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, 2002
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
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
540 Main Street, Klamath Falls, Oregon 97601
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (541) 882-3444
Securities registered pursuant to Section 12(b) of the Act: None
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
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
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES X NO
As of November 29, 2002, there were issued and outstanding 6,746,481 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 29, 2002 of $15.15,
was $85,830,492. For purposes of this calculation, common stock of the
Registrant held by officers and directors of the Registrant and the Klamath
First Federal Savings and Loan Association Employee Stock Ownership Plan are
considered affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Registrant's Annual Report to Shareholders for the Fiscal
Year Ended September 30, 2002 ("Annual Report") (Parts I and II).
2. Portions of Registrant's Definitive Proxy Statement for the 2003 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, 2002, the Company had total assets of $1.5 billion, total
deposits of $1.1 billion and shareholders' equity of $119.9 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 and expanded and complemented 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 2002 Annual Report to Shareholders ("Annual
Report"), included as Exhibit 13 to this Form 10-K.
The Association is a progressive, community-oriented financial institution
that focuses on serving customers 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,
2002, permanent residential one- to four-family real estate loans totaled $339.4
million, or 54.53% 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 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,
2002, the Association's total loan portfolio consisted of 66.43% fixed rate and
33.57% adjustable rate loans, after deducting loans in process and
non-performing loans.
Market Area
The Association continues to expand its market area in Oregon and
Washington. Upon the acquisition of 13 branches from WAMU in September 2001, the
Association had a presence in 26 of Oregon's 36 counties and had one
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in-store branch in the state of Washington. In fiscal 2002, new in-store
branches were opened in Hermiston, Eugene and Springfield, Oregon and Richland,
Washington. Also during fiscal 2002, a second branch was opened in Medford,
Oregon, expanding service to that community. 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
sectors. Tourism is a significant industry in many regions of the market area,
including Central Oregon and the Oregon coast. The addition of branches in the
Eugene-Springfield metropolitan area provides access to this major population
center.
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.
Year Ended
At September 30,
September 30, --------------------------------------
2002 2002 2001 2000
------ ------ ------ ------
Weighted average yield:
Loans receivable ............................ 7.36% 7.90% 7.86% 7.64%
Mortgage-backed and related securities ...... 5.54 5.18 6.02 5.86
Investment securities ....................... 4.80 4.72 5.64 6.00
Federal funds sold .......................... 1.70 2.09 4.13 5.59
Interest-earning deposits ................... 1.79 1.75 4.06 5.63
FHLB stock .................................. 6.05 6.25 6.75 6.69
Combined weighted average yield on
interest-bearing assets ....................... 6.28 6.35 6.99 7.22
---- ---- ---- ----
Weighted average rate paid on:
Tax and insurance reserve ................... 1.29 2.85 3.85 2.02
Passbook and statement savings .............. 0.75 1.13 2.26 1.78
Interest-bearing checking ................... 0.44 0.74 1.08 1.12
Money market ................................ 1.44 2.00 3.85 4.17
Certificates of deposit ..................... 4.00 4.35 5.76 5.40
FHLB advances/Short term borrowings ......... 5.07 5.69 5.95 5.90
Combined weighted average rate on
interest-bearing liabilities .................. 3.19 3.31 4.81 4.72
---- ---- ---- ----
Interest rate spread ........................... 3.09% 3.04% 2.18% 2.50%
==== ==== ==== ----
2
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 13 of the Annual Report, which
section is incorporated herein by reference.
Interest Sensitivity Gap Analysis
Reference is made to the section entitled "Interest Sensitivity Gap
Analysis" on page 10 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 14
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. 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 $339.4
million, or 54.53%, of the Association's total loan portfolio before net items
at September 30, 2002. The Association originates other loans secured by
multi-family residential and commercial real estate, construction and land
loans. Those loans amounted to $137.6 million, or 22.11%, of the total loan
portfolio before net items at September 30, 2002. Approximately 23.36%, or
$145.4 million, of the Association's total loan portfolio before net items, as
of September 30, 2002, consisted of non-real estate loans. Commercial real
estate and non-real estate loans increased significantly as a result of the WAMU
branch acquisition in September 2001. 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. Fiscal 2002 showed
continued growth in non-real estate 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 $15.4 million at September 30, 2002. At September 30, 2002, the
Association had 54 borrowing relationships with outstanding balances in excess
of $1.0 million, the largest of which amounted to $7.2 million and consisted of
eight loans, five of which were secured by commercial and single family real
estate and three of which were 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, 2002, $207.5
million, or 33.57%, of loans in the
3
Association's total loan portfolio after loans in process and non-performing
loans, consisted of adjustable rate loans. At September 30, 2001, $203.7
million, or 29.43%, of the Association's loans carried adjustable rates.
4
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,
--------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------- ----------------- ----------------- ---------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- ------- ------- ------- ------- --------
(Dollars in thousands)
Real estate loans:
Permanent residential
one- to four-family ...... $339,404 54.53% $421,499 60.12% $639,165 85.12% $647,130 83.56% $577,471 81.95%
Multi-family residential ... 21,595 3.47 23,257 3.32 19,015 2.53 18,412 2.38 19,230 2.73
Construction ............... 15,224 2.45 21,674 3.09 25,289 3.37 53,219 6.87 64,289 9.12
Agricultural ............... 4,889 0.79 4,218 0.60 -- -- -- -- -- --
Commercial ................. 91,703 14.73 99,318 14.17 42,277 5.63 37,079 4.79 29,457 4.18
Land ....................... 4,164 0.67 3,697 0.53 3,394 0.45 2,064 0.27 2,185 0.31
-------- ------- -------- ------- -------- ------- ------- ------- ------- --------
Total real estate loans ...... 476,979 76.64 573,663 81.83 729,140 97.10 757,904 97.87 692,632 98.29
-------- ------- -------- ------- -------- ------- ------- ------- ------- --------
Non-real estate loans:
Savings accounts ........... 1,262 0.20 2,091 0.30 1,957 0.26 1,800 0.23 1,991 0.28
Home improvement and home
equity loans ............. 65,092 10.46 50,464 7.20 8,338 1.11 6,726 0.87 5,750 0.82
Other consumer ............. 16,926 2.72 18,697 2.67 6,888 0.92 4,568 0.59 2,287 0.32
Commercial ................. 62,102 9.98 56,098 8.00 4,586 0.61 3,443 0.44 2,043 0.29
-------- ------- -------- ------- -------- ------- ------- ------- ------- --------
Total non-real estate loans .. 145,382 23.36 127,350 18.17 21,769 2.90 16,537 2.13 12,071 1.71
-------- ------- -------- ------- -------- ------- ------- ------- ------- --------
Total loans ................. 622,361 100.00% 701,013 100.00% 750,909 100.00% 774,441 100.00% 704,703 100.00%
======= ======= ======= ======= =======
Less:
Undisbursed portion of loans . 3,609 8,473 10,350 24,176 26,987
Deferred loan fees ........... 3,911 4,599 7,440 7,988 7,620
Allowance for loan losses .... 7,376 7,951 4,082 2,484 1,950
-------- -------- -------- -------- --------
Net loans .................... $607,465 $679,990 $729,037 $739,793 $668,146
======== ======== ======== ======== ========
5
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,
----------------------------------------------------------------
2002 2001
-------------------------- --------------------------
Amount Percent Amount Percent
--------- ------- --------- -------
(Dollars in thousands)
Fixed rate... . . . . . $410,499 66.43% $488,559 70.57%
Adjustable-rate......... 207,458 33.57 203,719 29.43
-------- ------ -------- ------
Total.............. $617,957 100.00% $692,278 100.00%
======== ====== ======== ======
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, 2002, $339.4 million, or 54.53%, of the
Association's total loan portfolio, before net items, consisted of permanent
residential one- to four-family mortgage loans, down from $421.5 million at
September 30, 2001. At September 30, 2002, the average balance of the
Association's permanent residential one- to four-family mortgage loans was
$78,397.
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, 2002, $311.4 million, or 50.40%, of the total loans
after loans in process and non-performing loans were fixed rate one- to
four-family loans and $28.4 million, or 4.59%, 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, while ARM loans are retained in the portfolio.
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, 2002,
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 offers several loan products which are competitive with other
institutions originating mortgages in the Association's primary market area. The
Association has introduced variable rate loan products that bear fixed rates for
the first three or five years and then reprice annually thereafter. The loans
which bear fixed rates for five years are indexed to the One-Year Constant
Maturity Treasury Bill Index and have a maximum rate increase of 5.00% over the
life of the loan. The loans which bear fixed rates for the first three years are
indexed to the FHLB of Seattle 12-Month Short Term Advance Rate and have a
maximum increase of 6.00% over the life of the loan. All ARM loan products have
a maximum increase or decrease of 2.00% in any one year. 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 Association qualifies an 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 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
6
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.
Commercial and Multi-Family Real Estate Loans. The Association originates
loans secured by multi-family and commercial real estate and also purchases
participations in loans secured by multi-family and commercial real estate when
suitable investments can be found. See "-- Loan Originations, Purchases, and
Sales." At September 30, 2002, $21.6 million, or 3.47%, of the Association's
total loan portfolio before net items consisted of loans secured by existing
multi-family residential real estate and $91.7 million, or 14.73%, 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. Substantially 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 $248,667 at September 30, 2002, the
largest of which was a $3.5 million commercial real estate loan secured by a
motel. Originations of commercial real estate and multi-family residential real
estate amounted to 11.2%, 16.46% and 11.09% of the Association's total loan
originations in the fiscal years ended September 30, 2002, 2001, and 2000,
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, 2002 the
Association purchased $1.7 million in commercial real estate participations. The
properties securing these loans were located within the Association's market
area.
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, 2002, $105.6 million, or 17.07%, after
7
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 construction loans 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. Speculative loans are scheduled to pay
off in 12 to 18 months. At September 30, 2002, construction loans amounted to
$15.2 million (including $4.6 million of speculative loans), or 2.45%, of the
Association's total loan portfolio before net items. The Association purchased
$1.7 million in commercial construction loans from WAMU as part of the branch
purchase. During the construction phase, the borrower pays only interest on the
disbursed loan proceeds until maturity, when the total amount is due. 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.
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 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's
underwriting criteria are designed to evaluate and minimize the risks of each
construction 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, 2002, $4.2
million, or 0.67%, of the Association's total loan portfolio consisted of land
loans.
Commercial Business Lending. The purchase of the branches from WAMU in
September 2001 included significant commercial business loans as well as the
lending expertise needed for commercial lending activities. As a result,
commercial business lending has increased due to both loans purchased from WAMU
and new originations during fiscal 2002. The Association's commercial business
lending activities focus 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, 2002, commercial business loans amounted
to $62.1 million, or 9.98% of the total loan portfolio and
8
42.72% of total non-real estate loans. Included in these loans are $14.2 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 cash flow and profitability of the business,
and creditworthiness of the borrower (and guarantors) and requires successful
operation and management of the business entity while liquidation of the
collateral is a secondary and sometimes insufficient source of repayment.
Consequently, repayment of such loans may be affected by adverse business or
economic conditions.
As part of its commercial business lending activities, the Association
issues standby letters of credit or performance bonds as an accommodation to its
borrowers. See "-- Loan Commitments and Letters of Credit."
Agricultural Lending. The Association did not offer loans on agricultural
properties or for agricultural production until the WAMU branch acquisition,
even though agriculture is a major industry in the Association's market area. As
part of the WAMU branch acquisition, the Association purchased $4.2 million of
agricultural real estate loans and $11.9 million of agricultural production
loans, as well as obtaining lending personnel with expertise in originating and
monitoring agricultural loans. At September 30, 2002, agricultural loans
amounted to $19.1 million, or 3.07%, of the total loan portfolio; $4.9 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. Payments on agricultural operating loans
depend on the successful operation of the farm, which may be adversely affected
by weather conditions that limit crop yields, fluctuations in market prices for
agricultural products and livestock, and changes in government regulations and
subsidies.
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. Uncertain supplies of water in some market areas 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
9
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, 2002,
the Association was 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, 2002, the Association's
consumer loans totaled $83.3 million, or 13.38%, 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 in September 2001. 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.
The Association has placed increasing emphasis on 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 consumer 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 and unsecured lines of
credit have interest rates that vary above the prime lending rate based on the
credit risk of the borrower, collateral, and loan amount. In both cases, the
rate adjusts monthly. The Association requires minimum payment of interest only,
and depending on the loan product, may require at least 2% of the unpaid
principal balance monthly. At September 30, 2002, $29.4 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,
2002, home equity loans and home improvement loans amounted to $65.1 million, or
78.16% of consumer loans, and 10.46% of total loans.
At September 30, 2002, the Association's automobile loan portfolio amounted
to $7.7 million, or 9.19%, of consumer loans and 1.23% of total loans at that
date. The maximum term for the Association's automobile loans is 72 months with
the amount financed based upon a percentage 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, 2002, unsecured consumer loans amounted to $5.1 million,
or less than 1%, of total loans. These loans are made for a maximum of 48 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
10
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, 2002, the Association had $248,000 in consumer
loans accounted for on a nonaccrual basis.
Loan Maturity and Repricing. The following table sets forth certain
information at September 30, 2002 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................... $ 19,116 $ 9,256 $ -- $ 28,372
Fixed rate........................ 853 1,626 308,948 311,427
Other mortgage loans:
Adjustable rate................... 32,996 72,276 237 105,509
Fixed rate........................ 609 4,516 22,385 27,510
Non-real estate loans:
Adjustable rate................... 64,557 8,951 69 73,577
Fixed rate........................ 3,616 19,244 48,702 71,562
-------- -------- -------- --------
Total loans..................... $121,747 $115,869 $380,341 $617,957
======== ======== ======== ========
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, 2002, which have fixed interest rates
and have adjustable rates, was $405.4 million and $90.8 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
60 days from commitment. The Association had outstanding loan commitments of
approximately $33.0 million at September 30, 2002 consisting of $12.9 million of
variable rate loans and $20.1 million of fixed rate loans. See Note 14 of the
Notes to 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 developers, builders, existing customers,
newspapers, radio, periodical advertising and walk-in customers, although
referrals from local realtors have 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.
11
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 a credit officer with
appropriate underwriting authority for approval. Certain large loans, where the
borrower has aggregate debt with the Association of $1 million or more, are
reviewed by the board of directors. For those relationships in which the
aggregate debt with the Association is $3 million or greater, board approval is
required prior to funding of the loan. 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,
2002, the Association originated $281.7 million in total loans, compared to
$136.5 million during the same period of 2001. 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, $68.7 million in fixed rate loans were
sold during the year ended September 30, 2002, 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. 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, 2002, the balance of such loans was $4.4 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, 2002, the balance of such purchased loans was $9.5
million. These loans were underwritten on the same basis as similar loans
originated by the Association.
12
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,
----------------------------------------------
2002 2001 2000
--------- ---------- --------
(In thousands)
Total net loans at beginning of period...................... $679,990 $729,037 $739,793
-------- -------- --------
Loans originated and purchased:
Real estate loans originated (1)........................... 161,278 93,907 81,671
Real estate loans purchased................................ 1,683 83,192 508
Non-real estate loans originated........................... 120,388 42,586 15,575
Non-real estate loans purchased............................ -- 99,720 --
-------- -------- --------
Total loans originated and purchased..................... 283,349 319,405 97,754
-------- -------- --------
Loan reductions:
Principal paydowns......................................... (287,526) (145,544) (98,853)
Loans sold................................................. (68,661) (30,709) (6,315)
Loans securitized.......................................... -- (190,300) --
Other reductions (2)....................................... 313 (1,899) (3,342)
-------- -------- --------
Total loan reductions................................... (355,874) (368,452) (108,510)
-------- -------- --------
Total net loans at end of period............................ $607,465 $679,990 $729,037
======== ======== ========
(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, 2002, the Association had $3.9 million of net
loan fees which had been deferred and are being recognized as income over the
contractual maturities of the related loans.
13
Asset Quality
Delinquent Loans. The following table sets forth information concerning
delinquent loans at September 30, 2002, 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 Commercial Commercial
1-4 family Real Estate Non-Real Estate Consumer Total
Amount Percentage Amount Percentage Amount Percentage Amount Percentage Amount Percentage
(Dollars in thousands)
Loans delinquent for
90 days and more..... $444 0.07% $ 353 0.06% $47 0.01% $247 0.04% $1,091 0.18%
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, and reviewed by the Board of Directors.
For commercial loans, the borrowers are assigned to a commercial lender who
is responsible for monitoring the relationship including collecting on
delinquencies. When necessary, repossession, foreclosure, or other action may be
taken including use of outside counsel.
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 the Notes to 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
14
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, 2002, the Association's total nonaccrual loans amounted
to $1.1 million, or 0.18% of total loans, before net items, compared with
$270,000, or 0.04% of total loans, before net items, at September 30, 2001.
Nonaccrual loans at September 30, 2002 by type are detailed in the table below.
The increase in nonaccrual loans is primarily attributable to increases in
nonaccrual commercial and consumer loans. The balance of these types of loans
increased considerably with the WAMU branch acquisition in 2001 and so it is not
unexpected that there is an increase in nonaccrual loans of these types.
At September 30, 2002, the Association had $188,000 in restructured loans.
Real estate owned increased from the prior year primarily as a result of
the foreclosure on a commercial property during the year ended September 30,
2002. Properties held as real estate owned at September 30, 2001 were all
subsequently sold.
The following table sets forth the amounts and categories of the
Association's non-performing assets at the dates indicated.
At September 30,
2002 2001 2000 1999 1998
(Dollars in thousands)
Non-accruing loans:
One- to four-family real estate ..................... $444 $270 $715 $915 $513
Commercial real estate............................... 353 -- -- 2,400 --
Commercial non-real estate........................... 47 -- -- -- --
Consumer............................................. 247 -- 95 -- 11
Accruing loans greater than 90
days delinquent........................................ -- -- -- -- --
------ ----- ------ ------ ----
Total non-performing loans........................... 1,091 270 810 3,315 524
------ ----- ------ ------ ----
Real estate owned........................................ 717 446 788 1,495 --
Other repossessed assets................................. 42 -- -- -- --
------ ----- ------ ------ ----
Total repossessed assets............................. 759 446 788 1,495 --
------ ----- ------ ------ ----
Total non-performing assets.......................... $1,850 $ 716 $1,598 $4,810 $524
====== ===== ====== ====== ====
Total non-performing assets as a
percentage of total assets............................. 0.12% 0.05% 0.16% 0.46% 0.05%
Total non-performing loans as a
percentage of total loans,
before net items....................................... 0.18% 0.04% 0.21% 0.62% 0.07%
Allowance for loan losses as a
percentage of total non-performing
assets................................................. 398.70% 1110.47% 255.44% 51.64% 372.14%
Allowance for loan losses as a percentage
of total non-performing loans.......................... 676.08% 2944.81% 503.95% 74.93% 372.14%
15
The allowance for loan losses as a percentage of both total non-performing
assets and total non-performing loans has decreased significantly at September
30, 2002. These decreases are the result of increases in non-performing loans
and non-performing assets at September 30, 2002. At September 30, 2001, the
allowance balance was greatly increased due 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 had not been an impact
causing the level of non-performing loans and assets to increase by September
30, 2001. At present, the performance of the purchased loans has exceeded
expectations and the Association believes that current reserves are adequate to
cover the risk in the portfolio based on current levels of delinquency and
non-performing assets.
For the year ended September 30, 2002, 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, 2002, total classified assets amounted to 0.30% of
total assets, an increase from 0.16% at September 30, 2001. Assets classified
substandard at September 30, 2002 totaled $4.4 million and included $353,781 in
one- to four-family residential loans, a $843,144 land development loan,
$2.1million in commercial real estate and $758,663 in foreclosed real estate
consisting of five single family residences, a commercial property, and a boat.
Assets classified substandard at September 30, 2001 totaled $2.7 million and
included $270,393 in one- to four-family construction loans, a $2.0 million land
development loan and $445,855 in foreclosed real estate consisting of single
family residences. 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 No. 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 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
16
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,
2002, the Association had an allowance for loan losses of $7.4 million, which
was equal to 398.70% of non-performing assets and 1.19% 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, 2002, 2001 and 2000
were $156,000, $387,000, and $1.8 million 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 and securitization 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 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.
17
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.
At or for the Year Ended September 30,
2002 2001 2000 1999 1998
(Dollars in thousands)
Total loans outstanding ....................... $ 622,361 $ 701,013 $ 750,909 $ 774,441 $ 704,703
Average loans outstanding ..................... $ 660,246 $ 611,095 $ 747,842 $ 721,658 $ 614,457
Allowance at beginning of period .............. $ 7,951 $ 4,082 $ 2,484 $ 1,950 $ 1,296
--------- --------- --------- --------- ---------
Loans charged off:
One- to four-family ...................... -- (3) -- -- --
Construction ............................. -- (19) (32) -- --
Commercial real estate ................... (323) -- (559) (392) --
Commercial business ...................... (134) (12) -- -- (17)
Consumer ................................. (290) (56) (16) (6) (3)
--------- --------- --------- --------- ---------
Total charge offs ................... (747) (90) (607) (398) (20)
--------- --------- --------- --------- ---------
Recoveries of loans previously charged off:
Commercial real estate ................... -- 34 440 -- --
Consumer ................................. 16 8 1 -- --
--------- --------- --------- --------- ---------
Total recoveries .................... 16 42 441 -- --
--------- --------- --------- --------- ---------
Provision for loans losses .................... 156 387 1,764 932 674
Acquisitions .................................. -- 3,761 -- -- --
Allowance reclassified with loan securitization -- (231) -- -- --
--------- --------- --------- --------- ---------
Allowance at end of period .................... $ 7,376 $ 7,951 $ 4,082 $ 2,484 $ 1,950
========= ========= ========= ========= =========
Allowance for loan losses as a percentage
of total loans outstanding ................... 1.19% 1.13% 0.54% 0.32% 0.28%
Ratio of net charge-offs to average loans
outstanding during the period ................ 0.11% 0.01% 0.02% 0.06% --%
18
The following tables set 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,
2002 2001 2000
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 Loan by Category Allowance Total Loans by Category Allowance Total Loans by Category
(Dollars in thousands)
Permanent
residential 1-4
family......... $1,191 0.19% 54.53% $1,292 0.19% 60.12% $1,449 0.19% 85.12%
Multi-family
residential.... 528 0.09 3.47 540 0.08 3.32 365 0.05 2.53
Construction..... 422 0.07 2.45 12 0.01 3.09 420 0.05 3.37
Agriculture...... 169 0.03 0.79 158 0.02 0.60 -- -- --
Commercial real
estate......... 2,611 0.42 14.73 3,611 0.52 14.17 1,403 0.19 5.63
Land............. 77 0.01 0.67 324 0.02 0.53 168 0.02 0.45
Commercial and
industrial..... 1,560 0.25 9.98 1,325 0.19 8.00 86 0.01 0.61
Consumer......... 818 0.13 13.38 689 0.10 10.17 191 0.03 2.29
------ ------ ------ ------ ------ ------
Total......... $7,376 1.19% 100.00% $7,951 1.13% 100.00% $4,082 0.54% 100.00%
====== ====== ====== ====== ====== ======
At September 30,
2000 1999
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.................... $1,103 0.14% 83.56% $1,141 0.16% 81.95%
Multi-family residential........ 267 0.03 2.38 124 0.02 2.73
Construction.................... 221 0.03 6.87 116 0.02 9.12
Agriculture..................... -- -- -- -- -- --
Commercial real estate.......... 730 0.09 4.79 444 0.07 4.18
Land............................ 28 -- 0.27 29 -- 0.31
Commercial and industrial....... 23 -- 0.44 14 -- 0.29
Consumer........................ 112 0.02 1.69 82 0.01 1.42
------ ------ ------ ------
Total........................ $2,484 0.31% 100.00% $1,950 0.28% 100.00%
====== ====== ====== ======
19
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 $102.8 million at September 30, 2002, plus an additional 10% if
the investments are fully secured by readily marketable collateral. See
"REGULATION OF THE ASSOCIATION-- 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 or Board of Directors 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, 2002,
the Company had no held to maturity securities. 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,
2002, the portfolio of securities available for sale consisted of $42.0 million
in tax exempt securities issued by states and municipalities, $18.1 million in
federal agency preferred stock, and $59.4 million in investment grade corporate
investments.
During the years ended September 30, 2002, 2001, and 2000, 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, Accounting for Derivative Instruments and Hedging Activities, would apply.
20
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,
2002 2001 2000
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
Available for sale:
U.S. Government obligations ... -- -- 40,120 40,852 49,190 48,786
State and municipal obligations 39,578 42,026 32,951 33,640 25,600 24,943
Corporate obligations ......... 61,648 59,423 65,404 64,718 43,899 42,899
FHLMC preferred stock ......... 18,715 18,093 15,716 15,466 -- --
-------- -------- -------- -------- -------- --------
Total ....................... $119,941 $119,542 $154,326 $154,813 $118,956 $116,898
======== ======== ======== ======== ======== ========
At September 30,
2002 2001 2000
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 0.23%
Available for sale:
U.S. Government obligations............................. -- -- 40,120 26.00 49,190 41.35
State and municipal obligations......................... 39,578 33.00 32,951 21.35 25,600 21.52
Corporate obligations................................... 61,648 51.40 65,404 42.38 43,899 36.90
FHLMC preferred stock................................... 18,715 15.60 15,716 10.18 -- --
-------- ------ -------- ------ -------- ------
Total................................................. $119,941 100.00% $154,326 100.00% $118,956 100.00%
======== ====== ======== ====== ======== ======
The following table sets forth the maturities and weighted average yields
of the debt securities in the investment portfolio at September 30, 2002.
One Year After One Through After Five Through After Ten
or Less Five Years Ten Years Years
Amount Yield Amount Yield Amount Yield Amount Yield
(Dollars in thousands)
Available for sale:
State and municipal
obligations (1) $100 4.45% $485 4.13% $790 4.42% $38,203 5.14%
Corporate obligations 17,890 3.42% 23,923 4.98% -- -- 19,835 2.46%
FHLMC preferred stock -- -- -- -- -- -- 18,715 3.10%
_______ _______ ____ _______
Total $17,990 $24,408 $790 $76,753
======= ======= ==== =======
(1) Interest on state and municipal obligations is tax-exempt for federal
income tax purposes. The yields reported have not been calculated on a
tax-equivalent basis.
21
At September 30, 2002 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 $12.0 million.
Mortgage-Backed and Related Securities
At September 30, 2002, the Company's net mortgage-backed and related
securities, all designated available-for-sale, totaled $650.8 million at fair
value ($640.3 million at amortized cost) and had a weighted average yield of
5.54%. At September 30, 2002, 24.50% 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, 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, 2002, the Company held $438.6 million of CMOs, comprised primarily
of three classes, planned amortization class tranches ("PACs"), Sequentials, 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 be more
stable and predictable than 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"). Sequentials, as the
name implies, pay principal and interest sequentially. For example, the "A"
tranche receives payments of principal and interest first, while the "B" and "C"
tranches only receive interest until the "A" tranche principal par value is
completely paid. Then the "B" tranche begins receiving principal and interest
until all of its principal is paid, and so on. Sequential pay CMOs are created
to obtain a more predictable cash flow than the underlying simple pass-through
securities. However, the cash flow risk from the underlying pool remains the
same. 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
22
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.
During the year ended September 30, 2002, MBS with a fair value of $376,335
were transferred from the held-to-maturity category to the available-for-sale
portfolio. The Company does not have plans to purchase or classify securities as
held-to-maturity in the foreseeable future.
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,
2002 2001 2000
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
Available for sale:
Fannie Mae .............. 128,867 130,233 56,833 57,194 13,498 13,598
FHLMC ................... 56,605 57,348 19,538 19,797 32,902 33,282
GNMA .................... 24,346 24,593 6,816 6,977 10,728 10,681
CMOs .................... 430,487 438,622 336,452 337,670 18,355 17,770
---------- ---------- ---------- ---------- ---------- ----------
Total ................. $ 640,305 $ 650,796 $ 421,260 $ 423,280 $ 77,643 $ 77,477
========== ========== ========== ========== ========== ==========
At September 30,
2002 2001 2000
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%
Available for sale:
Fannie Mae.... 128,867 20.13 56,833 13.49 13,498 17.38
FHLMC ........ 56,605 8.84 19,538 4.64 32,902 42.38
GNMA ......... 24,346 3.80 6,816 1.62 10,728 13.82
CMOs ......... 430,487 67.23 336,452 79.87 18,355 23.64
-------- ------ -------- ------ ------- ------
Total ...... $640,305 100.00% $421,260 100.00% $77,643 100.00%
======== ====== ======== ====== ======= ======
Other Interest-Earning Assets
The Company had an other interest-earning asset of $457,000 earning 8.07%
and maturing in May 2112.
Interest-Earning Deposits
The Company had interest-earning deposits in the FHLB of Seattle amounting
to $5.9 million and $4.9 million at September 30, 2002 and 2001, respectively.
Deposit Activities and Other Sources of Funds
23
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 individual retirement account ("IRA")
certificates and certificates of deposit. 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.
The Association occasionally accepts 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, 2002, these deposits totaled $2.3 million, or 0.20% of total
deposits.
Interest rates paid, maturity terms, service fees and withdrawal penalties
are established and reviewed on a periodic basis by the Association.
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, 2002, the Association experienced a net
decrease in deposits (before interest credited) of $38.2 million. The majority
of the decrease relates to declining balances in certificates of deposit. Early
in the year the Association made a conscious effort to reduce interest expense
on higher-priced certificate accounts resulting in a decrease of $87.1 million
for certificates as they matured and were not renewed. Checking, savings, and
money market accounts increased $76.3 million during the year.
At September 30, 2002, certificate accounts maturing during the year ending
September 30, 2003 totaled $275.7 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. The
majority of the Association's depositors are residents of the State of Oregon.
24
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, 2002.
Certificate
Maturity Period Accounts
(In thousands)
Three months or less................................... $11,930
Over three through six months.......................... 20,209
Over six through twelve months......................... 26,181
Over twelve months..................................... 50,440
--------
Total.............................................. $108,760
========
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,
2002 2001 2000
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
(Dollars in thousands)
Certificates of deposit ........ $ 456,719 39.99% ($87,161) $ 543,880 47.17% $171,132 $ 372,748 53.60%
---------- ------ -------- ---------- ------ -------- ---------- ------
Transaction accounts:
Non-interest checking .......... 142,773 12.50 12,124 130,649 11.33 76,309 54,340 7.81
Interest-bearing checking ...... 125,867 11.02 9,111 116,756 10.13 44,570 72,186 10.38
Passbook and statement savings . 86,001 7.53 8,355 77,646 6.74 29,699 47,947 6.90
Money market deposits .......... 330,646 28.96 46,753 283,893 24.63 135,733 148,160 21.31
---------- ------ -------- ---------- ------ -------- ---------- ------
Total transaction accounts ..... 685,287 60.01 76,343 608,944 52.83 286,311 322,633 46.40
---------- ------ -------- ---------- ------ -------- ---------- ------
Total deposits ................. $1,142,006 100.00% ($10,818) $1,152,824 100.00% $457,443 $ 695,381 100.00%
========== ====== ======== ========== ====== ======== ========== ======
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,
2002 2001 2000
(Dollars in thousands)
Beginning balance....................................... $1,152,824 $695,381 $720,401
---------- ---------- --------
Increase due to acquired deposits....................... -- 423,457 --
Net inflow (outflow) of deposits before
interest credited...................................... (38,002) 6,902 (49,728)
Interest credited....................................... 27,184 27,084 24,708
---------- ---------- --------
Net increase (decrease) in deposits..................... (10,818) 457,443 (25,020)
---------- ---------- --------
Ending balance.......................................... $1,142,006 $1,152,824 $695,381
========== ========== ========
25
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, 2002, 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, 2002, 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,
2002 2001 2000
Weighted average rate paid on:
FHLB advances................................................ 5.07% 5.73% 5.90%
Short term borrowings........................................ 4.75% 5.58% 9.01%
Year Ended September 30,
2002 2001 2000
(Dollars in thousands)
Maximum amount outstanding at any month end:
FHLB advances................................................ $205,250 $173,000 $230,000
Short term borrowings........................................ 1,700 6,400 3,000
Approximate average balance:
FHLB advances................................................ 168,333 170,521 207,218
Short term borrowings........................................ 1,705 3,265 1,290
Approximate weighted average rate paid on:
FHLB advances................................................ 5.71% 5.90% 5.88%
Short term borrowings........................................ 4.32% 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 corporation, 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 non-judicial foreclosures.
26
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. The Company also established Klamath First Capital Trust II in April
2002 for the purpose of issuing additional mandatorily redeemable preferred
securities. See Note 13 of the Notes to Consolidated Financial Statements
contained in the Annual Report.
27
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, 2002 was $258,994.
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 $13.5 million at September 30, 2002.
Among other benefits, the FHLB provides a central credit facility 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
28
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 the Association.
As insurer, the FDIC imposes deposit insurance premiums and is authorized
to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the SAIF or the BIF. The FDIC also has the authority to initiate enforcement
actions against savings institutions, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines that
the institution has engaged in unsafe or unsound practices or is in an unsafe or
unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1,
or core capital, to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a
risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semi-annual
basis, if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the United States Treasury or for any other reason deemed
necessary by the FDIC.
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 1.70 points for each $100 in domestic deposits for SAIF
and BIF insured institutions. These assessments, which may be revised based upon
the level of BIF and SAIF deposits, will continue until the bonds mature in 2017
through 2019.
Under the Federal Deposit Insurance Act, 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
29
"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, 2002, 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, it 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,
2002, the Association met the qualified thrift investment test and its QTL
percentage was 79.63%.
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 "-- Regulation of the Company."
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.
30
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). At September 30, 2002, the
Association had tangible capital of $95.5 million, or 6.6% of adjusted total
assets, which is approximately $73.6 million above the minimum requirement of
1.5% of adjusted total assets in effect on that date. At September 30, 2002, the
Association had $40.3 million of intangible assets consisting of core deposit
intangible and other intangible assets related to the Wells Fargo branch
acquisition in 1997 and 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, 2002, the
Association had core capital equal to $95.5 million, or 6.6% of adjusted total
assets, which is $37.2 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, 2002, the Association had total risk-based capital of
approximately $102.8 million, including $95.5 million in core capital and $7.3
million in qualifying supplementary capital, and risk-weighted assets of $733.7
million, or total capital of 14.0% of risk-weighted assets. This amount was
$44.1 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
31
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, 2002, the
Association's limit on loans to one borrower was $15.9 million. At September 30,
2002, the Association's largest aggregate amount of loans to one borrower was
$7.2 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 or 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
32
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.
33
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.
New Federal Legislation
Gramm-Leach-Bliley Financial Services Modernization Act of 1999. On
November 12, 1999, the Gramm-Leach-Bliley Financial Services Modernization Act
of 1999 ("GLBA") was signed into law. The purpose of this legislation is to
modernize the financial services industry by establishing a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms and other financial service providers. Generally, the GLBA:
a. repealed the historical restrictions and eliminates many federal and state
law barriers to affiliations among banks, securities firms, insurance
companies and other financial service providers;
b. provided a uniform framework for the functional regulation of the
activities of banks, savings institutions and their holding companies;
c. broadened the activities that may be conducted by national banks, banking
subsidiaries of bank holding companies and their financial subsidiaries;
34
d. provided an enhanced framework for protecting the privacy of consumer
information;
e. adopted a number of provisions related to the capitalization, membership,
corporate governance and other measures designed to modernize the FHLB
system;
f. modified the laws governing the implementation of the CRA; and
g. addressed a variety of other legal and regulatory issues affecting
day-to-day operations and long-term activities of financial institutions.
The GLBA also imposes certain obligations on financial institutions to
develop privacy policies, restrict the sharing of nonpublic customer data with
nonaffiliated parties at the customer's request, and establish procedures and
practices to protect and secure customer data. These privacy provisions were
implemented by regulations that were effective on November 12, 2000. Compliance
with the privacy provisions was required by July 1, 2001.
The USA Patriot Act. In response to the terrorist events of September 11th,
2001, President George W. Bush signed into law the Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism Act of 2001, or the USA PATRIOT Act, on October 26, 2001. The USA
PATRIOT Act gives the federal government new powers to address terrorist threats
through enhanced domestic security measures, expanded surveillance powers,
increased information sharing, and broadened anti-money laundering requirements.
By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act
takes measures intended to encourage information sharing among bank regulatory
agencies and law enforcement bodies. Further, certain provisions of Title III
impose affirmative obligations on a broad range of financial institutions,
including banks, thrifts, brokers, dealers, credit unions, money transfer agents
and parties registered under the Commodity Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the
following requirements with respect to financial institutions:
- Pursuant to Section 352, all financial institutions must
establish anti-money laundering programs that include, at minimum: (i)
internal policies, procedures, and controls, (ii) specific designation
of an anti-money laundering compliance officer, (iii) ongoing employee
training programs, and (iv) an independent audit function to test the
anti- money laundering program. - Section 326 of the Act authorizes
the Secretary of the Department of Treasury, in conjunction with other
bank regulators, to issue regulations by October 26, 2002 that provide
for minimum standards with respect to customer identification at the
time new accounts are opened.
- Section 312 of the Act requires financial institutions that
establish, maintain, administer, or manage private banking accounts or
correspondent accounts in the United States for non-United States
persons or their representatives (including foreign individuals
visiting the United States) to establish appropriate, specific, and,
where necessary, enhanced due diligence policies, procedures, and
controls designed to detect and report money laundering.
- Effective December 25, 2001, financial institutions are
prohibited from establishing, maintaining, administering or managing
correspondent accounts for foreign shell banks (foreign banks that do
not have a physical presence in any country), and will be subject to
certain recordkeeping obligations with respect to correspondent
accounts of foreign banks.
- Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal
Reserve Act and Bank Merger Act applications.
To date, it has not been possible to predict the impact the USA PATRIOT Act
and its implementing regulations may have on the Company and the Association.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley
Act") was signed into law by President Bush on July 30, 2002 in response to
public concerns regarding corporate accountability in connection with the recent
35
accounting scandals at Enron and WorldCom. The stated goals of the
Sarbanes-Oxley Act are to increase corporate responsibility, to provide for
enhanced penalties for accounting and auditing improprieties at publicly traded
companies and to protect investors by improving the accuracy and reliability of
corporate disclosures pursuant to the securities laws.
The Sarbanes-Oxley Act is the most far-reaching U.S. securities legislation
enacted in some time. The Sarbanes-Oxley Act generally applies to all companies,
both U.S. and non-U.S., that file or are required to file periodic reports with
the Securities and Exchange Commission ("SEC"), under the Securities Exchange
Act of 1934 ("Exchange Act").
The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and securities
exchanges to adopt extensive additional disclosure, corporate governance and
other related rules and mandates further studies of certain issues by the SEC
and the Comptroller General. The Sarbanes- Oxley Act represents significant
federal involvement in matters traditionally left to state regulatory systems,
such as the regulation of the accounting profession, and to state corporate law,
such as the relationship between a board of directors and management and between
a board of directors and its committees.
The Sarbanes-Oxley Act addresses, among other matters:
- audit committees;
- certification of financial statements by the chief executive
officer and the chief financial officer;
- the forfeiture of bonuses or other incentive-based compensation
and profits from the sale of an issuer's securities by directors
and senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
- a prohibition on insider trading during pension plan black out
periods;
- disclosure of off-balance sheet transactions;
- a prohibition on personal loans to directors and officers;
- expedited filing requirements for Form 4s;
- disclosure of a code of ethics and filing a Form 8-K for a change
or waiver of such code;
- "real time" filing of periodic reports
- the formation of a public accounting oversight board;
- auditor independence; and
- various increased criminal penalties for violations of securities
laws.
The Sarbanes-Oxley Act contains provisions which became effective upon
enactment on July 30, 2002 and provisions which will become effective from
within 30 days to one year from enactment. The SEC has been delegated the task
of enacting rules to implement various of the provisions with respect to, among
other matters, disclosure in periodic filings pursuant to the Exchange Act.
36
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
37
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 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. Subsequent to September 30, 2002, the Company was notified
by the IRS of its intention to perform an audit of the tax year 1999 (year ended
September 30, 2000).
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 Oregon state income tax returns have been audited during the past
five years. The Association is subject to Washington state Business and
Organization tax at the rate of 1.5% of gross receipts for the operations in
that state. There have not been any audits of the Company's Washington state tax
returns during the past five years.
38
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, 2002, the Association had 429 full-time and 103
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 59 President and Chief Executive Officer
Marshall J. Alexander 51 Executive Vice President and Chief
Financial Officer
Ben A. Gay 55 Executive Vice President and Chief
Credit Officer
Frank X. Hernandez 47 Senior Vice President and Chief
Operations Officer
Craig M. Moore 45 Senior Vice President/Chief Auditor/Corporate
Counsel/Secretary
M. Isabel Castellanos 41 Senior Vice President - Retail Banking
Walter F. Dodrill 51 Senior Vice President - Business Banking
James E. Essany 48 Senior Vice President - Corporate
Marketing Director
Nina G. Drake 49 Vice President - Human Resource Manager
_________________________________
(1) At September 30, 2002.
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 1983 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 31 years of experience in
banking, and has been an active member of numerous civic and community
organizations.
39
Marshall J. Alexander has 27 years of banking experience, including 16
years with the Association. He has served as Vice President and Chief Financial
Officer since August 1994 and was named an Executive Vice President in December
2000.
Ben A. Gay joined Klamath First in September 2001 after a 30-year career in
commercial banking and finance, on both the East and West coasts. Mr. Gay has
served in a variety of managerial positions in lending, credit risk and loan
management and has most recently served as a western regional executive for
credit risk management for Bank of America.
Frank X. Hernandez has been employed by the Association since 1992. He
served as Human Resources Officer until July 1998 when he was appointed Senior
Vice President and Chief Operating Officer. He has 21 years experience in
banking operations.
Craig M. Moore has a banking career of more than 25 years, with five of
those years at Klamath First. He is an attorney, a Certified Internal Auditor
and a Certified Financial Services Auditor.
M. Isabel Castellanos has 21 years experience in banking with extensive
experience in management, sales, and training.
Walter F. Dodrill has served as Senior Vice President and Manager of the
Business Banking Group of the Company since January 2002. Mr. Dodrill was
previously employed by Western Bank from February 1974 to December 2001. Western
Bank became a division of Washington Mutual in January 1996. Mr. Dodrill served
as Senior Vice President - Regional Credit Administrator and Senior Vice
President - Regional Manager for Western Bank. Mr. Dodrill has 29 years of
experience in banking and has been active in civic and community organizations.
James E. Essany is a native of Gary, Indiana and a graduate of Indiana
University with a Bachelor's of Science in Marketing. He began his banking
career in 1979 and worked with three financial institutions in Indiana before
joining Klamath First in May of 2000.
Nina G. Drake joined Klamath First in June 2002 as Vice President-Human
Resources. She has an extensive background in human resource management in
financial institutions and related industries. She earned her Master of Business
Administration in May 2002 and holds a lifetime certification as a Senior
Professional in Human Resource Management (SPHR).
40
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, 2002.
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
2420 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
41
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
42
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 Owned 4,911
Baker City, Oregon
1095 Oregon Avenue 2001 Owned 4,382
Bandon, Oregon
110 North Redwood Highway 199 2001 Owned 3,091
Cave Junction, Oregon
199 North Nehalem 2001 Owned 2,400
Clatskanie, Oregon
43
Year Square
Description/Address Opened Leased/Owned Footage
212 South 5th Street 2001 Owned 6,200
Coos Bay, Oregon
150 South Wall 2001 Owned 9,271
Coos Bay, Oregon
430 Highway 101 2001 Owned 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 Owned 2,416
Seaside, Oregon
2405 3rd Street 2001 Leased 4,690
Tillamook, Oregon
411 Pacific Avenue 2001 Owned 2,819
Tillamook, Oregon
620 Stewart Avenue 2002 Owned 2,721
Medford, Oregon
2659 Olympic Street 2002 Leased 528
Springfield, Oregon
4550 West 11th Avenue 2002 Leased 528
Eugene, Oregon
Backoffice Processing Facilities
600 Main Street 1998 Leased 2,800
Klamath Falls, Oregon
714 Main Street 2001 Leased 14,532
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 $23.4 million at September 30, 2002. See Note 6 of the Notes
to Consolidated Financial Statements contained in the Annual Report.
44
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, 2002.
45
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 16 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 5 and 6 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 Discussion
and Analysis of Financial Condition and Results of Operations" beginning on page
7 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 Discussion
and Analysis of Financial Condition and Results of Operations -- Market Risk and
Asset/Liability Management" beginning on page 7 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, 2002 and 2001*
Consolidated Statements of Earnings for the Years Ended
September 30, 2002, 2001 and 2000*
Consolidated Statements of Shareholders' Equity for the Years
Ended September 30, 2002, 2001 and 2000*
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2002, 2001 and 2000*
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 35 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, 2002.
46
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" and "Directors' Compensation" 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.
Equity Compensation Plan Information. The following table summarizes
share and exercise price information about the Corporations' equity
compensation plans as of September 30,2002.
(c)
Number of securities
(a) (b) remaining available
Number of securities Weighted-average for future issuance
to be issued upon exercise price under equity
exercise of of outstanding compensation plans
outstanding options, options, warrants (excluding securities
Plan category warrants and rights and rights reflected in column (a))
- ---------------------------------------- ------------------------- ------------------------- ----------------------------
Equity compensation plans approved
by security holders:
Option............................. 879,951 $13.144 18,024
Restricted stock plan.............. -- -- 21,851
Equity compensation plans not approved
by security holders: N/A N/A N/A
------------------------- ------------------------- ----------------------------
Total 879,951 $13.144 39,875
(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.
47
(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.
Item 14. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of
the Company's disclosure controls and procedures (as defined in
Section 13(a)-14(c) of the Securities Exchange Act of 1934 (the
"Act")) was carried out under the supervision and with the
participation of the Company's Chief Executive Officer, Chief
Financial Officer and several other members of the Company's senior
management within the 90-day period preceding the filing date of this
annual report. The Company's Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures as currently in effect are effective in enduring that the
information required to be disclosed by the Company in reports it
files or submits under the Act is (i) accumulated and communicated to
the Company's management (including the Chief Executive Officer and
Chief Financial Officer) in a timely manner, and (ii) recorded,
processed, summarized and reported within the time periods specified
in the SEC's rules and forms.
(b) Changes in Internal Controls: In the year ended September 30,
2002, the Company did not make any significant changes in, nor take
any corrective actions regarding, its internal controls or other
factors that could significantly affect these controls.
48
PART IV
Item 15. 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
99.1 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act
___________________
* Incorporated by reference to the Registrant's Registration
Statement on Form S-1, filed on June 19, 1995.
** Incorporated reference to the Registrant's Definitive Proxy
Statement for the 1996 Annual Meeting of Shareholders.
*** Incorporated by reference to the Registrant's Form 10-K for
the year ended September 30, 2001, filed on December 29, 2001.
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed during the quarter
ended September 30, 2002.
49
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 27, 2002 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 27, 2002
Kermit K. Houser Executive Officer and
Director (Principal
Executive Officer)
/s/ Marshall J. Alexander Executive Vice President and December 27, 2002
Marshall J. Alexander Chief Financial Officer
(Principal Financial
and Accounting Officer)
/s/ Rodney N. Murray Chairman of the Board December 27, 2002
Rodney N. Murray of Directors
/s/ Bernard Z. Agrons Director December 27, 2002
Bernard Z. Agrons
/s/ Timothy A. Bailey Director December 27, 2002
Timothy A. Bailey
/s/ James D. Bocchi Director December 27, 2002
James D. Bocchi
/s/ William C. Dalton Director December 27, 2002
William C. Dalton
/s/ Dianne E. Spires Director December 27, 2002
Dianne E. Spires
/s/ Donald N. Bauhofer Director December 27, 2002
Donald N. Bauhofer
Certification Required
by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, Kermit K. Houser, certify that:
(1) I have reviewed this annual report on Form 10-K of Klamath First Bancorp,
Inc.;
(2) Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
(4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
(5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
(6) The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 27, 2002
/s/ Kermit K. Houser
----------------------
Kermit K. Houser
President and Chief Executive Officer
Certification Required
by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, Marshall J. Alexander, certify that:
(1) I have reviewed this annual report on Form 10-K of Klamath First Bancorp,
Inc.;
(2) Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
(4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
(5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
(6) The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 27, 2002
/s/ Marshall J. Alexander
--------------------------
Marshall J. Alexander
Executive Vice President and Chief Financial Officer