-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TrwD/6++bbCFW6VbdjZ5mPxmnG7qCRA+SSdVILeJsFpgbtrx/ASmX+pQjITbv50i TjxeulLrfTX/U5sS3VI5NQ== 0001001277-04-000156.txt : 20040324 0001001277-04-000156.hdr.sgml : 20040324 20040324172121 ACCESSION NUMBER: 0001001277-04-000156 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040324 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SONOMA VALLEY BANCORP CENTRAL INDEX KEY: 0001120427 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 680454068 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-31929 FILM NUMBER: 04687950 BUSINESS ADDRESS: STREET 1: C/O SONOMA VALLEY BANCORP STREET 2: 202 WEST NAPA STREET CITY: SONOMA STATE: CA ZIP: 95476 10-K 1 for123103.txt 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 ended December 31, 2003 Commission File Number: 000-31929 ------------------------- SONOMA VALLEY BANCORP (Name of registrant at as specific in its charter) CALIFORNIA 68-0454068 (State of incorporation) (I.R.S. Employer Identification No.) 202 West Napa Street Sonoma, California 95476 (707) 935-3200 (Address, including zip code, and telephone number, including area code, of principal executive offices) ------------------------ Securities to be registered under section 12(b) of the Exchange Act: None Securities to be registered under section 12(g) of the Exchange Act: Name of each exchange Title of each class on which registered Common Stock, No Par Value None 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 period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) [ ] Yes [ X ] No Aggregate market value of Common Stock held by non-affiliates of Sonoma Valley Bancorp as of March 16, 2004 based on the current market price of the stock: $36,317,984 The number of shares of registrant's common stock outstanding as of March 15, 2004 was 1,484,823. DOCUMENTS INCORPORATE BY REFERENCE None. With the exception of historical facts stated herein, the matters discussed in this Form 10-K are "forward looking" statements that involve risks and uncertainties that could cause actual results to differ materially from projected results. Such "forward looking" statements include, but are not necessarily limited to statements regarding anticipated levels of future revenues and earnings from the operation of Sonoma Valley Bancorp's wholly owned subsidiary, Sonoma Valley Bank, projected costs and expenses related to operations of the bank's liquidity, capital resources, and the availability of future equity capital on commercially reasonable terms. Factors that could cause actual results to differ materially include, in addition to the other factors identified in this Form 10-K, the following: (i) increased competition from other banks, savings and loan associations, thrift and loan associations, finance companies, credit unions, offerors of money market funds, and other financial institutions; (ii) the risks and uncertainties relating to general economic and political conditions, both domestically and internationally, including, but not limited to, inflation, or natural disasters affecting the primary service area of the Bank or its major industries; or (iii) changes in the laws and regulations governing the Bank's activities at either the state or federal level. Readers of this Form 10-K are cautioned not to put undue reliance on "forward looking" statements which, by their nature, are uncertain as reliable indicators of future performance. Sonoma Valley Bancorp disclaims any obligation to publicly update these "forward looking" statements, whether as a result of new information, future events, or otherwise. PART I ITEM 1. BUSINESS General Sonoma Valley Bancorp ("Company") was incorporated under California law on March 9, 2000 at the direction of Sonoma Valley Bank for the purpose of forming a single-bank holding company structure pursuant to a plan of reorganization. The reorganization became effective November 1, 2000, after obtaining all required regulatory approvals and permits, shares of the Company's common stock were issued to shareholders of Sonoma Valley Bank in exchange for their Sonoma Valley Bank stock. Previously, Sonoma Valley Bank filed its periodic reports and current reports under the Securities Exchange Act of 1934 with the Federal Deposit Insurance Corporation. Following the reorganization, periodic and current reports are now filed with the Securities and Exchange Commission. The business operations of the Company continue to be conducted through its wholly-owned subsidiary, Sonoma Valley Bank ("Bank"), which began commercial lending operations on June 3, 1988. In addition to its main branch located in Sonoma, California, the Bank also operates a second branch office located in Glen Ellen, California. In March 2004, the Bank opened a branch, Banco de Sonoma, located in Boyes Hot Springs, California. The following discussion, therefore, although presented on a consolidated basis, analyzes the financial condition and results of operations of the Bank for the twelve month period ended December 31, 2003. Primary Services The Bank emphasizes the banking needs of small to medium-sized commercial businesses, professionals and upper middle to high income individuals and families in its primary service area of Sonoma, California and the immediate surrounding area. 2 The Bank offers depository and lending services keyed to the needs of its business and professional clientele. These services include a variety of demand deposit, savings and time deposit account alternatives, all insured by the FDIC up to its applicable limits. Special merchant and business services, such as coin, night depository, courier, on line cash management and merchant teller are available. The Bank offers bank by mail service, drive-up ATM service, extended hours including Saturday banking, drive-up windows and telephone voice response. In 2003, the bank began offering Internet Banking to its customer base. The initial customers using the product were existing Cash Management Commercial customers and by mid-year the bank offered Internet Banking to its entire customer base with products for both commercial and individual customers. The Bank's lending activities are directed primarily towards granting short and medium-term commercial loans, augmented by customized lines of credit, for such purposes as operating capital, business and professional start-ups, inventory, equipment, accounts receivable, credit cards, and interim construction financing, personal loans and loans secured by residential real estate. With the opening of our third Branch office, Banco de Sonoma Office in March 2004, the bank is offering additional services to the Latino community in our market place. In 2003, the Bank installed a bilingual ATM machine, and has bilingual officers and customer service employees. All of the employees at the Banco de Sonoma Office are bilingual. The business of the Bank is not seasonal. The Bank intends to continue with the same basic commercial banking activities it has operated with since beginning operations June 3, 1988. Retail deposit gathering activities at the branches comprise the bulk of sources for lending. The bank has approved borrowing levels at the Federal Home Bank for temporary funding needs. Competition In general, the banking business in California and in the market areas, which the Bank serves, is highly competitive with respect to both loans and deposits, and is dominated by a relatively small number of major banks, which have many offices operating over a wide geographic area. The Bank competes for loans and deposits with these and other regional banks, including several which are much larger than the Bank, as well as savings and loan associations, thrift and loan associations, finance companies, credit unions, offerors of money market funds and other financial institutions. The Bank's primary service area is currently served by branches of eight other banks (including three major banks: Citigroup, Bank of America and Wells Fargo Bank). In order to compete with the major financial institutions in its primary service area, the Bank uses its flexibility as an independent bank. This includes emphasis on specialized services and personalized attention. In the event there are customers whose loan demands exceed the Bank's lending limit, the Bank seeks to arrange for such loans on a participation basis with other financial institutions and intermediaries. The Bank also is able to assist those customers requiring other services not offered by the Bank by obtaining those services through its correspondent banks. 3 Concentration of Credit Risk The majority of the Bank's loan activity is with customers located within the county of Sonoma. While the Bank has a diversified loan portfolio, approximately 84% of these loans are secured by real estate in its service area. This concentration for the year ending December 31, 2003 is presented below: (in thousands of dollars) Secured by real estate: Construction/land development $ 19,421 Farmland 3,784 1-4 family residences 15,919 Commercial/multi-family 63,691 Employees As of December 31, 2003, the Company employed 49 full-time equivalent employees. In anticipation of opening the Banco de Sonoma branch in 2004 the bank began hiring additional employees in the 4th quarter of 2003. Supervision and Regulation The Company is a registered bank holding company under the Bank Holding Company Act, regulated, supervised and examined by the Federal Reserve Bank. As such, it must file with the Federal Reserve Bank an annual report and additional reports as the Federal Reserve Board may require. The Company is also subject to periodic examination by the Federal Reserve Board. In addition, both the Company and the Bank are extensively regulated under both federal and state laws and regulations. These laws and regulations are primarily intended to protect depositors, not shareholders. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions at issue. As a California state-licensed bank, the Bank is subject to regulation, supervision and periodic examination by the California Department of Financial Institutions. The Bank is also subject to regulation, supervision, and periodic examination by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank is not a member of the Federal Reserve System, but is nevertheless subject to certain regulations of the Board of Governors of the Federal Reserve System. As a state bank, the Bank's deposits are insured by the FDIC to the maximum amount permitted by law, which is currently $100,000 per depositor in most cases. For this protection, the Bank pays a semi-annual assessment. The regulations of these state and federal bank regulatory agencies govern most aspects of the Company's and the Bank's business and operations, including but not limited to, requiring the maintenance of non-interest bearing reserves on deposits, limiting the nature and amount of investments and loans which may be made, regulating the issuance of securities, restricting the payment of dividends, regulating bank expansion and bank activities, including real estate development activities. The Federal Reserve Board, the Federal Deposit Insurance Corporation, and the California Department of Financial Institutions have broad enforcement powers over depository institutions, including the power to prohibit a bank from engaging in business practices which are considered to be unsafe or unsound, to impose substantial fines and other civil and criminal penalties, to terminate deposit insurance, and to appoint a conservator or receiver under a 4 variety of circumstances. The Federal Reserve Board also has broad enforcement powers over bank holding companies, including the power to impose substantial fines and other civil and criminal penalties. Regulation of Bank Holding Companies As a bank holding company, the Company's activities are subject to extensive regulation by the Federal Reserve Board. The Bank Holding Company Act requires us to obtain the prior approval of the Federal Reserve Board before (i) directly or indirectly acquiring ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, we would own or control more than 5% of the shares of the other bank or bank holding company (unless the acquiring company already owns or controls a majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. The Federal Reserve Board will not approve any acquisition, merger or consolidation that would have a substantially anticompetitive result, unless the anticompetitive effects of the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The Federal Reserve Board also considers capital adequacy and other financial and managerial factors in its review of acquisitions and mergers. With certain exceptions, the Bank Holding Company Act also prohibits us from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities that, by statute or by Federal Reserve Board regulation or order, have been determined to be activities closely related to the business of banking or of managing or controlling banks. Federal Deposit Insurance The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, order or any condition imposed in writing by, or pursuant to written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital. Impact of Economic Conditions and Monetary Policies The earnings and growth of the Bank are and will be affected by general economic conditions, both domestic and international, and by the monetary and fiscal policies of the United States Government and its agencies, particularly the Federal Reserve Bank (FRB). One function of the FRB is to regulate the money supply and the national supply of bank credit in order to mitigate recessionary and inflationary pressures. Among the instruments of monetary policy used to implement these objects are open market transactions in United States Government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirement held by depository institutions. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. However, the effect of such policies on the future business and earnings of the Bank cannot be accurately predicted. 5 Recent and Proposed Legislation From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks and other financial institutions are frequently made in Congress, in the California legislature, and by various bank regulatory agencies. No prediction can be made as to the likelihood of any major changes or the impact such changes might have on the Bank. Certain changes of potential significance to the Bank which have been enacted recently or others which are currently under consideration by Congress or various regulatory or professional agencies are discussed below. The Financial Services Modernization Act of 1999 (also known as the "Gramm-Leach-Bliley Act" after its Congressional sponsors) substantially eliminates most of the separations between banks, brokerage firms, and insurers enacted by the Glass-Steagall Act of 1933. The reform legislation permits securities firms and insurers to buy banks, and banks to underwrite insurance and securities. States retain regulatory authority over insurers. The Treasury Department's Office of the Comptroller of the Currency has authority to regulate bank subsidiaries that underwrite securities and the Federal Reserve has authority over bank affiliates for activities such as insurance underwriting and real-estate development. In January 2001, the Basel Committee on Banking Supervision issued a proposal for a "New Capital Accord." The New Capital Accord incorporates a three-part framework of minimum capital requirements, supervisory review of an institution's capital adequacy and internal assessment process, and market discipline through effective disclosure to encourage safe and sound banking practices. The New Capital Accord is scheduled for implementation by the end of 2006. The federal banking agencies are required to take "prompt corrective action" in respect of depository institutions and their bank holding companies that do not meet minimum capital requirements. FDIC established five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." A depository institution's capital tier, or that of its bank holding company, depends upon where its capital levels are in relation to various relevant capital measures, including a risk-based capital measure and a leverage ratio capital measure, and certain other factors. Under the implementing regulations adopted by the federal banking agencies, a bank holding company or bank is considered "well capitalized" if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. An "adequately capitalized" bank holding company or bank is defined as one that has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% or greater and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with a composite CAMELS rating of 1). A bank holding company or bank is considered (A) "undercapitalized" if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of a bank with a composite CAMELS rating of 1); (B) "significantly undercapitalized" if the bank has (i) a total risk-based capital ratio of less than 6%, or (ii) a Tier 1 risk-based capital ratio of less than 3% or (iii) a leverage ratio of less than 3% and (C)"critically undercapitalized" if the bank has a ratio of tangible equity to total assets equal to or less than 2%. The Federal Reserve Board may reclassify a "well capitalized" bank holding company or bank as "adequately capitalized" or subject an "adequately capitalized" or "undercapitalized" institution to the supervisory actions applicable to the next lower capital category if it determines that the bank holding company or bank is in an unsafe or unsound condition or deems the bank holding company or bank to be engaged in an unsafe or unsound practice and not to have corrected the deficiency. The Company and Bank currently meet the definition of "well capitalized" institutions. 6 "Undercapitalized" depository institutions, among other things, are subject to growth limitations, are prohibited, with certain exceptions, from making capital distributions, are limited in their ability to obtain funding from a Federal Reserve Bank and are required to submit a capital restoration plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan and provide appropriate assurances of performance. If a depository institution fails to submit an acceptable plan, including if the holding company refuses or is unable to make the guarantee described in the previous sentence, it is treated as if it is "significantly undercapitalized". Failure to submit or implement an acceptable capital plan also is grounds for the appointment of a conservator or a receiver. "Significantly undercapitalized" depository institutions may be subject to a number of additional requirements and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized," requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Moreover, the parent holding company of a "significantly undercapitalized" depository institution may be ordered to divest itself of the institution or of nonbank subsidiaries of the holding company. "Critically undercapitalized" institutions, among other things, are prohibited from making any payments of principal and interest on subordinated debt, and are subject to the appointment of a receiver or conservator. Each federal banking agency prescribes standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares and other standards as they deem appropriate. The Federal Reserve Board and OCC have adopted such standards. Depository institutions that are not "well capitalized" or "adequately capitalized" and have not received a waiver from the FDIC are prohibited from accepting or renewing brokered deposits. As of December 31, 2003, the Company and Bank had no brokered deposits. The USA Patriot Act of 2001 ("USA Patriot Act") imposes additional obligations on U.S. financial institutions, including banks and broker dealer subsidiaries, to implement policies, procedures and controls which are reasonably designed to detect and report instances of money laundering and the financing of terrorism. In addition, provisions of the USA Patriot Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions. The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") intended to address corporate and accounting fraud. Sarbanes-Oxley applies to publicly reporting companies. In addition to the establishment of a new accounting oversight board, which will enforce auditing, quality control and independence standards and will be funded by fees from all publicly traded companies, the bill restricts provision of both auditing and consulting services by accounting firms. To maintain auditor independence, any non-audit services being provided to an audit client will require pre-approval by the Company's audit committee members. In addition, the audit partners must be rotated. Sarbanes-Oxley also requires chief executive officers and chief financial officers to certify to the accuracy of periodic reports filed with the Securities Exchange Commission (the "SEC"), subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. In addition, under Sarbanes-Oxley, legal counsel will be required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief legal officer, 7 and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the board of directors or the board itself. Longer prison terms and increased penalties will also be applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company's financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan "blackout" periods, and loans to company executives are restricted. Sarbanes-Oxley accelerates the time frame for disclosures by public companies, as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a company's securities within two business days of the change. Sarbanes-Oxley also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company's financial statements for the purpose of rendering the financial statements materially misleading. Sarbanes-Oxley also requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to shareholders. In addition, the Sarbanes-Oxley requires that each financial report required to be prepared in accordance with (or reconciled to) accounting principles generally accepted in the United States of America and filed with the SEC reflect all material correcting adjustments that are identified by a "registered public accounting firm" in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the SEC. Accounting Pronouncements In April 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". The Statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. This Statement had no impact on the Company's financial condition or results of operations. In May 2003, the Financial Accounting Standards Board issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity". SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both a liability and equity. It requires that an issuer classify certain financial instruments as a liability, although the financial instrument may previously have been classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. This Statement had no impact on the Company's financial condition or results of operations. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"), which covers guarantees such as standby letters of credit, performance guarantees, and direct or indirect guarantees of the indebtedness of others, but not guarantees of funding. FIN 45 requires a guarantor to recognize, at the inception of a guarantee, a liability 8 in an amount equal to the fair value of the obligation undertaken in issuing the guarantee, and requires disclosure about the maximum potential payments that might be required, as well as the collateral or other recourse obtainable. The recognition and measurement provisions of FIN 45 were effective on a prospective basis after December 31, 2002, and its adoption by the Company on January 1, 2003 has not had a significant effect on the Company's consolidated financial statements. In December 2003, the FASB revised Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which explains identification of variable interest entities and the assessment of whether to consolidate these entities. FIN 46 requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among the involved parties. The provisions of FIN 46 are effective for all financial statements issued after January 1, 2003. The Company has no variable interests in any entities which would require disclosure or consolidation. In December 2002, FASB issued SFAS No. 148, which provides three alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the impact on reported financial results. Finally, this Statement amends APB Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in interim financial information. This Statement is effective for fiscal and interim periods ending after December 15, 2003. The Company has elected to adopt the prospective transition method effective January 1, 2003 and, accordingly, compensation expense was recognized for any stock options granted on or after that date. The unvested portion of stock options granted prior to January 1, 2003 will continue to be accounted for under the provisions of APB Opinion No. 28. This Statement did not have an impact on the Company's financial condition or results of operations in 2003 since no stock options were granted. Since the method of determining the value of stock options prescribed under SFAS No. 123 is based on a valuation model that relies upon factors that are beyond the Company's control, such as stock price volatility and market interest rates, Management is not able to accurately predict the cost of options that may be granted in the future and the resulting impact on the Company's financial condition and results of operations. Additional information regarding stock options is contained in Notes A and M of the Notes to the Consolidated Financial Statements. 9 Statistical Data The following information is required by the Industry Guide 3, "Statistical Disclosure by Bank Holding Companies". The averages shown have been calculated using the average daily balance. Sequential Page Number I. Distribution of Assets, Liabilities and Share- holders' Equity; Interest Rates and Differential A. Average balance sheets 19 B. Analysis of net interest earnings 19 C. Rate/volume analysis 20 II. Investment Portfolio A. Book value (Amortized Cost) of investments 42 B. Weighted average yield and maturity 19, 23, 28 and 43 C. Securities of issuer exceeding ten percent of equity: None III. Loan Portfolio A. Types of loans 19 and 44 B. Maturities and sensitivities of loans to change in interest rates 28 and 45 C. Risk elements 1. Non-accrual, past due, and restructured loans 24 and 44 2. Potential problem loans: None 3. Foreign outstandings: None 4. Loan concentrations 23 and 44 D. Other Interest Bearing Assets: None IV. Summary of Loan Loss Experience 21, 24 and 45 V. Deposits A. Average balances and average rates paid 19 B. Other categories of deposits None C. Foreign outstandings None D. Maturity of time deposits greater than $100,000 28 E. Maturity of foreign time deposits greater than 100,000 None VI. Return on Equity and Assets 17 VII. Short-term Borrowings: None 10 ITEM 2. PROPERTIES The Company is headquartered in Sonoma, California. At the present time the Company's Bank has two branch offices with a third branch opening first quarter 2004. In 1995 the Bank leased additional office space adjacent to the Sonoma Branch and in September 1997 the Bank purchased property across the street from the Sonoma Branch. The Sonoma Branch is located at 202 W. Napa Street, Sonoma. The building contains approximately 6800 square feet and has been subleased on a long-term basis (the initial term expires in 2009, with option to extend for two additional five-year terms). The office is considered by management to be well maintained and adequate for the purpose intended. Lease payments made in 2003 totaled $224,979 compared to the $216,326 paid in 2002. The lease provides for future annual rents to be adjusted for changes in the Consumer Price Index ("CPI"), with a minimum annual increase of 4%, effective each March 1st. In July, 1995, the Bank leased a building at 463 Second Street West. The building contains approximately 2400 square feet and has been leased on a long term basis to coincide with the Sonoma Branch lease. The initial term expired in 2000, with the first option exercised to expire in 2005, with an option to extend for three additional five year terms and one additional four year term. At present the Bank utilizes all of the units. Lease payments made in 2003 totaled $37,006 compared with the $36,376 paid in 2002. The lease provides for future annual rents to be adjusted for changes in the Consumer Price Index ("CPI") effective each July 1st. In September, 1997 the Bank purchased a building at 472 Second St. West. The building contains approximately 1013 square feet. The Bank paid $246,943 for the property. At present the Bank is utilizing the parking area for additional parking for Bank employees and the Bank is renting out the building premises. Rental income in 2003 was $17,406 compared to $16,521 in 2002. The Glen Ellen Branch is located at 13751 Arnold Drive, Glen Ellen. The facility is approximately 600 square feet. The facility is leased for a five year term expiring in 2008 with the option to extend for two additional five year terms. Lease payments made in 2003 totaled $12,889 compared to $12,172 in 2002. The lease provides for future annual rents to be adjusted for changes in the CPI, with a minimum annual increase of 4% effective April 1st of each year. The Banco de Sonoma Branch, opened in March 2004, is located at 18615 Sonoma Hwy #108, Boyes Hot Springs. The facility is approximately 1200 square feet. The facility is leased for a five year term expiring in 2009 with an option to extend for two additional five year terms. The lease provides for future annual rents to be adjusted for changes in the CPI effective January 1st of each year. ITEM 3. LEGAL PROCEEDINGS In the normal course of operations, the Company and /or its Bank may have disagreements or disputes with vendors, borrowers, or employees, which may or may not result in litigation. These disputes are seen by the Company's management as a normal part of business. There are no pending actions reported and no threatened actions that management believes would have a significant material impact on the Company's financial position, results of operations or cash flows. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS The Company did not submit any matters to security holders during the fourth quarter of its last fiscal year ended December 31, 2003. 11 PART II ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS Following the reorganization the Company's common stock began trading on the Over the Counter Bulletin Board ("OTC BB") under the symbol "SBNK", and the Bank's stock ceased to be traded. The Company is not listed on any exchange or on the National Association of Securities Dealers Automated Quotation System ("NASDAQ"). Several brokers act as facilitators in the trades of Sonoma Valley Bancorp stock. They are: A.G. Edwards Hoefer and Arnett 703 2nd Street, Suite 100 555 Market Street, 18th floor Santa Rosa, CA 95409 San Francisco, CA 94105 Denise Gilseth Lisa Gallo (800) 972-4800 (800) 346-5544 Paine Webber Monroe Securities 6570 Oakmont Drive 47 State Street Santa Rosa, CA 95409 Rochester, NY 14614 John Rector Helen Rubeins (707) 539-1500 (888)995-5560 Edward Jones Sutro & Co. 515 First Street East P.O. Box 2859 Sonoma, CA 95476 Big Bear Lake, CA 92315 Gary Scott Troy Norlander (707) 935-1856 (800) 288-2811 Wedbush Morgan Securities 1300 S.W. Fifth Avenue, Suite 2000. Portland, OR 97201-5667 Joey Warmenhoven (503) 224-0480 12 The table below summarizes those trades of the common stock as reported by OTC BB, setting forth the high and low prices for the periods shown. The stock prices have been adjusted for stock dividends. Quarter Ended: High Low March 31, 2002 $ 21.32 $ 19.27 June 30, 2002 27.62 20.51 September 30, 2002 27.62 25.00 December 31, 2002 29.47 25.48 March 31, 2003 $ 29.52 $ 26.10 June 30, 2003 29.00 26.67 September 30, 2003 30.00 27.60 December 31, 2003 31.00 28.25 As of March 9, 2004, there were 1,661 holders of record of the Company's common stock. Payment of Dividends Under state law, the Board of Directors of a California state-licensed bank may declare a cash dividend, subject to the restriction that the amount available for the payment of cash dividends shall be the lesser of retained earnings of the bank or the bank's net income for its last three fiscal years (less the amount of any distributions to shareholders made during such period). However, under the Financial Institutions Supervisory Act, the FDIC has broad authority to prohibit a bank from engaging in banking practices which it considers to be unsafe or unsound. It is possible, depending upon the financial condition of the bank in question and other factors, that the FDIC may assert that the payment of dividends or other payments by a bank is considered an unsafe and unsound banking practice and therefore, implement corrective action to address such a practice. The Bank paid cash dividends of $300,000 on December 29, 2000, $500,000 on April 18, 2001, $500,000 on February 26, 2003 and $1,000,000 on June 18, 2003 to the Company. Future dividend payments from the Bank to the Company will depend on the Bank's future earnings and on the Bank's ability to meeting certain capital requirements and having an adequate allowance for loan losses. The Company paid a cash dividend of $0.25 cent per share to shareholders of record as of March 1, 2004 with payment made on March 15, 2004. The Board of Directors of the Company is currently reviewing our strategic plan to utilize our capital assets in order to enhance shareholder value. One of the initiatives includes review of the declaration of future cash dividends. No plan has yet been finalized. 13 Historically, the Company and the Bank have declared ten stock dividends of 5% each, two stock dividends of 10% in May 1996 and June 1997, one 2 for 1 stock split in March 1998 and a cash dividend in February 2004 as detailed below: Dividends Paid by the Bank -------------------------- Date Declared Record Date Date Paid ---------------------- ---------------------- --------------------- May 13, 1992 May 31, 1992 June 15, 1992 June 26, 1993 July 15, 1993 July 31, 1993 July 20, 1994 August 1, 1994 August 15, 1994 January 18, 1995 February 5, 1995 February 20, 1995 August 16, 1995 September 11, 1995 September 29, 1995 May 22, 1996 June 14, 1996 June 28, 1996 June 18, 1997 July 15, 1997 August 1, 1997 March 18, 1998 April 15, 1998 April 30, 1998 July 21, 1999 August 16, 1999 August 31, 1999 August 16, 2000 September 8, 2000 September 25, 2000 Dividends Paid by the Company ----------------------------- Date Declared Record Date Date Paid ---------------------- ---------------------- --------------------- July 18, 2001 August 3, 2001 August 17, 2001 June 17, 2002 July 2, 2002 July 16, 2002 June 18, 2003 July 2, 2003 July 16, 2003 February 18, 2004 March 1, 2004 March 15, 2004 14 ITEM 6. SELECTED FINANCIAL DATA SONOMA VALLEY BANCORP Selected Consolidated Financial Data dollars in thousands, except share and per share data For the years ended:
2003 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- ---- RESULTS OF OPERATIONS: Net interest income $ 8,906 $ 8,633 $ 8,236 $ 7,870 $ 6,699 $ 5,987 Provision for loan losses 20 393 342 335 240 335 Non-interest income 1,715 1,646 1,309 893 941 878 Non-interest expense 6,244 5,862 5,224 5,061 4614 4,100 Provision for income tax 1,446 1,275 1,379 1,160 976 843 -------- -------- -------- -------- -------- -------- $ 2,911 $ 2,744 $ 2,600 $ 2,207 $ 1,810 $ 1,587 ======== ======== ======== ======== ======== ======== SELECTED AVERAGE BALANCES: Assets $195,177 $164,200 $147,807 $135,924 $123,202 $107,202 Loans, net of unearned 123,044 116,867 100,605 86,547 73,222 70,838 Deposits 171,620 143,228 129,534 120,135 109,801 95,819 Shareholders' equity 20,232 17,964 15,121 12,984 11,490 9,976 PER SHARE DATA: Basic net income $2.00 $1.87 $1.77 $1.49 $1.21 $1.06 Fully diluted net income $1.83 $1.72 $1.66 $1.45 $1.19 $1.05 Period end book value $14.73 $13.09 $11.36 $9.67 $8.10 $7.16 Weighted average shares outstanding 1,457,431 1,464,344 1,473,151 1,478,573 1,497,447 1,502,803 FINANCIAL RATIOS: Return on average assets 1.49% 1.67% 1.76% 1.62% 1.47% 1.48% Return on average shareholders' equity 14.39% 15.27% 17.19% 17.00% 15.75% 15.91% Net yield on earning assets 5.24% 6.06% 6.25% 6.49% 6.04% 6.22% Cost Control ratio 56.95% 55.07% 52.72% 55.06% 58.52% 57.97% Average shareholders' equity to average assets 10.37% 10.94% 10.23% 9.55% 9.33% 9.31% CAPITAL RATIOS: Risk-based capital: Tier I 12.81% 12.31% 11.81% 12.78% 12.36% 12.57% Total 14.07% 13.57% 13.07% 14.04% 13.62% 13.83% Leverage ratio 10.50% 10.62% 10.38% 10.11% 9.54% 9.55% CREDIT QUALITY: Net charge-offs to average loans 0.14% 0.02% 0.05% -0.04% 0.04% 0.09% Allowance for possible loan losses to period end loans 2.15% 2.17% 2.25% 2.29% 2.19% 2.12%
15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Year Ended December 31, 2003 versus December 31, 2002 The business operations of the Company continue to be conducted through its wholly-owned subsidiary, Sonoma Valley Bank ("Bank"), which began commercial lending operations on June 3, 1988. Accordingly, the following discussion and analysis of the financial condition and the results of operations should be read in conjunction with the financial statements and notes included elsewhere in this annual report. Per share amounts for prior years have been adjusted for the Bank's prior 2 for 1 stock split declared March 18, 1998, 10% stock dividends declared June 18, 1997 and May 22, 1996 and 5% stock dividends declared in June 2003, June 2002, July 2001, August 2000, July 1999, January and August, 1995, July 1994, June 1993 and May, 1992. The continual growth and success of the company is dependent upon a stable economy, an increasing deposit base in the valley and economically viable technology to enhance customer service. Expansion of services in the valley such as the opening of a new branch, the placement of remote ATM in the local hospital, and the deployment of wire transfer services through an international network are some of the strategies for our continual successful performance. We continue to believe that community banking, through providing useful services in niche markets will prosper in spite of the consolidation taking place in the industry. Critical Accounting Policies The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States and general practices within the financial services industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. A summary of the Company's most significant accounting policies is contained in Note A to the consolidated financial statements. The Company considers its most critical accounting policies to consist of the allowance for loan and lease losses and the estimation of fair value, which are separately discussed below. Allowance for Loan and Lease Losses. The allowance for loan and lease losses represents management's best estimate of inherent losses in the existing loan portfolio. The allowance for loan and lease losses is increased by the provision for losses on loans and leases charged to expense and reduced by loans and leases charged off, net of recoveries. The provision for loan and lease losses is determined based on management assessment of several factors: reviews and evaluations of specific loans and leases, changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on specific borrowers and industry groups, historical loan and lease loss experience, the level of classified and nonperforming loans and the results of regulatory examinations. The Company's Audit Committee engage experienced independent loan portfolio review professionals many of which are former bank examiners. The Audit Committee determines the scope of such reviews and will provide the report of findings to the Board's Loan Committee after they have accepted it. These reviews are supplemented with periodic reviews by the Company's credit review function, as well as periodic examination of both selected credits and the credit review process by the applicable regulatory agencies. The information from these reviews assists management in the timely identification of problems and potential problems and provides a basis for deciding whether the credit represents a probable loss or risk that should be recognized. Changes in the financial condition of individual borrowers, in economic conditions, in historical loss experience and in the conditions of the various markets in which collateral may be sold may all affect the required level of the 16 allowance for loan and lease losses and the associated provision for loan and lease losses. Estimation of Fair Value. Accounting principles generally accepted in the United States require that certain assets and liabilities be carried on the Consolidated Balance Sheet at fair value or at the lower of cost or fair value. Furthermore, the fair value of financial instruments is required to be disclosed as a part of the notes to the consolidated financial statements for other assets and liabilities. Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, the shape of yield curves and the credit worthiness of counterparties. Fair values for the majority of the Company's available for sale investment securities are based on quoted market prices. In instances where quoted market prices are not available, fair values are based on the quoted prices of similar instruments with adjustment for relevant distinctions. For trading account assets, fair value is estimated giving consideration to the contractual interest rates, weighted average maturities and anticipated prepayment speeds of the underlying instruments and market interest rates. Overview Net income for 2003 was $2,911,007 compared with earnings of $2,744,333 in 2002. Basic earnings per share for 2003 was $2.00 compared with $1.87 in 2002. Return on average shareholders' equity declined to 14.39% in 2003 compared to 15.27% in 2002. Return on average total assets for 2003, 2002 and 2001 were 1.49%, 1.67% and 1.76%, respectively. While the bank continues to enjoy increased earnings over the last three years, the banks growth in assets has exceeded the earnings growth. Earning growth has been impacted by the decline in net interest margins, which is a combination of increased rate competition for loans and the lower market rates for investment securities. Retaining all of the banks earnings in its capital accounts has resulted in the decline in the return on equity, as the capital accounts increase at a faster growth rate than the increase in net income. The capital planning strategy going forward will deploy both a repurchase of share strategy with a cash dividend policy intended to better manage an adequate capital level. At December 31, 2003, total assets were $205.1 million, a 12.3% increase over the $182.6 million at December 31, 2002. The Company showed loans of $122.5 million in 2003, compared with $128.1 million at year-end 2002, a decline of 4.4%. Deposits increased, growing 12.6%, from $160.0 million at year-end 2002 to $180.1 million at year-end 2003. The loan-to-deposit ratio declined to 68.0% in 2003 from 80.0% in 2002. The decline in loans and the loan-to-deposit ratio is reflective of management's attention to the risk associated with making long term fixed rate loans at low interest rates and increased attention to loan quality due to concern about the economy. The company has acquired additional software to accommodate maintaining a portfolio of adjustable rate residential loans, which was not an option previously. Additionally, the bank has enhanced its ability to engage in mortgage origination for the secondary market, and will be using the increased liquidity for warehousing product available for sale. This activity is expected to enhance earnings for the company. Net Interest Income Net interest income is the difference between total interest income and total interest expense. Net interest income, adjusted to a fully taxable equivalent basis, increased $250,000 to $9.3 million, up 2.8% from 2002 net interest income of $9.0 million. Net interest income on a fully taxable equivalent basis, as shown on the table - Average Balances, Yields and Rates Paid (page 19), is higher than net interest income on the statements of operations because it reflects adjustments applicable to tax-exempt income from 17 certain securities and loans ($343,000 in 2003 and $366,000 in 2002, based on a 34% federal income tax rate). The increase in net interest income (stated on a fully taxable equivalent basis) was the net effect of a small increase of $13,000 in interest income and a $237,000 decrease in interest expense, which is a result of deposit rates declining faster than loan rates. Declining rates influenced net interest income in spite of the growth in earning assets. The decline in interest expense is expected to plateau as the effective interest cost for the bank is not expected to decline further. This combination of increased rate competition for loans and investments with an inability to lower interest costs will likely result in a flat earnings environment. Net interest income (stated on a fully taxable equivalent basis) expressed as a percentage of average earning assets, is referred to as net interest margin. The Company's net interest margin declined 82 basis points to 5.24% in 2003 from 6.06% in 2002. Interest Income As previously stated, interest income (stated on a fully taxable equivalent basis) increased by $13,000 to $11.0 million in 2003, a .12% increase over the $10.9 million realized in 2002. The $13,000 increase was the net effect of an 11.0% increase in average earning assets to $176.6 million offset by a 117 basis point decline in average yield for the year. 18 SONOMA VALLEY BANCORP AVERAGE BALANCES/YIELDS AND RATES PAID Rate/Volume
ASSETS Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield Balance Expense Rate Balance Expense Rate Rate Expense Rate - ------------------------- ------- ------- ------ -------- ------- ------ ------- ------- ----- Interest-earning assets: Loans(2): Commercial $85,965 $6,493 7.55% $75,696 $ 5,978 7.90% 61,888 $5,582 9.02% Consumer 11,632 889 7.64% 13,186 1,098 8.33% 14,583 1,370 9.39% Real estate construction 18,781 1,530 8.15% 19,040 1,689 8.87% 12,393 1,279 10.32% Real estate mortgage 3,820 333 8.72% 5,732 481 8.39% 8,983 823 9.16% Tax exempt loans (1) 3,147 263 8.36% 3,367 285 8.46% 2,566 220 8.57% Leases 67 22 32.84% 164 27 16.46% 409 42 10.27% Tax exempt leases (1) 47 10 21.28% 106 15 14.15% 165 15 9.09% Unearned loan fees (416) (424) (382) ----- ----- ----- Total loans 123,043 9,540 7.75% 116,867 9,573 8.19% 100,605 9,331 9.27% Investment securities Available for sale: Taxable 11,093 352 3.17% 6,029 365 6.05% 16,420 1,001 6.10% Tax exempt(1) 0 0 0.00% 0 0 0.00% 0 0 0.00% Hold to maturity: Taxable 392 13 3.32% 201 13 6.47% 203 13 6.40% Tax exempt (1) 11,270 736 6.53% 10,904 777 7.13% 11,779 837 7.11% ------ ----- ------ ----- ------ ----- Total investment 22,755 1,101 4.84% 17,134 1,155 6.74% 28,402 1,851 6.51% securities Federal funds sold 30,318 318 1.05% 14,053 216 1.54% 8,219 286 3.48% FHLB Stock 288 13 4.51% 275 15 5.45% 261 15 5.75% Total due from banks/Interest bearing 202 1 0.50% 73 1 1.37% 11 0 2.73% ------- ------ ------- ------ ------- ------ Total interest earning 176,606 10,973 6.21% 148,402 10,960 7.39% 137,498 11,483 8.35% assets ======= ====== ======= ====== ======= ====== Noninterest-bearing assets: Reserve for loan losses (2,772) (2,547) (2,263) Cash and due from banks 9,090 7,600 6,620 Premises and equipment 1,120 705 620 Other assets 11,133 10,040 5,332 -------- -------- -------- Total assets $195,177 $164,200 $147,807 ======== ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Interest bearing liabilities: Interest bearing deposits Interest bearing 29,819 $51 0.17% $23,794 $ 84 0.35% $21,940 $ 149 0.68% transaction Savings deposits 59,266 466 0.79% 48,052 656 1.37% 42,074 997 2.37% Time deposits 19,794 477 2.41% 18,362 547 2.98% 16,739 845 5.05% over $100,000 Other time deposits 25,209 730 2.90% 20,155 674 3.34% 18,913 885 4.68% deposits ------ --- ------ --- ------ --- Total interest bearing Deposits 134,088 1,724 1.28% 110,363 1,961 1.78% 99,666 2,876 2.89% Federal Funds purchased 0 0 0.00% 0 0 0.00% 0 0 0% Other short term 3 0 0.00% 0 0 0.00% 174 7 4.02% borrowings ------- ----- ------- ----- ------ ----- Total interest bearing liabilities 134,091 1,724 1.28% 110,363 $ 1,961 1.78% 99,840 $ 2,883 2.89% ===== ======= ======= Non interest bearing liabilities: Non interest bearing 37,531 32,865 29,868 demand deposits Other liabilities 3,323 3,008 2,978 Shareholders' equity 20,232 17,964 15,121 ------- ------- ------ Total liabilities and shareholders' equity 195,177 $164,200 $147,807 ======= ======== ======== shareholders' equity Interest rate spread 4.93% 5.61% 5.46% Interest income $10,973 6.21% $10,960 7.39% $11,483 8.35% Interest expense 1,724 0.98% 1,961 1.32% 2,883 2.10% ------- ------- ------- Net interest income/margin $9,249 5.24% $8,999 6.06% $8,600 6.25% ======= ======= =======
(1) Fully tax equivalent adjustments are based on a federal income tax rate of 34% in 2003, 2002 and 2001. (2) Non accrual loans have been included in loans for the purposes of the above presentation. Loan fees of approximately $405,000, $343,000 and $334,000 for the twelve months ended December 31, 2003, 2002 and 2001, respectively, were amortized to the appropriate interest income categories. 19 SONOMA VALLEY BANCORP Rate/Volume Analysis
2003 over 2002 2002 over 2001 --------------- --------------- Volume Rate Vol/Rate Total Volume Rate Vol/Rate Total ASSETS Interest-earning assets: Loans: Commercial 811 (261) (35) 515 1,245 (694) (155) 396 Consumer (129) (90) 11 (209) (131) (156) 15 (272) Real estate (23) (138) 2 (159) 686 (180) (96) 410 construction Real estate mortgage (160) 19 (6) (148) (298) (69) 25 (342) Tax exempt loans (19) (4) 0 (22) 69 (3) (1) 65 Leases (16) 27 (16) (5) (25) 25 (15) (15) Tax exempt leases (8) 8 (4) (5) (5) 8 (3) 0 Unearned fee income 0 0 0 0 0 0 0 0 ---- ----- ---- ---- ----- ------- ----- ---- Total loans 456 (439) (48) (33) 1,541 (1,069) (230) 242 Investment securities: Available for sale: Taxable 307 (174) (146) (13) (633) (7) 4 (636) Tax-exempt 0 0 0 0 0 0 0 0 Held to maturity: Taxable 12 (6) (6) 0 0 0 0 0 Tax-exempt 26 (65) (2) (41) (62) 2 0 (60) ---- ----- ---- ---- ----- ------- ----- ---- Total investment securities 345 (245) (154) (54) (695) (5) 4 (696) Federal funds sold 250 (69) (79) 102 203 (160) (113) (70) FHLB Stock 1 (3) (0) (2) 1 (1) 0 0 Due from banks-int bearing 2 (1) (1) 0 2 0 (1) 1 ---- ----- ---- ---- ----- ------- ----- ---- Total interest-earning assets 1,054 (757) (282) 13 1,052 (1,235) (340) (523) ===== ===== ===== ==== ===== ======= ===== ===== LIABILITIES Interest-bearing liabilities: Interest-bearing deposits: Savings deposits 21 (44) (11) (34) 13 (72) (6) (65) Interest-bearing demand deposits 153 (277) (65) (189) 142 (423) (60) (341) Time less than $100,000 43 (105) (8) (70) (26) (321) 9 (338) Time $100,000 and over 169 (90) (23) 56 172 (285) (58) (171) ---- ----- ---- ---- ----- ------- ----- ---- Total interest-bearing deposits 386 (516) (107) (237) 301 (1,101) (115) (915) Federal funds purchased 0 0 0 0 0 0 0 0 Other borrowings 0 0 0 0 (7) (7) 7 (7) ---- ----- ---- ---- ----- ------- ----- ---- Total interest-bearing liabilities 386 (516) (107) (237) 294 (1,108) (108) 922 Interest differential 668 (241) (175) 250 758 (127) (232) 399 ===== ===== ===== ==== ===== ======= ===== =====
Volume/Rate variances were allocated in the following manner: a. Changes affected by volume (change in volume times old rate) b. Changes affected by rates (change in rates times old volume) c. Changes affected by rate/volume (change in volume times change in rates) The total for each category was arrived at by totaling the individual items in their respective categories. 20 Interest Expense Total interest expense declined by $237,000 to $1.7 million. The average rate paid on all interest-bearing liabilities was 1.28%, compared to 1.78% in 2002. Average balances increased from $110.4 million to $134.1 million, a 21.5% gain. The gain in volume of average balances was responsible for a $279,000 increase in interest expense offset by a $516,000 decrease related to lower interest rates paid for a net decrease of $237,000. The lower rates paid on interest-bearing liabilities is a result of a declining interest rate environment. Individual components of interest income and interest expense are provided in the table - Average Balances, Yields and Rates Paid on page 19. Provision for Loan Losses The provision for loan losses charged to operations is based on the Bank's monthly evaluations of the loan portfolio and the adequacy of the allowance for loan losses in relation to total loans outstanding. The provisions to the allowance for loan losses amounted to $20,000 in 2003 and $393,000 in 2002. The decrease in the provision is the result management's evaluation and assessment of the loan portfolio and decline in the loan growth. Loans charged-off, net of recoveries, resulted in losses totaling $167,000 in 2003 and $27,000 in 2002. The increase in charge offs reflects loan problems related to the economic downturn. Refer to page 45, Note D for an analysis of the changes in the allowance for loan and lease losses. Non-interest Income Non-interest income of $1.7 million increased 4.5% in comparison with the $1.6 million recorded in 2002. The increase was primarily due to a $70,000 increase in service charges on deposit accounts. Non-interest Expense Total non-interest expense increased 6.5% to $6.2 million in 2003 from $5.9 million in 2002. Non-interest expense represented 3.2% of average total assets in 2003 and 3.6% in 2001. The expense/asset ratio is a standard industry measurement of a bank's ability to control its overhead or non-interest costs. During 2004, the Company will continue to emphasize cost controls. Certain costs are not controllable by management. Refer to Note I, page 49, for a detailed description of Non-Interest Income and Other Non-Interest Expense. Salaries and Benefits Salaries and benefits increased 1.5% from $3.4 million in 2002 to $3.5 million in 2003. The 2003 increase reflects normal merit increases and employee incentives paid as a result of the Company's earnings in 2003. Additionally, there continues to be significant increases in workers compensation and employee medical benefits. At December 31, 2003 and 2002 total full-time equivalent employees were 49 and 44 respectively. Year-end assets per employee were $4.2 million in 2003 and 2002 compared to $3.3 million in 2001. 21 Premises and Equipment Expenses related to premises and equipment increased by 24.4% to $769,000 in 2003 from $618,000 in 2002. Building lease expense on three locations and storage units increased to $289,000 in 2003 from $278,000 in 2002. Lease income for 2003 totaled $17,000 compared to lease income of $17,000 in 2002. The increase in premises and equipment expense is the result renovation and remodeling of the Operations Center and Sonoma Main Office facility. Other Non-interest Expense Other non-interest expense increased by 9.9% to $2.0 million in 2003 from $1.8 million in 2002. The increase was the result of a 22.2% increase in professional fees. Professional fees is the largest category of other non-interest expense, primarily comprised of accounting, legal and other professional fees. These services increased by $210,000 to $1,153,000 in 2003 from $944,000 in 2002. This increase is the result of the additional regulatory requirements as a result of Sarbanes-Oxley and the U.S. Patriot Act. Increases in other categories reflect the increased growth and volume of business in general. Provision for Income Taxes The provision for income taxes increased to an effective tax rate of 33.2% in 2003 compared with 31.7% in 2002. Balance Sheet Analysis Investment Securities Securities are classified as held to maturity if the Company has both the intent and the ability to hold these securities to maturity. As of December 31, 2003, the Company had securities totaling $16.6 million with a market value of $17.0 million categorized as held to maturity. Decisions to acquire municipal securities, which are generally placed in this category, are based on tax planning needs and pledge requirements. Securities are classified as available for sale if the Company intends to hold these debt securities for an indefinite period of time, but not necessarily to maturity. Investment securities which are categorized as available for sale are acquired as part of the overall asset and liability management function and serve as a primary source of liquidity. Decisions to acquire or dispose of different investments are based on an assessment of various economic and financial factors, including, but not limited to, interest rate risk, liquidity and capital adequacy. Securities held in the available for sale category are recorded at market value, which is $20.1 million compared to an amortized cost of $20.1 million as of December 31, 2003. At year end 2003 the overall portfolio had a market value of $37.2 million compared with an amortized cost of $36.6 million. Investment securities increased 166.8% to $36.7 million from $13.7 million in 2002. The Company purchases securities rated A or higher by Standard and Poor's and/or Moody's Investors Service. At year end the Company had two securities totaling $656,000 with ratings below A, both mature in 2004. Tax-exempt bonds are occasionally purchased without an A rating. In the opinion of management, there was no investment in securities at December 31, 2003 that would constitute a material credit risk to the Company. 22 The table below shows the components of the investment portfolio and average yields. For further information concerning the Company's total securities portfolio, including market values and unrealized gains and losses, refer to Note C of the Notes to Consolidated Financial Statements on pages 42 and 43.
Twelve months ended 12/31/03 Twelve months ended 12/31/02 Average Average Average Average Balance Yield Balance Yield ------- ------- ------- ------- U.S. Treasury securities $ 780 1.8% $ 2,529 6.0% U.S. federal agency issues 9,263 2.9% 1,596 6.1% State, county and municipal issues 11,662 6.4% 11,105 7.1% Corporate securities 1,050 6.4% 1,904 6.1% -------- -------- Total investment securities $ 22,755 4.8% $ 17,134 6.7% ======== ========
Loans A comparative schedule of average loan balances is presented in the table on page 19; year-end balances are presented in Note D to the Consolidated Financial Statements pages 44 and 45. Loan balances, net of deferred loan fees at December 31, 2003, were $122.5 million, a decrease of 4.4% over 2002. Commercial loans, comprising 75.0% of the portfolio, increased $2.7 million, or 3.0% over 2002. This increase represents the only category of loans showing growth in 2003. Included in commercial loans are loans made for commercial purposes and secured by real estate. Real Estate Construction loans declined $2.8 million, or 14.7% over 2002 balances. Consumer loans, including home equity loans, decreased $1.6 million or 12.1% over 2002 balances while real estate mortgage loans declined $3.7 million or 62.3%. In 1997 the Company began offering leasing opportunities to small businesses. Lease financing receivables for year end 2003 decreased $94,000 or 54.0%. Risk Elements The majority of the Company's loan activity is with customers located within Sonoma County. Approximately 84% of the total loan portfolio is secured by real estate located in the Company's service area (see Note P, on page 57 of the Consolidated Financial Statements, Concentration of Credit Risk). Significant concentrations of credit risk may exist if a number of loan customers are engaged in similar activities and have similar economic characteristics. The Company believes that it has policies in place to identify problem loans and to monitor concentration of credits of loan customers engaged in similar activities. Commitments and Letters of Credit Loan commitments are written agreements to lend to customers at agreed upon terms provided there are no violations of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Loan commitments may have variable interest rates and terms that reflect current market conditions at the date of commitment. Because many of the commitments are expected to expire without being drawn upon, the amount of total commitments does not necessarily represent the Company's anticipated future funding requirements. Unfunded loan commitments were $35.3 million at December 31, 2003 and $30.4 million at December 31, 2002. 23 Standby letters of credit commit the Company to make payments on behalf of customers when certain specified events occur. Standby letters of credit are primarily issued to support customers' financing requirements of twelve months or less and must meet the Company's normal policies and collateral requirements. Standby letters of credit outstanding were $725,000 at December 31, 2003 and $589,000 at December 31, 2002. Nonperforming Assets Management classifies all loans as non-accrual loans when they become more than 90 days past due as to principal or interest, or when the timely collection of interest or principal becomes uncertain, if earlier, unless they are adequately secured and in the process of collection. A loan remains in a non-accrual status until both principal and interest have been current for six months and meets cash flow or collateral criteria or when the loan is determined to be uncollectible and is charged off against the allowance for loan losses, or in the case of real estate loans, is transferred to other real estate owned. A loan is classified as a restructured loan when the interest rate is materially reduced, when the term is extended beyond the original maturity date or other concessions are made by the Company because of the inability of the borrower to repay the loan under the original terms. The Company had $1.2 million in non-accrual status at December 31, 2003 and $897,000 at December 31, 2002. There were $1.2 million in loans 90 days or more past due at December 31, 2003 and $796,000 in loans 90 days or more past due at December 31, 2002. Allowance for Loan Losses The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. The allowance is increased by provisions charged to operating expense and reduced by charge-offs, net of recoveries. The allowance is based on estimates, and ultimate losses may vary from the current estimates. These estimates are reviewed monthly and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. The review process is intended to identify loan customers who may be experiencing financial difficulties. In these circumstances, a specific reserve allocation or charge-off may be recommended. Other factors considered by management in evaluating the adequacy of the allowance include: loan volume, historical net loan loss experience, the condition of industries and geographic areas experiencing or expected to experience economic adversities, credit evaluations, and current economic conditions. The allowance for loan losses is not a precise amount, but based on the factors above, represents management's best estimate of losses that may be ultimately realized from the current loan portfolio. Worsening conditions in certain economic sectors and geographic areas could adversely affect the loan portfolio, necessitating larger provisions for loan losses than currently estimated. However, as of December 31, 2003, the Company believes its overall allowance for loan losses is adequate based on its analysis of conditions at that time. At December 31, 2003, the allowance for loan losses was $2.6 million, or 2.2% of year end loans, compared with $2.8 million or 2.2% of year end loans at December 31, 2002. Net charge-offs to average loans increased when compared with the prior year. The Company recorded net losses of $167,000 or .14% of average loans in 2003 compared to $27,000 or .02% of average loans in 2002. The continued low level of charge-offs in 2003 reflects the Company's attention and effort in managing and collecting past due loans by encouraging the customer to bring them to a current status or to pay them off. 24 Deposits A comparative schedule of average deposit balances is presented in the table on page 19; year-end deposit balances are presented in the table below. Total deposits increased $20.1 million (12.6%) in 2003, to $180.1 million. Demand deposits declined $813,000, or 2.1% in 2003. Savings deposits increased by $11.9 million, or 22.9% and interest bearing checking increased $7.8 million or 31.8% during 2003. Other time deposits of less than $100,000 decreased $325,000, or 1.6% and time deposits over $100,000 increased $1.5 million, for an increase of 6.2% over 2002 balances. The composition of deposits for the years ending December 31, 2003 and 2002 are as follows:
December 31, Percentage December 31, Percentage 2003 of Total 2002 of Total ------------ ---------- ------------ ---------- Interest bearing transaction deposits $32,467,678 18.0% $24,627,589 15.4% Savings deposits 63,680,697 35.4% 51,802,714 32.4% Time deposits, $100,000 and over 26,565,347 14.7% 25,018,603 15.6% Other time deposits 19,453,317 10.8% 19,778,540 12.4% ------------ ------------ ------ Total interest bearing deposits 142,167,039 78.9% 121,227,446 75.8% Noninterest-bearing deposits 37,947,577 21.1% 38,760,806 24.2% ------------ ------------ ------ Total deposits $180,114,616 100.0% $159,988,252 100.0% ============ ============ ======
Capital The Bank is subject to FDIC regulations governing capital adequacy. The FDIC has adopted risk-based capital guidelines which establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures. Under the current guidelines, as of December 31, 2003, the Bank was required to have minimum Tier I and total risk-based capital ratios of 4% and 8% respectively. To be well capitalized under Prompt Corrective Action Provisions requires minimum Tier I and total risk-based capital ratios should be 6% and 10% respectively. The FDIC has also adopted minimum leverage ratio guidelines for compliance by banking organizations. The guidelines require a minimum leverage ratio of 4 percent of Tier 1 capital to total average assets. Banks experiencing high growth rates are expected to maintain capital positions well above the minimum levels. The leverage ratio in conjunction with the risk-based capital ratio constitute the basis for determining the capital adequacy of banking organizations. Based on the FDIC's guidelines, the Bank's total risk-based capital ratio at December 31, 2003 was 13.44% and its Tier 1 risk-based capital ratio was 12.18%. The Bank's leverage ratio was 10.00%. All the ratios exceed the minimum guidelines of 8.00%, 4.00% and 4.00%, respectively. The ratios for the Holding Company at December 31, 2002, were 13.57%, 12.31% and 10.62%, respectively. The capital ratios for the Holding Company at December 31, 2003, were 14.07%, 12.81% and 10.49%, respectively. In February 2001, the Company approved a program to repurchase Sonoma Valley Bancorp stock up to $1 million and in August 2002 the Company approved the repurchase of an additional $1 million Sonoma Valley Bancorp stock. As of December 31, 2003, $1,448,737 was repurchased and retired, net of options which were exercised and then subsequently repurchased and retired. The Company is continuing to repurchase Sonoma Valley Bancorp stock up to the authorized amount. 25 Management believes that the Bank's current capital position, which exceeds guidelines established by industry regulators, is adequate to support its business. Off Balance Sheet Commitments The Company's off balance sheet commitments consist of commitments to extend credit and standby letters of credit. These commitments are extended to customers in the normal course of business and are described in Note O to the Consolidated Financial Statements on page 55. The Company also has contractual obligations consisting of operating leases for various facilities and payments to participants under the Company's supplemental executive retirement plan and deferred compensation plan, which are described in Note H. The following table summarizes the Company's contractual obligations as of December 31, 2003.
Payments due by period Less than 1 More than 5 Contractual Obligations Total year 1-3 years 3-5 Years years - ---------------------------------------------------------------------------------------------------- Operating Lease Obligations 1,623,625 302,802 582,837 594,949 143,037 Executive Officer Supplemental Retirement 1,733,623 5,000 29,502 186,543 1,512,578 Deferred Compensation 989,788 12,819 16,844 106,504 853,621
Liquidity Management The Company's liquidity is determined by the level of assets (such as cash, federal funds sold and available-for-sale securities) that are readily convertible to cash to meet customer withdrawal and borrowing needs. Deposit growth also contributes to the Company's liquidity needs. The Company's liquidity position is reviewed by management on a regular basis to verify that it is adequate to meet projected loan funding and potential withdrawal of deposits. The Company has a comprehensive Asset and Liability Policy which it uses to monitor and determine adequate levels of liquidity. At year end 2003, the Company's liquidity ratio (adjusted liquid assets to deposits and short term liabilities) was 29.03% compared to 20.39% and 21.08% at year end 2002 and 2001, respectively. Management expects that liquidity will remain adequate throughout 2004, as loans are not expected to grow significantly more than deposits, and excess funds will continue to be invested in quality liquid assets. Market Risk Management Overview. Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from interest rate risk inherent in its loan and deposit functions. The goal for managing the assets and liabilities of the Company is to maximize shareholder value and earnings while maintaining a high quality balance sheet without exposing the Company to undue interest rate risk. The Board of Directors has overall responsibility for the interest rate risk management policies. Sonoma Valley Bank has an Asset and Liability Management Committee (ALCO) that establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates. Asset/Liability Management. Activities involved in asset/liability management include but are not limited to lending, accepting and placing deposits and investing in securities. Interest rate risk is the primary market risk associated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities. To 26 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 and market value of equity under changing interest environments. The Company uses simulation models to forecast earnings, net interest margin and market value of equity. Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Using computer-modeling techniques, the Company is able to estimate the potential impact of changing interest rates on earnings. A balance sheet forecast is prepared quarterly using inputs of actual loans, securities and interest bearing liabilities (i.e. depositis/borrowings) positions as the beginning base. The forecast balance sheet is processed against four interest rate scenarios. The scenarios include a 100 and 200 basis point rising rate forecasts, a flat rate forecast and a 100 basis point falling rate forecast which take place within a one year time frame. The net interest income is measured during the year assuming a gradual change in rates over the twelve-month horizon. The Company's 2004 net interest income, as forecast below, was modeled utilizing a forecast balance sheet projected from year-end 2002 balances. The following table summarizes the effect on net interest income (NII) of a +/-100 and +200 basis point change in interest rates as measured against a constant rate (no change) scenario. Interest Rate Risk Simulation of Net Interest Income as of December 31, 2003 (In thousands) Variation from a constant rate scenario Change in NII +200bp $948 +100bp $434 -100bp ($328) The simulations of earnings do not incorporate any management actions, which might moderate the negative consequences of interest rate deviations. Therefore, they do not reflect likely actual results, but serve as conservative estimates of interest rate risk. Interest Rate Sensitivity Analysis. Interest rate sensitivity is a function of the repricing characteristics of the portfolio of assets and liabilities. These repricing characteristics are the time frames within which the interest-bearing assets and liabilities are subject to change in interest rates either at replacement, repricing or maturity. Interest rate sensitivity management focuses on the maturity of assets and liabilities and their repricing during periods of changes in market interest rates. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in the current portfolio that are subject to repricing at various time horizons. The differences are known as interest sensitivity gaps. A positive cumulative gap may be equated to an asset sensitive position. An asset sensitive position in a rising interest rate environment will cause a bank's interest rate margin to expand. This results as floating or variable rate loans reprice more rapidly than fixed rate certificates of deposit that reprice as they mature over time. Conversely, a declining interest rate environment will cause the opposite effect. A negative cumulative gap may be equated to a liability sensitive position. A liability sensitive position in a rising interest rate environment will cause a bank's interest rate margin to contract, while a declining interest rate environment will have the opposite effect. The following table sets forth the dollar amounts of maturing and/or repricing assets and liabilities for various periods. This does not include the impact of prepayments or other forms of convexity caused by changing interest rates. Historically, this has been immaterial and estimates for them are not included. 27 The Company has more liabilities than assets repricing during the next year. However, because the Company's asset rates change more than deposit rates, the Company's interest income will change more than the cost of funds when rates change. Its net interest margin should therefore increase somewhat when rates increase and shrink somewhat when rates fall. The Company controls its long term interest rate risk by keeping long term fixed rate assets (longer than 5 years) less than its long term fixed rate funding, primarily demand deposit accounts and capital. The following table sets forth cumulative maturity distributions as of December 31, 2003 for the Company's interest-bearing assets and interest-bearing liabilities, and the Company's interest rate sensitivity gap as a percentage of total interest-earning assets. The table shows $72.5 million in fixed rate loans over 5 years. Many variable rate credit lines reached floors in 2003, and were reclassified to the fixed rate category. As soon as interest rates increase, the loans will no longer be at floors and will be reclassified back to the floating rate category. (dollars in thousands)
December 31, 2003 3 months 12 months 3 years 5 years 15 years >15 years Totals - ------------------------------------------------------------------------------------------------- ASSETS: Fixed rate investments $300 $3,977 $11,268 $4,858 $15,298 $977 $36,678 Variable rate investments 295 295 Fixed rate loans 11,452 12,844 11,686 30,199 39,608 2,696 108,485 Variable rate loans 13,191 0 0 0 0 0 13,191 Interest-bearing balances 35 35 Fed funds sold 25,220 25,220 ------ ------ Interest bearing assets 50,198 16,821 22,954 35,057 54,906 3,968 183,904 ====== ====== ====== ====== ====== ===== ======= LIABILITIES: Interest bearing 32,468 32,468 transaction deposits Savings deposits 63,681 63,681 Time deposits Fixed rate >100m 5,933 13,199 5,251 2,254 26,637 Fixed rate <100m 5,437 8,743 4,114 1,043 19,337 Floating rate >100m 0 Floating rate <100m 44 44 Borrowings 0 0 ----- ------ Interest Bearing $107,563 $21,942 $9,365 $3,297 $ 0 $0 $142,167 Liabilities ======== ======= ====== ====== === ===== ======== Rate Sensitivity Gap (57,365) (5,121) 13,589 31,760 54,906 3,968 Cumulative Rate (57,365)(62,486) (48,897) (17,137) 37,769 41,737 Sensitivity Gap Cumulative Position to (27.97%)(30.47%) (23.84%) (8.36%) 18.41% 20.34% Total Assets
Inflation Assets and liabilities of a financial institution are principally monetary in nature. Accordingly, interest rates, which generally move with the rate of inflation, have potentially the most significant effect on the Company's net interest income. The Company attempts to limit inflation's impact on rates and net income margins by minimizing its effect on these margins through continuing asset/liability management programs. 28 Management's Discussion and Analysis The Year Ended December 31, 2002 versus December 31, 2001 Summary Net income for 2002 was $2.7 million compared with $2.6 million in 2001. Basic earnings per share for 2002 were $1.87 compared with $1.77 in 2001. Return on average assets was 1.67% in 2002 compared with 1.76% the previous year, while return on average equity was 15.27% in 2002 and 17.19% for the previous year. Total assets reached $182.6 million in 2002, an 16.0% increase over the $157.4 million at December 31, 2001. Loans increased 19.2% to $128.1 million, compared with $107.4 million at year-end 2001. Deposits also increased, growing 16.2% from $137.7 million at year-end 2001 to $160.0 million at year-end 2002. The loan-to-deposit ratio increased from 78.1% to 80.0%. Net Interest Income Net interest income on a fully tax equivalent basis increased by $399,000 to $9.0 million in 2002, up 4.6% from 2001 net interest income of $8.6 million. The net interest margin for 2002 decreased to 6.06% from 6.25% for the previous year. Individual components of interest income and interest expense are provided in the table - Average Balances, Yields and Rates Paid on page 19. Interest Income Interest income decreased by $523,000 to $11.0 million for a 4.6% decline over the $11.5 million realized in 2001. The volume of earning assets increased by 7.9% to $148.4 million from $137.5 million in 2001, while the yield on average earning assets declined 97 basis points. Interest Expense Interest expense decreased by $922,000 to $2.0 million in 2002 from $2.9 million in 2001. The average rate paid on all interest-bearing liabilities decreased from 2.89% in 2001 to 1.78% in 2002 while average balances increased from $99.8 million to $110.4 million, a 10.5% gain over 2001. The gain in volume of average balances was responsible for a $186,000 increase in interest expense and higher interest rates paid resulted in a decrease of $1,108,000 for a total decrease of $922,000. The higher rates paid on interest bearing liabilities is the result of a raising rate environment. Provision for Loan Losses The provision for loan losses was $393,000 in 2002 and $342,000 in 2001. The increase in the provision is primarily the result of loan growth and management's evaluation and assessment of the loan portfolio. Loans charged off, net of recoveries, resulted in losses totaling $27,000 in 2002 and losses of $47,000 in 2001. The increase in charge-offs reflects current economic conditions. Non-interest Income Non-interest income increased by 25.4% to $1.6 million from $1.3 million the previous year. The increase was due to increases in all categories of non interest income with a 189.0% increase in other non interest income, a 3.7% increase in service charge on deposit accounts and a 24.3% increase in other fee income. 29 Non-interest Expense Non-interest expenses increased 12.2% to $5.9 million in 2002 from $5.2 million in 2001. Non-interest expense represented 3.6% of average total assets at December 31, 2002 and 3.5% at December 31, 2001. Salaries and benefits increased by 9.3% from $3.1 million in 2001 to $3.4 million in 2002. The 2002 increase reflects normal merit increases, incentives and other increases in employee benefits. At December 31, 2002, total full-time equivalent employees were 44 compared to 47 at December 31, 2001. Year end assets per employee were $4.2 million in 2002 compared to $3.3 million in 2001. Expenses related to premises and equipment increased by 5.5% to $618,000 in 2002, from $586,000 in 2001. Building lease expense on three locations and storage units increased to $278,000 in 2002 from $268,000 in 2001. Other non-interest expenses increased by 21.0% to $1.8 million in 2002 from $1.5 million in 2001. The increase was primarily the result of a 66.2% increase in professional fees. Professional fees is the largest category of other non-interest expense, primarily comprised of accounting, legal and other professional fees. These services increased by $190,000 to $478,000 in 2002 from $288,000 in 2001. Advertising and business development show an increase of 90.2% or $95,000 to $200,848 in 2002 from $105,614 in 2001. Advertising/business development includes advertising, customer relations, shareholder relations, public relations, donations and civic dues and is a result of the bank's community involvement. Increases in other categories reflect the increased growth and volume of business in general. Provision for Income Taxes The provision for income taxes decreased to an effective tax rate of 31.72% in 2002 compared with 34.66% in 2001. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information regarding Quantitative and Qualitative Disclosures about Market Risk appears on page 26 through 28 under the caption "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations - Market Risk Management" and is incorporated herein by reference. 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Richardson & Company 550 Howe Avenue, Suite 210 Sacramento, California 95825 Telephone: (916) 564-8727 FAX: (916) 564-8728 REPORT OF RICHARDSON & COMPANY INDEPENDENT AUDITORS Board of Directors and Shareholders Sonoma Valley Bancorp and Subsidiary Sonoma, California We have audited the accompanying consolidated balance sheets of Sonoma Valley Bancorp and Subsidiary as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in the shareholders' equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Bancorp's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sonoma Valley Bancorp and Subsidiary as of December 31, 2003 and 2002, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. January 29, 2004 /s/ Richardson & Company 31 SONOMA VALLEY BANCORP AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, 2003 and 2002
ASSETS 2003 2002 ----------- ----------- Cash and due from banks $ 9,803,272 $ 8,387,953 Federal funds sold 25,220,000 23,095,000 Interest-bearing due from banks 330,930 34,646 ----------- ----------- Total cash and cash equivalents 35,354,202 31,517,599 Investment securities available-for-sale, at fair value 20,119,777 3,823,259 Investment securities held-to-maturity (fair value of $17,042,186 and $10,440,453, respectively) 16,558,153 9,923,737 Loans and lease financing receivables, net 119,833,989 125,269,181 Premises and equipment, net 1,313,995 875,697 Accrued interest receivable 906,958 799,282 Cash surrender value of life insurance 7,730,600 7,387,712 Other assets 3,288,463 3,006,260 ------------- ------------- Total assets $205,106,137 $182,602,727 ============ ============ LIABILITIES Noninterest-bearing demand deposits $ 37,947,577 $ 38,760,806 Interest-bearing transaction deposits 32,467,678 24,627,589 Savings and money market deposits 63,680,697 51,802,714 Time deposits, $100,000 and over 26,565,347 25,018,603 Other time deposits 19,453,317 19,778,540 ------------ ------------ Total deposits 180,114,616 159,988,252 Accrued interest payable and other liabilities 3,520,242 3,374,165 ------------ ------------ Total liabilities 183,634,858 163,362,417 Commitments and contingencies ( see accompanying notes ) SHAREHOLDERS' EQUITY Common stock, no par value; 10,000,000 shares authorized; 1,457,594 shares in 2003 and 1,401,146 in 2002 issued and outstanding 15,061,636 12,936,225 Retained earnings 6,386,083 6,215,790 Accumulated other comprehensive income 23,560 88,295 ------------ ------------ Total shareholders' equity 21,471,279 19,240,310 ------------ ------------ Total liabilities and shareholders' equity $205,106,137 $182,602,727 ============ ============
The accompanying notes are an integral part of these financial statements. 32 SONOMA VALLEY BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001 ---------------- --------------- ---------------- INTEREST INCOME Loans and leases $ 9,446,841 $ 9,470,998 $ 9,251,314 Taxable securities 365,459 378,511 1,013,330 Tax-exempt securities 485,460 512,708 552,110 Federal funds sold and other 318,798 216,362 286,083 Dividends 13,269 15,227 15,812 ----------- ----------- ----------- Total interest income 10,629,827 10,593,806 11,118,649 INTEREST EXPENSE Interest-bearing transaction deposits 50,454 84,241 149,078 Savings and money market deposits 466,081 655,841 996,864 Time deposits, $100,000 and over 729,758 674,089 844,351 Other time deposits 477,061 546,543 885,322 Other 31 7,221 ---------- ----------- ----------- Total interest expense 1,723,385 1,960,714 2,882,836 ---------- ---------- ----------- NET INTEREST INCOME 8,906,442 8,633,092 8,235,813 Provision for loan and lease losses 20,000 393,000 342,000 ---------- ---------- ----------- NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES 8,886,442 8,240,092 7,893,813 NON-INTEREST INCOME 1,715,123 1,641,191 1,309,315 NON-INTEREST EXPENSE Salaries and employee benefits 3,489,007 3,437,390 3,143,911 Premises and equipment 768,789 618,029 585,748 Other 1,986,365 1,806,954 1,494,285 ---------- ---------- ----------- Total non-interest expense 6,244,161 5,862,373 5,223,944 Income before provision ---------- ---------- ----------- for income taxes 4,357,404 4,018,910 3,979,184 Provision for income taxes 1,446,397 1,274,577 1,378,940 ---------- ---------- ----------- NET INCOME $2,911,007 $2,744,333 $ 2,600,244 ========== ========== =========== NET INCOME PER SHARE $ 2.00 $ 1.87 $ 1.77 NET INCOME PER SHARE ====== ====== ====== ASSUMING DILUTION $ 1.83 $ 1.72 $ 1.66 ====== ====== ======
The accompanying notes are an integral part of these financial statements. 33 SONOMA VALLEY BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the years ended December 31, 2003, 2002 and 2001
Accumulated Other Comprehensive Common Stock Retained Comprehensive Income Shares Amount Earnings Income Total ------------- --------- ----------- ----------- ------------- ------------ BALANCE AT JANUARY 1, 2001 1,281,680 $ 9,585,003 $ 4,641,551 $ 78,692 $ 14,305,246 5% stock dividend 63,104 1,381,976 (1,381,976) Fractional shares (11,955) (11,955) Redemption and retirement of stock (27,717) (207,323) (364,085) (571,408) Stock options exercised and 16,437 266,229 266,229 related tax benefits Net income for the year $2,600,244 2,600,244 2,600,244 Other comprehensive income, net of tax: Unrealized holding gains on securities available- for-sale arising during 82,706 the year, net of taxes ----------- of $57,842 Other comprehensive income, net of taxes 82,706 82,706 82,706 ---------- ---------- --------- ------------ --------- ---------- Total comprehensive income $2,682,950 ========== BALANCE AT DECEMBER 31, 2001 1,333,504 11,025,885 5,483,779 161,398 16,671,062 5% stock dividend 65,742 1,775,026 (1,775,026) Fractional shares (13,951) (13,951) Redemption and retirement of stock (14,596) (121,257) (223,345) (344,602) Stock options exercised and related tax benefits 16,496 256,571 256,571 Net income for the year $ 2,744,333 2,744,333 2,744,333 Other comprehensive income, net of tax: Unrealized holding gains on securities available- for-sale arising during (73,103) the year, net of taxes ----------- of $51,125 Other comprehensive income, net of taxes (73,103) (73,103) (73,103) ----------- ---------- ----------- ------------ --------- --------- Total comprehensive income $ 2,671,230 =========== (Continued)
34 SONOMA VALLEY BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Continued) For the years ended December 31, 2003, 2002 and 2001
Accumulated Other Comprehensive Common Stock Retained Comprehensive Income Shares Amount Earnings Income Total ------------- --------- ----------- ----------- ------------- ------------ BALANCE AT DECEMBER 31, 2002 1,401,146 $12,936,225 $ 6,215,790 $ 88,295 $19,240,310 5% stock dividend 68,665 1,997,422 (1,997,422) Fractional shares (14,193) (14,193) Redemption and retirement of stock (38,987) (361,296) (729,099) (1,090,395) Stock options exercised and related tax benefits 26,770 489,285 489,285 Net income for the year $ 2,911,007 2,911,007 2,911,007 Other comprehensive income, net of tax: Unrealized holding losses on securities available- for-sale arising during the year, net of taxes of $45,274 (64,735) ------------ Other comprehensive income, net of taxes (64,735) (64,735) (64,735) ------------ ----------- ------------- ------------ ------------- ----------- Total comprehensive income $ 2,846,272 =========== BALANCE AT DECEMBER 31, 2003 1,457,594 $15,061,636 $ 6,386,083 $ 23,560 $21,471,279 ========= =========== =========== ========== ===========
The accompanying notes are an integral part of these financial statements. 35 SONOMA VALLEY BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001 ----------- ----------- ----------- OPERATING ACTIVITIES Net income $ 2,911,007 $ 2,744,333 $ 2,600,244 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan and lease losses 20,000 393,000 342,000 Depreciation 224,774 144,659 142,683 Loss on sale of securities 5,098 Loss on sale of equipment 23 Amortization and other 115,551 43,971 71,782 Net change in interest receivable (107,676) 152,779 199,863 Net change in cash surrender value Of life insurance (342,888) (265,181) (113,227) Net change in other assets (47,325) (63,800) (111,557) Net change in interest payable and other liabilities 146,078 50,001 69,505 --------- --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 2,919,544 3,504,860 3,201,293 INVESTING ACTIVITIES Purchases of securities held-to-maturity (10,718,156) (1,129,886) Purchases of securities available-for-sale (17,216,738) (540,547) Proceeds from maturing securities held-to- Maturity 4,028,400 1,841,141 1,472,700 Proceeds from maturing securities available- for-sale 750,000 7,000,000 10,550,000 Proceeds from sales of securities available- for-sale 244,063 Net increase (decrease) in loans and leases 5,415,192 (20,629,972) (14,910,204) Purchases of premises and equipment (663,645) (399,704) (156,037) Purchases of life insurance (2,092,000) (3,000,000) Proceeds from disposal of equipment 550 ------------ ------------ ----------- NET CASH USED FOR INVESTING ACTIVITIES (18,404,397) (14,577,019) (7,173,427)
(Continued) 36 SONOMA VALLEY BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001 ----------- ----------- ----------- FINANCING ACTIVITIES Net change in demand, interest-bearing transaction and savings deposits $ 18,904,842 $ 13,505,460 $ 13,692,323 Net change in time deposits 1,221,521 8,827,814 866,584 Stock repurchases (1,090,395) (344,602) (571,408) Stock options exercised 299,681 214,375 214,858 Fractional shares purchased (14,193) (13,951) (11,955) ------------ ----------- ----------- NET CASH PROVIDED BY FINANCING ACTIVITIES 19,321,456 22,189,096 14,190,402 ------------ ----------- ----------- NET CHANGE IN CASH AND CASH EQUIVALENTS 3,836,603 11,116,937 10,218,268 ------------ ----------- ----------- Cash and cash equivalents at beginning of year 31,517,599 20,400,662 10,182,394 ------------ ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 35,354,202 $ 31,517,599 $ 20,400,662 ============ ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest expense $1,731,256 $1,965,215 $2,920,348 Income taxes $1,375,000 $1,663,975 $1,556,000 SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES: Stock dividend $1,997,422 $1,775,026 $1,381,976 Net change in unrealized gains and losses on securities $ (110,009) $ (124,228) $ 140,548 Net change in deferred income taxes on unrealized gains and losses on securities $ 45,274 $ 51,125 $ (57,842)
The accompanying notes are an integral part of these financial statements. 37 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003, 2002 and 2001 NOTE A--SIGNIFICANT ACCOUNTING POLICIES Business: Sonoma Valley Bancorp (the Bancorp), formed in 2000, is a bank holding company whose principal activity is the ownership and management of its wholly-owned subsidiary, Sonoma Valley Bank. Sonoma Valley Bank was organized in 1987 and commenced operations on June 3, 1988 as a California state-chartered bank. The Bank is subject to regulation, supervision and regular examination by the State Department of Financial Institutions and Federal Deposit Insurance Corporation. The regulations of these agencies govern most aspects of the Bank's business. Principles of Consolidation: The consolidated financial statements include the accounts of the Bancorp and the Bank. All material intercompany accounts and transactions have been eliminated. Nature of Operations: The Bank provides a variety of banking services to individuals and businesses in its primary service area of Sonoma, California and the immediate surrounding area. The Bank offers depository and lending services primarily to meet the needs of its business and professional clientele. These services include a variety of demand deposit, savings and time deposit account alternatives, and special merchant and business services. The Bank's lending activities are directed primarily towards granting short and medium-term commercial loans, customized lines of credit, for such purposes as operating capital, business and professional start-ups, inventory, equipment and accounts receivable, and interim construction financing. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles 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. Actual results could differ from those estimates. Cash and Cash Equivalents: For the purposes of reporting cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet captions "Cash and due from banks" and "Federal funds sold." Generally, federal funds are sold or purchased for one-day periods. Investment Securities: Securities are classified as held-to-maturity if the Bancorp has both the intent and ability to hold those debt securities to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the interest method over their contractual lives. Securities are classified as available-for-sale if the Bancorp intends to hold those debt securities for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Bancorp's assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available-for-sale are carried at fair value. Unrealized holding gains or losses are reported as increases or decreases in shareholders' equity, net of the related deferred tax effect. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. 38 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE A--SIGNIFICANT ACCOUNTING POLICIES (Continued) Loans and Lease Financing Receivables: Loans are stated at the amount of unpaid principal, less the allowance for loan losses and net deferred loan fees. Interest on loans is accrued and credited to income based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as an adjustment of the yield on the related loan. However, loan origination costs in excess of fees collected are not deferred but this treatment has an immaterial impact on the financial statements. Amortization of net deferred loan fees is discontinued when the loan is placed on nonaccrual status. All of the Bancorp's leases are classified and accounted for as direct financing leases. Under the direct financing method of accounting for leases, the total net rentals receivable under the lease contracts, net of unearned income, are recorded as a net investment in direct financing leases, and the unearned income is recognized each month as it is earned so as to produce a constant periodic rate of return on the unrecovered investment. Allowance for Loan and Lease Losses: The allowance is maintained at a level which, in the opinion of management, is adequate to absorb probable losses inherent in the loan and lease portfolio. Credit losses related to off-balance-sheet instruments are included in the allowance for loan and lease losses except if the loss meets the criteria for accrual under Statement of Financial Accounting Standards (SFAS) No. 5, in which case the amount is accrued and reported separately as a liability. Management determines the adequacy of the allowance based upon reviews of individual loans and leases, recent loss experience, current economic conditions, the risk characteristics of the various categories of loans and leases and other pertinent factors. The allowance is based on estimates, and ultimate losses may vary from the current estimates. These estimates are reviewed monthly and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Loans and leases deemed uncollectible are charged to the allowance. Provisions for loan and lease losses and recoveries on loans previously charged off are added to the allowance. Commercial loans are considered impaired, based on current information and events, if it is probable that the Bancorp will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Allowances on impaired loans are established based on the present value of expected future cash flows discounted at the loan's historical effective interest rate or, for collateral-dependent loans, on the fair value of the collateral. Cash receipts on impaired loans are used to reduce principal. Income Recognition on Impaired and Nonaccrual Loans and Leases: Loans and leases, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. If a loan or lease or a portion of a loan or lease is classified as doubtful or is partially charged off, the loan or lease is classified as nonaccrual. Loans and leases that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. 39 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE A--SIGNIFICANT ACCOUNTING POLICIES (Continued) Loans and leases may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower, in accordance with the contractual terms of interest and principal. While a loan or lease is classified as nonaccrual and the future collectibility of the recorded balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectibility of the recorded balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan or lease had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered. Premises and Equipment: Premises and equipment are stated at cost, less accumulated depreciation. The provision for depreciation is computed principally by the straight-line method over the estimated useful lives of the related assets. Income Taxes: Provisions for income taxes are based on amounts reported in the statements of operations (after exclusion of non-taxable income such as interest on state and municipal securities) and include deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred taxes are computed using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are recognized for deductible temporary differences and tax credit carryforwards, and then a valuation allowance is established to reduce that deferred tax asset if it is "more likely than not" that the related tax benefits will not be realized. Advertising: Advertising costs are charged to operations in the year incurred. Net Income Per Share of Common Stock: Net income per share of common stock is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year, after giving retroactive effect to the stock dividends and splits. Net income per share--assuming dilution is computed similar to net income per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Included in the denominator is the dilutive effect of stock options computed under the treasury method. 40 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE A--SIGNIFICANT ACCOUNTING POLICIES (Continued) Stock Option Accounting: At December 31, 2003, the Bancorp has two stock-based employee and director compensation plans, which are described more fully in Note M. The Bancorp adopted SFAS No. 148, Accounting for Stock-Based Compensation, an Amendment of SFAS No. 123 effective January 1, 2003 using the prospective application method. Under this method, the compensation expense and related tax benefit associated with stock option grants issued on or after January 1, 2003 are recognized in the income statement. The Bancorp accounts for options granted prior to January 1, 2003 under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reflected in net income for these options, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Bancorp had applied the fair value recognition provisions of SFAS Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation for options granted prior to January 1, 2003.
2003 2002 2001 ----------- ----------- ----------- Net income, as reported $ 2,911,007 $ 2,744,333 $ 2,600,244 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (179,899) (185,919) (179,899) ----------- ----------- ----------- Pro forma net income $ 2,731,108 $ 2,558,414 $ 2,420,345 =========== =========== =========== Earnings per share: Basic--as reported $ 2.00 $ 1.87 $ 1.77 Basic--pro forma 1.87 1.75 1.64 Diluted--as reported 1.83 1.72 1.66 Diluted--pro forma 1.72 1.61 1.54
Off-Balance-Sheet Financial Instruments: In the ordinary course of business the Bancorp has entered into off-balance-sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable. Operating Segments: Reportable segments are based on products and services, geography, legal structure, management structure and any other manner in which management desegregates a company for making operating decisions and assessing performance. The Bancorp has determined that its business is comprised of a single operating segment. 41 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE B--RESTRICTIONS ON CASH AND DUE FROM BANKS Cash and due from banks include amounts the Bank is required to maintain to meet certain average reserve and compensating balance requirements of the Federal Reserve. The total requirement at December 31, 2003 and 2002 was $3,400,000 and $2,886,000, respectively. NOTE C--INVESTMENT SECURITIES The amortized cost and approximate fair value of investment securities are summarized as follows:
Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------------- --------------- ---------------- -------------- December 31, 2003: Securities Available-For-Sale U.S. Treasury securities $ 515,928 $ 4,619 $ 520,547 U.S. Government agency securities 18,672,992 72,126 $ (57,548) 18,687,570 Corporate securities 890,820 20,840 911,660 ------------ --------- ---------- ------------ $ 20,079,740 $ 97,585 $ (57,548) $ 20,119,777 ============ ========= ========= ============ Securities Held-to-Maturity Municipal securities $ 16,558,153 $ 550,533 $ (66,500) $ 17,042,186 ------------ --------- ---------- ------------ $ 16,558,153 $ 550,533 $ (66,500) $ 17,042,186 ============ ========= ========= ============ December 31, 2002: Securities Available-For-Sale U.S. Treasury securities $ 533,848 $ 5,057 $ 538,905 U.S. Government agency securities 1,497,398 115,417 1,612,815 Corporate securities 1,641,968 46,555 $ (16,984) 1,671,539 ------------ --------- ---------- ------------ $3,673,214 $ 167,029 $ (16,984) $ 3,823,259 ============ ========= ========= ============ Securities Held-to-Maturity Municipal securities $ 9,923,737 $ 517,873 $ (1,157) $ 10,440,453 ------------ --------- ---------- ------------ $ 9,923,737 $ 517,873 $ (1,157) $ 10,440,453 ============ ========= ========= ============
42 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE C--INVESTMENT SECURITIES (Continued) Contractual maturities of investment securities at December 31, 2003 were as follows:
Securities Available-For-Sale Securities Held-To-Maturity ----------------------------- ------------------------------ Amortized Fair Amortized Fair Cost Value Cost Value -------------- --------------- -------------- -------------- Due in one year or less $3,155,579 $ 3,234,107 $ 1,042,976 $ 1,060,505 Due after one year through five years 13,886,939 13,837,497 2,288,096 2,345,770 Due after five years through ten years 3,037,222 3,048,173 7,600,195 7,814,824 Due after ten years 5,626,886 5,821,087 --------------- --------------- --------------- ---------------- $ 20,079,740 $ 20,119,777 $ 16,558,153 $ 17,042,186 =============== =============== =============== ================
During 2002, the Bancorp sold securities available-for-sale for total proceeds of approximately $244,062 resulting in gross realized losses of approximately $5,098 and no gross realized gains. During 2003 and 2001, the Bancorp did not sell any securities available-for-sale. As of December 31, 2003, investment securities with a carrying amount of $6,107,353 and an approximate fair value of $6,530,152 were pledged, in accordance with federal and state requirements, as collateral for public deposits. Investment securities with a carrying amount and fair value of $1,655,647 at December 31, 2003 were pledged to meet the requirements of the Federal Reserve and the U.S. Department of Justice. The following table shows the investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2003. Less Than 12 Months ----------------------- Fair Unrealized Description of Securities Value Losses - ------------------------- ------------ ---------- U.S. government agency securities $ 8,736,699 $ 57,548 Municipal securities 4,630,160 63,406 ------------ ---------- Total temporarily impaired securities $ 13,366,859 $ 120,954 ============ ========== There were no securities as of December 31, 2003 that were in a continuous loss position for 12 months or more. There were 9 Federal Home Loan Bank or Federal Home Loan Mortgage Corporation securities and 14 municipal securities that were temporarily impaired as of December 31, 2003. The primary cause of the impairment of these securities is interest rate volatility. The unrealized losses on these securities is expected to be short-term. 43 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE D--LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES The composition of the loan and lease portfolio was as follows at December 31:
2003 2002 -------------------------- ----------------------- Commercial $ 92,197,984 75.0% $ 89,507,230 69.7% Consumer 11,750,131 9.6% 13,374,774 10.4% Real estate mortgage 2,231,244 1.8% 5,911,082 4.6% Real estate construction 16,646,907 13.5% 19,507,906 15.2% Lease financing receivables, net of unearned income of $9,799 in 2003 and $33,781 in 2002 79,884 0.1% 174,409 0.1% ------------- ---- ----------- ---- 122,906,150 100.0% 128,475,401 100.0% ===== ===== Deferred loan fees and costs, net (437,536) (424,258) Allowance for loan and lease losses (2,634,625) (2,781,962) ------------ ------------ $119,833,989 $125,269,181 ============ ============
At December 31, 2003, the recorded investment in loans for which impairment has been recognized in accordance with Statement of Financial Accounting Standards (Statement) No. 114 totaled $1,145,000, with a corresponding valuation allowance of $424,000. At December 31, 2002, the recorded investment in loans for which impairment has been recognized in accordance with Statement No. 114 totaled $164,000, with a corresponding valuation allowance of $17,000. For the years ended December 31, 2003, 2002 and 2001, the average recorded investment in impaired loans was approximately $843,000, $143,000 and $192,000, respectively. During 2003 and 2002, $8,000 and $2,000 of interest was received and recognized on impaired loans, respectively. No interest was recognized on impaired loans during 2001. In addition, at December 31, 2003 and 2002, the Bancorp had other nonaccrual loans of approximately $115,300 and $801,700, respectively, for which impairment had not been recognized. The Bancorp has no commitments to loan additional funds to the borrowers of impaired or nonaccrual loans. 44 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE D--LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued) The maturity and repricing distribution of the loan and lease portfolio at December 31: 2003 2002 ----------- ---------- Fixed rate loan maturities Three months or less $ 11,452,282 $ 11,069,375 Over three months to twelve months 12,843,967 16,759,422 Over one year to five years 41,884,458 25,717,999 Over five years 42,304,207 46,803,191 Floating rate loans repricing Quarterly or more frequently 13,191,129 26,369,806 Quarterly to annual frequency 26,790 One to five years frequency 832,277 ----------- ----------- 121,676,043 127,578,860 Nonaccrual loans 1,230,107 896,541 ----------- ----------- $122,906,150 $128,475,401 ============ ============ An analysis of the changes in the allowance for loan and lease losses is as follows for the years ended December 31:
2003 2002 2001 ----------- ----------- ----------- Beginning balance $ 2,781,962 $ 2,415,555 $ 2,120,517 Provision for loan and lease losses 20,000 393,000 342,000 Loans charged off: Commercial (142,572) (10,741) (44,345) Consumer (41,161) (34,872) (31,680) ---------- ---------- ---------- (183,733) (45,613) (76,025) Recoveries: Commercial 8,320 9,474 10,363 Consumer 8,076 9,546 18,700 ----------- ----------- ----------- 16,396 19,020 29,063 ----------- ----------- ----------- Ending balance $ 2,634,625 $ 2,781,962 $ 2,415,555 =========== =========== ===========
45 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE E--PREMISES AND EQUIPMENT Premises and equipment consisted of the following at December 31: 2003 2002 ---------- ---------- Land $ 175,000 $ 175,000 Building 71,943 71,943 Leasehold improvements 660,272 418,802 Furniture, fixtures and equipment 1,688,809 1,306,225 ---------- --------- 2,596,024 1,971,970 Less: Accumulated depreciation (1,282,029) (1,096,273) ---------- ---------- $1,313,995 $ 875,697 ========== ========= NOTE F--TIME DEPOSITS The maturities of time deposits at December 31, 2003 are as follows: Maturing within one year $ 33,355,000 Maturing in one year to two years 8,443,000 Maturing two years through five years 2,550,000 Maturing after five years 1,671,000 ------------- $ 46,019,000 ============= NOTE G--FEDERAL FUNDS CREDIT LINES The Bancorp has uncommitted federal funds lines of credit agreements with other banks. The maximum borrowings available under these lines totaled $4,000,000 at December 31, 2003. The Bancorp pledged loans totaling $25,913,127 as collateral to secure advances from the Federal Home Loan Bank of up to $14,255,849. There were no borrowings outstanding under the agreements at December 31, 2003 or 2002. NOTE H--EMPLOYEE BENEFIT PLANS The Bancorp has a 401(k) Employee Savings Plan (the Plan) in which the Bancorp matches a portion of the employee's contribution each payday. All employees are eligible for participation following three months of employment. Bancorp contributions are 100% vested at all times. The Bancorp made contributions totaling $92,012 in 2003, $77,913 in 2002 and $60,845 in 2001. 46 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE H--EMPLOYEE BENEFIT PLANS (Continued) The Bancorp purchased single premium life insurance policies in connection with the implementation of retirement plans for four key officers and for the Board of Directors. The policies provide protection against the adverse financial effects from the death of a key officer and provide income to offset expenses associated with the plans. The officers are insured under the policies, but the Bancorp is the owner and beneficiary. At December 31, 2003 and 2002, the cash surrender value of these policies totaled $7,730,600 and $7,387,712, respectively. The retirement plans are unfunded and provide for the Bancorp to pay the officers and directors specified amounts for specified periods after retirement and allows them to defer a portion of current compensation in exchange for the Bancorp's commitment to pay a deferred benefit at retirement. If death occurs prior to or during retirement, the Bancorp will pay the officer's beneficiary or estate the benefits set forth in the plans. Deferred compensation is vested as to the amounts deferred. Liabilities are recorded for the estimated present value of future salary continuation benefits and for the amounts deferred by the officers and directors. At December 31, 2003 and 2002, the liability recorded for the executive officer supplemental retirement plan totaled $1,439,970 and $1,223,570, respectively. The amount of pension expense related to this plan for 2003 and 2002 was $216,400 and $325,365, respectively. At December 31, 2003 and 2002, the liability recorded for the director supplemental retirement plan totaled $293,653 and $208,626, respectively. The amount of pension expense related to this plan for 2003 and 2002 was $208,626 and $85,027, respectively. At December 31, 2003 and 2002, the liability recorded for the deferred compensation plan totaled $989,788 and $849,610, respectively. The amount of expense related to this plan for 2003 and 2002 was $82,542 and $74,407, respectively. The following are the components of the accumulated benefit obligation related to the executive officer and director supplemental retirement plans as of December 31:
Directors Officers ----------------------- ------------------------- 2003 2002 2003 2002 --------- --------- ----------- ----------- Projected benefit obligation $ 293,653 $ 208,626 $ 1,235,077 $ 1,032,706 Unamortized net transition obligation 204,893 190,864 --------- --------- ----------- ----------- Benefit obligation included in other liabilities $ 293,653 $ 208,626 $ 1,439,970 $ 1,223,570 ========= ========= =========== ===========
The weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.5% for 2003 and 2002. No compensation increases were assumed. The entire accumulated benefit obligation was fully vested at December 31, 2003 and 2002. 47 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE H--EMPLOYEE BENEFIT PLANS (Continued) The following is a reconciliation of the beginning and ending balances of the benefit obligation for the years ended December 31:
Directors Officers ----------------------- ------------------------- 2003 2002 2003 2002 --------- --------- ----------- ----------- Benefit obligation at beginning of year $ 208,626 $ 1,223,570 $ 898,205 Net periodic pension cost: Service cost 71,387 $ 76,182 319,856 302,632 Interest cost on projected benefit obligation 13,640 8,845 122,265 66,189 Amortization of unrecognized (56,811) (43,456) liability at transition Amendments 123,599 (168,910) -------- --------- ---------- -------- Net Periodic pension cost recognized 85,027 208,626 216,400 325,365 -------- --------- ----------- -------- Benefit obligation at end of year $ 293,653 $ 208,626 $ 1,439,970 $ 1,223,570 ========= ========= =========== ===========
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Directors Officers --------- -------- 2004 $ 5,000 2005 14,100 2006 15,402 2007 17,585 2008 23,562 $ 145,396 2009 to 2013 1,511,134 4,811,609 48 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE I--NON-INTEREST INCOME AND OTHER NON-INTEREST EXPENSE Non-interest income is comprised of the following for the years ended December 31:
2003 2002 2001 ----------- --------- --------- Service charges on deposit accounts $ 1,033,990 $ 964,198 $ 930,171 Other fee income 323,780 312,121 251,042 Life insurance earnings 342,888 357,181 113,227 Investment securities gains (losses) (5,098) Other ( none exceeding 1% of revenues ) 14,465 12,789 14,875 ----------- --------- --------- $ 1,715,123 $ 1,641,191 $ 1,309,315 =========== =========== ===========
Other non-interest expense is comprised of the following for the years ended December 31:
2003 2002 2001 ----------- --------- --------- Professional and consulting fees $ 679,460 $ 477,830 $ 287,471 Data processing 473,932 465,946 469,750 Stationary and supplies 160,992 159,909 158,335 Staff related 175,801 158,707 104,092 Advertising and business development 165,142 200,848 105,614 Postage and telephone 123,269 122,408 116,879 Assessments and insurance 30,948 83,633 79,042 Other ( none exceeding 1% of revenues) 176,821 137,673 173,102 ----------- ----------- ----------- $ 1,986,365 $ 1,806,954 $ 1,494,285 =========== =========== ===========
49 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE J--INCOME TAXES The provision for income taxes is comprised of the following: 2003 2002 2001 ------------ ----------- ----------- Current Federal $ 827,960 $ 1,073,157 $ 1,008,534 State 403,346 426,600 409,376 --------- ----------- ----------- 1,231,306 1,499,757 1,417,910 Deferred Federal 180,039 (195,491) (50,778) State 35,052 (29,689) 11,808 ------------ ----------- ----------- 215,091 (225,180) (38,970) ------------ ----------- ----------- $ 1,446,397 $ 1,274,577 $ 1,378,940 ============ =========== =========== The following is a reconciliation of income taxes computed at the Federal statutory income tax rate of 34% to the effective income tax rate used for the provision for income taxes:
2003 2002 2001 ------------ ----------- ----------- Income tax at Federal statutory rate $ 1,481,517 $1,366,429 $ 1,352,923 State franchise tax, less Federal income tax benefit 311,746 287,529 284,687 Interest on municipal obligations exempt from Federal tax (217,541) (259,885) (221,062) Life insurance earnings (141,113) (146,996) (46,598) Meals and entertainment 8,175 7,412 7,283 Other differences 3,613 20,088 1,707 ----------- ----------- ----------- Provision for income taxes $ 1,446,397 $ 1,274,577 $ 1,378,940 =========== =========== ===========
50 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE J--INCOME TAXES (Continued) The tax effects of temporary differences that give rise to the components of the net deferred tax asset recorded as an other asset as of December 31 were as follows:
2003 2002 2001 ------------ ----------- ----------- Deferred tax assets: Nonqualified benefit plans $ 1,021,410 $ 884,446 $ 719,760 Allowance for loan losses 959,891 1,015,774 877,944 Accrued liabilities 227,840 233,575 280,367 State franchise taxes 137,138 145,316 139,188 Other 13,773 45,119 27,186 ------------ ----------- ----------- Total deferred tax assets 2,360,052 2,324,230 2,044,445 Deferred tax liabilities: Depreciation 89,220 36,366 19,308 Unrealized securities holding gains 16,477 61,750 112,876 Other 42,041 35,565 29,392 ------------ ----------- ----------- Total deferred tax liabilities 147,738 133,681 161,576 ------------ ----------- ----------- Net deferred tax asset $ 2,212,314 $ 2,190,549 $ 1,882,869 =========== =========== ===========
Amounts presented for the tax effects of temporary differences are based upon estimates and assumptions and could vary from amounts ultimately reflected on the Bancorp's tax returns. Accordingly, the variances from amounts reported for prior years are primarily the result of adjustments to conform to the tax returns as filed. Refundable income taxes were $346,669 and $185,839 at December 31, 2003 and 2002, respectively. The income tax benefit related to net investment losses was $2,098 during 2002. There were no net investment gains or losses in 2003 or 2001. NOTE K--STOCK REPURCHASE The Bancorp has in effect a program to repurchase Sonoma Valley Bancorp stock. As of December 31, 2003, $2,006,404 was repurchased. 51 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE L--EARNINGS PER SHARE The following is the computation of basic and diluted earnings per share for the years ended December 31:
2003 2002 2001 ------------ ----------- ----------- Basic: Net income $ 2,911,007 $ 2,744,333 $ 2,600,244 =========== =========== =========== Weighted-average common shares outstanding 1,457,431 1,464,344 1,473,151 =========== =========== =========== Earnings per share $ 2.00 $ 1.87 $ 1.77 =========== =========== =========== Diluted: Net income $ 2,911,007 $ 2,744,333 $ 2,600,244 =========== =========== =========== Weighted-average common shares outstanding 1,457,431 1,464,344 1,473,151 Net effect of dilutive stock options - based on the treasury stock method using average market price 132,911 128,321 94,899 ----------- ----------- ----------- Weighted-average common shares outstanding and common stock equivalents 1,590,342 1,592,665 1,568,050 =========== =========== =========== Earnings per share- assuming dilution $ 1.83 $ 1.72 $ 1.66 =========== =========== ===========
NOTE M--STOCK OPTION PLAN The Bancorp has a stock option plan (the Plan), effective March 31, 1996 and terminating March 31, 2006, under which incentive and nonstatutory stock options, as defined under the Internal Revenue Code, may be granted. The Plan is administered by a Committee appointed by the Board. Options representing 454,024 shares of the Bancorp's authorized and unissued common stock may be granted under the Plan by the Committee to directors, full-time officers, and full-time employees of the Bancorp at a price to be determined by the Committee, but in the case of incentive stock options shall not be less than 100% of the fair market value of the shares on the date the incentive stock option is granted. In addition, the Bancorp shall grant options to purchase 3,089 shares of common stock to each Board member on March 1st of each year, provided the person was a member of the Board for the entire preceding year ending December 31st, at an option price equal to the fair market value as of the grant date. The options may have an exercise period of no more than 10 years and are vested upon granting, except for 63,943 of incentive options and 142,075 of nonstatutory options granted in April 1999, which are subject to a graded vesting schedule of 20% per year. No options were granted in 2003 or 2001. 52 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE M--STOCK OPTION PLAN (Continued) The Bancorp approved an equity incentive plan (the Plan), effective May, 2002 and terminating May, 2012, under which stock options, restricted stock, stock appreciation rights and stock bonuses may be granted. The Plan is administered by a Committee appointed by the Board. Options representing 82,370 shares of the Bancorp's authorized and unissued common stock may be granted under the Plan by the Committee to all employees of the Bancorp at a price to be determined by the Committee but shall not be less than 100% of the fair market value of the shares on the date the incentive stock option is granted. The options may have an exercise period of no more than 10 years and vesting is at the discretion of the Committee. The fair value of options granted is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 2002; dividend yield of zero; expected volatility of 33.36 percent; risk-free interest rate of 5.44 percent and expected life of 10 years. A summary of stock option activity, adjusted to give effect to stock dividends and stock splits follows for the years ended December 31:
Incentive Stock Options -------------------------------------------------------------------------------- 2003 2002 2001 ------------------------- ------------------------ ------------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Price Shares Exercise Price Shares Exercise Price ---------------- -------- -------------- -------- -------------- -------- Shares under option at beginning of year $ 12.36 113,624 $ 12.27 132,500 $12.28 135,185 Options granted 21.77 1,103 Options exercised 12.10 (15,445) 12.31 (17,426) 12.82 (2,685) Options cancelled 11.95 (2,553) -------- ------- Shares under option at end of year 12.40 98,179 12.36 113,624 12.27 132,500 ======== ======= ======= Options exercisable at end of year 95,090 94,683 92,602 Weighted-average fair value of options granted during the year $9.28
53 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE M--STOCK OPTION PLAN (Continued)
Nonstatutory Stock Options ------------------------------------------------------------------------------ 2003 2002 2001 ------------------------- ------------------------ ----------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Price Shares Exercise Price Shares Exercise Price Shares ---------------- -------- ------------- -------- -------------- -------- Shares under option at beginning of year $11.84 225,465 $ 11.84 225,465 $ 11.83 240,906 Options exercised 10.07 (12,352) 11.69 (15,441) ------- ------- _______ Shares under option at end of year 11.94 213,113 11.84 225,465 11.84 225,465 ======= ======= ======= Options exercisable at end of year 182,227 163,696 132,788
The following table summarizes information about fixed stock options outstanding at December 31, 2003:
Options Outstanding ---------------------------------------------------- Weighted-Average Range of Number Remaining Weighted-Average Exercise Prices Outstanding Contractual Life Exercise Price --------------- ----------- ---------------- ---------------- $8.19 to $9.79 31,448 3.27 years $ 8.69 $11.75 to $11.95 233,816 5.28 years 11.93 $14.59 to $16.16 44,925 4.18 years 15.08 $21.77 1,103 8.42 years 21.77 ------- $8.19 to $21.77 311,292 4.96 years 12.09 =======
Options Exercisable ------------------------------------ Range of Number Weighted-Average Exercise Prices Exercisable Exercise Price --------------- ----------- ---------------- $8.19 to $9.79 31,448 $ 8.69 $11.75 to $11.95 199,841 11.92 $14.59 to $16.16 44,925 15.08 $21.77 1,103 21.77 ---------- $8.19 to $21.77 277,317 12.11 ==========
54 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE N--RELATED PARTY TRANSACTIONS The Bancorp has entered into transactions with its directors, executive officers and their affiliates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. The following is a summary of the aggregate activity involving related party borrowers at December 31, 2003 and 2002: 2003 2002 ----------- ----------- Loans outstanding at beginning of year $ 4,607,000 $ 2,236,000 Loans disbursements 690,000 2,723,000 Loan repayments (2,202,000) (352,000) ----------- ----------- Loans outstanding at end of year $ 3,095,000 $ 4,607,000 =========== =========== At December 31, 2003, commitments to related parties of approximately $1,541,000 were undisbursed. Deposits received from directors and officers totaled $6,471,000 and $5,360,000 at December 31, 2003 and 2002, respectively. The Bancorp leases its Glen Ellen office from a director of the Bancorp under a noncancellable operating lease. Lease expense for the years ended December 31, 2003 and 2002 was $12,889 and $12,172, respectively. The remaining lease commitment is approximately $61,595 through March 2008 including a minimum inflationary increase of 4% per year. The monthly lease payments will be increased annually based upon the Consumer Price Index, but not less than 4% annually. The term of the lease is 5 years with an option to extend the lease term for an additional 5 years at the same Consumer Price Index limitations. NOTE O--COMMITMENTS AND CONTINGENT LIABILITIES Lease Commitments: The Bancorp leases its two Sonoma offices, the Glen Ellen office and the Banco de Sonoma office under noncancelable operating leases with remaining terms of approximately six years, two years, five years and five years, respectively. All of the leases require adjustments to the base rent for changing price indices and two have a minimum annual increase of four percent. The Sonoma main office lease has an option to renew for two consecutive five-year terms and the Sonoma annex office has an option to renew for two five-year periods and one four-year period. The Glen Ellen office and the Banco de Sonoma office lease each have an option to renew for two additional five-year terms. The following table summarizes future minimum commitments under the noncancelable operating leases. 55 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE O--COMMITMENTS AND CONTINGENT LIABILITIES (Continued) Year ended December 31: 2004 $ 302,802 2005 295,621 2006 287,216 2007 297,927 2008 297,022 Thereafter 143,037 ----------- $ 1,623,625 =========== Rental expense was $289,000 in 2003, $278,000 in 2002 and $268,000 in 2001. Financial Instruments with Off-Balance-Sheet Risk: The Bancorp's financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of business and which involve elements of credit risk, interest rate risk and liquidity risk. These commitments and contingent liabilities are commitments to extend credit and standby letters of credit. A summary of the Bancorp's commitments and contingent liabilities at December 31, is as follows: Contractual Amounts 2003 2002 ------------ ------------- Commitments to extend credit $ 35,309,000 $ 30,359,000 Standby letters of credit 725,000 589,000 Commitments to extend credit and standby letters of credit include exposure to some credit loss in the event of nonperformance of the customer. The Bancorp's credit policies and procedures for credit commitments and financial guarantees are the same as those for extension of credit that are recorded on the balance sheet. Because these instruments have fixed maturity dates, and because many of them expire without being drawn upon, they do not generally present any significant liquidity risk to the Bancorp. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bancorp evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bancorp 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, certificates of deposits and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Bancorp to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending facilities to customers. 56 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE O--COMMITMENTS AND CONTINGENT LIABILITIES (Continued) The Bancorp has not incurred any losses on its commitments in 2003, 2002 or 2001. As a guarantor of its customer's credit card accounts, the Bancorp is contingently liable for credit card receivable balances held by another financial institution should the customers default. The total amount guaranteed as of December 31, 2003 and 2002 was $153,500 and $181,000, respectively. NOTE P--CONCENTRATIONS OF CREDIT RISK Most of the Bancorp's business activity is with customers located within the State of California, primarily in Sonoma County. The economy of the Bancorp's primary service area is heavily dependent on the area's major industries which are tourism and agriculture, especially wineries, dairies, cheese producers and turkey breeders. General economic conditions or natural disasters affecting the primary service area or its major industries could affect the ability of customers to repay loans and the value of real property used as collateral. While the Bancorp has a diversified loan portfolio, approximately 84% of these loans are secured by real estate in its service area. The concentrations of credit by type of loan are set forth in Note D. The distribution of commitments to extend credit approximates the distribution of loans outstanding. In addition, the Bancorp has loan commitments in the wine/agricultural industry, tourism industry and construction loans, representing 8%, 13% and 23%, of outstanding loans, respectively. Standby letters of credit were granted primarily to commercial borrowers. The Bancorp, as a matter of policy, does not extend credit to any single borrower or group of related borrowers on a secured basis in excess of 25% of its unimpaired capital (shareholders' equity plus the allowance for credit losses) and on an unsecured basis in excess of 15% of its unimpaired capital. The concentrations of investments are set forth in Note C. The Bancorp places its investments primarily in financial instruments backed by the U.S. Government and its agencies or by high quality financial institutions, municipalities or corporations. The Bancorp has significant funds deposited with four correspondent banks. At December 31, 2003 the Bancorp had on deposit $7,500,000, $7,500,000 and $5,500,000 in federal funds sold to three of these institutions, which represented 35%, 35% and 26% of the Bancorp's net worth, respectively. In addition, deposits with two correspondent banks were in excess of the federally insured limit by $3,033,351 at December 31, 2003. While management recognizes the inherent risks involved in such concentrations, this concentration provides the Bancorp with an effective and cost efficient means of managing its liquidity position and item processing needs. Management closely monitors the financial condition of their correspondent banks on a continuous basis. The Bancorp also maintains additional deposit accounts with other correspondent banks should management determine that a change in its correspondent banking relationship would be appropriate. 57 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE P--CONCENTRATIONS OF CREDIT RISK (Continued) At December 31, 2003, the Bancorp had life insurance policies with cash surrender values of $2,248,787, $1,847,274 and $1,646,283 with three insurance companies, which represented 10%, 9% and 8%, respectively, of the Bancorp's net worth. Management closely monitors the financial condition and rating of these insurance companies on a regular basis. NOTE Q--REGULATORY MATTERS Banking regulations limit the amount of cash dividends that may be paid without prior approval of the Bank's regulatory agency. Cash dividends are limited to the lesser of retained earnings, if any, or net income for the last three years, net of the amount of any other distributions made to shareholders during such periods. As of December 31, 2003, $6,442,571 was available for cash dividend distribution without prior approval. The Bank is subject to various regulatory capital requirements administered by its primary federal regulator, the Federal Deposit Insurance Corporation (FDIC). 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 Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank'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 Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2003, that the Bank meets all capital adequacy requirements to which it is subject. 58 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE Q--REGULATORY MATTERS (Continued) As of December 31, 2003, 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 I risk-based and Tier I leverage ratios as set forth in the table. 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.
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ---------------- ------------------ ----------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- (in thousands) As of December 31, 2003: Total Capital (to Risk Weighted Assets) $ 22,493 13.4% >$ 13,393 >8.0% >$16,742 >10.0% Tier I Capital - - - - (to Risk Weighted Assets) $ 20,394 12.2% >$ 6,697 >4.0% >$10,044 > 6.0% Tier I Capital - - - - (to Average Assets) $ 20,394 10.0% >$ 8,165 >4.0% >$10,206 > 5.0% - - - - As of December 31, 2002: Total Capital (to Risk Weighted Assets) $ 20,852 13.4% >$ 12,444 >8.0% >$15,555 >10.0% Tier I Capital - - - - (to Risk Weighted Assets) $ 18,897 12.2% >$ 6,222 >4.0% >$ 9,333 > 6.0% Tier I Capital - - - - (to Average Assets) $ 18,897 10.5% >$ 7,207 >4.0% >$ 9,009 > 5.0% - - - -
NOTE R--CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY A condensed balance sheet as of December 31, 2003 and 2002 and the related condensed statement of operations and cash flows for the years ended December 31, 2003, 2002, and 2001 for Sonoma Valley Bancorp (parent company only) are presented as follows: 59 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE R--CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY (Continued) Condensed Balance Sheets December 31, 2003 and 2002
2003 2002 ------------ ------------ Assets Cash $ 869,931 $ 249,432 Other assets 258,863 89,551 Investment in common stock of subsidiary 20,417,945 18,985,494 ------------ ------------ $ 21,546,739 $ 19,324,477 ============ ============ Liabilities Accrued expenses $ 75,460 $ 84,167 Shareholders' equity Common stock 15,061,636 12,936,225 Retained earnings 6,409,643 6,304,085 ------------ ------------ $ 21,546,739 $ 19,324,477 ============ ============
Condensed Statements of Operations For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001 ----------- --------- ---------- Dividend from subsidiary $ 1,500,000 $ 500,000 Expenses 145,553 $ 125,091 36,620 ----------- --------- ---------- Income (loss) before income taxes and equity in undistributed income of subsidiary 1,354,447 (125,091) 463,380 Equity in undistributed net income of subsidiary 1,497,186 2,824,941 2,120,445 Income tax benefit 59,374 44,483 16,419 ----------- ----------- ----------- Net income $ 2,911,007 $ 2,744,333 $ 2,600,244 =========== =========== ===========
60 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE R--CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY (Continued) Condensed Statements of Cash Flows For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001 ---------- ---------- ---------- Operating activities: Net income $2,911,007 $2,744,333 $2,600,244 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiary (1,497,186) (2,824,941) (2,120,445) Net change in other assets 20,292 40,345 (17,218) Net change in accrued expenses (8,707) 84,167 --------- ---------- ---------- Net cash provided by operating activities 1,425,406 43,904 462,581 ---------- ---------- --------- Financing activities: Stock repurchases (1,090,395) (344,602) (571,408) Stock options exercised 299,681 214,375 214,858 Fractional shares purchased (14,193) (13,951) (11,955) ---------- ---------- --------- Net cash used by financing activities (804,907) (144,178) (368,505) Net change in cash and cash equivalents 620,499 (100,274) 94,076 Cash and cash equivalents at beginning of year 249,432 349,706 255,630 ---------- ---------- --------- Cash and cash equivalents at end of year $ 869,931 $ 249,432 $ 349,706 ========== ========== ========= Supplemental Disclosures of Noncash Activities: Stock Dividend $1,997,422 $1,775,026 $ 1,381,976
NOTE S--FAIR VALUES OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Bancorp as a whole. 61 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE S--FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued) The estimated fair values of the Bancorp and Subsidiary's financial instruments are as follows at December 31:
2003 2002 ---------------------- ------------------------ Estimated Estimated Carrying Fair Carrying Fair Amount Value Amount Value ---------- ----------- ----------- ----------- Financial assets: Cash and due from banks $9,803,272 $9,803,272 $ 8,387,953 $ 8,387,953 Interest-bearing due from banks 330,930 330,930 34,646 34,646 Federal funds sold 25,220,000 25,220,000 23,095,000 23,095,000 Investment securities available- for-sale 20,119,777 20,119,777 3,823,259 3,823,259 Investment securities held- to-maturity 16,558,153 17,042,186 9,923,737 10,440,453 Loans and lease financing receivables, net 119,833,989 120,308,741 125,269,181 125,970,797 Accrued interest receivable 906,958 906,958 799,282 799,282 Cash surrender value of life insurance 7,730,600 7,730,600 7,387,712 7,387,712 Financial liabilities: Deposits 180,114,616 180,913,343 159,988,252 160,920,406 Accrued interest payable 52,052 52,052 59,923 59,923
The carrying amounts in the preceding table are included in the balance sheet under the applicable captions. The following methods and assumptions were used by the Bancorp in estimating its fair value disclosures for financial instruments: Cash, due from banks and federal funds sold: The carrying amount is a reasonable estimate of fair value. Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The carrying amount of accrued interest receivable approximates its fair value. 62 SONOMA VALLEY BANCORP AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2003, 2002 and 2001 NOTE S--FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued) Loans and lease financing receivables, net: For variable-rate loans and leases that reprice frequently and fixed rate loans and leases that mature in the near future, with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other fixed rate loans and leases are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans or leases with similar terms to borrowers of similar credit quality. Loan and lease fair value estimates include judgments regarding future expected loss experience and risk characteristics and are adjusted for the allowance for loan and lease losses. The carrying amount of accrued interest receivable approximates its fair value. Cash surrender value of life insurance: The carrying amount approximates its fair value. Deposits: The fair values disclosed for demand deposits (for example, interest-bearing checking accounts and passbook accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates fair value. Off-balance sheet instruments: Off-balance sheet commitments consist of commitments to extend credit and standby letters of credit. The contract or notional amounts of the Bancorp's financial instruments with off-balance-sheet risk are disclosed in Note O. Estimating the fair value of these financial instruments is not considered practicable due to the immateriality of the amounts of fees collected, which are used as a basis for calculating the fair value, on such instruments. NOTE T--SUBSEQUENT EVENTS The Bank will open a new branch office, called Banco de Sonoma, in March 2004. A long-term lease has been entered into as of December 31, 2003, which is included in Note O. The Bank has deferred $40,000 of costs related primarily to leasehold improvements as of December 31, 2003. In January 2004, the Bank authorized the granting of options to purchase 45,000 shares to officers of the Bank at $31.06, resulting in compensation expense of approximately $50,000. On February 18, 2004, the Board of Directors declared a cash dividend of $0.25 per share to shareholders of record on March 1, 2004 and payable on March 15, 2004. 63 ITEM 9. CHANGES ON AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None ITEM 9A. CONTROLS AND PROCEDURES. We carried out an evaluation, under the supervision and with the participation of the our management, including our Chief Executive Officer and Chief Financial Officer, about the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this Form 10-K are effective in timely alerting them to material information required to be included in this Form 10-K. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Position with the Bank and Principal Director Age Occupations During the Past Five Years - -------- --- -------------------------------------- Secretary since 2001 and Director of the Bank Suzanne Brangham 61 since March, 1995; since 1975, president of Classix, Inc. and since 1994, president of 400 West Spain Corp. Director of the Bank since its formation in Dale T. Downing 62 1988; proprietor, Sonoma Market, Inc. and Glen Ellen Village Market, Inc., formerly Shone's Country Store, Inc. Director of the Bank since its formation in Frederick H. Harland 57 1988; proprietor, Harland & Lely Corporation since 1998, project manger, Lely Construction, Inc. since 1990; former Director and Chief Executive Officer of Sonoma Cheese Factory from 1969 to 1990. Director of the Bank since its formation in Robert B. Hitchcock 59 1988; Chairman of the Board 1988-1995 retired in 1992 as President, Nicholas Turkey Breeding Farms, a position held since 1982. Director of the Bank since its formation in Gerald J. Marino 64 1988; retired president, Marino Distributing Beer and Wine Company since 1968.
64
Director of the Bank since 1993; president of Gary D. Nelson 66 Gary D. Nelson Associates, Inc. since 1970. Chairman of the Board since 1995 and Director of Robert J. Nicholas 61 the Bank since its formation in 1988; retired in 1992 as Chairman, Nicholas Turkey Breeding Farms, a position held since 1982. Director of the Bank since 1992; general manager Angelo C. Sangiacomo 73 and partner, Sangiacomo Vineyards since 1950; founding director, Carneros Quality Alliance since 1959. Director of the Bank since 1993; retired as J. R. Stone 80 Chairman of World Products, Inc. in 1987. .. President and Chief Executive Officer of the Mel Switzer, Jr. 58 Bank since April 1990; director of the Bank since he joined in 1990. Director of the Bank since its formation in Harry W. Weise 73 1988; Secretary 1995-2001; retired president, North Bay Insurance Brokers, Inc. since 1968. ..
Position with the Bank and Principal Officer Age Occupations During the Past Five Years - ------- --- -------------------------------------- Mel Switzer, Jr. 58 President and Chief Executive Officer since April 1990. Mary Quade Dieter 55 Executive Vice President, Chief Operating Officer, Chief Financial Officer and Assistant Corporate Secretary since June 1997; Executive Vice President, Chief Financial Officer and Asst. Corporate Secretary since January 1993; Vice President, Chief Financial Officer and Assistant Corporate Secretary from June 1988 to January 1993. Senior Vice President and Chief Lending Officer Sean Cutting, 34 since August 2003; VP and Loan Group Manager Chief Lending Officer, since April 2003; VP and Commercial Loan Officer Senior Vice President since June 2002; Corporate Banking Officer at ABN AMRO Bank and Silicon Valley Bank from 1999-2001.
There are no family relationships between any of the directors or executive officers. 65
Position with the Bank and Principal Key Employee Age Occupations During the Past Five Years - ------------ --- -------------------------------------- Bob Thomas, CIO, Vice President 44 Vice President and Chief Information Officer since January 2003; AVP and IT Manage since January 2001; Information Technology Manager since January 2000; Network Communications Engineer at ReloAction from 1997-1999.
Audit Committee Financial Expert The Board of Directors has not designated an Audit Committee Financial Expert. All of the members of the Audit Committee are independent as determined by the NASD listing standards. Compliance with Section 16 of the Securities Exchange Act of 1934 Based solely upon a review of Forms 3, 4 and 5 delivered to the Company as filed with the Securities and Exchange Commission ("Commission"), directors and officers of the Company and persons who own more than 10% of the Company's common stock timely filed all required reports pursuant to Section 16(a) of the Securities Exchange Act of 1934, except Robert Nicholas, who was late reporting one transaction. Code of Ethics We have adopted a code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer, controller and other persons performing similar functions. A copy of our code of ethics can be found on our website at sonomavalleybank.com/svbethics.pdf. The Company will report any amendment or wavier to the code of ethics on our website within five (5) days. 66 ITEM. 11. EXECUTIVE COMPENSATION. As to the Company's Chief Executive Officer and each other key employee of the Company and Bank who received total remuneration in excess of $100,000 in 2003, the following table sets forth total remuneration received from the Company for services performed in all capacities during the last three years.
SUMMARY COMPENSATION TABLE ANNUAL COMPENSATION LONG-TERM COMPENSATION ------------------- ---------------------- SECURITIES NAME AND OTHER RESTRICTED UNDERLYING ALL PRINCIPAL ANNUAL STOCK OPTIONS/ OTHER POSITION YEAR SALARY BONUS COMP. AWARD(S) SARs COMP. =================== ======== ============ ========== =========== ============== ================ ========== Mel Switzer, Jr., 2001 $147,137(1) $104,032 $7,608(5) $ 0 0 $4,200(6) CEO, President 2002 $154,250(2) $120,727 $ 0(5) $ 0 0 $4,800(6) 2003 $157,879(3) $ 72,159 $ 2,374(5) $ 0 0 $5,600(6) =================== ======== ============ ========== =========== ============== ================ ========== Mary Quade 2001 $97,592 $69,355 $8,633(5) $ 0 0 $4,200(6) Dieter, COO, CFO, Executive VP 2002 $ 102,472 $ 80,485 $2,759(5) $ 0 0 $4,800(6) 2003 $106,571 $48,106 $ 102(5) $ 0 0 $5,600(6) =================== ======== ============ ========== =========== ============== ================ ========== Sean C. Cutting CLO, Senior VP 2002 $48,853(4) $ 4,890 $1,539(5) $ 0 0 $2,030(6) 2003 $ 108,567 $25,900 $ 820(5) $ 0 0 $4,800(6) =================== ======== ============ ========== =========== ============== ================ ========== Bob Thomas, 2001 $ 109,600 $ 10,631 $1,990(5) $ 0 0 $ 0 CIO, VP 2002 $ 117,880 $ 11,491 $1,720(5) $ 0 0 $ 0 2003 $137,750 $10,061 $2,484(5) $ 0 0 $ 0 =================== ======== ============ ========== =========== ============== ================ ==========
____________________________ (1) Includes $141,290 base salary and $5,847 in fringe benefits. (2) Includes $148,354 base salary and $5,896 in fringe benefits. (3) Includes $154,289 base salary and $3,590 in fringe benefits. (4) Hire date 6/17/2002 (5) Represents accrued and unused vacation. (6) Represents 401(k) employer's matching contributions. 67 Option Grants in 2003 The following table provides information relating to stock options granted by us during the year ended December 31, 2003.
Option Grants in Last Fiscal Year --------------------------------- Potential Percent of Total Realizable Value at Number of Options Granted Assumed Annual Securities to Exercise Rates of Stock Underlying Employees Price Price Appreciation Options in Fiscal Year Per Expiration For Option Terms Name Granted -------------- Share Date 5% 10% ---- ------- ----- ---- ------ ------- Mel Switzer, Jr. 0 - - - - - Mary Quade Dieter 0 - - - - - Sean C. Cutting 0 - - - - -
* Less than 1% Fiscal Year End Option Values The following table sets forth for each of our executive officers named in the Summary Compensation Table the number and value of exercisable and un-exercisable options for the year ended December 31, 2003.
Number of Securities Shares Underlying Unsecured Value of Unexercised Acquired Options In-The-Money Options on Value at December 31, 2003 at December 31, 2003 Name Exercise Realized ($) Exercisable Un-exercisable Exercisable Un-exercisable ---- -------- ------------ ----------- -------------- ----------- -------------- Mel Switzer, Jr. 0 0 60,422 3,089 1,053,431 54,678 Mary Quade Dieter 0 0 27,058 0 327,953 0 Sean C. Cutting 0 0 0 0 0 0
Compensation of Directors The directors of the Company are scheduled to meet at least quarterly and receive $100 for each meeting. The directors of the Bank receive $800 for each regular board meeting and $200 for each committee meeting attended of which they are a member. The Chairman of the Board of the Bank receives $1,100 for each meeting. The Chair of the Audit Committee receives $300 for each meeting attended. The President and Chief Executive Officer does not receive any director fees. Severance Agreements On October 21, 1998, the Bank entered into Severance Agreements with both its Chief Executive Officer, Mel Switzer, and its Chief Operating Officer, Mary Dieter. On March 17, 2004, the Bank entered into a Severance Agreement with its Chief Lending Officer, Sean C. Cutting. The Severance Agreement with Mr. Switzer provides for payment to him equal to two years of his base salary in the event that he is terminated within 24 months following a change of control of the 68 Company. Similarly, the Severance Agreements with Ms. Dieter and Mr. Cutting provides for payment to each equal to one year of their individual base salary in the event either is terminated within 24 months following a change of control of the Company. The Severance Agreements are not employment agreements and provide for payment of the severance only in the event of the occurrence of the specified circumstances. All Severance Agreements are effective through October 20, 2008, subject to extension by mutual agreement of the Company and each executive. The Company has assumed the obligations under these agreements. Aggregated Option Exercises in Last Fiscal Year and Ten-Year Options/SAR Repricings There was no re-pricing of options for the fiscal year ended December 31, 2003. Compensation Committee Interlocks and Insider Participation Directors, Robert J. Nicholas, Chairman, Dale T. Downing, Robert B. Hitchcock, Gary D. Nelson and Harry W. Weise serve on the Personnel and Policies Committee (the board committee performing equivalent functions of a compensation committee). There are no compensation committee interlocks or insider participation on our personnel and policies committee. Personnel and Policies Committee Report Compensation Philosophy The Committee continues to emphasize the important link between the Company's performance, which ultimately benefits all shareholders, and the compensation of its executives. Therefore, the primary goal of the Company's executive compensation policy is to closely align the interests of the shareholders with the interest of the executive officers, In order to achieve this goal, the Company attempts to (i) offer compensation opportunities that attract and retain executives whose abilities and skills are critical to the long-term success of the Company and reward them for their efforts in ensuring the success of the Company and (ii) encourage executives to manage from the perspective of owners with an equity stake in the Company. The Company currently uses three integrated components - Base Salary, Incentive Compensation and Stock Options - to achieve these goals. Base Salary The Base Salary component of total compensation is designed to compensate executives competitively within the industry and the marketplace. Base Salaries of the executive officers are established by the committee based upon Committee compensation data, the executives' job responsibilities, level of experience, individual performance and contribution to the business. In making base salary decisions, the Committee exercised its discretion and judgment based upon regional and personal knowledge of industry practice and did not apply and specific formula to determine the weight of any one factor. Incentive Bonuses The Incentive Bonus component of executive compensation is designed to reflect the Committee's belief that a portion of the compensation of each executive officer should be contingent upon the performance of the Company, as well as the individual contribution of each executive officer. The Incentive Bonus is intended to motivate and reward executive officers by allowing the executive officers to directly benefit from the success of the Company. The plan is weighted heavily towards achieving profitability before any bonus compensation would be earned and is presently based upon increasing returns on beginning equity. 69 Long Term Incentives The Committee provides the Company's executive officers with long-term incentive compensation in the form of stock option grants under the Company's 1996 Stock Option Plan and 2001 Equity Incentive Plan. The Committee believes that stock options provide the Company's executive officers with the opportunity to purchase and maintain an equity interest in the Company and t share in the appreciation of the value of the Company's Common Stock. The Committee believes that stock options directly motivate an executive officers to date have been granted at the fair market value of the Company's common stock on the date of grant. The committee considers each option subjectively, considering factors such as the individual performance of the executive officer and the anticipated contribution for the executive officer to the attainment of the Company's long term strategic performance goals. The number of stock options granted in prior years is also taken into consideration. In conclusion, the Committee believes that the company's current compensation levels are consistent with Company goals. Respectfully Submitted, Sonoma Valley Bancorp Personnel and Policies Committee, /s/ Robert J. Nicholas, Chairman /s/ Dale T. Downing /s/ Robert B. Hitchcock /s/ Gary D. Nelson /s/ Harry W. Weise 70 Comparison of Cumulative Total Return on Investment There can be no assurance that our stock performance will continue into the future with the same or similar trends depicted in the graph below. The market price of our common stock in recent years has fluctuated significantly and it is likely that the price of the stock will fluctuate in the future. We do not endorse any predictions of future stock performance. Furthermore, the stock performance chart is not considered by us to be (i) soliciting material, (ii) deemed filed with the Securities and Exchange Commission, or (iii) to be incorporated by reference in any filings by us under the Securities Act, or the Exchange Act. [OBJECT OMITTED] 71 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Equity Compensation Plan Information Compensation Plan Table The following table provides aggregate information as of the end of the fiscal year ended December 31, 2003 with respect to all compensation plans (including individual compensation arrangements) under which equity securities are authorized for issuance.
Plan category Number of securities Weighted-average Number of securities to be issued upon exercise price of remaining available exercise of outstanding options, for future issuance outstanding options, warrants and rights under equity warrants and rights compensation plans (excluding securities reflected in column (a)) (a) (b) (c) -------------------- ---------------------- -------------------- ----------------------- Equity compensation plans approved by security holders 311,292 $ 12.09 82,370 Equity compensation plans not approved by 0 0 0 security holders Total 311,292 $ 12.09 82,370
Principal Shareholders The following table sets forth certain information as of March 15, 2004, with respect to the beneficial ownership of our common stock for (i) each director, (ii) all of our directors and officers as a group, and (iii) each person known to us to own beneficially five percent (5%) or more of the outstanding shares of our common stock. The address for each listed shareholder is Sonoma Valley Bancorp, 202 W. Napa Street, Sonoma, California 95476. To our knowledge, except as indicated in the footnotes to this table or pursuant to applicable community property laws, the persons named in the table have sole voting and investment power with respect to the shares of common stock indicated. Common Stock Amount Name, Principal and Nature of Occupation and Address Beneficial Ownership Percent of - ---------------------- -------------------- Class(1) ---------- Suzanne Brangham 26,574 (2) 1.76% Dale T. Downing 77,873 (3)(7) 5.17% Frederick H. Harland 13,007 (4)(8) * 72 Common Stock Amount Name, Principal and Nature of Occupation and Address Beneficial Ownership Percent of - ---------------------- -------------------- Class(1) ---------- Robert B. Hitchcock 85,219 (3)(9) 5.66% Gerald J. Marino 72,002 (2) 4.77% Gary D. Nelson 73,063 (5)(10) 4.91% Robert J. Nicholas 80,732 (4) 5.40% Angelo C. Sangiacomo 28,892 (2)(11) 1.91% J. R. Stone 63,801 (2)(12) 4.23% Mel Switzer, Jr. 80,275 (6)(13) 5.18% Harry W. Weise 58,148 (3) 3.86% Directors and Executive Officers as a Group (13 695,566 (14) 39.50% persons including the above) * Less than 1% of outstanding shares of common stock. (1) Percentages are based on a total of 1,484,823 shares outstanding as of March 15, 2004. (2) Includes 24,709 shares subject to options exercisable within 60 days. (3) Includes 21,620 shares subject to options exercisable within 60 days. (4) Includes 9,266 shares subject to options exercisable within 60 days. (5) Includes 3,089 shares subject to options exercisable within 60 days. (6) Includes 63,511 shares subject to options exercisable within 60 days. (7) Includes 7,944 shares held by wife in an IRA account. (8) Includes 403 shares held by wife and 487 shares held by wife in an IRA account. (9) Includes 7,280 shares held by wife in an IRA account. (10) Includes 178 shares held in a Trust Account of which his wife is a Trustee and 21 shares held by son. (11) Includes 1,305 shares held by wife as a custodian of Uniform Transfer to Minors Act. (12) Includes 12,754 shares held by wife in an IRA account. (13) Includes 1,438 shares held by wife in an IRA account. (14) Includes a total of 278,884 shares subject ot options exercisable within 60 days. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Certain Relationships and Related Transactions We have and expect to have in the future to have banking transactions in the ordinary course of its business with its directors, officers, principal shareholders and their affiliates. These loans are granted on substantially the same terms, including interest rates, collateral, and repayment terms, as those prevailing at the same time for comparable transactions with others and, in the opinion of management, do not involve more than the normal risk of collectibility. The aggregate loan disbursements and loan payments made in connection with loans to directors, officers, principal shareholders, and affiliates, are as follows: 73 2003 2002 ---- ---- Balance, beginning of year $4,607,000 $2,236,000 Loan disbursements 690,000 2,723,000 Loan payments (2,202,000) (352,000) Balance, end of year $3,095,000 $4,607,000 During 2003, the highest amount of aggregate indebtedness of directors, officers, principal shareholders, and affiliates, was $ 3,113,688 as of July 31, 2003, which represented 15.45% of the Bank's equity capital as of such date. The Bank leases its Glen Ellen branch office from Sonoma Market Partnership in which director Dale Downing is a partner. Lease expense for the years ended December 31, 2003 and 2002 was $12,889 and $12,172, respectively. The remaining lease commitment is approximately $61,595 through March 2008 including a minimum inflationary increase of 4% per year. The monthly lease payments will be increased annually based upon the Consumer Price Index, but not less than 4% annually. The term of the lease is 5 years with an option to extend the lease term for two additional 5 year terms at the same Consumer Price Index limitations. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. Relationship with Independent Auditors The Company retained the firm of Richardson & Co. as independent auditors of the Company for the fiscal year ending December 31, 2003. Audit Fees The aggregate fees billed for professional services rendered for the audit of the Company's annual financial statements on Form 10-K and the review of the financial statements included in the Company's quarterly reports on Form 10-Q for the fiscal year ended December 31, 2002 was $ 41,720 and December 31, 2003 was $ 41,720. Audit-Related Fees The aggregate fees billed for assurance and related services by the principal accountant that are reasonably related to the performance of the audit or review of the Company's financial statements for the year ended December 31, 2002 was $ 4,695 and December 31, 2003 was $ 8,547. Tax Fees The aggregate fees billed for tax compliance, tax advice and tax planning rendered by our independent auditors for the fiscal year ended December 31, 2002 was $ 9,470 and December 31, 2003 was $ 9,470. The services comprising these fees include federal and state income tax returns, quarterly tax estimates and business property tax statements. All Other Fees There were no aggregate fees billed for any other professional services rendered by the Company's independent auditors for the fiscal year ended December 31, 2002 and 2003. 74 The Audit Committee approved 100% of the fees paid to the principal accountant for audit-related, tax and other fees. The Audit Committee pre-approves all non-audit services to be performed by the auditor in accordance with the Audit Committee Charter. The percentage of hours expended on the principal accountant's engagement to audit the Company's financial statements for the most recent fiscal year that were attributed to work performed by persons other than the principal accountant's full-time, permanent employees was 0%. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. Financial Statements The following financial statements of the Company are filed as part of this Annual Report:
Number Page 1. Independent Auditor's Report..................................... 31 2. Consolidated Balance Sheets as of December 31, 2003 and 2002..... 32 3. Consolidated Statements of Operations for the three years ended December 31, 2003, 2002 and 2001................................. 33 4. Consolidated Statements of Changes in Shareholders' Equity for the three years ended December 31, 2003, 2002 and 2001....... 34 and 35 5. Consolidated Statements of Cash Flows for the three years ended December 31, 2003, 2002 and 2001................................. 36 and 37 6. Notes to Consolidated Financial Statements....................... 38
Financial Statement Schedules All other schedules have been omitted since the required information is not present or is not present in sufficient amounts to require submission of the schedules or because the information is included in the financial statements or the notes thereto. 75 Exhibits - -------- The following Exhibits are attached or incorporated herein by reference: 3.1 Sonoma Valley Bancorp Articles of Incorporation, filed as Exhibit 3.1 to the Registrant's Registration Statement on Form S-8 filed on June 5, 2001. 3.3 Sonoma Valley Bancorp By-laws, filed as Exhibit 3.2 to the Registrant's Registration Statement on Form S-8 filed on June 5, 2001. 4.2 Agreement for the sale of Sonoma Valley Bank Stock dated September 23, 1992, filed as Exhibit 4.2 (formerly A-1) to the Form F-2 for the year ended December 31, 1992. 10.1 Lease for Sonoma branch office, filed as Exhibit 10.1 (formerly 7.1) to the Registrant's Registration Statement on Form F-1 filed on May 1, 1989. 10.2 Sonoma Valley Bank Chief Executive Officer Severance Agreement dated January 4, 1995, filed as Exhibit 10.2 to the Form 10-KSB for the year ended December 31, 1997. 10.3 Sonoma Valley Bank Supplemental Executive Retirement Plan, as amended on March 20, 1996, filed as Exhibit 10.3 to the Form 10-KSB for the year ended December 31, 1997. 10.4 Sonoma Valley Bank Deferred Compensation Plan, filed as Exhibit 10.4 to the Form 10-KSB for the year ended December 31, 1997. 10.5 Sonoma Valley Bank Master Trust Agreement for Executive Deferral Plans, filed as Exhibit 10.5 to the Form 10-KSB for the year ended December 31, 1997. 10.6 Sonoma Valley Bank 1996 Stock Option Plan, filed as Exhibit 10.6 to the Form 10-KSB for the year ended December 31, 1997. 10.7 Sonoma Valley Bank Severance Agreement with Mel Switzer, Jr. dated October 21, 1998, filed as Exhibit 10.7 to the From 10-KSB for the year ended December 31, 1998. 10.8 Sonoma Valley Bank Severance Agreement with Mary Dieter dated October 21, 1998, filed as Exhibit 10.8 to the From 10-KSB for the year ended December 31, 1998. 10.10 Sonoma Valley Bancorp Assumption of Severance Agreement [Form of], filed as Exhibit 10.1 to the Form 10-KSB for the year ended December 31, 2001. 10.11 Sonoma Valley Bancorp 2002 Equity Incentive Plan, filed as Exhibit A to the Company's Proxy Statement for the Annual Meeting held on May 14, 2002. 10.12 Sonoma Valley Bank Severance Agreement with Sean Cuttings dated March 18, 2004. 23.1 Consent of Richardson and Co., Independent Auditors. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act 76 (b) Reports on Form 8-K The following reports on Form 8-K were filed during the last quarter of the period covered by this report: Date of Event Reported Item Reported ---------------------- ------------- February 18, 2004 Announcing Cash Dividend February 15, 2004 Announcing Fiscal Year End 2003 Results 77 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SONOMA VALLEY BANCORP, A California corporation /S/ MEL SWITZER, JR. March 23, 2004 - --------------------------------- Mel Switzer, Jr. President and Chief Executive Officer (Principal Executive Officer) /S/ MARY QUADE DIETER March 23, 2004 - --------------------------------- Mary Quade Dieter Executive Vice President and Chief Operating Officer (Principal Finance and Accounting Officer) In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /S/ SUZANNE BRANGHAM March 23, 2004 - --------------------------------- uzanne Brangham, Secretary of the Board and Director /S/ DALE T. DOWNING March 23, 2004 - --------------------------------- Dale T. Downing, Director /S/ FREDERICK H. HARLAND March 23, 2004 - --------------------------------- Frederick H. Harland, Director /S/ ROBERT B. HITCHCOCK March 23, 2004 - --------------------------------- Robert B. Hitchcock, Director /S/ GERALD J. MARINO March 23, 2004 - --------------------------------- Gerald J. Marino, Director 78 /S/ GARY D. NELSON March 23, 2004 - --------------------------------- Gary D. Nelson, Director /S/ ROBERT J. NICHOLAS March 23, 2004 - --------------------------------- Robert J. Nicholas, Chairman of the Board and Director /S/ ANGELO C. SANGIACOMO March 23, 2004 - --------------------------------- Angelo C. Sangiacomo, Director /S/ JESSE R. STONE March 23, 2004 - --------------------------------- Jesse R. Stone, Director /S/ MEL SWITZER, JR. March 23, 2004 - --------------------------------- Mel Switzer, Jr., President, Chief Executive Officer and Director (Principal Executive Officer) /S/ HARRY WEISE March 23, 2004 - --------------------------------- Harry Weise, Director /S/ MARY QUADE DIETER March 23, 2004 - --------------------------------- Mary Quade Dieter, Executive Vice President, Chief Operating Officer and Chief Financial Officer (Principal Finance and Accounting Officer) 79 EX-10 3 exh10-12.txt SONOMA VALLEY BANK CHIEF LENDING OFFICER SEVERANCE AGREEMENT This SEVERANCE AGREEMENT (the "Agreement"), dated as of March 18, 2004, is made and entered into by and between Sonoma Valley Bank, a California Corporation (the "Company"), and Sean C. Cutting, (the "Executive"). WHEREAS, this Agreement is being entered into in order to set forth the specific severance compensation that the Company agrees it will pay to the Executive if the Executive's employment with the Company terminates under certain circumstances described herein; NOW, THEREFORE, in consideration of the continued service of the Executive as the Chief Lending Officer of the Company, the mutual covenants and agreements contained in this Agreement, and for such other good and valuable consideration, the receipt of which is hereby acknowledged, the parties hereto agree as follows: 1. Agreement to Provide Base Salary. In the event the Executive is, within 24 months following a Change in Control of the Company (as defined in Section 3 below) and during the Term of this Agreement (as defined in Section 7 below), actually terminated from his employment with the Company or constructively terminated from his employment with the Company, he shall receive in one lump sum cash payment in an amount equal to one year of his base salary at the time of such termination; provided that no benefit shall be payable hereunder if the Executive's employment is terminated by reason of any act or failure to act by the Executive which constitutes (i) gross malfeasance in the performance of his duties, (ii) fraud, deceit, theft or embezzlement against the Company that could reasonably subject the Executive to either civil or criminal liability, (iii) any act of personal dishonesty that is injurious to the Company, or (iv) disloyalty against the Company including without limitation aiding competitors of the Company. The Company, in its sole and absolute discretion, may pay the amount specified above to the Executive in 12 equal monthly installments. 2. Base Salary. For purposes of this Agreement, the Executive's base salary at any time shall be equal to his regular annual salary without regard to any bonuses, incentive payments, cash or non-cash allowances or other fringe benefits. 3. Change in Control For the purposes of this Agreement, a "Change in Control" means (i) the purchase or other acquisition by any person, entity or group of persons, within the meaning of section 13(d) or 14(d) of the Securities Exchange Act of 1934 ("Act"), or any comparable successor provisions, of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Act) of 30 percent or more of either the outstanding shares of common stock or the combined voting power of the Company's then outstanding voting securities entitled to vote generally, (ii) the approval by the shareholders of the Company of a reorganization, merger, or consolidation, in each case, with respect to which persons who were shareholders of the Company immediately prior to such reorganization, merger or consolidation do not, immediately thereafter, own more than 50 percent of the combined voting power entitled to vote generally in the election of directors of the reorganized, merged or consolidated Company's then outstanding securities, or (iii) a liquidation or dissolution of the Company or of the sale of all or substantially all of the Company's assets. 4. Constructive Termination. For purposes of this Agreement, the Executive shall be deemed to have been constructively terminated from his employment with the Company if he voluntarily terminates his employment within 24 months after a Change in Control and such termination occurs coincident with or after any of the following events (which event occurs within 24 months after a Change in Control), unless the Executive expressly acknowledges in writing that no constructive termination has taken place; (a) Any material diminution in the Executive's position, duties, titles, offices, responsibilities and status with the Company as they existed immediately prior to a Change in Control or the assignment to the Executive by the Company of any duties materially reduced therewith, or in derogation thereof; (b) A material diminution in the Executive's base salary in effect on the date of the Change in Control; (c) Any failure by the Company to continue in effect any benefit plan or arrangement or any material fringe benefit in which the Executive was participating immediately prior to a Change in Control, or to substitute and continue other plans providing the Executive with substantially similar benefits, or any action by the Company which would adversely affect the Executive's benefits under such benefit plan or arrangement or deprive the Executive of any material fringe benefit enjoyed by the Executive at the time of the Change in Control; (d) The Executive's relocation to a facility or a location more than thirty (30) miles from the Executive's then present location at which he performed his duties prior to a Change in Control; or (e) Any material breach by the Company of any provision of this Agreement. 5. Heirs and Successors. (a) Successors of the Company. The Company will require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession or assignment had taken place. Failure of the Company to obtain such agreement prior to the effectiveness of any such succession transaction shall automatically be a material breach of this Agreement. "Company" shall mean the Company as defined above and any successor or assign to its business and/or assets as aforesaid which executes and delivers the agreement provided in this Section 5 or which otherwise becomes bound by all terms and provisions of this Agreement by operation of law. (b) Heirs of the Executive. This Agreement shall inure to the benefit of and be enforceable by the Executive's personal and legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die after becoming entitled to the payment of benefits hereunder with any amount still payable to him, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's beneficiary, successor, devisees, legatees, or other designee or, if there be no such designee, to the Executive's estate. Until a contrary designation is made to the Company in writing, the Executive hereby designates as his beneficiary under this Agreement the person whose name appears below his signature on this Agreement. Notwithstanding the above, the Executive's beneficiary designation shall be deemed automatically revoked as to a named beneficiary if the beneficiary predeceases the Executive or if the Executive names a spouse as beneficiary, and the marriage is subsequently dissolved. Beneficiary designations received by the Company after the Executive's death shall not be taken into account. 6. General Release. If the Executive is entitled to severance benefits pursuant to this Agreement, the Executive hereby agrees that all of his rights under section 1542 of the Civil Code of the State of California are hereby waived. Section 1542 provides as follows: "A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor." Notwithstanding the provisions of section 1542, if the Executive is entitled to severance benefits pursuant to this Agreement, the Executive hereby irrevocably and unconditionally releases and forever discharges the Company and all of its officers, agents, directors, supervisors, employees, representatives and their successors and assigns and all persons acting by, through, under or in concert with any of them from any and all charges, complaints, grievances, claims, actions, and liabilities of any kind (including attorneys' fees, interest, expenses and costs actually incurred) of any nature whatsoever, known or unknown, suspected or unsuspected (hereinafter referred to as "Claims"), which the Executive has or may have in the future, arising out of the Executive's employment with the Company. All such Claims are forever barred by this Agreement and without regard to whether these Claims are based on any alleged breach of duty arising in contract or tort, any alleged employment discrimination or other unlawful discriminatory act, or any claim or cause of action regardless of the forum in which it may be brought, including without limitation, claims under the National Labor Relations Act, Title VII of the Civil Rights Act of 1964, as amended, the Civil Rights Act of 1991, the Age Discrimination in Employment Act of 1964, as amended, the Americans With Disability Act, the California Family Rights Act of 1991, the Federal Family and Medical Leave Act of 1993, the Vietnam Era Veterans Readjustment Assistance Act of 1974, the California Fair Employment and Housing Act, California Labor Code section 132a, any allegation of wrongful termination and any claim arising out of Article 1, section 8 of the Constitution of the State of California. 7. Term. The term of this Agreement shall be the period commencing March 18, 2004 and ending October 20, 2008; provided that the Company and the Executive may mutually agree in writing to extend such term. 8. Not a Contract of Employment. The terms and conditions of this Agreement shall not be deemed to constitute a contract of employment between the Company and the Executive. Nothing in this Agreement shall be construed to entitle the Executive to any benefit hereunder if his employment is terminated prior to a Change in Control, and nothing in this Agreement shall be construed to interfere with the Company's right to discharge or discipline the Executive prior to a Change in Control. 9. Arbitration. Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in Sonoma County, California, in accordance with the rules of the American Arbitration Association then in effect by an arbitrator selected by both parties within ten (10) days after either party has notified the other in writing that it desires a dispute between them to be settled by arbitration. In the event the parties cannot agree on such arbitrator within such ten (10) day period, each party shall select an arbitrator and inform the other party in writing of such arbitrator's name and address within five (5) days after the end of such ten (10) day period and the two arbitrators so selected shall select a third arbitrator within fifteen (15) days thereafter; provided, however, that in the event of a failure by either party to select an arbitrator and notify the other party of such selection within the time period provided above, the arbitrator selected by the other party shall be the sole arbitrator of the dispute. Each party shall pay its own expenses associated with such arbitration, including the expense of any arbitrator selected by such party, and the Company will pay the expenses of the jointly selected arbitrator. The decision of the arbitrator or a majority of the panel of arbitrators shall be binding upon the parties, and judgment in accordance with that decision may be entered in any court having jurisdiction thereover. The Executive and the Company agree not to initiate arbitration on a controversy or claim more than six (6) months after the event underlying the controversy or claim and to waive any statute of limitation to the contrary. Punitive damages shall not be awarded. 10. Notice. For purposes of this Agreement, notices on all of the communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage pre-paid as follows. If to the Company: Sonoma Valley Bank, 202 West Napa Street, Sonoma, California 95476, Attention: Chairman of the Board; and if to the Executive, at the address specified at the end of this Agreement. Notice may also be given at such other address as either party may have furnished to the other in writing and in accordance herewith, except that notices of change of address shall be effective only upon receipt. 11. Validity. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 12. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 13. Miscellaneous. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in a writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the time or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above-written. SONOMA VALLEY BANK: EXECUTIVE: By: Print Name: __________________ Title: _______________________ (Address for Notice) (Designated Beneficiary) (Address and Social Security number of Beneficiary) EX-23 4 ex23-1.txt EXHIBIT 23.1 Richardson & Company 550 Howe Avenue, Suite 210 Sacramento, California 95825 Telephone: (916) 564-8727 FAX: (916) 564-8728 CONSENT OF RICHARDSON & COMPANY We consent to the incorporation by reference in the Registration Statement (Form S-8) (SEC File Number 333-62294) pertaining to the Sonoma Valley Bancorp's 1996 Stock Option Plan as amended in April 1999 and the Registration Statement (Form S-8) (SEC File Number 333-88610) pertaining to the Sonoma Valley Bancorp's 2002 Equity Incentive Plan of our report dated January 29, 2004 with respect to the consolidated financial statements of Sonoma Valley Bancorp and Subsidiary included in its Annual Report (Form 10-K) for the year ended December 31, 2003, filed with the Securities and Exchange Commission. /s/ Richardson & Company Richardson & Company Sacramento, California March 22, 2004 EX-31 5 ex31-1.txt EXHIBIT 31.1 CERTIFICATION I, Mel Switzer, Jr., Chief Executive Officer of Sonoma Valley Bancorp, certify that: 1. I have reviewed this quarterly report on Form 10-K of Sonoma Valley Bancorp; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and 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 report is being prepared; (b) Omitted.; (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 evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) 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(s) 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 (or persons performing the equivalent functions): (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. Dated: March 23, 2004 /s/ Mel Switzer, Jr. --------------------------- Mel Switzer, Jr. Chief Executive Officer (Principal Executive Officer) EX-31 6 ex31-2.txt EXHIBIT 31.2 CERTIFICATION I, Mary Quade Dieter, Chief Financial Officer for Sonoma Valley Bancorp, certify that: 1. I have reviewed this quarterly report on Form 10-K of Sonoma Valley Bancorp; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and 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 report is being prepared; (b) Omitted.; (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 evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) 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(s) 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 (or persons performing the equivalent functions): (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. Dated: March 23, 2004 /s/ Mary Quade Dieter ------------------------------ Mary Quade Dieter Chief Financial Officer (Principal Finance and Accounting Officer) EX-32 7 ex32-1.txt EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT 2002 In connection with the annual report of Sonoma Valley Bancorp (the "Company") on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), We, Mel Switzer, Jr., Chief Executive Officer and Mary Quade Dieter, Chief Financial Officer, of the Company certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 for the Sarbanes-Oxley Act of 2002 , that to the best of our knowledge and belief: (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 result of operations of the Company. Dated: March 23, 2004 /s/ Mel Switzer, Jr. --------------------------- Mel Switzer, Jr., Chief Executive Officer (Principal Executive Officer) Dated: March 23, 2004 /s/ Mary Quade Dieter --------------------------- Mary Quade Dieter, Chief Financial Officer (Principal Financial and Accounting Officer) -----END PRIVACY-ENHANCED MESSAGE-----