SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-22957
RIVERVIEW BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Washington 91-1838969
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
900 Washington St., Ste. 900,Vancouver, Washington 98660
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (360) 693-6650
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
value $.01 per share
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(Title of Class)
Indicate by check mark whether the Registrant (1) filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if there is no disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and disclosure will not
be contained, to the best of the Registrant's knowledge, in any definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendments to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
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
as quoted on the Nasdaq National Market System under the symbol "RVSB" on
September 30, 2002, was approximately $64,907,872 (4,284,348 shares at $15.15
per share). It is assumed for purposes of this calculation that none of the
Registrant's officers, directors and 5% stockholders (including the Riverview
Bancorp, Inc. Employee Stock Ownership Plan) are affiliates. As of May 15,
2003, there were issued and outstanding 4,358,704 shares of the Registrant's
common stock.
DOCUMENTS INCORPORATED BY REFERENCE
1.Portions of Registrant's Definitive Proxy Statement for the 2003 Annual
Meeting of Shareholders (Part III).
PART I
Item 1. Business
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General
Riverview Bancorp, Inc. ("Company"), a Washington corporation, was organized
on June 23, 1997 for the purpose of becoming the holding company for Riverview
Savings Bank FSB, upon the its reorganization as a wholly-owned subsidiary of
the Company resulting from the conversion of Riverview, M.H.C., Camas,
Washington, from a federal mutual holding company to a stock holding company
("Conversion and Reorganization"). The Conversion and Reorganization was
completed on September 30, 1997. Riverview Savings Bank, FSB changed its name
to Riverview Community Bank (the "Bank") effective June 29, 1998. At March
31, 2003, the Company had total assets of $419.9 million, total deposits of
$320.7 million and shareholders' equity of $54.5 million. All references to
the Company herein include the Bank where applicable.
The Bank is regulated by the Office of Thrift Supervision ("OTS"), its primary
regulator, and by the Federal Deposit Insurance Corporation ("FDIC"), the
insurer of its deposits. The Bank's deposits are insured by the FDIC up to
applicable legal limits under the Savings Association Insurance Fund ("SAIF").
The Bank has been a member of the Federal Home Loan Bank ("FHLB") system since
1937.
The Company is a progressive community-oriented, financial institution, which
emphasizes local, personal service to residents of its primary market area.
The Company considers Clark, Cowlitz, Klickitat and Skamania counties of
Washington as its primary market area. The Company is engaged primarily in the
business of attracting deposits from the general public and using such funds
in its primary market area to originate mortgage loans secured by one- to-
four family residential real estate, multi-family, commercial construction,
commercial real estate and non-mortgage loans providing financing for business
commercial ("commercial") and consumer purposes. Commercial real estate loans
and commercial loans have grown from 10.40% and 1.90% of the loan portfolio,
respectively, in fiscal 1999 to 30.02% and 10.11%, respectively, in fiscal
2003. The Company continues to change the composition of its loan portfolio
and the deposit base as part of its migration to commercial banking. The
consolidation among financial institutions in the Company's primary market
area has created a significant gap in the ability of the consolidated
financial institutions to serve customers. The Company's strategic plan
includes targeting this customer base, specifically small and medium size
businesses, professionals and wealth building individuals. In pursuit of
these goals, the Company will emphasize controlled growth and the
diversification of its loan portfolio to include a higher portion of
commercial and commercial real estate loans. A related goal is to increase
the proportion of personal and business checking account deposits used to fund
these new loans. Significant portions of these new loan products carry
adjustable rates, higher yields or shorter terms and higher credit risk than
the traditional fixed-rate mortgages. The strategic plan stresses increased
emphasis on non-interest income, including increased fees for asset management
and deposit service charges. The strategic plan is designed to enhance
earnings, reduce interest rate risk and provide a more complete range of
financial services to customers and the local communities the Company serves.
The Company is well positioned to attract new customers and to increase its
market share given that the administrative headquarters and eight of its
twelve branches are located in Clark County, the fastest growing county in the
state of Washington according to the U.S. Census Bureau.
In order to support its strategy of growth without compromising its local,
personal service to its customers and a commitment to asset quality, the
Company has made significant investments in experienced branch, lending, asset
management and support personnel and has incurred significant costs in
facility expansion. The Company's efficiency ratios reflect this investment
and will remain relatively high by industry standards for the foreseeable
future due to the emphasis on growth and local, personal service. Control of
non-interest expenses remains a high priority for the management of the
Company.
The Company continuously reviews new products and services to give its
customers more financial options. With an emphasis on growth of non-interest
income and control of non-interest expense, all new technology and services
are reviewed for business development and cost saving purposes. The Company
continues to experience growth in the
2
customer usage of the online banking services. Customers are able to conduct
a full range of services on a real-time basis, including balance inquiries,
transfers and electronic bill-paying. This online service has also enhanced
the delivery of cash management services to commercial customers. The
internet banking branch web site is www.riverviewbank.com.
Market Area
The Company conducts operations from its home office in Vancouver and twelve
branch offices in Camas, Washougal, Stevenson, White Salmon, Battle Ground,
Goldendale, Vancouver (five branch offices) and Longview, Washington. The
Company's market area for lending and deposit taking activities encompasses
Clark, Cowlitz, Skamania and Klickitat Counties, throughout the Columbia River
Gorge area. The Company operates a trust and financial services company,
Riverview Asset Management Corporation, located in downtown Vancouver,
Washington. Riverview Mortgage, a mortgage broker division of the Company,
originates mortgage loans (including construction loans) for various mortgage
companies predominantly in the Portland, Oregon metropolitan areas, as well as
for the Company. The Business and Professional Banking Division located at
the downtown Vancouver main branch offers commercial and business banking
services. Vancouver is located in Clark County, which is just north of
Portland, Oregon.
Several businesses are located in the Vancouver area because of the favorable
tax structure and lower energy costs in Washington as compared to Oregon.
Washington has no state income tax and Clark County operates a public electric
utility that provides relatively lower cost electricity. Located in the
Vancouver area are Sharp Microelectronics, Hewlett Packard, Georgia Pacific,
Underwriters Laboratory and Wafer Tech, as well as several support industries.
In addition to this industrial base, the Columbia River Gorge Scenic Area has
been a source of tourism, which has transformed the area from its past
dependence on the timber industry.
The Company has strong competition from many financial institutions for
deposits and loan originations.
Lending Activities
General. At March 31, 2003, the Company's total net loans receivable,
including loans held for sale, amounted to $301.8 million, or 71.9% of total
assets at that date. The principal lending activity of the Company is the
origination of residential mortgage loans through its mortgage banking
activities, including residential construction loans and loans collateralized
by commercial properties. While the Company has historically emphasized real
estate mortgage loans secured by one- to- four residential real estate, it has
been diversifying its loan portfolio by focusing on increasing the number of
originations of commercial, commercial real estate and consumer loans. A
substantial portion of the Company's loan portfolio is secured by real estate,
either as primary or secondary collateral, located in its primary market area.
Loan Portfolio Analysis. The following table sets forth the composition of
the Company's loan portfolio by type of loan at the dates indicated.
3
At March 31,
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2003 2002 2001 2000 1999
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Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Real estate loans:
One- to- four family(1) $59,999 17.72% $73,536 22.62% $117,152 35.67% $102,542 37.61% $83,275 39.03%
Multi-family 6,313 1.86 9,895 3.04 11,073 3.37 10,921 4.01 7,558 3.54
Construction one- to- four
family 70,397 20.79 71,148 21.89 60,041 18.28 49,338 18.10 45,524 21.34
Construction multi-family 2,100 0.62 4,000 1.23 4,514 1.37 4,669 1.71 4,209 1.97
Construction commercial 4,531 1.34 5,230 1.61 6,806 2.07 3,597 1.32 6,184 2.90
Land 34,630 10.23 27,406 8.43 24,230 7.38 25,475 9.34 24,932 11.68
Commercial real estate 101,672 30.02 84,094 25.87 56,540 17.21 42,871 15.72 22,181 10.40
------- ----- ------ ----- ------ ----- ------ ----- ------ -----
Total real estate loans 279,642 82.58 275,309 84.69 280,356 85.35 239,413 87.81 193,863 90.86
Commercial 34,239 10.11 23,319 7.17 23,099 7.03 15,976 5.87 4,049 1.90
Consumer loans:
Automobile loans 1,458 0.43 2,132 0.66 3,223 0.98 2,875 1.05 3,146 1.47
Savings account loans 319 0.09 515 0.16 440 0.13 356 0.13 490 0.23
Home equity loans 21,088 6.23 21,598 6.65 18,761 5.71 11,148 4.09 9,096 4.26
Other consumer loans 1,927 0.56 2,134 0.67 2,596 0.80 2,864 1.05 2,728 1.28
------- ----- ------ ----- ------ ----- ------ ----- ------ -----
Total consumer loans 24,792 7.31 26,379 8.14 25,020 7.62 17,243 6.32 15,460 7.24
Total loans and loans held
for sale 338,673 100.00% 325,007 100.00% 328,475 100.00% 272,632 100.00% 213,372 100.00%
Less: ====== ====== ====== ====== ======
Undisbursed loans in process 31,222 30,970 26,223 18,880 22,278
Unamortized loan origination
fees, net of direct cost 2,901 2,970 3,475 3,355 2,770
Unearned discounts - - - 1 1
Allowance for loan losses 2,739 2,537 1,916 1,362 1,146
Total loans receivable, ------- ------- ------- ------- -------
net(1) $301,811 $288,530 $296,861 $249,034 $187,177
======= ======= ======= ======= =======
(1) Includes loans held for sale of $1.5 million, $1.8 million, $569,000, none, and $341,000 at
March 31, 2003, 2002, 2001, 2000 and 1999 respectively.
4
One- to- Four Family Real Estate Lending. The majority of the residential
loans are secured by one- to four- family residences located in the Company's
primary market area. Underwriting standards require that one- to four- family
portfolio loans generally be owner occupied and that loan amounts not exceed
80% or (95% with private mortgage insurance) of the lesser of current
appraised value or cost of the underlying collateral. Terms typically range
from 15 to 30 years as well as balloon mortgage loans with terms of either
five or seven years. The Company originates both fixed rate mortgages and
adjustable rate mortgages ("ARMs") with repricing based on Treasury Bill or
other index. The ability to generate volume in ARMs, however, is largely a
function of consumer preference and the interest rate environment.
In addition to originating one- to- four family loans for its portfolio, the
Company is an active mortgage broker for several third party mortgage lenders.
In recent periods, such mortgage brokerage activities have reduced the volume
of fixed rate one- to- four family loans that are originated and sold by the
Company. See "-- Loan Originations, Sales and Purchases" and "-- Mortgage
Brokerage."
The Company generally sells fixed-rate mortgage loans with maturities of 15
years or more and balloon mortgages to the Federal Home Loan Mortgage
Corporation ("FHLMC"), servicing retained. See "-- Loan Originations, Sales
and Purchases" and " -- Mortgage Loan Servicing."
As a marketing incentive, the Company offers ARM loans with a discounted or
"teaser" rate of up to 1.25% below the normal rate offered. The borrower,
however, is qualified at the fully indexed rate. Annual and lifetime interest
rate caps are based on the initial discounted rate. "Teaser" rate loans are
subject to a prepayment penalty during the first three years of the loan term
if the borrower repays more than 20% of the outstanding principal balance per
year. During the first year, the penalty is 3% of the outstanding principal
balance; during year two, the penalty is 2% of the outstanding principal
balance; and during year three, the penalty is 1% of the outstanding principal
balance. The Company does not originate negative amortization loans.
The retention of ARM loans in the portfolio helps reduce the Company's
exposure to changes in interest rates. There are, however, unquantifiable
credit risks resulting from the potential of increased costs arising from
changed rates to be paid by the customer. It is possible that during periods
of rising interest rates the risk of default on ARM loans may increase as a
result of repricing and the increased costs to the borrower. Furthermore,
because "teaser" rate loans originated by the Company generally provide for
initial rates of interest below the rates which would apply were the
adjustment index used for pricing initially (discounting), these loans are
subject to increased risks of default or delinquency. Another consideration
is that although ARM loans allow the Company to increase the sensitivity of
its asset base to changes in interest rates, the extent of this interest
sensitivity is limited by the periodic and lifetime interest rate adjustment
limits. Because of these considerations, the Company has no assurance that
yields on ARM loans will be sufficient to offset increases in its cost of
funds.
While one- to- four family residential real estate loans typically are
originated with 30-year terms and the Company permits its ARM loans to be
assumed by qualified borrowers, such loans generally remain outstanding for
substantially shorter periods because borrowers often prepay their loans in
full upon sale of the property pledged as security or upon refinancing the
original loan. In addition, substantially all of the fixed interest rate
loans in the Company's loan portfolio contain due-on-sale clauses providing
that the Company may declare the unpaid amount due and payable upon the sale
of the property securing the loan. The Company enforces these due-on-sale
clauses to the extent permitted by law. Thus, average loan maturity is a
function of, among other factors, the level of purchase and sale activity in
the real estate market, prevailing interest rates and the interest rates
payable on outstanding loans.
The Company requires title insurance insuring the status of its lien on all of
the real estate secured loans and also requires that the fire and extended
coverage casualty insurance (and, if appropriate, flood insurance) be
maintained in an amount at least equal to the lesser of the loan balance and
the replacement cost of the improvements. Where the value of the unimproved
real estate exceeds the amount of the loan on the real estate, the Company may
make exceptions to its property insurance requirements.
Construction Lending. The Company actively originates three types of
residential construction loans: (i) speculative construction loans, (ii)
custom/presold construction loans and (iii) construction/permanent loans.
Subject to market
5
conditions, the Company intends to increase its residential construction
lending activities. To a lesser extent, the Company also originates
construction loans for the development of multi-family and commercial
properties.
At March 31, 2003 and 2002, the composition of the Company's construction loan
portfolio was as follows:
At March 31,
------------------------------------
2003 2002
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Amount(1) Percent Amount(1) Percent
-------- ------- -------- -------
(Dollars in thousands)
Speculative construction $ 32,379 33.24% $ 26,791 28.43%
Commercial/multi-family construction 10,750 11.04 13,605 14.44
Custom/presold construction 7,286 7.48 13,094 13.89
Construction/permanent 26,590 27.30 26,078 27.67
Construction/land 20,412 20.94 14,673 15.57
-------- ------- -------- -------
Total $ 97,417 100.00% $ 94,241 100.00%
======== ======= ======== =======
(1)Includes loans in process.
Speculative construction loans are made to home builders and are termed
"speculative" because the home builder does not have, at the time of loan
origination, a signed contract with a home buyer who has a commitment for
permanent financing with either the Company or another lender for the finished
home. The home buyer may be identified either during or after the
construction period, with the risk that the builder will have to debt service
the speculative construction loan and finance real estate taxes and other
carrying costs of the completed home for a significant time after the
completion of construction until the home buyer is identified. At March 31,
2003, the Company had one borrower with aggregate outstanding speculative loan
balances of more than $1.0 million, which totaled $2.3 million and were
performing according to original terms. At March 31, 2003, three speculative
construction loans to one borrower that totaled $300,300 were on non-accrual.
Unlike speculative construction loans, presold construction loans are made for
homes that have buyers. Presold construction loans are made to home builders
who, at the time of construction, have a signed contract with a home buyer who
has a commitment for permanent financing for the finished home with the
Company or another lender. Custom construction loans are made to the
homeowner. Custom/presold construction loans are generally originated for a
term of 12 months. At March 31, 2003, the largest short-term custom
construction loan and presold construction loan had outstanding balances of
$549,000 and $250,000, respectively, and were performing according to original
terms.
Construction/permanent loans are originated to the homeowner rather than the
home builder along with a commitment by the Company to originate a permanent
loan to the homeowner to repay the construction loan at the completion of
construction. The construction phase of a construction/permanent loan
generally lasts six to nine months. At the completion of construction, the
Company may either originate a fixed-rate mortgage loan or an ARM loan or use
its mortgage brokerage capabilities to obtain permanent financing for the
customer with another lender. At completion of construction, the Company-
originated fixed interest rate permanent loan's interest rate is set at a
market rate and for adjustable interest rate loans the interest rates adjust
on their first adjustment date. See "-- Mortgage Brokerage." See "-- Loan
Originations, Sales and Purchases" and "-- Mortgage Loan Servicing." At March
31, 2003, the largest outstanding construction/permanent loan had an
outstanding balance of $553,000 and was performing according to its original
terms.
The Company also provides construction financing for non-residential
properties (i.e., multi-family and commercial properties). The Company has
increased its commercial lending resources with the intent of increasing the
amount of commercial real estate loan balances such as construction commercial
and construction multi-family loans. Construction lending affords the Company
the opportunity to achieve higher interest rates and fees with shorter terms
to maturity than does its single-family permanent mortgage lending.
Construction lending, however, generally involves 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. The nature of these loans is such that they are
generally more difficult to evaluate and monitor. If the estimate of
construction cost proves to be inaccurate, the Company may be required to
advance funds beyond the amount originally committed to permit completion of
the project. If the estimate of
6
value upon completion proves to be inaccurate, the Company may be confronted
with a project whose value is insufficient to assure full repayment. Projects
may also be jeopardized by disagreements between borrowers and builders and by
the failure of builders to pay subcontractors. The Company has sought to
address these risks by adhering to strict underwriting policies, disbursement
procedures and monitoring practices. In addition, because the Company's
construction lending is in its primary market area, changes in the local
economy and real estate market could adversely affect the Company's
construction loan portfolio. Of the $10.8 million commercial construction
loans outstanding at March 31, 2003, the loan commitment amount ranged between
$560,000 and $4.5 million. At March 31, 2003, the largest outstanding
construction commercial loan had an outstanding balance of $2.2 million and
was performing according to its original terms.
Multi-Family Lending. Multi-family mortgage loans generally have terms which
range up to 25 years with maximum loan-to-value ratio up to 75%. Both fixed
and adjustable rate loans are offered with a variety of terms to meet the
multi-family residential financing needs. At March 31, 2003, the largest
multi-family mortgage had an outstanding loan balance of $2.5 million and was
performing according to original terms.
Multi-family mortgage lending affords the Company 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 usually
are greater in amount, more difficult to evaluate and monitor and, therefore,
involve a greater degree of risk than one- to- four family residential
mortgage loans. Because payments on loans secured by multi-family 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. The Company seeks to minimize these
risks by strictly scrutinizing the financial condition of the borrower, the
quality of the collateral and the management of the property securing the
loan. The Company also generally obtains personal guarantees from financially
capable parties based on a review of personal financial statements.
Land Lending. The Company originates loans to local real estate developers
with whom it has established relationships for the purpose of developing
residential subdivisions (i.e., installing roads, sewers, water and other
utilities), as well as loans to individuals to purchase building lots. Land
development loans are secured by a lien on the property and made for a period
not to exceed five years with an interest rate that adjusts with the prime
rate, and are made with loan-to-value ratios not exceeding 75%. Monthly
interest payments are required during the term of the loan. Subdivision loans
are structured so that the Company is repaid in full upon the sale by the
borrower of approximately 90% of the subdivision lots. All of the Company's
land loans are secured by property located in its primary market area. In
addition, the Company also generally obtains personal guarantees from
financially capable parties based on a review of personal financial
statements. At March 31, 2003, the largest outstanding land loan was $3.4
million and was performing according to original terms.
Loans secured by undeveloped land or improved lots involve greater risks than
one- to- four family residential mortgage loans because such loans are
advanced upon the predicted future value of the developed property. If the
estimate of such future value proves to be inaccurate, in the event of default
and foreclosure, the Company may be confronted with a property the value of
which is insufficient to assure full repayment. The Company attempts to
minimize this risk by limiting the maximum loan-to-value ratio on land loans
to 65% of the estimated developed value of the secured property. Loans on raw
land may run the risk of adverse zoning changes, environmental or other
restrictions on future use.
Commercial Real Estate Lending. The Company originates commercial real estate
loans at both variable and fixed interest rates and secured by properties,
such as office buildings, retail/wholesale facilities and industrial
buildings, located in its primary market area. The principal balance of an
average commercial real estate loan generally ranges between $100,000 and $1.0
million. At March 31, 2003, the largest commercial real estate loan had an
outstanding balance of $5.2 million and is secured by an office building
located in the Company's primary market area. At March 31, 2003, the loan was
performing according to its original terms.
Commercial real estate lending affords the Company 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 usually
are greater in amount, more difficult to evaluate and monitor and, therefore,
involve a greater degree of risk than one- to- four family residential
mortgage loans. Because payments on loans secured by commercial properties
often depend upon 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. The Company seeks to minimize these risks by
limiting the maximum loan-to-value ratio to
7
75% and strictly scrutinizing the financial condition of the borrower, the
quality of the collateral and the management of the property securing the
loan. At March 31, 2003, the Company had no commercial real estate loans
accounted for on a nonaccrual basis.
Commercial Lending. The Company's commercial loan portfolio has increased to
10.11% of the total loan portfolio at March 31, 2003 from 1.90% at March 31,
1999. The Company was able to increase the balance of outstanding commercial
loans and commitments due to the local economy, the consolidation of some
local competitors offering commercial loans and the hiring of several
experienced commercial bankers from competitors in the local market. The
commercial loan portfolio has grown from 7.17% at March 31, 2002 to 10.11% at
March 31, 2003.
Commercial loans are generally made to customers who are well known to the
Company and are typically secured by business equipment or other property. The
Company's commercial loans may be structured as term loans or as lines of
credit. Commercial term loans are generally made to finance the purchase of
assets and have maturities of five years or less. Commercial lines of credit
are typically made for the purpose of providing working capital and usually
approved with a term of one year or less. Lines of credit are made at
variable rates of interest equal to a negotiated margin above an index rate
and term loans are at a fixed rate. The Company also generally obtains
personal guarantees from financially capable parties based on a review of
personal financial statements.
Commercial lending involves greater risk than residential mortgage lending and
involves risks that are different from those associated with residential and
commercial real estate lending. Real estate lending is generally considered
to be collateral based lending with loan amounts based on predetermined loan
to collateral values and liquidation of the underlying real estate collateral
is viewed as the primary source of repayment in the event of borrower default.
Although commercial loans are often collateralized by equipment, inventory,
accounts receivable or other business assets including real estate, the
liquidation of collateral in the event of a borrower default is often an
insufficient source of repayment because accounts receivable may be
uncollectible and inventories and equipment may be obsolete or of limited use,
among other things. Accordingly, the repayment of a commercial loan depends
primarily on the creditworthiness of the borrower (and any guarantors), while
liquidation of collateral is a secondary and often insufficient source of
repayment. At March 31, 2003, the Company had no commercial loan accounted
for on a nonaccrual basis.
Consumer Lending. The Company originates a variety of consumer loans,
including home equity lines of credit, home equity term loans, home
improvement loans, loans for debt consolidation and other purposes, automobile
loans, boat loans and savings account loans.
Home equity lines of credit and home equity term loans are typically secured
by a second mortgage on the borrower's primary residence. Home equity lines of
credit are made at loan-to-value ratios of 90% or less, taking into
consideration the outstanding balance on the first mortgage on the property.
Home equity lines of credit have a variable interest rate while home equity
term loans have a fixed rate of interest. The Company's procedures for
underwriting consumer loans include an assessment of the applicant's payment
history on other debts and ability to meet existing obligations and payments
on the proposed loans. Although the applicant's creditworthiness is a primary
consideration, the underwriting process also includes a comparison of the
value of the security, if any, to the proposed loan amount.
Consumer loans generally entail greater risk than do residential mortgage
loans, particularly in the case of consumer loans that are unsecured or
secured by assets that depreciate rapidly, such as mobile homes, automobiles,
boats and recreational vehicles. In such cases, repossessed collateral for a
defaulted consumer loan may not provide an adequate source of repayment for
the outstanding loan and the remaining deficiency often does not warrant
further substantial collection efforts against the borrower. 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 the borrower against
the Company as the holder of the loan, and a borrower may be able to assert
claims and defenses, which it has against the seller of the underlying
collateral. At March 31, 2003, one consumer loan for $22,300 is on
non-accrual.
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Loan Maturity. The following table sets forth certain information at March
31, 2003 regarding the dollar amount of loans maturing in the Company's
portfolio based on their contractual terms to maturity, but does not include
potential prepayments. Demand loans, loans having no stated schedule of
repayments and no stated maturity and overdrafts are reported as due in one
year or less. Loan balances do not include unearned discounts, unearned
income and allowance for loan losses.
After
One After 3 After 5
Within Year to Years to Years to Beyond
One Year 3 Years 5 Years 10 Years 10 Years Total
-------- ------- ------- -------- -------- -------
(In thousands)
Residential one-to-four
family:
Adjustable rate $ - $ - $ 76 $ 504 $22,825 $23,405
Fixed rate 731 8,860 10,904 5,107 10,992 36,594
Construction:
Adjustable rate 49,377 23,322 - - - 72,699
Fixed rate 24,718 - - - - 24,718
Other real estate:
Adjustable rate 9,546 4,382 10,217 25,821 11,985 61,951
Fixed rate 5,910 14,641 17,840 18,021 3,863 60,275
Commercial:
Adjustable rate 22,277 429 1,593 519 - 24,818
Fixed rate 2,555 1,971 4,790 105 - 9,421
Consumer:
Adjustable rate 309 55 627 412 19,024 20,427
Fixed rate 446 1,175 1,141 307 1,296 4,365
------- ------ ------ ------ ------ -------
Total gross loans $115,869 $54,835 $47,188 $50,796 $69,985 $338,673
======= ====== ====== ====== ====== =======
The following table sets forth the dollar amount of all loans due one year
after March 31, 2003 which have fixed interest rates or have floating or
adjustable interest rates.
Fixed- Floating or
Rates Adjustable Rates
------ ----------------
(In thousands)
Residential one- to- four family $ 35,863 $ 23,405
Construction loans - 23,322
Other real estate loans 54,365 52,405
Commercial 6,866 2,541
Consumer 3,919 20,118
------- -------
Total $101,013 $121,791
======= =======
Scheduled contractual principal repayments of loans do not reflect the actual
life of such assets. The average life of a loan is substantially less than
its contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Company the right to declare loans
immediately due and payable in the event, among other things, that the
borrower sells the real property. The average life of mortgage loans tends to
increase, however, when current mortgage loan market rates are substantially
higher than rates on existing mortgage loans and, conversely, decrease when
rates on existing mortgage loans are substantially higher than current
mortgage loan market rates. Furthermore, management believes that a
significant number of the Company's residential mortgage loans are outstanding
for a period less than their contractual terms because of the transitory
nature of many of the borrowers who reside in its primary market area.
Loan Solicitation and Processing. The Company's lending activities are subject
to the written, non-discriminatory, underwriting standards and loan
origination procedures established by the Board of Directors and management.
The
9
customary sources of loan originations are realtors, walk-in customers,
referrals and existing customers. The Company also uses commissioned loan
brokers and print advertising to market its products and services.
The Company's loan approval process is intended to assess the borrower's
ability to repay the loan, the viability of the loan, the adequacy of the
value of the property that will secure the loan, and, in the case of
commercial and multi-family real estate loans, the cash flow of the project
and the quality of management involved with the project. The Company's lending
policy requires borrowers to obtain certain types of insurance to protect the
Company's interest in the collateral securing the loan. Loans are approved at
various levels of management, depending upon the amount of the loan.
Loan Commitments. The Company issues commitments to originate residential
mortgage loans, commercial real estate mortgage loans, consumer loans and
commercial loans conditioned upon the occurrence of certain events. The
Company uses the same credit policies in making commitments as it does for
on-balance sheet instruments. Commitments to extend credit are conditional,
and are honored for up to 45 days subject to the Company's usual terms and
conditions. Collateral is not required to support commitments. At March 31,
2003, the Company had outstanding commitments to originate loans in the amount
of $21.4 million.
Loan Originations, Sales and Purchases. While the Company originates
adjustable-rate and fixed-rate loans, its ability to generate each type of
loan depends upon relative customer demand for loans in its primary market
area. During the years ended March 31, 2003 and 2002, the Company's total
loan originations were $298.4 million and $273.9 million, respectively, of
which 63.2% and 61.8%, respectively, were subject to periodic interest rate
adjustment and 36.8% and 38.2%, respectively, were fixed-rate loans.
The Company customarily sells the fixed-rate residential one- to- four family
mortgage loans that it originates with maturities of 15 years or more to the
FHLMC as part of its asset liability strategy. The sale of such loans allows
the Company to continue to make loans during periods when savings flows
decline or funds are not otherwise available for lending purposes; however,
the Company assumes an increased risk if such loans cannot be sold in a rising
interest rate environment. Changes in the level of interest rates and the
condition of the local and national economies affect the amount of loans
originated by the Company and demanded by investors to whom the loans are
sold. Generally, the Company's residential one- to- four family mortgage loan
origination and sale activity and, therefore, its results of operations, may
be adversely affected by an increasing interest rate environment to the extent
such environment results in decreased loan demand by borrowers and/or
investors. Accordingly, the volume of loan originations and the profitability
of this activity can vary significantly from period to period. Mortgage loans
are sold to the FHLMC on a nonrecourse basis whereby foreclosure losses are
generally the responsibility of the FHLMC and not the Company. Servicing is
retained on loans sold to FHLMC.
Interest rates on residential one- to -four family mortgage loan applications
are typically locked during the application stage for periods ranging from 30
to 90 days, the most typical period being 45 days. These loans are locked
with FHLMC under a best-efforts delivery program. The Company makes every
effort to deliver these loans before their ratelocks expire. This arrangement
requires the Company to deliver the loans to FHLMC within ten days of funding.
Delays in funding the loans can require a lock extension. The cost of a lock
extension at times is borne by the borrower and at times by the Company.
These lock extension costs paid by the Company are not expected to have a
material impact to operations. This activity is managed daily.
There can be no assurance that the Company will be successful in its efforts
to reduce the risk of interest rate fluctuation between the time of
origination of a mortgage loan and the time of the ultimate sale of the loan.
To the extent that the Company does not adequately manage its interest rate
risk, the Company may incur significant mark-to-market losses or losses
relating to the sale of such loans, adversely affecting financial condition
and results of operations.
The Company is not an active purchaser of loans.
The following table shows total loans originated, sold and repaid during the
periods indicated.
10
For the Years Ended March 31,
------------------------------
2003 2002 2001
------ ------ ------
(In thousands)
Total net loans receivable and loans held
for sale at beginning of period $288,530 $296,861 $249,034
Loans originated: ------- ------- -------
Mortgage loans:
One- to- four family 45,004 40,398 23,978
Multi-family 6,936 219 1,087
Construction one- to- four family 87,049 81,809 71,602
Construction commercial real estate 3,267 14,585 9,345
Construction multi-family 2,597 - -
Land and commercial real estate 61,671 57,942 31,957
Commercial 68,083 55,213 47,426
Consumer 23,784 23,697 21,062
------- ------- -------
Total loans originated 298,391 273,863 206,457
Residential one- to- four family loans sold (56,097) (35,701) (7,563)
Repayment of principal (227,101) (203,466) (147,415)
Loans securitized - (40,347) -
Decrease in other items, net (1,912) (2,680) (3,652)
------- ------- -------
Net increase (decrease) in loans 13,281 (8,331) 47,827
Total net loans receivable and loans held ------- ------- -------
for sale at end of period $301,811 $288,530 $296,861
======= ======= =======
Mortgage Brokerage. In addition to originating mortgage loans for retention
in its portfolio, the Company employs nine commissioned brokers who originate
mortgage loans (including construction loans) for various mortgage companies
predominately in the Portland metropolitan area, as well as for the Company.
The loans brokered to such mortgage companies are closed in the name of and
funded by the purchasing mortgage company and are not originated as an asset
of the Company. In return, the Company receives a fee ranging from 1% to 1.5%
of the loan amount that it shares with the commissioned broker. Loans brokered
to the Company are closed on the Company's books as if the Company had
originated them and the commissioned broker receives a fee of approximately
0.50% of the loan amount. During the year ended March 31, 2003, brokered
loans totaled $200.3 million (including $77.7 million brokered to the
Company). Gross fees of $1.7 million (excluding the portion of fees shared
with the commissioned brokers) were recognized for the year ended March 31,
2003.
Mortgage Loan Servicing. The Company is a qualified servicer for the FHLMC.
The Company's general policy is to close its residential loans on the FHLMC
modified loan documents to facilitate future sales to the FHLMC. Upon sale,
the Company continues to collect payments on the loans, to supervise
foreclosure proceedings, if necessary, and otherwise to service the loans.
The Company generally retains the servicing rights on the fixed-rate mortgage
loans that it sells to the FHLMC. At March 31, 2003, total loans serviced for
others were $128.2 million.
In 1994, the Company purchased the servicing rights to an underlying portfolio
of residential mortgage loans secured by properties predominately located in
the Seattle metropolitan area. At March 31, 2003, the carrying value of these
purchased servicing rights was $30,000 and was being amortized over the life
of the underlying loan servicing.
Loan Origination and Other Fees. The Company generally receives loan
origination fees and discount "points." Loan fees and points are a
percentage of the principal amount of the loan that is charged to the borrower
for funding the loan. The Company usually charges origination fees of 1.5% to
2.0% on one- to- four family residential real estate loans, long-term
commercial real estate loans and residential construction loans. Commercial
loan fees are based on terms of the
11
individual loan. Current accounting standards require fees received for
originating loans to be deferred and amortized into interest income over the
contractual life of the loan. Deferred fees associated with loans that are
sold are recognized as gain on sale of loans. The Company had $2.9 million of
net deferred loan fees at March 31, 2003. The Company also receives loan
servicing fees on the loans it sells and on which it retains the servicing
rights. See Note 8 of Notes to Consolidated Financial Statements.
Delinquencies. The Company's collection procedures for all loans except
consumer loans provide for a series of contacts with delinquent borrowers. A
late charge delinquency notice is first sent to the borrower when the loan
secured by real estate becomes 17 days past due. A follow-up telephone call,
or letter if the borrower cannot be contacted by telephone, is made when the
loan becomes 22 days past due. A delinquency notice is sent to the borrower
when the loan becomes 30 days past due. When payment becomes 60 days past
due, a notice of default letter is sent to the borrower stating that
foreclosure proceedings will commence unless the delinquency is cured. If a
loan continues in a delinquent status for 90 days or more, the Company
generally initiates foreclosure proceedings. In certain instances, however,
the Company may decide to modify the loan or grant a limited moratorium on
loan payments to enable borrowers to reorganize their financial affairs.
A delinquent consumer loan borrower is contacted on the fifteenth day of
delinquency. A letter of intent to repossess collateral is mailed to the
borrower after the loan becomes 45 days past due and repossession proceedings
are initiated after the loan becomes 90 days delinquent.
Delinquencies in commercial loans are handled on a case by case basis.
Generally, notices are sent and personal contact is made with the borrower
when the loan is 15 days past due. Loan officers are responsible for
collecting loans they originate or are assigned to them. Depending on the
nature of the loan or type of collateral securing the loan, negotiations, or
other actions, are undertaken depending upon what the circumstances warrant.
Nonperforming Assets. Loans are reviewed regularly and it is the Company's
general policy that when a loan is 90 days delinquent or when collection of
interest appears doubtful, it is placed on nonaccrual status, at which time
the accrual of interest ceases and the reserve for any unrecoverable accrued
interest is established and charged against operations. Typically, payments
received on a nonaccrual loan are applied to the outstanding principal and
interest as determined at the time of collection of the loan.
Real estate owned is real estate acquired in settlement of loans and consists
of real estate acquired through foreclosure or deeds in lieu of foreclosure.
The acquired real estate is recorded at net realizable value. The Company
periodically reviews the property's net realizable value and a charge to
operations is taken if the property's recorded value exceeds the property's
net realizable value.
The following table sets forth information with respect to the Company's
nonperforming assets. At the dates indicated, the Company had no restructured
loans within the meaning of Statement of Financial Accounting Standards
("SFAS") No. 15.
12
At March 31,
--------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
(Dollars in thousands)
Loans accounted for on a nonaccrual
basis:
Residential real estate $ 301 $ 830 $ 153 $ 833 $1,052
Commercial real estate - 297 - - -
Land - 180 - 320 -
Commercial - 54 50 99 208
Consumer 22 39 116 26 33
------ ------ ------ ------ ------
Total 323 1,400 319 1,278 1,293
------ ------ ------ ------ ------
Accruing loans which are contractually
past due 90 days or more - 122 226 - 5
------ ------ ------ ------ ------
Total of nonaccrual and
90 days past due loans 323 1,522 545 1,278 1,298
------ ------ ------ ------ ------
Real estate owned (net) 425 853 473 65 30
------ ------ ------ ------ ------
Total nonperforming assets $ 748 $2,375 $1,018 $1,343 $1,328
====== ====== ====== ====== ======
Total loans delinquent 90 days
or more to net loans 0.11% 0.53% 0.18% 0.51% 0.69%
Total loans delinquent 90 days or
more to total assets 0.08 0.39 0.13 0.37 0.43
Total nonperforming assets to
total assets 0.18 0.61 0.24 0.39 0.44
The gross amount of interest income on the nonaccrual loans that would have
been recorded during the year ended March 31, 2003 if the nonaccrual loans had
been current in accordance with their original terms was approximately $6,000.
For the year ended March 31, 2003, no interest was earned on the nonaccrual
loans and included in interest and fees on loans receivable interest income.
Loans not included in nonperforming or past due categories, but where
information about possible credit problems causes management to be uncertain
about the borrower's ability to comply with existing repayment terms, totaled
$2.4 million at March 31, 2003 and $2.9 million at March 31, 2002.
Asset Classification. The OTS has adopted various regulations regarding
problem assets of savings institutions. The regulations require that each
insured institution review and classify its assets on a regular basis. In
addition, in connection with examinations of insured institutions, OTS
examiners have authority to identify problem assets and, if appropriate,
require them to be classified. There are three classifications for problem
assets: substandard, doubtful and loss. Substandard assets have one or more
defined weaknesses and are characterized by the distinct possibility that the
insured institution will sustain some loss if the deficiencies are not
corrected. Doubtful assets have the weaknesses of substandard assets with the
additional characteristic that the weaknesses make collection or liquidation
in full on the basis of currently existing facts, conditions and values
questionable, and there is a high possibility of loss. An asset classified as
loss is considered uncollectible and of such little value that continuance as
an asset of the institution is not warranted. If an asset or portion thereof
is classified as loss, the insured institution establishes specific allowances
for loan losses for the full amount of the portion of the asset classified as
loss. All or a portion of general loan loss allowances established to cover
possible losses related to assets classified substandard or doubtful can be
included in determining an institution's regulatory capital, while specific
valuation allowances for loan losses generally do not qualify as regulatory
capital. Assets that do not currently expose the insured institution to
sufficient risk to warrant classification in one of the aforementioned
categories but possess weaknesses are designated "special mention" and
monitored by the Company.
13
The aggregate amount of the Company's classified assets, general loss
allowances, specific loss allowances and charge-offs were as follows at the
dates indicated:
At or For the Year
Ended March 31,
2003 2002
------ ------
(In thousands)
Substandard assets $2,740 $3,724
Doubtful assets -
Loss assets - -
General loss allowances 2,739 2,537
Specific loss allowances - -
Charge-offs 428 439
The substandard assets at March 31, 2003 are consisted of three residential
construction loans totaling $316,000, one land loan totaling $100,000, two
commercial real estate loans totaling $212,000, one consumer loan totaling
$22,000 and thirteen commercial borrowers with loans totaling $2.1 million.
Real Estate Owned. Real estate properties acquired through foreclosure or by
deed-in-lieu of foreclosure are recorded at the lower of cost or fair value
less estimated costs of disposal. Management periodically performs valuations
and an allowance for loan losses is established by a charge to operations if
the carrying value exceeds the estimated net realizable value. At March 31,
2003, the Company owned three properties with a recorded value of $425,000
compared to $853,000 at March 31, 2002. The $425,000 recorded value consists
of two land loans totaling $70,000 and one one-to four-family loan of
$355,000.
Allowance for Loan Losses. The Company maintains an allowance for loan losses
to provide for losses inherent in the loan portfolio. The adequacy of the
allowance is evaluated monthly to maintain the allowance at levels sufficient
to provide for inherent losses. A key component to the evaluation is the
Company's internal loan review and loan classification system. The internal
loan review system provides for at least an annual review by the internal
audit department of all loans that meet selected criteria. The Internal Loan
Classification Committee reviews and monitors the risk and quality of the
Company's loan portfolio. The Internal Loan Classification Committee members
include the Credit Administrator, Chairman and Chief Executive Officer, Chief
Financial Officer, Executive Vice President Credit Administration and Senior
Vice President Business & Professional Banking. Credit officers are expected
to monitor their portfolios and make recommendations to change loan grades
whenever changes are warranted. At least annually, loans that are delinquent
60 days or more and with specified outstanding loan balances are subject to
review by the internal audit department. The Internal Loan Classification
Committee meets quarterly to approve any changes to loan grades, monitor loan
grades and to recommend any changes to the loan grades.
The Company uses the OTS loan classifications of special mention, substandard,
doubtful and loss plus the additional loan classifications of pass and watch
in order to assign a loan grade to be used in the determination of the proper
amount of allowance for loan losses. The definition of a pass classification
represents a level of credit quality, which contains no well-defined
deficiency or weakness. The definition of watch classification is used to
identify a loan that currently contains no well-defined deficiency or
weakness, but it is determined to be desirable to closely monitor the loan.
The Company uses the loan classifications from the internal loan review and
Internal Loan Classification Committee in the following manner to determine
the amount of the allowance for loan losses. The calculation of the allowance
for loan losses must consider loan classification in order to determine the
amount of the allowance for loan losses for the required three separate
elements of the allowance for losses: general allowances, allocated allowances
and unallocated allowances.
14
The general allowance element relates to assets with no well-defined
deficiency or weakness (i.e., assets classified pass or watch) and takes into
consideration loss that is imbedded within the portfolio but has not been
realized. Borrowers are impacted by events well in advance of a lender's
knowledge that may ultimately result in a loan default and eventual loss.
Examples of such loss-causing events in the case of consumer or one- to four-
family residential loans would be a borrower job loss, divorce or medical
crisis. Examples in commercial or construction loans may be loss of customers
due to competition or economy changes. General allowances for each major loan
type are determined by applying loss factors that take into consideration past
loss experience, asset duration, economic conditions and overall portfolio
quality to the associated loan balance.
The allocated allowance element relates to assets with well-defined
deficiencies or weaknesses (i.e., assets classified special mention,
substandard, doubtful or loss). The OTS loss factors are applied against
current classified asset balances to determine the amount of allocated
allowances. Included in these allowances are those amounts associated with
loans where it is probable that the value of the loan has been impaired and
the loss can be reasonably estimated.
The unallocated allowance element is more subjective and is reviewed quarterly
to take into consideration estimation errors and economic trends that are not
necessarily captured in determining the general and allocated valuation.
At March 31, 2003, the Company had an allowance for loan losses of $2.7
million, or 0.89% of total outstanding net loans at that date. Based on past
experience and probable losses inherent in the loan portfolio, management
believes that loan loss reserves are adequate.
While the Company believes it has established its existing allowance for loan
losses in accordance with accounting principles generally accepted in the
United States of America ("generally accepted accounting principles" or
"GAAP"), there can be no assurance that regulators, in reviewing the Company's
loan portfolio, will not request the Company to increase significantly its
allowance for loan losses, thereby negatively affecting the Company's
financial condition and results of operations. The following table sets forth
an analysis of the Company's allowance for loan losses for the periods
indicated.
15
Year Ended March 31,
--------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
(Dollars in thousands)
Balance at beginning of period $2,537 $1,916 $1,362 $1,146 $ 984
------ ------ ------ ------ ------
Provision for loan losses 727 1,116 949 675 240
Recoveries:
Residential real estate 2 - - - -
Land 63 - - - -
Commercial - - - 1 -
Consumer 13 25 18 28 7
------ ------ ------ ------ ------
Total recoveries 78 25 18 29 7
------ ------ ------ ------ ------
Charge-offs:
Residential real estate 140 88 226 48 28
Land 17 - - - -
Commercial 119 185 27 282 -
Consumer 152 166 160 158 57
------ ------ ------ ------ ------
Total charge-offs 428 439 413 488 85
------ ------ ------ ------ ------
Net charge-offs 350 414 395 459 78
------ ------ ------ ------ ------
Dispositions (1) - 81 - - -
Net change in allowance for unfunded
loan commitments and lines of credit (175) - - - -
------ ------ ------ ------ ------
Balance at end of period $2,739 $2,537 $1,916 $1,362 $1,146
====== ====== ====== ====== ======
Ratio of allowance to total net
loans outstanding during period 0.89% 0.86% 0.63% 0.54% 0.60%
Ratio of net charge-offs(recoveries)
to average net loans outstanding
during period 0.12 0.14 0.14 0.21 0.04
Ratio of allowance to total of
nonaccrual and 90 days past due
loans 847.99 166.69 351.56 106.58 88.30
Changes in the allowance for unfunded loan commitments and lines of credit:
Year Ended March 31,
--------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
(Dollars in thousands)
Beginning Balance $ - $ - $ - $ - $ -
Net change in allowance for unfunded
loan commitments and lines of credit 175 - - - -
------ ------ ------ ------ ------
Ending Balance $ 175 $ - $ - $ - $ -
====== ====== ====== ====== ======
(1) Allowance reclassified with securitization of one-to four-family loans to
mortgage-backed securities.
16
The following table sets forth the breakdown of the allowance for loan losses
by loan category and is based on applying a specific loan loss factor to the
related loan category outstanding loan balances as of the date of the
allocation for the periods indicated.
At March 31,
-------------------------------------------------------------------------------
2003 2002 2001 2000 1999
--------------- --------------- --------------- --------------- ---------------
Loan Loan Loan Loan Loan
Category Category Category Category Category
as a as a as a as a as a
Percent Percent Percent Percent Percent
of Total of Total of Total of Total of Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
(Dollars in thousands)
Real estate - mortgage
One -to-four family $ 122 19.50% $ 191 24.99% $ 263 38.73% $ 259 40.34% $ 218 43.51%
Multi-family 24 2.05 37 3.36 42 3.66 41 4.30 10 3.95
Construction one-to-four
family 194 14.24 319 14.77 224 13.57 304 13.50 292 16.18
Construction multi-family 5 0.30 20 1.25 21 0.19 10 1.29 10 1.11
Construction commercial 20 1.31 26 1.38 34 1.41 17 1.02 44 1.56
Land 196 10.36 192 8.79 206 7.83 223 9.62 32 11.91
Commercial real estate 1,046 33.05 869 28.58 580 18.69 224 16.86 180 11.59
Commercial loans 796 11.13 668 7.92 354 7.64 160 6.28 198 2.12
Consumer loans:
Secured 141 7.63 180 8.47 154 7.65 90 5.70 89 6.65
Unsecured 33 0.43 27 0.49 34 0.63 29 1.09 37 1.42
Unallocated 162 - 8 - 4 - 5 - 36 -
Total allowance for loan ----- ------ ----- ------ ----- ------ ----- ------ ----- ------
losses $2,739 100.00% $2,537 100.00% $1,916 100.00% $1,362 100.00% $1,146 100.00%
===== ====== ===== ====== ===== ====== ===== ====== ===== ======
17
Investment Activities
OTS regulated institutions have authority to invest in various types of liquid
assets, including U.S. Treasury obligations, securities of various federal
agencies and of state and municipal governments, deposits at the applicable
FHLB, certificates of deposit of federally insured institutions, certain
bankers' acceptances and federal funds. Subject to various restrictions, OTS
regulated institutions may also invest a portion of their assets in commercial
paper, corporate debt securities and mutual funds, the assets of which conform
to the investments that federally chartered savings institutions are otherwise
authorized to make directly.
Federal regulations require the Company to maintain a minimum sufficient
liquidity to ensure its safe and sound operation. Liquid assets include cash,
cash equivalents consisting of short-term interest-earning deposits, certain
other time deposits, and other obligations generally having remaining
maturities of less than five years. See "Regulation." It is the intention of
management to hold securities with short maturities in the Bank's and
Company's investment portfolio in order to match more closely the
interest-rate sensitivities of The Bank's and Company's assets and
liabilities. At March 31, 2003, the Bank's liquidity ratio, the ratio of cash
and eligible investments to the sum of withdrawable savings and borrowings due
within one year, was 12.25%.
The Investment Committee, composed of the Company's Chief Executive Officer
and Chief Financial Officer, makes investment decisions. The Company's
investment objectives are: (i) to provide and maintain liquidity within
regulatory guidelines; (ii) to maintain a balance of high quality, diversified
investments to minimize risk; (iii) to provide collateral for pledging
requirements; (iv) to serve as a balance to earnings; and (v) to optimize
returns. At March 31, 2003, the Company's investment and mortgage-backed
securities portfolio totaled approximately $36.8 million and consisted
primarily of obligations of federal agencies, and Federal National Mortgage
Association ("FNMA") and FHLMC mortgage-backed securities.
At March 31, 2003, the Company's investment securities portfolio did not
contain any tax-exempt securities of any issuer with an aggregate book value
in excess of 10% of the Company's consolidated shareholders' equity, excluding
those securities issued by the U.S. Government or its agencies.
The Board of Directors sets the investment policy of the Company which
dictates that investments be made based on the safety of the principal amount,
liquidity requirements of the Company and the return on the investments. At
March 31, 2003, no investment securities were held for trading. The policy
does not permit investment in non-investment grade bonds and permits
investment in various types of liquid assets permissible under OTS regulation,
which includes U.S. Treasury obligations, securities of various federal
agencies, "bank qualified" municipal bonds, certain certificates of deposits
of insured banks, repurchase agreements and federal funds.
The Company has adopted SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," which requires the classification of securities
at acquisition into one of three categories: held to maturity, available for
sale or trading. See Note 1 of Notes to Consolidated Financial Statements.
18
The following table sets forth the investment securities portfolio and
carrying values at the dates indicated. The fair value of the investment
and mortgage-backed securities portfolio was $36.9 million, $59.8 million and
$76.1 million at March 31, 2003, 2002 and 2001, respectively.
At March 31,
-----------------------------------------------------------------
2003 2002 2001
------------------- ------------------- -------------------
Carrying Percent of Carrying Percent of Carrying Percent of
Value Portfolio Value Portfolio Value Portfolio
-------- --------- -------- --------- -------- ---------
(Dollars in thousands)
Held to maturity (at amortized cost):
Real estate mortgage investment
conduits ("REMICs") $ 1,803 4.90% $ 1,804 3.02% $ 1,805 2.38%
FHLMC mortgage-backed securities 589 1.60 964 1.62 1,680 2.21
FNMA mortgage-backed securities 909 2.47 1,618 2.71 2,920 3.84
Municipal securities - - - - 861 1.13
-------- -------- -------- -------- -------- --------
3,301 8.97 4,386 7.35 7,266 9.56
Available for sale (at fair value): -------- -------- -------- -------- -------- --------
FHLB debentures - - - - 6,937 9.13
REMICs 6,421 17.45 25,114 42.10 40,943 53.90
FHLMC mortgage-backed securities 6,097 16.57 10,972 18.39 451 0.59
FNMA mortgage-backed securities 551 1.50 913 1.53 1,745 2.30
School district bonds 2,751 7.48 2,601 4.36 2,625 3.46
Trust preferred securities 4,975 13.52 - - - -
Equity securities 12,700 34.51 15,674 26.27 15,999 21.06
-------- -------- -------- -------- -------- --------
33,495 91.03 55,274 92.65 68,700 90.44
-------- -------- -------- -------- -------- --------
Total investment securities $36,796 100.00% $59,660 100.00% $75,966 100.00%
======== ======== ======== ======== ======== ========
The following table sets forth the maturities and weighted average yields in
the securities portfolio at March 1, 2003.
Less Than One to More Than Five More Than
One Year Five Years to Ten Years Ten Years
--------------- --------------- --------------- ---------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1)
------ -------- ------ -------- ------ -------- ------ --------
(Dollars in thousands)
Municipal securities $ - -% $ 982 4.06% $1,126 4.27% $ 643 4.77%
REMICs - - - - 811 2.38 7,413 2.86
FHLMC mortgage-backed securities - - 6,250 6.24 2 10.50 434 4.23
FNMA mortgage-backed securities 28 5.52 839 6.83 - - 593 4.77
Trust preferred securities - - - - - - 4,975 3.20
Equity securities - - - - - - 12,700 3.81
------ -------- ------ -------- ------ -------- ------ --------
Total $ 28 5.52% $8,071 6.03% $1,939 3.48% $26,758 3.48%
====== ======= ====== ======= ====== ======= ======= =======
(1) For available for sale securities carried at fair value, the weighted
average yield is computed using amortized cost. Average yield
calculations exclude equity securities that have no stated yield or maturity.
19
In addition to U.S. Government treasury obligations, the Company invests in
mortgage-backed securities and real estate mortgage investment conduits
("REMICs"). Mortgage-backed securities ("MBS") (which are also known as
mortgage participation certificates or pass-through certificates) represent a
participation interest in a pool of single-family or multi-family mortgages.
Principal and interest payments on mortgage-backed securities are passed from
the mortgage originators, through intermediaries (i.e., FNMA, FHLMC, the
Government National Mortgage Association ("GNMA") or private issues) that pool
and repackage the participation interests in the form of securities, to
investors such as the Company. Mortgage-backed securities generally increase
the quality of the Company's assets by virtue of the guarantees that back
them, are more liquid than individual mortgage loans and may be used to
collateralize borrowings or other obligations of the Company. See Note 4 of
Notes to Consolidated Financial Statements for additional information.
REMICs are created by redirecting the cash flows from the pool of mortgages or
mortgage-backed securities underlying these securities to create two or more
classes (or tranches) with different maturity or risk characteristics designed
to meet a variety of investor needs and preferences. Management believes
these securities may represent attractive alternatives relative to other
investments because of the wide variety of maturity, repayment and interest
rate options available. Current investment practices of the Company prohibit
the purchase of high risk REMICs. At March 31, 2003, the Company held REMICs
with a net carrying value of $8.2 million, of which $1.8 million were
classified as held-to-maturity and $6.4 million of which were available-for-
sale. REMICs may be sponsored by private issuers, such as mortgage bankers or
money center banks, or by U.S. Government agencies and government sponsored
entities. At March 31, 2003, the Company owned no privately issued REMICs.
Investments in mortgage-backed securities, including REMICs, involve a risk
that actual prepayments will be greater than estimated prepayments over the
life of the security, which may require adjustments to the amortization of any
premium or accretion of any discount relating to such instruments thereby
reducing the net yield on such securities. There is also reinvestment risk
associated with the cash flows from such securities. In addition, the market
value of such securities may be adversely affected by changes in interest
rates.
The investment in school district bonds was $2.8 million at March 31, 2003
compared to $2.6 million at March 31, 2002. Total equity securities investment
was $12.7 million at March 31, 2003, compared to $15.7 million at March 31,
2002.
In the second quarter of fiscal 2003, the Company purchased $5.0 million of
trust preferred securities which are a portion of the mezzanine tranche of a
$500.0 million pooled preferred trust securities indexed to the three month
libor interest rate.
In the fourth quarter of fiscal 2003, the Company recognized a $2.3 million
non-cash pre-tax charge to operations for investments in FHLMC preferred
stock and FNMA preferred stock. The Company accounts for these securities in
accordance with SFAS No. 115. Under SFAS No. 115, if the decline in fair
market value below cost is determined to be other-than-temporary, the
unrealized loss will be realized as expense on the income statement. Based on
a number of factors, including the magnitude of the drop in the market value
below the Company's cost and the length of time the market value had been
below cost, management concluded that the decline in value was
other-than-temporary at the end of the fourth quarter of fiscal year 2003.
Accordingly, the other-than-temporary impairment was realized in the income
statement, in the amount of $700,000 for FNMA preferred stock and $1.6 million
FHLMC preferred stock. A corresponding reduction in unrealized losses in
shareholders' equity was realized in the amount of $462,000 for FNMA preferred
stock and $1.1 million for FHLMC preferred stock.
Deposit Activities and Other Sources of Funds
General. Deposits, loan repayments and loan sales are the major sources of
the Company's funds for lending and other investment purposes. Loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows and loan prepayments are significantly influenced by general interest
rates and money market conditions. 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.
20
Deposit Accounts. Deposits are attracted from within the Company's primary
market area through the offering of a broad selection of deposit instruments,
including demand deposits, negotiable order of withdrawal ("NOW") accounts,
money market accounts, regular savings accounts, certificates of deposit and
retirement savings plans. Historically the Company has focused on retail
deposits. Expansion in commercial lending has led to growth in business
deposits including demand deposit accounts. 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 its deposit accounts, the Company considers the rates offered by
its competition, profitability to the Company, matching deposit and loan
products and its customer preferences and concerns. The Company generally
reviews its deposit mix and pricing weekly.
21
Deposit Balances
The following table sets forth information concerning the Company's
certificates of deposit, other interest-bearing and non-interest bearing
deposits at March 31, 2003.
Percent
Interest Minimum of Total
Rate Term Category Amount Balance Deposits
- -------- ---- --------------------- ------- ------- --------
(In thousands)
0.350% None NOW accounts $ 100 $27,113 8.45%
1.824 None High Yield checking 25,000 35,537 11.08
0.750 None Regular savings 500 24,855 7.75
1.011 None Money market 2,500 53,717 16.75
None None Non-interest checking 100 78,464 24.46
------- -----
Total transaction accounts 219,686 68.49
Certificates of Deposit
-----------------------
1.564 91 Days Fixed-term, Fixed-rate 2,500 9,510 2.96
1.455 182-364 Days Fixed-term, Fixed-rate 2,500 13,592 4.24
2.055 12-17 Months Fixed-term, Fixed-rate 2,500 35,034 10.92
1.380 18 Months Fixed-term, Variable
rate, Individual
Retirement account
("IRA") 100 1,149 0.36
2.314 18-23 Months Fixed-term, Fixed-rate 2,500 2,518 0.79
3.304 24-35 Months Fixed-term, Fixed-rate 2,500 19,834 6.18
4.798 36-59 Months Fixed-term, Fixed-rate 2,500 6,404 2.00
5.353 60-83 Months Fixed-term, Fixed-rate 2,500 10,137 3.16
5.228 84-120 Months Fixed-term, Fixed-rate 2,500 2,878 0.90
------- -----
Total certificates of deposit 101,056 31.51%
------- -----
Total deposits $320,742 100.00%
======= ======
22
Deposit Flow
The following table sets forth the balances of deposit accounts in the
various types offered by the Company at the dates indicated.
At March 31,
----------------------------------------------------------------------------
2003 2002 2001
------------------------ ------------------------ ------------------------
Increase/ Increase/ Increase/
Balance Percent Decrease) Balance Percent Decrease) Balance Percent Decrease)
------- ------- -------- ------- ------- -------- ------- ------- --------
(Dollars in thousands)
Non-interest-bearing demand $78,464 24.46% $ 45,890 $32,574 12.54% $ 4,639 $27,935 9.45% $ 3,194
NOW accounts 27,113 8.45 (5,597) 32,710 12.60 567 32,143 10.88 11,167
High-yield checking 35,537 11.08 30,183 5,354 2.06 5,354 - - -
Regular savings accounts 24,855 7.75 2,916 21,939 8.45 3,112 18,827 6.37 (1,013)
Money market deposit accounts 53,717 16.75 (928) 54,645 21.04 8,921 45,724 15.47 1,104
Certificates of deposits which
mature(1):
Within 12 months 71,155 22.19 (15,784) 86,939 33.48 (55,084) 142,023 48.06 48,149
Within 12-36 months 22,619 7.05 3,249 19,370 7.46 (4,303) 23,673 8.01 897
Beyond 36 months 7,282 2.27 1,123 6,159 2.37 961 5,198 1.76 (330)
------- ------- -------- ------- ------- -------- ------- ------- --------
Total $320,742 100.00% $ 61,052 $259,690 100.00% $(35,833)$295,523 100.00% $ 63,168
======= ====== ======== ======= ====== ======== ======= ====== ========
__________________
(1) IRAs of $12.9 million, $12.8 million and $12.8 million at March 31,
2003, 2002 and 2001, respectively, are included in certificate balances.
Certificates of Deposit by Rates and Maturities
The following table sets forth the certificates of deposit in the Company
classified by rates as of the dates indicated.
At March 31,
--------------------------
2003 2002 2001
------ ------ ------
(In thousands)
Below 2.00% $43,969 $14,919 $ -
2.00 - 2.99% 17,483 30,028 -
3.00 - 3.99% 18,770 24,390 40
4.00 - 4.99% 7,452 13,014 5,772
5.00 - 5.99% 7,058 10,717 45,544
6.00 - 7.99% 6,324 19,400 119,538
------ ------ ------
Total $101,056 $112,468 $170,894
======= ======= =======
The following table sets forth the amount and maturities of certificates of
deposit at March 31, 2003.
Amount Due
--------------------------------------------------
Less Than 1-2 After After
One Year Years 2-3 Years 3 Years Total
-------- ------- --------- ------- -------
(In thousands)
Below 2.00% $ 39,225 $ 4,176 $ 500 $ 68 $ 43,969
2.00 - 2.99% 10,943 4,529 1,998 13 17,483
3.00 - 3.99% 12,755 4,399 391 1,225 18,770
4.00 - 4.99% 3,217 1,161 888 2,186 7,452
5.00 - 5.99% 2,086 790 780 3,402 7,058
6.00 - 7.99% 2,929 1,697 1,310 388 6,324
-------- ------- --------- ------- -------
Total $ 71,155 $16,752 $ 5,867 $ 7,282 $101,056
======== ======= ========= ======= =======
The following table presents the amount and weighted average rate of time
deposits equal to or greater than $100,000 at March 31, 2003.
Weighted
Maturity Period Amount Average Rate
- --------------- -------- ------------
(Dollars in thousands)
Three months or less $ 12,751 2.46%
Over three through six months 4,675 2.49
Over six through 12 months 4,309 2.69
Over 12 Months 8,552 4.21
-------- ------
Total $ 30,287 2.99%
======== ======
24
Deposit Activities
The following table sets forth the deposit activities of the Company for the
periods indicated.
Year Ended March 31,
--------------------------
2003 2002 2001
------ ------ ------
(In thousands)
Beginning balance $259,690 $295,523 $232,355
Net (decrease) increase
before interest credited 55,535 (44,789) 52,002
Interest credited 5,517 8,956 11,166
Net (decrease) increase in ------ ------ ------
savings deposits 61,052 (35,833) 63,168
------ ------ ------
Ending balance $320,742 $259,690 $295,523
======= ======= =======
In the unlikely event the Company is liquidated, depositors are entitled to
full payment of their deposit accounts prior to any payment being made to the
shareholders of the Company. Substantially all of the Bank's depositors are
residents of the States of Washington or Oregon.
Borrowings. Savings deposits are the primary source of funds for the
Company's lending and investment activities and for its general business
purposes. The Company relies upon advances from the FHLB-Seattle to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. Advances from the FHLB-Seattle are typically secured by the
Company's first mortgage loans and investment securities.
The FHLB functions as a central reserve bank providing credit for savings and
loan associations and certain other member financial institutions. As a
member, the Bank is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its mortgage loans and other assets (principally securities which are
obligations of, or guaranteed by, the United States) provided certain
standards related to creditworthiness have been met. Advances are made
pursuant to several different programs. Each credit program has its own
interest rate and range of maturities. Depending on the program, limitations
on the amount of advances are based either on a fixed percentage of an
institution's assets or on the FHLB's assessment of the institution's
creditworthiness. The FHLB determines specific lines of credit for each member
institution and the Bank has a 35% of total assets line of credit with the
FHLB-Seattle to the extent the Bank provides qualifying collateral and holds
sufficient FHLB stock. At March 31, 2003, the Bank had $40.0 million of
outstanding advances from the FHLB-Seattle under an available credit facility
of $104.9 million.
The following tables set forth certain information concerning the Company's
borrowings at the dates and for the periods indicated.
At March 31,
--------------------------
2003 2002 2001
------ ------ ------
Weighted average rate paid on
FHLB advances 4.90% 6.10% 6.62%
25
Year Ended March 31,
--------------------------
2003 2002 2001
------ ------ ------
(Dollars in thousands)
Maximum amounts of FHLB advances
outstanding at any month end $74,500 $99,500 $80,000
Average FHLB advances outstanding 53,174 89,499 72,825
Weighted average rate paid on
FHLB advances 5.53% 6.25% 6.79%
REGULATION
General
The Bank is subject to extensive regulation, examination and supervision by
the OTS as its chartering agency, and the FDIC, as the insurer of its
deposits. The activities of federal savings institutions are governed by the
Home Owners Loan Act and, in certain respects, the Federal Deposit Insurance
Act ("FDIA"), and the regulations issued by the OTS and the FDIC to implement
these statutes. These laws and regulations delineate the nature and extent of
the activities in which federal savings associations may engage. Lending
activities and other investments must comply with various statutory and
regulatory capital requirements. In addition, the Bank's relationship with
its depositors and borrowers is also regulated to a great extent, especially
in such matters as the ownership of deposit accounts and the form and content
of the Bank's mortgage documents.
The Bank is required to file reports with the OTS and the FDIC concerning its
activities and financial condition in addition to obtaining regulatory
approvals prior to entering into certain transactions such as mergers with, or
acquisitions of, other financial institutions. There are periodic
examinations by the OTS and the FDIC to review the Bank's compliance with
various regulatory requirements. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes. Any change in such
policies, whether by the OTS, the FDIC or Congress, could have a material
adverse impact on the Company, the Bank and their operations.
Federal Regulation of Savings Associations
Office of Thrift Supervision. The OTS is an office in the Department of the
Treasury subject to the general oversight of the Secretary of the Treasury.
The OTS has extensive authority over the operations of savings associations.
Among other functions, the OTS issues and enforces regulations affecting
federally insured savings associations and regularly examines these
institutions.
All savings associations are required to pay assessments to the OTS to fund
the agency's operations. The general assessments, paid on a semi-annual
basis, are determined based on the savings association's total assets,
including consolidated subsidiaries. The Bank's OTS assessment for the fiscal
year ended March 31, 2003 was $90,905.
Federal Home Loan Bank System. The FHLB System, consisting of 12 FHLBs, is
under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The
designated duties of the FHFB are to supervise the FHLBs, to ensure that the
FHLBs carry out their housing finance mission, to ensure that the FHLBs remain
adequately capitalized and able to raise funds in the capital markets, and to
ensure that the FHLBs operate in a safe and sound manner.
The Bank, as a member of the FHLB-Seattle, is required to acquire and hold
shares of capital stock in the FHLB-Seattle in an amount equal to the greater
of (i) 1.0% of the aggregate outstanding principal amount of residential
26
mortgage loans, home purchase contracts and similar obligations at the
beginning of each year, or (ii) 1/20 of its advances (i.e., borrowings) from
the FHLB-Seattle. The Bank is in compliance with this requirement with an
investment in FHLB-Seattle stock of $5.6 million at March 31, 2003.
Among other benefits, the FHLB provides a central credit facility primarily
for member institutions. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It makes advances to
members in accordance with policies and procedures established by the FHFB and
the Board of Directors of the FHLB-Seattle.
The FHLBs are required to provide funds for the resolution of troubled savings
institutions and to contribute to affordable housing programs through direct
loans or interest subsidies on advances targeted for community investment and
low- and moderate-income housing projects. These contributions have adversely
affected the level of FHLB dividends paid in the past and could do so in the
future. These contributions also could have an adverse effect on the value of
FHLB stock in the future.
Federal Deposit Insurance Corporation. The FDIC is an independent federal
agency established originally to insure the deposits, up to prescribed
statutory limits, of federally insured banks and to preserve the safety and
soundness of the banking industry. The FDIC maintains two separate insurance
funds: the Bank Insurance Fund ("BIF") and the SAIF. The Bank's deposit
accounts are insured by the FDIC under the SAIF to the maximum extent
permitted by law. As insurer of the Bank's deposits, the FDIC has
examination, supervisory and enforcement authority.
As insurer, the FDIC imposes deposit insurance premiums and is authorized to
conduct examinations of and to require reporting by FDIC-insured institutions.
It also may prohibit any FDIC-insured institution from engaging in any
activity the FDIC determines by regulation or order to pose a serious risk to
the SAIF or the BIF. The FDIC also has the authority to initiate enforcement
actions against savings institutions, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines
that the institution has engaged in unsafe or unsound practices or is in an
unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based system
under which all insured depository institutions are placed into one of nine
categories and assessed insurance premiums based upon their level of capital
and supervisory evaluation. Under the system, institutions classified as well
capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1, or
core capital, to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered
healthy pay the lowest premium while institutions that are less than
adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less
than 4% or a risk-based capital ratio of less than 8%) and considered of
substantial supervisory concern pay the highest premium. The FDIC makes risk
classification of all insured institutions for each semi-annual assessment
period.
The FDIC is authorized to increase assessment rates, on a semi-annual basis,
if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the United States Treasury or for any other reason
deemed necessary by the FDIC.
The premium schedule for BIF and SAIF insured institutions rangesfrom 0 to 27
basis points. However, SAIF insured institutions and BIF insured institutions
are required to pay a Financing Corporation assessment in order to fund the
interest on bonds issued to resolve thrift failures in the 1980s. This amount
is currently equal to about 1.88 basis points for each $100 in domestic
deposits for SAIF and BIF insured institutions. These assessments, which may
be revised based upon the level of BIF and SAIF deposits, will continue until
the bonds mature in 2017 through 2019.
Under the FDIA, insurance of deposits may be terminated by the FDIC upon a
finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated
27
any applicable law, regulation, rule, order or condition imposed by the FDIC
or the OTS. Management of the Bank does not know of any practice, condition
or violation that might lead to termination of deposit insurance.
Liquidity Requirements. Federal regulations require the Bank to maintain
sufficient liquidity to ensure its safe and sound operation. Liquid assets
include cash, cash equivalents consisting of short-term interest-earning
deposits, certain other time deposits and other obligations generally having
remaining maturities of less than five years. Liquidity management is both a
daily and long-term responsibility of management. The Company adjusts liquid
assets based upon management's assessment of (i) expected loan demand, (ii)
expected deposit flows, (iii) yields available on interest-bearing deposits,
and (iv) the objectives of its asset/liability management program.
Prompt Corrective Action. The OTS is required to take certain supervisory
actions against undercapitalized savings associations, the severity of which
depends upon the institution's degree of undercapitalization. Generally, an
institution that has a ratio of total capital to risk-weighted assets of less
than 8%, a ratio of Tier I (core) capital to risk-weighted assets of less than
4% or a ratio of core capital to total assets of less than 4% (3% or less for
institutions with the highest examination rating) is considered to be
undercapitalized. An institution that has a total risk-based capital ratio
less than 6%, a Tier I capital ratio of less than 3% or a leverage ratio that
is less than 3% is considered to be significantly undercapitalized and an
institution that has a tangible capital to assets ratio equal to or less than
2% is deemed to be critically undercapitalized. Subject to a narrow
exception, the OTS is required to appoint a receiver or conservator for a
savings institution that is critically undercapitalized.
At March 31, 2003, the Bank was categorized as "well capitalized" under the
prompt corrective action regulations of the OTS.
Standards for Safety and Soundness. The federal banking regulatory agencies
have prescribed, by regulation, standards for all insured depository
institutions 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 ("Guidelines"). 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 OTS determines that the
Bank fails to meet any standard prescribed by the Guidelines, the OTS may
require the Bank to submit to it an acceptable plan to achieve compliance with
the standard. Management is aware of no conditions relating to these safety
and soundness standards which would require submission of a plan of
compliance.
Qualified Thrift Lender Test. All savings associations, including the Bank,
are required to meet a qualified thrift lender ("QTL") test to avoid certain
restrictions on their operations. This test requires a savings association to
have at least 65% of its portfolio assets (as defined by regulation) in
qualified thrift investments on a monthly average for nine out of every 12
months on a rolling basis. As an alternative, the savings association may
maintain 60% of its assets in those assets specified in Section 7701(a)(19) of
the Internal Revenue Code ("Code"). Under either test, such assets primarily
consist of residential housing related loans and investments. At March 31,
2003, the Bank met the test and its QTL percentage was 75.65%.
Any savings association that fails to meet the QTL test must convert to a
national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and
is subject to national bank limits for payment of dividends. If such
association has not requalified or converted to a national bank within three
years after the failure, it must divest of all investments and cease all
activities not permissible for a national bank. In addition, it must repay
promptly any outstanding FHLB borrowings, which may result in prepayment
penalties. If any association that fails the QTL test is controlled by a
holding company, then within one year after the failure, the holding company
must register as a bank holding company and become subject to all restrictions
on bank holding companies. See "- Savings and Loan Holding Company
Regulations."
28
Capital Requirements. Federally insured savings associations, such as the
Bank, are required to maintain a minimum level of regulatory capital. The OTS
has established capital standards, including a tangible capital requirement, a
leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings associations.
The capital regulations require tangible capital of at least 1.5% of adjusted
total assets, as defined by regulation. At March 31, 2003, the Bank had
tangible capital of $48.2 million, or 11.66% of adjusted total assets, which
is approximately $42.0 million above the minimum requirement of 1.5% of
adjusted total assets in effect on that date. At March 31, 2003, the Bank had
$369,000 in core deposit intangible and $629,000 in servicing assets.
The capital standards also require core capital equal to at least 3% to 4% of
adjusted total assets, depending on an institution's supervisory rating. Core
capital generally consists of tangible capital. At March 31, 2003, the Bank
had core capital equal to $48.2 million, or 11.66% of adjusted total assets,
which is $35.8 million above the minimum leverage ratio requirement of 3% as
in effect on that date.
The OTS risk-based requirement requires savings associations to have total
capital of at least 8% of risk-weighted assets. Total capital consists of core
capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances
up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be
used to satisfy the risk-based requirement only to the extent of core capital.
In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet items, are multiplied by a risk weight, ranging from
0% to 100%, based on the risk inherent in the type of asset. For example, the
OTS has assigned a risk weight of 50% for prudently underwritten permanent
one- to- four family first lien mortgage loans not more than 90 days
delinquent and having a loan-to-value ratio of not more than 80% at
origination unless insured to such ratio by an insurer approved by FNMA or
FHLMC.
On March 31, 2003, the Bank had total risk-based capital of approximately
$50.9 million, including $48.2 million in core capital and $2.7 million in
qualifying supplementary capital, and risk-weighted assets of $320.4 million,
or total capital of 15.89% of risk-weighted assets. This amount was $25.3
million above the 8% requirement in effect on that date.
The OTS and the FDIC are authorized and, under certain circumstances required,
to take certain actions against savings associations that fail to meet their
capital requirements. The OTS is generally required to take action to restrict
the activities of an "undercapitalized association," which is an institution
with less than either a 4% core capital ratio, a 4% Tier 1 risked-based
capital ratio or an 8% risk-based capital ratio. Any such association must
submit a capital restoration plan and until such plan is approved by the OTS
may not increase its assets, acquire another institution, establish a branch
or engage in any new activities, and generally may not make capital
distributions. The OTS is authorized to impose the additional restrictions
that are applicable to significantly undercapitalized associations.
The OTS is also generally authorized to reclassify an association into a lower
capital category and impose the restrictions applicable to such category if
the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on the Bank or
the Company may have a substantial adverse effect on their operations and
profitability.
Limitations on Capital Distributions. The OTS regulations impose various
restrictions on savings associations with respect to their ability to make
distributions of capital, which include dividends, stock redemptions or
repurchases, cash-out mergers and other transactions charged to the capital
account.
Generally, savings institutions, such as the Bank, that before and after the
proposed distribution remain well-capitalized, may make capital distributions
during any calendar year equal to the greater of 100% of net income
29
for the year-to-date plus retained net income for the two preceding years.
However, an institution deemed to be in need of more than normal supervision
by the OTS may have its dividend authority restricted by the OTS. The Bank may
pay dividends in accordance with this general authority.
Savings institutions proposing to make any capital distribution need only
submit written notice to the OTS 30 days prior to such distribution. Savings
institutions that do not, or would not meet their current minimum capital
requirements following a proposed capital distribution, however, must obtain
OTS approval prior to making such distribution. The OTS may object to the
distribution during that 30-day period based on safety and soundness concerns.
See "Capital Requirements."
Loans to One Borrower. Federal law provides that savings institutions are
generally subject to the national bank limit on loans to one borrower. A
savings institution may not make a loan or extend credit to a single or
related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10% of unimpaired capital
and surplus, if secured by specified readily-marketable collateral. At March
31, 2003, the Bank's internal limit was 80% of the regulatory limit on loans
to one borrower or $6.1 million. At March 31, 2003, the Bank's largest single
loan to one borrower was $5.8 million, which was performing according to its
original terms.
Activities of Associations and Their Subsidiaries. When a savings association
establishes or acquires a subsidiary or elects to conduct any new activity
through a subsidiary that the association controls, the savings association
must notify the FDIC and the OTS 30 days in advance and provide the
information each agency may, by regulation, require. Savings associations
also must conduct the activities of subsidiaries in accordance with existing
regulations and orders.
The OTS may determine that the continuation by a savings association of its
ownership control of, or its relationship to, the subsidiary constitutes a
serious risk to the safety, soundness or stability of the association or is
inconsistent with sound banking practices or with the purposes of the FDIA.
Based upon that determination, the FDIC or the OTS has the authority to order
the savings association to divest itself of control of the subsidiary. The
FDIC also may determine by regulation or order that any specific activity
poses a serious threat to the SAIF. If so, it may require that no SAIF member
engage in that activity directly.
Transactions with Affiliates. Generally, transactions between a savings
association or its subsidiaries and its affiliates are required to be on terms
as favorable to the association as transactions with non-affiliates. In
addition, certain of these transactions, such as loans to an affiliate, are
restricted to a percentage of the association's capital. Affiliates of the
Bank include the Company and any company which is under common control with
the Bank. In addition, a savings association may not lend to any affiliate
engaged in activities not permissible for a bank holding company or acquire
the securities of most affiliates. The OTS has the discretion to treat
subsidiaries of savings associations as affiliates on a case by case basis.
Certain transactions with directors, officers or controlling persons are also
subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions
on loans to such persons and their related interests. Among other things,
such loans must be made on terms substantially the same as for loans to
unaffiliated individuals.
Community Reinvestment Act. Under the federal Community Reinvestment Act
("CRA"), all federally-insured financial institutions have a continuing and
affirmative obligation consistent with safe and sound operations to help meet
all the credit needs of their delineated communities. The CRA does not
establish specific lending requirements or programs nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to meet all the credit needs of its delineated
community. The CRA requires the federal banking agencies, in connection with
regulatory examinations, to assess an institution's record of meeting the
credit needs of its delineated community and to take this record into account
in evaluating regulatory applications 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, among others. The CRA requires public
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disclosure of an institution's CRA rating. The Bank received a "satisfactory"
rating as a result of its latest evaluation.
Regulatory and Criminal Enforcement Provisions. The OTS has primary