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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 JUNE 30, 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 (I.R.S. Employer
incorporation 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 July 31, 2003
--------------- -------------------
Common Stock, $.01 par value per share 11,379,991 shares*
* Includes 515,960 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 June 30, 2003 and December 31, 2002. . . . . . . . . . . . . . . . 2
Consolidated Statements of Income
for the Quarters and Six Months Ended June 30, 2003 and 2002 . . . . . . 3
Consolidated Statements of Comprehensive Income
for the Quarters and Six Months Ended June 30, 2003 and 2002 . . . . . . 4
Consolidated Statements of Changes in Stockholders' Equity
for the Six Months Ended June 30, 2003 and 2002. . . . . . . . . . . . . 5
Consolidated Statements of Cash Flows
for the Six Months Ended June 30, 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 June 30, 2003 and December 31,
2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Comparison of Results of Operations for the Quarters and Six Months
Ended June 30, 2003 and 2002 . . . . . . . . . . . . . . . . . . . . . . 14
Asset Quality. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Liquidity and Capital Resources. . . . . . . . . . . . . . . . . . . . . 21
Capital Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Market Risk and Asset/Liability Management . . . . . . . . . . . . . . . 23
Item 4 - Controls and Procedures . . . . . . . . . . . . . . . . . . . . . 27
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . 28
Item 2 - Changes in Securities and Use of Proceeds . . . . . . . . . . . . 28
Item 3 - Defaults upon Senior Securities . . . . . . . . . . . . . . . . . 28
Item 4 - Submission of Matters to a Vote of Stockholders . . . . . . . . . 28
Item 5 - Other Information . . . . . . . . . . . . . . . . . . . . . . . . 28
Item 6 - Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . 28
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
1
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands, except shares)
June 30, 2003 (Unaudited) and December 31, 2002
(Unaudited)
June 30 December 31
ASSETS 2003 2002
---------- -----------
Cash and due from banks $ 143,945 $132,910
Securities available for sale, cost $558,830
and $415,855
Encumbered 31,317 32,955
Unencumbered 532,652 388,267
---------- ----------
563,969 421,222
Securities held to maturity, fair value $12,460
and $13,414
Encumbered 579 --
Unencumbered 10,612 13,253
---------- ----------
11,191 13,253
Federal Home Loan Bank stock 33,814 32,831
Loans receivable:
Held for sale, fair value $40,478 and $39,984 39,602 39,366
Held for portfolio 1,624,514 1,534,100
Allowance for loan losses (26,075) (26,539)
---------- ----------
1,638,041 1,546,927
Accrued interest receivable 14,293 13,689
Real estate owned, held for sale, net 8,691 6,062
Property and equipment, net 20,216 20,745
Goodwill and other intangibles, net 36,613 36,714
Deferred income tax asset, net 1,810 2,786
Bank owned life insurance 32,748 31,809
Other assets 9,368 4,224
---------- ----------
$2,514,699 $2,263,172
LIABILITIES ========== ==========
Deposits:
Non-interest-bearing $ 191,134 $ 200,500
Interest-bearing 1,501,730 1,297,278
---------- ----------
1,692,864 1,497,778
Advances from Federal Home Loan Bank 507,952 465,743
Trust preferred securities 40,000 40,000
Other borrowings 42,014 41,202
Accrued expenses and other liabilities 31,537 24,700
Deferred compensation 3,728 3,372
Income taxes payable 1,723 --
---------- ----------
2,319,818 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:
11,366,835 shares and 11,306,977 shares
outstanding at June 30, 2003 and December 31,
2002, respectively. 121,384 120,554
Retained earnings 74,966 70,813
Accumulated other comprehensive income:
Unrealized gain on securities available for sale 3,340 3,488
Unearned shares of common stock issued to Employee
Stock Ownership Plan (ESOP) trust:
515,960 and 515,707 restricted shares outstanding
at June 30, 2003 and December 31, 2002, respectively,
at cost (4,264) (4,262)
Carrying value of shares held in trust for stock
related compensation plans (3,652) (3,190)
Liability for common stock issued to deferred, stock
related, compensation plans 3,107 2,974
---------- ----------
194,881 190,377
---------- ----------
$2,514,699 $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 Six Months Ended
June 30 June 30
------------------ ------------------
2003 2002 2003 2002
INTEREST INCOME: -------- -------- -------- --------
Loans receivable $ 29,396 $ 30,702 $ 58,240 $ 61,953
Mortgage-backed securities 3,183 2,886 6,235 5,442
Securities and cash equivalents 2,833 2,688 5,655 4,899
-------- -------- -------- --------
35,412 36,276 70,130 72,294
INTEREST EXPENSE:
Deposits 8,851 9,874 17,722 20,018
Federal Home Loan Bank advances 5,747 6,231 11,447 12,699
Trust preferred securities 546 338 1,113 338
Other borrowings 203 400 375 892
-------- -------- -------- --------
15,347 16,843 30,657 33,947
-------- -------- -------- --------
Net interest income before provision
for loan losses 20,065 19,433 39,473 38,347
PROVISION FOR LOAN LOSSES 2,250 4,000 4,500 7,000
-------- -------- -------- --------
Net interest income 17,815 15,433 34,973 31,347
OTHER OPERATING INCOME:
Loan servicing fees (83) 413 447 757
Other fees and service charges 1,839 1,548 3,497 2,806
Mortgage banking revenues 3,244 1,128 5,306 2,419
Gain (loss) on sale of securities -- 12 3 17
Miscellaneous 383 448 948 768
-------- -------- -------- --------
Total other operating income 5,383 3,549 10,201 6,767
OTHER OPERATING EXPENSES:
Salary and employee benefits 11,589 9,090 22,800 17,784
Less capitalized loan origination
costs (1,975) (1,292) (3,550) (2,605)
Occupancy and equipment 2,349 2,039 4,721 4,122
Information/computer data services 868 724 1,706 1,337
Miscellaneous 4,444 3,279 8,655 6,528
-------- -------- -------- --------
Total other operating expenses 17,275 13,840 34,332 27,166
-------- -------- -------- --------
Income before provision for income
taxes 5,923 5,142 10,842 10,948
PROVISION FOR INCOME TAXES 1,802 1,615 3,292 3,512
-------- -------- -------- --------
NET INCOME $ 4,121 $ 3,527 $ 7,550 $ 7,436
======== ======== ======== ========
Net income per common share (see Note 5):
Basic $ .38 $ .32 $ .70 $ .67
Diluted $ .37 $ .30 $ .68 $ .65
Cumulative dividends declared per
common share: $ .15 $ .15 $ .30 $ .30
See notes to consolidated financial statements
3
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (in thousands)
Quarters Ended Six Months Ended
June 30 June 30
------------------ ------------------
2003 2002 2003 2002
-------- -------- -------- --------
NET INCOME: $ 4,121 $ 3,527 $ 7,550 $ 7,436
OTHER COMPREHENSIVE INCOME (LOSS),
NET OF INCOME TAXES:
Unrealized holding gain (loss) during the
period, net of deferred income tax
(benefit) of $(126), $1,297, $(78) and
$151 respectively. (236) 2,409 (146) 281
Less adjustment for (gains)/losses
included in net income, net of income
tax (benefit) of $0, $4, $1 and $6;
respectively -- (8) (2) (11)
-------- -------- -------- --------
Other comprehensive income (loss) (236) 2,401 (148) 270
-------- -------- -------- --------
COMPREHENSIVE INCOME $ 3,885 $ 5,928 $ 7,402 $ 7,706
======== ======== ======== ========
See notes to consolidated financial statements
4
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited) (In thousands, except per share amounts)
For the Six Months Ended June 30, 2003 and 2002
Carrying Value
Of Shares Held
in Trust for
Common Stock Accumulated Unearned Stock-Related
And Additional Other Restricted Compensation Total
Paid-in Retained Comprehensive ESOP Plans Net of Stockholders'
Capital Earnings Income Shares Liability Equity
--------- -------- ---------- --------- ------------ ------------
BALANCE, January 1, 2002 $126,844 $ 68,104 $ 2,264 $ (4,769) $ (103) $ 192,340
Net income 7,436 7,436
Change in valuation of securities
available for sale, net of income taxes 270 270
Cash dividend on common stock
($ .30/share cumulative) (3,486) (3,486)
Purchase and retirement of
common stock (738) (738)
Proceeds from issuance of common
stock for exercise of stock
options 1,144 1,144
Amortization of compensation
related to MRP 17 17
--------- -------- --------- --------- ----------- -----------
BALANCE, June 30, 2002 $ 127,250 $ 72,054 $ 2,534 $ (4,769) $ (86) $ 196,983
========= ======== ========= ========= =========== ===========
BALANCE, January 1, 2003 $ 120,554 $ 70,813 $ 3,488 $ (4,262) $ (216) $ 190,377
Net income 7,550 7,550
Change in valuation of securities
available for sale, net of income
taxes (148) (148)
Cash dividend on common stock
($ .30/share cumulative) (3,397) (3,397)
Proceeds from reissued common stock
for exercise of stock options 437 437
Adjust prior year release of
earned ESOP shares (3) (2) (5)
Release of stock for MRP grant 444 (444) --
Amortization of compensation
related to MRP 67 67
Forfeiture or net change in the
number and/or carrying value of
shares held in trust for
compensation plans (48) 48 --
--------- -------- --------- --------- ------------ ------------
BALANCE, June 30, 2003 $ 121,384 $ 74,966 $ 3,340 $ (4,264) $ (545) $ 194,881
========= ======== ========= ========= ============ ============
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 Six Months Ended June 30, 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 (3) (40)
Issuance of common stock to deferred compensation
plan and/or exercised stock options 63 78
------ ------
Number of shares retired, end of period (1,834) (1,529)
------ ------
Shares issued and outstanding, end of period 11,367 11,672
====== ======
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 Six Months Ended June 30, 2003 and 2002
2003 2002
OPERATING ACTIVITIES ------ ------
Net income $ 7,550 $ 7,436
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,859 1,484
Loss (gain) on sale of securities (3) (17)
Increase in cash surrender value of bank owned
life insurance (939) (591)
Gain on sale of loans (4,403) (1,933)
Loss (gain) on disposal of real estate held for
sale and property and equipment (18) 130
Provision for losses on loans and real estate held for
sale 4,810 7,000
Federal Home Loan Bank stock dividend (983) (926)
Net change in:
Loans held for sale (236) 32,744
Other assets (4,488) 4,516
Other liabilities 9,167 (4,565)
--------- --------
Net cash provided (used) by operating activities 13,316 45,278
--------- --------
INVESTING ACTIVITIES:
Purchases of securities (385,312) (140,429)
Principal repayments and maturities of securities 232,046 78,025
Proceeds from sales of securities 10,089 4,541
Origination of loans, net of principal repayments (366,876) (140,857)
Purchases of loans and participating interest in
loans (24,321) (3,919)
Proceeds from sales of loans and participating
interest in loans 295,207 160,413
Purchases of property and equipment-net (1,154) (1,618)
Proceeds from sale of real estate held for sale-net 2,979 626
Net (funding) payout of deferred compensation plans (90) (10,000)
Cash (used for) provided by acquisitions -- (6,519)
Other -- (116)
--------- --------
Net cash used by investing activities (237,432) (59,853)
--------- --------
FINANCING ACTIVITIES
Increase in deposits $ 195,086 $ 97,578
Proceeds from FHLB advances 226,751 156,501
Repayment of FHLB advances (184,542) (227,300)
Proceeds from issuance of trust preferred securities -- 25,000
Proceeds from repurchase agreement borrowings 19,000 1,226
Repayments of repurchase agreement borrowings (19,587) (6,754)
Increase (decrease) in other borrowings 1,399 (3,165)
Cash dividends paid (3,388) (3,369)
Repurchases of stock, net of forfeitures -- (738)
ESOP shares earned (5) --
Other 437 1,144
--------- --------
Net cash provided by financing activities 235,151 40,123
--------- --------
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 11,035 25,548
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 132,910 67,728
--------- --------
CASH AND DUE FROM BANKS, END OF PERIOD $ 143,945 $ 93,276
========= ========
(Continued on next page)
7
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (in thousands)
For the Six Months Ended June 30, 2003 and 2002
(Continued from prior page)
2003 2002
------ ------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid in cash $ 30,473 $ 33,958
Taxes paid in cash $ -- $ 2,500
Non-cash transactions:
Loans, net of discounts, specific loss allowances
and unearned income, transferred to real estate
owned and other repossessed assets $ 6,224 $ 4,004
Net change in accrued dividends payable $ 9 $ 117
Other assets/liabilities $ -- $ 45
The following summarizes the non-cash activities relating
to acquisitions:
Fair value of assets and intangibles acquired $ -- (44,544)
Fair value of liabilities assumed -- 34,453
Fair value of stock issued and
options assumed to acquisitions' shareholders -- -
-------- --------
Cash paid out in acquisition (10,091)
Less cash acquired -- 3,572
-------- --------
Net cash acquired (used) $ -- $ (6,519)
======== ========
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, the valuation of
goodwill, estimation of deferred taxes, valuation and amortization of deferred
loan fees and 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 Six Months Ended
June 30 June 30
-------------- --------------
2003 2002 2003 2002
------ ------ ------ ------
Net income available to common stockholders:
Basic:
As reported $ 4,121 $ 3,527 $ 7,550 $ 7,436
Pro forma 3,885 3,288 7,002 7,172
Diluted:
As reported $ 4,121 $ 3,527 $ 7,550 $ 7,436
Pro forma 3,885 3,288 7,002 7,172
Net income per common share:
Basic:
As reported $ 0.38 $ 0.32 $ 0.70 $ 0.67
Pro forma 0.36 0.30 0.65 0.65
Diluted:
As reported $ 0.37 $ 0.30 $ 0.68 $ 0.65
Pro forma 0.35 0.28 0.63 0.62
The compensation expense included in the pro forma net income available to
diluted common stockholders and diluted earnings per common share is not
likely to be representative of the effect on reported net income for future
years because options vest over several years and additional awards generally
are made each year.
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 3.76% 2.58 to 3.56%
Expected volatility 36.0 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 4.99000%,
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: On May 31, 2003, the
Financial Accounting Standards Board (FASB) issued SFAS No. 150, Accounting
for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity. This statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as
equity. Some of the provisions of this statement are consistent with the
current definition of liabilities in FASB Concepts Statement No. 6, Elements
of Financial Statements. The remaining provisions of this statement are
consistent with the FASB's proposal to revise the definition to encompass
certain obligations that a reporting entity can or must settle by issuing its
own equity shares, depending on the nature of the relationship established
between the holder and the issuer. This statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June
15, 2003, except for mandatorily redeemable financial instruments of nonpublic
entities. The adoption of SFAS No. 150 has not had a material impact on the
Company's financial statements.
On April 30, 2003, FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under
SFAS No. 133. The new guidance amends SFAS No. 133 for decisions made as part
of the Derivatives Implementation Group "DIG" process that effectively
required amendments to SFAS No. 133, and decisions made in connection with
other FASB projects dealing with financial instruments and in connection with
implementation issues raised in relation to the application of the definition
of a derivative and characteristics of a derivative that contains financing
components. In addition, it clarifies when a derivative contains a financing
component that warrants special reporting in the statement of cash flows.
SFAS No. 149 is effective for contracts entered into or modified after June
30, 2003 and for hedging relationships designated after June 30, 2003. The
Bank is currently assessing the impact of SFAS No. 149 on the Consolidated
Financial Statements.
In June 2002, 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, 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
10
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 Company is currently evaluating the impact of the
interpretation on its financial statements and, except for the possible effect
related to the issuance of its trust preferred obligation, and an related
regulatory effects, does not currently believe the interpretation will have
significant effects.
In November 2002, 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 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 operating 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):
June 30 December 31 June 30
2003 2002 2002
Interest-bearing deposits included -------- -------- --------
in cash and due from banks $ 71,337 $ 42,921 $ 24,378
-------- -------- --------
Mortgage-backed securities 334,660 269,153 206,726
Other securities-taxable 211,053 141,404 144,323
Other securities-tax exempt 25,869 21,107 22,136
Equity securities with dividends 3,578 2,811 2,854
-------- -------- --------
Total securities 575,160 434,475 376,039
Federal Home Loan Bank (FHLB) stock 33,814 32,831 31,800
-------- -------- --------
$680,311 $510,227 $432,217
======== ======== ========
The following table provides additional detail on income from deposits and
securities for the periods indicated (in thousands):
Quarters Ended Six Months Ended
June 30 June 30
----------------- -----------------
2003 2002 2003 2002
------- ------- ------- -------
Mortgage-backed securities interest $ 3,183 $ 2,886 $ 6,235 $ 5,442
------- ------- ------- -------
Taxable interest and dividends 2,140 1,888 4,109 3,310
Tax-exempt interest 256 330 563 662
FHLB stock dividends 437 470 983 927
------- ------- ------- -------
2,833 2,688 5,655 4,899
------- ------- ------- -------
$ 6,016 $ 5,574 $11,890 $10,341
======= ======= ======= =======
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 Six Months Ended
June 30 June 30
---------------- ----------------
2003 2002 2003 2002
------ ------ ------ ------
Total shares originally issued 13,201 13,201 13,201 13,201
Less retired weighted average shares plus
unvested weighted average shares
allocated to MRP (1,879) (1,554) (1,889) (1,572)
Less unallocated shares held by the ESOP (516) (577) (516) (577)
------ ------ ------ ------
Basic weighted average shares outstanding 10,806 11,070 10,796 11,052
Plus unvested MRP and stock option
incremental shares considered
outstanding for diluted EPS
calculations 324 512 290 463
------ ------ ------ ------
Diluted weighted average shares
outstanding 11,130 11,582 11,086 11,515
====== ====== ====== ======
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 operations,
pricing, products and services and the Company's ability to successfully
resolve the outstanding credit issues. Accordingly, these factors should be
considered in evaluating the "forward-looking statements," and undue reliance
should not be placed on such statements. The Company undertakes no
responsibility to update or revise any "forward-looking statements."
General
Banner Corporation, a Washington corporation, is primarily engaged in the
business of planning, directing and coordinating the business activities of
its wholly owned subsidiary, Banner Bank. The Bank is a Washington-chartered
commercial bank 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 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 both
the quarter and six months ended June 30, 2003, compared to the same periods a
year earlier, as a result of growth in interest-bearing assets and liabilities
and despite decreases of 27 and 22 basis points, respectively, in the interest
rate spread. The net interest margin also decreased 33 and 28 basis points,
respectively, for the quarter and six months ended June 30, 2003, compared to
the same periods one year ago. 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 $1.75 million to $2.25 million for the quarter ended June 30, 2003,
compared to $4.0 million for the quarter ended June 30, 2002. For the six
months ended June 30, 2003, the provision for loan losses was $4.5 million,
compared to $7.0 million for the same period a year earlier. Other operating
income increased significantly for the quarter and six months ended June 30,
2003, largely as a result of increased mortgage banking activity and resulting
gain on the sale of loans, although other non-interest revenues also increased
significantly. Other operating expenses also increased for the quarter and
six months ended June 30, 2003, compared to the same periods ended June 30,
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 June 30, 2003 and December 31, 2002
General: Total assets increased $251.5 million, or 11.1%, from $2.263 billion
at December 31, 2002, to $2.515 billion at June 30, 2003. The growth largely
resulted from an increase in cash and securities, although growth in the loan
portfolio was also significant, 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 $91.1
million, or 5.9%, from $1.547 billion at December 31, 2002, to $1.638 billion
at June 30, 2003. Despite decreases of $30.1 million in one- to four-family
residential mortgages and $2.4 million in consumer loans as a result of
accelerated prepayments in the current low interest rate environment, the
balance of the loan portfolio experienced net growth, including an increase of
$28.3 million in mortgages secured by commercial real estate loans, an
increase of $4.3 million in multifamily real estate loans, an increase of
$36.9 million in construction and land loans and an increase of $53.7 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 $140.7 million, or 32.4%, from $434.5 million at December
31, 2002, to $575.2 million at June 30, 2003, as a result of additional
13
investing. FHLB stock increased $983,000 as a result of dividends paid by the
FHLB in the form of additional shares of stock. The Company also had an
increase of $939,000 in bank-owned life insurance from the growth of cash
surrender 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 $195.1
million, or 13.0%, from $1.498 billion at December 31, 2002, to $1.693 billion
at June 30, 2003. While non-interest-bearing deposits decreased $9.4 million,
or 4.7%, interest-bearing deposits increased by $204.5 million, or 15.8%, from
the prior year-end amounts. FHLB advances increased $42.2 million from $465.7
million at December 31, 2002, to $508.0 million at June 30, 2003.
Comparison of Results of Operations for the Quarters and Six Months Ended June
30, 2003 and 2002
General. For the quarter ended June 30, 2003, the Company had net income of
$4.1 million, or $.37 per share (diluted), compared to net income of $3.5
million, or $.30 per share (diluted), for the quarter ended June 30, 2002, an
increase of $594,000. The Company's operating results reflect the significant
growth of assets and liabilities, which was somewhat offset by a narrower net
interest margin. The Company's operating results also reflect significant
increases in other operating income and other operating expenses. Compared to
levels a year ago, total assets increased 16.2%, to $2.515 billion at June 30,
2003, net loans increased 5.5%, to $1.638 billion, deposits grew 18.6%, to
$1.693 billion, and borrowings, including trust preferred securities,
increased 12.4%, to $590.0 million. Average interest earning assets were
$2.255 billion for the quarter ended June 30, 2003, an increase of $255.9
million, or 12.8%, compared to the same period a year earlier. Average equity
was 8.09% of average assets for the quarter ended June 30, 2003, compared to
9.23% of average assets for the quarter ended June 30, 2002.
Net Interest Income. Net interest income before provision for loan losses
increased to $20.1 million for the quarter ended June 30, 2003, compared to
$19.4 million for the quarter ended June 30, 2002. Net interest margin
decreased 33 basis points for the quarter, reflecting a 27 basis point
decrease in net interest rate spread and a small increased use of
interest-bearing liabilities relative to interest-earning assets. Net
interest income before provision for loan losses increased to $39.5 million
for the six months ended June 30, 2003, compared to $38.3 million for the same
period ended June 30, 2002. For the six-month period, the net interest margin
decreased 28 basis points, reflecting a 22 basis point decrease in net
interest rate spread and a similar 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 June 30, 2003, was
$35.4 million, compared to $36.3 million for the quarter ended June 30, 2002,
a decrease of $864,000, or 2.4%. The decrease in interest income occurred
despite a $255.9 million, or 12.8%, growth in average balances of interest-
earning assets as a result of a 98 basis point decrease in the average yield
on those assets. The yield on average interest-earning assets decreased to
6.30% for the quarter ended June 30, 2003, compared to 7.28% for the same
period a year earlier. Average loans receivable for the quarter ended June 30,
2003, increased by $46.8 million, or 3.0%, when compared to the quarter ended
June 30, 2002. Nonetheless, interest income on loans for the quarter
decreased by $1.3 million, or 4.3%, compared to the prior year, as the impact
of the increase in average loan balances was more than offset by a 54 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
7.22% for the quarter ended June 30, 2003, compared to 7.76% for the quarter
ended June 30, 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 combined average balance of mortgage-backed securities, investment
securities, daily interest-bearing deposits and FHLB stock increased by $209.1
million for the quarter ended June 30, 2003, and the interest and dividend
income from those investments increased $442,000, compared to the quarter
ended June 30, 2002. The average yield on mortgage-backed securities
decreased to 3.71% for the quarter ended June 30, 2003, from 5.54% for the
comparable period in 2002, reflecting the effect of lower market rates on the
interest rates paid on the 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 3.92% for the quarter ended June 30, 2003, from 5.15% for the
comparable quarter in 2002, also reflecting the lower level of market rates.
Earnings on FHLB stock decreased by $33,000, to $437,000, in the quarter ended
June 30, 2003, from $470,000 in the comparable quarter in 2002. This resulted
from a 76 basis point decrease in the yield received on FHLB stock, offset by
an increase of $2.0 million in the average balance of FHLB stock for the
quarter ended June 30, 2003. The dividend yield on FHLB stock was 5.25% for
the quarter ended June 30, 2003, compared to 6.01% for the quarter ended June
30, 2002. Dividends on FHLB stock are established on a quarterly basis by
vote of the Directors of the FHLB.
Interest income for the six months ended June 30, 2003, decreased by $2.2
million, or 3.0%, to $70.1 million from $72.3 million for the comparable
period in 2002. Interest income from loans decreased $3.7 million, or 6.0%,
from the comparable period in 2002. The decrease in loan interest income
reflects the impact of a 52 basis point decrease in the yield on the loan
balances despite a $10.9 million growth in the average balance of loans
receivable. Interest income from mortgage-backed and investment securities
and FHLB stock for the six months ended June 30, 2003, increased $1.5 million,
from $10.3 million in 2002 to $11.9 million in the current period, reflecting
a substantial $208.7 million increase in average balances offset by a 137
basis point decrease in yield.
Interest Expense. Interest expense for the quarter ended June 30, 2003, was
$15.3 million, compared to $16.8 million for the comparable period in 2002, a
decrease of $1.5 million, or 8.9%. The decrease in interest expense was the
result of a decrease in the average cost of all interest-bearing liabilities
to 2.79% from 3.50%, primarily reflecting the lower levels of market interest
rates. Deposit interest expense decreased $1.0 million for the quarter ended
June 30, 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 $212.5 million, or 15.3%, to $1.599 billion for the quarter ended
June 30, 2003, from $1.386 billion for the quarter ended June 30,
14
2002, while, at the same time, the average rate paid on deposit balances
decreased 64 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 June 30, 2003, than for the same period preceding the quarter
ended June 30, 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 $522.5
million during the quarter ended June 30, 2003, compared to $450.0 million
during the quarter ended June 30, 2002, an increase of $72.5 million that,
combined with a 114 basis point decrease in the average cost of advances,
resulted in a $484,000 decrease in related interest expense. The average rate
paid on those advances decreased to 4.41% for the quarter ended June 30, 2003,
from 5.55% for the quarter ended June 30, 2002. FHLB advances are generally
fixed-rate, fixed-term borrowings. Funding was also provided in the second
quarter of 2003 by trust preferred securities (TPS) which had an average
balance of $40 million and an average cost of 5.48% (including amortization of
prepaid underwriting costs) for the quarter ended June 30, 2003. TPS
outstanding in the second quarter of the prior year had an average balance of
$22.3 million and an average rate of 6.09%. 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 $25.1 million, to $44.9 million
for the quarter ended June 30, 2003, from $70.1 million for the same period
in 2002, while the related interest expense decreased $197,000, to $203,000,
from $400,000 for the respective periods. The average rate paid on other
borrowings was 1.81% in the quarter ended June 30, 2003, compared to 2.29% 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.
15
A comparison of total interest expense for the six months ended June 30, 2003,
shows a decrease of $3.3 million, or 9.7%, from the comparable period in June
2002. The interest expense reflects an increase in average deposits of $191.4
million combined with a $48.8 million increase in FHLB advances, trust
preferred securities and other borrowings. The effect on interest expense of
the $240.2 million increase in average interest-bearing liabilities was offset
by a 71 basis point decrease in the interest rate paid on those liabilities.
The following tables provide additional comparative data on the Company's
operating performance:
Quarters Ended Six Months Ended
Average Balances June 30 June 30
---------------- ----------------------- -----------------------
(in thousands) 2003 2002 2003 2002
---------- ---------- ---------- ----------
Investment securities and
deposits $ 245,073 $ 172,660 $ 229,748 $ 150,393
Mortgage-backed obligations 343,686 209,030 331,068 203,695
Loans 1,633,218 1,586,389 1,607,865 1,596,968
FHLB stock 33,382 31,348 33,111 31,120
---------- ---------- ---------- ----------
Total average interest-
earning assets 2,255,359 1,999,427 2,201,792 1,982,176
Non-interest-earning assets 160,455 139,813 158,950 137,061
---------- ---------- ---------- ----------
Total average assets 2,415,814 2,139,240 2,360,742 $2,119,237
========== ========== ========== ==========
Deposits 1,598,829 1,386,332 1,552,883 1,361,457
Advances from FHLB 522,549 450,018 513,699 463,056
Trust preferred securities 40,000 22,253 40,000 11,188
Other borrowings 44,934 70,068 44,354 75,036
---------- ---------- ---------- ----------
Total average interest-
bearing liabilities 2,206,312 1,928,671 2,150,936 1,910,737
Non-interest-bearing
liabilities 13,980 13,191 15,548 11,716
---------- ---------- ---------- ----------
Total average
liabilities 2,220,292 1,941,862 2,166,484 1,922,453
Equity 195,522 197,378 194,258 196,784
---------- ---------- ---------- ----------
Total average liabilities
and equity $2,415,814 $2,139,240 $2,360,742 $2,119,237
========== ========== ========== ==========
Interest Rate Yield/Expense (rates are annualized)
--------------------------------------------------
Interest Rate Yield:
Investment securities and
deposits 3.92% 5.15% 4.10% 5.33%
Mortgage-backed obligations 3.71% 5.54% 3.80% 5.39%
Loans 7.22% 7.76% 7.30% 7.82%
FHLB stock 5.25% 6.01% 5.99% 6.00%
---------- ---------- ---------- ----------
Total interest rate
yield on interest-
earning assets 6.30% 7.28% 6.42% 7.35%
---------- ---------- ---------- ----------
Interest Rate Expense:
Deposits 2.22% 2.86% 2.30% 2.97%
Advances from FHLB 4.41% 5.55% 4.49% 5.53%
Trust preferred securities 5.48% 6.09% 5.61% 6.09%
Other borrowings 1.81% 2.29% 1.70% 2.40%
---------- ---------- ---------- ----------
Total interest rate expense
on interest-bearing
liabilities 2.79% 3.50% 2.87% 3.58%
---------- ---------- ---------- ----------
Interest spread 3.51% 3.78% 3.55% 3.77%
========== ========== ========== ==========
Net interest margin on
interest earning assets 3.57% 3.90% 3.62% 3.90%
---------- ---------- ---------- ----------
Additional Key Financial Ratios (ratios are annualized)
------------------------------------------------------
Return on average assets 0.68% 0.66% 0.64% 0.71%
Return on average equity 8.45% 7.17% 7.84% 7.62%
Average equity / average
assets 8.09% 9.23% 8.23% 9.29%
Average interest-earning
assets / interest-bearing
liabilities 102.22% 103.67% 102.36% 103.74%
Non-interest (other
operating) expenses /
average assets 2.87% 2.59% 2.93% 2.58%
Efficiency ratio
[non-interest (other
operating) expenses /
revenues] 67.88% 60.22% 69.11% 60.22%
16
Provision and Allowance for Loan Losses. During the quarter ended June 30,
2003, the provision for loan losses was $2.3 million, compared to $4.0 million
for the quarter ended June 30, 2002, a decrease of $1.8 million. For the six
months ended June 30, 2003, the provision for loan losses was $4.5 million,
compared to $7.0 million for the same period ended June 30, 2002. 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 than a year earlier and continued concerns about the
current economic environment, the provision in the current periods is lower
largely as a result of the recognition of the deterioration of the portfolio
through the very large provisions recorded in the fourth quarter of 2002,
which significantly added to the allowance for loan losses. Non-performing
loans increased to $28.1 million at June 30, 2003, compared to $19.9 million
at June 30, 2002, but declined from $37.1 million and $36.1 million,
respectively, at March 31, 2003 and December 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 $1.7 million for the current quarter,
compared to $6.3 million for the same quarter a year earlier. Net charge offs
declined to $5.0 million for the first six months of 2003, compared to $8.4
million for the six months ended June 30, 2002. A comparison of the allowance
for loan losses at June 30, 2003 and 2002, shows an increase of $9.4 million,
to $26.1 million at June 30, 2003, from $16.6 million at June 30, 2002. The
allowance for loan losses as a percentage of total loans (loans receivable
excluding allowance for losses) was 1.57% and 1.06% at June 30, 2003 and June
30, 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 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 probable
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. Realized losses 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 changes 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 June 30, 2003, the
Company had identified $27.2 million of impaired loans as defined by SFAS 114
and had established $4.5 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. 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.
17
The following tables are provided to disclose additional detail on the
Company's loans and allowance for loan losses (in thousands):
June 30 December 31 June 30
2003 2002 2002
---------- ---------- ----------
Loans (including loans held for sale):
Secured by real estate:
One- to four-family $ 299,524 $ 329,314 $ 353,819
Consumer secured by one- to
four-family 25,875 26,195 24,747
---------- ---------- ----------
Total one- to four-family 325,399 355,509 378,566
Commercial 407,419 379,099 367,166
Multifamily 76,598 72,333 81,942
Construction and land 376,385 339,516 340,117
Commercial business 328,130 285,231 263,796
Agricultural business 113,445 102,626 95,375
Consumer 36,740 39,152 41,705
---------- ---------- ----------
Total loans outstanding 1,664,116 1,573,466 1,568,667
Less allowance for loan losses 26,075 26,539 16,646
---------- ---------- ----------
Total net loans outstanding
at end of period $1,638,041 $1,546,927 $1,522,021
========== ========== ==========
Quarters Ended Six Months Ended
June 30 June 30
-------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
Balance, beginning of the period $ 25,551 $ 18,899 $ 26,539 $ 17,552
Acquisitions -- -- -- 460
Provision for loan losses 2,250 4,000 4,500 7,000
Recoveries of loans previously charged off:
Secured by real estate:
One- to four-family -- -- -- -
Commercial -- (9) -- --
Multifamily -- -- -- --
Construction and land -- -- -- --
Commercial business 218 13 313 13
Agricultural business 11 1 12 2
Consumer 15 46 29 55
-------- -------- -------- --------
244 51 354 70
Loans charged off:
Secured by real estate:
One- to four-family (12) (5) (12) (11)
Commercial (690) -- (1,878) --
Multifamily -- -- -- -
Construction and land (500) (487) (529) (487)
Commercial business (703) (5,703) (2,641) (7,289)
Agricultural business -- -- -- (141)
Consumer (65) (109) (258) (508)
-------- -------- -------- --------
(1,970) (6,304) (5,318) (8,436)
-------- -------- -------- --------
Net charge-offs (1,726) (6,253) (4,964) (8,366)
-------- -------- -------- --------
Balance, end of the period $ 26,075 $ 16,646 $ 26,075 $ 16,646
======== ======== ======== ========
Net charge-offs as a percentage
of average net book value of
loans outstanding for the period 0.11% 0.39% 0.31% 0.52%
18
The following is a schedule of the Company's allocation of the allowance for
loan losses:
June 30 December 31 June 30
2003 2002 2002
-------- ----------- --------
Specific or allocated loss allowances:
Secured by real estate:
One- to four-family $ 800 $ 670 $ 670
Commercial 4,900 5,284 1,988
Multifamily 413 361 410
Construction and land 6,609 5,892 3,651
Commercial business 8,237 8,788 7,231
Agricultural business 2,528 2,164 1,173
Consumer 494 698 637
-------- -------- --------
Total allocated 23,981 23,857 15,770
Estimated allowance for undisbursed
commitments 272 36 31
Unallocated 1,822 2,646 845
-------- -------- --------
Total allowance for loan losses $ 26,075 $ 26,539 $ 16,646
======== ======== ========
Allowance for loan losses as a
percentage of total loans outstanding
(loans receivable excluding allowance
for losses) 1.57% 1.69% 1.06%
Other Operating Income. Other operating income was $5.4 million for the
quarter ended June 30, 2003, an increase of $1.8 million from the quarter
ended June 30, 2002. This included a $2.1 million 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 June 30, 2003
totaled $166.5 million, compared to $68.7 million for the quarter ended June
30, 2002. Gain on sale of loans for the Company included $172,000 of fees on
$11.3 million of loans which were brokered and are not reflected in the volume
of loans sold. Loan servicing fees decreased by $496,000, to a negative
$83,000, for the quarter ended June 30, 2003, compared to $413,000 a year
earlier largely as a result of accelerated loan prepayments which led to more
rapid amortization of mortgage servicing rights as well as a $300,000
impairment charge with respect to the valuation of retained mortgage servicing
rights. Other fee and service charge income increased by $291,000, to $1.8
million for the quarter ended June 30, 2003, compared to $1.5 million for the
quarter ended June 30, 2002, primarily reflecting growth in customer
transaction accounts.
Other operating income for the six months ended June 30, 2003, increased $3.4
million from the comparable period in 2002. This includes a $2.9 million
increase in the gain on sale of loans, a $691,000 increase in other fee and
service charge income and a $310,000 decrease in loan servicing fees. Loan
sales increased from $160.7 million for the six months ended June 30, 2002, to
$295.2 million for the six months ended June 30, 2003.
Other Operating Expenses. Other operating expenses increased $3.4 million, to
$17.3 million for the quarter ended June 30, 2003, from $13.8 million for the
quarter ended June 30, 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 and staffing 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 $503,000 greater in the quarter ended
June 30, 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 $683,000 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 67.88% for the quarter
ended June 30, 2003, from 60.22% for the comparable period ended June 30,
2002. Other operating expenses as a percentage of average assets increased to
2.87% for the quarter ended June 30, 2003, compared to 2.59% for the quarter
ended June 30, 2002.
Other operating expenses for the six months ended June 30, 2003, increased
$7.2 million, from $27.2 million for the first six months of 2002 to $34.3
million in the current period. As explained earlier, the increase is largely
due to the increases in compensation, occupancy and advertising expenses as
the volume of activity has expanded and the bank positions itself for future
growth. The increased expenses in the current period also reflect a higher
level of cost associated with the collection and disposition of non-performing
assets.
Income Taxes. Income tax expense was $1.8 million for the quarter ended June
30, 2003, compared to $1.6 million for the comparable period in 2002. The
Company's effective tax rates for the quarters ended June 30, 2003 and 2002
were 30% and 31%, 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 second quarter of 2002. In addition, in the
current quarter, the company recorded $49,000 of tax credits associated with
an investment in limited partnerships focused on providing affordable housing
for low and moderate income families.
Income tax expense for the six months ended June 30, 2003, increased to $3.3
million, compared to $3.5 million in the comparable period in
19
2002. The Company's effective tax rates for the six months ended June 30,
2003 and 2002 were 30% and 32% respectively. Similar to the quarterly
results, the lower effective tax rate in the current period is primarily a
result of an increase in the relative effect of the tax-exempt income and the
affordable housing tax credits noted above.
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.
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 guidelines. The Company increases
its allowance for loan losses by charging provisions for probable 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 June 30, 2003, the Company had an allowance for loan losses of $26.1
million, which represented 1.57% of total loans and 93% of non-performing
loans, compared to 1.69% and 74%, respectively, at December 31, 2002.
During the two years ended December 31, 2002, the Bank 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. However, non-performing assets decreased to
$37.1 million, or 1.48% of total assets, at June 30, 2003, compared to $42.2
million, or 1.86% of total assets, at December 31, 2002, while increasing when
compared to the $26.1 million, or 1.21% of total assets, at June 30, 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 June 30, 2003, significant changes included a $6.3 million
decrease in non-performing commercial loans and a $4.3 million decrease in
non-performing construction/land loans, partially offset by a $2.3 million
increase in non-performing commercial real-estate loans and a $3.7 million
increase in foreclosed real estate owned. At June 30, 2003, the Bank's
largest non-performing asset exposure was two related land development loans
totaling $7.0 million secured by property located in the greater Seattle,
Washington area, one of which had been converted to real estate owned at that
date. The Company's next largest position in real estate owned was a 35-unit
multifamily complex with a carrying value of $1.6 million at June 30, 2003.
The Company had six additional non-performing credit relationships with
balances in excess of $1.0 million, the largest of which had an aggregate
carrying value of $1.6 million at June 30, 2003. While meaningful progress
was made in the most recent quarter, reducing non-performing loans and
improving asset quality will be important activities to enhance the Bank's
operating performance in future periods.
20
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):
June 30 December 31 June 30
2003 2002 2002
-------- ----------- --------
Non-performing assets at end of the period:
Nonaccrual Loans:
Secured by real estate:
One- to four-family $ 1,103 $ 455 $ 757
Commercial 7,644 7,421 859
Multifamily -- -- --
Construction and land 10,326 16,030 7,102
Commercial business 7,699 9,894 10,140
Agricultural business 342 194 429
Consumer 82 255 275
-------- -------- --------
27,196 34,249 19,562
Loans more than 90 days delinquent, still on accrual:
Secured by real estate:
One- to four-family 736 343 21
Commercial - -- --
Multifamily -- -- -
Construction and land 179 1,283 --
Commercial business -- 163 --
Agricultural business 11 -- 290
Consumer -- 70 3
-------- -------- --------
926 1,859 314
-------- -------- --------
Total non-performing loans 28,122 36,108 19,876
Real estate owned, held for sale, net
(REO), and other repossessed assets 9,018 6,062 6,253
-------- -------- --------
Total non-performing assets at the end
of the period $ 37,140 $ 42,170 $ 26,129
======== ======== ========
Non-performing loans as a percentage
of total net loans before allowance
for loan losses at end of the period 1.69% 2.29% 1.27%
Non-performing assets as a percentage
of total assets at end of the period. 1.48% 1.86% 1.21%
Troubled debt restructuring (TDRs)
at end of the period $ 443 $ 2,057 $ 598
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-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 and purchase of investment securities.
During the six months ended June 30, 2003, the Company purchased loans in the
amount of $24.3 million while loan originations, net of principal repayments,
totaled $366.9 million. For the six months ended June 30, 2003, securities
purchases net of principal repayments totaled $153.3 million. This activity
was funded primarily by principal repayments on loans and securities, sales of
loans, deposit growth and borrowings. During the six months ended June 30,
2003, the Company sold $295.2 million of loans, net deposit growth was $195.1
million, FHLB advances increased $42.2 million and other borrowings increased
$812,000.
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 June 30, 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 June 30, 2003, the Bank had
outstanding loan commitments totaling $624.6 million, including undisbursed
loans in process totaling $530.1 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 $879 million. Advances under this credit facility totaled
$508.0 million, or 20% of the Bank's assets, at June 30, 2003.
At June 30, 2003, certificates of deposit amounted to $1.025 billion, or 60%
of the Bank's total deposits, including $765.0 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
21
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
June 30, 2003 and 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 June 30, 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)
June 30, 2003:
The Company consolidated
Total capital to risk-
weighted assets $218,368 11.93% $146,420 8.00% N/A N/A
Tier 1 capital to risk-
weighted assets 194,757 10.64 73,210 4.00 N/A N/A
Tier 1 leverage capital
to average assets 194,757 8.20 95,028 4.00 N/A N/A
The Bank
Total capital to risk-
weighted assets 206,108 11.27 146,251 8.00 $ 182,814 10.00%
Tier 1 capital to risk-
weighted assets 182,525 9.98 73,125 4.00 109,688 6.00
Tier 1 leverage capital
to average assets 182,525 7.69 94,942 4.00 118,678 5.00
22
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. An additional exception to
these generalizations in the current market environment has been the
beneficial effect of interest rate floors on many of the Company's floating
rate loans which have helped maintain higher loan yields despite declining
levels of market interest rates. However, in the current low interest rate
environment, management anticipates that these rate floors will decline over
time. Further, because these rate floors exceed what would otherwise be the
note rate on certain variable or floating rate loans, those loans will be less
responsive to increasing market rates than has historically been the case,
injecting an additional element of interest rate risk into the Company's
operations.
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.
23
The table of Interest Rate Risk Indicators sets forth, as of June 30, 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)
+300 908 1.1% (51,923) (27.8%)
+200 (537) (0.7%) (26,678) (14.3%)
+100 (647) (0.8%) (3,877) (2.1%)
0 0 0 0 0
-100 (1,008) (1.3%) (8,287) (4.4%)
-200 (4,422) (5.5%) (12,128) (6.5%)
- -------------
(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 June 30, 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 June 30, 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 $159,000,
representing a one-year gap to total assets ratio of 6.32%.
24
Table of Interest Sensitivity Gap
As of June 30, 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 $ 259,069 $ 7,335 $ 6,140 $ 661 $ -- $ -- $ 273,205
Fixed-rate mortgage loans 70,455 49,247 119,820 104,580 144,682 42,862 531,646
Adjustable-rate mortgage loans 213,314 57,614 80,387 36,887 3,563 -- 391,765
Fixed-rate mortgage-backed
securities 40,129 27,295 81,474 50,289 58,908 22,483 280,578
Adjustable-rate mortgage-
backed securities 54,081 -- -- -- -- -- 54,081
Fixed-rate commercial /
agriculture loans 48,256 22,427 38,924 11,083 6,169 46 126,905
Adjustable-rate commercial/
agriculture loans 269,602 6,704 6,136 6,969 332 -- 289,743
Consumer and other loans 29,453 6,484 13,156 5,289 1,683 178 56,243
Investment securities and
interest-bearing deposits 235,263 20,605 18,685 3,765 6,608 60,726 345,652
---------- -------- -------- -------- -------- -------- ----------
Total rate-sensitive
assets 1,219,622 197,711 364,722 219,523 221,945 126,295 2,349,818
---------- -------- -------- -------- -------- -------- ----------
Interest-bearing liabilities (2):
Regular savings and NOW
accounts 45,050 45,050 105,118 105,118 -- -- 300,336
Money market deposit accounts 88,316 52,990 35,327 -- -- -- 176,633
Certificates of deposit 560,968 203,985 149,619 96,535 13,607 47 1,024,761
FHLB advances 131,400 49,294 157,400 60,930 108,928 -- 507,952
Other borrowings 29,874 -- -- -- -- -- 29,874
Trust preferred 40,000 -- -- -- -- -- 40,000
Retail repurchase agreements 9,803 1,583 271 -- 483 -- 12,140
---------- -------- -------- -------- -------- -------- ----------
Total rate-sensitive
liabilities 905,411 352,902 447,735 262,583 123,018 47 2,091,696
---------- -------- -------- -------- -------- -------- ----------
Excess (deficiency) of
interest-sensitive assets
over interest-sensitive
liabilities $ 314,211 $(155,191) $(83,013) $(46,030) $ 98,927 $126,248 $ 258,122
========== ======== ======== ======== ======== ======== ==========
Cumulative excess (deficiency)
of interest-sensitive assets $ 314,211 $ 159,020 $ 76,007 $ 32,947 $131,874 $258,122 $ 258,122
========== ======== ======== ======== ======== ======== ==========
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 134.70% 112.64% 104.46% 101.67% 106.30% 112.34% 112.34%
========== ======== ======== ======== ======== ======== ==========
Interest sensitivity gap to
total assets 12.49% (6.17%) (3.30%) (1.71%) 3.93% 5.02% 10.26%
========== ======== ======== ======== ======== ======== ==========
Ratio of cumulative gap to
total assets 12.49% 6.32% 3.02% 1.31% 5.24% 10.26% 10.26%
========== ======== ======== ======== ======== ======== ==========
(footnotes on following page)
25
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
$87,000, or (3.44%) 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.
26
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)-15(e)
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 June 30, 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.
27
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 management believes 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
The annual meeting of stockholders of the Company (meeting) was held on April
24, 2003. At the meeting there were a total number of 11,338,510 shares
eligible to vote of which 9,483,965 were received or cast at the meeting. The
result of the vote on the election of directors was as follows:
The following individuals were elected as directors:
FOR WITHHELD
-------------------------- -------------------------
percentage of percentage of
# of votes shares voted # of votes shares voted
---------- ------------- ---------- -------------
Gordon E. Budke 9,404,418 99.16% 79,547 .84%
David B. Casper 9,399,737 99.11% 84,228 .89%
The terms of Directors Robert D. Adams, Jesse G. Foster, D. Michael Jones,
Dean W. Mitchell, Brent A. Orrico, Wilbur Pribilsky and Gary Sirmon continued.
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8K
(a) Exhibits
31.1 Certificates of Chief Executive Officer and Chief Financial
Officer pursuant to the Securities Exchange Act Rules 13a-15(e)
31.2 and 15d-15(e) as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 dated August 8, 200315d-15(e).
32 Certificate of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 dated August 8, 2003.
(b) Report(s) on Form 8-K filed during the quarter ended June 30, 2003, are
as follows:
Date Filed Purpose
---------- -------
April 24, 2003 Announce Banner Corporation financial results
for the quarter ended March 31, 2003.
28
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
August 8, 2003 /s/D. Michael Jones
-------------------------------------
D. Michael Jones
President and Chief Executive Officer
(Principal Executive Officer)
August 8, 2003 /s/ Lloyd W. Baker
-------------------------------------
Lloyd W. Baker
Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)
29
Exhibit 31.1
CERTIFICATION
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 officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
August 8, 2003 /s/D. Michael Jones
----------------------------
D. Michael Jones
Chief Executive Officer
30
Exhibit 31.2
CERTIFICATION
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 officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
August 8, 2003 /s/Lloyd W. Baker
----------------------------
Lloyd W. Baker
Chief Financial Officer
31
Exhibit 32
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.
August 8, 2003 /s/D. Michael Jones
------------------------------
D. Michael Jones
Chief Executive Officer
August 8, 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.
32