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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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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 December 31, 1999
[_] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File No. 0-29480
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HERITAGE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-1857900
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
201 Fifth Avenue SW, Olympia, Washington 98501
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (360) 943-1500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share
(Title of class)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant is $65,603,146 and is based upon the last sales price as quoted on
the NASDAQ Stock Market for March 8, 2000.
The Registrant had 9,771,546 shares of common stock outstanding as of March
8, 2000.
DOCUMENTS TO BE INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement dated March 22, 2000
for the 2000 Annual Meeting of Stockholders will be incorporated by reference
into Part III of this Form 10-K.
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HERITAGE FINANCIAL CORPORATION
FORM 10-K
December 31, 1999
INDEX
Page
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PART 1
ITEM 1. BUSINESS...................................................... 3
LENDING ACTIVITIES............................................ 4
INVESTMENT ACTIVITIES......................................... 11
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS................. 14
SUPERVISION AND REGULATION.................................... 17
COMPETITION................................................... 21
ITEM 2. PROPERTIES.................................................... 21
ITEM 3. LEGAL PROCEEDINGS ............................................ 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS...................................................... 23
ITEM 6. SELECTED FINANCIAL DATA....................................... 24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................... 25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.... 38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURES.................................... 39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 40
ITEM 11. EXECUTIVE COMPENSATION........................................ 40
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................... 40
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
10-K.......................................................... 41
2
ITEM 1. BUSINESS
General
Heritage Financial Corporation, Inc. is a bank holding company incorporated
in the State of Washington in August 1997. We were organized for the purpose
of acquiring all of the capital stock of Heritage Bank upon our reorganization
from a mutual holding company form of organization to a stock holding company
form of organization (the "Conversion").
We are primarily engaged in the business of planning, directing and
coordinating the business activities of our wholly owned subsidiaries:
Heritage Savings Bank and Central Valley Bank, N.A. Heritage Bank is a
Washington-chartered savings bank whose deposits are insured by the Federal
Deposit Insurance Corporation (FDIC) under the Savings Association Insurance
Fund (SAIF). Heritage Bank conducts business from its main office in Olympia,
Washington and its eleven branch offices located in Thurston, Pierce and Mason
Counties. Central Valley Bank is a National Bank whose deposits are insured by
the FDIC under the Bank Insurance Fund (BIF). Central Valley Bank conducts
business from its main office in Toppenish, Washington, and its four branch
offices located in Yakima County.
Our business consists primarily of focusing on lending and deposit
relationships with small businesses including agribusiness and their owners in
our market area, attracting deposits from the general public and originating
for sale or investment purposes first mortgage loans on residential properties
located in western and central Washington. We also make residential
construction loans, income property loans and consumer loans.
On March 5, 1999, we merged with Washington Independent Bancshares, Inc.
whose wholly owned subsidiary was Central Valley Bank. In that merger we
exchanged 1,058,009 shares of our common stock for all of the outstanding
shares of Washington Independent common stock. This merger was accounted for
as a pooling of interests and accordingly, our financial information reported
herein has been restated to include the accounts and results of operations of
Washington Independent for all periods presented. Effective June 12, 1998, we
acquired North Pacific Bank, a Washington-chartered commercial bank, which was
merged into Heritage Bank effective November 20, 1998.
Effective with the year ending December 31, 1998 we changed our fiscal year
end from June 30th to December 31st. On December 31, 1998, we filed a
Transition Report Form 10-K with the SEC reporting for the six month period
ended December 31, 1998. This filing of Form 10-K for the fiscal year ended
December 31, 1999 will be the first full twelve month period filed with a
calendar year ending. Throughout this report every effort has been made to
clarify the accounting period being referenced (i.e. six months ending
December 31, 1998 or year ending June 30, 1998 etc.) and when appropriate year
to year comparisons are made that reflect equivalent twelve month periods
(i.e. twelve months ending December 31, 1998 to twelve months ending December
31, 1999).
Market Areas
We offer financial services to meet the needs of the communities we serve
through community-oriented financial institutions. Headquartered in Olympia,
Thurston County, Washington, we conduct business through Heritage Bank from
twelve full service offices, six in Pierce County, five in Thurston County and
one in Mason County. Heritage Bank has two mortgage origination offices, one
in Thurston County and one in Pierce County, both of which operate within
banking offices. We service Yakima County through Central Valley Bank from
their headquarters in Toppenish, Washington, using five branch offices.
Olympia enjoys a stable economic climate, largely due to government
employment and military personnel (Fort Lewis and McChord Air Force Base are
both located in our primary market area), both retired and active. State
government is by far the largest employer in Thurston County, employing over
40% of the total county work force. Federal, county and municipal government
together comprise nearly 50% of the county's civilian employment base.
3
Thurston County has a population of 202,700 as of April 1, 1999 and was one
of the fastest growing metropolitan counties in the state of Washington as
reported by the State Department of Natural Resources. Thurston County's
growth has been spurred by increased government employment and the expansion
of a large retirement population, including many former military personnel.
Pierce County, where Tacoma is located, has an official population of
700,000 according to the state Office of Financial Management. Its economy is
well-diversified, with the principal industries being aerospace, shipping,
military-related government employment, agriculture and forest products.
Our market area also includes Shelton and the surrounding Mason County area.
The population of Mason county was approximately 48,600 in 1999, and its
economy is substantially dependent upon the timber and forest products
industries.
Yakima County is located in central Washington. It has a population of
204,000, and its economy is substantially dependent upon agriculture. Yakima
County boasts the highest production of apples and hops of any county in the
nation.
Lending Activities
General. Our lending activities are carried on through the two banks,
Heritage Bank and Central Valley Bank. We traditionally have originated one-
to four-family residential mortgage loans and, to a lesser extent,
multifamily, commercial real estate, construction, and agricultural loans. In
the fiscal year ended June 30, 1994, we implemented a growth strategy intended
to broaden our products and services from traditional thrift products and
services to those more closely related to commercial banking. In this regard,
during this period, we began to emphasize relationship banking and to expand
our business lending capabilities. Beginning in 1996, Heritage Bank began
hiring commercial loan officers, experienced in the Puget Sound region. The
loan officers, in addition to bringing to us previous customer relationships,
have taken advantage of the opportunity to attract customers of banks that
have been acquired via mergers with out-of-area institutions. In June 1998, we
completed our acquisition of North Pacific Bank, a $84.9 million asset
commercial bank. In March 1999, we merged with Washington Independent
Bancshares, holding company for Central Valley Bank NA, a $61 million
commercial bank. These combinations accelerated our expansion of our
commercial banking focus. Taken together, these efforts contributed to an
increase in commercial loans to $192.1 million, or 46.0% of total loans, as of
December 31, 1999 from $128.2 million, or 39.2% of total loans, as of December
31, 1998. As we pursue our strategy, management is continuing to emphasize
strong asset quality.
Our overall lending operations are guided by loan policies which are
reviewed and approved annually by our board of directors, and which outline
the basic policies and procedures by which lending operations are conducted.
Generally, the policies address the types of loans, underwriting and
collateral requirements, terms, interest rate and yield considerations, and
compliance with laws and regulations in addition to establishing internal
lending limits. We supplement our own supervision of the loan underwriting and
approval process with periodic loan audits by experienced external loan
specialists who review credit quality, loan documentation and compliance with
laws and regulations.
4
The following table sets forth at the dates indicated our loan portfolio by
type of loan. These balances are net of deferred loan fees and prior to
deduction for the allowance for loan losses.
At June 30, At December 31,
---------------------------------------------------- ----------------------------------
1996 1997 1998 1998 1999
---------------- ---------------- ---------------- ---------------- ----------------
% of % of % of % of % of
Balance Total Balance Total Balance Total Balance Total Balance Total
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(Dollars in thousands)
Commercial.............. $ 30,913 15.54% $ 53,994 22.22% $117,655 37.46% $128,171 39.20% $192,088 45.98%
Real Estate Mortgages
One-four family
residential (1)....... 96,294 48.41 107,010 44.02 100,753 32.07 97,277 29.76 97,907 23.44
Five or more family
residential and
commercial
properties............ 55,658 27.98 66,260 27.26 72,406 23.05 70,139 21.45 94,242 22.56
Total real estate
mortgages............. 151,952 76.39 173,270 71.28 173,159 55.12 167,416 51.21 192,149 46.00
Real estate construction
One-four family
residential........... 14,840 7.46 13,142 5.41 19,505 6.21 26,640 8.15 23,293 5.58
Five or more family
residential and
commercial
properties............ 393 0.20 1,029 0.42 527 0.17 2,123 0.65 7,537 1.80
Total real estate
construction (2)...... 15,233 7.66 14,171 5.83 20,032 6.38 28,763 8.80 30,830 7.38
Consumer................ 1,900 0.96 2,692 1.11 4,477 1.43 4,000 1.22 4,273 1.02
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans............ 199,998 100.55% 244,127 100.44% 315,323 100.39% 328,351 100.43% 419,340 100.38%
Less deferred loan fees
and other.............. (1,090) -0.55 (1,079) -0.44 (1,228) -0.39 (1,400) -0.43 (1,578) -0.38%
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Net loans.............. $198,908 100.00% $243,048 100.00% $314,095 100.00% $326,951 100.00% $417,762 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
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(1) Includes loans held for sale of $5,286, $6,323, $6,411, $7,618, and $589,
respectively.
(2) Balances are net of undisbursed loan proceeds.
The following table presents at December 31, 1999, (i) the aggregate
maturities of loans in the named categories of our loan portfolio and (ii) the
aggregate amounts of fixed rate and variable or adjustable rate loans in the
named categories that mature after one year.
Maturing
---------------------------------
Within 1-5 After
1 year years 5 years Total
------- ------- -------- --------
(Dollars in thousands)
Commercial................................ $51,866 $37,174 $103,048 $192,088
Real estate construction.................. 25,206 4,955 669 30,830
------- ------- -------- --------
Total................................... $77,072 $42,129 $103,717 $222,918
======= ======= ======== ========
Fixed rate loans.......................... $27,864 $ 29,760 $ 57,624
Variable or adjustable rate loans......... 14,264 73,957 88,221
------- -------- --------
Total................................... $42,128 $103,717 $145,845
======= ======== ========
Real Estate Lending
One- to Four-Family Residential Real Estate Lending. The majority of our
residential loans are secured by one- to four-family residences located in our
primary market area. Our underwriting standards require that one- to four-
family portfolio loans generally be owner-occupied and that loan amounts not
exceed 80% (90% with private mortgage insurance) of the current appraised
value or cost, whichever is lower, of the underlying collateral. Terms
typically range from 15 to 30 years. We offer both fixed-rate mortgages and
adjustable rate mortgages ("ARMs") with repricing based on a Treasury Bill or
other index. Our ability to generate volume in ARMs however, is largely a
function of consumer preference and the interest rate environment. Our current
5
policy is not to make ARMs with discounted initial interest rates (i.e.,
"teasers"). We generally sell all government guaranteed mortgages, both fixed
rate and adjustable rate. In addition, in connection with management's
strategies to control our interest rate sensitivity position, management
determines from time to time to what extent it will retain or sell other ARMs
and other fixed rate mortgages. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Asset/Liability Management".
Multifamily and Commercial Real Estate Lending. We have made, and anticipate
continuing to make, on a selective basis, multifamily and commercial real
estate loans in our primary market areas. Commercial real estate loans are
made for small shopping centers, warehouses and professional offices,
generally owner occupied. Cash flow coverage to debt servicing requirements is
generally 1.2 times or more. Our underwriting standards generally require that
the loan-to-value ratio for multifamily and commercial real estate loans not
exceed 80% of appraised value or cost, whichever is lower.
Multifamily and commercial real estate mortgage lending affords our banks 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
multifamily and commercial real estate properties are often dependent on the
successful operation and management of the properties, repayment of these
loans may be affected by adverse conditions in the real estate market or the
economy. We seek 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. We also generally obtain
personal guarantees from financially capable borrowers based on a review of
personal financial statements.
Construction Loans. We originate one- to four-family residential
construction loans for the construction of custom homes (where the home buyer
is the borrower) and provide financing to builders for the construction of
pre-sold homes and speculative residential construction (i.e. built before a
buyer is identified). We lend to builders who have demonstrated a favorable
record of performance and profitable operations and who are building in
markets that management understands and in which management is comfortable
with the economic conditions. We further endeavor to limit our construction
lending risk through adherence to strict underwriting procedures. Loans to one
builder are generally limited on a case-by-case basis with unsold home limits
based on builder strengths. Our underwriting standards require that the loan-
to-value ratio for pre-sold homes and speculative residential construction not
exceed 80% of appraised value or builder's cost less overhead, whichever is
less. Speculative construction and land development loans are generally short
term in nature and priced with a variable rate of interest using the prime
rate as the index. We generally require builders to have some tangible form of
equity in each construction project. Also, we generally require prompt and
thorough documentation of all draw requests and utilize outside inspectors to
inspect the project prior to paying any draw requests from builders.
Construction lending affords us the opportunity to achieve higher interest
rates and fees with shorter terms to maturity than does our single-family
permanent mortgage lending. Construction lending, however, is generally
considered to involve a higher degree of risk than single-family permanent
mortgage lending because of the inherent difficulty in estimating both a
property's value at completion of the project and the estimated costs of the
project. As a result, these loans are generally more difficult to evaluate and
monitor. If the estimate of construction cost proves to be inaccurate, we 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, we may be confronted with a project whose value is insufficient
to assure full repayment. Projects may also be jeopardized by disagreements
between borrowers and builders and by the failure of builders to pay
subcontractors. Loans to builders to construct homes for which no purchaser
has been identified carry more risk because the payoff for the loan depends on
the builder's ability to sell the property prior to the time the construction
loan is due.
6
Commercial Business Lending
We offer commercial loans to sole proprietorships, partnerships and
corporations with an emphasis on real estate related industries and firms in
agricultural, health care, legal and other professions. The types of commercial
loans offered are business lines of credit secured primarily by real estate,
accounts receivable and inventory, business term loans secured by real estate
for either working capital or lot acquisition, Small Business Administration
("SBA") loans and unsecured business loans.
Commercial business lending generally involves greater risk than residential
mortgage lending and 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 our commercial business loans are often
collateralized by real estate, the decision to grant a commercial business loan
depends primarily on the credit worthiness and cash flow of the borrower (and
any guarantors), while liquidation of collateral is a secondary source of
repayment.
As of December 31, 1999, we had $192.1 million, or 46.0% of our total loans
receivable, in commercial business loans. Collateral for these loans is
generally owner occupied business or residential real estate. The average loan
size is approximately $200,000 with loans generally in amounts of $500,000 or
less.
Origination and Sales of Loans
We originate real estate and other loans with approximately two-thirds of the
residential mortgage volumes generated from our mortgage loan origination
office. Walk-in customers and referrals from real estate brokers are important
sources of loan originations.
Consistent with our asset/liability management strategy, we sell a majority
of our fixed rate and ARM residential mortgage loans into the secondary market.
At Heritage Bank, commitments to sell mortgage loans generally are made during
the period between the taking of the loan application and the closing of the
mortgage loan. The timing of making these sale commitments is dependent upon
the timing of the borrower's election to lock-in the mortgage interest rate and
fees prior to loan closing. Most of these sale commitments are made on a "best
efforts" basis whereby Heritage Bank is only obligated to sell the mortgage if
the mortgage loan is approved and closed by Heritage Bank. As a result,
management believes that market risk is minimal. At Central Valley Bank, all
mortgage loan production is brokered to other lenders prior to funding.
When we sell mortgage loans, we typically also sell the servicing of the
loans (i.e., collection of principal and interest payments). We serviced $18.8
million and $13.1 million in mortgage loans for others as of December 31, 1998
and December 31, 1999, respectively. We received fee income of $22,000 and
$34,000 for the six months ended December 31, 1998, and the year ended December
31, 1999 for these servicing activities on mortgage loans.
The following table presents summary information concerning our origination
and sale of residential mortgage loans and the gains achieved on such
activities.
Six month
Year ended June 30, ended Year ended
------------------- December 31 December 31
1997 1998 1998 1999
--------- --------- ----------- -----------
(Dollars in thousands)
One- to four-family
residential mortgage loans:
Originated.................. $ 104,145 $ 118,774 $68,434 $78,248
Sold........................ 87,003 101,903 57,490 58,266
Gains on sales of loans, net.. $ 2,006 $ 2,406 $ 1,297 $ 1,079
We have a minimal amount of purchased loans and loan participations.
7
Commitments and Contingent Liabilities
In the ordinary course of business, we enter into various types of
transactions that include commitments to extend credit that are not included
in our consolidated financial statements. We apply the same credit standards
to these commitments as we use in all our lending activities and have included
these commitments in our lending risk evaluations. Our exposure to credit loss
under commitments to extend credit is represented by the amount of these
commitments. At December 31, 1999, we had outstanding commitments to extend
credit, including letters of credit, in the amount of $87.9 million.
Delinquencies and Nonperforming Assets
Delinquency Procedures. When a borrower fails to make a required payment on
a loan, in the case of loans other than commercial loans, a late notice is
sent 15 days after the due date. If the delinquency is not cured by the 30th
day, a second notice is mailed and, if appropriate, the borrower is contacted
by telephone. Additional written and verbal contacts are made with the
borrower between 60 and 90 days after the due date.
In the event a real estate loan payment is past due for 45 days or more,
loan servicing personnel perform an in-depth review of the loan status, the
condition of the property, and the circumstances of the borrower. Based upon
the results of our review, we may negotiate and accept a repayment program
with the borrower, accept a voluntary deed in lieu of foreclosure or, when
deemed necessary, initiate foreclosure proceedings. If foreclosed on, real
property is sold at a public sale and we may bid on the property to protect
our interest. A decision as to whether and when to initiate foreclosure
proceedings is made by the loan committee and is based on such factors as the
amount of the outstanding loan in relation to the value of the property
securing the original indebtedness, the extent of the delinquency, and the
borrower's ability and willingness to cooperate in curing the delinquency.
Real estate acquired by us by deed in lieu of foreclosure is classified as
real estate owned until it is sold. When property is acquired, it is recorded
at the lower of cost or estimated fair value at the date of acquisition, not
to exceed net realizable value, and any write-down resulting therefrom is
charged to the allowance for loan losses. Upon acquisition, all costs incurred
in maintaining the property are expensed. Costs relating to the development
and improvement of the property, however, are capitalized to the extent of the
property's net realizable value.
We consider loans as in-substance foreclosed if the borrower has little or
no equity in the property based upon its estimated fair value, if repayment
can be expected only to come from operation or sale of the collateral, and if
the borrower has effectively abandoned control of the collateral or has
continued to retain control of the collateral but because of the borrower's
current financial status, it is doubtful that the borrower will be able to
repay the loan in the foreseeable future.
Delinquencies in the commercial business loan portfolio 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 which are assigned to them.
Depending on the nature of the loan and the type of collateral securing the
loan, we may negotiate and accept a modified payment program or take other
actions as the circumstances warrant.
Classification of Assets. Federal regulations require that our banks
classify assets on a regular basis. In addition, in connection with
examinations of each bank, the Washington State Department of Financial
Institutions, Division of Banks, the Office of the Comptroller of the
Currency, and FDIC 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 institution will sustain some loss if the deficiencies
are not corrected. Doubtful assets have the weaknesses of Substandard assets,
with the additional characteristics 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
8
considered uncollectible and of such little value that continuance as an asset
of the institution is not warranted. Assets classified as Substandard or
Doubtful require the institution to establish prudent general allowances for
loan losses. If an asset or portion thereof is classified as Loss, the
institution must charge off such amount. The most recent examination of
Heritage Bank was completed by the FDIC in March 1999. Central Valley Bank was
examined by the Office of the Comptroller of the Currency in January 2000. The
regulators' assessments of our banks' classified assets were consistent with
our banks' internal classifications. An examination of Heritage Bank by the
Division was in progress during March 2000.
Nonperforming Assets. Nonperforming assets consist of nonaccrual loans and
restructured loans and real estate owned. The following table sets forth at
the dates indicated information with respect to nonaccrual loans, restructured
loans and real estate owned by us.
June 30, December 31,
---------------------------- ----------------
1996 1997 1998 1998 1999
-------- -------- -------- ------- -------
(Dollars in thousands)
Nonaccrual loans.............. $ 65 $ 146 $ 385 $ 401 $ 1,804
Restructured loans............ -- -- -- -- --
-------- -------- -------- ------- -------
Total nonperforming loans... 65 146 385 401 1,804
Real estate owned............. -- -- 82 -- --
-------- -------- -------- ------- -------
Total nonperforming assets.. $ 65 $ 146 $ 467 $ 401 $ 1,804
-------- -------- -------- ------- -------
Accruing loans past due 90
days or more................. $ -- $ -- $ 15 $ 8 $ --
Potential problem loans....... 1,836 239 1,758 877 2,826
Allowance for loan losses..... 2,221 3,105 3,929 3,957 4,264
Nonperforming loans to loans.. 0.03% 0.06% 0.12% 0.12% 0.43%
Allowance for loan losses to
loans........................ 1.12% 1.28% 1.25% 1.21% 1.02%
Allowance for loan losses to
nonperforming loans.......... 3398.23% 2133.01% 1019.90% 984.70% 236.27%
Nonperforming assets to total
assets....................... 0.02% 0.05% 0.10% 0.08% 0.35%
Nonaccrual Loans. Our financial statements are prepared on the accrual basis
of accounting, including the recognition of interest income on our loan
portfolio, unless a loan is placed on a nonaccrual basis. Loans are considered
to be impaired and are placed on nonaccrual status when there are serious
doubts about the collectibility of principal or interest. Our policy is to
place a loan on nonaccrual status when the loan becomes past due for 90 days
or more. Amounts received on nonaccrual loans generally are applied first to
principal and then to interest only after all principal has been collected.
Interest on nonaccrual loans foregone was $11,738, and $59,613 for the six
months ended December 31, 1998 and the year ended December 31, 1999,
respectively. Previous period interest foregone was immaterial.
Analysis of Allowance for Loan Losses
The allowance for loan losses is maintained at a level considered adequate
by management to provide for reasonably foreseeable loan losses based on
management's assessment of various factors affecting the loan portfolio,
including a review of problem loans, business conditions and loss experience
and an overall evaluation of the quality of the underlying collateral, holding
and disposal costs and costs of capital. The allowance is increased by
provisions for loan losses charged to operations and reduced by loans charged
off, net of recoveries.
Over the past three years, we have increased our allowance for loan losses
during a period of loan growth and change in loan portfolio composition. While
our loan portfolio, and in particular commercial loans, have grown
substantially over the past three years, our asset quality has remained very
solid as demonstrated by the low charge-offs and the low nonperforming assets
to total assets ratio during that period. In the year ended December 31, 1999,
we experienced net charge-offs of $101,000. Because commercial business
lending
9
generally involves greater risk than those associated with residential and
commercial real estate lending, we have increased the portion of our general
allowance for loan losses allocated to our commercial loans over the past
three years.
While we believe that we use the best information available to determine the
allowance for loan losses, if circumstances differ substantially from the
assumptions used in determining the allowance, or unforeseen market conditions
result in adjustments to the allowance for loan losses, net income could be
significantly affected.
The following table sets forth, for the periods indicated, information
regarding changes in our allowance for loan losses:
Six Months
Year Ended June 30, Ended Year Ended
---------------------------- December 31, December 31,
1996 1997 1998 1998 1999
-------- -------- -------- ------------ ------------
(Dollars in thousands)
Total loans outstanding
at end of period(1).... $198,908 $243,048 $314,095 $326,952 $417,762
Average loans
outstanding during
period................. $186,383 $213,560 $251,816 $319,645 $361,116
Allowance balance at
beginning of period.... $ 2,084 $ 2,221 $ 3,105 $ 3,929 $ 3,957
Provision for loan
losses................. -- (265) 149 202 408
Allowance acquired with
North Pacific Bank..... -- -- 670 -- --
Charge-offs:
Real estate(2)........ (20) -- -- (36) (120)
Commercial............ (2) (2) -- (146) (117)
Consumer.............. (1) (7) (3) (5) (10)
-------- -------- -------- -------- --------
Total charge-offs... (23) (9) (3) (187) (247)
-------- -------- -------- -------- --------
Recoveries:
Real estate(2)........ 156 1,155 4 4 113
Commercial............ 4 3 1 9 32
Consumer.............. -- -- 3 -- 1
-------- -------- -------- -------- --------
Total recoveries.... 160 1,158 8 13 146
-------- -------- -------- -------- --------
Net (charge-offs)
recoveries....... 137 1,149 5 (174) (101)
-------- -------- -------- -------- --------
Allowance balance at end
of period.............. $ 2,221 $ 3,105 $ 3,929 $ 3,957 $ 4,264
======== ======== ======== ======== ========
Ratio of net (charge-
offs) recoveries during
period to average loans
outstanding............ 0.07% 0.54% 0.00% 0.05% (0.03%)
======== ======== ======== ======== ========
- --------
(1) Includes loans held for sale
(2) During the periods shown, all of the charge-offs and recoveries shown
under the Real Estate category relate to real estate mortgages. None of
the above activity related to real estate construction loans.
10
The following table shows the allocation of the allowance for loan losses
for the indicated periods. The allocation is based upon an evaluation of
defined loan problems, historical ratios of loan losses for us and industry
wide and other factors which may affect future loan losses in the categories
shown below:
At June 30, At December 31,
----------------------------------------------- -------------------------------
1996 1997 1998 1998 1999
--------------- --------------- --------------- --------------- ---------------
% of % of % of % of % of
Total Total Total Total Total
Amount Loans(1) Amount Loans(1) Amount Loans(1) Amount Loans(1) Amount Loans(1)
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
Balance applicable to:
Commercial.............. $ 593 15.4% $1,242 22.1% $2,217 37.4% $2,670 39.2% $3,070 45.8%
Real estate mortgages:
One- to four-family
residential........... 146 48.2 164 43.9 156 32.0 156 29.6 168 23.3
Five or more family
residential and
commercial
properties............ 1,112 27.9 900 27.2 678 22.9 669 21.3 721 22.5
Real estate
construction:
One- to four-family
residential........... 243 7.4 202 5.3 214 6.1 135 8.1 145 5.6
Five or more family
residential and
commercial
properties............ 12 0.2 31 0.4 10 0.2 16 0.6 17 1.8
Consumer................ 12 0.9 20 1.1 53 1.4 54 1.2 58 1.0
Unallocated............. 103 546 601 257 85
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total.................. $2,221 100.0% $3,105 100.0% $3,929 100.0% $3,957 100.0% $4,264 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
- --------
(1) Represents the total of all outstanding loans in each category as a
percent of total loans outstanding.
Investment Activities
At December 31, 1999, our investment securities portfolio totaled $42.5
million, consisting of $36.4 million of securities available for sale and $6.1
million of securities held to maturity. This compares with a total portfolio
of $47.6 million at December 31, 1998, comprised of $31.7 million of
securities available for sale and $15.9 million of securities held to
maturity. The composition of the two investment portfolios by type of
security, at each respective date, is presented in the tables below.
Our investment policies are established by the board of directors and
monitored by the Audit and Finance Committee. They are designed primarily to
provide and maintain liquidity, to generate a favorable return on investments
without incurring undue interest rate and credit risk, and to compliment our
bank's lending activities. These policies dictate the criteria for classifying
securities as either available for sale or held for investment. The policies
permit investment in various types of liquid assets permissible under
applicable regulations, which include U.S. Treasury obligations, U.S.
Government agency obligations, some certificates of deposit of insured banks,
mortgage backed and mortgage related securities, some corporate notes,
municipal bonds, FHLB stock and federal funds. Investment in non-investment
grade bonds is not permitted under the policies.
11
The following table summarizes the amortized cost, gross unrealized gains
and losses and the resulting fair value of securities available for sale:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -------
(Dollars in thousands)
December 31, 1998
U.S. Government and its agencies...... $26,597 $ 72 $ (96) $26,573
Collateralized mortgage obligations... 2,812 (10) 2,802
Corporate notes and other............. 2,100 224 -- 2,324
------- ---- ----- -------
Totals.............................. $31,509 $296 $(106) $31,699
======= ==== ===== =======
December 31, 1999
U.S. Government and its agencies...... $33,192 $-- $(669) $32,523
Collateralized mortgage obligations... 1,611 (28) 1,583
Corporate notes and other............. 2,100 185 (13) 2,272
------- ---- ----- -------
Totals.............................. $36,903 $185 $(710) $36,378
======= ==== ===== =======
We had no securities available for trading at June 30, 1997, June 30, 1998,
December 31, 1998, or December 31, 1999.
The following table sets forth information regarding the carrying value,
weighted average yields and maturities or periods to repricing of our
investment securities available for sale at December 31, 1999.
At December 31, 1999
--------------------------
Weighted
Fair Average
BookValue Value Yield
--------- ------- --------
(Dollars in thousands)
Obligations of US Government agencies:
Due within one year................................ $ 2,000 $ 1,987 5.54%
Due after 1 year but within 5 years................ 31,192 30,536 5.61
------- -------
33,192 32,523
------- -------
Corporate notes and other investments
Due after 1 year but within 5 years................ 500 501 6.86
Due after 5 years but within 10 years.............. 500 495 6.29
Due after 10 years................................. 1,100 1,276 4.93
------- -------
2,100 2,272
------- -------
Collateralized mortgage obligations..................
Due after 5 years but within 10 years.............. 296 289 5.98
Due after 10 years................................. 1,315 1,294 6.55
------- -------
1,611 1,583
------- -------
Total all investments available for sale............. $36,903 $36,378
======= =======
12
The following table summarizes the amortized cost, gross unrealized gains
and losses and the resulting fair value of investment securities held to
maturity:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -------
(Dollars in thousands)
December 31, 1998:
U.S. Government and its agencies...... $ 9,846 $ 26 $ (3) $ 9,869
Mortgage backed securities............ 3,262 86 -- 3,348
Municipal bonds....................... 2,789 77 (2) 2,864
------- ---- ---- -------
Total held for investment........... $15,897 $189 $ (5) $16,081
======= ==== ==== =======
December 31, 1999:
U.S. Government and its agencies...... $ 1,200 $-- $ (6) $ 1,194
Mortgage backed securities............ 2,399 95 (1) 2,493
Municipal bonds....................... 2,566 4 (38) 2,532
------- ---- ---- -------
Total held for investment........... $ 6,165 $ 99 $(45) $ 6,219
======= ==== ==== =======
The following table sets forth information regarding the carrying value,
weighted average yields and maturities or periods to repricing of our
investment securities held to maturity at December 31, 1999.
At December 31, 1999
----------------------
Weighted
Book Fair Average
Value Value Yield
------ ------ --------
(Dollars in thousands)
Obligations of US Government agencies:
Due within one year................................. $ 300 $ 300 6.10%
Due after 1 year but within 5 years................. 900 894 5.99
------ ------
1,200 1,194
------ ------
Municipal bonds
Due within one year................................. 456 459 7.03
Due after 1 year but within 5 years................. 1,412 1,398 6.80
Due after 5 years but within 10 years............... 700 676 6.11
------ ------
2,568 2,533
------ ------
Mortgage backed securities
Due within one year................................. 57 60 8.03
Due after 1 year but within 5 years................. 54 55 7.99
Due after 5 years but within 10 years............... 303 314 8.62
Due after 10 years.................................. 1,983 2,063 8.16
------ ------
2,397 2,492
------ ------
Total all investments held to maturity............ $6,165 $6,219
====== ======
- --------
(1) Tax equivalent weighted average yield.
We held $2.2 million of FHLB stock at December 31, 1999. The stock has no
contractual maturity and amounts in excess of the required minimum for FHLB
membership may be redeemed at par. At December 31, 1999, we were required to
maintain an investment in the stock of the FHLB of Seattle of at least $0.8
million.
13
Deposit Activities and Other Sources of Funds
General. Our primary sources of funds are deposits and loan repayments.
Scheduled loan repayments are a relatively stable source of funds, while
deposit inflows and outflows and unscheduled loan prepayments, which are
influenced significantly by general interest rate levels, interest rates
available on other investments, competition, economic condition and other
factors, are not. Our deposit balances increased by $38.1 million in 1999
including an increase of $49.3 million in Public fund deposits. Customer
deposits remain an important source, but these balances have been influenced
in the past by adverse market changes in the industry and may be affected by
similar developments in the future. Borrowings may be used on a short term
basis to compensate for reductions in other sources of funds (such as deposit
inflows at less than projected levels). Borrowings may also be used on a
longer term basis to support expanded lending activities and to match the
maturity of repricing intervals of assets.
Deposit Activities. We offer a variety of accounts for depositors designed
to attract both short-term and long-term deposits. These accounts include
certificates of deposit ("CDs"), regular savings accounts, money market
accounts, checking and negotiable order of withdrawal ("NOW") accounts, and
individual retirement accounts ("IRAs"). These accounts generally earn
interest at rates established by management based on competitive market
factors and management's desire to increase or decrease certain types or
maturities of deposits. At December 31, 1999, we had no brokered deposits. The
more significant deposit accounts offered by us are described below.
Certificates of Deposit. We offer several types of CDs with maturities
ranging from 30 days to five years and which require a minimum deposit of
$100. In addition, we offer a CD that has a maturity of four to 11 months and
a minimum deposit of $2,500, and permits additional deposits at the initial
rate throughout the certificate term. Interest is credited quarterly or at
maturity. Finally, negotiable CDs are offered in amounts of $100,000 or more
for terms of 30 days to 12 months. The negotiable CDs pay simple interest
credited at maturity.
Regular Savings Accounts. We offer savings accounts that allow for unlimited
deposits and withdrawals, provided that a $100 minimum balance is maintained.
Interest is compounded daily and credited quarterly.
Money Market Accounts. Money market accounts pay a variable interest rate
that is tiered depending on the balance maintained in the account. Minimum
opening balances vary. Interest is compounded daily and paid monthly.
Checking and NOW Accounts. Checking and NOW accounts are non-interest and
interest bearing and may be charged service fees based on activity and
balances. NOW accounts pay interest, but require a higher minimum balance to
avoid service charges.
Individual Retirement Accounts. IRAs permit annual contributions regulated
by law and pay interest at fixed rates. Maturities are available from one to
five years and interest is compounded daily and credited quarterly.
14
Sources of Funds
Deposit Activities. The following table sets forth for the periods indicated
the average balances outstanding and the weighted average interest rates for
each major category of deposits:
Year Ended June 30, Six Months Ended Year Ended
--------------------------------- December 31, December 31,
1997 1998 1998 1999
---------------- ---------------- ---------------- ----------------
Average Average Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate Balance Rate
(1) Paid (1) Paid (1) Paid (1) Paid
-------- ------- -------- ------- -------- ------- -------- -------
(Dollars in thousands)
Interest bearing demand
and money market
accounts............... $ 53,850 3.16% $ 62,577 3.12% $ 82,746 2.82% $ 91,281 2.69%
Savings................. 35,269 3.45 41,863 3.50 63,986 3.48 68,484 3.33
Certificates of
deposit................ 134,226 5.54 150,970 5.56 177,956 5.46 165,490 5.00
Total interest bearing
deposits.............. 223,345 4.64 255,410 4.62 324,688 4.40 325,255 4.00
Demand and other
noninterest bearing
deposits............... 16,412 -- 22,759 -- 36,540 -- 37,906 --
-------- ---- -------- ---- -------- ---- -------- ----
Total deposits......... $239,757 4.32% $278,169 4.25% $361,228 3.95% $363,161 3.58%
======== ==== ======== ==== ======== ==== ======== ====
- --------
(1) Average balances were calculated using average daily balances.
The following table sets forth for the periods indicated the change in the
balances of deposits during the year and the impact of interest credited
thereon.
Year Ended June Six months
30, Ended Year Ended
------------------ December 31, December 31,
1997 1998 1998 1999
-------- -------- ------------ ------------
(Dollars in thousands)
Net increase (decrease) in
deposits.................... $ 27,072 $109,505 $ 3,469 $ 38,070
Less: Interest credited.... (10,114) (11,494) (6,482) (12,631)
-------- -------- ------- --------
Net increase(decrease) before
interest credited........... $ 16,958 $ 98,011 $(3,013) $ 25,439
======== ======== ======= ========
Of the $98.0 million net increase in deposits for the year ended June 30,
1998, $82.4 million resulted from the acquisition of North Pacific Bank, which
was effective June 12, 1998.
The following table shows the amount and maturity of certificates of
deposits of $100,000 or more as of December 31, 1999:
December 31,
1999
------------
(Dollars in
thousands)
Remaining maturity:
Three months or less...................................... $52,017
Over three months through six months...................... 8,951
Over six months through 12 months......................... 12,211
Over twelve months........................................ 3,779
-------
Total................................................... $76,958
=======
At December 31, 1998 and December 31, 1999 certificates of deposits with
balances of $100,000 or more totaled $30.8 million and $77.0 million,
respectively.
15
Borrowings. Savings deposits are the primary source of funds for our lending
and investment activities and for our general business purposes. We rely upon
advances from the FHLB of Seattle to supplement our supply of lendable funds
and to meet deposit withdrawal requirements. The FHLB of Seattle has served as
one of our secondary sources of liquidity. Advances from the FHLB of Seattle
are typically secured by our first mortgage loans, and stock issued by the
FHLB of Seattle, which is held by us.
The FHLB functions as a central reserve bank providing credit for member
financial institutions. As a member, Heritage 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. It is
anticipated that Central Valley Bank will become a member early in 2000.
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 net worth or on the FHLB's assessment of the institution's
creditworthiness. Under its current credit policies, the FHLB of Seattle
generally limits advances to 20.0% of a member's assets, and overnight
borrowings may not exceed 5.0% of the institution's assets. The FHLB of
Seattle determines specific lines of credit for each member institution.
The following table is a summary of FHLB advances for the years ended June
30, 1997, June 30, 1998, the six months ended December 31, 1998, and the year
ended December 31, 1999:
At or for
the year At or for At or for
ended the six the year
June 30, months ended ended
------------ December 31, December 31,
1997 1998 1998 1999
----- ------ ------------ ------------
(Dollars in thousands)
Balance at period end.............. $ -- $ 890 $ 687 $2,800
Average balance during the period.. -- 27 693 958
Maximum amount outstanding at any
month end......................... -- 1,300 696 3,300
Average interest rate:
During the period................ -- 5.47% 6.20% 5.90%
At period end.................... -- 6.45% 6.20% 5.70%
16
The following table is a summary of other borrowed funds for the years ended
June 30, 1997 and June 30, 1998, the six months ended December 31, 1998 and
the year ended December 31, 1999.
At or for
the year At or for At or for
ended the six the year
June 30, months ended ended
------------ December 31, December 31,
1997 1998 1998 1999
----- ----- ------------ ------------
(Dollars in thousands)
Securities sold under agreements to
repurchase:
Balance at period end................ $ -- $ 610 $ -- $ --
Average balance during the period.... -- 21 320 --
Maximum amount outstanding at any
month end........................... -- 610 483 --
Average interest rate:
During the period.................. -- 3.25% 3.25% --
At period end...................... -- 3.25% -- --
Subordinated debentures:
Balance at period end................ $ -- $ 500 $ -- $ --
Average balance during the period.... -- 25 500 --
Maximum amount outstanding at any
month end........................... -- 500 500 --
Average interest rate:
During the period.................. -- 7.64% 7.64% --
At period end...................... -- 7.64% -- --
Notes Payable:
Balance at period end................ $ 525 $ 320 $ 17 $ 8
Average balance during the period.... 600 451 93 12
Maximum amount outstanding at any
month end........................... 675 547 319 16
Average interest rate:
During the period.................. 9.25% 9.23% 7.29% 0.00%
At period end...................... 9.25% 8.61% 0.00% 0.00%
Notes Payable at December 31, 1998 and December 31, 1999 include a non
interest bearing note to Tacoma City Light for energy conservation improvement
that was acquired in June 1998 with North Pacific Bank.
Supervision and Regulation
We and our banks are subject to extensive federal and Washington state
legislation, regulation and supervision. These laws and regulations are
primarily intended to protect depositors and the FDIC rather than
stockholders. The laws and regulations affecting banks and bank holding
companies have changed significantly over recent years, and it is reasonable
to expect that similar changes will continue in the future. Any change in
applicable laws, regulations or regulatory policies may have a material effect
on our business, operations and prospects. We cannot predict the nature or the
extent of the effects on our business and earnings that any fiscal or monetary
policies or new federal or state legislation may have in the future.
The following information is qualified in its entirety by reference to the
particular statutory and regulatory provisions described.
Heritage Financial. We are subject to regulation as a bank holding company
within the meaning of the Bank Holding Company Act of 1956, as amended, and
are supervised by the Federal Reserve. The Federal Reserve has the authority
to order bank holding companies to cease and desist from unsound practices and
violations of conditions imposed on it. The Federal Reserve is also empowered
to assess civil money penalties against companies and individuals who violate
the Bank Holding Company Act or orders or regulations thereunder in amounts up
to $1.0 million per day or order termination of non-banking activities of non-
banking subsidiaries of bank holding companies, and to order termination of
ownership and control of a non-banking
17
subsidiary by a bank holding company. Some violations may also result in
criminal penalties. The FDIC and OCC are authorized to exercise comparable
authority under the Federal Deposit Insurance Act, the National Bank Act and
other statutes with respect to state nonmember banks such as Heritage Bank or
national banks such as Central Valley Bank.
The Federal Reserve takes the position that a bank holding company is
required to serve as a source of financial and managerial strength to its
subsidiary banks and may not conduct its operations in an unsafe or unsound
manner. In addition, it is the Federal Reserve's position that in serving as a
source of strength to its subsidiary banks, bank holding companies should be
prepared to use available resources to provide adequate capital funds to its
subsidiary banks during periods of financial stress or adversity and should
maintain the financial flexibility and capital raising capacity to obtain
additional resources for assisting its subsidiary banks. A bank holding
company's failure to meet its obligations to serve as a source of strength to
its subsidiary banks will generally be considered by the Federal Reserve to be
an unsafe and unsound banking practice or a violation of the Federal Reserve's
regulations or both. The Federal Deposit Insurance Act requires an
undercapitalized institution to submit to the Federal Reserve a capital
restoration plan with a guaranty by each company having control of the bank's
compliance with the plan.
We are required to file an annual report and periodic reports with the
Federal Reserve and additional information as the Federal Reserve may require.
The Federal Reserve may examine us and any of our subsidiaries and charge us
for the cost of the examination.
We and any subsidiaries which we may control are deemed "affiliates" within
the meaning of the Federal Reserve Act, and transactions between our bank
subsidiaries and our affiliates are subject to numerous restrictions. With
some exceptions, we and our subsidiaries are prohibited from tying the
provision of various services, such as extensions of credit, to other services
offered by us or our affiliates.
Bank regulations require bank holding companies and banks to maintain a
minimum "leverage" ratio of core capital to adjusted quarterly average total
assets of at least 3%. In addition, banking regulators have adopted risk-based
capital guidelines under which risk percentages are assigned to various
categories of assets and off-balance sheet items to calculate a risk-adjusted
capital ratio. Tier I capital generally consists of common stockholders'
equity (which does not include unrealized gains and losses on securities),
less goodwill and certain identifiable intangible assets, while Tier II
capital includes the allowance for loan losses and subordinated debt, both
subject to some limitations. Regulatory risk-based capital guidelines require
Tier I capital of 4% of risk-adjusted assets and minimum total capital ratio
(combined Tier I and Tier II) of 8%.
Subsidiaries. Heritage Bank is a Washington state-chartered savings bank,
the deposits of which are insured by the FDIC. Heritage Bank is subject to
regulation by the FDIC and the Washington State Department of Financial
Institutions Division of Banks. Central Valley Bank is a nationally chartered
bank insured by the FDIC, and subject to the Office of the Comptroller of the
Currency, and is a member of the Federal Reserve System. Although Heritage
Bank is not a member of the Federal Reserve System, the Federal Reserve
supervisory authority over us may also affect Heritage Bank.
Among other things, applicable federal and state statutes and regulations
which govern a bank's operations relate to minimum capital requirements,
required reserves against deposits, investments, loans, legal lending limits,
mergers and consolidation, borrowings, issuance of securities, payment of
dividends, establishment of branches and other aspects of its operations. The
Division, the OCC and the FDIC also have authority to prohibit banks under
their supervision from engaging in what they consider to be unsafe and unsound
practices.
The banks are required to file periodic reports with the FDIC, the Division,
or the OCC, and are subject to periodic examinations and evaluations by those
regulatory authorities. Based upon these evaluations, the regulators may
revalue the assets of an institution and require that it establish specific
reserves to compensate for the differences between the regulator-determined
value and the book value of such assets. These examinations must be conducted
every 12 months, except that well-capitalized banks may be examined every 18
months. The
18
FDIC and the Division may each accept the results of an examination by the
other in lieu of conducting an independent examination.
As subsidiaries of a bank holding company, our banks are subject to various
restrictions in their dealings with us and with other companies that may
become affiliated with us.
In addition to earnings on the portion of net stock offering proceeds
retained by us, dividends paid by our subsidiaries will provide substantially
all of our cash flow. Applicable federal and Washington state regulations
restrict capital distributions by our banks, including dividends. Such
restrictions are tied to the institution's capital levels after giving effect
to such distributions. The FDIC and OCC have established the qualifications
necessary to be classified as a "well-capitalized" bank, primarily for
assignment of FDIC risk-based insurance premium rates beginning in 1993. To
qualify as "well-capitalized", banks must have a Tier I risk-adjusted capital
ratio of at least 6%, a total risk-adjusted capital ratio of at least 10%, and
a leverage ratio of at least 5%. Both Heritage Bank and Central Valley Bank
were qualified as "well-capitalized" at December 31, 1999.
Federal laws generally bar institutions which are not well capitalized from
accepting brokered deposits. The FDIC has issued rules which prohibit under-
capitalized institutions from soliciting or accepting brokered deposits.
Adequately capitalized institutions are allowed to solicit brokered deposits,
but only to accept them if a waiver is obtained from the FDIC.
Other Regulatory Developments. Congress has enacted significant federal
banking legislation in recent years. Included in this legislation have been:
The FIRREA and the Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA").
FIRREA, among other things,
. created two deposit insurance funds administered by the FDIC, the Bank
Insurance Fund ("BIF") and the SAIF;
. permitted commercial banks that meet certain housing-related asset
requirements to secure advances and other financial services from local
FHLBs;
. restructured the federal regulatory agencies for savings associations;
and
. greatly enhanced the regulators enforcement powers over financial
institutions and their affiliates.
FDICIA went substantially farther than FIRREA in establishing a more
rigorous regulatory environment. Under FDICIA, regulatory authorities are
required to enact a number of new regulations, substantially all of which are
now effective. These regulations include, among other things,
. a new method for calculating deposit insurance premiums based on risk,
. restrictions on acceptance of brokered deposits except by well-
capitalized institutions,
. additional limitations on loans to executive officers and directors of
banks,
. the employment of interest rate risk in the calculation of risk-based
capital,
. safety and soundness standards that take into consideration, among other
things, management, operations, asset quality, earnings and
compensation,
. a five-tiered rating system from well-capitalized to critically
undercapitalized, along with the prompt corrective action the agencies
may take depending on the category, and
. new disclosure and advertising requirements with respect to interest
paid on savings accounts.
FDICIA and regulations adopted by the FDIC impose additional requirements
for annual independent audits and reporting when a bank begins a fiscal year
with assets of $500 million or more. These banks, or their holding
19
companies, are also required to establish audit committees consisting of
directors who are independent of management.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994. This act provides banks with greater opportunities to merge with other
institutions and to open branches nationwide and also allows a bank holding
company whose principal operations are in one state to apply to the Federal
Reserve for approval to acquire a bank that is headquartered in a different
state. States cannot "opt out" but may impose minimum time periods, not to
exceed five years, for the target bank's existence. This act also allows bank
subsidiaries of bank holding companies to establish "agency" relationships
with their depository institution affiliates. In an agency relationship, a
bank can accept deposits, renew time deposits, close and service loans, and
receive payments for a depository institution affiliate. States cannot "opt
out". This act allows banks whose principal operations are located in
different states to apply to federal regulators to merge. This provision took
effect June 1, 1997, unless states enacted laws to either authorize such
transactions at an earlier date or prohibit such transactions entirely. The
Interstate Banking Act also allows banks to apply to establish de novo
branches in states in which they do not already have a branch office. This
provision took effect June 1, 1997, but (i) states must enact laws to permit
such branching and (ii) a bank's primary federal regulator must approve any
such branch establishment. The Washington legislature passed legislation that
allows, subject to certain conditions, mergers or other combinations,
relocations of banks' main office and branching across state lines in advance
of the June 1, 1997 date established by federal law.
Recent Legislation
Financial Services Reform Legislation. On November 12, 1999, the Gramm-
Leach-Bliley Act ("GLBA") was enacted into law. The GLBA removes various
barriers imposed by the Glass-Steagall Act of 1933, specifically those
prohibiting banks and bank holding companies from engaging in the securities
and insurance business. The GLBA also expands the bank holding company act
framework to permit bank holding companies with subsidiary banks meeting
certain capital and management requirements to elect to become a "financial
holding company".
Beginning March, 2000, financial holding companies may engage in a full
range of financial activities, including not only banking, insurance and
securities activities, but also merchant banking and additional activities
determined to be "financial in nature" or "complementary" to an activity that
is financial in nature. The GLBA also provides that the list of permissible
financial activities will be expanded as necessary for a financial holding
company to keep abreast of competitive and technological changes.
The GLBA also expands the activities in which insured state banks may
engage. Under the GLBA, insured state banks are given the ability to engage in
financial activities through a subsidiary, as long as the bank and its bank
affiliates meet and comply with certain requirements. First, the state bank
and each of its bank affiliates must be "well capitalized". Second, the bank
must comply with certain capital deduction and financial statement
requirements provided under the GLBA. Third, the bank must comply with certain
financial and operational safeguards provided under the GLBA. Fourth, the bank
must comply with the limits imposed by the GLBA on transactions with
affiliates.
Although the GLBA preserves the Federal Reserve as the umbrella supervisor
of financial holding companies, it adopts an administrative approach to
regulation that defers to the action and paperwork requirements of the
"functional" regulators of insurers, broker-dealers, investment companies and
banks. Thus, the various state and federal regulators of a financial holding
company's operating subsidiaries would retain their jurisdiction and authority
over those operating entities. As the umbrella supervisor, however, the
Federal Reserve has the potential to affect the operations and activities of a
financial holding company's subsidiaries through its power over the financial
holding company parent. In addition, the GLBA contains numerous trigger points
related to legal non-compliance and other serious problems affecting bank
affiliates that could lead to direct Federal Reserve involvement and to the
possible exercise of remedial authority affecting both financial holding
companies and their affiliated operating companies.
20
Deposit Insurance Matters. Heritage Bank's deposit accounts are insured by
the FDIC under the SAIF to the maximum extent permitted by law. Central Valley
Bank is insured by the FDIC under the BIF to the maximum extent permitted by
law. Each bank pays deposit insurance premiums to the FDIC based on a risk-
based assessment system established by the FDIC for all member institutions.
Under applicable regulations, institutions are assigned to one of three
capital groups that are based solely on the level of an institution's capital
("well capitalized", "adequately capitalized" or " undercapitalized"), which
are defined in the same manner as the regulations establishing the prompt
corrective action system under the FDIC as described above. The matrix so
created results in nine assessment risk classifications.
Pursuant to recent changes in federal law, the FDIC imposed a special
assessment on each depository institution with SAIF-assessable deposits which
resulted in the SAIF achieving its designated reserve ratio. In connection
with that, the FDIC reduced the assessment schedule for SAIF members,
effective January 1, 1997, to a range of 0% to 0.27%, with most institutions,
including Heritage Bank, paying 0%. This assessment schedule is the same as
that for the BIF, which reached its designated reserve ratio in 1995. In
addition, since January 1, 1997, SAIF members are charged an assessment of
approximately 0.06% of SAIF-assessable deposits for the purpose of paying
interest on the bonds issued by the Financing Corporation in the 1980s to help
fund the thrift industry cleanup. BIF-assessable deposits will be charged an
assessment to help pay interest on the bonds at a rate of approximately .013%
until the earlier of December 31, 1999 or the date upon which the last savings
association ceases to exist, after which time the assessment will be the same
for all insured deposits. Recent legislative changes provided for the merger
of the BIF and SAIF into the Deposit Insurance Fund on January 1, 1999, but
only if no insured depository institutions were savings associations on that
date. This merger did not occur.
Competition
We compete for loans and deposits with other thrifts, commercial banks,
credit unions, mortgage bankers and other institutions in the scope and type
of services offered, interest rates paid on deposits, pricing of loans, and
number and locations of branches, among other things. Many of our competitors
have substantially greater resources than we do. Particularly in times of high
or rising interest rates, we also face significant competition for investors'
funds from short term money market securities and other corporate and
government securities.
We compete for loans principally through the range and quality of the
services we provide, interest rates and loan fees, and the locations of our
banks' branches. We actively solicit deposit-related clients and compete for
deposits by offering depositors a variety of savings accounts, checking
accounts and other services.
Employees
At December 31, 1999, we had 222 full-time equivalent employees. We believe
that employees play a vital role in the success of a service company. None of
our employees are covered by a collective bargaining agreement with us and we
believe that we have a good relationship with our employees.
ITEM 2. PROPERTIES
Our executive offices and the main office of Heritage Bank are located in
approximately 22,000 square feet of the headquarters building and adjacent
office space which are owned and located in downtown Olympia. At December 31,
1999, Heritage Bank had six offices located in Tacoma and surrounding areas of
Pierce County, (all but one of which are owned) five offices located in
Thurston County (all of which are owned with one office located on leased
land) and one office in Shelton, Mason County (which is owned). Central Valley
Bank had five offices located in Yakima County (all of which are owned).
21
ITEM 3. LEGAL PROCEEDINGS
We and our banks have certain litigation and negotiations in progress
resulting from activities arising from normal operations. In our opinion, none
of these matters is likely to have a material adverse effect on our financial
position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
22
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock is traded on the NASDAQ National Market(R) under the symbol
HFWA. At December 31, 1999, we had approximately 1,492 stockholders of record
(not including the number of persons or entities holding stock in nominee or
street name through various brokerage firms) and 10,076,216 outstanding shares
of common stock. The last reported sales price on March 8, 2000 was $7.75 per
share. The following table sets forth for the quarters indicated the range of
high and low bid information per share of our common stock as reported on the
NASDAQ National Market(R).
1999 Quarter ended:
-----------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
High............................. $10.00 $8.69 $8.50 $8.75
Low.............................. $ 8.13 $7.73 $7.68 $7.37
Since our stock offering in January 1998, we have declared the following
quarterly cash dividends:
Cash
Dividend
Declared per share Record Date Paid
-------- --------- ---------------- ----------------
March 24, 1998................. $0.035 April 6, 1998 April 15, 1998
June 23, 1998.................. $0.040 July 6, 1998 July 15, 1998
September 18, 1998............. $0.045 October 6, 1998 October 15, 1998
December 17, 1998.............. $0.050 January 15, 1999 January 25, 1999
March 25, 1999................. $0.055 April 15, 1999 April 26, 1999
June 18, 1999.................. $0.060 July 15, 1999 July 27, 1999
September 17, 1999............. $0.065 October 15, 1999 October 27, 1999
December 16, 1999.............. $0.070 January 14, 1999 January 27, 1999
Dividends from us depend, in part, upon earnings from the investment of the
net proceeds from the Conversion retained by us and receipt of dividends from
our subsidiary banks. The FDIC and the Division have the authority under their
supervisory powers to prohibit the payment of dividends by Heritage Bank to
us. For a period of ten years after the Conversion, Heritage Bank may not,
without prior approval of the Division, declare or pay a cash dividend in an
amount in excess of one-half of the greater of the Bank's net income for the
current fiscal year or the average of the Bank's net income for the current
fiscal year and not more than two of the immediately preceding fiscal years.
In addition, Heritage Bank may not declare or pay a cash dividend on its
common stock if the effect of the dividend would be to reduce the Bank's net
worth below the amount required for the liquidation account. For Central
Valley Bank the approval of the Comptroller of the Currency is required if the
total of all dividends declared by Central Valley Bank in any calendar year
exceeds the total of its net income of that year combined with its retained
net income of the preceding two years, less any required transfer of surplus
or fund for the retirement of any preferred stock. Other than the specific
restrictions mentioned above, current regulations allow us and our subsidiary
banks to pay dividends on their common stock if our or our bank's regulatory
capital would not be reduced below the statutory capital requirements set by
the Federal Reserve, the OCC and the FDIC.
23
ITEM 6. SELECTED FINANCIAL DATA
For the six For the
For the year ended June 30, months ended year ended
---------------------------------- December 31, December 31,
1995 1996 1997 1998 1998 1999
------- ------- ------- ------- ------------ ------------
(Dollars in thousands, except per share data)
Operations Data:
Net interest income..... $10,138 $10,504 $12,043 $16,110 $11,017 $23,458
Provision for loan
losses................. -- -- (265) 149 202 408
Noninterest income...... 3,389 4,794 3,748 4,261 2,901 4,038
Noninterest expense..... 9,294 10,505 13,445 13,690 10,275 18,773
Provision (benefit) for
income taxes........... 1,345 1,617 12 2,273 1,275 2,958
Net income.............. 2,888 3,176 2,598 4,259 2,166 5,357
Earnings per share
Basic................. 0.28 0.31 0.25 0.41 0.20 0.50
Diluted............... 0.28 0.31 0.24 0.40 0.20 0.49
Dividend payout ratio
(1).................... NM NM NM 18.4% 47.3% 50.1%
Performance Ratios:
Net interest spread..... 3.45% 4.14% 4.30% 4.14% 4.13% 4.55%
Net interest margin
(2).................... 4.89% 4.63% 4.80% 5.05% 5.16% 5.49%
Efficiency ratio (3).... 68.71% 68.67% 85.15% 67.20% 73.83% 68.27%
Return on average
assets................. 1.28% 1.27% 0.94% 1.23% 0.92% 1.14%
Return on average
equity................. 11.81% 11.30% 8.74% 6.77% 4.36% 5.32%
At June 30, At December 31,
-------------------------------------- ------------------
1995 1996 1997 1998 1998 1999
-------- -------- -------- -------- -------- --------
Balance Sheet Data:
Total assets............ $239,827 $262,428 $291,323 $471,030 $475,871 $510,958
Loans receivable, net... 174,095 191,400 233,621 303,754 315,376 412,909
Loans held for sale..... 5,944 5,287 6,322 6,412 7,618 589
Deposits................ 205,517 226,951 254,024 363,529 366,998 405,068
Federal Home Loan Bank
advances............... -- -- 890 698 687 2,800
Other borrowings........ 3,252 -- 525 1,633 17 8
Stockholders' equity.... 26,488 29,161 31,588 98,593 100,559 95,264
Book value per share.... NM NM NM $ 9.20 $ 9.27 $ 9.50
Equity to assets ratio.. 11.04% 11.11% 10.84% 20.93% 21.13% 18.68%
Asset Quality Ratios:
Nonperforming loans to
loans.................. 0.12% 0.03% 0.06% 0.06% 0.12% 0.43%
Allowance for loan
losses to loans........ 1.14% 1.12% 1.28% 1.25% 1.21% 1.02%
Allowance for loan
losses to nonperforming
loans.................. 973.83% 3398.23% 2133.01% 1019.90% 984.70% 236.27%
Nonperforming assets to
total assets........... 0.09% 0.02% 0.05% 0.10% 0.08% 0.35%
Other Data:
Number of banking
offices................ 8 10 12 14 16 17
Number of full-time
equivalent employees... 144 145 170 180 229 222
- --------
(1) Dividend payout ratio is declared dividends per share divided by earnings
per share. Cash dividends prior to the January 1998 stock offering and
conversion are not comparable to prior periods due to the former mutual
holding company's waiver of its pro rata cash dividends.
(2) Net interest margin is net interest income divided by average interest
earning assets.
(3) The efficiency ratio is recurring noninterest expense divided by the sum
of net interest income and noninterest income, excluding nonrecurring
items. Heritage Bank paid a one-time assessment of $1.09 million to the
Savings Association Insurance Fund in November 1996 (fiscal year 1997).
This amount was excluded from the calculation of the efficiency ratio for
1997.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion is intended to assist in understanding the
financial condition and results of operations of the Company. The information
contained in this section should be read in conjunction with the December 31,
1999 audited consolidated financial statements and notes to those financial
statements included in this Form 10-K.
Statements concerning future performance, developments or events, concerning
expectations for growth and market forecasts, and any other guidance on future
periods, constitute forward-looking statements and are subject to a number of
risks and uncertainties which might cause actual results to differ materially
from stated expectations. Specific factors include, but are not limited to the
effect of interest rate changes, risks associated with acquisition of other
banks and opening new branches, the ability to control costs and expenses, and
general economic conditions. Additional information on these and other factors
which could affect our financial results are included in our filings with the
Securities and Exchange Commission.
General
In the fiscal year ended June 30, 1994, we began to implement a growth
strategy to broaden our products and services from traditional thrift
offerings to those more closely related to commercial banking. That strategy
entails:
. geographic and product expansion
. loan portfolio diversification
. development of relationship banking
. maintenance of asset quality
We incurred substantial expenses as we have carried out our growth strategy.
Those expenses have been concentrated in
. personnel hired in anticipation of growth and expanded market share
. maintaining the mortgage origination capacity during times of
fluctuating mortgage origination volumes
. facilities expansion
. upgrading data processing capabilities
These expenditures had a negative impact on our earnings in the fiscal year
ended June 30, 1997, the fiscal year ended June 30, 1998 and for the six
months ended December 31, 1998. Positive results from those expenditures
emerged in the second half of 1999 as the efficiency ratio improved from
73.83% for 1998 to 68.27% for 1999.
In the fiscal year ended June 30, 1998, our growth strategy was further
bolstered by two significant events:
. the January 1998 stock offering and conversion
. our acquisition of North Pacific Bancorporation.
Through the January 1998 stock offering, we raised $63.0 million in net new
capital which has, and will continue to, enhance our ability to implement our
growth strategy. Using $17.5 million of the net proceeds of the stock
offering, we completed out first bank acquisition in June 1998 by purchasing
all of the outstanding stock of North Pacific Bancorporation whose wholly
owned subsidiary was North Pacific Bank. The acquisition of North Pacific Bank
provided further geographical expansion into the Pierce County market area and
enhanced
25
expertise in commercial banking. While this acquisition had a significant
impact on our growth and financial condition at June 30, 1998, North Pacific
Bank's operations had a minimal impact on our earnings for the year ended June
30, 1998 due to the timing of the closing of the transaction on June 12, 1998.
During the six months ended December 31, 1998, we integrated the operations of
North Pacific Bank into Heritage Bank culminating in the merging of data
processing systems effective November 20, 1998 and substantially upgrading
North Pacific Bank's item processing capability to handle existing and
projected future volumes. We invested $1.1 million in item processing hardware
and software and facilities which became operational in December 1998.
Consistent with our strategy, on March 5, 1999 we merged with Washington
Independent Bancshares, Inc., whose wholly owned subsidiary was Central Valley
Bank. In the merger, we exchanged 1,058,009 shares of our common stock for all
of the outstanding shares of Washington Independent common stock. This merger
was accounted for as a pooling of interests and accordingly, our financial
information reported herein has been restated to include the accounts and
results of operations of Washington Independent for all periods presented.
Net Interest Income
Our profitability depends primarily on our net interest income, which is the
difference between the income we receive on our loan and investment portfolios
and our cost of funds, which consists of interest paid on deposits and
borrowed funds. Like most financial institutions, our interest income and cost
of funds are affected significantly by general economic conditions,
particularly changes in market interest rates and by government policies.
Changes in net interest income result from changes in volume, net interest
spread and net interest margin. Volume refers to the average dollar amounts of
interest earning assets and interest bearing liabilities. Net interest spread
refers to the difference between the average yield on interest earning assets
and the average cost of interest bearing liabilities. Net interest margin
refers to net interest income divided by average interest earning assets and
is influenced by the level and relative mix of interest earning assets and
interest bearing liabilities.
26
The following tables set forth, for the periods indicated statistics for us
related to net interest income. The average loan balances presented in the
table are net of allowances for loan losses. Nonaccrual loans have been
included in the tables as loans carrying a zero yield.
Year Ended December 31,
----------------------------------------------------
1998 1999
------------------------- -------------------------
Average Interest Average Interest
Balance Earned/ Average Balance Earned/ Average
(1) Paid Rate (1) Paid Rate
-------- -------- ------- -------- -------- -------
(Dollars in thousands)
Interest Earning Assets:
Loans..................... $289,745 $27,703 9.56% $361,116 $32,886 9.11%
Mortgage Backed
Securities............... 3,934 340 8.64 2,773 227 8.19
Investment securities and
FHLB stock............... 37,768 1,999 5.29 44,270 2,591 5.85
Interest earning
deposits................. 60,374 3,330 5.52 18,745 820 4.37
-------- ------- ------ -------- ------- ------
Total interest earning
assets................... 391,821 $33,372 8.52% 426,904 $36,524 8.56%
Noninterest earning
assets................... 35,274 44,637
-------- ------- ------ -------- ------- ------
Total assets............. $427,095 $471,541
======== ======= ====== ======== ======= ======
Interest Bearing
Liabilities:
Certificates of deposit... $166,818 $ 9,168 5.50% $165,490 $ 8,271 5.00%
Savings accounts.......... 53,264 1,836 3.45 68,484 2,279 3.33
Interest bearing demand
and money market
accounts................. 73,512 2,145 2.92 91,281 2,458 2.69
-------- ------- ------ -------- ------- ------
Total interest bearing
deposits................. 293,594 13,149 4.48 325,255 13,008 4.00
FHLB advances............. 381 22 5.67 1,021 57 5.53
Other borrowed funds...... 674 57 8.46 37 1 3.54
-------- ------- ------ -------- ------- ------
Total interest bearing
liabilities............. 294,649 $13,228 4.49% 326,313 $13,066 4.00%
Demand and other
noninterest bearing
deposits................. 28,932 37,906
Other noninterest bearing
liabilities.............. 6,473 6,712
-------- ------- ------ -------- ------- ------
Stockholders' equity...... 97,041 100,610
-------- ------- ------ -------- ------- ------
Total liabilities and
stockholders' equity.... $427,095 $471,541
======== ======= ====== ======== ======= ======
Net interest income....... $20,144 $23,458
Net interest spread....... 4.03% 4.55%
Net interest margin....... 5.14% 5.49%
Average interest earning
assets to average
interest bearing
liabilities.............. 132.98% 130.83%
- --------
(1) Calculated using average daily balances
27
Six Months Ended December 31,
----------------------------------------------------
1997 1998
------------------------- -------------------------
Average Interest Average Average Interest Average
Balance Earned/ Rate Balance Earned/ Rate
(1) Paid (2) (1) Paid (2)
-------- -------- ------- -------- -------- -------
(Dollars in thousands)
Interest Earning Assets:
Loans..................... $243,745 $11,679 9.58% $319,645 $15,329 9.59%
Mortgage Backed
Securities............... 4,929 208 8.45 3,593 151 8.42
Investment securities and
FHLB stock............... 16,335 486 5.94 46,178 1,186 5.14
Interest earning
deposits................. 15,769 442 5.61 57,248 1,544 5.39
-------- ------- ------ -------- ------- ------
Total interest earning
assets................... 280,778 $12,815 9.13% 426,664 $18,210 8.54%
Noninterest earning
assets................... 26,419 42,719
-------- ------- ------ -------- ------- ------
Total assets............. $307,197 $469,383
======== ======= ====== ======== ======= ======
Interest Bearing
Liabilities:
Certificates of deposit... $146,229 $ 4,088 5.59% $177,956 $ 4,861 5.46%
Savings accounts.......... 41,184 740 3.60 63,986 1,113 3.48
Interest bearing demand
and money market
accounts................. 60,877 972 3.19 82,746 1,165 2.82
-------- ------- ------ -------- ------- ------
Total interest bearing
deposits................ 248,290 5,800 4.67 324,688 7,139 4.40
FHLB advances............. 243 7 6.22 693 22 6.24
Other borrowed funds...... 563 24 8.54 891 32 7.16
-------- ------- ------ -------- ------- ------
Total interest bearing
liabilities............. 249,096 $ 5,832 4.68% 326,272 $ 7,193 4.41%
Demand and other
noninterest bearing
deposits................. 22,211 36,540
Other noninterest bearing
liabilities.............. 4,355 7,210
Stockholders' equity...... 31,536 99,361
-------- ------- ------ -------- ------- ------
Total liabilities and
stockholders' equity.... $307,197 $469,383
======== ======= ====== ======== ======= ======
Net interest income (2)... $ 6,983 $11,017
Net interest spread (2)... 4.45% 4.13%
Net interest margin (2)... 4.97% 5.16%
Average interest earning
assets to average
interest bearing
liabilities.............. 112.72% 130.77%
- --------
(1) Calculated using average daily balances
(2) Annualized
28
Year Ended June 30,
----------------------------------------------------
1997 1998
------------------------- -------------------------
Average Interest Average Interest
Balance Earned/ Average Balance Earned/ Average
(1) Paid Rate (1) Paid Rate
-------- -------- ------- -------- -------- -------
(Dollars in thousands)
Interest Earning Assets:
Loans..................... $213,560 $20,200 9.46% $251,816 $24,053 9.55%
Mortgage Backed
Securities............... 5,598 464 8.29 4,603 397 8.63
Investment securities and
FHLB stock............... 18,172 1,079 5.94 22,808 1,298 5.69
Interest earning
deposits................. 13,631 717 5.26 39,634 2,229 5.62
-------- ------- ------ -------- ------- ------
Total interest earning
assets................... 250,961 $22,460 8.95% 318,861 $27,977 8.77%
Noninterest earning
assets................... 24,416 27,690
-------- --------
Total assets............. $275,377 $346,551
======== ======= ====== ======== ======= ======
Interest Bearing
Liabilities:
Certificates of deposit... $134,226 $ 7,437 5.54% $150,970 $ 8,394 5.56%
Savings accounts.......... 35,269 1,216 3.45 41,863 1,463 3.50
Interest bearing demand
and money market
accounts................. 53,850 1,703 3.16 62,577 1,953 3.12
-------- ------- ------ -------- ------- ------
Total interest bearing
deposits................ 223,345 10,356 4.64 255,410 11,810 4.62
FHLB advances............. 27 1 4.99 156 10 6.09
Other borrowed funds...... 662 60 9.05 572 47 8.25
-------- ------- ------ -------- ------- ------
Total interest bearing
liabilities............. 224,034 $10,417 4.65% 256,138 $11,867 4.63%
Demand and other
noninterest bearing
deposits................. 16,412 22,759
Other noninterest bearing
liabilities.............. 5,195 4,768
Stockholders' equity...... 29,736 62,886
-------- ------- ------ -------- ------- ------
Total liabilities and
stockholders' equity.... $275,377 $346,551
======== ======= ====== ======== ======= ======
Net interest income....... $12,043 $16,110
Net interest spread....... 4.30% 4.14%
Net interest margin....... 4.80% 5.05%
Average interest earning
assets to average
interest bearing
liabilities.............. 112.02% 124.49%
- --------
(1) Calculated using average daily balances
29
The following table sets forth the amount of change in our net interest
income attributable to changes in volume and changes in interest rates.
Changes attributable to the combined effect of volume and interest rates have
been allocated proportionately to changes due to volume and the changes due to
interest rates.
Year to Date Ended
December 31, 1998
Compared to 1999
Increase(Decrease) Due to
----------------------------
Volume Rate Total
--------- -------- --------
Interest Earning Assets:
Loans............................................ $ 6,824 $ (1,641) $ 5,183
Mortgage backed securities....................... (100) (13) (113)
Investment securities and FHLB stock............. 344 248 592
Interest earning deposits........................ (2,296) (214) (2,510)
-------- -------- --------
Total interest income........................... 4,772 (1,620) 3,152
======== ======== ========
Interest bearing liabilities:
Certificates of deposit.......................... 73 824 897
Savings accounts................................. (525) 82 (443)
Interest bearing demand and money market
accounts........................................ (519) 206 (313)
-------- -------- --------
Total interest bearing deposits................. (971) 1,112 141
FHLB advances.................................... (36) 1 (35)
Other borrowings................................. 54 2 56
-------- -------- --------
Total interest bearing liabilities.............. $ (953) $ 1,115 $ 162
======== ======== ========
Six Months Ended
December 31, 1997
Compared to 1998
Increase(Decrease) Due to
----------------------------
Volume Rate Total
--------- -------- --------
Interest Earning Assets:
Loans............................................ 3,637 13 3,650
Mortgage backed securities....................... (56) (1) (57)
Investment securities and FHLB stock............. 886 (186) 700
Interest earning deposits........................ 1,164 (62) 1,102
-------- -------- --------
Total interest income........................... 5,631 (236) 5,395
======== ======== ========
Interest bearing liabilities:
Certificates of deposit.......................... (887) 113 (774)
Savings accounts................................. (410) 37 (373)
Interest bearing demand and money market
accounts........................................ (349) 157 (192)
-------- -------- --------
Total interest bearing deposits................. (1,646) 307 (1,339)
FHLB advances.................................... (14) -- (14)
Other borrowings................................. (14) 6 (8)
-------- -------- --------
Total interest bearing liabilities.............. (1,674) 313 (1,361)
======== ======== ========
30
Year Ended June 30, 1997
Compared to 1998
Increase(Decrease) Due to
----------------------------
Volume Rate Total
--------- ------- ---------
Interest Earning Assets:
Loans............................................ $ 3,619 $ 234 $ 3,853
Mortgage backed securities....................... (82) 15 (67)
Investment securities and FHLB stock............. 275 (56) 219
Interest earning deposits........................ 1,368 144 1,512
--------- ------ ---------
Total interest income........................... $ 5,180 $ 337 $ 5,517
========= ====== =========
Interest bearing liabilities:
Certificates of deposit.......................... $ (928) $ (29) $ (957)
Savings accounts................................. (227) (20) (247)
Interest bearing demand deposits................. (276) 26 (250)
--------- ------ ---------
Total interest on deposits...................... (1,431) (23) (1,454)
FHLB advances.................................... (7) (2) (9)
Other borrowed funds............................. 8 5 13
--------- ------ ---------
Total interest expense.......................... $ (1,430) $ (20) $ (1,450)
========= ====== =========
Financial Condition
Our total assets grew $35.1 million (7.4%) to $511.0 million at December 31,
1999 from $475.9 million at December 31, 1998. The asset growth corresponds
with deposit growth of $38.1 million (10.4%) to $405.1 million at December 31,
1999 from $367.0 million at December 31, 1998. Total loans grew by
$90.8 million (27.8%) to $417.7 million at December 31, 1999 from $327.0
million at December 31, 1998. $63.9 million (70.4%) of the loan growth was in
commercial loans as they grew to $192.1 million at December 31, 1999 from
$128.2 million at December 31, 1998, an increase of 49.9%.
On April 26, 1999 our board of directors authorized the repurchase in the
open market of 100,000 of our shares. This was accomplished in the second
quarter for $0.8 million, or $8.56 per share. On October 22, 1999 we announced
our intention to repurchase up to 10% of our outstanding common shares, or
approximately 1.1 million shares. During the fourth quarter of 1999, we
repurchased 821,050 shares, representing 7.5% of the 10.0% of stock intended
to be repurchased for $7.0 million at an average price of $8.55 per share.
Subsequent to year ending December 31, 1999, on February 18, 2000, we
announced the repurchase of an additional 10%, or approximately 975,000
shares. The additional share repurchase will take place over the next 18
months.
Results of Operations for the Years Ended December 31, 1999 and 1998
Net Income. Our net income was $5.4 million or $0.49 per diluted share for
the year ended December 31, 1999 as compared to $4.9 million or $0.44 per
diluted share for the same period last year. The 1998 amounts include merger
related charges of $748,000 on a pre-tax basis. Excluding these charges, net
income for the twelve months ended December 31, 1998 was $5.3 million or $0.48
per diluted share. These nonrecurring charges were related to severance and
other costs associated with the merger and integration of North Pacific Bank
into Heritage Bank in November 1998, costs associated with the formerly
proposed acquisition of Harbor Bancorp which was terminated by mutual
agreement in December 1998, and costs as