-----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, Ut/lpoQwpTTDIzQL62yUt978/LJIX+cytAJYsjBpo8ThzMIDsjhgX5X5yhHmBONZ aI67ZtDxnCxaqnCmDPybLg== 0000356171-99-000001.txt : 19990315 0000356171-99-000001.hdr.sgml : 19990315 ACCESSION NUMBER: 0000356171-99-000001 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990312 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRICO BANCSHARES / CENTRAL INDEX KEY: 0000356171 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 942792841 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-10661 FILM NUMBER: 99563894 BUSINESS ADDRESS: STREET 1: TRI COUNTIES BANK ADMINISTRATION STREET 2: 40 PHILADELPHIA DRIVE CITY: CHICO STATE: CA ZIP: 95973 BUSINESS PHONE: 9168980300 MAIL ADDRESS: STREET 1: TRI COUNTIES BANK ADMINISTRATION STREET 2: 40 PHILADELPHIA DRIVE CITY: CHICO STATE: CA ZIP: 95973 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year Commission File Number 0-10661 ended December 31, 1998 TriCo Bancshares (Exact name of registrant as specified in its charter) California 94-2792841 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 63 Constitution Drive, Chico, California 95973 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code:(530) 898-0300 Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: Common Stock, without par value ------------------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- The aggregate market value of the voting stock held by non-affiliates of the registrant, as of March 9, 1999, was approximately $87,133,000. This computation excludes a total of 1,838,380 shares which are beneficially owned by the officers and directors of Registrant who may be deemed to be the affiliates of Registrant under applicable rules of the Securities and Exchange Commission. The number of shares outstanding of Registrant's classes of common stock, as of March 9, 1999, was 7,119,177 shares of Common Stock, without par value. The following documents are incorporated herein by reference into the parts of Form 10-K indicated: Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1998, for Item 7, and Registrant's Proxy Statement for use in connection with its 1999 Annual Meeting of Shareholders, for Part III. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. X --- PART I 1. BUSINESS Formation of Bank Holding Company. TriCo Bancshares (hereinafter the "Company" or "Registrant") was incorporated under the laws of the State of California on October 13, 1981. It was organized at the direction of the Board of Directors of Tri Counties Bank (the "Bank") for the purpose of forming a bank holding company. On September 7, 1982, a wholly-owned subsidiary of the Company was merged with and into the Bank resulting in the shareholders of the Bank becoming the shareholders of the Company and the Bank becoming the wholly-owned subsidiary of the Company. (The merger of the wholly-owned subsidiary of the Company with and into the Bank is hereafter referred to as the "Reorganization.") At the time of the Reorganization, the Company became a bank holding company subject to the supervision of the Board of Governors of the Federal Reserve System (the "Board") in accordance with the Bank Holding Company Act of 1956, as amended. The Bank remains subject to the supervision of the State of California Department of Financial Institutions and the Federal Deposit Insurance Corporation (the "FDIC"). The Bank currently is the only subsidiary of the Company and the Company has not yet commenced any business operations independent of the Bank. Provision of Banking Services. The Bank was incorporated as a California banking corporation on June 26, 1974, and received its Certificate of Authority to begin banking operations on March 11, 1975. The Bank engages in the general commercial banking business in the California counties of Butte, Del Norte, Glenn, Kern, Lake, Lassen, Madera, Mendocino, Merced, Nevada, Sacramento, Shasta, Siskiyou, Stanislaus, Sutter, Tehama and Yuba. The Bank currently has 26 traditional branches and 8 in-store branches. It opened its first banking office in Chico, California in 1975, followed by branch offices in Willows, Durham and Orland, California. The Bank opened its fifth banking office at an additional location in Chico in 1980. On March 27, 1981, the Bank acquired the assets of Shasta County Bank and thereby acquired six additional offices. These offices are located in the communities of Bieber, Burney, Cottonwood, Fall River Mills, Palo Cedro and Redding, California. On November 7, 1987, the Bank purchased the deposits and premises of the Yreka Branch of Wells Fargo Bank, thereby acquiring an additional branch office. On August 1, 1988, the Bank opened a new office in Chico at East 20th Street and Forest Avenue. The Bank opened a branch office in Yuba City on September 10, 1990. The Bank opened four supermarket branches in 1994. These supermarket branches were opened on March 7, March 28, June 6 and June 13, 1994 in Red Bluff, Yuba City, and two in Redding respectively. The Bank added one conventional branch in Redding through its acquisition of Country National Bank on July 21, 1994. On November 7, 1995, the Bank opened a supermarket branch in Chico. In March 1996 the Bank opened its sixth supermarket branch in Grass Valley. The acquisition of Sutter Buttes Savings Bank in October 1996 added a branch in Marysville. Loan production offices were established in Bakersfield and Sacramento in 1996. On February 21, 1997, the Bank purchased nine branches from Wells Fargo Bank, N.A. The acquired branches are located in Crescent City, Weed, Mt. Shasta, Susanville, Covelo, Middletown, Patterson, Gustine and Chowchilla. This acquisition expanded the Bank's market area from the Sacramento Valley and intermountain areas to include parts of the northern coastal region and the northern San Joaquin Valley. In November 1998 the Bank converted its Bakersfield and Sacramento loan production offices to full service branches. On February 10, 1999, the Bank opened a video-banking supermarket branch in Chico. General Banking Services. The Bank conducts a commercial banking business including accepting demand, savings and time deposits and making commercial, real estate, and consumer loans. It also offers installment note collection, issues cashier's checks and money orders, sells travelers checks and provides safe deposit boxes and other customary banking services. Brokerage services are provided at the Bank's offices by the Bank's association with INVEST Financial Corporation. The Bank does not offer trust services or international banking services. The Bank's operating policy since its inception has emphasized retail banking. Most of the Bank's customers are retail customers and small to medium-sized businesses. The business of the Bank emphasizes serving the needs of local businesses, farmers and ranchers, retired individuals and wage earners. The majority of the Bank's loans are direct loans made to individuals and businesses in the area. At December 31, 1998, the total of the Bank's consumer installment loans outstanding was $72,512,000 (13.6%), the total of commercial loans outstanding was $211,773,000 (39.8%), and the total of real estate loans including construction loans of $37,076,000 was $248,148,000 (46.6%). The Bank takes real estate, listed and unlisted securities, savings and time deposits, automobiles, machinery, equipment, inventory, accounts receivable and notes receivable secured by property as collateral for loans. Most of the Bank's deposits are attracted from individuals and business-related sources. No single person or group of persons provides a material portion of the Bank's deposits, the loss of any one or more of which would have a materially adverse effect on the business of the Bank, nor is a material portion of the Bank's loans concentrated within a single industry or group of related industries. -2- In order to attract loan and deposit business from individuals and small to medium-sized businesses, branches of the Bank set lobby hours to accommodate local demands. In general, lobby hours are from 9:00 a.m. to 5:00 p.m. Monday through Thursday, and from 9:00 a.m. to 6:00 p.m. on Friday. Certain branches with less activity open later and close earlier. Some Bank offices also utilize drive-up facilities operating from 9:00 a.m. to 7:00 p.m. The supermarket branches are open from 9:00 a.m. to 7:00 p.m. Monday through Saturday and 11:00 a.m. to 5:00 p.m. on Sunday. The Bank offers 24-hour ATMs at all branch locations. The ATMs are linked to several national and regional networks such as CIRRUS and STAR. In addition, banking by telephone on a 24-hour toll-free number is available to all customers. This service allows a customer to obtain account balances and most recent transactions, transfer moneys between accounts, make loan payments, and obtain interest rate information. In February 1998, the Bank became the first bank in the Northern Sacramento Valley to offer banking services on the Internet. This banking service provides customers one more tool for anywhere, anytime access to their accounts. Other activities. In addition to the banking services referred to above, pursuant to California law, TCB Real Estate Corporation, a wholly-owned subsidiary of the Bank, was engaged in limited real estate investments until December 1998. At that time, TCB Real Estate Corporation divested its remaining real estate investments. Such investments consisted of holding certain real property for the purpose of development or as income earning assets. The amount of the Bank's assets committed to such investment did not exceed the total of the Bank's capital and surplus. In 1996 the FDIC directed the Bank to divest the properties held by TCB Real Estate Corporation and to terminate its operations. The Bank and the FDIC agreed to a plan that called for the divestiture by June 30, 1999. The Bank may in the future engage in other businesses either directly or indirectly through subsidiaries acquired or formed by the Bank subject to regulatory constraints. See "Regulation and Supervision." Employees. At December 31, 1998, the Company and the Bank employed 451 persons, including four executive officers. Full time equivalent employees were 370. No employees of the Company or the Bank are presently represented by a union or covered under a collective bargaining agreement. Management believes that its employee relations are excellent. Competition. The banking business in California generally, and in the Bank's primary service area specifically, is highly competitive with respect to both loans and deposits. It is dominated by a relatively small number of major banks with many offices operating over a wide geographic area. Among the advantages such major banks have over the Bank are their ability to finance wide ranging advertising campaigns and to allocate their investment assets to regions of high yield and demand. By virtue of their greater total capitalization such institutions have substantially higher lending limits than does the Bank. In addition to competing with savings institutions, commercial banks compete with other financial markets for funds. Yields on corporate and government debt securities and other commercial paper may be higher than on deposits, and therefor affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for available funds with money market instruments and mutual funds. During past periods of high interest rates, money market funds have provided substantial competition to banks for deposits and they may continue to do so in the future. In today's high growth stock market environment mutual funds have become a major source of competition for savings dollars. As a consequence of the extensive regulation of commercial banking activities in the United States, the business of the Company and its subsidiary are particularly susceptible to being affected by enactment of federal and state legislation which may have the effect of increasing or decreasing the cost of doing business, modifying permissible activities or enhancing the competitive position of other financial institutions. The Bank relies substantially on local promotional activity, personal contacts by its officers, directors, employees and shareholders, extended hours, personalized service and its reputation in the communities it services to compete effectively. Regulation and Supervision. As a registered bank holding company under the Bank Holding Company Act of 1956 (the "BHC Act"), the Company is subject to the regulation and supervision of the Board of Governors of the Federal Reserve System ("FRB"). The BHC Act requires the Company to file reports with the FRB and provide additional information requested by the FRB. The Company must receive the approval of the FRB before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, the Company would own or control more than 5 percent of the voting shares of such bank. -3- The Company and any subsidiaries it may acquire or organize will be deemed to be affiliates of the Bank within the Federal Reserve Act. That Act establishes certain restrictions which limit the extent to which the Bank can supply its funds to the Company and other affiliates. The Company is also subject to restrictions on the underwriting and the public sale and distribution of securities. It is prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property, or furnishing of services. The Company is prohibited from engaging in, or acquiring direct or indirect control of any company engaged in non-banking activities, unless the FRB by order or regulation has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Federal Reserve Regulation "Y" (12 C.F.R. Part 225) sets forth those activities which are regarded as closely related to banking or managing or controlling banks and, thus, are permissible activities that may be engaged in by bank holding companies subject to approval in certain cases by the FRB. Litigation has challenged the validity of certain activities authorized by the FRB for bank holding companies, and the FRB has various regulations and applications in this regard still under consideration. Under California law, dividends and other distributions by the Company are subject to declaration by the Board of Directors at its discretion out of net assets. Dividends cannot be declared and paid when such payment would make the Company insolvent. FRB policy prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowings or other arrangements that might adversely affect the holding company's financial position. The policy further declares that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. Other FRB policies forbid the payment by bank subsidiaries to their parent companies of management fees which are unreasonable in amount or exceed a fair market value of the services rendered (or, if no market exists, actual costs plus a reasonable profit). In addition, the FRB has authority to prohibit banks that it regulates from engaging in practices which in the opinion of the FRB are unsafe or unsound. Such practices may include the payment of dividends under some circumstances. Moreover, the payment of dividends may be inconsistent with capital adequacy guidelines. The Company may be subject to assessment to restore the capital of the Bank should it become impaired. The Company is subject to the minimum capital requirements of the FRB. As a result of these requirements, the growth in assets of the Company is limited by the amount of its capital accounts as defined by the FRB. Capital requirements may have an affect on profitability and the payment of distributions by the Company. If the Company is unable to increase its assets without violating the minimum capital requirements, or is forced to reduce assets, its ability to generate earnings would be reduced. Furthermore, earnings may need to be retained rather than paid as distributions to shareholders. The FRB has adopted guidelines utilizing a risk-based capital structure. These guidelines apply on a consolidated basis to bank holding companies with consolidated assets of $150 million or more. For bank holding companies with less than $150 million in consolidated assets, the guidelines apply on a bank-only basis unless the holding company is engaged in non-bank activity involving significant leverage or has a significant amount of outstanding debt that is held by the general public. The Company currently has consolidated assets of more than $150 million; accordingly, the risk-based capital guidelines apply to the Company on a consolidated basis. Qualifying capital is divided into two tiers. Tier 1 capital consists generally of common stockholder's equity, qualifying noncumulative perpetual preferred stock, qualifying cumulative perpetual preferred stock (up to 25 percent of total Tier 1 capital) and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets. Tier 2 capital consists of, among other things, allowance for loan and lease losses up to 1.25 percent of weighted risk assets, perpetual preferred stock, hybrid capital instruments, perpetual debt, mandatory convertible debt securities, subordinated debt and intermediate-term preferred stock. Tier 2 capital qualifies as part of total capital up to a maximum of 100 percent of Tier 1 capital. Amounts in excess of these limits may be issued but are not included in the calculation of risk-based capital ratios. As of December 31, 1998, the Company must have a minimum ratio of qualifying total capital to weighted risk assets of 8 percent, of which at least 4 percent must be in the form of Tier 1 capital. The Federal regulatory agencies have adopted a minimum Tier 1 leverage ratio which is intended to supplement risk-based capital requirements and to ensure that all financial institutions, even those that invest predominantly in low-risk assets, continue to maintain a minimum level of Tier 1 capital. These regulations provide that a banking organization's minimum Tier 1 leverage ratio be determined by dividing its Tier 1 capital by its quarterly average total assets, less goodwill and certain other intangible assets. Under the current rules, the Company is required to maintain a minimum Tier 1 leverage ratio of 4 percent. -4- Insurance of Deposits. The Bank's deposit accounts are insured up to a maximum of $100,000 per depositor by the FDIC. The FDIC issues regulations and generally supervises the operations of its insured banks. This supervision and regulation is intended primarily for the protection of depositors, not shareholders. As of December 31, 1998, the deposit insurance premium rate was $0.0122 per $100.00 in deposits. In November 1990, federal legislation was passed which removed the cap on the amount of deposit insurance premiums that can be charged by the FDIC. Under this legislation, the FDIC is able to increase deposit insurance premiums as it sees fit. This could result in a significant increase in the cost of doing business for the Bank in the future. The FDIC now has authority to adjust deposit insurance premiums paid by insured banks every six months. Risk-Based Capital Requirements. The Bank is subject to the minimum capital requirements of the FDIC. As a result of these requirements, the growth in assets of the Bank is limited by the amount of its capital accounts as defined by the FRB. Capital requirements may have an effect on profitability and the payment of dividends on the common stock of the Bank. If the Bank is unable to increase its assets without violating the minimum capital requirements or is forced to reduce assets, its ability to generate earnings would be reduced. Further, earnings may need to be retained rather than paid as dividends to the Company. Federal banking law requires the federal banking regulators to take "prompt corrective action" with respect to banks that do not meet minimum capital requirements. In response to this requirement, the FDIC adopted final rules based upon the five capital tiers defined by the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA); well capitalized, adequately capitalized, under capitalized, significantly under capitalized and critically under capitalized. For example, the FDIC's rules provide that an institution is "well-capitalized" if its total risk-based capital ratio is 10 percent or greater; its Tier 1 risk-based capital ratio is 6 percent or greater; its leverage ratio is 5 percent or greater; and the institution is not subject to a capital directive or an enforceable written agreement or order. A bank is "adequately capitalized" if its total risk-based capital ratio is 8 percent or greater; its Tier 1 risk-based capital ratio is 4 percent or greater; and its leverage ratio is 4 percent or greater (3 percent or greater for certain of the highest-rated institutions). An institution is "significantly undercapitalized" if its risk-based capital ratio is less than 6 percent; its Tier 1 risk-based capital ratio is less than 3 percent; or its tangible equity (Tier 1 capital) to total assets is equal to or less than 2 percent. An institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it engages in unsafe or unsound banking practices. No sanctions apply to institutions which are "well" or "adequately" capitalized under the prompt corrective action requirements. Undercapitalized institutions are required to submit a capital restoration plan for improving capital. In order to be accepted, such plan must include a financial guaranty from the institution's holding company that the institution will return to capital compliance. If such a guarantee were deemed to be a commitment to maintain capital under the federal Bankruptcy Code, a claim for a subsequent breach of the obligations under such guarantee in a bankruptcy proceeding involving the holding company would be entitled to a priority over third-party general unsecured creditors of the holding company. Undercapitalized institutions are prohibited from making capital distributions or paying management fees to controlling persons; may be subject to growth limitations; and acquisitions, branching and entering into new lines of business are restricted. Finally, the institution's regulatory agency has discretion to impose certain of the restrictions generally applicable to significantly undercapitalized institutions. In the event an institution is deemed to be significantly undercapitalized, it may be required to: sell stock; merge or be acquired; restrict transactions with affiliates; restrict interest rates paid on deposits; divest a subsidiary; or dismiss specified directors or officers. If the institution is a bank holding company, it may be prohibited from making any capital distributions without prior approval of the FRB and may be required to divest a subsidiary. A critically undercapitalized institution is generally prohibited from making payments on subordinated debt and may not, without the approval of the FDIC, enter into a material transaction other than in the ordinary course of business; engage in any covered transaction; or pay excessive compensation or bonuses. Critically undercapitalized institutions are subject to appointment of a receiver or conservator. Bank Regulation. The federal regulatory agencies are required to adopt regulations which will establish safety and soundness standards which will apply to banks and bank holding companies. These standards must address bank operations, management, asset quality, earnings, stock valuation and employee compensation. A bank holding company or bank failing to meet established standards will face mandatory regulatory enforcement action. The grounds upon which a conservator or receiver of a bank can be appointed have been expanded. For example, a conservator or receiver can be appointed for a bank which fails to maintain minimum capital levels and has no reasonable prospect of becoming adequately capitalized. Federal law also requires, with some exception, that each bank have an annual examination performed by its primary federal regulatory agency, and an outside independent audit. The outside audit must consider bank regulatory compliance in addition to financial statement reporting. -5- Federal law also restricts the acceptance of brokered deposits by insured depository institutions and contains a number of consumer banking provisions, including disclosure requirements and substantive contractual limitations with respect to deposit accounts. Governmental Monetary Policies and Economic Conditions. The principal sources of funds essential to the business of banks and bank holding companies are deposits, stockholder's equity and borrowed funds. The availability of these various sources of funds and other potential sources, such as preferred stock or commercial paper, and the extent to which they are utilized, depends on many factors, the most important of which are the FRB's monetary policies and the relative costs of different types of funds. An important function of the FRB is to regulate the national supply of bank credit in order to combat recession and curb inflationary pressure. Among the instruments of monetary policy used by the Federal Reserve Board to implement these objections are open market operations in United States Government securities, changes in the discount rate on bank borrowings, and changes in reserve requirements against bank deposits. 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. In view of the recent changes in regulations affecting commercial banks and other actions and proposed actions by the federal government and its monetary and fiscal authorities, including proposed changes in the structure of banking in the United States, no prediction can be made as to future changes in interest rates, credit availability, deposit levels, the overall performance of banks generally or the Company and its subsidiaries in particular. General. The Company conducts all of its business operations within a single geographic area and within a single industry segment. -6- 2. PROPERTIES As the Company has not yet acquired any properties independent of the Bank, its only subsidiary, the properties of the Bank and the Bank's subsidiaries comprise all of the properties of the Company. Bank Properties The Bank owns and leases properties which house administrative and data processing functions and 33 banking offices. Major owned and leased facilities are listed below. Park Plaza Branch Pillsbury Branch 780 Mangrove Avenue 2171 Pillsbury Road Chico, CA 95926 Chico, CA 95926 10,000 square feet 5,705 square feet Leased - term expires 2010 Owned Purchasing and Printing Department Hilltop Branch 2560-C Dominic Drive 1250 Hilltop Drive Chico, CA 95928 Redding, CA 96049 8,400 square feet 6,252 square feet Leased - term expires 1999 Owned Burney Branch Cottonwood Branch 37093 Main Street 3349 Main Street Burney, CA 96013 Cottonwood, CA 96022 3,500 square feet 4,900 square feet Owned Owned Willows Branch Fall River Mills Branch 210 North Tehama Street 43308 Highway 299 East Willows, CA 95988 Fall River Mills, CA 96028 4,800 square feet 2,200 square feet Owned Owned Orland Branch Durham Branch 100 E. Walker Street 9411 Midway Orland, CA 95963 Durham, CA 95938 3,000 square feet 2,150 square feet Owned Owned Palo Cedro Branch Yuba City Branch 9125 Deschutes Road 1441 Colusa Avenue Palo Cedro, CA 96073 Yuba City, CA 9599 3,400 square feet 6,900 square feet Owned Owned Chowchilla Branch Covelo Branch 305 Trinity Street 76405 Covelo Road Chowchilla, CA 93610 Covelo, CA 95428 6,000 square feet 3,000 square feet Leased - term expires 2009 Leased - month to month Crescent City Branch Gustine Branch 936 Third Street 319 Fifth Street Crescent City, CA 95531 Gustine, CA 95322 4,700 square feet 5,100 square feet Owned Owned Marysville Branch Middletown Branch 729 E Street 21097 Calistoga Street Marysville, CA 95901 Middletown, CA 95461 1,600 square feet 2,600 square feet Leased - term expires 2001 Leased - term expires 2002 Mt. Shasta Branch Patterson Branch 204 Chestnut Street 17 Plaza Mt. Shasta, CA 96067 Patterson, CA 95363 6,500 square feet 4,000 square feet Leased - term expires 2007 Owned Susanville Branch Weed Branch 1605 Main Street 303 Main Street Susanville, CA 96130 Weed, CA 96094 7,200 square feet 6,200 square feet Leased - term expires 2002 Owned TriCo Offices1 Yreka Branch 15 Independence Circle 165 South Broadway Chico, CA 95973 Yreka, CA 96097 7,000 square feet 6,000 square feet Leased - term expires 2011 Owned Redding Branch2 Data Processing Center 1810 Market Street 1103 Fortress Redding, CA 96001 Chico, CA 95926 14,000 square feet 13,600 square feet Owned Leased - term expires 2011 -7- Bakersfield Branch Sacramento Branch 5201 California Ave., Suite 102 1760 Challenge Way, Suite 100 Bakersfield, CA 93309 Sacramento, CA 95815 3,200 square feet 3,005 square feet Leased - term expires 2000 Leased - term expires 2000 Headquarters Building Redding Downtown Branch 63 Constitution Drive 1845 California Street Chico, CA 95973 Redding, CA 96001 30,000 square feet 3,265 square feet Owned Owned 1This leased building was vacated in 1998 and is being subleased. 2This building was vacated in 1997 and is available for lease. 3. LEGAL PROCEEDINGS Neither the Company nor the Bank is a party to any material legal proceedings, other than ordinary routine litigation incidental to the business of the Company and the Bank, nor is any of their property the subject of any such proceedings. 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS Not applicable. -8- PART II 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information The Common Stock of the Company trades on the NASDAQ National Market under the symbol "TCBK." The shares were first listed in the NASDAQ Stock Market in April 1993. The following table summarizes the Common Stock high and low trading prices and volume of shares traded by quarter as reported by NASDAQ. Prices of the Approximate Company's Common Trading Stock Volume Quarter Ended:1,2 High Low (in shares) March 31, 1997 $ 18.00 $ 14.17 485,400 June 30, 1997 19.17 14.76 517,300 September 30, 1997 19.50 16.17 335,800 December 31, 1997 22.67 17.09 338,900 March 31, 1998 22.67 20.00 293,600 June 30, 1998 22.58 18.33 398,300 September 30, 1998 19.83 15.33 394,600 December 31, 1998 18.50 14.08 330,800 1Quarterly trading activity has been compiled from NASDAQ trading reports. 2Stock prices and trading volumes adjusted to reflect 3-for-2 stock split effected October 30, 1998. Holders As of December 31, 1998, there were approximately 1,889 holders of record of the Company's Common Stock. Dividends The Company has paid quarterly dividends since March 1990. The Company paid quarterly dividends of $0.16 per share in the fourth quarter of 1998 and $0.11 per share in each of the previous seven quarters. The holders of Common Stock of the Company are entitled to receive cash dividends when and as declared by the Board of Directors, out of funds legally available therefor, subject to the restrictions set forth in the California General Corporation Law (the "Corporation Law"). The Corporation Law provides that a corporation may make a distribution to its shareholders if the corporation's retained earnings equal at least the amount of the proposed distribution. The Company, as sole shareholder of the Bank, is entitled to receive dividends when and as declared by the Bank's Board of Directors, out of funds legally available therefore, subject to the powers of the FDIC and the restrictions set forth in the California Financial Code (the "Financial Code"). The Financial Code provides that a bank may not make any distributions in excess of the lessor of: (i) the bank's retained earnings, or (ii) the bank's net income for the last three fiscal years, less the amount of any distributions made by the bank to its shareholders during such period. However, a bank may, with the prior approval of the California Superintendent of Banks (the "Superintendent"), make a distribution to its shareholders of up to the greater of (A) the bank's retained earnings, (B) the bank's net income for its last fiscal year, or (C) the bank's net income for its current fiscal year. If the Superintendent determines that the shareholders' equity of a bank is inadequate or that a distribution by the bank to its shareholders would be unsafe or unsound, the Superintendent may order a bank to refrain from making a proposed distribution. The FDIC may also order a bank to refrain from making a proposed distribution when, in its opinion, the payment of such would be an unsafe or unsound practice. The Bank paid dividends totaling $3,650,000 to the Company in 1998. As of December 31, 1998 and subject to the limitations and restrictions under applicable law, the Bank had funds available for dividends in the amount of $11,023,000. The Federal Reserve Act limits the loans and advances that the Bank may make to its affiliates. For purposes of such Act, the Company is an affiliate of the Bank. The Bank may not make any loans, extensions of credit or advances to the Company if the aggregate amount of such loans, extensions of credit, advances and any repurchase agreements and investments exceeds 10% of the capital stock and surplus of the Bank. Any such permitted loan or advance by the Bank must be secured by collateral of a type and value set forth in the Federal Reserve Act. -9-
6. FIVE YEAR SELECTED FINANCIAL DATA (in thousands, except share data) 1998 1997 1996 1995 1994 Statement of Operations Data:1 Interest income $65,138 $59,877 $49,148 $46,011 $43,240 Interest expense 25,296 23,935 19,179 17,988 15,680 Net interest income 39,842 35,942 29,969 28,023 27,560 Provision for loan losses 4,200 3,000 777 335 316 Net interest income after provision for loan losses 35,642 32,942 29,192 27,688 27,244 Noninterest income 12,869 9,566 6,636 5,933 5,025 Noninterest expense 34,692 32,932 23,485 21,661 22,058 Income before income taxes 13,819 9,576 12,343 11,960 10,211 Provision for income taxes 5,049 3,707 5,037 4,915 4,350 Net income $8,770 $5,869 $7,306 $7,045 $5,861 Share Data:2 Diluted earnings per share $1.21 $0.81 $ 1.04 $0.97 $0.78 Cash dividend paid per share 0.49 0.43 0.39 0.25 0.21 Common shareholders' equity at year end 10.22 9.31 8.73 7.95 6.73 Balance Sheet Data at year end4: Total loans, gross $532,433 $448,967 $439,218 $318,766 $307,103 Total assets 904,599 826,165 694,859 603,554 593,834 Total deposits 769,173 724,094 595,621 516,193 491,172 Total shareholders' equity 72,029 65,124 60,777 53,213 48,231 Selected Financial Ratios: Return on average assets 1.03% 0.75 % 1.18 % 1.22 % .99 % Return on average common shareholders' equity 12.80% 9.34 % 13.03 % 13.95 % 12.42 % Total risk-based capital ratio 11.83% 11.90 % 13.58 % 15.17 % 14.65 % Net interest margin3 5.28% 5.16 % 5.37 % 5.36 % 5.18 % Allowance for loan losses to total loans outstanding at end of year 1.54% 1.44 % 1.39 % 1.75 % 1.83 % 1 Tax-exempt securities are presented on an actual yield basis. 2 Retroactively adjusted to reflect 5-for-4 stock split effected in 1995, and 3-for-2 stock split effected in 1998. 3 Calculated on a tax equivalent basis. 4 The 1996 data reflects changes due to the purchase of Sutter Buttes Savings Bank. See Note S of Registrant's 1998 Annual Report to Shareholders.
-10- 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Management's Discussion and Analysis of Financial Condition and Results of Operations, included in Registrant's 1998 Annual Report to Shareholders, (pages 24 through 37 of Exhibit 13.1 as electronically filed) is incorporated herein by reference. 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Discussion is included Management's Discussion and Analysis (pages 24 through 37 of Exhibit 13.1 as electronically filed) and is incorporated herein by reference. 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following financial statements and independent auditor's report, included in Registrant's 1998 Annual Report to Shareholders, are incorporated herein by reference: Pages of Exhibit 13.1 as Electronically Filed Report of Independent Public Accountants 23 Consolidated Balance Sheets as of December 31, 1998 and 1997 1 Consolidated Statements of Income for the three years ended December 31, 1998, 1997 and 1996 2 Consolidated Statements of Changes in Shareholders' Equity for the three years ended December 31, 1998, 1997 and 1996 3 Consolidated Statements of Cash Flows for the three years ended December 31, 1998, 1997 and 1996 4 Notes to Consolidated Financial Statements 5 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None -11- PART III 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding Registrant's directors and executive officers will be set forth under the caption, "Proposal No. 1 - Election of Directors of the Company" in Registrant's Proxy Statement for use in connection with the Annual Meeting of Shareholders to be held on or about May 11, 1999. Said information is incorporated herein by reference. 11. EXECUTIVE COMPENSATION Information regarding compensation of Registrant's directors and executive officers will be set forth under the caption, "Proposal No. 1 - Election of Directors of the Company" in Registrant's Proxy Statement for use in connection with the Annual Meeting of Shareholders to be held on or about May 11, 1999. Said information is incorporated herein by reference. 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information regarding security ownership of certain beneficial owners, directors and executive officers of Registrant will be set forth under the caption, "Information Concerning the Solicitation" in Registrant's Proxy Statement for use in connection with the Annual Meeting of Shareholders to be held on or about May 11, 1999. Said information is incorporated herein by reference. 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information regarding certain relationships and related transactions is set forth under the caption, "Proposal No. 1 - Election of Directors of the Company" in Registrant's Proxy Statement for use in connection with the Annual Meeting of Shareholders to be held on or about May 11, 1999. Said information is incorporated herein by reference. -12- PART IV 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Index to Financial Statements: A list of the consolidated financial statements of Registrant incorporated herein is included in Item 8 of this Report. 2. Financial Statement Schedules: Schedules have been omitted because they are not applicable or are not required under the instructions contained in Regulation S-X or because the information required to be set forth therein is included in the consolidated financial statements or notes thereto. 3. Exhibits Filed herewith: Exhibit No. Exhibits 3.1 Articles of Incorporation, as amended to date, filed as Exhibit 3.1 to Registrant's Report on Form 10-K, filed for the year ended December 31, 1989, are incorporated herein by reference. 3.2 Bylaws, as amended to 1992, filed as Exhibit 3.2 to Registrant's Report on Form 10-K, filed for the year ended December 31, 1992, are incorporated herein by reference. 4.2 Certificate of Determination of Preferences of Series B Preferred Stock, filed as Appendix A to Registrant's Registration Statement on Form S-1 (No. 33-22738), is incorporated herein by reference. 10.1 Lease for Park Plaza Branch premises entered into as of September 29, 1978, by and between Park Plaza Limited Partnership as lessor and Tri Counties Bank as lessee, filed as Exhibit 10.9 to the TriCo Bancshares Registration Statement on Form S-14 (Registration No. 2-74796) is incorporated herein by reference. 10.2 Lease for Administration Headquarters premises entered into as of April 25, 1986, by and between Fortress-Independence Partnership (A California Limited Partnership) as lessor and Tri Counties Bank as lessee, filed as Exhibit 10.6 to Registrant's Report on Form 10-K filed for the year ended December 31, 1986, is incorporated herein by reference. 10.3 Lease for Data Processing premises entered into as of April 25, 1986, by and between Fortress-Independence Partnership (A California Limited Partnership) as lessor and Tri Counties Bank as lessee, filed as Exhibit 10.7 to Registrant's Report on Form 10-K filed for the year ended December 31, 1986, is incorporated herein by reference. 10.4 Lease for Chico Mall premises entered into as of March 11, 1988, by and between Chico Mall Associates as lessor and Tri Counties Bank as lessee, filed as Exhibit 10.4 to Registrant's Report on Form 10-K filed for the year ended December 31, 1988, is incorporated by reference. 10.5 First amendment to lease entered into as of May 31, 1988 by and between Chico Mall Associates and Tri Counties Bank, filed as Exhibit 10.5 to Registrant's Report on Form 10-K filed for the year ended December 31, 1988, is incorporated by reference. 10.9 Employment Agreement of Robert H. Steveson, dated December 12, 1989 between Tri Counties Bank and Robert H. Steveson, filed as Exhibit 10.9 to Registrant's Report on Form 10-K filed for the year ended December 31, 1989, is incorporated by reference. 10.11 Lease for Purchasing and Printing Department premises entered into as of February 1, 1990, by and between Dennis M. Casagrande as lessor and Tri Counties Bank as lessee, filed as Exhibit 10.11 to Registrant's Report on Form 10-K filed for the year ended December 31, 1991, is incorporated herein by reference. 10.12 Addendum to Employment Agreement of Robert H. Steveson, dated April 9, 1991, filed as Exhibit 10.12 to Registrant's Report on Form 10-K filed for the year ended December 31, 1991, is incorporated herein by reference. -13- 10.13 The 1993 Non-Qualified Stock Option Plan filed as Exhibit 4.1, the Non-Qualified Stock Option Plan filed as Exhibit 4.2 and the Incentive Stock Option Plan filed as Exhibit 4.3 to Registrant's Form S-8 Registration No. 33-88704 dated January 19, 1995 and the 1995 Incentive Stock Option Plan filed as Exhibit 4.1 to Registrant's Form S-8, Registration No. 33-62063 dated August 23, 1995, are incorporated herein by reference. 11.1 Computation of earnings per share. 13.1 TriCo Bancshares 1998 Annual Report to Shareholders.* 21.1 Tri Counties Bank, a California banking corporation, is the only subsidiary of Registrant. 23.1 Consent of Arthur Andersen LLP * Deemed filed only with respect to those portions thereof incorporated herein by reference. (b) Reports on Form 8-K: None -14- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 9, 1999 TRICO BANCSHARES By:/s/ Robert H. Steveson Robert H. Steveson, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: March 9, 1999 /s/ Robert H. Steveson Robert H. Steveson, President, Chief Executive Officer and Director (Principal Executive Officer) Date: March 9, 1999 /s/ Thomas J. Reddish Thomas J. Reddish, Vice President and Controller (Principal Financial and Accounting Officer) Date: March 9, 1999 /s/ Everett B. Beich Everett B. Beich, Director Date: March 9, 1999 /s/ William J. Casey William J. Casey, Director and Vice Chairman of the Board Date: March 9, 1999 /s/ Craig S. Compton Craig S. Compton, Director Date: March 9, 1999 /s/ Douglas F. Hignell Douglas F. Hignell, Secretary and Director Date: March 9, 1999 /s/ Brian D. Leidig Brian D. Leidig, Director Date: March 9 1999 /s/ Wendell J. Lundberg Wendell J. Lundberg, Director Date: March 9, 1999 /s/ Donald E. Murphy Donald E. Murphy, Director Date: March 9, 1999 /s/ Rodney W. Peterson Rodney W. Peterson, Director Date: March 9, 1999 /s/ Carroll R. Taresh Carroll R. Taresh, Director Date: March 9, 1999 /s/ Alex A. Vereschagin Alex A. Vereschagin, Jr., Director and Chairman of the Board -15-
EXHIBIT 11.1 COMPUTATIONS OF EARNINGS PER SHARE Years ended December 31 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Shares used in the computation of earnings per share1 Weighted daily average of shares outstanding 7,017,306 6,978,089 6,769,735 6,645,138 6,584,703 Shares used in the computation of diluted earnings per share 7,267,602 7,246,011 7,034,627 6,985,339 6,962,075 ========= ========= ========= ========= ========= Net income used in the computation of earnings per common stock: Income before adjustment for interest expense on convertible capital notes $8,770 $5,869 $7,306 $7,045 $5,861 Adjustment for preferred Stock dividend -- -- -- (245) (420) Net income, as adjusted $8,770 $5,869 $7,306 $6,800 $5,441 ====== ====== ====== ====== ====== Basic earnings per share $ 1.25 $ 0.84 $ 1.08 $ 1.02 $ 0.83 ======= ======= ======= ======= ======= Diluted earnings per share $ 1.21 $ 0.81 $ 1.04 $ 0.97 $ 0.78 ======= ======= ======= ======= ======= 1Retroactively adjusted for stock dividends and stock splits.
-1-
EXHIBIT 13.1 TRICO BANCSHARES CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts) December 31, Assets 1998 1997 Cash and due from banks $ 50,483 $ 48,476 Repurchase agreements -- 15,000 ----------------------------- Cash and cash equivalents 50,483 63,476 Securities held-to-maturity (approximate fair value $0 and $88,950), respectively -- 90,764 Securities available-for-sale 279,676 175,753 Loans: Commercial 211,773 165,813 Consumer 72,512 87,950 Real estate mortgages 211,072 160,954 Real estate construction 37,076 34,250 ----------------------------- 532,433 448,967 Less: Allowance for loan losses 8,206 6,459 ----------------------------- Net loans 524,227 442,508 Premises and equipment, net 16,088 18,901 Investment in real estate properties -- 856 Other real estate owned 1,412 2,230 Accrued interest receivable 5,821 5,701 Deferred income taxes 5,783 4,132 Intangible assets 7,564 8,902 Other assets 13,545 12,942 ----------------------------- Total assets $904,599 $826,165 ============================= Liabilities and Shareholders' Equity Deposits: Noninterest-bearing demand $148,840 $122,069 Interest-bearing demand 149,698 130,958 Savings 220,810 216,402 Time certificates, $100,000 and over 64,857 48,907 Other time certificates 184,968 205,758 ----------------------------- Total deposits 769,173 724,094 Federal funds purchased 14,000 15,300 Accrued interest payable 3,863 4,039 Other liabilities 7,610 6,168 Long-term debt and other borrowings 37,924 11,440 ----------------------------- Total liabilities 832,570 761,041 Commitments and contingencies (Note H) Shareholders' equity: Common stock, no par value: Authorized 20,000,000 shares; issued and outstanding 7,050,990 and 6,993,974 shares, respectively 48,838 48,161 Retained earnings 22,257 16,956 Accumulated other comprehensive income 934 7 ----------------------------- Total shareholders' equity 72,029 65,124 ----------------------------- Total liabilities and shareholders' equity $904,599 $826,165 ============================= See Notes to Consolidated Financial Statements
-1- Exhibit 13.1
TRICO BANCSHARES CONSOLIDATED STATEMENTS OF INCOME (in thousands, except earnings per share) Years Ended December 31, 1998 1997 1996 Interest income: Interest and fees on loans $ 48,506 $ 44,903 $ 38,227 Interest on investment securities--taxable 14,622 13,791 10,409 Interest on investment securities--tax exempt 1,860 630 120 Interest on federal funds sold 150 553 392 ------------------------------------------------- Total interest income 65,138 59,877 49,148 Interest expense: Interest on interest-bearing demand deposits 2,932 2,781 2,226 Interest on savings 6,473 6,400 5,032 Interest on time certificates of deposit 11,685 11,481 8,820 Interest on time certificates of deposit, $100,000 and over 1,775 2,020 1,123 Interest on short-term borrowing 816 537 359 Interest on long-term debt 1,615 716 1,619 ------------------------------------------------- Total interest expense 25,296 23,935 19,179 ------------------------------------------------- Net interest income 39,842 35,942 29,969 Provision for loan losses 4,200 3,000 777 ------------------------------------------------- Net interest income after provision for loan losses 35,642 32,942 29,192 Noninterest income: Service charges and fees 7,387 6,745 4,924 Other income 5,482 2,821 1,712 ------------------------------------------------- Total noninterest income 12,869 9,566 6,636 Noninterest expenses: Salaries and related expenses 16,803 15,671 11,989 Other, net 17,889 17,261 11,496 ------------------------------------------------- Total noninterest expenses 34,692 32,932 23,485 ------------------------------------------------- Net income before income taxes 13,819 9,576 12,343 Income taxes 5,049 3,707 5,037 ------------------------------------------------- Net income $ 8,770 $ 5,869 $ 7,306 ================================================= Basic earnings per common share $ 1.25 $ 0.84 $ 1.08 Diluted earnings per common share $ 1.21 $ 0.81 $ 1.04 See Notes to Consolidated Financial Statements
-2-
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Years ended December 31, 1998, 1997 and 1996 (in thousands, except share amounts) Common Stock Accumulated Number Other of Retained Comprehensive Comprehensive Shares Amount Earnings Income Total Income ------------------------------------------------------------------ Balance, December 31, 1995 4,464,828 $44,315 $9,548 ($650) $53,213 Issuance of Common Stock 102,868 2,134 2,134 Exercise of Common Stock options 89,950 1,157 1,157 Repurchase of Common Stock (16,423) (163) (132) (295) Common Stock cash dividends (2,646) (2,646) Stock option amortization 209 209 Comprehensive income: Net income 7,306 7,306 $7,306 Other comprehensive income, net of tax: Change in unrealized loss on securities, net of tax of $208, net of reclassification adjustment (Note A): (301) ---------- Other comprehensive income: (301) (301) (301) ---------- Comprehensive income $7,005 ---------------------------------------------------=============== Balance, December 31, 1996 4,641,223 47,652 14,076 (951) 60,777 Exercise of Common Stock options 22,526 332 332 Repurchase of Common Stock (1,100) (11) (19) (30) Common Stock cash dividends (2,970) (2,970) Stock option amortization 188 188 Comprehensive income: Net income 5,869 5,869 $5,869 Other comprehensive income, net of tax: Change in unrealized loss on securities, net of tax of $(665), net of reclassification adjustment (Note A): 958 ---------- Other comprehensive income: 958 958 958 ---------- Comprehensive income $6,827 ---------------------------------------------------=============== Balance, December 31, 1997 4,662,649 48,161 16,956 7 65,124 Exercise of Common Stock options 60,125 532 532 3-for-2 Common Stock split 2,330,371 Repurchase of Common Stock (2,055) (21) (39) (60) Common Stock cash dividends (3,430) (3,430) Stock option amortization 166 166 Comprehensive income: Net income 8,770 8,770 $8,770 Other comprehensive income, net of tax: Cumulative effect of change in accounting principle 337 Change in unrealized loss on securities, net of tax of $(539), net of reclassification adjustment (Note A): 590 ---------- Other comprehensive income: 927 927 927 ---------- Comprehensive income $9,697 ---------------------------------------------------=============== Balance, December 31, 1998 7,050,990 $48,838 $22,257 $934 $72,029 =================================================== See Notes to Consolidated Financial Statements
-3-
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Years ended December 31, 1998 1997 1996 Operating activities: Net income $ 8,770 $ 5,869 $ 7,306 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 4,200 3,000 777 Provision for losses on other real estate owned 377 169 202 Provision for premises impairment and lease loss 175 300 -- Depreciation and amortization 2,611 2,438 1,809 Amortization of intangible assets 1,338 1,342 34 (Accretion) amortization of investment security (discounts) premiums, net 128 (273) 28 Deferred income taxes (2,084) (601) (930) Investment security gains, net (316) (18) -- (Gain) loss on sale of loans (497) (260) 3 (Gain) loss on sale of other real estate owned, net 96 11 (5) Amortization of stock options 166 188 209 Change in assets and liabilities, net of effects from purchase of Sutter Buttes (1996 only): (Increase) decrease in interest receivable (120) (1,129) 344 Increase (decrease) in interest payable (176) 992 (495) (Increase) decrease in other assets and liabilities 678 (10,078) (6,273) ------------------------------------------ Net cash provided by operating activities 15,346 1,950 3,009 Investing activities : Proceeds from maturities of securities held-to-maturity 18,523 14,116 19,179 Purchases of securities held-to-maturity -- -- (5,516) Proceeds from maturities of securities available-for-sale 82,214 35,604 24,353 Proceeds from sales of securities available-for-sale 87,094 29,033 -- Purchases of securities available-for-sale (199,335) (173,327) (13,704) Net increase in loans (86,066) (13,915) (62,104) Purchases of premises and equipment (1,225) (5,968) (2,526) Proceeds from sale of other real estate owned 1,711 838 673 Proceeds from sale of premises and equipment 1,110 -- -- Proceeds from sale of real estate properties 554 -- -- Purchases and additions to real estate properties -- (288) -- Purchase of Sutter Buttes, net of cash acquired -- -- (997) ------------------------------------------ Net cash used by investing activities (95,420) (113,907) (40,642) Financing activities: Net increase in deposits 45,079 128,473 23,486 Net increase (decrease) in federal funds borrowed (1,300) 10,400 4,900 Borrowings under long-term debt agreements 31,500 -- -- Payments of principal on long-term debt agreements (5,016) (12,841) (2,011) Repurchase of Common Stock (60) (30) (295) Cash dividends-- Common (3,430) (2,970) (2,646) Issuance of Common Stock 308 170 1,157 ------------------------------------------ Net cash provided by financing activities 67,081 123,202 24,591 ------------------------------------------ Increase (decrease) in cash and cash equivalents (12,993) 11,245 (13,042) Cash and cash equivalents at beginning of year 63,476 52,231 65,273 ------------------------------------------ Cash and cash equivalents at end of year $ 50,483 $ 63,476 $ 52,231 ========================================== Supplemental information: Cash paid for taxes $ 6,965 $ 3,907 $ 5,727 Cash paid for interest expense $ 25,472 $ 22,943 $ 19,908 Non-cash assets acquired through foreclosure $ 644 $ 1,859 $ 1,628
Supplemental schedule of non-cash investing and financing activities: On October 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 133 (see Note A) and in connection with the adoption, elected to transfer investment securities carried at $78,901,000 from the held-to-maturity classification to the available-for-sale classification. On October 16, 1996, the Company purchased all of the capital stock of Sutter Buttes Savings Bank in exchange for cash of approximately $2,036,000 and approximately 102,900 shares of the Company's stock. Based on the average value of the Company's stock for the ten days preceding the transaction, the total purchase price was approximately $4,171,000. In conjunction with the acquisition, liabilities were assumed as follows: (in thousands) Fair value of assets acquired $64,931 Cash and stock paid for capital stock (4,171) -------- Liabilities assumed $60,760 ======== See Notes to Consolidated Financial Statements -4- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 1998, 1997 and 1996 Note A - General Summary of Significant Accounting Policies The accounting and reporting policies of TriCo Bancshares (the "Company") conform to generally accepted accounting principles and general practices within the banking industry. The following are descriptions of the more significant accounting and reporting policies. Principles of Consolidation The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiary, Tri Counties Bank (the "Bank"), and the wholly-owned subsidiaries of the Bank. All significant intercompany accounts and transactions have been eliminated in consolidation. Nature of Operations The Company operates twenty-six branch offices and seven in-store branch offices in the California counties of Butte, Del Norte, Glenn, Kern, Lake, Lassen, Madera, Mendocino, Merced, Nevada, Sacramento, Shasta, Siskiyou, Stanislaus, Sutter, Tehama and Yuba. The Company's operating policy since its inception has emphasized retail banking. Most of the Company's customers are retail customers and small to medium sized businesses. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with 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. Securities The Company classifies its debt and marketable equity securities into one of three categories: trading, available-for-sale or held-to-maturity. Trading securities are bought and held principally for the purpose of selling in the near term. Held-to-maturity securities are those securities which the Company has the ability and intent to hold until maturity. All other securities not included in trading or held-to-maturity are classified as available-for-sale. In 1998 and 1997, the Company did not have any securities classified as trading. Available-for-sale securities are recorded at fair value. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Unrealized gains and losses, net of the related tax effect, on available-for-sale securities are reported as other comprehensive income until realized. Premiums and discounts are amortized or accreted over the life of the related investment security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned. Realized gains and losses for securities are included in earnings and are derived using the specific identification method for determining the cost of securities sold. Effective October 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). The Statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The Statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The adoption of SFAS 133 did not materially impact the financial position or results of operations of the Company as the Company does not utilize derivative instruments in its operations. As allowed by the Statement, in connection with the adoption of SFAS 133, the Bank reclassified investment securities carried at $78,901,000 from the held-to-maturity classification to the available-for-sale classification. As a result of this transfer, an unrealized gain of $337,000, net of tax, was recognized in other comprehensive income as a cumulative effect of change in accounting principle. Loans Loans are reported at the principal amount outstanding, net of unearned income and the allowance for loan losses. Loan origination and commitment fees and certain direct loan origination costs are deferred, and the net amount is amortized as an adjustment of the related loan's yield over the estimated life of the loan. Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Accrual of interest on loans is generally discontinued either when reasonable doubt exists as to the full, timely collection of interest or principal or when a loan becomes contractually past due by 90 days or more with respect to interest or principal. When loans are 90 days past due, but in Management's judgment are well secured and in the process of collection, they may not be classified as nonaccrual. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of Management, the loans are estimated to be fully collectible as to both principal and interest. -5- Allowance for Loan Losses The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when Management believes that the collectibility of the principal is unlikely or, with respect to consumer installment loans, according to an established delinquency schedule. The allowance is an amount that Management believes will be adequate to absorb probable losses inherent in existing loans, leases and commitments to extend credit, based on evaluations of the collectibility, impairment and prior loss experience of loans, leases and commitments to extend credit. The evaluations take into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, commitments, and current and anticipated economic conditions that may affect the borrower's ability to pay. The Company defines a loan as impaired when it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Certain impaired loans are measured based on the present value of expected future cash flows discounted at the loan's original effective interest rate. As a practical expedient, impairment may be measured based on the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance. Mortgage Operations The Company sold substantially all of its conforming long term residential mortgage loans originated during 1998, 1997 and 1996 for cash proceeds equal to the fair value of the loans. The Company records originated mortgage servicing rights as assets by allocating the total costs incurred between the loan and the servicing right based on their relative fair values. The cost of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenues. The Company assesses capitalized mortgage servicing rights for impairment based upon the fair value of those rights at each reporting date. For purposes of measuring impairment, the rights are stratified based upon the product type, term and interest rates. Fair value is determined by discounting estimated net future cash flows from mortgage servicing activities using discount rates that approximate current market rates and estimated prepayment rates, among other assumptions. The amount of impairment recognized, if any, is the amount by which the capitalized mortgage servicing rights for a stratum exceeds their fair value. Impairment, if any, is recognized through a valuation allowance for each individual stratum. At December 31, 1998, the Company had no mortgage loans held for sale. At December 31, 1998 and 1997, the Company serviced real estate mortgage loans for others of $124 million and $147 million, respectively. Premises and Equipment Premises and equipment, including those acquired under capital lease, are stated at cost less accumulated depreciation and amortization. Depreciation and amortization expenses are computed using the straight-line method over the estimated useful lives of the related assets or lease terms. Asset lives range from 3-10 years for furniture and equipment and 15-40 years for land improvements and buildings. Investment in Real Estate Properties Investment in real estate properties is stated at the lower of cost or market value and consists of properties either acquired directly or transferred from other real estate owned for the purpose of development or to be held as income-earning assets. Subsequent to acquisition or transfer, properties included in the investment in real estate properties account are periodically evaluated. Any decline in market value below the carrying amount of a property is included in other expenses. Income and expenses on the investment in real estate properties are included in other expenses. Other Real Estate Owned Real estate acquired by foreclosure is carried at the lower of the recorded investment in the property or its fair value less estimated disposition costs. Prior to foreclosure, the value of the underlying loan is written down to the fair value of the real estate to be acquired less estimated disposition costs by a charge to the allowance for loan losses, when necessary. Any subsequent write-downs are recorded as a valuation allowance with a charge to other expenses in the income statement. Expenses related to such properties, net of related income, and gains and losses on their disposition, are included in other expenses. Identifiable Intangible Assets Identifiable intangible assets are included in other assets and are amortized using an accelerated method over a period of ten years. Income Taxes The Company's accounting for income taxes is based on an asset and liability approach. The Company recognizes the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the future tax consequences that have been recognized in its financial statements or tax returns. The measurement of tax assets and liabilities is based on the provisions of enacted tax laws. Cash Flows For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and Federal funds sold. -6- Stock-Based Compensation The Company uses the intrinsic value method to account for its stock option plans (in accordance with the provisions of Accounting Principles Board Opinion No. 25). Under this method, compensation expense is recognized for awards of options to purchase shares of common stock to employees under compensatory plans only if the fair market value of the stock at the option grant date (or other measurement date, if later) is greater than the amount the employee must pay to acquire the stock. Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123) permits companies to continue using the intrinsic value method or to adopt a fair value based method to account for stock option plans. The fair value based method results in recognizing as expense over the vesting period the fair value of all stock-based awards on the date of grant. The Company has elected to continue to use the intrinsic value method and the pro forma disclosures required by SFAS 123 are included in Note J. Comprehensive Income As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130). This statement establishes standards for the reporting and display of comprehensive income and its components in the financial statements. For the Company, comprehensive income includes net income reported on the statement of income and changes in the fair value of its available-for-sale investments reported as other comprehensive income. The changes in the components of other comprehensive income for the years ended December 31, 1998, 1997 and 1996 are reported as follows:
1998 1997 1996 (in thousands) Holding gain arising during the period, net of tax $1,128 $ 969 $(301) Reclassification adjustment for net realized gains on securities available for sale included in net income during the year, net of tax of $115, $7 and $0, respectively (201) (11) 0 ---------------------------------------- $ 927 $ 958 $(301) ========================================
Reclassifications Certain amounts previously reported in the 1997 and 1996 financial statements have been reclassified to conform to the 1998 presentation. These reclassifications did not effect previously reported net income or total shareholder's equity. Note B - Restricted Cash Balances Reserves (in the form of deposits with the Federal Reserve Bank) of $500,000 were maintained to satisfy Federal regulatory requirements at December 31, 1998 and December 31, 1997. These reserves are included in cash and due from banks in the accompanying balance sheet. -7- Note C - Investment Securities
The amortized cost and estimated fair values of investments in debt securities are summarized in the following tables: December 31, 1998 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value -------------------------------------------------------------- (in thousands) Securities Available-for-Sale U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 39,523 $ 260 $ -- $ 39,783 Obligations of states and political subdivisions 50,525 1,545 (44) 52,026 Mortgage-backed securities 166,557 415 (326) 166,646 Other securities 21,595 -- (374) 21,221 -------------------------------------------------------------- Totals $278,200 $2,220 $ (744) $279,676 ============================================================== December 31, 1997 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value -------------------------------------------------------------- (in thousands) Securities Held-to-Maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 21,805 $ 179 $ (16) $ 21,968 Obligations of states and political subdivisions 530 1 -- 531 Mortgage-backed securities 68,429 281 (2,259) 66,451 -------------------------------------------------------------- Totals $ 90,764 $ 461 $(2,275) $ 88,950 ============================================================== Securities Available-for-Sale U.S. Treasury securities and obligations of U.S. government corporations and agencies $100,886 $ 263 $ -- $101,149 Obligations of states and political subdivisions 13,218 582 (1) 13,799 Mortgage-backed securities 36,557 56 (429) 36,184 Short-term corporate obligations 19,960 -- -- 19,960 Other securities 4,661 -- -- 4,661 -------------------------------------------------------------- Totals $175,282 $ 901 $ (430) $175,753 ==============================================================
The amortized cost and estimated fair value of debt securities at December 31, 1998 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Estimated Amortized Fair Cost Value (in thousands) Securities Available-for-Sale Due in one year $ 21,555 $ 21,609 Due after one year through five years 7,612 7,714 Due after five years through ten years 52,368 52,454 Due after ten years 191,725 192,959 ----------------------- 273,260 274,736 Other Securities 4,940 4,940 ----------------------- Totals $278,200 $279,676 ======================= Proceeds from sales of securities available-for-sale were as follows: Gross Gross Gross For the Year Proceeds Gains Losses (in thousands) 1998 $87,094 $331 $ 15 1997 $29,033 $ 19 $ 1 1996 $ -- $ -- $ -- Investment securities with an aggregate carrying value of $118,962,000 and $109,967,000 at December 31, 1998 and 1997, respectively, were pledged as collateral for specific borrowings, lines of credit and local agency deposits. -8- Note D - Allowance for Loan Losses Activity in the allowance for loan losses was as follows: Years Ended December 31, 1998 1997 1996 (in thousands) Balance, beginning of year $6,459 $6,097 $5,580 Balance acquired from Sutter Buttes -- -- 623 Provision for loan losses 4,200 3,000 777 Loans charged off (2,755) (2,840) (1,192) Recoveries of loans previously charged off 302 202 309 --------------------------------- Balance, end of year $8,206 $6,459 $6,097 Loans classified as nonaccrual amounted to approximately $1,045,000, $4,721,000, and $9,044,000 at December 31, 1998, 1997, and 1996, respectively. These nonaccrual loans were classified as impaired and are included in the recorded balance in impaired loans for the respective years shown below. If interest on those loans had been accrued, such income would have been approximately $220,000, $460,000, and $902,000 in 1998, 1997 and 1996, respectively. As of December 31, the Company's recorded investment in impaired loans and the related valuation allowance were as follows (in thousands): 1998 Recorded Valuation Investment Allowance Impaired loans - Valuation allowance required $ 952 $490 No valuation allowance required 4,750 -- ----------------------------------- Total impaired loans $ 5,702 $490 1997 Recorded Valuation Investment Allowance Impaired loans - Valuation allowance required $ 1,476 $162 No valuation allowance required 11,739 -- ----------------------------------- Total impaired loans $13,215 $162 This valuation allowance is included in the allowance for loan losses shown above for the respective year. The average recorded investment in impaired loans was $9,459,000, $14,784,000, and $10,720,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Company recognized interest income on impaired loans of $565,000, $1,118,000, and $729,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Note E - Premises and Equipment Premises and equipment were comprised of: December 31, 1998 1997 (in thousands) Premises $11,441 $13,973 Furniture and equipment 13,141 12,912 ------------------------ 24,582 26,885 Less: Accumulated depreciation and amortization (11,897) (11,836) ------------------------ 12,685 15,049 Land and land improvements 3,403 3,852 ------------------------ $16,088 $18,901 ======================== Depreciation and amortization of premises and equipment amounted to $2,251,000, $2,100,000, and $1,497,000 in 1998, 1997 and 1996, respectively. In 1997, the Company provided $300,000 for the impairment of certain properties and leaseholds which it vacated. -9- Note F - Time Deposits At December 31, 1998, the scheduled maturities of time deposits were as follows (in thousands): Scheduled Maturities 1999 $235,357 2000 8,616 2001 5,301 2002 395 2003 and thereafter 156 -------- Total $249,825
Note G - Long-Term Debt and Other Borrowings Long-term debt is as follows: December 31, 1998 1997 (in thousands) FHLB loan, effective rate of 5.13% payable on April 28, 1998 -- $ 5,000 FHLB loan, fixed rate of 5.62% payable on February 4, 1999 $ 400 400 FHLB loan, fixed rate of 6.14% payable on March 21, 1999 3,000 3,000 FHLB loan, fixed rate of 5.84% payable on November 6, 2000 1,500 1,500 FHLB loan, fixed rate of 5.90% payable on January 16, 2001 1,000 1,000 FHLB loan, fixed rate of 5.20% payable on June 12, 2003 10,000 -- FHLB loan, fixed rate of 5.41% payable on April 7, 2008 20,000 -- FHLB loan, fixed rate of 5.35% payable on December 9, 2008 1,500 -- Capital lease obligation on premises, effective rate of 13% payable monthly in varying amounts through December 1, 2009 524 540 ------------------------ Total long-term debt $37,924 $11,440
The Company maintains a collateralized line of credit with the Federal Home Loan Bank of San Francisco. Based on the FHLB stock requirements at December 31, 1998, this line provided for maximum borrowings of $97,123,000 of which $37,400,000 was outstanding, leaving $59,723,000 available. The maximum month-end outstanding balances of short term reverse repurchase agreements in 1998 and 1997 were $20,000,000 and $16,300,000, respectively. The Company has available unused lines of credit totaling $51,000,000 for Federal funds transactions at December 31, 1998. Note H - Commitments and Contingencies (See also Note O) At December 31, 1998, future minimum commitments under non-cancelable capital and operating leases with initial or remaining terms of one year or more are as follows: Capital Operating Leases Leases (in thousands) 1999 $ 86 $ 831 2000 87 556 2001 88 433 2002 89 347 2003 90 217 Thereafter 562 2,240 --------------------------- Future minimum lease payments 1,002 $4,624 Less amount representing interest 478 --------------------------- Present value of future lease payments $ 524 Rent expense under operating leases was $1,066,000 in 1998, $1,059,000 in 1997, and $799,000 in 1996. The Company is a defendant in legal actions arising from normal business activities. Management believes that these actions are without merit or that the ultimate liability, if any, resulting from them will not materially affect the Company's financial position. Note I - Dividend Restrictions The Bank paid to the Company cash dividends in the aggregate amounts of $3,650,000, $3,000,000, and $4,800,000 in 1998, 1997 and 1996, respectively. The Bank is regulated by the Federal Deposit Insurance Corporation (FDIC) and the State of California Department of Financial Institutions. California banking laws limit the Bank's ability to pay dividends to the lesser of (1) retained earnings or (2) net income for the last three fiscal years, less cash distributions paid during such period. Under this regulation, at December 31, 1998, the Bank may pay dividends of $11,023,000. -10- Note J - Stock Options In May 1995, the Company adopted the TriCo Bancshares 1995 Incentive Stock Option Plan (`95 Plan) covering key employees. Under the 1995 Plan, the option price cannot be less than the fair market value of the Common Stock at the date of grant. Options for the `95 Plan expire on the tenth anniversary of the grant date. The Company also has outstanding options under one plan approved in 1993 and two plans approved in 1989. Options under the 1993 plan were granted at an exercise price less than the fair market value of the common stock and vest over a six year period. Options under the 1989 plan vest 20% annually. Unexercised options for the 1993 and 1989 plans terminate 10 years from the date of the grant.
Stock option activity is summarized in the following table: Weighted Weighted Average Average Number Option Price Exercise Fair value Of Shares* Per Share Price of Grants Outstanding at December 31, 1995 778,245 $4.95 to $8.80 $5.29 Options granted 30,000 12.25 to 12.25 12.25 $3.57 Options exercised (134,925) 4.95 to 5.24 5.09 Options forfeited (34,545) 5.24 to 5.24 5.24 Outstanding at December 31, 1996 638,775 4.95 to 12.25 5.31 Options granted 84,000 14.17 to 18.25 17.52 $5.59 Options exercised (33,789) 4.95 to 5.24 5.03 Options forfeited (18,900) 5.24 to 5.24 5.24 Outstanding at December 31, 1997 670,086 4.95 to 18.25 5.65 Options exercised (60,125) 4.95 to 18.25 5.12 Options forfeited (1,350) 18.25 to 18.25 18.25 Outstanding at December 31, 1998 608,611 $4.95 to $18.25 $7.37 *Adjusted for the 5-for-4 Common Stock split effected September 22, 1995 and 3-for-2 Common Stock split effected October 30, 1998.
Of the stock options outstanding as of December 31, 1998, options on 503,526 shares were exercisable at a weighted average price of $6.43. The Company has stock options outstanding under the four option plans described above. The Company accounts for these plans under APB Opinion No. 25, under which no compensation cost has been recognized except for the options granted under the 1993 plan. The Company recognized expense of $166,000, $188,000, and $209,000 for the 1993 Plan options in 1998, 1997 and 1996 respectively. Had compensation cost for these plans been determined in accordance SFAS 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below: 1998 1997 1996 Net income As reported $8,770 $5,869 $7,306 Pro forma $8,697 $5,829 $7,285 Basic earnings per share As reported $1.25 $0.84 $1.08 Pro forma $1.24 $0.83 $1.07 Diluted earnings per share As reported $1.21 $0.81 $1.04 Pro forma $1.20 $0.81 $1.03 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997 and 1996, respectively: risk-free interest rates of 6.06 and 6.76 percent; expected dividend yields of 2.46 and 3.48 percent; expected lives of 6 and 6 years; expected volatility of 30.49 and 30.22 percent, respectively. No options were granted in 1998. -11- Note K - Other Noninterest Expenses and Income The components of other noninterest expenses were as follows: Years Ended December 31, 1998 1997 1996 (in thousands) Equipment and data processing $ 3,551 $ 3,390 $ 2,483 Occupancy 2,353 2,214 1,682 Intangible amortization 1,338 1,342 34 Professional fees 1,046 998 901 Telecommunications 976 922 653 Advertising 879 753 713 Postage 548 535 436 Provision for premises impairment and lease loss -- 300 -- Net other real estate owned expense 540 277 261 Assessments 174 155 80 Other 6,484 6,375 4,253 --------------------------- Total other operating expenses $17,889 $17,261 $11,496 Commissions on sales of annuities and mutual funds in the amounts of $2,013,000, $1,963,000, and $1,255,000 for the years 1998, 1997 and 1996, respectively, are included in other income. Note L - Income Taxes The current and deferred components of the income tax provision were comprised of: Years Ended December 31, 1998 1997 1996 (in thousands) Current Tax Provision: Federal $ 5,245 $ 3,360 $ 4,439 State 1,888 948 1,528 ------------------------------------------- Total current 7,133 4,308 5,967 Deferred Tax Benefit: Federal (1,621) (614) (769) State (463) 13 (161) ------------------------------------------- Total deferred (2,084) (601) (930) ------------------------------------------- Total income taxes $ 5,049 $ 3,707 $ 5,037 Taxes recorded directly to shareholders' equity are not included in the preceding table. These taxes relating to changes in the unrealized gains and losses on available-for-sale investment securities amounting to $657,000 in 1998 and $736,000 in 1997, and benefits related to employee stock options of $224,000 in 1998 and $148,000 in 1997 were recorded directly to shareholders' equity. The provisions for income taxes applicable to income before taxes for the years ended December 31, 1998, 1997, and 1996 differ from amounts computed by applying the statutory Federal income tax rates to income before taxes. The effective tax rate and the statutory federal income tax rate are reconciled as follows: Years Ended December 31, 1998 1997 1996 Federal statutory income tax rate 34.0% 34.0% 34.2% State income taxes, net of federal tax benefit 6.8 6.4 7.4 Tax-exempt interest on municipal obligations (4.1) (1.9) (.3) Other (0.2) -- (.5) ----------------------------- Effective Tax Rate 36.5% 38.5% 40.8% -12- The components of the net deferred tax asset of the Company as of December 31, were as follows: 1998 1997 (in thousands) Deferred Tax Assets: Loan losses $ 3,160 $ 2,333 Deferred compensation 2,281 1,960 OREO write downs 638 227 Loss on investment in real estate -- 360 Intangible amortization 568 291 Stock option amortization 367 281 Nonaccrual interest 99 -- Other 491 -- -------------------------- Total deferred tax assets 7,604 5,452 Deferred Tax Liabilities: Depreciation (724) (828) Unrealized gain on securities (662) -- Securities accretion (338) (364) Capital leases (97) (92) Other -- (36) -------------------------- Total deferred tax liability (1,821) (1,320) -------------------------- Net deferred tax asset $ 5,783 $ 4,132 -13- Note M - Retirement Plans Substantially all employees with at least one year of service are covered by a discretionary employee stock ownership plan (ESOP). Contributions are made to the plan at the discretion of the Board of Directors. Contributions to the plan(s) totaling $ 640,000 in 1998, $828,000 in 1997, and $500,000 in 1996 are included in salary expense. The Company has a supplemental retirement plan for directors and a supplemental executive retirement plan covering key executives. These plans are non-qualified defined benefit plans and are unsecured and unfunded. The Company has purchased insurance on the lives of the participants and intends to use the cash values of these policies ($6,554,000 and $5,870,000 at December 31, 1998 and 1997, respectively) to pay the retirement obligations. The Company has an Executive Deferred Compensation Plan which allows directors and key executives designated by the Board of Directors of the Company to defer a portion of their compensation. The Company has purchased insurance on the lives of the participants and intends to use the cash values of these policies to pay the compensation obligations. At December 31, 1998 and 1997, the cash values exceeded the recorded liabilities. The following table sets forth the plans' status: December 31, 1998 1997 (in thousands) Change in benefit obligation: Benefit obligation at beginning of year $(3,693) $(3,704) Service cost (53) (120) Interest cost (256) (262) Amendments (6) -- Actuarial gain(loss) (69) 249 Benefits paid 144 144 ------------------- Benefit obligation at end of year $(3,933) $(3,693) Change in plan assets: Fair value of plan assets at beginning of year $ -- $ -- Fair value of plan assets at end of year $ -- $ -- Funded status $(3,933) $(3,693) Unrecognized net obligation existing at January 1, 1986 218 253 Unrecognized net actuarial loss 874 979 Unrecognized prior service cost 98 103 ------------------- Accrued benefit cost $(2,743) $(2,358) Years Ended December 31, 1998 1997 1996 (in thousands) Net pension cost included the following components: Service cost-benefits earned during the period $ 53 $120 $135 Interest cost on projected benefit obligation 256 262 204 Amortization of net obligation at transition 35 35 35 Amortization of prior service cost 10 10 10 Recognized net actuarial loss 47 68 27 ---------------------------- Net periodic pension cost $401 $495 $411 The net periodic pension cost was determined using a discount rate assumption of 7.0% for 1998, 7.0% for 1997 and 7.0% for 1996, respectively. The rates of increase in compensation used in each year were 0% to 5%. -14- Note N - Earnings per Share The Company adopted SFAS No. 128, Earnings per Share (SFAS 128), during 1997. SFAS 128 replaces primary and fully diluted earnings per share with basic and diluted earnings per share calculations. Basic earnings per share is computed by dividing net income, less dividends on preferred stock, by the weighted average common shares outstanding. Diluted earnings per share is computed by dividing net income, less dividends on preferred stock, by the weighted average common shares outstanding including the dilutive effects of potential common shares (e.g. stock options). Diluted earnings per share calculations result in the same primary earnings per share previously reported by the Company. The Company's basic and diluted earnings per share are as follows (in thousands except per share data):
Year Ended December 31, 1998 Weighted Average Income Shares Per-Share Amount Basic Earnings per Share Net income available to common shareholders $8,770 7,017,306 $1.25 Common stock options outstanding -- 259,296 Diluted Earnings per Share Net income available to common shareholders $8,770 7,276,602 $1.21 ====== ========= Year Ended December 31, 1997 Weighted Average Income Shares Per-Share Amount Basic Earnings per Share Net income available to common shareholders $5,869 6,978,089 $0.84 Common stock options outstanding -- 267,922 Diluted Earnings per Share Net income available to common shareholders $5,869 7,246,011 $0.81 ====== ========= Year Ended December 31, 1996 Weighted Average Income Shares Per-Share Amount Basic Earnings per Share Net income available to common shareholders $7,306 6,769,736 $1.08 Common stock options outstanding -- 264,891 Diluted Earnings per Share Net income available to common shareholders $7,306 7,034,627 $1.04 ====== =========
Note O - Related Party Transactions Certain directors, officers, and companies with which they are associated were customers of, and had banking transactions with, the Company or its Subsidiary in the ordinary course of business. It is the Company's policy that all loans and commitments to lend to officers and directors be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other borrowers of the Bank. The following table summarizes the activity in these loans for 1998. Balance Balance December 31, Advances/ December 31, 1997 New Loans Payments 1998 (in thousands) 6,627 5,167 2,660 9,134 -15- Note P - Financial Instruments With Off-Balance Sheet Risk The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Contractual Amount December 31, 1998 1997 (in thousands) Financial instruments whose contract amounts represent credit risk: Commitments to extend credit: Commercial loans $68,363 $52,579 Consumer loans 46,571 78,785 Real estate mortgage loans 26 667 Real estate construction loans 16,690 11,985 Standby letters of credit 3,287 1,789 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates of one year or less or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on Management's credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. Most standby letters of credit are issued for one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral requirements vary, but in general follow the requirements for other loan facilities. Note Q - Concentration of Credit Risk The Company grants agribusiness, commercial, consumer, and residential loans to customers located throughout the northern San Joaquin Valley, the Sacramento Valley and northern mountain regions of California. The Company has a diversified loan portfolio within the business segments located in this geographical area. Note R - Disclosure of Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practical to estimate that value. Cash and due from banks, accrued interest receivable and payable, and short-term borrowings are considered short-term instruments. For these short-term instruments their carrying amount approximates their fair value. Securities For all securities, fair values are based on quoted market prices or dealer quotes. See Note C for further analysis. Loans The fair value of variable rate loans is the current carrying value. These loans are regularly adjusted to market rates. The fair value of other types of fixed rate loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities. The allowance for loan losses is a reasonable estimate of the valuation allowance needed to adjust computed fair values for credit quality of certain loans in the portfolio. Deposit Liabilities and Long-Term Debt The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. These values do not consider the estimated fair value of the Company's core deposit intangible, which is a significant unrecognized asset of the Company. The fair value of time deposits and debt is based on the discounted value of contractual cash flows. -16- Commitments to Extend Credit and Standby Letters of Credit The fair value of letters of credit and standby letters of credit is not significant. The estimated fair values of the Company's financial instruments are as follows: December 31, 1998 Carrying Fair Amount Value (In thousands) Financial assets: Cash and short-term investments $ 50,483 $ 50,483 Securities: Available-for-sale 279,676 279,676 Loans, net 524,227 529,243 Accrued interest receivable 5,821 5,821 Financial liabilities: Deposits 769,173 769,591 Fed Funds purchased 14,000 14,000 Accrued interest payable 3,863 3,863 Other liabilities 7,610 7,610 Long-term borrowings $ 37,924 $ 37,808 December 31, 1997 Carrying Fair Amount Value (In thousands) Financial assets: Cash and short-term investments $ 63,476 $ 63,476 Securities: Held-to-maturity 90,764 88,950 Available-for-sale 175,753 175,753 Loans, net 442,508 446,439 Accrued interest receivable 5,701 5,701 Financial liabilities: Deposits 724,094 724,188 Federal Funds purchased 15,300 15,300 Accrued interest payable 4,039 4,039 Other liabilities 6,168 6,168 Long-term borrowings $ 11,440 $ 11,524 Note S - Acquisitions On February 21, 1997, the Bank purchased and assumed substantially all of the deposit liabilities of nine branches from Wells Fargo Bank, N.A, San Francisco. In connection with the acquisition of such deposit liabilities and related cash balances, the Bank also acquired certain other assets of the branches, including real estate (four branches), furniture and fixtures and a relatively insignificant amount of loans which were secured by deposit accounts. All assets constituting plant and equipment or other physical property will continue to be used in the banking business. Wells Fargo Bank retained all other revenue producing assets which had originated from these branches. A summary of the deposit liabilities and limited assets acquired by the Bank is shown below. These assets and liabilities were recorded in the respective captions in the Company's consolidated balance sheet on the acquisition date. Total deposits (liabilities) acquired $150,090,000 Less assets acquired Furniture and fixtures 214,000 Land and premises 585,000 Loans 183,000 ---------- Total assets acquired 982,000 Less premium paid for deposits 9,108,000 Net cash received by Tri Counties Bank for the deposits acquired $140,000,000 -17- On October 16, 1996, the Company acquired all of the capital stock of Sutter Buttes Savings Bank (Sutter Buttes) in exchange for cash of approximately $2,036,000 and approximately 102,900 shares of the Company's stock. Based on the average value of the Company's stock for the ten days preceding the transaction, the total purchase price was approximately $4,171,000. The transaction was accounted for as a purchase, with the excess of the purchase price over the fair value of Sutter Buttes' net assets being assigned to core deposit intangible assets. Results of operations of Sutter Buttes are included in the consolidated financial statements subsequent to October 16, 1996. Sutter Buttes was merged into the Bank concurrent with the acquisition. Pro forma operating results of the Company, assuming the Sutter Buttes acquisition had been made as of January 1, 1996 is as follows: UNAUDITED PRO FORMA COMBINED FINANCIAL DATA (in thousands, except per share data) Year ended December 31, 1996 Summary of Income: Net interest income $ 31,503 Provision for loan losses 997 Noninterest income 6,924 Noninterest expense 25,466 Net income 7,056 Net income available to common shareholders $ 7,056 Per Common Share: Basic earnings per common share $1.03 Diluted earnings per common share $0.99 Selected Balance Sheet Data: Investment securities $170,029 Loans 439,289 Assets 694,771 Deposits 595,621 Equity $ 60,689 -18- Note T - TriCo Bancshares Financial Statements TriCo Bancshares (Parent Only) Balance Sheets December 31, Assets 1998 1997 (in thousands) Cash $ 104 $ 82 Investment in Tri Counties Bank 71,164 64,510 Other assets 761 608 --------------------- Total assets $72,029 $65,200 Liabilities and shareholders' equity Total liabilities $ -- $ 76 Shareholders' equity: Common stock, no par value: Authorized 20,000,000 shares; issued and outstanding 7,050,990 and 6,993,974 shares, respectively 48,838 48,161 Retained earnings 22,257 16,956 Unrealized gain on securities available-for-sale, net 934 7 --------------------- Total shareholders' equity 72,029 65,124 --------------------- Total liabilities and shareholders' equity $72,029 $65,200 Statements of Income Years Ended December 31, 1998 1997 1996 (in thousands) Interest income $ -- $ -- $ -- Administration expense 369 321 296 -------------------------- Loss before equity in net income of Tri Counties Bank (369) (321) (296) Equity in net income of Tri Counties Bank: Distributed 3,650 3,000 4,800 Undistributed 5,338 3,031 2,654 Income tax credits 151 159 148 -------------------------- Net income $8,770 $5,869 $7,306
Statements of Cash Flows Years ended December 31, 1998 1997 1996 (in thousands) Operating activities: Net income $8,770 $5,869 $7,306 Adjustments to reconcile net income to net cash provided by (used for) operating activities: Undistributed equity in Tri Counties Bank (5,338) (3,031) (2,654) Deferred income taxes (153) (148) (157) Increase (decrease) in other operating assets and liabilities (76) (295) 279 ------------------------------------------ Net cash provided by operating activities 3,203 2,395 4,774 Investing activities: Capital contributed to Tri Counties Bank -- -- (4,741) ------------------------------------------ Net cash used for investing activities -- -- (4,741) Financing activities: Issuance of common stock 309 170 3,291 Repurchase of common stock (60) (30) (295) Cash dividends-- common (3,430) (2,970) (2,646) ------------------------------------------ Net cash provided by (used for) financing activities (3,181) (2,830) 350 ------------------------------------------ Increase (decrease) in cash and cash equivalents 22 (435) 383 Cash and cash equivalents at beginning of year 82 517 134 ------------------------------------------ Cash and cash equivalents at end of year $ 104 $ 82 $ 517
-19- Note U - Regulatory Matters The Company is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets. Management believes, as of December 31, 1998, that the Company meets all capital adequacy requirements to which it is subject. As of December 31, 1998, 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 below. There are no conditions or events since that notification that management believes have changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the table. To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio As of December 31, 1998: Total Capital (to Risk Weighted Assets): Consolidated $71,034 11.83% =>$48,016 =>8.0% =>$60,020 =>10.0% Tri Counties Bank $70,159 11.69% =>$48,012 =>8.0% =>$60,016 =>10.0% Tier I Capital (to Risk Weighted Assets): Consolidated $63,531 10.59% =>$24,008 =>4.0% =>$36,012 => 6.0% Tri Counties Bank $62,666 10.44% =>$24,006 =>4.0% =>$36,009 => 6.0% Tier I Capital (to Average Assets): Tri Counties Bank $62,666 7.23% =>$34,661 =>4.0% =>$43,327 => 5.0% As of December 31, 1997: Total Capital (to Risk Weighted Assets): Consolidated $62,673 11.90% =>$42,132 =>8.0% =>$52,665 =>10.0% Tri Counties Bank $62,059 11.80% =>$42,083 =>8.0% =>$52,604 =>10.0% Tier I Capital (to Risk Weighted Assets): Consolidated $56,215 10.67% =>$21,066 =>4.0% =>$31,599 => 6.0% Tri Counties Bank $55,601 10.57% =>$21,042 =>4.0% =>$31,563 => 6.0% Tier I Capital (to Average Assets): Tri Counties Bank $55,601 6.94% =>$21,042 =>4.0% =>$26,302 => 5.0%
-20- Note V - Summary of Quarterly Results of Operations (unaudited) The following table sets forth the results of operations for the four quarters of 1998 and 1997, and is unaudited; however, in the opinion of management, it reflects all adjustments (which include only normal recurring adjustments) necessary to present fairly the summarized results for such periods.
1998 Quarters Ended December 31, September 30, June 30, March 31, (Dollars in thousands, except per share data) Interest income $16,999 $17,190 $16,504 $15,394 Interest expense 6,116 6,742 6,500 5,938 -------- -------- -------- -------- Net interest income 10,883 10,448 10,004 9,456 Provision for loan losses 1,220 920 1,235 825 -------- --------- -------- --------- Net interest income after provision for loan losses 9,663 9,528 8,769 8,631 Noninterest income 3,146 2,762 3,955 3,006 Noninterest expense 8,738 8,459 9,108 8,387 -------- -------- -------- -------- Income before income taxes 4,071 3,831 3,616 3,250 Taxable-equivalent adjustment 319 278 223 129 Income tax expense 1,337 1,269 1,252 1,191 -------- -------- -------- -------- Net income $ 2,415 $ 2,284 $ 2,141 $ 1,930 ======= ======= ======= ======= Per common share: Net income (diluted)* $ 0.33 $ 0.31 $ 0.29 $ 0.27 ======= ======= ======= ======= Dividends $ 0.16 $ 0.11 $ 0.11 $ 0.11 ======= ======= ======= ======= 1997 Quarters Ended December 31, September 30, June 30, March 31, (Dollars in thousands, except per share data) Interest income $15,742 $15,597 $14,873 $13,993 Interest expense 6,101 6,127 6,099 5,608 -------- -------- -------- -------- Net interest income 9,641 9,470 8,774 8,385 Provision for loan losses 800 1,000 600 600 -------- -------- --------- --------- Net interest income after provision for loan losses 8,841 8,470 8,174 7,785 Noninterest income 2,584 2,477 2,408 2,097 Noninterest expense 8,620 8,200 8,820 7,292 -------- -------- -------- -------- Income before income taxes 2,805 2,747 1,762 2,590 Taxable-equivalent adjustment 100 98 95 35 Income tax expense 1,093 1,035 588 991 -------- -------- -------- -------- Net income $ 1,612 $ 1,614 $ 1,079 $ 1,564 ======= ======= ======= ======= Per common share: Net income (diluted)* $ 0.22 $ 0.22 $ 0.15 $ 0.21 ======= ======= ======= ======= Dividends $ 0.11 $ 0.11 $ 0.11 $ 0.11 ======= ======= ======= ======= *Adjusted to reflect the 3-for-2 common stock split effected October 30, 1998.
-21- Note W - Business Segments Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information, (SFAS 131). This Statement establishes standards for the reporting and display of information about operating segments and related disclosures. The Company is principally engaged in traditional community banking activities provided through its twenty-six branches and seven in-store branches located throughout Northern California. Community banking activities include the Bank's commercial and retail lending, deposit gathering and investment and liquidity management activities. In addition to its community banking services, the Bank offers investment brokerage and leasing services. The Company held investments in real estate through its wholly-owned subsidiary, TCB Real Estate. These activities are monitored and reported by Bank management as separate operating segments. The accounting policies of the segments are the same as those described in Note A. The Company evaluates segment performance based on net interest income, or profit or loss from operations, before income taxes not including nonrecurring gains and losses. As permitted under the Statement, the results of the separate branches have been aggregated into a single reportable segment, Community Banking. The Company's leasing, investment brokerage and real estate segments do not meet the prescribed aggregation or materiality criteria and therefore are reported as "Other" in the following table. Summarized financial information for the years ended December 31, 1998, 1997, and 1996 concerning the Bank's reportable segments is as follows: Community Banking Other Total 1998 Net interest income $ 39,789 $ 53 $ 39,842 Noninterest income 10,777 2,092 12,869 Noninterest expense 33,416 1,276 34,692 Net income 8,203 567 8,770 Assets $901,580 $3,019 $904,599 1997 Net interest income $ 35,942 $ -- $ 35,942 Noninterest income 7,551 2,015 9,566 Noninterest expense 32,932 597 32,932 Net income 4,977 892 5,869 Assets $825,229 $ 936 $826,165 1996 Net interest income $ 29,969 $ -- $ 29,969 Noninterest income 5,314 1,322 6,636 Noninterest expense 22,918 567 23,485 Net income 6,852 454 7,306 Assets $693,484 $1,375 $694,859 -22- REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of TriCo Bancshares and Subsidiary: We have audited the accompanying consolidated balance sheets of TriCo Bancshares (a California corporation) and Subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of TriCo Bancshares and Subsidiary as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP San Francisco, California January 22, 1999 -23- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As TriCo Bancshares (the "Company") has not commenced any business operations independent of Tri Counties Bank (the "Bank"), the following discussion pertains primarily to the Bank. Average balances, including such balances used in calculating certain financial ratios, are generally comprised of average daily balances for the Company. Interest income and net interest income are presented on a tax equivalent basis. In addition to the historical information contained herein, this Annual Report contains certain forward-looking statements. The reader of this Annual Report should understand that all such forward-looking statements are subject to various uncertainties and risks that could affect their outcome. The Company's actual results could differ materially from those suggested by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, variances in the actual versus projected growth in assets, return on assets, loan losses, expenses, rates charged on loans and earned on securities investments, rates paid on deposits, competition effects, fee and other noninterest income earned as well as other factors. This entire Annual Report should be read to put such forward-looking statements in context and to gain a more complete understanding of the uncertainties and risks involved in the Company's business. Overview 1998 was a defining year for Trico Bancshares and Tri Counties Bank. During the year the Company began to realize the potential of nine branches acquired from Wells Fargo Bank, N.A. (sometimes referred to as "Wells") in February 1997 and its Sacramento and Bakersfield loan production offices which were transformed into full service branches in November 1998. The Bank continued to refine its ability to identify and grow profitable business segments, while enhancing or divesting unprofitable segments. One example of these efforts was a gain of $897,000 on the sale of the Bank's $14,365,000 credit card portfolio in May of 1998. Also in 1998, the Bank adopted an employee incentive program that tied each employee's compensation to the financial performance of the employee's business unit, the business units they support, and the overall Bank. The combination of growth potential and increased internal cooperation resulted in a 49% increase in net income during 1998. Management believes the Bank is positioned to realize continued growth in earnings and returns for shareholders in 1999. The Company had earnings of $8,770,000 for the year ended December 31, 1998 versus $5,869,000 for 1997. Diluted earnings per share for the same years were $1.21 and $0.81, respectively. Net interest income for 1998 was $40,791,000 which was an increase of $4,521,000 (12.5%) over 1997. The interest income component of net interest income was up 9.8% or $5,882,000. Interest and fees on loans were up $3,603,000 (8.0%) to $48,506,000 as average loans outstanding increased $39,481,000 (8.8%) to $487,598,000. Interest income on investment securities and Federal Funds sold increased $2,279,000 (14.9%) to $17,581,000 mostly due to higher average balances. Interest expense was up $1,361,000 (5.7%) to $25,296,000. This increase was due to higher average balances of interest bearing liabilities, which increased $45,955,000 (7.6%) to $650,022,000, as the average rate paid on them declined 7 basis points. The net interest margin was 5.28% in 1998 versus 5.16% in 1997. The Bank provided $4,200,000 to the allowance for loan losses in 1998 compared to $3,000,000 in 1997. Net loan charge-offs in 1998 were $2,453,000 compared to $2,638,000 in 1997. At year end 1998 and 1997 the allowance for loan losses as a percentage of gross loans was 1.54% and 1.44%, respectively. Noninterest income is comprised of "service charges and fees" and "other income". Service charge and fee income increased $642,000 (9.5%) to $7,387,000 in 1998 versus year ago results. Both higher account volumes and higher fee rates contributed to the increase in this category. Other income was up $2,661,000 (94.3%) to $5,482,000 from $2,821,000 in 1997. Items contributing to the increase in other income included; a gain on sale of the credit card portfolio of $897,000, gain on the sale of investments of $316,000 in 1998 compared to $18,000 in 1997, and gain on sale of loans of $497,000 in 1998 versus $260,000 in 1997. Overall, noninterest income increased $3,303,000 (34.5%) for the year to $12,869,000. Noninterest expenses increased $1,760,000 (5.3%) to $34,692,000 in 1998. Approximately $360,000 of the increase was due to 1998 having a full year of expenses related to the nine branches purchased from Wells, while 1997 had only ten and one half months of related expenses. Salary and benefit expenses increased 7.2% to $16,803,000, and accounted for $1,132,000 of the $1,760,000 increase in noninterest expenses in 1998. Approximately $219,000 of the increase in salaries and benefits was due to a full twelve months of salary expenses from the Wells branches in 1998. Incentive and commission related salary expenses increased $632,000 (72.6%) to $1,502,000 in 1998. Base salaries and benefits increased $281,000 (1.8%) in 1998. The relatively small increase in base salaries was mainly due to a 0.5% increase in average full time equivalent employees (FTE's) from 374 during 1997 to 376 during 1998, and an average annual base salary increase of 1.3% during 1998. The large increase in incentive and commission related salary expense was more than offset by revenue growth. These results are consistent with the Bank's strategy of working more efficiently with fewer employees who are compensated in part based on their division's performance. Other expenses increased $628,000 (3.6%) to $17,889,000 in 1998. Approximately $141,000 of this increase was due to a full twelve months of other expenses from the Wells branches in 1998. $261,000 of the increase in other expenses was due to increased equipment and data processing expenses which increased to $3,551,000 in 1998. -24- Assets of the Company totaled $904,599,000 at December 31, 1998 which was an increase of $78,434,000 (9.5%) from 1997 ending balances. For 1998, the Company realized a return on assets of 1.03% and a return on shareholders' equity of 12.80% versus 0.75% and 9.34%, respectively, in 1997. The Company ended 1998 with a Tier 1 capital ratio of 10.59% and a total risk-based capital ratio of 11.83%. Management's continuing goal for the Bank is to deliver a full array of competitive products to its customers while maintaining the personalized customer service of a community bank. We believe this strategy will provide continued growth and the ability to achieve above average returns for our shareholders.
(A) Results of Operations Years Ended December 31, 1998 1997 1996 1995 1994 (in thousands, except earnings per share amounts) Interest income: Interest and fees on loans $ 48,506 $ 44,903 $ 38,227 $ 33,776 $ 30,641 Interest on investment securities--taxable 14,622 13,791 10,409 11,706 12,247 Interest on investment securities--tax exempt1 2,809 958 207 272 401 Interest on federal funds sold 150 553 392 371 123 ---------------------------------------------------------------- Total interest income 66,087 60,205 49,235 46,125 43,412 Interest expense: Interest on deposits 22,865 22,682 17,201 16,231 13,902 Interest on short-term borrowing 816 537 359 526 719 Interest on long-term debt 1,615 716 1,619 1,231 1,059 ---------------------------------------------------------------- Total interest expense 25,296 23,935 19,179 17,988 15,680 ---------------------------------------------------------------- Net interest income 40,791 36,270 30,056 28,137 27,732 Provision for loan losses 4,200 3,000 777 335 316 ---------------------------------------------------------------- Net interest income after provision for loan losses 36,591 33,270 29,279 27,802 27,416 Noninterest income: Service charges, fees and other 12,553 9,548 6,636 5,943 5,048 Investment securities gains (losses), net 316 18 -- (10) (23) ---------------------------------------------------------------- Total noninterest income 12,869 9,566 6,636 5,933 5,025 Noninterest expenses: Salaries and employee benefits 16,803 15,671 11,989 10,787 10,550 Other, net 17,889 17,261 11,496 10,874 11,508 ---------------------------------------------------------------- Total noninterest expenses 34,692 32,932 23,485 21,661 22,058 ---------------------------------------------------------------- Net income before income taxes 14,768 9,904 12,430 12,074 10,383 Income taxes 5,049 3,707 5,037 4,915 4,350 Tax equivalent adjustment2 949 328 87 114 172 ---------------------------------------------------------------- Net income $ 8,770 $ 5,869 $ 7,306 $ 7,045 $ 5,861 ================================================================ Basic earnings per common share2 $ 1.25 $ 0.84 $ 1.08 $ 1.03 $ 0.83 Diluted earnings per common share2 $ 1.21 $ 0.81 $ 1.04 $ 0.97 $ 0.78 Selected Balance Sheet Information Total Assets $904,599 $826,165 $694,859 $603,554 $593,834 Long-term Debt 37,924 11,440 24,281 26,292 18,499 Preferred Stock -- -- -- -- 3,899 1 Interest on tax-free securities is reported on a tax equivalent basis of 1.51 for 1998, 1.52 for 1997, 1.72 for 1996, 1.72 for 1995, and 1.75 for 1994. 2 Restated on a historical basis to reflect the 5-for-4 stock split effected September 22, 1995, and the 3-for-2 stock split effected October 30, 1998.
-25- Net Interest Income/Net Interest Margin Net interest income represents the excess of interest and fees earned on interest-earning assets (loans, securities and federal funds sold) over the interest paid on deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets. Net interest income for 1998 totaled $40,791,000 which was up 12.5% ($4,521,000) over the prior year. Average outstanding loan balances of $487,598,000 for 1998 reflected a 8.8% increase over 1997 balances. This increase contributed an additional $3,956,000 to interest income and was the major factor in the improvement in net interest income. The average yield received on loans fell 7 basis points to 9.95% which reduced interest income by $353,000. This decrease resulted from reductions in market interest rates throughout 1998. Increases in loan fees of $900,000 (43.7%) in 1998 added 18 basis points to the average loan yield. Average balances of investment securities increased $37,342,000 (15.3%) to $282,047,000. The higher volume of securities resulted in an increase in interest income of $2,251,000. An increase of 15 basis points in the average tax effective yield on investments added $431,000 to interest income. The Bank increased average tax effective yield of its combined investment portfolio by increasing the percentage of nontaxable investments to total investments. The effect of the increase in nontaxable investments outweighed the negative impact of lower market interest rates in 1998. Interest expense increased $1,361,000 (5.7%) to $25,296,000 in 1998. Higher volumes in all interest bearing deposit categories accounted for $775,000 of the increase, while decreases in rates paid on all deposit categories offset interest expense by $592,000. Higher volumes of short and long term borrowings added $1,252,000 to interest expense in 1998. Net interest margin for 1998 was 5.28% versus 5.16% in 1997. Net interest income for 1997 totaled $36,270,000 which was up 20.7% ($6,214,000) over the prior year. Average outstanding loan balances of $448,117,000 for 1997 reflected a 21.6% increase over 1996 balances. This increase contributed an additional $8,253,000 to interest income and was the major factor in the improvement in net interest income. The average yield received on loans fell 35 basis points to 10.02% which offset interest income by $1,577,000. The reduction of the loan yields was due to increased market competition and also in part to the acquisition of Sutter Buttes Savings Bank in October of 1996. A high percentage of Sutter Buttes' loans were mortgage loans with fixed interest rates averaging less than 8%. Average balances of investment securities increased $61,483,000 (33.6%) due primarily to the investment of net proceeds received in the Wells branch acquisition. The higher volume of securities resulted in an increase in interest income of $3,800,000. Interest expense increased $4,756,000 (24.8%) in 1997 over 1996. Higher volumes in all interest bearing deposit categories as a result of the purchase of certain deposits from Wells Fargo Bank accounted for the increase. Interest expense on time deposits was up $3,424,000 due to an increase in average balances of $64,519,000 in 1997. Average rates paid on interest bearing liabilities in 1997 were down 9 basis point to 3.96% which had a small favorable effect on interest expense. Net interest margin for 1997 was 5.16% versus 5.37% in 1996. Table One, Analysis of Net Interest Margin on Earning Assets, and Table Two, Analysis of Volume and Rate Changes on Net Interest Income and Expenses, are provided to enable the reader to understand the components and past trends of the Bank's interest income and expenses. Table One provides an analysis of net interest margin on earning assets setting forth average assets, liabilities and shareholders' equity; interest income earned and interest expense paid and average rates earned and paid; and the net interest margin on earning assets. Table Two presents an analysis of volume and rate change on net interest income and expense. -26-
Table One: Analysis of Net Interest Margin on Earning Assets 1998 1997 1996 Average Yield/ Average Yield/ Average Yield/ Balance1 Income Rate Balance1 Income Rate Balance1 Income Rate (dollars in thousands) Assets Earning assets: Loans2,3 $487,598 $48,506 9.95 % $448,117 $44,903 10.02% $368,550 $38,227 10.37% Securities - taxable 245,499 14,622 5.96 % 233,389 13,791 5.91% 180,836 10,409 5.76% Securities - nontaxable4 36,548 2,809 7.69 % 11,316 958 8.47% 2,386 207 8.68% Federal funds sold 2,663 150 5.63 % 9,956 553 5.55% 7,405 392 5.29% --------------------------------------------------------------------------------------------- Total earning assets 772,308 66,087 8.56 % 702,778 60,205 8.57% 559,177 49,235 8.80% Cash and due from banks 33,819 36,671 31,867 Premises and equipment 17,448 16,838 14,068 Other assets, net 32,921 33,413 23,046 Less: Unrealized gain (loss) on securities 355 (1,203) (1,841) Less: Allowance for loan losses (7,270) (6,185) (5,597) --------- --------- --------- Total assets $849,581 $782,312 $620,720 Liabilities and shareholders' equity Interest-bearing demand deposits $137,001 2,932 2.14 % $122,390 2,781 2.27% $ 89,278 2,226 2.49% Savings deposits 212,291 6,473 3.05 % 208,232 6,400 3.07% 163,637 5,032 3.08% Time deposits 257,805 13,460 5.22 % 251,874 13,501 5.36% 187,355 9,943 5.31% Federal funds purchased 8,025 446 5.56 % 4,144 235 5.67% 6,485 359 5.54% Repurchase agreements 6,474 370 5.72 % 5,331 302 5.66% 9,828 603 6.14% Long-term debt 28,426 1,615 5.68 % 12,096 716 5.92% 17,434 1,016 5.83% --------------------------------------------------------------------------------------------- Total interest-bearing liabilities 650,022 25,296 3.89 % 604,067 23,935 3.96% 474,017 19,179 4.05% Noninterest-bearing deposits 119,929 105,198 79,843 Other liabilities 11,109 10,204 10,776 Shareholders' equity 68,521 62,843 56,084 --------- --------- --------- Total liabilities and shareholders' equity $849,581 $782,312 $620,720 Net interest rate spread5 4.67 % 4.61% 4.75% Net interest income/net interest margin6 $40,791 5.28 % $36,270 5.16% $30,056 5.37% 1 Average balances are computed principally on the basis of daily balances. 2 Nonaccrual loans are included. 3 Interest income on loans includes fees on loans of $2,958,000 in 1998, $2,058,000 in 1997, and $1,926,000 in 1996. 4 Interest income is stated on a tax equivalent basis of 1.52 in 1998, 1.52 in 1997, and 1.70 in 1996. 5 Net interest rate spread represents the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities. 6 Net interest margin is computed by dividing net interest income by total average earning assets.
-27-
Table Two: Analysis of Volume and Rate Changes on Net Interest Income and Expenses 1998 over 1997 1997 over 1996 Yield/ Yield/ Volume Rate 4 Total Volume Rate 4 Total Increase (dollars in thousands) (decrease) in interest income: Loans1,2 $ 3,956 $ (353) $ 3,603 $ 8,253 $ (1,577) $ 6,676 Investment securities3 2,251 431 2,682 3,800 333 4,133 Federal funds sold (405) 2 (403) 135 26 161 ------------------------------------------------------------------------- Total 5,802 80 5,882 12,188 (1,218) 10,970 (decrease) in interest expense: Demand deposits (interest-bearing) 332 (181) 151 826 (271) 555 Savings deposits 125 (52) 73 1,371 (3) 1,368 Time deposits 318 (359) (41) 3,424 134 3,558 Federal funds purchased 220 (9) 211 (130) 6 (124) Repurchase agreements 65 3 68 (276) (25) (301) Long-term 967 (68) 899 (311) 11 (300) ------------------------------------------------------------------------- Total 2,027 (666) 1,361 4,904 (148) 4,756 ------------------------------------------------------------------------- Increase (decrease) in net interest income $ 3,775 $ 746 $ 4,521 $ 7,284 $ (1,070) $ 6,214 1 Nonaccrual loans are included. 2 Interest income on loans includes fees on loans of $2,958,000 in 1998, $2,058,000 in 1997, and $1,926,000 in 1996. 3 Interest income is stated on a tax equivalent basis of 1.52 in 1998, 1.52 in 1997, and 1.70 in 1996. 4 The rate/volume variance has been included in the rate variance.
Provision for Loan Losses In 1998, the Bank provided $4,200,000 for loan losses compared to $3,000,000 in 1997. Net loan charge-offs decreased $185,000 (7.0%) to $2,453,000 during 1998. Net charge-offs of consumer installment loans decreased $862,000 mainly due to the sale of the Bank's credit card portfolio in May 1998. Net charge-offs of commercial, financial and agricultural loans increased $497,000, while net charge-offs of real estate mortgage loans increased $180,000. The 1998 charge-offs represented 0.50% of average loans outstanding versus 0.59% the prior year. Nonperforming loans were 0.31% of total loans at year end versus 1.17% in 1997. The allowance for loan losses to nonperforming loans was 493% versus 123% at the end of 1997. (See balance sheet analysis "Allowance for Loan Losses" for further discussion.) The 1997 provision for loan losses of $3,000,000 was a significant increase over the 1996 provision of $777,000. Net loan charge-offs for 1997 increased to $2,638,000 from $883,000 in 1996. Consumer installment loans which include credit cards accounted for $591,000 of the increase while commercial, financial and agricultural loans accounted for $1,166,000 of the increase. Early in 1997 the bank adopted a more aggressive grading procedure for loans. This process resulted in a higher number of loans being classified and charged off. There also was an increase in bankruptcy filings which adversely affected the consumer loan and credit card portfolios. The 1997 charge-offs represented 0.59% of average loans outstanding versus 0.24% the prior year. Nonperforming loans were 1.17% of total loans at year end versus 2.06% in 1996. The allowance for loan losses to nonperforming loans was 123% versus 67% at the end of 1996. Service Charges and Fees and Other Income For 1998, service charge and fee income increased $642,000 (9.5%) to $7,387,000. Both higher account volumes and higher fee rates contributed to the increase in this category. Other income was up $2,661,000 (94.3%) to $5,482,000 from $2,821,000 in 1997. Items contributing to the increase in other income included; a gain on sale of the credit card portfolio of $897,000, gain on the sale of investments of $316,000 in 1998 compared to $18,000 in 1997, and gain on sale of loans of $497,000 in 1998 versus $260,000 in 1997. Overall, noninterest income increased $3,303,000 (34.5%) for the year to $12,869,000. For 1997 service charge and fee income was up 37.0% to $6,745,000 over 1996 results. The growth came from higher account volumes primarily due to the purchase of certain Wells deposit accounts and some selective fee increases. Other income was up 64.8% to $2,821,000 over 1996 results. Within this category commissions on the sale of annuities and mutual funds increased $708,000 or 56.4%, and gain on sale of loans increased to $260,000 versus a loss of $3,000 in 1996. Securities Transactions During 1998 the Bank realized net gains of $316,000 on the sale of securities with market values of $87,094,000. The Bank purchased $199,335,000 of securities with proceeds from the sale of securities noted above, proceeds from maturities of securities totaling $100,737,000, and cash received through deposit and borrowing growth that was not used to fund loan growth. For 1997 the Bank realized net gains of $18,000 on the sale of securities with market values of $29,033,000. The Bank purchased $173,327,000 of securities with proceeds from the sale of securities noted above, proceeds from maturities of securities totaling $49,720,000, and cash received in conjunction with the purchase of certain Wells deposits. -28- Salaries and Benefits Salary and benefit expenses increased 7.2% to $16,803,000, and accounted for $1,132,000 of the $1,760,000 increase in noninterest expenses in 1998. Approximately $219,000 of the increase in salaries and benefits was due to a full twelve months of salary expenses from the Wells branches in 1998. Incentive and commission related salary expenses increased $632,000 (72.6%) to $1,502,000 in 1998. Base salaries and benefits increased $281,000 (1.8%) in 1998. The relatively small increase in base salaries was mainly due to a 0.5% increase in average full time equivalent employees (FTE's) from 374 during 1997 to 376 during 1998, and an average annual base salary increase of 1.3% during 1998. The large increase in incentive and commission related salary expense was more than offset by revenue growth. These results are consistent with the Bank's strategy of working more efficiently with fewer employees who are compensated in part based on their division's performance. Salary and benefit expenses increased 30.7% or $3,682,000 in 1997. Base salaries increased $3,208,000 (40.5%) primarily due to the purchase of nine Wells branches and their associated staff. Other components of salaries and benefits which increased significantly included; overtime, $174,000; retirement plans, $275,000; and payroll taxes, $250,000. Management and employee incentive expense decreased $281,000. Approximately 50% of the total salary increase was directly related to the conversion and ongoing operations of the purchased branches. There was additional staffing in loan production offices and support functions plus normal salary increases which also contributed to the increased costs. Other Expenses Other expenses increased $628,000 (3.6%) to $17,889,000 in 1998. Approximately $141,000 of the increase in 1998 was due to a full twelve months of other expenses from the nine branches acquired in February of 1997. $261,000 of the increase in other expenses was due to increased equipment and data processing expenses which increased to $3,551,000 in 1998. Other expenses increased $5,765,000 (50.1%) in 1997. Of this amount $1,240,000 (21.5%) was directly related to the ongoing operations and $1,308,000 (22.7%) was for amortization of goodwill for the acquired branches. Another $326,000 (5.7%) were one time conversion costs for the nine branches. The following analysis excludes costs directly incurred by the new branches. Much of the cost was incurred to support the new branches. Occupancy and equipment costs increased $713,000 (19.5%), most of which was related to depreciation of equipment. Charges for ATM network and transactions increased $194,000 (77.0%) as a result of more terminals and increased volumes. Courier services were up $218,000 (76.0%) as the new branches are located in a large geographic area. Telecommunications increased $199,000 (30.5%). Loan origination fees waived for home equity loans increased $150,000 (220.6%) as a result of increased volume. The Bank also expensed $300,000 for declines in the value of certain bank premises which were vacated in connection with the Bank's decision to move its administrative offices and one branch office to new facilities. Provision for Taxes The effective tax rate on income was 36.5%, 38.5%, and 40.8% in 1998, 1997, and 1996, respectively. The effective tax rate was greater than the federal statutory tax rate due to state tax expense of $1,425,000, $961,000, and $1,367,000 in these years. Tax-free income of $1,860,000, $630,000, and $120,000 from investment securities in these years helped to reduce the effective tax rate. Return on Average Assets and Equity The following table sets forth certain ratios for the Company for the last three years (using average balance sheet data): 1998 1997 1996 Return on total assets 1.03% 0.75% 1.18% Return on shareholders' equity 12.80% 9.34% 13.03% Shareholders' equity to total assets 8.07% 8.04% 9.03% Common shareholders' dividend payout ratio 39.11% 50.61% 36.22% During 1998, return on assets increased to 1.03%. The increase in ROA was due to increased productivity and the Bank's progress in making loans in the new market areas of the nine branches acquired in 1997, and the Sacramento and Bakersfield offices. The Company's efficiency ratio (noninterest expense divided by net interest income plus noninterest income) decreased to 64.7% in 1998 from 71.9% in 1997. Return on assets decreased in 1997 to 0.75% from the 1.18% achieved in 1996. In 1998, return on shareholders' equity increased to 12.80% from 9.34% in 1997. The higher ROE in 1998 was due to a 49.4% increase in net income while average shareholders' equity increased only 9.0%. Return on shareholders' equity fell to 9.34% in 1997 from 13.03% in 1996. The lower ROE in 1997 resulted from average capital increasing 12.1% while net income decreased 19.7%. The shareholders' average equity to average assets ratio for 1998 increased to 8.07% from 8.04% for 1997. In 1997, the average shareholders' equity to average asset ratio decreased to 8.04% from 9.03%. The 1997 change reflected the increase in assets as a result of the Wells branch acquisition which outweighed the increase in shareholders' equity. In 1998, dividends paid to common shareholders totaled $3,430,000 compared to $2,970,000 in 1997. The resulting common shareholders' dividend payout ratio of 39.1% in 1998 compared to 50.6% in 1997. The dividend payout ratio increased to 50.6% in 1997 from 36.2% ($2,646,000) in 1996. -29- (B) Balance Sheet Analysis Loans The Bank concentrates its lending activities in four principal areas: commercial loans (including agricultural loans); consumer loans; real estate mortgage loans (residential and commercial loans and mortgage loans originated for sale); and real estate construction loans. At December 31, 1998, these four categories accounted for approximately 40%, 13%, 40%, and 7% of the Bank's loan portfolio, respectively, as compared to 37%, 20%, 36% and 7%, at December 31, 1997. The shift in the percentages was primarily due to the sale of the Bank's $14,365,000 credit card portfolio in May 1998. The interest rates charged for the loans made by the Bank vary with the degree of risk, the size and maturity of the loans, the borrower's relationship with the Bank and prevailing money market rates indicative of the Bank's cost of funds. The majority of the Bank's loans are direct loans made to individuals, farmers and local businesses. The Bank relies substantially on local promotional activity, personal contacts by bank officers, directors and employees to compete with other financial institutions. The Bank makes loans to borrowers whose applications include a sound purpose, a viable repayment source and a plan of repayment established at inception and generally backed by a secondary source of repayment. At December 31, 1998, loans totaled $532,433,000 which was an 18.6% ($83,466,000) increase over the balances at the end of 1997. The regions serviced by the nine branches acquired in 1997 and the Sacramento and Bakersfield branches accounted for $43,350,000 of the increase in loans during 1998. Loan demand continued to improve in 1998 as economic conditions and trends in interest rates were favorable for borrowers. The average loan to deposit ratio in 1998 was 67.2% as compared to 65.2% in 1997. At December 31, 1997 loans totaled $448,967,000 which was a 2.20% increase over the balances at the end of 1996. Demand for real estate construction and home equity loans continued to improve in 1997 as economic conditions remained favorable. Additions to the loan staff and improved calling programs also helped generate new customers. The average loan to deposit ratio in 1997 was 65.2% as compared to 70.8% in 1996, due primarily to the Wells branch acquisition.
Loan Portfolio Composite December 31, 1998 1997 1996 1995 1994 (dollars in thousands) Commercial, financial and agricultural $211,773 $165,813 $176,868 $152,173 $153,957 Consumer installment 72,512 87,950 75,498 64,445 58,471 Real estate mortgage 211,072 160,954 160,575 81,888 76,673 Real estate construction 37,076 34,250 26,348 20,260 18,002 ------------------------------------------------------------------------------ Total loans $532,433 $448,967 $439,289 $318,766 $307,103
Nonaccrual, Past Due and Restructured Loans During 1998, nonperforming assets decreased $4,402,000 (58.9%) to a total of $3,077,000. Nonperforming loans decreased $3,584,000 (68.3%) to $1,665,000, and other real estate owned (OREO) decreased $818,000 (36.7%) to $1,412,000 during 1998. The decrease in nonperforming loans was due in part to favorable economic conditions and two years of operation under an enhanced system which focuses on early identification of problem loans followed by prompt action to ensure performance or charge-off of the loan. The ratio of nonperforming loans to total loans at December 31, 1998 was 0.31% versus 1.17% at the end of 1997. Classifications of nonperforming loans as a percent of the total at the end of 1998 were as follows: secured by real estate, 75%; loans to farmers, 12%; commercial loans, 10%; and consumer loans, 3%. Nonperforming assets at December 31, 1997 totaled $7,479,000 which was a 28.5% decrease from year end 1996. The OREO component increased from $1,389,000 at year end 1996 to $2,230,000 at year end 1997. However, this increase was offset by a substantial decrease in nonperforming loans from $9,064,000 at year end 1996 to $5,249,000 at year end 1997. The decrease in nonperforming loans was due in part to the improved financial condition of certain borrowers and the impact of new monitoring procedures put into place at the end of 1996 in an effort to improve the timeliness of payments and collections and actively manage the level of nonperforming loans. The nonperforming loans at December 31, 1997 consisted of numerous loans including 12 loans over $100,000. The largest nonperforming loan balance to any one borrower was approximately $600,000. At December 31, 1997, the ratio of nonperforming loans to total loans was 1.17% as compared to 2.06% for year end 1996. Classifications of nonperforming loans as a percent of the total at the end of 1997 were as follows: secured by real estate, 79%; loans to farmers, 9%; commercial loans, 6%; and consumer loans, 6%. Commercial, real estate and consumer loans are reviewed on an individual basis for reclassification to nonaccrual status when any one of the following occurs: the loan becomes 90 days past due as to interest or principal, the full and timely collection of additional interest or principal becomes uncertain, the loan is classified as doubtful by internal credit review or bank regulatory agencies, a portion of the principal balance has been charged off, or the Bank takes possession of the collateral. The reclassification of loans as nonaccrual does not necessarily reflect Management's judgment as to whether they are collectible. Interest income is not accrued on loans where Management has determined that the borrowers will be unable to meet contractual principal and/or interest obligations, unless the loan is well secured and in process of collection. When a loan is placed on nonaccrual, any previously accrued but unpaid interest is reversed. Income on such loans is then recognized only to the extent that cash is received and where the future collection on principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of Management, the loans are estimated to be fully collectible as to both principal and interest. -30- Interest income on nonaccrual loans which would have been recognized during the year ended December 31, 1998, if all such loans had been current in accordance with their original terms, totaled $324,000. Interest income actually recognized on these loans in 1998 was $104,000. The Bank's policy is to place loans 90 days or more past due on nonaccrual status. In some instances when a loan is 90 days past due Management does not place it on nonaccrual status because the loan is well secured and in the process of collection. A loan is considered to be in the process of collection if, based on a probable specific event, it is expected that the loan will be repaid or brought current. Generally, this collection period would not exceed 30 days. Loans where the collateral has been repossessed are classified as OREO or, if the collateral is personal property, the loan is classified as other assets on the Company's financial statements. Management considers both the adequacy of the collateral and the other resources of the borrower in determining the steps to be taken to collect nonaccrual loans. Alternatives that are considered are foreclosure, collecting on guarantees, restructuring the loan or collection lawsuits. The following table sets forth the amount of the Bank's nonperforming assets as of the dates indicated.
December 31, 1998 1997 1996 1995 1994 (dollars in thousands) Nonaccrual loans $ 1,045 $ 4,721 $ 9,044 $ 2,213 $ 1,122 Accruing loans past due 90 days or more 620 528 20 220 24 ---------------------------------------------------------------------------- Total nonperforming loans 1,665 5,249 9,064 2,433 1,146 Other real estate owned 1,412 2,230 1,389 631 2,124 ---------------------------------------------------------------------------- Total nonperforming assets 3,077 7,479 $10,453 $ 3,064 $ 3,270 Nonincome producing investments in real estate held by Bank's real estate development subsidiary $ -- $ 856 $ 1,173 $ 1,173 $ 1,173 Nonperforming loans to total loans 0.31% 1.17% 2.06% 0.76% 0.37% Allowance for loan losses to nonper- forming loans 493% 123% 67% 229% 489% Nonperforming assets to total assets 0.34% 0.91% 1.50% 0.51% 0.55% Allowance for loan losses to nonper- forming assets 267% 86% 58% 182% 171%
Allowance for Loan Losses Activity In determining the adequacy of the allowance for loan losses, Management relies primarily on its review of the loan portfolio both to ascertain whether there are probable losses to be recorded and to assess the loan portfolio in the aggregate. Problem loans are examined on an individual basis to determine estimated probable loss. In addition, Management considers current and projected loan mix and loan volumes, historical net loan loss experience for each loan category and current and anticipated economic conditions affecting each loan category. The allowance for loan losses to total loans at December 31, 1998 was 1.54% versus 1.44% at the end of 1997. This increase was the net effect of many factors. Factors which caused the Bank to increase its reserve percentage included increases in historical net loan losses in 1998 and 1997 for commercial, financial, agriculture and real estate mortgage loans, and anticipated economic and operating conditions that are expected to adversely impact certain classes of borrowers. Offsetting these factors, which increased the reserve percentage, was the sale of the Bank's credit card portfolio in May 1998. The credit card portfolio had a reserve percentage of about 6% of outstanding credit card balances. Had the credit card portfolio not been sold, the overall loss reserve target would have been approximately 1.66% of loans at December 31, 1998. At December 31, 1997, the allowance for loan losses to total loans was 1.44% versus 1.39% at the end of 1996. The primary risk elements considered by Management with respect to installment and residential real estate loans is lack of timely payment and the value of the collateral. The primary risk elements considered by Management with respect to real estate construction loans are the financial condition of borrowers, fluctuations in real estate values in the Bank's market areas, fluctuations in interest rates, timeliness of payments, the availability of conventional financing, the demand for housing in the Bank's market areas and general economic conditions. The primary risk elements with respect to commercial loans are the financial condition of the borrower, general economic conditions in the Bank's market area, the sufficiency of collateral, the timeliness of payment and, with respect to adjustable rate loans, interest rate fluctuations. Based on the current conditions of the loan portfolio, Management believes that the $8,206,000 allowance for loan losses at December 31, 1998 is adequate to absorb probable losses inherent in the Bank's loan portfolio. No assurance can be given, however, that adverse economic conditions or other circumstances will not result in increased losses in the portfolio. -31-
The following table summarizes, for the years indicated, the activity in the allowance for loan losses: December 31, 1998 1997 1996 1995 1994 (dollars in thousands) Balance, beginning of year $ 6,459 $ 6,097 $ 5,580 $ 5,608 $ 5,973 Provision charged to operations 4,200 3,000 777 335 316 Loans charged off: Commercial, financial and agricultural (1,865) (1,289) (283) (149) (338) Consumer installment (702) (1,551) (909) (432) (71) Real estate mortgage (188) -- -- -- -- ------------------------------------------------------------------------------- Total loans charged-off (2,755) (2,840) (1,192) (581) (1,050) Recoveries: Commercial, financial and agricultural 164 85 243 98 205 Consumer installment 130 117 66 120 164 Real estate mortgage 8 -- -- -- -- ------------------------------------------------------------------------------- Total recoveries 302 202 309 218 369 ------------------------------------------------------------------------------- Net loans charged-off (2,453) (2,638) (883) (363) (681) Balance added through acquisition -- -- 623 -- -- ------------------------------------------------------------------------------- Balance, year end $ 8,206 $ 6,459 $ 6,097 $ 5,580 $ 5,608 =============================================================================== Average total loans $487,598 $448,117 $368,550 $308,473 $303,497 Ratios: Net charge-offs during period to average loans outstanding during period 0.50% 0.59% 0.24% 0.12% 0.22 % Provision for loan losses to aver- age loans outstanding 0.86% 0.67% 0.21% 0.11% 0.10 % Allowance to loans at year end 1.54% 1.44% 1.39% 1.75% 1.83 %
As part of its loan review process, Management has allocated the overall allowance based on specific identified problem loans and historical loss data. The following tables summarize the allocation of the allowance for loan losses at December 31, 1998 and 1997. December 31, 1998 (dollars in thousands) Percent of loans in each category to Amount total loans Balance at End of Period Applicable to: Commercial, financial and agricultural $3,345 39.8% Consumer installment 1,154 13.6% Real estate mortgage 3,153 39.6% Real estate construction 554 7.0% ------ ------ $8,206 100.0% December 31, 1997 (dollars in thousands) Percent of loans in each category to Amount total loans Balance at End of Period Applicable to: Commercial, financial and agricultural $2,157 36.9% Consumer installment 1,977 19.6% Real estate mortgage 2,266 35.9% Real estate construction 59 7.6% ------ ------ $6,459 100.0% -32- Investment in Real Estate Properties At December 31, 1997, property held by a subsidiary of the Bank for the purposes of development was $856,000. During 1998, the subsidiary divested all investment properties pursuant to an agreement between the Bank and the FDIC. Other Real Estate Owned The December 31, 1998 balance of Other Real Estate Owned (OREO) was $ 1,412,000 versus $2,230,000 in 1997. Properties foreclosed in 1998 and remaining in the Bank's possession at year end were valued at $432,000 net of a valuation allowance of $62,000. Properties transferred from fixed assets in 1998 and remaining in the Bank's possession at year end were valued at $575,000 net of a valuation allowance of $622,000. The Bank disposed of properties with a value of $1,680,000 in 1998. OREO properties consist of a mixture of land, single family residences and commercial buildings. OREO balances at December 31, 1996 were $1,389,000. Intangible Assets At December 31, 1998 and 1997, the Bank had intangible assets totaling $7,564,000 and $8,902,000, respectively. During 1997 the Bank recorded additions of $9,066,000 and $142,000 related to the Wells and Sutter Buttes acquisitions, respectively. Amortization of intangible assets amounting to $1,338,000 and $1,342,000 was recorded in 1998 and 1997, respectively. In 1996, the Bank recorded an intangible asset related to the Sutter Buttes acquisition in the amount of $1,070,000. Deposits Total deposits at December 31, 1998 increased $45,079,000 (6.2%) to $769,173,000 over the 1997 year end balances. All categories of deposits except CD's under $100,000 increased in 1998. Certificates of deposit with balances over $100,000 increased $16,047,000 to $64,857,000. State of California CD's, which increased to $40,000,000 as of December 31, 1998, accounted for $15,000,000 of the increase in CD's over $100,000. Deposits at the branches acquired from Wells Fargo Bank in 1997 increased $3,517,000 (2.4%) in 1998 for a total of $150,312,000 at December 31, 1998. The change in CD's balances and the use of State of California CD's is part of the Bank's overall deposit pricing strategy, and is closely monitored by the Bank. Deposits at December 31, 1997 were up $128,473,000 (21.6%) to $724,094,000 over the 1996 year end balances. Deposits at the branches acquired from Wells Fargo Bank totaled $146,795,000 at year end. These balances reflected a net runoff at these branches of 6.85% from the date of acquisition. During 1997, time certificates of deposit not related to the Wells branches decreased $18,937,000 or 8.4%. It is believed that competitive pressures from alternative products such as mutual funds and annuities contributed to this decline. Long-Term Debt In 1998, the Bank made principal payments of $5,016,000 on long-term debt obligations, and added $31,500,000 under long-term debt agreements. During 1997, the Bank retired $12,841,000 of long-term debt and did not add any long-term debt. Equity See Note U in the financial statements for a discussion of regulatory capital requirements. Management believes that the Company's capital is adequate to support anticipated growth, meet the cash dividend requirements of the Company and meet the future risk-based capital requirements of the Bank and the Company. Market Risk Management Overview. The goal for managing the assets and liabilities of the Bank is to maximize shareholder value and earnings while maintaining a high quality balance sheet without exposing the Bank to undue interest rate risk. The Board of Directors has overall responsibility for the Company's interest rate risk management policies. The Bank has an Asset and Liability Management Committee (ALCO) which establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates. Asset/Liability Management. Activities involved in asset/liability management include but are not limited to lending, accepting and placing deposits, investing in securities and issuing debt. Interest rate risk is the primary market risk associated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities. To mitigate interest rate risk, the structure of the balance sheet is managed with the goal that movements of interest rates on assets and liabilities are correlated and contribute to earnings even in periods of volatile interest rates. The asset/liability management policy sets limits on the acceptable amount of variance in net interest margin and market value of equity under changing interest environments. The Bank uses simulation models to forecast earnings, net interest margin and market value of equity. Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Using computer modeling techniques the Bank is able to estimate the potential impact of changing interest rates on earnings. A balance sheet forecast is prepared using inputs of actual loan, securities and interest bearing liability (i.e. deposits/borrowings) positions as the beginning base. The forecast balance sheet is processed against four interest rate scenarios which are provided by an independent economic forecasting company. The scenarios include a most likely rate forecast, a rising rate forecast, a flat rate forecast and a falling rate forecast. The Bank's 1999 earnings forecast is determined by utilizing a forecast balance sheet projected from year end 1998 balances. (The Bank does not hold any assets in trading accounts.) -33- The following assumptions were used in the modeling activity: Total asset growth of 4.1% based on ending balances Loan growth of 14.3% based on average balances Investment decrease of 3.1% based on ending balances Deposit growth of 3.1% based on average balances Balance sheet target balances were the same for all rate scenarios Ending prime rate of interest for most likely rates 7.75%, for rising rates 10.50%, for flat rates 7.75% and for falling rates 6.0% The following table summarizes the effect on earnings before taxes of changing interest rates as measured against a flat rate (no change) scenario. Interest Rate Risk Simulation of Income Before Income Taxes as of December 31, 1998 Estimated Impact on 1998 Income Before Income Taxes (in thousands) Variation from flat rate scenario Most likely rates $ 72 Rising rates $ 141 Falling rates $ (55) 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. The Bank also uses a second simulation model which rate shocks the balance sheet with an immediate parallel shift in interest rates of +/-100 basis points (bp). This simulation model provides estimates of the future market value of equity (MVE) and net interest margins (NIM). MVE measures the impact on equity due to the changes in the market values of assets and liabilities as a result of a change in interest rates. NIM is described above under the heading "Net Interest Income/Net Interest Margin". The Bank measures the volatility of these benchmarks using a twelve month time horizon. Using the December 31, 1998 balance sheet as the base for the simulation, the following table summarizes the effect on NIM and net interest income of a +/-100 basis point change in interest rates: Interest Rate Risk Simulation of NIM as of December 31, 1998 % Change Change in NIM in Net Interest from Current Margin 12 Mo. Horizon 12 Month Horizon (in thousands) -100bp 0 .69 % $275 0bp 0 .10 % $ 41 +100bp 0 .14 % $ 54 These results indicate that the balance sheet is asset sensitive since earnings increase when interest rates rise. The magnitude of the NIM change is within the Bank's policy guidelines. The asset liability management policy limits aggregate market risk, as measured in this fashion, to an acceptable level within the context of risk-return trade-offs. Gap analysis provides another measure of interest rate risk. The Bank does not actively use gap analysis in managing interest rate risk. It is presented here for comparative purposes. Interest rate sensitivity is a function of the repricing characteristics of the Bank's 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 Bank's current portfolio that are subject to repricing at various time horizons. The differences are known as interest sensitivity gaps. As reflected in the following repricing table at December 31, 1998, the Bank is liability sensitive in the short term (less than 6 months) and slightly asset sensitive within one year. This gap position would indicate that as interest rates rise, the Bank's earnings should be adversely impacted and conversely, as interest rates fall, earnings should be favorably impacted. Because the Bank may reprice its transaction deposits at will, transaction deposits may or may not reprice immediately with changes in interest rates. In recent years of moderate interest rate changes the Bank's earnings have reacted as though the gap position is slightly asset sensitive. -34-
Interest Rate Sensitivity - December 31, 1998 Repricing within: 3 3 - 6 6 - 12 1 - 5 Over months months months years 5 years (dollars in thousands) Interest-earning assets: Securities $ 51,568 $ 10,663 $ 17,281 $ 79,668 $ 120,495 Loans 241,777 29,153 39,999 91,776 129,728 ------------------------------------------------------------------------------ Total interest-earning assets $ 293,345 $ 39,816 $ 57,280 $ 171,444 $ 250,223 Interest-bearing liabilities Transaction deposits $ 370,508 $ --- $ --- $ --- $ --- Time 130,976 57,996 47,610 13,097 146 Short-term borrowings 14,000 --- --- --- --- Long-term borrowings 3,406 6 15 12,717 21,780 ------------------------------------------------------------------------------ Total interest-bearing liabilities $ 518,891 $ 58,002 $ 47,625 $ 25,814 $ 21,926 ------------------------------------------------------------------------------ Interest sensitivity gap $(225,546) $ (18,186) $ 9,656 $ 145,631 $ 228,297 Cumulative sensitivity gap $(225,546) $(243,731) $(234,075) $ (88,445) $ 139,852 As a percentage of earning assets: Interest sensitivity gap (27.77%) (2.24%) 1.19% 17.93% 28.11% Cumulative sensitivity gap (27.77%) (30.01%) (28.82%) (10.89%) 17.22%
Liquidity Liquidity refers to the Bank's ability to provide funds at an acceptable cost to meet loan demand and deposit withdrawals, as well as contingency plans to meet unanticipated funding needs or loss of funding sources. These objectives can be met from either the asset or liability side of the balance sheet. Asset liquidity sources consist of the repayments and maturities of loans, selling of loans, short-term money market investments, maturities of securities and sales of securities from the available-for-sale portfolio. With the transfer of investments categorized as held-to-maturity to the available-for-sale classification on October 1, 1998, the bank has increased the amount of securities that it can sell to meet funding requirements. These activities are generally summarized as investing activities in the Consolidated Statement of Cash Flows. Net cash used by investing activities totaled approximately $95,420,000 in 1998, which means that assets were not generally used for liquidity purposes. Increased loan balances were responsible for the major use of funds in this category. Liquidity is generated from liabilities through deposit growth and short-term borrowings. These activities are included under financing activities in the Consolidated Statement of Cash Flows. In 1998, funds totaling $67,081,000 were provided by financing activities. Internal deposit growth and additional long-term borrowings provided funds amounting to $45,079,000 and $31,500,000, respectively, although the funds generated through long-term borrowings were not used for liquidity purposes. The Bank also had available correspondent banking lines of credit totaling $51,000,000 at year end. While these sources are expected to continue to provide significant amounts of funds in the future, their mix, as well as the possible use of other sources, will depend on future economic and market conditions. Liquidity is also provided or used through the results of operating activities. In 1998, operating activities provided cash of $15,346,000. Since the adoption of SFAS 115 on January 1, 1994 and prior to 1997, Management targeted the available-for-sale portfolio (AFS) to be maintained at 35-40% of the total securities holdings. During 1997, the Board of Directors approved Management's recommendation that up to 100% of the future securities purchases be placed in the available-for-sale category. When SFAS 115 was implemented, it was believed that the unrealized losses which might be incurred in the AFS portfolio would be used in the determination of capital for regulatory reporting purposes. Subsequently, the FDIC issued a directive that eliminates using the unrealized losses in determining regulatory capital. Consequently, classifying securities in the AFS portfolio provides management more flexibility in managing the investment portfolio as securities may be sold as the Bank's needs dictate. In connection with the adoption of SFAS 133 on October 1, 1998, the Bank reclassified its entire portfolio of held-to-maturity investment securities, with a carrying value of $78,901,000, to the available-for-sale classification. The AFS securities plus cash in excess of reserve requirements totaled $329,659,000 at December 31, 1998, which was 36.4% of total assets at that time. This was up from $223,753,000 and 27.1% at the end of 1997. The overall liquidity of the Bank is enhanced by the sizable core deposits which provide a relatively stable funding base. The maturity distribution of certificates of deposit in denominations of $100,000 or more is set forth in the following table. These deposits are generally more rate sensitive than other deposits and, therefore, are more likely to be withdrawn to obtain higher yields elsewhere if available. The Bank participates in a program wherein the State of California places time deposits with the Bank at the Bank's option. At December 31, 1998 and 1997, the Bank had $40,000,000 and $25,000,000 respectively, of these State deposits. -35- Certificates of Deposit in Denominations of $100,000 or More Amounts as of December 31, 1998 1997 1996 (in thousands) Time remaining until maturity: Less than 3 months $47,957 $31,029 $19,443 3 months to 6 months 7,208 8,312 3,396 6 months to 12 months 3,812 7,572 7,480 More than 12 months 5,880 1,994 2,570 ------------------------------------------ Total $64,857 $48,907 $32,889
Loan demand also affects the Bank's liquidity position. The following table present the maturities of loans at December 31, 1998. Loan Maturities - December 31, 1998 After One But Within Within After 5 One Year 5 Years Years Total (in thousands) Loans with predetermined interest rates: Commercial, financial and agricultural $ 21,838 $ 32,357 $ 15,926 $ 70,121 Consumer installment 6,227 14,082 28,470 48,779 Real estate mortgage 4,581 25,476 82,073 112,130 Real estate construction 7,959 119 12 8,090 ------------------------------------------------------------ $ 40,605 $ 72,034 $126,481 $239,120 Loans with floating interest rates: Commercial, financial and agricultural $ 86,406 $ 25,788 $ 29,458 $141,652 Consumer installment 1,409 2,744 19,580 23,733 Real estate mortgage 10,705 21,148 67,089 98,942 Real estate construction 28,986 --- --- 28,986 ------------------------------------------------------------ $127,506 $ 49,680 $116,127 $293,313 ------------------------------------------------------------ Total loans $168,111 $121,714 $242,608 $532,433
The maturity distribution and yields of the available-for-sale investment portfolio is presented in the following tables. At December 31, 1998, the Bank had no held-to-maturity securities.
Securities Maturities and Weighted Average Tax Equivalent Yields - December 31, 1998 After One Year After Five Years Within but Through but Through After Ten One Year Five Years Ten Years Years Total Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield (dollars in thousands) Securities Available-for-Sale U.S. Treasury securities and obligations of U.S. government corporations and agencies $21,037 5.81% $5,122 6.28% $13,624 6.22% $ -- $39,783 6.01% Obligations of states and political subdivisions 572 7.53% 684 7.34% 606 6.54% 50,164 7.66% 52,026 7.65% Mortgage-backed securities -- 1,908 6.07% 38,224 5.64% 126,514 6.31% 166,646 6.15% Corporate bonds -- -- -- 16,281 6.30% 16,281 6.30% Other securities -- -- -- 4,940 4,940 -------------------------------------------------------------------------------------- Total securities available-for-sale $21,609 5.86% $7,714 6.32% $52,454 5.80% $197,899 6.50% $279,676 6.42% -------------------------------------------------------------------------------------- Total all securities $21,609 5.86% $7,714 6.32% $52,454 5.80% $197,899 6.50% $279,676 6.42%
The principal cash requirements of the Company are dividends on Common Stock when declared. The Company is dependent upon the payment of cash dividends by the Bank to service its commitments. The Company expects that the cash dividends paid by the Bank to the Company will be sufficient to meet this payment schedule. Off-Balance Sheet Items The Bank has certain ongoing commitments under operating and capital leases. (See Note H of the financial statements for the terms.) These commitments do not significantly impact operating results. As of December 31, 1998 commitments to extend credit were the Bank's only financial instruments with off-balance sheet risk. The Bank has not entered into any contracts for financial derivative instruments such as futures, swaps, options, etc. Loan commitments decreased to $134,937,000 from $145,805,000 at December 31, 1997. Much of the decrease was a result of the sale of the Bank's credit card portfolio. The commitments represent 25.3% of the total loans outstanding at year end 1998 versus 32.5% a year ago. -36- Disclosure of Fair Value The Financial Accounting Standards Board (FASB), SFAS 107, Disclosures about Fair Value of Financial Statements, requires the disclosure of fair value of most financial instruments, whether recognized or not recognized in the financial statements. The intent of presenting the fair values of financial instruments is to depict the market's assessment of the present value of net future cash flows discounted to reflect both current interest rates and the market's assessment of the risk that the cash flows will not occur. In determining fair values, the Bank used the carrying amount for cash, short-term investments, accrued interest receivable, short-term borrowings and accrued interest payable as all of these instruments are short term in nature. Securities are reflected at quoted market values. Loans and deposits have a long term time horizon which required more complex calculations for fair value determination. Loans are grouped into homogeneous categories and broken down between fixed and variable rate instruments. Loans with a variable rate, which reprice immediately, are valued at carrying value. The fair value of fixed rate instruments is estimated by discounting the future cash flows using current rates. Credit risk and repricing risk factors are included in the current rates. Fair value for nonaccrual loans is reported at carrying value and is included in the net loan total. Since the allowance for loan losses exceeds any potential adjustment for credit problems, no further valuation adjustment has been made. Demand deposits, savings and certain money market accounts are short term in nature so the carrying value equals the fair value. For deposits that extend over a period in excess of four months, the fair value is estimated by discounting the future cash payments using the rates currently offered for deposits of similar remaining maturities. At 1998 year end, the fair values calculated on the Bank's assets are 0.58% above the carrying values versus 0.26% above the carrying values at year end 1997. The change in the calculated fair value percentage relates to the securities and loan categories and is the result of changes in interest rates in 1998. (See Note R of the financial statements) Year 2000 Project The Company utilizes software and related information technologies that will be affected by the date change in the year 2000. Additionally, the Company relies on certain noninformation technology systems such as communications and building operations systems which have embedded microprocessors that could also be affected by the date change. The failure of these noninformation technology systems could interrupt or shutdown business operations for some period of time. Based on ongoing assessments and testing, the Company has determined that it will be required to modify or replace portions of its software so that its computer systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with modifications to existing software and conversions to new software, the adverse effects of the Year 2000 issue can be mitigated. However, if such modifications and conversions are not made, or are not completed in a timely manner, the Year 2000 issue could have a material impact on the operations and financial condition of the Company and could lead to enforcement actions by regulatory agencies. The Company is committed to attaining Year 2000 compliance, ensuring that its information systems accurately process dates and times, including calculating, comparing and sequencing data from, into and between the 20th and 21st centuries. Non-information technology systems that may use embedded technologies are included in the process. The Year 2000 Project Plan underway at the Company covers five phases; awareness and planning, assessment, renovation, validation/testing and implementation. Within this project, the Company has focused on the identification and prioritization of in-house systems, reliance on vendor supplied systems and software, the exchange/transmission of data with external parties, corporate borrower compliance efforts and ongoing customer awareness/communication. In addition, the Company is addressing contingency planning at the system, department and bank levels, with focus on mission critical systems and Company functions. The awareness and planning, and assessment phases are complete and the Company is completing tasks concurrently within the renovation, validation/testing and implementation phases. The target date to complete all testing and implementations is June 30, 1999. For all phases, the Company budgeted $175,000 for programming changes and testing of internally developed systems and software licensed from third parties. Most of the $175,000 budgeted will be incurred and expensed in 1999. The estimated costs of and time frames related to these projects are based on estimates of the Company's management and there can be no assurance that actual costs will not differ materially from the current expectations or that the proposed time frames can be maintained. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer code, the ability to formulate and implement contingency plans, if required, and similar uncertainties. The Company relies on various third party systems or services to conduct its business, including regional and national telecommunications and data processing services providers. The failure of any of these entities to satisfactorily address the year 2000 issue could have a material adverse affect on the Company's operations and financial condition. The Company is presently monitoring the progress of these and other entities' year 2000 compliance. -37- EX-23.1 2 EXHIBIT 23.1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference of our report dated January 22, 1999, included in the Form 10-K, into the Corporation's previously filed Form S-8 Registration Statements No. 33-88704 and No. 33-62063. /s/ Arthur Andersen LLP San Francisco, California March 11, 1999 EX-27 3 FINANCIAL DATA SCHEDULE
9 1,000 YEAR DEC-31-1998 DEC-31-1998 50,483 0 0 0 279,676 0 0 532,433 8,206 904,599 769,173 14,000 11,473 37,924 0 0 48,838 23,191 904,599 48,506 16,482 150 65,138 22,865 25,296 39,842 4,200 316 34,692 13,819 13,819 0 0 8,770 1.25 1.21 8.56 1,045 620 0 0 6,459 2,755 302 8,206 8,206 0 0
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