(Mark One)
[X] Quarterly
report pursuant to Section 13 or l5(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2004
[ ] Transition report
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition
period from ________ to ________
Commission File Number 000-24503
WASHINGTON BANKING
COMPANY
(Exact name of
registrant as specified in its charter)
| Washington | 91-1725825 | |||
|---|---|---|---|---|
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification Number) |
450 SW Bayshore Drive
Oak Harbor, Washington
98277
(Address of principal
executive offices) (Zip Code)
(360) 679-3121
(Issuer’s
telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the issuer: (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 if the registrant is an accelerated filer within the meaning of Rule 12b-2 under the Securities Exchange Act of 1934, as amended. Yes [ ] No [X]
The number of shares of the issuer’s Common Stock outstanding at May 7, 2004 was 5,409,999.
WASHINGTON BANKING COMPANY
AND SUBSIDIARIES
Condensed Consolidated Statements of Financial Condition
March 31, 2004 and December 31, 2003 (unaudited)
(Dollars in thousands)
| Assets | March 31, 2004 |
December 31, 2003 | ||||||
|---|---|---|---|---|---|---|---|---|
| Cash and due from banks | $ | 19,881 | $ | 15,454 | ||||
| ($416 and $1,138, respectively, are restricted) | ||||||||
| Interest-earning deposits | 352 | 356 | ||||||
| Federal funds sold | 22,445 | 4,795 | ||||||
| Total cash, restricted cash, and cash equivalents | 42,678 | 20,605 | ||||||
| Investment securities available for sale | 12,499 | 15,421 | ||||||
| Investment securities held to maturity | 14,583 | 14,745 | ||||||
| Total investment securities | 27,082 | 30,166 | ||||||
| Subsidiary investment | 334 | — | ||||||
| Federal Home Loan Bank stock | 2,303 | 2,280 | ||||||
| Loans held for sale | 8,936 | 8,251 | ||||||
| Loans receivable | 521,701 | 499,919 | ||||||
| Allowance for loan losses | (6,480 | ) | (6,116 | ) | ||||
| Total loans, net | 524,157 | 502,054 | ||||||
| Premises and equipment, net | 19,847 | 19,814 | ||||||
| Other real estate owned | 443 | 504 | ||||||
| Deferred tax assets | 1,611 | 1,659 | ||||||
| Other assets | 4,779 | 4,659 | ||||||
| Total assets | $ | 623,234 | $ | 581,741 | ||||
| Liabilities and Shareholders’ Equity | ||||||||
| Liabilities: | ||||||||
| Deposits | ||||||||
| Noninterest-bearing | $ | 84,116 | $ | 75,756 | ||||
| Interest-bearing | 463,219 | 425,741 | ||||||
| Total deposits | 547,335 | 501,497 | ||||||
| Fed funds purchased | — | 5,000 | ||||||
| Other borrowed funds | 12,500 | 12,500 | ||||||
| Junior subordinated debentures | 15,007 | — | ||||||
| Trust preferred securities | — | 15,000 | ||||||
| Other liabilities | 3,027 | 3,384 | ||||||
| Total liabilities | 577,869 | 537,381 | ||||||
| Commitments and contingencies | — | — | ||||||
| Shareholders’ equity: | ||||||||
| Preferred stock, no par value. Authorized 20,000 shares: | ||||||||
| no shares issued or outstanding | — | — | ||||||
| Common stock, no par value. Authorized 10,000,000 shares: | ||||||||
| issued and outstanding 5,408,749 and 5,357,880 | ||||||||
| shares in March 31, 2004 and December 31, 2003, respectively | 31,281 | 31,125 | ||||||
| Retained earnings | 14,025 | 13,273 | ||||||
| Accumulated other comprehensive income (loss), net | 59 | (38 | ) | |||||
| Total shareholders’ equity | 45,365 | 44,360 | ||||||
| Total liabilities and shareholders’ equity | $ | 623,234 | $ | 581,741 | ||||
| See accompanying notes to consolidated financial statements. | ||||||||
1
WASHINGTON BANKING
COMPANY
AND SUBSIDIARIES
Condensed Consolidated Statements of Income
Three months ended March 31, 2004 and 2003 (unaudited)
(Dollars
in thousands, except per share data)
| Three Months Ended March 31 | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 | |||||||
| Interest income: | ||||||||
| Interest and fees on loans | $ | 8,852 | $ | 8,502 | ||||
| Interest on taxable investment securities | 108 | 76 | ||||||
| Interest on tax-exempt investment securities | 163 | 169 | ||||||
| Other | 41 | 119 | ||||||
| Total interest income | 9,164 | 8,866 | ||||||
| Interest expense: | ||||||||
| Interest on deposits | 1,773 | 1,995 | ||||||
| Interest on other borrowings | 146 | 156 | ||||||
| Interest on junior subordinated debentures | 180 | — | ||||||
| Interest on trust preferred securities | — | 189 | ||||||
| Total interest expense | 2,099 | 2,340 | ||||||
| Net interest income | 7,065 | 6,526 | ||||||
| Provision for loan losses | (825 | ) | (763 | ) | ||||
| Net interest income after provision for loan losses | 6,240 | 5,763 | ||||||
| Noninterest income: | ||||||||
| Service charges and fees | 746 | 477 | ||||||
| Gain on sale of loans | 511 | 458 | ||||||
| Secondary market fees | 26 | 69 | ||||||
| ATM income | 126 | 99 | ||||||
| Other | 153 | 167 | ||||||
| Total noninterest income | 1,562 | 1,270 | ||||||
| Noninterest expense: | ||||||||
| Salaries and benefits | 3,772 | 3,085 | ||||||
| Occupancy | 1,022 | 850 | ||||||
| Office supplies and printing | 158 | 171 | ||||||
| Data processing | 117 | 115 | ||||||
| Consulting and professional fees | 86 | 54 | ||||||
| ATM Expense | 84 | 108 | ||||||
| Other | 930 | 765 | ||||||
| Total noninterest expense | 6,169 | 5,148 | ||||||
| Income before income taxes | 1,633 | 1,885 | ||||||
| Provision for income taxes | (538 | ) | (645 | ) | ||||
| Net income | $ | 1,095 | $ | 1,240 | ||||
| Net income per share, basic | $ | 0.20 | $ | 0.23 | ||||
| Net income per share, diluted | $ | 0.20 | $ | 0.23 | ||||
| Average number of shares outstanding, basic | 5,388,779 | 5,300,273 | ||||||
| Average number of shares outstanding, diluted | 5,596,123 | 5,474,794 | ||||||
| See accompanying notes to condensed consolidated financial statements. | ||||||||
2
WASHINGTON BANKING
COMPANY
AND SUBSIDIARIES
Condensed Consolidated Statements of Shareholders’ Equity
and Comprehensive Income
Three months ended March 31, 2004 and 2003 (unaudited)
(Dollars
and shares in thousands, except per share data)
| Common stock |
Retained | Accumulated other comprehensive income |
Total shareholders’ | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Shares |
Amount |
earnings |
(loss), net |
equity | |||||||||||||||
| Balances at December 31, 2002 | 4,541 | $ | 21,025 | $ | 18,363 | $ | 44 | $ | 39,432 | ||||||||||
| Comprehensive income: | |||||||||||||||||||
| Net income | — | — | 1,240 | — | 1,240 | ||||||||||||||
| Net change in unrealized gain (loss) on | |||||||||||||||||||
| securities available for sale, net of tax of $(1) | — | — | — | 3 | 3 | ||||||||||||||
| Total comprehensive income | 1,243 | ||||||||||||||||||
| Cash dividend, $0.06 per share | — | — | (325 | ) | — | (325 | ) | ||||||||||||
| Stock option compensation | — | 6 | — | — | 6 | ||||||||||||||
| Stock options exercised | 115 | 311 | — | — | 311 | ||||||||||||||
| Balances at March 31, 2003 | 4,656 | $ | 21,342 | $ | 19,278 | $ | 47 | $ | 40,667 | ||||||||||
| Balances at December 31, 2003 | 5,358 | $ | 31,125 | $ | 13,273 | $ | (38 | ) | $ | 44,360 | |||||||||
| Comprehensive income: | |||||||||||||||||||
| Net income | — | — | 1,095 | — | 1,095 | ||||||||||||||
| Net change in unrealized gain (loss) on | |||||||||||||||||||
| securities available for sale, net of tax of $(50) | — | — | — | 97 | 97 | ||||||||||||||
| Total comprehensive income | 1,192 | ||||||||||||||||||
| Cash dividend, $0.0725 per share | — | — | (343 | ) | — | (343 | ) | ||||||||||||
| Stock option compensation | — | 6 | — | — | 6 | ||||||||||||||
| Stock options exercised | 51 | 150 | — | — | 150 | ||||||||||||||
| Balances at March 31, 2004 | 5,409 | $ | 31,281 | $ | 14,025 | $ | 59 | $ | 45,365 | ||||||||||
| See accompanying notes to condensed consolidated financial statements. | |||||||||||||||||||
3
WASHINGTON BANKING
COMPANY
AND SUBSIDIARIES
Condensed
Consolidated Statements of Cash Flows
Three months ended March 31, 2004 and 2003
(unaudited)
(Dollars in thousands)
| Three Months Ended March 31 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 |
||||||||||
| Cash flows from operating activities: | |||||||||||
| Net income | $ | 1,095 | $ | 1,240 | |||||||
| Adjustments to reconcile net income to net cash | |||||||||||
| provided by operating activities: | |||||||||||
| Federal Home Loan Bank stock dividends | (23 | ) | (36 | ) | |||||||
| Deferred income tax benefit | (2 | ) | — | ||||||||
| Amortization of investment premiums, net | 8 | 25 | |||||||||
| Net increase in subsidiary investment | (327 | ) | — | ||||||||
| Provision for loan losses | 825 | 763 | |||||||||
| Net decrease (increase) in loans held for sale | (685 | ) | 2,420 | ||||||||
| Depreciation of premises and equipment | 450 | 356 | |||||||||
| Net loss (gains) on sale of other real estate | 14 | (8 | ) | ||||||||
| Net increase in other assets | (120 | ) | (525 | ) | |||||||
| Stock option compensation | 6 | 6 | |||||||||
| Net decrease in other liabilities | (357 | ) | (100 | ) | |||||||
| Net cash provided by operating activities | 884 | 4,141 | |||||||||
| Cash flows from investing activities: | |||||||||||
| Maturities/calls of investment securities available for sale | 3,000 | 500 | |||||||||
| Principal payments on mortgage-backed securities | 63 | 1,006 | |||||||||
| Maturities/calls of investment securities held to maturity | 160 | 125 | |||||||||
| Net increase in loans | (22,243 | ) | (18,546 | ) | |||||||
| Purchases of premises and equipment | (483 | ) | (906 | ) | |||||||
| Proceeds from the sale of other real estate owned | 47 | 75 | |||||||||
| Net cash used in investing activities | (19,456 | ) | (17,746 | ) | |||||||
| Cash flows from financing activities: | |||||||||||
| Net increase in deposits | 45,838 | 22,634 | |||||||||
| Net decrease in federal funds purchased | (5,000 | ) | — | ||||||||
| Dividends paid on common stock | (343 | ) | (325 | ) | |||||||
| Proceeds from stock options exercised | 150 | 311 | |||||||||
| Net cash provided by financing activities | 40,645 | 22,620 | |||||||||
| Net increase in cash and cash equivalents | 22,073 | 9,015 | |||||||||
| Cash and cash equivalents at beginning of period | 20,605 | 55,887 | |||||||||
| Cash and cash equivalents at end of period | $ | 42,678 | $ | 64,902 | |||||||
| Supplemental information: | |||||||||||
| Loans foreclosed and transferred to other real estate owned | $ | — | $ | 70 | |||||||
| Loans made on bank-owned property sold | — | 34 | |||||||||
| Cash paid for interest | 2,046 | 2,448 | |||||||||
| See accompanying notes to condensed consolidated financial statements. | |||||||||||
4
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
Three months ended March 31, 2004 and 2003 (unaudited)
(Dollars
in thousands, except per share data)
(1) Description of Business and Summary of Significant Accounting Policies
(a) Description of Business
Washington Banking Company (“WBCO”) is a registered bank holding company formed on April 30, 1996. At March 31, 2004, WBCO had three wholly-owned subsidiaries – Whidbey Island Bank (“WIB” or the “Bank”), the Company’s principal subsidiary; Washington Banking Capital Trust I (the “Trust”); and Washington Funding Group, Inc. (“WFG”). The business of the Bank, which is focused in the northern area of Western Washington, consists primarily of attracting deposits from the general public and originating loans. During the 1990s, the region experienced strong population growth and economic diversification. The region’s economy has evolved from one that was once heavily dependent upon forestry, fishing and farming to an economy with a much more diverse blend of industries including retail trade, services, manufacturing, tourism and a large military base presence. Although the Bank has a diversified loan portfolio, a substantial portion of its borrowers’ ability to repay their loans is dependent upon the economic conditions affecting this area.
The Trust, the second subsidiary of WBCO, was formed in June 2002 for the exclusive purpose of issuing trust preferred securities and common securities and using the $15,000 in proceeds from the issuance to acquire junior subordinated debentures issued by WBCO.
WFG, the third subsidiary of WBCO, was formed in January 2003 for the purpose of expanding the Bank’s current wholesale mortgage real estate lending platform. In addition to an existing office in Burlington, Washington, WFG opened offices in Bend, Coos Bay and Clackamas (Portland area), Oregon during the first quarter of 2003. WFG underwrites loans originated by mortgage brokers primarily in the Washington, Oregon and Idaho markets, and then sells a large majority of them to secondary market investors, including Freddie Mac and Fannie Mae.
The Company’s website address is www.wibank.com. Exchange Act reports are available free of charge from the Company’s website. The reports can also be obtained through the Securities and Exchange Commission’s (the “SEC”) EDGAR database at http://www.sec.gov. The contents of the Company’s Internet website are not incorporated into this report or into any other communication delivered to security holders or furnished to the SEC.
(b) Basis of Presentation
The accompanying interim condensed consolidated financial statements include the accounts of WBCO and two of its subsidiaries, WIB and WFG, (together, the “Company”). The accompanying interim condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the SEC. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the December 31, 2003 audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the SEC on March 24, 2004. In management’s opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. In preparing the consolidated financial statements, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses are required. Actual results could differ from those estimates.
(c) Segments
Pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosure about Segments of an Enterprise and Related Information, the Company has evaluated the requirements of this standard and has identified two reportable segments: Whidbey Island Bank and Washington Funding Group, Inc., both wholly-owned subsidiaries of Washington Banking Company. Disclosures required by this standard are included in Note 7.
5
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
Three months ended March 31, 2004 and 2003 (unaudited)
(Dollars
in thousands, except per share data)
(d) Reclassifications
Certain amounts in prior year’s financial statements may have been reclassified to conform to the 2004 presentation.
(e) Recent Financial Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, Consolidation of Variable Interest Entities, which was replaced by FASB Interpretation No. 46R (“FIN 46R”) in December 2003. FIN 46R became effective in the first quarter of 2004 and defined a variable interest entity (“VIE”) as a corporation, partnership, trust, or any other legal structure used for the business purpose that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. This interpretation requires a VIE to be consolidated or deconsolidated by a company generally based on the risk of loss or return. Most of the original provisions of Interpretation No. 46 were delayed until March 31, 2004 through the issuance of FIN 46R. The Company has a VIE in the form of a trust set up to issue trust preferred securities and accordingly, the implementation of FIN 46R required the deconsolidation of the Trust. The Company’s adoption of FIN 46R did not have a material impact on the Company’s financial position and results of operations. The restatement of prior years financial statements was not required by FIN 46R and the Company did not restate the prior year’s financial statements.
The following table sets forth the reconciliation of the numerators and denominators of the basic and diluted earnings per share (“EPS”) computations:
| Three Months Ended March 31, 2004 |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Income |
Weighted average shares |
Per share amount | |||||||||
| Basic EPS | |||||||||||
| Income available to common shareholders | $ | 1,095 | 5,388,779 | $ | 0.20 | ||||||
| Effect of dilutive securities: stock options | — | 207,344 | (0.00 | ) | |||||||
| Diluted EPS | $ | 1,095 | 5,596,123 | $ | 0.20 | ||||||
| Three Months Ended March 31, 2003 |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Income |
Weighted average shares |
Per share amount | |||||||||
| Basic EPS | |||||||||||
| Income available to common shareholders | $ | 1,240 | 5,300,273 | $ | 0.23 | ||||||
| Effect of dilutive securities: stock options | — | 174,521 | (0.00 | ) | |||||||
| Diluted EPS | $ | 1,240 | 5,474,794 | $ | 0.23 | ||||||
On February 26, 2004, the Board of Directors issued a 15% stock dividend to shareholders of record as of February 10, 2004. On October 24, 2002, the Company issued a 10% stock dividend to shareholders of record as of October 8, 2002. All periods presented have been restated to reflect the stock dividends. At March 31, 2004 and 2003, there were options to purchase 365,374 and 419,507 shares of common stock outstanding, respectively of which zero and 20,278 shares, respectively, were antidilutive and therefore not included in the computation of diluted net income per share.
Washington Capital Trust I (the “Trust”), a wholly-owned subsidiary of WBCO, is a statutory business trust created for the exclusive purposes of issuing and selling capital securities and utilizing sale proceeds to acquire junior subordinated debt issued to WBCO. On June 27, 2002, the Trust issued $15,000 of trust preferred securities with a
6
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
Three months ended March 31, 2004 and 2003 (unaudited)
(Dollars
in thousands, except per share data)
30-year maturity, callable after the fifth year by Washington Banking Company. The rate adjusts quarterly based on LIBOR plus 3.65%. These securities, within certain limitations, are considered Tier I capital for the purposes of regulatory capital requirements. Accordingly, the junior subordinated debentures are the sole assets of the Trust, and payments under the junior subordinated debentures will be the sole revenues of the Trust. All of the common securities of the Trust are owned by WBCO. Washington Banking Company has fully and unconditionally guaranteed the capital securities along with all obligations of the Trust under the trust agreements. Prior to FIN 46R, the Trust was a consolidated subsidiary of the Company. As a result of the adoption of FIN 46R, the Company deconsolidated the special purpose trust, as the Company is not considered to be the primary beneficiary under this accounting standard. Accordingly, on the Company’s Consolidated Statements of Financial Condition, the trust preferred securities that were issued by the Trust have been replaced by the junior subordinated debentures issued to the Trust by WBCO.
The following table sets forth the financial data pertaining to the previously consolidated special purpose trust:
| Name of trust |
Aggregate liquidation amount of trust preferred securities |
Aggregate liquidation amount of common securities |
Aggregate principal amount of notes |
Stated maturity of notes |
Per annum interest rate of notes |
Redemption option | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Washington Banking | On or after | |||||||||||||||||||
| Capital Trust I | $ | 15,000 | $ | 464 | $ | 15,464 | 2032 | 4.77 | % | June 27, 2007 | ||||||||||
The Company recognizes the financial effects of stock-based employee compensation based on the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation (“FIN 44”). Generally, stock options are issued at a price equal to the fair value of the Company’s stock as of the grant date. Under APB 25, options issued in this manner do not result in the recognition of employee compensation in the Company’s financial statements. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value provisions of FASB SFAS 123, Accounting for Stock-Based Compensation.
The following table sets forth the reconciliation of pro forma net income and pro forma earnings per share:
| Three Months Ended March 31 | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 | |||||||
| Net income, as reported | $ | 1,095 | $ | 1,240 | ||||
| Stock compensation recognized | 6 | 6 | ||||||
| Additional compensation for | ||||||||
| fair value of stock options | (22 | ) | (22 | ) | ||||
| Pro forma net income | $ | 1,079 | $ | 1,224 | ||||
| Basic earnings per share: | ||||||||
| As reported | $ | 0.20 | $ | 0.23 | ||||
| Pro forma | 0.20 | 0.23 | ||||||
| Diluted earnings per share: | ||||||||
| As reported | 0.20 | 0.23 | ||||||
| Pro forma | 0.19 | 0.22 | ||||||
7
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
Three months ended March 31, 2004 and 2003 (unaudited)
(Dollars
in thousands, except per share data)
On April 29, 2004, the Board of Directors declared a cash dividend of $0.0725 per share to shareholders of record as of May 10, 2004, which is payable on May 25, 2004.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Except for certain long-term guarantees, most guarantees expire in one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral supporting those commitments, for which collateral is deemed necessary, generally amounts to one hundred percent of the commitment amount at March 31, 2004. The Company routinely charges a fee for these credit facilities. Such fees are amortized into income over the life of the agreement, and unamortized amounts are not significant as of March 31, 2004.
As of March 31, 2004 the commitments under these agreements were as follows:
Standby letters of credit and financial guarantees $247
At March 31, 2004, the Company is the guarantor of trust preferred securities. The Company has issued subordinated debentures to a wholly-owned special purpose trust, which has issued trust preferred securities. The sole assets of the special purpose trust are the subordinated debentures issued by the Company. Washington Banking Company has fully and unconditionally guaranteed the capital securities along with all obligations of the Trust under the trust agreements. The maximum amount of future payments the Company will be required to make under these agreements is the principal and interest of the trust preferred securities, the principal of which totaled $15,000 at March 31, 2004.
The Company is organized based on the products and services that it offers. Under its current organizational structure, the Company is comprised of four individual companies: Washington Banking Company (the holding company) and three wholly-owned subsidiaries — Whidbey Island Bank, Washington Funding Group, Inc and Washington Banking Capital Trust I. The Company has identified two reportable segments: Whidbey Island Bank and Washington Funding Group, Inc. The Bank offers a full range of commercial banking services, while WFG generates loan fee income from the origination and sale of residential mortgage loans.
The principal activities conducted by the Bank are the origination of commercial business loans, commercial real estate loans, singly-family residential mortgages, multi-family residential mortgages, consumer loans and the associated loan servicing activities. The Bank also offers private banking services and deposit products and generates income from investment activities. The Bank derives a majority of its revenue from interest.
WFG was formed in January 2003 and began operations in April 2003. It provides a loan-funding source for mortgage brokers. It does not service any loans for secondary market investors. Although WFG sells the loans to several secondary market investors, two investors — Principal Residential Mortgage and Freddie Mac — purchase a significant portion of these loans.
The Bank and WFG are stand-alone business entities and have their own financial statements. Certain intercompany related income and expenses are allocated to each company. The accounting policies for each segment are described in the Summary of Significant Accounting Policies.
The Trust, the third wholly-owned subsidiary, was formed for the exclusive purpose of issuing trust preferred securities and common securities and using the proceeds from the issuance to acquire junior subordinated debentures issued by WBCO. For 2004, the Company implemented FIN 46R, which called for the deconsolidation of the Trust. Prior year information includes the consolidation of the Trust.
8
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
Three months ended March 31, 2004 and 2003 (unaudited)
(Dollars
in thousands, except per share data)
The following table sets forth the financial information for the Company’s segments:
| Three Months Ended March 31, 2004 |
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Bank |
WFG |
WBCO |
Intercompany eliminations |
Total consolidated | |||||||||||||
| Net interest income after | $ | 6,414 | $ | — | $ | (174 | ) | $ | — | $ | 6,240 | ||||||
| provision for loan losses | |||||||||||||||||
| Other income | 1,352 | 263 | (14 | ) | (39 | ) | 1,562 | ||||||||||
| Other expenses | 5,610 | 499 | 99 | (39 | ) | 6,169 | |||||||||||
| Income (loss) before tax | 2,156 | (236 | ) | (287 | ) | — | 1,633 | ||||||||||
| Income tax (expense) benefit | (709 | ) | 82 | 89 | — | (538 | ) | ||||||||||
| Net income (loss) | $ | 1,447 | $ | (154 | ) | $ | (198 | ) | $ | — | $ | 1,095 | |||||
| Total assets | $ | 621,501 | $ | 384 | $ | 60,372 | $ | (59,023 | ) | $ | 623,234 | ||||||
| Three Months Ended March 31, 2003 |
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Bank |
WFG |
Other |
Intercompany eliminations |
Total consolidated | |||||||||||||
| Net interest income after | $ | 5,951 | $ | — | $ | (188 | ) | $ | — | $ | 5,763 | ||||||
| provision for loan losses | |||||||||||||||||
| Other income | 1,270 | — | — | — | 1,270 | ||||||||||||
| Other expenses | 4,953 | 86 | 109 | — | 5,148 | ||||||||||||
| Income (loss) before tax | 2,268 | (86 | ) | (297 | ) | — | 1,885 | ||||||||||
| Income tax (expense) benefit | (775 | ) | 29 | 101 | — | (645 | ) | ||||||||||
| Net income (loss) | $ | 1,493 | $ | (57 | ) | $ | (196 | ) | $ | — | $ | 1,240 | |||||
| Total assets | $ | 558,160 | $ | 164 | $ | 71,094 | $ | (70,237 | ) | $ | 559,181 | ||||||
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Note Regarding Forward-Looking Statements: This Form 10-Q includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements describe Washington Banking Company’s (the “Company”) management’s expectations regarding future events and developments such as future operating results, growth in loans and deposits, continued success of the Company’s business plan and the strength of the local economy. The words “will,” “believe,” “expect,” “should,” “anticipate” and words of similar construction are intended in part to help identify forward-looking statements. Future events are difficult to predict, and the expectations described below are necessarily subject to risk and uncertainty that may cause actual results to differ materially and adversely. In addition to discussions about risks and uncertainties set forth from time to time in the Company’s filings with the Securities and Exchange Commission (the “SEC”), factors that may cause actual results to differ materially from those contemplated in such forward-looking statements include, among others, the following possibilities: (1) local and national general and economic conditions, including the possible impact of international conflict or further terrorist events, are less favorable than expected or have a more direct and pronounced effect than expected on the Company and adversely affect the Company’s ability to continue its internal growth at historical rates and maintain the quality of its earning assets; (2) changes in interest rates reduce interest margins more than expected or negatively affect liquidity; (3) projected business increases following strategic expansion or the opening or acquisition of new branches are lower than expected; (4) there are greater than expected costs or difficulties related to the integration of acquisitions; (5) there is increased competitive pressure among financial institutions; (6) legislation or regulatory requirements or changes that adversely affect the banking and financial services sector; and (7) the Company is unable to realize the efficiencies it expects to derive from its investment in personnel and infrastructure. However, you should be aware that these factors are not an exhaustive list, and you should not assume that these are the only factors that may cause actual results to differ from expectations. In addition, you should note that we do not intend to update any of the forward-looking statements or the uncertainties that may adversely impact those statements.
The following discussion and analysis should be read in conjunction with the financial statements and notes thereto presented elsewhere in this report.
Washington Banking Company (“WBCO” or the “Company”) is a registered bank holding company with three wholly-owned subsidiaries: Whidbey Island Bank (the “Bank” or “WIB”), Washington Banking Capital Trust I (the “Trust”) and Washington Funding Group, Inc. (“WFG”). The Company’s principal subsidiary, the Bank, is a Washington state-chartered bank that conducts a full-service community commercial banking business. Its business includes commercial, real estate and construction loan portfolios, and it is active in the consumer banking field, providing personal and consumer-oriented loan programs. The Bank also provides a wide range of deposit services, insured by the Federal Deposit Insurance Corporation (the “FDIC”), for individuals and businesses including checking and savings accounts as well as money market accounts, certificates of deposit, individual retirement accounts, safe deposit boxes and other consumer and business related financial services. The Bank also offers nondeposit managed investment portfolios, which are not FDIC insured, through the investment advisory company Elliott Cove Capital Management LLC. Several Whidbey Island Bank employees have been registered in Washington State as investment advisor representatives. These employees work with individuals, companies and institutions to help them determine their risk preferences and select a portfolio. Prior to the Bank’s affiliation with Elliott Cove, non-FDIC insured investment products were offered through the Bank’s wholly-owned subsidiary, WIB Financial Services, Inc. Another nondeposit product offered through WIB, which is not FDIC insured, is a sweep investment option available through a brokerage account.
The Bank’s primary market area is located in northwestern Washington State between Seattle and the Canadian border. Its geographical expansion to date has been concentrated along the I-5 corridor from Snohomish to Whatcom counties, however, additional areas will be considered if they meet the Company’s criteria.
The Trust was formed in June 2002 for the exclusive purpose of issuing trust preferred securities to acquire junior subordinated debentures issued by the Company. Those debentures are the sole assets of the Trust and payments on
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the debt will be the sole revenues of the Trust. The Company has fully and unconditionally guaranteed all obligations of the Trust.
WFG, a wholesale mortgage real estate lending company, is a Washington State corporation formed in January 2003. The primary purpose of this subsidiary is to provide a loan funding source for brokers of mortgage loans. The loans are originated and sold in the name of the Bank. In addition to an existing office in Burlington, Washington, WFG opened offices in Bend, Coos Bay and Clackamas (Portland area), Oregon during the first quarter of 2003. WFG underwrites loans originated by mortgage brokers primarily in the Washington, Oregon and Idaho markets, and then sells most of them to secondary market sources.
Headquartered in Oak Harbor, the Company’s market area has been expanded through the activities of WFG. Previously, the market area was that of the Bank, limited to northwestern Washington. WFG’s process of brokering mortgages has extended the Company’s market area beyond Washington State and now includes Oregon and Idaho. Washington, Oregon and Idaho all experienced population growth of above 20% during the 1990s, compared to a national average of 13.1%. The market areas encompass distinct economies, and none are particularly dependent upon a single industrial or occupational source. In Washington, the economies within the market areas have evolved from being heavily dependent upon forestry, fishing and farming to a more diverse blend of industries including retail trade, services, manufacturing, tourism and a large military presence. Unemployment levels in the Pacific Northwest over the past couple of years have been higher than national averages, but the business impact on the Company has not been atypical. The timing of a total economic recovery for the Pacific Northwest region remains uncertain, but in 2003 there was a slow, but steady recovery.
The Company’s strategy is one of value-added growth. Management believes that qualitative and sustainable growth of the Company, coupled with maintaining profitability, is currently the most appropriate path to providing good value for its shareholders. To date, the Company’s growth has been achieved organically and it attributes its reputation for focusing on customer service and satisfaction as one of the cornerstones to the Company’s success. Acquisition of banks or branches may also be used as a means of expansion if appropriate opportunities are presented. Management recognizes that growth requires expenditures of substantial sums to purchase or lease real property and equipment and to hire experienced personnel, and that earnings may be negatively affected. The Company’s primary long-term objectives are to improve profitability and operating efficiencies, to increase market penetration in areas currently served and to continue an expansion strategy in appropriate market areas.
Total Assets. Total assets grew to $623.2 million at March 31, 2004 from $581.7 million at December 31, 2003, an increase of 7.1%. This increase resulted mainly from growth in the loan portfolio and federal funds sold, which was funded by deposit growth.
Total Loans. Total loans were $530.6 million at March 31, 2004, an increase of 4.4% from $508.2 million at December 31, 2003. The Company increased its allowance for loan losses to $6.5 million at March 31, 2004 representing 1.22% of total loans, from $6.1 million or 1.20% of total loans at December 31, 2003. The allowance was increased to keep pace with loan growth and prospective losses inherent in the loan portfolio, while remaining conservative and maintaining adequate coverage.
Total Investment Securities. Total investment securities were $27.1 million and $30.2 million at March 31, 2004 and December 31, 2003, respectively, a decrease of 10.2% resulting from the maturity of available-for-sale investment securities without replacement due to low rate environment coupled with anticipated increase in loan demand.
Premises and Equipment. Premises and equipment, net of depreciation, were $19.8 million at both March 31, 2004 and December 31, 2003. Premises and equipment remained level as the Company has not undertaken any new construction projects during the first quarter. The cost of new equipment has been offset by depreciation expense.
Deposits. Deposits grew 9.1% to $547.3 million at March 31, 2004 from $501.5 million at December 31, 2003. Management’s philosophy is to develop long-term customer relationships. Management believes that the best way to establish customer loyalty is by placing an emphasis on meeting customers’ financial needs and providing
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exceptional service. Management attributes the Company’s successful deposit growth to its continuing deposit promotions, cross-sales efforts, strategic planning and other means. In addition, many customers are seeking the security of FDIC-insured deposit vehicles given the recent volatility of the investment market.
At March 31, 2004, average noninterest-bearing deposits increased 29.6% from March 31, 2003, while average interest-bearing deposits increased 8.4% for the same period. Average interest demand and money market deposits represented 44.08% of total average interest-bearing deposits at March 31, 2004 compared to 44.45% a year ago.
Average savings deposits and average CDs represented 10.04% and 45.88%, respectively, of total average interest-bearing deposits at March 31, 2004 compared to 8.02% and 47.53%, respectively, a year ago. All non-maturing deposit product averages increased during the first quarter of 2004 as management focused on establishing customer relationships and attracting deposits.
Shareholders’ Equity. The Company’s shareholders’ equity increased 2.3% to $45.4 million at March 31, 2004 from $44.4 million at December 31, 2003. The increase reflects earnings, proceeds from stock options exercised, stock option compensation and an increase in unrealized gain on available-for-sale securities, net of tax offset by the payment of cash dividends during the first three months of 2004.
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The following table sets forth at the Company's conolidated average balance sheet and analysis of net interest income and expense:
| Three Months Ended March 31, 2004 | Three Months Ended March 31, 2003 | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in thousands) | Average balance |
Interest earned/paid |
Average yield (1) |
Average balance |
Interest earned/paid |
Average yield (1) | ||||||||||||||
| Assets | ||||||||||||||||||||
| Loans (2) | $ | 515,732 | $ | 8,852 | 6.87% | $ | 441,424 | $ | 8,502 | 7.70% | ||||||||||
| Federal funds sold | 5,002 | 11 | 0.88% | 18,401 | 50 | 1.09% | ||||||||||||||
| Interest-earning cash | 684 | 2 | 1.17% | 11,952 | 33 | 1.10% | ||||||||||||||
| Investments: | ||||||||||||||||||||
| Taxable | 17,303 | 136 | 3.14% | 11,046 | 112 | 4.06% | ||||||||||||||
| Non-taxable (3) | 14,584 | 218 | 5.98% | 14,447 | 226 | 6.26% | ||||||||||||||
| Interest-earning assets | 553,305 | 9,219 | 6.66% | 497,270 | 8,923 | 7.18% | ||||||||||||||
| Noninterest-earning assets | 38,625 | 35,342 | ||||||||||||||||||
| Total assets | $ | 591,930 | $ | 532,612 | ||||||||||||||||
| Liabilities and | ||||||||||||||||||||
| Shareholders’ equity | ||||||||||||||||||||
| Deposits: | ||||||||||||||||||||
| Interest demand and money market | $ | 190,866 | $ | 360 | 0.75% | $ | 177,617 | $ | 514 | 1.16% | ||||||||||
| Savings | 43,480 | 85 | 0.78% | 32,028 | 69 | 0.86% | ||||||||||||||
| CDs | 198,656 | 1,328 | 2.67% | 189,913 | 1,412 | 2.97% | ||||||||||||||
| Interest-bearing deposits | 433,002 | 1,773 | 1.64% | 399,558 | 1,995 | 2.00% | ||||||||||||||
| Federal funds purchased | 5,489 | 15 | 1.09% | — | — | — | ||||||||||||||
| Junior subordinated debentures | 15,007 | 180 | 4.80% | — | — | — | ||||||||||||||
| Trust preferred securities | — | — | — | 15,000 | 189 | 5.04% | ||||||||||||||
| Other interest-bearing liabilites | 12,592 | 131 | 4.16% | 15,121 | 156 | 4.13% | ||||||||||||||
| Interest-bearing liabilities | 466,090 | 2,099 | 1.80% | 429,679 | 2,340 | 2.18% | ||||||||||||||
| Noninterest-bearing deposits | 78,728 | 60,757 | ||||||||||||||||||
| Other noninterest-bearing liabilities | 2,623 | 2,401 | ||||||||||||||||||
| Total liabilities | 547,441 | 492,837 | ||||||||||||||||||
| Shareholders’ equity | 44,489 | 39,775 | ||||||||||||||||||
| Total liabilities and | ||||||||||||||||||||
| shareholders’ equity | $ | 591,930 | $ | 532,612 | ||||||||||||||||
| Net interest income (3) | $ | 7,120 | $ | 6,583 | ||||||||||||||||
| Net interest spread (1) | 4.86% | 5.00% | ||||||||||||||||||
| Net interest margin (1) | 5.15% | 5.30% | ||||||||||||||||||
(1) Annualized
(2) Includes loan fees of $450 and $358 for the three months ended March 31, 2004
and 2003, respectively.
(3) Interest income on non-taxable
investments is presented on a fully taxable-equivalent basis using the federal statutory
rate of 34%.
These adjustments were $55 and $57 for the three months ended March 31, 2004 and 2003,respectively.
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The Company’s results of operations are dependent to a large degree on net interest income. Interest income and cost of funds are affected significantly by general economic conditions, particularly changes in market interest rates, and by government policies and the actions of regulatory authorities. The Company generates noninterest income generally through service charges and fees, gain on sale of loans and other sources. The Company’s noninterest expenses consist primarily of compensation and employee benefit expense, and occupancy expense.
Net Income. Net income for the first quarter of 2004 decreased 11.7% to $1.1 million or $0.20 per diluted share as compared to the first quarter of 2003. The decrease was due largely to the increase in noninterest expense.
Net Interest Income. Net interest income for the first quarter of 2004 increased 8.3% to $7.1 million from $6.5 million for the first quarter of 2003. The increase is largely due to interest income from increased average loan volume, combined with a decrease in the cost of funds. The continued low rate environment has improved the Company’s cost of funds and helped offset the lower interest-earning asset yield.
Average interest-earning assets for the first quarter increased to $553.3 million at March 31, 2004, compared to $497.3 million at March 31, 2003, a growth of 11.3%, while the average yield on interest-earning assets decreased to 6.66% compared to 7.18% in first quarter of the prior year. The average yield on loans decreased to 6.87% for the quarter ended March 31, 2004 from 7.70% for the first quarter of 2003.
The average cost of interest-bearing liabilities decreased in the first quarter of 2004 to 1.80% from 2.18% for the quarter ended March 31, 2003. Average interest-bearing liabilities for the quarter increased to $466.1 million at March 31, 2004 compared to $429.7 million a year ago, a growth of 8.5%.
The overall result of these changes was a decrease in the net interest spread to 4.86% for the quarter ended March 31, 2004 from 5.00% for the quarter ended March 31, 2003. Net interest margin (net interest income divided by average interest-earning assets) decreased to 5.15% in the first quarter of 2004 from 5.30% in the first quarter of 2003.
Noninterest Income. Noninterest income increased $292,000, or 23.0%, in the first quarter of 2004 compared to the like period in 2003. This increase was primarily due to an increase in service charges and fees on deposits in association with the Bank’s new overdraft product, Whidbey Overdraft Coverage.
In the past, selling single-family residential loans to the secondary market contributed significantly to the noninterest income, but slowing of mortgage activity caused a decrease in secondary market income.
The Company began hedging mortgage interest rate risk for WFG real estate loans in the second quarter of 2003. At March 31, 2004, net loss on hedging activities was $7,000. The net loss is included in the gain on sale of loans. WFG is not yet operating at a break even point.
Noninterest Expense. Noninterest expense increased $1.0 million in the first quarter of 2004, or 19.8% from a year ago. Three major components of noninterest expense — employee compensation, occupancy and other noninterest expense — increased 22.3%, 20.2% and 21.6%, respectively, for the quarter compared with the like period in 2003.
Employee compensation and occupancy increased primarily due to costs associated with the newly formed Washington Funding Group. Expense reduction measures have been initiated, including the closing of one of the WFG offices. The Company also experienced a cost increase in employee benefits. Other noninterest expense increased in association with telephone and advertising expense as a result of the expansion of the Company.
The efficiency ratio (noninterest expense divided by the sum of net interest income plus noninterest income less non-recurring gains) was 71.51% for the first quarter 2004 compared to 66.03% for the like period in 2003.
Income Taxes. For the first quarters of 2004 and 2003, the Company recorded an income tax provision of $538,000 and $645,000, respectively. The overall effective tax rate was approximately 33% and 34% for the three months ended March 31, 2004 and 2003, respectively.
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Loan Portfolio Composition. The Company originates a wide variety of loans including commercial, real estate and consumer loans. The following table sets forth the Company’s loan portfolio composition by type of loan:
| March 31, 2004 |
December 31, 2003 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in thousands) | Balance |
% of total |
Balance |
% of total | ||||||||||
| Commercial | $ | 88,384 | 16.7% | $ | 87,371 | 17.2% | ||||||||
| Real estate mortgages: | ||||||||||||||
| One-to-four family residential | 45,563 | 8.6% | 43,460 | 8.5% | ||||||||||
| Five-or-more family | ||||||||||||||
| residential and commercial | 144,046 | 27.1% | 133,539 | 26.3% | ||||||||||
| Total real estate mortgages | 189,609 | 35.7% | 176,999 | 34.8% | ||||||||||
| Real estate construction | 76,251 | 14.4% | 70,974 | 14.0% | ||||||||||
| Consumer | 175,955 | 33.2% | 172,406 | 34.0% | ||||||||||
| Subtotal | 530,199 | 100.0% | 507,750 | 100.0% | ||||||||||
| Less: allowance for loan losses | (6,480 | ) | (6,116 | ) | ||||||||||
| Deferred loan fees, net | 438 | 420 | ||||||||||||
| Loans, net | $ | 524,157 | $ | 502,054 | ||||||||||
Total loans, net, were $524.2 million at March 31, 2004, representing a 4.4% increase from year-end 2003. The majority of the increase was in real estate mortgage and real estate construction loans, which increased 7.1% and 7.4%, respectively at March 31, 2004 from year-end 2003. Included in real estate mortgages are loans originated and held for sale on the secondary market. At March 31, 2004, loans held for sale were $8.9 million as compared to $8.3 million at December 31, 2003, an increase of 8.3%. Of those loans, $6.0 million were originated by WFG and $2.9 million were originated by the Bank’s retail real estate division, compared to $3.8 million originated by WFG and $4.5 million originated from the Bank’s retail real estate division at December 31, 2003. The majority of the increase in real estate construction loans was due to residential construction, residential land development projects and a few large commercial construction loans.
The Company makes automobile and recreational vehicle loans for new and used vehicles originated indirectly by selected automobile dealers located in the Company’s market areas. Indirect loans were $105.9 million, or 60.17% of the consumer loan portfolio and 19.95% of the total loan portfolio at March 31, 2004. At December 31, 2003, indirect loans were $105.6 million, or 61.3% of the consumer loan portfolio and 20.80% of the total loan portfolio.
The Company is focusing on commercial lending and real estate construction lending while slowing the consumer loan growth by tightening underwriting standards for indirect loans, thereby further decreasing the consumer portfolio.
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Nonperforming Assets. The following table sets forth an analysis of the composition of the Company's nonperforming assets:
| (Dollars in thousands) | March 31, 2004 |
December 31, 2003 | ||||||
|---|---|---|---|---|---|---|---|---|
| Nonaccrual loans | $ | 4,512 | $ | 4,158 | ||||
| Restructured loans | — | — | ||||||
| Total nonperforming loans | 4,512 | 4,158 | ||||||
| Other real estate owned | 443 | 504 | ||||||
| Total nonperforming assets | $ | 4,955 | $ | 4,662 | ||||
| Impaired loans | $ | 2,563 | $ | 2,563 | ||||
| Accruing loans past due > 90 days | — | — | ||||||
| Potential problem loans | — | 314 | ||||||
| Allowance for loan losses | 6,480 | 6,116 | ||||||
| Nonperforming loans to loans | 0.85 | % | 0.82 | % | ||||
| Allowance for loan losses to loans | 1.22 | % | 1.20 | % | ||||
| Allowance for loan losses to nonperforming loans | 143.62 | % | 147.09 | % | ||||
| Nonperforming assets to total assets | 0.80 | % | 0.80 | % | ||||
Nonperforming loans increased to $4.5 million, or 0.85% of total loans, at March 31, 2004 from $4.2 million, or 0.82% of total loans, at December 31, 2003. The current allowance for loan losses of $6.5 million represents 143.62% of nonperforming loans as compared to 147.09% of nonperforming loans at December 31, 2003. The allowance for loan losses is 1.22% of total loans at March 31, 2004 as compared to 1.20% at December 31, 2003. The Company has identified one loan of approximately $2.6 million to a real estate development and timber company as impaired, due to the borrower’s financial status at year-end. The loan is current and well-secured, and no losses are expected.
Provision and Allowance for Loan Losses. The Company recorded an $825,000 provision for loan losses for the first quarter of 2004, compared with $763,000 for the like period a year ago. Net loan charge-offs were $461,000, representing 0.09% of average loans for the first quarter of 2004, compared with $402,000, or 0.09% of average loans for the like period last year.
The increase in charge-offs is attributed to a progressively tighter stance on consumer delinquencies and to certain loans to the construction trades. Management has tightened consumer-lending standards, formalized its credit review department, and established additional commercial guidelines and limits on lending to certain industries to mitigate risk.
Indirect loans may involve greater risk than other consumer loans, including direct automobile loans, due to the nature of third-party transactions. To mitigate these risks, the Company limits its indirect automobile loan purchases primarily to dealerships that are established and well known in their market areas and to applicants that are not classified as sub-prime. In addition, the Company has increased its oversight of the approval process and uses a loan grading system, which limits the risks inherent in dealer originated loans.
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The following table sets forth an analysis of the Company’s indirect and other net charge-offs to average loans:
| Three Months Ended March 31 | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 | |||||||
| Indirect net charge-offs | $ | (290 | ) | $ | (196 | ) | ||
| Other net charge-offs | (171 | ) | (206 | ) | ||||
| Total net charge-offs | $ | (461 | ) | $ | (402 | ) | ||
| Average indirect loans | $ | 105,752 | $ | 97,916 | ||||
| Average other loans | 409,980 | 343,508 | ||||||
| Total average lonas | $ | 515,732 | $ | 441,424 | ||||
| Indirect net charge-offs to average indirect loans | 0.27 | % | 0.20 | % | ||||
| Other net charge-offs to average other loans | 0.04 | % | 0.06 | % | ||||
| Net charge-offs to average loans | 0.09 | % | 0.09 | % | ||||
Net loan charge-offs attributed to indirect loans were $290,000, representing 77.13% of net consumer charge-offs during the first quarter of 2004, compared to $196,000 or 64.26% of net consumer charge-offs for the like period in 2003.
The allowance for loan losses is maintained at a level considered adequate by management to provide for anticipated loan losses based on management’s assessment of various factors affecting the loan portfolio. This includes a review of problem loans, general business and economic conditions, seasoning of the loan portfolio, bank regulatory examination results and finding of internal credit examiners, loss experience and an overall evaluation of the quality of the underlying collateral. Management reviews the allowance quarterly. The allowance is increased by provisions charged to operations and reduced by loans charged off, net of recoveries.
The following table sets forth the changes in the Company’s allowance for loan losses. The allocation is based on an evaluation of defined loan problems, historical ratios of loan losses and other factors that may affect future loan losses in the categories of loans shown:
| Three Months Ended March 31 | ||||||||
|---|---|---|---|---|---|---|---|---|
| (Dollars in thousands) | 2004 |
2003 | ||||||
| Balance at beginning of period | $ | 6,116 | $ | 5,514 | ||||
| Charge-offs: | ||||||||
| Commercial | (131 | ) | (71 | ) | ||||
| Real estate | — | (30 | ) | |||||
| Consumer | (531 | ) | (377 | ) | ||||
| Total charge-offs | $ | (662 | ) | $ | (478 | ) | ||
| Recoveries: | ||||||||
| Commercial | 44 | 4 | ||||||
| Real estate | 2 | — | ||||||
| Consumer | 155 | 72 | ||||||
| Total recoveries | $ | 201 | $ | 76 | ||||
| Net charge-offs | (461 | ) | (402 | ) | ||||
| Provision for loan losses | 825 | 763 | ||||||
| Balance at end of period | $ | 6,480 | $ | 5,875 | ||||
| Net charge-offs to average loans | 0.09 | % | 0.09 | % | ||||
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While management believes that 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 income could be significantly affected if circumstances differ substantially from the assumptions used in making the final determination. Management anticipates that normal growth of the loan portfolio, coupled with the steady but slow recovery in the local economy, may require continued increases in the allowance for loan losses during the year 2004.
The Company provides an array of deposit services, including noninterest-bearing checking accounts, interest-bearing checking and savings accounts, money market accounts and certificates of deposit (“CDs”). These accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. The Company does not pay brokerage commissions to attract deposits. It strives to establish customer relations to attract core deposits in noninterest-bearing transactional accounts and thus reduce its costs of funds.
The following table sets forth the average balances outstanding and average interest rates for each major category of deposits:
| Three Months Ended March 31 |
||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 |
|||||||||||||
| (Dollars in thousands) | Average balance |
Average rate |
Average balance |
Average rate | ||||||||||
| Interest-bearing demand and | ||||||||||||||
| money market deposits | $ | 190,866 | 0.75% | $ | 177,617 | 1.16% | ||||||||
| Savings deposits | 43,480 | 0.78% | 32,028 | 0.86% | ||||||||||
| CDs | 198,656 | 2.67% | 189,913 | 2.97% | ||||||||||
| Total interest-bearing deposits | 433,002 | 1.64% | 399,558 | 2.00% | ||||||||||
| Demand and other | ||||||||||||||
| noninterest-bearing deposits | 78,728 | 60,757 | ||||||||||||
| Total average deposits | $ | 511,730 | $ | 460,315 | ||||||||||
Sources of Funds. The Company’s sources of funds are customer deposits, loan repayments, current earnings, cash and demand balances due from other banks, federal funds, short-term investments, investment securities available for sale and trust preferred securities. These funds are used for loan originations and deposit withdrawals, to satisfy other financial commitments and to support continuing operations. The Company relies primarily upon customer deposits and investments to provide liquidity. The Company will mainly use such funds to make loans and to purchase securities, the majority of which are issued by federal, state and local governments. Additional funds are available through established Federal Home Loan Bank (“FHLB”) and correspondent bank lines of credit, which the Company may use to supplement funding sources.
The Company’s strategy includes maintaining a “well-capitalized” status for regulatory purposes, while maintaining a favorable liquidity position and proper asset/liability mix. With this strategy in mind, management evaluated potential capital-raising alternatives such as trust preferred securities, issuance of common stock and other sources. Management determined that issuing trust preferred securities would be in the best interest of the Company and on June 27, 2002, the Trust issued $15.0 million of trust preferred securities. Trust preferred securities are held as debt for tax purposes, while the proceeds of the offering count as Tier I capital without increasing the shareholder base, and therefore not diluting earnings per share.
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Deposits. Total deposits increased 9.1% to $547.3 million at March 31, 2004 from $501.5 million at December 31, 2003. The Company has not accepted brokered deposits. It has made a concerted effort to attract deposits in the market area it serves through competitive pricing and delivery of quality service. Historically, the Company has been able to retain a considerable amount of its deposits as they mature.
The Company’s deposits are expected to fluctuate according to the level of the Company’s deposit market share, economic conditions and normal seasonal variations, among other things. Certificates of deposit are the only deposit group that has stated maturity dates. At March 31, 2004, the Company had $209.7 million in CDs, of which approximately $122.7 million, or 58.51%, are scheduled to mature within one year. Declining interest rate markets and uncertain economic conditions may cause some customers to choose to move funds into core deposit accounts or withdraw funds, rather than renew CDs as they mature. Nevertheless, management anticipates that a sizable portion of outstanding CDs will renew upon maturity.
Borrowings. At March 31, 2004 the Company had a line of credit with the FHLB of $93.3 million, of which $12.5 million was advanced in long-term borrowings. The Company also had unused lines of credit with correspondent banks in the amount of $27.0 million at March 31, 2004.
Investments. The Company’s total portfolio of investment securities decreased 10.2% to $27.1 million at March 31, 2004 from $30.2 million at December 31, 2003. The investment portfolio consists of government agency securities, pass-through securities, corporate securities, municipal securities and preferred stock. No investment exceeds 10% of the shareholders’ equity. The following table summarizes the amortized cost, market value and recorded value of securities in the Company’s portfolio by contractual maturity groups:
| March 31, 2004 |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in thousands) | Amortized cost |
Market value |
Recorded value | ||||||||
| Amounts maturing: | |||||||||||
| Within one year | $ | 2,607 | $ | 2,641 | $ | 2,610 | |||||
| One to five years | 18,459 | 19,125 | 18,526 | ||||||||
| Six to ten years | 5,423 | 5,744 | 5,442 | ||||||||
| Over ten years | 504 | 504 | 504 | ||||||||
| Total | $ | 26,993 | $ | 28,014 | $ | 27,082 | |||||
At March 31, 2004, the Company’s investment portfolio consisted of $14.6 million, or 53.85% in held-to-maturity investments at carrying value, as compared with $14.7 million, or 48.88%, at December 31, 2003, and $12.5 million, or 46.15%, in available-for-sale securities at carrying value, as compared with $15.4 million, or 51.12%, at December 31, 2003. For liquidity purposes, the Company’s future security purchases will primarily be designated as available-for-sale and will increase as a percent of total investment securities at carrying value.
The Company’s shareholders’ equity increased to $45.4 million at March 31, 2004 from $44.4 million at December 31, 2003. This increase is due to net income of $1.1 million, proceeds from stock options exercised in the amount of $150,000, stock option compensation of $6,000 and an increase in unrealized gain on available-for-sale securities, net of tax of $97,000 offset by the payment of cash dividends of $343,000 during the first three months of 2004. Total assets increased to $623.2 million at March 31, 2004 from $581.7 million at December 31, 2003, an increase of 7.1%. Shareholders’ equity to total assets was 7.3% at March 31, 2004 compared to 7.6% at December 31, 2003.
Banking regulations require bank holding companies and banks to maintain a minimum leverage ratio of core capital to adjusted average total assets of at least 4%. In addition, banking regulators have adopted risk-based capital guidelines, under which risk percentages are assigned to various categories of assets and off-balance sheet items to calculate a risk-adjusted capital ratio. Tier I capital generally consists of common shareholders’ equity (which does not include unrealized gains and losses on securities), less goodwill and certain identifiable intangible assets, while Tier II capital includes the allowance for loan losses and subordinated debt, both subject to certain limitations.
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The FDIC established the qualifications necessary to be classified as a “well-capitalized” bank, primarily for assignment of FDIC insurance premium rates. As the following table indicates, the Company (on a consolidated basis) and the Bank qualified as “well-capitalized” at March 31, 2004 and December 31, 2003:
| FDIC Requirements |
Actual Ratios |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Adequately- capitalized |
Well- capitalized |
March 31, 2004 |
December 31, 2003 | |||||||||||
| Total risk-based capital ratio | ||||||||||||||
| Consolidated | 8 | % | 10 | % | 11 | .65% | 12 | .01% | ||||||
| Whidbey Island Bank | 8 | % | 10 | % | 11 | .29% | 11 | .69% | ||||||
| Tier 1 risk-based capital ratio | ||||||||||||||
| Consolidated | 4 | % | 6 | % | 10 | .52% | 10 | .85% | ||||||
| Whidbey Island Bank | 4 | % | 6 | % | 10 | .16% | 10 | .56% | ||||||
| Leverage ratio | ||||||||||||||
| Consolidated | 4 | % | 5 | % | 10 | .19% | 10 | .17% | ||||||
| Whidbey Island Bank | 4 | % | 5 | % | 9 | .84% | 9 | .89% | ||||||
There can be no assurance that additional capital will not be required in the near future due to greater-than-expected growth, unforeseen expenses or revenue shortfalls, or otherwise.
The Company had no material capital expenditures or commitments for the quarter ended March 31, 2004.
See “Notes to Condensed Consolidated Financial Statements.”
Future events are difficult to predict, and the expectations of management are necessarily subject to uncertainty and risk that may cause actual results to differ materially from those stated here. In making the following statements, management has made a number of assumptions including that: (1) the interest rate environment will remain flat through 2004, (2) the local economy will continue on a slow but steady course of improvement, and (3) residential real estate loan volumes will decline from 2003.
WBCO expects to continue its growth strategy and expand its presence in the Pacific Northwest. The Company’s commitment to maintaining asset quality, improving operating efficiency, being attentive to customer satisfaction and maximizing shareholder value remains strong. WBCO has identified long-term performance measurement targets. Those targets include a return on equity in excess of 18%, an efficiency ratio in the mid-50% range, earnings per share growth of at least 10% per year, and dividend growth of at least 8% annually. Management does not expect to attain these targets in the short-term, but rather measures its business plan progression against these long-term goals.
Management anticipates that 2004 performance will be affected by a number of factors. A primary consideration, and one that is subject to uncertainty, is the stability of the economy. During 2003, the market area in which the Company operates began to undergo a slow but steady economic recovery. In management’s opinion, the Company is beginning to experience a cautious transition, from that of heavy mortgage loan volumes into a period of increasing commercial lending activity. In light of this transition and an expected increase in competition for loans, management believes that the Company will achieve loan growth in the range of 10% - 15% for the year 2004.
The Company is projecting a modest increase in deposits of about 5% for 2004. If deposit rate repricing is required to maintain deposits or should rates increase more than expected, the net interest margin could be negatively impacted due to the Company’s current position of being slightly liability sensitive. Other unexpected changes,
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such as significant changes in the economy, substantial credit deterioration, or depositors moving sizeable amounts of their funds back into the stock market, could also affect the anticipated performance of the Company.
Residential real estate loan volumes are expected to decline from the high volumes recently experienced, and generate less fee income. As expected, WFG, the Company’s wholesale lending subsidiary, had a negative impact on the Company’s earnings in the first quarter. Although expense reduction and revenue enhancement measures have been implemented, WFG is not yet at breakeven and one office has been closed to further reduce expenses. In addition to continuing to focus on expense reduction measures, WFG is diversifying and expanding its product lines and offering online services to brokers.
Management believes that the Company will have ample opportunities to be successful. The Bank has a large portion of market share in Island County, which is where the Company was founded and has an established identity and reputation within the community. Management believes there are significant opportunities to gain a larger share of the market in the other three counties where the branches are still relatively young and not as well known. Given these opportunities and the preceding assumptions and considerations, management expects to grow earnings 6% - 12% over 2003. Opportunities will be pursued while applying credit discipline and deliberate analysis to ensure quality growth.
Readers should not construe these statements as assurances of future performance, and should note that management does not plan to update these projections as the year progresses.
A number of measures are used to monitor and manage interest rate risk, including income simulations and interest sensitivity (gap) analyses. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key assumptions in the model include prepayment speeds on mortgage-related assets, cash flows and maturities of other investment securities, loan and deposit volumes, and pricing. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes, changes in market conditions and management strategies, among other factors. At March 31, 2004, based on the measures used to monitor and manage interest rate risk, there had not been a material change in the Company’s interest rate risk since December 31, 2003. Should rates increase, the Company could be negatively impacted due to its current slightly liability sensitive position. For additional information, refer to the Company’s Form 10-K for year ended December 31, 2003 filed with the SEC on March 24, 2004.
As of the end of the period covered by this report, management evaluated the effectiveness of the design and operation of its disclosure controls and procedures. The principal executive and financial officers supervised and participated in this evaluation. Based on this evaluation, the chief executive and financial officer each concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information required to be included in the periodic reports to the SEC. The design of any system of controls is based in part upon various assumptions about the likelihood of future events, and there can be no assurance that any of the Company’s plans, products, services or procedures will succeed in achieving their intended goals under future conditions. In addition, there have been no significant changes in the internal controls or in other factors known to management that could significantly affect the internal controls subsequent to the most recent evaluation. Management found no facts that would require WBCO to take any corrective actions with regard to significant deficiencies or material weaknesses.
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(a) – (e) Not applicable
(a) Not applicable
(b) There have been no material changes in the procedures for shareholders to nominate directors to the Company’s board.
(a) Exhibits
31.1 Certification of Chief Executive Officer required by Rule 13a-14(b) or Rule 15d-14(a) and Section 302 of the
Sarbanes Oxley Act of 2002
31.2 Certification of Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(a) and Section 302 of the
Sarbanes Oxley Act of 2002
32.1 Certification of Chief Executive Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 906 of the
Sarbanes Oxley Act of 2002, 18 U.S.C. Section 1350
32.2 Certification of Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 906 of the
Sarbanes Oxley Act of 2002, 18 U.S.C. Section 1350
(b) Reports on Form 8-K
During the quarter ended March 31, 2004, the Company filed one report on Form 8-K announcing the release of the Company’s fourth quarter 2003 earnings and cash dividend notification. The Company also reported a stock dividend of 15% to shareholders of record which was declared as of February 10, 2004, and payable on February 26, 2004. The report was filed on January 27, 2004.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Date: May 17, 2004 | By | /s/ Michal D. Cann |
| Michal D. Cann President and Chief Executive Officer | ||
| Date: May 17, 2004 | By | /s/ Phyllis A. Hawkins |
| Phyllis A. Hawkins Senior Vice President and Chief Financial Officer |
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