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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
Commission File Number 005-57091
FIRST MUTUAL BANCSHARES, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
WASHINGTON 91-2005970
- --------------------------------------------------------------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
400 108th Avenue N.E., Bellevue, WA 98004
---------------------------------------------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (425) 453-5301
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [_] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. August 12, 2003 4,711,298
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FIRST MUTUAL BANCSHARES, INC.
QUARTERLY REPORT ON FORM 10-Q
JUNE 30, 2003
TABLE OF CONTENTS
Page
----
PART I: FINANCIAL INFORMATION............................................ 1
Forward-Looking Statements Disclaimer................................ 1
Item 1. Financial Statements.......................................... 1
Critical Accounting Policies................................ 2
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations......................... 17
General................................................... 17
Results of Operations..................................... 17
Net Income.............................................. 17
Net Interest Income..................................... 17
Other Operating Income.................................. 20
Operating Expenses...................................... 23
Key Financial Ratios.................................... 25
Financial Condition....................................... 25
Asset Quality............................................. 27
Portfolio Information..................................... 28
Deposit Information....................................... 29
Business Segments....................................... 29
Consumer Lending...................................... 30
Commercial Lending.................................... 31
Investment Securities................................. 32
Liquidity and Capital Reserves............................ 33
Banking Center Expansion.................................. 34
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 35
Item 4. Controls and Procedures....................................... 41
PART II: OTHER INFORMATION............................................... 42
Item 1. Legal Proceedings............................................. 42
Item 2. Changes in Securities and Use of Proceeds..................... 42
Item 3. Defaults Upon Senior Securities............................... 42
Item 4. Submission of Matters to a Vote of Security-Holders........... 42
Item 5. Other Information............................................. 43
Item 6. Exhibits and Reports on Form 8-K.............................. 43
SIGNATURES............................................................... 44
i
PART I: FINANCIAL INFORMATION
FORWARD-LOOKING STATEMENTS DISCLAIMER
- -------------------------------------
Our Form 10-Q contains statements concerning anticipated future operations,
trends, plans, capabilities, and prospects of First Mutual Bancshares, Inc. and
First Mutual Bank (together, the "Bank") that are forward-looking statements for
the purposes of the safe harbor provisions under the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements include
references to our expectations regarding future interest rate margins and the
simulation effects of changes in interest rates on our income and expenses, our
current intentions regarding the possible bulk sale of home improvement loans,
our current belief about the quality of our loan portfolio, trends in income and
expenses, the outlook for deposit growth and funding sources, and anticipated
sales of investment securities; observations pertaining to the potential
disparate movement of assets and liabilities, the anticipated benefits that may
be realized by our purchase of our headquarters building and information based
on our market risk models and analysis. Although we believe that the
expectations expressed in these forward-looking statements are based on
reasonable assumptions within the bounds of our knowledge of our business,
operations, and prospects, these forward-looking statements are subject to
numerous uncertainties and risks, and actual events, results, and developments
will ultimately differ from the expectations and may differ materially from
those expressed or implied in such forward-looking statements. Factors which
could affect actual results include economic conditions in our market area and
the nation as a whole, interest rate fluctuations, the impact of competitive
products, services, and pricing, credit risk management, our ability to control
our costs and expenses, loan delinquency rates, and the legislative and
regulatory changes affecting the banking industry. There are other risks and
uncertainties that could affect us which are discussed from time to time in our
filings with the Securities and Exchange Commission. These risks and
uncertainties should be considered in evaluating the forward-looking statements,
and undue reliance should not be placed on such statements. We are not
responsible for updating any such forward-looking statements.
ITEM 1. FINANCIAL STATEMENTS
In the opinion of management, the accompanying consolidated statements of
financial condition and related interim consolidated statements of income,
comprehensive income, stockholders' equity and cash flows reflect all
adjustments (which include reclassifications and normal recurring adjustments)
that are necessary for a fair presentation in conformity with accounting
principles generally accepted in the United States of America ("GAAP"). The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect amounts reported in the financial
statements. Changes in these estimates and assumptions are considered reasonably
possible and may have a material impact on the financial statements.
Certain reclassifications have been made to the 2002 financial statements to
conform to the 2003 presentation. All significant intercompany transactions and
balances have been eliminated.
1
The information included in this Form 10-Q should be read in conjunction with
the First Mutual Bancshares, Inc. Year 2002 Annual Report on Form 10-K to the
Securities and Exchange Commission. Interim results are not necessarily
indicative of results for a full year.
Critical Accounting Policies
- ----------------------------
Various elements of the Bank's accounting policies, by their nature, are
inherently subject to estimation techniques, valuation assumptions and other
subjective assessments. In particular, management has identified several
accounting policies that, due to the judgments, estimates, and assumptions
inherent in those policies, are critical to an understanding of the Bank's
financial statements. These policies relate to the methodology for the
determination of the provision and allowance for loan losses, deferred taxes,
valuation of interest rate locks, valuation of stock options, amortization of
deferred loan fees and costs, valuation and amortization of mortgage servicing
rights, and valuation of repossessed assets and real estate held for sale. These
policies and the judgments, estimates, and assumptions are described in greater
detail in subsequent sections of the Management Discussion and Analysis and in
the consolidated financial statements and footnotes thereto included in the
Bank's annual report on Form 10-K for the year ended December 31, 2002.
Management believes that the judgments, estimates, and assumptions used in the
preparation of the financial statements are appropriate given the factual
circumstances at the time. However, given the sensitivity of the financial
statements to these critical accounting policies, the use of other judgments,
estimates, and assumptions could result in material differences in the results
of operations or financial condition.
Consolidated Financial Statements of the Company begin on page 3.
2
ITEM 1. FINANCIAL STATEMENTS
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, December 31,
2003 2002
------------- -------------
ASSETS: (Unaudited)
CASH AND CASH EQUIVALENTS:
Interest-earning deposits $ -- $ 6,203,843
Noninterest-earning demand deposits
and cash on hand 7,252,455 8,767,684
------------- -------------
7,252,455 14,971,527
MORTGAGE-BACKED AND OTHER SECURITIES
AVAILABLE-FOR-SALE 76,176,569 58,380,204
LOANS RECEIVABLE, HELD-FOR-SALE 11,293,139 12,699,004
MORTGAGE-BACKED AND OTHER SECURITIES
HELD-TO-MATURITY 11,833,907 16,358,042
LOANS RECEIVABLE 673,655,558 622,374,515
RESERVE FOR LOAN LOSSES (8,081,630) (7,754,106)
------------- -------------
LOANS RECEIVABLE, net 665,573,928 614,620,409
ACCRUED INTEREST RECEIVABLE 3,540,766 3,435,343
LAND, BUILDINGS AND EQUIPMENT, net 23,297,935 10,964,441
FEDERAL HOME LOAN BANK (FHLB) STOCK, 10,755,900 10,443,200
at cost
MORTGAGE SERVICING RIGHTS 68,449 49,914
REAL ESTATE OWNED 39,733 --
OTHER ASSETS 1,354,179 3,373,168
------------- -------------
TOTAL $ 811,186,960 $ 745,295,252
============= =============
3
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Continued)
June 30, December 31,
2003 2002
------------- -------------
(Unaudited)
LIABILITIES:
Deposits:
Money market deposit and
checking accounts $ 152,296,100 $ 134,247,575
Regular savings 9,333,051 8,386,918
Time deposits 357,021,171 354,735,126
------------- -------------
Total deposits 518,650,322 497,369,619
Drafts payable 805,119 369,034
Accounts payable and other liabilities 14,597,251 8,080,632
Advance payments by borrowers for
taxes and insurance 1,786,267 1,798,233
FHLB advances 213,647,851 184,143,897
Other advances 500,000 250,000
Federal income taxes 134,078 -
Trust preferred securities 13,000,000 9,000,000
------------- -------------
Total liabilities 763,120,888 701,011,415
STOCKHOLDERS' EQUITY:
Common stock, $1 par value-
Authorized, 10,000,000 shares
Issued and outstanding, 4,711,177
and 4,247,166 shares, respectively 4,711,177 4,247,166
Additional paid-in capital 33,443,981 24,028,610
Retained earnings 9,215,050 15,214,220
Accumulated other comprehensive income:
Unrealized gain(loss) on securities
available-for-sale and interest rate
swap, net of federal income tax 695,864 793,841
------------- -------------
Total stockholders' equity 48,066,072 44,283,837
------------- -------------
TOTAL $ 811,186,960 $ 745,295,252
============= =============
4
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Quarters ended June 30, Six Months ended June 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(Unaudited)
INTEREST INCOME:
Loans Receivable $ 11,239,837 $ 10,592,882 $ 22,193,670 $ 21,391,388
Interest on AFS Securities 689,844 1,086,279 1,337,041 1,860,487
Interest on HTM Securities 170,969 332,123 373,217 697,136
Interest Other 176,390 159,819 381,174 308,277
------------ ------------ ------------ ------------
12,277,040 12,171,103 24,285,102 24,257,288
INTEREST EXPENSE:
Deposits 2,959,303 3,575,374 6,030,311 7,154,508
FHLB advances and other 1,880,793 1,895,191 3,742,599 3,896,130
------------ ------------ ------------ ------------
4,840,096 5,470,565 9,772,910 11,050,638
------------ ------------ ------------ ------------
Net interest income 7,436,944 6,700,538 14,512,192 13,206,650
PROVISION FOR LOAN LOSSES 325,000 85,000 460,000 135,000
------------ ------------ ------------ ------------
Net interest income, after provision
for loan losses 7,111,944 6,615,538 14,052,192 13,071,650
OTHER OPERATING INCOME:
Gain on sales of loans 183,792 205,809 379,057 457,524
Servicing fees, net of amortization 14,663 29,791 29,497 52,341
Gain on sales of investments 86,454 157,443 473,523 157,443
Fees on deposits 127,978 127,582 251,288 229,892
Other 470,302 227,767 735,527 515,135
------------ ------------ ------------ ------------
Total other operating income 883,189 748,392 1,868,892 1,412,335
BALANCE, carried forward 7,995,133 7,363,930 15,921,084 14,483,985
5
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Continued)
Quarters ended June 30, Six Months ended June 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(Unaudited) (Unaudited)
BALANCE, brought forward $ 7,995,133 $ 7,363,930 $ 15,921,084 $ 14,483,985
OPERATING EXPENSES:
Salaries and employee benefits 3,014,391 2,710,325 5,986,883 5,187,412
Occupancy 571,696 558,559 1,160,012 1,137,240
Other 1,342,462 1,200,124 2,553,887 2,286,356
------------ ------------ ------------ ------------
Total other operating expenses 4,928,549 4,469,008 9,700,782 8,611,008
------------ ------------ ------------ ------------
Income before federal income taxes 3,066,584 2,894,922 6,220,302 5,872,977
FEDERAL INCOME TAXES 1,036,967 978,524 2,103,527 1,985,771
------------ ------------ ------------ ------------
NET INCOME 2,029,617 1,916,398 4,116,775 3,887,206
============ ============ ============ ============
PER SHARE DATA(1):
Basic earnings per common share $0.43 $0.33 $0.88 $0.68
Earnings per common share, assuming dilution $0.42 $0.33 $0.85 $0.67
WEIGHTED AVERAGE SHARES OUTSTANDING 4,709,686 5,726,370 4,698,015 5,723,920
============ ============ ============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING
INCLUDING DILUTIVE STOCK OPTIONS 4,872,060(2) 5,841,556 4,842,794(2) 5,812,653
============ ============ ============ ============
(1) All per share data adjusted to reflect the 10% stock dividends issued May 8,
2002 and July 2, 2003.
(2) Weighted average shares outstanding including dilutive stock options have
been adjusted upward 7,260 shares for second quarter 2003 and 3,630 shares
for the first six months of 2003 due to the discovery of an administrative
error in our stock options software.
6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
Common stock Additional
------------------------- Paid-In Retained
Shares Amount Capital Earnings
----------- ----------- ----------- -----------
BALANCE, December 31, 2000 4,671,286 $ 4,671,286 $31,118,545 $10,140,569
=========== =========== =========== ===========
Options exercised, including tax
benefit of $117,015 54,680 54,680 292,751
Repayment of ESOP debt
Cash dividends declared ($0.22 per share) (1,036,847)
Comprehensive income:
Net income 6,922,131
Other comprehensive income(loss)--Change
in unrealized gain/(loss) on securities
available-for-sale, net of federal
income tax
----------- ----------- ----------- -----------
BALANCE, December 31, 2001 4,725,966 $ 4,725,966 $31,411,296 $16,025,853
=========== =========== =========== ===========
Options exercised, including tax benefit
of $169,903 67,573 67,573 551,848
Retirement of shares repurchased (1,019,256) (1,019,256) (13,963,793) (815,419)
10% stock dividend 472,883 472,883 6,029,259 (6,502,142)
Cash dividends declared ($0.28 per share) (1,291,442)
Comprehensive income:
Net income 7,797,370
Other comprehensive income(loss)--Change
in unrealized gain/(loss) on securities
available-for-sale, and interest rate
swap, net of federal income tax
----------- ----------- ----------- -----------
BALANCE, December 31, 2002 4,247,166 $ 4,247,166 $24,028,610 $15,214,220
=========== =========== =========== ===========
Options exercised, including tax benefit
of $133,773 34,524 34,524 337,418
Issuance of stock through employees'
stock plans 1,386 1,386 23,617
10% stock dividend 428,101 428,101 9,054,336 (9,482,437)
Cash dividends declared ($0.14 per share) (633,508)
Comprehensive income:
Net income 4,116,775
Other comprehensive income(loss)--Change
in unrealized gain/(loss) on securities
available-for-sale, and interest rate
swap, net of federal income tax
----------- ----------- ----------- -----------
BALANCE, June 30, 2003 $ 4,711,177 $ 4,711,177 $33,443,981 $ 9,215,050
=========== =========== =========== ===========
Employee Stock Accumulated
Ownership Comprehensive
Plan Debt Income (Loss) Total
----------- ----------- -----------
BALANCE, December 31, 2000 $ (97,821) $ 84,692 $45,917,271
=========== =========== ===========
Options exercised, including tax
benefit of $117,015 347,431
Repayment of ESOP debt 97,821 97,821
Cash dividends declared ($0.22 per share) (1,036,847)
Comprehensive income:
Net income 6,922,131
Other comprehensive income(loss)--Change
in unrealized gain/(loss) on securities
available-for-sale, net of federal
income tax (276,510) (276,510)
----------- ----------- -----------
BALANCE, December 31, 2001 $ -- $ (191,818) $51,971,297
=========== =========== ===========
Options exercised, including tax benefit
of $169,903 619,421
Retirement of shares repurchased (15,798,468)
10% stock dividend --
Cash dividends declared ($0.28 per share) (1,291,442)
Comprehensive income:
Net income 7,797,370
Other comprehensive income(loss)--Change
in unrealized gain/(loss) on securities
available-for-sale, and interest rate
swap, net of federal income tax 985,659 985,659
----------- ----------- -----------
BALANCE, December 31, 2002 $ -- $ 793,841 $44,283,837
=========== =========== ===========
Options exercised, including tax benefit
of $133,773 371,942
Issuance of stock through employees'
stock plans 25,003
10% stock dividend --
Cash dividends declared ($0.14 per share) (633,508)
Comprehensive income:
Net income 4,116,775
Other comprehensive income(loss)--Change
in unrealized gain/(loss) on securities
available-for-sale, and interest rate
swap, net of federal income tax (97,977) (97,977)
----------- ----------- -----------
BALANCE, June 30, 2003 $ -- $ 695,864 $48,066,072
=========== =========== ===========
7
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended June 30,
-------------------------
2003 2002
----------- -----------
(Unaudited)
OPERATING ACTIVITIES:
Net income $ 4,116,775 $ 3,887,206
Adjustments to reconcile net income to net cash
from operating activities:
Provision for loan losses 460,000 135,000
Depreciation and amortization 516,993 414,912
Deferred loan origination fees, net of accretion (658,069) (195,942)
Amortization of mortgage servicing rights 26,758 21,993
Gain on sales of loans (379,057) (457,523)
Gain on sale of securities available-for-sale (473,523) (157,443)
FHLB stock dividends (312,700) (293,700)
Changes in operating assets & liabilities:
Loans receivable held-for-sale 1,405,865 2,653,496
Accrued interest receivable (105,423) (75,834)
Other assets (297,401) (1,209,999)
Drafts payable 436,085 649,033
Accounts payable and other liabilities 8,930,031 2,736,732
Advance payments by borrowers for taxes and
insurance (11,966) 123,914
----------- -----------
Net cash provided by operating activities 13,654,368 8,231,845
----------- -----------
INVESTING ACTIVITIES:
Loan originations (168,157,504) (123,697,916)
Loan principal repayments 98,674,299 92,765,138
Increase in undisbursed loan proceeds 19,597,030 8,141,329
Principal repayments & redemptions on
mortgage-backed and other securities 26,670,861 7,440,951
Purchase of securities held-to-maturity (1,098,881) (250,000)
Purchase of securities available-for-sale (57,704,405) (39,526,461)
Purchases of premises and equipment (12,829,840) (1,063,189)
Purchase of FHLB stock -- (62,600)
Proceeds from sale of securities 18,773,622 10,787,110
----------- -----------
Net cash (used) by investing activities (76,074,818) (45,465,638)
8
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Six months ended June 30,
-------------------------
2003 2002
----------- -----------
(Unaudited)
FINANCING ACTIVITIES:
Net increase in deposit accounts 15,535,782 39,194,782
Interest credited to deposit accounts 5,744,921 7,001,231
Proceeds from trust preferred securities 4,000,000 9,000,000
Issuance of stock through employees's stock plans 25,003 --
Proceeds from advances 271,343,754 124,158,892
Repayment of advances (241,589,800) (146,532,300)
Dividends paid (596,451) (661,985)
Proceeds from exercise of stock options 238,169 58,609
----------- -----------
Net cash provided by financing activities 54,701,378 32,219,229
----------- -----------
NET (DECREASE) IN CASH AND CASH EQUIVALENTS (7,719,072) (5,014,564)
CASH & CASH EQUIVALENTS:
Beginning of year 14,971,527 14,615,303
----------- -----------
End of quarter 7,252,455 9,600,739
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Loans originated for mortgage banking activities 45,232,764 33,389,528
=========== ===========
Loans originated for investment activities 168,157,504 123,697,916
=========== ===========
Proceeds from sales of loans held-for-sale 46,638,629 36,043,024
=========== ===========
Cash paid during the six months ended June 30 for:
Interest 9,924,360 11,018,064
=========== ===========
Income taxes 2,028,000 1,540,000
=========== ===========
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING ACTIVITIES:
Loans securitized into securities
available-for-sale $ -- $14,485,309
Loans transferred to real estate
held-for-sale, net $ 39,733 $ --
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1.
The results of operations for the interim periods shown in this report are not
necessarily indicative of results to be expected for the fiscal year. In the
opinion of management, the information contained herein reflects all adjustments
necessary to make the results of operations for the interim periods a fair
statement of such operations.
Stock-Based Compensation Plans - Statement of Financil Accounting Standards
(SFAS) No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure, became effective for financial statements for fiscal years ending
after December 15, 2002. The new accounting standard amends APB Opinion No. 28,
Interim Financial Reporting and SFAS No. 123, Accounting for Stock-Based
Compensation, to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
compensation and to require disclosures about those effects in interim financial
information. Management has elected to continue to use the intrinsic value
method of accounting and as a result the provisions of this statement are not
expected to have a material effect on the Bank's financial position or results
of operations.
At June 30, 2003, the Bank had three stock-based employee/director compensation
plans, which are described more fully in the 2002 annual report. The plans are
accounted for under the recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to Employees, and related interpretations.
No stock-based employee or director compensation cost is reflected in net
income, as all options granted under those plans had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per share if
the fair value recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation, had been adopted.
Quarters Ended June 30, Years Ended June 30,
------------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net Income, as reported $ 2,029,617 $ 1,916,398 $ 4,116,775 $ 3,887,206
Deduct: Total stock-based employee/
director compensation expense
determined under fair value based
method for all awards, net of related
tax effects (56,053) (25,138) (104,913) (48,110)
----------- ----------- ----------- -----------
Pro forma net income $ 1,973,564 $ 1,891,260 $ 4,011,862 $ 3,839,096
=========== =========== =========== ===========
Earnings per share:
Basic - as reported $ 0.43 $ 0.33 $ 0.88 $ 0.68
Basic - pro forma $ 0.42 $ 0.33 $ 0.85 $ 0.67
Diluted - as reported $ 0.42 $ 0.33 $ 0.85 $ 0.67
Diluted - pro forma $ 0.41 $ 0.32 $ 0.83 $ 0.66
Weighted average shares outstanding:
Basic 4,709,686 5,726,370 4,698,015 5,723,920
Diluted 4,872,060 5,841,556 4,842,794 5,812,653
The compensation expense included in the pro forma net income and net income per
share figures in the previous table are not likely to be representative of the
effect on reported net income for future years because options vest over several
years and additional awards generally are made each year.
10
NOTE 2.
MORTGAGE-BACKED AND OTHER SECURITIES AVAILABLE-FOR-SALE
The amortized cost and estimated fair value of securities available-for-sale at
June 30, 2003, and December 31, 2002 are summarized as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
----------- ----------- ----------- -----------
JUNE 30, 2003:
Freddie Mac securities $17,565,877 $ 377,897 $ -- $17,943,774
Fannie Mae securities 45,788,433 1,110,632 12,500 46,886,565
US agency securities 10,979,198 367,032 -- 11,346,230
----------- ----------- ----------- -----------
$74,333,508 $ 1,855,561 $ 12,500 $76,176,569
=========== =========== =========== ===========
DECEMBER 31, 2002:
Freddie Mac securities $ 4,085,161 $ 175,273 $ -- $ 4,260,434
Fannie Mae securities 39,485,379 1,553,171 -- 41,038,550
US agency securities 12,963,967 117,253 -- 13,081,220
----------- ----------- ----------- -----------
$56,534,507 $ 1,845,697 $ -- $58,380,204
=========== =========== =========== ===========
NOTE 3.
MORTGAGE-BACKED AND OTHER SECURITIES HELD-TO-MATURITY
The amortized cost and estimated fair value of mortgage-backed and other
securities are summarized as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
----------- ----------- ----------- -----------
JUNE 30, 2003:
Fannie Mae securities $ 9,869,753 $ 370,031 $ -- $10,239,784
Freddie Mac securities 623,562 12,997 -- 636,559
Municipal bonds 1,330,318 4,770 9,075 1,326,013
REMICS 10,274 50 -- 10,324
----------- ----------- ----------- -----------
$11,833,907 $ 387,848 $ 9,075 $12,212,680
=========== =========== =========== ===========
DECEMBER 31, 2002:
Fannie Mae securities $14,265,994 $ 594,144 $ -- $14,860,138
Freddie Mac securities 729,270 14,146 -- 743,416
Municipal bonds 1,337,161 -- 40,936 1,296,225
REMICs 25,617 468 -- 26,085
----------- ----------- ----------- -----------
$16,358,042 $ 608,758 $ 40,936 $16,925,864
=========== =========== =========== ===========
11
NOTE 4.
NONPERFORMING ASSETS
The Bank had nonperforming assets as follows:
June 30, December 31,
2003 2002
---------- ----------
Nonperforming loans $ 882,044 $2,073,525
Real estate and repossessed assets held-for-sale 52,921 45,188
---------- ----------
Total Nonperforming Assets $ 934,965 $2,118,713
========== ==========
At June 30, 2003, and December 31, 2002, the Bank had two impaired loans
totaling $16,684, defined under Statement of Financial Accounting Standards
(SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan."
NOTE 5.
EARNINGS PER SHARE
Basic earnings per share (EPS) is computed by dividing net income by the
weighted-average number of shares outstanding during the year. Diluted EPS
reflects the potential dilutive effect of stock options and is computed by
dividing net income by the weighted-average number of shares outstanding during
the year, plus the dilutive common shares that would have been outstanding had
the stock options been exercised.
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for quarters ending June 30,
2003, and June 30, 2002:
Income Shares Per share
(numerator) (denominator) amount
---------------------------------------
Quarter ended June 30, 2003
- ---------------------------
Basic EPS:
Income available to common shareholders $ 2,029,617 4,709,686 $ 0.43
===========
Effect of dilutive stock options -- 162,374
----------- -----------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 2,029,617 4,872,060 $ 0.42
=======================================
Six months ended June 30, 2003
- ------------------------------
Basic EPS:
Income available to common shareholders $ 4,116,775 4,698,015 $ 0.88
===========
Effect of dilutive stock options -- 144,779
----------- -----------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 4,116,775 4,842,794 $ 0.85
=======================================
Quarter ended June 30, 2002
- ---------------------------
Basic EPS:
Income available to common shareholders $ 1,916,398 5,726,370 $ 0.33
===========
Effect of dilutive stock options -- 115,186
----------- -----------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 1,916,398 5,841,556 $ 0.33
=======================================
Six months ended June 30, 2002
- ------------------------------
Basic EPS:
Income available to common shareholders $ 3,887,206 5,723,920 $ 0.68
===========
Effect of dilutive stock options -- 88,733
----------- -----------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 3,887,206 5,812,653 $ 0.67
=======================================
12
NOTE 6.
RATE VOLUME ANALYSIS
(Dollars in thousands)
SECOND QUARTER 2003 SIX MONTHS ENDED JUNE 30, 2003
VS VS
SECOND QUARTER 2002 SIX MONTHS ENDED JUNE 30, 2002
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
TOTAL TOTAL
VOLUME RATE CHANGE VOLUME RATE CHANGE
- ------------------------------------------------------------------------------- ------------------------------------
INTEREST INCOME
Investments:
Available-for-sale securities $ (27) (369) (396) $ 128 (651) (523)
Held-to-maturity securities (127) (36) (163) (268) (58) (326)
Other equity investments 2 14 16 15 57 72
------------------------------------- ------------------------------------
Total investments (152) (391) (543) (125) (652) (777)
------------------------------------- ------------------------------------
Loans:
Residential $ 362 (114) 248 $ 590 (316) 274
Residential construction 291 (69) 222 564 (10) 554
Multifamily 205 (364) (159) 416 (752) (336)
Multifamily construction (35) 42 7 (102) 27 (75)
Commercial real estate and business 409 (472) (63) 859 (1,162) (303)
Commercial real estate construction (19) (43) (62) (23) (18) (41)
Consumer & other 422 33 455 755 (28) 727
------------------------------------- ------------------------------------
Total loans 1,635 (987) 648 3,059 (2,259) 800
------------------------------------- ------------------------------------
Total interest income 1,483 (1,378) 105 2,934 (2,911) 23
INTEREST EXPENSE
Deposits:
Money market deposit and checking $ 143 (139) 4 $ 251 (224) 27
Regular savings 3 (10) (7) 5 (19) (14)
Time deposits 118 (732) (614) 458 (1,599) (1,141)
------------------------------------- ------------------------------------
Total deposits 264 (881) (617) 714 (1,842) (1,128)
FHLB advances and other 466 (480) (14) 487 (641) (154)
------------------------------------- ------------------------------------
Total interest expense 730 (1,361) (631) 1,201 (2,483) (1,282)
Net interest income $ 753 (17) 736 $ 1,733 (428) 1,305
===================================== ====================================
13
NOTE 7.
SEGMENTS
The management reporting process measures the performance of the operating
segments based on the management structure of the Bank and is not necessarily
comparable with similar information for any other financial institution. The
operating segments are defined by product type and customer segments. We
continue to enhance our segment reporting process methodologies. These
methodologies are based on the management reporting process, which assigns
certain balance sheet and income statement items to the responsible operating
segment. New methodologies that are applied to the measurement of segment
profitability include:
A funds transfer pricing system, which allocates actual net interest
income between funds users and is based upon the funding needs and the
relative duration of the loans or securities within each segment.
The retail deposit-gathering banking center network income and expenses are
allocated to the business segments based on their asset size.
The calculation for the provision for loan losses is allocated to the
business segments.
Operating income and expenses are allocated to segments whenever they can
be directly attributed to their activities. Indirect income and overhead
costs are credited or charged to the segments whenever they are
specifically identified as providers or users of the ancillary internal
service, or are allocated based on some common denominator.
CONSUMER LENDING - Consumer lending includes residential and home equity
lending, direct consumer loans, and consumer dealer financing contracts
(Sales Finance). Residential lending offers loans to borrowers to purchase,
refinance, or build homes secured by one-to-four-unit family dwellings.
Consumer loans include lines of credit and loans for purposes other than
home ownership. In addition, this segment also sells conforming residential
loans into the secondary market. We may choose to retain or sell the right
to service the loans sold (i.e., collection of principal and interest
payments) depending upon market conditions.
COMMERCIAL LENDING - Commercial lending offers permanent and interim
construction loans for multifamily housing (over four units) and commercial
real estate properties, and loans to small- and medium-sized businesses for
financing inventory, accounts receivable, and equipment, among other
things. The underlying real estate collateral or business asset being
financed typically secures these loans.
INVESTMENT SECURITIES - The investment securities segment includes the
investment securities portfolio. Although management does not consider this
to be an operating business line, security investments are a necessary part
of liquidity management for the Bank.
These segments are managed separately because each business unit requires
different processes and different marketing strategies to reach the customer
base that purchases those products and services. All three segments derive a
majority of their revenue from interest, and management relies primarily on net
interest revenue in managing these segments. No single customer provides more
than 10% of the Bank's revenues.
14
Financial information for the Bank's segments is shown below for June 30,
2003, 2002 and 2001:
CONSUMER COMMERCIAL INVESTMENT
QUARTER ENDED JUNE 30: LENDING LENDING SECURITIES TOTALS
- ---------------------- ----------- ----------- ----------- -----------
Interest income 2003 $ 3,814,068 $ 7,425,655 $ 1,037,317 $12,277,040
2002 2,874,064 7,718,607 1,578,432 12,171,103
2001 3,202,322 8,577,888 1,662,730 13,442,940
Interest Expense 2003 1,398,265 2,541,249 900,582 4,840,096
2002 1,230,753 2,968,912 1,270,900 5,470,565
2001 1,947,901 4,666,613 1,544,580 8,159,094
Net Interest Income 2003 2,415,803 4,884,406 136,735 7,436,944
2002 1,643,311 4,749,695 307,532 6,700,538
2001 1,254,421 3,911,275 118,150 5,283,846
Provision for loan losses 2003 119,130 205,870 -- 325,000
2002 25,993 59,007 -- 85,000
2001 15,455 34,545 -- 50,000
Net interest income, after provision 2003 2,296,673 4,678,536 136,735 7,111,944
for loan losses 2002 1,617,318 4,690,688 307,532 6,615,538
2001 1,238,966 3,876,730 118,150 5,233,846
Other operating income 2003 352,381 394,703 136,105 883,189
2002 267,253 293,826 187,313 748,392
2001 472,429 222,015 174,287 868,731
Other operating expense 2003 2,019,261 2,616,509 292,779 4,928,549
2002 1,502,689 2,614,069 352,250 4,469,008
2001 1,303,342 1,992,484 204,248 3,500,074
Income before federal income taxes 2003 629,793 2,456,730 (19,939) 3,066,584
2002 381,882 2,370,445 142,595 2,894,922
2001 408,053 2,106,261 88,189 2,602,503
Federal income taxes 2003 214,130 835,288 (12,451) 1,036,967
2002 129,840 805,951 42,733 978,524
2001 138,738 716,129 25,570 880,437
Net income 2003 415,663 1,621,442 (7,488) 2,029,617
2002 252,042 1,564,494 99,862 1,916,398
2001 269,315 1,390,132 62,619 1,722,066
Total Interest Earning assets 2003 230,118,377 454,294,846 98,766,377 783,179,600
(ending period balances) 2002 160,233,123 434,946,950 107,698,115 702,878,188
2001 151,434,161 405,300,361 97,800,475 654,534,997
15
NOTE 7.
SEGMENTS (CONTINUED)
CONSUMER COMMERCIAL INVESTMENT
YEAR-TO-DATE ENDED JUNE 30: LENDING LENDING SECURITIES TOTALS
- --------------------------- ----------- ----------- ----------- -----------
Interest income 2003 $ 7,375,089 $14,818,332 $ 2,091,681 $24,285,102
2002 5,763,572 15,627,414 2,866,302 24,257,288
2001 6,085,660 17,282,370 3,684,298 27,052,328
Interest Expense 2003 2,780,110 5,211,693 1,781,107 9,772,910
2002 2,528,440 6,116,944 2,405,254 11,050,638
2001 3,775,551 9,509,999 3,323,866 16,609,416
Net Interest Income 2003 4,594,979 9,606,639 310,574 14,512,192
2002 3,235,132 9,510,470 461,048 13,206,650
2001 2,310,109 7,772,371 360,432 10,442,912
Provision for loan losses 2003 165,554 294,446 -- 460,000
2002 41,448 93,552 -- 135,000
2001 81,913 183,087 -- 265,000
Net interest income, after provision 2003 4,429,425 9,312,193 310,574 14,052,192
for loan losses 2002 3,193,684 9,416,918 461,048 13,071,650
2001 2,228,196 7,589,284 360,432 10,177,912
Noninterest income 2003 654,869 636,400 577,623 1,868,892
2002 583,442 617,712 211,181 1,412,335
2001 1,354,230 413,958 671,514 2,439,702
Noninterest expense 2003 4,000,564 5,125,697 574,521 9,700,782
2002 2,956,456 5,012,363 642,189 8,611,008
2001 2,507,400 4,125,240 531,015 7,163,655
Income before federal income taxes 2003 1,083,730 4,822,896 313,676 6,220,302
and cumulative effect of adoption of 2002 820,670 5,022,267 30,040 5,872,977
New Accounting principle 2001 1,075,026 3,878,002 500,931 5,453,959
Federal income taxes 2003 368,468 1,639,785 95,274 2,103,527
2002 279,028 1,707,571 (828) 1,985,771
2001 365,509 1,318,520 161,478 1,845,507
Income before Cumulative Effect of Adoption 2003 715,262 3,183,111 218,402 4,116,775
of New Accounting Principle 2002 541,642 3,314,696 30,868 3,887,206
2001 709,517 2,559,482 339,453 3,608,452
Cumulative effect of Adoption of New 2003 -- -- -- --
Accounting Principle, net of federal 2002 -- -- -- --
income tax 2001 (155,247) -- -- (155,247)
Net income 2003 715,262 3,183,111 218,402 4,116,775
2002 541,642 3,314,696 30,868 3,887,206
2001 554,270 2,559,482 339,453 3,453,204
Total Interest Earning assets (Averages) 2003 218,447,244 455,330,680 99,642,261 773,420,185
2002 153,146,576 424,580,671 105,565,733 683,292,980
2001 149,448,730 394,644,194 109,856,408 653,949,332
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
- -------
First Mutual Bancshares, Inc. (the "Company"), a Washington corporation, is a
holding company owning all of the equity of its wholly owned subsidiary, First
Mutual Bank. The Company is subject to regulation by the Federal Reserve Bank of
San Francisco. This discussion refers to the consolidated statements of the
Company and the Bank, and therefore the references to "Bank" in this discussion
refer to both entities.
First Mutual Bank is a Washington-chartered savings bank subject to regulation
by the State of Washington Department of Financial Institutions and the Federal
Deposit Insurance Corporation ("FDIC"). The Bank conducts business from its
headquarters in Bellevue, Washington, and has eleven full-service facilities
located in Bellevue (3), Kirkland (2), Redmond, Seattle (2), Issaquah, Monroe,
and Woodinville. The Bank also has income property loan production offices
located in Bellingham and Tacoma, Washington and a consumer loan office located
in Jacksonville, Florida. The Bank's business consists mainly of attracting
deposits from the general public as well as wholesale funding sources, and
investing those funds primarily in real estate loans, small and mid-sized
business loans, and consumer loans.
RESULTS OF OPERATIONS
- ---------------------
Net Income
----------
Net income increased 5.9%, from $1.92 million in the second quarter of 2002 to
$2.03 million in the same period of 2003. Net interest income, after provision
for loan losses, rose $496,000, and fee income increased $135,000. Partially
offsetting the growth in revenue was a rise of $460,000 in operating expenses.
Net Interest Income
-------------------
Quarters Ended Net Interest Margin
- -------------- -------------------
June 30, 2002 3.94%
September 30, 2002 3.95%
December 31, 2002 3.78%
March 31, 2003 3.84%
June 30, 2003 3.89%
17
Net interest income (after provision for loan loss) increased from $6.6 million
to $7.1 million and $13.1 million to $14.1 million, for the three-and six-month
periods ending June 30, 2003, as compared with the same periods in 2002. This
year's growth in net interest income was primarily attributable to the higher
level of earning assets in 2003 versus the prior year. Additionally, an increase
in funding liabilities in excess of asset growth and a shift in the composition
of those liabilities impacted the net interest margin and influenced net
interest income.
Our earning assets rose to $776 million as of June 30, 2003, an increase of $80
million over the level on June 30, 2002, based on solid growth in the loan
portfolio. Average earning assets increased by $85 million to $766 million,
compared to $681 million for the quarter ended June 30, 2002. Loan balances,
including loans held for sale, totaled $677 million as of the quarter end, net
of an $8.1 million reserve for loan losses, up 15% from $588 million at June 30,
2002. The overall loan growth was driven by a substantial expansion in several
different loan types. Most notably, permanent residential adjustable-rate loans
rose by $28 million, or 47%, to $86 million; home improvement loans grew $22.6
million to $50 million, an increase of 81%; and custom construction loans
increased $19 million, or 76%, to $45 million.
The loan portfolio growth was partially offset by a reduction in the level of
securities holdings, as we remain reluctant to aggressively acquire fixed-rate
investments in the current interest rate environment. Consequently, total
securities held fell from $95 million at June 30, 2002 to $88 million at June
30, 2003. Included in the $88 million were $10 million in securities purchased
but not-yet-funded. Funding for these securities is scheduled for August 2003.
Were these not-yet-funded trades excluded from the portfolio, securities
holdings would have totaled $78 million at June 30, 2003, an 18% decline from
the prior year.
Asset growth was funded by increases in deposits and wholesale borrowings
totaling nearly $89 million as compared to second quarter last year. This growth
exceeded the $80 million increase in earning assets between June 30, 2002 and
2003, as additional borrowings helped facilitate fixed asset acquisitions,
including $12 million for the First Mutual Center building (formerly the 400
Building) in the first quarter of 2003, and a 20% stock repurchase in mid 2002,
which contributed to a reduction in stockholder equity from $56 million at June
30, 2002 to $48 million as of June 30, 2003.
18
The yield on earning assets declined to 6.21% for the quarter ended June 30,
2003, compared to 6.95% for the second quarter last year, a reduction of 0.74%,
as adjustable-rate assets continued to reprice at 40-and 45-year historical low
rates. These falling asset yields typically result in compression of banks' net
interest margins, as adjustable-rate loans are systematic in their repricing,
while time deposit rates tend to lag the downward movement in major rate
indexes. As a result of the several factors detailed below, however, we were
able to substantially reduce our overall cost of funds and minimize such
effects.
As of June 30, 2002, deposits totaled $475 million, while Federal Home Loan Bank
(FHLB) and other wholesale borrowings totaled $169 million. Over the following
year, deposit growth totaled 9%, or $44 million, bringing the level of total
deposits to $519 million at June 30, 2003. Approximately 75% of this deposit
growth was in checking and money market accounts, which contributed to the
reduction in the overall cost of funds. Because we were unable to support the
asset growth with this level of new deposits, we relied more heavily upon
wholesale funds, particularly FHLB advances. We increased our wholesale
borrowings 27% from year ago levels, to $214 million, in order to accommodate
the additional assets. Consequently, wholesale borrowings accounted for a larger
percentage of total fundings as of June 30, 2003 than at the end of the second
quarter last year, with two primary implications for net interest income. First,
as rates have fallen, time deposit rates have generally lagged the market
indexes, and while deposit rates have begun to decline, they still frequently
exceed the wholesale market rates for funding. As a result, increasing the
relative level of wholesale borrowings in the current rate environment results
in a lower cost of funds than relying on additional retail time deposits for
funding. Secondly, on a forward-looking basis, as these wholesale borrowings are
tied to major market indexes, they should reprice in a systematic fashion,
similar to index-linked adjustable-rate loans. These borrowings also provide
sufficient flexibility in their terms such that, when appropriate, we can
coordinate the maturities and repricing dates of advances to coincide with the
terms of our loans. This should contribute to a more stable net interest margin
over time, relative to the margin compression and expansion that would occur
were retail time deposits used as the funding mechanism.
With deposit pricing declining in response to the change in overall mix,
combined with the additional use of wholesale funds, the cost of interest
bearing liabilities totaled 2.50% for the quarter ended June 30, 2003, down 86
basis points from 3.36% in the second quarter of 2002. As a result of the
interplay of these factors, net interest margin improved modestly from the
previous quarter, from 3.84% to 3.89%, but remained below the second quarter
2002 level of 3.94%. The net interest margin remained below the prior year's
level despite the greater reduction in liability cost than in asset yield, in
part, because of the decline in shareholder equity due to the share repurchase
last year.
Also affecting the net interest margin were interest rate floors embedded in the
commercial real estate loan portfolio. As of the June 30, 2003 quarter end,
approximately $153 million of the $402 million in loans in our commercial real
estate portfolio were subject to interest rate floors, with an average floor
rate of 7.20%. Of that $153 million, $113 million were subject to floors of
7.50% or greater. The majority of these loans are not subject to prepayment
penalties, and their balances have declined. In June 2002, $200 million of the
$383 million commercial portfolio included interest rate floors, with an average
floor rate of 7.50%, with $179 million subject to floors of 7.50% or greater.
While the level of such loans is falling on a monthly basis, with runoff of
loans with 7.50% and higher floors having accelerated to approximately 5.5% per
month in the most
19
recent quarter, the presence of such floors at interest rates well above current
market rates on a substantial percentage of the commercial loan portfolio has
helped to offset the margin compression that arises from asset yields falling
more rapidly than the cost of funds.
Other Operating Income
----------------------
Other operating income consisted of the following:
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Home Improvement Loan Sale Gain $ 26,000 $ 108,000 $ 79,000 $ 264,000
Residential Loan Sale Gain 158,000 98,000 300,000 194,000
---------- ---------- ---------- ----------
Gain on Sales of Loans: $ 184,000 $ 206,000 $ 379,000 $ 458,000
Gain on Sales of Investments $ 86,000 $ 157,000 $ 474,000 $ 157,000
Servicing Fees $ 15,000 $ 30,000 $ 29,000 $ 52,000
Fees on Deposits $ 128,000 $ 127,000 $ 251,000 $ 230,000
Other Income:
Rental Income 260,000 25,000 364,000 50,000
Loan Prepayment Fees 63,000 41,000 68,000 142,000
Visa/ATM Fee Income 23,000 14,000 39,000 28,000
Other 124,000 148,000 265,000 295,000
---------- ---------- ---------- ----------
Subtotal $ 470,000 $ 228,000 $ 736,000 $ 515,000
---------- ---------- ---------- ----------
========== ========== ========== ==========
TOTAL $ 883,000 $ 748,000 $1,869,000 $1,412,000
========== ========== ========== ==========
20
Other operating income increased to $883,000 in the second quarter of 2003 as
compared to $748,000 in the same quarter in 2002. Year-to-date other operating
income rose from $1.4 million for the six months ended June 30, 2002, to $1.9
million for the like period this year. The 18% rise for the quarter and 32% for
the first six months of the year were mainly attributable to the increase in
rental income.
GAIN ON SALES OF LOANS. Gain on sales of loans totaled $184,000 for the quarter
as compared to $206,000 for the second quarter ended June 30, 2002. Year-to-date
gain on sales of loans declined $79,000 from $458,000 at the end of June last
year to $379,000 this year. The difference between the two periods is largely
the result of a decline in home improvement loan sales partially offset by an
increase in residential loan sales.
HOME IMPROVEMENT LOAN SALES - Loan sales of home improvement loans have dropped
sharply, from $3.7 million in the second quarter of 2002, to $954,000 in the
most recent quarter. Year-to-date loan sales have fallen from $7.5 million last
year to $3 million in the first half of 2003. The gains from those sales have
decreased in a like manner. Fee income is down $82,000 on a quarter-to-quarter
comparison and $185,000 year-over-year. In contrast to declining loan sales,
loan originations year-to-date have risen 100%. Loan closings have increased by
$10.4 million on a quarter-to-quarter basis and $15.9 million on a first-half of
the year comparison. The drop in loan sales is attributable to our shift in the
second half of last year to a preference from selling these loans to retaining
them in our portfolio. As a result of that change in strategy, gains from loan
sales have fallen for the last couple of quarters and will likely be diminimus
in future periods.
Recently we initiated a re-evaluation of our policy of retaining most of the
home improvement loans in our portfolio. Although our internal discussions are
at the preliminary stage, we are considering a bulk sale of $10-$15 million
initially, with additional sales in future quarters. We have not entered into a
contract with a purchaser and since the policy change is only under initial
consideration we may elect to continue our current strategy and not sell loans,
other than on a diminutive basis. As there has been no change in the performance
level of the home improvement loan portfolio, our interest in a possible sale of
these loans is related to the utilization of capital and our sources of funds.
The home improvement loan function (Sales Finance Department) operates in 38
states and is divided geographically into the Western and Eastern Divisions.
Although the Western Division, which lends primarily in the Northwest, has
experienced increased loan closings, from $1.8 million per month in the second
quarter of 2002 to $2.5 million this year, the rapid growth has occurred in the
Eastern Division. Loan closings for that division were $1 million per month in
the second quarter of 2002 rising to $3.8 million in the like quarter of this
year. Although the trend for the Eastern Division has been dramatically upward
for the last year, we anticipate that it will level off in the second half. The
home improvement loan portfolio has grown from $26 million at June 30, 2002 to
its current balance of $48 million. This portfolio constitutes only 7% of our
total loan portfolio, but has accounted for about one third of the net loan
growth year-to-date.
RESIDENTIAL LOAN SALES - Gains from the sale of residential loans rose $60,000,
or 61%, on a quarter-to-quarter comparison. Year-to-date gains have increased by
$106,000, or 55%. Residential loan sales (excluding loans securitized for the
investment portfolio) rose $5.7 million, or 70%, in the second quarter of 2003
as compared to the same quarter last year. The year-to-date increase for 2003 is
$15 million, or 82%, over last year. On a sequential quarterly basis, loan sales
have increased from the first quarter of 2003. Sales in the second quarter were
$13.9 million as
21
compared to $8.2 million in the previous quarter. We anticipate that loan sales
in the third quarter will occur within a range of $15 - $20 million.
GAIN ON SALES OF INVESTMENTS. Gain on sales of investments totaled $86,000 for
the second quarter of 2003 as compared to $157,000 for the same quarter in 2002.
Year-to-date the gains were $474,000 this year and $157,000 for the period ended
June 30, 2002. Security sales for the second quarter of 2003 amounted to $4.8
million book value ($5.0 million par value) and $18.9 million ($23.6 million par
value) for the first six months of the year. On a comparative basis, sales of
investment securities for the second quarter and first half of 2002 totaled $11
million (book and par value), resulting in a gain of $131,000 (there were no
sales in the first quarter of 2002). During the second quarter of 2002, the Bank
also recognized a delayed payment of $26,000 on the sale of a limited liability
partnership which was sold in 2001. Gains on security investment sales are
opportunistic in nature, that is, we don't anticipate gains in our planning
activities. When mortgage rates decline and loan prepayments increase, we often
sell securities to realize the gains inherent in those securities before the
underlying loans are prepaid at par.
To date in the third quarter, we have sold $7.0 million ($15 million par value)
in securities with an expected gain of $203,000.
SERVICING FEES, NET OF AMORTIZATION. Servicing fees have decreased $15,000, or
50%, for the second quarter of 2003 as compared to the like quarter last year,
due to a decline in the servicing portfolio and the mix of service fees that we
receive on the current loans. The servicing portfolio totaled $52.3 million at
June 30, 2003, as compared to $65.5 million a year ago. Year-to-date servicing
fee income totaled $29,000 for the first six months of 2003 and $52,000 for the
like period last year.
FEE INCOME ON DEPOSITS. Fee income from deposits is essentially unchanged on a
quarter-to-quarter comparison, but up $21,000 on a year-to-date basis. Most of
that increase is related to fees on checking accounts.
OTHER INCOME. Other income totaled $470,000 compared to $228,000 in the second
quarter of last year. For the first six months of 2003, other income amounted to
$736,000 as compared to $515,000 for the like period the previous year. The rise
in other income is mainly due to the increases in rental income, loan prepayment
fees (for the quarter only), and Visa/ATM Fee income.
In March 2003, we purchased our corporate headquarters in Bellevue, First Mutual
Center (formerly the 400 Building), and as a result rental income in the second
quarter of 2003, was $260,000 as compared to $25,000 last year. Year-to-date
rental income is $364,000 this year versus $50,000 in 2002. We expect rental
income from First Mutual Center to decline from $235,000 in the second quarter
to $166,000 in the third quarter. A couple of our larger tenants are planning to
vacate their space and we anticipate that it will take us about six months to
re-lease their premises. Operating expenses for the quarter were $140,000, and
our cost of funds associated with the building was $33,000. We also avoided
about $180,000 in rental expense that we had previously paid to the former
owners. Even with the reduced rental income forecast, we anticipate a benefit
from the ownership of the building of $150,000 - $160,000 in pre-tax income in
the third quarter.
22
Loan prepayment fees contributed $63,000 for the quarter and $68,000
year-to-date. The comparable figures for 2002 were $41,000 and $142,000,
respectively. Loan prepayment fees can be erratic, as most of our loans do not
carry a prepayment penalty. Those loans that do have a prepayment penalty are
typically fixed-rate commercial real estate loans with three- to five-year
terms.
Visa/ATM fee income increased $9,000, or 60%, on a quarterly basis, and $11,000,
or 38%, on a year-to-date comparison. This income is generated from our
customers' use of other institutions ATM machines as well as their use of debit
cards that we issue through a third-party vendor. This income source has
increased over last year due to the jump in new checking accounts. The number of
business checking accounts increased by 56%, from 812 at June 30, 2002 to 1,264
as of June 30, 2003. Consumer checking accounts also increased from 4,247 in the
second quarter of 2002 to 5,045 this year, a growth in the number of accounts of
798, or 19%. Over the past year we have placed a greater emphasis on the
importance of attracting more checking accounts. We anticipate, as the number of
checking accounts continues to grow, that this source of non-interest income
will also increase.
Operating Expenses
------------------
Salaries and Employee Benefits rose $304,000, or 11.2%, on a quarter-to-quarter
comparison. On a year-to-date basis, the increase is 15.4%. This represents
significant slowing in the rate of growth in this expense category. The
equivalent figure in the first quarter of 2003 over the first quarter 2002 was
20%. A number of items contributed to our increased employee costs, including
annual salary raises of 3.67%, a 21% growth in staff, a 28% rise in commission
expense, and an increase in temporary help costs.
We have added 32 new employees in the last 12 months. The retail banking centers
added eight new employees, three of whom were assigned to the new Woodinville
location that opened for business July 1, 2003. New loan officers in the
Residential, Income Property, and Sales Finance (home improvement) departments
accounted for five of the new employees and the remaining 19 positions were
assigned to various back-office support departments.
We are expanding our retail banking center network. The Woodinville office
opened in July; the Sammamish Plateau office is scheduled for this fall; and two
additional banking centers are planned for next year. We continue to recruit new
loan officers and expect to further expand our Sales Finance Department.
Commission expense increased principally as a result of greater loan
originations. Loan officer commissions totaled $392,000 for the second quarter
of 2003, up from $308,000, or 28% for the same period last year. For the first
six months of this year, commission expense was $743,000, up from $504,000, or
47%, the previous year. Loan originations have increased from $90 million to
$110 million, a rise of 23% on a quarterly comparison and from $157 million to
$213 million, or 36%, on a year-to-date basis. The growth in production was
largely centered in the Residential and Consumer Lending Departments.
Our temporary staffing expenses have risen from $14,000 in the second quarter of
last year to $70,000 this year. The year-to-date results are similar, increasing
from $34,000 last year to $172,000 in 2003. Those costs include permanent
employees hired on a temporary basis pending a review of their capabilities, and
temporary staff employed for special projects such as the
23
reorganization of our loan servicing departments. We expect those expenses to
remain above last year's levels but to continue to decline from first and second
quarter's expenses of $102,000 and $70,000, respectively, to a range of $40,000
- - $60,000 per quarter.
Occupancy expenses are up $13,000, or 2%, on a quarter-to-quarter comparison.
Our rent costs are down $148,000, or 75%, for the second quarter as compared to
the like quarter last year, but our office building maintenance and repairs
expense and utilities expenses are both up from last year. The office building
maintenance and utilities costs increased $54,000 and $33,000, respectively.
These changes in expenses are a result of the purchase of the First Mutual
Center building in March of this year. The same is true for the year-to-date
results. For the first six months of 2003, occupancy costs rose $23,000, or 2%.
Costs associated with the repair and maintenance of our office buildings
increased $71,000, or 87%, for the first two quarters of 2003 as compared to the
same period last year. Utilities expense increased $47,000, or 126%, while rent
expense has declined $200,000, or 50%, all as a result of the purchase of the
corporate headquarters.
Other costs increased by $142,000, or 12%, from $1,200,000 in the second quarter
of 2002 to $1,342,000 this year. On a year-to-date comparison, other expenses
have risen by $268,000, or 12%, from $2.3 million to $2.6 million this year. The
growth in expense was largely attributable to marketing and office supplies but
was somewhat offset by the decline in telephone expense.
Our marketing costs have increased from $162,000 in the second quarter of 2002
to $242,000 this year. For the first two quarters of 2003, marketing expense
rose from $252,000 last year to $401,000 this year. We believe that our current
level of marketing support is adequate and we don't anticipate those expenses to
grow materially from their present levels.
Office supply expense increased $71,000, or 85%, on a quarterly comparison and
$94,000, or 60%, on a year-to-date comparison. The increase is largely a result
of the rise in the need for preprinted forms used in the consumer loan
origination process. Consumer loan originations, specifically home improvement
loan originations, have increased in excess of 100% for both the second quarter
and first six months of this year as compared to the like periods last year.
Telephone expense declined $95,000, or 110%, as compared to second quarter last
year and $119,000, or 73%, for the first six months of this year. In the second
quarter of this year, we received a $61,000 refund check from our long distance
telephone service provider for excessive charges that have occurred over the
past year. During this time we have been diligently working with this vendor to
resolve this issue.
24
Key Financial Ratios
- --------------------
The following tables provide additional comparative data regarding operating
performance:
- --------------------------------------------------------------------------------
Interest Rate Yield / Expense
Quarters Ended June 30,
2003 2002
---- ----
Interest Rate Yield:
Investment securities 4.55% 5.70%
FHLB stock 5.25% 6.00%
Loans 6.41% 7.16%
Total interest rate yield on
interest-earning assets 6.21% 6.95%
Interest Rate Expense:
Deposits 2.26% 3.03%
Interest rate swap 3.24% 0.00%
Trust preferred securities 5.53% 0.00%
Borrowings 2.87% 4.23%
Total interest rate expense on
interest-bearing liabilities 2.50% 3.36%
Interest spread 3.71% 3.59%
Net interest margin on
interest-earning assets 3.89% 3.94%
- --------------------------------------------------------------------------------
Return on average assets 1.01% 1.09%
Return on average equity 17.27% 13.99%
Average equity / average assets
5.87% 7.79%
Annualized operating expenses /
average assets 2.46% 2.54%
Efficiency Ratio 59.24% 60.00%
- --------------------------------------------------------------------------------
FINANCIAL CONDITION
- -------------------
Assets. Assets increased 9%, from $745 million at year-end 2002 to $811 million
as of June 30, 2003. The change in assets is principally the result of an
increase in the loan and the investment securities portfolios and the purchase
of the First Mutual Center building.
Loans. Loans receivable, including loans held-for-sale, rose from $635 million
at year-end 2002 to $685 million, an increase of $50 million, or 7.9%, in six
months. About 75% of that growth was from consumer and residential loans with
the remaining 25% coming from commercial real estate and business banking loans.
25
The home improvement loans (Sales Finance) portfolio, year-to-date 2003, has
grown at an annualized rate of 106%. In the second quarter of 2003, that
portfolio increased at an annualized rate of 121%.
In a change of strategy several years ago, we decreased our focus on the sale of
conforming residential loans and redirected our attention to custom construction
and non-conforming residential permanent loans. This strategic change has
provided strong loan growth in the residential portfolio at yields that exceed
our ROE targets. Annualized growth in residential loans year-to-date is 34% and
annualized growth in residential loans in the second quarter of 2003 was 36%.
The annualized growth in the custom construction loan portfolio in the second
quarter of 2003 was 60%. Custom construction loans are loans to qualified buyers
who are building a home on land they either own or purchase at the time the loan
is originated.
Business investment, as opposed to consumer activity, has been slow.
Nonetheless, our Business Banking loan portfolio grew at an annualized pace of
12% in the first half of 2003 and an annualized pace of 14% in the second
quarter of 2003.
Securities. We classify investment securities in one of the following
categories: 1) trading, 2) available-for-sale, or 3) held-to-maturity.
Securities classified as available-for-sale are reviewed regularly, and any
unrealized gains or losses are recorded in the shareholders' equity account. At
June 30, 2003, the balance of the unrealized gain, net of federal income taxes,
was $696,000, of which $1,217,000 was the gain related to the securities
available-for-sale which was partially offset by a loss of $521,000 related to
the interest rate swap purchased in connection with the $9 million trust
preferred securities issuance last year. The comparable figure for June 30, 2002
was a net unrealized gain of $794,000 ($1,200,000 gain related to the securities
available-for-sale and a loss of $406,000 from the interest rate swap).
Generally, for securities, falling interest rates will increase the amount
recorded as unrealized gain, and rising rates will decrease any unrealized
gains, as the market value of securities inversely adjusts to the change in
interest rates. Just the opposite is true for interest rate swaps.
Security investments (available-for-sale and held-to-maturity) increased $13.3
million, or 17.8%, from December 31, 2002, to the end of the second quarter of
2003. During the quarter $15.0 million (book and par value) in securities were
purchased; $4.8 million ($5.0 million par value) were sold; and $2.8 million
($2.7 million par value) matured or were called by the issuer. Ten million
dollars of the security purchases that occurred during the second quarter do not
settle until August 2003. These purchases were accounted for under "trade date
accounting," meaning that the securities were recorded on our balance sheet on
the date the trade occurred, which was in June 2003. The related net loss of
$8,250 was also included in comprehensive income, in the equity section of the
balance sheet as part of the securities available-for-sale mentioned previously.
These purchases were largely intended to replace sold securities and the early
repayment of principal. Subsequent to June 30, 2003 we have purchased $10
million in securities and sold $7 million ($15 million par value).
Liabilities. Deposits increased $21.3 million, or 4.3%, in the first six months
of 2003, totaling $519 million as compared to $497 million at year-end 2002.
This increase in deposits was used principally to fund the asset growth in the
loan portfolio.
26
FHLB advances have increased $30 million from year-end 2002 to $214 million as
of the end of the second quarter this year. As of June 30, 2003, we had the
authority to borrow up to a total of $324 million in FHLB advances, subject to
sufficient collateral to support those advances.
ASSET QUALITY
- -------------
Provision and Reserve for Loan Losses. The provision for loan losses was
$325,000 in the second quarter. Our provisions in prior quarters were $125,000,
$650,000 and $135,000 in the fourth and third quarters of 2002 and the first
quarter of 2003, respectively. The provision for loan losses reflects the amount
deemed appropriate to produce an adequate reserve for possible loan losses
inherent in the risk characteristics of the loan portfolio. In determining the
provision, we considered the amount and type of new loans added to the
portfolio, our level of non-performing loans, the amount of loans charged off,
and the economic conditions that we currently operate within.
Our portfolio loans increased $19 million in the second quarter, with most of
the growth attributable to our consumer and residential portfolios. Both of
these portfolios continue to perform at a satisfactory level, and we do not
anticipate any change in the foreseeable future.
Our non-performing assets dropped from $2.1 million at year-end 2002 to $935,000
at the end of the second quarter. The ratio of non-performing assets to total
assets declined from 0.28% to 0.12%. The comparable ratio for other banks at
March 31, 2003 is 0.86% (1). Net loans charged off for the quarter amounted to
$73,000; we charged off $21,000 for the like quarter last year and $188,000 in
all of 2002. Most of the charge-offs are related to our consumer loan portfolio,
which would indicate that we should continue to expect an increase in the level
of charge-offs if the consumer loan portfolio grows. Annualized charge-offs as a
percentage of our total loan portfolio was 0.04%, compared to 0.81% for other
financial institutions as of March 31, 2003 (1).
The local and national economies continue to be a concern to us. We believe,
however, that economic conditions have not changed appreciably since the end of
fourth quarter 2002.
The provision is determined at the end of each quarter when the makeup of the
portfolio and economic conditions affecting the portfolio can be ascertained. At
this time we believe the portfolio to be reasonably sound. Although we are
concerned about the economy, we do not currently foresee any economic conditions
developing in the next quarter that would require us to make an additional
provision directly attributable to the economy. We still expect to provide for
loan growth and any material change in the character of the portfolio.
(1) Source: First quarter 2003 FDIC Quarterly Banking Profile, All FDIC-Insured
Institutions
27
Non-Performing Assets. Our exposure to non-performing loans and repossessed
assets as of June 30, 2003 was:
Non-Performing Assets Amount
--------------------- ------
Single-Family residence, Eastern WA - No anticipated loss. $ 40,000
Two condos, Western WA - No anticipated loss. 175,000
Four business loans - We anticipate that there may be a total
loss with these loans in the third quarter. 150,000
One custom construction loan, Western WA- No anticipated loss. 478,000
Eight consumer loans - No anticipated loss. 54,000
Five consumer loans - We anticipate there may be a total loss with
these loans in third quarter. 25,000
---------
Total Non-Performing Loans 922,000
We have seven items of repossessed property,
principally spas and motorcycles. 13,000
---------
Total Non-Performing Assets $ 935,000
---------
Subsequent to quarter-end, the $478,000 custom construction loan was paid in
full. This loan represented 51% of our NPA balance at June 30, 2003.
The following table provides summary information concerning asset quality as of
June 30, 2003 and December 31, 2002:
June 30, 2003 December 31, 2002
------------- -----------------
Non-performing assets to total assets 0.12% 0.28%
Non-performing loans to total loans
outstanding 0.13% 0.33%
Allowance for loan losses to non-performing
loans 916% 374%
Allowance for loan losses to total loans 1.18% 1.22%
Net charge-offs to total loans (annualized) 0.04% 0.03%
PORTFOLIO INFORMATION
- ---------------------
The average loan size (excluding construction loans) in the commercial real
estate portfolio was $710,562 as of June 30, 2003, with an average loan-to-value
ratio of 65%. At quarter-end, none of these commercial loans were delinquent for
30 days or more, but two were past their contractual maturity date and in the
process of refinancing or being extended. Those two are current with their
payments. Small individual investors, or their limited liability companies, and
business owners typically own the properties securing these loans. The portfolio
is split between residential use (multifamily or mobile home parks) and
commercial use. At quarter-end, the breakdown was 45% residential and 55%
commercial. Adjustable-rate loans account for 90% of our total portfolio.
28
The loans in our commercial real estate portfolio are well diversified, secured
by small retail shopping centers, office buildings, warehouses, mini-storage
facilities, restaurants and gas stations, as well as other properties classified
as general commercial use.
To diversify our risk and to continue serving our customers, we sell
participation interests in some loans to other financial institutions. About 10%
of commercial real estate loan balances originated by the Bank have been sold in
this manner. We continue to service the customers loan and are paid a servicing
fee by the participant. Likewise, we occasionally buy an interest in loans
originated by other lenders. About $15 million of the portfolio (4%) has been
purchased in this manner.
DEPOSIT INFORMATION
- -------------------
The number of business checking accounts increased from 812 at June 30, 2002, to
1,264 as of June 30, 2003, a gain of 452 accounts, or 56%. Consumer checking
accounts also increased, from 4,247 in the second quarter of 2002 to 5,045 this
year, a growth in the number of accounts of 798, or 19%.
Deposit Mix
- -----------
Time Deposits 72%
Checking 6%
Money Market Accounts 20%
Statement Savings 2%
BUSINESS SEGMENTS
- -----------------
The management reporting process measures the performance of the operating
segments based on the management structure of the Bank and is not necessarily
comparable with similar information for any other financial institution. The
operating segments are defined by product type and customer segments. We
continue to enhance our segment reporting process methodologies. These
methodologies are based on the management reporting process, which assigns
certain balance sheet and income statement items to the responsible operating
segments. Methodologies that are applied to the measurement of segment
profitability include:
o A funds-transfer pricing system, which allocates actual net interest
income between funds users and is based upon the funding needs and the
relative duration of the loans or securities within each segment.
o The retail deposit-gathering banking center network income and
expenses are allocated to the business segments based on their asset
size.
o The calculation for the provision for loan losses is allocated to the
business segments.
o Operating income and expenses are allocated to segments whenever they
can be directly attributed to their activities. Indirect income and
overhead costs are credited or charged to the segments whenever they
are specifically identified as providers or users of the ancillary
internal service, or are allocated based on some common denominator.
29
The reportable segments include the following:
o Consumer Lending - Consumer lending includes residential and home
equity lending, direct consumer loans, and consumer dealer financing
contracts (Sales Finance). Residential lending offers loans to
borrowers to purchase, refinance, or build homes secured by
one-to-four-unit family dwellings. Consumer loans include lines of
credit and loans for purposes other than home ownership. In addition,
this segment also sells conforming residential loans into the
secondary market. We may choose to retain or sell the right to service
the loans sold (i.e., collection of principal and interest payments)
depending upon market conditions.
o Commercial Lending - Commercial lending offers permanent and interim
construction loans for multifamily housing (over four units) and
commercial real estate properties, and loans to small- and
medium-sized businesses for financing inventory, accounts receivable,
and equipment, among other things. The underlying real estate
collateral or business asset being financed typically secures these
loans.
o Investment Securities - The investment securities segment includes the
investment securities portfolio. Although management does not consider
this to be an operating business line, security investments are a
necessary part of liquidity management for the Bank.
These segments are managed separately because each business unit requires
different processes and different marketing strategies to reach the customer
base that purchases the products and services. All three segments derive a
majority of their revenue from interest income, and management relies primarily
on net interest revenue in managing these segments. No single customer provides
more than 10% of the Bank's revenues.
CONSUMER LENDING
- ----------------
Net income for the consumer lending segment increased from $252,000 in the
second quarter of 2002 to $416,000 in the same quarter in 2003. The increase in
net income was a result of an improvement in net interest income and
non-interest income partially offset by a rise in operating expenses.
Net interest income for the Consumer segment, net of the provision for loan
losses, totaled $2.3 million for the quarter ended June 30, 2003, an increase of
$679,000, or 42%, over the $1.6 million earned in the second quarter of 2002.
Driving this improvement in net interest income was a 44% increase in earning
assets, from $160 million at June 30, 2002 to $230 million at the end of the
second quarter of 2003. With these additional assets, interest income earned on
the portfolio rose $940,000 from the previous year's level. The Consumer
segment's asset growth since June 2002 has been centered in residential ARM
balances, custom construction ARMs, and sales finance loans. The growth in the
sales finance loans was a product of our decision to begin retaining a greater
portion of the sales finance loans that are originated outside the Northwest
within our portfolio. In addition to providing incremental earning assets, the
growth of custom construction and sales finance loans as a percentage of total
loans contributed to net interest income growth due to the higher margins earned
on these loans. Custom construction loans earn
30
a higher rate of interest because of the greater level of risk assumed as
compared to a permanent mortgage. Additionally, sales finance loans (consumer
dealer financing contracts) typically command higher interest rates.
Non-interest income increased from $267,000 in the three months ending June 30,
2002 to $352,000 in the same quarter this year. Despite the decline in gains
realized from the sale of our home improvement loans due to a change in strategy
from selling to retaining the loans in our portfolio, non-interest income has
continued to increase. The rise is principally due to the rental income that is
allocated to this segment in connection with the purchase of the First Mutual
Center building in March 2003, and which totaled $69,000 for the second quarter
this year.
Non-interest expense rose $517,000, or 34%, on a quarter-to-quarter comparison.
Compensation, loan servicing and supplies expenses were the primary contributors
to the increase. Loan officer commissions for this segment have risen from
$132,000 in the second quarter of 2002 to $322,000 for the same period this
year. Temporary office help has also increased due to the reorganization of our
loan production support departments as well as special projects. For this
segment, temporary office expense totaled $13,000 during the second quarter of
2002, rising to $29,000 for the like quarter this year. Because of the increase
in loan originations in the Sales Finance Department, both loan servicing costs
allocated to this segment and supplies expense contributed to the rise in
non-interest expense. Loan servicing costs for the second quarter of 2003
totaled $210,000, up from $80,000 last year, and supplies expense increased
$43,000, on a quarter-to-quarter comparison.
The year-to-date results are similar to the quarterly results. Net income
increased $174,000, from $542,000 in the six months ending June 30, 2002, to
$715,000 in 2003.
Net interest income, after provision for loan losses, for the first half of 2003
jumped $1.2 million, or 39% over the same period last year. As was noted
earlier, the principal driver of this improvement was the growth in earning
assets over the prior year, which resulted in additional interest income of $1.6
million, or 28% over the same period last year.
Non-interest income increased $71,000, from $583,000 for the first six months of
2002 to $655,000 in 2003. Like the quarterly results, the rental fee income
generated from the First Mutual Center building contributed $93,000 this year.
Non-interest expense, year-to-date 2003, rose to $4.0 million as compared to
$3.0 million last year. The $1.0 million increase was principally caused by the
growth in compensation, supplies and servicing support. Loan officer commissions
have increased $331,000, or 126%, for the first six months of this year compared
to the same period last year. Year-to-date supplies expense rose $59,000, or
283%, due to the increased number of forms needed to accommodate the jump in
originations in the home improvement loan area. The growth in loan volume was
accompanied by a need for more support to service those loans. Loan servicing
expense allocated to this segment has grown $301,000, or 225%, over the same
period last year.
COMMERCIAL LENDING
- ------------------
Net income for the commercial segment increased $57,000, or 4%, from $1,564,000
in the second quarter of 2002 to $1,621,000 in 2003. Net interest income and
operating expenses were flat for the quarter while non-interest income rose
$101,000.
31
The Commercial Lending segment's net interest income was relatively unchanged
compared to the second quarter of last year, increasing only $135,000, or 2.8%,
to $4.9 million compared to $4.7 million for the quarter ended June 30, 2002.
The $428,000 (14.4%) reduction in interest expense more than offset a $293,000
(3.8%) decline in interest income. Funding costs bank-wide have declined
compared to the second quarter of last year due to our increased reliance on
Federal Home Loan Bank advances, which have recently proven less expensive than
comparable maturity retail time deposits (see Results of Operations, Net
Interest Income section for more information). Unlike the Consumer Lending
segment, no extraordinary asset growth was observed in the overall Commercial
Lending segment, though various smaller divisions within the segment achieved
some success in building incremental assets over the last year. The relatively
muted growth of the Commercial Lending segment relative to the Consumer Lending
results was in line with expectations, given the soft local economy of the last
year and the resulting reduction in the number of quality commercial banking
relationship opportunities in the market.
Other operating income rose $101,000, or 34%, as compared to second quarter last
year. This increase was mainly due to the allocation of rental income generated
from the newly acquired First Mutual Center (FMC), which totaled $139,000 for
the Commercial Segment for the second quarter of 2003.
Non-interest expense was also fairly level for the quarter increasing only
$2,000, or 0.1%.
The year-to-date results for the Commercial Segment varied somewhat to the
trends experienced in the second quarter results. Net income declined $132,000,
or 4%, from $3.31 million to $3.18 million while net interest and non-interest
income and expense were up slightly.
Net interest income increased from $9.5 million to $9.6 million, or 1%, for the
first two quarters of 2003 compared to the same period last year. Again, the
reduction in interest expense had a greater impact on net interest income than
the decline in interest income, with interest expense declining $905,000, or
14.8%, on a year-to-date comparison over last year. As noted above, the
reduction in interest expense was a product of our utilization of FHLB advances
over the past year. Over the subject timeframe, these advances have frequently
been available at lower costs than retail time deposits, and have, consequently,
helped to reduce our overall funding costs.
Both non-interest income and expense rose modestly. Non-interest income
increased $19,000, or 3.0%, and operating expenses increased $113,000, or 2.3%,
for the first two quarters of 2003 as compared to the first half of last year.
INVESTMENT SECURITIES
- ---------------------
Net income decreased sharply for the Investment Securities segment, from
$100,000 in the second quarter of 2002 to a loss of $7,000 in 2003. This segment
was affected by a decrease in both net interest income and non-interest income.
Net interest income earned on the securities portfolio fell from $308,000 in the
second quarter of 2002 to $137,000 this year based on a $541,000 (34%) decline
in interest income versus a
32
$370,000 (29%) reduction in interest expense. This implied a net interest margin
of 0.55% for this segment in the second quarter of 2003, down from 1.14% for the
second quarter last year. The decline in margin was principally due to turnover
within the portfolio, with sales of $47 million and purchases of $72 million in
securities having occurred since June 30, 2002. As rates fell and loan
prepayments increased, we sold some of our higher yielding securities and
realize the gains inherent in them before the underlying loans prepaid at par.
The securities sold were then replaced with lower yielding instruments issued in
the current rate environment. Consequently, the margin on this segment has been
negatively affected.
Non-interest income declined from $187,000 in the second quarter of 2002 to
$136,000 in the same period this year. During the second quarter of 2003, gains
from the sale of $5 million of securities totaled $86,000 as compared to sales
of $11 million and gains totaling $131,000 for the like period last year.
Operating expenses fell by $59,000, to $293,000, in the second quarter this
year. This decline is largely due to the manner in which the banking center
operating expenses are allocated to each segment. The amount of banking center
non-interest expense allocated to each segment is based on the balance of its
earning assets. At June 30, 2003, the earning assets balance for the investment
securities segment totaled $99 million, down from $108 million a year ago.
Net income for the first half of 2003 increased $188,000. The positive impact
came mainly from non-interest income.
Net interest income on the investment portfolio declined from $461,000 for the
first six months of 2002 to $311,000 for the like period this year, as interest
income decreased $775,000 (27.0%) while interest expense dropped $624,000
(25.9%). Again, the reduction in the portfolio's net interest income was a
result of our decision to sell some higher yielding securities, realizing gains
before the underlying loans prepaid at par, then replacing those securities with
lower yielding instruments issued in the current rate environment.
Non-interest income jumped $366,000, or 174% on a year-to-date comparison. Much
of this increase was due to the gains realized from the sale of securities and
the allocation of rental income associated with the purchase of the First Mutual
Center building. The first half of 2003 contributed $474,000 to income from the
gains realized from the sale of investments as compared to $157,000 last year.
In addition, rental income from First Mutual Center allocated to the Investment
segment totaled $61,000 this year.
Like the second quarter results, non-interest expense for the first half of 2003
declined by $68,000, or 11%, due to the drop in earning assets and the related
allocated banking center expenses. As earning assets of a segment decline in
relation to the other two segments, the amount of banking center expenses
declines. Banking center expenses allocated to the Investment segment totaled
$578,000 for the first six months of 2002, dropping to $468,000 this year.
LIQUIDITY AND CAPITAL RESERVES
- ------------------------------
Net cash, as reported in the Statement of Cash Flows, decreased by $7.7 million,
or 52%, in the first six months of 2003. Our cash flows included the principal
repayments of loans and
33
securities, net FHLB advances, deposit growth, and trust preferred securities.
Our outflows were largely composed of loan originations, security purchases and
the acquisition of our corporate headquarters.
In the first six months of the year, loan principal repayments totaled $98.7
million. In addition, contractual repayments and redemptions on securities
amounted to $26.7 million. Proceeds from FHLB borrowings totaled $29.8 million,
net of repayment of advances, and deposits increased by $21.3 million. We also
received $4.0 million in funds from a trust preferred security offering.
We used these cash inflows to fund loan originations, which amounted to $168
million during the first half of 2003, and to purchase securities totaling $58.8
million. We also purchased $10 million in securities that will settle in August
2003. These purchases are not included in the cash flow numbers noted above but
are included in the "change in accounts payable and other liabilities" line item
on the Statement of Cash Flows. Since the purchases of securities took place in
the second quarter but do not settle until the third quarter, we have applied
"trade date accounting" and included the securities on our balance sheet. As a
result, we have increased our payable account to reflect the outflow of cash
that will occur in the third quarter upon settlement of the security purchases.
In addition, in March of this year we also purchased the First Mutual Center
building which required a cash outlay of $12 million.
Our long-term liquidity objective is to fund 70% of our growth through consumer
deposits. Whenever that source is inadequate to meet asset growth requirements,
FHLB advances are normally accessed. The current ratio of FHLB advances to
assets is 26.3%, which is below our credit limit of 40% of assets. Other sources
of liquidity include the sale of loans into the secondary market and net income
after the payment of dividends. The Company is also approved for a $5 million
line of credit of which we have drawn down $500,000.
The FDIC's statutory framework for capital requirements establishes five
categories of capital strength, ranging from a high of well capitalized to a low
of critically under-capitalized. An institution's category depends upon its
capital level in relation to relevant capital measures, including a risk-based
capital measure, a leverage capital measure, and certain other factors. At June
30, 2003, we exceeded the capital levels required to meet the definition of a
well-capitalized institution:
For Capital Well Capitalized
Actual Adequacy Minimum Minimum Ratio
Total capital (to risk-weighted assets):
First Mutual Bancshares, Inc. 11.38% 8.00% 10.00%
First Mutual Bank 11.12 8.00 10.00
Tier I capital (to risk-weighted assets):
First Mutual Bancshares, Inc. 9.97 4.00 6.00
First Mutual Bank 9.86 4.00 6.00
Tier I capital (to average assets):
First Mutual Bancshares, Inc. 7.33 4.00 5.00
First Mutual Bank 7.38 4.00 5.00
34
BANKING CENTER EXPANSION
- ------------------------
The Woodinville banking center is now complete and open for business. The grand
opening celebration occured the first week of August 2003. We are also committed
to lease a banking center on the Issaquah Plateau within the city of Sammamish.
This banking center location is expected to be operational by the end of 2003.
Another banking center location has been identified in the Canyon Park area of
Bothell. This office will be a three story, 12,000 square foot building which
will include our banking center. We believe that the opening date for this
office will likely occur in year 2005. The anticipated additional capital cost
for these three banking centers is $5.5 million.
We continue to seek opportunities to expand our banking center franchise in our
primary market area east of Lake Washington, from Renton to the Bothell/Kenmore
area. This expansion will continue to have an impact on expenses as banking
centers are opened. Income from banking center operations often requires a
number of years before it equals operating expenses.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is defined as the sensitivity of income and capital from changes in
interest rates, foreign currency exchange rates, commodity prices, and other
relevant market rates or prices. The primary market risk to which we are exposed
is interest rate risk. Our profitability is dependent to a large extent on our
net interest income, which is the difference between the interest received from
interest-earning assets and the interest expense incurred on interest-bearing
liabilities. Our objectives in asset/liability management are to utilize capital
effectively, provide adequate liquidity, and enhance net interest income,
without taking unreasonable risks subjecting the Bank unduly to interest rate
fluctuations.
Assumptions regarding interest rate risk are inherent in all financial
institutions. Interest rate risk is the risk to earnings or capital resulting
from adverse movements in interest rates. Interest rate sensitivity is the
relationship between market interest rates and net interest income due to the
repricing characteristics of assets and liabilities. We monitor interest rate
sensitivity by examining our one-year-and-longer gap positions on a regular
basis. Gap analysis and an income simulation model are used to manage interest
rate risk.
35
Gap Model
The Gap Report, which indicates the difference between assets maturing,
repricing, or prepaying within a period and total liabilities maturing or
repricing within the same period, is a traditional view of interest rate
sensitivity. Our twelve month interest rate sensitivity gap, expressed as a
percentage of assets, fell from 16.5% at December 2002 to 9.9% at June 30, 2003.
These results indicate that we remain asset sensitive, with more assets than
liabilities maturing or repricing within the next year, though significantly
less than at year end 2002. The gap report has implied an asset sensitive
position for a number of quarters, dating back to September 2001. The change in
the gap was driven by the mix of the additions to each side of the balance sheet
during the first six months of 2003, as well as the overall balance sheet
growth.
One-Year Interest Rate Sensitivity Gap
(in thousands)
June 30, 2003 December 31, 2002
One-Year Repricing / Maturing Assets $ 615,415 $ 600,577
One-Year Repricing / Maturing Liabilities 535,250 477,932
------------ ------------
One-Year Gap $ 80,165 $ 122,645
------------ ------------
Total Assets $ 811,187 $ 745,295
------------ ------------
One-Year Interest Rate Gap as a
Percentage of Assets 9.9% 16.5%
Asset growth of $66 million, or 8.8%, in the first six months of 2003 was
concentrated in assets that would not be subject to maturity or repricing in the
following twelve months. These assets included $12 million in new fixed assets,
in the form of the First Mutual Center building in Bellevue, purchased during
the first quarter of 2003, and $16 million of growth in fixed-rate consumer
loans. Additionally, the gap model reflected a $7 million net increase in the
investment portfolio, including overnight investment balances, compared to
December 2002. Included in the securities portfolio, as modeled for June 2003,
were $10 million in fixed-rate 15-year mortgage pass-through securities
scheduled to settle in the third quarter. Overall, those assets not subject to
maturity or repricing within twelve months rose $51 million over the six month
period, while assets expected to mature or reprice within that time horizon
increased $15 million from their level as of December 2002. Much of the latter
$15 million was centered in new residential adjustable-rate mortgages (ARMs),
including single- and multi-family classes, as well as commercial real estate
ARM balances. The interest rates on these loans typically adjust annually, with
the new loans generally tied to either the one-year London Interbank Offering
Rate (LIBOR) or FHLB rate.
By comparison, liabilities subject to maturity or repricing in the next twelve
months rose $57 million over the six-month period. This increase was driven by a
combination of growth in money market accounts subject to repricing over the
time horizon, a shift in volumes from longer term time deposits to six-month
certificates, and the rolling forward of long-term, fixed-rate FHLB advances.
Money market account balances rose approximately $15 million in the first
36
half of the year. Balances of six-month time deposits increased from $11 million
at December 31, 2002 to $45 million at June 30, 2003 in response to promotional
rates offered in the second quarter. As total time deposits increased only $2
million from December 2002 levels, this growth in six-month certificates also
represented a shift from other accounts, in this case longer term time deposits,
rather than incremental money. Nonetheless, the shift from longer term to
shorter term certificates contributed to the reduction in gap. Additionally, the
volume of our FHLB borrowings scheduled to mature within twelve months increased
by $30 million as long-term, fixed-rate advances continued to roll forward.
Overall, this combination of a greater increase for liabilities
maturing/repricing in the next twelve months than assets repricing in the same
period resulted in a net $42 million reduction in our dollar gap, reducing the
numerator of the gap-as-a-percentage-of-assets ratio. This gap ratio was further
reduced by the overall growth in the balance sheet during the period, which
increased the denominator of the gap ratio from $745 million to $811 million.
The combined effect of these two factors resulted in the reduction in the
one-year gap ratio from 16.5% to 9.9% of total assets.
Net Interest Income (NII) Simulation
RATE RAMP ESTIMATES
Net Interest Income and Net Market Value
June 30, 2003 December 31, 2002
Percentage Percentage
Change Change
- -----------------------------------------------------------------------------
Change in Interest Net Economic Net Economic
Rates Interest Value of Interest Value of
(in basis points) Income Equity Income Equity
- --------------------- ------------ ------------ ------------ ------------
+200 (0.65%) (17.6%) 1.94% (10.6%)
+100 n/a (9.7%) n/a (3.9%)
-100 (0.45%) 6.6% (1.44%) 0.2%
-200 n/a n/a n/a n/a
The above table refers to changes for the twelve-month periods beginning June
30, 2003 and December 31, 2002, respectively.
The June 30, 2003 results of our simulation model indicate that our net interest
income would be expected to decline in both rising and falling interest rate
environments, contracting 0.65% as rates increase by 200 basis points, and 0.45%
with a 100 basis point drop in rates. The magnitudes of these changes, less than
1.00% from the baseline in either scenario, suggest that little sensitivity
exists with regard to changes in interest rates, with relatively consistent net
interest income in the base case projection and the rising and falling rate ramp
scenarios. In both scenarios, differences in velocity (the timeframe and/or
frequency of repricing within the twelve-month period), index rates, optionality
such as rate floors, and prepayment characteristics result in a change in the
NII profile different than might be expected based on our asset sensitivity.
37
In the base case, NII rose to $30 million for the twelve-month estimate ending
June 30, 2004, an increase from $26 million projected at December 2002 for the
twelve months ending December 31, 2003. The improvement was driven by the above
mentioned asset growth of $66 million, including approximately $50 million in
loans and $7 million in investments, as well as modest improvement in the
projected net interest spread. While the June simulation model's yield on assets
fell 38 basis points compared to the December 2002 projections, the model's
liability costs declined by 43 basis points relative to December.
Net interest income sensitivity is also affected by the rate floors in our loan
portfolio. If the fully indexed rate on one of these loans reaches a level below
the level of the rate floor, the loan effectively becomes a fixed-rate
instrument, and may not reprice upwards in a rising rate scenario. Consequently,
in the rising rate scenario, the revenue generated on a significant percentage
of the loan portfolio remains constant as funding costs rise.
Incorporated into the model assumptions is the observed tendency for loan and
investment prepayments to accelerate in falling interest rate scenarios and slow
when interest rates rise. In all interest rate scenarios of the income
simulation, the balance sheet is assumed to remain stable, with no balance sheet
growth or contraction regardless of interest rate movements. Therefore, implicit
in this assumption are additional assumptions for higher new securities
purchases and loan production volumes at lower interest rate levels to offset
accelerated prepayments, and conversely, reduced securities purchases and loan
production when rates increase and prepayments slow.
Economic Value of Equity (EVE) Simulation
The EVE analysis goes beyond simulating earnings for a specified time period to
estimating the present value of all financial instruments in our portfolio, and
then analyzing how the economic value of the portfolio would be affected by
various alternative interest rate scenarios. The portfolio's economic value is
calculated by generating principal and interest cash flows for the entire life
of all assets and liabilities, then discounting these cash flows back to their
present values. The assumed discount rate used for each projected cash flow is
the yield currently available from alternative instruments of comparable risk
and duration.
In the simulated 200 basis point upward shift of the yield curve, EVE is
expected to decline. As interest rates rise, the discount rates used to
calculate the present values of assets and liabilities will increase, causing
the present values of both assets and liabilities to fall, with more prominent
effects on longer-term, fixed-rate instruments. Additionally, as noted above,
when interest rates rise, the cash flows on our assets will typically
decelerate, as borrowers become less likely to refinance or prepay their loans.
As a result, less cash is available to reinvest at the higher market rates. As
these effects were more pronounced for our assets, which would have declined in
value by an estimated 3.8% versus an approximately 2.6% decline in the value of
liabilities, the economic value of equity is negatively impacted in this
scenario, declining 18%. The additional long-term fixed-rate assets mentioned
above that were added to the simulation in the first half of 2003, including
those ARMs with rate floors that effectively became fixed-rate instruments,
increased the balance sheet sensitivity to an increase in interest rates.
The opposite occurs when rates decline, as the discount rates used to calculate
the present values of assets and liabilities will decrease, causing the present
values of both assets and liabilities to
38
rise. In keeping consistent with the explanation above, the EVE would be
expected to be positively impacted in this scenario. Counteracting this effect,
however, cash flows on our assets will tend to accelerate in a falling rate
scenario, as borrowers refinance their existing loans at lower interest rates.
We must then reinvest these cash flows at the lower market rates. These results
illustrate an effect referred to as negative convexity. Taking this negative
convexity into account, the simulation results indicated that the impact to EVE
was less pronounced in the falling rate scenario. In this case, the economic
values of both assets and liabilities at June 30, 2003 were positively impacted
when rates were assumed to fall by 100 basis points, assets by 1.7% and
liabilities by 1.3%. This resulted in a positive impact to the economic value of
equity of nearly 7%. Again, however, the additional long-term, fixed-rate assets
incorporated in the simulation after the first half of 2003 increased the
balance sheet sensitivity to the change in interest rates.
The sensitivity analysis does not represent a forecast. There are numerous
assumptions inherent in the simulation model as well as in the gap report. Some
of these assumptions include the nature and timing of interest rate levels,
including the shape of the yield curve, prepayments on loans and securities,
deposit decay rates, pricing decisions on loans and deposits, and
reinvestment/replacement of asset and liability cash flows. Customer preferences
and competitor and economic influences are impossible to predict, therefore, we
cannot make any assurances as to the outcomes of these analyses.
Securities
ITEM 3
------
The following table sets forth certain information regarding carrying values and
percentage of total carrying values of the Bank's consolidated portfolio of
securities classified as available-for-sale and held-to-maturity (in thousands).
-------------------------------------------------------------------------
At June 30,
-------------------------------------------------------------------------
2003 2002
----------------------------------- -----------------------------------
AVAILABLE-FOR-SALE: Carrying Value Percent of Total Carrying Value Percent of Total
- ------------------- ----------------------------------- -----------------------------------
US agency securities $ 11,346 15% $ -- 0%
Mortgage backed securities:
Freddie Mac 17,944 24% 5,172 7%
Fannie Mae (includes FNMA stock) 46,887 61% 68,191 93%
----------------------------------- -----------------------------------
Total mortgage-backed securities 64,831 85% 73,363 100%
----------------------------------- -----------------------------------
------------------------------------------------------------------------------------ -----------------------------------
TOTAL SECURITIES AVAILABLE-FOR-SALE $ 76,177 100% $ 73,363 100%
------------------------------------------------------------------------------------ -----------------------------------
-------------------------------------------------------------------------
At June 30,
-------------------------------------------------------------------------
2003 2002
----------------------------------- -----------------------------------
HELD-TO-MATURITY: Carrying Value Percent of Total Carrying Value Percent of Total
- ----------------- ----------------------------------- -----------------------------------
Municipal Bonds $ 1,330 11% $ 1,343 6%
Mortgage backed securities:
Freddie Mac 624 5% 1,027 5%
Fannie Mae 9,870 84% 19,430 89%
----------------------------------- -----------------------------------
Total mortgage-backed securities 10,494 89% 20,457 94%
CMO's 10 0% 44 0%
----------------------------------- -----------------------------------
------------------------------------------------------------------------------------ -----------------------------------
TOTAL SECURITIES HELD-TO-MATURITY $ 11,834 100% $ 21,844 100%
------------------------------------------------------------------------------------ -----------------------------------
----------------------------------------------------------------- ----------------
ESTIMATED MARKET VALUE $ 12,213 $ 22,535
----------------------------------------------------------------- ----------------
39
ITEM 3A
-------
The following table shows the maturity or period to repricing of the Bank's
consolidated portfolio of securities available-for-sale and held-to-maturity
(dollars in thousands):
------------------------------------------------------------------------------
Available-for-sale at June 30, 2003
------------------------------------------------------------------------------
One Year or Less Over One to Three Years Over Three to Five Years
------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
------------------------------------------------------------------------------
AVAILABLE-FOR-SALE:
- -------------------
US agency securities $ - 0.00% $ - 0.00% $ - 0.00%
Mortgage backed securities:
Freddie Mac 359 4.46% - 0.00% - 0.00%
Fannie Mae 654 4.37% - 0.00% - 0.00%
------------------------------------------------------------------------------
Total mortgage-backed securities 1,013 4.40% - 0.00% - 0.00%
------------------------------------------------------------------------------
Total securities available-for-sale --
Carrying Value $1,013 4.40% $ - 0.00% $ - 0.00%
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Total securities available-for-sale --
Amortized Cost $ 982 4.40% $ - 0.00% $ - 0.00%
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Held-to-Maturity at June 30, 2003
------------------------------------------------------------------------------
One Year or Less Over One to Three Years Over Three to Five Years
------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
------------------------------------------------------------------------------
HELD-TO-MATURITY:
- -----------------
US agency securities $ - 0.00% $ - 0.00% $ - 0.00%
Municipal Bonds - 0.00% - 0.00% - 0.00%
Mortgage backed securities:
Freddie Mac 624 3.61% - 0.00% - 0.00%
Fannie Mae 3,015 5.06% 4,143 5.64% - 0.00%
------------------------------------------------------------------------------
Total mortgage-backed securities 3,639 4.81% 4,143 5.64% - 0.00%
CMO's - 0.00% - 0.00% - 0.00%
------------------------------------------------------------------------------
Total securities held-to-maturity --
Carrying Value $3,639 4.81% $4,143 5.64% $ - 0.00%
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Total securities held-to-maturity --
Fair Market Value $3,782 4.82% $4,275 5.64% $ - 0.00%
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Available-for-sale at June 30, 2003
------------------------------------------------------------------------------
Over Five to Ten Years Over Ten to Twenty Years Over Twenty Years
------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
------------------------------------------------------------------------------
AVAILABLE-FOR-SALE:
- -------------------
US agency securities $ 6,340 4.08% $ 5,006 4.00% $ - 0.00%
Mortgage backed securities:
Freddie Mac 7,499 4.15% 10,086 4.50% - 0.00%
Fannie Mae 12,486 5.38% 33,747 4.45% - 0.00%
------------------------------------------------------------------------------
Total mortgage-backed securities 19,985 4.92% 43,833 4.46% - 0.00%
------------------------------------------------------------------------------
Total securities available-for-sale --
Carrying Value $26,325 4.72% $48,839 4.42% $ - 0.00%
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Total securities available-for-sale --
Amortized Cost $25,390 4.71% $47,962 4.41% $ - 0.00%
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Held-to-Maturity at June 30, 2003
------------------------------------------------------------------------------
Over Five to Ten Years Over Ten to Twenty Years Over Twenty Years
------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
------------------------------------------------------------------------------
HELD-TO-MATURITY:
- -----------------
US agency securities $ - 0.00% $ - 0.00% $ - 0.00%
Municipal Bonds - 0.00% 220 5.38% 1,110 6.16%
Mortgage backed securities:
Freddie Mac - 0.00% - 0.00% - 0.00%
Fannie Mae 1,638 5.50% 1,074 4.50% - 0.00%
------------------------------------------------------------------------------
Total mortgage-backed securities 1,638 5.50% 1,074 4.50% - 0.00%
CMO's - 0.00% 10 6.50% - 0.00%
------------------------------------------------------------------------------
Total securities held-to-maturity --
Carrying Value $1,638 5.50% $1,304 4.66% $1,110 6.16%
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Total securities held-to-maturity --
Fair Market Value $1,724 5.50% $1,331 4.66% $1,101 6.17%
------------------------------------------------------------------------------
------------------------
Total
------------------------
Weighted
Carrying Average
Value Yield
------------------------
AVAILABLE-FOR-SALE:
- -------------------
US agency securities $ 11,346 4.05%
Mortgage backed securities:
Freddie Mac 17,944 4.35%
Fannie Mae 46,887 4.70%
------------------------
Total mortgage-backed securities 64,831 4.60%
------------------------
Total securities available-for-sale --
Carrying Value 76,177 4.52%
------------------------
------------------------
Total securities available-for-sale --
Amortized Cost 74,334 4.51%
------------------------
------------------------
Total
------------------------
Weighted
Carrying Average
Value Yield
------------------------
HELD-TO-MATURITY:
- -----------------
US agency securities $ - 0.00%
Municipal Bonds 1,330 6.03%
Mortgage backed securities:
Freddie Mac 624 3.61%
Fannie Mae 9,870 5.31%
------------------------
Total mortgage-backed securities 10,494 5.21%
CMO's 10 6.50%
------------------------
Total securities held-to-maturity --
Carrying Value 11,834 5.31%
------------------------
------------------------
Total securities held-to-maturity --
Fair Market Value 12,213 5.31%
------------------------
40
ITEM 4. CONTROLS AND PROCEDURES
The Bank's Chief Executive Officer and Chief Financial Officer and other
appropriate officers have evaluated the Bank's disclosure controls and
procedures designed to ensure that information required to be disclosed in our
filings under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the Securities
Exchange Commission's rules and forms, and have concluded that, although there
are inherent limitations in all control systems and although we apply certain
reasonable cost/benefit considerations to the design of our disclosure controls
and procedures, as of June 30, 2003, those disclosure controls and procedures
are effective.
There have been no changes in the Bank's internal controls or in other factors
known to us that could significantly affect these controls subsequent to their
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
While we believe that our existing disclosure controls and procedures have been
effective to accomplish these objectives, we intend to continue to examine,
refine, and formalize our disclosure controls and procedures and to monitor
ongoing developments in this area.
41
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
At June 30, 2003, we were not engaged in any litigation, which in the opinion of
management, after consultation with our legal counsel, would be material to the
Bank.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
We issued a 10% stock dividend on July 2, 2003.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
The Annual Meeting of Shareholders of First Mutual Bancshares, Inc. was held on
April 24, 2003. The results of votes on the matter presented at the Meeting are
as follows:
The following individuals were elected as directors for the term noted:
Votes Votes
Director Votes For Withheld Abstained Term
- -------- --------- -------- --------- ----
James J. Doud, Jr. 3,986,184 56,691 230,686 3 years
Richard S. Sprague 4,010,078 32,797 230,686 3 years
Robert C. Wallace 3,980,390 62,485 230,686 3 years
The terms of the Class III and I directors expire at the Annual Meeting of
Shareholders for 2004 and 2005, respectively.
CLASS III DIRECTORS, term expires in 2004
- -----------------------------------------
Mary Case Dunnam
George W. Rowley, Jr.
John R. Valaas
CLASS I DIRECTORS, term expires in 2005
- ---------------------------------------
Janine Florence
F. Kemper Freeman, Jr.
Victor E. Parker
Robert J. Herbold
The First Mutual Bancshares, Inc. Board of Directors also announced at the
annual meeting that Robert J. Herbold had been elected by the Board to fill a
newly created position for a tenth director, Class I, for the Boards of
Directors of both the Company and the Bank. Mr. Herbold has accepted the
position effective May 1, 2003.
After nearly seven years at Microsoft as COO, Herbold retired in February 2001
and is currently working part time for Microsoft as Executive Vice President
assisting in the government,
42
industry, and customer areas. He is a highly sought-after public speaker and is
Managing Director of The Herbold Group LLC, a consulting company focused on
improving profitability. Prior to joining Microsoft, Herbold spent 26 years at
Procter & Gamble (NYSE: PG), culminating in five years as Senior Vice President,
Advertising and Information Services. He has a Bachelor of Science degree from
the University of Cincinnati, and both a Master's Degree in Mathematics and a
Ph.D. in Computer Science from Case Western Reserve University. Herbold serves
on the Board of Directors of Weyerhaeuser Corporation (NYSE: WY), Agilent
Technologies (NYSE: A), and Cintas Corporation (NYSE:CTAS). He was also recently
appointed by President Bush to the President's Council of Advisors on Science
and Technology.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(3.1) Articles of Incorporation, Incorporated by reference to the Current
Report on Form 8-K filed with the SEC on September 21, 2000.
(3.2) Amendment to Articles of Incorporation effective May 16, 2001.
(3.3) Bylaws (as amended and restated), Incorporated by reference from the
Form 10-K filed with the SEC on March 31, 2003.
(11) Statement regarding computation of per share earnings. Reference is
made to the Company's Consolidated Statements of Income attached hereto
as part of Item I Financial Statements, which are incorporated herein
by reference.
(31.1) Certification by President and Chief Executive Officer Pursuant to Rule
13a-14(a) and 15d-14(a) as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
(31.2) Certification by Executive Vice President and Principal Financial
Officer Pursuant to Rule 13a-14(a) and 15d-14(a) as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(32.1) Certification by President and Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(32.2) Certification by Executive Vice President and Principal Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
43
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 12, 2003 FIRST MUTUAL BANCSHARES, INC.
/s/ John R. Valaas
---------------------------------------
John R. Valaas
President and Chief Executive Officer
/s/ Roger A. Mandery
---------------------------------------
Roger A. Mandery
Executive Vice President
(Principal Financial Officer)
44