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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: 0-22953
OREGON TRAIL FINANCIAL CORP.
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(Exact name of registrant as specified in its charter)
Oregon 91-1829481
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
2055 First Street, Baker City, Oregon 97814
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (541) 523-6327
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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) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES NO X
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Indicate by check mark whether disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or
other information statements incorporated by reference in Part III of this
Form 10-K or any amendments to this Form 10-K. YES X NO
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As of April 14, 2003, there were issued and outstanding 3,107,692 shares
of the Registrant's Common Stock. The Registrant's voting stock is traded
over-the-counter and is listed on the Nasdaq National Market under the symbol
"OTFC." 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 on April 14, 2003 of $23.10, was
$71,787,685.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Registrant's Annual Report to Shareholders for the
Fiscal Year Ended March 31, 2003 ("Annual Report") (Parts I and II).
PART I
Item 1. Business
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General
Oregon Trail Financial Corp. ("Company"), an Oregon corporation, was
organized on June 9, 1997 for the purpose of becoming the holding company for
Pioneer Bank, A Federal Savings Bank ("Bank") upon the Bank's conversion from
a federal mutual to a federal stock savings bank ("Conversion"). The
Conversion was completed on October 3, 1997. At March 31, 2003, the Company
had total assets of $377.5 million, total deposits of $249.1 million and
shareholders' equity of $60.1 million. All references to the Company herein
include the Bank where applicable.
The Bank was organized in 1901. The Bank is regulated by the Office of
Thrift Supervision ("OTS") and its deposits are insured up to applicable
limits under the Savings Association Insurance Fund ("SAIF") of the Federal
Deposit Insurance Corporation ("FDIC"). The Bank also is a member of the
Federal Home Loan Bank ("FHLB") System.
The Bank is a community oriented financial institution whose principal
business is attracting retail deposits from the general public and using these
funds to originate one- to- four family residential mortgage loans and
consumer loans within its primary market area. The Bank also actively
originates home equity and second mortgage loans. Beginning in 1996, the Bank
began supplementing its traditional lending activities with commercial
business loans, agricultural loans, and the purchase of dealer-originated
automobile contracts.
In addition to its lending activities, the Bank invests excess liquidity
in short to long term U.S. Government and government agency securities and
mortgage-backed and related securities issued by U.S. Government agencies.
Investment securities and mortgage-backed and related securities constituted
28.6% of total assets at March 31, 2003. See "-- Investment Activities."
Market Area
The Bank's primary market area encompasses those regions surrounding its
offices in Baker, Grant, Harney, Malheur, Union, Wallowa, Wheeler and Umatilla
Counties in Oregon and Payette and Washington Counties in Idaho. The Bank's
home office is located in Baker City, Oregon with branches in Ontario, John
Day, Burns, Enterprise, La Grande, Island City, Vale, and Pendleton.
The principal industries of the market area are agriculture and timber
products. The Bank's market area is largely rural, with most of the farms and
ranches being relatively small and family owned. The local economies are also
dependent on retail trade with lumber, recreation and tourism providing
substantial contributions. Major employers in the market area include
Confederated Tribes of the Umatilla Indians, Eastern Oregon Correctional
Institute, Fleetwood Homes, St. Anthony's Hospital, U.S. Forest Service,
Bureau of Land Management, Snake River Correctional Institute, Oregon
Department of Transportation, Boise Cascade, Ore-Ida, Grande Ronde Hospital,
Holy Rosary Hospital, Powder River Correctional Facility, Treasure Valley
Community College, Eastern Oregon University, local school districts and local
government.
Pending Acquisition
On February 24, 2003, the Company entered into a definitive merger
agreement ("Agreement") with FirstBank NW Corp., Lewiston, Idaho ("FirstBank")
pursuant to which the Company will be merged into FirstBank NW Corp. The
Agreement also provides for the merger of the Bank with and into FirstBank's
subsidiary financial institution, FirstBank Northwest. Under the terms of the
Agreement, shareholders of the Company may elect to receive either cash or
shares of FirstBank common stock in exchange for their shares of Oregon Trail
common stock. The aggregate purchase price for the transaction is
approximately $74.0 million. Consummation of the merger is subject to
approval by FirstBank's
1
and the Company's shareholders and the receipt of all required regulatory
approvals. It is anticipated that the transaction will be completed in the
fourth quarter of calendar year 2003.
Lending Activities
General. The Bank's loan portfolio totaled $228.2 million at March 31,
2003, representing 60.5% of total assets at that date. The Bank concentrates
its lending activities within its primary market area. Historically, the
Bank's primary lending activity has been the origination of one- to- four
family residential mortgage loans. To a lesser extent, the Bank makes
mortgage loans for the purpose of constructing primarily single-family
residences.
As a result of management's desire to diversify its lending portfolio and
satisfy local demand for credit, the Bank has significantly increased its
origination of agricultural, indirect dealer and commercial business loans
since July 1996. During the fiscal year ended March 31, 2002, the Bank
purchased $39.3 million of commercial real estate loans. The properties
securing these loans are located in Washington and Oregon. Commercial
business and agricultural loans primarily include operating lines of credit
and term loans for fixed asset acquisitions.
The Bank has also been active in the origination of consumer loans, which
primarily consist of automobile loans and home equity loans, secured and
unsecured and, to a lesser extent, credit card loans, home improvement loans,
mobile home loans and loans secured by savings deposits. More recently, the
Bank has expanded its purchase of dealer-originated contracts to include those
secured by automobiles, motorcycles, all terrain and recreational vehicles,
including travel trailers. During the fiscal year ended March 31, 2003, the
Bank purchased $800,000 of dealer originated contracts secured by recreational
vehicles, campers, boats, snowmobiles, and all-terrain-vehicles.
2
Loan Portfolio Analysis. The following table sets forth the composition of the Bank's loan portfolio at
the dates indicated. The Bank had no concentration of loans exceeding 10% of total gross loans other than as
presented below.
At March 31,
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2003 2002 2001 2000 1999
--------------- --------------- --------------- --------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Mortgage Loans:
One-to-four-
family...........$ 94,456 40.75% $122,950 45.60% $137,354 53.97% $127,589 57.13% $109,089 58.00%
Multi-family...... 7,724 3.33 10,799 4.00 2,459 0.97 2,989 1.34 2,810 1.49
Commercial........ 30,874 13.32 36,397 13.50 18,235 7.17 14,808 6.63 13,703 7.29
Agricultural...... 3,952 1.71 3,505 1.30 3,548 1.39 2,420 1.08 2,240 1.19
Construction...... 676 0.29 1,255 0.47 1,399 0.55 3,648 1.63 2,825 1.50
Land.............. 23 0.01 34 0.01 124 0.05 158 0.07 330 0.17
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total mortgage
loans.......... 137,705 59.41 174,940 64.88 163,119 64.10 151,612 67.88 130,997 69.64
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer Loans:
Home equity and
second mortgage.. 12,313 5.31 14,039 5.21 15,890 6.24 14,983 6.71 16,262 8.65
Credit card....... 1,354 0.58 1,174 0.43 1,093 0.43 1,026 0.46 949 0.50
Automobile(1)..... 27,058 11.67 28,147 10.44 26,501 10.41 21,547 9.65 11,843 6.30
Loans secured by
deposit accounts. 288 0.13 502 0.19 528 0.21 452 0.20 416 0.22
Unsecured......... 6,357 2.74 6,066 2.25 4,909 1.93 3,414 1.53 2,836 1.50
Other............. 4,174 1.80 4,443 1.64 3,992 1.57 3,190 1.43 2,985 1.59
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer
loans.......... 51,544 22.23 54,371 20.16 52,913 20.79 44,612 19.98 35,291 18.76
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial business
loans............. 26,270 11.33 24,152 8.96 22,396 8.80 13,853 6.20 12,031 6.40
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Agricultural loans. 16,294 7.03 16,185 6.00 16,054 6.31 13,275 5.94 9,781 5.20
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans..... 231,813 100.00% 269,648 100.00% 254,482 100.00% 223,352 100.00% 188,100 100.00%
====== ====== ====== ====== ======
Less:
Net deferred loan
fees.............. 1,365 1,505 1,487 1,365 1,125
Allowance for loan
losses............ 2,221 2,280 2,098 1,396 1,228
-------- -------- -------- -------- --------
Total loans
receivable,
net............$228,227 $265,863 $250,897 $220,591 $185,747
======== ======== ======== ======== ========
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(1) Includes dealer-originated automobile contracts of $24.1 million, $24.3 million and $13.6 million at
March 31, 2003, 2002 and 2001, respectively.
3
One- to- Four Family Real Estate Lending. Historically, the Bank has
concentrated its lending activities on the origination of loans secured by
first mortgages on existing one- to- four family residences located in its
primary market area. At March 31, 2003, $94.5 million, or 40.8%, of the
Bank's total loan portfolio, consisted of such loans, with an average loan
balance of $62,000.
Generally, the Bank's fixed-rate one- to- four family mortgage loans have
maturities of 15 to 30 years and are fully amortizing with monthly payments
sufficient to repay the total amount of the loan with interest by the end of
the loan term. Generally, they are originated under terms, conditions and
documentation which permit them to be sold to private investors. The Bank's
fixed-rate loans customarily include "due on sale" clauses, which give the
Bank the right to declare a loan immediately due and payable in the event the
borrower sells or otherwise disposes of the real property subject to the
mortgage and the loan is not paid.
At March 31, 2003, $77.4 million, or 33.4%, of the total loans before net
items were fixed rate one- to- four family loans and $17.1 million, or 7.4%,
were adjustable rate mortgage loans ("ARM loans"). The Bank offers an ARM
product for its portfolio with an interest rate that is fixed for three years
then adjusts annually based on the one year Treasury constant maturity index.
The Bank's ARMs are typically based on a 30-year amortization schedule. The
Bank's current ARM loans do not provide for negative amortization and
generally provide for annual and lifetime interest rate adjustment limits of
2.0% and 6.0%, respectively.
At March 31, 2003, $9.8 million, or 57.4% of the Bank's total ARM loans
had interest rates that adjusted annually based on the Eleventh District Cost
of Funds Index ("COFI"). The COFI is a lagging index which, together with the
periodic and overall interest rate caps, may cause the yield on such loans to
adjust more slowly than the cost of interest-bearing liabilities especially in
a rapidly rising rate environment. In November 1995, the Bank discontinued
using the COFI index and began using the one year Treasury constant maturity
index.
Borrower demand for ARM loans versus fixed-rate mortgage loans is a
function of the level of interest rates, the expectations of changes in the
level of interest rates, the life expectancy of the loan and the difference
between the initial interest rates and fees charged for each type of loan.
The relative amount of fixed-rate mortgage loans and ARM loans that can be
originated at any time is largely determined by the demand for each in a
competitive environment.
The retention of ARM loans in the Bank's loan portfolio helps reduce the
Bank's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased costs
due to 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 payments required by the borrower.
In addition, although ARM loans allow the Bank to increase the sensitivity of
its asset base to changes in the interest rates, the extent of this interest
sensitivity is limited by the annual and lifetime interest rate adjustment
limits. Because of these considerations, the Bank has no assurance that
yields on ARM loans will be sufficient to offset increases in the Bank's cost
of funds. The Bank believes these risks, which have not had a material
adverse effect on the Bank to date, generally are less than the risks
associated with holding fixed-rate loans in the portfolio during a rising
interest rate environment.
The Bank requires title insurance insuring the status of its lien on all
loans where real estate is the primary source of security. The Bank also
requires the maintenance of fire and casualty insurance (and, if appropriate,
flood insurance).
The Bank's one- to- four family residential mortgage loans typically do
not exceed 80% of the lower of cost or appraised value of the security
property. Pursuant to underwriting guidelines adopted by the Bank's Board of
Directors, the Bank can lend up to 97% of the lower of cost or appraised value
of the property securing a one- to- four family residential loan; however, the
Bank obtains private mortgage insurance that insures the Bank on those loans
that exceed 80% of the appraised value of the security property.
4
Agricultural Lending. Agriculture is a major industry in the Bank's
market area. Subject to market conditions, the Bank intends to continue to
emphasize agricultural loans. In 1996, the Bank began originating a
significant number of loans to finance agricultural needs. This includes
collateral secured agricultural loans for the purchase of farmland and
equipment. At March 31, 2003, agricultural loans, including those secured by
agriculture real estate, amounted to $20.2 million, or 8.7%, of the total loan
portfolio; $4.0 million of these loans were secured by real estate. The Bank
has sought to limit its agricultural lending to borrowers with a strong
capital base, sufficient management depth, proven ability to operate through
agricultural business cycles, reliable cash flow and a willingness to provide
the Bank with the necessary financial reporting.
Agricultural operating loans are made to finance operating expenses over
the course of a growing season with such loans being typically made in amounts
of $500,000 or less. However, the Bank's largest agricultural operating loan
had an original commitment of $2.4 million (with $336,000 outstanding at March
31, 2003) which was provided to finance a farming operation that grows mint,
grain, and potatoes. This loan was performing in accordance with its terms at
March 31, 2003. Agricultural operating loans generally are made as a
percentage of the borrower's anticipated income to support budgeted operating
expenses. These loans generally are secured by a blanket lien on all crops,
livestock, equipment, accounts and products and proceeds thereof. The
variables that effect income during the year are yields and market prices.
Consideration is given to projected yields and commodity prices. The interest
rate is normally adjusted monthly based on the prime rate as published in The
Wall Street Journal, plus a negotiated margin of up to 2%. Because such loans
are made to finance annual operations and expenses, they are written on a
one-year review and renewable basis. The renewal is dependent upon prior
year's performance and the forthcoming year's projections as well as overall
financial strength of the borrower. The Bank carefully monitors these loans
and prepares monthly variance reports on income and expenses. To meet the
seasonal operating needs, borrowers may qualify for single payment notes,
revolving lines of credit and/or non-revolving lines of credit.
In underwriting agricultural operating loans, the Bank considers the cash
flow of the borrower based upon the expected income stream as well as the
value of collateral used to secure the loan. Collateral generally consists of
cattle or cash crops produced by the farm, such as grains, grass seed, peas,
sugar beets, mint, onions, potatoes, corn and alfalfa. In addition to
considering cash flow and obtaining a blanket security interest in the farm's
cash crop, the Bank may also collateralize an operating loan with the
equipment, breeding stock, real estate, and federal agricultural program
payments to the borrower.
The Bank also originates loans to finance the purchase of farm equipment
and will continue to pursue this type of lending in the future. Loans to
purchase farm equipment are made for terms of up to seven years. In funding
this need, the Bank uses both fixed and adjustable rate notes, depending on
the maturity requested.
Agricultural real estate loans primarily are secured by first liens on
farmland and improvements thereon located in the Bank's market area, to
service the needs of the Bank's existing customers. The largest such loan
totaled $821,000 and was performing according to its terms at March 31, 2003.
Loans are generally written in amounts up to 50% to 75% of the tax assessed or
appraised value of the property at terms ranging from 10 to 20 years. Such
loans have interest rates that generally adjust at least every five years
based upon the current five year Treasury Constant or The Wall Street Journal
prime, plus a negotiated margin. In originating an agricultural real estate
loan, the Bank considers the debt service coverage of the borrower's cash
flow, the appraised value of the underlying property, the experience and
knowledge of the borrower, and the borrower's past performance with the Bank
and/or market area.
Payments on an agricultural real estate loan depend, to a large degree,
on the results of operation of the related entity. The repayment is also
subject to both economic and weather conditions as well as market prices for
agricultural products, which can be highly volatile at times. Such loans are
not made to start up businesses but are generally reserved for profitable
operators with substantial equity and proven history. At March 31, 2003,
agricultural real estate loans totaled $4.0 million, or 1.7%, of the loan
portfolio.
Among the greatest and more common risks to agricultural lending can be
weather conditions and disease. This risk can be mitigated through
multi-peril crop insurance. The lack of water has the potential to decrease
yields and increase energy costs for the Bank's borrowers. Commodity prices
also present a risk which may be reduced by the use
5
of set price contracts. Required beginning and projected operating margins
provide for reasonable reserves to offset unexpected yield and price
deficiencies. The Bank also takes into consideration management succession,
life insurance and business continuation plans. The Bank is an approved Farm
Service Agency ("FSA") lender and at March 31, 2003 had three FSA guaranteed
loans with an outstanding balance of $283,000.
Construction Lending. The Bank also offers construction loans to
qualified borrowers for construction of single-family residences in the Bank's
primary market area. Typically, the Bank limits its construction lending to a
local builder for the construction of a single-family dwelling where a
permanent purchase commitment has been obtained or individuals are building
their primary residences. Construction loans generally have a six-month term
with only interest being paid during the term of the loan, and convert at the
end of six months to permanent financing and are underwritten in accordance
with the same standards as the Bank's mortgages on existing properties.
Construction loans generally have a maximum loan-to-value ratio of 80%.
Borrowers must satisfy all credit requirements which would apply to the Bank's
permanent mortgage loan financing for the subject property. On a limited
basis, the Bank lends to contractors for housing construction where the house
is not presold. The ability of a developer to sell developed lots or
completed dwelling units will depend on, among other things, demand, pricing,
availability of comparable properties and economic conditions.
Construction financing generally is considered to involve a higher degree
of risk of loss than long-term financing on improved, occupied real estate.
Risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction.
During the construction phase, a number of factors could result in delays and
cost overruns. If the estimate of construction costs proves to be inaccurate,
the borrower may be required to fund the cost overruns. The Bank has sought
to minimize this risk by limiting construction lending to qualified borrowers
in the Bank's market area and by limiting the aggregate amount of outstanding
construction loans. At March 31, 2003, construction loans amounted to
$676,000, or 0.3%, of the loan portfolio.
Multi-Family and Commercial Real Estate Lending. The multi-family
residential loan portfolio consists primarily of loans secured by apartment
buildings and the commercial real estate loan portfolio includes loans to
finance the construction or acquisition of small office buildings and retail
stores. The largest such loan totaled $2.8 million and was performing
according to its terms at March 31, 2003. At March 31, 2003, the Bank had
$7.7 million of multi-family residential and $30.9 million of commercial real
estate loans, which amounted to 3.3% and 13.3%, respectively, of the total
loan portfolio at such date. Multi-family and commercial real estate loans
are generally underwritten with loan-to-value ratios of up to 75% of the
lesser of the appraised value or the purchase price of the property. Such
loans generally are granted on 15 to 20 year terms on an adjustable rate with
established floors. On fixed rate loans, terms generally do not exceed ten
years.
Multi-family residential and commercial real estate lending entails
significant additional risks as compared with single-family residential
property lending. Multi-family residential and commercial real estate loans
typically involve large loan balances to single borrowers or groups of related
borrowers. The payment experience on such loans typically is dependent on the
successful operation of the real estate project. These risks can be
significantly impacted by supply and demand conditions in the market for
office, retail and residential space, and, as such, may be subject to a
greater extent to adverse conditions in the economy generally. To minimize
risk, the Bank generally obtains personal guarantees and annual financial
statements of the principals of the partnership or corporation. The Bank
reviews all significant commercial real estate loans on an annual basis to
ensure that the loan meets current underwriting standards. In addition, the
Bank underwrites commercial real estate loans at a rate of interest
significantly above that carried on the loan at the time of origination to
evaluate the borrower's ability to meet principal and interest payments on the
loan in the event of upward adjustments to the interest rate on the loan.
Consumer and Other Lending. The Bank originates a variety of consumer
loans. Such loans generally have shorter terms to maturity and higher
interest rates than mortgage loans. At March 31, 2003, the Bank's consumer
loans totaled approximately $51.5 million, or 22.2%, of the Bank's total
loans. The Bank's consumer loans consist primarily of home improvement and
equity loans, automobile loans, boat and recreational vehicle loans, unsecured
loans, credit card loans and deposit account loans.
6
The Bank offers open-ended "preferred" lines of credit on either a
secured or unsecured basis. Secured lines of credit are generally secured by
a second mortgage on the borrower's primary residence. Secured lines of
credit have an interest rate that is one to two percentage points above the
prime lending rate, as published in The Wall Street Journal, while the rate on
unsecured lines is three to four percentage points above this prime lending
rate. In both cases, the rate adjusts monthly. The majority of the approved
lines of credit at March 31, 2003 were equal to or less than $25,000. The
Bank requires repayment of at least 2% of the unpaid principal balance
monthly. At March 31, 2003, approved lines of credit totaled $22.7 million,
of which $11.4 million was outstanding.
The Bank offers closed-end home equity loans that are made on the
security of one-to-four family residences. Loans normally do not exceed 80%
of the appraised or tax assessed value of the residence, less the outstanding
principal of the first mortgage, and have terms of up to 15 years requiring
monthly payments of principal and interest. At March 31, 2003, home equity
loans and second mortgage loans, excluding personal lines of credit, amounted
to $6.9 million, or 3.0%, of total loans.
At March 31, 2003, the Bank's automobile loan portfolio amounted to $27.1
million, or 52.5%, of consumer loans and 11.7% of total loans at such date.
Since January 1997, a substantial portion of the Bank's automobile loans have
been originated indirectly by a network of approximately 36 automobile
dealers, most located in the Bank's market area and adjacent markets in Oregon
and Idaho. Indirect automobile loans accounted for approximately 75.5% of the
Bank's total consumer loan originations during the year ended March 31, 2003.
The applications for such loans are taken by employees of the dealer, the
loans are written on the dealer's contract pursuant to the Bank's underwriting
standards using the dealer's loan documents with terms substantially similar
to the Bank's. All indirect loans must be approved by specific loan officers
of the Bank who have experience with this type of lending. The automobile
dealers are paid a premium by the Bank. This premium is amortized over the
life of the loan. In addition to indirect automobile lending, the Bank also
originates automobile loans directly.
The maximum term for the Bank's automobile loans is 180 months with the
amount financed based upon a percent of purchase price. The Bank generally
requires all borrowers to maintain automobile insurance, including collision,
fire and theft, with a maximum allowable deductible and with the Bank listed
as loss payee.
At March 31, 2003, unsecured consumer loans amounted to $6.4 million, or
2.7%, of total loans. These loans are made for a maximum of 36 months or less
with fixed rates of interest and are offered primarily to existing customers
of the Bank to mitigate the additional risk of the unsecured status.
Since December 1992, the Bank has offered credit card loans through its
participation as a VISA card issuer. The Bank does not actively solicit
credit card business beyond its customer base and market area and has not
engaged in mailing of pre-approved credit cards. The rate currently charged
by the Bank on its credit card loans is the prime rate, as published in The
Wall Street Journal, plus 3% to 7%, and the Bank is permitted to change the
interest rate quarterly. Processing of bills and payments is contracted to an
outside servicer. At March 31, 2003, the Bank had a commitment to fund an
aggregate of $9.8 million of credit card loans, which represented the
aggregate credit limit on credit cards, and had $1.4 million of credit card
loans outstanding, representing 0.6% of its total loan portfolio. The Bank
intends to continue credit card lending and estimates that at current levels
of credit card loans, it makes a small monthly profit net of service expenses
and write-offs.
Consumer loans potentially have a greater risk than do residential
mortgage loans, particularly in the case of loans that are unsecured or
secured by rapidly depreciating assets such as automobiles and other vehicles.
In such cases, any repossessed collateral for a defaulted consumer loan may
not provide an adequate source of repayment of the outstanding loan balance as
a result of the greater likelihood of damage, loss or depreciation. The
remaining deficiency often does not warrant further substantial collection
efforts against the borrower beyond obtaining a deficiency judgment. In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy. Furthermore, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount that can be recovered on such loans. At
March 31, 2003, the Bank had $57,000 in consumer loans accounted for on a
nonaccrual basis.
7
Commercial Business Lending. The Bank originates commercial business
loans to small and medium sized businesses in its primary market area.
Commercial business loans are generally made to finance fixed asset
acquisitions, and for short-term working capital. Such loans are generally
secured by equipment, accounts receivable and inventory, although commercial
business loans are sometimes granted on an unsecured basis. Generally, loans
to finance short-term working capital are made for one year or less with
interest rates adjusted monthly at a rate equal to the prime rate, as
published in The Wall Street Journal, plus a margin of up to 3%. Loans to
finance the purchase of equipment are made for terms generally seven years or
less at either a fixed or adjustable rate. At March 31, 2003, the commercial
business loans amounted to $26.3 million, or 11.3%, of the total loan
portfolio.
At March 31, 2003, the largest outstanding commercial business loan was a
$1.7 million operating line of credit to a manufacturing company with a
balance of $1.2 million. Such loan was performing according to its terms at
March 31, 2003.
The Bank is an approved Small Business Administration ("SBA") lender and
at March 31, 2003, had two SBA loans that totaled $186,000. The Bank also
entered into an agreement with the Oregon Economic Development Department
("OEDD") to provide loan guarantees on small business loans. As of March 31,
2003, the Bank had one OEDD loans that totaled $143,000. The Bank intends to
continue to originate loans to local businesses within its primary market area
using these programs, subject to market conditions.
The Bank generally underwrites its commercial business loans on the basis
of the borrower's cash flow and ability to service the debt from earnings
rather than on the basis of underlying collateral value. The Bank seeks to
structure such loans to have more than one source of repayment. The borrower
is required to provide the Bank with sufficient information to allow the Bank
to make its lending determination. In most instances, this information
consists of at least three years of financial statements, tax returns, a
statement of projected cash flows, current financial information on any
guarantor and any additional information on the collateral. Generally, for
loans with maturities exceeding two years and balances exceeding $250,000, the
Bank requires that borrowers and guarantors provide updated financial
information at least annually.
The Bank's commercial business loans may be structured as term loans or
as lines of credit. Commercial business term loans are generally made to
finance the purchase of fixed assets and have maturities of seven years or
less. Commercial business lines of credit are typically made for the purpose
of providing working capital and are usually approved with a term of between
six months and one year.
Commercial business loans are often larger and may involve greater risk
than other types of lending. Because payments on such loans are often
dependent on successful operation of the business involved, repayment of such
loans may be subject to adverse conditions in the economy. The Bank seeks to
minimize these risks through its underwriting guidelines, which require that
the loan be supported by adequate cash flow of the borrower, profitability of
the business, collateral, and personal guarantees of the individuals in the
business. In addition, the Bank limits this type of lending to its market
area and to borrowers with which it has prior experience or who are otherwise
well known to the Bank.
Maturity of Loan Portfolio. The following table sets forth certain
information at March 31, 2003, regarding the dollar amount of loans maturing
in the Bank's portfolio based on their contractual terms to maturity, but does
not include scheduled payments or potential prepayments. Demand loans, loans
having no stated schedule of repayments
8
and no stated maturity, and overdrafts are reported as becoming due within one
year. Loan balances do not include undisbursed loan proceeds, unearned
discounts, unearned income and allowance for loan losses.
After After
One Year 3 Years
Within Through Through Over
One Year 3 Years 5 Years Five Years Total
-------- ------- ------- ---------- -----
(In thousands)
Mortgage loans:
One- to- four family.... $ 69 $ 390 $ 658 $93,339 $94,456
Multi-family............ 365 319 1,940 5,100 7,724
Commercial.............. 157 391 855 29,471 30,874
Agricultural............ -- -- 230 3,722 3,952
Construction............ -- -- -- 676 676
Land.................... -- -- 23 -- 23
Consumer loans:
Home equity and second
mortgage............... 103 391 1,007 10,812 12,313
Automobile.............. 384 5,964 15,191 5,519 27,058
Credit card............. 11 43 111 1,189 1,354
Loans secured by deposit
accounts............... 78 34 176 -- 288
Unsecured............... 296 381 390 5,290 6,357
Other................... 24 433 785 2,932 4,174
Commercial business
loans................... 9,298 2,607 4,886 9,479 26,270
Agricultural loans....... 12,005 1,075 1,304 1,910 16,294
------- ------- ------- -------- --------
Total................. $22,790 $12,028 $27,556 $169,439 $231,813
======= ======= ======= ======== ========
The following table sets forth the dollar amount of all loans due after
March 31, 2004, which have fixed interest rates and have floating or
adjustable interest rates.
Fixed Floating or
Rates Adjustable Rates
-------- ----------------
(In thousands)
Mortgage loans:
One- to- four family.................... $ 77,434 $16,953
Multi-family............................ 725 6,634
Commercial.............................. 2,171 28,546
Agricultural............................ 612 3,340
Construction............................ 676 -
Land.................................... 23 --
Consumer loans:
Home equity and second mortgage......... 6,638 5,571
Automobile.............................. 26,674 -
Credit card............................. -- 1,343
Loans secured by deposit accounts....... 210 --
Unsecured............................... 158 5,903
Other................................... 4,150 --
Commercial business loans................ 10,270 6,702
Agricultural loans....................... 2,248 2,041
-------- -------
Total.................................. $131,989 $77,033
======== =======
9
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 term because of prepayments. In addition, due on sale
clauses on loans generally give the Bank the right to declare loans
immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. 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
Bank'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 Bank's lending activities are
subject to the written, non-discriminatory, underwriting standards and loan
origination procedures established by the Bank's Board of Directors and
management. The customary sources of loan originations are realtors, walk-in
customers, referrals and existing customers. The Bank also advertises its
loan products by radio and newspaper. The Bank does not employ commissioned
loan originators.
Mortgage loan applications are initiated, underwritten and preliminarily
approved by loan officers before they are recommended for final review and
approval. Individual lending limits and credit approval limits are established
for branch and loan center personnel up to $350,000. Commercial lenders' and
administrative credit approval limits are established up to $750,000 depending
on position and lending knowledge. Loans to borrowers with an aggregate
borrowing relationship over $750,000 and up to $1.5 million requires approval
of either the President or Executive Vice President. Loans to borrowers with
an aggregate borrowing relationship in excess of $1.5 million and up to $2.5
million require the approval of the President and Executive Vice President.
Loans to borrowers with an aggregate borrowing relationship exceeding $2.5
million require approval by the President, Executive Vice President and two
board members.
Loan Originations, Sales and Purchases. Historically, the Bank's primary
lending activity has been the origination of one- to- four family residential
mortgage loans. In recent periods, the Bank has increased its origination of
consumer, commercial business and agricultural loans.
During the year ended March 31, 2003, the Bank began selling its
conforming loans along with the servicing of these loans. For the year ended
March 31, 2003, the Bank sold $22.0 million in fixed-rate one-to-four family
residential mortgage loans. At March 31, 2003, the Bank was not servicing any
loans for investors.
The Bank purchased $39.3 million of commercial real estate loans with
properties located in Washington and Idaho during the fiscal year 2002. The
balance of these loans at March 31, 2003 was $19.5 million and was performing
according to its terms.
The following table sets forth total loans originated, purchased, sold
and repaid during the periods indicated.
Year Ended March 31,
-----------------------------------
2003 2002 2001
-------- -------- --------
(In thousands)
Loans originated:
Mortgage loans:
One- to- four family................ $ 27,685 $ 26,446 $ 22,301
Multi-family........................ -- 450 -
Commercial.......................... 4,343 6,921 4,543
Construction........................ 743 265 1,092
Land................................ - 1 11
Consumer............................ 17,947 18,739 14,170
Commercial business loans........... 38,013 33,907 28,778
Agricultural loans.................. 32,440 35,378 32,888
-------- -------- --------
Total loans originated............ $121,171 $122,107 $103,783
======== ======== ========
(table continued on following page)
10
Year Ended March 31,
-----------------------------------
2003 2002 2001
-------- -------- --------
(In thousands)
Loans purchased:
Dealer-originated automobile
contracts.......................... $ 13,559 $ 14,499 $ 14,499
Dealer-originated other contracts... 800 1,635 --
Commercial real estate.............. -- 39,262 5,275
-------- -------- --------
Total loans purchased............. 14,359 55,992 19,774
Loans sold:
One-to-four family.................. 22,002 13,086 --
Loan principal repayments............ 151,164 150,047 93,251
-------- -------- --------
Net increase (decrease) in loans
receivable, net..................... $(37,636) $ 14,966 $ 30,306
======== ======== ========
Loan Commitments. The Bank issues commitments for loans and lines of
credit conditioned upon the occurrence of certain events. Such commitments
are made in writing on specified terms and conditions and are honored for up
to 40 days from approval, depending on the type of transaction. At March 31,
2003, the Bank had loan commitments of $42.5 million. See Note 17 of Notes to
Consolidated Financial Statements included in the Annual Report.
Loan Fees. In addition to interest earned on loans, the Bank receives
income from fees in connection with loan originations, loan modification, late
payments and for miscellaneous service related to its loans. Income from
these activities varies from period to period depending upon the volume and
type of loans made and competitive conditions.
The Bank charges loan origination fees which are calculated as a minimum
fee or as a percentage of the amount borrowed. In accordance with applicable
accounting procedures, loan origination fees and discount points in excess of
loan origination costs are deferred and recognized over the contractual
remaining lives of the related loans on a level yield basis. Discounts and
premiums on loans purchased are accreted and amortized in the same manner.
The Bank recognized $285,000, $215,000 and $71,000 of deferred loan fees
during the years ended March 31, 2003, 2002 and 2001, respectively, in
connection with loan refinancings, payoffs and ongoing amortization of
outstanding loans.
Nonperforming Assets and Delinquencies. Generally, the borrowers are
allowed to pay up to the 15th day following the due date before the Bank
initiates collection procedures. When a borrower fails to make a required
payment on a loan, the Bank attempts to cure the deficiency by contacting the
borrower and seeking the payment. Contacts are generally made 16 days after
the due date. In most cases, delinquencies are cured promptly. If a
delinquency continues, additional contact is made. The Bank prefers to work
with borrowers to resolve such problems, however, after the 90th day of
delinquency, foreclosure or other action is taken in an effort to minimize any
potential loss to the Bank.
When loans are contractually 90 days or more delinquent, they are placed
on nonaccrual status. Payments to such nonaccrual loans are applied to
principal when collection of the loan principal is doubtful. Loans are
reinstated to accrual status when current and collectibility of principal and
interest is no longer doubtful.
11
The following table sets forth information with respect to the Bank's
nonperforming assets and restructured loans at the dates indicated.
At March 31,
------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(Dollars in thousands)
Loans accounted for on a
nonaccrual basis:
Mortgage loans:
One- to- four family..... $ 89 $ 90 $ -- $ 131 $ 133
Nonresidential property.. 367 -- 45 -- -
Consumer loans........... 57 246 10 24 5
-------- -------- -------- -------- --------
Total................. 513 336 55 155 138
Foreclosed real estate..... 217 -- 41 -- 37
Other repossessed assets... 84 58 22 8
-------- -------- -------- -------- --------
Total nonperforming
assets............... $ 814 $ 394 $ 118 $ 163 $ 175
======== ======== ======== ======== ========
Nonaccrual loans as a
percentage of loans
receivable, net........... 0.22% 0.12% 0.02% 0.07% 0.07%
Nonaccrual loans as a
percentage of total
assets.................... 0.14% 0.08% 0.01% 0.04% 0.04%
Nonperforming assets as a
percentage of total
assets.................... 0.22% 0.10% 0.03% 0.04% 0.06%
Loans receivable, net...... $228,227 $265,863 $250,897 $220,591 $185,747
Total assets............... $377,485 $398,366 $388,881 $370,612 $313,473
An additional $25,000 of interest income would have been recorded for the
year ended March 31, 2003, had nonaccruing loans been current in accordance
with their original terms.
Real Estate Acquired in Settlement of Loans. See Note 1 of Notes to
Consolidated Financial Statements included in the Annual Report, regarding the
Bank's accounting for foreclosed real estate. At March 31, 2003, the Bank had
foreclosed real estate consisting of three homes for $217,000.
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 four classifications for problem
assets: substandard, other loans especially mentioned, 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. Other loans especially mentioned
have potential weaknesses that deserve management's close attention. Loans in
this classification have a plan that is approved by the borrower and the Bank
that will return the credit to a pass classification. Loans in this category
are not adversely classified and do not expose the Bank to sufficient risk to
warrant adverse classification. 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
12
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 "watch" and monitored by the Bank.
The aggregate amounts of the Bank's classified and watch assets, and of
the Bank's general and specific loss allowances at the dates indicated, were
as follows:
At March 31,
---------------------------
2003 2002 2001
------ ------- -------
(In thousands)
Loss.............................. $ -- $ -- $ -
Doubtful.......................... 39 2 --
Substandard assets................ 2,089 501 1,154
Other loans especially mentioned.. 4,639 930 1,607
Watch............................. 9,034 9,819 9,426
General loss allowances........... 2,221 2,280 2,098
Specific loss allowances.......... -- -- --
At March 31, 2003, doubtful assets consisted of two business loans of
$39,000.
At March 31, 2003, substandard assets consisted of six one- to- four
family mortgage loans of $323,000, ten consumer/dealer loans of $109,000 and
16 commercial/agricultural loans (seven borrowers) of $1.6 million.
At March 31, 2003, other loans especially mentioned consisted of 18
commercial/agricultural loans (11 borrowers) of $4.6 million.
At March 31, 2003, watch assets consisted of six one- to- four family
mortgage loans of $329,000, one consumer/dealer loan of $3,000 and 47
commercial/agricultural loans (26 borrowers) of $8.7 million.
Allowance for Loan Losses. The Bank has established a systematic
methodology for the determination of provisions for loan losses. The
methodology is set forth in a formal policy and takes into consideration the
need for an overall general valuation allowance as well as specific allowances
that are tied to individual loans.
In originating loans, the Bank recognizes that losses will be experienced
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. The Bank increases its allowance for loan losses
by charging provisions for loan losses against the Bank's income.
Allowances for losses on specific problem loans and real estate owned are
charged to earnings when it is determined that the value of these loans and
properties, in the judgement of management, is impaired. In addition to
specific reserves, the Bank also maintains general provisions for loan losses
based on the evaluation of known and inherent risks in the loan portfolio,
including management's continuing analysis of the factors and trends
underlying the quality of the loan portfolio. These factors include changes
in the size and composition of the loan portfolio, actual loan loss
experience, current and anticipated economic conditions, detailed analysis of
individual loans for which full collectibility may not be assured, and
determination of the existence and realizable value of the collateral and
guarantees securing the loans. The ultimate recovery of such loans is
susceptible to future market factors beyond the Bank's control,
13
which may result in losses or recoveries differing significantly from those
provided in the consolidated financial statement. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's valuation allowance on loans and real estate
owned. Generally, a provision for losses is charged against income quarterly
to maintain the allowance for loan losses.
The Company's methodology for calculating the necessary reserves for loan
losses requires the Company to reserve specific percentages of outstanding
loan balances with the percentages varying based upon the perceived risk of
the different loan types and loan classification within specific loan types.
The specific reserve percentages are based upon the various loans type's
historic performance, loss trends, industry norms and the general economic
environment. Additionally, the Company has unallocated reserves which keep
the Company's reserves in line with industry norms as well as the inherent
changes in the portfolio risk due to macroeconomic factors.
At March 31, 2003, the Bank had an allowance for loan losses of $2.2
million, which management believes is adequate to absorb losses inherent in
the portfolio. Although management is confident that the basis for making the
allowance is sound, future adjustments to the allowance for loan losses may be
necessary and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations. Furthermore, while the Bank believes it has
established its existing allowance for loan losses in accordance with
generally accepted accounting principles, there can be no assurance that
regulators, in reviewing the Bank's loan portfolio, will not request the Bank
to increase significantly its allowance for loan losses. In addition, because
future events affecting borrowers and collateral cannot be predicted with
certainty, there can be no assurance that the existing allowance for loan
losses is adequate or that substantial increases will not be necessary should
the quality of any loan deteriorate as a result of the factors discussed
above. Any material increase in the allowance for loan losses may adversely
affect the Bank's financial condition and results of operations.
14
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
Year Ended March 31,
-----------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
Allowance at beginning of
period.................... $2,280 $2,098 $1,396 $1,228 $ 847
------ ------ ------ ------ ------
Provision for loan losses.. 321 481 794 178 483
Recoveries:
Mortgage loans:
One- to- four family..... -- -- 1 23 --
Consumer loans:
Credit card.............. 5 10 5 7 9
Other.................... 42 32 13 2 4
------ ------ ------ ------ ------
Total recoveries........ 47 42 19 32 13
------ ------ ------ ------ ------
Charge-offs:
Mortgage loans:
One- to- four family..... -- -- -- -- 4
Consumer loans:
Credit card.............. 24 31 99 37 82
Automobile............... 266 199 11 1 15
Unsecured................ 69 47 1 -- --
Other.................... 48 25 -- 4 14
------ ------ ------ ------ ------
Commercial.............. 20 3 -- -- -
Agriculture............. - 36 -- -- --
------ ------ ------ ------ ------
Total charge-offs....... 427 341 111 42 115
------ ------ ------ ------ ------
Net charge-offs......... 380 299 92 10 102
------ ------ ------ ------ ------
Allowance at end of
period................. $2,221 $2,280 $2,098 $1,396 $1,228
====== ====== ====== ====== ======
Allowance for loan losses
as a percentage of total
loans outstanding at the
end of the period......... 0.96% 0.85% 0.82% 0.63% 0.66%
Net charge-offs as a
percentage of average
loans outstanding during
the period................ 0.15% 0.11% 0.04% --% 0.06%
Allowance for loan losses
as a percentage of
nonperforming loans at
end of period............. 432.94% 678.21% 3,814.55% 900.65% 889.86%
15
The following table sets forth the breakdown of the allowance for loan losses by loan category at the
dates indicated. Management feels that the allowance can be allocated by category only on an approximate
basis. The allocation of the allowance to each category is not necessarily indicative of future losses and
does not restrict the use of the allowance to absorb losses in any other category.
At March 31,
-----------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---------------- ---------------- ---------------- ---------------- -----------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in in in in in
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Mortgage loans:
One- to- four
family.......... $ 238 41.04% $ 313 46.08% $ 352 54.82% $ 338 24.21% $ 381 31.03%
Non-mortgage
loans............ 762 21.52 792 19.54 625 20.04 265 21.58 236 21.58
Commercial
business and
real estate...... 756 29.70 637 27.76 494 18.15 360 25.79 300 8.9
Agricultural
loans............ 367 7.03 260 6.00 331 6.35 314 22.49 250 3.19
Credit cards...... 95 0.58 82 0.43 76 0.43 26 1.86 29 0.55
Loans secured by
deposit accounts. 3 0.13 5 0.19 5 0.21 3 0.22 3 0.24
Unallocated....... - -- 191 -- 215 -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance
for loan
losses........ $2,221 100.00% $2,280 100.00% $2,098 100.00% $1,396 100.00% $1,228 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
16
Investment Activities
The Bank is permitted under federal law 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
FHLB-Seattle, certificates of deposit of federally insured institutions,
certain bankers' acceptances and federal funds. Subject to various
restrictions, the Bank may also invest a portion of its assets in commercial
paper and corporate debt securities. The Bank is required to maintain an
investment in FHLB stock. The Bank is also required under federal regulations
to maintain a minimum amount of liquid assets. See "REGULATION" herein and
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Liquidity and Capital Resources" included in the Annual Report.
Although the Bank generally purchases investment securities with excess
liquidity, during the years ended March 31, 2003, 2002 and 2001, the Bank
engaged in a leveraging strategy using funds borrowed from the Federal Home
Loan Bank to purchase investment securities. Total purchases amounted to
$62.2 million, $44.4 million and $17.0 million during the years ended March
31, 2003, 2002 and 2001, respectively, including $14.7 million in mortgage
backed securities, $35.5 million in short-term investments and $12.0 million
in collateralized mortgage obligations purchased in fiscal 2003. Purchases
were funded in fiscal 2003 by principal repayments of securities totaling
$38.4 million, by selling investment securities totaling $8.3 million and the
remaining purchases were funded by the overall decrease in outstanding loans
for the period. Purchases were funded in fiscal 2002 by selling investment
securities totaling $28.7 million, and principal repayment of securities
totaling $19.7 million. Purchases were funded by selling investment
securities totaling $37.8 million for the year ended March 31, 2001. The
Bank's investment securities purchases have generally been limited to U.S.
Government and government agency securities with contractual maturities of
between one and ten years and mortgage-backed and related securities issued by
the Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage
Corporation ("FHLMC") and Government National Mortgage Association ("GNMA")
with maturities of up to 30 years. During the year ended March 31, 1999, the
Bank began purchasing AAA rated municipal bonds of various local Oregon
governmental units with maturities ranging from 10 to 19 years. Such
municipal bonds totaled $7.2 million at March 31, 2003.
At March 31, 2003, the Bank held securities classified as
available-for-sale under SFAS 115. There were no trading securities at March
31, 2003. See Note 2 of Notes to Consolidated Financial Statements contained
in the Annual Report.
The Bank's investment policies generally limit investments to U.S.
Government and government agency securities, municipal bonds, certificates of
deposits, marketable corporate debt obligations, mortgage-backed and related
securities and certain types of mutual funds. The Bank's investment policy
does not permit engaging directly in hedging activities or purchasing high
risk mortgage derivative products or non-investment grade corporate bonds.
Investments are made based on certain considerations, which include the
interest rate, yield, settlement date and maturity of the investment, the
Bank's liquidity position, and anticipated cash needs and sources (which in
turn include outstanding commitments, upcoming maturities, estimated deposits
and anticipated loan amortization and repayments). The effect that the
proposed investment would have on the Bank's credit and interest rate risk and
risk-based capital is also considered.
At March 31, 2003, the Bank did not have any individual investment
(excluding U.S. government bonds and mutual funds) that had an aggregate book
value in excess of 10% of the Company's shareholders' equity at that date.
17
The following table sets forth the amortized cost and fair value of the Bank's debt and mortgage-backed
and related securities, by accounting classification and by type of security, at the dates indicated.
At March 31,
---------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- -----------------------
Carrying Percent of Carrying Percent of Carrying Percent of
Value(1) Total Value(1) Total Value(1) Total
-------- ---------- -------- ---------- --------- -----------
(Dollars in thousands)
Available for Sale:
U.S. Government agency
obligations............ $ 9,414 8.72% $10,972 11.87% $20,038 20.67%
Trust preferred
securities............. 7,168 6.64 6,837 7.40 6,860 7.08
Mortgage-backed and
related securities..... 63,616 58.94 74,100 80.18 70,010 72.23
Other................... 27,737 25.70 510 0.55 16 0.02
-------- ------ ------- ------ ------- ------
Total available for
sale securities...... $107,935 100.00% $92,419 100.00% $96,924 100.00%
======== ====== ======= ====== ======= ======
- ---------------
(1) The market value of the Bank's investment portfolio amounted to $107.9 million, $92.4 million and
$96.9 million at March 31, 2003, 2002 and 2001, respectively. At March 31, 2003, the amortized cost
of the principal components of the Bank's investment securities portfolio was as follows: U.S.
Government securities, $9.2 million; trust preferred securities, $6.8 million; mortgage-backed and
related securities, $61.2 million and other securities, $27.7 million.
The following table sets forth the maturities and weighted average yields of the debt and
mortgage-backed and related securities in the Bank's investment securities portfolio at March 31, 2003.
Less Than One to Five to Over Ten
One Year Five Years Ten Years Years No
------------- ------------- ------------- ------------- Maturity
Amount Yield Amount Yield Amount Yield Amount Yield Amount
------ ----- ------ ----- ------ ----- ------ ----- --------
(Dollars in thousands)
Available for Sale:
U.S. Government
agency obligations... $2,109 3.02% $ - --% $2,227 4.30% $ 5,168 2.42% $ -
Trust preferred
securities........... -- -- -- -- - - 7,168 4.56 -
Mortgage-backed and
related securities... 2 3.92 -- -- 3,353 4.29 60,261 5.79 --
Other................. -- -- -- -- -- -- - 27,737
------ ----- ------ ------- -------
Total available for
sale securities.... $2,021 $ -- $5,580 $72,801 $27,737
====== ===== ====== ======= =======
Total
Yield Amount
------ ------
Available for Sale:
U.S. Government
agency obligations... --% $ 9,414
Trust preferred
securities........... -- 7,168
Mortgage-backed and
related securities... -- 63,616
Other................. 1.58 27,737
----- --------
Total available for
sale securities.... $107,935
========
18
Deposit Activities and Other Sources of Funds
General. Deposits are the major external source of funds for the Bank's
lending and other investment activities. In addition, the Bank also generates
funds internally from loan principal repayments and prepayments, and maturing
investment securities. Scheduled loan repayments are a relatively stable
source of funds, while deposit inflows and outflows and loan prepayments are
influenced significantly by general interest rates and money market
conditions. Borrowings from the FHLB-Seattle may be used on a short-term
basis to compensate for reductions in the availability of funds from other
sources. The Bank also has an overnight credit line with Key Bank amounting
to $21.0 million and a $50.0 million reverse repurchase credit line with
Merrill Lynch.
Deposit Accounts. A substantial number of the Bank's depositors reside
in Oregon. The Bank's deposit products include a broad selection of deposit
instruments, including NOW accounts, demand deposit accounts, money market
accounts, statement savings accounts and term certificate accounts. Deposit
account terms vary with the principal differences being the minimum deposit to
open, early withdrawal penalties and the interest rate. The Bank reviews its
deposit mix and pricing weekly. The Bank does not utilize brokered deposits,
nor has it aggressively sought jumbo certificates of deposit. The Bank also
offers business deposit accounts in connection with its community banking
activities.
The Bank believes it is competitive in the type of accounts and interest
rates it offers on its deposit products. The Bank does not seek to pay the
highest interest rates on deposits, but competitive rates. The Bank
determines the rates paid based on a number of conditions, including rates
paid by competitors, rates on U.S. Treasury securities, rates offered on
various FHLB-Seattle lending programs, and the deposit growth rate the Bank is
seeking to achieve.
In the unlikely event the Bank is liquidated, depositors will be entitled
to full payment of their deposit accounts before any payments are made to the
Company as the sole stockholder of the Bank.
The following table sets forth information concerning the Bank's time
deposits and other interest-bearing deposits at March 31, 2003.
Weighted
Average Percentage
Interest Minimum of Total
Rate Term Category Amount Balance Deposits
- ------ ------------ -------------------------- ------- ------- --------
(In thousands,
except minimum balance)
N/A N/A Non-interest-bearing $ 25,563 $ 10 10.26%
0.25% N/A NOW accounts 38,637 10 15.51
1.13 N/A Money market accounts 61,984 1,000 24.88
0.83 N/A Statement savings accounts 20,171 5 8.10
Certificates of Deposit
-----------------------
4.83 3 to 5 years Fixed-term, fixed-rate 18,986 1,000 7.62
1.23 91 days Fixed-term, fixed-rate 3,501 1,000 1.40
1.47 182 days Fixed-term, fixed-rate 13,920 1,000 5.59
1.98 1 year Fixed-term, variable-rate 29,141 1,000 11.70
3.95 2 1/2 years Fixed-term, variable-rate 7,560 1,000 3.03
5.10 5 years Fixed-term, variable-rate 12,604 1,000 5.06
1.25 18 months Fixed-term, adjustable-rate 2,585 5 1.04
2.51 20 months Fixed-term, fixed-rate 5,885 1,000 2.36
3.60 varies Various term, fixed-rate 1,463 1,000 0.59
3.08 varies Jumbo certificates 7,126 96,000 2.86
-------- ------
TOTAL $249,126 100.00%
======== ======
19
The following table indicates the amount of the Bank's jumbo certificates
of deposit by time remaining until maturity as of March 31, 2003. Jumbo
certificates of deposit generally have principal amounts of $100,000 or more
and have negotiable interest rates.
Certificates
Maturity Period of Deposits
---------------------------------- ------------
(In thousands)
Three months or less............... $ 6,063
Over three through six months...... 6,056
Over six through twelve months..... 5,460
Over twelve months................. 9,867
-------
Total.............................. $27,446
=======
Deposit Flow. The following table sets forth the balances (inclusive of
interest credited) and changes in dollar amounts of deposits in the various
types of accounts offered by the Bank between the dates indicated.
At March 31,
--------------------------------------------------------------------------
2003 2002 2001
-------------------------- --------------------------- ---------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
------ ----- ---------- ------ ----- ---------- ------ -----
(Dollars in thousands)
Non-interest-bearing........ $ 25,563 10.26% $ 3,685 $ 21,878 8.54% $2,200 $ 19,678 7.75%
NOW checking................ 38,637 15.51 2,834 35,803 13.98 (169) 35,972 14.17
Statement savings accounts.. 20,171 8.10 1,800 18,371 7.17 2,120 16,251 6.40
Money market deposit........ 61,984 24.88 1,299 60,685 23.70 6,702 53,983 21.27
Time certificates which mature:
Within 1 year............. 64,294 25.81 (25,152) 89,446 34.93 (5,058) 94,504 38.25
After 1 year, but within
3 years.................. 25,874 10.38 6,343 19,531 7.63 (5,837) 25,368 7.83
After 3 years, but within
5 years.................. 12,275 4.93 2,902 9,373 3.66 2,682 6,691 2.33
Certificates maturing
thereafter............... 328 0.13 (663) 991 0.39 (339) 1,330 0.53
-------- ------ ------- -------- ------ ------ -------- ------
Total................... $249,126 100.00% $(6,952) $256,078 100.00% $2,301 $253,777 100.00%
======== ====== ======= ======== ====== ====== ======== ======
Time Deposits by Rates. The following table sets forth the amount of
time deposits in the Bank categorized by rates at the dates indicated.
At March 31,
--------------------------------------
2003 2002 2001
-------- -------- --------
(In thousands)
1.00 - 1.99%....... $ 35,930 $ 10,375 $ --
2.00 - 3.99%....... 36,681 53,067 --
4.00 - 4.99%....... 10,748 20,970 9,933
5.00 - 5.99%....... 10,841 16,677 38,223
6.00 - 6.99%....... 8,062 16,949 62,822
7.00% and over..... 509 1,303 16,915
-------- -------- --------
Total.............. $102,771 $119,341 $127,893
======== ======== ========
20
Deposit Activity. The following table sets forth the deposit activity of
the Bank for the periods indicated.
Year Ended March 31,
---------------------------------------
2003 2002 2001
-------- -------- --------
(In thousands)
Beginning balance............. $256,078 $253,777 $237,735
-------- -------- --------
Net (withdrawals) deposits
before interest credited..... (11,871) (5,730) 5,752
Interest credited............. 4,919 8,031 10,290
-------- -------- --------
Net increase (decrease)
in deposits.................. (6,952) 2,301 16,042
-------- -------- --------
Ending balance................ $249,126 $256,078 $253,777
======== ======== ========
Borrowings. The Bank utilizes advances from the FHLB-Seattle to
supplement its supply of investable funds and to meet deposit/withdrawal
requirements. The FHLB-Seattle functions as a central reserve bank providing
credit for savings associations and certain other member financial
institutions. As a member of the FHLB-Seattle, the Bank is required to own
capital stock in the FHLB-Seattle and is authorized to apply for advances on
the security of such stock and certain of its mortgage loans and other assets
(principally securities that are obligations of, or guaranteed by, the U.S.
Government) provided certain creditworthiness standards have been met.
Advances are made pursuant to several different credit programs, all of which
have their own interest rate guidelines and range of maturities. Depending on
the program, limitations on the amount of advances are based on the financial
condition of the member institution and the adequacy of collateral pledged to
secure the credit. The Bank is currently authorized to borrow from the FHLB
up to an amount equal to 30% of total assets. The Bank may increase the
amount of its FHLB advances if loan demand exceeds deposit growth.
During the year ended March 31, 2000, the Bank opened a $21.0 million
overnight line of credit with Key Bank and a $50.0 million reverse repurchase
agreement with Merrill Lynch. See Note 8 of Notes to Consolidated Financial
Statements included in the Annual Report.
The following table sets forth certain information regarding borrowings
by the Bank at the end of and during the periods indicated:
At or For the
Year Ended March 31,
---------------------------------
2003 2002 2001
-------- -------- -------
(Dollars in thousands)
Maximum amount of borrowings outstanding
at any month end:
FHLB advances........................... $82,725 $109,600 $87,300
Approximate average borrowings outstanding
with respect to:
FHLB advances........................... 72,681 84,989 75,871
Approximate weighted average rate paid on:
FHLB advances........................... 5.30% 5.33% 6.34%
21
Potential Adverse Impact of Changes in Interest Rates
The financial condition and results of operations of the Bank, and of
savings institutions in general, are significantly influenced by general
economic conditions, by the related monetary and fiscal policies of the
federal government, and by the regulations of the OTS, the FDIC and the Board
of Governors of the Federal Reserve System ("Federal Reserve"). Deposit flows
and the cost of funds are influenced by interest rates of competing
investments and general market rate conditions. Lending activities are
affected by the demand for mortgage financing and for consumer and other types
of loans, which in turn are affected by the interest rates at which such
financing may be offered and by other factors affecting the supply of housing
and the availability of funds.
The Bank's profitability is substantially dependent on its net interest
income, which is the difference between the interest income received from its
interest-earning assets and the interest expense incurred in connection with
its interest-bearing liabilities. When an institution's interest-bearing
liabilities exceed its interest-earning assets which mature within a given
period of time, material and prolonged increases in interest rates generally
would adversely affect net interest income, while material and prolonged
decreases in interest rates generally would have a favorable effect on net
interest income. Like most of the savings industry, the interest-earning
assets of the Bank have longer effective maturities than its deposits, which
largely mature or are subject to repricing within a shorter period of time.
As a result, a material and prolonged increase in interest rates generally
would adversely affect net interest income, while material and prolonged
decreases in interest rates generally would have a more favorable effect on
net interest income.
The mismatch between maturities and interest rate sensitivities of
balance sheet items results in interest rate risk. The extent of interest
rate risk to which the Bank is subject is monitored by management by modeling
the change in net portfolio value ("NPV") over a variety of interest rate
scenarios. NPV is the present value of expected cash flows from assets,
liabilities and off-balance sheet contracts. The calculation is intended to
illustrate the change in NPV that will occur in the event of an immediate
change in interest rates of at least 200 basis points with no effect given to
any steps which management might take to counter the effect of that interest
rate movement. At March 31, 2003, there was a $6.8 million, or 2.0%, decrease
in the Bank's NPV as a percent of the present value of assets, assuming a 200
basis point increase in interest rates. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Asset and
Liability Management and Interest Rate Risk" contained in the Annual Report
for a discussion of the NPV methods of analyzing interest rate risk and for an
illustration of the effect of an increase in interest rates on the Bank's
earnings.
Consequently, the Bank's net interest income could be adversely affected
during periods of rising interest rates. Further increases in market rates of
interest could have a material adverse effect on the Bank's net interest
income. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- Asset and Liability Management and Interest Rate
Risk" contained in the Annual Report Furthermore, there has been increased
scrutiny by the regulatory agencies as to financial institutions levels of
interest rate risk and Pioneer Bank has been examined by the OTS since it
increased its review of this area, with a "satisfactory" rating.
Changes in interest rates can affect the amount of loans originated by an
institution, as well as the value of its loans and other interest-earning
assets and the resultant ability to realize gains on the sale of such assets.
Changes in interest rates also can result in disintermediation, which is the
flow of funds away from savings banks into direct investments, such as U.S.
Government and corporate securities, and other investment vehicles which,
because of the absence of federal insurance premiums and reserve requirements,
generally can pay higher rates of return than savings associations.
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, and the regulations issued by the OTS and
22
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 $44,000.
Federal Home Loan Bank System. The FHLB System, consisting of 12 FHLBs,
is under the jurisdiction of the Federal Housing Finance Board ("FHFB"). 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 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 $6.7 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.
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 over all savings
associations.
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.
23
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. Risk classification
of all insured institutions is made by the FDIC 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 ranged from 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 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 Federal Deposit Insurance Act ("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 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. Monetary penalties may be
imposed for failure to meet liquidity requirements. The Bank has never been
subject to monetary penalties for failure to meet its liquidity requirements.
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." OTS regulations
also require that a capital restoration plan be filed with the OTS within 45
days of the date a savings institution receives notice that it is
"undercapitalized," "significantly undercapitalized" or "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 adopted Interagency Guidelines prescribing Standards for Safety
and Soundness. 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 a savings institution fails to meet any standard prescribed by
the
24
guidelines, the OTS may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard.
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 total assets less (i) specified liquid
assets up to 20% of total assets; (ii) intangibles, including goodwill; and
(iii) the value of property used to conduct business in certain "qualified
thrift investments " in at least nine out of each 12 month period 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 79.0%.
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 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."
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 $46.1 million, or 12.4% of adjusted total assets,
which is approximately $40.5 million above the minimum requirement of 1.5% of
adjusted total assets in effect on that date.
The capital standards also require core capital equal 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 $46.1 million, or 12.4% of adjusted total assets, which is
$34.9 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
$48.3 million, including $46.1 million in core capital and $2.2 million in
qualifying supplementary capital, and risk-weighted assets of $233.5 million,
or total capital of 20.7% of risk-weighted assets. This amount was $29.6
million above the 8% requirement in effect on that date.
25
The OTS is authorized to impose capital requirements in excess of these
standards on individual associations on a case-by-case basis. 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," generally defined to be one
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
Company or the Bank may have a substantial adverse effect on their operations
and profitability.
Limitations on Capital Distributions. The OTS imposes 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. The OTS also prohibits a savings association from declaring or paying
any dividends or from repurchasing any of its stock if, as a result of such
action, the regulatory capital of the association would be reduced below the
amount required to be maintained for the liquidation account established in
connection with the association's mutual to stock conversion.
The Bank may make a capital distribution without OTS approval provided
that the Bank notify the OTS 30 days before it declares the capital
distribution and that the following requirements are met: (i) the Bank has a
regulatory rating in one of the two top examination categories, (ii) the Bank
is not of supervisory concern, and will remain adequately or well capitalized,
as defined in the OTS prompt corrective action regulations, following the
proposed distribution , and (iii) the distribution does not exceed the Bank's
net income for the calendar year-to-date plus retained net income for the
previous two calendar years (less any dividends previously paid). If the Bank
does not meet these stated requirements, it must obtain the prior approval of
the OTS before declaring any proposed distributions.
In the event the Bank's capital falls below its regulatory requirements
or the OTS notifies it that it is in need of more than normal supervision, the
Bank's ability to make capital distributions will be restricted. In addition,
no distribution will be made if the Bank is notified by the OTS that would
constitute an unsafe and unsound practice, which would otherwise be permitted
by the regulation.
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 limit on loans to one borrower was $7.2 million. At
March 31, 2003, the Bank's largest aggregate loan to one borrower was $2.9
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
26
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 its delineated community. 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 such 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 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
enforcement responsibility over savings institutions and has the authority to
bring action against all "institution-affiliated parties," including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on
an insured institution. Formal enforcement action may range from the issuance
of a capital directive or cease and desist order to removal of officers or
directors, receivership, conservatorship or termination of deposit insurance.
Civil penalties cover a wide range of violations and can amount to $27,500 per
day, or $1.1 million per day in especially egregious cases. Under the FDIA,
the FDIC has the authority to recommend to the Director of the OTS that
enforcement action be taken with respect to a particular savings institution.
If action is not taken by the Director, the FDIC has authority to take such
action under certain circumstances. Federal law also establishes criminal
penalties for certain violations.
Savings and Loan Holding Company Regulations
The Company is a unitary savings and loan company subject to regulatory
oversight of the OTS. Accordingly, the Company is required to register and
file reports with the OTS and is subject to regulation and examination by the
OTS. In addition, the OTS has enforcement authority over the Company and its
non-savings association subsidiaries which also permits the OTS to restrict or
prohibit activities that are determined to a serious risk to the subsidiary
savings association.
Acquisitions. Federal law and OTS regulations issued thereunder
generally prohibit a savings and loan holding company, without prior OTS
approval, from acquiring more than 5% of the voting stock of any other savings
association or savings and loan holding company or controlling the assets
thereof. They also prohibit, among other things, any director or officer of a
savings and loan holding company, or any individual who owns or controls more
than 25% of the voting shares of such holding company, from acquiring control
of any savings association not a subsidiary of such savings and loan holding
company, unless the acquisition is approved by the OTS.
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Activities. As a unitary savings and loan holding company, the Company
generally is not subject to activity restrictions. If the Company acquires
control of another savings association as a separate subsidiary other than in
a supervisory acquisition, it would become a multiple savings and loan holding
company and the activities of the Company and any of its subsidiaries (other
than the Bank or any other SAIF insured savings association) would generally
become subject to additional restrictions. There generally are more
restrictions on the activities of a multiple savings and loan holding company
than on those of a unitary savings and loan holding company. Federal law
provides that, among other things, no multiple savings and loan holding
company or subsidiary thereof which is not an insured association shall
commence or continue for more than two years after becoming a multiple savings
and loan association holding company or subsidiary thereof, any business
activity other than: (i) furnishing or performing management services for a
subsidiary insured institution, (ii) conducting an insurance agency or escrow
business, (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary insured institution, (iv) holding or managing properties
used or occupied by a subsidiary insured institution, (v) acting as trustee
under deeds of trust, (vi) those activities previously directly authorized by
regulation as of March 5, 1987 to be engaged in by multiple holding companies
or (vii) those activities authorized by the Federal Reserve Board as
permissible for bank holding companies, unless the OTS by regulation,
prohibits or limits such activities for savings and loan holding companies.
Those activities described in (vii) above also must be approved by the OTS
prior to being engaged in by a multiple savings and loan holding company.
Qualified Thrift Lender Test. If the Bank fails the qualified thrift
lender test, within one year the Company must register as, and will become
subject to, the significant activity restrictions applicable to bank holding
com