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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
Form 10-K
[X] Annual Report Pursuant to section 13 or 15(d) of the
Securities and Exchange act of 1934
For the fiscal year ended December 31, 1998
Commission file number
0-23881
COWLITZ BANCORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-152984
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
927 Commerce Ave., Longview, Washington 98632
(Address of principal executive offices) (Zip Code)
(360) 423-9800
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act
Common Stock, No par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes__X___ No____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form of this form 10-K. [ X]
The approximate aggregate market value of Registrant's Common Stock held by
non-affiliates of the Registrant on February 28, 1999, was $ 21,218,148.
Common Stock, no par value on February 28, 1999: 4,002,377
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and the
Part of the Form 10-K into which the document is incorporated: Portions of the
registrants proxy statement dated April 13, 1999, for the 1999 annual meeting of
shareholders is incorporated by reference in Part III hereof.
TABLE OF CONTENTS
Page
Part I
Item 1. Business........................................................3
Item 2. Properties......................................................10
Item 3. Legal Proceedings...............................................10
Item 4. Submission of matters to vote of securities
holders.........................................................11
Part II
Item 5. Market price and dividends on registrant's
common equity and related stockholder matters...................11
Item 6. Financial Highlights............................................12
Item 7. Management's discussion and analysis of
financial condition and results of operations...................13
Item 8. Financial statements and supplementary data.....................29
Item 9. Changes in and disagreements with accountants
on accounting and financial disclosure..........................53
Part III
Item 10. Director and executive officers of
the registrant..................................................53
Item 11. Executive compensation..........................................53
Item 12. Security ownership of certain beneficial
owners and management...........................................53
Item 13. Certain relationships and related
transactions....................................................53
Part IV
Item 14. Exhibits, financial statement
schedules, and reports on form 8-K..............................53
2
Part I
Item 1. Business
Introduction
Cowlitz Bancorporation (the "Company") was organized in 1991 under
Washington law to become the holding company for Cowlitz Bank (the "Bank"), a
Washington state chartered bank that commenced operations in 1978. The principal
executive offices of the Company are located in Longview, Washington.
The Company offers or makes available a broad range of financial services
to its customers, primarily small and medium-sized businesses, professionals and
retail customers. In addition to the Bank's normal commercial and personal
banking services, which include commercial and real estate lending, consumer
lending, mortgage origination and trust services, the Bank has developed
relationships with a securities brokerage firm and insurance agency with an
estate planner to provide its customers access to a variety of financial
services which are generally not available in community banks. In 1997, the Bank
established a trust department to offer trust services to individuals,
corporations and institutions. It is the only such trust department in Cowlitz
County. It is the intention of the Company to provide customers with similar
banking services offered by larger competitors while retaining the character of
a community bank and the level of personal service which larger banks generally
no longer provide. During 1998, the Company acquired Business Finance
Corporation ("BFC") which provides asset-based lending services to companies
throughout the western United States.
The Company's goal is to maintain its position as a leading community based
provider of financial services in Cowlitz County and to become one of the
leading community based providers of financial services in other selected areas
of Washington and Oregon. The Company's growth strategy is based on providing
both exceptional personal service and a wide range of financial services to its
customers including: emphasizing personal service and developing strong
community ties, providing a broad range of financial products and services,
increasing business volume in existing markets, and exploring opportunities for
regional expansion through acquisitions.
Products and Services
The Company offers a broad portfolio of products and services tailored to
meet the banking requirements of targeted customers in its market area. It
believes this portfolio is generally competitive with the products and services
of its competitors, including major regional and national banks. These include:
Deposit Products. The Company provides an array of deposit products for
customers, including non-interest-bearing checking accounts, interest-bearing
checking and savings accounts, money market accounts and certificates of
deposit. These accounts generally earn interest at rates established by
management based on competitive market factors and management's desire to
increase certain types or maturities of deposit liabilities. The Company does
not pay brokerage commissions to attract deposits. It strives to establish
customer relations to attract core deposits in non-interest-bearing
transactional accounts and thus to reduce its cost of funds.
Loan Products. The Company offers a broad array of loan products to its
small to medium size business customers. The Company maintains sound loan
underwriting standards with written loan policies, conservative individual and
branch limits and reviews by the Loan Committee. Further, in the case of
particularly large loan commitments or loan participations, loans are reviewed
by the Board of Directors. Underwriting standards are designed to achieve a
high-quality loan portfolio, compliance with lending regulations and the desired
mix of loan maturities and industry concentrations. Management seeks to minimize
credit losses by closely monitoring the financial condition of its borrowers and
the value of collateral.
Commercial Loans. The Company offers specialized loans for its business and
commercial customers. These include equipment and inventory financing, operating
lines of credit and accounts receivable financing. Commercial lending is the
primary focus of the Company's lending activities, and a significant portion of
its loan portfolio consists of commercial loans. For regulatory purposes, a
substantial portion of the Company's commercial loans are designated as real
estate loans, as the loans are secured by mortgages and trust deeds on real
property, although the loans may be made for purposes of financing commercial
activities, such as accounts receivable, equipment purchases and inventory or
other working capital needs. Lending decisions are based on careful evaluation
of the financial strength, management and credit history of the borrower, and
the quality of the collateral securing the loan. Commercial loans secured by
real property are limited to70% of the value of the collateral. In some cases,
the Company may require personal guarantees and secondary sources of repayment.
3
Real Estate Loans. Real estate loans are available for construction,
purchasing and refinancing residential owner-occupied and rental properties.
Borrowers can choose from a variety of fixed and adjustable rate options and
terms. Real estate loans reflected in the loan portfolio also include loans made
to commercial customers that are secured by real property. The Company provides
customers access to long-term conventional real estate loans through its
mortgage loan department, which makes FNMA-conforming loans and sells them in
the secondary market.
Payments on loans are often dependent on the successful operation and
management of the properties securing the loans, and are therefore strongly
affected by the conditions of the local real estate market. Fluctuating land
values and local economic conditions make loans secured by real property
difficult to evaluate and monitor.
Consumer Loans. The Company provides loans to individual borrowers for a
variety of purposes, including secured and unsecured personal loans, home
equity, personal lines of credit and motor vehicle loans. Consumer loans can
carry significantly greater risks than other loan products, even if secured, if
the collateral consists of rapidly depreciating assets such as automobiles and
equipment. Repossessed collateral securing a defaulted consumer loan may not
provide an adequate source of repayment of the loan. Consumer loan collections
are dependent on borrowers' continuing financial stability, and are sensitive to
job loss, illness and other personal factors. The Company attempts to manage the
risks inherent in consumer lending by following strict credit guidelines and
conservative underwriting practices. The Company also offers Visa and MasterCard
credit cards to its customers.
Other Banking Products and Services. In support of its focus on
personalized service, the Company offers additional products and services for
the convenience of its customers. These include a debit card program, automated
teller machines located at each of the Company's offices and an automated
telephone banking service with 24-hour access to accounts that also allows
customers to speak directly with a customer service representative during normal
banking hours or leave a message after normal banking hours. The Company does
not currently charge fees for any of these services. The Company provides
drive-through facilities at four of its branches.
Trust Services. The Company has established a trust department, which is
the only one located in Cowlitz County. The trust department provides trust
services to individuals, partnerships, corporations and institutions and acts as
fiduciary of estates and conservatorships and as a trustee under various wills,
trusts and other plans. The Company believes this service will attract
additional customers to the Bank.
Other Financial Services. The Company believes that providing its customers
a full range of financial services is an important element of its strategy to
attract and retain customers. To this end, the Company has entered into lease
arrangements with Raymond James Financial Services, Inc., a securities broker,
and Commerce Business & Estate Planning Services, Inc., an insurance agency.
Each of these organizations maintains an office on the main floor of the Cowlitz
Financial Center, where the main office of the Company is located and has access
to space in the Company's other branches. Representatives of these companies
meet with clients at each of the Bank's branches, thereby making these services
available to all of the Company's customers. The Company has no financial
interest in either of these companies. The Company believes that by making
available through these relationships, brokerage and insurance services, it can
increase foot traffic through its branches and market more extensively its full
line of core banking products and services.
Acquisitions
On August 31, 1998, the Company acquired Business Finance Corporation (BFC)
of Bellevue, Washington. The acquisition was accounted for using the purchase
method, including issuance of common stock with a value of $465,000. A cash
payment was made in the amount of $1.8 million with an adjustment to be made
based on final determination of BFC's shareholder's equity. A future contingent
issuance of common stock valued at approximately $500,000 will be issued if BFC
achieves earning targets for the twelve-month period following acquisition.
Results
For the year ended December 31, 1998, the Company earned $2.2 million in
net income, or $.57 per diluted share. The Company's consolidated assets were
$178.3 million and shareholders' equity was $30.9 million at December 31, 1998.
Net loans were $130.2 million with total deposits of $122.4 million at year-end
1998. The Company's principal subsidiary Cowlitz Bank is the only community bank
headquartered in the county with five full service branches located in Longview
(2), Kelso, Kalama, and Castle Rock.
4
Market area
The Company's primary market area from which it accepts deposits and makes
loans is Cowlitz County, Washington, and the surrounding counties in Washington
and Oregon. As a community bank, the Bank has certain competitive advantages due
to its local focus, but is also more closely tied to the local economy than many
of its competitors, which serve a number of geographic markets. BFC provides
assets-based lending services throughout the western United States.
Employees
As of December 31, 1998, the Company employed a total of 105 full-time
equivalent employees. None of the employees are subject to a collective
bargaining agreement and the Company considers its relationships with its
employees to be favorable.
Risk Factors
Exposure to Local Economy
The Company's performance is materially dependent upon and sensitive to the
economy of its market area consisting primarily of Cowlitz County and the
surrounding areas in southwest Washington and northwest Oregon. Adverse economic
developments may affect loan demand and the collectibility of existing loans,
and have a negative effect on the Company's earnings and financial condition.
Historically, the economy of Cowlitz County depended primarily on the forest
products industry. Particularly in the 1980's, the Company's market area
experienced high unemployment as a result of the reduction in forest products
manufacturing jobs. While the forest products industry is still the leading
employer in Cowlitz County, the economy is becoming more diverse as
manufacturers enter the region. Subsequent developments have reduced the
dependence of the local economy on forest products manufacturing and have
increased the number of non-manufacturing jobs. There can be no assurance that
future economic changes will not have significant adverse effect on the Company.
Credit Risk
The Company, like other lenders, is subject to credit risk, which is the
risk of losing principal and interest due to customers' failure to repay loans
in accordance with their terms. Although the Company has established lending
criteria and most loans are secured by collateral, a downturn in the economy or
the local real estate market in Cowlitz County or a rapid increase in interest
rates could have a negative effect on collateral values and borrowers' ability
to repay.
Interest Rate Risk
The Company's earnings are largely derived from net interest income, which
is interest income and fees earned on loans and investment income, less interest
expense paid on deposits and other borrowings. Interest rates are highly
sensitive to many factors which are beyond the control of the Company's
management, including general economic conditions, and the policies of various
governmental and regulatory authorities. As interest rates change, net interest
income is affected. With fixed rate assets (such as fixed rate loans) and
liabilities (such as certificates of deposit), the effect on net interest income
depends on the maturity of the asset and liability. Although the Company strives
to minimize interest rate risk through asset/liability management policies, from
time to time maturities are not balanced. Further, while rates have remained
stable in recent periods, an unanticipated rapid decrease or increase in
interest rates could have an adverse effect on the spreads between the interest
rates earned on assets and the rates of interest paid on liabilities, and
therefore on the level of net interest income.
5
Regulation
The Company is subject to extensive regulations under federal and state
laws. These laws and regulations are intended primarily to protect depositors
and the deposit insurance fund, rather than shareholders. The Bank is a state
chartered commercial bank which is not a member of the Federal Reserve System
and is subject to primary regulation and supervision by the Director of
Financial Institutions of the State of Washington (the "Washington Director")
and by the Federal Deposit Insurance Corporation (the "FDIC"), which also
insures bank deposits. The Company is also subject to regulation and supervision
by the Board of Governors of the Federal Reserve System (the "Federal Reserve").
Federal and state regulations place banks at a competitive disadvantage compared
to less regulated competitors such as finance companies, credit unions, mortgage
banking companies and leasing companies. Although the Company has been able to
compete effectively in its market area in the past, there can be no assurance
that it will be able to continue to do so. Further, future changes in federal
and state banking regulations could adversely affect the Company's operating
results and ability to continue to compete effectively. See "Regulation and
Supervision."
Year 2000
Based on its current assessments and remediation plans, the Company does
not expect that it will suffer any material disruption of its business as a
result of Year 2000 issues. Although the Company has no reason to believe that a
material disruption will occur, the most likely worst case scenario would result
from a Y2K failure in the power supply, voice and data transmission systems or
the federal government. If such a failure were to occur, the Company would
implement its contingency plan. In such event, it is likely that there would be
temporary disruption of customer service and customer inconvenience and
additional costs from the implementation of the contingency plan. It is not
possible to quantify those costs at the present time. Although the Company
believes its contingency plan will satisfactorily address these issues, there
can be no assurance that the Company's contingency plan will function as
anticipated or that the results of operations of the Company will not be
adversely affected in the event of a prolonged disruption of service. For a more
detailed disclosure see "Management Discussion and Analysis, Year 2000."
Competition
Competition in the banking industry has intensified for deposits and loans
with decreased interest rates over the last one to two years. Furthermore,
competition from outside the traditional banking system from credit unions,
investment banking firms, insurance companies and related industries offering
bank-like products has widened the competition for deposits and loans. Based on
published reports, it is estimated that credit unions held approximately 56% of
deposits in the Company's market area as of June 30, 1997.
The banking industry in the market area is generally characterized by well
established branches of large banks with headquarters located out of the market
area and in many cases, out of the state. These large multi-bank holding company
branches located in the Longview-Kelso area have transferred a number of their
banking functions outside the local area. There are also thrift institutions,
including a branch of the country's largest thrift institution, and credit
unions within the market area that are very competitive in the deposit and
consumer lending areas.
The major competition for commercial banking services in Cowlitz County
comes from U.S. Bank, Key Bank, Bank of America (which does business in
Washington as Seafirst Bank) and Columbia State Bank. None of these competitors
are headquartered in Cowlitz County and many have relocated key functions (e.g.,
loan decisions) into regional offices outside of the area. Its local decision
making and strong community ties have allowed the Company to provide a level of
personal service and direct customer contact that management believes is
superior to that provided by other banks.
The offices of the major financial institutions have competitive advantages
over the Company in that they have high public visibility, may offer a wider
variety of products and are able to maintain advertising and marketing
activities on a much larger scale than the Company can economically maintain.
Since single borrower lending limits imposed by law are dependent on the capital
of the institution, the branches of larger institutions with substantial capital
bases also have an advantage with respect to loan applications which are in
excess of the Company's legal lending limits.
In competing for deposits, the Company is subject to certain limitations
not applicable to nonbank financial institution competitors. Previous laws
limiting the deposit instruments and lending activities of savings and loan
associations have been substantially eliminated, thus increasing the competition
from these institutions.
6
Regulation and Supervision
The Company and the Bank are subject to extensive regulation under federal
and state laws. The laws, together with the regulations promulgated under them,
significantly affect respective activities of the Company and the Bank and the
competitive environment in which they operate. The laws and regulations are
primarily intended to protect depositors and the deposit insurance fund, rather
than shareholders.
The description herein of the laws and regulations applicable to the
Company and the Bank, does not purport to be a complete description of the laws
and regulations mentioned herein or of all such laws and regulations. Any change
in applicable laws or regulations may have a material effect on the business and
prospects of the Company and the Bank. The operations of the Company and the
Bank may be affected by legislative and regulatory changes as well as by changes
in the policies of various regulatory authorities. The Company cannot accurately
predict the nature or the extent of the effects that such changes may have in
the future on its business and earnings.
Bank Holding Company Regulation. The Company is a bank holding company
within the meaning of the Bank Holding Company Act of 1956, as amended ("BHCA")
and, as such, is subject to the regulations of the Federal Reserve. Bank holding
companies are required to file periodic reports with and are subject to periodic
examination by the Federal Reserve. The Federal Reserve has issued regulations
under the BHCA requiring a bank holding company to serve as a source of
financial and managerial strength to its subsidiary banks. It is the policy of
the Federal Reserve that, pursuant to this requirement, a bank holding company
should stand ready to use its resources to provide adequate capital funds to its
subsidiary banks during periods of financial stress or adversity. Additionally,
under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), a bank holding company is required to guarantee the compliance of
any insured depository institution subsidiary that may become "undercapitalized"
(as defined in the statute) with the terms of any capital restoration plan filed
by such subsidiary with its appropriate federal banking agency up to the lesser
of (i) an amount equal to 5% of the institution's total assets at the time the
institution became undercapitalized, or (ii) the amount that is necessary (or
would have been necessary) to bring the institution into compliance with all
applicable capital standards as of the time the institution fails to comply with
such capital restoration plan. Under the BHCA, the Federal Reserve has the
authority to require a bank holding company to terminate any activity or
relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a
bank) upon the Federal Reserve's determination that such activity or control
constitutes a serious risk to the financial soundness and stability of any bank
subsidiary of the bank holding company.
The Company is prohibited by the BHCA from acquiring direct or indirect
control of more than 5% of the outstanding shares of any class of voting stock
or substantially all of the assets of any bank or merging or consolidating with
another bank holding company without prior approval of the Federal Reserve.
Additionally, the Company is prohibited by the BHCA from engaging in or from
acquiring ownership or control of more than 5% of the outstanding shares of any
class of voting stock of any company engaged in a non-banking business unless
such business is determined by the Federal Reserve to be so closely related to
banking as to be a proper incident thereto.
Capital Adequacy Guidelines for Bank Holding Companies. The Federal Reserve
is the federal regulatory and examining authority for bank holding companies.
The Federal Reserve has adopted capital adequacy guidelines for bank holding
companies. These guidelines are similar to, although not identical with, the
guidelines applicable to banks. See "Bank Capital Requirements." At December 31,
1998, the Company's Tier 1 leverage capital ratio was 15.81%, its Tier 1
risk-based capital ratio was 22.21% and its total risk-based capital ratio was
23.46%.
Bank Regulation. The Bank is organized under the laws of the State of
Washington and is subject to the supervision of the Department of Financial
Institutions ("DFI"), whose examiners conduct periodic examinations of state
banks. The Bank is not a member of the Federal Reserve System, so its principal
federal regulator is the FDIC, which also conducts periodic examinations of the
Bank. The Bank's deposits are insured, to the maximum extent permitted by law,
by the Bank Insurance Fund ("BIF") administered by the FDIC and are subject to
the FDIC's rules and regulations respecting the insurance of deposits. See
"Deposit Insurance."
Both federal and state laws extensively regulate various aspects of the
banking business such as reserve requirements, truth-in-lending and
truth-in-savings disclosures, equal credit opportunity, fair credit reporting,
trading in securities and other aspects of banking operations. Current federal
law also requires banks, among other things, to make deposited funds available
within specified time periods.
7
Insured state-chartered banks are generally prohibited under FDICIA from
engaging as principal in activities that are not permitted for national banks,
unless (i) the FDIC determines that the activity would pose no significant risk
to the appropriate deposit insurance fund, and (ii) the bank is, and continues
to be, in compliance with all applicable capital standards. The Company does not
believe that these restrictions will have a material adverse effect on its
current operations.
Bank Capital Requirements. The FDIC has adopted risk-based capital ratio
guidelines to which the Bank is subject. The guidelines establish a systematic
analytical framework that makes regulatory capital requirements more sensitive
to differences in risk profiles among banking organizations. Risk-based capital
ratios are determined by allocating assets and specified off-balance sheet
commitments to four risk weighted categories, with higher levels of capital
being required for the categories perceived as representing greater risk.
These guidelines divide a bank's capital into two tiers. Tier 1 includes
common equity, certain noncumulative perpetual preferred stock (excluding
auction rate issues) and minority interest in equity accounts of consolidated
subsidiaries, less goodwill and certain other intangible assets (except mortgage
servicing rights and purchased credit card relationships, subject to certain
limitations). Supplementary (Tier 2) capital includes, among other items,
cumulative perpetual and long-term, limited-life, preferred stock, mandatory
convertible securities, certain hybrid capital instruments, term-subordinated
debt and the allowance for loan and lease losses, subject to certain
limitations, less required deductions. Banks are required to maintain a total
risk-based capital ratio of 8%, of which 4% must be Tier 1 capital. The FDIC
may, however, set higher capital requirements when a bank's particular
circumstances warrant. Banks experiencing or anticipating significant growth are
expected to maintain capital ratios, including tangible capital positions, well
above the minimum levels.
In addition, the FDIC has established guidelines prescribing a minimum Tier
1 leverage ratio (Tier 1 capital to adjusted total assets as specified in the
guidelines). These guidelines provide for a minimum Tier 1 leverage ratio of 3%
for banks that meet certain specified criteria, including that they have the
highest regulatory rating and are not experiencing or anticipating significant
growth. All other banks are required to maintain a Tier 1 leverage ratio of 3%
plus an additional cushion of at least 100 to 200 basis points.
Certain regulatory capital ratios for the Company and the Bank at December
31, 1998 are set forth below:
Company Bank
Tier 1 Capital to Risk-Weighted Assets . . . . . . . . . 22.21% 12.07%
Total-Risk Based Capital to Risk-Weighted Assets . . . . 23.46% 13.32%
Tier 1 Leverage Ratio . . . . . . . . . . . . . . . . . 15.81% 8.72%
Dividends. The principal source of the Company's cash revenues is dividends
from the Bank. Under Washington law, the Bank may not pay dividends in an amount
greater than its retained earnings as determined by generally accepted
accounting principles. In addition, the DFI has the authority to require a
state-chartered bank to suspend payment of dividends. The FDIC has the authority
to prohibit a bank from paying dividends if, in its opinion, the payment of
dividends would constitute an unsafe or unsound practice in light of the
financial condition of the bank or if it would cause a bank to become
undercapitalized.
Lending Limits. Under Washington law, the total loans and extensions of
credit by a Washington-chartered bank to a borrower outstanding at one time may
not exceed 20% of such bank's capital and surplus. However, this limitation does
not apply to loans or extensions of credit which are fully secured by readily
marketable collateral having market value of at least 115% of the amount of the
loan or the extension of credit at all times.
Branches and Affiliates. Establishment of bank branches is subject to
approval of the DFI and FDIC and geographic limits established by state laws.
Washington's branch banking law permits a bank having its principal place of
business in the State of Washington to establish branch offices in any county in
Washington without geographic restrictions. A bank may also merge with any
national or state chartered bank located anywhere in the State of Washington
without geographic restrictions.
Under Oregon law, an out-of-state bank or bank holding company may merge
with or acquire an Oregon state chartered bank or bank holding company if the
Oregon bank, or in the case of a bank holding company, the subsidiary bank, has
been in existence for a minimum of three years, and the law of the state in
which the acquiring bank in located permits such merger. Branches may not be
acquired or opened separately, but once an out-of-state bank has acquired
branches in Oregon, either through a merger with or acquisition of substantially
all of the assets of an Oregon bank, the bank may open additional branches.
8
The Bank is subject to Sections 22 (h), 23A and 23B of the Federal Reserve
Act, which restrict financial transactions between banks and affiliated
companies. The statute limits credit transactions between a bank and its
executive officers and its affiliates, prescribes terms and conditions for bank
affiliate transactions deemed to be consistent with safe and sound banking
practices, and restricts the types of collateral security permitted in
connection with a bank's extension of credit to an affiliate.
FDICIA. FDICIA requires, among other things, federal bank regulatory
authorities to take "prompt corrective action" with respect to banks which do
not meet minimum capital requirements. For these purposes, FDICIA establishes
five capital tiers: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized.
The FDIC has adoped regulations to implement the prompt corrective action
provisions of FDICIA. Among other things, the regulations define the relevant
capital measures for the five capital categories. An institution is deemed to be
"well capitalized" if it has a total, risk-based capital ratio of 10% or
greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage
ratio of 5% or greater, and is not subject to a regulatory order, agreement or
directive to meet and maintain a specific capital level for any capital measure.
The Bank currently exceeds all of the ratios.
FDICIA further directs that each federal banking agency prescribe standards
for depository institutions and depository institutions holding companies
relating to internal controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth,
management compensation, a maximum ratio of classified assets to capital,
minimum earnings sufficient to absorb losses, a minimum ratio of market value to
book value of publicly traded shares and such other standards as the agency
deems appropriate.
Deposit Insurance. The Bank's deposits are insured up to $100,000 per
insured account by the BIF. As an institution whose deposits are insured by BIF,
the Bank is required to pay deposit insurance premiums to BIF.
FDICIA required the FDIC to issue regulations establishing a system for
setting deposit insurance premiums based upon the risks a particular bank or
savings association poses to the deposit insurance funds. This system bases an
institution's risk category partly upon whether the institution is well
capitalized, adequately capitalized or less than adequately capitalized. Each
insured depository institution is also assigned to one of three "supervisory"
categories based on reviews by regulators, statistical analysis of financial
statements and other relevant information. An institution's assessment rate
depends upon the capital category and supervisory category to which it is
assigned. Annual assessment rates currently range from $.03 per $100 of domestic
deposits for the highest rated institution to $0.27 per $100 of domestic
deposits for an institution in the lowest category. The Bank is currently in the
class of the highest rated institutions and, accordingly, pays the minimum
assessment for deposit insurance. Under legislation enacted in 1996 to
recapitalize the Savings Association Insurance Fund, the FDIC is authorized to
collect assessments against insured deposits to be paid to the Financing
Corporation ("FICO") to service FICO debt incurred in the 1980's. The current
FICO assessment rate for BIF insured deposits is 1.220 cents per $100 of
deposits per year. Any increase in deposit insurance of FICO assessments could
have an adverse effect on the Bank's earnings.
Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires
financial institutions regulated by the federal financial supervisory agencies
to ascertain and help meet the credit needs of their delineated communities,
including low-income and moderate-income neighborhoods within those communities,
while maintaining safe and sound banking practices. The regulatory agency
assigns one of four possible ratings to an institution's CRA performance and is
required to make public an institution's rating and written evaluation. The four
possible ratings are "outstanding," satisfactory," "needs to improve" and
"substantial noncompliance."
Under new regulations that apply to CRA performance ratings after July 1,
1997, many factors play a role in assessing a financial institution's CRA
performance. The institution's regulator must consider its financial capacity
and size, legal impediments, local economic conditions and demographics and the
competitive environment in which it operates. The evaluation does not rely on
absolute standards and financial institutions are not required to perform
specific activities or to provide specific amounts or types of credit.
The Company's most recent rating under CRA (using the regulations
applicable prior to July 1, 1997) is "outstanding." This rating reflects the
Company's commitment to meeting the credit needs of the communities it serves.
No assurance can be given, however, that the Company will be able to maintain an
"outstanding" rating under the new regulations in the future. The Bank has
recently had a CRA exam under the new regulations but has not yet received the
final results
9
Additional Matters. In addition to the matters discussed above, the Company
and the Bank are subject to additional regulation of their activities, including
a variety of consumer protection regulations affecting their lending, deposit
and collection activities and regulations affecting secondary mortgage market
activities.
The earnings of financial institutions, including the Company and the Bank,
are also affected by general economic conditions and prevailing interest rates,
both domestic and foreign and by the monetary and fiscal policies of the U.S.
Government and its various agencies, particularly the Federal Reserve.
Additional legislation and administrative actions affecting the banking
industry may be considered by the United States Congress, the Washington
Legislature and various regulatory agencies, including those referred to above.
It cannot be predicted with certainty whether such legislation or administrative
action will be enacted or the extent to which the banking industry in general or
the Company and the Bank in particular would be affected thereby.
2. Properties
The Company owns its main office space at the Cowlitz Financial Center. The
Bank occupies approximately 27,500 square feet of this facility. The Company
leases space in the Cowlitz Financial Center to Raymond James Financial
Services, Inc. and to Commerce Business & Estate Service, Inc., both of which
provide services to the Bank's customers. The Company owns branches in Kelso and
Kalama and leases facilities for branches in the Triangle Mall in Longview and
Castle Rock. Each facility has automated teller machines and each branch except
Kalama provides drive-up services. Business Finance Corporation leases its
facilities in Bellevue, Washington.
Cowlitz Bancorporation
Cowlitz Financial Center
927 Commerce Ave.
Longview, Wa 98632
(360) 423-9800
Kalama Branch Castle Rock Branch
195 N. 1st St. 202 Cowlitz St. W.
Kalama, Was 98625 Castle Rock, Wa 98625
(360) 673-2226 (360) 274-6685
Triangle Mall Branch Business Finance Corporation
800 Triangle Mall 1404 140th N.E., STE 103
Longview, Wa 98632 Bellevue, Wa 98007
(360) 577-6067 (425) 649-0258
Kelso Branch
13th & Grade St
Kelso, Wa 98626
(360) 423-7800
Item 3. Legal Proceedings
The Company may occasionally have pending routine litigation resulting from
the collection of the secured and unsecured indebtedness as part of its business
of providing financial services. In some cases, such litigation will involve
counterclaims or other claims against the Company. Such proceedings against
financial institutions sometimes also involve claims for punitive damages in
addition to other specific relief. Currently, the Company is not a party to any
litigation other than in the ordinary course of business. In the opinion of
management, the ultimate outcome of all pending legal proceedings will not
individually or in the aggregate have a material adverse effect on the financial
condition or the results of operations of the Company.
10
Item 4. Submission of matters to a vote of securities holders
No matters were submitted to a vote of securities holders of the registrant
during the quarter ended December 31, 1998.
PART II
Item 5. Market price and dividends on the registrant's common equity and
related stockholder matters
Effective March 12, 1998, Cowlitz Bancorporation stock began trading on the
Nasdaq National Market under the symbol "CWLZ". Prior to that date, there had
been no organized market for the Common Stock, and to the knowledge of the
Company, no third party bid and asked information was available.
1998
Market Price Cash Dividend
High Low declared
1st Quarter* 13.19 12.00 .013
2nd Quarter 14.13 11.88 .015
3rd Quarter 12.13 7.75 .015
4th Quarter 9.00 7.25 .015
*First day of trading was March 12, 1998
As of December 31, 1998 there were 4,001,999 shares of common stock
outstanding, held by approximately 335 shareholders.
Changes in Securities and Use of Proceeds
On March 12, 1998, the Company completed an initial public offering issuing
a total of 1,380,000 shares of common stock at $12.00 per share. After
underwriting discounts of $1.2 million and other offering expenses of $472,000
net proceeds were $14.9 million. Of these proceeds $1.1 million has been used to
repay long-term debt and a subordinated note, $1.8 million was used to acquire
BFC as described below and the remainder is being used for working capital. The
managing underwriters were Black & Company, Inc. and Pacific Crest Securities,
Inc.
Effective August 31, 1998, the Company acquired Business Finance
Corporation (BFC) of Bellevue, Washington. BFC provides factoring, leasing, and
inventory financing services in Washington, Oregon, California, and Nevada. The
acquisition was accounted for using the purchase method and included an initial
issuance of common stock with a value of $465,000. A cash payment was made in
the amount of $1.8 million, with an adjustment to be made based on final
determination of BFC's shareholders equity. A future contingent issuance of
common stock valued at approximately $500,000 will be issued if BFC achieves
earnings targets for the twelve-month period following the acquisition.
11
Item 6. Financial Highlights
Year Ended December 31,
1998 1997 1996 1995 1994
(dollars in thousands except per share data)
Income Statement Data
Interest income $16,366 $15,086 $13,633 $10,644 $7,492
Interest expense 6,501 6,943 6,174 4,548 2,841
------ ------ ------- ------- ------
Net interest income 9,865 8,143 7,459 6,096 4,651
Provision for loan loss 509 375 281 694 533
------ ------ ------- ------- ------
Net interest income after provision for
loan loss 9,356 7,768 7,178 5,402 4,118
Non-interest income 978 749 296 877 287
Non-interest expense 6,927 5,284 3,682 3,093 2,363
------ ------ ------- ------- ------
Income before provision for income
taxes 3,407 3,233 3,792 3,186 2,042
Provision for income taxes 1,181 1,109 1,295 1,088 697
------ ------ ------- ------- ------
Net income $2,226 $2,124 $2,497 $2,098 $1,345
====== ====== ======= ======= ======
Dividends
Cash $212 $126 $101 $80 $49
Ratio of dividends to net income 9.52% 5.93% 4.04% 3.81% 3.64%
Per Share Data
Diluted earnings per share $0.57 $0.78 $0.97 $0.83 $0.78
Cash dividends per common share $0.06 $0.05 $0.04 $0.03 $0.03
Weighted average shares outstanding 3,715,901 2,601,650 2,586,711 2,514,769 1,723,733
Balance Sheet Data (at period end)
Investment securities $11,530 $8,481 $5,391 $3,263 $3,565
Trading assets -- -- -- 2,016 2,781
Loans, net 130,232 129,993 124,657 105,900 75,564
Total assets 178,345 173,293 159,157 131,348 94,728
Total deposits 122,361 136,209 123,297 106,371 81,083
Total short-term borrowings 2,275 725 550 2,625 1,350
Total long-term borrowings 21,799 21,900 22,842 12,393 6,811
Total shareholders' equity 30,920 13,887 11,813 9,391 5,182
Selected Ratios
Return on average total assets 1.24% 1.28% 1.75% 1.90% 1.57%
Return on average shareholders'
equity 8.34% 16.65% 23.93% 26.06% 30.21%
Net interest margin 6.08% 5.33% 5.56% 5.91% 5.94%
Efficiency ratio (1) 63.89% 59.42% 47.48% 44.36% 47.85%
Asset Quality Ratios
Allowance for loan losses to:
Ending total loans 1.37% 1.49% 1.50% 1.64% 1.50%
Nonperforming assets (2) 54.66% 81.51% 328.82% 540.80% 548.57%
Nonperforming assets to ending total assets 1.86% 1.39% 0.36% 0.25% 0.22%
Net loan charge-offs to average loans 0.54% 0.23% 0.13% 0.09% 0.20%
Capital Ratios
Average shareholders' equity to average
assets 14.93% 7.69% 7.31% 7.30% 5.21%
Tier 1 capital ratio (3) 22.21% 9.61% 10.11% 9.86% 7.68%
Total risk based capital ratio(4) 23.46% 11.34% 11.88% 11.96% 10.42%
(1) Efficiency ratio is noninterest expense divided by the sum of net interest income plus noninterest income.
(2) Nonperforming assets consist of nonaccrual loans, loans contractually past due 90 days or more and other real estate owned.
(3) Tier 1 capital divided by risk-weighted assets.
(4) Total risk-based capital divided by risk-weighted assets.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations includes a discussion of certain significant business
trends and uncertainties as well as other forward-looking statements and is
intended to be read in conjunction with and is qualified in its entirety be
reference to the consolidated financial statements of the Company and
accompanying notes included elsewhere in this report. For a discussion of
important factors that could cause actual results to differ materially from such
forward-looking statements, see "risk factors."
Introduction
The Company has recently undertaken significant business changes to
strengthen its position as a leading bank in Cowlitz County and to expand its
services throughout western Washington. Beginning in November 1996, the Company
expanded its operating base by opening a branch in Kelso, Washington. In July
1997, the Company acquired three Wells Fargo Bank branches, located in Castle
Rock, Kalama, and Longview, Washington (the "Branch Acquisition"). In this
acquisition, the Company acquired branch sites, retained the existing employees
and assumed approximately $25.2 million in deposit liabilities, but did not
acquire any loans or other revenue producing assets. During 1997, the Company
established a trust department at its main office in Longview. In March 1998,
the Company completed an initial public offering and in September 1998, the
Company acquired Business Finance Corporation ("BFC") of Bellevue, Washington.
BFC provides asset-based lending services to companies throughout the western
United States.
Results of Operations
Net Interest Income
For financial institutions, the primary component of earnings is net
interest income. Net interest income is the difference between interest income,
principally from loans and investment securities portfolios, and interest
expense, principally on customer deposits. Changes in net interest income result
from changes in "volume," "spread" and "margin." Volume refers to the dollar
level of interest-earning assets and interest-bearing liabilities. Spread refers
to the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities. Net interest margin is the ratio of net interest
income to total interest-earning assets and is influenced by the level and
relative mix of interest-earning assets and interest-bearing liabilities.
Net interest income for the year ended December 31, 1998 was $9.9 million
an increase of 21.1% from $8.1 million in 1997, which was $684,000 higher than
1996. Total interest earning assets averaged $162.2 million for the year ended
December 31, 1998, compared to $152.9 million and $134.2 million for the
corresponding periods in 1997 and 1996, respectively. The increase in average
earning assets between 1998 and 1997 was attributable to an increase in taxable
securities and interest earning balances due from banks after the Company's IPO
in March of 1998, as well as the increase in loans after the Company's
acquisition of BFC. For the year ended December 31, 1997, the increase in
average earning assets was $18.6 million, the largest component of which was an
increase in the amount of loans. The overall tax-equivalent yield on interest
earning assets was 10.09% in 1998, compared to 9.87% in 1997 and 10.16% in 1996.
The yield on interest-earning assets increased in 1998 when compared to 1997 due
to loans at BFC which produce higher yields than loans at the Bank. Interest
yields also increased on investments. In 1997, yields were lower on earning
assets when compared to 1996, primarily due to lower interest rates on loans due
to market conditions in the Bank's market area.
Interest expense as a percentage of earning assets decreased to 4.01% in
1998, compared to 4.54% in 1997 and 4.60% in 1996. The average cost of interest
bearing liabilities remained 5.30% in 1998 and 1997 compared to 5.35% in 1996.
The Company's net interest spread was 4.79% in 1998, 4.57% in 1997, and 4.81% in
1996. The increase between 1998 and 1997 resulted from higher yields received on
interest earning assets. Local competitive pricing conditions and funding needs
for the Company's investments and loans were the primary determinants of rates
paid for deposits during 1998, 1997 and 1996.
13
Average Balances and Average Rates Earned and Paid. The following table
sets forth, for the periods indicated, information with regard to (i) average
balances of assets and liabilities, (ii) the total dollar amounts of interest
income on interest earning assets and interest expense on interest bearing
liabilities, (iii) resulting yields or costs, (iv) net interest income and (v)
net interest spread. Nonaccrual loans have been included in the table as loans
carrying a zero yield. Loan fees are recognized as income using the interest
method over the life of the loan.
Year Ended December 31,
1998 1997 1996
Average Average Interest Average Interest
Outstanding Interest Outstanding Earned/ Outstanding Earned/
Balance Earned/Paid Yield/Rate Balance Paid Yield/Rate Balance Paid Yield/Rate
(dollars in thousands)
ASSETS:
Loans $131,495 $14,103 10.73% $130,362 $13,700 10.51% $118,957 $12,721 10.69%
Taxable Securities 15,071 955 6.34% 10,261 667 6.50% 6,890 386 5.60%
Nontaxable securities(1) 81 4 4.94% - - 0.00% 36 3 8.33%
Trading assets - - 0.00% - - 0.00% 589 34 5.77%
Federal funds sold - - 0.00% - - 0.00% - - 0.00%
Interest earning balances
due from Banks 15,512 1,305 8.41% 12,259 719 5.87% 7,777 490 6.30%
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest
earning assets $162,159 $16,367 10.09% $152,882 $15,086 9.87% $134,249 $13,634 10.16%
Cash and due from banks 8,528 7,553 6,021
Premises and equipment, net 5,846 5,064 2,309
Allowance for loan losses (1,930) (1,935) (1,801)
Net intangibles 2,171 580 -
Other assets 2,045 1,846 1,861
-------- -------- --------
Total assets $178,819 $165,990 $142,639
======== ======== ========
LIABILITIES AND SHAREHOLDERS EQUITY:
Savings and interest-bearing
demand deposits $46,291 $1,894 4.09% $37,568 $1,253 3.34% $30,834 $1,031 3.34%
Certificates of deposits 52,682 3,048 5.79% 70,641 4,246 6.01% 64,863 3,960 6.11%
Long-term borrowings 21,755 1,469 6.75% 21,773 1,401 6.43% 17,315 1,073 6.20%
Short-term borrowings 1,865 90 4.83% 955 43 4.50% 2,359 110 4.66%
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest
bearing liabilities $122,593 $6,501 5.30% $130,937 $6,943 5.30% $115,371 $6,174 5.35%
Non-interest bearing deposits 28,672 21,621 16,196
Other liabilities 851 675 639
Total liabilities 152,116 153,233 132,206
Shareholders' equity 26,703 12,757 10,433
-------- -------- --------
Total liabilities and
shareholders' Equity $178,819 $165,990 $142,639
========= ======== ========
Net interest income $9,866 $8,143 $7,460
======= ======= ======
Net interest spread 4.79% 4.57% 4.81%
Average yield on earning assets 10.09% 9.87% 10.16%
Interest expense to
earning assets 4.01% 4.54% 4.60%
Net interest income to
earning assets 6.08% 5.33% 5.56%
(1) Interest earned on nontaxable securities has been computed on a 34 percent tax equivalent basis.
14
Analysis of changes in interest differential. The following table shows the
dollar amount of the increase (decrease) in the Company's net interest income
and expense and attributes such dollar amounts to changes in volume as well as
changes in rates. Rate/volume variance have been allocated to volume changes:
Year Ended December 31,
1998 versus 1997 1997 versus 1996
Increase Increase
(Decrease) Due to (Decrease) Due to
Total Increase/ Total Increase/
Volume Rate (Decrease) Volume Rate (Decrease)
(dollars in thousands)
Interest income:
Interest earning balances due
From banks $275 $311 $586 $262 $(33) $229
Trading account income - - - (34) (34)
Investment security income:
Taxable securities 304 (16) 288 219 62 281
Nontaxable securities 3 - 3 (2) - (2)
Loans, including fees on loans 116 287 403 1,193 (214) 979
---- ---- ----- ------ ----- ------
Total interest income 698 582 1,280 1,638 (185) 1,453
---- ---- ----- ------ ----- ------
Interest expense:
Savings and interest bearing
Demand 359 282 641 222 - 222
Certificates of deposit (1,043) (155) (1,198) 351 (65) 286
Short-term borrowings 44 3 47 (63) (4) (67)
Long-term borrowings (2) 70 68 288 40 328
---- ---- ----- ------ ----- ------
Total interest expense (642) 200 (442) 798 (29) 769
---- ---- ----- ------ ----- ------
Net interest spread $1,340 $382 $1,722 $840 $(156) $684
===== ==== ====== ====== ===== ======
Provision for Loan Losses
The amount of the allowance for loan losses is analyzed by management on a
regular basis to ensure that it is adequate to absorb losses inherent in the
loan portfolio as of the reporting date. When a provision for loan losses is
recorded, the amount is based on past charge-off experience, a careful analysis
of the current loan portfolio, the level of nonperforming and impaired loans,
evaluation of future economic trends in the Company's market area, and other
factors relevant to the loan portfolio. See Allowance for Loan Losses disclosure
for a more detailed discussion.
The Company's provision for loan losses was $509,000, $375,000 and $281,000
for the years ended December 31, 1998, 1997 and 1996, respectively. Net
charge-offs were $710,000 in 1998 compared to net charge-offs of $299,000 and
$150,000 for 1997 and 1996 respectively. Total charge-offs of $727,000 in 1998
reflect losses realized in the portfolio that the Company had recognized
previously through the provision for loan losses. Management continues to
closely monitor the loan quality and existing relationships.
Nonaccrual loans were $2.7 million at December 31, 1998 and $1.9 million at
December 31, 1997. During 1998, nonaccrual loans increased primarily in
commercial loans secured by real estate. Included in the nonaccrual loans of
$2.7 million are five borrowing relationships with an aggregate total of $1.7
million that are largely secured by real estate. Another component of this
increase is approximately $331,000 of loans at the Company's subsidiary BFC. It
is not unusual in the normal course of business for BFC to have loans that
become more than 90 days past due and are therefore placed on nonaccrual status,
although management does not necessarily believe that losses are probable on
these loans. Other real estate increased $485,000 during 1998, as a result of
the reclassification of these loans from nonacrual in 1997 to other real estate
owned in 1998. Any losses on nonaccrual loans, which are considered probable,
have been estimated by management in its regular quarterly assessment of the
allowance for loan losses as discussed in the Allowance for Loan Losses
disclosure. The increase in the provision for loan losses each year is largely
reflective of the increases in nonaccrual loans during the periods. For a more
detailed discussion see Allowance for Loan Losses disclosure.
15
Non-Interest Income
Non-interest income consists of the following components:
Non-interest income
December 31,
1998 1997 1996
Service charge on deposit accounts $ 656 $ 563 $ 387
Net gains on sales of securities 5 - (309)
Credit Card income 114 100 81
Fiduciary income 57 - -
ATM income 40 13 -
Safe deposit box fees 30 15 12
Insurance Commissions 9 13 26
Data processing income - 11 25
Other miscellaneous fees and income 67 34 74
------- ------ ------
Total non-interest income $ 978 $ 749 $ 296
======= ====== ======
Total non-interest income has ranged from $978,000 for 1998, to $749,000 for
1997 and $296,000 for 1996. Service charges on deposit accounts increased to
$656,000 in 1998 from $563,000 in 1997 and $387,000 in 1996 primarily because of
the increase in deposits from the Branch Acquisition in July 1997. ATM income
and safe deposit income have also increased after the Branch Acquisition. The
opening of the trust department added $57,000 in non-interest income during
1998. The increase in non-interest income of $453,000 from 1996 to 1997
primarily reflects the loss in the Company's trading account of $309,000 in
1996. The loss was due primarily to the volatility of interest rates during this
period. The Company did not conduct any trading activities during 1998 or 1997.
Non-Interest Expense
Non-interest expense consists principally of employees' salaries and
benefits, occupancy costs, data processing and communication expenses, FDIC
(Federal Deposit Insurance Corporation) insurance premiums, professional fees,
and other non-interest expenses. Non-interest expenses increased 31.1% to $6.9
million for the year ended December 31, 1998 compared to $5.3 million for the
year ended December 31, 1997, which was an increase of 43.5% compared to $3.7
million for the year ended December 31, 1996. As discussed below, the primary
reasons for this increase were increased staffing costs, as well as an increase
in other operating expense such as occupancy expense and amortization of the
deposit premium from the Branch Acquisition in July 1997 and the goodwill
amortization from the acquisition of BFC in September 1998.
A measure of the Company's ability to contain non-interest expenses is the
efficiency ratio. This statistic is derived by dividing total non-interest
expenses by total net interest income and non-interest income. The Company's
efficiency ratio increased to 63.89% for the year ended December 31, 1998
compared to 59.42% for the corresponding period in 1997 and 47.48% for the year
ended December 31, 1996, largely as a result of the Company's expansion
activities during these periods.
16
Salaries and benefits expense of $3.8 million in 1998 represented an
increase of $997,000 or 36% from $2.8 million reported in 1997 which was
$641,000 or 30% higher than the $2.1 million reported in 1996. In 1997, the
salary expense reflected the addition of the employees that remained with the
Bank after the Branch Acquisition in July 1997. During 1998, the salary and
benefit expense includes the addition of approximately 22 employees from the
branches for a twelve-month period. All of these employees were with the Company
at both December 31, 1997 and December 31, 1998, but only received five and
one-half months salary from the Company in 1997. Also contributing to the
increase were ordinary increases in salary for existing employees generally
ranging from three to six percent a year. At December 31, 1998, the Company had
105 full-time equivalent employees compared to 99 and 63 at December 31, 1997
and 1996, respectively.
Net occupancy expenses consist of depreciation on premises, lease costs,
equipment, maintenance and repair expenses, utilities and related expenses. The
Company's net occupancy expense in 1998 of $888,000 was $164,000 or 22.7% higher
than the $724,000 reported in 1997, which was $331,000 or 84.2% higher than the
$393,000 reported in 1996. The increase in occupancy expense in these periods
was due primarily to building a new branch in Castle Rock and the remodel of the
Triangle branch, both of which occurred in 1998. Also contributing to these
increases were the expansion of the Company's main office facility, the Branch
Acquisition in July 1997 and the opening of a branch in Kelso in late 1996.
Intangible assets included a deposit premium of $1.6 million and $1.8
million, net of accumulated amortization, at December 31, 1998 and 1997,
respectively. The deposit premium is being amortized using an accelerated method
over a ten-year life. Intangible assets at December 31, 1998 also included
goodwill of $1.5 million, net of accumulated amortization, representing the
excess of acquisition costs over the fair value of net assets that arose in
connection with the acquisition of Business Finance Corporation and is being
amortized on a straight-line basis over a fifteen-year period. At December 31,
1998, expenses related to the amortization of intangibles were $309,000 compared
to $123,000 at December 31, 1997 and $0 at December 31, 1996.
Other operating expenses such as insurance, legal and accounting expenses,
service charges, postage, and other business expenses were $1.7 million at
December 31, 1998, $1.4 million at December 31, 1997, and $1.0 million at
December 31, 1996. The increases from year to year were due to the Company's
continued growth and expansion.
Income Taxes
The provision for income taxes amounted to $1.2 million, $1.1 million and
$1.3 million for 1998, 1997, and 1996, respectively. The provision resulted in
an effective tax rate of 34.7% in 1998, 34.3% in 1997, and 34.2% in 1996.
Allowance for Loan Losses
The allowance for loan losses represents management's estimate of probable
losses which have occurred as of the date of the financial statements. The loan
portfolio is regularly reviewed to evaluate the adequacy of the allowance for
loan losses. In determining the level of the allowance, the Company evaluates
the allowance necessary for specific non-performing loans and estimates losses
inherent in other loan exposures. An important building block in determining the
adequacy of an allowance for loan losses is an analysis of loans by loan rating
categories. The risk of a credit is evaluated by the Company's management at
inception of the loan using an established grading system. This grading system
currently includes ten levels of risk. Risk gradings range from "1" for the
strongest credits to "10" for the weakest; a "10" rated loan would normally
represent a loss. These gradings are reviewed annually or when indicators show
that a credit may have weakened, such as operating losses, collateral impairment
or delinquency problems.
The result is an allowance with two components:
Specific Reserves: The amount of specific reserves is determined through a
loan-by-loan analysis of classified and nonperforming loans that considers
expected future cash flows, the value of collateral and other factors that may
impact the borrower's ability to pay.
17
General Allowance: The amount of the general allowance is based on loss
factors assigned to the Company's loan exposures based on internal credit
ratings. These loss factors are determined on the basis of historical charge-off
experience. The general allowance is composed of two categories. The first
component is calculated based upon the loan balances classified in the five
higher risk loan categories of "management attention", "special mention",
"substandard", "doubtful" and "loss" in the Company's Watch List. Suggested
regulatory loss reserve factors are then applied to each of these categories of
classified loan balances. The second component is calculated by applying
historical loss factors to the outstanding loan balance less any loans that are
included in the Company's specific or higher risk allowances discussed above.
Three levels of charge off history are considered by management in arriving at
this component of the general allowance. They are average five-year net
charge-offs, the previous year's actual net charge-offs and an estimated maximum
charge-off factor. Each of these amounts is combined with the first component of
the general allowance yielding a range for the total general allowance.
Management selects a general allowance somewhere within this calculated range.
Factors considered by management in making this decision include the volume and
mix of the existing loan portfolio, including the volume and severity of
nonperforming loans and adversely classified credits; analysis of net
charge-offs experienced on previously classified loans; the nature and value of
collateral securing the loans; the trend in loan growth, including any rapid
increase in loan volume within a relatively short period of time; management's
subjective evaluation of general and local economic and business conditions
affecting the collectibility of the Company's loans; the relationship and trend
over the past several years of recoveries in relation to charge-offs; and
available outside information of a comparable nature regarding the loan
portfolios of other banks, including peer group banks. This decision also
reflects management's attempt to ensure that the overall allowance appropriately
reflects a margin for the imprecision necessarily inherent in estimates of
expected loan losses.
The quarterly analysis of specific and general loss components of the
allowance is the principal method relied upon by management to ensure that
changes in estimated loan loss levels are adjusted on a timely basis. The
inclusion of historical loss factors in the process of determining the general
component of the allowance also acts as a self-correcting mechanism of
management's estimation process, as loss experience more remote in time is
replaced by more recent experience. In its analysis of the specific and the
general components of the allowance, management also considers the experience of
peer institutions and regulatory guidance in addition to the Company's own
experience.
Loans and other extensions of credit deemed uncollectable are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance.
Actual losses may vary from current estimates and the amount of the provision
may be either greater than or less than actual net charge-offs. The related
provision for loan losses, which is charged to income, is the amount necessary
to adjust the allowance to the level determined through the above process.
At December 31, 1998, approximately $700,000 of the allowance for loan
losses was allocated based on an estimate of the amount that was necessary to
provide for potential losses related to specific classified and nonperforming
loans (including impaired loans) only, while approximately $1.1 million
comprised the general portion of the allowance.
Management's evaluation of the factors above resulted in allowances for
loan losses of $1.8 million and $2.0 million at the end of 1998 and 1997,
respectively. The allowance as a percentage of year-end total loans declined
from 1.49% at year-end 1997 to 1.37% at year-end 1998. This decline reflects the
increased level of charge-offs in 1998 which were considered by management in
its determination of the adequacy of the allowance for loan losses in periods
prior to charge-off. As such, these charge-offs reflect the realization of
losses in the portfolio that were recognized previously through provisions for
loan losses.
The allowance for loan losses is based upon estimates of probable losses
inherent in the loan portfolio. The amount actually observed for these losses
can vary significantly from the estimated amounts.
18
The following table shows the Company's loan loss performance for the
periods indicated:
Year Ended December 31,
1998 1997 1996
(dollars in thousands)
Loans outstanding at end of period $132,046 $131,963 $126,551
Average loans outstanding during the period $131,495 $130,362 $118,957
Allowance for loan losses, beginning of period $1,970 $1,894 $1,763
Loans charged off:
Commercial 618 186 36
Real estate -- 3 30
Consumer 22 23 22
Credit cards 87 112 70
------ ------ ------
Total loans charged-off 727 324 158
------ ------ ------
Recoveries:
Commercial -- 5 5
Real estate 3 -- --
Consumer 4 20 1
Credit cards 10 -- 2
------ ------ ------
Total recoveries 17 25 8
------ ------ ------
Provision for loan losses 509 375 281
------ ------ ------
Adjustment incident to acquisition 45 -- --
------ ------ ------
Allowance for loan losses, end of period $1,814 $1,970 $1,894
====== ====== ======
Ratio of net loans charged-off to average loans outstanding 0.54% 0.23% 0.13%
Ratio of allowance for loan losses to loans at year end 1.37% 1.49% 1.50%
Financial Condition
Summary Balance Sheet
December 31, Increase (Decrease)
1998 1997 1996 12/31/97-12/31/98 12/31/96-12/31/97
(dollars) (percent) (dollars) (percent)
(dollars in thousands)
ASSETS
Cash and due from banks $22,705 $23,109 $20,905 $(404) (1.7)% $2,204 10.5%
Investment securities 11,530 8,481 5,391 3,049 36.0% 3,090 57.3%
Loans, net 130,232 129,993 124,657 239 0.2% 5,336 4.3%
Other assets 13,878 11,710 8,204 2,168 18.5% 3,506 42.7%
-------- -------- -------- ------- -------
Total assets $178,345 $173,293 $159,157 $5,052 2.9% $14,136 8.9%
======== ======== ======== ======= =======
LIABILITIES
Non-interest-bearing $33,062 $27,141 $16,821 $5,921 21.8% $10,320 61.4%
deposits
Interest-bearing deposits 89,299 109,068 106,476 (19,769) (18.1)% 2,592 2.4%
-------- -------- -------- ------- -------
Total deposits 122,361 136,209 123,297 (13,848) (10.2)% 12,912 10.5%
Other liabilities 25,064 23,197 24,047 1,867 8.0% (850) (3.5)%
SHAREHOLDERS' EQUITY 30,920 13,887 11,813 17,033 122.7% 2,074 17.6%
-------- -------- -------- ------- -------
Total liabilities and
shareholders' equity $178,345 $173,293 $159,157 $5,052 2.9% $14,136 8.9%
======== ======== ======== ======= =======
19
Investment Securities
At December 31, 1998, the Company's portfolio of investment securities
totaled $11.5 million, a 36% increase when compared to a securities portfolio of
$8.5 million at December 31, 1997. The investment portfolio increased during
1998 primarily as a result of the investment of the offering proceeds in March
1998.
The Company follows a financial accounting principle which requires the
identification of investment securities as held-to-maturity, available-for-sale
or trading assets. Securities designated as held-to-maturity are those that the
Company has the intent and ability to hold until they mature or are called.
Available-for-sale securities are those that management may sell if liquidity
requirements dictate or alternative investment opportunities arise. Trading
assets are purchased and held principally for the purpose of reselling them
within a short period of time. The mix of available-for-sale and
held-to-maturity investment securities is considered in the context of the
Company's overall asset-liability policy and illustrates management's assessment
of the relative liquidity of the Company. At December 31, 1998, the investment
portfolio consisted of 61.3% available-for-sale securities and 38.7%
held-to-maturity investments. At December 31, 1997, available-for-sale
securities were 47.4% and held-to-maturity investments were 52.6% of the
investment portfolio. The Company did not conduct any trading activities during
1998 or 1997. See Note 2 to the Consolidated Financial Statements.
The following table provides the book value of the Company's portfolio of
investment securities as of December 31, 1998 and 1997.
December 31,
1998 1997
Amortized Fair Amortized Fair
Cost Cost Value
(dollars in thousands)
Available-for-sale
U.S. Treasury securities $6,994 $7,065 $3,993 $4,017
------ ------ ------ ------
Total $6,994 $7,065 $3,993 $4,017
====== ====== ====== ======
Held-to-maturity
U.S. Treasury securities $999 $1,021 $2,978 $3,000
Municipal bond 199 199 -- --
Certificates of deposit 3,267 3,267 1,486 1,486
------ ------ ------ ------
Total $4,465 4,487 $4,464 $4,486
====== ====== ====== ======
At December 31, 1998, the Company's available-for-sale and held-to-maturity
investments had a total net unrealized gains of approximately $93,000. This
compares to net unrealized gains of approximately $46,000 at December 31, 1997.
Unrealized gains and losses reflect changes in market conditions and do not
represent the amount of actual profits or losses the Company may ultimately
realize. Actual realized gains and losses occur at the time investment
securities are sold or redeemed.
In 1991, the Company became a member and shareholder in the Federal Home
Loan Bank of Seattle. The Company's relationship and stock investment with the
FHLB provides a borrowing source for meeting liquidity requirements, in addition
to dividend earnings. Investment in FHLB stock was $2.9 million at December 31,
1998 compared to $2.7 million at December 31, 1997.
At December 31, 1998, net unrealized gains on available-for-sale securities
were $47,000 representing 0.41% of the total portfolio. Management has no
current plans to sell any of these securities.
The following table summarizes the contractual maturities and weighted
average yields of investment securities at December 31, 1998:
One After 5 Due
One year through through through
or less Yield 5 years Yield 10 years Yield 10 years Yield Total Yield
U.S. Treasury securities $2,008 6.13% $6,056 5.63% $-- -- -- -- $8,064 5.77%
Other securities 3,267 5.88% 100 4.00% 99 4.10% -- -- 3,466 5.78%
------ ------ --- ---- -------
Total $5,275 5.90% $6,156 5.23% $99 4.10% -- -- $11,530 5.78%
====== ====== === ==== =======
20
Loans
Outstanding loans totaled $132,046,000 at December 31, 1998, representing
an increase of $83,000 compared to $131,963,000 at December 31, 1997. Loan
commitments were $24.7 million at December 31, 1998. Loan commitments amounted
to $16.6 million at December 31, 1997.
The following table presents the composition of the Company's loan
portfolio at the dates indicated.
Year Ended December 31,
1998 1997
Amount Percentage Amount Percentage
(dollars in thousands)
Commercial $103,473 78.04% $93,829 70.75%
Real estate construction 3,206 2.42% 3,495 2.64%
Real estate commercial 7,026 5.30% 5,475 4.13%
Real estate mortgage 13,774 10.39% 24,167 18.22%
Consumer and other 5,063 3.82% 5,571 4.20%
Contracts purchased 45 0.03% 81 0.06%
-------- ------ -------- ------
132,587 100.00% 132,618 100.00%
====== ======
Deferred loan fees (541) (655)
-------- --------
Total loans 132,046 131,963
Allowance for loan losses (1,814) (1,970)
-------- --------
Total loans, net $130,232 $129,993
======== ========
The following table shows the maturities and sensitivity of the Company's
loans to changes in interest rates at the dates indicated:
December 31, 1998
Due after one
Due in one year through 5 years Due after 5
or less years Total Loans
(dollars in thousands)
Commercial Loans $40,416 $49,584 $13,473 $103,473
Real estate construction 1,251 1,537 418 3,206
Real estate commercial 2,744 3,367 915 7,026
Real estate mortgage 5,380 6,601 1,793 13,774
Consumer and other 1,996 2,447 620 5,063
Contracts purchased - - 45 45
------- -------- ------- --------
$51,787 $63,536 $17,264 $132,587
======= ======== ======= ========
Loans with fixed interest rates $97,584
Loans with floating interest rates 35,003
--------
Total $132,587
========
In May 1993, the Financial Accounting Standards Board (FASB) issued SFAS
No. 114, "Accounting by Creditors for Impairment of a Loan" and in October 1996
issued SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income
Recognition Disclosures, an amendment to SFAS No. 114." The adoption of SFAS
Nos. 114 and 118 did not have a material impact on the comparability of the
tables provided herein. The Company, during its normal loan review procedures,
considers a loan to be impaired when it is probable that the Company will be
unable to collect all amounts due according to the contractual terms of the loan
agreement. A loan is not considered to be impaired during a period of minimal
delay (less than 90 days). The Company measures impaired loans 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 market value of the collateral if the loan is collateral
dependent. Impaired loans are charged to the allowance when management believes,
after considering economic and business conditions, collection efforts, and
collateral position, that the borrowers financial condition is such that
collection of principal is not probable.
21
At December 31, 1998 and 1997, the Company's recorded investment in certain
loans that were considered to be impaired was $2.7 million and $2.3 million,
respectively. Of these impaired loans, $891,000 and $302,000 have related
valuation allowance of $65,000 and $199,000, while $1.8 million and $2.0 million
did not require a valuation allowance. The balance of the allowance for loan
losses in excess of these specific reserves is available to absorb losses from
all loans. The average recorded investment in impaired loans for the years ended
December 31, 1998, 1997, and 1996, was approximately $2.4 million, $1.3 million,
and $342,000, respectively. The Company's policy is to disclose as impaired
loans all loans that are past due 90 days or more as to either principal or
interest, except loans that are currently measured at fair value or the lower of
cost or fair value and credit card receivables, which are considered large
groups of smaller homogeneous loans and are collectively evaluated for
impairment. Interest payments received on impaired loans are recorded as
interest income, unless collection of the remaining recorded investment is not
probable, in which case payments received are recorded as a reduction of
principal. For the years ended December 31, 1998, 1997, and 1996, interest
income recognized on impaired loans totaled $77,000, $36,000, and $14,000,
respectively, all of which was recognized on a cash basis.
Generally, no interest is accrued on loans when factors indicate collection
of interest is doubtful or when the principal or interest payment becomes 90
days past due, unless collection of principal and interest are anticipated
within a reasonable period of time and the loans are well secured. For such
loans, previously accrued but uncollected interest is charged against current
earnings, and income is only recognized to the extent payments are subsequently
received and collection of the remaining recorded principal balance is
considered probable.
The Company manages the general risks inherent in the loan portfolio by
following loan policies and underwriting practices designed to result in prudent
lending activities. The following table presents information with respect to
nonperforming assets:
December 31,
1998 1997
Loans on nonaccrual status $2,737 $1,897
Loans past due greater than 90 days but not on nonaccrual status 9 432
Other real estate owned 573 88
Troubled debt restructurings -- --
------ ------
Total nonperforming assets $3,319 $2,417
====== ======
Percentage of nonperforming assets to total assets 1.86% 1.39%
The increase in nonperforming loans from December 31, 1997 to December 31,
1998 is reflective of 5 borrowing relationships with an aggregate principal
balance of $1.7 million primarily secured by real estate. Also included in the
increase is approximately $331,000 of loans at the Company's subsidiary BFC. It
is not unusual in the normal course of business for BFC to have loans that
become more than 90 days past due and are therefore placed on nonaccrual status,
although management does not necessarily believe that losses are probable on
these loans. Other real estate owned has increased $485,000 and all properties
are being actively marketed by local real estate agencies. Any probable losses
have been considered in management's analysis of the allowance for loan losses.
Deposits
The following table sets forth the average balances of the Company's
interest bearing liabilities, interest expense and average rates paid for the
period indicated:
Year Ended December 31,
1998 1997 1996
Average Interest Average Average Interest Average Average Interest Average
Balance Expense Rate Balance Expense Rate Balance Expense Rate
(dollars in thousands)
Interest-bearing checking $28,912 $1,396 4.83% $21,956 $766 3.49% $16,209 $533 3.29%
Savings 17,379 498 2.87% 15,612 487 3.12% 14,625 498 3.41%
Certificates of deposit 52,682 3,048 5.79% 70,641 4,246 6.01% 64,863 3,960 6.11%
Long-term borrowings 21,755 1,469 6.75% 21,773 1,401 6.43% 17,315 1,073 6.20%
Short-term borrowings 1,865 90 4.83% 955 43 4.50% 2,359 110 4.66%
-------- ------ -------- ------ -------- ------
Total interest-bearing $122,593 $6,501 5.30% $130,937 $6,943 5.30% $115,371 $6,174 5.35%
liabilities ====== ====== ======
Total noninterest-bearing liabilities 29,523 22,296 16,835
-------- -------- --------
Total interest and noninterest-
Bearing liabilities $152,116 $153,233 $132,206
======== ======== ========
22
Deposits decreased to $122.4 million at December 31, 1998, a decrease of
10.2% from $136.2 at December 31, 1997, primarily as a result of the Company
reducing pricing on certain of its higher yielding certificates after the
acquisition of deposits from the Branch Acquisitions in July of 1997, intending
to eliminate these higher cost certificates of deposit at maturity. The decline
in deposits has been primarily in time deposits. Nonvolatile, non-interest
bearing deposits, also referred to as core deposits, have grown as a percentage
of the Company's deposit base. To the extent that the Company is able to fund
operations with non-interest bearing core deposits, net interest spread, the
difference between interest income and interest expense, will improve. At
December 31,1998, non-interest bearing demand deposits were 27% of total
deposits, compared to 19.9% of total deposits at December 31, 1997
Interest bearing deposits consist of NOW, money market, savings and time
certificate accounts. By their nature, interest bearing account balances will
tend to grow or decline as the Company reacts to changes in competitors' pricing
and interest payment strategies. At December 31, 1998, total interest bearing
deposit accounts of $89.3 million decreased $19.8 million or 18.1% from December
31, 1997. This decline was concentrated in certificate of deposit accounts as
discussed above.
The Company has from time to time funded its growth with higher interest
rate certificates of deposit over $100,000. At December 31, 1998, time
certificates of deposit in excess of $100,000 totaled $13.6 million or 32.5% of
total outstanding time deposits, compared to $18.6 million or 29.7% of total
outstanding time deposits at December 31, 1997. This decline in time deposits in
excess of $100,000 during 1998 and 1997 reflects management's decision to allow
this type of deposit to run-off following the Branch Acquisition in July 1997.
The following table sets forth, by time remaining to maturity, all time
certificates of deposit accounts outstanding at December 31, 1998:
Time deposits of $100,000 or more (1) All other time deposits (2)
(dollars in thousands)
Reprice/Mature in three months or less $ 6,796 49.89% $ 10,547 37.26%
Reprice/Mature after three months through six months 1,179 8.65% 6,898 24.37%
Reprice/Mature after six months through one year 2,522 18.51% 5,908 20.87%
Reprice/Mature after one year through five years 2,806 20.60% 4,706 16.62%
Reprice/Mature after five years 320 2.35% 250 .88%
---------- ------ ------------ ------
Total $ 13,623 100.00% $ 28,309 100.00%
========== ====== ============ ======
(1) Time deposits of $100,000 or more represent 32.5% of total time deposits at December 31, 1998.
(2) All other time deposits represent 67.5% of total time deposits at December 31, 1998.
At December 31, 1998, other borrowings have the following times remaining
to maturity:
Due Due
after 3 after
Due in 3 months one year Due
months through through after 5
or less one year 5 years years Total
(dollars in thousands)
Short-term borrowings $2,275 $-- $-- $-- $2,275
Long-term borrowings -- 517 15,586 5,696 21,799
------ ---- ------- ------ -------
Total borrowings $2,275 $517 $15,586 $5,696 $24,074
====== ==== ======= ====== =======
Historically the Company has utilized borrowings from the FHLB as an
important source of funding for its growth. The Company has an established
borrowing line with the FHLB that permits it to borrow up to 25% of assets.
Advances from the FHLB have terms ranging from 1 through 15 years and at
December 31, 1998, bear interest at rates from 5.17% to 8.80%. At December 31,
1998, $21.7 million in advances were outstanding from the FHLB and the Company
had additional borrowing capacity for cash advances of $22.8 million. The
Company may increase its percentage of borrowings from the FHLB in the future if
circumstances warrant.
23
Asset-Liability Management/Interest Rate Sensitivity
The principal purpose of asset-liability management is to manage the
Company's sources and uses of funds to maximize net interest income under
different interest rate conditions with minimal risk. A part of asset-liability
management involves interest rate sensitivity, the difference between repricing
assets and repricing liabilities in a specific time period. The policy of the
Company is to control the exposure of the Company's earnings to changing
interest rates by generally maintaining a position within a narrow range around
an "earnings neutral" or "balanced" position. The Board of Directors has
established guidelines for maintaining the Company's earnings risk due to future
interest rate changes. This analysis provides an indication of the Company's
earnings risk due to future interest rate changes. At December 31, 1998, the
analysis indicated that the earnings risk was within the Company's policy
guidelines.
A key component of the asset-liability management is the measurement of
interest-rate sensitivity. Interest-rate sensitivity refers to the volatility in
earnings resulting from fluctuations in interest rates, variability in spread
relationships, and the mismatch of repricing intervals between assets and
liabilities. Interest-rate sensitivity management attempts to maximize earnings
growth by minimizing the effects of changing rates, asset and liability mix, and
prepayment trends.
The following table presents interest-rate sensitivity data at December 31,
1998. The interest rate gaps reported in the table arise when assets are funded
with liabilities having different repricing intervals. Since these gaps are
actively managed and change daily as adjustments are made in interest rate views
and market outlook, positions at the end of any period may not be reflective of
the Company's interest rate view in subsequent periods. Active management
dictates that longer-term economic views are balanced against the prospects of
short-term interest rate changes in all repricing intervals.
Estimated Maturity or Repricing at December 31, 1998
0-3 3-6 6-12 1-5 Over
Months Months Months Years 5 Years Total
(dollars in thousands)
Interest Earning Assets:
Interest earning balances due
From banks $11,816 $-- $-- $-- $-- $11,816
Investments available for sale 1,002 1,006 -- 5,057 -- 7,065
(1)
Investments held to maturity 991 1,979 297 1,098 100 4,465
Federal Home Loan Bank
Stock (1) 2,869 -- -- -- -- 2,869
Loans, including fees 41,506 4,790 5,491 62,995 17,264 132,046
------- ------- ------- ------- ------- --------
Total interest earning assets $58,184 $7,775 $5,788 $69,150 $17,364 $158,261
======= ======= ======= ======= ======= ========
Allowance for loan losses (1,814)
Cash and due from banks 10,889
Other assets 11,009
--------
Total assets $178,345
========
Interest Bearing Liabilities:
Savings and interest demand
Deposits $29,613 $-- $-- $-- $17,754 $47,367
Certificates of deposit 17,343 8,077 8,430 7,981 101 41,932
Borrowings 17,026 207 127 100 6,614 24,074
------- ------- ------- ------- ------- --------
Total interest bearing
Liabilities 63,982 8,284 8,557 8,081 24,469 $113,373
======= ======= ======= ======= ======= ========
Other liabilities 34,052
Shareholders' equity 30,920
--------
Total liabilities &
Shareholders' equity $178,345
Interest sensitivity gap (5,798) (509) (2,769) 61,069 (7,105) $44,888
------- ------- ------- ------- ------- ========
Cumulative interest sensitivity gap $(5,798) $(6,307) $(9,076) $51,993 $44,888
======= ======= ======= ======= =======
(1) Equity investments have been placed in the 0-3 month category
24
The table illustrates that the Company is liability sensitive in all
periods except in the 1-5 year period in which it is asset-sensitive. In an
environment of increasing interest rates, the theoretical net interest margins
of the Company would be adversely affected for the 12 months following December
31,1998, and favorably thereafter. Conversely, in a declining interest-rate
environment, the Company's theoretical net interest margins would be favorably
affected for the 12 month period following December 31, 1998, and adversely
thereafter.
Market Risk
Interest rate and credit risks are the most significant market risks
impacting the Company's performance. Other types of market risk, such as foreign
currency exchange rate risk and commodity price risk, do not arise in the normal
course of the Company's business activities. The Company relies on loan reviews,
prudent loan underwriting standards and an adequate allowance for loan losses to
mitigate credit risk.
Interest rate risk is managed through the monitoring of the Company's gap
position (see Asset-Liability Management/Interest Rate Sensitivity) and
sensitivity to interest rate risk by subjecting the Company's balance sheet to
hypothetical interest rate shocks. The Company's primary objective in managing
interest rate risk is to minimize the adverse impact of changes in interest
rates on the Company's net interest income and capital, while structuring the
Company's asset/liability position to obtain the maximum yield-cost spread on
that structure.
Rate shock is an instantaneous and complete adjustment in market rates of
various magnitudes on a static or level balance sheet to determine the effect
such a change in rates would have on the Company's net interest income for the
succeeding twelve months, and the fair values of financial instruments.
The Company utilizes asset/liability-modeling software to determine the
effect of a shift in market interest rates, with scenarios of interest rates
increasing 100 and 200 basis points and decreasing 100 and 200 basis points. The
model utilized to create the table presented below is based on the concept that
all rates do not move by the same amount or at the same time. Although certain
assets and liabilities may have similar maturities or periods to repricing, they
may not react correspondingly to changes in market interest rates. In addition,
interest rates on certain types of assets and liabilities may fluctuate with
changes in market interest rates, while interest rates on certain types of
assets may lag behind changes in market rates. Further, in the event of a change
in interest rates, prepayment and early withdrawal levels would likely deviate
from those assumed in the table. The ability of certain borrowers to make
scheduled payments on the adjustable rate loans may decrease in the event of an
interest rate increase due to adjustments in the amount of the payments.
The model attempts to account for such limitations by imposing weights on
the gaps between assets and liabilities. These weights are based on the ratio
between the amount of rate change and each category of asset/liability, and the
amount of any change in the federal funds rate. Local conditions and the
strategy of the Company determine the weights for loan and core deposits; the
others are set by national markets. In addition, a timing factor has been used
as (a) fixed rate instruments do not reprice immediately; (b)renewals may have
different term than original maturities; and (c) there is a timing factor
between rates on different instruments (i.e. core deposits usually reprice well
after there has been a change in the federal funds rate). Due to the various
assumptions used for this simulation analysis, no assurance can be given that
actual results will correspond with projected results.
The following table shows the estimated impact of the interest rate shock
on net interest income and the fair values of financial instruments at December
31, 1998:
Fair Values of Financial Instruments
Net Interest Income Assets Liabilities
Amount %Change Amount % Change Amount %Change
(all amounts in thousands)
+200 basis points 10,008 1.5% 165,303 (3.1)% 146,366 (1.0)%
+100 basis points 9,937 0.7% 169,973 (1.4)% 147,081 (0.5)%
Static 9,865 0.0% 170,617 0.0% 147,817 0.0%
- -100 basis points 9,793 (0.7)% 176,124 2.2% 148,603 0.5%
- -200 basis points 9,722 (1.5)% 179,438 4.1% 149,426 1.1%
25
Loans and certificates of deposit represent the majority of interest rate
exposure. Investments only represent 9.3% of interest earning assets and
therefore, the impact of the investments on net interest income of moving rates
would not be significant. Historically, savings and interest-bearing checking
accounts have not repriced in proportion to changes in overall market interest
rates. The change in net interest income can be attributed to the balance of
loans and certificates of deposit maturing/repricing. As a result, in an
increasing/decreasing interest rate environment net interest income would
increase/decrease.
The change in fair values of financial assets is mainly a result of total
loans representing 83.4% of total interest-earning assets. Of these loans $
97,584 have fixed interest rates, which decline in value during a period of
rising interest rates.
While asset/liability models have become a main focus of risk management,
the Company believes that statistical models alone do not provide a reliable
method of monitoring and controlling risk. The quantitative risk information
provided is limited by the parameters established in creating the related
models. Therefore, the Company uses these models only as a supplement to other
risk management tools.
Return on Equity and Assets
Net income for the year ended December 31, 1998, totaled $2.2 million for a
return on average shareholders' equity of 8.34% and a return on average total
assets of 1.24%. These returns compare to a 16.65% return on average equity and
1.28% return on average total assets for the corresponding period in 1997. These
declines reflect the additional common stock issued in the Company's March 1998
IPO and an increase in assets for the year ended December 31, 1998. The increase
in assets is related to the increase in cash after the March IPO.
Return on daily average assets and equity and certain other ratios for the
periods indicated are presented below:
Year Ended December 31,
1998 1997 1996
(dollars in thousands except per share data)
Net income $2,226 $2,124 $2,497
Average assets $178,819 $165,990 $142,639
Return on average assets 1.24% 1.28% 1.75%
Net income $2,226 $2,124 $2,497
Average equity $26,703 $12,757 $10,433
Return on average equity 8.34% 16.65% 23.93%
Cash dividends paid per share $0.06 $0.05 $0.04
Diluted earnings per share $0.57 $0.78 $0.97
Dividend payout ratio 10.53% 6.41% 4.12%
Average equity $26,703 $12,757 $10,433
Average assets $178,819 $165,990 $142,639
Average equity to asset ratio 14.93% 7.69% 7.31%
26
Liquidity
Liquidity represents the ability to meet deposit withdrawals to fund loan
demand, while retaining the flexibility to take advantage of business
opportunities. The Company's primary sources of funds are customer deposits,
loan payments, sales of assets, advances from the FHLB and the use of the
federal funds market. As of December 31, 1998, approximately $5.3 million of the
securities portfolio matures within one year.
On March 12, 1998, the Company completed an initial public offering issuing
a total of 1,380,000 shares of common stock at $12.00 per share. After
underwriting discounts of $1.2 million and other offering expenses of $472,000
net proceeds were $14.9 million. Of these proceeds $1.1 million has been used to
repay long-term debt and a subordinated note. On August 31, 1998 the Company
acquired BFC. The acquisition was accounted for using the purchase method,
including issuance of common stock with a value of $465,000. A cash payment was
made totaling $1.8 million, with an adjustment to be made based on final
determination of BFC's shareholders equity. A future contingent issuance of
common stock valued at approximately $500,000 will be issued if BFC achieves
earnings targets for the twelve-month period following the acquisition. As part
of the acquisition, goodwill was recorded in the amount of $1.6 million and is
being amortized on a straight-line basis over a 15 year period.
Historically the Company has utilized borrowings from the FHLB as an
important source of funding for its growth. The Company has an established
borrowing line with the FHLB that permits it to borrow up to 25% of assets.
Advances from the FHLB have terms ranging from 1 through 15 years and at
December 31, 1998, bear interest at rates from 5.17% to 8.80%. At December 31,
1998, $21.7 million in advances were outstanding from the FHLB and the Company
had additional borrowing capacity for cash advances of $22.8 million. The
Company may increase its percentage of borrowings from the FHLB in the future if
circumstances warrant.
Capital
The Company is required to maintain minimum amounts of capital to "risk
weighted" assets, as defined by banking regulators. The Company is required to
have Tier 1 and Total Capital ratios of 4.0% and 8.0%, respectively. At December
31, 1998, the Company's ratios were 22.21% and 23.46%, respectively. At December
31, 1997, the Company's ratios were 9.61% and 11.34%, respectively. The ratio of
shareholder's equity to average assets was 15.81% and 6.94% at December 31, 1998
and 1997, respectively. December 31, 1998 ratios are significantly higher than
those at December 31, 1997 due to the initial public offering on March 12, 1998
in which $14.9 million was raised in additional capital.
Year 2000
This section constitutes a Year 2000 readiness statement and contains
forward-looking statements that have been prepared on the basis of the Company's
best judgments and currently available information. These forward-looking
statements are inherently subject to significant business, third party and
regulatory uncertainties and contingencies, many of which are beyond the control
of the Company. In addition, these forward-looking statements are based on the
Company's current assessments and remediation plans, which are based on certain
representations of third party service providers and are subject to change.
Accordingly, there can be no assurance that the Company's results of operations
will not be adversely affected by difficulties or delays in the Company's or
third parties' Year 2000 readiness efforts. See "Risks" below for a discussion
of factors that may cause such forward-looking statements to differ from actual
results.
The Company has an active Y2K plan and committee addressing all systems
affected by the millennium issue. The plan includes five phases Awareness,
Assessment, Renovation, Validation, and Implementation.
Awareness
The Company's senior management participates on the committee as well as a
representative from each critical area of the Bank. The board of directors is
updated on the progress of the plan on a monthly basis. The awareness phase has
been completed but will continue to be an on going effort in regards to
educating customers and keeping abreast of all new Y2K issues. The Bank has
implemented several awareness programs for customers and is sponsoring Year 2000
seminars for its larger business customers.
27
Assessment
Assessment of the Company's systems has been completed and all
hardware/software as well as non-hardware/software systems have been identified.
The committee has developed a list of products and systems that could be
affected by the Year 2000 date change. All vendors and suppliers have been
contacted and have been individually assessed for both their criticality to the
operation of the Company and if they are satisfactory in their Year 2000
efforts.
Renovation and Validation
The Company is currently in the renovation and validation phases of the
project. All mission critical systems will be validated for Y2K compliance by
March 31, 1999 with minor systems completed by the end of the second quarter of
1999.
Implementation
Any system found to be not in compliance with the Year 2000 date change has
been brought to the attention of senior management and is being upgraded or
replaced. The systems that have been identified are included in the Company's
Year 2000 budget. A budget has been approved and the additional costs to address
the Year 2000 issues at this time are estimated to be $235,000. The Year 2000
related costs incurred by the Company to date are approximately $122,000.
Contingency plan
A contingency plan has been established that would be carried out in the
event that the preventative measures put in place do not prove successful. Each
area of the Company has completed a mission critical operating plan that would
be initiated using manual processing. In the event that this plan would need to
be implemented there would be a substantial increase in staffing and related
expenses. This plan addresses business operations to be carried out assuming the
telephone and electrical systems are in working order. The contingency plan will
continue to be updated throughout 1999.
Risks
The Company has attempted to assess the Year 2000 readiness of its loan and
deposit customers. If these customers were adversely affected by the Year 2000,
no assurance can be given that their ability to repay debt would not be
affected.
Based on its current assessments and remediation plans, the Company does
not expect that it will suffer any material disruption of its business as a
result of Year 2000 issues. Although the Company has no reason to believe that a
material disruption will occur, the most likely worst case scenario would result
from a Y2K failure in the power supply, voice and data transmission systems or
the federal government. If such a failure were to occur, the Company would
implement its contingency plan. In such event, it is likely that there would be
temporary disruption of customer service and customer inconvenience and
additional costs from the implementation of the contingency plan. It is not
possible to quantify those costs at the present time. Although the Company
believes its contingency plan will satisfactorily address these issues, there
can be no assurance that the Company's contingency plan will function as
anticipated or that the results of operations of the Company will not be
adversely affected in the event of a prolonged disruption of service.
28
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors
of Cowlitz Bancorporation:
We have audited the accompanying consolidated statements of condition of Cowlitz
Bancorporation (a Washington Corporation) and Subsidiaries as of December 31,
1998 and 1997, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cowlitz Bancorporation and
Subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Portland, Oregon
January 15, 1999
29
COWLITZ BANCORPORATION
CONSOLIDATED STATEMENTS OF CONDITION
December 31, 1998 and 1997
(in thousands of dollars, except number of shares)
1998 1997
ASSETS
Cash and due from banks........................................... $ 22,705 $ 23,109
Investment securities:
Investments available-for-sale (at fair value, cost of $6,994 and
$3,993 at December 31, 1998 and December 31, 1997,
respectively)................................................ 7,065 4,017
Investments held-to-maturity (at amortized cost, fair value
of $4,487 and $4,486 at December 31, 1998 and
December 31, 1997, respectively)............................. 4,465 4,464
---------- ---------
Total investment securities.................................. 11,530 8,481
---------- ---------
Loans............................................................. 132,046 131,963
Allowance for loan losses......................................... (1,814) (1,970)
---------- ---------
Loans, net..................................................... 130,232 129,993
---------- ---------
Premises and equipment, net of accumulated depreciation of $1,837
and $1,354 at December 31, 1998 and December 31, 1997,
respectively................................................... 5,859 5,653
Federal Home Loan Bank stock...................................... 2,869 2,658
Intangible assets, net of accumulated amortization of
$432 and $123 at December 31, 1998 and December 31, 1997,
respectively................................................... 3,110 1,847
Other assets...................................................... 2,040 1,552
---------- ---------
Total assets................................................. $ 178,345 $ 173,293
========== =========
LIABILITIES
Deposits:
Demand......................................................... $ 33,062 $ 27,141
Savings and interest-bearing demand............................ 47,367 46,454
Certificates of deposit........................................ 41,932 62,614
---------- ---------
Total deposits............................................... 122,361 136,209
Short-term borrowings............................................. 2,275 725
Long-term borrowings.............................................. 21,799 21,900
Other liabilities................................................. 990 572
---------- ---------
Total liabilities............................................ $ 147,425 $159,406
---------- ---------
SHAREHOLDERS' EQUITY
Preferred stock, no par value; 5,000,000 and no shares authorized
as of December 31, 1998 and December 31, 1997, respectively;
no shares issued and outstanding at December 31, 1998 and
December 31, 1997, respectively................................ $ - $ -
Common stock, no par value; 25,000,000 and 3,937,500 shares
authorized as of December 31, 1998 and December 31, 1997,
respectively; 4,001,999 and 2,604,543 shares issued and
outstanding at December 31, 1998 and December 31, 1997,
respectively.................................................. 18,251 3,262
Additional paid in capital........................................ 1,538 1,538
Retained earnings................................................. 11,085 9,071
Accumulated other comprehensive income............................ 46 16
---------- ---------
Total shareholders' equity................................... 30,920 13,887
---------- ---------
Total liabilities and shareholders' equity................... $ 178,345 $ 173,293
========== =========
The accompanying notes are an integral part of these statements.
30
COWLITZ BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME
December 31, 1998, 1997 and 1996
(in thousands of dollars, except per share amounts)
1998 1997 1996
INTEREST INCOME
Interest and fees on loans............................. $ 14,103 $ 13,700 $ 12,721
Interest on taxable investment securities.............. 955 667 386
Interest on non-taxable investments securities......... 3 - 2
Trading account interest............................... - - 34
Interest from other banks.............................. 1,305 719 490
----------- -------- ---------
Total interest income............................... 16,366 15,086 13,633
----------- -------- ---------
INTEREST EXPENSE
Savings and interest-bearing demand.................... 1,894 1,253 1,031
Certificates of deposit................................ 3,048 4,246 3,960
Short-term borrowings.................................. 90 43 110
Long-term borrowings................................... 1,469 1,401 1,073
----------- -------- ---------
Total interest expense.............................. 6,501 6,943 6,174
----------- -------- ---------
Net interest income before provision for loan losses 9,865 8,143 7,459
PROVISION FOR LOAN LOSSES.............................. (509) (375) (281)
----------- -------- ---------
Net interest income after provision for loan losses. 9,356 7,768 7,178
----------- -------- ---------
NONINTEREST INCOME
Service charges on deposit accounts................. 656 563 387
Other income........................................ 317 186 218
Net gains on sales of securities.................... 5 - (309)
----------- -------- ---------
Total noninterest income.......................... 978 749 296
----------- -------- ---------
NONINTEREST EXPENSE
Salaries and employee benefits...................... 3,775 2,778 2,137
Net occupancy and equipment expense................. 888 724 393
Business tax expense................................ 242 224 202
Amortization of intangibles......................... 309 123 -
Other operating expense............................. 1,713 1,435 950
----------- -------- ---------
Total noninterest expense......................... 6,927 5,284 3,682
----------- -------- ---------
Income before income tax expense.................. 3,407 3,233 3,792
INCOME TAX EXPENSE..................................... 1,181 1,109 1,295
----------- -------- ---------
Net income........................................ $ 2,226 $ 2,124 $ 2,497
=========== ======== =========
BASIC EARNINGS PER SHARE............................... $ 0.60 $ 0.82 $ 0.97
DILUTED EARNINGS PER SHARE............................. $ 0.57 $ 0.78 $ 0.97
The accompanying notes are an integral part of these statements.
31
COWLITZ BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended 1998, 1997, and 1996
(in thousands of dollars)
1998 1997 1996
CASH FLOWS FROM OPERATING ACTIVITIES
Net income..................................................... $ 2,226 $ 2,124 $ 2,497
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization................................. 833 557 191
Provision for loan losses..................................... 509 375 281
Net losses (gains) on sales of trading securities............ - - 309
Net losses (gains) on sales of investments securities
available-for-sale......................................... (5) - -
Net amortization of investment security premiums and
accretion of discounts..................................... (5) (2) (3)
(Increase) decrease in other assets.......................... 182 (248) 49
Increase (decrease) in other liabilities..................... (111) (83) 87
Federal Home Loan Bank stock dividends....................... (211) (195) (180)
Purchase of trading securities............................... - - (64,500)
Sales of trading securities.................................. - 66,204
----------- ---------- ----------
Net cash provided by operating activities.................. 3,418 2,528 4,935
----------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of investment securities
held-to-maturity............................................. 3,669 3,784 2,860
Proceeds from maturities of investment securities
available-for-sale........................................... 1,000 - -
Purchases of investment securities:
Held-to-maturity............................................. (3,665) (1,994) (2,969)
Available-for-sale........................................... (3,996) (4,857) (2,006)
Net (increase) decrease in loans............................... 1,065 (5,711) (19,038)
Purchases of premises and equipment............................ (725) (1,300) (2,797)
Proceeds from assumption of deposit liabilities................ - 22,885 -
Acquisition of business, net of cash acquired.................. (1,776) - -
----------- ---------- ----------
Net cash (used in) provided by investment activities....... (4,428) 12,807 (23,950)
----------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in demand, savings, and interest-bearing
demand deposits.............................................. 6,834 5,536 (1,207)
Net increase (decrease) in certificates of deposit............. (20,682) (17,841) 18,133
Dividends paid................................................. (212) (126) (101)
Net increase (decrease) in short-term borrowings............... 1,550 175 (2,075)
Proceeds from long-term borrowings............................. 5,000 2,000 15,070
Repayment of long-term borrowings.............................. (6,408) (2,942) (4,621)
Repurchase of common stock..................................... (494) - -
Issuance of common stock for cash, net of amount paid for
fractional shares and offering costs...................... 15,018 67 19
----------- ---------- ----------
Net cash provided by (used in) financing activities........ 606 (13,131) 25,218
----------- ---------- ----------
Net increase (decrease) in cash and due from banks......... (404) 2,204 6,203
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR..................... 23,109 20,905 14,702
----------- ---------- ----------
CASH AND DUE FROM BANKS AT END OF PERIOD......................... $ 22,705 $ 23,109 $ 20,905
=========== ========== ==========
CASH PAID FOR INTEREST........................................... $ 6,548 $ 6,990 $ 6,143
CASH PAID FOR INCOME TAXES....................................... $ 1,193 $ 1,068 $ 1,245
LOANS TRANSFERRED TO OREO........................................ $ 544 $ - $ -
The accompanying notes are an integral part of these statements.
32
COWLITZ BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands of dollars, except number of shares)
Accumulated
Additional Other Total
Common Stock Paid-in Retained Comprehensive Shareholders' Comprehensive
Shares Amount Capital Earnings Income Equity Income
BALANCE AT DECEMBER 31, 1995 2,585,608 $ 3,176 $ 1,538 $ 4,677 $ - $ 9,391
Comprehensive Income:
Net income........................... - - - 2,497 - 2,497 $ 2,497
Net changes in unrealized gains on
Investments available-for-sale, net
Of deferred taxes of $3........... - - - - 7 7 7
--------
Other comprehensive income, net of tax - - - - - - 7
--------
Comprehensive Income................. - - - - - - $ 2,504
========
Issuance of common stock for cash...... 4,795 19 - - - 19
Cash dividend paid ($.04 per share).... - - - (101) - (101)
--------- -------- ------ ------ ------- --------
BALANCE AT DECEMBER 31, 1996 2,590,403 3,195 1,538 7,073 7 11,813
Comprehensive Income:
Net income........................... - - - 2,124 - 2,124 $ 2,124
Net changes in unrealized gains on
investments available-for-sale, net
of deferred taxes of $5........... - - - - 9 9 9
--------- -------- ------ ------ ------- -------- --------
Other comprehensive income, net of tax - - - - - - 9
--------
Comprehensive Income................. - - - - - - $ 2,133
========
Issuance of common stock for cash...... 14,140 67 - - - 67
Cash dividend paid ($.05 per share).... - - - (126) - (126)
--------- -------- ------ ------ ------- --------
BALANCE AT DECEMBER 31, 1997 2,604,543 3,262 1,538 9,071 16 13,887
Comprehensive Income:
Net income........................... - - - 2,226 - 2,226 2,226
Net changes in unrealized gains on
investments available-for-sale, net
of deferred taxes of $16.......... - - - - 30 30 30
-------
Other comprehensive income, net of tax - - - - - - 30
-------
Comprehensive Income................. - - - - - - $ 2,256
=======
Issuance of common stock for cash.... 1,396,251 15,019 - - - 15,019
Purchase of treasury stock........... (50,000) (494) - - - (494)
Issuance of common stock for
acquisition.......................... 51,282 465 - - - 465
Cash dividends paid ($.06 per share). - - - (212) - (212)
Cash paid for fractional shares........ (77) (1) - - - (1)
--------- -------- ------ ------ ------- --------
BALANCE AT DECEMBER 31, 1998 4,001,999 $ 18,251 $1,538 $11,085 $ 46 $ 30,920
========= ======== ====== ====== ======= ========
The accompanying notes are an integral part of these statements.
33
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
1. Summary of Significant Accounting Policies
Nature of Operations
Cowlitz Bancorporation (the Company) is a one-bank holding company located
in Southwest Washington. The Company's principal subsidiary, Cowlitz Bank (the
Bank), a Washington state-chartered commercial bank, is the only community bank
headquartered in Cowlitz County and offers commercial banking services primarily
to small and medium-sized businesses, professionals, and retail customers.
During the third quarter of 1998 the Company acquired Business Finance
Corporation (BFC) of Bellevue, Washington. Business Finance Corporation provides
asset based financing to companies throughout the western United States.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All significant intercompany transactions and
balances have been eliminated.
Investment Securities
Investment securities are classified as either trading, available-for-sale
or held-to-maturity. Securities are classified as held-to-maturity when the
Company has the positive intent and ability to hold those securities to
maturity. Securities that are bought and held principally for the purpose of
selling them in the near term are classified as trading securities. Securities
not classified as either held-to-maturity or trading are classified as
available-for-sale. Trading securities are carried at fair value. Net unrealized
gains and losses on trading securities are included in the consolidated
statements of income. Available-for-sale securities are carried at fair value
with unrealized gains and losses, net of tax effect, added to or deducted from
shareholders' equity. Held-to-maturity securities are carried at amortized cost.
Loans
Interest income on simple interest loans is accrued daily on the principal
balance outstanding. Generally, no interest is accrued on loans when factors
indicate that collection of interest is doubtful or when principal or interest
payments become 90 days past due, unless collection of principal and interest is
anticipated within a reasonable period of time and the loans are well secured.
For such loans, previously accrued but uncollected interest is charged against
current earnings, and income is only recognized to the extent that payments are
subsequently received and collection of the remaining recorded investment is
probable. Loan fees are offset against operating expenses to the extent that
these fees cover the direct expense of originating loans. Fees in excess of
origination costs are deferred and amortized to income over the related loan
period.
Stock-Based Compensation
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," requires disclosure about stock -based compensation
arrangements regardless of the method used to account for them. As permitted by
SFAS No. 123, the Company has opted to continue to apply the accounting
provisions of Accounting Principles Board (APB) Opinion No. 25, and therefore
discloses the difference between compensation cost included in net income and
the related cost measured by the fair-value-based method defined by SFAS No.
123, including tax effects, that would have been recognized in the income
statement if the fair-value method has been used.
34
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
Allowance for Loan Losses
The allowance for loan losses is based on management's estimates.
Management determines the adequacy of the allowance based upon reviews of
individual loans, recent loss experience, current economic conditions, the risk
characteristics of the various categories of loans and other pertinent factors.
Actual losses may vary from the current estimates. These estimates are reviewed
periodically and are adjusted as deemed necessary. Loans deemed uncollectible
are charged to the allowance. Provisions for loan losses and recoveries on loans
previously charged off are added to the allowance.
A loan is impaired when, based on current information and events it is
probable that the Company will be unable to collect all amounts due according to
the contractual terms of the loan agreement. The Company's policy is to included
in impaired loans all loans that are past due 90 days or more as to either
principal or interest, except for loans that are currently measured at fair
value or at the lower of cost or fair value, and credit card receivables, which
are considered large groups of smaller balance homogeneous loans that are
collectively evaluated for impairment. The Company measures impairment based on
the present value of expected future cash flows discounted at the loan's
effective interest rate or, as a practical expedient, impairment is measured
based on the loan's observable market price or the fair value of the collateral
if the loan is collateral dependent. Impaired loans are charged to the allowance
when management believes, after considering economic and business conditions,
collection efforts, and collateral position, that the borrowers' financial
condition is such that collection of principal is not probable.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
The provision for depreciation is computed on the straight-line method over the
estimated useful lives for the majority of the assets, which range from 3 to
39.5 years.
Improvements are capitalized and depreciated over the lesser of their
estimated useful lives or the life of the lease. When property is replaced or
otherwise disposed of, the cost of such assets and the related accumulated
depreciation are removed from their respective accounts.
Intangible Assets
Intangible assets include a deposit premium of $1,570 and $1,847 (net of
accumulated amortization) at December 31, 1998 and 1997, respectively. The
deposit premium is being amortized using an accelerated method over a ten-year
life. Intangible assets at December 31, 1998 also include goodwill of $1,540
(net of accumulated amortization), representing the excess of acquisition costs
over the fair value of net assets that arose in connection with the acquisition
of Business Finance Corporation and is being amortized on a straight-line basis
over a fifteen-year period.
Other Borrowings
Federal funds purchased generally mature within one to four days from the
transaction date. Other short-term borrowed funds mature within one year from
the transaction date. Other long-term borrowed funds extend beyond one year.
35
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
Income Taxes
Income taxes are accounted for using the asset and liability method. Under
this method, a deferred tax asset or liability is determined based on the
enacted tax rates, which will be in effect when the differences between the
financial statement carrying amounts and tax bases of existing assets and
liabilities are expected to be reported in the Company's income tax returns. The
deferred tax provision for the year is equal to the net change in the deferred
tax asset or liability from the beginning to the end of the year, less amounts
applicable to the change in value related to investments available-for-sale. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date.
Earnings per Share
Earnings per share computations are computed using the weighted average
number of common and dilutive common equivalent shares (stock options) assumed
to be outstanding during the period using the treasury stock method.
The following table reconciles the numerator and denominator of the basic
and diluted earnings per share computations:
WeightedPer Share
Net Income Avg Shares Amount
For the year ended December 31, 1998
Basic earnings per share $ 2,226 3,715,901 $0.60
Stock Options 178,194
Diluted earnings per share $ 2,226 3,894,095 $0.57
For the year ended December 31, 1997
Basic earnings per share $ 2,124 2,601,650 $0.82
Stock Options 109,862
Diluted earnings per share $ 2,124 2,711,512 $0.78
For the year ended December 31, 1996
Basic earnings per share $ 2,497 2,586,711 $0.97
Stock Options -
Diluted earnings per share $ 2,497 2,586,711 $0.97
The Company for the periods reported had no reconciling items between net
income and income available to common shareholders.
Supplemental Cash Flow Information
For the purpose of presentation in the statements of cash flows, cash and
cash equivalents are defined as those amounts in the balance sheet caption "Cash
and due from banks" and include cash on hand, amounts due from banks and federal
funds sold. Federal funds sold generally mature the day following purchase.
36
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Off-Balance-Sheet Financial Instruments
In the ordinary course of business, the Company has entered into
off-balance-sheet financial instruments consisting of commitments to extend
credit, commitments under credit card arrangements and standby letters of
credit. Such financial instruments are recorded in the financial statements when
they become payable.
Recently Issued Accounting Standards
SAB No. 98
In February 1998, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 98 on computations of earnings per share. SAB No.
98, which was effective upon issuance, revised the SEC's guidance on the
treatment of stock options issued shortly before an Initial Public Offering
(IPO) in earnings per share calculations. Prior to the issuance of SAB No. 98,
the SEC required that stock options issued within one year of an IPO with
exercise prices below the IPO price be treated as outstanding for all reporting
periods for purposes of calculating earnings per share. The Company followed
this guidance for the stock options granted September 30, 1997 and, accordingly
treated the options as outstanding for all periods in computing both basic and
diluted earnings per share. SAB No. 98 now requires that only "nominal
issuances" of stock or stock options be reflected in all earnings per share
calculations for all periods presented. The Company's September 30, 1997, stock
options do not meet the SEC's definition of a nominal issuance. As required by
SAB No. 98, these stock options are now included in the calculation of diluted
earnings per share only for periods subsequent to their issuance on September
30, 1997, and are not included in the basic earnings per share calculation.
As required by SAB No. 98, the Company has restated its historical basic
and diluted earnings per share to conform with this new guidance. The following
is a summary of the historical and restated earnings per share amounts:
Year ended Year ended
December 30, 1997 December 30, 1996
Basic Diluted Basic Diluted
Previously reported EPS........ $ 0.76 $ 0.76 $ 0.90 $ 0.90
Restated EPS................... $ 0.82 $ 0.78 $ 0.97 $ 0.97
SFAS No. 133
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The Statement
establishes accounting and reporting standards requiring that derivative
instruments (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or a liability
measured at its fair value. The Statement requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gain and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting.
37
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. A
company may also implement the Statement as of the beginning of any fiscal
quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and
thereafter). SFAS No. 133 cannot be applied retroactively. SFAS No. 133 must be
applied to (a) derivative instruments and (b) certain derivative instruments
embedded in hybrid contracts that were issued, acquired, or substantively
modified after December 31, 1997 (and, at the company's election, before January
1, 1998).
The implementation of this Statement is not expected to have a material
impact on the Company's financial position or results of operation.
Comprehensive Income
The Company has adopted Statement of Financial Accounting Standards No. 130
"Reporting Comprehensive Income," effective January 1, 1998. This statement
establishes standards for the reporting and display of comprehensive income and
it's components in the financial statements. For the Company, comprehensive
income includes net income reported on the statements of income and changes in
the fair value of its available-for-sale investments reported as a component of
shareholders' equity.
The components of comprehensive income for the years ended December 31, 1998,
1997 and 1996 are as follows:
1998 1997 1996
Unrealized gain (loss) arising during
the period, net of tax.............. $ 33 $ 9 $ 7
Reclassification adjustment for
net realized gains (losses) on
securities available-for-sale
included in net income during the
year, net of tax of $2, $0, and $0.. 3 - -
--------- -------- ----------
Net unrealized gain included in
other comprehensive income....... $ 30 $ 9 $ 7
========= ======== ==========
Prior Year Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year presentation.
2. Investment Securities
The amortized cost and estimated fair values of investment securities at
December 31 are shown below:
December 31, 1998 Available-for-Sale
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Government and agency securities............ $ 6,994 $ 71 $ - $ 7,065
--------- --------- --------- --------
Total............................. $ 6,994 $ 71 $ - $ 7,065
========= ========= ========= ========
38
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
Held-to-Maturity
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Municipal Bonds.................................. $ 199 $ - $ - $ 199
U.S. Government and agency securities............ 999 22 - 1,021
Certificates of deposit.......................... 3,267 - - 3,267
--------- -------- ------ --------
Total............................. $ 4,465 $ 22 $ - $ 4,487
========= ======== ====== ========
December 31, 1997 Available-for-Sale
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Government and agency securities............ $ 3,993 $ 24 $ - $ 4,017
--------- -------- -------- --------
Total............................. $ 3,993 $ 24 $ - $ 4,017
========= ========= ========= ========
Held-to-Maturity
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Government and agency securities.............$ 2,978 $ 22 $ - $ 3,000
Certificates of deposit........................... 1,486 - - 1,486
--------- --------- --------- --------
Total..............................$ 4,464 $ 22 $ - $ 4,486
========= ========= ========= ========
Gross gains of $5, $0, and $379 and gross losses of $0, $0, and $688 were
realized on sales of trading and available-for-sales securities in 1998, 1997,
and 1996, respectively. There were no sales of held-to-maturity securities.
Maturity of Investments
The carrying amount and estimated fair value of debt securities by
contractual maturity at December 31, 1998, are shown below. Expected maturities
may differ from contractual maturities because borrowers may have the right to
call or prepay the obligation.
Available-for-Sale Held-to-Maturity
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
Due in one year or less...........................$ 2,002 $ 2,008 $ 3,267 $ 3,267
Due after one year through five years............. 4,992 5,057 1,099 1,121
Due after five years through fifteen years........ - - 99 99
--------- --------- --------- ----------
Total..............................$ 6,994 $ 7,065 $ 4,465 $ 4,487
========= ========= ========= ==========
At December 31, 1998 and 1997 a security with a par value of $1 million was
pledged to secure the treasury, tax and loan account at the Federal Reserve.
Another security with a par value of $1 million was pledged for trust deposits
held in the Bank.
39
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
3. Loans and Allowance for Loan Losses
The loan portfolio as of December 31 consists of the following:
1998 1997
Commercial loans.................................. $ 103,473 $ 93,829
Real estate:
Construction................................ 3,206 3,495
Mortgage.................................... 13,774 24,167
Commercial.................................. 7,026 5,475
Installment and other consumer.................... 5,063 5,571
Contracts purchased............................... 45 81
---------- ----------
132,587 132,618
Less:
Deferred loan fees (541) (655)
Allowance for loan losses (1,814) (1,970)
---------- ----------
Total loans, net................... $ 130,232 $ 129,993
========== ==========
An analysis of the change in the allowance for loan losses for the years ended
December 31 is as follows:
1998 1997 1996
Balance, beginning of year........................... $ 1,970 $ 1,894 $ 1,763
Provision for loan losses......................... 509 375 281
Loans charged to the allowance ................... (727) (324) (158)
Recoveries credited to the allowance.............. 17 25 8
Adjustment incident to acquisition................ 45 - -
--------- -------- --------
Balance, end of year................................. $ 1,814 $ 1,970 $ 1,894
========= ======== ========
Loans on which the accrual of interest has been discontinued amounted to
approximately $2,737, $1,897, and $407 at December 31, 1998, 1997, and 1996,
respectively. Interest forgone on nonaccrual loans was approximately $297, $177,
and $41 in 1998, 1997, and 1996, respectively.
At December 31, 1998 and 1997, the Company's recorded investment in certain
loans that were considered to be impaired was $2,736 and $2,270, respectively.
Of these impaired loans, $891 and $302 have related valuation allowances of $65
and $199, while $1,845 and $1,968 did not require a valuation allowance. The
balance of the allowance for loan losses in excess of these specific reserves is
available to absorb losses from all loans. The average recorded investment in
impaired loans for the years ended December 31, 1998, 1997, and 1996, was
approximately $2,420, $1,300, and $342, respectively. Interest payments received
on impaired loans are recorded as interest income, unless collection of the
remaining recorded investment is not probable, in which case payments received
are recorded as a reduction of principal. For the years ended December 31, 1998,
1997, and 1996 interest income recognized on impaired loans totaled $77, $36,
and $14, respectively, all of which was recognized on a cash basis.
40
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
4. Premises and Equipment
Premises and equipment consist of the following at December 31:
1998 1997
Land........................................ $ 858 $ 633
Buildings and improvements.................. 4,415 4,208
Furniture and equipment..................... 2,386 2,157
Construction in process..................... 37 9
--------- --------
7,696 7,007
Accumulated depreciation.................... (1,837) (1,354)
--------- --------
Total..................... $ 5,859 $ 5,653
========= ========
Depreciation included in net occupancy and equipment expense amounted to
$524, $432, and $191 for the years ended December 31, 1998, 1997, and 1996,
respectively.
5. Borrowings
Short-term borrowings consist of Federal Funds purchased of $2,275 and $725
at December 31, 1998 and 1997, respectively.
1998 1997
Long-term borrowings consist of the following at December 31:
Notes payable to Federal Home Loan Bank; interest from 5.17 percent to 8.80
percent at December 31, 1998, payable in monthly installments plus
interest due 1999 to 2013,
secured by certain investment securities and mortgage loans......... $21,738 $ 20,517
Note payable to a bank, due January 1999,paid in April 1998; interest at
prime plus 1 percent; interest not to fall below 8.5 percent or to
exceed 14 percent (9.25 percent at December 1997); principal payable in
annual installments; interest payable in
quarterly installments, secured by bank stock ...................... - 319
Subordinated promissory notes of the Company, due February 2000; interest
at 8.5 percent; interest payable semiannually on June 30
and December 31 ................................................ - 1,000
Contract payable to private party; interest 9.0 percent, payable in monthly
installments plus interest through
October 2010 ................................................ 61 64
------- ----------
Total ................................................ $21,799 $ 21,900
======= ==========
The aggregate maturities of notes payable subsequent to December 31, 1998,
are as follows:
1999 ................................................. $ 517
2000 ................................................. 5,933
2001 ................................................. 7,284
2002 ................................................. 2,184
2003 ................................................. 185
Thereafter ................................................. 5,696
-------
$21,799
=======
41
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
6. Income Taxes
The components of the provision for income taxes for the years ended December
31 were as follows:
1998 1997 1996
------- ------- --------
Current................................. $ 1,069 $ 1,044 $ 1,274
Deferred................................ 112 65 21
------- ------- --------
Total provision for income taxes.... $ 1,181 $ 1,109 $ 1,295
======= ======= ========
The federal statutory income tax rate and effective tax rate of the provision
do not vary significantly.
The tax effect of temporary differences that give rise to deferred tax assets
and deferred tax liabilities at December 31 was as follows:
1998 1997
------- -------
Deferred tax assets:
Allowance for loan losses $ 522 $ 596
Amortization of intangible assets 84 23
Loan origination fees 15 31
------- -------
621 650
------- -------
Deferred tax liabilities:
Cash-basis adjustments - (29)
Accumulated depreciation (91) (67)
Federal Home Loan Bank stock dividends (469) (396)
Unrealized gains on available-for-sale securities (24) (8)
Other - (1)
------- -------
(584) (501)
------- -------
Net deferred tax $ 37 $ 149
======= =======
7. Certificates of Deposit:
Included in certificates of deposit are certificates in denominations of
$100 or greater totaling $13,623 and $18,633 at December 31, 1998 and 1997,
respectively. Interest expense relating to certificates of deposit in
denominations of $100 or greater was $933, $1,297, and $1,360 for the years
ended December 31, 1998, 1997, and 1996, respectively.
8. Shareholders Equity and Regulatory Capital
Dividends are paid by the Company from its retained earnings, which are
principally provided through dividends and income from its subsidiaries.
However, state agencies restrict the amount of funds the Company's subsidiaries
may transfer to the Company in the form of cash dividends, loans or advances.
Transfers are limited by the subsidiary's retained earnings, which for the Bank
were $10,159 at December 31, 1998.
42
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
The Company and the Bank are subject to various regulatory capital
requirements as established by the applicable federal or state banking
regulatory authorities. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities and certain off-balance-sheet items. The quantitative
measures for capital adequacy require the Company and the Bank to maintain
minimum amounts and ratios of total and Tier 1 capital to risk weighted assets
and of Tier 1 capital to average assets (leverage). The Company's capital
components, classification, risk weightings and other factors are also subject
to qualitative judgements by regulators. Failure to meet minimum capital
requirements can initiate certain actions by regulators that, if undertaken,
could have a material effect on the Company's financial statements. Management
believes that as of December 31, 1998, the Company and the Bank meet all minimum
capital adequacy requirements to which they are subject. The most recent
notification from the Federal Deposit Insurance Corporation categorized the Bank
as well-capitalized under the regulatory framework for prompt corrective action.
Management believes that no events or changes in conditions have occurred
subsequent to such notification to change the Bank's category.
The following table presents selected capital information for the Company
(consolidated) and the Bank as of December 31, 1998 and 1997:
To Be Well
For Capital Capitalized under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
----------------- ------------------ --------------------
Amount Ratio Amount Ratio Amount Ratio
As of December 31, 1998
Total risk-based capital:
Consolidated.................... $ 29,330 23.46% $ 10,001 8.00% $ 12,501 10.00%
Bank ........................... 16,383 13.32 9,841 8.00 12,301 10.00
Tier 1 risk-based capital:
Consolidated.................... 27,764 22.21 5,000 4.00 7,501 6.00
Bank ........................... 14,842 12.07 4,921 4.00 7,381 6.00
Tier 1 (leverage) capital:
Consolidated.................... 27,764 15.81 7,026 4.00 8,782 5.00
Bank ........................... 14,842 8.72 6,806 4.00 8,507 5.00
As of December 31, 1997
Total risk-based capital:
Consolidated.................... 14,194 11.34 10,007 8.00 12,503 10.00
Bank ........................... 13,852 11.09 9,994 8.00 12,993 10.00
Tier 1 risk-based capital:
Consolidated.................... 12,025 9.61 5,003 4.00 7,505 6.00
Bank ........................... 12,285 9.83 4,997 4.00 7,496 6.00
Tier 1 (leverage) capital:
Consolidated.................... 12,025 6.94 7,002 4.00 8,752 5.00
Bank ........................... 12,285 7.12 6,898 4.00 8,623 5.00
43
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
9. Stock Option and Employee Stock Purchase Plans:
During 1997, the Company adopted the 1997 Stock Option Plan (the 1997 Plan),
which authorizes up to 525,000 shares of common stock for issuance thereunder.
Under the 1997 Plan, options may be granted to the Company's employees,
directors and consultants. The exercise price of incentive stock options under
the 1997 Plan must be at least equal to the fair value of the common stock on
the date of grant. Options granted under the 1997 Plan will generally vest over
a five-year period, at the discretion of the compensation committee. All
incentive stock options granted under the 1997 Plan will expire ten years from
the date of grant unless terminated sooner pursuant to the provisions of the
1997 Plan. At December 31, 1998 and December 31, 1997, options to purchase a
total of 446,000 and 385,000 shares, respectively, have been granted under the
1997 plan to executives and directors of the Company and the Bank.
The Company adopted an employee stock purchase plan during 1996. The Company
may sell up to 175,000 shares of common stock to its eligible employees under
the plan. During 1998, the Company sold 5,301 shares of stock under the plan.
The employee is granted the right to purchase the stock at a price equal to fair
value at the date of grant, as determined by the Board of Directors. These
grants are made to qualified employees each quarter and expire within the month
they are granted.
A summary of option activity for the years ended December 31, 1998, 1997 and
1996 is as follows:
1998 1998 1997 1997 1996 1996
Common Weighted Common Weighted Common Weighted
Shares Avg. Price Shares Avg. Price Shares Avg. Price
--------- ----------- ---------- ---------- --------- -----------
Balance, beginning of year.............. 400,208 $ 5.69 13,945 $ 4.29 - $ -
Granted.............................. 95,193 8.02 428,732 5.63 29,594 4.16
Exercised............................ (16,174) 5.55 (13,441) 4.43 (4,795) 4.06
Forfeited............................ (18,019) 10.52 (29,028) 4.67 (10,854) 4.06
Balance, end of year.................... 461,208 5.82 400,208 5.69 13,945 4.29
Exercisable, end of year................ 166,200 5.37 111,458 5.64 13,945 4.29
Fair value of options granted........... $ 1.08 $ 1.49 $ 0.06
At December 31, 1998, exercise prices for outstanding options ranged from
$5.71 to $7.94. For the options outstanding at December 31, 1998, the weighted
average contractual life is 9.1 years.
The Company accounts for both the 1997 Plan and the Employee Stock Purchase
Plan under APB Opinion No. 25, under which no compensation cost has been
recognized. Had compensation cost for these plans been determined consistently
with SFAS No. 123 and recognized over the vesting period, the Company's net
income and earnings per share would have been reduced to the following pro forma
amounts:
1998 1997 1996
------ -------- -------
Net Income: As reported $ 2,226 $ 2,124 $ 2,497
Pro Forma $ 2,152 $ 2,024 $ 2,496
Basic earnings per share: As reported $ 0.60 $ 0.82 $ 0.97
Pro Forma $ 0.58 $ 0.78 $ 0.97
Diluted earnings per share: As reported $ 0.57 $ 0.78 $ 0.97
Pro Forma $ 0.55 $ 0.75 $ 0.97
44
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option pricing model, with the following weighted-average
assumptions used for grants in 1998, 1997, and 1996: risk-free interest rate of
4.56 percent, 7 percent and 7 percent; expected dividend yield of 0.58 percent
for all years; and an expected volatility of 2.28 percent, 2.24 percent and 2.24
percent. Expected lives for options granted in 1998 and 1997 were 6 years and
0.25 year for options granted in 1996. Due to the discretionary nature of stock
option grants, the compensation cost included in the 1998, 1997 and 1996 pro
forma net income per SFAS No. 123 may not be representative of that expected in
future years.
10. Contingent Liabilities and Commitments with Off-Balance-Sheet Risk:
The Company's consolidated financial statements do not reflect various
commitments and contingent liabilities of the subsidiaries that arise in the
normal course of business and that involve elements of credit risk, interest
rate risk and liquidity risk. These commitments and contingent liabilities are
commitments to extend credit, credit card arrangements and standby letters of
credit. A summary of the subsidiary's undisbursed commitments and contingent
liabilities at December 31, 1998 is as follows:
Commitments to extend credit.................... $ 20,424
Credit card commitments......................... 3,974
Standby letters of credit....................... 258
---------
Total....................................... $ 24,656
=========
Commitments to extend credit, credit card arrangements and standby letters
of credit all include exposure to some credit loss in the event of
nonperformance of the customer. The Bank's credit policies and procedures for
credit commitments and financial guarantees are the same as those for extension
of credit that are recorded on the consolidated balance sheets. Because these
instruments have fixed maturity dates and many of them expire without being
drawn upon, they do not generally present a significant liquidity risk to the
Bank.
Most of the Bank's lending activity is with customers located in Cowlitz
County, Washington. An economic downturn in Cowlitz County would likely have a
negative impact on the Bank's results of operations, depending on the severity
of the downturn. The Bank maintains a diversified portfolio and does not have
significant on- or off- balance-sheet concentrations of credit risk in any one
industry.
11. Balances with the Federal Reserve Bank:
The Bank is required to maintain reserves in cash or with the Federal
Reserve Bank equal to a percentage of its reservable deposits. Required reserves
were approximately $1,023, $929, and $580 as of December 31, 1998, 1997, and
1996, respectively.
12. Related-Party Transactions:
Certain directors, executive officers and their spouses, associates and
related organizations, had banking transactions with the Bank in the ordinary
course of business. All loans and commitments to loan were made on substantially
the same terms and conditions, including collateral required as comparable
transactions with unaffiliated parties. Directors and executive officers are
charged the same rates of interest and loan fees as are charged to employees of
the Company, which interest rates and fees are slightly lower than charged to
nonemployee borrowers. The amounts of loans outstanding to directors, executive
officers, principal shareholders, and companies with which they are associated
was as follows: 45
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
December 31,
1998 1997
-------- --------
Beginning balance ............................ $ 1,077 $ 1,318
Loans made.................................... 186 704
Loan repayments made.......................... (319) (698)
Other......................................... - (247)
---------- --------
Ending balance................................ $ 944 $ 1,077
========= ========
Certain directors at December 31, 1996 were no longer directors at December
31, 1997. The balances outstanding to such persons are reflected in the Other
category above.
The chairman of the Company owns a securities brokerage franchise of
Raymond James Financial Services, Inc., which leases space from the Company.
13. Employee Benefit Plan:
The Company has a contributory retirement savings plan covering
substantially all full-time and part-time employees. The amount of the Company's
annual contribution is at the discretion of the Board of Directors. The Bank
contributed $164 and $115 for the years ended December 31, 1998 and 1997,
respectively.
14. Fair Value of Financial Instruments:
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires the disclosure of the fair value of financial instruments. A financial
instrument is defined as cash, evidence of ownership interest in an entity, or a
contract that conveys or imposes the contractual right or obligation to either
receive or deliver cash or another financial instrument. Examples of financial
instruments included in the Company's balance sheets are cash, federal funds
sold or purchased; debt and equity securities; loans; demand, savings and other
interest bearing deposits; notes and debentures. Examples of financial
instruments, which are not included in the Company's balance sheets, are
commitments to extend credit and standby letters of credit.
Fair value is defined as the amount at which a financial instrument could
be exchanged in a current transaction between willing parties, other than in a
forced sale or liquidation, and is best evidenced by a quoted market price if
one exists.
The statement requires the fair value of deposit liabilities with no stated
maturity, such as demand deposits, NOW and money market accounts, to equal the
carrying value of these financial instruments and does not allow for the
recognition of the inherent value of core deposit relationships when determining
fair value. While the statement does not require disclosure of the fair value of
nonfinancial instruments, such as the Company's premises and equipment, its
banking and trust franchises and its core deposit relationships, the Company
believes that these nonfinancial instruments have significant fair value.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
Cash and due from banks - For these short-term instruments, the carrying
amount is a reasonable estimate of fair value.
Investment securities - For securities held for investment purposes, fair
values are based on quoted market prices or dealer quotes. For other securities,
fair value equals quoted market prices, if available. If a quoted market price
is not available, fair value is estimated using quoted market prices for similar
securities.
46
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
Loans - For certain variable rate loans, fair value is estimated at
carrying value, as these loans reprice to market frequently. The fair value of
other types of loans is estimated by discounting the future cash flows, using
the current rates at which similar loans would be made to borrowers with similar
credit ratings and for the same remaining maturities.
Deposit Liabilities - The fair value of demand deposits, savings accounts
and certain money market deposits is the amount payable on demand at the
reporting date. The fair value of fixed-maturity certificates of deposit is
estimated by discounting future cash flows, using the rates currently offered
for deposits of similar remaining maturities.
Short-term borrowing - The carrying amounts of borrowings under repurchase
agreements and short-term borrowings approximate their fair values.
Long-term borrowing - Rates currently available to the Bank for debt with
similar terms and remaining maturities are used to estimate the fair value of
existing debt.
Commitments to extend credit, credit card commitments and standby letters
of credit - The fair values of commitments to extend credit, credit card
commitments and standby letters of credit were not material as of December 31,
1998 and 1997.
The estimated fair values of the Company's financial instruments at
December 31 were as follows:
1998 1997
----------------- -------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
Financial assets:
Cash and due from banks.................................... $ 22,705 $ 22,705 $ 23,109 $ 23,109
Investment securities...................................... 11,530 11,552 8,481 8,503
Loans, net of allowances for loan losses................... 130,232 133,491 129,993 130,093
Federal Home Loan Bank stock............................... 2,869 2,869 2,658 2,658
Financial liabilities:
Demand..................................................... 33,062 33,062 27,141 27,141
Savings and interest-bearing deposits...................... 47,367 47,367 46,454 46,454
Certificates of deposit.................................... 41,932 42,326 62,614 62,524
Short-term borrowings...................................... 2,275 2,275 725 725
Long-term borrowings....................................... 21,799 22,787 21,900 21,824
15. Segments of an Enterprise and Related Information:
The Company adopted Statement of Financial Accounting Standards No. 131,
"Disclosure about Segments of an Enterprise and Related Information" as of
January 1, 1998. This statement establishes standards for the reporting and
display of information about operating segments in financial statements and
related disclosures.
The Company is principally engaged in community banking activities through
its five Bank branches and corporate offices. The community banking activities
include accepting deposits, providing loans and lines of credit to local
individuals, businesses and governmental entities, investing in investment
securities and money market instruments, and holding or managing assets in a
fiduciary agency capacity on behalf of its customers and their beneficiaries. In
addition, beginning in 1998 with the acquisition of Business Finance
Corporation, the Company provides asset based financing to companies throughout
the Western United States.
47
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
The community banking and asset based financing activities are monitored
and reported by Company management as separate operating segments. As permitted
under the Statement, the five separate banking offices have been aggregated into
a single reportable segment, Community Banking. The asset based financing
operating segment does not meet the prescribed aggregation or materiality
criteria and therefore is reported as Other in the following table below.
The accounting policies for the Company's segment information provided
below are the same as those described in Note 1, except that some operating
expenses are not allocated to segments.
Summarized financial information for the year ended December 31, 1998
concerning the Company's reportable segments is shown in the following table.
Prior to 1998, the Company had only one operating segment, Community Banking.
Banking Other Intersegment Consolidated
---------- -------- ------------ -------------
Interest income $ 15,870 $ 556 $ (60) $ 16,366
Interest expense 6,501 60 (60) 6,501
---------- -------- ----------- -------------
Net interest income 9,369 496 - 9,865
Provision for loan loss 509 - - 509
Noninterest income 978 - - 978
Noninterest expense 6,710 217 - 6,927
---------- -------- ----------- -------------
Income before taxes 3,128 279 - 3,407
Provision for income taxes 1,086 95 - 1,181
---------- -------- ----------- -------------
Net income $ 2,042 $ 184 $ - $ 2,226
========== ======== =========== =============
Depreciation and amortization $ 524 $ - $ - $ 524
========== ======== =========== =============
Assets $ 175,410 $ 4,797 $ (1,862) $ 178,345
========== ======== =========== =============
16. Acquisition
On August 31, 1998, the Company acquired Business Finance Corporation (BFC)
of Bellevue, Washington. BFC provides asset-based financing to companies
throughout the Western United States. A cash payment of approximately $1,776 was
made and 51,282 shares of Company stock with a value of $465 were issued in
connection with the acquisition. Available cash resources were used to finance
the acquisition. A future contingent issuance of the Company's common stock
valued at approximately $500 will be made if BFC achieves certain earnings goals
for the twelve-month period following the acquisition. The value of any
subsequently issued shares will be allocated to cost in excess of the fair value
of the net assets acquired.
48
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
The BFC acquisition was recorded under the purchase method of accounting;
and accordingly, the results of operations of BFC for the period from August 31,
1998 are included in the accompanying consolidated financial statements. The
purchase price has been allocated to the assets acquired and liabilities assumed
based on fair market value at the date of acquisition. The fair value of assets
acquired and liabilities assumed is summarized as follows:
Factored receivables........... $ 2,357
Other assets................... 273
Goodwill ..................... 1,571
Liabilities assumed............ (1,836)
Stock issued................... (465)
---------
Cash paid for acquisition...... 1,900
Cash acquired.................. (124)
---------
Net cash paid for acquisition.. $ 1,776
=========
The following unaudited pro forma financial information for the Company
gives effect to the BFC acquisition as if it had occurred on January 1, 1997.
These pro forma results have been prepared for comparative purposes only and do
not purport to be indicative of the results of operations which actually would
have resulted had the acquisition occurred on the date indicated, or which may
result in the future for the combined companies under the ownership and
management of the Company. The pro forma results include certain adjustments,
such as additional expense as a result of goodwill amortization.
Pro Forma
(unaudited)
Year ended Year ended
December 31, 1998 December 31, 1997
Interest income......................... $ 16,519 $ $15,180
Net income.............................. $ 2,423 $ 2,210
Diluted earnings per share.............. $ 0.62 $ 0.81
49
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
17. Parent-Company-Only Financial Data:
The following sets forth condensed financial information of the Company on
a stand-alone basis:
Statements of Condition
(unconsolidated)
December 31,
1998 1997
Assets:
Cash and due from depository institutions...................... $ 11,250 $ 937
Investment in bank subsidiary.................................. 16,458 14,147
Investment in non-bank subsidiary.............................. 2,424 -
Receivables due from non-bank subsidiary....................... 579 -
Other assets................................................... 320 156
-------- ---------
Total assets............................................. $ 31,031 $ 15,240
======== =========
Liabilities and shareholders' equity:
Liabilities:
Long-term borrowings......................................... $ - $ 1,319
Other liabilities............................................ 111 34
Total liabilities........................................ 111 1,353
Shareholders' equity........................................... 30,920 13,887
-------- ---------
Total liabilities and shareholders' equity............... $ 31,031 $ 15,240
======== =========
Statements of Income
(unconsolidated)
Year Ended December 31,
-----------------------
1998 1997 1996
Income:
Income from subsidiaries....................................... $ 495 $ 54 $ 56
-------- ------- -------
Total income............................................. 495 54 56
-------- ------- -------
Expenses:
Interest expense............................................... 30 116 130
Other expense.................................................. 800 353 334
-------- ------- -------
Total expense............................................ 830 469 464
-------- ------- -------
Loss before income tax benefit and equity in
Undistributed earnings of subsidiaries................. (335) (415) (408)
Income tax benefit....................................... 97 135 138
-------- ------- -------
Net loss before equity in undistributed earnings
Of subsidiaries........................................ (238) (280) (270)
Equity in undistributed earnings of subsidiaries.................. 2,464 2,404 2,767
-------- ------- -------
Net income............................................... $ 2,226 $ 2,124 $ 2,497
======== ======= =======
50
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
Statements of Cash Flows
Year Ended December 31,
-----------------------
1998 1997 1996
Cash flow from operating activities:
Net income..................................................... $ 2,226 $ 2,124 $ 2,497
Adjustments to reconcile net income to net cash (used for)
operating activities:
Undistributed earnings of the subsidiaries ................ (2,464) (2,404) (2,767)
Decrease (increase) in other assets........................ (164) (149) 39
Increase (decrease) in other liabilities................... 77 23 (5)
-------- ------- --------
Net cash used by operating activities.................... (325) (406) (236)
-------- ------- --------
Cash flows from investing activities:
Capital payments from bank..................................... - 500 -
Acquisition of business, net of cash acquired.................. (1,776) - -
Advances to subsidiaries....................................... (579) - -
-------- ------- --------
Net cash (used for) provided by investing activities..... (2,355) 500 -
-------- ------- --------
Cash flows from financing activities:
Net repayments of long-term borrowings......................... (1,319) (159) (146)
Purchase of treasury stock..................................... (494) - -
Proceeds from issuance of common stock......................... 15,018 67 19
Dividends paid................................................. (212) (126) (101)
-------- ------- --------
Net cash provided by (used for) financing activities..... 12,993 (218) (228)
-------- ------- --------
Net increase (decrease) in cash and cash equivalents.............. 10,313 (124) (464)
Cash and cash equivalents at beginning of year.................... 937 1,061 1,525
-------- ------- --------
Cash and cash equivalents at end of year.......................... $ 11,250 $ 937 $ 1,061
========= ======== =========
18. Quarterly Financial Information (unaudited):
March 31 June 30 September 30 December 31
--------- -------- ------------ -----------
1998
Interest income................................................... $ 3,781 $ 4,189 $ 4,104 $ 4,292
Interest expense.................................................. 1,661 1,722 1,571 1,547
----------- -------- ------------ -----------
Net interest income............................................... 2,120 2,467 2,533 2,745
Provision for loan losses......................................... (106) (26) (111) (266)
Noninterest income................................................ 264 231 239 244
Noninterest expense............................................... 1,619 1,681 1,734 1,893
----------- -------- ------------ -----------
Income before income taxes................................... 659 991 927 830
Provision for income taxes........................................ 224 337 315 305
----------- -------- ------------ -----------
Net income................................................... $ 435 $ 654 $ 612 $ 525
=========== ======== ============ ===========
Basic earnings per share.......................................... $ .15 $ .16 $ .15 $ .13
=========== ======== ============ ===========
Diluted earnings per share........................................ $ .14 $ .15 $ .15 $ .13
=========== ======== ============ ===========
51
COWLITZ BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands of dollars, except number of shares and per share amounts)
March 31 June 30 September 30 December 31
---------- --------- ------------ -----------
1997
Interest income................................................... $ 3,594 $ 3,622 $ 3,919 $ 3,951
Interest expense.................................................. 1,761 1,676 1,796 1,709
---------- -------- ------------ -----------
Net interest income............................................... 1,833 1,946 2,123 2,242
Provision for loan losses......................................... (91) (98) (111) (75)
Noninterest income................................................ 154 161 219 215
Noninterest expense............................................... 1,116 1,214 1,509 1,446
---------- -------- ------------ -----------
Income before income taxes................................... 780 795 722 936
Provision for income taxes........................................ 265 271 245 328
---------- -------- ------------ -----------
Net income................................................... $ 515 $ 524 $ 477 $ 608
=========== ======== ============ ===========
Basic earnings per share.......................................... $ .20 $ .20 $ .18 $ .23
=========== ======== ============ ===========
Diluted earnings per share........................................ $ .20 $ .20 $ .18 $ .22
=========== ======== ============ ===========
As discussed in Footnote 1, the Company has restated its historical basic
and diluted earnings per share to conform with SAB No. 98.
Quarter ended Quarter ended Quarter ended Quarter ended
March 31, 1997 June 30, 1997 September 30, 1997 December 31, 1997
Basic Diluted Basic Diluted Basic Diluted Basic Diluted
----- ------- ----- ------- ----- ------- ----- -------
Previously reported EPS..... $ .17 $ .17 $ .19 $ .19 $ .17 $ .17 $ .22 $ .22
Restated EPS................ $ .20 $ .20 $ .20 $ .20 $ .18 $ .18 $ .23 $ .22
52
Item 9. Changes in and disagreements with accountants
None
PART III
Item 10. Directors and executive officers of the registrant
The response to this item is incorporated by reference to the sections
entitled "Security ownership of directors and executive officers, Election of
directors, Information regarding the board of directors and its committees," in
the Company's 1999 Proxy Statement.
Item 11 Executive Compensation
The response to this item is incorporated by reference to the section
entitled "Executive Compensation" in the Company's 1999 Proxy Statement.
Item 12 Security ownership of certain beneficial owners and management
The response to this item is incorporated by reference entitled "Security
ownership of directors and executive officers" in the Company's 1999 Proxy
Statement.
Item 13 Certain relationships and related transactions
The response to this item is incorporated by reference entitled "Related
party transactions" in the Company's 1999 Proxy Statement.
Item 14 Exhibits, Financial Statement schedules and reports on form 8-K
a. No Form 8-Ks were filed during the fourth quarter.
b. The exhibit list is set forth on the Exhibit Index included herein.
53
Signatures
Pursuant to the requirements of Section 13 or 159d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 25th day of
March, 1999.
COWLITZ BANCORPORATION
(Registrant)
/s/ Charles W. Jarrett
Charles W. Jarrett
President/Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on the 25th day of March, 1999.
Principal Executive Officer:
/s/ Charles W. Jarrett
President/Chief Operating Officer
Principal Executive Officer:
/s/ Don P. Kiser
Don P. Kiser
Vice President/Chief Financial Officer
Accounting Officer:
/s/ Donna P. Gardner
Donna P. Gardner
Vice-President/Secretary-Treasurer
Remaining Directors:
/s/ Benjamin Namatinia /s/ Mark F. Andrews, Jr.
Benjamin Namatinia Mark F. Andrews, Jr.
Chairman/Chief Executive Officer Director
/s/ E. Chris Searing /s/ Larry M. Larson
E. Chris Searing Larry M. Larson
Director Director
EXHIBIT INDEX
3.1* Form of Restated and Amended Articles of Incorporation of Registrant.
3.2* Bylaws of Registrant.
10.1* Advances Security and Deposit Agreement dated March 29, 1991 between
Federal Home Loan Bank of Seattle and Cowlitz Bank.
10.2* Federal Home Loan Bank of Seattle Form of Promissory Note
(Credit Line Fixed Rate Advance).
10.3* Purchase and Assumption Agreement dated as of March 5, 1997 between
Wells Fargo Bank, N.A. and Cowlitz Bank.
10.4* Lease Agreement dated October 7, 1963 between Twin City
Development Co. and Bank of Cowlitz County.
10.5* Assignment of Lease dated March 4, 1976 between Bank of the West
and Old National Bank of Washington.
10.6* Assignment of Lease dated March 30, 1979 between Old National Bank
of Washington and Pacific National Bank of Washington.
10.7* Extension of Lease dated April 1, 1989 between Triangle Development
Company and First Interstate Bank of Washington, N.A.
10.8* Employment Agreement dated January 1, 1998 between Cowlitz
Bancorporation and Charles W. Jarrett.
10.9* Employment Agreement dated January 1, 1998 between Cowlitz
Bancorporation and Ben Namatinia.
10.10* Cowlitz Bancorporation 1997 Stock Option Plan.
10.11* Form of Stock Option Agreement.
10.12* Cowlitz Bancorporation Employee Stock Purchase Plan.
11.1 Computation of Per Share Earnings. (Included in Note 1 to the
Consolidated Financial Statements included herein)
21* List of all Subsidiaries of the Registrant
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule.
* Incorporated by reference from Registration Statement on Form S-1, Reg.
No. 333-44355