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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
------------------------
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD
ENDED MARCH 31, 2003.
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD
FROM to :
------- --------
Commission File Number 0-26584
BANNER CORPORATION
(Exact name of registrant as specified in its charter)
------------------------
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
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
------- ------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes X No
------ ------
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title of class: As of April 30, 2003
--------------- --------------------
Common Stock, $.01 par value per share 11,352,099 shares*
* Includes 515,707 shares held by employee stock ownership plan (ESOP) that
have not been released, committed to be released, or allocated to
participant accounts.
BANNER CORPORATION AND SUBSIDIARIES
Table of Contents
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements. The Consolidated Financial Statements of
Banner Corporation and Subsidiaries filed as a part of the report are as
follows:
Consolidated Statements of Financial Condition
as of March 31, 2003 and December 31, 2002............................. 2
Consolidated Statements of Income
for the Quarters Ended March 31, 2003 and 2002......................... 3
Consolidated Statements of Comprehensive Income
for the Quarters Ended March 31, 2003 and 2002......................... 4
Consolidated Statements of Changes in Stockholders' Equity
for the Quarters Ended March 31, 2003 and 2002......................... 5
Consolidated Statements of Cash Flows
for the Quarters Ended March 31, 2003 and 2002......................... 7
Selected Notes to Consolidated Financial Statements.................... 9
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operation
Special Note Regarding Forward-Looking Statements...................... 13
General................................................................ 13
Recent Developments and Significant Events............................. 13
Comparison of Financial Condition at March 31, 2003 and
December 31, 2002...................................................... 13
Comparison of Results of Operations for the Quarters Ended
March 31, 2003 and 2002................................................ 14
Asset Quality.......................................................... 18
Liquidity and Capital Resources........................................ 19
Capital Requirements................................................... 20
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Market Risk and Asset/Liability Management............................. 21
Item 4 - Controls and Procedures......................................... 25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................ 26
Item 2. Changes in Securities and Use of Proceeds........................ 26
Item 3. Defaults upon Senior Securities.................................. 26
Item 4. Submission of Matters to a Vote of Stockholders.................. 26
Item 5. Other Information................................................ 26
Item 6. Exhibits and Reports on Form 8-K................................. 26
SIGNATURES............................................................... 27
CERTIFICATIONS........................................................... 28
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands, except shares)
March 31, 2003 (Unaudited) and December 31, 2002
(Unaudited)
March 31 December 31
2003 2002
ASSETS ---------- ----------
Cash and due from banks $ 126,396 $ 132,910
Securities available for sale, cost $562,091
and $415,855
Encumbered 36,123 32,955
Unencumbered 531,469 388,267
---------- ----------
567,592 421,222
Securities held to maturity, fair value
$11,580 and $13,414 11,469 13,253
Federal Home Loan Bank stock 33,378 32,831
Loans receivable:
Held for sale, fair value $48,324 and $39,984 47,213 39,366
Held for portfolio 1,543,425 1,534,300
Allowance for loan losses (25,551) (26,539)
---------- ----------
1,564,987 1,546,927
Accrued interest receivable 13,775 13,689
Real estate owned, held for sale, net 5,183 6,062
Property and equipment, net 20,629 20,745
Goodwill and intangibles, net 36,664 36,714
Deferred income tax asset, net 1,658 2,786
Bank owned life insurance 32,260 31,809
Other assets 3,863 4,224
---------- ----------
$2,417,854 $2,263,172
========== ==========
LIABILITIES
Deposits:
Non-interest-bearing $ 192,287 $ 200,500
Interest-bearing 1,422,060 1,297,278
---------- ----------
1,614,347 1,497,778
Advances from Federal Home Loan Bank 511,452 465,743
Trust preferred securities 40,000 40,000
Other borrowings 41,400 41,202
Accrued expenses and other liabilities 14,623 24,700
Deferred compensation 3,601 3,372
---------- ----------
2,225,423 2,072,795
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY
Preferred stock - $0.01 par value per share,
500,000 shares authorized, no shares issued -- --
Common stock - $0.01 par value per share,
27,500,000 shares authorized, 13,201,418 shares
issued: 11,347,571 shares and 11,306,977 shares
outstanding at March 31, 2003 and
December 31, 2002, respectively. 121,119 120,554
Retained earnings 72,545 70,813
Accumulated other comprehensive income:
Unrealized gain (loss) on securities available
for sale 3,576 3,488
Unearned shares of common stock issued to
Employee Stock Ownership Plan (ESOP) trust:
515,707 and 515,707 restricted shares outstanding
at March 31, 2003 and December 31, 2002,
respectively, at cost (4,264) (4,262)
Carrying value of shares held in trust for
stock related compensation plans (3,519) (3,190)
Liability for common stock issued to deferred,
stock related, compensation plan 2,974 2,974
---------- ----------
192,431 190,377
---------- ----------
$2,417,854 $2,263,172
========== ==========
See notes to consolidated financial statements
2
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) (in thousands except for per share amounts)
Quarters Ended
March 31
-----------------------
2003 2002
-------- --------
INTEREST INCOME:
Loans receivable $ 28,844 $ 31,251
Mortgage-backed securities 3,052 2,556
Securities and cash equivalents 2,822 2,211
-------- --------
34,718 36,018
INTEREST EXPENSE:
Deposits 8,871 10,144
Federal Home Loan Bank advances 5,700 6,468
Trust preferred securities 567 --
Other borrowings 172 492
-------- --------
15,310 17,104
-------- --------
Net interest income before provision for
loan losses 19,408 18,914
PROVISION FOR LOAN LOSSES 2,250 3,000
-------- --------
Net interest income 17,158 15,914
OTHER OPERATING INCOME:
Loan servicing fees 530 344
Other fees and service charges 1,658 1,258
Mortgage banking operations 2,062 1,291
Gain (loss) on sale of securities 3 5
Miscellaneous 565 320
-------- --------
Total other operating income 4,818 3,218
OTHER OPERATING EXPENSES:
Salary and employee benefits 11,211 8,694
Less capitalized loan origination costs (1,575) (1,313)
Occupancy and equipment 2,372 2,083
Information/computer data services 838 613
Advertising 866 299
Amortization of intangibles 50 75
Miscellaneous 3,295 2,875
-------- --------
Total other operating expenses 17,057 13,326
-------- --------
Income before provision for income taxes 4,919 5,806
PROVISION FOR INCOME TAXES 1,490 1,897
-------- --------
NET INCOME $ 3,429 $ 3,909
======== ========
Net income per common share (see Note 5):
Basic $ .32 $ .35
Diluted $ .31 $ .34
Cumulative dividends declared per common share: $ .15 $ .15
See notes to consolidated financial statements
3
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (in thousands)
Quarters Ended
March 31
----------------------
2003 2002
------- -------
NET INCOME: $ 3,429 $ 3,909
OTHER COMPREHENSIVE INCOME (LOSS),
NET OF INCOME TAXES:
Unrealized holding gain (loss) during the
period, net of deferred income tax (benefit)
of $48 and $(1,146); respectively. 90 (2,128)
Less adjustment for (gains)/losses included in
net income, net of income tax (benefit) of
$1 and $2; respectively (2) (3)
------- -------
Other comprehensive income (loss) 88 (2,131)
------- -------
COMPREHENSIVE INCOME $ 3,517 $ 1,778
======= =======
See notes to consolidated financial statements
4
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited) (In thousands)
For the Quarters Ended March 31, 2003 and 2002
Carrying Value
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 Share Plans Equity
--------- -------- ------- -------- ------- ---------
BALANCE, January 1, 2002 $ 126,844 $ 68,104 $ 2,264 $ (4,769) $ (103) $ 192,340
Net income 3,909 3,909
Change in valuation of
securities available for
sale, net of income taxes (2,131) (2,131)
Cash dividend on common
stock ($.15/share
cumulative) (1,737) (1,737)
Purchase and retirement
of common stock (738) (738)
Proceeds from issuance of
common stock for exercise
of stock options 269 269
Amortization of
compensation related to MRP 7 7
--------- -------- ------- -------- ------- ---------
BALANCE, March 31, 2002 $ 126,375 $ 70,276 $ 133 $ (4,769) $ (96) $ 191,919
========= ======== ======= ======== ======= =========
BALANCE, January 1, 2003 $ 120,554 $ 70,813 $ 3,488 $ (4,262) $ (216) $ 190,377
Net income 3,429 3,429
Change in valuation of
securities available for
sale, net of income taxes 88 88
Cash dividend on common
stock ($.15/share
cumulative) (1,697) (1,697)
Proceeds from reissued
common stock for exercise
of stock options 213 213
Adjust prior year release
of earned ESOP shares (3) (2) (5)
Release of treasury stock
for MRP grant 355 (355) -
Amortization of compensation
related to MRP 26 26
--------- -------- ------- -------- ------- ---------
BALANCE, March 31, 2003 $ 121,119 $ 72,545 $ 3,576 $ (4,264) $ (545) $ 192,431
========= ======== ======= ======== ======= =========
See selected notes to consolidated financial statements
5
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited) (continued) (in thousands)
For the Quarters Ended March 31, 2003 and 2002
2003 2002
------ ------
COMMON STOCK, SHARES ISSUED:
Number of shares, beginning of period 13,201 13,201
------ ------
Number of shares, end of period 13,201 13,201
------ ------
LESS COMMON STOCK RETIRED:
Number of shares, beginning of period (1,894) (1,567)
Purchase and retirement of common stock -- (40)
Issuance of common stock to deferred compensation
plan and/or exercised stock options 40 27
------ ------
Number of shares retired, end of period (1,854) (1,580)
------ ------
Shares issued and outstanding, end of period 11,347 11,621
UNEARNED, RESTRICTED ESOP SHARES:
Number of shares, beginning of period (516) (577)
Release of earned shares -- --
------ ------
Number of shares, end of period (516) (577)
====== ======
See notes to consolidated financial statements
6
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (in thousands)
For the Quarter Ended March 31, 2003 and 2002
2003 2002
--------- ---------
OPERATING ACTIVITIES
Net income $ 3,429 $ 3,909
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,166 435
Loss (gain) on sale of securities (3) (5)
Increase in cash surrender value of bank owned
life insurance (451) (231)
Loss (gain) on sale of loans (1,721) (1,021)
Loss (gain) on disposal of real estate held for
sale and property and equipment 17 29
Provision for losses on loans and real estate
held for sale 2,531 3,000
Federal Home Loan Bank stock dividend (547) (456)
Net change in:
Loans held for sale (7,847) 28,995
Other assets 1,591 7,043
Other liabilities (9,854) (6,865)
--------- ---------
Net cash provided (used) by operating
activities (10,689) 34,833
--------- ---------
INVESTING ACTIVITIES:
Purchases of securities (249,529) (94,960)
Principal repayments and maturities of securities 93,928 47,456
Proceeds from sales of securities 10,039 1,529
Origination of loans, net of principal repayments (123,670) (73,984)
Purchases of loans and participating interest
in loans (16,649) (18,399)
Proceeds from sales of loans and participating
interest in loans 128,738 91,684
Purchases of property and equipment-net (731) (657)
Proceeds from sale of real estate held for sale-net 1,083 413
Net (funding) payout of deferred compensation plans (26) (97)
Cash (used for) provided by acquisitions -- (6,520)
--------- ---------
Net cash used by investing activities (156,817) (53,535)
--------- ---------
FINANCING ACTIVITIES
Increase (decrease) in deposits $ 116,569 $ 83,774
Proceeds from FHLB advances 154,750 151,500
Repayment of FHLB advances (109,041) (192,300)
Proceeds from repurchase agreement borrowings 19,000 1,226
Repayments of repurchase agreement borrowings (16,756) (1,701)
Increase (decrease) in other borrowings (2,046) (4,264)
Cash dividends paid (1,691) (1,627)
Other 212 269
ESOP shares earned (5) --
Repurchases of stock, net of forfeitures -- (738)
--------- ---------
Net cash provided by financing activities 160,992 36,139
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENT (6,514) 17,437
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 132,910 67,728
--------- ---------
CASH AND DUE FROM BANKS, END OF PERIOD $ 126,396 $ 85,165
========= =========
(Continued on next page)
7
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (in thousands)
For the Quarters Ended March 31, 2003 and 2002
(Continued from prior page)
2003 2002
--------- ---------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid in cash $ 14,777 $ 16,847
Taxes paid in cash $ -- $ -
Non-cash transactions:
Loans, net of discounts, specific loss
allowances and unearned income, transferred to
real estate owned and other repossessed assets $ 635 $ 199
Net change in accrued dividends payable $ (6) $ 110
The following summarizes the non-cash activities
relating to acquisitions:
Fair value of assets and intangibles acquired $ -- $ (44,860)
Fair value of liabilities assumed 34,768
Fair value of stock issued and options assumed
to acquisitions' shareholders --
--------- ---------
Cash paid out in acquisition (10,092)
Less cash acquired 3,572
--------- ---------
Net cash acquired (used) $ -- $ (6,520)
========= =========
See notes to consolidated financial statements
8
BANNER CORPORATION AND SUBSIDIARIES
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Basis of Presentation and Critical Accounting Policies
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
of its wholly-owned subsidiary, Banner Bank (BB or the Bank). The Bank is a
Washington-chartered commercial bank that conducts business from its main
office in Walla Walla, Washington, and its 41 branch offices and eight loan
production offices located 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 Federal Deposit Insurance Corporation (FDIC).
In the opinion of management, the accompanying consolidated statements of
financial condition and related interim consolidated statements of income,
comprehensive income, changes in stockholders' equity and cash flows reflect
all adjustments (which include reclassifications and normal recurring
adjustments) that are necessary for a fair presentation in conformity with
generally accepted accounting principles (GAAP). The preparation of financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect amounts reported in the financial statements. Actual
results could differ from these estimates and may have a material impact on
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 financial
statements. These policies relate to the methodology for the determination of
the provision and allowance for loan and lease losses and the valuation of
goodwill, deferred taxes, valuation and amortization of mortgage servicing
rights, and valuation of real estate held for sale. These policies and the
judgments, estimates and assumptions are described in greater detail in
Management's Discussion and Analysis of Financial Condition and Results of
Operations and in Note 1 of the Notes to the Consolidated Financial Statements
in the Company's Annual Report on Form 10-K for the year ended December 31,
2002 filed with the Securities and Exchange Commission. 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 financial statements to
these critical accounting policies, the use of other judgments, estimates and
assumptions could result in material differences in the Company's results of
operations or financial condition.
Stock Compensation Plans: 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 Statement of Financial Accounting
Standards (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):
Quarters Ended
March 31
---------------------
2003 2002
------- -------
Net income available to common stock holders:
Basic:
As reported $ 3,429 $ 3,909
Pro forma 3,117 3,884
Diluted:
As reported $ 3,429 $ 3,909
Pro forma 3,117 3,884
Net income per common share:
Basic:
As reported $ 0.32 $ 0.35
Pro forma 0.29 0.35
Diluted:
As reported $ 0.31 $ 0.34
Pro forma 0.28 0.34
The compensation expense included in the pro forma net income available to
diluted common stock 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.
9
The fair value of options granted under the Company's stock option plans
(SOPs) is estimated on the date of grant using the Black-Scholes option-
pricing model with the following weighted average assumptions used for grants:
2003 2002
------------ ------------
Annual dividend yield 3.42 to 3.68% 2.58 to 3.56%
Expected volatility 42.3 to 49.6% 40.2 to 64.8%
Risk free interest rate 2.94 to 4.07% 2.63 to 5.21%
Expected lives 5 to 9 yrs 5 to 9 yrs
Certain reclassifications have been made to the 2002 financial statements
and/or schedules to conform to the 2003 presentation. These reclassifications
may have affected certain ratios for the prior periods. The effect of such
reclassifications is considered immaterial. All significant intercompany
transactions and balances have been eliminated.
The information included in this Form 10-Q should be read in conjunction with
Banner Corporation's 2002 Annual Report on Form 10-K for the year ended
December 31, 2002 filed with the Securities and Exchange Commission. Interim
results are not necessarily indicative of results for a full year.
Note 2: 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 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 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 4.63875%, which is reset quarterly to
equal three-month LIBOR plus 3.35%.
Accounting Standards Recently Adopted or Issued: In June 2002, the Financial
Accounting Standards Board (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 adopted SFAS No. 146
as of January 1, 2003. The adoption of SFAS No. 146 has not had a material
impact on the Company's consolidated results of operations, financial position
or cash flows.
In January 2003, the FASB issued Financial Accounting Standards Board
Interpretation Number (FIN) 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 46 requires that an
entity shall consolidate a VIE if that entity 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
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 46 is not
expected to have a material effect on the Company's financial statements.
In November 2002, the FASB issued FIN 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 45 did not have a material
impact on the Company's financial statements.
Note 3: Business Segments
The Company is managed by legal entity and not by lines of business. The Bank
is a community oriented commercial bank chartered in the State of Washington.
The Bank's primary business is that of a traditional banking institution,
gathering deposits and originating loans for portfolio in its primary market
area. The Bank offers a wide variety of deposit products to its consumer and
commercial customers. Lending activities include the origination of real
estate, commercial/agriculture business and consumer loans. The Bank is also
an active participant in the secondary market, originating residential loans
for sale on both a servicing released and servicing retained basis. In
addition to interest income on loans and investment securities, the Bank
receives other income from deposit service charges, loan servicing fees and
from the sale of loans and investments. The
10
performance of the Bank is reviewed by the Company's executive management and
Board of Directors on a monthly basis. All of the executive officers of the
Company are members of the Bank's 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 operation segments in interim
reports to stockholders. The Company has determined that its current business
and operations consist of a single business segment.
Note 4: Additional Information Regarding Interest-Bearing Deposits and
Securities
Encumbered Securities: Securities labeled "Encumbered" are pledged securities
that are subject to certain agreements which may allow the secured party to
either sell and replace them with similar but not the exact same security or
otherwise pledge the securities. In accordance with SFAS No. 140, the amounts
have been separately identified in the Consolidated Statements of Financial
Condition as "Encumbered."
The following table sets forth additional detail on BANR's interest-bearing
deposits and securities at the dates indicated (at carrying value) (in
thousands):
March 31 December 31 March 31
2003 2002 2002
-------- -------- --------
Interest-bearing deposits included
in cash and due from banks $ 52,117 $ 42,921 $ 24,555
-------- -------- --------
Mortgage-backed securities 359,365 269,153 212,028
Other securities-taxable 193,503 141,404 122,953
Other securities-tax exempt 22,499 21,107 22,836
Equity securities with dividends 3,694 2,811 2,887
-------- -------- --------
Total securities 579,061 434,475 360,704
Federal Home Loan Bank (FHLB) stock 33,378 32,831 31,330
-------- -------- --------
$664,556 $510,227 $416,589
======== ======== ========
The following table provides additional detail on income from deposits and
securities for the periods indicated (in thousands):
Quarters Ended
March 31
------------------------
2003 2002
------- -------
Mortgage-backed securities interest $ 3,052 $ 2,556
------- -------
Taxable interest and dividends 1,968 1,422
Tax-exempt interest 307 333
Federal Home Loan Bank stock dividends 547 456
------- -------
2,822 2,211
------- -------
$ 5,874 $ 4,767
======= =======
11
Note 5: Calculation of Weighted Average Shares Outstanding for Earnings Per
Share (EPS)
The following table reconciles total shares originally issued to weighted
shares outstanding used to calculate earnings per share data (in thousands):
Quarters Ended
March 31
------------------------
2003 2002
------- -------
Total shares originally issued 13,201 13,201
Less retired shares plus
unvested shares allocated to MRP (1,899) (1,591)
Less unallocated shares held by the ESOP (516) (577)
------ ------
Basic weighted average shares outstanding 10,786 11,033
Plus unvested MRP and stock option
incremental shares considered
outstanding for diluted EPS
calculations 254 416
------ ------
Diluted weighted average shares
outstanding 11,040 11,449
====== ======
12
ITEM 2 - 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 report and our Annual Report. We have used
"forward-looking statements" to describe future plans and strategies,
including our 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 operation,
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 (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). The Bank is a Washington-chartered commercial bank the deposits of
which are insured by the Federal Deposit Insurance Corporation (FDIC). The
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 conducts business from its main office in
Walla Walla, Washington, and its 41 branch offices and eight loan production
offices located in 19 counties in Washington, Oregon and Idaho.
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 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. As more fully explained below, the Company's net interest income
increased for the quarter ended March 31, 2003 compared to the same period a
year earlier, despite a 17 basis point decrease in the interest rate spread,
as a result of growth in interest-bearing assets and liabilities. The net
interest margin also decreased 24 basis points for the quarter ended March 31,
2003, compared to the same period one year prior. The Company's net income
also is affected by provisions for loan losses and the level of its other
income, including deposit service charges, loan 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. The provision for
loan losses decreased $750,000 for the quarter ended March 31, 2003, compared
to the same period ended March 31, 2002. Other operating income increased
significantly for the quarter ended March 31, 2003, largely as a result of
increased gain on the sale of loans, although other non-interest revenues also
increased significantly. Other operating expenses also increased
substantially for the quarter ended March 31, 2003, compared to the same
period ended March 31, 2002, reflecting the continued growth of the Company.
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
Selected Notes to the Consolidated Financial Statements.
Recent Developments and Significant Events
See Note 2 to Consolidated Financial Statements.
Comparison of Financial Condition at March 31, 2003 and December 31, 2002
General: Total assets increased $154.7 million, or 6.8%, from $2.263 billion
at December 31, 2002, to $2.418 billion at March 31, 2003. The growth largely
resulted from an increase in cash and securities and was funded primarily by
deposit growth and borrowings. Net loans receivable (gross loans less loans
in process, deferred fees and discounts, and allowance for loan losses)
increased $18.1 million, or 1.2%, from $1.547 billion at December 31, 2002, to
$1.565 billion at March 31, 2003. Despite decreases of $7.0 million in one-
to four-family residential mortgages, $3.8 million in multifamily real estate
loans and $2.3 million in consumer loans as a result of accelerated prepayment
in the current low interest rate environment, the balance of the loan
portfolio experienced net growth, including an increase of $5.5 million in
mortgages secured by commercial real estate loans, an increase of $8.4 million
in construction and land loans and an increase of $16.3 million in non-
mortgage commercial and agricultural 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 $144.6 million, or 33.3%, from $434.5 million at December 31, 2002,
to $579.1 million at March 31, 2003, as a result of additional investing.
FHLB stock increased $547,000 as a result of dividends paid by the FHLB in the
form of additional shares of stock. The Company also had an increase of
$451,000 in bank-owned life insurance from the growth of cash surrender
13
values on existing policies. The majority of the increase in assets was
funded by a growth in deposits. Asset growth was also funded by additional
borrowings and net income from operations. Deposits grew $116.6 million, or
7.8%, from $1.498 billion at December 31, 2002, to $1.614 billion at March 31,
2003. Non-interest-bearing deposits decreased $8.2 million, or 4.1%, while
interest-bearing deposits increased by $124.8 million, or 9.6%, from the prior
year-end amounts. FHLB advances increased $45.7 million from $465.7 million
at December 31, 2002, to $511.5 million at March 31, 2003. Other borrowings,
primarily reverse repurchase agreements with securities dealers, increased
$198,000, from $41.2 million at December 31, 2002 to $41.4 million at March
31, 2003.
Comparison of Results of Operations for the Quarters Ended March 31, 2003 and
2002
General. For the quarter ended March 31, 2003, the Company had net income of
$3.4 million, or $.31 per share (diluted), compared to net income of $3.9
million, or $.34 per share (diluted), for the quarter ended March 31, 2002, a
decrease of $480,000. The Company's operating results reflect significant
growth of assets and liabilities which was substantially offset by a narrower
net interest margin. As explained below, the provision for loan losses
decreased from the amount recognized in the prior year largely as a result of
the large provision that was recorded in the fourth quarter of 2002. The
Company's operating results also reflect a significant increase in other
operating income and other operating expenses. Compared to levels a year ago,
total assets increased 12.3%, to $2.418 billion, at March 31, 2003, net loans
decreased 0.9%, to $1.565 billion, deposits grew 14.3%, to $1.614 billion, and
borrowings increased 11.1%, to $592.9 million. Average interest earning
assets were $2.148 billion for the quarter ended March 31, 20023, an increase
of $183.1 million, or 9.3%, compared to the same period a year earlier.
Average equity was 8.37% of average assets for the quarter ended March 31,
2003, compared to 9.35% of average assets for the quarter ended March 31,
2002.
Net Interest Income. Net interest income before provision for loan losses
increased to $19.4 million for the quarter ended March 31, 2003 compared to
$18.9 million for the quarter ended March 31, 2002. Net interest margin
decreased 24 basis points for the quarter, reflecting a 17 basis point
decrease in net interest rate spread and the increased use of interest-bearing
liabilities relative to interest-earning assets. The changes in net interest
spread and net interest margin reflect the impact of the current very low
level of market interest rates as well the effects of changes in the asset and
liability mix and the level of non-performing loans.
Interest Income. Interest income for the quarter ended March 31, 2003, was
$34.7 million compared to $36.0 million for the quarter ended March 31, 2002,
a decrease of $1.3 million, or 3.6%. The decrease in interest income occurred
despite a $183.1 million, or 9.3%, growth in average balances of
interest-earning assets as a result of an 88 basis point decrease in the
average yield on those assets. The yield on average interest-earning assets
decreased to 6.56% for the quarter ended March 31, 2003, compared to 7.44% for
the same period a year earlier. Average loans receivable for the quarter ended
March 31, 2003, decreased by $25.5 million, or 1.6%, when compared to the
quarter ended March 31, 2002. Interest income on loans decreased by $2.4
million, or 7.7%, compared to the prior year, as the impact of the decrease in
average loan balances was compounded by a 49 basis point decrease in the
average yield. The decrease in average loan yield reflects the significant
decline in the level of market interest rates compared to prior year levels,
particularly the prime rate which affects a large portion of construction and
commercial loans, and lower mortgage rates which have led to a significant
amount of prepayments of real estate loans. 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 7.39% for the quarter ended
March 31, 2003, compared to 7.88% for the quarter ended March 31, 2002. While
the level of market interest rates was significantly lower than a year
earlier, 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 $208.6 million for the quarter ended
March 31, 2003, and the interest and dividend income from those investments
increased $1.1 million, compared to the quarter ended March 31, 2002. The
average yield on mortgage-backed securities decreased to 3.90% for the quarter
ended March 31, 2003, from 5.23% for the comparable period 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 more rapid
prepayments on certain higher-yielding portions of the portfolio, as well as
reinvestment and growth at current market rates. The average yield on
investment securities and short-term cash investments decreased to 4.30% for
the quarter ended March 31, 2003, from 5.58% for the comparable quarter in
2002, also reflecting the lower level of market rates. Earnings on FHLB stock
increased by $90,000, to $546,000, in the quarter ended March 31, 2003, from
$456,000 in the comparable quarter in 2002. This resulted from a 75 basis
point increase in the yield received on FHLB stock and an increase of $1.9
million in the average balance of FHLB stock for the quarter ended March 31,
2003. The dividend yield on FHLB stock was 6.74% for the quarter ended March
31, 2003, compared to 5.99% for the quarter ended March 31, 2002. Dividends
on FHLB stock are established on a quarterly basis by vote of the Directors of
the FHLB.
Interest Expense. Interest expense for the quarter ended March 31, 2003, was
$15.3 million compared to $17.1 million for the comparable period in 2002, a
decrease of $1.8 million, or 10.5%. The decrease in interest expense was due
to a decrease in the average cost of all interest-bearing liabilities to 2.96%
from 3.67% primarily reflecting the lower levels of market interest rates.
Deposit interest expense decreased $1.3 million for the quarter ended March
31, 2003, compared to the same quarter a year ago, despite the solid deposit
growth throughout the Company over the past twelve months, as a result of a
continuing decline in the cost of deposits. Average deposit balances
increased $170.5 million, or 12.8%, to $1.506 billion for the quarter ended
March 31, 2003, from $1.336 billion for the quarter ended March 31, 2002,
while, at the same time, the average rate paid on deposit balances decreased
69 basis points. To a significant degree, deposit costs for a 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 for the nine months preceding the quarter ended March
31, 2003, than for the same period preceding the quarter ended March 31, 2002.
The reduction in deposit costs, which tends to lag declines in market rates,
continued in the most recent quarter as a result of the cumulative effect of
declining rates in preceding quarters as well as very low rates in the current
quarter. Average FHLB advances totaled $504.8 million during the quarter
ended March 31, 2003, compared to $476.2 million during the quarter ended
March 31, 2002, an increase of $28.5 million that, combined with a 93 basis
point decrease in the average cost of advances, resulted in a $768,000
decrease in related interest expense. The average rate paid on those advances
decreased to 4.58% for the quarter ended March 31, 2003, from 5.51% for the
14
quarter ended March 31, 2002. FHLB advances are generally fixed-rate,
fixed-term borrowings. In the current quarter, additional funding was also
provided by trust preferred securities (TPS) which had an average balance of
$40 million and an average cost of 5.75% (including amortization of prepaid
underwriting costs). There were no TPS outstanding in the first quarter of
the prior year. Other borrowings consist of retail repurchase agreements with
customers and reverse repurchase agreements with investment banking firms
secured by certain investment securities. The average balance for other
borrowings decreased $36.3 million, to $43.8 million for the quarter ended
March 31, 2003, from $80.0 million for the same period in 2002, while the
related interest expense decreased $320,000, to $172,000 from $492,000 for the
respective periods. The average rate paid on other borrowings was 1.59% in
the quarter ended March 31, 2003, compared to 2.49% for the same quarter in
2002. 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.
The following tables provide additional comparative data on the Company's
operating performance:
Quarters Ended
Average Balances March 31
---------------- ------------------------
(in thousands) 2003 2002
---------- ----------
Investment securities and deposits $ 214,798 $ 127,626
Mortgage-backed obligations 317,765 198,301
Loans 1,582,231 1,607,697
FHLB stock 32,837 30,890
---------- ----------
Total average interest-earning asset 2,147,631 1,964,514
Non-interest-earning assets 157,412 134,909
---------- ----------
Total average assets $2,305,043 $2,099,423
========== ==========
Deposits 1,506,427 1,335,890
Advances from FHLB 504,751 476,239
Trust preferred securities 40,000 --
Other borrowings 43,766 80,035
---------- ----------
Total average interest-bearing liabilities 2,094,944 1,892,164
Non-interest-bearing liabilities 17,120 11,040
---------- ----------
Total average liabilities 2,112,064 1,903,204
Equity 192,979 196,219
---------- ----------
Total average liabilities and equity $2,305,043 $2,099,423
========== ==========
Interest Rate Yield/Expense (rates are annualized)
-------------------------------------------------
Interest Rate Yield:
Investment securities and deposits 4.30% 5.58%
Mortgage-backed obligations 3.90% 5.23%
Loans 7.39% 7.88%
FHLB stock 6.74% 5.99%
---------- ----------
Total interest rate yield on interest-earning
assets 6.56% 7.44%
---------- ----------
Interest Rate Expense:
Deposits 2.39% 3.08%
Advances from FHLB 4.58% 5.51%
Trust preferred securities 5.75% --
Other borrowings 1.59% 2.49%
---------- ----------
Total interest rate expense on interest-bearing
liabilities 2.96% 3.67%
---------- ----------
Interest spread 3.60% 3.77%
========== ==========
Net interest margin on interest earning assets 3.66% 3.90%
---------- ----------
Additional Key Financial Ratios (ratios are annualized)
-------------------------------------------------------
Return on average assets 0.60% 0.76%
Return on average equity 7.21% 8.08%
Average equity /average assets 8.37% 9.35%
Average interest-earning assets/interest-bearing
liabilities 102.51% 103.82%
Non-interest (other operating) expenses/average
assets 3.00% 2.57%
Efficiency ratio
[non-interest (other operating) expenses/revenues] 70.41% 60.21%
15
Provision and Allowance for Loan Losses. During the quarter ended March 31,
2003, the provision for loan losses was $2.3 million, compared to $3.0 million
for the quarter ended March 31, 2002, a decrease of $750,000. As noted above,
provision and allowance for loan losses is one of the most critical accounting
estimates included in the Company's financial statements. The decrease in the
provision for loan 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. Despite higher levels of
non-performing loans and net charge-offs than a year earlier and concerns
about the current economic environment, the provision in the current period is
lower largely as a result of the recognition of the deterioration of the
portfolio through the very large provision recorded in the fourth quarter of
2002, which significantly added to the allowance for loan losses.
Non-performing loans increased to $37.1 million at March 31, 2003, compared to
$28.7 million at March 31, 2002. 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 $3.2 million for the current quarter compared to $2.1
million for the same quarter a year earlier. Most of the charge-offs in the
current quarter were anticipated in the large provision for loan losses
recorded in the fourth quarter of 2002. A comparison of the allowance for
loan losses at March 31, 2003 and 2002, shows an increase of $6.7 million, to
$25.6 million at March 31, 2003, from $18.9 million at March 31, 2002. The
allowance for loan losses as a percentage of total loans (loans receivable
excluding allowance for losses) was 1.61% and 1.18% at March 31, 2003 and
March 31, 2002, respectively.
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 analysis of the factors
underlying the quality of the loan portfolio. These factors include changes
in the size and composition of the loan portfolio, delinquency rates, actual
loan loss experience, current 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
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. These 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 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 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 March 31, 2003, the
Company had identified $36.9 million of impaired loans as defined by SFAS 114
and had established $5.3 million of specific loss allowances for these loans.
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. During the current quarter the Company used reduced loss
factors with respect to one- to four-family loans while at the same time it
employed increased factors for non-residential loans compared to those applied
in the first quarter of 2002. 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.
16
The following tables are provided to disclose additional detail on the
Company's loans and allowance for loan losses (in thousands):
March 31 December 31 March 31
2003 2002 2002
---------- ---------- ----------
Loans (including loans held for sale):
Secured by real estate:
One- to four-family $ 323,495 $ 329,314 $ 364,611
Consumer secured by one- to
four-family 25,004 26,195 23,898
---------- ---------- ----------
Total one- to four-family 348,499 355,509 388,509
Commercial 384,589 379,099 379,448
Multifamily 68,494 72,333 80,264
Construction and land 347,956 339,516 352,076
Commercial business 301,418 285,231 269,713
Agricultural business 102,737 102,626 84,233
Consumer 36,845 39,152 43,118
---------- ---------- ----------
Total loans outstanding 1,590,538 1,573,466 1,597,361
Less allowance for loan losses 25,551 26,539 18,899
---------- ---------- ----------
Total net loans outstanding at
end of period $1,564,987 $1,546,927 $1,578,462
========== ========== ==========
Allowance for loan losses as a
percentage of total loans
outstanding 1.61% 1.69% 1.18%
Quarter Ended
March 31
-----------------------
2003 2002
-------- --------
Balance, beginning of the period $ 26,539 $ 17,552
Acquisitions -- 460
Provision 2,250 3,000
Recoveries of loans previously charged off:
Secured by real estate:
One- to four-family -- --
Commercial -- 9
Multifamily -- --
Construction and land -- --
Commercial business 95 --
Agricultural business 1 1
Consumer 14 9
-------- --------
110 19
Loans charged off:
Secured by real estate:
One- to four-family -- (6)
Commercial (1,188) --
Multifamily -- --
Construction and land (29) --
Commercial business (1,938) (1,586)
Agricultural business -- (141)
Consumer (193) (399)
-------- --------
(3,348) (2,132)
-------- --------
Net charge-offs (3,238) (2,113)
-------- --------
Balance, end of the period $ 25,551 $ 18,899
======== ========
Net charge-offs as a percentage of average
net book value of loans outstanding for
the period 0.20% 0.13%
17
The following is a schedule of the Company's allocation of the allowance for
loan losses:
March 31 December 31 March 31
2003 2002 2002
-------- -------- --------
Specific or allocated loss allowances:
Secured by real estate:
One- to four-family $ 873 $ 670 $ 1,034
Commercial 4,844 5,284 3,875
Multifamily 362 361 396
Construction and land 6,602 5,892 3,926
Commercial business 8,406 8,788 7,144
Agricultural business 2,286 2,164 1,125
Consumer 574 698 593
-------- -------- --------
Total allocated 23,947 23,857 18,093
Estimated allowance for undisbursed
commitments 178 36 30
Unallocated 1,426 2,646 776
-------- -------- --------
Total allowance for loan losses $ 25,551 $ 26,539 $ 18,899
======== ======== ========
Allowance for loan losses as a percent
of total loans outstanding (loans
receivable excluding allowance for
losses) 1.61% 1.69% 1.18%
Other Operating Income. Other operating income was $4.8 million for the
quarter ended March 31, 2003, an increase of $1.6 million from the quarter
ended March 31, 2002. This included a $771,000 increase in the gain on sale
of loans for the current quarter as lower interest rates led to increased
mortgage banking activity. Loan sales for the quarter ended March 31, 2003
totaled $128.7 million, including $29.7 million of loans sold by the Bank's
construction and mortgage loan subsidiary, Community Financial Corporation
(CFC), compared to $91.7 million for the quarter ended March 31, 2002. Gain
on sale of loans for the Company included $79,000 of fees on $6.6 million of
loans brokered by CFC, which are not reflected in the volume of loans sold.
Loan servicing fees increased by $186,000, to $530,000 for the quarter ended
March 31, 2003, compared to $344,000 a year earlier largely as a result of the
collection of prepayment fees. Other fee and service charge income increased
by $400,000, to $1.7 million for the quarter ended March 31, 2003, compared to
$1.3 million for the quarter ended March 31, 2002, primarily reflecting growth
in customer transaction accounts. Miscellaneous income increased by $245,000,
largely 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 $3.7 million, to
$17.1 million for the quarter ended March 31, 2003, from $13.3 million for
the quarter ended March 31, 2002. Other operating expenses 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 higher level of mortgage banking
activity is also reflected in the increase in capitalized loan origination
costs. The Company also significantly increased its commitment to advertising
and marketing expenditures which were $567,000 greater in the quarter ended
March 31, 2003 than in the same period in the prior year. The increase in
expenses includes operating costs associated with opening new branch offices
in Spokane and Pasco, Washington and new commercial lending centers in
Portland, Oregon and Bellevue (greater Seattle), Spokane and the Tri-Cities,
Washington. The increase in other operating expenses was partially offset by
a $262,000 increase in capitalized loan origination costs, reflecting a
greater level of loan origination activity. 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 70.41% for the quarter
ended March 31, 2003, from 60.21% for the comparable period ended March 31,
2002. Other operating expenses as a percentage of average assets increased to
3.00% for the quarter ended March 31, 2003, compared to 2.57% for the quarter
ended March 31, 2002.
Income Taxes. Income tax expense was $1.5 million for the quarter ended March
31, 2003, compared to $1.9 million for the comparable period in 2002. The
Company's effective tax rates for the quarters ended March 31, 2003 and 2002
were 30% and 33%, respectively. The lower effective tax rate in the current
quarter is primarily a result of an increase in the relative benefit of
tax-exempt income compared to the first quarter of 2002.
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.
18
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 March 31, 2003, the Company had an allowance for loan losses of $25.6
million, which represented 1.61% of total loans and 69% of non-performing
loans compared to 1.69% and 74%, respectively, at December 31, 2002.
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.
Non-performing assets increased to $42.4 million, or 1.76% of total assets, at
March 31, 2003, compared to $42.2 million, or 1.86% of total assets, at
December 31, 2002 and $31.5 million, or 1.46% of total assets, at March 31,
2002. 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
quarter ended March 31, 2003, significant changes included a $2.0 million
decrease in non-performing commercial real estate loans, a $2.7 million
decrease in non-performing construction/land loans and a $4.2 million increase
in non-performing commercial loans. At March 31, 2003, 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. The largest individual exposure on non-performing commercial business
loans had an aggregate carrying value of $3.8 million at March 31, 2003,
which, along with a related non-performing commercial real estate loan of $1.7
million, is secured by development property in Whatcom County. Reducing non-
performing loans and improving asset quality will be important activities to
enhance the Bank's operating performance in future periods.
The following tables set 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):
March 31 December 31 March 31
2003 2002 2002
-------- -------- --------
Non-performing assets at end of the period:
Nonaccrual Loans:
Secured by real estate:
One- to four-family $ 1,205 $ 455 $ 983
Commercial 5,385 7,421 --
Multifamily -- -- 897
Construction and land 14,606 16,030 12,916
Commercial business 14,036 9,894 12,245
Agricultural business 1,385 194 947
Consumer 217 255 500
-------- -------- --------
36,834 34,249 28,488
Loans more than 90 days delinquent,
still on accrual:
Secured by real estate:
One- to four-family -- 343 8
Commercial -- -- --
Multifamily -- -- --
Construction and land -- 1,283 --
Commercial business 266 163 189
Agricultural business 24 -- --
Consumer -- 70 25
-------- -------- --------
290 1,859 222
-------- -------- --------
Total non-performing loans 37,124 36,108 28,710
Real estate owned, held for sale,
net (REO), and other repossessed assets 5,319 6,062 2,762
-------- -------- --------
Total non-performing assets at the end
of the period $ 42,443 $ 42,170 $ 31,472
======== ======== ========
Non-performing loans as a percentage
of total net loans before allowance
for loan losses at end of the period 2.33% 2.29% 1.80%
Non-performing assets as a percentage
of total assets at end of the period 1.76% 1.86% 1.46%
Troubled debt restructuring (TDRs)
at end of the period $ 517 $ 2,057 $ 158
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 repayments of loans and mortgage-
19
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 quarter ended March 31,
2003, the Company purchased loans in the amount of $16.6 million while loan
originations, net of principal repayments, totaled $123.7 million. This
activity was funded primarily by principal repayments on loans and securities,
sales of loans, and deposit growth. During the quarter ended March 31, 2003,
the Company sold $128.7 million of loans, net deposit growth was $116.6
million, FHLB advances increased $45.7 million and other borrowings increased
$198,000.
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 quarter ended March 31, 2003, the Bank
used its sources of funds primarily to fund loan commitments, to purchase
securities, to repay FHLB advances and other borrowings, and to pay maturing
savings certificates and deposit withdrawals. At March 31, 2003, the Bank had
outstanding loan commitments totaling $523.5 million, including undisbursed
loans in process totaling $418.5 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 which, in aggregate, may equal the lesser of 35% of the
Bank's assets or unencumbered qualifying collateral, up to a total possible
credit line of $845 million. Advances under this credit facility totaled
$511.5 million, or 21% of the Bank's assets, at March 31, 2003.
At March 31, 2003, certificates of deposit amounted to $970.7 million, or 60%,
of the Bank's total deposits, including $721.9 million which were scheduled to
mature within one year. 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 customer deposits,
FHLB-Seattle advances, other borrowings, principal and interest payments and
sale of mortgage loans and that it can adjust the offering rates for savings
certificates to retain deposits in changing interest rate environments.
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. The 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-weighed 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 included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002 filed with the
Securities and Exchange Commission, for additional information regarding the
Company's and the Bank's regulatory capital requirements.)
The actual regulatory capital ratios calculated for the Company and the Bank
as of March 31, 2003 along with the minimum capital amounts and ratios were as
follows (dollars in thousands):
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)
March 31, 2003:
The Company-consolidated
Total capital to risk-
weighted assets $214,105 12.56% $136,388 8.00% N/A N/A
Tier 1 capital to risk-
weighted assets 192,019 11.26 68,194 4.00 N/A N/A
Tier 1 leverage capital
to average assets 192,019 8.48 90,585 4.00 N/A N/A
The Bank
Total capital to risk-
weighted assets 202,149 11.88 136,179 8.00 $170,224 10.00%
Tier 1 capital to risk-
weighted assets 180,096 10.58 68,090 4.00 102,134 6.00
Tier 1 leverage capital
to average assets 180,096 7.96 90,470 4.00 113,088 5.00
20
ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk
Market Risk and Asset/Liability Management
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 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 affecting 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
interest-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 approved policies
of 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 Board of 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.
21
The table of Interest Rate Risk Indicators sets forth, as of March 31, 2003,
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 of Interest Rate Risk Indicators
Estimated Change in
---------------------------------------------
Change (in Basis Points) Net Interest Income
in Interest Rates (1) Next 12 Months Net Market Value
------------------------ -------------------- -------------------
(Dollars in thousands)
+400 $ 3,611 4.5% $(72,812) (38.9%)
+300 2068 2.6% (50,071) (26.7%)
+200 347 0.4% (28,734) (15.3%)
+100 7 0.0% (8,144) (4.3%)
0 0 0 0 0
-100 (938) (1.2%) (3,274) (1.7%)
-200 (5,574) (6.9%) (4,399) (2.3%)
-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.
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 adjustable-rate 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.
The table of Interest Sensitivity Gap presents the Company's interest
sensitivity gap between interest-earning assets and interest-bearing
liabilities at March 31, 2003. The table sets 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 March 31, 2003, total interest-bearing assets
maturing or repricing within one year exceeded total interest-earning
liabilities maturing or repricing in the same time period by $174,000,
representing a one-year gap to total assets ratio of 7.21%.
22
Table of Interest Sensitivity Gap
As of March 31, 2003 Within 6 Months 1-3 3-5 5-10 Over 10
6 Months to One Year Years Years Years Years Total
---------- ---------- -------- -------- -------- -------- ----------
(dollars in thousands)
Interest-earning assets (1):
Construction loans $ 251,598 $ 1,070 $ 2,315 $ 837 $ -- $ -- $ 255,820
Fixed-rate mortgage loans 77,807 47,794 124,259 112,311 142,845 45,718 550,734
Adjustable-rate mortgage loans 194,296 54,870 74,990 28,496 3,600 -- 356,252
Fixed-rate mortgage-backed
securities 41,467 27,533 82,278 50,885 60,098 22,704 284,965
Adjustable-rate mortgage-backed
securities 74,403 -- -- -- -- -- 74,403
Fixed-rate commercial /agriculture
loans 35,229 22,781 35,488 10,690 6,369 81 110,638
Adjustable-rate commercial/
agriculture loans 250,510 6,090 5,324 5,424 159 -- 267,507
Consumer and other loans 26,800 6,814 13,308 5,498 1,641 182 54,243
Investment securities and
interest-bearing deposits 199,342 19,295 19,639 2,140 5,743 59,031 305,190
---------- --------- -------- -------- -------- -------- ----------
Total rate-sensitive assets 1,151,452 186,247 357,601 216,281 220,455 127,716 2,259,752
---------- --------- -------- -------- -------- -------- ----------
Interest-bearing liabilities (2):
Regular savings and NOW accounts 41,849 41,849 97,649 97,649 - -- 278,996
Money market deposit accounts 86,203 51,722 34,481 -- -- -- 172,406
Certificates of deposit 450,252 270,756 155,627 82,816 11,178 29 970,658
FHLB advances 134,900 46,594 145,100 74,930 109,079 849 511,452
Other borrowings 32,705 -- -- -- -- -- 32,705
Retail repurchase agreements 6,038 338 1,825 -- 494 -- 8,695
---------- --------- -------- -------- -------- -------- ----------
Total rate-sensitive
liabilities 751,947 411,259 434,682 255,395 120,751 878 1,974,912
---------- --------- -------- -------- -------- -------- ----------
Excess (deficiency) of interest-
sensitive assets over interest-
sensitive liabilities $ 399,505 $(225,012) $(77,081) $(39,114) $ 99,704 $126,838 $ 284,840
========== ========= ======== ======== ======== ======== ==========
Cumulative excess (deficiency) of
interest-sensitive assets $ 399,505 $ 174,493 $ 97,412 $ 58,298 $158,002 $284,840 $ 284,840
========== ========= ======== ======== ======== ======== ==========
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 153.13% 115.00% 106.10% 103.15% 108.00% 114.42% 114.42%
========== ========= ======== ======== ======== ======== ==========
Interest sensitivity gap to
total assets 16.52% (9.31%) (3.19%) (1.62%) 4.12% 5.25% 11.77%
========== ========= ======== ======== ======== ======== ==========
Ratio of cumulative gap to
total assets 16.52% 7.21% 4.02% 2.40% 6.52% 11.77% 11.77%
========== ========= ======== ======== ======== ======== ==========
(footnotes on following page)
23
Footnotes for Table of 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 periods 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- and variable-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, NOW, and money
market deposit accounts are subject to immediate withdrawal, 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 negative
$55,000 or (2.29%) of total assets. Interest-bearing liabilities for this
table exclude certain non-interest-bearing deposits which are included in the
average balance calculations in the table included in the Comparison of
Results of Operations section of this document.
24
ITEM 4 - Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of
Company 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 the
quarterly report. 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: In the quarter ended March 31, 2003, the
Company did not make any significant changes in, nor take any corrective
actions regarding, its internal controls or other factors that could
significantly affect those controls.
25
PART II - OTHER INFORMATION
Item 1. 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 2. Changes in Securities and Use of Proceeds
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Stockholders
Not Applicable
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8K
(a) Exhibits
99.1 Certifications pursuant to Section 906 of the Sarbanes-Oxley
Act.
(b) Report(s) on Form 8-K filed during the quarter ended March 31,
2003, are as follows:
Date Filed Purpose
---------- -------
February 10, 2003 Announce fourth quarter and year-to-date results
for the year ended December 31, 2002 and that
due to further deterioration of the loan
portfolio a fourth quarter loss provision of
$10.0 million was recorded.
26
SIGNATURES
- ----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Banner Corporation
May 14, 2003 /s/D. Michael Jones
------------------------------------
D. Michael Jones
President and Chief Executive Officer
(Principal Executive Officer)
May 14, 2003 /s/ Lloyd W. Baker
------------------------------------
Lloyd W. Baker
Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)
27
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 Quarterly Report on Form 10-Q of Banner Corporation;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;
4. The registrant's other certifying officers 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
quarterly 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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 officers 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 officers and I have indicated in this
quarterly 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.
May 14, 2003 /s/D. Michael Jones
---------------------------------
D. Michael Jones
Chief Executive Officer
28
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 Quarterly Report on Form 10-Q of Banner Corporation;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;
4. The registrant's other certifying officers 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
quarterly 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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 officers 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 officers and I have indicated in this
quarterly 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.
May 14, 2003 /s/Lloyd W. Baker
----------------------------
Lloyd W. Baker
Chief Financial Officer
29
Exhibit 99.1
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 Quarterly Report on Form 10-Q, 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.
May 14, 2003 /s/D. Michael Jones
---------------------------
D. Michael Jones
Chief Executive Officer
May 14, 2003 /s/Lloyd W. Baker
----------------------------
Lloyd W. Baker
Chief Financial Officer
A signed original of the written statement required by Section 906 has been
provided to Banner Corporation and will be retained by Banner Corporation and
furnished to the Securities and Exchange Commission or its staff upon request.
30