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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, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-22957
RIVERVIEW BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Washington 91-1838969
- ------------------------------------------------- -----------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
900 Washington St., Ste. 900,Vancouver, Washington 98660
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (360) 693-6650
-----------------------
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
-----------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and disclosure will not be
contained, to the best of the Registrant's knowledge, in any definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendments to this Form 10-K. X
-----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes X No
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The aggregate market value of the voting stock held by nonaffiliates of
the Registrant, based on the closing sales price of the registrant's Common
Stock as quoted on the Nasdaq National Market System under the symbol "RVSB"
on September 30, 2003 was approximately $89,352,396 (4,727,640 shares at
$18.90 per share). It is assumed for purposes of this calculation that none
of the Registrant's officers, directors and 5% stockholders (including the
Riverview Bancorp, Inc. Employee Stock Ownership Plan) are affiliates. As of
May 11, 2004, there were issued and outstanding 4,777,911 shares of the
Registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Registrant's Definitive Proxy Statement for the 2004
Annual Meeting of Shareholders (Part III).
PART I
Item 1. Business
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General
Riverview Bancorp, Inc. ("the Company"), a Washington corporation, was
organized on June 23, 1997 for the purpose of becoming the holding company for
Riverview Savings Bank FSB, upon its reorganization as a wholly-owned
subsidiary of the Company resulting from the conversion of Riverview, M.H.C.,
Camas, Washington, from a federal mutual holding company to a stock holding
company ("Conversion and Reorganization"). The Conversion and Reorganization
was completed on September 30, 1997. Riverview Savings Bank, FSB changed its
name to Riverview Community Bank (the "Bank") effective June 29, 1998. On July
18, 2003, the Company completed the acquisition of Today's Bancorp, Inc.
("Today's Bancorp"). The acquisition of Today's Bancorp's $122.3 million of
assets and $105.1 million of deposits were accounted for using the purchase
method of accounting. At March 31, 2004, the Company had total assets of
$520.5 million, total deposits of $409.1 million and shareholders' equity of
$65.2 million. All references to the Company herein include the Bank where
applicable.
The Bank is regulated by the Office of Thrift Supervision ("OTS"), its primary
regulator, and by the Federal Deposit Insurance Corporation ("FDIC"), the
insurer of its deposits. The Bank's deposits are insured by the FDIC up to
applicable legal limits under the Savings Association Insurance Fund ("SAIF").
The Bank has been a member of the Federal Home Loan Bank ("FHLB") system since
1937.
The Company is a progressive community-oriented, financial institution, which
emphasizes local, personal service to residents of its primary market area.
The Company considers Clark, Cowlitz, Klickitat and Skamania counties of
Washington as its primary market area. The Company is engaged primarily in the
business of attracting deposits from the general public and using such funds
in its primary market area to originate mortgage loans secured by one- to
four-family residential real estate, multi-family, commercial construction,
commercial real estate and non-mortgage loans providing financing for business
commercial ("commercial") and consumer purposes. Commercial real estate loans
and commercial loans have grown from 15.72% and 5.87% of the loan portfolio,
respectively, in fiscal 2000 to 42.29% and 13.73%, respectively, in fiscal
2004. The Company continues to change the composition of its loan portfolio
and the deposit base as part of its transition to commercial banking. The
Company's strategic plan includes targeting the commercial banking customer
base in our primary market area, specifically small and medium size
businesses, professionals and wealth building individuals. In pursuit of
these goals, the Company will emphasize controlled growth and the
diversification of its loan portfolio to include a higher portion of
commercial and commercial real estate loans. A related goal is to increase
the proportion of personal and business checking account deposits used to fund
these new loans. Significant portions of these new loan products carry
adjustable rates, higher yields or shorter terms and higher credit risk than
traditional fixed-rate mortgages. The strategic plan stresses increased
emphasis on non-interest income, including increased fees for asset management
and deposit service charges. The strategic plan is designed to enhance
earnings, reduce interest rate risk and provide a more complete range of
financial services to customers and the local communities the Company serves.
The Company is well positioned to attract new customers and to increase its
market share given that the administrative headquarters and nine of its
thirteen branches are located in Clark County, for most of the 1990s was the
fastest growing county in the State of Washington according to the U.S. Census
Bureau.
In order to support its strategy of growth without compromising its local,
personal service to its customers and a commitment to asset quality, the
Company has made significant investments in experienced branch, lending, asset
management and support personnel and has incurred significant costs in
facility expansion. The Company's efficiency ratios reflect this investment
and will remain relatively high by industry standards for the foreseeable
future due to the emphasis on growth and local, personal service. Control of
non-interest expenses remains a high priority for the Company's management.
The Company continuously reviews new products and services to give its
customers more financial options. With an emphasis on growth of non-interest
income and control of non-interest expense, all new technology and services
are
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reviewed for business development and cost saving purposes. The in house
processing of checks and production of images has supported the Bank's
increased service to customers and at the same time has increased efficiency.
The Company continues to experience growth in customer use of the online
banking services. Customers are able to conduct a full range of services on a
real-time basis, including balance inquiries, transfers and electronic
bill-paying. This online service has also enhanced the delivery of cash
management services to commercial customers. The internet banking branch web
site is www.riverviewbank.com.
Market Area
The Company conducts operations from its home office in Vancouver and thirteen
branch offices in Camas, Washougal, Stevenson, White Salmon, Battle Ground,
Goldendale, Vancouver (six branch offices) and Longview, Washington. The
Company's market area for lending and deposit taking activities encompasses
Clark, Cowlitz, Skamania and Klickitat Counties, throughout the Columbia River
Gorge area. The Company operates a trust and financial services company,
Riverview Asset Management Corporation, located in downtown Vancouver,
Washington. Riverview Mortgage, a mortgage broker division of the Company,
originates mortgage loans (including construction loans) for various mortgage
companies predominantly in the Portland, Oregon metropolitan areas, as well as
for the Company. The Business and Professional Banking Division located at
the downtown Vancouver main branch and the Cascade Park lending office offers
commercial and business banking services.
Vancouver is located in Clark County, which is just north of Portland, Oregon.
Several businesses are located in the Vancouver area because of the favorable
tax structure and lower energy costs in Washington as compared to Oregon.
Washington has no state income tax and Clark County operates a public electric
utility that provides relatively lower cost electricity. Located in the
Vancouver area are Sharp Microelectronics, Hewlett Packard, Georgia Pacific,
Underwriters Laboratory and Wafer Tech, as well as several support industries.
In addition to this industrial base, the Columbia River Gorge Scenic Area has
been a source of tourism, which has transformed the area from its past
dependence on the timber industry.
Lending Activities
General. At March 31, 2004, the Company's total net loans receivable,
including loans held for sale, amounted to $381.5 million, or 73.3% of total
assets at that date. The principal lending activity of the Company is the
origination of mortgage loans through its mortgage banking activities,
including residential, residential construction loans and loans collateralized
by commercial properties. While the Company has historically emphasized real
estate mortgage loans secured by one- to four- residential real estate, it has
been diversifying its loan portfolio by focusing on increasing the number of
originations of commercial, commercial real estate and consumer loans. A
substantial portion of the Company's loan portfolio is secured by real estate,
either as primary or secondary collateral, located in its primary market area.
Loan Portfolio Analysis. The following table sets forth the composition of
the Company's loan portfolio by type of loan at the dates indicated.
3
At March 31,
-----------------------------------------------------------------------------------
2004 2003 2002 2001 2000
--------------- --------------- --------------- -------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------- ------- ------ ------- ------ ------- ------ ------- ------ --------
(Dollars in thousands)
Real estate loans:
One- to four-
family (1) $ 44,601 10.61% $ 59,999 17.72% $ 73,536 22.62% $117,152 35.67% $102,542 37.61%
Multi-family 5,074 1.21 6,313 1.86 9,895 3.04 11,073 3.37 10,921 4.01
Construction one- to
four- family 78,094 18.58 70,397 20.79 71,148 21.89 60,041 18.28 49,338 18.10
Construction multi-
family - - 2,100 0.62 4,000 1.23 4,514 1.37 4,669 1.71
Construction commercial 1,453 0.35 4,531 1.34 5,230 1.61 6,806 2.07 3,597 1.32
Land 27,020 6.43 34,630 10.23 27,406 8.43 24,230 7.38 25,475 9.34
Commercial real estate 177,785 42.29 101,672 30.02 84,094 25.87 56,540 17.21 42,871 15.72
-------- ------ -------- ------ -------- ------ -------- ------ --------- ------
Total real estate
loans 334,027 79.47 279,642 82.58 275,309 84.69 280,356 85.35 239,413 87.81
Commercial 57,702 13.73 34,239 10.11 23,319 7.17 23,099 7.03 15,976 5.87
Consumer loans:
Automobile loans 1,622 0.39 1,458 0.43 2,132 0.66 3,223 0.98 2,875 1.05
Savings account loans 333 0.08 319 0.09 515 0.16 440 0.13 356 0.13
Home equity loans 23,778 5.66 21,088 6.23 21,598 6.65 18,761 5.71 11,148 4.09
Other consumer loans 2,864 0.67 1,927 0.56 2,134 0.67 2,596 0.80 2,864 1.05
-------- ------ -------- ------ -------- ------ -------- ------ --------- ------
Total consumer loans 28,597 6.80 24,792 7.31 26,379 8.14 25,020 7.62 17,243 6.32
Total loans and loans
held for sale 420,326 100.00% 338,673 100.00% 325,007 100.00% 328,475 100.00% 272,632 100.00%
====== ====== ====== ====== ======
Less:
Undisbursed loans in
process 31,204 31,222 30,970 26,223 18,880
Unamortized loan
origination fees, net
of direct cost 3,107 2,901 2,970 3,475 3,355
Unearned discounts - - - - 1
Allowance for loan
losses 4,481 2,739 2,537 1,916 1,362
-------- -------- -------- -------- --------
Total loans receivable,
net (1) $381,534 $301,811 $288,530 $296,861 $249,034
======== ======== ======== ======== ========
- --------------
(1) Includes loans held for sale of $407,000, $1.5 million, $1.8 million, $569,000 and none at March 31,
2004, 2003, 2002, 2001 and 2000, respectively.
4
One- to Four- Family Real Estate Lending. The majority of the residential
loans are secured by one- to four- family residences located in the Company's
primary market area. Underwriting standards require that one- to four- family
portfolio loans generally be owner occupied and that loan amounts not exceed
80% or (95% with private mortgage insurance) of the lesser of current
appraised value or cost of the underlying collateral. Terms typically range
from 15 to 30 years, and the Company also offers balloon mortgage loans with
terms of either five or seven years. The Company originates both fixed rate
mortgages and adjustable rate mortgages ("ARMs") with repricing based on
Treasury Bill or other index. The ability to generate volume in ARMs, however,
is largely a function of consumer preference and the interest rate
environment.
In addition to originating one- to four- family loans for its portfolio, the
Company is an active mortgage broker for several third party mortgage lenders.
In recent periods, these mortgage brokerage activities have reduced the volume
of fixed rate one- to- four family loans that are originated and sold by the
Company. See "-Loan Originations, Sales and Purchases" and "-Mortgage
Brokerage."
The Company generally sells fixed-rate mortgage loans with maturities of 15
years or more and balloon mortgages to the Federal Home Loan Mortgage
Corporation ("FHLMC"), servicing retained. See "-Loan Originations, Sales and
Purchases" and "-Mortgage Loan Servicing."
The retention of ARM loans in the portfolio helps reduce the Company's
exposure to changes in interest rates. There are; however, unquantifiable
credit risks resulting from the potential of increased costs arising from
changed rates to be paid by the customer. It is possible that during periods
of rising interest rates the risk of default on ARM loans may increase as a
result of repricing and the increased costs to the borrower. Another
consideration is that although ARM loans allow the Company to increase the
sensitivity of its asset base to changes in interest rates, the extent of this
interest sensitivity is limited by the periodic and lifetime interest rate
adjustment limits. Because of these considerations, the Company has no
assurance that yields on ARM loans will be sufficient to offset increases in
its cost of funds.
While one- to four- family residential real estate loans typically are
originated with 30-year terms and the Company permits its ARM loans to be
assumed by qualified borrowers, these loans generally remain outstanding for
substantially shorter periods because borrowers often prepay their loans in
full upon sale of the property pledged as security or upon refinancing the
original loan. In addition, substantially all of the fixed interest rate
loans in the Company's loan portfolio contain due-on-sale clauses providing
that the Company may declare the unpaid amount due and payable upon the sale
of the property securing the loan. Thus, average loan maturity is a function
of, among other factors, the level of purchase and sale activity in the real
estate market, prevailing interest rates and the interest rates payable on
outstanding loans.
The Company requires title insurance insuring the status of its lien on all of
the real estate secured loans and also requires that fire and extended
coverage casualty insurance (and, if appropriate, flood insurance) be
maintained in an amount at least equal to the lesser of the loan balance and
the replacement cost of the improvements. Where the value of the unimproved
real estate exceeds the amount of the loan on the real estate, the Company may
make exceptions to its property insurance requirements.
Construction Lending. The Company actively originates three types of
residential construction loans: (i) speculative construction loans, (ii)
custom/presold construction loans and (iii) construction/permanent loans.
Subject to market conditions, the Company intends to increase its residential
construction lending activities. To a lesser extent, the Company also
originates construction loans for the development of multi-family and
commercial properties.
5
At March 31, 2004 and 2003, the composition of the Company's construction loan
portfolio was as follows:
At March 31,
--------------------------------------
2004 2003
------------------ ------------------
Amount(1) Percent Amount(1) Percent
-------- ------- -------- -------
(Dollars in thousands)
Speculative construction $37,017 39.80% $32,379 33.24%
Commercial/multi-family construction 1,453 1.56 10,750 11.04
Custom/presold construction 15,949 17.15 7,286 7.48
Construction/permanent 25,128 27.02 26,590 27.30
Construction/land 13,461 14.47 20,412 20.94
------- ------ ------- ------
Total $93,008 100.00% $97,417 100.00%
======= ====== ======= ======
(1) Includes loans in progress.
Speculative construction loans are made to home builders and are termed
"speculative" because the home builder does not have, at the time of loan
origination, a signed contract with a home buyer who has a commitment for
permanent financing with either the Company or another lender for the finished
home. The home buyer may be identified either during or after the
construction period, with the risk that the builder will have to debt service
the speculative construction loan and finance real estate taxes and other
carrying costs of the completed home for a significant time after the
completion of construction until the home buyer is identified. At March 31,
2004, the Company had seven borrowers with aggregate outstanding speculative
loan balances of more than $1.0 million, which totaled $10.9 million and were
performing according to original terms.
Unlike speculative construction loans, presold construction loans are made for
homes that have buyers. Presold construction loans are made to home builders
who, at the time of construction, have a signed contract with a home buyer who
has a commitment for permanent financing for the finished home from the
Company or another lender. Custom construction loans are made to the
homeowner. Custom/presold construction loans are generally originated for a
term of 12 months. At March 31, 2004, the largest custom construction loan
and presold construction loan had outstanding balances of $1,920,000 and
$297,000, respectively, and were performing according to original terms.
Construction/permanent loans are originated to the homeowner rather than the
home builder along with a commitment by the Company to originate a permanent
loan to the homeowner to repay the construction loan at the completion of
construction. The construction phase of a construction/permanent loan
generally lasts six to nine months. At the completion of construction, the
Company may either originate a fixed rate mortgage loan or an ARM loan or use
its mortgage brokerage capabilities to obtain permanent financing for the
customer with another lender. At completion of construction, the
Company-originated fixed rate permanent loan's interest rate is set at a
market rate and for adjustable rate loans, the interest rates adjust on their
first adjustment date. See " Mortgage Brokerage," " Loan Originations, Sales
and Purchases" and " Mortgage Loan Servicing." At March 31, 2004, the largest
outstanding construction/permanent loan had an outstanding balance of $1.2
million and was performing according to its original terms.
The Company also provides construction financing for non-residential
properties (i.e., multi-family and commercial properties). The Company has
increased its commercial lending resources with the intent of increasing the
amount of commercial real estate loan balances such as construction commercial
and construction multi-family loans. Construction lending affords the Company
the opportunity to achieve higher interest rates and fees with shorter terms
to maturity than does its single-family permanent mortgage lending.
Construction lending, however, generally involves a higher degree of risk than
single-family permanent mortgage lending because of the inherent difficulty in
estimating both a property's value at completion of the project and the
estimated cost of the project. The nature of these loans is such that they are
generally more difficult to evaluate and monitor. If the estimate of
construction cost proves to be inaccurate, the Company may be required to
advance funds beyond the amount originally committed to permit completion of
the project. If the estimate of value upon completion proves to be
inaccurate, the Company may be confronted with a project whose value is
insufficient to assure full repayment. Projects may also be jeopardized by
disagreements between borrowers and builders and by the
6
failure of builders to pay subcontractors. The Company has sought to address
these risks by adhering to strict underwriting policies, disbursement
procedures and monitoring practices. In addition, because the Company's
construction lending is in its primary market area, changes in the local
economy and real estate market could adversely affect the Company's
construction loan portfolio. Of the $1.5 million commercial construction loans
outstanding at March 31, 2004, the loan commitment amount was $2.1 million. At
March 31, 2004, the outstanding construction commercial loan had an
outstanding balance of $1.5 million and was performing according to its
original terms.
Multi-Family Lending. Multi-family mortgage loans generally have terms up to
25 years with loan-to-value ratio up to 75%. Both fixed and adjustable rate
loans are offered with a variety of terms to meet the multi-family residential
financing needs. At March 31, 2004, the largest multi-family mortgage loan
had an outstanding loan balance of $2.5 million and was performing according
to it's original terms.
Multi-family mortgage lending affords the Company an opportunity to receive
interest at rates higher than those generally available from one- to four-
family residential lending. However, loans secured by such properties usually
are greater in amount, are more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to four- family
residential mortgage loans. Because payments on loans secured by multi-family
properties are often dependent on the successful operation and management of
the properties, repayment of such loans may be affected by adverse conditions
in the real estate market or the economy. The Company seeks to minimize these
risks by strictly scrutinizing the financial condition of the borrower, the
quality of the collateral and the management of the property securing the
loan. The Company also generally obtains personal guarantees from financially
capable parties based on a review of personal financial statements.
Land Lending. The Company originates loans to local real estate developers
with whom it has established relationships for the purpose of developing
residential subdivisions (i.e., installing roads, sewers, water and other
utilities), as well as loans to individuals to purchase building lots. Land
development loans are secured by a lien on the property and made for a period
not to exceed five years with an interest rate that adjusts with the prime
rate, and are made with loan-to-value ratios not exceeding 75%. Monthly
interest payments are required during the term of the loan. Subdivision loans
are structured so that the Company is repaid in full upon the sale by the
borrower of approximately 90% of the subdivision lots. All of the Company's
land loans are secured by property located in its primary market area. In
addition, the Company also generally obtains personal guarantees from
financially capable parties based on a review of personal financial
statements. At March 31, 2004, the largest outstanding land loan was $2.9
million and was performing according to it's original terms.
Loans secured by undeveloped land or improved lots involve greater risks than
one- to four- family residential mortgage loans because these loans are
advanced upon the predicted future value of the developed property. If the
estimate of these future value proves to be inaccurate, in the event of
default and foreclosure, the Company may be confronted with a property the
value of which is insufficient to assure full repayment. The Company attempts
to minimize this risk by limiting the maximum loan-to-value ratio on land
loans to 65% of the estimated developed value of the secured property. Loans
on raw land may run the risk of adverse zoning changes, environmental or other
restrictions on future use.
Commercial Real Estate Lending. The Company originates commercial real estate
loans at both variable and fixed interest rates and secured by properties,
such as office buildings, retail/wholesale facilities and industrial
buildings, located in its primary market area. The principal balance of an
average commercial real estate loan generally ranges between $100,000 and $1.0
million. At March 31, 2004, the largest commercial real estate loan had an
outstanding balance of $7.7 million and is secured by an office building
located in the Company's primary market area. At March 31, 2004, the loan was
performing according to its original terms.
Commercial real estate lending affords the Company an opportunity to receive
interest at rates higher than those generally available from one- to- four
family residential lending. However, loans secured by such properties usually
are greater in amount, more difficult to evaluate and monitor and, therefore,
involve a greater degree of risk than one- to- four family residential
mortgage loans. Because payments on loans secured by commercial properties
often depend upon the successful operation and management of the properties,
repayment of such loans may be affected by adverse conditions in the real
estate market or the economy. The Company seeks to minimize these risks by
limiting the maximum loan-to-value ratio to 75% and strictly scrutinizing the
financial condition of the borrower, the quality of the collateral and the
management of the property securing the loan. At March 31, 2004, the Company
had no commercial real estate loans accounted for on a
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nonaccrual basis.
Commercial Lending. The Company's commercial loan portfolio has increased to
13.73% of the total loan portfolio at March 31, 2004 from 5.87% at March 31,
2000 and 10.11% at March 31, 2003. The Company has been able to increase the
balance of outstanding commercial loans and commitments due to the local
economy, the consolidation of some local competitors offering commercial loans
and the hiring of several experienced commercial bankers from competitors in
the local market.
Commercial loans are generally made to customers who are well known to the
Company and are typically secured by business equipment or other property. The
Company's commercial loans may be structured as term loans or as lines of
credit. Commercial term loans are generally made to finance the purchase of
assets and have maturities of five years or less. Commercial lines of credit
are typically made for the purpose of providing working capital and usually
have a term of one year or less. Lines of credit are made at variable rates
of interest equal to a negotiated margin above an index rate and term loans
are at a fixed rate. The Company also generally obtains personal guarantees
from financially capable parties based on a review of personal financial
statements.
Commercial lending involves greater risk than residential mortgage lending and
involves risks that are different from those associated with residential and
commercial real estate lending. Real estate lending is generally considered
to be collateral based lending with loan amounts based on predetermined loan
to collateral values and liquidation of the underlying real estate collateral
is viewed as the primary source of repayment in the event of borrower default.
Although commercial loans are often collateralized by equipment, inventory,
accounts receivable or other business assets including real estate, the
liquidation of collateral in the event of a borrower default is often an
insufficient source of repayment because accounts receivable may be
uncollectible and inventories and equipment may be obsolete or of limited use,
among other things. Accordingly, the repayment of a commercial loan depends
primarily on the creditworthiness of the borrower (and any guarantors), while
liquidation of collateral is a secondary and often insufficient source of
repayment. At March 31, 2004, the Company had twelve commercial loans on
nonaccrual status totaling $851,000.
Consumer Lending. The Company originates a variety of consumer loans,
including home equity lines of credit, home equity term loans, home
improvement loans, loans for debt consolidation and other purposes, automobile
loans, boat loans and savings account loans.
Home equity lines of credit and home equity term loans are typically secured
by a second mortgage on the borrower's primary residence. Home equity lines of
credit are made at loan-to-value ratios of 90% or less, taking into
consideration the outstanding balance on the first mortgage on the property.
Home equity lines of credit have a variable interest rate while home equity
term loans have a fixed rate of interest. The Company's procedures for
underwriting consumer loans include an assessment of the applicant's payment
history on other debts and ability to meet existing obligations and payments
on the proposed loans. Although the applicant's creditworthiness is a primary
consideration, the underwriting process also includes a comparison of the
value of the security, if any, to the proposed loan amount.
Consumer loans generally entail greater risk than do residential mortgage
loans, particularly in the case of consumer loans that are unsecured or
secured by assets that depreciate rapidly, such as mobile homes, automobiles,
boats and recreational vehicles. In such cases, repossessed collateral for a
defaulted consumer loan may not provide an adequate source of repayment for
the outstanding loan and the remaining deficiency often does not warrant
further substantial collection efforts against the borrower. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability, and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Furthermore, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans.
Such loans may also give rise to claims and defenses by the borrower against
the Company as the holder of the loan, and a borrower may be able to assert
claims and defenses, which it has against the seller of the underlying
collateral. At March 31, 2004, one consumer loan for $65,100 was on
nonaccrual status.
Loan Maturity. The following table sets forth certain information at March
31, 2004 regarding the dollar amount of loans maturing in the Company's
portfolio based on their contractual terms to maturity, but does not include
potential prepayments. Demand loans, loans having no stated schedule of
repayments and no stated maturity and overdrafts are
8
reported as due in one year or less. Loan balances do not include unearned
discounts, unearned income and allowance for loan losses.
After
One After 3 After 5
Within Year to Years to Years to Beyond
One Year 3 Years 5 Years 10 Years 10 Years Total
-------- ------- ------- -------- -------- -------
(In thousands)
Residential one- to four-
family:
Adjustable rate $ - $ - $ 539 $ 693 $22,072 $ 23,304
Fixed rate 1,249 7,389 4,086 2,624 5,948 21,296
Construction:
Adjustable rate 48,553 16,602 - - - 65,155
Fixed rate 27,709 144 - - - 27,853
Other real estate:
Adjustable rate 23,198 12,590 9,928 66,686 13,768 126,170
Fixed rate 12,744 21,121 22,729 11,740 1,913 70,247
Commercial:
Adjustable rate 31,034 2,083 3,888 2,884 - 39,889
Fixed rate 6,073 7,036 4,450 348 - 17,907
Consumer:
Adjustable rate 562 293 24 2,573 18,715 22,167
Fixed rate 324 1,516 2,076 1,159 1,263 6,338
-------- ------- ------- ------- ------- --------
Total gross loans $151,446 $68,774 $47,720 $88,707 $63,679 $420,326
======== ======= ======= ======= ======= ========
The following table sets forth the dollar amount of all loans due within one
year of March 31, 2004, which have fixed interest rates or have floating or
adjustable interest rates.
Fixed- Floating or
Rates Adjustable Rates
--------- ----------------
(In thousands)
Residential one- to four- family $ 20,047 $ 23,304
Construction loans 144 16,602
Other real estate loans 57,503 102,972
Commercial 11,834 8,855
Consumer 6,014 21,605
--------- --------
Total $ 95,542 $173,338
========= ========
Scheduled contractual principal repayments of loans do not reflect the actual
life of such assets. The average life of a loan is substantially less than
its contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Company the right to declare loans
immediately due and payable in the event, among other things, that the
borrower sells the real property. The average life of mortgage loans tends to
increase, however, when current mortgage loan market rates are substantially
higher than rates on existing mortgage loans and, conversely, decrease when
rates on existing mortgage loans are substantially higher than current
mortgage loan market rates. Furthermore, management believes that a
significant number of the Company's residential mortgage loans are outstanding
for a period less than their contractual terms because of the transitory
nature of many of the borrowers who reside in its primary market area.
Loan Solicitation and Processing. The Company's lending activities are subject
to the written, non-discriminatory, underwriting standards and loan
origination procedures established by the Board of Directors and management.
The customary sources of loan originations are realtors, walk-in customers,
referrals and existing customers. The Company also uses commissioned loan
brokers and print advertising to market its products and services.
The Company's loan approval process is intended to assess the borrower's
ability to repay the loan, the viability of the loan,
9
the adequacy of the value of the property that will secure the loan, if any
and, in the case of commercial and multi-family real estate loans, the cash
flow of the project and the quality of management involved with the project.
The Company's lending policy requires borrowers to obtain certain types of
insurance to protect the Company's interest in any collateral securing the
loan. Loans are approved at various levels of management, depending upon the
amount of the loan.
Loan Commitments. The Company issues commitments to originate residential
mortgage loans, commercial real estate mortgage loans, consumer loans and
commercial loans conditioned upon the occurrence of certain events. The
Company uses the same credit policies in making commitments as it does for
on-balance sheet instruments. Commitments to extend credit are conditional,
and are honored for up to 45 days subject to the Company's usual terms and
conditions. Collateral is not required to support commitments. At March 31,
2004, the Company had outstanding commitments to originate loans in the amount
of $9.0 million.
Loan Originations, Sales and Purchases. While the Company originates
adjustable-rate and fixed-rate loans, its ability to generate each type of
loan depends upon relative customer demand for loans in its primary market
area. During the years ended March 31, 2004 and 2003, the Company's total
loan originations were $375.8 million and $298.4 million, respectively, of
which 70.4% and 63.2%, respectively, were subject to periodic interest rate
adjustment and 29.6% and 36.8%, respectively, were fixed-rate loans.
The Company customarily sells the fixed-rate residential one- to four- family
mortgage loans that it originates with maturities of 15 years or more to the
FHLMC as part of its asset liability strategy. The sale of these loans allows
the Company to continue to make loans during periods when savings flows
decline or funds are not otherwise available for lending purposes; however,
the Company assumes an increased risk if these loans cannot be sold in a
rising interest rate environment. Changes in the level of interest rates and
the condition of the local and national economies affect the amount of loans
originated by the Company and demanded by investors to whom the loans are
sold. Generally, the Company's residential one- to- four family mortgage loan
origination and sale activity and, therefore, its results of operations, may
be adversely affected by an increasing interest rate environment to the extent
such environment results in decreased loan demand by borrowers and/or
investors. Accordingly, the volume of loan originations and the profitability
of this activity can vary significantly from period to period. Mortgage loans
are sold to the FHLMC on a nonrecourse basis whereby foreclosure losses are
generally the responsibility of the FHLMC and not the Company. Servicing is
retained on loans sold to FHLMC.
Interest rates on residential one- to four- family mortgage loan applications
are typically locked with customers and FHLMC during the application stage for
periods ranging from 30 to 90 days, the most typical period being 45 days.
These loans are locked with FHLMC under a best-efforts delivery program. The
Company makes every effort to deliver these loans before their rate locks
expire. This arrangement requires the Company to deliver the loans to FHLMC
within ten days of funding. Delays in funding the loans can require a lock
extension. The cost of a lock extension at times is borne by the borrower and
at times by the Company. These lock extension costs paid by the Company are
not expected to have a material impact to operations. This activity is
managed daily.
There can be no assurance that the Company will be successful in its efforts
to reduce the risk of interest rate fluctuation between the time of
origination of a mortgage loan and the time of the ultimate sale of the loan.
To the extent that the Company does not adequately manage its interest rate
risk, the Company may incur significant mark-to-market losses or losses
relating to the sale of such loans, adversely affecting financial condition
and results of operations.
The Company is not an active purchaser of loans.
10
The following table shows total loans originated, sold and repaid during the
periods indicated.
For the Years Ended March 31,
------------------------------
2004 2003 2002
-------- -------- --------
(In thousands)
Total net loans receivable and loans
held for sale at beginning of period $301,811 $288,530 $296,861
-------- -------- --------
Loans originated:
Mortgage loans:
One- to four- family 35,963 45,004 40,398
Multi-family 2,065 6,936 219
Construction one- to four- family 104,913 87,049 81,809
Construction commercial real estate 482 3,267 14,585
Construction multi-family 341 2,597 -
Land and commercial real estate 99,508 61,671 57,942
Commercial 101,432 68,083 55,213
Consumer 31,135 23,784 23,697
-------- -------- --------
Total loans originated 375,839 298,391 273,863
Residential one- to four- family
loans sold (51,567) (56,097) (35,701)
Repayment of principal (329,443) (227,101) (203,466)
Loans securitized - - (40,347)
Today's Bank acquisition 85,610 - -
Decrease in other items, net (716) (1,912) (2,680)
-------- -------- --------
Net increase (decrease) in loans 79,723 13,281 (8,331)
-------- -------- --------
Total net loans receivable and loans held
for sale at end of period $381,534 $301,811 $288,530
======== ======== ========
Mortgage Brokerage. In addition to originating mortgage loans for retention
in its portfolio, the Company employs nine commissioned brokers who originate
mortgage loans (including construction loans) for various mortgage companies
predominately in the Portland metropolitan area, as well as for the Company.
The loans brokered to mortgage companies are closed in the name of and funded
by the purchasing mortgage company and are not originated as an asset of the
Company. In return, the Company receives a fee ranging from 1% to 1.5% of the
loan amount that it shares with the commissioned broker. Loans brokered to the
Company are closed on the Company's books as if the Company had originated
them and the commissioned broker receives a fee of approximately 0.50% of the
loan amount. During the year ended March 31, 2004, brokered loans totaled
$183.0 million (including $67.6 million brokered to the Company). Gross fees
of $1.5 million (excluding the portion of fees shared with the commissioned
brokers) were recognized for the year ended March 31, 2004. The interest rate
environment has a strong influence on the loan volume and amount of fees
generated from the mortgage broker activity. In general, during periods of
rising interest rates such as we are currently experiencing, the volume of
loans and amount of loan fees generally decreases as a result of slower
mortgage loan demand. Conversely, during periods of falling interest rates,
the volume of loans and amount of loan fees generally increase as a result of
the increased mortgage loan demand.
Mortgage Loan Servicing. The Company is a qualified servicer for the FHLMC.
The Company's general policy is to close its residential loans on the FHLMC
modified loan documents to facilitate future sales to the FHLMC. Upon sale,
the Company continues to collect payments on the loans, to supervise
foreclosure proceedings, if necessary, and otherwise to service the loans.
The Company generally retains the servicing rights on the fixed-rate mortgage
loans that it sells to the FHLMC. At March 31, 2004, total loans serviced for
others were $133.5 million.
11
In 1994, the Company purchased the servicing rights to an underlying portfolio
of residential mortgage loans secured by properties predominately located in
the Seattle metropolitan area. At March 31, 2004, the carrying value of these
purchased servicing rights was $20,000 and was being amortized over the life
of the underlying loan servicing.
The value of loans serviced for others is significantly affected by interest
rates. In general, during periods of falling interest rates, mortgage loans
repay at faster rates and the value of the mortgage servicing declines.
Conversely, during periods of rising interest rates, the value of the mortgage
servicing rights generally increases as a result of slower rates of
repayments. The Company may be required to recognize this decrease in value
by taking a charge against its earnings, which would cause its profits to
decrease. The Company has experienced a decrease and an increase in
prepayments of mortgages as interest rates have dramatically changed during
the past two years, which has impacted the value of the servicing asset.
Accordingly, the Company recognized an $307,000 increase in its servicing
portfolio for fiscal year 2004 reflecting the increase in interest rates and
slowing of prepayments and a $320,000 impairment charges for fiscal 2003
reflecting the decrease in mortgage interest rates and the increase in
prepayments. We believe, based on historical experience, that the amount of
prepayments and the related impairment charges should decrease as interest
rates increase.
Loan Origination and Other Fees. The Company generally receives loan
origination fees and discount "points." Loan fees and points are a
percentage of the principal amount of the loan that is charged to the borrower
for funding the loan. The Company usually charges origination fees of 1.5% to
2.0% on one- to four- family residential real estate loans, long-term
commercial real estate loans and residential construction loans. Commercial
loan fees are based on terms of the individual loan. Current accounting
standards require fees received for originating loans to be deferred and
amortized into interest income over the contractual life of the loan. Deferred
fees associated with loans that are sold are recognized as gain on sale of
loans. The Company had $3.1 million of net deferred loan fees at March 31,
2004. The Company also receives loan servicing fees on the loans it sells and
on which it retains the servicing rights. See Note 10 of Notes to
Consolidated Financial Statements.
Delinquencies. The Company's collection procedures for all loans except
consumer loans provide for a series of contacts with delinquent borrowers. A
late charge delinquency notice is first sent to the borrower when the loan
secured by real estate becomes 17 days past due. A follow-up telephone call,
or letter if the borrower cannot be contacted by telephone, is made when the
loan becomes 22 days past due. A delinquency notice is sent to the borrower
when the loan becomes 30 days past due. When payment becomes 60 days past
due, a notice of default letter is sent to the borrower stating that
foreclosure proceedings will commence unless the delinquency is cured. If a
loan continues in a delinquent status for 90 days or more, the Company
generally initiates foreclosure proceedings. In certain instances, however,
the Company may decide to modify the loan or grant a limited moratorium on
loan payments to enable borrowers to reorganize their financial affairs.
A delinquent consumer loan borrower is contacted on the fifteenth day of
delinquency. A letter of intent to repossess collateral is mailed to the
borrower after the loan becomes 45 days past due and repossession proceedings
are initiated after the loan becomes 90 days delinquent.
Delinquencies in commercial loans are handled on a case-by-case basis.
Generally, notices are sent and personal contact is made with the borrower
when the loan is 15 days past due. Loan officers are responsible for
collecting loans they originate or that are assigned to them. Depending on
the nature of the loan or type of collateral securing the loan, negotiations,
or other actions, are undertaken depending upon the circumstances.
Nonperforming Assets. Loans are reviewed regularly and it is the Company's
general policy that when a loan is 90 days delinquent or when collection of
interest appears doubtful, it is placed on nonaccrual status, at which time
the accrual of interest ceases and the reserve for any unrecoverable accrued
interest is established and charged against operations. Typically, payments
received on a nonaccrual loan are applied to the outstanding principal and
interest as determined at the time of collection of the loan.
Real estate owned is real estate acquired in settlement of loans and consists
of real estate acquired through foreclosure or deeds in lieu of foreclosure.
The acquired real estate is recorded at net realizable value. The Company
periodically reviews the property's net realizable value and a charge to
operations is taken if the property's recorded value exceeds the property's
net realizable value.
12
The following table sets forth information with respect to the Company's
nonperforming assets. At the dates indicated, the Company had no restructured
loans within the meaning of Statement of Financial Accounting Standards
("SFAS") No. 15, Accounting for Certain Investments in Debt and Equity
Securities.
At March 31,
----------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
(Dollars in thousands)
Loans accounted for on a
nonaccrual basis:
Residential real estate $ 24 $301 $ 830 $ 153 $ 833
Commercial real estate 309 - 297 - -
Land 31 - 180 - 320
Commercial 872 - 54 50 99
Consumer 65 22 39 116 26
------ ---- ------ ------- ------
Total 1,301 323 1,400 319 1,278
------ ---- ------ ------- ------
Accruing loans which are
contractually past due 90
days or more - - 122 226 -
------ ---- ------ ------- ------
Total of nonaccrual and
90 days past due loans 1,301 323 1,522 545 1,278
------ ---- ------ ------- ------
Real estate owned (net) 742 425 853 473 65
------ ---- ------ ------- ------
Total nonperforming
assets $2,043 $748 $2,375 $1,018 $1,343
====== ==== ====== ====== ======
Total loans delinquent
90 days or more to net
loans 0.34% 0.11% 0.53% 0.18% 0.51%
Total loans delinquent
90 days or more to
total assets 0.25 0.08 0.39 0.13 0.37
Total nonperforming assets
to total assets 0.39 0.18 0.61 0.24 0.39
The gross amount of interest income on the nonaccrual loans that would have
been recorded during the year ended March 31, 2004 if the nonaccrual loans had
been current in accordance with their original terms was approximately
$66,000. For the year ended March 31, 2004, no interest was earned on the
nonaccrual loans and included in interest and fees on loans receivable
interest income.
Loans not included in nonperforming or past due categories, but where
information about possible credit problems causes management to be uncertain
about the borrower's ability to comply with existing repayment terms, totaled
$4.9 million at March 31, 2004 and $2.4 million at March 31, 2003.
Asset Classification. The OTS has adopted various regulations regarding
problem assets of savings institutions. The regulations require that each
insured institution review and classify its assets on a regular basis. In
addition, in connection with examinations of insured institutions, OTS
examiners have authority to identify problem assets and, if appropriate,
require them to be classified. There are three classifications for problem
assets: substandard, doubtful and loss. Substandard assets have one or more
defined weaknesses and are characterized by the distinct possibility that the
insured institution will sustain some loss if the deficiencies are not
corrected. Doubtful assets have the weaknesses of substandard assets with the
additional characteristic that the weaknesses make collection or liquidation
in full on the basis of currently existing facts, conditions and values
questionable, and there is a high possibility of loss. An asset classified as
loss is considered uncollectible and of such little value that continuance as
an asset of the institution is not warranted. If an asset or portion thereof
is classified as loss, the insured institution establishes specific allowances
for loan losses for the full amount of the portion of the asset classified as
loss. All or a portion of general loan loss allowances established to cover
possible losses related to assets classified substandard or doubtful can be
included in determining an institution's regulatory capital, while specific
valuation allowances for loan losses generally do not qualify as regulatory
capital. Assets that do not
13
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are designated "special mention" and monitored by the Company.
The aggregate amount of the Company's classified assets, general loss
allowances, specific loss allowances and charge-offs were as follows at the
dates indicated:
At or For the Year
Ended March 31,
------------------
2004 2003
------ ------
(In thousands)
Substandard assets $4,932 $2,740
Doubtful assets 803 -
Loss assets - -
General loss allowances 4,481 2,739
Specific loss allowances - -
Charge-offs 1,182 428
The loans classified as substandard assets at March 31, 2004 comprise one land
development loan totaling $97,000, one home equity line of credit totaling
$65,000, 11 real estate secured commercial loans totaling $1.3 million and 49
commercial loans totaling $3.5 million. The acquisition of Today's Bancorp
significantly increased the amount and number of loans classified substandard.
Loans classified as doubtful assets at March 31, 2004 consisted of one real
estate secured loan totaling $475,000, and eight commercial loans totaling
$328,000.
Real Estate Owned. Real estate properties acquired through foreclosure or by
deed-in-lieu of foreclosure are recorded at the lower of cost or fair value
less estimated costs of disposal. Management periodically performs valuations
and an allowance for loan losses is established by a charge to operations if
the carrying value exceeds the estimated net realizable value. At March 31,
2004, the Company owned three properties with a recorded value of $742,000
compared to $425,000 at March 31, 2003. The $742,000 recorded value consists
of two land loans totaling $325,000 and one single family loan of $417,000.
Allowance for Loan Losses. The Company maintains an allowance for loan losses
to provide for losses inherent in the loan portfolio. The adequacy of the
allowance is evaluated monthly to maintain the allowance at levels sufficient
to provide for inherent losses. A key component to the evaluation is the
Company's internal loan review and loan classification system. The internal
loan review system provides for at least an annual review by the internal
audit department of all loans that meet selected criteria. The Internal Loan
Classification Committee reviews and monitors the risk and quality of the
Company's loan portfolio. The Internal Loan Classification Committee members
include the Credit Administrator, Chairman and Chief Executive Officer,
President and Chief Operating Officer, Executive Vice President Credit
Administration and Senior Vice President Business & Professional Banking.
Credit officers are expected to monitor their portfolios and make
recommendations to change loan grades whenever changes are warranted. At
least annually, loans that are delinquent 60 days or more and with specified
outstanding loan balances are subject to review by the internal audit
department. The Internal Loan Classification Committee meets quarterly to
approve any changes to loan grades, monitor loan grades and to recommend any
changes to the loan grades.
The Company uses the OTS loan classifications of special mention, substandard,
doubtful and loss plus the additional loan classifications of pass and watch
in order to assign a loan grade to be used in the determination of the proper
amount of allowance for loan losses. The definition of a pass classification
represents a level of credit quality, which contains no well-defined
deficiency or weakness. The definition of watch classification is used to
identify a loan that currently contains no well-defined deficiency or
weakness, but management has deemed it desirable to closely monitor the loan.
14
The Company uses the loan classifications from the internal loan review and
Internal Loan Classification Committee in the following manner to determine
the amount of the allowance for loan losses. The calculation of the allowance
for loan losses must consider loan classification in order to determine the
amount of the allowance for loan losses for the required three separate
elements of the allowance for losses: general allowances, allocated allowances
and unallocated allowances.
The general allowance element relates to assets with no well-defined
deficiency or weakness (i.e., assets classified pass or watch) and takes into
consideration loss that is imbedded within the portfolio but has not been
realized. Borrowers are impacted by events that may ultimately result in a
loan default and eventual loss well in advance of a lender's knowledge.
Examples of such loss-causing events in the case of consumer or one- to four-
family residential loans would be a borrower job loss, divorce or medical
crisis. Examples in commercial or construction loans may be loss of customers
due to competition or changes in the economy. General allowances for each
major loan type are determined by applying loss factors that take into
consideration past loss experience, asset duration, economic conditions and
overall portfolio quality to the associated loan balance.
The allocated allowance element relates to assets with well-defined
deficiencies or weaknesses (i.e., assets classified special mention,
substandard, doubtful or loss). The OTS loss factors are applied against
current classified asset balances to determine the amount of allocated
allowances. Included in these allowances are those amounts associated with
loans where it is probable that the value of the loan has been impaired and
the loss can be reasonably estimated.
The unallocated allowance element is more subjective and is reviewed quarterly
to take into consideration estimation errors and economic trends that are not
necessarily captured in determining the general and allocated allowance.
The increase in the balance of the allowance for loan losses at March 31, 2004
reflects the acquisition of Today's Bancorp, Inc., the proportionate increase
in loan balances, the change in mix of loan balances, the increase in
substandard assets and a change in loss rate when compared to March 31, 2003.
The acquisition of Today's Bancorp, Inc. added $2.6 million to the allowance
for loan losses and approximately $900,000 of the charge-offs was related to
loans acquired in the acquisition. The mix of the loan portfolio showed an
increase in the balances of commercial, commercial real estate loans, and
construction, and consumer loans at March 31, 2004 as compared to balances at
March 31, 2003. Substandard assets increased by $3.0 million to $5.7 million
at March 31, 2004 compared to $2.7 million at March 31, 2003. Substandard
asset balance of $5.7 million at March 31, 2004 is a decrease of $5.2 million
from the $10.9 million balance of substandard assets after the acquisition of
Today's Bancorp, Inc. The loss rate for other mention loans was increased
from 1.5% at March 31, 2003 to 4.0% at March 31, 2004 in order to reflect the
risk of loss.
At March 31, 2004, the Company had an allowance for loan losses of $4.5
million, or 1.16% of total outstanding net loans at that date. Based on past
experience and probable losses inherent in the loan portfolio, management
believes that loan loss reserves are adequate.
While the Company believes it has established its existing allowance for loan
losses in accordance with accounting principles generally accepted in the
United States of America ("generally accepted accounting principles" or
"GAAP"), there can be no assurance that regulators, in reviewing the Company's
loan portfolio, will not request the Company to increase significantly its
allowance for loan losses, thereby negatively affecting the Company's
financial condition and results of operations.
15
The following table sets forth an analysis of the Company's allowance for loan
losses for the periods indicated.
Year Ended March 31,
---------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
(Dollars in thousands)
Balance at beginning of period $2,739 $2,537 $1,916 $1,362 $1,146
------ ------ ------ ------ ------
Provision for loan losses 210 727 1,116 949 675
Recoveries:
Residential real estate - 2 - - -
Land - 63 - - -
Commercial 74 - - - 1
Consumer 17 13 25 18 28
------ ------ ------ ------ ------
Total recoveries 91 78 25 18 29
------ ------ ------ ------ ------
Charge-offs:
Residential real estate 21 140 88 226 48
Land 15 17 - - -
Commercial 882 119 185 27 282
------ ------ ------ ------ ------
Consumer 264 152 166 160 158
------ ------ ------ ------ ------
Total charge-offs 1,182 428 439 413 488
------ ------ ------ ------ ------
Net charge-offs 1,091 350 414 395 459
------ ------ ------ ------ ------
Dispositions (1) - - 81 - -
Allowance acquired from
Today's Bank 2,639
Net change in allowance for
unfunded loan commitments
and lines of credit (16) (175) - - -
------ ------ ------ ------ ------
Balance at end of period $4,481 $2,739 $2,537 $1,916 $1,362
====== ====== ====== ====== ======
Ratio of allowance to total
net loans outstanding
during period 1.16% 0.90% 0.87% 0.64% 0.54%
Ratio of net charge-offs to
average net loans
outstanding during period 0.31 0.12 0.14 0.14 0.21
Ratio of allowance to total
of nonaccrual and 90 days
past due loans 344.43 847.99 166.69 351.56 106.58
16
(1) Allowance reclassified with securitization of one-to four-family loans
to mortgage-backed securities.
Changes in the allowance for unfunded loan commitments and lines of credit:
Year Ended March 31,
---------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
(Dollars in thousands)
Beginning Balance $ 175 $ - $ - $ - $ -
Net change in allowance for
unfunded loan commitments and
lines of credit 16 175 - - -
------ ------ ------ ------ ------
Ending Balance $ 191 $ 175 $ - $ - $ -
====== ====== ====== ====== ======
The following table sets forth the breakdown of the allowance for loan losses
by loan category and is based on applying a specific loan loss factor to the
related loan category outstanding loan balances as of the date of the
allocation for the periods indicated.
At March 31,
---------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------------- ----------------- ----------------- ----------------- -----------------
Loan Loan Loan Loan Loan
Category Category Category Category Category
as a Percent as a Percent as a Percent as a Percent as a Percent
of Total of Total of Total of Total of Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ --------- ------ --------- ------ --------- ------ --------- ------ ---------
(Dollars in thousands)
Real estate
loans
One- to
four-family $ 89 11.46% $ 122 19.50% $ 191 24.99% $ 263 38.73% $ 259 40.34%
Multi-family 19 1.30 24 2.05 37 3.36 42 3.66 41 4.30
Construction
one-to four-
family 148 12.39 194 14.24 319 14.77 224 13.57 304 13.50
Construction
multi-family - - 5 0.30 20 1.25 21 0.19 10 1.29
Construction
commercial 7 0.37 20 1.31 26 1.38 34 1.41 17 1.02
Land 148 6.63 196 10.36 192 8.79 206 7.83 223 9.62
Commercial real
estate 2,259 45.68 1,046 33.05 869 28.58 580 18.69 224 16.86
Commercial
loans 1,589 14.82 796 11.13 668 7.92 354 7.64 160 6.28
Consumer loans:
Secured 175 6.92 141 7.63 180 8.47 154 7.65 90 5.70
Unsecured 37 0.43 33 0.43 27 0.49 34 0.63 29 1.09
Unallocated 10 - 162 - 8 - 4 - 5 -
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance
for loan
losses $4,481 100.00% $2,739 100.00% $2,537 100.00% $1,916 100.00% $1,362 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
17
Investment Activities
OTS regulated institutions have authority to invest in various types of liquid
assets, including U.S. Treasury obligations, securities of various federal
agencies and of state and municipal governments, deposits at the applicable
FHLB, certificates of deposit of federally insured institutions, certain
bankers' acceptances and federal funds. Subject to various restrictions, OTS
regulated institutions may also invest a portion of their assets in commercial
paper, corporate debt securities and mutual funds, the assets of which conform
to the investments that federally chartered savings institutions are otherwise
authorized to make directly.
Federal regulations require the Company to maintain a minimum sufficient
liquidity to ensure its safe and sound operation. Liquid assets include cash,
cash equivalents consisting of short-term interest-earning deposits, certain
other time deposits, and other obligations generally having remaining
maturities of less than five years. See "Regulation." It is the management's
intention of to hold securities with short maturities in the Bank's and
Company's investment portfolio in order to match more closely the interest
rate sensitivities of the Bank's and Company's assets and liabilities. At
March 31, 2004, the Bank's liquidity ratio, the ratio of cash and eligible
investments to the sum of withdrawable savings and borrowings due within one
year, was 15.97%.
The Investment Committee, composed of the Company's Chief Executive Officer,
President and Chief Financial Officer, makes investment decisions. The
Company's investment objectives are: (i) to provide and maintain liquidity
within regulatory guidelines; (ii) to maintain a balance of high quality,
diversified investments to minimize risk; (iii) to provide collateral for
pledging requirements; (iv) to serve as a balance to earnings; and (v) to
optimize returns. At March 31, 2004, the Company's investment and
mortgage-backed securities portfolio totaled $46.0 million and consisted
primarily of obligations of federal agencies, and Federal National Mortgage
Association ("FNMA") and FHLMC mortgage-backed securities.
At March 31, 2004, the Company's investment securities portfolio did not
contain any tax-exempt securities of any issuer with an aggregate book value
in excess of 10% of the Company's consolidated shareholders' equity, excluding
those securities issued by the U.S. Government or its agencies.
The Board of Directors sets the investment policy of the Company which
dictates that investments be made based on the safety of the principal amount,
liquidity requirements of the Company and the return on the investments. At
March 31, 2004, no investment securities were held for trading. The policy
does not permit investment in non-investment grade bonds and permits
investment in various types of liquid assets permissible under OTS regulation,
which includes U.S. Treasury obligations, securities of various federal
agencies, "bank qualified" municipal bonds, certain certificates of deposits
of insured banks, repurchase agreements and federal funds.
The Company has adopted Statement of Financial Accounting Standards ("SFAS")
No. 115, Accounting for Certain Investments in Debt and Equity Securities,
which requires the classification of securities at acquisition into one of
three categories: held to maturity, available for sale or trading. See Note 1
of Notes to Consolidated Financial Statements.
18
The following table sets forth the investment securities portfolio and carrying values at the dates
indicated. The fair value of the investment and mortgage-backed securities portfolio was $46.1 million,
$36.9 million and $59.8 million at March 31, 2004, 2003 and 2002, respectively.
At March 31,
-------------------------------------------------------------------------------
2004 2003 2002
----------------------- ----------------------- -----------------------
Carrying Percent of Carrying Percent of Carrying Percent of
Value Portfolio Value Portfolio Value Portfolio
-------- ---------- -------- ---------- -------- ----------
(Dollars in thousands)
Held to maturity (at
amortized cost):
Real estate mortgage
investment conduits
("REMICs") $ 1,802 3.92% $ 1,803 4.90% $ 1,804 3.02%
FHLMC mortgage-backed
securities 332 0.72 589 1.60 964 1.62
FNMA mortgage-backed
securities 383 0.83 909 2.47 1,618 2.71
------- ------ ------- ------ ------- ------
2,517 5.47 3,301 8.97 4,386 7.35
------- ------ ------- ------ ------- ------
Available for sale (at fair
value):
Agency securities 11,194 24.33 - - - -
REMICs 3,015 6.55 6,421 17.45 25,114 42.10
FHLMC mortgage-backed
securities 7,190 15.63 6,097 16.57 10,972 18.39
FNMA mortgage-backed
securities 402 0.88 551 1.50 913 1.53
Municipal securities 4,270 9.28 2,751 7.48 2,601 4.36
Trust preferred securities 5,019 10.91 4,975 13.52 - -
Equity securities 12,400 26.95 12,700 34.51 15,674 26.27
------- ------ ------- ------ ------- ------
43,490 94.53 33,495 91.03 55,274 92.65
------- ------ ------- ------ ------- ------
Total investment securities $46,007 100.00% $36,796 100.00% $59,660 100.00%
======= ====== ======= ====== ======= ======
The following table sets forth the maturities and weighted average yields in the securities portfolio at
March 31, 2004.
Less Than One to More Than Five to More Than
One Year Five Years Ten Years Ten Years
---------------- ----------------- ----------------- ----------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Amount Yield(1) Amount Yield (1) Amount Yield (1) Amount Yield(1)
------ -------- ------ --------- ------ -------- ------ --------
(Dollars in thousands)
Municipal
securities $ - -% $ 1,537 4.12% $ 587 4.30% $ 2,146 4.50%
Agency securities - - 11,194 3.17 - - - -
REMICs - - 271 2.17 - - 4,546 2.97
FHLMC mortgage-
backed securities 1 6.00 2,409 6.15 4,782 4.07 330 3.57
FNMA mortgage-
backed securities 23 7.13 144 6.88 7 11.95 611 4.22
Trust preferred
securities - - - - - - 5,019 2.97
Equity securities - - - - - - 12,400 1.72
---- ---- ------- ---- ------ ----- ------- ----
Total $ 24 7.09% $15,555 3.74% $5,376 4.11% $25,052 2.52%
==== ==== ======= ==== ====== ===== ======= ====
(1) For available for sale securities carried at fair value, the weighted average yield is computed using
amortized cost. Average yield calculations exclude equity securities that have no stated yield or
maturity.
19
In addition to U.S. Government treasury obligations, the Company invests in
mortgage-backed securities and real estate mortgage investment conduits
("REMICs"). Mortgage-backed securities ("MBS") (which are also known as
mortgage participation certificates or pass-through certificates) represent a
participation interest in a pool of single-family or multi-family mortgages.
Principal and interest payments on mortgage-backed securities are passed from
the mortgage originators, through intermediaries (i.e., FNMA, FHLMC, the
Government National Mortgage Association ("GNMA") or private issuers) that
pool and repackage the participation interests in the form of securities, to
investors such as the Company. Mortgage-backed securities generally increase
the quality of the Company's assets by virtue of the guarantees that back
them, are more liquid than individual mortgage loans and may be used to
collateralize borrowings or other obligations of the Company. See Note 6 of
Notes to Consolidated Financial Statements for additional information.
REMICs are created by redirecting the cash flows from the pool of mortgages or
mortgage-backed securities underlying these securities to create two or more
classes (or tranches) with different maturity or risk characteristics designed
to meet a variety of investor needs and preferences. Management believes
these securities may represent attractive alternatives relative to other
investments because of the wide variety of maturity, repayment and interest
rate options available. Current investment practices of the Company prohibit
the purchase of high risk REMICs. At March 31, 2004, the Company held REMICs
with a net carrying value of $4.8 million, of which $1.8 million were
classified as held-to-maturity and $3.0 million of which were
available-for-sale. REMICs may be sponsored by private issuers, such as
mortgage bankers or money center banks, or by U.S. Government agencies and
government sponsored entities. At March 31, 2004, the Company owned no
privately issued REMICs.
Investments in mortgage-backed securities, including REMICs, involve a risk
that actual prepayments will be greater than estimated prepayments over the
life of the security, which may require adjustments to the amortization of any
premium or accretion of any discount relating to such instruments thereby
reducing the net yield on such securities. There is also reinvestment risk
associated with the cash flows from such securities. In addition, the market
value of such securities may be adversely affected by changes in interest
rates.
The investment in municipal securities was $4.3 million at March 31, 2004
compared to $2.8 million at March 31, 2003. Total equity securities
investment was $12.4 million at March 31, 2004, compared to $12.7 million at
March 31, 2003.
In the second quarter of fiscal 2003, the Company purchased $5.0 million of
trust preferred securities which are a portion of the mezzanine tranche of
$500.0 million pooled preferred trust securities indexed to the three month
libor interest rate.
In the fourth quarter of fiscal 2003, the Company recognized a $2.3 million
non-cash pre-tax charge to operations for investments in FHLMC preferred stock
and FNMA preferred stock. Under SFAS No. 115, if the decline in fair market
value below cost is determined to be other-than-temporary, the unrealized loss
will be realized as expense on the income statement. Based on a number of
factors, including the magnitude of the drop in the market value below the
Company's cost and the length of time the market value had been below cost,
management concluded that the decline in value was other-than-temporary at the
end of the fourth quarter of fiscal year 2003. Accordingly, the
other-than-temporary impairment was realized in the income statement, in the
amount of $700,000 for FNMA preferred stock and $1.6 million FHLMC preferred
stock. A corresponding reduction in unrealized losses in shareholders' equity
was realized in the amount of $462,000 for FNMA preferred stock and $1.1
million for FHLMC preferred stock.
Deposit Activities and Other Sources of Funds
General. Deposits, loan repayments and loan sales are the major sources of
the Company's funds for lending and other investment purposes. Loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows and loan prepayments are significantly influenced by general interest
rates and money market conditions. Borrowings may be used on a short-term
basis to compensate for reductions in the availability of funds from other
sources. They may also be used on a longer term basis for general business
purposes.
20
Deposit Accounts. The Company's attracts deposits from within it's primary
market area by offering a broad selection of deposit instruments, including
demand deposits, negotiable order of withdrawal ("NOW") accounts, money market
accounts, regular savings accounts, certificates of deposit and retirement
savings plans. Historically the Company has focused on retail deposits.
Expansion in commercial lending has led to growth in business deposits
including demand deposit accounts. At the July 18, 2003 acquisition date of
Today's Bancorp, $105.1 million of deposits were acquired. The Bank continues
to see a shift in the customer demand in deposit products from certificates of
deposit to transaction accounts. Deposit account terms vary according to the
minimum balance required, the time periods the funds must remain on deposit
and the interest rate, among other factors. In determining the terms of its
deposit accounts, the Company considers the rates offered by its competition,
profitability to the Company, matching deposit and loan products and its
customer preferences and concerns. The Company generally reviews its deposit
mix and pricing weekly.
21
Deposit Balances
The following table sets forth information concerning the Company's
certificates of deposit, other interest-bearing and non-interest bearing
deposits at March 31, 2004.
Percent
Interest Minimum of Total
Rate Term Category Amount Balance Deposits
- -------- ---- ---------- -------- ------- --------
(In thousands)
0.200% None NOW accounts $ 100 $ 65,718 16.06%
1.300 None High yield checking 25,000 49,668 12.14
0.550 None Regular savings 500 29,334 7.17
0.948 None Money market 2,500 69,984 17.11
None None Non-interest checking 100 61,902 15.13
-------- ------
Total transaction accounts 276,606 67.61
Certificates of Deposit
-----------------------
1.201 91 Days Fixed-term, Fixed-rate 2,500 8,412 2.06
0.819 182-364
Days Fixed-term, Fixed-rate 2,500 14,934 3.65
1.053 12-17
Months Fixed-term, Fixed-rate 2,500 29,987 7.33
1.030 18
Months Fixed-term, Variable rate,
Individual Retirement
account("IRA") 100 1,391 0.34
2.120 18-23
Months Fixed-term, Fixed-rate 2,500 6,923 1.69
2.694 24-35
Months Fixed-term, Fixed-rate 2,500 28,768 7.03
3.786 36-59
Months Fixed-term, Fixed-rate 2,500 21,279 5.20
4.901 60-83
Months Fixed-term, Fixed-rate 2,500 15,526 3.80
4.814 84-120
Months Fixed-term, Fixed-rate 2,500 5,289 1.29
-------- ------
Total certificates of deposit 132,509 32.39%
-------- ------
Total deposits $409,115 100.00%
======== ======
22
Deposit Flow
The following table sets forth the balances of deposit accounts in the various types offered by the Company
at the dates indicated.
At March 31,
------------------------------------------------------------------------------------
2004 2003 2002
-------------------------- -------------------------- --------------------------
Increase/ Increase/ Increase/
Balance Percent Decrease) Balance Percent Decrease) Balance Percent Decrease)
------- ------- -------- ------- ------- -------- ------- ------- --------
(Dollars in thousands)
Non-interest-bearing
demand $ 61,902 15.13% $(16,562) $ 78,464 24.46% $ 45,890 $ 32,574 12.54% $ 4,639
NOW accounts 65,718 16.06 38,605 27,113 8.45 (5,597) 32,710 12.60 567
High-yield checking 49,668 12.14 14,131 35,537 11.08 30,183 5,354 2.06 5,354
Regular savings
accounts 29,334 7.17 4,479 24,855 7.75 2,916 21,939 8.45 3,112
Money market deposit
accounts 69,984 17.11 16,267 53,717 16.75 (928) 54,645 21.04 8,921
Certificates of
deposits which
mature (1):
Within 12 months 86,272 21.09 15,117 71,155 22.19 (15,784) 86,939 33.48 (55,084)
Within 12-36 months 32,422 7.92 9,803 22,619 7.05 3,249 19,370 7.46 (4,303)
Beyond 36 months 13,815 3.38 6,533 7,282 2.27 1,123 6,159 2.37 961
-------- ------ -------- -------- ------ -------- -------- ------ --------
Total $409,115 100.00% $ 88,373 $320,742 100.00% $ 61,052 $259,690 100.00% $(35,833)
======== ====== ======== ======== ====== ======== ======== ====== ========
(1) IRAs of $13.9 million, $12.9 million and $12.8 million at March 31, 2004, 2003 and 2002,
respectively, are included in certificate balances.
23
Certificates of Deposit by Rates and Maturities
The following table sets forth the certificates of deposit in the Company
classified by rates as of the dates indicated.
At March 31,
---------------------------------
2004 2003 2002
--------- --------- ---------
(In thousands)
Below 2.00% $ 63,241 $ 43,969 $ 14,919
2.00 - 2.99% 23,307 17,483 30,028
3.00 - 3.99% 14,221 18,770 24,390
4.00 - 4.99% 17,224 7,452 13,014
5.00 - 5.99% 10,230 7,058 10,717
6.00 - 7.99% 4,286 6,324 19,400
--------- --------- ---------
Total $ 132,509 $ 101,056 $ 112,468
========= ========= =========
The following table sets forth the amount and maturities of certificates of
deposit at March 31, 2004.
Amount Due
-----------------------------------------------------
Less Than 1-2 After After
One Year Years 2-3 Years 3 Years Total
--------- ------- --------- -------- --------
(In thousands)
Below 2.00% $ 55,806 $ 7,117 $ 247 $ 71 $ 63,241
2.00 - 2.99% 11,602 8,818 2,645 242 23,307
3.00 - 3.99% 6,625 3,363 185 4,048 14,221
4.00 - 4.99% 8,945 1,029 1,604 5,646 17,224
5.00 - 5.99% 842 3,831 1,884 3,673 10,230
6.00 - 7.99% 2,452 1,568 131 135 4,286
-------- -------- ------- -------- ---------
Total $ 86,272 $ 25,726 $ 6,696 $ 13,815 $ 132,509
======== ======== ======= ======== =========
The following table presents the amount and weighted average rate of time
deposits equal to or greater than $100,000 at March 31, 2004.
Weighted
Maturity Period Amount Average Rate
- --------------- -------- ------------
(Dollars in thousands)
Three months or less $ 14,332 1.76%
Over three through six months 7,859 2.51
Over six through 12 months 10,564 2.69
Over 12 Months 23,105 3.83
--------- ----
Total $ 55,860 2.90%
========= ====
24
Deposit Activities
The following table sets forth the deposit activities of the Company for the
periods indicated.
Year Ended March 31,
-------------------------------
2004 2003 2002
-------- -------- --------
(In thousands)
Beginning balance $320,742 $259,690 $295,523
Net (decrease) increase
before interest credited 83,618 55,535 (44,789)
Interest credited 4,755 5,517 8,956
-------- -------- --------
Net increase (decrease) in
savings deposits 88,373 61,052 (35,833)
-------- -------- --------
Ending balance $409,115 $320,742 $259,690
======== ======== ========
In the unlikely event the Bank is liquidated, depositors are entitled to full
payment of their deposit accounts prior to any payment being made to the
shareholders of the Company. Substantially all of the Bank's depositors are
residents of the States of Washington or Oregon.
Borrowings. Savings deposits are the primary source of funds for the
Company's lending and investment activities and for its general business
purposes. The Company relies upon advances from the FHLB-Seattle to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. Advances from the FHLB-Seattle are typically secured by the
Bank's first mortgage loans and investment securities.
The FHLB functions as a central reserve bank providing credit for savings and
loan associations and certain other member financial institutions. As a
member, the Bank is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its mortgage loans and other assets (principally securities which are
obligations of, or guaranteed by, the United States) provided certain
standards related to creditworthiness have been met. Advances are made
pursuant to several different programs. Each credit program has its own
interest rate and range of maturities. Depending on the program, limitations
on the amount of advances are based either on a fixed percentage of an
institution's assets or on the FHLB's assessment of the institution's
creditworthiness. The FHLB determines specific lines of credit for each member
institution and the Bank has a 35% of total assets line of credit with the
FHLB-Seattle to the extent the Bank provides qualifying collateral and holds
sufficient FHLB stock. At March 31, 2004, the Bank had $40.0 million of
outstanding advances from the FHLB-Seattle under an available credit facility
of $180.3 million, limited to available collateral.
The following tables set forth certain information concerning the Company's
borrowings at the dates and for the periods indicated.
At March 31,
---------------------------
2004 2003 2002
------ ------ ------
Weighted average rate on
FHLB advances 4.88% 4.90% 6.10%
25
Year Ended March 31,
-------------------------------
2004 2003 2002
-------- -------- --------
(Dollars in thousands)
Maximum amounts of FHLB
advances outstanding
at any month end $40,000 $74,500 $99,500
Average FHLB
advances outstanding 40,000 53,174 89,499
Weighted average rate on
FHLB advances 4.96% 5.53% 6.25%
REGULATION
General
The Bank, as a federally-chartered savings institution, is subject to federal
regulation and oversight by the OTS extending to all aspects of its
operations. The Bank also is subject to regulation and examination by the
FDIC, which insures the deposits of the Bank to the maximum extent permitted
by law, and requirements established by the Federal Reserve Board.
Federally-chartered savings institutions are required to file periodic reports
with the OTS and are subject to periodic examinations by the OTS and the FDIC.
The investment and lending authority of savings institutions are prescribed by
federal laws and regulations, and these institutions are prohibited from
engaging in any activities not permitted by the laws and regulations. This
regulation and supervision primarily is intended for the protection of
depositors and not for the purpose of protecting shareholders.
The OTS regularly examines the Bank and prepares reports for the consideration
of the Bank's Board of Directors on any deficiencies that it may find in the
Bank's operations. The FDIC also has the authority to examine the Bank in its
roles as the administrator of the SAIF. The Bank's relationship with its
depositors and borrowers also is regulated to a great extent by both federal
and state laws, especially in matters such as the ownership of savings
accounts and the form and content of the Bank's mortgage requirements. Any
change in these regulations, whether by the FDIC, the OTS or Congress, could
have a material adverse impact on the Company, the Bank and their operations.
Federal Regulation of Savings Institutions
Office of Thrift Supervision. The OTS has extensive authority over the
operations of savings institutions. As part of this authority, the Bank is
required to file periodic reports with the OTS and is subject to periodic
examinations by the OTS and the FDIC. When these examinations are conducted
by the OTS and the FDIC, the examiners may require the Bank to provide for
higher general or specific loan loss reserves. All savings institutions are
subject to a semi-annual assessment, based upon the institution's total
assets, to fund the operations of the OTS. The OTS also has extensive
enforcement authority over all savings institutions and their holding
companies, including the Bank and the Company. This enforcement authority
includes, among other things, the ability to assess civil money penalties,
issue cease-and-desist or removal orders and initiate injunctive actions. In
general, these enforcement actions may be initiated for violations of laws and
regulations and unsafe or unsound practices. Other actions or inactions may
provide the basis for enforcement action, including misleading or untimely
reports filed with the OTS. Except under certain circumstances, public
disclosure of final enforcement actions by the OTS is required.
In addition, the investment, lending and branching authority of the Bank is
prescribed by federal laws and it is prohibited from engaging in any
activities not permitted by these laws. For example, no savings institution
may invest in non-investment grade corporate debt securities. In addition,
the permissible level of investment by federal institutions in loans secured
by non-residential real property may not exceed 400% of total capital, except
with approval of the OTS. Federal savings institutions are also generally
authorized to branch nationwide. The Bank is in compliance with the noted
restrictions.
All savings institutions 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 institution's total assets,
including consolidated subsidiaries. The Bank's OTS assessment for the fiscal
year ended March 31, 2004 was $98,160.
26
Federal Home Loan Bank System. The Bank is a member of the FHLB of Seattle,
which is one of 12 regional FHLBs that administer the home financing credit
function of savings institutions. Each FHLB serves as a reserve or central
bank for its members within its assigned region. It is funded primarily from
proceeds derived from the sale of consolidated obligations of the FHLB System.
It makes loans or advances to members in accordance with policies and
procedures, established by the Board of Directors of the FHLB, which are
subject to the oversight of the Federal Housing Finance Board. All advances
from the FHLB are required to be fully secured by sufficient collateral as
determined by the FHLB. In addition, all long-term advances are required to
provide funds for residential home financing.
As a member, the Bank is required to purchase and maintain stock in the FHLB
of Seattle. At March 31, 2004, the Bank had $6.0 million in FHLB stock, which
was in compliance with this requirement. In past years, the Bank has received
substantial dividends on its FHLB stock. Over the past two fiscal years such
dividends have averaged 3.93% and 6.05% for the fiscal years ended March 31,
2004 and 2003, respectively.
Under federal law, the FHLBs are required to provide funds for the resolution
of troubled savings institutions and to contribute to low- and
moderately-priced housing programs through direct loans or interest subsidies
on advances targeted for community investment and low- and moderate-income
housing projects. These contributions have affected adversely the level of
FHLB dividends paid and could continue to do so in the future. These
contributions could also have an adverse effect on the value of FHLB stock in
the future. A reduction in value of the Bank's FHLB stock may result in a
corresponding reduction in the Bank's capital.
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 is a member of
the SAIF, which is administered by the FDIC. Deposits are insured up to the
applicable limits by the FDIC and this insurance is backed by the full faith
and credit of the United States government.
As insurer, the FDIC imposes deposit insurance premiums and is authorized to
conduct examinations of and to require reporting by FDIC-insured institutions.
It also may prohibit any FDIC-insured institution from engaging in any
activity the FDIC determines by regulation or order to pose a serious risk to
the SAIF or the BIF. The FDIC also has the authority to initiate enforcement
actions against savings institutions, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines
that the institution has engaged in unsafe or unsound practices or is in an
unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based system
under which all insured depository institutions are placed into one of nine
categories and assessed insurance premiums based upon their level of capital
and supervisory evaluation. Under the system, institutions classified as well
capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1 or
core capital, to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered
healthy pay the lowest premium while institutions that are less than
adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less
than 4% or a risk-based capital ratio of less than 8%) and considered of
substantial supervisory concern pay the highest premium. The FDIC makes risk
classification of all insured institutions for each semi-annual assessment
period.
The FDIC is authorized to increase assessment rates, on a semi-annual basis,
if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the United States Treasury or for any other reason
deemed necessary by the FDIC.
Since January 1, 1997, the premium schedule for BIF and SAIF insured
institutions has ranged from 0 to 27 basis points. However, SAIF- and
BIF-insured institutions are required to pay a Financing Corporation
assessment in
27
order to fund the interest on bonds issued to resolve thrift failures in the
1980s equal to approximately 1.50 points for each $100 in domestic deposits
annually. These assessments, which may be revised based upon the level of BIF
and SAIF deposits, will continue until the bonds mature.
Under the Federal Deposit Insurance Act ("FDIA"), the FDIC may terminate
deposit insurance 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.
Prompt Corrective Action. The OTS is required to take certain supervisory
actions against undercapitalized savings institutions, 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." Compliance with the plan must be guaranteed by any parent
holding company in an amount of up to the lesser of 5% of the institution's
assets or the amount which would bring the institution into compliance with
all capital standards. In addition, numerous mandatory supervisory actions
become immediately applicable to an undercapitalized institution, including,
but not limited to, increased monitoring by regulators and restrictions on
growth, capital distributions and expansion. The OTS also could take any one
of a number of discretionary supervisory actions, including the issuance of a
capital directive and the replacement of senior executive officers and
directors. At March 31, 2004, the Bank was categorized as "well capitalized"
under the prompt corrective action regulations of the OTS.
Standards for Safety and Soundness. The federal banking regulatory agencies
have prescribed, by regulation, standards for all insured depository
institutions relating to: (i) internal controls, information systems and
internal audit systems; (ii) loan documentation; (iii) credit underwriting;
(iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii)
earnings; and (viii) compensation, fees and benefits ("Guidelines"). The
Guidelines set forth the safety and soundness standards that the federal
banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the OTS determines that the
Bank fails to meet any standard prescribed by the Guidelines, the OTS may
require the Bank to submit an acceptable plan to achieve compliance with the
standard. OTS regulations establish deadlines for the submission and review
of such safety and soundness compliance plans. Management of the Bank is not
aware of any conditions relating to these safety and soundness standards which
would require submission of a plan of compliance.
Qualified Thrift Lender Test. All savings institutions, 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 institution 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 institution 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, 2004, the Bank met the test and
its QTL percentage was 75.50%.
Any savings institution 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
28
both a savings institution 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 to meet the QTL test, 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 institutions, 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 institutions. These capital
requirements must be generally as stringent as the comparable capital
requirements for national banks. The OTS is also authorized to impose capital
requirements in excess of these standards on individual institutions on a
case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of adjusted
total assets (as defined by regulation). At March 31, 2004, the Bank had
tangible capital of $49.4 million, or 9.81% of adjusted tangible assets, which
is approximately $41.9 million above the minimum requirement of 1.5% of
adjusted tangible assets in effect on that date. At March 31, 2004, the Bank
had $758,000 in core deposit intangible, $624,000 in servicing assets and $9.2
million in goodwill. The capital standards also require core capital equal to
at least 3% to 4% of adjusted total assets, depending on an institution's
supervisory rating. Core capital generally consists of tangible capital. At
March 31, 2004, the Bank had core capital equal to $49.4 million, or 9.81% of
adjusted tangible assets, which is $34.3 million above the minimum leverage
ratio requirement of 3% as in effect on that date.
The OTS also requires savings institutions to have core capital equal to 4% of
risk-weighted assets ("Tier 1 risk-based"). At March 31, 2004, the Bank had
Tier 1 risk-based capital of $49.4 million or 11.72% of risk-weighted assets,
which is approximately $32.6 million above the minimum on that date. The OTS
risk-based requirement requires savings institutions 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. The
OTS is also authorized to require a savings institution to maintain an
additional amount of total capital to account for concentration of credit risk
and the risk of non-traditional activities. 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 Fannie Mae or Freddie Mac.
On March 31, 2004, the Bank had total risk-based capital of approximately
$54.0 million, including $49.4 million in core capital and $4.6 million in
qualifying supplementary capital, and risk-weighted assets of $422.0 million,
or total capital of 12.78% of risk-weighted assets. This amount was $20.2
million above the 8% requirement in effect on that date.
The OTS and the FDIC are authorized and, under