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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM to :
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Commission File Number 0-26584
BANNER CORPORATION
(Exact name of registrant as specified in its charter)
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Washington 91-1691604
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification Number)
10 South First Avenue, Walla Walla, Washington 99362
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code; (509) 527-3636
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to section 12(g) of the Act:
Common Stock $.01 par value per share
(Title of class)
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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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. X
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES X NO
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The aggregate market value of the voting stock held by nonaffiliates of the
registrant based on the closing sales price of the registrant's
common stock quoted on the Nasdaq Stock Market
on June 28, 2002, was:
Common Stock - $288,880,441
The number of shares outstanding of the registrant's classes
of common stock as of February 28, 2003:
Common Stock, $.01 par value - 11,338,510 shares
Documents Incorporated by Reference
Portions of Proxy Statement for Annual Meeting of Shareholders to be held
April 24, 2003 are incorporated by reference into Part III.
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BANNER CORPORATION AND SUBSIDIARIES
Table of Contents
PART I Page #
Item 1. Business....................................................... 3
General...................................................... 3
Lending Activities........................................... 3
Asset Quality................................................ 7
Investment Activities........................................ 7
Deposit Activities and Other Sources of Funds................ 8
Personnel.................................................... 9
Taxation..................................................... 9
Environmental Regulation..................................... 10
Competition.................................................. 10
Regulation................................................... 11
Management Personnel......................................... 16
Available Information........................................ 17
Item 2. Properties..................................................... 17
Item 3. Legal Proceedings.............................................. 17
Item 4. Submission of Matters to a Vote of Security Holders............ 17
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.......................................... 18
Item 6. Selected Financial Data........................................ 19
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 21
Comparison of Results of Operations
Years ended December 31, 2002 vs. 2001................... 35
Years ended December 31, 2001 vs. 2000................... 39
Market Risk and Asset/Liability Management................. 45
Liquidity and Capital Resources.......................... 50
Capital Requirements..................................... 51
Effect of Inflation and Changing Prices.................. 51
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..... 51
Item 8. Financial Statements and Supplementary Data.................... 51
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..................................... 51
PART III
Item 10. Directors and Executive Officers of the Registrant............ 52
Item 11. Executive Compensation........................................ 52
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................. 52
Item 13. Certain Relationships and Related Transactions................ 52
Item 14. Controls and Procedures....................................... 53
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K................................................. 53
Signatures.................................................... 54
Certifications................................................ 55
PART 1
Item 1 - Business General
Banner Corporation (the Company or BANR), a Washington corporation, is
primarily engaged in the business of planning, directing and coordinating the
business activities of its wholly owned subsidiary, Banner Bank (BB or the
Bank). Prior to a consolidation of banking subsidiaries and a corresponding
name change which occurred on October 30, 2000, the Company's subsidiaries
included First Savings Bank of Washington (FSBW), Inland Empire Bank (IEB) and
Towne Bank. From October 30, 2000 until September 1, 2001, the Company's
subsidiaries were Banner Bank and Banner Bank of Oregon (BBO) (formerly IEB).
On September 1, 2001, BBO merged with BB. On January 1, 2002, the Company
completed the acquisition of Oregon Business Bank (OBB), which was also merged
with BB on that date. Banner Bank operates as a Washington-chartered
commercial bank the deposits of which are insured by the Federal Deposit
Insurance Corporation (FDIC) under both the Bank Insurance Fund (BIF) and the
Savings Association Insurance Fund (SAIF). The Bank conducts business from
its main office in Walla Walla, Washington, and, as of January 1, 2003, its 41
branch offices and seven loan production offices located in 19 counties in
Washington, Idaho and Oregon. The Company had total assets of $2.263 billion
at December 31, 2002.
The operating results of the Company depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets, consisting of loans and investment securities, and interest expense on
interest-bearing liabilities, composed primarily of savings deposits and
Federal Home Loan Bank (FHLB) advances. BANR's net income is significantly
affected by provisions for loan losses and the level of its other income,
including deposit service charges, loan origination and servicing fees, and
gains and losses on the sale of loans and securities, as well as its
non-interest operating expenses and income tax provisions. Net income for the
year ended December 31, 2002 was $9.3 million, or $0.82 per share. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for more detailed information about the Company's financial
performance.
Banner Bank is a regional bank which offers a wide variety of commercial
banking services and financial products to both businesses and individuals in
its primary market areas. The Bank's primary business is that of a
traditional banking institution, accepting deposits and originating loans in
locations surrounding its offices in portions of Washington, Oregon and Idaho.
The Bank is also an active participant in the secondary market, engaging in
mortgage banking operation largely through the origination and sale of
residential loans. Lending activities include commercial business and
commercial real estate loans, construction and land development loans, one- to
four-family residential loans and consumer loans. A portion of the Bank's
construction and mortgage lending activities are conducted through its
subsidiary, Community Financial Corporation (CFC), which is located in the
Lake Oswego area of Portland, Oregon. In addition to loans, the Bank
maintains a significant portion of its assets in marketable securities. The
securities portfolio is weighted toward mortgage-backed securities secured by
one- to four-family residential properties. This portfolio also includes a
significant amount of U.S. Government and agency (including
government-sponsored entities) securities, as well as tax-exempt municipal
securities primarily issued by entities located in the State of Washington.
The Company and the Bank are subject to regulation by the Federal Reserve
Board (FRB), the FDIC, and the State of Washington Department of Financial
Institutions, Division of Banks (Division).
Lending Activities
General: All of the Company's lending activities are conducted through the
Bank and its subsidiaries. The Bank offers a wide range of loan products to
meet the demands of its customers. The Bank originates loans for its own loan
portfolio and for sale in the secondary market. Management's strategy has been
to maintain a significant percentage of assets in the loan portfolio with more
frequent interest rate repricing terms or shorter maturities than traditional
long-term fixed-rate mortgage loans. As part of this effort, the Bank has
developed a variety of floating or adjustable interest rate products that
correlate more closely with the Bank's cost of funds. However, in response to
customer demand, the Bank continues to originate fixed-rate loans, including
fixed interest rate mortgage loans with terms of up to 30 years. The relative
amount of fixed-rate loans and adjustable-rate loans that can be originated at
any time is largely determined by the demand for each in a competitive
environment.
Lending activities historically have been primarily directed toward the
origination of real estate and commercial loans. Real estate lending
activities have been significantly focused on residential construction and
first mortgages on owner occupied, one- to four-family residential properties.
To an increasing extent in recent years lending activities have also included
the origination of multifamily and commercial real estate loans. Commercial
lending has been directed toward meeting the credit and related deposit needs
of various small- to medium-sized business and agri-business borrowers
operating in the Bank's primary market areas. During the past year the Bank
has significantly added to its resources engaged in commercial lending,
including senior credit administration personnel and experienced officers
focused on middle market corporate lending opportunities. The Bank has also
recently increased its emphasis on consumer lending. While continuing its
commitment to construction and residential lending, management expects
commercial, including commercial real estate, and consumer lending to become
increasingly important activities for the Bank.
At December 31, 2002, the Bank's net loan portfolio totaled $1.547 billion.
For additional information concerning the Bank's loan portfolio, see Item 7,
"Management's Discussion and Analysis of Financial Condition-Comparison of
Financial Condition at December 31, 2002 and 2001-Loans/Lending." See also
Table 5 contained therein, which sets forth the composition of the Company's
loan portfolio, and Tables 6 and 6(a), which contain information regarding the
loans maturing in the Company's portfolio.
One- to Four-Family Residential Real Estate Lending: The Bank originates
loans secured by first mortgages on one- to four-family residences and loans
for the construction of one- to four-family residences in the communities
where it has full service branches. In addition, the Bank operates loan
production offices in Bellevue, Puyallup, Kennewick and Oak Harbor,
Washington. The Bank's mortgage lending subsidiary, CFC, provides
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residential and construction lending in the Portland, Oregon area. At
December 31, 2002, $355.5 million, or 22.6% of the Company's loan portfolio,
consisted of permanent loans on one- to four-family residences.
The Bank and CFC offer fixed- and adjustable-rate mortgages (ARMs) at rates
and terms competitive with market conditions. Most ARM products offered
adjust annually after an initial period ranging from one to five years,
subject to a limitation on the annual increase of 1.0% to 2.0% and an overall
limitation of 5.0% to 6.0%. Generally, these ARM products utilize the weekly
average yield on U.S. Treasury securities adjusted to a constant maturity of
one year plus a margin of 2.75% to 3.25%. ARM loans held in the Bank's
portfolio do not permit negative amortization of principal and carry no
prepayment restrictions. The retention of ARM loans in the Bank's loan
portfolio can help reduce the Company's exposure to changes in interest rates.
However, borrower demand for ARM loans versus fixed-rate mortgage loans is a
function of the level of interest rates, the expectations of changes in the
level of interest rates and the difference between the initial interest rates
and fees charged for each type of loan. In recent years, borrower demand for
ARM loans has been limited and the Bank has chosen not to aggressively pursue
ARM loans by offering minimally profitable deeply discounted teaser rates. As
a result, ARM loans have represented only a small portion of loans originated
during this period.
The Bank's residential loans are generally underwritten and documented in
accordance with the guidelines established by the Federal Home Loan Mortgage
Corporation (Freddie Mac or FHLMC) and Federal National Mortgage Corporation
(Fannie Mae or FNMA). Government insured loans are generally underwritten and
documented in accordance with the guidelines established by the Department of
Housing and Urban Development (HUD) and the Veterans Administration (VA). In
the loan approval process, the Bank assesses the borrower's ability to repay
the loan, the adequacy of the proposed security, the employment stability of
the borrower and the credit worthiness of the borrower. Generally, the Bank
lends up to 95% of the lesser of the appraised value of the property or
purchase price of the property on conventional loans, although higher
loan-to-value ratios are available on certain government insured programs.
The Bank usually requires private mortgage insurance on residential loans with
a loan-to-value ratio at origination exceeding 80%.
The Bank and CFC sell residential loans on either a servicing-retained or
servicing-released basis. The decision to hold or sell loans is based on
asset/liability management goals and policies and market conditions. During
the past three years, the Bank has sold a significant portion of its
conventional residential mortgage originations and nearly all of its
government insured loans into the secondary market.
Construction and Land Lending: The Bank invests a significant portion of its
loan portfolio in residential construction loans to professional home
builders. To a lesser extent, the Bank also originates land loans and
construction loans for commercial and multifamily real estate. At December
31, 2002, construction and land loans totaled $339.5 million (including $54.9
million of land or land development loans and $41.5 million of commercial and
multifamily real estate construction loans), or 21.6% of total loans of the
Company. Residential construction lending is a primary focus of the Bank's
subsidiary, CFC, and the Company's largest concentration of construction and
development loans is in the Portland/Vancouver market area. The Bank also has
a significant amount of construction loans for properties in the Puget Sound
region and in the Tri-Cities market in Washington State.
Construction and land lending afford the Bank the opportunity to achieve
higher interest rates and fees with shorter terms to maturity than does
single-family permanent mortgage lending. Construction and land lending,
however, are generally considered to involve a higher degree of risk than
single-family permanent mortgage lending because of the inherent difficulty in
estimating both a property's value at completion of the project and the
estimated cost of the project. If the estimate of construction cost proves to
be inaccurate, the Bank may be required to advance funds beyond the amount
originally committed to permit completion of the project. If the estimate of
value upon completion proves to be inaccurate, the Bank may be confronted at,
or prior to, the maturity of the loan with a project the value of which is
insufficient to assure full repayment. Disagreements between borrowers and
builders and the failure of builders to pay subcontractors may also jeopardize
projects. Loans to builders to construct homes for which no purchaser has
been identified carry additional risk because the payoff for the loan is
dependent on the builder's ability to sell the property before the
construction loan is due. The Bank addresses these risks by adhering to
strict underwriting policies, disbursement procedures and monitoring
practices.
Construction loans made by the Bank include those with a sale contract or
permanent loan in place for the finished homes and those for which purchasers
for the finished homes may be identified either during or following the
construction period. The Bank monitors the number of unsold homes in its
construction loan portfolio and generally maintains the portfolio so that
approximately 25% of its construction loans are secured by homes with a sale
contract in place. The maximum number of speculative loans approved for each
builder is based on a combination of factors, including the financial capacity
of the builder, the market demand for the finished product and the ratio of
sold to unsold inventory the builder maintains. The Bank has chosen to
diversify the risk associated with speculative construction lending by doing
business with a large number of smaller builders spread over a relatively
large geographic area.
Loans for the construction of one- to four-family residences are generally
made for a term of twelve months. The Bank's loan policies include maximum
loan-to-value ratios of up to 80% for speculative loans. Individual
speculative loan requests are supported by an independent appraisal of the
property, a set of plans, a cost breakdown and a completed specifications
form. All speculative construction loans must be approved by senior loan
officers.
The Bank regularly monitors the construction loan portfolio and the economic
conditions and housing inventory in each of its markets and will decrease
construction lending if it perceives there are unfavorable market conditions.
The Bank believes that the internal monitoring systems it has in place
mitigate many of the risks inherent in its construction lending.
To a lesser extent, the Bank makes land loans to developers, builders and
individuals to finance the acquisition and/or development of improved lots or
unimproved land. In making land loans, the Bank follows underwriting policies
and disbursement and monitoring procedures similar to those for
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construction loans. The initial term on land loans is typically one to three
years with interest only payments, payable monthly, and provisions for
principal reduction as lots are sold and released.
Commercial and Multifamily Real Estate Lending: The Bank also originates
loans secured by multifamily and commercial real estate. At December 31,
2002, the Company's loan portfolio included $72.3 million in multifamily and
$379.1 million in commercial real estate loans. Multifamily and commercial
real estate lending affords the Bank an opportunity to receive interest at
rates higher than those generally available from one- to four-family
residential lending. However, loans secured by such properties are generally
greater in amount, more difficult to evaluate and monitor and, therefore,
riskier than one- to four-family residential mortgage loans. Because payments
on loans secured by multifamily and commercial properties are often dependent
on the successful operation and management of the properties, repayment of
such loans may be affected by adverse conditions in the real estate market or
the economy. In all multifamily and commercial real estate lending, the Bank
considers the location, marketability and overall attractiveness of the
properties. The Bank's current underwriting guidelines for commercial real
estate loans require an appraisal from a qualified independent appraiser and
an economic analysis of each property with regard to the annual revenue and
expenses, debt service coverage and fair value to determine the maximum loan
amount. In the approval process the Bank assesses the borrowers' willingness
and ability to repay the loan and the adequacy of the collateral in relation
to the loan amount.
Multifamily and commercial real estate loans originated by the Bank are both
fixed- and adjustable-rate loans generally with intermediate terms of five to
ten years. More recently originated multifamily and commercial loans are
linked to various U.S. Treasury indices or certain prime rates. Rates on these
adjustable-rate loans generally adjust annually after an initial period
ranging from one to ten years. Rate adjustments for some of the more seasoned
adjustable-rate loans in the portfolio predominantly reflect changes in the
FHLB National Monthly Median Cost of Funds index. The Bank's commercial real
estate portfolio consists of loans on a variety of property types with no
large concentrations by property type or location. At December 31, 2002,
multifamily and commercial real estate loans comprised 28.7% of the Company's
total loans.
Commercial Lending: The Bank is active in small- to medium-sized business
lending, including origination of loans guaranteed by the Small Business
Administration (SBA), and has engaged to a lesser extent in agricultural
lending primarily by providing crop production loans. The Bank sells most of
its SBA guaranteed loans into the secondary market on a servicing-retained
basis. Bank officers have devoted a great deal of effort to developing
customer relationships and the ability to serve these types of borrowers.
Management believes that many large banks have neglected these lending
markets, contributing to the Bank's success. Also during the past year, the
Bank has added experienced officers and staff focused on middle market
corporate lending opportunities for borrowers with credit needs generally in
the $3 million to $15 million range. Management intends to leverage the past
success of these officers with local decision making ability to continue to
expand this market niche. In addition to providing earning assets, it is
anticipated that this type of lending will increase the Bank's deposit base.
Expanding commercial lending and related commercial banking services is
currently an area of significant effort at the Bank and staffing has been
increased in the areas of credit administration, business development, and
loan and deposit operations.
Commercial loans may entail greater risk than residential mortgage loans.
Commercial loans may be unsecured or secured by special purpose or rapidly
depreciating assets, such as equipment, inventory and receivables, which may
not provide an adequate source of repayment on defaulted loans. In addition,
commercial loans are dependent on the borrower's continuing financial strength
and management ability, as well as market conditions for various products,
services and commodities. For these reasons, commercial loans generally
provide higher yields than residential loans but also require more
administrative and management attention. Loan terms, including the fixed or
adjustable interest rate, the loan maturity and the collateral considerations,
vary significantly and are negotiated on an individual loan basis.
The Bank underwrites its commercial business loans on the basis of the
borrower's cash flow and ability to service the debt from earnings rather than
on the basis of the underlying collateral value. The Bank seeks to structure
these loans so that they have more than one source of repayment. The borrower
is required to provide the Bank with sufficient information to allow the Bank
to make its lending determination. In most instances, this information
consists of at least three years of financial statements, tax returns, a
statement of projected cash flows, current financial information on any
guarantor and any additional information about the collateral. Closely held
business borrowers typically require personal guarantees by the principals.
The Bank's commercial business loans may be structured as term loans or as
lines of credit. Commercial business term loans are generally made to finance
the purchase of fixed assets and have maturities of five years or less.
Commercial business lines of credit are typically made for the purpose of
providing working capital and are usually approved with a term of one year.
Adjustable- or floating-rate loans are generally tied to various prime rate
and LIBOR indices. At December 31, 2002, commercial loans totaled $285.2
million, or 18.1% of the Company's total loans.
Agricultural Lending: Agriculture is a major industry in many eastern
Washington and Oregon locations. While agricultural loans are not a large
part of the portfolio, the Bank intends to continue to make agricultural loans
to borrowers with a strong capital base, sufficient management depth, proven
ability to operate through agricultural cycles, reliable cash flows and
adequate financial reporting. Payments on agricultural loans depend, to a
large degree, on the results of operation of the related farm entity. The
repayment is also subject to other economic and weather conditions as well as
market prices for agricultural products, which can be highly volatile at
times. At December 31, 2002, agricultural loans, including collateral secured
loans to purchase farm land and equipment, totaled $102.6 million, or 6.5% of
the loan portfolio.
Agricultural operating loans generally are made as a percentage of the
borrower's anticipated income to support budgeted operating expenses. These
loans generally are secured by a blanket lien on all crops, livestock,
equipment, accounts and products and proceeds thereof. In the case of crops,
consideration is given to projected yields and prices from each commodity.
The interest rate is normally fully floating based on the prime rate as
published in The Wall Street Journal, plus a negotiated margin. Because such
loans are made to finance a farm or ranch's annual operations, they are
written on a one-year review and renewable basis. The renewal is dependent
upon the prior year's performance and the forthcoming year's projections as
well as the overall financial strength of the borrower. The Bank carefully
monitors these loans and related variance reports on income
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and expenses compared to budget estimates. To meet the seasonal operating
needs of a farm, borrowers may qualify for single payment notes, revolving
lines of credit and/or non-revolving lines of credit.
In underwriting agricultural operating loans, the Bank considers the cash flow
of the borrower based upon the expected operating results as well as the value
of collateral used to secure the loans. Collateral generally consists of
cattle or cash crops produced by the farm, such as grains, fruit, grass seed,
peas, sugar beets, mint, onions, potatoes, corn and alfalfa. In addition to
considering cash flow and obtaining a blanket security interest in the farm's
cash crop, the Bank may also collateralize an operating loan with the farm's
operating equipment, breeding stock, real estate, and federal agricultural
program payments to the borrower.
The Bank also originates loans to finance the purchase of farm equipment.
Loans to purchase farm equipment are made for terms of up to seven years. The
Bank also originates agricultural real estate loans secured primarily by first
liens on farmland and improvements thereon located in the Bank's market area,
and generally only made to service the needs of the Bank's existing customers.
Loans are written in amounts up to 50% to 75% of the tax assessed or appraised
value of the property at terms ranging from five to 20 years. Such loans have
interest rates that generally adjust at least every five years based typically
upon a Treasury Index plus a negotiated margin. Fixed-rate loans are granted
on terms generally not to exceed five years with rates established at
inception based on margins set above the current five-year Treasury Note or
another generally accepted index. In originating agricultural real estate
loans, the Bank considers the debt service coverage of the borrower's cash
flow, the appraised value of the underlying property, the experience and
knowledge of the borrower, and the borrower's past performance with the Bank
and/or market area. Such loans normally are not made to start-up businesses
but are generally reserved for existing customers with substantial equity and
a proven history.
Among the more common risks to agricultural lending can be weather conditions
and disease. These risks can be mitigated through multi-peril crop insurance.
Commodity prices also present a risk, which may be reduced by the use of set
price contracts. Normally, required beginning and projected operating margins
provide for reasonable reserves to offset unexpected yield and price
deficiencies. In addition to these risks, the Bank also considers management
succession, life insurance and business continuation plans when evaluating
agricultural loans.
Consumer and Other Lending: The Bank originates a variety of consumer loans,
including home equity lines of credit, automobile loans and loans secured by
deposit accounts. While consumer lending has traditionally been a small part
of the Bank's business with loans made primarily to accommodate its existing
customer base, it has received renewed emphasis in 2002 and management
anticipates increased activity in future periods. At December 31, 2002, the
Company had $39.2 million, or 2.5% of its loans receivable, in outstanding
consumer related loans.
Similar to commercial loans, consumer loans often entail greater risk than do
residential mortgage loans, particularly in the case of consumer loans which
are unsecured or secured by rapidly depreciating assets such as automobiles.
In such cases, any repossessed collateral for a defaulted consumer loan may
not provide an adequate source of repayment of the outstanding loan balance as
a result of the greater likelihood of damage, loss or depreciation. The
remaining deficiency often does not warrant further substantial collection
efforts against the borrower beyond obtaining a deficiency judgment. In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy. Furthermore, the application
of various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans.
Such loans may also give rise to claims and defenses by a consumer loan
borrower against an assignee of such loans such as the Bank, and a borrower
may be able to assert against such assignee claims and defenses that it has
against the seller of the underlying collateral.
Loan Solicitation and Processing: The Bank originates real estate loans by
direct solicitation of real estate brokers, builders, depositors and walk-in
customers. Loan applications are taken by the Bank's loan officers and are
processed in each branch location. Most underwriting and loan administration
functions are performed by loan personnel at central locations.
Loan officers solicit commercial and agricultural loans through call programs
focused on local businesses and farmers. While commercial loan officers are
delegated reasonable commitment authority based upon their qualifications,
credit decisions on significant commercial and agricultural loans are made by
senior loan officers or in certain instances by the Board of Directors of the
Bank or the Company.
Consumer loans are originated through various marketing efforts directed
primarily toward existing deposit and loan customers of the Bank. Consumer
loan applications may be processed at branch locations or by administrative
personnel at the Bank's main office.
Loan Originations, Sales and Purchases
While the Bank originates a variety of loans, its ability to originate each
type of loan is dependent upon the relative customer demand and competition in
each market it serves. For the years ended December 31, 2002, 2001 and 2000,
the Bank originated loans, net of repayments, of $368.6 million, $346.3
million and $292.2 million, respectively.
In recent years, the Bank generally has sold most of its newly originated
fixed-rate one- to four-family residential mortgage loans and a portion of its
Small Business Administration (SBA) guaranteed loans to secondary market
purchasers as part of its interest rate risk management strategy. Proceeds
from sales of loans by the Company for the years ended December 31, 2002, 2001
and 2000, totaled $457.7 million, $270.3 million and $135.7 million,
respectively. Sales of loans generally are beneficial to the Bank because
these sales may generate income at the time of sale, provide funds for
additional lending and other investments and increase liquidity. The Company
sells loans on both a servicing-retained and a servicing-released basis. All
loans are sold without recourse. See "Loan Servicing." At December 31, 2002,
the Company had $39.4 million in loans held for sale.
6
The Bank purchases whole loans and loan participation interests primarily
during periods of reduced loan demand in its primary market area. Any such
purchases are made consistent with the Bank's underwriting standards; however,
the loans may be located outside of the Bank's normal lending area. During the
years ended December 31, 2002, 2001 and 2000, the Bank purchased $52.0
million, $4.9 million and $12.0 million, respectively, of loans and loan
participation interests.
Loan Servicing
The Bank receives fees from a variety of institutional owners in return for
performing the traditional services of collecting individual payments and
managing portfolios of sold loans. At December 31, 2002, the Bank was
servicing $252.9 million of loans for others. Loan servicing includes
processing payments, accounting for loan funds and collecting and paying real
estate taxes, hazard insurance and other loan-related items such as private
mortgage insurance. In addition to earning fee income, the Bank retains
certain amounts in escrow for the benefit of the lender for which the Bank
incurs no interest expense but is able to invest the funds into earning
assets. At December 31, 2002, the Bank held $6.6 million in escrow for its
portfolio of loans serviced for others. The loan servicing portfolio at
December 31, 2002 was composed primarily of $174.2 million of FHLMC mortgage
loans, $13.7 million of FNMA mortgage loans, and $20.8 million of Oregon
Housing Division loans. The remaining balance of the loan servicing portfolio
at December 31, 2002 consisted of loans serviced for a variety of private
investors. At December 31, 2002, the portfolio included loans secured by
property located primarily in the states of Washington and Oregon. For the
year ended December 31, 2002, $1.5 million of loan servicing fees, net of
$686,000 of servicing rights amortization, was recognized in operations.
Mortgage Servicing Rights: The Bank records mortgage servicing rights (MSRs)
with respect to loans it originates and sells in the secondary market on a
servicing-retained basis. In addition to the MSRs on the loans that it
originates and sells, the Bank has also purchased mortgage servicing rights,
although not in recent years. The cost of MSRs is capitalized and amortized
in proportion to, and over the period of, the estimated future net servicing
income. For the years ended December 31, 2002, 2001 and 2000, the Company
capitalized $1,046,000, $107,000 and $395,000, respectively, of MSRs relating
to loans sold with servicing retained. No MSRs were purchased in those
periods. Amortization of MSRs for the years ended December 31, 2002, 2001 and
2000, was $686,000, $574,000 and $251,000, respectively. Management
periodically evaluates the estimates and assumptions used to determine the
carrying values of MSRs and the amortization of MSRs. These carrying values
are adjusted when the valuation indicates the carrying value is impaired.
MSRs generally are adversely affected by current and anticipated prepayments
resulting from decreasing interest rates. At December 31, 2002, MSRs were
carried at a value, net of amortization, of $1,621,000.
Asset Quality
Classified Assets: State and federal regulations require that the Bank review
and classify its problem assets on a regular basis. In addition, in
connection with examinations of insured institutions, state and federal
examiners have authority to identify problem assets and, if appropriate,
require them to be classified. The Bank's Credit Policy Division reviews
detailed information with respect to the composition and performance of the
loan portfolio, including information on risk concentrations, delinquencies
and classified assets. The Credit Policy Division approves all
recommendations for new classified assets or changes in classifications, and
develops and monitors action plans to resolve the problems associated with the
assets. The Credit Policy Division also approves recommendations for
establishing the appropriate level of the allowance for loan losses.
Significant problem loans are transferred to the Bank's Special Assets
Department for resolution or collection activities. The Board of Directors is
given a detailed report on classified assets and asset quality at least
quarterly.
For additional information with respect to asset quality and non-performing
loans, see Item 7, "Management's Discussion and Analysis of Financial
Condition-Comparison of Financial Condition at December 31, 2002 and
2001-Asset Quality," and Table 10 contained therein.
Allowance for Loan Losses: In originating loans, the Bank recognizes that
losses will be experienced and that the risk of loss will vary with, among
other things, the type of loan being made, the credit worthiness of the
borrower over the term of the loan, general economic conditions and, in the
case of a secured loan, the quality of the security for the loan. As a
result, the Bank maintains an allowance for loan losses consistent with the
generally acceptable accounting principles (GAAP) guidelines. The Company
increases its allowance for loan losses by charging provisions for possible
loan losses against the Company's income. The allowance for losses on loans
is maintained at a level which, in management's judgment, is sufficient to
provide for estimated losses based on evaluating known and inherent risks in
the loan portfolio and upon continuing analysis of the factors underlying the
quality of the loan portfolio.
At December 31, 2002, the Company had an allowance for loan losses of $26.5
million, which represented 1.69% of net loans and 74% of non-performing loans
compared to 1.10% and 97%, respectively, at December 31, 2001. For additional
information concerning the Company's allowance for loan losses, see Item 7,
"Management's Discussion and Analysis of Financial Condition-Comparison of
Results of Operations for the Years ended December 31, 2002 and 2001-Provision
and Allowance for Loan Losses," and Tables 11 and 12 contained therein.
Investment Activities
Under Washington state law, banks are permitted to invest in various types of
marketable securities. Authorized securities include but are not limited to
U.S. Treasury obligations, securities of various federal agencies,
mortgage-backed securities, certain certificates of deposit of insured banks
and savings institutions, banker's acceptances, repurchase agreements, federal
funds, commercial paper, corporate debt and equity securities and obligations
of states and their political subdivisions. The investment policies of the
Bank are designed to provide and maintain adequate liquidity and to generate
favorable rates of return without incurring undue interest rate or credit
risk. The Bank's policies generally limit
7
investments to U.S. Government and government agency (including
government-sponsored entities) securities, municipal bonds, certificates of
deposit, marketable corporate debt obligations and mortgage-backed securities.
Investment in mortgage-backed securities includes those issued or guaranteed
by FHLMC, FNMA, Government National Mortgage Association (GNMA) and
privately-issued mortgage-backed securities that have an AA credit rating or
higher, as well as collateralized mortgage obligations (CMOs). A high credit
rating indicates only that the rating agency believes there is a low risk of
loss or default. However, all of the Bank's investment securities, including
those that have high credit ratings, are subject to market risk in so far as a
change in market rates of interest or other conditions may cause a change in
an investment's earning performance and/or market value.
At December 31, 2002, the Company's consolidated investment portfolio totaled
$434.5 million and consisted principally of U.S. Government and agency
obligations, mortgage-backed securities, municipal bonds, corporate debt
obligations, and stock of FNMA and FHLMC. From time to time, investment
levels may be increased or decreased depending upon yields available on
investment alternatives, and management's projections as to the demand for
funds to be used in the Bank's loan originations, deposits and other
activities. During the year ended December 31, 2002, investments and
securities increased by $117.8 million. Holdings of mortgage-backed securities
increased $62.0 million to $269.2 million, and U.S. Treasury and agency
obligations increased $40.6 million to $91.9 million. Ownership of corporate
and other securities increased $17.5 million to $45.8 million. Municipal
bonds decreased $2.3 million to $27.6 million.
The Company invests significantly in mortgage-backed securities. The
Company's mortgage-backed securities generally are collateralized by loans on
one- to four-family residential real estate. The average life of a
mortgage-backed security is usually less than its stated maturity due to
principal amortization and prepayments of the underlying mortgages.
Prepayments that are faster than anticipated may shorten the life of the
security and may result in rapid amortization of premiums or discounts and
thereby affect the net yield on such securities. Although prepayments of
underlying mortgages depend on many factors, including the type of mortgages,
the coupon rate, the age of mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates, the difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates generally is
the most significant determinant of the rate of prepayments. During periods
of declining mortgage interest rates, if the coupon rate of the underlying
mortgage loans exceeds the prevailing market interest rates offered for
mortgage loans, refinancing generally increases and accelerates the prepayment
of the underlying mortgage loans and the related security. Under such
circumstances, the Company may be subject to reinvestment risk because, to the
extent that the Company's mortgage-backed securities amortize or prepay faster
than anticipated, the Company may not be able to reinvest the proceeds of such
repayments and prepayments at a comparable rate. In contrast to
mortgage-backed securities in which cash flow is received (and hence,
prepayment risk is shared) pro rata by all securities holders, the cash flow
from the mortgage loans or mortgage-backed securities underlying CMOs is
segmented and paid in accordance with a predetermined priority to investors
holding various tranches of such securities or obligations. A particular
tranche of a CMO may therefore carry prepayment risk that differs from that of
both the underlying collateral and other tranches. At December 31, 2002, the
Company held CMOs with a net carrying value of $173.0 million, including $70.0
million of privately issued CMOs.
For detailed information on the Company's investment securities, see Item 7,
"Management's Discussion and Analysis of Financial Condition-Comparison of
Financial Condition at December 31, 2002 and 2001-Investments," and Tables 1,
2, 3, and 4 contained therein.
Off-Balance-Sheet Derivatives: Derivatives include "off-balance-sheet"
financial products whose value is dependent on the value of an underlying
financial asset, such as a stock, bond, foreign currency, or a reference rate
or index. Such derivatives include "forwards," "futures," "options" or
"swaps." The Company and the Bank generally have not invested in
"off-balance-sheet" derivative instruments, although investment policies
authorize such investments. However, as a part of mortgage banking
activities, the Bank issues "rate lock" commitments to borrowers and obtains
offsetting "best efforts" delivery commitments from purchasers of loans.
While not providing any trading or net settlement mechanisms, these
off-balance-sheet commitments do have many of the prescribed characteristics
of derivatives and as a result are accounted for as such in accordance with
Statement of Financial Accounting Standards (SFAS) Nos. 133 and 138.
Accordingly, on December 31, 2002, the Company recorded an asset of $70,000
and a liability of $70,000, representing the estimated market value of those
commitments. On December 31, 2002, the Company and the Bank had no other
investment related off-balance-sheet derivatives.
Deposit Activities and Other Sources of Funds
General: Deposits, FHLB advances (or borrowings) and loan repayments are the
major sources of the Bank's funds for lending and other investment purposes.
Scheduled loan repayments are a relatively stable source of funds, while
deposit inflows and outflows and loan prepayments are influenced by general
economic, interest rate and money market conditions and may vary
significantly. Borrowings may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources. They may also be
used on a longer-term basis for general business purposes.
The Bank competes with other financial institutions and financial
intermediaries in attracting deposits. There is strong competition for
transaction balances and savings deposits from commercial banks, credit unions
and nonbank corporations, such as securities brokerage companies, mutual funds
and other diversified companies, some of which have nationwide networks of
offices.
Deposit Accounts: Deposits generally are attracted from within the Bank's
primary market areas through the offering of a broad selection of deposit
instruments, including demand checking accounts, NOW accounts, money market
deposit accounts, regular savings accounts, certificates of deposit, cash
management services and retirement savings plans. Deposit account terms vary
according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rate, among other factors. In determining
the terms of deposit accounts, the Bank considers current market interest
rates, profitability to the Bank, matching deposit and loan products and
customer preferences and concerns. At December 31, 2002, the Bank had $1.498
billion of deposits including $573.0 million of transaction and savings
accounts and $924.8 million in time deposits. For additional information
concerning the Bank's deposit accounts, see Item 7, "Management's
8
Discussion and Analysis of Financial Condition-Comparison of Financial
Condition at December 31, 2002 and 2001-Deposit Accounts." See also Table 7
contained therein, which sets forth the balances of deposits in the various
types of accounts offered by the Bank, and Table 8, which sets forth the
amount of the Bank's jumbo certificates of deposit by time remaining until
maturity as of December 31, 2002.
Borrowings: While deposits are the primary source of funds for the Bank's
lending and investment activities and for its general business purposes, the
Bank also uses borrowings to supplement its supply of lendable funds, to meet
deposit withdrawal requirements and to more efficiently leverage its capital
position. The FHLB-Seattle serves as the Bank's primary borrowing source.
The FHLB-Seattle provides credit for member financial institutions. As a
member, the Bank is required to own capital stock in the FHLB-Seattle and is
authorized to apply for advances on the security of such stock and certain of
its mortgage loans and securities provided certain credit worthiness standards
have been met. Limitations on the amount of advances are based on the
financial condition of the member institution and the adequacy of collateral
pledged to secure the credit. At December 31, 2002, the Bank had $465.7
million of combined borrowings from the FHLB-Seattle at a weighted average
rate of 4.80%. At that date, the Bank had been authorized by the FHLB-Seattle
to borrow up to $695.0 million under a blanket floating lien security
agreement. The Bank also has access to additional short-term funds through a
$26.0 million commercial bank credit line. At December 31, 2002, the Bank had
no short-term funds borrowed on this commercial banking credit line. For
additional information concerning the Company's borrowings from the
FHLB-Seattle, see Item 7, "Management's Discussion and Analysis of Financial
Condition-Comparison of Financial Condition at December 31, 2002 and
2001-Borrowings," and Table 9 contained therein.
The Bank issues retail repurchase agreements, generally due within 90 days, as
an additional source of funds. At December 31, 2002, the Bank had issued
retail repurchase agreements totaling $10.7 million, with a weighted average
interest rate of 3.17%, which were secured by a pledge of certain FNMA, GNMA
and FHLMC mortgage-backed securities with a market value of $13.4 million.
The Bank also borrows funds through the use of secured wholesale repurchase
agreements with securities brokers. The broker holds Bank securities while
the Bank continues to receive the principal and interest payments from the
security. The Bank's outstanding borrowings at December 31, 2002 under
wholesale repurchase agreements totaled $30.5 million, with a weighted average
rate of 1.43%, and were collateralized by mortgage-backed securities with a
fair value of $33.0 million.
In addition to borrowings at the Bank, the Company has generated funding by
issuing $40 million of Trust Preferred Securities (TPS). The TPS were issued
in 2002 by special purpose business trusts owned by the Company and were sold
to pooled investment vehicles sponsored and marketed by investment banking
firms. The TPS have been recorded as liabilities on the Company's statement
of financial condition but qualify as Tier 1 capital for regulatory capital
purposes. See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Recent Developments and Significant
Events," and Note 13 of the Notes to the Consolidated Financial Statements for
additional information with respect to the TPS.
For additional information about deposits and other sources of funds, see Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources," and Notes 11, 12 and 13 of the
Notes to the Consolidated Financial Statements contained in Item 8.
Personnel
As of December 31, 2002, the Bank and its subsidiaries had 627 full-time and
84 part-time employees. The Company has no employees except for those who are
also employees of the Bank and its subsidiaries. The employees are not
represented by a collective bargaining unit. The Company believes its
relationship with its employees is good.
Taxation
Federal Taxation
General: For tax reporting purposes, the Company and the Bank report their
income on a calendar year basis using the accrual method of accounting and
file consolidated income tax returns. The Company and the Bank are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the reserve for bad debts discussed below.
The following discussion of tax matters is intended only as a summary and does
not purport to be a comprehensive description of the tax rules applicable to
the Company and the Bank. Reference is made to Note 14 of the Notes to the
Consolidated Financial Statements contained in Item 8 of this Form 10-K for
additional information concerning the income taxes payable by the Bank.
Provisions of the Small Business Job Protection Act of 1996 (the Job
Protection Act) significantly altered the Company's tax bad debt deduction
method and the circumstances that would require a tax bad debt reserve
recapture. Prior to enactment of the Job Protection Act, savings institutions
(the Bank was previously chartered as a savings institution) were permitted to
compute their tax bad debt deduction through use of either the reserve method
or the percentage of taxable income method. The Job Protection Act repealed
both of these methods for large savings institutions and allows bad debt
deductions based only on actual current losses. While repealing the reserve
method for computing tax bad debt deductions, the Job Protection Act allows
savings institutions to retain their existing base year bad debt reserves but
requires that reserves in excess of the balance at December 31, 1987, be
recaptured into taxable income. The tax liability for this recapture is
included in the Consolidated Financial Statements contained in Item 8 herein.
9
The base year reserve is recaptured into taxable income only in limited
situations, such as in the event of certain excess distributions, complete
liquidation or disqualification as a bank. None of the limited circumstances
requiring recapture are contemplated by the Company. The amount of the
Company's tax bad debt reserves subject to recapture in these circumstances
was approximately $5.3 million at December 31, 2002. As a result of the
remote nature of events that may trigger the recapture provisions, no tax
liability has been established in the accompanying Consolidated Financial
Statements.
In addition, as a result of certain acquisitions, the Company is required to
recapture certain tax bad debt reserves of the acquired business. The Company
has elected to recapture these reserves into income over a four-year period
using the deferral method. The recapture does not result in a charge to
earnings as the Company provided for this liability on the acquisition date.
Corporate Alternative Minimum Tax: The Internal Revenue Code (Code) imposes a
tax on alternative minimum taxable income (AMTI) at a rate of 20%. AMTI is
increased by an amount equal to 75% of the amount by which the corporation's
adjusted current earnings exceeds its AMTI (determined without regard to this
preference and prior to reduction for net operating losses). For taxable
years beginning after December 31, 1986, and before January 1, 1996, an
environmental tax of .12% of the excess of AMTI (with certain modifications)
over $2.0 million was imposed on corporations, including the Company, whether
or not an Alternative Minimum Tax (AMT) is paid.
Dividends-Received Deduction and Other Matters: The Company may exclude from
its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends-received deduction
is generally 70% in the case of dividends received from unaffiliated
corporations with which the Company and the Bank will not file a consolidated
tax return, except that if the Company or the Bank own more than 20% of the
stock of a corporation distributing a dividend, then 80% of any dividends
received may be deducted.
There have not been any Internal Revenue Service audits of the Company's or
the Bank's federal income tax returns during the past five years.
State Taxation
Washington Taxation: The Company and the Bank are subject to a Business and
Occupation (B&O) tax which is imposed under Washington law at the rate of
1.50% of gross receipts; however, interest received on loans secured by
mortgages or deeds of trust on residential properties, residential
mortgage-backed securities, and certain U.S. Government and agency securities
is not subject to such tax. The Company's B&O tax expense was $943,000, $1.1
million and $1.2 million for 2002, 2001 and 2000, respectively.
Oregon and Idaho Taxation: Corporations with nexus in the states of Oregon
and Idaho are subject to a corporate level income tax. The Company's
operations in those states resulted in corporate income taxes of approximately
$108,000, $320,000 and $281,000 (net of federal tax benefit) for 2002, 2001
and 2000, respectively. As the Company's operations in these states increase,
the state income tax provision will have an increasing effect on the Company's
effective tax rate and results of operations.
Environmental Regulation
The business of the Company is affected from time to time by federal and state
laws and regulations relating to hazardous substances. Under the federal
Comprehensive Environmental Response, Compensation and Liability Act (CERCLA),
owners and operators of properties containing hazardous substances may be
liable for the costs of cleaning up the substances. CERCLA and similar state
laws can affect the Bank both as an owner of branches and other properties
used in its business and as a lender holding a security interest in property
which is found to contain hazardous substances. While CERCLA contains an
exemption for holders of security interests, the exemption is not available if
the holder participates in the management of a property, and some courts have
broadly defined what constitutes participation in management of property.
Moreover, CERCLA and similar state statutes can affect the Bank's decision
whether or not to foreclose on a property. Before foreclosing on commercial
real estate, it is the Bank's general policy to obtain an environmental
report, thereby increasing the costs of foreclosure. In addition, the
existence of hazardous substances on a property securing a troubled loan may
cause the Bank to elect not to foreclose on the property, thereby reducing the
Bank's flexibility in handling the loan.
Competition
The Bank encounters significant competition both in attracting deposits and in
originating loans. The Bank's most direct competition for deposits has come
historically from other commercial and savings banks, savings associations and
credit unions in its market areas. The Bank also experiences competition from
securities firms, insurance companies, money market and mutual funds, and
other investment vehicles. The Bank expects continued strong competition from
such financial institutions and investment vehicles in the foreseeable future.
The ability of the Bank to attract and retain deposits depends on its ability
to provide transaction services and investment opportunities that satisfy the
requirements of depositors. The Bank competes for deposits by offering a
variety of accounts and financial services with competitive rates and terms,
at convenient locations and business hours, and delivered with a high level of
personal service and expertise.
Competition for loans comes principally from commercial banks, loan brokers,
mortgage banking companies, savings banks and credit unions. The competition
for loans is intense as a result of the large number of institutions competing
in the Bank's market areas. The Bank competes for loans primarily through
offering competitive rates and fees and providing timely decisions and
excellent service to borrowers.
10
Regulation
The Bank
General: As a state-chartered, federally insured commercial bank, the Bank is
subject to extensive regulation and must comply with various statutory and
regulatory requirements, including prescribed minimum capital standards. The
Bank is regularly examined by the FDIC and state banking regulators and files
periodic reports concerning its activities and financial condition with its
regulators. The Bank's relationship with depositors and borrowers also is
regulated to a great extent by both federal and state law, especially in such
matters as the ownership of deposit accounts and the form and content of
mortgage and other loan documents.
Federal and state banking laws and regulations govern all areas of the
operation of the Bank, including reserves, loans, investments, deposits,
capital, issuance of securities, payment of dividends and establishment of
branches. Federal and state bank regulatory agencies also have the general
authority to limit the dividends paid by insured banks and bank holding
companies if such payments should be deemed to constitute an unsafe and
unsound practice. The respective primary federal regulators of the Company
and the Bank have authority to impose penalties, initiate civil and
administrative actions and take other steps intended to prevent banks from
engaging in unsafe or unsound practices.
State Regulation and Supervision: The Bank is subject to the applicable
provisions of Washington, Oregon and Idaho law and regulations. State law and
regulations govern the Bank's ability to take deposits and pay interest
thereon, to make loans on or invest in residential and other real estate, to
make consumer loans, to invest in securities, to offer various banking
services to its customers and to establish branch offices.
Deposit Insurance: The FDIC is an independent federal agency that insures the
deposits, up to prescribed statutory limits, of depository institutions. The
FDIC currently maintains two separate insurance funds: the BIF and the SAIF.
As insurer of the Bank's deposits, the FDIC has examination, supervisory and
enforcement authority over the Bank.
Banner Bank's accounts are insured by both the BIF and the SAIF to the maximum
extent permitted by law. The Bank pays deposit insurance premiums based on a
risk-based assessment system established by the FDIC. Under applicable
regulations, institutions are assigned to one of three capital groups that are
based solely on the level of an institution's capital-"well capitalized,"
"adequately capitalized," and "undercapitalized"-which are defined in the same
manner as the regulations establishing the prompt corrective action system, as
discussed below. These three groups are then divided into three subgroups
which reflect varying levels of supervisory concern, from those which are
considered to be healthy to those which are considered to be of substantial
supervisory concern.
Since 1997, the premium schedule for BIF and SAIF insured institutions has
ranged from zero to 27 basis points. In recent years, the Bank has not been
required to make any premium payments to the FDIC. However, SAIF insured
institutions and BIF insured institutions are required to pay a Financing
Corporation (FICO) assessment in order to fund the interest on bonds issued to
resolve thrift failures in the 1980s. For the fourth quarter of 2002, the
annualized rate was 1.70 basis points for each $100 in domestic deposits.
These assessments, which may be revised based upon the level of BIF and SAIF
deposits, will continue until the bonds mature in the year 2015.
The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged
or is engaging in unsafe or unsound practices, is in an unsafe or unsound
condition to continue operations, or has violated any applicable law,
regulation, order or any condition imposed by an agreement with the FDIC. It
also may suspend deposit insurance temporarily during the hearing process for
the permanent termination of insurance if the institution has no tangible
capital. If insurance of accounts is terminated, the accounts at the
institution at the time of termination, less subsequent withdrawals, will
continue to be insured for a period of six months to two years, as determined
by the FDIC. Management is not aware of any existing circumstances that could
result in termination of the deposit insurance of the Bank.
Prompt Corrective Action: Federal statutes establish a supervisory framework
based on five capital categories: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution's category depends upon where its capital
levels are in relation to relevant capital measures, which include a
risk-based capital measure, a leverage ratio capital measure and certain other
factors. The federal banking agencies have adopted regulations that implement
this statutory framework. Under these regulations, an institution is treated
as well capitalized if its ratio of total capital to risk-weighted assets is
10% or more, its ratio of core capital to risk-weighted assets is 6% or more,
its ratio of core capital to adjusted total assets (leverage ratio) is 5% or
more, and it is not subject to any federal supervisory order or directive to
meet a specific capital level. In order to be adequately capitalized, an
institution must have a total risk-based capital ratio of not less than 8%, a
Tier 1 risk-based capital ratio of not less than 4%, and a leverage ratio of
not less than 4%. Any institution which is neither well capitalized nor
adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action
requirements, regulatory controls and restrictions which become more extensive
as an institution becomes more severely undercapitalized. Failure by the Bank
to comply with applicable capital requirements would, if unremedied, result in
restrictions on its activities and lead to enforcement actions, including, but
not limited to, the issuance of a capital directive to ensure the maintenance
of required capital levels. Banking regulators will take prompt corrective
action with respect to depository institutions that do not meet minimum
capital requirements. Additionally, approval of any regulatory application
filed for their review may be dependent on compliance with capital
requirements.
At December 31, 2002, the Bank was categorized as "well capitalized" under the
prompt corrective action regulations of the FDIC.
Capital Requirements: FDIC regulations recognize two types or tiers of
capital: core (Tier 1) capital and supplementary (Tier 2) capital. Tier 1
capital generally includes common stockholders' equity and noncumulative
perpetual preferred stock, less most intangible assets. Tier 2 capital,
11
which is limited to 100% of Tier 1 capital, includes such items as qualifying
general loan loss reserves, cumulative perpetual preferred stock, mandatory
convertible debt, term subordinated debt and limited life preferred stock;
however, the amount of term subordinated debt and intermediate term preferred
stock (original maturity of at least five years but less than 20 years) that
may in included in Tier 2 capital is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage limit
together with certain risk-based ratios. The FDIC's minimum leverage capital
requirement specifies a minimum ratio of Tier 1 capital to average total
assets. Most banks are required to maintain a minimum leverage ratio of at
least 4% to 5% of total assets. The FDIC retains the right to require a
particular institution to maintain a higher capital level based on an
institution's particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on ratios
of qualifying capital to risk-weighted assets. Assets are placed in one of
four categories and given a percentage weight-0%, 20%, 50% or 100%-based on
the relative risk of the category. In addition, certain off-balance-sheet
items are converted to balance-sheet credit equivalent amounts, and each
amount is then assigned to one of the four categories. Under the guidelines,
the ratio of total capital (Tier 1 capital plus Tier 2 capital) to
risk-weighted assets must be at least 8%, and the ratio of Tier 1 capital to
risk-weighted assets must be at least 4%. In evaluating the adequacy of a
bank's capital, the FDIC may also consider other factors that may affect a
bank's financial condition. Such factors may include interest rate risk
exposure, liquidity, funding and market risks, the quality and level of
earnings, concentration of credit risk, risks arising from nontraditional
activities, loan and investment quality, the effectiveness of loan and
investment policies, and management's ability to monitor and control financial
operating risks.
FDIC capital requirements are designated as the minimum acceptable standards
for banks whose overall financial condition is fundamentally sound, which are
well-managed and have no material or significant financial weaknesses. The
FDIC capital regulations state that, where the FDIC determines that the
financial history or condition, including off-balance-sheet risk, managerial
resources and/or the future earnings prospects of a bank are not adequate
and/or a bank has a significant volume of assets classified substandard,
doubtful or loss or otherwise criticized, the FDIC may determine that the
minimum adequate amount of capital for the bank is greater than the minimum
standards established in the regulation.
The Company believes that, under the current regulations, the Bank exceeds its
minimum capital requirements. However, events beyond the control of the Bank,
such as weak or depressed economic conditions in areas where the Bank has most
of its loans, could adversely affect future earnings and, consequently, the
ability of the Bank to meet is capital requirements. For additional
information concerning the Bank's capital, see Note 18 of the Notes to the
Consolidated Financial Statements.
Standards for Safety and Soundness: The federal banking regulatory agencies
have prescribed, by regulation, standards for all insured depository
institutions (Guidelines) relating to: (i) internal controls, information
systems and internal audit systems; (ii) loan documentation; (iii) credit
underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset
quality; (vii) earnings; and (viii) compensation, fees and benefits. The
Guidelines set forth the safety and soundness standards that the federal
banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the FDIC determines that the
Bank fails to meet any standard prescribed by the Guidelines, it may require
the Bank to submit to the FDIC an acceptable plan to achieve compliance with
the standard. The Company believes that at December 31, 2002, the Bank meets
all such standards.
Federal Reserve System: The Federal Reserve Board requires, under Regulation
D, reserves on all depository institutions that maintain transaction accounts
or nonpersonal time deposits. These reserves may be in the form of cash or
non-interest-bearing deposits with the regional Federal Reserve Bank. NOW
accounts and other types of accounts that permit payments or transfers to
third parties fall within the definition of transaction accounts and are
subject to Regulation D reserve requirements, as are any nonpersonal time
deposits at a bank. Under Regulation D, a bank must establish reserves equal
to 3% of the first $42.1 million of transaction accounts, of which the first
$6.0 million is exempt, and 10% of the remainder. Currently there is no
reserve requirement on nonpersonal time deposits. As of December 31, 2002,
the Bank met its reserve requirements.
Affiliate Transactions: The Company and the Bank are separate and distinct
legal entities. Various legal limitations restrict the Bank from lending or
otherwise supplying funds to the Company (an "affiliate"), generally limiting
such transactions with the affiliate to 10% of the Bank's capital and surplus
and limiting all such transactions to 20% of the Bank's capital and surplus.
Such transactions, including extensions of credit, sales of securities or
assets and provision of services, also must be on terms and conditions
consistent with safe and sound banking practices, including credit standards
that are substantially the same or at least as favorable to the Bank as those
prevailing at the time for transactions with unaffiliated companies.
Federally insured banks are subject, with certain exceptions, to certain
restrictions on extensions of credit to their parent holding companies or
other affiliates, on investments in the stock or other securities of
affiliates and on the taking of such stock or securities as collateral from
any borrower. In addition, such banks are prohibited from engaging in certain
tie-in arrangements in connection with any extension of credit or the
providing of any property or service.
Community Reinvestment Act: The Bank is also subject to the provisions of the
Community Reinvestment Act of 1977, which requires the appropriate federal
bank regulatory agency, in connection with its regular examination of a bank,
to assess the bank's record in meeting the credit needs of the community
serviced by the bank, including low and moderate income neighborhoods. The
regulatory agency's assessment of the bank's record is made available to the
public. Further, such assessment is required of any bank which has applied,
among other things, to establish a new branch office that will accept
deposits, relocate an existing office or merge or consolidate with, or acquire
the assets or assume the liabilities of, a federally regulated financial
institution.
12
Dividends: Dividends from the Bank constitute the major source of funds for
dividends paid by the Company. The amount of dividends payable by the Bank to
the Company will depend upon the Bank's earnings and capital position, and is
limited by federal and state laws, regulations and policies. Federal law
further provides that no insured depository institution may make any capital
distribution (which includes a cash dividend) if, after making the
distribution, the institution would be "undercapitalized," as defined in the
prompt corrective action regulations. Moreover, the federal bank regulatory
agencies also have the general authority to limit the dividends paid by
insured banks if such payments should be deemed to constitute an unsafe and
unsound practice.
The Company
General: The Company, as sole shareholder of the Bank, is a bank holding
company registered with the Federal Reserve. Bank holding companies are
subject to comprehensive regulation by the Federal Reserve under the Bank
Holding Company Act of 1956, as amended (BHCA), and the regulations of the
Federal Reserve. The Company is required to file with the Federal Reserve
annual reports and such additional information as the Federal Reserve may
require and is subject to regular examinations by the Federal Reserve. The
Federal Reserve also has extensive enforcement authority over bank holding
companies, including, among other things, the ability to assess civil money
penalties, to issue cease and desist or removal orders and to require that a
holding company divest subsidiaries (including its bank subsidiaries). In
general, enforcement actions may be initiated for violations of law and
regulations and unsafe or unsound practices.
Gramm-Leach-Bliley Financial Services Act of 1999: On November 12, 1999, the
Gramm-Leach-Bliley Financial Services Act of 1999 was signed into law. The
Act modernizes the financial services industry by establishing a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms and other financial service providers. Generally, the Act:
(a) repealed the historical restrictions and eliminated many federal and
state law barriers to affiliations among banks, securities firms,
insurance companies and other financial service providers;
(b) provided a uniform framework for the functional regulation of the
activities of banks, savings institutions and their holding
companies;
(c) broadened the activities that may be conducted by national banks,
banking subsidiaries of bank holding companies and their financial
subsidiaries;
(d) provided an enhanced framework for protecting the privacy of
consumer information;
(e) adopted a number of provisions related to the capitalization,
membership, corporate governance and other measures designed to
modernize the FHLB system;
(f) modified the laws governing the implementation of the Community
Reinvestment Act; and
(g) addressed a variety of other legal and regulatory issues affecting
day-to-day operations and long-term activities of financial
institutions.
Acquisitions: Under the BHCA, a bank holding company must obtain Federal
Reserve approval before: (1) acquiring, directly or indirectly, ownership or
control of any voting shares of another bank or bank holding company if, after
such acquisition, it would own or control more than 5% of such shares (unless
it already owns or controls the majority of such shares); (2) acquiring all or
substantially all of the assets of another bank or bank holding company; or
(3) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions, from
acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company that is not a bank or bank holding company and
from engaging directly or indirectly in activities other than those of
banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
nonbank activities which, by statute or by Federal Reserve regulation or
order, have been identified as activities closely related to the business of
banking or managing or controlling banks. The list of activities permitted by
the Federal Reserve includes, among other things: operating a savings
institution, mortgage company, finance company, credit card company or
factoring company; performing certain data processing operations; providing
certain investment and financial advice; underwriting and acting as an
insurance agent for certain types of credit-related insurance; leasing
property on a full-payout, non-operating basis; selling money orders,
travelers' checks and U.S. Savings Bonds; real estate and personal property
appraising; providing tax planning and preparation services; and, subject to
certain limitations, providing securities brokerage services for customers.
Interstate Banking and Branching: The Federal Reserve must approve an
application of an adequately capitalized and adequately managed bank holding
company to acquire control of, or acquire all or substantially all of the
assets of, a bank located in a state other than such holding company's home
state, without regard to whether the transaction is prohibited by the laws of
any state. The Federal Reserve may not approve the acquisition of a bank that
has not been in existence for the minimum time period (not exceeding five
years) specified by the statutory law of the host state. Nor may the Federal
Reserve approve an application if the applicant (and its depository
institution affiliates) controls or would control more than 10% of the insured
deposits in the United States or 30% or more of the deposits in the target
bank's home state or in any state in which the target bank maintains a branch.
Federal law does not affect the authority of states to limit the percentage of
total insured deposits
13
in the state which may be held or controlled by a bank holding company to the
extent such limitation does not discriminate against out-of-state banks or
bank holding companies. Individual states may also waive the 30% state-wide
concentration limit contained in the federal law.
The Federal banking agencies are authorized to approve interstate merger
transactions without regard to whether such transaction is prohibited by the
law of any state, unless the home state of one of the banks adopted a law
prior to June 1, 1997 which applies equally to all out-of-state banks and
expressly prohibits merger transactions involving out-of-state banks.
Interstate acquisitions of branches will be permitted only if the law of the
state in which the branch is located permits such acquisitions. Interstate
mergers and branch acquisitions will also be subject to the nationwide and
statewide insured deposit concentration amounts described above.
Dividends: The Federal Reserve has issued a policy statement on the payment
of cash dividends by bank holding companies, which expresses the Federal
Reserve's view that a bank holding company should pay cash dividends only to
the extent that the company's net income for the past year is sufficient to
cover both the cash dividends and a rate of earnings retention that is
consistent with the company's capital needs, asset quality and overall
financial condition. The Federal Reserve also indicated that it would be
inappropriate for a company experiencing serious financial problems to borrow
funds to pay dividends.
Capital Requirements: The Federal Reserve has established capital adequacy
guidelines for bank holding companies that generally parallel the capital
requirements of the FDIC for the Bank, although the Federal Reserve
regulations provide for the inclusion of certain trust preferred securities
for up to 25% of Tier 1 capital in determining compliance with the guidelines.
The Federal Reserve regulations provide that capital standards will be applied
on a consolidated basis in the case of a bank holding company with $150
million or more in total consolidated assets. The guidelines require that a
company's total risk-based capital must equal 8% of risk-weighted assets and
one half of the 8% (4%) must consist of Tier 1 (core) capital. As of December
31, 2002 the Company's total risk-based capital was 12.96% of risk-weighted
assets and its Tier 1 (core) capital was 11.66% of risk-weighted assets.
Stock Repurchases: A bank holding company, except for certain
"well-capitalized" and highly rated bank holding companies, is required to
give the Federal Reserve prior written notice of any purchase or redemption of
its outstanding equity securities if the gross consideration for the purchase
or redemption, when combined with the net consideration paid for all such
purchases or redemptions during the preceding twelve months, is equal to 10%
or more of its consolidated net worth. The Federal Reserve may disapprove
such a purchase or redemption if it determines that the proposal would
constitute an unsafe or unsound practice or would violate any law, regulation,
Federal Reserve order or any condition imposed by, or written agreement with,
the Federal Reserve.
At its August 2002 meeting, the Company's Board of Directors authorized the
repurchase of up to 5% (approximately 600,000 shares) of the Company's
outstanding common stock over a twelve-month period. Shares may be purchased
from time to time depending upon market conditions, price and other management
considerations. During the year ended December 31, 2002, the Company
repurchased 422,844 shares of its common stock, compared to the repurchase of
569,166 shares of common stock under the prior plan during the comparable
prior year period.
The USA PATRIOT Act: In response to the events of September 11, 2001,
President George W. Bush signed into law the Uniting and Strengthening America
by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism
Act of 2001, or the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act
gives the federal government new powers to address terrorist threats through
enhanced domestic security measures, expanded surveillance powers, increased
information sharing, and broadened anti-money laundering requirements. By way
of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act takes
measures intended to encourage information sharing among bank regulatory
agencies and law enforcement bodies. Further, certain provisions of Title III
impose affirmative obligations on a broad range of financial institutions,
including banks, thrifts, brokers, dealers, credit unions, money transfer
agents and parties registered under the Commodity Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the
following requirements with respect to financial institutions:
(a) Pursuant to Section 352, all financial institutions must establish
anti-money laundering programs that include, at a minimum: (i)
internal policies, procedures, and controls, (ii) specific
designation of an anti-money laundering compliance officer, (iii)
ongoing employee training programs, and (iv) an independent audit
function to test the anti-money laundering program.
(b) Section 326 of the Act authorizes the Secretary of the Department of
Treasury, in conjunction with other bank regulators, to issue
regulations that provide for minimum standards with respect to
customer identification at the time new accounts are opened, which
were issued in proposed form on July 23, 2002 and are still pending
final action.
(c) Section 312 of the Act requires financial institutions that
establish, maintain, administer, or manage private banking accounts
or correspondent accounts in the United States for non-United States
persons or their representatives (including foreign individuals
visiting the United States) to establish appropriate, specific, and,
where necessary, enhanced due diligence policies, procedures, and
controls designed to detect and report money laundering.
(d) Effective December 25, 2001, financial institutions are prohibited
from establishing, maintaining, administering or managing
correspondent accounts for foreign shell banks (foreign banks that
do not have a physical presence in any country), and will be subject
to certain recordkeeping obligations with respect to correspondent
accounts of foreign banks.
14
(e) Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal
Reserve Act and Bank Merger Act applications.
During the first quarter of 2002 the Federal Crimes Enforcement Network
(FinCEN), a bureau of the Department of Treasury, issued proposed and interim
regulations to implement the provisions of Sections 312 and 352 of the USA
PATRIOT Act. To date, it has not been possible to predict the impact the USA
PATRIOT Act and its implementing regulations may have on the Company and the
Bank.
Sarbanes-Oxley Act of 2002: The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley
Act) was signed into law by President Bush on July 30, 2002 in response to
public concerns regarding corporate accountability in connection with the
recent accounting scandals at Enron and WorldCom. The stated goals of the
Sarbanes-Oxley Act are to increase corporate responsibility, to provide for
enhanced penalties for accounting and auditing improprieties at publicly
traded companies and to protect investors by improving the accuracy and
reliability of corporate disclosures pursuant to the securities laws.
The Sarbanes-Oxley Act is the most far-reaching U.S. securities legislation
enacted in some time. The Sarbanes-Oxley Act generally applies to all
companies, both U.S. non-U.S., that file or are required to file periodic
reports with the Securities and Exchange Commission (SEC), under the
Securities Exchange Act of 1934 (Exchange Act).
The Sarbanes-Oxley Act included very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and
securities exchanges to adopt extensive additional disclosure, corporate
governance and other related rules and mandates further studies of certain
issues by the SEC and Comptroller General. The Sarbanes-Oxley Act represents
significant federal involvement in matters traditionally left to state
regulatory systems, such as the regulation of the accounting profession, and
to state corporate law, such as the relationship between a board of directors
and management and between a board of directors and its committees.
The Sarbanes-Oxley Act addressed, among other matters:
(a) audit committees
(b) certification of financial statements by the chief executive officer
and the chief financial officer
(c) the forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and
senior officer in the twelve-month period following initial
publication of any financial statements that later require
restatement
(d) a prohibition on insider trading during pension plan black out
periods
(e) disclosure of off-balance-sheet transactions
(f) a prohibition on personal loans to directors and officers
(g) expedited filing requirements for Form 4s
(h) disclosure of a code of ethics and filing a Form 8-K for a change or
waiver of such code
(i) "real time" filing of periodic reports
(j) the formation of a public accounting oversight board
(k) auditor independence
(l) various increased criminal penalties for violations of securities
laws
The Sarbanes-Oxley Act contains provisions which became effective upon
enactment on July 30, 2002 and provisions which will become effective from
within 30 days to one year from enactment. The SEC has been delegated the
task of enacting rules to implement various provisions with respect to, among
other matters, disclosure in periodic filings pursuant to the Exchange Act.
15
Management Personnel
Executive Officers
The following table sets forth information with respect to the executive
officers of the Company and the Bank as of December 31, 2002.
Name Age Position with Company Position with Bank
- ---- --- --------------------- ------------------
D. Michael Jones 60 President, Chief Executive President, Chief Executive
Officer, Director Officer, Director
Gary Sirmon 59 Chairman of the Board, Chairman of the Board,
Director Director
Jesse G. Foster 64 Vice Chairman of the Board, Vice Chairman of the
Director Board, Director
Lloyd W. Baker 54 Executive Vice President, Executive Vice President,
Chief Financial Officer Chief Financial Officer
Michael K. Larsen 60 Executive Vice President,
Real Estate Lending
Cynthia D.
Purcell 45 Executive Vice President,
Bank Operations
Richard B.
Barton 59 Executive Vice President,
Chief Credit Officer
Paul E. Folz 48 Executive Vice President,
Community Banking
John R. Neill 54 Executive Vice President,
Corporate Lending
Biographical Information
Set forth below is certain information regarding the executive officers of the
Company and the Bank. There are no family relationships among or between the
directors or executive officers.
D. Michael Jones joined Banner Bank in 2002 following an extensive career in
banking, finance and accounting. Mr. Jones served as President and Chief
Executive Officer from 1996 to 2001 for Source Capital Corporation, a lending
company in Spokane, Washington. From 1987 to 1995, Mr. Jones served as
President of West One Bancorp, a large regional banking franchise based in
Boise, Idaho.
Gary Sirmon joined First Savings Bank of Washington, Banner Bank's
predecessor, in 1980 as an Executive Vice President and served as its Chief
Executive Officer from 1982 until 2002.
Jesse G. Foster was formerly the Chief Executive Officer, President and a
Director of Inland Empire Bank (now Banner Bank), which he joined in 1962.
Lloyd W. Baker joined FSBW (now Banner Bank) in 1995 as Asset/Liability
Manager and has served as its Chief Financial Officer since 2000. His banking
career began in 1972.
Michael K. Larsen joined FSBW (now Banner Bank) in 1981 and has been the
Bank's senior real estate lending officer since 1982.
Cynthia D. Purcell was formerly the Chief Financial Officer of IEB (now Banner
Bank), which she joined in 1981.
Richard B. Barton joined Banner Bank in 2002. Mr. Barton's banking career
began in 1972 with Seafirst Bank and Bank of America, where he served as the
credit risk management executive for the west coast.
Paul E. Folz joined Banner Bank in 2002. Mr. Folz formerly served as
Washington Mutual's Senior Vice President for new market planning and
development, where he spearheaded the expansion of business banking into new
markets.
John R. Neill joined Banner Bank in 2002. Mr. Neill, who has over 25 years of
commercial banking and community development experience, formerly served as
Senior Vice President and Senior Client Manager for Bank of America's Central
Washington commercial banking division.
16
Available Information
The Company's website is www.banrbank.com. The website contains a link to the
Company's filings with the Securities and Exchange Commission, including
Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K and any amendments. Copies of these filing are available as soon
as reasonably practicable.
Item 2 - Properties
The Company's home office, which is owned by the Company, is located in Walla
Walla, Washington. As of December 31, 2002 the Bank has, in total, 41 branch
offices located in Washington, Oregon and Idaho. These offices are located in
the cities of Walla Walla (4), Kennewick (2), Richland, Pasco, Clarkston,
Sunnyside, Yakima (4), Selah, Wenatchee, Dayton, Bellingham, Ferndale, Lynden,
Blaine, Point Roberts, Spokane (2), Woodinville, Bothell, Everett, Kirkland,
Bellevue, Redmond, Renton and Seattle, Washington; Hermiston, Pendleton (2),
Umatilla, Boardman, Stanfield and Lake Oswego, Oregon; and Lewiston (2),
Idaho. Of these offices, 19 are owned by the Company and 22 are leased. The
leases expire from 2003 through 2023. In addition to these branch offices,
the Bank has eight leased loan production offices in Bellevue, Puyallup,
Kennewick, Spokane, Bellingham and Oak Harbor, Washington and Lake Oswego and
Condon, Oregon, and it leases administrative offices in Walla Walla (2), and
Bothell and Woodinville, Washington. Community Financial Corporation (CFC),
the wholly owned subsidiary of the Bank, located in Lake Oswego, Oregon,
leases space to operate its two loan production offices in Lake Oswego, Oregon
and Vancouver, Washington. The leases expire from 2003 through 2023. The
Company's net investment in its offices, premises, equipment and leaseholds
was $20.7 million at December 31, 2002.
Item 3 - Legal Proceedings
In the normal course of business, the Company and the Bank have various legal
proceedings and other contingent matters outstanding. These proceedings and
the associated legal claims are often contested and the outcome of individual
matters is not always predictable. These claims and counter claims typically
arise during the course of collection efforts on problem loans or with respect
to action to enforce liens on properties in which the Bank holds a security
interest. Presently the Company has three such counter claims by borrowers or
involved parties. The Company and the Bank are not a party to any pending
legal proceedings that they believe would have a material adverse effect on
the financial condition or operations of the Company.
Item 4 - Submission of Matters to a Vote of Security Holders
None
17
Part II
Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters
Stock Listing
The Company's common stock is traded over-the-counter on The Nasdaq Stock
Market(r) under the symbol "BANR" and newspaper stock tables list the Company
as "Banner Corp." Stockholders of record at December 31, 2002 totaled 1,016.
This total does not reflect the number of persons or entitles who hold stock
in nominee or "street" name through various brokerage firms. The following
tables show the reported high and low closing sale prices of the Company's
common stock for the years ended December 31, 2002, 2001 and 2000.
Cash
Year Ended Dividend
December 31, 2002 High Low Declared
----------------- ---- --- --------
First quarter $22.01 $16.96 $0.150
Second quarter 24.75 21.28 0.150
Third quarter 23.55 15.32 0.150
Fourth quarter 20.60 16.85 0.150
Cash
Year Ended Dividend
December 31, 2001 High Low Declared
----------------- ---- --- --------
First quarter $17.00 $15.06 $0.140
Second quarter 23.10 16.00 0.140
Third quarter 22.90 15.15 0.140
Fourth quarter 20.08 15.85 0.140
Cash
Year Ended Dividend
December 31, 2000 High Low Declared
----------------- ---- --- --------
First quarter (1) $16.59 $11.93 $0.127
Second quarter (1) 15.91 11.70 0.127
Third quarter (1) 14.87 11.99 0.127
Fourth quarter 15.25 12.94 0.140
- ------------
(1) Restated to reflect 10% stock dividend granted in November 2000.
See Note 2 of the Notes to the Consolidated Financial Statements.
18
Item 6 - Selected Consolidated Financial and Other Data
During May 1999, the Company announced its decision to change its fiscal year
end from March 31 to December 31 beginning with the period ended on December
31, 1999. The information presented for the nine months ended December 31,
1998 and for the twelve months ended December 31, 1999 is for comparative
purposes only and has not been subjected to a financial audit. These tables
set forth selected consolidated financial and other data of the Company at the
dates and for the periods indicated. This information is derived from and is
qualified in its entirety by reference to the detailed information and
Consolidated Financial Statements and Notes thereto presented elsewhere in
this or prior filings.
FINANCIAL CONDITION DATA: At December 31 At March 31 (1)
(In thousands) ------------------------------------------------- --------------
2002 2001 2000 1999 1999
---- ---- ---- ---- ----
Total assets $2,263,172 $2,087,094 $1,982,831 $1,820,110 $1,631,900
Loans receivable, net 1,546,927 1,575,425 1,471,769 1,308,164 1,102,669
Cash and securities (2) 567,385 384,403 393,871 406,886 436,679
Deposits 1,497,778 1,295,811 1,192,715 1,078,152 950,848
Borrowings 546,945 578,697 581,636 548,179 486,719
Stockholders' equity 190,377 192,340 193,795 179,173 183,608
Shares outstanding
excluding unearned,
restricted shares
held in ESOP 10,791 11,057 11,372 11,591 11,992
For the 9-month For the Year
For the Years period Ended Ended
OPERATING DATA: Ended December 31 December 31 March 31 (1)
(In thousands) --------------------------------------------- ---------------------- -------------
2002 2001 2000 1999 1999 1998 1999
---- ---- ---- ---- ---- ---- ----
(Unaudited) (Unaudited)
Interest income $ 144,276 $ 157,666 $ 158,298 $ 131,502 $ 101,032 $ 81,822 $ 112,292
Interest expense 65,969 85,944 89,594 69,360 53,201 44,283 60,442
--------- --------- --------- --------- --------- --------- ---------
Net interest income 78,307 71,722 68,704 62,142 47,831 37,539 51,850
Provision for loan
losses 21,000 13,959 2,867 2,516 1,885 2,210 2,841
--------- --------- --------- --------- --------- --------- ---------
Net interest income
after provision for
loan losses 57,307 57,763 65,837 59,626 45,946 35,329 49,009
Gains from sale of:
Loans 6,695 4,575 2,517 1,989 1,157 2,052 2,884
Securities 27 687 63 6 2 7 11
Other operating income 9,155 8,203 6,671 5,617 4,356 3,297 4,558
Other operating
expenses 60,445 59,636 46,502 39,873 30,522 22,394 31,745
--------- --------- --------- --------- --------- --------- ---------
Income before
provision for
income taxes 12,739 11,592 28,586 27,365 20,939 18,291 24,717
Provision for income
taxes 3,479 4,142 10,238 10,467 8,070 6,880 9,277
--------- --------- --------- --------- --------- --------- ---------
Net income $ 9,260 $ 7,450 $ 18,348 $ 16,898 $ 12,869 $ 11,411 $ 15,440
========= ========= ========= ========= ========= ========= =========
At or for the 9-month At or for the
At or for the Years period Ended Year Ended
PER SHARE DATA:(3) Ended December 31 December 31 March 31
(In thousands) --------------------------------------------- ---------------------- -------------
2002 2001 2000 1999 1999 1998 1999
---- ---- ---- ---- ---- ---- ----
(Unaudited) (Unaudited)
Net income: Basic $ 0.85 $ 0.67 $ 1.62 $ 1.46 $ 1.12 $ 0.99 $ 1.33
Diluted 0.82 0.64 1.60 1.41 1.09 0.94 1.27
Stockholders'
equity (4) 17.64 17.40 17.04 15.46 15.46 14.72 15.31
Cash dividends 0.60 0.56 0.52 0.44 0.33 0.24 0.35
Dividend payout
ratio (diluted) 73.17% 87.50% 32.63% 30.92% 30.25% 25.00% 27.14%
(footnotes follow tables)
19
KEY FINANCIAL RATIOS: (5)
At or For the 9-month At or For the
At or For the Years period Ended Year Ended
Ended December 31 December 31 March 31 (1)
--------------------------------------------- ---------------------- -------------
2002 2001 2000 1999 1999 1998 1999
---- ---- ---- ---- ---- ---- ----
(Unaudited) (Unaudited)
Performance Ratios:
Return on average
assets (6) 0.43% 0.36% 0.95% 1.00% 0.99% 1.09% 1.08%
Return on average
equity (7) 4.71 3.78 9.96 9.38 9.49 8.86 8.91
Average equity to
average assets 9.13 9.64 9.58 10.65 10.44 12.35 12.07
Interest rate
spread (8) 3.80 3.52 3.49 3.63 3.64 3.42 3.45
Net interest
margin (9) 3.91 3.73 3.77 3.90 3.91 3.81 3.83
Non-interest in-
come to average
assets 0.74 0.66 0.48 0.45 0.42 0.51 0.52
Non-interest ex-
pense to average
assets 2.81 2.92 2.42 2.36 2.35 2.15 2.21
Efficiency ratio(10) 64.18 70.01 59.65 57.16 57.22 52.21 53.53
Average interest-
earning assets
to interest-
bearing
liabilities 103.14 104.89 105.67 106.27 106.01 108.76 108.30
Asset Quality Ratios:
Allowance for loan
losses as a percent
of total loans at
end of period 1.69 1.10 1.03 1.02 1.02 1.10 1.10
Net charge-offs as
a percent of aver-
age outstanding
loans during the
period 0.78 0.75 0.06 0.10 0.09 0.10 0.14
Non-performing assets
as a percent of
total assets 1.86 1.01 0.59 0.48 0.48 0.37 0.57
Ratio of allowance
for loan losses to
non-performing
loans (11) 0.74 0.97 1.83 2.67 2.67 3.30 1.60
Consolidated Capital
Ratio:
Tier 1 leverage
capital ratio 8.77 7.71 8.25 8.39 8.39 9.82 9.44
(1) Certain amounts in the prior periods' financial statements have been reclassified to conform to the
current period's presentation. These reclassifications have affected certain ratios for the prior
periods. The effect of such reclassifications is immaterial.
(2) Includes securities available for sale and held to maturity.
(3) Per share data have been adjusted for the 10% stock dividend paid in August 1998 and November 2000.
(4) Calculated using shares outstanding excluding unearned restricted shares held in ESOP.
(5) Ratios are annualized.
(6) Net income divided by average assets.
(7) Net income divided by average equity.
(8) Difference between the average yield on interest-earning assets and the average cost of
interest-bearing liabilities.
(9) Net interest income before provision for loan losses as a percent of average interest-earning assets.
(10) Other operating expenses divided by the total of net interest income before loan losses and other
operating income (non-interest income).
(11) Non-performing loans consist of nonaccrual and 90 days past due loans.
20
Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
Special Note Regarding Forward-Looking Statements
Management's Discussion and Analysis (MD&A) and other portions of this report
contain certain "forward-looking statements" concerning the future operations
of the Company. Management desires to take advantage of the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995 and is
including this statement for the express purpose of availing the Company of
the protections of such safe harbor with respect to all "forward-looking
statements" contained in this Annual Report on Form 10-K and the Annual Report
to Stockholders. Management has used "forward-looking statements" to describe
future plans and strategies, including expectations of the Company's future
financial results. Management's ability to predict results or the effect of
future plans or strategies is inherently uncertain. Factors which could cause
actual results to differ materially include, but are not limited to, regional
and general economic conditions, changes in interest rates, deposit flows,
demand for mortgages and other loans, real estate values, competition, loan
delinquency rates, changes in accounting principles, practices, policies or
guidelines, changes in legislation or regulation, other economic, competitive,
governmental, regulatory and technological factors affecting operations,
pricing, products and services and the Company's ability to successfully
resolve the outstanding credit issues and recover check kiting losses.
Accordingly, these factors should be considered in evaluating the
"forward-looking statements," and undue reliance should not be placed on such
statements. The Company undertakes no responsibility to update or revise any
"forward-looking statements."
General
Banner Corporation, a Washington corporation, is primarily engaged in the
business of planning, directing and coordinating the business activities of
its wholly owned subsidiary, Banner Bank. The Bank is a Washington-chartered
commercial bank that conducts business from its main office in Walla Walla,
Washington, and, as of January 1, 2003, its 41 branch offices and seven loan
production offices located in 19 counties in Washington, Idaho and Oregon.
The operating results of the Company depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets, consisting of loans and investment securities, and interest expense on
interest-bearing liabilities, composed primarily of customer deposits and
Federal Home Loan Bank (FHLB) advances. Net interest income is primarily a
function of BANR's interest rate spread, which is the difference between the
yield earned on interest-earning assets and the rate paid on interest-bearing
liabilities, as well as a function of the average balance of interest-earning
assets as compared to the average balance of interest-bearing liabilities. As
more fully explained below, BANR's net interest income increased for the year
ended December 31, 2002 compared to the prior year, reflecting a growth in
interest-bearing assets and liabilities and a net interest margin increase of
18 basis points. BANR's net income also is significantly affected by
provisions for loan losses and the level of its other income, including
deposit service charges, loan origination and servicing fees, and mortgage
banking operations, as well as its non-interest operating expenses and income
tax provisions. The provision for loan losses increased significantly for the
year ended December 31, 2002, compared to the prior year, by an amount of $7
million. As explained more fully below, much of this increase reflects
continued weak economic conditions in some of the Puget Sound market areas
serviced by the Company. Other operating income increased for the year ended
December 31, 2002 largely as a result of increased service charges, mortgage
banking activity and investment in bank-owned life insurance. Other operating
expenses increased only slightly for the year ended December 31, 2002,
compared to the year earlier amount. However, as explained in the following
"Recent Developments and Significant Events" section of this discussion and
analysis and also in the "Comparison of Results of Operations for the Years
Ended December 31, 2002 and 2001," other operating expenses for the year ended
December 31, 2001 included a check kiting loss of $8.1 million, which was not
a factor in 2002. In addition, the Company's amortization expense for
goodwill decreased $3.2 million for the year ended December 31, 2002 with the
adoption of SFAS No. 142, which no longer requires amortization of goodwill.
Excluding the check kiting losses and adoption of SFAS No. 142, other
operating expense increased significantly compared to the year earlier
amounts, reflecting the continued growth of the Company, including the
acquisition of Oregon Business Bank, the opening of two new branch offices and
the strengthening of the Company's loan and deposit gathering and credit
administration capabilities.
Management's discussion and analysis of results of operations is intended to
assist in understanding the financial condition and results of operations of
the Company. The information contained in this section should be read in
conjunction with the Consolidated Financial Statements and accompanying Notes
to the Consolidated Financial Statements contained in Item 8 of this Form
10-K.
Recent Developments and Significant Events
Sale of $40 Million of Trust Preferred Securities: During fiscal 2002, the
Company completed the issuance of $40 million of trust preferred securities
(TPS) in two private placements of $25 million in April 2002 and $15 million
in December 2002. The TPS were issued by special purpose business trusts
owned by the Company and sold to pooled investment vehicles sponsored and
marketed by investment banking firms. The TPS have been recorded as a
liability on the statement of financial condition but qualify as Tier 1
capital for regulatory capital purposes. A portion of the proceeds from these
offerings was used to augment the Bank's capital with the remainder expected
to be used primarily to fund growth, including acquisitions. Remaining
proceeds may also be used to fund the Company's stock repurchase program and
for other general corporate purposes as necessary.
Under the terms of the transactions, the TPS have a maturity of 30 years and
are redeemable after five years with certain exceptions. The holders of the
TPS are entitled to receive cumulative cash distributions at a variable annual
rate. The initial $25 million issue has a current
21
interest rate of 5.38175%, which is reset semi-annually to equal six-month
LIBOR plus 3.70%. The second $15 million issue has a current rate of 4.760%,
which is reset quarterly to equal three-month LIBOR plus 3.35%.
Acquisition of Oregon Business Bank: On January 1, 2002, the Company
completed the acquisition of Oregon Business Bank (OBB), which was
headquartered in Lake Oswego, Oregon. BB paid $10.1 million in cash for all
the outstanding common shares of OBB. As a result of the merger of OBB into
BB, OBB operates as a division of BB. The acquisition was accounted for as a
purchase and resulted in the recording of $4.8 million of costs in excess of
the fair value of OBB's net assets acquired (goodwill). In addition, an
estimated $714,000 of core deposit intangibles was recorded, which is being
amortized on an accelerated basis over a five-year period resulting in a
first-year charge to earnings of $255,000. OBB was an Oregon state-chartered
commercial bank which had, before recording of purchase accounting
adjustments, approximately $38.9 million in total assets, $33.1 million in
loans, $33.2 million in deposits, and $4.7 million in shareholders' equity at
December 31, 2001. OBB operated one full service branch in Lake Oswego,
Oregon. In November 2002, BB opened a commercial lending office, also in Lake
Oswego, and relocated the OBB lending operation into that office.
Check Kiting Loss in 2001: On September 17, 2001, the Company announced that
it had become aware of irregularities associated with a former senior lending
officer. The irregularities included a check kiting scheme of a single
commercial loan customer, as well as activities designed to conceal credit
weaknesses of several loan customers. As a result of the check kiting scheme,
the Company recorded expense of $8.1 million for the year ended December 31,
2001. The Company also recognized net charge-offs of $9.3 million and $6.5
million for the years ended December 31, 2001 and 2002, respectively, for loan
losses associated with the credit manipulation activities.
Accounting Standards Recently Adopted: For additional information regarding
recently adopted accounting standards, see Note 2 of the Notes to the
Consolidated Financial Statements contained in Item 8.
In January 2002, the Company adopted SFAS No. 142, Goodwill and Other
Intangible Assets, which applies to all acquired intangible assets whether
acquired singly, as part of a group or in a business combination. This
statement requires that goodwill not be amortized; however, goodwill for each
reporting unit must be evaluated for impairment on at least an annual basis
using a two-step approach. The first step used to identify potential
impairment compares the estimated fair value of reporting unit to its carrying
amount, including goodwill. If the fair value of a reporting unit is less
than its carrying amount, the second step of the impairment evaluation, which
compares the implied fair value of goodwill to its carrying amount, must be
performed to determine the amount of the impairment loss, if any. This
statement also provides standards for financial statement disclosures of
goodwill and other intangible assets and related impairment losses. The
adoption of this statement has had a material impact on the Company's results
of operation. Goodwill is no longer being amortized, reducing the current
period operating expenses by $3.2 million a year, with a corresponding
increase in net income. The Company performed its initial assessment of
goodwill impairment during the second quarter of 2002 and its annual review
during the fourth quarter of 2002 and has determined that its goodwill was not
impaired.
Critical Accounting Policies
Various elements of the Company's accounting policies, by their nature, are
inherently subject to estimation techniques, valuation assumptions and other
subjective assessments. In particular, management has identified several
accounting policies that, due to the judgments, estimates and assumptions
inherent in those policies, are critical to an understanding of the financial
statements of the Company. These policies relate to the methodology for the
determination of the allowance for loan and lease losses and the valuation of
goodwill, mortgage servicing rights and real estate held for sale. These
policies and the judgments, estimates and assumptions are described in greater
detail in subsequent sections of Management's Discussion and Analysis of
Financial Condition and Results of Operations and in Note 1 of the Notes to
the Consolidated Financial Statements. Management believes that the
judgments, estimates and assumptions used in the preparation of the financial
statements are appropriate based on the factual circumstances at the time.
However, because of the sensitivity of the financial statements to these
critical accounting policies, the use of other judgments, estimates and
assumptions could result in material differences in the results of operations
or financial condition.
Comparison of Financial Condition at December 31, 2002 and 2001
General: Total assets increased $176.1 million, or 8.4%, from $2.087 billion
at December 31, 2001, to $2.263 billion at December 31, 2002. The growth
largely resulted from an increase in cash and securities and was funded
primarily by deposit growth and borrowings. This asset growth reflects the
acquisition of OBB as well as strong deposit growth in the market areas where
BANR operates. Net loans receivable (gross loans less loans in process,
deferred fees and discounts, and allowance for loan losses) decreased $28.5
million, or 1.8%, from $1.575 billion at December 31, 2001, to $1.547 billion
at December 31, 2002. The decrease in net loans primarily reflects a $66.9
million decrease in one- to four-family residential mortgages as a result of
accelerated prepayment in the current low interest rate environment.
Excluding those residential mortgages, the balance of the loan portfolio
experienced net growth, including an increase of $15.5 million in mortgages
secured by commercial real estate loans, a decrease of $6.7 million in
multifamily real estate loans, an increase of $3.7 million in construction and
land loans and an increase of $34.9 million in non-mortgage loans such as
commercial, agricultural and consumer loans. These increased balances reflect
the Company's continuing effort to increase the portion of its loans invested
in commercial real estate, construction, land development, and commercial
business and agricultural loans. While these loans are inherently of higher
risk than residential mortgages, management believes they can produce higher
credit-adjusted returns to the Company and provide better opportunities to
develop comprehensive banking relationships with borrowers than most
residential mortgages. Securities available for sale and held to maturity
increased $117.8 million, or 37.2%, from $316.7 million at December 31, 2001,
to $434.5 million at December 31, 2002, as a result of additional investing.
FHLB stock
22
increased $2.0 million as a result of dividends paid by the FHLB in the form
of additional shares of stock. The Company also had an increase of $11.5
million in bank-owned life insurance as a result of the purchase of $10.0
million of new policies and the growth of cash surrender values on both new
and existing policies. The majority of the increase in assets was funded by a
growth in deposits. Asset growth was also funded by the issuance of $40
million of trust preferred securities and net income from operations. Deposits
grew $202.0 million, or 15.6%, from $1.296 billion at December 31, 2001, to
$1.498 billion at December 31, 2002. Non-interest-bearing deposits increased
$19.7 million, or 10.9%, while interest-bearing deposits increased by $182.3
million, or 16.3%, from the prior year-end amounts. FHLB advances decreased
$36.2 million from $502.0 million at December 31, 2001, to $465.7 million at
December 31, 2002. Other borrowings, primarily reverse repurchase agreements
with securities dealers, decreased $35.5 million, from $76.7 million at
December 31, 2001 to $41.2 million at December 31, 2002.
Investments: At December 31, 2002, the Company's consolidated investment
portfolio totaled $434.5 million and consisted principally of U.S. Government
and agency obligations, mortgage-backed securities, municipal bonds, corporate
debt obligations, and FHLMC stock. From time to time, investment levels may be
increased or decreased depending upon yields available on investment
alternatives and management's projections as to the demand for funds to be
used in the Bank's loan originations, deposits and other activities. During
the year ended December 31, 2002 investments and securities increased by
$117.8 million. Holdings of mortgage-backed securities increased $62.0
million and U.S. Treasury and agency obligations increased $40.6 million.
Ownership of corporate and other securities increased $17.5 million.
Municipal bonds decreased $2.3 million.
Mortgage-Backed Obligations: At December 31, 2002, the Company's net
mortgage-backed securities including CMOs totaled $269.2 million, or 62.0% of
the consolidated investment portfolio and 11.9% of total assets. The Company
held CMOs with a net carrying value of $173.0 million. The estimated fair
value of the mortgage-backed securities at December 31, 2002 was $269.2
million, which is $3.5 million greater than the amortized cost of $265.7
million. At December 31, 2002, the Company's portfolio of mortgage-backed
securities had a weighted average coupon rate of 5.61%. At that date, 71.4%
of the mortgage-backed securities were fixed-rate and 28.6% were
adjustable-rate. The estimated weighted average remaining life of the
portfolio was 1.7 years based on the latest three months' "constant prepayment
rate" (CPR) or the most recent CPR if less than three months' history was
available.
Municipal Bonds: The Company's tax-exempt municipal bond portfolio, which at
December 31, 2002 totaled $27.6 million at estimated fair value ($20.6 million
at amortized cost), was comprised of general obligation bonds (i.e., backed by
the general credit of the issuer) and revenue bonds (i.e., backed by revenues
from the specific project being financed) issued by various authorities,
hospitals, water and sanitation districts located in the states of Washington
and Oregon. At December 31, 2002, general obligation bonds and revenue bonds
had total estimated fair values of $14.6 million and $13.1 million,
respectively. The Company also had taxable revenue bonds as of December 31,
2002 totaling $3.1 million at estimated fair value ($3.1 million at amortized
cost). Many of the Company's qualifying municipal bonds are not rated by a
nationally recognized credit rating agency (e.g., Moody's or Standard and
Poor's) due to the smaller size of the bonds. At December 31, 2002, the
Company's municipal bond portfolio had a weighted average maturity of
approximately 10.2 years and an average coupon rate of 6.12%. The largest
security in the portfolio was an industrial revenue bond issued by the City of
Kent, Washington, with an amortized cost of $3.1 million and a fair value of
$3.1 million.
Corporate Bonds: The Company's corporate bond portfolio, which totaled $41.7
million at fair value ($43.0 million at amortized cost) at December 31, 2002
was composed principally of short- and intermediate-term fixed- and
adjustable-rate securities issued by automobile finance companies and
long-term fixed- and adjustable-rate capital securities issued by financial
institutions. At December 31, 2002, the portfolio had a weighted average
maturity of 17.4 years and a weighted average coupon rate of 5.90%.
U.S. Government and Agency Obligations: The Company's portfolio of U.S.
Government and agency obligations had a fair value of $91.9 million ($91.2
million at amortized cost) at December 31, 2002, a weighted average maturity
of 4.0 years and a weighted average coupon rate of 4.84%. Many of the U.S.
Government and agency obligations owned by the Company include call features
which allow the issuing agency the right to call the securities at various
dates prior to the final maturity. Certain securities also include step-rate
features which provide for increases in the coupon rate at future dates if the
security is not called.
23
The following tables set forth certain information regarding carrying values and percentage of total
carrying values of the Company's consolidated portfolio of securities classified as available for sale,
carried at estimated fair market value, and held to maturity, carried at amortized cost (dollars in
thousands):
Table 1: Securities Available for Sale
- ---------------------------------------
At December 31
-----------------------------------------------------------------------------------
2002 2001 2000 1999
------------------- ------------------- ------------------- ------------------
Carrying Percent Carrying Percent Carrying Percent Carrying Percent
value of Total value of Total value of Total value of Total
----- -------- ----- -------- ----- -------- ----- --------
U.S. Government
Treasury and agency
obligations $ 91,914 21.83% $ 51,285 16.99% $ 61,425 19.89% $ 58,868 16.90%
Municipal bonds:
Taxable 5,404 1.28 5,173 1.71 5,115 1.66 4,751 1.36
Tax exempt 18,383 4.36 21,569 7.15 25,773 8.35 30,585 8.78
Corporate bonds 34,708 8.24 14,827 4.91 20,435 6.62 21,564 6.19
Mortgage-backed or
related securities:
Mortgage-backed
securities:
GNMA 27,729 6.58 37,903 12.56 16,642 5.39 18,306 5.26
FHLMC 38,166 9.06 1,544 0.51 3,044 0.98 3,324 0.95
FNMA 21,148 5.02 17,888 5.93 5,365 1.74 5,452 1.57
Other 8,000 1.90 8,000 2.65 -- -- -- --
-------- ------ -------- ------ -------- ------ --------- ------
Total mortgage-backed
securities 95,043 37.10 65,335 21.65 25,051 8.11 27,082 7.78
Mortgage-related securities
CMOs-agency backed 102,992 24.45 94,184 31.21 111,963 36.26 141,333 40.57
CMOs-non-agency 69,967 16.62 45,916 15.21 55,067 17.83 60,395 17.34
-------- ------ -------- ------ -------- ------ --------- ------
Total mortgage-related
securities 172,959 41.07 140,100 46.42 167,030 54.09 201,728 57.91
-------- ------ -------- ------ -------- ------ --------- ------
Total 268,002 78.17 205,435 68.07 192,081 62.20 228,810 65.69
-------- ------ -------- ------ -------- ------ --------- ------
Equity securities 2,811 0.66 3,558 1.17 3,969 1.28 3,769 1.08
-------- ------ -------- ------ -------- ------ --------- ------
Total securities
available for sale $421,222 100.00% $301,847 100.00% $308,798 100.00% $ 348,347 100.00%
======== ====== ======== ====== ======== ====== ========= ======
Table 2: Securities Held to Maturity
- -------------------------------------
Municipal bonds:
Taxable $ 1,103 8.32% $ 1,100 7.42% $ 997 5.63% $ 1,096 7.96%
Tax exempt 2,724 20.55 2,104 14.19 2,438 13.76 1,613 11.71
Corporate bonds 7,000 52.83 7,000 47.21 7,000 39.51 4,000 29.05
Mortgage-backed securities:
FHLMC certificates 676 5.10 1,062 7.16 1,992 11.24 1,196 8.69
FNMA certificates 475 3.58 688 4.64 -- -- -- --
-------- ------ -------- ------ -------- ------ --------- ------
Total mortgage-backed
securities 1,151 8.68 1,750 7.39 1,992 11.24 1,196 8.69
Asset-backed securities 1,275 9.62 2,874 19.38 5,290 29.86 5,865 42.59
-------- ------ -------- ------ -------- ------ --------- ------
Total $ 13,253 100.00% $ 14,828 100.00% $ 17,717 100.00% $ 13,770 100.00%
======== ====== ======== ====== ======== ====== ========= ======
Estimated market value $ 13,414 $ 14,902 $ 18,269 $ 13,716
======== ======== ======== =========
24
The following table shows the maturity or period to repricing of the Company's consolidated portfolio of
securities available for sale (dollars in thousands):
Table 3: Securities-Available for Sale-Maturity/Repricing and Rates
- --------------------------------------------------------------------
Available for Sale at December 31 2002
------------------------------------------------------------------------------------------
One Year Over One to Over Five to Over Ten to Over
or Less Five Years Ten Years Twenty Years Twenty Years Total
-------------- ------------ ------------- ------------ ------------- ------------
Weighted Weighted Weighted Weighted Weighted Weighted
Carry- Aver- Carry- Aver- Carry- Aver- Carry- Aver- Carry- Aver- Carry- Aver-
ing age ing age ing age ing age ing age ing age
Value Yield Value Yield Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
U. S. Government
Treasury and agency
obligations
Fixed-rate $ 6,872 5.91% $59,986 4.02% $ 5,021 4.17% $ -- --% $ -- --% $ 71,879 4.21%
Adjustable-
rate 20,035 3.45 -- -- -- -- -- -- -- -- 20,035 3.45
-------- -------- -------- -------- -------- --------
26,907 4.08 59,986 4.02 5,021 4.17 -- -- -- -- 91,914 4.04
Municipal bonds:
Taxable 252 6.80 1,675 6.58 1,845 7.21 1,388 8.08 244 5.05 5,404 7.12
Tax exempt 2,412 5.51 3,432 5.32 4,836 6.02 4,843 6.61 2,860 5.32 18,383 5.87
-------- -------- -------- -------- -------- --------
2,664 5.63 5,107 5.73 6,681 6.35 6,231 6.94 3,104 5.30 23,787 6.20
Corporate bonds:
Fixed-rate -- -- 10,625 5.50 -- -- -- -- 5,891 7.25 16,516 6.12
Adjustable-rate 18,192 3.04 -- -- -- -- -- -- -- -- 18,192 3.04
-------- -------- -------- -------- -------- --------
18,192 3.04 10,625 5.50 -- -- -- -- 5,891 7.25 34,708 4.51
Mortgage-backed
obligations:
Fixed-rate 1 7.75 7 7.75 9,898 4.80 25,755 5.30 39,412 5.60 75,073 5.39
Adjustable-rate 10,429 5.37 427 4.31 9,114 5.16 -- -- -- -- 19,970 5.25
-------- -------- -------- -------- -------- --------
10,430 5.37 434 4.37 19,012 4.97 25,755 5.30 39,412 5.60 95,043 5.36
Mortgage-related
obligations:
Fixed-rate -- -- -- -- 4,729 5.97 38,911 4.36 72,182 4.21 115,822 4.33
Adjustable-rate 57,137 3.83 -- -- -- -- -- -- -- -- 57,137 3.83
-------- -------- -------- -------- -------- --------
57,137 3.83 -- -- 4,729 5.97 38,911 4.36 72,182 4.21 172,959 4.16
-------- -------- -------- -------- -------- --------
Total mortgage-
backed or related
obligations 67,567 4.07 434 4.37 23,741 5.17 64,666 4.73 111,594 4.70 268,002 4.59
Equity
securities 2,811 5.62 -- -- -- -- -- -- -- -- 2,811 5.62
-------- -------- -------- -------- -------- --------
Total securities
available for
sale-carrying
value $118,141 3.97 $ 76,152 4.20 $ 35,443 4.88 $ 70,897 4.77 $120,589 4.83 $421,222 4.47
======== ======== ======== ======== ======== ========
Total securities
available for
sale-amortized
cost $117,507 $ 75,217 $ 34,512 $ 70,279 $118,340 $415,855
======== ======== ======== ======== ======== ========
25
The following table shows the maturity or period to repricing of the Company's consolidated portfolio of
securities held to maturity (dollars in thousands):
Table 4: Securities-Held to Maturity-Maturity/Repricing and Rates
- ------------------------------------------------------------------
Held to Maturity at December 31, 2002
------------------------------------------------------------------------------------------
One Year Over One to Over Five to Over Ten to Over
or Less Five Years Ten Years Twenty Years Twenty Years Total
-------------- ------------ ------------- ------------ ------------- ------------
Weighted Weighted Weighted Weighted Weighted Weighted
Carry- Aver- Carry- Aver- Carry- Aver- Carry- Aver- Carry- Aver- Carry- Aver-
ing age ing age ing age ing age ing age ing age
Value Yield Value Yield Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Municipal bonds:
Taxable $ 1,000 6.35% $ -- --% $ 103 9.62% $ -- --% $ -- --% $ 1,103 6.66%
Tax exempt 450 4.82 456 4.83 -- -- 530 5.05 1,288 6.26 2,724 5.55
------- ------- ------ ----- ------- -------
1,450 5.88 456 4.83 103 9.62 530 5.05 1,288 6.26 3,827 5.87
Corporate bonds:
Fixed-rate -- -- -- -- -- -- -- -- 7,000 10.36 7,000 10.36
Mortgage-backed
obligations:
Fixed-rate -- -- -- -- -- -- -- -- 1,151 8.47 1,151 8.47
Other asset-backed
securities:
Fixed-rate -- -- 1,275 8.66 -- -- -- -- -- -- 1,275 8.66
------- ------- ------ ----- ------- -------
Total securities
held to maturity:
Carrying value $ 1,450 5.88% $ 1,731 7.65% $ 103 9.62% $ 530 5.05% $ 9,439 9.57% $13,253 8.73%
======= ======= ====== ===== ======= =======
Total securities
held to maturity:
Fair market
value $ 1,457 $ 1,761 $ 110 $ 546 $ 9,540 $13,414
======= ======= ====== ===== ======= =======
26
Loans/Lending: The Company's net loan portfolio declined $28.5 million, or
1.8%, during the year ended December 31, 2002, compared to growth of $103.7
million, or 7.0%, during the year ended December 31, 2001 and $163.6 million
of growth in the year ended December 31, 2000. While the Company originates a
variety of loans, its ability to originate each type of loan is dependent upon
the relative customer demand and competition in each market it serves. During
the past year, the exceptionally low level of interest rates led to very
strong demand for new real estate loans, including construction loans;
however, the low rates also resulted in very high levels of prepayments on
existing loans. By contrast, demand for commercial loans declined during the
period in response to generally weak economic conditions. For the years ended
December 31, 2002, 2001 and 2000, the Company originated, net of repayments,
$368.6 million, $346.3 million and $292.2 million of loans, respectively.
In recent years, the Company generally has sold most of its newly originated
fixed-rate one- to four-family residential mortgage loans and a portion of its
Small Business Administration (SBA) guaranteed loans to secondary market
purchasers. Proceeds from sales of loans by the Company for the years ended
December 31, 2002, 2001 and 2000 totaled $457.7 million, $270.3 million and
$135.7 million, respectively. The Company sells loans on both a
servicing-retained and a servicing-released basis. See "Loan Servicing
Portfolio" below. The decision to hold or sell loans is based on
asset/liability management goals and policies and market conditions. Loans
held for sale decreased to $39.4 million at December 31, 2002 compared to
$43.2 million at December 31, 2001.
At various times, the Company also purchases whole loans and loan
participation interests in loans. During the years ended December 31, 2002,
2001 and 2000, the Company purchased $52.0 million, $4.9 million and $12.0
million, respectively, of loans and loan participation interests.
One- to Four-Family Residential Real Estate Lending: At December 31, 2002,
$355.5 million, or 22.6% of the Company's loan portfolio, consisted of
permanent loans on one- to four-family residences. The Bank and its
subsidiary, CFC, are active originators of one- to four-family residential
loans in communities where they have established offices in Washington, Oregon
and Idaho. In the low interest rate environment of the past year, demand for
residential loans was particularly strong and the Bank and CFC originated a
combined total of $505.4 million of one- to four-family residential loans for
the year. Despite this significant origination activity for the year ended
December 31, 2002, loans on one- to four-family residences decreased by $66.9
million compared to a year earlier as very low interest rates led to
accelerated prepayment activity and management chose to sell a substantial
portion of new loans originated.
Construction and Land Lending: The Bank invests a significant proportion of
its loan portfolio in residential construction loans to professional home
builders. To a lesser extent, the Bank also originates land loans and
construction loans for commercial and multifamily real estate. Residential
construction lending is a primary focus at the Bank's subsidiary, CFC, and the
Company's largest concentration of construction and development loans is in
the Portland/Vancouver market area. In addition, the Company has significant
construction and development loans concentrated in the greater Puget Sound
region and the Tri-Cities market area in Washington State. At December 31,
2002, construction and land loans totaled $339.5 million (including $54.9
million of land or land development loans and $41.5 million of commercial and
multifamily real estate construction loans), or 21.6% of total loans of the
Company, compared to $335.8, or 21.1%, at December 31, 2001. Construction and
land development loan originations totaled $445.0 million for the year ended
December 31, 2002.
Commercial and Multifamily Real Estate Lending: The Bank also originates
loans secured by multifamily and commercial real estate. Multifamily and
commercial real estate loans originated by the Bank are both fixed- and
adjustable-rate loans generally with intermediate terms of five to ten years.
More recently originated multifamily and commercial loans are linked to
various U.S. Treasury indices or certain prime rates. Rates on these
adjustable-rate loans generally adjust annually after an initial period
ranging from one to ten years. Rate adjustments for some of the more seasoned
adjustable-rate loans in the portfolio predominantly reflect changes in FHLB
National Monthly Median Cost of Funds index. The Bank's commercial real estate
portfolio consists of loans on a variety of property types with no
concentration by property type. At December 31, 2002, the Company's loan
portfolio included $72.3 million in multifamily and $379.1 million in
commercial real estate loans. Multifamily and commercial real estate loans
comprised 28.7% of total loans of the Company at December 31, 2002, compared
to 27.8% a year earlier.
Commercial Lending: The Bank is active in small- to medium-sized business
lending, including origination of loans guaranteed by the Small Business
Administration (SBA), and to a lesser extent has engaged in agricultural
lending. Also, during the past year the Bank has added experienced officers
and staff focused on middle market corporate lending opportunities for
borrowers with credit needs generally in a $3 million to $15 million range.
Management intends to leverage the past success of these officers with local
decision making ability to continue to expand this market niche. In addition
to providing earning assets, it is anticipated that this type of lending will
help increase the deposit base. Expanding commercial lending and related
commercial banking services is currently an area of significant effort at the
Bank and staffing has been increased in the areas of credit administration,
business development, and loan and deposit operations. At December 31, 2002,
commercial loans totaled $285.2 million, or 18.1% of total loans of the
Company, compared to $270, or 17.0%, at December 31, 2001. Loan terms,
including the fixed or adjustable interest rate, the loan maturity and the
collateral considerations, vary significantly and are negotiated on an
individual loan basis.
Agricultural Lending: Agriculture is a major industry in many eastern
Washington and Oregon locations. While not a large part of the Bank's
portfolio, agricultural loans experienced solid growth for the year ended
December 31, 2002. The Bank intends to continue to make agricultural loans to
borrowers with a strong capital base, sufficient management depth, proven
ability to operate through agricultural cycles, reliable cash flows and
adequate financial reporting. Payments on agricultural loans depend, to a
large degree, on the results of operation of the related farm entity. The
repayment is also subject to other economic and weather conditions as well as
market prices for agricultural products, which can be highly volatile at
times. At December 31, 2002, agricultural loans totaled $102.6 million, or
6.5% of the loan portfolio, compared to $76.5, or 4.8%, at December 31, 2001.
Consumer and Other Lending: The Bank originates a variety of consumer loans,
including home equity lines of credit, automobile loans and loans secured by
deposit accounts. While consumer lending has traditionally been a small part
of the Bank's business with loans made primarily to accommodate its existing
customer base, it has received renewed emphasis in 2002 and management
anticipates increased activity in future periods.
27
At December 31, 2002, the Company had $39.2 million, or 2.5% of its loans
receivable, in outstanding consumer loans, compared to $45.6 million, or 2.9%,
at December 31, 2001.
Loan Servicing Portfolio: At December 31, 2002, the Bank was servicing $252.9
million of loans for others, compared to $224.0 million at December 31, 2001.
The loan servicing portfolio at December 31, 2002 included $174.2 million of
FHLMC mortgage loans, $13.7 million of FNMA mortgage loans and $64.1 million
of loans serviced for a variety of private investors. The portfolio included
loans secured by property located primarily in the states of Washington or
Oregon. For the year ended December 31, 2002, $1.5 million of loan servicing
fees, net of $686,000 of servicing rights amortization, was recognized in
operations. For the prior year, net loan servicing fees were $1.2 million.
Mortgage Servicing Rights: The Bank records mortgage servicing rights (MSRs)
with respect to loans it originates and sells in the secondary market on a
servicing retained basis. The cost of MSRs is capitalized and amortized in
proportion to, and over the period of, the estimated future net servicing
income. For the years ended December 31, 2002, 2001 and 2000, the Company
capitalized $1,046,000, $107,000 and $395,000, respectively, of MSRs relating
to loans sold with servicing retained. Amortization of MSRs for the years
ended December 31, 2002, 2001 and 2000, was $686,000, $574,000 and $251,000,
respectively. Management periodically evaluates the estimates and assumptions
used to determine the carrying values of MSRs and the amortization of MSRs.
These carrying values are adjusted when the valuation indicates the carrying
value is impaired. MSRs generally are adversely affected by current and
anticipated prepayments resulting from decreasing interest rates. At December
31, 2002, MSRs were carried at a value, net of amortization, of $1,621,000,
compared to $1,261,000 at December 31, 2001.
28
The following table sets forth the composition of the Company's loan portfolio (including loans held for
sale) by type of loan as of the dates indicated (dollars in thousands):
Table 5: Loan Portfolio Analysis
- ---------------------------------
December 31 March 31
--------------------------------------------------------------------- --------------
2002 2001 2000 1999 1999
---------------- ------------------ --------------- --------------- ---------------
Percent Percent Percent Percent Percent
of of of of of
Amount Total Amount Total Amount Total Amount Total Amount Total
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
Type of Loan:
- ------------
Secured by real
estate:
One- to four-
family $ 355,509 22.59% $ 422,456 26.52% $ 418,057 28.11% $ 419,132 31.71% $ 389,468 34.93%
Commercial 379,099 24.09 363,560 22.82 366,071 24.62 330,258 24.99 265,393 23.80
Multifamily 72,333 4.60 79,035 4.96 84,282 5.67 66,287 5.02 54,053 4.85
Construction
and land 339,516 21.58 335,798 21.08 271,273 18.24 194,625 14.73 165,270 14.82
Commercial
business 285,231 18.13 270,022 16.95 228,676 15.38 194,817 14.74 149,569 13.42
Agricultural
business 102,626 6.52 76,501 4.80 67,809 4.56 55,052 4.17 46,839 4.20
Consumer 39,152 2.49 45,605 2.87 50,915 3.42 61,534 4.64 44,338 3.98
---------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total loans 1,573,466 100.00% 1,592,977 100.00% 1,487,083 100.00% 1,321,705 100.00% 1,114,930 100.00%
====== ====== ====== ====== ======
Less allowance
for loan losses (26,539) (17,552) (15,314) (13,541) (12,261)
---------- ---------- --------- --------- ---------
Total net loans
at end of
period $1,546,927 $1,575,425 $1,471,769 $1,308,164 $1,102,669
========== ========== ========== ========== ==========
29
The following table sets forth certain information at December 31, 2002 regarding the dollar amount of loans
maturing in the Bank's portfolio based on their contractual terms to maturity, but does not include
scheduled payments or potential prepayments. Demand loans, loans having no stated schedule of repayments
and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances are net of
loans in progress (undisbursed loan proceeds), unamortized premiums and discounts, and exclude the allowance
for loan losses (in thousands):
Table 6: Loan Maturity
- -----------------------
Maturing Maturing Maturing
Maturing within within within Maturing
Within 1 to 3 3 to 5 5 to 10 Beyond
One Year Years Years Years 10 Years Total
-------- -------- -------- -------- -------- ----------
Secured by real estate:
One- to four-family $ 32,904 $ 6,329 $ 9,163 $ 22,302 $248,810 $ 355,509
Commercial 35,444 37,198 62,887 173,918 69,652 379,099
Multifamily 2,659 1,260 8,478 36,308 23,628 72,333
Construction and land 165,965 165,038 1,028 1,806 5,677 339,516
Commercial business 136,098 46,447 54,906 35,765 12,015 285,231
Agricultural business 58,858 19,065 12,536 5,851 6,316 102,626
Consumer 6,479 7,702 10,501 4,251 10,224 39,152
-------- -------- -------- -------- -------- ----------
Total loans $438,407 $283,039 $159,499 $280,201 $412,322 $1,573,466
======== ======== ======== ======== ======== ==========
Contractual maturities of loans do not reflect the actual life of such assets. The average life of loans is
substantially less than their contractual maturities because of principal prepayments. In addition,
due-on-sale clauses on loans generally give the Bank the right to declare loans immediately due and payable
in the event that the borrower sells the real property subject to the mortgage and the loan is not repaid.
The average life of mortgage loans tends to increase, however, when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely, decreases when rates on existing
mortgage loans are substantially higher than current mortgage loan market rates.
The following table sets forth the dollar amount of all loans due after December 31, 2003, which have fixed
interest rates and floating or adjustable interest rates (in thousands):
Table 6(a): Loans Repricing after One Year
- -------------------------------------------
Fixed Floating or
Rates Adjustable Rates Total
----- ---------------- -----
Secured by real estate:
One- to four-family $267,596 $ 55,009 $ 322,605
Commercial 196,027 147,628 343,655
Multifamily 19,272 50,402 69,674
Construction and land 10,143 163,408 173,551
Commercial business 63,010 86,123 149,133
Agricultural business 21,724 22,044 43,768
Consumer 29,432 3,241 32,673
-------- -------- ----------
Total $607,204 $527,855 $1,135,059
======== ======== ==========
30
Deposit Accounts: Deposits generally are attracted from within the Bank's
primary market areas through the offering of a broad selection of deposit
instruments, including demand checking accounts, NOW accounts, money market
deposit accounts, regular savings accounts, certificates of deposit, cash
management services and retirement savings plans. Deposit account terms vary
according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rate, among other factors. At December 31,
2002, the Bank had $1.498 billion of deposits, including $573.0 million of
transaction and savings accounts and $924.8 million in time deposits, of which
$667.3 million had remaining maturities of one year or less. Total deposits
increased by $202.0 million, or 15.6%, for the year ended December 31, 2002.
As illustrated in the following table, certificates of deposit have accounted
for a larger percentage of the deposit portfolio than have transaction
accounts. However, as reflected in the balances and percentages in the table,
the Bank added significantly to demand, NOW and money market accounts in the
year ended December 31, 2002. Total transaction accounts (demand, NOW,
savings and money market accounts) increased by $87.3 million for the year, to
38.3% of total deposits at December 31, 2002, compared to 37.5% at December
31, 2001. Non-interest-bearing transaction accounts increased by $19.7
million over the same time period. The Bank's deposit balances at December
31, 2002 included $127.9 million of funds owned by various counties,
municipalities and other public entities in Washington, Oregon and Idaho.
Growing deposits in general and transaction accounts in particular is a core
element of the Company's business plan.
31
The following table sets forth the balances of deposits in the various types of accounts offered by the Bank
at the dates indicated (dollars in thousands):
Table 7: Deposits
- ------------------
At December 31
---------------------------------------------------------------------------------
2002 2001 2000
--------------------------- ------------------------------- ----------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
------ ----- ---------- ------ ----- ---------- ------ -----
Demand and NOW
checking $ 380,563 25.41% $ 73,015 $ 307,548 23.73% $ 90,153 $ 217,395 18.23%
Regular savings
accounts 44,334 2.96 2,106 42,228 3.26 (2,199) 44,427 3.72
Money market accounts 148,058 9.89 12,230 135,828 10.48 3,587 132,241 11.09
Certificates which
mature:
Within 1 year 667,322 44.54 107,428 669,133 51.64 54,260 614,873 51.56
After 1 year, but
within 2 years 170,698 11.40 (25,953) 87,376 6.74 (33,953) 121,329 10.17
After 2 years, but
within 5 years 77,857 5.20 30,823 48,025 3.71 (5,808) 53,833 4.51
After 5 years 8,946 0.60 2,318 5,673 0.44 (2,944) 8,617 0.72
---------- ------ -------- ---------- ------ -------- ---------- ------
Total $1,497,778 100.00% $201,967 $1,295,811 100.00% $103,096 $1,192,715 100.00%
========== ====== ======== ========== ====== ======== ========== ======
The following table indicates the amount of the Bank's jumbo certificates
of deposit by time remaining until maturity as of December 31, 2002.
Jumbo certificates of deposit require a minimum deposit of $100,000 and
rates paid on such accounts are negotiable (in thousands):
Jumbo
Table 8: Maturity Period-Jumbo CDs Certificates
- ----------------------------------- of Deposit
----------
Due in three months or less $ 208,833
Due after three months through six months 48,219
Due after six months through twelve months 97,973
Due after twelve months 112,568
---------
Total $ 467,593
=========
32
Borrowings: The FHLB-Seattle serves as the Bank's primary borrowing source.
The FHLB-Seattle provides credit for member financial institutions. As a
member, the Bank is required to own capital stock in the FHLB-Seattle and is
authorized to apply for advances on the security of such stock and certain of
its mortgage loans and securities provided certain credit worthiness standards
have been met. At December 31, 2002, the Bank had $465.7 million of
borrowings from the FHLB-Seattle at a weighted average rate of 4.80%, a
decrease of $36.2 million compared to a year earlier. Also at that date, the
Bank had an investment of $32.8 million in FHLB-Seattle capital stock.
Additional short-term funds are also available through a $26.0 million
commercial bank credit line; however, at December 31, 2002, the Bank had no
balances advanced on that credit line.
Table 9: FHLB Advances Outstanding at December 31, 2002
- --------------------------------------------------------
(dollars in thousands)
Adjustable-rate Fixed-rate Total
advances advances advances
-------------- --------------- ---------------
Rate* Amount Rate* Amount Rate* Amount
---- ------- ---- -------- ---- --------
Due in one year or less 1.41% $7,000 3.86% $149,191 3.75% $156,191
Due after one year through
two years -- -- 4.03 65,094 3.93 65,094
Due after two years through
three years -- -- 6.21 65,600 6.21 65,600
Due after three years
through four years -- -- 4.77 45,000 4.27 45,000
Due after four years through
five years -- -- 3.60 16,930 3.60 16,930
Due after five years -- -- 6.64 116,928 6.02 116,928
---- ------ ---- -------- ---- --------
1.41% $7,000 4.85% $458,743 4.80% $465,743
====== ======== ========
*Weighted average interest rate
The Bank also issues retail repurchase agreements, generally due within 90
days, and borrows funds through the use of secured wholesale repurchase
agreements with securities brokers as a source of funds. At December 31,
2002, retail repurchase agreements totaling $10.7 million, with a weighted
average rate of 3.17%, were secured by a pledge of certain mortgage-backed
securities with a market value of $13.4 million. The Bank's outstanding
borrowings under wholesale repurchase agreements at December 31, 2002 totaled
$30.5 million at a weighted average rate of 1.43%, with a weighted average
maturity of 18 days, and were collateralized by mortgage-backed securities
with a fair value of $33.0 million.
In addition to borrowings at the Bank, the Company has generated funding by
issuing $40 million of trust preferred securities (TPS). The TPS were issued
in 2002 by special purpose business trusts owned by the Company and were sold
to pooled investment vehicles. The TPS have been recorded as liabilities on
the Company's statement of financial condition but qualify as Tier 1 capital
for regulatory capital purposes. See "Recent Developments and Significant
Events" and Note 13 of the Notes to the Consolidated Financial Statements for
additional information with respect to the TPS. At December 31, 2002, the TPS
had a weighted average rate of 5.149%.
33
Asset Quality: During the last two years the Bank has experienced
deterioration in asset quality, which has had a significant effect on
operating results, primarily through increased loan loss provisioning and
increased loan collection costs. Table 10 highlights the deterioration in the
Bank's measures of asset quality during this period. Non-performing assets
increased to $42.2 million, or 1.86% of total assets, at December 31, 2002,
compared to $21.1 million, or 1.01% of total assets, at December 31, 2001, and
$11.7 million, or 0.59% of total assets at December 31, 2000. Problem loans
are primarily due from borrowers located in the Puget Sound region and are the
result of poor risk assessment at the time they were originated, coupled with
weakened economic conditions in that area. For the year ended December 31,
2002 the Bank had a $7.0 million increase in non-performing commercial real
estate loans and a $9.2 million increase in non-performing construction/land
loans. At December 31, 2002, the Bank's largest non-performing loan exposure
was two related land development loans totaling $7.0 million secured by
property located in the greater Seattle, Washington, area. At that date, the
largest non-performing commercial real estate loan had a carrying value of
$1.8 million and was secured by an office building also located in the Seattle
area. The largest individual exposure on non-performing commercial business
loans had an aggregate carrying value of $1.3 million at December 31, 2002.
Reducing non-performing loans and improving asset quality will be important
activities to enhance the Bank's operating performance in future periods. For
additional discussion concerning asset quality, non-performing loans and the
allowance for loan losses, see "Provision and Allowance for Loan Losses" and
Tables 11 and 12 contained therein.
The following table sets forth information with respect to the Bank's
non-performing assets and restructured loans within the meaning of SFAS No.
15, Accounting by Debtors and Creditors for Troubled Debt Restructuring, at
the dates indicated (dollars in thousands):
Table 10: Non-Performing Assets
- --------------------------------
At December 31 At March 31
------------------------------------- -----------
2002 2001 2000 1999 1999
------- ------- ------- ------ -------
Nonaccrual loans: (1)
Loans secured by real
estate:
One- to four-family $ 455 $ 1,006 $ 873 $ 623 $ 3,564
Commercial 7,421 415 1,741 129 351
Multifamily -- -- -- -- -
Construction/land 16,030 6,827 2,937 2,514 767
Commercial business 9,894 8,884 1,734 1,203 1,392
Agricultural business 194 86 529 -- 47
Consumer 255 291 18 9 17
------- ------- ------- ------ -------
Total loans outstanding 34,249 17,509 7,832 4,478 6,138
------- ------- ------- ------ -------
Loans more than 90 days
delinquent, still on accrual:
Loans secured by real estate:
One- to four-family 343 18 20 155 20
Commercial -- 325 -- -- 384
Multifamily -- -- -- -- -
Construction/land 1,283 -- -- -- -
Commercial business 163 39 1 25 -
Agricultural business -- -- 467 334 1,052
Consumer 70 152 54 79 82
------- ------- ------- ------ -------
Total loans outstanding 1,859 534 542 593 1,538
------- ------- ------- ------ -------
Total non-performing loans 36,108 18,043 8,374 5,071 7,676
Real estate/repossessed
assets held for sale (2) 6,062 3,011 3,287 3,576 1,644
------- ------- ------- ------ -------
Total non-performing
assets $42,170 $21,054 $11,661 $8,647 $9,320
======= ======= ======= ====== ======
Restructured loans (3) $ 2,057 $ 302 $ 337 $ 369 $ 380
Total non-performing loans to
net loans before allowance for
loan losses 2.29% 1.13% 0.56% 0.38% 0.69%
Total non-performing loans to
total assets 1.60% 0.86% 0.42% 0.28% 0.47%
Total non-performing assets to
total assets 1.86% 1.01% 0.59% 0.48% 0.57%
(1) For the year ended December 31, 2002, $1.8 million in interest income
would have been recorded had nonaccrual loans been current, and no interest
income on such loans was included in net income for such period.
(2) Real estate acquired by the Company as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate held for sale until
it is sold. When property is acquired, it is recorded at the lower of its
cost (the unpaid principal balance of the related loan plus foreclosure costs)
or net realizable value. Subsequent to foreclosure, the property is carried
at the lower of the foreclosed amount or net realizable value. Upon receipt
of a new appraisal and market analysis, the carrying value is written down
through the establishment of a specific reserve to the anticipated sales
price, less selling and holding costs. At December 31, 2002, the Company had
$6.1 million of real estate owned, which consisted of 13 single-family
residences valued at $4.2 million, a multifamily complex valued at $1.6
million and land valued at $274,000.
(3) These loans are performing under their restructured terms but are
classified substandard.
34
Comparison of Results of Operations for the Years Ended December 31, 2002 and
2001
General: Net income for the year ended December 31, 2002 was $9.3 million, or
$0.82 per share (diluted), compared to net income of $7.5 million, or $0.64
per share (diluted), for the year ended December 31, 2001. Net income for
both years was significantly adversely affected by extraordinary levels of
provision for loan losses. The prior period contained expenses associated
with the check kiting scheme and additional loan loss provision described in
the "Recent Developments and Significant Events" section above, as well as
expenses associated with conversion of the Bank's core data processing system.
BANR's full year 2002 operating results reflect significant growth of assets
and liabilities, an improved net interest margin and higher non-interest
income which were substantially offset by a higher level of loan loss
provision and increased other operating expenses. As explained more fully
below, the provision for loan losses increased not only as a result of the
credit manipulation activities described in the "Recent Developments and
Significant Events" section above, but also as a result of an increased level
of non-performing loans and charge-offs and reflects continued weak economic
conditions in some of the Puget Sound market areas serviced by the Company.
Compared to levels a year ago, total assets increased 8.4% to $2.263 billion
at December 31, 2002, net loans declined slightly by 1.8% to $1.547 billion,
deposits grew 15.6% to $1.498 billion and borrowings decreased 5.5% to $546.9
million. Average equity was 9.13% of average assets for the year ended
December 31, 2002, compared to 9.64% of average assets for the prior year.
Net interest margin increased 18 basis points for the year reflecting a 28
basis point increase in net interest rate spread, which was partially offset
by the increased use of interest-bearing liabilities relative to
interest-earning assets and lower yields on assets funded by
non-interest-bearing liabilities and stockholders' equity. The changes in net
interest spread and net interest margin are notable in light of the
significant volatility and changes in the level of market interest rates over
the last two years. Changes in the level of interest rates during this
two-year period initially reduced the Company's net interest margin; however,
largely as a result of declining funding costs, net interest margin increased
for the year just ended. While net interest margin improved for the year
ended December 31, 2002 compared to the year ended December 31, 2001, the
margin decreased to 3.86% for the most recent quarter ended December 31, 2002
compared to 3.98% for the quarter ended September 30, 2002. Funding costs
will likely continue to decline for the next few quarters; however, mitigating
the expected improvement in funding costs will be additional repayments of
higher yielding loans and securities.
Interest Income: Interest income for the year ended December 31, 2002 was
$144.3 million compared to $157.7 million for the year ended December 31,
2001, a decrease of $13.4 million, or 8.5%. The decrease in interest income
occurred despite an $81.6 million, or 4.2%, growth in average balances of
interest-earning assets as a result of a 101 basis point decrease in the
average yield on those assets. The yield on average interest-earning assets
decreased to 7.20% for the year ended December 31, 2002, compared to 8.21% for
the prior year. Average loans receivable for the year ended December 31, 2002
increased by $19.1 million, or 1.2%, when compared to the year ended December
31, 2001, reflecting only modest growth despite the addition of $33.5 million
of loans from the acquisition of OBB. Interest income on loans decreased by
$12.4 million, or 9.1%, compared to the prior year, as the effect of the
increase in average loan balances was substantially offset by an 89 basis
point decrease in the average yield. The decrease in average loan yield
reflects the significant decline in the level of market interest rates,
particularly the prime rate, compared to prior year levels. The loan mix
continued to change as the portion of the portfolio invested in one- to four-
family residential loans declined, while the portion invested in construction,
land development and commercial loans increased. Loans yielded 7.76% for the
year ended December 31, 2002, compared to 8.65% for the year ended December
31, 2001. While the level of market interest rates experienced a steep
decline throughout the year, loan yields were supported to a degree by certain
loans with rate floors and by changes in the portfolio mix. The average
balance of mortgage-backed securities, investment securities, daily
interest-bearing deposits and FHLB stock increased by $62.4 million for the
year ended December 31, 2002, although the interest and dividend income from
those investments decreased $977,000 compared to the prior year. The average
yield on mortgage-backed securities decreased from 6.08% for the year ended
December 31, 2001 to 5.13% for the current year. Yields on mortgage-backed
securities were lower in 2002, reflecting the effect of lower market rates on
the interest rates paid on the significant portion of those securities that
have adjustable rates and prepayments on certain higher-yielding portions of
the portfolio, as well as reinvestment at current market rates. The average
yield on investment securities and short-term cash investments decreased from
6.34% for the year ended December 31, 2001 to 4.77% for the current year, also
reflecting the lower level of market rates. Earnings on FHLB stock decreased
by $73,000 despite an increase of $2.0 million in the average balance of FHLB
stock for the year ended December 31, 2002. The dividend yield on FHLB stock
was 6.21% for the year ended December 31, 2002, compared to 6.88% for the year
ended December 31, 2001. Dividends on FHLB stock are established on a
quarterly basis by vote of the Directors of the FHLB and are paid by
distribution of additional shares of FHLB stock.
Interest Expense: Interest expense for the year ended December 31, 2002 was
$66.0 million, compared to $85.9 million for the prior year, a decrease of
$20.0 million, or 23.2%. The decrease in interest expense was as a result of
a decrease in the average cost of all interest-bearing liabilities from 4.69%
to 3.40%. The $152.5 million increase ($33.2 million from the OBB
acquisition) in average interest-bearing deposits for the year ended December
31, 2002, compared to December 31, 2001, reflects the solid deposit growth
throughout the Company over the past twelve months. Deposit interest expense
decreased $13.5 million for the year ended December 31, 2002, compared to the
prior year. Average deposit balances increased from $1.252 billion for the
year ended December 31, 2001, to $1.404 billion for the year ended December
31, 2002, while, at the same time, the average rate paid on deposit balances
decreased 142 basis points. To a significant degree, deposit costs for each
quarter reflect market interest rates and pricing decisions made three to
twelve months prior to the end of that quarter. Generally, market interest
rates for deposits were declining and lower throughout the year ended December
31, 2002, than in the year ended December 31, 2001. The reduction in deposit
costs, which tends to lag declines in market rates, continued during the most
recent quarter as a result of the cumulative effect of declining rates in
preceding quarters, as well as sharply lower rates in that quarter. The
significant decline in the cost of deposits was primarily responsible for the
improved net interest margin for the year ended December 31, 2002. Average
FHLB advances totaled $451.8 million during the year ended December 31, 2002,
compared to $505.6 million during the prior year, a decrease of $53.8 million
that, combined with a 60 basis point decrease in the average cost of advances,
resulted in a $5.9 million decrease in related interest expense. The average
rate paid on those advances decreased to 5.33% for the year ended December 31,
2002, from 5.93% for the prior year. FHLB advances are generally
35
fixed-rate, fixed-term borrowings. In recent quarters, a significant portion
of maturing FHLB advances have been repaid as a result of strong deposit
growth. In the current year, additional funding was also provided by the
issuance of $40 million of TPS. The average balance of TPS was $18.7 million
and the average rate paid was 6.16% (including amortization of prepaid loan
underwriting costs) for the year ended December 30, 2002. Other borrowings
consist of retail repurchase agreements with customers and repurchase
agreements with investment banking firms secured by certain investment
securities. The average balance for other borrowings decreased $7.1 million
from $73.7 million for the year ended December 31, 2001, to $66.6 million for
the current year, while the related interest expense decreased $1.8 million
from $3.3 million to $1.5 million for the respective periods. The average
rate paid on other borrowings was 2.28% in the year ended December 31, 2002,
compared to 4.41% for the prior year. The Company's other borrowings
generally have relatively short terms and therefore reprice to current market
levels more quickly than FHLB advances which generally lag current market
rates.
Provision and Allowance for Loan Losses: During the year ended December 31,
2002, the provision for loan losses was $21.0 million, compared to $14.0
million for the prior year, an increase of $7.0 million. As noted above,
provision for loan losses is one of the most critical accounting estimates
included in the Company's financial statements requiring significant
management judgment. The increase in the provision for losses reflects the
amount required to maintain the allowance for losses at an appropriate level
based upon management's evaluation of the adequacy of general and specific
loss reserves as more fully explained in the following paragraphs. The higher
provision in the current period reflects changes in the portfolio mix, higher
levels of non-performing loans and net charge-offs, deterioration in the
prospects for collection on previously identified non-performing loans, and
concerns about the current economic environment, especially with respect to
the Puget Sound region. Non-performing loans increased to $36.1 million at
December 31, 2002, compared to $18.0 million at December 31, 2001.
Non-performing loans are primarily concentrated in the Seattle metropolitan
area where continued economic weakness has diminished certain borrowers'
ability to meet loan obligations. Net charge-offs were $12.5 million, or
0.78% of average loans, for the current year, compared to $11.7 million, or
0.75% of average loans, for the prior year. Net charge-offs for the years
ended December 31, 2002 and 2001, included $6.5 and $9.3 million,
respectively, associated with the credit manipulation activities of a former
senior commercial loan officer which were designed to conceal weaknesses of
several loan customers as described in the "Recent Developments and
Significant Events" section above. A comparison of the allowance for loan
losses at December 31, 2002 and 2001, shows an increase of $9.0 million from
$17.6 million at December 31, 2001, to $26.5 million at December 31, 2002.
The allowance for loan losses as a percentage of net loans (loans receivable
excluding allowance for losses) was 1.69% and 1.10% at December 31, 2002 and
December 31, 2001, respectively. The allowance for loan losses equaled 74% of
non-performing loans at December 31, 2002, compared to 97% of non-performing
loans at December 31, 2001.
In originating loans, the Company recognizes that losses will be experienced
and that the risk of loss will vary with, among other things, the type of loan
being made, the credit worthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. As a result, the Company maintains an allowance for
loan losses consistent with the generally accepted accounting principles
(GAAP) guidelines outlined in SFAS No. 5, Accounting for Contingencies. The
Company has established systematic methodologies for the determination of the
adequacy of its allowance for loan losses. The methodologies are set forth in
a formal policy and take into consideration the need for an overall general
valuation allowance as well as specific allowances that are tied to individual
problem loans. The Company increases its allowance for loan losses by charging
provisions for possible loan losses against the Company's income and values
impaired loans consistent with the guidelines in SFAS No. 114, Accounting by
Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors
for Impairment of a Loan Income Recognition and Disclosure.
The allowance for losses on loans is maintained at a level sufficient to
provide for estimated losses based on evaluating known and inherent risks in
the loan portfolio and upon management's continuing evaluation of the factors
underlying the quality of the loan portfolio. These factors include changes
in the size and composition of the loan portfolio, actual loan loss
experience, current and anticipated economic conditions, detailed analysis of
individual loans for which full collectibility may not be assured, and
determination of the existence and realizable value of the collateral and
guarantees securing the loans. Losses that are related to specific assets are
usually applied as a reduction of the carrying value of the assets and charged
immediately against the allowance for loan loss reserve. Recoveries on
previously charged off loans are credited to the allowance. The reserve is
based upon factors and trends identified by management at the time financial
statements are prepared. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the allowance
for loan losses. Such agencies may require additions to the allowance based
upon judgments different from management. Although management uses the best
information available, future adjustments to the allowance may be necessary
due to economic, operating, regulatory and other conditions beyond the
Company's control. The adequacy of general and specific reserves is based on
management's continuing evaluation of the pertinent factors influencing the
quality of the loan portfolio, including changes in the size and composition
of the loan portfolio, delinquency rates, actual loan loss experience and
current and anticipated economic conditions and analysis of specific loans.
Large groups of smaller-balance homogeneous loans are collectively evaluated
for impairment. Loans that are collectively evaluated for impairment include
residential real estate and consumer loans. Smaller balance non-homogeneous
loans also may be evaluated collectively for impairment. Larger balance
non-homogeneous residential construction and land, commercial real estate,
commercial business loans and unsecured loans are individually evaluated for
impairment. Loans are considered impaired when, based on current information
and events, management determines that it is probable that the Bank will be
unable to collect all amounts due according to the contractual terms of the
loan agreement. Factors involved in determining impairment include, but are
not limited to, the financial condition of the borrower, value of the
underlying collateral and current status of the economy. Impaired loans are
measured based on the present value of expected future cash flows discounted
at the loan's effective interest rate or, as a practical expedient, at the
loan's observable market price or the fair value of collateral if the loan is
collateral dependent. Subsequent changes in the value of impaired loans are
included within the provision for loan losses in the same manner in which
impairment initially was recognized or as a reduction in the provision that
would otherwise be reported. As of December 31, 2002, the Company had
identified $33.1 million of impaired loans as defined by SFAS No. 114 and had
established $5.4 million of specific reserves for these loans.
36
The Company's methodology for assessing the appropriateness of the allowance
consists of several key elements, which include specific allowances, an
allocated formula allowance, and an unallocated allowance. Losses on specific
loans are provided for when the losses are probable and estimable. General
loan loss reserves are established to provide for inherent loan portfolio
risks not specifically provided for. The level of general reserves is based
on analysis of potential exposures existing in the Bank's loan portfolio
including evaluation of historical trends, current market conditions and other
relevant factors identified by management at the time the financial statements
are prepared. The formula allowance is calculated by applying loss factors to
outstanding loans, excluding loans with specific allowances. Loss factors are
based on the Company's historical loss experience adjusted for significant
factors including the experience of other banking organizations that, in
management's judgment, affect the collectibility of the portfolio as of the
evaluation date. The unallocated allowance is based upon management's
evaluation of various factors that are not directly measured in the
determination of the formula and specific allowances. This methodology may
result in losses or recoveries differing significantly from those provided in
the financial statements.
While the Company believes that it has established existing allowance for loan
losses in accordance with GAAP, there can be no assurance that regulators, in
reviewing the Bank's loan portfolio, will not request the Bank to increase
significantly its allowance for loan losses. In addition, because future
events affecting borrowers and collateral cannot be predicted with certainty,
there can be no assurance that the existing allowance for loan losses is
adequate or that substantial increases will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed above.
Any material increase in the allowance for loan losses may adversely affect
the Company's financial condition and results of operations.
The following table sets forth an analysis of the Company's gross allowance
for possible loan losses for the periods indicated (dollars in thousands):
Table 11: Changes in Allowance for Loan Losses
- -----------------------------------------------
Nine Months
Years Ended Ended Year Ended
December 31 December 31 March 31
---------------------------- ----------- ----------
2002 2001 2000 1999 1999
-------- -------- -------- -------- ---------
Balance, beginning of
period $17,552 $ 15,314 $ 13,541 $ 12,261 $ 7,857
Allowances added through
business combinations 460 -- -- 477 2,693
Sale of credit card
portfolio -- (174) -- --
Provision 21,000 13,959 2,867 1,885 2,841
Recoveries of loans
previously charged off:
Secured by real estate:
One- to four-family -- 2 2 -- -
Commercial -- -- 2 1 60
Multifamily -- -- -- -- -
Construction and land 39 -- -- -- --
Commercial business 209 118 40 450 143
Agricultural business 3 -- 1 6 1
Consumer 74 22 66 11 21
-------- -------- -------- -------- --------
325 142 111 468 225
-------- -------- -------- -------- --------
Loans charged off:
Secured by real estate:
One- to four-family (102) (97) (90) (532) (25)
Commercial (103) -- (31) -- (35)
Multifamily -- -- -- --
Construction and land (1,129) (107) (12) (24) (69)
Commercial business (10,643) (10,541) (403) (841) (911)
Agricultural business (157) (208) (16) (19) (5)
Consumer (664) (910) (479) (134) (310)
-------- -------- -------- -------- --------
(12,798) (11,863) (1,031) (1,550) (1,355)
-------- -------- -------- -------- --------
Net charge-offs (12,473) (11,721) (920) (1,082) (1,130)
-------- -------- -------- -------- --------
Balance, end of
period $ 26,539 $ 17,552 $ 15,314 $ 13,541 $ 12,261
======== ======== ======== ======== ========
Ratio of allowance to
net loans before
allowance for loan
losses 1.69% 1.10% 1.03% 1.02% 1.10%
Ratio of net loan
charge-offs to the
average net book value
of loans outstanding
during the period 0.78% 0.75% 0.06% 0.09% 0.14%
37
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates
indicated (dollars in thousands):
Table 12: Allocation of Allowance for Loan Losses
- ---------------------------------------------------
At December 31 At March 31
-------------------------------------------------------------------- ----------------
2002 2001 2000 1999 1999
----------------- --------------- ---------------- --------------- ----------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------- ------- ------- ------ ------ -------- ------ ------- ------ -------
Specific or allocated
loss allowances (1):
Loans secured by real
estate:
One- to four-
family $ 670 22.59% $ 2,366 26.52% $ 2,256 27.48% $ 2,334 31.71% $ 2,757 34.93%
Commercial/
multifamily 5,645 28.69 4,560 27.78 5,457 30.29 4,273 30.01 3,567 23.80
Construction and
land 5,892 21.58 3,431 21.08 2,738 18.24 1,638 14.73 1,597 14.82
Commercial/
agricultural
business 10,952 24.65 5,650 21.75 3,540 19.94 2,830 18.91 2,522 13.42
Consumer 698 2.49 774 2.87 879 4.05 1,023 4.64 841 3.98
Unallocated general
loss allowance (1) 2,682 N/A 771 N/A 444 N/A 1,443 N/A 977 N/A
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total allowance for
loan losses $26,539 100.00% $17,552 100.00% $15,314 100.00% $13,541 100.00% $12,261 100.00%
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
(1) The Company establishes specific loss allowances when individual loans are identified that present a
possibility of loss (i.e., that full collectibility is not reasonably assured). The remainder of the
allocated and unallocated allowance for loan losses is established for the purpose of providing for
estimated losses which are inherent in the loan portfolio.
38
Other Operating Income: Other operating income was $15.9 million for the year
ended December 31, 2002, an increase of $2.4 million from the year ended
December 31, 2001. This included a $313,000 increase in loan servicing income
and a $2.1 million increase in the gain on sale of loans for the current year
as lower interest rates led to increased mortgage banking activity. Loan
sales for the year ended December 31, 2002 totaled $457.7 million, including
$96.7 million of loans sold by CFC, compared to $265.8 million for the year
ended December 31, 2001. Other fee and service charge income for the Company
increased by $100,000 to $5.8 million for the year ended December 31, 2002,
from $5.7 million for the year ended December 31, 2001, primarily reflecting
growth in customer transaction accounts. Miscellaneous income increased by
$539,000, largely as a result of the Company's increased investment in
bank-owned life insurance and the resulting increase in cash surrender value.
Other Operating Expenses: Other operating expenses increased $809,000 from
$59.6 million for the year ended December 31, 2001, to $60.4 million for the
year ended December 31, 2002. However, as explained in the "Recent
Developments and Significant Events" section above, other operating expenses
for the year ended December 31, 2001 included a check kiting loss of $8.1
million, which was not a factor in 2002. Other operating expenses for the
year ended December 31, 2001 also included approximately $1.4 million of
expenses associated with the conversion of the Company's core data processing
system. In addition, the amortization of goodwill decreased $3.2 million for
the year ended December 31, 2002 as a result of the adoption of SFAS No. 142.
Excluding the check kiting charge, data processing conversion costs and change
in goodwill amortization, other operating expenses increased $13.5 million
compared to the prior year. Increases in other operating expenses, excluding
the check kiting charge, conversion costs and change in goodwill amortization,
reflect the overall growth in assets and liabilities, customer relationships
and complexity of operations as the Company continues to expand. The higher
level of operating expenses in the current year includes significant increases
in compensation for credit examination and special assets personnel as well as
additional executive management and production staff hired to re-position the
Company for future growth. In addition, compensation was higher as a result
of increased incentive compensation caused by the elevated level of mortgage
banking activity in the current year. The Company also significantly
increased its commitment to advertising and marketing expenditures which were
$1.0 million greater in the year ended December 31, 2002 than in the prior
year. The increase in expenses includes operating costs associated with OBB,
which was acquired on January 1, 2002, and opening new branch offices in
Spokane and Pasco, Washington. The increase also reflects expenses associated
with the expanding operations at BB's mortgage lending subsidiary, CFC.
Further, in the quarter ended December 31, 2002, the Company opened new
commercial lending centers in Portland, Bellevue (greater Seattle), and the
Tri-Cities. The higher operating expenses associated with the Company's
transition to more of a commercial bank profile caused the Company's
efficiency ratio to increase to 64.18% for the year ended December 31, 2002,
from 56.76% (70.01% including the amortization of goodwill and the recognition
of the check kiting loss) for the prior year ended December 31, 2001. Other
operating expenses as a percentage of average assets increased to 2.81% for
the year ended December 31, 2002, compared to 2.41% (2.92% including the
amortization of goodwill and the check kiting loss) for the prior year.
Income Taxes: Income tax expense was $3.5 million for the year ended December
31, 2002, compared to $4.1 million for the prior year. The Company's
effective tax rates for the years ended December 31, 2002 and 2001 were 27.3%
and 35.7%, respectively. The lower effective tax rate in the current year is
primarily a result of a decrease in the relative effect of the non-deductible
intangible amortization expense reflecting the discontinuance of the
amortization of goodwill as well as an increase in the relative benefit of
tax-exempt income compared to the prior year.
Comparison of Results of Operations for the Years Ended December 31, 2001 and
2000
General: Net income for the year ended December 31, 2001 was $7.5 million, or
$0.64 per share (diluted), compared to net income of $18.3 million, or $1.60
per share (diluted), for the year ended December 31, 2000. The decrease in
net income resulted from the expenses associated with the check kiting scheme
and additional loan loss provision described in the "Recent Developments and
Significant Events" section above. Excluding those charges and the related
tax effect, net income for the year ended December 31, 2001 would have
increased $1.0 million compared to the prior year. BANR's operating results
(excluding the check kiting and credit manipulation charges) reflect
significant growth of assets and liabilities, which was offset by a higher
level of loan loss provision and other operating expenses. As explained
below, the provision for loan losses increased for reasons other than the
credit manipulation activities and other operating expense included certain
unusual data processing conversion and related technology expenses. Net
interest margin decreased by four basis points for the year reflecting changes
in the level of market rates and the increased use of interest-bearing
liabilities relative to interest-earning assets. The Company's operating
results also reflect a significant increase in other operating revenues,
particularly gain on sale of loans from mortgage banking operations and
miscellaneous income. Average equity was 9.64% of average assets for the year
ended December 31, 2001, compared to 9.58% of average assets for the prior
year. The modest changes in net interest spread and net interest margin are
notable in light of the significant volatility and changes in the level of
market interest rates during this two-year period. After declining on a
sequential basis in the first and second quarters of the year 2001, both net
interest spread and net interest margin expanded in the final two quarters as
deposit costs, which tend to lag changes in market rates, declined more
rapidly than asset yields.
Interest Income: Interest income for the year ended December 31, 2001 was
$157.7 million, compared to $158.3 million for the year ended December 31,
2000, a decrease of $632,000, or 0.4%. The decrease in interest income
occurred despite a $97.4 million, or 5.3%, growth in average balances of
interest-earning assets as a result of a 47 basis point decrease in the
average yield on those assets. The yield on average interest-earning assets
decreased to 8.21% for the year ended December 31, 2001, compared to 8.68% for
the prior year. Average loans receivable for the year ended December 31, 2001
increased by $146.5 million, or 10.3%, when compared to the year ended
December 31, 2000, reflecting the Bank's significant internal growth.
Interest income on loans increased by $4.4 million, or 3.3%, compared to the
prior year, as the impact of the increase in average loan balances was
substantially offset by a 58 basis point decrease in the average yield. The
decrease in
39
average loan yield reflects the significant decline in the level of market
interest rates, particularly the prime rate, compared to prior year levels,
which offset continued changes in the mix of the loan portfolio. The loan mix
continued to change as the portion of the portfolio invested in one- to
four-family residential loans declined, while the portion invested in
construction, land development and commercial loans increased. Loans yielded
8.65% for the year ended December 31, 2001, compared to 9.23% for the year
ended December 31, 2000. While the level of market interest rates experienced
a steep decline throughout the year, during the third and fourth quarters,
loan yields were supported to a degree by certain loans with rate floors and
by changes in the portfolio mix. The average balance of mortgage-backed
securities, investment securities, daily interest-bearing deposits and FHLB
stock decreased by $49.0 million for the year ended December 31, 2001, and the
interest and dividend income from those investments decreased $5.0 million,
compared to the prior year. The average yield on mortgage-backed securities
decreased from 6.80% for the year ended December 31, 2000, to 6.08% for the
year ended December 31, 2001. Yields on mortgage-backed securities were lower
in 2001, reflecting the effect of lower market rates on the interest rates
paid on the significant portion of those securities that have adjustable rates
and more rapid prepayments on certain higher-yielding portions of the
portfolio. The average yield on investment securities and short-term cash
investments decreased from 6.65% for the year ended December 31, 2000, to
6.34% for the year ended December 31, 2001, also reflecting the lower level of
market rates. Earnings on FHLB stock increased by $305,000, resulting from an
increase of $3.0 million in the average balance of FHLB stock for the year
ended December 31, 2001 and a higher dividend yield. The dividend yield on
FHLB stock was 6.88% for the year ended December 31, 2001, compared to 6.50%
for the year ended December 31, 2000.
Interest Expense: Interest expense for the year ended December 31, 2001 was
$85.9 million, compared to $89.6 million for the prior year, a decrease of
$3.7 million, or 4.1%. The decrease in interest expense was due to a decrease
in the average cost of all interest-bearing liabilities from 5.19% to 4.69%.
The $111.3 million increase in average interest-bearing deposits for the year
ended December 31, 2001, compared to December 31, 2000, reflects the solid
deposit growth throughout the Company over that period. Deposit interest
expense decreased $418,000 for the year ended December 31, 2001, compared to
the prior year. Average deposit balances increased from $1.141 billion for
the year ended December 31, 2000 to $1.252 billion for the year ended December
31, 2001, while, at the same time, the average rate paid on deposit balances
decreased 45 basis points. To a significant degree, deposit costs for each
quarter reflect market interest rates and pricing decisions made three to
twelve months prior to the end of that quarter. Generally, market interest
rates for deposits were declining and lower throughout the year ended December
31, 2001, than in the year ended December 31, 2000. The reduction in deposit
costs, which tends to lag declines in market rates, accelerated during the
fourth quarter as a result of the cumulative effect of declining rates in the
two preceding quarters as well as sharply lower rates in that quarter. The
significant decline in the cost of deposits for the fourth quarter was largely
responsible for an improved net interest spread for both the quarter and year
ended December 31, 2001, although as noted above, the net interest margin for
the year actually declined by four basis points as a result of the increased
use of interest-bearing liabilities relative to interest-bearing deposits.
Average FHLB advances totaled $505.6 million during the year ended December
31, 2001, compared to $509.7 million during the prior year, a decrease of $4.0
million that, combined with a 26 basis point decrease in the average cost of
advances, resulted in a $1.6 million decrease in related interest expense.
The average rate paid on those advances decreased to 5.93% for the year ended
December 31, 2001, from 6.19% for the prior year. Other borrowings consist of
retail repurchase agreements with customers and repurchase agreements with
investment banking firms secured by certain investment securities. The
average balance for other borrowings decreased $1.6 million from $75.3 million
for the year ended December 31, 2000, to $73.7 million for the year ended
December 31, 2001, while the related interest expense decreased $1.7 million
from $4.9 million to $3.3 million for the respective periods. The average
rate paid on other borrowings was 4.41% in the year ended December 31, 2001,
compared to 6.52% for the prior year. Similar to deposits, the cost of FHLB
advances reflects to a degree a lagged effect from prior year market interest
rate levels, while the Company's other borrowings generally have relatively
short terms and therefore reprice to current market levels more quickly.
Provision and Allowance for Loan Losses: During the year ended December 31,
2001, the provision for loan losses was $14.0 million, compared to $2.9
million for the prior year, an increase of $11.1 million. As explained above,
provision for loan losses is one of the most critical accounting estimates
included in the Company's financial statements requiring significant
management judgment. The increase in the provision for losses reflects the
amount required to maintain the allowance for losses at an appropriate level
based upon management's evaluation of the adequacy of general and specific
loss reserves as more fully explained above. The higher provision in the year
ended December 31, 2001 reflects changes in the portfolio mix, higher levels
of non-performing loans and net charge-offs, and concerns about the economic
environment, but primarily reflects charges associated with the credit
manipulation activities of a former senior commercial loan officer which were
designed to conceal weaknesses of several loan customers. The provision for
loan losses for the year ended December 31, 2001 included $10.2 million of
charges associated with the credit manipulation activities. Non-performing
loans increased to $18.0 million at December 31, 2001, compared to $8.4
million at December 31, 2000. Non-performing loans at December 31, 2001
included $9.2 million of nonaccrual loans associated with the credit
manipulation activities. Net charge-offs were $11.7 million for the year
ended December 31, 2001, compared to $1.0 million for the prior year. Net
charge-offs for the year ended December 31, 2001 included $9.3 million
associated with the credit manipulation activities. A comparison of the
allowance for loan losses at December 31, 2001 and 2000 shows an increase of
$2.2 million from $15.3 million at December 31, 2000, to $17.6 million at
December 31, 2001. The allowance for loan losses as a percentage of net loans
(loans receivable excluding allowance for losses) was 1.10% and 1.03% at
December 31, 2001 and December 31, 2000, respectively. The allowance for loan
losses equaled 97% of non-performing loans at December 31, 2001, compared to
183% of non-performing loans at December 31, 2000.
Other Operating Income: Other operating income was $13.5 million for the year
ended December 31, 2001, an increase of $4.2 million from the year ended
December 31, 2000. This included a $2.1 million increase in the gain on sale
of loans as lower interest rates led to increased mortgage banking activity.
Loan sales for the year ended December 31, 2001 totaled $265.8 million,
compared to $143.8 million for the year ended December 31, 2000. Other fee
and service charge income for the Company increased by $453,000 to $5.7
million for the year ended
40
December 31, 2001, compared to $5.3 million for the year ended December 31,
2000. Miscellaneous income increased by $990,000, in large part reflecting
the Company's increased investment in bank-owned life insurance and the
resulting increase in cash surrender value.
Other Operating Expenses: Other operating expenses increased $13.1 million
from $46.5 million for the year ended December 31, 2000, to $59.6 million for
the year ended December 31, 2001. As noted above, other operating expense for
the year ended December 31, 2001 included a charge of $8.1 million associated
with a check kiting scheme that had been concealed by a former senior lending
officer of BB. Excluding the check kiting charge, other operating expense
increased $5.0 million compared to the prior year. Increases in other
operating expenses, excluding the check kiting charge, reflect the overall
growth in assets and liabilities, customer relationships and complexity of
operations as the Company expanded. The increase in expenses reflects the
inclusion of a full year of costs associated with two new bank branches that
were opened during the year ended December 31, 2000. The increase also
reflects expenses associated with the expanding operations at BB's lending
subsidiary, CFC. The increase in other operating expenses was partially
offset by a $1.4 million increase in capitalized loan origination costs,
reflecting a greater level of loan origination activity. Additionally, during
the year ended December 31, 2001, the Company incurred approximately $1.4
million of expenses associated with the conversion of the Company's core data
processing system and an additional $200,000 for other technology
enhancements. The higher operating expenses associated with the Company's
transition to more of a commercial bank profile, coupled with the recognition
of the check kiting loss, caused the Company's efficiency ratio, excluding the
amortization of goodwill, to increase to 66.27% (70.01% including goodwill),
for the year ended December 31, 2001, from 55.59% (59.65% including goodwill)
for the prior year ended December 31, 2000. Other operating expenses as a
percentage of average assets increased to 2.92% (2.81% excluding the
amortization of goodwill) for the year ended December 31, 2001, compared to
2.42% (2.30% excluding the amortization of goodwill) for the prior year. The
Company's efficiency ratio adjusted to exclude amortization of goodwill, the
check kiting loss and the unusual conversion and technology expenses, would
have been 54.89% for the year and, excluding the same items, adjusted
operating expenses as a percentage of average assets would have been 2.33%.
Income Taxes: Income tax expense was $4.1 million for the year ended December
31, 2001, compared to $10.2 million for the prior year. The Company's
effective tax rates for the years ended December 31, 2001 and 2000 were 35.7%
and 35.8%, respectively. The effective tax rate was nearly unchanged as a
larger relative effect of the non-deductible goodwill amortization expense in
the current year was offset by the recovery of amounts accrued for certain tax
matters relating to years closed to audit.
Yields Earned and Rates Paid
The earnings of the Company depend largely on the spread between the yield on
interest-earning assets (primarily loans and investment securities) and the
cost of interest-bearing liabilities (primarily deposit accounts and FHLB
advances), as well as the relative size of the Company's interest-earning
assets and interest-bearing liability portfolio.
Changes in the economic and interest rate environment, competition in the
marketplace and changes in asset and liability mix can cause the Company's
average interest rate spread to increase or decrease. Strong competition for
both loans and deposits has placed pressure on average interest rate spreads
for all of the periods reflected in Table 13. In addition, volatile market
interest rates over those periods have impacted spreads both positively and
negatively. However, while changes in asset yields and liability costs have
been significant, rising sharply in 1999 and 2000 and then declining even more
sharply in 2001 and 2002, the changes in net interest spread and margin have
been relatively modest. After increasing in prior periods, the Company's net
interest margin declined modestly in 2000 and 2001 and then increased in 2002,
returning to a level comparable with 1999. Much of the margin expansion that
occurred in the earlier periods reflects the positive impact of changes in the
mix of assets and liabilities. In particular, during this time the relative
portion of the Company's assets invested in securities declined while the
amount invested in loans increased. In addition, the mix of the loan
portfolio shifted to include a greater amount of relatively higher yielding
construction and commercial loans. On the liability side, increases in lower
costing transaction accounts were generally offset by increasing use of higher
costing borrowings. For the year ended December 31, 2002, strong deposit
growth, including significant growth in transaction accounts, allowed for less
reliance on borrowings which, coupled with lower interest rates, led to an
increase in net interest margin for that year. Counterbalancing to a degree
the positive impact of mix changes on the net interest spread has been the
somewhat adverse impact on net interest margin resulting from the increased
use of leverage, which can be seen in the declining ratio of average
interest-earning assets to interest-bearing liabilities. Management believes
that in the future increased net interest income will come primarily from
increased volumes, although continued changes in asset and liability mix and a
slightly more favorable interest rate environment may also add to net interest
income.
Table 13, Analysis of Net Interest Spread, sets forth, for the periods
indicated, information regarding average balances of assets and liabilities as
well as the total dollar amounts of interest income from average
interest-earning assets and interest expense on average interest-bearing
liabilities, resultant yields, interest rate spread, net interest margin, and
ratio of average interest-earning assets to average interest-bearing
liabilities. Average balances for a period have been calculated using the
daily average during such period.
41
Table 13: Analysis of Net Interest Spread (dollars in thousands)
- -----------------------------------------
Year Ended December 31, 2002 Year Ended December 31, 2001 Year Ended December 31, 2000
----------------------------- ------------------------------ ----------------------------
Average Interest & Yield/ Average Interest & Yield/ Average Interest & Yield/
Balance Dividends Cost Balance Dividends Cost Balance Dividends Cost
------- --------- ---- ------- --------- ---- ------- --------- ----
Interest-earning
assets:
Mortgage loans $1,180,199 $ 95,342 8.08% $1,197,445 $103,459 8.64% $1,083,775 $ 97,106 8.96%
Commercial/
agricultural
loans 366,606 25,217 6.88 316,081 27,003 8.54 271,144 27,372 10.10
Consumer and
other loans 42,230 2,793 6.61 56,379 5,303 9.41 68,531 6,916 10.09
---------- -------- ----- ---------- -------- ----- ---------- -------- ------
Total
loans(1) 1,589,035 123,352 7.76 1,569,905 135,765 8.65 1,423,450 131,394 9.23
Mortgage-backed
securities 209,493 10,738 5.13 200,429 12,196 6.08 225,794 15,358 6.80
Securities and
deposits 172,339 8,226 4.77 120,993 7,672 6.34 147,607 9,818 6.65
FHLB stock 31,587 1,960 6.21 29,551 2,033 6.88 26,580 1,728 6.50
---------- -------- ----- ---------- -------- ----- ---------- -------- ------
Total investment
securities 413,419 20,924 5.06 350,973 21,901 6.24 399,981 26,904 6.73
---------- -------- ----- ---------- -------- ----- ---------- -------- ------
Total interest-
earning
assets 2,002,454 144,276 7.20 1,920,878 157,666 8.21 1,823,431 158,298 8.68
-------- ----- -------- ----- -------- ------
Non-interest-
earning assets 148,706 122,712 98,282
---------- ---------- ----------
Total assets $2,151,160 $2,043,590 $1,921,713
========== ========== ==========
Interest-bearing
liabilities:
Savings
accounts $ 43,383 225 1.07 $ 42,946 725 1.69 $ 49,523 1,449 2.93
Checking and
NOW accounts(2) 311,210 644 0.41 243,171 1,364 0.56 199,394 1,169 0.59
Money market
accounts 146,504 1,592 2.18 129,896 4,249 3.27 137,876 5,632 4.08
Certificates of
deposit 903,329 36,745 3.79 835,957 46,364 5.55 753,922 44,870 5.95
---------- -------- ----- ---------- -------- ----- ---------- -------- ------
Total
deposits 1,404,426 39,206 2.79 1,251,970 52,702 4.21 1,140,715 53,120 4.66
Other interest-
bearing
liabilities:
FHLB advances 451,816 24,094 5.33 505,631 29,990 5.93 509,665 31,568 6.19
Trust preferred
securities 18,685 1,151 6.16 -- -- -- -- -- -
Other
borrowings 66,578 1,518 2.28 73,695 3,252 4.41 75,260 4,906 6.52
---------- -------- ----- ---------- -------- ----- ---------- -------- ------
Total
borrowings 537,079 26,763 4.98 579,326 33,242 5.74 584,925 36,474 6.24
---------- -------- ----- ---------- -------- ----- ---------- -------- ------
Total interest-
bearing
liabilities 1,941,505 65,969 3.40 1,831,296 85,944 4.69 1,725,640 89,594 5.19
-------- ----- -------- ----- -------- ------
Non-interest-
bearing
liabilities 13,177 15,277 11,906
---------- ---------- ----------
Total
liabilities 1,954,682 1,846,573 1,737,546
---------- ---------- ----------
Stockholders'
equity 196,478 197,017 184,167
---------- ---------- ----------
Total liabili-
ties and
Stockholders'
equity $2,151,160 $2,043,590 $1,921,713
========== ========== ==========
Net interest
income/rate
spread $ 78,307 3.80% $ 71,722 3.52% $ 68,704 3.49%
======== ===== ======== ===== ======== =====
Net interest
margin 3.91% 3.73% 3.77%
===== ===== =====
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities 103.14% 104.89% 105.67%
====== ====== ======
(footnotes follow tables)
42
Table 13: Analysis of Net Interest Spread (dollars in thousands) (continued)
- -----------------------------------------
Year Ended December 31, 1999 Nine Months Ended December 31, 1999 (3)
--------------------------------- -----------------------------------
Average Interest & Yield/ Average Interest & Yield/
Balance Dividends Cost Balance Dividends Cost
------- --------- ---- ------- --------- ----
Interest-earning assets:
Mortgage loans $ 921,520 $ 80,289 8.71% $ 943,498 $ 61,589 8.66%
Commercial/agricultural
loans 219,982 20,751 9.43 230,067 16,230 9.36
Consumer and other loans 54,736 5,428 9.92 57,600 4,288 9.88
---------- --------- ------ ---------- --------- ------
Total loans (1) 1,196,238 106,468 8.90 1,231,165 82,107 8.85
Mortgage-backed securities 238,888 14,953 6.26 241,760 11,630 6.38
Securities and deposits 135,223 8,360 6.18 128,330 6,009 6.21
FHLB stock 23,360 1,721 7.37 23,565 1,286 7.24
---------- --------- ------ ---------- --------- ------
Total investment
securities 397,471 25,034 6.30 393,655 18,925 6.38
---------- --------- ------ ---------- --------- ------
Total interest-earning
assets 1,593,709 131,502 8.25 1,624,820 101,032 8.25
--------- ------ --------- ------
Non-interest-earning assets 97,338 99,356
---------- ----------
Total assets $1,691,097 $1,724,176
========== ==========
Interest-bearing liabilities:
Savings accounts $ 58,568 1,752 2.99 $ 58,942 1,336 3.01
Checking and NOW accounts(2) 1,161 1,161 0.62 191,705 896 0.62
Money market accounts 145,182 5,358 3.69 149,269 4,152 3.69
Certificates of deposit 610,136 32,530 5.33 629,856 25,091 5.29
---------- --------- ------ ---------- --------- ------
Total deposits 1,000,748 40,801 4.08 1,029,772 31,475 4.06
Other interest-bearing
liabilities:
FHLB advances 420,647 24,284 5.77 425,293 18,505 5.78
Trust preferred securities -- -- -- -- -- -
Other borrowings 78,292 4,275 5.46 77,680 3,221 5.50
---------- --------- ------ ---------- --------- ------
Total borrowings 498,939 28,559 5.72 502,973 21,726 5.73
---------- --------- ------ ---------- --------- ------
Total interest-bearing
liabilities 1,499,687 69,360 4.62 1,532,745 53,201 4.61
--------- ------ --------- ------
Non-interest-bearing
liabilities 11,251 11,422
---------- ----------
Total liabilities 1,510,938 1,544,167
---------- ----------
Stockholders' equity 180,159 180,009
---------- ----------
Total liabilities and
stockholders' equity $1,691,097 $1,724,176
========== ==========
Net interest income/
rate spread $ 62,142 3.63% $ 47,831 3.64%
========= ====== ========= ======
Net interest margin 3.90% 3.91
====== ======
Ratio of average interest-
earning assets to average
interest-bearing
liabilities 106.27% 106.01%
====== ======
(1) Average balances include loans accounted for on a nonaccrual basis and loans 90 days or more past due.
Amortized net deferred loan fees are included with interest and dividends on loans.
(2) Average balances include non-interest-bearing deposits.
(3) Yield/cost rates are annualized.
(4) Restated to be comparable to current period's presentation.
43
Table 14, Rate/Volume Analysis, sets forth the effects of changing rates and volumes on net interest income
of the Company. Information is provided with respect to (i) effects on interest income attributable to
changes in volume (changes in volume multiplied by prior rate) and (ii) effects on interest income
attributable to changes in rate (changes in rate multiplied by prior volume). Effects on interest income
attributable to changes in rate and volume (changes in rate multiplied by changes in volume) have been
allocated between changes in rate and changes in volume.
Table 14: Rate/Volume Analysis (in thousands)
- -------------------------------
Year Ended Year Ended Year Ended
December 31, 2002 December 31, 2001 December 31, 2000
Compared to Year Ended Compared to Year Ended Compared to Year Ended
December 31, 2001 December 31, 2000 December 31, 1999
Increase (Decrease) Due to Increase (Decrease) Due to Increase (Decrease) Due to
-------------------------- -------------------------- -------------------------
Rate Volume Net Rate Volume Net Rate Volume Net
---- ------ --- ---- ------ --- ---- ------- ---
Interest-earning assets:
Mortgage loans $ (6,641) $ (1,476) $ (8,117) $ (3,560) $ 9,913 $ 6,353 $ 2,357 $14,460 $16,817
Commercial/
agricultural loans (5,716) 3,930 (1,786) (4,557) 4,188 (369) 1,549 5,072 6,621
Consumer and other
loans (1,362) (1,148) (2,510) (444) (1,169) (1,613) 95 1,393 1,488
-------- -------- -------- -------- ------- -------- ------- ------- -------
Total loans (1) (13,719) 1,306 (12,413) (8,561) 12,932 4,371 4,001 20,925 24,926
-------- -------- -------- -------- ------- -------- ------- ------- -------
Mortgage-backed
securities (1,985) 527 (1,458) (1,534) (1,628) (3,162) 1,250 (845) 405
Securities and
deposits (2,195) 2,749 554 (441) (1,705) (2,146) 662 796 1,458
FHLB stock (207) 134 (73) 105 200 305 (215) 222 7
-------- -------- -------- -------- ------- -------- ------- ------- -------
Total investment
securities (4,387) 3,410 (977) (1,870) (3,133) (5,003) 1,697 173 1,870
-------- -------- -------- -------- ------- -------- ------- ------- -------
Total net change in
interest income on
interest-earning
assets (18,106) 4,716 (13,390) (10,431) 9,799 (632) 5,698 21,098 26,796
-------- -------- -------- -------- ------- -------- ------- ------- -------
Interest-bearing
liabilities:
Deposits (19,347) 5,851 (13,496) (5,366) 4,948 (418) 6,209 6,110 12,319
-------- -------- -------- -------- ------- -------- ------- ------- -------
FHLB advances (2,874) (3,022) (5,896) (1,328) (250) (1,578) 1,865 5,419 7,284
Trust preferred
securities -- 1,151 1,151 -- -- -- -- -- --
Other borrowings (1,678) (56) (1,734) (1,641) (13) (1,654) 946 (315) 631
-------- -------- -------- -------- ------- -------- ------- ------- -------
Total borrowings (4,552) (1,927) (6,479) (2,969) (263) (3,232) 2,811 5,104 7,915
-------- -------- -------- -------- ------- -------- ------- ------- -------
Total net change in
interest expense on
interest-bearing
liabilities (23,899) 3,924 (19,975) (8,335) 4,685 (3,650) 9,020 11,214 20,234
-------- -------- -------- -------- ------- -------- ------- ------- -------
Net change in net
interest income $ 5,793 $ 792 $ 6,585 $ (2,096) $ 5,114 $ 3,018 $(3,322) $ 9,884 $ 6,562
======== ======== ======== ======== ======= ======== ======= ======= =======
(1) Does not include interest on loans 90 days or more past due.
44
Market Risk and Asset/Liability Management
The financial condition and operations of the Company are influenced
significantly by general economic conditions, including the absolute level of
interest rates as well as changes in interest rates and the slope of the yield
curve. The Company's profitability is dependent to a large extent on its net
interest income, which is the difference between the interest received from
its interest-earning assets and the interest expense incurred on its interest-
bearing liabilities.
The activities of the Company, like all financial institutions, inherently
involve the assumption of interest rate risk. Interest rate risk is the risk
that changes in market interest rates will have an adverse impact on the
institution's earnings and underlying economic value. Interest rate risk is
determined by the maturity and repricing characteristics of an institution's
assets, liabilities and off-balance-sheet contracts. Interest rate risk is
measured by the variability of financial performance and economic value
resulting from changes in interest rates. Interest rate risk is the primary
market risk impacting the Company's financial performance.
The greatest source of interest rate risk to the Company results from the
mismatch of maturities or repricing intervals for rate sensitive assets,
liabilities and off-balance-sheet contracts. This mismatch or gap is
generally characterized by a substantially shorter maturity structure for
interest-bearing liabilities than interest-earning assets; however, in the
current low interest rate environment, accelerated prepayments and calls on
loans and securities have resulted in shorter expected lives on many earning
assets than has historically been the case, reversing this general
characterization. Additional interest rate risk results from mismatched
repricing indices and formulae (basis risk and yield curve risk), and product
caps and floors and early repayment or withdrawal provisions (option risk),
which may be contractual or market driven, that are generally more favorable
to customers than to the Company.
The principal objectives of asset/liability management are: to evaluate the
interest rate risk exposure of the Company; to determine the level of risk
appropriate given the Company's operating environment, business plan
strategies, performance objectives, capital and liquidity constraints, and
asset and liability allocation alternatives; and to manage the Company's
interest rate risk consistent with regulatory guidelines and policies approved
by the Board of Directors. Through such management, the Company seeks to
reduce the vulnerability of its earnings and capital position to changes in
the level of interest rates. The Company's actions in this regard are taken
under the guidance of the Asset/Liability Management Committee, which is
comprised of members of the Company's senior management. The committee
closely monitors the Company's interest sensitivity exposure, asset and
liability allocation decisions, liquidity and capital positions, and local and
national economic conditions and attempts to structure the loan and investment
portfolios and funding sources of the Company to maximize earnings within
acceptable risk tolerances.
Sensitivity Analysis
The Company's primary monitoring tool for assessing interest rate risk is
asset/liability simulation modeling, which is designed to capture the dynamics
of balance sheet, interest rate and spread movements and to quantify
variations in net interest income resulting from those movements under
different rate environments. The sensitivity of net interest income to changes
in the modeled interest rate environments provides a measurement of interest
rate risk. The Company also utilizes market value analysis, which addresses
changes in estimated net market value of equity arising from changes in the
level of interest rates. The net market value of equity is estimated by
separately valuing the Company's assets and liabilities under varying interest
rate environments. The extent to which assets gain or lose value in relation
to the gains or losses of liability values under the various interest rate
assumptions determines the sensitivity of net equity value to changes in
interest rates and provides an additional measure of interest rate risk.
The interest rate sensitivity analysis performed by the Company incorporates
beginning-of-the-period rate, balance and maturity data, using various levels
of aggregation of that data, as well as certain assumptions concerning the
maturity, repricing, amortization and prepayment characteristics of loans and
other interest-earning assets and the repricing and withdrawal of deposits and
other interest-bearing liabilities into an asset/liability computer simulation
model. The Company updates and prepares simulation modeling at least
quarterly for review by senior management and the directors. The Company
believes the data and assumptions are realistic representations of its
portfolio and possible outcomes under the various interest rate scenarios.
Nonetheless, the interest rate sensitivity of the Company's net interest
income and net market value of equity could vary substantially if different
assumptions were used or if actual experience differs from the assumptions
used.
45
Tables 15 and 15(a), Interest Rate Risk Indicators, set forth as of December
31, 2002 and 2001, the estimated changes in the Company's net interest income
over a one-year time horizon and the estimated changes in market value of
equity based on the indicated interest rate environments.
Table 15: Interest Rate Risk Indicators (dollars in thousands)
- ---------------------------------------
As of December 31, 2002
Estimated Change in
---------------------------------------------
Change (in Basis Points) Net Interest Income
in Interest Rates (1) Next 12 Months Net Market Value
- ------------------------ -------------------- ----------------------
+400 $ 3,741 4.7% $ (52,299) (27.2%)
+300 1,671 2.1% (34,418) (18.1%)
+200 (606) (0.8%) (17,807) (9.4%)
+100 (1,546) (1.9%) (5,019) (2.6%)
0 0 0.0% 0 0.0%
-100 (683) (0.9%) (3,335) (1.8%)
-200 (4,157) (5.2%) (10,032) (5.3%)
-300 n/a n/a n/a n/a
-400 n/a n/a n/a n/a
Table 15(a): Interest Rate Risk Indicators (dollars in thousands)
- ------------------------------------------
As of December 31, 2001
Estimated Change in
---------------------------------------------
Change (in Basis Points) Net Interest Income
in Interest Rates (1) Next 12 Months Net Market Value
- ------------------------ -------------------- ----------------------
+400 $ 631 0.8% $ (84,482) (43.7%)
+300 1,123 1.4% (53,360) (27.6%)
+200 698 0.9% (30,333) (15.7%)
+100 (186) (0.2%) (11,231) (5.8%)
0 0 0% 0 0%
-100 (334) (0.4%) 1,846 1.0%
-200 (1,258) (1.6%) (1,692) (0.9%)
-300 n/a n/a n/a n/a
-400 n/a n/a n/a n/a
- ----------
1) Assumes an instantaneous and sustained uniform change in market interest
rates at all maturities.
46
Another although less reliable monitoring tool for assessing interest rate
risk is "gap analysis." The matching of the repricing characteristics of
assets and liabilities may be analyzed by examining the extent to which such
assets and liabilities are "interest sensitive" and by monitoring an
institution's interest sensitivity "gap." An asset or liability is said to be
interest sensitive within a specific time period if it will mature or reprice
within that time period. The interest rate sensitivity gap is defined as the
difference between the amount of interest-earning assets anticipated, based
upon certain assumptions, to mature or reprice within a specific time period
and the amount of interest-bearing liabilities anticipated to mature or
reprice, based upon certain assumptions, within that same time period. A gap
is considered positive when the amount of interest-sensitive assets exceeds
the amount of interest-sensitive liabilities. A gap is considered negative
when the amount of interest-sensitive liabilities exceeds the amount of
interest-sensitive assets. Generally, during a period of rising rates, a
negative gap would tend to adversely affect net interest income while a
positive gap would tend to result in an increase in net interest income.
During a period of falling interest rates, a negative gap would tend to result
in an increase in net interest income while a positive gap would tend to
adversely affect net interest income.
Certain shortcomings are inherent in gap analysis. For example, although
certain assets and liabilities may have similar maturities or periods of
repricing, they may react in different degrees to changes in market rates.
Also, the interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market rates, while interest rates on other
types may lag behind changes in market rates. Additionally, certain assets,
such as ARM loans, have features that restrict changes in interest rates on a
short-term basis and over the life of the asset. Further, in the event of a
change in interest rates, prepayment and early withdrawal levels would likely
deviate significantly from those assumed in calculating the table. Finally,
the ability of some borrowers to service their debt may decrease in the event
of a severe interest rate increase.
Tables 16 and 16(a), Interest Sensitivity Gap, present the Company's interest
sensitivity gap between interest-earning assets and interest-bearing
liabilities at December 31, 2002 and 2001. The tables set forth the amounts
of interest-earning assets and interest-bearing liabilities which are
anticipated by the Company, based upon certain assumptions, to reprice or
mature in each of the future periods shown. At December 31, 2002, total
interest-bearing liabilities maturing or repricing within one year exceeded
total interest-earning assets maturing or repricing in the same time period by
$200.2 million, representing a one-year gap to total assets ratio of 8.84%.
Management is aware of the sources of interest rate risk and in its opinion
actively monitors and manages it to the extent possible. The interest rate
risk indicators and interest sensitivity gaps for the Company as of December
31, 2002 and 2001 are within policy guidelines. Management considers that the
Company's current level of interest rate risk is reasonable.
47
Table 16: Interest Sensitivity Gap
- -----------------------------------
as of December 31, 2002
- -----------------------
After After After After
6 Months, 1 Year 3 Years, 5 Years
Within Within Within Within Within Over
6 Months 1 Year 3 Years 5 Years 10 Years 10 Years Total
---------- -------- --------- --------- ---------- ---------- --------
(dollars in thousands)
Interest-earning assets:(1)
Construction loans $ 239,747 $ 1,236 $ 1,818 $ 436 $ -- $ -- $ 243,237
Fixed-rate mortgage loans 77,666 47,131 131,239 109,811 141,993 46,425 554,265
Adjustable-rate mortgage
loans 200,050 56,350 74,033 25,392 3,647 -- 359,472
Fixed-rate mortgage-backed
securities 29,138 19,318 55,877 35,220 38,205 14,825 192,583
Adjustable-rate mortgage-
backed securities 76,167 -- -- -- -- -- 76,167
Fixed-rate commercial/
agricultural loans 29,776 16,490 33,779 10,489 3,706 90 94,330
Adjustable-rate commercial/
agricultural loans 253,248 4,269 5,200 3,718 304 -- 266,739
Consumer and other loans 28,841 7,330 14,135 6,658 1,923 327 59,214
Investment securities and
interest-earning deposits 152,375 4,213 19,553 2,350 6,308 56,275 241,074
--------- --------- --------- --------- -------- -------- ----------
Total rate sensitive
assets 1,087,008 156,337 335,634 194,074 196,086 117,942 2,087,081
--------- --------- --------- --------- -------- -------- ----------
Interest-bearing
liabilities:(2)
Regular savings and NOW
accounts 33,654 33,653 78,524 78,524 -- -- 224,355
Money market deposit
accounts 74,049 44,429 29,619 -- -- -- 148,097
Certificates of deposit 436,714 230,610 170,698 77,857 8,917 29 924,825
FHLB advances 44,790 106,400 130,694 61,930 121,079 849 465,742
Other borrowings 30,352 -- -- -- -- -- 30,352
Retail repurchase
agreements 8,393 125 1,796 -- 428 -- 10,742
--------- --------- --------- --------- -------- -------- ----------
Total rate sensitive
liabilities 627,952 415,217 411,331 218,311 130,424 878 1,804,113
--------- --------- --------- --------- -------- -------- ----------
Excess (deficiency) of
interest-sensitive assets
over interest-sensitive
liabilities $ 459,056 $(258,880) $ (75,697) $ (24,237) $ 65,662 $117,064 $ 282,968
========= ========= ========= ========= ======== ======== ==========
Cumulative excess
(deficiency) of interest-
sensitive assets $ 459,056 $ 200,176 $ 124,479 $ 100,242 $165,904 $282,968 $ 282,968
========= ========= ========= ========= ======== ======== ==========
Cumulative ratio of
interest-earning assets
to interest-bearing
liabilities 173.10% 119.19% 108.56% 105.99% 109.20% 115.68% 115.68%
========= ========= ========= ========= ======== ======== ==========
Interest sensitivity gap to
total assets 20.28% (11.44%) (3.34%) (1.07%) 2.90% 5.17% 12.50%
========= ========= ========= ========= ======== ======== ==========
Ratio of cumulative gap to
total assets 20.28% 8.84% 5.50% 4.43% 7.33% 12.50% 12.50%
========= ========= ========= ========= ======== ======== ==========
(footnotes follow tables)
48
Table 16(a): Interest Sensitivity Gap
- --------------------------------------
as of December 31, 2001
- ------------------------
After After After After
6 Months, 1 Year 3 Years, 5 Years
Within Within Within Within Within Over
6 Months 1 Year 3 Years 5 Years 10 Years 10 Years Total
---------- -------- --------- --------- ---------- ---------- --------
(dollars in thousands)
Interest-earning assets:(1)
Construction loans $ 226,785 $ 4,000 $ 2,581 $ 1,284 $ -- $ -- $ 234,650
Fixed-rate mortgage loans 55,894 39,456 129,272 97,285 158,105 172,712 652,724
Adjustable-rate mortgage
loans 184,250 60,550 57,062 11,278 -- -- 313,140
Fixed-rate mortgage-backed
securities 8,421 8,143 41,922 27,563 25,418 17,357 128,824
Adjustable-rate mortgage-
backed securities 74,579 3,562 -- -- -- -- 78,141
Fixed-rate commercial/
agricultural loans 13,181 10,950 36,882 25,072 8,655 1,285 96,025
Adjustable-rate commercial/
agricultural loans 239,283 -- -- -- -- -- 239,283
Consumer and other loans 27,170 8,472 15,561 6,817 3,981 -- 62,001
Investment securities and
interest-earning deposits 48,873 17,880 17,535 5,520 16,338 43,824 149,970
--------- --------- -------- --------- -------- -------- ----------
Total rate sensitive
assets 878,436 153,013 300,815 174,819 212,497 235,178 1,954,758
--------- --------- -------- --------- -------- -------- ----------
Interest-bearing liabilities:(2)
Regular savings and NOW
accounts 25,407 25,409 59,287 59,287 -- -- 169,390
Money market deposit
accounts 67,971 40,783 27,189 -- -- -- 135,943
Certificates of deposit 419,725 249,007 105,815 29,583 5,558 114 809,802
FHLB advances 88,100 87,370 99,984 100,600 125,079 849 501,982
Other borrowings 59,826 -- -- -- -- -- 59,826
Retail repurchase
agreements 13,937 447 2,368 -- -- -- 16,752
--------- --------- -------- --------- -------- -------- ----------
Total rate sensitive
liabilities 674,966 403,016 294,643 189,470 130,637 963 1,693,695
--------- --------- -------- --------- -------- -------- ----------
Excess (deficiency) of
interest-sensitive assets
over interest-sensitive
liabilities $ 203,470 $(250,003) $ 6,172 $ (14,651) $ 81,860 $234,215 $ 261,063
========= ========= ======== ========= ======== ======== ==========
Cumulative excess
(deficiency) of interest-
sensitive assets $ 203,470 $ (46,533) $(40,361) $ (55,012) $ 26,848 $261,063 $ 261,063
========= ========= ======== ========= ======== ======== ==========
Cumulative ratio of
interest-earning assets
to interest-bearing
liabilities 130.15% 95.68% 97.06% 96.48% 101.59% 115.41% 115.41%
========= ========= ======== ========= ======== ======== ==========
Interest sensitivity gap to
total assets 9.75% (11.98%) 0.30% (0.70%) 3.92% 11.22% 12.51%
========= ========= ======== ========= ======== ======== ==========
Ratio of cumulative gap to
total assets 9.75% (2.23%) (1.93%) (2.64%) 1.29% 12.51% 12.51%
========= ========= ======== ========= ======== ======== ==========
(footnotes follow tables)
49
Footnotes for Tables 16 and 16(a): Interest Sensitivity Gap
- ------------------------------------------------------------
(1) Adjustable-rate assets are included in the period in which interest rates
are next scheduled to adjust rather than in the period in which they are due
to mature, and fixed-rate assets are included in the period in which they are
scheduled to be repaid based upon scheduled amortization, in each case
adjusted to take into account estimated prepayments. Mortgage loans and other
loans are not reduced for allowances for loan losses and non-performing loans.
Mortgage loans, mortgage-backed securities, other loans and investment
securities are not adjusted for deferred fees and unamortized acquisition
premiums and discounts.
(2) Adjustable-rate liabilities are included in the period in which interest
rates are next scheduled to adjust rather than in the period they are due to
mature. Although the Bank's regular savings, demand, NOW, and money market
deposit accounts are subject to immediate withdrawal, based on historical
experience management considers a substantial amount of such accounts to be
core deposits having significantly longer maturities. For the purpose of the
gap analysis, these accounts have been assigned decay rates to reflect their
longer effective maturities. If all of these accounts had been assumed to be
short-term, the one-year cumulative gap of interest-sensitive assets would
have been $13.5 million, or 0.60% of total assets at December 31, 2002, and
$(192.3) million, or (9.21%), at December 31, 2001. Interest-bearing
liabilities for this table exclude certain non-interest-bearing deposits that
are included in the average balance calculations reflected in Table 13,
Analysis of Net Interest Spread, included in the section, "Yields Earned and
Rates Paid."
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, borrowings, proceeds from
loan principal and interest payments and sales of loans, and the maturity of
and interest income on mortgage-backed and investment securities. While
maturities and scheduled amortization of loans and mortgage-backed securities
are a predictable source of funds, deposit flows and mortgage prepayments are
greatly influenced by market interest rates, economic conditions and
competition.
The primary investing activity of the Company, through its subsidiaries, is
the origination and purchase of loans. During the years ended December 31,
2002, 2001 and 2000, the Company purchased loans of $52.0 million, $4.9
million and $12.0 million, respectively, while loan originations, net of
repayments, totaled $368.6 million, $346.3 million and $292.2 million,
respectively. This activity was funded primarily by principal repayments on
loans and securities, sales of loans, and deposit growth. During the years
ended December 31, 2002, 2001 and 2000, the Company sold $457.7 million,
$270.3 million and $135.7 million, respectively, of loans. Net deposit growth
was $202.0 million, $103.1 million and $114.6 million for the years ended
December 31, 2002, 2001 and 2000, respectively. FHLB advances decreased $36.2
million and $5.1 million for the years ended December 31, 2002 and 2001,
respectively, and increased $40.6 million for the year ended December 31,
2000. Other borrowings decreased $35.5 million for the year ended December
31, 2002, increased $2.2 million for the year ended December 31, 2001 and
decreased $7.1 million for the year ended December 31, 2000.
The Bank must maintain an adequate level of liquidity to ensure the
availability of sufficient funds to accommodate deposit withdrawals, to
support loan growth, to satisfy financial commitments and to take advantage of
investment opportunities. During the years ended December 31, 2002, 2001 and
2000, the Bank used its source of funds primarily to fund loan commitments, to
purchase securities, and to pay maturing savings certificates and deposit
withdrawals. At December 31, 2002, the Bank had outstanding loan commitments
totaling $410.9 million, including undisbursed loans in process and unused
credit lines, totaling $358.4 million. The Bank generally maintains
sufficient cash and readily marketable securities to meet short-term liquidity
needs. The Bank maintains a credit facility with the FHLB-Seattle, which
provides for advances that in the aggregate may equal the lesser of 35% of the
Bank's assets or adjusted qualifying collateral, up to a total possible credit
line of $695.0 million at December 31, 2002. Advances under this credit
facility totaled $465.7 million, or 20.6% of the Bank's assets, at December
31, 2002.
At December 31, 2002, savings certificates amounted to $924.8 million, or
61.7% of the Bank's total deposits, including $667.3 million which were
scheduled to mature by December 31, 2003. Historically, the Bank has been
able to retain a significant amount of its deposits as they mature.
Management believes it has adequate resources to fund all loan commitments
from savings deposits and FHLB-Seattle advances and sale of mortgage loans and
that it can adjust the offering rates of savings certificates to retain
deposits in changing interest rate environments.
50
Capital Requirements
The Company is a bank holding company registered with the Federal Reserve.
Bank holding companies are subject to capital adequacy requirements of the
Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA),
and the regulations of the Federal Reserve. Banner Bank, as a state-
chartered, federally insured commercial bank, is subject to the capital
requirements established by the FDIC.
The capital adequacy requirements are quantitative measures established by
regulation that require the Company and the Bank to maintain minimum amounts
and ratios of capital. The Federal Reserve requires the Company to maintain
capital adequacy that generally parallels the FDIC requirements. The FDIC
requires the Bank to maintain minimum ratios of Tier 1 total capital to
risk-weighted assets as well as Tier 1 leverage capital to average assets. At
December 31, 2002 the Company and the Bank exceeded all current regulatory
capital requirements. (See Item 1, "Business Regulation," and Note 18 of the
Notes to the Consolidated Financial Statements for additional information
regarding the Company's and the Bank's regulatory capital requirements.
Table 17, Regulatory Capital Ratios, shows the regulatory capital ratios of
the Company and its subsidiary Bank as of December 31, 2002 and minimum
regulatory requirements for the Bank to be categorized as "well-capitalized."
Table 17: Regulatory Capital Ratios
- ------------------------------------
The The "Well-capitalized"
Capital Ratios Company Bank Minimum Ratio
- ---------------------- ------- ------ ------------------
Total capital to risk-
weighted assets 12.96% 10.73% 10.00%
Tier 1 capital to risk-
weighted assets 11.66 9.43 6.00
Tier 1 leverage capital
to average assets 8.77 7.08 5.00
Effect of Inflation and Changing Prices
The Consolidated Financial Statements and related financial data presented
herein have been prepared in accordance with accounting principles generally
accepted in the United States of America, which require the measurement of
financial position and operating results in terms of historical dollars,
without considering the changes in relative purchasing power of money over
time due to inflation. The primary effect of inflation on operations of the
Company is reflected in increased operating costs. Unlike most industrial
companies, virtually all the assets and liabilities of a financial institution
are monetary in nature. As a result, interest rates generally have a more
significant effect on a financial institution's performance than do general
levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and services.
ITEM 7A - Quantitative and Qualitative Disclosures about Market Risk
See pages 45-50 of Management's Discussion and Analysis of Financial Condition
and Results of Operations.
ITEM 8 - Financial Statements and Supplementary Data
For financial statements, see index on page 57.
ITEM 9 - Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None
51
Part III
ITEM 10 - Directors and Executive Officers of the Registrant
The information contained under the section captioned "Proposal I - Election
of Directors" in the Registrant's Proxy Statement is incorporated herein by
reference.
Information regarding the executive officers of the Registrant is provided
herein in Part I, Item 1 hereof.
Reference is made to the cover page of this Annual Report and the section
captioned "Compliance with Section 16(a) of the Exchange Act" of the Proxy
Statement for the Annual Meeting of the Stockholders regarding compliance with
Section 16(a) of the Securities Exchange Act of 1934.
ITEM 11- Executive Compensation
Information regarding management compensation and transactions with management
and others is incorporated by reference to the section captioned "Proposal I -
Election of Directors" in the Proxy Statement for the Annual Meeting of
Stockholders.
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The following table summarizes share and exercise price information about the
Company's equity compensation plans as of December 31, 2002.
(c)
Number of securities
remaining available
(a) (b) for future issuance
Number of securities Weighted average under equity
to be issued upon exercise price compensation plans
exercise of of outstanding (excluding securities
outstanding options options, warrants reflected in
Plan category warrants and rights and rights column (a))
- ---------------- ------------------- ----------------- -------------------
Equity compen-
sation plans
approved by
security holders:
Option plan 1,760,975 $14.66 310,342
Restricted stock
plan 13,317 n/a 39,190
Equity compen-
sation plans
not approved
by security
holders: none n/a none
--------- -------
Total 1,774,292 349,932
========= =======
{a} Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" in the Proxy Statement for the Annual Meeting of Stockholders.
{b} Security Ownership of Management
Information required by this item is incorporated herein by reference to the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" in the Proxy Statement for the Annual Meeting of Stockholders.
{c} Changes in Control
The Company is not aware of any arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a
subsequent date result in a change in control of the Company.
ITEM 13 - Certain Relationships and Related Transactions
The information contained under the section captioned "Transactions with
Management" in the Proxy Statement for the Annual Meeting of Stockholders is
incorporated herein by reference.
52
ITEM 14 Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the
Company's disclosure controls and procedures (as defined in Section 13 (a)-
14(c) of the Securities Exchange Act of 1934 (the "Act")) was carried out
under the supervision and with the participation of the Company's Chief
Executive Officer, Chief Financial Officer and several other members of the
Company's senior management within the 90-day period preceding the filing date
of this Annual Report on form 10-K for the year ended December 31, 2002. The
Company's Chief Executive Officer and Chief Financial Officer concluded that
the Company's disclosure controls and procedures as currently in effect are
effective in ensuring that the information required to be disclosed by the
Company in the reports it files or submits under the Act is (i) accumulated
and communicated to the Company'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.
(b) Changes in Internal Controls: The Company has not made any significant
changes in, nor taken any corrective actions regarding, its internal controls
or other factors that could significantly affect these controls subsequent to
the date of that evaluation.
Part IV
ITEM 15 - Exhibits, Financial Statement Schedules and Reports on Form 8-K
{a} {1} Financial Statements
See Index to Consolidated Financial Statements on page 57.
{2} Financial Statement Schedules
All financial statement schedules are omitted because they are not
applicable or not required, or because the required information is
included in the Consolidated Financial Statements or the Notes thereto or
in Part 1, Item 1.
{b} Reports on 8-K:
Reports on Form 8-K filed during the quarter ended December 31,
2002 are as follows:
Date Filed Purpose
---------- -------
10/28/2002 On October 28, 2002 the Registrant announced that
its Board of Directors had elected a new member,
Gordon E. Budke, a Certified Public Accountant
who retired from Coopers & Lybrand in October
1997. Mr. Budke will stand for election at the
Registrant's annual meeting in April 2003.
12/23/2002 On December 20, 2002 the Registrant announced
that as a result of further deterioration in the
quality of the loan portfolio, it anticipates its
fourth quarter loan loss provision will be
approximately $7.0 million. The increase in the
provision will substantially eliminate fourth
quarter profitability for the Registrant.
{c} Exhibits
See Index of Exhibits on page 100.
53
Signatures of Registrant
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized on March 20, 2003.
Banner Corporation
/s/ D. Michael Jones
-------------------------------------
D. Michael Jones
President and Chief Executive 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 Company
and in the capacities indicated on March 20, 2003.
/s/ D. Michael Jones /s/ Lloyd W. Baker
- --------------------------------- -------------------------------------
D. Michael Jones Lloyd W. Baker
President and Chief Executive Executive Vice President and
Officer; Director Chief Financial Officer
(Principal Executive Officer) (Principal Financial and Accounting
Officer)
/s/ David Casper /s/ Robert D. Adams
- --------------------------------- -------------------------------------
David Casper Robert D. Adams
Director Director
/s/ Steven Sundquist /s/Jesse G. Foster
- --------------------------------- -------------------------------------
Steven Sundquist Jesse G. Foster
Director Director
/s/ Gary Sirmon /s/ Dean W. Mitchell
- --------------------------------- -------------------------------------
Gary Sirmon Dean W. Mitchell
Chairman of the Board Director
/s/ Brent A. Orrico /s/Wilber Pribilsky
- --------------------------------- -------------------------------------
Brent A. Orrico Wilber Pribilsky
Director Director
/s/ Margaret C. Langlie /s/Gordon E. Budke
- --------------------------------- -------------------------------------
Margaret C. Langlie Gordon E. Budke
Director Director
54
CERTIFICATIONS
CERTIFICATION OF CHIEF EXECUTIVE OFFICER OF BANNER CORPORATION
PURSUANT TO RULES 13a-14 AND 15d -14 UNDER THE SECURITIES ACT OF 1934
I, D. Michael Jones, certify that:
1. I have reviewed this Annual Report on Form 10-K of Banner Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation
Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
March 20, 2003 /s/D. Michael Jones
-------------------------------
D. Michael Jones
Chief Executive Officer
55
CERTIFICATIONS
CERTIFICATION OF CHIEF FINANCIAL OFFICER OF BANNER CORPORATION
PURSUANT TO RULES 13a-14 AND 15d -14 UNDER THE SECURITIES ACT OF 1934
I, Lloyd W. Baker, certify that:
1. I have reviewed this Annual Report on Form 10-K of Banner Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation
Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
March 20, 2003 /s/Lloyd W. Baker
-------------------------------
Lloyd W. Baker
Chief Financial Officer
56
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
BANNER CORPORATION AND SUBSIDIARIES
(Item 8 and Item 14 (a) (1))
Page
----
Report of Management................................................. 58
Report of Audit Committee............................................ 58
Independent Auditors' Report......................................... 59
Consolidated Statements of Financial Condition as of December 31,
2002 and 2001....................................................... 60
Consolidated Statements of Income for the Years Ended December 31,
2002, 2001 and 2000................................................. 61
Consolidated Statements of Comprehensive Income for the Years Ended
December 31, 2002, 2001, and 2000................................... 62
Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended December 31, 2002, 2001, and 2000....................... 63
Consolidated Statements of Cash Flows for the Years Ended December
31, 2002, 2001 and 2000............................................. 67
Notes to the Consolidated Financial Statements....................... 69
57
March 14, 2003
Report of Management:
To the Stockholders:
The management of Banner Corporation (the Company) is responsible for the
preparation, integrity, and fair presentation of its published financial
statements and all other information presented in this annual report. The
financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America and, as such,
include amounts based on informed judgments and estimates made by management.
In the opinion of management, the financial statements and other information
herein present fairly the financial condition and operations of the Company at
the dates indicated in conformity with accounting principles generally
accepted in the United States of America.
Management is responsible for establishing and maintaining an effective system
of internal control over financial reporting. The internal control system is
augmented by written policies and procedures and by audits performed by an
internal audit staff, which reports to the Audit Committee of the Board of
Directors. Internal auditors monitor the operation of the internal control
system and report findings to management and the Audit Committee. When
appropriate, corrective actions are taken to address identified control
deficiencies and other opportunities for improving the system. The Audit
Committee provides oversight to the financial reporting process. There are
inherent limitations in the effectiveness of any system of internal control,
including the possibility of human error and circumvention or overriding of
controls. Accordingly, even an effective internal control system can provide
only reasonable assurance with respect to financial statement preparation.
Further, because of changes in conditions, the effectiveness of an internal
control system may vary over time.
The Audit Committee of the Board of Directors is comprised entirely of outside
directors who are independent of the Company's management. The Audit
Committee is responsible for the selection of the independent auditors. It
meets periodically with management, the independent auditors and the internal
auditors to ensure that they are carrying out their responsibilities. The
Committee is also responsible for performing an oversight role by reviewing
and monitoring the financial, accounting, and auditing procedures of the
Company in addition to reviewing the Company's financial reports. The
independent auditors and the internal auditors have full and free access to
the Audit Committee, with or without the presence of management, to discuss
the adequacy of the internal control structure for financial reporting and any
other matters which they believe should be brought to the attention of the
Committee.
/s/D. Michael Jones, Chief Executive Officer
/s/Lloyd W. Baker, Chief Financial Officer
March 14, 2003
Report of the Audit Committee of the Board of Directors
The Audit Committee of the Board of Directors is comprised entirely of
independent directors who are not employees of the Company. The Audit
Committee has reviewed the audited financial statements of Banner Corporation
with management of the Company, including a discussion of the quality of the
accounting principles applied and significant judgments and estimates
affecting the financial statements. The Audit Committee has also discussed
with the outside auditors the auditors' opinion of the quality of those
principles and significant judgments as applied by management in preparation
of the financial statements. In addition, the members of the Audit Committee
have discussed among themselves, without management or the outside auditors
present, the information disclosed to the committee by management and the
outside auditors and have met regularly with the internal audit staff, without
management present, to review compliance with approved policies and
procedures. In reliance on these reviews and discussions, the Audit Committee
believes that the financial statements of Banner Corporation and subsidiaries
are fairly presented.
/s/Gordon E. Budke
Audit Committee Chairman
58
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Banner Corporation and Subsidiaries
Walla Walla, Washington
We have audited the accompanying consolidated statements of financial
condition of Banner Corporation and subsidiaries (the Company) as of December
31, 2002 and 2001, and the related consolidated statements of income,
comprehensive income, changes in stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 2002. These consolidated
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 auditing standards generally
accepted in the United States of America. 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, such consolidated financial statements present fairly, in all
material respects, the financial condition of Banner Corporation and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Notes 2 and 3 to the financial statements, the Company adopted
Statement of Financial Accountings Standards No. 142, Goodwill and Other
Intangible Assets, on January 1, 2002.
/s/Deloitte and Touche LLP
DELOITTE & TOUCHE LLP
Seattle, Washington
March 14, 2003
59
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except shares)
December 31, 2002 and 2001
2002 2001
---------- ----------
ASSETS
Cash and due from banks $ 132,910 $ 67,728
Securities available for sale, cost
$415,855 and $298,332
Encumbered 32,955 64,126
Unencumbered 388,267 237,721
---------- ----------
421,222 301,847
Securities held to maturity, fair value
$13,414 and $14,902 13,253 14,828
Federal Home Loan Bank stock 32,831 30,840
Loans receivable:
Held for sale, fair value $39,984 and $43,647 39,366 43,235
Held for portfolio 1,534,100 1,549,742
Allowance for loan losses (26,539) (17,552)
---------- ----------
1,546,927 1,575,425
Accrued interest receivable 13,689 12,929
Real estate held for sale, net 6,062 3,011
Goodwill and intangibles, net 36,714 31,437
Property and equipment, net 20,745 18,151
Deferred income tax asset, net 2,786 1,443
Bank owned life insurance 31,809 20,304
Other assets 4,224 9,151
---------- ----------
$2,263,172 $2,087,094
========== ==========
LIABILITIES
Deposits:
Non-interest-bearing $ 200,500 $ 180,813
Interest-bearing 1,297,278 1,114,998
---------- ----------
1,497,778 1,295,811
Advances from Federal Home Loan Bank 465,743 501,982
Trust preferred securities 40,000
Other borrowings 41,202 76,715
Accrued expenses and other liabilities 24,700 17,591
Deferred compensation 3,372 2,655
---------- ----------
2,072,795 1,894,754
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock - $0.01 par value, 500,000
shares authorized, no shares issued -- -
Common stock - $0.01 par value, 27,500,000
shares authorized, 13,201,418 shares issued:
11,306,977 shares and 11,634,159 shares
outstanding at December 31, 2002 and
2001, respectively 120,554 126,844
Retained earnings 70,813 68,104
Accumulated other comprehensive income (loss):
Unrealized gain (loss) on securities
available for sale 3,488 2,264
Unearned shares of common stock issued to
Employee Stock Ownership Plan (ESOP) trust:
515,707 and 577,039 restricted shares outstanding
at December 31, 2002 and 2001, respectively,
at cost (4,262) (4,769)
Carrying value of shares held in trust for
stock related compensation plans (3,190) (2,870)
Liability for common stock issued to deferred,
stock related, compensation plan 2,974 2,767
---------- ----------
(216) (103)
---------- ----------
190,377 192,340
---------- ----------
$2,263,172 $2,087,094
========== ==========
See notes to consolidated financial statements
60
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except for per share data)
For the Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
-------- -------- --------
INTEREST INCOME:
Loans receivable $123,352 $135,765 $131,394
Mortgage-backed securities 10,738 12,196 15,358
Securities and cash equivalents 10,186 9,705 11,546
-------- -------- --------
144,276 157,666 158,298
-------- -------- --------
INTEREST EXPENSE:
Deposits 39,206 52,702 53,120
Federal Home Loan Bank advances 24,094 29,990 31,568
Trust preferred securities 1,151 -- -
Other borrowings 1,518 3,252 4,906
-------- -------- --------
65,969 85,944 89,594
-------- -------- --------
Net interest income before provision
for loan losses 78,307 71,722 68,704
PROVISION FOR LOAN LOSSES 21,000 13,959 2,867
-------- -------- --------
Net interest income 57,307 57,763 65,837
OTHER OPERATING INCOME:
Loan servicing fees 1,471 1,158 1,069
Other fees and service charges 5,804 5,704 5,251
Mortgage banking operations 6,695 4,575 2,517
Gain on sale of securities 27 687 63
Miscellaneous 1,880 1,341 351
-------- -------- --------
Total other operating income 15,877 13,465 9,251
OTHER OPERATING EXPENSES:
Salary and employee benefits 38,262 29,865 26,392
Less capitalized loan origination costs (5,780) (4,897) (3,519)
Occupancy and equipment 8,522 7,947 7,084
Information/computer data services 3,331 4,191 2,526
Advertising 2,220 1,171 788
Check kiting loss -- 8,100 -
Amortization of goodwill and intangibles 255 3,180 3,170
Miscellaneous 13,635 10,079 10,061
-------- -------- --------
Total other operating expenses 60,445 59,636 46,502
-------- -------- --------
Income (loss) before provision for
income taxes 12,739 11,592 28,586
PROVISION FOR INCOME TAXES 3,479 4,142 10,238
-------- -------- --------
NET INCOME (LOSS) $ 9,260 $ 7,450 $ 18,348
======== ======== ========
Earnings (Loss) per common share: see
Notes 2 and 25
Basic $ 0.85 $ 0.67 $ 1.62
Diluted $ 0.82 $ 0.64 $ 1.60
Cumulative dividends declared per
common share $ 0.60 $ 0.56 $ 0.52
See notes to consolidated financial statements
61
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
For the Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
------- ------- -------
NET INCOME $ 9,260 $ 7,450 $18,348
OTHER COMPREHENSIVE INCOME (LOSS), NET
OF INCOME TAXES:
Unrealized holding gain (loss) during
the period, net of deferred income
tax (benefit) of $637, $2,107
and $2,344 1,241 3,836 4,248
Less adjustment for gains included in
net income, net of income tax of $10,
$240 and $21 (17) (447) (42)
------- ------- -------
Other comprehensive income (loss) 1,224 3,389 4,206
------- ------- -------
COMPREHENSIVE INCOME $10,484 $10,839 $22,554
======= ======= =======
See notes to consolidated financial statements
62
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
For the Years Ended December 31, 2002, 2001 and 2000
Carrying Value,
Net of Liability,
Of Shares Held
Common Stock Accumulated Unearned in Trust for
and Additional Other Restricted Stock-Related Total
Paid-in Retained Comprehensive ESOP Compensation Stockholders'
Capital Earnings Income (Loss) Shares Plans Equity
--------- -------- ------------- ---------- ------------ ------------
BALANCE, January 1, 2002 $ 126,844 $ 68,104 $ 2,264 $ (4,769) $ (103) $ 192,340
Net income 9,260 9,260
Change in valuation of
securities available for sale,
net of income taxes 1,224 1,224
Cash dividend on common stock (6,551) (6,551)
($.60/share cumulative)
Purchase and retirement of
common stock (8,391) (8,391)
Proceeds from issuance of
common stock for exercise
of stock options 1,205 1,205
Net issuance of stock through
employees' stock plans,
including tax benefit 896 507 (155) 1,248
Amortization of compensation
related to MRP 42 42
--------- -------- ------------- ---------- ------------ ------------
BALANCE, December 31, 2002 $ 120,554 $ 70,813 $ 3,488 $ (4,262) $ (216) $ 190,377
========= ======== ============= ========== ============ ============
Continued
63
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
For the Years Ended December 31, 2002, 2001 and 2000
Carrying Value,
Net of Liability,
Of Shares Held
Common Stock Accumulated Unearned in Trust for
and Additional Other Restricted Stock-Related Total
Paid-in Retained Comprehensive ESOP Compensation Stockholders'
Capital Earnings Income (Loss) Shares Plans Equity
--------- -------- ------------- ---------- ------------ ------------
BALANCE, January 1, 2001 $ 133,839 $ 66,893 $ (1,125) $ (5,234) $ (578) $ 193,795
Net income 7,450 7,450
Change in valuation of
securities available for
sale, net of income taxes 3,389 3,389
Cash dividend on common stock (6,239) (6,239)
($.56/share cumulative)
Purchase and retirement of
common stock (10,162) (10,162)
Proceeds from issuance of
common stock for exercise
of stock options 2,277 2,277
Net issuance of stock through
employees' stock plans,
including tax benefit 890 465 (48) 1,307
Amortization of compensation
related to MRP 523 523
--------- -------- ------------- ---------- ------------ ------------
BALANCE, December 31, 2001 $ 126,844 $ 68,104 $ 2,264 $ (4,769) $ (103) $ 192,340
========= ======== ============= ========== ============ ============
Continued
64
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
For the Years Ended December 31, 2002, 2001 and 2000
Carrying Value,
Net of Liability,
Of Shares Held
Common Stock Accumulated Unearned in Trust for
and Additional Other Restricted Stock-Related Total
Paid-in Retained Comprehensive ESOP Compensation Stockholders'
Capital Earnings Income (Loss) Shares Plans Equity
--------- -------- ------------- ---------- ------------ ------------
BALANCE, January 1, 2000 $ 123,204 $ 69,170 $ (5,331) $ (6,162) $ (1,708) $ 179,173
Net income 18,348 18,348
Change in valuation of
securities available for
sale, net of income taxes 4,206 4,206
Cash dividend on common stock (5,887) (5,887)
($.52/share cumulative)
Stock dividend 14,731 (14,731) --
Purchase and retirement of
common stock (5,373) (5,373)
Proceeds from issuance of
common stock for exercise of
stock options 578 578
Issuance of stock in connection
with acquisition 53 53
Net issuance of stock through
employees' stock plans,
including tax benefit 646 928 78 1,652
Other (7) (7)
Amortization of compensation
related to MRP 1,052 1,052
--------- -------- ------------- ---------- ------------ ------------
BALANCE, December 31, 2000 $ 133,839 $ 66,893 $ (1,125) $ (5,234) $ (578) $ 193,795
========= ======== ============= ========== ============ ============
65
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
For the Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
------ ------ ------
COMMON STOCK, SHARES ISSUED
Number of shares, beginning of period 13,201 13,201 13,201
------ ------ ------
Number of shares, end of period 13,201 13,201 13,201
------ ------ ------
LESS COMMON STOCK RETIRED/REPURCHASED
Number of shares, beginning of period (1,567) (1,196) (864)
Purchase and retirement of common stock (423) (569) (394)
Reissuance of common stock to deferred compensation
plans and/or exercised stock options 96 198 60
Stock issued in acquisitions -- -- 2
Shares of stock retired/repurchased, ------ ------ ------
end of period (1,894) (1,567) (1,196)
------ ------ ------
SHARES OUTSTANDING, END OF PERIOD* 11,307 11,634 12,005
====== ====== ======
UNEARNED, RESTRICTED ESOP SHARES:*
Number of shares, beginning of period (577) (633) (746)
Release of earned shares 61 56 113
------ ------ ------
Number of shares, end of period (516) (577) (633)
====== ====== ======
* Adjusted for stock dividends: see Note 2.
See notes to consolidated financial statements
66
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
------ ------ ------
OPERATING ACTIVITIES:
Net income $ 9,260 $ 7,450 $18,348
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,798 6,300 7,647
Loss (gain) on sale of securities (27) (687) (63)
Increase in cash surrender value of bank
owned life insurance (1,505) (1,114) (348)
Loss (gain) on sale of loans (5,649) (4,468) (2,121)
Loss (gain) on disposal of real estate held
for sale and property and equipment 920 289 84
Provision for losses on loans and real
estate held for sale 21,000 14,050 3,058
FHLB Stock dividend (1,957) (2,033) (1,727)
Change, net of acquisition, in:
Loans held for sale 3,869 (35,301) 1,585
Other assets 4,000 (7,075) (1,689)
Other liabilities 7,698 5,758 (141)
------ ------ ------
Net cash (used)provided by operating activities 41,407 (16,831) 24,633
------ ------ ------
INVESTING ACTIVITIES:
Purchases of securities (355,224)(125,381) (22,728)
Principal repayments and maturities of
securities 234,787 136,247 43,133
Proceeds from sales of securities 4,670 4,828 21,703
Origination of loans, net of principal
repayments (368,621)(346,316)(292,237)
Purchases of loans and participating interest
in loans (51,999) (4,860) (11,986)
Proceeds from sales of loans and participating
interest in loans 457,671 270,254 135,670
Purchases of property and equipment-net (5,452) (3,592) (3,868)
Proceeds from sale of real estate held for
sale-net 2,481 4,221 1,520
Investment in bank owned life insurance (10,000) (5,000) (10,000)
Cash (used for) provided by acquisitions (6,519) -- (6)
Purchases of FHLB stock -- -- (2,537)
Net (Funding) payout of deferred compensation
plans (311) (131) (136)
Other intangibles (25) --
------ ------ ------
Net cash used by investing activities (98,542) (69,730)(141,472)
------ ------ ------
FINANCING ACTIVITIES
Increase (decrease) in deposits 168,468 103,096 114,563
Proceeds from FHLB advances 310,931 213,064 873,179
Repayment of FHLB advances (347,170)(218,180)(832,605)
Proceeds from issuance of trust preferred
securities 38,723 -- --
Proceeds from repurchase agreement borrowings 2,082 9,430 993
Repayments of repurchase agreement borrowings (31,447) (12,994) (4,301)
Increase (decrease) in other borrowings (6,849) 5,638 (3,705)
Cash dividends paid (6,479) (6,284) (5,553)
Repurchases of stock, net of forfeitures (8,391) (10,158) (5,233)
ESOP shares earned 1,244 1,044 1,510
Exercised stock options 1,205 2,277 578
------ ------ ------
Net cash provided by financing activities 122,317 86,933 139,426
------ ------ ------
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANK 65,182 372 22,587
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 67,728 67,356 44,769
------ ------ ------
CASH AND DUE FROM BANK, END OF PERIOD $132,910 $67,728 $67,356
======= ====== ======
Continued on next page
67
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2002, 2001 and 2000
(in thousands)
(continued from prior page)
2002 2001 2000
------ ------ ------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $67,372 $86,684 $88,444
Taxes paid 4,900 7,580 10,161
Non-cash transactions:
Loans, net of discounts, specific loss allowances
and unearned income transferred to real estate
owned 6,442 4,159 1,922
Net change in accrued dividends payable 72 45 336
Stock issued to Rabbi Trust/MRP 155 52 86
Fair value of derivatives issued on loan rate
lock commitments and offsetting commitments to sell 70 -- --
Recognize tax benefit of vested MRP shares 4 259 2
Non-cash portion of 10% stock dividend -- -- 14,731
Other assets/liabilities 1,418 188 118
The following summarizes the non-cash activities
relating to acquisitions:
Fair value of assets and intangibles acquired,
including goodwill $(44,544) $ -- $ (48)
Fair value of liabilities assumed 34,453 -- --
Fair value of stock issued and
options assumed to acquisitions' shareholders -- -- 48
------ ------ ------
Cash paid out in acquisition (10,091) -- --
Less cash acquired 3,572 -- --
------ ------ ------
Net cash (used for) provided by acquisitions $ (6,519) $ -- $ --
======= ====== ======
See notes to consolidated financial statements
68
BANNER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business: Banner Corporation (BANR or the Company) is a bank
holding company incorporated in the State of Washington. The Company is
primarily engaged in the business of planning, directing and coordinating the
business activities for its wholly owned subsidiary, Banner Bank (BB or the
Bank). BB is a Washington-chartered commercial bank the deposits of which are
insured by the Federal Deposit Insurance Corporation (FDIC) under both the
Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF).
BB conducts business from its main office in Walla Walla, Washington, and, as
of January 1, 2003, its 41 branch offices and seven loan production offices
located in 19 counties in Washington, Oregon and Idaho.
The Company is subject to regulation by the Federal Reserve Board (FRB). The
Bank is subject to regulation by the State of Washington Department of
Financial Institutions Division of Banks and the FDIC.
The operating results of the Company depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets, consisting of loans and securities, and interest expense on
interest-bearing liabilities, composed primarily of savings deposits, Federal
Home Loan Bank (FHLB) advances, trust preferred securities and repurchase
agreements. Net interest income is a function of the Company's interest rate
spread, which is the difference between the yield earned on interest-earning
assets and the rate paid on interest-bearing liabilities, as well as a
function of the average balance of interest-earning assets as compared to the
average balance of interest-bearing liabilities. BANR's net income is
significantly affected by provisions for loan losses and the level of its
other income, including deposit service charges, loan origination and
servicing fees, and gains and losses on the sale of loans and securities, as
well as its non-interest operating expenses and income tax provisions.
Principles of Consolidation: The consolidated financial statements include
the accounts of BANR and its wholly owned subsidiaries. All material
intercompany transactions, profits and balances have been eliminated.
Use of Estimates: The preparation of the financial statements in conformity
with generally accepted accounting principles (GAAP) requires management to
make estimates and assumptions that affect amounts reported in the financial
statements. Various elements of the Company's accounting policies, by their
nature, are inherently subject to estimation techniques, valuation assumptions
and other subjective assessments. In particular, management has identified
several accounting policies that, due to the judgments, estimates and
assumptions inherent in those policies, are critical to an understanding of
the Company's financial statements. These policies relate to the methodology
for the determination of the allowance for loan and lease losses, the
valuation of goodwill and other intangible assets, the valuation of mortgage
servicing rights, and the valuation for real estate held for sale. Management
believes that the judgments, estimates and assumptions used in the preparation
of the Company's financial statements are appropriate given the factual
circumstances at the time. However, given the sensitivity of the Company's
financial statements to the critical accounting policies, the use of other
judgments, estimates and assumptions could result in material differences in
the Company's results of operation of financial condition.
Securities: Securities are classified as held to maturity when the Company
has the ability and positive intent to hold them to maturity. Securities
classified as available for sale are available for future liquidity
requirements and may be sold prior to maturity. Securities held to maturity
are carried at cost, adjusted for amortization of premiums and accretion of
discounts to maturity. Unrealized losses on securities held to maturity due to
decreases in fair value are recognized when it is determined that an other
than temporary decline in value has occurred. Securities available for sale
are carried at fair value. Unrealized gains and losses on securities available
for sale are excluded from earnings and are reported net of tax as accumulated
other comprehensive income, a component of stockholders' equity, until
realized. Realized gains and losses on sale are computed on the specific
identification method and are included in operations on the trade date sold.
Investment in FHLB Stock: The Company's investment in the stock of the FHLB
is carried at cost and is classified as restricted, as the Company can only
sell stock back to the FHLB at par value or to other member banks. Dividends
are included within interest income on securities and cash equivalents.
Loans Receivable: The Bank originates mortgage loans for both portfolio
investment and sale in the secondary market. At the time of origination,
mortgage loans are designated as held for sale or held for investment. Loans
held for sale are stated at lower of cost or estimated fair value determined
on an aggregate basis. The Bank also originates commercial, agricultural and
consumer loans for portfolio investment. Loans receivable not designated as
held for sale are recorded at the principal amount outstanding, net of
allowance for loan losses, deferred fees, discounts and premiums. Premiums,
discounts and deferred loan fees are amortized to maturity using the
level-yield methodology.
Interest is accrued as earned unless management doubts the collectibility of
the loan or the unpaid interest. Interest accruals are generally discontinued
when loans become 90 days past due for interest. All previously accrued but
uncollected interest is deducted from interest income upon transfer to
nonaccrual status. Future collection of interest is included in interest
income based upon an assessment of the likelihood that the loans will be
repaid or recovered. A loan may be put on nonaccrual status sooner than this
policy would dictate if, in management's judgment, the loan may be
uncollectible. Such interest is then recognized as income only if it is
ultimately collected.
Allowance for Loan Losses: The adequacy of general and specific reserves is
based on management's continuing evaluation of the pertinent factors
underlying the quality of the loan portfolio, including changes in the size
and composition of the loan portfolio, delinquency rates, actual loan loss
experience and current economic conditions. Large groups of smaller-balance
homogeneous loans are collectively evaluated for impairment. Loans
69
that are collectively evaluated for impairment include residential real estate
and consumer loans. Smaller balance non-homogeneous loans also may be
evaluated collectively for impairment. Larger balance non-homogeneous
residential construction and land, commercial real estate, commercial business
loans and unsecured loans are individually evaluated for impairment. Loans
are considered impaired when, based on current information and events,
management determines that it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. Factors involved in determining impairment include, but are not
limited to, the financial condition of the borrower, value of the underlying
collateral and current status of the economy. Impaired loans are measured
based on the present value of expected future cash flows discounted at the
loan's effective interest rate or, as a practical expedient, at the loan's
observable market price or the fair value of collateral if the loan is
collateral dependent. Subsequent changes in the value of impaired loans are
included within the provision for loan losses in the same manner in which
impairment initially was recognized or as a reduction in the provision that
would otherwise be reported.
The Company's methodology for assessing the appropriateness of the allowance
consists of several key elements, which include specific allowances, an
allocated formula allowance and an unallocated allowance. Losses on specific
loans are provided for when the losses are probable and estimable. General
loan loss reserves are established to provide for inherent loan portfolio
risks not specifically provided for. The level of general reserves is based
on analysis of potential exposures existing in the Bank's loan portfolio
including evaluation of historical trends, current market conditions and other
relevant factors identified by management at the time the financial statements
are prepared. The formula allowance is calculated by applying loss factors to
outstanding loans, excluding loans with specific allowances. Loss factors are
based on the Company's historical loss experience adjusted for significant
factors including the experience of other banking organizations that, in
management's judgment, affect the collectibility of the portfolio as of the
evaluation date. The unallocated allowance is based upon management's
evaluation of various factors that are not directly measured in the
determination of the formula and specific allowances. This methodology may
result in losses or recoveries differing significantly from those provided in
the financial statements.
When available information confirms that specific loans or portions thereof
are uncollectible, these amounts are charged off against the allowance for
loan losses. The existence of some or all of the following criteria will
generally confirm that a loss has been incurred: the loan is significantly
delinquent and the borrower has not evidenced the ability or intent to bring
the loan current; the Company has no recourse to the borrower, or if it does,
the borrower has insufficient assets to pay the debt; or the fair value of the
loan collateral is significantly below the current loan balance and there is
little or no near-term prospect for improvement.
Loan Origination and Commitment Fees: Loan origination fees, net of certain
specifically defined direct loan origination costs, are deferred and
recognized as an adjustment of the loans' interest yield using the level-yield
method over the contractual term of each loan adjusted for actual loan
prepayment experience. Net deferred fees or costs related to loans held for
sale are recognized in income at the time the loans are sold. Loan commitment
fees are deferred until the expiration of the commitment period unless
management believes there is a remote likelihood that the underlying
commitment will be exercised, in which case the fees are amortized to fee
income using the straight-line method over the commitment period. If a loan
commitment is exercised, the deferred commitment fee is accounted for in the
same manner as a loan origination fee. Deferred commitment fees associated
with expired commitments are recognized as fee income.
Real Estate Held for Sale: Property acquired by foreclosure or deed in lieu
of foreclosure is recorded at the lower of estimated fair value, less cost to
sell, or the principal balance of the defaulted loan. Development,
improvement and direct holding costs relating to the property are capitalized.
The carrying value of such property is periodically evaluated by management
and, if necessary, allowances are established to reduce the carrying value to
net realizable value. Gains or losses at the time the property is sold are
charged or credited to operations in the period in which they are realized.
The amounts the Bank will ultimately recover from real estate held for sale
may differ substantially from the carrying value of the assets because of
future market factors beyond the Bank's control or because of changes in the
Bank's strategy for recovering the investment.
Property and Equipment: The provision for depreciation is based upon the
straight-line method applied to individual assets and groups of assets
acquired in the same year at rates adequate to charge off the related costs
over their estimated useful lives:
Buildings and leased improvements . . . . . . . . . . . . .10-30 years
Furniture and equipment . . . . . . . . . . . . . . . . . . 3-10 years
Routine maintenance, repairs and replacement costs are expensed as incurred.
Expenditures which significantly increase values or extend useful lives are
capitalized. The Company reviews buildings, leasehold improvements and
equipment for impairment whenever events or changes in circumstances indicate
that the undiscounted cash flows for the property are less than its carrying
value. If identified, an impairment loss is recognized through a charge to
earnings based on the fair value of the property.
Goodwill and Other Intangible Assets: Goodwill and other intangible assets
represent the excess of purchase price over the fair value of net assets
acquired by the Company. The excess cost over fair value of net assets
acquired consists of goodwill and core deposit premiums. The Company's
goodwill was being amortized using the straight-line method over 14 years.
Other intangible assets are amortized over their estimated useful lives. As
of January 1, 2002, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, which
eliminates the amortization of goodwill relating to past and future
acquisitions. See further discussion under the heading "Recently Adopted
Accounting Standards" in Note 2 as well as the discussion in Notes 3 and 21.
Mortgage Servicing Rights: Purchased servicing rights represent the cost of
acquiring the right to service mortgage loans. Originated servicing rights are
recorded when mortgage loans are originated and subsequently sold or
securitized with the servicing rights retained. The total cost of mortgage
loans sold is allocated to the servicing rights and the loans (without the
servicing rights) based on relative fair values. The cost relating to
purchased and originated servicing is capitalized and amortized in proportion
to, and over the period of, estimated future net servicing income.
70
The Bank assesses the fair value of unamortized servicing rights for
impairment on a stratum-by-stratum basis every quarter by using secondary
market quotes for comparable packages of serviced loans. For purposes of
measuring impairment, the servicing rights are stratified based on their
interest rate, original and remaining terms to maturity and balances
outstanding.
Derivative Instruments: In June 1998 the Financial Accounting Standards Board
(FASB) issued SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended. The Company adopted SFAS No. 133 effective on January
1, 2001. Derivatives include "off-balance-sheet" financial products whose
value is dependent on the value of an underlying financial asset, such as a
stock, bond, foreign currency, or a reference rate or index. Such derivatives
include "forwards," "futures," "options" or "swaps." The Company and the Bank
generally have not invested in "off-balance-sheet" derivative instruments,
although investment policies authorize such investments. However, as a part
of mortgage banking activities, the Bank issues "rate lock" commitments to
borrowers and obtains offsetting "best efforts" delivery commitments from
purchasers of loans. While not providing any trading or net settlement
mechanisms, these off-balance-sheet commitments do have many of the prescribed
characteristics of derivatives and as a result are accounted for as such in
accordance with Statement of Financial Accounting Standards (SFAS) Nos. 133
and 138. Accordingly, on December 31, 2002, the Company recorded an asset of
$70,000 and a liability of $70,000, representing the estimated market value of
those commitments. On December 31, 2002, the Company and the Bank had no
other investment related off-balance-sheet derivatives. The adoption of SFAS
No. 133 did not have a material impact on the Company's consolidated results
of operations, financial position or cash flows.
Transfers and Servicing of Financial Assets: In September 2000, the FASB
issued SFAS No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, which revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures, but carries over most of the
provisions of SFAS No. 125 without reconsideration. SFAS No. 140 was effective
for transfers and servicing of financial assets and extinguishments of
liabilities occurring after March 31, 2001. The provisions of this statement
did not have a material effect on the Company's financial position or results
of operations.
Income Taxes: The Company files a consolidated income tax return including
all of its wholly owned subsidiaries on a calendar year basis. 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 effect on deferred
taxes of a change in tax rates is recognized in income in the period of
change. Where state income tax laws do not permit consolidated income tax
returns, applicable state income tax returns are filed.
Stock Compensation Plans: The Company loaned the Employees Stock Ownership
Plan (ESOP) the funds necessary to fund the purchase of 8% of the Company's
initial public offering of common stock. The loan to the ESOP will be repaid
principally from the Company's contribution to the ESOP, and the collateral
for the loan is the Company's common stock purchased by the ESOP. As the debt
is repaid, shares are released from collateral based on the proportion of debt
service paid in the year and allocated to participants' accounts. As shares
are released from collateral, compensation expense is recorded equal to the
average current market price of the shares, and the shares become outstanding
for earnings-per-share calculations. Stock and cash dividends on allocated
shares are recorded as a reduction of retained earnings and paid or
distributed directly to participants' accounts. Stock and cash dividends on
unallocated shares are recorded as a reduction of debt and accrued interest
(see additional discussion in Note 16). The Company stock purchased for a
Rabbi Trust obligation and the related liability for deferred compensation are
recorded at acquisition cost.
The Company measures its employee stock-based compensation arrangements under
the provisions outlined in Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees. Accordingly, no compensation cost
has been recognized for its stock option plans. If the compensation cost for
the Company's compensation plans had been determined consistent with SFAS No.
123, Accounting for Stock-Based Compensation, the Company's net income
available to diluted common stockholders and diluted earnings per common share
would have been reduced to the pro forma amounts indicated below (in thousands
except per share amounts):
Years Ended
December 31
--------------------------
2002 2001 2000*
------ ------ ------
Net income attributable to common stock:
Basic:
As reported $ 9,260 $ 7,450 $ 18,348
Pro forma 8,357 6,561 17,168
Diluted:
As reported $ 9,260 $ 7,450 $ 18,348
Pro forma 8,357 6,561 17,168
Net income per common share:
Basic:
As reported $ 0.85 $ 0.67 $ 1.62
Pro forma 0.76 0.59 1.52
Diluted:
As reported $ 0.82 $ 0.64 $ 1.60
Pro forma 0.74 0.57 1.49
* Per share amounts adjusted for stock dividends: see Note 2
71
The compensation expense included in the pro forma net income attributable to
diluted common stockholders and diluted earnings per common share is not
likely to be representative of the effect on reported net income for future
years because options vest over several years and additional awards generally
are made each year.
The fair value of options granted under the Company's SOPs is estimated on the
date of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions used for grants:
Years Ended
December 31
--------------------------------------------
2002 2001 2000
------------- ------------- -------------
Annual dividend yield 2.58 to 3.56% 3.25% 4.25%
Expected volatility 40.2 to 64.8% 28.3 to 57.8% 28.2 to 41.1%
Risk free interest rate 2.63 to 5.21% 4.25 to 5.09% 6.18 to 6.95%
Expected lives 5 to 9 yrs 5 to 9 yrs 5 to 9 yrs
Wholesale Repurchase Agreements: The Company enters into agreements under
which it sells securities subject to an obligation to repurchase the same or
similar securities. Under these arrangements, the Company transfers legal
control over the assets but still retains effective control through an
agreement that both entitles and obligates the Company to repurchase the
assets. As a result, repurchase agreements are accounted for as financing
arrangements and not as a sale and subsequent repurchase of securities. The
obligation to repurchase the securities is reflected as a liability in the
Consolidated Statements of Financial Condition while the dollar amount of
securities underlying the agreements remains in the respective asset accounts.
Those securities are classified as encumbered. (See Note 13.)
Average Balances: Average balances are obtained from the best available
daily, weekly or monthly data, which the Company's management believes
approximate the average balances calculated on a daily basis.
Reclassification: Certain amounts in the prior periods' financial statements
have been reclassified to conform to the current period's presentation.
Note 2: RECENT DEVELOPMENTS AND ACQUISITIONS
Sale of $40 Million of Trust Preferred Securities: During 2002, the Company
completed the issuance of $40 million of trust preferred securities (TPS) in
two private placements of $25 million in April 2002 and $15 million in
December 2002. The TPS were issued by special purpose business trusts owned
by the Company and sold to pooled investment vehicles sponsored and marketed
by investment banking firms. The TPS have been recorded as a liability on the
statement of financial condition but qualify as Tier 1 capital for regulatory
capital purposes. The proceeds from these offerings were partially used to
augment the Bank's capital with the remainder expected to be used primarily to
fund growth, including acquisitions. Remaining proceeds may also be used to
fund the Company's stock repurchase program and other general corporate
purposes as necessary.
Under the terms of the transactions, the TPS have a maturity of 30 years and
are redeemable after five years with certain exceptions. The holders of the
TPS are entitled to receive cumulative cash distributions at a variable annual
rate. The initial $25 million issue has a current interest rate of 5.38175%,
which is reset semi-annually to equal six-month LIBOR plus 3.70%. The second
$15 million issue has a current rate of 4.760%, which is reset quarterly to
equal three-month LIBOR plus 3.35%.
Acquisition of Oregon Business Bank: On January 1, 2002, the Company
completed the acquisition of Oregon Business Bank (OBB), which was
headquartered in Lake Oswego, Oregon. BB paid $10.1 million in cash for all
the outstanding common shares of OBB. As a result of the merger of OBB into
BB, OBB operates as a division of BB. The acquisition was accounted for as a
purchase and resulted in the recording of $4.8 million of costs in excess of
the fair value of OBB's net assets acquired (goodwill). In addition, an
estimated $714,000 of core deposit intangibles was recorded which will be
amortized on an accelerated basis over a five-year period resulting in a
first-year charge to earnings of $255,000. OBB was an Oregon state-chartered
commercial bank which had, before recording of purchase accounting
adjustments, approximately $38.9 million in total assets, $33.1 million in
loans, $33.2 million in deposits, and $4.7 million in shareholders' equity at
December 31, 2001. OBB operated one full service branch in Lake Oswego,
Oregon.
Declaration of 10% Stock Dividend: On October 19, 2000, BANR's Board of
Directors declared a 10% stock dividend payable November 10, 2000 to
shareholders of record on October 31, 2000. All earnings per share data have
been adjusted to reflect the 10% stock dividend.
Accounting Standards Recently Adopted or Issued: In January 2002, the Company
adopted SFAS No. 142, Goodwill and Other Intangible Assets, which applies to
all acquired intangible assets whether acquired singly, as part of a group, or
in a business combination. This statement requires that goodwill not be
amortized; however, goodwill for each reporting unit must be evaluated for
impairment on at least an annual basis using a two-step approach. The first
step used to identify potential impairment compares the estimated fair value
of a reporting unit to its carrying amount, including goodwill. If the fair
value of a reporting unit is less than its carrying amount, the second step of
the impairment evaluation, which compares the implied fair value of goodwill
to its carrying amount, must be performed to determine the amount of the
impairment loss, if any. This statement also provides standards for financial
statement disclosures of goodwill and other intangible assets and related
impairment losses. The adoption of this statement has had a material impact
on the Company's results of operation. Goodwill is no longer being amortized,
reducing other current period operating expenses by $3.2 million a year, with
a corresponding increase in net income.
72
The Company performed its initial and annual assessment of goodwill impairment
during the second and fourth quarters of 2002, respectively, and determined
that its goodwill was not impaired.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation Transition and Disclosure. SFAS No. 148 amends SFAS No. 123 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, SFAS No. 148 amends the disclosure requirements of SFAS No. 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 provisions of SFAS No. 148
are effective for financial statements for fiscal years and interim periods
ending after December 15, 2002. The disclosure provisions of SFAS No. 148
have been adopted by the Company (see Note 1). SFAS No. 148 did not require
the Company to change to the fair value based method of accounting for
stock-based compensation.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain
Financial Institutions, allowing financial institutions meeting certain
criteria to reclassify unidentifiable intangible asset balances to goodwill
and cease amortization beginning as of January 1, 2002. SFAS No. 147 also
amends SFAS 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. The Company adopted SFAS No. 147 on October 1, 2002. The
adoption of SFAS No. 147 did not materially impact the Company's consolidated
results of operations, financial position or cash flows.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This statement requires recording costs
associated with exit or disposal activities at their fair values when a
liability has been incurred. Under previous guidance, certain exit costs were
accrued upon management's commitment to an exit plan, which is generally
before an actual liability has been incurred. The Company will adopt SFAS No.
146 as of January 1, 2003. The adoption of SFAS No. 146 will not have a
material impact on the Company's consolidated results of operations, financial
position or cash flows.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Correction.
This statement eliminates extraordinary accounting treatment for reporting
gain or loss on debt extinguishment, and amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings, or
describe their applicability under changed conditions. The Company adopted
SFAS No. 145 as of June 1, 2002. The adoption of SFAS No. 145 did not have a
material impact on the Company's consolidated results of operations, financial
position or cash flows.
In August 2001, SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, was issued. The statement supercedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of, but retains the requirements relating to recognition and
measurement of an impairment loss and resolves certain implementation issues
resulting from SFAS No. 121. The statement was adopted by the Company on
January 1, 2002 and did not have a material impact on the results of
operations or financial condition of the Bank.
In January 2003, the FASB issued FIN No. 46, Consolidation of Certain Variable
Interest Entities An Interpretation of ARB No. 51, to clarify when an entity
should consolidate another entity known as a Variable Interest Entity (VIE),
more commonly referred to as a special purpose entity or SPE. A VIE is an
entity in which equity investors do not have characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties, and may include many types of SPEs. FIN No. 46 requires that
an entity shall consolidate a VIE if that enterprise has a variable interest
that will absorb a majority of the VIE's expected losses if they occur,
receive a majority of the VIE's expected residual returns if they occur, or
both. FIN No. 46 is effective for newly created VIEs beginning February 1,
2003 and for existing VIEs as of the third quarter of 2003. The adoption of
FIN No. 46 is not expected to have any effect on the Company's financial
statements.
In November 2002, the FASB issued Financial Accounting Standards Board
Interpretation No. (FIN) No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others, which requires the guarantor to recognize as a liability the fair
value of the obligation at the inception of the guarantee. The disclosure
requirements in FIN 45 are effective for financial statements of interim or
annual periods ending after December 15, 2002. Management believes that the
Company has no material guarantees that are required to be disclosed in the
financial statements. The recognition provisions are to be applied on a
prospective basis to guarantees issued after December 31, 2002. The adoption
of the recognition provisions of FIN No. 45 is not expected to have a material
impact on the Company's financial statements.
73
Note 3: ADOPTION OF SFAS NO. 142 GOODWILL
The following table shows the pro forma effects of SFAS No. 142 applied to the
prior comparative periods (in thousands except per share amounts):
Years Ended December 31
--------------------------
2002 2001 2000
------ ------ ------
Reported Net Income (loss) $ 9,260 $ 7,450 $18,348
Add Back: Goodwill amortization -- 3,180 3,170
------ ------ ------
Adjusted Net Income $ 9,260 $10,630 $21,518
====== ====== ======
Basic earnings per share as reported $ 0.85 $ 0.67 $ 1.62
Goodwill amortization -- 0.28 0.28
------ ------ ------
Adjusted basic earnings per share $ 0.85 $ 0.95 $ 1.90
====== ====== ======
Diluted earnings per share as reported $ 0.82 $ 0.64 $ 1.60
Goodwill amortization -- 0.28 0.27
------ ------ ------
Adjusted diluted earnings per share $ 0.82 $ 0.92 $ 1.87
====== ====== ======
Note 4: CASH, DUE FROM BANKS AND CASH EQUIVALENTS
Cash, due from banks and cash equivalents consisted of the following (in
thousands):
December 31 December 31
2002 2001
------ ------
Cash on hand and due from banks $89,989 $55,320
Cash equivalents:
Short-term cash investments 121 10,008
Federal funds sold 42,800 2,400
------ ------
$132,910 $67,728
======= ======
For the purpose of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, overnight investments and short-term
deposits with original maturities of less than 90 days.
FRB regulations require depository institutions to maintain certain minimum
reserve balances. Included in cash and demand deposits were reserves required
by the FRB of $28 million and $26 million at December 31, 2002 and 2001,
respectively.
74
Note 5: SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated fair value of securities available for sale
are summarized as follows (dollars in thousands):
December 31, 2002
-------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair Percent of
cost gains losses value Total
--------- ---------- ---------- --------- ----------
U.S. Government and
agency obligations $ 91,210 $ 704 $ -- $ 91,914 21.83%
Municipal bonds:
Taxable 5,146 355 (97) 5,404 1.28%
Tax exempt 17,875 536 (28) 18,383 4.36%
--------- ---------- ---------- --------- ----------
Total municipal bonds 23,021 891 (125) 23,787 5.64%
Corporate bonds 35,975 274 (1,541) 34,708 8.24%
Mortgage-backed or
related securities:
FHLMC certificates 37,416 751 (1) 38,166 9.06%
FHLMC collateralized
mortgage
obligations 46,301 296 (58) 46,539 11.05%
Total FHLMC
mortgage-backed --------- ---------- ---------- --------- ----------
securities 83,717 1,047 (59) 84,705 20.11%
GNMA certificates 26,860 869 -- 27,729 6.58%
GNMA collateralized
mortgage obligations 6,505 108 -- 6,613 1.57%
Total GNMA
mortgage-backed --------- ---------- ---------- --------- ----------
securities 33,365 977 -- 34,342 8.15%
FNMA certificates 20,552 596 -- 21,148 5.02%
FNMA collateralized
mortgage obligations 49,617 292 (69) 49,840 11.83%
Total FNMA
mortgage-backed --------- ---------- ---------- --------- ----------
securities 70,169 888 (69) 70,988 16.58%
Other mortgage-backed
securities 8,000 -- -- 8,000 1.90%
Other collateralized
mortgage
obligations 69,308 851 (192) 69,967 16.62%
Equity securities:
FHLMC stock 1,026 1,595 -- 2,621 0.62%
FNMA stock 3 74 -- 77 0.02%
FARMERMAC stock 10 46 -- 56 0.01%
Miscellaneous
equities 51 6 -- 57 0.01%
--------- ---------- ---------- --------- ----------
$ 415,855 $ 7,353 $ (1,986) $ 421,222 100.00%
========= ========== ========== ========= ==========
Proceeds from sales of securities during the year ended December 31, 2002 were
$4,670,000. Gross gains of $27,000 and gross losses of $0 were realized on
those sales.
75
Note 5: SECURITIES AVAILABLE FOR SALE (continued)
December 31, 2001
-------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair Percent of
cost gains losses value Total
--------- ---------- ---------- --------- ----------
U.S. Government and
agency obligations $ 50,535 $ 750 $ -- $ 51,285 16.99%
Municipal bonds:
Taxable 5,315 97 (239) 5,173 1.71%
Tax exempt 21,093 601 (125) 21,569 7.15%
--------- ---------- ---------- --------- ----------
Total municipal bonds 26,408 698 (364) 26,742 8.86%
Corporate bonds 15,962 -- (1,135) 14,827 4.91%
Mortgage-backed or
related securities:
FHLMC certificates 1,509 37 (2) 1,544 0.51%
FHLMC collater-
alized mortgage
obligations 35,738 549 (69) 36,218 12.00%
Total FHLMC
mortgage-backed --------- ---------- ---------- --------- ----------
securities 37,247 586 (71) 37,762 12.51%
GNMA certificates 37,840 166 (103) 37,903 12.56%
GNMA collateralized
mortgage obliga-
tions 566 1 -- 567 0.19%
Total GNMA
mortgage-backed --------- ---------- ---------- --------- ----------
securities 38,406 167 (103) 38,470 12.75%
FNMA certificates 17,744 162 (18) 17,888 5.93%
FNMA collateralized
mortgage obliga-
tions 57,191 396 (188) 57,399 19.02%
Total FNMA
mortgage-backed --------- ---------- ---------- --------- ----------
securities 74,935 558 (206) 75,287 24.95%
Other mortgage-backed
securities 8,000 -- -- 8,000 2.65%
Other collateralized
mortgage obligations 45,480 711 (275) 45,916 15.21%
Equity securities:
FHLMC stock 1,026 2,029 (2) 3,053 1.01%
FNMA stock 303 100 -- 403 0.13%
FARMERMAC stock 10 65 -- 75 0.02%
Miscellaneous equities 20 7 -- 27 0.01%
--------- ---------- ---------- --------- ----------
$ 298,332 $ 5,671 $ (2,156) $ 301,847 100.00%
========= ========== ========== ========= ==========
Proceeds from sales of securities during the year ended December 31, 2001 were
$4,828,000. Gross gains of $687,000 and gross losses of $0 were realized on
those sales.
At December 31, 2002 and 2001, the Company's investment portfolio did not
contain any securities of an issuer (other than the U.S. Government, its
agencies and U.S. Government sponsored entities) which had an aggregate book
value in excess of 10% of the Company's stockholders' equity at that date.
At December 31, 2002, $11.3 million of purchased and recorded securities were
unsettled with the related payable recorded in accrued expenses and other
liabilities. In addition, the Bank had entered into forward commitments with
notional amounts totaling $25.3 million to purchase "when issued" securities
to settle on the first available settlement date in January 2003. These "when
issued" securities were not required to be reported as derivatives as they
could not be settled until January 2003, the first available day for
settlement.
The amortized cost and estimated fair value of securities available for sale
at December 31, 2002 and 2001, by contractual maturity, are shown below (in
thousands). Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
December 31, 2002 December 31, 2001
--------------------- ---------------------
Amortized Estimated Amortized Estimated
Cost fair value Cost fair value
--------- ---------- --------- ----------
Due in one year or less $ 17,331 $ 17,537 $ 13,943 $ 14,097
Due after one year through
five years 79,661 75,725 53,042 53,938
Due after five years through
ten years 53,546 59,079 20,250 20,427
Due after ten years 264,227 266,070 209,738 209,827
--------- ---------- --------- ----------
414,765 418,411 296,973 298,289
Equity securities 1,090 2,811 1,359 3,558
--------- ---------- --------- ----------
$ 415,855 $ 421,222 $ 298,332 $ 301,847
========= ========== ========= ==========
76
Note 6: SECURITIES HELD TO MATURITY
The amortized cost and estimated fair value of securities held to maturity are
summarized as follows (dollars in thousands):
December 31, 2002
-----------------------------------------------------
Gross Gross Estimated
Percent Amortized unrealized unrealized fair
of total cost gains losses value
-------- --------- ---------- ---------- ---------
Mortgage-backed securities:
FHLMC certificates: 5.10% $ 676 $ 44 $ -- $ 720
FNMA certificates 3.58% 475 26 -- 501
-------- --------- ---------- ---------- ---------
8.68% 1,151 70 -- 1,221
Municipal bonds:
Taxable 8.32% 1,103 7 -- 1,110
Tax Exempt 20.55% 2,724 54 -- 2,778
-------- --------- ---------- ---------- ---------
28.87% 3,827 61 -- 3,888
Corporate bonds 52.83% 7,000 30 -- 7,030
Asset-backed securities 9.62% 1,275 -- -- 1,275
-------- --------- ---------- ---------- ---------
100.00% $ 13,253 $ 161 $ -- $ 13,414
======== ========= ========== ========== =========
December 31, 2001
-----------------------------------------------------
Gross Gross Estimated
Percent Amortized unrealized unrealized fair
of total cost gains losses value
-------- --------- ---------- ---------- ---------
Mortgage-backed securities:
FHLMC certificates 7.16% $ 1,062 $ 43 $ -- $ 1,105
FNMA certificates 4.64% 688 29 -- 717
-------- --------- ---------- ---------- ---------
11.80% 1,750 72 -- 1,822
Municipal bonds:
Taxable 7.42% 1,100 34 -- 1,134
Tax exempt 14.19% 2,104 36 -- 2,140
-------- --------- ---------- ---------- ---------
21.61% 3,204 70 -- 3,274
Corporate bonds 47.21% 7,000 -- (67) 6,933
Asset-backed securities 19.38% 2,874 -- (1) 2,873
-------- --------- ---------- ---------- ---------
100.00% $ 14,828 $ 142 $ (68) $ 14,902
======== ========= ========== ========== =========
The amortized cost and estimated fair value of securities held to maturity at
December 31, 2002 and 2001, by contractual maturity, are shown below (in
thousands):
December 31, 2002 December 31, 2001
--------------------- ---------------------
Amortized Estimated Amortized Estimated
Cost fair value Cost fair value
--------- ---------- --------- ----------
Due in one year or less $ 1,450 $ 1,457 $ 375 $ 382
Due after one year through
five years 1,731 1,761 4,772 4,826
Due after five years through
ten years 103 110 102 110
Due after ten years 9,969 10,086 9,579 9,584
--------- ---------- --------- ----------
$ 13,253 $ 13,414 $ 14,828 $ 14,902
========= ========== ========= ==========
77
Note 7: ADDITIONAL INFORMATION REGARDING INTEREST INCOME FROM SECURITIES AND
CASH EQUIVALENTS
The following table sets forth the composition of income from securities and
cash equivalents for the periods indicated (in thousands):
Years Ended
December 31
-------------------------
2002 2001 2000
------ ------ ------
Taxable interest income $ 6,869 $ 5,952 $ 7,853
Tax-exempt interest income 1,274 1,619 1,859
Other stock dividend income 83 101 106
Federal Home Loan Bank stock dividend income 1,960 2,033 1,728
Total income from securities and cash ------ ------ ------
equivalents $10,186 $ 9,705 $11,546
====== ====== ======
Note 8: LOANS RECEIVABLE
Loans receivable at December 31, 2002 and 2001 are summarized as follows
(dollars in thousands) (includes loans held for sale):
December 31, 2002 December 31, 2001
----------------- -----------------
Amount Percent Amount Percent
------- ------- ------- -------
Loans:
Secured by real estate:
One- to four-family $ 355,509 22.59% $ 422,456 26.52%
Commercial 379,099 24.09 363,560 22.82
Multifamily 72,333 4.60 79,035 4.96
Construction and land 339,516 21.58 335,798 21.08
Commercial business 285,231 18.13 270,022 16.95
Agricultural business 102,626 6.52 76,501 4.80
Consumer 39,152 2.49 45,605 2.87
--------- ------- --------- -------
Total loans 1,573,466 100.00% 1,592,977 100.00%
======= =======
Less allowance for loan losses 26,539 17,552
--------- ---------
Total net loans at end of period $1,546,927 $1,575,425
========= =========
Loan amounts are net of unearned, unamortized loan fees of $5,554,000 and
$5,945,000 at December 31, 2002 and 2001, respectively.
A substantial portion of the loans are to borrowers in the states of
Washington, Oregon and Idaho. Accordingly, their ultimate collectibility is
particularly susceptible to, among other things, changes in market and
economic conditions within these states.
Loans serviced for others totaled $252,936,000 and $224,034,000 at December
31, 2002 and 2001, respectively. Custodial accounts maintained in connection
with this servicing totaled $6,584,000 and $4,432,000 at December 31, 2002 and
2001, respectively.
The Company's outstanding loan commitments totaled $410,907,000 and
$374,458,000 at December 31, 2002 and 2001, respectively. In addition, the
Company had outstanding commitments to sell loans of $66,211,000 and
$48,303,000 at December 31, 2002 and 2001, respectively.
The Company's loans by geographic concentration at December 31, 2002 were as
follows (in thousands):
Washington Oregon Idaho Other Total
Secured by real estate: ---------- ------ ----- ----- -----
One-to four-family $ 284,489 $ 42,402 $ 7,682 $20,936 $ 355,509
Commercial 215,004 139,980 12,128 11,987 379,099
Multifamily 59,388 5,485 1,263 6,197 72,333
Construction and land 191,194 140,320 454 7,548 339,516
Commercial business 217,479 45,817 19,751 2,184 285,231
Agricultural business 35,338 63,615 3,350 323 102,626
Consumer 24,556 12,225 1,449 922 39,152
--------- ------- ------ ------ ---------
$1,027,448 $449,844 $46,077 $50,097 $1,573,466
========= ======= ====== ====== =========
The Company's outstanding loans receivable from directors and officers of the
Company and entities related to the directors and officers totaled
$7,387,000 and $6,647,000 as of December 31, 2002 and 2001, respectively.
78
The amount of impaired loans and the related allocated reserve for loan losses
were as follows (in thousands):
December 31, 2002 December 31, 2001
----------------- -----------------
Loan Allocated Loan Allocated
amount reserves amount reserves
Impaired loans: ------ -------- ------ --------
Non-accrual $33,083 $ 5,424 $16,659 $ 1,783
Accrual -- -- -- --
------ ------ ------ ------
$33,083 $ 5,424 $16,659 $ 1,783
====== ====== ====== ======
As of December 31, 2002, the Company is not committed to advance any more
funds on its impaired loans.
The average balance of impaired loans and the related interest income
recognized were as follows:
Years Ended
December 31
--------------------------
2002 2001 2000
------ ------ ------
Average balance of impaired loans $ 23,334 $ 8,923 $ 3,899
Interest income recognized -- -- --
For the years ended December 31, 2002, 2001 and 2000 interest income of
$1,842,000, $493,000 and $510,000, respectively, would have been recorded had
on-accrual loans been current.
The Company originates both adjustable- and fixed-rate loans. At December 31,
2002 and 2001, the maturity and repricing composition of those loans, less
undisbursed amounts and deferred fees, were as follows (in thousands):
December 31 December 31
2002 2001
Fixed-rate (term to maturity): ----------- -----------
Due in one year or less $ 85,935 $ 98,438
Due after one year through three years 73,482 78,152
Due after three years through five years 102,545 108,710
Due after five years through ten years 144,688 152,968
Due after ten years 284,847 349,197
----------- -----------
$ 691,497 $787,465
=========== ===========
Adjustable-rate (term to rate adjustment):
Due in one year or less $ 732,867 $772,367
Due after one year through three years 71,877 14,501
Due after three years through five years 68,103 15,574
Due after five years through ten years 9,122 3,070
Due after ten years -- --
----------- -----------
$ 881,969 $805,512
=========== ===========
The adjustable-rate loans have interest rate adjustment limitations and are
generally indexed to the Bank's internal cost of funds, the FHLB's National
Cost of Funds Index and 11th District Cost of Funds, One Year Constant
Maturity Treasury Index, or prime rate (The Wall Street Journal). Future
market factors may affect the correlation of the interest rate adjustment with
the rates the Bank pays on the short-term deposits that primarily have been
utilized to fund these loans.
The Bank has invested, as of December 31, 2002, $20,000 in a limited
partnership, Homestead Equity Fund II (HEF), that develops low income housing
projects. The Bank's 16.7% partnership interest commits it to invest up to
$2,000,000 in the partnership. In connection with HEF's initial development
of a project, the Bank has made a commercial loan to the partnership that has
an outstanding balance of $4,990,000 at December 31, 2002. The Bank is
committed on this loan to advance up to $6,930,000. The loan is secured by
notes from the limited partners, which includes the Bank, to make capital
contributions to the partnership.
79
Note 9: ALLOWANCE FOR LOAN LOSSES
An analysis of the changes in the allowance for loan losses is as follows
(dollars in thousands):
Years Ended
December 31
--------------------------
2002 2001 2000
------ ------ ------
Balance, beginning of period $ 17,552 $ 15,314 $ 13,541
Allowance added through business combinations 460 -- --
Sale of credit card portfolio -- -- (174)
Provision 21,000 13,959 2,867
Recoveries of loans previously charged off:
Secured by real estate:
One- to four-family -- 2 2
Commercial -- -- 2
Multifamily -- -- --
Construction and Land 39
Commercial business 209 118 40
Agricultural business 3 -- 1
Consumer 74 22 66
------ ------ ------
325 142 111
Loans charged off:
Secured by real estate:
One- to four-family (102) (97) (90)
Commercial (103) -- (31)
Multifamily -- -- --
Construction and land (1,129) (107) (12)
Commercial business (10,643) (10,541) (403)
Agricultural business (157) (208) (16)
Consumer (664) (910) (479)
------ ------ ------
(12,798) (11,863) (1,031)
------ ------ ------
Net charge-offs (12,473) (11,721) (920)
------ ------ ------
Balance, end of period $ 26,539 $ 17,552 $ 15,314
====== ====== ======
Ratio of allowance to net loans before
allowance for loan losses 1.69% 1.10% 1.03%
Ratio of net loan charge-offs to the average net
book value of loans outstanding during the
period 0.78% 0.75% 0.06%
The following is a schedule of the Company's allocation of the allowance for
loan losses (dollars in thousands):
December 31
--------------------------
2002 2001 2000
------ ------ ------
Specific or allocated loss allowance:
Secured by real estate:
One- to four-family $ 670 $ 2,366 $ 2,256
Commercial 5,284 3,967 4,556
Multifamily 361 593 731
Construction and land 5,892 3,431 2,738
Commercial business 8,788 4,660 3,540
Agricultural business 2,164 990 170
Consumer 698 774 879
------ ------ ------
Total allocated 23,857 16,781 14,870
Unallocated 2,682 771 444
------ ------ ------
Total allowance for loan losses $ 26,539 $ 17,552 $ 15,314
====== ====== ======
Ratio of allowance for loan losses to non-
performing loans 0.74% 0.97% 1.83%
80
Note 10: PROPERTY AND EQUIPMENT
Land, buildings and equipment owned by the Company and its subsidiaries at
December 31, 2002 and 2001 are summarized as follows (in thousands):
December 31
-------------------
2002 2001
------ ------
Buildings and leasehold improvements $ 21,214 $ 18,751
Furniture and equipment 19,728 17,247
------ ------
40,942 35,998
Less accumulated depreciation 23,115 20,171
------ ------
17,827 15,827
Land 2,918 2,324
------ ------
$ 20,745 $ 18,151
====== ======
The Bank's obligation under long-term property leases over the next five years
is as follows: 2003, $1,824,000; 2004, $1,478,000; 2005, $961,000; 2006,
$836,000; 2007, $529,000; and thereafter, $619,000.
Note 11: DEPOSITS
Deposits consist of the following at December 31, 2002 and 2001 (dollars in
thousands):
December 31 Percent of December 31 Percent of
2002 Total 2001 Total
----------- ---------- ----------- ----------
Demand, NOW and money market
accounts, including non-
interest-bearing deposits at
December 31, 2002 and 2001 of
$200,500 and $180,813,
respectively, 0% to 4% $ 528,621 35.30% $ 443,376 34.22%
Regular savings, 0% to 1% 44,334 2.96 42,228 3.26
Certificate accounts:
0.00% to 2% 97,727 6.52 18,364 1.42
2.01% to 4% 609,870 40.72 338,342 26.11
4.01% to 6% 153,431 10.24 272,614 21.03
6.01% to 8% 63,773 4.26 180,857 13.96
8.01% to 10% 22 -- 22 --
10.01% to 12% -- -- 8
--------- ---------- --------- ----------
924,823 61.74 810,207 62.52
--------- ---------- --------- ----------
$1,497,778 100.00% $1,295,811 100.00%
========= ========== ========= ==========
Deposits at December 31, 2002 and 2001 include public funds of $127,922,000
and $109,127,000, respectively. Securities with a carrying value of
$24,811,000 and $15,562,000 were pledged as collateral on these deposits at
December 31, 2002 and 2001, respectively, which exceeded the minimum
collateral requirements established by state regulations.
Scheduled maturities of certificate accounts at December 31, 2002 and 2001 are
as follows (in thousands):
December 31
------------------
2002 2001
------ ------
Due in one year or less $667,322 $669,133
Due after one year through two years 109,294 87,376
Due after two years through three years 61,404 18,443
Due after three years through four years 33,832 11,227
Due after four years through five years 44,025 18,355
Due after five years 8,946 5,673
------ ------
$924,823 $810,207
======= =======
Included in deposits are deposit accounts in excess of $100,000 of
$467,470,000 and $385,070,000 at December 31, 2002 and 2001, respectively.
Interest on deposit accounts in excess of $100,000 totaled $16,364,000 for the
year ended December 31, 2002 and $19,024,000 for the year ended December 31,
2001.
81
The following table sets forth the deposit activities of the Bank for the
periods indicated (in thousands):
Years Ended
December 31
------------------------------------
2002 2001 2000
--------- --------- ---------
Beginning balance $1,295,811 $1,192,715 $1,078,152
Acquisitions, at book value 33,151 -- --
Net increase (decrease) before
interest credited 129,610 50,394 61,443
Interest credited 39,206 52,702 53,120
--------- --------- ---------
Net increase in deposits 201,967 103,096 114,563
--------- --------- ---------
Ending balance $1,497,778 $1,295,811 $1,192,715
========= ========= =========
Deposit interest expense by type for the years ended December 31, 2002, 2001
and 2000 was as follows (in thousands):
Years Ended
December 31
--------------------------------
2002 2001 2000
------ ------ ------
Certificates $34,263 $46,367 $44,892
Demand, NOW and money market accounts 4,470 5,604 6,782
Regular savings 473 731 1,446
------ ------ ------
$39,206 $52,702 $53,120
====== ====== ======
Note 12: ADVANCES FROM FEDERAL HOME LOAN BANK OF SEATTLE
The Bank has entered into borrowing arrangements with the FHLB to borrow funds
under a short-term floating rate cash management advance program and
fixed-term loan agreements. All borrowings are secured by stock of, and cash
held by, the FHLB. Additionally, specific securities issued, insured or
guaranteed by the U.S. Government or agencies thereof with a carrying value of
$204,739,000 at December 31, 2002 are pledged as security for the loans along
with a blanket pledge of qualifying loans receivable. At December 31, 2002,
FHLB advances were scheduled to mature as follows; however, certain advances
totaling $168,000,000 and due after one year have provisions for early
termination exercisable at the discretion of the FHLB (dollars in thousands):
Adjustable-rate Fixed-rate Total
advances advances advances
-------------- -------------- --------------
Rate* Amount Rate* Amount Rate* Amount
----- ------ ---- ------ ----- ------
Due in one year or less 1.41% $7,000 3.86% $149,191 3.75% $156,191
Due after one year through
two years -- -- 4.03 65,094 4.03 65,094
Due after two years through
three years -- -- 6.21 65,600 6.21 65,600
Due after three years through
four years -- -- 4.77 45,000 4.77 45,000
Due after four years through
five years -- -- 3.60 16,930 3.60 16,930
Due after five years -- -- 6.02 116,928 6.02 116,928
----- ------ ---- ------ ----- ------
1.41% $7,000 4.85% $458,743 4.80% $465,743
====== ======= =======
* Weighted average interest rate
The maximum and average outstanding balances and average interest rates on
advances from the FHLB were as follows for the years ended December 31, 2002,
2001 and 2000 (dollars in thousands):
Years Ended
December 31
--------------------------------
2002 2001 2000
------ ------ ------
Maximum outstanding at any month end $ 465,743 $ 515,598 $ 545,198
Average outstanding 451,816 505,631 509,665
Weighted average interest rates:
Annual 5.33% 5.93% 6.19%
End of period 4.80% 5.68% 6.27%
Interest expense during the period $ 24,094 $ 29,990 $ 31,568
As of December 31, 2002, the Bank has established a borrowing line with the
FHLB to borrow up to the lesser of 35% of its total assets or the total
blanket pool of unpledged eligible collateral which would give it a maximum
total credit line of $695,136,000 at December 31, 2002.
82
Note 13: OTHER BORROWINGS
Other borrowings consist of retail repurchase agreements, wholesale repurchase
agreements and other short-term borrowings.
Retail Repurchase Agreements: At December 31, 2002, retail repurchase
agreements carry interest rates ranging from 1.59% to 7.20%, payable at
maturity, and are secured by the pledge of certain FNMA, GNMA and FHLMC
mortgage-backed securities with a carrying value of $13,393,000 as of December
31, 2002. The Bank has the right to pledge or sell these securities, but they
must replace them with substantially the same security.
A summary of retail repurchase agreements at December 31, 2002 and 2001 by the
period remaining to maturity is as follows (dollars in thousands):
December 31
-------------------------------------
2002 2001
----------------- -------------------
Weighted Weighted
average average
rate Balance rate Balance
-------- ------- -------- -------
Retail repurchase agreements:
Due in one year or less 2.38% $ 8,518 2.04% $14,521
Due after one year through two years 6.76 1,629 7.18 941
Due after two years through three years 4.04 166 7.00 1,427
Due after three years through four years -- -- -- --
Due after five years 5.00 428 -- --
-------- ------- -------- -------
3.17% $10,741 2.75% $16,889
======= =======
The maximum and average outstanding balances and average interest rates on
retail repurchase agreements and other short-term borrowings, such as Fed
Funds, were as follows for the years ended December 31, 2002, 2001 and 2000,
respectively (dollars in thousands):
Years Ended
December 31
--------------------------------
2002 2001 2000
------ ------ ------
Maximum outstanding at any month end $19,146 $16,889 $12,806
Average outstanding 14,741 14,769 10,217
Weighted average interest rates:
Annual 3.74% 3.38% 6.67%
End of period 3.17% 2.75% 6.31%
Interest expense during the period $ 552 $ 499 $ 681
Wholesale Repurchase Agreements: The table below outlines the wholesale
repurchase agreements as of December 31, 2002 and 2001. The agreements to
repurchase are secured by mortgage-backed securities with a carrying value of
$32,955,000 at December 31, 2002. The broker holds the security while BB
continues to receive the principal and interest payments from the security.
Upon maturity of the agreement the pledged securities will be returned to BB.
A summary of wholesale repurchase agreements at December 31, 2002 and 2001 by
the period remaining to maturity is as follows (dollars in thousands):
December 31, 2002 December 31, 2001
----------------- ------------------
Weighted Weighted
average average
rate Balance rate Balance
-------- ------- -------- -------
Due in one year or less 1.43% $30,461 2.34% $59,826
The maximum and average outstanding balances and average interest rates on
wholesale repurchase agreements were as follows for the years ended December
31, 2002, 2001 and 2000 (dollars in thousands):
Years Ended
December 31
--------------------------------
2002 2001 2000
------ ------ ------
Maximum outstanding at any month end $60,604 $63,160 $65,810
Average outstanding 51,837 58,926 65,043
Weighted average interest rates:
Annual 1.86% 4.67% 6.50%
End of period 1.43% 2.34% 6.64%
Interest expense during the period $ 966 $ 2,753 $ 4,225
83
Trust Preferred Securities: The Company is the guarantor of two separate
issues of trust preferred securities, as discussed below:
On April 9, 2002, Banner Capital Trust I (BCT I), a wholly owned subsidiary of
the Company formed on the same date, issued $25 million of Floating Rate
Capital Securities. In connection with BCT I's issuance of these securities,
the Company issued to BCT I $25,774,000 of Floating Rate Junior Subordinated
Debentures, due 2032 (the Debentures due 2032). The sole assets of BCT I are
and will be the Debentures due 2032. The Capital Securities and Debentures
due 2032 have floating interest rates equal to six-month LIBOR plus 3.70%.
Interest is paid and the rates adjusted on October 22 and April 22. The
Capital Securities and Debentures due 2032 were issued at an initial rate of
6.0154% and at December 31, 2002 the rate was 5.38175%.
On December 19, 2002, Banner Capital Trust II (BCT II), a wholly owned
subsidiary of the Company formed on the same date, issued $15 million of
Floating Rate Capital Securities. In connection with BCT II's issuance of
these securities, the Company issued to BCT II $15,446,000 of Floating Rate
Junior Subordinated Debentures, due 2033 (the Debentures due 2033). The sole
assets of BCT II are and will be the Debentures due 2033. The Capital
Securities and the Debentures due 2033 have floating interest rates equal to
three-month LIBOR plus 3.35%, with a coupon cap of 12.5% through January 7,
2008. Interest is paid and the rates adjust on January 7, April 7, July 7 and
October 7, with the first payment due April 7, 2003. The Capital Securities
and Debentures due 2033 were issued at an initial rate of 4.760%.
Financial data pertaining to trust preferred securities were as follows (dollars in thousands):
December 31, 2002
Aggregate
Liquidation Aggregate Aggregate
Amount of Liquidation Principal
Trust Amount of Amount
Preferred Common of Stated Per Annum Extension Redemption
Name of Trust Securities Securities Debentures Maturity Interest Rate Period Option
------------- ---------- ---------- ---------- -------- ------------- --------- ----------
Banner Capital $ 25,000 $ 774 $ 25,774 2032 5.38175% Ten On or after
Trust I Consecutive April 22,
Semi-annual 2007
Periods
Banner Capital 15,000 446 15,446 2033 4.760 20 On or after
Trust II Consecutive January 7,
---------- Quarters 2008
Consolidated
TPS liability $ 40,000
==========
Additional Credit Line: The Bank also has established a $26,000,000 Fed Funds credit line with a
correspondent bank that will expire in July 2003. There were no balances outstanding under this credit
line at December 31, 2002 and 2001.
Note 14: INCOME TAXES
Provisions of the Small Business Job Protection Act of 1996 (the Job
Protection Act) significantly altered the Company's tax bad debt deduction
method and the circumstances that would require a tax bad debt reserve
recapture. Prior to enactment of the Job Protection Act, savings institutions
were permitted to compute their tax bad debt deduction through use of either
the reserve method or the percentage of taxable income method. The Job
Protection Act repealed both of these methods for large savings institutions
and allows bad debt deductions based only on actual current losses. While
repealing the reserve method for computing tax bad debt deductions, the Job
Protection Act allows savings institutions to retain their existing base year
bad debt reserves but requires that reserves in excess of the balance at
December 31, 1987, be recaptured into taxable income. The tax liability for
this recapture is included in the accompanying Consolidated Financial
Statements.
The base year reserve is recaptured into taxable income only in limited
situations, such as in the event of certain excess distributions, complete
liquidation or disqualification as a bank. None of the limited circumstances
requiring recapture are contemplated by the Company. The amount of the
Company's tax bad debt reserves subject to recapture in these circumstances
approximates $5,318,000 at December 31, 2002. Due to the remote nature of
events that may trigger the recapture provisions, no tax liability has been
established in the accompanying Consolidated Financial Statements.
In addition, as a result of certain acquisitions, the Company is required to
recapture certain tax bad debt reserves of the acquired institution. The
Company has elected to recapture these reserves into income over a four-year
period using the deferral method. The recapture does not result in a charge
to earnings as the Company provided for this liability on the acquisition
date.
84
The provision for income taxes for the years ended December 31, 2002, 2001,
and 2000 differs from that computed at the statutory corporate tax rate as
follows (in thousands):
Years Ended
December 31
--------------------------------
2002 2001 2000
------ ------ ------
Taxes at statutory rate $ 4,459 $ 4,057 $10,005
Increase (decrease) in taxes:
Tax-exempt interest (485) (465) (571)
Amortization of goodwill -- 1,099 1,096
Investment in life insurance (521) (386) (115)
Difference in fair market value versus
basis of released ESOP shares 147 100 (10)
State income taxes net of federal tax
benefit 108 320 281
Other (229) (583) (448)
------ ------ ------
Provision for income taxes $ 3,479 $ 4,142 $10,238
====== ====== ======
The provision for income tax expense for the years ended December 31, 2002,
2001 and 2000 is composed of the following (in thousands):
Years Ended
December 31
--------------------------------
2002 2001 2000
------ ------ ------
Current $ 5,326 $ 5,115 $ 9,560
Deferred (1,847) (973) 678
------ ------ ------
$ 3,479 $ 4,142 $10,238
====== ====== ======
Income taxes are provided for the temporary differences between the tax basis
and financial statement carrying amounts of assets and liabilities. Components
of the Company's net deferred tax assets (liabilities) at December 31, 2002
and 2001 consisted of the following (in thousands):
December 31
-------------------
2002 2001
Deferred tax assets: ------ ------
Loan loss reserves per books $ 9,345 $ 6,191
Deferred compensation and vacation 2,028 1,863
Book vs. tax amortization of intangibles 112 --
Book vs. tax amortization of loan acquisition
premiums 113 --
Deferred servicing rights 31 --
Other 33 490
------ ------
11,662 8,544
------ ------
Deferred tax liabilities:
Change in method of accounting for amortization of
premium and discount on investments 37 84
Tax basis bad debt reserves to be recovered 85 240
FHLB stock dividends 4,794 3,959
Depreciation 1,017 797
Deferred loan fees and servicing rights 567 760
Book vs.tax amortization of deposit acquisition
premium 111 --
Other 386 10
------ ------
6,997 5,850
------ ------
4,665 2,694
Income tax benefit related to unrealized gain/loss
on securities available for sale (1,879) (1,251)
------ ------
Deferred tax asset (liability), net $ 2,786 $ 1,443
====== ======
Management has evaluated the weight of available evidence and concluded that
it is more likely than not that the Company will realize the net deferred tax
asset in future years.
85
Note 15: EMPLOYEE BENEFIT PLANS
The Bank has its own profit sharing plan for all eligible employees. The plan
is funded annually at the discretion of the Board of Directors. Contributions
charged to operations for the years ended December 31, 2002, 2001 and 2000
were $571,000, $467,000 and $0, respectively.
The Bank has entered into a salary continuation agreement with certain of its
senior management. This program was funded by purchasing single premium life
insurance contracts. The program provides for aggregate continued annual
compensation for all participants totaling $240,000 for life with a 15-year
guarantee. Participants vest ratably each plan year until retirement,
termination, death or disability. The Bank is recording the salary
continuation obligation over the estimated remaining service lives of the
participants. Expenses related to this program for the years ended December
31, 2002, 2001 and 2000 were $175,500, $149,500 and $241,300, respectively.
The plan's projected benefit obligation is $2,018,800, of which $1,273,900 was
vested at December 31, 2002. The assumed discount rate was 7.00% for the years
ended December 31, 2002, 2001 and 2000, respectively. At December 31, 2002,
an accumulated benefit obligation of $1,273,900 and cash value of life
insurance of $2,712,700 were recorded. At December 31, 2001, an obligation of
$1,143,700 and cash value of life insurance of $2,551,300 were recorded.
Increases in cash surrender value and related net earnings from the life
insurance contracts partially offset the expenses of this program, resulting
in a net cost of $14,100, $40,000 and $131,200 for the years ended December
31, 2002, 2001 and 2000, respectively.
The Bank also has a non-qualified, non-contributory retirement compensation
plan for certain employees whose benefits are based upon a percentage of
defined participant compensation. Expenses related to the plan included in
the years ended December 31, 2002, 2001 and 2000 results of operations were
$45,000, $96,000 and $84,000, respectively. The recorded liability under this
plan was $805,100 and $759,500 on December 31, 2002 and 2001, respectively.
The Bank is carrying life insurance on these employees to partially offset the
cost of the plan. The policies had recorded cash surrender values of $490,000
and $480,000 at December 31, 2002 and 2001, respectively.
The Company and the Bank also offer non-qualified deferred compensation plans
to members of their Boards of Directors and certain employees. The plans
permit each participant to defer a portion of director fees, non-qualified
retirement contributions, salary or bonuses until the future. Compensation is
charged to expense in the period earned. In order to fund the plans' future
obligations the Company has purchased life insurance polices, contributed to
money market investments and purchased common stock of the Company which are
held in a "Rabbi Trust." As the Company is the owner of the investments and
beneficiary of life insurance contracts, and in order to reflect the Company's
policy to pay benefits equal to accumulations, the assets and liabilities
under the plans are reflected in the consolidated balance sheets of the
Company. Common stock of the Company held for such plans is reported as a
contra-equity account and was recorded at original cost of $2,974,000 at
December 31, 2002 and $2,767,000 at December 31, 2001. The money market
investments and cash surrender value of the life insurance policies are
included in other assets.
During the year ended December 31, 2001, the Company adopted a Supplemental
Executive Retirement Program (SERP) for selected senior executives
(individually, the Executive). At termination of employment at or after
attaining age 62 with at least 15 years of service, the Executive's annual
benefit under the SERP would be computed as the product of 3% of the
Executive's final average compensation (defined as the three calendar years of
Executive's annual cash compensation, including bonuses, which produce the
highest average within the Executive's final eight full calendar years of
employment) and the Executive's annual years of service, reduced by certain
amounts, such as the amount payable to the Executive under the Company's
401(k) profit sharing plan and its ESOP, employer-contributed deferred
compensation, and any amount payable to an Executive under the salary
continuation agreements described above. The maximum benefit would be 60% of
final average compensation, less applicable reductions. A reduced benefit is
payable at termination of employment at or after attaining age 59 1\2 with at
least 15 years of service. Expenses relating to this SERP totaled $510,000
and $180,000 for the years ended December 31, 2002 and 2001, respectively, and
none in the prior periods.
Note 16: EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST
The Company established for eligible employees an ESOP and related trust that
became effective upon the former mutual holding company's conversion to a
stock-based holding company. Eligible employees of BB as of January 1, 1995
and eligible employees of the Company employed after such date who have been
credited with at least 1,000 hours during a twelve-month period are
participants.
The ESOP borrowed $8,728,500 from the Company in order to purchase the common
stock. The loan will be repaid principally from the Company's contributions
to the ESOP over a period not to exceed 25 years, and the collateral for the
loan is the unreleased, restricted common stock purchased by the ESOP.
Contributions to the ESOP will be discretionary; however, the Company intends
to make annual contributions to the ESOP in an aggregate amount at least equal
to the principal and interest requirements of the debt. The interest rate for
the loan is 8.75%.
Participants generally become 100% vested in their ESOP account after seven
years of credited service or if their service was terminated due to death,
early retirement, permanent disability or a change in control of the Company.
Prior to the completion of one year of credited service, a participant who
terminates employment for reasons other than death, retirement, disability or
change in control of the Company will not receive any benefit. Forfeitures
will be reallocated among remaining participating employees in the same
proportion as contributions. Benefits are payable upon death, retirement,
early retirement, disability or separation from service. The contributions to
the ESOP are not fixed, so benefits payable under the ESOP cannot be
estimated. ESOP compensation expense for the years ended December 31, 2002,
2001 and 2000, was $1,259,000, $1,093,000 and $1,510,000, respectively.
As of December 31, 2002, the Company has 515,707 unearned, restricted shares
remaining to be released to the ESOP. The fair value of unearned, restricted
shares held by the ESOP trust was $9,666,000 at December 31, 2002.
86
Note 17: STOCK-BASED COMPENSATION PLANS AND STOCK OPTIONS
The Company operates the following stock-based compensation plans as approved
by the shareholders: the 1996 Management Recognition and Development Plan
(MRP), the 1996 Stock Option Plan, the 1998 Stock Option Plan and the 2001
Stock Option Plan (together, SOPs).
Under the MRP, the Company is authorized to grant up to 528,075 shares of
restricted stock to its directors, officers and employees of BANR. Shares
granted under the MRP vest ratably over a five-year period. The consolidated
statements of income for the year ended December 31, 2002, 2001 and 2000,
reflect an accrual of $51,000, $543,000 and $1,137,000, respectively, in
compensation expense for the MRP including $8,300, $19,500 and $84,500,
respectively, of expense for dividends on the allocated, restricted stock. A
summary of the changes in the granted, but not vested, MRP shares for the
years ended December 31, 2002, 2001 and 2000 follows:
Years Ended
December 31
-------------------------
2002 2001 2000*
------ ------ ------
Shares granted not vested, beginning of period 8,421 86,324 183,527
Shares granted 7,000 3,025 4,476
Shares vested (2,104) (80,597) (90,330)
Shares forfeited -- (331) (11,349)
------ ------ ------
Shares granted not vested, end of period 13,317 8,421 86,324
====== ====== ======
* Adjusted for stock dividend: see Note 2
Under the 1996, 1998 and 2001 SOPs, the Company has reserved 2,284,186 shares
for issuance pursuant to the exercise of stock options which may be granted to
directors and employees. The exercise price of the stock options is set at
100% of the fair market value of the stock price at date of grant. Such
options vest ratably over a five-year period and any unexercised options will
expire ten years after date of grant or 90 days after employment or service
ends.
Details of stock options granted, vested, exercised, forfeited or terminated
are as follows:
Weighted
average Weighted Number of option shares
fair value average ------------------------------
at date exercise
of grant price Total Granted Exercisable
-------- -------- --------- -------- -----------
Balances January 1, 2000* $ 13.75 1,753,804 881,074 872,730
--------- ------- -------
For the year ended
December 31, 2000:*
Options granted $ 4.37 $ 13.47 224,525 224,525 --
Options vested -- (312,039) 312,039
Options forfeited 14.64 (54,902) (31,668) (23,234)
Options exercised 8.42 (66,391) -- (66,391)
Options terminated -- -- --
Number of option shares --------- ------- -------
at December 31, 2000 $ 13.88 1,857,036 761,892 1,095,144
--------- ------- ---------
For the year ended
December 31, 2001:
Options granted $ 7.03 $ 16.62 152,825 152,825 --
Options vested -- (338,365) 338,365
Options forfeited 18.79 (35,459) (21,214) (14,245)
Options exercised 11.55 (195,288) -- (195,288)
Options terminated -- -- --
Number of option shares --------- ------- -------
at December 31, 2001 $ 14.28 1,779,114 555,138 1,223,976
--------- ------- ---------
For the year ended
December 31, 2002:
Options granted $ 8.73 $ 20.16 158,750 158,750 --
Options vested -- (163,526) 163,526
Options forfeited 18.20 (83,977) (48,174) (35,803)
Options exercised 13.38 (88,662) -- (88,662)
Options terminated 16.43 (4,250) (4,250) --
Number of option shares --------- ------- -------
at December 31, 2002 $ 14.66 1,760,975 497,938 1,263,037
========= ======= =========
* Adjusted for stock dividends: see Note 2
87
Note 17: STOCK BASED COMPENSATION (continued)
Financial data pertaining to outstanding stock options granted or assumed
as a result of certain acquisitions at December 31, 2002 were as follows: *
Weighted average Number of Weighted average Weighted average
exercise price Number of option shares exercise price remaining
Exercise of option shares option shares vested and of option shares contractual
Price granted granted exercisable exercisable life
- --------- ---------------- ------------- ----------- ----------- -----------
$ 1.18 $ 1.18 1,265 1,265 $ 1.18 6.0 yrs
3.82 to 3.89 3.89 3,167 3,167 3.89 5.2 yrs
4.26 to 5.58 4.89 38,328 38,328 4.89 5.2 yrs
7.56 7.56 253 253 7.56 6.0 yrs
8.03 8.03 2,532 2,532 8.03 6.0 yrs
10.51 10.51 14,764 14,764 10.51 6.0 yrs
12.19 to 13.95 12.69 1,109,624 964,375 12.59 4.2 yrs
14.09 to 15.29 14.70 52,250 25,740 14.81 6.1 yrs
16.31 to 17.84 16.60 179,325 41,965 16.67 8.2 yrs
18.55 to 19.82 19.38 84,500 -- -- 0.0 yrs
20.02 to 21.44 21.15 124,055 93,846 22.05 5.2 yrs
23.28 22.21 150,912 76,802 -- 6.0 yrs
--------- ---------
$ 14.66 1,760,975 1,263,037 $ 13.69 4.6 yrs
========= =========
* Adjusted for stock dividends: see Note 2
Note 18: REGULATORY CAPITAL REQUIREMENTS
The Company is a bank holding company registered with the Federal Reserve.
Bank holding companies are subject to capital adequacy requirements of the
Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA),
and the regulations of the Federal Reserve. Banner Bank is a state-chartered
federally insured institution subject to the capital requirements established
by the FDIC.
The capital adequacy requirements are quantitative measures established by
regulation that require the Company and the Bank to maintain minimum amounts
and ratios of capital. The Federal Reserve requires the Company to maintain
capital adequacy that generally parallels the FDIC requirements. The FDIC
requires the Bank to maintain minimum ratios of total capital and Tier 1
capital to risk-weighted assets as well as Tier 1 leverage capital to average
assets.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
created a statutory framework that increased the importance of meeting
applicable capital requirements. For the Bank, FDICIA established five
capital categories: well-capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution's category depends upon where its capital
levels are in relation to relevant capital measures, which include a risk-
based capital measure, a leverage ratio capital measure, and certain other
factors. The federal banking agencies (including the FDIC) have adopted
regulations that implement this statutory framework. Under these regulations,
an institution is treated as well-capitalized if its ratio of total capital to
risk-weighted assets is 10.00% or more, its ratio of core capital to risk-
weighted assets is 6.00% or more, its ratio of core capital to adjusted total
assets is 5.00% or more and it is not subject to any federal supervisory order
or directive to meet a specific capital level. In order to be adequately
capitalized, an institution must have a total risk-based capital ratio of not
less than 8.00%, a Tier 1 risk-based capital ratio of not less than 4.00%, and
leverage ratio of not less than 4.00%. Any institution which is neither
well-capitalized nor adequately capitalized will be considered
undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action
requirements, regulatory controls and restrictions which become more extensive
as an institution becomes more severely undercapitalized. Failure by the Bank
to comply with applicable capital requirements would, if unremedied, result in
restrictions on its activities and lead to enforcement actions against it by
the FDIC, including, but not limited to, the issuance of a capital directive
to ensure the maintenance of required capital levels. FDICIA requires the
federal banking regulators to take prompt corrective action with respect to
depository institutions that do not meet minimum capital requirements.
Additionally, FDIC approval of any regulatory application filed for its review
may be dependent on compliance with capital requirements.
FDIC regulations recognize two types or tiers of capital: core (Tier 1)
capital and supplementary (Tier 2) capital. Tier 1 capital generally includes
common stockholders' equity and noncumulative perpetual preferred stock, less
most intangible assets. Tier 2 capital, which is limited to 100% of Tier 1
capital, includes such items as qualifying general loan loss reserves,
cumulative perpetual preferred stock, mandatory convertible debt, term
subordinated debt and limited life preferred stock; however, the amount of
term subordinated debt and intermediate term preferred stock (original
maturity of at least five years but less than 20 years) that may in included
in Tier 2 capital is limited to 50% of Tier 1 capital.
88
The FDIC currently measures an institution's capital using a leverage limit
together with certain risk-based ratios. The FDIC's minimum leverage capital
requirement specifies a minimum ratio of Tier 1 capital to average total
assets. Most banks are required to maintain a minimum leverage ratio of at
least 4% to 5% of total assets. The FDIC retains the right to require a
particular institution to maintain a higher capital level based on an
institution's particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on ratios
of qualifying capital to risk-weighted assets. Assets are placed in one of
four categories and given a percentage weight 0%, 20%, 50% or 100% based on
the relative risk of the category. In addition, certain off-balance-sheet
items are converted to balance-sheet credit equivalent amounts, and each
amount is then assigned to one of the four categories. Under the guidelines,
the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-
weighted assets must be at least 8%, and the ratio of Tier 1 capital to risk-
weighted assets must be at least 4%. In evaluating the adequacy of a bank's
capital, the FDIC may also consider other factors that may affect a bank's
financial condition. Such factors may include interest rate risk exposure,
liquidity, funding and market risks, the quality and level of earnings,
concentration of credit risk, risks arising from nontraditional activities,
loan and investment quality, the effectiveness of loan and investment
policies, and management's ability to monitor and control financial operating
risks.
FDIC capital requirements are designated as the minimum acceptable standards
for banks whose overall financial condition is fundamentally sound, which are
well-managed and have no material or significant financial weaknesses. The
FDIC capital regulations state that, where the FDIC determines that the
financial history or condition, including off-balance-sheet risk, managerial
resources and/or the future earnings prospects of a bank are not adequate
and/or a bank has a significant volume of assets classified substandard,
doubtful or loss or otherwise criticized, the FDIC may determine that the
minimum adequate amount of capital for the bank is greater than the minimum
standards established in the regulation.
The Company believes that, under the current regulations, the Bank exceeds its
minimum capital requirements. However, events beyond the control of the Bank,
such as weak or depressed economic conditions in areas where the Bank has most
of its loans, could adversely affect future earnings and, consequently, the
ability of the Bank to meet is capital requirements.
89
Note 18: REGULATORY CAPITAL REQUIREMENTS (continued)
The Company may not declare or pay cash dividends on, or repurchase, any of
its shares of common stock if the effect thereof would cause equity to be
reduced below applicable regulatory capital maintenance requirements or if
such declaration and payment would otherwise violate regulatory requirements.
The following table shows the regulatory capital ratios of the Company and the
Bank and the minimum regulatory requirements:
Minimum to be
categorized as
Minimum "well-capitalized"
for capital under prompt
adequacy corrective action
Actual purposes provisions
-------------- -------------- --------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(dollars in thousands)
December 31, 2002:
The Company-consolidated
Total capital to risk-
weighted assets $211,240 12.96% $130,412 8.00% N/A N/A
Tier 1 capital to risk-
weighted assets 190,012 11.66 65,206 4.00 N/A N/A
Tier 1 leverage capital
to average assets 190,012 8.77 86,660 4.00 N/A N/A
The Bank
Total capital to risk-
weighted assets 174,553 10.73 130,100 8.00 $162,625 10.00%
Tier 1 capital to risk-
weighted assets 153,373 9.43 65,060 4.00 97,575 6.00
Tier 1 leverage capital
to average assets 153,373 7.08 86,593 4.00 108,241 5.00
December 31, 2001:
The Company-consolidated
Total capital to risk-
weighted assets 177,054 11.57% 122,458 8.00% N/A N/A
Tier 1 capital to risk-
weighted assets 158,513 10.36 61,229 4.00 N/A N/A
Tier 1 leverage capital
to average assets 158,513 7.71 82,222 4.00 N/A N/A
The Bank
Total capital to risk-
weighted assets 173,773 11.40 121,982 8.00 152,477 10.00%
Tier 1 capital to risk-
weighted assets 155,232 10.18 60,991 4.00 91,486 6.00
Tier 1 leverage capital
to average assets 155,232 7.56 82,169 4.00 102,712 5.00
Company management believes that under the current regulations as of December
31, 2002, the Company and the Bank individually met all capital adequacy
requirements to which they were subject. Further, there have been no
conditions or events since that date that have materially adversely changed
the Tier 1 or Tier 2 capital of the Company or the Bank. On January 23, 2003,
the Company invested $25 million of additional Tier 1 capital in the Bank.
90
Note 19: CONTINGENCIES
In the normal course of business, the Company and/or its subsidiaries have
various legal proceedings and other contingent matters outstanding. These
proceedings and the associated legal claims are often contested and the
outcome of individual matters is not always predictable. These claims and
counter claims typically arise during the course of collection efforts on
problem loans or with respect to action to enforce liens on properties in
which the Bank holds a security interest. Presently the Company has three
such counter claims by borrowers or involved parties. Based upon the
information known to the Company at this time, management believes that any
liability ultimately arising from these actions would not have a material
adverse effect on the results of operations or consolidated financial position
at December 31, 2002.
In connection with certain asset sales, the Bank typically makes
representations and warranties about the underlying assets conforming to
specified guidelines. If the underlying assets do not conform to the
specifications, the Bank may have an obligation to repurchase the assets or
indemnify the purchaser against any loss. The Bank believes that the
potential for loss under these arrangements is remote. Accordingly, no
contingent liability is recorded in the financial statements.
Note 20: INTEREST RATE RISK
The financial condition and operation of the Company are influenced
significantly by general economic conditions, including the absolute level of
interest rates as well as changes in interest rates and the slope of the yield
curve. The Company's profitability is dependent to a large extent on its net
interest income, which is the difference between the interest received from
its interest-earning assets and the interest expense incurred on its
interest-bearing liabilities.
The activities of the Company, like all financial institutions, inherently
involve the assumption of interest rate risk. Interest rate risk is the risk
that changes in market interest rates will have an adverse effect on the
institution's earnings and underlying economic value. Interest rate risk is
determined by the maturity and repricing characteristics of an institution's
assets, liabilities and off-balance-sheet contracts. Interest rate risk is
measured by the variability of financial performance and economic value
resulting from changes in interest rates. Interest rate risk is the primary
market risk impacting the Company's financial performance.
The greatest source of interest rate risk to the Company results from the
mismatch of maturities or repricing intervals for rate-sensitive assets,
liabilities and off-balance-sheet contracts. Additional interest rate risk
results from mismatched repricing indices and formulae (basis risk and yield
curve risk), product caps and floors, and early repayment or withdrawal
provisions (option risk), which may be contractual or market driven, that are
generally more favorable to customers than to the Company.
The Company's primary monitoring tool for assessing interest rate risk is
"asset/liability simulation modeling," which is designed to capture the
dynamics of balance sheet, interest rate and spread movements, and to quantify
variations in net interest income and net market value resulting from those
movements under different rate environments. Another monitoring tool used by
the Company to assess interest rate risk is "gap analysis." The matching of
repricing characteristics of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are "interest
sensitive" and by monitoring the Company's interest sensitivity "gap."
Management is aware of the sources of interest rate risk and in its opinion
actively monitors and manages it to the extent possible, and considers that
the Company's current level of interest rate risk is reasonable.
Note 21: GOODWILL AND INTANGIBLES
Goodwill and intangibles consisted of the following (in thousands):
December 31
---------------------
2002 2001
------ ------
Costs in excess of net assets acquired (goodwill)
net of accumulated amortization of $12,594,000
and $12,594,000, respectively (see Note 3) $ 36,230 $ 31,437
Core deposit intangible, net of accumulated
amortization of $255,000 and $0, respectively 459 --
Internet domain name, net of accumulated
amortization of $0 and $0, respectively 25 --
-------- --------
$ 36,714 $ 31,437
======== ========
91
Acquisition of OBB: The following table summarizes the estimated fair values
of the assets acquired and liabilities assumed at the date of acquisition (in
thousands):
January 1, 2002
---------------
Cash $ 3,572
Securities 1,531
Loans receivable 33,648
Property and equipment 237
Other assets 49
Core deposit intangible 714
Goodwill 4,793
--------
Total Assets Acquired 44,544
--------
Deposits (33,499)
Borrowings (701)
Other liabilities (253)
--------
Total Liabilities Assumed (34,453)
--------
Net Assets Acquired $ 10,091
========
The $714,000 of acquired intangible assets was assigned to core deposit
intangible and is being amortized on an accelerated basis over a five-year
useful life. Loans receivable and deposits were assigned fair market
valuation premiums of $534,000 (three-year average life) and $347,000
(two-year average life), respectively. The premiums are being amortized using
a level-yield method. The $4.8 million of goodwill was assigned to OBB's
ongoing business relationships. None of the goodwill is expected to be
deductible for income tax purposes.
Intangible Assets: The gross carrying amount and accumulated amortization of
the Company's intangible assets other than goodwill as of December 31, 2002 is
as follows (in thousands):
December 31, 2002
-------------------------------------
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
-------- ------------ --------
Core Deposit Intangible (CDI) $ 714 $ (255) $ 459
Mortgage Servicing Rights (MSR)* $ 1,715 $ (94) $ 1,621
Internet Domain Name $ 25 $ -- $ 25
-------- ------------ --------
$ 2,454 $ (349) $ 2,105
======== ============ ========
*Amortization of mortgage servicing rights is recorded as a reduction of
loan servicing income. Mortgage servicing rights are recorded on an
individual basis with the gross carrying amount and accumulated
amortization fully written off if the loan repays in full.
Amortization expense for the year ended December 31, 2002 and 2001 includes
$255,000 and $0, respectively, of expense related to the CDI amortization and
$686,000 and $574,000, respectively, of expense related to the MSR
amortization.
Estimated amortization expense in future years with respect to existing
intangibles (in thousands):
Internet
Year Ended CDI MSR Domain Name TOTAL
----------------- ----- ----- ----------- -----
December 31, 2003 $ 200 $ 300 $ 2 502
December 31, 2004 143 238 2 383
December 31, 2005 86 198 2 286
December 31, 2006 30 165 2 197
December 31, 2007 -- 137 2 139
92
Note 22: FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments
is made in accordance with the requirements of SFAS No. 107, Disclosures About
Fair Value of Financial Instruments. The estimated fair value amounts have
been determined by the Company using available market information and
appropriate valuation methodologies. However, considerable judgment is
necessary to interpret market data in the development of the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
The estimated fair value of financial instruments is as follows (in
thousands):
Years Ending December 31
------------------------------------------
2002 2001
-------------------- --------------------
Carrying Estimated Carrying Estimated
value fair value value fair value
-------- ---------- -------- ----------
Assets:
Cash and due from banks $ 132,910 $ 132,910 $ 67,728 $ 67,728
Securities available for sale 421,222 421,222 301,847 301,847
Securities held to maturity 13,253 13,414 14,828 14,902
Loans receivable held for sale 39,366 39,984 43,235 43,647
Loans receivable 1,507,561 1,534,437 1,532,190 1,547,699
FHLB stock 32,831 32,831 30,840 30,840
Mortgage servicing rights 1,621 1,903 1,261 1,375
Liabilities:
Demand, NOW and money market
accounts 528,621 528,621 443,376 443,376
Regular savings 44,344 44,344 42,228 42,228
Certificates of deposit 924,823 931,317 810,207 820,147
FHLB advances 465,743 486,414 501,982 509,016
Trust preferred securities and
other borrowings 81,202 81,331 76,715 76,875
Off-balance-sheet financial instruments:
Commitments to sell loans 70 70 $ -- $ 83
Commitments to originate loans (70) (70) -- (83)
Commitments to purchase securities -- 166 -- --
Fair value estimates, methods, and assumptions are set forth below for the
Company's financial and off-balance-sheet instruments:
Cash and due from banks: The carrying amount of these items is a reasonable
estimate of their fair value.
Securities: The estimated fair values of investment securities and mortgaged-
backed securities available for sale and held to maturity are based on quoted
market prices or dealer quotes.
Loans Receivable: Fair values are estimated for portfolios of loans with
similar financial characteristics. Loans are segregated by type such as
multifamily real estate, residential mortgage, nonresidential,
commercial/agricultural, consumer and other. Each loan category is further
segmented into fixed- and adjustable-rate interest terms and by performing and
non-performing categories.
The fair value of performing residential mortgages held for sale is estimated
based upon secondary market sources by type of loan and terms such as fixed or
variable interest rates. For performing loans held in portfolio, the fair
value is based on discounted cash flows using as a discount rate the current
rate offered on similar products.
Fair value for significant non-performing loans is based on recent appraisals
or estimated cash flows discounted using rates commensurate with risk
associated with the estimated cash flows. Assumptions regarding credit risk,
cash flows and discount rates are judgmentally determined using available
market information and specific borrower information.
FHLB Stock: The fair value is based upon the redemption value of the stock
which equates to its carrying value.
Deposit Liabilities: The fair value of deposits with no stated maturity, such
as savings, checking and NOW accounts, is equal to the amount payable on
demand. The market value of certificates of deposit is based upon the
discounted value of contractual cash flows. The discount rate is determined
using the rates currently offered on comparable instruments.
FHLB Advances and Other Borrowings: The fair value of FHLB advances and other
borrowings is estimated based on discounting the estimated future cash flows
using rates currently available to the Company for debt with similar remaining
maturities.
Commitments: Commitments to sell loans with notional balances of $32,568,000
and $48,303,000 at December 31, 2002 and 2001, respectively, have a carrying
value of ($70,000) and $0, representing the fair value of such commitments.
Interest rate lock commitments to originate loans held
93
for sale with notional balances of $32,568,000 and $48,303,000 at December 31,
2002 and 2001, respectively, have a carrying value of $70,000 and $0. Other
commitments to fund loans totaled $378,339,000 and $289,122,000 at December
31, 2002 and 2001, respectively, and have a carrying value of $0 at both
dates, representing the cost of such commitments. Commitments to purchase
securities at December 31, 2002, with a notional balance of $25.3 million,
have a carrying value of zero, representing the cost of such commitments.
There were no commitments to sell securities at December 31, 2002. There were
no commitments to purchase or sell securities at December 31, 2001.
Limitations: The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 2002. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore, current estimates of fair value may differ significantly from the
amounts presented herein.
Fair value estimates are based on existing on- and off-balance-sheet financial
instruments without attempting to estimate the value of anticipated future
business. The fair value has not been estimated for assets and liabilities
that are not considered financial instruments. Significant assets and
liabilities that are not financial instruments include the deferred tax
assets/liabilities; land, buildings and equipment; costs in excess of net
assets acquired; and real estate held for sale.
Note 23: BANNER CORPORATION (BANR)
(PARENT COMPANY ONLY)
Summary financial information is as follows (in thousands):
BANR
Balance Sheets
December 31, 2002 and 2001
December 31
-------------------
2002 2001
ASSETS ------ ------
Cash $ 34,381 $ 540
Investment in subsidiaries 194,958 189,059
Deferred tax asset 340 405
Other assets 2,235 2,896
------- -------
$231,914 $192,900
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities $ 317 $ 560
Trust preferred securities 41,220 --
Stockholders' equity 190,377 192,340
------- -------
$231,914 $192,900
======= =======
BANR
Statements of Income
For the years ended December 31, 2002, 2001 and 2000
Years Ended
December 31
2002 2001 2000
------ ------ ------
INTEREST INCOME:
Certificates and time deposits $ 442 $ 61 $ 48
Investments -- -- --
------ ------ ------
442 61 48
OTHER INCOME (EXPENSE):
Dividend income from subsidiaries 6,715 8,644 8,351
Equity in undistributed income of subsidiaries 4,231 -- 11,288
Interest on other borrowings (1,185) -- --
Other expense (1,837) 1,898 2,027
------ ------ ------
8,366 6,807 17,660
PROVISION FOR (BENEFIT FROM)
INCOME TAXES (894) (643) (688)
------ ------ ------
NET INCOME $ 9,260 $ 7,450 $18,348
====== ====== ======
94
BANR
Statements of Cash Flows
For the years ended December 31, 2002, 2001 and 2000
Years Ended
December 31
--------------------------
2002 2001 2000
------ ------ ------
OPERATING ACTIVITIES:
Net income $ 9,260 $ 7,450 $18,348
Adjustments to reconcile net income
to net cash provided by operating
activities:
Equity in undistributed earnings
of subsidiaries (4,232) -- (11,288)
Amortization 65 177 302
(Increase) decrease in deferred taxes 65 -- --
(Increase) decrease in other assets 1,916 141 (447)
Increase (decrease) in other liabilities (262) (203) (1,167)
------ ------ ------
Net cash provided (used) by operating activities 6,812 7,565 5,748
------ ------ ------
INVESTING ACTIVITIES:
Funds transferred to deferred compensation trust (71) (76) (60)
Acquisitions of subsidiaries (1,220) -- (7)
Dividends received from subsidiaries -- 2,265 4,000
Payments received on loan to ESOP
for release of shares 1,244 1,043 1,510
Additional funds returned from
(invested in) subsidiaries -- -- (1,100)
------ ------ ------
Net cash provided (used) by investing activities (47) 3,232 4,343
------ ------ ------
FINANCING ACTIVITIES:
Proceeds from issuance of junior subordinated
debentures 39,943 -- --
Repurchases of stock (8,391) (10,158) (5,233)
Repurchase of forfeited MRP shares -- (4) (120)
Net proceeds from exercise of stock options 2,002 3,645 913
Cash dividends paid (6,478) (6,284) (5,553)
------ ------ ------
Net cash provided(used) by financing activities 27,076 (12,801) (9,993)
------ ------ ------
NET INCREASE (DECREASE) IN CASH 33,841 (2,004) 98
CASH, BEGINNING OF PERIOD 540 2,544 2,446
------ ------ ------
CASH, END OF PERIOD $34,381 $ 540 $ 2,544
====== ====== ======
95
BANR
Statements of Cash Flows (continued)
For the year ended December 31, 2002, 2001 and 2000
Years Ended
December 31
--------------------------
2002 2001 2000
------ ------ ------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 2,126 $ -- $ --
Taxes paid -- -- --
Non-cash transactions:
Net change in accrued dividends payable 72 45 336
Net change in unrealized gain (loss) in
deferred compensation trust and related
liability, including subsidiaries 117 133 173
Recognize tax benefit of vested MRP shares,
including subsidiaries 3 259 2
Non-cash portion of 10% stock dividend -- -- 14,731
The following summarizes the non-cash activities
relating to acquisitions:
Fair value of assets acquired adjustment $ -- $ -- $ (48)
Fair value of liabilities assumed -- -- --
Fair value of stock issued to acquisitions'
shareholders subsequent adjustments n/a n/a 48
------ ------ ------
Cash paid out in acquisition -- -- --
Less cash acquired -- -- --
------ ------ ------
Net cash acquired (used) $ -- $ -- $ -
====== ====== ======
Note 24: STOCK REPURCHASE
The Company has periodically engaged in stock repurchase activity. During the
years ended December 31, 2002 and 2001, the Company repurchased 422,844 and
569,166 shares of its stock at average prices of $19.84 and $17.85 per share,
respectively. On August 28, 2002, the Company's Board of Directors approved
continuance of a stock repurchase program authorizing the purchase of up to 5%
of total shares outstanding over the next twelve months.
Note 25: CALCULATION OF WEIGHTED AVERAGE SHARES OUTSTANDING USED TO CALCULATE
EARNINGS PER SHARE (in thousands)
Years Ended
December 31
--------------------------
2002 2001 2000*
------ ------ ------
Total shares issued 13,201 13,201 13,201
Less stock repurchased/retired
including shares allocated to MRP (1,692) (1,389) (1,150)
Less unallocated shares held by the ESOP (577) (633) (746)
------ ------ ------
Basic weighted average shares outstanding 10,932 11,179 11,305
Plus MRP and stock option incremental
shares considered outstanding for diluted
EPS calculations 420 421 182
------ ------ ------
Diluted weighted average shares outstanding 11,352 11,600 11,487
====== ====== ======
* Weighted average shares, restated for stock dividend: see Note 2
96
Note 26: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Results of operations on a quarterly basis were as follows (in thousands
except for per share data):
Year Ended December 31, 2002
-------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 36,018 $ 36,276 $ 36,349 $ 35,633
Interest expense 17,104 16,843 16,270 15,752
------- ------- ------- -------
Net interest income 18,914 19,433 20,079 19,881
Provision for loan losses 3,000 4,000 4,000 10,000
Net interest income after provision ------- ------- ------- -------
for loan losses 15,914 15,433 16,079 9,881
Non-interest income 3,218 3,549 3,931 5,179
Non-interest expense 13,326 13,840 15,300 17,979
Income before provision for ------- ------- ------- -------
income taxes 5,806 5,142 4,710 (2,919)
Provision for income taxes 1,897 1,615 1,329 (1,362)
------- ------- ------- -------
Net operating income $ 3,909 $ 3,527 $ 3,381 $ (1,557)
======= ======= ======= =======
Basic earnings per share $ 0.35 $ 0.32 $ 0.31 $ (0.14)
Diluted earnings per share $ 0.34 $ 0.30 $ 0.30 $ (0.14)
Cash dividends declared $ 0.15 $ 0.15 $ 0.15 $ 0.15
Year Ended December 31, 2001
-------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 40,578 $ 39,739 $ 39,858 $ 37,491
Interest expense 23,107 22,545 21,544 18,748
------- ------- ------- -------
Net interest income 17,471 17,194 18,314 18,743
Provision for loan losses 950 2,950 5,959 4,100
Net interest income after provision ------- ------- ------- -------
for loan losses 16,521 14,244 12,355 14,643
Non-interest income 2,865 3,635 3,314 3,651
Non-interest expense 15,711 15,201 15,601 13,123
Income before provision for income ------- ------- ------- -------
taxes 3,675 2,678 68 5,171
Provision for income taxes 1,366 1,059 212 1,505
------- ------- ------- -------
Net operating income $ 2,309 $ 1,619 $ (144) $ 3,666
======= ======= ======= =======
Basic earnings per share $ 0.21 $ 0.14 $ (0.01) $ 0.33
Diluted earnings per share $ 0.20 $ 0.14 $ (0.01) $ 0.32
Cash dividends declared $ 0.14 $ 0.14 $ 0.14 $ 0.14
Year Ended December 31, 2000
-------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 36,630 $ 39,108 $ 40,923 $ 41,637
Interest expense 19,985 21,777 23,690 24,142
------- ------- ------- -------
Net interest income 16,645 17,331 17,233 17,495
Provision for loan losses 545 819 651 852
Net interest income after provision ------- ------- ------- -------
for loan losses 16,100 16,512 16,582 16,643
Non-interest income 1,631 1,822 2,225 3,573
Non-interest expense 10,810 11,285 11,686 12,721
Income before provision for income ------- ------- ------- -------
taxes 6,921 7,049 7,121 7,495
Provision for income taxes 2,496 2,506 2,515 2,721
------- ------- ------- -------
Net operating income $ 4,425 $ 4,543 $ 4,606 $ 4,774
======= ======= ======= =======
Basic earnings per share $ 0.39* $ 0.40* $ 0.41 $ 0.42
Diluted earnings per share $ 0.38* $ 0.40* $ 0.40 $ 0.42
Cash dividends declared $ 0.13* $ 0.13* $ 0.13 $ 0.14
* Restated for stock dividend, see Note 2
97
Note 27: BUSINESS SEGMENTS
The Company has been managed by legal entity or bank, not by lines of
business. In prior periods, business segment reporting included results for
each subsidiary bank; however, during the year ended December 31, 2001, all of
the subsidiary banks were merged into a single legal entity, BB, with a
consolidated management team. For comparative purposes, prior period segment
information has been regrouped to match current business segments/grouping
after merger of the Bank subsidiaries.
BB is a community oriented commercial bank chartered in the State of
Washington. The performance of BB is reviewed by the Company's executive
management team and the Board of Directors on a monthly basis. All of the
executive officers of the Company are members of the BB management team.
Generally accepted accounting principles establish standards to report
information about operating segments in annual financial statements and
require reporting of selected information about operating segments in interim
reports to stockholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Company has concluded that, as a result of the mergers of its subsidiary
banks completed during 2000 and 2001, it has one segment.
Financial highlights by legal entity were as follows (in thousands):
Year Ended December 31, 2002
----------------------------
Condensed Income Statement
BB Other* Total
------ ------ ------
Net interest income (loss) $ 79,051 $ (744) $ 78,307
Provision for loan losses 21,000 -- 21,000
Other income 15,877 -- 15,877
Other expenses 58,608 1,837 60,445
------ ------ ------
Income (loss) before income taxes 15,320 (2,581) 12,739
Income taxes (benefit) 4,374 (895) 3,479
------ ------ ------
Net income (loss) $ 10,946 $(1,686) $ 9,260
====== ====== ======
December 31, 2002
-----------------------------------
Total Assets $ 2,260,296 $ 2,876 $ 2,263,172
========= ====== =========
* Includes intercompany eliminations and holding company amounts.
Year Ended December 31, 2001
----------------------------
Condensed Income Statement
BB Other* Total
------ ------ ------
Net interest income (loss) $ 71,660 $ 62 $ 71,722
Provision for loan losses 13,959 -- 13,959
Other income 13,465 -- 13,465
Other expenses 57,738 1,898 59,636
------ ------ ------
Income (loss) before income taxes 13,428 (1,836) 11,592
Income taxes (benefit) 4,785 (643) 4,142
------ ------ ------
Net income (loss) $ 8,643 $(1,193) $ 7,450
====== ====== ======
December 31, 2001
-----------------------------------
Total Assets $ 2,081,147 $ 5,947 $ 2,087,094
========= ====== =========
98
Year Ended December 31, 2000
----------------------------
Condensed Income Statement
BB Other* Total
------ ------ ------
Net interest income (loss) $ 68,654 $ 50 $ 68,704
Provision for loan losses 2,867 -- 2,867
Other income 9,324 (73) 9,251
Other expenses 44,547 1,955 46,502
------ ------ ------
Income (loss) before income taxes 30,564 (1,978) 28,586
Income taxes (benefit) 10,926 (688) 10,238
------ ------ ------
Net income (loss) $ 19,638 $ (1,290) $ 18,348
====== ====== ======
December 31, 2000
----------------------------------
Total Assets $1,981,944 887 $1,982,831
========= ====== =========
* Includes intercompany eliminations and holding company amounts and trusts.
99
BANNER CORPORATION
Index of Exhibits
Exhibit
- -------
3{a} Articles of Incorporation of Registrant [incorporated by reference to
Exhibit B to the Proxy Statement for the Annual Meeting of Stockholders
dated June 10, 1998].
3{b} Bylaws of Registrant [incorporated by reference to Exhibit 3.2 filed
with the Current Report on Form 8-K dated July 24, 1998 (file No.
0-26584)].
10{a} Employment Agreement with Gary L. Sirmon [incorporated by reference to
exhibits filed with the Annual Report on Form 10-K for the year ended
March 31, 1996 (File No. 0-26584)].
10{b} Executive Salary Continuation Agreement with Gary L. Sirmon
[incorporated by reference to exhibits filed with the Annual Report on
Form 10-K for the year ended March 31, 1996 (File No. 0-26584)].
10{c} Employment Agreement with Michael K. Larsen [incorporated by reference
to exhibits filed with the Annual Report on Form 10-K for the year
ended March 31, 1996 (File No. 0-26584)].
10{d} Executive Salary Continuation Agreement with Michael K. Larsen
[incorporated by reference to exhibits filed with the Annual Report on
Form 10-K for the year ended March 31, 1996 (File No. 0-26584)].
10{e} 1996 Stock Option Plan (incorporated by reference to Exhibit A to the
Proxy Statement for the Annual Meeting of Stockholders dated June 10,
1996).
10{f} 1996 Management Recognition and Development Plan (incorporated by
reference to Exhibit B to the Proxy Statement for the Annual Meeting of
Stockholders dated June 10, 1996).
10{g} Employment and Non-Competition Agreement with Jesse G. Foster
[incorporated by reference to exhibits filed with the Annual Report on
Form 10-K for the year ended March 31, 1997 (file No. 0-26584)].
10{h} Supplemental Retirement Plan as Amended with Jesse G. Foster
[incorporated by reference to exhibits filed with the Annual Report on
Form 10-K for the year ended March 31, 1997 (file No. 0-26584)].
10{i} Towne Bank of Woodinville 1992 Stock Option Plan [incorporated by
reference to exhibits filed with the Registration Statement on Form S-8
dated April 2, 1998 (file No. 333-49193)].
10{j} Whatcom State Bank 1991 Stock Option Plan [incorporated by reference to
exhibits filed with the Registration Statement on Form S-8 dated
February 2, 1999 (file No. 333-71625)].
10{k} Employment Agreement with Lloyd W. Baker [incorporated by reference to
exhibits filed with the Annual Report on Form 10-K for the year ended
December 31, 2001 (file No. 0-26584)].
10{l} Employment Agreement with S. Rick Meikle [incorporated by reference to
exhibits filed with the Annual Report on Form 10-K for the year ended
December 31, 2001 (file No. 0-26584)].
10{m} Separation and Transition Agreement with S. Rick Meikle [incorporated
by reference to exhibits filed with the Annual Report on Form 10-K for
the year ended December 31, 2001 (file No. 0-26584)].
10{n} Employment Agreement with D. Michael Jones [incorporated by reference
to exhibits filed with the Annual Report on Form 10-K for the year
ended December 31, 2001 (file No. 0-26584)].
10{o} Form of Supplemental Executive Retirement Program Agreement with Gary
Sirmon, S. Rick Meikle, Michael K. Larsen, Lloyd W. Baker and Cynthia
D. Purcell [incorporated by reference to exhibits filed with the Annual
Report on Form 10-K for the year ended December 31, 2001 (file No.
0-26584)].
10{p} 1998 Stock Option Plan (incorporated by reference to Exhibit A to the
Proxy Statement for the Annual Meeting of Stockholders dated June 10,
1998).
10{q} 2001 Stock Option Plan (incorporated by reference to Exhibit B to the
Proxy Statement of the Annual Meeting of Stockholders dated March 16,
2001).
10{r} Form of Employment Contract entered into with Cynthia D. Purcell,
Richard B. Barton, Paul E. Folz and John R. Neill.
21 Subsidiaries of the Registrant.
23 Independent Auditors Consent.
99 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
100
Exhibit 21
Subsidiaries of the Registrant
Parent
- -----------------------
Banner Corporation
Percentage of Jurisdiction of
Subsidiaries ownership State of Incorporation
- ----------------------- ------------- ----------------------
Banner Bank (1) 100% Washington
Banner Capital Trust I (1) 100% Delaware
Banner Capital Trust II (1) 100% Delaware
Community Financial Corporation (2) 100% Oregon
Northwest Financial Corporation (2) 100% Washington
- --------------------
(1) Wholly owned by Banner Corporation
(2) Wholly owned by Banner Bank
101
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
=============================================================================
We consent to the incorporation by reference in Registration Statement Nos.
333-10819, 333-49193, 333-71625, and 333-67168 of Banner Corporation on Form
S-8 of our report dated March 12, 2003, which includes an explanatory
paragraph related to the adoption of Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets, appearing in the
Annual Report on Form 10-K of Banner Corporation for the year ended December
31, 2002.
/s/Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Seattle, Washington
March 24, 2003
102
Exhibit 99
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF BANNER CORPORATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 and in connection with this Annual Report on Form 10-K, that:
- the report fully complies with the requirements of Sections 13(a) and 15(d)
of the Securities Exchange Act of 1934, as amended, and
- the information contained in the report fairly presents, in all material
respects, the Company's financial condition and results of operations.
March 20, 2003 /s/D. Michael Jones
--------------------------
D. Michael Jones
Chief Executive Officer
March 20, 2003 /s/Lloyd W. Baker
--------------------------
Lloyd W. Baker
Chief Financial Officer
103