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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM to :
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Commission File Number 0-26584
BANNER CORPORATION
(Exact name of registrant as specified in its charter)
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Washington 91-1691604
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification Number)
10 South First Avenue, Walla Walla, Washington 99362
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code; (509) 527-3636
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to section 12(g) of the Act:
Common Stock $.01 par value per share
(Title of class)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. X
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES X NO
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The aggregate market value of the voting stock held by nonaffiliates of the
registrant based on the closing sales price of the registrant's
common stock quoted on the Nasdaq Stock Market
on June 28, 2002, was:
Common Stock - $288,880,441
The number of shares outstanding of the registrant's classes
of common stock as of February 28, 2003:
Common Stock, $.01 par value - 11,338,510 shares
Documents Incorporated by Reference
Portions of Proxy Statement for Annual Meeting of Shareholders to be held
April 24, 2003 are incorporated by reference into Part III.
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BANNER CORPORATION AND SUBSIDIARIES
Table of Contents
PART I Page #
Item 1. Business....................................................... 3
General...................................................... 3
Lending Activities........................................... 3
Asset Quality................................................ 7
Investment Activities........................................ 7
Deposit Activities and Other Sources of Funds................ 8
Personnel.................................................... 9
Taxation..................................................... 9
Environmental Regulation..................................... 10
Competition.................................................. 10
Regulation................................................... 11
Management Personnel......................................... 16
Available Information........................................ 17
Item 2. Properties..................................................... 17
Item 3. Legal Proceedings.............................................. 17
Item 4. Submission of Matters to a Vote of Security Holders............ 17
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.......................................... 18
Item 6. Selected Financial Data........................................ 19
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 21
Comparison of Results of Operations
Years ended December 31, 2002 vs. 2001................... 35
Years ended December 31, 2001 vs. 2000................... 39
Market Risk and Asset/Liability Management................. 45
Liquidity and Capital Resources.......................... 50
Capital Requirements..................................... 51
Effect of Inflation and Changing Prices.................. 51
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..... 51
Item 8. Financial Statements and Supplementary Data.................... 51
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..................................... 51
PART III
Item 10. Directors and Executive Officers of the Registrant............ 52
Item 11. Executive Compensation........................................ 52
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................. 52
Item 13. Certain Relationships and Related Transactions................ 52
Item 14. Controls and Procedures....................................... 53
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K................................................. 53
Signatures.................................................... 54
Certifications................................................ 55
PART 1
Item 1 - Business General
Banner Corporation (the Company or BANR), a Washington corporation, is
primarily engaged in the business of planning, directing and coordinating the
business activities of its wholly owned subsidiary, Banner Bank (BB or the
Bank). Prior to a consolidation of banking subsidiaries and a corresponding
name change which occurred on October 30, 2000, the Company's subsidiaries
included First Savings Bank of Washington (FSBW), Inland Empire Bank (IEB) and
Towne Bank. From October 30, 2000 until September 1, 2001, the Company's
subsidiaries were Banner Bank and Banner Bank of Oregon (BBO) (formerly IEB).
On September 1, 2001, BBO merged with BB. On January 1, 2002, the Company
completed the acquisition of Oregon Business Bank (OBB), which was also merged
with BB on that date. Banner Bank operates as a Washington-chartered
commercial bank the deposits of which are insured by the Federal Deposit
Insurance Corporation (FDIC) under both the Bank Insurance Fund (BIF) and the
Savings Association Insurance Fund (SAIF). The Bank conducts business from
its main office in Walla Walla, Washington, and, as of January 1, 2003, its 41
branch offices and seven loan production offices located in 19 counties in
Washington, Idaho and Oregon. The Company had total assets of $2.263 billion
at December 31, 2002.
The operating results of the Company depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets, consisting of loans and investment securities, and interest expense on
interest-bearing liabilities, composed primarily of savings deposits and
Federal Home Loan Bank (FHLB) advances. BANR's net income is significantly
affected by provisions for loan losses and the level of its other income,
including deposit service charges, loan origination and servicing fees, and
gains and losses on the sale of loans and securities, as well as its
non-interest operating expenses and income tax provisions. Net income for the
year ended December 31, 2002 was $9.3 million, or $0.82 per share. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for more detailed information about the Company's financial
performance.
Banner Bank is a regional bank which offers a wide variety of commercial
banking services and financial products to both businesses and individuals in
its primary market areas. The Bank's primary business is that of a
traditional banking institution, accepting deposits and originating loans in
locations surrounding its offices in portions of Washington, Oregon and Idaho.
The Bank is also an active participant in the secondary market, engaging in
mortgage banking operation largely through the origination and sale of
residential loans. Lending activities include commercial business and
commercial real estate loans, construction and land development loans, one- to
four-family residential loans and consumer loans. A portion of the Bank's
construction and mortgage lending activities are conducted through its
subsidiary, Community Financial Corporation (CFC), which is located in the
Lake Oswego area of Portland, Oregon. In addition to loans, the Bank
maintains a significant portion of its assets in marketable securities. The
securities portfolio is weighted toward mortgage-backed securities secured by
one- to four-family residential properties. This portfolio also includes a
significant amount of U.S. Government and agency (including
government-sponsored entities) securities, as well as tax-exempt municipal
securities primarily issued by entities located in the State of Washington.
The Company and the Bank are subject to regulation by the Federal Reserve
Board (FRB), the FDIC, and the State of Washington Department of Financial
Institutions, Division of Banks (Division).
Lending Activities
General: All of the Company's lending activities are conducted through the
Bank and its subsidiaries. The Bank offers a wide range of loan products to
meet the demands of its customers. The Bank originates loans for its own loan
portfolio and for sale in the secondary market. Management's strategy has been
to maintain a significant percentage of assets in the loan portfolio with more
frequent interest rate repricing terms or shorter maturities than traditional
long-term fixed-rate mortgage loans. As part of this effort, the Bank has
developed a variety of floating or adjustable interest rate products that
correlate more closely with the Bank's cost of funds. However, in response to
customer demand, the Bank continues to originate fixed-rate loans, including
fixed interest rate mortgage loans with terms of up to 30 years. The relative
amount of fixed-rate loans and adjustable-rate loans that can be originated at
any time is largely determined by the demand for each in a competitive
environment.
Lending activities historically have been primarily directed toward the
origination of real estate and commercial loans. Real estate lending
activities have been significantly focused on residential construction and
first mortgages on owner occupied, one- to four-family residential properties.
To an increasing extent in recent years lending activities have also included
the origination of multifamily and commercial real estate loans. Commercial
lending has been directed toward meeting the credit and related deposit needs
of various small- to medium-sized business and agri-business borrowers
operating in the Bank's primary market areas. During the past year the Bank
has significantly added to its resources engaged in commercial lending,
including senior credit administration personnel and experienced officers
focused on middle market corporate lending opportunities. The Bank has also
recently increased its emphasis on consumer lending. While continuing its
commitment to construction and residential lending, management expects
commercial, including commercial real estate, and consumer lending to become
increasingly important activities for the Bank.
At December 31, 2002, the Bank's net loan portfolio totaled $1.547 billion.
For additional information concerning the Bank's loan portfolio, see Item 7,
"Management's Discussion and Analysis of Financial Condition-Comparison of
Financial Condition at December 31, 2002 and 2001-Loans/Lending." See also
Table 5 contained therein, which sets forth the composition of the Company's
loan portfolio, and Tables 6 and 6(a), which contain information regarding the
loans maturing in the Company's portfolio.
One- to Four-Family Residential Real Estate Lending: The Bank originates
loans secured by first mortgages on one- to four-family residences and loans
for the construction of one- to four-family residences in the communities
where it has full service branches. In addition, the Bank operates loan
production offices in Bellevue, Puyallup, Kennewick and Oak Harbor,
Washington. The Bank's mortgage lending subsidiary, CFC, provides
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residential and construction lending in the Portland, Oregon area. At
December 31, 2002, $355.5 million, or 22.6% of the Company's loan portfolio,
consisted of permanent loans on one- to four-family residences.
The Bank and CFC offer fixed- and adjustable-rate mortgages (ARMs) at rates
and terms competitive with market conditions. Most ARM products offered
adjust annually after an initial period ranging from one to five years,
subject to a limitation on the annual increase of 1.0% to 2.0% and an overall
limitation of 5.0% to 6.0%. Generally, these ARM products utilize the weekly
average yield on U.S. Treasury securities adjusted to a constant maturity of
one year plus a margin of 2.75% to 3.25%. ARM loans held in the Bank's
portfolio do not permit negative amortization of principal and carry no
prepayment restrictions. The retention of ARM loans in the Bank's loan
portfolio can help reduce the Company's exposure to changes in interest rates.
However, borrower demand for ARM loans versus fixed-rate mortgage loans is a
function of the level of interest rates, the expectations of changes in the
level of interest rates and the difference between the initial interest rates
and fees charged for each type of loan. In recent years, borrower demand for
ARM loans has been limited and the Bank has chosen not to aggressively pursue
ARM loans by offering minimally profitable deeply discounted teaser rates. As
a result, ARM loans have represented only a small portion of loans originated
during this period.
The Bank's residential loans are generally underwritten and documented in
accordance with the guidelines established by the Federal Home Loan Mortgage
Corporation (Freddie Mac or FHLMC) and Federal National Mortgage Corporation
(Fannie Mae or FNMA). Government insured loans are generally underwritten and
documented in accordance with the guidelines established by the Department of
Housing and Urban Development (HUD) and the Veterans Administration (VA). In
the loan approval process, the Bank assesses the borrower's ability to repay
the loan, the adequacy of the proposed security, the employment stability of
the borrower and the credit worthiness of the borrower. Generally, the Bank
lends up to 95% of the lesser of the appraised value of the property or
purchase price of the property on conventional loans, although higher
loan-to-value ratios are available on certain government insured programs.
The Bank usually requires private mortgage insurance on residential loans with
a loan-to-value ratio at origination exceeding 80%.
The Bank and CFC sell residential loans on either a servicing-retained or
servicing-released basis. The decision to hold or sell loans is based on
asset/liability management goals and policies and market conditions. During
the past three years, the Bank has sold a significant portion of its
conventional residential mortgage originations and nearly all of its
government insured loans into the secondary market.
Construction and Land Lending: The Bank invests a significant portion of its
loan portfolio in residential construction loans to professional home
builders. To a lesser extent, the Bank also originates land loans and
construction loans for commercial and multifamily real estate. At December
31, 2002, construction and land loans totaled $339.5 million (including $54.9
million of land or land development loans and $41.5 million of commercial and
multifamily real estate construction loans), or 21.6% of total loans of the
Company. Residential construction lending is a primary focus of the Bank's
subsidiary, CFC, and the Company's largest concentration of construction and
development loans is in the Portland/Vancouver market area. The Bank also has
a significant amount of construction loans for properties in the Puget Sound
region and in the Tri-Cities market in Washington State.
Construction and land lending afford the Bank the opportunity to achieve
higher interest rates and fees with shorter terms to maturity than does
single-family permanent mortgage lending. Construction and land lending,
however, are generally considered to involve a higher degree of risk than
single-family permanent mortgage lending because of the inherent difficulty in
estimating both a property's value at completion of the project and the
estimated cost of the project. If the estimate of construction cost proves to
be inaccurate, the Bank may be required to advance funds beyond the amount
originally committed to permit completion of the project. If the estimate of
value upon completion proves to be inaccurate, the Bank may be confronted at,
or prior to, the maturity of the loan with a project the value of which is
insufficient to assure full repayment. Disagreements between borrowers and
builders and the failure of builders to pay subcontractors may also jeopardize
projects. Loans to builders to construct homes for which no purchaser has
been identified carry additional risk because the payoff for the loan is
dependent on the builder's ability to sell the property before the
construction loan is due. The Bank addresses these risks by adhering to
strict underwriting policies, disbursement procedures and monitoring
practices.
Construction loans made by the Bank include those with a sale contract or
permanent loan in place for the finished homes and those for which purchasers
for the finished homes may be identified either during or following the
construction period. The Bank monitors the number of unsold homes in its
construction loan portfolio and generally maintains the portfolio so that
approximately 25% of its construction loans are secured by homes with a sale
contract in place. The maximum number of speculative loans approved for each
builder is based on a combination of factors, including the financial capacity
of the builder, the market demand for the finished product and the ratio of
sold to unsold inventory the builder maintains. The Bank has chosen to
diversify the risk associated with speculative construction lending by doing
business with a large number of smaller builders spread over a relatively
large geographic area.
Loans for the construction of one- to four-family residences are generally
made for a term of twelve months. The Bank's loan policies include maximum
loan-to-value ratios of up to 80% for speculative loans. Individual
speculative loan requests are supported by an independent appraisal of the
property, a set of plans, a cost breakdown and a completed specifications
form. All speculative construction loans must be approved by senior loan
officers.
The Bank regularly monitors the construction loan portfolio and the economic
conditions and housing inventory in each of its markets and will decrease
construction lending if it perceives there are unfavorable market conditions.
The Bank believes that the internal monitoring systems it has in place
mitigate many of the risks inherent in its construction lending.
To a lesser extent, the Bank makes land loans to developers, builders and
individuals to finance the acquisition and/or development of improved lots or
unimproved land. In making land loans, the Bank follows underwriting policies
and disbursement and monitoring procedures similar to those for
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construction loans. The initial term on land loans is typically one to three
years with interest only payments, payable monthly, and provisions for
principal reduction as lots are sold and released.
Commercial and Multifamily Real Estate Lending: The Bank also originates
loans secured by multifamily and commercial real estate. At December 31,
2002, the Company's loan portfolio included $72.3 million in multifamily and
$379.1 million in commercial real estate loans. Multifamily and commercial
real estate lending affords the Bank an opportunity to receive interest at
rates higher than those generally available from one- to four-family
residential lending. However, loans secured by such properties are generally
greater in amount, more difficult to evaluate and monitor and, therefore,
riskier than one- to four-family residential mortgage loans. Because payments
on loans secured by multifamily and commercial properties are often dependent
on the successful operation and management of the properties, repayment of
such loans may be affected by adverse conditions in the real estate market or
the economy. In all multifamily and commercial real estate lending, the Bank
considers the location, marketability and overall attractiveness of the
properties. The Bank's current underwriting guidelines for commercial real
estate loans require an appraisal from a qualified independent appraiser and
an economic analysis of each property with regard to the annual revenue and
expenses, debt service coverage and fair value to determine the maximum loan
amount. In the approval process the Bank assesses the borrowers' willingness
and ability to repay the loan and the adequacy of the collateral in relation
to the loan amount.
Multifamily and commercial real estate loans originated by the Bank are both
fixed- and adjustable-rate loans generally with intermediate terms of five to
ten years. More recently originated multifamily and commercial loans are
linked to various U.S. Treasury indices or certain prime rates. Rates on these
adjustable-rate loans generally adjust annually after an initial period
ranging from one to ten years. Rate adjustments for some of the more seasoned
adjustable-rate loans in the portfolio predominantly reflect changes in the
FHLB National Monthly Median Cost of Funds index. The Bank's commercial real
estate portfolio consists of loans on a variety of property types with no
large concentrations by property type or location. At December 31, 2002,
multifamily and commercial real estate loans comprised 28.7% of the Company's
total loans.
Commercial Lending: The Bank is active in small- to medium-sized business
lending, including origination of loans guaranteed by the Small Business
Administration (SBA), and has engaged to a lesser extent in agricultural
lending primarily by providing crop production loans. The Bank sells most of
its SBA guaranteed loans into the secondary market on a servicing-retained
basis. Bank officers have devoted a great deal of effort to developing
customer relationships and the ability to serve these types of borrowers.
Management believes that many large banks have neglected these lending
markets, contributing to the Bank's success. Also during the past year, the
Bank has added experienced officers and staff focused on middle market
corporate lending opportunities for borrowers with credit needs generally in
the $3 million to $15 million range. Management intends to leverage the past
success of these officers with local decision making ability to continue to
expand this market niche. In addition to providing earning assets, it is
anticipated that this type of lending will increase the Bank's deposit base.
Expanding commercial lending and related commercial banking services is
currently an area of significant effort at the Bank and staffing has been
increased in the areas of credit administration, business development, and
loan and deposit operations.
Commercial loans may entail greater risk than residential mortgage loans.
Commercial loans may be unsecured or secured by special purpose or rapidly
depreciating assets, such as equipment, inventory and receivables, which may
not provide an adequate source of repayment on defaulted loans. In addition,
commercial loans are dependent on the borrower's continuing financial strength
and management ability, as well as market conditions for various products,
services and commodities. For these reasons, commercial loans generally
provide higher yields than residential loans but also require more
administrative and management attention. Loan terms, including the fixed or
adjustable interest rate, the loan maturity and the collateral considerations,
vary significantly and are negotiated on an individual loan basis.
The Bank underwrites its commercial business loans on the basis of the
borrower's cash flow and ability to service the debt from earnings rather than
on the basis of the underlying collateral value. The Bank seeks to structure
these loans so that they have more than one source of repayment. The borrower
is required to provide the Bank with sufficient information to allow the Bank
to make its lending determination. In most instances, this information
consists of at least three years of financial statements, tax returns, a
statement of projected cash flows, current financial information on any
guarantor and any additional information about the collateral. Closely held
business borrowers typically require personal guarantees by the principals.
The Bank's commercial business loans may be structured as term loans or as
lines of credit. Commercial business term loans are generally made to finance
the purchase of fixed assets and have maturities of five years or less.
Commercial business lines of credit are typically made for the purpose of
providing working capital and are usually approved with a term of one year.
Adjustable- or floating-rate loans are generally tied to various prime rate
and LIBOR indices. At December 31, 2002, commercial loans totaled $285.2
million, or 18.1% of the Company's total loans.
Agricultural Lending: Agriculture is a major industry in many eastern
Washington and Oregon locations. While agricultural loans are not a large
part of the portfolio, the Bank intends to continue to make agricultural loans
to borrowers with a strong capital base, sufficient management depth, proven
ability to operate through agricultural cycles, reliable cash flows and
adequate financial reporting. Payments on agricultural loans depend, to a
large degree, on the results of operation of the related farm entity. The
repayment is also subject to other economic and weather conditions as well as
market prices for agricultural products, which can be highly volatile at
times. At December 31, 2002, agricultural loans, including collateral secured
loans to purchase farm land and equipment, totaled $102.6 million, or 6.5% of
the loan portfolio.
Agricultural operating loans generally are made as a percentage of the
borrower's anticipated income to support budgeted operating expenses. These
loans generally are secured by a blanket lien on all crops, livestock,
equipment, accounts and products and proceeds thereof. In the case of crops,
consideration is given to projected yields and prices from each commodity.
The interest rate is normally fully floating based on the prime rate as
published in The Wall Street Journal, plus a negotiated margin. Because such
loans are made to finance a farm or ranch's annual operations, they are
written on a one-year review and renewable basis. The renewal is dependent
upon the prior year's performance and the forthcoming year's projections as
well as the overall financial strength of the borrower. The Bank carefully
monitors these loans and related variance reports on income
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and expenses compared to budget estimates. To meet the seasonal operating
needs of a farm, borrowers may qualify for single payment notes, revolving
lines of credit and/or non-revolving lines of credit.
In underwriting agricultural operating loans, the Bank considers the cash flow
of the borrower based upon the expected operating results as well as the value
of collateral used to secure the loans. Collateral generally consists of
cattle or cash crops produced by the farm, such as grains, fruit, grass seed,
peas, sugar beets, mint, onions, potatoes, corn and alfalfa. In addition to
considering cash flow and obtaining a blanket security interest in the farm's
cash crop, the Bank may also collateralize an operating loan with the farm's
operating equipment, breeding stock, real estate, and federal agricultural
program payments to the borrower.
The Bank also originates loans to finance the purchase of farm equipment.
Loans to purchase farm equipment are made for terms of up to seven years. The
Bank also originates agricultural real estate loans secured primarily by first
liens on farmland and improvements thereon located in the Bank's market area,
and generally only made to service the needs of the Bank's existing customers.
Loans are written in amounts up to 50% to 75% of the tax assessed or appraised
value of the property at terms ranging from five to 20 years. Such loans have
interest rates that generally adjust at least every five years based typically
upon a Treasury Index plus a negotiated margin. Fixed-rate loans are granted
on terms generally not to exceed five years with rates established at
inception based on margins set above the current five-year Treasury Note or
another generally accepted index. In originating agricultural real estate
loans, the Bank considers the debt service coverage of the borrower's cash
flow, the appraised value of the underlying property, the experience and
knowledge of the borrower, and the borrower's past performance with the Bank
and/or market area. Such loans normally are not made to start-up businesses
but are generally reserved for existing customers with substantial equity and
a proven history.
Among the more common risks to agricultural lending can be weather conditions
and disease. These risks can be mitigated through multi-peril crop insurance.
Commodity prices also present a risk, which may be reduced by the use of set
price contracts. Normally, required beginning and projected operating margins
provide for reasonable reserves to offset unexpected yield and price
deficiencies. In addition to these risks, the Bank also considers management
succession, life insurance and business continuation plans when evaluating
agricultural loans.
Consumer and Other Lending: The Bank originates a variety of consumer loans,
including home equity lines of credit, automobile loans and loans secured by
deposit accounts. While consumer lending has traditionally been a small part
of the Bank's business with loans made primarily to accommodate its existing
customer base, it has received renewed emphasis in 2002 and management
anticipates increased activity in future periods. At December 31, 2002, the
Company had $39.2 million, or 2.5% of its loans receivable, in outstanding
consumer related loans.
Similar to commercial loans, consumer loans often entail greater risk than do
residential mortgage loans, particularly in the case of consumer loans which
are unsecured or secured by rapidly depreciating assets such as automobiles.
In such cases, any repossessed collateral for a defaulted consumer loan may
not provide an adequate source of repayment of the outstanding loan balance as
a result of the greater likelihood of damage, loss or depreciation. The
remaining deficiency often does not warrant further substantial collection
efforts against the borrower beyond obtaining a deficiency judgment. In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy. Furthermore, the application
of various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans.
Such loans may also give rise to claims and defenses by a consumer loan
borrower against an assignee of such loans such as the Bank, and a borrower
may be able to assert against such assignee claims and defenses that it has
against the seller of the underlying collateral.
Loan Solicitation and Processing: The Bank originates real estate loans by
direct solicitation of real estate brokers, builders, depositors and walk-in
customers. Loan applications are taken by the Bank's loan officers and are
processed in each branch location. Most underwriting and loan administration
functions are performed by loan personnel at central locations.
Loan officers solicit commercial and agricultural loans through call programs
focused on local businesses and farmers. While commercial loan officers are
delegated reasonable commitment authority based upon their qualifications,
credit decisions on significant commercial and agricultural loans are made by
senior loan officers or in certain instances by the Board of Directors of the
Bank or the Company.
Consumer loans are originated through various marketing efforts directed
primarily toward existing deposit and loan customers of the Bank. Consumer
loan applications may be processed at branch locations or by administrative
personnel at the Bank's main office.
Loan Originations, Sales and Purchases
While the Bank originates a variety of loans, its ability to originate each
type of loan is dependent upon the relative customer demand and competition in
each market it serves. For the years ended December 31, 2002, 2001 and 2000,
the Bank originated loans, net of repayments, of $368.6 million, $346.3
million and $292.2 million, respectively.
In recent years, the Bank generally has sold most of its newly originated
fixed-rate one- to four-family residential mortgage loans and a portion of its
Small Business Administration (SBA) guaranteed loans to secondary market
purchasers as part of its interest rate risk management strategy. Proceeds
from sales of loans by the Company for the years ended December 31, 2002, 2001
and 2000, totaled $457.7 million, $270.3 million and $135.7 million,
respectively. Sales of loans generally are beneficial to the Bank because
these sales may generate income at the time of sale, provide funds for
additional lending and other investments and increase liquidity. The Company
sells loans on both a servicing-retained and a servicing-released basis. All
loans are sold without recourse. See "Loan Servicing." At December 31, 2002,
the Company had $39.4 million in loans held for sale.
6
The Bank purchases whole loans and loan participation interests primarily
during periods of reduced loan demand in its primary market area. Any such
purchases are made consistent with the Bank's underwriting standards; however,
the loans may be located outside of the Bank's normal lending area. During the
years ended December 31, 2002, 2001 and 2000, the Bank purchased $52.0
million, $4.9 million and $12.0 million, respectively, of loans and loan
participation interests.
Loan Servicing
The Bank receives fees from a variety of institutional owners in return for
performing the traditional services of collecting individual payments and
managing portfolios of sold loans. At December 31, 2002, the Bank was
servicing $252.9 million of loans for others. Loan servicing includes
processing payments, accounting for loan funds and collecting and paying real
estate taxes, hazard insurance and other loan-related items such as private
mortgage insurance. In addition to earning fee income, the Bank retains
certain amounts in escrow for the benefit of the lender for which the Bank
incurs no interest expense but is able to invest the funds into earning
assets. At December 31, 2002, the Bank held $6.6 million in escrow for its
portfolio of loans serviced for others. The loan servicing portfolio at
December 31, 2002 was composed primarily of $174.2 million of FHLMC mortgage
loans, $13.7 million of FNMA mortgage loans, and $20.8 million of Oregon
Housing Division loans. The remaining balance of the loan servicing portfolio
at December 31, 2002 consisted of loans serviced for a variety of private
investors. At December 31, 2002, the portfolio included loans secured by
property located primarily in the states of Washington and Oregon. For the
year ended December 31, 2002, $1.5 million of loan servicing fees, net of
$686,000 of servicing rights amortization, was recognized in operations.
Mortgage Servicing Rights: The Bank records mortgage servicing rights (MSRs)
with respect to loans it originates and sells in the secondary market on a
servicing-retained basis. In addition to the MSRs on the loans that it
originates and sells, the Bank has also purchased mortgage servicing rights,
although not in recent years. The cost of MSRs is capitalized and amortized
in proportion to, and over the period of, the estimated future net servicing
income. For the years ended December 31, 2002, 2001 and 2000, the Company
capitalized $1,046,000, $107,000 and $395,000, respectively, of MSRs relating
to loans sold with servicing retained. No MSRs were purchased in those
periods. Amortization of MSRs for the years ended December 31, 2002, 2001 and
2000, was $686,000, $574,000 and $251,000, respectively. Management
periodically evaluates the estimates and assumptions used to determine the
carrying values of MSRs and the amortization of MSRs. These carrying values
are adjusted when the valuation indicates the carrying value is impaired.
MSRs generally are adversely affected by current and anticipated prepayments
resulting from decreasing interest rates. At December 31, 2002, MSRs were
carried at a value, net of amortization, of $1,621,000.
Asset Quality
Classified Assets: State and federal regulations require that the Bank review
and classify its problem assets on a regular basis. In addition, in
connection with examinations of insured institutions, state and federal
examiners have authority to identify problem assets and, if appropriate,
require them to be classified. The Bank's Credit Policy Division reviews
detailed information with respect to the composition and performance of the
loan portfolio, including information on risk concentrations, delinquencies
and classified assets. The Credit Policy Division approves all
recommendations for new classified assets or changes in classifications, and
develops and monitors action plans to resolve the problems associated with the
assets. The Credit Policy Division also approves recommendations for
establishing the appropriate level of the allowance for loan losses.
Significant problem loans are transferred to the Bank's Special Assets
Department for resolution or collection activities. The Board of Directors is
given a detailed report on classified assets and asset quality at least
quarterly.
For additional information with respect to asset quality and non-performing
loans, see Item 7, "Management's Discussion and Analysis of Financial
Condition-Comparison of Financial Condition at December 31, 2002 and
2001-Asset Quality," and Table 10 contained therein.
Allowance for Loan Losses: In originating loans, the Bank recognizes that
losses will be experienced and that the risk of loss will vary with, among
other things, the type of loan being made, the credit worthiness of the
borrower over the term of the loan, general economic conditions and, in the
case of a secured loan, the quality of the security for the loan. As a
result, the Bank maintains an allowance for loan losses consistent with the
generally acceptable accounting principles (GAAP) guidelines. The Company
increases its allowance for loan losses by charging provisions for possible
loan losses against the Company's income. The allowance for losses on loans
is maintained at a level which, in management's judgment, is sufficient to
provide for estimated losses based on evaluating known and inherent risks in
the loan portfolio and upon continuing analysis of the factors underlying the
quality of the loan portfolio.
At December 31, 2002, the Company had an allowance for loan losses of $26.5
million, which represented 1.69% of net loans and 74% of non-performing loans
compared to 1.10% and 97%, respectively, at December 31, 2001. For additional
information concerning the Company's allowance for loan losses, see Item 7,
"Management's Discussion and Analysis of Financial Condition-Comparison of
Results of Operations for the Years ended December 31, 2002 and 2001-Provision
and Allowance for Loan Losses," and Tables 11 and 12 contained therein.
Investment Activities
Under Washington state law, banks are permitted to invest in various types of
marketable securities. Authorized securities include but are not limited to
U.S. Treasury obligations, securities of various federal agencies,
mortgage-backed securities, certain certificates of deposit of insured banks
and savings institutions, banker's acceptances, repurchase agreements, federal
funds, commercial paper, corporate debt and equity securities and obligations
of states and their political subdivisions. The investment policies of the
Bank are designed to provide and maintain adequate liquidity and to generate
favorable rates of return without incurring undue interest rate or credit
risk. The Bank's policies generally limit
7
investments to U.S. Government and government agency (including
government-sponsored entities) securities, municipal bonds, certificates of
deposit, marketable corporate debt obligations and mortgage-backed securities.
Investment in mortgage-backed securities includes those issued or guaranteed
by FHLMC, FNMA, Government National Mortgage Association (GNMA) and
privately-issued mortgage-backed securities that have an AA credit rating or
higher, as well as collateralized mortgage obligations (CMOs). A high credit
rating indicates only that the rating agency believes there is a low risk of
loss or default. However, all of the Bank's investment securities, including
those that have high credit ratings, are subject to market risk in so far as a
change in market rates of interest or other conditions may cause a change in
an investment's earning performance and/or market value.
At December 31, 2002, the Company's consolidated investment portfolio totaled
$434.5 million and consisted principally of U.S. Government and agency
obligations, mortgage-backed securities, municipal bonds, corporate debt
obligations, and stock of FNMA and FHLMC. From time to time, investment
levels may be increased or decreased depending upon yields available on
investment alternatives, and management's projections as to the demand for
funds to be used in the Bank's loan originations, deposits and other
activities. During the year ended December 31, 2002, investments and
securities increased by $117.8 million. Holdings of mortgage-backed securities
increased $62.0 million to $269.2 million, and U.S. Treasury and agency
obligations increased $40.6 million to $91.9 million. Ownership of corporate
and other securities increased $17.5 million to $45.8 million. Municipal
bonds decreased $2.3 million to $27.6 million.
The Company invests significantly in mortgage-backed securities. The
Company's mortgage-backed securities generally are collateralized by loans on
one- to four-family residential real estate. The average life of a
mortgage-backed security is usually less than its stated maturity due to
principal amortization and prepayments of the underlying mortgages.
Prepayments that are faster than anticipated may shorten the life of the
security and may result in rapid amortization of premiums or discounts and
thereby affect the net yield on such securities. Although prepayments of
underlying mortgages depend on many factors, including the type of mortgages,
the coupon rate, the age of mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates, the difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates generally is
the most significant determinant of the rate of prepayments. During periods
of declining mortgage interest rates, if the coupon rate of the underlying
mortgage loans exceeds the prevailing market interest rates offered for
mortgage loans, refinancing generally increases and accelerates the prepayment
of the underlying mortgage loans and the related security. Under such
circumstances, the Company may be subject to reinvestment risk because, to the
extent that the Company's mortgage-backed securities amortize or prepay faster
than anticipated, the Company may not be able to reinvest the proceeds of such
repayments and prepayments at a comparable rate. In contrast to
mortgage-backed securities in which cash flow is received (and hence,
prepayment risk is shared) pro rata by all securities holders, the cash flow
from the mortgage loans or mortgage-backed securities underlying CMOs is
segmented and paid in accordance with a predetermined priority to investors
holding various tranches of such securities or obligations. A particular
tranche of a CMO may therefore carry prepayment risk that differs from that of
both the underlying collateral and other tranches. At December 31, 2002, the
Company held CMOs with a net carrying value of $173.0 million, including $70.0
million of privately issued CMOs.
For detailed information on the Company's investment securities, see Item 7,
"Management's Discussion and Analysis of Financial Condition-Comparison of
Financial Condition at December 31, 2002 and 2001-Investments," and Tables 1,
2, 3, and 4 contained therein.
Off-Balance-Sheet Derivatives: Derivatives include "off-balance-sheet"
financial products whose value is dependent on the value of an underlying
financial asset, such as a stock, bond, foreign currency, or a reference rate
or index. Such derivatives include "forwards," "futures," "options" or
"swaps." The Company and the Bank generally have not invested in
"off-balance-sheet" derivative instruments, although investment policies
authorize such investments. However, as a part of mortgage banking
activities, the Bank issues "rate lock" commitments to borrowers and obtains
offsetting "best efforts" delivery commitments from purchasers of loans.
While not providing any trading or net settlement mechanisms, these
off-balance-sheet commitments do have many of the prescribed characteristics
of derivatives and as a result are accounted for as such in accordance with
Statement of Financial Accounting Standards (SFAS) Nos. 133 and 138.
Accordingly, on December 31, 2002, the Company recorded an asset of $70,000
and a liability of $70,000, representing the estimated market value of those
commitments. On December 31, 2002, the Company and the Bank had no other
investment related off-balance-sheet derivatives.
Deposit Activities and Other Sources of Funds
General: Deposits, FHLB advances (or borrowings) and loan repayments are the
major sources of the Bank's funds for lending and other investment purposes.
Scheduled loan repayments are a relatively stable source of funds, while
deposit inflows and outflows and loan prepayments are influenced by general
economic, interest rate and money market conditions and may vary
significantly. Borrowings may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources. They may also be
used on a longer-term basis for general business purposes.
The Bank competes with other financial institutions and financial
intermediaries in attracting deposits. There is strong competition for
transaction balances and savings deposits from commercial banks, credit unions
and nonbank corporations, such as securities brokerage companies, mutual funds
and other diversified companies, some of which have nationwide networks of
offices.
Deposit Accounts: Deposits generally are attracted from within the Bank's
primary market areas through the offering of a broad selection of deposit
instruments, including demand checking accounts, NOW accounts, money market
deposit accounts, regular savings accounts, certificates of deposit, cash
management services and retirement savings plans. Deposit account terms vary
according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rate, among other factors. In determining
the terms of deposit accounts, the Bank considers current market interest
rates, profitability to the Bank, matching deposit and loan products and
customer preferences and concerns. At December 31, 2002, the Bank had $1.498
billion of deposits including $573.0 million of transaction and savings
accounts and $924.8 million in time deposits. For additional information
concerning the Bank's deposit accounts, see Item 7, "Management's
8
Discussion and Analysis of Financial Condition-Comparison of Financial
Condition at December 31, 2002 and 2001-Deposit Accounts." See also Table 7
contained therein, which sets forth the balances of deposits in the various
types of accounts offered by the Bank, and Table 8, which sets forth the
amount of the Bank's jumbo certificates of deposit by time remaining until
maturity as of December 31, 2002.
Borrowings: While deposits are the primary source of funds for the Bank's
lending and investment activities and for its general business purposes, the
Bank also uses borrowings to supplement its supply of lendable funds, to meet
deposit withdrawal requirements and to more efficiently leverage its capital
position. The FHLB-Seattle serves as the Bank's primary borrowing source.
The FHLB-Seattle provides credit for member financial institutions. As a
member, the Bank is required to own capital stock in the FHLB-Seattle and is
authorized to apply for advances on the security of such stock and certain of
its mortgage loans and securities provided certain credit worthiness standards
have been met. Limitations on the amount of advances are based on the
financial condition of the member institution and the adequacy of collateral
pledged to secure the credit. At December 31, 2002, the Bank had $465.7
million of combined borrowings from the FHLB-Seattle at a weighted average
rate of 4.80%. At that date, the Bank had been authorized by the FHLB-Seattle
to borrow up to $695.0 million under a blanket floating lien security
agreement. The Bank also has access to additional short-term funds through a
$26.0 million commercial bank credit line. At December 31, 2002, the Bank had
no short-term funds borrowed on this commercial banking credit line. For
additional information concerning the Company's borrowings from the
FHLB-Seattle, see Item 7, "Management's Discussion and Analysis of Financial
Condition-Comparison of Financial Condition at December 31, 2002 and
2001-Borrowings," and Table 9 contained therein.
The Bank issues retail repurchase agreements, generally due within 90 days, as
an additional source of funds. At December 31, 2002, the Bank had issued
retail repurchase agreements totaling $10.7 million, with a weighted average
interest rate of 3.17%, which were secured by a pledge of certain FNMA, GNMA
and FHLMC mortgage-backed securities with a market value of $13.4 million.
The Bank also borrows funds through the use of secured wholesale repurchase
agreements with securities brokers. The broker holds Bank securities while
the Bank continues to receive the principal and interest payments from the
security. The Bank's outstanding borrowings at December 31, 2002 under
wholesale repurchase agreements totaled $30.5 million, with a weighted average
rate of 1.43%, and were collateralized by mortgage-backed securities with a
fair value of $33.0 million.
In addition to borrowings at the Bank, the Company has generated funding by
issuing $40 million of Trust Preferred Securities (TPS). The TPS were issued
in 2002 by special purpose business trusts owned by the Company and were sold
to pooled investment vehicles sponsored and marketed by investment banking
firms. The TPS have been recorded as liabilities on the Company's statement
of financial condition but qualify as Tier 1 capital for regulatory capital
purposes. See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Recent Developments and Significant
Events," and Note 13 of the Notes to the Consolidated Financial Statements for
additional information with respect to the TPS.
For additional information about deposits and other sources of funds, see Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources," and Notes 11, 12 and 13 of the
Notes to the Consolidated Financial Statements contained in Item 8.
Personnel
As of December 31, 2002, the Bank and its subsidiaries had 627 full-time and
84 part-time employees. The Company has no employees except for those who are
also employees of the Bank and its subsidiaries. The employees are not
represented by a collective bargaining unit. The Company believes its
relationship with its employees is good.
Taxation
Federal Taxation
General: For tax reporting purposes, the Company and the Bank report their
income on a calendar year basis using the accrual method of accounting and
file consolidated income tax returns. The Company and the Bank are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the reserve for bad debts discussed below.
The following discussion of tax matters is intended only as a summary and does
not purport to be a comprehensive description of the tax rules applicable to
the Company and the Bank. Reference is made to Note 14 of the Notes to the
Consolidated Financial Statements contained in Item 8 of this Form 10-K for
additional information concerning the income taxes payable by the Bank.
Provisions of the Small Business Job Protection Act of 1996 (the Job
Protection Act) significantly altered the Company's tax bad debt deduction
method and the circumstances that would require a tax bad debt reserve
recapture. Prior to enactment of the Job Protection Act, savings institutions
(the Bank was previously chartered as a savings institution) were permitted to
compute their tax bad debt deduction through use of either the reserve method
or the percentage of taxable income method. The Job Protection Act repealed
both of these methods for large savings institutions and allows bad debt
deductions based only on actual current losses. While repealing the reserve
method for computing tax bad debt deductions, the Job Protection Act allows
savings institutions to retain their existing base year bad debt reserves but
requires that reserves in excess of the balance at December 31, 1987, be
recaptured into taxable income. The tax liability for this recapture is
included in the Consolidated Financial Statements contained in Item 8 herein.
9
The base year reserve is recaptured into taxable income only in limited
situations, such as in the event of certain excess distributions, complete
liquidation or disqualification as a bank. None of the limited circumstances
requiring recapture are contemplated by the Company. The amount of the
Company's tax bad debt reserves subject to recapture in these circumstances
was approximately $5.3 million at December 31, 2002. As a result of the
remote nature of events that may trigger the recapture provisions, no tax
liability has been established in the accompanying Consolidated Financial
Statements.
In addition, as a result of certain acquisitions, the Company is required to
recapture certain tax bad debt reserves of the acquired business. The Company
has elected to recapture these reserves into income over a four-year period
using the deferral method. The recapture does not result in a charge to
earnings as the Company provided for this liability on the acquisition date.
Corporate Alternative Minimum Tax: The Internal Revenue Code (Code) imposes a
tax on alternative minimum taxable income (AMTI) at a rate of 20%. AMTI is
increased by an amount equal to 75% of the amount by which the corporation's
adjusted current earnings exceeds its AMTI (determined without regard to this
preference and prior to reduction for net operating losses). For taxable
years beginning after December 31, 1986, and before January 1, 1996, an
environmental tax of .12% of the excess of AMTI (with certain modifications)
over $2.0 million was imposed on corporations, including the Company, whether
or not an Alternative Minimum Tax (AMT) is paid.
Dividends-Received Deduction and Other Matters: The Company may exclude from
its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends-received deduction
is generally 70% in the case of dividends received from unaffiliated
corporations with which the Company and the Bank will not file a consolidated
tax return, except that if the Company or the Bank own more than 20% of the
stock of a corporation distributing a dividend, then 80% of any dividends
received may be deducted.
There have not been any Internal Revenue Service audits of the Company's or
the Bank's federal income tax returns during the past five years.
State Taxation
Washington Taxation: The Company and the Bank are subject to a Business and
Occupation (B&O) tax which is imposed under Washington law at the rate of
1.50% of gross receipts; however, interest received on loans secured by
mortgages or deeds of trust on residential properties, residential
mortgage-backed securities, and certain U.S. Government and agency securities
is not subject to such tax. The Company's B&O tax expense was $943,000, $1.1
million and $1.2 million for 2002, 2001 and 2000, respectively.
Oregon and Idaho Taxation: Corporations with nexus in the states of Oregon
and Idaho are subject to a corporate level income tax. The Company's
operations in those states resulted in corporate income taxes of approximately
$108,000, $320,000 and $281,000 (net of federal tax benefit) for 2002, 2001
and 2000, respectively. As the Company's operations in these states increase,
the state income tax provision will have an increasing effect on the Company's
effective tax rate and results of operations.
Environmental Regulation
The business of the Company is affected from time to time by federal and state
laws and regulations relating to hazardous substances. Under the federal
Comprehensive Environmental Response, Compensation and Liability Act (CERCLA),
owners and operators of properties containing hazardous substances may be
liable for the costs of cleaning up the substances. CERCLA and similar state
laws can affect the Bank both as an owner of branches and other properties
used in its business and as a lender holding a security interest in property
which is found to contain hazardous substances. While CERCLA contains an
exemption for holders of security interests, the exemption is not available if
the holder participates in the management of a property, and some courts have
broadly defined what constitutes participation in management of property.
Moreover, CERCLA and similar state statutes can affect the Bank's decision
whether or not to foreclose on a property. Before foreclosing on commercial
real estate, it is the Bank's general policy to obtain an environmental
report, thereby increasing the costs of foreclosure. In addition, the
existence of hazardous substances on a property securing a troubled loan may
cause the Bank to elect not to foreclose on the property, thereby reducing the
Bank's flexibility in handling the loan.
Competition
The Bank encounters significant competition both in attracting deposits and in
originating loans. The Bank's most direct competition for deposits has come
historically from other commercial and savings banks, savings associations and
credit unions in its market areas. The Bank also experiences competition from
securities firms, insurance companies, money market and mutual funds, and
other investment vehicles. The Bank expects continued strong competition from
such financial institutions and investment vehicles in the foreseeable future.
The ability of the Bank to attract and retain deposits depends on its ability
to provide transaction services and investment opportunities that satisfy the
requirements of depositors. The Bank competes for deposits by offering a
variety of accounts and financial services with competitive rates and terms,
at convenient locations and business hours, and delivered with a high level of
personal service and expertise.
Competition for loans comes principally from commercial banks, loan brokers,
mortgage banking companies, savings banks and credit unions. The competition
for loans is intense as a result of the large number of institutions competing
in the Bank's market areas. The Bank competes for loans primarily through
offering competitive rates and fees and providing timely decisions and
excellent service to borrowers.
10
Regulation
The Bank
General: As a state-chartered, federally insured commercial bank, the Bank is
subject to extensive regulation and must comply with various statutory and
regulatory requirements, including prescribed minimum capital standards. The
Bank is regularly examined by the FDIC and state banking regulators and files
periodic reports concerning its activities and financial condition with its
regulators. The Bank's relationship with depositors and borrowers also is
regulated to a great extent by both federal and state law, especially in such
matters as the ownership of deposit accounts and the form and content of
mortgage and other loan documents.
Federal and state banking laws and regulations govern all areas of the
operation of the Bank, including reserves, loans, investments, deposits,
capital, issuance of securities, payment of dividends and establishment of
branches. Federal and state bank regulatory agencies also have the general
authority to limit the dividends paid by insured banks and bank holding
companies if such payments should be deemed to constitute an unsafe and
unsound practice. The respective primary federal regulators of the Company
and the Bank have authority to impose penalties, initiate civil and
administrative actions and take other steps intended to prevent banks from
engaging in unsafe or unsound practices.
State Regulation and Supervision: The Bank is subject to the applicable
provisions of Washington, Oregon and Idaho law and regulations. State law and
regulations govern the Bank's ability to take deposits and pay interest
thereon, to make loans on or invest in residential and other real estate, to
make consumer loans, to invest in securities, to offer various banking
services to its customers and to establish branch offices.
Deposit Insurance: The FDIC is an independent federal agency that insures the
deposits, up to prescribed statutory limits, of depository institutions. The
FDIC currently maintains two separate insurance funds: the BIF and the SAIF.
As insurer of the Bank's deposits, the FDIC has examination, supervisory and
enforcement authority over the Bank.
Banner Bank's accounts are insured by both the BIF and the SAIF to the maximum
extent permitted by law. The Bank pays deposit insurance premiums based on a
risk-based assessment system established by the FDIC. Under applicable
regulations, institutions are assigned to one of three capital groups that are
based solely on the level of an institution's capital-"well capitalized,"
"adequately capitalized," and "undercapitalized"-which are defined in the same
manner as the regulations establishing the prompt corrective action system, as
discussed below. These three groups are then divided into three subgroups
which reflect varying levels of supervisory concern, from those which are
considered to be healthy to those which are considered to be of substantial
supervisory concern.
Since 1997, the premium schedule for BIF and SAIF insured institutions has
ranged from zero to 27 basis points. In recent years, the Bank has not been
required to make any premium payments to the FDIC. However, SAIF insured
institutions and BIF insured institutions are required to pay a Financing
Corporation (FICO) assessment in order to fund the interest on bonds issued to
resolve thrift failures in the 1980s. For the fourth quarter of 2002, the
annualized rate was 1.70 basis points for each $100 in domestic deposits.
These assessments, which may be revised based upon the level of BIF and SAIF
deposits, will continue until the bonds mature in the year 2015.
The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged
or is engaging in unsafe or unsound practices, is in an unsafe or unsound
condition to continue operations, or has violated any applicable law,
regulation, order or any condition imposed by an agreement with the FDIC. It
also may suspend deposit insurance temporarily during the hearing process for
the permanent termination of insurance if the institution has no tangible
capital. If insurance of accounts is terminated, the accounts at the
institution at the time of termination, less subsequent withdrawals, will
continue to be insured for a period of six months to two years, as determined
by the FDIC. Management is not aware of any existing circumstances that could
result in termination of the deposit insurance of the Bank.
Prompt Corrective Action: Federal statutes establish a supervisory framework
based on five capital categories: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution's category depends upon where its capital
levels are in relation to relevant capital measures, which include a
risk-based capital measure, a leverage ratio capital measure and certain other
factors. The federal banking agencies have adopted regulations that implement
this statutory framework. Under these regulations, an institution is treated
as well capitalized if its ratio of total capital to risk-weighted assets is
10% or more, its ratio of core capital to risk-weighted assets is 6% or more,
its ratio of core capital to adjusted total assets (leverage ratio) is 5% or
more, and it is not subject to any federal supervisory order or directive to
meet a specific capital level. In order to be adequately capitalized, an
institution must have a total risk-based capital ratio of not less than 8%, a
Tier 1 risk-based capital ratio of not less than 4%, and a leverage ratio of
not less than 4%. Any institution which is neither well capitalized nor
adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action
requirements, regulatory controls and restrictions which become more extensive
as an institution becomes more severely undercapitalized. Failure by the Bank
to comply with applicable capital requirements would, if unremedied, result in
restrictions on its activities and lead to enforcement actions, including, but
not limited to, the issuance of a capital directive to ensure the maintenance
of required capital levels. Banking regulators will take prompt corrective
action with respect to depository institutions that do not meet minimum
capital requirements. Additionally, approval of any regulatory application
filed for their review may be dependent on compliance with capital
requirements.
At December 31, 2002, the Bank was categorized as "well capitalized" under the
prompt corrective action regulations of the FDIC.
Capital Requirements: FDIC regulations recognize two types or tiers of
capital: core (Tier 1) capital and supplementary (Tier 2) capital. Tier 1
capital generally includes common stockholders' equity and noncumulative
perpetual preferred stock, less most intangible assets. Tier 2 capital,
11
which is limited to 100% of Tier 1 capital, includes such items as qualifying
general loan loss reserves, cumulative perpetual preferred stock, mandatory
convertible debt, term subordinated debt and limited life preferred stock;
however, the amount of term subordinated debt and intermediate term preferred
stock (original maturity of at least five years but less than 20 years) that
may in included in Tier 2 capital is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage limit
together with certain risk-based ratios. The FDIC's minimum leverage capital
requirement specifies a minimum ratio of Tier 1 capital to average total
assets. Most banks are required to maintain a minimum leverage ratio of at
least 4% to 5% of total assets. The FDIC retains the right to require a
particular institution to maintain a higher capital level based on an
institution's particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on ratios
of qualifying capital to risk-weighted assets. Assets are placed in one of
four categories and given a percentage weight-0%, 20%, 50% or 100%-based on
the relative risk of the category. In addition, certain off-balance-sheet
items are converted to balance-sheet credit equivalent amounts, and each
amount is then assigned to one of the four categories. Under the guidelines,
the ratio of total capital (Tier 1 capital plus Tier 2 capital) to
risk-weighted assets must be at least 8%, and the ratio of Tier 1 capital to
risk-weighted assets must be at least 4%. In evaluating the adequacy of a
bank's capital, the FDIC may also consider other factors that may affect a
bank's financial condition. Such factors may include interest rate risk
exposure, liquidity, funding and market risks, the quality and level of
earnings, concentration of credit risk, risks arising from nontraditional
activities, loan and investment quality, the effectiveness of loan and
investment policies, and management's ability to monitor and control financial
operating risks.
FDIC capital requirements are designated as the minimum acceptable standards
for banks whose overall financial condition is fundamentally sound, which are
well-managed and have no material or significant financial weaknesses. The
FDIC capital regulations state that, where the FDIC determines that the
financial history or condition, including off-balance-sheet risk, managerial
resources and/or the future earnings prospects of a bank are not adequate
and/or a bank has a significant volume of assets classified substandard,
doubtful or loss or otherwise criticized, the FDIC may determine that the
minimum adequate amount of capital for the bank is greater than the minimum
standards established in the regulation.
The Company believes that, under the current regulations, the Bank exceeds its
minimum capital requirements. However, events beyond the control of the Bank,
such as weak or depressed economic conditions in areas where the Bank has most
of its loans, could adversely affect future earnings and, consequently, the
ability of the Bank to meet is capital requirements. For additional
information concerning the Bank's capital, see Note 18 of the Notes to the
Consolidated Financial Statements.
Standards for Safety and Soundness: The federal banking regulatory agencies
have prescribed, by regulation, standards for all insured depository
institutions (Guidelines) relating to: (i) internal controls, information
systems and internal audit systems; (ii) loan documentation; (iii) credit
underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset
quality; (vii) earnings; and (viii) compensation, fees and benefits. The
Guidelines set forth the safety and soundness standards that the federal
banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the FDIC determines that the
Bank fails to meet any standard prescribed by the Guidelines, it may require
the Bank to submit to the FDIC an acceptable plan to achieve compliance with
the standard. The Company believes that at December 31, 2002, the Bank meets
all such standards.
Federal Reserve System: The Federal Reserve Board requires, under Regulation
D, reserves on all depository institutions that maintain transaction accounts
or nonpersonal time deposits. These reserves may be in the form of cash or
non-interest-bearing deposits with the regional Federal Reserve Bank. NOW
accounts and other types of accounts that permit payments or transfers to
third parties fall within the definition of transaction accounts and are
subject to Regulation D reserve requirements, as are any nonpersonal time
deposits at a bank. Under Regulation D, a bank must establish reserves equal
to 3% of the first $42.1 million of transaction accounts, of which the first
$6.0 million is exempt, and 10% of the remainder. Currently there is no
reserve requirement on nonpersonal time deposits. As of December 31, 2002,
the Bank met its reserve requirements.
Affiliate Transactions: The Company and the Bank are separate and distinct
legal entities. Various legal limitations restrict the Bank from lending or
otherwise supplying funds to the Company (an "affiliate"), generally limiting
such transactions with the affiliate to 10% of the Bank's capital and surplus
and limiting all such transactions to 20% of the Bank's capital and surplus.
Such transactions, including extensions of credit, sales of securities or
assets and provision of services, also must be on terms and conditions
consistent with safe and sound banking practices, including credit standards
that are substantially the same or at least as favorable to the Bank as those
prevailing at the time for transactions with unaffiliated companies.
Federally insured banks are subject, with certain exceptions, to certain
restrictions on extensions of credit to their parent holding companies or
other affiliates, on investments in the stock or other securities of
affiliates and on the taking of such stock or securities as collateral from
any borrower. In addition, such banks are prohibited from engaging in certain
tie-in arrangements in connection with any extension of credit or the
providing of any property or service.
Community Reinvestment Act: The Bank is also subject to the provisions of the
Community Reinvestment Act of 1977, which requires the appropriate federal
bank regulatory agency, in connection with its regular examination of a bank,
to assess the bank's record in meeting the credit needs of the community
serviced by the bank, including low and moderate income neighborhoods. The
regulatory agency's assessment of the bank's record is made available to the
public. Further, such assessment is required of any bank which has applied,
among other things, to establish a new branch office that will accept
deposits, relocate an existing office or merge or consolidate with, or acquire
the assets or assume the liabilities of, a federally regulated financial
institution.
12
Dividends: Dividends from the Bank constitute the major source of funds for
dividends paid by the Company. The amount of dividends payable by the Bank to
the Company will depend upon the Bank's earnings and capital position, and is
limited by federal and state laws, regulations and policies. Federal law
further provides that no insured depository institution may make any capital
distribution (which includes a cash dividend) if, after making the
distribution, the institution would be "undercapitalized," as defined in the
prompt corrective action regulations. Moreover, the federal bank regulatory
agencies also have the general authority to limit the dividends paid by
insured banks if such payments should be deemed to constitute an unsafe and
unsound practice.
The Company
General: The Company, as sole shareholder of the Bank, is a bank holding
company registered with the Federal Reserve. Bank holding companies are
subject to comprehensive regulation by the Federal Reserve under the Bank
Holding Company Act of 1956, as amended (BHCA), and the regulations of the
Federal Reserve. The Company is required to file with the Federal Reserve
annual reports and such additional information as the Federal Reserve may
require and is subject to regular examinations by the Federal Reserve. The
Federal Reserve also has extensive enforcement authority over bank holding
companies, including, among other things, the ability to assess civil money
penalties, to issue cease and desist or removal orders and to require that a
holding company divest subsidiaries (including its bank subsidiaries). In
general, enforcement actions may be initiated for violations of law and
regulations and unsafe or unsound practices.
Gramm-Leach-Bliley Financial Services Act of 1999: On November 12, 1999, the
Gramm-Leach-Bliley Financial Services Act of 1999 was signed into law. The
Act modernizes the financial services industry by establishing a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms and other financial service providers. Generally, the Act:
(a) repealed the historical restrictions and eliminated many federal and
state law barriers to affiliations among banks, securities firms,
insurance companies and other financial service providers;
(b) provided a uniform framework for the functional regulation of the
activities of banks, savings institutions and their holding
companies;
(c) broadened the activities that may be conducted by national banks,
banking subsidiaries of bank holding companies and their financial
subsidiaries;
(d) provided an enhanced framework for protecting the privacy of
consumer information;
(e) adopted a number of provisions related to the capitalization,
membership, corporate governance and other measures designed to
modernize the FHLB system;
(f) modified the laws governing the implementation of the Community
Reinvestment Act; and
(g) addressed a variety of other legal and regulatory issues affecting
day-to-day operations and long-term activities of financial
institutions.
Acquisitions: Under the BHCA, a bank holding company must obtain Federal
Reserve approval before: (1) acquiring, directly or indirectly, ownership or
control of any voting shares of another bank or bank holding company if, after
such acquisition, it would own or control more than 5% of such shares (unless
it already owns or controls the majority of such shares); (2) acquiring all or
substantially all of the assets of another bank or bank holding company; or
(3) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions, from
acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company that is not a bank or bank holding company and
from engaging directly or indirectly in activities other than those of
banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
nonbank activities which, by statute or by Federal Reserve regulation or
order, have been identified as activities closely related to the business of
banking or managing or controlling banks. The list of activities permitted by
the Federal Reserve includes, among other things: operating a savings
institution, mortgage company, finance company, credit card company or
factoring company; performing certain data processing operations; providing
certain investment and financial advice; underwriting and acting as an
insurance agent for certain types of credit-related insurance; leasing
property on a full-payout, non-operating basis; selling money orders,
travelers' checks and U.S. Savings Bonds; real estate and personal property
appraising; providing tax planning and preparation services; and, subject to
certain limitations, providing securities brokerage services for customers.
Interstate Banking and Branching: The Federal Reserve must approve an
application of an adequately capitalized and adequately managed bank holding
company to acquire control of, or acquire all or substantially all of the
assets of, a bank located in a state other than such holding company's home
state, without regard to whether the transaction is prohibited by the laws of
any state. The Federal Reserve may not approve the acquisition of a bank that
has not been in existence for the minimum time period (not exceeding five
years) specified by the statutory law of the host state. Nor may the Federal
Reserve approve an application if the applicant (and its depository
institution affiliates) controls or would control more than 10% of the insured
deposits in the United States or 30% or more of the deposits in the target
bank's home state or in any state in which the target bank maintains a branch.
Federal law does not affect the authority of states to limit the percentage of
total insured deposits
13
in the state which may be held or controlled by a bank holding company to the
extent such limitation does not discriminate against out-of-state banks or
bank holding companies. Individual states may also waive the 30% state-wide
concentration limit contained in the federal law.
The Federal banking agencies are authorized to approve interstate merger
transactions without regard to whether such transaction is prohibited by the
law of any state, unless the home state of one of the banks adopted a law
prior to June 1, 1997 which applies equally to all out-of-state banks and
expressly prohibits merger transactions involving out-of-state banks.
Interstate acquisitions of branches will be permitted only if the law of the
state in which the branch is located permits such acquisitions. Interstate
mergers and branch acquisitions will also be subject to the nationwide and
statewide insured deposit concentration amounts described above.
Dividends: The Federal Reserve has issued a policy statement on the payment
of cash dividends by bank holding companies, which expresses the Federal
Reserve's view that a bank holding company should pay cash dividends only to
the extent that the company's net income for the past year is sufficient to
cover both the cash dividends and a rate of earnings retention that is
consistent with the company's capital needs, asset quality and overall
financial condition. The Federal Reserve also indicated that it would be
inappropriate for a company experiencing serious financial problems to borrow
funds to pay dividends.
Capital Requirements: The Federal Reserve has established capital adequacy
guidelines for bank holding companies that generally parallel the capital
requirements of the FDIC for the Bank, although the Federal Reserve
regulations provide for the inclusion of certain trust preferred securities
for up to 25% of Tier 1 capital in determining compliance with the guidelines.
The Federal Reserve regulations provide that capital standards will be applied
on a consolidated basis in the case of a bank holding company with $150
million or more in total consolidated assets. The guidelines require that a
company's total risk-based capital must equal 8% of risk-weighted assets and
one half of the 8% (4%) must consist of Tier 1 (core) capital. As of December
31, 2002 the Company's total risk-based capital was 12.96% of risk-weighted
assets and its Tier 1 (core) capital was 11.66% of risk-weighted assets.
Stock Repurchases: A bank holding company, except for certain
"well-capitalized" and highly rated bank holding companies, is required to
give the Federal Reserve prior written notice of any purchase or redemption of
its outstanding equity securities if the gross consideration for the purchase
or redemption, when combined with the net consideration paid for all such
purchases or redemptions during the preceding twelve months, is equal to 10%
or more of its consolidated net worth. The Federal Reserve may disapprove
such a purchase or redemption if it determines that the proposal would
constitute an unsafe or unsound practice or would violate any law, regulation,
Federal Reserve order or any condition imposed by, or written agreement with,
the Federal Reserve.
At its August 2002 meeting, the Company's Board of Directors authorized the
repurchase of up to 5% (approximately 600,000 shares) of the Company's
outstanding common stock over a twelve-month period. Shares may be purchased
from time to time depending upon market conditions, price and other management
considerations. During the year ended December 31, 2002, the Company
repurchased 422,844 shares of its common stock, compared to the repurchase of
569,166 shares of common stock under the prior plan during the comparable
prior year period.
The USA PATRIOT Act: In response to the events of September 11, 2001,
President George W. Bush signed into law the Uniting and Strengthening America
by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism
Act of 2001, or the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act
gives the federal government new powers to address terrorist threats through
enhanced domestic security measures, expanded surveillance powers, increased
information sharing, and broadened anti-money laundering requirements. By way
of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act takes
measures intended to encourage information sharing among bank regulatory
agencies and law enforcement bodies. Further, certain provisions of Title III
impose affirmative obligations on a broad range of financial institutions,
including banks, thrifts, brokers, dealers, credit unions, money transfer
agents and parties registered under the Commodity Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the
following requirements with respect to financial institutions:
(a) Pursuant to Section 352, all financial institutions must establish
anti-money laundering programs that include, at a minimum: (i)
internal policies, procedures, and controls, (ii) specific
designation of an anti-money laundering compliance officer, (iii)
ongoing employee training programs, and (iv) an independent audit
function to test the anti-money laundering program.
(b) Section 326 of the Act authorizes the Secretary of the Department of
Treasury, in conjunction with other bank regulators, to issue
regulations that provide for minimum standards with respect to
customer identification at the time new accounts are opened, which
were issued in proposed form on July 23, 2002 and are still pending
final action.
(c) Section 312 of the Act requires financial institutions that
establish, maintain, administer, or manage private banking accounts
or correspondent accounts in the United States for non-United States
persons or their representatives (including foreign individuals
visiting the United States) to establish appropriate, specific, and,
where necessary, enhanced due diligence policies, procedures, and
controls designed to detect and report money laundering.
(d) Effective December 25, 2001, financial institutions are prohibited
from establishing, maintaining, administering or managing
correspondent accounts for foreign shell banks (foreign banks that
do not have a physical presence in any country), and will be subject
to certain recordkeeping obligations with respect to correspondent
accounts of foreign banks.
14
(e) Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal
Reserve Act and Bank Merger Act applications.
During the first quarter of 2002 the Federal Crimes Enforcement Network
(FinCEN), a bureau of the Department of Treasury, issued proposed and interim
regulations to implement the provisions of Sections 312 and 352 of the USA
PATRIOT Act. To date, it has not been possible to predict the impact the USA
PATRIOT Act and its implementing regulations may have on the Company and the
Bank.
Sarbanes-Oxley Act of 2002: The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley
Act) was signed into law by President Bush on July 30, 2002 in response to
public concerns regarding corporate accountability in connection with the
recent accounting scandals at Enron and WorldCom. The stated goals of the
Sarbanes-Oxley Act are to increase corporate responsibility, to provide for
enhanced penalties for accounting and auditing improprieties at publicly
traded companies and to protect investors by improving the accuracy and
reliability of corporate disclosures pursuant to the securities laws.
The Sarbanes-Oxley Act is the most far-reaching U.S. securities legislation
enacted in some time. The Sarbanes-Oxley Act generally applies to all
companies, both U.S. non-U.S., that file or are required to file periodic
reports with the Securities and Exchange Commission (SEC), under the
Securities Exchange Act of 1934 (Exchange Act).
The Sarbanes-Oxley Act included very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and
securities exchanges to adopt extensive additional disclosure, corporate
governance and other related rules and mandates further studies of certain
issues by the SEC and Comptroller General. The Sarbanes-Oxley Act represents
significant federal involvement in matters traditionally left to state
regulatory systems, such as the regulation of the accounting profession, and
to state corporate law, such as the relationship between a board of directors
and management and between a board of directors and its committees.
The Sarbanes-Oxley Act addressed, among other matters:
(a) audit committees
(b) certification of financial statements by the chief executive officer
and the chief financial officer
(c) the forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and
senior officer in the twelve-month period following initial
publication of any financial statements that later require
restatement
(d) a prohibition on insider trading during pension plan black out
periods
(e) disclosure of off-balance-sheet transactions
(f) a prohibition on personal loans to directors and officers
(g) expedited filing requirements for Form 4s
(h) disclosure of a code of ethics and filing a Form 8-K for a change or
waiver of such code
(i) "real time" filing of periodic reports
(j) the formation of a public accounting oversight board
(k) auditor independence
(l) various increased criminal penalties for violations of securities
laws
The Sarbanes-Oxley Act contains provisions which became effective upon
enactment on July 30, 2002 and provisions which will become effective from
within 30 days to one year from enactment. The SEC has been delegated the
task of enacting rules to implement various provisions with respect to, among
other matters, disclosure in periodic filings pursuant to the Exchange Act.
15
Management Personnel
Executive Officers
The following table sets forth information with respect to the executive
officers of the Company and the Bank as of December 31, 2002.
Name Age Position with Company Position with Bank
- ---- --- --------------------- ------------------
D. Michael Jones 60 President, Chief Executive President, Chief Executive
Officer, Director Officer, Director
Gary Sirmon 59 Chairman of the Board, Chairman of the Board,
Director Director
Jesse G. Foster 64 Vice Chairman of the Board, Vice Chairman of the
Director Board, Director
Lloyd W. Baker 54 Executive Vice President, Executive Vice President,
Chief Financial Officer Chief Financial Officer
Michael K. Larsen 60 Executive Vice President,
Real Estate Lending
Cynthia D.
Purcell 45 Executive Vice President,
Bank Operations
Richard B.
Barton 59 Executive Vice President,
Chief Credit Officer
Paul E. Folz 48 Executive Vice President,
Community Banking
John R. Neill 54 Executive Vice President,
Corporate Lending
Biographical Information
Set forth below is certain information regarding the executive officers of the
Company and the Bank. There are no family relationships among or between the
directors or executive officers.
D. Michael Jones joined Banner Bank in 2002 following an extensive career in
banking, finance and accounting. Mr. Jones served as President and Chief
Executive Officer from 1996 to 2001 for Source Capital Corporation, a lending
company in Spokane, Washington. From 1987 to 1995, Mr. Jones served as
President of West One Bancorp, a large regional banking franchise based in
Boise, Idaho.
Gary Sirmon joined First Savings Bank of Washington, Banner Bank's
predecessor, in 1980 as an Executive Vice President and served as its Chief
Executive Officer from 1982 until 2002.
Jesse G. Foster was formerly the Chief Executive Officer, President and a
Director of Inland Empire Bank (now Banner Bank), which he joined in 1962.
Lloyd W. Baker joined FSBW (now Banner Bank) in 1995 as Asset/Liability
Manager and has served as its Chief Financial Officer since 2000. His banking
career began in 1972.
Michael K. Larsen joined FSBW (now Banner Bank) in 1981 and has been the
Bank's senior real estate lending officer since 1982.
Cynthia D. Purcell was formerly the Chief Financial Officer of IEB (now Banner
Bank), which she joined in 1981.
Richard B. Barton joined Banner Bank in 2002. Mr. Barton's banking career
began in 1972 with Seafirst Bank and Bank of America, where he served as the
credit risk management executive for the west coast.
Paul E. Folz joined Banner Bank in 2002. Mr. Folz formerly served as
Washington Mutual's Senior Vice President for new market planning and
development, where he spearheaded the expansion of business banking into new
markets.
John R. Neill joined Banner Bank in 2002. Mr. Neill, who has over 25 years of
commercial banking and community development experience, formerly served as
Senior Vice President and Senior Client Manager for Bank of America's Central
Washington commercial banking division.
16
Available Information
The Company's website is www.banrbank.com. The website contains a link to the
Company's filings with the Securities and Exchange Commission, including
Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K and any amendments. Copies of these filing are available as soon
as reasonably practicable.
Item 2 - Properties
The Company's home office, which is owned by the Company, is located in Walla
Walla, Washington. As of December 31, 2002 the Bank has, in total, 41 branch
offices located in Washington, Oregon and Idaho. These offices are located in
the cities of Walla Walla (4), Kennewick (2), Richland, Pasco, Clarkston,
Sunnyside, Yakima (4), Selah, Wenatchee, Dayton, Bellingham, Ferndale, Lynden,
Blaine, Point Roberts, Spokane (2), Woodinville, Bothell, Everett, Kirkland,
Bellevue, Redmond, Renton and Seattle, Washington; Hermiston, Pendleton (2),
Umatilla, Boardman, Stanfield and Lake Oswego, Oregon; and Lewiston (2),
Idaho. Of these offices, 19 are owned by the Company and 22 are leased. The
leases expire from 2003 through 2023. In addition to these branch offices,
the Bank has eight leased loan production offices in Bellevue, Puyallup,
Kennewick, Spokane, Bellingham and Oak Harbor, Washington and Lake Oswego and
Condon, Oregon, and it leases administrative offices in Walla Walla (2), and
Bothell and Woodinville, Washington. Community Financial Corporation (CFC),
the wholly owned subsidiary of the Bank, located in Lake Oswego, Oregon,
leases space to operate its two loan production offices in Lake Oswego, Oregon
and Vancouver, Washington. The leases expire from 2003 through 2023. The
Company's net investment in its offices, premises, equipment and leaseholds
was $20.7 million at December 31, 2002.
Item 3 - Legal Proceedings
In the normal course of business, the Company and the Bank have various legal
proceedings and other contingent matters outstanding. These proceedings and
the associated legal claims are often contested and the outcome of individual
matters is not always predictable. These claims and counter claims typically
arise during the course of collection efforts on problem loans or with respect
to action to enforce liens on properties in which the Bank holds a security
interest. Presently the Company has three such counter claims by borrowers or
involved parties. The Company and the Bank are not a party to any pending
legal proceedings that they believe would have a material adverse effect on
the financial condition or operations of the Company.
Item 4 - Submission of Matters to a Vote of Security Holders
None
17
Part II
Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters
Stock Listing
The Company's common stock is traded over-the-counter on The Nasdaq Stock
Market(r) under the symbol "BANR" and newspaper stock tables list the Company
as "Banner Corp." Stockholders of record at December 31, 2002 totaled 1,016.
This total does not reflect the number of persons or entitles who hold stock
in nominee or "street" name through various brokerage firms. The following
tables show the reported high and low closing sale prices of the Company's
common stock for the years ended December 31, 2002, 2001 and 2000.
Cash
Year Ended Dividend
December 31, 2002 High Low Declared
----------------- ---- --- --------
First quarter $22.01 $16.96 $0.150
Second quarter 24.75 21.28 0.150
Third quarter 23.55 15.32 0.150
Fourth quarter 20.60 16.85 0.150
Cash
Year Ended Dividend
December 31, 2001 High Low Declared
----------------- ---- --- --------
First quarter $17.00 $15.06 $0.140
Second quarter 23.10 16.00 0.140
Third quarter 22.90 15.15 0.140
Fourth quarter 20.08 15.85 0.140
Cash
Year Ended Dividend
December 31, 2000 High Low Declared
----------------- ---- --- --------
First quarter (1) $16.59 $11.93 $0.127
Second quarter (1) 15.91 11.70 0.127
Third quarter (1) 14.87 11.99 0.127
Fourth quarter 15.25 12.94 0.140
- ------------
(1) Restated to reflect 10% stock dividend granted in November 2000.
See Note 2 of the Notes to the Consolidated Financial Statements.
18
Item 6 - Selected Consolidated Financial and Other Data
During May 1999, the Company announced its decision to change its fiscal year
end from March 31 to December 31 beginning with the period ended on December
31, 1999. The information presented for the nine months ended December 31,
1998 and for the twelve months ended December 31, 1999 is for comparative
purposes only and has not been subjected to a financial audit. These tables
set forth selected consolidated financial and other data of the Company at the
dates and for the periods indicated. This information is derived from and is
qualified in its entirety by reference to the detailed information and
Consolidated Financial Statements and Notes thereto presented elsewhere in
this or prior filings.
FINANCIAL CONDITION DATA: At December 31 At March 31 (1)
(In thousands) ------------------------------------------------- --------------
2002 2001 2000 1999 1999
---- ---- ---- ---- ----
Total assets $2,263,172 $2,087,094 $1,982,831 $1,820,110 $1,631,900
Loans receivable, net 1,546,927 1,575,425 1,471,769 1,308,164 1,102,669
Cash and securities (2) 567,385 384,403 393,871 406,886 436,679
Deposits 1,497,778 1,295,811 1,192,715 1,078,152 950,848
Borrowings 546,945 578,697 581,636 548,179 486,719
Stockholders' equity 190,377 192,340 193,795 179,173 183,608
Shares outstanding
excluding unearned,
restricted shares
held in ESOP 10,791 11,057 11,372 11,591 11,992
For the 9-month For the Year
For the Years period Ended Ended
OPERATING DATA: Ended December 31 December 31 March 31 (1)
(In thousands) --------------------------------------------- ---------------------- -------------
2002 2001 2000 1999 1999 1998 1999
---- ---- ---- ---- ---- ---- ----
(Unaudited) (Unaudited)
Interest income $ 144,276 $ 157,666 $ 158,298 $ 131,502 $ 101,032 $ 81,822 $ 112,292
Interest expense 65,969 85,944 89,594 69,360 53,201 44,283 60,442
--------- --------- --------- --------- --------- --------- ---------
Net interest income 78,307 71,722 68,704 62,142 47,831 37,539 51,850
Provision for loan
losses 21,000 13,959 2,867 2,516 1,885 2,210 2,841
--------- --------- --------- --------- --------- --------- ---------
Net interest income
after provision for
loan losses 57,307 57,763 65,837 59,626 45,946 35,329 49,009
Gains from sale of:
Loans 6,695 4,575 2,517 1,989 1,157 2,052 2,884
Securities 27 687 63 6 2 7 11
Other operating income 9,155 8,203 6,671 5,617 4,356 3,297 4,558
Other operating
expenses 60,445 59,636 46,502 39,873 30,522 22,394 31,745
--------- --------- --------- --------- --------- --------- ---------
Income before
provision for
income taxes 12,739 11,592 28,586 27,365 20,939 18,291 24,717
Provision for income
taxes 3,479 4,142 10,238 10,467 8,070 6,880 9,277
--------- --------- --------- --------- --------- --------- ---------
Net income $ 9,260 $ 7,450 $ 18,348 $ 16,898 $ 12,869 $ 11,411 $ 15,440
========= ========= ========= ========= ========= ========= =========
At or for the 9-month At or for the
At or for the Years period Ended Year Ended
PER SHARE DATA:(3) Ended December 31 December 31 March 31
(In thousands) --------------------------------------------- ---------------------- -------------
2002 2001 2000 1999 1999 1998 1999
---- ---- ---- ---- ---- ---- ----
(Unaudited) (Unaudited)
Net income: Basic $ 0.85 $ 0.67 $ 1.62 $ 1.46 $ 1.12 $ 0.99 $ 1.33
Diluted 0.82 0.64 1.60 1.41 1.09 0.94 1.27
Stockholders'
equity (4) 17.64 17.40 17.04 15.46 15.46 14.72 15.31
Cash dividends 0.60 0.56 0.52 0.44 0.33 0.24 0.35
Dividend payout
ratio (diluted) 73.17% 87.50% 32.63% 30.92% 30.25% 25.00% 27.14%
(footnotes follow tables)
19
KEY FINANCIAL RATIOS: (5)
At or For the 9-month At or For the
At or For the Years period Ended Year Ended
Ended December 31 December 31 March 31 (1)
--------------------------------------------- ---------------------- -------------
2002 2001 2000 1999 1999 1998 1999
---- ---- ---- ---- ---- ---- ----
(Unaudited) (Unaudited)
Performance Ratios:
Return on average
assets (6) 0.43% 0.36% 0.95% 1.00% 0.99% 1.09% 1.08%
Return on average
equity (7) 4.71 3.78 9.96 9.38 9.49 8.86 8.91
Average equity to
average assets 9.13 9.64 9.58 10.65 10.44 12.35 12.07
Interest rate
spread (8) 3.80 3.52 3.49 3.63 3.64 3.42 3.45
Net interest
margin (9) 3.91 3.73 3.77 3.90 3.91 3.81 3.83
Non-interest in-
come to average
assets 0.74 0.66 0.48 0.45 0.42 0.51 0.52
Non-interest ex-
pense to average
assets 2.81 2.92 2.42 2.36 2.35 2.15 2.21
Efficiency ratio(10) 64.18 70.01 59.65 57.16 57.22 52.21 53.53
Average interest-
earning assets
to interest-
bearing
liabilities 103.14 104.89 105.67 106.27 106.01 108.76 108.30
Asset Quality Ratios:
Allowance for loan
losses as a percent
of total loans at
end of period 1.69 1.10 1.03 1.02 1.02 1.10 1.10
Net charge-offs as
a percent of aver-
age outstanding
loans during the
period 0.78 0.75 0.06 0.10 0.09 0.10 0.14
Non-performing assets
as a percent of
total assets 1.86 1.01 0.59 0.48 0.48 0.37 0.57
Ratio of allowance
for loan losses to
non-performing
loans (11) 0.74 0.97 1.83 2.67 2.67 3.30 1.60
Consolidated Capital
Ratio:
Tier 1 leverage
capital ratio 8.77 7.71 8.25 8.39 8.39 9.82 9.44
(1) Certain amounts in the prior periods' financial statements have been reclassified to conform to the
current period's presentation. These reclassifications have affected certain ratios for the prior
periods. The effect of such reclassifications is immaterial.
(2) Includes securities available for sale and held to maturity.
(3) Per share data have been adjusted for the 10% stock dividend paid in August 1998 and November 2000.
(4) Calculated using shares outstanding excluding unearned restricted shares held in ESOP.
(5) Ratios are annualized.
(6) Net income divided by average assets.
(7) Net income divided by average equity.
(8) Difference between the average yield on interest-earning assets and the average cost of
interest-bearing liabilities.
(9) Net interest income before provision for loan losses as a percent of average interest-earning assets.
(10) Other operating expenses divided by the total of net interest income before loan losses and other
operating income (non-interest income).
(11) Non-performing loans consist of nonaccrual and 90 days past due loans.
20
Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
Special Note Regarding Forward-Looking Statements
Management's Discussion and Analysis (MD&A) and other portions of this report
contain certain "forward-looking statements" concerning the future operations
of the Company. Management desires to take advantage of the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995 and is
including this statement for the express purpose of availing the Company of
the protections of such safe harbor with respect to all "forward-looking
statements" contained in this Annual Report on Form 10-K and the Annual Report
to Stockholders. Management has used "forward-looking statements" to describe
future plans and strategies, including expectations of the Company's future
financial results. Management's ability to predict results or the effect of
future plans or strategies is inherently uncertain. Factors which could cause
actual results to differ materially include, but are not limited to, regional
and general economic conditions, changes in interest rates, deposit flows,
demand for mortgages and other loans, real estate values, competition, loan
delinquency rates, changes in accounting principles, practices, policies or
guidelines, changes in legislation or regulation, other economic, competitive,
governmental, regulatory and technological factors affecting operations,
pricing, products and services and the Company's ability to successfully
resolve the outstanding credit issues and recover check kiting losses.
Accordingly, these factors should be considered in evaluating the
"forward-looking statements," and undue reliance should not be placed on such
statements. The Company undertakes no responsibility to update or revise any
"forward-looking statements."
General
Banner Corporation, a Washington corporation, is primarily engaged in the
business of planning, directing and coordinating the business activities of
its wholly owned subsidiary, Banner Bank. The Bank is a Washington-chartered
commercial bank that conducts business from its main office in Walla Walla,
Washington, and, as of January 1, 2003, its 41 branch offices and seven loan
production offices located in 19 counties in Washington, Idaho and Oregon.
The operating results of the Company depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets, consisting of loans and investment securities, and interest expense on
interest-bearing liabilities, composed primarily of customer deposits and
Federal Home Loan Bank (FHLB) advances. Net interest income is primarily a
function of BANR's interest rate spread, which is the difference between the
yield earned on interest-earning assets and the rate paid on interest-bearing
liabilities, as well as a function of the average balance of interest-earning
assets as compared to the average balance of interest-bearing liabilities. As
more fully explained below, BANR's net interest income increased for the year
ended December 31, 2002 compared to the prior year, reflecting a growth in
interest-bearing assets and liabilities and a net interest margin increase of
18 basis points. BANR's net income also is significantly affected by
provisions for loan losses and the level of its other income, including
deposit service charges, loan origination and servicing fees, and mortgage
banking operations, as well as its non-interest operating expenses and income
tax provisions. The provision for loan losses increased significantly for the
year ended December 31, 2002, compared to the prior year, by an amount of $7
million. As explained more fully below, much of this increase reflects
continued weak economic conditions in some of the Puget Sound market areas
serviced by the Company. Other operating income increased for the year ended
December 31, 2002 largely as a result of increased service charges, mortgage
banking activity and investment in bank-owned life insurance. Other operating
expenses increased only slightly for the year ended December 31, 2002,
compared to the year earlier amount. However, as explained in the following
"Recent Developments and Significant Events" section of this discussion and
analysis and also in the "Comparison of Results of Operations for the Years
Ended December 31, 2002 and 2001," other operating expenses for the year ended
December 31, 2001 included a check kiting loss of $8.1 million, which was not
a factor in 2002. In addition, the Company's amortization expense for
goodwill decreased $3.2 million for the year ended December 31, 2002 with the
adoption of SFAS No. 142, which no longer requires amortization of goodwill.
Excluding the check kiting losses and adoption of SFAS No. 142, other
operating expense increased significantly compared to the year earlier
amounts, reflecting the continued growth of the Company, including the
acquisition of Oregon Business Bank, the opening of two new branch offices and
the strengthening of the Company's loan and deposit gathering and credit
administration capabilities.
Management's discussion and analysis of results of operations is intended to
assist in understanding the financial condition and results of operations of
the Company. The information contained in this section should be read in
conjunction with the Consolidated Financial Statements and accompanying Notes
to the Consolidated Financial Statements contained in Item 8 of this Form
10-K.
Recent Developments and Significant Events
Sale of $40 Million of Trust Preferred Securities: During fiscal 2002, the
Company completed the issuance of $40 million of trust preferred securities
(TPS) in two private placements of $25 million in April 2002 and $15 million
in December 2002. The TPS were issued by special purpose business trusts
owned by the Company and sold to pooled investment vehicles sponsored and
marketed by investment banking firms. The TPS have been recorded as a
liability on the statement of financial condition but qualify as Tier 1
capital for regulatory capital purposes. A portion of the proceeds from these
offerings was used to augment the Bank's capital with the remainder expected
to be used primarily to fund growth, including acquisitions. Remaining
proceeds may also be used to fund the Company's stock repurchase program and
for other general corporate purposes as necessary.
Under the terms of the transactions,