10-Q 1 sep04q.txt WABC FORM 10-Q FOR 09-30-2004 Page 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2004 Commission File Number: 001-9383 WESTAMERICA BANCORPORATION (Exact Name of Registrant as Specified in its Charter) CALIFORNIA 94-2156203 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1108 Fifth Avenue, San Rafael, California 94901 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, including Area Code (707) 863-6000 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. Yes [ x ] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ x ] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Title of Class Shares outstanding as of November 2, 2004 Common Stock, 31,843,961 No Par Value Page 2
TABLE OF CONTENTS Page ------------- Forward Looking Statements 2 PART I - FINANCIAL INFORMATION Item 1 - Financial Statements 3 Notes to Unaudited Condensed Consolidated Financial Statements 7 Financial Summary 9 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3 - Quantitative and Qualitative Disclosure about Market Risk 26 Item 4 - Controls and Procedures 26 PART II - OTHER INFORMATION Item 1 - Legal Proceedings 26 Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 26 Item 3 - Defaults upon Senior Securities 27 Item 4 - Submission of Matters to a Vote of Security Holders 27 Item 5 - Other Information 27 Item 6 - Exhibits 27 Exhibit 11 - Computation of Earnings Per Share 29 Exhibit 31.1 - Certification of Chief Executive Officer pursuant to 30 Securities Exchange Act Rule 13a-14(a) and 15d-14(a) Exhibit 31.2 - Certification of Chief Financial Officer pursuant to 31 Securities Exchange Act Rule 13a-14(a) and 15d-14(a) Exhibit 32.1 - Certification Required by 18 U.S.C. Section 1350 32 Exhibit 32.2 - Certification Required by 18 U.S.C. Section 1350 33
FORWARD-LOOKING STATEMENTS This report on Form 10-Q contains forward-looking statements about Westamerica Bancorporation for which it claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on Management's current knowledge and belief and include information concerning the Company's possible or assumed future financial condition and results of operations. A number of factors, some of which are beyond the Company's ability to predict or control, could cause future results to differ materially from those contemplated. These factors include but are not limited to (1) a slowdown in the national and California economies; (2) economic uncertainty created by terrorist threats and attacks on the United States and the actions taken in response; (3) the prospect of additional terrorist attacks in the United States and the uncertain effect of these events on the national and regional economies; (4) changes in the interest rate environment; (5) changes in the regulatory environment; (6) significantly increasing competitive pressure in the banking industry; (7) operational risks including data processing system failures or fraud; (8) the effect of acquisitions and integration of acquired businesses including those related to our pending acquisition of Redwood Empire Bancorp; (9) volatility of rate sensitive deposits and assets; (10) asset/liability matching risks and liquidity risks; (11) compliance costs associated with the Company's internal control structure and procedures for financial reporting; and (12) changes in the securities markets. The reader is directed to the Company's annual report on Form 10-K for the year ended December 31, 2003 and Registration Statement on Form S-4 dated October 15, 2004, for further discussion of factors which could affect the Company's business and cause actual results to differ materially from those expressed in any forward-looking statement made in this report. The Company undertakes no obligation to update any forward-looking statements in this report. Page 3 PART I - FINANCIAL INFORMATION Item 1. Financial Statements WESTAMERICA BANCORPORATION CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands)
At September 30, At --------------------------December 31, 2004 2003 2003 --------------------------------------- Assets: Cash and cash equivalents $165,277 $189,269 $189,628 Money market assets 534 633 534 Investment securities available for sale 967,266 1,245,311 1,413,911 Investment securities held to maturity, with market values of: $1,089,568 at September 30, 2004 1,080,392 $575,862 at September 30, 2003 569,996 $542,729 at December 31, 2003 535,377 Loans, gross 2,301,991 2,364,418 2,323,330 Allowance for loan losses (54,388) (54,180) (53,910) --------------------------------------- Loans, net of allowance for loan losses 2,247,603 2,310,238 2,269,420 Premises and equipment, net 35,267 35,566 35,748 Interest receivable and other assets 139,732 131,780 131,767 --------------------------------------- Total Assets $4,636,071 $4,482,793 $4,576,385 ======================================= Liabilities: Deposits: Noninterest bearing $1,323,446 $1,213,578 $1,240,379 Interest-bearing: Transaction 561,206 559,031 561,696 Savings 1,119,356 1,075,625 1,058,082 Time 641,798 687,895 603,834 --------------------------------------- Total deposits 3,645,806 3,536,129 3,463,991 Short-term borrowed funds 578,285 433,348 590,646 Federal Home Loan Bank advance 0 105,000 105,000 Notes Payable 21,429 9,643 24,643 Liability for interest, taxes and other expenses 38,627 47,751 51,734 --------------------------------------- Total Liabilities 4,284,147 4,131,871 4,236,014 --------------------------------------- Shareholders' Equity: Authorized - 150,000 shares of common stock Issued and outstanding: 31,716 at September 30, 2004 222,344 32,723 at September 30, 2003 218,703 32,287 at December 31, 2003 218,461 Deferred compensation 2,146 1,824 1,824 Accumulated other comprehensive income: Unrealized gain on securities available for sale, net of tax 8,186 16,004 13,191 Retained earnings 119,248 114,391 106,895 --------------------------------------- Total Shareholders' Equity 351,924 350,922 340,371 --------------------------------------- Total Liabilities and Shareholders' Equity $4,636,071 $4,482,793 $4,576,385 ======================================= See accompanying notes to unaudited consolidated financial statements.
Page 4 WESTAMERICA BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited) (In thousands, except per share data)
Three months ended Nine months ended September 30, September 30, 2004 2003 2004 2003 ---------------------------------------------------- Interest Income: Loans $32,911 $37,491 $100,337 $117,324 Money market assets and funds sold 0 2 1 6 Investment securities available for sale Taxable 7,171 8,632 26,581 25,051 Tax-exempt 3,550 3,922 11,068 11,733 Investment securities held to maturity Taxable 5,725 697 10,325 4,235 Tax-exempt 4,547 4,216 13,275 10,335 ---------------------------------------------------- Total interest income 53,904 54,960 161,587 168,684 ---------------------------------------------------- Interest Expense: Transaction deposits 163 145 399 598 Savings deposits 955 1,440 3,057 4,711 Time deposits 2,135 2,400 5,943 8,055 Short-term borrowed funds 1,473 747 3,890 2,559 Federal Home Loan Bank advance 0 1,172 897 4,339 Debt financing and notes payable 316 385 968 1,173 ---------------------------------------------------- Total interest expense 5,042 6,289 15,154 21,435 ---------------------------------------------------- Net Interest Income 48,862 48,671 146,433 147,249 ---------------------------------------------------- Provision for loan losses 600 750 2,100 2,550 ---------------------------------------------------- Net Interest Income After Provision For Loan Losses 48,262 47,921 144,333 144,699 ---------------------------------------------------- Noninterest Income: Service charges on deposit accounts 7,465 6,735 21,693 19,809 Merchant credit card 899 993 2,633 2,755 Financial services commissions 409 249 956 666 Mortgage banking 41 185 304 712 Trust fees 265 245 773 760 Securities (losses) gains (14) 2,150 2,169 2,443 Loss on extinguishment of debt 0 (2,166) (2,204) (2,166) Other 2,723 2,622 7,990 7,445 ---------------------------------------------------- Total Noninterest Income 11,788 11,013 34,314 32,424 ---------------------------------------------------- Noninterest Expense: Salaries and related benefits 13,054 13,495 39,912 40,792 Occupancy 3,022 3,076 8,913 9,116 Equipment 1,101 1,319 3,536 4,074 Data processing 1,525 1,520 4,563 4,597 Professional fees 411 529 1,332 1,400 Other 5,378 5,595 16,217 16,567 ---------------------------------------------------- Total Noninterest Expense 24,491 25,534 74,473 76,546 ---------------------------------------------------- Income Before Income Taxes 35,559 33,400 104,174 100,577 ---------------------------------------------------- Provision for income taxes 10,464 9,327 30,121 29,822 ---------------------------------------------------- Net Income $25,095 $24,073 $74,053 $70,755 ==================================================== Other Comprehensive Income: Change in unrealized gain on securities available for sale, net 9,602 (9,998) (5,005) (3,148) ---------------------------------------------------- Other Comprehensive Income $34,697 $14,075 $69,048 $67,607 ==================================================== Average Shares Outstanding 31,713 32,770 31,841 32,959 Diluted Average Shares Outstanding 32,352 33,273 32,452 33,442 Per Share Data: Basic Earnings $0.79 $0.73 $2.33 $2.15 Diluted Earnings 0.78 0.72 2.28 2.12 Dividends Paid 0.28 0.26 0.82 0.74 See accompanying notes to unaudited consolidated financial statements.
Page 5 WESTAMERICA BANCORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited) (In thousands)
Accumulated Compre- Common Deferred hensive Retained Shares Stock Compensation Income/loss Earnings Total ------------------------------------------------------------------------------ Balance, December 31, 2002 33,411 $215,926 $1,272 $19,152 $105,149 $341,499 Net income for the period 70,755 70,755 Stock issued for stock options 327 5,650 5,650 Stock option tax benefits 3,514 3,514 Restricted stock activity 24 407 552 959 Purchase and retirement of stock (1,039) (6,794) (37,080) (43,874) Dividends (24,433) (24,433) Unrealized loss on securities available for sale, net (3,148) (3,148) ------------------------------------------------------------------------------ Balance, September 30, 2003 32,723 $218,703 $1,824 $16,004 $114,391 $350,922 ============================================================================== Balance, December 31, 2003 32,287 $218,461 $1,824 $13,191 $106,895 $340,371 Net income for the period 74,053 74,053 Stock issued for stock options 237 7,084 7,084 Stock option tax benefits 2,003 2,003 Restricted stock activity 16 467 322 789 Purchase and retirement of stock (824) (5,671) (35,531) (41,202) Dividends (26,169) (26,169) Unrealized loss on securities available for sale, net (5,005) (5,005) ------------------------------------------------------------------------------ Balance, September 30, 2004 31,716 $222,344 $2,146 $8,186 $119,248 $351,924 ============================================================================== See accompanying notes to unaudited condensed consolidated financial statements.
Page 6 WESTAMERICA BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
For the nine months ended September 30, 2004 2003 -------------------------- Operating Activities: Net income $74,053 $70,755 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of fixed assets 2,885 3,105 Amortization of intangibles 1,722 1,479 Loan loss provision 2,100 2,550 (Amortization) deferral of net loan origination fees (46) 148 Decrease in interest income receivable 541 300 (Increase) decrease in other assets (4,204) 58,158 (Decrease) increase in income taxes payable (3,494) 3,266 Decrease in interest expense payable (134) (689) Increase (decrease) in other liabilities 7,383 (51,707) Gain on sales of investment securities (2,169) (2,443) Loss on extinguishment of debt 2,204 2,166 Net loss on writedown of equipment 9 140 Originations of loans for resale (3,622) (7,797) Net proceeds from sale of loans originated for resale 3,583 7,949 Net gain on sale of property acquired in satisfaction of debt (231) (94) Writedown on property acquired in satisfaction of debt 0 307 -------------------------- Net Cash Provided by Operating Activities 80,580 87,593 -------------------------- Investing Activities: Net repayments of loans 19,801 125,521 Purchases of investment securities available for sale (96,027) (835,207) Purchases of investment securities held to maturity (641,443) (365,878) Purchases of property, plant and equipment (2,414) (3,273) Proceeds from maturity of securities available for sale 317,231 423,784 Proceeds from maturity of securities held to maturity 89,976 197,298 Proceeds from sale of securities available for sale 209,085 153,128 Proceeds from sale of property and equipment 0 1,859 Proceeds from property acquired in satisfaction of debt 321 1,132 -------------------------- Net Cash Used In Investing Activities (103,470) (301,636) -------------------------- Financing Activities: Net increase in deposits 181,814 242,062 Net (decrease) increase in short-term borrowings (12,361) 83,612 Net payments to Federal Home Loan Bank (107,204) (67,166) Repayments of notes payable (3,214) (14,964) Exercise of stock options/issuance of shares 6,875 5,498 Repurchases/retirement of stock (41,202) (43,874) Dividends paid (26,169) (24,433) -------------------------- Net Cash (Used In) Provided By Financing Activities (1,461) 180,735 -------------------------- Net Decrease In Cash and Cash Equivalents (24,351) (33,308) -------------------------- Cash and Cash Equivalents at Beginning of Period 189,628 222,577 -------------------------- Cash and Cash Equivalents at End of Period $165,277 $189,269 ========================== Supplemental Disclosure of Noncash Activities: Loans transferred to other repossessed collateral $0 $1,800 Unrealized loss on securities available for sale ($5,005) ($3,148) Supplemental Disclosure of Cash Flow Activity: Interest paid for the period 15,019 21,122 Income tax payments for the period 30,010 27,105 Income tax benefit from stock option exercises 2,003 3,514 See accompanying notes to unaudited consolidated financial statements.
Page 7 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1: Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. The results of operations reflect interim adjustments, all of which are of a normal recurring nature and which, in the opinion of Management, are necessary for a fair presentation of the results for the interim period presented. The interim results for the three and nine months ended September 30, 2004 and 2003 are not necessarily indicative of the results expected for the full year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes as well as other information included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. Note 2: Significant Accounting Policies Certain accounting policies underlying the preparation of these financial statements require Management to make estimates and judgments. These estimates and judgments may affect reported amounts of assets and liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. The most significant of these involve the Allowance for Loan Losses, which is discussed in Note 1 to the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. Note 3: Goodwill and Other Intangible Assets The Company has recorded goodwill and core deposit intangibles associated with purchase business combinations and, effective January 1, 2002, accounts for them in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. Accordingly, goodwill is not amortized, but is periodically evaluated for impairment. During 2004, no impairment of goodwill has been recorded. Core deposit intangibles are amortized over their expected useful lives; such lives are periodically reassessed to determine if any amortization adjustments are indicated. During the third quarter of 2004, no such adjustments were recorded. The following table summarizes the Company's goodwill and core deposit intangible assets, which are included with interest receivable and other assets in the Consolidated Balance Sheets, as of January 1, 2004 and September 30, 2004 (dollars in thousands).
January 1 September 30 (Dollar in Thousands) 2004 Additions Reductions 2004 ---------------------------------------------------- Goodwill $22,968 $0 $0 $22,968 Accumulated Amortization ($3,972) $0 $0 ($3,972) ---------------------------------------------------- Net $18,996 $0 $0 $18,996 ==================================================== Core Deposit Intangibles $7,783 $0 $0 $7,783 Accumulated Amortization ($4,345) $0 $408 ($4,753) ---------------------------------------------------- Net $3,438 $0 $408 $3,030 ==================================================== At September 30, 2004, the estimated aggregate amortization of intangibles, in thousands of dollars, for the remainder of 2004 and annually through 2009 is $136, $469, $427, $427, $427 and $427, respectively. The weighted average amortization period for core deposit intangibles is 7.1 years.
Page 8 Note 4: Stock Options As permitted by Statement of Financial Accounting Standards ("SFAS") No. 123 "Accounting for Stock-Based Compensation", the Company accounts for its stock option plans using the intrinsic value method. Accordingly, compensation expense is recorded on the grant date only if the current price of the underlying stock exceeds the exercise price of the option. Had compensation cost been determined based on the fair value method established by SFAS 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
Three months ended Nine months ended September 30, September 30, ---------------------------------------------------- 2004 2003 2004 2003 ---------------------------------------------------- (In thousands, except per share data) Compensation cost based on fair value method, net of tax effect $526 $589 $1,578 $1,767 Net income: As reported $25,095 $24,073 $74,053 $70,755 Pro forma 24,569 23,484 72,475 68,988 Basic earnings per share: As reported $0.79 $0.73 $2.33 $2.15 Pro forma $0.77 $0.72 $2.28 $2.09 Diluted earnings per share: As reported $0.78 $0.72 $2.28 $2.12 Pro forma $0.76 $0.71 $2.23 $2.06
Note 5: Post Retirement Benefits The Company offers a continuation of group insurance coverage to employees electing early retirement until age 65 and pays a portion of these early retirees' insurance premiums, as determined at their date of retirement. The Company also reimburses 50 percent of Medicare Part B premiums for all retirees and spouses over 65. An actuarial-based accrual method is used to account for post-retirement benefits. In accordance with SFAS No.132 "Employers' Disclosures about Pensions and Other Post-Retirement Benefits", the Company provides the following interim disclosure related to its post-retirement benefit plan. The following table sets forth the net periodic post retirement benefit costs for the nine months ended September 30.
For the nine months ended September 30, --------------------------------------- 2004 2003 2002 --------------------------------------- (In thousands) Service cost $139 $11 $155 Interest cost 128 127 129 Amortization of unrecognized transition obligation 46 46 46 --------------------------------------- Net periodic cost $313 $184 $330 =======================================
Note 6: Pending Acquisition On August 25, 2004, Westamerica signed a definitive agreement to acquire Redwood Empire Bancorp, parent company of National Bank of the Redwoods. The transaction is valued at approximately $148 million, of which approximately $57 million will be paid in cash and the remainder by issuance of Westamerica common stock. The acquisition is expected to be completed in the first quarter of 2005. Page 9 WESTAMERICA BANCORPORATION Financial Summary (Unaudited) (dollars in thousands, except per share amounts)
Three months ended Nine months ended September 30, September 30, ---------------------------------------------------- 2004 2003 2004 2003 ---------------------------------------------------- Net Interest Income (FTE)** $54,528 $54,264 $163,405 $162,650 Provision for loan losses (600) (750) (2,100) (2,550) Noninterest income: Investment securities gains (losses) (14) 2,150 2,169 2,443 Loss on extinguishment of debt 0 (2,166) (2,204) (2,166) Other 11,802 11,029 34,349 32,147 ---------------------------------------------------- Total noninterest income 11,788 11,013 34,314 32,424 Noninterest expense (24,491) (25,534) (74,473) (76,546) Provision for income taxes (FTE)** (16,130) (14,920) (47,093) (45,223) ---------------------------------------------------- Net income $25,095 $24,073 $74,053 $70,755 ==================================================== Average shares outstanding 31,713 32,770 31,841 32,959 Diluted average shares outstanding 32,352 33,273 32,452 33,442 Shares outstanding at period end 31,716 32,723 31,716 32,723 As Reported: Basic earnings per share $0.79 $0.73 $2.33 $2.15 Diluted earnings per share 0.78 0.72 2.28 2.12 Return on assets 2.19% 2.18% 2.20% 2.20% Return on equity 30.05% 29.25% 30.56% 29.38% Net interest margin 5.11% 5.31% 5.20% 5.44% Net loan losses to average loans 0.03% 0.12% 0.10% 0.15% Efficiency ratio* 36.9% 39.1% 37.7% 39.2% Average Balances: Total assets $4,557,925 $4,373,156 $4,497,287 $4,293,136 Earning assets 4,260,701 4,072,793 4,198,373 3,995,287 Total loans 2,247,664 2,331,855 2,266,184 2,377,121 Total deposits 3,616,319 3,500,911 3,514,373 3,392,758 Shareholders' equity 332,219 326,529 323,723 322,003 Balances at Period End: Total assets $4,636,071 $4,482,793 Earning assets 4,356,635 4,180,358 Total loans 2,301,991 2,364,418 Total deposits 3,645,806 3,536,129 Shareholders' equity 351,924 350,922 Financial Ratios at Period End: Allowance for loan losses to loans 2.36% 2.29% Book value per share $11.10 $10.72 Equity to assets 7.59% 7.83% Total capital to risk-adjusted assets 12.29% 11.61% Dividends Paid Per Share $0.28 $0.26 $0.82 $0.74 Dividend Payout Ratio 36% 36% 36% 35% The above financial summary has been derived from the Company's unaudited consolidated financial statements. This information should be read in conjunction with such financial statements, notes and the other information included elsewhere herein. *The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income on a tax-equivalent basis and noninterest income). ** Fully taxable equivalent
Page 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Pending Acquisition On August 25, 2004, Westamerica Bancorporation and subsidiaries (the "Company") signed a definitive agreement to acquire Redwood Empire Bancorp, parent company of National Bank of the Redwoods. The transaction is valued at approximately $148 million, of which approximately $57 million will be paid in cash and the remainder by issuance of the Company's common stock. It is the intention of the Company to reduce the allocation of its operating cash flow toward the repurchase and retirement of its common stock in order to meet the approximate $57 million cash payment for the transaction. Further information related to the pending acquisition, including unaudited pro forma combined financial data, can be found in the Company's Registration Statement on Form S-4 that was filed with the Securities and Exchange Commission on October 15, 2004. The acquisition is expected to be completed in the first quarter of 2005, subject to receipt of regulatory approvals and satisfaction of other conditions set forth in the definitive agreement. Overview of Financial Results The Company reported third quarter 2004 net income of $25.1 million or diluted earnings per share of $0.78. These results compare with net income for the third quarter 2003 of $24.1 million or $0.72 per share. On a year-to-date basis, the Company reported net income for the nine months ended September 30, 2004 of $74.1 million or diluted earnings per share of $2.28, compared with $70.8 million or $2.12 per share for the same period of 2003. Following is a summary of the components of income. Income from certain securities and loans is presented on a fully taxable equivalent ("FTE") basis to reflect its exemption from federal income taxation for the periods indicated (dollars in thousands).
Three months ended Nine months ended September 30, September 30, ---------------------------------------------------- 2004 2003 2004 2003 ---------------------------------------------------- Net interest income (FTE) $54,528 $54,264 $163,405 $162,650 Provision for loan losses (600) (750) (2,100) (2,550) Noninterest income: Securities gains (losses) (14) 2,150 2,169 2,443 FHLB advance prepayment fees 0 (2,166) (2,204) (2,166) Other 11,802 11,029 34,349 32,147 ---------------------------------------------------- Total noninterest income 11,788 11,013 34,314 32,424 Noninterest expense (24,491) (25,534) (74,473) (76,546) Provision for income taxes (FTE) (16,130) (14,920) (47,093) (45,223) ---------------------------------------------------- Net income $25,095 $24,073 $74,053 $70,755 ==================================================== Average diluted shares 32,352 33,273 32,452 33,442 Diluted earnings per share $0.78 $0.72 $2.28 $2.12 Average total assets 4,557,925 4,373,156 4,497,287 4,293,136 Net income (annualized) to average total assets 2.19% 2.18% 2.20% 2.20%
Net income for the third quarter of 2004 was $1.0 million or 4.2% more than for the same quarter of 2003. The increase in net interest income (FTE) ($264 thousand) was attributable to the effect of higher average earning assets (up $187.9 million) and growth in lower interest-bearing liabilities, partially offset by a 20 basis point ("bp") decline in the net interest margin. The loan loss provision declined $150 thousand. Noninterest income increased $775 thousand primarily due to growth in deposit fee income. Noninterest expense declined $1.0 million because of lower personnel and other operational costs. The higher tax provision (up $1.2 million) was the result of increased pretax income reduced in part by higher low-income housing investment tax credits. Comparing the first nine months of 2004 to the prior year, net income rose $3.3 million or 4.7%. The increase was attributable to higher net interest income (FTE), a lower loan loss provision, higher noninterest income (up $1.9 million) and lower noninterest expense (down $2.1 million). The tax provision increased $1.9 million on an FTE basis. The improved net interest income (FTE) (up $755 thousand) was the result of higher average earning assets (up $203.1 million) and growth in lower interest-bearing liabilities, offset by a 24 bp decline in the net interest margin. Page 11 Net Interest Income Following is a summary of the components of net interest income for the periods indicated (dollars in thousands):
Three months ended Nine months ended September 30, September 30, ---------------------------------------------------- 2004 2003 2004 2003 ---------------------------------------------------- Interest and fee income $53,904 $54,960 $161,587 $168,684 Interest expense (5,042) (6,289) (15,154) (21,435) FTE adjustment 5,666 5,593 16,972 15,401 ---------------------------------------------------- Net interest income (FTE) $54,528 $54,264 $163,405 $162,650 ==================================================== Average earning assets $4,260,701 $4,072,793 $4,198,373 $3,995,287 Net interest margin (FTE) 5.11% 5.31% 5.20% 5.44%
Net interest income (FTE) during the third quarter of 2004 increased $264 thousand or 0.5% from the same period in 2003, to $54.5 million. The increase was attributable to higher average low rate interest-bearing liabilities and higher average earning assets, partly offset by a lower net interest margin and lower fee income. Comparing the first nine months of 2004 with the prior year, net interest income (FTE) rose $755 thousand or 0.5%. The increase was caused by the net effect of higher average earning assets, higher average low rate interest-bearing liabilities, one additional accrual day, and a lower loan fee income and a declining net interest margin. Interest and Fee Income Interest & fee income (FTE) for the third quarter of 2004 decreased $983 thousand or 1.6% from the same period in 2003. The decline was the net effect of higher average earning assets, more than offset by lower yields earned on those assets and lower loan fee income. Average earning assets grew $187.9 million or 4.6%. The earning asset growth was led by expansion in the investment portfolio of $272.1 million as follows: mortgage backed securities and collateralized mortgage obligations (up $278.9 million), US Agency obligations (up $38.3 million) and municipal securities (up $23.5 million). Other securities declined $63.3 million. The growth in the investments was diminished by an $84.2 million reduction in loans including commercial real estate loans (down $115.0 million) and direct consumer loans (down $6.1 million), net of a $14.0 million increase in indirect consumer loans, a $13.6 million increase in residential real estate loans and a $11.1 million increase in commercial loans. The average yield on the Company's earning assets decreased for the third quarter from 5.92% in 2003 to 5.58% (down 34 bp). This downward trend in yields was reflective of a change in the earning asset mix and general interest rate declines during 2003 and into much of 2004, as evident in indirect consumer loans (90 bp decline in yield), residential real estate loans (47 bp decline) and commercial real estate loans (35 bp decline). As a result, the loan portfolio yield decreased 44 bp. The investment portfolio yield rose 3 bp, the net result of a decline in premium write-offs from mortgage prepayments, resulting in increases in yields on mortgage backed securities and collateralized mortgage obligations (up 152 bp) and other securities (up 50 bp), partially offset by declines in U.S. Agency obligations (down 31 bp) and municipal securities (down 24 bp). Comparing the first nine months of 2004 to 2003, interest and fee income (FTE) decreased by $5.5 million or 3.0%. The decline was the combined effect of lower yields, lower fee income, a higher volume of earning assets and one additional accrual day. Average earning assets increased $203.1 million or 5.1%, mainly due to increases in mortgage backed securities and collateralized mortgage obligations (up $248.8 million), municipal securities (up $95.4 million), U.S. Agency obligations (up $41.4 million), residential real estate loans (up $17.7 million), commercial loans (up $11.1 million) and indirect consumer loans (up $6.2 million). The following components decreased: commercial real estate loans (down $130.8 million), direct consumer loans (down $8.8 million), construction loans (down $6.3 million), other securities (down $61.8 million) and U.S. Treasury securities (down $9.7 million). Page 12 The average yield on earning assets for the first nine months of 2004 was 5.68% compared with 6.15% for the same period in 2003. Major decreases in loan yields included a 95 bp decline in indirect consumer loans, a 75 bp decrease in residential real estate loans, a 43 bp decline in the yield on commercial real estate loans and a 20 bp decrease in the yield on commercial loans and a 36 bp decline in personal credit lines. As a result, the composite loan yield declined 59 bp. The investment portfolio yield decreased 7 bp, primarily the net result of lower yields on U.S. Agency obligations (down 49 bp) and municipal securities (down 36 bp), partially offset by higher yields on other securities (up 115 bp), mortgage backed securities and collateralized mortgage obligations (up 92 bp). Interest Expense Interest expense decreased $1.2 million or 19.8% in the third quarter of 2004 compared to the same year-ago period due to a change in the mix of average interest bearing liabilities and declining rates paid on those liabilities. The decrease resulted from a drop in the average rate paid on interest-bearing liabilities from 0.89% in 2003 to 0.69% in 2004. The average rate on money market savings declined 27 bp while the average rate paid on federal funds purchased rose 42 bp and the yield on public CDs rose 33 bp. A $76.5 million or 2.7% increase in average interest-bearing liabilities in the third quarter resulted in a decrease in volume-related expense as higher rate interest bearing liabilities were replaced by lower rates. Federal Home Loan Bank ("FHLB") advances with higher rates decreased from $124.1 million to none whereas federal funds purchased increased $135.7 million and money market savings increased $65.9 million. During the first nine months of 2004, interest expense decreased $6.3 million or 29.3% from 2003, again due to a lower average rate paid on interest-bearing liabilities and a lower volume of those liabilities. The average rate paid was 0.70% in 2004 compared with 1.03% in 2003. Most deposit categories declined including money market savings (down 31 bp), Jumbo CDs (down 33 bp), public CDs (down 15 bp), regular savings (down 11 bp), retail CDs (down 31 bp), money market checking accounts (down 5 bp) and preferred money market (down 30 bp). The rates on customer sweep accounts declined 27 bp and long term debt decreased 129 bp. Interest-bearing liabilities grew $93.8 million or 3.4% for the nine months ended September 30, 2004 and caused a mix-related decrease in interest expense as higher rate liabilities were replaced with lower rate liabilities. FHLB advances were reduced by $122.5 million. Jumbo CDs and public CDs also declined $23.4 million and $12.0 million, respectively. The following lower rate categories increased: federal funds purchased (up $151.6 million), repurchase agreements (up $49.4 million), money market savings (up $62.6 million). In all periods, the Company has continuously attempted to reduce high-rate time deposits while increasing the balances of more profitable, lower-cost transaction accounts in order to minimize the effect of adverse cyclical trends. Net Interest Margin (FTE) The following summarizes the components of the Company's net interest margin for the periods indicated:
Three months ended Nine months ended September 30, September 30, ---------------------------------------------------- 2004 2003 2004 2003 ---------------------------------------------------- Yield on earning assets 5.58% 5.92% 5.68% 6.15% Rate paid on interest-bearing liabilities 0.69% 0.89% 0.70% 1.03% ---------------------------------------------------- Net interest spread 4.89% 5.03% 4.98% 5.12% Impact of all other net noninterest bearing funds 0.22% 0.28% 0.22% 0.32% ---------------------------------------------------- Net interest margin 5.11% 5.31% 5.20% 5.44% ====================================================
During the third quarter of 2004, the net interest margin declined 20 bp compared to the same period in 2003. Yields on earning assets declined faster than did rates paid on interest-bearing liabilities, resulting in a 14 bp decline in net interest spread. The unfavorable impact of lower rates earned on loans, triggered by market trends, was partially mitigated by the effect of paydowns of FHLB advances and decreases in rates paid on deposits and long-term debt. The decline in the net interest spread was further widened by the lower value of noninterest-bearing funding sources. While the average balance of these sources increased $96.7 million or 11.5%, their value decreased 6 bp because of the lower market rates of interest at which they could be invested. Page 13 Similarly, on a year-to-date basis, the net interest margin decreased 24 bp when compared to the same period in 2003. Earning asset yields decreased 47 bp and the cost of interest-bearing liabilities fell by 33 bp, resulting in a 14 bp decline in the net interest spread. Noninterest-bearing funding sources increased $102.8 million or 13.0% and because of lower market rates of interest their margin contribution decreased by 10 bp, with their value decreasing to 22 bp. Summary of Average Balances, Yields/Rates and Interest Differential The following tables present, for the periods indicated, information regarding the Company's consolidated average assets, liabilities and shareholders' equity, the amounts of interest income from average earning assets and the resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include nonperforming loans. Interest income includes proceeds from loans on nonaccrual status only to the extent cash payments have been received and applied as interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income exempt from federal income taxation at the current statutory tax rate (dollars in thousands).
For the three months ended September 30, 2004 --------------------------------------- Interest Rates Average Income/ Earned/ Balance Expense Paid --------------------------------------- Assets: Money market assets and funds sold $534 $0 0.00% Investment securities: Available for sale Taxable 712,378 7,171 4.03% Tax-exempt 286,551 5,291 7.39% Held to maturity Taxable 586,377 5,725 3.91% Tax-exempt 427,197 7,081 6.63% Loans: Commercial Taxable 351,467 5,105 5.78% Tax-exempt 238,481 4,029 6.72% Commercial real estate 752,395 13,955 7.38% Real estate construction 34,977 619 7.04% Real estate residential 365,559 4,047 4.43% Consumer 504,785 6,547 5.16% -------------------------- Total loans 2,247,664 34,302 6.08% -------------------------- Total earning assets 4,260,701 59,570 5.58% Other assets 297,224 ------------- Total assets $4,557,925 ============= Liabilities and shareholders' equity Deposits: Noninterest bearing demand $1,305,840 $-- -- Savings and interest-bearing transaction 1,696,316 1,118 0.26% Time less than $100,000 266,584 999 1.49% Time $100,000 or more 347,579 1,136 1.30% -------------------------- Total interest-bearing deposits 2,310,479 3,253 0.56% Short-term borrowed funds 550,909 1,473 1.05% Federal Home Loan Bank advance 0 0 0.00% Debt financing and notes payable 21,428 316 5.90% -------------------------- Total interest-bearing liabilities 2,882,816 5,042 0.69% Other liabilities 37,050 Shareholders' equity 332,219 ------------- Total liabilities and shareholders' equity $4,557,925 ============= Net interest spread (1) 4.89% Net interest income and interest margin (2) $54,528 5.11% ========================== (1) Net interest spread represents the average yield earned on earning assets minus the average rate paid on interest-bearing liabilities. (2) Net interest margin is computed by calculating the difference between interest income and expense, divided by the average balance of earning assets.
Page 14
For the three months ended September 30, 2003 --------------------------------------- Interest Rates Average Income/ Earned/ Balance Expense Paid --------------------------------------- Assets: Money market assets and funds sold $633 $2 1.25% Investment securities: Available for sale Taxable 863,851 8,632 4.00% Tax-exempt 315,930 5,882 7.45% Held to maturity Taxable 181,909 697 1.53% Tax-exempt 378,615 6,528 6.90% Loans: Commercial Taxable 367,465 5,191 5.60% Tax-exempt 211,364 3,842 7.21% Commercial real estate 867,422 17,310 7.92% Real estate construction 37,311 666 7.08% Real estate residential 351,973 4,306 4.89% Consumer 496,320 7,497 5.99% -------------------------- Total loans 2,331,855 38,812 6.61% -------------------------- Total earning assets 4,072,793 60,553 5.92% Other assets 300,363 ------------- Total assets $4,373,156 ============= Liabilities and shareholders' equity: Deposits: Noninterest bearing demand $1,203,378 $-- -- Savings and interest-bearing transaction 1,599,917 1,585 0.39% Time less than $100,000 303,334 1,191 1.56% Time $100,000 or more 394,282 1,209 1.21% -------------------------- Total interest-bearing deposits 2,297,533 3,985 0.69% Short-term borrowed funds 363,394 747 0.81% Federal Home Loan Bank advance 124,086 1,172 3.72% Debt financing and notes payable 21,262 385 7.24% -------------------------- Total interest-bearing liabilities 2,806,275 6,289 0.89% Other liabilities 36,974 Shareholders' equity 326,529 ------------- Total liabilities and shareholders' equity $4,373,156 ============= Net interest spread (1) 5.03% Net interest income and interest margin (2) $54,264 5.31% ==========================
Page 15
For the nine months ended September 30, 2004 --------------------------------------- Interest Rates Average Income/ Earned/ Balance Expense Paid --------------------------------------- Assets: Money market assets and funds sold $534 $1 0.25% Investment securities: Available for sale Taxable 851,878 26,581 4.16% Tax-exempt 297,013 16,505 7.41% Held to maturity Taxable 367,698 10,325 3.74% Tax-exempt 415,066 20,685 6.64% Loans: Commercial Taxable 346,449 14,709 5.67% Tax-exempt 238,281 11,956 6.70% Commercial real estate 779,075 43,520 7.46% Real estate construction 36,844 1,905 6.91% Real estate residential 357,836 12,023 4.48% Consumer 507,699 20,349 5.35% -------------------------- Total loans 2,266,184 104,462 6.16% -------------------------- Total earning assets 4,198,373 178,559 5.68% Other assets 298,914 ------------- Total assets $4,497,287 ============= Liabilities and shareholders' equity: Deposits: Noninterest bearing demand $1,257,089 $-- -- Savings and interest-bearing transaction 1,640,438 3,456 0.28% Time less than $100,000 274,261 2,958 1.44% Time $100,000 or more 342,585 2,985 1.16% -------------------------- Total interest-bearing deposits 2,257,284 9,399 0.56% Short-term borrowed funds 566,044 3,890 0.90% Federal Home Loan Bank advance 32,204 897 3.66% Debt financing and notes payable 21,798 968 5.92% -------------------------- Total interest-bearing liabilities 2,877,330 15,154 0.70% Other liabilities 39,145 Shareholders' equity 323,723 ------------- Total liabilities and shareholders' equity $4,497,287 ============= Net interest spread (1) 4.98% Net interest income and interest margin (2) $163,405 5.20% ==========================
Page 16
For the nine months ended September 30, 2003 --------------------------------------- Interest Rates Average Income/ Earned/ Balance Expense Paid --------------------------------------- Assets: Money market assets and funds sold $633 $6 1.27% Investment securities: Available for sale Taxable 758,691 25,151 4.42% Tax-exempt 335,827 17,573 6.98% Held to maturity Taxable 222,775 4,235 2.53% Tax-exempt 300,240 15,937 7.08% Loans: Commercial Taxable 367,947 15,779 5.73% Tax-exempt 205,727 11,247 7.31% Commercial real estate 909,838 54,466 8.00% Real estate construction 43,103 2,343 7.27% Real estate residential 340,160 13,334 5.23% Consumer 510,346 24,014 6.29% -------------------------- Total loans 2,377,121 121,183 6.81% -------------------------- Total earning assets 3,995,287 184,085 6.15% Other assets 297,849 ------------- Total assets $4,293,136 ============= Liabilities and shareholders' equity: Deposits: Noninterest bearing demand $1,150,518 $-- -- Savings and interest-bearing transaction 1,553,206 5,309 0.46% Time less than $100,000 311,104 4,062 1.75% Time $100,000 or more 377,930 3,993 1.41% -------------------------- Total interest-bearing deposits 2,242,240 13,364 0.80% Short-term borrowed funds 364,850 2,559 0.93% Federal Home Loan Bank advance 154,695 4,339 3.70% Debt financing and notes payable 21,695 1,173 7.21% -------------------------- Total interest-bearing liabilities 2,783,480 21,435 1.03% Other liabilities 37,135 Shareholders' equity 322,003 ------------- Total liabilities and shareholders' equity $4,293,136 ============= Net interest spread (1) 5.12% Net interest income and interest margin (2) $162,650 5.44% ==========================
Page 17 Summary of Changes in Interest Income and Expense due to Changes in Average Asset & Liability Balances and Yields Earned & Rates Paid The following tables set forth a summary of the changes in interest income and interest expense from changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. Changes not solely attributable to volume or rates have been allocated in proportion to the respective volume and rate components (dollars in thousands).
Three months ended September 30, 2004 compared with three months ended September 30, 2003 --------------------------------------- Volume Rate Total --------------------------------------- Interest and fee income: Money market assets and funds sold ($0) ($2) ($2) Investment securities: Available for sale Taxable (1,546) 85 (1,461) Tax-exempt ($543) (48) (591) Held to maturity Taxable $2,962 2,066 5,028 Tax-exempt $815 (262) 553 Loans: Commercial Taxable ($238) 152 (86) Tax-exempt $463 (276) 187 Commercial real estate ($2,220) (1,135) (3,355) Real estate construction (43) (4) (47) Real estate residential 163 (422) (259) Consumer 124 (1,074) (950) --------------------------------------- Total loans (1,751) (2,759) (4,510) --------------------------------------- Total earning assets (63) (920) (983) --------------------------------------- Interest expense: Deposits: Savings and interest-bearing transaction 90 (557) (467) Time less than $100,000 (142) (50) (192) Time $100,000 or more (151) 78 (73) --------------------------------------- Total interest-bearing deposits (203) (529) (732) --------------------------------------- Short-term borrowed funds 457 269 726 Federal Home Loan Bank advance (1,172) 0 (1,172) Debt financing and notes payable 3 (72) (69) --------------------------------------- Total interest-bearing liabilities (915) (332) (1,247) --------------------------------------- Increase in Net Interest Income $852 ($588) $264 =======================================
Page 18
Nine months ended September 30, 2004 compared with nine months ended September 30, 2003 --------------------------------------- Volume Rate Total --------------------------------------- Interest and fee income: Money market assets and funds sold ($1) (4) ($5) Investment securities: Available for sale Taxable 3,013 (1,583) $1,430 Tax-exempt ($2,090) 1,022 ($1,068) Held to maturity Taxable $3,536 2,554 $6,090 Tax-exempt $5,780 (1,032) $4,748 Loans: Commercial Taxable ($894) (176) ($1,070) Tax-exempt $1,705 (996) $709 Commercial real estate ($7,385) (3,561) ($10,946) Real estate construction (324) (114) ($438) Real estate residential 695 (2,006) ($1,311) Consumer (52) (3,613) ($3,665) --------------------------------------- Total loans (6,255) (10,466) (16,721) --------------------------------------- Total earning assets 3,983 (9,509) (5,526) --------------------------------------- Interest expense: Deposits: Savings and interest-bearing transaction 295 (2,148) (1,853) Time less than $100,000 (439) (665) (1,104) Time $100,000 or more (342) (666) (1,008) --------------------------------------- Total interest-bearing deposits (486) (3,479) (3,965) --------------------------------------- Short-term borrowed funds 1,386 (55) 1,331 Federal Home Loan Bank advance (3,396) (46) (3,442) Debt financing and notes payable 9 (214) (205) --------------------------------------- Total interest-bearing liabilities (2,487) (3,794) (6,281) --------------------------------------- Increase in Net Interest Income $6,470 ($5,715) $755 =======================================
Page 19 Provision for Loan Losses The level of the provision for loan losses during each of the periods presented reflects the Company's continued efforts to reduce credit costs by enforcing underwriting and administration procedures and aggressively pursuing collection efforts with troubled debtors. The Company provided $600 thousand for loan losses in the third quarter of 2004 and $750 thousand in the same quarter of 2003. For the first nine months of 2004, $2.1 million was provided while in 2003, $2.6 million was provided. The lower provision reflects management's assessment of credit risk in the loan portfolio. For further information regarding net credit losses and the allowance for loan losses, see the "Classified Loans" section of this report. Noninterest Income The following table summarizes the components of noninterest income for the periods indicated (dollars in thousands).
Three months ended Nine months ended September 30, September 30, ---------------------------------------------------- 2004 2003 2004 2003 ---------------------------------------------------- Service charges on deposit accounts $7,465 $6,735 $21,693 $19,809 Merchant credit card 899 993 2,633 2,755 ATM fees and interchange 664 644 1,889 1,805 Debit card fees 654 556 1,841 1,613 Other service fees 466 404 1,322 1,153 Mortgage banking income 41 185 304 712 Financial services commissions 409 249 956 666 Trust fees 265 245 773 760 Securities gains (losses) (14) 2,150 2,169 2,443 Loss on extinguishment of debt 0 (2,166) (2,204) (2,166) Other noninterest income 939 1,018 2,938 2,874 ---------------------------------------------------- Total noninterest income $11,788 $11,013 $34,314 $32,424 ====================================================
Noninterest income for the third quarter of 2004 was $11.8 million, up $775 thousand or 7.0% compared with the same quarter of 2003. Higher income from service charges on deposits (up $730 thousand) mainly resulted from enhanced overdraft processing programs and repricing of checking account fees (effective as of February 2004), partially reduced by lower income from account analysis deficit fees and fees collected on deposited items returned. A $160 thousand increase in financial services commission income was largely due to higher sales of fixed and variable annuities and mutual funds. Mortgage banking income declined $144 thousand due to lower loan funding activity. Losses on sales of securities of $14 thousand were recorded in the third quarter of 2004 whereas $2.2 million gains were recorded a year ago, which offset the $2.2 million loss on extinguishment of debt. Noninterest income for the nine months of 2004 was $34.3 million, up $1.9 million or 5.8% from 2003, mainly due to growth in deposit fee income. Service charges on deposit accounts rose $1.9 million or 9.5% primarily due to enhanced overdraft processing programs and repricing of checking account fees, partially reduced by lower income from account analysis deficit fees and fees collected on deposited items returned. A $228 thousand or 14.1% increase in debit card fees was attributable to increased usage. Financial services commission income increased $290 thousand or 43.4% largely due to higher sales of fixed and variable annuities and mutual funds. Other service fees rose $169 thousand or 14.7% mostly due to higher income from international money transfers in foreign currencies. Mortgage banking income declined $408 thousand or 57.3% mainly due to less loan funding activity. Securities gains fell from $2.4 million to $2.2 million which offset a loss on extinguishment of debt of $2.2 million each in the respective periods. Merchant credit card income declined $122 thousand or 4.4% primarily due to higher interchange expense. Page 20 Noninterest Expense The following table summarizes the components of noninterest expense for the periods indicated (dollars in thousands).
Three months ended Nine months ended September 30, September 30, ---------------------------------------------------- 2004 2003 2004 2003 ---------------------------------------------------- Salaries and related benefits $13,054 $13,495 $39,912 $40,792 Occupancy 3,022 3,076 8,913 9,116 Equipment 1,101 1,319 3,536 4,074 Data processing services 1,525 1,520 4,563 4,597 Courier service 923 941 2,695 2,796 Telephone 529 519 1,636 1,368 Postage 288 381 1,046 1,202 Professional fees 411 529 1,332 1,400 Merchant credit card 292 317 833 975 Stationery and supplies 333 331 930 957 Advertising/public relations 241 243 746 775 Employee recruiting 10 117 78 226 Loan expense 289 339 839 995 Operational losses 265 237 747 638 Repossessed collateral expense (5) 12 (5) 14 Amortization of deposit intangibles 136 165 408 578 Other noninterest expense 2,077 1,993 6,264 6,043 ---------------------------------------------------- Total $24,491 $25,534 $74,473 $76,546 ==================================================== Average full time equivalent staff 980 1,016 992 1,032 Noninterest expense to revenues (FTE) 36.93% 39.12% 37.67% 39.24%
Noninterest expense for the third quarter of 2004 was $24.5 million, $1.0 million or 4.1% lower than in 2003. Salaries and related benefits declined $441 thousand or 3.3% mainly due to lower incentives and bonuses (down $322 thousand), lower costs of workers compensation insurance (down $126 thousand), lower payroll taxes and a decrease in salaries and wages as a result of a decline in the number of full-time equivalent employees, partially offset by annual salary merit increases. Equipment expense fell $218 thousand or 16.5% compared with 2003 mostly due to lower maintenance costs and depreciation, and because 2003 included higher write-offs of obsolete equipment. Professional fees declined $118 thousand or 22.3% mainly due to lower legal costs. Employee recruiting costs fell $107 thousand or 91.5%. Noninterest expense was $74.5 million for the nine months of 2004, which was $2.1 million or 2.7% less than 2003. Salaries and related benefits were down $880 thousand or 2.2% as a result of declines in salaries and wages (down $375 thousand) due to a fewer number of full-time equivalent employees and lower incentives and bonuses (down $746 thousand), partially offset by an increase in workers compensation insurance costs. Equipment expense fell by $538 thousand or 13.2% from 2003 primarily due to lower depreciation and lower repair and maintenance costs. Occupancy expense declined $203 thousand or 2.2% mainly due to lower utility expenses, partially offset by an increase in rent payments for branches. Amortization of deposit intangibles declined $170 thousand or 29.4% largely due to the expiration of the deposit intangibles from a prior acquisition. Postage decreased $156 thousand or 13.0%. Loan expense declined by $156 thousand or 15.7% mostly due to lower commercial loan activity and fewer foreclosures. Employee recruiting fell by $148 thousand or 65.5%. Merchant credit card expense fell $142 thousand or 14.6% mostly due to lower rates negotiated in October of 2003. Courier service costs fell $101 thousand or 3.6%. Telephone expense rose $268 thousand or 19.6% mostly due to the cost of additional data lines installed in connection with network upgrades. Other noninterest expense was higher by $221 thousand or 3.7% primarily the net result of a $414 thousand increase in limited partnership operating losses from tax-credit related low-income housing investments, a $129 thousand increase in debit card network fees and an increase in internet banking expense, partially reduced by a $245 thousand decrease in life insurance costs, a $100 thousand decline in contingency settlement costs and a decrease in customer checks. Page 21 Provision for Income Tax During the third quarter of 2004, the Company recorded an income tax provision (FTE) of $16.1 million, $1.2 million (8.1%) higher than the third quarter of 2003; on a year-to-date basis, the income tax provision (FTE) was $47.1 million for 2004 compared to $45.2 million for 2003. The current quarter provision represents an effective tax rate (FTE) of 39.1% compared to 38.3% for the third quarter of 2003; for the first nine months of 2004, the effective tax rate (FTE) was 38.9%, compared to 39.0% recorded in 2003. The provision for income taxes for all periods presented is primarily attributable to the respective level of earnings and the incidence of allowable deductions, in particular tax credits generated from low-income housing investments, and for California franchise taxes, higher excludable interest income on loans within designated enterprise zones. Classified Loans The Company closely monitors the markets in which it conducts its lending operations and continues its strategy to control exposure to loans with high credit risk and to increase diversification of earning assets. Loan reviews are performed using grading standards and criteria similar to those employed by bank regulatory agencies. Loans receiving lesser grades fall under the "classified" category, which includes all nonperforming and potential problem loans, and receive an elevated level of attention to ensure collection. Repossessed collateral is recorded at the lower of cost or market. The following is a summary of classified loans and repossessed collateral on the dates indicated (dollars in thousands):
At September 30, At --------------------------December 31, 2004 2003 2003 --------------------------------------- Classified loans $20,868 $23,479 $23,460 Repossessed collateral 0 742 90 --------------------------------------- Classified loans and repossessed collateral $20,868 $24,221 $23,550 ======================================= Allowance for loan losses / classified loans 261% 231% 230%
Classified loans at September 30, 2004, decreased $2.6 million (11.1%) from September 30, 2003, reflecting the effectiveness of the Company's high underwriting standards and active workout policies. The decrease ($2.6 million or 11.1%) in classified loans from December 31, 2003, was due to payoffs, upgrades and chargeoffs, partly offset by new downgrades. Repossessed collateral decreased to none from $742 thousand at September 30, 2003 and from $90 thousand at year-end 2003, primarily due to two foreclosed properties totaling $662 thousand sold by the end of 2003, and two small foreclosed properties sold in 2004, respectively. Nonperforming Loans Nonperforming loans include nonaccrual loans and loans 90 days past due as to principal or interest and still accruing. Loans are placed on nonaccrual status when they become 90 days or more delinquent, unless the loan is well secured and in the process of collection. Interest previously accrued on loans placed on nonaccrual status is charged against interest income. In addition, loans secured by real estate with temporarily impaired values and commercial loans to borrowers experiencing financial difficulties are placed on nonaccrual status even though the borrowers continue to repay the loans as scheduled. Such loans are classified as "performing nonaccrual" and are included in total nonperforming loans. When the ability to fully collect nonaccrual loan principal is in doubt, cash payments received are applied against the principal balance of the loan until such time as full collection of the remaining recorded balance is expected. Any subsequent interest received is recorded as interest income on a cash basis. Page 22 The following is a summary of nonperforming loans and repossessed collateral on the dates indicated (dollars in thousands):
At September 30, At --------------------------December 31, 2004 2003 2003 --------------------------------------- Performing nonaccrual loans $2,777 $2,145 $1,658 Nonperforming, nonaccrual loans 3,996 5,484 5,759 --------------------------------------- Total nonaccrual loans 6,773 7,629 7,417 Loans 90 days past due and still accruing 182 272 199 --------------------------------------- Total nonperforming loans 6,955 7,901 7,616 Repossessed collateral 0 742 90 --------------------------------------- Total nonperforming loans and repossessed collateral $6,955 $8,643 $7,706 ======================================= Allowance for loan losses / nonperforming loans 782% 686% 708%
Performing nonaccrual loans at September 30, 2004 rose $632 thousand (29.5%) from the same period in the previous year and $1.1 million (67.5%) from December 31, 2003. The increase from both periods was due to new loans placed on performing nonaccrual, partially offset by payoffs, chargeoffs, loans being returned to accrual status and loans being placed on nonperforming nonaccrual. Nonperforming nonaccrual loans at September 30, 2004 decreased $1.5 million or 27.1% from the same period a year ago and $1.8 million (30.6%) from year-end, 2003. The decreases resulted from loans being returned to accrual status, transfers to repossessed collateral or being charged off or paid off, partially offset by loans being added to nonperforming nonaccrual. Changes in repossessed collateral are in the "Classified Loans" section. The Company had no restructured loans as of September 30, 2004, 2003 and December 31, 2003. The amount of gross interest income that would have been recorded for nonaccrual loans for the three and nine month periods ended September 30, 2004, if all such loans had performed in accordance with their original terms, was $102 thousand and $332 thousand, respectively, compared to $110 thousand and $415 thousand, respectively, for the third quarter and the first nine months of 2003. The amount of interest income that was recognized on nonaccrual loans from all cash payments, including those related to interest owed from prior years, made during the three and nine months ended September 30, 2004, totaled $85 thousand and $252 thousand, respectively, compared to $299 thousand and $516 thousand, respectively, for the comparable periods in 2003. These cash payments represent annualized yields of 5.46% and 4.99%, respectively, for the third quarter and the first nine months of 2003 compared to 17.36% and 8.77%, respectively, for the third quarter and the first nine months of 2003. Total cash payments received during the third quarter of 2004 which were applied against the book balance of nonaccrual loans outstanding at September 30, 2003, totaled approximately $3 thousand, compared with none in 2003. Cash payments received totaled approximately $101 thousand for the nine months ended September 30, 2004, compared with approximately $283 thousand for 2003. The overall credit quality of the loan portfolio continues to be acceptable; however, total nonperforming assets could fluctuate from period to period. The performance of any individual loan can be impacted by external factors such as the interest rate environment or factors particular to the borrower. The Company expects to maintain the level of nonperforming assets; however, the Company can give no assurance that additional increases in nonaccrual loans will not occur in the future. Page 23 Allowance for Loan Losses The Company's allowance for loan losses is maintained at a level estimated to be adequate to provide for losses that can be estimated based upon specific and general conditions. These include credit loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other factors. The allowance is allocated to segments of the loan portfolio based in part on quantitative analyses of historical credit loss experience, in which criticized and classified loan balances are analyzed using a linear regression model to determine standard allocation percentages. The results of this analysis are applied to current criticized and classified loan balances to allocate the allowance to the respective segments of the loan portfolio. In addition, loans with similar characteristics not usually criticized using regulatory guidelines due to their small balances and numerous accounts, are analyzed based on the historical rate of net losses and delinquency trends, grouped by the number of days the payments on these loans are delinquent. A portion of the allowance is also allocated to specific impaired loans. As of the date of this report, Management considers the $54.4 million allowance for loan losses, which constituted 2.36% of total loans at September 30, 2004, to be adequate as an allowance against inherent losses. However, the risk exists of future losses which cannot be precisely quantified or attributed to particular loans or classes of loans. Management continues to evaluate the loan portfolio and assess current economic conditions that will dictate future required allowance levels. The following table summarizes the loan loss provision, net credit losses and allowance for loan losses for the periods indicated (dollars in thousands):
Three months ended Nine months ended September 30, September 30, ---------------------------------------------------- 2004 2003 2004 2003 ---------------------------------------------------- Balance, beginning of period $53,949 $54,159 $53,910 $54,227 Loan loss provision 600 750 2,100 2,550 Loans charged off (1,116) (1,422) (3,998) (5,291) Recoveries of previously charged off loans 955 693 2,376 2,694 ---------------------------------------------------- Net credit losses (161) (729) (1,622) (2,597) ---------------------------------------------------- Balance, end of period $54,388 $54,180 $54,388 $54,180 ==================================================== Allowance for loan losses / loans outstanding 2.36% 2.29%
Asset and Liability Management The fundamental objective of the Company's management of assets and liabilities is to maximize economic value while maintaining adequate liquidity and a conservative level of interest rate risk. The Company actively solicits loans and transaction deposit accounts. Asset and liability management techniques include adjusting the duration, liquidity, volume, rates and yields, and other attributes of its loan products, investment portfolio, time deposits, and other funding sources to achieve Company objectives. The primary analytical tool used by the Company to gauge interest rate risk is a simulation model to project changes in net interest income ("NII") that result from forecast changes in interest rates. The analysis calculates the difference between a NII forecast over a 12-month period using a flat interest rate scenario, and a NII forecast using a rising rate scenario where the Fed Funds rate is made to rise evenly by 100 bp and 200 bp, and a falling rate scenario of 75 bp over the 12-month forecast interval triggering a response in the other forecasted rates. Company policy requires that such simulated changes in NII should be within certain specified ranges or steps must be taken to reduce interest rate risk. The results of the model indicate that the mix of interest rate sensitive assets and liabilities at September 30, 2004 would not result in a fluctuation of NII that would exceed the parameters established by Company policy. A variety of factors affect the timing and magnitude of interest rate changes such as general economic conditions, fiscal policy, monetary policy, political developments, terrorism, and a variety of other factors. Given current conditions, the Company is anticipating rising rates, although the timing of increasing rates remains uncertain. The Company generally maintains an interest rate risk position near neutral, such that changing interest rates will not cause significant changes in net interest income. During the first nine months of 2004, the Company sold $209.1 million of available-for-sale securities to reduce the average duration of the securities portfolios in a rising rate environment. The Company realized securities gains of $2.2 million from these sales. Also, during the same period, the Company retired $105 million in FHLB advances with a weighted average interest rate of 3.67% in an effort to reduce its aggregate cost of funds. The majority of the retired FHLB advances had scheduled maturity dates prior to January 15, 2005, while others had scheduled maturity dates ranging from May to August 2005. Losses totaling $2.2 million were incurred to retire the FHLB advances prior to their scheduled maturity dates. Page 24 Liquidity The Company's principal source of asset liquidity is marketable investment securities available for sale. At September 30, 2004, investment securities available for sale totaled $967 million, representing a decrease of $278 million from September 30, 2003. In addition, at September 30, 2004, the Company had customary lines for overnight borrowings from other financial institutions in excess of $500 million. Additionally, as a member of the Federal Reserve System, the Company has access to borrowing from the Federal Reserve. The Company's short-term debt rating from Fitch Ratings is F1. Management expects the Company can access short-term debt financing if desired. The Company's long-term debt rating from Fitch Ratings is A with a stable outlook. Management is confident the Company could access additional long-term debt financing if desired. In addition, the Company generates significant liquidity from its operating activities. The Company's profitability during the first nine months of 2004 and 2003 generated substantial cash flows, which are included in the totals provided from operations of $80.6 million and $87.6 million, respectively. The operating cash flow in 2004 was more than sufficient to pay for $26.2 million in shareholder dividends and $41.2 million of stock repurchases. In 2003, the operating activities provided more than sufficient to pay for $24.4 million in shareholder dividends and $43.9 million of stock repurchases. During the first three quarters of 2004, other financing activities included a $181.8 million increase in deposits, partially reduced by a $12.4 million decrease in short-term borrowings and a $107.2 million payment of FHLB advances and prepayment fees. During the first nine months of 2003, other financing activities included the net result of a $242.1 million increase in deposits and $83.6 million in proceeds from short-term borrowings, reduced by a $67.2 million payment of FHLB advances and prepayment fees. During the first nine months of 2004 the Company had net cash outflows in its investing activities. Purchases net of sales and maturities of investment securities of $121.1 million were reduced by net repayments of loans of $19.8 million, resulting in net cash used for investing activities of $103.4 million. The investment securities portfolio increase was generally financed by a $181.8 million increase in deposits. The Company had net cash outflows in its investing activities during both nine month periods ended September 30. In 2003, purchases net of sales and maturities of investment securities were $426.9 million, which was in part offset by net repayments of loans of $125.5 million. The investment securities portfolio increase was generally financed by a $242.1 million increase in deposits, and a $83.6 million increase in short-term borrowings. The Company anticipates that loan demand will increase moderately during the remainder of 2004 and into 2005, consistent with economic conditions. The growth of deposit balances is expected to exceed the anticipated growth in loan demand during the period. Depending on economic conditions, interest rate levels, and a variety of other conditions, excess deposit growth will be used to purchase investment securities or to reduce short-term borrowings. Westamerica Bancorporation ("the Parent Company") is separate and apart from Westamerica Bank ("the Bank") and must provide for its own liquidity. In addition to its operating expenses, the Parent Company is responsible for the payment of dividends to its shareholders, and interest and principal payments on outstanding senior debt. Substantially all of the Parent Company's revenues are obtained from service fees and dividends received from the Bank. Payment of such dividends to the Parent Company by the Bank is limited under regulations for Federal Reserve member banks and California law. The amount that can be paid in any calendar year, without prior approval from federal and state regulatory agencies, cannot exceed the net profits (as defined) for that year plus the net profits of the preceding two calendar years less dividends paid. Management believes that such restrictions will not have an impact on the Parent Company's ability to meet its ongoing cash obligations. The Parent Company maintains a customary $10 million line of credit, under which no amount was outstanding at September 30, 2004. Such line of credit was renewed for a one-year term on October 29, 2004 with a new borrowing capacity of $35 million. Page 25 Capital Resources The current and projected capital position of the Company and the impact of capital plans and long-term strategies is reviewed regularly by Management. The Company repurchases shares of its common stock in the open market with the intention of lessening the dilutive impact of issuing new shares to meet stock performance, option plans, and other ongoing requirements. In addition, other programs have been implemented to optimize the Company's use of equity capital and enhance shareholder value. Pursuant to these programs, the Company repurchased 824 thousand and 1.0 million shares during the first nine months of 2004 and 2003, respectively. The Company's primary capital resource is shareholders' equity, which was $351.9 million at September 30, 2004. This amount represents an increase of $11.6 million or 3.4% from December 31, 2003, the net result of the issuance of stock ($9.9 million) and comprehensive income for the period ($69.0 million), partially offset by share repurchases ($41.2 million) and dividends paid ($26.2 million). Due to the net effect of an increase in equity capital combined with earning asset growth the Company's ratio of equity to total assets declined slightly to 7.59% at September 30, 2004, from 7.83% a year ago. The equity to assets ratio was 7.44% at December 31, 2003. The following summarizes the ratios of capital to risk-adjusted assets for the periods indicated:
At September 30, At Minimum --------------------------December 31, Regulatory 2004 2003 2003 Requirement ---------------------------------------------------- Tier I Capital 10.93% 10.35% 10.13% 4.00% Total Capital 12.29% 11.61% 11.39% 8.00% Leverage ratio 7.09% 7.14% 6.85% 4.00%
The risk-based capital ratio increased at September 30, 2004, compared to the prior year primarily due to an increase in shareholders' equity as a result of increased net income, partially offset by the Company's common stock repurchases and dividends paid to shareholders. Also, a decline in risk-weighted assets contributed to this improvement. The risk-based capital ratio increased at September 30, 2004 from December 31, 2003 primarily due to the combination of an increase in shareholders' equity as a result of increased net income and a reduction in risk-weighted assets. Capital ratios are reviewed by Management on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet the Company's anticipated future needs. All ratios as shown in the table above are in excess of the regulatory definition of "well capitalized". Page 26 Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Company's Board of Directors. Interest rate risk as discussed above is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange risk, equity price risk and commodity price risk, are not significant in the normal course of the Company's business activities. Item 4. Controls and Procedures The Company's principal executive officer and principal financial officer have evaluated the effectiveness of the Company's "disclosure controls and procedures," as such term is defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended, as of September 30, 2004. Based upon their evaluation, the principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls, since the date the controls were evaluated. PART II - OTHER INFORMATION Item 1 - Legal Proceedings Due to the nature of the banking business, the Company's Subsidiary Bank is at times party to various legal actions; all such actions are of a routine nature and arise in the normal course of business of the Subsidiary Bank. Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds (a) None (b) None (c) Issuer Purchases of Equity Securities The table below sets forth the information with respect to purchases made by or on behalf of Westamerica Bancorporation or any "affiliated purchaser" (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of common stock during the quarter ended September 30, 2004 (in thousands, except per share data).
(c) (d) Total Maximum Number Number of Shares of Shares (b) Purchased that May (a) Average as Part of Yet Be Total Price Publicly Purchased Number of Paid Announced Under the Shares per Plans Plans or Period Purchased Share or Programs* Programs ----------------------------------------------------------------- July 1 through July 31 68 $51.63 68 667 ----------------------------------------------------------------- August 1 through August 31 22 53.05 22 2,000 ----------------------------------------------------------------- September 1 through September 30 2 55.27 2 1,998 ----------------------------------------------------------------- Total 92 $52.04 92 1,998 =================================================================
* Includes 1 thousand, 2 thousand and 2 thousand shares purchased in July, August and September, respectively, by the Company in private transactions with the independent administrator of the Company's Tax Deferred Savings/Retirement Plan (ESOP). The Company includes the shares purchased in such transactions within the total number of shares authorized for purchase pursuant to the currently existing publicly announced program. Page 27 The Company repurchases shares of its common stock in the open market to optimize the Company's use of equity capital and enhance shareholder value and with the intention of lessening the dilutive impact of issuing new shares to meet stock performance, option plans, and other ongoing requirements. On August 28, 2003 the Board of Directors authorized a program for the purchase of up to two million shares of the Company's common stock from time to time through September 1, 2004. A replacement plan was approved by the Board of Directors on August 27, 2004 to repurchase up to two million shares prior to September 1, 2005. Item 3 - Defaults upon Senior Securities None Item 4 - Submission of Matters to a Vote of Security Holders None Item 5 - Other Information (a) None (b) None Item 6 - Exhibits Exhibit 2: Agreement and Plan of Reorganization among the Company, Westamerica Bank, Redwood Empire Bancorp and National Bank of the Redwoods dated as of August 25, 2004 is incorporated by reference from Annex A of the Company's Registration Statement on Form S-4 dated October 15, 2004 (File No. 333-119783) Exhibit 11: Computation of Earnings Per Share on Common and Common Equivalent Shares and on Common Shares Assuming Full Dilution Exhibit 31.1: Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-(14)(a) Exhibit 31.2: Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-(14)(a) Exhibit 32.1: Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 32.2: Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Page 28 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. WESTAMERICA BANCORPORATION (Registrant) Date: November 9, 2004 /s/ DENNIS R. HANSEN -------------------- Dennis R. Hansen Senior Vice President and Controller (Chief Accounting Officer)