-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KlluOclAP5/BqQAWljv8e6kcNVU5DpFmVBQOjJV8/ba1ibJPzA4Fa+R2OmbdGnlz W9QaJkKq5lBeTtRWgqM5sA== 0000939057-99-000071.txt : 19990707 0000939057-99-000071.hdr.sgml : 19990707 ACCESSION NUMBER: 0000939057-99-000071 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990706 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST WASHINGTON BANCORP INC /WA/ CENTRAL INDEX KEY: 0000946673 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTIONS, NOT FEDERALLY CHARTERED [6036] IRS NUMBER: 911691604 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-26584 FILM NUMBER: 99659489 BUSINESS ADDRESS: STREET 1: 10 S FIRST AVENUE CITY: WALLA WALLA STATE: WA ZIP: 99362 BUSINESS PHONE: 5095273636 MAIL ADDRESS: STREET 1: 10 S FIRST AVENUE CITY: WALLA WALLA STATE: WA ZIP: 99362 FORMER COMPANY: FORMER CONFORMED NAME: FIRST SAVINGS BANK OF WASHINGTON BANCORP INC DATE OF NAME CHANGE: 19950614 10-K/A 1 FIRST WASHINGTON BANCORP, INC. FORM 10-K/A FORM 10-K/A SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] AMENDED ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended............................... March 31, 1999 -------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------------- ----------------- Commission File Number 0-26584 ------- FIRST WASHINGTON BANCORP, INC. ------------------------------ (Exact name of registrant as specified in its charter) Washington 91-1691604 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 10 S. First Avenue Walla Walla, Washington 99362 -------------------------------------------------------- (Address of principal executive offices and zip code) (509) 527-3636 ------------------- (Registrant's telephone number, including area code) N/A ------------------------- (Former name, former address and former fiscal year, if changed since last report.) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to section 12(g) of the Act: Common Stock $.01 par value per share ------------------------------------- (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 files pursuant to Item 405 of Regulations 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 this form 10-K or any amendment to this form 10-K. X ----- The aggregate market value of the voting stock held by nonaffiliates of the registrant as of May 31, 1999: Common Stock - $224,478,399 The number of shares outstanding of the issuer's classes of common stock as of May 31, 1999: Common Stock, $.01 par value - 11,330,440 shares DOCUMENTS INCORPORATED BY REFERENCE None The registrant hereby amends Part I, item 1 of its Annual Report for the fiscal year ended March 31, 1999 as follows: (see attached) 2 PART 1 Item 1 - Business General First Washington Bancorp, Inc. (the Company or FWWB), a Washington corporation, is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly owned subsidiaries, First Savings Bank of Washington (FSBW), Inland Empire Bank (IEB) and Towne Bank (TB) (together, the Banks). FSBW is a Washington-chartered savings bank the deposits of which are insured by the Federal Deposit Insurance Corporation (FDIC) under the Savings Association Insurance Fund (SAIF). FSBW conducts business from its main office in Walla Walla, Washington and its 16 branch offices and three loan production offices located in southeast, central, north central and western Washington. Effective January 1, 1999, FWWB completed the acquisition of Whatcom State Bancorp whose wholly owned subsidiary, Whatcom State Bank (WSB), was merged with FSBW and operates as Whatcom State Bank, a Division of First Savings Bank of Washington. WSB, which is based in Bellingham, operates five full service branches and a loan office in northwest Washington. IEB is an Oregon-chartered commercial bank whose deposits are insured by the FDIC under the Bank Insurance Fund (BIF). IEB conducts business from its main office in Hermiston, Oregon and its five branch offices and two loan production offices located in northeast Oregon. TB is a Washington-chartered commercial bank whose deposits are insured by the FDIC under BIF. TB conducts business from six full service branches in the Seattle, Washington, metropolitan area. The Company's main office is located at 10 S. First Avenue, Walla Walla, Washington 99362 and its telephone number is (509) 527-3636. The operating results of the Company depend substantially on its net interest income, which is the difference between interest income on interest-earning assets, consisting of loans and securities, and interest expense on interest- bearing liabilities, composed primarily of deposits and borrowings. Net interest income is a function of the Company's interest rate spread, which is the difference between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, as well as a function of the average balance of interest-earning assets as compared to the average balance of interest-bearing liabilities. The Company's net income also is affected by provisions for loan losses and the level of its other income, including deposit service charges, loan and servicing fees, and gains and losses on the sale of loans and securities, as well as its non-interest operating expenses and income tax provisions. First Savings Bank of Washington is a community oriented savings bank which has traditionally offered a wide variety of deposit products to its retail customers while concentrating its lending activities on real estate loans. Lending activities have been focused primarily on the origination of loans secured by one- to four-family residential dwellings, including emphasis on loans for construction of residential dwellings. To a lesser extent, lending activities also have included the origination of multi-family, commercial real estate and consumer loans. FSBW's primary business has been that of a traditional thrift institution, originating loans for portfolio in its primary market area. FSBW has also been an active participant in the secondary market, originating residential loans for sale and on occasion acquiring loans for portfolio. More recently, FSBW has begun making non-mortgage commercial and agribusiness loans to small businesses and farmers and has expanded its consumer lending activities. In addition to loans, FSBW has maintained a significant portion of its assets in marketable securities. The securities portfolio has been weighted toward mortgage-backed securities secured by one- to four-family residential properties. This portfolio also has included a significant amount of tax exempt municipal securities, primarily issued by entities located in the State of Washington. In addition to interest income on loans and investment securities, FSBW receives other income from deposit service charges, loan servicing fees and from the sale of loans and investments. FSBW also has a wholly-owned subsidiary, Northwest Financial Corporation, which serves as the trustee under FSBW's mortgage loan documents and receives commissions from the sale of annuities. Inland Empire Bank is a community oriented commercial bank which historically has offered a wide variety of deposits and loan products to its consumer and commercial customers. Lending activities have included origination of consumer, commercial, agribusiness and real estate loans. IEB also has engaged in mortgage banking activity with respect to residential lending within its local markets, originating loans for sale generally on a servicing released basis. Additionally, IEB has maintained a significant portion of its assets in marketable securities, particularly U.S. Treasury and government agency securities as well as tax exempt municipal securities issued primarily by entities located in the State of Oregon. IEB operates a division, Inland Financial Services, which offers insurance and brokerage services to its customers. IEB has two wholly owned subsidiaries: Pioneer American Property Company, which owns a building that is leased to IEB, and Inland Securities Corporation, which previously made a market for IEB's stock but is currently inactive. 3 TB is a community oriented commercial bank chartered in the State of Washington. TB's lending activities consist of granting commercial loans, including commercial real estate, land development and construction loans, and consumer loans to customers throughout King and Snohomish counties in western Washington. TB is a "Preferred Lender" with the Small Business Administration (SBA) and generates SBA guaranteed loans for portfolio and for resale. The Company and the Banks are subject to regulation by the Federal Reserve Board (FRB) and the FDIC, the State of Washington Department of Financial Institutions, Division of Banks (Division), and the State of Oregon Department of Consumer and Business Services and the State of Idaho, Department of Finance. The Board of Directors of the company passed a resolution on October 22, 1998 authorizing a changing its fiscal year end from March 31st to December 31st. The change will be effective for the year ending 1999. Acquisitions and Mergers Towne Bank On April 1, 1998 FWWB completed the acquisition of Towne Bancorp, Inc. FWWB paid $28.2 million in cash and common stock for all of the outstanding common shares and stock options of Towne Bancorp, Inc., which was the holding company for Towne Bank (TB), headquartered in Woodinville, Washington, a Seattle suburb. As a result of the merger of Towne Bancorp, Inc. into FWWB, TB became a wholly owned subsidiary of FWWB. The acquisition was accounted for as a purchase and resulted in the recording of $19.2 million of costs in excess of the fair value of Towne Bancorp, Inc. net assets acquired (goodwill). Goodwill assets are being amortized over a 14-year period resulting in a current charge to earnings of $343,800 per quarter or $1,375,000 per year. Founded in 1991, TB is a community business bank which had, before recording of goodwill, approximately $146 million in total assets, $134 million in deposits, $120 million in loans and $9.3 million in shareholders' equity at March 31, 1998. TB operates six full service branches in the Seattle, Washington, metropolitan area in Woodinville, Kirkland, Redmond, Bellevue, Renton and Bothell. Whatcom State Bancorp, Inc. On January 1, 1999 FWWB completed the acquisition of Whatcom State Bancorp, Inc. FWWB paid $12.1 million in common stock for all the outstanding common shares and stock options of Whatcom State Bancorp, Inc., which was the holding company for Whatcom State Bank (WSB), headquartered in Bellingham, Washington. As a result of the merger of Whatcom State Bancorp, Inc. into FWWB, WSB became a division of FSBW. The acquisition was accounted for as a purchase and resulted in the recording of approximately $6.3 million of costs in excess of the fair value of Whatcom State Bancorp, Inc. net assets acquired (goodwill). Goodwill assets are being amortized over a 14-year period resulting in a current charge to earnings of approximately $114,300 per quarter or $457,000 per year. Founded in 1980, WSB is a community commercial bank which had, before recording of goodwill, approximately $99 million in total assets, $85 million in deposits, $79 million in loans, and $5.4 million in shareholders' equity at December 31, 1998. WSB operates five full service branches in the Bellingham, Washington, area Bellingham, Ferndale, Lynden, Blaine and Point Roberts. Seaport Citizens Bank Subsequent to year end, on April 1, 1999 FWWB and FSBW completed the acquisition of Seaport Citizens Bank (SCB). FSBW paid $10.1 million in cash for all the outstanding common shares of SCB, which is headquartered in Lewiston, Idaho. As a result of the merger of SCB into FSBW, SCB became a division of FSBW. The acquisition will be accounted for as a purchase and result in the recording of approximately $6.2 million of costs in excess of the fair value of SCB's net assets acquired (goodwill). Goodwill assets will be amortized over a 14-year period and will result in a current charge to earnings of approximately $107,200 per quarter, beginning in the first quarter of fiscal 2000, or $429,000 per year. Founded in 1979, SCB is a commercial bank which had, before recording of goodwill, approximately $45 million in total assets, $41 million in deposits, $27 million in loans, and $4.1 million in shareholders' equity at March 31, 1999. SCB operates two full service branches in the Lewiston, Idaho, area. 4 Adoption of Dividend Reinvestment and Stock Purchase Plan In October 1997, the Company adopted a dividend reinvestment and stock purchase plan. Under the terms of the plan all registered stockholders with 100 or more shares of stock may automatically reinvest all or a portion of their cash dividends in additional shares of the Company's common stock. In addition, qualifying participants may also make optional monthly cash payments of $50 to $1,500 to purchase additional shares of Company stock. Lending Activities General: Historically, the Banks have offered a wide range of loan products to meet the demands of their customers. The Banks originate loans for both their own loan portfolios and for sale in the secondary market. Management's strategy has been to maintain a significant percentage of assets in these loan portfolios in loans with more frequent interest rate repricing terms or shorter maturities than traditional long term fixed-rate mortgage loans. As part of this effort, the Banks have developed a variety of floating or adjustable interest rate products that correlate closer with the Banks cost of funds. In response to customer demand, however, the Banks continue to originate fixed-rate loans including fixed interest rate mortgage loans with terms up to 30 years. The relative amount of fixed-rate loans and adjustable-rate loans that can be originated at any time is largely determined by the demand for each in a competitive environment. FSBW's primary lending focus is on the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences and loans for the construction of one- to four-family residences. FSBW also originates, to a lesser degree, consumer, commercial real estate, multi-family real estate and land loans. More recently, FSBW has begun marketing non-mortgage commercial and agribusiness loans to small businesses and farmers. Management expects this type of lending to increase at FSBW. At March 31, 1999, FSBW's net loan portfolio totaled $773.5 million. Over 68% of FSBW's first mortgage loans are secured by properties located in the State of Washington. The aggregate amount of loans that FSBW is permitted to make under applicable federal regulations to any one borrower, including related entities, is the greater of 20% of unimpaired capital and surplus or $500,000. At March 31, 1999, the maximum amount which FSBW could have lent to any one borrower and the borrower's related entities was $21.6 million. At March 31, 1999, FSBW had no loans to one borrower with an aggregate outstanding balance in excess of this amount. FSBW had 47 borrowers with total loans outstanding in excess of $2.0 million at March 31, 1999. At that date, the largest amount outstanding to any one borrower and the borrower's related entities totaled $12.0 million, which consisted of 39 single family, land development and lot loans in the Tacoma, Bellevue and Tri-Cities, Washington; and Portland, Oregon areas. At March 31, 1999, all except $2.8 million of these loans were performing in accordance with their terms. The $2.8 million is a series of loans on multiple four-plex developments (and 1 five-plex) in Hermiston, Oregon. The loans have been classified as impaired and loan loss reserves of $551,000 have been allocated to absorb potential losses. Lending activities at Inland Empire Bank have included origination of consumer, commercial, agribusiness and commercial real estate loans. In particular, IEB has developed significant expertise and market share with respect to small business and agricultural loans within its local markets. In addition, IEB has originated one- to four-family residential real estate loans for sale in the secondary market. At March 31, 1999, IEB's net loan portfolio totaled $142.2 million. The aggregate amount of loans that IEB is permitted to make under applicable state and federal regulations to any one borrower, including related entities, is 15% of the aggregate paid-up and unimpaired capital and surplus. At March 31, 1999, the maximum amount IEB could have lent to any one borrower and the borrower's related entities was $2.9 million ($4.7 million if secured by real estate). At that date, the largest amount outstanding to any one borrower of IEB totaled $3.3 million and was made to an alfalfa feed processor and exporter. Lending activities at Towne Bank have included origination of consumer, commercial, commercial real estate and construction loans. In particular, TB has developed significant expertise and growing market share with respect to small business loans within its local markets. 5 At March 31, 1999, TB's net loan portfolio totaled $187.0 million. The aggregate amount of loans TB is permitted to make under applicable state and federal regulations to any one borrower, including related entities, is 20% of the aggregate paid-up and unimpaired capital and surplus. At March 31, 1999, the maximum amount TB could have lend to any one borrower and the borrower's related entities was $3.3 million. At that date, the largest amount outstanding to any one borrower of TB totaled $2.5 million which is a two motel operation in the Seattle area. One- to Four-Family Residential Real Estate Lending: The Banks originate loans secured by first mortgages on owner-occupied, one- to four-family residences and loans for the construction of one- to four-family residences in the communities where they have established full service branches. In addition, the Banks operate loan production offices in Bellevue, Puyallup, Oak Harbor and Spokane, Washington and LaGrande and Condon, Oregon. FSBW also has a significant relationship with a mortgage loan broker in the greater Portland, Oregon market. At March 31, 1999, $407.7 million, or 34.2% of the Company's loan portfolio, consisted of permanent loans on one- to four-family residences. Historically, FSBW has originated both fixed-rate loans and adjustable-rate residential loans for its portfolio. Since the early 1980s, FSBW has restructured its loan portfolio to reflect a larger percentage of adjustable- rate loans. Fifteen and 30-year fixed-rate residential loans generally have been sold into the secondary market; however, a portion of the fixed-rate loans originated by FSBW have been retained in the loan portfolio to meet asset/liability management objectives. The number of fixed-rate loans retained by FSBW increased substantially during 1996 and remained high in fiscal years 1997 and 1998 in response to the capital deployment and growth objectives of the Company. For the past year FSBW has been selling a larger portion of its newly originated fixed rate loans as a part of its interest rate risk management strategy. Both before and after their acquisition by the Company, WSB and SCB engaged in residential lending, including secondary market activities, in a fashion very similar to FSBW. Historically, Inland Empire Bank has sold most of its residential loans into the secondary market and has continued to so do subsequent to its acquisition by the Company. Generally IEB has sold loans on a servicing-released basis such that no revenue is realized by IEB after the sale. Generally, Towne Bank has not engaged in one- to four-family residential lending. In the loan approval process, the Banks assess the borrower's ability to repay the loan, the adequacy of the proposed security, the employment stability of the borrower and the creditworthiness of the borrower. As part of the loan application process, qualified independent appraisers inspect and appraise the security property. All appraisals are subsequently reviewed by a loan underwriter and, if necessary, by the Banks' chief appraiser. The Banks' residential loans are generally underwritten and documented in accordance with the guidelines established by Freddie Mac and Fannie Mae. Government insured loans are generally underwritten and documented in accordance with the guidelines established by the Department of Housing and Urban Development (HUD) and the Veterans Administration (VA). The Banks' loan underwriters are approved as underwriters under HUD's delegated underwriter program. The Banks sell whole loans on either a servicing-retained or servicing- released basis. All loans are sold without recourse. Occasionally, the Banks will sell a participation interest in a loan or pool of loans to an investor. In these instances, the Banks retain a small percentage of the loan(s) and pass through a net yield to the investor on the percentage sold. The decision to hold or sell loans is based on asset/liability management goals and policies and market conditions. Recently, FSBW has sold a significant portion of its conventional fixed-rate mortgage originations and all of its government insured loans into the secondary market. IEB has continued to sell most of its residential loan originations. 6 The Banks offer adjustable-rate mortgages (ARMs) at rates and terms competitive with market conditions. The Banks offer several ARM products which adjust annually after an initial period ranging from one to five years subject to a limitation on the annual increase of 1.0% to 2.0% and an overall limitation of 5.0% to 6.0%. Certain ARM loans are originated with an option to convert the loan to a 30-year fixed-rate loan at the then prevailing market interest rate. Generally these ARM products utilize the weekly average yield on one-year U.S. Treasury securities adjusted to a constant maturity of one year plus a margin of 2.75% to 3.25%. ARM loans held in the Banks' portfolios do not permit negative amortization of principal and carry no prepayment restrictions. Borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates and fees charged for each type of loan. In recent years borrower demand for ARM loans has been limited and the Banks have chosen not to aggressively pursue ARM loans by offering minimally profitable deeply discounted teaser rates. As a result ARM loans have represented only a very small portion of loans originated during this period. The retention of ARM loans in the Banks' loan portfolios can help reduce the Company's exposure to changes in interest rates. There are, however, unquantifiable credit risks resulting from the potential of increased interest to be paid by the customer due to increases in interest rates. It is possible that, during periods of rising interest rates, the risk of default on ARM loans may increase as a result of repricing and the increased costs to the borrower. Furthermore, because the ARM loans originated by the Banks generally provide, as a marketing incentive, for initial rates of interest below the rates which would apply were the adjustment index plus the margin used for pricing initially, these loans are subject to increased risks of default or delinquency. The Banks attempt to reduce the potential for delinquencies and defaults on ARM loans by qualifying the borrower based on the borrower's ability to repay the ARM loan assuming that the maximum interest rate that could be charged at the first adjustment period remains constant during the loan term. Another consideration is that although ARM loans allow the Banks to increase the sensitivity of their asset bases to changes in the interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits (caps). Because of these considerations, the Company has no assurance that yields on ARM loans will be sufficient to offset increases in its cost of funds. It is the Banks' normal policy to lend up to 95% of the lesser of the appraised value of the property or purchase price of the property on conventional loans, although ARM loans are normally restricted to not more than 90%. Higher loan-to-value ratios are available on certain government insured programs and on a recently introduced limited program strictly underwritten and insured by United Guaranty Insurance Corporation. The Banks generally require private mortgage insurance on residential loans with a loan- to-value ratio at origination exceeding 80%. Construction and Land Lending: FSBW and TB invest a significant proportion of their loan portfolio in residential construction loans to professional home builders. This activity has been prompted by favorable economic conditions in the Northwest, lower long-term interest rates and an increased demand for housing units as a result of the migration of people from other parts of the country to the Northwest. To a lesser extent, FSBW and TB also originates land loans. IEB also originates construction and land loans although to a much smaller degree than FSBW and TB. At March 31, 1999, construction and land loans totaled $217.1 million, or 18.2% of total loans of the Company. Construction loans made by the Banks include both those with a sale contract or permanent loan in place for the finished homes and those for which purchasers for the finished homes may be identified either during or following the construction period. The Banks monitor the number of unsold homes in their construction loan portfolios, and generally maintain the portfolios so that no more than 60-70% of their construction loans are secured by homes for which there is not a sale contract in place. 7 Construction and land lending affords the Banks the opportunity to achieve higher interest rates and fees with shorter terms to maturity than does single-family permanent mortgage lending. Construction and land lending, however, is generally considered to involve a higher degree of risk than single-family permanent mortgage lending because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost of the project. The nature of these loans is such that they are generally more difficult to evaluate and monitor. If the estimate of construction cost proves to be inaccurate, the Banks may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion proves to be inaccurate, the Banks may be confronted at, or prior to, the maturity of the loan with a project whose value is insufficient to assure full repayment. Projects may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. Loans to builders to construct homes for which no purchaser has been identified carry more risk because the payoff for the loan is dependent on the builder's ability to sell the property prior to the time that the construction loan is due. The Banks have sought to address these risks by adhering to strict underwriting policies, disbursement procedures, and monitoring practices. The maximum number of speculative loans approved for each builder is based on a combination of factors, including the financial capacity of the builder, the market demand for the finished product, and the ratio of sold to unsold inventory the builder maintains. The Banks have chosen to diversify the risk associated with speculative construction lending by doing business with a large number of smaller builders spread over a relatively large geographic area. Loans for the construction of one- to four-family residences are generally made for a term of 12 months. The Banks' loan policies include maximum loan- to-value ratios of up to 80% for speculative loans. Each individual speculative loan request is supported by an independent appraisal of the property and the loan file includes a set of plans, a cost breakdown and a completed specifications form. All speculative construction loans must be approved by senior loan officers. At March 31, 1999, the Company's speculative construction portfolio included loans to 221 individual builders in 90 separate communities. At March 31, 1999, the Company had 29 home builders, who individually in the aggregate, had construction loans outstanding with balances exceeding $1.0 million. The Company regularly monitors the construction loan portfolio and the economic conditions and housing inventory in each of its markets and will decrease construction lending if it perceives there are unfavorable market conditions. The Company believes that the internal monitoring system in place mitigates many of the risks inherent in its construction lending. To a much lesser extent, the Banks make land loans to developers, builders and individuals to finance the acquisition and/or development of improved lots or unimproved land. In making land loans the Banks follow underwriting policies and disbursement procedures similar to those for construction loans. The initial term on land loans is typically one to three years with interest only payments, payable monthly, and provisions for principal reduction as lots are sold and released. Multifamily and Commercial Real Estate Lending: The Banks also originate loans secured by multifamily and commercial real estate. At March 31, 1999, the Company's loan portfolio included $57.5 million in multifamily and $267.4 million in commercial real estate loans (including commercial real estate construction lending). Multifamily and commercial real estate lending affords the Banks an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending. However, loans secured by such properties are generally greater in amount, more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multifamily and commercial properties are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. In all multi-family and commercial real estate lending, the Banks consider the location, marketability and overall attractiveness of the properties. The Banks current underwriting guidelines for commercial real estate loans require an appraisal from a qualified independent appraiser and an economic analysis of each property with regard to the annual revenue and expenses, debt service coverage and fair value to determine the maximum loan amount. In the approval process the Banks assess the borrowers willingness and ability to repay and the adequacy of the collateral. 8 Multifamily and commercial real estate loans originated by the Banks are predominately fixed rate loans with intermediate terms of 10 years. More recently originated multifamily and commercial loans are linked to various constant maturity U.S. Treasury indices or certain prime rates. Rates on these ARM loans generally adjust annually after an initial period ranging from one to ten years. Rate adjustments for the more seasoned ARM loans in the portfolio predominantly reflect changes in the Federal Home Loan Bank (FHLB) National Monthly Median Cost of Funds index. The Banks' commercial real estate portfolios consist of loans on a variety of property types including motels, nursing homes, office buildings, and mini-warehouses. Multifamily loans generally are secured by small to medium sized projects. At March 31, 1999, the Banks' loan portfolio included 136 multifamily loans, the average loan balance of which was $407,000. At March 31, 1999, the Banks had 59 multifamily or commercial real estate loans with balances over $1.0 million, the largest of which was $3.3 million. Most of the properties securing these multifamily and commercial real estate loans are located in the Northwest however the Company has acquired some participation loans on properties located in California. Agriculture/commercial Lending. Inland Empire Bank has been very active in small business and agricultural lending, Towne Bank has also been very active in commercial lending, however TB generally has not engaged in agricultural lending. IEB and TB's management have devoted a great deal of effort to developing customer relationships and the ability to serve this type of borrower. It is management's belief that many very large banks have in the past neglected small business lending, thus contributing to IEB's and TB's success. IEB and TB will continue to emphasize this segment of lending in their market areas. Management intends to leverage their past success and local decision making ability to continue to expand this market niche. Historically, Towne Bank has sold most of its small business administration loans into the secondary market, servicing retained, and has continued to so do subsequent to its acquisition by the Company. First Savings Bank has recently begun making non-mortgage agricultural and commercial loans. FSBW has staffed its Walla Walla, Tri-Cities, Clarkston, Yakima and Wenatchee offices with experienced commercial bankers and anticipates a steady growth in the origination of small business and agricultural loans. It is expected the growth will come primarily from FSBW's existing customer base and referrals from officers and Directors. In addition to providing higher yielding assets, it is anticipated that this type of lending will increase the deposit base of these branches. Expanding non mortgage agricultural/commercial lending is currently an area of significant effort at FSBW. Similar to IEB and TB, WSB and SCB have been active in commercial lending. Similar to consumer loans, agricultural and commercial loans may entail greater risk than do residential mortgage loans. Agricultural and commercial loans may be unsecured or secured by special purpose or rapidly depreciating assets, such as equipment, crops, live stock, inventory and receivables which may not provide an adequate source of repayment on defaulted loans. In addition, agricultural and commercial loans are dependent on the borrower's continuing financial stability and management ability as well as market conditions for various products, services and commodities. For these reasons, agricultural and commercial loans generally provide higher yields than residential loans but also require more administrative and management attention. Interest rates on agricultural and commercial loans may be either fixed or adjustable. Loan terms including the fixed or adjustable interest rate, the loan maturity and the collateral considerations vary significantly and are negotiated on an individual loan basis. At March 31, 1999, agribusiness/commercial loans totaled $196.7 million, or 16.5% of total loans of the Company. In all agricultural and commercial lending, the Banks consider the borrowers credit worthiness and ability to repay and the adequacy of the offered collateral. Current underwriting guidelines for agricultural/commercial loans require an economic analysis with regard to annual revenue and expenses, debt service coverage, collateral and fair value to determine the maximum loan amount. Before the Banks make a commercial loan, the borrower must obtain the approval of various levels of Bank personnel, depending on the size and characteristics of the loan. Consumer and Other Lending: The Banks originate a variety of consumer loans, including secured second mortgage loans, automobile loans, credit card loans and loans secured by deposit accounts. Consumer and other lending has traditionally been a small part of FSBW's and TB's business. However, recent efforts at FSBW have led to a substantial increase in credit card loans to its existing customer base. Inland Empire Bank, on the other hand, has been an active originator of consumer loans. At March 31, 1999, the Company had $44.4 million, or 3.7% of its loans receivable, in outstanding consumer and other loans. 9 Consumer loans often entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Such loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loans such as the Banks, and a borrower may be able to assert against such assignee claims and defenses that it has against the seller of the underlying collateral. Loan Solicitation and Processing: The Banks originate real estate loans by direct solicitation of real estate brokers, builders, depositors, and walk-in customers. Loan applications are taken by the Banks' loan officers and are processed in each branch location. Most underwriting and all audit functions are performed by loan administration personnel at each Bank's main office. Applications for fixed-rate and adjustable-rate mortgages on one- to four- family properties are generally underwritten and closed based on Freddie Mac/ Fannie Mae standards, and other loan applications are underwritten and closed based on the Banks' own written guidelines. Consumer loans are originated through various marketing efforts directed primarily toward existing deposit and loan customers of the Banks. Consumer loan applications may be processed at branch locations or by administrative personnel at the Banks' main offices. Commercial and agricultural loans are solicited by loan officers of each Bank by means of call programs focused on local businesses and farmers. Credit decisions on significant commercial and agricultural loans are made by senior loan officers or in certain instances by the Board of Directors of each Bank or the Company. Loan Originations, Sales and Purchases While the Banks originate a variety of loans, their ability to originate loans and their ability to originate each type of loan is dependent upon the relative customer demand and competition for loans in each market. For the years ended March 31, 1999, 1998 and 1997, the Banks originated $734.1 million, $513.5 million and $330.3 million of loans, respectively. The Company's net loan portfolio grew $345.8 million or 45.7% in fiscal 1999 ($146.4 million excluding acquisitions) compared to $111.0 million of growth in fiscal 1998 and $230.6 million of growth in fiscal 1997 ($90.5 million excluding acquisitions). In recent years prior to 1996 the Company generally sold most of its 30-year fixed-rate one- to four-family residential mortgage loans to secondary market purchasers. For the years ended March 31, 1996 and 1997 the Company sold a smaller portion of its fixed-rate loan originations choosing to retain loans in response to its capital deployment and growth objectives. Beginning in the second half of fiscal year 1998 the Company increased the amount of new fixed- rate residential loan sold as part of its interest rate risk management strategy. Sales of loans by the Company for the years ended March 31, 1999, 1998 and 1997 totaled $125.7 million, $80.6 million and $36.6 million, respectively. Sales of whole loans generally are beneficial to the Company since these sales may generate income at the time of sale, provide funds for additional lending and other investments and increase liquidity. The Company sells loans on both a servicing-retained and a servicing-released basis. See "Loan Servicing-Loan Servicing Portfolio." At March 31, 1999, the Company had $12.4 million in loans held for sale. The Banks, especially FSBW, purchase whole loans and loan participation interests primarily during periods of reduced loan demand in their primary market. Any such purchases are made consistent with the Banks' underwriting standards; however, the loans may be located outside of the Banks' normal lending area. During the years ended March 31, 1999, 1998 and 1997, the Company purchased $86.2 million, $51.1 million and $74.1 million, respectively, of loans and loan participation interests. 10 Loan Portfolio Analysis. The following table sets forth the composition of the Company's loan portfolio (including loans held for sale) by type of loan as of the dates indicated. March 31 -------------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ----------------- ---------------- --------------- --------------- --------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in thousands) Type of Loan: ------------- One- to four-family real estate $ 407,673 34.24% $423,850 51.53% $395,418 55.86% $311,472 68.24% $199,585 59.81% Commercial and multifamily properties 324,858 27.28 167,859 20.41 129,198 18.25 77,613 16.99 73,443 22.01 Construction and land 217,094 18.23 132,409 16.10 110,262 15.58 62,177 13.62 57,913 17.36 Agriculture/ commercial 196,743 16.52 67,611 8.22 47,846 6.76 871 .19 902 .27 Consumer and other 44,346 3.73 30,842 3.74 25,092 3.55 4,333 .96 1,842 .55 --------- ------ ------- ------ -------- ------ ------- ------ -------- ------ Total loans 1,190,714 100.00% 822,571 100.00% 707,816 100.00% 456,466 100.00% 333,685 100.00% --------- ====== ------- ====== -------- ====== ------- ====== ------- ====== Undisbursed funds for loans in progress 71,638 54,500 52,412 35,244 28,507 Deferred loan fees and discounts 4,146 3,297 2,775 1,876 2,226 Allowance for loan losses 12,261 7,857 6,748 4,051 3,549 Total loans ---------- -------- -------- -------- -------- receivable, net $1,102,669 $756,917 $645,881 $415,295 $299,403 ========== ======== ======== ======== ======== 11
Loan Maturity and Repricing The following table sets forth certain information at March 31, 1999 regarding the dollar amount of loans maturing in the Company's portfolio based on their contractual terms to maturity, but does not include scheduled payments or potential prepayments. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances are net of undisbursed loan proceeds, unamortized premiums and discounts, and exclude the allowance for loan losses (in thousands): Maturing Maturing Maturing Maturing within within within Maturing Within 1 to 3 to 5 to Beyond One Year 3 Years 5 Years 10 Years 10 Years Total -------- -------- --------- --------- -------- ---------- One-to four- family real estate $ 3,549 $ 3,645 $ 6,098 $ 15,774 $360,418 $ 389,484 Commercial and multifamily properties 24,235 50,053 60,833 116,501 67,823 319,445 Construction and land 141,881 13,313 1,955 3,968 4,138 165,255 Agriculture/ commercial 96,955 20,000 36,009 35,213 8,189 196,366 Consumer and other 16,555 9,239 11,421 2,549 4,616 44,380 --------- -------- --------- --------- -------- ---------- Total loans $ 283,175 $ 96,250 $ 116,316 $ 174,005 $445,184 $1,114,930 ========= ======== ========= ========= ======== ========== Contractual maturities of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their contractual maturities because of scheduled principal repayments and prepayments. In addition, due-on-sale clauses on loans generally give the Company the right to declare loans immediately due and payable in the event that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decreases when rates on existing mortgage loans are substantially higher than current mortgage loan market rates. The following table sets forth the dollar amount of all loans due after March 31, 2000, which have fixed interest rates and floating or adjustable interest rates (in thousands). Fixed Floating or Rates Adjustable Rates Total ----- ---------------- ----- One-to four-family real estate $315,081 $ 70,854 $385,935 Commercial and multifamily properties 190,606 104,604 295,210 Construction and land 7,965 15,409 23,374 Agriculture/commercial 42,759 56,652 99,411 Consumer and other 21,238 6,587 27,825 -------- -------- -------- Total $577,649 $254,106 $831,755 ======== ======== ======== 12 Loan Servicing General: The Banks receive fees from a variety of institutional owners in return for performing the traditional services of collecting individual payments and managing portfolios of sold loans. At March 31, 1999, the Banks were servicing $268.8 million of loans for others. Loan servicing includes processing payments, accounting for loan funds and collecting and paying real estate taxes, hazard insurance and other loan-related items such as private mortgage insurance. When the Banks receive the gross loan payment from individual borrowers, they remit to the investor a predetermined net amount based on the yield on that loan. The difference between the coupon on the underlying loan and the predetermined net amount paid to the investor is the gross loan servicing fee. In addition, the Banks retain certain amounts in escrow for the benefit of the lender for which the Banks incur no interest expense but are able to invest the funds into earning assets. At March 31, 1999, the Banks held $4.1 million in escrow for their portfolios of loans serviced for others. Loan Servicing Portfolio: The loan servicing portfolio at March 31, 1999 was composed primarily of $32.8 million of Fannie Mae mortgage loans and $198.0 million of Freddie Mac mortgage loans. The balance of the loan servicing portfolio at March 31, 1999, consisted of loans serviced for a variety of private investors. At March 31, 1999, the portfolio included loans secured by property located primarily in the states of Washington or Oregon. For the year ended March 31, 1999, $798,000 of loan servicing fees, net of $278,000 of servicing rights amortization, were recognized in operations. Mortgage Servicing Rights: In addition to the origination of mortgage servicing rights (MSRs) on the loans that FWWB originates and sells in the secondary market on a servicing retained basis, FWWB has also purchased mortgage servicing rights. The cost of MSRs is capitalized and amortized in proportion to, and over the period of, the estimated future net servicing income. For the years ending March 31, 1999 and 1998 FWWB capitalized $981,000 and $442,000, respectively, of mortgage servicing rights relating to loans sold with servicing retained, in addition, $270,000 of MSR's were obtained in the acquisition of WSB. No MSRs were purchased in fiscal years 1999, 1998 and 1997. Amortization of MSR's for the year ended March 31, 1999 was $278,000 compared to $100,000 for the year ended March 31, 1998. Management periodically evaluates the estimates and assumptions used to determine the carrying values of MSRs and the amortization of MSRs. These carrying values are adjusted when the valuation indicates the carrying value is impaired. At March 31, 1999, MSRs were carried by FWWB at a value, net of amortization, of $1,671,000, and no valuation allowance for impairment was considered necessary. MSRs generally are adversely affected by current and anticipated prepayments resulting from decreasing interest rates. Asset Quality Each Bank's asset classification committee meets at least monthly to review all classified assets, to approve action plans developed to resolve the problems associated with the assets and to review recommendations for new classifications, any changes in classifications and recommendations for reserves. The committee reports to the Board of Directors quarterly as to the current status of classified assets and action taken in the preceding quarter. State and Federal regulations require that the Banks review and classify their problem assets on a regular basis. In addition, in connection with examinations of insured institutions, state and federal examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets must have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a significant possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations have also created a special mention category, described as assets which do not currently expose an insured institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management's close attention. If an asset or portion thereof is classified loss, the insured institution establishes specific allowances for loan losses for the full amount of the portion of the asset classified loss. A portion of general loan loss allowances established to cover possible losses related to assets classified substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. 13 At March 31, 1999, 1998 and 1997, the aggregate amounts of the Banks' classified assets (as determined by the Banks) were as follows (in thousands): At March 31 --------------------------------------- 1999 1998 1997 ---- ---- ---- Loss $ 60 $ - - $ - - Doubtful 58 - - - - Substandard assets 8,302 2,776 4,175 Special mention 3,008 - - - - Non-performing Assets and Delinquencies. Real Estate Loans: When a borrower fails to make a required payment when due, the Banks follow established collection procedures. The first notice is mailed to the borrower within 10 to 17 days after the payment due date and attempts to contact the borrower by telephone begin within five to ten days after the late notice is mailed to the borrower. If the loan is not brought current by 30 days after the payment due date, the Banks will mail a second written notice to the borrower. If a satisfactory response is not obtained, continuous follow-up contacts are attempted until the loan has been brought current. Generally, for residential loans within 30 to 45 days into the delinquency procedure, the Banks notify the borrower that home ownership counseling is available. In most cases, delinquencies are cured promptly; however, if after 90 days of delinquency no response has been received nor an approved reinstatement plan established, foreclosure according to the terms of the security instrument and applicable law is initiated. Interest income on loans after 90 days of delinquency is no longer accrued and the full amount of accrued and uncollected interest is reversed. Agriculture/commercial and Consumer Loans: When a borrower fails to make payments as required, a late notice is sent to the borrower. If payment is still not made the responsible loan officer is advised and contact is made my telephone or letter. Continuous follow-up contacts are attempted until the loan has been brought current. Generally, if the loan is not current within 45 to 60 days, action is initiated to take possession of the security. A small claims or lawsuit is normally filed on unsecured loans or deficiency balances at 90 to 120 days. Loans over 90 days delinquent, repossessions, loans in foreclosure and bankruptcy no longer accrue interest unless a satisfactory repayment plan has been agreed upon, the loan is a full recourse contract or fully secured by a deposit account. 14 The following table sets forth information with respect to the Banks' non-performing assets and restructured loans within the meaning of SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructuring, at the dates indicated (dollars in thousands). At March 31 --------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Loans accounted for on a nonaccrual basis: Real estate One- to four-family $3,564 $ 448 $1,644 $ 526 $336 Commercial and multifamily 351 -- 187 -- -- Construction and land 767 367 -- -- -- Agriculture/commercial 1,439 414 206 -- -- Consumer and other 17 41 45 -- 5 ------ ------ ------ ------ ---- Total 6,138 1,270 2,082 526 341 Accruing loans which are contractually ------ ------ ------ ------ ---- past due 90 days or more: Real estate One-to four family 20 52 -- -- -- Commercial and multifamily 384 33 -- - Construction and land -- 32 -- - -- Agriculture/commercial 1,052 -- -- -- -- Consumer and other 82 33 30 12 - ------ ------ ------ ------ ---- Total 1,538 150 30 12 - ------ ------ ------ ------ ---- Total non-performing loans 7,676 1,420 2,112 538 341 Real estate/repossessed assets held for sale 1,644 882 1,057 712 588 ------ ------ ------ ------ ---- Total non-performing assets $9,320 $2,302 $3,169 $1,250 $929 ====== ====== ====== ====== ==== Restructured loans (1) $ 380 $ 305 $ 238 $ 156 $165 Total non-performing loans to net loans 0.69% 0.19% 0.33% 0.13% 0.11% Total non-performing loans to total assets 0.47% 0.20% 0.21% 0.07% 0.07% Total non-performing assets to total assets 0.57% 0.20% 0.31% 0.17% 0.19% (1) These loans are performing under their restructured terms but are classified substandard. For the year ended March 31, 1999, $269,000 in interest income would have been recorded had nonaccrual loans been current, and no interest income on such loans was included in net income for such period. 15 Allowance for Loan Losses General: In originating loans, the Banks recognize that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan. As a result, the Banks maintain an allowance for loan losses consistent with the generally acceptable accounting principles (GAAP) guidelines outlined in SFAS No. 5, Accounting for Contingencies. The Banks have established systematic methodologies for the determination of the adequacy of their allowance for loan losses. The methodologies are set forth in a formal policy and take into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual problem loans. The Banks increase their allowance for loan losses by charging provisions for possible loan losses against the Banks' income. On April 1, 1995, the Company and its subsidiary Banks adopted SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures, an amendment of SFAS No. 114. These statements require that impaired loans that are within their scope be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. Subsequent changes in the measurement of impaired loans shall be included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. The adoption of these statements had no material impact on the Company's or Banks' financial condition or results of operations. Prior to the adoption of these statements a reserve for specific losses was provided for loans when any significant, permanent decline in value was deemed to have occurred. As of March 31, 1999, the Company and its subsidiary Banks had identified $3.7 million of impaired loans as defined by the statement and had established $739,000 of specific reserves for these loans. The statements also apply to all loans that are restructured in a troubled debt restructuring, subsequent to the adoption of SFAS No. 114, as defined by SFAS No. 15. A troubled debt restructuring is a restructuring in which the creditor grants a concession to the borrower that it would not otherwise consider. At March 31, 1999, the Company had $380,000 of restructured loans that, though performing, were classified substandard. The allowance for losses on loans is maintained at a level sufficient to provide for estimated losses based on evaluating known and inherent risks in the loan portfolio and upon management's continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience, current economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. Additions to these allowances are charged to earnings. Realized losses and charge-offs that are related to specific loans are applied as a reduction of the carrying value of the assets and charged immediately against the allowance for losses. Recoveries on previously charged off loans are credited to the allowance. The reserve is based upon factors and trends identified by management at the time financial statements are prepared. The Company's methodology for assessing the appropriateness of the allowance consists of several key elements, which include specific allowances, an allocated formula allowance, and an unallocated allowance. Losses on specific loans are provided for when the losses are probable and estimable. The formula allowance is calculated by applying loss factors to outstanding loans, excluding loans with specific allowances. Loss factors are based on the Company's historical loss experience adjusted for significant factors including the experience of other banking organizations that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. The unallocated allowance is based upon management's evaluation of various factors that are not directly measured in the determination of the formula and specific allowances. Although management uses the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond the Banks' control. 16 At March 31, 1999, the Company had an allowance for loan losses of $12.3 million which represented 1.10% of net loans and 160% of non-performing loans compared to 1.03% and 533%, respectively, at March 31, 1998. The provision for loan losses for the year ended March 31, 1999, increased by $1.2 million to $2.8 million compared to $1.6 million for fiscal 1998. This increase is reflective of the growth in loans receivable which, excluding loans acquired through business combination, increased by $165.7 million for the 1999 fiscal year compared to an increase of $111.0 million in the 1998 period. The increase also is reflective of changes in the portfolio mix which resulted in the need for a higher level of loss allowance as well as the impact of a greater amount of non-performing loans and net charge-offs for the year. Specifically, excluding loans acquired through acquisitions, changes in the loan mix included increases of $119.8 million in commercial and multifamily real estate loans, $59.3 million in construction and land loans, and $27.9 million in commercial and agricultural loans, while one- to four-family loans declined by $40.3 million and consumer loans declined by $1 million. Income producing real estate loans, construction and land loans, commercial and agricultural loans are generally riskier than one- to four-family residential loans resulting in a higher provision for losses. Adding to the need for the increased provision for loan losses for the year ended March 31, 1999 was an increase in the amount of non-performing loans which grew to $7.7 million compared to $1.4 million a year earlier. Further adding to the increase in the provision for loan losses was an increase in the level of net charge-offs which increased from $519,000 for the year ended March 31, 1998, to $1.1 million for the year ended March 31, 1999 (see Notes 7 and 8 to the Consolidated Financial Statements for further analysis of the loan portfolio mix and allowance for loan losses). While the Company believes that the Banks have established their existing allowance for loan losses in accordance with Generally Accepted Accounting Principles (GAAP), there can be no assurance that regulators, in reviewing the Banks' loan portfolio, will not request the Banks to increase significantly their allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect the Company's financial condition and results of operations. Real Estate Held for Sale, Repossessed Assets: Real estate acquired by the Company as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate held for sale until it is sold. When property is acquired it is recorded at the lower of its cost (the unpaid principal balance of the related loan plus foreclosure costs), or net realizable value. Subsequent to foreclosure, the property is carried at the lower of the foreclosed amount or net realizable value. Upon receipt of a new appraisal and market analysis, the carrying value is written down through the establishment of a specific reserve to the anticipated sales price less selling and holding costs. At March 31, 1999, the Company had $1.4 million of real estate owned and $205,000 of other repossessed assets. 17 The following table sets forth an analysis of the Company's gross allowance for possible loan losses for the periods indicated. Years Ended March 31 ------------------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (Dollars in thousands) Allowance at beginning of period $ 7,857 $6,748 $4,051 $3,549 $3,429 ------- ------ ------ ------ ------ Acquisitions 2,693 -- 1,416 -- -- ------- ------ ------ ------ ------ Provision for loan losses 2,841 1,628 1,423 524 391 Recoveries: ------- ------ ------ ------ ------ Secured by real estate One - to four-family -- 6 38 -- -- Commercial and multifamily 60 -- -- -- -- Construction and land -- -- -- -- -- Agriculture/commercial 144 29 -- -- -- Consumer and other 21 16 16 -- -- ------- ------ ------ ------ ------ Total recoveries 225 51 54 -- -- ------- ------ ------ ------ ------ Charge-offs: Secured by real estate One - to four-family 25 359 127 -- -- Commercial and multifamily 35 -- -- -- 271 Construction and land 69 11 -- -- -- Agriculture/commercial 916 19 3 -- -- Consumer and other 310 181 66 22 -- ------- ------ ------ ------ ------ Total charge-offs 1,355 570 196 22 271 ------- ------ ------ ------ ------ Net charge-offs 1,130 519 142 22 271 ------- ------ ------ ------ ------ Balance at end of period $12,261 $7,857 $6,748 $4,051 $3,549 ======= ====== ====== ====== ====== Ratio of allowance to net loans outstanding at the end of the period 1.10% 1.03% 0.94% 0.97% 1.17% Ratio of net loan charge-offs to the average net book value of loans outstanding during the period 0.14% 0.08% 0.04% 0.01% 0.10% 18 The following table sets forth the breakdown of the allowance for loan losses by loan category for the periods indicated. At March 31 --------------------------------------------------------------------------------------- 1999 1998 (2) 1997 1996 1995 --------------- ----------------- --------------- -------------- ----------------- Percent Percent Percent Percent Percent of Loans of Loans of Loans of Loans of Loans in Each in Each in Each in Each in Each Category Category Category Category Category to to to to to Total Total Total Total Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- (Dollars in thousands) Specific or allocated loss allowances: Secured by real estate One-to four- family $ 2,757 34.24% $ 1,059 51.53% $ 1,098 55.86% $ -- 68.24% $ 11 59.81% Commercial and multifamily 3,567 27.28 849 20.41 547 18.25 -- 16.99 46 22.01 Construction and land 1,597 18.23 856 16.10 844 15.58 -- 13.62 -- 17.36 Agriculture/ commercial 2,522 16.52 835 8.22 422 6.76 -- .19 -- .27 Consumer and other 841 3.73 307 3.74 237 3.55 -- .96 -- .55 Unallocated general loss allowance(1)(2) 977 N/A 3,951 N/A 3,600 N/A 4,051 N/A 3,492 N/A Total allowance ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ for loan losses $12,261 100.00% $ 7,857 100.00% $ 6,748 100.00% $ 4,051 100.00% $ 3,549 100.00% ======= ====== ======= ====== ======= ====== ======= ====== ======= ====== - ------------- (1) The Company establishes specific loss allowances when individual loans are identified that present a possibility of loss (i.e., that full collectibility is not reasonably assured). The remainder of the allowance for loan losses is established for the purpose of providing for estimated losses which are inherent in the loan portfolio. (2) For 1997 the Company has not changed how it determines the adequacy of its allowance for loan losses other than to allocate the non-specific loan loss reserves to loan categories that were the basis for its accrual. In the periods prior to 1997, it was not the Company's practice to allocate general loan loss allowances to specific loan categories. 19
Investment Activities Under Washington and Oregon state law, banks are permitted to invest in various types of marketable securities. Authorized securities include but are not limited to U.S. Treasury obligations, securities of various federal agencies, mortgage-backed securities, certain certificates of deposit of insured banks and savings institutions, banker's acceptances, repurchase agreements, federal funds, commercial paper, corporate debt and equity securities and obligations of states and their political sub-divisions. The investment policies of the Banks are designed to provide and maintain adequate liquidity and to generate favorable rates of return without incurring undue interest rate or credit risk. The Banks' policies generally limit investments to U.S. Government and agency securities, municipal bonds, certificates of deposit, marketable corporate debt obligations and mortgage-backed securities. Investment in mortgage-backed securities includes those issued or guaranteed by Freddie Mac (FHLMC), Fannie Mae (FNMA), Government National Mortgage Association (GNMA) and privately-issued collateralized mortgage-backed securities that have an AA credit rating or higher. A high credit rating indicates only that the rating agency believes there is a low risk of loss or default. However, all of the Banks' investment securities, including those that have high credit ratings, are subject to market risk in so far as a change in market rates of interest or other conditions may cause a change in an investment's market value. At March 31, 1999, the Company's consolidated investment portfolio totaled $364.2 million and consisted principally of U.S. Government and agency obligations, mortgage-backed securities, municipal bonds, corporate debt obligations, and stock of FNMA and FHLMC. From time to time, investment levels may be increased or decreased depending upon yields available on investment alternatives, and management's projections as to the demand for funds to be used in the Banks' loan originations, deposits and other activities. During fiscal 1999 investments and securities increased by $61.6 million (including $45.7 million obtained in the acquisitions of TB and WSB). Holdings of mortgage-backed securities increased $45.7 million and U.S. Treasury and agency obligations decreased $9.1 million. Ownership of corporate and other securities increased $20.0 million. Municipal bonds increased $5.0 million primarily from acquisitions. Mortgage-Backed and Mortgage-Related Securities: The Company purchases mortgage-backed securities in order to: (i) generate positive interest rate spreads on large principal balances with minimal administrative expense; (ii) lower the credit risk of the Company as a result of the guarantees provided by FHLMC, FMNA, and GNMA or credit enhancements provided other entities or the structure of the securities; (iii) enable the Company to use mortgage-backed securities as collateral for financing; and (iv) increase liquidity. The Company invests primarily in federal agency issued or guaranteed mortgage- backed and mortgage-related securities, principally FNMA, FHLMC and GNMA. The Company also invests in privately issued collateralized mortgage obligations (CMOs) and real estate mortgage investment conduits (REMICs). At March 31, 1999, net mortgage-backed securities totaled $242.8 million, or 14.9% of total assets. At March 31, 1999, 47.6% of the mortgage-backed securities were adjustable-rate and 52.5% were fixed-rate. The estimated fair value of the Company's mortgage-backed securities at March 31, 1999, was $242.8 million, which is $607,000 less than the amortized cost of $243.4 million. At March 31, 1999, the Company's portfolio of mortgage-backed securities had a weighted average coupon rate of 6.53%. The estimated weighted average remaining life of the portfolio was 3.2 years based on the last 3 months "constant prepayment rate" (CPR) or the most recent CPR if less than 3 months history is available. Mortgage-backed securities known as PC's or mortgage pass-through certificates generally represent a participation interest in a pool of single-family mortgage loans. The principal and interest payments on these loans are passed from the mortgage originators, through intermediaries (generally U.S. Government agencies and government sponsored enterprises) that pool and resell the participation interests in the form of securities, to investors such as the Company. Mortgage participation certificates generally yield less than the loans that underlie such securities because of the cost of payment guarantees and credit enhancements. In addition, PC's are usually more liquid than individual mortgage loans and may be used to collateralized certain liabilities and obligations of the Company. These types of securities also permit the Company to optimize its regulatory capital because of their low risk weighting. 20 CMOs and REMICs are mortgage-related obligations and may be considered as derivative financial instruments because they are created by redirecting the cash flows from the pool of mortgage loans or mortgage-backed securities underlying these securities into two or more classes (or tranches) with different maturity or risk characteristics. Management believes these securities may represent attractive alternatives relative to other investments due to the wide variety of maturity, repayment and interest rate options available; however, the complex structure of certain CMOs increases the difficulty in assessing the portfolio's risk and its fair value. Yields on privately issued CMOs generally exceed the yield on similarly structured agency CMOs because they expose the Company to certain risks not inherent in agency CMOs, such as credit risk and liquidity risk. Neither the U.S. government nor any of its agencies guarantees these assets generally because the loan size, credit underwriting or underlying collateral do not meet certain industry standards. Consequently, the potential for loss of principal is higher for privately issued securities. In addition, because the universe of potential investors for privately issued CMOs is smaller, these securities are somewhat less liquid than are agency issued or guaranteed securities. At March 31, 1999 the Company held CMOs and REMICs with a net carrying value of $209.9 million, including $59.3 million of privately issued CMOs. Of the Company's $242.8 million mortgage-backed securities portfolio at March 31, 1999, $120.0 million with a weighted average yield of 5.52% had contractual maturities or period to repricing within ten years and $122.8 million with a weighted average yield of 6.85% had contractual maturities or period to repricing over ten years. However, the actual maturity of a mortgage-backed security is usually less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and may result in rapid amortization of premiums or discounts and thereby affect the net yield on such securities. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of declining mortgage interest rates, if the coupon rate of the underlying mortgage loans exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgage loans and the related security. Under such circumstances, the Company may be subject to reinvestment risk because, to the extent that the Company's mortgage-backed securities amortize or prepay faster than anticipated, the Company may not be able to reinvest the proceeds of such repayments and prepayments at a comparable rate. In contrast to mortgage-backed securities in which cash flow is received (and hence, prepayment risk is shared) pro rata by all securities holders, the cash flow from the mortgage loans or mortgage-backed securities underlying REMICs or CMOs is segmented and paid in accordance with a predetermined priority to investors holding various tranches of such securities or obligations. A particular tranche of REMICs and CMOs may therefore carry prepayment risk that differs from that of both the underlying collateral and other tranches. Municipal Bonds: The Company's tax exempt municipal bond portfolio, which at March 31, 1999, totaled $34.3 million at estimated fair value ($33.0 million at amortized cost), was comprised of general obligation bonds (i.e., backed by the general credit of the issuer) and revenue bonds (i.e., backed by revenues from the specific project being financed) issued by various authorities, hospitals, water and sanitation districts located in the states of Washington, Oregon and Idaho. At March 31, 1999, general obligation bonds and revenue bonds had total estimated fair values of $19.9 million and $14.4 million, respectively. The company also acquired taxable revenue bonds in fiscal year 1999 totaling $2.8 million at estimated fair value ($2.7 million at amortized cost). Many bank qualifying municipal bonds are not rated by a nationally recognized credit rating agency (e.g., Moody's or Standard and Poor's) due to their smaller size. At March 31, 1999, the Company's municipal bond portfolio had a weighted average maturity of approximately 10.2 years and an average coupon rate of 6.38%. The largest security in the portfolio was an industrial revenue bond issued by the City of Kent, Washington, with an amortized cost of $3.6 million and a fair value of $3.6 million. Corporate Bonds: The Company's corporate bond portfolio, which totaled $24.3 million at fair value ($24.7 million at amortized cost) at March 31, 1999, was composed of short and long-term fixed-rate and adjustable-rate securities. At March 31, 1999, the portfolio had a weighted average maturity of 18.8 years and a weighted average coupon rate of 6.58%. The longest term security, has an amortized cost of $3.2 million and a term to maturity of 28.0 years. 21 U.S. Government and Agency Obligations: The Company's portfolio of U.S. Government and agency obligations had a fair value of $56.5 million ($56.5 million at amortized cost) at March 31, 1999. The Company's subsidiary, FSBW, has invested a small portion of its securities portfolio in structured notes. The structured notes in which FSBW has invested provide for periodic adjustments in coupon rates or prepayments based on various indices and formulae. At March 31, 1999, structured notes, which totaled $4.0 million at fair value ($4.0 million at amortized cost), consisted of a U.S. Government agency obligation which matured in 2004 and 2005. In addition, most of the U.S. Government agency obligations owned by the Company include call features which allow the issuing agency the right to call the securities at various dates prior to the final maturity. Off Balance Sheet Derivatives: Derivatives include "off balance sheet" financial products whose value is dependent on the value of an underlying financial asset, such as a stock, bond, foreign currency, or a reference rate or index. Such derivatives include "forwards," "futures," "options" or "swaps." The Company generally has not invested in "off balance sheet" derivative instruments, although investment policies authorize such investments. On March 31, 1999 the Company had no off balance sheet derivatives and no outstanding commitments to purchase or sell securities. 22 The following tables sets forth certain information regarding carrying values and percentage of total carrying values, which is estimated market value, of the Company's consolidated portfolio of securities classified as available for sale and held to maturity (in thousands). At March 31 ------------------------------------------------------- Available for Sale: 1999 1998 1997 - ------------------- ------------------ ------------------ ----------------- Percent Percent Percent Carrying of Carrying of Carrying of Value Total Value Total Value Total -------- ----- -------- ------ -------- ------ U.S. Government Treasury and agency obligations $ 56,518 15.61% $ 65,594 21.69% $ 67,417 24.45% Municipal bonds (tax exempt) 32,259 8.91 32,093 10.61 33,969 11.81 Municipal bonds (taxable) 2,833 0.78 -- .-- -- .-- Corporate bonds 24,335 6.72 4,304 1.42 7,997 2.78 Other 3,441 0.95 3,298 1.09 3,758 1.31 Mortgage-backed or related securities Mortgage-backed securities: GNMA 22,508 6.22 16,862 5.58 20,273 7.05 FHLMC 3,502 0.97 3,361 1.11 3,868 1.35 FNMA 6,841 1.89 6,048 2.00 7,281 2.53 -------- ------ -------- ------ -------- ------ Total mortgage- backed securities 32,851 9.08 26,271 8.69 31,422 10.93 Mortgage-related securities CMOs-agency backed 150,438 41.56 146,300 48.38 117,212 40.77 CMOs-Non-agency 59,346 16.39 24,559 8.12 25,741 8.95 -------- ------ -------- ------ -------- ------ Total mortgage- related securities 209,784 57.95 170,859 56.50 142,953 49.72 -------- ------ -------- ------ -------- ------ Total 242,635 67.03 197,130 65.19 174,375 60.65 -------- ------ -------- ------ -------- ------ Total securities available for sale $362,021 100.00% $302,419 100.00% $287,516 100.00% ======== ====== ======== ====== ======== ====== Held to Maturity: Municipal bonds (tax exempt) $ 1,991 92.39% $ -- --% -- --% CMOs - agency backed 164 7.61 -- -- -- -- Certificates of deposit -- -- 194 100.00% 987 100.00 -------- ------ -------- ------ -------- ------ Total $ 2,155 100.00% $ 194 100.00% $ 987 100.00% ======== ====== ======== ====== ======== ====== Estimated market value $ 2,235 $ 194 $ 987 ======== ======== ======== 23 The following table shows the maturity or period to repricing of the Company's consolidated portfolio of securities (dollars in thousands): At March 31 1999 ------------------------------------------------------------------------------------------------- Over One to Over Five to Over Ten to Over One Year or Less Five Years Ten Years Twenty Years Twenty Years Total ---------------- --------------- --------------- --------------- ---------------- ---------------- Weight- Weight- Weight- Weight- Weight- Weight- Carry- ed Carry- ed Carry- ed Carry- ed Carry- ed Carry- ed ing Average ing Average ing Average ing Average ing Average ing Average Value Yield Value Yield Value Yield Value Yield Value Yield Value Yield ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- Available for sale -------- U. S. Government Treasury and agency obligations Fixed- rate $ 5,519 5.59% $43,836 5.86% $ 2,999 6.14% $ -- --% $ -- -- % $ 52,354 5.93% Adjustable- rate 4,164 5.69 -- -- -- -- -- -- -- -- 4,164 5.69 -------- ------- ------- ------- -------- -------- 9,683 5.63 43,836 5.86 2,999 6.14 -- -- -- -- 56,518 5.91 Municipal bonds- taxable - -- -- -- 1,029 6.68 1,555 8.08 249 5.05 2,833 7.29 Municipal bonds- exempt 1,878 5.29 4,875 5.59 12,854 6.32 9,230 6.94 3,422 5.52 32,259 6.23 -------- ------- ------- ------- -------- -------- 1,878 5.29 4,875 5.59 13,883 6.35 10,785 7.10 3,671 5.49 35,092 6.32 Corporate bonds Fixed- rate 11,380 5.90 4,021 5.81 3,005 6.49 -- -- 5,929 7.26 24,335 5.51 Mortgage- backed obligations: Fixed-rate -- -- 406 6.12 371 9.04 1,466 10.12 23,841 6.70 26,084 6.92 Adjustable- rate 6,135 6.71 632 6.54 -- -- -- -- -- -- 6,767 6.70 -------- ------- ------- ------- -------- -------- 6,135 6.71 1,038 6.38 371 9.04 1,466 10.12 23,841 6.70 32,851 6.87 Mortgage- related obligations: Fixed- rate 422 10.55 -- -- 3,535 6.89 5,525 6.09 91,800 6.89 101,282 6.86 Adjustable- rate 108,502 5.37 -- -- -- -- -- -- -- -- 108,502 5.37 -------- ------- ------- ------- -------- -------- 108,924 5.39 -- -- 3,535 6.89 5,525 6.09 91,800 6.89 209,784 6.09 -------- ------- ------- ------- -------- -------- Total mortgage- backed or related obliga- tions 115,059 5.46 1,038 6.38 3,906 7.09 6,991 6.94 115,641 6.85 242,635 6.20 Other stock 37 6.25 3,404 8.80 -- -- -- -- -- -- 3,441 8.77 -------- ------- ------- ------- -------- -------- Total securities available for sale carrying value $138,037 5.54% $57,174 6.02% $23,793 6.17% $17,776 6.33% $125,241 6.82% $362,021 6.08% ======== ======= ======= ======= ======== ======== Total securities available for sale amortized cost $139,494 $53,725 $23,227 $17,101 $124,993 $358,540 ======== ======= ======= ======= ======== ======== Held to Maturity Mortgage- related obligation fixed rate -- -- -- -- -- -- -- 164 5.73 164 5.73 Municipal bonds-exempt 285 6.54 1,172 7.45 434 7.80 100 10.00 -- -- 1,991 7.52 -------- ------- ------- ------- -------- -------- Fixed- rate $ 285 6.54% $ 1,172 7.45% $ 434 7.80% $ 100 10.00% $ 164 5.73% $ 2,155 7.39% ======== ======= ======= ======= ======== ======== 24
Deposit Activities and Other Sources of Funds General: Deposits, FHLB advances (or borrowings) and loan repayments are the major sources of the Banks' funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer-term basis for general business purposes. The Banks do not currently solicit brokered deposits. Deposit Accounts: Deposits are attracted from within the Banks' primary market areas through the offering of a broad selection of deposit instruments, including demand checking accounts, NOW accounts, money market deposit accounts, regular savings accounts, certificates of deposit and retirement savings plans. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of their deposit accounts, the Banks consider current market interest rates, profitability to the Banks, matching deposit and loan products and their customer preferences and concerns. The Banks generally review their deposit mix and pricing weekly. The Banks compete with other financial institutions and financial intermediaries in attracting deposits. Competition from mutual funds has been particularly strong in recent years due to the performance of the stock market. In addition, there is strong competition for savings dollars from commercial banks, credit unions, and nonbank corporations, such as securities brokerage companies and other diversified companies, some of which have nationwide networks of offices. The Banks, especially FSBW, have been most successful in attracting a broad range of retail time deposits and, at March 31, 1999, the Banks had a total of $580.0 million in retail time deposits, of which $276.7 million had original maturities of one year or longer. As illustrated in the following table, certificates of deposit have accounted for a larger percentage of the deposit portfolio than have other transaction accounts. However, as reflected in the balances and percentages for March 31, 1999, 1998 and 1997, the acquisitions of IEB, TB and WSB have added significantly to demand, NOW and Money Market accounts for the Company. 25 The following table sets forth the balances of deposits in the various types of accounts offered by the Banks at the dates indicated (in thousands). AT MARCH 31 ------------------------------------------------------------------------------ 1999 1998 1997 ----------------------------- ----------------------------- ------------------ % of Increase % of Increase % of Amount Total (Decrease) Amount Total (Decrease) Amount Total -------- ------ -------- -------- ------ --------- ------- ------ Demand and NOW checking $179,609 18.89% 67,420 $112,189 18.62% $ 7,820 $104,369 18.78% Regular savings accounts 59,133 6.22 17,049 42,084 6.99 (2,047) 44,131 7.94 Money market accounts 132,077 13.89 55,435 76,642 12.72 (227) 76,869 13.83 Certificates which mature: Within 1 year 405,306 42.63 165,232 240,074 39.84 27,221 212,853 38.31 After 1 year, but within 2 years 93,343 9.82 18,824 74,519 12.37 20,966 53,553 9.64 After 2 years, but within 5 years 71,832 7.55 28,327 43,505 7.22 2,542 40,963 7.37 Certificates maturing thereafter 9,548 1.00 (3,961) 13,509 2.24 (9,459) 22,968 4.13 -------- ------ -------- -------- ------ ------- -------- ------ Total $950,848 100.00% 348,326 $602,522 100.00% $46,816 $555,706 100.00% ======== ====== ======= ======== ====== ======= ======== ======
The following table sets forth the deposit activities of the Banks for the periods indicated (in thousands). Year Ended March 31, ---------------------------- 1999 1998 1997 ------ ------ ------ Beginning balance $602,522 $555,706 $383,070 Acquisitions 218,368 - - 134,610 Net increase (decrease) before interest credited 95,939 21,527 16,290 Interest credited 34,019 25,289 21,736 -------- -------- -------- Net increase in savings deposits 348,326 46,816 172,636 -------- -------- -------- Ending balance $950,848 $602,522 $555,706 ======== ======== ======== The following table indicates the amount of the Banks' jumbo certificates of deposit by time remaining until maturity as of March 31, 1999. Jumbo certificates of deposit require a minimum deposit of $100,000 and rates paid on such accounts are negotiable (in thousands). Jumbo Maturity Period Certificates - --------------- of deposits ----------- Six months or less $ 90,248 Six through twelve months 51,946 Over twelve months 43,895 --------- Total $ 186,089 ========= 26 Borrowings: Deposits are the primary source of funds for the Banks' lending and investment activities and for their general business purposes. FSBW also uses borrowings to supplement its supply of lendable funds, to meet deposit withdrawal requirements and to more effectively leverage its capital position. The FHLB-Seattle serves as FSBW's primary borrowing source. Advances from the FHLB-Seattle are typically secured by FSBW's first mortgage loans. At March 31, 1999, FSBW had $408.3 million of borrowings from the FHLB-Seattle at a weighted average rate of 5.74%. FSBW has been authorized by the FHLB-Seattle to borrow up to 45% of it's total assets under a blanket floating lien security agreement, permitting a borrowing capacity of $537.1 million at March 31, 1999. Additional funds may be obtained through commercial banking credit lines. The FHLB-Seattle functions as a central reserve bank providing credit for member financial institutions. As a member, FSBW is required to own capital stock in the FHLB-Seattle and is authorized to apply for advances on the security of such stock and certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the U.S. Government) provided certain creditworthiness standards have been met. Advances are made pursuant to several different credit programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. FSBW also uses retail repurchase agreements due generally within 90 days as a source of funds. At March 31, 1999, retail repurchase agreements totaling $5.8 million with interest rates from 4.90% to 7.18% were secured by a pledge of certain FNMA, GNMA and FHLMC mortgage-backed securities with a market value of $9.8 million. FSBW also borrows funds through the use of secured wholesale repurchase agreements with securities brokers. The broker holds FSBW's securities while FSBW continues to receive the principal and interest payments from the security. FSBW's outstanding borrowings at March 31, 1999, under wholesale repurchase agreements, totaled $72.7 million and were collateralized by mortgage-backed securities with a fair value of $75.2 million. (See "Management's Discussion and Analysis of Financial Position and Results of Operations - Liquidity and Capital Resources." And Notes 11 and 12 of the consolidated Financial Statements) Personnel As of March 31, 1999, the Company had 429 full-time and 72 part-time employees. The employees are not represented by a collective bargaining unit. The Company believes its relationship with its employees is good. Taxation Federal Taxation General. For tax reporting purposes, the Company and the Banks report their income on a calendar year basis using the accrual method of accounting. The Company and the Banks are subject to federal income taxation in the same manner as other corporations with some exceptions including particularly the reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Company and the Banks. Bad Debt Reserve. Historically, savings institutions such as FSBW which met certain definitional tests primarily related to their assets and the nature of their business ("qualifying thrift") were permitted to establish a reserve for bad debts and to make annual additions thereto, which may have been deducted in arriving at their taxable income. FSBW's deductions with respect to "qualifying real property loans," which are generally loans secured by certain interests in real property, were computed using an amount based on FSBW's actual loss experience, or a percentage equal to 8% of FSBW's taxable income, computed with certain modifications and reduced by the amount of any permitted additions to the non-qualifying reserve. Due to FSBW's loss experience, it generally recognized a bad debt deduction equal to 8% of taxable income. 27 In August 1996, provisions repealing the current thrift bad debt rules were enacted by Congress as part of "The Small Business Job Protection Act of 1996." The new rules eliminate the 8% of taxable income method for deducting additions to the tax bad debt reserves for all thrifts for tax years beginning after December 31, 1995. These rules also require that all institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). FSBW has previously recorded a deferred tax liability equal to the bad debt recapture and as such the new rules will have no effect on the net income or federal income tax expense. For taxable years beginning after December 31, 1995, because FSBW is a "large" bank (i.e., assets in excess of $500 million), FSBW's bad debt deduction will be determined on the basis of net charge-offs during the taxable year. The new rules also require FSBW to recapture its $1.5 million post-1987 additions to tax basis bad debt reserves ratably over a six taxable year period beginning with fiscal year March 1999. The recapture of the post-1987 additions to tax basis bad debt reserves will require FSBW to pay approximately $85,000 a year in federal income taxes (based upon current federal income tax rates). This will not result in a charge to earnings as these amounts are included in the deferred tax liability at March 31, 1999. The unrecaptured base year reserves will not be subject to recapture as long as the institution qualifies as a bank as defined by the statute. In addition, the balance of the pre-1988 bad debt reserves continues to be subject to provisions of present law referred to below that require recapture in the case of certain excess distributions to shareholders. Distributions. To the extent that FSBW makes "nondividend distributions" to the Company, such distributions will be considered to result in distributions from the balance of their bad debt reserves as of December 31, 1987 (or a lesser amount if FSBW's loan portfolio decreased since December 31, 1987) and then from the supplemental reserve for losses on loans ("Excess Distributions"), and an amount based on the Excess Distributions will be included in FSBW's taxable income. Nondividend distributions include distributions in excess of FSBW's current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of FSBW's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from FSBW's bad debt reserves. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, approximately one and one-half times the Excess Distribution would be includable in gross income for federal income tax purposes, assuming a 34% federal corporate income tax rate. FSBW does not intend to pay dividends that would result in a recapture of any portion of their tax bad debt reserve. Corporate Alternative Minimum Tax. The Code imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. AMTI is increased by an amount equal to 75% of the amount by which the corporation's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). For taxable years beginning after December 31, 1986, and before January 1, 1996, an environmental tax of .12% of the excess of AMTI (with certain modification) over $2.0 million is imposed on corporations, including the Banks, whether or not an Alternative Minimum Tax ("AMT") is paid. Under President Clinton's 1999 budget proposal, the corporate environmental income tax would be reinstated for taxable years beginning after December 31, 1996 and before January 1, 2008. Dividends-Received Deduction and Other Matters. The Company may exclude from its income 100% of dividends received from the Banks as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Banks will not file a consolidated tax return, except that if the Company or the Banks own more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted. There have not been any IRS audits of the Company's or the Banks' federal income tax returns during the past five years. 28 Environmental Regulation The business of the Company is affected from time to time by federal and state laws and regulations relating to hazardous substances. Under the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), owners and operators of properties containing hazardous substances may be liable for the costs of cleaning up the substances. CERCLA and similar state laws can affect the Company both as an owner of branches and other properties used in its business and as a lender holding a security interest in property which is found to contain hazardous substances. While CERCLA contains an exemption for holders of security interests, the exemption is not available if the holder participates in the management of a property, and some courts have broadly defined what constitutes participation in management of property. Moreover, CERCLA and similar state statutes can affect the Company's decision of whether or not to foreclose on a property. Before foreclosing on commercial real estate, it is the Company's general policy to obtain an environmental report, thereby increasing the costs of foreclosure. In addition, the existence of hazardous substances on a property securing a troubled loan may cause the Company to elect not to foreclose on the property, thereby reducing the Company's flexibility in handling the loan. Competition The Banks encounter significant competition both in attracting deposits and in originating real estate loans. Their most direct competition for deposits has come historically from other commercial and savings banks, savings associations and credit unions in their market areas. More recently, the Banks have experienced an increased level of competition from securities firms, insurance companies, money market and mutual funds, and other investment vehicles. The Banks expect continued strong competition from such financial institutions and investment vehicles in the foreseeable future. The ability of the Banks to attract and retain deposits depends on their ability to provide investment opportunities that satisfy the requirements of investors as to rate of return, liquidity, risk of loss of principal, convenience of locations and other factors. The Banks compete for deposits by offering depositors a variety of deposit accounts and financial services at competitive rates, convenient business hours, and a high level of personal service and expertise. The competition for loans comes principally from commercial banks, loan brokers, mortgage banking companies, other savings banks and credit unions. The competition for loans has increased substantially in recent years as a result of the large number of institutions competing in the Banks' market areas as well as the increased efforts by commercial banks and credit unions to expand mortgage loan originations. The Banks compete for loans primarily through offering competitive rates and fees and providing excellent services to borrowers and home builders. Factors that affect competition include general and local economic conditions, current interest rate levels and the volatility of the mortgage markets. 29 Regulation The Banks General: As state-chartered, federally insured financial institutions, the Banks are subject to extensive regulation. Lending activities and other investments must comply with various statutory and regulatory requirements, including prescribed minimum capital standards. The Banks are regularly examined by the FDIC and their state banking regulators and file periodic reports concerning their activities and financial condition with their regulators. The Banks' relationship with depositors and borrowers also is regulated to a great extent by both federal and state law, especially in such matters as the ownership of savings accounts and the form and content of mortgage documents. Federal and state banking laws and regulations govern all areas of the operation of the Banks, including reserves, loans, mortgages, capital, issuance of securities, payment of dividends and establishment of branches. Federal and state bank regulatory agencies also have the general authority to limit the dividends paid by insured banks and bank holding companies if such payments should be deemed to constitute an unsafe and unsound practice. The respective primary federal regulators of the Company and the Banks have authority to impose penalties, initiate civil and administrative actions and take other steps intended to prevent banks from engaging in unsafe or unsound practices. State Regulation and Supervision: As a state-chartered savings bank, FSBW is subject to applicable provisions of Washington law and regulations. As a state chartered commercial Bank, TB is subject to applicable provisions of Washington law and regulations. As a state-chartered commercial bank, IEB is subject to applicable provisions of Oregon law and regulations. State law and regulations govern the Banks' ability to take deposits and pay interest thereon, to make loans on or invest in residential and other real estate, to make consumer loans, to invest in securities, to offer various banking services to its customers, and to establish branch offices. Under state law, savings banks in Washington also generally have all of the powers that federal mutual savings banks have under federal laws and regulations. The Banks are subject to periodic examination and reporting requirements by and of their state banking regulators. Deposit Insurance: The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of depository institutions. The FDIC currently maintains two separate insurance funds: the BIF and the SAIF. As insurer of the Banks' deposits, the FDIC has examination, supervisory and enforcement authority over the Banks. FSBW's accounts are insured by the SAIF and IEB's and TB's accounts are insured by the BIF to the maximum extent permitted by law. The Banks pay deposit insurance premiums based on a risk-based assessment system established by the FDIC. Under applicable regulations, institutions are assigned to one of three capital groups that are based solely on the level of an institution's capital "well capitalized," "adequately capitalized," and "undercapitalized" which are defined in the same manner as the regulations establishing the prompt corrective action system, as discussed below. These three groups are then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered to be healthy to those which are considered to be of substantial supervisory concern. The matrix so created results in nine assessment risk classifications. Pursuant to the Deposit Insurance Funds Act of 1996 (the "DIF Act"), which was enacted on September 30, 1996, the FDIC imposed a special assessment on each depository institution with SAIF-assessable deposits which resulted in the SAIF achieving its designated reserve ratio. In connection therewith, the FDIC reduced the assessment schedule for SAIF members, effective January 1, 1997, to a range of 0% to 0.27%, with most institutions, including FSBW, paying 0%. This assessment schedule is the same as that for the BIF, which reached its designated reserve ratio in 1995. In addition, since January 1, 1997, SAIF members are charged an assessment of .065% of SAIF-assessable deposits for the purpose of paying interest on the obligations issued by the Financing Corporation ("FICO") in the 1980s to help fund the thrift industry cleanup. BIF-assessable deposits will be charged an assessment to help pay interest on the FICO bonds at a rate of approximately .013% until the earlier of December 31, 1999 or the date upon which the last savings association ceases to exist, after which time the assessment will be the same for all insured deposits. The DIF Act provides for the merger of the BIF and the SAIF into the Deposit Insurance Fund on January 1, 1999, but only if no insured depository institution is a savings association on that date. 30 The FDIC may terminate the deposit insurance of any insured depository institution if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances that could result in termination of the deposit insurance of the Banks. Prompt Corrective Action: Under Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action. Under the regulations, an institution shall be deemed to be: (i) "well capitalized" if it has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure; (ii) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, has a Tier I risk-based capital ratio of 4.0% or more, has a Tier I leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized;" (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, has a Tier I risk-based capital ratio that is less than 4.0% or has a Tier I leverage capital ratio that is less than 4.0% (3.0% under certain circumstances); (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, has a Tier I risk-based capital ratio that is less than 3.0% or has a Tier I leverage capital ratio that is less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. A federal banking agency may, after notice and an opportunity for a hearing, reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category if the institution is in an unsafe or unsound condition or engaging in an unsafe or unsound practice. (The FDIC may not, however, reclassify a significantly undercapitalized institution as critically undercapitalized.) An institution generally must file a written capital restoration plan which meets specified requirements, as well as a performance guaranty by each company that controls the institution, with the appropriate federal banking agency within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. Immediately upon becoming undercapitalized, an institution shall become subject to various mandatory and discretionary restrictions on its operations. At March 31, 1999, the Banks were categorized as "well capitalized" under the prompt corrective action regulations of the FDIC. Standards for Safety and Soundness: The federal banking regulatory agencies have prescribed, by regulation, standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings and (viii) compensation, fees and benefits (Guidelines). The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the FDIC determines that either Bank fails to meet any standard prescribed by the Guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard. FDIC regulations establish deadlines for the submission and review of such safety and soundness compliance plans. Capital Requirements: The FDIC's minimum capital standards applicable to FDIC-regulated banks and savings banks require the most highly-rated institutions to meet a "Tier 1" leverage capital ratio of at least 3% of total assets. Tier 1 (or "core capital") consists of common stockholders' equity, noncumulative perpetual preferred stock and minority interests in consolidated subsidiaries minus all intangible assets other than limited amounts of purchased mortgage servicing rights and certain other accounting adjustments. All other banks must have a Tier 1 leverage ratio of at least 100-200 basis points above the 3% minimum. The FDIC capital regulations establish a minimum leverage ratio of not less than 4% for banks that are not highly rated or are anticipating or experiencing significant growth. 31 Any insured bank with a Tier 1 capital to total assets ratio of less than 2% is deemed to be operating in an unsafe and unsound condition unless the insured bank enters into a written agreement, to which the FDIC is a party, to correct its capital deficiency. Insured banks operating with Tier 1 capital levels below 2% (and which have not entered into a written agreement) are subject to an insurance removal action. Insured banks operating with lower than the prescribed minimum capital levels generally will not receive approval of applications submitted to the FDIC. Also, inadequately capitalized state nonmember banks will be subject to such administrative action as the FDIC deems necessary. FDIC regulations also require that banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of total capital (which is defined as Tier 1 capital and Tier 2 or supplementary capital) to risk weighted assets of 8% and Tier 1 capital to risk-weighted assets of 4%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item. The components of Tier 1 capital are equivalent to those discussed above under the 3% leverage requirement. The components of supplementary capital currently include cumulative perpetual preferred stock, adjustable-rate perpetual preferred stock, mandatory convertible securities, term subordinated debt, intermediate-term preferred stock and allowance for possible loan and lease losses. Allowance for possible loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of capital counted toward supplementary capital cannot exceed 100% of Tier 1 capital. FDIC capital requirements are designated as the minimum acceptable standards for banks whose overall financial condition is fundamentally sound, which are well-managed and have no material or significant financial weaknesses. The FDIC capital regulations state that, where the FDIC determines that the financial history or condition, including off-balance sheet risk, managerial resources and/or the future earnings prospects of a bank are not adequate and/or a bank has a significant volume of assets classified substandard, doubtful or loss or otherwise criticized, the FDIC may determine that the minimum adequate amount of capital for that bank is greater than the minimum standards established in the regulation. The Company believes that, under the current regulations, the Banks will continue to meet their minimum capital requirements in the foreseeable future. However, events beyond the control of the Banks, such as a downturn in the economy in areas where the Banks have most of their loans, could adversely affect future earnings and, consequently, the ability of the Banks to meet their capital requirements. Activities and Investments of Insured State-Chartered Banks: Federal law generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. Under regulations dealing with equity investments, an insured state bank generally may not directly or indirectly acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. An insured state bank is not prohibited from, among other things, (i) acquiring or retaining a majority interest in a subsidiary, (ii) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank's total assets, (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors', trustees' and officers' liability insurance coverage or bankers' blanket bond group insurance coverage for insured depository institutions, and (iv) acquiring or retaining the voting shares of a depository institution if certain requirements are met. Federal law provides that an insured state-chartered bank may not, directly, or indirectly through a subsidiary, engage as "principal" in any activity that is not permissible for a national bank unless the FDIC has determined that such activities would pose no risk to the insurance fund of which it is a member and the bank is in compliance with applicable regulatory capital requirements. Any insured state-chartered bank directly or indirectly engaged in any activity that is not permitted for a national bank must cease the impermissible activity. 32 Federal Reserve System: In 1980, Congress enacted legislation which imposed Federal Reserve requirements (under "Regulation D") on all depository institutions that maintain transaction accounts or nonpersonal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank. NOW accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any nonpersonal time deposits at a bank. Under Regulation D, a bank must establish reserves equal to 3% of the first $47.8 million of transaction accounts, of which the first $4.4 million is exempt, and 10% on the remainder. The reserve requirement on nonpersonal time deposits with original maturities of less than 1-1/2 years is 0%. As of March 31, 1999, the Banks met their reserve requirements. Affiliate Transactions: The Company and the Banks are legal entities separate and distinct. Various legal limitations restrict the Banks from lending or otherwise supplying funds to the Company (an "affiliate"), generally limiting such transactions with the affiliate to 10% of the Bank's capital and surplus and limiting all such transactions to 20% of the Bank's capital and surplus. Such transactions, including extensions of credit, sales of securities or assets and provision of services, also must be on terms and conditions consistent with safe and sound banking practices, including credit standards, that are substantially the same or at least as favorable to the Banks as those prevailing at the time for transactions with unaffiliated companies. Federally insured banks are subject, with certain exceptions, to certain restrictions on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. In addition, such banks are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or the providing of any property or service. Community Reinvestment Act: Banks are also subject to the provisions of the Community Reinvestment Act of 1977, which requires the appropriate federal bank regulatory agency, in connection with its regular examination of a bank, to assess the bank's record in meeting the credit needs of the community serviced by the bank, including low and moderate income neighborhoods. The regulatory agency's assessment of the bank's record is made available to the public. Further, such assessment is required of any bank which has applied, among other things, to establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. Dividends: Dividends from the Banks will constitute the major source of funds for dividends which may be paid by the Company. The amount of dividends payable by the Banks to the Company will depend upon the Banks' earnings and capital position, and is limited by federal and state laws, regulations and policies. Federal law further provides that no insured depository institution may make any capital distribution (which would include a cash dividend) if, after making the distribution, the institution would be "undercapitalized," as defined in the prompt corrective action regulations. Moreover, the federal bank regulatory agencies also have the general authority to limit the dividends paid by insured banks if such payments should be deemed to constitute an unsafe and unsound practice. The Company General: The Company is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA) and the regulations of the Federal Reserve. The Company is required to file with the Federal Reserve annual reports and such additional information as the Federal Reserve may require and is subject to regular examinations by the Federal Reserve. The Federal Reserve also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (1) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company. 33 The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain nonbank activities which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the Federal Reserve includes, among other things: operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers' checks and U.S. Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers. Interstate Banking and Branching. The Federal Reserve must approve an application of an adequately capitalized and adequately managed bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than such holding company's home state, without regard to whether the transaction is prohibited by the laws of any state. The Federal Reserve may not approve the acquisition of a bank that has not been in existence for the minimum time period (not exceeding five years) specified by the statutory law of the host state. Nor may the Federal Reserve approve an application if the applicant (and its depository institution affiliates) controls or would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch. Federal law does not affect the authority of states to limit the percentage of total insured deposits in the state which may be held or controlled by a bank holding company to the extent such limitation does not discriminate against out-of-state banks or bank holding companies. Individual states may also waive the 30% state-wide concentration limit contained in the federal law. The Federal banking agencies are authorized to approve interstate merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks adopted a law prior to June 1, 1997 which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Interstate acquisitions of branches will be permitted only if the law of the state in which the branch is located permits such acquisitions. Interstate mergers and branch acquisitions will also be subject to the nationwide and statewide insured deposit concentration amounts described above. Dividends: The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the company's capital needs, asset quality and overall financial condition. The Federal Reserve also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Bank holding companies, except for certain "well-capitalized" bank holding companies, are required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of their consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption of it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order, or any condition imposed by, or written agreement with, the Federal Reserve. Capital Requirements: The Federal Reserve has established capital adequacy guidelines for bank holding companies that generally parallel the capital requirements of the FDIC for the Banks. The Federal Reserve regulations provide that capital standards will be applied on a consolidated basis in the case of a bank holding company with $150 million or more in total consolidated assets. The Company's total risk based capital must equal 8% of risk-weighted assets and one half of the 8% (4%) must consist of Tier 1 (core) capital. As of March 31, 1999 the Company's total risk based capital was 15.15% of risk-weighted assets and its risk based capital of Tier 1 (core) capital was 13.99% of risk-weighted assets. 34 MANAGEMENT PERSONNEL Executive Officers The following table sets forth information with respect to the executive officers of the Company. Name Age (1) Position with Company Position with Banks - ---- ------- --------------------- ------------------- Gary Sirmon 55 Chief Executive Officer, FSBW - Chief Executive President and Director Officer, President and Director, IEB, TB - Director D. Allan Roth 62 Secretary/Treasurer FSBW - Executive Vice Executive Vice President President and Chief Financial Officer Michael K. Larsen 56 Executive Vice President FSBW - Executive Vice President and Chief Lending Officer Jesse G. Foster 60 Director IEB - Chief Executive Officer, President and Director Lloyd Baker 50 Senior Vice President FSBW - Senior Vice President S. Rick Meikle 51 Director TB - Chief Executive Officer, President and Director - --------------- (1) As of March 31, 1999. Biographical Information Set forth is certain information regarding the executive officers of the Company, directors or executive officers. There are no family relationships among or between the directors or executive officers. Gary Sirmon is Chief Executive Officer, President and a Director of the Company and FSBW; and a Director of IEB and TB. He joined FSBW in 1980 as an Executive Vice President and assumed his current position in 1982. D. Allan Roth is Executive Vice President and Chief Financial Officer of FSBW and is Secretary/Treasurer and an Executive Vice President of the Company. He joined FSBW in 1965. Michael K. Larsen is Executive Vice President and Chief Lending Officer of FSBW and is an Executive Vice President of the Company. He joined FSBW in 1981. Jesse G. Foster is the Chief Executive Officer, President and a Director of IEB and a Director of the Company. He joined IEB in 1962. Lloyd Baker is a Senior Vice President with FSBW and is an Senior Vice President of the Company. He joined FSBW in 1995 as a Vice President. S. Rick Meikle is Chief Executive Officer, President and a Director of TB and a Director of the Company. He helped form TB in 1991. 35 Signatures of Registrant Pursuant to the requirements of the Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on July 2, 1999. FIRST WASHINGTON BANCORP, INC. /s/ Gary Sirmon -------------------------------------- Gary Sirmon President and Chief Executive Officer /s/ D. Allan Roth -------------------------------------- D. Allan Roth Executive Vice President and Chief Financial Officer (Principle Financial and Accounting Officer) 36 EX-27 2
9 0000946673 FIRST WASHINGTON BANCORP EXHIBIT 27 1,000 YEAR MAR-31-1999 MAR-31-1999 72503 2562 18815 0 362201 2155 2235 1102669 12261 1631900 950848 199220 10725 287499 0 0 130770 0 1631900 89615 21357 1320 112292 34019 60442 51850 2841 11 31745 24717 15440 0 0 15440 1.46 1.40 3.83 6138 1538 380 0 7857 1355 225 12261 11284 0 977
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