1 - Regulation and Supervision of this report for information on the
regulation and supervision which governs our activities. Regulatory authorities
have extensive discretion in their supervisory and enforcement activities,
including the imposition of restrictions on our operations, the classification
of our assets and determination of the level of our allowance for loan losses.
Banking regulations, designed primarily for the protection of depositors, may
limit our growth and the return to you, our investors, by restricting certain of
our activities, such as:
- the payment of dividends to its shareholders,
- possible mergers with or acquisitions of or by other institutions,
- desired investments,
- loans and interest rates on loans,
- interest rates paid on deposits,
- the possible expansion of branch offices, and
- the ability to provide securities or trust services.
We also are subject to capitalization guidelines set forth in federal
legislation and could be subject to enforcement actions to the extent that we
are found by regulatory examiners to be undercapitalized. We cannot predict what
changes, if any, will be made to existing federal and state legislation and
regulations or the effect that such changes may have on our future business and
earnings prospects. Any change in such regulation and oversight, whether in the
form of regulatory policy, regulations, legislation or supervisory action, may
have a material impact on our operations.
We are exposed to risks in connection with the loans we make.
A significant source of risk for us arises from the possibility that losses will
be sustained because borrowers, guarantors and related parties may fail to
perform in accordance with the terms of their loans. We have underwriting and
credit monitoring procedures and credit policies, including the establishment
and review of the allowance for loan losses, that we believe to be appropriate
to minimize this risk by assessing the likelihood of nonperformance, tracking
loan performance and diversifying our respective loan portfolios. Such policies
and procedures, however, may not prevent unexpected losses that could adversely
affect our results of operations.
-11-
Technological advances impact our business.
The banking industry is undergoing technological changes with frequent
introductions of new technology-driven products and services. In addition to
improving customer services, the effective use of technology increases
efficiency and enables financial institutions to reduce costs. Our future
success will depend, in part, on our ability to address the needs of our
customers by using technology to provide products and services that will satisfy
customer demands for convenience as well as to create additional efficiencies in
our operations. Many of our competitors have substantially greater resources
than we do to invest in technological improvements. We may not be able to
effectively implement new technology-driven products and services or
successfully market such products and services to our customers.
There are potential risks associated with future acquisitions and expansions.
We intend to continue to explore expanding our branch system through opening new
bank branches and in-store branches in existing or new markets in northern and
central California. In the ordinary course of business, we evaluate potential
branch locations that would bolster our ability to cater to the small business,
individual and residential lending markets in California. Any given new branch,
if and when opened, will have expenses in excess of revenues for varying periods
after opening that may adversely affect our results of operations or overall
financial condition.
In addition, to the extent that we acquire other banks in the future, our
business may be negatively impacted by certain risks inherent with such
acquisitions. These risks include:
- incurring substantial expenses in pursuing potential acquisitions
without completing such acquisitions,
- losing key clients as a result of the change of ownership to us,
- the acquired business not performing in accordance with our
expectations,
- difficulties arising in connection with the integration of the
operations of the acquired business with our operations,
- needing to make significant investments and infrastructure, controls,
staff, emergency backup facilities or other critical business
functions that become strained by our growth,
- management needing to divert attention from other aspects of our
business,
- potentially losing key employees of the acquired business,
- incurring unanticipated costs which could reduce our earnings per
share,
- assuming potential liabilities of the acquired company as a result of
the acquisition, and
- an acquisition may dilute our earnings per share, in both the short
and long term, or it may reduce our tangible capital ratios.
As result of these risks, any given acquisition, if and when consummated, may
adversely affect our results of operations or financial condition. In addition,
because the consideration for an acquisition may involve cash, debt or the
issuance of shares of our stock and may involve the payment of a premium over
book and market values, existing shareholders may experience dilution in
connection with any acquisition.
Compliance with changing regulation of corporate governance and public
disclosure may result in additional risks and expenses.
Changing laws, regulations and standards relating to corporate governance and
public disclosure, including the Sarbanes-Oxley Act of 2002 and new Securities
and Exchange Commission regulations, are creating uncertainty for
publicly-traded companies such as TriCo. These laws, regulations and standards
are subject to varying interpretations in many cases and, as a result, their
application in practice may evolve over time as new guidance is provided by
regulatory and governing bodies, which could result in continuing uncertainty
regarding compliance matters and higher costs necessitated by ongoing revisions
to disclosure and governance practices. We are committed to maintaining high
standards of corporate governance and public disclosure. As a result, our
efforts to comply with evolving laws, regulations and standards have resulted
in, and are likely to continue to result in, increased expenses and a diversion
of management time and attention. In particular, our efforts to comply with
Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations
regarding management's required assessment of its internal control over
financial reporting and its external auditors' audit of that assessment has
required the commitment of significant financial and managerial resources. We
expect these efforts to require the continued commitment of significant
resources. Further, the members of our board of directors, members of our audit
or compensation committees, our chief executive officer, our chief financial
officer and certain other executive officers could face an increased risk of
personal liability in connection with the performance of their duties. It may
also become more difficult and more expensive to obtain director and officer
liability insurance. As a result, our ability to attract and retain executive
officers and qualified board and committee members could be more difficult.
-12-
Our growth and expansion may strain our ability to manage our operations and our
financial resources.
Our financial performance and profitability depend on our ability to execute our
corporate growth strategy. In addition to seeking deposit and loan and lease
growth in our existing markets, we may pursue expansion opportunities in new
markets. Continued growth, however, may present operating and other problems
that could adversely affect our business, financial condition, results of
operations and cash flows. Accordingly, there can be no assurance that we will
be able to execute our growth strategy or maintain the level of profitability
that we have recently experienced.
Our growth may place a strain on our administrative, operational and financial
resources and increase demands on our systems and controls. This business growth
may require continued enhancements to and expansion of our operating and
financial systems and controls and may strain or significantly challenge them.
In addition, our existing operating and financial control systems and
infrastructure may not be adequate to maintain and effectively monitor future
growth. Our continued growth may also increase our need for qualified personnel.
We cannot assure you that we will be successful in attracting, integrating and
retaining such personnel.
We depend on key personnel and the loss of one or more of those key personnel
may materially and adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry is
intense and there are a limited number of qualified persons with knowledge of,
and experience in, the California community banking industry. The process of
recruiting personnel with the combination of skills and attributes required to
carry out our strategies is often lengthy. Our success depends to a significant
degree upon our ability to attract and retain qualified management, loan
origination, finance, administrative, marketing and technical personnel and upon
the continued contributions of our management and personnel. In particular, our
success has been and continues to be highly dependent upon the abilities of our
senior executive management team of Messrs. Smith, O'Sullivan, Mastorakis,
Hagstrom, Reddish, Carney, Miller and Rios, who have expertise in banking and
experience in the California markets we serve and have targeted for future
expansion. We also depend upon a number of other key executives who are
California natives or are long-time residents and who are integral to
implementing our business plan. The loss of the services of any one of our
senior executive management team or other key executives could have a material
adverse effect on our business, financial condition, results of operations and
cash flows.
Our business is subject to interest rate risk and variations in interest rates
may negatively affect our financial performance.
A substantial portion of our income is derived from the differential or "spread"
between the interest earned on loans, securities and other interest-earning
assets, and interest paid on deposits, borrowings and other interest-bearing
liabilities. Because of the differences in the maturities and repricing
characteristics of our interest-earning assets and interest-bearing liabilities,
changes in interest rates do not produce equivalent changes in interest income
earned on interest-earning assets and interest paid on interest-bearing
liabilities. Accordingly, fluctuations in interest rates could adversely affect
our interest rate spread and, in turn, our profitability. In addition, loan
origination volumes are affected by market interest rates. Rising interest
rates, generally, are associated with a lower volume of loan originations while
lower interest rates are usually associated with higher loan originations.
Conversely, in rising interest rate environments, loan repayment rates may
decline and in falling interest rate environments, loan repayment rates may
increase. Although we have been successful in generating new loans and leases
during 2005, the continuation of historically low long-term interest rate levels
may cause additional refinancing of commercial real estate and 1-4 family
residence loans, which may depress our loan volumes or cause rates on loans to
decline. In addition, an increase in the general level of short-term interest
rates on variable rate loans may adversely affect the ability of certain
borrowers to pay the interest on and principal of their obligations or reduce
the amount they wish to borrow. Additionally, as short-term market rates have
risen over the past eighteen months, although we have increased the rates we
paid on borrowings and other interest-bearing liabilities, we have not
proportionally increased interest rates we paid on deposits. If short-term rates
continue to rise, in order to retain existing deposit customers and attract new
deposit customers we may need to increase rates we pay on deposit accounts.
Because we have deferred increasing rates we paid on deposit accounts during a
period of rising short-term market rates, we may need to accelerate the pace of
rate increases on our deposit accounts as compared to the pace of future
increases in short-term market rates. Accordingly, changes in levels of market
interest rates could materially and adversely affect our net interest spread,
asset quality, loan origination volume, business, financial condition, results
of operations and cash flows.
-13-
If we cannot attract deposits, our growth may be inhibited.
We plan to increase the level of our assets, including our loan portfolio. Our
ability to increase our assets depends in large part on our ability to attract
additional deposits at favorable rates. We intend to seek additional deposits by
offering deposit products that are competitive with those offered by other
financial institutions in our markets and by establishing personal relationships
with our customers. We cannot assure you that these efforts will be successful.
Our inability to attract additional deposits at competitive rates could have a
material adverse effect on our business, financial condition, results of
operations and cash flows.
Our allowance for loan losses may not be adequate to cover actual losses.
A significant source of risk arises from the possibility that losses could be
sustained because borrowers, guarantors, and related parties may fail to perform
in accordance with the terms of their loans. The underwriting and credit
monitoring policies and procedures that we have adopted to address this risk may
not prevent unexpected losses that could have a material adverse effect on our
business, financial condition, results of operations and cash flows. Unexpected
losses may arise from a wide variety of specific or systemic factors, many of
which are beyond our ability to predict, influence, or control. Like all
financial institutions, we maintain an allowance for loan losses to provide for
loan defaults and non-performance. Our allowance for loan losses may not be
adequate to cover actual loan losses, and future provisions for loan losses
could materially and adversely affect our business, financial condition, results
of operations and cash flows. The allowance for loan losses reflects our
estimate of the probable losses in our loan portfolio at the relevant balance
sheet date. Our allowance for loan losses is based on prior experience, as well
as an evaluation of the known risks in the current portfolio, composition and
growth of the loan portfolio and economic factors. The determination of an
appropriate level of loan loss allowance is an inherently difficult process and
is based on numerous assumptions. The amount of future losses is susceptible to
changes in economic, operating and other conditions, including changes in
interest rates, that may be beyond our control and these losses may exceed
current estimates. Federal and state regulatory agencies, as an integral part of
their examination process, review our loans and allowance for loan losses. While
we believe that our allowance for loan losses is adequate to cover current
losses, we cannot assure you that we will not increase the allowance for loan
losses further or that regulators will not require us to increase this
allowance. Either of these occurrences could have a material adverse affect on
our business, financial condition and results of operations.
We rely on communications, information, operating and financial control systems
technology from third-party service providers, and we may suffer an interruption
in those systems that may result in lost business. We may not be able to obtain
substitute providers on terms that are as favorable if our relationships with
our existing service providers are interrupted.
We rely heavily on third-party service providers for much of our communications,
information, operating and financial control systems technology. Any failure or
interruption or breach in security of these systems could result in failures or
interruptions in our customer relationship management, general ledger, deposit,
servicing and loan origination systems. We cannot assure you that such failures
or interruptions will not occur or, if they do occur, that they will be
adequately addressed by us or the third parties on which we rely. The occurrence
of any failures or interruptions could have a material adverse effect on our
business, financial condition, results of operations and cash flows. If any of
our third-party service providers experience financial, operational or
technological difficulties, or if there is any other disruption in our
relationships with them, we may be required to locate alternative sources of
such services, and we cannot assure you that we could negotiate terms that are
as favorable to us, or could obtain services with similar functionality as found
in our existing systems without the need to expend substantial resources, if at
all. Any of these circumstances could have a material adverse effect on our
business, financial condition, results of operations and cash flows.
-14-
Our future ability to pay dividends is subject to restrictions. As a result,
capital appreciation, if any, of our common stock may be your sole source of
gains in the future.
Since we are a holding company with no significant assets other than Tri
Counties Bank, we currently depend upon dividends from the bank for a
substantial portion of our revenues. Our ability to continue to pay dividends in
the future will continue to depend in large part upon our receipt of dividends
or other capital distributions from Tri Counties Bank. The ability of Tri
Counties Bank to pay dividends or make other capital distributions to us is
subject to the regulatory authority of the DFI. As of December 31, 2005, the
Bank could have paid approximately $47 million in dividends without the prior
approval of the Federal Reserve or the DFI. The amount that Tri Counties Bank
may pay in dividends is further restricted due to the fact that the bank must
maintain a certain minimum amount of capital to be considered a "well
capitalized" institution as further described under Item 1 - Capital
Requirements in this report.
From time to time, we may become a party to financing agreements or other
contractual arrangements that have the effect of limiting or prohibiting us or
Tri Counties Bank from declaring or paying dividends. Our holding company
expenses and obligations with respect to our trust preferred securities and
corresponding junior subordinated deferrable interest debentures issued by us
may limit or impair our ability to declare or pay dividends. Finally, our
ability to pay dividends is also subject to the restrictions of the California
Corporations Code.
Only a limited trading market exists for our common stock which could lead to
price volatility.
Our common stock is quoted on the Nasdaq National Market and trading volumes
have been modest. The limited trading market for our common stock may cause
fluctuations in the market value of our common stock to be exaggerated, leading
to price volatility in excess of that which would occur in a more active trading
market of our common stock. In addition, even if a more active market in our
common stock develops, we cannot assure you that such a market will continue or
that shareholders will be able to sell their shares.
If we fail to maintain an effective system of internal and disclosure control,
we may not be able to accurately report our financial results or prevent fraud.
As a result, current and potential shareholders could lose confidence in our
financial reporting, which would harm our business and the trading price of our
securities.
Effective internal and disclosure controls are necessary for us to provide
reliable financial reports and effectively prevent fraud and to operate
successfully as a public company. If we cannot provide reliable financial
reports or prevent fraud, our reputation and operating results would be harmed.
We review and analyze our internal control over financial reporting for
Sarbanes-Oxley Section 404 compliance. As part of that process we may discover
material weaknesses or significant deficiencies in our internal control as
defined under standards adopted by the Public Company Accounting Oversight
Board, or PCAOB, that require remediation. Under the PCAOB standards, a
"material weakness" is a significant deficiency or combination of significant
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. A "significant deficiency" is a control deficiency or combination
of control deficiencies, that adversely affect a company's ability to initiate,
authorize, record, process, or report external financial data reliably in
accordance with generally accepted accounting principles such that there is a
more than remote likelihood that a misstatement of a company's annual or interim
financial statements that is more than inconsequential will not be prevented or
detected.
-15-
As a result of weaknesses that may be identified in our internal control, we may
also identify certain deficiencies in some of our disclosure controls and
procedures that we believe require remediation. If we discover weaknesses, we
will make efforts to improve our internal and disclosure control. However, there
is no assurance that we will be successful. Any failure to maintain effective
controls or timely effect any necessary improvement of our internal and
disclosure controls could harm operating results or cause us to fail to meet our
reporting obligations, which could affect our ability to remain listed with the
Nasdaq National Market. Ineffective internal and disclosure controls could also
cause investors to lose confidence in our reported financial information, which
would likely have a negative effect on the trading price of our securities.
Anti-takeover provisions and federal law may limit the ability of another party
to acquire us, which could cause our stock price to decline.
Various provisions of our articles of incorporation and bylaws could delay or
prevent a third party from acquiring us, even if doing so might be beneficial to
our shareholders. These provisions provide for, among other things:
- specified actions that the Board of Directors shall or may take when
an offer to merge, an offer to acquire all assets or a tender offer is
received,
- a shareholder rights plan which could deter a tender offer by
requiring a potential acquisitor to pay a substantial premium over the
market price of our common stock,
- advance notice requirements for proposals that can be acted upon at
shareholder meetings, and
- the authorization to issue preferred stock by action of the board of
directors acting alone, thus without obtaining shareholder approval.
The Bank Holding Company Act of 1956, as amended, and the Change in Bank Control
Act of 1978, as amended, together with federal regulations, require that,
depending on the particular circumstances, either Federal Reserve approval must
be obtained or notice must be furnished to the Federal Reserve and not
disapproved prior to any person or entity acquiring "control" of a state member
bank, such as Tri Counties Bank. These provisions may prevent a merger or
acquisition that would be attractive to shareholders and could limit the price
investors would be willing to pay in the future for our common stock.
We are exposed to risk of environmental liabilities with respect to properties
to which we take title.
In the course of our business, we may foreclose and take title to real estate
and could be subject to environmental liabilities with respect to these
properties. We may be held liable to a governmental entity or to third parties
for property damage, personal injury, investigation and clean-up costs incurred
by these parties in connection with environmental contamination, or may be
required to investigate or clean-up hazardous or toxic substances, or chemical
releases at a property. The costs associated with investigation or remediation
activities could be substantial. In addition, if we are the owner or former
owner of a contaminated site, we may be subject to common law claims by third
parties based on damages and costs resulting from environmental contamination
emanating from the property. If we become subject to significant environmental
liabilities, our business, financial condition, results of operations and cash
flows could be materially adversely affected.
We could sustain losses if our asset quality declines.
Our earnings are significantly affected by our ability to properly originate,
underwrite and service loans. We could sustain losses if we incorrectly assess
the creditworthiness of our borrowers or fail to detect or respond to
deterioration in asset quality in a timely manner. Problems with asset quality
could cause our interest income and net interest margin to decrease and our
provisions for loan losses to increase, which could adversely affect our results
of operations and financial condition.
Our recent results may not be indicative of our future results.
We may not be able to sustain our historical rate of growth or may not even be
able to grow our business at all. Various factors, such as economic conditions,
regulatory and legislative considerations and competition, may also impede or
prohibit our ability to expand our market presence. If we experience a
significant decrease in our historical rate of growth, our results of operations
and financial condition may be adversely affected due to a high percentage of
our operating costs being fixed expenses.
-16-
The amount of common stock owned by, and other compensation arrangements with,
our officers and directors may make it more difficult to obtain shareholder
approval of potential takeovers that they oppose.
As of March 7, 2006, directors and executive officers beneficially owned
approximately 21% of our common stock and our ESOP owned approximately 8%.
Agreements with our senior management also provide for significant payments
under certain circumstances following a change in control. These compensation
arrangements, together with the common stock and option ownership of our board
of directors and management, could make it difficult or expensive to obtain
majority support for shareholder proposals or potential acquisition proposals of
us that our directors and officers oppose.
We may issue additional common stock or other equity securities in the future
which could dilute the ownership interest of existing shareholders
In order to maintain our capital at desired or regulatorily-required levels, or
to fund future growth, our board of directors may decide from time to time to
issue additional shares of common stock, or securities convertible into,
exchangeable for or representing rights to acquire shares of our common stock.
The sale of these shares may significantly dilute your ownership interest as a
shareholder. New investors in the future may also have rights, preferences and
privileges senior to our current shareholders which may adversely impact our
current shareholders.
Holders of our junior subordinated debentures have rights that are senior to
those of our common stockholders.
We have supported our continued growth through the issuance of trust preferred
securities from special purpose trusts and accompanying junior subordinated
debentures. At December 31, 2005, we had outstanding trust preferred securities
and accompanying junior subordinated debentures totaling $41,238,000. Payments
of the principal and interest on the trust preferred securities are
conditionally guaranteed by us. Further, the accompanying junior subordinated
debentures we issued to the trusts are senior to our shares of common stock. As
a result, we must make payments on the junior subordinated debentures before any
dividends can be paid on our common stock and, in the event of our bankruptcy,
dissolution or liquidation, the holders of the junior subordinated debentures
must be satisfied before any distributions can be made on our common stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The Company is engaged in the banking business through 49 offices in 22 counties
in Northern and Central California including nine offices in Butte County, eight
in Shasta County, four in Sacramento County, three each in Placer, Siskiyou,
Stanislaus and Sutter Counties, two in Glenn County, and one each in Contra
Costa, Del Norte, Fresno, Kern, Lake, Lassen, Madera, Mendocino, Merced, Nevada,
Tehama, Tulare, Yolo and Yuba Counties. All offices are constructed and equipped
to meet prescribed security requirements.
The Company owns 18 branch office locations and one administrative building and
leases 31 branch office locations and 3 administrative facilities. Most of the
leases contain multiple renewal options and provisions for rental increases,
principally for changes in the cost of living index, property taxes and
maintenance.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor its subsidiaries, are party to any material pending
legal proceeding, nor is their property the subject of any material pending
legal proceeding, except routine legal proceedings arising in the ordinary
course of their business. None of these proceedings is expected to have a
material adverse impact upon the Company's business, consolidated financial
position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the shareholders during the fourth
quarter of 2005.
-17-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock Market Prices and Dividends
The Company's common stock is traded on the NASDAQ National Market System
("NASDAQ") under the symbol "TCBK." The following table shows the high and the
low prices for the common stock, for each quarter in the past two years, as
reported by NASDAQ1:
=============================================
2005: High Low
---------------------------------------------
Fourth quarter $24.49 $21.00
Third quarter $25.07 $20.84
Second quarter $22.34 $19.07
First quarter $23.40 $19.35
2004:
Fourth quarter $24.25 $20.43
Third quarter $20.99 $16.94
Second quarter $19.19 $16.76
First quarter $18.69 $15.78
=============================================
1Stock prices adjusted to reflect 2-for-1 stock split effected April 30, 2004.
As of March 7, 2006 there were approximately 1,754 shareholders of record of the
Company's common stock.
The Company has paid cash dividends on its common stock in every quarter since
March 1990, and it is currently the intention of the Board of Directors of the
Company to continue payment of cash dividends on a quarterly basis. There is no
assurance, however, that any dividends will be paid since they are dependent
upon earnings, financial condition and capital requirements of the Company and
the Bank. As of December 31, 2005, $47,054,000 was available for payment of
dividends by the Company to its shareholders, under applicable laws and
regulations. The Company paid cash dividends of $0.12 per common share in the
quarter ended December 31, 2005, $0.11 per common share in each of the quarters
ended September 30, 2005, June 30, 2005, March 31, 2005, December 31, 2004,
September 30, 2004 and June 30, 2004, and $0.10 per common share in the quarter
ended March 31, 2004.
Stock Based Compensation Plans
The following table shows shares reserved for issuance for outstanding options,
stock appreciation rights and warrants granted under our equity compensation
plans as of December 31, 2005. All of our equity compensation plans have been
approved by shareholders.
(a) (c) Number of securities
Number of securities (b) remaining available for
to be issued upon Weighted average issuance under equity
exercise of exercise price of compensation plans
outstanding options, outstanding options, (excluding securities
Plan category warrants and rights warrants and rights reflected in column (a))
-----------------------------------------------------------------------------------------------------
Equity compensation plans
not approved by shareholders - N/A -
Equity compensation plans
approved by shareholders 1,636,762 $11.44 502,436
-----------------------------------------------------------------------
Total 1,636,762 $11.44 502,436
-18-
Stock Repurchase Plan
The Company adopted a stock repurchase plan on July 31, 2003, which was amended
on March 11, 2004 for the repurchase of up to 500,000 shares of the Company's
common stock from time to time as market conditions allow. The 500,000 shares
authorized for repurchase under this plan represented approximately 3.2% of the
Company's approximately 15,704,000 common shares outstanding as of July 31,
2003. This plan has no stated expiration date for the repurchases. As of
December 31, 2005, the Company had purchased 374,371 shares under this plan as
adjusted for the 2-for-1 stock split in the form of a common stock dividend
effective April 30, 2004. The following table shows the repurchases made by the
Company or any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the
Exchange Act) during the fourth quarter of 2005:
Period (a) Total number (b) Average price (c) Total number of (d) Maximum number
of Shares purchased paid per share shares purchased as of shares that may yet
part of publicly be purchased under the
announced plans or plans or programs
programs
-----------------------------------------------------------------------------------------------------
Oct. 1-31, 2005 18,571 $21.39 18,571 130,329
Nov. 1-30, 2005 4,700 $21.30 4,700 125,629
Dec. 1-31, 2005 - - - 125,629
-----------------------------------------------------------------------------------------------------
Total 23,271 $21.37 23,271 125,629
-19-
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data are derived from our
consolidated financial statements. This data should be read in connection with
our consolidated financial statements and the related notes located at Item 8 of
this report.
TRICO BANCSHARES
Financial Summary
(in thousands, except per share amounts)
=========================================================================================================
Year ended December 31, 2005 2004 2003 2002 2001
---------------------------------------------------------------------------------------------------------
Interest income $98,756 $84,932 $73,969 $64,696 $71,998
Interest expense 20,529 13,363 13,089 12,914 23,486
---------------------------------------------------------------------------------------------------------
Net interest income 78,227 71,569 60,880 51,782 48,512
Provision for loan losses 2,169 2,901 1,058 2,755 3,754
Noninterest income 24,890 24,794 22,909 19,180 16,238
Noninterest expense 62,110 60,828 55,719 46,016 41,253
---------------------------------------------------------------------------------------------------------
Income before income taxes 38,838 32,634 27,012 22,191 19,743
Provision for income taxes 15,167 12,452 10,124 8,122 7,324
---------------------------------------------------------------------------------------------------------
Net income $23,671 $20,182 $16,888 $14,069 $12,419
---------------------------------------------------------------------------------------------------------
Earnings per share2:
Basic $1.51 $1.29 $1.11 $1.00 $0.88
Diluted 1.45 1.24 1.07 0.98 0.86
Per share2:
Dividends paid $0.45 $0.43 $0.40 $0.40 $0.40
Book value at December 31 9.52 8.79 8.16 7.01 6.21
Tangible book value at December 31 8.25 7.45 6.79 6.72 5.84
Average common shares outstanding2 15,708 15,660 15,282 14,038 14,146
Average diluted common shares outstanding2 16,331 16,270 15,757 14,386 14,438
Shares outstanding at December 31 15,708 15,723 15,668 14,122 14,002
At December 31:
Loans, net $1,368,809 $1,158,442 $969,570 $673,836 $646,320
Total assets 1,841,275 1,627,506 1,469,638 1,145,265 1,006,093
Total deposits 1,496,797 1,348,833 1,236,823 1,005,237 880,393
Debt financing and notes payable 31,390 28,152 22,887 22,924 22,956
Junior subordinated debt 41,238 41,238 20,619 - -
Shareholders' equity 149,493 138,132 127,960 99,014 86,933
Financial Ratios:
For the year:
Return on assets 1.38% 1.33% 1.27% 1.35% 1.27%
Return on equity 16.30% 15.20% 14.24% 15.03% 14.19%
Net interest margin1 5.14% 5.32% 5.23% 5.61% 5.58%
Net loan losses to average loans 0.04% 0.12% 0.34% 0.22% 0.47%
Efficiency ratio1 59.64% 62.46% 65.62% 63.73% 62.60%
Average equity to average assets 8.49% 8.72% 8.91% 9.00% 8.94%
At December 31:
Equity to assets 8.12% 8.50% 8.71% 8.65% 8.65%
Total capital to risk-adjusted assets 10.79% 11.86% 11.56% 11.97% 11.68%
Allowance for loan losses to loans 1.17% 1.24% 1.31% 1.99% 1.88%
1 Fully taxable equivalent
2 Per share figures retroactively adjusted to reflect 2-for-1 stock split in the
form of a stock dividend effective April 30, 2004
-20-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company's discussion and analysis of its financial condition and results of
operations is intended to provide a better understanding of the significant
changes and trends relating to the Company's financial condition, results of
operations, liquidity, interest rate sensitivity, off balance sheet arrangements
and certain contractual obligations. The following discussion is based on the
Company's consolidated financial statements which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. Please read the Company's audited consolidated financial statements and
the related notes included as Item 8 of this report.
Critical Accounting Policies and Estimates
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, the Company evaluates
its estimates, including those that materially affect the financial statements
and are related to the adequacy of the allowance for loan losses, investments,
mortgage servicing rights, and intangible assets. The Company bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. The Company's
policies related to estimates on the allowance for loan losses, other than
temporary impairment of investments and impairment of intangible assets, can be
found in Note 1 to the Company's audited consolidated financial statements and
the related notes included as Item 8 of this report.
The Company uses the intrinsic value method to account for its stock option
plans (in accordance with the provisions of Accounting Principles Board Opinion
No. 25). Under this method, compensation expense is recognized for awards of
options to purchase shares of common stock to employees under compensatory plans
only if the fair market value of the stock at the option grant date (or other
measurement date, if later) is greater than the amount the employee must pay to
acquire the stock. Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation (SFAS 123) permits companies to continue
using the intrinsic value method or to adopt a fair value based method to
account for stock option plans. The fair value based method results in
recognizing as expense over the vesting period the fair value of all stock-based
awards on the date of grant. The Company elected to continue to use the
intrinsic value method. In December 2004, the Financial Accounting Standards
Board (FASB) issued FASB Statement of Financial Accounting Standards No. 123
(revised 2004), Share-Based Payment (SFAS 123R), which replaces SFAS No. 123 and
supersedes APB Opinion No. 25. SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
financial statements based on their fair values beginning with the first interim
reporting period of the Company's fiscal year beginning after June 15, 2005,
with early adoption encouraged. The pro forma disclosures previously permitted
under SFAS 123 no longer will be an alternative to financial statement
recognition. The Company adopted SFAS 123R on January 1, 2006 using the modified
prospective method that requires compensation expense be recorded for all
unvested stock options at January 1, 2006. The Company expects that the adoption
of SFAS 123R will impact the Company's consolidated results of operations and
earnings per share similarly to the current pro forma disclosures under SFAS
123.
As the Company has not commenced any business operations independent of the
Bank, the following discussion pertains primarily to the Bank. Average balances,
including balances used in calculating certain financial ratios, are generally
comprised of average daily balances for the Company. Within Management's
Discussion and Analysis of Financial Condition and Results of Operations,
interest income and net interest income are generally presented on a fully
tax-equivalent (FTE) basis.
-21-
The following discussion and analysis is designed to provide a better
understanding of the significant changes and trends related to the Company and
the Bank's financial condition, operating results, asset and liability
management, liquidity and capital resources and should be read in conjunction
with the consolidated financial statements of the Company and the related notes
at Item 8 of this report.
Results of Operations
Net Income
Following is a summary of the Company's net income for the past three years
(dollars in thousands, except per share amounts):
Year ended December 31,
------------------------------------------------------------------------------
Components of Net Income 2005 2004 2003
----------------------------------
Net interest income * $79,258 $72,589 $62,005
Provision for loan losses (2,169) (2,901) (1,058)
Noninterest income 24,890 24,794 22,909
Noninterest expense (62,110) (60,828) (55,719)
Taxes * (16,198) (13,472) (11,249)
----------------------------------
Net income $23,671 $20,182 $16,888
==================================
Net income per average fully-diluted share $1.45 $1.24 $1.07
Net income as a percentage of average
shareholders' equity 16.30% 15.20% 14.24%
Net income as a percentage of average
total assets 1.38% 1.33% 1.27%
==============================================================================
* Fully tax-equivalent (FTE)
Earnings in 2005 increased $3,489,000 (17.3%) from 2004. Net interest income
(FTE) grew $6,669,000 (9.2%) due to a $178,629,000 (13.1%) increase in average
earning assets that was partially offset by a net interest margin that fell 18
basis points. The loan loss provision was reduced by $732,000 in 2005 from 2004,
and noninterest income increased $96,000 (0.4%) while noninterest expense
increased $1,282,000 (2.1%).
Earnings in 2004 increased $3,294,000 (19.5%) from 2003. Net interest income
(FTE) grew $10,584,000 (17.1%) due to a $180,193,000 (15.2%) increase in average
earning assets along with a net interest margin that rose 9 basis points. The
loan loss provision increased $1,843,000 in 2004 from 2003, and noninterest
income increased $1,885,000 (8.2%) while noninterest expense also increased
$5,109,000 (9.7%).
The Company's return on average total assets was 1.38% in 2005 compared to 1.33%
and 1.27% in 2004 and 2003, respectively. Return on average equity in 2005 was
16.30% compared to 15.20% and 14.24% in 2004 and 2003, respectively.
Net Interest Income
The Company's primary source of revenue is net interest income, which is the
difference between interest income on earning assets and interest expense on
interest-bearing liabilities. Net interest income (FTE) increased $6,669,000
(9.2%) from 2004 to $79,258,000 in 2005. Net interest income (FTE) increased
$10,584,000 (17.1%) to $72,589,000 from 2003 to 2004.
Following is a summary of the Company's net interest income for the past three
years (dollars in thousands):
Year ended December 31,
------------------------------------------------------------------------------
Components of Net Interest Income 2005 2004 2003
----------------------------------
Interest income $98,756 $84,932 $73,969
Interest expense (20,529) (13,363) (13,089)
FTE adjustment 1,031 1,020 1,125
----------------------------------
Net interest income (FTE) $79,258 $72,589 $62,005
==============================================================================
Net interest margin (FTE) 5.14% 5.32% 5.23%
==============================================================================
-22-
Interest income (FTE) increased $13,835,000 (16.1%) from 2004 to 2005, due to
increased volume of earning assets and higher yields on earning assets. During
2005, the average balance of interest-earning assets increased $178,629,000
(13.1%). The average yield on the Company's earning assets increased from 6.30%
in 2004 to 6.47% in 2005. The increase in average yield on interest-earning
assets increased interest income (FTE) by $1,268,000, while the increase in
average balances of interest-earning assets added $12,567,000 to interest income
(FTE) during 2005.
Interest expense increased $7,166,000 (53.6%) in 2005 from 2004 due to a
$122,117,000 (11.3%) increase in average balance of interest-bearing liabilities
and a 47 basis point increase in the average rate paid on interest-bearing
liabilities from 1.23% to 1.70%. The increase in average yield on
interest-bearing liabilities increased interest expense by $4,309,000, while the
increase in average balances of interest-bearing liabilities added $2,857,000 to
interest expense during 2005.
Interest income (FTE) increased $10,858,000 (14.5%) from 2003 to 2004, the net
effect of higher average balances of those assets partially offset by lower
earning-asset yields. The total yield on earning assets dropped from 6.34% in
2003 to 6.30% in 2004, following the trend in overall interest markets in which
federal funds rates were reduced in mid-2003 from 1.25% to 1.00%, rose beginning
in mid-2004, and ended 2004 at 2.25%. The average yield on loans decreased 52
basis points to 6.85% during 2004. The decrease in average yield on
interest-earning assets reduced interest income (FTE) by $4,466,000, while a
$180,193,000 (15.2%) increase in average balances of interest-earning assets
added $15,324,000 to interest income (FTE) during 2004.
Interest expense increased $274,000 (2.1%) in 2004 from 2003, due to a higher
average balance of interest-bearing liabilities that was partially offset by
lower rates paid. The average rate paid on interest-bearing liabilities was
1.23% in 2004, 16 basis points lower than in 2003. The decrease in the average
rate paid on interest-bearing liabilities decreased interest expense by
$1,510,000 from 2003 to 2004, while a $142,598,000 (15.2%) increase in average
balances of interest-bearing liabilities increased interest expense by
$1,784,000 in 2004.
Net Interest Margin
Following is a summary of the Company's net interest margin for the past three
years:
Year ended December 31,
------------------------------------------------------------------------------
Components of Net Interest Margin 2005 2004 2003
----------------------------------
Yield on earning assets 6.47% 6.30% 6.34%
Rate paid on interest-bearing liabilities 1.70% 1.23% 1.39%
----------------------------------
Net interest spread 4.76% 5.07% 4.95%
Impact of all other net
noninterest-bearing funds 0.38% 0.25% 0.28%
----------------------------------
Net interest margin (FTE) 5.14% 5.32% 5.23%
==============================================================================
During 2003, it became increasingly difficult to decrease rates on
interest-bearing liabilities as market interest rates continued to decrease and
hit a low in mid-2003. In addition, the positive impact of all other net
noninterest bearing funds on net interest margin was reduced due to the lower
market rates of interest at which they could be invested. During 2004, the
Company was able to slightly improve its net interest margin by further
decreasing rates paid on interest-bearing deposits even though short-term
interest rates began to rise from their lows in mid-2004. During 2005,
short-term interest rates continued to rise while long-term interest rates
remained steady or decreased slightly. As a result the average yield the Company
was able to earn on interest-earning assets did not increase as fast as the rate
it paid on interest-bearing liabilities, thus decreasing net interest margin.
-23-
Summary of Average Balances, Yields/Rates and Interest Differential
The following tables present, for the past three years, information regarding
the Company's consolidated average assets, liabilities and shareholders' equity,
the amounts of interest income from average earning assets and resulting yields,
and the amount of interest expense paid on interest-bearing liabilities. Average
loan balances include nonperforming loans. Interest income includes proceeds
from loans on nonaccrual loans only to the extent cash payments have been
received and applied to interest income. Yields on securities and certain loans
have been adjusted upward to reflect the effect of income thereon exempt from
federal income taxation at the current statutory tax rate (dollars in
thousands):
Year ended December 31, 2005
-----------------------------------------------
Interest Rates
Average income/ earned/
balance expense paid
-----------------------------------------------
Assets
Loans $1,251,699 $86,379 6.90%
Investment securities - taxable 256,217 10,574 4.13%
Investment securities - nontaxable 34,557 2,809 8.13%
Federal funds sold 804 25 3.11%
------------ ----------
Total earning assets 1,543,277 99,787 6.47%
----------
Other assets 166,098
------------
Total assets $1,709,375
============
Liabilities and shareholders' equity
Interest-bearing demand deposits $243,619 492 0.20%
Savings deposits 465,586 3,435 0.74%
Time deposits 374,989 10,975 2.93%
Federal funds purchased 51,114 1,784 3.49%
Other borrowings 29,651 1,361 4.59%
Junior subordinated debt 41,238 2,482 6.02%
------------ ----------
Total interest-bearing liabilities 1,206,197 20,529 1.70%
----------
Noninterest-bearing demand 332,224
Other liabilities 25,757
Shareholders' equity 145,197
------------
Total liabilities and shareholders' equity $1,709,375
============
Net interest spread (1) 4.76%
Net interest income and interest margin (2) $79,258 5.14%
========= ========
(1) Net interest spread represents the average yield earned on interest-earning
assets less the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by dividing net interest income by total
average earning assets.
-24-
Year ended December 31, 2004
-----------------------------------------------
Interest Rates
Average income/ earned/
balance expense paid
-----------------------------------------------
Assets
Loans $1,060,556 $72,637 6.85%
Investment securities - taxable 268,219 10,549 3.93%
Investment securities - nontaxable 34,282 2,748 8.02%
Federal funds sold 1,591 18 1.13%
------------ ----------
Total earning assets 1,364,648 85,952 6.30%
----------
Other assets 158,426
------------
Total assets $1,523,074
============
Liabilities and shareholders' equity
Interest-bearing demand deposits $230,637 423 0.18%
Savings deposits 475,796 3,444 0.72%
Time deposits 285,446 6,304 2.21%
Federal funds purchased 36,716 510 1.39%
Other borrowings 24,985 1,301 5.21%
Junior subordinated debt 30,500 1,381 4.53%
------------ ----------
Total interest-bearing liabilities 1,084,080 13,363 1.23%
----------
Noninterest-bearing demand 283,975
Other liabilities 22,265
Shareholders' equity 132,754
------------
Total liabilities and shareholders' equity $1,523,074
============
Net interest spread (1) 5.07%
Net interest income and interest margin (2) $72,589 5.32%
========== ========
(1) Net interest spread represents the average yield earned on interest-earning
assets less the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by dividing net interest income by total
average earning assets.
Year ended December 31, 2003
-----------------------------------------------
Interest Rates
Average income/ earned/
balance expense paid
-----------------------------------------------
Assets
Loans $827,673 $60,997 7.37%
Investment securities - taxable 306,647 10,903 3.56%
Investment securities - nontaxable 38,562 3,065 7.95%
Federal funds sold 11,573 129 1.11%
------------ ----------
Total earning assets 1,184,455 75,094 6.34%
----------
Other assets 146,099
------------
Total assets $1,330,554
============
Liabilities and shareholders' equity
Interest-bearing demand deposits $208,347 488 0.23%
Savings deposits 384,455 3,441 0.90%
Time deposits 299,799 7,328 2.44%
Federal funds purchased 17,645 189 1.07%
Other borrowings 22,903 1,288 5.62%
Junior subordinated debt 8,333 355 4.26%
------------ ----------
Total interest-bearing liabilities 941,482 13,089 1.39%
----------
Noninterest-bearing demand 245,538
Other liabilities 24,941
Shareholders' equity 118,593
------------
Total liabilities and shareholders' equity $1,330,554
============
Net interest spread (1) 4.95%
Net interest income and interest margin (2) $62,005 5.23%
========== ========
(1) Net interest spread represents the average yield earned on interest-earning
assets less the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by dividing net interest income by total
average earning assets.
-25-
Summary of Changes in Interest Income and Expense due to Changes in Average
Asset and Liability Balances and Yields Earned and Rates Paid
The following table sets forth a summary of the changes in the Company's
interest income and interest expense from changes in average asset and liability
balances (volume) and changes in average interest rates for the past three
years. The rate/volume variance has been included in the rate variance. Amounts
are calculated on a fully taxable equivalent basis:
2005 over 2004 2004 over 2003
-----------------------------------------------------------------------------
Yield/ Yield/
Volume Rate Total Volume Rate Total
-----------------------------------------------------------------------------
Increase (decrease) in (dollars in thousands)
interest income:
Loans $13,091 $651 $13,742 $17,163 ($5,523) $11,640
Investment securities (515) 601 86 (1,728) 1,057 (671)
Federal funds sold (9) 16 7 (111) - (111)
-----------------------------------------------------------------------------
Total 12,567 1,268 13,835 15,324 (4,466) 10,858
-----------------------------------------------------------------------------
Increase (decrease) in
interest expense:
Demand deposits (interest-bearing) 24 45 69 52 (117) (65)
Savings deposits (74) 65 (9) 818 (815) 3
Time deposits 1,978 2,693 4,671 (351) (673) (1,024)
Federal funds purchased 200 1,074 1,274 204 117 321
Junior subordinated debt 486 615 1,101 944 82 1,026
Other borrowings 243 (183) 60 117 (104) 13
-----------------------------------------------------------------------------
Total 2,857 4,309 7,166 1,784 (1,510) 274
-----------------------------------------------------------------------------
Increase (decrease) in
net interest income $9,710 ($3,041) $6,669 $13,540 ($2,956) $10,584
=============================================================================
Provision for Loan Losses
In 2005, the Bank provided $2,169,000 for loan losses compared to $2,901,000 in
2004. Net loan charge-offs decreased $798,000 (63.0%) to $468,000 during 2005.
The 2005 charge-offs represented 0.04% of average loans outstanding versus 0.12%
in 2004. Nonperforming loans net of government agency guarantees as a percentage
of total loans were 0.21% and 0.42% at December 31, 2005 and 2004, respectively.
The ratio of allowance for loan losses to nonperforming loans was 548% at the
end of 2005 versus 296% at the end of 2004.
In 2004, the Company provided $2,901,000 for loan losses compared to $1,058,000
in 2003. The increase in the loan loss provision in 2004 was mainly due to the
increase in loan balances. Net loan charge-offs decreased $1,516,000 (54%) to
$1,266,000 during 2004. The 2004 net charge-offs represented 0.12% of average
loans outstanding in 2004 versus 0.34% in 2003. Nonperforming loans net of
government agency guarantees were 0.42% of total loans at December 31, 2004
versus 0.45% at December 31, 2003. The ratio of allowance for loan losses to
nonperforming loans was 296% at the end of 2004 versus 293% at the end of 2003.
-26-
Noninterest Income
The following table summarizes the Company's noninterest income for the past
three years (dollars in thousands):
Year ended December 31,
---------------------------------------------------------------------------
Components of Noninterest Income 2005 2004 2003
-----------------------------------
Service charges on deposit accounts $13,619 $13,239 $12,495
ATM fees and interchange 3,139 2,652 2,220
Other service fees 2,055 1,939 1,782
Amortization of mortgage servicing rights (661) (739) (1,356)
Recovery of (provision for) mortgage
servicing rights valuation allowance - 600 (600)
Gain on sale of loans 1,679 1,659 4,168
Commissions on sale of
nondeposit investment products 2,242 2,327 1,766
Gain on sale of investments - - 197
Increase in cash value of life insurance 1,507 1,499 1,296
Other noninterest income 1,310 1,618 941
-----------------------------------
Total noninterest income $24,890 $24,794 $22,909
===========================================================================
Noninterest income increased $96,000 (0.4%) to $24,890,000 in 2005. Service
charges on deposit accounts was up $380,000 (2.9%) due to the introduction of a
business overdraft privilege product and an increase in overdraft fees. ATM fees
and interchange, and other service fees were up $487,000 (18.4%) and $116,000
(6.0%) due to expansion of the Company's ATM network and customer base through
de-novo branch expansion and existing branch growth. Overall, mortgage banking
activities, which includes amortization of mortgage servicing rights, mortgage
servicing fees, provision for mortgage servicing valuation allowance, and gain
on sale of loans, accounted for $1,946,000 of noninterest income in 2005
compared to $2,448,000 in 2004. Included in the mortgage banking results for
2004 was a $600,000 recovery of mortgage servicing rights valuation allowance.
Commissions on sale of nondeposit investment products decreased $85,000 (3.7%)
in 2005 due to slightly lower demand for annuity products. Other noninterest
income decreased $308,000 (19.0%) in 2005 primarily due to a $566,000 gain on
sale of foreclosed assets recorded in 2004.
Noninterest income increased $1,885,000 (8.2%) to $24,794,000 in 2004. Service
charges on deposit accounts were up $744,000 (6.0%) due to growth in number of
customers. ATM fees and interchange, and other service fees were up $432,000
(19.5%) and $157,000 (8.8%) due to expansion of the Company's ATM network and
customer base through de-novo branch expansion. Overall, mortgage banking
activities, which includes amortization of mortgage servicing rights, mortgage
servicing fees, provision for mortgage servicing valuation allowance, and gain
on sale of loans, accounted for $2,448,000 of noninterest income in the 2004
compared to $3,061,000 in 2003. The decrease in the amortization of mortgage
servicing rights and the recovery of mortgage servicing valuation allowance
taken in 2004 are the result of the recent slowdown in mortgage refinance
activity. While the Company benefits from decreased amortization and recovery of
mortgage servicing valuations of mortgage servicing rights during periods of low
levels of mortgage refinance activity, it may also experience decreased gain on
sale of loans. Commissions on sale of nondeposit investment products increased
$561,000 (31.8%) in 2004 due to higher demand for annuity products. Other
noninterest income increased $677,000 (71.9%) to $1,618,000 due to increases in
gain on sale of foreclosed assets and lease brokerage income from $113,000 and
$0, respectively, in 2003 to $566,000 and $227,000, respectively, in 2004.
-27-
Securities Transactions
During 2005 the Bank had no sales of securities but received proceeds from
maturities of securities totaling $58,755,000, and used $40,013,000 to purchase
securities.
During 2004 the Bank had no sales of securities but received proceeds from
maturities of securities totaling $79,442,000, and used $59,091,000 to purchase
securities.
Noninterest Expense
The following table summarizes the Company's other noninterest expense for the
past three years (dollars in thousands):
Year ended December 31,
---------------------------------------------------------------------------
Components of Noninterest Expense 2005 2004 2003
-----------------------------------
Salaries and benefits $33,926 $33,191 $29,714
Other noninterest expense:
Equipment and data processing 5,783 5,315 4,947
Occupancy 4,041 3,926 3,493
Advertising 1,732 1,026 1,062
ATM network charges 1,644 1,322 1,043
Telecommunications 1,521 1,773 1,539
Intangible amortization 1,381 1,358 1,207
Professional fees 1,247 2,481 2,315
Courier service 1,151 1,057 1,026
Postage 889 864 855
Assessments 312 297 268
Change in reserve for unfunded commitments 281 649 192
Operational losses 225 428 657
Net other real estate owned expense - 11 124
Other 7,977 7,130 7,277
-----------------------------------
Total other noninterest expenses 28,184 27,637 26,005
-----------------------------------
Total noninterest expense $62,110 $60,828 $55,719
===========================================================================
Average full time equivalent staff 604 537 505
Noninterest expense to revenue (FTE) 59.64% 62.46% 65.62%
Salary and benefit expenses increased $735,000 (2.2%) in 2005 compared to 2004.
Base salaries decreased $29,000 (0.1%) to $20,910,000 in 2005. The decrease in
base salaries was mainly due to reduced overtime offset by an increase in
average full time equivalent employees from 537 at December 31, 2004 to 604 at
December 31, 2005, and annual salary increases. Incentive and commission related
salary expenses increased $534,000 (11.8%) to $5,053,000 in 2005. The increase
in incentive and commission expenses was directly tied to significant loan,
deposit, and revenue growth during 2005. Benefits expense, including retirement,
medical and workers' compensation insurance, and taxes, increased $230,000
(3.0%) to $7,963,000 during 2005.
Salary and benefit expenses increased $3,477,000 (11.7%) to $33,191,000 in 2004
compared to 2003. Base salaries increased $1,867,000 (9.8%) to $20,939,000 in
2004. The increase in base salaries was mainly due to a 6.3% increase in average
full time equivalent employees from 505 at December 31, 2003 to 537 at December
31, 2004, primarily due to the opening of branches in Folsom, Turlock and
Woodland in December 2003, April 2004, and November 2004, respectively.
Incentive and commission related salary expenses increased $65,000 (1.5%) to
$4,519,000 in 2004. The small increase in incentive and commission related
salary expense is consistent with performance targets being reached to similar
extents in 2004 and 2003. These results are consistent with the Bank's strategy
of working more efficiently with fewer employees who are compensated in part
based on their business unit's performance or on their ability to generate
revenue. Benefits expense, including retirement, medical and workers'
compensation insurance, and taxes, increased $1,545,000 (25.0%) to $7,733,000
during 2004.
Other noninterest expense increased $547,000 (2.0%) to $28,184,000 in 2005.
Increases in the areas of equipment and data processing, occupancy, advertising,
ATM network charges and courier service were mainly due to the first full year
of operation of the Turlock and Woodland branches, the opening in 2005 of
branches in Lincoln, Folsom, Sacramento, and Roseville, and enhancements to data
processing and ATM network equipment. The decrease in professional fees was
mainly due to reduced legal expenses and consulting fees. The decrease in
consulting fees was mainly due to the expiration of consulting services related
to the Company's overdraft privilege product, the expiration of which is not
expected to have an impact on revenue from the overdraft privilege product.
-28-
Other noninterest expenses increased $1,632,000 (6.3%) to $27,637,000 in 2004.
Increases in the areas of equipment and data processing, occupancy,
telecommunications, and courier service from 2003 to 2004 were mainly due to the
opening of branches in Folsom, Turlock and Woodland in December 2003, April
2004, and November 2004, respectively.
Provision for Taxes
The effective tax rate on income was 39.1%, 38.2%, and 37.5% in 2005, 2004, and
2003, respectively. The effective tax rate was greater than the federal
statutory tax rate due to state tax expense of $3,993,000, $3,008,000, and
$2,636,000, respectively, in these years. Tax-exempt income of $1,778,000,
$1,728,000, and $1,940,000, respectively, from investment securities, and
$1,507,000, $1,499,000, and $1,296,000, respectively, from increase in cash
value of life insurance in these years helped to reduce the effective tax rate.
Financial Ratios
The following table shows the Company's key financial ratios for the past three
years:
Year ended December 31, 2005 2004 2003
--------------------------------
Return on average total assets 1.38% 1.33% 1.27%
Return on average shareholders' equity 16.30% 15.20% 14.24%
Shareholders' equity to total assets 8.12% 8.50% 8.71%
Common shareholders' dividend payout ratio 29.88% 33.34% 36.36%
==============================================================================
Loans
The Bank concentrates its lending activities in four principal areas: commercial
loans (including agricultural loans), consumer loans, real estate mortgage loans
(residential and commercial loans and mortgage loans originated for sale), and
real estate construction loans. At December 31, 2005, these four categories
accounted for approximately 10%, 37%, 45%, and 8% of the Bank's loan portfolio,
respectively, as compared to 12%, 35%, 46%, and 7%, at December 31, 2004. The
shift in the percentages was primarily due to the Bank's ability to
significantly increase all loan categories except commercial, financial and
agricultural during 2005, which increased only modestly in 2005. The shift in
percentages is reflected in the Company's assessment of the adequacy of the
allowance for loan losses. The increase in consumer loans during 2005 was mainly
due to increases in home equity lines of credit and automobile loans. The
increase in real estate mortgage loans during 2005 was mainly due to increases
in commercial real estate mortgage loans. The interest rates charged for the
loans made by the Bank vary with the degree of risk, the size and maturity of
the loans, the borrower's relationship with the Bank and prevailing money market
rates indicative of the Bank's cost of funds.
The majority of the Bank's loans are direct loans made to individuals, farmers
and local businesses. The Bank relies substantially on local promotional
activity and personal contacts by bank officers, directors and employees to
compete with other financial institutions. The Bank makes loans to borrowers
whose applications include a sound purpose, a viable repayment source and a plan
of repayment established at inception and generally backed by a secondary source
of repayment.
At December 31, 2005 loans, including net deferred loan costs, totaled
$1,385,035,000 which was an 18.1% ($212,068,000) increase over the balances at
the end of 2004. Demand for home equity loans and auto loans (both classified as
consumer loans) remained strong throughout 2005. Commercial real estate mortgage
loan and construction loan activity was strong in 2005. Commercial and
agriculture related loan growth continued to be relatively weak in 2005, and
competition for such loans was high. The average loan-to-deposit ratio in 2005
was 88.4% compared to 83.1% in 2004.
-29-
At December 31, 2004 loans, including net deferred loan costs, totaled
$1,172,967,000 which was a 19.4% ($190,507,000) increase over the balances at
the end of 2003. Demand for home equity loans and auto loans (both classified as
consumer loans) were strong throughout 2004. Commercial real estate mortgage
loan activity was strong in 2004. Commercial and agriculture related loan growth
continued to be relatively weak in 2004, and competition for such loans was
high. The average loan-to-deposit ratio in 2004 was 83.1% compared to 72.2% in
2003.
Loan Portfolio Composite
The following table shows the Company's loan balances, including net deferred
loan costs, for the past five years:
December 31,
(dollars in thousands) 2005 2004 2003 2002 2001
----------------------------------------------------------------------------
Commercial, financial and agricultural $143,175 $140,332 $142,252 $125,982 $130,054
Consumer installment 508,233 410,198 320,248 201,858 155,046
Real estate mortgage 623,511 544,373 458,369 319,969 326,897
Real estate construction 110,116 78,064 61,591 39,713 46,735
----------------------------------------------------------------------------
Total loans $1,385,035 $1,172,967 $982,460 $687,522 $658,732
============================================================================
Classified Assets
The Company closely monitors the markets in which it conducts its lending
operations and continues its strategy to control exposure to loans with high
credit risk. Asset reviews are performed using grading standards and criteria
similar to those employed by bank regulatory agencies. Assets receiving lesser
grades fall under the "classified assets" category, which includes all
nonperforming assets and potential problem loans, and receive an elevated level
of attention to ensure collection.
The following is a summary of classified assets on the dates indicated (dollars
in thousands):
At December 31, 2005 At December 31, 2004
------------------------- ------------------------
Gross Guaranteed Net Gross Guaranteed Net
-----------------------------------------------------
Classified loans $13,086 $7,110 $5,976 $22,337 $9,436 $12,901
Other classified assets - - - - - -
-----------------------------------------------------
Total classified assets $13,086 $7,110 $5,976 $22,337 $9,436 $12,901
=====================================================
Allowance for loan losses/
Classified loans 271.5% 112.6%
Classified assets, net of guarantees of the U.S. Government, including its
agencies and its government-sponsored agencies at December 31, 2005, decreased
$6,925,000 (53.7%) to $5,976,000 from $12,901,000 at December 31, 2004.
Nonperforming Assets
Loans on which the accrual of interest has been discontinued are designated as
nonaccrual loans. Accrual of interest on loans is generally discontinued either
when reasonable doubt exists as to the full, timely collection of interest or
principal or when a loan becomes contractually past due by 90 days or more with
respect to interest or principal. When loans are 90 days past due, but in
Management's judgment are well secured and in the process of collection, they
may not be classified as nonaccrual. When a loan is placed on nonaccrual status,
all interest previously accrued but not collected is reversed. Income on such
loans is then recognized only to the extent that cash is received and where the
future collection of principal is probable. Interest accruals are resumed on
such loans only when they are brought fully current with respect to interest and
principal and when, in the judgment of Management, the loans are estimated to be
fully collectible as to both principal and interest. The reclassification of
loans as nonaccrual does not necessarily reflect management's judgment as to
whether they are collectible.
Interest income on nonaccrual loans which would have been recognized during the
year ended December 31, 2005, if all such loans had been current in accordance
with their original terms, totaled $957,000. Interest income actually recognized
on these loans in 2005 was $736,000.
-30-
The Bank's policy is to place loans 90 days or more past due on nonaccrual
status. In some instances when a loan is 90 days past due management does not
place it on nonaccrual status because the loan is well secured and in the
process of collection. A loan is considered to be in the process of collection
if, based on a probable specific event, it is expected that the loan will be
repaid or brought current. Generally, this collection period would not exceed 30
days. Loans where the collateral has been repossessed are classified as other
real estate owned ("OREO") or, if the collateral is personal property, the loan
is classified as other assets on the Company's financial statements.
Management considers both the adequacy of the collateral and the other resources
of the borrower in determining the steps to be taken to collect nonaccrual
loans. Alternatives that are considered are foreclosure, collecting on
guarantees, restructuring the loan or collection lawsuits.
The following tables set forth the amount of the Bank's nonperforming assets net
of guarantees of the U.S. government, including its agencies and its
government-sponsored agencies, as of the dates indicated:
December 31, 2005 December 31, 2004
------------------------- -------------------------
(dollars in thousands): Gross Guaranteed Net Gross Guaranteed Net
------------------------------------------------------
Performing nonaccrual loans $9,315 $6,933 $2,382 $11,043 $7,442 $3,601
Nonperforming, nonaccrual loans 579 - 579 1,418 174 1,244
------------------------------------------------------
Total nonaccrual loans 9,894 6,933 2,961 12,461 7,616 4,845
Loans 90 days past due and still accruing - - - 61 61
------------------------------------------------------
Total nonperforming loans 9,894 6,933 2,961 12,522 7,616 4,906
Other real estate owned - - - - - -
------------------------------------------------------
Total nonperforming loans and OREO $9,894 $6,933 $2,961 $12,522 $7,616 $4,906
======================================================
Nonperforming loans to total loans 0.21% 0.42%
Allowance for loan losses/nonperforming loans 548% 296%
Nonperforming assets to total assets 0.16% 0.30%
December 31, 2003 December 31, 2002
------------------------- -------------------------
(dollars in thousands): Gross Guaranteed Net Gross Guaranteed Net
------------------------------------------------------
Performing nonaccrual loans $10,997 $7,936 $3,061 $13,199 $8,432 $4,767
Nonperforming, nonaccrual loans 2,551 1,252 1,299 4,091 718 3,373
------------------------------------------------------
Total nonaccrual loans 13,548 9,188 4,360 17,290 9,150 8,140
Loans 90 days past due and still accruing 34 - 34 40 - 40
------------------------------------------------------
Total nonperforming loans 13,582 9,188 4,394 17,330 9,150 8,180
Other real estate owned 932 - 932 932 - 932
------------------------------------------------------
Total nonperforming loans and OREO $14,514 $9,188 $5,326 $18,262 9,150 $9,112
======================================================
Nonperforming loans to total loans 0.45% 1.19%
Allowance for loan losses/nonperforming loans 293% 167%
Nonperforming assets to total assets 0.36% 0.80%
December 31, 2001
-------------------------
(dollars in thousands): Gross Guaranteed Net
-------------------------
Performing nonaccrual loans $2,733 - $2,733
Nonperforming, nonaccrual loans 3,120 $387 2,733
-------------------------
Total nonaccrual loans 5,853 387 5,466
Loans 90 days past due and still accruing 584 - 584
-------------------------
Total nonperforming loans 6,437 387 6,050
Other real estate owned 71 - 71
-------------------------
Total nonperforming loans and OREO $6,508 $387 $6,121
=========================
Nonperforming loans to total loans 0.92%
Allowance for loan losses/nonperforming loans 216%
Nonperforming assets to total assets 0.61%
-31-
During 2005, nonperforming assets net of government guarantees decreased
$1,945,000 (39.6%) to $2,961,000. Nonperforming loans decreased $1,945,000
(39.6%) to $2,961,000. The ratio of nonperforming loans to total loans at
December 31, 2005 was 0.21% versus 0.42% at the end of 2004. Classifications of
nonperforming loans as a percent of total loans at the end of 2005 were as
follows: secured by real estate, 61%; loans to farmers, 3%; commercial loans,
15%; and consumer loans, 21%.
During 2004, nonperforming assets net of government guarantees decreased
$420,000 (7.9%) to a total of $4,906,000. Nonperforming loans net of government
guarantees increased $512,000 (11.7%) to $4,906,000, and other real estate owned
(OREO) decreased $932,000 to $0 during 2004. The ratio of nonperforming loans to
total loans at December 31, 2004 was 0.42% versus 0.45% at the end of 2003.
Classifications of nonperforming loans as a percent of total loans at the end of
2004 were as follows: secured by real estate, 75%; loans to farmers, 11%;
commercial loans, 8%; and consumer loans, 6%.
Allowance for Loan Losses
Credit risk is inherent in the business of lending. As a result, the Company
maintains an allowance for loan losses to absorb losses inherent in the
Company's loan and lease portfolio. This is maintained through periodic charges
to earnings. These charges are shown in the consolidated income statements as
provision for loan losses. All specifically identifiable and quantifiable losses
are immediately charged off against the allowance. However, for a variety of
reasons, not all losses are immediately known to the Company and, of those that
are known, the full extent of the loss may not be quantifiable at that point in
time. The balance of the Company's allowance for loan losses is meant to be an
estimate of these unknown but probable losses inherent in the portfolio.
For the remainder of this discussion, "loans" shall include all loans and lease
contracts, which are a part of the Bank's portfolio.
Assessment of the Adequacy of the Allowance for Loan Losses
The Company formally assesses the adequacy of the allowance on a quarterly
basis. Determination of the adequacy is based on ongoing assessments of the
probable risk in the outstanding loan and lease portfolio, and to a lesser
extent the Company's loan and lease commitments. These assessments include the
periodic re-grading of credits based on changes in their individual credit
characteristics including delinquency, seasoning, recent financial performance
of the borrower, economic factors, changes in the interest rate environment,
growth of the portfolio as a whole or by segment, and other factors as
warranted. Loans are initially graded when originated. They are re-graded as
they are renewed, when there is a new loan to the same borrower, when identified
facts demonstrate heightened risk of nonpayment, or if they become delinquent.
Re-grading of larger problem loans occurs at least quarterly. Confirmation of
the quality of the grading process is obtained by independent credit reviews
conducted by consultants specifically hired for this purpose and by various bank
regulatory agencies.
The Company's method for assessing the appropriateness of the allowance includes
specific allowances for identified problem loans and leases, formula allowance
factors for pools of credits, and allowances for changing environmental factors
(e.g., interest rates, growth, economic conditions, etc.). Allowances for
identified problem loans are based on specific analysis of individual credits.
Allowance factors for loan pools are based on the previous 5 years historical
loss experience by product type. Allowances for changing environmental factors
are management's best estimate of the probable impact these changes have had on
the loan portfolio as a whole.
The Components of the Allowance for Loan Losses
As noted above, the overall allowance consists of a specific allowance, a
formula allowance, and an allowance for environmental factors. The first
component, the specific allowance, results from the analysis of identified
credits that meet management's criteria for specific evaluation. These loans are
reviewed individually to determine if such loans are considered impaired.
Impaired loans are those where management has concluded that it is probable that
the borrower will be unable to pay all amounts due under the contractual terms.
Loans specifically reviewed, including those considered impaired, are evaluated
individually by management for loss potential by evaluating sources of
repayment, including collateral as applicable, and a specified allowance for
loan losses is established where necessary.
-32-
The second component, the formula allowance, is an estimate of the probable
losses that have occurred across the major loan categories in the Company's loan
portfolio. This analysis is based on loan grades by pool and the loss history of
these pools. This analysis covers the Company's entire loan portfolio including
unused commitments but excludes any loans, which were analyzed individually and
assigned a specific allowance as discussed above. The total amount allocated for
this component is determined by applying loss estimation factors to outstanding
loans and loan commitments. The loss factors are based primarily on the
Company's historical loss experience tracked over a five-year period and
adjusted as appropriate for the input of current trends and events. Because
historical loss experience varies for the different categories of loans, the
loss factors applied to each category also differ. In addition, there is a
greater chance that the Company has suffered a loss from a loan that was graded
less than satisfactory than if the loan was last graded satisfactory. Therefore,
for any given category, a larger loss estimation factor is applied to less than
satisfactory loans than to those that the Company last graded as satisfactory.
The resulting formula allowance is the sum of the allocations determined in this
manner.
The third component, the environmental factor allowance, is a component that is
not allocated to specific loans or groups of loans, but rather is intended to
absorb losses that may not be provided for by the other components.
There are several primary reasons that the other components discussed above
might not be sufficient to absorb the losses present in portfolios, and the
environmental factor allowance is used to provide for the losses that have
occurred because of them.
The first reason is that there are limitations to any credit risk grading
process. The volume of loans makes it impractical to re-grade every loan every
quarter. Therefore, it is possible that some currently performing loans not
recently graded will not be as strong as their last grading and an insufficient
portion of the allowance will have been allocated to them. Grading and loan
review often must be done without knowing whether all relevant facts are at
hand. Troubled borrowers may deliberately or inadvertently omit important
information from reports or conversations with lending officers regarding their
financial condition and the diminished strength of repayment sources.
The second reason is that the loss estimation factors are based primarily on
historical loss totals. As such, the factors may not give sufficient weight to
such considerations as the current general economic and business conditions that
affect the Company's borrowers and specific industry conditions that affect
borrowers in that industry. The factors might also not give sufficient weight to
other environmental factors such as changing economic conditions and interest
rates, portfolio growth, entrance into new markets or products, and other
characteristics as may be determined by Management.
Specifically, in assessing how much environmental factor allowance needed to be
provided at December 31, 2005, management considered the following:
- with respect to loans to the agriculture industry, management
considered the effects on borrowers of weather conditions and overseas
market conditions for exported products as well as commodity prices in
general;
- with respect to changes in the interest rate environment, management
considered the recent changes in interest rates and the resultant
economic impact it may have had on borrowers with high leverage and/or
low profitability; and
- with respect to loans to borrowers in new markets and growth in
general, management considered the relatively short seasoning of such
loans and the lack of experience with such borrowers.
Each of these considerations was assigned a factor and applied to a portion or
all of the loan portfolio. Since these factors are not derived from experience
and are applied to large non-homogeneous groups of loans, they are available for
use across the portfolio as a whole.
-33-
The following table sets forth the Bank's allowance for loan losses as of the
dates indicated:
December 31,
-------------------------------------------------------------
2005 2004 2003 2002 2001
-------------------------------------------------------------
(dollars in thousands)
Specific allowance $754 $820 $1,003 $5,299 $5,672
Formula allowance 8,582 7,015 6,106 4,912 4,039
Environmental factors allowance 6,890 6,690 5,781 3,475 2,701
-------------------------------------------------------------
Total allowance $16,226 $14,525 $12,890 $13,686 $12,412
=============================================================
Allowance for loan
losses to loans 1.17% 1.24% 1.31% 1.99% 1.88%
Based on the current conditions of the loan portfolio, management believes that
the $16,226,000 allowance for loan losses at December 31, 2005 is adequate to
absorb probable losses inherent in the Bank's loan portfolio. No assurance can
be given, however, that adverse economic conditions or other circumstances will
not result in increased losses in the portfolio.
The following table summarizes, for the years indicated, the activity in the
allowance for loan losses:
December 31,
-----------------------------------------------------------------
2005 2004 2003 2002 2001
-----------------------------------------------------------------
(dollars in thousands)
Balance, beginning of year $14,525 $12,890 $13,686 $12,412 $11,670
Addition through merger - - 928 - -
Provision charged to operations 2,169 2,901 1,058 2,755 3,754
Loans charged off:
Commercial, financial and
agricultural (220) (901) (1,142) (668) (2,861)
Consumer installment (1,459) (731) (475) (299) (134)
Real estate mortgage - - (2,136) (819) (218)
-----------------------------------------------------------------
Total loans charged-off (1,679) (1,632) (3,753) (1,786) (3,213)
-----------------------------------------------------------------
Recoveries:
Commercial, financial and
agricultural 396 70 206 197 92
Consumer installment 774 175 79 94 34
Real estate mortgage 41 121 686 14 75
-----------------------------------------------------------------
Total recoveries 1,211 366 971 305 201
-----------------------------------------------------------------
Net loans charged-off (468) (1,266) (2,782) (1,481) (3,012)
-----------------------------------------------------------------
Balance, year end $16,226 $14,525 $12,890 $13,686 $12,412
=================================================================
Average total loans $1,251,699 $1,060,556 $827,673 $660,668 $647,317
-----------------------------------------------------------------
Ratios:
Net charge-offs during period to
average loans outstanding during3
period 0.04% 0.12% 0.34% 0.22% 0.47%
Provision for loan losses to
average loans outstanding 0.17% 0.27% 0.13% 0.42% 0.58%
Allowance to loans at year end 1.17% 1.24% 1.31% 1.99% 1.88%
-----------------------------------------------------------------
-34-
The following tables summarize the allocation of the allowance for loan losses
between loan types:
December 31, 2005 December 31, 2004 December 31, 2003
------------------------- ------------------------ ------------------------
(dollars in thousands) Percent of Percent of Percent of
loans in each loans in each loans in each
category to category to category to
Amount total loans Amount total loans Amount total loans
Balance at end of period applicable to:
Commercial, financial and agricultural $1,930 10.3% $2,180 11.9% $2,634 14.5%
Consumer installment 6,099 36.7% 5,067 35.0% 3,946 32.5%
Real estate mortgage 6,967 45.0% 6,366 46.4% 5,564 46.7%
Real estate construction 1,230 8.0% 912 6.7% 746 6.3%
--------- -------- --------- -------- --------- --------
$16,226 100.0% $14,525 100.0% $12,890 100.0%
========= ======== ========= ======== ========= ========
December 31, 2002 December 31, 2001
----------------------- -----------------------
(dollars in thousands) Percent of Percent of
loans in each loans in each
category to category to
Balance at end of period applicable to: Amount total loans Amount total loans
Commercial, financial and agricultural $6,664 18.4% $6,801 19.8%
Consumer installment 2,630 29.4% 1,744 23.5%
Real estate mortgage 3,908 46.4% 3,389 49.6%
Real estate construction 484 5.8% 478 7.1%
--------- -------- --------- --------
$13,686 100.0% $12,412 100.0%
========= ======== ========= ========
Other Real Estate Owned
The other real estate owned (OREO) balance was $0 at both December 31, 2005 and
2004. The Bank disposed of properties with a value of $932,000 in 2004. OREO
properties may consist of a mixture of land, single family residences, and
commercial buildings.
Intangible Assets
At December 31, 2005 and 2004, the Bank had intangible assets totaling
$19,926,000 and $20,927,000, respectively. The intangible assets resulted from
the Bank's 1997 acquisitions of certain Wells Fargo branches and Sutter Buttes
Savings Bank, the 2003 acquisition of North State National Bank, and an
additional minimum pension liability related to the Company's supplemental
retirement plans. Intangible assets at December 31, 2005 and 2004 were comprised
of the following:
December 31,
2005 2004
--------------------------
(dollars in thousands)
Core-deposit intangible $3,061 $4,442
Additional minimum pension liability 1,346 966
Goodwill 15,519 15,519
--------------------------
Total intangible assets $19,926 $20,927
==========================
Amortization of core deposit intangible assets amounting to $1,381,000,
$1,358,000, and $1,207,000, was recorded in 2005, 2004, and 2003, respectively.
The minimum pension liability intangible asset is not amortized but adjusted
annually based upon actuarial estimates.
Deposits
Deposits at December 31, 2005 increased $147,964,000 (11.0%) to $1,496,797,000
over 2004 year-end balances. All categories of deposits except savings increased
in 2005. Included in the December 31, 2005 certificate of deposit balance is
$20,000,000 from the State of California. The Bank participates in a deposit
program offered by the State of California whereby the State may make deposits
at the Bank's request subject to collateral and credit worthiness constraints.
The negotiated rates on these State deposits are generally favorable to other
wholesale funding sources available to the Bank.
-35-
Deposits at December 31, 2004 increased $112,010,000 (9.1%) over the 2003
year-end balances to $1,348,833,000. All categories of deposits increased in
2004. Included in the December 31, 2004 certificate of deposit balances is
$20,000,000 from the State of California.
Long-Term Debt
The Company repaid $51,000 and $43,000 of long-term debt during 2005 and 2004,
respectively. See Note 7 to the consolidated financial statements at Item 8 of
this report for a discussion about the Company's other borrowings, including
long-term debt.
Junior Subordinated Debt
See Note 8 to the consolidated financial statements at Item 8 of this report for
a discussion about the Company's issuance of junior subordinated debt during
2005 and 2004.
Equity
See Note 10 and Note 19 in the consolidated financial statements at Item 8 of
this report for a discussion of shareholders' equity and regulatory capital,
respectively. Management believes that the Company's capital is adequate to
support anticipated growth, meet the cash dividend requirements of the Company
and meet the future risk-based capital requirements of the Bank and the Company.
Market Risk Management
Overview. The goal for managing the assets and liabilities of the Bank is to
maximize shareholder value and earnings while maintaining a high quality balance
sheet without exposing the Bank to undue interest rate risk. The Board of
Directors has overall responsibility for the Company's interest rate risk
management policies. The Bank has an Asset and Liability Management Committee
(ALCO) which 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,
investing in securities and issuing debt. 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 volatile interest
rates. The asset/liability management policy sets limits on the acceptable
amount of variance in net interest margin, net income and market value of equity
under changing interest environments. Market value of equity is the net present
value of estimated cash flows from the Bank's assets, liabilities and
off-balance sheet items. The Bank uses simulation models to forecast net
interest margin, net income and market value of equity.
Simulation of net interest margin, net income and market value of equity under
various interest rate scenarios is the primary tool used to measure interest
rate risk. Using computer-modeling techniques, the Bank is able to estimate the
potential impact of changing interest rates on net interest margin, net income
and market value of equity. A balance sheet forecast is prepared using inputs of
actual loan, securities and interest-bearing liability (i.e.
deposits/borrowings) positions as the beginning base.
In the simulation of net interest margin and net income under various interest
rate scenarios, the forecast balance sheet is processed against seven interest
rate scenarios. These seven interest rate scenarios include a flat rate
scenario, which assumes interest rates are unchanged in the future, and six
additional rate ramp scenarios ranging from +300 to -300 basis points around the
flat scenario in 100 basis point increments. These ramp scenarios assume that
interest rates increase or decrease evenly (in a "ramp" fashion) over a
twelve-month period and remain at the new levels beyond twelve months.
-36-
The following table summarizes the effect on net interest income and net income
due to changing interest rates as measured against a flat rate (no interest rate
change) scenario. The simulation results shown below assume no changes in the
structure of the Company's balance sheet over the twelve months being measured
(a "flat" balance sheet scenario), and that deposit rates will track general
interest rate changes by approximately 50%:
Interest Rate Risk Simulation of Net Interest Income and Net Income as of
December 31, 2005
Estimated Change in Estimated Change in
Change in Interest Net Interest Income (NII) Net Income (NI)
Rates (Basis Points) (as % of "flat" NII) (as % of "flat" NI)
+300 (ramp) (1.89%) (3.42%)
+200 (ramp) (1.31%) (2.38%)
+100 (ramp) (0.75%) (1.35%)
+ 0 (flat) - -
-100 (ramp) 0.54% 0.99%
-200 (ramp) 1.24% 2.25%
-300 (ramp) 2.09% 3.80%
In the simulation of market value of equity under various interest rate
scenarios, the forecast balance sheet is processed against seven interest rate
scenarios. These seven interest rate scenarios include the flat rate scenario
described above, and six additional rate shock scenarios ranging from +300 to
-300 basis points around the flat scenario in 100 basis point increments. These
rate shock scenarios assume that interest rates increase or decrease immediately
(in a "shock" fashion) and remain at the new level in the future.
The following table summarizes the effect on market value of equity due to
changing interest rates as measured against a flat rate (no change) scenario:
Interest Rate Risk Simulation of Market Value of Equity as of December 31, 2005
Estimated Change in
Change in Interest Market Value of Equity (MVE)
Rates (Basis Points) (as % of "flat" MVE)
+300 (shock) (5.21%)
+200 (shock) (3.71%)
+100 (shock) (1.99%)
+ 0 (flat) -
-100 (shock) 1.06%
-200 (shock) 1.17%
-300 (shock) -
These results indicate that given a "flat" balance sheet scenario, and if
deposit rates track general interest rate changes by approximately 50%, the
Company's balance sheet is slightly liability sensitive. "Liability sensitive"
implies that earnings decrease when interest rates rise, and increase when
interest rates decrease. The magnitude of all the simulation results noted above
is within the Bank's policy guidelines. The asset liability management policy
limits aggregate market risk, as measured in this fashion, to an acceptable
level within the context of risk-return trade-offs.
The simulation results noted above do not incorporate any management actions,
which might moderate the negative consequences of interest rate deviations. In
addition, the simulation results noted above contain various assumptions such as
a flat balance sheet, and the rate that deposit interest rates change as general
interest rates change. Therefore, they do not reflect likely actual results, but
serve as conservative estimates of interest rate risk.
As with any method of measuring interest rate risk, certain shortcomings are
inherent in the method of analysis presented in the preceding tables. For
example, although certain of the Bank's assets and liabilities may have similar
maturities or repricing time frames, they may react in different degrees to
changes in market interest rates. In addition, the interest rates on certain of
the Bank's asset and liability categories may precede, or lag behind, changes in
market interest rates. Also, the actual rates of prepayments on loans and
investments could vary significantly from the assumptions utilized in deriving
the results as presented in the preceding table. Further, a change in U.S.
Treasury rates accompanied by a change in the shape of the treasury yield curve
could result in different estimations from those presented herein. Accordingly,
the results in the preceding tables should not be relied upon as indicative of
actual results in the event of changing market interest rates. Additionally, the
resulting estimates of changes in market value of equity are not intended to
represent, and should not be construed to represent, estimates of changes in the
underlying value of the Bank.
-37-
Interest rate sensitivity is a function of the repricing characteristics of the
Bank's portfolio of assets and liabilities. One aspect of these repricing
characteristics is the time frame within which the interest-bearing assets and
liabilities are subject to change in interest rates either at replacement,
repricing or maturity. An analysis of the repricing time frames of
interest-bearing assets and liabilities is sometimes called a "gap" analysis
because it shows the gap between assets and liabilities repricing or maturing in
each of a number of periods. Another aspect of these repricing characteristics
is the relative magnitude of the repricing for each category of interest earning
asset and interest-bearing liability given various changes in market interest
rates. Gap analysis gives no indication of the relative magnitude of repricing
given various changes in interest rates. Interest rate sensitivity management
focuses on the maturity of assets and liabilities and their repricing during
periods of changes in market interest rates. Interest rate sensitivity gaps are
measured as the difference between the volumes of assets and liabilities in the
Bank's current portfolio that are subject to repricing at various time horizons.
The following interest rate sensitivity table shows the Bank's repricing gaps as
of December 31, 2005. In this table transaction deposits, which may be repriced
at will by the Bank, have been included in the less than 3-month category. The
inclusion of all of the transaction deposits in the less than 3-month repricing
category causes the Bank to appear liability sensitive. Because the Bank may
reprice its transaction deposits at will, transaction deposits may or may not
reprice immediately with changes in interest rates. In recent years of moderate
interest rate changes the Bank's earnings have reacted as though the gap
position is slightly asset sensitive mainly because the magnitude of
interest-bearing liability repricing has been less than the magnitude of
interest-earning asset repricing. This difference in the magnitude of asset and
liability repricing is mainly due to the Bank's strong core deposit base, which
although they may be repriced within three months, historically, the timing of
their repricing has been longer than three months and the magnitude of their
repricing has been minimal.
Due to the limitations of gap analysis, as described above, the Bank does not
actively use gap analysis in managing interest rate risk. Instead, the Bank
relies on the more sophisticated interest rate risk simulation model described
above as its primary tool in measuring and managing interest rate risk.
Interest Rate Sensitivity - December 31, 2005
Repricing within:
-------------------------------------------------------------------------------
(dollars in thousands) Less than 3 3 - 6 6 - 12 1 - 5 Over
months months months years 5 years
-------------------------------------------------------------------------------
Interest-earning assets:
Federal funds sold $2,377 $ -- $ -- $ -- $ --
Securities 32,180 19,812 39,610 138,229 30,447
Loans 548,537 68,852 98,172 483,820 185,654
-------------------------------------------------------------------------------
Total interest-earning assets $583,094 $88,664 $137,782 $622,049 $216,101
-------------------------------------------------------------------------------
Interest-bearing liabilities
Transaction deposits $682,370 $ -- $ -- $ -- $ --
Time 157,453 107,140 84,218 97,085 119
Federal funds purchased 96,800 - - - -
Other borrowings 8,611 15 32 22,732 -
Junior subordinated debt 41,238 - - - -
-------------------------------------------------------------------------------
Total interest-bearing liabilities $986,472 $107,155 $84,250 $119,817 $119
-------------------------------------------------------------------------------
Interest sensitivity gap ($403,377) ($18,490) $53,531 $502,232 $215,983
Cumulative sensitivity gap ($403,377) ($421,868) ($368,336) $133,895 $349,878
As a percentage of earning assets:
Interest sensitivity gap (24.48%) (1.12%) 3.25% 30.48% 13.11%
Cumulative sensitivity gap (24.48%) (25.60%) (22.35%) 8.13% 21.23%
-38-
Liquidity
Liquidity refers to the Bank's ability to provide funds at an acceptable cost to
meet loan demand and deposit withdrawals, as well as contingency plans to meet
unanticipated funding needs or loss of funding sources. These objectives can be
met from either the asset or liability side of the balance sheet. Asset
liquidity sources consist of the repayments and maturities of loans, selling of
loans, short-term money market investments, maturities of securities and sales
of securities from the available-for-sale portfolio. These activities are
generally summarized as investing activities in the Consolidated Statement of
Cash Flows. Net cash used by investing activities totaled approximately
$199,357,000 in 2005. Increased loan balances were responsible for the major use
of funds in this category.
Liquidity is generated from liabilities through deposit growth and short-term
borrowings. These activities are included under financing activities in the
Consolidated Statement of Cash Flows. In 2005, financing activities provided
funds totaling $192,340,000. Internal deposit growth provided funds amounting to
$147,964,000. The Bank also had available correspondent banking lines of credit
totaling $50,000,000 at year-end 2005. In addition, at December 31, 2005, the
Company had loans and securities available to pledge towards future borrowings
from the Federal Home Loan Bank of up to $279,671,000. As of December 31, 2005,
the Company had $31,390,000 of long-term debt and other borrowings as described
in Note 7 of the consolidated financial statements of the Company and the
related notes at Item 8 of this report. While these sources are expected to
continue to provide significant amounts of funds in the future, their mix, as
well as the possible use of other sources, will depend on future economic and
market conditions. Liquidity is also provided or used through the results of
operating activities. In 2005, operating activities provided cash of
$29,919,000.
The Bank classifies its entire investment portfolio as available for sale (AFS).
The AFS securities plus cash and cash equivalents in excess of reserve
requirements totaled $342,422,000 at December 31, 2005, which was 18.6% of total
assets at that time. This was down from $347,573,000 and 21.4% at the end of
2004.
The maturity distribution of certificates of deposit in denominations of
$100,000 or more is set forth in the following table. These deposits are
generally more rate sensitive than other deposits and, therefore, are more
likely to be withdrawn to obtain higher yields elsewhere if available. The Bank
participates in a program wherein the State of California places time deposits
with the Bank at the Bank's option. At December 31, 2005, 2004 and 2003, the
Bank had $20,000,000 of these State deposits.
Certificates of Deposit in Denominations of $100,000 or More
Amounts as of December 31,
-----------------------------------
(dollars in thousands) 2005 2004 2003
-----------------------------------
Time remaining until maturity:
Less than 3 months $83,280 $57,500 $39,264
3 months to 6 months 43,125 13,910 11,018
6 months to 12 months 30,416 17,581 9,413
More than 12 months 38,958 40,415 34,805
-----------------------------------
Total $195,779 $129,406 $94,500
===================================
-39-
Loan demand also affects the Bank's liquidity position. The following table
presents the maturities of loans, net of deferred loan costs, at December 31,
2005:
After
One But
Within Within After 5
One Year 5 Years Years Total
---------------------------------------------------------------
(dollars in thousands)
Loans with predetermined interest rates:
Commercial, financial and agricultural $19,091 $33,579 $2,750 $55,420
Consumer installment 66,493 116,712 63,916 247,121
Real estate mortgage 29,172 99,471 139,264 267,907
Real estate construction 28,787 639 7,559 36,985
---------------------------------------------------------------
$143,543 $250,401 $213,489 $607,433
Loans with floating interest rates: ---------------------------------------------------------------
Commercial, financial and agricultural $61,291 $25,217 $1,247 $87,755
Consumer installment 261,112 - - 261,112
Real estate mortgage 27,569 74,480 253,555 355,604
Real estate construction 29,914 24,505 18,712 73,131
---------------------------------------------------------------
$379,886 $124,202 $273,514 $777,602
---------------------------------------------------------------
Total loans $523,429 $374,603 $487,003 $1,385,035
===============================================================
The maturity distribution and yields of the investment portfolio at December 31,
2005 is presented in the following table. The timing of the maturities indicated
in the table below is based on final contractual maturities. Most
mortgage-backed securities return principal throughout their contractual lives.
As such, the weighted average life of mortgage-backed securities based on
outstanding principal balance is usually significantly shorter than the final
contractual maturity indicated below. At December 31, 2005, the Bank had no
held-to-maturity securities.
After One Year After Five Years
Within but Through but Through After Ten
One Year Five Years Ten Years Years Total
------------------------------------------------------------------------------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------------------------------------------------------------------------------------
Securities Available-for-Sale (dollars in thousands)
------------------------------
Obligations of US government
corporations and agencies $153 5.46% $8,536 5.18% $177,151 3.97% $22,993 5.58% $208,833 4.19%
Obligations of states and
political subdivisions 276 5.37% 1,030 6.64% 13,953 7.98% 22,490 7.39% 37,749 7.57%
Corporate bonds 2,050 7.65% - - - - 11,646 5.39% 13,696 5.73%
--------------------------------------------------------------------------------------------------------------------------
Total securities available-for-sale $2,479 7.26% $9,566 5.34% $191,104 4.26% $57,129 6.25% $260,278 4.76%
==========================================================================================================================
The principal cash requirements of the Company are dividends on common stock
when declared. The Company is dependent upon the payment of cash dividends by
the Bank to service its commitments. The Company expects that the cash dividends
paid by the Bank to the Company will be sufficient to meet this payment
schedule. Dividends from the Bank are subject to certain regulatory
restrictions.
Off-Balance Sheet Items
The Bank has certain ongoing commitments under operating and capital leases. See
Note 5 of the financial statements at Item 8 of this report for the terms. These
commitments do not significantly impact operating results. As of December 31,
2005 commitments to extend credit and commitments related to the Bank's deposit
overdraft privilege product were the Bank's only financial instruments with
off-balance sheet risk. The Bank has not entered into any contracts for
financial derivative instruments such as futures, swaps, options, etc.
Commitments to extend credit were $626,490,000 and $445,054,000 at December 31,
2005 and 2004, respectively, and represent 45.2% of the total loans outstanding
at year-end 2005 versus 38.0% at December 31, 2004. Commitments related to the
Bank's deposit overdraft privilege product totaled $35,002,000 and $28,815,000
at December 31, 2005 and 2004, respectively.
-40-
Certain Contractual Obligations
The following chart summarizes certain contractual obligations of the Company as
of December 31, 2005:
Less than 1-3 3-5 More than
(dollars in thousands) Total one year years years 5 years
----------------------------------------------------------------
Federal funds purchased $96,800 $96,800 - - -
FHLB loan, fixed rate of 5.41%
payable on April 7, 2008, callable
in its entirety by FHLB on a quarterly
basis beginning April 7, 2003 20,000 - 20,000 - -
FHLB loan, fixed rate of 5.35%
payable on December 9, 2008 1,500 - 1,500 - -
FHLB loan, fixed rate of 5.77%
payable on February 23, 2009 1,000 - - 1,000 -
Capital lease obligation on premises,
effective rate of 13% payable
monthly in varying amounts
through December 1, 2009 293 - - 293 -
Other collateralized borrowings,
fixed rate of 1.44% payable on
January 3, 2006 8,597 8,597 - - -
Junior subordinated debt, adjustable rate
of three-month LIBOR plus 3.05%,
callable in whole or in part by the
Company on a quarterly basis beginning
October 7, 2008, matures October 7, 2033 20,619 - - - 20,619
Junior subordinated debt, adjustable rate
of three-month LIBOR plus 2.55%,
callable in whole or in part by the
Company on a quarterly basis beginning
July 23, 2009, matures July 23, 2034 20,619 - - - 20,619
Operating lease obligations 7,095 1,522 2,600 1,888 1,085
Deferred compensation(1) 1,464 264 481 454 265
Supplemental retirement plans(1) 4,528 477 938 926 2,187
Employment agreements 119 119 - - -
----------------------------------------------------------------
Total contractual obligations $182,634 $107,779 $25,519 $4,561 $44,775
================================================================
(1) These amounts represent known certain payments to participants under
the Company's deferred compensation and supplemental retirement plans.
See Note 14 in the financial statements at Item 8 of this report for
additional information related to the Company's deferred compensation
and supplemental retirement plan liabilities.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Market Risk Management" under Item 7 of this report.
-41-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Page
Consolidated Balance Sheets as of December 31, 2005 and 2004 43
Consolidated Statements of Income for
the years ended December 31, 2005, 2004, and 2003 44
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 2005, 2004, and 2003 45
Consolidated Statements of Cash Flows for the years ended
December 31, 2005, 2004, and 2003 46
Notes to Consolidated Financial Statements 47
Management's Report of Internal Control over Financial Reporting 74
Independent Registered Public Accounting Firm's Reports 75
-42-
TRICO BANCSHARES
CONSOLIDATED BALANCE SHEETS
At December 31,
2005 2004
---------------------------------
(in thousands, except share data)
Assets:
Cash and due from banks $90,562 $70,037
Federal funds sold 2,377 -
---------------------------------
Cash and cash equivalents 92,939 70,037
Securities available-for-sale 260,278 286,013
Federal Home Loan Bank stock, at cost 7,602 6,781
Loans, net of allowance for loan losses
of $16,226 and $14,525 1,368,809 1,158,442
Foreclosed assets, net of allowance for losses
of $180 and $180 - -
Premises and equipment, net 21,291 19,853
Cash value of life insurance 41,768 40,479
Accrued interest receivable 7,641 6,473
Goodwill 15,519 15,519
Other intangible assets, net 4,407 5,408
Other assets 21,021 18,501
---------------------------------
Total assets $1,841,275 $1,627,506
=================================
Liabilities and Shareholders' Equity:
Liabilities:
Deposits:
Noninterest-bearing demand $368,412 $311,275
Interest-bearing 1,128,385 1,037,558
---------------------------------
Total deposits 1,496,797 1,348,833
Federal funds purchased 96,800 46,400
Accrued interest payable 4,506 3,281
Reserve for unfunded commitments 1,813 1,532
Other liabilities 19,238 19,938
Other borrowings 31,390 28,152
Junior subordinated debt 41,238 41,238
---------------------------------
Total liabilities 1,691,782 1,489,374
---------------------------------
Commitments and contingencies (Notes 5, 9, 14 and 16)
Shareholders' equity:
Common stock, no par value: 50,000,000
shares authorized; issued and outstanding:
15,707,835 at December 31, 2005 71,412
15,723,317 at December 31, 2004 70,699
Retained earnings 81,906 67,785
Accumulated other comprehensive loss, net (3,825) (352)
---------------------------------
Total shareholders' equity 149,493 138,132
---------------------------------
Total liabilities and shareholders' equity $1,841,275 $1,627,506
=================================
Share data for all periods have been adjusted to reflect the 2-for-1 stock split
paid on April 30, 2004. The accompanying notes are an integral part of these
consolidated financial statements.
-43-
TRICO BANCSHARES
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31,
------------------------------------------
2005 2004 2003
------------------------------------------
(in thousands, except per share data)
Interest and dividend income:
Loans, including fees $86,379 $72,637 $60,997
Debt securities:
Taxable 10,268 10,312 10,692
Tax exempt 1,778 1,728 1,940
Dividends 306 237 211
Federal funds sold 25 18 129
------------------------------------------
Total interest and dividend income 98,756 84,932 73,969
------------------------------------------
Interest expense:
Deposits 14,902 10,171 11,257
Federal funds purchased 1,784 510 189
Other borrowings 1,361 1,301 1,288
Junior subordinated debt 2,482 1,381 355
------------------------------------------
Total interest expense 20,529 13,363 13,089
------------------------------------------
Net interest income 78,227 71,569 60,880
Provision for loan losses 2,169 2,901 1,058
------------------------------------------
Net interest income after provision for loan losses 76,058 68,668 59,822
------------------------------------------
Noninterest income:
Service charges and fees 18,152 17,691 14,541
Gain on sale of investments - - 197
Gain on sale of loans 1,679 1,659 4,168
Commissions on sale of non-deposit investment products 2,242 2,327 1,766
Increase in cash value of life insurance 1,507 1,499 1,296
Other 1,310 1,618 941
------------------------------------------
Total noninterest income 24,890 24,794 22,909
------------------------------------------
Noninterest expense:
Salaries and related benefits 33,926 33,191 29,714
Other 28,184 27,637 26,005
------------------------------------------
Total noninterest expense 62,110 60,828 55,719
------------------------------------------
Income before income taxes 38,838 32,634 27,012
------------------------------------------
Provision for income taxes 15,167 12,452 10,124
------------------------------------------
Net income $23,671 $20,182 $16,888
==========================================
Earnings per share:
Basic $1.51 $1.29 $1.11
Diluted $1.45 $1.24 $1.07
Per share data for all periods have been adjusted to reflect the 2-for-1 stock
split paid on April 30, 2004. The accompanying notes are an integral part of
these consolidated financial statements.
-44-
TRICO BANCSHARES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years Ended December 31, 2005, 2004 and 2003
Accumulated
Shares of Other
Common Common Retained Comprehensive
Stock Stock Earnings (Loss) Income Total
------------------------------------------------------
(in thousands, except share data)
Balance at December 31, 2002 14,121,930 $50,472 $46,239 $2,303 $99,014
Comprehensive income: ---------
Net income 16,888 16,888
Change in net unrealized gain on
Securities available for sale, net (529) (529)
Change in minimum pension liability, net 40 40
---------
Total comprehensive income 16,399
Stock options exercised 154,294 717 717
Tax benefit of stock options exercised 440 440
Issuance of stock and options
related to merger 1,447,024 18,383 18,383
Repurchase of common stock (55,000) (245) (608) (853)
Dividends paid ($0.40 per share) (6,140) (6,140)
------------------------------------------------------
Balance at December 31, 2003 15,668,248 $69,767 $56,379 $1,814 $127,960
Comprehensive income: ---------
Net income 20,182 20,182
Change in net unrealized gain on
Securities available for sale, net (1,936) (1,936)
Change in minimum pension liability, net (230) (230)
---------
Total comprehensive income 18,016
Stock options exercised 222,669 1,348 1,348
Tax benefit of stock options exercised 330 330
Repurchase of common stock (167,600) (746) (2,047) (2,793)
Dividends paid ($0.43 per share) (6,729) (6,729)
------------------------------------------------------
Balance at December 31, 2004 15,723,317 $70,699 $67,785 ($352) $138,132
Comprehensive income: ---------
Net income 23,671 23,671
Change in net unrealized loss on
Securities available for sale, net (3,336) (3,336)
Change in minimum pension liability, net (137) (137)
---------
Total comprehensive income 20,198
Stock options exercised 136,289 972 972
Tax benefit of stock options exercised 425 425
Repurchase of common stock (151,771) (684) (2,477) (3,161)
Dividends paid ($0.45 per share) (7,073) (7,073)
------------------------------------------------------
Balance at December 31, 2005 15,707,835 $71,412 $81,906 ($3,825) $149,493
======================================================
Share and per share data for all periods have been adjusted to reflect the
2-for-1 stock split paid on April 30, 2004. The accompanying notes are an
integral part of these consolidated financial statements.
-45-
TRICO BANCSHARES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
----------------------------------------------------
2005 2004 2003
----------------------------------------------------
(in thousands)
Operating Activities:
Net income $23,671 $20,182 $16,888
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation of premises and equipment, and amortization 3,821 3,402 3,059
Amortization of intangible assets 1,381 1,358 1,207
Provision for loan losses 2,169 2,901 1,058
Amortization of investment securities premium, net 1,236 1,845 3,514
Gain on sale of investments - - (197)
Originations of loans for resale (76,542) (88,158) (175,640)
Proceeds from sale of loans originated for resale 77,398 89,015 177,860
Gain on sale of loans (1,679) (1,659) (4,168)
Amortization of mortgage servicing rights 661 739 1,356
(Recovery of) provision for mortgage
servicing rights valuation allowance - (600) 600
Loss (gain) on sale of fixed assets 94 (23) 2
Gain on sale of foreclosed assets - (566) (113)
Increase in cash value of life insurance (1,507) (1,499) (1,296)
Deferred income tax benefit (2,223) (1,130) (282)
Change in:
Interest receivable (1,168) (446) 159
Interest payable 1,225 643 (289)
Other assets and liabilities, net 1,382 3,459 3,299
----------------------------------------------------
Net cash provided by operating activities 29,919 29,463 27,017
----------------------------------------------------
Investing activities:
Net cash obtained in mergers and acquisitions - - 7,450
Proceeds from maturities of securities available-for-sale 58,755 79,442 205,021
Proceeds from sale of securities available-for-sale - - 22,320
Purchases of securities available-for-sale (40,013) (59,091) (168,953)
Purchase of Federal Home Loan Bank stock (821) (1,997) (210)
Loan originations and principal collections, net (212,536) (192,992) (221,235)
Proceeds from sale of premises and equipment 24 545 20
Purchases of premises and equipment (4,766) (3,753) (2,746)
Proceeds from sale of foreclosed assets - 1,490 726
Investment in subsidiary - (619) (619)
Purchase of life insurance - - (22,475)
----------------------------------------------------
Net cash used by investing activities (199,357) (176,975) (180,701)
----------------------------------------------------
Financing activities:
Net increase in deposits 147,964 112,010 105,537
Net change in federal funds purchased 50,400 6,900 39,500
Payments of principal on long-term other borrowings (51) (43) (37)
Net change in short-term other borrowings 3,289 5,308 -
Issuance of junior subordinated debt - 20,619 20,619
Repurchase of common stock (3,161) (2,793) (853)
Dividends paid (7,073) (6,729) (6,140)
Exercise of stock options 972 1,348 717
----------------------------------------------------
Net cash provided by financing activities 192,340 136,620 159,343
----------------------------------------------------
Net change in cash and cash equivalents 22,902 (10,892) 5,659
----------------------------------------------------
Cash and cash equivalents and beginning of year 70,037 80,929 75,270
----------------------------------------------------
Cash and cash equivalents at end of year $92,939 $70,037 $80,929
====================================================
Supplemental disclosure of noncash activities:
Unrealized loss on securities available for sale ($5,757) ($3,263) ($990)
Loans transferred to foreclosed assets - - 613
Supplemental disclosure of cash flow activity:
Cash paid for interest expense 19,304 12,720 13,378
Cash paid for income taxes 16,215 14,630 8,160
Income tax benefit from stock option exercises 425 330 440
The acquisition of North State National Bank Involved the following:
Common stock issued 18,383
Liabilities assumed 126,648
Fair value of assets acquired, other than cash and cash equivalents (118,697)
Core deposit intangible (3,365)
Goodwill (15,519)
Net cash and cash equivalents received $7,450
The accompanying notes are an integral part of these consolidated financial
statements.
-46-
TRICO BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2005, 2004 and 2003
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company, and
its wholly-owned subsidiary, Tri Counties Bank (the "Bank"). All significant
intercompany accounts and transactions have been eliminated in consolidation.
Nature of Operations
The Company operates 32 branch offices and 17 in-store branch offices in the
California counties of Butte, Contra Costa, Del Norte, Fresno, Glenn, Kern,
Lake, Lassen, Madera, Mendocino, Merced, Nevada, Placer, Sacramento, Shasta,
Siskiyou, Stanislaus, Sutter, Tehama, Tulare, Yolo and Yuba. The Company's
operating policy since its inception has emphasized retail banking. Most of the
Company's customers are retail customers and small to medium sized businesses.
Use of Estimates in the Preparation of Financial Statements The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires Management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. On an on-going basis, the Company evaluates its estimates,
including those related to the adequacy of the allowance for loan losses,
investments, intangible assets, income taxes and contingencies. The Company
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. The
allowance for loan losses, goodwill and other intangible assessments, income
taxes, and the valuation of mortgage servicing rights, are the only accounting
estimates that materially affect the Company's consolidated financial
statements.
Significant Group Concentration of Credit Risk
The Company grants agribusiness, commercial, consumer, and residential loans to
customers located throughout the northern San Joaquin Valley, the Sacramento
Valley and northern mountain regions of California. The Company has a
diversified loan portfolio within the business segments located in this
geographical area.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash on hand, amounts due from banks and federal funds sold.
Investment Securities
The Company classifies its debt and marketable equity securities into one of
three categories: trading, available-for-sale or held-to-maturity. Trading
securities are bought and held principally for the purpose of selling in the
near term. Held-to-maturity securities are those securities which the Company
has the ability and intent to hold until maturity. All other securities not
included in trading or held-to-maturity are classified as available-for-sale. In
2005 and 2004, the Company did not have any securities classified as either
held-to-maturity or trading.
Available-for-sale securities are recorded at fair value. Unrealized gains and
losses, net of the related tax effect, on available-for-sale securities are
reported as a separate component of other accumulated comprehensive income
(loss) in shareholders' equity until realized.
Premiums and discounts are amortized or accreted over the life of the related
investment security as an adjustment to yield using the effective interest
method. Dividend and interest income are recognized when earned. Realized gains
and losses for securities are included in earnings and are derived using the
specific identification method for determining the cost of securities sold.
Unrealized losses due to fluctuations in fair value of securities held to
maturity or available for sale are recognized through earnings when it is
determined that an other than temporary decline in value has occurred.
Federal Home Loan Bank Stock
The Bank is a member of both the Federal Home Loan Bank of San Francisco
("FHLB"), and as a condition of membership, it is required to purchase stock.
The amount of FHLB stock required to be purchased is based on the borrowing
capacity desired by the Bank. While technically these are considered equity
securities, there is no market for the FHLB stock. Therefore, the shares are
considered as restricted investment securities. Such investment is carried at
cost.
-47-
Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at
the lower of aggregate cost or fair value, as determined by aggregate
outstanding commitments from investors of current investor yield requirements.
Net unrealized losses are recognized through a valuation allowance by charges to
income. At December 31, 2005 and 2004, the Company had no loans held for sale.
Mortgage loans held for sale are generally sold with the mortgage servicing
rights retained by the Company. The carrying value of mortgage loans sold is
reduced by the cost allocated to the associated mortgage servicing rights. Gains
or losses on sales of mortgage loans are recognized based on the difference
between the selling price and the carrying value of the related mortgage loans
sold.
Loans
Loans are reported at the principal amount outstanding, net of unearned income
and the allowance for loan losses. Loan origination and commitment fees and
certain direct loan origination costs are deferred, and the net amount is
amortized as an adjustment of the related loan's yield over the estimated life
of the loan. Loans on which the accrual of interest has been discontinued are
designated as nonaccrual loans. Accrual of interest on loans is generally
discontinued either when reasonable doubt exists as to the full, timely
collection of interest or principal or when a loan becomes contractually past
due by 90 days or more with respect to interest or principal. When loans are 90
days past due, but in Management's judgment are well secured and in the process
of collection, they may be classified as accrual. When a loan is placed on
nonaccrual status, all interest previously accrued but not collected is
reversed. Income on such loans is then recognized only to the extent that cash
is received and where the future collection of principal is probable. Interest
accruals are resumed on such loans only when they are brought fully current with
respect to interest and principal and when, in the judgment of Management, the
loans are estimated to be fully collectible as to both principal and interest.
All impaired loans are classified as nonaccrual loans.
Reserve for Unfunded Commitments
The reserve for unfunded commitments is established through a provision for
losses - unfunded commitments charged to noninterest expense. The reserve for
unfunded commitments is an amount that Management believes will be adequate to
absorb probable losses inherent in existing commitments, including unused
portions of revolving lines of credits and other loans, standby letters of
credits, and unused deposit account overdraft privilege. The reserve for
unfunded commitments is based on evaluations of the collectibility, and prior
loss experience of unfunded commitments. The evaluations take into consideration
such factors as changes in the nature and size of the loan portfolio, overall
loan portfolio quality, loan concentrations, specific problem loans and related
unfunded commitments, and current economic conditions that may affect the
borrower's or depositor's ability to pay.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses
charged to expense. Loans and deposit related overdrafts are charged against the
allowance for loan losses when Management believes that the collectibility of
the principal is unlikely or, with respect to consumer installment loans,
according to an established delinquency schedule. The allowance is an amount
that Management believes will be adequate to absorb probable losses inherent in
existing loans and leases, based on evaluations of the collectibility,
impairment and prior loss experience of loans and leases. The evaluations take
into consideration such factors as changes in the nature and size of the
portfolio, overall portfolio quality, loan concentrations, specific problem
loans, and current economic conditions that may affect the borrower's ability to
pay. The Company defines a loan as impaired when it is probable the Company will
be unable to collect all amounts due according to the contractual terms of the
loan agreement. Impaired loans are measured based on the present value of
expected future cash flows discounted at the loan's original effective interest
rate. As a practical expedient, impairment may be measured based on the loan's
observable market price or the fair value of the collateral if the loan is
collateral dependent. When the measure of the impaired loan is less than the
recorded investment in the loan, the impairment is recorded through a valuation
allowance.
Credit risk is inherent in the business of lending. As a result, the Company
maintains an allowance for loan losses to absorb losses inherent in the
Company's loan portfolio. This is maintained through periodic charges to
earnings. These charges are shown in the Consolidated Income Statements as
provision for loan losses. All specifically identifiable and quantifiable losses
are immediately charged off against the allowance. However, for a variety of
reasons, not all losses are immediately known to the Company and, of those that
are known, the full extent of the loss may not be quantifiable at that point in
time. The balance of the Company's allowance for loan losses is meant to be an
estimate of these unknown but probable losses inherent in the portfolio. For
purposes of this discussion, "loans" shall include all loans and lease contracts
that are part of the Company's portfolio.
The Company formally assesses the adequacy of the allowance on a quarterly
basis. Determination of the adequacy is based on ongoing assessments of the
probable risk in the outstanding loan portfolio, and to a lesser extent the
Company's loan commitments. These assessments include the periodic re-grading of
credits based on changes in their individual credit characteristics including
delinquency, seasoning, recent financial performance of the borrower, economic
factors, changes in the interest rate environment, growth of the portfolio as a
whole or by segment, and other factors as warranted. Loans are initially graded
when originated. They are re-graded as they are renewed, when there is a new
loan to the same borrower, when identified facts demonstrate heightened risk of
nonpayment, or if they become delinquent. Re-grading of larger problem loans
occur at least quarterly. Confirmation of the quality of the grading process is
obtained by independent credit reviews conducted by consultants specifically
hired for this purpose and by various bank regulatory agencies.
-48-
The Company's method for assessing the appropriateness of the allowance for loan
losses and the reserve for unfunded commitments includes specific allowances for
identified problem loans and leases as determined by SFAS 114, formula allowance
factors for pools of credits, and allowances for changing environmental factors
(e.g., interest rates, growth, economic conditions, etc.). Allowance factors for
loan pools are based on the previous 5 years historical loss experience by
product type. Allowances for specific loans are based on SFAS 114 analysis of
individual credits. Allowances for changing environmental factors are
Management's best estimate of the probable impact these changes have had on the
loan portfolio as a whole.
Based on the current conditions of the loan portfolio, Management believes that
the allowance for loan losses and the reserve for unfunded commitments, which
collectively stand at $18,039,000 at December 31, 2005, are adequate to absorb
probable losses inherent in the Company's loan portfolio. No assurance can be
given, however, that adverse economic conditions or other circumstances will not
result in increased losses in the portfolio.
Servicing
Servicing assets are recognized as separate assets when rights are acquired
through purchase or through sale of financial assets. Generally, purchased
servicing rights are capitalized at the cost to acquire the rights. For sales of
mortgage loans, a portion of the cost of originating the loan is allocated to
the servicing right based on relative fair value. Fair value is based on market
prices for comparable mortgage servicing contracts, when available, or
alternatively, is based on a valuation model that calculates the present value
of estimated future net servicing income. The valuation model incorporates
assumptions that market participants would use in estimating future net
servicing income, such as the cost to service, the discount rate, the custodial
earnings rate, an inflation rate, ancillary income, prepayment speeds and
default rates and losses. Capitalized servicing rights are reported in other
assets and are amortized into non-interest income in proportion to, and over the
period of, the estimated future servicing income of the underlying financial
assets.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost. Impairment is determined by stratifying
rights into tranches based on predominant risk characteristics, such as interest
rate, loan type and investor type. Impairment is recognized through a valuation
allowance for an individual tranche, to the extent that fair value is less than
the capitalized amount for the tranche. If the Company later determines that all
or a portion of the impairment no longer exists for a particular tranche, a
reduction of the allowance may be recorded as an increase to income.
Servicing fee income is recorded for fees earned for servicing loans. The fees
are based on a contractual percentage of the outstanding principal; or a fixed
amount per loan and are recorded as income when earned. The amortization of
mortgage servicing rights is netted against loan servicing fee income.
The following table summarizes the Company's mortgage servicing rights recorded
in other assets as of December 31, 2005 and 2004.
December 31, December 31,
(Dollars in thousands) 2004 Additions Reductions 2005
-------------------------------------------------
Mortgage Servicing Rights $3,476 $823 ($661) $3,638
Valuation allowance - - - -
-------------------------------------------------
Mortgage servicing rights, net
of valuation allowance $3,476 $823 ($661) $3,638
=================================================
At December 31, 2005 and 2004, the Company serviced real estate mortgage loans
for others of $373 million and $368 million, respectively. At December 31, 2005
and 2004, the fair value of the Company's mortgage servicing rights assets was
$3,673,000 and $3,568,000, respectively. The fair value of mortgage servicing
rights was determined using a discount rate of 10%, prepayment speeds ranging
from 8% to 22%, depending on stratification of the specific servicing right, and
a weighted average default rate of 0%. Based on conditions at December 31, 2005,
estimated aggregate annual amortization expense related to mortgage servicing
rights is expected to be $633,000 in each of the next five years.
Off-Balance Sheet Credit Related Financial Instruments
In the ordinary course of business, the Company has entered into commitments to
extend credit, including commitments under credit card arrangements, commercial
letters of credit, and standby letters of credit. Such financial instruments are
recorded when they are funded.
-49-
Premises and Equipment
Land is carried at cost. Buildings and equipment, including those acquired under
capital lease, are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization expenses are computed using the
straight-line method over the estimated useful lives of the related assets or
lease terms. Asset lives range from 3-10 years for furniture and equipment and
15-40 years for land improvements and buildings.
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure are held for sale and
are initially recorded at fair value at the date of foreclosure, establishing a
new cost basis. Subsequent to foreclosure, management periodically performs
valuations and the assets are carried at the lower of carrying amount or fair
value less cost to sell. Revenue and expenses from operations and changes in the
valuation allowance are included in other noninterest expense.
Goodwill and Other Intangible Assets Goodwill represents the excess of costs
over fair value of assets of businesses acquired. Goodwill and other intangible
assets acquired in a purchase business combination and determined to have an
indefinite useful life are not amortized, but instead tested for impairment at
least annually. Intangible assets with estimable useful lives are amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment.
As of the date of adoption, the Company had identifiable intangible assets
consisting of core deposit premiums and minimum pension liability. Core deposit
premiums are amortized using an accelerated method over a period of ten years.
Intangible assets related to minimum pension liability are adjusted annually
based upon actuarial estimates.
The following table summarizes the Company's core deposit intangibles as of
December 31, 2005 and 2004.
December 31, December 31,
(Dollar in Thousands) 2004 Additions Reductions 2005
-------------------------------------------------
Core deposit intangibles $13,643 - - $13,643
Accumulated amortization (9,201) - ($1,381) (10,582)
-------------------------------------------------
Core deposit intangibles, net $4,442 - ($1,381) $3,061
=================================================
Core deposit intangibles are amortized over their expected useful lives. Such
lives are periodically reassessed to determine if any amortization period
adjustments are indicated. The following table summarizes the Company's
estimated core deposit intangible amortization for each of the five succeeding
years:
Estimated Core Deposit
Intangible Amortization
Years Ended (Dollar in thousands)
------------- -------------------------
2006 $1,395
2007 $490
2008 $523
2009 $328
2010 $260
Thereafter $65
The following table summarizes the Company's minimum pension liability
intangible as of December 31, 2005 and 2004.
December 31, December 31,
(Dollar in Thousands) 2004 Additions Reductions 2005
--------------------------------------------
Minimum pension liability intangible $966 $380 - $1,346
============================================
Intangible assets related to minimum pension liability are adjusted annually
based upon actuarial estimates.
The following table summarizes the Company's goodwill intangible as of December
31, 2005 and 2004.
December 31, December 31,
(Dollar in Thousands) 2004 Additions Reductions 2005
--------------------------------------------
Goodwill $15,519 - - $15,519
============================================
-50-
Impairment of Long-Lived Assets and Goodwill
Long-lived assets, such as premises and equipment, and purchased intangibles
subject to amortization, are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to estimated undiscounted future
cash flows expected to be generated by the asset. If the carrying amount of an
asset exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of would be separately presented
in the balance sheet and reported at the lower of the carrying amount or fair
value less costs to sell, and are no longer depreciated. The assets and
liabilities of a disposed group classified as held for sale would be presented
separately in the appropriate asset and liability sections of the balance sheet.
On December 31 of each year, goodwill is tested for impairment, and is tested
for impairment more frequently if events and circumstances indicate that the
asset might be impaired. An impairment loss is recognized to the extent that the
carrying amount exceeds the asset's fair value. This determination is made at
the reporting unit level and consists of two steps. First, the Company
determines the fair value of a reporting unit and compares it to its carrying
amount. Second, if the carrying amount of a reporting unit exceeds its fair
value, an impairment loss is recognized for any excess of the carrying amount of
the reporting unit's goodwill over the implied fair value of that goodwill. The
implied fair value of goodwill is determined by allocating the fair value of the
reporting unit in a manner similar to a purchase price allocation. The residual
fair value after this allocation is the implied fair value of the reporting unit
goodwill.
Income Taxes
The Company's accounting for income taxes is based on an asset and liability
approach. The Company recognizes the amount of taxes payable or refundable for
the current year, and deferred tax assets and liabilities for the future tax
consequences that have been recognized in its financial statements or tax
returns. The measurement of tax assets and liabilities is based on the
provisions of enacted tax laws.
Stock-Based Compensation
The Company uses the intrinsic value method to account for its stock option
plans (in accordance with the provisions of Accounting Principles Board Opinion
No. 25). Under this method, compensation expense is recognized for awards of
options to purchase shares of common stock to employees under compensatory plans
only if the fair market value of the stock at the option grant date (or other
measurement date, if later) is greater than the amount the employee must pay to
acquire the stock. Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation (SFAS 123) permits companies to continue
using the intrinsic value method or to adopt a fair value based method to
account for stock option plans. The fair value based method results in
recognizing as expense over the vesting period the fair value of all stock-based
awards on the date of grant. The Company has elected to continue to use the
intrinsic value method.
Had compensation cost for the Company's option plans been determined in
accordance with SFAS 123, the Company's net income and earnings per share would
have been reduced to the pro forma amounts indicated below:
(in thousands, except per share amounts) 2005 2004 2003
Net income As reported $23,671 $20,182 $16,888
Pro forma $23,267 $19,710 $16,622
Basic earnings per share As reported $1.51 $1.29 $1.11
Pro forma $1.48 $1.26 $1.09
Diluted earnings per share As reported $1.45 $1.24 $1.07
Pro forma $1.42 $1.21 $1.05
Stock-based employee compensation
cost, net of related tax effects,
included in net income As reported $0 $0 $0
Pro forma $404 $472 $266
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 2005, 2004, and 2003: risk-free interest rate of
3.90%, 3.39%, and 2.87%; expected dividend yield of 2.2%, 2.3%, and 3.3%;
expected life of 6.5 years, 6 years, and 6 years; expected volatility of 21%,
19%, and 27%, respectively. The weighted average grant date fair value of an
option to purchase one share of common stock granted in 2005, 2004, and 2003 was
$4.30, $3.15, and $4.29, respectively.
The Company adopted SFAS 123R on January 1, 2006 using the modified prospective
method that requires compensation expense be recorded for all unvested stock
options at January 1, 2006. The adoption of SFAS 123R impacted the Company's
consolidated results of operations and earnings per share similarly to the
current pro forma disclosures under SFAS 123.
-51-
Earnings Per Share
Basic earnings per share represents income available to common shareholders
divided by the weighted-average number of common shares outstanding during the
period. Diluted earnings per share reflects additional common shares that would
have been outstanding if dilutive potential common shares had been issued, as
well as any adjustments to income that would result from assumed issuance.
Potential common shares that may be issued by the Company relate solely from
outstanding stock options, and are determined using the treasury stock method.
Earnings per share have been computed based on the following:
Years ended December 31,
------------------------------
2005 2004 2003
------------------------------
(in thousands)
Net income $23,671 $20,182 $16,888
Average number of common shares outstanding 15,708 15,660 15,282
Effect of dilutive stock options 623 610 475
------------------------------
Average number of common shares outstanding
used to calculate diluted earnings per share 16,331 16,270 15,757
==============================
There were no options excluded from the computation of diluted earnings per
share for the years ended December 31, 2005, 2004, and 2003, respectively,
because the effect of these options was antidilutive.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income.
The components of other comprehensive income and related tax effects are as
follows:
Years Ended December 31,
-------------------------------------------
2005 2004 2003
-------------------------------------------
(in thousands)
Unrealized holding losses on available-for-sale securities ($5,757) ($3,263) ($990)
Tax effect 2,421 1,327 461
-------------------------------------------
Unrealized holding losses on available-for-sale securities, net of tax (3,336) (1,936) (529)
-------------------------------------------
Change in minimum pension liability (292) (385) 67
Tax effect 155 155 (27)
-------------------------------------------
Change in minimum pension liability, net of tax (137) (230) 40
-------------------------------------------
($3,473) ($2,166) ($489)
===========================================
The components of accumulated other comprehensive loss, included in
shareholders' equity, are as follows:
December 31,
---------------------------
2005 2004
---------------------------
(in thousands)
Net unrealized (loss) gain on available-for-sale securities ($4,750) $1,007
Tax effect 1,997 (424)
---------------------------
Unrealized holding (losses) gains on available-for-sale
securities, net of tax (2,753) 583
---------------------------
Minimum pension liability (1,851) (1,559)
Tax effect 779 624
---------------------------
Minimum pension liability, net of tax (1,072) (935)
---------------------------
Accumulated other comprehensive loss ($3,825) ($352)
===========================
-52-
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued FASB
Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based
Payment (SFAS 123R), which replaces SFAS No. 123, Accounting for Stock-Based
Compensation, (SFAS 123) and supersedes APB Opinion No. 25, Accounting for Stock
Issued to Employees. SFAS 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the financial
statements based on their fair values beginning with the first interim reporting
period of the Company's fiscal year beginning after June 15, 2005, with early
adoption encouraged. The pro forma disclosures previously permitted under SFAS
123 no longer will be an alternative to financial statement recognition. The
Company adopted SFAS 123R on January 1, 2006 using a modified version of
prospective application ("modified prospective application"). Under modified
prospective application, as it is applicable to the Company, SFAS 123R applies
to new grants and to grants modified, repurchased, or cancelled after January 1,
2006. Additionally, compensation cost for the portion of grants for which the
requisite service has not been rendered (generally referring to non-vested
grants) that are outstanding as of January 1, 2006 must be recognized as the
remaining requisite service is rendered during the period of and/or the periods
after the adoption of SFAS 123R. The attribution of compensation cost for those
earlier grants will be based on the same method and on the same grant-date fair
values previously determined for the pro forma disclosures required for
companies that did not adopt the fair value accounting method for stock-based
employee compensation.
Based on the stock-based compensation awards outstanding as of December 31, 2005
for which the requisite service was not fully rendered prior to January 1, 2006,
the Company expects to recognize total pre-tax compensation cost of
approximately $869,000 related to outstanding stock option grants, of which
approximately $139,000 is expected to be recognized in the first quarter of
2006, in accordance with the accounting requirements of SFAS 123R. Future levels
of compensation cost recognized related to stock-based compensation awards
(including the aforementioned expected costs during the period of adoption) may
be impacted by new awards and/or modifications, repurchases and cancellations of
existing awards before and after the adoption SFAS 123R.
In May 2005, the FASB issued FASB Statement of Financial Accounting Standards
No. 154, Accounting Changes and Error Corrections, (SFAS 154) a Replacement of
APB Opinion No. 20 and FASB Statement No. 3. SFAS 154 establishes, unless
impracticable, retrospective application as the required method for reporting a
change in accounting principle in the absence of explicit transition
requirements specific to a newly adopted accounting principle. Previously, most
changes in accounting principle were recognized by including the cumulative
effect of changing to the new accounting principle in net income of the period
of the change. Under SFAS 154, retrospective application requires (i) the
cumulative effect of the change to the new accounting principle on periods prior
to those presented to be reflected in the carrying amounts of assets and
liabilities as of the beginning of the first period presented, (ii) an
offsetting adjustment, if any, to be made to the opening balance of retained
earnings (or other appropriate components of equity) for that period, and (iii)
financial statements for each individual prior period presented to be adjusted
to reflect the direct period-specific effects of applying the new accounting
principle. Special retroactive application rules apply in situations where it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. Indirect effects of a change in accounting principle are
required to be reported in the period in which the accounting change is made.
SFAS 154 carries forward the guidance in APB Opinion 20 "Accounting Changes,"
requiring justification of a change in accounting principle on the basis of
preferability. SFAS 154 also carries forward without change the guidance
contained in APB Opinion 20, for reporting the correction of an error in
previously issued financial statements and for a change in accounting estimate.
SFAS 154 is effective for accounting changes and corrections of errors made in
fiscal years beginning after December 15, 2005.
Reclassifications
Certain amounts previously reported in the 2004 and 2003 financial statements
have been reclassified to conform to the 2005 presentation. These
reclassifications did not affect previously reported net income or total
shareholders' equity.
-53-
Note 2 - Restricted Cash Balances
Reserves (in the form of deposits with the Federal Reserve Bank) of $10,795,000
and $8,477,000 were maintained to satisfy Federal regulatory requirements at
December 31, 2005 and 2004. These reserves are included in cash and due from
banks in the accompanying balance sheets.
Note 3 - Investment Securities
The amortized cost and estimated fair values of investments in debt and equity
securities are summarized in the following tables:
December 31, 2005
------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------------------------------------------------------
Securities Available-for-Sale (in thousands)
Obligations of U.S. government corporations and agencies $214,781 $495 $(6,443) $208,833
Obligations of states and political subdivision 36,484 1,283 (18) 37,749
Corporate debt securities 13,763 116 (183) 13,696
------------------------------------------------------------
Total securities available-for-sale $265,028 $1,894 $(6,644) $260,278
============================================================
December 31, 2004
------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------------------------------------------------------
Securities Available-for-Sale (in thousands)
Obligations of U.S. government corporations and agencies $238,865 $1,566 $(1,536) $238,895
Obligations of states and political subdivisions 32,380 2,527 -- 34,907
Corporate debt securities 13,761 108 (1,658) 12,211
------------------------------------------------------------
Total securities available-for-sale $285,006 $4,201 $(3,194) $286,013
============================================================
The amortized cost and estimated fair value of debt securities at December 31,
2005 by contractual maturity are shown below. Actual maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. At December 31, 2005,
obligations of U.S. government corporations and agencies with a cost basis
totaling $214,781,000 consist almost entirely of mortgage-backed securities
whose contractual maturity, or principal repayment, will follow the repayment of
the underlying mortgages. For purposes of the following table, the entire
outstanding balance of these mortgage-backed securities issued by U.S.
government corporations and agencies is categorized based on final maturity
date. At December 31, 2005, the Company estimates the average remaining life of
these mortgage-backed securities issued by U.S. government corporations and
agencies to be approximately 3.0 years. Average remaining life is defined as the
time span after which the principal balance has been reduced by half.
Estimated
Amortized Fair
Cost Value
---------------------------------
(in thousands)
Investment Securities
Due in one year $2,428 $2,479
Due after one year through five years 9,521 9,566
Due after five years through ten years 196,800 191,104
Due after ten years 56,279 57,129
---------------------------------
Totals $265,028 $260,278
=================================
-54-
Proceeds from sales of investment securities were as follows:
Gross Gross Gross
For the Year Proceeds Gains Losses
---------------------------------------------------------------------
(in thousands)
2005 $ -- $ -- $--
2004 -- -- --
2003 $22,320 $197 $--
Investment securities with an aggregate carrying value of $171,921,000 and
$184,287,000 at December 31, 2005 and 2004, respectively, were pledged as
collateral for specific borrowings, lines of credit and local agency deposits.
Gross unrealized losses on investment securities and the fair value of the
related securities, aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss position, at
December 31, 2005, were as follows:
Less than 12 months 12 months or more Total
----------------------- --------------------- --------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
-------------------------------------------------------------------
Securities Available-for-Sale: (in thousands)
Obligations of U.S. government
corporations and agencies $71,953 ($1,828) $114,511 ($4,615) $186,464 ($6,443)
Obligations of states and
political subdivisions 2,130 (18) -- -- 2,130 (18)
Corporate debt securities -- -- 6,746 (183) 6,746 (183)
-------------------------------------------------------------------
Total securities available-for-sale $74,083 ($1,846) $121,257 ($4,798) $195,340 ($6,644)
===================================================================
Obligations of U.S. government corporations and agencies: The unrealized losses
on investments in obligations of U.S. government corporations and agencies were
caused by interest rate increases. The contractual cash flows of these
securities are guaranteed by U.S. Government Sponsored Entities (principally
Fannie Mae and Freddie Mac). It is expected that the securities would not be
settled at a price less than the amortized cost of the investment. Because the
decline in fair value is attributable to changes in interest rates and not
credit quality, and because the Company has the ability and intent to hold these
investments until a market price recovery or maturity, these investments are not
considered other-than-temporarily impaired. At December 31, 2005, 56 debt
securities representing obligations of U.S. government corporations and agencies
had unrealized losses with aggregate depreciation of 3.3% from the Company's
amortized cost basis.
Obligations of states and political subdivisions: The unrealized losses on
investments in obligations of states and political subdivisions were caused by
interest rate increases. It is expected that the securities would not be settled
at a price less than the amortized cost of the investment. Because the decline
in fair value is attributable to changes in interest rates and not credit
quality, and because the Company has the ability and intent to hold these
investments until a market price recovery or maturity, these investments are not
considered other-than-temporarily impaired. At December 31, 2005, 4 debt
securities representing obligations of states and political subdivisions had
unrealized losses with aggregate depreciation of 0.8% from the Company's
amortized cost basis.
Corporate debt securities: The investments in corporate debt securities with
unrealized losses are comprised of variable-rate trust preferred bonds issued by
bank holding companies that mature in 2027 and 2028. The unrealized losses on
corporate debt securities were caused by interest rate increases. One of the
bank holding companies representing $4,849,000 of the $6,746,000 of corporate
bonds with unrealized losses are rated investment grade by major outside credit
rating agencies, and their credit ratings have not diminished since the bonds
were purchased by the Company. The two bank holding companies representing the
remaining $1,897,000 of bonds are not rated by credit rating agencies. At least
annually, the Company performs its own analysis of the credit worthiness of each
of the corporate debt issuing companies in question. Nothing in those analyses
indicates that the unrealized losses are due to anything other than increases in
interest rates. Because the decline in fair value is attributable to changes in
interest rates and not credit quality, and because the Company has the intent
and ability to hold these investments until a market price recovery or maturity,
these investments are not considered other-than-temporarily impaired. At
December 31, 2005, 3 corporate debt securities had unrealized losses with
aggregate depreciation of 2.6% from the Company's amortized cost basis.
-55-
Note 4 - Loans
A summary of the balances of loans follows:
December 31,
---------------------------
2005 2004
---------------------------
(in thousands)
Mortgage loans on real estate:
Residential 1-4 family $98,960 $94,296
Commercial 527,937 453,157
---------------------------
Total mortgage loan on real estate 626,897 547,453
---------------------------
Consumer:
Home equity lines of credit 283,574 223,345
Home equity loans 85,695 86,092
Auto Indirect 119,640 80,668
Other 14,246 15,658
---------------------------
Total consumer loans 503,155 405,763
---------------------------
Commercial 143,267 140,446
---------------------------
Construction:
Residential 1-4 family 31,356 30,653
Other construction 79,641 48,073
---------------------------
Total construction 110,997 78,726
---------------------------
Total loans 1,384,316 1,172,388
---------------------------
Less: Allowance for loan losses (16,226) (14,525)
Net deferred loan costs 719 579
---------------------------
Total loans, net $1,368,809 $1,158,442
===========================
Loans with an aggregate carrying value of $434,985,000 and $70,930,000 at
December 31, 2005 and 2004, respectively, were pledged as collateral for
specific borrowings and lines of credit.
The following tables summarize the activity in the allowance for loan losses,
reserve for unfunded commitments, and allowance for losses (which is comprised
of the allowance for loan losses and the reserve for unfunded commitments) for
the periods indicated (dollars in thousands):
Years Ended December 31,
------------------------------------
2005 2004 2003
------------------------------------
Allowance for loan losses:
Balance at beginning of year $14,525 $12,890 $13,686
Addition through merger - - 928
Provision for loan losses 2,169 2,901 1,058
Loans charged off (1,679) (1,632) (3,753)
Recoveries of previously
charged-off loans 1,211 366 971
------------------------------------
Net charge-offs (468) (1,266) (2,782)
------------------------------------
Balance at end of year $16,226 $14,525 $12,890
====================================
Reserve for unfunded commitments:
Balance at beginning of year $1,532 $883 $691
Provision for losses -
Unfunded commitments 281 649 192
------------------------------------
Balance at end of year $1,813 $1,532 $883
====================================
Balance at end of year:
Allowance for loan losses $16,226 $14,525 $12,890
Reserve for unfunded commitments 1,813 1,532 883
------------------------------------
Allowance for losses $18,039 $16,057 $13,773
====================================
As a percentage of total loans:
Allowance for loan losses 1.17% 1.24% 1.31%
Reserve for unfunded commitments 0.13% 0.13% 0.09%
------------------------------------
Allowance for losses 1.30% 1.37% 1.40%
====================================
-56-
Loans classified as nonaccrual, net of guarantees of the U.S. government,
including its agencies and its government-sponsored agencies, amounted to
approximately $2,961,000, $4,845,000 and $4,360,000 at December 31, 2005, 2004,
and 2003, respectively. These nonaccrual loans were classified as impaired and
are included in the recorded balance in impaired loans for the respective years
shown below. If interest on those loans had been accrued, such income would have
been approximately $957,000, $1,231,000 and $1,071,000 in 2005, 2004 and 2003,
respectively. Loans 90 days past due and still accruing, net of guarantees of
the U.S. government, including its agencies and its government-sponsored
agencies, amounted to approximately $0, $61,000 and $34,000 at December 31,
2005, 2004, and 2003, respectively.
As of December 31, the Company's recorded investment in impaired loans, net of
guarantees of the U.S. government, and the related valuation allowance were as
follows (in thousands):
2005
-------------------------------------
Recorded Valuation
Investment Allowance
-------------------------------------
Impaired loans -
Valuation allowance required $2,961 $717
No valuation allowance required -- --
-------------------------------------
Total impaired loans $2,961 $717
=====================================
2004
-------------------------------------
Recorded Valuation
Investment Allowance
-------------------------------------
Impaired loans -
Valuation allowance required $4,845 $543
No valuation allowance required -- --
-------------------------------------
Total impaired loans $4,845 $543
=====================================
This valuation allowance is included in the allowance for loan losses shown
above for the respective year. The average recorded investment in impaired loans
was $3,903,000, $4,603,000 and $6,270,000 for the years ended December 31, 2005,
2004 and 2003, respectively. The Company recognized interest income on impaired
loans of $736,000, $965,000 and $372,000 for the years ended December 31, 2005,
2004 and 2003, respectively.
Note 5 - Premises and Equipment
Premises and equipment were comprised of:
December 31,
---------------------------------
2005 2004
---------------------------------
(in thousands)
Premises $17,349 $15,524
Furniture and equipment 21,234 20,143
---------------------------------
38,583 35,667
Less: Accumulated depreciation (21,084) (19,646)
---------------------------------
17,499 16,021
Land and land improvements 3,792 3,832
---------------------------------
$21,291 $19,853
=================================
Depreciation of premises and equipment amounted to $3,210,000, $2,899,000 and
$2,701,000 in 2005, 2004, and 2003, respectively.
The Company leases one building for which the lease is accounted for as a
capital lease. The cost basis of the building under this capital lease is
$831,000 with accumulated depreciation of $717,000 and $690,000 at December 31,
2005 and 2004, respectively. The cost basis and accumulated depreciation of this
building under capital lease are recorded in the balance of premises and
equipment. Depreciation related to this building under capital lease is included
in the depreciation of premises and equipment noted above.
-57-
At December 31, 2005, future minimum commitments under non-cancelable capital
and operating leases with initial or remaining terms of one year or more are as
follows:
Capital Operating
Leases Leases
----------------------------------
(in thousands)
2006 $93 $1,522
2007 94 1,345
2008 95 1,255
2009 96 1,080
2010 - 808
Thereafter - 1,085
----------------------------------
Future minimum lease payments 378 $7,095
Less amount representing interest 85
-----------
Present value of future lease payments $293
===========
Rent expense under operating leases was $1,855,000 in 2005, $1,644,000 in 2004,
and $1,442,000 in 2003.
Note 6 - Deposits
A summary of the balances of deposits follows:
December 31,
---------------------------
2005 2004
---------------------------
(in thousands)
Noninterest-bearing demand $368,412 $311,275
Interest-bearing demand 244,193 230,763
Savings 438,177 474,414
Time certificates, $100,000 and over 195,779 129,406
Other time certificates 250,236 202,975
---------------------------
Total deposits $1,496,797 $1,348,833
===========================
Certificate of deposit balances of $20,000,000 from the State of California were
included in time certificates, $100,000 and over, at December 31, 2005 and 2004.
The Bank participates in a deposit program offered by the State of California
whereby the State may make deposits at the Bank's request subject to collateral
and credit worthiness constraints. The negotiated rates on these State deposits
are generally favorable to other wholesale funding sources available to the
Bank.
Overdrawn deposit balances of $1,201,000 and $1,033,000 were classified as
consumer loans at December 31, 2005 and 2004, respectively.
At December 31, 2005, the scheduled maturities of time deposits were as follows
(in thousands):
Scheduled
Maturities
--------------
2006 $348,811
2007 70,105
2008 13,408
2009 9,987
2010 3,585
Thereafter 119
--------------
Total $446,015
==============
-58-
Note 7 - Other Borrowings
A summary of the balances of other borrowings follows:
December 31,
2005 2004
-------------------------
(in thousands)
FHLB loan, fixed rate of 5.41% payable on April 7, 2008, callable
in its entirety by FHLB on a quarterly basis beginning April 7, 2003 $20,000 $20,000
FHLB loan, fixed rate of 5.35% payable on December 9, 2008 1,500 1,500
FHLB loan, fixed rate of 5.77% payable on February 23, 2009 1,000 1,000
Capital lease obligation on premises, effective rate of 13% payable
monthly in varying amounts through December 1, 2009 293 344
Other collateralized borrowings, fixed rate of 1.44% payable on January 3, 2006 8,597 5,308
-------------------------
Total other borrowings $31,390 $28,152
=========================
The Company maintains a collateralized line of credit with the Federal Home Loan
Bank of San Francisco. Based on the FHLB stock requirements at December 31,
2005, this line provided for maximum borrowings of $398,971,000 of which
$119,300,000 was outstanding, leaving $279,671,000 available. The total of
borrowings from the FHLB at December 31, 2005 consists of the $22,500,000
described in the table above, and $96,800,000 of borrowings that mature
overnight and are classified as federal funds purchased.
At December 31, 2005, the Company had $8,597,000 of other collateralized
borrowings. Other collateralized borrowings are generally overnight maturity
borrowings from non-financial institutions that are collateralized by securities
owned by the Company.
The Company maintains a collateralized line of credit with the Federal Reserve
Bank of San Francisco. Based on the collateral pledged at December 31, 2005,
this line provided for maximum borrowings of $12,709,000 of which $0 was
outstanding, leaving $12,709,000 available.
The Company has available unused correspondent banking lines of credit from
commercial banks totaling $50,000,000 for federal funds transactions at December
31, 2005.
-59-
Note 8 - Junior Subordinated Debt
On July 31, 2003, the Company formed a subsidiary business trust, TriCo Capital
Trust I, to issue trust preferred securities. Concurrently with the issuance of
the trust preferred securities, the trust issued 619 shares of common stock to
the Company for $1,000 per share or an aggregate of $619,000. In addition, the
Company issued a Junior Subordinated Debenture to the Trust in the amount of
$20,619,000. The terms of the Junior Subordinated Debenture are materially
consistent with the terms of the trust preferred securities issued by TriCo
Capital Trust I. Also on July 31, 2003, TriCo Capital Trust I completed an
offering of 20,000 shares of cumulative trust preferred securities for cash in
an aggregate amount of $20,000,000. The trust preferred securities are
mandatorily redeemable upon maturity on October 7, 2033 with an interest rate
that resets quarterly at three-month LIBOR plus 3.05%, or 4.16% for the first
quarterly interest period. TriCo Capital Trust I has the right to redeem the
trust preferred securities on or after October 7, 2008. The trust preferred
securities were issued through an underwriting syndicate to which the Company
paid underwriting fees of $7.50 per trust preferred security or an aggregate of
$150,000. The net proceeds of $19,850,000 were used to finance the opening of
new branches, improve bank services and technology, repurchase shares of the
Company's common stock under its repurchase plan and increase the Company's
capital. The trust preferred securities have not been and will not be registered
under the Securities Act of 1933, as amended, or applicable state securities
laws and were sold pursuant to an exemption from registration under the
Securities Act of 1933. The trust preferred securities may not be offered or
sold in the United States absent registration or an applicable exemption from
the registration requirements of the Securities Act of 1933, as amended, and
applicable state securities laws.
As a result of the adoption of FIN 46R, the Company deconsolidated TriCo Capital
Trust I as of and for year ended December 31, 2003. The $20,619,000 of junior
subordinated debentures issued by TriCo Capital Trust I were reflected as junior
subordinated debt in the consolidated balance sheets at December 31, 2005 and
2004. The common stock issued by TriCo Capital Trust I was recorded in other
assets in the consolidated balance sheet at December 31, 2005 and 2004.
Prior to December 31, 2003, TriCo Capital Trust I was a consolidated subsidiary
and was included in liabilities in the consolidated balance sheets, as "Trust
preferred securities." The common securities and debentures, along with the
related income effects were eliminated in the consolidated financial statements.
On June 22, 2004, the Company formed a second subsidiary business trust, TriCo
Capital Trust II, to issue trust preferred securities. Concurrently with the
issuance of the trust preferred securities, the trust issued 619 shares of
common stock to the Company for $1,000 per share or an aggregate of $619,000. In
addition, the Company issued a Junior Subordinated Debenture to the Trust in the
amount of $20,619,000. The terms of the Junior Subordinated Debenture are
materially consistent with the terms of the trust preferred securities issued by
TriCo Capital Trust II. Also on June 22, 2004, TriCo Capital Trust II completed
an offering of 20,000 shares of cumulative trust preferred securities for cash
in an aggregate amount of $20,000,000. The trust preferred securities are
mandatorily redeemable upon maturity on July 23, 2034 with an interest rate that
resets quarterly at three-month LIBOR plus 2.55%, or 4.10% for the first
quarterly interest period. TriCo Capital Trust II has the right to redeem the
trust preferred securities on or after July 23, 2009. The trust preferred
securities were issued through an underwriting syndicate to which the Company
paid underwriting fees of $2.50 per trust preferred security or an aggregate of
$50,000. The net proceeds of $19,950,000 were used to finance the opening of new
branches, improve bank services and technology, repurchase shares of the
Company's common stock under its repurchase plan and increase the Company's
capital. The trust preferred securities have not been and will not be registered
under the Securities Act of 1933, as amended, or applicable state securities
laws and were sold pursuant to an exemption from registration under the
Securities Act of 1933. The trust preferred securities may not be offered or
sold in the United States absent registration or an applicable exemption from
the registration requirements of the Securities Act of 1933, as amended, and
applicable state securities laws.
The $20,619,000 of junior subordinated debentures issued by TriCo Capital Trust
II were reflected as junior subordinated debt in the consolidated balance sheets
at December 31, 2005 and 2004. The common stock issued by TriCo Capital Trust II
was recorded in other assets in the consolidated balance sheets at December 31,
2005 and 2004.
The debentures issued by TriCo Capital Trust I and TriCo Capital Trust II, less
the common securities of TriCo Capital Trust I and TriCo Capital Trust II,
continue to qualify as Tier 1 or Tier 2 capital under interim guidance issued by
the Board of Governors of the Federal Reserve System (Federal Reserve Board).
Note 9 - Commitments and Contingencies (See also Notes 5 and 16)
The Company has entered into employment agreements or change of control
agreements with certain officers of the Company providing severance payments to
the officers in the event of a change in control of the Company and termination
for other than cause.
The Company is a defendant in legal actions arising from normal business
activities. Management believes, after consultation with legal counsel, that
these actions are without merit or that the ultimate liability, if any,
resulting from them will not materially affect the Company's consolidated
financial position or results from operations.
-60-
Note 10 - Shareholders' Equity
Stock Split
On March 11, 2004, the Board of Directors of TriCo Bancshares approved a
two-for-one stock split of its common stock. The stock split was effected in the
form of a stock dividend that entitled each shareholder of record at the close
of business on April 9, 2004 to receive one additional share for every share of
TriCo common stock held on that date. Shares resulting from the split were
distributed on April 30, 2004.
Dividends Paid
The Bank paid to the Company cash dividends in the aggregate amounts of
$11,190,000, $3,075,000 and $2,810,000 in 2005, 2004 and 2003, respectively. The
Bank is regulated by the Federal Deposit Insurance Corporation (FDIC) and the
State of California Department of Financial Institutions. California banking
laws limit the Bank's ability to pay dividends to the lesser of (1) retained
earnings or (2) net income for the last three fiscal years, less cash
distributions paid during such period. Under this regulation, at December 31,
2005, the Bank may pay dividends of $47,054,000.
Shareholders' Rights Plan
On June 25, 2001, the Company announced that its Board of Directors adopted and
entered into a Shareholder Rights Plan designed to protect and maximize
shareholder value and to assist the Board of Directors in ensuring fair and
equitable benefit to all shareholders in the event of a hostile bid to acquire
the Company.
The Company adopted this Rights Plan to protect stockholders from coercive or
otherwise unfair takeover tactics. In general terms, the Rights Plan imposes a
significant penalty upon any person or group that acquires 15% or more of the
Company's outstanding common stock without approval of the Company's Board of
Directors. The Rights Plan was not adopted in response to any known attempt to
acquire control of the Company.
Under the Rights Plan, a dividend of one Preferred Stock Purchase Right was
declared for each common share held of record as of the close of business on
July 10, 2001. No separate certificates evidencing the Rights will be issued
unless and until they become exercisable.
The Rights generally will not become exercisable unless an acquiring entity
accumulates or initiates a tender offer to purchase 15% or more of the Company's
common stock. In that event, each Right will entitle the holder, other than the
unapproved acquirer and its affiliates, to purchase either the Company's common
stock or shares in an acquiring entity at one-half of market value.
The Right's initial exercise price, which is subject to adjustment, is $49.00
per Right. The Company's Board of Directors generally will be entitled to redeem
the Rights at a redemption price of $.01 per Right until an acquiring entity
acquires a 15% position. The Rights expire on July 10, 2011.
Stock Repurchase Plan
On March 11, 2004, the Board of Directors of TriCo Bancshares approved an
increase in the maximum number of shares to be repurchased under the Company's
stock repurchase plan originally announced on July 31, 2003 from 250,000 to
500,000 effective on April 9, 2004, solely to conform with the two-for-one stock
split noted above. The 250,000 shares originally authorized for repurchase under
this plan represented approximately 3.2% of the Company's approximately
7,852,000 common shares outstanding as of July 31, 2003. This plan has no stated
expiration date for the repurchases, which may occur from time to time as market
conditions allow. As of December 31, 2005, the Company repurchased 374,371
shares under this plan as adjusted for the 2-for-1 stock split paid on April 30,
2004, which leaves 125,629 shares available for repurchase under the plan.
-61-
Note 11 - Stock Options
In May 2001, the Company adopted the TriCo Bancshares 2001 Stock Option Plan
(2001 Plan) covering officers, employees, directors of, and consultants to the
Company. Under the 2001 Plan, the option price cannot be less than the fair
market value of the Common Stock at the date of grant except in the case of
substitute options. Options for the 2001 Plan expire on the tenth anniversary of
the grant date. Vesting schedules under the 2001 Plan are determined
individually for each grant.
In May 1995, the Company adopted the TriCo Bancshares 1995 Incentive Stock
Option Plan (1995 Plan) covering key employees. Under the 1995 Plan, the option
price cannot be less than the fair market value of the Common Stock at the date
of grant. Options for the 1995 Plan expire on the tenth anniversary of the grant
date. Vesting schedules under the 1995 Plan are determined individually for each
grant.
As of December 31, 2005, options for the purchase of 502,436 and 0 common shares
remained available for grant under the 2001 and 1995 Plans, respectively. Stock
option activity is summarized in the following table:
Weighted Weighted
Average Average
Number Option Price Exercise Fair Value
Of Shares Per Share Price of Grants
Outstanding at
December 31, 2002 1,254,800 $2.62 to $12.38 $ 7.96
Options granted 553,174 $1.59 to $13.33 $ 9.97 $4.29
Options exercised (154,294) $1.59 to $ 9.13 $ 4.65
Options forfeited (4,984) $5.37 to $12.13 $10.79
Outstanding at
December 31, 2003 1,648,696 $1.59 to $13.33 $8.94
Options granted 235,520 $17.38 to $17.40 $17.38 $3.15
Options exercised (222,669) $1.59 to $13.33 $6.06
Outstanding at
December 31, 2004 1,661,547 $2.62 to $17.40 $10.52
Options granted 112,000 $19.35 to $20.58 $19.87 $4.30
Options exercised (136,289) $2.62 to $17.40 $7.14
Options forfeited (496) $5.65 to $5.65 $5.65
Outstanding at
December 31, 2005 1,636,762 $5.65 to $20.58 $11.44
The following table shows the number, weighted-average exercise price, and the
weighted average remaining contractual life of options outstanding, and the
number and weighted-average exercise price of options exercisable as of December
31, 2005 by range of exercise price:
Outstanding Options Exercisable Options
------------------------------------------------ -----------------------------
Weighted-Average
Range of Weighted-Average Remaining Weighted-Average
Exercise Price Number Exercise Price Contractual Life Number Exercise Price
$4-$6 1,442 $5.82 4.07 1,442 $5.82
$6-$8 33,000 $6.21 0.53 33,000 $6.21
$8-$10 831,800 $8.26 4.83 831,800 $8.26
$10-$12 40,000 $11.72 6.94 24,000 $11.72
$12-$14 387,000 $12.72 7.41 238,000 $12.67
$16-$18 231,520 $17.38 8.17 116,608 $17.38
$18-$20 65,000 $19.35 9.15 13,000 $19.35
$20-$22 47,000 $20.58 9.39 1,000 $20.58
Of the stock options outstanding as of December 31, 2005, 2004, and 2003,
options on shares totaling 1,258,850, 1,098,151, and 985,136, respectively, were
exercisable at weighted average prices of $10.07, $9.06, and $7.75,
respectively.
The Company accounts for these plans under APB Opinion No. 25, under which no
compensation cost has been recognized.
-62-
Note 12 - Other Noninterest Income and Expenses
The components of other noninterest income were as follows:
Years Ended December 31,
2005 2004 2003
------------------------------
(in thousands)
Sale of customer checks $218 $227 $229
Gain on sale of foreclosed assets -- 566 113
Lease brokerage income 301 227 --
Commission rebates 498 206 146
Other 293 392 453
------------------------------
Total other noninterest income $1,310 $1,618 $941
==============================
Mortgage loan servicing fees, net of amortization of mortgage loan servicing
rights, totaling $267,000, $189,000, and ($515,000) were recorded in service
charges and fees noninterest income for the years ended December 31, 2005, 2004,
and 2003, respectively.
The components of other noninterest expense were as follows:
Years Ended December 31,
2005 2004 2003
------------------------------
(in thousands)
Equipment and data processing $5,783 $5,315 $4,947
Occupancy 4,041 3,926 3,493
Advertising 1,732 1,026 1,062
ATM network charges 1,644 1,322 1,043
Telecommunications 1,521 1,773 1,539
Intangible amortization 1,381 1,358 1,207
Professional fees 1,247 2,481 2,315
Courier service 1,151 1,057 1,026
Postage 889 864 855
Assessments 312 297 268
Change in reserve for unfunded commitments 281 649 192
Operational losses 225 428 657
Net foreclosed assets expense - 11 124
Other 7,977 7,130 7,277
------------------------------
Total other noninterest expense $28,184 $27,637 $26,005
==============================
-63-
Note 13 - Income Taxes
The components of consolidated income tax expense are as follows:
------------------------------
2005 2004 2003
------------------------------
(in thousands)
Current tax expense
Federal $12,937 $10,234 $7,686
State 4,453 3,348 2,720
------------------------------
17,390 13,582 10,406
------------------------------
Deferred tax benefit
Federal (1,763) (790) (198)
State (460) (340) (84)
------------------------------
(2,223) (1,130) (282)
------------------------------
Total tax expense $15,167 $12,452 $10,124
==============================
A deferred tax asset or liability is recognized for the tax consequences of
temporary differences in the recognition of revenue and expense for financial
and tax reporting purposes. The net change during the year in the deferred tax
asset or liability results in a deferred tax expense or benefit.
Taxes recorded directly to shareholders' equity are not included in the
preceding table. These taxes (benefits) relating to changes in minimum pension
liability amounting to ($155,000) in 2005, ($155,000) in 2004, and $27,000 in
2003, unrealized gains and losses on available-for-sale investment securities
amounting to ($2,421,000) in 2005, ($1,327,000) in 2004, and ($461,000) in 2003,
and benefits related to employee stock options of ($425,000) in 2005, ($330,000)
in 2004, and ($440,000) in 2003 were recorded directly to shareholders' equity.
The temporary differences, tax effected, which give rise to the Company's net
deferred tax asset recorded in other assets are as follows as of December 31 for
the years indicated:
2005 2004
--------------------------
Deferred tax assets: (in thousands)
Allowance for losses $7,538 $6,670
Deferred compensation 3,060 2,653
Accrued pension liability 2,330 2,012
Unrealized loss on securities 1,997 -
State taxes 1,474 1,234
Intangible amortization 1,238 1,152
Additional minimum pension liability 778 624
Nonaccrual interest 402 518
OREO write downs 76 76
Other - 8
--------------------------
Total deferred tax assets 18,893 14,947
==========================
Deferred tax liabilities:
Depreciation (1,205) (1,637)
Core deposit premium (904) (1,102)
Securities income (789) (660)
Merger related fixed asset valuations (379) (379)
Securities accretion (179) (143)
Capital leases (75) (85)
Unrealized gain on securities - (424)
Other, net (218) (171)
--------------------------
Total deferred tax liability (3,749) (4,601))
--------------------------
Net deferred tax asset $15,144 $10,346
==========================
The Company believes that a valuation allowance is not needed to reduce the
deferred tax assets as it is more likely than not that the results of future
operations will generate sufficient taxable income to realize the deferred tax
assets.
-64-
The provisions for income taxes applicable to income before taxes for the years
ended December 31, 2005, 2004 and 2003 differ from amounts computed by applying
the statutory Federal income tax rates to income before taxes. The effective tax
rate and the statutory federal income tax rate are reconciled as follows:
Years Ended December 31,
-----------------------------
2005 2004 2003
-----------------------------
Federal statutory income tax rate 35.0% 35.0% 35.0%
State income taxes, net of federal tax benefit 6.7 6.3 6.3
Tax-exempt interest on municipal obligations (1.5) (1.8) (2.4)
Increase in cash value of insurance policies (1.4) (1.6) (1.7)
Other 0.3 0.2 0.3
-----------------------------
Effective Tax Rate 39.1% 38.2% 37.5%
=============================
Note 14 - Retirement Plans
401(k) Plan
The Company sponsors a 401(k) Plan whereby substantially all employees age 21
and over with 90 days of service may participate. Participants may contribute a
portion of their compensation subject to certain limits based on federal tax
laws. The Company does not contribute to the 401(k) Plan. The Company did not
incur any expenses attributable to the 401(k) Plan during 2005, 2004, and 2003.
Employee Stock Ownership Plan
Substantially all employees with at least one year of service are covered by a
discretionary employee stock ownership plan (ESOP). Contributions are made to
the plan at the discretion of the Board of Directors. Contributions to the plan
totaling $1,279,000 in 2005, $1,447,000 in 2004, and $975,000 in 2003 are
included in salary expense. Company shares owned by the ESOP are paid dividends
and included in the calculation of earnings per share exactly as other common
shares outstanding.
Deferred Compensation Plans
The Company has deferred compensation plans for directors and key executives,
which allow directors and key executives designated by the Board of Directors of
the Company to defer a portion of their compensation. The Company has purchased
insurance on the lives of the participants and intends to hold these policies
until death as a cost recovery of the Company's deferred compensation
obligations of $7,278,000, and $6,309,000 at December 31, 2005 and 2004,
respectively. Earnings credits on deferred balances totaling $599,000 in 2005,
$591,000 in 2004, and $465,000 in 2003 are included in noninterest expense.
Supplemental Retirement Plans
The Company has supplemental retirement plans for directors and key executives.
These plans are non-qualified defined benefit plans and are unsecured and
unfunded. The Company has purchased insurance on the lives of the participants
and intends to hold these policies until death as a cost recovery of the
Company's retirement obligations.
The cash values of the insurance policies purchased to fund the deferred
compensation obligations and the retirement obligations were $41,768,000 and
$40,479,000 at December 31, 2005 and 2004, respectively.
The Company recorded in other liabilities an additional minimum pension
liability of $3,197,000 and $2,525,000 related to the supplemental retirement
plans as of December 31, 2005 and 2004, respectively. These amounts represent
the amount by which the accumulated benefit obligations for these retirement
plans exceeded the fair value of plan assets plus amounts previously accrued
related to the plans. These additional liabilities have been offset by an
intangible asset to the extent of previously unrecognized net transitional
obligation and unrecognized prior service costs of each plan. The amount in
excess of previously unrecognized prior service cost and unrecognized net
transitional obligation is recorded as a reduction of shareholders' equity in
the amount of $1,072,000 and $935,000, representing the after-tax impact, at
December 31, 2005 and 2004, respectively. The accumulated benefit obligation is
recorded in other liabilities.
-65-
Information pertaining to the activity in the supplemental retirement plans,
using a measurement date of December 31, is as follows:
December 31,
2005 2004
--------------------
(in thousands)
Change in benefit obligation:
Benefit obligation at beginning of year (8,771) ($6,846)
Service cost (417) (326)
Interest cost (533) (449)
Amendments (7) (1,640)
Actuarial loss (654) (0)
Benefits paid 517 490
--------------------
Benefit obligation at end of year ($9,865) ($8,771)
====================
Change in plan assets:
Fair value of plan assets at beginning of year $ -- $ --
--------------------
Fair value of plan assets at end of year $ -- $ --
====================
Funded status ($9,865) ($8,771)
Unrecognized net obligation existing at January 1, 1986 27 35
Unrecognized net actuarial loss 2,790 2,231
Unrecognized prior service cost 1,507 1,720
Intangible asset (1,346) (966)
Accumulated other comprehensive income (1,851) (1,559)
--------------------
Accrued benefit cost ($8,738) ($7,310)
====================
Accumulated benefit obligation ($8,738) ($7,310)
The following table sets forth the net periodic benefit cost recognized for the
supplemental retirement plans:
Years Ended December 31,
2005 2004 2003
----------------------------
(in thousands)
Net pension cost included the following components:
Service cost-benefits earned during the period $417 $326 $125
Interest cost on projected benefit obligation 533 449 418
Amortization of net obligation at transition 6 10 35
Amortization of prior service cost 224 160 81
Recognized net actuarial loss 94 81 153
----------------------------
Net periodic pension cost $1,273 $1,026 $812
============================
The following table sets forth assumptions used in accounting for the plans:
Years Ended December 31,
2005 2004 2003
------------------------
Discount rate used to calculate benefit obligation 5.50% 6.25% 6.25%
Discount rate used to calculate net periodic pension cost 6.25% 6.25% 6.50%
Average annual increase in executive compensation 5.00% 5.00% 5.00%
Average annual increase in director compensation 2.50% 2.50% 2.50%
-66-
The following table sets forth the expected benefit payments to participants and
estimated contributions to be made by the Company under the supplemental
retirement plans for the years indicated:
Expected Benefit Estimated
Payments to Company
Years Ended Participants Contributions
------------- -----------------------------------------
(in thousands)
2006 $530 $530
2007 517 517
2008 516 516
2009 516 516
2010 516 516
2011-2015 2,500 2,500
Note 15 - Related Party Transactions
Certain directors, officers, and companies with which they are associated were
customers of, and had banking transactions with, the Company or the Bank in the
ordinary course of business. It is the Company's policy that all loans and
commitments to lend to officers and directors be made on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with other borrowers of the Bank.
The following table summarizes the activity in these loans for 2005:
Balance Balance
December 31, Advances/ Removed/ December 31,
2004 New Loans Payments 2005
----------------------------------------------------------------
(in thousands)
$8,975 $9,525 $8,354 $10,146
Note 16 - Financial Instruments With Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit, standby
letters of credit, and deposit account overdraft privilege. Those instruments
involve, to varying degrees, elements of risk in excess of the amount recognized
in the balance sheet. The contract amounts of those instruments reflect the
extent of involvement the Company has in particular classes of financial
instruments.
The Company's exposure to loss in the event of nonperformance by the other party
to the financial instrument for commitments to extend credit and standby letters
of credit written is represented by the contractual amount of those instruments.
The Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. The Company's exposure
to loss in the event of nonperformance by the other party to the financial
instrument for deposit account overdraft privilege is represented by the
overdraft privilege amount disclosed to the deposit account holder.
December 31,
--------------------------
2005 2004
(in thousands)
Financial instruments whose amounts represent risk:
Commitments to extend credit:
Commercial loans $121,414 $99,377
Consumer loans 339,247 247,710
Real estate mortgage loans 29,730 20,266
Real estate construction loans 127,572 66,789
Standby letters of credit 8,527 10,912
Deposit account overdraft privilege 35,002 28,815
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates of one year or less or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each
customer's credit worthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is based
on Management's credit evaluation of the customer. Collateral held varies, but
may include accounts receivable, inventory, property, plant and equipment and
income-producing commercial properties.
-67-
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support private borrowing arrangements. Most standby letters
of credit are issued for one year or less. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers. Collateral requirements vary, but in general follow the
requirements for other loan facilities.
Deposit account overdraft privilege amount represents the unused overdraft
privilege balance available to the Company's deposit account holders who have
deposit accounts covered by an overdraft privilege. The Company has established
an overdraft privilege for certain of its deposit account products whereby all
holders of such accounts who bring their accounts to a positive balance at least
once every thirty days receive the overdraft privilege. The overdraft privilege
allows depositors to overdraft their deposit account up to a predetermined
level. The predetermined overdraft limit is set by the Company based on account
type.
-68-
Note 17 - Disclosure of Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument for which it is practical to estimate that
value. Cash and due from banks, fed funds purchased and sold, accrued interest
receivable and payable, and short-term borrowings are considered short-term
instruments. For these short-term instruments their carrying amount approximates
their fair value.
Securities
For all securities, fair values are based on quoted market prices or dealer
quotes. See Note 3 for further analysis.
Loans
The fair value of variable rate loans is the current carrying value. The
interest rates on these loans are regularly adjusted to market rates. The fair
value of other types of fixed rate loans is estimated by discounting the future
cash flows using current rates at which similar loans would be made to borrowers
with similar credit ratings for the same remaining maturities. The allowance for
loan losses is a reasonable estimate of the valuation allowance needed to adjust
computed fair values for credit quality of certain loans in the portfolio.
Deposit Liabilities and Long-Term Debt
The fair value of demand deposits, savings accounts, and certain money market
deposits is the amount payable on demand at the reporting date. These values do
not consider the estimated fair value of the Company's core deposit intangible,
which is a significant unrecognized asset of the Company. The fair value of time
deposits and debt is based on the discounted value of contractual cash flows.
Commitments to Extend Credit and Standby Letters of Credit
The fair value of commitments is estimated using the fees currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the present credit worthiness of the counter parties. For fixed
rate loan commitments, fair value also considers the difference between current
levels of interest rates and the committed rates. The fair value of letters of
credit is based on fees currently charged for similar agreements or on the
estimated cost to terminate them or otherwise settle the obligation with the
counter parties at the reporting date.
Fair values for financial instruments are management's estimates of the values
at which the instruments could be exchanged in a transaction between willing
parties. These estimates are subjective and may vary significantly from amounts
that would be realized in actual transactions. In addition, other significant
assets are not considered financial assets including, any mortgage banking
operations, deferred tax assets, and premises and equipment. Further, the tax
ramifications related to the realization of the unrealized gains and losses can
have a significant effect on the fair value estimates and have not been
considered in any of these estimates. The estimated fair values of the Company's
financial instruments are as follows:
December 31, 2005 December 31, 2004
---------------------------- -----------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------------------------- -----------------------------
Financial assets: (in thousands) (in thousands)
Cash and due from banks $90,562 $90,562 $70,037 $70,037
Federal funds sold 2,377 2,377 - -
Securities available-for-sale 260,278 260,278 286,013 286,013
Federal Home Loan Bank stock, at cost 7,602 7,602 6,781 6,781
Loans, net 1,368,809 1,363,623 1,158,442 1,148,272
Cash value of life insurance 41,768 41,768 40,479 40,479
Accrued interest receivable 7,641 7,641 6,473 6,473
Financial liabilities:
Deposits 1,496,797 1,387,789 1,348,833 1,265,358
Accrued interest payable 4,506 4,506 3,281 3,281
Federal funds purchased 96,800 96,800 46,400 46,400
Other borrowings 31,390 31,943 28,152 29,224
Junior subordinated debt $41,238 $41,238 $41,238 $41,238
Contract Fair Contract Fair
Off-balance sheet: Amount Value Amount Value
---------------------------- -----------------------------
Commitments $617,963 $6,180 $434,142 $4,341
Standby letters of credit $8,527 $85 $10,912 $109
Overdraft privilege commitments $35,002 $350 $28,815 $288
-69-
Note 18 - TriCo Bancshares Financial Statements
TriCo Bancshares (Parent Only) Balance Sheets
December 31,
--------------------------
2005 2004
Assets --------------------------
(in thousands)
Cash and Cash equivalents $1,219 $1,150
Investment in Tri Counties Bank 188,226 177,062
Other assets 1,778 1,430
--------------------------
Total assets $191,223 $179,642
--------------------------
Liabilities and shareholders' equity
Other liabilities $492 $272
Junior subordinated debt 41,238 41,238
--------------------------
Total liabilities $41,730 $41,510
--------------------------
Shareholders' equity:
Common stock, no par value: authorized 50,000,000
shares; issued and outstanding 15,707,835 and
15,723,317 shares, respectively $71,412 $70,699
Retained earnings 81,906 67,785
Accumulated other comprehensive loss, net (3,825) (352)
--------------------------
Total shareholders' equity 149,493 138,132
--------------------------
Total liabilities and shareholders' equity $191,223 $179,642
==========================
Statements of Income Years Ended December 31,
2005 2004 2003
----------------------------------
(in thousands)
Dividend income $ 18 $ 18 $ 18
Interest expense (2,482) (1,381) (355)
Administration expense (536) (617) (559)
----------------------------------
Loss before equity in net income
of Tri Counties Bank (3,000) (1,980) (896)
Equity in net income of Tri Counties Bank:
Distributed 11,190 3,075 2,810
Undistributed 14,213 18,249 14,592
Income tax benefit (1,268) (838) (382)
----------------------------------
Net income $23,671 $20,182 $16,888
==================================
Statements of Cash Flows Years ended December 31,
-------------------------------------------
2005 2004 2003
-------------------------------------------
Operating activities (in thousands)
Net income $23,671 $20,182 $16,888
Adjustments to reconcile net income to net cash provided
by operating activities:
Undistributed equity in Tri Counties Bank (14,213) (18,249) (14,592)
Net change in other assets and liabilities (127) 204 (72)
-------------------------------------------
Net cash provided by operating activities 9,331 2,137 2,224
Investing activities:
Investment in TriCo Capital Trust I -- -- (619)
Investment in TriCo Capital Trust II -- (619) --
Capital contributed to Tri Counties Bank -- (19,000) (28,383)
-------------------------------------------
Net cash used in investing activities -- (19,619) (29,002)
-------------------------------------------
Financing activities:
Issuance of junior subordinated debt -- 20,619 20,619
Issuance of common stock related to acquisition -- -- 18,383
Issuance of common stock through option exercise 972 1,348 717
Repurchase of common stock (3,161) (2,793) (853)
Cash dividends paid -- common (7,073) (6,729) (6,140)
-------------------------------------------
Net cash provided by (used for) financing activities (9,262) 12,445 32,726
Increase (decrease) in cash and cash equivalents 69 (5,037) 5,948
Cash and cash equivalents at beginning of year 1,150 6,187 239
-------------------------------------------
Cash and cash equivalents at end of year $1,219 $1,150 $6,187
===========================================
-70-
Note 19 - Regulatory Matters
The Company is subject to various regulatory capital requirements administered
by federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory, and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Company's consolidated financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Company must meet
specific capital guidelines that involve quantitative measures of the Company's
assets, liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier 1 capital to risk-weighted assets, and of Tier 1
capital to average assets. Management believes, as of December 31, 2005, that
the Company meets all capital adequacy requirements to which it is subject.
As of December 31, 2005, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Bank must maintain
minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set
forth in the table below. There are no conditions or events since that
notification that Management believes have changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the table.
Minimum
To Be Well
Capitalized Under
Minimum Prompt Corrective
Actual Capital Requirement Action Provisions
--------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------------
As of December 31, 2005: (dollars in thousands)
Total Capital (to Risk Weighted Assets):
Consolidated $189,994 10.79% $140,906 8.0% N/A N/A
Tri Counties Bank $188,727 10.72% $140,791 8.0% $175,989 10.0%
Tier 1 Capital (to Risk Weighted Assets):
Consolidated $171,955 9.76% $70,453 4.0% N/A N/A
Tri Counties Bank $170,688 9.70% $70,396 4.0% $105,593 6.0%
Tier 1 Capital (to Average Assets):
Consolidated $171,995 9.72% $70,785 4.0% N/A N/A
Tri Counties Bank $170,688 9.66% $70,702 4.0% $88,378 5.0%
As of December 31, 2004:
Total Capital (to Risk Weighted Assets):
Consolidated $172,332 11.86% $116,217 8.0% N/A N/A
Tri Counties Bank $171,262 11.80% $116,102 8.0% $145,128 10.0%
Tier 1 Capital (to Risk Weighted Assets):
Consolidated $155,025 10.67% $58,108 4.0% N/A N/A
Tri Counties Bank $155,205 10.69% $58,051 4.0% $87,077 6.0%
Tier 1 Capital (to Average Assets):
Consolidated $155,025 9.86% $62,877 4.0% N/A N/A
Tri Counties Bank $155,205 9.88% $62,817 4.0% $78,521 5.0%
-71-
Note 20 - Summary of Quarterly Results of Operations (unaudited)
The following table sets forth the results of operations for the four quarters
of 2005 and 2004, and is unaudited; however, in the opinion of Management, it
reflects all adjustments (which include only normal recurring adjustments)
necessary to present fairly the summarized results for such periods.
2005 Quarters Ended
---------------------------------------------------------
December 31, September 30, June 30, March 31,
---------------------------------------------------------
(dollars in thousands, except per share data)
Interest income $26,876 $25,334 $23,910 $22,636
Interest expense 6,100 5,519 4,789 4,121
------- ------- ------- -------
Net interest income 20,776 19,815 19,121 18,515
Provision for loan losses 561 947 561 100
------- ------- ------- -------
Net interest income after
provision for loan losses 20,215 18,868 18,560 18,415
Noninterest income 6,621 6,632 6,310 5,327
Noninterest expense 15,800 15,680 15,517 15,113
------- ------- ------- -------
Income before income taxes 11,036 9,820 9,353 8,629
Income tax expense 4,302 3,859 3,616 3,390
------- ------- ------- -------
Net income $ 6,734 $ 5,961 $ 5,737 $ 5,239
======= ======= ======= =======
Per common share:
Net income (diluted) $ 0.41 $ 0.37 $ 0.35 $ 0.32
======= ======= ======= =======
Dividends $ 0.12 $ 0.11 $ 0.11 $ 0.11
======= ======= ======= =======
2004 Quarters Ended
---------------------------------------------------------
December 31, September 30, June 30, March 31,
---------------------------------------------------------
(dollars in thousands, except per share data)
Interest income $22,441 $21,951 $20,628 $19,912
Interest expense 3,768 3,494 3,087 3,014
------- ------- ------- -------
Net interest income 18,673 18,457 17,541 16,898
Provision for loan losses (183) 1,166 1,305 613
------- ------- ------- -------
Net interest income after
provision for loan losses 18,856 17,291 16,236 16,285
Noninterest income 5,736 6,361 6,942 5,755
Noninterest expense 15,815 15,223 15,407 14,383
------- ------- ------- -------
Income before income taxes 8,777 8,429 7,771 7,657
Income tax expense 3,422 3,226 2,924 2,880
------- ------- ------- -------
Net income $ 5,355 $ 5,203 $ 4,847 $ 4,777
======= ======= ======= =======
Per common share:
Net income (diluted) $ 0.33 $ 0.32 $ 0.30 $ 0.29
======= ======= ======= =======
Dividends $ 0.11 $ 0.11 $ 0.11 $ 0.10
======= ======= ======= =======
-72-
Note 21 - Acquisition
The Company acquired North State National Bank on April 4, 2003. The acquisition
and the related merger agreement dated October 3, 2002, was approved by the
California Department of Financial Institutions, the Federal Deposit Insurance
Corporation, and the shareholders of North State National Bank on March 4, March
7, and March 19, 2003, respectively. At the time of the acquisition, North State
had total assets of $140 million, investment securities of $41 million, loans of
$76 million, and deposits of $126 million. The acquisition was accounted for
using the purchase method of accounting. The amount of goodwill recorded as of
the merger date, which represented the excess of the total purchase price over
the estimated fair value of net assets acquired, was approximately $15.5
million. The Company recorded a core deposit intangible, which represents the
excess of the fair value of North State's deposits over their book value on the
acquisition date, of approximately $3.4 million. This core deposit intangible is
scheduled to be amortized over a seven-year average life.
On April 4, 2003, under the terms of the merger agreement, the Company paid
$13,090,057 in cash, issued 723,512 shares of common stock, and issued options
to purchase 79,587 shares of common stock at an average exercise price of $6.22
per share in exchange for all of the 1,234,375 common shares and options to
purchase 79,937 common shares of North State National Bank outstanding as of
April 4, 2003.
The pro forma financial information in the following table illustrates the
combined operating results of the Company and North State National Bank for the
year ended December 31, 2003 as if the acquisition of North State National Bank
had occurred as of January 1, 2003. The pro forma financial information is
presented for informational purposes and is not necessarily indicative of the
results of operations that would have occurred if the Company and North State
National Bank had constituted a single entity as of or January 1, 2003. The pro
forma financial information is also not necessarily indicative of the future
results of operations of the combined company. In particular, any opportunity to
achieve certain cost savings as a result of the acquisition has not been
included in the pro forma financial information.
For the year ended December 31, 2003
----------------------------------------
(in thousands except earnings per share)
Net interest income $62,316
Provision for loan losses 1,250
Noninterest income 23,100
Noninterest expense 56,711
Income tax expense 10,331
-------
Net income $17,124
=======
Basic earnings per share $1.10
Diluted earnings per share $1.05
Pro forma per share data for all periods in the preceding table have been
adjusted to reflect the 2-for-1 stock split paid on April 30, 2004.
The only significant pro forma adjustment is the amortization expense relating
to core deposit intangible, and the income tax benefit associated with the pro
forma adjustment.
-73-
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of TriCo Bancshares is responsible for establishing and maintaining
effective internal control over financial reporting. Internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with U.S. generally
accepted accounting principles.
Under the supervision and with the participation of management, including the
principal executive officer and principal financial officer, the Company
conducted an evaluation of the effectiveness of internal control over financial
reporting based on the framework in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on this evaluation under the framework in Internal Control - Integrated
Framework, management of the Company has concluded the Company maintained
effective internal control over financial reporting, as such term is defined in
Securities Exchange Act of 1934 Rules 13a-15(f), as of December 31, 2005.
Internal control over financial reporting cannot provide absolute assurance of
achieving financial reporting objectives because of its inherent limitations.
Internal control over financial reporting is a process that involves human
diligence and compliance and is subject to lapses in judgment and breakdowns
resulting from human failures. Internal control over financial reporting can
also be circumvented by collusion or improper management override. Because of
such limitations, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial
reporting. However, these inherent limitations are known features of the
financial reporting process. Therefore, it is possible to design into the
process safeguards to reduce, though not eliminate, this risk.
Management is also responsible for the preparation and fair presentation of the
consolidated financial statements and other financial information contained in
this report. The accompanying consolidated financial statements were prepared in
conformity with U.S. generally accepted accounting principles and include, as
necessary, best estimates and judgments by management.
KPMG LLP, an independent registered public accounting firm, has audited the
Company's consolidated financial statements as of and for the year ended
December 31, 2005, and the Company's assertion as to the effectiveness of
internal control over financial reporting as of December 31, 2005, as stated in
its reports, which are included herein.
/s/ Richard P. Smith
-------------------------------------
Richard P. Smith
President and Chief Executive Officer
/s/ Thomas J. Reddish
-------------------------------------
Thomas J. Reddish
Executive Vice President and
Chief Financial Officer
March 7, 2006
-74-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
TriCo Bancshares:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that TriCo
Bancshares and subsidiaries (the Company) maintained effective internal control
over financial reporting as of December 31, 2005, based on criteria established
in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that TriCo Bancshares and subsidiaries
maintained effective internal control over financial reporting as of
December 31, 2005, is fairly stated, in all material respects, based on criteria
established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Also, in our
opinion, TriCo Bancshares and subsidiaries maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2005,
based on criteria established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
TriCo Bancshares and subsidiaries as of December 31, 2005 and 2004, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
2005, and our report dated March 7, 2006, expressed an unqualified opinion on
those consolidated financial statements.
/s/ KPMG LLP
Sacramento, California
March 7, 2006
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
TriCo Bancshares:
We have audited the accompanying consolidated balance sheets of TriCo Bancshares
and subsidiaries (the Company) as of December 31, 2005 and 2004, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 2005.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of TriCo Bancshares and
subsidiaries as of December 31, 2005 and 2004, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2005, in conformity with U.S. generally accepted accounting
principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of TriCo
Bancshares and subsidiaries' internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated March 7, 2006 expressed an unqualified
opinion on management's assessment of, and the effective operation of, internal
control over financial reporting.
/s/ KPMG LLP
Sacramento, California
March 7, 2006
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
During 2004 and 2005 there were no changes in the Company's accountants.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As of December 31, 2005, the end of the period covered by this Annual Report on
Form 10-K, the Company's Chief Executive Officer and Chief Financial Officer
evaluated the effectiveness of the Company's disclosure controls and procedures
(as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based
upon that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer each concluded that as of December 31, 2005, the Company's disclosure
controls and procedures were effective to ensure that the information required
to be disclosed by the Company in this Annual Report on Form 10-K was recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and instructions for Form 10-K.
(b) Management's Report on Internal Control over Financial Reporting
The Company's management is responsible for establishing and maintaining
effective internal control over financial reporting (as defined in Rule
13a-15(f) under the Securities Exchange Act of 1934 as amended). The Company's
internal control over financial reporting is under the general oversight of the
Board of Directors acting through the Audit Committee, which is composed
entirely of independent directors. KPMG LLP, the Company's independent
registered public accounting firm, has direct and unrestricted access to the
Audit Committee at all times, with no members of management present, to discuss
its audit and any other matters that have come to its attention that may affect
the Company's accounting, financial reporting or internal controls. The Audit
Committee meets periodically with management, internal auditors and KPMG LLP to
determine that each is fulfilling its responsibilities and to support actions to
identify, measure and control risk and augment internal control over financial
reporting. Internal control over financial reporting, however, cannot provide
absolute assurance of achieving financial reporting objectives because of its
inherent limitations.
Under the supervision and with the participation of management, including the
Company's Chief Executive Officer and Chief Financial Officer, the Company
conducted an evaluation of the effectiveness of internal control over financial
reporting as of December 31, 2005 based on the framework in "Internal Control -
Integrated Framework" issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based upon that evaluation, management concluded that the
Company's internal control over financial reporting was effective as of December
31, 2005. Management's report on internal control over financial reporting is
set forth on page 74 of this Annual Report on Form 10-K, and is incorporated
herein by reference. Management's assessment of the effectiveness of the
Company's internal control over financial reporting has been audited by KPMG
LLP, an independent registered public accounting firm, as stated in its report,
which is set forth on page 75 of this Annual Report of Form 10-K, and is
incorporated herein by reference.
(c) Changes in Internal Control over Financial Reporting
No change in the Company's internal control over financial reporting occurred
during the fourth quarter of the year ended December 31, 2005, that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
All information required to be disclosed in a current report on Form 8-K during
the fourth quarter of 2005 was so disclosed.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors and executive officers of the registrant
required by this Item 10 is incorporated herein by reference from the Company's
Proxy Statement for the annual meeting of shareholders to be held on May 23,
2006, which will be filed with the Commission pursuant to Regulation 14A.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated herein by reference
from the Company's Proxy Statement for the annual meeting of shareholders to be
held on May 23, 2006, which will be filed with the Commission pursuant to
Regulation 14A.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this Item 12 is incorporated herein by reference
from the Company's Proxy Statement for the annual meeting of shareholders to be
held on May 23, 2006, which will be filed with the Commission pursuant to
Regulation 14A.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is incorporated herein by reference
from the Company's Proxy Statement for the annual meeting of shareholders to be
held on May 23, 2006, which will be filed with the Commission pursuant to
Regulation 14A.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item 14 is incorporated herein by reference
from the Company's Proxy Statement for the annual meeting of shareholders to be
held on May 23, 2006, which will be filed with the Commission pursuant to
Regulation 14A.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as part of this report:
1. All Financial Statements.
The consolidated financial statements of Registrant are included
beginning at page 42 of Item 8 of this report, and are incorporated
herein by reference.
2. Financial statement schedules.
Schedules have been omitted because they are not applicable or are not
required under the instructions contained in Regulation S-X or because
the information required to be set forth therein is included in the
consolidated financial statements or notes thereto at Item 8 of this
report.
3. Exhibits.
The following documents are included or incorporated by reference in
this annual report on Form 10-K, and this list includes the Exhibit
Index.
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Exhibit No. Exhibit Index
----------- -------------
3.1* Restated Articles of Incorporation dated May 9, 2003, filed as Exhibit
3.1 to TriCo's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2003.
3.2* Bylaws of TriCo Bancshares, as amended, filed as Exhibit 3.2 to
TriCo's Form S-4 Registration Statement dated January 16, 2003 (No.
333-102546).
4* Certificate of Determination of Preferences of Series AA Junior
Participating Preferred Stock filed as Exhibit 3.3 to TriCo's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2001.
10.1* Rights Agreement dated June 25, 2001, between TriCo and Mellon
Investor Services LLC filed as Exhibit 1 to TriCo's Form 8-A dated
July 25, 2001.
10.2* Form of Change of Control Agreement dated as of August 23, 2005,
between TriCo, Tri Counties Bank and each of Bruce Belton, Craig
Carney, Gary Coelho, W.R. Hagstrom, Andrew Mastorakis, Rick Miller,
Richard O'Sullivan, Thomas Reddish, and Ray Rios filed as Exhibit 10.2
to TriCo's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2005.
10.4* TriCo's Non-Qualified Stock Option Plan filed as Exhibit 4.2 to
TriCo's Form S-8 Registration Statement dated January 18, 1995 (No.
33-88704).
10.5* TriCo's Incentive Stock Option Plan filed as Exhibit 4.3 to TriCo's
Form S-8 Registration Statement dated January 18, 1995 (No. 33-88704).
10.6* TriCo's 1995 Incentive Stock Option Plan filed as Exhibit 4.1 to
TriCo's Form S-8 Registration Statement dated August 23, 1995 (No.
33-62063).
10.7* TriCo's 2001 Stock Option Plan, as amended, filed as Exhibit 10.7 to
TriCo's Quarterly Report on Form 10-Q for the quarter ended June 30,
2005.
10.8* Amended Employment Agreement between TriCo and Richard Smith dated as
of August 23, 2005 filed as Exhibit 10.8 to TriCo's Quarterly Report
on Form 10-Q for the quarter ended September 30, 2005.
10.9* Tri Counties Bank Executive Deferred Compensation Plan restated April
1, 1992, and January 1, 2005 filed as Exhibit 10.9 to TriCo's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2005.
10.10* Tri Counties Bank Deferred Compensation Plan for Directors effective
January 1, 2005 filed as Exhibit 10.10 to TriCo's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2005.
10.11* 2005 Tri Counties Bank Deferred Compensation Plan for Executives and
Directors effective January 1, 2005 filed as Exhibit 10.11 to TriCo's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2005.
10.13* Tri Counties Bank Supplemental Retirement Plan for Directors dated
September 1, 1987, as restated January 1, 2001, and amended and
restated January 1, 2004 filed as Exhibit 10.12 to TriCo's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2004.
10.14* 2004 TriCo Bancshares Supplemental Retirement Plan for Directors
effective January 1, 2004 filed as Exhibit 10.13 to TriCo's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2004.
10.15* Tri Counties Bank Supplemental Executive Retirement Plan effective
September 1, 1987, as amended and restated January 1, 2004 filed as
Exhibit 10.14 to TriCo's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2004.
-79-
10.16* 2004 TriCo Bancshares Supplemental Executive Retirement Plan effective
January 1, 2004 filed as Exhibit 10.15 to TriCo's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2004.
10.17* Form of Joint Beneficiary Agreement effective March 31, 2003 between
Tri Counties Bank and each of George Barstow, Dan Bay, Ron Bee, Craig
Carney, Robert Elmore, Greg Gill, Richard Miller, Andrew Mastorakis,
Richard O'Sullivan, Thomas Reddish, Jerald Sax, and Richard Smith,
filed as Exhibit 10.14 to TriCo's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2003.
10.18* Form of Joint Beneficiary Agreement effective March 31, 2003 between
Tri Counties Bank and each of Don Amaral, William Casey, Craig
Compton, John Hasbrook, Michael Koehnen, Wendell Lundberg, Donald
Murphy, Carroll Taresh, and Alex Vereshagin, filed as Exhibit 10.15 to
TriCo's Quarterly Report on Form 10-Q for the quarter ended September
30, 2003.
10.19* Form of Tri-Counties Bank Executive Long Term Care Agreement effective
June 10, 2003 between Tri Counties Bank and each of Craig Carney,
Andrew Mastorakis, Richard Miller, Richard O'Sullivan, and Thomas
Reddish, filed as Exhibit 10.16 to TriCo's Quarterly Report on Form
10-Q for the quarter ended September 30, 2003.
10.20* Form of Tri-Counties Bank Director Long Term Care Agreement effective
June 10, 2003 between Tri Counties Bank and each of Don Amaral,
William Casey, Craig Compton, John Hasbrook, Michael Koehnen, Donald
Murphy, Carroll Taresh, and Alex Vereschagin, filed as Exhibit 10.17
to TriCo's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003.
10.21* Form of Indemnification Agreement between TriCo Bancshares/Tri
Counties Bank and each of the directors of TriCo Bancshares/Tri
Counties Bank effective on the date that each director is first
elected, filed as Exhibit 10.18 to TriCo'S Annual Report on Form 10-K
for the year ended December 31, 2003.
10.22* Form of Indemnification Agreement between TriCo Bancshares/Tri
Counties Bank and each of Craig Carney, W.R. Hagstrom, Andrew
Mastorakis, Rick Miller, Richard O'Sullivan, Thomas Reddish, Ray Rios,
and Richard Smith filed as Exhibit 10.21 to TriCo's Quarterly Report
on Form 10-Q for the quarter ended June 30, 2004.
21.1 Tri Counties Bank, a California banking corporation, TriCo Capital
Trust I, a Delaware business trust, and TriCo Capital Trust II, a
Delaware business trust, are the only subsidiaries of Registrant
23.1 Independent Registered Public Accounting Firm's Consent
31.1 Rule 13a-14(a)/15d-14(a) Certification of CEO
31.2 Rule 13a-14(a)/15d-14(a) Certification of CFO
32.1 Section 1350 Certification of CEO
32.2 Section 1350 Certification of CFO
* Previously filed and incorporated by reference.
-80-
(c) Exhibits filed:
See Exhibit Index under Item 15(a)(3) above for the list of exhibits
required to be filed by Item 601 of regulation S-K with this report.
(d) Financial statement schedules filed:
See Item 15(a)(2) above.
-81-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: March 7, 2006 TRICO BANCSHARES
By: /s/ Richard P. Smith
----------------------------------------
Richard P. Smith, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant in
the capacities and on the dates indicated.
Date: March 7, 2006 /s/ Richard P. Smith
----------------------------------------
Richard P. Smith, President, Chief
Executive Officer and Director
(Principal Executive Officer)
Date: March 7, 2006 /s/ Thomas J. Reddish
----------------------------------------
Thomas J. Reddish, Executive Vice
President and Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: March 7, 2006 /s/ Donald J. Amaral
----------------------------------------
Donald J. Amaral, Director
Date: March 7, 2006 /s/ William J. Casey
----------------------------------------
William J. Casey, Director and Chairman
of the Board
Date: March 7, 2006 /s/ Craig S. Compton
----------------------------------------
Craig S. Compton, Director
Date: March 7, 2006 /s/ John S.A. Hasbrook
----------------------------------------
John S.A. Hasbrook, Director
Date: March 7, 2006 /s/ Michael W. Koehnen
----------------------------------------
Michael W. Koehnen, Director
-82-
Date: March 7, 2006 /s/ Donald E. Murphy
----------------------------------------
Donald E. Murphy, Director and
Vice Chairman of the Board
Date: March 7, 2006 /s/ Steve G. Nettleton
----------------------------------------
Steve G. Nettleton, Director
Date: March 7, 2006 /s/ Carroll R. Taresh
----------------------------------------
Carroll R. Taresh, Director
Date: March 7, 2006 /s/ Alex A. Vereschagin
----------------------------------------
Alex A. Vereschagin, Jr., Director
-83-
Exhibit 23.1
Consent of Independent Registered Public Accounting Firm
The Board of Directors
TriCo Bancshares:
We consent to the incorporation by reference in the registration statements
(Nos. 33-88702, 33-62063, and 33-66064) on Form S-8 of TriCo Bancshares of our
reports dated March 7, 2006, with respect to the consolidated balance sheets of
TriCo Bancshares and subsidiaries as of December 31, 2005 and 2004, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
2005, management's assessment of the effectiveness of internal control over
financial reporting as of December 31, 2005, and the effectiveness of internal
control over financial reporting as of December 31, 2005, which report appears
in the December 31, 2005, annual report on Form 10-K of TriCo Bancshares.
/s/ KPMG LLP
Sacramento, California
March 7, 2006
-84-
Exhibit 31.1
Rule 13a-14/15d-14 Certification of CEO
I, Richard P. Smith, certify that;
1. I have reviewed this annual report on Form 10-K of TriCo Bancshares;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) and internal control
over financial reporting (as defined in Exchange Act Rules 13a-15(f)
and 15d-15(f)) for the registrant and we have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this annual report is being prepared;
b. Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c. Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluations; and
d. Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's fourth quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors:
a. All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: March 7, 2006 /s/ Richard P. Smith
----------------------------------------
Richard P. Smith
President and Chief Executive Officer
-85-
Exhibit 31.2
Rule 13a-14/15d-14 Certification of CEO
I, Thomas J. Reddish, certify that;
1. I have reviewed this annual report on Form 10-K of TriCo Bancshares;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) and internal control
over financial reporting (as defined in Exchange Act Rules 13a-15(f)
and 15d-15(f)) for the registrant and we have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this annual report is being prepared;
b. Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c. Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluations; and
d. Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's fourth quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors:
a. All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: March 7, 2006 /s/ Thomas J. Reddish
----------------------------------------
Thomas J. Reddish
Executive Vice President and
Chief Financial Officer
-86-
Exhibit 32.1
Section 1350 Certification of CEO
In connection with the Annual Report of TriCo Bancshares (the "Company") on Form
10-K for the year ended December 31, 2005 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), I, Richard P. Smith,
President and Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ Richard P. Smith
------------------------------------------
Richard P. Smith
President and Chief Executive Officer
A signed original of this written statement required by Section 906 has been
provided to TriCo Bancshares and will be retained by TriCo Bancshares and
furnished to the Securities and Exchange Commission or its staff upon request.
Exhibit 32.2
Section 1350 Certification of CFO
In connection with the Annual Report of TriCo Bancshares (the "Company") on Form
10-K for the year ended December 31, 2005 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), I, Thomas J. Reddish,
Vice President and Chief Financial Officer of the Company, certify, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ Thomas J. Reddish
------------------------------------------
Thomas J. Reddish
Executive Vice President and
Chief Financial Officer
A signed original of this written statement required by Section 906 has been
provided to TriCo Bancshares and will be retained by TriCo Bancshares and
furnished to the Securities and Exchange Commission or its staff upon request.
-87-