US SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2003.
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR TRANSITION PERIOD FROM TO
------ ------
Commission file number 0-25286
CASCADE FINANCIAL CORPORATION
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Washington 91-1661954
------------------------------ -----------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2828 Colby Avenue
Everett, Washington 98201
-------------------------------------- --------
(Address of principal executive offices) (Zip Code)
(425) 339-5500
--------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by a 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 twelve months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety days. Yes X No
----- -----
Indicate by a check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of October 31, 2003
- ---------------------------- --------------------------------
Common Stock ($.01 par value) 6,587,511
CASCADE FINANCIAL CORPORATION
FORM 10-Q
for the Quarter Ended September 30, 2003
----------------------------------------
INDEX
PART I - Financial Information:
Item 1 - Financial Statements:
- Condensed Consolidated Balance Sheets..................................3
- Condensed Consolidated Statements of Operations........................4
- Consolidated Statements of Comprehensive Income........................5
- Condensed Consolidated Statements of Cash Flows........................6
- Notes to Condensed Consolidated Financial Statements...................8
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations.....................................12
Item 3 - Quantitative and Qualitative Disclosures about Market Risk.......22
Item 4 - Controls and Procedures..........................................25
PART II - Other Information.................................................27
2
PART I -- FINANCIAL INFORMATION
-------------------------------
CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
(unaudited)
September 30, December 31,
ASSETS 2003 2002
- ------ ------------- ------------
Cash on hand and in banks $ 9,880 9,640
Interest-earning deposits in other institutions 9,795 10,955
Securities available-for-sale 171,123 159,897
Securities held-to-maturity (market value of
$87,682 and $49,639) 88,361 49,078
Loans 571,292 553,549
Allowance for loan losses (7,642) (6,872)
------- -------
Loans, net 563,650 546,677
Premises and equipment, at cost, net 8,543 9,261
Bank owned life insurance 11,029 10,619
------- -------
Accrued interest receivable and other assets 7,153 8,026
TOTAL ASSETS $869,534 804,153
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
- -----------
Deposits $554,653 509,850
Federal Home Loan Bank advances 192,000 197,500
Securities sold under agreements to repurchase 40,588 20,569
Trust preferred securities 10,000 10,000
Advance payments by borrowers for taxes
and insurance 1,334 1,507
Dividends payable 461 324
Accrued expenses and other liabilities 6,993 6,254
Deferred federal income taxes 1,052 1,509
------- -------
TOTAL LIABILITIES 807,081 747,513
Stockholders' Equity:
- --------------------
Preferred stock, $.01 par value, 500,000
shares authorized; no shares issued or
outstanding - -
Common stock, $.01 par value, 25,000,000
shares authorized; 6,584,914 and 6,657,547
shares issued and outstanding 66 67
Additional paid-in capital 11,774 10,134
Retained earnings, substantially restricted 50,189 45,438
Cumulative other comprehensive income, net 424 1,001
------- -------
TOTAL STOCKHOLDERS' EQUITY 62,453 56,640
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $869,534 804,153
======= =======
See notes to condensed consolidated financial statements
3
CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
Interest income: ---------------------- -------------------
Loans $ 9,375 10,352 28,518 31,711
Securities held-to-maturity 729 441 2,079 601
Securities available-for-sale 2,198 1,651 6,484 6,281
FHLB stock dividends 190 204 608 598
Interest-earning deposits 14 100 97 228
--------- --------- --------- ---------
Total interest income 12,506 12,748 37,786 39,419
Interest expense:
Deposits 2,712 3,148 8,467 9,490
Borrowings 2,664 3,024 8,181 9,739
Trust preferred securities 284 284 851 865
--------- --------- --------- ---------
Total interest expense 5,660 6,456 17,499 20,094
Net interest income 6,846 6,292 20,287 19,325
Provision for loan losses 300 375 975 1,495
--------- --------- --------- ---------
Net interest income after
provision for loan losses 6,546 5,917 19,312 17,830
Other income:
Gain on sale of loans 275 159 748 388
Service charges 488 415 1,338 1,219
Gain on sale of securities
available-for-sale 405 532 1,745 919
Net (loss) gain on sale of
real estate owned, investment
property and other repossessed
assets - (2) 48 351
Bank owned life insurance 155 7 450 23
Other 30 35 90 111
--------- --------- --------- ---------
Total other income 1,353 1,146 4,419 3,011
Other expenses:
Salaries and employee benefits 2,341 2,144 7,147 6,620
Occupancy 643 544 1,894 1,694
Marketing 107 129 329 299
Data processing 65 63 204 190
Debt prepayment fees 146 244 863 569
Other 1,031 974 2,888 2,835
--------- --------- --------- ---------
Total other expenses 4,333 4,098 13,325 12,207
Income before income taxes 3,566 2,965 10,406 8,634
Federal income taxes 1,133 907 3,310 2,717
--------- --------- --------- ---------
Net income $ 2,433 2,058 7,096 5,917
========= ========= ========= =========
Earnings per share:
Basic $ 0.37 0.32 1.09 0.93
Diluted 0.36 0.31 1.05 0.90
Dividends declared per share $ 0.05 - 0.15 -
Weighted average number of
shares outstanding:
Basic 6,571,118 6,444,037 6,534,596 6,375,358
Diluted 6,809,920 6,642,442 6,758,129 6,588,826
See notes to condensed consolidated financial statements
4
CASCADE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands, unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
------------------ -----------------
Net Income $2,433 2,058 7,096 5,917
Increase in unrealized gain on
securities available-for-sale,
net of tax (benefit) expense of
$(158) and $45 for the three
months ended September 30, 2003
and 2002, respectively and $296
and $550 for the nine months
ended September 30, 2003 and
2002, respectively. (307) 87 575 1,067
Less reclassification adjustment
for gains included in net income,
net of tax expense of $138 and
$181 for the three months ended
September 30, 2003 and 2002,
respectively and $593 and $313
for the nine months ended
September 30, 2003 and 2002,
respectively. (267) (351) (1,152) (606)
----------------- ----------------
Comprehensive Income $1,859 1,794 6,519 6,378
----------------- ----------------
See notes to condensed consolidated financial statements
5
CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands, unaudited)
Nine Months Ended September 30,
2003 2002
Cash flows from operating activities: -------------------------------
Net income $ 7,096 5,917
Adjustments to reconcile net income to net ---------------------
cash provided by (used in) operating activities:
Depreciation and amortization of premises
and equipment 1,081 909
Increase in cash surrender value of Bank
Owned Life Insurance (410) 17
Amortization of retained servicing rights 159 145
Gain on sale of premises and equipment -- --
Provision for losses on loans 975 1,495
Deferred loan fees, net of amortization 12 (186)
Net gain on sales of securities available-
for-sale (1,745) (919)
Net gain on sales of real estate owned,
investment property and other repossessed
assets (48) (351)
Federal Home Loan Bank stock dividend received (608) (597)
Deferred federal income taxes (160) 325
Net change in accrued interest receivable and
other assets over accrued expenses and other
liabilities 1,787 562
---------------------
Net cash provided by operating activities 8,139 7,317
Cash flows from investing activities:
Loans originated, net of principal repayments (18,246) 17,286
Principal repayments on securities held-
to-maturity 60,806 11,140
Purchase of securities held-to-maturity (100,089) (53,025)
Principal repayments on securities available-
for-sale 89,424 20,143
Purchases of securities available-for-sale (300,598) (127,711)
Proceeds from sales of securities available-
for-sale 201,427 140,243
Proceeds from sale of investment property -- 956
Purchases of premises and equipment (371) (1,039)
Proceeds from sales/retirements of premises
and equipment 8 2
Net cash provided by (used in) investing ---------------------
activities (67,639) 7,995
Subtotal, carried forward $ (59,500) 15,312
---------------------
See notes to condensed consolidated financial statements
6
CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands, unaudited)
Nine Months Ended September 30,
2003 2002
-------------------------------
Subtotal, brought forward $ (59,500) 15,312
---------------------
Cash flows from financing activities:
Proceeds from issuance of common stock 492 913
Dividends paid (978) --
Repurchase of common stock (83) (374)
Net increase in deposits 44,803 57,280
Net increase (decrease) in Federal Home
Loan Bank advances (5,500) (34,000)
Net increase (decrease) in securities sold
under agreements to repurchase 20,019 (19,617)
Net increase in advance payments by borrowers
for taxes and insurance (173) (602)
Net cash provided by financing activities 58,580 4,804
Net increase (decrease) in cash and
cash equivalents (920) 20,116
Cash and cash equivalents at beginning of period 20,595 11,622
Cash and cash equivalents at end of period $ 19,675 31,738
Supplemental disclosures of cash flow
information-cash paid during the period for:
Interest $ 17,864 17,892
Federal income taxes 3,100 2,605
Supplemental schedule of noncash investing
and financing activities:
Net mortgage loans transferred to real
estate owned 286 1,199
Mark to market on securities available-for-sale 874 (698)
Retirement of treasury stock in retained earnings (1,230) --
Dividends declared (1,115) --
See notes to condensed consolidated financial statements
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
(unaudited)
1. Presentation of Financial Information
The accompanying financial information is unaudited and has been prepared
from the consolidated financial statements of Cascade Financial Corporation
(the "Corporation"), its subsidiaries, Cascade Bank (the "Bank" or "Cascade")
and Cascade Capital Trust I (the "Trust"), and the Bank's subsidiary, Cascade
Investment Services, Inc. All significant intercompany balances have been
eliminated in the consolidation. In the opinion of management, the financial
information reflects all adjustments (consisting of normal recurring
adjustments) necessary for a fair presentation of the financial condition,
results of operations, and cash flows of the Corporation pursuant to the
requirements of the SEC for interim reporting.
Certain information and footnote disclosures included in the Corporation's
financial statements for the year ended December 31, 2002, have been condensed
or omitted from this report. Accordingly, these statements should be read with
the financial statements and notes thereto included in the Corporation's
December 31, 2002 Annual Report on Form 10-K.
2. Commitments and Contingencies
In the normal course of business there are various commitments to fund
mortgage loans. Management does not anticipate any material loss as a result
of these commitments.
Periodically there have been various claims and lawsuits against the
Corporation or the Bank, such as claims to enforce liens, condemnation
proceedings on properties in which the Bank holds security interests, claims
involving the making and servicing of real property loans and other issues
incidental to the Corporation's and the Bank's business. In the opinion of
management no material loss is expected from any of such pending lawsuits.
3. Financial Statement Reclassification
Certain amounts in the financial statements for 2002 have been
reclassified to conform with the financial statement classification for 2003.
8
4. Stockholders' Equity
a) Earnings Per Share
The following table presents the computation of basic and diluted net
income per share for the three and nine-month periods ended September 30:
Three Three Nine Nine
Months Months Months Months
Ended Ended Ended Ended
2003 2002 2003 2002
-------------------------------------------
Dollars in thousands, except share
and per share amounts
Numerator:
- ---------
Net income $ 2,433 2,058 7,096 5,917
==========================================
Denominator:
- -----------
Denominator for basic net income
per share-Weighted average shares 6,571,118 6,444,037 6,534,596 6,375,358
Effect of dilutive securities:
Stock options 238,802 198,405 223,533 213,468
Denominator for diluted net income ------------------------------------------
per share-Weighted average shares
and assumed conversion of dilutive
stock options 6,809,920 6,642,442 6,758,129 6,588,826
==========================================
Basic net income per share $ 0.37 0.32 1.09 0.93
==========================================
Diluted net income per share $ 0.36 0.31 1.05 0.90
==========================================
As of September 30, 2003 and 2002, there were anti-dilutive options to purchase
shares of 0 and 85,058, respectively, excluded from the above disclosure.
b) Cash Dividend Declared
On September 23, 2003, the company declared its fifth consecutive
quarterly cash dividend payment. The dividend was $0.07 per share and paid on
October 22, 2003 to shareholders of record on October 8, 2003.
c) Stock-based compensation
The Corporation measures its employee stock-based compensation
arrangements using the provisions outlined in Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees," which is an
intrinsic value-based method of recognizing compensation costs. As none of the
Corporation's stock options have an intrinsic value at grant date, no
compensation cost has been recognized for its stock option plans.
The Corporation applies Accounting Principles Board (APB) Opinion 25,
"Accounting for Stock Issued to Employees," in accounting for its stock option
plans. Had compensation cost on the fair value at the grant dates for the
Corporation's stock option plan been determined to be consistent with the
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
9
Stock Based Compensation," the Corporation's net income and earnings per share
would have been reduced to the pro forma amounts indicated below:
Three Three Nine Nine
Months Months Months Months
Ended Ended Ended Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2003 2002 2003 2002
-------------------------------------------
Dollars in thousands, except
per share amounts
Net income
As reported $2,433 2,058 7,096 5,917
Less SFAS 123 compensation costs 35 16 113 92
--------------------------------------
Pro forma $2,398 2,042 6,983 5,825
======================================
Net income per common share
Basic
As reported $ 0.37 0.32 1.09 0.93
Pro forma 0.36 0.32 1.07 0.91
Diluted
As reported $ 0.36 0.31 1.05 0.90
Pro forma 0.35 0.31 1.03 0.88
5. Recently Issued Accounting Standards
In June 2001, the Financial Accounting Standards Board issued Statement
No. 143, Accounting for Asset Retirement Obligations, which addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. The
standard applies to legal obligations associated with the retirement of long-
lived assets that result from the acquisition, construction, development and
(or) normal use of the asset. Statement No. 143 requires that the fair value of
a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
fair value of the liability is added to the carrying amount of the associated
asset and this additional carrying amount is depreciated over the life of the
asset. The liability is accreted at the end of each period through charges to
operating expense. If the obligation is settled for other than the carrying
amount of the liability, the Company will recognize a gain or loss on
settlement. The Statement was adopted in March 2003 and did not have a material
effect on the results of our operations or financial position.
In June 2002, the Financial Accounting Standards Board issued Financial
Accounting Standard (FAS) No. 146, Accounting for Costs Associated with Exit or
Disposal Activities. This Statement addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). The provisions of this
Statement are effective for exit and disposal activities that are initiated
after December 31, 2002. This statement was adopted January 1, 2003 and did
not have a material effect on the results of our operations or financial
position.
In October 2002, the Financial Accounting Standards Board issued Financial
Accounting Standard (FAS) No. 147, Acquisitions of Certain Financial
10
Institutions-an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9. This Statement addresses FAS No. 72, Accounting for
Certain Acquisitions of Banking or Thrift Institutions, and FASB Interpretation
No. 9, Applying APB Opinions No. 16 and 17 When a Savings and Loan Association
or a Similar Institution Is Acquired in a Business Combination Accounted for by
the Purchase Method, provided interpretive guidance on the application of the
purchase method to acquisitions of financial institutions. Except for
transactions between two or more mutual enterprises, this Statement removes
acquisitions of financial institutions from the scope of both Statement 72 and
Interpretation 9 and requires that those transactions be accounted for in
accordance with FASB Statements No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets. In addition, this Statement amends FASB
Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, to include in its scope long-term customer-relationship intangible
assets of financial institutions such as depositor- and borrower-relationship
intangible assets and credit cardholder intangible assets. This statement was
adopted in December 2002 and did not have a material effect on the results of
our operations or financial position.
In December 2002, the Financial Accounting Standards Board issued
Financial Accounting Standard (FAS) No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123.
This Statement amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
disclosure provisions of this statement were adopted in December 2002 and did
not have a material effect on the results of our operations or financial
position.
In November 2002, the FASB issued Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, clarifying the accounting treatment and
financial statement disclosure of certain guarantees issued and outstanding.
Interpretation No. 45 clarifies that a guarantor is required to recognize, at
the inception of certain guarantees, a liability for the fair value undertaken
in issuing the guarantee. In addition, guarantors must disclose the
approximate term and nature of the guarantee, the maximum potential amount of
future payments, current carrying amount of the liability and the nature of
recourse provisions and collateral. The initial recognition and measurement
provisions of Interpretation No. 45 are effective for guarantees issued or
modified after December 31, 2002. Management does not expect the adoption of
the initial recognition and measurement provisions of Interpretation No. 45 to
have a material impact on our consolidated financial statements, results of
operations or liquidity. Disclosure provisions of Interpretation No. 45 became
effective and were adopted by us on December 31, 2002.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, addressing consolidation by business enterprises of
certain variable interest entities. Under the provisions of Interpretation No.
46, an enterprise must consolidate a variable interest entity if that
enterprise will absorb a majority of the entity's expected losses or receive a
majority of the entity's residual returns, or both, regardless of the
enterprise's direct or indirect ability to make decisions about the entity's
activities through voting or similar rights. Interpretation No. 46 applies
immediately to interests in variable interest entities created or acquired
11
after January 31, 2003 and to the first fiscal year or interim period beginning
after June 15, 2003 for interests in variable interest entities acquired before
February 1, 2003. Application of this Interpretation did not have a material
effect on our financial statements.
In April 2003, the Financial Accounting Standards Board issued Financial
Accounting Standard (FAS) No. 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities. The provisions of this Statement are
effective for contracts entered into or modified after June 20, 2003 and
hedging relationships designated after September 30, 2003. Except for the
provisions related to FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities, all provisions of this Statement should be
applied prospectively. The provisions of the Statement related to Statement
133 implementation issues that have been effective for fiscal quarters that
begin prior to June 15, 2003, should continue to be applied in accordance with
their respective effective dates. Management does not expect the adoption of
the provisions of this Statement to have a material effect on the Company's
operating results or financial position.
In May 2003, the Financial Accounting Standards Boards issued Financial
Accounting Standard (FAS) No. 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity. The provisions of this
Statement are effective for financial instruments entered into or modified
after May 31, 2003 and otherwise are effective at the beginning of the first
interim period beginning after June 15, 2003. It is to be implemented by
reporting the cumulative effect of a change in accounting principle for
financial instruments created before May 15, 2003 and still existing at the
beginning of the interim period of adoption. Restatement is not permitted.
The Company has adopted the provisions of this Statement and as a result,
reclassified its Trust Preferred Securities from mezzanine capital to
liabilities.
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
------------------------------------------------
The following discussion is intended to assist in understanding the financial
condition and results of the Corporation. The information contained in this
section should be read with the unaudited condensed consolidated financial
statements and its accompanying notes, and the December 31, 2002 audited
consolidated financial statements and its accompanying notes included in our
recent Annual Report on Form 10-K.
This section contains forward-looking statements that are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. Those factors include, but are not limited to: the impact of the
current national and regional economic recession on small business loan demand
in the Puget Sound area; loan delinquency rates; the Bank's ability to continue
to attract quality commercial business; interest rate movements; changes in the
demographic make-up of the company's market area; fluctuation in demand for the
Bank's products and services; the Corporation's ability to attract and retain
qualified people, and other factors. For a discussion of factors that could
cause actual results to differ, and for certain mandated SEC guide 3
information that has not materially changed, please see the Annual Report on
Form 10-K for the year ended December 31, 2002.
12
Cascade Financial Corporation is a bank holding company incorporated in
the state of Washington. The Corporation's sole operating subsidiary is
Cascade Bank, a Washington state chartered commercial bank. The Corporation
and the Bank are headquartered in Everett, Washington. The Bank offers loan,
deposit and other financial services through its fifteen branches located in
Snohomish and King Counties (Washington).
Selected Financial Data
- -----------------------
The following table sets forth certain selected financial data concerning
the Corporation for the periods indicated:
At or for the At or for the
three months nine months
ended ended
September 30, September 30,
2003 2002 2003 2002
----------------------------------
Return on average assets 1.11% 1.08% 1.13% 1.04%
Return on average stockholders' equity 15.54 15.19 15.87 15.51
Average stockholders' equity to
average assets 7.17 7.09 7.11 6.70
Other expenses to average assets 2.00 2.16 2.11 2.14
Efficiency ratio 52.84 55.10 53.93 54.65
Average interest-bearing assets to
average interest-bearing liabilities 110.55 111.59 110.55 110.48
CHANGES IN FINANCIAL CONDITION
------------------------------
Total assets increased 8.1% or $65.3 million to $869.5 million at
September 30, 2003, compared to $804.2 million at December 31, 2002. Net loans
increased 3.1% or $17.0 million to $563.7 million at September 30, 2003, from
$546.7 million at December 31, 2002.
Investment securities increased $50.5 million to $259.5 million at
September 30, 2003, compared to $209.0 million at December 31, 2002. This
investment growth was partially funded by a decrease in interest-earning
deposits held at other institutions, which decreased $1.2 million from $11.0
million at December 31, 2002 to $9.8 million at September 30, 2003. The
investments made during the quarter, as well as the existing investment
portfolio, are concentrated in the securities of Government Sponsored
Enterprises (GSEs, e.g FNMA or FHLMC) and collateralized mortgage obligations
(CMOs) backed by pools of single family residential mortgages. All additions
to the investment portfolio during the quarter were rated A or better in terms
of credit quality by Moody's and/or Standard & Poors.
September 30, 2003 December 31, 2002
Gross Gross
Amortized Unrealized Fair Amortized Unrealized Fair
Cost Gains Value Cost Gains Value
(Losses) (Losses)
---------------------------- ----------------------------
Securities available
-for-sale:
Mortgage-backed
Securities $ 55,604 378 55,982 $ 89,145 928 90,073
Agency notes 94,948 384 95,332 55,285 589 55,874
FHLB stock 14,557 - 14,557 13,950 - 13,950
Other 5,371 (119) 5,252 - - -
-------------------------- --------------------------
$170,480 643 171,123 $158,380 1,517 159,897
========================== ==========================
13
September 30, 2003 December 31, 2002
Gross Gross
Amortized Unrealized Fair Amortized Unrealized Fair
Cost Gains Value Cost Gains Value
(Losses) (Losses)
---------------------------- ----------------------------
Securities held-
to-maturity:
Mortgage-backed
Securities $ 14,529 (8) 14,521 $ 4,212 167 4,378
Agency notes 73,832 (671) 73,161 44,866 394 45,261
-------------------------- --------------------------
$ 88,361 (679) 87,682 $ 49,078 561 49,639
========================== ==========================
As the Bank continued its focus on deposit generation, total deposits
increased by $44.8 million from $509.9 million at December 31, 2002 to $554.7
million at September 30, 2003. Other borrowings outstanding in aggregate
increased modestly. Federal Home Loan Bank-Seattle (FHLB) advances decreased
by $5.5 million from $197.5 million at December 31, 2002 to $192.0 million at
September 30, 2003. Securities sold under agreements to repurchase increased
$20.0 million from $20.6 million at December 31, 2002 to $40.6 million at
September 30, 2003.
Stockholders' equity increased by $5.9 million from $56.6 million at
December 31, 2002 to $62.5 million at September 30, 2003. The increase is
primarily attributable to the retention of most of the net income for the
period, which was $7.1 million. The Corporation's cash dividends reduced
stockholders' equity by $1.1 million. A quarterly dividend was declared
September 23, 2003 and payable on October 22, 2003. Accumulated comprehensive
income decreased by $577,000 to $424,000 as of September 30, 2003 compared to
$1,001 as of December 31, 2002.
Loan Portfolio
Virtually all the Bank's loans are to businesses and individuals in the
Puget Sound area. Business loans are made to businesses within that area.
Real estate construction loans are primarily extended to builders and
developers of single family, residential real estate. The vast majority of
these projects focus on entry level homes and/or first trade-up homes.
Commercial real estate loans fund small non-owner occupied buildings. Home
equity and consumer loans are primarily second mortgages on the borrower's
primary residence. These loans comprise 71% of the home equity and consumer
portfolio. The balance of this category is non-residential, e.g. automobiles,
credit cards, or boats.
Residential loans, held in the Bank's portfolio, are primarily adjustable
rate loans secured by single family residences. Multi-family loans are usually
adjustable rate loans secured by mortgages on projects with five or more units.
As displayed in the following table, total loans increased by $17.8
million to $573.5 million as of September 30, 2003, compared to $555.7 million
December 31, 2002. In keeping with the Bank's evolution to a commercial bank,
loans more closely associated with a commercial bank, i.e. business and
commercial real estate loans grew $71.3 million to $276.7 million as of
September 30, 2003 compared to $205.4 million as of December 31, 2002. Real
estate construction loans dipped due to a combination of factors. A strong
housing market led to good sales volumes and hence, loan paydowns by builders.
Also, the Bank was repaid in full on one large project. Residential and
consumer lending balances declined as refinancing activity continued with the
dramatic fall in rates. Since the Bank sells almost all its 15 year and 30 year
14
fixed rate residential originations, the continuing mortgage refinancing wave
has led to a $16.0 million (13.0%) reduction in our residential loan balances.
The following summary reflects the Bank's loan portfolio as of the dates
indicated:
Sept. 30, % of Dec. 31, % of
Types of Loans 2003 Portfolio 2002 Portfolio
- ----------------------------------------------------------------------------
($ in thousands)
Business $198,003 34.5% $142,273 25.6%
Real estate construction (net) 71,145 12.4 84,229 15.1
Commercial real estate 78,733 13.7 63,108 11.4
Home equity and consumer 34,168 6.0 49,331 8.9
Residential 106,580 18.6 122,561 22.0
Multifamily 84,873 14.8 94,245 17.0
-----------------------------------------
Total loans 573,502 100% 555,747 100%
Deferred loan fees (2,210) (2,198)
-----------------------------------------
Loans $571,292 $553,549
(Loans held-for-sale are included in residential loans and at less than 1% of
total loans, they are not considered material.)
Asset Quality
- -------------
Non-performing assets (non-performing loans and real estate owned) totaled
$1.6 million and $1.4 million at September 30, 2003 and December 31, 2002,
respectively. Non-performing loans, those on non-accrual, those that are
ninety days past due, and those that management otherwise has serious
reservations about their collectibility, increased to $1.2 million at September
30, 2003, compared to $1.0 million at December 31, 2002, which represents 0.21%
and 0.17% of total loans, respectively. Of the $1.2 million, $678,000 were
Business loans, $417,000 were Residential, and $115,000 were Home equity and
consumer loans. Real estate owned was $356,000 as of September 30, 2003
compared to $461,000 at December 31, 2002.
At September 30, 2003 the Bank's loan loss allowance totaled $7.6 million
compared to $6.9 million at December 31, 2002. The allowance for loan losses
was 1.33% of total loans outstanding at September 30, 2003 compared to 1.24% at
December 31, 2002. The allowance for loan losses was 632% of non-performing
loans at September 30, 2003 compared to 719% at December 31, 2002. The
allowance for loan losses is maintained at a level sufficient to provide for
losses based on management's evaluation of known and inherent risks in the
portfolio. This evaluation includes analyses of the financial condition of the
borrower, the value of the collateral securing selected loans, consideration of
historical loss experience and management's projection of trends affecting
credit quality. The increase in the allowance is primarily attributable to the
continued emphasis on business and construction lending, and a slowdown in the
economy of our market area. Management believes that the allowance for losses
on loans is adequate to provide for losses that may be inherent in the loan
portfolio.
During the quarter ended September 30, 2003, loan charge-offs equaled
$268,000 while recoveries were $34,000 resulting in net charge-offs of
$234,000. Of the net charge-offs, $141,000 were Consumer loans and $68,000 were
Business loans. During the comparable quarter ended September 30, 2002, loan
15
charge-offs equaled $214,000 while recoveries were $47,000 resulting in net
charge-offs of $167,000.
The following table provides summary information concerning asset quality
as of and for the periods ended September 30, 2003 and December 31, 2002
respectively:
September 30, December 31,
2003 2002
------------ ------------
Non-performing loans to total assets .14 % .12 %
Non-performing loans to total loans
outstanding .21 .17
Non-performing assets to total assets .18 .18
Allowance for loan losses to non-
performing loans 632 719
Allowance for loan losses to total loans 1.33 1.24
Net charge-offs to total loans .04 .07
RESULTS OF OPERATIONS
---------------------------------------
Comparison of the Three and Nine Months
Ended September 30, 2003 and 2002
Overview
Net income increased 18.2% to $2.4 million for the three months ended
September 30, 2003 compared to $2.0 million during the comparable period in
2002. Diluted net income per share was $0.36 for the quarter ended September
30, 2003 and $0.31 per share for the quarter ended September 30, 2002, an
increase of 16%. This increase is primarily attributable to the increase in net
interest income of $554,000 to $6.8 million for the quarter ended September 30,
2003. Other income increased by $207,000 to $1.4 million for the quarter ended
September 30, 2003 as compared to the quarter ended September 30, 2002. Other
expense increased $235,000 to $4.3 million for the quarter ended September 30,
2003 as compared to the quarter ended September 30, 2002. During the quarter,
the Bank paid $146,000 in prepayment fees on Federal Home Loan Bank (FHLB)
advances compared to $244,000 during the quarter ended September 30, 2002.
Net income for the nine months ended September 30, 2003 was $7.1 million
compared with $5.9 million during the comparable period in 2002. Net income
per diluted share was $1.05 for the nine months ended September 30, 2003,
compared with $0.90 in 2002. The $962,000 increase in net interest income and
the $1.4 million increase in other income more than offset the $1.1 million
increase in other expenses which included an increase of $294,000 in FHLB
prepayment fees and an increase of $527,000 in salaries and employee benefits.
Net Interest Income
Net interest income increased 8.8% or $554,000 to $6.8 million for the
three months ended September 30, 2003 compared to $6.2 million for the three
months ended September 30, 2002. An increase in average earning assets offset
the contraction in net interest margin. Net interest income for the nine
months ended September 30, 2003 was $20.3 million compared to $19.3 million for
the same period ended September 30, 2002.
16
Average interest earning assets increased $95.4 million or 12.8% to $839.8
million for the three months ended September 30, 2003 and $69.8 million or 9.4%
to $815.7 for the nine months ended September 30, 2003 compared to the same
periods in 2002. Average total loans (including loans held for sale) increased
$8.3 million to $560.1 million and average investment securities increased
$103.0 million to $264.5 million for the three months ended September 30, 2003
compared to the same quarter of the prior year.
At or for the At or for the
three months ended nine months ended
September 30, September 30,
2003 2002 2003 2002
------------------------------------------
(dollars in thousands)
Average interest earning assets $839,846 $744,384 $815,723 $745,930
Average interest bearing liabilities 756,543 667,058 737,889 675,201
Yield on interest earning assets 5.92% 6.81% 6.19% 7.06%
Cost of interest bearing liabilities 2.97% 3.84% 3.17% 3.98%
Net interest spread 2.96% 2.97% 3.02% 3.08%
Net interest margin 3.25% 3.37% 3.32% 3.46%
The net interest margin decreased 12 basis points to 3.25% for the three
months ended September 30, 2003 compared to the same quarter the prior year.
The decrease in the net interest margin is the result of a decrease in the
ratio of interest earning assets to total assets due to the purchase of Bank
Owned Life Insurance (BOLI) and a decrease in asset yields that exceeded the
decrease in liability costs. The yield on interest earning assets decreased 89
basis points to 5.92% for the three months ended September 30, 2003, compared
to 6.81% for the three months ended September 30, 2002. The cost of funds
decreased to 2.97% for the three months ended September 30, 2003 compared to
3.84% for the same period in 2002, a drop of 87 basis points. For the nine
months ended September 30, 2003, the net interest margin dropped 14 basis
points from 3.46% to 3.32%. As was the case with the quarterly results, the
decrease in the ratio of interest earning assets to total assets and the yield
on earnings assets decreased more than the cost of interest bearing
liabilities, 87 basis points versus 81 basis points respectively.
The yield on assets fell as the steep decline in rates led to the
refinancing or rate modification on many loans in the Bank's portfolio. Also,
mortgage backed securities repaid more rapidly than forecasted and investment
securities with call features, were called. Asset yields were also lowered by
the increased percentage of earning assets represented by investment securities
and cash equivalents.
On the other hand, the cost of liabilities declined as the rates paid on
deposits and repurchase agreements dropped with the general level of interest
rates and FHLB advances were prepaid. Deposits continued to reprice to slightly
lower rates throughout the quarter. Also, during the quarter ending September
30, 2003, the Bank prepaid $9.0 million in long term, high rate FHLB advances
that resulted in prepayment fees, but lowered the cost of funds as the bank
replaced these high rate advances with low rate, short-term advances.
17
Provision for Loan Losses
Cascade's provision for loan losses was $300,000 for the three months and
$975,000 for the nine months ended September 30, 2003. The provision was
$375,000 and $1.5 million for the same periods in 2002. The provision is based
on management's evaluation of known and inherent risks in the portfolio.
The immediate prospects for the economy in the Corporation's market area
(Snohomish County and East King County of Washington state) have stabilized,
but remain less than robust. The area's largest employer, Boeing, continues to
layoff employees due to the slowing demand for commercial aircraft. The
slowdown in many areas of technology has had a negative impact on the demand
for commercial real estate in our market area. The vacancy rates for Class A,
high rise office space has increased in Seattle and Bellevue to 25% today.
While the impact on the Bank's asset quality has been muted to date, a
continued economic slump will have adverse ramifications for some borrowers and
hence lenders in our market. On the positive side, Microsoft has continued to
add to its payroll and the housing market remains strong.
This economic slowdown comes at a time when management intends to
emphasize the growth of the business and construction portfolios. These loans
typically have a higher credit risk that may require additions to the reserve
in future periods. Management monitors these loans at an increased level to
maintain credit quality and adequate reserve levels.
Other Income
Other income increased $207,000 or 18.1% to $1.4 million for the three
months ended September 30, 2003 as compared to $1.1 million for the three
months ended September 30, 2002. Other income was $4.42 million and $3.01
million for the nine months ended September 30, 2003 and September 30, 2002
respectively. For the three months ended September 30, 2003, gain on the sale
of investment securities decreased by $127,000 to $405,000 compared to $532,000
for the same period in the prior year. The Bank increased its checking fees by
reducing the number and amount of waived service charges. Service fee income
rose to $488,000 during the quarter ended September 30, 2003 compared to
$415,000 for the same period in the prior year. Gain on sale of loans
increased $116,000 from $159,000 to $275,000 due to continued high levels of
refinance activity. Other income was reduced by the amortization of mortgage
servicing rights that exceeded fees by $29,000.
Other Expense
Other expense was $4.3 million for the three months and $13.3 million for
the nine months ended September 30, 2003 compared with $4.1 million for the
three months and $12.2 million for the nine months ended September 30, 2002.
Salary and employee benefit expenses increased $197,000 to $2.3 million
during the three months ended September 30, 2003 compared to the same quarter
last year. Salary and employee benefit expenses were $7.1 million for the
nine-month period ended September 30, 2003 and $6.6 million in the same period
in 2002. The increase in salary and employee benefit expenses is primarily due
to annual salary increases and the increase in employees as a result of bank
growth.
18
The remaining other operating expense categories, excluding prepayment
fees, totaled $1.9 million for the three months ended September 30, 2003 and
$5.3 million for the nine months period as of the same date. For the same
periods in 2002, other operating expenses were $1.7 million and $5.0 million
respectively.
Prepayment fees on Federal Home Loan Bank advances were $146,000 for the
three months ended September 30, 2003 and $863,000 for the nine-month period.
For the three-month and nine-month periods ended September 30, 2002, the Bank
incurred $244,000 and $569,000 in prepayment fees, respectively. The
prepayments of advances were made possible by deposit growth exceeding asset
growth. The advances prepaid were high rate and were extinguished to lower the
cost of funds and improve the net interest margin.
Federal income tax expense increased $226,000 to $1.1 million, an increase
of 24.9% during the three months ended September 30, 2003 compared to the same
period last year. For the three months ended September 30, 2003, the
Corporation's effective tax rate was 32% compared to 31% for the same period in
2002. For the nine months ended September 30, 2003 the Corporation's effective
tax rate was 32% compared to 31% for the same period in 2002. Tax benefits
related to bank owned life insurance and interest on tax-exempt loans accounted
for the difference from the "expected" Federal income tax rate of 34% during
each of the periods.
Segment Results
The following is a summary of selected operating segment information for
the three-month and nine-month periods ended September 30, 2003 and 2002. The
Corporation manages its operations and prepares management reports with a
primary focus on its various business units. The accounting policies of the
individual units are the same as those of the Corporation. The Corporation
allocates centrally provided services to the business units based upon
estimated usage of those services. All amounts are in thousands.
For the three months ended September 30, 2003
- ---------------------------------------------
Income Administration/
Business Residential Construction Property Consumer Treasury Total
-------- ----------- ------------ -------- -------- -------------- ------
(In thousands)
Condensed Income Statement
Net Interest after
provision for loan losses $2,178 259 929 1,633 294 1,253 6,546
Other income 9 275 7 1 459 602 1,353
Direct expense 333 128 114 38 331 3,389 4,333
Allocated overhead 511 291 202 431 99 (1,534) -
----------------------------------------------------------------------------------------
Income before income tax 1,343 115 620 1,165 323 - 3,566
Federal income taxes 427 36 197 370 103 - 1,133
----------------------------------------------------------------------------------------
Net income $ 916 79 423 795 220 - 2,433
----------------------------------------------------------------------------------------
19
For the three months ended September 30, 2002
- ---------------------------------------------
Income Administration/
Business Residential Construction Property Consumer Treasury Total
-------- ----------- ------------ -------- -------- -------------- ------
(In thousands)
Condensed Income Statement
Net Interest after
provision for loan losses $1,446 385 1,010 1,545 568 963 5,917
Other income 25 190 - 1 337 593 1,146
Direct expense 257 144 69 23 318 3,287 4,098
Allocated overhead 416 398 248 496 173 (1,731) -
----------------------------------------------------------------------------------------
Income before income tax 798 33 693 1,027 414 - 2,965
Federal income taxes 245 8 212 315 127 - 907
----------------------------------------------------------------------------------------
Net income $ 553 25 481 712 287 - 2,058
----------------------------------------------------------------------------------------
For the nine months ended September 30, 2003
- --------------------------------------------
Income Administration/
Business Residential Construction Property Consumer Treasury Total
-------- ----------- ------------ -------- -------- -------------- ------
(In thousands)
Condensed Income Statement
Net Interest after
provision for loan losses $5,403 1,143 2,828 4,588 1,137 4,213 19,312
Other income 39 760 7 3 1,215 2,395 4,419
Direct expense 927 376 296 99 966 10,661 13,325
Allocated overhead 1,217 816 574 1,150 296 (4,053) -
----------------------------------------------------------------------------------------
Income before income tax 3,298 711 1,965 3,342 1,090 - 10,406
Federal income taxes 1,049 226 625 1,063 347 - 3,310
----------------------------------------------------------------------------------------
Net income $2,249 485 1,340 2,279 743 - 7,096
----------------------------------------------------------------------------------------
For the nine months ended September 30, 2002
- ---------------------------------------------
Income Administration/
Business Residential Construction Property Consumer Treasury Total
-------- ----------- ------------ -------- -------- -------------- ------
(In thousands)
Condensed Income Statement
Net Interest after
provision for loan losses $3,945 1,538 2,847 4,056 1,463 3,981 17,830
Other income 52 481 - 6 976 1,496 3,011
Direct expense 822 474 237 79 889 9,706 12,207
Allocated overhead 979 1,006 588 1,237 419 (4,229) -
----------------------------------------------------------------------------------------
Income before income tax 2,196 539 2,022 2,746 1,131 - 8,634
Federal income taxes 691 170 636 864 356 - 2,717
----------------------------------------------------------------------------------------
Net income $1,505 369 1,386 1,882 775 - 5,917
----------------------------------------------------------------------------------------
Income property includes commercial real estate and multi-family lending.
20
Liquidity and Sources of Funds
The Bank monitors its liquidity position to assure that it will have
adequate resources to meet its customers' needs. Potential uses of funds are
new loans; the disbursement of construction loans in process; draws on unused
business lines of credit and unused consumer lines of credit; and deposit
withdrawals. As of September 30, 2003, Cascade had $31.2 million of
construction loans in process, $36.8 million in unused business lines of credit
and $26.5 million in unused consumer lines of credit. While most of the loans
in process will be funded as the construction projects move toward completion,
only a modest portion of the business and consumer lines will require funding.
Historically, the Bank's business customers use approximately 40% of their
lines, and about 50% of the home equity lines of credit are not drawn upon at
any point in time.
Funding needs are met through the sale of loans, existing liquidity
balances, repayment of existing loans, deposit growth, FHLB-Seattle advances,
and other borrowings. Cascade maintains balances in FHLB deposits, which
equaled $9.8 million as of September 30, 2003 and $11.0 million at December 31,
2002. Liquidity is also provided by the Bank's unencumbered securities
portfolio. Securities that could be pledged to secure additional funding were
$133.5 million at the end of the quarter and $105.9 million as of December 31,
2002.
Subject to the availability of eligible collateral, the Bank's credit line
with the FHLB-Seattle is 35% of total assets or up to approximately $299.0
million at current asset levels. At September 30, 2003, the Bank had $192.0
million in outstanding advances and an unused line of credit from the FHLB-
Seattle of approximately $107.0 million. The Bank also uses reverse repurchase
agreements to provide a flexible source of funding. At September 30, 2003 the
Bank had $40.6 million in reverse repurchase agreements outstanding. The Bank
also has a $10 million Fed funds line with a correspondent bank, which was not
used during the quarter.
Capital Resources
The Corporation's primary source of capital is the retention of its net
income. On September 23, 2003, the Board of Directors voted to declare the
Corporation's fifth cash dividend. The dividend was $0.07 per share and paid
on October 22nd to shareholders of record on October 8th. The $461,000 dividend
payout represented 19% of quarterly earnings.
The Corporation also receives capital through the exercise of options
granted to employees and directors. The Corporation permits employees and
directors to tender shares of Cascade's stock which they have held for a
minimum of six months to exercise options.
At its May 2003 meeting, the Board of Directors authorized a stock
repurchase program of up to 5% of the Corporation's stock. As of September 30,
2003, no stock had been repurchased under this program. The repurchase program
does not obligate the Corporation to acquire any specific number of shares.
On March 1, 2000 Cascade Capital Trust I issued ten million par value
Trust Preferred Securities. Cascade Capital Trust I is a statutory business
trust created for the exclusive purposes of issuing and selling capital
securities and utilizing sale proceeds to acquire junior subordinated debt
21
issued by Cascade Financial Corporation. Accordingly, the junior subordinated
debentures are the sole assets of the Trust, and payments under the junior
subordinated debentures will be the sole revenues of the Trust. All of the
common securities of the Trust are owned by the Corporation. The Corporation
has adopted the provisions of FASB Statement No. 150 and as a result,
reclassified its Trust Preferred Securities from mezzanine capital to
liabilities.
Capital Requirements
Cascade Bank is in full compliance with all capital requirements
established by the FDIC and the Washington State Department of Financial
Institutions. The Bank's regulatory capital requirements are expressed as a
percentage of assets. As of September 30, 2003, for the purposes of this
calculation, the Bank's total assets and total risk based assets were $864.8
million and $626.9 million respectively. The related excess capital amounts as
of September 30, 2003 are presented in the following table ($ amounts in
000's):
September 30, 2003 December 31, 2002
Core capital Amount Percentage Amount Percentage
- ------------ --------------------- ---------------------
Tier 1 (Core) capital $70,277 8.13% $64,536 8.07%
Less: Minimum requirement 34,591 4.00 32,007 4.00
------ ----- ------ -----
Excess $35,686 4.13% $32,529 4.07%
====== ===== ====== =====
Risk-based capital Amount Percentage Amount Percentage
- ------------------ --------------------- --------------------
Risk-based capital $77,919 12.43% $71,336 13.11%
Less: Minimum requirement (1) 50,149 8.00 43,516 8.00
------ ----- ------ -----
Excess $27,770 4.43% $27,820 5.11%
====== ===== ====== =====
(1) Based on risk-weighted assets.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") was signed into law on December 19, 1991. Among other things, the
FDICIA provides the FDIC, effective December 19, 1992, with broad powers to
take "prompt corrective action" to resolve problems of insured depository
institutions. The actions the FDIC can take depend upon whether the
institution in question is "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Under FDIC guidelines, Cascade Bank is a "well capitalized"
institution as of September 30, 2003, which requires a core capital to assets
of at least 6% and a risk based capital to assets of at least 10%.
The Corporation, as a bank holding company regulated by the Federal
Reserve, is also subject to capital requirements that are similar to those for
Cascade Bank. The Corporation is well capitalized under Federal Reserve
guidelines with a Tier 1 ratio of 8.33% and a Risk Based ratio of 12.69%.
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
ASSET/LIABILITY MANAGEMENT
-------------------------------------------------------------------
The Bank, like other financial institutions, is subject to fluctuations in
interest rates because its interest-bearing liabilities re-price on different
terms than its interest-earning assets.
The Bank has sought to manage its interest rate exposure through the
structure of its balance sheet. To limit its interest rate risk, the Bank has
22
migrated its loan mix toward prime based business and construction loans. The
Bank sells virtually all new 15 and 30 year fixed rate residential loans with
servicing released to its correspondent mortgage banks on a best efforts basis.
The Bank's fixed rate portfolio loans secured by real estate consist primarily
of mortgages with initial fixed rate periods of three or five years that after
the initial period convert to one year adjustable rate loans.
The growth in the Bank's investment portfolio has been generally limited
to collateralized mortgage obligations (CMOs) with expected average lives under
five years and callable Agency securities. The callable Agency securities have
intermediate maturities with durations less than five years but final
maturities of up to 15 years in some cases. Given the steepness of the yield
curve, these securities offer very attractive yields compared to securities
with shorter final maturities. Since many of these securities are classified
as "available-for-sale", in an increasing interest rate environment, these
securities could produce mark to market losses that would be reflected in the
Corporation's comprehensive income. If however, interest rates decline, these
securities could be called by the issuer. During the quarter ended September
30, 2003, $37.5 million of these securities were called.
The Bank extends the maturity of its liabilities by offering long-term
deposit products to customers, and by obtaining longer term FHLB-Seattle
advances. As of September 30, 2003, $185 million of the $192.0 million of
advances had original maturities greater than one year and the remaining $7
million had original maturities of less than one month. All but $37 million of
the advances have remaining maturities greater than one year. Of the total
amount, $140 million of these advances have provisions that allow the FHLB to
convert the advance to a LIBOR based, adjustable rate borrowing. The FHLB would
exercise this option if interest rates rise. In a +200 basis point rate shock
scenario, only a total of $20 million would be converted. In October 2003, the
Bank entered into an interest rate swap agreement to convert the $10 million in
Trust Preferred Securities from a fixed 11% rate to a LIBOR based liability, at
6 month LIBOR + 520 basis points. The swap will be accounted for as a cash
flow hedge against the Trust Preferred Securities under FAS 133, Accounting
for Derivative Instruments and Hedging Activities.
Cascade uses a simulation model to measure its interest rate risk, which
is defined as the impact on net interest income resulting from changes in
market interest rates. Cascade uses mark to market reports to measure the
impact of changes in rates on the fair value of its balance sheet in rate shock
scenarios. Cascade's Board of Directors has established policies that limit the
reduction in the Bank's net interest income, the fair value of equity and
adjusted capital/asset ratios under certain interest rate shock scenarios.
Using standard rate shock methodology, as of September 30, 2003 the Bank's
net interest income increases 0.11% in the up 200 basis points scenario and
decreases 5.15% in the down 200 basis point scenario, both within the Board
established limit of a 10% decline. The Bank's fair value of equity decreases
10.10% in the up 200 basis points shock and increases 10.5% in the down 200
basis point scenario. The established limit is a 30% decline. The minimum
adjusted capital to asset limit is 5% in either scenario. In the up 200 basis
point scenario, the capital/asset ratio is 7.17%. In the down 200 basis point
shock, the capital ratio is 8.41%.
23
These assumptions are inherently uncertain and, as a result, the model
cannot precisely predict the impact of higher or lower interest rates. Actual
results will differ from simulated results.
24
Item 4 - Controls and Procedures
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
------------------------------------------------
An evaluation of the Registrant's disclosure controls and procedures (as
defined in section 13(a) - 14(c) of the Securities Exchange Act of 1934 (the
"Exchange Act")) was carried out under the supervision and with the
participation of the Registrant's Chief Executive Officer, Chief Financial
Officer and several other members of the Registrant's senior management as of
the last day of the quarter. The Registrant's Chief Executive Officer and Chief
Financial Officer concluded that the Registrant's disclosure controls and
procedures as currently in effect are effective in ensuring that the
information required to be disclosed by the Registrant in the reports it files
or submits under the Exchange Act is (i) accumulated and communicated to the
Registrant's management (including the Chief Executive Officer and Chief
Financial Officer) in a timely manner, and (ii) recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms.
CHANGES IN INTERNAL CONTROLS
----------------------------
In the quarter ended September 30, 2003, the Registrant did not make any
significant changes in, nor take any corrective actions regarding, its internal
controls or other factors that could significantly affect these controls.
DISCLOSURE CONTROLS AND INTERNAL CONTROLS
-----------------------------------------
Disclosure controls are procedures that are designed with the objective of
ensuring that information required to be disclosed in Cascade Financial
Corporation's reports filed under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's (SEC) rules and forms. Disclosure controls are also
designed with the objective of ensuring that such information is accumulated
and communicated to management, as appropriate to allow timely decisions
regarding required disclosure. Internal Controls are procedures which are
designed with the objective of providing reasonable assurance that (1)
transactions are properly authorized; (2) assets are safeguarded against
unauthorized or improper use; and (3) transactions are properly recorded and
reported, all to permit the preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
--------------------------------------------
Cascade Financial Corporation's management does not expect that our
disclosure controls or our internal controls will prevent all error and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Further, the design of the control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within Cascade Financial
Corporation have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or
more people, or by management override of the control. The design of any system
25
of controls also is based in part upon certain assumptions about the likelihood
of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
controls may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected.
26
PART II-OTHER INFORMATION
-------------------------
Item 1. Legal Proceedings.
- ---------------------------
The Corporation and the Bank is involved in litigation and negotiations in
progress resulting from activities arising from normal operations. In the
opinion of management, none of these matters is likely to have a materially
adverse effect on the Corporation's financial position.
Item 2. Changes in Securities.
- -------------------------------
Not applicable
Item 3. Defaults upon Senior Securities.
- -----------------------------------------
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders.
- -------------------------------------------------------------
Not applicable
Item 5. Other information.
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Not applicable
Item 6. Exhibits and Reports on Form 8-K.
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(a) Exhibits
3.1 Certificate of Incorporation of Cascade Financial Corporation(1)
3.2 Bylaws of Cascade Financial Corporation(1)
10.1 Cascade Financial Corporation 1994 Employee Stock Purchase Plan(1)
10.2 Cascade Financial Corporation 1992 Stock Option and Incentive Plan(2)
10.3 Cascade Financial Corporation Employee Stock Ownership Plan(2)
10.4 Cascade Financial Corporation 1997 Stock Option Plan(3)
10.5 Employment Agreement Extension with Carol K. Nelson dated July 23,
2003
31.1 Certifications of the Chief Executive officer pursuant to Section 302
of the Sarbanes-Oxley Act
31.2 Certifications of the Chief Executive officer pursuant to Section 302
of the Sarbanes-Oxley Act
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act
(b) Reports on Form 8-K
On July 22, 2003, the Corporation released earnings information for the
second quarter ended June 30, 2003, under Item 9 of Form 8-K.
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(1) Incorporated by reference to the Corporation's Registration Statement on
Form S-4 (File No. 33-83200).
(2) Incorporated by reference to the Corporation's Form 10-KSB for December
31, 1995.
(3) Incorporated by reference to Appendix E to the Prospectus included in the
Corporation's Registration Statement on Form S-4 (File no. 333-24203).
27
Signatures
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CASCADE FINANCIAL CORPORATION
November 12, 2003 /s/ Lars H. Johnson
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By: Lars H. Johnson,
Executive Vice President
(Chief Financial Officer)
28