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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-26556
KLAMATH FIRST BANCORP, INC.
(Exact name of registrant as specified in its charter)
Oregon 93-1180440
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
540 Main Street, Klamath Falls, Oregon 97601
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (541) 882-3444
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Securities registered pursuant to
Section 12 (b) of the Act: None
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Securities registered pursuant to
Section 12 (g) of the Act: Common Stock, par value $.01 per share
- --------------------------------- --------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
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Indicate by check mark whether disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or other information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K.
YES NO X
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As of November 30, 2001, there were issued and outstanding 6,848,667 shares of
the Registrant's common stock. The Registrant's voting stock is traded
over-the-counter and is listed on the Nasdaq National Market under the symbol
"KFBI." The aggregate market value of the voting stock held by nonaffiliates of
the Registrant, based on the closing sales price of the Registrant's common
stock as quoted on the Nasdaq National Market on November 30, 2001 of $13.19,
was $72,463,051.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Registrant's Annual Report to Shareholders for the Fiscal
Year Ended September 30, 2001 ("Annual Report") (Parts I and II).
2. Portions of Registrant's Definitive Proxy Statement for the 2002 Annual
Meeting of Shareholders (Part III).
PART I
Item 1. Business
General
Klamath First Bancorp, Inc. ("Company"), an Oregon corporation, was organized on
June 16, 1995 for the purpose of becoming the holding company for Klamath First
Federal Savings and Loan Association ("Association") upon the Association's
conversion from a federal mutual to a federal stock savings and loan association
("Conversion"). The Conversion was completed on October 4, 1995. At September
30, 2001, the Company had total assets of $1.5 billion, total deposits of $1.2
billion and shareholders' equity of $114.1 million. All references to the
Company herein include the Association where applicable.
The Association was organized in 1934. The Association is regulated by the
Office of Thrift Supervision ("OTS") and its deposits are insured up to
applicable limits under the Savings Association Insurance Fund ("SAIF") of the
Federal Deposit Insurance Corporation ("FDIC"). The Association also is a member
of the Federal Home Loan Bank ("FHLB") System through the FHLB of Seattle.
In July 1997, the Association acquired 25 former First Interstate Bank branches
from Wells Fargo Bank, N.A. The branches are located in rural communities
throughout Oregon, expanding and complementing the then existing network of the
Association's branches. The acquisition was accounted for as a purchase and
resulted in the addition of approximately $241.3 million in deposits on the
acquisition date of July 18, 1997.
In September 2001, the Association acquired 13 branches from Washington Mutual
Bank ("WAMU"), 11 of which are located on the northern and southern Oregon coast
and two of which are located in northeastern Oregon. These locations enhance the
Association's geographic coverage on the coast and in northeastern Oregon. The
acquisition was accounted for as a purchase and resulted in the addition of
approximately $179.3 million in loans, assumption of $423.5 million in deposits,
and addition of 124 experienced branch personnel on the acquisition date of
September 7, 2001. As part of the purchase, the Company also recorded $15.0
million of core deposit intangible and $24.1 million of other intangible assets.
See Note 2 of the Notes to Consolidated Financial Statements contained in the
Annual Report and the Form 8-K/A filed on November 21, 2001.
The Association is a progressive, community-oriented financial institution that
focuses on customer service within its primary market area. Accordingly, the
Association is primarily engaged in attracting deposits from the general public
through its offices and using those and other available sources of funds to
originate permanent residential one- to four-family real estate loans within its
market area, as well as commercial real estate and multi-family residential
loans, loans to consumers, and loans for commercial purposes. At September 30,
2001, permanent residential one- to four-family real estate loans totaled $421.5
million, or 60.12% of total loans. While the Association has historically
emphasized fixed rate mortgage lending, it has been diversifying its loan
portfolio by focusing on increasing the number of originations of commercial
real estate loans, multi-family residential loans, residential construction
loans, small business loans and non-mortgage consumer loans. Significant
progress was made toward increasing the commercial and consumer loans in the
portfolio with the purchase of the branches from WAMU. These newer loan products
generally carry adjustable rates, higher yields, or shorter terms than the
traditional fixed rate mortgages. This lending strategy is designed to enhance
earnings, reduce interest rate risk, and provide a more complete range of
financial services to customers and the local communities served by the
Association. At September 30, 2001, the Association's total loan portfolio
consisted of 70.57% fixed rate and 29.43% adjustable rate loans, after deducting
loans in process and non-performing loans.
Announcement of Stock Repurchase
In September 2001, the Company announced its intention to repurchase 5% of its
outstanding common stock, or approximately 340,800 shares, to be accomplished
through the open market over a twelve month period. As of November 30, 2001, the
Company had repurchased 217,000 shares, or 63.67% of the planned shares, at a
weighted average price of $13.18.
Market Area
As a result of the branch acquisition in 2001, the Association's market area
expanded to include 53 locations in 26 of Oregon's 36 counties. In addition to
the 13 branches acquired from WAMU, new in-store branches have been opened in
Pendleton and Ontario, Oregon and Kennewick and Richland, Washington. During
2001, a new branch was also completed in Redmond, Oregon, providing more
complete service to that community than the previously operated loan center. The
Association's primary market area, which encompasses the State of Oregon and
some adjacent areas of California, Idaho, and Washington, can be characterized
as a predominantly rural area containing a number of communities that are
experiencing moderate to rapid population growth. The population growth in the
market area, particularly in Southern Oregon, has been supported in large part
by the agreeable climate, and by favorable real estate values. The economy of
the market area is still based primarily on agriculture and lumber and wood
products, but is experiencing diversification into light manufacturing, health
care and other services, and other sectors. Tourism is a significant industry in
many regions of the market area including Central Oregon and the Oregon coast.
Yields Earned and Rates Paid
The following table sets forth, for the periods and at the date indicated, the
weighted average yields earned on interest-earning assets, the weighted average
interest rates paid on interest-bearing liabilities, and the interest rate
spread between the weighted average yields earned and rates paid.
At Year Ended
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September 30, September 30,
2001 2001 2000 1999
----- ----- ----- -----
Weighted average yield:
Loans receivable................................................ 7.92% 7.86% 7.64% 7.80%
Mortgage-backed and related securities.......................... 5.74 6.02 5.86 5.50
Investment securities........................................... 5.58 5.64 6.00 5.88
Federal funds sold.............................................. 3.27 4.13 5.59 4.93
Interest-earning deposits....................................... 2.81 4.06 5.63 4.75
FHLB stock...................................................... 7.00 6.75 6.69 7.50
Combined weighted average yield on
interest-bearing assets........................................... 6.71 6.99 7.22 7.25
----- ----- ----- -----
Weighted average rate paid on:
Tax and insurance reserve....................................... 1.29 3.85 2.02 2.07
Passbook and statement savings.................................. 2.05 2.26 1.78 2.15
Interest-bearing checking. . . . . . . . . . . ................. 1.37 1.08 1.12 1.23
Money market . . . ............................................ 3.21 3.85 4.17 3.87
Certificates of deposit......................................... 5.32 5.76 5.40 5.38
FHLB advances/Short term borrowings............................. 5.73 5.95 5.90 5.26
Combined weighted average rate on
interest-bearing liabilities...................................... 4.44 4.81 4.72 4.52
----- ----- ----- -----
Interest rate spread............................................... 2.27% 2.18% 2.50% 2.73%
===== ===== ===== =====
Average Balances, Net Interest Income and Yields Earned and Rates Paid
Reference is made to the section entitled "Average Balances, Net Interest Income
and Yields Earned and Rates Paid" on page 16 of the 2001 Annual Report to
Shareholders ("Annual Report")included as Exhibit 13 to this Form 10- K, which
section is incorporated herein by reference.
Interest Sensitivity Gap Analysis
Reference is made to the section entitled "Interest Sensitivity Gap Analysis" on
page 13 of the Annual Report, which section is incorporated herein by reference.
Rate/Volume Analysis
Reference is made to the section entitled "Rate/Volume Analysis" on page 17 of
the Annual Report, which section is incorporated herein by reference.
Lending Activities
General. As a federally chartered savings and loan association, the Association
has authority to originate and purchase loans secured by real estate located
throughout the United States. Notwithstanding this nationwide lending authority,
over 65% of the mortgage loans in the Association's portfolio are secured by
properties located in Klamath, Jackson and Deschutes counties in Southern and
Central Oregon. With the expanded market area provided by the branch
acquisitions in 1997 and 2001, the Association's mortgage lending has
diversified throughout the state of Oregon. It is management's intention,
subject to market conditions, that the Association will continue to originate
long-term mortgage loans for the purchase, construction or refinance of one- to
four-family residential real estate to meet the needs of customers in our market
area. However, to enhance interest income and reduce interest rate risk, the
Association is placing increased emphasis on the origination or purchase of
adjustable rate loans secured by one- to four- family residential, multi-family
residential and commercial real estate, the majority of which are located
outside Klamath, Jackson, and Deschutes counties. Subject to market conditions,
the Association sells loans to Fannie Mae (formerly the Federal National
Mortgage Association) and other agents.
Permanent residential one- to four-family mortgage loans amounted to $421.5
million, or 60.12%, of the Association's total loan portfolio before net items,
at September 30, 2001. The Association originates other loans secured by
multi-family residential and commercial real estate, construction and land
loans. Those loans amounted to $152.2 million, or 21.71%, of the total loan
portfolio, before net items, at September 30, 2001. Approximately 18.17%, or
$127.4 million, of the Association's total loan portfolio, before net items, as
of September 30, 2001, consisted of non-real estate loans. Commercial real
estate and non-real estate loans increased significantly as a result of the WAMU
branch acquisition. The acquisition included $179.3 million in loans of which
$118.8 million were commercial real estate and commercial business loans and
$50.7 million were consumer loans.
Permissible loans-to-one borrower by the Association are generally limited to
15% of unimpaired capital and surplus. The Association's loan-to-one borrower
limitation was $17.8 million at September 30, 2001. At September 30, 2001, the
Association had 52 borrowing relationships with outstanding balances in excess
of $1.0 million, the largest of which amounted to $5.4 million and consisted of
seven loans, five of which were secured by commercial and single family real
estate and two of which are unsecured.
The Association has emphasized the origination or purchase of adjustable rate
loans in order to increase the interest rate sensitivity of its loan portfolio.
The Association has been successful in expanding the production of adjustable
rate consumer loans and has purchased adjustable rate single family,
multi-family residential and non- residential real estate loans. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- Market Risk and Asset/Liability Management" and
"INTEREST SENSITIVITY GAP ANALYSIS" in the Annual Report. At September 30, 2001,
$203.7 million, or 29.43%, of loans in the Association's total loan portfolio,
after loans in process and non-performing loans, consisted of adjustable rate
loans. At September 30, 2000, $78.6 million, or 10.62%, of the Association's
loans carried adjustable rates. The dramatic increase in adjustable rate loans
is primarily attributable to the portfolio of loans acquired with the WAMU
branches.
Loan Portfolio Analysis. The following table sets forth the composition of the
loan portfolio by type of loan at the dates indicated.
At September 30,
---------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
--------------- --------------- --------------- --------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(Dollars in thousands)
Real estate loans:
Permanent residential
one- to four-family $421,499 60.12% $639,165 85.12% $647,130 83.56% $577,471 81.95% $498,595 86.47%
Multi-family residential 23,257 3.32 19,015 2.53 18,412 2.38 19,230 2.73 16,881 2.93
Construction 21,674 3.09 25,289 3.37 53,219 6.87 64,289 9.12 30,487 5.29
Agricultural 4,218 0.60 -- -- -- -- -- -- -- --
Commercial 99,318 14.17 42,277 5.63 37,079 4.79 29,457 4.18 22,639 3.93
Land 3,697 0.53 3,394 0.45 2,064 0.27 2,185 0.31 1,586 0.27
------- ------- ------- ------ ------- ------- ------- ------ ------- ------
Total real estate loans 573,663 81.83 729,140 97.10 757,904 97.87 692,632 98.29 570,188 98.89
------- ------- ------- ------ ------- ------- ------- ------ ------- ------
Non-real estate loans:
Savings accounts 2,091 0.30 1,957 0.26 1,800 0.23 1,991 0.28 1,711 0.30
Home improvement and 50,464 7.20 8,338 1.11 6,726 0.87 5,750 0.82 3,486 0.60
home equity loans
Other consumer 18,697 2.67 6,888 0.92 4,568 0.59 2,287 0.32 1,148 0.20
Commercial 56,098 8.00 4,586 0.61 3,443 0.44 2,043 0.29 42 0.01
------- ------- ------- ------ ------- ------- ------- ------ ------- ------
Total non-real estate loans 127,350 18.17 21,769 2.90 16,537 2.13 12,071 1.71 6,387 1.11
------- ------- ------- ------ ------- ------- ------- ------ ------- ------
Total loans 701,013 100.00% 750,909 100.00% 774,441 100.00% 704,703 100.00% 576,575 100.00%
======= ====== ======= ====== ======
Less:
Undisbursed portion of loans 8,473 10,350 24,176 26,987 17,096
Deferred loan fees 4,599 7,440 7,988 7,620 6,358
Allowance for loan losses 7,951 4,082 2,484 1,950 1,296
------- ------- ------- ------- -------
Net loans $679,990 $729,037 $739,793 $668,146 $551,825
======= ======= ======= ======= =======
The following table sets forth the amount of fixed-rate and adjustable rate
loans, net of loans in process and non-performing loans, included in the total
loan portfolio at the dates indicated.
At September 30,
--------------------------------------------------
2001 2000
----------------------- -------------------------
Amount Percent Amount Percent
------- ------- ------- -------
(Dollars in thousands)
-------- ------- -------- -------
Fixed rate . . . . . $488,559 70.57% $661,160 89.38%
Adjustable-rate... 203,719 29.43 78,598 10.62
-------- ------- -------- -------
Total........ $692,278 100.00% $739,758 100.00%
======== ======= ======== =======
Permanent Residential One- to Four-Family Mortgage Loans. The primary lending
activity of the Association has been the origination of permanent residential
one- to four-family mortgage loans. Management believes that this policy of
focusing on single-family residential mortgage loans has been successful in
contributing to interest income while keeping delinquencies and losses to a
minimum. At September 30, 2001, $421.5 million, or 60.12%, of the Association's
total loan portfolio, before net items, consisted of permanent residential one-
to four-family mortgage loans, down from $639.2 million at September 30, 2000.
The decrease in one- to four-family mortgages resulted primarily from the sale
and securitization of $190.3 million of such loans in February 2001. At
September 30, 2001, the average balance of the Association's permanent
residential one- to four-family mortgage loans was $77,957.
The Association presently originates both fixed-rate mortgage loans and
adjustable rate mortgages ("ARMs") secured by one- to four-family properties
with terms of 15 to 30 years. Historically, most of the loans originated by the
Association have been fixed rate loans secured by one- to four-family
properties. At September 30, 2001, $386.4 million, or 55.82%, of the total loans
after loans in process and non-performing loans were fixed rate one- to
four-family loans and $37.5 million, or 5.42%, were ARM loans. Borrower demand
for ARM loans versus fixed-rate mortgage loans is a function of the level of
interest rates, the expectations of changes in the level of interest rates and
the difference between the initial interest rates and fees charged for each type
of loan. The relative amount of fixed-rate mortgage loans and ARM loans that can
be originated at any time is largely determined by the demand for each in a
competitive environment. In order to improve interest rate risk, the Association
sells the majority of its conforming fixed rate one- to four-family mortgage
production.
The Association qualifies the ARM loan borrower based on the borrower's ability
to repay the loan using the fully indexed rate. As a result, the Association
believes that the potential for delinquencies and defaults on ARM loans when
rates adjust upwards is lessened.
The loan fees charged, interest rates and other provisions of the Association's
ARM loans are determined by the Association on the basis of its own pricing
criteria and competitive market conditions. At September 30, 2001, the
Association charged origination fees ranging from 1.00% to 1.75% on its ARM
loans.
In an attempt to increase adjustable rate mortgages in the loan portfolio, the
Association uses below market "teaser" rates which are competitive with other
institutions originating mortgages in the Association's primary market area.
Initially, ARM loans are priced at the competitive teaser rate and after one
year reprice at 2.875% over the One-Year Constant Maturity Treasury Bill Index,
with a maximum increase or decrease of 2.00% in any one year and 6.00% over the
life of the loan. The Association has also introduced variable rate loan
products that bear fixed rates for the first three or five years and then
reprice annually thereafter. As a supplement to origination of ARM loans, the
Association purchases ARMs from other institutions when suitable loans can be
found which meet its underwriting criteria.
The retention of ARM loans in the Association's loan portfolio helps reduce the
Association's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased costs due
to changed rates to be paid by the customer. It is possible that, during periods
of rising interest rates, the risk of default on ARM loans may increase as a
result of repricing with increased costs to the borrower. The ARM loans
originated by the Association generally provide, as a marketing incentive, for
initial rates of interest below the rates which would apply were the adjustment
index used for pricing initially (discounting). Increased risks of default or
delinquency could occur because of discounting the rate. Another consideration
is that although ARM loans allow the Association to increase the sensitivity of
its asset base to changes in the interest rates, the extent of this interest
sensitivity is limited by the periodic and lifetime interest rate adjustment
limits. Because of these considerations, the Association has no assurance that
yields on ARM loans will be sufficient to offset increases in the Association's
cost of funds.
The loan-to-value ratio, maturity and other provisions of the loans made by the
Association generally have reflected the policy of making loans in accordance
with sound lending practices, market conditions and underwriting standards
established by the Association. The Association's lending policies on permanent
residential one- to four-family mortgage loans generally limit the maximum
loan-to-value ratio to 97% of the lesser of the appraised value or purchase
price of the property. All permanent residential one- to four-family mortgage
loans in excess of an 80% loan-to-value ratio require private mortgage
insurance.
The Association also has a limited amount of non-owner-occupied permanent
residential one- to four-family mortgage loans in its portfolio. These loans are
underwritten using generally the same criteria as owner-occupied permanent
residential one- to four-family mortgage loans, except that the maximum
loan-to-value ratio is generally 80% of the lesser of the appraised value or
purchase price of the property and such loans are generally provided at an
interest rate higher than owner-occupied loans.
The Association offers fixed-rate, permanent residential one- to four-family
mortgage loans with terms of 15 to 30 years. Substantially all permanent one- to
four-family loans have original contractual terms to maturity of 30 years. Such
loans are amortized on a monthly basis with principal and interest due each
month and customarily include "due-on-sale" clauses. The Association enforces
due-on-sale clauses to the extent permitted under applicable laws. Substantially
all of the Association's mortgage loan portfolio consists of conventional loans.
Historically, the Association has not originated significant amounts of mortgage
loans on second residences. However, with the branch offices in Bend and
Redmond, located near popular ski areas and other outdoor activities, and the
concentration of branches along the Oregon coast, also located in an
increasingly popular resort and vacation area, the Association believes that
there is an opportunity to engage in such lending within the parameters of its
current underwriting policies. At September 30, 2001, $4.3 million, or 0.62%, of
the Association's loan portfolio consisted of loans on second homes.
Commercial and Multi-Family Real Estate Loans. The Association has historically
engaged in a limited amount of multi-family and commercial real estate lending.
The Association purchases participations in loans secured by multi-family and
commercial real estate in order to increase the balance of adjustable rate loans
in the portfolio. See "-- Loan Originations, Purchases, and Sales." At September
30, 2001, $23.3 million, or 3.32%, of the Association's total loan portfolio,
before net items, consisted of loans secured by existing multi-family
residential real estate and $99.3 million, or 14.17%, of the Association's total
loan portfolio, before net items, consisted of loans secured by existing
commercial real estate. The Association's commercial and multi-family real
estate loans primarily include loans secured by office buildings, small shopping
centers, churches, mini-storage warehouses and apartment buildings. All of the
Association's commercial and multi-family real estate loans are secured by
properties located in the Association's primary market area. The average
outstanding balance of commercial and multi-family real estate loans was
$272,390 at September 30, 2001, the largest of which was a $4.7 million
commercial real estate loan secured by a grocery store. This loan has performed
in accordance with its terms since origination. Originations of commercial real
estate and multi-family residential real estate amounted to 16.46%, 11.09%, and
5.74% of the Association's total loan originations in the fiscal years ended
September 30, 2001, 2000, and 1999, respectively. As part of the WAMU
acquisition in September 2001, the Association purchased $9.1 million in
multi-family residential loans and $54.6 million in commercial real estate
loans. During the year ended September 30, 2000 the Association purchased
$507,600 in commercial real estate participations.
The Association's commercial and multi-family loans generally have terms which
range up to 25 years and loan-to-value ratios of up to 75%. The Association
currently originates fixed and adjustable rate commercial and multi-family real
estate loans. Commercial real estate and multi-family adjustable rate loans are
priced to be competitive with other commercial lenders in the Association's
market area. A variety of terms are available to meet specific commercial and
multi-family residential financing needs. As of September 30, 2001, $100.1
million, or 14.46%, after loans in process and non-performing loans, of other
mortgage loans, including commercial and multi-family residential real estate
loans, had adjustable rates of interest.
Multi-family residential and commercial real estate lending is generally
considered to involve a higher degree of risk than permanent residential one- to
four-family lending. Such lending typically involves large loan balances
concentrated in a single borrower or groups of related borrowers. In addition,
the payment experience on loans secured by income-producing properties is
typically dependent on the successful operation of the related real estate
project and thus may be subject to a greater extent to adverse conditions in the
real estate market or in the economy generally. The Association generally
attempts to mitigate the risks associated with multi-family residential and
commercial real estate lending by, among other things, lending on collateral
located in its market area and following strict underwriting standards. Loans
considered for purchase are subjected to the same underwriting standards as
those originated in-house.
Construction Loans. The Association makes all-in-one construction loans
(construction loans that convert to permanent financing) to individuals for the
construction of their single-family residences. The Association also makes loans
to builders for the construction of single-family residences which are not
presold at the time of origination ("speculative loans") and for construction of
commercial properties. Permanent construction loans generally begin to amortize
as permanent residential one- to four-family mortgage loans within one year of
origination unless extended. Speculative loans are scheduled to pay off in 12 to
18 months. At September 30, 2001, construction loans amounted to $21.7 million
(including $7.6 million of speculative loans), or 3.09%, of the Association's
total loan portfolio before net items. The Company purchased $1.7 million in
commercial construction loans from WAMU as part of the branch purchase. Much of
the Association's speculative construction lending had been in the Portland,
Oregon market. There was a softening of the market due to rising interest rates
and oversupply in that market early in fiscal year 2000. As a result,
construction loan volumes decreased significantly during the years ended
September 30, 2001 and 2000. Permanent construction loans have rates and terms
which generally match the non-construction loans then offered by the
Association, except that during the construction phase, the borrower pays only
interest on the loan. The Association's construction loan agreements generally
provide that loan proceeds are disbursed in increments as construction
progresses. The Association periodically reviews the progress of the underlying
construction project through physical inspections. Permanent construction loans
are underwritten pursuant to the same general guidelines used for originating
permanent one- to four-family loans. Permanent construction lending is generally
limited to the Association's primary market area.
Construction financing is generally considered to involve a higher degree of
risk of loss than financing on improved, owner-occupied real estate because of
the uncertainties of construction, including the possibility of costs exceeding
the initial estimates and, in the case of speculative loans, the need to obtain
a purchaser. The Association has sought to minimize the risks associated with
permanent construction lending by limiting construction loans to qualified
owner-occupied borrowers with construction performed by qualified state licensed
builders located primarily in the Association's market area. The Association
also originates construction loans in the Portland, Oregon metropolitan area
through mortgage brokers. These loans are underwritten using the same standards
as loans from the branch locations.
The Association's underwriting criteria are designed to evaluate and minimize
the risks of each construction loan. Interim construction loans are qualified at
permanent rates in order to ensure the capability of the borrower to repay the
loan.
Loan proceeds are disbursed only as construction progresses and inspections
warrant. These loans are underwritten to the same standards and to the same
terms and requirements as one- to four-family purchase mortgage loans, except
the loans provide for disbursement of funds during a construction period of up
to one year. During this period, the borrower is required to make monthly
payments of accrued interest on the outstanding loan balance. Disbursements
during the construction period are limited to no more than the percent of
completion. Up to 97% loan-to-value upon completion of construction may be
disbursed if private mortgage insurance above 80% loan-to-value is in place.
Land Loans. The Association makes loans to individuals for the purpose of
acquiring land upon which to build their permanent residence. These loans
generally have 20 year amortization periods, with a balloon payment due in five
years, and maximum loan-to-value ratios of 80%. As of September 30, 2001, $3.7
million, or 0.53%, of the Association's total loan portfolio consisted of land
loans.
Commercial Business Lending. With the purchase of the branches from WAMU,
commercial business loans increased significantly. The Association's commercial
business lending activities focuses primarily on small to medium size businesses
owned by individuals well known to the Association and who reside in the
Association's primary market area. At September 30, 2001, commercial business
loans amounted to $56.1 million, or 8.00% of the total loan portfolio and 44.05%
of total non-real estate loans. Included in these loans are $11.9 million of
agricultural loans. See "-- Agricultural Lending."
Commercial business loans may be unsecured loans, but generally are secured by
various types of business collateral other than real estate (such as, inventory,
equipment, etc.). In many instances, however, such loans are often also secured
by junior liens on real estate. Lines of credit are generally renewable and made
for a one-year term and are generally variable rate indexed to the prime rate.
Term loans are generally originated with three to five year maturities, with a
maximum of seven years, on a fully amortizing basis. As with commercial real
estate loans, the Association generally requires annual financial statements
from its commercial business borrowers and, if the borrower is a corporation,
personal guarantees from the principals.
Commercial business lending generally involves greater risk than residential
mortgage lending and involves risks that are different from those associated
with residential, commercial and multi-family real estate lending. Real estate
lending is generally considered to be collateral based lending with loan amounts
based on predetermined loan to collateral values and liquidation of the
underlying real estate collateral is viewed as the primary source of repayment
in the event of borrower default. Although commercial business loans are often
collateralized by equipment, inventory, accounts receivable or other business
assets, the liquidation of collateral in the event of a borrower default is
often not a sufficient source of repayment because accounts receivable may be
uncollectible and inventories and equipment may be obsolete or of limited use,
among other things. Accordingly, the repayment of a commercial business loan
primarily depends on the creditworthiness of the borrower (and any guarantors),
while liquidation of collateral is a secondary and sometimes insufficient source
of repayment.
As part of its commercial business lending activities, the Association issues
standby letters of credit or performance bonds as an accommodation to its
borrowers.
Agricultural Lending. Historically, the Association has not offered loans on
agricultural properties or for agricultural production, even though agriculture
is a major industry in the Association's market area. As part of the WAMU branch
acquisition, the Company purchased $4.2 million of agricultural real estate
loans and $11.9 million of agricultural production loans. At September 30, 2001,
agricultural loans amounted to $16.1 million, or 2.33%, of the total loan
portfolio; $4.2 million of these loans were secured by real estate.
In underwriting agricultural operating loans, the Association considers the cash
flow of the borrower based upon the expected income stream as well as the value
of collateral used to secure the loan. Collateral generally consists of
livestock or cash crops produced by the farm, such as grains, corn, and alfalfa.
In addition to considering cash flow and obtaining a blanket security interest
in the farm's cash crop, the Association may also collateralize an operating
loan with the equipment, breeding stock, real estate, and federal agricultural
program payments to the borrower.
Agricultural real estate loans primarily are secured by first liens on farmland
and improvements thereon located in the Association's market area, to service
the needs of the Association's existing customers.
Among the greater and more common risks to agricultural lending can be weather
conditions and disease. These risks can be mitigated through multi-peril crop
insurance. During the last fiscal year, water reservoir supplies in the
Association's market area have been down 30% to 70% compared to historical
averages. The lack of water has the potential to decrease yields and increase
energy costs for the Association's borrowers. However, very few of the
Association's agricultural loans are secured by real estate or operations in the
Klamath Basin, which was affected by curtailment of irrigation water during the
summer of 2001, and those being financed have liquid secondary sources of
repayment. Commodity prices also present a risk which may be reduced by the use
of set price contracts.
Federal savings and loan associations are authorized to make loans secured by
business or agricultural real estate in amounts up to 400% of capital and to
make additional loans to businesses and farms (which may, but need not be
secured by real estate) in amounts up to 20% of assets provided that all loans
in excess of the 10% of assets must be made to small businesses and farms that
qualify as small businesses. Effective January 1, 2002 the OTS increased the
dollar amount limit in the definition of small business loans from $1 million to
$2 million and farm loans from $500,000 to $2 million. As of September 30, 2001,
the Association is well within the regulatory limits for such business loans.
Consumer and Other Lending. The Association originates a variety of consumer
loans. Such loans generally have shorter terms to maturity and higher interest
rates than mortgage loans. At September 30, 2001, the Association's consumer
loans totaled approximately $71.3 million, or 10.17%, of the Association's total
loans. A total of $50.6 million in consumer loans were added to the portfolio as
part of the WAMU branch acquisition. The Association's consumer loans consist
primarily of home improvement and equity loans, automobile loans, boat and
recreational vehicle loans, unsecured loans, and deposit account loans.
In recent periods, the Association has emphasized the origination of consumer
loans due to their shorter terms and higher yields than residential mortgage
loans. The Association anticipates that it will continue to be an active
originator of these loans. Factors that may affect the ability of the
Association to increase its originations in this area include the demand for
such loans, interest rates and the state of the local and national economy.
The Association offers open-ended "preferred" lines of credit on either a
secured or unsecured basis. Secured lines of credit are generally secured by a
second mortgage on the borrower's primary residence. Secured lines of credit
have an interest rate that is one to two percentage points above the prime
lending rate while the rate on unsecured lines is two to three percentage points
above this prime lending rate. In both cases, the rate adjusts monthly. The
Association requires repayment of at least 2% of the unpaid principal balance
monthly. At September 30, 2001, $4.5 million was outstanding on approved lines
of credit.
The Association offers home equity and home improvement loans that are made on
the security of primary residences. Loans normally have terms of up to 15 years
requiring monthly payments of principal and interest. At September 30, 2001,
home equity loans and home improvement loans amounted to $50.5 million, or
70.82% of consumer loans, and 7.20% of total loans.
At September 30, 2001, the Association's automobile loan portfolio amounted to
$9.5 million, or 13.37%, of consumer loans and 1.36% of total loans at such
date. The maximum term for the Association's automobile loans is 72 months with
the amount financed based upon a percent of purchase price. The Association
generally requires all borrowers to maintain the automobile insurance, including
collision, fire and theft, with a maximum allowable deductible and with the
Association listed as loss payee.
At September 30, 2001, unsecured consumer loans amounted to $848,816, or less
than 1%, of total loans. These loans are made for a maximum of 36 months or less
with fixed rates of interest and are offered primarily to existing customers of
the Association.
Consumer loans potentially have a greater risk than do residential mortgage
loans, particularly in the case of loans that are unsecured or secured by
rapidly depreciating assets such as automobiles and other vehicles. In such
cases, any repossessed collateral for a defaulted consumer loan may not provide
an adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining deficiency
often does not warrant further substantial collection efforts against the
borrower beyond obtaining a deficiency judgment. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Furthermore, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount that can be recovered on such loans. At September 30, 2001, the
Association had no consumer loans accounted for on a nonaccrual basis.
Loan Maturity and Repricing. The following table sets forth certain information
at September 30, 2001 regarding the dollar amount of total loans, after loans in
process and non-performing loans, maturing in the Association's portfolio, based
on the contractual terms to maturity or repricing date. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and overdrafts
are reported as due in one year or less.
After One Year
Within One Year Through 5 Years After 5 Years Total
--------------- --------------- ------------- ---------
(In thousands)
Permanent residential
one- to four-family:
--------- -------- -------- --------
Adjustable rate.......... $22,500 $ 15,045 $ -- $ 37,545
Fixed rate............... 1,762 2,715 381,929 386,406
Other mortgage loans:
Adjustable rate.......... 30,039 68,442 1,640 100,121
Fixed rate............... 3,902 11,581 25,993 41,476
Non-real estate loans:
Adjustable rate......... 55,383 10,649 21 66,053
Fixed rate.............. 4,934 19,099 36,644 60,677
--------- -------- -------- --------
Total loans............ $118,520 $127,531 $446,227 $692,278
========= ======== ======== ========
Scheduled contractual amortization of loans does not reflect the actual term of
the Association's loan portfolio. The average life of loans is substantially
less than their contractual terms because of prepayments and due-on-sale
clauses, which gives the Association the right to declare a conventional loan
immediately due and payable in the event, among other things, that the borrower
sells the real property subject to the mortgage and the loan is not repaid.
The dollar amount of all loans, net of loans in process and non-performing
loans, due one year after September 30, 2001, which have fixed interest rates
and have adjustable rates, was $478.0 million and $95.8 million, respectively.
Loan Commitments. The Association issues commitments for fixed and adjustable
rate loans conditioned upon the occurrence of certain events. Such commitments
are made on specified terms and conditions and are honored for up to 45 days
from commitment. The Association had outstanding loan commitments of
approximately $20.8 million at September 30, 2001 consisting of $5.8 million of
variable rate loans and $15.0 million of fixed rate loans. See Note 14 of Notes
to the Consolidated Financial Statements contained in the Annual Report.
Loan Solicitation and Processing. The Association originates real estate and
other loans at each of its offices. Loan originations are obtained by a variety
of sources, including mortgage brokers, developers, builders, existing
customers, newspapers, radio, periodical advertising and walk-in customers,
although referrals from local realtors has been the primary source. Loan
applications are taken by lending personnel, and the loan processing department
obtains credit reports, appraisals and other documentation involved with a loan.
All of the Association's lending is subject to its written nondiscriminatory
underwriting standards, loan origination procedures and lending policies
prescribed by the Association's Board of Directors. Property valuations are
required on all real estate loans and are prepared by employees experienced in
the field of real estate or by independent appraisers approved by the
Association's Board of Directors. Additionally, all appraisals on loans in
excess of $250,000 must meet applicable regulatory standards.
The Association's loan approval process is intended to assess the borrower's
ability to repay the loan, the viability of the loan, the adequacy of the value
of the property that will secure the loan, and, in the case of commercial and
multi-family real estate loans, the cash flow of the project and the quality of
management involved with the project. The Association generally requires title
insurance on all loans and also that borrowers provide evidence of fire and
extended casualty insurance in amounts and through insurers that are acceptable
to the Association. A loan application file is first reviewed by a loan officer
of the Association, then is submitted to underwriting and finally is presented
to the loan committee for approval. The Association can generally make loan
commitments, subject to property valuation and possible other conditions of
approval, in three to five days if income and credit data of the borrower are
readily available.
Loan Originations, Purchases and Sales. The Association has originated a
majority of the loans in its portfolio. During the year ended September 30,
2001, the Association originated $136.5 million in total loans, compared to
$97.2 million in the same period of 2000. The higher level of loan originations
was attributable to decreasing interest rates and the expansion of the branch
network. The Association has a program to sell loans to Fannie Mae and other
lenders. Through this program, $30.7 million in fixed rate loans were sold
during the year ended September 30, 2001, all of which were one- to four-family
mortgages. Servicing was retained on the loans sold to Fannie Mae and was
released on loans sold to other brokers. Also during the year ended September
30, 2001, the Company securitized $190.3 million of fixed rate single family
mortgages through Fannie Mae. Servicing was retained on these loans.
As noted previously, the Association purchased $179.3 million in loans from WAMU
as part of the branch acquisition. The Association has also purchased permanent
residential one- to four-family mortgage loans on detached residences from
various localities throughout the Western United States, primarily Oregon,
Washington, and California. These loans were underwritten on the same basis as
permanent residential one- to four-family real estate loans originated by the
Association. At September 30, 2001, the balance of such loans was $7.3 million.
The Association also purchases multi-family and commercial real estate mortgage
loans secured by properties within the Association's primary market area. At
September 30, 2001, the balance of such purchased loans was $13.1 million. These
loans were underwritten on the same basis as similar loans originated by the
Association.
The following table shows total loans originated, purchased and sold, loan
reductions and the net increase in the Association's loans during the periods
indicated.
Year Ended September 30,
-------------------------------------
2001 2000 1999
--------- --------- ---------
(In thousands)
Total net loans at beginning of period...... $729,037 $739,793 $668,146
--------- --------- ---------
Loans originated and purchased:
Real estate loans originated (1)........... 93,907 81,671 209,723
Real estate loans purchased................ 83,192 508 15,500
Non-real estate loans originated........... 42,586 15,575 14,471
Non-real estate loans purchased............ 99,720 -- --
--------- --------- ---------
Total loans originated................... 319,405 97,754 239,694
--------- --------- ---------
Loan reductions:
Principal paydowns......................... (145,544) (98,853) (159,161)
Loans sold................................. (30,709) (6,315) (5,584)
Loans securitized.......................... (190,300) -- --
Other reductions (2)....................... (1,899) (3,342) (3,302
--------- --------- ---------)
Total loan reductions................... (368,452) (108,510) (168,047)
--------- --------- ---------
Total net loans at end of period............ $679,990 $729,037 $739,793
========= ========= =========
(1) Includes decreases/increases from loans-in-process.
(2) Includes net reductions due to deferred loans fees, discounts net of amortization,
provision for loan loss and transfers to real estate owned.
Loan Origination and Other Fees. In addition to interest earned on loans, the
Association receives loan origination fees or "points" for originating loans.
Loan points are a percentage of the principal amount of the real estate loan and
are charged to the borrower in connection with the origination of the loan. The
amount of points charged by the Association varies, though it generally is 1.00%
on permanent loans and 1.75% on construction loans.
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 91,
which deals with the accounting for non-refundable fees and costs associated
with originating or acquiring loans, the Association's loan origination fees and
certain related direct loan origination costs are offset, and the resulting net
amount is deferred and amortized as income over the contractual life of the
related loans as an adjustment to the yield of such loans, or until the loan is
paid in full. At September 30, 2001, the Association had $4.6 million of net
loan fees which had been deferred and are being recognized as income over the
contractual maturities of the related loans.
Asset Quality
Delinquent Loans. The following table sets forth information concerning
delinquent loans at September 30, 2001, in dollar amount and as a percentage of
the Association's total loan portfolio. The amounts presented represent the
total outstanding principal balances of the related loans, rather than the
actual payment amounts which are past due.
Permanent residential
1-4 family Construction Non-Real Estate Total
------------------- ------------------- ------------------- -------------------
Amount Percentage Amount Percentage Amount Percentage Amount Percentage
------ ---------- ------ ---------- ------ ---------- ------ ----------
(Dollars in thousands)
Loans delinquent
for 90 days and more..... $270 0.04% $ -- --% $-- --% $270 0.04%
Delinquency Procedures. When a borrower fails to make a required payment on a
loan, the Association attempts to cure the delinquency by contacting the
borrower. In the case of loans past due, appropriate late notices are generated
on the seventh and fifteenth days after the due date. If the delinquency is not
cured, the borrower is contacted by telephone the twenty-fifth day after the
payment is due.
For real estate loans, in the event a loan is past due for 30 days or more, the
Association will attempt to arrange an in-person interview with the borrower to
determine the nature of the delinquency; based upon the results of the interview
and its review of the loan status, the Association may negotiate a repayment
program with the borrower. If a loan remains past due at 60 days, the
Association performs an in-depth review of the loan status, the condition of the
property and the circumstances of the borrower. If appropriate, an alternative
payment plan is established. At 90 days past due, a letter prepared by the
Association is sent to the borrower describing the steps to be taken to collect
the loan, including acceptance of a voluntary deed-in-lieu of foreclosure, and
of the initiation of foreclosure proceedings. A decision as to whether and when
to initiate foreclosure proceedings is made by senior management, with the
assistance of legal counsel, at the direction of the Board of Directors.
For consumer loans, at 60 days past due a letter demanding payment is sent to
the borrower. If the delinquency is not cured prior to becoming 90 days past
due, repossession procedures are implemented for collateralized loans. At 90
days past due, consumer loans are generally charged off and sent to an outside
collection agency.
Nonaccrual, Past Due and Restructured Loans. The Association's non-performing
assets consist of nonaccrual loans, accruing loans greater than 90 days
delinquent, real estate owned and other repossessed assets. All loans are
reviewed on a regular basis and are placed on a nonaccrual status when, in the
opinion of management, the collection of additional interest is deemed
insufficient to warrant further accrual. Generally, the Association places all
loans more than 90 days past due on nonaccrual status. Uncollectible interest on
loans is charged-off or an allowance for losses is established by a charge to
earnings equal to all interest previously accrued and interest is subsequently
recognized only to the extent cash payments are received until delinquent
interest is paid in full and, in management's judgment, the borrower's ability
to make periodic interest and principal payments is back to normal in which case
the loan is returned to accrual status.
Real estate acquired by foreclosure is classified as real estate owned until
such time as it is sold. See Note 1 of Notes to the Consolidated Financial
Statements contained in the Annual Report. When such property is acquired, it is
recorded at the lower of the balance of the loan on the property at the date of
acquisition (not to exceed the net realizable value) or the estimated fair
value. Costs, excluding interest, relating to holding the property are expensed
as incurred. Valuations are periodically performed by management and an
allowance for losses is established by a charge to operations if the carrying
value of the property exceeds its estimated net realizable value. From time to
time, the Association also acquires personal property which is classified as
other repossessed assets and is carried on the books at estimated fair market
value and disposed of as soon as commercially reasonable.
As of September 30, 2001, the Association's total nonaccrual loans amounted to
$270,000, or 0.04% of total loans, before net items, compared with $810,000, or
0.21% of total loans, before net items, at September 30, 2000. Nonaccrual loans
at September 30, 2000 consisted primarily of 12 loans on one- to four-family
residences. Most of these loans were subsequently obtained through foreclosure
and sold, thus reducing the balance of nonaccrual loans.
At September 30, 2001, the Association had no restructured loans.
Real estate owned decreased from the prior year primarily as a result of the
sale of real estate properties during the year ended September 30, 2001.
The following table sets forth the amounts and categories of the Association's
non-performing assets at the dates indicated. The Association had no material
troubled debt restructurings as defined by SFAS No. 15 at any of the dates
indicated.
At September 30,
2001 2000 1999 1998 1997
------ ------ ------ ------ ------
(Dollars in thousands)
Non-accruing loans:
One- to four-family real estate ...... $270 $715 $915 $513 $245
Commercial real estate................ -- -- 2,400 -- --
Consumer.............................. -- 95 -- 11 9
Accruing loans greater than 90
days delinquent......................... -- -- -- -- --
------ ------ ------ ------ ------
Total non-performing loans............ 270 810 3,315 524 254
------ ------ ------ ------ ------
Real estate owned......................... 446 788 1,495 -- --
Other repossessed assets.................. -- -- -- -- --
------ ------ ------ ------ ------
Total repossessed assets.............. 446 788 1,495 -- --
------ ------ ------ ------ ------
Total non-performing assets........... $ 716 $1,598 $4,810 $524 $254
====== ====== ====== ====== ======
Total non-performing assets as a
percentage of total assets.............. 0.05% 0.16% 0.46% 0.05% 0.03%
====== ====== ====== ====== ======
Total non-performing loans as a
percentage of total loans,
before net items........................ 0.10% 0.21% 0.62% 0.07% 0.04%
====== ====== ====== ====== ======
Allowance for loan losses as a
percentage of total non-performing
assets.................................. 1110.47% 255.44% 51.64% 372.14% 510.38%
======= ====== ====== ====== ======
Allowance for loan losses as a percentage
of total non-performing loans........... 2944.81% 503.95% 74.93% 372.14% 510.38%
======= ====== ====== ====== ======
The allowance for loan losses as a percentage of both total non-performing
assets and total non-performing loans has increased significantly at September
30, 2001. These increases are a direct result of allowance recorded related to
the loans purchased from WAMU. Because the majority of the loans purchased from
WAMU were commercial and consumer loans with higher associated risks, the
allowance increased, yet, because the loans were added in September 2001 there
has not been an impact causing the level of non-performing loans and assets to
increase.
For the year ended September 30, 2001, the amount of gross income that would
have been recorded in the period then ended if non-accrual loans and troubled
debt restructurings had been current according to their original terms, and the
amount of interest income on such loans that was included in net income for each
of such periods, were, in both cases, less than 1% of total interest income.
Classified Assets. Federal regulations require that each insured savings
association classify its assets on a regular basis. In addition, in connection
with examinations of insured institutions, federal examiners have authority to
identify problem assets and, if appropriate, classify them. There are four
categories used to classify problem assets: "special mention," "substandard,"
"doubtful," and "loss." Special mention assets are not considered classified
assets, but are assets of questionable quality that have potential or past
weaknesses that deserve management's close attention and monitoring. Substandard
assets have one or more defined weaknesses and are characterized by the distinct
possibility that the insured institution will sustain some loss if the
deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified loss is considered uncollectible and of such little value that
continuance as an asset of the institution is not warranted. If an asset or
portion thereof is classified loss, the insured institution must either
establish specific allowances for loan losses in the amount of 100% of the
portion of the asset classified loss or charge-off such amount. General loss
allowances established to cover probable losses related to special mention
assets and assets classified substandard or doubtful may be included in
determining an institution's regulatory capital, while specific valuation
allowances for loan losses do not qualify as regulatory capital. Federal
examiners may disagree with an insured institution's classifications and the
amounts reserved.
As of September 30, 2001, total classified assets amounted to 0.18% of total
assets, consistent with 0.16% at September 30, 2000. Assets classified
substandard at September 30, 2001 totaled $2.7 million and included $270,393 in
one- to four-family residential loans, a $2.0 million land development loan and
$445,855 in foreclosed real estate consisting of single family residences.
Assets classified substandard at September 30, 2000 totaled $1.7 million and
included $358,288 in one- to four-family construction loans and $788,400 in
foreclosed real estate consisting of single family residences that were
originally speculative construction loans. These problem assets were not
concentrated in any one market area.
Impaired Loans. Management generally identifies loans to be evaluated for
impairment when such loans are on nonaccrual status or have been restructured.
However, not all nonaccrual loans are impaired. In accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan," as amended by SFAS 118,
loans are considered impaired when it is probable that the Association will be
unable to collect all amounts contractually due, including scheduled interest
payments. Factors involved in determining impairment include, but are not
limited to, the financial condition of the borrower, the value of the underlying
collateral, and current economic conditions.
Allowance for Loan Losses. The allowance for loan losses is maintained at a
level considered adequate by management to provide for probable loan losses
based on management's assessment of various factors affecting the loan
portfolio, including a review of all loans for which full collectibility may not
be reasonably assured, an overall evaluation of the quality of the underlying
collateral, economic conditions, historical loan loss experience and other
factors that warrant recognition in providing for an adequate loan loss
allowance. The level of allowance for loan losses is determined based on
stratifying the loan portfolio in to classes based on risk. For example, loans
are stratified based on type of interest rate (fixed or adjustable), age of the
loan (less seasoned loans are assigned a higher percentage), geographic
location, and type of loan. Each stratum is assigned an appropriate level of
allowance percentage based on historical loss experience and risk level assigned
to the type of loans. While management believes it uses the best information
available to determine the allowance for loan losses, unforeseen market
conditions could result in adjustments to the allowance for loan losses and net
earnings could be significantly affected, if circumstances differ substantially
from the assumptions used in making the final determination. At September 30,
2001, the Association had an allowance for loan losses of $8.0 million, which
was equal to 1110.47% of non-performing assets and 1.13% of total loans.
Provisions for loan losses are charged to earnings to bring the total allowance
for loan losses to a level deemed appropriate by management. Management
considers historical loan loss experience, the volume and type of lending
conducted by the Association, industry standards, the amount of non-performing
assets, general economic conditions (particularly as they relate to the
Association's market area), and other factors related to the collectibility of
the Association's loan portfolio in their determination of the adequacy of the
allowance and the provision. The provisions for loan losses charged against
income for the years ended September 30, 2001, 2000 and 1999 were $387,000, $1.8
million, and $932,000, respectively. Management believes that the amount
maintained in the allowance will be adequate to absorb probable losses in the
portfolio.
The year ended September 30, 2001 included two transactions that affected the
allowance and provision for loan losses. The sale of $190.3 million in fixed
rate single family loans to Fannie Mae reduced the required allowance on
mortgage loans. In conjunction with the sale, $231,000 of allowance was
reclassified as part of the basis of the resulting mortgage-backed securities.
The reduction in the loan portfolio reduced the need for additional allowance
and thus the provision for loan losses was much lower this year than the
previous year. The WAMU acquisition added $179.3 million of loans to the
portfolio, a significant proportion of which were commercial and consumer loans.
These non-homogeneous loans by nature have higher credit risk. As part of the
acquisition, an allowance for loan losses was established related to the
acquired loans based on the types of loans and the best information available
regarding the factors which may affect their collectibility. The higher balance
of the allowance for loan losses reflects these changes whereby a block of low
risk single family mortgage loans were sold and were replaced by a block of
higher risk loans from the acquired branches.
The following table sets forth for the periods indicated information regarding
changes in the Association's allowance for loan losses. All information is
before net items.
Year Ended September 30,
--------------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
(Dollars in thousands)
Total loans outstanding........................ $701,013 $750,909 $774,441 $704,703 $576,575
========== ======== ========= ========= =========
Average loans outstanding...................... $611,095 $747,842 $721,658 $614,457 $515,555
========== ======== ========= ========= =========
Allowance at beginning of period............... $ 4,082 $ 2,484 $ 1,950 $ 1,296 $ 928
-------- -------- -------- -------- --------
Loans charged off:
One- to four-family......................... (3) -- (392) -- --
Construction................................ (19) (32) -- -- (2)
Commercial real estate...................... -- (559) -- -- --
Commercial business......................... (12) -- -- (17) --
Consumer.................................... (56) (16) (6) (3) --
--------- ------- --------- --------- ---------
Total charge offs (90) (607) (398) (20) (2)
-------- -------- -------- -------- --------
Recoveries of loans previously charged off:
Commercial real estate...................... 34 440 -- -- --
Consumer.................................... 8 1 -- -- --
-------- ------ --------- --------- --------
Total recoveries 42 441 -- -- --
-------- -------- --------- --------- --------
Net chargeoffs (48) (166) (398) (20) (2)
Provision for loans losses..................... 387 1,764 932 674 370
Acquisitions................................... 3,761 -- -- -- --
Allowance reclassified with loan securitization (231) -- -- -- --
---------- -------- --------- --------- ---------
Allowance at end of period..................... $ 7,951 $ 4,082 $ 2,484 $ 1,950 $ 1,296
========== ======== ========= ========= =========
Allowance for loan losses as a percentage
of total loans outstanding.................... 1.13% 0.54% 0.32% 0.28% 0.22%
==== ==== ==== ==== ====
Ratio of net charge-offs to average loans
outstanding during the period................. 0.01% 0.02% 0.06% --% --%
==== ==== ==== === ===
The following table sets forth the breakdown of the allowance for loan losses by
loan category and summarizes the percentage of total loans, before net items, in
each category to total loans, before net items, at the dates indicated.
At September 30,
-------------------------------------------------------------------------------------------------------------
2001 2000 1999
Percent of Percent of Percent of
----------------------------------- ----------------------------------- -----------------------------------
Amount Allowance in Percent of Amount Allowance in Percent of Amount Allowance in Percent of
of Category to Total Loans of Category to Total Loans of Category to Total Loans
Allowance Total Loans by Category Allowance Total Loans by Category Allowance Total Loans by Category
--------- ------------ ----------- --------- ------------ ----------- --------- ------------ -----------
(Dollars in thousands)
Permanent residential
1-4 family............. $1,292 0.19% 60.12% $1,449 0.19% 85.12% $1,103 0.14% 83.56%
Multi-family residential. 540 0.08 3.32 365 0.05 2.53 267 0.03 2.38
Construction............. 12 0.01 3.09 420 0.05 3.37 221 0.03 6.87
Agriculture.............. 158 0.02 0.60 -- -- -- -- -- --
Commercial real estate... 3,611 0.52 14.17 1,403 0.19 5.63 730 0.09 4.79
Land..................... 324 0.02 0.53 168 0.02 0.45 28 -- 0.27
Commercial and industrial 1,325 0.19 8.00 86 0.01 0.61 23 -- 0.44
Consumer................. 689 0.10 10.17 191 0.03 2.29 112 0.02 1.69
------ ----------- --------- ----------- --------- -----------
Total................. $7,951 1.13% 100.00% $4,082 0.54% 100.00% $2,484 0.31% 100.00%
====== =========== ========= =========== ========= ===========
At September 30,
------------------------------------------------------------------------
1998 1997
Percent of Percent of
----------------------------------- -----------------------------------
Amount Allowance in Percent of Amount Allowance in Percent of
of Category to Total Loans of Category to Total Loans
Allowance Total Loans by Category Allowance Total Loans by Category
--------- ------------ ----------- --------- ------------ -----------
(Dollars in thousands)
Permanent residential
1-4 family............. $1,141 0.16% 81.95% $887 0.15% 86.51%
Multi-family residential. 124 0.02 2.73 121 0.02 2.93
Construction............. 116 0.02 9.12 -- -- 5.31
Agriculture.............. -- -- -- -- -- --
Commercial real estate... 444 0.07 4.18 250 0.04 3.93
Land..................... 29 -- 0.31 12 -- 0.27
Commercial and industrial 14 -- 0.29 -- -- 0.01
Consumer................. 82 0.01 1.42 26 0.01 1.04
------- ----------- --------- -----------
Total................. $1,950 0.28% 100.00% $1,296 0.22% 100.00%
======= =========== ========= ===========
Although the Association believes that it has established its allowance for loan
losses in accordance with accounting principles generally accepted in the United
States of America, there can be no assurance that regulators, in reviewing the
Association's loan portfolio, will not request the Association to significantly
increase its allowance for loan losses, thereby reducing the Association's net
worth and earnings. In addition, because future events affecting borrowers and
collateral cannot be predicted with certainty, there can be no assurance that
the existing allowance for loan losses is adequate or that substantial increases
will not be necessary should the quality of any loans deteriorate as a result of
the factors discussed above. Any material increase in the allowance may
adversely affect the Association's financial condition and results of operation.
Investment Activities
Federally chartered savings institutions have the authority to invest in
securities of various federal agencies, certain insured certificates of deposit
of banks and savings institutions, certain bankers' acceptances, repurchase
agreements and federal funds. Subject to various restrictions, federally
chartered savings institutions may also invest their assets in commercial paper,
investment grade corporate debt securities and mutual funds whose assets conform
to the investments that a federally chartered savings institution is otherwise
authorized to make directly. OTS regulations restrict investments in corporate
debt securities of any one issuer in excess of 15% of the Association's
unimpaired capital and unimpaired surplus, as defined by federal regulations,
which totaled $118.8 million at September 30, 2001, plus an additional 10% if
the investments are fully secured by readily marketable collateral. See
"REGULATION -- Federal Regulation of Savings Associations -- Loans to One
Borrower" for a discussion of additional restrictions on the Association's
investment activities.
The investment securities portfolio is managed in accordance with a written
investment policy adopted by the Board of Directors and administered by the
Investment Committee, which consists of the President and four Board members.
Generally, the investment policy is to invest funds among various categories of
investments and maturities based upon the need for liquidity, to achieve the
proper balance between its desire to minimize risk and maximize yield, and to
fulfill the asset/liability management policy. The President and the Chief
Financial Officer may independently invest up to 1.0% of total assets of the
Company within the parameters set forth in the Investment Policy, to be
subsequently reviewed with the Investment Committee at its next scheduled
meeting. Transactions or investments in any one security determined by type,
maturity and coupon in excess of $10.0 million or 1.0% of assets are not
permitted.
Investment securities held to maturity are carried at cost and adjusted for
amortization of premiums and accretion of discounts. As of September 30, 2001,
the investment securities portfolio held to maturity consisted of $135,388 in
tax-exempt securities issued by states and municipalities and $457,000 in other
obligations. Securities to be held for indefinite periods of time and not
intended to be held to maturity are classified as available for sale and carried
at fair value. Securities available for sale include securities that management
intends to use as part of its asset/liability management strategy that may be
sold in response to changes in interest rates or significant prepayment risks or
both. As of September 30, 2001, the portfolio of securities available for sale
consisted of $40.9 million in securities issued by the U.S. Treasury and other
federal government agencies, $33.6 million in tax exempt securities issued by
states and municipalities, $15.5 million in federal agency preferred stock, and
$64.7 million in investment grade corporate investments.
During the years ended September 30, 2001, 2000, and 1999, neither the Company
nor the Association held any off-balance sheet derivative financial instruments
in their investment portfolios to which the provisions of SFAS No. 133,
"Disclosure about Derivative Financial Instruments and Fair Value of Financial
Instruments," would apply.
The following tables set forth certain information relating to the investment
securities portfolio held to maturity and securities available for sale at the
dates indicated.
At September 30,
---------------------------------------------------------------------------------
2001 2000 1999
----------------------- ----------------------- -------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- --------- --------- --------- --------- ---------
(In thousands)
Held to maturity:
State and municipal obligations............. $ 135 $ 137 $ 267 $ 270 $ 560 $ 577
Other obligations........................... 457 457 457 457 -- --
Available for sale:
U.S. Government obligations................. 40,120 40,852 49,190 48,786 74,227 73,960
State and municipal obligations............. 32,951 33,640 25,600 24,943 24,848 23,881
Corporate obligations....................... 65,404 64,718 43,899 42,899 62,037 60,807
FHLMC preferred stock....................... 15,716 15,466 -- -- -- --
--------- --------- --------- --------- --------- ---------
Total..................................... $154,783 $155,270 $119,413 $117,355 $161,672 $159,225
========= ========= ========= ========= ========= =========
At September 30,
---------------------------------------------------------------------------------
2001 2000 1999
------------------------ ------------------------ -------------------------
Amortized Percent of Amortized Percent of Amortized Percent of
Cost Portfolio Cost Portfolio Cost Portfolio
--------- --------- --------- --------- --------- ---------
(Dollars in thousands)
Held to maturity:
State and municipal obligations............. $ 135 0.09% $ 267 0.22% $ 560 0.35%
Other obligations........................ 457 0.29 457 0.38 -- --
Available for sale:
U.S. Government obligations................. 40,120 25.92 49,190 41.20 74,227 45.91
State and municipal obligations............. 32,951 21.29 25,600 21.44 24,848 15.37
Corporate obligations....................... 65,404 42.26 43,899 36.76 62,037 38.37
FHLMC preferred stock....................... 15,716 10.15 -- -- -- --
--------- --------- --------- --------- --------- ---------
Total..................................... $154,783 100.00% $119,413 100.00% $161,672 100.00%
========= ========= ========= ========= ========= =========
The following table sets forth the maturities and weighted average yields of the
debt securities in the investment portfolio at September 30, 2001.
One Year After One Through After Five Through After Ten
or Less Five Years Ten Years Years Totals
------------------- -------------------- -------------------- -------------------- -----------
Amount Yield Amount Yield Amount Yield Amount Yield
-------- ----- ------- ----- -------- ----- ------ ----- ---------
(Dollars in thousands)
Held to maturity:
State and municipal
obligations.............$ 135 9.96% $ -- -- $ -- -- $ -- -- $ 135
Other obligations.......... -- -- -- -- -- -- 457 8.07% 457
Available for sale:
U.S. Government
obligations............... 15,003 4.68% 15,200 4.35% 9,917 3.50% -- -- 40,120
State and municipal
obligations............... -- -- 586 6.00% 943 6.42% 31,422 7.62% 32,951
Corporate obligations...... 10,012 6.47% 35,562 5.42% -- -- 19,830 4.29% 65,404
FHLMC preferred stock...... 15,716 4.66% -- -- -- -- -- -- 15,716
-------- ------- -------- ------ --------
Total.................... $40,866 $51,348 $10,860 $51,709 $154,783
======== ======= ======== ====== ========
At September 30, 2001 the Company did not hold any securities from a single
issuer, other than the U.S. Government, whose aggregate book value was in excess
of 10% of the Company's shareholders' equity, or $11.4 million.
Mortgage-Backed and Related Securities
At September 30, 2001, the Company's net mortgage-backed and related securities
totaled $423.3 million at fair value ($421.3 million at amortized cost) and had
a weighted average yield of 5.74%. At September 30, 2001, 12.87% of the
mortgage-backed and related securities were adjustable rate securities.
Mortgage-backed and related securities ("MBS") can be divided into two main
groups. The first group, called mortgage participation certificates or
pass-through certificates, typically represents a participation interest in a
pool of single-family or multi-family mortgages. The principal and interest
payments on these mortgages are passed from the mortgage originators, through
intermediaries (generally U.S. Government agencies and government sponsored
enterprises) that pool and resell the participation interests in the form of
securities, to investors such as the Company. Such U.S. Government agencies and
government sponsored enterprises, which guarantee the payment of principal and
interest to investors, primarily include the Federal Home Loan Mortgage
Corporation ("FHLMC"), Fannie Mae (formerly the Federal National Mortgage
Association), the Government National Mortgage Association ("GNMA") and the U.S.
Small Business Administration ("SBA").
The second group, called collateralized mortgage obligations ("CMOs"), consists
of securities created from and secured by the securities in the first group
described above. CMOs are an example of a security called a derivative, because
they are derived from mortgage pass-through securities. Underwriters of CMOs
create these securities by dividing up the interest and principal cash flows
from the pools of mortgages and selling these different slices of cash flows as
a new and different class of individual securities or "tranches." At September
30, 2001, the Company held $337.7 million of CMOs, comprised of two classes,
planned amortization class tranches ("PACs") and Floaters. The least volatile
CMOs are PACs. With PACs, the yields, average lives, and lockout periods when no
payments are received are designed to closely follow the actual performance of
the underlying MBS. PACs are available in a variety of short term maturities,
usually two, three, five, or seven years. CMO floaters are similar to adjustable
rate mortgages; they carry an interest rate that changes in a fixed relationship
to an interest rate index, typically the London Interbank Offer Rate ("LIBOR").
Floaters usually have caps that determine the highest interest that can be paid
by the securities. Except for caps on floaters, PACs and floaters may help to
manage interest rate risk by reducing asset duration. They also may help manage
price volatility since they typically have short maturities or coupons that
reset monthly or quarterly to reflect changes in the index rate.
MBS typically are issued with stated principal amounts, and the securities are
backed by pools of mortgages that have loans with interest rates that fall
within a specific range and have varying maturities. MBS generally yield less
than the loans that underlie such securities because of the cost of payment
guarantees and credit enhancements. In addition, MBS are usually more liquid
than individual mortgage loans and may be used to collateralize certain
liabilities and obligations of the Company. These types of securities also
permit the Association to optimize its regulatory capital because they have low
risk weighting.
Expected maturities of MBS will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties. Prepayments that are faster than anticipated may
shorten the life of the security and may result in a loss of any premiums paid
and thereby reduce the net yield on such securities. Although prepayments of
underlying mortgages depend on many factors, including the type of mortgages,
the coupon rate, the age of mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates, generally the difference between the interest rates on
the underlying mortgages and the prevailing mortgage interest rates is the most
significant determinant of the rate of prepayments. During periods of declining
mortgage interest rates, if the coupon rate of the underlying mortgages exceeds
the prevailing market interest rates offered for mortgage loans, refinancing
generally increases and accelerates the prepayment of the underlying mortgages
and the related security. Under such circumstances, the Company may be subject
to reinvestment risk because, to the extent that the Company's MBS amortize or
prepay faster than anticipated, the Company may not be able to reinvest the
proceeds of such repayments and prepayments at a comparable rate.
The following tables set forth certain information relating to the
mortgage-backed and related securities portfolio held to maturity and available
for sale at the dates indicated.
At September 30,
-------------------------------------------------------------------------------
2001 2000 1999
------------------------ ----------------------- ----------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
---------- -------- --------- ------- --------- -------
(In thousands)
Held to maturity:
GNMA........................................ $ 1,621 $ 1,642 $ 2,160 $ 2,146 $ 2,601 $ 2,596
Available for sale:
Fannie Mae.................................. 56,833 57,194 13,498 13,598 24,319 24,410
FHLMC....................................... 19,538 19,797 32,902 33,282 18,375 18,371
GNMA........................................ 6,816 6,977 10,728 10,681 11,783 11,768
CMOs........................................ 336,452 337,670 18,355 17,770 18,598 18,146
---------- -------- --------- ------- --------- -------
Total..................................... $421,260 $423,280 $77,643 $77,477 $75,676 $75,291
========== ======== ========= ======= ========= =======
At September 30,
--------------------------------------------------------------------------------
2001 2000 1999
------------------------ ------------------------ ------------------------
Amortized Percent of Amortized Percent of Amortized Percent of
Cost Portfolio Cost Portfolio Cost Portfolio
--------- ---------- --------- ---------- --------- ----------
(Dollars in thousands)
Held to maturity:
GNMA........................................ $ 1,621 0.38% $ 2,160 2.78% $ 2,601 3.44%
Available for sale:
Fannie Mae.................................. 56,833 13.49 13,498 17.38 24,319 32.13
FHLMC....................................... 19,538 4.64 32,902 42.38 18,375 24.28
GNMA........................................ 6,816 1.62 10,728 13.82 11,783 15.57
CMOs........................................ 336,452 79.87 18,355 23.64 18,598 24.58
---------- -------- --------- ------- --------- -------
Total..................................... $421,260 100.00% $77,643 100.00% $75,676 100.00%
========== ======== ========= ======= ========= =======
Interest-Earning Deposits
The Company had interest-earning deposits in the FHLB of Seattle amounting to
$4.9 million and $4.4 million at September 30, 2001 and 2000, respectively.
Deposit Activities and Other Sources of Funds
General. Deposits are the primary source of the Association's funds for lending
and other investment purposes. In addition to deposits, the Association derives
funds from loan principal repayments. Loan repayments are a relatively stable
source of funds, while deposit inflows and outflows are significantly influenced
by general interest rates and money market conditions. Borrowings may be used on
a short-term basis to compensate for reductions in the availability of funds
from other sources. They may also be used on a longer term basis for general
business purposes.
Deposits. The Association's deposits are attracted principally from within the
Association's primary market area through the offering of a broad selection of
deposit instruments, including checking accounts, negotiable order of withdrawal
("NOW") accounts, money market deposit accounts, passbook and statement savings
accounts, and certificates of deposit. Included among these deposit products are
individual retirement account ("IRA") certificates of approximately $112.7
million at September 30, 2001. Deposit account terms vary, with the principal
differences being the minimum balance required, the time period the funds must
remain on deposit and the interest rate.
Beginning in 1996, the Association began accepting deposits from outside its
primary market area through both private placements and brokered deposits if the
terms of the deposits fit the Association's specific needs and are at a rate
lower than the rates on similar maturity borrowings through the FHLB of Seattle.
At September 30, 2001, these deposits totaled $11.7 million, or 1.01% of total
deposits.
Interest rates paid, maturity terms, service fees and withdrawal penalties are
established by the Association on a periodic basis. Determination of rates and
terms are predicated on funds acquisition and liquidity requirements, rates paid
by competitors, growth goals and federal regulations.
For the year ended September 30, 2001, the Association experienced a net
increase in deposits (before interest credited) of $430.4 million. Of the
increase, $423.5 million is attributable to the acquisition of the branches from
WAMU. The remaining increase of $6.9 million is primarily related to increases
in deposits throughout the branch network and specifically at the four new
branch locations established during fiscal year 2001.
At September 30, 2001, certificate accounts maturing during the year ending
September 30, 2002 totaled $366.2 million. Based on historical experience, the
Association expects that a significant amount will be renewed with the
Association at maturity. In the event a significant amount of such accounts are
not renewed at maturity, the Association would not expect a resultant adverse
impact on operations and liquidity because of the Association's borrowing
capacity. See "-- Borrowings."
In the unlikely event the Association is liquidated, depositors will be entitled
to full payment of their deposit accounts prior to any payment being made to the
Company, which is the sole shareholder of the Association. Substantially all of
the Association's depositors are residents of the State of Oregon.
The following table indicates the amount of certificate accounts with balances
of $100,000 or greater by time remaining until maturity as of September 30,
2001.
Certificate
Maturity Period Accounts
------------
(In thousands)
Three months or less............... $40,130
Over three through six months...... 31,555
Over six through twelve months..... 21,679
Over twelve months................. 41,274
--------
Total.......................... $134,638
========
The following table sets forth the deposit balances in the various types of
deposit accounts offered by the Association at the dates indicated.
At September 30,
2001 2000 1999
--------------------------- -------------------------------- -----------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
--------- ------ -------- -------- ------ -------- -------- ------
(Dollars in thousands)
Certificates of deposit.......... $543,880 47.17% $171,132 $372,748 53.60% ($19,338) $392,086 54.43%
Transaction accounts:
Non-interest checking............ 130,649 11.33 76,309 54,340 7.81 2,021 52,319 7.26
Interest-bearing checking........ 116,756 10.13 44,570 72,186 10.38 4,883 67,303 9.34
Passbook and statement savings... 77,646 6.74 29,699 47,947 6.90 (11,843) 59,790 8.30
Money market deposits............ 283,893 24.63 135,733 148,160 21.31 (743) 148,903 20.67
--------- ------ -------- -------- ------ -------- -------- ------
Total transaction accounts....... 608,944 52.83 286,311 322,633 46.40 (5,682) 328,315 45.57
--------- ------ -------- -------- ------ -------- -------- ------
Total deposits................... $1,152,824 100.00% $457,443 $695,381 100.00% ($25,020) $720,401 100.00%
========= ====== ======== ======== ====== ======== ======== ======
The majority of the increases noted for the year ended September 30, 2001 relate
to the WAMU branch acquisition.
The following table sets forth the deposit activities of the Association for the
periods indicated.
Year Ended September 30,
--------------------------------------
2001 2000 1999
----------- ---------- --------
(Dollars in thousands)
Beginning balance........................ $695,381 $720,401 $689,541
----------- ---------- --------
Increase due to acquired deposits........ 423,457 -- --
Net inflow (outflow) of deposits before
interest credited....................... 6,902 (49,728) 6,251
Interest credited........................ 27,084 24,708 24,609
---------- -------- --------
Net increase (decrease) in deposits...... 457,443 (25,020) 30,860
---------- -------- --------
Ending balance........................... $1,152,824 $695,381 $720,401
========== ======== ========
Borrowings. Deposit liabilities are the primary source of funds for the
Association's lending and investment activities and for its general business
purposes. The Association may rely upon advances from the FHLB of Seattle,
reverse repurchase agreements and bank lines of credit to supplement its supply
of lendable funds and to meet deposit withdrawal requirements. The FHLB of
Seattle serves as the Association's primary borrowing source after deposits.
The FHLB of Seattle functions as a central reserve bank providing credit for
savings and loan associations and certain other member financial institutions.
As a member, the Association is required to own capital stock in the FHLB of
Seattle and is authorized to apply for advances on the security of certain of
its mortgage loans and other assets (principally securities which are
obligations of, or guaranteed by, the U.S. Government) provided certain
creditworthiness standards have been met. Advances are made pursuant to several
different credit programs. Each credit program has its own interest rate and
range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. As a member of the FHLB,
the Association maintains a credit line that is a percentage of its regulatory
assets, subject to collateral requirements. At September 30, 2001, the credit
line was 30% of total assets of the Association. Advances are collateralized in
aggregate, as provided for in the Advances, Security and Deposit Agreements with
the FHLB, by certain mortgages or deeds of trust and securities of the U.S.
Government and agencies thereof.
The Company has established credit lines at two commercial banks. These credit
lines represent aggregate borrowing capacity of $16.7 million. At September 30,
2001, borrowings under these lines of credit totaled $1.7 million.
The following table sets forth certain information regarding borrowings by the
Company and Association at the end of and during the periods indicated:
At September 30,
---------------------
2001 2000
---- ----
Weighted average rate paid on:
FHLB advances............................... 5.73% 5.90%
Short term borrowings....................... 5.58% 9.01%
Year Ended September 30,
-------------------------
2001 2000
-------- --------
(Dollars in thousands)
Maximum amount outstanding at any month end:
-------- --------
FHLB advances............................... $173,000 $230,000
Short term borrowings....................... 6,400 3,000
Approximate average balance:
FHLB advances............................... 170,521 207,218
Short term borrowings....................... 3,265 1,290
Approximate weighted average rate paid on:
FHLB advances............................... 5.90% 5.88%
Short term borrowings....................... 8.22 9.34
Subsidiaries. The Association established an operating subsidiary, Pacific
Cascades Financial, Inc., effective July 14, 2000. Pacific Cascades Financial,
Inc. is an Oregon chartered corporations, of which the Association owns 100% of
its capital stock. Pacific Cascades Financial serves as the Association's
trustee on deeds of trust and as trustee handles normal reconveyance
transactions on paid-off Association loans, and handles non-judicial
foreclosures.
The Association also owns 100% of the capital stock of Klamath First Financial
Services, Inc. Klamath First Financial serves as an investment subsidiary,
providing investment and brokerage services to customers.
The Company established a subsidiary, Klamath First Capital Trust I, in July
2001 for the purpose of issuing mandatorily redeemable preferred securities. See
Note 13 to the Consolidated Financial Statements contained in the Annual Report.
REGULATION OF THE ASSOCIATION
General
The Association is subject to extensive regulation, examination and supervision
by the OTS as its chartering agency, and the FDIC, as the insurer of its
deposits. The activities of federal savings institutions are governed by the
Home Owners Loan Act ("HOLA") and, in certain respects, the Federal Deposit
Insurance Act, and the regulations issued by the OTS and the FDIC to implement
these statutes. These laws and regulations delineate the nature and extent of
the activities in which federal savings associations may engage. Lending
activities and other investments must comply with various statutory and
regulatory capital requirements. In addition, the Association's relationship
with its depositors and borrowers is also regulated to a great extent,
especially in such matters as the ownership of deposit accounts and the form and
content of the Association's mortgage documents. The Association is required to
file reports with the OTS and the FDIC concerning its activities and financial
condition in addition to obtaining regulatory approvals prior to entering into
certain transactions such as mergers with, or acquisitions of, other financial
institutions. There are periodic examinations by the OTS and the FDIC to review
the Association's compliance with various regulatory requirements. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the OTS, the FDIC or Congress, could have a
material adverse impact on the Company, the Association and their operations.
Federal Regulation of Savings Associations
Office of Thrift Supervision. The OTS is an office in the Department of the
Treasury subject to the general oversight of the Secretary of the Treasury. The
OTS has extensive authority over the operations of savings associations. Among
other functions, the OTS issues and enforces regulations affecting federally
insured savings associations and regularly examines these institutions.
All savings associations are required to pay assessments to the OTS to fund the
agency's operations. The general assessments, paid on a semi-annual basis, are
determined based on the savings association's total assets, including
consolidated subsidiaries. The Association's OTS assessment for the fiscal year
ended September 30, 2001 was $188,441.
Federal Home Loan Bank System. The FHLB System, consisting of 12 FHLBs, is under
the jurisdiction of the Federal Housing Finance Board ("FHFB"). The designated
duties of the FHFB are to supervise the FHLBs, to ensure that the FHLBs carry
out their housing finance mission, to ensure that the FHLBs remain adequately
capitalized and able to raise funds in the capital markets, and to ensure that
the FHLBs operate in a safe and sound manner.
The Association, as a member of the FHLB of Seattle, is required to acquire and
hold shares of capital stock in the FHLB of Seattle in an amount equal to the
greater of (i) 1.0% of the aggregate outstanding principal amount of residential
mortgage loans, home purchase contracts and similar obligations at the beginning
of each year, or (ii) 1/20 of its advances (i.e., borrowings) from the FHLB of
Seattle. The Association is in compliance with this requirement with an
investment in FHLB of Seattle stock of $12.7 million at September 30, 2001.
Among other benefits, the FHLB provides a central credit facility primarily for
member institutions. It is funded primarily from proceeds derived from the sale
of consolidated obligations of the FHLB System. It makes advances to members in
accordance with policies and procedures established by the FHFB and the Board of
Directors of the FHLB of Seattle.
Federal Deposit Insurance Corporation. The FDIC is an independent federal agency
established originally to insure the deposits, up to prescribed statutory
limits, of federally insured banks and to preserve the safety and soundness of
the banking industry. The FDIC maintains two separate insurance funds: the Bank
Insurance Fund ("BIF") and the SAIF. The Association's deposit accounts are
insured by the FDIC under the SAIF to the maximum extent permitted by law. As
insurer of the Association's deposits, the FDIC has examination, supervisory and
enforcement authority over all savings associations.
Under applicable regulations, the FDIC assigns an institution to one of three
capital categories based on the institution's financial information, as of the
reporting period ending seven months before the assessment period. The capital
categories are: (i) well-capitalized, (ii) adequately capitalized, or (iii)
undercapitalized. An institution is also placed in one of three supervisory
subcategories within each capital group. The supervisory subgroup to which an
institution is assigned is based on a supervisory evaluation provided to the
FDIC by the institution's primary federal regulator and information that the
FDIC determines to be relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. An institution's assessment rate
depends on the capital category and supervisory category to which it is assigned
with the most well-capitalized, healthy institutions receiving the lowest rates.
Effective January 1, 1997, the premium schedule for BIF and SAIF insured
institutions ranged from 0 to 27 basis points. However, SAIF insured
institutions and BIF insured institutions are required to pay a Financing
Corporation assessment in order to fund the interest on bonds issued to resolve
thrift failures in the 1980s. This amount is currently equal to about 2.1 basis
points for each $100 in domestic deposits for both BIF and SAIF members. These
assessments, which may be revised based upon the level of BIF and SAIF deposits,
will continue until the bonds mature in the year 2015.
The FDIC is authorized to raise the assessment rates in certain circumstances.
The FDIC has exercised this authority several times in the past and may raise
insurance premiums in the future. If such action is taken by the FDIC, it could
have an adverse effect on the earnings of the Association.
Under the FDIA, insurance of deposits may be terminated by the FDIC upon a
finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or the
OTS. Management of the Association does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
Liquidity Requirements. Under OTS regulations, each savings institution is
required to maintain an average daily balance of specified liquid assets equal
to a monthly average of not less than a specified percentage of its net
withdrawable deposit accounts plus short-term borrowings. This liquidity
requirement is currently 4%, but may be changed from time to time by the OTS to
any amount within the range of 4% to 10%. Monetary penalties may be imposed for
failure to meet liquidity requirements. The Association has never been subject
to monetary penalties for failure to meet its liquidity requirements.
Prompt Corrective Action. The OTS is required to take certain supervisory
actions against undercapitalized savings associations, the severity of which
depends upon the institution's degree of undercapitalization. Generally, an
institution that has a ratio of total capital to risk-weighted assets of less
than 8%, a ratio of Tier I (core) capital to risk- weighted assets of less than
4%, or a ratio of core capital to total assets of less than 4% (3% or less for
institutions with the highest examination rating) is considered to be
"undercapitalized." An institution that has a total risk-based capital ratio
less than 6%, a Tier I capital ratio of less than 3% or a leverage ratio that is
less than 3% is considered to be "significantly undercapitalized" and an
institution that has a tangible capital to assets ratio equal to or less than 2%
is deemed to be "critically undercapitalized." Subject to a narrow exception,
the OTS is required to appoint a receiver or conservator for a savings
institution that is "critically undercapitalized." OTS regulations also require
that a capital restoration plan be filed with the OTS within 45 days of the date
a savings institution receives notice that it is "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized." Compliance
with the plan must be guaranteed by any parent holding company in an amount of
up to the lesser of 5% of the institution's assets or the amount which would
bring the institution into compliance with all capital standards. In addition,
numerous mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The OTS also could take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
At September 30, 2001, the Association was categorized as "well capitalized"
under the prompt corrective action regulations of the OTS.
Standards for Safety and Soundness. The federal banking regulatory agencies have
prescribed, by regulation, standards for all insured depository institutions
relating to: (i) internal controls, information systems and internal audit
systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate
risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings; and
(viii) compensation, fees and benefits ("Guidelines"). The Guidelines set forth
the safety and soundness standards that the federal banking agencies use to
identify and address problems at insured depository institutions before capital
becomes impaired. If the OTS determines that the Association fails to meet any
standard prescribed by the Guidelines, the agency may require the Association to
submit to the agency an acceptable plan to achieve compliance with the standard.
Management is aware of no conditions relating to these safety and soundness
standards which would require submission of a plan of compliance.
Qualified Thrift Lender Test. All savings associations, including the
Association, are required to meet a qualified thrift lender ("QTL") test to
avoid certain restrictions on their operations. This test requires a savings
association to have at least 65% of its portfolio assets (as defined by
regulation) in qualified thrift investments on a monthly average for nine out of
every 12 months on a rolling basis. As an alternative, the savings association
may maintain 60% of its assets in those assets specified in Section 7701(a)(19)
of the Internal Revenue Code ("Code"). Under either test, such assets primarily
consist of residential housing related loans and investments. At September 30,
2001, the Association met the test and its QTL percentage was 74.70%.
Any savings association that fails to meet the QTL test must convert to a
national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. See "-- Savings and Loan Holding Company Regulations."
Capital Requirements. Federally insured savings associations, such as the
Association, are required to maintain a minimum level of regulatory capital. The
OTS has established capital standards, including a tangible capital requirement,
a leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings associations.
The capital regulations require tangible capital of at least 1.5% of adjusted
total assets (as defined by regulation). At September 30, 2001, the Association
had tangible capital of $73.2 million, or 5.2% of adjusted total assets, which
is approximately $51.9 million above the minimum requirement of 1.5% of adjusted
total assets in effect on that date. At September 30, 2001, the Association had
$44.1 million of intangible assets consisting of core deposit intangible and
other intangible assets related to the Wells Fargo branch acquisition in 1997and
the WAMU branch acquisition in 2001.
The capital standards also require core capital equal to at least 3% to 4% of
adjusted total assets, depending on an institution's supervisory rating. Core
capital generally consists of tangible capital. At September 30, 2001, the
Association had core capital equal to $73.2 million, or 5.2% of adjusted total
assets, which is $16.5 million above the minimum leverage ratio requirement of
4% as in effect on that date.
The OTS risk-based requirement requires savings associations to have total
capital of at least 8% of risk-weighted assets. Total capital consists of core
capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital.
In determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet items, are multiplied by a risk weight, ranging from 0% to
100%, based on the risk inherent in the type of asset. For example, the OTS has
assigned a risk weight of 50% for prudently underwritten permanent one- to- four
family first lien mortgage loans not more than 90 days delinquent and having a
loan-to-value ratio of not more than 80% at origination unless insured to such
ratio by an insurer approved by Fannie Mae or FHLMC.
On September 30, 2001, the Association had total risk-based capital of
approximately $81.0 million, including $73.2 million in core capital and $7.8
million in qualifying supplementary capital, and risk-weighted assets of $782.5
million, or total capital of 10.4% of risk-weighted assets. This amount was
$18.4 million above the 8% requirement in effect on that date.
The OTS is authorized to impose capital requirements in excess of these
standards on individual associations on a case-by-case basis. The OTS and the
FDIC are authorized and, under certain circumstances required, to take certain
actions against savings associations that fail to meet their capital
requirements. The OTS is generally required to take action to restrict the
activities of an "undercapitalized association" (generally defined to be one
with less than either a 4% core capital ratio, a 4% Tier 1 risked-based capital
ratio or an 8% risk-based capital ratio). Any such association must submit a
capital restoration plan and until such plan is approved by the OTS may not
increase its assets, acquire another institution, establish a branch or engage
in any new activities, and generally may not make capital distributions. The OTS
is authorized to impose the additional restrictions that are applicable to
significantly undercapitalized associations.
The OTS is also generally authorized to reclassify an association into a lower
capital category and impose the restrictions applicable to such category if the
institution is engaged in unsafe or unsound practices or is in an unsafe or
unsound condition.
The imposition by the OTS or the FDIC of any of these measures on the Company or
the Association may have a substantial adverse effect on their operations and
profitability.
Limitations on Capital Distributions. The OTS imposes various restrictions on
savings associations with respect to their ability to make distributions of
capital, which include dividends, stock redemptions or repurchases, cash-out
mergers and other transactions charged to the capital account. The OTS also
prohibits a savings association from declaring or paying any dividends or from
repurchasing any of its stock if, as a result of such action, the regulatory
capital of the association would be reduced below the amount required to be
maintained for the liquidation account established in connection with the
association's mutual to stock conversion.
The Association may make a capital distribution without OTS approval provided
that the Association notifies the OTS 30 days before it declares the capital
distribution and that the following requirements are met: (i) the Association
has a regulatory rating in one of the two top examination categories, (ii) the
Association is not of supervisory concern, and will remain adequately or well
capitalized, as defined in the OTS prompt corrective action regulations,
following the proposed distribution, and (iii) the distribution does not exceed
the Association's net income for the calendar year-to-date plus retained net
income for the previous two calendar years (less any dividends previously paid).
If the Association does not meet these stated requirements, it must obtain the
prior approval of the OTS before declaring any proposed distributions.
In the event the Association's capital falls below its regulatory requirements
or the OTS notifies it that it is in need of more than normal supervision, the
Association's ability to make capital distributions will be restricted. In
addition, no distribution will be made if the Association is notified by the OTS
that a proposed capital distribution would constitute an unsafe and unsound
practice, which would otherwise be permitted by the regulation.
Loans to One Borrower. Federal law provides that savings institutions are
generally subject to the national bank limit on loans to one borrower. A savings
institution may not make a loan or extend credit to a single or related group of
borrowers in excess of 15% of its unimpaired capital and surplus. An additional
amount may be lent, equal to 10% of unimpaired capital and surplus, if secured
by specified readily-marketable collateral. At September 30, 2001, the
Association's limit on loans to one borrower was $17.8 million. At September 30,
2001, the Association's largest aggregate amount of loans to one borrower was
$5.4 million, all of which were performing according to their original terms.
Activities of Associations and Their Subsidiaries. When a savings association
establishes or acquires a subsidiary or elects to conduct any new activity
through a subsidiary that the association controls, the savings association must
notify the FDIC and the OTS 30 days in advance and provide the information each
agency may, by regulation, require. Savings associations also must conduct the
activities of subsidiaries in accordance with existing regulations and orders.
The OTS may determine that the continuation by a savings association of its
ownership control of, or its relationship to, the subsidiary constitutes a
serious risk to the safety, soundness or stability of the association or is
inconsistent with sound banking practices or with the purposes of the FDIA.
Based upon that determination, the FDIC or the OTS has the authority to order
the savings association to divest itself of control of the subsidiary. The FDIC
also may determine by regulation or order that any specific activity poses a
serious threat to the SAIF. If so, it may require that no SAIF member engage in
that activity directly.
Transactions with Affiliates. Savings associations must comply with Sections 23A
and 23B of the Federal Reserve Act relative to transactions with affiliates in
the same manner and to the same extent as if the savings association were a
Federal Reserve member Association. Generally, transactions between a savings
association or its subsidiaries and its affiliates are required to be on terms
as favorable to the association as transactions with non-affiliates. In
addition, certain of these transactions, such as loans to an affiliate, are
restricted to a percentage of the association's capital. Affiliates of the
Association include the Company and any company which is under common control
with the Association. In addition, a savings association may not lend to any
affiliate engaged in activities not permissible for a savings association
holding company or acquire the securities of most affiliates. The OTS has the
discretion to treat subsidiaries of savings associations as affiliates on a case
by case basis.
Certain transactions with directors, officers or controlling persons are also
subject to conflict of interest regulations enforced by the OTS. These conflict
of interest regulations and other statutes also impose restrictions on loans to
such persons and their related interests. Among other things, such loans must be
made on terms substantially the same as for loans to unaffiliated individuals.
Community Reinvestment Act. Under the federal Community Reinvestment Act
("CRA"), all federally- insured financial institutions have a continuing and
affirmative obligation consistent with safe and sound operations to help meet
all the credit needs of its delineated community. The CRA does not establish
specific lending requirements or programs nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to meet all the credit needs of its delineated community. The CRA
requires the federal banking agencies, in connection with regulatory
examinations, to assess an institution's record of meeting the credit needs of
its delineated community and to take such record into account in evaluating
regulatory applications to establish a new branch office that will accept
deposits, relocate an existing office, or merge or consolidate with, or acquire
the assets or assume the liabilities of, a federally regulated financial
institution, among others. The CRA requires public disclosure of an
institution's CRA rating. The Association received a "satisfactory" rating as a
result of its latest evaluation.
Regulatory and Criminal Enforcement Provisions. The OTS has primary enforcement
responsibility over savings institutions and has the authority to bring action
against all "institution-affiliated parties," including stockholders, and any
attorneys, appraisers and accountants who knowingly or recklessly participate in
wrongful action likely to have an adverse effect on an insured institution.
Formal enforcement action may range from the issuance of a capital directive or
cease and desist order to removal of officers or directors, receivership,
conservatorship or termination of deposit insurance. Civil penalties cover a
wide range of violations and can amount to $27,500 per day, or $1.1 million per
day in especially egregious cases. Under the FDIA, the FDIC has the authority to
recommend to the Director of the OTS that enforcement action be taken with
respect to a particular savings institution. If action is not taken by the
Director, the FDIC has authority to take such action under certain
circumstances. Federal law also establishes criminal penalties for certain
violations.
REGULATION OF THE COMPANY
General
The Company is a unitary savings and loan holding company within the meaning of
the HOLA. As such, it is registered with the OTS and is subject to OTS
regulations, examinations, supervision and reporting requirements. The Company
is also subject to the information, proxy solicitation, insider trading
restrictions, and other requirements of the Securities Exchange Act of 1934, as
amended.
Company Acquisitions
The HOLA and OTS regulations issued thereunder generally prohibit a savings and
loan holding company, without prior OTS approval, from acquiring more than 5% of
the voting stock of any other savings association or savings and loan holding
company or controlling the assets thereof. They also prohibit, among other
things, any director or officer of a savings and loan holding company, or any
individual who owns or controls more than 25% of the voting shares of such
holding company, from acquiring control of any savings association not a
subsidiary of such savings and loan holding company, unless the acquisition is
approved by the OTS.
Holding Company Activities
As a unitary savings and loan holding company, the Company generally is not
subject to activity restrictions. If the Company acquires control of another
savings association as a separate subsidiary, it would become a multiple savings
and loan holding company. There generally are more restrictions on the
activities of a multiple savings and loan holding company than a unitary savings
and loan holding company. Specifically, if either federally insured subsidiary
savings association fails to meet the QTL test, the activities of the Company
and any of its subsidiaries (other than the Company or other federally insured
subsidiary savings associations) would thereafter be subject to further
restrictions. The HOLA provides that, among other things, no multiple savings
and loan holding company or subsidiary thereof which is not an insured
association shall commence or continue for more than two years after becoming a
multiple savings and loan association holding company or subsidiary thereof, any
business activity other than: (i) furnishing or performing management services
for a subsidiary insured institution, (ii) conducting an insurance agency or
escrow business, (iii) holding, managing, or liquidating assets owned by or
acquired from a subsidiary insured institution, (iv) holding or managing
properties used or occupied by a subsidiary insured institution, (v) acting as
trustee under deeds of trust, (vi) those activities previously directly
authorized by regulation as of March 5, 1987 to be engaged in by multiple
holding companies or (vii) those activities authorized by the Federal Reserve
Board as permissible for bank holding companies, unless the OTS by regulation,
prohibits or limits such activities for savings and loan holding companies.
Those activities described in (vii) above also must be approved by the OTS prior
to being engaged in by a multiple holding company.
Potential Impact of Current Legislation on Future Results of Operations
On November 12, 1999, the Gramm-Leach-Bliley Act (the "GLB Act") was enacted
into law. The GLB Act made sweeping changes in the financial services in which
various types of financial institutions may engage. The Glass- Steagull Act,
which generally prevented banks from affiliating with securities and insurance
firms, was repealed. A new "financial holding company," which owns only well
capitalized and well managed depository institutions, will be permitted to
engage in a variety of financial activities, including insurance and securities
underwriting and agency activities.
The GLB Act permits unitary savings and loan holding companies in existence on
May 4, 1999, including the Company, to continue to engage in all activities that
they were permitted to engage in prior to the enactment of the Act. Such
activities are essentially unlimited, provided that the thrift subsidiary
remains a qualified thrift lender. Any thrift holding company formed after May
4, 1999, will be subject to the same restrictions as a multiple thrift holding
company. In addition, a unitary thrift holding company in existence on May 4,
1999, may be sold only to a financial holding company engaged in activities
permissible for multiple savings and loan holding companies.
The GLB Act is not expected to have a material effect on the activities in which
the Company and the Association currently engage, except to the extent that
competition with other types of financial institutions may increase as they
engage in activities not permitted prior to enactment of the GLB Act.
Affiliate Restrictions
The affiliate restrictions contained in Sections 23A and 23B of the Federal
Reserve Act apply to all federally insured savings associations and any such
"affiliate." A savings and loan holding company, its subsidiaries and any other
company under common control are considered affiliates of the subsidiary savings
association under the HOLA. Generally, Sections 23A and 23B: (i) limit the
extent to which the insured association or its subsidiaries may engage in
certain covered transactions with an affiliate to an amount equal to 10% of such
institution's capital and surplus, and contain an aggregate limit on all such
transactions with all affiliates to an amount equal to 20% of such capital and
surplus, and (ii) require that all such transactions be on terms substantially
the same, or at least as favorable to the institution or subsidiary, as those
provided to a non-affiliate. The term "covered transaction" includes the making
of loans, purchase of assets, issuance of a guarantee and other similar types of
transactions. Also, a savings association may not make any loan to an affiliate
unless the affiliate is engaged only in activities permissible for bank holding
companies. Only the Federal Reserve may grant exemptions from the restrictions
of Sections 23A and 23B. The OTS, however, may impose more stringent
restrictions on savings associations for reasons of safety and soundness.
Qualified Thrift Lender Test
The HOLA requires any savings and loan holding company that controls a savings
association that fails the QTL test, as explained under "-- Qualified Thrift
Lender Test," to, within one year after the date on which the association ceases
to be a QTL, register as and be deemed a bank holding company subject to all
applicable laws and regulations.
TAXATION
Federal Taxation
General. The Company and the Association report their income on a fiscal year
basis using the accrual method of accounting and are subject to federal income
taxation in the same manner as other corporations, with some exceptions. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Company and the Association.
Bad Debt Reserve. Historically, savings institutions such as the Association
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrift") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have been
deducted in arriving at their taxable income. The Association's deductions with
respect to "qualifying real property loans," which are generally loans secured
by certain interest in real property, were computed using an amount based on the
Association's actual taxable income, computed with certain modifications and
reduced by the amount of any permitted additions to the non- qualifying reserve.
Each year the Association selected the most favorable way to calculate the
deduction attributable to an addition to the tax bad debt reserve.
The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." The new
rules eliminated the 8% of taxable income method for deducting additions to the
tax bad debt reserves for all thrifts for tax years beginning after December 31,
1995. These rules also require that all institutions recapture all or a portion
of their bad debt reserves added since the base year (last taxable year
beginning before January 1, 1988). The Association has previously recorded a
deferred tax liability equal to the bad debt recapture and as such the new rules
will have no effect on net income or federal income tax expense. For taxable
years beginning after December 31, 1995, the Association's bad debt deduction
will be determined on the basis of net charge-offs during the taxable year. The
new rules allow an institution to suspend bad debt reserve recapture for the
1996 and 1997 tax years if the institution's lending activity for those years is
equal to or greater than the institution's average mortgage lending activity for
the six taxable years preceding 1996 adjusted for inflation. For this purpose,
only home purchase or home improvement loans are included and the institution
can elect to have the tax years with the highest and lowest lending activity
removed from the average calculation. If an institution is permitted to postpone
the reserve recapture, it must begin its six year recapture no later than the
1998 tax year (fiscal year ending September 30, 1999 for the Company). The
unrecaptured base year reserves will not be subject to recapture as long as the
institution continues to carry on the business of banking. In addition, the
balance of the pre-1988 bad debt reserves continue to be subject to provisions
of present law referred to below that require recapture in the case of certain
excess distributions to shareholders.
Distributions. To the extent that the Association makes "nondividend
distributions" to the Company, such distributions will be considered to result
in distributions from the balance of its bad debt reserves as of December 31,
1987 (or a lesser amount if the Association's loan portfolio decreased since
December 31, 1987) and then from the supplemental reserve for losses on loans
("Excess Distributions"), and an amount based on the Excess Distributions will
be included in the Association's taxable income. Nondividend distributions
include distributions in excess of the Association's current and accumulated
earnings and profits, distributions in redemption of stock and distributions in
partial or complete liquidation. However, dividends paid out of the
Association's current or accumulated earnings and profits, as calculated for
federal income tax purposes, will not be considered to result in a distribution
from the Association's bad debt reserve. The amount of additional taxable income
created from an Excess Distribution is an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution. The
Association does not intend to pay dividends that would result in a recapture of
any portion of its tax bad debt reserve.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended
(" Code") imposes a tax on alternative minimum taxable income ("AMTI") at a rate
of 20%. The excess of the tax bad debt reserve deduction using the percentage of
taxable income method over the deduction that would have been allowable under
the experience method is treated as a preference item for purposes of computing
the AMTI. In addition, only 90% of AMTI can be offset by net operating loss
carryovers. AMTI is increased by an amount equal to 75% of the amount by which
the Association's adjusted current earnings exceeds its AMTI (determined without
regard to this preference and prior to reduction for net operating losses). For
taxable years beginning after December 31, 1986, and before January 1, 1996, an
environmental tax of 0.12% of the excess of AMTI (with certain modification)
over $2.0 million is imposed on corporations, including the Association, whether
or not an Alternative Minimum Tax ("AMT") is paid.
Dividends-Received Deduction. The Company may exclude from its income 100% of
dividends received from the Association as a member of the same affiliated group
of corporations. The corporate dividends-received deduction is generally 70% in
the case of dividends received from unaffiliated corporations with which the
Company and the Association will not file a consolidated tax return, except that
if the Company or the Association owns more than 20% of the stock of a
corporation distributing a dividend, then 80% of any dividends received may be
deducted.
Other Federal Tax Matters. There have not been any Internal Revenue Service
audits of the Company's or the Association's federal income tax returns during
the past five years.
State Taxation
The Company and the Association are subject to an Oregon corporate excise tax at
a statutory rate of 6.6% of income. Neither the Company's nor the Association's
state income tax returns have been audited during the past five years. The
Association is subject to Washington state Business and Organization tax for the
operations in that state. There have not been any audits of the Company's state
income tax returns during the past five years.
Competition
The Association originates most of its loans to and accepts most of its deposits
from residents of its market area. The Association is the oldest financial
institution headquartered in Klamath Falls. The Association believes that it is
a major competitor in the markets in which it operates. Nonetheless, the
Association faces competition in attracting deposits and making real estate
loans from various financial institutions, including banks, savings associations
and mortgage brokers. In addition, the Association has faced additional
significant competition for investors' funds from short-term money market
securities and other corporate and government securities. The financial
institution industry in the Association's market area is characterized by a mix
of local independent financial institutions and offices of larger out-of-state
financial institutions, including several multi-national bank holding companies.
The ability of the Association to attract and retain savings deposits depends on
its ability to generally provide a rate of return and liquidity risk comparable
to that offered by competing investment opportunities. The Association competes
for loans principally through the interest rates and loan fees it charges and
the efficiency and quality of services it provides borrowers. Competition may
increase as restrictions on the interstate operations of financial institutions
continue to be reduced.
Personnel
As of September 30, 2001, the Association had 385 full-time and 104 part-time
employees. The employees are not represented by a collective bargaining unit.
The Association believes its relationship with its employees is good.
Executive Officers. The following table sets forth certain information regarding
the executive officers of the Company.
Name Age(1) Position
Kermit K. Houser 58 President and Chief Executive Officer
Robert A. Tucker 53 Executive Vice President and Chief Credit
Officer (Retired effective October 2001)
Ben A. Gay 54 Executive Vice President and Chief Credit
Officer (Effective September 2001)
Marshall J. Alexander 50 Executive Vice President and Chief
Financial Officer
Frank X. Hernandez 46 Senior Vice President and Chief Operations
Officer
Craig Moore 44 Senior Vice President/Chief Auditor/Corporate
Counsel
______________
(1) At September 30, 2001.
Kermit K. Houser has served as President and Chief Executive Officer of the
Company and the Association since November 2000. Mr. Houser was previously
employed in various capacities by the Bank of America from 1991 to November
2000, as senior vice president and manager for commercial banking, executive
vice president and senior credit officer, and most recently, as senior vice
president and market executive for Bank of America's South Valley commercial
banking, in Fresno, California. Mr. Houser has 30 years of experience in
banking, and has been an active member of numerous civic and community
organizations.
Robert A. Tucker has been employed by the Association since 1973. He has served
as Senior Vice President since November 1989. He served as Chief Operating
Officer from March 1997 to June 1998 and has served as Chief Lending Officer and
Secretary since July 1998. Mr. Tucker retired from the Company effective October
2001.
Ben A. Gay joined Klamath First in September 2001 after a 30-year career in
commercial banking and insurance, on both the East and West coasts. Mr. Gay has
served in a variety of managerial positions in credit risk and loan management
and has most recently served as a western regional executive for credit risk
management for a major banking concern.
Marshall J. Alexander has been employed by the Association since 1986. He has
served as Vice President and Chief Financial Officer since August 1994 and was
named an Executive Vice President in December 2000.
Frank X. Hernandez has been employed by the Association since 1991. He served as
Human Resources Officer until July 1998 when he was appointed Senior Vice
President and Chief Operating Officer.
Craig M. Moore has a banking career of more than 20 years, with four of those
years at Klamath First. He is an attorney, a Certified Internal Auditor and a
Certified Financial Services Auditor.
Item 2. Properties
The following table sets forth the location of the Association's offices and
other facilities used in operations as well as certain additional information
relating to these offices and facilities as of September 30, 2001.
Year Square
Description/Address Opened Leased/Owned Footage
- ------------------------ ------ ------------ -------
Main Office
540 Main Street 1939 Owned 25,660
Klamath Falls, Oregon
Branch Offices
2943 South Sixth Street 1972 Owned 3,820
Klamath Falls, Oregon
2323 Dahlia Street 1979 Owned 1,876
Klamath Falls, Oregon
512 Walker Avenue 1977 Owned 4,216
Ashland, Oregon
1420 East McAndrews Road 1990 Owned 4,006
Medford, Oregon
61515 S. Highway 97 1993 Owned 5,415
Bend, Oregon
2300 Madison Street 1995 Owned 5,000
Klamath Falls, Oregon
721 Chetco Avenue 1997 Owned 5,409
Brookings, Oregon
293 North Broadway 1997 Owned 5,087
Burns, Oregon
111 West Main Street 1997 Owned 1,958
Carlton, Oregon
103 South Main Street 1997 Owned 2,235
Condon, Oregon
259 North Adams 1997 Owned 5,803
Coquille, Oregon
106 Southwest 1st Street 1997 Owned 4,700
Enterprise, Oregon
Year Square
Description/Address Opened Leased/Owned Footage
- ------------------------ ------ ------------ -------
555 1st Street 1997 Owned 1,844
Fossil, Oregon
708 Garibaldi Avenue 1997 Owned 1,400
Garibaldi, Oregon
29804 Ellensburg Avenue 1997 Owned 3,136
Gold Beach, Oregon
111 North Main Street 1997 Owned 4,586
Heppner, Oregon
810 South Highway 395 1997 Leased 6,000
Hermiston, Oregon
200 West Main Street 1997 Owned 4,552
John Day, Oregon
1 South E Street 1997 Owned 5,714
Lakeview, Oregon
206 East Front Street 1997 Owned 2,920
Merrill, Oregon
165 North 5th Street 1997 Owned 2,370
Monroe, Oregon
217 Main Street 1997 Owned 6,067
Nyssa, Oregon
48257 East 1st Street 1997 Owned 3,290
Oakridge, Oregon
227 West Main Street 1997 Owned 2,182
Pilot Rock, Oregon
716 Northeast Highway 101 1997 Owned 2,337
Port Orford, Oregon
178 Northwest Front Street 1997 Owned 2,353
Prairie City, Oregon
315 North Main Street 1997 Owned 3,638
Riddle, Oregon
38770 North Main Street 1997 Owned 2,997
Scio, Oregon
Year Square
Description/Address Opened Leased/Owned Footage
- ------------------------ ------ ------------ -------
508 Main Street 1997 Owned 2,282
Moro, Oregon
144 South Main Street 1997 Owned 2,146
Union, Oregon
165 North Maple Street 1997 Owned 2,192
Yamhill, Oregon
475 NE Windy Knolls Drive 1998 Owned 3,120
Bend, Oregon
185 East California 1998 Owned 2,116
Jacksonville, Oregon
1217 Plaza Boulevard, Suite A 2000 Leased 2,400
Central Point, Oregon
948 Southwest 9th Street 2001 Owned 3,277
Redmond, Oregon
2203 SW Court Place 2001 Leased 540
Pendleton, Oregon
1775 East Idaho Avenue 2001 Leased 693
Ontario, Oregon
2727 South Quillan Street 2001 Leased 693
Kennewick, Washington
2801 Duportail Street 2001 Leased 966
Richland, Washington
303 11th Street 2001 Leased 2,920
Astoria, Oregon
2245 Main Street 2001 Leased 4,911
Baker City, Oregon
1095 Oregon Avenue 2001 Leased 4,382
Bandon, Oregon
110 North Redwood Highway 199 2001 Leased 3,091
Cave Junction, Oregon
199 North Nehalem 2001 Leased 2,400
Clatskanie, Oregon
Year Square
Description/Address Opened Leased/Owned Footage
- ------------------------ ------ ------------ -------
212 South 5th Street 2001 Leased 6,200
Coos Bay, Oregon
150 South Wall 2001 Leased 9,271
Coos Bay, Oregon
430 Highway 101 2001 Leased 4,783
Florence, Oregon
2212 Island Avenue 2001 Leased 4,616
LaGrande, Oregon
1611 Virginia Avenue 2001 Leased 5,631
North Bend, Oregon
761 Avenue G 2001 Leased 2,416
Seaside, Oregon
2405 3rd Street 2001 Leased 4,690
Tillamook, Oregon
411 Pacific Avenue 2001 Leased 2,819
Tillamook, Oregon
Backoffice Processing Facilities
600 Main Street 1998 Leased 2,800
Klamath Falls, Oregon
714 Main Street 2001 Leased 15,185
Klamath Falls, Oregon
533 Main Street 2000 Leased 1,325
Klamath Falls, Oregon
The net book value of the Company's investment in office, properties and
equipment totaled $16.9 million at September 30, 2001. See Note 6 of Notes to
the Consolidated Financial Statements contained in the Annual Report.
Item 3. Legal Proceedings
Periodically, there have been various claims and lawsuits involving the Company,
mainly as a defendant, such as claims to enforce liens, condemnation proceedings
on properties in which the Association holds security interests, claims
involving the making and servicing of real property loans and other issues
incident to the Association's business. The Company is not a party to any
pending legal proceedings that it believes would have a material adverse effect
on the financial condition or operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended September 30, 2001.
PART II
Item 5. Market for the Registrant's Common Equity and Related Shareholder
Matters
The information contained under the section captioned "Common Stock
Information" on page 19 of the Annual Report is incorporated herein by
reference.
Item 6. Selected Financial Data
The information contained under the section captioned "Selected
Consolidated Financial Data" on pages 8 and 9 of the Annual Report is
incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of
Operations" beginning on page 10 of the Annual Report is incorporated
herein by reference.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Market Risk and Asset/Liability Management" beginning on
page 10 of the Annual Report is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
(a) Financial Statements
Independent Auditors' Report*
Consolidated Balance Sheets as of September 30, 2001 and 2000*
Consolidated Statements of Earnings for the Years Ended
September 30, 2001, 2000 and 1999*
Consolidated Statements of Shareholders' Equity for the Years
Ended September 30, 2001, 2000 and 1999*
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2001, 2000 and 1999*
Notes to the Consolidated Financial Statements*
* Included in the Annual Report attached as Exhibit 13 hereto and
incorporated herein by reference. All schedules have been omitted as
the required information is either inapplicable or included in the
Consolidated Financial Statements or related Notes contained in the
Annual Report.
(b) Supplementary Data
The information entitled "Consolidated Supplemental Data - Selected
Quarterly Financial Data" on page 39 of the Annual Report is
incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There have been no changes in or disagreements with Accountants on
accounting and financial disclosure during the year ended September
30, 2001.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information contained under the section captioned "Proposal I -
Election of Directors" contained in the Company's Proxy Statement, and
"Part I -- Business -- Personnel -- Executive Officers" of this
report, is incorporated herein by reference. Reference is made to the
cover page of this report for information regarding compliance with
Section 16(a) of the Exchange Act.
Item 11. Executive Compensation
The information contained under the sections captioned "Executive
Compensation," "Directors' Compensation" and "Benefits" under
"Proposal I - Election of Directors" in the Proxy Statement is
incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the section captioned "Security Ownership of
Certain Beneficial Owners and Management" of the Proxy
Statement.
(b) Security Ownership of Management
The information required by this item is incorporated herein
by reference to the sections captioned "Proposal I -
Election of Directors" and "Security Ownership of Certain
Beneficial owners and Management" of the Proxy Statement.
(c) Changes in Control
The Company is not aware of any arrangements, including any
pledge by any person of securities of the Company, the
operation of which may at a subsequent date result in a
change in control of the Company.
The information required by this item is incorporated herein by
reference to the sections captioned "Proposal I - Election of
Directors" and "Security Ownership of Certain Beneficial Owners and
Management" of the Proxy Statement.
Item 13. Certain Relationships and Related Transactions
The information set forth under the section captioned "Proposal I -
Election of Directors - Certain Transactions with the Association" in
the Proxy Statement is incorporated herein by reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits
3(a) Articles of Incorporation of the Registrant*
3(b) Bylaws of the Registrant*
10(a) Employment Agreement with Kermit K. Houser
10(b) Employment Agreement with Marshall J. Alexander
10(c) Employment Agreement with Frank X. Hernandez
10(d) Employment Agreement with Craig M. Moore
10(e) Employment Agreement with Ben A. Gay
10(f) 1996 Stock Option Plan**
10(g) 1996 Management Recognition and Development Plan**
13 Annual Report to Shareholders
21 Subsidiaries of the Registrant
23 Consent of Deloitte & Touche LLP with respect to
financial statements of the Registrant
___________________
* Incorporated by reference to the Registrant's Registration Statement on
Form S-1, filed on June 19, 1995.
** Incorporated by reference to the Registrant's Definitive Proxy
Statement for the 1996 Annual Meeting of
Shareholders.
(b) Reports on Form 8-K
One Current Report on Form 8-K was filed during the quarter ended
September 30, 2001. On September 12, 2001, the Company filed a Current
Report on Form 8-K in which it announced the completion of the
acquisition of 13 branches from Washington Mutual Bank.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
KLAMATH FIRST BANCORP, INC.
Date: December 28, 2001 By: /s/ Kermit K. Houser
Kermit K. Houser
President and Chief Executive Officer
Pursuant to the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities
and on the dates indicated.
SIGNATURES TITLE DATE
/s/ Kermit K. Houser President, Chief December 28, 2001
Kermit K. Houser Executive Officer and
Director (Principal
Executive Officer)
/s/ Marshall J. Alexander Executive Vice President and December 28, 2001
Marshall J. Alexander Chief Financial Officer
(Principal Financial
and Accounting Officer)
/s/ Rodney N. Murray Chairman of the Board December 28, 2001
Rodney N. Murray of Directors
/s/ Bernard Z. Agrons Director December 28, 2001
Bernard Z. Agrons
/s/ Timothy A. Bailey Director December 28, 2001
Timothy A. Bailey
/s/ James D. Bocchi Director December 28, 2001
James D. Bocchi
/s/ William C. Dalton Director December 28, 2001
William C. Dalton
/s/ J. Gillis Hannigan Director December 28, 2001
J. Gillis Hannigan
/s/ Dianne E. Spires Director December 28, 2001
Dianne E. Spires