U.S. SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
Form 10-K
[X] Annual Report Pursuant to section 13 or 15(d) of the
Securities and Exchange act of 1934
For the fiscal year ended December 31, 2001
Commission file number
0-23881
COWLITZ BANCORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-152984
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
927 Commerce Ave., Longview, Washington 98632
(Address of principal executive offices) (Zip Code)
(360) 423-9800
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act
Common Stock, No par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form of this form 10-K. |X|
The aggregate market value of Registrant's Common Stock held by non-affiliates
of the Registrant on February 28, 2002, was $14,633,200.
Common Stock, no par value on February 28, 2002: 3,692,560
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and the Part
of the Form 10-K into which the document is incorporated: Portions of the
registrants proxy statement dated April 19, 2002, for the 2002 annual meeting of
shareholders is incorporated by reference in Part III hereof.
1
TABLE OF CONTENTS
Page
Part I
Item 1. Business............................................................. 3
Item 2. Properties........................................................... 11
Item 3. Legal Proceedings.................................................... 11
Item 4. Submission of matters to vote of securities holders.................. 12
Part II
Item 5. Market price and dividends on registrant's common equity and related
stockholder matters................................................. 12
Item 6. Selected Financial Data.............................................. 13
Item 7. Management's discussion and analysis of financial condition and
results of operations............................................... 14
Item 8. Financial statements and supplementary data.......................... 33
Item 9. Changes in and disagreements with accountants on accounting and
financial disclosure................................................ 71
Part III
Item 10. Director and executive officers of the registrant................... 71
Item 11. Executive compensation.............................................. 71
Item 12. Security ownership of certain beneficial owners and management...... 71
Item 13. Certain relationships and related transactions...................... 71
Part IV
Item 14. Exhibits, financial statement schedules, and reports on form 8-K.... 71
Note: This document has not been reviewed, or confirmed for accuracy or
relevancy by the Federal Deposit Insurance Corporation.
2
Part I
Item 1. Business
Introduction
Cowlitz Bancorporation (the "Company") was organized in 1991 under
Washington law to become the holding company for Cowlitz Bank (also the
"Company" or the "Bank"), a Washington state chartered bank that commenced
operations in 1978. The principal executive offices of the Company are located
in Longview, Washington.
The Company offers or makes available a broad range of financial
services to its customers, primarily small and medium-sized businesses,
professionals and retail customers. The Bank's commercial and personal banking
services include commercial and real estate lending, consumer lending, mortgage
origination and trust services. From 1998 through 2001, the Company also
provided asset-based lending services to companies throughout the Western United
States through its subsidiary, Business Finance Corporation ("BFC"), which was
sold in the first quarter of 2002.
The Company's goal is to expand its position as a community-based
provider of financial services. The Company's growth strategy is based on
providing both exceptional personal service and a wide range of financial
services to its customers. This is done by emphasizing personal service and
developing strong community ties, offering financial products and services that
are focused on small and medium-sized businesses, and increasing business volume
in existing markets. In accordance with this strategy, during 1999 and 2000, the
Company acquired or opened several mortgage and escrow branches. Bay Mortgage
and Bay Escrow of Bellevue, Washington, Bay Mortgage and Bay Escrow of Seattle,
Washington, Bay Mortgage of Silverdale, Washington, and Bay Mortgage of
Vancouver, Washington (collectively "Bay Mortgage") have joined together with
the Longview mortgage operations as a division of Cowlitz Bank. Bay Mortgage
serves customers throughout the greater Bellevue/Seattle market area, Cowlitz
County, and through the Vancouver office, the greater Portland, Oregon market.
The Bank also expanded its commercial banking activities in the Seattle/Bellevue
area with the September 1999 opening of a branch in Bellevue, Washington, which
is doing business as Bay Bank. In mid-2000, the Company acquired Northern Bank
of Commerce ("NBOC") of Portland, Oregon, which operates as a branch of the Bank
doing business as Northern Bank of Commerce. NBOC operates its main office in
downtown Portland, and has 12 limited service branches located within retirement
centers in the Portland metropolitan area.
Products and Services
The Company offers a broad portfolio of products and services tailored
to meet the financial needs of targeted customers in its market areas. It
believes this portfolio is generally competitive with the products and services
of its competitors, including major regional and national banks. These products
and services include:
Deposit Products. The Company provides a range of deposit products for
customers, including non-interest-bearing checking accounts, interest-bearing
checking and savings accounts, money market accounts and certificates of
deposit. These accounts generally earn interest at rates established by
management based on competitive market factors and management's desire to
increase certain types or maturities of deposit liabilities. During times of
asset growth, or as liquidity needs arise, the Company will utilize broker
deposits as a source of funding. The Company strives to establish customer
relations to attract core deposits in non-interest-bearing transactional
accounts and thus to reduce its cost of funds.
Loan Products. The Company offers a broad range of loan products to its
retail and business customers. The Company maintains loan underwriting standards
with written loan policies, conservative individual and branch limits and
reviews by the loan committee. Further, in the case of particularly large loan
commitments or loan participations, loans are reviewed by the Company's board of
directors. Underwriting standards are designed to achieve a high-quality loan
portfolio, compliance with lending regulations and the desired mix of loan
maturities and industry concentrations. Management seeks to minimize credit
losses by closely monitoring the financial condition of its borrowers and the
value of collateral.
Commercial Loans. Commercial lending is the primary focus of the
Company's lending activities, and a significant portion of its loan portfolio
consists of commercial loans. The Company offers specialized loans for its
business and commercial customers. These include equipment and inventory
financing, operating lines of credit and accounts receivable financing. For
regulatory purposes, a substantial portion of the Company's commercial loans are
designated as real estate loans, as the loans are secured by mortgages and trust
deeds on real property, although the
3
loans may be made for purposes of financing commercial activities, such as
accounts receivable, equipment purchases and inventory or other working capital
needs. Lending decisions are based on careful evaluation of the financial
strength, management and credit history of the borrower, and the quality of the
collateral securing the loan. Commercial loans secured by real property are
generally limited to 80% of the value of collateral. In some cases, the Company
may require personal guarantees and secondary sources of repayment. In competing
with major regional and national banks, the Company is limited by its single
borrower lending limits imposed by law. See "Risk Factors" for further
discussion.
Real Estate Loans. Real estate loans are available for construction,
purchasing and refinancing residential owner-occupied and rental properties.
Borrowers can choose from a variety of fixed and adjustable rate options and
terms. Real estate loans reflected in the loan portfolio also include loans made
to commercial customers that are secured by real property.
The Company provides customers access to long-term conventional real
estate loans primarily through Bay Mortgage. Bay Mortgage specializes in all
facets of residential lending from single family homes to small multi-plexes,
including FHA and VA loans, construction and bridge loans.
Consumer Loans. The Company provides loans to individual borrowers for a
variety of purposes, including secured and unsecured personal loans, home
equity, personal lines of credit and motor vehicle loans. Consumer loans can
carry significantly greater risks than other loan products, even if secured, if
the collateral consists of rapidly depreciating assets such as automobiles and
equipment. Repossessed collateral securing a defaulted consumer loan may not
provide an adequate source of repayment of the loan. Consumer loan collections
are dependent on borrowers' continuing financial stability, and are sensitive to
job loss, illness and other personal factors. The Company attempts to manage the
risks inherent in consumer lending by following strict credit guidelines and
conservative underwriting practices. The Company also offers Visa and MasterCard
credit cards to its customers.
Other Banking Products and Services. In support of its focus on
personalized service, the Company offers additional products and services for
the convenience of its customers. These services include a retirement home
branch network, a debit card program, automated teller machines at five branch
locations and an automated telephone banking service with 24-hour access to
accounts that also allows customers to speak directly with a customer service
representative during normal banking hours. The Company does not currently
charge fees for any of these services, with the exception of ATM transactions
through other financial institutions. The Company provides drive-through
facilities at four of its branches, including the Triangle Mall branch in
Longview, which is exclusively a drive-up facility. In 2001, the Company
implemented a website, internet banking, and cash management system to enhance
the services available to both business and private account holders. Account
inquires, wire transfers, bill pay services, and general management of account
portfolios are services now available on line.
Trust Services. Cowlitz Bank is the only bank in Cowlitz County to offer
complete trust services. The trust department, located in the offices of the
main branch in Longview, WA, focuses on the needs of the customer, providing
trust services to individuals, partnerships, corporations and institutions and
acting as fiduciary of living trusts, estates and conservatorships. The trust
department also acts as trustee under wills, trusts, and other plans. The
Company believes these services add to the value of Cowlitz Bank as a community
bank by providing local access to services that have been previously sought from
out of the area institutions.
Internet Banking. Continuing the Company's desire to provide valuable
financial services to its customers, a website and Internet banking and cash
management system was introduced in the second quarter of 2001. Through this
upgrade of our technology capabilities, the Company is able to provide our
clients secure access, information, and services while enhancing the advantages
they presently enjoy. Business clients can avail themselves of a comprehensive
cash management program which allows them to easily and securely move money
between accounts, wire funds, receive funds, pay bills, and generally manage
their financial resources. Retail customers now have the ability to access
account information, pay bills, and manage their accounts from the comfort of
their homes. By offering on-line banking services, the Company hopes to
strengthen existing customer relationships and to attract new customers in the
future.
Other Financial Services. The Company believes that providing its
customers a full range of financial services is an important element of its
strategy to attract and retain customers. To this end, the Company has entered
into a lease arrangement with Raymond James Financial Services, Inc., a
securities broker. This organization maintains an office on the main floor of
the Cowlitz Financial Center, where the main office of the Company is located,
and has access to space in the Company's other branches to allow representatives
of Raymond James to meet with clients. The Company has no financial interest in
Raymond James Financial Services, Inc.
4
Acquisitions
On July 1, 2000, the Company acquired Northern Bank of Commerce (NBOC),
of Portland, Oregon for approximately $3.8 million in cash, including
acquisition costs. The Company has accounted for the transaction using the
purchase method of accounting. Under the terms of the agreement, the
shareholders of NBOC received $2.48 in cash for each share of NBOC stock.
The following table summarizes the acquisition of NBOC. As part of the
transaction, goodwill of $946,000 was recognized.
(dollars in thousands)
Fair value of assets acquired, including goodwill $ 47,192
Less liabilities assumed 43,357
--------
Cash paid for acquisition (3,835)
Less cash acquired 7,023
--------
Net cash received in acquisition $ 3,188
========
The following unaudited pro forma financial information for the Company
gives effect to the acquisitions of NBOC, as if it had occurred on January 1,
2000. These pro forma results have been prepared for comparative purposes only
and do not purport to be indicative of the results of operations which actually
would have resulted had the acquisition occurred on the dates indicated, or
which may result in the future for the combined companies under the ownership
and management of the Company. The pro forma results include certain
adjustments, such as additional expense, as a result of goodwill amortization.
Year Ended December 31,
--------------------------
2001 2000
----------- -----------
(Pro forma)
(dollars in thousands, except per share amounts)
Net interest income $ 13,845 $ 14,326
=========== ===========
Net loss $ (1,450) $ (279)
=========== ===========
Net interest income per share $ 3.72 $ 4.49
=========== ===========
Losses per share $ (.39) $ (0.20)
=========== ===========
During 1999, the Company acquired Bay Mortgage, of Bellevue, Washington,
Bay Mortgage of Seattle, and Bay Escrow of Seattle, Washington. The acquisitions
were accounted for using the purchase method of accounting and included cash
payments of $1.8 million and issuance of common stock with a value of $977,000.
During 2001, additional payments totaling $772,000 were recorded in connection
with the acquisitions, pursuant to a performance earn-out agreement. The
additional acquisition costs have been recorded as goodwill associated with the
purchase.
Market areas
The Company's primary market areas from which it accepts deposits and
makes loans are Cowlitz County, in southwest Washington, King County,
Washington, the Portland metropolitan area in Oregon, and the surrounding
counties in Washington and northwest Oregon. As a community bank, Cowlitz Bank
has certain competitive advantages due to its local focus, but is also more
closely tied to the local economy than many of its competitors, which serve a
number of geographic markets. Bay Mortgage is concentrated in western Washington
and northwest Oregon.
Employees
As of December 31, 2001, the Company employed a total of 199 full-time
equivalent employees. None of the employees are subject to a collective
bargaining agreement and the Company considers its relationships with its
employees to be favorable.
5
Risk Factors
Exposure to Regional Economy
Historically, the Company has been extremely dependent upon and
sensitive to the economy of Cowlitz County, which is firmly dependent on three
industries, pulp and paper, wood products, and aluminum. These industries have
been in a state of decline for the past 15 years, and Cowlitz County felt the
impact particularly in 2001. The impact of the permanent loss of at least 800
manufacturing jobs, double-digit unemployment, two contentious strikes, and
increasing power rates, are factors that have severely dampened the local
economy. The Company's expansion into the Seattle, Washington, and Portland,
Oregon markets has greatly reduced its dependence on the economy of Cowlitz
County. However, the Company is still dependent on the economy in the Pacific
Northwest region, which has experienced similar challenges in unemployment,
increased utility costs, and general economic weakness in the Portland and
Seattle metro areas.
Credit Risk
The Company, like other lenders, is subject to credit risk, which is the
risk of losing principal and interest due to customers' failure to repay loans
in accordance with their terms. Although the Company has established lending
criteria and most loans are secured by collateral, the downturn in the economy
and the real estate market or a rapid increase in interest rates could have a
negative effect on collateral values and borrowers' ability to repay. The
Company's targeted customers are small to medium-size businesses, professionals
and retail customers that may have limited capital resources to repay loans
during an economic downturn.
Interest Rate Risk
The Company's earnings are largely derived from net interest income,
which is interest income and fees earned on loans and investment income, less
interest expense paid on deposits and other borrowings. Interest rates are
highly sensitive to many factors which are beyond the control of the Company's
management, including general economic conditions, and the policies of various
governmental and regulatory authorities. As interest rates change, net interest
income is affected. With fixed rate assets (such as fixed rate loans) and
liabilities (such as certificates of deposit), the effect on net interest income
depends on the maturity of the asset and liability. Although the Company strives
to minimize interest rate risk through asset/liability management policies, from
time to time maturities are not balanced. Further, an unanticipated rapid
decrease or increase in interest rates could have an adverse effect on the
spreads between the interest rates earned on assets and the rates of interest
paid on liabilities and, therefore, on the level of net interest income.
Regulation
The Company is subject to extensive regulations under federal and state
laws. These laws and regulations are intended primarily to protect depositors
and the deposit insurance fund, rather than shareholders. Cowlitz Bank is a
state chartered commercial bank which is not a member of the Federal Reserve
System and is subject to primary regulation and supervision by the Director of
Financial Institutions of the State of Washington (the "Washington Director")
and by the Federal Deposit Insurance Corporation (the "FDIC"), which also
insures bank deposits. The Company is also subject to regulation and supervision
by the Board of Governors of the Federal Reserve System (the "Federal Reserve").
Federal and state regulations place banks at a competitive disadvantage compared
to less regulated competitors such as finance companies, credit unions, mortgage
banking companies and leasing companies. Although the Company has been able to
compete effectively in its market area in the past, there can be no assurance
that it will be able to continue to do so. Further, future changes in federal
and state banking regulations could adversely affect the Company's operating
results and ability to continue to compete effectively. See "Regulation and
Supervision."
Competition
Competition in the banking industry has intensified for deposits and
loans over the last few years. Competition from outside the traditional banking
system from credit unions, investment banking firms, insurance companies and
related industries offering bank-like products has increased the competition for
deposits and loans.
The banking industry in the market areas in which the Company operates
is generally characterized by well established, large banks. There are also
thrift institutions, other community banks and credit unions within the market
areas that are very competitive in deposit and consumer lending areas.
6
The major competition for commercial and mortgage banking services in
Cowlitz County comes from U.S. Bank, Key Bank, Bank of America and Columbia
State Bank. None of these competitors are headquartered in Cowlitz County and
many have relocated key functions (e.g., loan decisions) into regional offices
outside of the area. However, within the past two years, competition has
increased with the start-up of two community banks in Longview. In the Company's
greater Seattle market area, the main sources of competition are U.S. Bank, Key
Bank, Bank of America, Wells Fargo, Washington Mutual, Evergreen State Bank,
Western Bank, Columbia Bank, First Horizon, and other community banks and
mortgage companies located in the greater Seattle/Bellevue area. For NBOC in the
Portland area, competition comes from banks such as Washington Mutual, US Bank,
Bank of America, Wells Fargo, Centennial Bank, Bank of the Northwest, and Key
Bank. The retirement center branches compete with smaller, in-store branches
(such as Washington Mutual branches in Fred Meyer stores) and credit unions.
Offices of the major financial institutions have competitive advantages
over the Company in that they have high public visibility, may offer a wider
variety of products and are able to maintain advertising and marketing
activities on a much larger scale than the Company can economically maintain.
Since single borrower lending limits imposed by law are dependent on the capital
of the institution, the branches of larger institutions with substantial capital
bases also have an advantage with respect to loan applications that are in
excess of the Company's legal lending limits.
In competing for deposits, the Company is subject to certain limitations
not applicable to non-bank financial institution competitors. Previous laws
limiting the deposit instruments and lending activities of savings and loan
associations have been substantially eliminated, thus increasing the competition
from these institutions. In the Company's Cowlitz County market area, the main
source of competition for deposits is the relatively large number of credit
unions.
With significant competition in the Company's market areas, there can be
no assurance that the Company can continue to attract significant loan and
deposit customers. The inability to attract these customers could have an
adverse effect on the Company's financial position and results of operations.
Regulation and Supervision
The Company and the Bank are subject to extensive regulation under
federal and state laws. The laws, together with the regulations promulgated
under them, significantly affect respective activities of the Company and the
Bank and the competitive environment in which they operate. The laws and
regulations are primarily intended to protect depositors and the deposit
insurance fund, rather than shareholders.
The description herein of the laws and regulations applicable to the
Company and the Bank, does not purport to be a complete description of the laws
and regulations mentioned herein or of all such laws and regulations. Any change
in applicable laws or regulations may have a material effect on the business and
prospects of the Company and the Bank. The operations of the Company and the
Bank may be affected by legislative and regulatory changes as well as by changes
in the policies of various regulatory authorities. The Company cannot accurately
predict the nature or the extent of the effects that such changes may have in
the future on its business and earnings.
Bank Holding Company Regulation. The Company is a bank holding company
within the meaning of the Bank Holding Company Act of 1956, as amended ("BHCA")
and, as such, is subject to the regulations of the Federal Reserve. Bank holding
companies are required to file periodic reports with, and are subject to
periodic examination by, the Federal Reserve. The Federal Reserve has issued
regulations under the BHCA requiring a bank holding company to serve as a source
of financial and managerial strength to its subsidiary banks. It is the policy
of the Federal Reserve that, pursuant to this requirement, a bank holding
company should stand ready to use its resources to provide adequate capital
funds to its subsidiary banks during periods of financial stress or adversity.
Additionally, under the Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA"), a bank holding company is required to guarantee the compliance
of any insured depository institution subsidiary that may become
"undercapitalized" (as defined in the statute) with the terms of any capital
restoration plan filed by such subsidiary with its appropriate federal banking
agency up to the lesser of (i) an amount equal to 5% of the institution's total
assets at the time the institution became undercapitalized, or (ii) the amount
that is necessary (or would have been necessary) to bring the institution into
compliance with all applicable capital standards as of the time the institution
fails to comply with such capital restoration plan. Under the BHCA, the Federal
Reserve has the authority to require a bank holding company to terminate any
activity or relinquish control of a non-bank subsidiary (other than a non-bank
subsidiary of a bank) upon the Federal Reserve's determination that such
activity or control constitutes a serious risk to the financial soundness and
stability of any bank subsidiary of the bank holding company.
7
Capital Adequacy Guidelines for Bank Holding Companies. The Federal
Reserve is the federal regulatory and examining authority for bank holding
companies. The Federal Reserve has adopted capital adequacy guidelines for bank
holding companies. These guidelines are similar to, although not identical with,
the guidelines applicable to banks. See "Bank Capital Requirements." At December
31, 2001, the Company's Tier 1 leverage capital ratio was 6.51%, its Tier 1
risk-based capital ratio was 8.84% and its total risk-based capital ratio was
10.10%.
Bank Regulation. The Bank is organized under the laws of the State of
Washington and is subject to the supervision of the Department of Financial
Institutions ("DFI"), whose examiners conduct periodic examinations of state
banks. Cowlitz Bank is not a member of the Federal Reserve System, so its
principal federal regulator is the FDIC, which also conducts periodic
examinations of the Bank. The Bank's deposits are insured, to the maximum extent
permitted by law, by the Bank Insurance Fund ("BIF") administered by the FDIC
and are subject to the Federal Deposit Insurance Corporation's ("FDIC") rules
and regulations respecting the insurance of deposits. See "Deposit Insurance."
Both federal and state laws extensively regulate various aspects of the
banking business such as reserve requirements, truth-in-lending and
truth-in-savings disclosures, equal credit opportunity, fair credit reporting,
trading in securities and other aspects of banking operations. Current federal
law also requires banks, among other things, to make deposited funds available
within specified time periods.
Insured state-chartered banks are generally prohibited under FDICIA from
engaging as principal in activities that are not permitted for national banks,
unless (i) the FDIC determines that the activity would pose no significant risk
to the appropriate deposit insurance fund, and (ii) the bank is, and continues
to be, in compliance with all applicable capital standards. The Company does not
believe that these restrictions will have a material adverse effect on its
current operations.
Bank Capital Requirements. The FDIC has adopted risk-based capital ratio
guidelines to which the Bank is subject. The guidelines establish a systematic
analytical framework that makes regulatory capital requirements more sensitive
to differences in risk profiles among banking organizations. Risk-based capital
ratios are determined by allocating assets and specified off-balance sheet
commitments to four risk weighted categories, with higher levels of capital
being required for the categories perceived as representing greater risk.
These guidelines divide a bank's capital into two tiers. Tier 1 includes
common equity, certain non-cumulative perpetual preferred stock (excluding
auction rate issues) and minority interest in equity accounts of consolidated
subsidiaries, less goodwill and certain other intangible assets (except mortgage
servicing rights and purchased credit card relationships, subject to certain
limitations). Supplementary (Tier 2) capital includes, among other items,
cumulative perpetual and long-term, limited-life, preferred stock, mandatory
convertible securities, certain hybrid capital instruments, term-subordinated
debt and the allowance for loan and lease losses, subject to certain
limitations, less required deductions. Banks are required to maintain a total
risk-based capital ratio of 8%, of which 4% must be Tier 1 capital. The FDIC
may, however, set higher capital requirements when a bank's particular
circumstances warrant. Banks experiencing or anticipating significant growth are
expected to maintain capital ratios, including tangible capital positions, well
above the minimum levels.
In addition, the FDIC has established guidelines prescribing a minimum
Tier 1 leverage ratio (Tier 1 capital to adjusted total assets as specified in
the guidelines). These guidelines provide for a minimum Tier 1 leverage ratio of
3% for banks that meet certain specified criteria, including that they have the
highest regulatory rating and are not experiencing or anticipating significant
growth. All other banks are required to maintain a Tier 1 leverage ratio of not
less than 4%.
Certain regulatory capital ratios for the Company and the Bank at
December 31, 2001 are set forth below:
Company Bank
------- ----
Total-Risk Based Capital to Risk-Weighted Assets ......... 10.10% 10.72%
Tier 1 Capital to Risk-Weighted Assets ................... 8.84% 9.46%
Tier 1 Leverage Ratio .................................... 6.51% 6.99%
Dividends. The principal source of the Company's cash revenues is
dividends from Cowlitz Bank. Under Washington law, Cowlitz Bank may not pay
dividends in an amount greater than its retained earnings as determined by
generally accepted accounting principles. In addition, the DFI has the authority
to require a state-chartered bank to suspend payment of dividends. The FDIC has
the authority to prohibit a bank from paying dividends if, in its opinion,
8
the payment of dividends would constitute an unsafe or unsound practice in light
of the financial condition of the bank or if it would cause a bank to become
undercapitalized.
Lending Limits. Under Washington law, the total loans and extensions of
credit by a Washington-chartered bank to a borrower outstanding at one time may
not exceed 20% of such bank's capital and surplus. However, this limitation does
not apply to loans or extensions of credit which are fully secured by readily
marketable collateral having market value of at least 115% of the amount of the
loan or the extension of credit at all times.
Branches and Affiliates. Establishment of bank branches is subject to
approval of the DFI and FDIC and geographic limits established by state laws.
Washington's branch banking law permits a bank having its principal place of
business in the State of Washington to establish branch offices in any county in
Washington without geographic restrictions. A bank may also merge with any
national or state chartered bank located anywhere in the State of Washington
without geographic restrictions.
Under Oregon law, an out-of-state bank or bank holding company may merge
with or acquire an Oregon state chartered bank or bank holding company if the
Oregon bank, or in the case of a bank holding company, the subsidiary bank, has
been in existence for a minimum of three years, and the law of the state in
which the acquiring bank in located permits such merger. Branches may not be
acquired or opened separately, but once an out-of-state bank has acquired
branches in Oregon, either through a merger with or acquisition of substantially
all of the assets of an Oregon bank, the bank may open additional branches.
The Bank is subject to Sections 22 (h), 23A and 23B of the Federal
Reserve Act, which restrict financial transactions between banks and affiliated
companies. The statute limits credit transactions between a bank and its
executive officers and its affiliates, prescribes terms and conditions for bank
affiliate transactions deemed to be consistent with safe and sound banking
practices, and restricts the types of collateral security permitted in
connection with a bank's extension of credit to an affiliate.
FDICIA. FDICIA requires, among other things, federal bank regulatory
authorities to take "prompt corrective action" with respect to banks which do
not meet minimum capital requirements. For these purposes, FDICIA establishes
five capital tiers: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized.
The FDIC has adopted regulations to implement the prompt corrective
action provisions of FDICIA. Among other things, the regulations define the
relevant capital measures for the five capital categories. An institution is
deemed to be "well capitalized" if it has a total, risk-based capital ratio of
10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a
leverage ratio of 5% or greater, and is not subject to a regulatory order,
agreement or directive to meet and maintain a specific capital level for any
capital measure. At the end of the 1st and 2nd quarters of 2001, Cowlitz Bank
had dropped below well capitalized in the total risk-based capital category. By
the 3rd quarter of 2001, the Bank had increased capital to a level that brought
the ratios back into the well-capitalized category. Cowlitz Bank currently
exceeds all of these ratios.
FDICIA further directs that each federal banking agency prescribe
standards for depository institutions and depository institution holding
companies relating to internal controls, information systems, internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth, management compensation, a maximum ratio of classified assets to
capital, minimum earnings sufficient to absorb losses, a minimum ratio of market
value to book value of publicly traded shares and such other standards as the
agency deems appropriate.
The Federal Reserve Board classifies a bank holding company as "well
capitalized" if it has a total, risk-based capital ratio of 10% or greater and a
Tier 1 risk-based capital ratio of 6% or greater. At the end of the 2nd quarter
of 2001, the Company had dropped below well capitalized in the total risk-based
capital category. By the 3rd quarter of 2001, the Company had increased capital
to a level that brought the ratios back into the well capitalized category. The
Company currently exceeds all of these ratios.
Deposit Insurance. The Bank's deposits are insured up to $100,000 per
insured account by the Bank Insurance Fund (BIF). As an institution whose
deposits are insured by BIF, Cowlitz Bank is required to pay deposit insurance
premiums to BIF.
FDICIA required the FDIC to issue regulations establishing a system for
setting deposit insurance premiums based upon the risks a particular bank or
savings association poses to the deposit insurance funds. This system bases an
institution's risk category partly upon whether the institution is well
capitalized, adequately capitalized or less than
9
adequately capitalized. Each insured depository institution is also assigned to
one of three "supervisory" categories based on reviews by regulators,
statistical analysis of financial statements and other relevant information. An
institution's assessment rate depends upon the capital category and supervisory
category to which it is assigned. Annual assessment rates currently range from
zero per $100 of domestic deposits for the highest rated institution to $0.27
per $100 of domestic deposits for an institution in the lowest category. In the
first and second quarters of 2001, the Bank paid an assessment rate of $0.10 per
$100 of domestic deposits, which decreased to $0.03 for the third and fourth
quarters of 2001. Beginning in the first quarter of 2002, the assessment rate
for Cowlitz Bank will increase to $.17 per $100 of domestic deposits. Under
legislation enacted in 1996 to recapitalize the Savings Association Insurance
Fund, the FDIC is authorized to collect assessments against insured deposits to
be paid to the Financing Corporation ("FICO") to service FICO debt incurred in
the 1980's. The current FICO assessment rate for BIF insured deposits is $1.82
cents per $100 of deposits per year. Any increase in deposit insurance of FICO
assessments could have an adverse effect on Cowlitz Bank's earnings.
Gramm-Leach-Bliley Act. On November 12, 1999, the Gramm-Leach-Bliley Act
(the "GLB Act") was signed into law, which significantly reforms various aspects
of the financial services business. Among the provisions in the GLB Act are
those which:
o establish a new framework under which bank holding companies and banks
can own securities firms, insurance companies and other financial
companies; and
o provide consumers with new protections regarding the transfer and use of
their non-public personal information by financial institutions; and
o change the Federal Home Loan Bank ("FHLB") system in numerous ways
including a change in the manner of calculating the Resolution Funding
Corporation obligations payable by the FHLB and a broadening of the
purposes for which FHLB advances may be used.
Community Reinvestment Act. The Community Reinvestment Act ("CRA")
requires financial institutions regulated by the federal financial supervisory
agencies to ascertain and help meet the credit needs of their delineated
communities, including low-income and moderate-income neighborhoods within those
communities, while maintaining safe and sound banking practices. The regulatory
agency assigns one of four possible ratings to an institution's CRA performance
and is required to make public an institution's rating and written evaluation.
The four possible ratings are "outstanding," satisfactory," "needs to improve"
and "substantial non-compliance."
Under new regulations that apply to CRA performance ratings after
July 1, 1997, many factors play a role in assessing a financial institution's
CRA performance. The institution's regulator must consider its financial
capacity and size, legal impediments, local economic conditions and demographics
and the competitive environment in which it operates. The evaluation does not
rely on absolute standards and financial institutions are not required to
perform specific activities or to provide specific amounts or types of credit.
The Company's most recent rating under CRA is "outstanding." This rating
reflects the Company's commitment to meeting the credit needs of the communities
it serves. No assurance can be given, however, that the Company will be able to
maintain an "outstanding" rating under the new regulations in the future.
Additional Matters. In addition to the matters discussed above, the
Company and Cowlitz Bank are subject to additional regulation of their
activities, including a variety of consumer protection regulations affecting
their lending, deposit and collection activities and regulations affecting
secondary mortgage market activities.
The earnings of financial institutions, including the Company and
Cowlitz Bank, are also affected by general economic conditions and prevailing
interest rates, both domestic and foreign and by the monetary and fiscal
policies of the U.S. Government and its various agencies, particularly the
Federal Reserve.
Additional legislation and administrative actions affecting the banking
industry may be considered by the United States Congress, the Washington
Legislature and various regulatory agencies, including those referred to above.
It cannot be predicted with certainty whether such legislation or administrative
action will be enacted or the extent to which the banking industry in general or
the Company and Cowlitz Bank in particular would be affected.
10
Cowlitz Bancorporation/CFC Bay Bank Northern Bank of Commerce
- -------------------------- -------- -------------------------
927 Commerce Ave. 10500 NE 8th Street, STE 1750 1001 SW 5th Ave., Suite 250
Longview, Wa 98632 Bellevue, Wa 98004 Portland, Or 97204
(360) 423-9800 (425) 452-1543 (360) 308-0959
Cowlitz Bank Northern Bank of Commerce
Kalama Branch Bay Mortgage & Escrow - Bellevue Retirement Centers:
- ------------- -------------------------------- -------------------
195 N. 1st St. 10500 NE 8th Street, STE 1550 Gresham Manor (Gresham, Or)
Kalama, Wa 98625 Bellevue, Wa 98004 Springridge at Charbonneau (Wilsonville,Or)
(360) 673-2226 (425) 635-5151 Creekside Retirement (Beaverton,Or)
Carman Oaks (Lake Oswego, Or)
Cowlitz Bank Beaverton Lodge (Beaverton, Or)
Triangle Mall Branch Bay Mortgage & Escrow - Seattle Parkrose Chateau (Portland, Or)
- -------------------- ------------------------------- Royal Marc (Milwaukie, Or)
800 Triangle Mall 2825 Eastlake E., STE 300 Vinyard Place (Milwaukie, Or)
Longview, Wa 98632 Seattle, Wa 98102 Somerset Lodge (Gladstone, Or)
(360) 577-6067 (206) 324-7777 Edgewood Downs (Beaverton, Or)
Summerfield Estates (Tigard, Or)
Cowlitz Bank Rock Creek (Hillsboro, Or)
Kelso Branch Bay Mortgage - Vancouver
- ------------ ------------------------
1000 South 13th 201 NE Park Plaza Drive STE 296
Kelso, Wa 98626 Vancouver, Wa 98684
(360) 423-7800 (360) 944-9431
Cowlitz Bank
Castle Rock Branch Bay Mortgage - Silverdale
- ------------------ -------------------------
202 Cowlitz St. W. 9230 Bay Shore Dr. NW STE 201
Castle Rock, Wa 98611 Silverdale, Wa 98383
(360) 274-6685 (360) 308-0959
Item 3. Legal Proceedings
The Company from time to time enters into routine litigation resulting
from the collection of secured and unsecured indebtedness as part of its
business of providing financial services. In some cases, such litigation will
involve counterclaims or other claims against the Company. Such proceedings
against financial institutions sometimes also involve claims for punitive
damages in addition to other specific relief. Currently, the Company is not a
party to any litigation other than in the ordinary course of business, except as
noted below. In the opinion of management, the ultimate outcome of all pending
legal proceedings will not individually or in the aggregate have a material
adverse effect on the financial condition or the results of operations of the
Company.
On March 8, 2002, a lawsuit was filed against the Company by
Independent Financial Network, Inc. ("IFN"), and one of IFN's shareholders,
Scott Rerucha. The Company acquired certain assets and operations from IFN in
1999 pursuant to a purchase agreement with IFN, Mr. Rerucha, and other
individuals. The operations acquired from IFN are the core of the Company's Bay
Mortgage division. The complaint alleges, among other things, that the Company
has materially breached its obligations under the purchase agreement and
requests that the plaintiffs be awarded unspecified damages and that Mr. Rerucha
be relieved of his non-competition obligations under the purchase agreement. The
Company does not believe it has breached its obligations under the IFN agreement
and intends to vigorously defend this action.
11
Item 4. Submission of matters to a vote of securities holders
None.
PART II
Item 5. Market price and dividends on the registrant's common equity and related
stockholder matters
Effective March 12, 1998, Cowlitz Bancorporation stock began trading on
the Nasdaq National Market under the symbol "CWLZ". Prior to that date, there
had been no organized market for the Common Stock, and to the knowledge of the
Company, no third party bid and ask information was available.
2001 2000
------------------------------ ------------------------------
Market Price Market Price
--------------- Cash Dividend --------------- Cash Dividend
High Low Declared High Low Declared
---- --- -------- ---- --- --------
1st Quarter $6.00 $4.56 $.018 $5.25 $4.50 $.018
2nd Quarter $5.50 $5.00 $.018 $5.75 $4.44 $.018
3rd Quarter $6.00 $5.01 $.000 $4.88 $4.28 $.018
4th Quarter $6.00 $5.25 $.000 $5.13 $4.38 $.018
During 2001, the Company paid three dividends, including the $.018
declared in the fourth quarter of 2000, which was paid in the first quarter of
2001. The Company suspended dividends indefinitely after the 2nd quarter of
2001. Based upon the number of record holders, there were 3,692,560 shares of
common stock outstanding, held by 329 shareholders of record, which excludes
shares held in street name, as of February 28, 2002.
12
Item 6. Selected Financial Data
As of and for the Year Ended December 31,
------------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -----------
(dollars in thousands except per share data)
Income Statement Data
Interest income ............................... $27,227 $22,848 $15,276 $15,838 $15,032
Interest expense .............................. 13,382 9,940 5,248 5,973 6,889
----------- ----------- ----------- ----------- -----------
Net interest income ........................... 13,845 12,908 10,028 9,865 8,143
Provision for loan loss ....................... 5,262 1,155 1,349 509 375
----------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan loss ............................ 8,583 11,753 8,679 9,356 7,768
Non-interest income ........................... 9,591 5,219 3,191 978 749
Non-interest expense .......................... 19,474 15,492 10,794 6,927 5,284
----------- ----------- ----------- ----------- -----------
Income (loss) before provision for income taxes (1,300) 1,480 1,076 3,407 3,233
Provision for income taxes .................... 150 611 420 1,181 1,109
----------- ----------- ----------- ----------- -----------
Net income (loss) ............................. $(1,450) $869 $656 $2,226 $2,124
=========== =========== =========== =========== ===========
Dividends
Cash .......................................... 200 281 281 212 126
Ratio of dividends to net income .............. N/A 32.34% 42.84% 9.52% 5.93%
Per Share Data
Diluted earnings per share .................... $(0.39) $0.22 $0.16 $0.57 $0.78
Cash dividends per common share ............... $0.05 $0.07 $0.07 $0.06 $0.05
Weighted average shares outstanding ........... 3,691,728 3,885,946 4,054,657 3,715,901 2,601,650
Balance Sheet Data (at period end)
Investment securities ......................... $34,303 $12,071 $12,991 $11,530 $8,481
Loans, net .................................... 229,215 229,078 147,105 129,160 129,993
Total assets .................................. 370,660 296,898 198,495 178,345 173,293
Total deposits ................................ 315,490 241,216 137,607 122,361 136,209
Total short-term borrowings ................... 2,750 1,275 3,825 2,275 725
Total long-term borrowings .................... 19,009 21,348 24,281 21,799 21,900
Total shareholders' equity .................... 28,748 30,409 31,490 30,920 13,887
Selected Ratios
Return on average total assets ................ (0.41)% 0.34% 0.37% 1.24% 1.28%
Return on average shareholders' equity ........ (4.72)% 2.82% 2.08% 8.34% 16.65%
Net interest margin ........................... 4.21% 5.51% 6.31% 6.08% 5.33%
Efficiency ratio (1) .......................... 83.09% 85.46% 81.66% 63.89% 59.42%
Asset Quality Ratios
Allowance for loan losses to:
Ending total loans ....................... 2.55% 1.95% 1.53% 1.39% 1.49%
Non-performing assets (2) ................ 80.09% 58.18% 76.88% 54.66% 81.51%
Non-performing assets to ending total assets .. 2.02% 2.64% 1.49% 1.86% 1.39%
Net loan charge-offs to average loans ......... 1.60% 0.43% 0.67% 0.54% 0.23%
Capital Ratios
Shareholders' equity to average assets ........ 8.14% 11.93% 17.73% 17.29% 8.37%
Tier 1 capital ratio (3) ................. 8.84% 9.74% 17.51% 22.21% 9.61%
Total risk-based capital ratio (4) ....... 10.10% 10.99% 18.76% 23.46% 11.34%
(1) Efficiency ratio is non-interest expense divided by the sum of net
interest income plus non-interest income.
(2) Non-performing assets consist of non-accrual loans, loans contractually
past due 90 days or more, other real estate owned, and other repossessed
assets.
(3) Tier 1 capital divided by risk-weighted assets.
(4) Total risk-based capital divided by risk-weighted assets.
Certain interest income, non-interest income, and non-interest expense amounts
have been restated from prior years to conform to the current year presentation.
These reclassifications have no effect on the Company's previously stated
results of operation or earnings per share.
13
Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations includes a discussion of certain significant
business trends and uncertainties as well as other forward-looking statements
and is intended to be read in conjunction with and is qualified in its entirety
by reference to the consolidated financial statements of the Company and
accompanying notes included elsewhere in this report. For a discussion of
important factors that could cause actual results to differ materially from such
forward-looking statements, see "Risk Factors."
Critical Accounting Policies
Cowlitz Bancorporation (the "Company") and its wholly owned subsidiary,
Cowlitz Bank (also the "Company" or the "Bank") have identified their most
critical accounting policy to be that related to the allowance for loan losses.
The Company utilizes both quantitative and qualitative considerations in
establishing an allowance for loan losses believed to be appropriate as of each
reporting date. Quantitative factors include historical loss experience, recent
delinquency and charge-off experience, changes in the levels of non-performing
loans, portfolio size, and other known factors with specific loans. Qualitative
factors include assessments of the types and quality of the loans within the
loan portfolio as well as current local, regional, and national economic
considerations. Changes in the above factors could have a significant affect on
the determination of the allowance for loan losses. Therefore, a full analysis
is performed by management on a quarterly basis to ensure that changes in
estimated loan loss levels are adjusted on a timely basis. For further
discussion of this significant management estimate, see "Allowance for Loan
Losses."
Introduction
For all periods reported, the Company has reclassified certain income
and expense items relating to the loans funded or processed by Bay Mortgage in
order to conform with changes in the current period presentation. Fees collected
on loans brokered, but not funded, by Bay Mortgage to outside lenders had been
recorded as interest income but are now properly classified as non-interest
income. Similarly, loan origination fees related to loans held-for-sale and
previously reported as interest income have been reclassified. Loan origination
fees on loans held-for-sale, net of certain direct origination costs, are
deferred and amortized as an adjustment of the yield on the related loan using
the interest method. Such net deferred loan origination fees are recognized when
the related loans are subsequently sold or repaid. These reclassifications have
no effect on the Company's previously reported financial position, results of
operations, or earnings per share.
The Company has recently undertaken significant business changes to
strengthen its position as a leading provider of financial services in Cowlitz
County and to expand its services throughout western Washington and the
Portland, Oregon markets.
In July of 2000, the Company acquired Northern Bank of Commerce ("NBOC")
of Portland, Oregon in a business combination accounted for using the purchase
method. Also in July of 2000, the Company expanded its mortgage division by
opening a branch of Bay Mortgage in Silverdale, Washington. The results of
operations of the Company for year ended December 31, 2000 do not include the
results of operations for NBOC prior to the date of purchase. In addition, the
balance sheet annual averages used throughout this report have not been adjusted
to reflect the acquisition and expansion in mid-2000.
During 1999, the Company also expanded its business operations.
Beginning in February 1999, the Company opened a loan office in Vancouver,
Washington. In July and August 1999, the Company acquired Bay Mortgage of
Bellevue, Washington and Bay Mortgage of Seattle, Washington, both of which are
residential mortgage companies located in the greater Seattle area. In September
1999, Cowlitz Bank opened a branch in Bellevue doing business as Bay Bank and
acquired Bay Escrow of Seattle, Washington. The addition of the new mortgage
divisions, collectively "Bay Mortgage," has increased the Company's non-interest
income through fees associated with the origination and sale of residential
mortgage loans.
14
In 1999, 2000, and 2001, the Company's business also included Business
Finance Corporation ("BFC"), its finance subsidiary which was acquired in
September of 1998. This operation was sold in its entirety in the first quarter
of 2002.
The Company's results of operation for 2001 were greatly affected by the
overall slowing of the national economy. During 2001 the Federal Reserve Board
cut the fed fund interest rates eleven times, dropping the rate from 6.5% to
1.75%. Cowlitz Bank responded with corresponding reductions in its internal
prime rate from 9.50% at the beginning of 2001 to 4.75% currently. Approximately
40% of Cowlitz Bank's loan portfolio is indexed to the prime rate, and such
significant reductions over a relatively short period of time, greatly reduced
the yields earned on the Bank's loan portfolio, and interest-earning assets in
general. However, many of the interest rates paid on interest -bearing
liabilities did not re-price as quickly as the assets. Over one-half of the
Bank's funding is in fixed rate certificates of deposit and borrowings from the
Federal Home Loan Bank (FHLB), which do not re-price until the maturity of the
instrument. These factors created a narrowing of the interest spread between
interest-earning assets and interest-bearing liabilities, reducing the Company's
net interest income yield and net income from the banking segment. (See the net
interest income section for additional discussion.) Adverse economic conditions
also contributed to the increase in charged off loans and the Company's decision
to record greater loan loss provisions than in past periods.
Although the environment of lowering interest rates presented unique
challenges to the banking segment, the mortgage segment flourished under those
conditions. Bay Mortgage originated over three times the volume of residential
mortgage loans during 2001 compared to 2000. The resulting income from interest,
fee and sales premiums on these loans, allowed Bay Mortgage to contribute a
substantial after tax net income to the Company's results of operation. However,
the boom in residential lending presented funding challenges that the banking
segment absorbed. Loans held-for-sale grew from $10.0 million at December 31,
2000 to $37.3 million at December 31, 2001. During the 1st and 2nd quarters of
2001, in order to fund the rapid increase in loan volume, management utilized
the broker CD market as a funding and liquidity source. Although the loans
held-for-sale are typically sold within 14-45 days after funding, at the peak
during 2001, approximately $68.0 million of loans had been funded, but remained
unsold. Management purchased brokered certificates to fund this activity, but as
asset origination volumes declined, the CD's had not yet matured, which resulted
in excess liquidity. A portion of this excess cash was used to increase the
Company's investment portfolio by $22.2 million, but the Company's cash and cash
equivalents are still $24.6 million higher at December 31, 2001 than at December
31, 2000. The Company anticipates a reduction in broker CD's as they mature
unless the volume of loan originations continues at the rapid pace experienced
in 2001.
For the 12 months ended December 31, 2001, the Company's net loss was
$1.5 million or $(.39) per diluted share of common stock compared to $869,000
net income or $.22 per diluted share for 2000. The 2001 results of operation
included a $2.3 million net loss from the Company's finance subsidiary, Business
Finance Corporation. During 2001, the collection of certain accounts receivable
at BFC was considered doubtful so a provision for loan losses of $1.6 million
was recorded to fully reserve for the charge-off of those credits. In addition,
an analysis of the carrying value of goodwill on the balance sheet of BFC
revealed an impairment of that asset, so the Company wrote down the goodwill
asset value to zero. This decision resulted in a charge against income of $1.2
million, which contributed to the $2.3 million loss in 2001 for that operating
segment.
Total assets at December 31, 2001 were $370.7 million, up 24.9% compared
to assets of $296.9 million at December 31, 2000. Gross loans increased $1.6
million or less than 1% from $233.6 million at December 31, 2000 to $235.2
million at December 31, 2001. Non-performing assets as a percentage of total
assets decreased from 2.64% at December 31, 2000 to 2.02% at December 31, 2001.
Total non-performing assets decreased from $7.8 million to $7.5 million over the
same period. Total liabilities for the Company increased 28.3% or $75.4 million
from $266.5 million at the end of 2000 to $341.9 million at the end of 2001.
Deposits increased to $315.5 million at December 31, 2001, an increase of $74.3
million from $241.2 million at December 31, 2000. As discussed above, this
increase was primarily due to the need to fund the growth of loans held-for-sale
during 2001.
15
Results of Operations
Certain reclassifications have been made to prior year interest income,
non-interest income and non-interest expense. These restatements reduced
interest income by $3.2 million from $26.0 million to $22.8 million in 2000, and
by $1.4 million from $16.7 million to $15.3 million in 1999. Non-interest
expense was reduced by $1.2 million from $16.7 million to $15.5 million in 2000,
and by approximately $100,000 from $10.9 million to $10.8 million in 1999.
Non-interest income was increased by the net effect of the interest income and
non-interest expense reclassifications. The non-interest income previously
reported in 2000 was $3.3 million, and was increased by $1.9 million to $5.2
million. The 1999 restatement was $1.4 million, increasing non-interest income
from $1.8 million to $3.2 million.
Net Interest Income
For financial institutions, the primary component of earnings is net
interest income. Net interest income is the difference between interest income,
principally from loans and investment securities portfolios, and interest
expense, principally on customer deposits. Changes in net interest income result
from changes in "volume," "spread" and "margin." Volume refers to the dollar
level of interest-earning assets and interest-bearing liabilities. Spread refers
to the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities. Net interest margin is the ratio of net interest
income to total interest-earning assets and is influenced by the level and
relative mix of interest-earning assets and interest-bearing liabilities.
Other than the reclassifications discussed above, a number of factors
affected the Company's interest yields, margins, and spread when comparing the
twelve months ending December 31, 2001 to the same period for 2000. Following
the trend of the Federal Reserve Board in cutting the national fed funds rate,
the Company enacted eleven decreases in its prime rate during 2001. Variable
rate loans re-price immediately to changes in prime, but fixed rate liabilities,
particularly certificates of deposit do not immediately adjust with prime
changes, but do so when the CD matures and is replaced at the lower rate. The
Company's current mix of loans includes approximately 60% fixed rate loans, and
40% that re-price to prime. The falling rate environment experienced during 2001
caused yields on assets to decline more rapidly than the liability costs,
narrowing the interest spread. Increased volumes of both interest-earning assets
and average interest-bearing liabilities have offset the decline in rates earned
and paid, resulting in the increase in both interest income and interest expense
in 2001 when compared to 2000 and 1999. The decline in interest margin from year
to year is due to the mix of interest-earning assets, and interest-bearing
liabilities. Higher yielding fixed rate commercial loans made up a lower
percentage of the total interest-earning assets due to the increase in volume of
lower rate residential mortgage loans held-for-sale, interest-bearing deposits
due from banks, and available-for-sale investments. Conversely, certificates of
deposit, which typically carry a higher rate than other deposit products, made
up a higher percentage of the average total interest-bearing liabilities mix in
2001. The increase in low rate interest-bearing deposits due from banks, and the
increase in high rate certificates of deposit are the result of the same market
factors. The Company purchased funds through the broker CD market to create the
liquidity needed to fund the rapid growth of the mortgage division during 2001.
Although the mortgage loans held-for-sale typically sell within 15-45 days after
funding, interest rates were dropping so quickly early in and throughout 2001,
the Company's pipeline of loans funded but not yet sold increased from $10.0
million at the end of December to over $50.0 million at March 31, 2001. This
rapid increase in volume outstripped the Company's available liquidity,
necessitating the use of wholesale funding. The volume of loans funded but not
yet sold remained at approximately $40.0 million throughout 2001, but peaked at
about $68.0 million in the fourth quarter of 2001. Rather than create additional
liquidity by purchasing additional brokered funds, management utilized the
broker loan market, removing the necessity of the Bank to fund the high volumes
of loans, and also hired additional employees to speed up and streamline the
loan selling process. These changes brought the volume of loans held-for-sale to
$37.3 million at December 31, 2001, reversing the Company's liquidity position.
This resulted in excess cash and deposits due from banks which were invested at
a lower fed funds rate, weakening the interest yields, spread, and margins. The
Company anticipates a reduction in broker CD's as they mature, unless the volume
of mortgage loan originations continues at the rapid pace experienced in 2001.
16
The yield earned on loans outstanding (including residential mortgage
loans held-for-sale) during 2001 was 8.97% compared to 10.20% in 2000, and
10.37% in 1999. The increase in the average volume of loans from year to year
more than offset the decline in rates causing the total interest income on loans
to increase to $25.1 million in 2001 compared to $21.3 million for 2000 and
$13.9 million in 1999. The yield earned on taxable securities decreased to 5.42%
in 2001 from 7.79% in 2000 primarily due to overall interest rate reductions.
The average interest-earning balances due from banks increased significantly to
$28.4 million during 2001 from $12.9 million in 2000 and $9.5 million in 1999.
As a result, total interest earned on balances due from banks also increased
from year to year, but the yield earned decreased to 3.62% in 2001 from 4.7% in
2000, and 4.89% in 1999. The total yield earned on all interest-earning assets
declined to 8.28% in 2001 from 9.76% and 9.61% for the years 2000 and 1999,
respectively. As discussed above, the decline is due to the interest rate cuts,
the higher percentage of loans which are lower rate mortgage loans
held-for-sale, and the higher percentage of cash and due from banks. Despite the
drop in yields earned, volumes increased significantly, explaining the increase
in total interest earned.
Liability costs were also affected during 2001 by the declining rate
environment. The rates paid on all interest-bearing liabilities were lower in
2001 when compared to 2000 and 1999, but did not fall as fast or as far as
interest-earning assets, narrowing the interest spread to 3.46% in 2001 from
4.43% in 2000 and 5.11% in 1999. The yield on savings and interest-bearing
demand deposit accounts decreased to 2.91% compared to 3.35% and 2.99% in 2000
and 1999, respectively. Certificates of deposit also had a decline in average
rates paid to 5.70% during 2001 from 6.31% in 2000, but was higher than 5.39% in
1999. Both of these types of deposits experienced increases in volume and
interest expense from year to year as a response to liquidity needs. Long-term
borrowings had a decline in rate, volume and interest expense in 2001 when
compared to 2000. In 2001, the Company took advantage of an opportunity to
refinance a $2.5 million loan with the FHLB at a much lower rate. For all
interest-bearing liabilities, the average rate paid decreased to 4.82% in 2001
from 5.33% in 2000.
Net interest income for the year ended December 31, 2001 was $13.8
million, an increase of 7.0% from $12.9 million in 2000, which was $2.9 million
higher than 1999. The net interest margins for the periods ended December 31,
2001, 2000, and 1999 were 4.21%, 5.52%, and 6.31%, respectively. Interest
expense as a percentage of average earning assets decreased to 4.07% in 2001,
compared to 4.25% in 2000 and 3.30% in 1999.
17
Average Balances and Average Rates Earned and Paid. The following table
sets forth, for the periods indicated, information with regard to (i) average
balances of assets and liabilities, (ii) the total dollar amount of interest
income on interest-earning assets and interest expense on interest-bearing
liabilities, (iii) resulting yields or costs, (iv) net interest income and (v)
net interest spread. Non-accrual loans have been included in the table as loans
carrying a zero yield. Loan fees are recognized as income using the interest
method over the life of the loan.
As of and For The Year Ended December 31,
------------------------------------------------------------------------------------------------------
2001 2000 1999
--------------------------------- -------------------------------- ---------------------------------
Average Interest Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
----------- ---------- -------- ----------- ---------- ------- ----------- ---------- --------
(dollars in thousands)
ASSETS:
Loans ...................... $279,556 $25,088 8.97% $208,574 $21,283 10.20% $134,017 $13,901 10.37%
Taxable securities ......... 20,087 848 5.42% 11,127 651 7.79% 15,205 681 5.93%
Non-taxable securities(1) .. 200 11 5.50% 200 11 5.50% 200 11 5.50%
Federal funds sold ......... 544 14 2.57% 1,281 83 6.48% 6 -- 0.00%
Interest-earning balances
due from bank .......... 28,415 1,269 3.62% 12,905 823 4.70% 9,514 686 4.89%
-------- ------- ----- ------- ------- ------ -------- ------- -------
Total interest-
earning assets ...... 328,802 27,230 8.28% 234,087 22,851 9.76% 158,942 15,279 9.61%
------- ------- -------
Cash and due from banks .... 11,774 9,500 8,792
Premises and equipment ..... 5,452 5,793 5,953
Allowance for loan losses .. (4,139) (3,738) (1,996)
Net intangibles ............ 5,068 5,191 3,911
Other assets ............... 6,207 3,996 2,055
-------- -------- --------
Total assets ......... $353,164 $254,829 $177,657
======== ======== ========
LIABILITIES AND
SHAREHOLDERS' EQUITY:
Savings and interest-
bearing demand
deposits ................ $89,336 $2,600 2.91% $64,667 $2,169 3.35% $49,128 $1,469 2.99%
Certificates of deposit .... 164,736 9,382 5.70% 97,715 6,164 6.31% 43,299 2,332 5.39%
Long-term borrowings ....... 20,166 1,285 6.37% 21,979 1,501 6.83% 22,067 1,350 6.12%
Short-term borrowings ...... 3,523 115 3.26% 2,115 106 5.01% 2,117 97 4.58%
-------- ------- ----- ------- ------- ------ -------- ------- -------
Total interest-
bearing
Liabilities ......... 277,761 13,382 4.82% 186,476 9,940 5.33% 116,611 5,248 4.50%
------- ------- -------
Non-interest-bearing
deposits ................. 41,652 35,564 28,602
Other liabilities .......... 3,050 2,007 1,024
-------- -------- --------
Total liabilities ..... 322,463 224,047 146,237
Shareholders' equity ....... 30,701 30,782 31,420
-------- -------- --------
Total liabilities and
shareholders' equity.. $353,164 $254,829 $177,657
======== ======== ========
Net interest income $13,848 $12,911 $10,031
======= ======= =======
Net interest spread 3.46% 4.43% 5.11%
Average yield on earning assets 8.28% 9.76% 9.61%
Interest expense to earning assets 4.07% 4.25% 3.30%
Net interest income to earning assets 4.21% 5.52% 6.31%
(1) Interest earned on non-taxable securities has been computed on a 34 percent
tax equivalent basis. (2) Certain interest income amounts have been restated
from prior years to conform to the current year presentation. These restatements
have no effect on the Company's previously reported net income or earnings per
share.
18
Analysis of changes in interest differential. The following table shows
the dollar amount of the increase (decrease) in the Company's net interest
income and expense and attributes such dollar amounts to changes in volume as
well as changes in rates. Rate/volume variances have been allocated to volume
changes:
Year Ended December 31,
------------------------------------------------------------------------------
2001 versus 2000 2000 versus 1999
------------------------------------- -------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------- Total Increase/ ------------------- Total Increase/
Volume Rate (Decrease) Volume Rate (Decrease)
------ ---- ---------- ------ ---- ----------
(dollars in thousands)
Interest income:
Interest-earning balances due
from banks ............................ $562 $(140) $422 $159 $(17) $142
Federal funds sold ........................ (19) (50) (69) 83 -- 83
Investment security income:
Taxable securities .................... 485 (264) 221 (318) 283 (35)
Non-taxable securities ................ -- -- -- -- -- --
Loans, including fees on loans ............ 6,370 (2,565) 3,805 7,608 (226) 7,382
------- ------- ------- ------- ------- -------
Total interest income ................. 7,398 (3,019) 4,379 7,532 40 7,572
------- ------- ------- ------- ------- -------
Interest expense:
Savings and interest-bearing
demand ................................ 718 (287) 431 521 179 700
Certificates of deposit ................... 3,817 (599) 3,218 3,433 399 3,832
Short-term borrowings ..................... 46 (37) 9 -- 9 9
Long-term borrowings ...................... (116) (100) (216) (6) 157 151
------- ------- ------- ------- ------- -------
Total interest expense ................ 4,465 (1,023) 3,442 3,948 744 4,692
------- ------- ------- ------- ------- -------
Net interest spread ............................ $2,877 $(1,940) $937 $3,584 $(704) $2,880
======= ======= ======= ======= ======= =======
Non-interest income
Non-interest income consists of the following components:
Year Ended December 31,
--------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands)
Service charge on deposit accounts ............ $ 737 $ 714 $ 698
Gains on loans sold ........................... 4,872 1,813 852
Brokerage fees ................................ 2,450 1,497 857
Fiduciary income .............................. 238 301 151
Credit card income ............................ 507 381 381
Escrow fees ................................... 895 316 105
ATM income .................................... 82 70 54
Safe deposit box fees ......................... 32 31 32
Gain/(loss) on sale of repossessed assets ..... (429) 92 --
Gain/(loss) on sale of AFS securities ......... 89 (4) (2)
Other miscellaneous fees and income ........... 118 8 63
------- ------- -------
Total non-interest income ..................... $ 9,591 $ 5,219 $ 3,191
======= ======= =======
Total non-interest income has increased year-to-year to $9.6 million in
2001, from $5.2 million in 2000 and $3.2 million in 1999. The majority of this
income is due to the brokerage fees and gains on loans sold, both of which have
been generated by the increased volume of residential mortgage loans originated
by Bay Mortgage. With the falling rate environment experienced in 2001, there
has been a significant increase in mortgage lending activity. Lower interest
rates have attracted consumers to refinance existing mortgages, apply for new
mortgage or construction loans, or request bridge loans for short-term
financing. Each of these types of loans generates additional non-interest income
for the Bank, and from 2000 to 2001 has added $4.6 million of additional
non-interest income. Gains on loan sold increased $3.1 million from $1.8 million
in 2000 to $4.9 million in 2001, which was an increase from the 1999 level of
$852,000. Escrow fees increased $579,000 from $316,000 in 2000 to $895,000 in
2001 and $105,000 in 1999. Brokerage fees, which includes points and processing
fees on loans held-for-sale and fees collected for lenders the Bank brokers
loans to, also increased significantly from year to year. In 2001, the Company
recorded $2.5 million of such fees, an increase of $1.0 million from $1.5
million in 2000, and an increase over the 1999 level of $857,000. Non-
19
interest income was reduced in 2001 by $429,000 in losses taken on the sales of
repossessed assets. These losses occur when the Bank's recorded value in a
repossessed asset, usually real property, is higher than the amount actually
realized upon sale of the asset.
Non-interest Expense
Non-interest expense consists of the following components:
Year Ended December 31,
------------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands)
Salaries and employee benefits .......... $ 9,365 $ 8,641 $ 5,766
Net occupancy and equipment ............. 2,440 2,115 1,457
Amortization of intangible assets ....... 582 559 445
Impairment of BFC goodwill .............. 1,215 -- --
Business taxes .......................... 613 415 274
Data processing and communications ...... 543 430 238
Stationary and supplies ................. 378 340 227
Parking/travel/education ................ 333 356 235
Credit Card Expense ..................... 408 307 315
Loan expense ............................ 716 230 202
Advertising ............................. 246 232 149
Professional fees ....................... 641 492 379
Postage and freight ..................... 478 331 164
FDIC insurance .......................... 214 94 15
Other miscellaneous expenses ............ 1,302 950 928
------- ------- -------
Total non-interest expense .............. $19,474 $15,492 $10,794
======= ======= =======
Non-interest expenses increased 25.8% to $19.5 million for the year
ended December 31, 2001 compared to $15.5 million for the year ended December
31, 2000, which was an increase of 43.5% compared to $10.8 million for the year
ended December 31, 1999. Much of the increase in non-interest expense from 2000
to 2001 is the direct result of the increase in volume at Bay Mortgage, which
management expects to decrease if mortgage volumes decline. The write-down of
goodwill originally associated with the purchase of BFC contributed $1.2 million
of non-interest expense in 2001. Another factor in the increase is the expenses
relating to the operations of NBOC which was acquired in mid 2000, but had a
full year of operations and expenses in 2001.
A measure of the Company's ability to contain non-interest expenses is
the efficiency ratio. This measurement is derived by dividing total non-interest
expenses by total net interest income and non-interest income. The Company's
efficiency ratio decreased slightly to 83.09% for the year ended December 31,
2001 compared to 85.46% for the corresponding period in 2000 and 81.66% for the
year ended December 31, 1999. The decrease in 2001 when compared to 2000 is the
result of management's efforts to reduce overhead expenses of its banking
operations in an attempt to offset the narrowing interest spread.
Salaries, benefits, and commissions expense of $9.4 million in 2001
represented an increase of $724,000 or 8.4% from the $8.6 million reported in
2000 which was $2.9 million or 49.9% higher than the $5.8 million reported in
1999. The increase from 2000 to 2001 is partially due to the NBOC employee's
wages paid for a full year in 2001, but only for half of the year in 2000. Also
contributing was the overall increase in the number of employees at Bay
Mortgage, where the full time equivalent count increased from 64 at the end of
2000 to 88 at the end of 2001. These additional employees were brought in to
help process and sell the increased volume of loans originated during the year.
The increase of 24 employees in the mortgage division was offset by a staff
reduction of ten full time equivalent employees in other divisions. The increase
from 1999 to 2000 reflects the addition of 22 employees from the acquisition of
NBOC, and reduction of six employees due to streamlining of operations. In
addition, the 2000 expense includes the severance salary of the Company's former
president in the amount of $540,000. Another factor contributing to the increase
in salaries and employee benefits from 1999 to 2000 is that new employees, which
were added in the third quarter of 1999 in connection with the acquisition of
Bay Mortgage and the start up of Bay Bank, were on the payroll for all of 2000.
Also contributing to the increases in both years were ordinary wage increases
for existing employees, which generally range from three to six percent each
year. At December 31, 2001, the Company had 199 full-time equivalent employees
compared to 185 and 169 at December 31, 2000 and 1999, respectively. Many of the
additional employees in 2001 are commissioned mortgage loan officers.
20
Net occupancy and equipment expenses consist of depreciation on
premises, lease costs, equipment, maintenance and repair expenses, utilities and
related expenses. The Company's net occupancy expense in 2001 of $2.4 million
was $325,000 or 15.4% higher than the $2.1 million reported in 2000, which was
$658,000 or 45.2% higher than the $1.5 million reported in 1999. The majority of
the increase is the result of NBOC's full year of operation in 2001 compared to
only half of the year in 2000. The increase in occupancy expenses in 2000
reflects an increase of approximately $513,000 in lease payments due to the
acquisition of Bay Mortgage, NBOC, the start up of Bay Bank, and due to rental
increases over the period. The year 2000 also includes increased depreciation
expense of approximately $100,000, which resulted from the equipment and
leasehold improvements acquired during the period.
For the period ended December 31, 2001, expenses related to the
amortization of intangibles were $582,000 compared to $559,000 and $445,000 for
the periods ended December 31, 2000 and 1999 respectively. An additional cost of
$1.2 million was recorded in 2001 to recognize to the impairment of goodwill
originally associated with the purchase of BFC. Intangible assets included a
deposit premium of $767,000 and $1.0 million, net of accumulated amortization,
at December 31, 2001 and 2000, respectively. The deposit premium is being
amortized using an accelerated method over a ten-year life. Intangible assets at
December 31, 2001 and 2000 also included goodwill of $3.6 and $4.3 million, net
of accumulated amortization, respectively. Goodwill represents the unamortized
portion of excess of acquisition costs over the fair value of net assets that
arose in connection with the Company's business acquisitions. Goodwill at Bay
Mortgage was increased by $772,000 at December 31, 2001 as the result of
additional payments recorded relating to an earn-out agreement specified in the
purchase contract. All goodwill has been amortized on a straight-line basis over
a 15-year period. However, beginning in January 2002, with the adoption of SFAS
No. 142, non-interest expenses will be reduced because no amortization expense
will be recognized on unidentifiable intangible assets, including the Company's
goodwill unless the unidentifiable intangible asset is deemed to be impaired.
This will result in a decrease of amortization expense of $325,000 per year. The
intangible asset associated with the deposit premium will continue to amortize
as discussed above, with an estimated amortization expense of $265,000.
In 2001, FDIC insurance premiums increased because in 2000 the Bank was
not required to pay an assessment charge on deposits. However, for the first two
quarters of 2001, the Bank was required to pay $0.10 per $100 of domestic
deposits, which decreased in the 3rd and 4th quarters to $0.03. Beginning in the
1st quarter of 2002, the assessment rate increases to $0.17 per $100 of domestic
deposits. These assessment charges are imposed based on FDIC analysis of the
Bank's capital position, rating, and other factors. As these factors improve or
deteriorate, the assessment rates change.
Loan expenses were much higher in 2001 compared to 2000 and 1999 due to
the volume increases experienced at Bay Mortgage, and the increased loan costs
associated with booking those loans. Another factor was the expenses related to
repossessed assets such as carrying costs and repossession costs of assets
obtained in exchange for defaulted loans.
Professional fees include exam and audit expenses, consulting and legal
fees, and other professional fees. The increase in these expenses in 2001 is the
result of higher legal fees relating to the repossession of assets on defaulted
loans, and general consulting fees to business brokers regarding the sale of
BFC, which was finalized in February of 2002, as well as consulting on other
strategic alternatives.
Other operating expenses such as business taxes, travel and meals,
postage and freight, advertising, data and loan processing costs, office
supplies, and other business expenses were $4.3 million at December 31, 2001,
$3.4 million at December 31, 2000, and $2.5 million at December 31, 1999. The
increases from year to year were due to the Company's continued growth and
expansion, and specifically in 2001, the growth experienced at Bay Mortgage.
Income Taxes
The provision for income taxes amounted to $150,000, $611,000, and
$420,000 for 2001, 2000, and 1999, respectively. The provision resulted in an
effective tax rate of (11.5)% in 2001, 41.3% in 2000, and 39.0% in 1999. The
variance from the 34% corporate tax rate is due to the amortization of goodwill
associated with the BFC and the Northern Bank of Commerce acquisitions, and key
man insurance expense, that are not deductible for income tax purposes. In 2001,
there were significant expenses recorded for book purposes, including $1.2
million of BFC goodwill impairment expense, not deductible for tax purposes.
After making these and certain other adjustments to the net loss before tax of
$1.3 million, the result was taxable income of $441,000 resulting in the
Company's reported $150,000 provision for income taxes.
21
Provision for Loan Losses
The amount of the allowance for loan losses is analyzed by management on
a regular basis to ensure that it is adequate to absorb losses inherent in the
loan portfolio as of the reporting date. When a provision for loan losses is
recorded, the amount is based on past charge-off experience, a careful analysis
of the current loan portfolio, the level of non-performing and impaired loans,
evaluation of future economic trends in the Company's market area, and other
factors relevant to the loan portfolio. See "Allowance for Loan Losses"
disclosure for a more detailed discussion.
The Company's provision for loan losses was $5.3 million for the year
ended December 31, 2001. For the year ending December 31, 2000 the provision was
$1.2 million and was $1.3 million in 1999. Included in 2001 was an increase to
the provision resulting from charge-offs of $1.6 million at BFC for doubtful
accounts receivable. While this substantial provision was necessary, with the
subsequent sale of BFC in February of 2002, management believes it won't
reoccur. Charge-offs, net of recoveries, were $3.8 million in 2001, $863,000 in
2000 and $882,000 in 1999. As discussed more fully in the "Allowance for Loan
Losses" section, the Company recognized an adjustment to the allowance for loan
losses of $2.0 million at the time of its acquisition of NBOC in 2000. At
December 31, 2001, the allowance for loan losses was 2.55% of total loans
compared to 1.95% at December 31, 2000 and 1.53% at December 31, 1999.
The allowance for loan losses is based upon estimates of probable losses
inherent in the loan portfolio. The amount actually realized for these losses
can vary significantly from the estimated amounts.
The following table shows the Company's loan loss performance for the
periods indicated:
Year Ended December 31,
----------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands)
Loans outstanding at end of period ........................ $235,212 $233,639 $149,386
Average loans outstanding during the period ............... $239,678 $202,016 $134,017
Allowance for loan losses, beginning of period ............ $ 4,561 $ 2,281 $ 1,814
Loans charged off:
Commercial ............................................ 2,729 1,983 838
Real estate ........................................... 1,743 -- 41
Consumer .............................................. 53 36 50
Credit cards .......................................... 86 51 96
-------- -------- --------
Total loans charged-off ............................ 4,611 2,070 1,025
-------- -------- --------
Recoveries:
Commercial ............................................ 115 1,183 104
Real estate ........................................... 652 -- 15
Consumer .............................................. 15 9 1
Credit cards .......................................... 3 15 23
-------- -------- --------
Total recoveries ................................... 785 1,207 143
-------- -------- --------
Provision for loan losses ................................. 5,262 1,155 1,349
-------- -------- --------
Adjustment incident to acquisition ........................ -- 1,988 --
-------- -------- --------
Allowance for loan losses, end of period .................. $ 5,997 $ 4,561 $ 2,281
======== ======== ========
Ratio of net loans charged-off to average loans outstanding 1.60% 0.43% 0.66%
Ratio of allowance for loan losses to loans at year-end ... 2.55% 1.95% 1.53%
22
Financial Condition
Summary Balance Sheet
December 31, Increase (Decrease)
--------------------------- ---------------------------------------------
2001 2000 1999 12/31/00 - 12/31/01 12/31/99 - 12/31/00
---- ---- ---- ------------------- -------------------
(dollars) (percent) (dollars) (percent)
(dollars in thousands)
ASSETS
Cash and cash equivalents ... $ 50,177 $ 25,589 $ 19,054 $ 24,588 96.1% $ 6,535 34.3%
Investment securities ....... 34,303 12,071 12,991 22,232 184.2% (920) (7.1)%
Loans, net .................. 229,215 229,078 147,105 137 0.1% 81,973 55.7%
Loans, held-for-sale ........ 37,322 10,013 2,255 27,309 272.7% 7,758 344.0%
Other assets ................ 19,643 20,147 17,090 (504) (0.3)% 3,057 17.9%
--------- --------- --------- --------- ---------
Total assets ............ $ 370,660 $ 296,898 $ 198,495 $ 73,762 24.8% $ 98,403 49.6%
========= ========= ========= ========= =========
LIABILITIES
Non-interest-bearing deposits $ 43,225 $ 40,201 $ 28,004 $ 3,024 7.5% $ 12,197 43.6%
Interest-bearing deposits ... 272,265 201,015 109,603 71,250 35.4% 91,412 83.4%
--------- --------- --------- --------- ---------
Total deposits .............. 315,490 241,216 137,607 74,274 30.8% 103,609 75.3%
Other liabilities ........... 26,422 25,273 29,398 1,149 4.6% (4,125) (14.0)%
--------- --------- --------- --------- ---------
Total liabilities ....... 341,912 266,489 167,005 75,423 28.3% 99,484 59.8%
SHAREHOLDERS' EQUITY ........ 28,748 30,409 31,490 (1,661) (5.5)% (1,081) (3.4)%
--------- --------- --------- --------- ---------
Total liabilities and
shareholders equity ... $ 370,660 $ 296,898 $ 198,495 $ 73,762 24.8% $ 98,403 49.6%
========= ========= ========= ========= =========
Investment Securities
At December 31, 2001, the Company's portfolio of investment securities
totaled $34.3 million, 1.8 times the amount of investment securities of $12.1
million owned at December 31, 2000. The large increase in securities in 2001 is
the result of investing some of the Company's excess liquidity from broker
deposits originally purchased to fund the growth of the mortgage division.
The Company follows financial accounting principles which requires the
identification of investment securities as held-to-maturity, available-for-sale
or trading assets. Securities designated as held-to-maturity are those that the
Company has the intent and ability to hold until they mature or are called.
Available-for-sale securities are those that management may sell if liquidity
requirements dictate or alternative investment opportunities arise. Trading
assets are purchased and held principally for the purpose of reselling them
within a short period of time. The mix of available-for-sale and
held-to-maturity investment securities is considered in the context of the
Company's overall asset-liability management policy and illustrates management's
assessment of the relative liquidity of the Company. At December 31, 2001, the
investment portfolio consisted of 88.0% available-for-sale securities and 12.0%
held-to-maturity investments. At December 31, 2000, available-for-sale
securities were 62.1% and held-to-maturity investments were 37.9% of the
investment portfolio. The Company did not conduct any trading activities during
2001 or 2000.
23
The following table provides the amortized cost and fair value of the
Company's investment securities as of December 31, 2001 and 2000.
December 31,
---------------------------------------------------
2001 2000
---------------------- ----------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------- --------- --------- ----------
(dollars in thousands)
Available-for-sale
U.S. Government and agency securities....... $ 19,566 $ 19,644 $ 7,441 $ 7,499
Mortgage backed securities................. 10,606 10,544 - -
---------- --------- --------- ----------
Total.............................. $ 30,172 $ 30,188 $ 7,441 $ 7,499
========== ========= ========= ==========
Held-to-maturity
U.S. Government and agency securities....... $ 1,016 $ 1,055 $ 1,007 $ 1,006
Municipal bonds............................. 200 203 200 198
Certificates of deposit..................... 2,899 2,899 3,365 3,365
---------- --------- --------- ----------
Total.............................. $ 4,115 $ 4,157 $ 4,572 $ 4,569
========== ========= ========= ==========
At December 31, 2001, the Company's available-for-sale and
held-to-maturity investments had total net unrealized gains of approximately
$58,000. This compares to net unrealized losses of approximately $55,000 at
December 31, 2000. Unrealized gains and losses reflect changes in market
conditions and do not represent the amount of actual profits or losses the
Company may ultimately realize. Actual realized gains and losses occur at the
time investment securities are sold or redeemed.
In 1991, the Company became a member and shareholder in the Federal Home
Loan Bank of Seattle. The Company's relationship and stock investment with the
FHLB provides a borrowing source for meeting liquidity requirements, in addition
to dividend earnings. Investment in FHLB stock was $3.5 million at December 31,
2001 compared to $3.3 million at December 31, 2000.
At December 31, 2001, net unrealized gains on available-for-sale
securities were $16,000 representing less than one tenth of one percent of the
total portfolio. Management has no current plans to sell any of these
securities.
The following table summarizes the contractual maturities and weighted
average yields of both available-for-sale and held-to-maturity investment
securities at December 31, 2001.
One After 5
One year through through
Or less Yield 5 years Yield 10 years Yield Total Yield
--------- ----- -------- ----- -------- ----- ----- -----
(dollars in thousands)
U.S. Government and
agency securities....... $ 1,248 6.78% $ 19,412 4.35% $ -- -- $ 20,660 4.50%
Mortgage backed securities... 510 4.49% 8,579 4.93% 1,455 5.52% 10,544 4.99%
Other securities............. 2,999 2.95% 100 4.15% -- -- 3,099 2.99%
--------- --------- --------- ---------
Total............... $ 4,757 4.12% $ 28,091 4.53% $ 1,455 5.52% $ 34,303 4.51%
========= ========= ========= =========
For the purposes of the maturity schedule, mortgage-backed securities,
which are not due at a single maturity date, have been allocated over maturity
groupings based on the expected maturity of the underlying collateral.
Mortgage-backed maturity securities may mature earlier than their stated
contractual maturities because of accelerated principal repayments of the
underlying loans.
Loans
Gross outstanding loans totaled $235.2 million at December 31, 2001,
representing an increase of $1.6 million compared to $233.6 million at December
31, 2000. Loan commitments were $53.7 million at December 31, 2001 and amounted
to $54.4 million at December 31, 2000.
24
The following table presents the composition of the Company's loan portfolio at
the dates indicated.
December 31,
---------------------------------------------------
2001 2000
--------------------- ----------------------
Amount Percent Amount Percent
(dollars in thousands)
Commercial.................................. $ 50,152 21.26% $ 46,738 19.94%
Real estate construction.................... 26,520 11.24 10,744 4.58
Real estate commercial...................... 111,437 47.23 130,272 55.58
Real estate mortgage........................ 36,190 15.34 34,402 14.68
Consumer and other.......................... 11,650 4.94 12,247 5.22
---------- ------ ---------- ------
235,949 100.00% 234,403 100.00%
====== ======
Deferred loan fees.......................... (737) (764)
---------- ----------
Total loans........................ 235,212 233,639
Allowance for loan losses................... (5,997) (4,561)
---------- ----------
Total loans, net................... $ 229,215 $ 229,078
========== ==========
The following table shows the contractual maturities of the Company's
loans and sensitivity to changes in interest rates at the dates indicated:
December 31, 2001
-----------------------------------------------------
Due after one
Due in one through Due after Total
year or less 5 years 5 years Loans
------------ ------- ------- -----
(dollars in thousands)
Commercial loans............................ $ 40,640 $ 7,667 $ 1,845 $ 50,152
Real estate construction.................... 21,675 2,192 2,653 26,520
Real estate commercial...................... 41,224 52,106 18,107 111,437
Real estate mortgage........................ 15,341 15,927 4,922 36,190
Consumer and other.......................... 3,817 6,369 1,464 11,650
---------- --------- ---------- ----------
$ 122,697 $ 84,261 $ 28,991 $ 235,949
========== ========= ========== ==========
Loans with fixed interest rates............. $ 141,701
Loans with floating interest rates.......... 94,248
----------
Total.............................. $ 235,949
==========
Allowance for Loan Losses
The allowance for loan losses represents management's estimate of
probable losses which have occurred as of the date of the financial statements.
The loan portfolio is regularly reviewed to evaluate the adequacy of the
allowance for loan losses. In determining the level of the allowance, the
Company evaluates the amount necessary for specific non-performing loans and
estimates losses inherent in other loans. An important element in determining
the adequacy of an allowance for loan losses is an analysis of loans by loan
rating categories. The risk of a credit is evaluated by the Company's management
at inception of the loan using an established grading system. This grading
system currently includes ten levels of risk. Risk gradings range from "1" for
the strongest credits to "10" for the weakest; a "10" rated loan would normally
represent a loss, and all loans rated 6-10 are collectively the Company's watch
list. The specific gradings from 6-10 are "management attention", "special
mention", "substandard", "doubtful", or "loss". When indicators such as
operating losses, collateral impairment or delinquency problems show that a
credit may have weakened, the credits will be downgraded as appropriate.
Similarly, as borrowers bring loans current, show improved cash flows,